1 njcl 2017/2 thomas neumann* * editor of nordic journal of commercial law. phd, master of laws. associate professor at the department of law, aalborg university, e-mail: thn@law.aau.dk. 150 foreword .................................................................................... 151 by thomas neumann a time-limit running wild? article 39(2) cisg and domestic limitation periods .......................................... 152 179 by ulrich schroeter entire agreement clauses: convergence between us and danish contract law? ........................................ 180 208 by katerina mitkidis, and thomas neumann public service compensation in the aviation sector: the swedish airports state aid cases .......................... 209 – 231 by michele giannino cisg advisory council opinion no. 17 limitation and exclusion clauses in cisg contracts ................................................................ 232 – 315 by ingeborg schwenzer, yesim atamer, eric bergsten, m. joachim bonell, michael bridge, alejandro garro, roy goode, john gotanda, han shiyuan, sergei lebedev, pilar perales viscasillas, jan ramberg, hiroo sono, ulrich schroeter, claude witz, and sieg eiselen njcl 2017/2 151 foreword dear readers. now that the journal had its baptism of fire with the publication of a special issue on csr, the time has come to wish you all happy new year and to publish this first regular issue under the auspices of aalborg university. this slightly delayed second issue of 2017 contains four contributions. in the first contribution, ulrich schroeter, with whom i have shared research interests for a long time, analyses the cut-off period contained in 1980 un sales convention’s article 39(2) and its relation to domestic limitation periods with a particular focus on court practice. in the spirit of the journal’s ambition of making high quality publications available to a wide audience, i proudly publish this revised version of ulrich schroeter’s article which was first published in a tribute to joseph m. lookofsky in 2015. in the second contribution katerina mitkidis and i address issues relating to what has been called americanisation of contracts in the nordic region. specifically, we address the curious use of entire agreement clauses in contracts governed by danish law – an entirely different legal context than the american one that the clauses typically are utilised in. i owe it to my dear colleague katerina mitkidis to emphasise that she has been the lead author on this contribution from start til finish. in the third contribution, michele giannino analyses the challenges arising from public aid to airports given in the form of public service compensation. this contribution is the first publication since the journal’s revival written by – if i may – an outsider, in the sense that michele giannino is an italian qualified lawyer with a background also from leicester and london. it pleases me to publish gianino’s view on an eu law regulated problem in a nordic context. the fourth contribution is a revival of an old njcl tradition. the journal grew from the community surrounding my friend and academic mentor albert h. kritzer, who was the founder and editor of the cisg database hosted by pace law in new york. in the beginning of the journal’s history, several articles addressing issues relating to the cisg was published, including also the opinions of the cisg advisory council. however, during the years this tradition was lost. by publishing the cisg advisory council’s opinion number 17 on limitation and exclusion clauses i revive the journal’s tradition of being the advisory council’s “publisher”. i would like to thank all the contributors of njcl: the peer reviewers whom i give very short deadlines, the authors who submitted their manuscripts, and my assistant signe lindbjerg without whom the task of running this journal would be insurmountable. i also thank dreyers fond for sponsoring the journal, making it possible to provide open access to good research for anyone, anywehere in the world. / thomas neumann microsoft word ballardini_rosa_maria.doc nordic journal of commercial law issue 2013#2 intellectual property protection for computer programs: developments, challenges and pressure for change by rosa maria ballardini *1 *1 assistant professor of ip law hanken school of economics nordic journal of commercial law issue 2013#2 1 1 introduction this book is a study of how computer programs have challenged the thinking about and the actual use of intellectual property rights (iprs) around the world. in general, the intellectual property (ip) system is governed by the same rules and applies equally to all fields of developments. however, the particular nature of computer software has challenged these fundamentals. software is a pluralistic product that contains several elements, each of which could fall into different categories of ip laws. computer programs can be defined as “a combination of computer instructions and data definitions that enable computer hardware to perform computational or control functions”1. ip protection applies differently depending on the manner in which those instructions and definitions are expressed. currently, several protection mechanisms are available for software, including copyright, patents, trademarks, contracts, licensing agreements, and technical measures of protection. it has been suggested that none of these mechanisms, if used individually, successfully provide an adequate level of protection to computer programs. software technology started to appear during the 1950s, when the first computer programs were developed. as soon as it became evident that computer software was a highly complex technology that required large monetary investments, both a wide market for software and significant potential for monetary rewards were envisaged. debates regarding the adequacy of the existing protection mechanisms for software were then initiated. it became immediately clear that each of the existing ip protection mechanisms possessed certain limitations when applied to software. these problems have generated a global debate regarding the extent to which software should be afforded ip protection. several perspectives have been presented, and a large variety of solutions have been proposed. some of the proposals embrace rather extremist views. for example, some suggest the complete abolition of ip protection for software in favour of an ip-free regime or the development of a completely new protection mechanism tailored to the special needs of software. in contrast, others see the ip system as playing an extremely important role in securing investments and ensuring progress in the software field and thus advocate a strong level of protection. in addition, several more balanced proposals have been launched, many of which have attempted to shape the existing ip rules such that they meet the needs of computer software. this thesis effectively contributes to this debate by providing a number of balanced, reasonable, and feasible answers to some of the major issues in the software intellectual property ecosystem. the proposed solutions were generated within the framework of the currently existing body of ip laws. 1 ieee std 610.12-1990, standard glossary of software engineering terminology (1990), new york, the institute of electrical and electronics engineers, at 66. nordic journal of commercial law issue 2013#2 2 2 structure of the book this dissertation comprises an introductory chapter, discussing the background, the research aims, the methods implied, and the research results achieved, and four original essays. the four essays cover a relatively wide range of themes, the common denominator being the process of adapting intellectual property rights to computer software. regarding copyright law, this thesis provides new perspectives on the protection of the functional elements of computer programs in the european context in essay i. copyright is a globally accepted mechanism for protecting computer programs.2 copyright can adequately protect certain aspects of software (namely, the code itself). however, the principles upon which the copyright system is based create several issues with software copyright. among these issues, the most discussed (but unsolved) problem is most likely that copyright generally does not extend to utilitarian products and thus cannot provide protection to the software’s functions (the “idea-expression” dichotomy). other shortcomings include the contrast between the long duration of copyright protection and the short lifespan of software as well as the challenges inherent in determining the “originality” of the code. new technological developments have generated other problems, such as the difficulties created by the increased use of modularisation and object-oriented designs in computer programming3. with regard to copyright, this thesis focuses on the issues related to the “idea-expression” dichotomy by proposing a workable model that could be used in european jurisdictions. this book considers the related developments that have occurred in the united states. however, the decision to propose solutions for europe was driven by the absence of a consistent interpretative framework for addressing these issues in europe (as the relevant american jurisprudence is relatively extensive). the primary problem is the pluralistic nature of software, which is simultaneously literary and functional. computer programs are unique in that the software functions are fully independent from the literary lines of code. in other words, even though the source codes of two programs might look completely different, the codes can perform the exact same function and produce the same (or similar) instructions. this means that with computer programs the expression is often an integral part of the idea itself such that the two are inseparable and, therefore, drawing the line between the literary parts of programs and the mechanical ones has been extremely challenging. on the other hand, however, such a distinction is important for the purposes of ip protection because of the different scope of copyright and patents, namely the fact that 2 see, for examples, the wipo treaty on trade related aspects of intellectual property rights, marocco, 15 april 1994 (trips). 3 lipton j, “ip’s problem child: shifting the paradigms for software protection” (2006), 58 hasting law journal 2, at 205-251. nordic journal of commercial law issue 2013#2 3 copyright protects the expression of ideas, while patents the implementation of such ideas – so called “idea-expression dichotomy” doctrine in copyright law. on these bases, the paper identifies two specific sets of problems inherent to software copyright: • risks of under-protection, because copyright does not protect the way that the program works. • risks of over-protection, due to the difficulty of drawing boundaries between the literary and functional aspects of software, which has lead copyright to be occasionally extended to functions, protecting software in a “patent-like” manner. essay i argues that these risks are particularly problematic in europe, especially due to the traditional reluctance to afford patent protection to computer programs under the dictate of article 52(2)(3) of the european patent convention and, accordingly, the solution is sought not only within the framework of the existing copyright laws, but also based on patent rules. the paper identifies the more pressing questions on the copyright and patent scope of protection for software and suggests that two specific rules should be considered for the european framework: first, the article advocates the adoption of explicit statutory limitations against nonliteral infringement to keep the scope of software copyright within the sphere of literary works of art; and, second, the paper suggests that keeping software within the umbrella of patent law is essential in order to impede copyright from expanding to protect the functional elements of software in a “patent-like” manner. indeed, some recent developments occurred in the legislative side, like the recently passed sas institute v world programming ltd. decision by the european court of justice, have confirmed the importance and validity of the issues discussed and the solutions proposed in essay i of this dissertation. the patent discourse is conducted in essay ii and essay iii, which discuss different problems related with the application of patent law to software. overall, the discussion of the software patent framework in this thesis was triggered by the “crisis of the patent system”4 (especially in the united states), which many claim was caused by the extension of patent protection to computer software.5 indeed, sings exist both to support and to defeat this claim. on the one hand, the question of patentable subject matter in computer programs continues to appear in legal disputes and has not been resolved. some highly controversial software patents that have been granted have indicated the lack of novelty and inventiveness of these types of patents in general. the relatively low threshold for disclosure required for patents in the software field (e.g., there is no need to disclose the source code) is often controversial. additionally, “patent thickets” are said to dominate the software patents sector. the software industry sees the patent 4 burk d, and lemley m, the patent crisis and how the courts can solve it (2009), the university of chicago press. 5 bessen j, and meurer m, patent failure. how judges, bureaucrats, and lawyers put innovators at risk (2008), princeton university press. nordic journal of commercial law issue 2013#2 4 system mostly as a cost rather than as an incentive for innovation, and companies operating in the field often claim to use their patents mainly for defensive purposes rather than to secure protection for their inventions. this information seems to suggest that the system is fundamentally flawed. however, given that the system has not yet kept progress from occurring in the field, it seems that methods of addressing these issues (regardless of their legitimacy) have emerged. this thesis provides a richer understanding of the reasons for and consequences of extending patent protection to software. overall, the analysis sheds light on the most challenging legal questions associated with the software patent framework and provides a solid foundation for proposing suitable solutions. with regard to patent protection, this thesis mainly proposes solutions tailored to europe because of the background and personal interests of the researcher and because relatively few systematic studies on software patent protection exist within the european legal regime. indeed, u.s. approaches, case law and literature have been widely analysed. essay ii attempts to answer the question of whether the traditional european approach to computer-implemented inventions (cii) patents, which states that computer programs “as such” do not deserve patent protection because they do not have “technical” character and do not make a “technical” contribution, should be considered obsolete and thus be overruled. the study investigates and provides evidence of the discrepancies existing in the interpretation of the “technical” requirement for cii patents both at the epo and at the national level, and it shows that a general lack of legal consensus exists regarding cii patentability. furthermore, it argues that this disharmony might overall distort the european market and impede economic growth in the software field. essay ii concludes that the traditional european system, where only “technical” inventions receive patent status, has become obsolete under current rules and, accordingly, it formulates a more workable approach to enhance the clarity of art. 52’s dictate in the field of computer programs. namely, the paper suggests that the traditional concept of the “inventive step” should be reformulated and that no elimination of non-technical claim features should be attempted. essay iii provides suggestions for how to interpret the patent law requirements in such a way to eliminate efficiently or reduce substantially the problems associated with “patent thickets” in the field of software within the european system. patent thickets are caused by overlapping patent rights, on the one hand, and the large volume of patents being issued, on the other. focusing on the reasons for overlapping patent rights, essay iii finds that overlapping software patents are caused by the lack of relevant prior art in the field and the abstractness of software patent claims. however, although several studies have been conducted and initiatives have been put into place to improve the prior art repositories, the abstractness of software patent claims has not been sufficiently considered. however, the study demonstrates that abstraction is actually one of the major causes of the growing software patent thicket and, as such, it represents a fundamental issue to be addressed. in particular, the paper suggests that the more abstract the claims, the more difficult to evaluate the concrete applicability of the inventions, and the more interpretation is required to assess the question of patentability. therefore, extensive disclosure nordic journal of commercial law issue 2013#2 5 is highly necessary in software patent applications in order to facilitate the process. accordingly, the article argues in favour of enhancing disclosure for computer program patents in order to reduce the abstract nature of the software patents claims, better define the boundaries between patentable inventions and prior art, help narrowing the scope of the patents granted, and overall reduce the number of applications filed, this way smoothing the software patent thicket. finally, the discourse on software copyright and patents is contextualized within the framework of the free libre and open source software in essay iv. open source has become an integral part of the legal environment for software. therefore, to provide a complete overview of the challenges associated with ip and software, it is necessary to properly consider this phenomenon. essay iv aims to deepen understandings of the dynamics governing the simultaneous use of copyright, patents, and open source in a commercial context in order to expose the legal risks associated with this configuration and highlight the coping mechanisms that can be implemented in order to navigate these risks. the study specifically focuses on the problems that proprietary companies may encounter if they incorporate both open source and ip protected code in the final proprietary software that they release to the market. thus far, the research has independently focused on either open source as a phenomenon or proprietary software, while few studies have investigated the relationship and interactions between the two. this luck of readily available information and literature material, as well as the very little court cases handed down on the matter justified the use of an empirical study under the form of a case study research (csr) method. indeed, the case study was conducted with the intention of generating new knowledge rather than answering one, or few specific questions and, therefore, the most valuable contribution of the study lies in the new theoretical and practical knowledge that it presents, rather than in having provided specific solutions to the problems investigated. 3 conclusions this doctoral dissertation was written with four objectives in mind: 1. to improve understanding of the problems associated with applying intellectual property laws (copyright and patents) to computer programs; 2. to study how copyright and patents interact within each other’s framework and within the overall ip framework when applied to computer programs (to introduce a new perspective to the overall discussion); 3. to propose practical, balanced and more workable solutions to the problems within the copyright and patent software frameworks in the european jurisdiction; 4. to study whether the legal risks associated with the hybrid protection models are problematic in practice, to illuminate the causes of the issues at stake, and to assess which coping mechanisms could be used to alleviate these problems. this thesis has various theoretical and practical implications. the importance of computer programs around the world is undisputable. currently, software can be found everywhere. however, software is still being developed. thus, clear legal rules regarding software protection nordic journal of commercial law issue 2013#2 6 are more necessary than ever. the boundaries of intellectual property protection for computer programs remain murky in several respects. as explained earlier, in fact, software has been remarkably difficult to classify within a specific category of intellectual property. the issue has been discussed for more than thirty years, and the fact that recent developments have not yielded a solution shows the complexity of the debate and the problems involved. this thesis has engaged some of the most controversial aspects of the debate surrounding the application of the most widely used ip protection mechanisms for software: copyright and patents. the end result is a holistic study that actively and substantially contributes to the academic discussion of software ip protection. the findings are practical, readily available tools that, if implemented, might enhance clarity and legal security in this important field of technology. the results of the study could generally serve scholars, lawyers, software companies, and policymakers. microsoft word weckstrom_katja_korjattu.doc nordic journal of commercial law issue 2013#1 governing innovation and expression: new regimes, techniques and strategies an introduction by katja weckström* * doctor of laws, university lecturer of commercial law, åbo akademi university (turku, finland) nordic journal of commercial law issue 2013#1 1 1 introduction new multi-party agreements have changed the international intellectual property law landscape and increased its global impact. two central actors, the eu and the us routinely leverage their bargaining strength by including extensive intellectual property chapters in their bilateral agreements with developing countries. a shift in international intellectual property law-making seems apparent. stagnated multi-lateral processes in established forums such as the world intellectual property organization (wipo) and the world trade organization (wto) are abandoned and issues are shifted to faster side-tracks unburdened with even semi-open or semidemocratic decision-making. the pace of generating intellectual property norms with general or global effect thus remains high, but keeping step with contemporary legal problems has legitimacy costs. we also see a topical shift, where more general and controversial issues are decided in these new forums. are these norms open to scrutiny from the rest of the legal system? substantive intellectual property law-making is also in flux on the national and regional level. patent laws are under reform in the eu and the us. furthermore, the changing political and societal role of social media raises questions related to privacy and more generally the regulation of internet-based expression and communication. social networks and location services challenge data protection and privacy laws. at the same time, criminal enforcement of intellectual property rights proliferates and the threat of damages may assume the role of a deterrent. the question of whether intellectual property rights holders may target internet service providers instead of direct infringers poses a direct challenge to our virtual infrastructure. new bottlenecks and gatekeepers emerge continuously. what are the legal hurdles social networks and internet service providers currently face? how should they be regulated – and why? the focus of the book is on new regimes, strategies and techniques in regulating such recent and on-going changes. the authors ask whether such reforms are “business as usual” or whether they could signify more fundamental changes in the way innovation, creativity and especially internet-based expression are governed globally and locally. the book is divided in three parts under the following themes: new innovation and intellectual property regimes; governing the internet and social networks; and new strategies and techniques of enforcement. nordic journal of commercial law issue 2013#1 2 2 new innovation and intellectual property regimes prof. fiona macmillan asks whether the public domain is real, meaning has a concrete legal function and meaning, or whether it is only a figment of our imagination. if it is real, then what is its nature and function and even more, its potential? can we divide intellectual space into common or public space, which rivals private space that is created via ownership of intellectual property and can we argue that law could or should respect these boundaries in securing that prime intellectual space be kept outside the privatized sphere? macmillan argues that “the public domain is the only space in which the power of corporate giants can be challenged and resisted” and that preserving the binary opposition between public and private is risky, if we equal public and private with one simple legal tool, private property rights. instead, we need to recognize a more complex architecture of ownership in intellectual space that defines the publicly or commonly owned in terms of exclusion of prime intellectual space from private ownership. macmillan concludes that a concept of (true) group or communal rights mirroring the roman concept of res universitatus need be developed that may separate culturally or socially significant spaces from public ownership, but inside promoting creativity, innovation, invention and cultural conversation. prof. yoshiyuki tamura challenges some conceptual fallacies behind the idea of not protecting intellectual works. he argues that intellectual works, which are the result of human intellectual, creative or inventive labor, can remain “unprotected” by intellectual property legislation without necessarily stifling innovation or creativity in society. he deals, in turn, with the three most common flawed assumptions for protecting intellectual works; 1) that there is a “thing” or object that embodies an intellectual work, 2) that no or insufficient protection of this “object” will have negative consequences for society because the object belongs to its creator; and 3) that protection of intellectual works should be provided for by law. tamura introduces a pluralistic market-oriented theory to justifying intellectual property, which takes into account the cost from the legal intellectual property institutions themselves. protection of intellectual works by way of legislation is only justified, if adequate protection cannot be achieved by the market itself. thus, he argues that we need to recognize the role of market mechanisms in creating and supporting incentives, when intellectual property legislation and protection is tailored. prof. doris estelle long argues for recognizing deviant globalization in multilateral protection of intellectual property. deviant globalization may provide grounds for revised standards of protection, thus serving both a predictive and normative function. long argues that deviant globalization, “with its emphasis on trade and innovation across socio-economic levels, and its focus on unmet consumer demands … [brings] … new understandings of the relationship between compensation, access, and distributional innovation in present intellectual property debates.” this globalization is “deviant” not in the moral sense, but because it deviates in significant ways from the globalization that is the focus of scholars, economists and popular writers that influence intellectual property law-making. long introduces some ground norms of deviant globalization: 1) fair compensation fuels the market; 2) consumers matter; 3) innovative nordic journal of commercial law issue 2013#1 3 business models deserve adequate breathing space to flourish; and 4) markets necessarily require regulation, which challenge and enrich traditional intellectual property standards. 3 governing the internet and social networks advocate general niilo jääskinen discusses some recent judgments of the european union court of justice on liability of online service providers for intellectual property infringement occurring by the services they offer. jääskinen distinguishes between the legal obligations placed on internet access providers and online service platforms, which facilitate participation to the internet. these services may or may not, partly or completely fall within the safe harbors of the e-commerce directive depending on the degree to which the functionality of the service depends on third-party content. the question of liability for internet access providers concern the extent of the service provider’s obligation to assist in the protection of ip rights. scarlet extended, promusicae and bonnier each discussed issues relating to monitoring or filtering of traffic and disclosure of user data to right holders, which pitted data protection against effective copyright protection. a different setting altogether underlies the other strand of cases (google france, l’oreal and others, sabam and wintersteiger) concerning online service platforms, since they concerned comparative advertising, trademark protection and territorial jurisdiction. jääskinen concludes that the current situation which advances case-by-case balancing of rights and interests of different parties in national courts creates legal uncertainty, and urges the eu legislator to remedy the situation. krisztina stump compares eu and us law concerning liability for online service platform providers for defamatory content. this chapter focuses on legal responsibilities related to the passive hosting of third party content including illegal defamatory content, i.e. any false statement that harms the reputation of another person, on e.g. a social network, a dating website, a blog or a video sharing site. in addition to the question of monitoring vast amounts of content and other internet-typical issues, defamatory content poses the legal hurdle of widespread anonymity with both cost and uncertainty relating to it. stump notes the effect of practical and technical realities in molding secondary liability doctrines in this area, but raises and discusses the many counterarguments against liability for online service platform providers that render technical or practical measures unsuitable due to the very nature of the content in question. stump notes the strengths and weaknesses of the approach to liability in the us and the eu, performs an extensive comparison of regulatory approaches in eu member states and concludes with a nuanced analysis of alternative liability regimes for illegal third party content. edward morris and sarah clayton discuss social media marks governance by drawing parallels to cyber-squatting at the turn of the millennium in the area of domain names. the authors recognize the problems involved in all contemporary internet service providers having to administer and manage terms of service as well as breaches and disputes separately and nordic journal of commercial law issue 2013#1 4 uniquely. due to the increasing number of cases and the lack of uniform rules the authors advocate for a centralized regulatory regime for social media marks and a mandatory dispute resolution policy for social media. since social media marks are linked to similar technology of assignable accounts as domain names, social medial marks disputes could easily be incorporated into icann’s uniform domain-name dispute resolution policy (udrp). juha vesala discusses unfair conditions imposed on content creators by powerful buyers as abuse of dominant position. he focuses on the licensing terms imposed by some popular content platforms like apple’s itunes and google news, leveraging their position on the market to force (unnecessarily broad) assignment of rights in exchange for access to the platform. while concerns are warranted and the effects may be harmful to consumer welfare, competition law offers only limited relief against unfair prices and terms in content licensing. contemporary standards of competition law limit liability of content platforms to relatively extreme conditions, which are likely not to be commercially necessary for content distributors to employ. nevertheless, disproportionate or unnecessary conditions that credibly threaten content creation and consumer welfare in the market concerned may warrant intervention to the extent that achievement of pro-competitive benefits could be reached by less restrictive means. katja weckström discusses preliminary and interim injunctions against internet service providers to end copyright or trademark infringement on their respective services. she discusses injunctions against internet access providers and the interplay between national and eu law stemming from the e-commerce directive, enforcement directive and copyright directive. she argues that none of the directives support an interpretation that right holders are entitled to an injunction against intermediaries when there is proof that infringement occurs. instead, the enforcement directive distinguishes between injunctions against infringers (article 11) and injunctions against intermediaries (article 9), where the latter requires careful scrutiny of the effects of the measure on the rights of the infringer, the intermediary and the right holder. she concludes that the legislator has placed a number of procedural safeguards in order to guide courts in decision-making and in tailoring the injunction to abide by standards of reasonableness and proportionality. 4 new strategies and techniques of enforcement prof. peter yu discusses the combined effect of several global and national ip enforcement measures on us consumers, technology developers and small and mid-sized firms. from this point of view, yu scrutinizes the content of the anti-counterfeiting trade agreement (acta) and trans-pacific strategic economic partnership agreement (tpp) and assesses the public interest costs and benefits of wording and policy underlying the agreements. similarly, he assesses two national legislative proposals stop online piracy act (sopa) and protect ip act (pipa) and their potential effect, if implemented. all of the enforcement measures discussed nordic journal of commercial law issue 2013#1 5 raise broader policy concerns than mere protection or non-protection of ip against counterfeiting or piracy. yu concludes that policy in this area should be more carefully drafted, since the proposed measures seem to fail equally in protecting ip holders and civil liberties. prof. john cross discusses remedies available for misappropriation of not positive, but negative secret information. a negative trade secret is information that suggests what not to do and naturally becomes valuable, if it is unknown to others in the industry. trade secret protection is particularly problematic, when it comes to injunctions, since protection seizes at the moment that the information is no longer secret. consequently, everyone is free to use the information at that point. thus, enjoining a misappropriator permanently, when other companies are free to use the information, may become unreasonable. on the other hand, the misappropriator should not enjoy an economic advantage over others for having wrongfully broken trade secret protection. negative trade secret protection seeks to remedy the harm of someone else using the information in question. however, it is difficult to tailor a remedy against something that the misappropriator is not doing. injunctive relief, ordering the misappropriator to stop engaging in activity that it is not engaging in makes no sense, which renders injunctions unsuitable in these cases. similarly, damages are problematic, since any measurable loss usually boils down to testing costs of the right holder. assessing the damage from not doing something places strain on royalty calculations, however, this may be the only available remedy for protecting negative secret information. branislav hazuha, hsaio-chien liu and toshihide watabe have undertaken to measure consumer acceptance of a variety of technological protection measures in place to secure respect of copyright protection. this unique study shows that consumer attitudes differ greatly depending on the underlying social norm of acceptance of the protection measure in question which corresponds to a lesser or greater need of external incentives to achieve compliance. the results of the study show that the cost and efficiency of individual technological protection measures may vary and it identifies the factors which have major impact on the cost and efficiency of individual measures in relation to different types of copyrighted works (music and movies on pre-recorded media, broadcasted television programs and videogames for video consoles). this information is valuable for policy makers and copyright holders in designing new strategies and techniques for exercising and enforcing exclusive rights. anne-mari lummevuo discusses patent law hurdles to the protection of employee inventions in situations, where the invention is a product of global r & d and cross-border collaboration in a multinational company. arising conflicts of law are not traditional conflicts of laws, where ultimately one law applies, but the company must comply with all conflicting or mutually exclusive national laws in order to secure global patent protection for the invention in relevant markets. lummevuo highlights junctures at which national law may hinder effective transfer of entitlement from the inventor to the company, which in turn may harm the effective securing of protection of these inventions. lummevuo also discusses the issue of compensation, which may place the company in an awkward position between legal obligations and equality of nordic journal of commercial law issue 2013#1 6 employees from different countries that have different labor laws. lummevuo offers insight into recognizing potential conflicts as well as examples to solutions that assure compliance, which ultimately secures protection of the fruits of the company’s main endeavor. rosa maria ballardini, pamela lönnqvist, perttu virtanen, nari lee, marcus norrgård and olli pitkänen discuss the challenges of the “one-size fits all” european patent system in the software context. the study investigates the tension between technologyneutrality and technology-specificity within the “inner limits” of patent protection, i.e. when applied to the question of acquisition of rights. thus, the focus is on how the european patent organization tailors the european patent convention to the complex technological reality of software patenting. ballardini et. al. found that epo boards factor the technology-specificity differently depending on the particular patentability requirement in question. while faced with the question of whether the invention satisfies the requirement of constituting patentable subject matter, epo favored a technology-neutral approach, while technology-specificity was the norm, when assessing inventive step, person-skilled-in-the-art or disclosure requirements. ballardini et. al conclude that technologically oriented concepts of patent law might be more adequate (than technology policy-driven principles or technology based standards in legislation) for taking into account the specific characteristics of different technologies. we conclude with a brief disussion from the concluding panel on the three themes of the 4th conference on innovation and communications law. prof. peter mezei. prof. john cross and prof. adam candeub served as panelists that sought to identify recurring points of contention and reflection in the discussions and individual presentations at the conference. special issue njcl 2017/1 1 to pursue or not to pursue csr and sustainability goals vibe garf ulfbeck,* kateřina peterková mitkidis,** and alexandra horváthová*** (editors) * professor vibe garf ulfbeck, director of the centre for enterprise liability, faculty of law, university of copenhagen, denmark, e-mail: vibe.ulfbeck@jur.ku.dk. ** kateřina peterková mitkidis, phd, assistant professor, intralaw center, department of law, aarhus university, denmark, e-mail: katpe@law.au.dk. *** judr. alexandra horváthová, ll.m., s.j.d., postdoctoral fellow at centre for enterprise liability, faculty of law, university of copenhagen, denmark, e-mail: alexandra.horvathova@jur.ku.dk. 2 foreword ................................................................................... 3 8 by vibe garf ulfbeck, kateřina peterková mitkidis, and alexandra horváthová directors‘ duties and corporate social responsibility under german law – is tort law litigation changing the picture? .................................................................................... 9 27 by peter rott occupational pension funds (iorps) & sustainability: what does the prudent person principle say? ............. 28 54 by alexandra horvátová, rasmus kristian feldthusen, and vibe garf ulfbeck sustainability requirements in eu public and private procurement – a right or an obligation? ....................... 55 – 89 by marta andrecka, and kateřina peterková mitkidis corporate social responsibility and international investment law: tension and reconciliation ............ 90 – 119 by ying zhu csr and the law of the wto – the impact of tuna dolphin ii and ec–seal products .................................................. 120 – 148 by carola glinski njcl 2017/1 3 foreword over the past decades, it has become increasingly more common to talk about “corporate social responsibility” (csr). what is meant hereby is perhaps not entirely clear but the general assumption seems to be that csr refers to companies’ social responsibility, their commitments to pursue sustainability goals, not only under their legal obligations to do so, but also based on a voluntary engagement of going beyond law.1 the concept of sustainability goals is most commonly understood as based on the triple-bottom line, balancing economic, social and environmental interests.2 sustainability goals thus refer not only to the economic part of business, but also to safeguarding workers’ rights, protecting human rights, pursuing environmental goals and combating corruption. the commitments are largely voluntary in the sense that they are presumed to go beyond direct obligations under state law. however, in a broader perspective, the concept of voluntariness has been be contested.3 the pressure for companies to abide by sustainability standards has intensified over the past two decades. this movement originates from diverse factors. one is the media attention to unethical behaviour of branded companies that has influenced consumers’ preferences in product and producer choices and has raised their awareness about social issues. the media and non-governmental organisations’ attention has led to a number of legal disputes involving consumer law claims.4 secondly, international law has been developing with increasing speed and has initiated an international and regional dialogue on such topics as companies’ attitude to corruption or safety of working conditions. since the first adoption of the oecd guidelines for multinational enterprises in 1976,5 we have seen the emergence of the un 1 communication from the commission, a renewed eu strategy 2011-14 for corporate social responsibility, com (2011) 681 final, 3.1. 2 un, report of the world commission on environment and development: our common future, 20 march 1997, transmitted to the ga as an annex to document a/42/427 development and international cooperation: environment, para 27. 3 for an early criticism of the voluntary understanding of csr see e.g. doreen mcbarnet, ‘corporate social responsibility beyond law, through law, for law’ in doreen mcbarnet, aurora voiculescu and tom campbell, the new corporate accountability (cup 2009) 12; halina ward, ‘legal issues in corporate citizenship’ (2003) global ansvar swedish partnership for global responsibility, london: international institute for environment and development; jennifer a zerk, multinationals and corporate social responsibility: limitations and opportunities in international law (cup 2006) 33-36. 4 for a prominent case from the usa, see nike, kasky v. nike, inc., 45 p.3d 243 (cal. 2002) and nike, inc. v. kasky, 539 u.s. 654 (2003); for a case from a european jurisdiction, see e.g. hamburg consumer protection agency’s case against lidl, <www.ecchr.eu/en/our_work/business-and-human-rights/working-conditions-insouth-asia/bangladesh-lidl.html> accessed 4 april 2017. 5 current edition oecd (2011), oecd guidelines for multinational enterprises, oecd publishing. foreword 4 global compact in 2000,6 the proposal and failure of the binding un norms on the responsibilities of transnational corporations with regard to human rights in 2003,7 followed by the adoption of a soft-law un ‘protect, respect and remedy framework’ in 20088 and the guiding principles in 2011.9 currently, the un is yet again negotiating a binding international agreement on business and human rights issues.10 lastly, various states have already acknowledged the importance of additional corporate social and environmental obligations and have introduced new laws that either directly or indirectly enhance the corporate interest in csr. laws on non-financial reporting and human rights due diligence are examples of this.11 this increased awareness and regulatory activity put companies under such pressure that in a practical sense the element of voluntariness in csr seems to be disappearing. moreover, it may be questioned whether some private law rules, tort law in particular, may in fact create a legal obligation on the part of the company to pursue csr goals in order to avoid liability. in parallel with this and shifting the focus to states, they are under different kinds of obligations to pursue sustainability goals. many of these are binding at the international law level. this is true for instance with respect to obligations on the states that are parties to the european convention on human rights, the ilo conventions and the united nations convention against corruption. and it is crucial not only for the protected subjects but also for corporations coming as investors that states 6 <www.unglobalcompact.org>accessed 4 may 2017. 7 norms on the responsibilities of transnational corporations and other business enterprises with regard to human rights, u.n. doc. e/cn.4/sub.2/2003/12/rev.2 (2003). 8 un human rights council, report of the special representative of the secretarygeneral on the issue of human rights and transnational corporations and other business enterprises, john ruggie: protect, respect and remedy: a framework for business and human rights, u.n. doc. a/hrc/8/5, 7 april 2008. 9 un human rights council, report of the special representative of the secretary general on the issue of human rights and transnational corporations and other business enterprises, john ruggie: guiding principles on business and human rights: implementing the united nations “protect, respect and remedy” framework, u.n. doc. a/hrc/17/31, 21 march 2011. 10 un human rights council, elaboration of an international legally binding instrument on transnational corporations and other business enterprises with respect to human rights, a/hrc/res/26/9, 14 july 2014 (the third session of the un working group will take place from 23rd to 27th october 2017.) 11 e.g., at the eu level, directive 2013/34/eu on the annual financial statements, consolidated financial statements and related reports of certain types of undertakings, oj 2014 l182/19, art 19a; denmark, section 99a of the financial statements act (lbkg 2015-12-10 nr 1580 årsregnskabsloven); uk, modern slavery act 2015; netherlands, 2017 child labour due diligence law (wet zorgplicht kinderarbeid). njcl 2017/1 5 adhere to their international commitments. in order to reiterate the states’ obligations, various soft law instruments require states to pursue sustainability goals. most notably, the first pillar of the un ‘protect, respect and remedy framework’ refers to the states’ obligation to actively protect human rights. in sum, several factors and instruments at national and international law level push for the pursuance of sustainability goals by companies and states alike. however, when making governance decisions whether to pursue or not to pursue sustainability goals, companies and governments may face a confusing dilemma. whereas not pursuing sustainability goals would seem to involve next to reputational, economic and business also legal risks, including the risk of liability; the decision to pursue sustainability goals may not be risk free either and may equally involve liability issues or other legal risks. the reason for this is that at both national and international levels and at both private law and public law levels, there are legal rules and norms that seem to be pulling in opposite directions. at the private law level, there may for example be a conflict between tort law obligations on the one hand and company law obligations to pursue profit maximisation on the other hand.12 directors in companies bear the duty of care towards shareholders. whether this duty has been exercised or not is traditionally assessed by the reaction of the market; positive economic outcome has been associated with well exercised duty of care. pursuing csr goals is costly and most often without a direct link to economic benefits for the company, since such benefits are usually seen only in the long term.13 that is why it has often been argued that the pursuance of csr goals in fact breaches company law and may thus lead to directors’ liability.14 a parallel conflict may arise with regard to pension funds, where directors may be obliged to act against the wishes of the fund’s members to pursue csr goals in order to avoid liability for not acting with due care to make the most profitable investments.15 with regard to states, there may be a conflict between their international obligations to pursue sustainability goals on the one hand and public procurement law, trade law or investment law obligations to pursue economic wealth and growth on the other. while it is clear that states have the obligations to protect human rights and the environment 12 see the contributions of peter rott in this issue. 13 for an economic analysis of pursuing environmental csr goals, see forest l reinhardt, robert n stavins and richard hk vietor, ‘corporate social responsibility through an economic lens’ (2008) 2 rev environ econ policy 219. 14 for discussion on this topic and extended literature references until 2009, see e.g. doreen mcbarnet, ‘corporate social responsibility beyond law, through law, for law’, university of edinburgh school of law working paper no. 2009/03, 18-21, available through papers.ssrn.com. 15 see the contributions of alexandra horváthová, rasmus kristian feldthusen and vibe ulfbeck in this issue. foreword 6 and to combat corruption against anybody aiming to breach relevant rules,16 it is less clear whether states may actively promote sustainability issues when acting as a market actor. the possibility to include sustainability criteria into public procurement tenders has been widely limited by their frequent disconnection from the subject matter of the specific contracts.17 inclusion of social requirements into public procurement tenders then may be considered as a smoke screen for a preferential treatment of local suppliers; and thus, their inclusion might lead to the invalidation of the concluded contract and, in an extreme case, to state liability. when looking into international investment law, the situation is even more tense. the pursuance of the sustainability agenda by a host state may lead to a breach of the non-discrimination and fair and equitable treatment principles, and in extreme situations even result in an expropriation of the investment under international investment law.18 finally, also constitutional law may pose limits to states’ pursuance of sustainability goals. this issue has arisen in connection to the recent urgenda case. the case opened the path for courts to find a state responsible for not pursuing sustainability goals in the interests of its citizens. however, it also raised an important question of how far courts can go in imposing sustainability obligations on the state without breaching the principle of division of powers. these conflicting legal rules and norms, some pushing for the pursuance of csr and sustainability goals and some suggesting the risk of liability for the same, were in the focus of the conference titled ‘to pursue or not to pursue csr goals: legal risks and liabilities’ held in copenhagen on 6-7 october 2016. this conference was an initiative of the centre for enterprise liability, copenhagen university (cevia)19 and the international and transnational tendencies in law centre, aarhus university (intralaw)20 and co-organised with the sustainable market actors for responsible trade (smart)21 project and the csr legal research network.22 the speakers addressed the issue of whether companies, states and other entities that are required by transnational private regulation and soft law to pursue csr and sustainability goals in their activities may in fact face legal risks and liabilities for doing or not 16 in respect to human rights, the states’ obligation to protect was clearly reaffirmed in the first pillar of the ‘protect, respect, remedy framework’ and the subsequent guiding principles, see supra notes 8 and 9. 17 see the contribution of marta andrecka and kateřina peterková mitkidis in this issue. 18 see the contribution of ying zhu in this issue. 19<http://jura.ku.dk/virksomhedsansvar/english/>accessed 8 may 2017. 20<http://law.au.dk/en/research/forskergrupper/international-and-transnationaltendencies-in-law-intralaw/> accessed 8 may 2017. 21<http://www.smart.uio.no>accessed 8 may 2017. 22<https://csr-legal-research.com>accessed 8 may 2017. njcl 2017/1 7 doing so. this special issue presents five of the contributions, discussing the topic both from the company (private) and state (public) perspectives. the special issue opens up with a contribution by peter rott, who furthers the discussion on directors’ duties and corporate social responsibility (csr) in light of several developments in german law (and beyond), namely case law relating to directors’ duties under the legality principle and developments in tort law that may have impact on the duty to avoid unnecessary risks to the benefit of the company. the author concludes that these legal developments may not only justify the pursuance of csr but they may even pave the way towards a duty to include (at least aspects of) csr into the policy and operations of the corporation under the business judgment rule in the quest to avoid unnecessary risks. in parallel to the company’s view, the second contribution by alexandra horváthová, rasmus kristian feldthusen and vibe ulfbeck discusses similar issues from the perspective of directors of pension funds in the eu. the contribution addresses the question of whether the prudent person principle included in the iorp directive23 is compatible with the esg-principles introduced by the new 2016 directive on pension funds,24 and whether this means that all investments made by pension funds from the eu have to be made in an environmentally and socially responsible way in order to avoid the risk of legal liability claims. the authors find that the compliance of the two depends on the assessment if such sustainability investments are in the ‘best interest’ of the investors. this assessment is to be made by the fund’s directors. if this assessment is conducted in a diligent and procedurally correct manner, there is a little chance for any liability claim for pursuing or not pursuing sustainability goals to be successful. the third contribution by marta andrecka and kateřina peterková mitkidis bridges the private and public law spheres by discussing and comparing sustainability requirements in procurement processes of public organisations and private companies. the authors find a number of similarities, particularly in respect to the topics covered and the processes used, and differences, namely with respect to the drivers of sustainability procurement and the applicable legal regulation. the authors conclude that while there is an obvious right to include sustainability considerations into both public and private procurement processes, there are only contours of the legal obligation to do so, and that, quite counterintuitively, there seem to be more legal risks associated with the inclusion of sustainability requirements into procurement processes rather than with ignoring them. 23 directive 2003/41/ec on the activities and supervision of institutions for occupational retirement provision, oj 2003 l 235/10. 24 directive (eu) 2016/2341 on the activities and supervision of institutions for occupational retirement provision (iorps), oj 2016 l 354/37. foreword 8 the fourth contribution by ying zhu analyses the tension between international investment law (iil) and the pursuance of sustainability goals by the host state. while iil calls for restricting the host state’s interference with foreign corporations; pursuance of sustainability goals necessarily requires governmental regulation. the author proposes to reconcile the tension by taking account of sustainability goals in international investment arbitration through adopting a balanced interpretation of international investment obligations. the final contribution by carola glinski investigates the tension between national and private csr measures on the one hand and the wto law on the other. the contribution addresses three issues: the extraterritorial character of csr measures (national ‘non-product related production measures’), the attribution of private csr regulation to the importing state and under what conditions private transnational csr standards can be considered as ‘international standards.’ while taking an analysis of the tuna dolphin ii25 and ec – seal products26 decisions as a point of departure, the author concludes that the decisions show a mixed picture of the admissibility of csr measures, containing arguments pointing both towards the discriminatory character of csr measures and to their legitimate purpose of protection of national moral perceptions. the discriminatory character of csr measures may be disguised and will depend on how the actual csr measures are drafted. finally, the author comes to the conclusion that there is currently no legal basis for holding states responsible for purely private csr regulation. by contrasting examples from different legal systems, the special issue thus analyses in more detail the character of the outlined conflicts to examine whether companies and states may in fact be in a “catch 22” situation or whether the conflicting goals can be to some extent reconciled. we thank the speakers at the conference, the contributors and njcl for making this special issue possible and hope that this publication will bring more academic dialogue between the advocates and opponents of the legal basis of csr and sustainability concerns. 25 us – measures concerning the importation, marketing and sale of tuna and tuna products, wt/ds/381/ab/r. 26 ec – measures prohibiting the importation and marketing of seal products, wt/ds/400/ab/r, wt/ds 401/ab/r. microsoft word liguo_zhang_korjattu.doc nordic journal of commercial law issue 2013#1 in search of a balanced solution to access to standard essential patents in the ict industry by liguo zhang* * ll.d., post-doctoral researcher at the faculty of law at the university of helsinki. nordic journal of commercial law issue 2013#1 1 1 introduction 1.1 background industrial standards generally define the characteristics of products, related processes and production methods for common and repeated use throughout the relevant industry. standards can secure quality and safety of industrial products and services. standards are also a common language of industry, which secure the interoperability and compatibility of the components of a product or a network supplied by different manufacturers or suppliers. 1 in a complex industrial society, standards have permeated every part of our lives. standards usually are established by consensus in a formal, coordinated process in a standard-setting body. key participants in a market, such as designers, technology providers, producers, consumers, other potential users, and regulatory authorities, may come together to seek formal consensus on making a standard following an established procedure in a standard-setting body. in a science and technology -based society, standardization necessarily relies on up-to-date technological knowledge. the technical committee of a standard-setting body is always composed of experts who are knowledgeable in a particular field and who pool and expand their knowledge to create up-to-date standards. hence, standardization in a science and technology -based society has to be backed by intense innovation. the emergence and creation of new technology is highly dependent on the patent system. a patent grants an inventor the right to prevent others from using its ideas for a limited time. as an incentive, a patent enables the inventor to earn profits that exceed the ordinary rate of return on an investment.2 since without the patent system the market would yield less than an optimum level of innovative activities, the patent system is designed to stimulate investment in research and development (r&d) and invention and to stimulate public disclosure of technological information. patents may also signal ownership of a particular piece of technology, thereby preventing trespass by others. furthermore, patents may stimulate commercial exploitation of technology by creating a 1 according to the international standard organization (iso) definition, standards are documented agreements containing technical specifications or other precise criteria to be used consistently as rules, guidelines, or definitions of characteristics to ensure that materials, products, processes and services are fit for their purposes (iso 2002). quality and safety standards define the design or performance characteristics that products must have either to be sold on the market or to obtain “approval,” “certification,” or “listing” by a standard-setting body. interoperability standards specify whether and how one type of product will be able to fit or communicate with other products (e.g., mobile telecommunication standards, tv transmission standards, or computer operating system interfaces with applications programs). see james j. anton and dennis a. yao, “standard-setting consortia, antitrust, and high-technology industries,” antitrust l j 64 (1995): 247, 248, 262-63. 2 robert cooter and thomas ulen, law and economics, 4th ed (boston: pearson/addison wesley, 2004), 122. nordic journal of commercial law issue 2013#1 2 defined set of legal rights known to both parties at the outset of negotiations and making trade in technological resources possible.3 nonetheless, a patent grants an individual the right to exploit a piece of knowledge exclusively, while a standard is intended to identify a common pool of knowledge to be used by everyone.4 there is an obvious tension between the private character of patents and the public nature of standards.5 because standards define design or performance characteristics that products or services must have, they inevitably overlap some claims of patents. when these patents are essential to a standard, it is unlikely for anyone to bypass them in implementing the standard. when it is not possible to make, sell, use or operate equipment or methods technically which comply with a standard without infringing a patent, the patent is considered essential to the standards.6 the interaction between patents and standards has lately raised growing concerns in the ict industry. these highly controversial issues include industry standards embracing patented technologies, excessive royalties for the use of standard essential patents, and the refusal to grant licenses for the use of standard essential patents. 1.2 research questions the issue of how best to balance standardization and getting access to essential patents is no more settled in academia than in industry. this study sets out to investigate the patent licensing practice pertaining to standards in the ict industry, and the eu regulations on standardization and intellectual property licensing. this study is an effort to (1) evaluate the basic presumption of conflict between standards and patents, which may lead to the notion of sacrificing one for the other, (2) re-evaluate the effect of traditional approaches that aim to guarantee access to patented technology, (3) attempt to find an appropriate solution to balance standardization and access to essential patents. 3 edmund w kitch, “the nature and function of the patent system,” journal of law & economics 20 (1977): 277, 278. 4 rudi bekkers, bart verspagen, and jan smits, “intellectual property rights and standardization: the case of gsm,” telecommunications policy 26 (2002): 172. 5 rudi bekkers, geert duysters, and bart verspagen, “intellectual property rights, strategic technology agreements and market structure: the case of gsm,” research policy 31 (2002): 1142. 6 clause 15.6 of the etsi ipr policy suggests a definition of an ipr as essential: “essential as applied to ipr means that it is not possible on technical (but not commercial) grounds, taking into account normal technical practice and the state of the art generally available at the time of standardization, to make, sell, lease, otherwise dispose of, repair, use or operate equipment or methods which comply with a standard without infringing that ipr. for the avoidance of doubt in exceptional cases where a standard can only be implemented by technical solutions, all of which are infringements of iprs, all such iprs shall be considered essential.” nordic journal of commercial law issue 2013#1 3 to do this, i first demonstrate that standards and patents are not inherently in contradiction. i then apply a theoretical framework of property rule and liability rule entitlements developed by calabresi and melamed to analyze the traditional means of access to patents. i also want to borrow a model of governing the common resources from ostrom to explain the relationship between standardization and licensing essential patents from the perspective of governing intellectual resources. the purpose of applying these theoretical frameworks is to evaluate the current standardization and patent licensing practice more effectively in order to determine the optimal arrangement in law to balance encouragement of individuals to contribute to standardization and encouragement of exploitation of patented technology. my approach provides a framework to analyze standardization and patent licensing from angles that diverge from traditional approaches. this study will propose a theoretical base for legal policy in facilitating standardization and access to essential patents. this book is composed of four parts. the first introduces the general issues, such as the aim of the study, background information, methodology and a road map of the study. the second part examines the european union’s standardization policy and the legal framework governing standardization. the third part examines the function of and interaction between patents and standards in the ict industry. the fourth part examines the licensing of patents in the light of standardization circumstances. 1.3 main contributions this study suggested that patent and standardization does not have to be conflict from the perspective of promotion of the application of new technology, the patent policy should switch from promotion of invention to promotion of commercialization of invention. it demonstrated several defects of current ssos ipr rules and clarified the way to define fair, reasonable and non-discriminatory (frand) terms. moreover, it extended common pool resource governing framework to the exploitation of standards and patents. finally, it developed a cooperative approach to facilitate technology exploitation. 2 analysis of traditional solutions to access to standard essential patents 2.1 patent hold-up, patent ambush and patent wars in the mobile telecommunication sector in the ict industry, patents have provoked the most controversy, particularly since they tend to overlap and block the development of necessary improvements.7 the overlap of standards and patents in the mobile telecommunication sector especially illustrates such a complex sample. 7 mark a lemley, “intellectual property rights and standard-setting organizations,” california law review 90 (2002): 1971. nordic journal of commercial law issue 2013#1 4 because of the high level of r&d, investment and patenting intensity in this sector, technologies are fragmented into many separate, exclusive areas via the ownership of patents or other intellectual property rights (iprs) on the part of many different firms, thus creating a dense web of patents.8 for instance, the european telecommunication standardization institute (etsi) ipr database shows that there are 4,380 patents declared as essential to the gsm standards and 8,666 declared as essential to the umts 3g standards in the database.9 8 carl shapiro, “navigating the patent thicket: cross licensing, patent pools, and standard setting,” in innovation policy and the economy (adam jaffe et al., eds., nat’l bureau of econ. research, 2001), 2001, 120. 9 these data were found on the etsi ipr database, accessed april 2009, http://webapp.etsi.org/ipr/. nordic journal of commercial law issue 2013#1 5figure: u.s. registered patents declared essential to the umts 3g standards. source: etsi ipr database, 24 march 2010. intense patenting and general standardization of technologies have resulted in intensive patent battles in the ict industry in the last decade. since 2001, almost all of the market players in the mobile technology sector have been involved in patent infringement suits.10 since 2006, the 10 “smart-phone lawsuits: the great patent battle,” the economist, october 21, 2010, http://whttp://www.economist.com/node/17309237?story_id=17309237&cfid=156955783&cftoken=16103439. nordic journal of commercial law issue 2013#1 6 number of mobile phone-related patent complaints has increased by 20% annually.11 the graphic below shows the patent infringement suits in the mobile technology sector between major players recent years. figure: patent law suits in the mobile sector: 2000-2011.12 these patent battles indicate the high transaction cost for acquiring necessary patents, which may impede the commercialization of technology and further innovation. when a firm attempts to develop a product or service compliant with a standard, it inevitably infringes on the patents of others. obtaining a license is thus generally necessary for any stakeholder to be viable in the market. however, firms that own patents essential to a standard may refuse to license them, thereby blocking access to the standard so as to exclude their competitors from the market, or may take the advantage of their dominant position to charge excessive royalties or impose other unfair conditions on standard implementers, especially when implementers 11 ibid. 12 the data were collected from the reports in the guardian and reuters websites. this graphic does not cover all patent suits in the sector. nordic journal of commercial law issue 2013#1 7 have made considerable investments. this dynamic is referred to as the “patent hold-up” and “patent ambush” problem.13 this study identifies three underlying reasons that may contribute to this situation. first, the complexity of technology in the ict industry demands specialization or new division of labor in the r&d field. many firms are working on developing new technologies within a specific area. the specialization in the ict industry results in fragmentation of the technology. many firms exclusively control a narrow but overlapping technological field through owning patents. the fragmented technologies and dispersed patent rights make any further improvement and commercialization of these patented technologies inevitably infringe other patents. second, the ict industry relies heavily on standardization, which creates a general specification to secure compatibility and interoperability. standards embracing patent claims may aggravate patent ambush and patent hold-up problems because it may diminish alternative non-infringing technologies.14 nonetheless, the intensive patenting and highly dispersed patent rights in the ict industry make it difficult to avoid embracing patent claims in technical standards. third, the high degree of specialization in the r&d industry creates an opportunity for the new business of trading patents. non-practicing entities (npes) purchase patents to build up a patent portfolio and then rely on revenues from licensing patents. the highly fragmented technologies and dispersed patent rights make the operation of this kind of business much easier than it was in the past. because npes do not produce a product, they usually do not need to cross-license with other patent holders. then npes may aggressively sue the patent users for the purpose of monetary revenue. this causes further difficulty for technology users in commercializing patented technology. 2.2 current solutions: the market approach and the intervention approach the solutions to the problems demonstrated above are diverse, but none of them alone is effective enough to work. i categorize these solutions into two groups: the market approach and the intervention approach. the market approach emphasizes that the market may effectively allocate a technological resource to someone who can exploit it most efficiently. the effective transaction can create a 13 for the patent hold-up problem, see mark a lemley and carl shapiro, “patent holdup and royalty stacking,” texas law review 85 (2007): 1991. 14 liguo zhang, “refusal to license intellectual property rights under article 82 ec in light of standardisation context,” european intellectual property review 32 (2010): 403. nordic journal of commercial law issue 2013#1 8 surplus that benefits everyone. the market approach proposes to strengthen patent rights as a property rule entitlement, such as improving patent quality, providing strong protection to patent holders against infringers thereby facilitating individual bargaining and transaction. some licensing models and business models have been developed such as cross-licensing and patent-licensing entities. the operation of these models is premised on the patent being a clearly defined property right. the intervention approach suggests applying compulsory licensing or the rules on abuse of patents against patent holders. since compulsory licensing forces patented technology to be shared among other relevant parties, compulsory licensing would be the simplest and most expedient way to get access to patented technology. in the case of compulsory licensing, liability rules apply to the patent. compared to property rules, under which prices are subject to strictly individual valuation and are set by the right-holder alone, liability rules impose compensation objectively determined by authority to a right-holder where the right is infringed.15 but the extent to which liability rules should apply to patents is a controversial question. the eu approach on refusal to license iprs emphasizes the prevention of the emergence of new product and the bar to technical development.16 the german approach emphasizes competition by substitution.17 2.3 evaluating the benefit and cost of the market approach the market always has transaction costs. especially the transaction costs are high where property rights are uncertain and the boundary of rights is not clear, there are many parties to negotiate between, the parties are not familiar with each other, and the enforcement of rights is not easy.18 when these costs are high enough, transactions through the market become inefficient. some proposals have been made to improve the quality of patents in order to define clear property rights eligible for effective transaction. such measures include enhancing the standard of invention, avoiding vague claims, insisting on more adequate disclosure, publicizing patent applications and improving opposition procedures, as well as improving examination quality. moreover, the market approach endorses patents as property rule entitlements, which are backed by strong injunction relief against infringement. 15 guido calabresi and a. douglas melamed, “property rules, liability rules, and inalienability: one view of the cathedral,” harvard law review 85 (1972): 1092. 16 case 418/01 ims health v. ndc [2004] ecr i-5039; case t-201/04 microsoft v. commission, september 17, 2007. 17 german federal supreme court, standard tight-head drum (standard-spundfass),kzr 40/02, 36 iic (2005). 18 cooter and ulen, law and economics, 94. nordic journal of commercial law issue 2013#1 9 nevertheless, the market approach may come with three drawbacks which make it less effective. first, patent rights are far from an ideal property right.19 the function of the market approach is premised on the patent being a clearly defined property right, but patent rights are far from this, and the likelihood of improving patent quality to a significant extent in the near future is quite small. therefore licensing of patents often involves law-suits by which parties may figure out the real and valid patent rights. this explains why many patent holders can conclude a cross-licensing agreement only after they have brought the other into a law-suit. this indicates high transaction costs which make the market approach less efficient. second, where the number of complementary patents with respect to a product is so large that the transaction costs are very high, cross-licensing patents and patent pools which have been regarded as effective means of reducing the negotiation costs in such a situation may fail to function. the diversity of business interests and the collective action problems such as free-riding and the prisoner’s dilemma, which are inherently derived from cooperation negotiations, make crosslicensing patents and forming a patent pool more difficult. third, patent licensing entities may behave as an intermediary between patent holders and patent users, thereby lubricating patent licensing. however, patent licensing entities may involve patent trolls or patent privateering.20 in the mobile technology sector, some companies outsource their patents to npes against competitors they specify. moreover, patent licensing entities may gain a dominant position by aggressively acquiring patents to build a comprehensive patent portfolio. in addition, crosslicensing and patent pooling may be used by competitors to prevent competition. as a result, the market approach can raise antitrust concerns. such practices are the by-product of the strong patent exclusivity and market approach. patent battles are naturally part of the market approach. global patent battles between major players in the mobile technology sector have raised concerns about patents. patent battles, prima facie, may increasing costs and raise the threshold for companies to operate in the market. nonetheless, the battles reflect the two facts: the intense competition for the market and innovation in this sector and the increasing patent opportunism of npes. patent exclusivity is a powerful tool for sweeping away competitors. this pressure may push companies to innovate and to own more patents, which are considered effective ammunition in the competition war. in addition, patent battles also indicate the problem of patent quality. many patents do not survive a challenge in court. patent holders can conclude a cross-license 19 james bessen and michael j. meurer, patent failure: how judges, bureaucrats, and lawyers put innovators at risk (princeton university press, 2008). 20 ipr privateering can be defined as “the assertion of iprs by an entity (the privateer), typically in the form of an npe, against a target company for the direct benefit of the privateer and the consequential benefit of a sponsor company, where the consequential benefits are significantly greater than the direct benefits. the strategy, in part, relies upon the intransparencies of ownership and motivation permitted in the ip system.” see thomas l ewing, “indirect exploitation of intellectual property rights by corporations and investors: ip privateering & modern letters of marque & reprisal” (licentiate thesis, chalmers university of technology, 2011), 2–4. nordic journal of commercial law issue 2013#1 10 agreement only when they can figure out whether the patents in question are really essential or valid through a series of law-suits. despite these disadvantages or costs of market approaches, property rule entitlements are still the basis for patent system to function and are the precondition for any other approaches to work. both the invention of advanced technologies and the creation of industry standards entail considerable investment in r&d. they are not created by accident. from the standardsetting perspective, the property rules are desirable to provide an incentive for patent holders to contribute to standardization. this is necessary to create technological superior standards, which are essential to the development and utilization of technology. in term of standardization, innovative companies may pay more attention to standard-setting activities and would be willing to contribute their technology to standards so that their patents becoming essential to standards. through cross-licensing of patents, they can get access to each other’s patent portfolio. essential patents become the currency between companies operating in the relevant market. those companies that do not own any essential patents or own only a few will however be at a disadvantage in the competition. consequently, they have to pay royalties to use others’ patents or stay out of the market. essential patents become the ticket to enter the market. this may encourage companies to devote more effort and resource to developing essential technologies, but if those that do not own essential patents are excluded from market by blocked access to industry standards, the competition in the market may be reduced significantly. with respect to industry standards, what causes real harm to the industry is that essential patents are used to exclude new entrants rather than to charge a high royalty. 2.4 evaluating the benefit and cost of the intervention approach when the parties fail to negotiate an agreement, a surplus from exchange cannot be achieved. as a result, the resource is wasted. the intervention approach tries to minimize disagreements and failure to cooperate, therefore reducing the resulting harm. the approach suggests the law rather than market allocate property rights to the party who values them the most.21 this approach advocates compulsory licensing or the rules on abuse of patents to minimize the loss caused by failure in private agreement. under compulsory licensing, legislation or a court requires patent holders to license would-be licensees to use the invention at the pre-set royalty. compulsory licensing forces patented technology to be shared among other relevant parties. since compulsory licensing may reduce transaction costs and increase the utilization of the patented technologies, it would be the simplest and most expedient way to get access to patented technology. 21 cooter and ulen, law and economics, 97–98. nordic journal of commercial law issue 2013#1 11 compulsory licensing may destroy patent holder ability to control who can use their patent, however, a regulated royalty rate will apply.22 under compulsory licensing, patent holders could no longer exclude competitors that are willing to pay pre-set royalties from using their inventions. patent holders can only have two advantages: receiving revenues from the licensee and the cost advantage over their royalty-paying competitors.23 in this case, liability rules replacing property rules apply to patents. compared to property rules, under which prices are subject to strictly individual valuation and are set by the right holder alone, liability rules entail compensation objectively determined by an authority for an owner where a right is infringed.24 but liability rules represent only an approximation of the value of the right to its original owner, and willingness to pay such an approximate value for the right does not indicate that the infringer values the patent rights more than the owner. consequently, the allocation of technological resources may not reflect the economic efficiency. 25 from an economic perspective, property rule entitlements enable the right holder to maximize its benefit from its right, and utilize the right in the most beneficial way according to its own subjective valuation to enhance its welfare. a liability rule ignores the right holder’s subjective valuation and disrupts the right holder’s plan to exploit the right based on that valuation.26 only in exceptional circumstances therefore can patents become liability rule entitlements. thus compulsory licensing is usually instituted as a remedy for abuse of patent, to safeguard the public interest, to restore competition, and to exploit a secondary patent. the eu competition rules on refusal to license iprs have highlighted blocking the appearance of a new product or technical development as one of such exceptional circumstances.27 the german approach on refusal to license iprs lay down a criterion whether competition by substitution is blocked.28 however, both approaches seem to be missing one factor in identifying malpractices on the part of ipr owners, because technological superiority could be a reason that the competitors are not able to develop a new product or better technology. being technologically superior should not become a burden for an innovator. in the light of standardization, applying a liability rule indiscriminately to essential patents would unduly impair not only its effectiveness in generating the inventive and innovative activities of creating patents but also of making high-quality standards. when applying competition law to patent hold-up, malpractice should be considered as a factor. in terms of standardization, leverage of a 22 kitch, “the nature and function of the patent system,” 287. 23 fritz machlup, an economic review of the patent system (washington, dc: us government printing office, 1958), 13. 24 calabresi and melamed, “property rules, liability rules, and inalienability,” 1092. 25 ibid., 1125–1126. 26 margaret jane radin, “humans, computers, and binding commitment,” indiana law journal 75 (2000): 1154–1155. 27 case 418/01 ims health v. ndc [2004] ecr i-5039; case t-201/04 microsoft v. commission, september 17, 2007. 28 german federal supreme court, standard tight-head drum (standard-spundfass),kzr 40/02, 36 iic (2005). nordic journal of commercial law issue 2013#1 12 standard into the technology licensing market and the violation of ipr rules of standard-setting organizations (ssos) could be examples of malpractices. 3 alternatives to the traditional approaches access to patents has been a traditional problem with respect to the patent system since the system was first created, but these problems in the current ict industry are derived from new r&d models and new business models, which differ from the traditional one. specifically, the global patent explosion, the separation of technology creation from technology implementation, the convergence of many technologies in various sectors, and high standarddependence in the industry are major reasons for these problems. the traditional approaches to access to patents may thus no longer be appropriate. ostrom’s approach of governing common-pool resources which derives from governance of natural resources may be extended to governing standardization and access to essential intellectual property.29 industry standards or patents are intellectual resources by their nature. unlike natural resources, which existed before exploitation, intellectual resources must be created before they can be exploited and shared. the goal of natural resource governance usually is to secure sustainability; while intellectual resource governance is to secure innovation, growth, and progress.30 the governance of the standardization process and access to the essential patents needs institutions within which participants not only manage and share existing resources but also engage in producing those resources and which encourage the creation of new resources in the future.31 although intellectual resources, are non-rival and non-exclusive by nature, and are therefore shareable without risk of the congestion or overconsumption that occurs in natural resources, allowing access to intellectual resources but without reward for contributors may generally diminish the motivation to contribute to creating such resources. innovation brings about technological breakthroughs which enable the introduction of new product to the market. because patent holders invest heavily in r&d and in filing for patents, they may favor standardization as a way to share their innovations with those who could commercialize and use the technology, and as a way to obtain a reasonable return on their r&d investment. since the purely innovative firms rely on licensing patents and transferring technology, their interests rely on the success of the licensees and a successful and competitive downstream market, a policy that favors patent holders may prevent standards from satisfying user needs and may also make 29 michael j madison, brett m frischmann, and katherine j strandburg, “constructing commons in the cultural environment,” cornell law review 95 (2010): 657. 30 ibid., 672. 31 ibid., 681, 687. nordic journal of commercial law issue 2013#1 13 standards difficult to implement. a policy that favors standard implementers and consumers may deter patent holders from participating in standardization and also may stifle innovation. patent holders may choose not to contribute technology and may invest to support competing standards, which have a favorable ipr policy, or to establish proprietary standards. therefore, legal policy has to strike a balance between standardization and access to patented technology. policy must balance the interests of all stakeholders: patent holders, standard implementers, and consumers. 3.1 cooperation through contracts industry may establish a cooperative scheme to exploit technological resources via agreements. patent pools are established through private contractual agreements, by which patent holders agree to put their patents into a package for the purpose of jointly licensing their patent portfolios to pool members and other third parties. patent holders have the freedom to join or not join a pool. in this sense, patent pools are based on property rules. the market mechanism takes effect in the process of forming patent pools. nonetheless, the licensing of pooled technology may be subject to liability rules. whether to join a pool or not and the share of the holder’s patents can enjoy in the pool are at the patent holder’s own discretion. but in licensing pooled technology, to whom a license can be granted and at what royalty rate a license can be granted cannot be determined by any members of the patent pool individually. these licensing matters are usually decided by all members collectively or by a managing entity. in special circumstances, patent pool licensing might be subject to frand terms and conditions, which are usually required by competition rules. in this case, the price of pooled technology cannot be determined by patent holders or the entity responsible for managing the pool. the price is restricted by the industrial common practice and the general expectation in the industry. in this sense, the pooled patents become partial liability rule entitlements. patent pools can reduce transaction costs and increase efficiency by codifying the complementary patents into a single package and establishing a method for valuing the patents and dividing up the licensing revenue. nevertheless, the reality is that the patent pools are not successful in the mobile technology sector. the practice in the mobile sector shows the diversity of business interests and the collective action problems such as free-riding and the prisoner’s dilemma, make forming a patent pool very difficult. 3.2 cooperation through organizations a collective scheme to exploit technological resources can also be developed through organizations. one example is the collective society. nowadays standards are increasingly nordic journal of commercial law issue 2013#1 14 developed through industrial consortiums. standard-setting and the selection process provide an opportunity for private parties to develop institutions by which they can contract around the strong exclusivity of patent rights, bargaining from a property rule to a liability rule.32 this is a self-governing process by which ssos allow stakeholders to jointly choose an effective technology as industry standards to create common goods for the industry. ssos may provide a place for patent holders to establish a licensing scheme to avoid the disadvantage of strong property rule entitlement of patents. many ssos have established ip rules with the intention of mitigating patent ambush and patent hold-up problems related to standards. the ip rules usually include two structures. first, it requires members to declare patents they consider to be essential to a standard. second, members make commitment that those declared essential patents they owe should be licensed to any users on frand terms. where ssos adopt ipr rules that permit technology input providers and users to reduce the problems of opportunistic behavior and patent hold-up, this practice may help to lubricate standard implementation and technology transfer. frand licensing conditions in sso ipr rules are a key element in such a self-governance structure. frand licensing conditions and terms may draw a balance between patent holders and standard implementers, and leave more flexibility for both parties. frand licensing terms impose on patent holders the obligation to grant a license if the offer requesting a license to use the right holders’ technology is considered fair and reasonable, and the patent holders cannot refuse such an offer. this makes patent rights not purely property rule entitlements. neither are patent rights under frand licensing terms pure liability rule entitlements either, because patent holders still have the right to decide the royalty rate, which however is limited by the general industry practice and reflects the general expectation in the industry. establishing a licensing scheme within or assisted by an sso has several advantages. members of ssos are knowledgeable industry insiders, which usually involves repeatedly licensing patents, either as licensors or licensees. second, the internal governance of an sso may provide administrative support for a licensing arrangement. a patent licensing scheme created by patent holders and patent users in the framework of standardization can facilitate high-volume licensing. nonetheless, after investigating several major telecommunication ssos’ ip rules, this study found that there are several defects in terms of such ip rules. the first is incorrect declaration of essential patents either intentionally or inadvertently, and second the licensing may not comply with frand terms. several cases related to the enforcement of frand commitments show that these defects may undermine the efforts of ssos in dealing with patent hold-up and patent ambush. 32 lemley, “intellectual property rights and standard-setting organizations,” 1971. nordic journal of commercial law issue 2013#1 15 to fix these problems, legal policy should therefore create conditions for improving sso ipr rules and frand terms, rather than undermining the enforcement of sso rules and frand licensing terms. the study proposes that leveraging industry standards to exclude competitors may be subject to compulsory license, frand commitments should be enforceable, and npes should be regulated properly to avoid patent opportunism, in addition, ssos should bear responsibility of monitoring their ip rules. some measures should be taken in order to make frand commitments enforceable. first, competition rules can impose frand licensing terms and conditions on licensors that gain a dominant position in the relevant market. second, a licensor’s commitments to an sso in order to have its technology incorporated in a standard should be considered legally binding. in this case, the principle of bona fide will apply, and later violation of such frand commitments after its technology is successfully incorporated in a standard can invoke legal liability. nonetheless, frand licensing terms should not be so interpreted as to that infringers can use the terms as a defense in patent infringement suits against injunction relief. frand licensing terms should still maintain great flexibility for patent right holders in deciding a royalty rate, and sustain the possibility of using injunctive relief against infringers. furthermore, ssos should also play a role in promoting a license of essential patents to ensure the standards they have established are accessible. thus, it is important for a sso to be open, transparent and to establish a properly governance structure. thesis title: standardization and patent licensing in the european union, publications of ipr university center (issn 1796-8194), december 2012, 261 pages, isbn: 978-952-6787-0-4 contracts, risks and management = contractual risk management nordic journal of commercial law issue 2012#2 treaty conflicts in investment arbitration by ahmad ali ghouri* * dr. ahmad ali ghouri publicly defended his doctoral thesis on november 23, 2012 with opponent dr. stephan schill of max-planck institut für ausländisches öffentliches recht und völkerrecht and was awarded the degree of doctor of laws by the faculty of law at the university of turku on december 18, 2012. nordic journal of commercial law issue 2012#2 1 1 introduction the thesis assesses one of the core problems arising in international investment law, namely, the conflicts that international investment treaties may create with other international agreements. this topic is so important because investment treaties are primarily intended to protect the interests of foreign investors, and do not clarify how they relate to other international agreements protecting interests that may compete with the interests of foreign investors. tensions exist, inter alia, between international investment law and other branches of international law, such as human rights, international environmental, and eu law. these tensions are exacerbated by the fragmented nature of international investment law as a law governed by several thousand bilateral treaties. ultimately, the multiple problems of fragmentation may put the legitimacy of international investment treaties and investor-state arbitration into question. this summary gives an overview of the approach, methods questions, hypothesis, presentation, and findings of the research, which are elaborated on in the 200 pages of the original thesis. 1. approach differently from several other authors that criticise international investment law fundamentally and advocate for institutional change, i propose as a solution to the fragmentation problem to go back to the principles of general international law relating to international treaties and to the law of sources. my research does not attempt a reconceptualization of international investment obligations, but it elaborates on the implications for states and foreign investors of other international obligations arising from non-investment treaties. the thesis therefore stresses that international investment law cannot be seen in isolation from the rest of international law; that principles of treaty interpretation mandate taking into account other international legal obligations under article 31(3)(c) of the vienna convention on the law of treaties; and that investor-state arbitral tribunals should make use of balancing as an interpretative technique to deal with conflicting rights and interests. accordingly, this requires arbitral tribunals to realign their interpretative methodologies and practice in order to establish the investor-state arbitration as a legitimate system of rights adjudication. the argument is developed that investment tribunals should make decisions based on a balancing of economic and other values where these are in issue. this is required as such tribunals must apply the rules of treaty interpretation laid down in the vienna convention on the law of treaties. this includes a duty to interpret international treaties in the light of international law in general. thus where a case raises issues covered by other international agreements such as environmental protection, health and safety or human rights, the tribunal is bound to take into account the standards contained in these other agreements when determining the scope and meaning of the investment agreement before it. in my opinion, a global agreement on investment or a complete structural reformation of the investor-state arbitral system is not necessary, although it is also highly improbably, to address the concerns about system’s legitimacy. instead, investor-state arbitral tribunals need to identify and take up the issues of treaty conflicts and develop interpretive and conflict resolution techniques to resolve them. i contend that the vlct article 31(3) (c) equips investor-state nordic journal of commercial law issue 2012#2 2 arbitral tribunals with the required jurisdiction to take self-initiated cognisance of rights and obligation arising from non-investment treaties that have direct bearing on an investment dispute. once tribunals have assumed jurisdiction to consider and apply non-investment treaties while interpreting investment treaties, the important questions of normative overlaps and conflicts would arise. the research discusses the effects of cross-fertilisation of investment and non-investment treaties when their respective norms reciprocate and complement each other, resulting in jurisprudential development through inter-regime transplants. the research explains how such cross-fertilisation of treaties can results in unavoidable normative conflicts in some instances, and also how such conflicts can arise from within the investment treaties regime. after critical assessment of the inter-temporal rules to resolve treaty conflicts that are found within and outside the vclt, this research assesses the role of value-oriented reasoning which international dispute settlement systems have developed for the resolution of treaty conflicts, and suggests the doctrinal, methodological and practical possibilities for the employment of such reasoning by investor-state tribunals. this would lead to achieving a balance in determining the amount of compensation payable to foreign investors for violations by host states of investment treaty rights when such violations are directly attributable to conflicting non-investment obligations. therefore, my research suggests legally and practically plausible paradigms that investor-state arbitral tribunals can use in their adjudicative techniques, interpretive methodologies, and remedial mechanisms to resolve normative conflicts present in investment and non-investment treaties. if investor-state tribunals follow these methodological and adjudicative techniques, they would not only effectively address issues pertaining to the system’s legitimacy but also develop concrete substantive rules of international investment law that are coherent with other parallel systems existing within international law. undeniably, future investment treaty practice will also play an important role in reconstructing the normative framework of international investment law. however, the focus of this research remains on the present edifice of investment arbitration which thousands of existing investment treaties have created, and where investment treaty norms are being constantly tested and are evolving through the process of treaty interpretation. the question of how future investment treaties should be drafted to ensure that tribunals undertake the balancing of values is, therefore, beyond the scope of this research. 2. research methods the general research methods employed in this research are doctrinal analysis of evolving jurisprudence of international investment law and investigation of its cross-fertilisation with other systems or regimes of international law, especially with international human rights regime. i have used the rights to health, safety and the environment as an example of human rights because state regulations in these areas are the most common means of domestic implementation of international human rights obligations. however, the analysis in this research possibly extends to all types of human rights. the primary means of analysis is cases decided by international courts and arbitral tribunals. the analysis is based on the similarities and differences in the interpretive reasoning of such courts and tribunals. there are doctrinal differences between the precedential strength and nordic journal of commercial law issue 2012#2 3 value of an arbitral award compared to a decision of an international court. however, the continuously increasing, uncontested and consistent modern jurisprudence of the investor-state arbitral tribunals is likely to become part of the authoritative source of international law similar to other judicial decisions. modern arbitral jurisprudence may eventually develop into international custom that has a greater legally binding effect, particularly when arbitral jurisprudence defines the general principles of law in a contemporary treaty and factual context. furthermore, where arbitral tribunals commonly recognise the persuasive value of earlier arbitral awards, there is a tendency to gradually increase the persuasion level to a “duty” to adopt solutions established in a series of consistent cases, which could be discarded only on compelling contrary grounds. this tendency reflects the fact that arbitral tribunals have a deep rooted perception of the unity of international investment law, which would gradually develop the overarching rules applicable to all investment disputes. i have also discussed issues arising in this research in the light of prevalent ideologies and legal doctrines that eminent scholars of international law have offered on the subject. additionally, a section of the research presents an empirical analysis of a comprehensive collection of numerical data of bilateral investment treaties of the eu member states. 3. research questions as indicated, the primary modus operandi of this research has remained the examination of methodologies and reasoning that investor-state arbitral tribunals have used when determining the rights and liabilities of foreign investors and host states. the biggest problem with the investor-state arbitral system is the ambiguity over the extent to which the system allows balancing foreign investors’ interests against the broader public interests, especially when the host states are under another international treaty obligation to protect those interests. these increasingly conflicting interests pose a serious challenge to the system’s normative framework. the present reluctance of arbitral tribunals to interpret and apply investment treaties in the purview of non-investment treaty obligations by utilising the available interpretive bases, and their failure to balance the conflicting rights and obligations arising from different treaties by utilising the available principles and rules of international law is posing a serious threat to the system’s legitimacy. in this context, my research has addressed the following questions: 1. how has the present investor-state arbitral system evolved? a. whether the current investor-state arbitral system developed harmoniously, aligned with the policy objectives and interests of variant international actors including developed and developing states, international institutions and multinational businesses? b. how does the present investor-state arbitral system operate? c. have the investor-state arbitral tribunals applied the emerging international investment norms consistently to ensure that the entire system develops such adjudicative principles as subscribe them a legitimate system of rights adjudication? 2. what are different normative functions that can be ascribed to investment treaties? nordic journal of commercial law issue 2012#2 4 a. are the objects and purposes of investment treaties restricted only to the protection of foreign investors’ rights, or do they expressly or impliedly extend to the protection of citizens’ rights to health, safety and the environment? b. what legal bases are available to tribunals within parameters of investment treaty regime to reformulate and balance the foreign investors’ rights against the rights of citizens? 3. what are the available policy options for investor-state arbitral tribunals to address the system’s legitimacy deficit? a. what should be the policy dimensions for tribunals to transform international investment arbitration into a collective value system, protecting foreign investors’ rights as well as higher development objectives, giving room for and safeguarding greater public policy objectives? b. the investor-state arbitral system is broadly premised on the application and interpretation of investment treaties. are there principles or rules applicable to the interpretation of treaties that tribunals can use to realign their interpretations for addressing the system’s legitimacy concerns and to transform the investor-state arbitration into a collective value system? 4. what is the relationship between the investor-state arbitral system and other systems of international law? a. are the rights and obligations that states have acquired under non-investment treaties relevant in the interpretation of investment treaties? b. do investor-state arbitral tribunals need to develop methodologies to integrate this ostensibly autonomous system within the broader normative structures or systems of non-investment treaties, such as human rights and environmental protection treaties? if so, what doctrinal bases are available in the law of treaties to develop such methodologies? c. do tribunals have jurisdiction, competency or power to consider and apply the obligations acquired by states under non-investment treaties when interpreting investment treaties? d. how do investment treaties interact with regional economic integration treaties, such as the treaty on the functioning of the european union (tfeu)? 5. is there a hierarchy of conflicting treaty norms? a. how do investment treaty obligations potentially conflict with obligations arising from non-investment treaties? b. how would or should tribunals resolve the potential conflicts between investment treaties and non-investment treaties? c. how should tribunals resolve the system’s internal conflicts arising from different objects and purposes of a combination of two or more investment treaties that are relevant and applicable to the subject matter of a dispute? d. how should tribunals choose between two mutually inconsistent and conflicting provisions within an investment treaty? nordic journal of commercial law issue 2012#2 5 e. are the general international law principles and rules of priority between conflicting treaties workable in the investor-state arbitral system or the system should devise its indigenous rules of priority, while benefiting from the general principles and rules? all of these questions share some degree of overlap and meet at different levels of enquiry in this research. the questions address the serious challenges facing investor-state arbitration to develop as a legitimate, coherent, reliable and useful system of rights adjudication based on collective values for both developed and developing countries as well as their citizens. 4. hypothesis the primary hypothesis is that investor-state arbitral tribunals need to develop a pragmatic approach in their interpretive methods with a view to achieving the system’s integration into the normative framework of international law. this integration would result from: 1. clarifications of the nature, content and scope of the principles and rules of international investment law; 2. refinement of the adjudicative methodologies to assure that tribunals take cognisance of the norms, rights and obligations arising from non-investment treaties that conflict with investment treaties; and 3. developing the normative framework to resolve these conflicts by balancing and prioritising conflicting obligations. the theme of this research is that the entire corpus of the investor-state arbitral system needs to develop a new approach to the ways tribunals determine rights and duties of states and foreign investors, and how they interpret and implement investment treaties. in order to address the broader human rights and public interest concerns, all stakeholders should be able to draw on the investor-state arbitral system effectively and efficiently. the normative evolution of the investment principles and rules is progressing on the bases of the investor-state arbitral system’s own particular philosophy and unique characteristics, which would result in the formulation of distinct rules of international investment law. however, investor-state arbitral tribunals must be conscious that this normative formulation remains collaborative and develops within the parameters of other branches of international law, and of established international norms that require promotion of collective good and protection of universal values. as investor-state arbitral tribunals are the formative place of international investment law, they must assume the adjudicative duty of constructing the system as a distinct but internally and externally coherent legal regime which takes account of the rights and obligations of every stakeholder when determining the rights and obligations under investment treaties. this would develop the investor-state arbitral system as a system of collective values having the capacity to resolve frictions arising from increasingly overlapping and incompatible obligations that states have acquired in investment and non-investment treaties. this would also re-establish the role of treaties as a means for orderly and peaceful settlement of international disputes by providing pragmatic explanation for states to continue benefiting from the multifaceted and multipurpose utilisation of treaties in their international dealings. nordic journal of commercial law issue 2012#2 6 the investor-state arbitral system’s phenomenal but incoherent evolution, divergent views of its success, and the increasing normative interaction with other systems of international law suggest that the system is now poised at a critical crossroads. the system is facing grave concerns about its legitimacy but simultaneously has an opportunity to address these concerns by realigning and readjusting its adjudicative methodologies. 5. beneficiaries and stakeholders the primary audiences for this research are international investment arbitrators, arbitration centres and international lawyers. the primary beneficiaries are individuals who do not always have the opportunity or even the legal capacity to protect their rights and interests in the decentralised and state-focused system of international law. human and environmental rights activists, groups, organisations, and lawyers will also greatly benefit from this research. other beneficiaries include states that have concluded investment treaties, and foreign investors who are subjects of those treaties, since sustainable development is a value shared by all. the research is applicable to existing and future investor-state disputes, and will also help foreign investment strategists and policy makers. at the time of writing, there are a total 227 concluded and 141 pending cases at the international centre for the settlement of investment disputes (icsid) alone. 6. structure and presentation of research the thesis consists of the following five previously published articles. short abstracts of the articles are provided here. 1. the evolution of bilateral investment treaties, investment treaty arbitration and international investment law, international arbitration law review, vol. 14, no. 6, pages 189-204, december 2011. this article explores the evolution of the current regime involving foreign direct investment, bilateral investment treaties and investment treaty arbitration. it considers why a harmonised multilateral investment agreement has never been adopted. it reflects on past attempts to harmonise the customary foreign direct investment regime, the resolution of investment disputes over the past century, and the establishment of arbitration centres across the world. it looks at how investor-state arbitral system works and how its substantive norms can potentially conflict with obligations arising from international trade agreements. 2. investment treaty arbitration and the development of international investment law as a ‘collective value system’: a synopsis of a new synthesis, journal of world investment and trade, volume 10, number 6, pages 921-936, december 2009. this article provides a critical account of the development of investor-state arbitration and ensuing substantive rules of international investment law. it examines the emerging design of international investment law as a distinct substantive regime within international law. this is followed by an analysis of the views of known scholars on the determination of substantive rules of international investment law, highlighting the controversies and problems within the investor-state arbitral system. after illuminating the problems arising from conflicting arbitral awards and the complicated nexus of international obligations that states have acquired, the article argues that solution to the investor-state arbitral system’s problems is in finding new foundations for the system based on solid substantive rules and the realisation and affirmation nordic journal of commercial law issue 2012#2 7 of collective values. the article sets out a road map for the accomplishment of this collective value system. 3. positing for balancing: investment treaty rights and the rights of citizens, contemporary asia arbitration journal, volume 4, number 1, pages 95-119, may 2011. substantive bilateral investment treaty rules have the potential to undermine the rights to health, safety and the environment of the citizens of host states if stricter state regulations to protect these rights amount to regulatory expropriation or breach other investment treaty rights. this article argues that bilateral investment treaty rules are comparable with, and stand parallel to, the domestic laws of host states and investor-state arbitral tribunals should balance these rights when they conflict with each other. tribunals act as de facto courts since they enforce rights that are assertable against the public at large and not against the host state alone. similar to the bilateral investment treaty “rules”, an analysis of the legal nature of “rights” created by bits also reveals that these rights are comparable with the domestic law rights. the article articulates three legal arguments founded on substantive bilateral investment treaty clauses, human rights, and property rights on the basis of which, three specific rights, i.e., the rights to health, safety and the environment of citizens of host states may stand parallel to the rights that bilateral investment treaties create for foreign investors. these arguments, both individually and taken together, call for balancing these citizens’ rights with the rights of foreign investors in the event of their conflict. 4. determining hierarchy between conflicting treaties: are there vertical rules in the horizontal system? asian journal of international law, vol. 2, issue 2, june 2012. this article addresses the general issues of treaty conflicts and their resolution in international law. treaties are contractual instruments that may provide special rules of priority in case they conflict with other treaties. when a treaty does not provide such rules, however, priority is determined by the rules of the vclt and/or general principles of law. this article argues that both the vclt and general principles of law do not provide an adequate solution to treaty conflicts. it suggests that the solution to treaty conflicts rests in a value-oriented reading of international law and treaty norms. norms represent values and values represent interests or benefits for which the international society requires protection. conflicts of treaty norms are, therefore, conflicts of values that courts and dispute settlement bodies resolve by ordering a hierarchy of competing interests, and by protecting the most important interests in a given context. 5. resolving incompatibilities of bilateral investment treaties of the eu member states with the ec treaty: individual and collective options, european law journal, volume 16, issue 6, pages 806–830, november 2010. bilateral investment treaties concluded by the member states of the european union contain substantially similar clauses, including free movement of capital and dispute resolution through investor-state arbitration. article 307 ec treaty (present article 351 tfeu) provides for the primacy of pre-accession treaties over the ec treaty and simultaneously requires the member states to eliminate their mutual incompatibilities. the european court of justice has declared that the free movement of capital clauses of austrian and swedish pre-accession extra-eu bits are incompatible with the ec treaty as they will impede future restrictions on the movement of nordic journal of commercial law issue 2012#2 8 capital imposed by community legislation. a similar “free movement of capital” clause is present in all extra-eu bits of the member states, whether preor post-accession. article 307, however, does not apply to the post-accession treaties, which are equally capable of achieving the same results of impeding the application of the ec treaty. in addition, the application of intra-eu bits gives investors from bit party states access to the investor-state arbitration, which is not available to the investors from those member states that do not have bits with other member states. this is discrimination and may distort the principle of equal treatment within the eu. furthermore, the newly acceding eu member states are facing extensive arbitral claims for carrying out the bit-eu conflicting obligations within their respective territories. there is a need to identify and explain rules for the resolution of these conflicts. 7. findings the normative framework of customary international law for foreign direct investment has remained disputed among developed and developing countries throughout modern history. on one hand, developed countries insisted on full protection and security for their citizens’ assets abroad, and payment of prompt, adequate and effective compensation for any expropriations. on the other hand, developing countries have traditionally asserted their right to expropriate and payment of compensation in accordance with their domestic standards. the customary rules of diplomatic protection of citizens’ assets abroad also remained problematic and inadequate. the un general assembly, the oecd, and several other forums made unsuccessful efforts to bring the international community to an agreement on the substantive norms governing foreign direct investment. the normative paradigm of foreign direct investment has now shifted from the customary international law to investment treaties. with several thousand bilateral investment treaties and chapters on investment in free trade agreements, we now have an extensive and complex network of treaties providing substantive and procedural protections to foreign investors. most of the near 400 known decided and pending investor-state disputes before international investment tribunals applied and would apply the rules and principles of international investment law that essentially emerge from investment treaties. the decisions of investor-state tribunals determine rights that are assertable against the entire world and not merely against the defending states. awards of these tribunals not only decide the matters in dispute between a foreign investor and a host state, these awards have implications for other treaty regimes and for the overall development of international law. investor-state arbitral tribunals are under enormous pressure by legal scholars, human rights groups and non-governmental organisations to take cognisance of applicable public interests when deciding investment disputes. the entire structure of the investor-state arbitral system revolves around the interpretation of investment treaties and this research has demonstrated that a wide variety of sources of international law, as well as international investment law, provide that investment treaties do not operate in isolation from other non-investment treaties that states parties to an investment treaty have concluded. the principle of systemic integration of treaties, the minimum requirements of justice, considerations of domestic and international public policy, and the overall normative environment: all support the relevance and application of party states’ other treaties when interpreting investment treaties. where the relevance and application of non-investment treaties for the interpretation of investment treaties is clearly established, non-investment treaties cross-fertilise or interact with nordic journal of commercial law issue 2012#2 9 investment treaties in two important ways. first, a non-investment treaty may provide jurisprudential explanation for the substantive rules and principles that are common in both types of treaties. secondly, a non-investment treaty may provide rules or principles that are incompatible with an investment treaty and play a supervisory or overriding role in investorstate arbitration. the practice of investor-state arbitral tribunals reveals somewhat inconsistent and disguised presence of both these types of treaty interactions. however, tribunals have not clearly established normative bases and doctrinal justifications for the supervisory interactions, and have not fully materialised the functional outcomes and potential benefits that can be realised from such interactions. this research showed how in particular settings various investment and non-investment treaty interactions may result in serious treaty conflicts. investor-state tribunals as treaty interpreters are obligated by the requirements of justice prescribed by the un charter and the vclt and by the principle of systemic integration provided by the vclt article 31(3) (c) to take cognisance of treaty conflicts emerging from cross-fertilisation of treaties and to effectively resolve these conflicts in order to satisfy the ends of justice and to develop the investor-state arbitral system as a legitimate system of rights adjudication. investor-state tribunals have a timely and perfect opportunity to clarify that the application of non-investment treaties on investor-state disputes is required by the vclt article 31(3) (c). such direct application of noninvestment treaties on investor-state disputes is necessary not only to align the development of investment norms within the broader normative framework of public international law but also to strengthen the system’s integrity, to bring consistency and interpretive balance pivotal for value judgements, and to disprove the allegations of undermining public interests levelled against the system. this research has also revealed that the normative conflicts in investment treaty arbitration do not always emerge from their interaction with non-investment treaties. in some cases, the distinct investment and non-investment objects and purposes contained within investment treaties may also result in conflict with each other. similar conflicts also arise from the combined application of the icsid convention and bits, again based on their variant economic and non-economic objects and purposes. to resolve all these conflicts, whether between two investment treaties or within an investment treaty, tribunals need to balance between competing treaty norms. where the conflicting norms are so far incompatible with each other that they cannot be simultaneously applied, tribunals need to determine hierarchy between conflicting treaty norms. additionally, when bit rules, which are primarily commercial and private in nature, collide with the public in nature and internationally valued rules present in domestic laws, tribunals need to balance these colliding rules to achieve a just settlement of disputes. further on the need for balancing, and from a different perspective, analysis of the bits’ substantive “rules” reveals that these rules are also potentially discriminatory against the citizens of host states because they create more favourable procedural and substantive rights for foreign investors. a similar “rights” based analysis of bits highlights that the rights of foreign investors under bits can be divided into private and public rights. they are private to the extent of the right to supra-national arbitration, which is assertable against the host state alone acting as an international person. the other substantive rights given by bits, such as the right to fair and equitable treatment or full protection and security, to foreign investors are public rights in nature since they are assertable against the public at large including the citizens of the host nordic journal of commercial law issue 2012#2 10 state. this legal dynamic calls for balancing because it makes the investor’s rights comparable to those rights of the citizens that are present in bits, or that can be impliedly established from bit provisions (for example, the right to health, safety and the environment), or that arise from non-investment treaties concluded by host states. for the resolution of these treaty conflicts and to achieve the required balance, tribunals need to interpret investment treaties by applying the total sum of international law, including the human rights, environmental protection and development components. tribunals must take account of the factual and analytic truth of conflicting state obligations arising from investment and non-investment treaties, and use their discretion to strike a balance between conflicting rights and obligations instead of unduly favouring foreign investors. however, such balancing requires an interpretive methodology that is based on rationalisation of treaty conflicts in terms of value conflicts, where conflicting values are prioritised one over the other on the bases of collective good and universal well-being aiming at protection of the fundamental interests of the mankind. international courts and tribunals have already adopted the practice of value-based prioritising of interests arising from conflicting norms in two treaties or within one treaty. adherence to this value-based balancing and prioritising of conflicting treaties and treaty norms would develop the investor-state arbitral system as a system of collective values, and will enhance its legitimacy and integrity as a just system for rights adjudication. however, investor-state tribunals are falling short on their determination of applicable international law to resolve treaty conflicts. they are not vigilantly monitoring and taking cognisance of the conflicts existing between investment and non-investment treaties. their jurisdiction might be limited to a particular treaty and a dispute, but the limits of applicable law are set by the vclt article 31(3) (c), which prescribes the application of all relevant treaties in treaty interpretation. this is the law and interpretation method that tribunals can and must apply and follow. given the increasing normative overlap and interaction between the international investment regime and other fields of international law, such as the wto agreements and treaties relating to the protection of environment, public health, and human rights, tribunals cannot interpret and apply investment treaties in isolation. in order to achieve coherence between international investment law and the wider spectrum of public international law, this research suggests that investor-state tribunals should achieve an interpretive compatibility between investment treaties and other rules of international law. this would facilitate the “systemic integration” of international law, which is required by the vclt article 31(3) (c), and by the notions of justice to be maintained and promoted under the un charter and international law generally. as we have seen in the reasoning and interpretive approach of the romak award and the dissenting opinions in the abaclat and tokios tokelés arbitrations, in cases of incompatibility between the objects and purposes of the icsid convention and a bit, the tribunals and individual arbitrators ultimately have to choose between the collective normative framework agreed in the multilateral icsid convention and the mutual agreements manifested in bilateral investment treaties. the designation of the development-oriented icsid convention as “basic” treaty on investment protections as compared to investor-oriented bits and application of the icsid convention’s development objects and purposes when interpreting bits, are positive developments in the right direction. these developments highlight the element of public good and collective values in the investor-state arbitration system. although the romak, abaclat and tokios tokelés arbitrations involving bit-icsid incompatibility were nordic journal of commercial law issue 2012#2 11 not related to state measures directly aimed at protection of public interests, in particular fact situations, where the bit-icsid objects and purposes conflict would generate conflict between investment protection and non-economic development objectives of host states, similar value oriented interpretation, balancing or prioritisation would result in the promotion and protection of development objectives and public interests. furthermore, in sharp contrast with foreign investors’ rights and protections, states have gradually strengthened the protection of public interest in the shape of rights to health, safety and the environment of their citizens in the latest generation of concluded and proposed bits. although such provisions in future bits would not immediately affect the normative regime of several thousand existing bits, by requiring states to maintain the regulatory regime prevailing at the time of entry of foreign investment, these recent and future bits would have at least the effect of maintaining the status quo for the minimum level of protections available in domestic laws of host states for citizen’s rights to health, safety and the environment. a gradual transition from the modest recognition and conservation of these rights to a general authorisation of more abstract standards of human rights is expected in the light of increasing pressure on states to curtail the privileges granted to foreign investors that may prove detrimental to public interests. in this vein, the investor-state tribunals should also assume a positive role and develop the investor-state arbitral system that is responsive to the needs for balancing the rights and obligations of all stakeholders. there is no legal obstacle for the investor-state arbitral system to promote greater sustainability objectives and protect public interests corresponding to collective values and fundamental human rights. the rules and principles of treaty interpretation well equip tribunals with the required legal bases for the promotion of such objectives. tribunals should endeavour to bring the system to a level where it has minimum inconsistencies with the general framework of international law and has the ability to resolve tensions between the complex webs of obligations acquired by states in other regional or multilateral forums vis-à-vis investment treaties. the tribunals’ adherence to the systemic integration of treaties will bring doctrinal clarifications in the system and would help alleviate the problems posed to the system’s utility. without a pragmatic systemic reassessment, the legitimacy of the existing system will continue to be questioned. if positive steps that i have suggested in this research are not taken, the system may fail to harness both from within and also with its relationship with other systems of international law. there is a need to adopt a more balanced approach to resolve tensions between competing rights, interests and values, and prove that investor-state arbitration is a legitimate system for rights adjudication. in the context of intra-eu bits and the tfeu-bits incompatibility, investment tribunals have shown a strong tendency to reject the eu law arguments against their jurisdiction. the assumption of jurisdiction in the eastern sugar, aes and eureko arbitrations, despite the eu commission’s and the respondent states’ strong objections, reveals the willingness of tribunals to secure the foreign investor’s procedural right to international arbitration granted in the investment treaties. although the first post lisbon treaty (or tfeu) eureko tribunal made some expansive assertions to distinguish the subject matters covered by the bit and tfeu, the jurisdiction of investment tribunals over matters relating to foreign investment would remain intact for a number of parallel reasons. however, the eureko arbitration was initiated before the entry into force of the lisbon treaty and this fact gained some weight in the tribunal’s reasoning to avoid the application of lisbon treaty. future cases may be treated differently, nordic journal of commercial law issue 2012#2 12 however, there is no legal impediment if tribunals are inclined to exercise jurisdiction in the matters coming under intra-eu bits. as it is clear from the eureko award, the tribunals would ultimately apply and decide the matter in accordance with the eu law; and, if the tribunals act in line with the interpretive approach proposed by this research, there are no apparent legal hazards if the matters pertaining to eu law are decided by the arbitral tribunals. the first step for the eu commission towards blocking this jurisdiction would surely be to require its member states to terminate their intra-eu bits; although such termination, if achieved, would not eliminate the other legal bases available for arbitral tribunals to assume and exercise their jurisdiction. microsoft word satu_majamaa_lopullinen.docx nordic journal of commercial law special edition 2011 intellectual property law and human rights finding an intertwined way to promote development in developing countries by satu majamaa 1 nordic journal of commercial law special edition 2011 1 introduction the world trade organization (wto) was established in 1994.1 its member states, developing and developed countries have consequently cooperated more than 17 years on issues such as free trade, intellectual property protection and development. many of the issues that are important to developing countries, like the protection of traditional knowledge, the right to development and access to medicines, have been brought up for discussion even though the economic and social development, especially on africa’s part, has not been as fast as expected. the right to development was adopted in un’s declaration in 1986.2 in the declaration, achieving a balance between individuals, groups and states is mentioned as a vital factor in reaching a higher level of development. the international intellectual property system is facing a crisis that highlights the need for a common framework for human rights and intellectual property laws. this kind of framework should aim at defining which system protects whom; the scope of protection; and who receives protection within the framework. it should also define whether the standards that already exist are legally binding and if so, whom these standards bind. additionally, such framework should form rules that solve the currently existing conflicts between overlapping international and national laws. there is also a need for an institutional actor that would regulate the variety of different lawmaking actors that are currently active in the field, in order to reach sustainable solutions globally. this essay identifies how intellectual property law could help transform conceptions of human rights in aid, into a stronger and more sustainable development process. the second chapter examines what human rights and intellectual property protection has traditionally entailed, focusing also on the intertwined nexus between human rights and intellectual property law. the third chapter begins with presentation of the legal tools that exist, and continues to sketch development tools that could be useful within intellectual property regulation. the fourth chapter describes current problems and examines okediji’s human rights and cultural narratives that could help form more sustainable legal instruments. finally, i will draw the conclusion that although there are still many unsolved problems the development is in the hands of developing countries, and not outside their influence. 1 the agreement establishing the world trade organization, signed in marrakesh, morocco on april 15, 1994. 2 ga res. 128, un gaor, 41st sess., supp. no. 53, un doc. a/res/41/128 (1986) 186. 2 nordic journal of commercial law special edition 2011 2 traditional way of protecting human rights and intellectual property 2.1 background human rights and the public interest have been used to justify the protection of ip in relation to its economic and utilitarian purposes, since the creation of early ip systems. the human rights approach was first specifically mentioned in the context of the french revolution. the 1789 declaration of the rights of man and of the citizen talks about “property” among the “natural and imprescriptibly rights of man”. 3 human rights protection started booming after the second world war. while different human rights instruments, bodies and jurisprudence evolved, the de facto separation of human rights into categories that vary from protection of life to cultural rights was created.4 one should notice, however, that even though the rights in the field of intellectual property and human rights law have different theoretical background, their evolution was fairly similar. there were two factors that brought the intellectual property protection into human rights agenda. these concerned the cultural rights of indigenous peoples that international treaties had long neglected and the linkage between intellectual property and trade through the trips5 agreement.6 recently also regional and bilateral “trips-plus” treaties have paid attention to intellectual property protection.7 in 2000, the u.n. human rights system acknowledged the trips agreement. the u.n. subcommission on the promotion and protection of human rights adopted then resolution 2000/78 called for a human rights approach to the implementation of intellectual property rights and the development of an international intellectual property system. the resolution strongly criticized intellectual property protection claiming that “actual or potential conflicts exist between the implementation of the trips agreement and the realization of economic, social and cultural rights”9. the commission stated that conflicts existed between the transfers 3 anderson and wager 2006, p.721. 4 see meron 1982, norm making and supervision in international human rights: reflections on institutional order, 76 am. j. int'l l. 754. 5 agreement on trade-related aspects of intellectual property rights, is annex 1c of the marrakesh agreement establishing the world trade organization, signed in marrakesh, morocco on 15 april 1994, legal instrumentsresults of the uruguay round vol 31, 33 i.l.m. 1197 (1994) (trips agreement). 6 helfer 2003, pp.51-52. 7 these treaties are named “trips-plus” because they include more intellectual property protection and stricter rules than those in trips and bind developing countries to implement trips before the end of specified transition periods. see drahos 2002 p. 791. 8 u.n. econ. & soc. council [esosoc], sub-comm'n on promotion & protection. of human rights, intellectual property rights and human rights, res. 2000/7, u.n. doc. e/cn.4/sub.2/res/2000/7 (aug. 17, 2000). 9 ibid. preamble para 11. 3 nordic journal of commercial law special edition 2011 of technology to developing countries, and that there were problems regarding biopiracy and the protection of the culture of indigenous communities. this resolution did not include examination of intellectual property rights, but tried to find a balance between rights of knowledge products owners and product users. however, commission resolutions do not have legal force, so the resolution is nonbinding.10 nevertheless, the goal of the resolution was to set a new agenda based on monitoring and including an intellectual property protection system into the u.n. human rights framework and granting human rights primacy. after the adoption of the resolution, different human rights bodies in the u.n. have often addressed different intellectual property rights. for instance, access to medication in the context of pandemics such as hiv/aids, tuberculosis and malaria is addressed annually in the u.n. human rights council resolution.11 the millennium development goals were adopted in 2000 to commit nations to global partnership in order to adopt the time-bound targets given in the united nations millennium declaration.12 goals include e.g. combating hiv/aids, malaria and other diseases and eradicating extreme poverty. growing international aid, assistance and cooperation have without a doubt an important part in reaching these goals although experience shows that aid has its limitations as a development tool and that sustainable development can be achieved only if greater economic dynamism and better-functioning markets are created in the developing world.13 2.2 intellectual property protection arising from human rights even though the author’s right to his or hers intellectual production was already acknowledged in the universal declaration of human rights14 in 1948, it might be difficult to remember that intellectual creations are protected by human rights. article 27(2) of the udhr states that “everyone has the right to the protection of the moral and material interest resulting from any scientific, literary or artistic production of which he is the author”. this right is repeated also in other human rights instruments, most importantly in the international covenant on economic, social and cultural rights.15 these rights were unutilized until the resurging public 10 helfer 2007, p. 985. 11 ibid. p. 986. 12 ga res 55/2/a, united nations millennium declaration, adopted 18 september 2000, un millennium development goals 2000. 13 gervais 2004. 14 universal declaration of human rights art. 27, g.a. res. 217a (iii), u.n. gaor, u.n. doc. a/810 (dec. 10, 1948) (hereinafter udhr). 15 article 15, ga res 2200a, international covenant on economic, social and cultural rights un gaor, 21st sess, supp no 16 at 49, un doc a/6316 (1966) (entered into force 3 january 1976), (hereinafter icescr). 4 nordic journal of commercial law special edition 2011 health crisis, namely the hiv/aids pandemic in sub-saharan africa. this crisis elevated the effects of strong patent protection for pharmaceuticals and the corresponding limited opportunities for developing countries to secure access to medicines.16 since states have a responsibility to afford human rights protection, they have been traditionally accountable for human rights violations against their citizens via obligations that human rights law has imposed upon them. the doctrine of sovereignty has thus been assaulted by human rights protection, since it justifies direct intervention into state affairs, when the intervention benefits the citizens of that state. by including the requirement of oversight and international dispute settlement in the trips agreement, international economic law has also come closer to the human rights system. members of the wto can thus observe other member states intellectual property laws and provisions and intervene when necessary through filing a complaint before the dispute settlement body, i.e. the wto body that has enforcement power.17 the united nations (un) committee on economic, social, and cultural rights tried to draw a distinction between the human rights and present ip systems in its general comment on icescr article 15.1(c). according to the committee, the distinction between ip and human rights is that human rights are inherent to the human person as such, whereas affording ip rights are mainly a means by which the state seeks to provide incentives for innovation and creativity and encourage the production of innovative and creative products.18 it should be noted that the protection of iprs is also the main reason why states give effect to the fundamental rights deriving from article 15.1(c). these rights thus overlap with iprs.19 2.3 human rights protection within intellectual property regulation interestingly, the human rights framework securing the rights of creators is not specifically mentioned in the international intellectual property system. none of the multilateral treaties such as the paris20, berne21 or rome22 conventions mentions human rights protection nor is 16 okediji 2007, pp. 364-365. 17 ibid. p.358. 18 ecosoc’s general comment 63 on article 15.1(c) of the icescr, adopted 21.11.2005 by the un committee on economic, social and cultural rights, un document e/c.12/gc717. 19 anderson and wager 2006, p. 722. 20 paris convention for the protection of industrial property, mar. 20, 1883, 21 u.s.t. 1583, 828 u.n.t.s. 305 (revised july 14, 1967) (hereinafter paris convention). 21 berne convention for the protection of literary and artistic works, sept. 9, 1886, 25 u.s.t. 1341, 828 u.n.t.s. 221 (last revised july 24, 1971) (berne convention). 22 international convention for the protection of performers, producers of phonograms and broadcasting organizations, oct. 26, 1961, 496 u.n.t.s. 43 (hereinafter rome convention) 5 nordic journal of commercial law special edition 2011 that basis mentioned in the trips agreement. under these conventions, legal protection covers investors, authors and other owners’ intellectual property rights, as private rights. since the end of the nineteenth century, when intellectual property system of protection was created, regulations were adopted in international diplomatic conferences. treaty making aimed at gradually expanding the protected subject matter and scope of exclusive rights, through periodic revisions of the berne, paris and rome conventions. through the creation of the trips agreement in 1994, the international intellectual property system became bimodal, where rules were issued, discussed and negotiated separately in two intergovernmental organizations; the wto and the world intellectual property organisation (wipo).23 article 7 of the trips agreement refers to the objectives of ip protection and underlines the importance of the public interest rationale, i.e. the promotion of benefit to society as a whole. according to the article 7, “the protection and enforcement of iprs should contribute to the promotion of technological innovation and to the transfer and dissemination of technology, to the mutual advantage of producers and users of technological knowledge and in a manner conducive to social and economic welfare, and to a balance of rights and obligation”. thus, the article emphasizes the need for balance between users and producers, as well as rights and obligations. 2.4 standards for research? the idea of a human rights approach or human rights framework is not clearly articulated in the context of international intellectual property rights. another question that remains unanswered is how human rights can effectively coerce and assure development outcomes other than being the moral force that connects the two bodies of law. traditionally, the research has concentrated on how human rights and ip rights are in conflict or co-operate. okediji, however, explores what the main features of the human rights arguments designed to aid economic development are and she seeks to link these to narratives considering the welfare prospects of intellectual property law that arise within the trips agreement.24 a good starting point for the research and for finding common ground in the two bodies of law is that the normative roots are often seen as essentially the same, that is, value produced by humans is recognized through protecting the fruits of creative efforts. the concept of protecting intangible goods originates from protection of labor, which is crucial to life and living. human rights framework considers the intellectual property system as an additional part of universal 23 helfer 2007, pp. 979-981. 24 okediji 2007, p.359. 6 nordic journal of commercial law special edition 2011 values. in addition, intellectual property rights are seen to complement the human rights system.25 3 analytical tools 3.1 analysis of thetrips agreement yu has demonstrated that by analyzing trips, one can find four narratives that clarify trips negotiations. 26 understanding the objectives that were presented in the negotiations helps us understand the current situation and problems that intellectual property protection is facing globally. the first, bargain narrative views the trips agreement as a product of a compromise between developed and developing countries.27 the second, coercion or imperialistic narrative is typical for scholars who are sympathetic to developing countries and often consider the trips agreement an unfair trade instrument that developed countries forced on developing countries.28 according to the ignorance narrative developing countries are pictured as countries that did not understand the importance of intellectual property rights during trips negotiations. 29 the last, self-interest narrative suggests that the developing countries agreed to the achieved level of protection, because they thought that this kind of protection would be necessary for knowledge development.30 the self –interest narrative is interesting for this study since it concentrates on the benefits that the localized innovations create for developing nations. according to the theory, innovation i.e. creation and application of new ideas, is one of the most important factor that drive developing nations to innovate. supporters of this narrative believe that trips is vital in order to receive the rents achievable from the emerging foreign markets, and an important tool in measuring global development.31 what is more, supporters believe that trips could also be the instrument that would help emerging economies in a similar way that development occurred in developed countries gradually achieving protection of intangible property. 32 25 ibid. pp. 367-368. 26 k yu 2005, pp. 371-378. 27 ibid. p. 371. 28 ibid. p. 373. 29 ibid. p. 375. 30 ibid. p. 376. 31 alford 1995 pp. 67-68. 32 gervais 2007, pp. 11-12. 7 nordic journal of commercial law special edition 2011 3.2 human rights tools as noted above, the udhr and icescr recognize the moral and material interests of authors and inventors. these instruments enable protection of creators and innovators as well as their intellectual products. nevertheless, also the right of the public to benefit from the cultural and scientific product has been recognized within the scope of these rights. the clauses do not, however, offer normative clarity or elaborate on the terminology and leave many questions unanswered. such unclarity leaves space for governments and activists on both sides to argue for or against revising the trips agreement utilizing human rights rhetoric. this kind of debate risks also creating a legal environment in which every claim enjoys the distinctive protection attached to human rights.33 human rights regulations in relation to intellectual property are underdeveloped and many questions remain unanswered. the relationships for instance, between icescr and udhr and intellectual property clauses or the other economical, political and social rights that enjoy the human rights protection are unclear. also the intertwined system between other multilateral instruments that wipo, wto or bilateral trade and investment treaties have set out in relation to human rights and intellectual property protection is confusing.34 3.3 intellectual property and development tools intellectual property regulation does not itself lead to more innovation or creativity. when patenting could be refused for promoting innovation in pharmaceuticals this mildness resulted in low-cost and wide access to drugs.35 regulation does not increase inward of foreign direct investment (fdi) either. consequently, many developing countries have requested the developed countries to apply technology transfer, which is included in trips article 66.2. article 66.2 lays down obligations on developed member states to provide incentives to institutions and enterprises that act in their territory in order to stimulate technology transfers to least-developed member states. this would help them “to create a sound and viable technological base”. in addition, capacity building is often mentioned as a tool to reach innovations by developing countries.36 enhancing capacity building in the form of education is important for it can bring long-term success and economic growth to the society. universities can have a vital part in developing national innovation systems and innovation structures since they train scientist and technically qualified personnel. universities are, to a certain extent, a kind of laboratories, where research and development (r&d) plays a key role. 33 helfer 2007, pp. 975-976. 34 ibid. pp. 976-977. 35 roffe, spennemann and von braun, 2006, pp.10-13. 36 trips agreement art. 66.2. and art. 67. 8 nordic journal of commercial law special edition 2011 they affect innovation by interacting with society and private enterprises.37a country can send its students to foreign universities and require new knowledge in technical, administrative or scientific fields. in addition, financial means should be used in order to draw graduates back to their home country. if a country would not have, for instance patent protection, it would be difficult for it to attract technology-minded employers. 38 secondly, excellent universities should be created so that they could cooperate with foreign institutions. in the education sector, attention should also be paid to connecting creativity and computer technology rather than viewing the separately.39 it is, however, problematic, especially for least-developed countries where the patenting of pharmaceuticals causes severe problems, since they cannot afford the level of r&d required for drug innovation, which would allow them easier and cheaper access. also utilizing mechanisms for compulsory licensing or parallel importation generally causes problems, as well as, paying for the most effective patent-protected drugs.40 administrative personnel, the judiciary and politicians should be organized and trained to work successfully within the new framework. training and capacity building requires both time and money. it would be important for developing countries to attempt solving the situation themselves rather than allowing the developed nations to do so and hence loose the flexibility or the possibility inherent in making services fit their needs. when it comes to building intellectual property registration offices, wipo is providing technical knowledge regionally for instance in africa.41 if the human rights model where state is the responsible actor to implement universal norms and follow these obligations in their domestic environment would be applied to intellectual property framework that aims for helping development processes, the state would then also have an obligation to take part in innovation policies. state policies should, in any case, be aiming to support creative action and better the prospects for development by the means of technological growth and by encouraging more fdi’s in the country. fdi promotion is also important since it brings along formal or informal knowledge and technology transfer. this increases the amount of local jobs. combating corruption also plays a key role since investors try to avoid countries where it is common. as gervais has stated economic development beyond the beginning phase, does not take place without adequate intellectual property protection. the trips agreement should consequently be considered and accepted as a “given in the intellectual property policy portfolio” and defended as a good 37 abdelgafar 2006 pp. 68-69. 38 kitch 1994, p. 166. 39 gervais 2007, p. 56. 40 maskus 2011, pp. 6-7. 41 gervais 2007, p. 57. 9 nordic journal of commercial law special edition 2011 reference source for developing nations, when it comes to deciding how future development could be achieved.42 4 the road to development 4.1 the human rights narrative okediji notes that the human rights narrative has internationalized intellectual property as a norm and this narrative could and already has mandated that it is state’s responsibility to balance intellectual property rights against each other’s interests. this development can be seen for instance in the high commissioner’s report.43 such development, however, leads to problems since pure human rights protection, the right to enjoy the fruits of one´s creation, does not give the same scope of protection that the trips agreement offers. problems arise when examining the domain of literary and artistic works. since the impact of implementing the trips agreement cannot be measured in terms of human lives, like the case is for example with intellectual property rights in relation to access to medicines, the human rights narrative loses a lot of its moral appeal and political force. 44 still, since there is no other norm in the current system, it seems plausible that most nations would agree to a human rights analysis as a set of balancing principles, if such an analysis were complete enough to take in consideration all interests.45 it is the responsibility of each state to discuss development concerns that relate to intellectual property regulation. one should ask whether the level of protection of public interests, such as education and basic r&d infrastructure to support cultural industries, is sufficient and whether the passed laws adequately support the establishment and functioning creative enterprises. okediji suggest that crisis tools should be developed in order to help to create effective measurements how innovation is best stimulated in developing countries and try answer whether or how intellectual property rights can aid that process in the current global scheme. consequently, the human rights narrative must pay attention to more specific human rights guarantees and determine whether intellectual property rights as they are now and in the light of the conditions they produce, can truly be applied together with the fundamental 42 ibid. pp. 58-59. 43 intellectual property rights and human rights: report of the secretary-general, escor´, commission on human rights, sub-commission on the promotion and protection of human rights 52nd sess, provisional agenda item4, §ii.b.2, un doc e/cn.4/sub.2/2001/12, at 7 (2001), requested by sub-commission and prepared by the office of the high commission of human rights (high commissioner’s report), para 7. 44 okediji 2007, pp.369-371. 45 cahoy 2011, p.502. 10 nordic journal of commercial law special edition 2011 principles of the human rights framework. this would entail paying global and national attention to local conditions, when trying to improve social conditions. 46 4.2 cultural narratives cultural narratives have become important among intellectual property rights when protecting indigenous knowledge. they are based on the idea of self-determination and link tightly to the human rights narrative.47 indigenous knowledge is defined as “the knowledge held, evolved and passed only by indigenous peoples about their environment, plants and animals and the interaction of the two”. 48 this form of knowledge does not usually satisfy the requirements for ip protection. the benefits from the products that utilize this kind of knowledge are hardly brought back to the original knowledge holders (producers). this has lead to proposals of “benefit-sharing agreements” although narratives often oppose that intellectual property rights would be granted for indigenous knowledge.49 cultural narratives seek recognition for protecting innovations under alternative systems in developing countries. it would be important to add also non-european values into the international system. okediji criticizes the current cultural narratives of overemphasizing the cultural differences between intellectual property rights and indigenous knowledge and putting too little attention on cultural relevance of intellectual property rights to all societies and especially cultural narratives role in developed countries. the creativity has arisen from different interest and reflects great variety of values. copyright, for example is consequently reflecting cultural connections from western cultures. the cultural narratives thus accept the artificial values that constitute e.g. copyrightable subject matter and cannot rightly hereby include the interest of people in developing countries. regulations on intellectual property rights can restrict state sovereignty in the same way that human rights do if the governments are accountable for these regulations as they are under the human rights framework in international law.50 46 okediji 2007, pp.372-373. 47 “substantive issues arising in the implementation of the international covenant on economic, social and cultural rights, human rights and intellectual property” statement by the committee on economic, social and cultural rights, 14 december 2001, e/c.12/2001 13. 48 daes ”some observations and current developments on the protection of the intellectual property of indigenous peoples” (23 july 1998). 49 okediji 2007, p.374. 50 ibid. p. 375. 11 nordic journal of commercial law special edition 2011 4.3 current problems and further development the term intellectual property is still mainly associated with patents. other forms of ip such as trademarks, copyrights and design rights or trade secrets are continuously excluded from the discourse. the emphasis on patents is detrimental to considering solutions through other forms of ip rights. consequently, questions about how e.g. collective trademarks could serve rural development in emerging economies are systematically eliminated.51 most people cannot define what intellectual property means when asked, or associate it with negative adjectives, like arrogant.52 academics do research on intellectual property mainly within the context of fdi and an open market paradigm.53 while findings on the de facto impact of “stronger” ip regimes on increased trade and fdi provide various policy implications, it is surprising that none of the authors looks at ip and examines to what extent ip protection is capable of promoting indigenous innovation in developing countries.54 helfer has created three ways to approaching the human rights framework for intellectual property’s further development. these are 1) using human rights to expand intellectual property, 2) using human rights to impose external limit on intellectual property and 3) achieving human rights ends through intellectual property means.55 in the first model, those actors that rely on intellectual property in order to succeed would draw on the author’s rights and property rights when they are mentioned in human right treaties to increase existing protection.56 some visible signs of acceptance of this version of the framework already exist, since for example constitutional courts in different european countries have referred to the human rights section in their domestic constitutions in order to legitimize intellectual property protection.57 the second approach relies on external limitations on intellectual property. this kind of approach would probably face resistance. these groups can namely rely on other fundamental rights and on a framework that uses human rights law to limit intellectual property. national courts and the european court of human rights are using the right to freedom of expression for this purpose with the help of the european convention on human rights.58 court decisions rely on human rights protection and try to tackle the problems arising from 51 ghafele 2010, p.247. 52 gallup organization, “global consumer awareness, attitudes, and opinions on counterfeiting and piracy”, third global congress combating counterfeiting and piracy (geneva: wipo, january 31, 2007) 53 yeates 2002. 54 ghafele 2010, p. 248. 55 helfer 2007, p. 971. 56 helfer 2007, p. 1015. 57 see case about germany, straus 2005. 58 geiger 2004, pp. 268, 277. 12 nordic journal of commercial law special edition 2011 intellectual property protection. time will show where this approach will lead. the first two approaches, thus take the current framework of intellectual property protection, and bring in human rights law to strengthen arguments for moving that starting point in one direction or the other.59 the third option has a different starting point, since it first analyzes the minimum outcomes in terms of poverty, education or health that are required of states through human rights law. then it goes back to identify the tools that have helped states to reach these standards. helfer points out that in this framework intellectual property has only minor role. 60 nevertheless, governments should support those intellectual property laws that help improve the human rights situation, and change legislation that hinders fulfillment of human rights obligations. a report by the u.n. high commissioner for human rights clarifies this goal-focused approach by examining the impact of the trips on the right to health. according to cescr committee, the right to health means also that states have an obligation to enhance medical research and ease the access to lower-priced treatments and essential medicines. the report states that patent protection can decrease the affordability of drugs. however, affordability depends on other factors than intellectual property, “such as the level of import duties, taxes, and local market approval costs.” 61 consequently, governments can better access to patented pharmaceuticals in two ways. first, they could utilize the flexibilities that already exist in trips, such as issuing compulsory licenses to manufacturers of generic drugs and importing cheaper drugs from other countries.62 second, they could benefit from the mechanisms that could make the system affordable outside of the intellectual property system, for example through differential pricing.63 it must be noted that for instance, the protection of public health has taken different forms and depends on the time, place and current international agreements. the most startling example is the protection of medicines in the paris convention that permitted member states to reject patent protection for drug compositions when promoting competition and innovation.64 after the entry into force of the trips agreement, the pharmaceutical sector became one of the most active users of the patent system and the amount of patents applied for pharmaceutical products rose sharply.65 many of the human rights instruments consequently criticize the trips agreement, trips-plus treaties and intellectual property rights generally. according to 59 helfer 2007, pp. 1017-1018. 60 ibid. p. 1018. 61 high commissioner’s report, p 43. 62 ibid. pp 47-49. 63 helfer 2007, p. 1019. 64 roffe, spennemann and von braun 2006, pp.10-11. 65 correa, 2007 p. 1. 13 nordic journal of commercial law special edition 2011 helfer, criticism and different studies fail in many cases, however, to provide a detailed textual analysis of human rights framework for intellectual property protection. it is hardly discussed how this framework interfaces with existing intellectual property protection standards in national and international law.66 the existing conventions and agreements like the trips agreement fail to address successfully how development can take place in the current legal environment. there are many unanswered questions considering for example how to create balanced intellectual property system that takes into consideration different right-holders needs and uses the human rights doctrines in sustainable way to enable development. in addition, it is unclear whose responsibility it is to create such a policy that uses intellectual property as a development tool which regulations should also be monitored internationally. 5 conclusions many problems remain unsolved even thought the debate about the possibilities how human rights law could be reflecting to intellectual property law and vice versa is ongoing. it is important to notice the special features of the two different fields of law have to be taken into consideration especially when it comes to monitor mechanisms in the case of infringements. it is still an open question what kind of international institution that would supervise the legal proceedings would be optimal for the development. the developing countries should actively take action and create institutions and local innovation systems that would support the country’s own interests, cultural narratives, economic goals and local policies. the way to do this is with the help of the trips agreement, which includes harmonized system of mandatory rights. it is important to notice that changes in the ip framework can be done differently in the developing countries than they have been done in the developed countries. with the help of the trips agreement, states and communities can be held accountable for their claims in order to pursue development goals. by making the public also more aware of intellectual property rights and applying the trips agreement more and more, countries will have better access to technology that they need in order to reach development goals and support domestic innovations. 66 helfer 2007, p.987. 14 nordic journal of commercial law special edition 2011 references abdelgafar, the illusive trade-off: intellectual property rights, innovation systems and egypt’s pharmaceutical industry university of toronto press (2006) alford, to steal a book is an elegant offence: intellectual property law in chinese civilization stanford university press, (1995) anderson and wager, human rights, development, and the wto: the cases of intellectual property and competition policy, journal of international economic law 9(3) (2006) cahoy, breaking patents, michigan journal of international law, vol 32, spring (2011) correa, carlos m: “guidelines for the examination of pharmaceutical patents: developing a public health perspective” working paper, ictsd-unctad-who, geneva, january (2007) drahos, bits and bips: bilateralism in intellectual property, 4 j. world intellectual property law 791 (2002) daes ”some observations and current developments on the protection of the intellectual property of indigenous peoples” (23.july 1998) geiger, fundamental rights, a safeguard for the coherence of intellectual property law?, 35 int'l rev. intell. prop. & competition l (2004) ghafele, of  war  and  peace:  analyzing  the   international  discourse  on  intellectual  property   law,   intellectual  property  quarterly,  3  (2010) helfer, human rights and intellectual property: conflict or coexistence? 5 minnesota intellectual property review 47 (2003) helfer, toward a human rights framework for intellectual property, u.c. davis law review march (2007) kitch, the patent policy of developing countries 13 ucla pac basin lj (1994) meron, norm making and supervision in international human rights: reflections on institutional order, 76 am. j. int'l l. 754 (1982) okediji, the limits of development strategies at the intersection intellectual property and human rights and gervais daniel j: trips and development in daniel gervais, intellectual property, trade and development, strategies to optimize economic development in a trips-plus era. oxford university press (2007) k yu, trips and its discontents, 10 marquette intellectual property law review (2006) roffe, spennemann and von braun ,“from paris to doha” in negotiating health: intellectual property and access to medicines, london, sterling. va(2006) straus, design protection for spare parts gone in europe? proposed changes to the ec directive: the commission's mandate and its doubtful extension, 27 eur. intell. prop. rev (2005) yeates “globalization and social policy: from global neoliberal hegemony to global political pluralism” 2 global social policy bulletin 69 (2002) reports intellectual property rights and human rights: report of the secretary-general, escor’ commission on human rights, sub-commission on the promotion and protection of human rights, 52nd sess, privisional agenda item 4, §ii.b.”, un document e/cn.4/sub.2/2001/12, at 7(2001), requested by subcommission and prepared by the office of the high commission of human rights. 15 nordic journal of commercial law special edition 2011 maskus, parallel imports in pharmaceuticals, implications for prices and competition in developing countries, final report to world intellectual property organisation, (2011). available at: http://www.wipo.int/about-ip/en/studies/pdf/ssa_maskus_pi.pdf resolutions and general comments, statements ga res 2200a, international covenant on economic, social and cultural rights un gaor, 21st sess, supp no 16 at 49, un doc a/6316 (1966) (entered into force 3 january 1976). ga res 41/128, 1986 declaration on the right to development, adopted by the general assembly at its 41st session, at the 97th plenary meeting on 4 december1986. u.n. econ. & soc. council [esosoc], sub-comm'n on promotion & protection. of human rights, intellectual property rights and human rights, res. 2000/7, u.n. doc. e/cn.4/sub.2/res/2000/7 (aug. 17, 2000). ga res 55/2/a, united nations millennium declaration, adopted 18 september 2000. ecosoc’s general comment 63 on article 15.1(c) of the icescr, adopted 21.11.2005 by the un committee on economic, social and cultural rights, un document e/c.12/gc717. substantive issues arising in the implementation of the international covenant on economic, social and cultural rights, human rights and intellectual property, statement by the committee on economic, social and cultural rights, 14 december 2001, e/c.12/2001 13. gallup organization, global consumer awareness, attitudes, and opinions on counterfeiting and piracy”, third global congress combating counterfeiting and piracy (geneva: wipo, january 31, 2007) internet un millennium development goals 2000, available: http://www.un.org/millenniumgoals/ contracts, risks and management = contractual risk management nordic journal of commercial law issue 2012#1 intell ectual property licensing for the purposes of the technology transfer block exemption regulation (ttber) by mirza gogic* * master of laws at stockholm university. 1 nordic journal of commercial law issue 2012#1 1 introduction interaction between technology licensing and eu competition rules drastically changed seven years ago. before this change in approach, applying competition law rules to licensing agreements was a relatively simple matter of identifying restrictive provisions of the agreement and proofing them against a block exemption regulation. there was no need to fully understand the competition policy or mechanics of article 101 tfeu 1 . it all changed when the commission decided to modernize its approach, which ended in adoption of technology transfer block exemption regulation (ttber) and extensive guidelines related to licensing agreements. in order to give a full picture on this interaction the paper will examine in detail how and why intellectual property rights [hereinafter iprs] are being licensed, what kind of licenses exist, and what the key issues in licensing iprs are. because the focus is on block exemption regulation and the hardcore restrictions therein, only the four iprs that the ttber applies to, will be analyzed. since the vast majority of scholarship globally that cover the issues related to interaction between competition rules and intellectual property rights licensing, turn immediately to the very core of the problem (hardcore restrictions in the agreement, position of the contracting parties, reduction of dynamic efficiency etc.) there is a need for scholarship that outlines the starting point and assumptions underlying the aforementioned issues and thoroughly guides a less ip-educated reader of such materials into the area with less difficulty. one must keep in mind that the commission’s concern is aggravated regarding iprs, due to the fact that they are territorial in their nature (the content of iprs in one country is determined by the law of that country and effective only within that jurisdiction), which makes their exercise inherently restrictive of the free movement of goods in the 1 article 101 prohibits as incompatible with the internal market: all agreements between undertakings, decisions by associations of undertakings and concerted practices which may affect trade between member states and which have as their object or effect the prevention, restriction or distortion of competition within the internal market;and any such agreements or decisions prohibited pursuant to it shall be automatically void. third paragraph of article 101 exempts: — any agreement or category of agreements between undertakings, — any decision or category of decisions by associations of undertakings, — any concerted practice or category of concerted practices, which contributes to improving the production or distribution of goods or to promoting technical or economic progress, while allowing consumers a fair share of the resulting benefit, and which does not: (a) impose on the undertakings concerned restrictions which are not indispensable to the attainment of these objectives; (b) afford such undertakings the possibility of eliminating competition in respect of a substantial part of the products in question. 2 nordic journal of commercial law issue 2012#1 internal market. the inherent contradiction between free trade and ipr protection has been recognized globally. the agreement on trade related aspects of intellectual property rights (trips) 2 , which is administered by the world trade organization, sets forth minimum standards for protection of iprs for wto member states, thus leveling the playground for holders of iprs and other players on the market. 2 why license? the holder of intellectual property right is permitted to preclude third parties from using and exploiting the subject matter protected by these rights. this means that iprs are exclusionary property rights, which differ from other forms of property rights by the fact that they are intangible. the economic justification for these types of property rights that confer a legal monopoly on their holders (to exclude others from using these rights) is to resolve the problem of „free riders“. basically, if everyone were to use the invention freely, there would be no incentive to innovate. all market actors would wait for someone else to invest in invention, and then simply copy the final product, once it is placed on the market. such free-riding would create a significant blow to the free market economy, which heavily relies on innovation. another argument in favor of iprs and the legal monopoly created is that throughout the history, some sort of innovation protection system, starting from the point where the country starts do develop its own industry, seems to be required for development to take place. a striking feature of the industrial revolution is that, it is easily demonstrated that the countries with high level of protection for patents had a higher level of industrialization than the countries that refused to grant patent protection, or granted only weaker form of protection. thirdly, it is argued that protection of iprs and granting a monopoly to the inventor represents a reward for the innovator, since there is, as reward theory states, a moral responsibility for a society to reward the inventor. however, the exclusive monopolistic character of iprs is coupled with the fact that they are transferable, as well as marketable. not every inventor is able to exploit his invention economically, which requires not only inventing the process or the idea, but transforming it to the final product incorporating that idea. that is why licensing plays an important role in the free market economy, and industrial world in general. a license agreement usually takes the form of a written contractual arrangement between the holder of ipr (the licensor) and another party (the licensee), who wishes to obtain a legal permission from the licensor, either to operate within the bounds of the licensors ipr, or to exploit the licensors technological innovation which is protected by 2 see resource book on trips and development :an authoritative and practical guide to the trips agreement available at: http://iprsonline.org/unctadictsd/resourcebookindex.htm , last visited november 20, 2011. http://iprsonline.org/unctadictsd/resourcebookindex.htm 3 nordic journal of commercial law issue 2012#1 ipr. 3 simply stated, a license is a permission granted by the licensor to the licensee, to do something, that the licensor has the right otherwise to prohibit. it represents an authorization, by the owner of the ipr to the licensee to use the rights under certain conditions and limitations without the fear of being sued. still the biggest incentive for licensing ip is financial gain, since licensing creates revenue. most licenses bear royalties, either in a form of a lump sum, or as running royalties (periodic payments based on the number of sales of items incorporating ipr). even in cases where a license does not bear royalties, still it can create cost savings by means of cross-licensing (plainly, an exchange of licenses between two holders of iprs), in which case there is no need to pay cash royalty, and therefore, the license still creates income. another important incentive for licensing is penetration of new geographic and product markets. an ip owner may authorize a licensee to enter into a geographic (or product) market not currently served (or offered) by the licensor. not only does a licensor receive an income in a form of royalty payment by the licensee, but also he gets the chance to monitor the success of the licensee in the given market, and if it proves that licensee is successful, the licensor can enter the market as well. in certain cases, the right holder is only able to offer a limited product line, and there licensing provides for variety and range of choice in the market, which serves to increase the interest of the basic product. licensing has the effect of strengthening the licensed property, since the recognition by others of the validity of patent rights, as evidenced by the presence of licensees paying royalties, is deemed by the courts to be a “secondary indicia of patentability“, and the more licenses are granted, the stronger the licensed patents become. 4 now that we have seen why one should license in the first place, it is important to briefly deal with the types of different iprs that can be licensed. it is important to note that every type of ipr is eligible for licensing. however, since this paper deals with the impact of ip licensing on eu competition law and the treatment of licensing agreements in technology transfer block exemption regulation5 [hereinafter: ttber] and technology transfer guidelines 6 [hereinafter: tt guidelines] only „core“ technologies shall be dealt with in this paper. there are four core technologies according to the ttber and tt guidelines: patents, know-how, design rights and software copyright. 7 3 duncan curley, intellectual property licences and technology transfer, chandos publishing, new hampshire, 2004, at 4. 4 alexander i. poltorak and paul j.lerner, essentials of licensing intellectual property, john wiley & sons,inc, hoboken new jersey, 2004, at 3-4. 5 commission regulation (ec) no 772/2004 of 27 april 2004 on the application of article 81(3) of the treaty to categories of technology transfer agreements 6 commission notice — guidelines on the application of article 81 of the ec treaty to technology transfer agreements (2004/c 101/02) 7 article 1(1)(b) and 1(1)(h) of the ttber and para 46 of the tt guidelines 4 nordic journal of commercial law issue 2012#1 patent gives its owner the right to prevent others from producing, using, selling or importing the patented invention. it is a set of exclusive rights given to the inventor by the state in exchange for disclosing the invention. in order for the set of rights to be given to the inventor, the invention usually has to be novel, it requires the invention to be industrially applicable and the existence of inventive step is crucial. important thing about the patent is that they are national by their nature, which means that they usually only have effect in the issuing country. for the purpose of the ttber, according to the article 1(1)(h) patents means: patents, patent applications, utility models, applications for registration of utility models, designs, topographies of semiconductor products, supplementary protection certificates for medicinal products or other products for which such supplementary protection certificates may be obtained and plant breeder's certificates. know-how according to the ttber means a set of non-patented practical information, resulting from experience and testing, which is secret, substantial and identified. according to article 1(1)(h) secret means not generally known or easily accessible, substantial means significant and useful for the production of the contract products, and it is identified if described in a sufficiently comprehensive manner so as to make it possible to verify that it fulfills the criteria of secrecy and substantiality; it comprises of body of information, parts of which may be known individually, but the compilation is secret, and therefore has a competitive value. the fact that the information is not publicly available confers the competitive advantage on its possessor. for example, it may be a manufacturing process or a chemical formula, or even a business method. know-how is potentially immortal, and its life extends as long as the information is kept secret. once the information is disclosed, the know-how ceases to exist. in this area lies the most important difference between know-hows and patents: if already patented invention is rediscovered and practiced by an independent inventor, that inventor will still be an infringer of patent. if know-how is rediscovered lawfully (i.e. by reverse engineering), once it is known, the protection is lost. starting from 2004, the commission has decided to include designs to the core technology group, by defining it under the scope of patent. industrial design is a combination of applied art and applied science, whereby the aesthetics, ergonomics and usability of products may be improved for marketability and production. the role of an industrial designer is to create and execute design solutions towards problems of form, usability, physical ergonomics, marketing, brand development and sales. 8 software copyright represents an extension of copyright law to machine-readable software. software copyright is commonly used by proprietary software companies to prevent unauthorized 8 jocelyn de noblet., industrial design, a.f.a.a. , paris, 1993 5 nordic journal of commercial law issue 2012#1 copying of their software. transfers of technology frequently include software programs showing methods for production and processing. the computer software envisaged as core technology is included for the primary purpose of assisting in production of the contract products and can be contrasted with the software license that accompanies shrink wrapped software sold purely to consumer. 9 tt guidelines clearly state that the ttber only covers the licensing of other types of intellectual property such as trademarks and copyright, other than software copyright, to the extent that they are directly related to the exploitation of the licensed technology and do not constitute the primary object of the agreement. this condition ensures that agreements covering other types of intellectual property rights are only block exempted to the extent that these other intellectual property rights serve to enable the licensee to better exploit the licensed technology. when it comes to licensing iprs, legal practice differs between “the carrot“ and “the stick“ licenses. a license taken voluntarily by the party is what is commonly known as a carrot license. the owner of the ipr has attracted the licensees into taking a license by showing them the benefits to be realized by the usage of property, and the user has decided to take „the carrot“ and adapt and utilize the property. this represents an amicable way of licensing, unlike the stick licensing where the parties are „punished“ by being obliged to take a license, usually after being caught infringing other party‘s iprs. after one is caught infringing iprs, the owner of the rights can, under the threat of a legal action taken against the offender, make the infringer take the license, and of course pay the royalties for using the ipr. in case that an offender declines to take the license, the owner of the infringed property can always „beat the offender with the stick of his iprs“. it is easy to understand why stick licensing is more profitable and less difficult to accomplish. carrot licensing requires a licensor to acquaint the licensee with the ipr, its appeal and desirability. this step is already taken in stick licensing even before the parties have made contact (it is not even necessary that the owner of ipr is involved in the first step at all). no effort is required by the property owner in relation to the offender up to this point, since the offender has not only educated himself on the benefits and advantages of the property, but has already committed himself to use it. the offender has already invested in production facilities, specialized equipment is most likely purchased, and advertizing materials are prepared. this puts the infringer in a very bad negotiating position, since unless he accepts the stick license, all of his efforts done previously will be in vain. now that we have discussed two basic licensing strategies, it is important to examine the different types of licenses that exist. an exclusive license provides that the licensor shall not grant additional 9 steven d. anderman and john kallaugher, technology transfer and the new eu competition rules intellectual property licensing after modernisation, oxford university press, new york, 2006 at 295 6 nordic journal of commercial law issue 2012#1 licenses for the given territory to other parties, as well as exploit the licensed iprs himself. this basically means that the licensee will be able to exploit the license on the given territory on exclusive basis, without anyone else operating with the licensed ipr in the area covered by the license. it is commonly thought that through exclusive license all of the licensors rights apart from ownership of the ipr are transferred to the licensee. however, some licenses, known as limited exclusive licenses are only limited in certain aspects. for instance, a license may be exclusive only for a certain period of time, and then it becomes non-exclusive, or a licensor can impose certain restrictions on a licensee in regards of field of use of the given license (i.e. new patent on improved automobile transmission, which is only to be used in engines with less than 220 horsepower). the largest part of exclusive licenses are carrot licenses, since they require a potential investment and risk taking on behalf of the licensee, which makes him reluctant to make the investment, unless protected at least for a certain period of time. the cjeu has made a distinction between different types of exclusive licenses in nungesser (maize seeds) case 10 . inra (french national institute for agricultural research) developed new strains of hybrid maize seed, and later gave nungesser kg the exclusive right to produce and distribute varieties of the seed in germany, agreeing not to import the seed in germany itself, and to prevent others from doing so. nungesser kg used such rights to stop parallel import of seed in germany from another source in france, and one importer complained to the commission, which found that exclusivity and territorial protection were caught under article [101(1)], so nungesser kg appealed to the court of justice. the court distinguished between an open exclusive license, which relates only to the relationship between the licensor and the licensee, whereby the licensor agrees not to grant any further licenses on that territory and not to operate there itself, and on the other hand, closed exclusive license that contains provisions which affect third parties and create absolute territorial protection. non-exclusive license exists where the licensor remains free to grant other licenses for the territory assigned to the initial licensee, or if it wishes so, can exploit the ipr in that territory itself. a sole license is the license where the licensor agrees not to license other licenses on the territory reserved for the licensee, but remains free himself to exploit the given area. the iprs can therefore be exploited by the licensor, licensee and no-one else. as expected, most of the licensees would like to have a monopoly in the licensed ipr, and would pay extra to obtain it. the result of this is that the exclusive license will require a higher price of the same licensed property than the non-exclusive one. this higher price, doesn‘t mean that the licensor will always strive to grant the exclusive license, since it only includes a single royalty (even if it is a 10 l.c. nungesser kg and kurt eisele v commission of the european communities. case 258/78. european court reports 1982 page 02015 at para 53 7 nordic journal of commercial law issue 2012#1 running-royalty) while with the ipr licensed to more than one licensee on a nonexclusive basis, gives the licensor more than one source of income. it seems at first that the licensor is faced with the trade-off between the higher income secured through the exclusive license, and a number of lower payouts secured through the number of non-exclusive licenses for the same property. however, this is a simplified way of looking at things since the licensor is in fact, while granting an exclusive license, putting all his eggs in one basket. if the exclusive licensee breaches the contract, faces bankruptcy or any other interruption of his business occurs, the licensor is faced with the loss of the income deriving from the exclusive license. now that we now basic principles and definitions required to better understand the process and motives for licensing, it is time to turn to the licensing agreements in more detail. since this paper will deal only with the core technologies according to the ttber and tt guidelines, patent (as well as design rights categorized as patents in the ttber) know-how and software copyright licenses only, shall be dealt with in detail. 3 patent license while drafting a patent license, a draftsperson in charge will at least have to give three basic definitions: licensed patents, licensed territory and licensed products. of course, depending on the circumstances, more than these 3 basic definitions can be included, but without these, the license would be obsolete. licensed patents are those patents which are subject to the license. a license can be composed of one or more patents. in addition to the patents enumerated in the definition, it is common to include the phrase „and any continuations, divisions and reissues thereof“, which is intended to make sure that any further patents arising out of the patent application that mature into the enumerated patent are included in the license, along with any patents resulting from the correction of any enumerated patent (reissues). licensed products are products that may be produced, used and sold by the licensee under the terms of license. on one hand, the licensed product can include all products covered by one or more claims of the licensed patent(s). situations where the licensee discards that the product is covered by the licensed patent claims (and by doing so, avoids paying the royalties), can easily be avoided by including a list of products (when known) with the words „including but not limited to the following products“ in the contract. on the other hand, the licensed product can comprise only of a single specified product. after discussing what is licensed and how it may be used, the third crucial point is defining where it may be used. territory may be defined quite broadly, for instance eu wide, or in the territory of a several countries, but also it can be defined narrowly, like for instance, a single location, such as licensee‘s business premises (in which case an address is included). 11 11 see poltorak and lerner supra note 3. at 54-56 8 nordic journal of commercial law issue 2012#1 it is important to note that the rights secured by the patent need not be licensed altogether, since the licensor can allow a licensee to produce the patented invention and use it himself, but not to sell it. contract law plays an important role in this aspect of license agreements, since in countries whose legal systems accept the concept of “implied license”, these kind of clauses are de facto limited by the courts. if for instance, a licensee could obtain a license to produce the goods, but not to use or sell them, in case that this license would end up in court litigation (and it most certainly would), the court would include in the license at least a right to sell the product (if it could be implied that the licensee is in business of manufacturing and selling similar type of products, and that was the purpose of entering in the agreement in the first place). one important privilege of exclusive licenses is the fact that the licensee gets locus standi to sue against infringements of the licensed property. thus, this feature of exclusive licenses should be borne in mind when drafting the contract and granting rights to the licensee. the other privilege that can be granted to the licensee is permission to sublicense, which is a privilege that has to be tightly controlled. another very important part of licensing agreements are patent marking provisions. in order for the patentee to claim damages from an infringer, the infringer has to be notified of the ongoing infringement. once notified, the damages accrue from the date of the notice. notice can be actual (i.e. letter from the patentee, in which it states that the patent covers the products, and of course identifies the patent), or constructive. constructive notice consists of labeling the patented product with the patent number. if there is no patent number, and the product is commercialized, damages in respect of the infringement begin to accrue only when the infringer is placed on actual notice. this labeling requirement also applies to the licensee, since his failure to do so has the same effect as the failure to mark the product by the patentee. this is the main reason why most of the patent licensing contracts also have a clause related to patent marking. since the licensee is paying for the usage of the patent, in case of an infringement, he will ask the licensor to make certain actions in order to stop the free-rider issues. two of the most likely ways to do so are to stick license the infringer (which is in case of an exclusive or sole license a problem for the licensor, since it will have problems licensing the second licensee for the territory already exclusively assigned to the first licensee) or to enforce a patent against an infringer. „[according] to the 2003 report of economic survey published by the american intellectual property lawyers association, the average cost of patent litigation is $2m, trademark litigation is $600k, and other types of ip litigation average between $500k and $800k.“ 12 since the costs of a patent litigation are so high, in situations where the infringement act is a de minimis act, it would not be economically 12 william j. ‘bill’ robinson, ip litigation strategies: patents: markman hearings part 2, foley & lardner llp, los angeles, ca, findlaw, september 30, 2003 9 nordic journal of commercial law issue 2012#1 beneficial for the licensor to start a patent litigation procedure. for such reasons, it is common in a patent license that a licensor abstains from granting a licensee the right to decide when an infringement action will be started. this goes against the licensee‘s interests, since the payment of royalties is entitling him to freedom without an unlicensed competition, which thus makes it the obligation for the licensor to sue immediately after the infringement is being known. as a mean of motivating the licensor to sue promptly, a contract can stipulate that no royalties will accrue while the infringement continues. in order to sue the infringer only the licensor has the standing (or in a case of an exclusive license, the licensee can sue as well). in non-exclusive licenses the licensees can only join the patentee as claimants. a potential licensee will almost always demand the warrant that the patent(s) in question are valid and enforceable, and that the use (sale, production and everything else that has been agreed upon for the licensed patent) of protected property right will not infringe the rights of a third party. in the practice of patent licensing, it is known that sometimes licensees seek to include in contract a warranty that the licensed patent will not infringe any of the third parties rights. such thing is in most cases a tremendous burden for the licensor, since it is virtually impossible to be certain of the validity of the patent. the second warranty includes not only domestic patents, but foreign patents and previous publications and public activities, all of which are most likely unknown to the licensor, most of the patentees can only offer a representation that they are unaware of the prior art in the present time. the licensee can even go further by demanding a warranty that the licensor has no other patent which could be potentially infringed under by licensee actions according to the license, and this demand, unlike the previous one is most likely to be met by the licensor. if a patentee would attempt to license a patent beyond its term, it would clearly represent an abuse of patent, and attempts like that are capable of rendering the patent unenforceable. of course any shorter period would be allowed. in most patent licenses the term is set to the expiration of the patent, and in cases where there are multiple patents merged in a single license, the term is set to the expiration of the last patent to expire. this can be quite different in cases of exclusive licenses (where the licensor has transferred on a licensee the right to sue the infringers of a patent) where the term can be set even after expiration of patent, to allow the licensee to finish the litigation he already started. in such cases, it is important to mention that the royalties stop to accrue upon the expiration of the patent. it is possible that the patent license is terminated before the end of its term. this situation arises when one of the parties has breached the license agreement materially and has failed to cure the breach on time (after a notice by the party that did not breach the agreement). what happens in situations that arise out of the breach of contract can be agreed upon in the „termination“ part of the agreement. provisions typically found in „termination“ part of the agreement are those 10 nordic journal of commercial law issue 2012#1 pertaining to the disposal of any inventory of licensed product on hand when the license is terminated. most commonly, the licensee is allowed to sell any such inventory, complete any work in process, and fill any existing contracts, subject to the obligation to pay the appropriate royalty. 13 the overturning of patents is not uncommon, because patent-issuing offices lack the resources to thoroughly examine every patent application and therefore rely on private-party court challenges for an in-depth examination of important, but questionable patents that are issued. commercially significant patents are often declared invalid or restricted in important ways. a typical source of invalidity is the existence of prior art that causes the patent to fail the novelty requirement. thus, patents do not always grant secure property rights to the patent holders. 14 what effect has this situation on the license? it basically depends on whether the license is to a single patent or to a multiple number of patents. in a single patent license, the invalidity or unenforceability of the patent would result in termination of the license, which would relieve the licensee from paying the royalty. in a multiple patent license however, where the invalidity of the patent affects less than all the patents licensed, the answer is not so simple. the license itself is usually not terminated (unless explicitly stated so in the termination clause of the agreement), but it continues to remain in force concerning the still valid patents. this complicates the question of royalties, especially if running royalties were agreed upon. there is a possibility that they remain the same, or that they are reduced, and for such reasons, the invalidity or unenforceability clause is usually part of the agreement, the absence of which always leads to a litigation. finally, every decently drafted patent licensing agreement will address the issue of improvements. a licensee may request that any improvement made by the patentee on the patent in question is included in the license. usually, these requests are nothing uncommon in patent licensing, but they also frequently contribute to a raise in the royalty rate. even though economically, it makes perfect sense that the licensee (in the case of sole or non-exclusive license) should be able to compete with the licensor or other licensees in situations where additional improvements are made, licensors are sometimes reluctant to grant these improvements for free. this is usually the case in paid-up licenses, where a lump sum is paid up in front, and no running-royalties are included. on the other end of the rope is the situation where the licensee makes certain improvements on the licensed property (all of which, of course, he is free to use). in most of those situations, the licensors were eager to ask for the licensees to assign any of those improvements back to them. since such grantback clauses in a number of cases contravene competition law, licensors are now merely stipulating for a non-exclusive license of any such improvements. 13 poltorak and lerner supra note 3. at 63 14 james j.anton and dennis a.yao, patents, invalidity, and the strategic transmission of enabling information, journal of economics & management strategy, jun2003, vol. 12 issue 2, at 154 11 nordic journal of commercial law issue 2012#1 4 computer software license the licensing of software is different from licensing any other form of intellectual property rights, because it encompasses not only the underlying technology but the program or "the product." 15 the specificity of software which makes it different from other forms of iprs that are being licensed, is that it is sold directly to the user, rather than being licensed. another issue regarding the software license is that these kinds of licenses are rarely negotiated (but are rather in a form of a shrink-wrap contract). in case that there is an opportunity to negotiate a contract for a software license, four issues are paramount: the scope of use, performance guarantees, termination provisions, and indemnification. 16 the basic purpose of a software license is to increase the sales of the computer software in question. the problematic nature of software is that as a product, it is intangible, which basically means that after only one copy has been obtained, the user can merely give the software to someone else, multiply it, or rent it to others. this is the reason why the scope of the computer software license is highly specific when it comes to the intended use, the place of use, and most importantly, number of users. if the license allows the software to be installed on the computer network, usually the number of network users is specified (the royalty rate depends on this number). as mentioned before, the computer software that is considered a technology transfer for the purposes of the ttber is used for production and processing, which makes the licensee‘s business depending on it. it is the attitude of the commission that the ttber applies only to agreements between two undertakings concerning the licensing of technology for the purpose of the production of contract products. this is particularly important is software licensing, since only those types of computer software licenses that are related the production of specific products can benefit from the block exemption. in case of an unexpected loss of the license, the licensee would find himself in serious problems. that is the reason why many licenses include termination provisions, which provide for a grace period, during which they can find an alternative for the software previously used, and in exchange licensors usually demand audit provisions which could help the detection of any violation of the license restrictions, and also quite usually severe damages are stipulated. it is easy to understand how and why is the software indispensable for the operation of the licensee‘s business, and the failure of the software could have detrimental effect on the licensee. when negotiating the license, licensors do their best to limit their responsibility and exposure to such events. since most likely the disclaimer of all damages could not be negotiated (or enforced by 15 see david a. rice, licensing the use of computer program copies and the copyright act first sale doctrine, 1990, 30 jurimetrics j. 157, at 166-72 (discussing how the inapposite nature of software licensing differs from other established forms of copyright-related licensing) 16 poltorak and lerner supra note 3. at 92 12 nordic journal of commercial law issue 2012#1 almost any court in the world), the next best thing the licensors usually do, is try to exclude consequential damages and limit a licensee‘s recovery to the amount paid in royalties or license fees. frequently, the licensors will try to limit their responsibility to the performance of the licensed software, by disclaiming any warranties that is fit for any particular purpose. in case these warranties are disclaimed, the computer software only needs to be one of „merchantable quality“ (which means that it only needs not to be a piece of rubbish). this is the reason why licensees of customized software (software adapted for special purposes) should be particularly careful to these warranty provisions, and if possible try to ensure that the license specifies the performance criteria for the licensed software, and that the licensor warrants that the software will meet these criteria. 17 in case that the licensed software is invalid, remedies usually agreed upon are that a licensor will provide a license from a third party at no cost, or that a licensor will provide substitute software free of any such infringement claims that occurred related to the original software, and finally, a licensor can return the license fees. lastly, when it comes to backup copies of the software, unlike the purchase of the copyrighted computer program, the licensee is usually not allowed to make such copies unless it is agreed upon in the license. 5 know-how license as explained above, know-how can be defined to include tangible materials as recipes, formulae, designs, drawings, patterns, blueprints, technical records, specifications, lists of materials, technical products and process manuals, written instructions for operating the process and analytical means for checking and controlling the product and process. it can also include intangible information consisting of practical procedures, details of workshop practice, technical training or personal visitation and inspection. it may additionally include information relating to the patented invention not included in a patent specification, inventions capable of being patented but not patented (yet), inventions incapable of being patented in a certain country because the patent law of the country excludes that subject matter, inventions incapable of being patented because of lack of inventive height, industrial designs not patented because of the reasons mentioned above, skills, experience and craftsmanship of the technicians. 18 the difficulty with licensing know-how stems in large from the delicacy and the brittleness of its existence, since it is the secrecy and not the underlying of information that creates its values. with the loss of that secrecy, the value is lost as well. the implications it has on the license, and even more on the licensor is that the licensee will not cease to use the property, he just won‘t be obliged to pay for that usage any longer. just as explained above, unlike the patent license, where the licensed 17 see poltorak and lerner supra note 3. at 93 18 hale a. newcomer, legal protection and licensing of 'know-how' internationally, 1970, american business law journal, vol. 7 issue 3, at 228 13 nordic journal of commercial law issue 2012#1 property is closely defined, know-how usually takes the form of a large collection of related materials. it is up for the licensee to see that it got sufficient disclosure and assistance to enable it to utilize the licensed property properly and effectively. it may wish to require the disclosure and level of assistance which will enable him to effectively utilize the licensed know-how. such definition will usually contain an open-ended commitment on the part of the licensor and a warranty that a licensee will be able to effectively utilize the licensed property. 19 when negotiating the level of help and assistance, the licensor may wish to limit the amount he will provide, or to require certain payment for assistance beyond a specified level. while patents only have the effect in the issuing country, know-how is worldwide effective, which makes the potential scope (geographic) of the license worldwide. another crucial difference between patents and know-hows is that the patents have a limited term, while know-how is potentially unlimited, which makes the term of such licenses also potentially unlimited (the term can also be defined as a fixed period as well). the importance of termination provisions needs not to be emphasized. what happens if the licensed property becomes publicly available? as seen above, the licensee will not be obliged to pay the royalty fee, and will be free to use the know-how which has ceased to be valid (since „the genie is out of the bottle“, the know-how is obsolete). that is why, the termination clause providing for the termination of the license in such cases has the effect of licensee not being obliged to pay for something that has just become freely available to everyone else, and should by all means insist on having this provision in his agreement. in case the licensee does a rather sloppy job of not insisting on it, it will have to pay for such information until the license expires. without a doubt, the most valuable part of know-how is maintenance of secrecy, which makes the provisions headed towards the preservation of confidentiality the crucial part of the license. it makes sense that the least licensee can do, is treat the licensed property as bonus pater familias. in an ideal world, the know-how information should be limited to those who „need to know“, and all such individuals should execute the agreement acknowledging the confidential nature of the information. it would be best if the parties to the agreement would acknowledge that the confidential information is critical, and that any disclosure (unauthorized or unintended) would cause irreparable harm, that the loss engendered by such disclosure could not be adequately compensable in money, and that the parties thereof stipulate to the prompt entry of preliminary and permanent injunctions barring such disclosure, in addition to such other remedies as may be appropriate. 20 another very important aspect of licensing know-how is concerned with the licensee as an individual. after a licensor has agreed to license his secret know-how to a certain licensee, usually after he is certain that the licensee is fit to keep the secret, it would be quite dangerous if that licensee could sublicense the know-how to a third party, of which the licensor knows nothing of (and which might even be the closest competitor of the licensor in the worst case scenario). in order to avoid such scenarios, 19 see poltorak and lerner supra note 3. at 70 20 see poltorak and lerner supra note 3. at 73 14 nordic journal of commercial law issue 2012#1 it is advised to include a provision in the license, which forbids the licensee any assignment of the know-how. the least a licensor should agree to is that any assignment of the licensed know-how is conditional on his written approval. termination of a license in the event that the secret information becomes publicly known has already been discussed, but another issue closely related to it still needs to be mentioned. if the information is publicly known, and the know-how is usually a compilation of knowledge already known to the public, the licensee already acquainted with the information may attempt to reconstruct it from publicly known and available sources. every licensee would have the incentive to do so, and since already familiarized with the information, he would certainly have higher chances of success. in order to prevent such events, the usual thing to do, is to define the „publicly known“ term in the licensing agreement as „from a single source“. this basically means that unless the licensed property is found in one single source, it is not publicly known. as in any other licensing agreements, the licensee may demand warranties that the licensed property will not infringe third parties rights, which in the case of know-how seems to be a bit harsh, and that is why the usual thing to do is to seek warranty that the licensor has the right and authority to grant the license, and that the grant will not constitute a violation of any agreement between the licensor and a third party. of course, just as in the case of patent licenses, where the licensees may wish to include all the improvements made subsequently, such demands are also usually made by the licensees of know-how. 6 royalties after discussing the types of ip licenses and what is specific for every individual kind of license, the question that is usually considered first, and in almost every case longest, are royalties and royalty rates. not only are the parties agreeing on how much money should be paid to the licensor for licensing his iprs, but in which form should he receive this compensation is also a hot issue. 6.1 paid-up license paid-up license is a kind of license where the royalty is a fixed sum of money. depending on what is agreed, it can be paid over a period of time (usually the schedule of payments has been agreed) or can be paid as a lump sum. peculiarity of this type of royalty payment is that, once it is agreed, it is not dependant on the success of the license. sales made by the licensee can go sky high or can be practically nil, but still the royalty is a fixed sum agreed upon by the parties. since this kind of payment method is a two-edged sword, both for the licensor and the licensee, it is most commonly used in situations where future sales are relatively easily predictable. and because it gets harder to predict future sales the longer the forecast period is, paid-up licenses are being used where the license term is short (or where the licensed property will expire shortly). paid-up licenses are preferred not only by larger companies which try to avoid the difficulties with accounting the sales of 15 nordic journal of commercial law issue 2012#1 licensed products (which is a trait of running royalty licenses) but also by small licensors which often have only one patent (or any other kind of ipr). in a case where such ipr is for one reason or another found invalid or unenforceable, the licensor is left without income if the running royalty license is agreed upon. generally, paid-up license in situations like this, once paid is nonrefundable (unless explicitly agreed differently). 6.2 running royalty license running royalty license is, unlike the paid-up license, based on actual sales. if a licensee needs to pay for the license a percentage from actual sales of licensed product(s), than the need to forecast the sales, or the success of the license is out of the equation. this kind of royalty payment is preferred by the licensee with cash flow problems, and most likely it will be used where the license concerns the production and sales of consumer products (not industrial), since most of the economists agree that this allows the licensees to transfer part of the cost for the license to the consumers (by raising end price of the final product). basically, the royalty rate is determined in a way that it reflects the benefits the licensee enjoys because of the license. usually, the royalty is set within the range of ¼ to ½ of the expected benefit or net profit of the license. for instance, in situations where the licensee expects a net profit of 8% of the sales price, the royalty rate would be 2% (8% x 0.25). there is a number of factors which are taken into consideration when negotiating the royalty rate. typically in a process of haggling, the licensor will point out the costs required to create the licensed ipr, and on the other hand, a licensee will point out the costs needed for investments made in order to make any profit. a higher royalty could be justified in situations where the use of licensed ipr will most likely boost the sales of other products (or services) of the licensee. of course, the significance of licensed property as the component of the product (or service) it is incorporated in is also an important factor. the position of the property in the product market is one of the determining factors of royalty rate. if the product incorporating the licensed property has no close substitutes or the substitutes are rather costly, than the royalty rate can be high. the very strength of ipr must be included into equation when discussing the royalty rate. they are usually higher for patents and trademarks, than for know-hows, primarily because it is easier to enforce these rights, and another important element related to ipr is how easily can these rights be circumvented. when situations occur, in which it is possible to compare royalty rates for a certain property between independent licensees, than there might be an „industrial standard royalty rate“. one, or both of the parties may seek the royalty rate (higher or lower, depending on the party in question) by comparing the rate to the previously granted licenses. the degree of exclusivity of rights granted also has a 16 nordic journal of commercial law issue 2012#1 bearing on the designation of the royalty rates. an exclusive license clearly has a higher royalty level, than a sole or non-exclusive one. the difference in value will depend also on the market sector concerned, as well as the relative strengths of other licensees. 21 as it can be seen from the factors relevant in determination of a royalty rate, the most basic principle entrenched in the core of royalty rate determination is risk and price balancing. every licensee will seek to minimize the risk of projects that they are investing into (but if the reward will be substantial, most of the investors are willing to take bigger risks), so they will seek out the license for a more certain property. the greater the perceived risk associated with a new technology, greater the reluctance to invest substantial resources to acquire and commercialize it, and as a result, the lower the price the technology will be able to command. once the relationship between the price and the risk is recognized, the solution becomes obvious: reduce the risk associated with a technology, and the price it commands will increase. 22 most of the experts in the area of licensing agreements and negotiations related thereto agree that the best strategy a licensor can do, is to offer not only ipr, but whenever possible a proven product (or service) related thereto. the licensee will be willing to pay more for a packet-ready technology. another thing that is gladly suggested is to license not only a single ipr but a sort of a package deal, wherever possible, so that for example, the license includes not only a patent, but also applicable trademark, blueprints, market research data, list of qualified suppliers and everything else that could help commercializing the patented technology. this information is important for the buyer, since it reduces the risk of failure, which as stated before, keeps the position of the licensor in royalty rate negotiations high. 7 enforcement and supervision of a license a rather common miscomprehension is that once the license is executed, no more work needs to be done. however, after it is executed, the license needs to be supervised, firstly in the aspect of royalties: is the licensee paying the royalties on time prescribed under the agreement? basically, this question simplifies the situation since it contains three different issues. primarily, has the licensee made the payments on time, as prescribed in the agreement? then, were all the payments made by the licensee received by the licensor? and finally, are all the sales being reported? one might be surprised that quite often „it slips from the licensee‘s mind“ to make the scheduled payment. it is up for the licensor to remind the licensee in writing that the payment is overdue, and in order to do so, the licensee needs to actually know when the license payment is due. not 21http://www.medius-associates.com/public_downloads/articles/royalty_rates_current_issues_and_trends.pdf, last visited august 21, 2011 22 poltorak and lerner supra note 3. at 107 17 nordic journal of commercial law issue 2012#1 surprisingly, licensees sometimes fail to report all of their sales, so the first step the licensors make is comparing the payment with the previous payments made, or the payments from other licensees. if the licensor, during the contemplation of the license finds certain anomalies, or finds any reason to be suspicious, than possibly the licensee has failed to report all of its sales. it is easier to monitor a licensee which is a public company, since the company law of many countries allows at least some kind of information to be disclosed to a licensor regarding the communication between the licensee and its shareholders (through which the licensor can find more information about the sales). also other sources can be indicative, such as licensees’ web site (it is hard to claim that the business is not doing good if the web site shows that the licensee is expanding its business), press releases, annual reports and so on. another common thing a number of licensees do is not reporting sales of new products or new models of old products (this occurs usually after a certain period of time elapses since the license agreement is made). this is why the web site of the licensee is always a good starting point for the licensor to monitor the product catalogue of the licensee, in case some new products „magically“ appear. most license agreements usually include a provision which allows a licensor to audit books of a licensee (only to extent of verifying the accuracy of information the licensee is providing). since audits are expensive, they are not taken so easily, but often a threat of an audit is enough to achieve the desired result. finally, the licensor should (in case a territory has been allocated to the licensee) monitor if the licensee is selling outside the designated geographic area (a question that raises many competition law concerns). if the license includes limitations on the product (power, capacity, size) the licensor should make sure that none of the products sold fall in the proscribed areas. 8 conclusion as it can be seen from this paper, intellectual property rights are crucial for free market economy, which relies heavily on innovation. without encouraging the innovation by giving the award for an innovator in the form of legal monopoly, there would simply be no progress made, and the commission is placing special emphasis on dynamic efficiency when enforcing its competition policy. since not every inventor is able to materialize the invention, and iprs are transferable and marketable as well, the most common thing to do is to license them to someone that is able to fully exploit them. not only does the inventor use iprs to directly create income, but it is also common to cross-license another holder of similar rights, or even grant a license in order to penetrate and test unexplored markets. the article discussed core technologies that can be licensed: patents, know-how and software copyright, with strongest emphasis on peculiarities of patent licensing agreements, since it is the most frequently used type of ipr that can invoke competition policy concerns, but still know-how and software licensing are dealt with in detail. after covering specific types of agreements, general overview of royalties and license enforcement is given, the reader is (hopefully) given a full picture on how licensing works in real life. even though the deadline for adopting new ttber is april 30th 18 nordic journal of commercial law issue 2012#1 2014 and some changes are expected to be made, this article will remain compatible with the next technology transfer toolbox, and serve as a effective and practical introduction in order to better understand the interaction between iprs and competition rules. microsoft word shoarian_rahimi_final.doc nordic journal of commercial law issue 2014#1 sanctions and their effects on contractual obligations: from the perspective of international instruments and iranian law by ebrahim shoarian* and farshad rahimi** 1 *1 phd in private law, associate professor, department of law, faculty of law and social sciences, university of tabriz, e_shoarian@tabrizu.ac.ir; also an adjunct professor in tehran university (international aras campus) and arbitrator of iccima arbitration center. the authors would like to express their thanks to dr. katja lindroos for her valuable comments and suggestions. ** research assistant in international business law, department of law, university of tabriz, farshadrahimi1990@gmail.com nordic journal of commercial law issue 2014#1 1 abstract according to the principles of pacta sunt servanda the contract should remain intact as far as possible. nevertheless, it is highly likely that the parties might be unable to live up to their obligations on ground of occurrence of some unpredictable events. traditionally, such phenomena may range from war, an earthquake, or a strike to tornadoes. sanctions or embargoes are new instances of such phenomena that may make contract performance either impossible or extensively onerous. these sanctions involve different legal consequences besides economic, political and social effects. nonetheless, it should be noted that the main subject of the present article is only confined to examine the effects of sanctions on contractual obligations from the perspective of significant international instruments like upicc, pecl, the cisg and the iranian national law. in this respect, we have focused on some important legal concepts like force majeure and hardship and their relationships with the imposition of sanctions. in so doing, after a brief overview of different kinds of sanctions from different perspectives, we have concentrated on correlation with the above institutional norms and its effects on contractual obligations. in the end, we address the available remedies arising out of sanctions impositions. key words sanctions, effects, contractual obligations, international instruments, the iranian law nordic journal of commercial law issue 2014#1 2 1 introduction it is suggested that “sanctions” and “embargoes” refer to governmental and international actions that distort free flow of trade in goods, services, or ideas for decidedly adversarial and political rather than economic purposes. over time, sanctions and embargoes have become a principal tool of foreign policy.1 these sanctions and embargoes involve different legal consequences besides economic, political and social effects. however, the main subject matter of the present article is only confined to examine the effects of sanctions on contractual obligations from the perspective of iranian national law and some other significant international instruments like upicc2, pecl3 and the cisg4. it should also be noted that the subject of this article is not the contracts which have been prohibited by sanctions rather those contracts which their performance have turned out to be onerous or impossible as a result of sanctions. so, to carry out this comparative study, after a brief glance at the category of sanctions and embargoes and their different impacts, the subject of possibility of excusing the non-performing party due to sanctions and embargoes will be examined. to do this, we will focus on the subject from the view point of iranian national law and said international instruments considering that these phenomena can influence both national and international contracts. it deserves noting that the reason behind addressing the iranian civil code lies in the fact that iran has been targeted by sanctions extensively in recent times and as a result, iranian traders have difficulty doing business and living up to their contractual obligations. this requires us to examine the correlation between sanctions and some relevant legal concepts namely hardship and force majeure. finally, we will address effects resulting from these phenomena. 2 general overview of sanctions and embargoes and their different impacts in one classification and from the viewpoint of source of imposition, sanctions can be divided into three categories, that is, sanctions imposed by un, by the eu and sanctions imposed by countries individually.5 furthermore and from the perspective of their purposes, sanctions can also be split into economic and political embargoes and sanctions that are imposed for the sake 1 michael r. czinkota and ilkka a. ronkainen and michael h. moffett, fundamentals of international business, 76 (wessex pub 2d ed. 2009). 2 unidroit principles of international commercial contracts 3 principle of european contract law 4 united nations convention on contracts for the international sale of goods 5 farshad shamgholi, sanctions against iran and their effects on the global shipping industry, 1-25 (spring 2012), available at: http://lup.lub.lu.se/luur/download?func=downloadfile&recordoid=2520391&fileoid=3046709. nordic journal of commercial law issue 2014#1 3 of safety and health.6 these sanctions regardless of their types can affect different kinds of contracts. some of them like bank sanctions and oil embargoes involve economic and legal effects that, among others, cause the inflation rate to rise and the obligor not to meet his contractual obligations. in some other cases, sanctions have to do with peoples moral and human rights. in these cases, non-performance of contract can lead to non-pecuniary damages.7 nonetheless, as mentioned above the main objective of the present article is to examine effects of imposition of sanctions and embargoes on contractual obligations under iranian national law and the above-mentioned international instruments. 3 the relationship between sanction, force majeure and hardship 3.1 contract law starting points it is firmly acknowledged that the principle of pacta sunt servanda is a generally accepted principle in all legal systems. the contracts must stay intact as far as possible. this is because avoidance or termination of contract, among other things, can give rise to additional costs that are not acceptable from the standpoint of economic analysis. this is specifically the case in relation to international sales contracts since in most cases, goods are transferred from country to country, and the expenditures of restitution of goods can trigger unintended difficulties in the case of termination of the contract. nevertheless, in some cases, unexpected changes in the circumstances come into existence that makes contract performance impossible, or excessively difficult. examples of these events can be earthquakes, wars, floods, and hurricanes and the like. sanctions and embargoes are among recent examples of such phenomena that may make contract performance, depended on circumstances, impossible or burdensome. for these reasons, all national legal systems have recognized some rules to deal with these kinds of problems. the two major legal concepts dealing with the problem of changed circumstances are those of force majeure and hardship. as a result, it is necessary to examine the effects of sanctions on contractual obligations having the two mentioned concepts in mind. this is 6 nico j schrijver, the use of economic sanctions by the u.n security council: an international law perspective, in harry h.g. post (ed), international economic law and armed conflict, 125 (martinus nijhoff pub 1994). 7 for examples of such effects see: michéle barry, effect of the u.s. embargo and economic decline on health in cuba, 151-153 (18 january 2000· annals of internal medicine· volume 132· number 2), karine morin and steven h. miles, the health effects of economic sanctions and embargoes: the role of health professionals, 159-160 (18 january 2000· annals of internal medicine· volume 132). nordic journal of commercial law issue 2014#1 4 because conditions and effects of two legal concepts are not the same.8 however, since responses to the problem of change of circumstances differ considerably from one legal system to another this section of article has limited its scope to examine the iranian civil law and some other important instruments like pecl, the cisg, and upicc. nevertheless, before delving into the position of the iranian civil code and mentioned instruments it would be of help to give some perspective concerning these legal concepts to have a better understanding of effects of sanctions on contractual obligations. 3.2 definitions of force majeure and hardship there is no authoritative definition for the concept of force majeure. the approach of national legislation with respect to force majeure varies considerably from country to country.9 nevertheless, the term may be used as a general term referring to some kind of events that serve as a basis for an exemption from liability; therefore, certain general characteristics of the concept of force majeure can be determined. these conditions are where (i) the event is of an external nature, (ii) it could not be foreseen or prevented and (iii) it renders performance of a contractual obligation impossible at all or for a certain time.10 the concept of hardship also does not exist in all legal systems, and even, in those systems in which the concept has taken roots, its conditions and effects are not the same, so coming up with a comprehensive definition of hardship is a very difficult task. 11 nevertheless, reference to international instruments like upicc can give us much more harmonized and unified definition. upicc rules on hardship are stated in arts 6.2.1-6.2.3. according to art 6.2.2 8 in fact, hardship is at stake where the performance of the disadvantaged party has become much more burdensome, but not impossible, while force majeure means that the performance of the party concerned has become impossible, at least temporarily. moreover, there seems to be a functional difference between the two concepts. hardship constitutes a reason for a change in the contractual program of the parties. the aim of the parties remains to implement the contract. force majeure, however, is situated in the context of non-performance, and deals with the suspension or termination of the contract. (joern rimke, force majeure and hardship: application in international trade practice with specific regard to the cisg and the unidroit principles of international commercial contracts, 202 (kluwer 1999-2000). in fact, the effects of applying of hardship are less drastic. rather than immediate exemption from damages and then possible termination, for example, article 6.2.3 of unidroit principles allows the affected party first to request negotiations and then to obtain either termination or adjustment of contract (luke nottage (2007), changing contract lenses: unexpected supervening events in english, new zealand, u.s., japanese, and international sales law and practice, 405 (indiana journal of global legal studies: vol. 14: iss. 2, article 9), available at: http://www.repository.law.indiana.edu/ijgls/vol14/iss2/9). 9 liu chengwei, ‘remedies for non-performance -perspectives from cisg, unidroit principles and pecl’ 246, available at: www.jus.uio.no/sisu/. 10 id. 11the various national laws solve in very different ways the problem of changes of circumstances which make the obligation of one party much more onerous but which do not amount to force majeure. some accept it as basis for modifying the contract, others do not. (ole lando and hugh beale (ed), principles of european contract law, parts i and ii, 327, (kluwer law international, 2000). nordic journal of commercial law issue 2014#1 5 where the occurrence of events fundamentally alters the equilibrium of the contract either because the cost of parties’ performance has increased or because the value of performance a party receives has diminished and subject to subparagraphs a to d the hardship comes to existence.12 after a brief review of two critical concepts, it is time to examine the effect of sanctions under the iranian legal system and the above-mentioned instruments. this will be done by giving two simple hypothetical examples and, of course having the two mentioned concepts namely, force majeure and hardship in mind as follows: in the first illustration, an iranian seller and a swiss company entered into a contract for delivery of certain quantity of oil to the latter. after the conclusion of the contract, the authorities of united nations put a temporary sanction against iran banning any import from it. therefore, the seller encountered difficulty handing over of the goods to the buyer. if we suppose that the seller is able to supply the goods from a neighboring country and with the same conditions that meet the requirements of the contract but it costs him too much and fundamentally alter the equilibrium of the contract what will the situation of the contract be like? in the second illustration, the same parties with the same subject and conditions conclude a contract. nevertheless, after the conclusion of the contract, the seller faces a permanent sanction that makes it impossible for him to meet his contractual obligation. again, the question is what will the situation of the contract be like? in response to the above-mentioned hypotheses, we can probe the subject matter from the standpoint of iranian national law and international instruments. in so doing, after giving some general perspective of conditions of occurrence of force majeure and hardship, the situation of contract will be examined under discussed laws. 3.3 force majeure requirements in the context of the cisg, article 79 sets out circumstances in which the non-performing party is excused from liability to pay damages. according to that art “a party is not liable for a failure to perform any of its obligations if he proves that the failure was due to an impediment beyond his control and that he could not reasonably be expected to have taken the impediment into account at the time of the conclusion of the contract or to have avoided or overcome it or its consequences”. 12 see also article 6.111 of pecl and 1-110 of dcfr. in these articles, in spite of the fact, that the title of articles are not hardship but their contents and comments refer to this concept. nordic journal of commercial law issue 2014#1 6 as it is self-explanatory, article 79 does not refer to force majeure and hardship or other similar concepts that exist in national legislations. this article is described as a limitation to the system of strict liability for damages that the cisg sets up in art. 45, 74 etc.13 as follows from the context of the article, three conditions are to be met in order to excuse the non-performing party from the liability to pay damages. firstly, the defaulting party must prove that the nonperformance was due to an impediment beyond his control. secondly, he must prove that it could not reasonably be expected from him to have taken the impediment into account at the time of conclusion of the contract (i.e. unforeseeability). finally, he could not have avoided or overcome it or its consequences (i.e. unavoidability).14 from such a wording, some authors have pointed out that the article reflects the concept of force majeure.15 with respect to the impediments, it is generally suggested that the debtor’s sphere of control is wide. in fact, there will rarely be impediments such as natural disasters (hurricanes, earthquakes, diseases etc.), effects of war or terrorist attacks which are beyond his control.16 it should be kept in mind that these events per se do not constitute an impediment beyond the control of the obligor. but it must be determined by taking the circumstances of any particular case into account separately.17 in short, it can be argued that what makes performance of contract objectively impossible can be regarded as an impediment but enumerating a comprehensive list of events that can make performance of contractual obligation impossible is both impractical and unreasonable.18 the second condition under art.79(1) is that the promisor could not reasonably be expected to have taken the impediment into account at the time of the conclusion of the contract. this does not necessarily mean that the provision can only apply to impediments that arise after the conclusion of the contract. it may be the case that the impediment already existed at that time but it was not recognizable to the debtor.19 finally, under the third yardstick the impediment and its consequences must be of a kind that the debtor cannot avoid or overcome it. according to the tallon “to avoid” means taking all 13 peter huber and alastair mullis, the cisg a new textbook for students and practitioners, 258 (sellier 2007). 14 dionysios p. flambouras, the doctrines of impossibility of performance and clausula rebus sic stantibus in the 1980 vienna convention on contracts for the international sales of goods and the principles of european contract law: a comparative analysis, 236, available at: http://www.cisg.law.pace.edu/cisg/biblio/flabouras1.html. 15 denis tallon, in bianca-bonell commentary on the international sales law, 575 (giuffrè, milan, 1987), available at: http://www.cisg.law.pace.edu/cisg/biblio/tallon-bb79.html 16 peter huber and alastair mullis, op.cit., at 259. 17 dionysios p. flambouras, op.cit., at 267. 18 niklas lindström, changed circumstances and hardship in the international sale of goods, available at: http://www.cisg.law.pace.edu/cisg/biblio/lindstrom.html. 19 peter huber and alastair mullis, op.cit., at 262. nordic journal of commercial law issue 2014#1 7 the necessary steps to prevent the occurrence of the impediment and “to overcome” means to take the necessary steps to preclude the consequences of the impediment.20 the same rules in the unidroit principles of international commercial contracts are stated in paragraph 1 of art.7-1-721. except for minor differences in syntax, where the most noticeable difference being absence of a counterpart to cisg art. 79(2),22 art. 7.1.7 reflects the same rules that does article 79 of the cisg.23 according to paragraph 1 of art. 7.1.7 “non-performance by a party is excused if that party proves that the non-performance was due to an impediment beyond its control and that it could not be reasonably be expected to have taken the impediment into account at the time of the conclusion of the contract or to have avoided or overcome it or its consequences.” in construing impediment in this provision, it has been stated that it does not necessarily have to be exogenous, i.e. external to the obligor’s sphere of risk.24 as to the criterion of foreseeability of impediment it has been argued that the reason for that stems from the fact that if the obligor could have anticipated the risk of the event and its consequences, it would have, negotiated the contract differently, either by not assuming the obligation, or by inserting a force majeure or exemption clause in the contract. it could be thus said that foreseeability is merely availability at an early stage.25 furthermore, the possibility to avoid an impediment or to overcome it or its consequences must be interpreted narrowly. accordingly, there would be a rare circumstance that amounts to force majeure. as a result, where the failure to perform the contract is due to promisors own behavior or where the judicial seizure of assets is the result of promisors own conduct, he would not be able to rely on force majeure.26 20 denis tallon, op.cit., at 58. 21 according to that article: non-performance by a party is excused if that party proves that the non-performance was due to an impediment beyond its control and that it could not reasonably be expected to have taken the impediment into account at the time of the conclusion of the contract or to have avoided or overcome it or its consequences. 22 according to paragraph 2 of article 79 of the cisg: if the party’s failure is due to the failure by a third person whom he has engaged to perform the whole or a part of the contract, that party is exempted from liability only if he is exempt under paragraph 1 and the person whom he has so engaged would be so exempt if the provisions of that paragraph were applied to him. 23 alejandro m. garro, exemption of liability for damages: comparison between provisions of the cisg (art. 79) and the counterpart provisions of the unidroit principles (art. 7.1.7), in j felemegas (ed), an international approach to the interpretation of the united nations convention on contracts for the international sale of goods (1980) as uniform sales law, 237( cambridge univ. 2007). 24 jan kleinheisterkamp, in stefan vogenauer and jan kleinheisterkamp (eds), commentary on the unidroit principles of international commercial contracts (picc),771 (oxford university press 2009). 25 id. 26 id. at 772. nordic journal of commercial law issue 2014#1 8 art 8:108 of pecl has the same wording with the article 79 of the cisg and 7.1.7 upicc. comment c expressly states that the circumstances of the impediment are like those “traditionally required for force majeure”.27 the scope of application of article 8:108 is defined by comment a to the pecl, which states that “unlike the equivalent article of cisg 79 article 8:108 has to apply only in cases where an impediment prevents performance.”28 it can be inferred from this comment that pecl presupposes that impediments in art. 79 encompass both circumstances in which performance is impossible and circumstances in which performing of contract is not impossible but involves onerous difficulty. nevertheless, it should be kept in mind that the subject-matter is not so simple in the context of art. 79 of the cisg and as it will be discussed later there is strong controversy among scholars about the ambit of impediment in the context of the cisg. under the iranian civil code, rules on liability exemptions can be inferred from art. 22729 and 22930 of the iranian civil code (cc). according these articles, three conditions are to be satisfied in order to excuse the non-performing party from liability. these conditions are externality, irresistibility and unavoidability of supervening event.31 nevertheless, the unforeseeability requirement cannot be derived from these articles directly. however, katouzian argues that this requirement is contained within the requirement of unavoidability.32 as a result, as far as it is concerned with force majeure requirements it can be argued that the iranian civil code is consistent with international instruments. 3.4 hardship requirements as mentioned above the term hardship and force majeure are not mentioned in article 79 of the cisg. as a result, the issue whether hardship falls within article 79 ambit is a highly controversial subject among scholars and in jurisprudence. 27 ole lando and hugh beale (eds), op.cit., at 327. 28 id. 29 art. 227of iranian cc:“the party in breach is to pay damages only where it cannot prove that the nonperformance was on the grounds of an extraneous event”. 30 art. 229 of iranian cc: “if the obligor cannot live up to its obligations as a result of occurrence of an event which is out of its control it will not be liable to pay damages”. 31 nasser katouzian, iranian civil law: general principles of contracts, volume iv, 202 (tehran, enteshar pub 4th ed 2004). 32 nasser katouzian, op.cit., p. 218. nordic journal of commercial law issue 2014#1 9 according to some commentators and case law, the scope of impediments under the cisg has been confined to cases where contract performance becomes impossible.33 in line with this group of writers, flambouras have pronounced that the drafting history of the convention is a legitimate and valuable aid in the interpretation of the convention’s provisions. it reveals that article 79 of the cisg is indeed a stricter version of its predecessor, article 74 ulis, which had been criticized for excusing non-performance too readily, such as where performance merely became more difficult. as a result, the concept of hardship does not fall within the scope of the cisg.34 nevertheless, it seems that recent literature and case law show high tendency toward including hardship situations under art. 79 of the cisg and therefore it is suggested that hardship situations be dealt with under the cisg itself.35to support this view, huber argues that if arts. 79(1) and (5) of the cisg be interpreted alongside each other, it becomes clear that hardship falls within the scope of the cisg. in his opinion, it goes without saying that in cases in which force majeure occurs, demand of specific performance is unreasonable. however, it seems that the cisg, by setting forth 79(5) wanted to cover situations in which the performance of contract is still possible, but involves considerable difficulty.36 to come up with a solution to the effect of hardship under the cisg, schlechtriem has pointed out that article 50 of the cisg is a basis for adjustment of the contract as a main effect of hardship.37 in this connection, one court has held that the legal consequences of economic hardship include an obligation by the parties to renegotiate the contract.38 33 sarah howard jenkins, exemption for nonperformance: ucc, cisg, unidroit principles a comparative assessment, 2025, tulane law review (1998), available at: http://www.cisg.law.pace.edu/cisg/biblio/jenkins.html; jennifer m. bund, force majeure clauses: drafting advice for the cisg practitioner, 387 (17 journal of law and commerce 1998), available online at: http://www.cisg.law.pace.edu/cisg/biblio/bund.html; nuova fucinati, s.p.a. v. fondmetal international a.b. , tribunale civile di monza (italy), 14.01.1993, available at: http://www.unilex.info/case.cfm?id=21 (111). 34 dionysios flambouras, exemption and hardship: remarks on the manner in which the principles of european contract law (articles 6:111 and 8:108) may be used to interpret or supplement cisg article 79, in john felemegas (ed), an international approach to the interpretation of the united nations convention on contracts for the international sale of goods (1980) as uniform sales law, 501 (cambridge univ. 2007). 35 peter j. mazzacano, force majeure, impossibility, frustration & the like: excuses for non-performance; the historical origins and development of an autonomous commercial norm in the cisg, (nordic journal of commercial law issue 2011#2), p.48; ingeborg schwenzer, force majeure and hardship in international sales contracts, (victoria university of wellington law review april 2009), p.713; niklas lindström, changed circumstances and hardship in the international sale of goods, (nordic journal of commercial law 2006), also available at http://www.cisg.law.pace.edu/cisg/biblio/lindstrom.html#iv. 36 peter huber and alastair mullis, op.cit., at 193,196. 37 peter schlechtriem, in harry m. flechtner (ed), transcript of a workshop on the sales convention: leading cisg scholars discuss contract formation, validity, excuse for hardship, avoidance, nachfrist, contract interpretation, parol evidence, analogical application, and much more, 22 (18 journal of law & commerce 1999), available online at: http://cisgw3.law.pace.edu/cisg/biblio/workshop-79.html. 38 uncitral digest of case law on the united nations convention on contracts for the international sale of goods, united nations commission on international trade law, 388 (2012 edition). nordic journal of commercial law issue 2014#1 10 in contrast to the cisg, upicc has set forth separate provisions on hardship. rules on hardship in upicc are stated in arta 6.2.2-6.2.3. article 6.2.139 establishes the starting point for any analysis of the hardship provisions of upicc. art 6.2.240 defines hardship as a situation where the occurrences of events fundamentally alter the equilibrium of the contracts, provided that, those events meet the requirements which are laid down in subparagraphs (a) to (d).41art 6.2.3 concerns the consequences of occurrence of hardship that will be examined in detail later in this article. provisions on hardship in the pecl have been stated in art. 6:111. in spite of the fact that pecl employs the terminology «change of circumstance» rather than «hardship» in the context of the mentioned provision, it is evident when one looks at the conditions and effects of change of circumstances that art. 6:111 reflects the concept of hardship. this is acknowledged when one looks at the draft common frame of reference (dcfr), which is an advanced version of pecl.42 the iranian civil code has not set out a specific provision to deal with hardship situations. nevertheless, article 167 of iranian constitution requires judges to make use of "islamic sources and fatwas"43 in matters where the iranian codes are silent. in so doing, some authors44 by relying on the osro-o-haraj –rule (the osr rule) in sharia have pointed out that the concept of hardship can find its way into our legal system. the osr rule literally means onerous difficulty and from legal points of view it implies situations where contract performance becomes considerably difficult. in this case the obligor will be granted some rights like extension of time for performance or will be exonerated from obligation. it should, however, be noted that unlike the hardship institution, the scope of the osr rule is not confined to economic difficulty.45 in relation to the consequences of hardship in iranian civil code, there are controversies among scholars that will be discussed under relevant titles. 39 according to art 6.2.1 where the performance of a contract becomes more onerous for one of the parties that party is nevertheless bound to perform its obligation subject to provision on hardship. 40 according to art 6.2.2 there is hardship where the occurrence of events fundamentally alters the equilibrium of the contract either because the cost of party’s performance has increased or because the value of performance a party receives has diminished. 41 art. 6.2.2 unidriot principles 2010, official cmt 1. 42 where the official comments to art 1:101 of dcfr state that: exceptional hardship, under this article, gives the court the choice of revising the terms regulating the obligation or terminating it altogether.( in christian von bar and eric clive (eds), principles, definitions and model rules of european private law, draft common frame of reference (dcfr), prepared by the study group on a european civil code and the research group on ec private law (acquis group),vol.2 (sellier 2009), official cmt a. 43 fatwa is a legal opinion or ruling issued by an islamic scholar. 44 mostafa mohaghegh damad, qawa’ed-e-figh, maxims of figh, 110 (samt pub 2000). 45 ebrahim shoarian and ebrahim torabi, principles of european contract law and iranian law, a comparative study, 259 (forouzesh pub 2010). nordic journal of commercial law issue 2014#1 11 4 determination criteria the concept of hardship and force majeure and their elements has been made clear, to some extent, under the discussed laws. in this section, we will examine conditions in which sanctions can be regarded as hardship or force majeure under the same laws. with respect to conditions in which sanctions may amount to hardship, however, it should be noted that we will focus on unidroit principles given that the iranian civil code and the cisg have not set forth clearcut yardsticks to distinguish the two concepts. according to the paragraph a of article 6.2.2 upicc, sanctions must occur or become known to the affected party after the conclusion of the contract. as a result, if sanctions come into existence before the conclusion of the contract on condition that the effected party is aware of their existence, he will not be able to resort to them. on the other hand, if it is unreasonable to expect the obligor to take the sanctions into account at the time of the conclusion of the contract he will be able to rely on sanctions. it should, of course, be noted that where the imposition of sanctions on specific countries is a commonplace phenomenon the disadvantaged party will hardly be able to invoke hardship since it is often possible to anticipate the occurrence of sanctions and its effects.47 if at the time of the conclusion of the contract, sanctions were already in force, it is assumed that contracting parties has made the contract by assuming its risks. as a result, they will not be able to invoke sanctions to release themselves from liability. the situation will be different, however, where the subject-matter of the contract itself is targeted by the sanctions. in such a case, as it is confirmed by the national law of some countries like swiss, french, english and american law, the contract will be void and unenforceable on the grounds of violation of public policy.48 in addition, the sanction must be beyond the control of the disadvantaged party to qualify as hardship.49 by taking the origin of the sanction into consideration, this condition with respect to sanctions is usually met. this is because, sanctions are exterior to the defaulting party's activity and its behavior has, except where the disadvantaged party is a governmental organization, nothing to do with its occurrence. it should, of course, be noted that satisfaction of this condition in itself does not release the defaulting party from liability. this is because of the uncontrollable character of the sanction should be judged not only by taking into account of its origin but also having regard to the defaulting party’s ability to avoid or overcome it. therefore, if the obligor is able to avoid the sanction or overcome it he will not be able to 46 ewan mckendrick, in stefen vogenauer and jan kleinheisterkamp (eds), commentary on the unidroit principles of international commercial contracts (picc), 721 (oxford univ. 2009). 47 elliott geisinger, philippe bartsch, julie raneda and solomon ebere, the impact of international trade sanctions on contractual obligations on international commercial arbitration, 405-437 (i.b.l.j. 2012). 48 art 6.2.2(c) of upicc. nordic journal of commercial law issue 2014#1 12 invoke the liability exemption.50 finally, the affected party can only rely on the exemption when he has not already assumed the risk of sanctions.51 in sum, it must be said that in order for sanctions to qualify as hardship, its permanent or temporary feature does not play a decisive role and, therefore, regards should be paid to all relevant circumstances of any particular case. as to the force majeure, it has been made clear that apart from some differences in syntax, all mentioned instruments and the iranian civil code require the same criteria that can summarized in three conditions. firstly, the sanction must be beyond the obligor’s control. secondly, it could not reasonably be expected from the obligor to have taken the sanction into account at the time of the conclusion of the contract. thirdly, it was not possible for him to avoid the sanction or overcome it or its consequences. with respect to the first criterion, it is necessary to note that sanctions are often to be regarded as an impediment beyond the control of obligor since his/her will plays no role in the occurrence of sanctions. but, the situation of issue may change where the contracting parties or at least one of them is a governmental organization. in this situation, given the fact that sanctions are imposed mostly on grounds of government actions, it will be difficult for the affected party to claim that the imposition of sanctions was beyond its control. with regard to the second criterion, as we mentioned in examining hardship, if imposition of a sanction against a specific part of the world is a usual event, it seems that the obligor is rarely unable to take an impediment into consideration at the time of conclusion of the contract. in relation to third criterion, we must admit that since in most cases the imposition of sanction does not have anything to do with obligor’s will, he will often be unable to avoid a sanction or overcome it. but with respect to the consequences of a sanction, it might be argued that if the seller is able to supply the goods from other places or if the buyer is able to pay the contract price from other usual means of payment, the obligor would be unable to invoke a sanction as force majeure. but it ought to be born in mind that, if performance of the contractual obligation costs too much and makes the performance extremely onerous for him, the situation may constitute hardship. in any event, in determining the situation of sanctions all relevant circumstances must be considered and it is impossible to treat sanctions as hardship or force majeure as such. in a case involving a swiss national embargo on export of certain types of machinery that could potentially be used in the production of nuclear weapons, the swiss federal supreme court ruled that the enactment of embargo qualified as a supervening legal impossibility within the meaning of article 119 co. the supreme court specified, however, that the seller of such 50 denis tallon, op.cit., at 579. 50 art 6.2.2(d) of upicc. nordic journal of commercial law issue 2014#1 13 goods may still be held liable for any damages resulting from non-performance, if he knew or could have known about the future embargo at the time the contract was made. in this case although the court accepted the fact that the enactment of embargo qualified as a supervening legal impossibility it rejected to release the obligor from liability. this reflects the idea that the external character of a sanction does not in itself make the event beyond the promisor’s control but it should also be unforeseeable and unavoidable. 5 breach of contract caused by sanction and its effects 5.1 damage claims as mentioned above, imposition of a sanction may make contract performance either impossible or excessively difficult. in the first case, the breach of contract is definite but in the latter, this is not the case, at least, immediately. therefore, effects and remedies resulting from such events must be examined for force majeure and hardship separately. in cases where the sanctions qualify as force majeure, according to all above-mentioned instruments, the affected party will be excused from liability to pay damages.52 it should, however, be noted that where the sanction is only temporary, the excuse has effect for the period during which the sanction is in force.53 this is also the case under the iranian civil code. according to article 227 of iranian cc: «the party in breach is to pay damages only where it cannot prove that the non-performance was on the grounds of an extraneous event». in addition article 229 of iranian cc sets forth: »if the obligor cannot live up to its obligations as a result of occurrence of an event which is out of its control it will not be liable to pay damages.» however, with respect to the hardship, the subject-matter of exoneration from paying damages may seem confusing at first glance. this is because in the case of hardship there is no breach of contract on the side of disadvantaged party. so the question is raised whether recovery of damages and subsequently exoneration from paying damages come into play or not. in response, it should be noted that the exemption from liability of paying damages is not relevant in this situation. this is because the time of performance of the contract has not yet been expired. as a result there is no breach of contract on behalf of the disadvantaged party. for this 51 art79(5) of cisg; comment d on art 8:108 to pecl(in ole lando and h beale, op.cit., at 379); 7.1.7(1), in jan kleinheisterkamp, in stefan vogenauer and jan kleinheisterkamp (eds), op.cit., at 775. 52 art79(3) of cisg, 8:108(2) of pecl,7.1.7(2) of upicc nordic journal of commercial law issue 2014#1 14 reason, upicc has dealt with hardship in the chapter on performance. on the other hand, rules on force majeure have been dealt in the chapter on non-performance.54 accordingly, the hardship does not present the matter of breach of contract and the aggrieved party cannot recover damages on grounds of hardship, rather, to safeguard the affected party because of changed circumstances, the legislator has enabled the disadvantaged party to ask other party to renegotiate the conditions of contract. in fact, in these situations the consequences of burden is dealt with as an aspect of performance.55 nevertheless, this result may be disputed if one take notice of article 6:111(3)(c) of pecl. in studying the rules of pecl in art 6:111(2)(c) the court may award damages for the loss suffered through a party refusing to negotiate or breaking off negotiations contrary to good faith and fair dealing. but it should be said that awarding to such damages is not on account of hardship rather it results from breach of obligation to observe good faith. in this regard, official comment states that the obligation to renegotiate is independent and carries its own sanction. the compensation provided by article 6:111(3)(c) of pecl will normally consist of damages for the harm caused by refusal to negotiate or breaking of negotiation in bad faith.56 5.2 termination or avoidance of the contract regardless of the fact that sanctions make contract performance impossible or burdensome the question is raised whether the aggrieved party will be able to put an end to the life of contract or not. to answer the question we must examine the situation of sanctions in two different assumptions namely where they constitute force majeure and where they amount to hardship. in the framework of the cisg answering this question calls for close attention to art 79(5) which reads: "nothing in this article prevents either party from exercising any right other than to claim damages under this convention." in short, the aggrieved party’s right to avoid the contract is not affected by article 79.57 like cisg, official comments on pecl with regard to art. 8:108 has pointed out that the aggrieved party may put an end to the contract by a unilateral declaration provided that the non-performance is fundamental. it follows that in principle it will be for the creditor to 53 joseph m. perillo, force majeure and hardship under the unidroit principles of international commercial contracts, 120, available at: http://www.cisg.law.pace.edu/cisg/biblio/perillo3.html 54 liu chengwei, op.cit., at 330. 55 ole lando and h beale, op.cit., at 326. 56 john honnold, uniform law for international sales under the 1980 united nations convention, 490 (3rd ed. 1999), for an opposite view see: denis tallon, op.cit., at 589 (where he state: specific performance is, by definition, impossible and avoidance useless). nordic journal of commercial law issue 2014#1 15 exercise this right by giving notice of termination to the debtor under article 9:303.58 as a result, according to this instrument as well, regardless of the exemption of obligor on ground of sanction, the obligee will be able to terminate the contract. in upicc also, if non-performance is excused, the obligor is only protected against obligee’s claim for damages resulting from non-performance. as explicitly pointed out in art. 7.1.7(4), force majeure does not prevent the obligee from exercising a right to terminate the contract under the conditions of art 7.3.1. with the termination of the contract, all losses directly caused by the sanction (force majeure) are eventually born by the obligor.59 under the iranian civil code in the event of occurrence of sanction that qualifies as force majeure the contract is automatically extinguished and the obligor, therefore, released from liability.60 however, the question whether the obligee may terminate the contract where an imposed sanction qualifies as hardship will be a different issue. this stems from the fact that effects of hardship differs from the effects of force majeure. the following will address the effects of sanctions, when it qualifies as hardship under discussed laws. however, given the fact that there are no specific rules to deal with the issue in the cisg we have not covered the cisg in this section. the unidroit principles in article 6.3.3 allow, in the case of hardship, the disadvantaged party to request renegotiations. however, the request for renegotiation does not entitle the affected party to withhold performance. if the parties cannot agree on an adjustment of contract within a "reasonable" time, either party may resort to a court. then it is up to the court to either terminate the contract at a date and on terms to be fixed, or adapt the contract with a view to restoring its equilibrium.61 it should be noted that «termination» in this article is not the same as termination which takes place in the event of non-performance. the court has discretion with respect to the time and the terms of termination, which it does not have in the case of termination for non-performance.62 as a result it can be inferred, that in cases which a sanction amounts to hardship, the aggrieved party has no discretion to terminate the contract unless the time for performance expires. art 6:111 of pecl includes the same rule as upicc. 57 ole lando and h beale, op.cit., at 381. 58 jan kleinheisterkamp, in stefan vogenauer and jan kleinheisterkamp (eds), op.cit.,, at 775. 60 ebrahim shoarian and ebrahim torabi, op.cit., at 308. 60 frederick r. fucci, hardship and changed circumstances as grounds for adjustment or non-performance of contracts practical considerations in international infrastructure investment and finance, available at: http://www.cisg.law.pace.edu/cisg/biblio/fucci.html; abd al-razzaq ahmad al-sanhuri, masader al-haq in islamic jurisprudence, vol. 6, 90 (halabi law books pub, 2d ed, 1998). 61 ewan mckendrick, in stefan vogenauer and jan kleinheisterkamp (eds), op.cit., at 724. nordic journal of commercial law issue 2014#1 16 when it comes to the iranian civil code there is no agreement among scholars as to the possibility of termination of contract because of hardship. this derives from the fact that the iranian civil code has not set out special rules to deal with hardship situations. nevertheless, according to some shari'a commentators, if the hardship causes the obligee to sustain unreasonable loss, he will be able to terminate the contract. some other commentators are of the opinion that in such cases the contract will be terminated automatically.63 5.3 modification of the contract the possibility of modification of the contract in the event of imposition of a sanction is another remedy that needs to be examined. in this regard, it is necessary to distinguish between the situation in which a sanction makes contract performance impossible and the situation in which contract performance becomes burdensome as result of a sanction. in situations where a sanction makes contract performance extremely difficult, both pecl and upicc recognize the possibility of contract modification. in fact, the primary effect of hardship is the contract modification that is made by affected party’s request from the other side of contract.64 nevertheless, the request should be made without undue delay and should indicate the grounds on which it is based.65 in cases where the parties stipulate the possibility and methods of modification, these bind them. if the parties fail to reach an agreement, either party may resort to the court. however, in cases where the contract is silent about the possibility and method of modification, it does not mean that the affected party cannot request modification of the contract. in these situations, modification is made by asking the other party to renegotiate the condition of contract. if the court finds hardship, it may terminate the contract at a date and on terms to be fixed, or adapt the contract with a view to restoring its equilibrium.66 but it should be noted that the court’s decision to terminate or to modify the contract is very much a last resort. the whole procedure is devised to encourage the parties to reach an amicable settlement; hence the obligation to enter negotiations.67 however, if the court decides to modify the contract, it may 62 islamic encyclopedia (in arabic), vol. 30, 31 (kuwait minister of religious endowment and islamic affairs, 2d ed, 1983); alireza yazdanian, adjustment of contractual obligations on the base of islamic law, 129,131,(journal of magalat wa barrasiha, vol.39, no.82, 2006), available at: http://www.noormags.com/view/fa/articlepage/486455. 63 6:111(2)of pecl; 6.2.3(1)upicc. 64 6.2.3(1)upicc. 65 pecl art. 6:111(3)(a)(b)]; upicc art. 6.2.3(4)(a)(b). 66 ole lando and h beale, op.cit., at 324. nordic journal of commercial law issue 2014#1 17 be done through extending time of performance, increasing or reducing the price or the contract quantity or ordering a compensatory payment.68 the iranian civil code is silent with respect to the effects of hardship and accordingly the possibility of contract modification where sanction makes contract performance burdensome. however, the appropriate view seems to be one of considering the modification of contract as a suitable method of dealing with the effect of hardship. in addition, some islamic commentators have confirmed the possibility of modification of the contract in the case of a change of circumstances.69 as far as the possibility of contract modification in cases of force majeure is concerned, it ought to be said that where sanction makes contract performance impossible the possibility of contract modification ought to be ignored. therefore, in these situations given that performance of contract is impossible it is not practical to modify it. 5.4 suspension of performance with regard to the remedy of suspension of performance, it is also important to distinguish between situations where the imposed sanctions make contract performance impossible and where they make it unduly burdensome. as to the force majeure situation, the cisg and pecl are silent. however, as far as the cisg is concernedit has been held that the performance claim is suspended. although arts.46 and 62 do not include any express statement regarding this, the idea lying behind art. 79(3) can be applied by analogy.70 unlike the cisg and pecl, upicc has dealt expressly with the issue. article 7.1.7(4) reads, “nothing in this article prevents a party from exercising a right to terminate the contract or to withhold performance or request interest on money due”. as a result, the obligee may withhold its performance in accordance with art. 7.1.3 until the force majeure situation comes to an end under art. 7.1.7(2) or until the delay eventually amounts to a fundamental breach. 71 nonetheless, where the imposed sanction is permanent; performance suspension will not be relevant at all. since, in such case, the non-performance will amount to a fundamental breach and the aggrieved party will be able to terminate the contract. 67 id. 69 alireza yazdanian, op.cit., at 131. 70 yeşim m. atamer, availability of remedies other than damages in case of exemption according to art. 79 cisg, in a büchler m müller-chen(ed), private law national – global – comparative, 98 (festschrift für ingeborg schwenzer, stämpfli verlag/intersentia 2011). 70jan kleinheisterkamp, in stefan vogenauer and jan kleinheisterkamp(eds), op.cit., at 775. nordic journal of commercial law issue 2014#1 18 the iranian civil code is also silent in this regard. nonetheless, some commentators have pointed out that if force majeure is only temporary, the performance of contractual obligations will be suspended until the impediment ceases.72 however, when it comes to hardship situations, the probability of suspension of performance can be examined from two standpoints having regard to the fact that who is the claimant. where the claimant of performance suspension is the obligee it will not be relevant at all. this stems from the fact that on the one hand, the due date of performance has not expired and on the other hand, the obligor may still want to perform his obligations. to put it differently, given that the obligor has not committed any breach, the obligee cannot withhold its performance unless the parties are to perform their obligations simultaneously that in this case the obligee may be able to withhold its performance.73 however, when it comes to the obligor it may be argued that given the effects of hardship, the obligor will be able to withhold its obligation until the contract is adopted to new circumstances. but, according to art. 6.2.3(2) of upicc the request for negotiation does not in itself entitle the disadvantaged party (obligor) to withhold its performance. in interpreting the provision , it has been pointed out that the words “in itself” have a great significance. the entitlement of affected party to suspend performance does not follow from the impact of events that have created the hardship. nevertheless, where the consequences of event are sufficiently extraordinary 74 the disadvantaged party may be entitled to withhold performance.75 5.5 specific performance where a sanction makes contract performance either impossible or burdensome another question raised is whether the other party can still insist on specific performance or not. in cases where sanction makes contract performance impossible, the pecl exclude any form of specific performance.76 however, in the framework of the cisg, even if the affected party is exempted from liability on account of force majeure, this does not impair other party’s right to demand specific performance.77 this position has been criticized by many commentators on the grounds that it involves unreasonable results. 71 nasser katouzian, op.cit., at 201. 72 art.7.1.3 upicc; art.9:201 pecl. 73 see illustration 4 to art. 6.2.3 upicc. 74 ewan mckendrick, in stefan vogenauer and jan kleinheisterkamp (eds), op.cit., at 724. 75 ole lando and h beale, op.cit., at 381. 76 peter huber and alastair mullis, op.cit., at 264. nordic journal of commercial law issue 2014#1 19 in this respect, as some authors have stated, the unidroit principles seem to find a flexible answer to the question of what is to become of the right to performance.78 the unidroit principles adhere to the principle that the excuse is general, but in art. 7.1.7(4) they make important exceptions in determining certain claims which are not affected by force majeure, namely the right to terminate the contract or withhold delivery or request interest on money due. the official comment makes some of its dispositions clear: “in some cases the impediment will prevent any performance at all but in many others, it will simply delay performance and the effect of the article will be to give extra time for performance”. it should be noted that in this event the extra time may be greater (or less) than the length of the interruption because the crucial question will be what the effect of the interruption on the progress of the contract is.79 as a result, in the framework of upicc the possibility of demanding specific performance in the case of exemption will depend on the circumstances of each particular case. however, where sanction makes contract performance burdensome, the cisg has not set out special rule in relation to the possibility of demanding specific performance. on the other hand, art.6.2.2 (2) of the upicc has explicitly set out that the request of renegotiations cannot per se justify suspension of contract on behalf of the affected party. this means that the other party can still demand specific performance. but, as we mentioned above where the consequences of event are sufficiently extraordinary, the disadvantaged party may be entitled to withhold performance. therefore, in this situation, the other party will be unable to demand specific performance at least for a period in which the event is in progress. in spite of the fact that the iranian civil code is silent with respect to the consequences of force majeure, some authors have pointed out that if force majeure is permanent (in our assumption the sanction), the obligation will be eliminated automatically and demanding of specific performance will be impossible. however, in cases where force majeure is temporary, the other party cannot demand specific performance in the period in which the sanction is in progress.80 the iranian civil code has also laid down no rule on hardship situations but some islamic commentators are of the opinion that in these situations onerous part of the obligation is eliminated. nonetheless, the other part is still valid. in addition, according to figh rules hardship cannot give rise to the right to terminate the contract, rather, its effect is modification of contract.81 77 liu chengwei, op.cit., at.326. 78 art 7.1.7(4)unidroit principles 2010, official cmt 2. 79 nasser katouzian, supra note 34; mehdi shahidi, effects of contracts and obligations, 64 ( majd pub, 2d ed. 2004). 80 sharifi elhamoddin, safari nahid, a comparative study on effects of hardship in principles of european contract law (pecl),unidroit principles of international commercial contracts and iranian law, comparative law review, 20 (september 2010, vol.5 issue 2). nordic journal of commercial law issue 2014#1 20 6 conclusion the present article was an attempt to address the effects of sanctions as new instances of excusing events on contractual obligations under the iranian civil code and international instruments. in so doing, we examined the standards of exemption under both force majeure and hardship situation considering that sanctions might make contract performance either impossible or excessively burdensome. as far as it is concerned to force majeure requirements, it can be said that all international instruments require the same. however, the iranian civil code does not deal with the issue specifically. nonetheless, the same rules can be derived from articles 227 and 229 of the iranian civil code. when it comes to hardship situations, it has also been made clear that, except the cisg, upicc and pecl has set out specific rules in this regard. nevertheless, according to the majority of scholars, article 79 of the cisg ought to be read in a way that encompasses hardship situations as well. the iranian civil code, again, has not set out special rule in this regard. however, its inclusion in the iranian civil code is justified through osro-o-haraj rule. but, as far as it is concerned to the effects of sanctions the following conclusions can be drawn with respect to the issue. as for the damage claims, the study showed that the effects of a sanction will be different where it makes contract performance impossible (first situation) and where it makes it excessively difficult (second situation). in the former case, under all discussed laws the defaulting party will be exempted from liability to pay damages. but in the latter case under both upicc and pecl exemption from liability to pay damages will be irrelevant since hardship does not pose a breach of contract. the iranian civil code and the cisg are silent in this regard. with respect to avoidance or termination of contract, in the first situation all international instruments enable the aggrieved party to declare the contract avoided. on the other hand, under the iranian civil code, the contract will be terminated ipso facto and there is no need for a declaration of avoidance. in the second situation, the possibility of termination of contract will be treated as a last resort remedy. in the iranian legal system there is controversy among scholars. some are of the opinion that the contract will be avoided automatically and some believe that the aggrieved party has an option to do this. as to the remedy of modification of the contract, in the first situation both upicc and pecl recognize modification as a main effect of hardship. despite the cisg’s silence in this regard this position is also verified under the cisg. in the second situation to speak of modification of contract will be irrelevant. with respect to remedy of specific performance, in the first situation the pecl exclude it at all. the cisg when interpreted literally took quite the opposite position. however, under upicc the possibility of demanding specific performance will depend on the circumstances of each nordic journal of commercial law issue 2014#1 21 particular case. in the second situation, the possibility of specific performance will generally depend on the severity of sanction. microsoft word katrin_puolakainen_lopullinen.docx nordic journal of commercial law special edition 2011 current issues in patenting nanotechnology by katrin puolakainen 1 nordic journal of commercial law special edition 2011 1 introduction 1.1 what is nanotechnology? the prefix nano derives from the greek word ‘nanos’ that means dwarf. a nanometer (nm) is a unit of measurement equal to one billionth of a meter. for example, a single sheet of paper is about 100,000 nanometers thick. another commonly used example is the thickness of a human hair: one nanometer is about 1/80,000 of the diameter of the average human hair. the size of a red blood cell is around 7000 nanometers. clearly nanotechnology refers to things on an incredibly small size scale. nobel-prize winner richard feynman delivered a lecture in 1959, in which he explored the question of whether in the future it would be possible to manipulate matter at atomic level1. feynman was the first one to introduce the idea of nanotechnology. nanotechnology is the study of manipulating matter on an atomic and molecular scale, and generally it deals with structures sized between 1 and 100 nanometers in at least one dimension. the term nanotechnology defined by the european patent office “covers entities with a controlled geometrical size of at least one functional component below 100 nanometers in one or more dimensions susceptible of making physical, chemical or biological effects available which are intrinsic to that size. it covers equipment and methods for controlled analysis, manipulation, processing, fabrication or measurement with a precision below 100 nanometers”.2 because at this size scale the laws of quantum mechanics begin to affect the basic properties of matter, atoms and molecules have different properties and provide a variety of surprising and interesting uses3, for example, in the field of heat and electric conductivity and strength4. nanotechnology has infinite possibilities and huge potential. nanotechnology today is, for example, used in several materials to improve their qualities: the substantial structure of carbon nanotubes makes them stronger and lighter than any other composition of material. in addition, carbon nanotubes have unique electrical properties and efficient conduction of heat, which makes them potentially useful in a wide variety of applications. the somewhat futuristic belief of some experts is that nanodevices distributed throughout the brain may permit copying of thought patterns and copy a person’s personality in order to create artificial intelligence. 1 feynman, 1959. 2 http://www.epo.org/topics/issues/nanotechnology.html 11.2.2011. 3 helsinkinano loppuraportti, p. 7. 4 schellekens 2010, p. 48. 2 nordic journal of commercial law special edition 2011 1.2 intellectual property issues related to nanotechnology nanotechnology is an emerging technology and thus interesting intellectual property questions arise related to its protection. characteristic to nanotechnology is its interdisciplinary nature. nanotechnology is a broad multidiscipline science covering aspects of biology, chemistry, physics, and other disciplines. the interdisciplinary nature of nanotechnology makes it challenging for the patent authorities to examine the patentability of nanotech inventions; the difficulty lies in finding all relevant prior art. typical to nanotechnology is also the fact that the building blocks of the technology were patented at the outset. more and more of the patents issued in the field of nanotechnology are issued to universities, which is no wonder considering the fact that universities conduct most of the basic research. as patentees, universities differ from private equities. research and development of nanotechnology requires a huge investment; researchers and their financiers need an incentive to continue research and innovation. the potential income from patenting and licensing inventions serves this purpose well. thus one important issue is the licensing of nanotechnology, and of course proper protection of the intellectual property rights against infringement. the special characteristics of nanotechnology in this paper are approached from the european and the united states point of view, but the aim is to keep the paper on a generic level and address nanotechnology related problems common around the globe. 2 patentability of nanotechnology 2.1 discovery or an invention? to be patentable, a nanotechnology invention must consist of patentable subject matter. the first question raised by nanotechnology is whether some nanotechnology inventions are inventions at all, or are they rather scientific discoveries or products of nature. it is globally accepted that abstract ideas and “products of nature” or discoveries5 are not patentable6. as the u.s. supreme court has stated, “phenomena of nature, though just discovered, mental processes, and abstract intellectual concepts are not patentable, as they are the basic tools of 5 in the u.s. the term “invention” means invention or discovery (35 u.s.c. 100a), and thus according to the u.s. terminology discoveries are patentable. in the epc the term “discovery” has a similar meaning as the term “product of nature” in the u.s., and it is not patentable according to the epc 2000 art 52(2). 6 european legislation epc 2000 art. 52. in the u.s. “product of nature” is a judicially created doctrine, see gottschalk v. benson, 409 u.s. 63, 67 (1972) and benson, 409 u.s. at 67. statutory law does not restrict patentability subject-matter. 3 nordic journal of commercial law special edition 2011 scientific and technological work”7. in the u.s., the concepts encompassed by the product of nature doctrine have not been clearly defined by the united states supreme court or the united states court of appeals for the federal circuit, which has lead to a situation where the patent office and district courts have been left to determine whether a particular invention is properly classified as a product of nature. this has resulted inconsistent rulings, and because of the presumption of validity that attaches to issued patents has been significantly discredited, this jeopardizes both investments in emerging technologies and incentives to innovate.8 in the european patent system only inventions can become object of a patent right, and the examples of what cannot be regarded as inventions are listed in the epc. according to article 52(2) epc, discoveries, scientific theories and mathematical methods, aesthetic creations, schemes, rules and methods for performing mental acts, playing games or doing business, and programs for computers and presentations of information are not regarded as inventions. this means that a naturally occurring substance or a new found property of such substance can not be regarded as an invention. however, it has to be kept in mind that only discoveries as such are not patentable, which means that products and processes that arise from the human effort are inventions and thus may be patentable. for example, the process for isolating or synthesizing naturally occurring substances are patentable inventions, if they also meet the other requirements of patentability.9 sometimes it is still difficult to distinguish between an unpatentable scientific discovery and a patentable invention. questions like ‘should an obvious practical application of a newly discovered natural phenomenon be patentable’ or ‘should a product or process claimed in such broad terms that it covers any practical application of a newly discovered natural phenomenon be patentable’ arise.10 i agree with holman on answering both these questions in the negative. however, the problem is that it is hard to maintain consistent practice in issuing patents, because of the large amount of patent authorities. 2.2 patentability requirements 2.2.1 novelty to be patentable, an invention has to meet a number of requirements: it has to be novel, inventive and susceptible of industrial application. these are called the patentability requirements. the novelty and inventive step criteria are most discussed in the field of nanotechnology. 7 benson, 409 u.s. at 67 8 parasidis 2010, p. 333. 9 schellekens 2010, p. 60. 10 holman 2007 p. 540. 4 nordic journal of commercial law special edition 2011 an invention is novel, if it is not a part of the state of the art. to be patentable, it also has to be new. the most obvious questions regarding nanotechnology inventions and their novelty are size-related. is size alone enough to confer novelty upon an invention? could prior art that does not specifically refer to nano size anticipate a nano-scale invention? if the prior art refers only to the size scale of micro or larger, the nano-scale equivalent is generally not anticipated, for an invention is only anticipated if it has been described completely in the prior art. the technical board of appeal addressed the issue of size in orica australia/basf case11 as follows: orica’s patent concerned addition polymer particles that can be stably dispersed in liquids. the particles are less than 100 nm and can be dispersed because of their coresheath structure. basf sought revocation of the patent inter alia for the lack of novelty. it elicited a prior us patent about dispersions for the preparation of high gloss coatings. the particle size in this patent was limited to a minimum of 111 nm. the tba found no implicit disclosure of particle sizes of between 10 and 100nm and upheld orica’s patent. therefore, little or no problems are to be expected, if the ranges mentioned in a patent and the prior art are disjunctive.12 another issue to discuss is what happens in cases where the ranges mentioned in a patent about a nano-scale invention overlap with those mentioned in the existing prior art. the issue was addressed in smithkline beecham biologicals/wyeth13. the invention in this case concerned the adjuvant qualities of a lipid in a vaccine. if an adjuvant substance in a vaccine is combined with an effective substance it reinforces the latter’s effectiveness. according to the patent, the adjuvant effect of the lipid in this case can be improved by reducing its particle size. the patent in question describes experiments that empirically demonstrate the improvement in effectiveness at smaller particle sizes, but the reason why this effect occurs is not given. a range for the particle size mentioned in prior art documents is 80–500 nm, while the patent indicates a partially overlapping range of 60–120 nm. in consideration whether this prior art document destroyed the novelty of the invention or not, the technical board of appeal (tba) formulated as its criterion whether a person ordinarily skilled in the art (posita) would seriously contemplate applying the technical teaching of the prior art document in the range of overlap. in this case, the tba found based on certain circumstances14, that the overlap was not novelty defeating. the patent office scrutinizes whether the prior art document seriously contemplates the application of the invention in the overlapping part of the range. it has allowed claiming an 11 t0547/99. 12 schellekens 2010, p. 51-54. see also kallinger et al. 2008, p. 99–100. 13 t0552/00. 14 the overlap in this case represented only 10 % of the broad range of prior art; the prior art did not indicate any preferred size-related sub-range of the particles and the posita would probably end up with particles not in the size range of the patent. 5 nordic journal of commercial law special edition 2011 overlapping range in various cases, which raises the question, whether this practice is the first step in creating a patent thicket.15 in cases when the prior art does not refer to size, it might destroy the novelty of a nano-scale invention, assuming that it contains an enabling disclosure. a nano-scale invention may still be novel despite of the fact that it is covered by the terms of a prior art document, if the posita cannot practice the invention at the nano scale without knowledge of the claimed invention or engaging in inventive activity. nanotechnology is still a nascent and rather uncharted technology and the knowledge concerning it is constantly growing, thus non-size-related prior art may become ever more enabling prior art. in the united states, the §102 of the patent act16 precludes obtaining or enforcing patents covering an invention previously known or used by others. this paragraph pertains to novelty. if a printed prior art reference discloses within its four corners all aspects of a subsequently claimed invention, the reference anticipates the claimed invention. for example, in a patent application concerning forming self-aligned nano-electrodes17, the applicant was able to overcome an anticipatory reference by demonstrating that it failed to clearly disclose one of the claimed elements, a transistor.18 2.2.2 inventive step besides novelty, an invention must also involve an inventive step in order to be patentable. in other words, the invention must not be obvious to the posita, having regard to the state of the art. in nanotechnology inventions, mere downsizing is not necessarily enough to reach the requirements of an inventive step. in many fields downsizing can be considered as an obvious measure to take. one way to confer inventiveness on a nano-scale invention is the use of other processes to arrive at the nano-scale products. if the processes needed to produce nano-scale products are different from the processes used with bigger products, and those processes are not obvious to the posita, that may constitute an inventive step. inventiveness can also be derived from other sources, such as a new unexpected function at the nano scale that solves a problem stated in the patent. another way for nano-scale inventions to acquire inventiveness is that prejudice has to be overcome in order to arrive at a nano-scale invention. according to epo, a prejudice is ‘‘a widely held but incorrect opinion of a technical fact’’19. the idea of 15 schellekens 2010, p. 51-54. 16 35 u.s.c §102 17 u.s. patent no. 7,312,155 (filed apr. 7, 2004, issued dec. 25, 2007). available at http://www.patentstorm.us/ patents/7312155.html. 18 troilo 2005, p. 37. see also williamson & carpenter 2010, p. 134. 19 schellekens 2010, p. 56. 6 nordic journal of commercial law special edition 2011 prejudice is very strictly applied and it will become more difficult to use as knowledge of nanotechnology develops further.20 in the u.s. the required inventiveness of the patentable invention is expressed in 35 u.s.c. § 103. a patent may not be obtained, “if the differences between the subject matter sought to be patented and the prior art are such that the subject matter as a whole would have been obvious at the time the invention was made to a person having ordinary skill in the art to which said subject matter pertains”21. the uspto uses guidelines based on two u.s. supreme court decisions in order to determine whether an invention is obvious. the first case, graham v. john deere co., is from the year 1966. the supreme court established four factors for determining obviousness: 1) the scope and content of the relevant prior art; 2) the differences between the prior art and the claims at issue; 3) the level of ordinary skill in the pertinent art; and 4) secondary considerations such as commercial success, long felt but unsolved needs, and failure of others. based on these four factors, the court of appeals for the federal circuit used the tsm test22 for years. forty years later the supreme court again addressed the issue of obviousness in ksr int'l co. v. teleflex, inc. the court found that the tsm test was rigid, and while it didn’t overrule the test, it stated that the tsm test is only one of many tests to determine obviousness. the court found that a posita is also a person of ordinary creativity and thus in many cases where “familiar items may have obvious uses beyond their primary purposes [and the posita]will be able to fit the teachings of multiple patents together like pieces of a puzzle”.23 2.2.3 industrial applicability according to the european patent convention, an invention must be industrially applicable in order to be patentable24. an invention is considered as susceptible of industrial application if it can be made or used in any kind of industry, including agriculture. this however does not mean that industrial applicability requires ability to make a product for the public at large. basic materials may find application in industry through having a use as research tools. it has to be noted that this kind of research tool must, in order to be patentable, have a concrete use as a research instrument without the necessity to engage in further research. another issue concerning nanotechnology inventions is that it is sometimes not yet possible to produce nanoscale substances in large amounts. that may cast doubt over the industrial applicability of a patent on a nano-scale substance, for it is difficult to build an industry on tiny quantities of a 20 schellekens 2010, p. 54–56. see also kallinger et al. 2008, p. 100–101. 21 35 u.s.c. § 103(a) 22 the tsm test held that obviousness rejections needed some evidence of teaching, suggestion, or motivation to combine the relevant prior art. 23 williamson & carpenter 2010, p. 132-133. 24 epc art. 52 and 57. 7 nordic journal of commercial law special edition 2011 substance. for example, the production of carbon nanotubes at an industrial scale is still not completely solved. distinctive to nanotechnology due to the size scale, is also the fact that it is still difficult to verify that nanotech inventions work as claimed by the patentee. instruments to measure effects on a nano scale and even metrologies are often lacking. the disclosure of the invention has an important role as it has to be elaborate enough to convince the posita that the invention works as claimed. if the invention doesn’t work, it has generally no practical use and therefore does not meet the requirement of industrial applicability.25 the requirement of industrial applicability is similar to the u.s. term of utility26. the invention defined by the claims of the patent has to have utility, which means it has to be operative and function for its intended purpose. while the utility requirement is not usually an issue in traditional inventions such as mechanical or electrical applications, it may pose a problem in an emerging field like nanotechnology. in emerging technologies the utility of an invention may not always be known at the time of conception or reduction to practice. in the interdisciplinary field of nanotechnology it is difficult to determine a good balance of claims in a patent application; claiming incredible uses of the invention may lead to the patent being denied on lack of utility and on the other hand unnecessarily limiting the claims not to cover anticipated improvements may render a patent useless.27 as previously stated, special characteristics in nanotechnology are its interdisciplinary nature and the fact that the technology is still in its infancy. the utility of the new inventions may not be known at the time of conception, which poses a challenge in patenting nanotechnology. partly due to the lack of sufficient knowledge and partly due to companies intellectual property strategies, nanotechnology patents are broadly claimed; a “land-grab” mentality predominates in nanotechnology. these and other issues related to nanotechnology inventions are addressed in the next chapter. 3 operational environment of nanotechnology patenting 3.1 operational framework of nanotechnology patents nanotechnology is a branch of technology at its infancy and it typically requires high expertise and funding. it is not possible to do nano-scale research without requisite equipment and laboratory facilities. although private corporations invest in nanotechnology research and patenting as well, unique to nanotechnology patents is that they are held in large proportion by 25 schellekens 2010, p. 56–58. 26 it has to be noted, that the requirements are not congruent. the european patent law does not consider utility as a patentability criterion, which can be read in the decision t 0388/04. 27 troilo 2005, p. 37–38 and halluin & westin 2004, p. 235–236. 8 nordic journal of commercial law special edition 2011 universities28. the amount of university filings in epo applications has risen 600 % since the 1980s, and in nanotechnology and the life sciences universities file up to 50 % of all patent applications29. universities collaborate with companies and industry. while the inventions resulted in academic research may not yet have commercial or industrial use themselves, private companies can carry on developing them into industrially applicable products. in addition, universities have top know-how and the advantage of research exemption30 at their use. private corporations have therefore a good reason to fund academic research. nanotechnology has grown explosively under the last years, and much of that growth is funded by government grants. industry is another significant financier, for it sponsors certain research agreements.31 nanotechnological research is carried out in various universities throughout the world. as an emerging technology it offers scientists many interesting research subjects and huge potential for scientific breakthroughs. over the last decades the universities’ patenting activity has increased. the two main elements that lead to this development are the emergence of new technologies and the adoption of the bayh-dole act in the u.s. in 198032. the bayh-dole act, also known as university and small business patent procedures act, gives u.s. universities, small businesses and non-profits intellectual property control of their inventions and other intellectual property that results from federal government funding. the bayh-dole act encourages universities to collaborate with industry to promote the development and commercialization of the inventions made at universities using federal research funding. universities have the right to elect title to federally funded inventions, and the obligation to file for patents on these inventions they elect to own.33 the act has said to have greatly influenced europe’s view on universities’ obtaining of patents and some countries in europe even have similar legislation in force today.34 research universities engage in the transfer of technology inter alia to facilitate the commercialization of university discoveries for the public good, to forge closer ties to 28 lemley 2005, p. 615. 29 laflame 2010, p. 626. 30 the research exemption excludes certain uses of patented subject matter from their ability to infringe a patent. however, the scope of the research exemption differs within several epc jurisdictions. 31 shaddox 2006, p. 166. 32 laflame 2010, p. 625–626. 33 berneman & denis 2002, p. 228–229. 34 laflame 2010, p. 626. 9 nordic journal of commercial law special edition 2011 industry and to promote economic growth35. the above said and the fact that academic patenting could mean potential new jobs in the management of university intellectual property are used as justification for academic patenting and regional governments’ support to it36.37 3.2 patenting building blocks partly due to legislation changes, and partly due to the increased magnitude of intellectual property rights around the world, patent applications are filed earlier and more often than ever. the case with a new technology like nanotechnology is that the basic ideas, the building blocks of nanotechnology, are patented at the outset38. universities have patented building blocks of nanotechnology due to their role in basic research. out of ten foundational nanotechnology inventions identified by lemley39, seven are owned by universities.40 this is possible because universities still probably have the best requisites to do fundamental research on new technologies. for one reason or another, most of the so called enabling technologies of the twentieth century, the computer, software, the internet and biotechnology, were not patented from the very beginning of their rise. the core building blocks of these technologies ended up in the public domain through policy decision, shortsightedness, personal belief, government regulation or some other reason. in nanotechnology, on the contrary, both universities and companies are patenting early and often. many of the most basic ideas in nanotechnology are already patented; patents have issued for example on carbon nanotubes, semiconducting nanocrystals, atomic force microscopes and a method of making self-assembling nanolayer. these however are not the only patented building blocks and probably more basic ideas in nanotechnology will end up patented. patent applications can sometimes spend long times in the patent office, and because many of these applications will never be published, it is impossible to tell, which currently unpatented technologies will ultimately be patented.41 35 berneman & denis 2002, p. 227. 36 laflame 2010, p. 626. 37 academic patenting has also faced criticism: according to laflame some scholars see that fostering academic patents might lead to a lower "quality" of these patents and that the academic research might shift towards more “applied” science due to the incentives created by this fostering 38 lemley 2005, p. 605. 39lemley lists patents on carbon nanotubes (3), semiconducting nanocrystals (2), light-emitting nanocrystals, metal oxide nanorods, atomic force microscopes, a method of making a self-assembling nanolayer, and a method of producing nanotubes through chemical vapor deposition. 40 lemley 2005, p. 614–616. 41 lemley 2005, p. 606–615. 10 nordic journal of commercial law special edition 2011 only a few of the basic building blocks are unpatented. buckminsterfullerene42 is probably the most well-known example. buckminsterfullerene is composed of 60 or 70 carbon atoms shaped in a highly symmetrical spherical structure. even though the substance in itself is unpatented, a huge number of patents have been issued on buckyball technology. from the classic buckyball shape the fullerene field has grown to a variety of carbon-based structures, including the above mentioned carbon nanotubes. the fullerenes are important, because unlike most carbon forms, they have the ability to enclose and incorporate other elements, including metals and noble gases. thus fullerene structures have huge potential for manufacturing novel compounds and polymers for many different types of applications in a broad array of technology fields.43 it has to be noted that patent laws prohibit the patenting of abstract ideas, thus preventing early-stage patenting of broad concepts. dr. zekos sees the danger in patenting nanotechnology, which is still in its embryonic form, being the possible patenting of merely science and abstract ideas belonging to humanity. as mentioned above, many of the most basic ideas in nanotechnology are indeed already patented or may end up being patented.44 the issue of broad claiming in nanotechnology patents is dealt with next. 3.3 broad claiming and the “land grab” mentality in nanotechnology developing basic building blocks in nanotechnology is itself a complex and uncertain process and turning those building blocks into useable products takes considerable further research and time. nanotechnology inventions require high investment in research and development. this and the long and doubtful process of innovating insinuate that nanotechnology patents should be reasonably broad, but not to the extent they prohibit further innovation.45 the temptation of claiming broadly and so receiving an issued patent that covers much more than the actual invention is understandable. the patent “land-grab” mentality means that corporate entities (and other potential patentees) seek and carve out far-reaching patent rights. patentees often use the expedient of using broad and ambiguous terms in their patent claims to broaden the scope of protection for their invention. in some cases the specific types of nanoparticles, like quantum dots or nanotubes, are ambiguously described in the written description section of the patent instead of the actual patent claims. as an example of nonspecific terminology is the use of the word “nanoparticle”: it could refer to any shape nano-scale particle. patents using such ambiguous terms are often subjected to claim interpretation to determine their true scope. claim terms should be construed by first referring to intrinsic 42 buckminsterfullerene is named after the geodesic architect buckminster fuller. the substance is affectionately named “buckyballs”. 43 halluin & westin 2004, p. 229–231. 44 zekos 2006, p. 310 and 361. 45 zekos 2006, p. 361. 11 nordic journal of commercial law special edition 2011 evidence, which includes the claims, the specification, and the prosecution history of a patent application. if the intrinsic evidence is not enough to clear the meaning of a claim term, then extrinsic evidence, such as dictionaries and relevant technical treatises, may be consulted.46 of course, by claiming broadly and using ambiguous terms in their patent applications, applicants take the risk of negative claim interpretation. broad claiming in nanotechnology has lead to growing uncertainty amongst researchers, developers, policy-makers and investors regarding who really owns what particular element of technology. with focused claim drafting the patent owners may find it easier to convince investors and acquiring companies, who are wary of broad and possibly overlapping patents, of the defensibility and validity of their patents.47 the far-reaching patent rights provided by early nanotechnology patents seem to overlap. this could lead to a vast amount of litigation in the future48. in the u.s., commentators blame the uspto and its problems of the trend of uncertainty and patent overlaps49. the epo and other patent authorities around the world face the same problems. 3.4 the challenges patent authorities encounter in nanotechnology the amount of patent applications has surged, and the applications are more complex than ever. distinctive to nanotechnology patent applications is that they are of multidisciplinary nature and their proper examination requires wide know-how of the examiners. in europe, epo’s workload has been said to have multiplied by 20 over the past 25 years. the patent filings have increased exponentially, but probably more problematic than that is the increase in the number of claims and pages in the average application. the average number of claims in an application has risen from 12 to 20 in two decades and the pages have increased over the same time period from 16 to 30. the applications especially in the fields of new technologies are increasingly complex and typically also have the most number of claims per application. the workload is only expected to increase in the future, mainly because of the improved integration of the european market for technology through the london protocol or the european patent litigation agreement, the potentially sharp increase in patent filings 46 o’neill et al. 2007, p. 30–33. 47 o’neill et al. 2007, p. 30, 39 48 litigation on overlapping patents in nanotechnology is not only a future scenario, but reality today (as shown on the before mentioned cases in this paper). the point is that the amount of litigation may grow, depending of course partly on the patent authorities’ choices and decisions made concerning nanotechnology patents and licensing now and in the future. 49 o’neill et al. 2007, p. 30. 12 nordic journal of commercial law special edition 2011 originating from fast developing countries and the arrival of new actors.50 the described development has lead to pressure to increase productivity of the examiners at the epo. basically increasing productivity in this case means that examiners are spending less time on each application and thus the quantity of issued patents increases at the cost of quality.51 the epo set up a nanotechnology working group in 2003 to ensure that it was well-prepared for the impact of nanotechnology. the working group has called on internal and external expertise to develop a strategy for facing the patent challenges ahead. the most welcomed action taken by the epo to tackle nanotechnology was the introduction of the "y01n" tags to label nanotechnology in epo databases. the interdisciplinary nature of nanotechnology made it difficult for anyone to retrieve existing patent documents and other literature on nanotechnology from the databases available before the new “y01n” tags. the y10n code is constantly updated and improved along with the progression of the technology.52 the tagging system used in epo helps both inventors and patent examiners in their search for prior art. in the u.s. the uspto has also improved the quality of examination of nanotechnology patent applications. the uspto created a nanotechnology class53 to organize most nanotechnology subject matter in a logical manner. even though this significantly aides the patent examiners in their prior art search, it is still difficult to find relevant prior art. the uspto has also utilized a nanotechnology customer partnership program to help identify sources of prior art and establish technical training programs for examiners.54 finding relevant prior art is in fact a very challenging task. instrumental in examining prior art could be the peer to patent project55. noveck calls for creating a wiki-based “peer-review” system that will allow the expert community to provide relevant prior art for pending applications. the information would supplement the results found by the examiner and provided by the applicant. the system could response to difficulties third parties face in providing relevant prior 50 for one more reason, see van zeebroeck et al. 2008: “the size of patent applications is strongly affected by their geographical origin and technological area, with us drafting styles and biotechnologies leading the race. the strong effect of the filing route followed by applications prior to be filed at the epo (and the well-known increasing success of the pct option) suggests that the internationalization of patenting procedures and of technology markets encourages applicants to draft their applications only once according to the contingencies and modes of the largest market, namely the us, and to transfer their us-styled applications across the world, including the epo.” 51 laflame 2010, p. 630–632. 52 nanotechnology in european patents challenge and opportunity (available at http://www.epo.org/newsissues/issues/nanotechnology.html) 53 class 977 contains 263 subclasses. class 977 is a cross-reference classification, and prior to issuance a nanotechnology patent is first assigned a main classification in an area related to its specific technology, and then assigned a secondary nanotechnology classification to provide a supplemental search resource. 54 williamson & carpenter 2010, p. 133. 55 the peer to patent project is based on beth noveck’s 2002 paper “peer to patent”: collective intelligence, open review and patent reform. 13 nordic journal of commercial law special edition 2011 art to an examiner during patent examination, as well as the difficulties patent examiners face trying to take into account all relevant prior art. one advantage in this system is its costeffectiveness: instead of wasting a huge amount of money in litigation, “bad” patents will be ferreted out expeditiously and with minimal costs. the uspto has adopted a pilot program utilizing this proposed system for reviewing applications for technology center 2100, the chief group for software patents. the program has already led to communal prior art submissions against many big companies, like yahoo and general electric.56 other issues complicating matters even more in both the u.s. and in europe, are the facts that nanotechnology nomenclature is still quite diverse and nanotechnology standards are only beginning to be developed. besides that, the patenting authorities employ thousands of people. the epo is employing 7000 from over 30 countries57 and the uspto employs nearly 10 00058. this makes it challenging to provide the same level of education to everyone and maintain uniform practices in policymaking concerning, for example, the broadness of patent claims. 4 challenges and approaches to possible solutions 4.1 challenges there are three main challenges in the field of nanotechnology: patent thickets caused by broad and overlapping patents, patent trolls and infringement actions. what makes infringement actions special in this field is the fact that when operating on such a small scale, detecting infringement activity is difficult. the consequence of broad and overlapping nanotechnology patents being first filed and then granted is a patent thicket. a patent thicket is an unintentional formation of overlapping patent rights that belong to different owners. patent thickets require that those seeking to commercialize new technology obtain licenses from multiple patentees. patent thickets have the potential of preventing all parties from making a product that encompasses numerous patented technologies.59 as said, patent thickets are unwanted, because they typically stifle competition in market and furthermore impede innovation. a nanotechnology advisory firm called luxresearch consults clients for investment in nanotechnology. the firm has developed the luxreport, a report on nanotechnology patents. the report analyzed over one thousand patents related to the building blocks of 56 duane 2008, p. 70–72. 57 the epo, available at http://www.epo.org/about-us/jobs/why/who.html. accessed at 10.3.2010. 58 the uspto 2011-2015 strategic human capital plan, p.24. available at http://www.uspto.gov/ about/stratplan/uspto_2011-2015_strategic_human_capital_plan.pdf. accessed at 10.3.2010. 59 paredes 2006, p. 492–493. 14 nordic journal of commercial law special edition 2011 nanotechnology. the report stated that many of the issued patents overlap, to the extent of making a potential patent thicket.60 nanotechnology seems to follow similar paths to the radio industry in its infancy. the early years of radio industry in the 1920’s were privately funded and there was extensive patenting among a diverse group of unaffiliated private entities. the diverse group of investors, each of whom were keen on exploiting their patents for maximum advantage, owning the key patents in the industry lead to rife patent litigation and patent blocking. in cases where two patents, owned by competing entities, were essential to practice a particular innovation, the patent battles resulted in deadlock. such situations also halted progress, because in the radio industry one innovation builds on others and the end product is the result of many related technologies. despite the reluctance of cross-licensing between key position corporations, finally some crosslicensing agreements on patents had to be arranged. it has been stated that the development in the radio industry was forestalled by an overarching unwillingness to cross-license patents, and it is hard to object to that statement.61 in the radio industry the seminal inventions were privately funded and privately owned and had strong immaterial property protection. in comparison nanotechnology is both privately and publicly financed, but has likewise strong ip protection. as a result of the bayh-dole act though, in u.s. the publicly funded nanotechnology research will end up privately owned. this means that nanotechnology industry is in fact in a very similar state as the radio industry once was.62 the development of a nanotechnology patent thicket could impede the licensing process required for further innovation. in nanotechnology, like in the radio industry, it is often necessary to obtain licenses from many different patent owners to enable the production of new technology. the accumulated transaction costs of all the required licenses may become prohibitive for the licensee. it has been marked that, in the field of nanotechnology, patent holders are not likely to collaborate voluntarily in order to form patent pools and circumnavigate these patent thicket licensing problems. most of the nanotechnology research is already funded, so the inventors don’t have the need to pool patents. they rather keep their patents and licenses exclusive in order to gain greater profits in the future. other reasons are for example the fact that there has been little demonstrated need for pooling and nanotechnology as a multidisciplinary field makes it likely for researchers specializing in one area to find it difficult to compare the values of patents from other branches of science. in 60 paredes 2006, p. 491. 61 sabety 2005, p. 495–497 62 sabety 2005, p. 507. 15 nordic journal of commercial law special edition 2011 addition to the above-mentioned, nanotechnology is still in its infancy and as such an uncertain investment for financiers.63 although thousands of nanotechnology patents have been issued and even more have entered the application process in the united states, there is still very little nanotechnology-specific infringement litigation that would have reached judgment. especially in common law countries ample case law would provide useful guidelines on the validity of nanotechnology patents. considering the pace of nanotechnology development and innovations, infringing patents and applications are bound to have come up, so why is there still no significant nanotechnologyspecific infringement case law? the obvious reason is the expense of litigation. also many innovators are in a situation where they simply lack standing. this leads to those innovators attempting to license "bad" patents rather than contest them. one factor deterring patent litigation is the assumption of symmetry: if a competitor sues you for infringement you can sue them back.64 the following two examples will shed little light on this issue. in the u.s. the first nanotechnology patent case in federal circuit was the in re kumar case. the central question in the case was the overlapping size of nanoparticles used in polishing applications. although the court disposed of the case on procedural grounds, the unanimous opinion touches upon a number of important issues for future nanotech patent cases. then again, this was not a case involving litigation between two companies regarding infringement of a nanotech patent, but rather a determination by the pto.65 another example of a nanotechnology specific patent litigation is cabot microelectronics’ decision to pursue legal action against dupont air products nanomaterials (da nanomaterials) and korea's cheil industries: cabot claimed da nanomaterials is manufacturing and marketing slurries that infringe on its patents. cabot made this decision at the turn of year 2006/2007. after this a long process followed. da nanomaterials brought a non-infringement lawsuit against cabot and both parties were to submit pretrial filings by january 15, 2010. finally, a jury in the united states district court for the district of arizona rendered a verdict according to which da nanomaterials’ products do not infringe cabot’s patents. even without knowing the exact legal and other expenses both parties had to carry during litigation, the process was undoubtedly remarkably costly.66 63 tullis 2005, p. 295–297. 64 tullis 2005, p. 298–299. see also lemley 2008, p. 615. 65 baluch et al. 2005, p. 342–344. 66 online news concerning the case are available at: http://www.nanotechbuzz.com/50226711/ cabot_alleges_nanotechnology_patent_infringement.php, http://www.azonano.com/news.asp?newsid=14832, http://www.azonano.com/news.asp?newsid=15188 and http://www.azonano.com/news.asp?newsid=18478. accessed at 7.4.2011. 16 nordic journal of commercial law special edition 2011 nanotechnology is a difficult branch of technology from patent owner’s and licensee’s point of view, when they are considering the policing and enforcing nanotechnology patent rights against possible infringers. the exceptionally small scale makes it hard to analyze, observe and police the infringing activity of nanotechnology. furthermore, a vast number of new innovations and improvements to existing technology are occurring almost daily across multiple disciplines. thus the nature of nanotechnology as a small-scale multidisciplinary branch of science makes it difficult to determine whether a third party is infringing.67 zekos has stated that because of this difficulty, nanotechnology industry will follow the footsteps of biotechnology: to avoid a patent thicket at the research stage it will not limit the scope or issuance of patents, but merely ignore them.68 as mentioned before, the patent authorities are having a hard time reviewing nanotechnology patent applications thoroughly, partly because of the amount of the applications and partly because of the multidisciplinary nature of nanotechnology. this results in “bad” patents being issued, which in turn leads to increased and costly litigation, a burden on invention because of fear of potential infringement, and the rise of patent trolls.69 patent trolls are companies or persons that use their patents against one or more alleged infringers in a manner considered unduly aggressive or opportunistic. often these patent trolls have no intention of manufacturing or marketing the patented inventions themselves. among some industry representatives universities are considered to be patent trolls: universities don’t need a license to other people’s patent rights and thus have no interest in cross-licensing, so they are only interested in money70. related to patent trolls is the term warehousing. in other words, these companies warehouse patent rights to extract cash from others that are found to be infringing these rights. in some cases the mere threat of costly litigation results in payment of tribute. part of the problem is the patents resulting from publicly funded research. universities should avoid warehousing patent rights as an investment and instead use their patents that have resulted from publicly funded research as tools to provide a nascent company with a competitive position that can attract capital to build a business.71 67 sutton et al. 2009, p. 180. 68 zekos 2006, p. 363. 69 duane 2008, p. 67. 70 lemley 2008, p. 615–616. 71 sabety 2005, p. 509–510. see also duane 2008, p. 68–69. 17 nordic journal of commercial law special edition 2011 4.2 possible solutions a resolution to patent thicket could be found in licensing, but it has been argued that limiting the scope of overlapping claims is at least equally important72. when considering licensing nanotechnology, probably most of the questions unique to nanotechnology are related to size, but what the licensees should consider more, is the intellectual property matters. in the nanotechnology context the licensees should investigate intellectual property matters in detail. often licensees do a comprehensive market survey and financial analysis and investigate carefully the technical aspects of the subject of the license but do not give the intellectual property the attention it deserves. as mentioned before, nanotechnology is a field of broad and overlapping patents. that is why it is important to include into the licensing due diligence report a review of the quality of the patents, with extra attention to the scope of the claims and the possibility for competitors to design around the technology.73 as mentioned, the development of nanotechnology patent thicket could impede the licensing process required for further innovation. at this point one option could be compulsory licensing. compulsory licensing means that government forces the patent holder to grant use to the state or others. the trips agreement74 sets out specific provisions that shall be followed if a compulsory license is issued, and the requirements of such issues. article 31 of the trips agreement permits world trade organization members to grant compulsory patent licenses under the limited circumstances of national emergency, antitrust violations, and public noncommercial use.75 on one hand, compulsory licensing can be seen as a solution to certain problems in the field of nanotechnology, but on the other hand it can also be seen as a scheme that stifles innovation and investment. the only two statutory compulsory licensing provisions in the u.s. are for inventions related to atomic energy and air pollution control76. developing downstream products comprises high risks and development costs, which makes proper patent protection highly important for companies. one aspect of this is the venture capitalists’ eagerness to invest in start-up companies: it decreases if there’s a risk that government shatters the patent barriers that protect their investments. another issue is the decrease of public disclosure of technological process, when companies rely rather on trade secrets than patents to protect their 72 burk and lemley 2003, p. 1614. 73 shaddox 2006, p. 165–167. 74 the agreement on trade-related aspects of intellectual property rights 75 tullis 2005, p. 293–297 and 311. 76 according to lemley (2008), some have even suggested that all publicly funded research should be subject to compulsory licensing. the opinion reflects the fear that universities might treat their licensing offices as revenue generation devices, which might lead to university patent policies that are not often consonant with the ultimate public interest. 18 nordic journal of commercial law special edition 2011 inventions.77 compulsory licensing is widely criticized and rarely used and thus it may not be the answer to solving problems caused by the patent thicket in the field of nanotechnology. it has been argued that limiting the scope of overlapping claims are at least equally important as licensing when trying to find a resolution to patent thicket. one tool to narrow broad claims that comprise these overlapping patent rights could be the written description requirement. one purpose of written description requirement is to ensure that the inventor actually has invented what the patent application claims; to obtain a valid patent an applicant must include in his or her application a specification adequately disclosing the invention and how to make and use it. the requirement protects against overbroad claim amendments by requiring patent applicants to provide a description sufficient to show that they are in possession of the invention. thus the written description requirement derives in part from considerations of patent breadth. the assessment whether the written description sufficiently supports a patent’s claims is made through the eyes of the posita. it is considered probable that the third parties are likely to perceive what the posita is likely to understand.78 according to paredes, the written description requirement can be used to prevent or even clear the patent thicket in nanotechnology. he states that “each legal principle under the written description requirement should be examined and applied appropriately to each nanomaterial with broad, overlapping patents”. also the strong presumption of compliance with the written description requirement should be inapplicable to new technologies.79 4.3 recommendations as mentioned earlier, broad and overlapping patent claims lead to patent thickets and at worse to patent blocks, if patent owners are not willing to cooperate with others. to prevent possible deadlock situations, cross-licensing and patent pools should be used more in the field of nanotechnology. patent owners and licensees should also cooperate more to prevent infringement actions. a cross license is an agreement between two or more parties that grants each the right to practice the other’s patents. despite the fact that the term ‘cross licensing’ implies that neither party pays monetary royalties to the other party, cross licenses may or may not involve fixed fees or running royalties, which can run in one direction or in both. cross licenses may also involve various geographic or field-of-use restrictions. it is common that cross licenses involve some but not all relevant patents held by either party.80 parties are often symmetric in a sense that they 77 miller 2005, p. 79–80. 78 paredes 2006, p. 493–496. 79 paredes 2006, p. 512. 80 shapiro 2001, p. 127. 19 nordic journal of commercial law special edition 2011 both are usually companies and have certain essential patents in a certain field of technology. this symmetry also means that usually when a competitor sues a company, the company can sue them back81. universities, as mentioned before, don’t need a license to other parties’ patents due to research exemption. this has lead to some commercial parties claiming that universities are patent trolls who only want to gain profit by licensing their own patents. in certain situations cross-licensing is also a means to eliminate or at least minimize costly legal battles; cross-licensing can offer a viable alternative to litigation for companies whose technologies have an overlapping scope. parties should be encouraged to grant cross licenses when in this situation of similar or overlapping scopes. covenants not to sue in cross-license agreements can decrease the costs associated with fighting infringement suits. cross-licensing may also be a feasible strategy for late-comers looking to enter a technical area where there are already existing players. usually late-comers are in a defendant position because the existing players have the basic patent rights of the technical area in question. however, if a late-comer enters the market with a patent portfolio that fences in an existing player’s technology, the latecomer may be able to force the existing player into a cross-license agreement in order to maintain its possibilities of expanding its technology outwards. the terms of a cross license in this situation may well be advantageous to the late-comer because of the late-comer’s superior bargaining rights. in nanotechnology these situations occur for example in the area of nanotube technology, which is an area currently experiencing increased cross-licensing.82 by definition, a patent pool is a consortium of at least two companies agreeing to cross-license patents relating to a particular technology. under a patent pool, an entire group of patents is licensed in a package, usually to anyone willing to pay the associated royalties. 83 under a package license, two or more patent holders agree to the terms on which they will jointly license their complementary patents and divide up the proceeds. patent pools are a form of self-regulation. pooling patents has its pros and cons. pros of selfregulation are among other things the use of top-level expertise when making the regulation and also increased commitment to the regulation. according to some studies the parties involved in making the rules of a regulation are usually more willing to accept and conform it. self-regulation is also more adaptable and cost efficient than government based regulation. it is said that self-regulation improves the equality of private parties in comparison to government officials. the criticism of self-regulation sums up in its inefficiency, possibly low sanctioning and the rise of free rider mentality. it has also been stated that self-regulation concentrates on the private interest at the expense of the public interest.84 81 lemley 2008, p. 615. 82 sutton et al. 2009, p. 179. 83 shapiro 2001, p. 127. 84 vuorinen 2008, p. 49–50. 20 nordic journal of commercial law special edition 2011 patent pools bind only their member patent owners and licensors. one of the most important provisions in patent pools is the obligation to license certain key patents to the pool. pooling the building block patents of nanotechnology could lead to both increased licensing in the field and broader access to technology. pooling is a good option when compared to compulsory licensing. especially in the u.s. the government intervention is traditionally seen as detrimental to competition and to free market economy. the attitude towards compulsory licensing is not too approving in other parts of the world either. self-regulation, such as patent pools, is said to restrain the authorities’ interference and to provide the rise of field-specific appreciation85. thus patent pools could be one answer to dealing with the patent thicket problem. as mentioned many times above, nanotechnology is at its infancy. this basically means that the patent thicket will probably thicken and become a bigger issue in few years because of the vastly growing amount of patent applications in the field. forming patent pools seems to be a rational measure to take to avoid, among others, government interference and costly infringement litigations. noticing infringement in nanotechnology, as stated above, is quite challenging. cooperation between licensor and the licensee is one means to increase possibilities of detecting infringement actions early on. mutual cooperation provisions can facilitate some of the burden faced by licensors in enforcing and policing their patent rights. mutual cooperation provisions demand that both parties to the agreement cooperate to protect each other’s patent rights. these provisions may require that both the licensor and the licensee participate in gathering evidence and pursuing court action in the event of infringement. this can lead to the identification of infringing activity early on, before any significant financial or other harm comes to either party. furthermore, mutual cooperation in a patent infringement action can lead to better chances of success in proving cause of action.86 5 conclusion nanotechnology is one of the rising fields in technology of our age. its special characteristics are its size and multidisciplinary nature. nanotechnology is still at its infancy and has huge potential. some nanotech related inventions are already a part of our daily lives and in the future innovations of this field will become more and more frequently used in everyday life. nanotechnology poses many questions. nowadays it is clear that nanotechnology inventions are generally patentable. patentability criteria apply to nanotechnology the same way as to innovations from other fields of technology. the most notable issue to consider in nanotech patent applications is often related to size: whether the innovation in question is novel and entails an inventive step compared to similar inventions that operate on a different size scale. it 85 vuorinen 2008, p. 50. 86 sutton et al. 2009, p. 180. 21 nordic journal of commercial law special edition 2011 is also clear that a naturally occurring substance or a new found property of such substance can not be patented as such, but products or processes that arise from human effort are inventions and thus patentable. the authorities in both europe and the u.s. have faced same problems as the amount of patent applications filed in the field of nanotechnology has grown vastly. measures, like creating a labeling system for nanotechnology inventions or educating the staff are taken, but there’s still more to do. the patent authorities should be encouraged to find and use new, innovative methods in examining patent applications. one example introduced in this paper is the peer to patent project. as the wise men have said; problems can’t be solved using the same way of thinking used when they were created87. noveck’s wiki-based “peer-review” system is a modern creation that would not have been feasible a few decades ago, but fits well in the information society of today. problematic in nanotechnology patenting is the fact that so many overlapping patents have already issued and there are probably more to come. this forms an undesirable patent thicket. as possible solutions to problems caused by patent thicket and blocking patents, voluntary licensing, both in the form of simple cross-licensing and creating patent pools, are introduced. patentees should be encouraged to license more and to cooperate more. licensors and licensees should work together in order to stop infringement activity. it seems that there is no need to change patenting legislation because of nanotechnology. patent laws offer enough room to patent nanotechnological inventions. in the future, and already today, more attention should be paid to the scope of claims in nanotechnology patent applications and creating nanotechnology standards as well as a clear nomenclature. 87 a quote from albert einstein: "we can't solve problems by using the same kind of thinking we used when we created them." 22 nordic journal of commercial law special edition 2011 bibliography articles and books andrew s. baluch, leon radomsky, stephen b. maebius: in re kumar: the first nanotech patent case in the federal circuit. nanotechnology law & business vol. 2 no. 4 november/december 2005. available at: http://www.foley.com/files/tbl_s31publications/fileupload137/3173/in%20re%20 kumar%20-%20radomsky%20-%20maebius.pdf louis p. berneman, kathleen a. denis: university licensing trends and intellectual capital. the lesi guide to licensing best practices: strategic issues and contemporary realities. new york 2002. dan l. burk, mark a. lemley: policy levers in patent law. virginia law review, november 2003. john matthew duane: lending a hand: the need for public participation in patent examination and beyond. chicago-kent journal of intellectual property 2008. richard p. feynman: there's plenty of room at the bottom. available at: http://www.zyvex.com/nanotech/feynman.html. albert p. halluin – lorelei p. westin: nanotechnology: the importance of intellectual property rights in an emerging technology. journal of the patent and trademark office society march 2004. helsinkinano-hankkeen loppuraportti. helsinki 2005. christopher m. holman: patent border wars: defining the boundary between scientific discoveries and patentable inventions. trends in biotechnology, vol.25 no.12 december 2007. christian kallinger – victor veefkind richard michalitsch yves verbandt andreas neuman manfred scheu: patenting nanotechnology: a european patent office perspective. nanotechnology law & business, spring 2008. michael laflame, jr.: the european patent system: an overview and critique. houston journal of international law, summer 2010. mark a. lemley: patenting nanotechnology. stanford law review, vol. 58, no. 2 november 2005. mark a. lemley: are universities patent trolls? fordham intellectual property, media and entertainment law journal, spring 2008. john c. miller: the handbook of nanotechnology: business, policy and intellectual property law. hoboken, new jersey 2005. sean o'neill, kirk hermann, marlene klein, jeff landes, raj bawa: broad claiming in nanotechnology patents: is litigation inevitable? nanotechnology law & business march 2007. efthimios parasidis: a uniform framework for patent eligibility. tulane law review december 2010. j. peter paredes: written description requirement in nanotechnology: clearing a patent thicket? journal of the patent and trademark office society, june 2006. ted sabety: nanotechnology innovation and the patent thicket: which ip policies promote growth? albany law journal of science and technology 2005 maurice schellekens: patenting nanotechnology in europe: making a good start? an analysis of issues in law and regulation. the journal of world intellectual property 2010 vol. 13, no. 1. robert c. shaddox: the big picture: nanotechnology impacts everyone. licensing best practices: strategic, territorial, and technology issues. hoboken, new jersey 2006. carl shapiro: navigating the patent thicket: cross licenses, patent pools, and standard setting. innovation policy and the economy, mit press 2001. 23 nordic journal of commercial law special edition 2011 paul j. sutton chinh h. pham joanna toke: nanotechnology licence pitfalls. journal of intellectual property law & practice, 2009, vol. 4, no. 3. louis m. troilo: patentability and enforcement issues related to nanotechnology inventions. nanotechnology law & business 2005. terry k. tullis: application of the government license defense to federally funded nanotechnology research: the case for a limited patent compulsory licensing regime. ucla law review, october 2005. jarkko vuorinen: patenttipoolit itsesääntelyn ilmentyminä. lakimies 1/2008. mark williamson – james carpenter: traversing art rejections in nanotechnology patent applications – no small task. nanotechnology law & business, 2010. n. van zeebroeck – n. stevnsborg – b. van pottelsberghe de la potterie – d. guellec – e. archontopoulos: patent inflation in europe. world patent information, vol. 30, issue 1, march 2008. georgios i. zekos: patenting abstract ideas in nanotechnology. the journal of world intellectual property (2006) vol. 9, no. 1. other epo: nanotechnology in european patents challenge and opportunity available at: http://www.epo.org/news-issues/issues/nanotechnology.html (accessed 10.3.2011) statutes 35 u.s.c. epc 2000 trips agreement case law gottschalk v. benson 409 u.s. 63, 67. available at http://scholar.google.com/scholar_case? case=14331103368635133702&amp;q=gottschalk+v.+benson&amp;hl=en&amp;as_sdt=2002 t0552/00 smithkline beecham biologicals/wyeth, reason 20 [online]. available at http://legal.european-patent-office.org/dg3/pdf/t000552eu1.pdf. accessed at february 2011. t0547/99 orica australia pty ltd/ basf aktiengesellschaft. available at http://www.epo.org/lawpractice/case-law-appeals/recent/t990547eu1.html abbreviations epo european patent office phosita person having ordinary skill in the art trips the agreement on trade-related aspects of intellectual property rights microsoft word elli_valimaki_lopullinen.docx nordic journal of commercial law special edition 2011 calculation of royalties in compulsory licensing of pharmaceutical patents in europe – how much is justified? by elli välimäki 1 nordic journal of commercial law special edition 2011 1 the formula behind the sum rent-seeking companies are not aiming at increasing the quantity of capital services that their asset yields in certain period of time, but rather at investing in intangibles with the objective of gaining high returns in the future. in such cases the quantity is not really contributing to production or the economy. this causes such a company to posses so called monopoly rents, which are gold to the company itself as well as to the stock market, but unfortunately the benefits do not necessarily extend to the national economy.1 pharmaceutical companies are of such sort. they seek to invest in research and development (r&d) to gain high prices with possible future patented products during the patented lifecycle of their medicine. this causes controversy in the aspect of social welfare. pharmaceutical companies are often seen as inhumane in their quest for high rents at the price of human lives and health. in the battle against monopoly rents, legislation on compulsory licensing has been devised. compulsory licensing may be used by states to disrupt abuse of a monopoly position, to prevent or stop other anti-competitive actions or to simply provide easier access to medication. such compulsory licenses oblige the patent owner to license its patented medicine to another pharmaceutical company, often a producer of generic drugs. the issuing court may decide on a certain price for the license, i.e. a royalty payable to the patent owner, or it may condemn the patent to be licensed for free. the objective of this study is to answer the following sub-problems: how is the value of pharmaceutical patents calculated? what is the value of research and development for pharmaceutical companies? how is society affected by a compulsory license? through these sub-problems i seek to resolve what all the factors to be taken into consideration in order to calculate a justifiable amount of royalties paid for compulsory licenses in europe, are. the research is geographically restricted to europe in order to limit the study merely to developed countries, hence bypassing the biggest ethical problem of patents that is present in least developed countries (ldc). also, the united states is set aside, because of their heavy emphasis on the exclusive ownership of patents, and lack of case law concerning compulsory licensing of medical patents. moreover, the eu countries reflect relatively homogenous legislation and economies. 1 comment by jack e. tirplett in lev (2001), p. 192 2 nordic journal of commercial law special edition 2011 2 the x in the formula 2.1 a brief look at eu legislation on compulsory licensing compulsory licenses were originally created because individual intellectual property (ip) owners refused to license thei invention. it is an exception from the ip owner’s exclusive right and justifies the use of a protected right without the owner’s permission. hence compulsory licensing is often described as a deep-inflected process, the use of which must be based on cogent reasons.2 altogether the compulsory legislation in the eu is manifold, consisting of eu laws, eu courts’ decisions, and international obligations such as wto’s trips agreement. it is, however, not in the scope of this study to discuss the legislative sections to detail.3 at its simplest, compulsory licensing can be divided into: 1. merger-related compulsory licensing, and 2. non-merger related compulsory licensing. the first is more commonly used, and not as controversial as the latter.4 in the trips agreement compulsory licensing is, on the other hand, divided into 1) patents licensed for domestic production, and 2) patents licensed for export to ldcs. trips entered into force in 1995, including the articles on compulsory licensing to domestic markets. compulsory licensing concerning export was added to the agreement in 2003 through the doha declaration.5 the then european community and its member countries, in their own right, joined the wto in january 1995, and hence became bound by its regulations, including the trips agreement and its regulations on compulsory licensing.6 trips does not list the reasons for which compulsory licensing may be used, but rather leaves this to the member countries’ discretion.7 however, the agreement does, in article 31, list some conditions for the use of compulsory licensing. most importantly it states that in order to apply 2 vilanka (2004) 3 therefore, only the most important facts will be introduced, while the reader is welcome to look to the citations for more detailed information. 4 kanter (2006), p. 351 5 trips and health 6 wto – member information 7 trips and health 3 nordic journal of commercial law special edition 2011 for a license, the person or company should on reasonable commercial terms have attempted to negotiate a voluntary license. only if the negotiations for a voluntary license fail, a compulsory license is possible. it is also deemed that in case a compulsory license is issued, an adequate remuneration must be awarded to the patent holder: “the right holder shall be paid adequate remuneration in the circumstances of each case, taking into account the economic value of the authorization.” moreover, according to the trips agreement the compulsory license cannot be exclusive to the licensee, i.e. the patent holder still retains the right to produce, sell and market the drug. the compulsory licensing should also be subject to legal review within the country.8 in the european union compulsory licensing is mostly used in merger-related cases concerning provisions on competition law. in the interpretation of these provisions three important cases have added to the case law of the court of justice of the european union concerning compulsory licensing. those cases are magill,. 9after the ims health case the national court of germany asked for clarification to the relevant competition law standards, to which the european court of justice responded in 2004. the court concluded that the denial to license one’s intellectual property right to a competitor asking for such a license, is not in itself an abuse of a dominant position, but will be considered abusive if the following factors are met: 1. the refusal to license prevents the emergence of a new product, for which consumer demand exists; 2. no objective consideration can justify the refusal; and 3. the refusal provides the intellectual property owner with monopoly in the secondary markets of its intellectual property.10 the microsoft case, however, developed these circumstances. from microsoft it followed that 1) the intellectual property right (ipr) needs only realize the risk of eliminating competition, because of its necessity in the market, 2)the refusal to license may stifle innovation within the market, 3) and the refusal cannot be objectively justified by taking into consideration the innovation level of the market as a whole, compared to the innovation level of the dominant firm. in all, the result of the microsoft-case weakened the requirements necessary for issuing a compulsory licensing.11 yet the eu commission argues that evenin instances where these 8 trips article 31 9 magill c-241/91p, rte and itp v. commission, 1995 ecr i-743; c-418/01 ims health gmbh & co. ohg v. ndc health gbh & co. kg (2004); and comp/37.792, microsoft, march 2004 10 c-418/01 ims health gmbh & co. ohg v. ndc health gbh & co. kg (2004) 11 comp/37.792, microsoft, march 2004 4 nordic journal of commercial law special edition 2011 circumstances are not met, every case is evaluated on a case-by-case basis, and the refusal to license may be considered abusive.12 eu member countries may in some cases have national legislative norms on compulsory licensing, but mostly member state legislation should nowadays be in harmony with the eu legislation as well as the international obligations, especially in the area of competition law and issues concerning the common market and their efficient functioning. in all, the area of compulsory licensing is, however, constantly evolving as a result of vivid debate and controversy. 2.2 the odd one out, iprs or compulsory licensing viewpoints on compulsory licensing vary somewhat greatly, as does the reasoning for its necessity. however, as compulsory licensing might be thought of as an exception to general intellectual property legislation, it is no surprise that, like most exceptions, it causes difference in opinions. the value of a patent or technology is a very subjective issue. even to the extent that innovators do not necessarily understand the actual market value of their invention when being compulsorily licensed.13 the value of the patent perceived by the patent owner is not however the only problem. the possibility exists that by imposing compulsory licensing on pharmaceutical companies, the country in question reduces the company’s future incentives to invest in research and development and introduce new products to the market. similarly, the country’s medicine authority’s duty of regulating the terms and quality of licensed products may become more difficult. the gathering of data on adverse events may become challenging. moreover, such issues as enforcement of product recalls, informing on the correct use of products, as well as ensuring that licensed products are available for patients, may be affected.14 on the other hand fears persist that strong protection of intellectual property rights will cause a price increase in pharmaceuticals, the decline of local pharmaceutical industries, inhibition of access to treatment for patients, and that investment in the country will not increase.15 as a result, compulsory licensing is sought to resolve these fears. it is however, unsure whether it is strong ipr protection or compulsory licensing that causes more harm in the aforementioned areas. 12 katsoulacos (2008), p. 288 13 rozek (2000), p. 890 14 rozek (2000), p. 890-891 15 rozek (2000), p. 892 5 nordic journal of commercial law special edition 2011 it is often thought that patent protection provides pharmaceutical companies with monopoly power. this is not however completely true. instead of being provided with a monopoly position, pharmaceutical companies are for a limited time-period granted the exclusive right to produce, sell and market products embodying a clearly-defined innovation. therefore, only one treatment type with only a certain active ingredient is protected, whilst all other treatments are possible to produce. conclusively, competition does not suffer as a mere result of patent protection.16 in general intellectual property protection does not have any effect on the prices of pharmaceuticals as long as therapeutic alternatives exist.17 however, if a pharmaceutical company has a strong patent position, meaning that it possesses many interlinked patents, then competition may decrease as a result of no alternative treatment methods being free of patent protection.18 similarly, the possibility exists that no other treatment method is possible for a certain disease, and that a patent protects the only possible one. in such cases competition could indeed be obscured and the patent owner have monopoly. hence, pharmaceuticals with no therapeutic alternatives have higher prices than compared with prices of generic products lacking intellectual property protection. this however might be the cost of encouraging innovation and improving health care.19 some fears exist that strong ipr protection will result in success for only the largest companies, as smaller ones cannot afford to wait for the expiration of patents. patents however encourage companies to innovate, as well as to make innovations public. as a result, when patents expire, generic companies have more innovations to copy than would be without the patent protection. moreover, when patent laws were introduced in italy, employment within the pharmaceutical sector grew faster than employment nationally. similarly, pharmaceutical companies’ spending grew by over 300 per cent during 1978 and 1993, meaning that the effect of the patent protection might already have affected the gnp. in canada a 269 per cent growth in the medical r&d employment was experienced as a result of changing the legislation from providing for compulsory licensing to protecting patents. the overall employment in the pharmaceutical industry in canada grew by 35 per cent. evidence also shows that pharmaceutical companies choose locations for their plants and other facilities based on the ipr environment of countries, hence having an effect on the foreign direct investment (fdi) injected into national economies.20 although iprs protect local companies from foreign infringers within the domestic market, intellectual property legislation signals to foreign investors that the country recognizes the rights 16 rozek (2000), p. 892 17 rozek and berkowitz (1998), p. 215-216 18 narin (1998), p. 71 19 rozek and berkowitz (1998), p. 215-216 20 rozek (2000), p. 894-896 6 nordic journal of commercial law special edition 2011 of foreign firms and that foreign investors may make strategic business decisions without government interference. strong protection of intellectual property also indicates to investors that the country has a transparent legal system with unbiased application of commercial laws, as well as reduced corruption in government activities. moreover, there is evidence to show that patents reflect the owning company’s position in the market. therefore, the financial market and customers may infer from acquired or filed patents that the firm has strong market presence and may potentially gain dominant status. in addition, patents indicate strong r&d, productivity and innovation activity. venture capitalists, on the other hand, translate patents to signals of a well-managed company that has defined a market niche for itself. as a result, a country’s fdi correlates with the strength of the country’s patent protection. if the country promotes compulsory licensing, investors and others observing the pharmaceuticals market may find this alarming and refrain from investing in that country.21 it is often stated that strong iprs restrict access to healthcare. one viewpoint is that as prices of pharmaceuticals rise less people can afford them. this might be true in countries where social security and welfare are not covered for by the government. one example could be that of the united states. however, in the european union at least most member countries have a social security system that provides for the healthcare of citizens. in france for example all medication and doctor appointments are covered through various refund policies. consequently, the medication consumption in france is probably higher than necessary. therefore, in countries where social welfare exists the prices of pharmaceuticals cannot be the mere reason for improper access to healthcare. as a result of market factors and legislative factors, prices of pharmaceuticals vary between countries. these prices are a result of market forces and legislation. adifference in prices may cause parallel importation. pharmaceutical companies strictly control their own product exports and imports so as to prevent parallel imports from lower priced countries to higher priced countries. compulsory licensing enhances this problem. when a patented pharmaceutical is compulsorily licensed, the price of the product decreases. not only is the patent owner incapable of controlling the quality of the licensed products, but also incapable of supervising parallel trade. as a result countries with compulsory licensing laws may receive products later than those without such laws as pharmaceutical companies do not want to create additional sources of supply in countries where they may be imported elsewhere. hence, consumers are in the end the ones to suffer.22 moreover, the cost of regulation increases, as the final quality control of the licensee’s products is dependent on government inspection, since pharmaceutical companies no longer have as 21 bird and cahoy (2008), p. 297-298 22 rozek (2000) p. 898-899 7 nordic journal of commercial law special edition 2011 strong an incentive to invest in reputation or distribute information to healthcare providers, since licensees would be able to free-ride.23 nevertheless, the patent owner is likely to produce the same drug for at least some markets, including the market where a compulsory license has been issued, which means that the patent owner will still have to comply with the minimum requirements of drug control and providing information to health care providers. the fact that licensees are not familiar with the research that resulted in the innovated drug may cause patients, physicians, pharmacists and payers to receive inaccurate information about the drug. this in turn increases the necessity for adequate consumer protection laws.24 altogether, in considering whether to utilize compulsory licensing various values and priorities need to be weighed, and while it may have some benefits some problems may arise as well. 3 the value of intangible assets the chart below exemplifies the basic nature of intangibles. economic benefit increases only moderately at low levels of ownership, while the curve takes a steep rise at complete or near to complete ownership. this means that at full ownership the possibilities of economic benefits are unlimited. the unlimited economic benefits can be obtained through high prices, which are possible to maintain, if full ownership exists. hence, it may result in the previously mentioned rent monopoly. chart 1 the two dimensions of intangible economic benefits25 23 rozek and rainey (2001), p. 471-472 24 rozek and rainey (2001), p. 472 25 cohen (2005), p. 63 ownership e co n om ic b en ef it 8 nordic journal of commercial law special edition 2011 it is therefore clear that the issue of ownership and its value need to be inspected in more detail. the value of ownership is a two-faceted concept, where both the owned intangible asset and the research and development having led to the ownership play an essential role. 3.1 how to valuate medicine patents in order to calculate a justifiable sum for a royalty, it is more than necessary to evaluate the value of the patent being licensed. in the following three different methods for the valuation of patents, income, market and cost approach, will be described. 3.1.1 the income approach the income approach is based on evaluating the value of an intangible asset today based on the cash flow or profit it will generate in the future. according to cohen, the income approach works because of the following underlying financial principles: ceteris paribus, investors are more willing to pay greater amounts for investments that generate greater profits. ceteris paribus, time is money, i.e. the sooner the profits are generated the greater the investments can be. ceteris paribus, the smaller the risks of the cash flow, the bigger the investment.26 the income approach then comprises of three steps, which are: 1. “identify the asset from which we are trying to derive economic benefit. 2. estimate the expected cash flows from that asset over time. 3. assign an appropriate measure of risk to our prediction.”27 in the case of a medicine patent the first step is easy as the object is the patent in itself. what comes to the third step, on the other hand, the medicine patents in question, i.e. under the risk of being compulsorily licensed, are usually enjoying some sort of monopoly position within the market, and hence the biggest risks of cash flow are dangerous side-effects occurring or a competing product28 entering the market. it is then the third step that causes the most distress 26 cohen (2005), p. 74 27 see cohen (2005), p. 74 28 here note that a competing product would be another medicine with another active substance for the same disease or another therapeutic method. 9 nordic journal of commercial law special edition 2011 with medicine patents. during the life cycle of the patent it is of course relatively easy to predict profits it generates as the patent owner defines the price of the product.29 however, after the expiration of the patent the cash flow becomes russian roulette, as the price of the drug may drop by 60% in result of generics entering the market. the formula for calculating the net present value of an intangible asset would be npv= c0 + ∑ ct/(1+rt) t where: npv = net present value c0 = the negative cash flow of acquiring the asset ct = the cash flow in period t rt = the discount rate in period t, which describes the time and risk associated with the cash flow.30 in valuating medicine patents, the initial cost of acquiring the product would therefore be the investment in r&d, as well as all production and marketing costs. the r&d costs may also be difficult to estimate, as they might not be product specific, i.e. many drugs are the sum of years and years of research, which in the beginning might have been for a somewhat different product.31 also, the discount rate includes only the market risk, while project-specific risks are not incorporated in the above formula. this is the formula’s limitation as the cash flows with many intangible assets may fluctuate greatly, hence the project specific risk is not adequately important to take into account.32 every medicine patent, as well, is a project of its own, with specific risks depending on the disease treated and differing possibilities of unexpected side effects arising. in its very simplest form the discount rate can be seen as the opportunity cost of investing in the specific medicine patent rather than in another medicine.33 therefore, as the risk of compulsory licensing on a certain patent rises, so does the opportunity cost, and in result the discount rate applied to the net present value. 29 no country specific medication pricing policies are taken into consideration. 30 cohen (2005), p. 75-76 31 dimasi et al. (2003) 32 cohen (2005), p. 77 33 cohen (2005), p. 77 10 nordic journal of commercial law special edition 2011 3.1.2 the market approach according to the market approach an intangible asset can be valued on the basis of the value of a comparable asset on the market. in using the market approach in valuating medicine patents the problem is not in defining the market, but rather finding comparable assets, especially with patents under the threat of compulsory licensing. therefore, the market approach works best for commodities, which can be relatively easily defined and are traded in an active market. the market approach permits us to evaluate the relative value of an asset through benchmarking, but assumes that the comparable assets are priced correctly. moreover, the market approach evaluates the price of a product not the value of the actual patent.34 however, as the price generates cash flow from the patented product, the price of the product does give indication to the value of the underlying patent, as noted in the previous section. all these issues must be kept in mind when using the market approach for valuation of a pharmaceutical patent. in valuating a pharmaceutical patent with no generic equivalents through the market approach, the first step is to define the market, to discover the comparable. the market may be defined as all pharmaceutical patents, only patents with certain indication, patents for certain age groups or patents with a certain indication to a specific age group. if the valuated patent has no generic equivalent, the most specifically defined market may not have any comparable products to compare with. therefore, the discovery of a comparable may demand defining of a less specific market.35 after discovering a comparable, it is necessary to evaluate the reason for a customer to pay more or less for your product in relevance to the comparable. history gives some indication to possible future success or failure, but not necessarily. the wider the scope of the drug the higher the price may be, but not necessarily. the price and value of a drug are also affected by the remaining life-time of the drug, e.g. if no significant generics are on the way, the life of the drug is longer. moreover, the likeliness of infringement of the patent affects the pricing, and value. the likeliness of infringement can also be evaluated through the ownership and economic benefit graph dealt with earlier, as the greater the ownership, the less possibility there is for infringement. conclusively, the price of a patented product may not be an accurate reflection of the comparable medicine, as many product specific issues affect the price36. in addition, it is a relevant issue whether a compulsory license can be considered as equal to an infringement. the action and the effects are relevantly same the only difference being that one is legal and the other is not. if so, then the threat of compulsory licensing would already in itself affect the price of the product and the value of the patent, as the full ownership is threatened. 34 cohen (2005), p. 91-92 35 cohen (2005), p. 92 36 cohen (2005), p. 93-94 11 nordic journal of commercial law special edition 2011 chart 2 the incentive to appropriate an intangible37 as can be noted from the above chart the incentive to appropriate increases with the economic benefit. to some extent, with some precautions, the same happens with compulsory licensing. the greater the market share of a patented drug, the greater the profits, and hence, the greater the monopoly. the incentive to appropriate in the form of compulsory licensing increases as well, as improperly high profits from medicines are frowned upon. for example, in cases where the increased monopoly position is misused, the threat of compulsory licensing increases. in conclusion, the market approach does have its benefits, but may also be relatively difficult to use in the calculation of the value of medicine patents under the threat of compulsory licensing, as there may not exist any adequately comparable patented drugs and the price of the drug is affected by many different aspects. also, in many eu countries authorities influence the final prices of drugs, meaning that the prices do not evolve according to the theory of demand and supply. nonetheless, the market approach does give us useful insight to the price of a drug versus the value of the underlying patent, as well as to the incentives to appropriate. 3.1.3 the cost approach the cost approach is the third method of valuating medicine patents. it is all about calculating the ratio of an asset’s cost and value. the cost approach consists of three different costs: the original cost, the book cost and the replacement cost. the original cost is the cost of acquiring or producing the patent, and is often the wrong one to use, as the cost of an asset almost always changes over time. book cost, on the other hand, is everything that is written in the company’s 37 see cohen (2005), p. 95 e co n om ic b en ef it ownership incentive to appropriate 12 nordic journal of commercial law special edition 2011 financial statements. in consideration of pharmaceutical patents, the book cost’s accuracy in representing the patent’s real worth may depend on the following issues: 1. if the patent has been incorporated into a new drug. 2. where in the european medicines agency’s (emea) or national authority’s approval process the drug stands. 3. how successful the drug has been in sales. 4. what is the prediction for competition and demand for the drug after the expiration of its patent. 5. what is the patent’s age. replacement cost is the cost of acquiring a replacement for the product. the cost of replacement is higher the higher the scarcity of the product.38 this causing an interesting context for pharmaceutical patents, as the replacement cost of the product is very high during the patent’s lifespan, but after expiration the replacement cost may drop enormously, as the production of generics is relatively easy after the patent owner has performed the basic research and produced the patented drug. however, the replacement cost also indicates that if the value of the patent is the cost it would take to replace the drug, then in compulsory licensing the patent owner should be compensated with the amount necessary to replace the drug, i.e. the cost of developing and producing another drug as beneficial as the prior. another possibility is that, since no adequatelypriced substitute is available, the patent owner will be compensated for lost profits.39 in conclusion, the value of a medicine patent can be evaluated by the transaction cost necessary to replace it, hence the more costly it is to replace the medicine patent the more valuable the patent is. although the original cost may often be the wrong cost of an intangible to use in valuation, nonetheless it is not too far from correct with medicine patents, as usually the highest costs of a medicine patent are the initial costs of acquiring the patent. this meaning that the original cost will not be too low, but instead the value of the patent may depreciate during its lifespan, in which case the original cost would be too high. the book cost, on the other hand, may not be accurate enough for medicine patents because research and development as well as obtaining market approval are very long processes, hence connoting that firstly, not all costs might be found, and secondly not all costs can simply be allocated to a certain patent. it can therefore be concluded that the cost approach consists of three potential viewpoints, which however include the risk of inaccuracy. 38 cohen (2005), p. 109-112 39 cohen (2005), p. 112 13 nordic journal of commercial law special edition 2011 3.1.4 patent citations patent citations (in subsequent patents) are used to justify the novelty of an invention. they are placed in a patent application to demonstrate the differences to prior innovations and to connote the boundaries of the application.40 however, patent citations are found to be industry specific and national. interestingly enough, though, in the united states 73% of citations in patents are to publicly funded science, i.e. to university publications and research in government laboratories or otherwise government funded. patent citations also reflect the time it takes for researchers to improve prior inventions. countries where patent citations are often to recent studies, have shorter technology cycle times. this in turn suggests that the inventors of the specific country are better at incremental adaptation.41 clearly patent citations indeed provide more information than one would immediately imagine. in fact another way of evaluating the value of a company’s patents is to look at the citations to a company’s patents in subsequent patent applications.42 it has been argued that calculating patent citations gives a more precise approximation of the economic value of inventive activity than unweighted patent counts or r&d expenditures.43 such citations give an idea of the company’s research capabilities as well as the effects that the company’s research has on a wider scale than just the company itself. moreover, studies suggest that the amount of patents granted in one year to a certain company, the amount of citations to the company’s patents in subsequent patent applications, and the amount of citations in the company’s own patents can be used to predict the stock returns and market-to-book values of a public company.44 these studies have of course targeted public companies, and therefore some precautions must be taken when reflecting the findings to private companies. hall et al. have however since the 1990s been studying the correlation between the number of patent citations and companies’ stock market value.45 an average us drug or medicine patent in 1998 had six science citations. this rate is, however, increasing at tremendous speed. patents that are adjudicated by courts as pioneering patents are usually cited five times more often than other patents.46 narin (1998) suggests the probability that if patents are cited three times more often than the average, then the patent has technological and economical importance, which would be approximately 10 per cent of 40 harhoff et al. (1999), p. 511 41 narin (1998), p. 61-63 42 lev (2001), p. 59-60 43 harhoff et al. (1999), p. 511 44 lev (2001), p. 59-60 45 harhoff et al. (1999), p. 511; hall et al. 46 narin (1998), p. 63-70 14 nordic journal of commercial law special edition 2011 patents. narin’s guess is not too far from the truth as hall et al. proved that companies having two to three times the median number of citations per patent have a 35 per cent value premium, while patents being cited 20 times or more have a market value premium of 54 per cent. pharmaceutical patents belong to the latter group.47 although market value of a company is not directly connected to the compensable value of a patent, it is connected indirectly. pharmaceutical patents have an impact of over 50 per cent over the average on the company’s market value.48 consequently, the market value (and stock prices) of the company rises with the value of the patents. therefore, the more valuable a patent is perceived to be the more valuable it will become to the owner through increasing market value. valuable patents, in a sense, increasingly generate their own value. in theory, however, this value should not be affected by compulsory licensing as the ownership of the patent still persists and the amount of citations is not affected. the problem that could evolve with patent citation valuation, if used in compulsory licensing decisions, is that of time. this means that, the age of the patent has an effect on the number of citations. if a compulsory license were awarded at an early stage of the patent’s lifecycle it might not yet be cited at all, which would even through methods of calculation give a future value of zero citations. hence, a risk persists when estimating citations during the first years of the patent’s life cycle.49 however, as mentioned pharmaceutical patents often have more than 20 cites per patent, which could suggest that they are cited consistently throughout their lifespan. 3.2 the value of research one argument for the pharmaceutical companies’ ability to gain large profits with necessities such as medicine is that they need cash flow to invest in further r&d. clearly then, this research has value that must be taken into consideration, if the generated profits are lowered as a result of compulsory licensing. the problem arises on how to measure this value. hounshell (1998) strongly believes that calculating the return on investment (roi) of r&d is highly problematic. he feels that it is not possible to measure roi of r&d at the company level, the industry level or the national level, and if this is claimed done then the claimant is not in reality truly assessing the costs and benefits of r&d. the reason for such a strong viewpoint is that especially long-term research is highly uncertain while the benefits of research are 47 hall et al., p. 4 48 hall et al., p. 32 49 hall et al., p. 13-14 15 nordic journal of commercial law special edition 2011 ambiguous and therefore most models are not sophisticated enough to give accurate answers, if even probabilistic ones.50 the profits arising from r&d are wide-ranging, as they consist of primary, secondary and tertiary effects. firstly, new and improved products and processes may be discovered. secondly, research may provide for the continuity of programs, improved capability for recruiting scientists and research engineers, as well as increased organizational capabilities. finally, research is also an investment to the future value of the whole company, while also the employment for highly trained people is always secured.51 although the profits gained from r&d can be seen as very complex and wide-ranging as they extend all the way to the society, and the actual return on investment in numbers of r&d may be impossible to calculate accurately, evidence can be presented on the effects of r&d to corporate growth and its direct relation to the non-rivalry and network attributes of intangibles.52 lev (2001) discusses a study performed in 1980-99 in 83 publicly traded chemical companies to measure the return on r&d to the investing companies. statistical estimation was used to estimate the contribution of one r&d dollar to the income of physical assets and of brands. the contribution was analysed by evaluating the r&d dollars spent to operating income in that year and the operating incomes of the two subsequent decades, as successful r&d projects have long-term impact on profitability of the company. the following results were gained from the research: one invested r&d dollar increases current and future operating income by an average of two dollars. conclusively, the annual before tax roi of chemical r&d would be 27 per cent, or ≈17 per cent after taxes. the weighted average cost of capital in most chemical companies (in the us) is 8-10 per cent, therefore indicating an annual cost-benefit differential of about 7 per cent of r&d. high economies of scale exist in chemical r&d, i.e. roi increases with investment. return on chemical r&d is above-cost-of-capital, while physical assets and advertising expenses generate only an average return. chemical r&d prospects are fully appreciated by investors.53 50 hounshell (1998), p. 6-7 51 hounshell (1998), p. 10-13 52 lev (2001), p. 51 53 lev (2001), p. 53-54 16 nordic journal of commercial law special edition 2011 if we assume that pharmaceutical companies belong to chemical companies, we could note that if roi does indeed rise with investment, then the r&d of pharmaceuticals is relatively high as drug r&d expenses are known to be high. as this return on investment would also most probably be affected by compulsory licensing then it should also be remunerated according to the differential. another study to evaluate the r&d contribution to the growth of businesses was realized in 1970-1980 by relating a performance measure such as profits and sales statistically to r&d expenditures while controlling for the effects of other investments on the business’ growth. however, the primary problem with the level of accuracy of this method is that research projects may last for decades and hence the investment in r&d may take a long time to generate sales, which on the other hand are often at least to some extent unknown. moreover, the profit and sales figures may be coloured by biases and distortions as companies wish to manage investors’ perceptions.54 of course the returns on long-term research are also much less certain than on short-term research with project specific investments. if the result of research lies in the unknown future, the only certainty is that without the research the company will not stay competitive.55 nonetheless, the study suggested that basic research has a much higher rate of return on r&d concerning corporate productivity and growth than other types of r&d. one reason for this is that basic research has a much higher risk than applied r&d, but does not come close to explaining the whole truth.56 then again the results of the study suggesting that basic research is more profitable than applied research might include some inaccuracy, as a result of the time lag in generation of profits in long-term research. yet others believe that stock prices and returns provide adequate information on company value and performance, which in turn means that r&d contribution can be assessed using market values while patents provide yet an additional signal of the company’s r&d and technology. this is however somewhat contradictory to investor actions, as stock prices are positively affected by corporate announcements of new r&d projects.57 therefore the mere initiation of a research project raises stock prices hence increasing the value of the company’s r&d. at this point, however, the actual results, if any, of the research are yet to be discovered. also, it is important to acknowledge that although important it is not the mere research that generates profits, but also technical capabilities, market knowledge, marketing expertise and manufacturing capabilities are needed for the final results.58 54 lev (2001), p. 55-57 55 hounshell (1998), p. 13 56 lev (2001), p. 57 57 lev (2001), p. 57-58 58 hounshell (1998), p. 15 17 nordic journal of commercial law special edition 2011 patents are the asset traded most often, through licensing and sales. the amount of royalty income is also constantly increasing. moreover, it seems that investors value a royalty dollar two to three times higher than that of regular income. the reason for the high valuation may be that of income stability, as patents are usually licensed for several years. however, patent royalties also affect investors’ valuation of the company’s r&d. companies’ r&d is valuated relatively higher, if their patents are licensed. it may be that investors believe the quality and prospects of companies being able to license are relatively higher. consequently r&d contributes to the productivity, growth and capital market value of a company.59 this would suggest that the amount of royalties paid in compulsory licensing has an effect on the valuation of the company’s r&d as well as investor interest. hence, this could mean that compulsory licensing could indeed benefit the company, if royalties were deemed high. a study performed by scherer in 1977 suggests that company r&d expenditure is 36 per cent higher with companies under compulsory licensing in comparison to unaffected companies in the same industry. company sales were also taken into account. moreover, he found that firstmover advantages are weighted by companies, as important as patents, if not even of higher importance. first-mover advantages function as a non-patent barrier to imitation, while companies may earn excessive profits and enjoy low costs during their head-start. the companies perceived by consumers as the pioneers of a certain product will also enjoy trust and reputation, which in turn provides the possibility of large market shares and premium prices. moreover, imitators often have to spend a relatively equal amount to research and development, but not being able to enjoy as large market shares.60 this applies especially to consumer goods, but also in most markets where first-mover advantage is valued higher than patent protection. the same does not however apply tomedicine patents. the first-mover inventing a medicine patent is usually found to spend over € 270 million (exchange rate of 26.8.2011; usd 400 million) for the early stages of research, such as early screening tests and animal tests. then at the next stage full-scale controlled tests of the surviving molecules in human beings are carried out. the objective of such expenditures is to identify useful molecules and then prove their effectiveness in aiding people safely. this proven, the evidence on efficacy becomes public knowledge for all to see. without medicine patents imitators would have to spend only a few million to devise their own production methods to “cheap-ride” on the pioneer’s invention.61 also the production of a generic compound only takes a few years. in most countries generic compounds receive market registration simply by showing their bio-equivalence to the pioneering brand. in all, the production of generic medicines is very profitable as market 59 lev (2001), p. 61 60 scherer (2010), p. 22; dimasi et al. (2003) 61 scherer (2010), p. 22 18 nordic journal of commercial law special edition 2011 approval is achieved in a short time, hence being able to enter the market very soon after the expiration of the pioneering patent.62 therefore, it can be assumed that in pharmaceutical companies with compulsory licensed products the r&d expenditure is not 36 per cent higher, but rather lower than it would be without the compulsory licensing. silberston and taylor (1971) demanded english company officials to evaluate the effects on r&d expenditures if a worldwide compulsory licensing regime at “reasonable” royalties was constituted. the weighted average effect was 8 per cent in all industries, except for pharmaceuticals, where a negative impact of 64 per cent was predicted.63 in 1981-1983 edwin mansfield, on the other hand, interviewed 100 us company r&d executives on the number of inventions that would not have been developed without patent protection. most industries reported a prediction of 14 per cent decrease, while the pharmaceutical industry estimated a decrease of 60 per cent.64 finally levin et al. (1987) had a sample of 650 us r&d executives to resolve the effectiveness of first-mover advantages in appropriating benefits from new products. on average 130 industries patents were deemed less effective than superior sales or service efforts. however, in pharmaceutical firms patent protection was named as the most important or equally important to the most important method in the accrual of benefits.65 in conclusion, the assessment of research is possible, but flexibility is necessary for the unanticipated achievements, while the assessment in itself is very burdensome. within the chemical industry it is a common dilemma whether the value of basic research can be captured, as evolving results may be minor or take years to come upon.66 in pharmaceutical research the largest problem is very likely the allocation of costs. medicine research may take decades, during which projects are initiated and terminated. the problem then is to assess to which degree each project has contributed to the invention of the final product. in consideration of compulsory licensing, however, the patented drug is already on the market, and has been issued with a specific price. in determining a royalty fee it would then be within the court’s discretion to evaluate whether the patent owner has already valuated the research having led to the patent and product, and then incorporated it into the product price, or not. 62 grabowski (2002), p. 852 63 see scherer (2010), p. 22 64 mansfield (1986), p. 175-176 65 levin et al. (1987), p. 796 66 jasinski (1998), p. 39-41 19 nordic journal of commercial law special edition 2011 3.3 compensating the value of a medicine patent one of the underlying reasons for governments to grant patents is that of information publicity. patents are granted so that the underlying information becomes public and that other people can then do their best to improve the invention. some companies have very weak patent policies, meaning that their patents are not interlinked well, therefore making them easy to use by others for improving them or infringing them. one could say that such weak patent policies realize the underlying meaning of patent protection. however,on the other hand, there are companies with very strong patent positions. such companies have many patents, which are incredibly intertwined, making it very difficult to penetrate that technology.67 rozek (2000), for example, feels that only market forces should be allowed to have an effect on the terms of agreements. according to him, the role of the government is not to decide, which patents should be licensed and on what terms. therefore, governments or courts should not have a say in the amount of royalties paid for licensing, or the licensing for that matter. the mere function of the government would be to provide the legal framework for such negotiations and the enforcement of contracts, including adequate antitrust and consumer protection laws.68 however, the question then arises, what the function of the government would be in cases of violation of these laws. hence, it could be stated that two different situations of compensation should exist in compulsory licensing: 1) cases where compulsory licensing is imposed, because of social or other such reasons, and 2) cases where compulsory licensing is imposed as a penalty for violating existing legislation. compensation methods would perhaps then have to differ between the two, i.e. in one market forces should be used to determine the justifiable amount of compensation, while in the latter, it would be left to the court’sdiscretion. compulsory licensing does not usually specify the form of license to be used, but rather states the requirement of a “reasonable” royalty or as in the trips of an “adequate” remuneration. as previously noted, there can be many different consequences of compulsory licensing. these consequences, however, depend, inter alia, on the licensing agreement’s form. consequently, the assessment of compulsory licensing is difficult and case specific. some possible forms of licensing are a fixed-fee license, a license that achieves coordinated production, and a license with a sales-correlated royalty. if the royalty rate of a sales-correlated royalty is small, then the economic effects are relatively same as with fixed-fee licenses, which have a royalty rate of zero, where the fixed fee is only a transfer of wealth between licensor and licensee, hence having no consequence on economic surplus.69 67 narin (1998), p.71 68 rozek (2000), p. 891 69 gilbert and shapiro (1996), p. 12753 20 nordic journal of commercial law special edition 2011 in compulsory licensing a fixed-fee would lower welfare even in the short run, if the licensee has high costs in the absence of the license, as well as relatively high costs with the license in relation to the costs of the licensor. such a case would exist when the license is essential for the licensee to compete in the market. however, the license would not make the licensee a very efficient competitor. even a royalty-free license could therefore harm economic efficiency by easing the entry of a high-cost company. coordinated production, on the other hand, is an optimal method of licensing, if the two parties together can earn better profits than on their own. in such licensing, production levels are coordinated and deviation from them may result in a penalty, if so agreed. such licensing may in the short run achieve more efficient production. however, this method is not usable in compulsory licensing, and in fact, the threat of compulsory licensing may in such licensing cases lower welfare. the parties have a natural incentive to deliver a license agreement, but the threat of compulsory licensing may provide the licensee with a method to gain more favourable terms of licensing.70 as mentioned earlier, in the pharmaceutical industry the licensor is in fact the party with the highest costs, while the licensee needs to invest a relatively small amount to take up production of the licensed product. this would suggest that, ceteris paribus, a fixed-fee license, or sales correlated royalty with a small rate, would in the short term enhance welfare. this conclusion is however quite a simplification, and needs to be taken with reservation. the remuneration for a patent’s compulsory license may be considered adequate as long as it safeguards the legitimate interests of the patent owner. the adequacy of remunerations should also always be guided by the specific circumstances of each case. if the compulsory licensing is used for the restoring of the competitive environment or to meet a pubic need, this should be taken into account when deciding on the adequacy of the remuneration. the trips agreement even suggests that if compulsory licensing is used to remedy anti-competitive acts, the remuneration should be set apart from the regular level of commercial remuneration, so as to reflect its corrective or punitive nature. this would mean that in some cases adequate (and reasonable) remuneration could be zero, if competitive conditions wish to be restored.71 some think that the adequate remuneration should be based on the economic value of the patent, i.e. the potential value for the patent owner. this economic value could then be used as a benchmark, which is discounted by certain factors, as previously discussed. then again, a few feel that although the economic value may be taken into account, the remuneration does not need to be based on this value, while others think that the remuneration should be based exactly on the amount of actual or potential financial income the licensee gains with the license. another possibility would be to calculate adequate remunerations in the same manner 70 gilbert and shapiro (1996), p. 12752-3 71 taubman (2008), p. 953-954 21 nordic journal of commercial law special edition 2011 as commercial damages in infringement cases, which in the trips is stated as ‘damages adequate to compensate for the injury’ that has been caused by a certain infringement.72 however, yet again arises the question whether compulsory licenses can be compared to infringements. the damages awarded in infringement cases are in fact a penalty for the infringer, as well as a compensation for the patent holder of course. therefore, it somehow does not seem logical that a “penalty” of such would be deemed to the licensee when the government or court has indeed provided the license. taubman (2008) concludes his analysis of the trips agreement ‘adequate remuneration’ for compulsory licensing by stating that remuneration is adequate if it reasonably compensates for any conflict with the regular exploitation of the patent, as well as for any prejudice of legitimate interests.73 this interpretation would also allow for a punitive approach in cases where compulsory licensing is used as a penalty for anti-competitive measures. similarly, the use of discount factors is possible to reflect humanitarian or public sector uses.74 consequently, the value of the patent is an important basis for the evaluation of the remuneration, and anticompetitive issues need to be taken into account, as well as social issues. moreover, the licensee’s financial gains should also be taken into consideration, which would suggest a salescorrelated royalty. the problem, however, persists on how to move from theory to reality, from words to numbers. 4 1+1=2 it has now been demonstrated that compulsory licensing is a very complicated issue with many different faces. it has also been noted, that the issues to consider when determining a royalty in compulsory licensing are various. figure 1 below demonstrates the interconnection of licenses, prices, r&d and market effects. although the figure describes the market for technology, the basic idea is the same for pharmaceuticals. the economic effects are of even more importance with pharmaceuticals than with technology, but as the figure does not measure extent, it is irrelevant here. 72 taubman (2008), p. 956; trips, article 45 73 article 30 of the trips agreement. 74 taubman (2008), p. 957 22 nordic journal of commercial law special edition 2011 figure 1 linkages between the conditions in the market for technology and economic outcomes75 both, search and transaction costs, as well as other production costs, and license fees affect the price of the product sold. the r&d expenditures invested to the product by the patent owner are at least to some extent incorporated into the price of the pharmaceutical. a licensee, independent of whether as a result of a voluntary or compulsory license, also incorporates its production costs, as well as the licensing fees payable to the patent owner, to the product price. according to basic economic theories price is determined by demand and supply of a product, and generally demand decreases as prices rise. this again is reflected in the gnp. the demand for pharmaceuticals is, however, quite inelastic, and price does not have such a large impact on the demand, hence the effect of spending on pharmaceuticals stays relatively constant, assuming ceteris paribus. the largest effect on national welfare and growth would therefore be through the spending of pharmaceutical companies, i.e. spending on research and development. consequently, another arrow could be added to aoki and schiff’s figure pointing from search and transaction costs to national welfare. also, another balloon should be added in the final row to indicate employment. patent legislation has evidently a large impact on pharmaceutical companies’ spending, r&d employment, as well as, employment in general in the pharmaceutical industry, and foreign direct investment. italy and canada are good examples of the effects of patent legislation and compulsory licensing on national economic issues. it is often stated that patent laws prevent access to medicine, and that therefore compulsory licensing should be promoted, and preferably with low royalties. the truth is that even with reasonable royalties to be paid as 75 see aoki and schiff, p. 193 license fees incentives to innovate conditions in the market for technology search and transaction costs which downstream uses are viable & prices charged to end-users the distribution of welfare economic welfare outcomes in the downstream markets final economic outcomes 23 nordic journal of commercial law special edition 2011 remuneration for compulsory licensing, if realized at a large scale, a 64 per cent decrease in research and development expenditures could result. the assumption that compulsory licensing does not affect innovation incentives is correct in almost all other industries, as the effect of a compulsory licensing regime is predicted at an 8 per cent decrease of innovation. similarly, 60 per cent of medicine inventions would not exist without patent protection. most industries also valuate first-mover advantage as more important than patents, which is the first priority for the pharmaceutical industry. since the effects of the patent legislation and its exceptions are so deeply inflicting to the society and economy as a whole, it becomes clear that the calculation of royalties in compulsory licensing of medicine patents is not of the easiest sort. it is not simply the value of the patent to be taken into consideration, or the value of research and development, but also the objectives of the compulsory licenses have great weight. however, in order to maintain pharmaceutical companies’ incentive to innovate even with the existence of the threat of compulsory licensing, the basis for every royalty calculation is the value of the patent. through calculating patent citations various studies have concluded that pharmaceutical patents often have more than 20 citations per patent, and hence have 54 per cent market value premium for companies. the number of citations is therefore one method of valuating a patent, but in the case of compulsory licensing the aforementioned time lag may be problematic. three different valuation methods were defined in this study. those were the income, market and cost approach. it was noted that all of the three have some problems when applying to the valuation of pharmaceutical patents. with the market approach the biggest problem is that of finding a comparable for the patent to be compulsorily licensed. as the market approach works best for commodities, we will now eliminate it as a possible valuation method of pharmaceutical patents. the cost approach, on the other hand, determines various different costs that could be used to valuate a patent. with pharmaceutical patents, the least inaccurate would most probably be that of transaction cost. this would then mean that the value of the patent would be as much as it costs to produce a new medicine that can generate the same roi. it is near to impossible to predict the costs of producing the next cash cow for the company, because it may take for two decades. the closest prediction would be to say that it will be more than 270 million euros, and of course this is not the transaction cost of a specific patent, but a general estimate resulting from various studies. it seems clear that the income approach is closest to our demands. the income approach demands for the identification of the intangible asset, an estimation of expected cash flows and the assignment of an appropriate risk for the prediction. then by using the formula npv= c0 + ∑ ct/(1+rt) t the net present value (npv) of the patent could be realized. the initial cash flow in this formula would for the most part be research and development costs and of course, those of launching and advertisement expenses. this in turn makes the valuation of r&d important. one invested r&d dollar increases current and future operating income by an average of two dollars, while the mere initiation of a research project raises stock prices of the pharmaceutical 24 nordic journal of commercial law special edition 2011 company, hence increasing the value of the company’s r&d. however, all research cannot be valuated equally. basic research has a much higher rate of return on r&d concerning corporate productivity and growth than other types of r&d. moreover, also the licensing of patents has an effect on the value of r&d as investors valuate licensed patents relatively higher. as a result r&d contributes to the productivity, growth and capital market value of the company. in order to use the income approach the aforementioned would therefore be the most important factors to take into consideration. in addition in the discount rate at least the opportunity cost of investing in the specific drug instead of another medicine would have to be taken into account. the threat of compulsory licensing of course then increases the discount rate, if another medicine would not have faced the same threat. even if the value of a patent would be calculated as relatively low, and this calculation used as the basis for determining the royalty in compulsory licensing, other factors must be taken into consideration as well. as mentioned, the fee that the licensee has to pay is reflected onto the price of the medicine. if the royalty is low, then the price of the pharmaceutical will be lower, and most likely decrease from the pre-compulsory license price. this will increase the probability of parallel trade to higher priced countries. patent owner companies are keen on controlling such trade very closely, but are not able to do so when the supplier is a licensee. it therefore starts to become obvious that the calculation of royalties in compulsory licensing should be divided into two different situations: 1. compulsory licensing used to resolve social or other such issues, and 2. compulsory licensing used as a penalty for violating existing legislation. although in the first scenario, the objective of the compulsory license will in most cases be that of lowering the price of the drug, the royalties should not be deemed too low in order to prevent parallel trade, decrease of incentive to innovate, as well as the decrease of economic growth and employment. the more often compulsory licensing is used for social matters without adequate remuneration, the more relevant the potential ill effects of compulsory licensing become. on the other hand, in situations where compulsory licensing is used as penalty, royalties of course can be lower in order to actually realize the effect of a penalty. moreover, if in fact deemed as a penalty for illegal actions then the license and low royalty could be better justified, hence the incentive to innovate might not be threathened. however, in such cases it must be taken into consideration that investors indeed value a royalty dollar to two to three times higher than that of regular income. the reason for the high valuation may be that of income stability, which of course is equally stabile in cases of compulsory license. therefore, it must be kept in mind that even if the royalty is low, the pharmaceutical company might be winning in other areas, as for example with a rising stock price. 25 nordic journal of commercial law special edition 2011 in conclusion, remuneration can be calculated by basing it on the economic value of the patent, which is then discounted by certain factors76, by taking the economic value into account but not using it as a basis, or on the value that the patent generates to the licensee. however, another possibility would be to calculate adequate remunerations in the same manner as commercial damages in infringement cases, which in the trips agreement is stated as ‘damages adequate to compensate for the injury’ that has been caused by a certain infringement. it is however, a relevant issue whether a compulsory license can be considered as equal to an infringement. the action and the effects are relevantly same, the only difference being that one is legal and the other is not. hence the damages awarded in infringement cases are in fact a penalty for the infringer and a compensation for the patent holder. therefore, especially in situations where compulsory licensing is used as a penalty for illegal actions, it seems illogical to “compensate” the patent owner. which ever manner is chosen for determining the royalties paid for compulsory licenses, it must be kept in mind that the pharmaceutical industry does not function as any other industry; legislation and all actions have tremendous effects that are inflicted deep into the economy, the patents and their exclusivity are valued very high by their owners while research and development has its very own value to be calculated.most of all, even with a compulsory license the patent owner can still continue to produce, sell and advertise its product, and hence constantly generate profits. for future development of this study, it would be profitable to analyse the financial data of pharmaceutical companies that have experienced compulsory licensing, as well as of those generic companies having been awarded such licenses. such data could provide with important information on the actual effects of compulsory licenses on both the licensor and the licensee. moreover, the analysis of existing case law compared to the financial data would be prosperous. as a final note, it should be taken into account that much of the literature used in this study is based on information concerning the us market. although this has been taken into account when arriving to conclusions, there may still exist a systematic error as a result of using such information in consideration of the eu markets. 76 here note that in the income approach the discount rate is calculated already when evaluating the economic value of the patent. 26 nordic journal of commercial law special edition 2011 references aoki, reiko – schiff, aaron (2008) promoting access to intellectual property: patent pools, copyright collectives, and clearinghouses; r&d management 38, 2, 2008; p. 189-204 bird, robert – cahoy, daniel (2008) the impact of compulsory licensing on foreign direct investment: a collective bargaining approach; american business law journal, volume 45, issue 2, 283–330. cohen, jeffrey (2005) intangible assets: valuation and economic benefit; john wiley & sons, incorporated: hoboken, nj, usa dimasi, joseph – hansen, ronald – grabowski, henry (2003) the price of innovation: new estimates of drug development costs; journal of health economics 22 (2003); p. 151-185 gilbert, richard – shapiro, carl (1996) an economic analysis of unilateral refusals to license intellectual property; colloquium paper; vol. 93, national academy of sciences, usa; p. 12749–12755 grabowski, henry (2002) patents, innovation and access to new pharmaceuticals; journal of international economic law; p. 849-860 hall, bronwyn – jaffe, adam – trajtenberg, manuel; market value and patent citations; http://www.google.fi/url?sa=t&source=web&cd=1&ved=0cbcqfjaa&url=http%3a%2f%2fciteseerx .ist.psu.edu%2fviewdoc%2fdownload%3fdoi%3d10.1.1.69.9945%26rep%3drep1%26type%3dpdf& rct=j&q=patent%20citations%20and%20market%20value&ei=sixltpz6bph1-gb_rfmwcq&usg= afqjcnhwpkrecncv-mkcobg7rjuxxegw2a&sig2=q0vewsr7hg_aw--8hk2o8a&cad=rja; retrieved 17.8.2011 harhoff, dietmar – narin, francis – scherer, f.m. – vopel, katrin (1999) citation frequency and the value of patented inventions; the review of economic and statistics, august 1999, 81(3); p. 511-515 hounshell, david (1998) measuring the return on investment in r&d: voices from the past, visions of the future in assessing the value of research in the chemical sciences; national academies press: washington, dc, usa; p. 6-17 jasinski, joseph (1998) assessing the value of research at ibm in assessing the value of research in the chemical sciences; national academies press: washington, dc, usa; p. 33-42 kanter, daniel (2006) ip and compulsory licensing on both sides of the atlantic; european competition law review 2006, 27(7); p. 351-364 katsoulacos, yannis (2008) optimal legal standards for redusals to license intellectual property: a welfarebased analysis; journal of competition law & economics, 5(2), p. 269–295 lev, baruch (2001) intangibles: management, measurement and reporting; brookings institution press: washington, dc, usa levin, richard klevorick, alvin nelson, richard winter, sidney – gilbert, richard – griliches, zvi (1987) appropriating the returns from industrial research and development; brookings papers on economic activity, vol. 1987, no. 3, special issue on microeconomics; p. 783-831 mansfield, edwin (1986) patents and innovation: an empirical study; management science vol. 32 no.2; p. 173-181 narin, francis (1998) patents and publicly funded research in assessing the value of research in the chemical sciences; national academies press: washington, dc, usa; p. 59-72 27 nordic journal of commercial law special edition 2011 rozek, richard – berkowitz, ruth (1998) the effects of patent protection on the prices of pharmaceutical products: is intellectual property protection raising the drug bill in developing countries? the journal of world intellectual property, vol. 1, no. 2; p. 179-243 rozek, richard – rainey, renee (2001) broad-based compulsory licensing of pharmaceutical technologies; the journal of world intellectual property, volume 4, issue 4; p. 463-480. rozek, richard (2000) the effects of compulsory licensing on innovation and access to health care; the journal of world intellectual property, volume 3, issue 6; p. 889-917 scherer, f.m (2010) a half century of research on patent economics; the wipo journal: analysis of intellectual property issues, 2010 volume 2, issue 1; p. 20-27 taubman, antony (2008) rethinking trips: ’adequate remuneration’ for non-voluntary patent licensing; journal of international economic law 11(4); p. 927–970; oxford university press. trips and health: frequently asked questions; compulsory licensing of pharmaceuticals and trips; http://www.wto.org/english/tratop_e/trips_e/public_health_faq_e.htm; retrieved 25.8.2011 trips: agreement on trade-related aspects of intellectual property rights; part iii — enforcement of intellectual property rights; http://www.wto.org/english/tratop_e/trips_e/t_agm4_e.htm; retrieved 23.8.2011 vilanka, olli (2004) yksilöllinen tekijänoikeus ja kollektiivilisenssit; http://www.iprinfo.com/page.php? page_id=36&action=articledetails&a_id=239&id=19; retrieved 25.8.2011 wto – member information; http://www.wto.org/english/thewto_e/countries_e/italy_e.htm; retrieved 25.8.2011 case law and legislation c-418/01 ims health gmbh & co. ohg v. ndc health gbh & co. kg (2004) magill, c-241/91p, rte and itp v. commission, 1995 ecr i-743 comp/37.792, microsoft, march 2004 trips, article 31 1 eu regulatory models for platforms on the content and carrier layers: convergence and changing policy patterns andrej savin* * associate professor, copenhagen business school. eu regulatory models for platforms 8 1. introduction: technological convergence & its challenges ........................................................................................... 9 2. from “services” to “platforms” the emergence of a new policy .................................................................................................... 15 2.1. the “silo” approach............................................................. 15 2.2. the shift to platforms ....................................................... 17 3. converged platforms in the new proposals ....................... 21 3.1. telecoms and ott services.............................................. 22 3.2. information society services and filtering ............. 24 3.3. audio-video media services and video-on-demand .. ............................................................................................ 29 4. the interplay of convergence and regulation and possible alternatives .................................................................... 32 njcl 2018/1 9 abstract digital “intermediaries” have been the subject of the lawmakers’ interest both in the eu and elsewhere for at least two decades now. in recent years, however, and coinciding with the introduction of the new digital single market strategy in 2015, “platforms” in specific rather than “intermediaries”, “information society services (isss)” or “networks” have incresingly been the target of eu regulators’ attention. this article traces the eu’s increased focus on platforms and argues that its source can be found in a desire to respond to technology convergence. the first part of the article looks at why convergence and the emerging platform regulation stand in a relationship and attempts to outline the boundaries of that relationship. the second part argues that the eu has already undergone a regulatory shift from “services” to “platforms” and traces this idea from its 2015 dsm strategy origins to several other documents, including the 2016 communication on platforms. the third part looks at how the emergence of the idea and its elevation to a policy goal has already prompted changes in each of the three regulatory layers. the concluding part establishes that the eu policy shift from isss, networks and services as main regulatory units to platforms is sector-specific and prompted by attempts to address convergence. i argue that this approach may not necessarily be beneficial and look into alternatives involving a rethink of platform regulation across rather than within different layers. 1. introduction: technological convergence & its challenges in 1997, the eu issued a green paper on the convergence of telecoms, media and it technologies and its implication for regulation.1 in it, the commission stated that the “convergence is occurring at the technological level.” summarising the phenomenon, the document defined it as the ability of both new and traditional communications services (voice, data, sound and pictures) to be conveyed over many different networks or, in other words, the ability of different networks to carry similar services. rather than each requiring own infrastructure, the technology has enabled all converged services to be provided over the internet. while there is increasing confusion over the meaning of the 1 european commission, green paper on the convergence of the telecommunications, media and information technology sectors, and the implications for regulation, 3. 12. 1997., com(97)623 (1997 green paper). eu regulatory models for platforms 10 term convergence,2 scholars are in agreement on its main feature: the blurring of the boundaries between telecommunications, broadcasting and the information society services. this, in turn, opens up the question of whether the sharp dividing lines between telecommunications, media and iss policies also need to be gradually erased. the 1997 paper signified the launch of a convergence strategy at the eu level and the arousing of eu interest in the implications of converged technologies on regulation. today, convergence is both still relevant and more manifest than before: the majority of telecoms, media and it services are provided exclusively over the internet. while traditional television and radio are still in existence, they are being threatened by streaming services, voip telephone has largely replaced the fixed one, newspapers in print are being digitised and sms messaging is being pushed out by its digital counterparts. the implications of this should be clear economies based on knowledge and innovation depend on services and these are delivered at decreasing prices and increasing efficiency thanks to convergence. but, to what extent have converged services really resulted in converged policies in the follow-up to the 1997 paper? in this paper i will argue that the most manifest policy change in recent years has been a shift in regulation from services to platforms and that, rather than being a natural way to address convergence, this attempt subjects new phenomena to old laws. the title of the 1997 green paper already suggested that eu was acutely aware that convergence must have some impact on regulation. it postulated that regulatory barriers at different levels of the market can hinder the development of new services. the rules defined for “national, analogue and mono-media environment” are claimed not to be suitable for the converged ones and new models are explored. the green paper itself suggests that three such potential regulatory models might be possible. the first would maintain legacy regulation3 without substantive modification. this model had not been used in eu it regulation. the second model would carve out new regulation but only where needed and largely within the existing regulatory and enforcement structures. this has been the regulatory model impliedly adopted and most of eu laws in the digital world still use it in some form or another. the third model would radically reassess the way new converged services need to 2 see michael latzer, “convergence, co-evolution and complexity in european communications policy”, in k. donders et al. (eds.) the palgrave handbook of european media policy (palgrave macmillan 2014). 3 by legacy regulation we mean laws that applied to pre-internet networks and services. njcl 2018/1 11 be regulated, abandon the existing laws and write completely new ones, based on converged services. this is, i will argue in section 4, the model that needs to be applied to platforms in the future but has not been hitherto. while the 1997 document may suggest that convergence already plays its firmly-established role in eu policy, this is not the case. there are two signs testifying to the fact that a comprehensive eu policy in this field does not exist yet.4 first, for such a policy to exist, policymaking would have to shift from separate policies to a converged one. although the 1997 document might imply that this has already happened (or is about to), this is not the case. the green paper had only been a recognition of the realities of convergence and an invitation to a debate. a look at documents in the three regulatory layers5 reveals the existence of non-converged policies. in the latest wave of reforms of digital laws, prompted by the 2015 digital single market strategy,6 each of the three layers (isss, audio-video ands telecoms) have separate policy goals and principles and are equipped with different tools to achieve them. this confirms the view that member states are reluctant to abandon the legacy policies which have, after all, been a long time in the development and required substantial political compromise. second, a comprehensive approach to convergence would also imply that regulatory and enforcement structures have shifted from vertical to horizontal. this has not happened either. in telecommunications, national regulatory authorities are charged with enforcement of telecoms policies.7 in the iss world, this is the case with business authorities, consumer protection agencies, data protection authorities and others. in audio-video world, the enforcement is in the hands of broadcasting and other agencies. there are no regulatory authorities in charge of converged "platforms". 4 for an overview of eu regulatory reaction to convergence in the earlier parts of the century see pablo ibáñez colomo, european communications law and technological convergence: deregulation, re-regulation and regulatory convergence in television and telecommunications (kluwer 2012). 5 the digital world, as will be seen in section 2 below, is subject to three separate policy and regulatory “circles”, which co-exist with each other and which each from their own perspective regulate intermediaries as and when needed. the first, telecoms framework, applies to the carriage of signals. the second covers information society services (isss) and the third audio-video media services (avms) both on the content layer. 6 6.5.2015 com(2015) 192 final. 7 the idea of a single eu agency has been flashed but never adopted due to high resistance from member states. the ultimate goal of moving from ex ante to competition regulation of telecoms, however, would confirm the declared desire to match convergence in the real world with convergence in regulation. eu regulatory models for platforms 12 based on the developments above, a preliminary conclusion could be drawn: the eu lawmaker seems to believe that the fact that the same services are delivered over different networks does not make these services the same nor does it necessarily imply that they should be regulated through a single regulatory framework. but this does not mean that eu does not regulate platforms. on the contrary. as will be demonstrated in section 3, new laws specifically targeting platforms have been proposed since 2015. this leads to another observation which is crucial in this paper: the eu regulator feels prompted to regulate platforms resulting from converged services by simply translating the legacy regulatory objectives to them. this statement, as will be discussed in section 4 below, informs the eu’s regulatory approach to convergence and to platforms from 2015 up to the present moment. i will argue that this approach already is and will continue to be the source of considerable conflict in the future because legacy tools may not be capable of addressing horizontal services. two main claims are made in this paper. the first is that convergence forced the eu to think about platforms and move from its decades-old approach to it regulation. the second is that the eu’s model for platform regulation is not based on a thorough rethink of the role of converged platforms but attempts to translate the regulatory aims and principles of the pre-platform era. the first claim is that converging technologies and the emergence of platforms stand in a relationship. this relationship had already been indicated in the 90s. the most prescient statement in the 1997 green paper is that converging technologies lead to “platform independence” and it is the implication of this statement for the regulation of modern digital economy that is the subject of this paper. rather than rely on single networks (usually proprietary, sometimes government-owned but often government-controlled), platforms can choose the one that best suits their own and the needs of their clients, thus making them independent and, by analogy, more efficient. while i am not claiming that convergence has been the only cause of the emergence of platforms,8 i maintain that it has been one of the main causes, since network effects stand both as the main consequence of convergence and as the trigger for platform deployment. put in different words, convergence has created network effects by making services more accessible and cheaper. this, in turn, enabled business models based on 8 there is as yet insufficient research to explain the rise of platform-economy. njcl 2018/1 13 platforms which only work where there are network effects to flourish. more than 20 years after the eu green paper, the digital economy is the economy of platform independence.9 the transformative power of converged platforms arises from the ability to connect market actors in unprecedented ways, eliminating the gatekeepers and lowering transaction costs, thus opening possibilities for new value creation. platforms have become ubiquitous precisely because of their ability to transform the linear model of doing business by facilitating the exchange of goods and services. platforms which do not own any production capacity themselves are able to transform businesses by dramatically lowering the cost of b2b and b2c interaction. the regulator’s interest in platforms should, therefore, not come as a surprise. most companies have either moved to platforms models already or are in the process of doing so. while it is difficult to define platforms due to their diversity and numbers, there are a couple of common elements that define them: they are technology-enabled businesses that facilitate interactions between different groups. in this, they are synonymous with "intermediaries".10 although there is no official eu definition of platforms, the 2016 commission staff working document accompanying the communication on platforms,11 and in line with an earlier attempt at a definition,12 platforms are defined as “two-sided” or “multi-sided” markets “where users are brought together by a platform operator in order to facilitate a transaction”.13 i have indicated earlier that eu regulators chose to adapt its present legacy rules to the needs of convergence. this means that no horizontal policies (those that target converged platforms rather than only services of a particular type) have been developed. in spite of this, there is no doubt that platforms stand as a distinct regulatory unit in the minds of eu regulators, since not only does the eu maintain its distinct regime on intermediaries (thus singling them out as being something 9 see geoffrey parler, marshall w van alstyne, sangeet paul choudary, platfrom revolution (w.w. norton & company : new york 2016). 10 although not with internet intermediaries, which are companies engaging in selling retail internet access. 11 european commission, swd(2016) 172. 12 public consultation on the regulatory environment for platforms, online intermediaries, data and cloud computing and the collaborative economy, available at https://ec.europa.eu/digital-single-market/en/news/public-consultation-regulatory environment-platforms-online-intermediaries-data-and-cloud, accessed 7.11.2016. 13 this definition makes little sense, as there are no reasons why platforms could not be one-sided (e.g. serving only members of a club or a gaming community). eu regulatory models for platforms 14 different than platforms), but it also usually explicitly emphasises that there is no need for its change. the eu regulation of platforms arises from the need to address convergence but stands on the shoulders of its vertical policies in three layers of digital regulation. in addition to saying that convergence and platform regulation stand in a direct relationship, this article’s second main claim is that the eu’s platform regulation is inadequate. while documents referred to in sections 2 and 3 testify to the commission’s interest in platforms and confirm its awareness of the problem, attempts to regulate platforms remain problematic. the reason for this is not only that the eu’s attempts to regulate platforms clash with its existing laws on information society services (isss) and networks & services (telecoms) but also that platforms remain diverse by type, function and business model. to believe, as the eu does, that telecoms providers, transport services, streaming media and user-generated sites should all be treated the same is, at best, naïve and, at worst, counterproductive. convergence may very well have been the trigger for eu’s interest in platforms but does not, in and of itself, justify a unified approach. the emergence of platforms, just like converged technologies, problematises the commission's legacy "silo" model of regulation where carrier (telecoms wires) and content (what these wires carry) have their own regulatory circles. in this paper, i put forward two claims regarding that model. the first, examined in section 2, is that the slow but gradual policy shift in the eu from networks and services to platforms as main subjects of regulation results not from a coherent set of new objectives but from a desire to make platforms fit current objectives. the second claim, examined in section 3, is that the move to platforms as regulatory objects in the new proposals results from the need to overcome the legacy regulatory model of non-converged services and answer to specific challenges of convergence. i will argue that this move will prove to be inadequate precisely because an overarching convergence-based platform policy is lacking. finally, in section 4, in criticism of this approach, i look at the alternative regulatory models for platforms stranding the content and carrier and submit the claim that platforms require an integrated rather than silo approach. if governments desire to regulate the intermediaries efficiently, they need to abandon the legacy approach based on networks and services in favour of objectives and tools that better match the new reality. njcl 2018/1 15 2. from “services” to “platforms” the emergence of a new policy 2.1. the “silo” approach a careful reader attempting to look at how the eu regulated “platforms” in its it laws in the early 2000s would hardly notice the word mentioned in any of the policy documents then circulated. a further, more detailed, analysis of the relevant laws would not be more revealing either. a conclusion that platforms are not the subject of eu regulatory effort would, therefore, quickly impose itself and would, partially at least, be correct. what would be noticed, instead, is that the digital world is subject to three separate regulatory circles, each developed before technological convergence took swing. the first of these applies to the transmission of signals. this is the regulation of “wires” that carry the signal or, in technical terms, of electronic networks and services. this regulatory circle, the outline of which had been laid down in various laws in the late 80s but which, in its present form dates to 2002, with some important revisions being proposed in 2009, is traditionally referred to as telecommunications regulatory framework.14 in 2016 the commission suggested significant reform, including codification of different directives.15 the proposals are still pending as of may 2018. the main policy objective in telecoms has traditionally been to liberalize telecoms networks and service followed by a degree of harmonization. the chosen tool has been ex ante asymmetric regulation of undertakings with the significant market power. the second regulatory circle applies to the content being carried through wires. in broadest terms it can be described as encompassing all information society services (isss) which, in turn, are defined as services provided at a distance, for remuneration (although not necessarily against a payment) and at an individual request (rather than being broadcast). these services encompass the entirety of content distributed on the internet. the framework directive in this area is the e-commerce 14 european commission, regulatory framework for electronic communications in the european union, december 2009, available at https://ec.europa.eu/digital-singlemarket/sites/digitalagenda/files/copy%20of%20regulatory%20framework%20for%20electonic%20co mmunications%202013%20no%20crops.pdf 15 see proposal for a directive of the european parliament and of the council establishing the european electronic communications code (recast) com(2016)590. for details, see andrej savin, eu telecommunications law (edward elgar: cheltenham 2018). eu regulatory models for platforms 16 directive,16 although separate laws cover copyright, privacy, payments, consumer protection, jurisdiction, etc.17 the main policy objective has been to facilitate the free movement of information society services and the main tool has been home country control, limited isp liability and comprehensive data and consumer protection measures. the third regulatory circle, which covers media in general, revolves around content over which there exists editorial control. typically, this category is defined as encompassing audio-video media services. the avms directive18 is the framework directive that controls this area. the main policy objective has been the free movement of audio-video media services and the main tool home country control coupled with various content-control measures. the current regulatory model and this is a crucial point in this paper is a vertical model based on three separate regulatory pillars.19 in this model, electronic communications, linear and non-linear audiovisual and information society services are each subject to separate regulatory framework. that separate pillars existed in the 80s and 90s, when the respective frameworks had been set up, should come as no surprise. there would have been no converged services and no need for converged laws. however, while technology has been converging, regulatory layers have largely not. where they have, this has been forced through practical problems of convergence. the subject of regulatory intervention of each circle, respectively, are telecoms networks and services, information society services and audio-video media services. platforms do not feature in any of the three. this is partially a result of the choice made following the 1997 green paper: no new regulatory framework in response to convergence. in a paper written in 2016, destreel and larouche explore the possibility of targeted regulatory framework for digital networks and services and 16 directive 2000/31/ec of the european parliament and of the council of 8 june 2000 on certain legal aspects of information society services, in particular electronic commerce, in the internal market, oj l 178/1, 17.7.2000. 17 for details, see andrej savin, eu internet law (2nd edition, edward elgar: cheltenham 2017). 18 directive 2010/13/eu of the european parliament and of the council of 10 march 2010 on the coordination of certain provisions laid down by law, regulation or administrative action in member states concerning the provision of audiovisual media services (audiovisual media services directive), oj l 95/1, 15.4.2010. for a proposal for update, see com/2016/0287, 25.5.2016. 19 see also alexandre de streel and pierre larouche, an integrated regulatory framework for digital networks and services, cerre policy report, cerre report, 27 january 2016. njcl 2018/1 17 advise the commission to abandon the current vertical model in favour of one “based on horizontal layers, distinguishing between digital networks and all types of digital services.”20. the key point requiring new laws is precisely the substitutability of different services. since such services can be easily substituted, the existence of separate regulatory silos is superficial. but, although substitutability may point in the direction of “level playing field”, which is the idea that like services should be regulated alike, this is not what is claimed here. there is a subtle difference between applying the existing laws to a new category of services and creating new laws for it. the level playing field does the former. convergence arguably requires the latter. the lack of converged laws, coupled with an ad hoc approach to regulating platforms (explored in section 3) may have unexpected results since regulatory objectives, principles and regulatory tools do not correspond to the technological and social realities. 2.2. the shift to platforms starting from 2015, when the digital single market strategy had been adopted, an interesting trend can be noted. the eu policy documents gradually begin talking about regulating "platforms" rather than "networks" or "services" and the proposals on platform regulation are openly debated and tabled (see section 3 below). these calls signal a shift to platforms as legitimate regulatory targets. there should be no confusion here. a platform can be subject to different sector-specific laws, competition, advertising, telecoms, etc., without special platformspecific rules or, indeed, policies. this has been the case since the mid 90s when the internet gradually emerged as a medium. a platformspecific law, however, targets platforms only. a policy shift would signify a move from a more traditional regulatory model to platform-specific laws. such a shift can result from a comprehensive policy or a set of ad hoc corrections. it is important to emphasise that platforms in the eu have not been targeted as a result of a comprehensive call for the analysis of their effects on the economy. this is a point of considerable importance. the general regulatory direction in the digital world has always been clear. rather than a change in the agenda, the move has been local and a result of the perceived disruption that platforms have caused deeper down the policy tree and a desire to address it. thus (see section 3), ott platforms needed to be brought to a level playing field with the 20 alexandre de streel, pierre larouche, ibid 8. eu regulatory models for platforms 18 traditional ones, user-generated services needed to be forced to install filtering and video distribution platforms needed to be made similar to traditional linear television. the absence of a general policy direction in the most important document is nothing short of striking. the 2015 dsm suggested that market power of some platforms may be a reason for concern. in response to that, it claimed that a “fit for purpose environment for platforms and intermediaries” is needed. no further comment is offered, making this one of the shortest policy elaborations on offer. combatting illegal content online, in particular, is alleged to be in the need of action. here, the commission suggests that platforms facilitate the distribution of illegal content. the commission promises action in five areas: transparency in search results, platforms’ use of information they collect, relations between platforms and suppliers, intra-platform movability of users and illegal content. no detailed analysis of the nature of platforms, their emergence or their operation is offered or referred to here. platforms are taken for granted as is the fact that future intervention might be necessary. although the promised platform regulatory intervention is classified under one of the three other proposed reforms of the digital single market, there is little doubt that the lawmakers give it relative importance. a number of follow-up documents set the commission’s promised action in motion and set out the foundations for the eu policy on platforms. the 2016 communication on platforms was followed by a 2017 communication and 2018 guidelines on illegal content. although lacking mandatory force of law, the three documents serve as guidelines and, in the case of 2018, as a benchmark to be met in case targeted stakeholders wish to avoid further legislation. the 2016 communication on platforms21 is a neither a comprehensive document on platforms nor a proper policy paper but a brief 15-page-long outline of the principles that the commission declares will guide it in its effort to regulate platforms and an outline of the ways in which these principles will be implemented. to be the former, it lacks a commissioned body of research normally accompanying other proposals and to be the latter it lacks separate objectives and tools (although it does declare some basic principles). the communication begins with a brief and relatively superficial overview of the importance of platforms. the principles the commission promises to take into account are: 21 25.5.2016 com(2016) 288 final. njcl 2018/1 19 • a level playing field for comparable digital services; • responsible behaviour of online platforms to protect core values; • transparency and fairness for maintaining user trust and safeguarding innovation; • open and non-discriminatory markets in a data-driven economy. several important policy goals can nevertheless be discerned from this. probably the most striking statement is the idea that a level playing field should exist for comparable digital services. put in other words, this means that like should be regulated alike. although the level playing field has not been formulated properly in legal theory, it is occasionally used in different policies to either decrease the burden on the incumbent provider or to increase the burden on the disruptive one. kenny and suter22 suggest that the ‘level playing field’ argument only makes sense a) if the parties operate in the same market, b) if the regulation is actually burdensome on one but not on the other party, c) whether the regulation as a whole favours one party but not the other and, finally, d) if the benefits of symmetric regulation actually outweigh the benefit of asymmetric. it is doubtful whether level playing field should be applied as a general principle for regulating digital platforms which are as diverse in their design as they are in the choice of the business model they apply. similar doubts can be raised in respect of “responsible behaviour”, “transparency” or “fairness” terms which are vague and would be left to national courts. based on the foregoing, the commission promises action in three separate areas. first, it promises to bring a level playing field to ott services. the suggestion is that telecoms rules should be reviewed and that scope and extent of existing legislation should be reduced (deregulation) while applying a limited set of laws to all comparable services (harmonisation).23 the second promise is to ensure that online platforms “act responsibly”. while this refers to increased instances of copyright violations, hate speech and other transgressions online, the reality is that the illegalities referred to are diverse. the promised action include reforming of the audio-visual media services directive, a new copyright package and self-regulation.24 very significantly, the 22 robert kenny & tim suter, “an unraveling of the digital single market, a review of the proposed avmsd” (communications chambers 2016). 23 this will be analysed in section 3.1 below. 24 these are analysed in section 3.2 below. eu regulatory models for platforms 20 communication does not promise a radical change in the regime for intermediary liability.25 the third step is “fostering trust, transparency and fairness” and relates to first, reform of consumer protection laws and, second, to fairness in business-to-consumer relations.26 the final suggestion is to keep open and non-discriminatory markets in the effort to foster a data-driven economy. fulfilling some of the promises made in the 2016 communication, the commission followed up with the 2017 communication on tackling illegal content online and the 2018 recommendation on the same subject. unlike the 2016 communication on platforms, which is a policy outline specifically targeting platforms, these documents are more general in seeking to eliminate different types of illegal content, not necessarily only generated or spread by platforms. nevertheless, it is abundantly clear that platforms are the real target of any intended action. the 2017 communication, for example, contains the words “towards an enhanced responsibility of online platforms” as its subtitle, leaving little doubt as to its objectives. the 2018 recommendation is in particular important as a policy paper since it threatens27 action unless the changes it proposes are not followed. this indicates the commission’s impatience but also a change in attitude as threats of this kind are relatively rare in eu law. the recommendation starts from the premise that platforms ought to be more proactive and do more to step up the fight against illegal content online. the commission makes the assumption that “platforms” ought to be the target of such efforts. little or no effort is made to distinguish between different types of platforms and little evidence is otherwise provided to support the commission’s claims. furthermore, the document declares that no clash is intended or created with articles 1215 of the e-commerce directive. as i will discuss in section 3.2 below, this is precisely a sudden shift in policy that generates conflict. the recommendation calls for clearer ‘notice and action’ procedures, more efficient tools and proactive technologies, stronger safeguards to ensure fundamental rights, special attention to small companies and closer cooperation with authorities. special rules are introduced for “terrorist” content online and this includes the obligation to remove such content 25 articles 12-14 of the e-commerce directive protect intermediaries (as conduits, caches and hosts) from liability until the moment of notification. article 15 removes the obligation of permanent monitoring. 26 the latter is looked at in section 3.2 below. 27 cf. preamble 33. njcl 2018/1 21 within an hour of referral, faster detection and removal, better referral and regular reporting to the commission, in particular about referrals. the problems with the guidelines are abundant. first, they lack effective safeguards. the safeguards they do provide are either vague or left to member states. second, the monitoring, which would effectively arise as an obligation if the guidelines were to be followed, is in conflict with article 15 of the e-commerce directive. finally, different kinds of illegal content do not necessarily lend themselves to similar mechanisms for removal. an analysis of the policy documents drafted since 2015 reveals a surprising approach to platforms. first, the post-2015 approach cannot be labelled a proper policy as it lacks separate objectives, principles and tools, borrowing, instead, heavily from legacy policies. second, there is no doubt that the common thread is the fear that platforms may facilitate the spreading of illegal content online and the fear that platforms may treat different players on the market unfairly. thus, platforms need to be “more transparent” and “more responsible” and the “level playing field” needs to be imposed on different market players. while lip service is paid to platforms’ importance, the eu policy is not enabling new and improved uses nor is it designed to promote. instead, it can be labelled as “defensive” or “reactive”. such as it is, the new policy has shifted the regulatory interest. section 3 reveals whether the new focus has brought significant changes. 3. converged platforms in the new proposals in the previous section, i have demonstrated that the eu gradually included platforms in some of its documents, in spite of the absence of a comprehensive policy that would address platform regulation. i noted that the main aspect of this partial approach is an attempt to address platforms as a threat to existing business models. this new eu model gradually shifted the regulatory focus from intermediaries, networks and services, which were the regulatory units of most eu it regulation in the 90s and 00s, to platforms. the change took place consistently in each of the three content and carrier regulatory circles described in section 2.1 in each of them, platforms brought about by the converged technological reality caused a defensive policy shift and brought a proposal shielding legacy technologies from the converged platforms. the effect is least prominent in the main part of the new telecoms proposal but is apparent in each of the other layers. in telecoms services, converged ott platforms threatening traditional telecoms models are subjected to traditional telecoms rules. in eu regulatory models for platforms 22 information society services, collaborative platforms based on usergenerated content are subjected to traditional ip models. in audio-video media services, on-demand platforms are subjected to regulatory models suitable for linear broadcasting. i will look at each in turn. 3.1. telecoms and ott services the european telecommunications regulatory framework in its present form dates to 2002. the main feature of that framework is that telecoms networks and services are subject to ex ante sector-specific regulation. rather than regulate after the harm had taken place, as is the case with competition law, the lawmaker gives national telecoms authorities the right to impose remedies ex ante in all cases where a significant market power (smp) exists and where there is a risk that anticompetitive effects might follow. the telecoms framework consists of general rules (framework directive28), coupled with the rules on authorisation (authorisation directive29), access (access directive30), universal service (universal service directive31) and privacy (eprivacy directive32). changes to the eu telecommunications regulatory package have been tabled in 2016,33 after an abortive attempt in 2015.34 the proposal aims to codify the present laws, modernise various aspects that are considered to be outdated, streamline the procedural aspects and remove regulatory barriers to investment. among the most notable challenges the eecc had to address, however, is the status of over-the-top providers (otts). in simplest terms, otts can be defined as media companies that distribute content and services (voip, instant messaging, streaming, etc.) through the internet rather than other proprietary channels. ott services are the result of a converged internet and a manifestation of what such an internet means in practice. instead of relying on their own purpose-built networks, which would be subject to telecoms regulation, otts use the internet, thus falling under the definition of information society services (isss). as such, they are 28 directive 2002/21. 29 directive 2002/20. 30 directive2002/19. 31 directive 2002/22/ec. 32 directive 2002/58. 33 proposal for a european electronic communications code (eecc), 14.9.2016. com(2016) 590 final. 34 the 2013 proposal, com(2013) 627 final, have been significantly reduced so that the regulation adopted in 2015 only dealt with roaming and net neutrality, regulation 2015/2120 (eu), oj l310/1, 26.11.2015. njcl 2018/1 23 subject to the significantly simpler and less onerous regime that covers isss.35 the incumbent telecommunications companies argue that otts compete unfairly and that either the regulatory regime imposed on them should be relaxed and/or that otts should be subject to telecoms-style ex ante regulation. the impact assessment document for the telecoms proposal leaves no doubt that the commission is aware of the problem but also leaves the impression that no radical measures were contemplated.36 having considered the options, the eecc proposal addresses the issue in a significant but measured way, proposing a somewhat changed definition of electronic communications services as a solution. in its article 2(4), it suggests that telecoms services are internet access services and interpersonal communication services. the latter are then divided into number-dependent and number-independent ones. it then subjects the number-dependent interpersonal communication services to a limited set of obligations, with the effect of putting the converged ott services under the scope of some of the obligations, albeit very limited ones. a somewhat more radical intervention is envisaged in the eprivacy regulation,37 designed as a replacement of the 2002 eprivacy directive.38 recital 11 and article 4(1)(b) of the proposal directly refer to eecc definition of electronic communications services which, in turn, now covers interpersonal communication services. article 2(1) subjects such services to the new proposed regulation. significantly, the eecc definition of electronic communications services informs the two proposals differently. while the eecc only subjects ott services (and only number-based ones at that) to a relatively restricted set of new rules (as seen in the preceding paragraphs), the eprivacy proposal suggests more radical changes. in principle, all obligations which the proposal imposes on telecoms services apply equally both to traditional and to ott services. this relates to confidentiality (article 5), permitted processing (article 6), storage and erasure (article 7), protection of information (article 8), consent (article 9) and others (chapters iii, iv and v). this means that a very wide group of platforms – those providing interpersonal communication services – are fully subject to eprivacy rules. while it is unclear whether the proposal would be 35 berec, report on ott services, january 2016, bor (16) 35. 36 14.9.2016 swd(2016) 304 final. 37 10.1.2017 com(2017) 8 final. 38 directive 2002/58/ec, oj l 201/37, 31.7.2002. eu regulatory models for platforms 24 adopted and, if so, in what form, if it is adopted in its present form, this would signify a significant shift to significantly more regulated otts. two observations can be made in respect of the latest telecoms proposals and their potential impact on the regulation of platforms. each is, in its own right, revealing. first, the changes have been prompted by convergence. this is one of the instances where the preparatory documents declare the aims very clearly, both for the eecc39 and the eprivacy regulation.40 in this sense, there is no doubt that the proposals are informed by the realities of the converged internet. second, there is a shift from networks and services to platforms as regulatory units at least in case of the eprivacy directive. while the eecc proposal extended the scope of telecoms rules to otts, it did so in a very narrow set of circumstances. this is not the case of the eprivacy proposal, which subjects platforms to its full set of tools, without going into details as to whether such legislation is appropriate. the difference in the two proposals could not be more striking. but, rather than rethink the need for privacy intervention in platforms of different kinds, the proposal simply extends the legacy regulatory objectives (comprehensive privacy) and tools (articles 6, 8, 9, etc.) to platforms without fundamentally rethinking either. 3.2. information society services and filtering information society services have for a long time been subject to a stable set of laws dating to late 90s and early 2000s. the framework directive in this area is the electronic commerce directive from 2001.41 the directive subjects information society services, which are defined as services provided at a distance, by electronic means, at individual request and for remuneration (although not necessarily against a payment), to the laws of the home state, introduces some information requirements and insulates intermediaries from liability in a well-defined set of cases. in addition to this, sector-specific e-commerce laws have been passed covering a number of areas including copyright,42 privacy43 and consumer protection.44 no open calls for revision of the e-commerce directive have been made, either in the 2015 digital single market strategy, nor in any of the other policy documents. on the contrary, policy papers mentioned in 39 recital 7. 40 recital 11. 41 directive 2000/31/ec,oj l178/1, 17.7.2000. 42 directive 2001/ 29/ec (infosoc), oj l167/10, 22.6.2001. 43 directive 95/46/ec (data protection), oj l281/31, 23 november 1995. 44 directive 2011/ 83/ec (consumer rights), oj l304/64, 22.11.2011. njcl 2018/1 25 section 2 all declare that any changes, proposed or contemplated, do not modify general e-commerce laws and the isp liability regime in specific.45 the key components of that regime, i would argue, are home country control (article 3(1)) and isp liability insulation (articles 12-15). while the former ensures that a provider acting legally in their state of origin can simply export their services, the latter ensures that such provider would not be liable for acts which it does not itself initiate or actively monitor. the 2015 dsm strategy indicated a number of areas which the commission promised to look into but a close look at the strategy would not give the impression that deep-going changes are demanded. nevertheless, several proposals have a significant impact for platform regulation and two in particular demonstrate the regulatory move from services to platforms which we have indicated in section 2 as well as the translation of legacy-era objectives onto the platform world. the proposal for a directive on copyright in the digital single market46 is a result of a prolonged process of reform, prompted mostly by the increased demands for copyright law to take account of new technologies, changed patterns of production and use of intellectual property goods and increase in user-generated content. the proposal aims to improve exceptions, improve licensing practices and “achieve a well-functioning marketplace for copyright”. in light of the latter, article 13 proposes measures on the use of protected content by isp providers “storing and giving access to large amounts of works and other subjectmatter uploaded by their users.” the proposed text does not define such providers. the first obligation that they would have to be subjected to is to take measures to ensure the functioning of agreements concluded with rightholders in cooperation with them. this means an obligation to conclude appropriate licensing agreements. in the alternative (the text uses the connection “or”), i.e. in case these agreements have willingly not been concluded or have proven difficult or impossible, the providers have the obligation to prevent the availability on their services of works or other subject-matter identified by rightholders through cooperation with them. this includes measures for effective content recognition technologies which need to be appropriate and proportionate. explaining the operation of the proposed measures in relation to articles 12-15 of the e-commerce directive, preamble 38 maintains that the regime outlined in article 13 applies wherever the e-commerce 45 p. 9 in the 2016 communication, paragraphs 14 and 17 of the preamble to 2018 recommendation, paragraph 38 of the copyright in the dsm proposal. 46 14.9.2016 com(2016) 593 final. eu regulatory models for platforms 26 exception does not. this suggests that the lawmaker believes platforms to still be subject to isp liability exemption. hoping to clarify the situation further, it adds that it is necessary to verify whether the service provider plays an active role, including by optimising the presentation of the uploaded works or subjectmatter or promoting them, irrespective of the nature of the means used therefor. analysing the provisions in light of the current eu law and cjeu cases that interpret it, it is difficult to justify its existence and escape the feeling that, if adopted, it would cause a direct clash with existing laws.47 there are several reasons for this. first, article 15 of the e-commerce directive obliges member states not to impose on isps a general obligation to monitor or to seek illegal activities. article 13 of the proposal demands that isps engage in automated monitoring in the form of “effective filtering”. generic filtering requires monitoring by its very nature. matters are further complicated by cjeu’s interpretation in sabam which clearly indicates that generic and indiscriminate filtering is, in itself, illegal.48 this case has subsequently been slightly modified in upc,49 where the court ruled that injunctions not specifying the measures but allowing the isp to demonstrate that it had taken all reasonable measures were legal. the difference, however, is that even under upc it is the isps that bear the burden of proving that they took reasonable measures while under article 13 a pre-defined set of such measures (state-of-the-art filtering) is imposed. second, it would appear that the proposed article 13 demands that either agreements should be concluded or that “effective” filtering should be installed. it then maintains that not complying with either of these two would remove the protection provided by article 14 ecd. in other words, the proposal maintains that only article 13-compliant isps would benefit from article 14 ecd. while it is true that article 14 of the e-commerce directive provides exemption from liability only for bona fide providers, it is not clear why and when “optimising the presentation” might eliminate protection nor what amounts to 47 see, for example, stalla-bourdillon et al., ‘open letter to the european commission on the importance of preserving the consistency and integrity of the eu acquis relating to content monitoring within the information society’ (september 30, 2016). available at ssrn: https://ssrn.com/abstract=2850483. 48 c-70/10 scarlet extended sa v société belge des auteurs, compositeurs et éditeurs scrl (sabam) , 24 november 2011, ecli:eu:c2011:771. 49 c-314/12 upc telekabel wien gmbh v constantin film verleih gmbh and wega filmproduktiongesellschaft gmbh, 27 march 2014, ecli:eu:c2014:192. njcl 2018/1 27 “promoting” the works. this is in direct conflict with cjeu’s reading of article 14 in both google france50 and l’oreal v ebay.51 in the former, the court said that non-active providers should benefit from protection except where they, having obtained the knowledge, fail to act. in the latter, the court suggests that only the operator who was well aware of the circumstances would lose the protection. taken together with article 15, this should be taken to mean that ecd does not require filtering as an essential component for the existence of insulation from liability (although they may very well form part of an individual court order). the fascinating element in the proposal is the clash in objectives and tools. while intermediaries in the legacy world are shielded as long as they lack information on the alleged illegalities (and, thereafter, remove or filter out specific content), the platforms in the new policy need to filter out in advance if they are to be shielded at all. in the former, the assumption is that intermediaries are innocent until proven otherwise. in the latter, they are assumed to be a spreading ground for illegal content. the proposal on the transparency on business-to-business platforms had first been announced in the 2015 dsm strategy, where transparency in search results, platforms’ usage of information they collect and relations between platforms and suppliers have been flagged as areas of interest. in april 2018, following a detailed inquiry,52 the commission proposed a regulation on promoting fairness and transparency for business users of online intermediation services.53 as mentioned, in spite of the commission’s declared reservations towards openly legislating on platforms, the policy documents do promise that some action will be taken. the main premise of the proposal that platforms act as gatekeepers on which businesses depend represents a summary of one of the commission’s main new policy positions regarding the digital world. the present proposal seems to be aimed at bringing extra requirements for clarity and transparency in situations where platforms could abuse their dominance. the regulation would apply to online intermediaries and search engines providing services to business users with a place of establishment in the eu and offering goods and services to eu consumers. it is not important for the purposes of the proposal if platforms themselves have a place of business or residence in the eu, as 50 c-236/08 and c-238/08 [2010] ecr i-02417. 51 c-324/09 12 july 2011, ecli:eu:c2011:474. 52 see impact assessment, 26.4.2018 swd(2018) 138 final. 53 26.4.2018 com(2018) 238 final. eu regulatory models for platforms 28 long as business users they offer services to have such a place and engage in targeting eu consumers. a platform based in the us (such as google) would therefore fall in the scope of the regulation in as much as its clients are businesses dealing with eu consumers. although the word “platforms” is only used in the preamble, there is no doubt that platforms are the real target. this means that a search engine or a social network based in the united states would fall under the new rules. although the list of obligations the platforms would be subject to is diverse, it can be summarised as increased obligation of transparency in all situations where platforms’ actions could unfairly influence the businesses that rely on them. particularly important, however, is article 5, forcing online platforms to set out in their terms and conditions the main parameters determining ranking and the reasons for their relative importance. where businesses have an opportunity to pay to influence ranking, such possibility would also have to be disclosed. online platforms do not have to disclose any trade secrets as defined in the eu trade secrets directive. two features of the proposal, in particular, should cause concern. first, the proposal covers search engines, on whose definition wide agreement exists, and “online intermediation services”, known as platforms both colloquially and in eu policy papers (see section 2). the latter are defined in article 2(2) as • information society services within the meaning of eu law; • which allow business users to offer goods or services to consumers, with a view to facilitating the initiating of direct transactions between those business users and consumers, irrespective of where those transactions are ultimately concluded; • provided to business users on the basis of contractual relationships between those business users and their own clients (business or private) this definition is exceptionally wide in its scope. in essence, it is enough for a platform to offer services facilitating the interaction between businesses and their clients for it to fall under the obligations. no financial threshold is offered and the platform need not operate on a subscription model (advertising income would be enough). the second problem is the scope of the proposed article 5 which would force platforms to disclose “the main parameters determining ranking and the reasons for the relative importance” of those parameters as opposed to others in their terms and conditions. njcl 2018/1 29 while the other demand, to disclose that ranking might be influenced by payment, is reasonable from the viewpoint of fair competition, the disclosure of ranking criteria is poorly defined. for search engines, paragraph 2 of article 5 requires the main parameters determining ranking to be disclosed in an “easily and publicly available description, drafted in clear and unambiguous language.” article 5(3) explicitly excludes the possibility of disclosure of any trade secrets as defined in directive 2016/943. it is difficult to explain how platforms and search engines can release meaningful information without also releasing elements of trade secrets. both proposals demonstrate the broad strokes with which the lawmaker aims to regulate platforms and search engines. while the copyright in the dsm covers all user-generated websites (or at least a large majority thereof), the transparency on business networks proposal covers all search engines and all platforms. it is true that the ecommerce directive applies to all information society services, a category even broader than platforms. the nature of the regulatory intervention in that document, however, is radically different than the two proposals above. when the clinton administration considered the best approach to regulating the internet in the 90s, it adopted the laissezfaire approach which, in turn, had influenced the drafters of the ecommerce directive to take the enabling of free movement of information society services as its main goal.54 this leads to an important distinction between information society services and/or intermediaries as opposed to platforms as regulatory targets. while the eu policy in the case of the former had been drafted to enable their spread (home country control, limited liability), the policy in case of the latter had been mainly defensive it has been targeting platforms as obstacles. this has meant that platforms in the iss world have been taken out of the scope of legacy regulatory objectives (free movement of digital services) but taken within the scope of legacy tools (full liability, disclosure of ranking criteria). even more significantly, this is not done with the objective of making platforms spread their services liberally but, on the contrary, with a view to preventing their (perceived and real) illegal activity. 3.3. audio-video media services and video-on-demand audio-video media services (avms), as indicated earlier, are regulated separately from information society and telecoms services. the 54 for deatails, see andrej savin, eu internet law (2nd edition, edward elgar: cheltenham 2017), chapter 1. eu regulatory models for platforms 30 chief differentiating factor is the existence of editorial control: media are communication intermediaries with editorial control. where media are not subject to such control, they may fall under one of the other frameworks. the purpose of the 2010 avms directive was to bring minimum harmonisation in a number of areas but also to create a level playing field for emerging audio–video media, preserve cultural diversity, protect children and consumers, safeguard media pluralism, combat hate speech and guarantee the independence of national regulators.55 although the directive is only a minimum/partial harmonisation of the relevant law, it covers a significant number of issues, including general principles, hate speech, protection of disabled users, promotion of eu works, jurisdiction, protection of minors and advertising. the directive’s main regulatory tool the home country control principle subjects all audio-video services to the law of the country in which they originate. that convergence prompted the legislative changes is stated explicitly in the 2010 directive (preamble, paragraph 14). this is confirmed in article 1, which states that all media irrespective of the manner of delivery and the technology used – are covered. the linear (broadcast) and non-linear (on-demand) means of communications are thus both covered, with each also being subjected to a set of rules specific to their own mode of delivery. the 2013 green paper explored the effects of convergence further, paving the way for the reform of the 2010 directive.56 the avms revision finally proposed in 2016 after a long period of consultations57 is under the direct influence of convergence between television and services distributed via the internet. in the proposed article 28a, it subjects video-sharing platforms to special content-related obligations. the commission gave three reasons to justify further need for regulatory reform: insufficient protection of minors and consumers on videosharing platforms; the lack of a level playing field between the new and old platforms, in addition to internal market problems; and, finally, inadequate rules regarding commercial communications. all three point to platforms, either specifically, as is the case with first two, or indirectly, 55 directive 2010/13/eu, 15.4.2010., oj l 95/1. see mark d. cole and jenny metzdorf (eds), the eu audiovisual media services directive: comparative commentary on the avmsd and national implementation (nomos/hart, oxford 2016). 56 green paper, preparing for a fully converged audiovisual world: growth, creation and values, 24.4.2013 com(2013) 231 final. 57 25.5.2016, com(2016) 287 final. not yet adopted. njcl 2018/1 31 as is the case with the last one. a move towards regulation of platforms is, therefore, the major driving point in the proposal. to understand the impact that the proposal might have on platforms, one must look at the present regulatory regime for video-sharing platforms. for something to even qualify as an audio-video media service under the 2010 avms directive it has to be under the editorial responsibility of a media service provider. if it is not, it would still (likely) be covered as an information society service under the e-commerce directive. under the proposal, a completely new category is introduced in addition to linear and non-linear services video-sharing platform service. these are defined as • storage of a large amount of programmes or usergenerated videos where the provider has no editorial responsibility • organisation of the content is determined by the provider, manually or automatically, in particular by hosting, displaying, tagging and sequencing; • the principle purpose is provision to the general public • the service is made available through telecoms networks it should be clear that this definition encompasses a very large number of platforms of all sizes. thus defined in very broad terms, video sharing platforms are subjected to article 28a and forced to protect minors from content which may impair their physical, mental or moral development and protect all citizens against hate speech. in order to achieve such objectives, platforms would need to use terms and conditions, install mechanisms for users to flag inappropriate content, use age verification systems, install mechanisms allowing users to rate the harmful content and use parental control systems. the interesting aspect of this change is that it is the member states that are addressees of the obligation and not the providers themselves. they are to use, among other, co-regulation.58 the proposal has been met with mild approval from media associations59 but also calls to better adapt to the needs of particular professions.60 on the other hand, critics have also been vocal. analysing the text, cerre concluded that it could endanger the freedom of expression and that guidance on what should constitute incitement to 58 on co-regulation in eu law, see christopher marsden, internet co-regulation: european law, regulatory governance and legitimacy in cyberspace (cambridge university press 2011). 59 see ebu opinion, available at https://www.ebu.ch/news/2016/05/revision-ofaudiovisual-media-se. 60 see cineuropa, 16.4. 2018. http://cineuropa.org/en/newsdetail/351846/. eu regulatory models for platforms 32 hatred and violence should be established as soon as possible.61 in a paper commenting on the trilogue negotiations, edri commented that a proper definition of user-generated video is needed. it also suggested that article 28a be completely deleted or at least substantially changed through amendments.62 it is difficult to argue against the need to reform the current directive and its broad scope should not leave anyone surprised. first, the breadth matches similar interventions in the e-commerce and telecoms discussed above. second, the intervention had been envisaged in the 2015 dsm document, when the commission promised that it would look at the rules applicable to “all market players”. it promised at that point to examine if the scope of the rules should be extended to “new services and players”. this is a typical “level playing field” intervention, attempting not to create a new set of objectives and principles but trying instead to bring the new media under the scope of legacy rules. most worrying, however, is the explicitness with which both the original 2010 avms and the 2016 proposal encompass “platforms”, which are simply taken to be modern extensions of regulated media and thus, in the lawmakers’ mind at least, justifiably subject to intervention. the new platforms may have a separate article dedicated to them, but the proposed measures are exactly the same that apply to linear and nonlinear television. the appropriateness of such an approach is questionable. it is also difficult to escape a feeling of unease, however, as the us reno v aclu case63 comes to mind. 4. the interplay of convergence and regulation and possible alternatives the main claim of this article has been that a gradual shift from regulating networks and services to regulating platforms is notable in eu digital policymaking and that this shift had been prompted by, among other things, convergence of services. i argued that the eu’s interest in regulating platforms arises partially from convergence, which had erased the clear boundaries between networks that provide digital services on the content and carrier layers. there is no doubt that technological convergence has its effect on the content (information society services) 61 sally broughton micova, key issues in the avmsd revision debates: video-sharing platforms and regulator independence, cerre position paper, 19 march 2017. 62 edri, edri position on avmsd trilogue negotiations, 14 september 2017, available at https://edri.org/files/avmsd/edriposition_trilogues_20170914.pdf 63 in reno v. american civil liberties union, 521 u.s. 844 (1997), the us supreme court struck down anti-indecency provisions of us communications decency act. njcl 2018/1 33 as well as carrier levels (telecommunications networks and services) although the nature of the policy response to this still remains somewhat obscure. there should, on the surface, be no surprise in eu’s fascination with platforms, which have come to represent the powerful and dominant intermediaries. in platform revolution,64 parker and others are arguing that networked markets are transforming the economy and that disruptive platforms are connecting the actors on the market in unprecedented ways. platforms eliminate the gatekeepers typical of the linear model and unlock new value. these platforms are made possible by network effects and superior marginal economy. but, while it may be obvious that the eu takes interest in platforms, why has it shifted its regulatory interest from intermediaries? the eu law on intermediaries, after all, is well-established and it would have been logical to target them instead. particularly in favour of that would be the relatively broad definition of intermediaries both in the e-commerce directive itself and the subsequent cjeu interpretation of articles 12-15. there is nothing in cjeu case-law that points in the direction of narrowing the scope of the original definition. the cjeu case-law on injunctions very clearly indicates both that different types of injunctions can be used to prevent current and future infringements and that such injunctions must be specific in their aims and means.65 the answer should be sought in the nature of eu regulatory intervention concerning platforms, already discussed above. the eu of mid 90s and early 2000s sought to position the intermediaries as the enablers of the internet. it thus insulated them from liability, ordered member states not to place unreasonable obstacles to their proliferation and sought to subject them only to the laws of their state of origin. the post-2015 eu it policy is of a very different nature. while intermediaries have been targeted in the 2000s in order to enable the spread of digital services, the focus of the 2015 dsm document is largely on creating the level-playing field and constraining the spread of illegal content. the policy documents analysed above indicate that the eu is committed to maintaining the most important parts of its regulatory regime on intermediaries while targeting platforms in fear of their power and the consequences of the public’s increased dependence on them. 64 geoffrey parler, marshall w van alstyne, sangeet paul choudary, platfrom revolution (w.w. norton & company : new york 2016). 65 see c-360/10 sabam, 16 february 2012, ecli:eu:c:2012:85 and c-314/12 upc telekabel wien, 27 march 2014, ecli:eu:c:2014:192. eu regulatory models for platforms 34 here, isss are still the legitimate regulatory targets, platforms are the necessary evil. section 2 shed light on the eu’s growing policy body on platforms while section 3 showed that regulatory interventions are already under way. we saw that the eu largely applies the existing regulatory tools to new platforms. critically, however, the tools available in the legacy world and taken over by platform-specific laws discussed in section 3 are by their very nature harsh since they target non-compliant intermediaries. thus, full spectrum of eprivacy obligations on the carrier layer or full liability or filtering for intermediaries on the content layer. such tools are designed to catch exceptional illegalities and not created as a toolset controlling the operation of intermediaries in normal situations. there is no doubt that some of the proposed laws are targeted. this is mainly true of the changes proposed to the telecoms framework (although not the eprivacy part). it is also true, however, that the remainder of the proposals do not contain essentially new solutions for platforms. the eu model is, simply put, too ‘crude’ and too reliant on old ideas. but if such responses are questionable, what would the alternatives look like? in order to answer that we must recollect that technological convergence generates friction when regimes come into conflict. ibáñez colomo had argued that this is the case where regulatory objectives pursued by regulation and specific tools chosen to implement them do not match.66 in this situation, legacy tools are used to achieve the new and modified objectives. from this point, two paths are possible. the first path is to deregulate. in some cases deregulation removes some of the assumptions made by legacy regulation. the most typical example of this is the eu’s gradual reduction of the number of markets susceptible to ex ante telecoms regulation. another path is the regulatory convergence in pursuit of technological convergence. the current “silo” approach is not converged but has one regulatory regime for each of the three layers. a converged path would result in a gradual creation of a single regulatory regime, consisting not only in a unified set of rules covering all (or the majority of services) but also in the redefinition of authorities in charge of the enforcement. regulatory convergence may, but does not necessarily, mean the development of new tools. the lawmaker can react “defensively” to convergence where the current objectives are not judged to be in the need of new regulatory tools. the 2010 avms directive had simply extended its regime to on 66 pablo ibáñez colomo, n4 19. see also pages 19-22 for possibilities for a regulatory evolution away from the legacy regime. njcl 2018/1 35 demand services, judging the objectives to justify this. the principle of technology neutrality, which is built into all eu digital directives on the content and carrier layer, takes as a starting point the idea that laws should not be drafted with a particular technology in mind. nevertheless, the principle is not designed to prevent regulatory convergence by continually applying the same regulatory paradigm to every changing technologies. instead, it is meant to bring extra flexibility by removing the need for each new technology to be covered by a matching law. a consequence of non-reaction to convergence is the application of several regimes to technologically converged services. regulatory convergence need not follow with equal speed in all targeted areas and may proceed faster in some. but, what has been eu’s reaction? we have seen that there has been early recognition of the problem (1997). we have also seen that the vertical approach had not been abandoned and that, on the contrary, three “pillars” had been maintained, also in the latest round of reforms. that, in itself may not signify deeper problems but it indicates, especially in light of the proposals discussed in section 3, that the eu reaction is largely defensive. in the first section i stated that the fact that services are delivered over different networks does not, in the eu lawmaker’s eyes, make these services the same nor does it necessarily imply that they should be regulated through a single regulatory framework. this crucial statement came to inform the eu policy and caused the sector-specific interference into platforms. while the convergence made some intervention necessary (as we saw in section 3), the legacy-informed regulatory paradigm prevented logical development of a unified approach. it is not known to what extent the current regulatory models can be applied to platforms. the present regulatory model is, in its essence, a collection of legacy objectives and tools. that new regulatory forms occasionally need to be invented is a well-known fact but the regulation discussed in section 3 is not new. section 3.1 explained how otts are subjected to present laws in a narrow class of cases. section 3.2 talked about the current filtering regime being imposed on platforms in an extended set of circumstances and platforms bring forced to disclose their ranking criteria. section 3.3 talked about extending the present regime to video-sharing platforms. in none of the cases can there be any talk about a new set of rules. instead, the lawmakers' reaction is the same: disruptive platforms are seen to be escaping the present regime, are occasionally reprimanded for not doing more themselves, and ultimately subjected to stricter laws. eu regulatory models for platforms 36 i submit that the eu lawmaker's current approach to platforms is both too broad in scope and misguided.67 too broad, because it is not clear if platforms necessarily raise any new issues which cannot be dealt with through present laws and which would require sweeping intervention of the type seen in the proposal on transparency of filtering of ugc content. in discussing the pitfalls of regulating platforms, hatzopoulous points out the lack of consensus on definition, the subject and the scope of regulation.68 the dilemma is not only whether to regulate but also whether to opt for ex ante or ex post, general or specific, national or eu. the commission’s documents to date have provided little to no material to support one form of regulation over another. self-regulation – an approach that platforms themselves prefer – may very well be adequate but only if properly enforced. misguided, because it misses the key point that convergence has been forced upon us and needs to be addressed. the crucial questions that need to be asked are: what has convergence done to vertical regulation and what needs to be done differently? in a comprehensive report based on the examination of services at different layers, cerre suggested that horizontal regulation is better suited to converged technological realities. so far, the eu lawmaker had attempted to legislate within distinct legal pillars. instead, converged services need to be tackled horizontally across these circles if and when needed, through clear objectives and principles and by good enforcement mechanisms by authorities capable of addressing the problem. substitutability ought to be a leading factor in favouring horizontal regulation of services. this naturally leads to at least a simplification of the regulatory framework to one applying to networks (traditional telecoms/carrier) and another to all services (both isss and avms). even in this division, some regulation on the carrier layer – such as the eprivacy directive – would almost certainly need to be revised so that it does not cover non-telecoms services. the horizontal model would also take most advantage of the already existing legislation (competition law, consumer protection, privacy, contract law, etc.) the problem with the commission’s approach is not only the lack of understanding of the subject that is to be regulated, nor the inherent difficulties of regulating it, but the volatility of its approach. while 2015 67 in particular on why this is the case in legislation targeting alleged discriminatory practices of platforms, see jan krämer et al., internet platforms and nondiscrimination, cerre report, 5 december 2017. 68 vassilis hatzopoulous, the collaborative economy and eu law (bloomsbury 2018), in particular chapters 1 and 7. njcl 2018/1 37 dsm strategy indicates a soft approach, the 2018 guidelines moves towards a hard one. while earlier regulatory initiatives take a subjectspecific approach, the later ones (such as the 2018 proposal on transparency) take a more sweeping brush. and, while the latest proposal takes a somewhat new method in emphasizing transparency, the majority of the other ones are firmly based on a model of thinking based on legacy technologies. convergence is both an important phenomenon and one that has been recognised as such in the eu as early as 1997, but the eu lawmaker, rather than changing policy objectives and tools in pursuit of converged realities, chose to maintain the legacy model of regulation and extend its tools to platforms. nevertheless, the eu lawmaker has been thrown into the reality of converged technologies. i indicated that, post2015, this has been primarily through the emergence of platform-specific regulation. but, rather than attempt to rethink its digital policies, the eu has chosen to act defensively it attempted to translate the regulatory objectives and tools form the legacy world to the new and threatening phenomenon. ultimately, it seems that new and more dynamic regulatory models may be needed in order to properly address the phenomenon of convergence. microsoft word neumann_thomas.doc nordic journal of commercial law issue 2014#2 international commercial law from a nordic and baltic perspective: status and current challenges by thomas neumann* * thomas neumann (phd, master of laws) is associate professor at the department of law at the school of business and social sciences, aarhus university, and he is the founder and editor of the cisgnordic.net research database. nordic journal of commercial law issue 2014#2 1 abstract on 18 september 2014 the secretariat of the united nations commission on international trade law (uncitral) and the department of law at aarhus university hosted a joint conference to take stock of the recent changes in the field of international commercial law in the nordic and baltic region. the region had long been a place of numerous reservations against the full and unrestricted application of the 1980 un sales convention (cisg). when finland decided to withdraw one of its reservations in the spring of 2012, a change in the legal framework for international commercial businesses was a fact. the withdrawal by finland was followed by withdrawals by sweden, denmark, latvia, lithuania and norway. hence, the need to reconsider the legal framework surrounding international business was born. this is a summary report of the conference held at aarhus university on thursday the 18th of september 2014 covering various commercial law aspects relating to globalisation, the role of the cisg, legal traditions, uniformity in text and application, formation of contracts, battle of forms, form requirements, validity issues, withdrawal of reservations, contract drafting and visualisation, and incoterms. the full audiovisual conference book is available online at cisgnordic.net. nordic journal of commercial law issue 2014#2 2 1 introductory remarks on 18 september 2014 the secretariat of the united nations commission on international trade law (uncitral) and the department of law at aarhus university hosted a joint conference to take stock of the recent changes in the field of international commercial law in the nordic and baltic region. the region had long been a place of numerous reservations against the full and unrestricted application of the 1980 un sales convention (cisg).1 when finland decided to withdraw one of its reservations in the spring of 2012, a change in the legal framework for international commercial businesses was a fact. the withdrawal by finland was followed by withdrawals by sweden, denmark, latvia, lithuania and norway. hence, the need to reconsider the legal framework surrounding international business was born. though withdrawals of reservations to the cisg in the nordic and baltic countries increased textual uniformity, the conference identified a number of aspects that scholars, practitioners and businesses should be aware of. this is a summary report of the conference held at aarhus university. the conference invited scholars and practitioners with knowledge of the region to share their views on what they believed were important issues affecting international trade. the purpose of this report is to extract some of the underpinning thoughts of each speaker’s topic to the benefit of future scholarship. the content of this report is attributed to the present author, and so are any mistakes in the reproduction of the speakers’ presentations. readers are encouraged to refer to the keynote speeches made on the day of the conference.2 2 globalisation of the region 2.1 the many facets of promoting the cisg legal officer luca castellani (hereinafter castellani),3 representing the secretariat of uncitral, outlined the strategies of uncitral and the impact of its work. starting with the cisg, which he described as one of the pillars in the unification of international 1 united nations convention on contracts for the international sale of goods, (adopted 10 march to 11 april 1980, entered into force 1 january 1988) 1489 unts 3. 2 thomas neumann (ed.) ‘audiovisual conference book’ (cisg nordic, 14. november 2014) <www.cisgnordic.net/conferencebook.shtml> accessed on 14 november 2014. 3 luca castellani is legal officer at the secretariat of the united nations commission on international trade law (uncitral). see the following for full biography and keynote speech: luca castellani, ‘the many facets of promoting the cisg: broader adoption, scope of application, uniform interpretation and domestic use’ (audiovisual conference book, 14 november 2014) <www.cisgnordic.net/conferencebook.shtml> accessed on 14 november 2014. nordic journal of commercial law issue 2014#2 3 commercial law, castellani explained how the uncitral strategy for the adoption of the cisg is two-fold. the first part is aimed at states for which the cisg may assist in the modernisation of commercial law and in avoiding regional fragmentation occurring due to regional legislative efforts not adequately considering the global level. an example of successful regional use of the convention has been seen in the region of the former yugoslavia, where all successor states are now party to the convention.4 in addition, countries with scarce local legal capacity may find the adoption of the cisg to be a cost-efficient solution. though the adoption of the cisg is widespread, it is not yet universal as large economies like those of india, indonesia, iran, thailand and the united kingdom are yet to adopt the convention. the second part is aimed at trading parties, who may adopt the cisg through a contractual opt-in, where the convention would not apply on a default basis. to encourage adoption of the cisg by parties, the secretariat of uncitral finds it important to communicate the benefits and application practice of the cisg. currently, the clout programme and the uncitral digest of case law help businesses, their advisors, and adjudicators in achieving a uniform interpretation of the convention text. legal consultant and senior researcher helena haapio (hereinafter haapio) later submitted further ideas on communication of legal instruments and contracts.5 elaborating on the work of states in regard to the convention, castellani described that the secretariat of uncitral has now adopted a proactive approach facilitating review of existing reservations. a certain number of states have made reservations, which effectively hinder uniformity of the convention, and some of these reservations do not seem to be relevant anymore. such reservations could be removed and new adopting states should be careful considering possible reservations. associate professor thomas neumann (hereinafter neumann) and ph.d. candidate aleksandra tolea (hereinafter tolea) elaborated on the undesirable effects of reservations later on. in addition, professor jan ramberg (hereinafter ramberg) described it as a breach of international obligations to retain reservation no longer warranted by domestic circumstances.6 though the cisg has won widespread adoption, castellani pointed out that uncitral is the host of several other instruments that supplements the cisg. among these, castellani made a 4 the territory of kosovo is neither a member state of the united nations nor a cisg contracting state according to united nations, ‘member states of the united nations’ (united nations, unknown publication date), <http://www.un.org/en/members/index.shtml> accessed 29 october 2014; united nations commission on international trade law, ‘status of cisg’ (uncitral, 2014) <http://www.uncitral.org/uncitral/en/uncitral_texts/sale_goods/1980cisg_status.html> accessed 14 october 2014. 5 see infra page 21. 6 see infra pages 8, page 10, and page 4 respectively. nordic journal of commercial law issue 2014#2 4 point of two instruments in particular. the first one was the 1974 limitation convention7, which introduces legal certainty in regard to the temporal limits for bringing legal proceedings in disputes relating to international sales of goods. the instrument complements the cisg and was originally part of the drafting process of the cisg, but due to technicalities it was removed from the cisg. though the limitation convention brings legal certainty to its field, it is not as widely adopted as the cisg. this is due in part to prioritisations by local parliaments and to the fact that the matter covered by the instrument is sometimes considered a public policy issue. moreover, the early adoption of the limitation convention by then-socialist countries might have created confusion on its actual scope and content. the second instrument mentioned was the 2005 convention on electronic communications.8 the cisg does not expressly deal with the many aspects of electronic communication in international contract for the obvious reason that it was drafted before the birth of the internet. furthermore, many issues, such as private international law issues, pose special challenges in regard to the use of electronic communications in international contracts. the convention on electronic communications would eliminate the need for private international law analysis by introducing a uniform system regulating practical issues like electronic contract formation, input errors by users, automatic sales systems etc. as such, the instrument is an important supplement to the cisg, especially with respect to updating its part ii, but yet again, the instrument is not as widely adopted as the cisg. despite the fact that the cisg has its limits, it does introduce uniformity for the international sale of goods. and even more, the convention serves as a blueprint for the modernisation of regional and domestic legislation. mr. tadas klimas (hereinafter klimas) later gave an example on point in his presentation.9 acting as a basis for legal reform is a task that is beyond the typical purpose of a convention, but due to its drafting history the rules of the convention suit any legal family or economic system. hence, it is possible to trace inspiration from the cisg in the domestic legislation of several countries, such as china, or in regional instruments like the draft common frame of reference (dcfr). finally, castellani made reference to the question, whether uncitral should undertake the drafting of new texts to promote further unification of international sales and contract law. the debate was opened by an official proposal to revise the cisg made by switzerland in 2012.10 it was noted that this has not been done since 1983. the debate on whether uncitral is the right forum for new legislative work in the field is open. 7 united nations convention on the limitation period in the international sale of goods, (adopted 14 june 1974, entered into force 1 august 1988) 1511 unts 99. 8 united nations convention on the use of electronic communications in international contracts, (adopted 23 november 2005, entered into force 1 march 2013) un doc. a/60/515. 9 see infra page 11. 10 united nations commission on international trade law, possible future work in the area of international contract law, u.n. doc. a/cn.9/758 (8 may 2012). nordic journal of commercial law issue 2014#2 5 2.2 regionalism and globalism ramberg11 addressed the issues of regionalism and globalism in the scandinavian region. the legislative cooperation between denmark, norway and sweden has a long history, especially in the field of maritime law. in the field of sales law the cooperation resulted in the countries having practically identical domestic sales laws that came into force in 1905 to 1907.12 when the first international uniform sales law (ulis) was brought about in 1964, the scandinavian countries, except for denmark, chose to modernise their sales laws instead of ratifying the ulis.13 when the adoption of the cisg later became relevant, the question resurfaced whether the scandinavian states should retain their common legal heritage or let the international trend, represented by the convention, supersede. practical considerations of not creating unnecessary confusion or uncertainty called for bringing domestic sales law in line with international trends. and so, finland, norway and sweden decided to revise their domestic sales laws to bring them in line with the cisg.14 denmark was expected to follow suit, but decided to safeguard the common legal heritage by retaining its original sales act of 1906. ramberg predicted that this position would not change anytime soon, as the shortcomings of the revised sales laws in the other countries become more apparent over time. when the nordic countries chose to adopt the convention, they opted for an exclusion of the rules on formation of contracts contained in cisg part ii pursuant to article 92. this was partly due to the fact that the scandinavian states did not want to abandon their common legal heritage, but also because the matter of formation of contract was considered to be one of general contract law, already covered by domestic law thereby leaving no particular need for specialised rules on formation of contracts regarding the sale of goods. therefore, all nordic countries except iceland made a declaration according to article 92 upon the ratification of the convention. in spite of the resistance to abandoning the common legal heritage, the confusion created by the convention now triggered the withdrawal of these reservations. upon ratification of the convention the nordic states also chose to make a declaration according to article 94 according to which the cisg is excluded in inter-nordic trade. ramberg emphasised that the reservation is permissible in situations, where legislation of the reservation countries is »closely related». since we now know that denmark did not follow suit, when the other nordic countries modernised their sales laws, it could be argued that the nordic states are obliged to withdraw their reservations, as it would otherwise render the countries in breach of their international obligations due to the fact the domestic laws in relation to denmark are no 11 jan ramberg is professor emeritus at stockholm university. see the following for full biography and keynote speech: jan ramberg, ‘regionalism and globalism from a nordic perspective’ (audiovisual conference book, 14 november 2014) <www.cisgnordic.net/conferencebook.shtml> accessed on 14 november 2014. 12 for historical reasons finland did not turn towards the scandinavian legislative tradition until the 1960ies. 13 convention relating to a uniform law on the international sale of goods, the hague, 1 july 1964. 14 iceland followed with a revision inspired by the norwegian sale of goods act in year 2000. nordic journal of commercial law issue 2014#2 6 longer closely related. this is not the same as saying that courts should not apply the internordic reservation. quite the contrary, since the reservation is still in effect. the concept of scandinavian sales law may experience a change, as the adoption of the cisg and its principles continues to influence the region. one day this could lead to the withdrawal of the reservation according to article 94. it could also lead to the abandoning of the inappropriate distinction between direct and indirect loss contained in the finnish, norwegian and swedish sales laws, replacing it with rules compatible with articles 74 and 79 of the cisg. increased influence by the cisg and its principles in the region does not mean that the convention will always govern in practice. parties may still choose to opt out of the provisions of the convention and should be encouraged to do so, when they seek more certainty than what they get from the open and abstract rules of the convention. in this respect the international chamber of commerce provides assistance. with part ii of the cisg on formation of contracts now in force in the nordic region, the question of a possible revision of the scandinavian contract laws once again becomes relevant. also prof. kai krüger (hereinafter krüger) raised this issue in his speech.15 as also pointed out by castellani, some laws fail to address formation of contract other than by offer and acceptance and so do the scandinavian contract laws. they also fail to address the effect of precontractual behaviour and how to deal with contract interpretation. the laws contain abstract terms that provide little guidance for the specific case. of course case law and scholarly works can be of assistance, but it is not the same as legislation. ramberg suggested that the best might be to let the contract laws remain as a reminder of a glorious past and instead turn to a reform, relying on soft law like the unidroit principles and principles of european contract law (pecl). in such reform other important instruments of uncitral should of course be considered. ramberg posed the rhetorical question, whether legal problems are better solved by way of hard law or soft law. he advocated that hard law like the cisg is not always the best way, if the goal is to achieve uniformity. usages, standard forms and general principles sometimes serve the business community better. this is recognised in the nordic laws according to which usages supersede the law. also the use of standard terms provides an important cooperation between the law and commercial interests in certain trades, such as the nl09 or nsab2000. in conclusion, ramberg stated that regionalism will continue to exist in important commercial sectors, but that this does not impede the globalisation of legislation and principles, when global trade has to be considered. this would be the case in many fields, such as sales, finance, insurance, and electronic communications. 15 see infra page 16. nordic journal of commercial law issue 2014#2 7 3 status and experiences from the nordic region 3.1 the nordic legal tradition – an obstacle to uniform application? professor camilla baasch andersen (hereinafter andersen)16 started by challenging the current comparative legal scholarship in which the nordic legal family is rarely treated as a separate entity. while the nordic legal tradition neither belongs to the civil legal tradition nor the common law one, it bears resemblance of both systems, thus forming its own. as a caveat to anyone studying the nordic legal tradition, andersen pointed out that there are variations in legal style between the nordic countries. hence, the finnish view on precedential value and legal reasoning in court decisions appear to be rather different from the danish and to some extent the scandinavian style. for example, the lack of transparent reasoning by danish courts that can be traced through 100-year old scholarship contributes to a failure to develop autonomous international law. continuing with her focus on legal reasoning, andersen stressed that international law like the cisg requires a different approach and the consultation of legal sources not typical for domestic disputes. the different method is warranted by article 7 of the convention, according to which it is necessary to consult scholarship and previously decided disputes involving the cisg, also from the courts in other countries. andersen refers to the global jurisconsultorium – a term coined to encompass the need for global sharing of experience in applying the convention.17 only by doing so is it reasonable to expect the development of some uniform application of the convention, though it was pointed out that only 3% of more than 3,000 publicly known cisg-related decisions make a clear reference to either scholarship or case law. those cases are often characterised by containing very extensive legal reasoning by the court, thus making the decision transparent. acknowledging that complete uniformity in the application of the cisg is utopia, judges as well as lawyers have a responsibility for applying the convention in accordance with the autonomous method laid down in article 7. often, a judge will only refer to material presented to the court by the counsel, but this is no guarantee. actually, even when a judge is presented with the sources required by article 7, the nordic legal tradition may affect the style of the decision. 16 camilla baasch andersen is professor at university of western australia. see the following for full biography and keynote speech: camilla baasch andersen, ‘nordic legal tradition an obstacle to uniform application?’ (audiovisual conference book, 14 november 2014) <www.cisgnordic.net/conferencebook.shtml> accessed on 14 november 2014. 17 the ‘[…] process of consultation which takes place across borders and legal systems with the aim of producing autonomous and uniform interpretations and applications of a given rule of a uniform law’ is described as the global jurisconsultorium according to camilla andersen, ‘the global jurisconsultorium of the cisg revisited’ (2009) 1 vindobona journal of international commercial law & arbitration 43, p. 47. nordic journal of commercial law issue 2014#2 8 an example of the possible effect of the nordic legal tradition is a case before the copenhagen maritime and commercial court involving an international sale of frozen goods.18 andersen explained that the counsel for the seller brought case law of dutch origin to the court’s attention, and that the final reasoning of the court resembles the persuasive arguments of those cases. however, the danish court makes no transparent reference known in its decision. in effect, such court decisions resemble court decisions affected by the unwanted homeward trend, but may not necessarily be so. actually, the decision is in line with the well-established international practice requiring buyers of frozen goods to thaw and examine a sample of the goods upon delivery. andersen thus concluded that although the non-transparent legal reasoning in danish court decisions makes it impossible for judges, practitioners and scholars to decipher the court’s reasoning, the nordic style is not in itself detrimental to the uniform application of the convention. as long as the international reasoning is followed, autonomous international principles are being created and upheld albeit without citations, which make it apparent, that this is in fact happening. 3.2 the nordic article 92 reservations and their withdrawal: implications and problems neumann19 opened by pointing out that the convention’s goal of uniformity is threatened not only by the homeward trend in practice but also by domestic transformations, translations and reservations. the focus of neumann’s presentation was on the problems relating to the reservations against the full and unrestricted application of the convention that exist in the nordic region. all nordic nations declared that upon ratification the convention should not be applicable to inter-nordic sales according to article 94. as pointed out previously by ramberg, the reservation could now be considered a breach of international obligations, since the nordic countries no longer have closely related sales laws. as the only nordic country denmark chose to exclude the application of the cisg from parts of its territory, namely the faroe islands and greenland, thus undermining uniformity. businesses involved in international transactions in those parts of the danish reign would have to consider rules of private international law to determine the applicable sales law. 18 [31 january 2002] copenhagen maritime and commercial court, denmark, cisgnordic.net id: 020131dk. 19 thomas neumann is associate professor at aarhus university. see the following for full biography and keynote speech: thomas neumann, ‘the nordic article 92 reservations and their withdrawal: implications and problems’ (audiovisual conference book, 14 november 2014) <www.cisgnordic.net/conferencebook.shtml> accessed on 14 november 2014. nordic journal of commercial law issue 2014#2 9 four out of the five nordic countries, being denmark, finland, norway and sweden, also chose to exclude the application of part ii, again undermining uniformity since the need to resort to the rules of private international law remained. in norway, the incorporation method further impaired uniformity, since the convention was transformed and translated to a domestic hybrid law in the norwegian language intended for both domestic and international sales. it was believed that norwegian businesses could do with one law for all types of sales. the argument neglects the fact that the norwegian hybrid law would only apply, when the rules of private international law points to norwegian law. authors have described the transformation as a major mistake, and is now rectified with the withdrawal of the article 92 reservation and the decision to incorporate the authentic versions of the convention. krüger later elaborated on the norwegian position.20 iceland, which did not make a declaration according to article 92, also decided to transform and translate the convention upon its incorporation into icelandic law. when doing so, inspiration was taken from the norwegian hybrid law, and thus the exclusion of part ii effective in norway carried over into icelandic law, where part ii is still not in effect today. ironically, the only nordic country not having declared that it will not be bound by cisg part ii, is the only nordic country, where part ii is not in force now that the remaining countries all have withdrawn their reservations. in this regard it is worth noting that the withdrawals were made at different points in time and that part ii therefore enters into force at different points in time in the nordic countries. the withdrawal of the article 92 reservations creates a new challenge. the challenge of knowing which contract formations will fall under the new part ii regime. article 100 prohibits retroactive effect of the convention and so does, for example, the danish law incorporating part ii and general treaty law. the provision states that the cisg will only apply, when a proposal to conclude a contract has been made after the convention has entered into force. therefore, one may ask what the definition of a proposal is, as this will be decisive. looking within the convention itself, article 14 addresses proposals. some proposals are considered offers, if certain requirements are met, and other proposals may merely be invitations to make an offer. if an invitation to make an offer falls before part ii has entered into force, and the following offer and acceptance fall afterwards, it will be pivotal to know the definition of the word proposal. if the word proposal and the definition of an offer are equated, part ii will govern the above negotiation situation in its entirety. this would to some extent introduce a retroactive effect in regard to the invitation to make an offer and the period falling before part ii’s entry into force, and it would be contrary to the understanding of the word ‘proposal’ within the context of the convention itself. the alternative would be to let proposals also include invitations to make an offer. under such view, part ii would not govern the contract formation period mentioned 20 see infra page 16. nordic journal of commercial law issue 2014#2 10 above. this solves the problem of retroactive effect and definition of the word proposal, but may lead to a position, where it is the very first contact between the parties that decides the application of part ii. such an interpretation would seem arbitrary, coincidental and artificial. the problem is exacerbated, if the contract formation period consists of a number of offers and counter-offers taking place across the date for entry into force of part ii, or when no clear offer and acceptance model has been followed by the parties. the problem will arguably be increasingly irrelevant as time passes, but it will be relevant for all contracts entered into whenever a country withdraws a reservation or adopts the cisg. how a nordic court would handle this conundrum is hard to guess, particularly in the light of the fact that the nordic judiciary has yet to strongly prove that they have a sophisticated grasp of the cisg. in summary, neumann listed the improvements to textual uniformity that has taken place in the nordic region. firstly, the withdrawal of the article 92 reservations and secondly the incorporation of the authentic versions of the cisg in norway. challenges for the future include firstly the interpretive challenge of the definition of a proposal in relation to the entry into force of part ii. secondly, a rectification of iceland’s incorporation and translation of the convention could be considered. thirdly, uniformity still has territorial limitation due to the exclusion of the faroe islands and greenland according to article 93. finally, the exclusion of the convention in inter-nordic sales has lost some of its rationale and may be a breach of international obligations. 4 status and experiences from the baltic region 4.1 the baltic reservations against freedom of form: background, withdrawal, and status tolea21 provided an overview of history, legitimacy and current challenges in regard to the declarations made by the baltic countries’ not to apply the rules on freedom of form. such exclusion was allowed upon the adoption of the cisg according to article 96 with the prerequisite that the country making the declaration must have domestic writing requirement for sales contracts. latvia adopted the convention and made the reservation according to article 96 in 1998, lithuania in 1996, and estonia in 1994. in lithuania and estonia the reservation appeared to be justified, since these two countries had domestic form requirements for sales contracts at the time. in lithuania the old socialistic civil code containing strict form requirements was still in force. in estonia, the general part of a new civil code was in force containing a principle of 21 aleksandra tolea is phd candidate at syddansk university. see the following for full biography and keynote speech: aleksandra tolea, ‘the baltic reservations against freedom of form: background, withdrawal, and status’ (audiovisual conference book, 14 november 2014) <www.cisgnordic.net/conferencebook.shtml> accessed on 14 november 2014. nordic journal of commercial law issue 2014#2 11 freedom of form, however it was supplemented by an old socialistic code containing form requirements for sales contracts. thus, the reservations were justified at the time. this position later deteriorated, when both countries abolished the domestic form requirements. by contrast, latvia did not have domestic form requirements for sales contracts when the cisg was adopted, since the civil code in force at the time contained the principle of freedom of form. thus, there were no objective reasons for the reservation, and the decision may best be explained by historical factors. klimas later elaborated on some of the historical and political factors that affected the legislative process in the baltic region, particularly in lithuania.22 all baltic countries have now withdrawn their reservations23 and in regard to latvia and lithuania this happened upon the initiative of the secretariat of uncitral. castellani earlier explained about the active role of the secretariat in processes like this one.24 though the withdrawal increases the textual uniformity of the convention, it is important to point out that uniformity is just as important in practice. klimas and to some extent attorney and partner karsten duch lynggaard (hereinafter lynggaard) developed this aspect further.25 a particular paradox pertaining to the exclusion of freedom of form can be identified. though they are only relevant in the baltic countries preceding the withdrawal of the reservations, they are still relevant in countries, where a similar reservation still is in force. the first problem relates to the handling of a reservation against the freedom of form, when the basis for it has deteriorated. the theory outlines two options. one possible way is to resort to the rules of private international law, which in turn will point out the relevant domestic law applicable. the other way is to apply the rules of the reserving state directly. each solution may lead to the application of a domestic law in which no form requirement exists and in turn lead to results contrary to the reason behind the exclusion of freedom of form in the convention in the first place. this is not to say that courts should not apply the reservation, since according to article 97(4) reservations are effective until the expiry of at least six months after notice to the un depositary has been given. with such paradox in mind, tolea rhetorically asked what could be learned from the baltic experience so far. 22 see infra page 11. 23 estonia (18 march 2004) depositary notification c.n.276.2004.treaties-1; latvia (13 november 2012) depositary notification c.n.638.2012.treaties-x.10; lithuania (1 november 2013) depositary notification c.n.900.2013.treaties-x.10. 24 see supra page 2. 25 see same page immediately below and infra page 13 respectively. nordic journal of commercial law issue 2014#2 12 4.2 reception of the cisg in the baltics: an epidemiology klimas’26 presentation was devoted to explaining the reason why the reception of the cisg in lithuania has been cold. at the outset in his experience with developing a law school in lithuania and his time as chief counsel for the chairman of the lithuanian parliament, klimas began by describing a general problem with legal reforms and setting the historical context. the modernisation of contract law is faced with an uncomfortable truth: the fact that there is a general resistance towards any legal reform and that a widespread denial of a problem in receiving western laws in lithuania exists. the reason for this can be traced back to the perestroika – restructuring and reformation – of also lithuania. klimas asserted that no proper reform of the legal system ever took place. there is no mentioning of reform or the former soviet legal system to be found in lithuanian legal textbooks. the country as such never decided how to handle its independence from the soviet union. hence, the country never broke with its past legal system. doing so would require deciding what to do with the large proportion of people involved in the old system, many of which belonged to the judiciary and government. rightfully so, this was a delicate and precarious matter. consequently, nothing was done, and so the path of ignoring the need for reform was chosen. this put the country in a position, where it became even more difficult to reform the legal system, since a reform would have to involve the offices and people that were eschewed in the first place, and because the existing functional legal system could be used as an argument against a need for reform. even though the existing legal system was a functional one qua its police, judiciaries, recognition of contracts etc., it was fundamentally different to that of western countries. where the old soviet legal system had the purpose of retaining order, the traditional western legal systems had the purpose of delivering justice. and even though many, also from lithuania, would claim a similar purpose of the lithuanian legal system, the two are fundamentally different. where delivery of justice is based on principles, the retaining of order is not. the fact that the chance for reform was never grasped also meant that old thought-patterns were retained. this slows the adoption process of more modern legal regimes like the cisg, since they require a completely different mind-set. this explains perhaps why it is problematic to logically explain, why the baltic countries made reservations upon the ratification of the cisg. as also pointed out by tolea27 there simply is no logical explanation. 26 tadas klimas is attorney at the law offices of tadas klimas. see the following for full biography and keynote speech: tadas klimas, ‘reception of the cisg in the baltics: an epidemiology’ (audiovisual conference book, 14 november 2014) <www.cisgnordic.net/conferencebook.shtml> accessed on 14 november 2014. 27 see supra page 10. nordic journal of commercial law issue 2014#2 13 two specific examples from contract law were given to illustrate the effects of the resistance towards legal reform.28 first, the test of foreseeability as a limitation for damages is a wellreasoned and well-known one. however, the idea has been rejected in latvian law, since it appears alien. upon the ratification of the cisg the test of foreseeability was also adopted, at least on the books. but this raises the question of the efficacy of the ratification of the cisg, since the concept of foreseeability, an inherent part of the cisg, is unwanted and indeed unknown in the latvian legal system. second, the cisg also contains the concept of fundamental breach. similar concepts are known in many domestic legal systems. the concept of fundamental breach is one that provides the aggrieved party with the right to terminate the contract. not only businesses in lithuania but also, upon observation and belief, a great many lawyers, lack an understanding of the concept and its underlying idea that businesses have to act or demonstrate facts, e.g. fundamental breach, to access remedies. instead, a very passive role is adopted. most contracts contain provisions that display an ignorance of the concept of fundamental breach as providing an option, which permits termination by the aggrieved party. the disputing parties instead insist that there must be agreement to terminate. the majority of contracts also seem to equate termination with the unlawful cessation of performance. in general, it often appears that the parties expect to have their relations checked by some authority. this is of course due to the fact that this is the way the system used to be. haapio later developed the idea that new ways of information design of legal documents, such as contracts or the cisg, are needed in international business.29 finally, klimas concluded his epidemiology of the reception of the cisg in lithuania by pointing out an important improvement. the fact that the cisg has been adopted has raised the level of the legal discourse in the country. as also pointed out by castellani,30 the adoption of the convention in itself has created a need to understand the legal concepts contained within it. this is the first step towards a critical attitude towards the existing domestic legal system and possibly reform. countries not adopting the cisg may never trigger such development. though it may be a slow process, the reception of the cisg and its concepts are changing for the better. 28 for more on the experience with the cisg in the baltic states, see tadas klimas, ‘baltic states, belarus, and ukraine’ in larry a. dimatteo (eds), international sales law. a global challenge (new york, cambridge university press 2014) pp. 331-337. 29 see infra page 21. 30 see supra page 2. nordic journal of commercial law issue 2014#2 14 4.3 ten years later: a practitioner´s view of the future in order to flesh out the environment that internationally trading businesses are faced with lynggaard31 gave a number of examples that demonstrated how different countries are in regard to law, history, politics, and moral. the introduction of the cisg was supposed to remove at least some of the legal uncertainties threatening business, and it has done that to some extent. lynggard made reference to the reluctance of danish courts to clearly make reference to the cisg and case law from other countries as also addressed by andersen32 and added that the problem is also seen within the field of eu law. the courts of denmark are known for being very reluctant in using the opportunity to refer questions for preliminary ruling to the european court of justice. asking courts to openly consider decisions by courts from other cisg states appears to be too much to ask for. however, the reluctance of danish courts is also partly due to practice among lawyers of not utilising the cisg or case law from other jurisdictions. this is ostensibly rooted in the fear of being excluded from the bar association or insurance company – which might be the result, if a lawyer advises on foreign law. however, this neglects the fact that the convention and cisg related case law from other jurisdictions are not foreign, but danish law. naturally, if the lawyers are reluctant to use certain legal sources in their proceedings, this will in turn influence the courts. the convention is part of the law in the baltic region, and here it plays a less significant role in the daily life of the contract lawyer. though the convention acts as a gap-filler, there is a need for very explicit contracts particularly in cross-border transactions involving parties with very different background. the sanctity of a contract is honoured in the baltic region and salient parts like performance, delivery, limitation of liability and remedies will therefore often be agreed upon. this may not necessarily be the position in jurisdictions, where the contract is not considered more than a piece of paper. however, this is not the case in the baltic region, though the courts may be reluctant to openly use the convention and its sources. knowing this it has been observed that parties decide to opt-out of the cisg and choose a domestic law instead, since in case of dispute a judge would act more predictably if presented with a more familiar legal regime. thus, the convention is serving its gap-filling purpose and contemporary legal problems are often hidden elsewhere. a rapidly developing sector of international business is the development and sale of software, where rapidly growing firms are seen overtaking old well-established enterprises in revenue and value. compare for example the world’s largest shipping company, the 100-year old mearsk with a market value of usd 458 billion to google who reached a market value of more than usd 4000 billion in less than 20 years. the fast growing trend is the same in smaller software 31 karsten duch lynggaard is attorney and partner at magnusson. see the following for full biography and keynote speech: karsten duch lynggaard, ‘ten years later: a practitioners view of the future’ (audiovisual conference book, 14 november 2014) <www.cisgnordic.net/conferencebook.shtml> accessed on 14 november 2014. 32 see supra page 6. nordic journal of commercial law issue 2014#2 15 firms, and these often have a wish to abide by the law, but face significant barriers in informing themselves. the problems occurring most often in practice relate to international consumer sales, sale to children, trustworthy payment, virtual currencies, and marketing standards, such as incentives for sharing information or references to weapons in games. the software firms are faced with enormous costs of clarifying these legal questions, since they potentially may be selling and marketing their products in every country in the world. this is where future legislative efforts for example by the united nations could assist international trade and the development of business as has been done through the cisg. lynggaard pointed out that such legislative efforts would not only be for the sake of consumers, but very much also for lawabiding businesses. as long as no public regulation is being drafted, the private actors in the market will set the standard through contracts and the platforms they provide for trading. this is already happening in business-to-business transactions with the platform alibaba. 5 formation of contracts 5.1 the problems caused by cisg part ii professor ole lando (hereinafter lando)33 began by welcoming the incorporation of cisg part ii into nordic law. the reservations excluding the application of cisg part ii was made according to the wish of the nordic states to retain, in their eyes, the better rules contained in the nordic contract acts. though it may be true that some rules contained in the nordic contract acts were more suitable in the 1980ies, the reservations created legal uncertainty for international trade. not until criticism by the international chamber of commerce was it possible to obtain enough political momentum to have the reservations withdrawn. though the incorporation of part ii in the nordic laws would deal with this uncertainty, it brings with it a number of problems that deserve to be pointed out. first, the role of good faith in the cisg becomes relevant in context of also formation of contract. the convention states in its article 7(1) that in the interpretation of cisg regard is to be had to the observance of good faith. lando pointed out that a restriction of good faith to the interpretation of the convention is too narrow.34 as the soft laws, the unidroit principles, the principles of european contract law (pecl) and the common european sales law (cesl), several courts have adopted good faith as a general obligation for the parties to abide by and so could the 33 ole lando is professor emeritus at copenhagen business school. see the following for full biography and keynote speech: ole lando, ‘the problems caused by cisg part ii’ (audiovisual conference book, 14 november 2014) <www.cisgnordic.net/conferencebook.shtml> accessed on 14 november 2014. 34 see for more on good faith, for example ole lando, ‘is good faith an overarching general clause in the principles of european contract law?’ in mads t. andenæs (eds), liber amicorum guido alpa: private law beyond the national systems (british institute of international and comparative law, london 2007). nordic journal of commercial law issue 2014#2 16 nordic courts. however, the role of good faith is contested in the literature as well as in case law. second, with part ii follows the price conundrum. on one hand article 14 requires an offer to contain a way to determine the price. on the other hand, article 55 provides a gap-filling rule for contracts not specifying a price. it is possible to consider a proposal without a price an offer that implicitly incorporates the market price according to article 55. the root of the conundrum is the requirement of price for a proposal to be an offer. soft law systems, including the unidroit principles, the common european sales law, and the principles of european contract law do not operate with such a requirement. third, the issue of revocability of offers presents itself. the convention contains a compromise between differing legal systems and this may result in ambiguities. when article 16(2)(a) states that an offer fixing a time for acceptance is irrevocable this may be understood differently depending on whether one has outset in the common law or civil law tradition. determining whether an offer containing a fixed time for acceptance is to be considered irrevocable therefore depends on an interpretation according to article 8. the rule may lead to uncertainty where it is unclear whether a civil law offeree knows or should know that the common law offeror, who states a fixed time for acceptance of his offer, considers it to be irrevocable according to article 8(2). fourth, cisg part ii contains a gap regarding the battle of forms. since the conclusion of contracts very often does not follow a simple offer and acceptance model, the rule of material alterations in article 19(1) is insufficient. the provision in article 19(1) determining that an acceptance may not contain material alterations has been understood in two ways in the literature. one way is to see the provision as a ‘last shot’ doctrine concluding the contract on the basis of the terms presented last. however, it seems arbitrary to let a coincidental fact like the last shot be decisive. an alternative way is to see article 19 as a ‘knock out’ doctrine according to which the contract is concluded on the basis of only the terms between the offer and the acceptance that are common in substance. this has been the position of german case law, the unidroit principles, the principles of european contract law (pecl), the draft common frame of reference (dcfr) and the common european sales law (cesl). associate professor kasper steensgaard (hereinafter steensgaard) later elaborated on the problems relating to the battle of forms.35 before turning to his conclusion, lando briefly pointed out that cisg insufficiently deals with hardship, commercial letters of confirmation, validity, and that one could consider revising or amending the cisg as has been proposed by the swiss government or perhaps in the form of a 35 see infra page 18. nordic journal of commercial law issue 2014#2 17 world contract code.36 admitting at the same time that such ideas would require enormous effort by states and individuals, they would enable dealing with some of the insufficiencies just mentioned. in conclusion, lando pointed out that in spite of its flaws, the cisg has been a success. it meets the needs of modern commerce. it has helped abolishing ancient relics of a dead past. it has inspired national legislative drafting, and it has gained widespread adoption by states. future discussion will decide if it is worth the extensive efforts to revise or amend the convention. 5.2 point of no return threshold for binding commercial agreements in the cisg part ii setting krüger37 outlined a number of effects that the adoption of cisg part ii will have in norwegian law. since cisg part ii entered into force in norway on 1 november 201438, it has replaced domestic law in regard to the definition of offer and acceptance, the concept of »knowledge» as a key requisite with the concept of »reaches» instead, and the rules on late or non-conforming acceptance. it was emphasised that part ii does not entirely replace norwegian domestic law on formation of contracts and sales. this is true of course outside the scope of the convention, such as consumer sales or private sales. in business-to-business transaction it is seen that due to discrepancies in the definition of »goods» creates room for the domestic rules in international transaction of shares or stock. the parties may also displace the rules of the convention with one of their choice according to cisg article 6 or following a usage according to article 9. and of course, domestic law is still the applicable law, when the international transaction is taking place between parties located in two different nordic countries according to the reservations made pursuant to cisg article 94. a number of important issues for international transactions are not regulated in the cisg and will thus have to be referred to domestic law. matters relating to burden of proof, agents’ authority to form contracts and voidable statements pursuant to the norwegian formation of contracts act § 36 remain applicable. krüger then pointed out that norwegian courts have developed rules for handling formation of contract by other means than the offer-and 36 see michael joachim bonell and ole lando, ‘future prospects of the unification of contract law in europe and worldwide: a dialogue between michael joachim bonell and ole lando on the occasion of the seminar in honour of ole lando held in copenhagen on 29 august 2012’ (2013) 18 uniform law review revue de droit uniforme 17; ole lando, ‘a vision of a future world contract law’ (2005) 2 uniform commercial code law journal 3. 37 kai krüger is professor emeritus at university of bergen. see the following for full biography and keynote speech: kai krüger, ‘point of no return threshold for binding commercial agreement in the forthcoming nordic cisg part ii setting’ (audiovisual conference book, 14 november 2014) <www.cisgnordic.net/conferencebook.shtml> accessed on 14 november 2014. 38 see the norwegian incorporation law lov-2014-02-28-2, lov om endringar i kjøpsloven og avtaleloven. nordic journal of commercial law issue 2014#2 18 acceptance model and that these probably will be applicable, since the convention’s part ii does not govern such modes of formation (article 9(2)). looking into the future it would be important to consider how the cisg regime is going to affect norwegian law developed by the courts in regard to letters of intent, tacit agreements and customary form requirements. perhaps the introduction of the cisg in norway might challenge the law in areas not covered by the convention. one such welcome challenge would be of the concept »dispositivt utsagn» by the convention’s »reaches». continuing his focus on case law, krüger pointed out that due to the shortage of publicly known case law on the cisg in the nordic region, it would be necessary to look outside the region to find case law guidance on matters now introduced into norwegian law. if the introduction of part ii in norwegian law could trigger reconsiderations of the old norwegian formation of contracts act, then perhaps it is time to revitalise the nordic jurists’ meeting of 1990 in which the focus was on replacing the nordic formation of contract acts. in fact, a norwegian commission worked on the idea for two years, only to abort it due to a lack of interest in the region. should such work be reopened it could now derive inspiration from tools like the principles of european contract law (pecl), the unidroit principles, the draft common frame of reference (dcfr) and the common european sales law (cesl) and would certainly have to consider issues of interpretation, good faith, merger clauses, battle of forms, confidentiality and negative interest protection. the final point of krüger was that since the cisg does not contain rules on choice of law, it is still up to the parties to decide on the law applicable. if they do not, the system of rather intricate rules will be decisive. as a rule of thumb the law applying to a dispute relating to a contract being negotiated would follow from the »would-be» rule. otherwise the rules applicable in norway, also after the introduction of cisg part ii are those of the seller’s law in sales disputes and the law with the closest connection in other disputes. in summary, a number of rules have been displaced in norway, though domestic rules of formation and sales are not being replaced in their entirety. some changes are welcome, some insignificant, and some are introducing new challenges, such as the introduction of new concepts that questions the existing body of case law. nordic journal of commercial law issue 2014#2 19 5.3 from section 6 nca to article 19 cisg. new rules on non-conforming acceptances: overlaps and pitfalls steensgaard39 addressed the new rules on contract formation with particular focus on conflicting standard terms and conditions. steensgaard’s position was that many businesses will go about doing their business as usual and that this could lead to unfortunate surprises with the implementation of part ii of the cisg in the nordic region. both the convention and the nordic contract laws contain the mirror image principle according to which an acceptance must mirror the terms of the offer for a contract to be concluded. if the acceptance deviates from the terms of the offer, it is considered a rejection together with a new offer. in case an acceptance merely contains additional terms that would otherwise be implied according to the default law, such as passing of the risk at first carrier, it follows from both the nordic contract laws and the convention that an effective acceptance in substance has been given and a contract has been concluded. in the situation where the offeree neither accepts nor rejects the offer, but merely wishes to continue negotiations by asking for different terms, the convention’s part ii may lead to results different to especially the danish contract law. according to a danish supreme court decision40 it is considered a rejection of the offer to request new terms, whereas it is a common view that merely asking for different terms under the cisg is not a rejection of the offer. hence, the offer can still be accepted in the time for acceptance until it is revoked. so even though both nordic domestic contract laws and the cisg build upon the mirror image principle, they may lead to different outcomes. a number of exceptions to the mirror image principle exist in both the nordic contract laws and the convention. even though they all lead to a duty for the offeror to object to a nonconforming acceptance unless he wishes to be bound by it, they are triggered by different circumstances. the nordic contract acts require in article 6(2) that the offeree must believe that the acceptance was conforming and the offeror must not be unaware of this – the so-called double subjective standard. this renders the exception extremely narrow. in comparison, the exemption under the cisg article 19(2) is based on a materiality test. the test is supplemented by a non-exhaustive list of terms considered material if altered according to article 19(3). though the list has the effect of narrowing the exemption to a degree, it is difficult to find 39 kasper steensgaard is associate professor at aarhus university. see the following for full biography and keynote speech: kasper steensgaard, ‘from § 6 nca to art. 19 cisg. new rules on nonconforming acceptances overlaps and pitfalls’ (audiovisual conference book, 14 november 2014) <www.cisgnordic.net/conferencebook.shtml> accessed on 14 november 2014; kasper steensgaard, 'chapter 5. article 19 cisg & scandinavian domestic law: conflict or peaceful coexistence?' in joseph lookofsky and mads bryde andersen (eds), the cisg convention and domestic contract law: harmony, cross-inspiration, or discord? (djøf publishing 2014). 40 [1994] ugeskrift for retsvæsen, p. 344 et seqq., ufr.1994.344h. nordic journal of commercial law issue 2014#2 20 examples of non-material alterations. though a few examples exist in case law, there is no clearly discernable tendency giving guidance on the materiality test. turning to the standard terms and conditions steensgaard stated that the adding of standard terms will break the mirror image rule according to both the nordic contract laws and the cisg, and that none of these contain any provisions dealing with standard terms. neither is any of the exceptions suitable for solving issues relating to conflicting standard terms. in domestic laws the matter is treated differently. in some legal systems, often common law ones, the typical solution to the conflict of standard terms is to consider that last presented terms accepted by way of conduct – a last-shot doctrine. also this is the commonly held position under the nordic contract laws. in contrast, other legal systems, such as the german one, a knockout doctrine is preferred from the view that there has been a manifest intention to contract on the basis of some of the terms. this too is the trending position under cisg when applied by german courts. however, when applied by courts of the united states, a last-shot doctrine is favoured exclusively. hence, the trading parties may experience unfortunate results of their contract formation behaviour under the new part ii regime, as they may experience that asking for new terms would be considered a rejection of the offer. they may also find that the exception to the mirror image principle is triggered by different circumstances and that no uniform solution to the conflict of standard terms applies. 6 shortcomings and challenges 6.1 incoterms and cisg article 30 et seqq. professor, dr. and partner burghard piltz (hereinafter piltz)41 gave from his outset also as a practicing lawyer his view on some of the challenges relating to the seller´s obligations following the cisg and the incoterms.42 when listing the seller’s obligations following from the cisg and the incoterms respectively, it appears that the former imposes a duty to transfer the property right in the goods, whereas the incoterms is silent on this matter. vice versa, the incoterms contains further obligations for the seller to deal with documents, give notice in relation to shipping and dealing with customs and security clearance. however, the two documents may also appear quite similar, when it comes to some of the rules on passing of the risk of accidental loss or damage to the goods during transport. 41 burghard piltz is attorney and partner at ahlers & vogel. see the following for full biography and keynote speech: burghard piltz, ‘incoterms and cisg article 30 et seqq.’ (audiovisual conference book, 14 november 2014) <www.cisgnordic.net/conferencebook.shtml> accessed on 14 november 2014. 42 see incoterms® 2010 english edition (international chamber of commerce (icc) icc publication no. 715e, 2010 edition). nordic journal of commercial law issue 2014#2 21 for the sake of trading businesses, piltz began developing the differences between the two instruments. the outset was taken in cisg article 31, which deals with the seller’s obligation to deliver the goods. the article encompasses three situations, but more importantly, it deals with two issues; the act that the seller has to perform to deliver and the place of delivery. first, in regard to the seller’s act of delivery a distinction has to be made between handing over the goods and placing goods at disposal. this distinction is known to both the cisg and the incoterms. in article 31(b), article 31(c) and the incoterms e-group clauses, d-group clauses and the fas clause, the seller has an obligation to place the goods at disposal. this does not involve for example dealing with loading of the goods. in contrast, cisg article 31(a) and incoterms c-group clauses , and the fob clause require the seller to hand over the goods to the carrier. the distinction in both instruments is a deviation from the obligations laid down in many domestic laws, including those of germany, italy and spain.43 in domestic law it is commonly observed that the seller has a duty to hand over the goods to the buyer, but no such obligation exists neither in the cisg nor in the incoterms. second, in regard to the place of delivery it is necessary to determine, if the sale involves carriage. the mere fact that an international sale is taking place is not sufficient to conclude that carriage is involved. one way to determine this would be to determine, if the place where the seller is obliged to deliver is different from the place, where the buyer is to take delivery. in those situations a carrier must naturally be involved. on one hand, such a situation exists when the parties have agreed to apply incoterms clauses cip, cpt, cfr or cif and such situation is presupposed by article 31(a). on the other hand, article 31(b), article 31(c), incoterms clauses exw, fas, fob, fca, dat, dap and ddp operate with the same place for the seller’s delivery and the buyer’s taking of delivery and would thus not presuppose involvement of a carrier. the lesson here is that the common contention by businesses that article 31(a) and the fob clause are equivalent is wrong, since the former operates with a difference in place of delivery and place of taking delivery, whereas the latter does not. before coming to his conclusion, piltz pointed out yet another caveat for businesses; that the incoterms d-group clauses are in no way reflected in the cisg. applying a d-group clause to the contract would impose many additional obligations on the seller than what follows from the cisg. piltz summarised his findings and emphasised that though it seems innocuous to equate the cisg and the incoterms where these appear to be similar an agreement to apply the incoterms is a displacement of the rules in the cisg according to article 6. and thus, piltz raised the important question, whether a single reference to for example fca in the contract is sufficient to conclude a meeting of the minds in regard to all of the ten pages of stipulations in 43 this is true also for the scandinavian countries according to the danish sale of goods act (lbk nr. 140 af 17/02/2014) § 11, swedish sale of goods act (köplag 1990:931) § 7, norwegian sale of goods act (lov 198805-13 nr 27) § 7(1) og § 7(2). nordic journal of commercial law issue 2014#2 22 the icc booklet on the incoterms. the question was left for future discussions to reflect upon. 6.2 responding to the challenges: making contracts and the law work for business haapio44 brought to the conference the voice of the in-house counsel, with a focus on promoting business success and preventing disputes. businesspeople often see lawyers as dispute-oriented people. cross-border contracts involve many challenges. one problem is that businesspeople are unfamiliar with the default legal framework for international trade, such as the cisg. where the cisg was supposed to remove barriers, encourage trade and create uniformity, it sometimes fails to do so. this problem is aggravated by individual states’ reservations against the unrestricted application of the convention. another problem is that many contracts are overly complex for the businesspeople involved. if contracts are hard to understand, they may not be implemented or interpreted the way they were intended. the complexity is partly linked to the use of language. though english is the language of business, it is quite a different matter to negotiate a deal in »broken english» than it is to understand legal english. still contracts are often drafted with the legal community in mind, forgetting the business community. no wonder business people are reluctant to read contracts. the problem is rooted in the legal dominance, mindset and lack of design that features in contract drafting. instead of engaging and guiding the trading partners, contracts often alienate them. this is essentially a failure to communicate.45 a shift away from a dispute-oriented paradigm, where the focus is on the legal community, to a user-oriented paradigm, where the focus is on helping the business community to succeed in their ventures and prevent problems, would promote trade as envisaged also by the drafters of the cisg. the shift could be built on proactive law, with simplification and visualisation as tools for drafting and communicating the law and contracts. it entails helping businesses understand contracts and the underlying laws, as well as assisting contract drafters in crafting contracts that clearly communicate what the business parties want and what they should do and not do. 44 helena haapio is legal consultant at lexpert ltd. and senior researcher and university of vaasa. see the following for full biography and keynote speech: helena haapio, ‘responding to the challenges: making contracts and the law work for business’ (audiovisual conference book, 14 november 2014) <www.cisgnordic.net/conferencebook.shtml> accessed on 14 november 2014. 45 helena haapio, next generation contracts: a paradigm shift (helsinki, lexpert ltd. 2013); helena haapio, ‘using the cisg proactively’ in larry a. dimatteo (ed.), international sales law. a global challenge (new york, cambridge university press 2014), pp. 704–724; george j. siedel and helena haapio, proactive law for managers – a hidden source of competitive advantage (farnham, gower publishing 2011). nordic journal of commercial law issue 2014#2 23 though contracts will continue to serve as instruments of protection in case of a dispute, it is essential that the contracts act as a blueprint for performance, if businesses are to realise benefits and opportunities. one may actually say that contracts that end up in court have already failed. however, there is a tendency in the legal community not to learn from such mistakes. good contract drafting is a puzzle involving all parts of the business, such as financial, technical and operational aspects, and not just the legal part. a contract must be seen as a business or management instrument rather than solely a legal document. haapio concluded with the optimistic point that we in the legal profession already have access to the necessary skills and tools to improve the communication of law and contracts. there is plenty of literature and case law to learn from, but there has been a tendency in academia to omit communication of this to businesses in their language, which is not necessarily limited to text only. the next step in haapio’s view is to make the law and contracts user-friendly by means of simplification and visualisation. several examples of this already exist, and one should not forget to mention that this has been the tradition for a long time in the communication of the meaning of the various incoterms trade terms. in addition, a prototype of a visual guide to the cisg already exists.46 6.3 unreasonable contract terms, domestic validity rules and the cisg: how far do the fundamental principles of the cisg replace and/or supplement domestic contract law, including the nordic contracts act § 36? professor rené franz henschel (hereinafter henschel)47 opened by rhetorically asking whether the principles of the convention supplement, replace or perhaps coexist with domestic validity rules? the question is relevant for example in determining whether contract terms are reasonable or not. validity issues have been excluded from the scope of the cisg according to article 4, unless the matter is expressly governed in the convention. an example of a validity issue that is expressly governed by the convention is the rules on form requirements. the wording of article 4 is a deviation from the general method laid down in article 7(2), where it is stated that matters governed, but not expressly settled in the convention, are to be solved by applying general principles underlying the convention. domestic law is referred to as a last resort. the 46 stefania passera, helena haapio, rob waller, oliver tomlinson, christopher edwards, olivia zarcate, gonzalo arellano, julia mariani, visual cisg – a prototype of legal information design, 10 october 2013 <http://legaldesignjam.com/wp-content/uploads/2013/11/cisg_booklet.pdf> accessed 20 october 2014. 47 rené franz henschel is professor at aarhus university. see the following for full biography and keynote speech: rené franz henschel, ‘unreasonable contract terms, domestic validity rules and the cisg: how far do the fundamental principles of the cisg replace and/or supplement domestic contract law, including the nordic contracts act § 36?’ (audiovisual conference book, 14 november 2014) <www.cisgnordic.net/conferencebook.shtml> accessed on 14 november 2014. nordic journal of commercial law issue 2014#2 24 requirement in article 4 that the matter must be expressly governed by the convention seems to lead to the conclusion that there is no room for underlying principles in regard to validity matters. consequently, a literal interpretation of the convention supports a direct referral to domestic law. however, looking into the literature and case law gives a different result. according to the literature, domestic validity tests are influences by the rules of the convention, thus establishing a connection between the two. the connection is seen in at least two court decisions. the first one by the appellate court of zweibrücken.48 here the court stated that a waiver of liability must not be contrary to the fundamental values of the cisg. granted that the validity test is one of domestic character, it does in fact establish a connection to the values embedded in the cisg. the second decision by the supreme court of austria49 confirms the position taken by the german court. in addition to the stand that contract terms may not contradict the fundamental values of the cisg, it was stated that neither must domestic validity rules contradict such values. though these two cases have also been criticised, they do form part of the body of case law that should be considered when applying the global jurisconsultorium.50 henschel summarised the alternative interpretation of validity rules in relation to the cisg as follows. where domestic rules on validity provide the mechanism for example a test of the reasonableness of contract terms, the convention provides the values that act as the guideline for carrying out the test. in a nordic context, such a domestic validity mechanism is seen in the danish contract act’s § 36. the possible interplay between the convention and domestic law may affect the parties’ inclusion of liability limiting clauses found in standard terms and conditions. 7 conclusion the conference took stock of the field of international commercial law and its many facets. the withdrawal of the cisg reservations in the nordic and baltic regions yields an increased textual uniformity. specifically, the introduction of cisg part ii to the nordic countries has a positive effect insofar as norway has rectified the mistake of translating and transforming the convention. for the sake of uniformity one could hope that iceland would follow suit, since the incorporation of cisg part ii is currently in limbo in icelandic law, where it has neither been incorporated into domestic law nor justified by a declaration to the united nations. when it comes to the domestic rules on formation of contracts, the decades old legislative cooperation among the nordic countries seems to have withered, and there are no compelling reasons why the inter-nordic reservation should remain. now that the nordic rules on 48 [31 march 1998] appellate court zweibrücken, germany. 49 [7 september 2000] oberste gerichtshof, austria. 50 see andersen supra fn. 17. nordic journal of commercial law issue 2014#2 25 formation of contracts are no longer closely related, the inter-nordic reservation can no longer be justified. in fact it may be a breach of international obligations to retain the reservation. the conference questioned whether the form requirement in the baltic countries was justified at the time of the adoption of the cisg, and if the justification had later deteriorated. it was pointed out that even though the convention and some of its concepts were subject to a cold reception in those countries, the convention has in fact raised the level of discourse in the region, which is a prerequisite for legislative reform to take place in the future. the baltic countries’ choice not to adhere to the principle of freedom of form for international sales contracts has now lost its grounding, since none of the countries imposes form requirements on domestic sales contracts. the withdrawal of reservations in this regard is therefore welcomed. the withdrawals of reservations have changed the legal framework in the nordic and baltic region, and they increase textual uniformity and bring new interpretive challenges to the table. courts, legal advisors and businesses in the region must now familiarise themselves with the concepts and methodology of the convention. in fact, the convention may play a role in the application of also domestic law. the conference provided an example to the point regarding the validity of unreasonable contract terms. in the nordic context the incorporation of cisg part ii means that new rules on formation of contract will apply, dealing with issues relating for example to the role of good faith, the conundrum regarding offers without a price and the incorporation of standard terms. the cisg has been a significant instrument in the unification of international sales law, and it has served as a blueprint for legal reform and as a means to avoid regional fragmentation. however, the conference emphasised that the limited scope of the convention and the inadequate regulation of for example transport risk or electronic commerce, renders supplementary instruments essential for trading businesses. in this regard the significance of soft law instruments like the incoterms, unidroit principles, pecl can hardly be overstated, but also hard law like the convention on electronic communications is important to deal with the concerns of modern day business. naturally, the individual sales agreement plays a significant role in providing the parties with legal certainty and predictability. it was emphasised at the conference that much is to be gained by educating business people. the current paradigm of legal communication and drafting was challenged by the conference for example by thoughts on visualisation techniques. scholars and practitioners in the field of international commercial law can assist international trade by considering that the business community needs more than just instruments of protection. looking into the future, the conference found that the fast developing online industry is not dependent on the geographic location of its customers, and therefore it challenges the current international legal framework. the online industry is by its nature highly internationalised and involves potentially all jurisdictions. businesses craving certainty and predictability could benefit from future uniform standards in the fields of consumer law and advertising. 1 occupational pension funds (iorps) & sustainability: what does the prudent person principle say? alexandra horváthová,* rasmus kristian feldthusen,** and vibe garf ulfbeck*** * judr. alexandra horváthová, ll.m., s.j.d. is a postdoctoral fellow at centre for enterprise liability, faculty of law, university of copenhagen, denmark, email: alexandra.horvathova@jur.ku.dk. ** professor rasmus kristian feldthusen, centre for legal studies in welfare and market, faculty of law, university of copenhagen, denmark, e-mail: rasmus.kristian.feldthusen@jur.ku.dk. *** professor vibe garf ulfbeck is a director of the centre for enterprise liability, faculty of law, university of copenhagen, denmark, e-mail: vibe.ulfbeck@jur.ku.dk. njcl 2017/1 29 1. introduction ..................................................................................... 30 2. international accountability standards on capital markets ................................................................................................ 31 2.1. the principles for responsible investment and esg: how close to csr? ................................................................ 32 2.2. looking at the sustainability goal from another perspective: investors’ right to be informed ........... 35 3. prudent person principle in the united kingdom, denmark and the netherlands: protecting occupational pension funds .................................................................................... 37 3.1. introduction of the prudent person and its meaning ..................................................................................... 37 3.2. prudent person principle in practice: what can be taken into consideration? ................................................ 42 3.2.1. the united kingdom ................................................. 42 3.2.2. denmark ......................................................................... 44 3.2.3. the netherlands ........................................................ 45 3.3. liability issues under the prudent person principle ............................................................................................ 48 4. the new 2016 directive ................................................................. 50 4.1. the 2016 directive and responsible investments .... 50 4.2. liability issues under the new directive ................... 52 5. conclusions ........................................................................................ 53 iorps & sustainability 30 abstract the european union encourages individuals to save in private and occupational pension funds to complement their state saving-plans. throughout their lives, employers directly sponsor occupational retirement saving plans, so individual employees may top up their future pensions. while the european union clearly supports the formation and cross-border participation in these financial vehicles by adopting eu regulatory framework, the eu has also decided to determine a common investment decision standard to be used in all member states, called the prudent person principle. according to this principle, the fund the future retirement for many shall be managed with care, the skill of an expert, prudence and due diligence. under this principle, the pension fund’s governing body is given a broad authority to invest the pension assets in a prudent fashion in light of the particular investment plan of a fund. at the same time, the eu is also moving towards more responsible investment and inclusion of the esg-principles (environment, social and governance). the question we aim to answer in this paper is how these two principles co-exist and whether, due to the new directive adopted by the occupational pension funds in 2016, all funds are obliged to make only responsible, environmentally and socially beneficial investments. 1. introduction occupational pension funds [also known as “institutions for occupational retirement provision” (‘iorp’)] are financial institutions that manage employers’ collective retirement schemes in order to provide benefits to employees. the occupational funds play an important role in securing a reasonable retirement plan for workers once their careers end. currently, in the european union there are more than 125,000 occupational pension funds, holding assets worth €2.5 trillion on behalf of 75 million europeans, which represents 20% of the eu’s working-age population.1 as the large funds administered by the occupational pension funds are invested in stocks, bonds and other securities, they also have a huge impact on the business world. investment and divestment decisions of the occupational pension funds may thus favour one sector, e.g. sustainable energy with cheap access to finances to the detriment of e.g. the fossil industry. the question, however, is whether “sustainable” investment design may be detrimental to the return on investment, and in the affirmative, whether the board of the occupational pension fund may be found liable towards the beneficiaries for the losses incurred. this question has been a subject of discussions and a few court cases.2 at the 1 revision of the occupational pension funds directive – frequently asked questions, brussels, (european commission,1 july 2016, p.1) <https://ec.europa.eu/info /system/files/memo-faq-iorp-directive-revision-01072016_en.pdf> accessed 10 july 2017. 2 will be described and analysed in section 3. njcl 2017/1 31 same time, all the eu member states have adopted a new investment standard – “the prudent person principle” applying now to all eu member states.3 in this article, authors first explain the relevance of accountability standards in capital markets and their recent application across the pension fund industry. the importance of this section lies in introducing a movement that has taken place in the entire financial industry and has affected all the intermediaries, including the occupational pension funds. the analysis starts with general remarks on the international accountability standards that have been stirring the discussion about what sustainability means. this section provides the reader with the necessary background for understanding the later discourse on “responsible investment”. afterwards, the authors move to analyse the prudent person principle, the origins of this principle, and its nature in three selected jurisdictions, namely denmark, the netherlands and the uk. subsequently, the recent 2016 eu directive on occupational pension funds is analysed with the focus on its introduction of the “principles for responsible investment”. the article reflects on the possible liability issues arising from the prudent person principle and “responsible investment”. 2. international accountability standards on capital markets capital markets finance the economy. financial institutions represent the source of capital for corporations, acquisitions as well as new ventures. financial institutions stand at the beginning of capital distribution to any other existing or future business. financial institutions have a unique opportunity to contribute to solving the big challenges our societies face, be it contribution to limiting the global warming to a maximum of 2 degrees celsius, respecting human rights in business or the fight against child labour. financial institutions stand at the very beginning of the value creation and therefore these institutions have the ability to redefine the entire value chain and focus on using their financial leverage towards a positive change. sustainable development has been identified as a possible benefit for business and finance. commercial banks, investment banks, pension funds as well as other financial intermediaries have realised this and many have already started to take this factor into their equation, naming it “sustainability”, “csr” or “esg” in their materials and references. international accountability standards (ias) are understood as recognised principles assisting corporations with their social and environmental responsibility. within the financial sector, there are different ias that have been adopted. the guideline wave started in 2003, 3 details are available online at: <http://ec.europa.eu/info/law/institutionsoccupational-retirement-provision-iorp-directive-2003-41-ec/implementation /implementation-eu-countries_en> accessed 1 september 2017. iorps & sustainability 32 when several banks adopted the equator principles.4 numerous financial institutions have voluntarily undertaken to commit themselves to ensure due diligence procedures, analyse and manage the impact of their clients’ projects in accordance with the world bank’s environmental and social standards and the international finance corporation’s (ifc) performance standards. initially, a small group of leading financial institutions created principles that would help them analyse projects for environmental and social risk in emerging markets.5 currently eighty-nine financial institutions apply the equator principles. beside the equator principles, in 2006 the ifc also adopted the ifc sustainability framework.6 yet, probably the most known in the financial industry are the principles for responsible investment that has been working with the esg abbreviation environmental, social and governance.7 2.1. the principles for responsible investment and esg: how close to csr? the principles for responsible investment (pri), adopted in 2006, complement the un global compact and the un environment program finance initiative. the pri introduced six principles in the area of esg issues. these six principles were developed by investors and are supported by more than 1,400 signatory institutions from more than fifty countries, currently representing more than us$59 trillion of assets.8 the crucial argument of the pri is that esg factors have a material effect on the returns delivered to clients and beneficiaries. 4 ten major international commercial banks abn amro, barclays, citigroup, crédit lyonnais, crédit suisse, hypovereinsbank, rabobank and the royal bank of scotland together with westlb and westpact adopted the equator principles, a charter to ensure that the projects they finance are socially responsible and respect environment. until today additional seventy-nine financial institutions have signed up the initiative. 5 see suellen lambert lazarus, 'the equator principles: retaining the gold standard: a strategic vision at 10 years' in karen wendt (ed), responsible investment banking: risk management frameworks, sustainable financial innovation and softlaw standards (responsible investment banking: risk management frameworks, sustainable financial innovation and softlaw standards, springer 2015), at 124-125; see also ‘about the equator principles strategic review – 2010/2011’, <www.equator-principles.com/index.php/strategicreview-2010-2011> accessed 3 may 2017. 6 the ifc sustainability framework includes (i) the policy on environmental and social sustainability, (ii) the performance standards, (iii) the access to information policy and (iv) environmental and social categorization, <www.ifc.org/wps/wcm/connect/topics _ext_content/ifc_external_corporate_site/sustainability+and+disclosure/environment al-social-governance/sustainability+framework> accessed 3 may 2017. 7 <www.unpri.org/about> accessed 3 may 2017. 8 see principles for responsible investment: an investor initiative in partnership with unep finance initiative and the un global compact at 4. <www.unpri.org/about> accessed 3 may 2017. njcl 2017/1 33 according to the pri, the management of the signatory institutions, where consistent with their fiduciary responsibilities, commit themselves to: incorporate esg issues into investment analysis and decision making processes; be active owners and incorporate esg issues into their ownership policies and practices; seek appropriate disclosure on esg issues by the entities in which they invest; promote acceptance and implementation of the principles within the investment industry; enhance their effectiveness in implementing the principles; report on their activities and progress towards implementing the principles; however, what are the esg factors that the principles refer to and how do they depart from the notions that we already know, such as csr? the pri on their website enumerate only few examples of the esg factors. from environmental indicators it names climate change, greenhouse gases, waste and pollution, from social indicators it names slavery or child labour and from governance indicators it names issues as executive pay, board diversity or tax strategy. when breaking down the three areas, the pri itself does not provide financial institutions with an exhaustive list of factors that they should take into consideration in order to carry out responsible investment.9 this approach of the un’s drafting indicates the understanding that the esg factors are changing. depending on the specific financial sector, region and the development of the market itself the esg factors may vary. moreover, also the formulation of the factors for individual institutions is of crucial importance, given that the entire idea behind the pri as well as the un global compact emphasises the active engagement of the financial institutions with their clients, investors as well as the societies within which they operate.10 thus, the pri together with esg represent a procedural side of understanding and determining sustainability goals that continue to develop in the light of societal change and scientific discoveries. reflecting on the commonalities between the esg notion and the csr notion that has been present since the fifties,11 the concepts are very 9 the pri association itself also adheres to the standards, but it is also incoherent. while the environmental package is compliant to iso 14001 (certification standard), the social area works with a charity in order to narrow down the factors and within the governance, the pri association is governed by the pri association board. 10 see thomas beschorner & martin müller, ‘social standards: towards an active ethical involvement of businesses in developing countries’ (2006) 73 journal of business ethics 7, 11-20. 11 in 1953 bowen wrote a seminal book on social responsibilities of the businessman. for more on the esg and csr, see tineke lambooy, ‘legal aspects of corporate social responsibility’ (2014) 30 utrecht journal of international and european law 78; john l. campbell, ‘why would corporations behave in socially responsible ways? an iorps & sustainability 34 similar. they both take environmental and societal factors into consideration. human rights have been taken as a basis for both notions.12 the above mentioned ias are based on environmental, labour and/or human rights, adopted by the un, ilo, oecd as well as numerous independent states through their individual constitutions. the main characteristic of both notions is that they are evolving and reflect the standing of our society/ies. the only difference between the two is the incorporation of governance considerations in the esg, which presumably was affected by the oecd corporate governance wave.13 moreover, esg should be perceived as a merge between the unctad, unep, un global compact and pri principles. looking at the esg from a quantitative perspective, for determining esg performance indicators effectively, it is essential to identify the appropriate key performance indicators (kpi). the european federation on financial analysts societies (effas) states that kpis for esg should meet certain requirements: significance, measurability, comparability, reliability, usefulness and traceability. usually, the environmental, economic and social corporate data and information are being monitored, coded, registered and aggregated into kpis.14 linking objectives of nonfinancial indicators with the financial goals of a corporation should contribute materially to reaching long-time sustainable performance and to the sustainability reporting itself. thus, kpis and esg have always been perceived as contributing to long-time performance of an institution and thus being in the interest of the shareholders. institutional theory of corporate social responsibility’ (2007) 32 academy of management review 3. 12 for csr see douglass cassel, 'human rights and business responsibilities in the global marketplace' (2001) 11 business ethics quarterly 261. 13 in 1996 the oecd ministers decided that a business sector advisory group on corporate governance should be established to review international corporate governance matters and develop a set of standards which should be followed by oecd countries. it has been understood that corporate activity has a direct impact on society and therefore the oecd advisory group on corporate governance has recognized that that societal interests should have an impact on corporate governance and that “(…) corporate actions must be compatible with societal objectives (…)” the principles were introduced in 1999 and since then the latest revision took place in 2015. the principles focus on publicly traded companies, both financial and non-financial. the principles have been intended to help policy makers evaluate and improve the legal, regulatory and institutional framework for corporate governance. see michael galanis alan dignam, 'governing the world: the development of the oecd's corporate goverancne principles' (1999) 10 european business law review 396. 14 felix schnella & ralf frank hendrik garz, kpis for esg: a guideline for the integration of esg into financial analysis and corporate validation (2010). njcl 2017/1 35 2.2. looking at the sustainability goal from another perspective: investors’ right to be informed aside from what is considered the “right thing to do” and the fact that it could be argued that the financial institutions should be the first to adhere to esg standards as they represent the start of the flow of capital, it is necessary to realise the relevance of esg from another perspective. this perspective is from the side of investors and their right to information.15 this right is materialised through diverse disclosure mechanisms required by capital market regulation. disclosure on capital markets has additional relevance, as keeping fair and honest markets16 and preventing fraud or minimising systemic risk.17 hence, information about all market participants, including corporations and financial institutions is normally considered of the utmost relevance. investors consider a variety of factors when determining their investments. annual reports, including both financial and non-financial information, have served as the traditional source of information. yet, with the access to information online or through databases, investors are in a better position to receive greater amount of data. often the question arises to what extent investors may effectively evaluate such data, but this is not the focus of this paper. capital markets come with plenty of solutions to assess also non-financial information. investment companies have developed esg index funds which track the performance of companies with superior esg index ratings and provide low cost, tax efficient and esg investment.18 investors have to simply invest in these indexes.19 aside of the indices, there are few investors who focus only on 15 ronald j. gilson & reiner h. kraakman, 'the mechanisms of market efficiency' (1984) 70 virginia law review 549. 16 see e.g. michael e. parrish, securities regulation and the new deal (yale university press 1970) at 3-5; the purpose of the us securities act of 1933, as stated in its preamble is ‘[t]o provide full and fair disclosure of the character of securities sold in interstate commerce and foreign commerce and through the mails, and to prevent fraud in the sale thereof, and for other purposes.’ furthermore, the senate committee on banking and commerce stated that ‘[t]he purpose of this bill is to protect the investing public and honest business. the basic policy is that of informing the investor of the facts concerning securities to be offered for sale in interstate and foreign commerce and providing protection against fraud and misrepresentation.’ s. rep. no. 47, 73rd cong., 1st sess. 1 (1933). 17 see e.g. emilios avgouleas, 'what future for disclosure as a regulatory technique? lessons from behavioural decision theory and the global financial crisis' in justion o'brien ian g. mcneil (ed), the future of financial regulation (the future of financial regulation, hart publishing 2010) at 205. 18 msci has developed 11 esg indices with over $56 billion in assets (december 2016); <www.msci.com/esg-index-family> accessed 16 may 2017. 19 on the broad spread of esg indices see bloomberg esg data; < www.bloomberg.com/professional/blog/esg-indices-bringing-environmental-socialgovernance-data-fore-asia-globally> accessed 16 may 2017. iorps & sustainability 36 sustainable investing, such as robecosam or vontobel. furthermore, bloomberg, yahoo and the financial times also report on esg performance. bloomberg operates an esg<go> terminal which provides data on companies’ environmental, social and governance metrics. this service provides an overview of a company’s sustainability initiatives and ranks its performance within an industry.20 moreover, stock exchanges also support such initiatives. fifty-eight stock exchanges have collaborated with pri and thus over seventy percent of listed equity markets, have made a public commitment to advance sustainability in their individual markets.21 twelve stock exchanges have incorporated esg reporting into their listing rules and fifteen provide formal guidance to issuers.22 it is thus obvious that this kind of information is taken into consideration by various market participants. the efficient market theory states that share prices reflect all known information relating to a share.23 all new information has the potential to affect the fundamental valuation of stock price. the more complete and reliable the information available is, the more accurate the valuation of the future performance of the respective security. the attention to esg issues might be relatively recent, yet this has already been implemented by most of the financial institutions. even if extra-financial information may not necessarily affect the price of a company’s share during normal operations,24 in cases where reputational or monetarily quantifiable litigation risk exists, investment professionals pay much attention to the respective pieces of information.25 this is the rationale behind the companies’ disclosure requirements on extra-financial aspects, which capture additional dimensions of corporate performance that are not accounted for within financial data.26 20 bloomberg, bloomberg esg function for sustainability investors adds robeco sam data, september 29, 2016, <www.bloomberg.com/company/announcements/esg-functionadds-robecosam/> accessed 16 may 2017. 21 sustainable stock exchanges initiative, 2016 report on progress, at 6; <www.sseinitiative.org/wp-content/uploads/2012/03/sse-report-on-progress2016.pdf> accessed 22 may 2017. 22 more recently, the london stock exchange issued esg guidelines for listed companies. it has also sent its guidelines to more than 2,700 companies listed on its uk and italian exchanges; <www.lseg.com/esg> accessed 16 may 2017. 23 see donald c. langevoort, 'theories, assumptions, and securities regulation: market efficiency revisited' (1992) 150 university of pennsylvania law review 851, at 851-852 and lawrence a. cunningham, 'capital market theory, mandatory disclosure, and price discovery' (1994) washington and lee law review 843. 24 some practitioners consider esg data to be a distraction, see patrick sheehan, esg data can be a distraction, financial times, march 6, 2017. 25 this has been shown by the recent stock fall of the stock value of the volkswagen by thirty percent due to its diesel emission scandal. 26 such disclosure obligation was recently introduced in the eu by the directive 2014/95/eu of the european parliament and of the council of 22 october 2014 njcl 2017/1 37 to summarise, the above description shows that various soft law instrument strongly encourage institutional investors such as pension funds to take esg-factors into account when making investment or divestment decisions. this raises the question whether under the national law, pension funds are also entitled to take such considerations into account or whether they may risk liability by doing so. under the existing systems, understanding the concept of the “prudent person” is central if this question is to be answered. 3. prudent person principle in the united kingdom, denmark and the netherlands: protecting occupational pension funds 3.1. introduction of the prudent person and its meaning the prudent person rule was historically developed in common law jurisdictions, namely england and the us, via case-law. fiduciary duties in both countries in the nineteenth century were conservative, this was due to the legal restrictions on possible trustees’ investment as a fiduciary was perceived more as a conservator of wealth than a reproducer.27 however, with the evolvement of the markets and novel investment possibilities, the limiting perception of a fiduciary was altered. and the rule of the “prudent person” was clarified in the famous case of harvard college v. amory28 decided by the massachusetts supreme judicial court in 1830. the decision states that: ‘all that can be required of a trustee to invest, is, that he shall conduct himself faithfully and exercise sound discretion. he is to observe how men of prudence, discretion, and intelligence manage their own affairs, not in regard to speculation, but in regard to the permanent disposition of their funds, considering the probable income, as well as the probable safety of the capital to be invested.’29 this more “modern” form in precise statutory language was applied to pensions in both the united states and the united kingdom, by the employee retirement income security act of 1974 (erisa) in the us30 amending directive 2013/34/eu as regards disclosure of non-financial and diversity information by certain large undertakings and groups, oj l 330/1. 27 mayo adams shattuck, 'the development of the prudent man rule for fiduciary investment in the united states in the twentieth century' (1951) 12 ohio state law journal 491, at 492. 28 9 pick. (mass.) 446 (1830). 29 ibid. 30 section 404(a) of erisa stipulates: (1)subject to sections 1103(c) and (d), 1342, and 1344 of this title, a fiduciary shall discharge his duties with respect to a plan solely in the interest of the participants and beneficiaries and— (a)for the exclusive purpose of: (i) providing benefits to participants and their beneficiaries; and (ii) defraying reasonable expenses of administering the plan; (b) with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with iorps & sustainability 38 and in the pensions act 1995 in the uk.31 pension law has in the anglosaxon tradition been perceived as a unique combination of trust and contract law principles.32 before the prudent person principle was introduced at eu level (see further below), the member states by and large had applied different quantitative portfolio regulations in the financial sector. these quantitative regulations came in different shapes, for example imposing limits on investing in certain assets or restrictions on assets allocation. typically, those instruments, the holding of which was limited or forbidden, were those with high price volatility and/or low liquidity and/or high credit risk, such as equities, venture capital/unquoted shares and real estate, as well as foreign assets.33 quantitative portfolio regulations and restrictions have been the subject of criticism on the grounds that they lead to lower returns, are inflexible when necessary to adjust and adapt investment strategies and tend to discourage competition among investors. in 1998 davis found that in oecd states, where a prudent person rule was applied, there is a higher rate on investment in equities as compared to states with quantitative portfolio regulations and that the former had a higher rate of return during 1967-1990.34 this contributed to a policy shift also in the eu and the adoption of the prudent person principle in directive 2003/41 like aims; (c) by diversifying the investments of the plan so as to minimize the risk of large losses, unless under the circumstances it is clearly prudent not to do so; and (d) in accordance with the documents and instruments governing the plan insofar as such documents and instruments are consistent with the provisions of this subchapter and subchapter iii. (2) in the case of an eligible individual account plan (as defined in section 1107(d)(3) of this title), the diversification requirement of paragraph (1)(c) and the prudence requirement (only to the extent that it requires diversification) of paragraph (1)(b) is not violated by acquisition or holding of qualifying employer real property or qualifying employer securities (as defined in section 1107(d)(4) and (5) of this title). 31 sections 33-36 of the pension act 1995. 32 john h. langbein, 'the secret life of the trust: the trust as an instrument of commerce' (1997) 107 yale law journal 165 (‘[t]he typical trust … embodies a contractlike relationship … about how the trustee will manage the trust assets and distribute them to the trust beneficiaries. the difference between a trust and a third-party beneficiary contract is largely a lawyer’s conceptualism. when, therefore, we enforce a trust … we are already in the realm of contract-like behaviour.’) and eileen e. gillese, 'pension plans and the law of trusts' (1996) 75 canadian bar review 221, 250 (‘pension law … is the intersection of competing system of law: contract law and trust law.’). 33 philip e. davis, 'prudent person rules or quantitative restrictions? the regulation of long-term institutional investors' portfolios' (2002) 1 journal of pension economics and finance 157, 169. 34 philip e. davis, financial market activity of life insurance companies and pension funds, 1998, bank for international settlements, economic paper no 21, bis, basle. njcl 2017/1 39 on the activities and supervision of institutions for occupational retirement provision.35 directive 2003/41 in its preamble stipulates that the prudent person rule represents the underlying principle for capital investment of iorps.36 the prudent person rule is defined in article 18 of directive 2003/41.37 the aim of this rule is to ensure adequate diversification, thus protecting the beneficiaries the pensioners against insolvency of a fund, lower returns and inability of pay out the retirement and other investment risks that are inherent in investment industry. the eu prudent person rule focuses on the process and behaviour of the person doing the investment. as explained by bevis longstreth: ‘prudent is to be found principally in the process by which investment strategies are developed, adopted, implemented, and monitored in light of the purpose for which funds are held, invested, and deployed. prudence is demonstrated by the process through which risk is managed, rather than by the definition of specific risks that are imprudent. under a modern paradigm, no investment is imprudent per se. the products and techniques of investment are essentially neutral. it is the way in which they are used, and how decisions as to their use are made, that should be examined to determine whether the prudence standard has been met. even the most aggressive and 35 bernhard ebbinghaus, 'the privatization and marketization of pensions in europe: a double transformation facing the crisis' (2015) 1 european policy analysis 56. 36 article 6 of preamble, directive 2003/41. 37 according to this article, pension funds shall invest in accordance with the following rules: (a) the assets shall be invested in the best interests of members and beneficiaries. in the case of a potential conflict of interest, the institution, or the entity which manages its portfolio, shall ensure that the investment is made in the sole interest of members and beneficiaries; (b) the assets shall be invested in such a manner as to ensure the security, quality, liquidity and profitability of the portfolio as a whole. assets held to cover the technical provisions shall also be invested in a manner appropriate to the nature and duration of the expected future retirement benefits; (c) the assets shall be predominantly invested on regulated markets. investment in assets which are not admitted to trading on a regulated financial market must in any event be kept to prudent levels; (d) investment in derivative instruments shall be possible insofar as they contribute to a reduction of investment risks or facilitate efficient portfolio management. they must be valued on a prudent basis, taking into account the underlying asset, and included in the valuation of the institution's assets. the institution shall also avoid excessive risk exposure to a single counterparty and to other derivative operations; (e) the assets shall be properly diversified in such a way as to avoid excessive reliance on any particular asset, issuer or group of undertakings and accumulations of risk in the portfolio as a whole. investments in assets issued by the same issuer or by issuers belonging to the same group shall not expose the institution to excessive risk concentration; (f) investment in the sponsoring undertaking shall be no more than 5 % of the portfolio as a whole and, when the sponsoring undertaking belongs to a group, investment in the undertakings belonging to the same group as the sponsoring undertaking shall not be more than 10 % of the portfolio. when the institution is sponsored by a number of undertakings, investment in these sponsoring undertakings shall be made prudently, taking into account the need for proper diversification. iorps & sustainability 40 unconventional investment should meet that standard if arrived at through a sound process, while the most conservative and traditional one may not measure up if a sound process is lacking.’38 the prudent person rule thus requires iorps to have a robust system of internal checks and balances and a governance system in place rather than quantitative restrictions. however, some rules on crossinvesting are still in place under the directive,39 and quantitative investment principles are still allowed under certain conditions.40 after the 2003 directive, the solvency ii directive (2009/138/ec) was adopted in 2009. the solvency ii aimed at the taking-up and the pursuit of the business of insurance and reinsurance within the eu. the purpose of the directive was to provide a legal framework for insurance and reinsurance undertakings to conduct insurance business throughout the internal market, thus making it easier for insurance and reinsurance undertakings with head offices in the eu to cover risks and commitments situated therein. similarly, to the 2003 directive, the solvency ii also marked a transition from a rule-based approach to a risk-based approach to investing and thus introduced the prudent person principle for investments made by insurance and reinsurance undertakings on a unified legislative basis, cf. article 132 of the directive.41 the prudent person 38 bevis longstreth, modern investment management and the prudent man rule (oxford university press 1986), at 7. 39 article 18 (1(f) directive 2003/41. 40 see article 18, subsection 5-7. 41 according to article 132 of solvency ii, the prudent person principle is defined in the following way: 1. member states shall ensure that insurance and reinsurance undertakings invest all their assets in accordance with the prudent person principle, as specified in paragraphs 2, 3 and 4. 2. with respect to the whole portfolio of assets, insurance and reinsurance undertakings shall only invest in assets and instruments whose risks the undertaking concerned can properly identify, measure, monitor, manage, control and report, and appropriately take into account in the assessment of its overall solvency needs in accordance with point (a) of the second subparagraph of article 45(1). all assets, in particular those covering the minimum capital requirement and the solvency capital requirement, shall be invested in such a manner as to ensure the security, quality, liquidity and profitability of the portfolio as a whole. in addition the localisation of those assets shall be such as to ensure their availability. assets held to cover the technical provisions shall also be invested in a manner appropriate to the nature and duration of the insurance and reinsurance liabilities. those assets shall be invested in the best interest of all policy holders and beneficiaries taking into account any disclosed policy objective. in the case of a conflict of interest, insurance undertakings, or the entity which manages their asset portfolio, shall ensure that the investment is made in the best interest of policy holders and beneficiaries. 3. without prejudice to paragraph 2, with respect to assets held in respect of life insurance contracts where the investment risk is borne by the policy holders, the second, third and fourth subparagraphs of this paragraph shall apply. where the benefits provided by a contract are directly linked to the value of units in an ucits as defined in directive njcl 2017/1 41 principle is placed in what is referred to as the 2nd pillar of the solvency ii directive dealing with qualitative restrictions. the 1st pillar deals with quantitative requirements and the 3rd pillar with disclosure and market discipline. according to paragraph 71 in the preamble the stipulated reason is: ‘insurance and reinsurance undertakings should have assets of sufficient quality to cover their overall financial requirements. all investments held by insurance and reinsurance undertakings should be managed in accordance with the ‘prudent person’ principle.’ the reason for including the reference to solvency ii in this paper, is the mixed nature of the most of the occupational pension schemes that include the saving as well as the insurance part. one part of the occupational pension scheme consists of classical saving that is combined with the savings of others while the second part is a form of a life insurance, yet these are often invested on the capital markets together. therefore, we find both 2003 directive and solvency ii highly relevant for our discourse. due to the member states’ diverse reference in their respective regulation governing the iorps, the authors had to analyse the prudent person principle implementation through the lens of 2003 directive in the uk and the netherlands and through the lens of solvency ii in denmark. this also allows us to examine the interpretation of this principle, given that in theory, the understanding of the prudent person principle should be universal across the financial industry. given that the general principle of article 18 in directive 2003/41 for iorp’s and article 132 of solvency ii have been subject to 85/611/eec, or to the value of assets contained in an internal fund held by the insurance undertakings, usually divided into units, the technical provisions in respect of those benefits must be represented as closely as possible by those units or, in the case where units are not established, by those assets. where the benefits provided by a contract are directly linked to a share index or some other reference value other than those referred to in the second subparagraph, the technical provisions in respect of those benefits must be represented as closely as possible either by the units deemed to represent the reference value or, in the case where units are not established, by assets of appropriate security and marketability which correspond as closely as possible with those on which the particular reference value is based. where the benefits referred to in the second and third subparagraphs include a guarantee of investment performance or some other guaranteed benefit, the assets held to cover the corresponding additional technical provisions shall be subject to paragraph 4. 4. without prejudice to paragraph 2, with respect to assets other than those covered by paragraph 3, the second to fifth subparagraphs of this paragraph shall apply. the use of derivative instruments shall be possible insofar as they contribute to a reduction of risks or facilitate efficient portfolio management. investment and assets which are not admitted to trading on a regulated financial market shall be kept to prudent levels. assets shall be properly diversified in such a way as to avoid excessive reliance on any particular asset, issuer or group of undertakings, or geographical area and excessive accumulation of risk in the portfolio as a whole. investments in assets issued by the same issuer, or by issuers belonging to the same group, shall not expose the insurance undertakings to excessive risk concentration. iorps & sustainability 42 transposition by the member states, in the following sections we analyse the specificities of the application of the prudent person rule in the three chosen jurisdictions to assess the character of the rule in practice. 3.2. prudent person principle in practice: what can be taken into consideration? first of all, it is necessary to re-emphasise that the prudent person rule is a behaviour-oriented principle rather than outcome-focused. thus, the key element of the eu version of the prudent person rule is the attention on a trustee’s or fiduciary’s exercise of due diligence. this means that pension fund managers will be judged not by a retrospective assessment of whether their investment decisions were successful, but by whether they followed a reasonable process in reaching their decisions.42 3.2.1. the united kingdom in the united kingdom, the duties and powers of iorps derive from three sources (1) the trust document and rules of the pension scheme; (2) the general law and principles of equity applicable to trustees, which is a mixture of legislation, including the trustees act of 1925, and case law, and (3) the law specific to trustees of occupational pension schemes, found predominantly in the pensions act 1995 and pension schemes act 2015. the iorps in the uk are bound to exercise reasonable care and to show the prudence and diligence that an ordinary man of business would in the exercise of his or her own affairs. according to the decision dating back to the 19th century, the duty is to ‘… take such care as an ordinary prudent man would take if he were minded to make an investment for the benefit of other people for whom he felt morally bound.’43 furthermore, in the light of the sections 33-36 of the pension act 1995, according to the investment principles, the trustees of a trust scheme – a pension fund – must make sure that there is prepared, maintained and from time to time revised a written statement of the principles governing decisions about investments for the purposes of the scheme. subsection 3 of section 35 42 bevis longstreth, modern investment management and the prudent man rule (oup, 1987), at 7. (‘prudence is to be found principally in the process by which investment strategies are developed, adopted, implemented, and monitored in light of the purpose for which funds are held, invested, and deployed. prudence is demonstrated by the process through which risk is managed, rather than by the definition of specific risks that are imprudent. under a modern paradigm, no investment is imprudent per so. the products and techniques of investment are essentially neutral. it is the way in which they are used, and how decisions as to their use are made, that should be examined to determine whether the prudence standard has been met. even the most aggressive and unconventional investment should meet that standard if arrived at thought a sound process, while the most conservative and traditional one may not measure up if a sound process is lacking.’) 43 re whitely (1886) 33 ch d 347 as cited in moore, n. trustees’ duties in relation to money purchase pension schemes in tolley’s trust law international vol. 13, no. 1 (1999). njcl 2017/1 43 stipulates that the investment policy must include (a) the kinds of investments to be held, (b) the balance between different kinds of investments, (c) risks, (d) the expected return on investments, (e) the realisation of investments, and (f) such other matters as may be prescribed. section 36 further provides the rules and factors that should be taken into consideration when choosing an investment. the section 36 further stipulates that the trustee (iorp) must have regard to (a) the need for diversification of investments, insofar as they are appropriate for the circumstances of the scheme and (b) to the suitability to the scheme of investments of the description of investment (investment policy) proposed. these broad rules have however been narrowed down in the light of the uk case law. the case of cowan vs. scargill44 has often been cited. at the core of the case was the question of whether it was lawful for the trustees to restrict funds to investments in the uk and prohibit investments in industries competing with the coal industry. judge megarry vc reached the conclusion that the trustees had breached their duty of loyalty by giving preference to the interests of the union in protecting the coal industry at the expense of the interests of the pension savers (members of the mineworker’s pension scheme). the court case has been cited as laying down the rule that the trustees may not take into account interests of other groups of stakeholders than the best interest of the beneficiaries, meaning the financial interest of the members. after cowan vs. scargill [1984] a scottish case was decided in martin v the city of edinburgh district council.45 after the labour party had won the majority in the city of edinburgh district council it requested that the city disinvested all investments in or related to south africa due to the apartheid regime at that time. judge lord murray held that the council was in breach of trust in pursuing a policy of disinvesting in south africa as it had failed to expressly consider whether this cause of action was in the best interest of the beneficiaries. the interpretation of the above cases is debated especially as to whether they exclude any non-financial considerations on behalf of the trustees, assuming that esg is a non-financial consideration which is debated too. in 2014, the law commission (england and wales) published their report “fiduciary duties of investment intermediaries” and in their summary they state:46 ‘a.18 trustees may take account of any financial factor which is relevant to the performance of an investment. these include risks to a company’s long-term sustainability, such as environmental, social or governance factors (often referred to as “esg” factors). a.19 the law commission’s conclusion is that there is no impediment to trustees taking account of environmental, 44 cowan v. scargill [1984] 2 all er 750. 45 [1989] pensions law reports 8 (court of session). 46 <https://web.archive.org/web/20140924081849/http://lawcommission.justice.gov .uk/docs/lc350_fiduciary_duties_summary.pdf> accessed 16 june 2017. iorps & sustainability 44 social or governance factors where they are, or may be, financially material.’ the law commission’s recommendations still await the uk government’s response. however, on the basis of the existing case law and the expressed opinion of the law commission, the position seems to be that esg can be given weight in decision-making as to investments or divestments but only to the extent this is in the best interest of the beneficiaries, meaning the financial interest of the beneficiaries. 3.2.2. denmark in denmark the prudent person principle came into profound discussion with the implementation of the solvency ii directive.47 the prudent person principle in the solvency ii directive has been implemented by amending the danish financial business act, article 158, subsection 1.48 the wording of the article is: ‘(1) in their investment of assets insurance companies shall safeguard the interests of policyholders and beneficiaries in the best possible way.’ in the preparatory work regarding the previous rule in the financial business act art. 15849 on how insurance companies were to invest it was – amongst other requirements required that the board ensured a sufficient diversification and aimed towards the largest possible return on investment.50 this implied according to the financial authority that investments could be divided into 4 groups:51 1) investments already made, 2) new investments, where the board in selecting and de-selecting investments pursue the highest possible return on investments, 3) new investments, where the board consciously decides on an investment, which does not pursue the highest return on investment, 4) new investments, where the board knows that self-elected costs concerning selection and/or post-control – for example complying with environment-requirements (at least) equivalent to danish requirements – implies, that the highest possible return on investments is not achieved. 47 directive 2003/41 was implemented by act no. 1561 of december 19, 2007 on company pensions, making applicable the rules in directive 2002/83/ef on life insurance to company pensions. 48 law no. 308, 28th of march 2015. 49 law compilation no. 182 of 18th. of february 2015 with later changes. 50 the danish wording was: ’de midler, et forsikringsselskab eller en pensionskasse råder over, skal investeres på en hensigtsmæssig og for de forsikrede tjenlig måde, således at der er betryggende sikkerhed for, at selskabet til enhver tid kan opfylde sine forpligtelser.’ 51 memorandum of the financial authority dated october 9, 1997 ’pensionskassers og livsforsikringsselskabernes investeringsstrategi, herunder om etiske investeringer.’ njcl 2017/1 45 investments as mentioned in no. 3 and 4 were considered illegal by the financial authority.52 the financial authority did however not state that an investment strategy consisting of ”ethical investments” is illegal but it has to pursue the highest possible return of investment. the question on whether the above mentioned limitations on ethical investments should stay in place was debated in the danish parliament. the minister of economy at the time, marianne jelved, argued that the roi-criteria should remain and said (translated): ‘the requirement of pursuing the highest possible return on investment protects the pension-savers from the board of the pension fund to invest the capital in a way which is detrimental to the economic interests of the pension-savers.’53 the danish position according to the previous rules was thus, according to the danish financial authority and the minister of economy, that a pension fund was not allowed to give priority to esg considerations in making investment decisions if the board from the outset knew that the investment would result in a smaller return on investment in the longrun.54 the question is whether the new formulation in article 158, subsection is going to change this position. according to the preparatory works to the provision it is anticipated that this will not be the case.55 3.2.3. the netherlands the prudent person standard under the dutch pension act 2007 (pensioenwet) together with the obligatory occupational pension schemes act (wet verplichte beroepspensioenregeling) regulates the dutch iorps. in addition to these acts, the foundation of labour on request from the ministry of social affairs and employment adopted the guidelines for pension fund governance, stipulating among other principles the obligation for governing principles of iorps. according to the dutch pension act, the prudent person rule is an open standard described in article 135 in the following way: ‘1. a pension fund will conduct an investment policy in accordance with the prudent person rule, and specifically based on the following premises: a. the assets are invested in the interest of entitlement beneficiaries and pensionable persons; and b. investments in the contributing company are limited to a maximum of 5% of the portfolio as a whole, and if the contributing company belongs to a 52 memorandum of the financial authority dated october 9, 1997 ”pensionskassers og livsforsikringsselskabernes investeringsstrategi, herunder om etiske investeringer.” 53 statement by the minister of business and growth in connection with parliamentdecision (beslutningsforslag) no. b 72 of 12th of january 1999 (om demokratiske og samfundsmæssigt bæredygtige pensionsinvesteringer.) <http://webarkiv.ft.dk /?/samling/19981/beslutningsforslag_oversigtsformat/b72.htm> accessed 1 september 2017 54 to the knowledge of the authors, there is no case law that can confirm this position. 55 karnov note 2147 to § 158 in act no 174 of 31 january 2017. iorps & sustainability 46 group, investments in the companies belonging to the same group as the contributing company are limited to a maximum of 10% of the portfolio. if a group of companies pays premiums to the pension fund, investments in these contributing companies will be made prudently, taking into account the need for appropriate diversification; c. the investments are valued at market price. 1. further rules to safeguard prudent investment policy will be set in or pursuant to an order in council. 2. the requirements set out in the first paragraph, opening lines and point b, and the rules set based on the second paragraph in regard to the diversification of assets to not apply to investments in government bonds.’ as one can see, the dutch prudent person rule is a mixture of a loyalty principle (1a), followed by quantitative limitations in the contributing company (1b). in the explanatory memorandum to the bill, in relation to the prudent person rule the following is stated: ‘the prudent-person rule has been chosen as the point of departure for the supervision of investments … what is important in this regard is that the investments must comply with the principles of security, quality and risk diversification. in doing so, an important choice was made at the european level in favour of qualitative supervision of investments rather than quantitative restrictions on investments, which have characterised the financial supervision of pension funds in many other member states for so many years… the interpretation of the concept of a 'prudent person' does not derogate essentially in practice from the interpretation given to the term "soundly" in section 9b of the pension and savings funds act in past years by the dutch central bank. it is expressly not the intention to give a stricter interpretation to the concept of "prudent person" than that given to the concept of "sound investment". qualitative rules make it possible to deal better and with greater care with individual circumstances (in relation to investments) than is possible in the case of fixed quantitative criteria. the interests of members and pensioners are served much better by doing so. the other side of the coin is that supervision based on qualitative criteria is more difficult than supervision based on fixed quantitative criteria....’56 the dutch pension act itself stipulates that more detailed rules are to be laid down by council, which was carried out in the ftk decree decree on the financial assessment framework for pension funds (besluit financieel toetsingskader pensioenfondsen). the ftk decree leaves the pension funds’ freedom to invest in markets, asset classes and investment instruments intact.57 according to maatman, any investment restrictions 56 actuarieel genootschap, the prudent-person rule in relation to investment policy, 2010), at 8, emphasis added. 57 see the notes to the decree on the financial assessment framework for pension funds, law gazette 2006, 710, at 16, referred in rené h. maatman, 'the dutch pension system' in andreas g.f. hoepner james p. hawley, keith l. johnson, joakim sandberg, esward j. waitzer (ed), cambridge handbook of institutional investment and fiduciary duty (cambridge handbook of institutional investment and fiduciary duty, cambridge university press 2014) 80. njcl 2017/1 47 that result from the ftk decree have prudential character, they should concern the pension fund’s balance sheet ratios and the solvency requirements formulated by the dutch national bank (dnb).58 based on the above, it seems that the prudent person rule provides great flexibility to pension funds’ investment policy. however, in addition to the ftk decree, dnb also provided a binding instruction relating to the application of the prudent person rule.59 as to the facts of the case, referred to as “the gold case”, the pension fund’s assets were allocated as follows: 78% government bonds, 13% commodities (gold), 8% cash investment and 1% real estate. dnb instructed the pension fund to reduce its gold allocation from 13% to 3%. the pension fund appealed dnb’s instruction in a court of law.60 regarding the rationale for dnb’s instruction, the first argument of dnb was that as 55% of the 22% of the fund’s non-government bond assets were invested in gold, the pension fund was extremely dependent on the gold investment. according to the court, this was a mere quantitative argument that fails to take into account the diversification of the assets in the pension fund’s overall portfolio. in the eyes of the court, dnb could not successfully substantiate why a 3% gold allocation was more in line with the prudent person rule than a 13%.61 secondly, dnb claimed that gold investment was risky and volatile due to the fall of gold prices in 1980s and its constant fluctuation. yet, the court held that this argument, given that the price of gold has been stable for the previous ten years, was not convincing.62 ultimately, dnb emphasised that no other pension fund had a similar investment policy as the relevant pension fund. this argument was also rejected by the court, as any pension fund should be free to select an asset allocation that accurately corresponds to the nature and duration of its liabilities, as long as the objective of the prudent person rule is achieved.63 due to the instruction of dnb, the pension fund further claimed that it had lost €9.5m.64 in the light of this case and the explanatory memorandum, the prudent person rule is understood in the netherlands as a flexible principle that requires prudent aka sound investments in the name of pensioners. pension funds should not be limited by any quantitative restrictions. 58 ibid. 59 dnb executive order 6102, <www.zerohedge.com/article/here-comes-executiveorder-6102-qe-generation-dutch-central-bank-orders-pension-fund-sell-it?page=4> accessed 5 july 2017. 60 leen preesman, 'court overturns dutch regulator's order to slash gold allocation' investment & pensions europe, 16 march 2012. 61 ibid. 62 clifford chance, 'prudent pension investments: court nullifies dutch central bank instruction', clifford chance client briefing, april 2012. 63 ibid. 64 leen preesman, 'spvg continues battle with dnb over gold allocation', investment & pensions europe, 11 september 2013. to the knowledge of authors, the court has not ruled on the liability issue of the dnb for the financial loss of the pension fund. iorps & sustainability 48 according to the court, dnb, as the prudent supervisor, has to always provide a well-reasoned tailor-made instruction in the light of the pension fund’s asset allocation and the nature and duration of its liabilities.65 in other words, as long as the pension funds carry out their investment decisions in the light of proper procedures and take into considerations all other requirements stipulated by law, led by the financial interest of pensioners, the dnb may not intervene. 3.3. liability issues under the prudent person principle the analysis of the understanding of the prudent person principle in all the three legal systems show that the basic approach has changed from the application of quantitative restrictions and the apprehensions that certain investments could be imprudent “per se” to a “liberalised” approach where the focus is on procedure and where no investment should be regarded as per se imprudent as long as it can be documented that the procedure surrounding the decision making was prudent. as has been shown in section two, various soft law instruments encourage the pursuance of esg goals by pension funds. this raises the question how far the board can go in the pursuance of such goals under the prudent person rule without incurring liability towards members for not having sought the most financially beneficial investments. the prudent person principle is a flexible concept leaving room for different interpretations in different national legal systems. this also means that there are different approaches to the extent to which esg can be taken into account in different legal systems, within the limits of national implementation. in english law, such considerations seem to have been allowed for as long as the financial interests of the beneficiaries have also been taken into account. it is unclear whether under english law, it is only possible to give priority to esg if this at the same time is considered to be the most financially beneficial investment to make, and to what extent this should be evaluated in the short or in the long term. in dutch law, the focus has been on avoiding quantitative restrictions. the issue of esg friendly investments seems not to have been directly addressed. in danish law, in contrast, it has been quite clear that pension funds prior to the implementation of the solvency ii directive have been required to seek the highest possible return for their members. it has only been possible to make esg investments to the extent that such investments were at the same time the most financially beneficial investments. this would seem to imply that pension fund members could be able to hold board members liable for losses suffered by the members for investments that do not give the highest possible return, but are for instance esg friendly for purely idealistic reasons. as explained, the introduction of the prudent person principle in the solvency ii directive does not seem to change this. 65 chance, 'prudent pension investments: court nullifies dutch central bank instruction', clifford chance client briefing, april 2012. njcl 2017/1 49 however, in order to succeed with a liability claim several requirements must be met. firstly, the plaintiff must be able to prove that he or she has suffered a loss and that the loss has been caused by the investment decision. in other words, the member of the pension funds must be able to show that the value of his or her pension has decreased due to the investment. obviously, it may be extremely difficult for the member of the pension fund to lift the burden of proof in this regard. secondly, the plaintiff must prove that there is a basis of liability for the claim. in most legal systems, board members are subject to ordinary fault based liability. for board members in financial institutions the duties are specified in more detail than for other board members.66 on this basis it has been discussed whether board members in the financial sector (in banks in particular), are subject to a professional liability standard, meaning a stricter liability standard than “the reasonable man” (bonus pater) standard. at first sight, the prudent person principle might seem to support this view. however, as explained above, the main function of the prudent person principle has been to shift the focus from quantitative restrictions to procedure. consequently, it cannot be assumed that the introduction of the prudent person principle in itself has introduced a stricter liability. in contrast, it could be argued that the turning away from quantitative restrictions to a procedural approach implies a much more complicated liability assessment as no investments can be regarded imprudent per se. also, the fact that an investment is esg friendly and thus may not in the short run be the most financially beneficial but may well be so in the long run, could be argued. consequently, the task of arguing that there is a basis of liability for making an esg investment rather than a more financially beneficial investment may be a demanding one for the pension fund member. however, with regard to pension funds the liability issue may be complicated further by that fact that members of the pension funds to some extent have the right to vote and exercise influence on the investment decisions. this raises the question to what extent such votes may influence the liability assessment. under danish law, it is the board that is responsible for making the investment decisions. votes by members may be taken into consideration but the board is not obliged to follow such votes.67 rather, the board is obliged to make “prudent” investment decisions. this means that even if a majority of members of the pension fund has been in favour of pursuing an esgfriendly investment, the board still has the right to pursue non-esg objectives, provided the board – in contrast to the members – believes that these investments will give the best return to the pension fund members. 66 for danish law, see fil §§ 70-71. 67 see pensionsmarkedsrådets rapport om etiske investinger, 2007, p. 8 with reference to two administrative decisions handed down by the danish financial supervisory body (finanstilsynet). iorps & sustainability 50 4. the new 2016 directive in 2014, the european commission proposed a revision of directive 2003/41/ec in order to improve the governance, risk management, transparency and information disclosure of iorps. this endeavour was materialised in december 2016, when the directive 2016/2341/eu was adopted and published in the official journal of the european union.68 there are several reasons why a new directive has been adopted. first of all, the financial crisis has emphasised the need for sound governance of financial institutions. second, the pensioner-to-employee ratio has increased, which calls for more retirement savings and for strong and reliable retirement savings. due to the aging of the eu’s population and the increasing investment in these pension institutions across the eu, accumulation of capital in these vehicles by private individuals is unstoppable.69 third, pension funds represent a strong player on the market, supporting a functioning capital market across the eu and thus greater support for cross-border activity has been necessary.70 according to the european council, directive 2016/2341 improves the soundness of the iorps, information disclosure to the members, enhances the crossborder investment and portfolio transfers and beneficiaries and also encourages responsible investment.71 member states have until 13 january 2019 to transpose the new directive. 4.1. the 2016 directive and responsible investments given the specific focus of this paper, we do not analyse in detail all the changes that the new directive brings. in the following sections we focus only on the directive’s new embracement of responsible investment and the possible consequences thereof. we have analysed the notion of responsible investment in the light of the principles for responsible investment (pri), adopted in 2006, in the section 2.1. the same understanding has been adopted by directive 2016/2341 when referring to the un pri (article 58 preamble). directive 68 directive (eu) 2016/2341 of the european parliament and of the council of 14 december 2016 on the activities and supervision of institutions for occupational retirement provision (iorps) oj l 354/37. 69 currently, there are around four people of working age for every person aged over 65 years. by 2060, there will be only two people working for every retired one. this means an increased pressure on pension systems. on the other hand, presently the iorps across the europe hold assets worth €2.5 trillion on behalf of around 75 million europeans, which represents 20% of the eu’s working-age population. it is highly presumable that this representation will only rise in the future. 70 european commission, memo: revision of the occupational pension funds directive – frequently asked questions, brussels, july 1, 2016, at 1 and 2<https://ec.europa.eu/info/system/files/memo-faq-iorp-directive-revision01072016_en.pdf> accessed 1 september 2017. 71 ibid at 2 and 3. njcl 2017/1 51 2003/41 did not mention responsible investment, esg or csr. at the time of the adoption of the directive, these topics were far away from investment industry. however, the new 2016 directive has adopted the pri as the standard. article 58 of the preamble to the 2016/2341 directive stipulates that: ‘environmental, social and governance factors, as referred to in the united nations-supported principles for responsible investment, are important for the investment policy and risk management systems of iorps. member states should require iorps to explicitly disclose where such factors are considered in investment decisions and how they form part of their risk management system. the relevance and materiality of environmental, social and governance factors to a scheme's investments and how such factors are taken into account should be part of the information provided by an iorp under this directive. this does not preclude an iorp from satisfying the requirement by stating in such information that environmental, social and governance factors are not considered in its investment policy or that the costs of a system to monitor the relevance and materiality of such factors and how they are taken into account are disproportionate to the size, nature, scale and complexity of its activities.’72 the investment policy represents a decisive aspect for investment execution and the iorps should at least every three years review their investment principles, while being available to their members, beneficiaries and competent authorities (paragraph 60 of preamble). the investment policy plays an incremental role for a management of the iorp as it serves as a guideline for investments decisions. at the same time, the management decides under the prudent person principle that remains the key investment rule for iorps. in comparison to the 2003/41 directive, the 2016/2341 directive, in most parts is identical. only one new provision has been introduced that is directly connected to the pri and esg. according to article 19(1)(b) the iorps, ‘… within the prudent person rule, member states shall allow iorps to take into account the potential long-term impact of investment decisions on environmental, social and governance factor;’73 thus, reading the article 19 (1)(b) in the light of the preamble to directive 2016/2341, from 2019 all iorps across the eu should be allowed to take into consideration the esg and pri when making an investment. the only obligation is for the pension fund to disclose such consideration in its investment principles (article 30) and towards prospective members (article 41). yet, the directive is clear that all member states shall provide for the iorps to take the esg into account when investing. in addition to the clear reference to esg in the investment policy and prospectuses, directive 2016/2341 introduced an obligation for the 72 emphasis added. 73 emphasis added. iorps & sustainability 52 iorp’s own governance system. according to article 21, the iorps’ sound and prudent management, besides including adequate and transparent organisational structure, shall include considerations for esg factors related to investment assets in investment decisions, and shall be subject to regular internal review. furthermore, also the risk management, both internal and outsourced, take the esg into review together with an assessment of new or emerging risks, including risks related to climate change (article 25(2) and 28(2)). ultimately, directive 2016/2341 obviously made a step forward in considering the esg and loudly stipulates the pension funds’ right to consider the esg and pri in their investment policy. it has been stated that it is the strongest and clearest requirement on such issues yet seen in an eu text.74 4.2. liability issues under the new directive while the 2016/2341 directive apparently “nudges” towards esg and pri, the specific wording of the member states’ transposition is only to be seen. it could be argued that pension funds should be forerunners in pursuing esg goals and it is plausible that some member states will want to go a step further in nudging and will require the iorps to simply take the esg into account within their investment policy (due to the minimum harmonisation directive). however, based on the wording of directive 2016/2341 itself, there is no plausibility for liability in case of non-pursuance of esg in a concrete investment decision. the only obligation for the pension funds with regard to esg is to take esg factors into account in their system of governance, while not being obliged to take esg as a “factor” itself when investing. the natural question to raise is what the difference between the two is. what is the difference between taking esg into consideration within a corporate governance of an iorp vis-à-vis the investment decision? for the moment, the answer is unclear. the esg represents a set of value standards while the pri represents a procedural tool. the pri should transpose the esg into every investment decision. the character of the esg and pri also lies in their unfolding and active character. the first step of a pension fund is to define what it understands as specific esg factors, depending on the fund’s own activity and nature of investment. secondly, once the esg factors are determined, the pension fund has to identify the kpis together with the formula for their measurability, comparability and traceability. in practice these are coded as indicators into an investment algorithm in 74 catherine howart, shareaction chief executive stated that ‘[t]his is a landmark movement for responsible investment in europe. european policymakers are to be applauded for their bold action is not only recognizing the clear financial risks posed by esg factors, but also for mandating european pension funds to act on them.’ <https://shareaction.org/press-release/iorps-ii-groundbreaking-esg-risk-protection-measures-afforded-to-european-pension-savers-the-ukmust-afford-savers-the-same-says-shareaction/> accessed 8 july 2017. njcl 2017/1 53 order to better estimate the investment’s performance. thus, while the pension fund within its prudent management has the obligation to include consideration of esg into its investment performance estimate and to its internal review (article 21), it does not have the obligation to invest accordingly, meaning esg-friendly. from a technical perspective, within its investment algorithm, it will consider esg friendly factors as not positive indicators, thus modelling its investment on esg non-friendly factors, identifying those as more economically beneficial. in other words, the pension funds have to do the analysis and adopt the esg kpis, yet according to directive 2016/2341 they do not have an obligation to invest based on the outcome. it must be presumed that membership votes in favour of an esg-friendly investment policy will not change this. such a vote may be taken as advice but the responsibility to make the prudent investments still rests on the board. it could be considered whether those pension funds that directly stipulate their adherence to esg-friendly policy in their investment statement could have an obligation to live up to this policy, given the contractual character of the relationship between the members, beneficiaries and the fund. it is a difficult question, open for future endeavours, to what extent such policy could be considered to be “selfbinding” on the pension fund’s management so that members and beneficiaries would be able to base a liability claim on it. directive 2016/2341 does not state the binding character of the investment policy; therefore the national law would have to be assessed to reflect on the legal character of an investment policy.75 5. conclusions pension schemes all over the world do not only provide a financial safe haven for a retired workforce, but also represent substantial investors on capital markets. pension funds’ savings are used to support economic growth and to finance the corporate sectors. the iorp directive from 2003 introducing the prudent person principle aimed at developing a pan-european pension market, with prudential investment supervision across the entire europe while providing the opportunity for cross-border pension activities. the directive was later followed up by the solvency ii directive building also on the prudent person principle. the effect of this principle is a turn away from rule-based quantitative restrictions to a risk-based and procedurally oriented focus. at the same time numerous soft law instruments encourage esg-friendly regulation. under the 2003 directive, the iorps across the eu were obliged to adhere to the prudent person principle, while keeping open the substantive factors that should be considered. now, the 2016 directive suggests also the substantive factors, namely the 75 in the danish national legal system there is case law to the effect that internal guidelines may have an impact when determining liability questions, see u 2009.1835 h. iorps & sustainability 54 esg. yet, keeping the mandatory or non-mandatory nature of the esg values for the member states to decide. even though, under the prudent person principle the approach towards investments has been liberalised, the “best interest” of beneficiaries remains the key principle for all the pension funds. thus ultimately, it is to be seen whether the esg-friendly investments will be over time considered as in the “best interest” of beneficiaries”. in other words, whether these will render the highest returns. from the liability perspective, the management of iorps is left with a reasonable margin of appreciation. as long as they prudently assess the existing information, all that is stipulated as significant in their investment policy, they should be considered prudent. it will be difficult for fund members and/or beneficiaries to succeed with any liability claims as long as the management has acted diligently and procedurally correctly. contracts, risks and management = contractual risk management nordic journal of commercial law issue 2012#2 deviant globalization: the next step in the multilateral protection of intellectual property by doris estelle long 1 1 professor of law, director of the intellectual property law center and chair, intellectual property, information technology and privacy group, the john marshall law school, chicago (usa). the author would like to thank dean john corkery and associate dean ralph ruebner for the research grant that supported the development of this article. she would also like to thank the organizers and participants of the following conferences where evolving versions of this article were presented: changing conditions, rehinking rules: a roundtable on intellectual property law and policy, in hong kong in january 2012; the fourth annual conference on innovation and communications law in turku, finland in may 2012, the 12th ip scholars conference in stanford in august 2012; and the faculty works in progress series at the john marshall law school in september 2012. special thanks peter yu, katja lindroos and patricia judd for their insightful comments on various aspects of this article, to ross hersemann and bernadette savarese for their invaluable research assistance, and to anne abramson and raizel liebler for always finding needles in haystacks i didn’t know existed. finally, and by no means last, i would like to thank vicki allums, a valued colleague whose countless discussions with me regarding the role of trade, ipr, social justice and the informal economy have helped expand my perspectives. as always any errors in the article belong solely to me. nordic journal of commercial law issue 2012#2 abstract deviant globalization is a "powerful engine of wealth creation ...[p]articipating in deviant globalization is often an individual’s fastest ticket out of poverty and a way for an entire community to experience economic development.” although some aspects of deviant globalization undeniably include illegal conduct, such “illegality is not necessarily criminal or even unsavory in nature. “deviant globalization” in the intellectual property arena serves as a powerful force for the creation of revised standards of protection. it serves both a predictive and a normative function. it serves a predictive function because it incorporates the experimental standards we are already witnessing in domestic and international efforts to reinvent intellectual property standards for the 21st century. it serves a normative function because it creates a new normative standard that incorporates social and economic norms from the informal market into formal normative values against which decisions regarding intellectual property standards can be evaluated and revised. with its emphasis on trade and innovation across socio-economic levels, and its focus on unmet consumer demands, deviant globalization based standards would bring new understandings of the relationship between compensation, access, and distributional innovation in present intellectual property debates. more effective support for distributional innovation under deviant globalization does not require that the needs of intellectual property owners be ignored. however, it does require that their interests be re-balanced with those of sellers and consumers. by focusing on compensation streams, deviant globalization puts the economic viability of piracy into play, not its moral necessity. regulation is not the enemy of deviant globalization. irrational regulation is. some experiments in crafting effective deviant globalization models will undoubtedly fail. yet even such failures will be useful in recalibrating present international norms so that intellectual property protection can continue to provide the innovative foundation for a vibrant, socially just, global marketplace for the 21st century. nordic journal of commercial law issue 2012#2 1 1 introduction we are leaving an era of unprecedented multilateral integration. fueled by the twin engines of globalization and technological development, the latter decades of the 20th century, and the first decade of the 21st century, have cabined a period of unparalleled global integration,2 leading to an exponential growth in multilateral standard-making. plurilateral free trade agreements that reduced trade barriers and opened new markets for economic growth flourished,3 while regional and multilateral treaties defined the boundaries of intellectual property rights in the digital universe.4 no area seemed unaffected by the leveling affects of the integratory process unleashed by globalization and the communicative capabilities of the digital environment.5 at the same time, the challenges posed by digital distribution on the internet, including the social media networks that flourish on it, the rise of digital piracy, and increasing awareness of the inadequacy of present protection modalities to promote innovation in a developmentally diverse global economy,6 created demands for recalibrations to the present global intellectual property regime that have only grown more urgent as we enter the second decade of the 21st century. these demands are made in the context of an international legal and diplomatic environment that has itself changed in response to the economic and technological developments of the new century. such changes do not prevent the development of new strategies for enforcing intellectual property rights or alterations to present models to provide adequate protection for new types of innovation or breathing space for the development and regulation of social networks. but they make the realization of the necessary changes to accomplish these goals more difficult to achieve on a multilateral basis. 2 see kenneth pomeranz & steven topik, the world that trade created: society, culture and the world economy. 1400 to the present (2nd ed. m.e. sharpe 2006); doris estelle long, ‘globalization: a future trend or a satisfying mirage’ (2001) 49 j.copyright society 313. 3 although the major initiators of such free trade agreements were the european union, and the united states, other countries including china and australia also negotiated plurilateral trade agreements with other countries. 4 see european union directive on copyright in the information society, directive 2001/29/ec; wipo copyright treaty; wipo performances and phonograms treaty. 5 the author has described this leveling affect previously in long (2001) at 325-326. 6 among the types of new protection modalities are those to protect indigenous innovation, including traditional knowledge, reconfigured mechanisms to allow freer access to intellectual property protected goods and services, particularly in connection with copyrighted works, pharmaceuticals and green technologies, and greater flexibilities to encourage technology transfers to meet consumer needs and encourage sustainable economic development. nordic journal of commercial law issue 2012#2 2 out of the experimentation that is the necessary result of the present multilateral phase i refer to as “dís·integration”7 will arise new normative modalities for protection, access and enforcement of intellectual property rights reflecting the norms of “deviant globalization.” based on the teachings of the so-called “informal market,” and its fundamental principles, “deviant globalization” provides the opportunity to bring the social norms of the unregulated marketplace more firmly into international harmonization standards. ultimately, the inclusion of this new normative foundation will lead to domestic and international regimes that provide a more balanced relationship between intellectual property protection, social justice and sustainable development. but to reach these new “standards,” we will first have to pass through an era of unprecedented domestic and regional experimentation where models may vary. but those that survive will reshape intellectual property rights for the 21st century. 1.1 from integratory processes to dís·integratory experimentation the official closing of the negotiations for the anti-counterfeiting trade agreement (acta) in 2011 signaled the end of an era of unparalleled multilateral harmonization. the forces of integration, measured generally from the beginning of the uruguay rounds in 1986 that established the agreement on trade related aspects of intellectual property rights (trips) to the final negotiating rounds of acta in 2011, combined trade, intellectual property and multinational governance into powerful tools for harmonization.8 definitional boundaries for patents,9 trademarks,10 geographic indications11 and industrial designs12 were delineated under trips while enforcement procedures were strengthened;13 substantive treaties regarding the protection of copyright and related rights on the internet were established;14 and multilateral 7 i use the accented term “dís·integration” to place the emphasis on the “dis” prefix to the critical “integration” term. unlike the more common term “dis·ín·tegration, the previous multilateral activities of the integratory periods have not disappeared (or disintegrated), but they have become less prevalent. thus, even in stages of dís·integration, integration is still possible, although perhaps more difficult to achieve. 8 see long (2001) at 324 325; peter yu, ‘acta and its complex politics’ (2011) 3 wipo journal 1, 10 (juxtaposing acta’s non-multilateral approach with prior bilateral, plurilateral and regional trade and investment agreements and warning “if acta represents the future of the international norm-setting process…the world will likely go through a long period of non-multilateralism.”); doris estelle long, ‘the dís·integratory impact of acta on intellectual property governance structures’ (2012)(working draft on file with author)(describing the alternate processes of integration and dís·integration in the history of international intellectual property harmonization). 9 trips, arts. 27, 28 (definition of patentable invention and description of minimum rights, respectively). 10 trips, arts. 15, 16 (definition of trademark and description of minimum rights, respectively). 11 trips, arts. 22, 23 (definition of geographic indications and particularized treatment for wines and spirits, respectively). 12 trips, art. 25 (definition of industrial designs). 13 trips, arts. 41 – 61 (imposing treaty obligations to provide “effective enforcement” through civil, border and criminal measures with potential trade sanctions for failure to meet such obligations). 14 wipo copyright treaty (providing the exclusive right to authors to make a work “available” on the internet); wipo performances and phonograms treaty (providing similar rights to performers and phonogram producers). nordic journal of commercial law issue 2012#2 3 treaties streamlining application obligations and procedures for patents and trademarks were created.15 on a regional level, the integratory forces of multilateralism were most obvious in the increasing size of the european union (eu), and the number of directives and regulations aimed at intellectual property standards it adopted.16 even the treatment of domain names containing unauthorized third party trademarks was the subject of multilateral activity, albeit in the form of an agreed-upon private contractual remedy -the uniform dispute resolution policy adopted by the internet corporation for assigned names and numbers (icann).17 history demonstrates that such integratory multilateralism, however, is not monolithic. during the immediately prior period of integration, there were also instances of regionalism and dís·integration.18 furthermore, integration itself is cyclical. there have been other periods of intense international cooperation followed by a retreat to respective “corners” until the next round of integratory multilateral activity arises again.19 the current dís·integratory phase of multilateralism, however, has been propelled by forces that have never before been so prevalent in domestic and international standard-making processes.20 in addition to the geographic 15 see, e.g., the patent law treaty (establishing multilateral standards for patent application obligations), and the trademark law treaty and the singapore treaty on the law of trademarks (the same for trademarks). 16 these directives and regulations ultimately covered almost every aspect of the intellectual property sphere. from biotechnology-based patents to copyright in the digital age, from community trademarks to enforcement. for a complete list of present intellectual-property centered directives and regulations of the european union, see http://ec.europa.eu/internal_market/copyright/acquis/index_en.htm). 17 see generally www.icann.org/udrp. under the uniform dispute resolution process (udrp), registrants agree to obligate individual domain name registrants for certain generic top level domains (gtlds) to submit cybersquatting disputes to electronic arbitration with specified institutions including the wipo arbitration center. 18 examples of such dís·integratory forces include the development of regional instruments for intellectual property protection including european union directives and andean community decisions. see long (2001) at 329 – 334; dr. rafael leal-arcas, ‘proliferation of regional trade agreements: complementing or supplanting multilateralism?’ (2011) 11 chicago j. international l. 598 ( analyzing the impact of the proliferation of regional trade agreements on the multilateralism of the world trade organization); susan sell, ‘intellectual property and public policy in historical perspective: contestation and settlement,’ (2004) 38 loy. la l. rev. 267 (discussing the repeated processes of contest and settlement in the development of international standards in intellectual property ) but cf. ruth okediji, ‘back to bilateralism? pendulum swings in international intellectual property protection,’ (2003-2004) 1 u. ottawa l. & tech. j. 125 (contending that bilateral and plurilateral agreements are the dominant forms for multinational norm making). 19 among the most notable instances in the 20th century of this cycle of dís·integration may be the developments leading up to the negotiation of the trips agreement, see monique cordray, ‘gatt v. wipo’ (1994) 76 j. pat. & trademark off. soc’y 121, and the universal copyright convention, see silke von lewinski, international copyright law and policy (oxford university press 2008) 4.33 – 4.48; hamish r. sandison, ‘the berne convention and the universal copyright convention: the american experience’ (1986-1987) 11 colum.-vla j.l. & arts 89. 20 see doris estelle long, ‘exposing the processes of empire in the international protection of intellectual property’ in ip in context: law and society perspectives on intellectual property (cambridge u. press 2012)(describing the historical processes that created the foundational international intellectual property conventions of the 19th century)(forthcoming). http://ec.europa.eu/internal_market/copyright/acquis/index_en.htm http://www.icann.org/udrp nordic journal of commercial law issue 2012#2 4 regionalism and glocalization that economic globalization has engendered,21 new dís·integratory forces, including the waning of the westphalian model for sovereign power,22 the emerging power of civil society,23 and the role of digital communications in empowering previously unempowered actors at the domestic and international level,24 have altered the processes for international standard setting in ways that are still evolving.25 what is most unique about this upcoming phase of dís·integration is that it has not been triggered solely by the withdrawal of developed countries from existing institutional structures. nor has it been triggered by countries seeking higher protectionist standards. to the contrary, with the greater communicative abilities of the internet and other digital mobilizing media, and the larger array of civil society organizations seeking reduced intellectual property protection to promote greater access to information and sustainable development, the present dís·integration cycle has been equally driven by the developing world’s search for innovation strategies for emerging 21 see benjamin barber, jihad v. mcworld: how globalism and tribalism are reshaping the world (ballatine 1996)(describing the conflicting trends of globalization and regional alienation); thomas freidman, lexus and the olive tree (harper collins 1999)(same). these seeds of dís·integration, however, have been present almost since the earliest stages of the present era of globalization. see long (2001) at 335 – 340. 22 see joseph a. camilleri & jim falk, the end of sovereignty? the politics of a shrinking and fragmented world (edward elgar 1992)(analyzing the evolving interactions between nation states, regional ethnicities and transnational actors in shaping the world political system); joseph s. nye, jr., soft power: the means to success in world politics (public affairs 2004)(exploring the impact of “soft power” in shaping world politics, including the soft power exercised by such non-governmental actors as multinational corporations); anne-marie slaughter, a new world order (princeton university press 2005)(exploring the impact of “government networks” and supranational organizations in the present global political order); long (2001) at 328 (“whether the erosion of sovereign power is the result of a transfer to sub-state entities on the basis of regional, ethnic or other divisions, or the result of a reconstitution of state entities into new “transgovernmental” orders, nation states no longer have the same power they exercised in the pre-globalized world.”). but see daniel drezner, all politics is global: explaining international regulatory regimes (princeton university press 2007)(contending that nation states still dominate international regulatory efforts). 23 see rodney hall & thomas biersteker (eds), the emergence of private authority in global governance (cambridge university press 2003)(examining the erosion of power of nation states and the emergence of diverse multinational actors, including ngos); anna spain, ‘who’s going to copenhagen?: the rise of civil society in international treaty-making’ (2009) 14 asil insights 25 (detailing the rise of civil society participation in international treaty making). one clear indication of the power of such civil societies is the number of ngos accredited as observers at wipo proceedings. for the 1996 diplomatic conference that led to the adoption of the wipo copyright treaty no official accreditation of ngos was made, although some delegations included “advisors” that were members of ngos. for the beijing audio visual treaty in june 2012, nine ngos were accredited as observers. 24 see joseph s. nye, jr., power in the global information age: from realism to globalization (routledge 2004)(describing how the internet has spread power to smaller, less structurally organized actors internationally than previously); yochai benkler, the wealth of networks: how social production transforms markets and freedom (yale university press 2006)(describing the weakening of path dependency and future empowerment of various actors through the development of the internet). 25 thanks to peter yu for suggesting a tri-partite division for such dís·integratory forces in the form of regionalism, rejection of westphalian models and institutional governance. in addition to these forces, i believe that another force for dís·integration has come into significant prominence–digital communications with its ability both to enhance and to narrow international avenues of communications. see cass r. sunstein, republic.com (princeton university press 2002)(warning that cyberspace threatens the exchange of information by allowing like-minded individuals to speak only to one another). nordic journal of commercial law issue 2012#2 5 economies and models of protection that promote sustainable development and innovation.26 “dís·integration” does not mean that multilateral cooperation will cease. to the contrary, the recent creation of the beijing audio-visual performances treaty in june 2012 (bavt) demonstrates that older institutions may still serve as a focus for multinational standard-making processes. but a closer study of the bavt demonstrates a lack of the potential leveling effect on international standards of earlier multilateral efforts, such as trips and the wipo copyright treaty (wct).27 in this period of increasing dís·integration, a multiplicity of forums have arisen to take the place of earlier traditional institutions.28 these multiple forums provide the necessary “laboratories” for experimentation that will form the critical next step in multilateral harmonization processes. this experimentation, however, may be hampered by the initial absence of institutional structures to accommodate, or even encourage, cross-forum communication. this absence is only heightened by the dís·integratory impact of the internet where like-minded entities talk only to each other and rhetorical excesses multiply.29 this limited communication combined with a lack of transparency that remains the shuddering norm for certain multinational standard setting efforts – including most recently acta and the trans-pacific partnership (tpp) -may well prolong the present period of dís·integration. but if such communication difficulties are the downside of dís·integration, the concomitant rise in experimentation is the upside. because out of the experimentation that is the necessary 26 see lawrence helfer, ‘regime shifting: the trips agreement and new dynamics of international intellectual property lawmaking’ (2004) 29 yale j. international l.1 (describing the movement to alternative forums to secure alternative models of protection under human rights, biodiversity and public health regimes); joyeeta gupta, ‘global sustainable development governance: institutional challenges from a theoretical perspective,’ (2002) in international environmental agreements: politics, law and economics 361 – 388 (kluwer academic publishers)(identifying multiple pathways as the most effective method for achieving global sustainable development). 27 compare beijing audio visual performances treaty, art. 11(3) (right to equitable remuneration for broadcasting and communication to the public subject to domestic law, including determination to reject such rights in toto) & art. 18 (reservation allowed to article 11(3) broadcast and public communication obligations) with wipo performances and phonograms treaty, art. 15(3) (domestic rejection limited to equitable remuneration for broadcast and communication rights) & article 21 (reservation limited to equitable remuneration rights under article 15(3)). for a brief examination of the critical role that harmonized standards play in leveling global ip protection, see doris estelle long, ‘“democratizing” globalization: practicing the policies of cultural inclusion,’ (2002) 10 cardozo j. of int’l & comp. l 217. 28 these include both regional associations such as asean who are increasingly addressing intellectual property issues, civil society organizations, such as the electronic frontier foundation, and new forums established to deal with development and intellectual property including the world summit on the information society. 29 see sunstein (2002)(describing the threat to free speech as a result of the ability to reduce discussions on the internet to those among like minded individuals); pamela samuelson, ‘the copyright principles project: directions for reform’ (2010) 25 berkeley technology l.j. 1175, 1179 (“too much discourse about copyright law in the past fifteen years has been burdened by rhetorical excesses and an unwillingness to engage in rational discourse with those having different perspectives.”). but cf peter yu, ‘trips and its achilles’ heel’ (2011) 18 j. of intellectual property l. 479, 530. ( “[i]f less developed countries want to drive the discussions on international intellectual property enforcement norms, they need to frame the public debate better.” (footnote omitted).). nordic journal of commercial law issue 2012#2 6 result of dís·integration will arise the next critical stage in the development of rational intellectual property protection standards for the 21st century—“deviant globalization.” 2 “deviance” as the new intellectual property norm in deviant globalization: black market economy in the 21st century,30 nils gilman, jesse goldhammer and steven weber describe “deviant globalization” as the underground corollary or “underside”31 of globalization. they use the term to refer to markets which “satisfy demand for goods and services that are otherwise illegal or unavailable in the formal, licit economy.”32 included among the types of goods and services examined by gilman et al are the global sex trade, the market for human organs, hazardous waste, arms trafficking, terrorist funding, and the “global hacker service economy.”33 interestingly, gilman et al do not directly examine one of the most infamous examples of “deviant globalization” under their definition – the trade in counterfeit and pirated goods and services, including the rise of rogue websites on the internet that specialize in such goods and services.34 despite this limitation, gilman et al’s description of the fundamental benefits of deviant globalization provide a useful normative background for future intellectual property standards. the “dynamic process of creative destruction”35 that deviant globalization harnesses; its ability to “chang[e] the landscape and distribution of power in the world economy” by altering concepts of “what is do-able in economic life”36 and to materially improve the economic well-being “of hundreds of millions of people;”37 make it a useful paradigm for incorporating social justice considerations more clearly into intellectual property norms. in fact, deviant globalization is “a powerful engine of wealth creation 30 nils gilman, jesse goldhammer & steven weber, deviant globalization: black market economy in the 21st century (continuum international publishing group 2011) 31 gilman (2011) at 1. 32 gilman (2011) at 3. they go on to define “deviant globalization” as “the ultimate arbitrage activity, growing at the intersection of ethical difference and regulatory inefficiency. wherever there is a fundamental disagreement about what is right as well as a connection to the global market, deviant entrepreneurs are there to meet the unfulfilled demands.” gilman (2011) at 3. see also moisés naím, illicit: how smugglers, traffickers, and copycats are hijacking the global economy (doubleday 2005) at 226 (describing “illicit trade networks” whose “clear goal” is “profit by breaking laws.”). 33 see scott berinato, ‘inside the global hacker service economy’ (2011) in gilman (2011) at 215 – 232. 34 digital music report 2012: expanding choice. going global. (2012)(available at http://www.ifpi.org/content/library/dmr2012.pdf)(describing the scope of global digital piracy including peer-topeer networks, blogs, cyberlockers, forums, websites, streaming sites, smartphone-based applications and stream ripping applications and estimating that “one in four… of internet users access unauthorized services on a monthly basis”) 16. 35 gilman (2011) at 2-3. 36 gilman (2011) at 5. 37 gilman (2011) at 5. http://www.ifpi.org/content/library/dmr2012.pdf)(describing nordic journal of commercial law issue 2012#2 7 ...[p]articipating in deviant globalization is often an individual’s fastest ticket out of poverty and a way for an entire community to experience economic development.”38 the potential positive economic and developmental effects of deviant globalization do not exist in a vacuum. for every instance of an individual surviving by virtue of hard work and creative efforts in the informal market of deviant globalization, there are also those who are in virtual slavery to the organizations that control counterfeit distribution markets in which street vendors earn a subsistence wage, at best. in a five year observation of the pirate market in florence, italy, i have discovered that, while deviant globalization may provide economic benefits to some, it also presents serious human rights challenges when pirate markets are tied to immigration issues. additional risks posed by the informal economy include: 1) the lack of a formal social security network with the result that inability to work due to health or other reasons translates into even greater poverty; 2) abuses of the workers at the lowest rung who are part of a process that includes undeniable human rights abuses;39 3) a strong undercurrent of violence in connection with certain organizational structures;40 and 4) enhanced financial support for organized crime and paramilitary operations since the ultimate purposes of the monies raised through this alternative economy can include funding of such operations.41 yet focusing solely on the “abusive” or “immoral” aspects of this “underground” economy ignores broad aspects of it whose illegality arises simply because it does not conform strictly to legal 38 gilman (2011) at 3-4. gilman et al also acknowledge the “dark side” of deviant globalization on the poor, recognizing that it is also “a symbol of their exclusion and abjection” because deviant globalization not only often entails harrowing individual suffering, but it can also provide money and power to self-dealing government officials, brutal warlords and fanatical terrorists.” gilman (2011) at 4. see also oecd, the economic impact of counterfeiting and piracy (2008). see generally willem van schendel & itty abraham, illicit flows and criminal things: states, borders and the other side of globalization (indiana university press 2005)(describing the distinctions between criminal syndicates and other illicit flows of goods and services globally). 39these abuses do not only occur in cases of human organ or sex trafficking, but are also apparent in the treatment of street sellers of counterfeit goods, particularly where such distributors have other legal issues connected to their status, such as immigration status. 40 see naím (2005)(describing the violence that often accompanies smuggling and human trafficking enterprises); tim phillips, knockoff: the deadly trade in counterfeit goods (kogan page 2007)(describing the use of violence to maintain counterfeit networks). 41 see ronald k. noble, testimony before the us house committee on international relations, ‘the links between intellectual property crime and terrorist financing,’ 108th congress (july 16, 2003)(describing a developing trend of paramilitary organizations to use intellectual piracy as a preferred form of fundraising); doris estelle long, ‘strategies for securing the cyber safety net against terrorists: a multi-disciplinary approach’ (2009) in terrorism and global insecurity: a multidisciplinary perspective (ed. klint alexander. linton atlantic books, ltd.)(exploring the burgeoning role that cyberspace plays in supporting funding activities to support diverse paramilitary and terrorists groups); gregory f. treverton, carl matthies, karla j. cunningham, jeremiah goulka, greg ridgeway, anny wong, film piracy, organized crime and terrorism (rand 2009)(describing the links between film piracy as a funding source for terrorist groups). but cf joe karaganis, ‘rethinking piracy’ (2011) in media piracy in emerging economies (social science research council)(identifying lack of price competition as the key factor in the rise of media piracy). nordic journal of commercial law issue 2012#2 8 regulatory obligations, such as obtaining marketing permits or paying taxes.42 such “illegality” is not the same as the “moral deviance” of engaging in sex, arms or even human organ trafficking that underlies gilman et al’s analysis. although some aspects of deviant globalization undeniably fit within these categories, the informal market, as a whole, is not necessarily criminal or even unsavory in nature. consequently, i have used the term “deviant globalization” in this article to refer to a broader underground (or informal) globalization. this globalization is “deviant,” not in the sense of moral deviancy, or criminality. instead, it is “deviant” because this globalized market deviates in significant ways from the globalization that has been the focus of scholars, economists and popular writers for the past several decades.43 these “traditional globalization studies have largely focused on the impact of the regulated, lawful market.44 (the sole exception may be the treatment of the informal economy that has developed as part of the e-commerce explosion on the internet.) the term “deviant globalization” not only acknowledges that an unregulated, informal, underground, black market has existed for as long as the regulated one,45 it acknowledges that this “alternative” market, in all its hard goods and digital forms, is worthy of serious study. more to the point, the term “deviant globalization” acknowledges that these nontraditional, under-regulated markets provide normative values that can be used to shape the outcome of a wide-range of present debates over intellectual property rights in the 21st century in ways that harness the “creative destructive” power of deviant globalization to create more socially just regimes. these regimes assure balanced protection for intellectual property owners and those who seek access to the goods and services protected by such rights by placing the norms of the underground economy at the heart of the regime. “deviant globalization” in the intellectual property arena, as i define it, serves both a predictive and a normative function. it serves a predictive function because it incorporates the 42 see van schendel (2005) at 4 (“many transnational movements of people, commodities and ideas are illegal because they defy the norms and rules of formal political authority, but they are quite acceptable, “licit,” in the eyes of participants in these transactions and flows.”). 43 see also ryan matthews & watts wacker, the deviant’s advantage: how fringe ideas create mass markets (crown business 2002) at xvi (“by definition, everything that is different is deviant. of course there is a positive and negative deviance – the former a force for transformation the latter a source of unspeakable evil.”). 44 although there are innumerable studies by economists and others of the impact of globalization, among the most noteworthy works in the area, all of which focused on the regulated marketplace are david held, anthony mcgrew, david goldblatt & jonathan perraton, global transformations: politics, economics and culture (blackwell publishers ltd. 2000); joseph e. stiglitz, globalization and its discontents (ww norton 2002); a.g. hopkins, globalization in world history (w.w.norton and company 2002). even historians of global trade focused primarily on regulated cross-border trade through the ages. see kenneth pomeranz & steven topik, the world that trade created: society, culture and the world economy. 1400 to the present (2nd ed. m.e. sharpe 2006). 45 in fact, there is some indication that in recent years this underground, informal economy may actually have grown larger than the traditional global marketplace. robert neuwirth, stealth of nations: the rise of the informal economy (pantheon books 2011) at 18 – 19, 26 – 28; naím (2005) at 4-5. some economists have claimed that the informal economy actually pre-dates the regulated formal economy we associate with globalization. see neuwirth (2011) at 24. nordic journal of commercial law issue 2012#2 9 experimental standards we are already witnessing in domestic and international effort to reinvent intellectual property standards for the 21st century. it serves a normative function because it creates a new normative standard that incorporates social and economic norms from the informal market into formal normative values against which decisions regarding intellectual property standards can be evaluated and revised. 2.1 a brief primer on deviant globalization similar to the traditional hard goods market, no single instance of deviant globalization operates in precisely the same way; but every informal market shares certain characteristics that make deviant globalization a valuable source for intellectual property norms. from the markets operated by the inhabitants of the favelas of brazil, to the garbage pickers of lagos; from the sellers of counterfeit purses in italy, to the bazaars of the middle east, these informal markets fulfill consumer needs unmet by the regulated marketplace. although some of these needs may well be for illicit goods and services, others are filled by goods the government is unable or unwilling to provide. thus, for example, in the underground market described by neuwirth in stealth of nations46 are the individuals who sell legitimate products at discounted wholesale prices in the early morning markets, street vendors of legitimate, but cheaply priced, tourist souvenirs, and those who provide food and beverages to such vendors out of the back of trucks and food carts. all of these vendors share common traits of selling goods below the prices of traditional brick and mortar sellers because they do not have to maintain permanent housings or pay taxes on their business earnings. some of these sellers earn significant incomes that allow them to expand their businesses. all of them are earning monies that would not be available through the regulated market.47 similarly, garbage pickers in various countries locate recyclable materials and create an unregulated supply network for these goods that not only has potential environmental benefits,48 but also provide income to those at the lowest economic rungs of society. 46 neuwirth (2011) at 1-16. see also oecd, competition policy and the informal economy (2009)(describing various ways in which the informal economy interacts with the formal economy, including as an alternative outlet for product of the formal sector). 47 neuwirth (2011)(describing diverse markets where the participants in the informal economy earn monies otherwise unavailable to them); naím (2005) ) at 109-130 (describing the incomes earned through trade in counterfeit and pirated goods). but see oecd (2009) at 3335 (contending that despite its size in developing countries the informal economy harms competition because informal firms are less productive and unable to achieve economies of scale). 48 the environmental benefits secured by these untapped avenues for recycling and other forms of green technology must, of course, be contrasted with environmentally dangerous informal markets in toxic waste exports and computer waste. see jennifer clapp, ‘toxic exports: despite global treaty, hazardous waste trade continues’ (2011) in gilman (2011); naím (2005) at 167 – 169. nordic journal of commercial law issue 2012#2 10 these unregulated efforts highlight a critical element of deviant globalization – its innovative nature. such innovation is amply demonstrated by the development of new technological models for distributing content on the informal markets of the internet. from the early file trading software of napster, to websites such as thepiratebay that provide global digital access to streaming content, the unregulated economy of the internet has been a hallmark of distributive innovation. distributive innovation, however, is not limited to the technologically proficient. to the contrary, deviant globalization encourages innovation at all levels of the socio-economic strata. among the oil workers in lagos, nigeria, for example, there was an unfulfilled need for inexpensive, but safe, drinking water. individuals began selling water in plastic bags to meet this need. this new business has proven so successful some sellers have even developed names and symbols to mark their water as reliable.49 2.2 the “norms” of deviant globalization with its emphasis on trade and innovation across socio-economic levels and its focus on unmet consumer demands, deviant globalization based models would bring new understandings of the relationship between compensation, access, and distributional innovation in present intellectual property debates. these new understandings would bring social norming principles in a more direct manner into the creation of formally recognized intellectual property norms. 50 although every informal market is different, there are four over-arching operational principles of deviant globalization that are most useful in recalibrating present intellectual property norms. they are: 1. fair compensation fuels the market; 2. consumers matter; 3. innovative business models deserve adequate breathing space to flourish; and 4. markets necessarily require regulation. as discussed more fully below, each of these has potentially wide application in the creation of new experimental models for intellectual property rights protection during this present dís·integratory phase of multilateral standard-making. 49 neuwirth (2011) at 42-43. 50 see steven a. hetcher, norms in a wired world (cambridge university press 2007)(analyzing the various roles of norms, including social norms, in setting conduct rule on the internet); ned snow, ‘copytraps’ (2009) 84 indiana l.j. 285 (advocating for revisions to us copyright law that more accurately reflect the social norms of end users). nordic journal of commercial law issue 2012#2 11 2.3 fair compensation fuels the market fair compensation is the bedrock goal of a functioning informal market. the foundational principle of deviant globalization is filling market demand through fair prices for desired goods and services. the underground market is uniquely sensitive to competitive demands. yet at the heart of the informal economy is compensation – or more specifically the financial and other rewards available for providing desired goods and services. any effort to redefine distributional rights for intellectual property, including terms of access and use, must begin by addressing the question of compensation – who, when, where and for what activities. placing compensation at the center of normative considerations does not obligate that all uses of intellectual property require monetary rewards. but it does require a principled examination of the impact of any exceptions or limitations on such rewards, as well as the adverse impact on the market if more than monetary compensation is required. if the goal of deviant globalization is to fill market demand, than eliminating the availability of a demanded product is less desirable than assuring reasonable compensation to the ip owner, so long as that product is not potentially harmful to the public. the norms derived from deviant globalization suggest that present compensation boundaries must be recalibrated to support a fair return for the use of intellectual property based goods and services. such fairness may well require an alteration in methods for licensing intellectual property rights globally, including reconsideration of exhaustion and remedial relief. the most obvious applications of the fair compensation principle arises in the context of intellectual property licensing, including compulsory licenses on reasonable terms. yet the compensation principle actually alters the shape of the debate over access rights. by placing the initial focus on fair compensation, deviant globalization changes the issue from one about compensated access to one about the nature of a rational compensation system. thus, for example, debates over p2p file trading or methods for dealing with so-called “rogue websites” such as the pirate bay, change from demands for greater enforcement51 to new methods that follow the money trail to rebalance the economic harms of piracy.52 the elimination of consumer access to websites is replaced as the focus of enforcement efforts.53 instead, as discussed in greater detail below, advertisers and website operators who earn money from the illegal activity become the focus, with monetary relief for the copyright owner as the basis for remediation. 51 see anti-counterfeiting trade agreement; stop online piracy act (sopa), h.r. 3261, 112th cong., 1st sess. (october 26, 2011. 52 see online protection and enforcement of digital trade act (open act), h.r. 3782, 112 th cong., 2d sess. (january 18, 2012). 53 see 17 usc § 512(c) (providing for removal of end user access to internet service providers as a remedy for unauthorized posting of copyrighted content). nordic journal of commercial law issue 2012#2 12 alternatively, future deviant globalization models may well create new licensing models to deal with the problems of p2p file trading or the use of trademarks as keyword buys.54 although initial attempts to treat p2p file trading as a form of communication to the public for which license fees were owed initially failed in the united states,55 new models may be less restrictive in their efforts to rebalance access with compensation. radio stations and other broadcast entities currently pay composers and performers for their broadcast/public performance of copyrighted music.56 similar payment obligations could readily be imposed for websites earning money from hosting copyrighted content. more radically, fair use and compulsory licensing systems may be imposed to allow broader uses of trademarks for non-source designating purposes -the “information asset” nature of a mark.57 briefly, the term “information asset” refers to the “informational values” of a mark unrelated to consumer product information (the traditional search-designating function of trademarks most closely associated with the concept of “goodwill.”).58 such informational value may develop from the same types of investments and uses that give rise to the source-designating function protected under traditional trademark-rights analysis. but the information content that is valued is not directly related to individual purchaser decision making. to the contrary, similar to copyrighted works, these information-asset marks have value due to their expressive or emotive content.59 because this informational value of a mark is the creature of investment, 54 see google adwords at https://adwords.google.com. any such licensing scheme would necessarily have to overcome potential limitations including the general prohibition against the compulsory licensing of marks. doris estelle long, ‘rebooting trademarks for the 21st century’ (2011) 49 u. louisville l. rev. 517 (suggesting that such limitations might be dealt with by recognizing a new type of trademark – the information asset mark – which lacks a source designation function). 55 see united states of america v. american society of composers, authors and publishers (ascap), 627 f.3d 64 ( 2nd cir. 2010). 56 see generally wipo performances and phonograms treaty, art. 11 ; beijing audio visual performances treaty, art. 15. 57 long (2011) at 523. 58 long (2011) at 541543. 552553. 59 long (2011) at 541 – 542. https://adwords.google.com/ nordic journal of commercial law issue 2012#2 13 third party uses of such “information assets” may warrant compensation.60 they may also be subject to compulsory licenses or even fair use/fair dealing style exceptions.61 conceivably the most direct impact the adoption of deviant globalization models may have is on the issue of remedial rights for intellectual property violations. injunctive relief that prevents access is already being replaced by judicially mandated compulsory licenses in certain situations.62 denials of injunctive relief are becoming increasingly prevalent where there is evidence of consumer harm if the injunction issues.63 such denials should increase under new deviant globalization models. considering the issue of fair prices and fair trade, deviant globalization models may create a one-item-one-payment system that supports international exhaustion for certain intellectual property based goods. limitations on such exhaustion would be premised primarily on the harm to the consumer. thus, copyrighted goods would generally be subject to exhaustion. by contrast, trademarked goods might be excluded from such exhaustion, at least in instances where the same mark represents different consumer meanings or different goodwill.64 deviant globalization will provide critical guidance on the question of intellectual property and “fair trade,” particularly in connection with the issue of access to medicines and critical technologies at reasonable prices. the recent decision by the controller of india's patent office in granting natco pharma ltd. a compulsory license to sell sorafenib, the generic version of the german-based bayer ag's (bayer) patented kidney and lung cancer drug nexavar, 60 long (2011) at 550. 61since the closest analogue to the information-asset mark is a digital copyrighted work, digital licensing models for such works, including for example, the present sound exchange performing rights and creative commons licensing schemes, could serve as beneficial models. sound exchange is a performing rights organization that collects and distributes digital performance rights royalties in the united states. creative commons is a nonprofit organization that offers several types of model licenses to permit the uncompensated licensing of copyrighted materials. long (2011) at 548-552. see generally about the licenses, creative commons, http://creativecommons.org/licenses; katie pimentel, “trademark use as keywords: a comparative look at trademark use as keywords in paid search and digital public performance rights for sound recordings’ (2010) 9 j. marshall rev. intell. prop. l. 553, 573 (suggesting a compensation model under which keyword buys are compensated similar to digital copyrights). 62 ebay inc. v. mercexchange llc, 547 us 388 (2006). although many countries do not presently allow judges to deviate from statutory remedies, as such remedial actions are modified in the face of deviant globalization norms, judges would be given the right to deny injunctive relief in certain cases where such denial serves distributional innovation goals. 63ebay, 547 us 388. cf. scarlet extended sa v. société belge des auteurs, compositeurs et éditeurs scrl (sabam), case c70/10 [2012] e.c.d.r. 4 (ecj (3rd chamber))(injunction denied in connection with unauthorized peer-to-peer file trading). 64 because of the unique nature of patents, that only exist in the event of a domestic grant, international exhaustion is arguably less applicable. but cf 35 us §§271(f)(imposing liability for the supply of “any component of a patented invention” combined outside the united states “in a manner that would infringe the patent if such combination occurred within the united states) & 271(g)(imposing liability for the importation of a product “made by a process patented in the united states”). http://creativecommons.org/licenses nordic journal of commercial law issue 2012#2 14 reflects the increasing concern about the cost of patent protected medicines.65 in support of his decision to grant a compulsory license to a local manufacturer, the controller cited the high prices bayer charged for the drug, (us$5,600 per month as opposed to natco’s claimed $177 per month), the small amounts of the product bayer had imported to meet domestic needs, and bayer’s failure to manufacture the drug in india. under indian law, a compulsory license can be granted if the patent owner fails to make the drug available “on reasonable terms.”66 according to the controller, these terms are not met “[i]f the drug is so highly priced that the ordinary public cannot afford it.”67 in establishing lack of affordability, the controller relied on the limited amount of the drug bayer sold in light of anticipated need: “it stands to common logic that a patented article … was not bought by the public due to only one reason, i.e., its price was not reasonably affordable to them.”68 ultimately, the controller granted natco a non-exclusive license to manufacture and sell the drug in india for $177 per month in exchange for a 6% royalty. what is most notable about this decision is the controller’s grudging recognition that the fairness of the price charged was not solely a matter of price comparison between the generic manufacturer and the patent holder who had incurred substantial research and development costs. although the controller held that a “reasonably affordable price has to be construed predominantly with reference to the public,”69 the term “predominant” is significant. it represents a partial acceptance of bayer’s argument that reasonableness must be judged at least in part with consideration of an inventor’s right to recoup its investment. ultimately, the royalty the controller established reflected this recoupment principle.70 considerations of consumers needs, balanced with consideration of the inventor’s need to recover costs of innovation and testing, which second comers never incur, reflects the beginning stages of a deviant globalization model. by combining the foundational principles of reasonable compensation for intellectual property owners with fair trade norms this case presages the benefits and future paths deviant globalization provides in configuring a rational balance between compensation and access. in determining the reasonableness of a particular price or royalty rate, however, given the increasing emphasis on global trade, determinations of the adequacy of the return on investment under deviant globalization principles will most likely consider the global sales history for the product. this expanded treatment of global sales data 65 in the matter of natco pharma ltd and bayer corporation, application for compulsory license under section 84(1) of the patents act, 1970, in respect of patent no. 215758 (controller of patents, mumbai)(march 9, 2012). 66 natco, india at 15. 67 natco, india at 16. 68 natco, india at 36. 69 natco, india at 36 70 natco, india at 59. section 90 of the relevant indian law required the controller to consider “the expenditure incurred by the patentee in making the invention, the expenditure incurred by the patentee in making the invention or in developing it and obtaining a patent and keeping it in force” as well as “other relevant factors.” section 90(1) of the indian patents amendment act of 2002. lack of evidence from bayer regarding actual development costs prevented the controller from reaching a more accurate determination of the amount of recoupment required. nordic journal of commercial law issue 2012#2 15 underscores the significance differential pricing should play in future compensation determinations under future deviant globalization models.71 2.4 consumers matter. for markets to flourish, consumers must have trust in the goods they buy. no one knowingly buys a counterfeit drug with the expectation that it will not work. goods and services which physically harm people are not part of an effectively working marketplace. while you can buy novelty items as part of the informal market that break after a few uses,72 sellers of day-to-day items generally do not sell defective goods if they are seeking repeat business. thus, the woman who sells food to the workers in the informal market in sao paolo does not knowingly sell them contaminated food. similarly, sellers of pirated videos in the indoor markets of lima, do not sell defective dvds.73 because consumers need to be protected, enforcement of intellectual property rights under deviant globalization models will increasingly be tiered to focus initially on methods for dealing effectively with the unauthorized manufacture and distribution of physically harmful goods, then on economically harmful ones. for developing countries, limited budgets necessarily give rise to variable enforcement modalities. this present reality under deviant globalization models will be acknowledged as a permissible (legal) choice. issues of “effective enforcement” under trips74 and other multinational instruments,75 will place consumer health and safety issues as a baseline against which the effectiveness of enforcement efforts may be judged. countries that focus primarily on the eradication of physically harmful goods in the initial stages of enforcement capacity building will not be distracted by potential threats of wto sanctions for ineffective enforcement activities. for developing and least developed countries with limited enforcement budgets, deviant globalization supports public enforcement efforts, including enhanced 71 such differential pricing models will need to be supported by recalibrations of obligations by customs and other authorities for controlling the diversion of such differentially-priced goods away from the consumers in the countries for which they were distributed. 72 tourist goods are notoriously unreliable given the transitory nature of the consuming public. i have witnessed countless sales of outdated, damaged or used goods to unwitting tourists. for example, in venice, italy, i watched tourists pay full price for fake rubberized tomatoes that splat into squishy blobs when thrown on the pavement. tourists would buy tomatoes which failed to splat after two or three throws because the seller has used them as the “demonstration” version he’d been using to secure sales. of course, by the time the buyer discovered the shoddy workmanship, the vendor had already moved on. 73 by contrast, based on my personal experiences, the quality of other items sold in the market, which fell outside local dvd labeling requirements, including non-prescription medicine, were more questionable. 74 trips, art. 41 (imposing an obligation on member countries to provide “effective enforcement” of intellectual property rights). 75 see acta, art. 6.1 (requiring “enforcement procedures … to permit effective action against any act of infringement of intellectual property rights”). cf. wipo copyright treaty, art. 11 (requiring “effective legal remedies against the circumvention of effective technological measures”). nordic journal of commercial law issue 2012#2 16 penalties, that are first directed to removing potentially harmful goods from the marketplace. under deviant globalization models, such “harm” will first be defined as those goods which present potential threats to public health and safety. thus, counterfeit medicines, ingestible goods, cosmetics, automobile parts and other products whose quality is critical to public health and safety should be the subject of strong sanctions. furthermore, to adequately protect the public, these sanctions should not be applied solely on proof of actual harm. instead, they should be applied to remove the potential for such harm so that consumers can be assured that only safe goods are being offered in the market. the removal of harmful goods from local markets, however, will form only one portion of more directed means to stop the flow of counterfeit goods across borders. new modalities for regulating such flows will emerge. customs standards may be revised to permit the seizure of harmful counterfeit goods in transit.76 when dealing with the issue of pirate websites, distinctions may initially be made based on the types of goods offered by the websites. music and copyrighted works might be subject to monetary compensation while purveyors of potentially harmful goods, such as counterfeit drugs, would be subject to removal and coordinated efforts to prevent their re-appearance. this could include an array of methodologies such as access blocking by isps and/or better monitoring of the accuracy of domain name registrant identities for commercial websites to support stricter prohibitions against re-registration of prohibited websites. these prohibitions will be enforced by alternatives to present notice and take down provisions.77 such alternatives, however, will not be limited to notice and notice options,78 but will undoubtedly include diverse streamlined administrative/court processes that ensure that only sites that provide counterfeit goods are removed. 79 as countries move farther along the development curve, “harm” from counterfeit goods will be defined as including the “economic harms” posed by counterfeiting. these harms would 76 presently trips does not require in-transit enforcement measures. even acta only treats in-transit enforcement as an optional choice. acta, art. 16(2)(“a party may adopt or maintain procedures with respect to suspect in-transit goods…”)(emphasis added). 77 see 17 usc § 512(c)(establishing procedures for isp takedowns of infringing materials on notice from copyright owners); canadian modernization act, c-11 §41.25 (establishing procedures for notice to isps of infringing materials with subsequent notice to end users). 78 see canadian copyright modernization act, c-11, §§41.25 – 4.126 (describing notice and notice procedures for removal by isps of allegedly infringing third party content; compliance is unrelated to safe harbor status). 79 these stricter provisions will most likely include stronger evidentiary proofs of counterfeit activity. see londonsire records, inc. v. doe 1 et al, 542 f. supp.2d 153 (d. mass. 2008)(court requires “concrete showing of a prima facie claim of actionable harm; specificity of the discovery request; the absence of alternative means to obtain the requested identity disclosure; a “central need” for the information; and no undue harm to end user’s expectations of privacy); bonnier audio ab v. perfect communication sweden ab, case no. c-461/10, [2012] ecj eur-lex lexis 452 (ecj (third chamber)(upholding national law that required “clear evidence that someone has committed an infringement” for disclosure of identity of allegedly infringing party and that further limited disclosure “only if the reasons for the measure outweigh the nuisance or other harm which the measure entails for the person affected by it or for some other conflicting interest)(swedish copyright law). nordic journal of commercial law issue 2012#2 17 include adversely affecting the ability to grow local industries that support the manufacturing and distribution of legitimate products. as “glocalization” becomes more significant, early focus on economic harm may be directed to those industries that have a purely local presence, or to goods which fill uniquely local needs. subsequent development, however, should also include protection against economic harm for all brands, and not merely local ones. this re-emphasis on protecting consumers will also support a re-examination and re-emergence of the parallel market. sustainable development and technology transfer have long been recognized as critical linchpins to the growth of effective local markets.80 they have even been memorialized as part of the international intellectual property regime under trips.81 since the heart of the parallel market is the provision of goods and services at affordable prices to those under-served by traditional markets, the renewed focus on compensation rights described above will be combined with consumer protection concerns to redefine the limitations on the importation and distribution of grey market goods. for example, the importation of grey market medicines might be allowed to combat a local pandemic, so long as the efficacy of such drugs is unquestioned.82 as we obtain more experience in striking realistic enforcement modalities, concerns over economic harm may be further refined by models that make more nuanced distinctions between socially beneficial uses and other deviant globalization norms. to provide fair access to consumers, courts may make more realistic appraisals of consumer need for low cost compulsory licenses in the face of countervailing ip owners’ rights. thus, medicine to treat pandemics or even diseases, such as diabetes, that affect the quality of life, and/or its longevity, are more likely to be subject to defendable compulsory licenses than those that treat male pattern baldness. similarly, compulsory licenses for operating software or smart phone 80 see trips, art. 7 (providing that protection and enforcement of intellectual property rights “should contribute to the promotion of technological innovation and to the transfer and dissemination of technology…”); un system task team on the post-2015 un development agenda, science, technology and innovation and intellectual property rights: the vision for development (may 2012)(advocating for creation of improved platforms through which scientific and other developmental knowledge can be shared). 81 see trips, art. 7 (“the protection and enforcement of intellectual property rights should contribute to the promotion of technological innovation and to the transfer and dissemination of technology, to the mutual advantage of producers and users of technological knowledge and in a manner conducive to social and economic welfare, and to a balance of rights and obligations.”) & art. 66(2)(“developed country members shall provide incentives to enterprises and institutions in their territories for the purpose of promoting and encouraging technology transfer to least developed country members in order to enable them to create a sound and viable technological base.”)(emphasis added in both). 82 see trips, art. 31bis (providing for compulsory licenses for importation of patented drugs to meet domestic needs); william w. fisher iii & cyrill p. rigamonti, the south africa aids controversy: a case study in patent law and policy (2005)(available at http://cyber.law.harvard.edu/people/tfisher/south%20africa.pdf)(case study of aids pandemic in south africa and dispute over importation of grey market generics). in order to meet the meet the efficacy concerns of consumers, definitions of acceptable grey market pharmaceuticals may need to be refined to assure that the sources for such goods are legitimate ones. thus, the importation and sale of legitimate generic drugs should be permissible while counterfeit goods (which are not subject to quality control) would remain excludable. http://cyber.law.harvard.edu/people/tfisher/south%20africa.pdf)(case nordic journal of commercial law issue 2012#2 18 technology may be more readily defensible than those that allow the continuing provision of illegal music, films or videogames. 2.5 innovative business models deserve adequate breathing space to flourish. one of the strengths of deviant globalization is that it allows people at the lowest economic rung of economic development to earn a living through innovative actions. in deviant globalization, “innovation” includes entrepreneurial innovation such as that recognized in the task force on science, technology and innovation of the u.n. millennium project.83 the complex interplay of factors that leads to successful innovation is beyond the scope of this article. yet what appears abundantly clear is that successful entrepreneurial innovation necessarily includes distributional processes and techniques as well as new goods and services. more effective support for distributional innovation under deviant globalization models does not require that needs of intellectual property owners be ignored or given short shrift. but it does require that their interests be re-balanced with those of sellers and consumers. thus present “free access” demands for the sake of encouraging innovation or creativity84 have less importance than the economic significance of permitting alternative avenues of distribution. so-called “rogue sites” that offer either unauthorized downloadable or streaming, unedited copyrighted content, are located at the point of greatest intersection between deviant and traditional globalization. the fair trade norms of deviant globalization offer the most likely sources for rational solutions to this knotty problem. there is no question that rogue sites that provide copyrighted content in a digital format represent a distributional innovation. this distributional innovation is arguably supported by deviant globalization norms because it provides goods consumers demand, in a form and with use limitations that meet their reasonable needs. at the same time, compensation flow considerations require that copyright owners receive some compensation for the communication to the public of their content. 83. un millennium project, task force on sci., tech., and innovation, innovation: applying knowledge in development (2005) (prepared by calestous juma & lee yee-cheong), available at http://www.unmillenniumproject.org/documents/science-complete.pdf. this report emphasized the entrepreneurial foundations of innovation and its critical role in helping transform countries from reliance on the exploitation of natural resources to technological innovation as a basis for development. 84 these demands include heightened fair use rights for the display of user generated content derived from the unauthorized use of third party works. as noted above the resolution to such challenges using deviant globalization norms to create intellectual property standards would not necessarily establish predictable exceptions under fair use/fair dealing doctrines. instead, such issues might well be resolved by revised compulsory licensing regimes that treat posting as equivalent to broadcasting, requiring compensation to the copyright owner by the website operator, not the end user. http://www.unmillenniumproject.org/documents/science-complete.pdf nordic journal of commercial law issue 2012#2 19 present efforts that focus on going after the compensation earned by rogue website owners and third parties who provide advertising and sales support for such compensation streams85 represent a deviant globalization based solution. the innovative approach of these websites gives consumers access to digital content that would otherwise be unavailable. such distributive innovations, similar to peer-to-peer (p2p) file trading software, may be worth encouraging. the monies earned from such innovations, however, should form a source of compensation for the copyright owners whose content fuels the popularity of these unauthorized distribution sources. compensation streams can also form a potent source for eliminating rogue sites that are merely freeloaders as opposed to valuable, if low-cost, economic actors. alternatively, they can also be used to eliminate pirate sites whose social benefit is outweighed by the economic harms caused to content owners and related local industries, including authorized distributors. by focusing on compensation streams, deviant globalization puts the economic viability of piracy into play, not its moral necessity. as economics comes more clearly into focus, deviant globalization analysis will lead to greater differentiations in treatment between websites providing access to useful technologies, as opposed to those which merely meet consumer desires for inexpensive luxury or non-essential goods. while consumers may desire free, unlimited access to movies and music, these demands for access raise distinctly different economic and social justification issues than demands for similar access to computer operating software. while the first may be dealt with through outright prohibition or compensation streams to ip owners from the money trail; the second may trigger a greater reliance on compulsory license and differential pricing supports to meet fair trade needs of consumers, and investment returns for innovators. i would also expect more useful licensing models for both content owners and providers of intellectual property based goods and services to develop in the next decade of deviant globalization. creative commons86 has undeniably expanded the licensing modalities for copyrighted works to allow authors to permit unlimited uses of their works. as authors become more familiar with the benefits and perils of blogs, content branding and other distributive innovations, they, however, are revising the types of licenses they need. present popular licensing models have evolved from unlimited uses to limited reproduction rights, supported by full original source accreditation. such distributive licensing innovations should continue in all areas of open source and open access modalities. micropayments, limited field, limited country, copy forward and other technological supported limitations and methodologies will continue to develop to rationalize compensation streams and access rights under deviant globalization models. new compensation flows to support 85 see online protection and enforcement of digital trade act (open act), h.r. 3782, 112th cong., 2d sess. (january 18, 2012)(establishing potential liability of advertising agencies, credit card companies, and others who earn money as a direct result of the provision of pirated copyright content; this technique has been referred to as “following the money trail”). 86 see creative commons website at www.creativecommons.org. http://www.creativecommons.org/ nordic journal of commercial law issue 2012#2 20 creative uses of copyrighted works to produce goods and services that form part of an economically viable new market will be developed that reflect the economic focus of deviant globalization. for example, utilization of western movies to create a local movie industry, such as in nigeria,87 creates new product for underserved markets. some form of compensation may be required for such derivative works,88 but local experimentation should develop more rational economic models. these models will not only reflect different compensation methodologies – including micropayments and post production royalty streams89 – but will also differentiate between substantial uses with minimal transformational aspects on one hand, which would arguably require compensation,90 and insubstantial uses (such as minimal sampling) and transformational new works that require no such compensation.91 these innovative licensing models will be matched by expanded exceptions that give new business models room to develop before intellectual property owners close them down.92 it will also require new considerations of the territorial boundaries of present collective rights licensing models. experimentation in this area is already underway.93 it should gain greater momentum as the treatment of orphan works, new models for such licensing webhosting facilities that serve as the present equivalent of 87 see olufunmilayo arewa, ‘the rise of nollywood: creators, entrpreneurs and pirates’ (2012) ucla irvine legal research paper series no. 2012-11 (examining the role of piracy in the creation of the nigerian film industry and in its distribution networks). 88 for example, adapting a novel into a screenplay may require compensation. by contrast, creating parodies or other original (non-superseding) derivative works may not require such compensation under deviant globalization norms. see doris estelle long, ‘dissonant harmonization: limitations on cash ‘n carry creativity’ (2007) 70 albany l. rev.1163 (advocating a more nuanced approach to the right of copyright owners’ ability to control adaptive uses of their works). 89 such post-production royalty streams support local development by sharing investment risks with intellectual property owners. under this model, only successful works would give rise to a compensation obligation. 90 such minimal transformational uses are at variance with the fair use principles recognized under campbell v. acuff-rose music, inc., 510 u.s. 569 (1994), and its progeny and are closer to the virtual copying that is the keystone of pirated material on the internet. 91 see campbell v. acuff-rose music, inc., 510 u.s. 569 (1994)(fair use applies where work is transformative and does not supersede the original). us courts are inconsistent in their treatment of sampling. while the court in bridgeport music inc. v. dimension films, 410 f.3d 792 (6th cir. 2005), found arguably minimal sampling of four notes qualified as infringing, other courts have recognized that sampling may qualify as non-infringing if the amount is quantitatively or qualitatively insignificant. see newton v. diamond, 349 f.3d 591 (9th cir 2003)(sampling of 3-note sequence qualified as de minimis infringement). 92 an interesting foreshadowing of this treatment occurred in a case in the united states involving a claimed fair use defense of infringing conduct based on unauthorized p2p file trading. in sony bmg music entertainment v. tenenbaum, 672 f. supp.2d 217, 236 (d. mass. 2009), the court specifically recognized that copyright infringement based on new business models might qualify for a fair use defense until the issues surrounding such new uses have been clarified: “the court can also envision a fair use defense for a defendant who shared files during a period before the law concerning file sharing was clear and paid outlets were readily available. …a defendant who shared files online during this interregnum, sampling the new technology and its possibilities, but later shifted to paid outlets once the law became clear and authorized sources available, would present a strong case for fair use.” 93 see phil hardy, online music licensing – a way out of the maze, wipo magazine (february 2011)(describing various approaches of european union collective rights organizations to the challenge of digital cross border music licensing). nordic journal of commercial law issue 2012#2 21 traditional broadcasting facilities and workable models for global collective licensing rights are created. 2.6 markets necessarily require regulation. even in the “wild frontier” of deviant globalization, rules exist. they may be unspoken; but they are based on the need to allocate space and supply lines in a transparent manner. critically for intellectual property owners, these regulations often represent consensus-based concepts of economic and/or social fairness. such consensus may become more difficult to achieve in the multi-forum era of dís·integration, but the norms that will be created using deviant globalization models should ultimately reflect a consensus based on the economic realities of the whole economy. in his discussion of the system d market in sao paolo in stealth of nations,94 neuwirth describes a woman who cooks pastries at night, and arrives in the early morning hours to sell those pastries and hot coffee to the early traders in the underground wholesale market that occurs before the early morning street vendors arrive. she sells the goods out of the back of her truck, which is always parked in the same location. when neuwirth asked her about the availability of the spot everyday she told him that she “holds it by custom and … will continue to operate there until she chooses to leave the business.”95 there are rules even in the markets of deviant globalization. “vendors pay no rent to occupy the curbside, and there’s no protection money, taxes, or other fees… ‘you simply ask, ‘can i set up next to you?’ and if it’s okay, you do it.’ (if it’s no, and you set up anyway, you will surely have a fight.)” 96 regulation is not the enemy of deviant globalization. irrational regulation is. under deviant globalization, such irrationality should be minimized by the guiding norms that place economic opportunity for all -ip owners, developing economies and consumers—at the center of the analysis. conclusion the emerging period of dís·integration provides an unparalleled opportunity for experimentation at the domestic and regional level – shorn of the strictures of multilateral institutionalism of the previous integratory period. yet such experimentation is not without its perils. just as the earlier period of integration was purportedly co-opted by the interests of 94 neuwirth (2011). 95 neuwirth (2011) at 15. 96 neuwirth (2011) at 14 – 15. nordic journal of commercial law issue 2012#2 22 multinationals and other intellectual property holders,97 the present era may be co-opted by emerging powers of the anti-integration regime, including google, concert promoters, 98 and others who have opposed any extension of intellectual property protection to the digital universe.99 moreover, the experimentation that is the natural result of dís·integration will only be successful if such experimentations are created and shared in a transparent manner so that early efforts can be refined in the face of practical experiences. eventually, a new institutional structure to promote such sharing should emerge. this structure should be designed to facilitate the creation and refinement of deviant globalization based solutions to a panoply of issues that can only be imagined in this article. at its heart, deviant globalization – with its focus on the operational and economic norms of the informal economy – is about balancing the competing interests of intellectual property owners, consumers and the general public in an economically and socially just manner. some experiments in crafting effective deviant globalization models will undoubtedly fail. yet even such failures will be useful in recalibrating present international protection norms so that intellectual property protection can continue to provide the innovative foundation for a vibrant, socially just, global marketplace for the 21st century. 97see michael ryan, knowledge diplomacy: global competition and the politics of intellectual property (brookings institute 1998); susan k. sell, private power, public law: the globalization of intellectual property rights (cambridge university press 2003). 98 in an era where the music industry holds less sway, concert promoters have emerged as the new power. 99 this includes the organizations that created the successful stop sopa campaigns in the united states and the stop acta campaign in europe. the ability to generate such widespread internet power in the face of largely rhetorical claims – that acta will “destroy the internet” – demonstrates the power that is at least equivalent to that ascribed to multinationals during globalization. microsoft word kadi_sanaafinal.doc nordic journal of commercial law issue 2013#2 tax issues and tax treatment of the societas europaea by sanaa kadi*1 *1 ll.m master of laws in contract and commercial law, 2009, university of helsinki doctoral student, faculty of law, university of helsinki nordic journal of commercial law issue 2013#2 1 1 introduction according to the treaty on the functioning of the european union (tfeu)1, companies of the union do not actually have to be in a certain member state in order to be associated with it. however, the question of companies’ nationality has remained for a long time a subject of controversy in european company law. although the question of transfer of the seat has been mentioned in the treaty, experts and national representatives have not been able to issue an adequate solution. some members like france, germany and italy are not always ready to accept the movement of the company headquarters without re-incorporation into the new legislative system, while some states as the united kingdom (uk) or denmark opt for company cross-border relocations without losing the legal identity. the difference in the application of national principles gives constantly rise to conflicts between national laws and are only resolved by the interference of the european union’s (eu) legal bodies.2 for example, the centros case describes very well the danish reaction towards the creation of a branch of the english centros ltd in denmark and considered that the founder of the company had the intention to circumvent the danish minimum capital requirement, especially that the company was not engaged in any real activity in england.3 the common rule in the transfer of the seat of an societas europaena (se) is that the transfer does not change the identity of the european company; it only changes the applicable law.4 the se statute provides that the company can transfer the seat to another state without affecting the legal person.5 until now, at least 60 ses out of the overall number of registered ses have transferred their seat from one state to another without any difficulty.6 however, if we take in consideration the cartesio case’s decision7, where a hungarian limited partnership applied for transferring its seat to italy but intended to continue its business activities under hungarian law, the hungarian company register refused to transfer the head office and the case was referred to the european union court of justice (ecj). however, the ecj decision was surprising as it continued to support its previous daily mail case which gives a member state the possibility to restrict the transfer of a company’s central administration into 1 consolidated version of the treaty on the funtioning of the european union, 30.3.2010, oj c 83 p. 47-199. 2robakov:pp.17-18 3see the centros case c-212/97 of 9.3.1999 4grundmann: pp.685 5wymeersch: pp. 690 6http://www.worker-participation.eu/european-company/se-companies/facts-and-figures page visited on 21.02.2012 7see cartesio case c-210/06 of 16.12.2008 nordic journal of commercial law issue 2013#2 2 another member state.8 this opinion has also been confirmed by the vale case (c-378-10). therefore, freedom of establishment afforded in art. 49 and 54 of the tfeu, (previously 43 and 48 ec), accords the right to cross-border conversion for companies, however this right is not absolute, as the sovereignty of the member state and its national laws may have important weight on the rights of the company to freedom of establishment. the decision would suggest that whether or not a member state accepts the conversion of a foreign company into a national company depends on that member state only.9 the mobility of the se is probably the most important advantage of the company form. besides its national founding and its similarity to a plc of the state where it is registered, the se enjoys a european legal personality, which allows it to benefit from an unequalled freedom of movement. the jurisprudence of the ecj afforded this freedom for legal entities, but it has been until now more theoretical than real. since the famous case of centros10 in 1999 until the sevic11 case in 2005, the court has recognized the right for a company to register in any state it wants and then not to exercise its activities in this state but to carry out the entirety of its activities through a subsidiary based in another state (centros). in überseering12 the court stated that a member state shall admit to a company of another state the possibility to be a party to legal proceedings in order to represent and defend their rights, although there is no european convention on mutual recognition of legal entities . in inspire art13, the court provided that a member state shall not introduce specific rules or impose obligations on foreign companies even if those rules are simple formalities. then in the sevic case, the court decided against a member state that refused a company resulting from a cross-border merger to be registered. since that, it is required that all member states should recognize the validity of cross-border mergers. this jurisprudence represents an important progress in the freedom of movement of companies. however the court recognized the validity of cross-border mergers only on the basis that the tfeu allows companies to establish ‘agencies, branches and subsidiaries’ in the internal market, companies were, in reality, unable to move freely in the eu.14 so mobility is one of the substantive particularities that the se company has compared to other companies. se regulation is beneficial for the banking and insurance sector, financial and insurance companies under the form of ses are dominant, and this is due to the facility of managing their capital with total flexibility through their branches, as they can report only to the authority 8see cartesio case c-210/06 of 16.12.2008, see also worker participation (page visited on 11.7.2012) http://www.worker-participation.eu/company-law-and-cg/ecj-case-law/cartesio 9see loyens: pp. 3-4 (visited on 11.07.2012) http://www.loyensloeff.com/enus/news/publications/newsletters/eutaxalert/eu_tax_alert_84.pdf 10case c-212/97, centros ltd v erhvervs-og selskabsstyrelsen [1999] ecr i01459 11case c-411/03, sevic systems aktiengesellschaft v. amtsgericht neuwied 12case c-208/00, überseering bv v nordic construction company baumanagement gmbh 13case c-167/01, kamer van koophandel en fabrieken voor amsterdam and inspire art ltd 14lenoir: pp.15-16 nordic journal of commercial law issue 2013#2 3 which is at the level of the holding se and reduce thereby the external capital control requirements.15 this article discusses these relevant tax issues of the se . on the tax level, the se is to be subject to the fiscal law of the country of residence, however, when the company will exercise its taxable activities by the intermediary of entities situated in another country, the losses suffered by these entities will be deducted from the profits of the se.16 as the legal characteristics of an se will vary depending on the state where the company is registered, this concludes to the fact that different interpretations concerning tax treatment of an se apply, since it will be mainly governed by the domestic tax laws as the se regulation contains no rules concerning tax law.17 so, the question is, is there a role for the national regimes in preparing a harmonized treatment in order to prevent obstacles that can face the establishment of an se in another member state?18 what kind of tax treatment does the se get when it is created? and what are the problems faced during the running of an se? 2 tax issues and tax treatment of the se the internal market aims at creating a free market where the mobility of persons, goods and capital is free, but the different tax systems of the member states would lead to differences in the treatment between companies of the member state on one hand, and between companies of different member states on the other hand. in june 1967, the commission published a “programme for the harmonisation of direct taxes”. in order to adapt to the needs of the common market, neutral rules had to be set out, so that the companies are able to increase their productivity and significantly enhance their competitive strength. the commission approved 3 directives until 1990 and started different proposals as well to harmonize direct taxation rules.19 the se is treated in the same way as any other multinational company; the se is subject to the tax regime of the national legislation applicable to the company and its subsidiaries. every se is subject to taxes and charges in the member state where its registered office is situated. however, the original project drafted by sanders aimed at creating a supranational corporate form with uniform rules at all levels, but, as far as the member states were involved in the development if the idea, the realisation of the project was encountering serious obstacles, because any member state would allow a national company to lump with another foreign 15cathiard: see http://avocats.fr/space/catherine.cathiard/content/_c823a8f5-c663-4937-89b5dd1f9899484f published on 30.08.2011 16merle: pp.25 17helminen, mar: pp.28 18wenz 1:pp.11 19da costa & bilreiro: pp.81–82 nordic journal of commercial law issue 2013#2 4 company prior to liquidation which will permit the taxation of hidden reserves.20 therefore, the rules that apply when taxing an se are national; however, they are also influenced by eu law as well, starting from the common principles, the eu treaty requirements of equal treatment between domestic and foreign entities and the provisions of the directives on taxation.21 member states are responsible for taking part in the process of introducing a new tax framework for the se statute with regard to its uniformity and to prepare a harmonized treatment in order to prevent obstacles such as high costs that make the establishment of an se in another member state difficult.22 the idea of establishing a company in another state does not raise business considerations only, but it must also include tax considerations, because the corporate tax rate, the tax treatment of dividends or the tax deductions have their impact on the way of choosing the state where to establish a company. tax considerations can influence also the decision of whether to own the company directly or through other foreign companies.23 a simple example is the case of two shareholders a and b, living in two different member states, one state is using “the imputation system”24, and the other state is using “the classical system”25, a and b are holding shares in the same company, but will be taxed unequally, and this would be considered as an obstacle to investment in the internal market.26 the eu has always aimed at providing a free circulation of capital in the internal market without tax discriminations. it has been however difficult to harmonize the taxation of dividend payments in the eu.27 20da costa & bilreiro: pp.155, see also werlauff 2, pp. 135, see helminen,s : pp. 22 21werlauff 1: pp.174 22wenz 1: pp. 11 23helminen, m: pp. 235 24for the imputation system: see da costa & bilreiro: pp.85 ”... both the company and shareholder are taxed, but in order to avoid double taxation of the company income, the shareholder is granted a credit against its income tax liability equal to all or part of the corporation paid on the profits from which the dividend derives.” 25see da costa & bilreiro: pp.85”…in the classical system, profits distributed in the form of dividends are fully taxed twice, once at corporate level and again at shareholder level. however, some member states have introduced a shareholder relief in order to mitigate the double taxation of dividends. to achieve this effect, either a lower tax rate on the dividends is applied or a specific imputation tax credit established as a percentage of the dividend received is granted. the classical system results in double taxation more frequently. “ 26da costa & bilreiro: pp.85 27da costa & bilreiro: pp.85 nordic journal of commercial law issue 2013#2 5 3 tax issues of an se 3.1 the development of direct taxation in the eu before going on the tax issues of the se, one can ask whether member states are really willing to harmonize tax rules in the eu and to what extent? because it is likely evident that member states will not easily withdraw their tax rights in favour of the eu’s interests. especially if the eu tax regime would be a neutral one, member states would be left without guarantees concerning their national tax incomes. 28 there has been less development in the field of direct taxation than in the field of indirect taxation, since the treaty of the european union (teu)29 does not contain an explicit formulation concerning harmonization of the direct taxation. for many years, several groups of experts have tried to examine and search for the best tax systems that would ameliorate competition in the eu. the neumark committee in 1962 issued the first proposal on corporate tax harmonization. the van den tempel report in 1970 advised to adopt a classical corporate tax system to afford tax equality and avoid double taxation situations. in 1990, nontariff barriers to cross-border commerce were removed, and three directives on corporate taxation were adopted.30 a report was communicated in 1992 by dr. ruding about the conclusions recommendations on corporate taxation in the eu. notingthe differences between the corporate tax systems and the tax rates and tax bases in the member states, and the relief of double taxation and cross-border losses relief, the report recommended the introduction of a common system of corporate tax. besides that, complete harmonisation was not recommended in the report, instead priority was given to creating a minimum standard to prevent distortion in the different tax regimes. in 1996, the commission propsed a new tax plan in order to face the distortive tax competition and prevailing measures for the withholding tax on dividends, royalties and interests (the monti package). in 1998, a request was made by the ecofin council in vienna to the commission, to identify the principal provisions, which prevents the progress of cross-border business in the eu. in 1999, the council of ministers presented an assessment consisting of an analytical study of company taxation in the eu; the project resulted in 2001 in a comprehensive study and a communication supplementing that study. thus, the commission finally got a detailed mandate on the differences in business taxation and the tax rates between member states and the principal distortions of company taxation in the eu. notwithstanding the good report which included the ruding recommendations, the globalization, development of e-commerce, the increase of cross-border companies in the eu and many other factors have completely transformede the point of view on the internal market 28da costa & bilreiro: pp.83 29 consolidated version of the treaty on the european union, 9.5.2008, oj c 115, p. 13-45. 30the parent-subsidiary directive, the merger directive, and the arbitration convention. nordic journal of commercial law issue 2013#2 6 of 1990. tax policy again needed to be reviewed.31 contrary to what was planned in the 1970 and 1975 statutes for a european company and substantially the 1989 and 1991 statutes, the actual se statute does not contain any provision on the tax regime that should be applied for an se.32 3.2 tax aspects in the se the tax system of the se has been discussed, especially questions that concern cross-border changes when forming the company and also structural changes of se companies that are already established. as there is no specific tax regime for the se company, we can still find company law issues for that kind of companies, because we can make reference to national and harmonized tax law as well as tax law of international agreements concerning double taxation for cross-border structural changes especially regarding transfer of seat and merger.33 a se is in fact subject to different regimes, several features of taxation will be examined in order to understand and explain the most important issues concerning taxation of an se.34 when the creation of se companies started in practice in october 2004, the experience showed that an international merger was likely to be the most problematic from the tax perspective and the area that needs to be most urgently solved because it involves not only an instrument of structural change as is the case for the transfer of seat.35 the tax issues concerning the establishment of an se are not definitively harmonized in the member states.36 different sources of taxation of an se are introduced, in case where there is no specific tax rules the alternative is to go to the domestic tax rules applicable on plcs. different tax problems are raised, e.g. problems most often related to the different tax regimes of the member states which are not in harmony with each other,37 because the tax treatment is strongly dependent on the domestic law of the concerned state, and relating to the merger directive by which the requirements of tax treatment concerning the establishment of an se was implemented by january 1st, 2006.38 the tax merger directive39 which concerns a joint tax system applicable to mergers, asset contributions and share exchanges between entities in 31for further reading, see da costa & bilreiro: pp. 149-154 32wenz 1: pp. 6-7 33grundmann: pp.696 34wenz 1: pp. 7 35grundmann: pp. 698 36helminen, m: pp. 237 37wenz 1: pp. 10 38helminen, m: pp. 237 39 directive 2005/19/ec of 17 february 2005, which amended the directive 90/434/eec of 23 july 1990. nordic journal of commercial law issue 2013#2 7 different member states, will also apply to the se by establishing the tax neutrality of crossborder transactions in europe.40 the se is a new legal entities to which the tax merger directive applies. so if we resume the legal basis of the taxation of an se, according to the se statute, the european company on its tax issues is regulated by the national tax laws, tax treaties which have been concluded by the member states and the general principles of the eu treaty, for example the four freedoms, as well as the ec direct tax directives such as the merger directive (90/434/eec) amended by the 2005/19/ec directive, and the parent subsidiary directive (90/435/eec).41 the merger tax directive is considered as the most important harmonisation achievement in corporate tax law, thus an identical tax regime applies to the se company formation, change of structure and business operation to those of a plc under national law. a se has however a more advantageous position compared to the plc concerning some transactions under eu law and which are still impossible for a plc under domestic law.42 the parent-subsidiary directive is also considered as one of the most significant instruments of taxation for multinational entities across the eu, the directive provides a common treatment for companies having subsidiaries across the eu in order to prevent the double-taxation of the profits of a subsidiary set in one member state supplied to its parent company situated in another state, the directive guarantees thereby tax neutrality for investments across the internat market.43 3.3 the role of ecj case law in the taxation of the se besides the fact that member states have complete sovereignty in direct taxation, they should always comply with eu law; national tax rules must not be discriminatory towards nationals of other member states or be an obstacle in front of the four freedoms established by the teu. therefore a host state must treat the non-resident and the resident taxpayers equally when they are subject to the same taxation. otherwise this would infringe the eu treaty. the ecj provides through its case law the same requirements from the member states that there should be no barriers against nationals of other member states, e.g. (the daily mail case44). however, it is unfortunate to observe that generally member states do treat differently their taxpayers on the basis of their nationality and according to whether or not the counterparty to the transaction is subject to the origin state tax system. normally, an origin state cannot tax 40lenoir: pp.13 41helminen, mar: pp.28 42grundmann: pp.697 43da costa & bilreiro: pp.85–86 44case 81/87, r v. hm treasury. ex parte daily mail & general trust plc [1987] 2 cmlr 1, see craig & de búrca: pp. 433 nordic journal of commercial law issue 2013#2 8 residents differently on the scale of domestic tax borders, if two taxpayers of the same state are subject to a specific tax rule, but the tax rule is different and less favourable when one taxpayer is resident and the other is a national of another member state, then the discrimination is clear.45 when an infringement of the ec treaty by a member state occurs, the point is whether this member state is able to justify the infringing measure. in general, member state s refer to the clearly stated derogations of the treaty which are very limited; the member state often explain the measures as taken in the public interest. the very limited public interest justification provided in eu case law are the need to protect the cohesion of the tax regime, e.g., case c204/90 bachmann v. belgium46, and case c-300/90 commission v. belgium47, the prevention of tax evasion, e.g., case c-264/96, imperial chemicals industries plc v. colmer (inspector of taxes) ici,48 and the effectiveness of tax supervision, e.g., case 120/78, rewe-zentrale ag v. bundesmonopolverwaltung für brantwein (cassis de dijon)49. but even if the ecj has set criteria for justification for the member state s, the possibility to use them is very restricted, as the member state must establish a direct relationship between the discriminatory rule and the justified advantage presented by the member state. furthermore, the tax evasion justification is in contradiction with the freedom of establishment. the exercise of a fundamental right cannot be at the same time an abuse, thus, it is hard for a member state to prove and justify a discriminatory or less favourable tax rule on the basis of tax evasion, because the tax avoidance must be proved within the scope of the internal market and not restricted to the concerned member state. in addition to that, as the eu lawpermits each member state to apply its tax system within its territory, the member state cannot restrict the application of the treaty freedoms to preclude nationals searching for advantages to reduce tax payment in other member states. therefore a member state cannot successfully argue that the reduction of its tax revenues could be a justification for imposing less favourable tax rules. moreover, a member state must also prove how the restrictive measure taken against a national is going to achieve the aimed goal of the justification and would not constitute an excessive measure, as e.g. in, case c-118/96, safir.50 so, it is clear that the ecj case law has a relevant impact on the tax systems of the different member states and plays an important role in keeping watch on the potential abuses and discriminatory or restrictive measures taken by the member states. 45gammie: pp.40 46craig & de búrca: pp. 670, 748, 754 47craig & de búrca: pp.670, 735 48see http://eur-lex.europa.eu/ 49craig & de búrca: pp. 88, 324 (footnote 73), 581, 583, 604-608, 637-643, 746, 1105, 1116, 1128, 1132 50gammie: pp.41 nordic journal of commercial law issue 2013#2 9 in order to understand the importance of the ecj case law on the creation of an se, it is necessary to understand the connection between the tax rules systems of the different member states, the merger directive and the ecj case law. if a member state allows domestic mergers and reorganisations without imposing taxation, what could be the justification for taxing a similar cross-border transaction. if the member state justifies the measure taken against the cross-border transaction on the basis of the protection of the state’s tax incomes, the case law will likely deny this justification. furthermore, the merger directive might guarantee a tax neutral treatment to the cross-border transaction especially in case of the existence of a permanent establishment in the member state concerned. member states can’t therefore justify discriminatory measures on the basis of incapacity to collect future taxes, as future tax could be allocated to another member state on the ground of a multilateral or bilateral tax treaty. most corporate tax systems aim to arrange that there would no longer be taxation on incomes, profits and gains of cross-border mergers moving out of the state concerned. 51 concerning the re-registration of an se in another member state, a reference to the daily mail case52 is relevant for its unambiguous statement. the ecj examined the compatibility of the requirement of consent to move the central management of the company with art. 43 of theteu on the freedom of establishment. however, later case law exemplified that the daily mail -principle is valid for the state of incorporation, but not considered as a principle that every state can rely on, e.g., inspire art ltd. case c-167/01, and c-208/00überseering53 . there is no indication that the court would conclude that the freedom of establishment includes the right to move the actual central administration of the company whereas the legal person remains under the domestic law of the state of origin which means that a member state would be able to impose restrictions on movement when the company nationality and legal person are subject to its national law. however, under art. 8 (1) of the se regulation, the se is able to transfer its registered office from one state to another without losing its legal personality. if any restrictive measure is taken against an se when transferring its registered office, it will be contrary to art. 43 of the ec treaty. moreover, under art. 8 of the se regulation, the procedure of transfer requires the delivery of a certificate of compliance with the transfer requirement from the state of actual registration, among the requirements, a certification that the creditors’ interests are protected in case of tax debts. 54 according to the se regulation, the transfer of a registered office of an se which would result in a change in the applicable law shall not take effect if any competent authority of the member state of registration opposes it,55 which means that tax authorities may oppose the transfer of the registered office of an se on 51gammie: pp.42 52craig & de búrca: pp. 433 53see http://eur-lex.europa.eu/ 54gammie: pp. 42-43 55see art.8 (14) of the se regulation. nordic journal of commercial law issue 2013#2 10 the ground of public interest. however the amendment directive permits to an se to defer tax registration if it maintains a pe in the state of origin, in order to protect future taxing rights. it is obvious under ecj case law that a host state should not apply less favourable treatment to a secondary establishment of a foreign company in the form of a branch or an agency, e.g., case 270/83 commission v. france.56 actually, member states apply different rules on how to treat corporate groups on the tax level, therefore the role of the ecj case law would be determined on the basis of those specific national rules. in addition to group taxation treatment varying from one state to another, the se benefits from its capacity to transfer its registered office in order to choose the host state that would be the most advantageous for tax matters and particularly for tax relief on losses.57 3.4 the tax residence of the se the condition that the registered office and the head office of an se must be located in the same member state is very important in company law because it connects the formal criterion which is the registered office and the factual criterion which is the head office as it constitutes the same rule in all member states. this condition constitutes also the general rule in most of the member states’ national rules. however, the point is what the terms used for tax law purposes are? the most frequently used norm related to the tax residence of companies is the concept of “place of management” or “place of effective management”. this concept is obviously different from the concept of registered office, but because the se regualtion requires the se to have the registered office and head office in the same member state, this difference does not constitute a big problem. however, it is not really clear whether the concepts “place of effective management” and “head office” have the same meaning. according to the commentaries of art. 4 (3) of the oecd model law, the two concepts may have the same meaning, but it is not considered a final rule. thus, it is important to define terms in tax treaties and national legislation. generally, national tax legislation always defines the concept of place of effective management, and if its determination is not equivalent to the head office, there would be a negative result on the taxation of the se.58 so, different problems may result from that confusion of concepts and need to be examined for the good implementation of the se especially for tax purposes as it is a relevant issue for both ses and the member states. the easier solution in this respect is the interpretation of the concepts of place of effective management and head office by being the same concept. furthermore, another solution could be the mutual agreement procedure. however, this method could apply only when dealing with problems of interpretation and to solve a dual residence conflict. another option would be the 56craig & de búrca: pp. 755-756 57gammie: pp.44 58soler: pp.12 nordic journal of commercial law issue 2013#2 11 adoption of tax treaties at eu level, for example by complying with eu law criteria and adopting in this respect adequate tax treaties, and also to adopt a european model convention or a european multilateral tax treaty. another revelatory solution could be to adopt particular tax regulation for the se regulation no matter if it was on eu level or on national level provided that the se regulation refer to both of them. for this solution, the best is to establish a directive that would regulate tax aspects of the se as its implementation would concern national laws as well.59 this last suggestion would be a practical option from the point of view of its effect on the national laws of the member states and its uniformity as a general rule as well. 4 tax treatment of an se 4.1 taxation of current business operations if we search for the problematic areas concerning the taxation of the se, focus must be 1) the formation, 2) the subsequent structural change and 3) the current business operation. during those three phases relating to the running of an se, and especially in domestic laws, the crossborder merger and transfer of seat are still the areas that cause most of the problems in the tax treatment of the se.60 the general problems that occur are for example double taxation or discriminatory taxation against cross-border transactions. the most important question in relation to tax law is, should the se benefit from different treatment under national law than the one given to other types of companies? the se benefits from a tax regime that intends to eliminate the obstacles that may occur in cross-border business operations. some scholars adopt an optimistic view by emphasizing the possibility to apply a model of taxation on a consolidated basis and dividing the revenues between the member staes concerned to start the experience with the ses. this method would give national tax authorities the opportunity to test new tax treatment and make the transition to it easier.61 regarding matters not regulated by the se regulation, art. 9(1), explicitly points to the rules that would apply to a public limited-liability company (plc) formed in the member state where the se is registered.62 as the taxation of the se is a matter which is not regulated by the regulation, we can conclude that an se could be treated as a plc is treated in each member state. this would mean that the direct tax position of an se will be similar to the direct tax 59soler: pp.12-13 60grundmann: pp.697 61grundmann: pp. 698 62art. 9(1)c of the se regulation, see helminen mar: pp.28 nordic journal of commercial law issue 2013#2 12 position of a domestic plc, an se having its registered office in france, would consequently incur the same tax treatment as the societe anonyme, and an se having its registered office in germany would incur the same tax treatment as the aktiengesellschaft. however, it is also provided in the regulation that it does not cover tax issues63 of the european company, which could mean that the reference to plcs in art. 9(1) may not constitute an obligation. according to the teu and the principle of equalilty , each member state should give ses registered in its territory the same tax treatment as national plcs. so an se’s income will be taxed according to the national corporate income tax of the state of its residence. either way, this does not mean that an se would not run the risk of being taxed in another state and having therefore a double taxation problem. 64 when the se is formed by means of cross-border merger (art. 2.1, 17-31), the situation becomes similarly problematic as is the case with cross-border mergers; the problem arises when there is a cross-border merger of an se that already exists because the general tax regime applies and the direct application of the eu merger tax regime cannot be questioned. for the transfer of the seat of an already existing se (art. 8) the same rules apply as for the transfer of seat of domestic companies according to the member states’ domestic laws, and the question is; does the regime of the merger tax directive -which applies to cross-border transfer of an existing se since 2005 apply to these cases by analogy or not? 65 the point is that there should be no problem relating to the place of residence of an se, because the se must always have its registered office and its central management in the same state-even in the same address. however, this point will not prevent a dual-residence conflict, as it is probable that another state may demand the residence of the se. notwithstanding, the majority of tax treaties will consider the residence of a corporation to be the place where the company’s effective management is situated. besides that, the difference between the two concepts of « central management » and « effective management » in relation to tax treatment may still remain different depending on the perspective of eu company law or the perspective of tax treaties. 66 furthermore, when an se has permanent establishment (pe) income in several states, this would mean that the se will be taxed in the states where it carries on business activities. an se could also be taxed on the basis of the national source states withholding taxes in the states where the se has income. therefore, tax treatment of an se would depend on the domestic corporate tax rules of each state.67 63see note 20 of the preamble of the se regulation. 64helminen mar: pp.28-29 65grundmann: pp.697-698 66helminen, mar: pp.30 67helminen, mar: pp.29 nordic journal of commercial law issue 2013#2 13 so, it is clear that the se, which is supposed to be a uniform legal entity across europe, will have to be subject to different national tax systems. and even if the tax regimes of the different member states look identical, there are differences, for example concerning corporate tax rates. for example, the corporate tax rate in france is 33,33%, while in the uk it ranges from 21 to 28 %. other differences may be observed in the system of tax deductions and amortizations. also, the capital gains of a corporation from the sale of shares of another corporation may be exonerated from taxes in some member states, like germany, and taxable in other member states, as in italy. also whether the exemption method or the credit method applies to pe income impacts on the choice of member state in which to establish an se. 68 the se is also subject to tax treaties to which member states have agreed respectively, in the same manner as any domestic plc in the member state concerned. an se does not therefore benefit only from those tax treaties concluded by the member state where it has its registered office, but would also benefit from tax treaties concluded by member states where the se is established through pes.69 4.2 tax treatment 4.2.1 tax treatment when forming an se as the se may be formed by different means, every way would have its specific features concerning the tax treatment of the company. the merger between companies governed by the law of different states falls within the scope of the merger directive 90/434/eec amended by the amendment directive 2005/19/ec when the assets and liabilities transferred represents a permanent establishment. the creation of a holding se is regulated by the merger directive, if the acquiring company and the acquired company are established in different member states. the creation of a subsidiary se is subject to the merger directive if the contribution in kind is effected between companies resident in different member states and has as its object a branch or a business of activity. finally, the conversion of a plc to an se is treated tax-neutrally by all member states.70 thus, where the requirements of the tax merger directive are fulfilled; the establishment of an se may be considered tax free.71 68helminen, mar: pp.29 69helminen, mar: pp.29 70conci: pp.15 71werlauff 1: pp.176 nordic journal of commercial law issue 2013#2 14 on the basis of the tax merger directive, the conversion of a public limited company into a se does not normally cause any tax consequences.72 so as a matter of fact, the tax regime for the plc applies to the se. the same applies for corporate tax harmonisation measures, if we look at the reference made in art. 9(1)(c) of the se regulation, which points to the areas not governed by the regulation by referring to the provisions of law adopted by the member states whether these provisions are from eu law or domestic law in which the se has its registered office. furthermore, the se has, at least in principle, under the national law the same status as a plc and therefore an se may not be discriminated against according to art. 9(2) of the se regulation.73 the merger directive and the amendment directive74 provide that the se offers the possibility of a tax-neutral formation through the eu, and a tax-neutral transfer of seat across the borders. tax-neutral means that there would be no discrimination between a national legal entity and a european legal one.75 however, forming an se as a holding company (art.2.2-4) or a subsidiary (art.32) or by conversion (art.37), does not cause problems because the tax merger directive provides that the companies shall be authorised to continue the book values and benefit from tax-neutral treatment. concerning the creation of an se subsidiary with compensation in the form of shares, the same prescription applies to the transfer of production units to the se subsidiary. finally, concerning the conversion of an existing public-liability company into an se, the identity is not affected and that’s why the conversion does not impose any transfer of assets.76 4.2.2 tax treatment when forming an se by cross-border merger of plcs in the case of cross-border formation of a merger se, the se will be treated as “tax neutral” on the level of the founding companies if the pe is in the outbound states. the se is treated tax neutrally also on the level of the shareholders and on the level of the se itself.77 the tax merger directive guarantees normally a tax freedom and a tax succession to the transaction. but this guarantee is not always safe, because there are some cases where the transaction can be taxed. for example such a situation would occur when there is a higher quantity of cash payment than authorised by the directive, or when a non-continuing company does not stay in its state of origin in the form of a subsidiary with tax liability, so that the 72helminen, m: pp. 237 73grundmann: pp.696 74council directive 2005/19/ec amending the merger directive. 75wenz 2: pp.49 76grundmann: pp.697 77wenz 2: pp.50 nordic journal of commercial law issue 2013#2 15 operation of the succession’s principle would apply to it. or when a non-continuing company has a subsidiary in a third country, forasmuch as the subsidiary itself cannot have a subsidiary in a third country.78 in order to better understand what has been said above, an example can be presented, where we have plc companies a and b, respectively from state a and state b, which have formed an se with its registered office and head office in state a. the se is regulated by the law of state a and, the se has permanent establishments (pes) in state b and in another, state c. according to art.4 (2) of the merger directive, in the valuation of the pe located in state b subject to taxation of state b, the assets and liabilities must be transferred to the se at the tax book value used immediately before the merger, if these assets and liabilities are really in relation with the pe situated in the state b and they have a role in generating the profits or losses of the pe. therefore, state b must treat the pe neutrally as it can tax the profits of the pe within the scope of art.7 (1) and 13(2) of the tax treaty with state a.79 in the case of pe situated in state c for state c tax issue, the obligation imposed on state b is expanded to state c. the se can take over the assets and liabilities of the pe situated in state c and can calculate potential new depreciations, gains and losses as if the merger did not exist. tax neutrality is foreseen by all member states.80 now, if we try to measure the treatment of pes situated in states b and c for state a tax purposes, the merger directive has no rules on the situation when the se recieves assets and liabilities. this situation is relevant for member states that apply the universal taxation principle81; some of those member states impose the valuation of pes at their previous tax book values, which permits those states to tax profits that accumulated outside their tax territory.82 france has implemented the merger directive correctly concerning both the formation of an se by merger by acquisition and the merger by formation of a new company. however the uk did not implement the tax merger directive correctly; as tax law in the uk does not contain rules allowing roll-over relief for assets and liabilities in the case of cross-border mergers, this constitutes an infringement of art. 4 of the tax merger directive. concerning art. 8 of the tax merger directive, uk legislation affords for roll-over relief for the shares received by the transferring company only if the merger qualifies as reorganization, otherwise the shareholder will be taxed on income profits and capital gains.83 78werlauff 1: pp.176 79conci: pp.16 80art 10(1) of the merger directive, conci: pp. 17 81such as denmark, finland, sweden, greece, ireland, uk 82conci: pp.17 83ibfd: pp. 38, 43, 53 nordic journal of commercial law issue 2013#2 16 4.2.3 tax treatment when forming a holding se when two or more public or private limited-liability companies in different member states participate in the formation of a holding se, the rules of the directive on tax free transfers of shares guarantee that there would be no rise to tax liability and right to succession for the shareholders, when the shares are placed in the se as non-cash investments, since the transaction is regulated by the directive.84 thus, the formation of a holding se is treated tax neutrally. tax treatment on the level of the shareholders of the founding companies is also neutral.85both france and the uk have implemented the tax merger directive correctly concerning the formation of a holding se.86 4.2.4 tax treatment when forming a subsidiary se in order to benefit from tax freedom provided by the directive, companies taking part in this transaction, must be public limited-liability companies or private limited-liability companies, as the directive does not apply to other forms of entities, the investment must be an undertaking or a branch of an undertaking, and the payment shall be in the form of shares issued by the se that received the investment.87 the subsidiary se is treated tax neutrally on the level of the founding companies and on the level of the se.88both france and the uk have implemented the merger directive correctly concerning the formation of a subsidiary se.89 4.2.5 tax treatment when forming an se by transformation of a plc into an se there is no provision in the directive concerning this transaction. however, the continuity of legal personality when the transformation is performed would prevent tax liability. as the domestic laws do not levy taxes on the transformation of a public company to a private one, the principle of equal treatment of companies should ensure a tax freedom to companies transforming into ses.90 so in this case, there are no tax issues at the level of the converting 84werlauff 1: pp.176 85wenz 2: pp.50 86ibfd: pp. 38, 43, 53 87werlauff 1: pp.176 88wenz 2: pp. 50 89ibfd: pp. 38, 43, 53 90werlauff 1: pp.177 nordic journal of commercial law issue 2013#2 17 company, at the level of the shareholders and at the level of the se.91 both france and the uk legislations treat tax neutrally the formation of an se by conversion of a plc into an se.92 4.3 tax treatment when running an se the member states have complete sovereignty on how to treat the se company on the tax level, which means that every state is free to impose the tax treatment of its choice to the ses registered in its territory.93 what tax issues are involved when running an se? it is important to determine the incomes and capital gains of an se and their taxation, as well as the taxation of profits of the different pes of an se, the taxation of dividends, interests and royalties of an se group, transfer pricing issues of an se group as well as the cross-border balancing of an se. other tax issues are the tax consolidation of an se group, thin capitalisation in an se group, the application of cfc regime with regard to the subsidiaries of an se, and the shareholders taxation of an se.94 4.4 tax problems facing the se company it is important to discuss some of the potential problems that the se faces when carrying on its activities. the first tax matter that constitutes a problem for the se is that the company is not always relieved for the losses suffered in one member state against profits gained in another member state, which may lead to the double taxation problem. the problem is the same concerning the se and its branches and subsidiaries established abroad when the balancing of profits and losses is not applied or might be applied at a limited scale. it is more possible for one single entity to be relieved from foreign tax losses than what would be for a parent company and its foreign subsidiary. one of the solutions could be the situation where a company with losses from one member state merges into an se with another company with benefits from another member state; the merger would set off the losses if the se took as the place of residence the state of the profitable company. 95 another problem the se may face, as it has been faced by other cross-border companies, is the source state withholding taxes or the deduction at source on dividends, interests and royalties. 91wenz 2: pp.50 92ibfd: pp. 43, 53 93helminen, mar: pp.28 94wenz 2: pp.50 95helminen, mar: pp. 30-31 nordic journal of commercial law issue 2013#2 18 there is not only the problem of double taxation, but also the problem of differences from one member state to another between the articles subject to source taxation as well as the difference of the amount imposed on each article. however, the se benefits from the parent-subsidiary directive which accords to the se that no withholding taxes are imposed on se when it pays dividends to its parent company in another member state or got from its subsidiary in another member state. 96 the se as a cross-border legal form may encounter also the problem of transfer pricing adjustments and double taxation, for example for overhead costs, or service fees, which may differ from one member state to another. however, the member state s have ratified the convention on the elimination of double taxation which applies to the se as well. however, the procedure that the company must go through under the convention, in order to solve the problem of transfer pricing, is very expensive and complicated.97 the se is treated in the same way as any other domestic company as regards to the thin capitalisation, which may occur when there is a high use of debt from the entity, and therefore, causes losses in tax incomes of the state concerned. thus, the state may ignore the deductibility of the debt interests. however, after the ecj decision in the case lankhorst-hohorst gmbh v. finanzamt steinfurt98, the problem of thin capitalisation risk on ses was limited. 99 the se may face another problem when having subsidiaries established in low-tax states. the state may tax directly the profits of a controlled foreign company situated in a low tax jurisdiction as incomes of the owners of the company, this situation is called the cfc regime and many member states such as france, germany and the uk have adopted this regime. however, cfc regimes are criticised on the point that they are against the freedom of establishment provided in art.49 of the tfeu (ex art. 43 of the teu), and also in conflict with the free movement of capital principle set in art. 63 of the tfeu (ex art. 56 of the teu). notwithstanding, those regimes are still applied.100 originally, one of the principal problems that businesses face in the eu is the lack of crossborder relief or full consolidation, because the domestic laws do not take in consideration losses suffered by the subsidiaries established abroad.101 thus, the difference between domestic tax systems in europe makes it hard to know what the requirements are for a company not to 96helminen, mar: pp. 31 97helminen, mar: pp. 32 98see case c 324/00 of 12 december 2002: http://curia.europa.eu/jurisp/cgibin/gettext.pl?lang=en&num=79978787c19000324&doc=t&ouvert=t&seance=arret&where=() 99helminen, mar: pp. 32 100helminen, mar: pp. 32 101da costa &bilreiro: pp.139 nordic journal of commercial law issue 2013#2 19 suffer from a double taxation situation. because an se runs also the risk of being double-taxed like any other company having cross-border business.102 4.5 tax treatment when transferring the seat of an se as already mentioned an se can transfer its registered office from one member state to another and still not lose its legal personality. according to thetax merger directive the transfer of seat in member states is possible without any direct tax consequences as the directive provides that the establishment will permanently remain in the original state where the seat was first established.103 the amendment directive contains provisions concerning tax treatment of a cross-border transfer of the corporate seat of an se from one member state to another.104 however, some argue against the idea that the transfer of seat of an se would raise the problem of changing tax residence and the possible obstacles for that transfer. besides the fact that art. 8 of the se regulation does not provide any taxation rules, there is a particular connection between the se and tax authorities. concerning the latter to be a potential creditor of the se before its transfer, as well as the position of the creditors and the guarantees afforded for them in order to protect their rights and their implications in the transfer. depending on national tax provisions and tax procedures, when considering tax authorities as a creditor of the se moving abroad, the question is whether the tax administration of the state of origin is a creditor for taxes that have not been evaluated yet. it is supposed that the tax authorities should be considered as tax creditor for the se transferring its seat across borders only when taxes are officially computed and notified to the taxpayer.105 another relevant point in the se regulation is art. 8 (15) when the transfer of the se is not permitted because of particular procedures such as the liquidation or insolvency. in this situation, tax authorities could be a creditor of the se. additionally, art. 8 (15) refers to similar procedures which could be understood as a reference to tax procedures against the se. another situation is when the transferring se would be considered as still resident because of any action brought before the transfer. it is important to know if the provision means only actions before the courts or also administrative tax procedures (as the tax authorities enjoy of special powers procured by the state). finally, according to art. 8 (14), member states have the possibility to object to the transfer of the registered office on grounds of public interests for example for tax evasion reasons. however, ecj case law has been clear,ruling against those member state limitations that concern future taxes.106 the transfer of seat of an se from one state to another 102 helminen, mar: pp. 32 103helminen, m: pp. 237 104wenz 2: pp.49 105soler: pp.13 106soler: pp.13-14 nordic journal of commercial law issue 2013#2 20 is normally treated tax neutrally in the inbound state and the outbound state. nevertheless, according to the amendment directive,107 it is recommended that a pe of the transferring se stays subject to the taxation in the outbound state. also at the level of the shareholders, there is no taxation when transferring the seat of an se.108 it is provided in art. 10b (1) and (2) that when the se transfers its registered office from one member state to another, in connection with the transfer of the registered office, when an se ceases to be resident in the first member state and becomes a resident of the second member state, both actions of transfer and cessation of residence should not give rise to any taxation of capital gains calculated in the member state from which the registered office has been transferred derived from those assets and liabilities of the se which in consequence remains effectively connected with a pe of the se in the original member state and plays a part in generating the profits or losses taken into account for tax purposes. this should apply only if the se calculates any new depreciation and any gains or losses in respect of the assets and liabilities that remain effectively connected with that pe, as though the transfer had not taken place or the se had not so ceased to be a tax resident. however, art. 10b (3), provides an exception which is that if the se is entitled to have any new depreciation or any gains or losses in respect of the assets and liabilities remaining in that member state calculated on a basis different from what has been previously stated, the paragraph one of the art. 10b should not apply to the assets and liabilities in respect of which option is exercised. furthermore, when provisions or reserves properly constituted by the se before the transfer of the registered office are partly or wholly exempt from tax and are not derived from pes abroad, the member state shall take the necessary measures to ensure that such provisions or reserves might be carried over with the same exemption, by a pe in the member state from which the registered office was transferred. in addition to that, the member state should allow the pe situated in its territory of the se transferring its registered office to take over losses of the se which have not been exhausted for tax purposes, provided that the loss carried forward or carried back would have been available in similar circumstances to a company which continued to have its registered office or which continued to be tax resident in that member state.109 moreover, according to art. 10d of the amendment directive, the transfer of the registered office of an se should not of itself give rise to any taxation of the income, profits or capital gains of the shareholders. however, the application of this provision should not prevent the member state from taxing the gain arising out of the subsequent transfer of the securities representing the capital of the se that transfers its registered office. 107see the amendment directive, title iv b on rules applicable to the transfer of the registered office of an se or an sce, art.10b (1) 108wenz 2: pp.50 109see art.10c of the amendment directive nordic journal of commercial law issue 2013#2 21 however, some would argue that when the registered office of an se is transferred, the result that follows this transfer is automatically the transfer of tax residence, this could lead to additional taxes that the se would have to face even if in some member state s change of residence with a remaining of a pe in the state of origin would be treated tax neutrally. in addition to that, some of the bilateral treaties have adopted new tax rules according to which capital gains that derive from the sale of shares are taxed in the state of origin; this should be regarded as a limitation of the ec treaty freedoms. so, even if art. 8 (1) removes company law obstacles in order to enable the transfer, the same provisions would not remove tax law obstacles. however, the amendment directive ensures the financial interests of the state when the transfer includes also a change for tax purposes, the guarantees ensured concern the assets connected with the pe in the state of origin.110 besides, it is added in the amendment directive that a member state may however, refuse to apply or withdraw the benefit of all or any part of the provisions stated in the directive, if it appears that the merger, division, partial division, transfer of assets, exchange of shares or transfer of registered office of the se has as its principal objectives tax evasion or tax avoidance, or if it resultsin a company no longer fulfilling the necessary conditions for the representation of employees on company organs according to which were in force prior to that operation. this would mean that member state s have the possibility to deny the provisions of the directive, if they judge that an se company is transferring its registered office in order to evade taxation. and as it has been mentioned before on many occasions, one of the advantages for ses is to benefit from tax neutral treatment in some situations, which would makes it attractive for businesses. so, if at the end, the member state will refuse to apply the provisions for which the company was attractive, there would be no purposes for businesses to transform or merge into an se. in addition to that, the amendment directive is addressed to other companies as well, which means that not only the se would benefit from tax neutral treatment. 5 prospects and tax solutions for the se actually, all companies engaged in cross-border business activities face different national tax systems in the so called single territory, which often leads to discrimination and double taxation situations as well as the extra costs for tax administrative procedures. the commission provides that the corporate taxation systems need to be co-ordinated in order to tackle cross-border tax problems.111 it is important to consider the interest expenses when purchasing a company, thus knowing in which state a loan interests raised in order to acquire a foreign company will be tax deductible. 110soler: pp. 14-15 111da costa & bilreiro: pp.163 nordic journal of commercial law issue 2013#2 22 in some states,112 if a foreign company is directly acquired by a corporation, the interest would be deductible in the corporation state, however, in the case where the foreign company is acquired through another foreign company, it is not possible to deduct the interest, instead of that and depending on the domestic tax law of the other state, interests could be deductible there. that is why it is very important to compare the corporate tax rate of the different states and their tax regimes before taking the final decision establishing an se company, for example, if the tax rate is higher abroad than in the home state, it would be better and wiser to deduct the interests abroad than in the home state.113 although the se should not be considered as a tax planning tool, it has many advantages which may lead to see it as such. the se has many advantages which may push businesses to choose it as a convenient instrument for their activities, especially when transferring the seat or in crossborder mergers. the se is qualified to have better approach for the bilateral tax treaties as it is a transnational company with a larger dimension than the national companies. the se also benefits from the credit versus exemption system to avoid double taxation, and to offset losses of foreign pes or subsidiaries from profits in the state of establishment of the se. an se can benefit as well from the neutral tax treatment of the transfer of assets between its foreign pes, the reduction of tax burden of its capital gains and the avoidance of cfc regimes.114 however, not all critiques are from the same point of view in respect of tax advantages, because even if the se seems to be a perfect tax planning tool, it may still encounter some tax problems in the same way as other national companies do. the se would be an opportunity for the eu to look forward the enhancement of the corporate taxation in the eu. one solution is the implementation of the european union company income tax (the eucit) which would constitute the adoption of a tax code applicable at the eu level.115 another solution could be to fix the same tax bases and tax rates for corporations in all of the european union. notwithstanding the fact that this solution should be impossible because of the political and practical obstacles, it could solve the biggest problem of corporate taxation in the eu.116 moreover, another prospect of a corporate tax system would be the single compulsory harmonized tax base which would consist of replacing all national tax codes for one single corporate tax code applicable for all companies across europe without considering the size or the cross-frontier activities of those entities. it is obvious that this mechanism will eliminate the actual differences in tax bases and the determination of the applicable tax law on cross-border entities. this system would eliminate the double taxation situations and many 112in finland for example, see helminen, marjaana: finnish international taxation, pp. 235 113helminen, m: pp. 235 114wenz 2: pp.48 115da costa & bilreiro: pp. 165 116helminen, mar: pp. 33 nordic journal of commercial law issue 2013#2 23 other major obstacles. however, not all problems would cease to exist, such as the taxation of partnerships in relation to tax on persons.117 home state taxation (hst) could be also a solution for the tax problems the se faces, thus, an se will face only the national tax system of its state of residence, and all profits gained in different member state s would be taxed in the home state.118 according to gammie, hst is considered to be the most practical solution as a start, and that member states would regret their unsuccessful attempt to adopt tax rules specific for the se not only to make its adoption easier but also in order to avoid tax evasion of domestic systems.119 however, a counterargument could be the fact that the merger directive and the 2005 amendment directive has brought considerable solutions for the se. furthermore, member states still have the chance of future amendment of the se statute in order to find a solution for tax treatment of the se that would be suitable for all member states. according to soler, the amendment directive tries to disguise the free movement of the se with the economical interests of the member state. as the condition of the pe remaining in the state of origin is to ensure the taxation on capital gains, this leads to the result that the transfer of an se and the transfer of a national entity would incur a similar treatment. soler argues that in order to avoid tax problems when transferring the registered office of an se is to eliminate completely exit taxation and any other tax barriers because the se statute benefits from the mobility without restrictions and that is why tax treatment should meet the requirements of such freedom.120 another solution could also be the common-base taxation (cbt), where an eu group of companies would be taxed only once on its consolidated profits, the group’s overall income is consolidated then allocated on the basis of a special scale, and every state will tax the income at its domestic tax rate. this way, the group’s benefits are taxed once, and every state will preserve its tax sovereignty and get its tax revenue. 121 6 conclusion it is worth pointing out that the se is the company form which is most uniformall over europe, so that companies are familiar with it if they want to establish themselves in another member state.122 however, the problem of different languages and legal traditions in the eu persists, 117da costa& bilreiro: pp 166-167 118helminen, mar: pp. 33, see also da costa & bilreiro: pp. 167 119gammie: pp. 45 120soler: pp. 15 121helminen, mar: pp. 33, see also da costa & bilreiro: pp. 165 122werlauff 3: pp.160 nordic journal of commercial law issue 2013#2 24 even for a common corporate form 123 like the se, the establishment in a specific member state or the transfer from one state to another will require certain knowledge of each member state traditions, which would likely be an obstacle to se mobility, and reduce its mobility across the internal market.124 notwithstanding, the corporate tax problems facing the se, we can also add the obligation for an se to comply with many uncoordinated domestic tax regimes, and to be also subject to the expensive costs as a result of that. as a consequence, ses will always take as a place of residence the state with the best choice of corporate tax system,125 which once again may not be a good choice for example for employee involvement or for other issues. the supporters of the positive integration propose a solution: to introduce concrete legislative actions that would tackle the problems of the european corporate taxation for example concerning the cross-border loss compensation in the eu. however, the negative integration has also a consequential role when interpreting the eu treaty by the ecj. although, the ecj decisions treat only the particular subject problem, the positive integration could handle the larger taxation issues.126 the requirement of bringing a new tax framework in order to combat tax obstacles, with regard to the se company, must not be regarded as a preferential demand in favour of the se at the expense of other national legal entities or business organisations, because this solution may in fact only lead to an excessive and exaggerated use of ses to escape taxation and impede the functioning of the internal market because of harmful tax policy within the eu.127 the ability for an se to choose the member state of establishment that is the most advantageous for tax purposes and the possibility to move from a state to another without any restriction for the same reasons is considered an important feature within the single market.128 so, besides all the tax problems, the se will always have the issue of selecting the member state that suits its tax purposes the best as a state of residence, unless member state s find a common system to unify their different corporate tax systems. however, the cross-border merger directive offer the same possibility for all companies, therefore the se cannot be considered as the only form of company with this advantage. there are still some doubts whether the se has achieved all of its objectives, especially concerning the uniformity and the mobility of the se, uniformity has not been completely fulfilled yet, the indeterminable reference to national laws raises the same questions of 123teichmann: pp.157 124werlauff 3: pp.160 125 helminen, mar: pp. 33 126helminen, mar: pp. 34 127wenz 2: pp.50 128gammie: pp.45 nordic journal of commercial law issue 2013#2 25 uncertainty about the uniformity of the statute. for the mobility of the se, the real seat principle which is against the freedom of establishment and other tax obstacles that considerably restrict the mobility of the se need to be adjusted. it is argued also that one can question whether there is a need for a supranational entity, and more supranational companies,129 if it does not bring anything new to company law except its name and its european supranational identity. the se has not achieved many of practical objectives especially concerning the freedom of establishment and mobility and has fulfilled very little of what was theoretically expected. however, it is expected that the amendments of the se statute would bring new solutions for the different problems that have been faced in practice and also for the theoretical problems that may occur during the running of the se. the solutions would certainly increase competitiveness in the eu company law as well. bibliography statutes and treaties tfeu: treaty on the functioning of the european union se regulation: council regulation no 2157/2001 of 8th october 2001 on the statute for a european company, oj l294 10.11.2001 employee directive: council directive 2001/86/ ec of 8th october 2001 supplementing the statute for a european company with regard to the involvement of employees. parent-subsidiary directive: council directive 90/435/eec of 23 july 1990, on the common system of taxation applicable in the case of parent companies and subsidiaries of different member states. tax merger directive: council directive 90/434/eec of 23 july 1990, on the common system of taxation applicable to mergers, divisions, transfers of assets and exchanges of shares concerning companies of different member states. 129grundmann: pp. 760 nordic journal of commercial law issue 2013#2 26double taxation convention: convention 90/436/eec on the elimination of double taxation in connection with the adjustment of profits of associated enterprises. the amendment directive: council directive 2005/19/ec of 17 february 2005 amending the council directive 90/434/eec of 23 july 1990, on the common system of taxation applicable to mergers, divisions, transfers of assets and exchanges of shares concerning companies of different member states. the cross-border mergers directive: directive 2005/56/ec of the european parliament and of the council of 26 october 2005 on cross-border mergers of limited liability companies. the preparatory works bulletin of the european communities, supplement 5/89: − proposal for a regulation on the statute for a european company. − proposal for a directive complementing the statute for a european company with regard to the involvement of employees in the european company. presented by the commission to the council on the 25 august1989 http://aei.pitt.edu/8562/01/31735055261568_1.pdf law reviews & articles conci: conci, paolo, the tax treatment of the creation of an se, european taxation 44/2004:1, p.15-27 gammie: gammie, malcom, eu taxation and the societas europaeaharmless creature or trojan horse? european taxation 44/2004:1, p.35-45 nordic journal of commercial law issue 2013#2 27helminen, mar: helminen, marjaana, the tax treatment of the running of an se, european taxation 44/2004:1, p.28–34 helminen, s: helminen, sakari, european company se, turku law journal 2/2001, p.19–45 lenoir: lenoir, noëlle, the societas europaea (se) in europe, a promising start and an option with good prospects. utrecht law review, volume 4, issue 1 (march) 2008, igitur, p13-21 http://www.utrechtlawreview.org/publish/articles/000057/article.pdf soler: soler roch, maria teresa: tax residence of the se, european taxation 44/2004:1, p.11-15 teichmann: teichmann, christoph, “law as a product”regulatory competition in the common market and the european private company, edited by bartman, steef m, european company law in accelerated progress, european company law series, volume 1, kluwer law international, (the netherlands, 2006), p145-157 wenz 1: wenz, martin, european company, societas europaea, legal concept and tax issues, european taxation 44/2004:1, p.4-11 wenz 2: wenz, martin, taxation of the european company (societas europaea, se) key tax issues and faqs on se taxation, kluge, norbert & stollt, michael, the european companyprospects for worker boardlevel participation in the enlarged eu, (brussels, 2006), p43-50 http://www.seeurope-network.org/homepages/seeurope/file_uploads/booklet2006.pdf werlauff 3: werlauff, erik, the se as a legal form for financial companies, edited by bartman, steef m, european company law in accelerated progress, european company law series, volume 1, kluwer law international, (the netherlands, 2006), p159-174 nordic journal of commercial law issue 2013#2 28wymeersh: wymeersh, eddy, the transfer of the company`s seat in european company law, common market law review 40/2003, p.661-695 legal literature craig & de búrca: eu law, text, cases and materials, second edition, (oxford, 1998) da costa & bilreiro: da costa, carla tavares & bilreiro, alexandra de meester: the european company statute, european business law and practice series, (kluwer law international, 2003) grundmann: grundmann, stefan, european company law: organization, finance and capital markets, ius communicatis series, volume 1, interesentia, antwerpen, (oxford, 2007) helminen, m: helminen, marjaana, finnish international taxation, second edition, wsoy (helsinki, 2005) merle: merle, philippe, droit commercial, sociétés commerciales, 2éme edition, précis dalloz (paris, 1990) werlauff 1: werlauff, erik, se-the law of the european company, (copenhagen 2003) werlauff 2: werlauff, erik, eu company law, common business law of 28 states, second edition, (copenhagen, 2003) internet cathiard: cathiard, catherine,the european company (se) : good reasons to adopt the european company status, 30.08.2011 http://avocats.fr/space/catherine.cathiard/content/_c823a8f5-c663-4937-89b5-dd1f9899484f nordic journal of commercial law issue 2013#2 29eur-lex: http://eur-lex.europa.eu/ ibfd: survey on the societas europaea, prepared by the international bureau of fiscal documentation ibfd, published on the european commission’s web site, september 2003, http://ec.europa.eu/taxation_customs/resources/documents/survey.pdf loyens: loyens, loeff, preliminary rulings requested by the hungarian supreme court on cross-border conversion of companies (vale), eu tax alert, edition 84, october 2010, http://www.loyensloeff.com/en-us/news/publications/newsletters/eutaxalert/eu_tax_alert_84.pdf robakov: robakov, jevgeni, societas europaea, analysis of adoption and practical functioning, master thesis, jönköping university, (2007) http://hj.divaportal.org/smash/record.jsf?pid=diva2:3511 seeurope: http://www.seeurope-network.org/homepages/seeurope/secompanies.html worker-participation: http://www.worker-participation.eu 1 airbnb and the swedish tenancy legislation: an analysis of unexplored possibilities robert einefors* * phd candidate in civil law, faculty of law, school of business, economics and law at the university of gothenburg, sweden. njcl 2018/1 173 1. introduction ................................................................................... 174 1.1. airbnb and the swedish context .................................. 174 1.2. the regulations on subletting a rental apartment and their implications in an airbnb-context .......... 176 1.2.1. the tenant’s possibility to sublet the apartment without the landlord’s consent 176 1.2.2. the rent tribunal’s case law on airbnb ......... 178 1.3. the lack of incentives for the landlord to allow short-term sublets.............................................................. 181 2. the aim of the article – a commercial model that gives the landlord incentives to allow short-term sublets.. 182 2.1. the framework of the airbnb-model – the involved parties and their interests.............................................. 183 3. the swedish tenancy legislation’s regulations on rent ............................................................................................................... 184 3.1. the main rule – the collective bargaining system and fair rents decided by the apartment’s utility value ........................................................................................ 185 4. the tenant’s possibility to charge the sublessee a rent that is higher than the tenant’s own ................................... 186 4.1. the main rule – only a limited extra fee for furnished apartments is possible .................................. 186 4.2. the exception – higher rents may be charged when the apartment is being sublet for recreational purposes ................................................................................... 187 5. the landlord’s possibility to charge the tenant an extra airbnb-fee for allowing short-term sublets through airbnb ................................................................................................. 190 5.1. is the airbnb-fee classified as rent or does it constitute a separate agreement? ............................... 191 5.2. the practical implications of the airbnb-fee’s classification as rent ........................................................ 193 5.2.1. the collective bargaining system is applicable on the airbnb-fee ..................................................... 193 5.2.2. the airbnb-fee must be specified in the tenancy agreement or in a collective bargaining agreement ........................................... 194 5.2.3. the regional rent tribunal can try the fairness of the airbnb-fee .................................... 196 6. conclusion ....................................................................................... 198 airbnb and the swedish tenancy legislation 174 abstract this article discusses the possibilities of airbnb in a swedish context, with a focus on rental apartments. although airbnb has become more common, it has so far had a limited impact in sweden compared to many other countries. one of the presumed reasons for this is the relatively strict tenancy legislation. two aspects of the tenancy legislation that are central in an airbnbcontext are that a tenant may not sublet an apartment without the permission of the landlord or the rent tribunal, according to ch. 12 sec. 39 and 40 of the land code (sfs 1970:994), and that the landlord is not allowed to charge the tenant a higher rent than the one that has been specified in the tenancy agreement, according to ch. 12 sec. 19 of the land code. since the landlord does not have an economic incentive to allow such sublets if the landlord cannot charge an extra fee, this has led to a situation where rental apartments rarely are being sublet through airbnb, even when they are not being used by the tenant, e.g. during vacation periods. this article analyses the possibility to create a commercial model which makes it possible for the landlord to charge an extra fee for allowing the tenant to sublet the apartment short-term through e.g. airbnb and also makes it possible for the tenant to, in turn, charge the sublessee a rent that is higher than the tenant’s own rent. the main conclusion is that it is possible to construct such a model, thereby giving both the landlord and the tenant economic incentives to sublet the rental apartment during shorter periods of time when the apartment is not used by the tenant. the article further analyses the practical implications of relevant regulations in the tenancy legislation, and how landlords and tenants may use the commercial model in a way that corresponds to the legislation’s requirements. 1. introduction 1.1. airbnb and the swedish context just like in countries all over the world, sweden has seen the rise of the ‘sharing economy’, with airbnb1 serving as one of the front figures. the growth of airbnb has led to an increase in short-term subletting, as well as an increased discussion about the swedish housing legislation and its adaptability in the sharing economy-context. however, a report prepared for the european commission has found that sharing economy platforms do not appear to be as popular in sweden as elsewhere in 1 the focus of this article is airbnb, since it is the largest intermediary platform for short-term sublets in an international context. the article is, however, of course also relevant for similar platforms. njcl 2018/1 175 europe.2 one of the presumed reasons for this is that the swedish housing regulation is considered inadequate for the short-term subletting situations facilitated by airbnb and similar services.3 in the swedish context, the housing legislation can give rise to four different types of situations, depending on which type of housing that is being sublet and whether the agreement covers the whole dwelling or just a part of it: 1. subletting a rental apartment that the tenant rents from a landlord (hyresrätt), which as a main rule requires the landlord’s approval. 2. subletting a tenant owner apartment (bostadsrätt4) in a multidwelling building owned by a tenant owner association, which as a main rule requires the approval of the board of directors of the association. 3. subletting a dwelling of which the owner has full ownership (in the form of a detached house or a condominium, ägarlägenhetsfastighet), which does not require permission from another party.5 4. subletting only a part, e.g. a single room, while still retaining the rights to use the rest of the dwelling, which does not require permission even if the dwelling is a hyresrätt or bostadsrätt.6 in an airbnb-context, the most relevant types of sublets are those of rental apartments and tenant owner apartments. this stems from the 2 see sofia ranchordás, ’home-sharing in the digital economy: the cases of brussels, stockholm and budapest’ (2016) paper prepared for the european commission, p. 47. <https://ec.europa.eu/docsroom/documents/16950/attachments/1/translations/en/ renditions/pdf> accessed 15 june 2018 3 ibid. p. 50. 4 a bostadsrätt is an apartment within a building that is owned by a tenant owner association. when buying a bostadsrätt, the buyer does not become the legal owner of the apartment, but instead becomes a member of the tenant owner association and acquires an exclusive right to use the apartment. since the tenant owner association is the legal owner of the apartments in the building, the owner of the bostadsrätt needs the permission of the board to sublet the apartment. 5 the swedish form of condominium, ägarlägenhetsfastighet, is still uncommon in sweden. it was introduced in 2009 and at the end of 2017 only 1321 such apartments had been built, see statistics sweden, ‘fastighetsbeståndet, korrigerad 2018-01-18’. <http://www.scb.se/hitta-statistik/statistik-efter-amne/boende-byggande-ochbebyggelse/fastighetstaxeringar/fastighetstaxeringar/pong/tabell-ochdiagram/fastighetsbestandet/> accessed 15 june 2018 6 regarding rental apartments, see ch. 12 sec. 41 of the land code, jordabalken, and erika p björkdahl, hyra av bostad och lokal (iustus förlag 2018) p. 261 ff. regarding tenant owner apartments, see ch. 7 sec. 8 of the tenant owner apartment act, bostadsrättslagen, (sfs 1991:614) and bob nilsson hjort & ingrid uggla, bostadsrättslagen: en kommentar (norstedts juridik 2014) 7 kap. 8 § section 01. partiell sublokation. airbnb and the swedish tenancy legislation 176 fact that the demand for short-term rentals through airbnb is biggest in the major cities, where rental apartments and tenant owner apartments constitute the majority of the dwellings. these two types together represent 90 % of the dwellings in stockholm, 80 % of the dwellings in gothenburg and 82 % of the dwellings in malmö.7 the focus of this article is to examine the legislation on rental apartments (situation 1) and its possibilities in an airbnb-context, which has not yet been analysed deeper in the swedish context. before the closer aim of the article is presented, however, we first need to understand the context by analysing the regulations on subletting a rental apartment. 1.2. the regulations on subletting a rental apartment and their implications in an airbnb-context 1.2.1. the tenant’s possibility to sublet the apartment without the landlord’s consent as mentioned in section 1.1 above, the main rule is that the tenant needs the approval of the landlord to be allowed to sublet the apartment, according to ch. 12 sec. 39 of the land code. there are, however, exceptions to this rule. if the landlord does not permit the tenant to sublet the apartment, then the tenant may appeal to the regional rent tribunal, hyresnämnden, according to ch. 12 sec. 40 of the land code. the rent tribunal shall allow the tenant to sublet if certain conditions are met, and the decision of the rent tribunal cannot be appealed.8 in an airbnb-context, it is also important to note that if the tenant wants to sublet the apartment to several different sublessees during a period of time, then the tenant needs the landlord’s (or the rent tribunal’s) permission in each separate case.9 the conditions that need to be met for the rent tribunal to give its permission for the tenant to sublet are found in ch. 12 sec. 40 of the land code, which states that the rent tribunal shall give its permission if: ‘1. the tenant because of age, sickness, temporary work or studies in another town, a longer stay abroad, special family circumstances or other comparable circumstances has considerable reasons to sublet, and 2. the landlord does not have a legitimate reason to refuse.’ 7 see statistics sweden, ’vanligast med 2 rum och kök på 57 kvadratmeter’, < http://www.scb.se/hitta-statistik/artiklar/2016/vanligast-med-2-rum-och-kok-pa57-kvadratmeter/ > accessed 15 june 2018 8 see ch. 12 sec. 70 of the land code. 9 see e.g. the official report sou 2007:74, upplåtelse av den egna bostaden, p. 29. njcl 2018/1 177 the first condition that needs to be met is thus that the tenant has considerable reasons to sublet the apartment. the condition is relatively strict, as indicated by the fact that the reasons need to be considerable. the section exemplifies a number of situations that are considered to constitute considerable reasons but is also applicable on other comparable situations. a common denominator of the different reasons is that the tenant has a substantial reason not to use the apartment during a period of time but still has a legitimate interest in retaining the right to return to the apartment.10 an example of a situation that is not considered to constitute a considerable reason is when a tenant wants to sublet solely to earn monetary compensation – not even if the tenant due to economic difficulties is temporarily unable to pay the rent.11 in earlier versions of the section, the requirements were even more strict and only covered situations where the tenant because of sickness or other unexpected events could not use the apartment during a period of time.12 the tenant also needed to show that the tenant would leave the apartment for ‘some time’ and that it was probable that the tenant would return to the apartment within a foreseeable period of time. at the end of the 20th century, the section was made more permissive. the change was motivated by the will to make the law more permissive for tenants who were sick or elderly, or persons that wanted to try living together with a partner, since these categories of tenants had a hard time showing that it was probable that they would return to the apartment within a foreseeable period of time.13 the change was also motivated by the view that it was too strict to demand that the tenant was forced to leave the apartment due to circumstances that the tenant could not influence, and the lawmaker pointed out that the tenant could have considerable reasons to sublet due to more or less voluntary choices (e.g. when trying a new job in a different city or when ‘test-living’ with a partner).14 the change was implemented by removing the requirement stating that the tenant would have to leave the apartment for ‘some time’.15 this does, however, not mean that the time aspect does not affect the assessment. the rent tribunals regularly deny appeals by tenants who wish to sublet during periods of less than a month, since the tenant rarely is considered to have a considerable reason to sublet in these cases.16 10 see leif holmqvist & rune thomsson, hyreslagen: en kommentar (norstedts juridik 2015), 40 §. 11 see the official report sou 1991:86, ny hyreslag, p. 127-128. 12 see government bill prop. 1968:91, med förslag till lag angående ändring i lagen den 19 juni 1942 (nr 429) om hyresreglering m.m. och om fortsatt giltighet av lagen, m.m., supplement a p. 225. 13 see government bill prop. 1997/98:46, ändringar i hyreslagen m.m., p. 20. 14 ibid. 15 ibid. p. 57. 16 see the official report sou 2017:86, hyresmarknad utan svarthandel och otillåten andrahandsuthyrning, p. 172. airbnb and the swedish tenancy legislation 178 the section was, yet again, made even more permissive in 2009, when the situation a longer stay abroad was added as a considerable reason.17 since the probably most common reason for a tenant to leave the apartment is when the tenant leaves on a holiday, this section is especially interesting in an airbnb-context. the reason for the change was that the lawmaker wanted to increase the possibilities for tenants to sublet, thereby counteracting the prevalent lack of dwellings in urban areas.18 the lawmaker further concluded that being able to sublet the apartment many times can be a prerequisite for the tenant to be able to travel abroad for a longer period of time.19 it was also clarified that the situation is not applicable if the tenant will be staying abroad only during ‘one or a few months’.20 it is thus unclear how long the stay needs to be to constitute a longer stay abroad, but based on the preparatory works the duration likely needs to be at least three months. finally, although the section exemplifies longer stays abroad, this does not exclude longer stays within the country, if the situation is comparable to a stay abroad.21 even if the tenant has considerable reasons to sublet the apartment, the rent tribunal shall deny the application if the second condition of ch. 12 sec. 40 of the land code is not met, i.e. if the landlord has a legitimate reason to refuse. the typical example of a situation where the landlord has a legitimate reason for a refusal is when the sublessee is known to be a disorderly person and therefore could be expected to disturb neighbours.22 1.2.2. the rent tribunal’s case law on airbnb the limits of ch. 12 sec. 40 of the land code in regard to subletting a rental apartment through airbnb has not been tried by any of the eight regional rent tribunals. the rent tribunal in stockholm has, however, tried the applicability of the corresponding legislation for tenant owner apartments. to understand the relevance of this decision, we first need to briefly compare the legislations on rental and tenant owner apartments. as mentioned in section 1.1, an owner of a tenant owner apartment needs the approval of the board of directors to be able to sublet the apartment. the board’s decision may be appealed to the rent tribunal, 17 see sfs 2008:1074, lag om ändring i jordabalken. 18 see government bill prop. 2008/09:27, ökade möjligheter till andrahandsuthyrning, p. 9. 19 ibid. p. 10. 20 ibid. p. 21. the lawmaker did thus not clarify how many months that are needed for a stay to be considered longer. it did, however, not share the commission of inquiry’s opinion that a longer stay should be at least six months, cf. the official report sou 2007:74, upplåtelse av den egna bostaden, p. 90. 21 ibid. p. 21 f. 22 see e.g. charlotte andersson & emil andersson, lägenhetsbyten och andrahandsuthyrning (norstedts juridik 2015), p. 28 and government bill prop. 1997/98:46, ändringar i hyreslagen m.m., p. 19. njcl 2018/1 179 in the same way as a tenant may appeal the landlord’s decision. the corresponding rules for both situations are very similar, but where a tenant needs to have a considerable reason to sublet, an owner of a tenant owner apartment only needs to have a reason.23 as in the case of rental apartments, the rent tribunal shall deny the appeal of the owner of the tenant owner apartment if the tenant owner association has a legitimate reason to refuse the owner to sublet. in short, these sections in the regulations on rental apartments and tenant owner apartments are very similar, but the legislation on subletting a tenant owner apartment is more permissive.24 in 2015, the rent tribunal in stockholm tried a case where an owner of a tenant owner apartment wanted the tribunal’s permission to sublet the apartment to seven different people during a period of approximately one month.25 the contact with the sublessees had been established through airbnb. the owner of the tenant owner apartment had recently moved and wanted to sublet the apartment during the period before the new owner of the apartment moved in, to avoid paying double costs for two different dwellings. the tribunal stated that this may constitute an acceptable reason according to the tenant owner apartment act.26 however, the tribunal found that the intended sublets showed more similarities with a commercial hotel business than with the purposes that the legislation was aimed at, since the rental fees were in level with hotel fees, the number of sublets were high and the durations of the stays were short. as such, the owner of the apartment was not considered to have a reason for subletting the apartment in the way that she desired, according to the interpretation of ch. 7 sec. 11 of the tenant owner apartment act. finally, the rent tribunal further found 23 see ch. 7 sec. 11 of the tenant owner apartment act. the similarities between these regulations are not by chance. they were originally almost identical, but the regulation on tenant owner apartments was revised and the rules on sublets of this kind of apartments were made more permissive in 2003 and 2014, see government bill prop. 2002/03:12, olika bostadsrättsfrågor, p. 68-72 and government bill prop. 2013/14:142, ökad uthyrning av bostadsrättslägenheter, p. 11-14. 24 the reasons for this are, among other things, that the owner of a tenant owner apartment has paid for the apartment and that the exclusive right to the apartment constitutes a right that can be said to be somewhere in-between an ownership right and a tenancy, see government bill prop. 2002/03:12, olika bostadsrättsfrågor, p. 49-50 and government bill prop. 2013/14:142, ökad uthyrning av bostadsrättslägenheter, p. 12-13. 25 see hyresnämnden i stockholm [the rent tribunal in stockholm] case no. 874115, 2015-08-17. 26 cf. government bill prop. 2013/14:142, ökad uthyrning av bostadsrättslägenheter, p. 13 f. where the lawmaker stated that the owner of a tenant owner apartment in some cases should be allowed to sublet even if the owner will not return to the apartment, for example if it is hard to sell because of the state of the market. it should, however, be mentioned that similar reasons have not been mentioned in the preparatory works on the corresponding regulations on rental apartments. airbnb and the swedish tenancy legislation 180 that the association also had legitimate reasons to refuse the sublets since the high number of unknown people in the building would lead to inconveniences for the other apartment owners. a central point of the case that was tried by the rent tribunal in stockholm is that the rent tribunal found that an owner of a tenant owner apartment may have a reason to sublet during a period of time, but not a legitimate reason to sublet the apartment through several subsequent short-term sublets of a commercial nature. this could be interpreted in two ways. either the rent tribunal meant that the apartment owner’s reason to construct the sublets this way was purely to earn money, which the lawmaker explicitly has stated does not constitute a reason.27 the reasoning could also be understood in the way that each separate subletting did not fulfil the requirements to constitute reasons because the time periods were too short – an interpretation that is based on the fact that the apartment owner needs the association’s or rent tribunal’s permission for each separate subletting. irrespective of which of the interpretations that was the basis for the decision, it is clear that several subsequent short-term sublets of a commercial nature does not constitute a reason that gives the apartment owner the right to sublet without the association’s permission. the case further shows that irrespective of the apartment owner’s reason for subletting, the association has a legitimate reason to refuse because of the fact that the high number of unknown people in the building would lead to inconveniences for the other apartment owners. although the case that was tried by the rent tribunal in stockholm only concerned tenant owner apartments, the outcome in a case regarding a rental apartment would almost undoubtedly have been the same, because of the similarities between the two regulations (and the fact that the regulation on tenant owner apartments is more permitting). it should, however, be noted that sweden has eight different rent tribunals and the decision of a rent tribunal to allow or deny a tenant or an owner of a tenant owner apartment to sublet may not be appealed further.28 as such, there is no court of record that creates precedents in these cases, and there is a risk that different rent tribunals may judge similar cases differently. the different rent tribunals, however, continually work together and exchange opinions to mitigate this risk 27 ibid. p. 14. 28 see ch. 12 sec. 70 of the land code regarding rental apartments and ch. 11 sec. 3 of the tenant owner apartment act regarding tenant owner apartments. at the time when this article is being written, however, the government is drafting a government bill which could make it possible to appeal these decisions. if the government bill is put forward in its current form and the legislative proposals are enacted, it will be possible for the rent tribunal to allow a decision to be appealed to svea court of appeal, if the case is of importance to guide the application of the law, see the government’s referral to the council on legislation (5 july 2018), lagrådsremiss, en modernare och mer ändamålsenlig prövning av hyresoch arrendenämnden, p. 49 ff. njcl 2018/1 181 and to create a uniform interpretation of the legislation.29 further, the cited decision corresponds well with the preparatory works and nothing indicates that other rent tribunals would judge similar cases differently. in regard to rental apartments, the conclusion is therefore that a tenant will not be able to use airbnb for short-term subletting of the tenant’s apartment, if the landlord does not allow it. 1.3. the lack of incentives for the landlord to allow shortterm sublets what has been analysed so far is the possibility to forcibly sublet the apartment without the landlord’s approval. the landlord can of course choose to allow these kinds of short-term sublets, if the landlord so wishes. the relevant question is then if a landlord can be expected to allow a tenant to use airbnb for short-term subletting. the common view on this question is, however, that a landlord does not have any incentives to do so. there are two main reasons for this. the first reason is that short-term sublets are linked to increased risks and inconveniences for the landlord and the other tenants in the building. the risks and inconveniences that usually are mentioned are the risks of increased wear and/or damage to the apartment or other parts of the property as well as an increased risk of disturbances and other inconveniences due to the many unknown people that would be staying in the building.30 because of these reasons, in connection with the fact that the tenant’s aim of subletting short-term usually is to earn extra money, sabo [the swedish association of public housing companies] and fastighetsägarna [the swedish association of property owners] jointly recommend that landlords do not allow commercial short-term sublets.31 the second reason for the common view that landlords cannot be expected to allow a tenant to use airbnb for short-term subletting is closely related to the first one and is that the landlord is not allowed to charge the tenant a higher rent than the one that has been specified in the tenancy agreement.32 this means that the landlord, if the landlord voluntarily allows the tenant to sublet the apartment short-term even though it is not required, will not be able to charge economic compensation that covers the increased risks, nor the increased 29 see e.g. the foreword to charlotte andersson & emil andersson, lägenhetsbyten och andrahandsuthyrning (norstedts juridik 2015). 30 see e.g. fastighetsägarna [the swedish association of property owners], ‘korttidsuthyrning av bostadsrätt’ < http://www.fastighetsagarna.se/fakta/brf/andrahandsuthyrning/riktlinjer-foruthyrning-av-bostadsratt/ > accessed 15 june 2018 31 see fastighetsägarna & sabo ‘riktlinjer för andrahandsuthyrning’ (alfredssons 2015), p. 6. 32 ibid. p. 8 and ch. 12 sec. 19 of the land code. airbnb and the swedish tenancy legislation 182 administrative costs related to administering the subletting.33 from an economic point of view, the landlord thus would not have any incentives to allow commercial short-term sublets through airbnb. however, the main point of this article is to argue that it is possible for the landlord to charge an extra fee to allow short-term sublets through airbnb and similar services, thereby creating economic incentives for the landlord to allow such sublets. 2. the aim of the article – a commercial model that gives the landlord incentives to allow shortterm sublets both the eu and the swedish lawmaker are generally positive toward an increased use of the services of the sharing economy.34 however, as was concluded in the previous sections, a tenant will not be able to use airbnb for short-term subletting of the tenant’s apartment, if the landlord does not allow it. further, the landlord cannot be expected to allow short-term sublets if the landlord does not gain an extra monetary compensation. the possibility of charging such an extra fee for allowing short-term sublets has not been analysed in a swedish context and it is not an actual practice on the market. the main implications of this is that many apartments are not used when the tenant is away – especially during vacation periods35 or weekends. these are also the periods when the demand for apartments through airbnb can be expected to be the highest.36 33 this does not mean that the landlord is unable to sue the tenant for e.g. reparation costs if the sublessee damages the apartment, see ch. 12 sec. 24 of the land code and e.g. erika p björkdahl, hyra av bostad och lokal (iustus förlag 2018), p. 257-259. such a proceeding is, however, associated with ‘unnecessary’ time and costs, compared to the alternative of not allowing the subletting to begin with. 34 regarding the swedish lawmaker, see e.g. kommittédirektiv 2015:136, in which the government appointed a commission of inquiry to analyse various models that facilitate sharing economy-transactions between private individuals, and to examine whether there was a need to change the existing legislation to better promote positive developments of the sharing economy. see also the commission of inquiry’s official report, sou 2017:26 delningsekonomi på användarnas villkor. regarding the eu, see e.g. comission, ‘a european agenda for the collaborative economy’, (communication) com (2016) 356 final. <https://ec.europa.eu/docsroom/documents/16881/attachments/2/translations/en/ renditions/pdf> accessed 15 june 2018 35 which rarely will be for a long enough period of time to constitute a considerable reason to sublet, see section 1.2.1 above. 36 the vacation periods are also the periods when the amount of unauthorised sublets in sweden are the highest, where airbnb is suspected to be one of the contributing factors, see the official report sou 2017:86, hyresmarknad utan svarthandel och otillåten andrahandsuthyrning, p. 177 f. njcl 2018/1 183 the specific aim of this article is thus to analyse if, under the swedish tenancy legislation, it is possible to construct a commercial model through which the landlord may demand extra compensation when allowing a tenant to use the apartment for short-term subletting through airbnb. 2.1. the framework of the airbnb-model – the involved parties and their interests before we take a closer look at the possibilities of charging an extra fee for the short-term subletting, we need to look at the different parties that are involved, and the interests that the commercial model (henceforth called the ‘airbnb-model’) needs to satisfy. in other words, we need to lay down the framework of the model in order to see which legal questions and considerations that it gives rise to and that need to be analysed to determine if the airbnb-model is possible to construct. on a general level, the airbnb-model includes three different parties and two different relations (exluding airbnb, whose intermediary function is not analysed further in this article). the three different parties are the landlord, the tenant and the sublessee and the two relations are between the landlord and the tenant and between the tenant and the sublessee. as mentioned above, the interest of the landlord is to be able to charge an extra fee for allowing short-term sublets. the tenant, in turn, will generally – just like the landlord – have an interest in charging the sublessee a fee that is higher than the tenant’s own rent for the relevant period of time that the apartment is being sublet. in other words, the tenant also has an interest in charging a premium and thereby earning extra monetary compensation when subletting short-term (especially since the airbnb-model would include the extra fee charged by the landlord). this interest partly stems from the fact that the tenant, in relation to the landlord, is responsible for the sublessee’s actions and in the worst case might lose the apartment if the sublessee misbehaves to a substantial extent.37 the sublet might also involve an increased risk of damages to the tenant’s possessions, e.g. furniture.38 finally, the tenant of course generally has an interest in earning extra income if it is possible to do so by subletting the apartment when the tenant is not using it.39 37 see e.g. erika p björkdahl, hyra av bostad och lokal (iustus förlag 2018), p. 257-259. 38 it should however be mentioned that, in the case of sublets through airbnb, this risk is decreased through airbnb’s ’host guarantee’, see airbnb ’the $1,000,000 host guarantee’ < https://www.airbnb.com/guarantee?locale=en > accessed 15 june 2018 39 cf. boverket [national board of housing, building and planning] rapport 2015:39, andrahandsmarknaden: hyror, utbud och institutioner (boverket 2015), p. 70, where boverket carried out a survey examining the tenant’s/owner’s reasons for subletting houses, tenant owner apartments and rental apartments. 54 % answered that their reason for airbnb and the swedish tenancy legislation 184 finally, the sublessee of course has an interest to pay as little rent as possible. the relevant question in this context is, however, if the sublessee is willing to pay a rent that exceeds the tenant’s own rent for the apartment, since the interests of the landlord and the tenant to both gain a premium from the short-term sublet would otherwise not be able to be met. the short answer to this question is that sublessees are willing to pay such a premium. since the sublessees are looking for short-term accommodation, their other possibilities are mainly hotels or hostels. the comparable costs a sublessee is willing to pay is therefore decided by the costs of staying at a hotel or hostel, which generally are more expensive per night than the daily cost of a monthly rent of a rental apartment. this intuitive assumption has also been confirmed in a study of the airbnb-market in stockholm, carried out by the european commission.40 in conclusion, both the landlord and the tenant have an interest in earning an extra monetary compensation through the short-term sublet, and the sublessee can be expected to be willing to pay such a premium. the relevant legal questions that then arise are if (i) the tenant is allowed to charge a higher rent from the sublessee than the tenant’s own rent (thereby earning a premium that can be split with the landlord) and (ii) if the landlord is allowed to charge the tenant an extra fee (henceforth called the ‘airbnb-fee’) for allowing the short-term sublet. 3. the swedish tenancy legislation’s regulations on rent the main regulations on rent in the tenancy legislation are applicable both on the relation between the landlord and the tenant, i.e. the first-hand lease, and on the relation between the tenant and the sublessee, i.e. the sublet agreement. before the exceptions for both of these relations are analysed, the relevant rules are therefore briefly explained.41 subletting was ’of economical reasons’ or ’good extra income’, and 36 % because of ’work/study in another town or travel abroad’. it should also be mentioned that 83 % of the sublets were long-term (more than three months) and 17 % between 0-3 months. 40 see commission, ’study on the assessment of the regulatory aspects affecting the collaborative economy in the tourism accomodation sector in the 28 member states (580/pp/gro/ima/15/15111j) task 4, market case study – stockholm’ (european union 2018) p. 13, which specifies that the average monthly rent for long-term apartments in stockholm in 2016 were 1009 eur, the average monthly rate for airbnb listings of an entire room/apartment was 3837 eur and the average monthly rate for a hotel room was 5019 eur. 41 for a comprehensive explanation in english of the swedish rental legislation and the implications of the collective bargaining system, see e.g. haymanot baheru, ‘swedish legislation of residential tenancies: an interaction between collective bargaining and mandatory regulation’ (2017) revista electrónica de direito no. 3. njcl 2018/1 185 3.1. the main rule – the collective bargaining system and fair rents decided by the apartment’s utility value the basis of the regulations on rent in ch. 12 of the land code is that the landlord and the tenant (or the tenant and the sublessee) are free to negotiate and decide the level of the rent themselves.42 however, the legislation on residential tenancies is partly characterised as a social protection legislation and is formed to ensure a general protection of residential tenants.43 residential tenants are thereby guaranteed a certain amount of protection, due to the social importance of a tenant’s need of a legally secured dwelling. as such, although the landlord and the tenant in principle are free to decide the rent themselves, the tenancy legislation provides a safeguard to prevent unfairly high levels of rent. a tenant who is unhappy with the rent may appeal to the regional rent tribunal, which will decide if the rent is fair or not. the fairness of the rent is decided by an assessment of the ‘utility value’ (sw. bruksvärde) of the apartment.44 if the rent is unfairly high compared to the utility value of the apartment, the rent tribunal shall determine the fair level of rent that shall be paid instead.45 the utility value of the apartment is determined by a comparison with the rent for other comparable apartments in the same municipality and whose rents have been negotiated through the so-called collective bargaining system, or through a general fairness assessment if such a comparison cannot be made.46 the comparison is based on the apartment’s general quality, benefits connected to the apartment and other factors that have an impact on the apartment’s value in the view of a tenant, compared to other comparable apartments.47 examples of factors that affect the utility value are size, level of modernity, layout, location within the building, general standard and soundproofing, elevators, laundry and storage facilities, the building’s location and proximity to public transportation, etc.48 factors that do not affect the utility value are e.g. the year that the building was built, the landlord’s costs of production, operation and management costs, and the tenant’s personal preferences or needs.49 42 see e.g. erika p björkdahl, hyra av bostad och lokal (iustus förlag 2018), p. 78. 43 see e.g. the official report sou 2017:86, hyresmarknad utan svarthandel och otillåten andrahandsuthyrning, p. 37 f. 44 see ch. 12 sec. 55 of the land code. 45 ibid. 46 ibid. 47 see the official report sou 2000:33, bruksvärde, förhandling och hyra – en utvärdering, p. 22. 48 see government bill prop. 2009/10:185, allmännyttiga kommunala bostadsaktiebolag och reformerade hyressättningsregler, p. 67. 49 ibid p. 22. the rent for newly built houses may, during the first 15 years, however be decided differently, see ch. 12 sec. 55 c of the land code. airbnb and the swedish tenancy legislation 186 as mentioned, the utility value is mainly decided by a comparison with apartments whose rents have been determined through the collective bargaining system. in short, the collective bargaining system decides the rents for the collective residential rental apartments that are included in the system, through negotiations between organisations representing tenants on one hand and landlords on the other. the system is very widespread – almost all buildings that contain more than two residential apartments are included.50 the system also indirectly regulates the rents for (the very few) apartment buildings that have no affiliation with a tenants’ union, through the negotiated rents’ impact on the utility value of the unaffiliated apartments. the tenancy legislation is based on the idea that several tenants unions exist, but in practice almost all residential tenants (90 % of all residential rental apartments) are represented by hyresgästföreningen [the swedish tenants’ union].51 the landlords are predominantly represented by two different associations: sabo [the swedish association of public housing companies] which represents the municipal housing companies and fastighetsägarna [the swedish association of property owners] which represents the private landlords. in conclusion, the rents of residential apartments in sweden are decided through the collective bargaining system. an agreement between the tenants’ union and the landlords’ association directly decides the rents of the affected apartments. if the tenants’ union and the landlords’ association cannot reach an agreement (or if the relevant apartment is not included in the system), the rent can instead be decided by the rent tribunal, which determines the utility value of the apartment through a comparison with other apartments whose rents have been decided through the collective bargaining system. 4. the tenant’s possibility to charge the sublessee a rent that is higher than the tenant’s own 4.1. the main rule – only a limited extra fee for furnished apartments is possible as was briefly mentioned in section 3, the tenancy legislation’s main regulations on rent are applicable both on the relation between the landlord and the tenant and on the relation between the tenant and the 50 see tore ljungkvist, skälig hyra – en studie av bruksvärdessystemet (jure 2015), p. 26. it should also be noted that an agreement on a collective bargaining procedure covers the whole residential building, even if some of the tenants are not members of a tenants union (unless the tenant and landlord in writing has agreed that the tenant opts out), see sec. 3 of the collective bargaining act [hyresförhandlingslag] (1978:304). 51 see hyresgästföreningen [the swedish tenants union], ’hyresförhandling’ < https://www.hyresgastforeningen.se/var-verksamhet/vad-vi-gor/forhandlar-hyror/ > accessed 15 june 2018 njcl 2018/1 187 sublessee. this means that the fairness of the rent that the sublessee has to pay to the tenant for the sublet apartment can be tried by the regional rent tribunal, in the same way that the tenant may appeal to the rent tribunal if the landlord charges an unfairly high rent.52 this further means that the fairness of the rent also will be measured by the utility value of the apartment. since the utility value is derived from the apartment itself, the utility value is the same for both the tenant and the sublessee (since the same apartment is the object of both agreements). therefore, if the tenant charges the sublessee a rent that is higher than the tenant’s own, the sublessee may appeal to the rent tribunal which will judge the rent to be unfair and change it. there is, however, a common factor that can give the tenant right to charge a premium from the sublessee in relation to the tenant’s own rent. if the tenant rents an unfurnished apartment and, in turn, sublets the apartment equipped with the tenant’s own furniture, then the tenant may charge a higher rent. in other words, the utility value of the apartment increases due to the fact that it is furnished. the rent tribunal generally accepts an increased rent of 5-15 %, depending on to what extent the apartment has been furnished and on the quality of the furniture.53 the tenant thus, as a main rule, has a possibility to earn 5-15 % of the tenant’s own rent as a premium when subletting. this sum, however, is not enough to fully satisfy the interests of both the landlord and the tenant to share a large enough premium when subletting short-term through airbnb (see section 2 above). we therefore need to look at another exception to the main rule that restricts the rent, to see if the tenant is able to charge a high enough rent to fulfil the conditions for the commercial airbnb-model that we are looking to create. 4.2. the exception – higher rents may be charged when the apartment is being sublet for recreational purposes the tenancy legislation contains an exception to the abovementioned main rule on the rent level’s connection to the utility value of the apartment. the exception states that the sublessee cannot turn to the rent tribunal and claim that the rent exceeds the apartment’s utility value, if the duration of the sublet is less than nine months and the apartment is being sublet for recreational purposes.54 the types of sublets that we currently are analysing will never reach a duration of nine 52 the sublessee may also demand a retroactive repayment of any rent that has been paid within a year and that has exceeded the ‘fair’ rent as decided by the rent tribunal, see ch. 12 sec. 55 e of the land code. 53 see the official report sou 2007:74, upplåtelse av den egna bostaden, p. 63. 54 see ch. 12 sec. 53 of the land code, which states that ch. 12 sec. 55 is not applicable in these cases. also ch. 12 sec. 55 e is exempt in these cases, which means that the sublessee cannot demand retroactive repayment, cf. footnote 52 above. airbnb and the swedish tenancy legislation 188 months, and this part of the exception is therefore satisfied. the relevant condition is instead if the apartment is being sublet for recreational purposes, and if this condition is fulfilled in the case of short-term sublets through airbnb. the tenancy legislation does not state how the term recreational purposes is defined, nor has it been defined or discussed further in the preparatory works. the definition of the term has, however, been analysed by the rent tribunal in stockholm, in case no. 8171-06, 200709-27.55 in the case, the rent tribunal stated that the definition of ‘recreational purposes’ has not been described in the legislation, nor in the preparatory works or in earlier precedents. because of the lack of a definition, the tribunal found that the interpretation of the condition should be understood in light of the purpose of the legislation and of the how the wording is understood in its normal ‘non-judicial’ usage. the interpretation in each separate case should, according to the tribunal, as a main rule be based on the circumstances when the parties entered into the agreement, and that the purpose of the sublet should be decided by how the parties intended for the apartment to be used. the tribunal continued by explaining that the purpose of the sublet is not decided by how the parties themselves classify the sublet in the agreement, because this would mean that the parties could circumvent the purpose of the legislation through their own definition.56 the definition in the agreement is, however, one of the factors that is taken into account in the overall assessment of the purpose of the sublet. the tribunal finally concluded that the description of the purpose of the sublet that was being tried was more similar to a complementary dwelling than a sublet for recreational purposes. the kinds of sublets that are being examined in this article are short-term sublets through airbnb, with a specific focus on situations when the tenant does not use the apartment because the tenant has left on a trip during the holiday. if the sublessee is a person that is visiting the city during a holiday, the sublet should – according to the reasoning 55 it should be noted that the cited case was appealed to svea hovrätt [svea court of appeal], which is the court of record that creates the precedents in these cases, see sec. 10 of the law (1994:831) on the judicial process of certain tenancy cases in svea hovrätt. svea court of appeal tried the case and came to the same conclusion as the rent tribunal, see öh 7232-07. svea court of appeal, however, merely stated that it did not find any reason to “make another assessment than the one made by the rent tribunal”. it is therefore unclear if svea court of appeal made the same assessments regarding the term recreational purposes as the rent tribunal did. 56 see also öh 9977-09 [svea court of appeal], where the court found that an agreement constituted a ‘normal’ residential tenancy agreement, although the contract stated that the tenant only was allowed to use the apartment for recreational purposes. the reason for this was that the court found that it had been shown that none of the parties had intended for the apartment to only be used for recreational purposes. njcl 2018/1 189 in the case from the rent tribunal – be classified as a sublet for recreational purposes. this means that the tenant is able to charge a rent that exceeds the utility value of the apartment, without a possibility for the sublessee to appeal to the regional rent tribunal. this, in turn, satisfies the prerequisite mentioned in section 2.1, i.e. that the tenant is able to generate a premium which exceeds the tenants own rent for the apartment. in this context, it should also be noted that some people use airbnb when travelling for work purposes. due to the lack of clarity in regard to the definition of ‘recreational purposes’ in the tenancy legislation, it is unclear if work purposes could be considered to be included in the definition of recreational purposes. the case from the rent tribunal suggests that sublets for work purposes would not be included in this definition, mainly because ‘work’ is not included in how ‘recreational’ is understood in the normal ‘non-judicial’ usage of the word. the purpose of the legislation is, further, to prevent that a tenant exploits e.g. a lack of dwellings (which might force sublessees to pay more because of the difficulty to find available dwellings) to charge an unfairly high rent.57 sublets for recreational purposes are explicitly excluded since the protective motives of the legislation do not arise in these kinds of situations.58 a sublet for work purposes might, however, give rise to such considerations, for example if the worker must live in the city for a period of time and there is a lack of dwellings (in contrast to a person on vacation, who enjoys the voluntary choice of travelling to whichever city the person pleases). in conclusion, a tenant may charge the sublessee a higher rent if the apartment is being sublet to a sublessee that will use it for recreational purposes, which in turn satisfies one of the preconditions for the airbnb-model to work (that the tenant may charge a premium which exceeds the tenants own rent for the apartment). to be entirely sure that the sublet is included in this category, however, the landlords and tenants that use the model should make sure that the sublease agreement is formulated explicitly as a lease to use the apartment only for recreational purposes.59 further, they need to make sure that the sublessee also intends to use the apartment for recreational purposes and not for work purposes. 57 see government bill prop. 1987/88:162, om hyran vid andrahandsupplåtelse av bostadslägenheter, m.m., p. 11. 58 ibid. p. 13. 59 in practice, this can be achieved by adding the prerequisite to the tenant’s terms and conditions when listing the apartment on airbnb. these terms and conditions become a part of the legally binding agreement between the tenant and the sublessee when they reach an agreement through airbnb, see section 8.1.2 of airbnb’s terms of service. < https://www.airbnb.se/terms > accessed 20 september 2018 airbnb and the swedish tenancy legislation 190 5. the landlord’s possibility to charge the tenant an extra airbnb-fee for allowing short-term sublets through airbnb a central aspect of this part of the analysis is that the landlord’s permission to sublet short-term is something that can be regarded as an extra contractual right, i.e. a right that the tenant is not already ensured through the rights that are directly derived from the tenancy itself and safeguarded through ch. 12 of the land code. a tenant would, of course, not accept a system where the tenant needs to pay extra for a right that is already included in the rights that the tenant is guaranteed through the tenancy legislation (and therefore already paid for through the rent).60 the tenant would in such a case instead be able to appeal to the rent tribunal, which would grant the tenant permission to sublet without an extra cost. however, as concluded in section 1.2.2, the tenancy legislation does not include a right for the tenant to enforce the allowance of the landlord in the case of short-term sublets, and the allowance is therefore regarded as an extra contractual right.61 as was mentioned in section 3.1, the swedish tenancy legislation departs from the premise that the landlord and the tenant are free to negotiate and agree on the level of the rent themselves. the next question that is relevant in the analysis of the airbnb-model is therefore not if they can agree on an extra rent for the short-term subletting, but if the agreed extra compensation constitutes rent or if it should be classified as payment for a separate agreement and not a part of the tenancy agreement. the question is relevant because the tenancy legislation’s special provisions are only applicable on fees that are classified as rent (i.e. fees that are considered to be a part of the tenancy agreement). if the extra airbnb-fee is classified as rent it therefore has to be adapted to the tenancy legislation, whereas a fee that is not classified as rent as a main rule would constitute a separate agreement, which would be interpreted through the use of common principles of contract law.62 my assessment is that the extra fee should be classified as rent, thereby making the tenancy legislation applicable. the reasons for this, 60 the same can of course also be said regarding the tenants’ union, which will safeguard the tenant’s rights in the negotiations with the landlord, cf. section 5.2.1 below. 61 cf. e.g. rbd 44:81 [the rents and tenancies court of appeal] (which was the court of record until 1994, when it was dissolved and svea court of appeal became the new court of record). in this case the tenancy agreement contained a generally formulated consent by the landlord for the tenant to sublet the apartment. the consent was regarded as a contractual provision which could be renegotiated. see further erika p björkdahl, hyra av bostad och lokal (iustus förlag 2018) p. 258 f. 62 cf. official report sou 2004:91, reformerad hyressättning, p. 139-140, where the same question was analysed in regard to the classification of tenants’ options to include or exclude domestic appliances or other services provided by the landlord. njcl 2018/1 191 as well as the practical implications of the fee’s classification as rent, are explained in the following sections. 5.1. is the airbnb-fee classified as rent or does it constitute a separate agreement? the definition of ‘rent’ is not clarified in the tenancy legislation, nor in the older preparatory works. it has, however, been analysed in the doctrine and official reports. in these documents, the definition of rent has been discussed in the context of payment for services in connection with the tenancy agreement. the conclusion in these documents has been that services that are connected to the ‘core area’ of the tenancy should be interpreted as a part of the tenancy agreement, and that the payment in these cases constitutes rent.63 the exact limit for which services that should be considered to be connected to the ‘core area’ of the tenancy is unclear. the most discussed example is when the landlord gives tenants the option to add or remove domestic appliances or in other ways change the physical standard of the apartment. these options are considered to fall within the ‘core area’ and the compensation therefore constitutes rent.64 services that constitute a complementary function to the apartment, without changing the apartment’s physical constitution, are, however, harder to classify.65 although the definition of ‘rent’ is unclear in the case of services in connection with the tenancy agreement, there should be less doubt regarding the classification in the case of the extra airbnb-fee for allowing short-term commercial sublets. as mentioned in section 5, the landlord’s permission to commercially sublet an apartment short-term through airbnb is regarded as an extra contractual right. if the tenant is given such a right in the tenancy agreement, the agreement should be regarded as a mixed agreement, since the tenant then may use the apartment for mixed purposes, i.e. both for residential purposes and commercial purposes (when the landlord’s conditions for allowing the use of the airbnb-model are met).66 in other words, the right to use the apartment for short-term commercial sublets through airbnb does not 63 see anders victorin & anders dahlquist-sjöberg, flexibilitet och besittningsskydd (kungliga tekniska högskolan 2003), p. 18 and 21, official report sou 2004:91, reformerad hyressättning, p. 138 ff. and official report sou 2008:94, tillval i hyresrätt, p. 128 ff. 64 ibid. 65 see e.g. official report sou 2008:94, tillval i hyresrätt, p. 130, where it is mentioned that payment for services in the form of e.g. dry cleaning, ticket bookings and food deliveries does not constitute rent if the services are provided in separate agreements, but may constitute rent if the services are a part of the tenancy agreement. 66 it is important to note that the apartment needs to be explicitly let for mixed purposes, see further section 5.2.3 below. airbnb and the swedish tenancy legislation 192 constitute a service, but instead an extra contractual right in the form of an extension of the purpose of the tenancy agreement. the tenancy legislation does not hinder tenancy agreements that allow for the apartment to be used for mixed purposes, and examples of such uses are when the tenant is given a contractual right to use the apartment both as a dwelling and as a dental practice or as an atelier.67 it should be noted that the apartment in these cases will be legally classified as a residential apartment (in contrast to a commercial apartment), as long as the residential component of the tenancy is not only of trifling importance compared to the commercial component.68 this means that the compulsory protective provisions of the legislation that are aimed at residential apartments often are applicable in situations where apartments are being let for mixed uses, including the situations discussed in this article. the assessment of the fairness of the rent can however be affected by the commercial component even if the tenancy is legally classified as a residential tenancy (see further section 5.2.3 below). in this part of the article, however, it is enough to note that the court has tried the fairness of rents for apartments that have been let for mixed purposes, and has not made a distinction between the payments pertaining to the different uses – the payment for both uses has constituted rent.69 since the right to use an apartment for short-term commercial sublets through airbnb should be regarded as a contractual right to use the apartment for commercial purposes, the airbnb-fee should be considered to constitute rent. the non-compulsory nature of the airbnb-fee (i.e. that the tenant does not need to pay the fee if the tenant does not use the possibility to sublet short-term) does not change this assessment, and can be compared to the discussion on options to add or remove domestic appliances which have been deemed to constitute rent, regardless of their non-compulsory nature.70 the same can be said regarding the fact that the airbnb-fee is a ‘one-time’ fee, as compared to most other costs which usually are periodical and affect the monthly level of the rent, 67 see e.g. erika p björkdahl, hyra av bostad och lokal (iustus förlag 2018) p. 38 ff. 68 see government bill prop. 1967:141, med förslag till lag angående ändring i vissa delar av lagen den 14 juni 1907 (nr 36 s. 1) om nyttjanderätt till fast egendom m.m., p. 124. 69 see e.g. rbd 11:84 [the rents and tenancies court of appeal]. 70 see official report sou 2004:91, reformerad hyressättning, p. 138 ff. and official report sou 2008:94, tillval i hyresrätt, p. 93. in this context, it should also be mentioned that this fact also means that the penal prohibition on separate compensation as a condition for letting an apartment in ch. 12 sec. 65 of the land code is not applicable on the airbnb-fee, cf. kjell adolfsson & sten hillert, hyresrätt som dellikvid (iustus förlag 1991) p. 66, anna christensen, hemrätt i hyreshuset (juristförlaget 1994) p. 332 and the official report sou 2017:86, hyresmarknad utan svarthandel och otillåten andrahandsuthyrning, p. 52. njcl 2018/1 193 which in the discussions on options to add or remove domestic appliances has not been deemed to change the fee’s nature as rent.71 in conclusion, the extra airbnb-fee that a landlord will charge a tenant for short-term commercial sublets through airbnb should be regarded as payment for an extra contractual right to use the apartment for a specified commercial purpose, and the fee should be classified as rent. 5.2. the practical implications of the airbnb-fee’s classification as rent since the airbnb-fee is classified as rent, the tenancy legislation is applicable. this has certain practical implications that should be noted by a landlord that wants to use the airbnb-model. the central implications are briefly explained in the following subsections. 5.2.1. the collective bargaining system is applicable on the airbnb-fee as mentioned in section 3.1, almost all buildings that contain more than two residential apartments are included in the collective bargaining system, and it is therefore important to note the implications of the system when analysing the airbnb-model. the main implication of the collective bargaining system’s applicability in this context is that the landlord has an obligation to negotiate with the tenants union before increasing the rent of one or more apartments.72 if the landlord does not fulfil this obligation, and instead enters into an agreement with the tenant (i.e. charges the tenant the airbnb-fee for allowing the short-term sublet without prior negotiation with the tenants union), then the agreement is null and void.73 in these cases, the landlord needs to repay the airbnb-fee to the tenant (with interest).74 the landlord is, further, also liable to pay damages to the tenants union because of the non-compliance with the obligation to negotiate.75 the obligation does not require the landlord (or the landlords association) and the tenants union to actually enter into an agreement. the landlord is only obligated to initiate the negotiation. if the landlords’ 71 see official report sou 2004:91, reformerad hyressättning, p. 136 ff. and official report sou 2008:94, tillval i hyresrätt, p. 65. although the reasons for this was not explicitly discussed in the reports, it is a natural consequence of the fact that the legal definition of a tenancy agreement does not require the compensation (rent) to be of a reoccurring nature, see nja 1948 s. 101 [swedish supreme court]. 72 see sec. 5 of the rent bargaining act (1978:304). the definition of ’rent’ in this act is interpreted extensively, just as the definition in ch. 12 of the land code, see anders victorin, kollektiv hyresrätt (norstedts 1980) p. 189 f. 73 see sec. 23 of the rent bargaining act. 74 ibid. 75 see sec. 26 of the rent bargaining act. airbnb and the swedish tenancy legislation 194 association and the tenants union do not reach an agreement, then the landlord and the tenant may negotiate individually or take the case to the regional rent tribunal, which will try the fairness of the rent.76 this being said, my own assessment is that there should be a high chance that the landlord (or the landlords association) and the tenants union will be able to reach an agreement in these cases, if they choose to use the model. the airbnb-model does in a way constitute an extra cost for the tenants, but the cost is associated with an even higher income through the short-term sublet. tenants who do not wish to use the possibility to short-term sublet their apartments will, further, not have to pay anything extra. since the sublessees in general are willing to pay a relatively high premium compared to the tenant’s monthly rent,77 the tenants union and the landlords association should be able to agree on fees that fairly split the extra income between the landlord and the tenant. 5.2.2. the airbnb-fee must be specified in the tenancy agreement or in a collective bargaining agreement ch 12. sec. 19 of the land code specifies that the rent of the apartment must be specified in the tenancy agreement or in a collective bargaining agreement.78 this section has less implications for landlords that are a part of the collective bargaining system, since these landlords generally will fulfil this requirement through collective bargaining agreements with the tenants union. the section, however, has bigger implications for (the few) landlords that do not need to adhere to the bargaining rules. the main practical effect of ch. 12 sec. 19 of the land code in these cases is fairly self-explanatory – even the landlords that are not part of the collective bargaining system will need to negotiate with their tenants and may not add the airbnb-fee before having reached agreements with the tenants. the landlord also has to follow the procedural rules set out in ch. 12 sec. 53-55 d of the land code. however, these procedural rules are not the focus of this article and will not be described further here.79 76 see sec. 24 and 25 of the rent bargaining act. see also e.g. bertil bengtsson, richard hager & anders victorin, hyra och annan nyttjanderätt till fast egendom (norstedts juridik 2013) p. 138 f. and erika p björkdahl, hyra av bostad och lokal (iustus förlag 2018) p. 219. 77 cf. footnote 40. 78 see ch. 12 sec. 19 of the land code. if the rent is decided through a collective bargaining agreement, then the tenancy agreements needs to contain so-called bargaining clauses, which state that the tenants are bound to the agreements between the tenant’s union and the landlord (or landlord’s association), see sec. 2 of the rent bargaining act. 79 for more information on these rules, see e.g. erika p björkdahl, hyra av bostad och lokal (iustus förlag 2018) p. 217 ff. njcl 2018/1 195 ch. 12 sec. 19 of the land code further states that the amount of rent for rental apartments needs to specified in the tenancy agreement. the purpose of the provision is to make sure that the tenant is able to calculate the extent of the tenant’s financial obligations beforehand.80 as such, the landlord is not allowed to e.g. yearly adjust the rent in accordance with a specified index or in other ways reserve the right to one-sidedly change the rent. the rent does, however, not need to take on a fixed value during the whole rental period. the parties may agree on a rent that is e.g. 7000 sek the first year, 8000 sek the second, and 9000 sek the third year.81 the only costs, pertaining to the rent, whose amounts do not need to be specified are costs for heating, cooling, hot water, electricity and fees relating to water and sewage systems. these costs may instead be based on the tenant’s actual use of the services. the fact that the rent needs to be specified does not hinder the airbnb-fee. the preparatory works explicitly specify that different rents may be charged for different periods as long as they have been specified beforehand. this can be achieved when the landlord negotiates with the tenant or tenant’s union. in the latter case, it’s also possible to specify different rent levels in the collective bargaining agreement, for example by specifying that apartments in different size intervals, or based on the number of rooms, are charged certain fees. it is also possible to specify different fees for apartments in different parts of the cities (where apartments in the central parts would be charged a higher fee), and so on. although ch. 12 sec. 19 does not hinder the airbnb-fee, it does however limit the possible designs of the fee. because of the provision, it is not possible to construct an airbnb-fee that would be calculated as a percentage of the extra rent that the tenant charges the sublessee (i.e. a percentage of the part of the sublessee’s rent that exceeds the tenant’s own rent). such a calculation of the fee might otherwise have been an appealing solution, because of its fairness and straightforward enforcement (a tenant that is able to charge a higher rent from the sublessee thereby would have to pay a higher airbnb-fee to the landlord, whereas a tenant that would not be able to charge as much would have to pay less for the possibility to sublet short-term). it could be argued that a percentage-based airbnb-fee should be allowed since it does not contravene the underlying reasons behind the prohibition of rents with non-specified amounts, because the tenant in this case would be able to calculate the extent of the financial obligations since the tenant itself would directly decide the level of the airbnb-fee through the rent that the tenant charges the sublessee (and because the provision’s protective purpose is already met, since the tenant will charge a premium that exceeds the extra cost of the airbnb-fee). the preparatory works, 80 see government bill prop. 1973:23, med förslag till ändring i jordabalken, m.m., p. 159 f. 81 ibid. p. 160. airbnb and the swedish tenancy legislation 196 however, clarify that ch. 12 sec. 19 of the land code is to be interpreted strictly and the only unspecified costs of rent that are allowed are the costs for heating, water, etc. that have been specified in the article.82 in conclusion, the airbnb-fee needs to be specified in the tenancy agreement or in a collective bargaining agreement beforehand and cannot be applied by the landlord on an ad-hoc basis. ch. 12 sec. 19 of the land code further prevents the fee from being calculated as a percentage of the premium that the tenant charges from the sublessee, and the fee therefore needs to be specified numerically in the agreements. 5.2.3. the regional rent tribunal can try the fairness of the airbnb-fee the third central implication of the fact that the airbnb-fee is classified as rent is that the tenant is able to appeal to the regional rent tribunal, which then will try the fairness of the fee. the fairness will be tried in accordance with the main rules that have been explained in section 3.1. as mentioned, the ‘utility value’ of an apartment is mainly based on physical factors such as size and layout, level of modernity, location within the building and in the city, proximity to transportation, etc. the airbnb-model, however, does not affect the physical factors of the apartment, but rather how the apartment may be used. the relevant question in this section is therefore if the legislation allows for increased utility values that are connected to mixed uses of an apartment, i.e. that the apartment is used both for residential and commercial purposes.83 otherwise, the airbnb-model would not be able to affect the rent tribunal’s assessment, which would undermine the model if a tenant raises complaints and appeals to the rent tribunal. the preparatory works have not discussed the effects of mixed uses of apartments on the apartments’ utility values.84 the question has, however, been discussed in court cases. bostadsdomstolen [the rents and tenancies court of appeal] tried the question in rbd 11:84, where a tenancy apartment was used both for residential and for commercial purposes.85 the court found that the allowance to use the apartment for 82 ibid. 83 cf. section 5.1 above. 84 cf. government bill prop. 1974:150, angående riktlinjer för bostadspolitiken, m.m., p. 470 ff., government bill prop. 1983/84:137, med förslag till ändringar i hyreslagstiftningen, p. 67 ff., government bill prop. 1993/94:199, ändringar i hyresförhandlingslagen, m.m., p. 79 f, government bill prop. 2005/06:80, reformerad hyressättning, p. 48 and government bill prop. 2009/10:185, allmännyttiga kommunala bostadsaktiebolag och reformerade hyressättningsregler, p. 66 ff. see, however, government bill prop. 1968:91, med förslag till lag angående ändring i lagen den 19 juni 1942 (nr 429) om hyresreglering m.m. och om fortsatt giltighet av lagen, m.m., supplement a p. 53, where it was briefly mentioned that the compared apartments normally should be used in the same way. 85 see also rbd 22:84 and rbd 20:89. njcl 2018/1 197 commercial purposes constituted a benefit that affected the assessment of the fairness of the rent. the court then continued by clarifying that the assessment of the fair rent is affected both by the nature of the commercial use and to what extent the commercial use is allowed. the court finally found that the rent should be calculated based on the different uses. if a part of the apartment is used as a dwelling and another part for commercial purposes, then the rent should be decided by calculating the different utility values of the separate parts. if the apartment instead is alternately used as a dwelling during a period of time and for commercial purposes during other periods, then the rent should be calculated based on the durations of the different uses. in this context, it is also important to note that a condition for the mixed purposes of use to have an impact on the fairness-assessment, is that the apartment explicitly is let for mixed purposes. as such, it is not enough that the tenant actually uses the apartment for mixed purposes. this was clarified in rbd 22:84 [the rents and tenancies court of appeal], where the court found that the commercial part of the use of an apartment did not affect the assessment of the fair rent, since the apartment was not being let for mixed use but only as a residential apartment. the landlord could therefore not demand a higher rent because of the commercial use but was instead pointed to the possibility to claim a breach of contract, since the apartment had been used for a purpose that was not included in the purpose of the parties’ agreement. in the context of the airbnb-model, the landlords therefore need to ensure that the tenants’ possibility to commercially sublet the apartment short-term through airbnb, i.e. the mixed use for both residential and commercial purposes, is clearly stated in the tenancy agreement. this right can be combined with restrictions, and it is for example possible to reach an agreement which states that the tenant may only commercially sublet short-term when the tenant leaves the apartment for vacation, for a maximum period of two months per year, etc.86 it is also possible to add a condition that the tenant needs the landlord’s approval in each specific case. these additions to the tenancy agreements may be added through renegotiations between the landlord and the tenants union through a collective bargaining agreement (see section 5.2.1 above). it should also be noted that the utility value of the apartment’s use for commercial purposes of course is affected by similar factors as the assessment of the utility value for residential purposes, i.e. size and layout, level of modernity, location within the building and in the city, etc. these factors need to be taken into account when the airbnb-fee is 86 the parties are free to agree on provisions as long as the provisions do not violate any compulsory rules in the tenancy regulation. regarding the possible scope of different kinds of provisions, see e.g. erika p björkdahl, hyra av bostad och lokal (iustus förlag 2018), p. 64 ff. airbnb and the swedish tenancy legislation 198 decided, to ensure that the airbnb-fee would be considered to be fair in an assessment by the rent tribunal. as mentioned in section 5.2.2, this can be achieved in the collective bargaining agreement by specifying different airbnb-fees for apartments in different size intervals, in different parts of the city, etc. in conclusion, the landlord’s allowance to let the tenant sublet the apartment short-term through airbnb, which constitutes a short-term commercial purpose, is a factor that may be included in the rent tribunal’s assessment of the utility value of the apartment. a prerequisite for this is, however, that the apartment explicitly is being let both for residential purposes as well as commercial purposes, in the form of short-term commercial sublets. the regulations that allow a tenant to appeal the rent to the rent tribunal therefore do not constitute a hindrance to the airbnb-model. 6. conclusion the swedish case law has shown that a tenant will not be able to sublet an apartment to short-term sublessees through airbnb without the landlord’s permission. the landlord cannot be expected to permit such sublets without earning extra compensation, which generally is prohibited through ch. 12 sec. 19 of the land code that states that the landlord may not charge a higher rent than the one which is specified in the tenancy agreement. as has been described in the article, however, the legislation should not constitute a hindrance to the construction of a commercial airbnbmodel, which makes it possible for both the landlord and the tenant to earn a premium when using the apartment for short-term sublets through airbnb and similar services. there are, however, certain aspects that need to be observed for the model to fulfil the requirements of the tenancy legislation: 1. the apartment should only be sublet short-term to sublessees that will use it for recreational purposes. this should be explicitly stated in the sublease agreement and the tenant should also make sure that the sublessee actually intends to use the apartment for recreational purposes. further, work purposes are most likely not included in the definition of recreational purposes.87 2. the landlord must negotiate with the tenant or tenants association before using the model and charging an extra airbnb-fee.88 3. the airbnb-fee must be specified in the tenancy agreement or in a collective bargaining agreement. further, the airbnb-fee must be specified as a numerical amount, and may not be charged as a percentage of the extra rent earned by the tenant.89 87 see section 4.2 and 5. 88 see section 5.2.1. 89 see section 5.2.2. njcl 2018/1 199 4. the apartment must be explicitly let for mixed uses, i.e. both for residential purposes and commercial purposes, the latter in the form of short-term commercial sublets.90 aspect 2-4 stem from the fact that the airbnb-fee legally should be classified as rent. the classification also means that the tenant may appeal the level of rent to the regional rent tribunal, which then will assess the fairness of the total rent, including the airbnb-fee, based on the utility value of the apartment. as discussed in section 5.2.3, the use of the apartment (i.e. the possibility to use the apartment for commercial short-term sublets) is a factor that may be taken into account in the rent tribunals assessment as long as the mixed use is explicitly agreed between the landlord and the tenant. the possible use of the airbnb-model is, from a practical perspective, to a large extent dependent on if hyresgästföreningen [the swedish tenants union] deems it to be desirable for tenants. my own assessment is that the chances of this should be fairly good. the airbnbmodel gives the tenants a chance to earn extra money and avoid ‘unnecessary’ rent when the apartment is not being used. further, the use of the model is voluntary, and it does not have a direct impact on tenants who choose not to use it. the model might also lead to a decrease in the number of unauthorised sublets, which has increased during recent years.91 these advantages of course need to be weighed against the fact that the model would lead to more unknown people in the apartment buildings, which might lead to inconveniences for the other tenants. it might be argued that the model could be abused to circumvent the regulations on rent or be used during longer periods of time when a ‘real’ sublessee in need of a dwelling could have used the apartment instead. the regulations on rent can, however, already today be circumvented by dishonest landlords that collude with a ‘fake’ tenant.92 in the case of abuse during longer periods when a ‘real’ sublessee could have used the apartment, this could be counteracted through provisions in the agreements stating when the airbnb-model may be used (e.g. when the tenant leaves the apartment for vacation for a month or two and for a maximum period of two months per year). the correct use of the model might also be safeguarded by the tenant’s union. 90 see section 5.2.3. 91 cf. the offical report sou 2017:86, hyresmarknad utan svarthandel och otillåten andrahandsuthyrning, p. 177-178. 92 in these cases, ch. 7 sec. 31 of the land code states that the sublessee enjoys all the legal rights that the sublessee would have had if there had not been a ’fake’ tenant inbetween, i.e. the sublessee is considered to be a normal tenant in relation to the landlord, and not a sublessee. the section is applicable when the landlord and the tenant are colluding to circumvent the legislation, and would therefore also be applicable in cases of collusion through the use of the airbnb-model. airbnb and the swedish tenancy legislation 200 in conclusion, the airbnb-model might give rise to some aspects that need to be handled for the model to work in a way that satisfies all involved parties, but these aspects should not be insurmountable. 1 intermediary platforms – the contractual legal framework marie jull sørensen* * co-editor of nordic journal of commercial law. phd, master of laws. associate professor at the department of law, aalborg university, e-mail: mjs@law.aau.dk. njcl 2018/1 63 1. introduction ..................................................................................... 64 2. legal frameworks ........................................................................... 67 2.1. the platform as an employer ........................................... 67 2.2. the platform as the main contracting party ............ 75 2.3. the platform as a mere intermediary ........................... 78 2.3.1. the danish intermediary rule ............................... 79 2.4. the platform as a secondary obligated party .......... 84 3. finishing remarks ............................................................................ 88 the contractual platform framework 64 abstract from a consumer protection perspective, this contribution analyses four contractual legal frames potentially applicable to the triangular contractual structure of online intermediary platforms. for each framework, criteria are derived, and it is discussed how and if these criteria are met in regards to intermediary platforms. the legal frameworks are 1. the platform as employer; 2. the platform as the main contracting party; 3. the platform as intermediary and 4. the platform as a secondary obligated party. it is discussed how the intermediary platforms challenge some of the basic considerations behind some of the legal frameworks. the contribution helps qualify the ongoing deliberations of legislators and academics on (re-)framing the legal frame(s) of intermediary platforms. 1. introduction intermediary platforms are the key drivers of the platform economy. under the positive value-laden concept of ‘sharing economy’, the platforms experienced goodwill in the early rise of the platform economy. however, following the honeymoon period, first the affected ‘old’ businesses raised the issue of unfair competition and demanded a level playing field. later, concerns about the challenge of protection paradigms of employees and consumers were voiced. the element of ‘sharing’ was not as prevailing for some of the platforms as first advertised and therefore, detached from the concept of sharing, the platforms are to be governed by the existing legal framework of contract law. here, the identification of the parties plays a crucial role in order to establish their legal position. however, preliminary research has shown that the platforms’ triangular contractual structure (the two-sided structure) does not fit well into existing legal frames based on a two-party structure (‘chain’/‘tube’). evidently, challenges arise especially in the areas where legislators have intervened into the principle of freedom of contract. this legal intervention has taken place in the areas where a weaker party can be identified such as in the case of the relationship between a consumer and a trader and an employee and an employer. thus, especially consumers have been a still increasing object for protective legislation in denmark and in the eu. if the legal paradigm of consumer protection does not apply to the platform structure, the consumer is not protected, and the policy question then arises, whether this is a desirable consequence of the platforms. if not, action needs to be taken in order to either make the existing protective legislation apply or to make a new consumer protection scheme suited for the platform economy. such a scheme does not necessarily need to entail legislation but could also be facilitation of self-regulation or utilising digital platforms as partners in the regulation – at least in the areas where the platforms have clear incentives to behave in a way compatible with njcl 2018/1 65 public policy. but before engaging into developing new legislation or finding other alternatives, it is important to establish the extent of application of the existing legislation in relation to platforms, and therefore, this article will provide an insight into how platforms fit into four legal frames relevant for consumer protection. the four legal frames are identified within danish law, and they are selected because of their potential influence on consumer protection when applied on the triangular business structure of intermediary platforms. the frameworks are: 1. the platform as employer; 2. the platform as the main contracting party; 3. the platform as intermediary and 4. the platform as a secondary obligated party.1 in framework 1 and 3, it is relevant to delimit the scope of the article to peer2peer (p2p) intermediary platforms on which a peer-provider and a peer-customer register in order to enter into to the main contract with each other. in framework 2 and 4, the provider can also be a business since the focal point in these frameworks is to determine if the platform instead of or maybe along with the provider can be liable for performance of the main contract. however, in all frameworks, the article does not include social platforms and search engines etc. ‘peer-provider’ is to be understood as a private person selling his labour or his goods – however, much of the uncertainty is exactly related to whether such a private person is actually something else when acting through the platform. the p2p platform, in particular, raises questions in regards to consumer protection of the peer-customer2 and also protection of the non-business peer-provider. the legal frameworks to be discussed here are focused primarily on the contractual relation between the three parties. the methodology of the analyses presented in this article is legal dogmatic as the aim primarily is to establish the legal position of consumers in the situation where the current danish legal paradigm of consumer protection is faced with p2p or b2c intermediary platforms. the focus in the article will be on danish law with incorporation of views and cases of other jurisdictions in order to qualify the discussion of the legal frameworks. ‘the jury in this case will be handed a square peg and asked to choose between two round holes’ (district judge vince chhabria, california).3 the quote is frequently used by scholars because of its perfect illustrative metaphor of the core legal challenge with intermediary platforms – not just in relation to the specific dispute in the case. the 1 parts of this contribution contains content from a book chapter in danish, sørensen, marie jull, digitale formidlingsplatforme: disruption af forbrugerretsparadigmet? in dahl, børge; riis, thomas; trzaskowski, jan, festskrift til peter møgelvang-hansen, 2016, 185 and an article in danish, sørensen, marie jull, digitale formidlingsplatforme formidlingsreglen i dansk forbrugerret, ugeskrift for retsvæsen (ufr), u2017b.119. 2 busch, christoph; schulte-nölke, hans; wiewiórowska-domagalska, aneta and zoll, frederic, the rise of the platform economy: a new challenge for eu consumer law? eucml, 1 2016, 3. 3 cotter v. lyft, inc., 60 f. supp. 3d 1067, 1081 (n.d. cal. 2015). the contractual platform framework 66 quote is from a us case regarding the legal status of a platform-driver on the platform lyft (a ‘driver-on-demand’-platform). the platform-driver (the ‘square peg’) claimed to be an employee of the platform (a round hole) and not an independent contractor (the other hole). the quote illustrates that establishing the legal position of this platform worker comes with much difficulty, as set legal definitions might not be compatible with the ‘new’ reality of intermediary platforms. this is not only the case in the us and not only the case with platform workers. the existing carpet of neatly crafted and fairly close attached legally defined boxes might not fit when the real life of intermediary platforms is rolled out over the carpet. the real life platform participants and transactions will not fall into the boxes, as they do not fit the legal definition of the boxes. thus, leaving the platforms floating over the boxes, giving room for the platforms to define themselves and creating their own ‘legal’ regimes with the risk of legal uncertainty and lack of protection for platform users and others. most platforms define themselves merely as providers of a facilitating tool and, therefore, only as intermediaries. for this contribution, the term ‘intermediary’ is not to be understood as a strict legal term, but only as someone who establishes contact between two parties with variant degrees of interference and control. according to contract law, as an intermediary, the platform has no contractual obligations in regards to the contract between the two users. the existing substantial consumer protection regulation based on the existence of a weak party vis-á-vis a business4 does not normally apply to p2p transactions in regards to the main contract. it will, however, apply in the user-platform contract. the four legal frames all entail a framing where consumer protection might be triggered because of a possible alternative identification of either the platform or the peer-seller. there are many variations of intermediary platforms5 – also within p2p platforms but it is not for this article to categorise them. the analyses of the four legal frames will be conducted at a general level deriving criteria and discussing their applicability on platforms. 4 ecj case law has developed a ‘system of protection’ which also entails other presumptions. see for example banco españiol de crédito, c-618/10, para 39 42 ecli:eu:c:2012:349, 14 june 2012. see also schulte-nölke, hans, the brave new world of eu consumer law – without consumers, or even without law?, eucml 4 (2015). 5 se blandt andre tilenius, stephanie, the new curated consumer marketplace model: 10 criteria for success, forbes 10/03/1013 and cand. jur. styrishave, michael, digitale platforme i en kontraktretlig kontekst, (2016, master thesis, aalborg university). njcl 2018/1 67 2. legal frameworks 2.1. the platform as an employer establishing whether the relation between the platform and the peer-provider is an employment relationship is of course relevant only when the platform is a labour-platform – a peer-provider selling his labour (such as transportation or cleaning) to the peer-customer. if the peer-provider is actually an employee of the platform, it will affect the contractual relationship with the peer-customer, and in addition, the peer-provider will be protected by labour law.6 in the case of an employment relationship between the peer-provider and the platform, the peer-customer will have entered into a contract with the platform, providing that the peer-provider has not somehow gone out of his mandate as employee. the peer-customer can then claim consumer rights against the platform as his counter party in the main contract. in denmark, no court cases have been filed regarding the issue of employment on intermediary platforms. through an analysis of danish case law regarding the definition of employee/employer in general, danish scholar ole hasselbalch has derived five elements to be considered when determining whether a person is to be regarded as an independent contractor or an employee:7 1) the degree of the potential employer’s right to direct and control the work performed by the person in question (subordination); 2) the arrangement of the financial relationship between the parties (for example, how the pay is disbursed and calculated and who is the bearer of the entrepreneurial risk and provider of the material); 3) the obligation to carry out the work personally or the right to have someone else perform the work; 4) the personal relationship between the potential employee and employer, including the place of work and 5) the potential employee’s social and 6 see for elaboration on labour protection, for example: de stefano, valerio, the rise of the ‘just-in-time workforce’: on-demand work, crowdwork and labour protection in the ‘gig-economy, international labour office inclusive labour markets, labour relations and working conditions branch. geneva: ilo, 2016, conditions of work and employment series no. 71. there might be slight differences between member states’ and eu’s definition of the scope of labour law in regards to ‘worker’ and ‘employee’. the eu is known to have a broad scope both in the high end in regard to business managers and in the low end in regards to accepting a low threshold of working hours see christensen, emma engelsted and jensen, julie pia, den kommende ferielov – lønmodtagerens retsstilling, 2017, https://projekter.aau.dk/projekter/files/280805747/den_kommende_ferielov___lon modtagerens_retsstilling.pdf. 7 hasselbalch, ole, ansættelsesret & personalejura, 4. udgave, 2012, p. 31 et seqq. the 5 elements are translated by jens kristiansen in the concept of ’employee’: the position in denmark, in waas, bernd (ed) and van voss, guus heerma, restatement of labour law in europe, the concept of employee, i, 141. the contractual platform framework 68 occupational position, especially whether the worker is primarily considered to be comparable with an employee or a self-employed worker (an overall assessment). the labour platforms come in different shapes with different ways of contracting and interacting with the peerprovider. presumably, for those platforms who provide a single service (e.g. transportation, cleaning, delivery of food or other etc.) and where this single service is connected to a platform brand with a distinct service profile (e.g. uber), it will be easier to fit the platforms into the category of employer. if the platform instructs/suggests to the peer-provider to perform the service in a certain way and sets out the legal frame as well as the operational frame (payment system, routing software) to fulfil the main contract, this will address the first of the five elements presented. if the platform sets the price for the service and controls the payments and also limits the supplier to perform the service personally, this will address the second and third element. labour platforms can be based both on white-collar labour and blue-collar labour. if the peer-provider has to work away from home, which is typical for blue-collar labour, this might speak in favour of an employee/employer relationship, especially if the work does not require a specific skill. lastly, and related to element number 5, if companies providing similar services in a similar way usually are considered employers, this will speak in favour of an employee/employer relationship. in general, what can be regarded as the pivotal point in categorising a peer-provider as an employee is the fact that most peer-providers have the freedom to decide when and for how long they want to work and to a certain extend also what tasks they accept. thus, one of the traditionally most important elements in the employment relationship – the fixed working hours – is not present. this element will vary in importance depending on the type of platform work. in addition, especially in regards to the transportation platforms, another element speaking against an employment relationship is the fact that the drivers use their own material (cars or bikes). this is typically a fact that will indicate that the driver is an independent contractor or selfemployed person. the danish court cases against uber drivers have not been concerned with employment relationships but have focused on illegal transportation of passengers.8 within eu labour law, the definition of employee has been subject to several ecj cases, in particular within the area of free movement of workers9 and competition.10 there have not yet been cases targeted 8 u2017.796 ø. the uber drivers were convicted of illegal transport of passengers among other because of lack of the necessary permits. 9 communication from the commission to the council, the european parliament, the european economic and social committee and the committee of the regions, reaffirming the free movement of workers: rights and major developments, com(2010)373 final. njcl 2018/1 69 specifically at platform workers. the eu commission welcomes the platform economy but also acknowledges the challenges it brings in regards to the different considerations of the three parties.11 in the agenda for the collaborative economy, the commission states that: in order to help people make full use of their potential, increase participation in the labour market and boost competitiveness, while ensuring fair working conditions and adequate and sustainable social protection, member states should: assess the adequacy of their national employment rules considering the different needs of workers and self-employed people in the digital world as well as the innovative nature of collaborative business models; 12 also in this specific agenda in regards to the three party relations, the commission refers to the definition of ‘worker’ developed in ecj case law.13 here, a cumulative list consists of three criteria to be assessed on a case-by-case basis (text in parentheses added by the author). the existence of a subordination link; (distinction between self-employed and worker) the nature of work; (genuine activity) and the presence of a remuneration (distinction between a volunteer and a worker) the subordination link refers to the platform directing the choice of activity, the remuneration and the working conditions. in further elaboration on the three criteria in regards to collaborative economy, the commission makes clear that in order to meet the first criteria, it is not sufficient merely to pass on payments from one user to another. however, if the peer-provider is not free to choose what services she provides and how and for how much, this will speak in favour of the platform being subordinate. to meet the first criteria, it is not necessary for the platform to actually manage and supervise continuously. the 10 schiek, dagmar; gideon, andrea (2018): outsmarting the gig-economy through collective bargaining – eu competition law as a barrier to smart cities?, international review of law, computers & technology. 11communication from the commission to the european parliament, the council, the european economic and social committee and the committee of the regions, a european agenda for the collaborative economy, com(2016)356 final, 2 et seq. 12 a european agenda for the collaborative economy, com(2016)356 final, 13 et seq. 13 a european agenda for the collaborative economy, com(2016)356 final, 12 and communication from the commission to the council, the european parliament, the european economic and social committee and the committee of the regions, reaffirming the free movement of workers: rights and major developments, com(2010)373 final, 4-6 (with references to ecj case law). the contractual platform framework 70 second criteria aims at leaving out “services on such a small scale as to be regarded as purely marginal and accessory.”14 the performed service by the peer-provider must be an activity with economic value that is effective and genuine. finally, to meet the last criteria, the work must not be volunteer work where the peer-provider does not receive any remuneration. as mentioned, the ecj has not yet had the opportunity to apply these criteria on a platform worker. the closest it gets is in c-434/15 elite taxi where the court had to decide whether uber is an information society service or a transport service. the ag, m. szpunar, states very clearly that uber drivers are not necessarily employees but could also be subcontractors, and adds that “the controversy surrounding the status of drivers with respect to uber… is wholly unrelated to the legal questions before the court in this case.”15 however, the ag also makes very clear that: while this control [the control performed by uber towards the drivers] is not exercised in the context of a traditional employer-employee relationship, one should not be fooled by appearances. indirect control such as that exercised by uber, based on financial incentives and decentralised passenger-led ratings, with a scale effect, makes it possible to manage in a way that is just as — if not more — effective than management based on formal orders given by an employer to his employees and direct control over the carrying out of such orders.16 the ecj did not go into similar statements about the employee status of the uber drivers but it did adopt the argumentation regarding control in their argumentation for uber not being merely an information society service: … in addition, uber exercises decisive influence over the conditions under which that service is provided by those drivers. on the latter point, it appears, inter alia, that uber determines at least the maximum fare by means of the eponymous application, that the company receives that amount from the client before paying part of it to the nonprofessional driver of the vehicle, and that it exercises a certain control over the quality of the vehicles, the drivers and their conduct, which can, in some circumstances, result in their exclusion. 14 a european agenda for the collaborative economy, com(2016)356 final, 12-13 et seq. 15 advocate general in ecj c-434/15, elite taxi, [2017] ecli:eu:c:2017:981, para 54. 16 ag in c-434/15 elite taxi, para 52. njcl 2018/1 71 that intermediation service must thus be regarded as forming an integral part of an overall service whose main component is a transport service and, accordingly, must be classified not as ‘an information society service’ within the meaning of article 1(2) of directive 98/34, to which article 2(a) of directive 2000/31 refers, but as ‘a service in the field of transport’ within the meaning of article 2(2)(d) of directive 2006/123. 17 the uber case can be interpreted as bringing the uber driver a step closer to being regarded as an employee, but it is important to note that the ecj did not address this issue directly. however, the question regarding the employment status of platform workers has been addressed in different countries.18 in the uk employment tribunal’s case, mr. y. aslam vs. uber19, the tribunal found that uber de facto controlled the drivers (as if they were workers20) regardless of what the formal contract stated; “… it follows from all of the above that the terms on which uber rely do not correspond with the reality of the relationship between the organisation and the drivers…”21 ‘the reality’ was documented by drivers and it revealed for example how uber warned the drivers when the drivers didn’t accept rides or cancelled rides while having the uber app switched on. if the rating benchmark was not met or a minimum number of cancellation was exceeded, the sanctions could be a temporary deactivation or even a total deactivation of the driver’s account. similar ‘realities’ can be seen in other cases regarding uber22 and similar issues have been raised in cases regarding platforms offering other services than passenger transportation such as plumbing and courier services.23 the uk court accepted that the driver’s 17 c-434/15 elite taxi, para 39 and 40. 18 see presentation of some of the law suits at http://uberlawsuit.com/. 19 uk employment tribunal, case 2202550/2015 mr. y. aslam, mr. j. farrar and others vs. uber b.v., uber london ltd and uber britannia ltd. the ruling was appealed to the employment appeal tribunal but was dismissed. 20 in the uk ‘worker’ has a broader definition than ‘employee’. the difference is not to be which considerations to take into account but relates to the boundaries. thus, these boundaries are broader in relations to ‘worker’. jones, benjamin and prassl, jeremias in the concept of ’employee’: the position in the uk, in waas, bernd (ed) and van voss, guus heerma, restatement of labour law in europe, the concept of employee, i, 753 et seqq. in the tribunal case, the difference between ‘employee’ and ‘worker’ was not up for discussion. 21 uk employment tribunal, case 2202550/2015 mr. y. aslam, mr. j. farrar and others vs. uber b.v., uber london ltd and uber britannia ltd., para 96. 22 see for example california unemployment insurance appeals board, 2015, case no. 5371509 – reopened, and labour commissioner, california, case no. 11-46739, berwick vs. uber technologies. 23 the cases are mentioned in jamie grierson and rob davies, pimlico plumbers loses appeal against self-employed status, the guardian, fri 10 feb 2017 15.40 gmt, the contractual platform framework 72 status as worker was only relevant when the driver is actually logged on to the app. however, also during the time the driver is not logged on, the driver can experience so-called ‘nudging’24 from uber.25 through nudging, uber will ‘gently’ push the drivers to work more or work specific places by sending messages. even though the uk case dealt with the uk ‘worker’ definition which is different from the danish definition of employee, the case still illustrates an important point when dealing with intermediary platforms with a high level of self-made contractual framing. misclassification of platform workers through linguistics in the contract is not decisive for how to perceive a peer-provider. the challenge here as in most cases regarding these platforms is, however, that if the legal position of the platform and its users mainly are to be determined on a case-by-case basis because of unclear legislation, this will not necessarily be sufficient for the majority of platform users, because the starting point (before cases are filed) will always be the legal frame set by the platform in its user-platform contracts. in the us (more specifically in california), several cases have also been tried and some have been settled. in the california cases, the socalled borello test is applied listing a number of elements to consider when determining whether a putative employee is to be regarded as such.26 the elements of the test are very similar to the elements considered in danish and uk case law. pursuant to the borello test, the question is "whether the person [or company] to whom service is rendered has the right to control the manner and means of accomplishing the result desired"27. it is also referred to as the ‘right of control’-test. as is also the case in the uk cases, the california cases focus on labour law rights and are therefore interpretations of the definition of an employee in labour law. however, if an https://www.theguardian.com/business/2017/feb/10/pimlico-loses-appeal-againstplumbers-worker-status-in-gig-economy-case and sarah butler and hilary osborne, courier wins holiday pay in key tribunal ruling on gig economy, the guardian, fri 6 jan 2017 19.39 gmt, https://www.theguardian.com/business/2017/jan/06/courierwins-holiday-pay-in-latest-key-tribunal-ruling-for-gig-economy. 24 ‘nudging’ is “any aspect of the choice architecture that alters people’s behaviour in a predictable way without forbidding any options or significantly changing their economic incentives. to count as a mere nudge, the intervention must be easy and cheap to avoid”, see loewenstein, george and chater, nick, putting nudges in perspective, behavioural public policy (2017) 1, 27 with references. 25 rosenblat, alex and stark, luke, algorithmic labor and information asymmetries: a case study of uber’s drivers, international journal of communication, 2016, 10, 3758– 3784 and rosenblat, alex, "the truth about how uber's app manages drivers", harvard business review, april 6, 2016. 26 supreme court of california, march 23, 1989, no. s003956, s.g. borello & sons, inc. v. dep't of industrial relations. 27 supreme court of california, march 23, 1989, no. s003956, s.g. borello & sons, inc. v. dep't of industrial relations. njcl 2018/1 73 employee/employer relationship is established within labour law, this will presumably strongly indicate that the contractual relation with the peer-customer will be affected. several cases in california have ruled that specific drivers on the platforms uber and lyft are to be regarded as employees and not independent contractors.28 in line with the uk case, the california cases emphasise that the reality differs from the formal contract, e.g. “the reality, however, is that defendants (uber) are involved in every aspect of the operation.”29 we have yet to see a class action ruling in this area.30 attempts so far in the us have either been rejected by the court on the grounds that the cases are not suited for a class action31 or a settlement has been reached before the trial32. without going into detail, in summary, the foreign courts have emphasised that the platforms (despite not being expressed in the contract/terms of use) control the peer-provider through sanctions (or warnings of sanctions), if the quality goals set by the platform are not met. the platforms have the power to deactivate the account at any time (‘terminate at will’). also, some platforms set standards for the material (cars) and run background checks on the providers. in addition, the peer-providers are prevented from expanding their ‘business’ and might not be able to set their own prices or charge tips. finally, some platforms offer some kind of instruction, guidance or education for their peer 28 see for example labour commissioner, california, case no. 11-46739, berwick vs. uber technologies. the case is mentioned in http://qz.com/430583/a-legal-victory-foran-uber-driver-in-california-could-challenge-its-business-model/ og http://www.npr.org/sections/thetwo-way/2015/06/17/415262801/california-laborcommission-rules-uber-driver-is-an-employee-not-a-contractor. the ruling has been appealed. same result: california unemployment insurance appeals board, 2015, case no. 5371509 – reopened. 29 labour commissioner, california, case no. 11-46739, berwick vs. uber technologies. the case is also mentioned in http://qz.com/430583/a-legal-victory-for-an-uberdriver-in-california-could-challenge-its-business-model/ and http://www.npr.org/sections/thetwo-way/2015/06/17/415262801/california-laborcommission-rules-uber-driver-is-an-employee-not-a-contractor. the ruling has been appealed. 30 in united states district court, northern district of california, c-13-3826-emc and c-13-cv-03826-emc, 2016, o ‘connor vs. uber technologies, the court denies o’conner et. al. motion for preliminary approval of a settlement agreement with uber on the grounds that it is unfair for the drivers. 31 see for example united states district court for the southern district of florida, civil action no. 16-23670-civ-scola, sebastian a. rojas vs. uber technologies, inc. and others. 32 class action was granted to o’connor against uber by the united states district court, northern district of california in case no. c-13-3826 emc, 2015. the parties later agreed on a settlement, but a preliminary approval was denied by the same court in c-13-3826-emc and c-13-cv-03826-emc, 2016. the contractual platform framework 74 providers.33 having in mind that platforms are diverse, these elements all speak in favour of an employee/employer relationship. on the other hand, the platforms have argued that they do not control the peerproviders, because (and also according to their own standardised contract/terms of use) it is solely up to the peer-providers when they want to work (check in on the app) and what tasks they accept on the app. in addition, some of the peer-providers bring their own material and pay for their own expenses in regard to this material. even though many cases so far have ruled in favour of the peerproviders (the employees), the california courts have been reluctant to state with much certainty that their rulings should apply in similar cases without a case-by-case evaluation.34 some of the thoughts are presented in the following quote from district judge vince chhabria from the northern district of california. and even though mr. chhabria works in another judicial system, the cases have shown similar challenges crossborder in relations to finding the right legal box for peer-providers on labour platforms. as should now be clear, the jury in this case will be handed a square peg and asked to choose between two round holes. the test the california courts have developed over the 20th century for classifying workers isn't very helpful in addressing this 21st century problem. some factors point in one direction, some point in the other, and some are ambiguous. perhaps lyft drivers who work more than a certain number of hours should be employees while the others should be independent contractors. or perhaps lyft drivers should be considered a new category of worker altogether, requiring a different set of protections. but absent legislative intervention, california's outmoded test for classifying workers will apply in cases like this. and because the test provides nothing remotely close to a clear answer, it will often be for juries to decide. that is certainly true here.35 the quote is also valid in denmark and emphasises that the criteria set up for defining an employee is not appropriate when dealing with platform workers. the judge reveals his concern with the case-by-case evaluation based on outdated criteria, and the jury is forced to put the platform worker (the square peg) into one of two unfit boxes (two round 33 see the facts of united states district court, northern district of california, c-13cv-04065-vc, 2015, cotter vs. lyft. 34 the court has denied to make a so called summary judgment in case no. 13-cv04065-vc, order denying cross-motions for summary judgment, united states district court, northern district of california, cotter vs. lyft. 35 vince chhabria, united states district judge in case no. 13-cv-04065-vc, order denying cross-motions for summary judgment, united states district court, northern district of california, cotter vs. lyft. njcl 2018/1 75 holes). along the lines of mr. chhabria, some scholars have suggested a category of employee suited for peer-providers on intermediary platforms, e.g. an ‘independent worker’.36 it varies to which degree the scholars believe the same labour law rights should apply, but they do agree that this platform worker is in need of protection. an obvious downside if a new category of ‘worker’ is introduced is that if this worker is not granted the same rights and benefits as an employee, businesses in general might feel tempted to transform parts of their labour force into this ‘employee-light’ category. in regard to consumer protection, such a new category will more easily place the peer-provider in an employmentlike relation with the platform and this will result in the platform being the main contracting party of the peer-customer triggering consumer protection for the peer-customer. 2.2. the platform as the main contracting party in contract law, it is presumed that you are a party to the contract you engage in, unless it is very clear that you are not.37 as long as no specific legislation regulates the contractual role of platforms in the triangular structure, it must thus be a precondition for the platform in order to avoid being considered the main contracting party to clearly present itself as merely an intermediary when the provider and the peercustomer engage into a contract through the platform. in line with this presumption, the danish courts and the danish consumer complaints board38 have resolved a number of cases. after performing an overall assessment, the high court of eastern denmark ruled in u2016.1062 ø that an online travel agency platform had not provided sufficient information of its role as merely an intermediary. the terms and conditions in the user contract contained an opt-out clause, 36 see for example harris, seth, d. and krueger, alan b., a proposal for modernizing labor laws for twenty-first-century work: the ‘independent worker’, brookings, december 2015. 37 lynge andersen, lennart and madsen, palle bo, aftaler og mellemmænd, 2017. see also rognstad, ole-andreas, mellommenns sivilrettslige ansvar ved handel på internett, temanord 2004:512, s. 27. same position is taken in swd(2016) 163, commission staff working document guidance on the implementation/application of directive 2005/29/ec on unfair commercial practices accompanying the document communication from the commission to the european parliament, the council, the european economic and social committee and the committee of the regions a comprehensive approach to stimulating cross-border e-commerce for europe's citizens and businesses, section 5.2.2. also, if a platform performs commercial communication on behalf of a peer-provider, the id of the peer-provider must be clearly stated, cf. lov om tjenester i informationssamfundet, herunder visse aspekter af elektronisk handel, no. 227 of 22/04/2002 (law on e-commerce) para 9(1). 38 the consumer complaints board is an independent board that decides consumer complaints. the consumer complaints board consists of a chairman (a judge) and representatives of consumer and business organisations. the contractual platform framework 76 and in the footer and header as well as right before and after payment, this opt-out clause was also mentioned. the overall assessment included the interpretation of the information given. the court stated that it cannot “be presumed that the ordinary consumer, solely based on this information, can deduct the consequences for his legal position in his relations to” the platform. this line of argumentation entails that a correct information given in a correct way about the platform being only an intermediary is not necessarily sufficient if the peer-customer (the consumer) is not able to understand the consequences of this information. this extended qualification of the duty to inform is in line with the tendency of consumer protection in regards to the duty to collect informed legal consent (“express consent and acknowledgement”)39 and also in line with the requirements of terms in consumer contracts in regard to establishing whether a term is clear.40 other information on the platform’s website referred to the travel agency as ‘technical organiser’ and even though this information might point in favour of the platform, it was not considered decisive for the case. also, it was not considered pivotal that travel agencies normally do not enter into contracts in their own name.41 following this case, the other regional court in denmark ruled opposite when it tried a case concerning an online travel agency platform. in u2018.574v, the court emphasised that from the homepage of the travel agency, it appears that the customer can choose between more than one million overnight accommodations and that the payment is to be paid directly to the accommodation. the name and address of the accommodation as well as price and duration was provided on the confirmation of the reservation. also on the confirmation, it was stated that payment was to be made directly to the place of accommodation and it was also the place of accommodation that determined the fees for cancellation and alterations. the confirmation also made a referral to contact the place of accommodation if any problems with the booking occur. as a last point, the court emphasised that the terms and conditions found on the agency’s homepage states that the customer enters into a contract directly with the accommodation and that the agency only is a liaison between the customer and the accommodation. based on these facts and without 39 directive 2011/83/eu of the european parliament and of the council of 25 october 2011 on consumer rights, amending council directive 93/13/eec and directive 1999/44/ec of the european parliament and of the council and repealing council directive 85/577/eec and directive 97/7/ec of the european parliament and of the council, article 7(2). 40 council directive 93/13/eec of 5 april 1993 on unfair terms in consumer contracts, article 5. 41 further analyses of the case, see østergaard, kim, pakkerejsedirektivets krav om et almindeligt, forståeligt, tydeligt, klart og letlæseligt sprog, in dahl, børge; riis, thomas; trzaskowski, jan, festskrift til peter møgelvang-hansen, 2016, 564 et seqq. njcl 2018/1 77 further reasoning, the court stated that the customer should have understood that the agency was not the main contracting party. the court did not attach importance to the fact that the agency tried to help solve the problems the customer encountered because of nonperformance from the reserved place of accommodation (help to find other accommodation as well as payout of compensation). neither did the court mention that the customer actually typed in name and credit card information in the booking flow. albeit lacking in detailed reasoning, this court case shows that there is a limit to how ‘inattentive’ a customer can be. the customer testified that he did not know that the platform was not the main contracting party. different from the earlier court case, the court in this case does not seem to go into interpreting the information given on the platform and in the confirmation. the court simply acknowledges that the information is given and even though the platform does not explain the consequences of its contractual disclaimer (as was one of the focal points in the earlier case), it seems that the court finds that the information is given in such a clear-cut manner that an explanation is unnecessary. normally, the contract will form the base of the legal position of two parties. in line with consumer protection legislation, the mentioned case law as well as board cases indicate that in regards to consumer contracts, there is a special consideration to be taking into account. as the weaker party, the (average)42 consumer must be protected against agreed standard terms such as opt-out clauses which (potentially) is to the detriment of her. information on such terms must be provided in a clear and intelligible manner. despite an opt-out clause in the terms and conditions, the additional information as well as the expectations of the consumer based on the behaviour of the platform will be decisive in categorising the platform as the main contracting party.43 thus, case law emphasises that the opt-out clause in the terms and conditions should be supplemented by a clear indication of who the peer-provider is and this should happen preferably at the beginning of the booking flow. also, it will help make the identification of the peer-provider clear, if the supplier explicitly is mentioned as the one performing the obligations in the contract. even though the platform in giving information uses the correct legal terms, case law indicates that additional information and 42 the notion of ’average consumer’ is developed in ecj case law and incorporated into recent eu consumer protection regulation and danish case law and statutory law. see østergaard, kim, pakkerejsedirektivets krav om et almindeligt, forståeligt, tydeligt, klart og letlæseligt sprog, i dahl, børge; riis, thomas; trzaskowski, jan, festskrift til peter møgelvang-hansen, 2016, 560 et seqq. with references. see also among others incardona, rossella; poncibó, cristina, the average consumer, the unfair commercial practices directive, and the cognitive revolution, journal of consum policy, 2007, 21-38. 43 see also the application of the same principle in case law in rechnagel, hardy, endnu en søog handelsretsdom om speditørens retlige status som fragtfører, ufr, u1980b.47. the contractual platform framework 78 matching behaviour also is necessary in order to ensure that the consumer understands that the platform is not the main contracting party. in late 2016, the ecj too had the opportunity to rule in a case regarding a platform that potentially gives the impression of being the main contracting party to a consumer. in c-149/15 wathelet, the court interprets the concept of ’seller’ stemming from the sales directive.44 the court emphasises that in order to be perceived as a ‘seller’, you do not have to be the owner of the good. the ga, h. saugmandsgaard øe, expresses the opinion that when the platform gives the impression of ‘seller’, the intermediary platform makes an ‘irrevocable decision’45 that despite the intended contractual constellation is crucial for the liability of the platform. the ecj agrees with the ga and leaves it up to member states to decide, when an intermediary gives the impression of a seller. as help for performing such an assessment, the ecj provides some guidelines: the intermediary can be regarded as the seller if: “he fails to duly inform the consumer that he was not the owner of the goods in question, which involves, on the part of that court, taking into consideration all of the circumstances of the case… the degree of participation and the amount of effort employed by the intermediary in the sale, the circumstances in which the goods were presented to the consumer and the latter’s behaviour may, in particular, be relevant in that regard in order to determine whether the consumer could have understood that the intermediary was acting on behalf of a private individual.”46 danish case law seems to include these elements as emphasis is placed both on how and what information is provided and on the perception of the consumer. 2.3. the platform as a mere intermediary sénéchal defines the intermediary platforms as … a hybrid figure oscillating between distribution on their own behalf and intermediation with certain characteristics of the commercial agency while radically deviating in that the online 44 directive 1999/44/ec of the european parliament and of the council of 25 may 1999 on certain aspects of the sale of consumer goods and associated guarantees. 45 ga in ecj c-149/15, wathelet, [2016] ecli:eu:c:2016:840, para 75. 46 c-149/15 wathelet, para 44. see case comments in dodsworth, timothy j., intermediaries as sellers – a commentary on whathelet, european journal of consumer and market law, issue 5, 2017, 213. njcl 2018/1 79 platform has not the economic dependence of a commercial agent.47 the quote underlines that the platforms do not seem to fit into the commercial agent box. consequently, if the platforms are what they claim they are – merely intermediaries the question then is how they are regulated – if regulated at all. besides potentially being governed by sectorial laws, the intermediary platforms are not governed by specific legislation in relations to the triangular structure other than the ecommerce directive.48 however, this is only partly true for the intermediary platforms covered by danish law. 2.3.1. the danish intermediary rule the danish intermediary rule was first introduced in the new danish consumer contract act of 1977 governing off premises selling and the right of withdrawal.49 the rule constitutes a part of the consumer definition. in denmark, a consumer is a person who primarily acts outside his trade or business.50 a consumer contract is a contract between a consumer and a natural or legal person acting within his trade or business.51 the intermediary rule adds: “.... the law also applies for contracts on goods and services from non-traders, if the contract is concluded or mediated through or with the help from a business.”52 basically, it means that when two peers enter into a contract through a (business) platform, this contract becomes a consumer contract. the peer-customer is then protected as a consumer vis-à-vis the other private person (the seller). the latter then has to comply with consumer law. the danish intermediary rule has lived a somewhat quiet life but has become pertinent with the rise of the platform economy. 47 sénéchal, juliette, the diversity of the services provided by online platforms and the specificity of the counter-performance of these services a double challenge for european and national contract law, eucml 5, 2016, 41. 48 it must be presumed that an intermediary platform which is governed by sector specific law also is a service provider within the scope of the e-commerce directive. see a discussion on the application of the e-commerce directive and platforms in cauffman, caroline, the commission’s european agenda for the collaborative economy – (too) platform and service provider friendly? eucml 6, 2016, 235 – 243. 49 see for more information on the danish intermediary rule: m. j. sørensen, digitale formidlingsplatforme formidlingsreglen i dansk forbrugerret, ufr, u2017b.119 and m. j. sørensen, uber – a business model in search of a new contractual legal frame, eucml 1, 2016, 15 -19. 50 the consumer contract law, no. 1457 of 12/17/2013, para 2(3) as well as all other consumer protection laws within the area of civil law. 51 the consumer contract law, no. 1457 of 12/17/2013, para 2(1) and other civil law legislation on consumer protection. 52 now to be found in the consumer contract law, no. 1457 of 12/17/2013, para 2(3) as well as all other consumer protection laws within the area of civil law. the contractual platform framework 80 in 1977, the danish legislators were of the opinion that the need for protection of the peer-customer “presumably significantly” is the same when contracting through an intermediary as it is when the intermediary itself is the contracting party.53 in the preparatory work, it is clarified that the peer-customer in both situations negotiates with a professional, but the peer-customer is not aware that the main contracting party (the provider) is not a professional, when the intermediary is only an intermediary. this is underlined by referring to the fact that the intermediary often puts a standard contract at the disposal of the parties.54 in 1978, the intermediary rule was added to the danish sales act for the same reason55: “the crucial point is that the peer-customer negotiate with a professional who often possess a superior level of expertise.”56 the preparatory work goes on to state as an example that goods bought at auctions performed by a business platform should be seen as a consumer purchase if the good is to be used for private purposes by the consumer. the intermediary rule does not refer to known agency figures.57 it consists of three cumulative criteria: 1) the intermediary must act within his trade or business;58 2) the intermediary must play an active part in the transaction between the peer-customer and the peer-provider;59 lastly, 3) the intermediary must not be the main contracting party or act in its own name. of specific interest is the second criteria, which will be unfolded in the following paragraph. active part to be regarded as an active part under the danish intermediary rule, the intermediary has to do more than just connect the two contracting parties. if the intermediary only provides space on its website, a billboard or other passive possibilities of exchange of contact information, according to the preparatory work, this will not constitute 53 l 39, 1977 om forslag til lov om visse forbrugeraftaler, comments on para 1(4). (preparatory work of the danish consumer contract act) 54 l 39, 1977 om forslag til lov om visse forbrugeraftaler, comments on para 1(4). (preparatory work of the danish consumer contract act) 55 bekendtgørelse af lov om køb, no 140 of 17/02/2014. 56 l 119, 1978-1979 forslag til lov om ændring af købeloven, comments on para 4a(2). later repeated in l 220, 2004 om visse forbrugeraftaler og om ændring af lov om forsikringsaftaler og lov om beskatningen af pensionsordninger m.v., section 4.2.1.1. 57 see karstoft, susanne, retlig regulering af ’elektroniske loppemarkeder’, ufr, u2006b.55. 58 l 39, 1977 om forslag til lov om visse forbrugeraftaler, comments on para 1(4). and betænkning no. 845/1978 om forbrugerkøb, 59. (both preparatory work of the danish consumer contract act). 59 l 39, 1977 om forslag til lov om visse forbrugeraftaler, comments on para 1(4) and l 27, 1994 om forslag til lov om ændring af lov om aftaler og andre retshandler på formuerettens område og visse andre love, comments on para 38a. njcl 2018/1 81 as an active intermediary.60 if the platform praises the goods or services or in other ways takes part in the negotiations or transaction, it will be regarded as an active part and the intermediary rule will apply if the two other criteria are met. defining the criterion of active participation has been the focal point in a couple of danish cases. in sh2009.n.0001.07 from june 18 2009 (qxl), the maritime and commercial court found the online auction platform qxl to be an active intermediary. the argumentation can be divided into two: firstly, the court found that qxl was acting as agent for the peer-provider (authorised to act on behalf of the peer-provider) based on the fact that a contract was automatically concluded as soon as the peer-customer won the bidding round. secondly, qxl participated significantly in the entering into contract between the peer-provider and peer-customer by making available a promoting and professional distance selling system. in addition, the contract was concluded by filling out a form drawn up by qxl and later confirmed by qxl. qxl received a fee for each contract concluded. in a second court ruling, u2000.2559 ø (regional east court), the court was also of the opinion (though without stating on what ground) that a lawyer met the criteria of the intermediary rule when intermediating a sale of property between two peers. the lawyer handled the negotiation on behalf of the provider and produced all documentation. it was without bearing that the peer-customer himself was represented by a legal advisor. also, in a statement from the danish consumer ombudsman, no. 08/04028, the ombudsman found that a business intermediating contracts between two peers was an active intermediary because it collected a fee for each contract and provided a payment system for the two parties. the legal consequences in the mentioned qxl case, the court ruled that qxl is governed by the intermediary rule which means that the contract between the peer-provider and the peer-customer is to be regarded as a consumer contract. according to the court, this also means that certain information duties contained in consumer protection legislation is triggered and this information (e.g. information about the right of withdrawal)61,62 is to be provided by qxl.63 qxl had given some 60 betænkning nr. 845/1978 om forbrugerkøb, sp. 18 and l 27, 1994 forslag til lov om ændring af lov om aftaler og andre retshandler på formuerettens område og visse andre love, comments on para 38a(3). 61 see also case from the consumer ombudsman fom 08/04028. 62 rognstad finds that the expectations to the role of the intermediary also can create a ground for liability for information for the intermediary. this means that the commercial practice regulation will influence the area, cf. rognstad, ole-andreas, mellommenns sivilrettslige ansvar ved handel på internett, temanord 2004:512, section 3.4. the contractual platform framework 82 general information about consumer rights, but the court did not find the information sufficient. placing the information duty on the intermediary also finds support in the preparatory work of the intermediary rule: the starting point is that it is the business intermediary who is required to fulfill the duty of information and that notice about the exercise of the right of withdrawal etc. can be given to the intermediary. the counterparty of the peer-customer is, however, still the peer-provider and obligations and rights that follow from the (consumer) contract lies therefor with the two peers and not the intermediary.64,65 however, whether a specific information duty lies with the intermediary or the peer-provider has to be determined by an “interpretation of the specific rule in the act.”66 thus, when the legislation refer to a ‘business’ or a ‘trader’ to give certain information, it must be assessed whether it is the intermediary or the private peerprovider who is the obligated party. the preparatory report no. 1440/2004 states that ”the starting point is that the rules must be interpreted in line with the wording of the text…”, which means that when the rules refer to the ‘business’, it refers to the intermediary.67 this, however, only applies to information duties and to the duty to receive notice on right of withdrawal from the peer-customer. qxl tried to argue against an obligation to give information by referring to the principle of exemption of liability for intermediaries in 63 relevant in the case is the danish consumer contract act and the danish law on ecommerce. see for a general discussion on information duties of platforms in wendehorst, christiane, platform intermediary services and duties under the ecommerce directive and the consumer rights directive, eucml 5, 2016 and in sandfeld jacobsen, søren, formidleransvaret i forbindelse med sociale tjenester på internettet, ufr, u2009b.291. 64 l 220, 2004 om visse forbrugeraftaler og om ændring af lov om forsikringsaftaler og lov om beskatningen af pensionsordninger m.v., bemærkningerne til § 3. (preparatory work for the danish consumer contract act) 65 see a discussion of the scope of the consumer rights directive in regards to digital platforms and a general discussion of the information duty of the intermediary, wendehorst, christiane, platform intermediary services and duties under the ecommerce directive and the consumer rights directive, eucml 5, 2016, 30 et seqq. and možina, damjan, retail business, platform services and information duties, eucml 5, 2016, 25 et seqq. 66 l 220, 2004 om visse forbrugeraftaler og om ændring af lov om forsikringsaftaler og lov om beskatningen af pensionsordninger m.v., bemærkningerne til § 3. (preparatory work for the danish consumer contract act) 67 betænkning 1440/2004 om revision af forbrugeraftaleloven, p. 106 (karnov edition)(preparatory work for the danish consumer contract act) njcl 2018/1 83 article 16 of the danish e-commerce act68 implementing the ecommerce directive. the court rejected this argument with reference to the active participation of qxl that exempted them from the scope of application of the liability exemption rules in articles 14-16. in danish law, the information duties in the consumer protection legislation are sanctioned with fines. thus, the platforms can face a fine if they do not comply with the information duties triggered by the intermediary rule. the consumer can still only claim his material consumer protection rights (e.g. the right of withdrawal and right to remedies) towards the provider. as a consequence, in the case where the information duty lies with the platform, the civil law sanctions are still put upon the peer-provider, as she in the case of information about the right of withdrawal then has to provide the legally stated extended period of the right of withdrawal to the consumer. the eu commission has expressed concern with rules such as the danish intermediary rule as it, in their opinion, is too burdensome on the peer-provider.69 the commission states: in line with eu consumer and marketing rules, member states are encouraged to seek a balanced approach to ensure that consumers enjoy a high level of protection in particular from unfair commercial practices, while not imposing disproportionate information obligations and other administrative burdens on private individuals who are not traders but who provide services on an occasional basis.”70 determining a ‘balanced approach’ is ultimately a policy question. the downside of the ‘balance’ prompted by the danish intermediary rule is that the protection of the peer-customer might be illusory as the peerprovider is unable to support the costs associated with compliance with consumer protection legislation and therefore might not provide consumer protection in practice. in addition, when the peer-provider is to be regarded as a business/trader within the contractual triangular structure, it is unclear whether this classification will influence the application of sector specific regulation such as hotel regulation which presumably is inadequate in p2p relations. in relation to legal certainty and transparency, the intermediary rule has an advantage as it eliminates the legal uncertainty as to whether the 68 lov nr. 227 af 22. april, 2002 om tjenester i informationssamfundet herunder visse aspekter af elektronisk handel (law on e-commerce). 69 a european agenda for the collaborative economy, com(2016)356 final, section 2.1. see a critical analyses of this agenda, cauffman, caroline, the commission’s european agenda for the collaborative economy – (too) platform and service provider friendly?, maastricht european private law institute, working paper no. 2016/07. 70 communication from the commission to the european parliament, the council, the european economic and social committee and the committee of the regions, a european agenda for the collaborative economy, com(2016)356 final, 11. the contractual platform framework 84 peer-provider is a private person or a business. this is a challenge for other member states and the eu without the intermediary rule.71 2.4. the platform as a secondary obligated party seemingly, danish and eu contractual consumer protection law is based on a two party relationship between a provider and a peercustomer (chain economy). in regards to the two-sided market, the platform economy is constructed as a triangular contractual relationship with the platform in one corner and a provider and customer in the two other corners, respectively. even though the contract between the provider and the customer (the main contract) is concluded with the help of the platform and sometimes with great influence from the platform, according to contract law, the contractual obligations lies only with the provider and the customer. even if the two parties of the main contract wanted to obligate the platform in any way, this would not be possible as it would be contrary to the principle of relativity of contracts as well as freedom of contract. aside from the exception in the second legal frame, this section will briefly elaborate on how, within the current contractual legal paradigm, the platform could perhaps in some other situations be obligated in regards to the main contract. in the triangular business structure, the peer-customer does not only engage into a contract with the provider (the main contract). the peer-customer also engages into a consumer contract with the platform when accepting the terms and conditions for the use of the platform (the user contract).72 normally, this contract is disconnected from the main contract between the provider and the peer-customer. some danish legal theorists claim that in modern contract law, a tendency towards a more objectified contract law can be traced.73 thus, there has been a movement away from the subjective theory of interpretation based on the will of the parties. this appears valid especially in the case of consumer contracts, where presumably there is a weak party who should be protected against the will of the trader.74 the following examples can be given in this regard: in the unfairness test in regards to unfair consumer contracts, one part of the test is whether the consumer would have engaged into a contract if he knew/understood a specific term.75 71 the eu commission suggests a maximum for the peer-provider, so that when the peer-provider exceeds a threshold of turnover, income, number of sales or other, the peer-provider becomes a business, a european agenda for the collaborative economy, com(2016)356 final. 72 see for a discussion of the acceptance of ’terms of use’ as ‘a contract’, larsen, torsten bjørn and feldthusen, rasmus kristian: de sociale mediers brugervilkår del i – aftalen, erhvervsjuridisk tidsskrift, t.2016.266. 73 bryde andersen, mads, opgør med relativitetsprincippet, ufr, u2001.121. ulfbeck, vibe, kontrakters relativitet, 1. ed, 2000, 47 et seqq. 74 see also bryde andersen, mads, opgør med relativitetsprincippet, ufr, u2001.121. 75 ecj c-415/11, aziz, [2013] ecli:eu:c:2013:164, para 69. njcl 2018/1 85 another part of the unfairness test is to compare the contested term with mandatory law in the area. if the term gives the consumer less protection/benefits, this will indicate that the term is unfair.76 also, if a term differs from mandatory law, the term has to be presented in a very clear and intelligible manner to be valid. if it is not clear and intelligible, it must be interpreted most favourable to the consumer.77 moving away from weighing the will especially of the trader makes room for the theory of interpretation involving the expectation of the consumer. in the outline edition of the dcfr, it is stated that the protection of reasonable reliance and expectations is a core aim of the dcfr, just as it was in pecl. usually this protection is achieved by holding the mistaken party to the obligation which the other party reasonably assumed was being undertaken.78 one of the arguments for the danish intermediary rule was exactly that the peer-customer is given the impression that the intermediary somehow plays a part in the main contract. the platform might give this impression either by failing to give sufficient information about their intermediary role or by giving the impression that the platform somehow puts up guarantees for the performance in the main contract. the latter might be the case if the platform informs the peer-customer, or as part of its brand gives the impression to the peer-customer that the platform checks the providers, educates them, monitors them, controls them etc. also, the platform might enhance this impression by making commercial statements like ‘we deliver good service’ related to their business as a whole in order to boost their brand. applying a high level of consumer protection as aimed for and expressed in the treaty of the functioning of the internal market,79 one cannot rule out that there might be cases where the peer-customer could have developed such reasonable expectation about the platform’s part as a guarantor for elements of the main contract. what exactly the platform guarantees will depend on the specific information/branding. as such a ‘guarantor’, the platform will be liable together with the provider for non-performance of the main contract if ‘the guarantee’ is related to the performance. if ‘the guarantee’ is more related to the provider (background check and control) or the 76 c-415/11, aziz, para 68. 77 council directive 93/13/eec of 5 april 1993 on unfair terms in consumer contracts, article 5. 78 principles, definitions and model rules of european private law, draft common frame of reference (dcfr), outline edition, edited by christian von bar, eric clive; schulte-nölke, hans; beale, hugh; herre, johnny; huet, jérôme; storme, matthias; swann, stephen; varul, paul; veneziano, anna and fryderyk zoll, sellier, 2009, 73. 79 treaty on the functioning of the european union, article 114 and 169. the contractual platform framework 86 services performed by the platform itself, the platform could be liable for damage in that regard. another specific challenge stemming from the triangular structure is if the platform controls all information given to the peer-customer. the peer-customer and the provider cannot always contact each other directly as their identity is not known to the other party before entering into a contract. this limits the provider’s ability to apply with his information duties. if the provider is a business or the triangular setup is governed by the danish intermediary rule, the duty to inform is the extended duties in consumer protection legislation. one could argue that the platform is obligated to give this information either in general, as they seem to be the closest to provide the (pre-contractual) information, or in the situations where they do not make it possible for the supplier to give the information to the consumer. this is in line with the notion that whoever controls the flow of information should also be obligated to provide it. (economic) risk is also an issue one could discuss when looking at the triangular business structure. assessment of risk is related to social considerations and policy. however, normally, contractual considerations about risk will be related to the distribution of risk between two contracting parties. in the triangular structure, the provider and peer-customer bear the risk of the main contract. the platform bears the risk of running a business that is depended on a large number of users. in most cases, if the platform collects provision for each contract, this provision is not repaid if the contract is breached. also, on some platforms, the users do not have to engage into contract to give the platform a profit. the platform can earn a profit from selling the data collected from the users and from selling advertisements regardless of transactions on the platform. thus, one might say that the possibility of earnings does not seem to follow the (economic) risk and traditionally, alignment of risk and profit is a law and economics issue that influences contract law.80 from the point of view of who is nearest to bear the risk,81 it might be tempting to point the finger at the platform in the case where both the provider and customer are peers. it would not be impossible to imagine arguments about risk and control in combination with the argument on reasonable expectations or guarantees. in c434/15, the ga stated: “… i take the view that the finding made immediately above prevents uber being treated as a mere intermediary between drivers and passengers. drivers who work on the uber platform do not pursue an independent activity that exists independently of 80 bryde andersen, mads, grundlæggende aftaleret, 2013, 456. 81 more on who is the nearest to bear the risk in madsen, christian frank and østergaard, kim, nærmest til at bære risikoen i kontraktretten, juristen, 2, 2017. njcl 2018/1 87 the platform. on the contrary, the activity exists solely because of the platform, without which it would have no sense.”82 despite the fact that the quote aims to argue for uber being a supplier of transportation and not just a service provider, the quote also indicates that the platform in this case cannot be seen as a party disconnected from the main contract (‘as a mere intermediary’). lastly, there are some non-party considerations that can be addressed in viewing the triangular contractual structure of platforms. it is not new that contract law holds non-party considerations such as social responsibility and the promotion of welfare.83 it depends on one’s political stand how (if at all) these issues should be taken into consideration when looking at the contractual structure of platforms. the platforms help cut transaction costs through easy and standardised access to relevant parties. the platforms also expand the market and in some ways boost competition. because of the reliance on a crucial number of users, in some sectors of business platforms could, however, be counter productive for the market. the labour platforms might supply a new way of income for people outside the labour market.84 on the other hand, labour platforms do not necessarily feel obligated to follow rules on minimum wage and other rights constituted in labour law and therefore can be accused of undermining the labour marked as well as performing unfair competition.85 the list of pros and cons of these platforms are much longer, but this short list illustrates, that arguments fitting many different political views can be found. however, as with the risk assessment, these considerations are traditionally linked to contract law governing the contract between two parties. it will probably be relevant to take these considerations into account, if a specific regulation of platforms was to be formulated. 82 ag c-434/15 elite taxi, para 56. 83 principles, definitions and model rules of european private law, draft common frame of reference (dcfr), outline edition, edited by christian von bar, eric clive; schulte-nölke, hans; beale, hugh; herre, johnny; huet, jérôme; storme, matthias; swann, stephen; varul, paul; veneziano, anna and fryderyk zoll, sellier, 2009, 14. see also lynge andersen, lennart and madsen, palle bo, aftaler og mellemmænd, 7. ed, karnov group, 2017, 117 and bryde andersen, mads, opgør med relativitetsprincippet, ufr, u2001.121. 84 see for example de stefano, valerio, the rise of the ‘just-in-time workforce’: ondemand work, crowdwork and labour protection in the ‘gig-economy’, international labour office geneva, no 71, inwork. 85 see for example adams, abi; freedland, mark; prassl, jeremias, the ‘zero-hours contract’: regulating casual work, or legitimating precarity, university of oxford legal research paper series, no 00/2015. the contractual platform framework 88 3. finishing remarks this contribution has analysed and discussed four existing potential legal frames to apply to the triangular contractual structure of platforms. as with all legal frameworks, weighed principles and considerations result in criteria that have to be met in order for the platform to be governed by the framework. even though the danish intermediary rule (the second legal frame) is burdensome on the provider and the benchmark for sufficient information (the third legal frame) for disclaiming can be discussed and challenged, these two legal frames are both fitted to the triangular structure and do not seem to result in situations in conflict with their purpose – mainly the protection of the peer-customer (the consumer). however, in order to have an effect, firstly, the peer-customer has to be aware of his legal position and secondly, he has to be able and willing to pursue his rights. the triangular structure makes the conditions hard for these legal frames to be effective because the platform to a large extent controls information and because the counter party of the platform presumably is a weak peer-customer. the employee framework as well as the framework of a secondary obligated party are not designed to the triangular structure and seem to conflict with underlying considerations when platforms enter the scene. here, ‘reality’ floats on top of the carpet of legal boxes. as a consequence, the considerations about social security, consumer protection, and ultimately welfare that traditionally justify both labour law and consumer law are challenged. whether these considerations are also relevant in the case of platforms is of course a policy question, but if there is a need to take regulatory steps to respond to this potentially unintended challenge of the underlying considerations, there are several ways to go. in broad terms, there are three headlines for such next steps: 1. regulation, 2. self-regulation and 3. regulating/facilitating selfregulation. a step within the first headline is taken by a group of european researchers (the eli working group).86 the group is a continuation of the research group on the law of digital services. it is still a work in progress, but through a draft of european model rules for online intermediary platforms (mrd),87 the working group aims to 86 the model rules draft is drafted by a group of 35 researchers from 10 different eu countries (the eli working group) who started the work in 2015. the group is a continuation of the research group on the law of digital services and is lead by c. busch; h. schulte-nölke; a. wiewiórowska-domagalska; f. zoll and g. dannemann. since 2017, the project has been incorporated as a project of the european law institute (eli). 87 an early draft is published in bush, christoph; schulte-nölke, hans; wiewiórowskadomagalska, aneta; dannemann, gerhard and zoll, frederic, ´discussion draft of a directive on online intermediary platforms´(2016), 4 european journal of consumer and market law, 164. see some critical thoughts on this discussion draft in maultzsch, felix, ‘contractual liability of online platform operators: european proposals and established principles’ (2017), goethe-universität frankfurt am main njcl 2018/1 89 provide a general piece of legislation securing transparency as well as allocating risk in the triangular structure. the preliminary scope is primarily platforms where users register in order to engage into contract with each other. the mrd is sector neutral and follows in line of existing eu consumer (contract) law, especially the consumer acquis which to a large extent employs information duties as the preferred regulatory technique. the mrd is still undergoing adjustments, but two of the more innovative proposed provisions are specifically relevant to present here in the light of the four legal frames discussed in this article.88 the two provisions constitute parts of the proposed liability regime in the mrd. the first provision entails that if a platform obtains credible evidence of illegal conduct by a user and this conduct potentially is harmful to another user engaging into contract with the first user, the platform is obliged to take adequate measures in order to protect the users. if the platform fails to take these measures, it becomes liable for damage caused by this failure. the provision contains elements from the e-commerce legislation, complicity rules in criminal law as well as tort law. in regard to the challenges in the four legal frames, this provision allocates some of the contractual as well as non-contractual risk present when two parties engage into contract/contact. the damaged user can make his claim either to the platform or to the other user. albeit not obligating the platform to monitor the users, the provision allocates risk to the platform, because of the platform’s ability to control the users’ access to the platform. in addition to this alignment of control and risk, the provision also is an obvious accommodation of the expectation a user might have to the platform in situations like these. apart from the sanctions for the platform, this provision is in alignment with the platform’s own incentive to create and preserve trust as the most important requisite for the triangular business structure. the second of the two selected mdr liability provisions states that if a customer can reasonably rely on the platform having predominant influence over the provider, the platform and the provider are joint liable for breach of the main contract. the provision is supplemented with a non-exhaustive list of elements to consider when determining whether the customer has this reasonable reliance. the list refers to how the contract is concluded; whether the platform can withhold payments from the customer; who determines the content of the main contract; who sets the price etc. similar to the first provision, this provision aligns risk and control (predominant influence) – this time, the rights conferred upon the peercustomer relate specifically to the non-performance of the main contract. also, in this provision, a strong emphasis is placed on reliance < https://ssrn.com/abstract=3074301> < http://dx.doi.org/10.2139/ssrn.3074301> accessed july 6, 2018. 88 a commentary of an early draft of the model rules draft (when it was a proposal for a directive) is in press and is expected to be published in the fall of 2018. the contractual platform framework 90 (expectation). the provision seems to accommodate most of the considerations discussed in the fourth legal frame regarding quasi guarantees, expectations and control. in contrast to the first liability provision, without this second provision, the platform might not have incentive by itself to undertake the risk allocated to it in the provision. thus, this provision will in fact provide an allocation of risk which most likely would not be actualised otherwise. as the criterion of ‘predominant influence’ (also in combination with ‘reliance’) is openended, the application of the provision will often be preconditioned by a case-by-case evaluation. this weakens the effectiveness of the provision as the platform controls the initial legal contractual framing of the triangular structure and the starting point will there for presumably be the self-definition as ‘intermediary’ disclaiming all liability. if step number 2 regarding self-regulation is preferred, the platforms will find themselves floating on top of the carpet of legally defined boxes because it does not fit into the boxes, and they will thus create their own ‘legal’ environment applicable on the triangular contractual structure. because the two-sided business structure is based on trust through reputation, the platform’s interests will to a certain extent be aligned with the interests of the legislators (and users). however, in regard to transparency and extended liability, there will most likely be discrepancies. to a certain extent, these discrepancies could perhaps be squared up by supplementing the self-regulation with facilitating regulation (step 3) such as putting up (technical) standards for review systems, payment systems etc. as well as open-ended provisions/standards on behaviour. without additional regulation or regulation of self-regulation, the four legal frames presented in this contribution will apply. whether these frames provide the right balance between all the different relevant considerations, such as consumer protection and protection of peerproviders on one side and market development on the other side, is ultimately a question of policy. this contribution has aimed to qualify future legal and political work in regard to this balance. microsoft word neumann_thomas.doc nordic journal of commercial law issue 2013#1 the continued saga of the cisg in the nordic countries: reservations and transformation reconsidered by thomas neumann*1 *1 the author, thomas neumann (phd, master of laws) is assistant professor at the department of law at the school of business and social sciences, aarhus university in denmark, and he is the founder and editor of the cisgnordic.net case law database. the author wishes to thank ása ólafsdóttir for useful feedback. nordic journal of commercial law issue 2013#1 1 1 introduction recently, there have been significant legislative changes in the nordic rules concerning formation of contracts. some of these changes have already taken effect while others will have effect in the near future. the present article provides an overview of the current status and challenges regarding the nordic legislative changes. the changes are related primarily to the processes of withdrawing reservations made according to article 92 of the un convention on contracts for international sales of goods (hereinafter cisg or the convention).1 before turning to the details it is beneficial first to introduce some salient parts of the convention history in a nordic perspective and to define more precisely, which countries are considered to be nordic. the cisg is currently in force in 78 states.2 its purpose is to create a uniform set of rules regarding formation and performance of contracts concerning trade in goods. by providing a textually uniform framework for businesses and by demanding its uniform application, the convention is supposed to remove barriers to trade that exist in the form of differences between domestic rules.3 by having one and the same convention for the formation of contracts and contract performance it becomes easier for parties engaged in international trade of goods to predict their legal status, since the rules ideally are the same. consequently, transaction costs are lowered and in the end, peace among nations is fostered. this of course presumes that both the convention text and its application are uniform.4 obviously, the trading parties are robbed of the possibility to predict their legal status, if the courts of the cisg contracting states do not apply the rules in a uniform manner. the same is true, if the convention text that is being applied is not the same across countries. differences in the convention text or in its application lead to forum shopping and increase in transaction costs, which it was the intention to remove in the first place. 1 united nations convention on contracts for the international sale of goods, (adopted 10 march to 11 april 1980, entered into force 1 january 1988) 1489 unts 3. 2 united nations commission on international trade law, status of cisg, http://www.uncitral.org/uncitral/en/uncitral_texts/sale_goods/1980cisg_status.html accessed 27 may 2013. 3 preamble of the cisg; ‘documents of the conference and summary records of the plenary meetings and of the meetings of the main committees’ official records (vienna 10 march – 11 april 1980) un doc a/conf.97/19, 195-196; harry m. flechtner (ed), uniform law for international sales under the 1980 united nations convention (4th edition wolters kluwer, austin 2009) 117 and camilla b. andersen, francesco g. mazzotta, bruno zeller, a practitioner’s guide to cisg (juris publishing, new york november 2010) 73. 4 joseph lookofsky, ‘hensynet til fremmed retspraksis ved fortolkning af cisg’ [2005] ugeskrift for retsvæsen 45; john felemegas, an international approach to the interpretation of the united nations convention on contracts for the international sale of goods (1980) as uniform sales law (cambridge university press, cambridge 2007) 5-6. nordic journal of commercial law issue 2013#1 2 uniformity faces its adversaries at the textual level in two ways. firstly, because the convention exists in six equally authentic language versions which have discrepancies among themselves. secondly, the application of the convention text as a whole is undermined, when contracting states make reservations against the application of parts of the convention. though reservations may be seen as the necessary tool to provide the flexibility needed to convince states to actually adopt instruments like the cisg, they have the consequence that the provisions of the cisg are allowed to be applied differently (if applied at all) from state to state, and thus a reservation is a threat to uniformity at both the textual level and consequently also at the application level.5 fortunately, a number of states are in the process of revoking their reservations. the latest notification of withdrawal was received by uncitral in january 2013 and was made by china in regard to its original reservation against the freedom of form rule in the convention.6 other soviet-influenced states like latvia and estonia have also withdrawn their reservations against the freedom of form made according to cisg article 12 and article 96.7 for the sake of uniformity such withdrawals are welcomed. 1.1 terminology in the nordic countries we also see a movement towards greater uniformity through withdrawal of reservations. the nordic countries are here defined as being denmark, finland, iceland, norway, and sweden. the nordic region includes also the five countries’ associated territories. the associated territories are the autonomous regions of greenland and the faroe islands that belong to the danish reign, and åland that belongs to the finnish republic. upon ratification of the cisg, denmark excluded the application of the convention in regard to greenland and the faroe islands and there are no signs of this being changed anytime soon.8 finland did not make a similar reservation in regards to åland, so here the convention is applicable like in the rest of the republic. the term scandinavia is sometimes used in legal texts about the same five countries mentioned above.9 as has been rightfully pointed out, not all of the five countries are ‘… classically 5 camilla b. andersen ‘recent removals of reservations under the international sales law: winds of change heralding a greater unity of the cisg’ (2012) 8 journal of business law 698, 706. 6 depositary notification c.n.98.2013.treaties-x.10. 7 latvia in november 2012 according to depositary notification c.n.638.2012.treaties-x.10 and estonia already back in march 2004 according to depositary notification c.n.276.2004.treaties-1. 8 cisg article 93(1) and united nations treaty collection, <treaties.un.org> as of 29 january 2013. 9 konrad zweigert and hein kötz, introduction to comparative law (3rd edn clarendon press, oxford 1998), 277. see also this material for a description of nordic legal history, pages 276 to 285. nordic journal of commercial law issue 2013#1 3 scandinavian …’.10 this is due to the fact that the term scandinavia traditionally relates to a region that comprises denmark, norway, and sweden only. even though only two of these countries are located on the scandinavian peninsula, they are grouped together because of the strong linguistic, cultural, and political ties the three countries share.11 as an example, the languages of the three countries are mutually intelligible, whereas the finnish, greenlandic, icelandic, and faroese languages are not. despite that denmark, norway and sweden have common legal characteristics that could be of interest, it is more correct to select a broader term like nordic, since it includes the remaining countries that have the same characteristics being discussed at present without redefining an already established cultural-linguistic term as scandinavia. the term fennoscandia could be considered as it includes finland. but since this term is a geological term covering finland, norway, sweden, and parts of russia, but leaves out denmark and iceland, it is unsuitable for the present context.12 for these reasons, the five countries are described as the nordic countries. this is consistent with the fact that the governments of the same countries’ have designated their formal cooperative the nordic council.13 1.2 the nordic reservations when the nordic countries became cisg contracting states more than 20 years ago, they all, except iceland, excluded part ii of the cisg from being applicable and thus, they disturbed the uniformity of the convention text.14 the reservation against part ii is permitted by article 92. in fact, the provision was included in the cisg on the initiative of the very same countries, and only 10 camilla b. andersen ‘recent removals of reservations under the international sales law: winds of change heralding a greater unity of the cisg’ (2012) 8 journal of business law 698, 706. 11 a distinction is made between the 20th century nordism covering the five countries and the older 19th century scandinavism taking place in denmark, norway and sweden, which left its mark for example in the norwegian national anthem of 1864 confirming that the community was considered to cover only three countries; ‘… now we three brothers stand united …’ [author’s translation] by bjørnestjerne bjørnson, 1859-1668. 12 see for example naturhistoriska riksmuseet, geology of fennoscandia, http://www.nrm.se/en/ menu/researchandcollections/departments/laboratoryforisotopegeology/moreaboutisotopegeology/geologyoffenn oscandia.291_en.html updated 30 september 2009, accessed 16 november 2012. 13 see <norden.org>, accessed on 14 november 2012. 14 iceland did not become a contracting state until about 10 years after the other nordic states. nordic journal of commercial law issue 2013#1 4 the nordic countries have made use of it.15 this position is currently changing, since the other four countries are in the process of withdrawing their reservations and incorporating part ii. the concerns that led to the reservations according to article 92 were two-fold. first, the rules on revocation of offers in cisg article 16 were common law inspired rules which were too different from the current domestic rule. since the rule of revocation of offers in the convention contains a number of exceptions, this argument has been described as ‘… provincial nitpicking…’.16 second, the lack of regulation of validity issues in the cisg would increase legal uncertainty. also this argument is less persuasive, since adoption of part ii would not necessarily create more uncertainty than adoption of part iii and the reservation would in any event be limited to the situations where the rules of private international law point to the application of the laws of one of the nordic countries.17 though a removal of the reservations against the application of cisg part ii is to be welcomed, the process presents a number of challenges. the purpose of this article is to provide an insight into the background and current process of the nordic withdrawals, thus clarifying the current state of the process and outlining some of the particular challenges that the nordic countries are facing in this period of transition. it should be pointed out that iceland, despite what has been noted elsewhere in the literature, did not make a reservation against part ii according to article 92.18 iceland only made a reservation according to article 94, thus excluding application of the cisg in inter-nordic sales. 2 current status even though scholars previously have pointed out that the reservations should be revoked, it was not until recent criticism by the international chamber of commerce that the process of 15 ingeborg schwenzer (ed), commentary on the un convention on the international sale of goods (cisg) (3rd edn oxford university press, oxford 2010) 1182. 16 joseph lookofsky, ‘the cisg in denmark and danish courts’ (2011) 80 nordic journal of international law 295, 300. 17 joseph lookofsky, ‘the cisg in denmark and danish courts’ (2011) 80 nordic journal of international law 295, 300. 18 harry m. flechtner (ed), uniform law for international sales under the 1980 united nations convention (4th edition wolters kluwer, austin 2009) 699. compare with united nations treaty collection (treaties.un.org) and joseph lookofsky, understanding the cisg (4th edn djøf publishing, copenhagen 2012) 167 fn 17. nordic journal of commercial law issue 2013#1 5 withdrawal sparked.19 the nordic governments decided to start the process by first mapping the pros and cons of a possible withdrawal under the auspices of the nordic council of ministers. the conclusion of the work was, perhaps unsurprisingly, that a withdrawal would increase uniformity, enable prediction of legal status and reduce transaction costs.20 the process of withdrawal in the nordic countries involves two levels. at one level, the national legislature must pass the necessary laws to make part ii part of domestic law. domestic law governs this part. at another level, the state must notify the un, so that the withdrawal can take effect. this part is governed by international law. though a reservation must be permitted by the treaty or convention affected, it may subsequently be revoked at any time,21 requiring only a notification to the depositary at the united nations. according to article 97(4), a withdrawal takes effect on the first day of the month, six months after notification of withdrawal has been received by the un depositary. this appears to be a straightforward rule. however, the nordic countries have (some may say ‘had’) strong bonds of brotherhood, which are reflected also in their joint drafting of legislation. so, when time for notification came about, uncitral expected a joint deposit of notification, as this was the way that the original reservation against part ii was made.22 the fact that a joint notification was not made, when finland went solo already on 28 november 2011, meant that it had to be clarified, whether uncitral had to await notification of all nordic states, before the 6month period would start running.23 if not, the period would start running on an individual basis. whether or not the fact that no joint notification was made can be taken as a change in the nordic common legal culture is not to be explored at present. the relevant point in this regard is that uncitral is not demanding a joint withdrawal, and that the nordic countries are not 19 joseph lookofsky, ‘alive and well in scandinavia: cisg part ii’ (1999) 18 journal of law and commerce 289, 289-299; joseph lookofsky, ‘the cisg in denmark and danish courts’ (2011) 80 nordic journal of international law 295; norway, justitsog politidepartementet, ‘forslag om å trekkje den norske reservasjonen mot fnkonvensjonen 11. april 1980 om kontraktar for internasjonale lausøyrekjøp (cisg) del ii om avtaleinngåing og spørgsmål om gjennomføring av del ii av konvensjonen i norsk rett m.m.’ (snr. 201203482, may 2012) 5. 20 jan kleineman og tom madell, avtalsslutande vidinternationella köp avvaror (507 temanord / nordic council of ministers, copenhagen 2009) 11-14 and 61-71. 21 ingeborg schwenzer (ed), commentary on the un convention on the international sale of goods (cisg) (3rd edn oxford university press, oxford 2010) 1182; the vienna convention on the law of treaties (adopted 23 may 1969. entered into force on 27 january 1980) 1155 unts 331, article 22(1): ‘unless the treaty otherwise provides, a reservation may be withdrawn at any time and the consent of a state which has accepted the reservation is not required for its withdrawal.’ 22 camilla b. andersen ‘recent removals of reservations under the international sales law: winds of change heralding a greater unity of the cisg’ (2012) 8 journal of business law 698, 708. 23 camilla b. andersen ‘recent removals of reservations under the international sales law: winds of change heralding a greater unity of the cisg’ (2012) 8 journal of business law 698, 708. nordic journal of commercial law issue 2013#1 6 expecting them to do so, thus permitting individual notifications and dates of entry into force of part ii. currently, denmark, finland, and sweden have completed the necessary paperwork at both domestic and international levels.24 therefore, cisg part ii entered into force in finland on 1 june 2012,25 in sweden on 1 december 2012,26 and in denmark on 1 february 2013.27 norway has not yet notified the un, which is due to the fact that a hearing had to be completed during the summer of 2012, thus slowing the domestic process.28 the domestic legislative results of the hearing is still pending.29 considering that the official standpoint of the norwegian ministry of justice is to incorporate part ii, it is justified to say that ‘… there is ample reason to remain optimistic eventually the reservations will be removed …’ with the effect that part ii will apply throughout most of the nordic region.30 upon a closer look, particularly norway and iceland may be facing challenges in the withdrawal process. these are accounted for immediately below. 3 considerations regarding norway and iceland 3.1 two doctrines to put it simply, there are two approaches that states can have to international treaties, a monist one and a dualist one. on one hand, treaties may become part of the notion of ‘law’ in a monist state without further legislative acts. on the other hand, treaties must be made part of a dualist state’s domestic law by way of legislative act for the treaty to become part of the ‘law’ in 24 in denmark: lov om ændring af international købelov og lov om aftaler og andre retshandler på formuerettens område (lov nr 1376 af 28/12/2011); in finland: valtioneuvoston asetus kansainvälistä tavaran kauppaa koskevista sopimuksista tehdyn yleissopimuksen voimaansaattamisesta sekä yleissopimuksen eräiden määräysten hyväksymisestä annetun lain voimaantulosta annetun asetuksen 2 §:n muuttamisesta (suomen säädöskokoelman n:o 265/2012); in sweden: lagom ändring i lagen (1987:822) om internationellaköp (sfs 2011:852). 25 journal of the united nations (30 november 2011) no. 2011/230. 26 journal of the united nations (26 may 2012) no. 2012/102. 27 journal of the united nations, (4 july 2012) no. 2012/128. see also thomas neumann, ‘de nordiske landes tilbagekaldelse af forbeholdet mod cisg del ii’ (2012) 4 juristen 186, 188. 28 norway, justitsog politidepartementet, ‘forslag om å trekkje den norske reservasjonen mot fn-konvensjonen 11. april 1980 om kontraktar for internasjonale lausøyrekjøp (cisg) del ii om avtaleinngåing og spørgsmål om gjennomføring av del ii av konvensjonen i norsk rett m.m.’ (snr. 201203482, may 2012); ole lando, ‘danmark tilslutter sig de internationale regler om købeaftalers indgåelse’ [2012] ugeskrift for retsvæsen 149, 150. 29 the process can be followed at http://www.regjeringen.no/nb/dep/jd/dok/hoeringer/hoeringsdok/ 2012/hoyring---forslag-om-a-trekkje-den-norsk.html?id=682611 accessed 27 may 2013. 30 camilla b. andersen ‘recent removals of reservations under the international sales law: winds of change heralding a greater unity of the cisg’ (2012) 8 journal of business law 698, 708. nordic journal of commercial law issue 2013#1 7 such a state.31 the difference being that the citizens of the state can derive rights and obligations from the treaty directly in a monist state whereas a citizen in a dualist state must await approval of the domestic legislature. this approval can simply be a reference to the treaty, thereby incorporating the treaty into domestic law, or other methods, such as transformation.32 as long as a dualist state has not taken legislative steps towards incorporating a treaty it may very well be in breach of the agreement made between the states, but the citizen (businesses in case of the cisg) can do nothing to remedy this fact.33 the nordic countries follow the dualist approach and therefore they all took domestic legislative steps to incorporate the convention.34 denmark chose to adhere to the cisg by making a reference to it in its authentic form and at the same time leaving the domestic sale of goods act from 1906 for domestic sales. sweden and finland created new sale of goods acts meant for domestic sales, and at the same time they did like denmark and left the cisg (also in its authentic form) for international sales by way of reference. at the ratification of the convention (excluding part ii) in the 1980ies norway chose to transform and translate the convention into the local language in order to create one law for both domestic and international sales. iceland did the same, but since iceland took inspiration from the norwegian transformation law without having made a reservation against part ii like norway, the icelandic merchant and trade act35 now contains the transformed version of cisg part iii on the performance of contracts, but not part ii on contract formation. the fact that norway and iceland follow the dualist approach to international law the citizens of the two states can only rely on the rules of the cisg to the extent that it they have been incorporated by the domestic legislature. in the case of iceland, a business would not be able to rely on cisg part ii since this part has not been given effect yet by the national legislature, despite that the necessary international paperwork has been done.36 however, this position needs further qualification since now potentially two different versions of the cisg are in play. therefore, it must be determined whether the rules of private international law point towards the non-icelandic party’s law according to article 1(1)(b). if it does and that particular state has adopted also part ii of the convention, then part ii is to be applied to the contract whereas if the rules of private international law point to icelandic law it does not apply. 31 martin dixon, textbook on international law (6th edn oxford university press, oxford 2007) 88-90. 32 peter germer (ed), statsforfatningsret (2nd edn jurist og økonomforbundets forlag, københavn 1988) 276-278. 33 anthony aust, modern treaty law and practice (2nd edn cambridge university press, cambridge 2007) 188. 34 anthony aust, modern treaty law and practice (2nd edn cambridge university press, cambridge 2007) 195. 35 icelandic merchant and trade act. lög um lausafjárkaup, 2000 nr. 50 16. maí. 36 meaning notification to the un and the expiry of the subsequent waiting period of twelve months according to cisg article 99. nordic journal of commercial law issue 2013#1 8 a similar situation occurs in norway since part ii has not (and was not supposed to be) incorporated. however, the problem is exacerbated further in the two countries because of their choice of incorporation method. upon ratification, norway decided to transform the cisg into a norwegian language act. it is this act that has been approved by the domestic legislature and therefore it is this act that businesses can rely upon when the rules of private international law names norwegian law as being applicable. one could say that there would be no danger in applying a norwegian language version of the cisg compared to using one of the other six authentic un versions. however, this is not true. allowing another linguistic layer also adds another layer of uncertainty since a norwegian judge may interpret concepts and notions in the norwegian language in conformity with norwegian domestic sales law. and even if this would not happen, a party would not be able to rely on the wording of the provisions in the authentic versions of the cisg when these have not been transformed into norwegian domestic law, such as for example article 80, which have no direct equivalent in the norwegian act. more on this further below. again, the position is modified to the extent that a full and unrestricted authentic version of the cisg is to be applied by virtue of the rules of private international law according to cisg article 1(1)(b). both the reservation against part ii of the convention and the choice to transform the cisg into the local language counteract the predominant purpose of the cisg – to create a uniform sales law. since there are no current signs of changes being made to the icelandic model, the focus in the following is on norwegian law, though the problems may be equally true for icelandic law. it should however be pointed out that iceland has not taken any steps yet to incorporate cisg part ii, neither by reference nor by transformation. 3.2 the transformation model the rationale in norway for choosing the transformation model was that particularly small norwegian enterprises would not have the capacity to comprehend and operate with two parallel frameworks. they would, it was believed, benefit from having only one sales law that would govern both kinds of sales.37 the norwegian ministry of justice has in their hearing notice repeated the original intention of not excluding any cisg provisions in the process of translation and transformation, but they 37 norway, justitsog politidepartementet, ‘forslag om å trekkje den norske reservasjonen mot fn-konvensjonen 11. april 1980 om kontraktar for internasjonale lausøyrekjøp (cisg) del ii om avtaleinngåing og spørgsmål om gjennomføring av del ii av konvensjonen i norsk rett m.m.’ (snr. 201203482, may 2012) 8-9. nordic journal of commercial law issue 2013#1 9 also point out that the current structure of the norwegian sales code is different to the authentic cisg texts, and that the goal of uniformity thereby is not promoted.38 the original solution of translation and transformation has been described as ‘… a major mistake …’, among other reasons, because it creates discrepancies between language versions, which in turn question whether the norwegian legislature intended to depart from the authentic cisg rules or merely made a mistake.39 even worse – the purpose of informing in particular smes is counteracted, if the norwegian hybrid law does not contain a loyal translation of all provisions from the authentic cisg texts, since the same smes would then have to consider whether the rules of private international law make the authentic texts or the norwegian text applicable according to article 1(1)(b). to illustrate; despite the intentions, a rule like article 80 cisg has no clear equivalent in the norwegian version. it appears simply to have dropped out. looking closely at the norwegian sale of goods act (nsga) and reading its preparatory works reveals that the drafters were of the opinion that they had included article 80 in nsga § 22(1) and § 30.40 however, it has been questioned, whether the different systematic placement and transformation has changed the function of the provision41 and in turn, whether the norwegian language version is to prevail over the six authentic un language versions of the cisg. similar problems appear in the countries that chose to incorporate the convention by reference, since they attached to the law as an appendix a local language translation of the convention. however, in these situations the local translations are provided for information purposes. legally, it is the authentic un versions of the cisg that has been incorporated into domestic law by way of reference. hence, the un versions supersede the local translations in these situations. in the case of norway this is different. norway is a dualist state like the other nordic countries, and therefore conventions and other international agreements must receive parliamentary approval to become law in the state. since norway approved the transformed version of the convention, this version is in principal the law in norway and is the applicable version, when the rules of private international law lead to the application of norwegian law. however, from an international law perspective it is for the state to ensure that all state bodies implement the 38 norway, justitsog politidepartementet, ‘forslag om å trekkje den norske reservasjonen mot fn-konvensjonen 11. april 1980 om kontraktar for internasjonale lausøyrekjøp (cisg) del ii om avtaleinngåing og spørgsmål om gjennomføring av del ii av konvensjonen i norsk rett m.m.’ (snr. 201203482, may 2012) 9. 39 kai krüger, norsk kjøpsrett (4th revised edn alma mater, bergen 1999) 671-672. 40 norwegian preparatory works, ot. prp. nr. 80 (1986-1987), om a kjøpslov b lov om samtykke til ratifikasjon av fn-konvensjonen om kontrakter for internasjonale løsørekjøp, vedtatt 11 april 1980, 184. 41 thomas neumann, the duty to cooperate in international sales (sellier european law publishers, munich 2012) 211-215. nordic journal of commercial law issue 2013#1 10 agreements entered into by the state.42 this means that norway has promised the international community to implement the cisg in its authentic form – the un versions. from the perspective of international law, the authentic language versions of the convention supersede the norwegian one. only the latter view supports the un’s – and therefore also norway’s – original goal of creating a uniform sales law to the benefit of world trade. 3.3 full or partial incorporation in august 2012 the norwegian ministry of justice completed a public hearing of the proposal to revoke the reservation against cisg part ii.43 a long range of associations and public institutions were invited to consider two aspects. first, whether the reservation against part ii should be withdrawn or not. second, which method should be used to incorporate part ii into domestic law in case a withdrawal was supported. considering that the convention originally was transformed and translated, the ministry outlined two possible methods of incorporation. one where only cisg part ii would be incorporated into norwegian law in its authentic form by reference. another where the entire cisg including part ii would be incorporated in its authentic form by reference, thus abolishing the old translated version. the ministry of justice points out in its hearing paper that the advantages of the second option is that the authentic texts of the convention would be applicable, thus making it possible for non-norwegian trading parties to get informed of the applicable law and predict their legal status when trading with a partner from norway.44 the ministry has thus recognized that the original solution has such significant drawbacks that it should not be repeated. the norwegian bar association,45 the legal advisor to the norwegian government,46 and the confederation of norwegian enterprise47 has expressed their support for the withdrawal and 42 anthony aust, modern treaty law and practice (2nd edition cambridge university press, cambridge 2007) 179; mark e. villiger, commentary on the 1969 vienna convention on the law of treaties (martinus nijhoff, leiden 2009) 366; and article 26 of the vienna convention on the law of treaties [vclt] (adopted 23 may 1969. entered into force on 27 january 1980) 1155 unts 331. granted that norway has not ratified the vclt, but a similar principle of pacta sunt servanda follows from customary international law. 43 norway, justitsog politidepartementet, ‘forslag om å trekkje den norske reservasjonen mot fn-konvensjonen 11. april 1980 om kontraktar for internasjonale lausøyrekjøp (cisg) del ii om avtaleinngåing og spørgsmål om gjennomføring av del ii av konvensjonen i norsk rett m.m.’ (snr. 201203482, may 2012). 44 norway, justitsog politidepartementet, ‘forslag om å trekkje den norske reservasjonen mot fn-konvensjonen 11. april 1980 om kontraktar for internasjonale lausøyrekjøp (cisg) del ii om avtaleinngåing og spørgsmål om gjennomføring av del ii av konvensjonen i norsk rett m.m.’ (snr. 201203482, may 2012) 1 and 10. 45 letter of 13 august 2012 by den norske advokatforening, http://www.regjeringen.no/pages/37887275/ dna.pdf accessed 28 november 2012. nordic journal of commercial law issue 2013#1 11 the method of incorporation through reference to the entire text of the convention. also uncitral expressed that a withdrawal would be beneficial to trading parties and would promote uniformity, though the question of the method of incorporation is not addressed in the letter to the norwegian ministry of justice.48 no authority has expressed support for maintaining the reservation, though a number of bodies declared that they had no remarks. this is most likely due to the fact that the cisg applies to an area of life that these bodies are not concerned with.49 the ministry of justice points out in its hearing letter that an argument against the withdrawal could be that norwegian businesses will then be faced with two parallel frameworks for entering into contracts – one for domestic contracts and one for international ones.50 the point made is in line with the rationale for the original transformation – not to have two parallel sets of rules. however, it is also pointed out that it would only be possible to maintain the existing domestic/international hybrid law in situations, where the rules of private international law point towards the laws of norway being applicable. this could perhaps muddy the waters even more, since norwegian enterprises would have to use the domestic hybrid law and the authentic cisg texts depending whether the rules of private international law point to norwegian law or another state’s law. the default and simpler alternative is to let the requirements for applying the (authentic versions) cisg be decisive. for the sake of simplicity, for obeying international law, and in order to promote uniformity and predictability of legal status for both norwegian and non-norwegian enterprises it appears to be most correct to remedy the choice of transforming and translating the convention by now incorporating the convention in its full authentic versions. should iceland reconsider the current model of incorporation too, the same would apply there. 46 letter of 15 august 2012 by regjeringsadvokaten, http://www.regjeringen.no/pages/37887275/rea.pdf accessed 28 november 2012. 47 letter of 25 june 2012 by næringslivets hovedorganisasjon, http://www.regjeringen.no/pages/37887275/ nho.pdf accessed 28 november 2012. 48 letter of 6 august 2012 by united nations commission on international trade law, http://www.regjeringen.no/pages/37887275/uncitral.pdf accessed 28 november 2012. 49 the bodies that refrained from taking a stand on the question are concerned with labour law, rights of children, fishing rights, culture etc. 50norway, justitsog politidepartementet, ‘forslag om å trekkje den norske reservasjonen mot fn-konvensjonen 11. april 1980 om kontraktar for internasjonale lausøyrekjøp (cisg) del ii om avtaleinngåing og spørgsmål om gjennomføring av del ii av konvensjonen i norsk rett m.m.’ (snr. 201203482, may 2012) 7. nordic journal of commercial law issue 2013#1 12 4 common considerations for the nordic countries aside from the particular challenges that norway is currently considering, there are at least two features of general nature that should be pointed out, as they relate to the withdrawal process in all of the four countries concerned. 4.1 temporal problems when part ii enters into force, it is relevant to consider, in which factual situations the new rules will apply, in particular in the time near to the entering into force.51 at some point offers and acceptances being made will have to move from being governed by domestic law to being governed by cisg part ii. the problem here is to determine which point in time is relevant for deciding whether a contract formation process has taken place before or after part ii entered into force. when part ii has entered into force, time will render such temporal problems increasingly irrelevant, but for now they may play a role. the starting point is that in line with the general prohibition against retroactive effect and the recommendation made by the nordic council of ministers the withdrawals of the reservations and the current domestic laws of incorporation are not meant to give cisg part ii retroactive effect.52 therefore, and according to article 100, part ii will not apply to contract formation processes that have taken place entirely before the date of entry into force. the remaining parts of cisg will of course apply, since these are already in force in the nordic countries.53 determining which conduct will change this position is significant for the contracting parties, in particular if there have been attempts of revoking or withdrawing an offer. in this regard, article 100 states that the convention only applies when ‘… the proposal for concluding the contract is made on or after the date when the convention enters into force …’. the significant time is thus the proposal to form a contract. 51 bernhard gomard and rené franz henschel, ‘ophævelsen af de nordiske landes forbehold for del ii i fn’s konvention om aftaler om internationale køb (cisg)’ (2012) 2 erhvervsjuridisk tidsskrift 103, 106-108. see also cisg article 100 and ingeborg schwenzer (ed), commentary on the un convention on the international sale of goods (cisg) (3rd edn oxford university press, oxford 2010) 1197. 52 harry m. flechtner (ed), uniform law for international sales under the 1980 united nations convention (4th edition wolters kluwer, austin 2009) 702. also the vienna convention on the law of treaties (adopted 23 may 1969. entered into force on 27 january 1980) 1155 unts 331, article 4. jan kleineman and tom madell, avtalsslutande vidinternationella köp avvaror (507 temanord / nordic council of ministers, copenhagen 2009) 70. 53 this presumes that the reservation according to article 94 does not apply and that the general requirements for applying the cisg are fulfilled. nordic journal of commercial law issue 2013#1 13 the choice of the word proposal in article 100 is ambiguous. on one hand, there can be little doubt that a proposal for concluding a contract comprises offers according to the requirements set forth in article 14.54 however, a proposal can be more than just offers. this is confirmed directly in article 14(1), where it is stated that some proposals constitute offers, when a number of requirements are fulfilled. if a proposal does not meet the requirements of article 14(1), it is an invitation to make an offer according to article 14(2), but the notion proposal is still used. thereby, it is seen that the notion proposal is a collective name that covers at least offers and invitations to make an offer. the danish bar association has criticised the danish domestic incorporation law for the very same ambiguity and suggested that the word proposal should be replaced by offer to make it clear that the decisive time is the making of an offer.55 however, the choice to include words that contain the same ambiguity as in cisg appears most loyal, and specifying that the relevant time in denmark is the time, where an offer is made would be to deviate from the authentic text of the convention again and to ignore the fact that the drafters of the cisg chose the word proposal over the word offer. the simplest interpretation would be to equate the term proposal and offer. this would make it easier to determine, whether a proposal fulfils the requirements for being an offer, and whether the offer was made before or after part ii entered into force or not. however, under the interpretation that the term proposal covers also invitations to make an offer, it is possible to apply part ii to the entire negotiation period of the parties and at the same time consider that part ii itself is meant to regulate proposals already from the time that they are mere invitations. a third possible interpretation would be to let the time of the first contact between the parties be significant for the application of part ii. in this way the parties can predict that the applicable law for contract formation will remain the same from the very beginning of a negotiation and not change during the negotiation period, merely because of a distinction between proposals and offers. such interpretation would consider situations of contract formation, where the parties have not followed a clear model of offer and acceptance. since there is justifiable doubt regarding the decisive time for applying part ii, the trading parties should be particularly aware when entering into negotiations around the time, where part ii enters into force. businesses with the capacity to investigate and decide on applicable laws could consider doing so, but small businesses without such capacity are left with the default rules and the courts should a dispute arise. 54 bernhard gomard and rené franz henschel, ‘ophævelsen af de nordiske landes forbehold for del ii i fn’s konvention om aftaler om internationale køb (cisg)’ (2012) 2 erhvervsjuridisk tidsskrift 103, 107. 55 bernhard gomard and rené franz henschel, ‘ophævelsen af de nordiske landes forbehold for del ii i fn’s konvention om aftaler om internationale køb (cisg)’ (2012) 2 erhvervsjuridisk tidsskrift 103, 107. nordic journal of commercial law issue 2013#1 14 should domestic courts get the chance to decide over a dispute involving a temporal issue like the one described here, it should be careful in considering and justifying its view. only by doing so is the obligation to promote future uniformity in article 7(1) clearly obeyed. when the offer, acceptance, and the first contact between the parties takes place after part ii enters into force, there is no doubt that part ii is applicable. further, it should be stressed that no matter when the proposal for concluding the contract has been made, the discussion outlined above is only relevant, when the rules of private international law point to the laws of one of the four withdrawing nordic countries according to article 1(1)(b), assuming that the other party has his place of business in a non-nordic state, where part ii is in force. otherwise the inter-nordic reservation renders the cisg inapplicable in total. 4.2 the inter-nordic reservation the current processes of withdrawal that are taking place in the nordic countries address only the reservations made according to article 92. in order to get the full picture, it should be emphasised that all nordic countries, including iceland, have made reservations according to article 94.56 the reason for this is that all of the five nordic countries used to have rather similar domestic sales laws, despite the fact that finland and iceland did not participate directly in the law making process like the other countries.57 when the cisg was adopted by the nordic countries, they decided to exclude application of the cisg altogether, when the trading parties had their place of business in each their nordic country.58 the rationale being that some uniformity in the domestic sales acts had already been achieved. since the reservation according to article 94 was made, each country has chosen different legislative paths. denmark chose to incorporate the authentic versions of the cisg by reference and at the same time leave the original domestic sale of goods act from 1906 for domestic sales. sweden and finland created new domestic sale of goods acts, but at the same time they incorporated the authentic cisg texts for international sales. norway and iceland chose to translate and transform the cisg completely turning it into a new hybrid law meant for both domestic and international sales. these different developments have undermined the original 56 united nations commission on international trade law, status of cisg, http://www.uncitral.org/uncitral/en/uncitral_texts/sale_goods/1980cisg_status.html accessed 13 november 2012. 57 berte elen konow, john egil bergem and stein rognlien, kjøpsloven 1988 og fn-konvensjonen 1980 om internasjonale løsørekjøp: med kommentarer (3rd edn gyldendal akademisk, oslo 2008) 23. 58 denmark, finland, iceland, norway and sweden have all made a reservation according to cisg art. 94. nordic journal of commercial law issue 2013#1 15 rationale for excluding the application of the cisg in inter-nordic sales, and its justification has rightfully been questioned.59 one may wonder why the nordic governments have not taken the initiative to withdraw also the reservation made according to article 94. in fairness, it should be mentioned that the nordic contract acts still show great similarity, and that the changes primarily have been in the sales acts. in relation to the current processes of withdrawing the article 92 reservations it is worth noting that even though part ii will soon be applicable in all of the nordic countries part ii is inapplicable when both parties are from nordic countries as long as the reservation according to article 94 is still effective. there are currently no indicators that this reservation is about to be withdrawn. 5 conclusion the processes of withdrawing the exclusion of cisg part ii can be summarized as being a step ahead in promoting uniformity, since the convention moves closer to applying in its full authentic versions in all of the nordic countries. as part ii enters into force in the respective countries, it is necessary to consider that this affects only situations falling under one of the nordic legal systems according to article 1(1)(b). further more, trading parties and most definitely courts should be aware that not only contract formation processes starting with an offer being made after part ii enters into force may be governed by part ii, though this question is open to interpretations. the withdrawal processes are running on a parallel and individual basis instead of being made jointly. this means that part ii will enter into force at different times in the following order; finland, sweden, denmark and most likely also norway. norway is facing particular challenges due to their particular way of transforming and translating the convention. the withdrawal process has the benefit that the cisg may now finally be applicable in norway in its full authentic form. for the sake of uniformity, this is welcomed. also iceland chose to transform and translate the cisg upon ratification, but did not take a reservation against the application of cisg part ii. if norway decides to incorporate the full 59 joseph lookofsky, ‘the cisg in denmark and danish courts’ (2011) 80 nordic journal of international law 295, 301-302; jan ramberg and johnny herre, köplagen (fritze, stockholm 1995) 47; joseph lookofsky, understanding the cisg (4th edn djøf publishing, copenhagen 2012) 169. nordic journal of commercial law issue 2013#1 16 authentic versions of the convention, iceland will be left as the only country sticking to this unfortunate method. there are at present no signs of this changing. common for all the nordic countries are that they have excluded the application of the convention according to article 94, when the sale is taking place among two parties with a place of business in each their nordic country. this position remains unaffected by the current processes of withdrawal of the reservation according to article 92. for the sake of the uniform development, increased predictability of legal status, lowering of transaction costs and eventually fostering of peace among nations, the withdrawals that are currently taking place are to be acclaimed. one can only point out that reservations like the ones for inter-nordic sales according to article 94 and the ones outside the nordic region regarding form requirements according to article 93 could be reconsidered as they impair a uniform application of the convention. 1 peer-to-peer lending – a new digital intermediary, new legal challenges tanja jørgensen* * professor, phd, at aarhus university, denmark. legal challenges of p2p lending 232 1. introduction ................................................................................... 233 2. legal challenges – a new digital intermediary platform ............................................................................................................... 237 2.1. public law – the platform ............................................... 237 2.1.1. eu authorisation ..................................................... 237 2.1.2. payment services....................................................... 238 2.1.3. additional licences – banking .......................... 239 2.1.4. money laundering and terrorist financing 244 2.2. private law – the relationship between the parties .. .......................................................................................... 245 2.2.1. syndicated loans – a parallel ............................ 246 2.2.2. the legislation ......................................................... 247 2.2.3. consumer credit – the borrower and the platform/investors ................................................. 248 2.2.4. investor protection – the investors and the platform ....................................................................... 252 2.2.5. execution of the loan agreements – the investors and the borrower ................................ 257 2.2.6. the relationship between the investors ........ 258 3. is the existing legislation sufficient? .................................. 258 njcl 2018/1 233 abstract in an increasingly digitalised world, this article deals with peer-topeer (p2p) lending as a new online source of financing, which differs from e.g. financing in traditional banks. the article elaborates on the following questions: how should p2p lending be put in the context of the existing legislation? is the existing legislation sufficient to meet the impact that p2p lending may have on modern society? or is new special legislation necessary? lenders can be both individuals and companies, but the main focus of this article is on individuals. it includes the european commission’s proposal for a regulation on european crowdfunding service providers (ecsp) for business (com/2018/0113 final) and parallels are drawn to syndicated loans known from banking. how p2p lending fits into the existing legal framework in regard to banks, payment services, money laundering and terrorist financing, consumer credit, investor protection etc. is still veiled in some uncertainty. the most remarkable example of the legal implications is the case of trustbuddy ab. on 23 june 2014, the danish financial supervisory authority (fsa) decided that the p2p platform, trustbuddy ab, needed to be licensed as a bank. the fsa concluded that trustbuddy ab was not a credit intermediary and in reality, the lenders were investors. to create a sound business and to promote an eu market for p2p lending, a further clarification and adjustment of the existing legislation may yet be needed; especially since there are still several legal challenges in regard to private individuals being peers. 1. introduction digital innovation has opened up new possibilities for nontraditional players and the growth of the online alternative finance market. one of the most important examples of how new business models based on financial technology (fin-tech) emerge, is the crowdfunding movement. as a major part of this movement, ‘crowdlending’ – known as peer-to-peer (p2p) lending – has spread throughout europe, including the nordic countries. the development has been fuelled by the global financial crisis, which both has eroded consumers’ trust in banks and made consumer loans less attractive for banks by increased regulatory oversight and capital requirements, and historically low interest rates induce investors to look for alternative sources of profit.1 the first p2p lending emerged in 2005, but especially in the last five years the numbers have increased.2 in europe, p2p lending counts 1 christoph busch and vanessa mak, ‘peer-to-peer lending in the european union’ [2016] 4 eucml 181, 181. 2 the platform zopa is known for being the world’s first p2p lender, when it was launched in the united kingdom (uk) in 2005, see altfi opinion, ‘the world’s legal challenges of p2p lending 234 for more than 50% of the online alternative finance market, where the volume in 2016 reached €7,671m (2013: €1,127m; 2015: €5,431m).3 yet p2p lending still only constitutes a tiny fraction of the overall lending market; for example the german market for consumer lending alone has a volume of about €175,000m, and in the uk the percentage market share might be around 2-3%.4 thus, the potential for further growth seems considerable – especially taking the significant increase of p2p lending in recent years into account. in 2016, the european online alternative finance market – excluding the uk – grew by 101% reaching €2,063m; the average annual growth was 85% in 2013-2015. the top three national eu markets for online alternative finance by market volume are france (€443.98m), germany (€321.84m) and the netherlands (€194.19m). however, the markets of finland (€142.23m), spain (€130.90m), italy (€127.06m) and georgia (€102.58m) experienced a boom in 2016. also, the nordics are exhibiting rapid regional growth. when reviewed together, they (denmark (€88m), finland (€142m), iceland, (€1m), norway (€4.9m) and sweden (€86.5m)) account for over €322m.5 the uk remains the largest individual market in europe, even though the market share has declined from 81% in 2015 to 73% in 2016 (€5,608m). as digital intermediaries, p2p lending platforms are online ‘credit marketplaces’ which promote the contact between borrowers and lenders. though there is not a fixed definition of p2p lending, in this article the term is used for the matching of investors (lenders) and project owners (borrowers) through the use of an electronic information system (the platform) managed by a service provider, which as a legal person facilitates the granting of loans. in a limited interpretation, p2p lending only covers private individuals lending to one-another. however, the most common use also includes businesses as peers; for example ‘private individual’-to-business. since p2p platforms often have specialized in a certain type of borrower, they reflect this. however, the platforms’ business models may be defined in other ways, as for example by loans secured against a property. p2p business lending – understood as individuals or institutional funders that provide a loan to a business borrower – in 2016 represented original p2p lender has announced a governance restructuring ahead of the hotlyanticipated launch of its bank’: http://www.altfi.com/article/4284_zopa-createsseparate-board-for-neo-bank-hires-four-new-neds. all the web pages in this article are latest retrieved 31 may 2018. 3 tania ziegler et al., expanding horizons: the 3rd european alternative finance industry report (university of cambridge, 2018) 16 and 20-29. the report covers 14 different alternative finance models and by estimate 90% of the visible alternative finance market in europe. 4 moritz renner, ‘peer-to-peer lending in germany’ [2016] 5 eucml 224 and rainer lenz, ‘peer-to-peer lending: opportunities’ and risks’ [2016] 4 ejrr 688, 690. 5 ziegler (n 3) 16, 20-29 and 75. njcl 2018/1 235 17.0% (€ 349.96m) of european alternative finance volume. in the nordics, the p2p business lending sector grew from 2015 to 2016 by 97% to €55m representing 17% of regional volume. finland has the largest share by 86% (€47m) and is only followed by denmark 14% (€8m) and sweden, where less than 1% (€0.1m) is reported.6 the top three national eu markets are the netherlands (€124m), france (€71m) and finland (€48m).7 in p2p business lending the main focus is to promote credit to small and medium sized enterprises (smes). examples of platforms are the danish flex funding, kreditmatch and lendino (since 2013-14). the rationale is often that entrepreneurs may have difficulties raising loans in the banks. the european commission’s proposal for a regulation on european crowdfunding service providers (ecsp) for business (hereafter the proposal) from 8 march 2018 especially focuses on the challenges that small and nascent firms have, particularly when they move from the start-up phase into the expansion phase where access to bank financing often is scarce, see the proposal preamble 2.8 p2p lending is thus found to represent one of the latest forms of financing that works towards so-called ‘financial inclusion’.9 it is part of the commission’s priority of establishing a capital market union (cmu), which aims to broaden access to finance for innovative companies, start-ups and other unlisted firms.10 p2p consumer lending – understood as individuals or institutional funders who provide a loan to a consumer borrower – in 2016 represented 33.8% (€696.81m) of european alternative finance volume and thereby has the largest market share. in the nordics, the p2p consumer lending market has been recovering from the bankruptcy of the major platform trustbuddy ab in 2015 and therefore barely represents 21% of regional alternative finance volumes. in 2016 the volumes were approximately €67m and grew by 83% from 2015. finland has the largest share by 93% (€62m) and is only followed by sweden, 6 ziegler (n 3) 75-78. 7 ibid 31. 8 com/2018/0113 final – 2018/048 (cod). the proposal is included in a package of measures to deepen the capital markets union (also) from 8 march 2018, together with the communication ‘completing capital markets union by 2019 – time to accelerate delivery’. 9 for a critical investigation of the ambiguous social outcomes, see chris rogers and chris clarke, ‘mainstreaming social finance: the regulation of the peer-to-peer lending marketplace in the united kingdom’ [2016] 18(4) bjpir 930. 10 the ‘cmu should create an appropriate regulatory environment that enhances crossborder access to information on the companies looking for credit, quasi-equity and equity structures, in order to promote growth of non-bank financing models, including crowdfunding and peer-to-peer lending’; see european parliament resolution of 9 july 2015 on building a capital markets union (2015/2634(rsp)), par. 47. legal challenges of p2p lending 236 where 7% (€5m) is reported.11 the top three national eu markets are germany (€181m), france (€179m) and georgia (€103m).12 examples of p2p platforms that promote credits to consumers around the world are: auxmoney (germany; since 2007), better rates (denmark; since 2015), kokos.pl (poland; since 2008), lendico (germany – also operates in austria, brazil, the netherlands, poland, south africa, and spain; since 2013), lending club (united states (us); since 2006), lendinvest (uk; since 2008), ratesetter (uk; since 2010), viainvest (latvia – also operates in czech, poland, romania, spain and sweden; since 2008), smava (germany; since 2007) and zopa (uk; since 2005). the proposal exempts among others in art. 2(2)(a) crowdfunding services that are provided to project owners that are consumers, as defined in the consumer credit directive art. 3(a).13 they are considered better protected in this directive, see 2.2.3 below. furthermore, the proposal exempts in art. 2(2)(d) crowdfunding offers with a consideration of more than €1m per crowdfunding offer, which shall be calculated over a period of 12 months in regard to a particular crowdfunding project. eventhough the consumer terminology is not used in regard to investment, the proposal will apply to private individuals as investors (lenders). p2p loans are mainly unsecured. however, p2p property lending – understood as individuals or institutional funders that provide a loan secured against a property to a consumer or business borrower – counts 4.6% (€ 95.15m) of european alternative finance volume. the top three national eu markets are denmark (€55m), estonia (€31m) and latvia (€5m). it is seemingly absent in the nordic countries, except from denmark and sweden (€1m).14 an example of such a p2p platform is the danish udenombanken via the company reel finans pantebrevsselskab a/s (since 2014). furthermore, there are other ways in which loans can be secured. for example auxmoney has, since 2010, allowed a security assignment of cars in car loans.15 there is no statistical material found in regard to other secured loans. this article deals with p2p lending as a new source of financing compared to e.g. financing in traditional banks. it will elaborate on the following questions: how should p2p lending be put in the context of the existing legislation? is the existing legislation sufficient to meet the impact that p2p lending may have on modern society? or is new special 11 ziegler (n 3) 75-78. 12 ibid 31. 13 european parliament and council directive 2008/48/ec of 26 june 2013 of 23 april 2008 on credit agreements for consumers and repealing council directive 87/102/eec [2008] oj l 133/66. 14 ziegler (n 3) 31. 15 renner (n 4) 224 and christian berger and bernd skiera, ‘elektronische kreditmarktplätze: funktionsweise, gestaltung und erkenntnisstand bei dieser form des "peer-topeer lending"’ [2012] 45 kredit und kapital, 289, 291. njcl 2018/1 237 legislation necessary? the peers can be both private individuals (natural persons as consumers) and businesses (legal persons), but the main focus of the article will be on individuals. tax law is not included in this article, but also creates some challenges for the p2p platforms. 2. legal challenges – a new digital intermediary platform how p2p lending fits into the existing legal framework in regard to banks, payment services, money laundering and terrorist financing, consumer credit, investor protection etc. is still veiled in some uncertainty. the answers are more clear in some legal areas than others, and mainly depend on how the platform is set up and in which country it operates in. despite of the forthcoming eu regulation as set out in the proposal, which creates some clarification, legal challenges still surround p2p lending. the most remarkable example of the multifaceted legal implications is the case of trustbuddy ab. on 23 june 2014, the danish fsa decided that a) the p2p platform trustbuddy ab needed to be licensed as a bank. the fsa concluded that it was not a credit intermediation, and the lenders were in reality investors. among others, the fsa also b) found the validity of the contracts doubtful, where trustbuddy ab got unrestricted rights and monitoring possibilities, but the credit risk still was the investors. the case furthermore underlines c) that it is important to make sure that the digital platform is set up in the correct manner to obtain the benefits of the new digital possibilities for financing. litra a) above both relates to public law and the so-called outer layer of legislation that constitutes the conditions under which the platform and its users can operate, see 2.1 below. litra b) above relates to private law and the layer of legislation that regulates the relations between the three parties (platform, lender and borrower), see 2.2 below. litra c) above roughly relates to the inner layer of regulation that consists of the platforms’ self-regulation; since this layer most often reflects the two other layers by compliance considerations, the inner layer is included in 2.1 and 2.2 below. the case of trustbuddy ab will be elaborated on later. 2.1. public law – the platform since the way in which the platforms are set up varies, it has to be specifically assessed in each case to which extent the platform needs to comply with the legislation. some activities may need an authorisation and others may not. below are some of the major areas dealt with, where financial supervisory authorities are involved. 2.1.1. eu authorisation as a first step for fostering cross border crowdfunding activities and thus enhance the operation of the single market, p2p platforms as legal challenges of p2p lending 238 crowdfunding service providers16 will with the proposed regulation be given the option to apply for a single union-wide authorisation and supervision by a single authority, the european securities and markets authority (esma). this provides a one-stop-shop access to the eu market, where the platforms can exercise their activities under uniform requirements as outlined in the proposal, see e.g. the proposal preamble 7 and explanatory memorandum 5. the requirements focus on their ongoing supervision, operations, organisation, transparency and marketing communications as outlined in art. 1. a platform can choose to provide or continue providing services on a domestic basis under applicable national law and the proposed regulation does thereby not replace national rules on crowdfunding where they exist. the regulation will only apply to legal persons, who choose to seek authorisation/are authorised in accordance with art. 10, see art. 2(1)(c) e.c. such eu authorisation covers both the provision of services in a single member state and on a cross-border basis. authorisation under the applicable national rules is then withdrawn. crowdfunding services that are provided by natural or legal persons that have been authorised as an investment firm in accordance with the 2nd markets in financial instruments directive (mifid ii) art. 7 will also be exempted from the regulation, see the proposal art. 2(2)(b), and shall seek an authorisation under the directive to provide investment-based cross-border crowdfunding services.17 2.1.2. payment services most often, the platform transfers the loan amount from the lender(s) to the borrower and later on interest and repayments from the borrower to the lender(s). a platform’s holding of clients’ funds and the provision of payment services require an authorisation in accordance with the 2nd directive on payment services.18 these funds shall be safeguarded in accordance with the national provisions transposing the directive; in the proposal this is emphasised in art. 9(3). the directive includes provisions on capital, supervision, good business practice, 16 the proposal regards the authorisation of crowdfunding service providers as defined in the proposal art. 3(1)(a), which both includes investment-based and lending-based business models. in the following the word platform is used for crowdlending service providers that manage the p2p platforms. 17 european parliament and council directive 2014/65/eu of 15 may 2014 on markets in financial instruments and amending directive 2002/92/ec and directive 2011/61/eu [2014] oj l173/349. 18 european parliament and council directive 2015/2366/eu of 25 november 2015 on payment services in the internal market, amending directives 2002/65/ec, 2009/110/ec and 2013/36/eu and regulation (eu) no 1093/2010, and repealing directive 2007/64/ec [2015] oj l337/35. njcl 2018/1 239 transparency of conditions and information requirements and other obligations in relation to the use of payment services. the mandatory authorisation requirement in the 2nd directive on payment services cannot be satisfied by an authorisation as a crowdfunding service provider according to the proposal. in the proposal this is clarified in art. 9, cf. preamble 21. therefore, platforms or third parties acting on their behalf shall in accordance with art. 9(2) not hold clients’ funds or provide payment services, unless those funds are intended for the provision of payment services related to (here) p2p lending, and the platform or the third party acting on its behalf is a payment service provider as defined in the 2nd directive on payment services art. 4(11). if this is not the case, the platform shall put in place and maintain arrangements to ensure that the project owners accept funding offers or any payment only by means of a payment service provider, see the proposal art. 9(4). in order to enable a proper supervision of such activities, platforms shall in accordance to the proposal art. 9(1) inform their clients: whether, and on which terms and conditions they or a third party, provide asset safekeeping services, including references to applicable national law; and whether payment services and the holding and safeguarding of funds are provided by the platform or through a third party provider acting on their behalf. national competent authorities shall according to the proposal art. 13(2)(a) notify esma without delay the fact that a platform, or a third party provider acting on behalf of that platform, has lost its authorisation as a payment institution in accordance with the 2nd directive on payment services art. 13. esma shall then withdraw the platform’s authorisation as a crowdfunding service provider, where esma is of the opinion that the facts affect the good repute of the management of the platform, or indicate a failure of the governance arrangements, internal control mechanisms or procedures referred to in art. 5, see the proposal art. 13(3). this wide discretion seems narrowed by the detailed 2nd directive on payment services. the national competent authority of the member state is then notified of esma’s decision to withdraw the authorisation of the platforms; see the proposal art. 13(4). 2.1.3. additional licences – banking since a p2p platform most often only transfers the payments, it does not need more than the mandatory authorisation requirement in the 2nd directive on payment services. however, the platform operator may in some member states for example need a permit under the general industrial law, which is the case in the german industrial act, § 34 c abs. 1 1. satz nr. 2 gewerbeordnung, gewo. the platform may also be set up in ways that demand additional requirements. a platform may for example need to have a license as a mortgage trading company, if it deals with real estate loans. this is the case for the danish udenombanken, legal challenges of p2p lending 240 which therefore is more strictly regulated than other danish platforms. yet, the question that has got most attention is whether a platform engages in banking activities or not. for an investor, the question is of great importance, since the investment is only covered in accordance with the directives on deposit guarantee and investor-compensation schemes, if it is a licensed banking activity.19 p2p lending is traditionally defined in contrast to banking. whereas a commercial bank accumulates risks by taking positions on its balance sheet, a platform does not take risks through its own contractual positions, but decentralises the risks by spreading them to its users.20 as suggested, this is not the case if the platform engages in banking activities. a platform needs a license as a bank, if it takes deposits or other repayable funds from the public and grants credits for its own account, cf. the definition of a credit institution in the credit requirements regulation art. 4(1)(1), see the 4th credit requirements directive art. 3(1)(1).21 according to the 4th credit requirements directive art. 9 member states shall prohibit persons or undertakings that are not credit institutions from carrying out the business of taking deposits or other repayable funds from the public. taking the interpretation of the danish fsa, finanstilsynet, into account, a p2p platform will normally not be covered by the rules, if separate accounts in banks are created, where it has no rights of disposal.22 when the lender pays out the loan amount, the intention should also be to create a binding loan agreement and not to have the amount returned in its whole.23 in 2007, the former belgian fsa, the banking, finance and insurance commission, commission bancaire, financière et des assurances, cbfa, concluded in a concrete project that the platform would only receive funds as an agent of the borrower and the lender and would not use these funds for its own account. the belgian banking monopoly was not violated, since: ‘the platform was prepared (i) to transfer the funds to the account of the beneficiary on the same bank working day they were received; (ii) to ask a recognized accountant to 19 european parliament and council directive 2014/49/eu of 16 april 2014 on deposit guarantee schemes [2014] oj l 173/149, and european parliament and council directive 97/9/ec of 3 march 1997 on investor-compensation schemes [1997] oj l 84/22. 20 lenz (n 4) 688. 21 european parliament and council regulation (eu) no 575/2013 of 26 june 2013 on prudential requirements for credit institutions and investment firms (crr) [2013] oj l 179/1 and european parliament and council directive 2013/36/eu of 26 june 2013 on access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms [2013] oj l 179/338. 22 finanstilsynet, note of 4 july 2012. 23 søren brinkmann and allan nielsen, ‘crowdfunding. en ny andelsbevægelse’ [2014] 8 rr 56, 62. njcl 2018/1 241 certify the efficiency of this modus operandi and (iii) to send a copy of this certification to the cbfa’.24 to the best of the present author’s knowledge, there have been two cases, where a platform has been sanctioned by a national fsa: the austrian fsa, österreiche finanzmarktaufsicht, instructed by administrative decision dated 22 december 2009 the club nick2nick to stop its platform bankless-life.at, since the platform did not possess any licence pursuant to the austrian banking act, § 4 abs. 7 1. satz bankwesengesetz (bwg), and did not cooperate with a licenced credit institute.25 members of the club used the platform for the procurement of private credits, and the club operated an illicit banking business by neither possessing a permit to accept deposits nor to grant credits or, respectively, procure credits.26 furthermore, it was not entitled to perform payment services pursuant to the austrian payment act, § 64 abs. 9 1. satz zahlungsdienstegesetz (zadig) and lacked a permit under the industrial trade law to mediate private or mortgage credits.27 on 23 june 2014 the danish fsa decided that trustbuddy ab – which was established in 2009 as a listed company in sweden with businesses among others in denmark, norway, sweden, finland, spain and poland – had to comply with the danish financial business act, lov om finansiel virksomhed § 7, stk. 1, and therefore needed to be licensed as a bank.28 at trustbuddy’s webpage persons and companies could create profiles called accounts to use the services that trustbuddy offered; among others it was explained to the lenders that their accounts were viewed as normal deposit accounts, but with higher interests. the amounts transferred to trustbuddy by the lenders were actually put into an account in a bank in trustbuddy’s name in each country it operated within. trustbuddy had unrestricted rights to the bank accounts. the lenders did not have any influence on how the money was managed, and who the borrowers were. they could only claim their deposit from trustbuddy and not directly from the borrowers; it was emphasised by the fact that the lenders’ names were not part of the credit agreements. the fsa found that this was not credit intermediation, and the lenders were in reality investors. among others the fsa also found the validity 24 cbfa, verslag van het directiecomit [2007] 81, 82: https://www.nbb.be/doc/cp/nl/publications/ver/pdf/cbfa_dc_2007.pdf, as described by veerle colaert, ‘on the absence of peer-to-peer lending in belgium’ [2016] 4 eucml 182, 183. 25 www.fma.gv.at/fma-untersagt-den-betrieb-der-kreditvermittlungsplattform-banklesslife-at. 26 www.bankless-life.at. 27 www.fma.gv.at/verein-nick2nick. see also nicolas raschauer and thomas müller, ‘peer-to-peer lending in austria’ [2016] 5 eucml 222, 223. 28 www.finanstilsynet.dk/~/media/lovgivning/regler-og-praksis/2014/20140625-afgrelse-over-for-trustbuddy-ab-version-til-offentliggrelse.pdf?la=da. legal challenges of p2p lending 242 of the contracts doubtful, where trustbuddy got unrestricted rights and monitoring possibilities, while the investors still bore the credit risk. afterwards, trustbuddy put a stop to deposits from danes, and swedish depositors funded loans to the danes. after an injunction from the swedish fsa, finansinspektionen, the platform was closed in october 2015. partly without approval of the lenders, trustbuddy had lend sek 300m €31.92m) out. sek 37m (€3,94m) had been lent out with no specification of which depositors the money came from. sek 44m (€4.68m) were missing, which was the difference between the available balance on the customer accounts and the amount trustbuddy owed to the depositors.29 the danish case of trustbuddy seems not only to have influenced the danish market by lowering p2p consumer lending, but has also influenced other platforms. for example, the danish platform better rates emphasises on its webpage that it is not a bank, but a payment service, and the wording seems to refer to the decision of the danish fsa.30 in germany – as in the us – the “peer-to-peer” loans are in practice always raised through the conduit of a licensed bank, because only licensed banks are entitled to originate loans.31 the making of loans requires a license by the german fsa, bundesanstalt für finanzdienstleistungsaufsicht, bafin, if the lender acts ‘commercially’ or ‘on a scale which requires a commercially set-up business operation’ according to the german banking act, § 32 abs. 1 in connection with § 1 abs. 1 2. satz nr. 2 kreditwesengesetz, kwg. in practice, bafin interprets the notion of commercial activity in a broad manner and holds it to be sufficient that the lender intends to be active over a certain period of time and has the intent to make profits; a single transaction may be enough, if only the lender envisages further transactions.32 also, the taking of deposits, which is whenever an individual or institution receives external funds from the public, constitutes a regulated banking activity according to kwg, see the same provisions above. the bafin assumes that lending on p2p platforms is a regulated taking of deposits, if an individual or institution accepts funds from six or more investments and with a total volume of more than €12.500 or from more than 25 investments irrespective of the volume of the transaction. the bafin will not treat funds as “external”, if the loans are structured as subordinated debt; yet, a platform still would need a bank licence to originate loans.33 29 tanja jørgensen, ‘peer-to-peer lending in denmark’ [2016] 4 eucml 185, 185-186, for elaboration of the case in a danish context. 30 www.betterrates.dk. 31 lenz (n 4) 692. 32 bafin, merkblatt zum tatbestand des kreditgeschäfts, 8 january 2009, updated 2 may 2016, and renner (n 4) 224-225. 33 bafin, merkblatt zum tatbestand des einlagengeschäfts, 11 march 2014, sub v, and renner (n 4) 225. njcl 2018/1 243 in germany, licensed banks therefore both do the payment service and originate the loans, which means that they intermediate between both market sides by making the initial loan to individual borrowers and then passing on the credit risk to individual lenders.34 the platform users are normally not aware of the involvement of banks, and the banks are called white-label banks, as their names do not appear. the use of banks makes it more expensive for platforms, as banks request a fee of 0.5% to 1.5% of the loan amount.35 the german market may thereby imply legal challenges for the specific platform that wants to engage in cross boarder activities and in general be an obstacle for the growth of a european internal p2p lending market. however, different implementations in the member states as well as interpretations by national fsas may be an obstacle, too. for example, the absence of peer-to-peer lending in belgium may be explained by the belgian extensive implementation of the 4th credit requirements directive art. 9, which does not use the words ‘carrying out the business of’. any deposit-taking activity by persons other than credit institutions is therefore – irrespective of whether this is a business activity – prohibited in belgium. a candidate-borrower on a p2pplatform would be considered to make an ‘appeal to the public’ in order to receive repayable funds and therefore to violate the banking monopoly. only legal persons, as p2p borrowers may fall under an exemption in the belgian prospectus act, 68bis, 6o, which uses a very wide definition of ‘investment instrument’, including any ‘standardized loan document of which the content is identical for all lenders, except for the amount in principal, which may vary’.36 other challenges that platforms may encounter in relation to banking monopoly are related to the platforms’ competition against banks. when for example the danish platforms are asked if they face any challenges, they reply that banks may in their basis capital include equity investments in data centres, which is not offered to payment institutions by the danish fsa. another challenge may be that, when banks lend to smes, they can achieve guarantee from the danish growth fund, vækstfonden, which is a state investment fund, but platforms cannot.37 being a licensed bank may therefore have certain benefits for a platform. hence, in november 2016, the uk platform zopa announced that it would apply for a banking license. zopa’s digital bank is scheduled to launch in 2018 and will use data accessed by introducing open banking. 34 ibid 224 and lenz (n 4) 692. 35 lenz (n 4) 692. 36 colaert (n 24) 183. 37 jørgensen, ‘peer-to-peer lending in denmark’ (n 29) 187. legal challenges of p2p lending 244 it will offer customers a broader set of personal finance products including deposit accounts, credit cards and a money management app.38 2.1.4. money laundering and terrorist financing as any other financial service, p2p lending may be exposed to money laundering and terrorism financing practices. this is emphasized in the commission’s report on the assessment of the risks of money laundering and terrorist financing affecting the internal market and relating to cross-border situations.39 when funding transactions must take place via entities that are authorised under the 2nd directive on payment services they are subject to the 4th anti-money laundering directive.40 such entity authorisation under the 2nd directive on payment services is mandatory for platforms under the proposal, see the proposal art. 9. as part of the know your customer-principle in the 4th antimoney laundering directive, the platform shall obtain information about the costumer. since p2p lending is web-based there is stricter requirements for documentation than attendance in person. when the platforms are asked, one of the challenges is that the national competent authorities may have slightly different demands when the 4th anti-money laundering directive is interpreted; for example the danish fsa may have stricter demands to identification of the customer than the swedish fsa, which accepts digital signature.41 for platforms under the proposal, the requirements for the ‘good repute’ of managers include in art. 10 the absence of any criminal record under anti-money laundering legislation. according to the proposal art. 13(2)(b) national competent authorities shall notify esma without delay about the fact that a platform, or its managers, employees or third parties acting on its behalf, have breached national provisions implementing the 4th anti-money laundering directive. this also applies to national competent authorities designated under the provisions of the directive. esma shall then withdraw the authorisation as persuant to the proposal art. 13(3), see 2.2.1 above, where the details in regard of payment services also apply to money laundering or terrorism financing. 38 altfi opinion, ‘zopa boss janardana details plans for customer-centric bank’: http://www.altfi.com/article/3116_zopa_boss_janardana_sheds_light_on_customer_c entric_bank. retrieved 31 may 2018. 39 com(2017) 340 final, report from the commission to the european parliament and the council on the assessment of the risks of money laundering and terrorist financing affecting the internal market and relating to cross-border activities. 40 european parliament and council directive 2015/849/eu of 20 may 2015 on the prevention of the use of the financial system for the purposes of money laundering or terrorist financing, amending regulation (eu) no 648/2012 of the european parliament and of the council, and repealing directive 2005/60/ec of the european parliament and of the council and commission directive 2006/70/ec [2015] oj l 141/73. 41 jørgensen, ‘peer-to-peer lending in denmark’ (n 29) 187. njcl 2018/1 245 with a view to further ensuring financial stability by preventing risks of money laundering and terrorism financing, the commission shall, after consulting esma, assess the necessity and proportionality of subjecting platforms to obligations for compliance with the national provisions implementing the 4th anti-money laundering directive and adding such platforms to the list of obliged entities for the purposes of the directive, see the proposal art. 38(2)(g) and preamble 24. this will – 24 months of entry into application of the proposed regulation – be presented in a report to the european parliament and the council on the application of this regulation, accompanied where appropriate by a legislative proposal. 2.2. private law – the relationship between the parties the relationship between the various parties structures the legal conflicts in a private law context. as in other types of crowdfunding, generally three types of parties are involved in p2p lending. the intermediary in the form of a service provider that brings together project owners and investors through an online platform, cf. the proposal preamble 3. the project owner that seeks an activity or more activities (the project) to be funded, cf. the proposal art. 3(1)(f). the investors who fund the proposed project, cf. the proposal art. 3(1)(g) on investors and art. 3(1)(h) on business projects. dealing with p2p lending, the project owner and investors respectively are synonyms for the borrower and the lenders, who fund the project with loans, and the word used depends on the context. legal conflicts may arise from any stage of the (potential) project as from setting up and marketing the project to the completion of the project by the project owner’s final repayment or to the events of default. a platform’s disruptive business model can often be conceived of the following process:42 1) the potential borrower makes an inquiry to the platform indicating amount and maturity of the wished loan. 2) the platform assesses the underlying credit risk and sets a risk-appropriate interest rate, if the platform finds the risk acceptable. 3) the platform publishes the project to its users, if the borrower agrees with the platform’s terms, including pricing. 4) potential lenders have a predefined period, often two or four weeks, in which to place their offers to provide portions of the required loan amount. the remaining amount needed is visible for the platform users. the users have to sign a service contract with the platform and complete a due diligence process to comply with the 4th anti-money laundering directive to gain access to the platform. 5) the loan is originated, if the sum of investment offers matches the required loan amount. the platform collects the money from the lenders’ bank accounts and transfers it to the borrower. the transfers of cash and credit claims are done concurrently as 42 for the following process, see lenz (n 4) 691-692. legal challenges of p2p lending 246 counterclaims, after deduction of platform fees from the borrower and lenders for their matching. the lenders receive a credit claim documenting the borrower’s legal commitment to pay interest and to redeem the principal. 6) until the loan matures, the platform services the loan, collecting and distributing interest and redemption payments. the lenders carry the losses, if the borrower defaults. even though the platform is not liable for losses, it is often obliged to manage missed payments. during this process, the platforms most often charge fees for their services. for example, the platform zopa charge an origination fee to help cover the cost of setting up the loan, a loan servicing fee to each loan contract, which is deducted directly from each borrower repayment before the principal and interest is passed on to investors, and a 1% fee, if an investor wants to sell their loans to access their money quickly. 2.2.1. syndicated loans – a parallel both p2p lending and syndicated loans are generally characterized by more lenders contributing to the total loan amount of a borrower, and an intermediary that sets up and manages the loan contracts. these similarities may contribute to how the legal conflicts in regard to p2p lending may be solved by a national court. as an intermediary, the p2p platform shares the same coordinating function as the lead bank, which facilitates the establishment of the syndicated loan agreement, and the agent bank which often is the same bank as the lead bank and afterwards administers the loan and the repayment (interest, amortization, notifications etc.).43 even though the functions and structures are much the same, p2p-lending has a digital set-up and often has another focus than syndicated loans. in syndicated loans the lenders and the intermediary are traditionally banks, and the borrower – e.g. large enterprises – often uses the loan amount to large and/or risky projects, where capital requirements may hinder one bank from granting the whole amount. in p2p lending banks are traditionally not parties but instead considered an opposition to banking. yet, this is not without exemptions as noted in point 2.1.3 above and underlined by the fact that banks may be institutional investors. the loan amounts are most often smaller than in syndicated loans and used for other purposes as the borrowers are e.g. smes or consumers. the most important difference is that all the platforms interfaces with borrowers, lenders and payment service providers have to be fully standardized and automated by using software.44 having this in mind, parallels to syndicated loans will be included in the following. 43 lars gorton and tanja jørgensen, ‘roles and functions of the lead bank and the agent bank in a syndicated loan agreement’ [2009] 1 euredia 33, 43, 51-52. 44 lenz (n 4) 693. njcl 2018/1 247 2.2.2. the legislation the relationship between the parties is regulated by the contracts. national rules and principles in contract law and agency will therefore as background law define the relationship between the platform and the borrower and the lenders. further, consumers may enjoy specific protection in national law, which often is quite similar, since the member states have implemented the eu consumer directives such as the consumer credit directive (2.2.3 below), the unfair commercial practices directive and the unfair terms in consumer contracts directive. the unfair commercial practices directive protects amongst others consumers against aggressive marketing techniques. the unfair terms in consumer contracts directive ensures among others that unfair terms in standard contracts are not binding in the member states and includes a non-exhaustive list of the terms which may be regarded as unfair.45 when borrowers and lenders create a mandatory ‘client account’ at the platform, the platform’s standard terms are accepted. in the member states there are not many cases in this regard, as p2p lending is still a quite new phenomenon. the polish court of competition and consumer protection, sąd ochrony konkurencji i konsumentów, made decisions on unfair terms and conditions of the platform finansowo.pl. in three cases, which were brought forward by the consumer association towarzystwo lexus. the clauses concerned the unlimited possibility to amend the terms and conditions, the user exclusively carrying costs and risks connected with using the platform and the exclusion of the platform’s liability in case of technical problems when using the platform. the clauses which were held to be unfair were: ‘finansowo.pl reserves the right to amend this regulation at any time’ in the judgment of 22 june 2010, ‘use of the service finansowo.pl is possible only and exclusively at the user’s own risk and expense’ in the judgment 22 june 2010 and ‘finansowo.pl shall not be liable for any damages resulting by service suspension, system or technical failures’ in the judgment 22 june 2010.46 in the case of trustbuddy, the danish fsa in its decision of 23 june 2014 (2.1.3 above) found the validity of the contracts doubtful, where trustbuddy got unrestricted rights and monitoring possibilities, but the credit risk still was the investors; however, this is not a civil court judgement. 45 council directive 93/13/eec of 5 april 1993 on unfair terms in consumer contracts [1993] oj l 95/29 and european parliament and council directive 2005/29/ec of 11 may 2005 concerning unfair business-to-consumer commercial practices in the internal market and amending council directive 84/450/eec, directives 97/7/ec, 98/27/ec and 2002/65/ec of the european parliament and of the council and regulation (ec) no 2006/2004 of the european parliament and of the council [2005] l 149/22. 46 case xvii amc 10/10, msig 2010/203/12669, case xvii amc 9/10 msig 2010/203/12678 and case xvii amc 8/10 msig 2010/203/12668. the cases are described by joanna rupa, ‘peer-to-peer lending in poland’ [2016] 5 eucml 226, 227. legal challenges of p2p lending 248 the emergence of p2p platforms has given private individuals a whole new possibility to lend to each other. it questions whether the traditional consumer protection in only business-to-consumer (b2c) relationships is sufficient. the question is dealt with below in 2.2.3, where the result also relates to other consumer directives. 2.2.3. consumer credit – the borrower and the platform/investors in the consumer credit directive art. 3(a), a consumer means ‘a natural person who, in transactions covered by this directive, is acting for purposes which are outside his trade, business or profession’. the regulation proposed will not apply to crowdfunding services that are provided to project owners that are such consumers, since the regulation aims to foster cross-border business funding, see the proposal art. 2(2)(a) and preamble 8. instead, the protection in consumer credit directive and the mortgage credit directive are considered as more strict rules to safeguard consumers than the proposal, see the proposal explanatory memorandum 1.47 the mortgage credit directive art. 4(1) uses the consumer credit directive art. 3(a) consumer definition. the mortgage credit directive applies according to its art. 3(1) specifically for: (a) credit agreements which are secured either by a mortgage or by another comparable security commonly used in a member state on residential immovable property or secured by a right related to residential immovable property; and (b) credit agreements which purpose is to acquire or retain property rights in land or in an existing or projected building. these credit agreements are exempted from the consumer credit directive, see this directive art. 2(2)(a) and (b). even though the specific rules differ, the consumer credit directive and the mortgage credit directive seek to protect consumers with the aim to create an internal consumer credit market. however, as p2p borrowers, consumers may not always enjoy the demanded protection. the consumer credit directive only applies; when the creditor is ‘a natural or legal person who grants or promises to grant credit in the course of his trade, business or profession’, see art. 3(b) cf. the scope in art. 2(1) and the definition of a ‘credit agreement’ in art. 3(c). the same is the case in the mortgage credit directive art. 4(2) for an agreement within the scope of the directive, see art. 3. this demand for a b2c relationship raises two main questions in regard to p2p lending: 47 european parliament and council directive 2014/17/eu of 4 february 2014 on credit agreements for consumers relating to residential immovable property and amending directives 2008/48/ec and 2013/36/eu and regulation (eu) no 1093/2010 [2014] oj l 60/34. njcl 2018/1 249 is a private individual as a p2p lender granting ‘credit in the course of his trade, business or profession’ and thereby a ‘creditor’ as defined in the consumer credit directive? it can be argued that a private individual as a p2p lender does not fit the directive art. 3(b) definition of a creditor. according to the belgian scholarly debate, the belgian rules on consumer credit, which refers to the wording of the directive, will not apply to p2p lenders, nor to the platform, and therefore create great risks of over indebtedness and abuse for p2p borrowers.48 also in poland such a loan agreement would be considered between two consumers, since the platform only offers the marketplace, where borrowers and lenders can find each other. the answer to the question will depend on the specific situation and is not quite clear. however, even though a private individual as a lender aims to make profit, it seems awkward to view it in ‘course of his trade, business or profession’ as long as the profit cannot be considered a salary to make a living of. the raison d’être of the b2c demand is that private individuals as lenders shall not be subject to the strict obligations of business lenders. instead a p2p lender's investment can be viewed as an alternative to having the means placed in a deposit account. the consequence is that p2p lending, where the lender is a private individual cannot be qualified as consumer credit. this leads to significant risks of over indebtedness and abuse of inexperienced borrowers, as they do not necessarily enjoy the protection laid out in the eu consumer directives. yet, national provisions may cover such lending anyway. according to the danish credit agreement act, kreditaftaleloven § 1, stk. 2, the act also applies to credit agreements where the credit is granted by a not-professional person, if the agreement is concluded or disseminated on behalf of the lender by a professional person. it has another background than p2p lending and therefore has a wording that focuses on preventing circumvention of the act.49 to conclude, the consumer borrower will only be covered by the higher consumer protection in (here) the consumer credit directive and the mortgage credit directive, when the lender grants ‘credit in the course of his trade, business or profession’. in other situations, the general law such as on contracts and marketing will only cover the borrower. to which extent shall the platform fulfil the obligations in the consumer credit directive and the mortgage credit directive? in other words: is the platform a 48 cf. from a belgian context colaert (n 24) 182 with references to david raes, ‘le peer to peer lending en droit belge – espoir ou désespoir’ in cahiers aedbf/evbfr belgium (ed), digital finance/la finance numérique (anthemis/intersentia 2015) 83, 100 and sylvie decoster and clarisse lewalle, ‘le crowdfunding: réglementation applicable, enjeux et perspectives’ (2014) revue bancaire et financière – banken financiewezen 455, 464 and 467. 49 tanja jørgensen, ‘kreditformidlere – nu i dansk ret’ [2011] et 243, 244-245. legal challenges of p2p lending 250 creditor or an intermediary regulated by the consumer credit directive or the mortgage credit directive? in case c-311/15, trustbuddy ab, the finnish supreme court, korkien oikeus, asked the court of justice of the european union (cjeu), the question of whether a p2p lending platform can be considered to be a ‘creditor’ under the consumer credit directive, if it markets credit to consumers via the internet. however, the answer from the cjeu will remain unanswered. after trustbuddy went into bankruptcy, the case was deleted from the court’s register. as the danish fsa found that trustbuddy conducted banking activity, see 2.1.3 above, the platform was likely in the specific case a creditor. the referred request for a preliminary ruling was: is [the consumer credit directive art. 3(b)] to be interpreted as meaning that a trade is to be regarded as a creditor if it markets credit to consumers via the internet in the form of so-called peer-to-peer lending and exercises, as regards the consumers, the decision-making power generally appertaining to creditors with respect to the terms and conditions, the granting of credit and debt recovery, even though the funds for credits come from anonymous private individuals and are kept separate from the trader’s own funds? since a platform normally within its business just facilitates the interaction between the parties, the general answer seems to be that a platform hardly ‘grants or promises to grant credit in the course of his trade, business or profession’ and seems thereby not to be a creditor as defined in the consumer credit directive art. 3(b). if the lender is a private individual, there is furthermore hardly any credit agreement in the b2c sense of the consumer credit directive art. 3(c) and the mortgage credit directive art. 4(3), and the situation thereby falls outside the scope of the directives. in case of a b2c relationship between the lender and the borrower, the consumer credit directive or the mortgage credit directive will apply, if the contract falls within the more detailed scope in the consumer credit directive art. 2 and the mortgage credit directive art. 3. in this situation a platform seems to fall within the definition of a credit intermediary in the consumer credit directive art. 3(f) meaning ‘a natural or legal person who is not acting as a creditor and who, in the course of his trade, business or profession, for a fee, which may take a pecuniary form or any other agreed form of financial consideration: (i) presents or offers credit agreements to consumers; (ii) assists consumers by undertaking preparatory work in respect of credit agreements other than as referred to in (i); or (iii) concludes credit agreements with consumers on behalf of the creditor’. however, a platform that merely introduces a consumer to a creditor or credit intermediary will fall without the njcl 2018/1 251 mortgage credit directive's definition of a credit intermediary. a credit intermediary in the directive's art. 4(5) means: a natural or legal person who is not acting as a creditor or notary and not merely introducing, either directly or indirectly, a consumer to a creditor or credit intermediary, and who, in the course of his trade, business or profession, for remuneration, which may take a pecuniary form or any other agreed form of financial consideration: (a) presents or offers credit agreements to consumers; (b) assists consumers by undertaking preparatory work or other pre-contractual administration in respect of credit agreements other than as referred to in point (a); or (c) concludes credit agreements with consumers on behalf of the creditor. a platform will as a credit intermediary have to fulfil the specific obligations of credit intermediaries in the consumer credit directive or the mortgage credit directive. according to the consumer credit directive art. 21, a credit intermediary shall indicate the extent of his powers in advertising and documentation intended for consumers and indicate the intermediary’s service fee payable by the consumer and agreed between the consumer and the credit intermediary on paper or another durable medium before the conclusion of the credit agreement. in the mortgage credit directive a credit intermediary shall fulfil the more extensive information requirements in art. 15, and the requirement for establishment and supervision of credit intermediaries in chapter 11, including holding a professional indemnity insurance in art. 29(2)(a) and entering into a register of admitted credit intermediaries led by a competent authority in their home member state in art. 29(4). in the two-fold contracting structure of german p2p lending, the licensed bank fulfils the lenders potential obligations under §§ 491 et seq. bgb, and the platform as a loan broker only has to comply with residual duties of information.50 in other member states platforms will most often take on the obligations of the creditors, and many of the articles in the consumer credit directive and the mortgage credit directive also apply to credit intermediaries.51 in the consumer credit directive the obligations are mainly standard information to be included in advertising in art. 4 and pre-contractual and contractual information, including the annual percentage rate of charge (apr), in art. 5 and 10; the apr shall for example contain a platform's origination and loan servicing fees. in the mortgage credit directive they are mainly the conduct of business obligations in art. 7, the obligation to provide information free of charge to consumers in art. 8, knowledge and competence requirements for 50 renner (n 4) 224. 51 for elaboration, see tanja jørgensen, ‘kreditformidlere – fremtidige regler’ [2011] et 256-258. legal challenges of p2p lending 252 staff in art. 9, standard information to be included in advertising in art. 11, general information in art. 13, pre-contractual information in art. 14, adequate explanations in art. 16 and standards for advisory services in art. 22. the obligations raise legal challenges in at least two situations. often unique users ids are used to keep the privacy of the borrower and lender. however, before a consumer is bound by a credit agreement, the consumer shall know the identity and the geographical address of the creditor as well as, if applicable, the identity and geographical address of the credit intermediary involved, see the consumer credit directive art. 5(1)(b) with reference to the standard european consumer credit information form set out in annex ii. this also applies to the credit agreement, see the directive art. 10(2)(b). it is not in accordance with the pre-contractual information duty, when for example the platform better rates writes that it is first in the final loan agreement that the investors real names can be seen by the borrower according to the danish consumer agreement act, kreditaftaleloven, as implements the directive.52 p2p lending thereby includes knowledge of the borrower’s need for finance to a wider audience than lending normally does. it is the creditor – here the p2p lender – that is subject to assessing the consumer’s credit worthiness both in the consumer credit directive art. 8 and the mortgage credit directive art. 18, which especially may prevent over indebtedness of the potential borrower. however, most platforms as intermediaries conduct their own assessment of the underlying credit risk and fit it in to the platform’s risk categories. p2p platforms may though accept higher risks than banks, and borrowers who are rejected by banks may therefore end up being accepted by p2p platforms.53 reversely, this raises certain considerations in regard to the protection of the investor as creditor, see 2.2.4 below. 2.2.4. investor protection – the investors and the platform with the new digital platforms, private individuals have got an opportunity to lend money and make investments that they have not previously had. both in p2p lending and syndicated loans, the lenders enjoy the advantages of severalty, including spreading of the risk, and there is thus some correlation between the loan amount and the number of lenders involved. for example, at the platform auxmoney the minimum investment amount is €25. an investment of € 2,500 can therefore be split into 100 different loan projects to diversify the investment portfolio. p2p lending often requires a great deal of trust from the investors, which needs to be met with corresponding responsibility from the platforms. for example, to save time and not have to study each loan 52 www.betterrates.dk. 53 lenz (n 4) 697. njcl 2018/1 253 project individually, auxmoney has created a portfolio builder, which automatically invests in various loan projects. the investors thereby entrust their money to the platform's discretion without knowing precisely which projects they invest in. there are significant risks for investors innate in p2p lending, and inexperienced investors do not necessarily know the consequences. the investor often receives limited information about the borrower as well as about the platforms’ credit assessment methods, and furthermore, both platforms and borrowers have some incentive not to be too critical about the disclosure of risks. there is a natural conflict of interest between investor protection and the platform’s business model, where the platform generates its income through a fee that usually corresponds to a certain percentage of the transaction volume, which thereby provides a steady incentive for the platform to stimulate the platform’s transaction volume by exaggerating investment opportunities and profit chances, while playing down the risks of investment projects.54 this makes p2p lending even more risky. it is illustrated by the striking case of trustbuddy above, where the investors lacked insight in the credit assessment, the risk was played down and where the platform furthermore had all the powers until the money was returned to the lenders. despite of the risks, p2p lenders are to date not shielded by the eu directives on investor protection. though, some member states require p2p platforms to get licensed and to operate under existing eu frameworks, such as the 2nd markets in financial instruments directive and the alternative investment fund managers directive. other member states have introduced national bespoke regimes on investor protection. in the netherlands six key regulatory changes were introduced in 2016: 1) investment limits so that lenders will be able to invest € 80.000 per platform, 2) a crowdfunding investment test for lenders, 3) an active confirmation and cancellation option whereby the platform will offer a period of reflection for lenders to either confirm or cancel their investment with two options: the ‘active confirmation’ option that requires platforms to send an email requesting lenders to confirm their investment within 24 hours, where the investment is cancelled in the absence of a response, and the ‘active cancellation’ option, which is the reverse of this, and the lender is sent an email offering cancellation of their investment, and the investment is finalised, if the lender takes no action, 4) asset segregation, where the assets of the platform should be kept separate from the assets of the lender/borrower at all times as the investment transitions through the platform, 5) monitoring of exemption holders, when considering the competence of directors, and assessing corporate credit risk, including determining the repayment capacity of 54 lenz (n 4) 696. legal challenges of p2p lending 254 companies and implementation of systems to allow payments between lenders and borrowers to continue in case the platform temporarily or permanently should stop functioning, and 6) a semi-annual reporting obligation with the main purpose to monitor the market developments.55 the proposal for a regulation on european crowdfunding service providers (ecsp) for business, does not intend to interfere with national bespoke regimes or existing licenses, including those under the 2nd markets in financial instruments directive, the 2nd directive on payment services or the alternative investment fund managers directive. it rather seeks to provide platforms with the option to apply for a single union-wide authorisation to scale up their operations throughout the eu. in this regard, it also seeks to empower investors with the necessary information, including the information on the underlying risks and to support investors’ trust by requiring platforms to have the necessary safeguards in place to minimise risks materialising, see the proposal explanatory memorandum 1. the proposal also covers private individuals as investors, since an ‘investor’ according to art. 3(1)(g) means ‘any person that, through a crowdfunding platform, grants loans or acquires transferable securities’. the provisions on investor protection and transparency set out in the proposal chapter iv are quite extensive. pursuant to art. 14, all information, including marketing communications, from the platform to clients about themselves, about the costs and charges, conditions, including project selection criteria, or about the nature of and risks associated with the services shall be clear, comprehensible, complete and correct. it shall be provided to potential clients, before they enter into a transaction and be available on a clearly identified section of the platform’s website and in a non-discriminatory manner. art. 15 sets out an initial assessment of appropriateness of a prospective investor, which is quite similar to the test in the 2nd markets in financial instruments directive and to the crowdfunding investment test for lenders, which has been devised in the netherlands in 2016.56 for the purposes of the assessment, the platforms shall request information about the prospective investor’s basic knowledge and understanding of risk in investing in general and in the types of investments offered on the crowdfunding platform, including specific information on past investments and any relevant knowledge or professional experience in relation to crowdfunding investments. where a prospective investor 55 matthew williams, ‘peer-to-peer lending in the netherlands’ [2016] 4 eucml 188, 190. the regulatory changes was introduced via the revised decree on the supervision of the conduct of financial enterprises, besluit gedragstoezicht financiële ondernemingen wft, and a change in supervisory policy on behalf of the fsa, autoriteit financiële markten. 56 id. njcl 2018/1 255 does not provide the information required, or where a platform on the basis of this information considers that the prospective investor has insufficient knowledge, the platform shall inform this prospective investor that the services offered on the platform may be inappropriate and give a risk warning. platforms shall take the measures necessary to comply with the assessment of appropriateness for each investor every two years. furthermore, art. 15(5) provides that platforms shall offer investors the possibility to simulate their ability to bear losses, calculated as 10% of their net worth, based on specific information dealing with income, assets and financial commitments. a risk warning, the lack of requested information from the prospective investor or the results of the simulation will not prevent prospective investors and investors from investing in projects. the platform shall according to art. 16 provide prospective investors with a key investment information sheet (kiis) drawn up by the project owner for each crowdfunding offer. it shall contain the detailed information set out in the annex to the proposal and an explanatory statement, appearing directly underneath the title of the key investment information sheet: this crowdfunding offer has been neither verified nor approved by esma or national competent authorities. the appropriateness of your education and knowledge have not been assessed before you were granted access to this investment. by making this investment, you assume full risk of taking this investment, including the risk of partial or entire loss of the money invested. it shall also contain this risk warning: investment in this crowdfunding offer entails risks, including the risk of partial or entire loss of the money invested. your investment is not covered by the deposit guarantee and investor compensation schemes established in accordance with [the directives on deposit guarantee and investor-compensation schemes] you may not receive any return on your investment. this is not a saving product and you should not invest more than 10% of your net wealth in crowdfunding projects. you may not be able to sell the investment instruments when you wish. there are strict requirements to the form of the kiis. according to art. 16(3) it shall not only be ‘clear, comprehensible, complete and correct’ and not contain any footnotes other than law references, it shall legal challenges of p2p lending 256 also be presented in a stand-alone, durable medium which consists of maximum 6 sides of a4-sized paper format if printed and be ‘clearly distinguishable from marketing communications’. on the other hand, all marketing communications to investors shall be clearly identifiable as such, and national competent authorities shall publish and keep updated on their websites national laws, regulations and administrative provisions applicable to marketing communications of platforms, see art. 19(1) and art. 20. the platform shall keep kiis updated for the whole period of validity of the offer, see art. 16(4). when a platform identifies a material omission, a material mistake or a material inaccuracy, the project owner shall according to art. 16(6) complement or amend that information in the kiis. where this is not possible, the platform must not make the crowdfunding offer or cancel the existing offer until the key investment information sheet complies with the requirements of this article. according to art. 16(1) and (7) kiis shall be drafted in at least one of the official languages of the member states concerned or in a language customary in the sphere of international finance and an investor may request a platform to arrange for a translation of kiis into a language of the investor’s choice. where the platform does not provide the requested translation of kiis, the platform shall clearly advise the investor to refrain from making the investment. art. 17 deals with bulletin boards. platforms that allow their investors to interact directly with each other to buy and sell loan agreements or transferable securities which were originally crowdfunded on their platforms shall according to section 1 inform their clients that they do not operate a trading system and that such buying and selling activity on their platforms is at the client’s own discretion and responsibility. if the platforms suggest a reference price for the buying and selling, they shall inform their clients that this price is non-binding and substantiate it, see section 2. an example of such a bulletin board, is the platform zopa. here it is possible for the investors to sell active loans to other investors in the market. there is a 1% fee and a market rate adjustment fee associated with this service, which is available while the loans are up to date with repayments and there are other investors looking to buy the loans.57 art. 18 gives the right for the investor to access the records and demand that the platform for five years keeps all records related to their services and transactions on a durable medium and maintains all agreements between the platforms and their clients. 57 http://help.zopa.com/customer/en/portal/articles/2796228-are-there-any-feesassociated-with-peer-to-peer-investments-at-zopa-. njcl 2018/1 257 2.2.5. execution of the loan agreements – the investors and the borrower a p2p loan is often structured as a monthly annuity loan. it is contracted in the lender’s and borrower’s names and at their expense. the platform normally services the loan until the loan matures by collecting and distributing interest and redemption payments. the payment transactions are safeguarded in accordance with the national provisions transposing the 2nd directive on payment services, see 2.1.2 above. if the directives apply, a consumer borrower has a right to withdraw from a contract within 14 days according to the consumer credit directive art. 14 and a right to early repayment according to the consumer credit directive art. 16 or the mortgage credit directive art. 25. the lenders carry the losses in the event of default. as a starting point, the platform is as not liable for losses, but may be held liable especially in cases of grossly behaviour, where for example the platform’s negligence or malpractice has caused the lenders losses. a typical situation could be risk assessment, where a platform conceals a known high-risk project to the lenders by categorising it as a low-risk project or exaggerating profit chances while playing down the risks of the project. in the event of default, more platforms manage missed payments. it could be a sale of non-performing loans on behalf of lenders to a debt collection agent for a fixed price to recover a minimum percentage of the credit claim or an automated litigation and recovery processes.58 for example the platform better rates helps in the event of default to send out reminders and to enforce the claim by civil courts. at the platform zopa, a loan is classed as defaulted, if a borrower reaches four months’ worth of missed repayments. as a capital loss some of the original investment would be lost, and this amount would be deducted from the investor’s client account at zopa, while zopa tries to make recoveries on the loans. in case of the borrower’s bankruptcy, the investments are not covered by the deposit guarantee and investor compensation schemes, and the lenders will suffer losses. yet, the lenders will be covered in the case of licensed banking, see 2.1.3 above. in the event of the platform’s bankruptcy, the lenders will still have their residual claims on the repayments with interest. yet, asset segregation is of great importance to identify the claims. at all times of the transitions, the assets of the platform ought to be kept separate from the assets of the lender/borrower for example via a partnership with a licensed payment service provider or by creating a separate legal entity to manage the users’ assets. in the netherlands there is a legal demand on platforms to secure asset segregation, see above.59 58 lenz (n 4) 696. 59 williams (n 54) 190. legal challenges of p2p lending 258 2.2.6. the relationship between the investors there is hardly any relationship between the individual investors to a project. each investor provides separately the funds to the borrower, even though the loan agreements are contracted on the same terms. the principle of severalty will apply as in syndicated loans.60 an investor is thus not responsible for the obligations of another by performing the loan amount to the borrower and the principle of joint and several liability in for example the danish promissory note law, gældsbrevsloven § 2, will not apply. however, something else may in rare situations have been contracted. the decision power when dealing with increased risks including upcoming default situations will as a starting point be the single investors, but unlikely syndicated loans investors have by contract entrusted the platform wide powers and there seems no need for joint decision as for example in a “peer-democracy” after drawdown. 3. is the existing legislation sufficient? p2p lending is a fairly new activity, but the intense growth in the last couple of years fuelled by new digital technologies indicates that it is only in its initial stage. as a starting point p2p platforms have to fit within the existing legislation. yet, the existing legislation seems not quite sufficient to meet the impact that p2p lending may have on modern society. on the positive side, p2p lending has brought a new dimension to the financial market by giving access to new types of investments and new investors, such as private investors. furthermore, it has given borrowers such as consumers and smes access to finance that may be on better terms and at lower costs; finance that they may not have been able to obtain elsewhere. even though p2p lending often is conceived as a competition to banks, it may fill in the gap, where traditional banking can be considered inapt, while it has become more difficult to obtain credit in banks as a result of the financial crises and stricter capital requirements.61 on a european level, the platforms’ use of technology (fintech) can elude factors as geographical proximity which creates barriers to the internal market. p2p lending may bring investors greater accessibility and ability to diversify risk with a more resilient and effective financial infrastructure as a result. it may even deliver a more inclusive financial system both domestically and globally.62 yet, also negative consequences of p2p lending are lurking in the form of new and different risks. the investor often receives limited information about the borrower as well as about the platforms’ credit 60 gorton (n 43) 48-49. 61 jørgensen, ‘peer-to-peer lending in denmark’ (n 29) 187. 62 lenz (n 4) 688, with reference to a speech by bank of england governor mark carney. njcl 2018/1 259 assessment methods, and furthermore both platforms and borrowers have some incentives not to be too critical concerning the disclosure of risks; a natural conflict of interest exists between investor protection and the platform’s business model.63 the borrowers’ poor credit history or lack of access to bank loans may add to the risk of losses for investors and the risk of overindebtedness of borrowers. due to a divergence in the credit risk assessment, there might be an adverse selection process operating in which low-risk customers borrow from banks and high-risk customers use p2p platforms. since p2p platforms may accept higher risks than banks, borrowers who are rejected by banks may therefore end up being accepted by p2p platforms.64 while institutional investors may benefit from the new types of investments, the contrary may be the consequence for inexperienced private investors, which are unaware of the inherent risks. yet, p2p lenders are to date not shielded by the eu directives on investor protection. the consumer borrower will likely only be covered by the higher consumer protection in especially the consumer credit directive and the mortgage credit directive, when the lender grants ‘credit in the course of his trade, business or profession’. taking up a loan in a mixed p2p and b2p platform, the consumer borrower may be protected in one situation but not in another. from the platforms’ point of view, p2p lending requires significant software investments, and they are today met with different requirements throughout the eu. the necessary involvement of a credit institution in for example germany makes it more expensive for platforms.65 however, in a national context the platform “just” needs to be set up in the correct manner to meet the public law requirements by for example having a licence to offer payment services and not engaging in bank activities on its own. as a fairly new activity, only a small number of member states have introduced legislation on p2p lending, and most member states still seem to prefer a ‘wait-and-see’ approach.66 however, p2p lending is rapidly developing with great risks to borrowers and investors, which will call for action. to avoid legislative fragmentation by uncoordinated regulatory activities at the member state level that create new barriers to the emerging eu crowdfunding market, a dedicated, single european regulatory framework on crowdfunding, including p2p lending, will be a suitable solution.67 expanding the european commission’s proposal for a regulation on european crowdfunding service providers (ecsp) for 63 lenz (n 4) 696. 64 lenz (n 4) 697. 65 lenz (n 4) 692 and 2.1.3 above. 66 busch (n 1) 181, and christian twigg-flesner, ‘disruptive technology – disrupted law? how the digital revolution affects (contract) law’ in alberto de franceschi (ed), european contract law and the digital single market (intersentia 2016). 67 busch (n 1) 181, and lenz (n 4) 700. legal challenges of p2p lending 260 business to a mandatory framework, which also covers consumer borrowing, could do it. yet, such a framework is not likely in the near future, when the commission states ‘[g]iven the predominantly local nature of crowdfunding, there is no strong case for eu level policy intervention’.68 the most feasible way may therefore be to adjust today’s legislation – at which level it is possible – to a new digital reality, where the existing market structures are changing. one likely, suitable solution could for example be to include both p2p lenders and borrowers in the existing frameworks. to illustrate, in the context of the consumer credit directive and the mortgage credit directive the protection of the consumer borrower could be clarified in situations, where the credit is granted by a private individual via an intermediary acting in the course of his trade, business or profession. 68 commission staff working document of 3 may 2016, ‘crowdfunding in the eu capital markets union’, swd(2016) 154 final, 31. platform work and the danish model – legal perspectives natalie videbæk munkholm * & christian højer schjøler ** * associate professor, department of law, aarhus bss, aarhus university, denmark ** assistant professor, department of law, university of southern denmark, denmark. njcl 2018/1 117 1. introduction ................................................................................... 118 2. the danish model .......................................................................... 121 3. notion of employee – an overview ........................................ 123 4. employee collective bargaining aspects .......................... 126 4.1. competition law and platform work .......................... 127 4.1.1. danish competition authorities – case law on atypical employees and collective agreements .......................................................................................... 128 4.1.2. case law of the court of the justice of the eu .......................................................................................... 130 4.2. lawfulness of strike and secondary action ........... 134 4.3. lawfulness of blockade ................................................... 135 4.4. scope of a negotiated agreement ............................... 136 4.4.1. jurisdiction of the labour court...................... 137 4.4.2. who is covered .......................................................... 137 5. first collective agreement for platform work ............... 138 6. discussion ......................................................................................... 139 6.1. first attempt for agreement for platform workers. . .......................................................................................... 139 6.2. platform work and competition law. ......................... 142 6.3. platform work and flexicurity. ................................... 144 platform work and the danish model 118 abstract labour law and services provided via online platforms or digital apps, platform work, appear to be an ill-matched couple as the business model of the platforms often relies on the worker not being an employee, whereas labour law categorises persons performing work as either self-employed or employees, depending on the circumstances of the relationship. recent european and national case law concerning uber illustrate that the classification of platform work is complicated. this article examines platform work in the light of the danish model of providing a legal basis for decent pay and working conditions by way of collective bargaining. collective agreements are a prerequisite for the danish model to be extended to persons providing services via digital platforms. platform businesses operate in an uncertain realm where the use of collective agreements could be questionable from a labour law as well as from a competition law perspective. the article takes a closer look at such legal perspectives by drawing out principles from national case law as well as case law of the european court of justice. the article further discusses a trial-agreement concluded between a trade union and a platform business in denmark. the article concludes that collective agreements would be in line with the danish model as well as with competition law, as long as the circumstances of each contract of service are characteristic of employment and as long as the service providers are not genuinely self-employed. the article contributes to the discourse on collective agreements as a means to ensure decent pay and working conditions as well as societal values and protections for persons providing services in the form of labour via online websites and digital apps. 1. introduction technological developments allow for new business models and new forms of work. this has always been the case. recent developments in digital technology likewise enable new models for providing services. the use of online websites or digital apps to assist the exchange of services between private persons are often referred to as ‘platform economy’, and it is often promoted as a manner of executing the economic principle of sharing assets or services, referred to as the ‘sharing economy’.1 1 e.g. <https://deleoekonomien.dk/> the article in essence distinguishes between digital platforms as regards to the object of exchange. the term ‘sharing’ is appropriate, where assets are shared, such as a car or an apartment. as recognized for more than a century, labour is however not a commodity. evidently, labor hours, as they are provided by a human being, cannot simply be shared as an ‘asset’, and thus is not appropriately categorised as ‘sharing economy’. this perspective is easily neglected also in denmark, e.g. in 2017, a trade association for platform businesses emerged with the objective of ensuring that ‘danes in companionship and with respect for each other njcl 2018/1 119 business models vary, also businesses using digital platforms. there is no one-size-fits-all model for using online websites or apps to connect service providers and users. certain elements can nonetheless be examined as typical. the term ‘platform work’ in this article thus refers to the phenomenon where a private person offers a service in the form of working hours to another private person or corporate entity, where the connection is made via an intermediary online website or a digital app. the person offering work is referred to as ‘service provider’, the website or app is referred to as ‘the platform’, the legal entity offering and constructing the model of the intermediary app or website is referred to as ‘the platform provider’, the recipient of the service is referred to as ‘the user’.2 the dichotomy in labour and employment law provides that the relationship between the parties can be categorised as either one of employment or one of contracts for services by self-employed persons. this division is often referred to as ‘the binary divide’.3 as an employee a person is entitled to certain rights and protections, and as self-employed, any rights or protections are the responsibility of the service provider. in can earn and save money in sharing the available resources through collaborative platforms’, foreningen for platformsøkonomi i danmark <http://danskeplatforme.dk/>. instead, in the view of the authors, digital platforms enable new and welcome avenues for providing services in the form of labour, e.g. cleaning services, transportation, etc., and could more accurately be termed new business models. 2 see a.o. these sources for more on the legal aspects of platform work: jeremias prassl, ‘pimlico plumbers, uber drivers, cycle couriers, and court translators: who is a worker?’ (social science research network 2017) ssrn scholarly paper id 2948712 <https://papers.ssrn.com/abstract=2948712> accessed 20 august 2018; jeremias prassl and martin risak, ‘uber, taskrabbit, and co.: platforms as employers rethinking the legal analysis of crowdwork’ (2015) 37 cllpj 619; valerio de stefano, ‘the rise of the “just-in-time workforce”: on-demand work, crowdwork and labour protection in the “gig-economy”’ (2016) working paper <http://www.ilo.org/travail/whatwedo/publications/wcms_443267/lang-en/index.htm> accessed 20 august 2018; jon erik dølvik and kristin jesnes, nordic labour markets and the sharing economy : – report from a pilot project (nordisk ministerråd 2017) <http://urn.kb.se/resolve?urn=urn:nbn:se:norden:org:diva-4754> accessed 20 august 2018; marianne jenum hotvedt, ‘arbeidsgiveransvar i formidlingsøkonomien? tilfellet uber’ (2016) 55 lov og rett 484; ane kristiansen and søren kaj andersen, ‘digitale platforme og arbejdsmarkedet’ (2017) 38 forskningscenter for arbejdsmarkedsog organisationsstudier <http://faos.ku.dk/publikationer> accessed 20 august 2018; miriam a cherry and antonio aloisi, ‘“dependent contractors” in the gig economy: a comparative approach’ [2016] ssrn electronic journal <http://www.ssrn.com/abstract=2847869> accessed 20 august 2018; jennifer pinsof, ‘a new take on an old problem: employee misclassification in the modern gigeconomy’ (2016) mttlr 22, 341. 3 alan bogg and mark freedland, the contract of employment (oxford university press 2016) 238 where the evolution of the binary divide is explored. platform work and the danish model 120 non-standard contracts of work the distinction can be blurred. this is apparent with work performed via platforms, where the platform provider often utilises a contractual term, by which the service provider is not an employee, but where at the same time the actual relationship between the platform and the service provider is atypical for selfemployed persons. the categorisation as employees or self-employed is of influence not only for the rights and protections of the individual service provider. correct classification allows for fundamental societal considerations to be enforced. a number of employee rights and protections are a result of broader societal considerations and choices, e.g. ensuring a sustainable and healthy work force by providing safety at work, maximum working hours and paid annual leaves; a decent level of social security, e.g. pension payments, sick leave pay and maternity leave pay; and protecting societal values such as equality and protection against discrimination. indeed, the classification as either employee or self-employed is vital to ensure that a given society’s basic rights and protection for persons performing work in employment also applies when such work is performed via an intermediary digital app or a website.4 at the collective level where social partners aim to conclude collective agreements, the binary divide is likewise of essence. collective agreements is the primary tool of choice to ensure a proper balance in the employment relationship as well as in society at large as a key feature of the danish welfare system. however, if a service provider on digital platforms is categorised as self-employed, a collective agreement providing binding payment structures would violate competition law, collective action aimed at concluding agreements for genuinely selfemployed persons would be unlawful under danish law, and the labour court would not have jurisdiction to assess complaints of breach of contract. and vice-versa. in april 2018, 3f, the largest trade union in denmark (united federation of danish workers) concluded a collective agreement with a digital platform, hilfr, which acts as intermediary between private cleaners and customers.5 this article draws into focus existing labour law principles used to assess the status of persons in less than typical employment situations, case law from the danish competition authorities and the cjeu regarding collective agreements for non-typical employment situations.6as the agreement with hilfr is ground-breaking in denmark, perhaps worldwide,7 the article also takes a closer look at the innovative elements of the agreement. 4 prassl and risak (n 2) 622. 5 <https://www.3f.dk/english> accessed 20 august 2018. 6 the agreement is available at <https://www.3f.dk/fagforening/fag/rengoeringsassistent(privatansat)/overenskomsten-hilfr> accessed 20 august 2018. 7 collective agreements for quasi self-employed are not uncommon. according to eva grosheide and beryl haar, ‘employee-like worker: competitive entrepreneur or njcl 2018/1 121 2. the danish model denmark is a small scandinavian country of 5.7 million inhabitants. the danish constitution, dating back to 1849, establishes a constitutional monarchy and the framework for a democratic rule. the legislative power lies with the parliament and government in unison, and the rule of law is prevalent in denmark.8 in the late nineteenth century, labour was in abundant supply, working conditions were very poor, and the only way to improve working conditions was by acting collectively to gain bargaining leverage. a system of collective bargaining and conflicts emerged. in 1899, a lengthy nationwide conflict was brought to an end with the historic september agreement. the september agreement carved out the fundamental principles for the industrial relations system in denmark, and recognised inter alia the right to bargain collectively, the right to strike, the duty of peace and the employer’s managerial power. the social partners acknowledged the opposite party’s right to exist and the right for employees and employers to freely join trade unions and employer’s confederations.9 these principles continue to be the foundation of the danish collective bargaining system.10 in 1910, parliament provided a dispute resolution system, based on a distinction between conflicts of interest and conflicts of rights, whereas conflicts of rights should be settled by way of dispute resolution rather than by way of conflict. statutory legislation provided a specialised and effective dispute resolution system for the social partners, i.e. the act on the labour court, arbejdsretsloven11 and the act on a public conciliator, forligmandsloven.12 the social partners are otherwise self-regulatory as there is no statutory regulation of trade unions, collective agreements submissive employee? reflections on ecj, c-413/13, fnv kunsten informatie’, in maciej laga and others (eds.), labour law and social rights in europe. the jurisprudence of international courts (gdansk university press 2017), one social partner has adopted minimum fees for self-employed persons in a.o. architectural firms in the netherlands. 8 e.g. denmark tops the world justice project, rule of law index, 2017-18, <https://worldjusticeproject.org/our-work/publications/rule-law-index-reports/wjprule-law-index-2017-2018-report> 9 ole hasselbalch, labour law in denmark (fourth edition, kluwer law international b v 2016) 32; jens kristiansen, the growing conflict between european uniformity and national flexibility: the case of danish flexicurity and european harmonisation of working condition (djøf 2015) 25. 10 e.g. recognized in the current version of the general agreement concluded by the danish employers’ confederation, da, and the danish confederation of trade unions, lo, <http://www.da.dk/bilag/general%20agreement_net.pdf> 11 statutory act no. 1003 of 24/08/2017 on the labour court and industrial arbitrations. available in english at <http://arbejdsretten.dk/generelt/labourcourt/labour-court-act.aspx> accessed 19 april 2018. 12 statutory act no. 709 of 20/08/2002 on conciliation in collective disputes. platform work and the danish model 122 and the lawfulness of industrial conflicts.13 the right to collective bargaining is not explicitly protected in the constitution.14 the state interferes as little as possible in matters regarding pay and working conditions. such matters are considered to be more suitably settled by way of collective bargaining.15 this understanding is supported by a very high unionisation rate,16 in 2017 approx. 67%, and a high coverage of collective agreements, in 2015 approx. 74% of private sector and 100% of public sector employees.17 within the boundaries of the labour market, the social partners act as the primary legislative power.18 as a result, there is no general statutory legislation on what constitutes an employment relationship, on working conditions, minimum wages,19 normal daily or weekly working hours20, overtime payment, sick leave pay, maternity leave pay, pensions, continuing education or lawful termination of employment.21 statutory regulation is traditionally passed only when avenues of negotiation have been exhausted in areas of social security, or for groups of workers in need of special protection or traditionally not unionised. working conditions in denmark are primarily regulated by way of collective agreements.22 this system of bargaining is referred to as the danish model. denmark’s membership of the european union and the duty to implement directives by statutory law has forced the legislators to play a more active role.23 at the political level, denmark is reluctant towards eu legislation on topics 13 hasselbalch (n 9) 51. 14 jens kristiansen, den kollektive arbejdsret (3rd ed, juristog økonomforbundet 2014) 112. 15 hasselbalch (n 9) 44; kristiansen (n 9) 13. 16 in 2008 the average unionization rate in europe was less than 25 percent. kristiansen (n 9) 45. 17 dagpengekommissionen, det danske arbejdsmarked, oktober 2015, 22 . 18 hasselbalch (n 9) 44. 19 there are only three minor exceptions: vocational trainees are by statutory legislation ensured a minimum wage equal to the wage in the normal collective agreement in the trade in question and the pay of ‘crown servants’ is ultimately fixed by the parliament, if the organizations do not come to an understanding during the negotiations. and finally, if the job is created as a initiative under the public unemployment scheme, a statutory act requires the pay to be settled according to the collective agreement within the trade. hasselbalch (n 9) 135. 20 ibid 120. 21 kristiansen (n 9) 31. the provisions with formal and substantive criteria for lawful dismissals exist, but are fragmented. e.g. statutory acts applicable to all employees prohibit dismissal on specific grounds, and statutory acts for certain groups of employees provide notice-periods and a standard of reasonableness in cases of dismissal. 22 ‘collective agreement with erga omnes applicability | eurofound’ <https://www.eurofound.europa.eu/efemiredictionary/collectiveagreement-with-erga-omnes-applicability> accessed 19 april 2018. 23 kristiansen (n 9) 17. njcl 2018/1 123 traditionally reserved for collective bargaining.24 at the legal level, the social partners aim to implement eu directives by collective agreements, supplemented by minimum legislation applicable to those who are not covered by an implementing agreement.25 collective agreements are automatically binding for signatories and their members, but not applicable erga omnes.26 employers can be bound either via membership of an employers’ association, party to an agreement, or through an individual agreement with a trade union.27 agreements define their own scope of application. typically, the agreement provides that when an agreement is in force, the employer must extend the provisions to all employees performing the type of work covered by the agreement, regardless of their membership status. sectoral agreements typically run for a period of 2-3 years and regulate material working conditions such as wages, working hours, overtime pay, rules of termination and work place union representatives.28 for persons performing work via digital platforms in denmark who would be categorised as employees, the customary avenue of ensuring reasonable pay and working conditions is by way of concluding collective agreements.29 3. notion of employee – an overview at the collective level the question of employee-status has surfaced in danish law not only with regards to who is eligible to receive the rights provided for in the agreement, but also in regards to the 24 e.g. a unified ‘no’ to the european commission’s 2014 proposal to legislate on minimum wages in all eu member states, ‘denmark: heated debate about introducing minimum wage | eurofound’ <https://www.eurofound.europa.eu/publications/article/2015/denmark-heateddebate-about-introducing-minimum-wage> accessed 20 august 2018. 25 this has been the model of implementation since 2001, where denmark passed supplementing statutory legislation to implement directive 97/81 concerning the framework agreement on part-time work. 26 kristiansen (n 9) 40; the members of the signing organizations can be seen as ‘partakers’ rather than ‘parties’ given the very limited right to supplement or deviate from the agreement they are bound by through their membership of the organisation. hasselbalch (n 9) 58. 27 if the employer is not a member of an employer organization, the employer can accede to the industry wide agreement by concluding an adoption agreement with a national trade union party to such an industry wide agreement. 28 hasselbalch (n 9) 60. 29 for some groups of employees, the legislators have provided, that pay and working conditions must abide by the standards in the agreements concluded by the ‘most representative’ associations in denmark. this is the case for e.g. posted workers, taxidrivers, and apprentices. platform work and the danish model 124 jurisdiction of the labour court and the lawfulness of collective action.30 this section gives an overview of the general principles for assessing employee status as the basic foundation for the assessment at the individual level. there is no uniform statutory definition of what constitutes an ‘employee’.31 the question of whether at person is entitled to certain rights as an employee is assessed according to the specific scope and definition provided in the relevant legal basis compared to the particularities of the relationship in casu.32 the sui generis definition of the term ‘employee’ would be ‘a person receiving remuneration for personal work in a service relationship’.33 general principles of what is characteristic for an employment relationship has been derived from case law. most notably, the status agreed to by the parties themselves is indicative but not decisive. the danish approach is functional, based on the social realities of the relationship between the parties.34 first, and often most prevalent, is the degree of the right of the employer to make decisions in the contractual relationship and the duty of the employee to follow such directives. in platform work, this would concern instructions on how the work is to be performed, a right to control the work, and a duty of the service provider to report to the platform. second important feature is the economic arrangement between the parties, in particular how the remuneration is calculated and paid. it is characteristic of an employment relationship that the employee receives set remunerations calculated on the basis of time or results. the employee typically does not bear the risk of the success of the work, and likewise does not benefit from surplus. an employee typically does not bear the costs related to the work, such as materials. it is characteristic of self-employment to pay for an office/workshop, materials, tools, and to pay sales tax, etc. third, a duty to perform the work personally is typical of an employment relationship. fourth, the degree of connectedness between the parties, such as the length of the work, the intensity of the contractual relationship, and whether the contract supplies the main or supplementing income for the worker. fifth, the social perception of the relationship, i.e. whether the worker in relation to the social perception and to his occupational position is similar to an ordinary employee.35 none of these elements are decisive in themselves, and the court will 30 ole hasselbalch, ’arbejdsretten’, iii, 1.2.2., <http://arbejdsretu.lovportaler.dk/> accessed 20 august 2018. 31 jens kristiansen, ‘the concept of employee: the position in denmark’, in bernd waas and guus heerma von voss (eds.), restatement of labour law in europe, volume i, the concept of employee, hart 2017. 32 hasselbalch (n 30) iii, 1. 33 kristiansen (n 31), 135, statutory act no 240 of 17/03/2010 on a written statement, s 1(2). 34 hasselbalch (n 30) iii, 1. 35 hasselbalch (n 30) iii, 1. njcl 2018/1 125 carry out the assessment based on all the circumstances of each specific case. the notion of employee is not constant, and legislation as well as case law take into consideration aspects outside the relationship between the employer and the employee. this is the case for legislation with an underlying health or social security purpose,36, statutory acts based on eu-directives which must be applied in conformity with the underlying eu directive and cjeu case law,37 and legislation counteracting risks of abuse.38 so far, no case law has emerged in danish labour law specifically assessing the employment status of service providers under digital platforms. however, it is very likely that, depending on the specific setup of the individual platform business, the degree of influence on setting the prices, the degree of instructions as to how to carry out the work or on personal conduct when providing services, the degree of managerial powers delegated to the platform provider or its algorithm, the degree of elements of the algorithm influencing the economic foundation for the earnings, would render that the relationship could be assessed more characteristic of employment than of self-employed. even if the classification of a person under danish law would be as self-employed, this cannot exclude a person from being classified as a worker under eu law, and as such being eligible to enjoy rights provided in eu directives.39 in lawrie-blum the court adopted a definition, whereby: ‘the essential feature of an employment relationship [ ] is that for a certain period of time a person performs services for and under the direction of another person in return for which he receives remuneration’40 a key feature of being classified as employee in eu law is the element of subordination to the employer’s directions and the element of performing work for an external entity. a self-employed person under eu-law can choose the type and amount of work and tasks to be 36 e.g. the holiday act, ferieloven, the act on occupational injury insurance, arbejdsskadesikringsloven, the act on sick leave benefits, sygedagpengeloven, the act on unemployment insurance benefits, arbejdsløshedsforsikringsloven, and the act on supplementing pensions payments, atp-loven, hasselbalch (n 30) iii, 1.2.1., 1), and the act on occupational health and safety, arbejdsmiljøloven, hasselbalch (n 30) iii, 1.2.1., 2). 37 e.g. the act on a written statement, ansættelsesbevisloven, the act on equal treatment of men and women in regards to access to employment, ligebehandlingsloven, and the act on non-discrimination in employment, forskelsbehandlingsloven, hasselbalch (n 30) iii, 1.2.1., 2); ole hasselbalch, ‘lønmodtagerbegrebet i eu-retlig kontekst’, (2018) euret og menneskeret, 25, 3. 38 e.g. the act on bankruptcy, konkursloven, and the act on an employees’ remuneration guarantee fund, lov om lønmodtagernes garantifond. 39 on the concept of employee in eu law and danish law, see hasselbalch (n 37). 40 case c-66/85 lawrie-blum [1985, para 17. platform work and the danish model 126 executed and performs work via the organisational entity of his own business. the case law of the cjeu additionally suggests that selfemployed persons can lose their qualification as independent undertakings if the independence of a self-employed person is merely notional, thereby disguising an employment relationship, the cjeu in allonby.41 likewise, if undertakings operate as auxiliary organs forming an integral part of the principal’s undertaking, as promoted in confederación española.42 in fnv43 the court provided that self-employed persons could be ‘fake self-employed’ in that they did not enjoy the freedom typical of self-employed status under each specific contract, see further section 5.1.2. in uber systems spain the court considered uber to primarily be a transport service because of the decisive influence over the conditions for transportation and the conduct of the drivers.44 the court did not take a specific stance on the employment status of the uber-drivers, but the decisive influences strongly indicate a status as employees.45 the court reiterated its view on uber as primarily being a transport service and, accordingly, not an ‘information society service’ in the later uber france sas case.46 4. employee collective bargaining aspects collective agreements are concluded between a collective entity representing employees and an employers’ association or a single employer. the status of service providers via platforms as employees or self-employed with regard to collective agreements presents additional legal thresholds, namely the lawfulness of collective action, the 41 case c-256/01 allonby [2004], para 71. 42 case c-217/05 confederación española de empresarios de estaciones de servicio [2006], para 43 vis-à-vis agents and their principal. 43 case c-413/13 fnv kiem [2014]. 44 case c-434/15 uber systems spain sl [2017], para 39. 45 other jurisdictions have assessed the status of uber-drivers. in the uk, aslam and others v uber b.v. and others, the employment tribunal found an uber driver to be a ‘worker’ for the purpose of the employment rights act 1996, employment tribunals 28.10.2016, 2202551/2015 upheld by employment appeal tribunal 10.11.2017, appeal no. ukeat/0056/17/da. conversely, the australian fair work commission on 21 december 2017 concluded that an uber driver was not an employee and not protected against unfair dismissal. 46 case c-320/16 uber france sas [2018], para 22. similarly, the status of deliveroo drivers/food deliveries in other jurisdictions. the uk central arbitration committee did not consider deliveroo-drivers to be employees, cf tur 1/985(2016), independent workers’ union of great britain (iwgb) v roofoods limited t/a deliveroo, and similarly in italy regarding a similar food delivery service, foodora, cf tribunale ordinario di torino, sentenza n. 778/2018 pubbl. il. 07/05/2018 rg n. 4764/2017; the spanish juzgado de lo social in valencia found deliveroo-drivers to be workers, cf sentencia del juzgado nº 6 de valencia nº 244/2018 de 1 de junio. njcl 2018/1 127 jurisdiction of the labour court, and the lawfulness of agreements concerning remuneration under competition law. 4.1. competition law and platform work the purpose of bargaining pay and working conditions collectively is, inter alia, to restrict the internal competition for jobs between employees, which historically has led to the ‘race to the bottom’. collective agreements in reality restrict competition. in a narrow sense by essentially fixating the labour costs of the employer, as well as indirectly by appointing a specific financial institution as the sole provider of e.g. compulsory occupational pensions.47 in denmark, section 3 of the statutory act on competition, konkurrenceloven48 explicitly provides that the act does not apply to salaries and working conditions. this exemption has been in force since the first act on price agreements in 193649 was continued in the act on monopolies in 1955 amendments50 and is now an essential feature of the competition act. according to the preparatory works, collective agreements are not acts of unilateral price fixing, but are the result of negotiations between two opposing parties pursuing specific interests, where the element of negotiation ensures that the provisions are wellbalanced.51 the social partners pursue social rather than competitive interests.52 the mechanism of collective bargaining ensures societal considerations as well as counteracts abuse of power by the social partners.53 although collective action is invoked with the purpose of applying pressure on the opposite party,54 the mitigating function of the public conciliator and the legal principles developed in case law ensure that such actions remain proportional to the aim of the conflict.55 the legal test for exemption under section 3 is qualitative. if a collective agreement does not regulate salaries and working conditions, the agreement is not exempt from competition law.56 47 ruth nielsen, 'samspillet mellem konkurrenceretten og arbejdsretten', in jens hartig danielsen and others (eds.), festskrift til jens fejø (djøf 2012) 324. 48 statutory act no 155 of 1/3/2018 on competition, 49 statutory act on price agreements, prisaftaleloven, rigsdagstidende 1936-37, 4948. 50 statutory act on supervision regarding monopoly and obstacles to competition, section 2(2), lov om tilsyn med monopol og konkurrencebegrænsninger, no 102 of 31/3/1955, and report of the ministry of industry, ‘fra monopollov til konkurrencelov’, betænkning 1075/1986, 35 and 52. 51 rigsdagstidende 1936-37, 4948 52 hasselbalch (n 30) xxi, 2.2. 53 hasselbalch (n 30) xxi, 2.2 54 collective action can in denmark lawfully be invoked by the workers’ (strikes and blockades) as well as by the employers’ (lockout and boycott) representatives. 55 hasselbalch (n 30) xxi, 2.2 56 hasselbalch (n 30) xxi, 2.2 platform work and the danish model 128 at the eu level, collective agreements are not expressly exempt from the scope of article 101(1) of the treaty of the functioning of the eu (tfeu). the social aim of collective agreements can however outweigh the aim of unrestricted competition, as will be elaborated further below in 4.1.2. 4.1.1. danish competition authorities – case law on atypical employees and collective agreements the case law of the danish competition authorities illustrates that it is possible for collective agreements to fulfil the conditions in section 3 even for self-employed persons, when entering into contracts of business on similar working conditions as regular employees. the term used is indicative but not decisive, and the specifics of the circumstances must be compared to the characteristics of those performing services in permanent employment and to those genuinely self-employed. determining factors are that self-employed workers perform services under the same terms as employees, at the same entity and under the instruction of the employer whilst performing the tasks. likewise, it is taken into consideration whether the agreement provides pay and working conditions typical for the industry, and whether mandatory social security payments were made. this was the case in a ruling in 199357 where the competition appeals tribunal took into account that the use of the term ‘freelance’ indicated that the agreement did not concern ‘pay and working conditions’, the freelance photographers had registered businesses with a duty to pay sales taxes, and the relationship with the media houses with regard to power of instruction and loyalty obligations did not differ significantly from what is often the case in commercial relations. as such, some persons covered by the agreement would in fact be genuinely self-employed, and for these persons the price-list was a violation of the competition act. likewise, in a ruling concerning freelancers from 1999,58 where a ‘guideline’ for pay and working terms was assessed, the term ‘freelance’ was used for any employment contract of less than 6 months, including casual contracts. as the guideline in reality regulated prices for selfemployed, the tribunal stated that the proper mechanism would be to conclude collective agreements. however, freelance journalists providing services on casual contracts cannot be classified as self-employed solely because the assignments are not permanent. as the services of casual freelance journalists had the same characteristics as the services of the permanent employees at the same media houses, the guideline was similar to collective agreement provisions concerning casual work, and was exempt from the competition act. 57 section 70-76 of competition appeals tribunal ruling of 10/9/2003 (n 60). 58 competition appeals tribunal, ruling of 7 april 1999, j. no. 97-218.349. njcl 2018/1 129 in 2003,59 the tribunal assessed the lawfulness of a notice of collective action. the collective action was in support of a claim for a collective agreement providing standard payments for freelance journalists. the dispute concerned whether the notice, using the term freelancers, would cover also self-employed persons and constitute a breach of the competition act. the union argued that the term ‘freelancer’ covered two groups of workers providing services on casual contracts but not genuinely self-employed freelancers. the tribunal returned the case for renewed deliberation without assessing the substance of the case as the notice could unintentionally include genuinely self-employed persons. the case was later withdrawn.60 in 2005,61 the tribunal inter alia62 ruled on fixed prices for veterinary services. a collective agreement provided set hourly rates for meat quality controls63 for employed as well as for substitute veterinarians. the substitute veterinarians providing the services could be employed elsewhere and could also be self-employed. the distinction between salaries and working conditions on the one side, and terms for conducting trade between businesses on the other side, should be carried out comparing the circumstances of the situation to the characteristics of either employment status or self-employed services. the starting point is whether one person is under the instruction of the other party, including a right to dismiss. a duty to pay mandatory contributions to social security measures, such as social pensions, sick leave payments and occupational injury insurance, is also characteristic of employment status. the tribunal stated that the veterinarians were under the instruction of the public authority while providing the services, that payments were paid out as ordinary remuneration, and that the veterinarians accrued holidays with pay and social security contributions. the tribunal also noted that the substitutes performed the work as a supplement to their main occupation. it was significant that during the contracts, the substitute veterinarians provided services under the same working conditions as permanently employed veterinarians. the tribunal regarded the veterinarians as employees during the substitute contracts, 59 competition appeals tribunal ruling of 10/9 2003, j.nr. 02-85.078, j.nr. 02-85.080 og j.nr. 02-85.081 <https://www.kfst.dk/media/14175/20030910-kendelse-tv2danmark-danske-dagblades-forenings-forhandlingsorganisation-og-danskmagasinp.pdf> accessed 20 august 2018. 60 press release 25/2/2004: <https://www.kfst.dk/afgoerelserruling/konkurrenceomraadet/styrelsesafgoerelser/2004/dansk-journalistforbundsvarsling-af-kollektive-kampskridt/> accessed 20 august 2018. 61 ruling of 26 october 2005, j.nr. 3/1120-0301-0374/sek/lob, <https://www.kfst.dk/media/13665/20051026-afgoerelse-praktiserende-dyrlaegersarbejdsgiverforenings-vedtaegter.pdf> accessed 20 august 2018. 62 other questions were assessed. 63 ruling of 2005 (n 62), para 29-34 and 65-77. platform work and the danish model 130 regardless of their main occupation as self-employed, and the agreements were exempt from the competition act. in particular, the choice to compare the circumstances under each contract was innovative and relevant, and an approach that also the cjeu has taken, see 4.1.2. 4.1.2. case law of the court of the justice of the eu article 101(1) in the treaty of the functioning of the eu (tfeu) prohibits all agreements which may prevent, restrict or distort competition within the internal market. agreements determining minimum prices are mentioned as the first example of ‘blacklisted’ measures in article 101(1) tfeu, as they ‘directly or indirectly fix purchase or selling prices or any other trading conditions’. such agreements, fixing minimum prices for an industry, have, in the case law of the cjeu, consistently been considered to entail a significant restriction on competition.64 cjeu case law has, however, exempted agreements regarding salaries and working conditions, which corresponds with the approach in danish competition law.65 in the case of albany, the court assessed whether collective agreements establishing mandatory and exclusive pension funds constituted an unlawful restriction of competition. advocate general jacobs argued that collective agreements are, by their very nature, restrictive of competition, since generally employees cannot offer to work for wages below the agreed minimum.66 in reality, collective agreements probably do not have a notable restrictive effect on the competition between employers.67 the cjeu found it beyond question that certain restrictions of competition are inherent in collective agreements. however, as collective agreements pursue social policy objectives of improving living and working conditions and provide social protection,68 they were not a violation of the provisions in the treaty. the cjeu has on this account accepted that mandatory pensions,69 social security schemes with regard to occupational injuries,70 and insurance with regards to sickness leave,71 are outside the scope of 64 fnv kiem (n 44) opinion ag wahl, paras 35 -36 referring to case c-243/83 binion, para 44. 65 ruth nielsen, ‘kollektive overenskomster og konkurrenceretten’, (2001) ufr 2001b.27. 66 case c-67/96 albany [1999] opinion ag jacobs, para 178. 67 ibid, para 182 in which he points to the labour costs being only one of many production cost factors. 68 case c-67/96 albany [1999], para 59. 69 c-67/96 (n 69); joined cases c-115/97 and c-117/97brentjens’ handelsonderneming bv [1999]: case c-2019/97 drijvende bokken [1999]; joined cases c-180/98 and c184/98 stichting pensioenfonds medische specialisten [2000]. 70 case c-218/00 cisal [2002]. 71 case c-222/98 woude [2000]. njcl 2018/1 131 article 101(1).72 the court takes the view that the social objectives would be seriously undermined if management and labour were subject to article (85(1) (now article 101(1)) of the treaty when seeking jointly to adopt measures to improve conditions of work and employment,73 and that agreements concluded in the context of collective negotiations between management and labour in pursuit of such objectives must be regarded as falling outside the scope of article 85(1) of the treaty.74 however, the exemption is not without limits. in 2004, the european commission pursued the belgian architects’ association for breach of article 101(1) tfeu by adopting a scale of set fees for architects.75 according to the commission, architects are undertakings because they provide services on a long-term basis and for remuneration.76 as a result the fee scale was an independent act by the association of a prescriptive character77 with the object of restricting competition, and the association was imposed a fine of 100.000 euros.78 in a more recent cjeu ruling, fnv from 2014, the court assessed the line between employed or self-employed with regard to selfemployed dutch musicians. a dutch association for self-employed musicians, fnv, concluded a collective agreement with a dutch orchestra’s association, providing fixed minimum fees for self-employed musicians when providing services as substitutes in orchestras.79 the cjeu reiterated the arguments of albany, brentjens and drijvende bokken that self-employed service providers are – in principle – undertakings subject to article 101(1). self-employed persons offer their services for remuneration on the market and in relation to the principal perform their activities as independent economic operators.80 if an association acts in the name of and on behalf of selfemployed service providers, the association does not act as a social partner, but as an association of undertakings.81 such agreements would therefore not be the result of collective bargaining between employers and employees and would not be exempt from the scope of article 101. the treaty encourages dialogue between management and labour in 72 the danish labour court in ruling of 17 november 2000, ar 1996.225, aligned its case law with the rulings of the ecj in albany, brentjens and drijvende bokken, nielsen (n 66) 31. 73 c-115/97 (n 70) para 56. 74 ibid para 57. 75 orde van architecten (commission decision of 24 june 2004), para 1. 76 ibid para 38. 77 ibid para 78. 78 ibid para 138. 79 c-413/13 (n 44) para 6. see also eva grosheide and mark barenberg, ‘minimum fees for the self-employed: a european response to the uber-ized economy’, (2016) 22(2) cjel 194. 80 c-413/13 (n 44) para 27. 81 ibid para 28-30. platform work and the danish model 132 order to improve working conditions; the treaty does not however encourage dialogue between self-employed service providers.82 if an agreement is concluded on behalf of self-employed service providers, it is not a result of negotiations between employers and employees and is not exempt from the scope of article 101 tfeu. if, on the other hand, the self-employed service providers were in fact ‘false self-employed’, that is, if they are service providers in a situation comparable to that of employees,83 agreements concluded on their behalf would be regarded as a result of negotiations between employers and employees. it is not always easy to establish the status of self-employed persons as ‘undertakings’.84 a service provider can lose his status of ‘selfemployed’ if he does not determine his own conduct on the market, is entirely dependent on his principal, does not bear any of the financial or commercial risks, and thus operates as an auxiliary within the principal’s undertaking.85 on the other hand, an essential feature of being an ‘employee’ is that for a certain period of time one person performs services of and under the direction of another person in return for which he receives remuneration.86 according to advocate general wahl, the provisions of the tfeu treaty on ‘employment’ (articles 145 to 150 tfeu) and ‘social policy’ (articles 151 to 161 tfeu) all centre on the notion of the ‘worker’.87 the decisive factor is whether the person acts under the direction of an employer, in particular with regard to his freedom to choose the time, place and content of his work, does not share the employer’s commercial risks, and, for the duration of that relationship, forms an integral part of that employer’s undertaking, forming an economic unit.88 the court stated that in order for the substitute musicians to be classified, not as ‘workers’ but as genuine ‘undertakings’, the national courts must ascertain whether the circumstances are similar to characteristics of ‘workers’ under eu law. particular emphasis should be put on whether the relationship with the orchestra would not be one of subordination under the duration of the contract, e.g. whether the substitutes enjoy more independence and flexibility than employees performing the same activity, when comparing 82 ibid para 29, with reference to joined cases c-180/98 and c-184/98, pavlov and others, para 69. 83 ibid, para 31. 84 ibid, para 32. 85 ibid, para 33 86 ibid, para 34, with reference to recent cases of c-46/12 n, para 40, and c-270/13 haralambidis, para 28. 87 c-413/13 (n 44) paras 36-40. 88 ibid, para 36, referring to cases c-256/01, allonby, para 72; c-3/87, agegate, para 36; and c-22/98, becu and others, para 26. njcl 2018/1 133 the determination of working hours, the place and manner of performing the tasks assigned, i.e. the rehearsals and concerts.89 notably, the court used the criteria established in case law for losing status as an ‘undertaking’, i.e. not having the independence and flexibility during the contract’s characteristic of self-employed. the court found that during the performances of the contracts, the selfemployed musicians were in fact in a comparable situation to the employees, as the self-employed musicians did not enjoy more freedom during the contracts compared to the employed musicians, but would be under instructions as to the time, place and manner of performing music alongside the employed musicians. the court introduced the notion ‘false independent’ for self-employed persons providing services in a situation comparable to ‘workers’. it could be questioned if the court, by introducing the concept of ‘false self-employed’, meant to introduce a new category or a third category in between the status as employee or self-employed undertaking. similarly, whether the court intended to prevent abusive misclassifications by promoting a realist assessment of the binary divide as seen in previous cases.90 the realist mode of interpretation prescribed puts much emphasis on determining whether the service provider is a subordinate of the employer. in the case of fnv this would be sufficiently fulfilled by comparing the independence or subordination of the substitutes whilst performing one single contract of service as a musician. whether or not the substitutes were genuinely independent in other contracts or in between orchestra contracts was not assessed and could be viewed as having no relevance to the assessment of whether they had lost their full status as an ‘undertaking’ in relation to this one type of contract, and as such on the classification of the provisions in the collective agreement applying to the substitutes. from the case law of denmark and the cjeu, collective agreements could be accepted for persons providing services via digital platforms as not being in violation of competition law, as the relationship during the performance of the contracts would be viewed as most similar to employment, which is the approach of danish law, or most dissimilar to genuine self-employment, which is the most recent approach of the cjeu. the term used to denote the service provider or the contractual basis as casual is indicative but not decisive. even unilaterally issued guidelines and recommendations that are not the result of a collective bargaining process could be exempt from 89 c-413/13 (n 44), para 37. the national court of appeals of the hague determined, that the self-employed substitutes were in fact ‘false self-employed’ and that the stipulation of minimum fees fell ‘by reason of its nature and purpose’ outside the scope of article 101(1) tfeu, grosheide and barenberg (n 80), 223. 90 grosheide and barenberg (n 80) 224. platform work and the danish model 134 the danish competition act. insofar as the content reflects negotiated provisions in agreements and insofar as the working conditions are exactly the same as those covered by the existing agreements, such unilateral recommendations would not constitute a risk of abuse or violations of danish competition law. the status under eu law of unilateral recommendations is more uncertain. eu competition law has room for allowing collective agreements to be negotiated for workers in atypical employment relationships as long as the collective agreement pursues a social purpose and has a collective entity representing employees on the employee side. danish competition law as well as recent eu case law on article 101(1) tfeu allow the assessment of the classification of the relationship to be performed on one single contract of work, emphasising the degree of flexibility and independence during the contract compared to employed persons performing the same work. in this sense, it would be likely to find examples of service providers via platforms who provide services on limited contracts, and where for the duration of the contract the service provider would be in a situation of subordination in particular regarding the time, place and manner of work, as soon as the contract terms have been accepted by the self-employed person. this could be the case when a platform worker has accepted an offer of e.g. cleaning, and the cleaning must be performed at the time, place and in a manner adhering to training or directions set out by the platform provider. some platform workers could also very likely – as highlighted in the fnv case – be viewed as not taking a commercial risk, but instead becoming an auxiliary to the principal, an integral part of the platform’s undertaking. 4.2. lawfulness of strike and secondary action the status of the service providers as employees or self-employed also influences the lawfulness of collective action under danish collective labour law. in denmark, a social partner can demand that an employer enters into a collective agreement, and this can be supported by way of collective action. one of the prerequisites for lawful collective action91 is that the social partner has a reasonable interest in concluding an agreement with the specific employer for the specific type of work. this entails that the entity has employees who perform the type of work covered by the agreement or by the social partner demanding the agreement.92 in 2007,93 the labour court assessed the lawfulness of collective action in support of a collective agreement for freelance journalists. the 91 hasselbalch (n 30) xxi, 2.4., labour law in denmark (n 9) 257-263 and lønmodtagerbegrebet i eu-retlig kontekst (n 37). 92 hasselbalch (n 30), xxi, 2.4. 93 labour court ruling of 24 august 2007, a2007.293. njcl 2018/1 135 dispute hinged on the employment status of freelance journalists providing services to the employer. the freelance journalists performed work of the same character, under the same working conditions and with the same remuneration as permanently employed journalists. the media houses receiving the services withheld taxes on behalf of the freelancers, some freelance assignments were partly permanent and editors could adjust the materials delivered by freelancers. the labour court, referring to the ruling of 1999 of the competition tribunal,94 stated that freelancers are not considered self-employed persons solely based on the services being provided as individual assignments. when the service is provided on terms that are more characteristic of employees than of selfemployed persons, this is a basis for negotiating pay and working conditions for the freelance journalists. the freelance journalists performing casual work thus constituted an interest of the trade union to conclude an agreement for journalists, including freelance journalists. additionally, the labour court stated that secondary action in support of a main conflict for freelance workers could be lawful, and that members of the same trade union could refuse to perform work targeted by the main conflict, so-called ‘strike work’, also when the subjects of the conflict were freelance journalists. finally, the labour court approved a right to engage in collective action for the freelancers performing work on employee-like working terms. the approach of the labour court resembles the approach of the cjeu in the fnv case, and the competition appeals tribunal in the case regarding substitute veterinarians. it would be in line with labour law principles to view persons providing services via digital platforms as employees in the context of providing a basis for an interest to engage in conflict against the platform provider. likewise, it would be in line with principles of labour law to allow for support of the main conflict with secondary actions, and to allow for employees organised in the same trade union to refuse to carry out work targeted by the action, as well as for (organised) service providers to engage in collective action themselves. 4.3. lawfulness of blockade lawful collective action against an employer can also be invoked in the form of a blockade. if the blockade is lawful according to collective labour law principles, the members of the negotiating trade union are obliged to follow such actions. this is the case for strikes as well as for blockades, even when the lawfulness under the competition act is not yet determined. 94 above 4.1.1. platform work and the danish model 136 in a supreme court ruling of 2001,95 a freelance photographer was excluded from the journalists trade union. the union produced new price lists for freelance press photographers. the media houses refused to pay the new prices. the union initiated a blockade, by which photographers were not allowed to deliver materials to media houses until the media houses consented to pay the new prices. one freelance photographer continued to deliver photos to a media house targeted by the blockade. as a consequence, the member was excluded. the court found that the decision to impose a blockade on deliveries was a collective action in support of payments for services. it was of no effect on the validity and the lawfulness of the action under labour law that the action in support of the list could be rendered unlawful under the competition act. this did not give the member reason to believe that his deliveries were exempt from the blockade. the exclusion was upheld. the mechanism of imposing a blockade against an employer also binds freelancers that are members of the same trade union. the duty not to supply services rests on members performing work as employees as well as member performing work as self-employed. collective agreements supported by collective action can only be concluded on behalf of employees. service providers on digital platforms could, however, constitute a legal basis for collective action, as long as the service providers are not genuinely independent businesses but work on terms similar to those of employees. likewise, the mechanism of industrial conflict can be invoked against a platform company using the services of persons that perform work as freelancers but are not genuinely independent businesses. if the main conflict is lawful, secondary conflicts could be invoked, and members of the same unions involved in the conflicts could refuse to perform strike-work. likewise, the freelancers themselves are expected to adhere to a blockade against a company, e.g. a platform company. 4.4. scope of a negotiated agreement when the social partners have negotiated an agreement applicable to employees at an entity, the question arises regarding who at the entity is covered by the agreement. the agreement typically covers only work performed by employees.96 the labour court takes a functional rather than a formalistic approach when assessing whether persons performing work are employees or self-employed. 95 supreme court ruling of 17 october 2001, ufr 2002.82h (first instance eastern high court ruling øld of 15 september 2000). 96 kristiansen (n 14) 237. njcl 2018/1 137 4.4.1. jurisdiction of the labour court the issue surfaced as early as 192297 before the labour court (then permanent industrial tribunal). the dispute concerned the uncertain employment status of milk-distributors, as their remunerations were calculated as payments per litre (milk, cream and butter) and not per hour. the labour court did not assume that the milk-distributors were self-employed persons, despite the remuneration scheme. the milkdistributors were covered by the agreement and the complaint could be assessed by the court. 4.4.2. who is covered in 2010 an industrial arbitration ruling98 assessed which of the freelance journalists working at the entity were covered by the collective agreement for freelancers, and who were on the other hand genuinely self-employed and not covered by the agreement. in his assessment, the arbitrator set a high threshold for persons being assessed as a freelancer working on employment terms. the presumption was that collective agreements cover only employees in a traditional sense. as neither the title of the agreement, nor specific elements during the negotiation process indicated otherwise, the trade union could not establish evidence that the parties had agreed to extend the agreement to freelance journalists working as self-employed, nor to freelance journalists working as atypical self-employed. the arbitrator assessed all the specific circumstances. the decisive element was whether the service providers had gained status as genuinely self-employed, i.e. registered businesses, paying sales taxes, performing and invoicing work under the auspices of the business, advertised their services as a business, used accountants, had several customers, used business contacts, worked from home or from a studio. the amount of work performed for the media company was not decisive. for the applicability of an agreement it is not sufficient to assess the relationship between the employer and the service provider, including the similarities to employment. the assessment also takes into consideration the factual business setup of the self-employed person. for platform work, this assessment would be similarly carried out. the amount of work performed by the individual service providers is not decisive, whereas the specifics of the relationship as well as the business setup of the service providers are. some service providers perform work from an organised business setup, indicative of status as genuinely self-employed and would not be covered by the agreement. other service providers at the same platform, on the same contracts and 97 ruling of the permanent industrial tribunal, ar 642, of 18/12 1922. 98 industrial arbitration ruling of 5 april 2010, case fv 2009.0015. platform work and the danish model 138 performing the same work would have less organised business setups – if any, and would thus be covered by the agreement. 5. first collective agreement for platform work in april 2018, 3f and the digital platform hilfr concluded a collective agreement for cleaners performing cleaning services via the hilfr app. the agreement is valid for 1 year from august 2018 with a view to be renegotiated in 2019 as a 3-year agreement. the parties to the agreement state that this is a first attempt to connect digital platforms with the danish model. the purpose is inter alia to gain experiences from the first agreement with a view to establish more permanent agreements in the future. the agreement is innovative. the agreement applies to ‘employed cleaning assistants’, but not to ‘freelancers’ otherwise associated with the platform. the agreement assigns the cleaners a default status as freelancers for the first 100 hours of services. when a cleaner has performed 100 hours of service, the status automatically changes to one of ‘employee’. from this point on, the agreement starts to apply to the service provider (now employee). the agreement does not preclude the cleaner from choosing ‘employee’status before having provided 100 hours of services, or to retain his/her ‘freelancer’-status after having provided 100 hours of services. this is a major novelty for collective agreements. the agreement provides the workers themselves with an unrestricted choice of being covered or not being covered by the agreement. another novelty is that the agreement provides the worker with an unrestricted choice of status in the relationship with the platform provider, choosing his/her own status as either employee or freelancer. this is not in line with the principles for determining status as employee developed in danish labour and employment law. the platform can refuse a request for ‘employee’-status from cleaners who have worked less than 100 hours if providing a fair and objective reason for such refusal. the standard of fair and objective reasons is well-established in danish labour law and refers to reasons concerned with the conduct of business.99 employed cleaning assistants are entitled to an hourly minimum pay corresponding to the sectoral agreement. the employee is entitled to charge higher hourly rates but not lower. the agreement grants the employee several novel rights: partial payment in case of late cancellation of accepted cleaning jobs, pension contributions paid by hilfr, holidays 99 persons covered by the general agreement between the confederation of danish trade unions and the confederation of danish employers are protected by a standard of reasonableness in dismissals – i.e. a fair and objective reason for dismissal, cf. section 4(2). likewise, a choice not to employ an applicant can be viewed as restricted by the same standard, see e.g. hasselbalch (n 9). njcl 2018/1 139 with pay, sick leave pay, protection against removal of profile (or otherwise making the profile inaccessible) without due cause and only after notice in writing, and an explicit right to daily breaks, and daily and weekly rest periods. the parties agree not to be bound by the provisions in the agreement after the expiry or termination of the agreement. this is likewise novel in danish collective labour law, as it is customary that the employer continues to be obliged to apply the provisions in the agreement until a new agreement has been concluded by the same parties, or until the parties have endured a collective dispute of a certain length and severity.100 6. discussion 6.1. first attempt for agreement for platform workers. choosing to negotiate an agreement specific to platform work builds on the understanding that the service providers would not already be covered by existing agreements. the less innovative and more traditional approach would have been to assess the status of the cleaners according to the normal concept of employee in danish labour law and the case law of the labour court and industrial arbitration, and assess whether the cleaners could in fact be covered by existing collective agreements for cleaners. a strict and more traditional interpretation of the scope for freelance or non-typical employees would be in line with the arbitrator’s assessment of the application of the journalists’ agreement in 2010, above 4.4.2. however, special emphasis was made on the business setup of the self-employed freelancers. in this the cleaners at hilfr would perhaps differ. the trade union adhered to the notion that a special agreement is required. second, the agreement aims at solving a number of issues by adapting certain provisions of working conditions to persons performing work via digital platforms. with regard to these substantial provisions, the agreement constitutes a significant step forward regarding job security, wage standards and social security measures for persons performing work via platforms. classifying the persons as employees and providing the employees with typical workers’ rights and remunerations constitutes a solid step forward and indeed a solution in part. third, giving the employees an unrestricted choice to opt-in or optout of the collective agreement is in conflict with the basic elements of collective labour law. allowing individual derogations of an entire agreement goes against a fundamental feature of collective agreements on the part of the workers’ association – to be binding by nature thereby securing the rights of their members. collective agreements in denmark have mandatory 100 general agreement s 7(2). platform work and the danish model 140 effect; that is, employers and employees bound by a collective agreement are not allowed to reach individual agreements in conflict with the collectively negotiated terms. this is also referred to as the inderogability of collective agreements.101 inderogability prevents individual derogations from, for instance, working time provisions in an agreement, which is in the strong interest of the employee association inter alia because of the imbalance in the bargaining power of the individual employee towards the employer – an imbalance brought back into balance by the collectivity in the collective bargaining.102 the general theoretical approach of asymmetry in bargaining power of the employer and the employee also presents questions as to the element of free choice. putting the worker in a position to individually choose to opt-in or opt-out of the collectively bargained provisions could be viewed with some scepticism. traditionally, such options are frowned upon, as they allow the employer to exercise coercion on the worker, to opt-out of the binding collective provisions and instead negotiate individually, in a setting of implied stronger bargaining power by the employer. this sincerely questions the element of ‘free choice’ of the worker agreeing to provisions negotiated individually and in the interest of the employer. this debate has surfaced in denmark in recent times. in 2002, the part-time act, deltidsloven,103 was amended to provide a legal basis for the employer and employee to agree to a part-time working arrangement, allowing such individual agreement to overrule any limitations in collective agreements. the amendment was intensely debated in the parliament labour market committee, arbejdsmarkedsudvalget.104 the notion of ‘voluntarily’ agreeing to part-time work was heavily criticised. the critics stated that the option to individually agree on terms counter to terms collectively negotiated ‘removes the protection of the worker from the collective agreement, and the employer becomes the stronger party’. the critics also 101 jonas malmberg, ‘the collective agreement as an instrument for regulation of wages and employment conditions’, diva (stockholm institute for scandinavian law 2002) 199 <http://urn.kb.se/resolve?urn=urn:nbn:se:uu:diva-124492> accessed 20 august 2018; lord wedderburn, 'inderogability, collective agreements, and community law', 1992 ilj 21 4, 245. 102 see arbitration tribunal decision of 19 november 1998, where the chairperson ruled that the members of the employee organization could not derogate from the provisions on working time in the applicable collective agreement due to the protective incentive of the provisions. the collective interest of the employee organization could even limit the individual members’ freedom of action for the same reason. 103 stautory act no 815 af 26/9/2002 on part-time work. 104 52 consultation reports were received by the committee, 79 deputations visited the committee, and the committee asked the minister of employment 210 questions during the deliberations cf reports of the parliament labour market committee, ‘betænkning af den 8/5/2002 over forslag til lov om ændring af lov om gennemførelse af deltidsdirektivet, betænkning af 25/5/2002’ and ‘betænkning af 29/5/2002’. njcl 2018/1 141 maintained that the proposal allowed the employer to force the individual employee into a part-time agreement, with a reduction of wages as a consequence.105 the political compromise in 2002 was to establish two conditions for the admissibility of part-time agreements contrary to collective agreements: 1) part-time work can only be agreed to during the employment relationship, not upon employment,106 and 2) provisions in collective agreements requiring a minimum of 15 hours of work per week must be respected.107 the free choice of application is novel and surprising. the worker’s association is bound by the collective agreement and cannot enforce the provisions of the agreement if their members have chosen to opt out of the agreement. however, if a member, despite choosing to opt out of the employee status, would in fact be regarded as an employee under eu law108 concerning, for instance, a right to protection against discrimination on grounds of race, or a right to equal pay, the collective agreement cannot preclude the employee her right to invoke inter alia a right to equal pay or a compensation for direct discrimination. the agreement does not frame the 100 hours threshold into a stipulated period of, for instance, two months. a freelancer meeting the threshold after a long period of, for instance 10 months, has only had 12 hours a month work through the platform on average, and will from that point on be regarded as an employee with regards to the agreement. conversely, a freelancer opting in or automatically receiving status as employee with a right to minimum pay under the agreement can result in a breach of the competition act, if the freelancer is genuinely selfemployed. self-employed persons collectively establishing agreements regarding their fees have been deemed cartels by the cjeu as well as by national courts.109 questions that arise are: what is considered fair and objective reasons for dismissing workers for putting forth a request to become employees? how will the duty of not undermining the agreement play out for the platform? how will the provision on allowing the agreement to be terminated without a new agreement and without a termination 105 betænkning af 8/5/2002 (n 104), statement by the minority. 106 the part-time act s 4a(1). 107 the part-time act s 4a(1). 108 the definition of worker in art. 45 tfeu is used in the case law of the ecj to determine who is considered as a worker, when applying eu directives in the social field, such as directives on; working time, case c-428/09 isère; collective redundancies, case c-229/14 balkaya; equality/non-discrimination in employment, case c-432/14 o. in other directives it is left to the member state to define in accordance with national law and practice, provided the definitions respect the purpose of the directive and the effectiveness of eu law, such as the framework agreement on part-time work; case c393/10 o´brien; hasselbalch (n 37). 109 grosheide and haar (n 7) 1. platform work and the danish model 142 conflict be interpreted by the parties given its conflict with the procedure set out in section 9 of the act on a labour court? how will the workers react when the initiative is placed with them for being freelance, not covered by the agreement, or being an employee, covered by the agreement, and what is the legal framework for coercion by the platform by way of other means than dismissal? and how will the fixed threshold of 100 hours be interpreted as this is not in accordance with the principles developed in labour law nor in competition law? how are the 100 hours calculated – can a service provider fall out of the scope of the agreement again, e.g. if having been on leave or travelling and starting over, and how will any remunerations, pensions and holiday payments in this case be calculated? which hours count towards the 100 hours, how about jobs that have not been concluded satisfactorily, or where the user made last-minute-cancellations? can the service provider change his/her mind, and opt-in/opt-out at will? could the parties agree on a partial opt-in/opt-out and thus choose to apply some of the provisions, but not others? the trial agreement is a remarkable attempt at resolving the difficult relationship between the binary divide and platform work and is novel as it introduces innovative features from a danish collective labour law perspective. the effects remain to be seen, i.e. the purpose of concluding the agreement as a trial agreement. 6.2. platform work and competition law. although the ruling of fnv was a novelty in eu competition law, platform work may not be entirely compatible with the facts in the fnv case. most notably, service providers via platforms will most often not perform services alongside permanently employed persons performing the same job. on the other hand, the work performed and the conditions for performing the work to a large extent resembles normal cleaning assistant work elsewhere in the industry. the elements of having the liberty to arrange their own working hours and the liberty to accept or decline jobs offered, are not similar to employees in comparable employments as cleaners. some elements are worth looking further into. in the freelance journalists’ cases of the tribunal, the tribunal looked to the cause for not being covered by a collective agreement. in the competition cases, the tribunal stated that the element of the media house being covered by a collective agreement or not, was an element outside the control of the freelance journalist, and in itself could not render that the employment status changed according to features related to the recipient of the services, when all other aspects were the same, including the setup of the freelance journalists. the same applies in the case of platform work. the cause for the service provider to be self-employed in this context is primarily controlled by the employer. the contractual setup as self-employed is the choice of the employer, not of the service provider, njcl 2018/1 143 unless in the situations where the service provider has chosen a setup as genuinely self-employed. this element of the choice being outside the control of the service provider could likewise play a role in assessing whether collective agreements concluded for persons perhaps selfemployed perhaps employees would be assessed as providing pay and working conditions in line with section 3 of the competition act. one final argument to be explored is whether it could be said that an association of workers is still considered a social partner when negotiating a collective agreement and bargaining for minimum fees for genuinely self-employed persons, if the association is acting solely in the interest of its own members, the employees. the objective of the negotiations of the association for the genuinely self-employed would be to prevent ‘social dumping’ or in other terms prevent a ‘race to the bottom’.110 in her opinion to the fnv case, ag wahl made a compelling argument for the exemption to article 101(1) tfeu to also include such agreements by applying a perspective on the social policy objectives of collective bargaining.111 she argued that the elimination of wage competition between workers — the raison d’être for collective bargaining — implies that an employer under no circumstances can hire other workers for a salary below the one set out in the collective agreement. on that basis, and from the perspective of a worker, why should there be a difference if she is replaced by a less costly worker or by a less costly self-employed person. according to ag wahl, preventing social dumping is an objective that can be legitimately pursued by a collective agreement containing rules affecting self-employed persons and that it may also constitute one of the core subjects of negotiation. further, she points out, that in the laval case, the court accepted that the right to take collective action for the protection of the workers of the member state against possible social dumping may constitute an overriding reason of public interest within the meaning of the case-law of the court which, in principle, justifies a restriction of one of the fundamental freedoms guaranteed by the treaty.112 there still seems to be avenues of pursuit available for the trade unions to aim at concluding collective agreements with the digital platform providers on behalf of their service providers. the outer limits are set by competition law, eu labour law and danish labour law that the worker must not be genuinely self-employed. for collective bargaining to be lawful under danish law, selfemployed persons providing services on terms more similar to those characteristic of employees than of self-employed would form the basis for a recognised interest for trade unions to initiate demands for a 110 grosheide and barenberg (n 80) 224. 111 c-413/13 (n 44) paras 74-79. 112 case c-341/05 laval un partneri ltd [2007], para 103. platform work and the danish model 144 collective agreement to be concluded, including by way of collective action. likewise, all collective action remedies could be put into play when supporting a demand for collective agreement, also for those in less than typical employment. finally, the element of combatting social dumping by concluding collective agreements for all persons performing work within the sector, including those working on less than typical employee terms, could be used as leverage in order to fulfil the criteria for not being in breach of competition law in the eu and in denmark, as well as for abiding by the requirements of recognised interest established under danish collective labour law. platform work and the danish model are not inherently incompatible, regardless of the contractual terms of ‘self-employed’ or the setup of many small contracts of service. labour law as well as competition law from the cjeu and national courts provide appropriate, clear and specific legal principles that can be put into practice when approaching the issues concerned with platform work in the context of the danish model. this would perhaps give leverage to negotiating the next generation of collective agreements applicable to persons providing services via digital platforms, as existing principles would bring the agreements some way, and this could perhaps moderate the urgency for inventing brand new solutions on all accounts. 6.3. platform work and flexicurity. flexicurity and collective bargaining are key components of the danish welfare model. flexicurity consists of three elements: flexible labour laws allowing employers flexibility in terminating employment relationships, generous state-financed unemployment benefits securing a basic income for workers during periods of unemployment, and an active labour market policy inter alia promoting and financing acquiring skills and education to meet the changing needs of the market.113 113 for more on the flexicurity model see: christian lyhne ibsen and mikkel mailand, ‘striking a balance? flexibility and security in collective bargaining’ (2010) 32 economic and industrial democracy 161; henning jørgensen and per kongshøj madsen, flexicurity and beyond: finding a new agenda for the european social model (djøf 2007) <http://vbn.aau.dk/en/publications/flexicurity-and-beyond(ff3ac5f0-4fe1-11dca457-000ea68e967b)/export.html> accessed 20 august 2018; per kongshøj madsen, ‘flexicurity towards a set of common principles?’ (2007) 23 ijcllir 525; thomas bredaard and flemming larsen, 'external and internal flexicurity: comparing denmark and japan' (2010) 31 cllpj 745. on alleged detriments of the flexicurity system in light of crisis, see e.g. henning joergensen, 'danish "flexicurity" in crisis or just stresstested by the crisis?' report to the friedrich ebert foundation, october 2010; werner eichhorst, veronica escudero, paul marx and steven tobin, ‘the impact of the crisis on employment and the role of labour market institutions’ (2010) international institute for labour studies, 29. njcl 2018/1 145 the possibility of completing collective agreements for workers is the primary and preferred tool for ensuring proper working conditions for workers in all industries in denmark. moreover, the agreements provide a level of protection against arbitrary dismissals, thus moderating the ‘flexible’ part of the flexicurity model. the agreements also provide a certain minimum level salary which is necessary in order to be eligible for social security benefits, when out of employment. the criteria for being eligible for social security payments in times of unemployment, sickness, retirement or other types of supported leaves from active employment should be a smooth fit, in order to ensure easy transition and an efficient ‘security’ part of flexicurity. in the current realities of an increased fragmentation in career paths and in employment, updating the legal criteria for eligibility for benefits to constitute a proper fit has been on the agenda of the social partners as well as the government lately. the first initiative was the amendment to the regulation on unemployment payments,114 where several types of work now can count towards the working hours thresholds for becoming eligible for social security payments. the blurred lines between what constitutes work as employee or work as self-employed could be set straight by collective agreements for platform workers, whereas with the current agreement, this is not entirely clear yet. there is still some way to go for the social partners and the platform providers to meet and negotiate proper pay and working conditions for the persons who are not genuinely self-employed. the algorithms and digital apps are new tools enabling new, fast and extended ways of creating contact, exchanging services and creating a basis for business, whereas the service of personal labour remains more or less the same. 114 statutory act no 1670 of 26/12/2017 amending the act on unemployment insurance; on the calculations, <https://www.information.dk/debat/2018/01/nyedagpengesystem-fyldt-faelder-folk-smaajobs>. 1 corporate social responsibility and international investment law: tension and reconciliation ying zhu* * j.s.d. candidate, yale law school. the author would like to thank vibe garf ulfbeck, katerina mitkidis, alexandra horváthová, james tierney, sam leander, and participants in the international conference on “to pursue or not to pursue csr goals legal risks and liabilities” hosted by university of copenhagen faculty of law, for their helpful comments and suggestions. i am grateful to the oscar m. ruebhausen fund for the financial support of this research. all errors are of course my own. njcl 2017/1 91 1. introduction ..................................................................................... 92 2. investor protection vs. investor responsibilities: the evolution of the tension between iil and csr ........ 94 3. the right to regulate csr and international investment obligations ................................................................ 97 3.1. non-discrimination .............................................................. 97 3.2. fair and equitable treatment ..................................... 102 3.3. indirect expropriation .................................................... 105 4. the obligations to regulate csr? incorporating csr standards into investment treaties .................................... 109 4.1. balancing investor rights and social interests in investment treaties .......................................................... 109 4.2. incorporating csr standards into investment treaties .................................................................................. 111 4.2.1. canada ......................................................................... 111 4.2.2. the eu .......................................................................... 115 4.3. challenges of interpreting and enforcing csr provisions in investment treaties .............................. 117 5. conclusion ....................................................................................... 119 csr and international investment law 92 abstract a host state’s pursuance of corporate social responsibility (csr) goals may lead to a violation of international investment law (iil). this tension results from the imbalance between international economic regulation and social regulation of foreign investments. the paper explores the tension between iil and csr, analyses the recent practice of reconciling the tension through incorporating csr provisions into investment treaties, and proposes to solve the tension through a more balanced interpretation of substantive obligations in international investment arbitration. the host state’s regulation of foreign investments to promote their social and environmental responsibilities may violate iil in three aspects: first, the host state may violate the non-discrimination principle by differentiating between foreign investments having different social and environmental impacts. second, the host state may violate the fair and equitable treatment (fet) standard if the regulation on csr issues has frustrated foreign corporations’ legitimate expectations at the time of investment. third, the regulation in pursuit of csr taken by the host state may constitute indirect expropriation if the measure has substantially deprived the value of foreign investments. as a response to these tensions, recent years have seen a new approach taken by canada, brazil and the eu of incorporating csr provisions to investment treaties. nonetheless, the effectiveness of these csr provisions is questionable, as a result of the traditional role of foreign investors as third-party beneficiaries in investment treaties, the ‘soft law’ nature of csr norms, and the unclear definition of csr in these provisions. in conclusion, the paper proposes to harmonise the host state’s pursuance of csr goals and iil obligations by making a balanced interpretation of international investment obligations: first, in the discrimination assessment, the tribunal should take account of noneconomic factors of foreign investments in the determination of whether two investors suffering different treatments are ‘in like circumstances’, and should allow differentiation between investors to be justified by a legitimate csr policy. second, in the fet examination, the tribunal should strike a balance between the stability requirement under the fet standard and the evolving nature of the host state’s regulation on csr issues. third, in the expropriation analysis, the tribunal should take account of the host state’s sovereign right to regulate csr in the assessment of whether a csr measure constitutes indirect expropriation. 1. introduction the growth of multinational enterprises (mnes) in the past century has prompted international regulation of mnes in two dimensions. in the economic dimension, mnes are leading drivers of foreign direct investments (fdi) which can stimulate economic developments in both njcl 2017/1 93 home and host states.1 considering fdi as an economic motivational force, and maintaining awareness of the political risk faced by foreign investors in overseas investments, the international community has constructed the international investment law (iil) regime to protect foreign investments.2 today, this regime consists of 3304 international investment agreements (iias), including 2946 bilateral investment treaties (bits) and 358 treaties with investment provisions.3 these investment treaties contain substantive provisions that oblige host states to provide foreign investors non-discriminatory treatment, fair and equitable treatment, and adequate compensation in case of expropriation. they also include an investor-state dispute settlement mechanism (isds) that allows foreign investors to bring claims against host states before international arbitral tribunals. the social dimension of mne regulation is a different story. the increasing global recognition of the role of mnes in the protection of the social welfare of the host state, including labour rights, human rights, environmental protection and anti-corruption, has lent impetus to a corporate social responsibility (csr) movement.4 unlike iil, which restrains the host state’s intervention in the activities of foreign investors, the csr movement promotes the regulation of the private sector to protect social and environmental interests. such regulation on csr issues, in a broad sense, consists of two kinds of rules: on the one hand, a series of soft initiatives have been drafted in the international and national levels to encourage businesses to take voluntary actions above legal requirements for societal goods.5 on the other hand, states have enacted hard rules enforcing social and environmental responsibilities of corporations 1 r. doak bishop, james crawford, and william michael reisman, foreign investment disputes: cases, materials, and commentary (kluwer law international 2005) 7. 2 josé e. alvarez, the public international law regime governing international investment (brill 2011) 13-30. 3 unctad, world investment report 2016, investor nationality: policy challenges (2016) 101 <http://unctad.org/en/publicationslibrary/wir2016_en.pdf> accessed 27 march 2017. 4 alice de jonge, transnational corporations and international law: accountability in the global business environment (edward elgar publishing 2011) 1-2. 5 in the international realm, a series of international standards for corporate responsibility have been developed, including global reporting initiative, un global compact, ilo tripartite declaration, oecd guidelines for multinational enterprises, iso standards and the un guiding principles on business and human rights. in the national realm, recent years have seen the evolution of csr from a voluntary business-led concept to a public policy that calls for governmental regulation. see, e.g. federal ministry of labour and social affairs, csr made in germany (2012) 8 <http://download. diplo.de/new_delhi/csr-made-in-germany.pdf> accessed 27 march 2017; atle midttun, et al. ‘public policies for corporate social responsibility in four nordic countries: harmony of goals and conflict of means’ (2015) 54.4 business & society 464, 473-480. csr and international investment law 94 through domestic legislation and administration.6 these hard rules on csr issues have been in tension with states’ international investment obligations as a result of their adverse impacts on foreign investments, while the soft csr initiatives, in the recent years, have been incorporated into investment treaties to reconcile this tension. this paper explores the tension between csr and iil, and examines the approaches to reconcile this tension. part 2 of the paper addresses the evolution of the tension between the csr movement and iil. part 3 illustrates three specific tensions between the host state’s regulation on csr issues and their international investment obligations, including nondiscrimination, fair and equitable treatment and no expropriation without adequate compensation. part 4 analyses the recent practice taken by canada, brazil and the eu to incorporate soft csr standards to investment treaties, and examines whether this new approach is effective to reconcile the aforementioned tension between iil and csr regulation by the host states. part 5 concludes that a better balance between investor protection and investor responsibilities should be struck in international investment arbitration. 2. investor protection vs. investor responsibilities: the evolution of the tension between iil and csr prior to wwii, both the international investment regime and the notion of social responsibilities of corporations were at early stages and had little interaction with each other. the substantive obligations employed by bilateral and multilateral investment treaties in the contemporary world originate from the legal terms in bilateral treaties of ‘friendship, commerce and navigation’ (fcn) concluded in the colonial era.7 the fcn treaties oblige one party to provide ‘special protection’ or ‘full and perfect protection’ to the property of nationals of the other party in its territories and oblige the parties to provide national treatment and most-favoured nation (mfn) treatment and to pay compensation in case of expropriation.8 these substantive obligations in the fcn treaties were drafted to serve the policy of protection of overseas investments, with no attention paid to the social benefits of the host countries. although the awareness of corporate’s responsibilities to society can date back to the longstanding 6 the narrow view of csr as purely voluntary norms has been criticized by some commentators for its misunderstanding of the relationship between csr and law. see, e.g. jennifer a. zerk, ‘multinationals and corporate social responsibility: limitations and opportunities in international law’ (vol. 48, cup 2006) 29-42. 7 rudolf dolzer and christoph schreuer, principles of international investment law (2nd edn, oup 2012) 6. 8 kenneth j. vandevelde, ‘a brief history of international investment agreements’ (2005) 12 uc davis j. int'l l. & pol'y 157, 159. njcl 2017/1 95 debate about the relationship between business and society since the industrial revolution in 1800s, the notion of csr was in the ‘philanthropic’ era, in which companies viewed their social contributions more as donations to charities than anything else.9 moreover, the corporate responsibility at that time was viewed as a domestic issue within certain civilised countries and had not yet risen to a global problem.10 the boom of foreign investments after the second world war called for global regulation in two dimensions: in the economic dimension, there was a demand, especially by developed countries, for a stronger mechanism at the international level to protect these investments. from the 1950s to the 1970s, european countries, pioneered by germany, began to conclude bilateral investment treaties to protect overseas investments.11 this practice was joined by the us in the 1970s and by china in the 1980s.12 moreover, the creation of the international centre for settlement of investment disputes (icsid), an investor-state dispute settlement mechanism, in 1965 marked a major innovation in investment protection. in the social dimension, the development of foreign investments had brought global awareness of the significant social impacts of multinationals in host states, especially in developing countries. in response, a series of international instruments were drawn up to provide global codes of conduct for mnes, such as the united nations draft code for transnational corporations,13 the tripartite declaration of principles concerning multinational enterprises and social policy (ilo tripartite declaration), 14 and the oecd guidelines for multinational 9 archie b. carroll, ‘a history of corporate social responsibility: concepts and practices’ in andrew crane (ed) the oxford handbook of corporate social responsibility (oup 2008) 21. rhys jenkins, ‘globalization, corporate social responsibility and poverty’ (2005) 81.3 international affairs 525, 526. 10 for the early development of csr notion in the uk and the us, see jenkins (n 9) and carroll (n 9) 21-24. 11 dolzer and schreuer (n 7) 6-7. vandevelde (n 8) 169-70. 12 ibid. 13 from 1974 to 1990, the united nations drafted a series of codes to regulate the behaviour of transnational corporations. the last draft in 1990 stressed the need for foreign investors to obey the law of the host state, to follow the host state’s economic policies and to refrain from interfering in the host state’s domestic political affairs. however, the draft codes were never adopted. draft united nations code of conduct for transnational corporations, un doc. e/1990/94 (1990). see also de jonge (n 4) 29. 14 in 1977, the international labour organization (ilo) adopted the tripartite declaration of principles concerning multinational enterprises and social policy. the ilo tripartite declaration, as a voluntary and non-binding instrument, provides standards for employment, training, conditions of work and life, and industrial relations. international labour organization, tripartite declaration of principles concerning multinational enterprises and social policy (1977) 17 ilm 422 (1978). the ilo tripartite declaration was revised in 2000, 2002, 2006 and 2017. csr and international investment law 96 enterprises (oecd guidelines).15 compared with investment treaties, these international instruments are of a voluntary nature and lack effective enforcement mechanisms. a fierce confrontation between investment protection and the regulation of investors' social responsibilities took place during the negotiation for the multilateral agreement on investment (mai) in the 1990s. the draft mai, negotiated under the auspices of the oecd, was crafted as an investment protection and promotion agreement based on earlier models of investment protection standards.16 the ngo community had criticised the one-sided nature of the draft mai due to its inclusion of only provisions on investor protection, without any regulation of the investor’s social responsibilities.17 upon the extensive campaign by ngos, some general provisions on labour and environmental standards were incorporated into the preamble of the draft mai, and some quid pro quo clauses, including an additional labour and environment clause and a ‘no lowering of standards’ clause, were proposed during the drafting processes.18 although the negotiations of the mai broke down in 1998 and the draft was never adopted, the success of including environment and labour issues into the draft has contributed to future reconciliation between investor protection and investor regulation under the international investment regime.19 since the 1990s, the tension between investment protection and the enhancement of investors’ social responsibilities has increased as a result of the proliferation of investment arbitration cases in which foreign investors have claimed their investment treaty rights against the host state’s regulation in the fields of human rights and environmental protection.20 the international investment regime has been criticised for 15 in 1976, the organization for economic co-operation and development (oecd) adopted its guidelines for multinational enterprises. the guidelines covered a variety of enterprise activities, including general policies of operation, disclosure of information, competition, financing, taxation, employment, industrial relations, science and technology. however, like the ilo tripartite declaration, the guidelines were ‘voluntary and not legally enforceable’. oecd, ‘oecd guidelines for multilateral enterprises’ (1976) 12-17 <www.oecd.org/corporate/mne/50024800.pdf> accessed 27 march 2017. the most recent version of the guidelines was adopted in 2011 <http://dx.doi.org/10.1787/9789264115415-en> accessed 27 march 2017. 16 peter t. muchlinski, ‘the rise and fall of the multilateral agreement on investment: where now?’ [2000] the international lawyer 1033, 1038. 17 peter muchlinski, ‘corporate social responsibility’ in peter muchlinski, federico ortino, and christoph schreuer (eds), the oxford handbook of international investment law (oup 2008) 642, 642. 18 muchlinski (n 16) 1048. 19 muchlinski (n 17). 20 from 1995 to 2004, the number of claims registered in icsid was four times that of the previous 30 years. by the end of 2016, there have been 696 publicly known investorstate arbitration claims, which involve 107 countries as respondents. gus van harten njcl 2017/1 97 its ‘chilling effect’ on the host state’s right to regulate foreign investments for public interests.21 meanwhile, the rapid development of international csr standards has contributed to the reform of investment treaties.22 in recent years, several countries and regions, including brazil, canada and the eu, have incorporated csr standards and guidelines into their newly concluded investment agreements. the following sections will first analyse the tension between host states’ obligations under investment treaties and their rights to regulate foreign investors’ social responsibilities, and will then examine whether the recent practice of incorporating csr provisions into investment treaties is effective to reconcile this tension. 3. the right to regulate csr and international investment obligations states have sovereign rights to protect society and the environment in its territories from harm by foreign investors.23 nonetheless, their regulation on the social and environmental responsibilities of foreign investors may conflict with their substantive obligations under investment treaties, including the non-discrimination principle, the fair and equitable treatment standard and the compensation requirement for expropriation of foreign investments. 3.1. non-discrimination discrimination is a negative formulation of the principle of equality of treatment in international law, which entails like persons in similar circumstances being treated differently without justifiable grounds.24 the and martin loughlin, ‘investment treaty arbitration as a species of global administrative law’ (2006) 17.1 ejil 121, 124. unctad, ‘world investment report 2016, investor nationality: policy challenges’ (2016) 104. 21 jorge e. viñuales, foreign investment and the environment in international law (vol. 94, cup 2012) 2; nicolas hachez and jan wouters, ‘international investment dispute settlement in the twenty-first century: does the preservation of the public interest require an alternative to the arbitral model?’ in freya baetens (ed), investment law within international law: integrationist perspectives (cup 2013) 417. burke-white, william w. and andreas von staden, ‘private litigation in a public law sphere: the standard of review in investorstate arbitrations’ (2010) 35 yale j intl l. 283; van harten and loughlin (n 20). 22 since 1990s, new soft international instruments have been made to balance business protection against their responsibilities to the social welfare of the host states. see, e.g., the 2000 un global compact, the 2006 un principles for responsible investment, and the 2011 guiding principles on business and human rights. 23 suzanne a. spears, ‘the quest for policy space in a new generation of international investment agreements’ (2010) 13.4 journal of international economic law 1037, 1038. 24 plama consortium ltd v republic of bulgaria [2008] icsid case no. arb/03/24, award [184]; afm maniruzzaman, ‘expropriation of alien property and the principle of nondiscrimination in international law of foreign investment: an overview’ (1998) 8 j. transnat'l l. & pol'y 69, 69. csr and international investment law 98 non-discrimination principle in iil prohibits a host state from unreasonable differentiation between foreign investors and other similar investors. in investment treaties, non-discrimination is mainly reflected in two provisions: the national treatment (nt) provision and the mostfavoured nation treatment (mfn) provision,25 which employ very similar language, except that mfn prevents discriminatory treatment between foreign investors of different nationalities,26 while nt prohibits discrimination between foreign investors and domestic investors.27 investment tribunals conducting discrimination assessment need to first determine whether the investors being treated differently are ‘in like circumstances’. many investment tribunals held that two investors are comparable under the non-discrimination clause if they are in a competitive relationship, i.e., in the ‘same business or economic sector’.28 however, states' regulation on csr issues usually uses a different basis of comparison. for example, it is not uncommon that states' regulation in social and environmental realms may distinguish between different groups of enterprises based on their size and activities. in 2014, the european parliament and the council adopted the directive on disclosure of nonfinancial and diversity information relating to csr issues by large companies and groups.29 the directive only applies to large enterprises 25 christopher dugan, et al., investor-state arbitration (oup 2011) 397. federico ortino, ‘non-discriminatory treatment in investment disputes’ in pm dupuy, f francioni and eu petersmann (eds), human rights in international investment law and arbitration (oup 2009) 346. 26 the mfn clause provides that a foreign investor and its investment should not be treated less favourably compared with the investor or investment in like circumstances from any third country. for example, article 1103 of the nafta provides: ‘each party shall accord to investors of another party treatment no less favourable than that it accords, in like circumstances, to investors of any other party or of a non-party with respect to the establishment, acquisition, expansion, management, conduct, operation, and sale or other disposition of investments.’ north american free trade agreement 1994 [hereinafter nafta], art 1103(1). 27 the nt clause requires that the host state accord a foreign investor and its investments no less favourable treatment than that accorded to its own investor and investments in like circumstances. for instance, article 1102 of the nafta provides: ‘each party shall accord to investors of another party treatment no less favourable than that it accords, in like circumstances, to its own investors with respect to the establishment, acquisition, expansion, management, conduct, operation, and sale or other disposition of investments.’ nafta, art 1102(1). 28 s.d. myers, inc. v government of canada [2000] uncitral, partial award [248], [250]; pope & talbot, inc. v government of canada [2001] uncitral, award on the merits of phase 2 [78]; marvin roy feldman karpa v united mexican states [2002] icsid case no. arb(af)/99/1, award [171]; champion trading company, ameritrade international, inc. v arab republic of egypt [2006] icsid case no. arb/02/9, award [130]. 29 directive 2014/95/eu of the european parliament and the council of 22 october 2014 amending directive 2013/34/eu as regards disclosure of non-financial and diversity information by certain large undertakings and groups [2014] oj l 330/1. njcl 2017/1 99 with more than 500 employees, leaving small and medium-sized enterprises (smes) untouched.30 another common basis of distinction is the activities conducted by enterprises. for instance, highly polluting industries, such as chemical, oil refining and steel industries may face a heavier burden of environmental protection than other less-polluting industries. since sizes and activities of enterprises are not a basis of comparison in the discrimination assessment under iil, a foreign investor may claim that the host state’s measure involving such distinction constitutes discrimination because of its different treatments of investors in the same business or economic sector. a large foreign enterprise, for example, may claim that the aforementioned eu directive is discriminatory, since it has been treated differently from those smes in the same business sector. in parkerings v. lithuania, the host state’s regulation for the protection of cultural heritage was claimed by the foreign investor as a violation of the non-discrimination clause, since the regulation had differentiated between investors based on their sizes. in this case, lithuania rejected the foreign investor’s construction project but permitted another similar project because of the former’s proximity to a culturally and environmentally sensitive old town. the foreign investor argued that lithuania had violated the non-discrimination clause by differentiating between two investors in like circumstances. fortunately, this claim was correctly refused by the tribunal. the tribunal noted that although the two projects had shown obvious similarities, except for their different sizes,31 the potential negative impact of the foreign investor’s project in the old town was increased by its considerable size and by its proximity to the old town, and as a result, the foreign investor’s project ‘was not similar with’ the other comparator.32 other than the tribunals adopting the ‘same business or economic sector’ approach, a small number of tribunals held that investors in different business or economic sectors are also comparable.33 this broad interpretation of likeness makes it possible for foreign investors to claim that the host state’s social or environmental regulation, which makes a distinction between different business sectors, is discriminatory. in arcelor, several steel producers claimed before the european court of justice (ecj) that the european emissions trading directive (established to fulfil the commitments under kyoto protocol) and the french implementing measures violated the equal treatment standard, because the emission trading system was applied to the steel sector, but not to the chemical and 30 ibid. 31 parkerings-compagniet as v. republic of lithuania [2007] icsid case no. arb/05/8, award [381]. 32 ibid [392]. 33 occidental exploration and production company v. the republic of ecuador [2004] lcia case no. un3467, final award [173]. csr and international investment law 100 aluminium sectors, which also produce large emissions of greenhouse gases. the court examined whether the three sectors were in comparable situations. noting that the purpose of the directive was to reduce greenhouse gases emissions, the court held that ‘the different sources of greenhouse gas emissions relating to economic activities are in principle in a comparable situation, since all emissions of greenhouse gases are liable to contribute to dangerous interference with the climate system and all sectors of the economy which emit such gases can contribute to the functioning of the allowance trading scheme’.34 the court also based its conclusion on the text of the directive, stating that ‘policies and measures should be implemented across all sectors of the economy of the union’.35 with respect to the respondent’s argument that these three sectors were not in a competitive relationship, the court objected that, as regards the comparability of the three sectors, ‘the possible existence of competition between those sectors cannot constitute a decisive criterion’.36 for this reason, the court found these sectors to be comparable under the equal treatment clause.37 a more balanced interpretation of ‘in like circumstances’ can be achieved by taking account of not only the business sector of the investments, but also other non-economic factors, such as the investment’s social and environmental impacts in the likeness assessment. the investment agreement for the comesa common investment area has been a pioneer in this respect. article 17(2) of this treaty provides that the references to ‘like circumstances’ in the national treatment clause ‘requires an overall examination on a case by case basis of all the circumstances of an investment including’ ‘its effects on third persons and the local community’ and ‘its effects on the local, regional or national environment, including the cumulative effects of all investments within a jurisdiction on the environment’.38 this interpretation of ‘like circumstances’ will provide guidance for future tribunals assessing the national treatment clause to balance the foreign investor’s right against the host state’s right to protect public interests affected by the foreign investor’s activities. 34 socie ́te ́ arcelor atlantique et lorraine and others v premier ministre and others [2008] case c­127/07, judgment [34]. 35 ibid [35]. 36 ibid [36]. 37 however, the ecj finally held that the eu emissions trading directive did not violate the equal treatment clause, because it was a novel and complex scheme whose implementation could have been disturbed by involving too many participants, and therefore, involving only steel sector as the first step was within the discretion of the community legislature. ibid [60]-[61]. 38 investment agreement for the comesa common investment area, art 17(2) <www.tralac.org/wp-content/blogs.dir/12/files/2011/uploads/investment_ agreement_for_the_ccia.pdf > accessed 1 may 2017. njcl 2017/1 101 another way to achieve such balance is by treating legitimate social or environmental protection objectives as justifiable grounds for discriminatory treatment of foreign investors. however, although almost all the tribunals have acknowledged that a host state’s discriminatory treatment against foreign investors can be justified if such treatment is based on a rational public policy, there is no clear-cut answer among the tribunals with respect to what constitutes a ‘rational’ policy and how the challenged measure should be designed to achieve that policy. in the cases so far decided by investment tribunals, rational public policies have been interpreted broadly, encompassing a wide range of governmental objectives, including economic development,39 environmental protection40 and cultural policies.41 therefore, it is doubtless that csr goals should be seen as a ‘rational’ policy by investment tribunals. however, the existence of rational policy by itself does not justify a differentiation. some tribunals have required a reasonable relationship between the rational public policy and the challenged governmental measure. for example, the pope & talbot award required that the difference in treatment must be in a ‘reasonable nexus’ with a rational public policy.42 the parkerings tribunal adopted a similar approach, noting that ‘a less favourable treatment is acceptable if a state’s legitimate objective justifies such different treatment in relation to the specificity of the investment.’43 other tribunals have examined whether the different treatment against the foreign investor was necessary to achieve the relative public goals.44 a typical example was s.d. myers v. canada, which concerned a canadian ban on the export of a hazardous chemical, polychlorinated biphenyl (pcb). the claimant, a us company exporting pcb from canada to the us, alleged that it had been discriminated against compared with domestic investors, because the business of the us investor inevitably involved exporting pcb materials to the us, which was not the case for the domestic investors. this discrimination, argued by the claimant, was a violation of article 1102 (national treatment) of the nafta. in this case, the tribunal upheld the respondent’s legitimate objective of ensuring the economic strength of the domestic industry. but merely having a legitimate objective, in the view of the tribunal, could not of itself justify the differentiation.45 since there were two alternative measures that could have achieved the same objective without infringing the investor’s right, 39 gami investments, inc. v. the government of the united mexican states (2004), uncitral, final award [114]. s.d. myers (n 28) [255]; pope & talbot (n 28) [87]. 40 marion unglaube v. republic of costa rica [2012] icsid case no. arb/08/1, award [264]; parkerings (n 31) [392] and [396]. 41 parkerings (n 31) [396]. 42 pope & talbot (n 28) [79]. 43 parkerings (n 31) [371]. 44 s.d. myers (n 28) [215]; arcelor (n 34) [47]. 45 s.d. myers (n 28) [255]. csr and international investment law 102 the tribunal concluded that the measure taken by the respondent was not justifiable.46 these different approaches adopted by tribunals in the ‘justification’ analysis make it uncertain whether the discriminatory treatments of foreign investors can be justified by a purpose of promoting csr goals. it would be relatively easy to justify a discriminatory measure in pursuit of csr if the tribunal adopts a ‘rational nexus’ approach. on the other hand, if the tribunal adopts a necessity test, the host state needs to prove that the discriminatory treatment was ‘necessary’ to achieve the csr policies. 3.2. fair and equitable treatment the fair and equitable treatment (fet) standard has been a key component in a majority of bilateral and multilateral investment treaties, and has been the most frequently invoked standard in investment arbitration.47 although the fet clauses have diverse language, most of them require host states to accord foreign investors and their investments ‘fair and equitable treatment’, without a further illustration of what is ‘fair’ and ‘equitable’.48 for instance, article 10 of the energy charter treaty (ect) provides that: ‘each contracting party shall, in accordance with the provisions of this treaty, encourage and create stable, equitable, favourable and transparent conditions for investors of other contracting parties to make investments in its area. such conditions shall include a commitment to accord at all times to investments of investors of other contracting parties fair and equitable treatment …’49 one main function of the fet standard is to ensure the stability of the investment environment in the host state. before making an investment, a prudent foreign investor will conduct a careful investigation of the host state’s investment environment, including an examination of the host state’s legal framework as well as any undertakings made by the host state, in order to have a general expectation of the potential success of an investment and, accordingly, to decide whether and how to make an investment. stability of the host state’s investment environment is a key issue here.50 if, after the establishment of the foreign investment, the host 46 ibid. 47 dolzer and schreuer (n 7) 130. 48 a small number of investment treaties refer the fet standard to the minimum standard of treatment (mst) in customary international law. see, e.g., the us model bit 2012, article 5; the china-korean fta 2015, article 12.5. however, a reference to mst does little help to anchor the meaning of fet, since the meaning of mst itself is unclear. w. michael reisman, ‘canute confronts the tide: states versus tribunals and the evolution of the minimum standard in customary international law’ (2015) 30.3 icsid review 616. 49 the energy charter treaty 1994, article 10 (emphasis added). 50 muthucumaraswamy sornarajah, the settlement of foreign investment disputes (kluwer law international 2000) 25-60. njcl 2017/1 103 state changes its law (e.g. by enacting new legislation or revoking the investor’s operating licenses) or breaches its assurances (e.g. by violating specific representations made by governmental officials to the foreign investor), it would frustrate the investor’s initial expectations with respect to the planning of its investment. to ensure the predictability and stability of the host state’s legal framework, the tribunals have interpreted the fet standard such that a host state’s conduct that frustrates the foreign investor’s legitimate expectations at the time of investments will lead to a violation of the fet standard in iil.51 as the tribunal in biwater gauff v. tanzania stated: ‘[t]he purpose of the fair and equitable treatment standard is to provide to international investments treatment that does not affect the basic expectations that were taken into account by the foreign investor to make the investment, as long as these expectations are reasonable and legitimate and have been relied upon by the investor to make the investment’.52 the fet standard is in tension with the host state’s right to regulate social responsibilities of foreign investors, since this sovereign right is subject to an obligation of not infringing the foreign investor’s legitimate and reasonable expectations at the time of investments. in investment arbitration, this tension has often been seen in cases involving the host state’s regulation of the environmental responsibilities of foreign investors due to the rapidly evolving environmental law as a result of the growing scale of pollution and ecological degradation, increasing environmental consciousness and scientific development. 53 first, the host state may frustrate the foreign investor’s expectations by enacting new legislation on investors’ environmental obligations. glamis gold v. us is an illustrative example. glamis was a canadian company that mined gold on federal land in southeastern california. its open pit mining project was located in a culturally sensitive area where there existed designated native american sites. to protect cultural sites, the u.s. federal government denied the project based on the ‘undue impairment’ standard that was newly enacted in a solicitor’s m-opinion. this was, however, claimed by the foreign investor as a frustration of its legitimate expectations, which were based on the preexisting mining law that adopts a less strict ‘unnecessary or undue degradation’ standard. the investor’s argument was supported by the tribunal, which held that the shift in standards ‘represented a significant change from settled practice 51 cms v argentina [2005] 14 icsid reports 158, award [274]; lg&e v argentina [2007] 21 icsid review-filj 203, decision on liability [125]; unglaube (n 40) [248]. duke energy v ecuador [2008] icsid case no. arb/04/19, award [337]-[340]. 52 biwater v tanzania [2008] icsid case no. arb/05/22, award [602]. 53 daniel bodansky, jutta brunnee and ellen hey, the oxford handbook of international environmental law (oup 2007) 30. daniel bodansky, the art and craft of international environmental law (harvard university press 2010) 19. csr and international investment law 104 and, arguably, surprised claimant.’54 despite this, the tribunal finally held that the adoption of the novel standard by the us government did not violate the fet clause, since the m-opinion did not occasion ‘a gross denial of justice, manifest arbitrariness, blatant unfairness, a complete lack of due process, evident discrimination, or a manifest lack of reasons.’55 second, the host state might frustrate the foreign investor’s expectations by enacting ‘novel’ environmental regulation. the term ‘novel’ means that the environmental regulation is in contrast with the assurances made by the host state upon which the foreign investor has based its expectations. such assurances may come from the existing law of the host state. for example, in bilcon v. canada, the tribunal held that canada’s usage of a novel concept of ‘community core values’ in the environmental impact assessment had frustrated the foreign investor’s legitimate expectations and constituted a violation of the fet clause.56 in this case, the u.s. investors constructed and operated a mining quarry and marine terminal project located in nova scotia, canada. this project, however, was denied by a canadian review panel in the environmental assessment, because of the project’s potential harm to the ‘community core values’, which, the panel held, could not be remedied by any mitigation measure. the investors claimed that the term ‘community core values’ was a novel concept that had not been mentioned in any existing environmental legislation. the tribunal, upholding that investor’s position, held that the novel usage of the concept of ‘community core values’ frustrated the investors’ reliance on the canadian government’s previous encouragement of the investment.57 the tribunal concluded that this ‘distinct, unprecedented and unexpected’ approach taken by the canadian review panel in the environmental assessment had violated the fet standard.58 the environmental regulation by the host state may also frustrate the foreign investor’s expectations if it contradicts the assurances that have previously been made by the host state’s officials to the foreign investors. in metalclad v. mexico, the us investor metalclad invested in a hazardous waste landfill in mexico. after having received both federal and state permits to construct and operate the landfill, and having been assured by federal officials that it had all authority necessary to undertake the project, metalclad started its construction, which, however, was later halted by the municipal government for environmental reasons. in this case, the tribunal protected the foreign investor’s expectations based on the representations made by the host state’s federal officials, holding that a denial of a construction permit by the mexican municipal government had 54 glamis gold, ltd. v us [2009] uncitral, award [759]. 55 ibid [762]. 56 bilcon v canada [2015] uncitral pca case no. 2009-04, award [589]-[591]. 57 ibid [589]. 58 ibid [601]. njcl 2017/1 105 violated the fet standard since the federal officials had promised the foreign investor that the investor had received all the permits needed to start construction.59 the aforementioned cases have shown the circumstances in which the host state’s efforts to promote environmental responsibilities of foreign investors, either through legislation or administration, may constitute a violation of the fet standard in iil. in all these cases, a key goal is striking a balance between the stability requirement under the fet standard and the dynamic environmental regulation by the host state. on the one hand, the host state should ensure a certain degree of stability of its legal framework to protect foreign investments in its territories; on the other hand, the stability requirement must not be interpreted as an absolute standard, and the host state should enjoy sovereign right to adjust domestic environmental regulation to evolving social needs.60 an appropriate balancing point seems to be that, under the fet standard, the host state can change its environmental regulation as long as this change is made in due process and does not result in a discriminatory effect on foreign investments. 3.3. indirect expropriation expropriation, as the most severe form of infringement on property rights, has been a central concern in iil.61 modern investment treaties do not prohibit the host state from expropriating foreign investments in its territory, but require that the expropriation must be conducted in a legal method, that is (1) for a public purpose, (2) not arbitrary or discriminatory, (3) in due process, and (4) accompanied by prompt, adequate and effective compensation. expropriation can be categorised into direct and indirect expropriation. direct expropriation occurs when the governmental measure leads to transfer of ownership of property from investors to states or third parties.62 today, direct expropriation has been very rare, since a drastic and open taking of foreign property will jeopardise host 59 metalclad v mexico [2000] 5 icsid reports 212, award [88]-[89]. 60 the tribunal in saluka v. czech republlic held in this respect: ‘no investor may reasonably expect that the circumstances prevailing at the time the investment is made remain totally unchanged. in order to determine whether frustration of the foreign investor’s expectations was justified and reasonable, the host state’s legitimate right subsequently to regulate domestic matters in the public interest must be taken into consideration as well. (…) the determination of a breach of [the fet clause] by the czech republic therefore requires a weighing of the claimant’s legitimate and reasonable expectations on the one hand and the respondent’s legitimate regulatory interests on the other.’ saluka v czech republic [2006] 15 icsid reports 274, partial award [305]-[306]. 61 dolzer and schreuer (n 7) 98. 62 catherine yannaca-small, ‘“indirect expropriation” and the “right to regulate” in international investment law’ 3 (oecd working paper, no. 2004/4, 2004) <www.oecd.org/investment/internationalinvestmentagreements/33776546.pdf> accessed 27 march 2017. csr and international investment law 106 states’ reputation in attracting foreign investments.63 alternatively, states tend to conduct indirect expropriation, which can be defined as any governmental measure that substantially impairs the value of the investment without affecting the ownership.64 for instance, in goetz v. burundi, the tribunal held that burundi’s revocation of a free-zone status granted to the foreign investor had forced the investor ‘to halt all activities’ and had constituted a ‘measure having similar effect’ to expropriation.65 in cme v. czech republic, the tribunal held that the host state’s interference with the contract rights of the foreign investor’s subsidiary, which had destroyed the commercial value of the investments, had amounted to an indirect expropriation.66 although the concept of indirect expropriation has been incorporated into many multilateral and bilateral investment agreements,67 it is difficult to differentiate between indirect expropriations, in which the host states have to pay compensation to aggrieved investors, and the legitimate right of host states to regulate their internal affairs.68 in this context, an important question is: if the host state’s enforcement of the social responsibilities of the foreign investor has substantially deprived the foreign investor from utilising its investments, does the host state’s regulation constitute an indirect expropriation so that an adequate compensation should be paid, or is it within the host state’s right to regulate so that no compensation is needed? investment jurisprudence on this question has been inconsistent. some tribunals have adopted the ‘sole effects doctrine’, which means, to determine whether a governmental measure constitutes an indirect expropriation, one should examine only the effects of the measure on the property allegedly expropriated, with no consideration of the 63 dolzer and schreuer (n 7) 101. 64 w. michael reisman and robert d. sloane, ‘indirect exproprion and its valuation in the bit generation’ (2004) 74.1 british yearbook of international law, 115; yannacasmall (n 62) 3-4; anne k. hoffman, ‘indirect expropriation’ in august reinisch (ed) standards of investment protection (oup 2008) 151. 65 goetz v burundi [1999] 6 icsid reports 5, award [124]. 66 cme v. czech republic [2001] 9 icsid reports 121, partial award [591]. 67 for instance, article 1110 of the nafta stipulates that ‘[n]o party may directly or indirectly nationalize or expropriate an investment … or take a measure tantamount to nationalization or expropriation’ (emphasis added); article 13 of the ect reads ‘[i]nvestments of investors … shall not be nationalised, expropriated or subjected to a measure or measures having effect equivalent to nationalisation or expropriation’ (emphasis added); article 6 of the 2012 united states model bit also provides that ‘[n]either party may expropriate or nationalize a covered investment either directly or indirectly through measures equivalent to expropriation or nationalization.’ (emphasis added) 68 markus perkams, ‘the concept of indirect expropriation in comparative public lawsearching for light in the dark’, in stephan w. schill (ed) international investment law and comparative public law (oup 2010) 107-8; generation ukraine, inc. v ukraine award [2003] icsid case no.arb/00/9 award [20.29]; saluka (n 60) [263]. njcl 2017/1 107 objective underlying the measure.69 under this approach, even if a measure is adopted for enforcing social responsibilities of corporations, it will result in compensation by the host state in circumstances that the measure has substantially deprived the investors from utilising their investments. as stated by the iran-united states claims tribunal in the phelps dodge case, ‘the tribunal understands the financial, economic and social concerns that inspired the law pursuant to which [iran] acted, but those reasons and concerns cannot relieve the respondent of the obligation to compensate phelps dodge for its loss.’70 in spp v. egypt, the egyptian government withdrew an approval of a foreign tourist project to protect nearby cultural heritage. the tribunal found that the withdrawal of approval had amounted to indirect expropriation, and egypt should pay fair compensation to the foreign investor even though ‘antiquities are involved’.71 in metalclad v. mexico, the tribunal held that an ecological decree issued by mexico to prohibit the operation of a foreign hazardous waste facility had constituted indirect expropriation, and that the tribunal ‘need not decide or consider the motivation or intent of the adoption of the ecological decree.’72 contrary to the sole effects doctrine, the ‘police powers doctrine’ provides that regulatory conducts within the police powers of the state do not constitute indirect expropriation as long as they are in good faith and non-discriminatory. in s.d. myers v. canada, the tribunal rejected the investor’s claim that the canadian ban on the export of pcb, a hazardous material, constituted indirect expropriation. the tribunal held that ‘[r]egulatory conduct by public authorities is unlikely to be the subject of legitimate complaint under article 1110 of nafta, although the tribunal does not rule out that possibility.’73 the tribunal also stated that both the purpose and the effect of the export ban had to be considered to determine indirect expropriation.74 the methanex v. us case concerned a ban on the use or sale of the gasoline additive mtbe in california, us. the foreign investor argued that the ban had expropriated parts of its investments. the tribunal rejected this claim, holding that a governmental regulation does not constitute indirect expropriation if it is: 1) for public purpose, 2) nondiscriminatory, 3) enacted in due process and, 4) without specific contrary commitments given by the government to the investors.75 69 valentina vadi, public health in international investment law and arbitration (routledge, 2012) 137. 70 phelps dodge, 10 iran-us ctr 130 [22]. 71 spp v egypt [1992] 3 icsid reports 189 award [159]. 72 metalclad (n 59) [109]-[111]. 73 s.d. myers (n 28) [281]. 74 ibid. 75 methanex v us [2005] 44 ilm 1345, award [7]. csr and international investment law 108 the same approach was adopted in the subsequent chemtura v. canada case.76 in this case, the canadian government cancelled the registrations of the us investor’s products that involved the use of lindane, a hazardous insecticide. the us investor claimed that the canadian government’s act was tantamount to expropriation under article 1110 of nafta. however, the tribunal held that the canadian government ‘took measures within its mandate, in a non-discriminatory manner, motivated by the increasing awareness of the dangers presented by lindane for human health and the environment. a measure adopted under such circumstances is a valid exercise of the state's police powers and, as a result, does not constitute an expropriation.’77 the third category of tribunals, citing the jurisprudence of the european court of human rights, have tended to adopt a proportionality test to strike a balance between investment interests and the host state’s right to regulate public interests. in lg&g v. argentina, the tribunal held that ‘[w]ith respect to the power of the state to adopt its policies, it can generally be said that the state has the right to adopt measures having a social or general welfare purpose. in such a case, the measure must be accepted without any imposition of liability, except in cases where the state’s action is obviously disproportionate to the need being addressed.’78 this proportionality test has been adopted by the azurix v. argentina tribunal concerning argentina’s water regulation. in this case, the us investor azurix was granted an exclusive right to operate the water and sewage systems in the argentinian province of buenos aires based on a 30-year concession. however, several months after the commencement of the operation, there was an incident of algae outbreak that resulted in the contamination of local water. blaming azurix for this incident, the argentinian government encouraged consumers to refuse to pay their water bills and eventually terminated the concession. azurix argued that argentina’s conduct was tantamount to expropriation under the argentina-us bit, while argentina insisted that its regulatory actions were for public purpose and did not amount to expropriation. the tribunal examining the claim correctly recognised the necessity to distinguish noncompensable regulatory actions from compensable indirect expropriation. the tribunal noted: ‘in the exercise of their public policy function, governments take all sorts of measures that may affect the economic value of investments without such measures giving rise to a need to compensate.’79 this approach is in contrast to the ‘sole effects doctrine’ which refuses to take account of the intent of the host state in the assessment of indirect expropriation. on the other hand, the azurix tribunal also disagreed with the police powers doctrine that generally 76 chemtura v canada [2010] uncitral, award [138]. 77 ibid [266]. 78 lg&e (n 51) [195]. 79 azurix v. argentina [2006] 14 icsid reports 374, award [310]. njcl 2017/1 109 excludes all bona fide regulation from an obligation to compensate. adopting a third method, the tribunal sought guidance in the jurisprudence of the european court of human rights, especially by reference to the james and others v. uk case, holding that ‘a measure depriving a person of his property [must] pursue, on the facts as well as in principle, a legitimate aim “in the public interest”’, and must also bear ‘a reasonable relationship of proportionality between the means employed and the aim sought to be realized’.80 among the three doctrines, the sole effects doctrine is often criticised for its restriction on state’s right to regulate.81 this doctrine ignores social and environmental goals underlying the measure, obscures the boundary between indirect expropriation and legitimate regulations, and has ‘chilling effects’ on the host state’s efforts to regulate public interests. compared with the sole effects doctrine, the police powers doctrine saves the regulatory space of host states, ensuring that a legitimate measure for public objectives does not lead to compensable indirect expropriation. the proportionality doctrine also takes due regard for the state’s right to regulate, and strikes a balance between the investors’ interests and the host state’s interests by requiring the act of the host state to be proportional to achieve public policies. 4. the obligations to regulate csr? incorporating csr standards into investment treaties 4.1. balancing investor rights and social interests in investment treaties although most investment treaties do not explicitly recognise the right or duty of host states to regulate for policy objectives other than investment protection and promotion,82 recently a growing number of investment treaties have included social and environmental protection provisions to balance the foreign investor’s rights against the public interests of the host state. some investment treaties pursue this balance by indicating non-economic objectives such as public health, environmental protection and labour rights in the preamble of the treaty.83 these social 80 ibid [311]. 81 see, e.g., rahim moloo and justin jacinto, ‘environmental and health regulation: assessing liability under investment treaties’ (2011) 29 berkeley j. int'l l. 1, 63; j. martin wagner, ‘international investment, expropriation and environmental protection’ (1999) 29.3 golden gate ul rev. 465, 517-525; suzy h. nikièma, ‘best practices: indirect expropriation’ (international institute for sustainable development, 2012) <www.iisd.org/pdf/2012/best_practice_indirect_expropriation.pdf> accessed 27 march 2017. 82 spears (n 23) 1045. 83 one example is the 2012 us model bit, the preamble of which states the parties’ desire to achieve the economic and investment objectives ‘in a manner consistent with the protection of health, safety, and the environment, and the promotion of csr and international investment law 110 and environmental objectives in preambles serve as guidance for the interpretation of treaty provisions by investment tribunals,84 though they could not provide a practical method for balancing the competing interests of foreign investors and the public. some treaties have gone a step further by adopting the ‘no lowering of standards’ provision, which, responding to the ‘polluter haven’ hypothesis, prevents states from lowering its environmental or labour standards as an inducement to foreign investments.85 for example, article 1114(2) of the nafta stipulates that it is ‘inappropriate to encourage investment by relaxing domestic health, safety or environmental measures’.86 however, this ‘no lowering of standards’ provision is in nonbinding ‘best efforts’ language and is not linked up to the dispute settlement mechanism.87 as a third approach, some investment treaties incorporate exception clauses that exclude the host state’s acts in pursuit of certain public objectives from violating substantive investment obligations. one type of such exception clause is modelled on article xx of the general agreement on tariffs and trade (gatt) and article xiv of the general agreement on trade in services (gats). however, different from the wto law, there has been no coherent style of general exceptions clause in investment treaties.88 the threshold for justifying non-conforming state measures under legitimate public objectives varies among different treaties: some treaties require the host state’s non-conforming measures to be ‘necessary’89 or ‘proportional’90 to achieve public objectives, while others have a less strict requirement that the measure should be ‘appropriate’91 for the relevant objectives. another kind of exceptions clause applies in particular to the iil’s prohibition on performance requirements. for example, the nafta prohibits the host state from imposing performance requirements on internationally recognized labor rights’. the 2012 us model bit, preamble <www.state.gov/documents/organization/188371.pdf> accessed 1 may 2017. 84 vienna convention on the law of treaties [1969] 1155 u.n.t.s. 331, 8 i.l.m. 679, art 31(1). 85 muchlinski (n 17) 671. mary e. footer, ‘bits and pieces: social and environmental protection in the regulation of foreign investment’ (2009) 18 mich. st. u. coll. lj int'l l. 33, 43. 86 nafta, article 1114(2). 87 muchlinski (n 17) 671-2. footer (n 85) 43. 88 for a detailed analysis of different types of general exceptions clauses in investment treaties, see spears (n 23) 1060-2. 89 the 2004 canadian foreign investment protection agreement (fipa), art 10 <www.italaw.com/documents/canadian2004-fipa-model-en.pdf> accessed 1 may 2017. 90 the 2007 colombian model bit, art viii <www.italaw.com/documents /inv_model_bit_colombia.pdf> accessed 1 may 2017. 91 investment agreement for the comesa common investment area (n 38) art 22(2). njcl 2017/1 111 foreign investors, except that the measures are ‘necessary to protect human, animal or plant life or health’ or ‘necessary for the conservation of living or non-living exhaustible natural resources’, provided that they are not applied arbitrarily or unjustifiably, and that they ‘do not constitute a disguised restriction on international trade or investment’.92 the above-mentioned approaches for reconciling investor and social interests have one thing in common: they balance competing interests by protecting the right of states to regulate (through the exceptions clause) social or environmental issues or by imposing obligations on states to regulate (through ‘no lowering of standards’ provision) such issues, but they do not impose direct obligations on foreign investors themselves to respect social responsibilities.93 unlike these approaches, recent years have seen a new approach of incorporating csr standards into investment treaties. 4.2. incorporating csr standards into investment treaties an early attempt to adopt csr norms in investment treaties can be seen in the 2007 draft norwegian model bit, which includes an article stating that ‘[p]arties agree to encourage investors to conduct their investment activities in compliance with the oecd guidelines on multinational enterprises and to participate in the united nations global compact’.94 this provision does not impose direct csr obligations on foreign investors, but uses weak language to indicate the parties’ agreement to ‘encourage’ investors to abide by csr standards. recently, a notable phenomenon of including csr provisions into investment agreements has been seen in canadian, brazilian and eu treaty-making practice. 4.2.1. canada canada has incorporated csr norms into its investment treaties in the last few years. the 2013 benin-canada bit, for example, provides that the ‘guiding principles’ of the obligations of the contracting parties include ‘national treatment, most-favoured-nation treatment, minimum standard of treatment, compensation for losses, compensation for 92 nafta, article 1106(6). 93 unep, ‘corporate social responsibility and regional trade and investment agreements’ (2011) 24 < http://unep.ch/etb/publications/csr%20publication/unep_corporate%20social% 20responsibility.pdf> accessed 1 may 2017. 94 the 2007 norwegian draft model bit, art 32 < http://investmentpolicyhub.unctad.org/download/treatyfile/2873> accessed 1 may 2017. however, due to the critical public comments on the draft from both business groups and ngos, the norwegian government withdrew the drat bit in 2009. see damon vis-dunbar, ‘norway shelves its draft model bilateral investment treaty’ (investment treaty news, 8 june 2009) <www.iisd.org/itn/2009/06/08/norway-shelvesits-proposed-model-bilateral-investment-treaty/> accessed 1 may 2017. csr and international investment law 112 expropriation, transparency, subrogation and corporate social responsibility’.95 (emphasis added) article 16 of this bit, entitled ‘corporate social responsibility’, obliges the parties to encourage enterprises in its territory to commit to internationally recognised csr standards. it provides: ‘each contracting party should encourage enterprises operating within its territory or subject to its jurisdiction to voluntarily incorporate internationally recognized standards of corporate social responsibility in their practices and internal policies, such as statements of principle that have been endorsed or are supported by the contracting parties. these principles address issues such as labour, the environment, human rights, community relations and anti-corruption.’96 this csr provision marks a start of incorporating soft icsr terms into hard international investment treaties, despite the fact that the provision has a soft character by using the terms ‘encourage’ and ‘voluntarily’, and that the csr provision cannot form a basis for a claim raised by the foreign investor against the host state in investment arbitration.97 moreover, the provision does not refer to particular intentional instruments on ‘internationally recognized standards of corporate social responsibility’. most subsequent canadian investment treaties that adopt csr provisions have employed an almost identical wording as that adopted in article 16 of the 2013 benin-canada bit.98 however, the csr provision of the 2013 canada-honduras fta seems to provide a lower csr requirement than that in other canadian investment treaties. different from other treaties that require states to encourage enterprises to commit to csr in their ‘practices and internal policies’, the 2013 canadahonduras fta only requires states to encourage csr in the enterprises’ ‘internal policies’.99 on the other hand, the 2014 canada-mali bit and the 2015 burkina faso-canada bit provide a relatively stricter csr obligation than that of other treaties. instead of requiring parties to encourage enterprises to ‘voluntarily incorporate’ internationally recognised csr standards, both bits delete the word ‘voluntarily’ and oblige parties to encourage enterprises to ‘incorporate’ those standards.100 a unique wording has also been adopted by article 16 of the 2014 canada-senegal bit, which not only obliges states to encourage csr commitments by the enterprises, but also directly encourage such 95 the 2013 benin-canada bit, art 4. 96 ibid, art 16. 97 ibid, art 23. 98 the 2014 cameroon-canada bit, art 15; the 2014 canada-nigeria bit, art 16; the 2014 canada-serbia bit, art 16; the 2014 canada-republic of korea fta, art 8.16; the 2014 canada-côte d'ivoire bit, art 15. 99 the 2013 canada-honduras fta, chapter 10, art 10.16. 100 the 2014 canada-mali bit, art 15(3); the 2015 burkina faso-canada bit, art 16. njcl 2017/1 113 enterprises ‘to make investments whose impacts contribute to the resolution of social problems and preserve the environment.’101 although almost all csr provisions in canadian investment treaties prohibit the foreign investor from bringing investment arbitration claims based on a violation of the csr provision by the host state,102 one exception is the 2015 burkina faso-canada bit, which does not prohibit an arbitration claim formed on the basis of the csr provision.103 as a result, the foreign investor who has incurred damages by reason of a violation of the csr provision by the host state can claim for compensation in the investor-state arbitration process under article 21 of the burkina faso-canada bit. 4.2.2 brazil in 2015, brazil concluded a series of agreements on cooperation and facilitation of investments (acfis) in the context of strong political opposition to traditional bits.104 different from bits aimed at investment protection, the acfis focus on the objectives of investment facilitation and risk mitigation. in terms of substantive obligations, the brazilian acfis provide only limited standards of treatment for foreign investments (including nt and mfn clauses, but excluding fet and indirect expropriation clauses). moreover, the acfis replace investorstate arbitration with two institutions—a joint committee and focal points – to implement the agreement and to settle potential disputes mainly through consultation, negotiation and mediation. this novel mechanism aims to deter foreign investors from judicially challenging host states’ measures.105 the brazilian acfis are also novel for its inclusion of csr provisions. different from canadian bits, most brazilian acfis impose csr obligations directly on investors rather than on state parties. for instance, in the 2015 brazil-angola acfi, the 2015 brazil-mozambique acfi, the 2015 brazil-malawi acfi and the 2015 brazil-mexico acfi, the csr provisions require ‘investors and their investments’ to strive to 101 the 2014 canada-senegal bit, art 16. 102 the 2014 cameroon-canada bit, art 20; the 2014 canada-nigeria bit, art 21; the 2014 canada-serbia bit, art 21; the 2014 canada-republic of korea fta, art 8.18 and 8.19; the 2014 canada-mali bit, art 20; the 2014 canada-côte d'ivoire bit, art 20. the 2013 canada-honduras fta, art 10.19; the 2014 canada-senegal bit, art 21. 103 the 2015 burkina faso-canada bit, art 21. 104 fabio morosini and michelle ratton sanchez badinmorosini, ‘the brazilian agreement on cooperation and facilitation of investments (acfi): a new formula for international investment agreements?’ (investment treaty news, 4 august 2015) <www.iisd.org/itn/2015/08/04/the-brazilian-agreement-on-cooperation-andfacilitation-of-investments-acfi-a-new-formula-for-international-investmentagreements/> accessed 1 may 2017. nitish monebhurrun, ‘novelty in international investment law: the brazilian agreement on cooperation and facilitation of investments as a different international investment agreement model’ (2017) 8 journal of international dispute settlement 79, 82. 105 morosini and badinmorosini (n 104). csr and international investment law 114 achieve the highest possible level of contribution to the sustainable development of the host state and the local community.106 however, a different approach can be seen in the 2015 brazil-chile acfi, in which article 15 imposes csr obligations on both states and investors: on the one hand, state parties recognise the importance of encouraging investors within its jurisdiction to apply social responsibility;107 on the other hand, investors should do their best to comply with social responsibilities.108 another different approach has been adopted by the 2015 brazilcolumbia acfi, which merely obliges state parties to ensure that undertakings within their territories incorporate the voluntary social responsibilities into their business conducts, without a direct obligation imposed on investors or investments.109 the csr provisions in the brazilian acfis are also innovative for the reason that they provide detailed implementation guidelines, covering a wide variety of csr principles, including protecting environment, respecting human rights, cooperation with local community, creating employment opportunities, facilitating the training of workers, observing the legislation on environment, health, safety and labour issues, and refraining from discrimination against workers.110 investors are also recommended to bear the supply chain responsibility by encouraging their business partners to observe these principles. despite this wide coverage, these acfis do not provide any csr standard on corruption. instead, they either require investors to respect local political processes and activities,111 or require investors to refrain from undue interference in local political activities.112 this might contribute to a cover-up of corruption issues.113 although the brazilian acfis have stipulated a wide arrange of csr standards, they have also emphasised the voluntary and non-binding nature of these standards. all of these acfis stress that the csr principles 106 the 2015 brazil-angola acfi, art 10; the 2015 brazil-mozambique acfi, art 10; the 2015 brazil-malawi acfi, art 9; the 2015 brazil-mexico acfi, art 13. 107 the 2015 brazil-chile acfi, art 15(1). 108 ibid, art 15(2). 109 the 2015 brazil-columbia acfi, art 13. 110 the 2015 brazil-angola acfi, annex ii; the 2015 brazil-mozambique acfi, annex ii; the 2015 brazil-malawi acfi, art 9(2); the 2015 brazil-mexico acfi, art 13(2); the 2015 brazil-columbia acfi, art 13. 111 the 2015 brazil-angola acfi, annex ii; the 2015 brazil-mozambique acfi, annex ii; the 2015 brazil-malawi acfi, art 9(2); the 2015 brazil-mexico acfi, art 13(2). 112 the 2015 brazil-columbia acfi, art 13. 113 monebhurrun (n 104) 98. however, it is also noteworthy that some brazilian acfis have particular anti-corruption clauses, indicating the parties’ obligations to prevent corruption and their rights to refuse protection of investments related to corruption. see the 2015 brazil-chile acfi, art 14 and the 2015 brazil-colombia acfi, art 14. njcl 2017/1 115 are ‘voluntary’ standards.114 moreover, they all use soft terms, such as ‘highest possible level’,115 ‘seek to ensure’116 or ‘do their best’117, to define the state parties’ or the investors’ obligations to pursue such voluntary standards. the soft nature of csr principles has also been reflected in the enforcement mechanism of these csr provisions. with respect to some acfis, although the treaties allow state-state arbitration as a dispute settlement mechanism, they exclude claims based on the csr provision from arbitration processes. for example, according to article 23 of the brazil-columbia acfi, a claim based on the csr clause may not be submitted to arbitration.118 in other acfis, states may not even be possible to be subject to a csr claim in the state-state arbitration, since the csr obligations are imposed on investors rather than on states.119 nonetheless, csr provision may be implemented in a relatively soft way through the administration of joint committee and national focal points. 4.2.2. the eu in 2011, the european parliament published a resolution on the future european investment policy, in which it calls for a corporate social responsibility clause ‘to be included in every fta the eu signs’.120 following this policy, in recent years, the eu has included csr provisions in its newly concluded association agreements and free-trade agreements (ftas). compared with bilateral and multilateral investment treaties, these association agreements cover a much wider variety of topics, including political, economic and social cooperation between the parties, which naturally makes association agreements a better platform for reconciling investment protection and social interests than other investment agreements. in these association agreements, csr provisions are usually placed in the chapter on promoting trade/investment 114 almost all brazilian acfis have expressly stated that the csr principles are ‘voluntary’. see the 2015 brazil-angola acfi, art 10; the 2015 brazil-mozambique acfi, art 10; the 2015 brazil-malawi acfi, art 9; the 2015 brazil-mexico acfi, art13; the 2015 brazil-columbia acfi, art 13.the only exception might be the 2015 brazilchile acfi, but in this treaty, the voluntary character of the csr norms could be inferred from the article’s reference to the oecd guidelines. see the 2015 brazil-chile acfi, art 15(2). 115 the 2015 brazil-angola acfi, art 10; the 2015 brazil-mozambique acfi, art 10; the 2015 brazil-malawi acfi, art 9; the 2015 brazil-mexico acfi, art 13. 116 the 2015 brazil-columbia acfi, art 13. 117 the 2015 brazil-chile acfi, art 15(2). 118 the 2015 brazil-columbia acfi, art 23. 119 the 2015 brazil-angola acfi, art 10; the 2015 brazil-mozambique acfi, art 10; the 2015 brazil-malawi acfi, art 9; the 2015 brazil-mexico acfi, art 13. 120 european parliament resolution of 6 april 2011 on the future european international investment policy (2010/2203(ini)) [2011] 2012/c 296 e/05. csr and international investment law 116 favouring sustainable development and in the chapter on ‘cooperation on employment, social policy and equal opportunities’. the csr provisions in the eu association agreements and ftas impose the obligations to promote csr at state parties rather than directly at investors, and they all use non-binding language to describe the state’s obligation to promote csr. for example, the 2012 colombia-eu-peru fta has a particular title (title ix) on trade and sustainable development, under which article 271 provides that the parties should strive to facilitate and promote trade and fdi in environmental goods and services, and that ‘[t]he parties agree to promote best business practices related to corporate social responsibility’.121 similarly, article 293 of the 2012 eu-ukraine association agreement provides that the parties shall strive to facilitate and promote trade and fdi in environmentally friendly goods, services, technologies and energies, and shall strive to facilitate trade in products that contribute to sustainable development, including products ‘respecting corporate social responsibility and accountability principles’.122 in the 2016 eu-kazakhstan enhanced partnership and cooperation agreement, article 154 (entitled ‘trade and investment promoting sustainable development’) provides that the parties agree to promote ‘trade and investment in environmental goods and services and in climate-friendly products and technologies’ and to promote ‘corporate social responsibility practices’.123 unlike the above-mentioned agreements that generally mention ‘corporate social responsibility’, other eu association agreements refer to specific international corporate social responsibility (icsr) standards. the 2014 eu-georgia association agreement, under the title of ‘trade and investment promoting sustainable development’, provides that the parties agree to promote csr, by reference to ‘relevant internationally recognised principles and guidelines, especially the oecd guidelines for multinational enterprises.’124 the 2014 eu-moldova association agreement and the 2012 eu-ukraine association agreement refer to several icsr guidelines, including the oecd guidelines, the un global compact, and the ilo tripartite declaration.125 these treaties have employed different enforcement mechanisms of csr provisions. in some treaties, the csr provision is implemented in a soft and non-binding way. under the 2012 colombia-eu-peru fta and the 2012 eu-ukraine association agreement, for instance, the csr 121 the 2012 colombia-eu-peru fta, art 271(2) and (3). 122 the 2012 eu-ukraine association agreement, art 293(2) and (3). 123 the 2016 eu-kazakhstan enhanced partnership and cooperation agreement, art 154. 124 the 2014 eu-georgia association agreement, art 231(e). see also art 352. 125 the 2014 eu-moldova association agreement, art 367 (e). the 2012 eu-ukraine association agreement, art 422. njcl 2017/1 117 provisions cannot be claimed under state-state arbitration,126 though the implementation of csr can be monitored and facilitated in other soft ways, including consultations and an examination by a group of experts.127 on the other hand, the 2014 eu-georgia association agreement and the 2014 eu-moldova association agreement do not exempt the csr provisions from state-state arbitration.128 as a third case, although a dispute regarding the csr provision could be arbitrated under the 2016 eu-kazakhstan agreement, an arbitration result regarding the csr provision is excluded from the protection provided by the treaty’s compliance procedure, including the remedies for non-compliance. 129 from a comparative perspective, the canadian, brazilian and eu practice of incorporating csr provisions into investment agreements have similarities and differences. on the one hand, they all acknowledge the soft and non-binding nature of csr obligations and adopt a ‘best efforts’ approach to encourage the promotion of csr. furthermore, the vast majority of investment treaties concluded by these three entities do not allow the csr provisions to be claimed in the investor-state or statestate arbitration mechanisms. on the other hand, these treaties have adopted different approaches with regard to designation of liability. most of the canadian and eu treaties address the obligation to promote csr to state parties, while a majority of brazilian acfis directly encourage investors and their investments to abide by csr standards. the contents of the csr obligations in these treaties are also different: the canadian investment treaties generally refer to ‘corporate social responsibility’ in their csr provisions; the brazilian investment treaties specify several icsr instruments; some of the eu investment treaties generally mention corporate social responsibility, while others indicate specific icsr standards. 4.3. challenges of interpreting and enforcing csr provisions in investment treaties there have not been any investment cases concerning the interpretation of the csr provisions in these investment treaties. 126 the 2012 colombia-eu-peru fta, art 285(5). the 2012 eu-ukraine association agreement, art 322. 127 in both treaties, a party may seek consultations to another party with respect to sustainable development issues (including csr), and may, after 90 days of the delivery of the consultation request, request that a group of experts be convened to examine the matter. the group of experts, comprised of one national from either party and a chairman from a third country, will produce a non-binding report determining whether a party has fulfilled its obligations on sustainable development. see the 2012 colombiaeu-peru fta, art 283-5. the 2012 eu-ukraine association agreement, art 301. 128 the 2014 eu-georgia association agreement, chapter 14. the 2014 eu-moldova association agreement, s 3. 129 the 2016 eu-kazakhstan enhanced partnership and cooperation agreement, art 155 and chapter 14(3)(2). csr and international investment law 118 although it has been argued that csr standards can be the quid pro quo for the dominating objective of investor protection in investment treaties,130 there are several challenges concerning the interpretation and enforcement of these csr provisions. first, investment agreements are triangular treaties that impose obligations on state parties to protect foreign investors as third-party beneficiaries.131 does the incorporation of csr provisions into investment treaties change the very nature of investment treaties by imposing obligations not only on host states, but also on foreign investors?132 how should the csr provisions be interpreted alongside with other substantive obligations of host states, and how should the csr provisions be enforced in the singe-direction investor-state arbitration mechanism in which only foreign investors can be claimants? as noted above, most canadian, brazilian and eu investment treaties have excluded csr provisions from being a basis of claim in the arbitration process. nonetheless, the arbitral tribunals may consider csr provisions as a context when interpreting other substantive clauses in investment treaties, such as nondiscrimination, fet and expropriation. second, contrary to investment obligations which have a ‘hard law’ character, most csr standards in international instruments are seen as ‘soft law’ for their non-binding and voluntary language and the absence of an effective enforcement mechanism. what does it mean to incorporate these soft csr norms into hard investment treaties? should we expect these soft norms to act as a restriction to the hard investment obligations, or should we treat these norms as a ‘good efforts’ approach due to their voluntary nature in other international instruments? according to canadian, brazilian and eu practice, the csr provisions in investment treaties have explicitly treated csr as voluntary, and therefore, it seems at least by now an exaggeration to consider those csr provisions as an effective method to balance public interests against investors’ rights. third, the tribunals may face difficulties in the interpretation of these csr provisions as a result of the unclear definition of csr itself. a general reference to ‘corporate social responsibility’, as the approach adopted in canadian investment treaties, may create difficulty for future tribunals to define csr.133 as a different approach, the brazilian acfis and some eu investment treaties refer to specific icsr instruments, such as the ilo 130 muchlinski (n 17) 643. 131 anthea roberts, ‘triangular treaties: the extent and limits of investment treaty rights’ (2015) 56.2 harv. int'l l.j. 353, 353. 132 it seems that canada and the eu have bypassed this question since they designate the obligation to promote csr on states rather than on investors. brazil, on the other hand, has imposed csr obligations on investors, but the brazilian acfis themselves are nontraditional investment treaties. 133 however, this approach has its own advantage: the csr provision will be flexible to be interpreted by further investment tribunals taking account of the most recent development of csr standards. njcl 2017/1 119 tripartite declaration or the oecd guidelines, which can provide a clearer guidance for tribunals to determine the particular csr standards adopted by the parties. 5. conclusion the tension between iil and csr has been reflected in investment arbitral cases in which host states’ regulation of social and environmental responsibilities of foreign investors, through legally binding legislation and administration, has been claimed by foreign investors as a breach of international investment obligations. as a response to this tension, recent years have seen a new approach, pioneered by canada, brazil and the eu, of incorporating soft csr standards into investment treaties. nonetheless, the effectiveness of this new approach is still uncertain, as a result of the traditional role of foreign investors as third-party beneficiaries in investment treaties, the ‘soft law’ nature of csr norms, and the unclear definition of csr in these provisions. in such circumstances, international investment tribunals are taking the critical responsibility of balancing foreign investor’s right to a fair investment environment and the host state’s right to regulate social responsibilities of foreign investments. a more balanced interpretation of international investment obligations should be struck in investment arbitration, by taking account of csr policies in the assessment of nondiscrimination, fet, and indirect expropriation. first, the tribunal should consider non-economic factors in the determination of whether two investors are ‘in like circumstances’ in the discrimination assessment, and should regard csr policy as a rational policy that can justify a discriminatory treatment if there is a rational relationship between the differentiation in question and the csr policy it pursues. second, investment tribunals should take the dynamic and evolving nature of regulation on csr issues into consideration, and should refrain from interpreting the stability requirement of the fet standard in an absolute way. third, the tribunal should take account of the host state’s sovereign right to regulate csr in the assessment of whether the host state’s regulation on csr issues constitutes indirect expropriation that calls for a compensation paid by the host state to the foreign investor. 1 entire agreement clauses: convergence between us and danish contract law? katerina mitkidis* & thomas neumann** * phd, master of laws. assistant professor, intralaw center, department of law, aarhus university, e-mail: katpe@law.au.dk. orcid.org/0000-0002-27750843 ** phd, master of laws. associate professor department of law, aalborg university, e-mail: thn@law.aau.dk. founder and editor of the cisgnordic.net research database. orcid.org/0000-0002-0477-7429. njcl 2017/2 181 1. introduction .................................................................................. 182 2. commercial contract drafting ............................................. 186 3. ea clauses under american law ............................................ 191 3.1. ea clauses and determining the contractual content .................................................................................. 191 3.2. ea clauses and contract interpretation ............... 194 3.3. summary on us law ............................................................ 195 4. ea clauses under danish law ................................................. 195 4.1. background comments on the danish legal system 195 4.2. the inseparable issues of contractual content and contract interpretation ............................................... 198 4.3. principles guiding the judiciary ................................. 199 4.4. possible implications of ea clauses governed by danish law ............................................................................ 201 4.5. final remarks on the treatment of ea clauses under danish law ............................................................... 204 5. discussion – legal transplants, convergence, transnationalization or? ......................................................... 205 6. conclusion ....................................................................................... 207 ea clauses: us and danish law? 182 abstract the majority of worldwide concluded commercial contracts are nowadays written in english and based on anglo-american contract models. this happens regardless of the governing law of the specific contract. when relying on those models, contractual parties often embrace not only the actual wording, but also the contract drafting style typical for common law countries. in this way, common law concepts and rules can be transferred to civil law jurisdictions, however, without certainty about the legal effects. this is especially pertinent to boilerplate provisions. on this background, the article aims to elucidate the influence of american contract law and contract drafting style on danish contract law and practice, taking the entire agreement (ea) clause as an example. while applying comparative law method, and more specifically taking the departure in various theories on diffusion of law, it aims to investigate the treatment of ea clauses in contracts governed by danish law and opens up a discussion whether on the example of ea clauses we can observe americanization of danish contract law or whether we should rather speak of legal transplants or convergence between american and danish contract law. the findings suggest that the use of ea clauses in contracts governed by danish law can indeed be deemed legal transplants, but that it is impossible to identify whether this transplanting process has been successful. for now, the available court decisions from the two jurisdictions dealing with the topic of ea clauses do not show mutual appreciation between the two legal systems, although the results are not as divergent as expected. therefore, what we are experiencing seems to be convergence or transnationalization of contractual practice rather than contract law. we might thus conclude that the contract drafting process overtakes the judiciary, which is more attached to national rules and values. this does not seem to be the case for denmark only, but appears to be a common observation in other civil law jurisdictions as well. in line with the irritant perspective on the legal transplants theory, it can then be expected that the contract drafting practice will in turn influence national legal rules and the courts’ approach. this effect can already be seen in danish legal scholarship and its presumption that the judges will not entirely disregard ea clauses, but take a middle road in interpreting them. 1. introduction english is a lingua franca of international business.1 moreover, the majority of nowadays concluded commercial contracts are not only 1 c nickerson, ‘english as a lingua franca in international business context’ (2005) 24 english for special purposes 367; d echenberg, ‘negotiating international contracts: does the process invite a review of standard contracts from the point of view of national legal requirements?’ in g cordero-moss (ed), boilerplate clauses, international commercial njcl 2017/2 183 written in english but also based on anglo-american contract models.2 while both england and the usa can be defined as sources of the commonly used contract models, due to the size of national economies, it is mostly american law and contracting that finds its way to other countries. this development has been described in legal scholarship as the ‘reception of american law’3 or even the ‘americanization’4 of law. the present article is one of the outcomes of a research project aiming to elucidate the influence of common law on civil law in the area of contract law and contract drafting practice. it takes the influence of american contract law and contract drafting style on danish contract law and practice as an example.5 the purpose of the clauses is described in detail in sections iii and iv. however, briefly it can be said that ea clauses aim to confine the full agreement between the contractual parties into the contractual text; they intend to exclude any extrinsic communication, agreements and evidence from determining the contract’s content and, depending on jurisdiction, contract interpretation. the ea clauses are typical examples of boilerplate provisions characteristic of common law contract models.6 the use of common lawinspired boilerplate provisions has proliferated globally through commercial contracting, in both common and civil law countries. in order to ascertain the use of ea clauses in danish contracts, the authors have conducted interviews with representatives of danish companies and legal practice. the investigation confirmed that indeed ea clauses are present in an absolute majority of international contracts regardless of the contracts and the applicable law (cambridge university press 2011), 16 (hereinafter cordero-moss ed., boilerplate clauses). 2 g cordero-moss, ‘international contracts between common law and civil law: is non-state law to be preferred? the difficulty of interpreting legal standards such as good faith’ (2007) 7(1) global jurist 1, 1. 3 w wiegand, ‘the reception of american law in europe’ (1991) 39 ajcl 229. 4 m shapiro, ‘the globalization of law’ (1993) 1 ind.j.global legal studies 37, 39; fw grosheide, ‘legal borrowing and drafting international commercial contracts’ in k boele-woelki et al. (eds), comparability and evaluation: essays on comparative law, private international law, and international commercial arbitration, in honour of dimitra kokkiniiatridou (m. nijhoff publishers 1994), 74-75. 5 see also katerina mitkidis, the use of entire agreement clauses in contracts governed by danish law, 2017/3 erhversjuridisk tidskrift 198 (reporting empirical observations gained through an interviews-based study on the use of ea clauses in contracts governed by danish law). 6 a müller, protecting the integrity of a written agreement: a comparative analysis of the parol evidence rule, merger clauses and no oral modification clauses in u.s., english, german and swiss law and international instruments (cisg, picc, pecl, dcfr and cesl) (eleven international publishing 2013), 177-178; r strugała, ‘merger clauses in contracts governed by polish law’ (2013) 3 wroclaw review of law, administration and economics 14, 15. ea clauses: us and danish law? 184 governing law, and sometimes also in domestic contracts.7 this widespread use of common law-originated boilerplate provisions, and namely ea clauses, calls for more investigation into this phenomenon, especially due to their hesitant and somewhat unclear acceptance by civil law judiciary.8 thus, while applying comparative law method and taking the departure in theories of diffusion of law9 (including the legal transplant theory),10 this article aims to investigate the treatment of ea clauses in contracts governed by danish law and open up the discussion whether on the example of ea clauses we can indeed observe americanization of danish contract law or whether we should rather speak of legal transplants or convergence between american and danish contract law. possibly, the answer is neither of the above, but a development of transnational contract law and practice that is increasingly disconnected from national legal systems. the article has both theoretical and practical relevance; it contributes to the legal scholarship on transnationalization tendencies in private law as well as provides danish companies with a better understanding of the background and original purpose of ea clauses and the treatment of these clauses under danish jurisdiction, therefore allowing them to better manage the connected business and legal risks. the question at hand will be approached through the following steps: (i) reviewing currently predominant contract drafting style and the reasons behind it, (ii) identifying the original function of ea clauses under american law and assessing whether this function is fulfilled under american law, (iii) assessing whether the original function is achieved when ea clauses are included in contracts governed by danish law, and (iv) discussing whether on the example of the use of ea clauses in danish contracts we can observe americanization of danish law, convergence between the two legal systems or development of a transnational contracting practice disconnected from national laws. the article presents a micro-comparison of ea clauses in two jurisdictions, namely the usa and denmark. the selection of the usa for the comparison is straightforward as explained in the introduction part above. denmark is then chosen for several reasons. firstly, denmark, although home to a number of large multinational companies, is a smaller 7 the collected data (anonymized) are on file with the corresponding author and reported in mitkidis (n 5); for data from another civil law jurisdiction, see e.g. d beenders and jw meijer, ‘uitleg van commerciële contracten in de praktijk’ (2013) 9 aa 646 (reporting that over a half of dutch contracts, including those between domestic parties, include an ea clause). 8 for danish case law, see below section v. for a prominent civil law case on this issue, see the decision of the dutch supreme court hr 5 april 2013, nj 2013, 214 (establishing the exact opposite effect of an ea clause than its original one). 9 w twining, ‘diffusion of law: a global perspective’ (2004) 49 j legal plur 1, 5. 10 a watson, legal transplants: an approach to comparative law (2nd edn, university of georgia press 1993). njcl 2017/2 185 country with strong economic ties to the usa,11 and thus presumably exposed to the influence of the us contracting practice. secondly, denmark is part of scandinavia, which is a legal region known for its pragmatic court approach. the effects of ea clauses that american owners and business partners of danish corporations expect may not materialize here. finally, the article aims to contribute new knowledge to legal scholarship, as there is currently no comprehensive literature on this issue in regard to denmark.12 the starting point of this article is an investigation into a legal institution originating in one jurisdiction and comparing its effects while being repeatedly used in another jurisdiction. the point of departure is thus the idea of borrowings, or in other words, diffusion of laws and legal institutions among jurisdictions.13 traditionally, legal transplants scholarship has been concerned with moving of an entire legal system or a portion of it (meaning a legal rule in the form of a statute) to a new location, through copying or imposing laws in order to establish a legal system where there was not such one, in order to fill in existing gaps in the recipient’s legal system or to replace it entirely.14 this narrow understanding of legal transplants has been broadened and many variants have been identified, this leading to speaking rather of diffusion of law as a broader term than legal transplants.15 diffusion of law through commercial contracts are one of the variants.1617 11 the usa is denmark’s main non-european trading partner, see http://www.worldstopexports.com/denmarks-top-import-partners/. 12 within danish jurisdiction, one master thesis studying ea clauses from the law and economics perspective has been found, see al carstensen and jk christensen, fuldstændighedsklausuler i b2b kontrakter (merger clauses in b2b contracts) (supervised by p møgelvang-hansen and o lando, 2009). for studies on ea clauses from other jurisdictions, see strugała (n 6); müller (n 6); hw bjørnstad, entire agreement-klausuler (skriftserie 177, institutt for privatrett, university of oslo 2009); m fontaine and f de ly, drafting international contracts: an analysis of contract clauses (2nd edn, martinus nijhoff 2009), 129-150; l gorton, ‘merger clauses in business contracts’ (2008) erhvervsjuridisk tidsskrift 344; d van dorst, the entire agreement clause, (msc thesis supervised by mw hesselink, 2015); o kirman, (re)defining the entire agreement clause, (msc thesis supervised by v mak and g van dijk, 2015/16). 13 ‘history of a system of law is largely a history of borrowings of legal materials from other legal systems and of assimilation of materials from outside of the law.’ see watson (n 10), 22 (citing roscoe pound). twining (n 9); m graziadei, ‘comparative law as the study of transplants and receptions’ in m reimann and r zimmermann (eds), the oxford handbook of comparative law (oxford university press 2006). 14 watson (n 10). 15 twining (n 9), 17; a watson, ‘legal transplants and european private law’ (2000) 4.4 ejcl, http://www.ejcl.org/ejcl/44/44-2.html. 16 see e.g. l-w lin, ‘legal transplants through private contracting: codes of vendor conduct in global supply chains as an example’ (2009) 57(3) ajcl 711. 17 nb, we use the term diffusion of law in line with twining (n 9). for the purpose of this article, this term encompasses among others also the term of legal transplant. ea clauses: us and danish law? 186 contractual freedom allows parties to include in their contract provisions originating from another legal system than the governing law of the contract, or the domestic law of the parties for that matter. such foreign provisions and legal constructs can then be seen as a type of a legal transplant,18 and ea clauses are a frequently seen example of the same in danish contract practice. 2. commercial contract drafting major legal transplants (most often) happen as a conscious process; the exporter wants to impose her legal rules and institutions upon the importer or the importer wants to copy the rules of the exporter. however, the diffusion of ea clauses from american to danish law happen mostly unintentionally as a result of day-to-day contract drafting and negotiation practice rather than fulfilling specific legal needs.19 today, when a lawyer starts drafting a new contract, (s)he will rarely start from scratch. in order to save time and money,20 lawyers will usually reach for a similar, previously written contract, the company’s standard terms and conditions or a pre-printed contract form (contract models).21 the existence of such models is moreover of great importance when a contract is negotiated by a businessperson without the involvement of a lawyer.22 rarely the contract model is used in full, but the final contract is a mix of provisions coming from different sources and different jurisdictions that do not necessarily respect the legal system and culture of the governing law of the contract.23 in fact, it is not uncommon that the governing law is chosen only after the contract is negotiated.24 thus, in an 18 due to its closer ties to economic interests rather than national legal culture and sentiments, contract law and commercial law are considered easier transferable than for example public or constitutional law. see o kahn-freund, ‘on uses and misuses of comparative law’ (1974) 37(1) mlr 1, 12-13; twining (n 9), 29; and r cotterrell, ‘is there a logic of legal transplants?’ in d nelken and j feest, adapting legal cultures (hart publishing 2001), 82. 19 not all uses of ea clauses are however unintended. companies may want to include the clauses into their contracts to fulfil the functions originally assigned to them by common law or other strategic functions, such as ascertaining a strong negotiation position if a dispute arises (see cordero-moss ed., boilerplate clauses (n 1), 4) or simply influencing the behaviour of the parties (see echenberg (n 1), 5). 20 mc vettese, ‘multinational companies and national contracts’ in cordero-moss ed., boilerplate clauses (n 1), 20-21. 21 la dimatteo, international contracting: law and practice (kluwer law international 2013), 37. 22 vettese (n 20), 22; dimatteo (n 21), 38. 23 g cordero-moss, anglo-american contract models and norwegian or other civilian governing law: introduction and method (skriftserie 169, institutt for privatrett, university of oslo 2007), 8. 24 f bortolotti, drafting and negotiating international commercial contracts: a practical guide (international chamber of commerce 2013), 100. njcl 2017/2 187 extreme situation, some of the provisions originating from foreign law or contract models may not only be incompatible, but directly a breach of the governing law of the contract or the laws of the country where the contract is performed.25 in order to avoid such negative effects, companies using common law-inspired contract models in contracts governed by a civil law system should systematically compare each provision of the contract model and each legal concept with the governing law of the contract to make sure that the content is consistent with it. however, such exercise is extremely time consuming and thus costly and would mean that the use of contract models does not reduce but escalate negotiation costs.26 that is why companies often accept the original wording of a contract model without critically assessing it against the governing law and treat it as an acceptable legal risk. often, they are lucky; the inconsistency between the origins of contract models and the governing law usually does not cause troubles during the contract performance.27 it may, however, bring uncertainties to the contractual parties when a dispute arises as to what effects these provisions will have under the governing law. civil law judges and arbiters will have to ask the questions whether to respect the parties contractual text and approach it as a correction of the governing law or whether the principles underlying the governing law should prevail over the expressed words of the contractual parties.28 one of the major consequences of the use of common law-inspired contract models is the trend towards drafting self-sufficient contracts.29 in the words of corderro-moss, self-sufficient contracts mean contracts that are ‘uniformly interpreted on the basis of its own terms.’30 logically, they are long and as exhaustive as possible. drafting such contracts is counter-intuitive in civil law countries. traditionally, commercial contracts originating in civil law countries are concise and address only major aspects of the specific deal.31 there are a couple of reasons for this. firstly, the contractual parties in civil law 25 s hecker et al., ‘between a rock and a hard place: anti-corruption compliance and antitrust law in russia’ (debevoise&plimpton, fcpa update: a global anticorruption newsletter, 2015-03), http://www.debevoise.com/~/media/files/insights/publications/2015/03/fcpa_upda te_march_2015.pdf. 26 et canuel, ‘comparative commercial law: methodologies, black letter law and law-in-action’ (2012) nordic journal of commercial law 1, 24. 27 in the danish context, this can be proved by the small number of court decisions on the use of ea clauses in contracts governed by danish law. 28 cordero-moss (n 2), 19-21. 29 g cordero-moss, ‘conclusion: the self-sufficient contract, uniformly interpreted on the basis of its own terms: an illusion, but not fully useless’ in cordero-moss ed., boilerplate clauses (n 1). 30 ibid 31 r nielsen, contract law in denmark (djøf publishing 2011), 90. ea clauses: us and danish law? 188 jurisdictions can rely on the definitions, regulation and principles codified in the governing law of the contract.32 thus, there is no point in drafting lengthy contracts just to repeat what is stated in the background law or to run the risk that such formulation could be overturned by an adjudicator applying the underlying principles of the governing law, such as the principles of fairness and reasonableness. concise contracts are thus an expression of transaction efficiency.33 secondly, contract law in civil law countries, including denmark, is based on the principle of consensualism.34 according to this principle, a contract is born when the parties agree on the principal matters of the object of the contract. this is reinforced by the subjective theory of interpretation in determining contracts’ content typical for civil law countries, when the subjective intent of the parties is the starting point.35 in contrast, contracts originating in common law countries are traditionally lengthy and detailed.36 they are based on the principle of predictability.37 a major aspect of predictability is that contractual parties are able to forecast an outcome if a dispute arises from their contract. while in civil law countries predictability is supported by codification of law, in common law countries it is secured by the parol evidence rule. within the us context,38 the parol evidence rule in essence means that when an adjudicator construes a contract, he will be bound by the actual contractual text and will not be able to use extrinsic evidence presented by the parties, which contradicts or alters the writing, if the parties intended the contract to integrate all their prior or contemporaneous agreements.39 the background idea is that commercial parties are able to understand and 32 vettese (n 20), 24. 33 tomas lindholm in mb andersen and j christoffersen (eds), forhandlingene ved det 38. nordiske juristmøde i københavn, 21.-23. august 2008, volume 2, (2008), available at http://nordiskjurist.org/meetings/fremmede-retsbegreber-i-nordisk-kontraktsret/, 616. 34 nielsen (n 31), 76. 35 there is no clear subjective or objective theory of interpretation, but shades and mixtures of both. however, civil law countries take most often subjective theory as their starting point in contract interpretation, while common law countries start from the objective theory. see jm perillo, ‘the origins of the objective theory of contract formation and interpretation’ (2000) 69 fordham l.rev. 427; fontaine and de ly (n 12), 106-114. 36 vettese, (n 20), 23. 37 cordero-moss (n 2), 1; lindholm (n 33), 616. 38 while shared by all common law countries, the rule has developed slightly differently in various common law jurisdictions. for a general overview, see fontaine and de ly (n 12), 114ff. 39 ra lord, williston on contracts (4th edn, thomson reuters 1990), para 33.1 (hereinafter williston on contracts); al corbin, jm perillo and je murray, corbin on contracts (lexis nexis, matthew bender 2015; release no. 15s2), chapter 5 (hereinafter corbin on contracts); ucc § 2-202 (amended 2002); restatement (second) of contracts § 213 (1981). njcl 2017/2 189 evaluate business opportunities and risks and enter into agreements based on this understanding.40 as a consequence, they should be able to rely on what they have agreed to in writing and judicial intervention into the deal should be limited. that is why business actors in common law countries aim to cover as many details as possible in the contractual text and to make the contract complete and integrated ‘on its face’, so that there is only a little room for determining the content of the contract based on other circumstances and documents. ea clauses are typical means to express the parties’ intention to conclude a completely integrated contract and to reinforce the parol evidence rules.41 the substantive parol evidence contract is then accompanied by objective style of contract interpretation that is based on the principle of formalism.42 when interpreting a contract, us adjudicators are not restricted to move within the four corners of a contract, but in case of a conflict between the wording of a contract and any extrinsic evidence, the express terms of the contract will prevail.43 the spread of the common law-inspired contract models brought not only the actual wording of contractual provisions, but naturally also the drafting style as such.44 the unification of international contract drafting style, as we will show below on the example of ea clauses, obscures the presumed sharp distinctions between civil and common contract law and may even influence the legal interpretation of contracts. the trend of self-sufficient contracts, however, goes beyond the use of common law-originated contract models. it has also been tied with the effort to disconnect a contract from its governing law as much as possible, to create ‘a barrier from the real world.’45 this comes from the fact that when a contract’s governing law is different from the one of a contracting party, this party will most often not have as detailed knowledge of the governing legal system as needed to understand the system’s consequences for the contract and the business. it is thus safer for the contracting party to secure that the contract itself will be self-sufficient and that the influence of the governing law will be minimal.46 although various tools have been developed in contract practice to secure the contract’s self-sufficiency, the idea that a contract may be entirely self-sufficient and completely disconnected from the governing law is rather illusory. first of all, the contractual parties cannot naturally 40 similarly, in regard to english law, see cordero-moss (n 2), 4-5. 41 see below section iv.a. 42 ml movsesian, ‘formalism in american contract law: classical and contemporary’ (2012) 12 ius gentium 115; la dimatteo, ‘false dichotomies in commercial contract interpretation’ (2012) 11 journal of international trade law and policy 27. 43 ucc § 1-303 (e) (amended 2001). 44 d plechinger, ‘der skal være en udløbsdato på sådan en post’ (based on an interview with søren jenstrup), advokaten 4/2015, 21-22. 45 vettese (n 20), 26. 46 corderro-moss classifies ea clauses as clauses ‘aiming at fully detaching the contract from the applicable law’, see cordero-moss ed., boilerplate clauses (n 1), 353-358. ea clauses: us and danish law? 190 foresee all possible events and thus no contract can be fully complete. nevertheless, detailed wording lowers the possibility of contract interpretation using extrinsic evidence.47 secondly, the governing law may contain some mandatory provisions that the contractual parties cannot ignore. and finally, the governing law’s rules on interpretation will affect the extent to which the contract can be considered the whole agreement between the parties. still, ea clauses are a major means aiming to establish selfsufficiency of a contract and detaching a contract from its governing law. their main function is to exclude all or specifically named extrinsic evidence, such as prior agreements, precontractual documents and communication, and sometimes even general conditions and trade usage from the contract for the purpose of its interpretation.48 ea clauses seem to contain both substantive and evidentiary elements to it; though this view differs across jurisdictions. in the usa, the parol evidence rule and thus also ea clauses are considered a substantive contract law issue.49 in civil law countries, ea clauses have a stronger evidentiary connotation.50 a common ea clause may read as follows: ‘[t]his agreement constitutes the entire agreement between the parties pertaining to the subject matter contained herein, and supersedes all prior agreements, representations and understandings of the parties.’51 the general motivation for inclusion of an ea clause into a contract is to achieve certainty as to the scope of the understanding between the contractual parties, especially for the purpose of its interpretation by courts if a dispute arises.52 however, as a typical boilerplate provision, an ea clause is often not given much thought during negotiations. after lengthy negotiations, the parties may truly believe that the contract is the complete understanding between them and that the ea clause merely restates this.53 however, as we will see below, they may be mistaken. 47 ea farnsworth, farnsworth on contracts (3rd edn, aspen publishers 2004), para 7.1, 219 (hereinafter farnsworth on contracts), para 7.3, 232; bortolotti (n 24), 100-101. 48 fontaine and de ly (n 12), 131. 49 williston on contracts (n 39), para 33.1 (stating that there is a general agreement in scholarship and case law that the parol evidence rule is a rule of substantive law of contracts.); and similarly farnsworth on contracts (n 47), para 7.2, 222. 50 gorton (n 12), 2; see also cisg-ac opinion no 3, ‘parol evidence rule, plain meaning rule, contractual merger clause and the cisg’, 23 october 2004, rapporteur: professor richard hyland, rutgers law school, camden, nj, usa. 51 example taken from corbin on contracts (n 39), para 25.8. 52 gorton (n 12), 1. 53 tl stark, negotiating and drafting contract boilerplate (lexis nexis, law journal press 2003), para 18.01. njcl 2017/2 191 3. ea clauses under american law before looking into the treatment of ea clauses by danish law, we have to establish what the original purpose of these clauses is under american law and to what extent it is achieved in practice. it may be a simplification to address american contract law as one set of legal rules since american contract law is essentially common law, which can develop differently among various states. still, american contract law is more consistent among the states than one would expect. firstly, common law of contracts in various states share basic principles. these can be found in the restatement (second) of the law of contracts, a treatise with a strong authoritative power that is frequently cited in american court decisions and jurisprudence. secondly, the uniform commercial code has been adopted with the purpose of harmonizing major parts of commercial law across the country. finally, other aspects, such as one language and legal education, contribute to the integrated american legal culture.54 it is this common core of american contract law that is considered in this article. 3.1. ea clauses and determining the contractual content in the usa, the use of ea clauses emerged as a reaction to uncertainties connected to the application of the parol evidence rule;55 specifically, as a defence against self-serving testimonies by the parties that they agreed on something different from what is covered by the text of their contract.56 if an ea clause is found enforceable, it will (most often) not only invoke strict application of the parol evidence rule, i.e. prevent consideration of any extrinsic evidence contradicting, modifying or varying the contractual terms, but also prevent consideration of any additional terms when determining the contractual content. the parol evidence rule applies when the contractual parties intended to conclude a completely integrated contract.57 in order to establish whether a contract is completely integrated, the adjudicator considers primarily the text of the contract. however, the adjudicator may consider extrinsic evidence if it proves that the contract was not intended to be completely integrated.58 in order to prove the intention to enter into a completely integrated contract, parties started including an ea clause in the contractual text. traditionally, courts have found the presence of an ea clause to be conclusive evidence of the parties’ intention to enter into 54 jm smits, ‘law making in the european union: on globalization and contract law in divergent legal cultures’ (2007) 67 la.l.rev. 1181, 1183. 55 wallach speaks about the ‘private parol evidence rule’, see gi wallach, ‘declining sanctity of written contracts-impact of the uniform commercial code on the parol evidence rule’ (1979) 44 mo.l.rev. 651, 677. 56 farnsworth on contracts (n 47), para 7.3, 233; fontaine and de ly (n 12), 118. 57 ucc § 2-202 (amended 2002); restatement (second) of contracts § 213 (1981). 58 restatement (second) of contracts § 209(3) (1981). ea clauses: us and danish law? 192 a completely integrated contract.5960 however, this strict interpretation has since been relaxed. as wallach wrote ‘[...] the erosion which the parol evidence rule has undergone under the uniform commercial code is being paralleled, as yet to a significantly lesser degree, by an erosion of the impact of merger clauses.’61 restatement second then pointed out that ‘a writing cannot of itself prove its own completeness.’62 this view has been picked up by a large amount of court decisions stating that the ea clause is a strong, but only one evidence to 59 farnsworth on contracts (n 47), para 7.3, 233; wallach (n 55), 677; from a vast amount of case law, see e.g. adr north america, l.l.c. v agway, inc., 303 f.3d 653 (6th circ. 2002) (‘... a written integration clause is conclusive evidence that the parties intended the document to be the final and complete expression of their agreement and that the parties intended to supersede any prior contract on the same subject matter ...’); wayman v amoco oil co., 923 f.supp. 1322 (d. kansas 1996) (ea clause given effect although not read); smith v central soya of athens, inc., 604 f. supp. 518 (ednc 1985) (‘the existence of a merger clause generally provides unambiguous and unassailable evidence of the parties’ intent with reference to the terms of the contract. it clearly precludes a court from admitting extrinsic evidence on a theory that the writing was not a final expression.’); rahemtulla v hassam, 539 f.supp.2d 755 (m.d. pa. 2008) (‘where a written contract contains an integration clause, the law declares the writing to not only be the best, but the only evidence of [the parties’] agreement.’); harbour town yacht club boat slip owners’ ass’n v safe berth management, inc., 421 f.supp.2d 908 (d.s.c. 2006) (‘... if the writing on its face appears to express the whole agreement, parol evidence cannot be admitted to add another term thereto. the parol evidence rule is particularly applicable where the writing in question has an integration clause.’); an ea clause is applied even in a stricter manner where one of the parties is the state, see e.g. sterling, winchester & long, l.l.c. v u.s., 83 fed.cl. 179 (fed. cl. 2008) (‘when a document contains an integration clause, no additional terms may be added, whether consistent or inconsistent, through parol evidence.’). 60 this view still prevails in certain jurisdictions, such as n.y., see a schwartz and re scott, ‘contract interpretation redux’ (2010) 119 y. l. j. 926, 928. 61 wallach (n 55), 678. 62 restatement (second) of contracts § 210, comment b (1981). njcl 2017/2 193 be considered in determining parties’ intention in regard to contract’s integration.6364 in relation to this, the question whether the clause was negotiated by the parties has gained importance. when ea clauses came to use, contractual parties were aware of why they included such a clause into their contract. this is, however, not common nowadays when ea clauses have to a large extent become standardized and included in commercial contracts as a part of boilerplate provisions. this has raised doubts about the factual intention of the parties, the understanding and the use of ea clauses.65 nowadays, it is widely accepted that non-negotiated ea clauses may be qualified as unconscionable,66 and therefore easier dislodged.67 a connected issue is the character of and the power balance between the contractual parties. the courts are more willing to give effects to an ea 63 jm perillo, calamari and perillo on contracts (6th edn, st paul: west 2009), para 3.6 (hereinafter calamari and perillo on contracts); from vast amount of case law, see e.g. enrico farms, inc. v h. j. heinz co., 629 f.2d 1304 (9th circ. 1980) (‘... an integration clause in the written agreement is not necessarily conclusive as to the parties’ intent to include their entire agreement in the writing.’); mecklenburg furniture shops, inc. v mai systems corp., 800 f.supp. 1328 (w.d.n.c. 1992) (‘... where the instrument contains an integration clause, that clause may well be conclusive on the issue of integration. nonetheless, the court must not limit its consideration to the integration clause. rather, the court should consider all the surrounding circumstances, including the prior negotiations of the parties, and the terms of the collateral agreement.’); sicor ltd. v cetus corp., 51 f.3d 848 (9th circ. 1995) (‘... an integration clause in the written contract is but one factor in this analysis’); judson atkinson candies, inc. v kenray associates, inc., 719 f.3d 635 (7th circ. 2013) (‘because an integration clause is only some evidence of the parties’ intentions, the court should consider an integration clause along with all other relevant evidence on the question of integration. as such, the mere inclusion of an integration clause does not control the question of whether a writing is or was intended to be a completely integrated agreement.’); budnick converting, inc. v nebula glass intern., inc., 866 f.supp.2d 976 (s.d. ill. 2012) (‘... a merger or integration clause is strong evidence of the parties’ intent, not only to be bound by the agreement, but to have it override conflicting provisions that may have been contained in previous or contemporaneous dealings between the parties ...’); haywood v university of pittsburgh, 976 f.supp.2d 606 (w.d. pa. 2013) (‘an integration clause which states that a writing is meant to represent the parties’ entire agreement is also a clear sign that the writing is meant to be just that and thereby expresses all of the parties’ negotiations, conversations, and agreements made prior to its execution.’) 64 this view prevails for example in california, see schwartz and scott (n 60), 928. 65 rj mooney, ‘a friendly letter to the oregon supreme court: let’s try again on the parol evidence rule’ (2005) 84 or.l.rev. 369, 387 (‘if, however, as is more generally true, one or both parties did not read the clause, did not understand it, or had no realistic choice with respect to it, the court should declare it to be unenforceable boilerplate...’). 66 ucc § 2-302 (amended 2002); restatement (second) of contracts § 208 (1981). see also kl macintosh, ‘when are merger clauses unconscionable?’ (1988) 64 denv.u.l.rev. 529; and seibel v layne & bowler, inc., 56 or.app. 387 (or. ct. app. 1984). 67 calamari and perillo on contracts (n 63), para 3.6. ea clauses: us and danish law? 194 clause if both parties are experienced commercial subjects with a comparable negotiation power.68 3.2. ea clauses and contract interpretation if given effect, an ea clause will prevent extrinsic evidence in determining the content of a contract. however, it will generally not affect the use of extrinsic evidence for interpreting ambiguities in the contractual text.69 this means that in a dispute decided upon by a us court about a contract including an ea clause, the judge should proceed in the following way. first he should decide whether the contract is a (fully) integrated one taking into consideration the merger clause. if the answer is positive, then he moves to the question of what is the content of the contract. in answering this question, he will disregard any extrinsic evidence that would contradict, modify or add any terms to the actual contractual text. finally, if there are any ambiguities in the contract, he will interpret the meaning of such provisions with the aim of respecting the parties’ intention. when interpreting the contractual text, he may use all extrinsic evidence. however, following the formalist (textual) interpretation, the extrinsic evidence must not contradict the contractual text.70 while this process seems quite straightforward, it is not as simple to follow in practice as the issues of determining the contractual content and its interpretation may overlap and may be (and indeed often are) easily confused.71 in order to avoid confusion and give effect to an ea clause in regard to contract interpretation, it is advised that the parties expressly refer to what cannot be used when explaining the meaning of a contractual text. such a clause could read as follows:72 this agreement constitutes the final agreement between the parties. it is the complete and exclusive expression of the parties’ agreement on the matters contained in this agreement. all prior and contemporaneous negotiations and agreements between the parties on the matters contained 68 rumsfeld v freedom ny, inc., 329 f.3d 1320 (fed. cir. 2003) (‘where, as here, the parties are both commercial entities or the government, integration clauses are given particularly great weight.’). 69 restatement (second) of contracts § 216, comment e (1981) (‘but such a [ea] clause does not control ... the interpretation of the written terms.’); see also gb smith and tj hall, ‘merger clauses and parol evidence rule’ (new york law journal, 20 february 2015), http://www.newyorklawjournal.com/id=1202718353003/merger-clauses-andparol-evidence-rule?slreturn=20170124032213. 70 ucc § 2-202 (b) (amended 2002). 71 mn kniffin, ‘conflating and confusing contract interpretation and the parol evidence rule: is the emperor wearing someone else’s clothes?’ (2009) 62 rutgers l.rev. 75, 80-81. from scholarship, see example in fontaine and de ly, who categorize ea clauses as interpretation clauses despite their original purpose (i.e. to invoke the parol evidence rule), while discussing their effects both on contract determination and interpretation, see fontaine and de ly (n 12), chapter 3 (c). 72 example borrowed from stark (n 53), para 18.05. njcl 2017/2 195 in this agreement are expressly merged into and superseded by this agreement. the provisions of this agreement may not be explained, supplemented, or qualified through evidence of trade usage or a prior course of dealings. 3.3. summary on us law to summarize, under american law ea clauses are an important – though generally rebuttable – evidence of the parties’ intention to conclude an integrated contract.73 thus, it has exclusionary effect in determining the content of the contract, but – unless expressly stated – it does not affect the interpretation of the meaning of the text. the weight assigned to an ea clause is decided on a case-to-case basis74 and depends, among other things, on the way the provision is drafted and the types and power of the contractual parties. it is thus advised that if contractual parties indeed want to secure enforceability of an ea clause in the usa, it should be carefully drafted and made as conspicuous as possible, for example by using bold letters.75 4. ea clauses under danish law this part of the article moves to the analysis of the use of ea clauses in contracts governed by danish law. before entering into analysis of ea clauses under danish law, a basic overview of danish (contract) law is needed. 4.1. background comments on the danish legal system while danish law is commonly classified as pertaining to the civil law family, it is more correct to classify it as belonging to the nordic legal subfamily as it carries features that distinguishes it from the germanic and romanic legal systems. 76 for example, the nordic countries have not adopted the structure typical for civil legal systems.77 neither do they operate with big codifications, but with statutes dealing with specific 73 in fact, omission of an ea clause has been taken into consideration by some courts when determining completeness of contracts; see e.g. rajala v allied corp., 66 b.r. 582 (d. kansas 1986). 74 steak n shake enterprises, inc. v globex company, 110 f.supp.3d 1057 (d. colorado 2015). 75 stark (n 53), para 18.01 and para 18.03. see also seibel v layne & bowler, inc., 56 or.app. 387 (or. ct. app. 1984) (‘we think that a merger clause which would deny effect to an express warranty must be conspicuous to prevent an even greater surprise.’). 76 k zweigert and h kötz, an introduction to comparative law (3rd edn, oxford university press 2011), part iv; however, nordic legal systems are sometimes considered as a separate legal family, see e.g. j lookofsky, ‘desperately seeking subsidiarity: danish private law in the scandinavian, european, and global context’ (2009) 161 duke j.comp.& int'l l. 161, 170. 77 lookofsky (n 76), 170. ea clauses: us and danish law? 196 topics.78 in the contract law area, the sale of goods act (købeloven)79 and the contracts act (aftaleloven)80 are the most important ones. these statutes date back to 1906 and 1917, respectively, and are examples of the nordic legal cooperation which has led to the statutes being adopted not only by denmark, but also by sweden and norway.81 the acts are characterized by not being as exhaustive as civil codifications tend to be; rather they reflect the general principles of contract law, contract formation and contractual obligations.82 for example, there is no general statutory regulation of contract interpretation, thus leaving this matter to the courts.83 hence, the courts play a particular role in the development of the law in areas like the one dealt with in the present article. though courts do rely on previous decisions,84 it is worth noting that denmark does not adhere to the doctrine of stare decisis.85 instead, judges may simply signal what arguments led them to decide in a particular way,86 and this combination of little non-exhaustive statutory regulation and the lack of official stare decisis has been described as ‘statutory light’ and ‘precedent light’.87 the fact that ea clauses are not subject to particular statutory regulation in denmark makes it important to understand how the danish judiciary approaches determination of contractual content and contract interpretation in order to predict the implications of including an ea clause in a contract governed by danish law. thus far, very few decisions from denmark have been identified as clearly dealing with this issue, though as previously explained, ea clauses are increasingly being used by danish corporations in contracts governed by danish law. two decisions by the copenhagen maritime and commercial court (sandrew metronome international v angel scandinavia88 and rotate aviation v air kilroe89), however, 78 o lando et al., restatement of nordic contract law 14 (djøf 2016) (hereinafter restatement of nordic contract law), 14; p møgelvang-hansen, ‘the nordic tradition: application of boilerplate clauses under danish law’ in cordero-moss ed., boilerplate clauses (n 1), 233. 79 lovbekendtgørelse af 17.2.2014 nr. 140 købelov (købeloven). 80 lovbekendtgørelse af 2.3.2016 nr. 193 om aftaler og andre retshandler på formuerettens område (aftaleloven). 81 on nordic cooperation, see nielsen (n 31), 38-40. 82 p møgelvang-hansen, ‘contracts and sales in denmark’ in b dahl et al., danish law in a european perspective (2nd edn, karnov 2002), 238. 83 restatement of nordic contract law (n 78), 28. 84 t håstad (ed), the nordic contracts act: essays in celebration of its one hundred anniversary (djøf 2015), 25-28 (at 28 stating that ‘... the danish ... supreme court has changed over the last two decades from being a court of appeals to becoming a court of precedents.’). 85 restatement of nordic contract law (n 78), 18. 86 lookofsky (n 76), 177-178. 87 lookofsky (n 76), 178. 88 sh2005.h-0132-02. 89 sh2012.h-0011-11. njcl 2017/2 197 do consider the implication of an ea clause, though due to the less formalistic approach by the danish judiciary, the background law is not possible to decipher. while in the former case the copenhagen maritime and commercial court ignored the ea clause, in the latter the court adhered to it entirely; in both cases without further explanation as to the applicable background law. instead, the court relied fully on contract interpretation as it saw fit in both decisions. most likely, the court in sandrew metronome international v angel scandinavia did not rely on any particular law. when deciding disputes, especially in the area of contract law, danish judges are often unwilling to or not able to rely on strict formal statutes as these are very limited and even when such are available, they generally do not feel strictly bound by the wording of such statutes.90 instead, the judges will aim to reach a reasonable and fair outcome.91 one scholar has described the ways of the danish judiciary as one where the judge has an idea about the outcome and then reasons backwards to test the correctness of his conclusion.92 this particular style may seem unfamiliar and perhaps even inappropriate to lawyers outside the nordic region, and the danish courts have indeed been criticized for their lack of transparency and predictability when they decide without any clear legal basis. one author critically describes the courts as giving oracle-like decisions.93 however, dealing with contractual disputes through a weighing of values, principles and considerations of the particular trade rather than by formal rules is also a pragmatic one, and it has proved to be both an effective and respected way of dispute resolution.94 to provide but one example of the style of the danish judiciary, one may again turn to sandrew metronome international v angel scandinavia.95 the decision by the court is reasoned entirely by facts and is rather short – approximately 500 words. in no place does the court refer to applicable law, rules or principles. this style of the danish judiciary is common in 90 restatement of nordic contract law (n 78), 16. 91 the statutory expression of the principle of reasonableness can be found in art 36 of the contracts act. 92 j lookofsky, ‘the limits of commercial contract freedom: under the unidroit “restatement” and danish law’ (1998) 46 ajcl 485, 489-490. 93 c torp, ‘i anledning af højesterets 250-aarige bestaaen’ (1911) ugeskrift for retsvæsen b 49, 54. see also mb andersen, grundlæggende aftaleret (4th edn, gjellerup 2013), 446. 94 håstad (ed) (n 84), 30 (‘for a pragmatist the consequences of a rule may be more important than its contents.’). 95 see also bonansea v bombardier copenhagen maritime and commercial court 1 december 2008 cisgnordic.net id: 081201dk in which a similar approach is followed in clearly international contractual disputes. however, compare mjm athletic surplus v con.com copenhagen maritime and commercial court 26 february 2010 cisgnordic.net id: 100226dk in which the court’s reasoning was clearly based on application of the cisg. ea clauses: us and danish law? 198 decisions both involving domestic as well as international disputes, and it makes it difficult to draw general conclusions to be followed in the future. though particularly international disputes may place on the court a duty to carefully consider conflict of law rules or rules aiming at achieving uniformity in the field, the danish judiciary has not felt compelled to change their style.96 4.2. the inseparable issues of contractual content and contract interpretation danish contract law does not distinguish between determining the contractual content and contract interpretation as is done in common law.97 as described above, in the usa the judge will first establish which terms form the contract and then interpret them. at least that is the starting point, although often confused in practice and theory.98 in denmark as well as in other civil law countries the two steps merge together. ascertaining the borders of a contract – i.e. which terms are in and which are out – is a part of the contract interpretation exercise. thus, as a result of interpretation, a term may be supplemented by other documents or even added to the contractual text. the parol evidence rule is not known in denmark. when interpreting a contract, including the determination of its borders, a danish judge will consider the intention of the parties at the time of the conclusion of the contract.99 quite naturally, the intention is proven primarily by the text of the contract.100 prior negotiations, statements and agreements, whether written or oral, are thus prima facie irrelevant,101 however, they may be furnished as proof without any restrictions according to the principle of freely admissible evidence in section 344 of the administration of justice act.102 the presence of an ea clause in a contract challenges this free admissibility of extrinsic evidence and is dealt with below. 96 j lookofsky, ‘de danske domstoles håndtering af cisg’ (2012) 2012(27,28,29) ugeskrift for retsvæsen b 281, 281-289. 97 p høghberg, ‘avtaletolkning’ in mb andersen et al. (eds), aftaleloven 100 år: baggrund, status, udfordringer, fremtid (djøf 2015), 161. 98 n 79 99 møgelvang-hansen (n 82), 254. 100 nj clausen et al., dansk privatret (19th ed., djøf 2016), 140. 101 ugeskrift for retsvæsen 1973.338 h (the supreme court decided that witness statement on prior negotiation is not admissible as the contract included a clear provision on the disputed matter.). 102 lovbekendtgørelse af 13.10.2016 nr. 1257 retsplejeloven § 344. b gomard, hvg pedersen and a ørgaard, almindelig kontraktsret (5th edn, djøf 2015), para 3.2.2; jm lookofsky, consequential damages in comparative context (djøf 1989), 59 (describes this as ‘a scandinavian version of the [parol evidence] rule.’). njcl 2017/2 199 4.3. principles guiding the judiciary the pragmatic approach taken by danish courts is not to be equated with an absolute power by the judge to render the decision he desires, nor is it to be understood as a complete vacuum of law in which no guidelines exist. rather, the danish judiciary adheres to a number of considerations. these considerations permeate the danish legal system in general and in particular the field of contract law. to understand how the judiciary may receive ea clauses in practice requires insight into those guiding principles. hence, they are elaborated further below as they explain the somewhat inconclusive answer to the question raised in this article. the interpretation rules contained in the unidroit principles of international commercial contracts (hereinafter unidroit principles 2010) are similar to those applying in danish law.103 in relation to the topic of this article, it is worth noting that danish interpretation rules include interpretation in accordance with the common intention of the parties,104 interpretation of communication in line with a party’s intentions when the other party could not be unaware of it,105 and that all circumstances may be relied upon to demonstrate the party’s/parties’ intentions.106 the principle according to which any circumstance may be relied upon also links to the general rules on legal procedures that any evidence is permissible and can be weighed by the judge without any formal restrictions.107 this principle goes before the parties’ agreement regarding evidence,108 and upholding clauses restricting this principle would be to uphold agreements not anchored in the will of the parties since the parties are precluded from proving the contents of the agreement that was in fact made.109 however, there are authors calling for caution in setting aside an ea clause since the commercial parties’ contractual freedom combined with the principle of pacta sunt servanda should prevail over the procedural rules in relation to evidence.110 though this may be true, danish law relies heavily on considerations often tied to non-contractual circumstances. due to the principle of freedom of form and since evidence can be freely admitted, agreements are interpreted as a whole, meaning that the parties may refer to the purpose of the agreement, gap-filling rules, written and oral communication, previous and subsequent conduct, usual conduct in 103 andersen (n 93), 312. 104 unidroit principles 2010 art 4.1; restatement of nordic contract law (n 78), para 5-1. 105 unidroit principles 2010 art 4.2; restatement of nordic contract law (n 78), para 5-2. 106 unidroit principles 2010 art 4.3; restatement of nordic contract law (n 78), para 5-5. 107 lovbekendtgørelse af 13.10.2016 nr. 1257, retsplejeloven, para 344. 108 andersen (n 93), 328. 109 andersen (n 93), 328. 110 gorton (n 12), 8. ea clauses: us and danish law? 200 the trade, etc.,111 as expressed in section 5-5 of the restatement of nordic contract law: ‘in interpreting a contract […] due consideration must be given to all the relevant circumstances of the relationship, and in particular to: (a) the wording of the contract; (b) the nature and purpose of the contract; (c) the circumstances in which the contract was concluded, including the preliminary negotiations; (d) the conduct of the parties, including conduct subsequent to the conclusion of the contract; (e) the interpretation which the parties have previously given to similar clauses and the practices established between the parties; (f) rules of law, usage and the meanings commonly given to terms and expressions in the branch of activity concerned; (g) reasonableness and loyalty; and (h) the principles in § 5-6 to § 5-10.’112 when engaged in contract interpretation, danish law and the danish judiciary do not distinguish clearly between contract interpretation and gap-filling. rather, the two are seen as parts of an integrated process utilizing various methods and rules; hence it is crucial to know that the judiciary relies on a number of considerations that permeate the interpretation process.113 several considerations may be taken into account, and the most salient ones are described below. it is important to stress that these principles do not form part of a hierarchical structure. instead, they must be balanced.114 the considerations that may be relied upon contradict each other and form an enigma of equally plausible reasons for a particular court decision. the enigma consists of at least three primary considerations and a number of variations of them. the first one is the consideration of the promisor’s intentions according to which the judiciary is occupied by reaching an interpretation of the contract that does not impose an obligation on the promisor that it would usually not assume.115 this entails two things. first, the subjective will of the promisor is relied upon to determine the agreement between the parties when the promisee could not be unaware of that intention.116 the reasonable person standard plays a role when determining what the promisee should have been aware of.117 second, the parties’ implied expectations may be decisive in determining the content of the agreement between them and where those implied expectations do not hold true, it may be a reason for modifying or setting aside the agreement in part or in total according to paragraph 36 of the danish contracts act.118 in relation to ea clauses, it is relevant to know that the parties’ presumptions, that may not necessarily be expressed in the wording of the contract, may be 111 andersen (n 93), 310-311. 112 restatement of nordic contract law (n 78), para 5-5. 113 andersen (n 93), 312. 114 mb andersen and e runesson, ‘an overview of nordic contract law’ in andersen et al. (n 97), 39. 115 andersen et al. (n 97), 39. 116 andersen (n 93), 448. 117 andersen (n 93), 448. see also restatement of nordic contract law (n 78), para 5-4. 118 andersen (n 93), 448-449. njcl 2017/2 201 relied upon by the court to interpret the parties’ agreement or to render parts of it invalid.119 the second consideration is whether to protect the promisee’s reliance in the promisor and to uphold the understanding the promisee had of the promise made by the promisor.120 this entails securing a predictable supply chain by not allowing deviations from the promisee’s reasonable understanding of the promise made, by upholding the contract, and by protecting justified expectations that are based on or verified by for example conduct of the party/parties, practice between them, or usage in the trade.121 thus, it may be that a court would be reluctant to blindly apply an ea clause if it means to exclude considerations protecting the promisee’s reliance when it appears only from non-contractual circumstances. the third consideration is of public interest, such as eliminating unreasonable contract practice, protecting certain parties, or creating incentives for a certain behaviour.122 often, such considerations include thoughts on distribution of risk, protecting weak parties, promoting loyal behaviour, and discouraging abuse of legal or contractual rights.123 when two or more guiding principles are relevant for the dispute at hand, but they contradict each other, a weighing is necessary. this weighing is not governed by any rules. instead, the judiciary will consider whether giving preference to one or the other consideration leads to a desired distribution of risk between the parties, and whether the result appears to be proportional.124 therefore, knowing that non-contractual circumstances form an integrated part of establishing both the content of the parties’ agreement as well as interpreting it, makes it difficult to support that ea clauses will have an effect resembling the one known in us law when the contract is governed by danish law and decided upon by a danish judiciary. it may simply be asking too much of the judiciary, and despite the lack of transparent reasoning in danish court decisions, this article shall attempt to address the possible implications of ea clauses in a danish context immediately below. 4.4. possible implications of ea clauses governed by danish law considering the many guiding principles, the unwillingness of danish courts to adhere to strict formalistic rules, the sparse reasoning in 119 andersen (n 93), 57-58. 120 andersen and runesson (n 114), 40. 121 andersen (n 93), 449-459. 122 andersen and runesson (n 114), 40. 123 andersen (n 93), 455-462. 124 andersen (n 93), 468-471. ea clauses: us and danish law? 202 decisions, and the low amount of decisions on ea clauses make it difficult to predict the effect of ea clauses governed by danish law. on one hand, sandrew metronome international v angel scandinavia shows that the judiciary is willing to consider extrinsic evidence no matter the unequivocal inclusion of an ea clause in the contract. in the particular dispute, angel scandinavia had sublicensed the right to distribute a movie to movie theatres in sweden, norway and finland, as well as the right to distribute the movie outside theatres in denmark, sweden, norway and finland to metronome int’l. the latter were to pay for the sublicense by paying royalties, though a minimum payment of dkk 6 million was agreed upon. angel scandinavia reserved the right to distribute the movie to theatres in denmark. the dispute concerned whether the guarantee of a minimum royalty payment provided by metronome int’l for the distribution of the movie should be reduced by the income angel scandinavia had from distributing the same movie to theatres in denmark. the dispute involved both the sublicense agreement and a number of standard documents. to shed light on the understanding of the royalty calculations, reference to the negotiations was made. the decision rendered by the copenhagen maritime and commercial court illustrates not only the dissociation from the applicable background law by the court in its reasoning, but also that the circumstances of the dispute are weighed in light of the considerations described previously. the parties neither disputed that the ea clause formed a part of the agreement, nor did any of them argue that it was invalid. one party argued that the ea clause was irrelevant since there was no contradiction between the prior negotiations, the correspondence between the parties, and the final contract. the other party argued that the ea clause prohibited any extrinsic evidence. the court stated in its extremely brief reasoning that the understanding of the disputed crossing clause were to be based on an ‘overall assessment of the parties’ agreement, including the schedule of definitions, the general terms and conditions, the standard terms, the delivery schedule, and the prior negotiations.’125 hence, it seems like the ea clause was ignored by the court as it was willing to conduct an overall assessment of the contract and prior negotiations regardless of whether those were contradictory or not. on this background, it is questionable whether the inclusion of an ea clause in a contract will have any effect resembling what is expected under us law. instead, it seems that ea clauses in a danish context place the judiciary in a quandary; first, by asking it to distinguish between contract determination and contract interpretation, and second, by asking it to adhere to strict rules of formality contrary to the pragmatic principle-guided approach normally applied. in the case of sandrew metronome international v angel scandinavia there is no 125 sandrew metronome international v angel scandinavia, p. 20. translation of the original text by thomas neumann. njcl 2017/2 203 evidence that the court considered the parties’ intention of including the ea clause, thus setting aside both the principle according to which the understanding that will give terms of the contract effect is preferred126 and the party autonomy. on the other hand, one of the considerations is in fact the protection of the parties’ will. in rotate aviation v air kilroe the court decided to uphold an ea clause agreed upon. more specifically, the court had to decide whether or not the meaning expressed in a letter of intent could be used to shed light on an understanding of the final sales contract. the dispute concerned whether rotate aviation was entitled to payment for acting as an agent regarding the sale of three aeroplanes from air kilroe to blue air. rotate aviation’s efforts had resulted in blue air signing a letter of intent to purchase and to deposit a refundable sum and later non-refundable sums depending on the approval of the aeroplanes at a pre-inspection. later, blue air decided to not take delivery of the aeroplanes and demanded the deposits to be returned with reference to the letter of intent. with reference to the agency agreement, rotate aviation demanded half of the non-refundable sums as payment for its efforts. as a part of sorting out the contractual relationship between air kilroe as the seller and blue air as the buyer, the court stated expressly that according to the ea clause contained in the sales contract ‘[…] the letter of intent cannot be given consideration.’127 the court gave preference to the unequivocal and undisputed ea clause, thus following the supremacy of party autonomy and in turn also decided that rotate aviation as an agent could not rely on the initial letter of intent. the decision excluded terms of returning deposits from the letter of intent and gave preference only to the refund clauses contained in the final agreement. thus, rotate aviation’s share of the nonrefundable deposits were calculated based on the main agreement leaving aside the letter of intent due to the ea clause included in the final agreement, but not in the letter of intent. one way of reconciling these otherwise divergent decisions is looking towards the background of the parties in dispute. the danish judiciary will often do this as a part of a three-step approach to contract clauses in dispute: is the clause agreed upon(?), how is the clause to be interpreted(?), and is the clause so unreasonable that it should be set aside or changed(?).128 in neither of the two cases addressed previously was it disputed that the ea clause had been agreed upon, leaving it to the court to decide on the interpretation and effect of the clause, but in doing so, the court moved beyond the four corners of the contract. in sandrew metronome international v angel scandinavia both parties were from scandinavian countries. the former most likely from sweden and 126 restatement of nordic contract law (n 78), para 5-7. 127 rotate aviation v air kilroe, p. 16. translation of the original text by thomas neumann. 128 ll andersen and pb madsen, aftaler og mellemmænd (6th edn, karnov 2012), 27. ea clauses: us and danish law? 204 the latter from denmark. this means that the dispute essentially was between parties from the same nordic legal tradition. a tradition that normally does not adhere to strict requirements in respect to contract form as explained earlier. in contrast, the parties in rotate aviation v air kilroe were from denmark and the uk respectively, meaning that the dispute was a civil law/common law one. the parties could rightfully be thought to have different expectations as to the effect of an ea clause. the court could have considered this aspect in its decision, but due to the unfortunate tradition of oracle-like decisions, it is not possible to decipher this from the decisions themselves. a qualified guess is that the judiciary has followed the familiar three-step approach to tease out the proper application of the ea clause, thus ignoring the american effects and intentions behind such ea clauses and instead given priority to the likely expectations of the parties in the specific disputes. 4.5. final remarks on the treatment of ea clauses under danish law there seems to be a common understanding in the nordic scholarship that an ea clause can limit, but not eliminate the free admissibility of extrinsic evidence; an ea clause is considered to raise the burden of proof, i.e. particularly strong evidence is necessary to prove that the intention of the parties differs from what is expressed in the contractual text.129 this conclusion seems to be grounded in the underlying values and principles of danish (contract) law. the courts are presumed to weigh the freedom of contract against their own rules for free admissibility and assessment of evidence. as none of those principles are apparently stronger, the scholarship presumes that judges would likely give a limited effect to both. the discussion on the two available danish cases indicates, however, that danish adjudicators might instead of taking the middle road turn fully one or the other way. as suggested above, the origin of the contractual parties might be the determining factor for establishing ea clauses’ effect. if both parties come from denmark (or nordic countries for that matter), it might be too outstretched, in the face of the principle of free admission and assessment of evidence, to assign to the clause its original aim. however, if one of the parties comes from a common law country, and if the contract, although governed by danish law, is clearly based on a common law model (and especially if there is other connection to a common law country), subjecting the ea clause to danish interpretation 129 møgelvang-hansen (n 78), 236; gomard et al. (n 102), para 3.2.2; el andersen and n nørager, ‘hvorledes indga ̊r erhvervslivet aftaler?’ (2008) erhvervsjuridisk tidsskrift 34, 37; andersen (n 93), 328. njcl 2017/2 205 rules might result in a situation where the clause does not make legal sense and the parties’ intention is not respected.130 from the discussion so far, it becomes obvious that the scant reference to ea clauses in danish case law can give us only hints of danish courts’ treatment of these us-originated provisions. what we can deduce is that when establishing the content of and interpreting commercial contracts in the light of an ea clause, danish courts tend to give more importance to the underlying values and principles of reasonableness and fairness rather than going into technical details of the governing law’s rules. this can be (even unconsciously) led by the objective of not compromising the danish contract interpretation rules. thus, the overall conclusion is that ea clauses do not keep their original function when inserted in contracts governed by danish law, as their outcomes are at least uncertain. does that mean that the effects of ea clauses in contracts concluded in the us jurisdiction and the danish jurisdiction are fundamentally different? 5. discussion – legal transplants, convergence, transnationalization or? part 3 and 4 above discussed the treatment of ea clauses in us and danish law respectively. originating in common law jurisdiction, ea clauses are foreign to civil law systems, and thus also to the danish one. yet, they are regularly used in contracts drafted by danish companies and governed by danish law. is this practice an expression of a legal transplanting process, convergence between the two systems or neither of these, but rather a proof of transnationalization of commercial contract law? the use of ea clauses by danish companies can indeed be considered a legal transplant or more broadly an example of diffusion of law; a non-morally loaded rule originating from a foreign jurisdiction is through the means of commercial contracts applied in a new setting.131 the question that should be answered is whether ea clauses maintain their original purpose in the danish context. 130 for discussion on this issue, see g cordero-moss and c wallgren-lindholm in andersen and christoffersen (n 33); l gorton, ‘syndicated loans – some thoughts on the reception of anglo-american contract practice into swedish law’ (2007) 18(2) e.b.l.r. 313, 334. 131 in line with the transferists, led by watson, such transfer of rules may successfully happen regardless of the cultural and political differences between the two jurisdictions. though, transferists have been criticized for disregarding such differences, watson himself clarifies that the rule in the new setting will be affected and not work exactly the same as in the original jurisdiction, see watson (n 10), 82. we do not take a position within this article in regard to the tranferists v culturalists debate; instead we take what is common for the legal transfer theory as our point of departure. ea clauses: us and danish law? 206 the original purpose of ea clauses was to exclude any extrinsic evidence for the purpose of construing a contract; ea clauses were not to have any effect on contract interpretation. however, nowadays, as we have described in section iv, this original purpose is not always achieved even in the us jurisdiction and has developed in two directions. on the one hand, the effects of an ea clause, once taken as the ultimate proof that contractual parties intended to conclude a fully integrated agreement, have eroded.132 it is now more often taken as only one and rebuttable evidence in this respect. on the other hand, when given effect in the question of determining the contractual content, ea clauses are sometimes also given effect in respect of interpretation. nor in a danish context do ea clauses fulfil the original purpose as their interpretation by adjudicators is uncertain in the sense that danish principles of contract law and rules on evidence will in general not be overruled by the text of a commercial contract. therefore, it may very well be that an adjudicator decides to give a full effect to an ea clause as seen in rotate aviation v air kilroe, but that is most probably a result of application of the principles of reasonableness and the pragmatic approach. however, it should here be stated again that this is only a qualified guess of the authors, as the brief reasoning in the case does not reveal the arguments that led the judge to decide in this way. this conclusion is nevertheless supported by the fact that the same court decided in the exact opposite direction in sandrew metronome international v angel scandinavia. in light of the above, the results in individual cases in the usa and denmark may not be as different as we could reasonably expect, taking the varying rules on contract interpretation into account.133 however, the differences in the legal cultures and the divergent reasons why ea clauses are not consistently interpreted in either of the jurisdictions persist; ea clauses are treated differently in the two jurisdictions despite the similar outcomes. 134 this makes it impossible to assess whether we can speak of a successful legal transplant. in this situation, it is thus necessary to move beyond the legal transplants theory to explain this phenomenon and its legal implications. the theory of legal convergence, and namely the natural legal convergence, comes into discussion here.135 as the business community becomes increasingly transnational, the behaviour of companies is increasingly aligned. this is the result of the effectiveness of 132 wallach (n 55), 678. 133 gorton (n 12), 8. 134 as teubner points out speaking about ‘transplants’ is misleading, suggesting that the transplanted material will stay the same in the new environment, see g teubner, ‘legal irritants: good faith in british law or how unifying law ends up in new divergences’ (1998) 61 mlr 11, 12. 135 jh merryman, ‘on the convergence (and divergence) of the civil law and the common law’ (1981) 17 stan.j.int'l l. 357, 369-371. njcl 2017/2 207 the business world and its ‘yearning for simplicity’.136 the presence of differences between national legal systems gives rise to legal uncertainty of commercial subjects and thus may hamper international transactions.137 elimination of the differences is desirable, though not easy to attain.138 unifying contractual content through its reuse by companies is one way to achieve such a convergence. the bottom-up (natural) convergence is considered by merryman as ‘the most effective mode of convergence of laws, superior to legal transplantation and to active unification in the depth and permanence of its consequences.’139 the fact that contractual parties adjust their behaviour to the clauses might then be seen as a proof that the law develops independently from scholarship, courts and legislation.140 however, in the authors’ opinion, it is too soon to speak about convergence of common and civil contract law or about existence of transnational contract law. as there is neither consistency in the application of ea clauses in various jurisdictions nor a single adjudication body to decide on international contract law disputes, the national contract law systems and national courts will remain the determining factor for assigning ea clauses any legal effects. for now, the available court decisions from the jurisdictions do not show mutual appreciation between the two legal systems, although the results are not as divergent as expected. overall, what we are experiencing seems to be convergence or transnationalization of contractual practice rather than contract law. moreover, looking at the overwhelming prevalence of american contract models, we can even speak of americanization of contractual practice, meaning an active reception of an american contract drafting style rather than natural convergence.141 6. conclusion this article examined the diffusion process of ea clauses from the us to danish jurisdiction. through conducted interviews and study of available literature, it was established that danish companies use ea 136 l nottage, ‘comment on civil law and common law: two different paths leading to the same goal’ (2001) 32(3) vuwlawrw 843, http://www.nzlii.org/nz/journals/vuwlawrw/2001/43.html (citing merryman). 137 merryman (n 135error! bookmark not defined.), 363. 138 the 1980 united nations convention on contracts for the international sale of goods (cisg) has been the major effort for unification of international law of contracts so far. while ratified by 85 states (as of 22 february 2017), due to the subjection of its interpretation to national courts, the convention faces problems with its unified application. 139 merryman (n 135error! bookmark not defined.), 371 (‘often legal transplantation and unification of laws are merely ways of formalizing a legal consensus already reached by political-cultural rapprochement.’) 140 v hagstrøm in andersen and christoffersen (n 33), 632. 141 w wiegand, ‘americanization of law: reception or convergence?’ in lm friedmann and hn scheiber (eds), legal culture and the legal profession (westview press 1996), 148. ea clauses: us and danish law? 208 clauses regularly in international contracts. however, based on a scholarship review and discussion of two danish cases, we find that ea clauses do not always keep their original effects in contracts governed by danish law, similarly as they do not in contracts governed by american law. from danish case law it is obvious that danish courts are not ready to give up their wide discretion and their decision practice based on reasonableness and pragmatism reflected in short reasoning and ‘oraclelike’ decisions. from the conducted analysis that identified the pertaining differing approaches of the judiciaries in the two countries in regard to ea clauses, we can conclude that while we cannot truly speak of convergence between the us and danish contract law systems, we can speak of convergence, and specifically americanization of the danish contracting practice in this respect. this does not seem to be the case for denmark only, but appears to be a common observation in other civil law jurisdictions as well.142 in regard to transnationalization of commercial contract law, we might thus conclude that the contract drafting process overtakes the judiciary that is more attached to national rules and values. in line with the irritant perspective on the legal transplants theory presented by teubner, it can then be expected that the contract drafting practice will in turn influence national legal rules and the courts’ approach.143 this effect can already be seen in danish legal scholarship and its presumption that the judges will not entirely disregard ea clauses, but take a middle road in interpreting them. however, the presumption that contracting practice influences the legal rules and judiciary approach would imply that there is a clear and unified purpose behind inclusion of ea clauses into contracts by danish companies, which the legislative and judiciary powers will aim to protect. whether such common purpose in reality exists, is however a topic for another article. based on the present research, an advice to danish as well as arguably companies from other civil law jurisdictions using ea clauses is for them to adapt the clauses to the intended purpose rather than to the governing law. this means to specify in the clause whether it is intended to have a substantive (establishing the contractual content) or interpretation related (gap-filling, clarifying ambiguities) effect; and which documents, norms and conduct are to be excluded as evidence for establishing and/or interpreting the contract. doing so may not secure that the adjudicators would feel obliged to follow such a clause, but would make it much more difficult for them to argue against it. 142 n 13 143 teubner (n 134). nordic journal of commercial law issue 2015#1 better together: the evolution of tying theory and doctrine in eu competition law and us antitrust law by jarkko vuorinen* * the views expressed herein are those of the author and do not represent any official view of the finnish competition and consumer authority nordic journal of commercial law issue 2015#1 2 abstract the article analyzes the economic theories of tying and tying case law in eu competition law and us antitrust law. the article aims to identify the economic rationales motivating the use of tying practices and appraises their implications to competition policy. the question is not only whether the law is consistent with economic theory or not, but whether economic theory can meet the demands of the law. moreover, the article compares case law from the us and the eu and links the case law approaches to economic theory. the analysis of the us and eu experience reveals that regulation of tying has a long and rich history. the article argues that tying doctrine has changed in recent years. today the benefits of tying are better understood. nordic journal of commercial law issue 2015#1 3 1 tying, the leverage theory and case law 1.1 the definition of tying tying is an old sales strategy where distinct products, which are complements in use, distribution or production, are offered in combination. tying is a classical competition law problem, but has in recent years attracted renewed interest as the practice is widely used in many high-technology industries. the benefits and drawbacks of tying have been debated, in particular, in competition authority and court cases relating to microsoft’s activities1, where allegations of anticompetitive tying have played a major role. ultimately, many commentators have argued that existing rules on tying are obsolete and the field is in desperate need of modernization.2 although the words tying and bundling are often used interchangeably, tying, mixed bundling and pure bundling are separate concepts. tying takes place when customers are required to buy product b when they buy product a. product a is referred to as the tying product and product b the tied product. bundling in turn means that the seller of product a adds product b to the package at no separate charge. in mixed bundling a and b are separately available, but if they are bought together, a discount is offered. pure bundling refers to a situation where both products a and b are only offered in a bundle. shoe sales constitute a prime example of pure bundling. shoes are always sold in pairs. set menus in restaurants, in turn, are an example of mixed bundling as the menus tend to be cheaper than purchasing the individual component dishes à la carte.3 the main difference between tying, on the one hand, and mixed bundling, on the other, is that in mixed bundling the seller does not coerce the customer to buy the bundled product. however, the differences between pure bundling, mixed bundling and tying are not always clear-cut, as even mixed bundling may, de facto, coerce the buyer. if the prices charged for the individual products are high in relation to the bundle price and the consumer needs almost all the products, the buyer may, in effect, have no reasonable option but to buy the bundle.4 nevertheless, bundled discounts lack the one main negative aspect of tying and pure bundling, namely that the customer cannot buy the tied product separately. tying can be implemented with several techniques. contracts are one prevalent technique. the seller may sell product a only if the buyer makes a contractual commitment to purchase the prod1 united states v. microsoft corp., 253 f.3d 34 (d.c. cir. 2001); microsoft v. commission. commission decision case 3/37.792. march 24, 2004; case t-201/04 microsoft v. commission. september 17, 2007 2 evans, david s.: tying: the poster child for antitrust modernization (november 2005). available at ssrn: http://ssrn.com/abstract=863031 or http://dx.doi.org/10.2139/ssrn.863031, p. 2., visited november 27, 2013. 3 bishop, simon & walker, mike: the economics of ec competition law: concepts, application and measurement. 3rd ed. london. sweet & maxwell. thomon reuters, 2010, 276; guidance on the commission’s enforcement priorities in applying article 82 of the ec treaty to abusive exclusionary conduct by dominant undertakings. 2009/c 45/02, paragraph 48. 4 langer, jurian: tying and bundling as a leveraging concern under ec competition law. alphen aan den rijn. kluwer law international, 2007, 5. nordic journal of commercial law issue 2015#1 4 uct b as well. consequently, tying may amount to refusal to supply, if the buyer is unable to buy one of the products separately. second, tying may be technical. in technical tying, the component products are technically integrated so that it is impossible or impractical to separate them. finally, certain pricing practices may amount to tying, if the joint price of products a and b is so attractive that there are no incentives to buy products separately.5 almost all ties comprise a set of complementary products. complementarity may be a function of production or consumption related factors. if it is more efficient to produce products together, the products are complements in production, though they still may be used separately. if a customer is likely to utilize the products together, they are said to be complements in utilization. complements are perfect, if each item is worthless except if not used with the other. for example, mobile phones require chargers and vice-versa.6 1.2 the leverage theory and arguments against allowing tying in order to understand how and why tying and bundling practices are regulated, it is necessary to analyze the theories that motivate their legal treatment. these theories are varied. they provide different perspectives to the application of law in tying cases and different answers to the question whether tying is a defensible practice. leverage theory is perhaps the most often utilized theory in the history of antitrust. the theory views tying with suspicion. under the theory, tying is held to be per se detrimental to competition. the base case is that a company with market power in a market may use tying to leverage its market power in a second market to, possibly, monopolize that market.7 this is called offensive leverage. as a result of the reduced competition, the dominant company is able achieve higher profits than by selling each product separately.8 moreover, market power is used to force customers to buy an unwanted bundle that they would not otherwise take, and which gives to the seller an unearned advantage over competitors in the tied product market. under the leverage theory, the undesirability of leverage has traditionally not been based on its exclusive or foreclosure effects, but, rather, on the assumption that the tying monopolist will, over 5 ahlborn, christian & bailey, david & crossley helen: an antitrust analysis of tying: position paper. gclc research papers on article 82 ec. july 2005, 166-216. http://www.coleurope.eu/content/gclc/ documents/gclc%20research%20papers%20on%20article%2082%20ec.pdf, pp. 168-169, visited january 15, 2010. 6 hovenkamp, herbert j.: antitrust and nonexcluding ties (october 1, 2012). u iowa legal studies research paper no. 12-36. available at ssrn: http://ssrn.com/abstract=2143869 or http://dx.doi.org/10.2139/ ssrn.2143869, p. 2, visited november 27, 2013. 7 whinston, michael d.: tying, foreclosure, and exclusion. 80 american economic review 837 (1990). 8 bishop, simon & walker, mike: the economics of ec competition law: concepts, application and measurement. 3rd ed. london. sweet & maxwell. thomon reuters, 2010, 277. nordic journal of commercial law issue 2015#1 5 time, extract higher prices from consumers than would be attainable in a competitive market.9 the proponents of the leverage theory argue that in most cases tying is as blatantly anticompetitive and consequently, should, treated as illegal per se. the use of a per se rule entails that its proponents think that it is better to condemn all tying cases than to try to separate harmful tying from beneficial tying.10 today, the main argument against of tying is that the practices exclude competition.11 the proponents of the theory fear that tying unreasonably limits rivals’ opportunities to compete, in particular, in the tied product market. indeed, tying can be particularly anticompetitive when a dominant company strategically uses tying practices in order to foreclose rivals from the tied product market. in the tied market, tying may constitute a significant entry barrier. if a company has market power in two goods, rivals with only one of the goods in their portfolio may be severely handicapped and only competitive if they enter both the tying and the tied market.12 further, research has suggested that a company selling a bundle of complementary products has a considerable advantage over competitors who sell these products individually and and the bigger the size of the bundle is, the bigger the advantage it conveys is.13 finally, it has been argued that the foreclosure on the tied market today may be used to protect the current market power from future erosion. this is called defensive leverage. if the tied product could become a substitute to the original product in the future, leveraging the tied product market can protect a company’s position in the tying market.14 9 hovenkamp, erik n. and hovenkamp, herbert j.: tying arrangements (may 14, 2012). u iowa legal studies research paper no. 12-28. available at ssrn: http://ssrn.com/abstract=1999063 or http://dx.doi. org/10.2139/ssrn.1999063, p.5, visited november 27, 2013. 10 evans, david s. & padilla, a. jorge & ahlborn, christian: the antitrust economics of tying: a farewell to per se illegality. (april 21, 2003). antitrust bulletin, 2003. available at ssrn: http://ssrn.com/abstract=381940 or doi:10.2139/ssrn.381940, p. 65, visited january 21, 2010. 11 hovenkamp, erik n. and hovenkamp, herbert j.: tying arrangements (may 14, 2012). u iowa legal studies research paper no. 12-28. available at ssrn: http://ssrn.com/abstract=1999063 or http://dx.doi. org/10.2139/ssrn.1999063, p. 9, visited november 27, 2013 12 devlin, alan j., a neo-chicago perspective on the law of product tying (2007). american business law journal, vol. 44, no. 521, 2007. available at ssrn: http://ssrn.com/abstract=1429864, p. 4, visited january 20, 2010. 13 nalebuff, barry j., competing against bundles (august 20, 2000). yale school of management working paper no. es-02. available at ssrn: http://ssrn.com/abstract=239684 or doi:10.2139/ssrn.239684, visited novmber 12, 2013. 14 këllezi, pranvera: rhetoric or reform: does the law of tying and bundling reflect the economic theory? (november 24, 2009). article 82 ec: reflections on its recent evolution, ezrachi, ed., hart publishing, 2009. available at ssrn: http://ssrn.com/abstract=1512583, pp. 4, 6, visited december 2, 2013. nordic journal of commercial law issue 2015#1 6 1.3 tying doctrine in us case law in us antitrust law, section 1 of the sherman act, which concerns agreements in restraint of trade, has traditionally constituted the primary legal basis for contesting tying. tying can, nevertheless, be challenged under section 2 of the sherman act, which makes it illegal to monopolize, under section 3 of the clayton act, which prohibits exclusive arrangements that may substantially lessen competition, and under section 5 of the ftc act, which prohibits unfair methods of competition. during the early 20th century, us courts applied a per se rule to tying and held that tying serves no legitimate business purpose.15 indeed, as justice frankfurter argued in its oft-cited dicta: “tying agreements serve hardly any purpose beyond the suppression of competition.”16 under the early approach, courts found that a firm was engaged in illegal tying in only three-requisites were met. first, the seller had to have“sufficient economic power” in the tying product market and the tying practice had to affect “a not insubstantial amount of interstate commerce” in the tied product market. third criterion for holding a practice tying, namely that two separate products must be tied together, was often addressed in an ad hoc manner as the courts lacked a systematic standard.17 a number of cases suggest that “sufficient economic power” was presumed from facts that would not warrant such a conclusion today. for example, in international salt18 a patent right was held to give sufficient market power to the seller to trigger the prohibition of tying the patented product with unpatented products. further, the possible efficiency gains were not analyzed.19 early cases suggest that tying was viewed with extreme suspicion and it was deemed illegal without analyzing in detail the actual effects the practices had. the early doctrine was modified in jefferson parish20. the case remains the leading tying case in us antitrust law. in the case, east jefferson hospital had an exclusive contract with roux & associates to provide anesthesiology services to the hospital’s patients. in 1977, an anesthesiologist, who had unsuccessfully applied for admission to the medical staff of the hospital, claimed that the contract between the east jefferson hospital and roux & associates violated antitrust law. the anesthesiologist sued the hospital under, among others, section 1 of the sherman act. the supreme court unanimously held that the sherman act 1 was not breached, but there was a disagreement on the reasons. the four-judge minority voted for the introduction of a rule of 15 see, for example, times-picayune publishing v. united states, 345 u.s. 594 (1953); united states steel corp. et al v. fortner enterprises, 394 u.s. 495 (1969). 16 standard oil co. of california v. united states, 337 u.s. 293, 306 (1949). 17 see, for example, northern pacific railway co. et al. v. united states, 356 u.s. 1 (1958). 18 international salt co., inc. v. united states 332 u.s. 392 (1947). 19 evans, david s. & padilla, a. jorge & ahlborn: the antitrust economics of tying: a farewell to per se illegality. (april 21, 2003). antitrust bulletin, 2003. available at ssrn: http://ssrn.com/abstract=381940 or doi:10.2139/ssrn.381940, p. 10, visited january 21, 2010. 20 jefferson parish hospital district no. 2 v. hyde, 466 u.s. 2 (1984). nordic journal of commercial law issue 2015#1 7 reason21, but the majority opined that it was “far too late in the history of our antitrust jurisprudence to question the proposition that certain tying arrangements pose an unacceptable risk of stifling competition and therefore are unreasonable ‘per se’.22 the majority did not, however, deny that tying could in some instances be pro-competitive. rather, it appears that deference to precedent prevented the application of the rule of reason to tying.23 although the supreme court held that the hospital did not have sufficient market power in the market and, thus, the tying practice was allowed, an opportunity to review the tying doctrine arose.24 the supreme court formulated a four-part test to idenfity prohibited tying practices. the test has since been called the modified per se rule. under the test, prohibited tying requires 1) two separate products; 2) that are tied and the consumers have no option to choose between the products; 3) and the seller has sufficient market power in the tying product; and 4) the tying affects a not insubstantial volume of commerce. however, most importantly, the supreme court recognized that under some circumstances tying may provide benefits to consumers.25 the modified per se rule was confirmed in eastman kodak v. image technical services26. in the case, the accusation was that kodak had illegally tied the sale of its photocopier spare parts to the purchase of kodak photocopiers and accompanying repair services. the district court granted a summary judgment for kodak, which was reversed by the court of appeals for the ninth circuit. the supreme court held that kodak had, in fact, engaged in tying. the court reached the conclusion even if kodak did not have sufficient market power in the market for photocopiers as such. it was, nevertheless, sufficient that the firm dominated the market for the brand’s spare parts and the servicing of the machines. the customers were locked into buying kodak spare parts after buying a photocopier because switching costs were prohibitively high in relation to the aftermarket value of a photocopier. thus, kodak could force its customer pay monopoly prices for the tied spare parts or services. the supreme court again applied the modified per se rule. however, the impact 21 ibid., pp. 32-34. 22 ibid., p. 9. 23 evans, david s.: tying: the poster child for antitrust modernization (november 2005). available at ssrn: http://ssrn.com/abstract=863031 or http://dx.doi.org/10.2139/ssrn.863031, p. 2., visited november 27, 2013. 24 jefferson parish hospital district no. 2 v. hyde, 466 u.s. 2, 26-27 (1984). 25 “it is clear, however, that not every refusal to sell two products separately can be said to restrain competition. if each of the products may be purchased separately in a competitive market, one seller’s decision to sell the two in a single package imposes no unreasonable restraint on either market, particularly if competing suppliers are free to sell either the entire package or its several parts… buyers often find packages sale attractive; a seller’s decision to offer such packages can merely be an attempt to compete effectively – conduct that is entirely consistent with the sherman act.” ibid., pp. 11-12. 26 eastman kodak v. image technical services, inc. et al., 504 u.s. 451 (1992). nordic journal of commercial law issue 2015#1 8 of tying was not analyzed in the specific circumstances of the case. nevertheless, a minority of the judges was of the opinion that the rule of reason approach should have been applied.27 1.4 tying in eu case law in eu competition law, tying has been addressed as abuse of dominant position (article 102 tfeu), although tying may also fall under the scope of unlawful restrictive agreements (article 101 tfeu). in particular, the wording of articles 101(1)(e) and 102(d) tfeu suggests that the anticompetitive nature of tying has already been taken into account in the provisions, because the act of tying is treated as a possible violation. both provisions prohibit a conduct that involves “making the conclusion of contracts subject to acceptance by the other parties of supplementary obligations which, by their nature or according to commercial usage, have no connection with the subject of such contracts.” thus far there have been only few tying cases in the eu. there are three contractual tying cases (british sugar, hilti, and tetra pak ii) and one case involving technological tying (microsoft). before the late 1980s, tying was viewed with suspicion. british sugar28 was one of the first eu commission investigations that targeted tying. a sugar merchant napier brown had complained that british sugar abused its dominant position in the uk to drive napier brown out of the uk sugar retail market. napier brown argued that british sugar engaged in prohibited tying as the firm supplied sugar to its customers only if they allowed the firm to deliver the sugar. the commission held that the practice was illegal tying, because it eliminated all competition in the delivery market. in particular, the mere fact that british sugar had mopolised a separate market activity was sufficient to find anti-competitive effects. thus, the case indicates that the commission employed a very strict approach to tying. one of the most important tying cases in the eu competition law involved hilti29, europe’s largest manufacturer of nail guns. the case involved the supply of nail guns, and related nails and cartridge strips, which were particularly manufactured for hilti’s nail guns. competing nail producers complained to the commission that hilti had abused its dominant position by limiting their entry into the market for hilti-compatible nails, by tying the sale of nails to the sale of cartridge strips used in hilti’s nail guns. hilti argued that it delivered powder-actuated fastening guns, which constituted one integrated system, and for this reason it no longer delivered any separate components. the commission rejected this argument and held that hilti had a dominant position in the markets for nail guns, hilti-compatible nails, and cartridge strips. the commission held that hilti’s practice constituted an abuse of dominant position and excluded independent nail makers from the markets. moreover, the practice exploited consumers as they were left with no alternative source of nails, which exploited them. 27 justice scalia, o’connor and thomas dissented and proposed the rule of reason analysis. 28 napier brown v. british sugar. commission decision 88/519/eec, 1988 o.j. (l 284) 41. 29 eurofix-bauco v. hilti. commission decision 88/138/eec, 1988 o.j. (l 065) 19. nordic journal of commercial law issue 2015#1 9 hilti appealed to the general court30 and claimed that safety and reliability concerns motivated its business practices. the court rejected the argument, and held that it was inappropriate for a dominant company to take action to eliminate competing products, which the company considered dangerous or of lesser quality than its own products. the general court pointed out that the legislature carried the primary responsibility for regulating product safety and safety regulation should not be carried out by unilateral measures of companies in a dominant position. thus, hilti’s tying practices constituted an excessive measure, in particular, since the company had been unable to prove that other nail manufacturers’ nails were, in fact, dangerous in its tools. hilti appealed but the european court of justice upheld the earlier decision.31 another important tying case is tetra pak ii32. tetra pak obliged the buyers of its machines to also buy cartons from it. in addition, tetra pak reserved to itself an exclusive right for the maintenance, reparation, and the supply of spare parts. tetra pak argued that it offered an integratedproduct, but the commission and the general court33 found that this conduct constituted an abuse of dominant position. tetra pak’s arguments for the protection of public health were rejected with reference to the ruling in hilti. the courts held that other less restrictive means, such as legislation, capable of guaranteeing public health existed. in tetra pak, the concept of “commercial usage” raised questions. tetra pak claimed that the tying of machines and cartons was not illegal, because it was “commercial usage” to connect the products and their combined sale promoted efficiency. however, this argument was not accepted, since there were independent carton manufacturers that were specialized in these products and which did not simultaneously manufacture machines. tetra pak appealed to the european court of justice34 which upheld the earlier decision. in particular, it held that a commercial usage acceptable in a competitive market may not be accepted in a market where competition is restricted, unless there is an objective justification for the usage. thus, in the case of a dominant company it may be abusive to tie the sales of products even though this forms commercial usage in the market or there is a natural link between the two products. the ruling is dubious from an economic point of view: if both companies with and without market powers tie certain products together, the likely explanation is that this practice either cuts costs or enhances value to consumers.35 otherwise, companies would not have survived in competitive markets. even though holding a dominant position confers a special responsibility 30 case t-30/89. hilti ag v. commission [1990] ecr ii-163. 31 case c-53/92p. hilti ag v. commission [1994] ecr i-667. 32 tetra pak v. commission (tetra pak ii) . commission decision 92/163/eec, 1992 o.j. (l 072) 1. 33 case t-83/91. tetra pak ii [1994] ecr ii-755. 34 case c-333/94 p tetra pak international sa v commission [1996] ecr i-5951. 35 geradin, damien & ahlborn, christian & denicolò, vincenzo & padilla blanco, atilano jorge: dg comp’s discussion paper on article 82: implications of the proposed framework and antitrust rules for dynamically competitive industries (march 2006). available at ssrn: http://ssrn.com/abstract=894466 or http:// dx.doi.org/10.2139/ssrn.894466, p. 40, visited november 27, 2013. nordic journal of commercial law issue 2015#1 10 on the dominant undertaking, forbidding it from using a common commercial usage that its competitors use may be excessive. the lessons to be learnt from hilti and tetra pak ii are that dominance was no longer presumed as before, and the requirement of market power was analyzed in detail. there were signs that in theory eu courts could perhaps accept tying practices if they could be justified. hilti’s and tetra pak’s safety and quality concerns were not, however, such reasons. since the rulings in hilti and tetra pak ii, the commission has confirmed that in principle exclusionary conduct may, for example, be considered objectively necessary for health or safety reasons related to the nature of the product in question. however, the commission has also stressed that under most circumstances public authorities should set and enforce such safety standards. therefore, a dominant undertaking should not, ordinarily, take steps to exclude competing products which it considers dangerous or inferior to its own product.36 2 arguments in favor of tying 2.1 the three challenging theories 2.1.1 the chicago school and the single monopoly profit theorem since the 1990s, theories that advocate the per se prohibition of tying have been under sustained attack both in the us and the eu. however, the major outline of the critique was well known long before 1990s. in particular, the chicago school attacked the leverage theory already in the 1970s and argued that the theory contained a serious logical flaw. the chicago school based this argument on the single monopoly profit theorem. the theorem posits that a dominant company can achieve the benefit of its monopoly position only once in the tying product market and thus, it cannot extend its monopoly power to the tied product market.37 to the contrary, the chicago argued that monopolizing the other market could lead to lower profits and consequently, dominant companies rarely have the economic incentives to leverage their market power. in fact, a dominant company may have an interest in keeping the tied market competitive, since the increase in demand for the tied product increases the demand for the tying product. consequently, the leverage theory leads to erroneous conclusions when the tying 36 this was later held in the commission’s guidance. see communication from the commission. guidance on the commission’s enforcement priorities in applying article 82 of the ec treaty to abusive exclusionary conduct by dominant undertakings. (2009/c 45/02), paragraph 29. 37 ahlborn, christian & bailey, david & crossley helen: an antitrust analysis of tying: position paper. gclc research papers on article 82 ec. july 2005, 166-216. http://www.coleurope.eu/content/gclc/ documents/gclc%20research%20papers%20on%20article%2082%20ec.pdf, p. 173, visited january 21, 2010. evans, david s. & padilla, a. jorge & ahlborn, christian: the antitrust economics of tying: a farewell to per se illegality. (april 21, 2003). antitrust bulletin, 2003. available at ssrn: http://ssrn.com/ abstract=381940 or doi:10.2139/ssrn.381940, pp. 47-49, visited january 21, 2010. nordic journal of commercial law issue 2015#1 11 product is monopolized and the tied product remains competitive. the chicago school argued that the single monopoly profit theorem also applied to products the demand for which is both independent and complementary.38 the chicago school provides an alternative explanation for tying practices: they are primarily a vehicle of beneficial price discrimination, which can increase output and allocative efficiency.39 in particular, stigler40 has argued that tying enables companies to capture more consumer surplus from consumers who have different valuations on the separate goods. indeed, if there is a need to reduce heterogeneity in customer valuations, tying may be a good strategy.41 moreover, the chicago school emphasizes many other benefits that tying may have. for example, there may be economic efficiencies such as lower production, distribution and transaction costs if tying is used. tying may also reduce the costs of finding the best product combinations and sometimes a combined product can be worth more to consumers more than the individual components. in addition, tying may help to improve product quality and lower prices if tying and tied products are complements.42 therefore, the chicago school argues that tying should be treated as legal per se, since the vast majority of tying practices will, in fact, be beneficial for competition. 2.1.2 post-chicago theories the post-chicago theories, in turn, argue that the assumptions the chicago school made do not hold. if competition in the tied product market is imperfect, tying and bundling can exclude competitors and soften price competition.43 the post-chicago theories recognize the majority of the chicago school arguments, but also point out that the single monopoly profit theorem is too general and holds only under restrictive assumptions. in particular, the single monopoly profit 38 ibid. 39 bork, robert h.: the antitrust paradox: a policy at war with itself. new york. free press, 1978, 376-378, 396398. 40 evans, david s. & salinger, michael: why do firns bundle and tie? evidence from competitive markets and implications for tying law. 22 yale j. on reg. 37, 49, (2005) referring stigler, george: a note on block booking. the organisation of industry 165 (1968). 41 nalebuff, barry: bundling, tying, and portfolio effects. dti economics paper no. 1. february 2003. http:// www.bis.gov.uk/files/file14774.pdf, p. 34, visited january 12, 2010. 42 ahlborn, christian & bailey, david & crossley helen: an antitrust analysis of tying: position paper. gclc research papers on article 82 ec. july 2005, 166-216. http://www.coleurope.eu/content/gclc/ documents/gclc%20research%20papers%20on%20article%2082%20ec.pdf, pp. 170-173, visited january 15, 2010; evans, david s. & padilla, a. jorge & ahlborn, christian: the antitrust economics of tying: a farewell to per se illegality. (april 21, 2003). antitrust bulletin, 2003. available at ssrn: http://ssrn.com/ abstract=381940 or doi:10.2139/ssrn.381940, pp. 42-46, visited january 21, 2010. 43 bishop, simon & walker, mike: the economics of ec competition law: concepts, application and measurement. 3rd ed. london. sweet & maxwell. thomon reuters, 2010, 290-291. nordic journal of commercial law issue 2015#1 12 theorem may fail if the tied market is not perfectly competitive.44 for example, whinston45 has argued that a company that has market power in both the tying and tied markets may use tying in order to deter potential competitors from entering the tied market if economies of scale are required. in particular, if the tied product does not require the use of the tying product, there may be cases where tying is used to increase profits in the tied product market. instead of focusing solely on a static perspective of markets and short term profit maximization, the post-chicago theories argue that there is a need to take into account the dynamic effects of tying and adopt a long term perspective on profit maximization. such analyses appear to confirm that leveraging can, in fact, be a good strategy for monopolists. in particular, pil choi and stefanadis46 have presented a model where a company monopolizes both complementary products, but also faces competition in both of these markets. the authors also assume that market entry for new competitors to either of the markets is only possible if they can make a successful innovation. innovations, however, require investments. if the monopoly company bundles the two products under these circumstances, successful entry to either of the markets requires simultaneous innovations in both markets. this drives up the costs of market entry. consequently, bundling may reduce rivals willingness to invest and innovate and, thus, effectively prevent market entry. in this case, tying does not necessarily lead to foreclosure in the product market but in the research and development market. moreover, bundling may help spread out innovation costs over many products, which allows a dominant company to recover its costs, and profit from research. even if the post-chicago theories critique the chicago school’s permissive stance, the theories do not suggest a full return to the leverage theory. instead, the theories recognize the benefits of tying and bundling and neither advocate that tying should be treated as per se illegal nor promote a per se legal approach.47 the theories hold that such strong categorizations are not feasible. whether tying should be permited depends on the circumstances in each invididual case.48 therefore, postchicago theories advocate that the rule of reason approach should be applied. 44 ahlborn, christian & bailey, david & crossley, helen: an antitrust analysis of tying: position paper. gclc research papers on article 82 ec. july 2005, 166-216. http://www.coleurope.eu/content/gclc/ documents/gclc%20research%20papers%20on%20article%2082%20ec.pdf, pp. 174-175, visited january 15, 2010 45 whinston, michael d.: tying, foreclosure, and exclusion. 80 american economic review 837 (1990). 46 choi, j.p & stefanadis, c.: tying, investment, and the dynamic leverage theory. 32 rand journal of economics 52 (2001). 47 ahlborn, christian & bailey, david & crossley, helen: an antitrust analysis of tying: position paper. gclc research papers on article 82 ec. july 2005, 166-216. http://www.coleurope.eu/content/gclc/ documents/gclc%20research%20papers%20on%20article%2082%20ec.pdf, p. 176, visited january 15, 2010 48 evans, david s. & padilla, a. jorge & ahlborn, christian: the antitrust economics of tying: a farewell to per se illegality. (april 21, 2003). antitrust bulletin, 2003. available at ssrn: http://ssrn.com/abstract=381940 or doi:10.2139/ssrn.381940, p. 54, visited january 21, 2010. nordic journal of commercial law issue 2015#1 13 2.1.3 transaction cost theory finally, transaction cost economics deploys another another framework for analysis and argues that tying is useful, since combining two products tends to increase output and lower prices by avoiding double marginalization. an integrated complementary monopoly is most likely to eliminate double marginalization and, thus, will lead to lower prices, higher output and increased consumer welfare than distinct complementary monopolies.49 the double marginalization effect clearly illustrates that there is something worse than a monopoly, namely a chain of monopolies. the explanation that transaction cost economics gives to tying is that tying contracts involve voluntary partial integration of production. integration aims to overcome market failures that high transaction costs and the leverage the complementarities between tying and tied product cause.50 indeed, contractual negotiations between sellers and buyers may involve significant costs, in particular, if multiple expensive negotiations and many individual contracts characterize the industry.51 in this respect, bundling may lower transaction costs and help to avoid market failures, which suggest that tying can arise without any exercise of market power or coercive forcing. in general, tying reduces transaction costs and the problems of uncertainty and contractual incompleteness. these problems are typical to the exchange of new and complex technologies.52 2.2 tying and efficiency benefits today many scholars and authorities argue that tying and bundling do not necessarily have anticompetitive effects.53 indeed, it is widely held that tying can help to provide better products in a more cost effective way.54 for example, bundling is a common practice in the industries that are 49 hovenkamp, herbert j.: antitrust and the close look: transaction cost economics in competition policy (december 2010). available at ssrn: http://ssrn.com/abstract=1661993, p. 2, december 30, 2010; hovenkamp, erik n. and hovenkamp, herbert j., tying arrangements (may 14, 2012). u iowa legal studies research paper no. 12-28. available at ssrn: http://ssrn.com/abstract=1999063 or http://dx.doi. org/10.2139/ssrn.1999063, visited november 28, 2013. 50 meese, alan j.: “tying meets the new institutional economics: farewell to the chimera of forcing”. (1997). faculty publications. paper 542, http://scholarship.law.wm.edu/facpubs/542, p. 10, visited january 22, 2010. 51 crane, daniel a.: mixed bundling, profit sacrifice, and consumer welfare. emory law journal, vol. 54, 2006; cardozo legal studies research paper no. 137. available at ssrn: http://ssrn.com/abstract=838265, p. 8, visited january 21, 2010. 52 gallini, nancy & trebilcock, nancy: intellectual property rights and competition policy: a framework for analysis of economic and legal issues. in oecd policy roundtables. competition policy and intellectual property rights. 1997. http://www.oecd.org/dataoecd/34/57/1920398.pdf, p. 347, visited april 13, 2010. 53 dg competition discussion paper on the application of article 82 of the treaty to exclusionary abuses. public consultation. brussels, december 2005, paragraph 178; 54 see carlton , dennis w. & waldman, michael: tying (august 1, 2008). 3 issues in competition law and policy 1859, 2008. available at ssrn: http://ssrn.com/abstract=1529843, p. 1860, visited january 14, 2010; communication from the commission. guidance on the commission’s enforcement priorities in applying article 82 of the ec treaty to abusive exclusionary conduct by dominant undertakings. (2009/c 45/02), paragraph 49. nordic journal of commercial law issue 2015#1 14 characterized by significant competition such as, for example, the automobile industry. this suggests that the practice has efficiency benefits. tying and bundling appear to be pervasive in the economy and, as a result, it has become the dominant form of sales: most goods and services are bundles even though we do not even notice it. for example, a car includes a bundle of tires, engine, breaks and so on.55 bork56 has pointed out that “every person who sells anything imposes a tying arrangement. this is because every product or service could be broken down into smaller components capable of being sold separately, and every seller refuses at some point to break the product down any further…” in this respect, it is important to note that what constitutes a standard bundle has changed as time has passed. for example, air conditioners and sound systems were once optional accessories, but today they have transformed into standard equipment found in all cars. consequently, what constitutes two goods at one moment in time can become a single good some time later.57 for example, word processing software included neither spell checkers nor grammar checkers in the early 1980s. instead, separate programs were sold for these purposes. today word processing software includes both of these once stand-alone products.58 moreover, mobile phones today are not just for making calls, but they are used for surfing the internet, taking photos and playing music. consequently, it can be said that in high-tech industries technological progress often entails product integration.59 in many cases, this benefits the consumers. thus, it cannot be categorically said that bundling is anti-competitive or that it tends to harm consumer welfare. instead, tying may have several benefits. first, it may reduce decision-making, search and transaction costs. the opposite of bundling is à la carte pricing, which means that consumers pay for the exact amounts of goods or services that they want. in idealized markets, units are divided as narrowly as consumers wish as the theory suggests that the more choice consumers have, the better the efficiency of the markets.60 however, research in behavioral economics suggests that too many options may lead to no choice at all. therefore, bundling may be beneficial as it restricts consum55 liebowitz, stan j. & margolis, stephen e.: bundles of joy: the ubiquity and efficiency of bundles in the technology markets. 5 j. competition l. & econ 1, 3 (2009). 56 bork, robert h.: the antitrust paradox: a policy at war with itself. new york. free press 1978, 378. 57 liebowitz, stan j. & margolis, stephen e.: bundles of joy: the ubiquity and efficiency of bundles in the technology markets. 5 j. competition l. & econ 1, 8-9, (2009). 58 evans, david s. & schmalensee, richard: some economic aspects of antitrust analysis in dynamically competitive industries. http://www.nber.org/papers/w8268.pdf?new_window=1, p. 40, visited september 14, 2010. 59 geradin, damien & ahlborn, christian & denicolò, vincenzo & padilla blanco, atilano jorge: dg comp’s discussion paper on article 82: implications of the proposed framework and antitrust rules for dynamically competitive industries (march 2006). available at ssrn: http://ssrn.com/abstract=894466 or http:// dx.doi.org/10.2139/ssrn.894466, p. 41, visited november 27, 2013. 60 liebowitz, stan j. & margolis, stephen e.: bundles of joy: the ubiquity and efficiency of bundles in the technology markets. 5 j. competition l. & econ 1, 4 (2009). nordic journal of commercial law issue 2015#1 15 er choice and may prevent consumers from being overwhelmed by the too many alternatives.61 choice can also be costly: rational choices may take time and effort, and, therefore, bundling may lead to reductions in transaction and search costs.62 second, it is likely that tying can increase the efficiency of production and distribution. for example, packaging and distribution costs can be saved by utilizing the same systems for multiple products. evans and salinger63 conducted an empirical stydy on cold remedies and found that some of the products are combinations of products that had been previously available separately. interestingly, the price of the combined products was much lower than the sum charged for the component drugs when sold separately. the finding is understandable when the reader bears in mind that the cost of producing the active ingredients constitutes a small part of the total costs, while packaging the tablets and putting the active ingredients into appropriate dosage form make up a much larger part of the overall costs. indeed, cost savings and quality improvements are commonly cited as for bundling. for example, manufacturers assemble cars, since buying a car is less expensive for customers than buying all the components individually. in particular, if most consumers want to buy both products a and b, that is consumer valuations of the separate products are positively correlated, and there are cost savings from selling the two together, there are incentives for a monopolist to sell them bundled. for example, bundling two products together may allow the seller to achieve economies of scope in production, which may be passed on to consumers in bundled discounts.64 experiences from the automobile industry confirm that giving many options to consumers increases complexity costs and, thus, there may be diseconomics of scope if multiple separate products are produced.65 third, tying may be used to safeguard brand names and goodwill. in particular, franchise ties are implemented to control quality control, as the franchisor wants to maintain high quality and uniformity in all stores.66 moreover, sometimes complex products work together with other complex products, and in the case of malfunction, a brand owner may be blamed without reason for other 61 nalebuff, barry: bundling, tying, and portfolio effects. dti economics paper no. 1. february 2003. http:// www.bis.gov.uk/files/file14774.pdf, p. 32, visited january 12, 2010. 62 evans, david s.: tying: the poster child for antitrust modernization (november 2005). available at ssrn: http://ssrn.com/abstract=863031 or http://dx.doi.org/10.2139/ssrn.863031, p. 7., visited november 27, 2013. 63 evans, david s. & salinger, michael: why do firns bundle and tie? evidence from competitive markets and implications for tying law. 22 yale j. on reg. 37, 38, 52 (2005). 64 nalebuff, barry: bundling, tying, and portfolio effects. dti economics paper no. 1. february 2003. http:// www.bis.gov.uk/files/file14774.pdf, p. 31, visited january 12, 2010. 65 evans, david s.: tying: the poster child for antitrust modernization (november 2005). available at ssrn: http://ssrn.com/abstract=863031 or http://dx.doi.org/10.2139/ssrn.863031, p. 6, visited november 27, 2013. 66 hovenkamp, erik n. and hovenkamp, herbert j.: tying arrangements (may 14, 2012). u iowa legal studies research paper no. 12-28. available at ssrn: http://ssrn.com/abstract=1999063 or http://dx.doi. org/10.2139/ssrn.1999063, pp.14-15, visited november 27, 2013. nordic journal of commercial law issue 2015#1 16 manufacturers’ faults.67 therefore, tying may promote product quality and protect the goodwill of the brand owner, which benefits both the brand owner and the consumers. in general, independent manufacturers may aim to serve too many brand owners, which may lead to sacrifices in performance.68 sometimes it may be too much to assume that the primary good would be compatible with all possible independent manufacturers’ complementary products.69 however, as said above tying may be an excessive way to protect quality and the same result may be achieved by less restrictive means, for example, by issuing specifications for the complementary product.70 fourth, economic theory suggest that the pervasiveness of tying may even imply that the practice is typically beneficial or at least harmless; otherwise, it would not have been able to survive in competitive markets.71 devlin argues that a company that has significant market power but does not have a monopoly in the tying market is unlikely to introduce a tying practice that harms consumers. if it did so, it would only give a competitive advantage to its competitors in the tying market. thus, harmful tying may exist only when there is little or no competition in the tying market.72 in conclusion, it appears that tying characterizes modern markets and is often motivated by legitimate efficiency concerns. perhaps the most common efficiency-based rationale for tying is that it minimizes transaction costs, but it can also reduce costs in production, distribution, marketing, licensing and create economies of scale and scope. moreover, tying can reduce search costs for the optimal combination of products working together, which plays a major role when complex products are involved.73 market power plays a crucial role in assessing whether tying has anticompetitive effects. since tying is typically efficient and courts and authorities have difficulties in identifying anticompetitive tying with enough certainty, there should be a hurdle for legal intervention.74 kobayashi argues that in highly competitive markets, efficiency should be the presump67 in hilti the european court of justice refused to accept that tying is justified because of safety concerns. case t-30/89. hilti v. commission [1991] ecr ii-1439, paragraph 20; see also bishop, simon & walker, mike: the economics of ec competition law: concepts, application and measurement. 3rd ed. london. sweet & maxwell. thomon reuters, 2010, 281. 68 hovenkamp, herbert j.: tying arrangements and lawful alternatives: transaction costs considerations. (september 2011). u iowa legal studies research paper no. 11-26. available at ssrn: http://ssrn.com/ abstract=1763386, pp. 1, 9, visited september 2, 2011. 69 tirole, jean, the analysis of tying cases: a primer. competition policy international, vol. 1, no. 1, pp. 1-25, spring 2005. available at ssrn: http://ssrn.com/abstract=702641, p. 15, visited january 14, 2010. 70 see, for example, international business machines corporation v. united states, 298 us 131 (1936). 71 evans, david s. & padilla, a. jorge & ahlborn: the antitrust economics of tying: a farewell to per se illegality. (april 21, 2003). antitrust bulletin, 2003. available at ssrn: http://ssrn.com/abstract=381940 or doi:10.2139/ssrn.381940, p. 3, visited january 21, 2010. 72 devlin, alan j., a neo-chicago perspective on the law of product tying (2007). american business law journal, vol. 44, no. 521, 2007. available at ssrn: http://ssrn.com/abstract=1429864, pp. 15-16, visited january 20, 2010. 73 schmidt, hedvig: competition law, innovation and antitrust. an analysis of tying and technological integration. cheltenham. edward elgar, 2009, pp. 16-17. 74 see also carlton , dennis w. and waldman, michael: tying (august 1, 2008). 3 issues in competition law and policy 1859, 2008. available at ssrn: http://ssrn.com/abstract=1529843, visited january 14, 2010. nordic journal of commercial law issue 2015#1 17 tive explanation for tying.75 if no other motivation than efficiency for tying is found, intervention is not necessary.76 2.3 tying high-technology products tying is typical in technology rich markets, since these markets are characterized by networking and interconnection.77 it is beyond doubt that consumers have, in fact, benefited, for example, from smartphones, which have integrated the functions of many different, previously separate products. moreover, many consumers like the idea that various softwares are integrated in operating system at no or very little extra cost. however, the tying doctrine is largely based on precedents involving physical products; these precedents may not well apply to the integration of high technology products.78 therefore, it has been suggested that high technology products deserve a different treatment in competition law. however, the difficult question has remained the same, namely whether there is a single product market or multiple product markets and whether there is foreclosure. high-technology markets are different from many traditional markets. if markets are characterized by network effects, consumer lock-in may take place quickly. if anticompetitive tying is suspected, the timing of legal intervention should be at the early stage of markets; otherwise, markets may already have tipped. these concerns suggest that tying may raise bigger concerns in high-technology markets than in the traditional settings. on the other hand, innovation rates can be so high in high technology industries that companies that fail to keep up with technological developments will benefit little from anticompetitive tying. interestingly, it appears that the monopolization of a tied market is not the only concern in high-technology markets. rather, tying may be used to consolidate market power in the tying market. these issues were debated in relation to microsoft’s practices both in the us and the eu. 75 kobayashi, bruce h.: does economics provide a reliable guide to regulating commodity bundling by firms? a survey of the economic literature. journal of competition law & economics, vol. 1, no. 4, december 2005, pp. 707-746; george mason law & economics research paper no. 05-35. available at ssrn: http://ssrn.com/abstract=836724, p. 2, visited january 16, 2010. 76 see also carlton, dennis w. & waldman, michael: how economics can improve antitrust doctrine towards tie-in sales: comment on tirole’s ‘an analysis of tying cases: a primer’. competition policy international, vol. 1, no. 1, pp. 27-40, spring 2005. available at ssrn: http://ssrn.com/abstract=702645, p. 34, visited january 15, 2010. 77 hovenkamp, erik n. and hovenkamp, herbert j.: tying arrangements (may 14, 2012). u iowa legal studies research paper no. 12-28. available at ssrn: http://ssrn.com/abstract=1999063 or http://dx.doi. org/10.2139/ssrn.1999063, p.16, visited november 27, 2013. 78 au, thomas h.: anticompetitive tying and bundling arrangements in the smartphone industry. 16 stan. tech. l. rev. 188 (2012) nordic journal of commercial law issue 2015#1 18 2.3.1 tying and microsoft iii today, there are hints that the benefits of tying practices are noted in legal practice and, as a result, the courts may be close to adopting the rule of reason approach to tying. the change is clearly visible in the judgment of the court of appeals of the federal circuit in microsoft iii79. the case dealt with antitrust charges the us department of justice and 21 states had raised. the complaint involved measures that microsoft had taken in respect to netscape’s web browser and sun’s java technologies. in relation to the former, the question was whether microsoft had illegally tied its web browser with its pc operating system or not. in 2000, the us district court for the district of columbia held microsoft liable for tying and monopolization under section 1 and section 2 of the sherman act. the court held that microsoft was aware of middlewares, which could have developed rivals to it on the operating systems market. in order to prevent this, microsoft tried to make developers ignore the interfaces of the netscape navigator web browser and sun’s java technology.80 as for tying the court applied the modified per se rule and held that microsoft had formed an illegal tying arrangement. the court concluded that operating systems and browsers are separate products with separate consumer demand. moreover, the court held that microsoft had monopoly power in the tying market and not an insubstantial amount of commerce was foreclosed. the last test criterion, namely the forced bundling -requirement, was also fulfilled, as microsoft had taken measures to prevent unbundling. the fact that microsoft provided the browser for free did not change the issue, because consumers pay, in one way or another, for the browser alongside the windows operating system.81 finally, the court held that technical necessity or business efficiencies did not explain tying, but “it was the result of a deliberate and purposeful choice to quell incipient competition before it reached truly minatory proportions.” microsoft appealed to the federal circuit. the federal circuit distinguished the modified per se rule of jefferson parish and applied the rule of reason approach instead.82 it concluded that microsoft iii was vitally different from the preceding tying cases, because the tie involved technological integration and enhanced the value of the tying product to its users.83 in particular, the separate-products test did not fit with the facts of the case. the test was too backward-looking, because it focused on historic consumer behavior from the time period before tying was implemented and on companies that had not integrated the tying and tied goods. the test was a poor fit to the new innovative integration that takes place in technologically dynamic markets.84 79 united states v. microsoft corp., 253 f. 3d 34 (d.c. cir. 2001). 80 united states v. microsoft corp., 87 f. supp 2d 30, 38-39 (d.d.c. 2000). 81 ibid., pp. 49-50. 82 united states v. microsoft corp., 253 f. 3d 34, 84 (d.c. cir. 2001). 83 ibid., p. 90 84 ibid., p. 89. nordic journal of commercial law issue 2015#1 19 the federal circuit concluded that the separate product test also had other deficits. the company that at first merges previously distinct functionalities may be unjustifiedly condemned, because at the moment of integration there still tends to be a distinct market for the tied product. in particular, this is problematic in platform software markets, where integration is common – even among companies without market power.85 as a result, the formal application of per se rules may jeopardize platform innovation in the pc, network computer and information appliance markets.86 therefore, the federal circuit concluded that the rule of reason approach should be utilized in software platforms and remanded the tying question to the district court for reconsideration. the judgment appears to indicate that technological integration deserves favorable treatment compared to the other forms of tying.87 the refusal of the federal circuit to apply the per se rule to platform software suggests that high technology products may form an exception to that rule. in the end of 2001, the us government and microsoft, however, reached a settlement, and the tying charge was dropped. 2.3.2 tying and microsoft in the eu microsoft88 is perhaps the most important and the most complex tying case prosecuted under eu competition law. in the end of 1998, sun microsystems inc. made a complaint to the commission. sun alleged that microsoft had abused its dominant position by not disclosing certain crucial information on its operating system to competitors. access to that information would have been vital to the competitors to enable them design products that would have fully interoperable with microsoft’s pc operating systems. after receiving the complaint, the commission launched an investigation into microsoft’s conduct, including tying windows media player with windows operating system. windows media player had been installed as a non-removable part of windows since may 1999. the commission gave its decision in 2004. microsoft’s argument that the operating system and the windows media player constituted one integrated product was rejected. the commission held media players as products that must be held to be separate from operating systems. it cited numerous reasons for its finding. first, consumer demand for media players and operating systems is not identical. stand-alone media players that could be installed on pcs existed, and software companies specialized in supplying such players. thus, there clearly was consumer demand for media players and the demand was different from consumer demand for pc operating systems.89 the commission, however, acknowledged that the direct consumer demand test may be outdated, since it focused on past consumer 85 ibid., pp. 92-93. 86 ibid., p. 95. 87 ahlborn, christian & bailey, david & crossley helen: an antitrust analysis of tying: position paper. gclc research papers on article 82 ec. july 2005, 166-216. http://www.coleurope.eu/content/gclc/ documents/gclc%20research%20papers%20on%20article%2082%20ec.pdf, pp. 183-184, visited january 21, 2010. 88 microsoft v. commission. commission decision case 3/37.792. march 24, 2004. 89 ibid., paragraph 804. nordic journal of commercial law issue 2015#1 20 behavior before product integration. however, despite microsoft’s product integration there still was significant demand for alternative media players.90 second, operating systems and media players were clearly two distinct products. microsoft had developed windows media player versions for competitors’ operating systems and released and promoted upgrades to the player with no connection to the general windows operating system upgrades. this worked to further demonstrate that operating system and media players were not the same product. moreover, windows media player and operating system had different functionalities and microsoft applied different licensing agreements to them.91 the commission also rejected microsoft’s argument that bundling the media player with the operating system was a normal commercial practice as independent companies that offered media players still existed. in addition, sun and linux vendors did not bundle their own media players but, instead, offered third party players. finally, microsoft’s windows was the only operating system which did not allow its users to remove the bundled media player code.92 this was significant as it entailed that customers were not allowed to obtain the tying product without the tied product. microsoft tried to argue that windows media player was offered for free and there was no obligation to use it, but the commission rejected this by pointing out that article 102 (d) tfeu includes neither reference to paying nor to the forced use of the tied product. as long as windows media player was automatically added, alternative media player suppliers were competitively disadvantaged.93 the commission, however, acknowledged that it is not enough to prove the foreclosure effect for competitors by only demonstrating that the tied product is bundled with the dominant tying product. since other media players could be for example downloaded from the internet, foreclosing competition could not simply be assumed.94 however, microsoft’s market share at the time had been over 90% with respect to operating systems. tying windows media player with the windows operating system provided a distribution system that had no comparable. this made users less likely to use alternative media players, since they already had an integrated media player. 95 the alternative channels of getting a media player, such as downloading, were less efficient. tying helped microsoft get the same distribution in three months as it would have gotten in one year by downloading96. moreover, tying helped microsoft get content providers to supply content in the windows media player format, which increased the format’s popularity and further complicated market entry for new competitors. since windows was installed on the majority of pcs, software developers had sizable incentives to write applications for the windows media player.97 this 90 ibid., paragraph 808. 91 ibid., paragraphs 805, 810-812. 92 ibid., paragraphs 822-823. 93 ibid., paragraphs 830-833. 94 ibid., paragraph 841. 95 ibid., paragraphs 844-845. 96 ibid., paragraph 911. 97 ibid., paragraph 891, 895. nordic journal of commercial law issue 2015#1 21 was likely to cause network effects in favor of microsoft media player. the relevant market data confirmed a rising trend in windows media player and windows media format use.98 however, the data simultaneously showed that windows media player was not better in quality than its competitors.99 finally, although competitors may not have been affected by the dominant company’s anti-competitive conduct, the absence effects does not disprove that tying may foreclose competition, the commission held. otherwise, legal intervention would always come too late, when markets would have already tipped.100 finally, the commission rejected microsoft’s argument that media players could not be viewed as substitutes for operating systems, and, thus they could not threaten its dominant position. the commission concluded that media players could become substitutes, if they were combined with java.101 here the commission implicitly referred to the theory of defensive leverage. moreover, the commission applied the offensive leverage theory, when it held that the media player market was a gateway to other related markets such as content encoding software, format licensing, wireless information device software, 1240 drm solutions and online music delivery. the grand chamber of the general court confirmed the commission’s decision and microsoft did not appeal to the court of justice of the european union.102 2.3.3 is google the next case? microsoft was one of the first but not necessary the last technical tying case subjected to competition law scrutiny. edelman argues that google has used tying and bundling to expand its dominant position on the market for algorithmic searches to other markets. google is a dominant high-tech company. it has an extremely popular web search service that features not only algorithmic search results, but offers a slew of google services such as google maps, google images, google shopping, you tube, etc. these services get prominent placement in search results whereas competing services receive a less favorable treatment. consequently, google’s services get considerable user traffic.103 in practice, the preferential treatment google accords to its own services, directly affects competitors’ viability. they get fewer clicks as users tend to contend with using google’s services and do not bother to search for what competitors offer. moreover, it is a well known fact that users tend to favor the most popular search results. they tend to assume that links to google’s services appear first since they refer to the most popular or the best services. however, many do not realize 98 ibid., paragraph 944. 99 ibid., paragraph 951. 100 ibid., paragraph 946. 101 ibid., paragraphs 971-972. 102 case t-201/04. microsoft corp. v. commission [2007] ecr ii-03601. 103 edelman, benjamin: does google leverage market power through tying and bundling? (may 12, 2014). journal of competition law and economics 11, no. 2 (june 2015): 365-400. available at ssrn: http://ssrn. com/abstract=2436940 or http://dx.doi.org/10.2139/ssrn.2436940, pp. 5-6, visited august 5, 2015. nordic journal of commercial law issue 2015#1 22 that google consciously favors its services and put its competitors at a disadvantage by placing its own services on top.104 google has been the subject of an antitrust investigation in the usa. in january 2013, the us federal trade commission (ftc) published the results of the investigation: “the ftc also conducted an extensive investigation into allegations that google biased its search results to disadvantage certain vertical websites; and that google entered into anticompetitive exclusive agreements for the distribution of google search on both desktop and in the mobile arena. the agency decided not to take action in connection with these allegations.”105 the question of search-related practices was unanimously (5-0) dismissed. the ftc argued that although additional changes made to google’s search algorithms may harm competitors, they were considered to be innovations that improved the product and user experience. after the ftc ruling the eu commission sent a statement of objections to google in april 15, 2015. the commission alleged that google had abused its dominant position in the markets for general search services by giving a favorable treatment to its own services by placing them prominently on customers’ screens. the investigation is still on-going but if google is found to infringe competition law, google may be forced to change the way it does business in europe. one possible remedy could be that google would be obliged to give its competitors’ services treatment equal to the one it gives its own service.106 many experts have argued that google controls the search engine space and dictates what sites and services appear easily accessible on computer screens in the same way that microsoft previously controlled the desktop world.107 in their view, the commission has a valid case. however, many experts are wondering whether there are enough similarities between google’s and microsoft’s practices to warrant the intervention. some commentators have also argued in support of google’s practices. some have, first, claimed that competition law imposes no restrictions on search services tying. consequently, google is free to provide whatever results it likes. furthermore, the critics have pointed out that it is uncertain whether google’s offering even consists of different products. the google experience could be interpreted to be one integrated product. consequently, integrating algorithmich search with 104 edelman, benjamin: leveraging market power through tying: does google behave anti-competitively? harvard business school working paper, no. 14-112, may 2014, pp. 8-10. 105 google agrees to change its business practices to resolve ftc competition concerns in the markets for devices like smart phones, games and tablets, and in online search. january 3, 2013. https://www.ftc.gov/ news-events/press-releases/2013/01/google-agrees-change-its-business-practices-resolve-ftc, visited january 15, 2014. 106 european commission – press release. antitrust: commission sends statements of objections to google on comparison shopping service; opens separate formal investigatin on android. http://europa.eu/rapid/ press-release_ip-15-4780_en.htm, visited april 20, 2015. 107 edelman, benjamin g.: does google leverage market power through tying and bundling? (may 12, 2014). journal of competition law and economics 11, no. 2 (june 2015): 365-400. available at ssrn: http://ssrn. com/abstract=2436940 or http://dx.doi.org/10.2139/ssrn.2436940, p. 34, visited august 5, 2015. nordic journal of commercial law issue 2015#1 23 a complementarity service offering can be argued to offer benefits for the consumer, as the consumer needs to spend less effort to find what she needs. moreover, google’s services are free to the users and nothing forces the customers to use them. the no-cost nature of the services makes it difficult to argue that consumers would suffer harm. free service provision is possible, as google does not operate on traditional bilateral markets, but on twoor multisided markets.108 google can offer services for free to the consumers, because it gets its revenue from search related online advertising, that is, from advertisers. in the traditional brick-and-mortar world, google’s business model resembles a free advertising newspaper that also is free for readers but not for advertisers. consequently, the business model is not only specific to the high-technology markets. some commentators think that google’s business model and products are innovative and have gained popularity among consumers for good reason. others109 have categorized it as predatory pricing. the problem caused by the predatory pricing diagnosis is not confined to google alone. multisided market business models are, in fact, the norm in internet business: nearly all companies use one market to attract users with zero-cost or below-cost pricing while revenue is earned on the other side of the market. moreover, google is not free from competitive pressure as there are so-called vertical search engines, such as, for example, amazon in books, which are aimed at seeking specific information. competition is said to be only a click away. also arguments advicing caution have been raised.110 these commentators have argued that the competitive consequences of google’s practices are highly uncertain. it may, for example, be difficult to rule whether google’s actions are pro-competitive behavior or anticompetitive, because the market is new and not necessarily well understood. the uncertainties should result in cautious interventions. aggressive, erroneous application of competition law – that is interventions against innovations and business practice that later turn out to be pro-competitive – could be fatal to the markets. false positives tend to be more problematic than false negatives, since selfcorrecting market mechanisms mitigate the effects of false negatives but not the consequences of false positives.111 finally, it is also uncertain whether google’s practices, in particular, amout to tying or whether they, in fact, constitute some other type of abuse. 108 koerber, torsten: let’s talk about android – observations on competition in the field of mobile operating systems (july 4, 2014). german version: nzkart 2014, 378 386. available at ssrn: http://ssrn.com/ abstract=2462393, p. 4, visited september 14, 2014. 109 see bottin cartographes/google france, where the zero pricing of the google maps api was held to be predatory pricing. tribunal de commerce de paris, 15ème chambre, jugement du 31 janvier 2012, bottin cartographes google france, google inc. 110 manne, geoffrey a. & wright, joshua d.: google and the limits of antitrust: the case against the antitrust case against google (march 24, 2010). lewis & clark law school legal studies research paper no. 2010-19; george mason law & economics research paper no. 10-25; harvard journal of law and public policy, vol. 34, no. 1, winter 2011. available at ssrn: http://ssrn.com/abstract=1577556 or http://dx.doi. org/10.2139/ssrn.1577556 , visited january 10, 2014. 111 easterbrook, frank. h.: the limits of antitrust. 63 texas law review 1 (1984). nordic journal of commercial law issue 2015#1 24 the commission has also opened a separate investigation into the android mobile operating system. the commission investigates whether google has hindered the development and market access of rival mobile operating systems, applications and services.112 the android investigation is also complicated. also here it appears that microsoft differs from google.113 for example, microsoft’s dominant position in the operating system markets had lasted several years and entry barriers were high, whereas the strong market position of android is still rather young and entry barriers are perhaps lower than in the case of windows. it remains to be seen whether android can maintain its position on these dynamic markets. 2.4 tying doctrine in eu competition law what is the current state of law in the eu? in eu competition law, tying is prohibited if a fiveprong test is met: 1) the tying undertaking is dominant in the tying market; 2) the tying and tied goods are two distinct products or services; 3) customers cannot obtain the tying product without the tied product and; 4) tying forecloses competition and; 5) tying cannot be justified by objective factors or efficiencies.114 dominance in the market for the tying product has always been a precondition for the finding of abuse. however, no requirement for dominance in the tied market has ever been imposed, but such dominance may make the finding of abuse more likely.115 the approach is natural as tying is likely harmless, if the tying product and tied product markets are competitive. attempts at intro112 european commission – press release. antitrust: commission sends statements of objections to google on comparison shopping service; opens separate formal investigatin on android. http://europa.eu/rapid/ press-release_ip-15-4780_en.htm, visited april 20, 2015. 113 koerber, torsten: let’s talk about android – observations on competition in the field of mobile operating systems (july 4, 2014). german version: nzkart 2014, 378 386. available at ssrn: http://ssrn.com/ abstract=2462393, pp. 18-19, visited september 14, 2014. 114 the first four criteria were defined in microsoft. the fifth criterion is based on case law. see microsoft. commission decision case 3/37.792. march 24, 2004, paragraph 794 and t-228/97 irish sugar v. commission 1999 ii-02969, pargraph 189. 115 dg competition discussion paper on the application of article 82 of the treaty to exclusionary abuses. public consultation. brussels, december 2005, paragraph 184. see also tetra pak ii where it was held that “an undertaking which enjoys a quasi-monopoly on certain markets and a leading position on distinct, though closely associated, markets is placed in a situation comparable to that of holding a dominant position on those markets as a whole. conduct by such an undertaking on those distinct markets which is alleged to be abusive may therefore be covered by article 86 of the treaty without any need to show that it is dominant on them. “ nordic journal of commercial law issue 2015#1 25 ducing unattractive tying practices when consumers have plentiful choice will only likely lead to consumers ending up choosing competitors’ products.116 customer demand is decisive when courts rule on what kind of product or service packages can be held to constitute distinct products. the standard test is that the tied products are held to be distinct, if a considerable number of customers have purchased or would have purchased the tying product without the tied product from the supplier. moreover, there may be direct or indirect evidence suggesting that the products are distinct. direct evidence may show that customers buy the tying product and tied product separately from other manufacturers, whereas indirect evidence may show that the tied product is manufactured and sold without the tying product, or that companies that have only little market power tend not to tie.117 commercial usage may indicate that two products are not distinct, but as in tetra pak ii, it does not automatically guarantee that a certain practice is lawful. the appraisal of anti-competitive foreclosure is perhaps the vaguest of the criteria: both in british sugar and hilti tying did not require commission to demonstrate that practices had a significant effect on the tied market, but in microsoft the foreclosure effects were analyzed in detail. the commission even stated that “the higher the tied percentage of total sales on the tied market, the larger is normally the foreclosure effect.” moreover, the foreclosure effect may increase if there are significant economies of scale, a production or design learning curve, network effects or entry barriers in the tied market.118 moreover, if the dominant firm offers a bundle with multiple products, the anticompetitive foreclosure effect may be stronger–especially if the competitors cannot easily replicate the bundle.119 foreclosure is a particulary relevant concern in the us, where it has been one of the key elements assessed in tying cases. for example, in brantley120 customers complained that a cable television provider only sold channels in large packages. the complaint was dismissed as no foreclosure effect had ensued: the plaintiffs were not able to show that any independent program provider would have been excluded from the market by the arrangement. in addition to suppressing existing competition, tying practices may be used to pre-emptively to stave off competitors and protect a dominant position in the tying market.121 in particular, long run tying or bundling strategies may have considerable anticompetitive effects. in these strategies, tying is often implemented through technical means, which is often costly to reverse and may 116 hovenkamp, erik n. and hovenkamp, herbert j.: tying arrangements (may 14, 2012). u iowa legal studies research paper no. 12-28. available at ssrn: http://ssrn.com/abstract=1999063 or http://dx.doi. org/10.2139/ssrn.1999063, p.3, visited november 27, 2013. 117 guidance on the commission’s enforcement priorities in applying article 82 of the ec treaty to abusive exclusionary conduct by dominant undertakings. 2009/c 45/02, paragraph 51. 118 dg competition discussion paper on the application of article 82 of the treaty to exclusionary abuses. public consultation. brussels, december 2005, paragraphs 196 and 199. 119 guidance on the commission’s enforcement priorities in applying article 82 of the ec treaty to abusive exclusionary conduct by dominant undertakings. 2009/c 45/02, paragraph 54. 120 brantley v. nbc universal, inc. 675 f.3d 1192, 1196 (9th cir. 2012). 121 guidance on the commission’s enforcement priorities in applying article 82 of the ec treaty to abusive exclusionary conduct by dominant undertakings. 2009/c 45/02, paragraph 52. nordic journal of commercial law issue 2015#1 26 prevent the resale of the component products.122 however, this question is controversial. some commentators have highlighted that interventions are more sensible when tying is implemented with contracts rather than by product design. interventing in internal company activities ’for which unspecified relationships and transactions are not mediated by the price system’ imposes significant costs and has uncertain consequences.123 the commission has not included the third and fifth criteria in its ‘official test’ contained in its guidance paper. yet, at least the efficiency and objective reasons defenses still appear to be valid and effective defenses.124 thus, under eu law tying understakins may invoke objective justifications or claim that tying, in fact, increases economic efficiency. to assess whether tying practices are prohibited, the commission analyzes whether tying or bundling leads to production, distribution or transaction cost savings. moreover, it analyzes whether tying or bundling can facilitate the launch of new combined products and whether the practices allow the efficiency benefits from production or buying large quantities of the tied product to pass to consumers.125 how to categorize the eu law tying test? it is uncertain whether the commission’s decision in microsoft changed the test fundamentally. some commentators have suggested that the commission followed the us modified per se rule established in jefferson parish.126 others have argued that the rule of reason approach was applied instead.127 it is, nevertheless, evident that commission did something new in microsoft. it analyzed the potential pro-competitive effects and foreclosure effects of tying in more detail and depth than before, which suggest that it had adopted a more lenient approach to tying.128 3 conclusion recent court decisions indicate that courts are increasingly willing and capable to analyze the effects tying has on competition. this appears to be leading to the gradual abandonment of the per se prohibition of tying. the alternative, the rule of reason approach is the best suited for tying cases in high-technology industries, in particular. treating tying as per se illegal or using doctrines that effectively lead to such outcomes appears a suboptimal strategy and is likely to result in unnecessary interventions in cases where the tying practices have little or no competitive effects. 122 ibid., paragraph 53. 123 carlton, dennis w. & waldman, michael: tying (august 1, 2008). 3 issues in competition law and policy 1859, 2008. available at ssrn: http://ssrn.com/abstract=1529843, pp. 1860, 1876, visited january 14, 2010. 124 see guidance on the commission’s enforcement priorities in applying article 82 of the ec treaty to abusive exclusionary conduct by dominant undertakings. 2009/c 45/02, paragraphs 50 and 62. 125 ibid., paragraph 62. 126 evans, david s. & salinger, michael: why do firns bundle and tie? evidence from competitive markets and implications for tying law. 22 yale j. on reg. 37, 45 (2005). 127 kuoppamäki, petri: uusi kilpailuoikeus. 2. painos. sanoma pro oy 2012, p. 258. 128 schmidt, hedvig: competition law, innovation and antitrust. an analysis of tying and technological integration. cheltenham. edward elgar, 2009, 52, 114. nordic journal of commercial law issue 2015#1 27 indeed, the legal formalism appears to lead courts to unfoundedly assume tying to have only negative effects and either commit insufficient resources to the analysis of efficiencies or even ignore it in its entirety. although the chicago school has profoundly influenced antitrust law, tying doctrine has remained resistant to its sway. this is understandable, because per se legality appears to be too much. tying can have both negative and positive effects and should be judged taking into account such effects. the rule of reason approach was applied in microsoft iii129 in the us and there were signs of effects-based analysis in microsoft130 in the eu, but it may be too early to say whether they marked a turning point towards a more favorable approach to tying and technical integration. nevertheless, it is more likely that the tying doctrine is changing. today the benefits of tying are better understood and must be taken into account in the application of tying doctrine. 129 united states v. microsoft corp. 253 f.3d 34 (d.c. cir. 2001) 130 microsoft v. commission. commission decision case 3/37.792. march 24, 2004. contracts, risks and management = contractual risk management nordic journal of commercial law issue 2012#1 the intersection of comparative advertising and trademark laws in the united states and the european union a comparative analysis based on smith v. chanel and l’oréal v. bellure by cynthia w. sharp nordic journal of commercial law issue 2012#1 1 introduction united states and european union trademark laws have common foundations in the paris convention for the protection of industrial property and also in the agreement on traderelated aspects of intellectual property rights (trips agreement). as parties to these international agreements, both jurisdictions are obligated to adhere to certain fundamental parameters regarding trademark law and its enforcement. despite these shared roots, a comparison of the european court of justice’s ruling in l’oréal v. bellure with the factually similar us ninth circuit court of appeals case smith v. chanel reveals a divergence between the us and the eu in these two jurisdictions’ construal of the interaction between trademark law and comparative advertising law. this variance reflects differences in the cultural and policy considerations behind these jurisdictions’ creation of the laws. ultimately, however, it is due to fundamental differences in subsequent interpretations of those laws, as illustrated by diverging developments in the relevant case law. an understanding of these differences and developments can help clarify not only the reasons for their emergence, but may also help predict future directions the laws may take. this paper is divided into four main sections. section 1 presents an overview of comparative advertising laws in the eu and the us, providing background for the case law discussion that follows. section 2 delves further into these jurisdictions’ respective trademark and comparative advertising laws to reveal their interrelationship, the foundations upon which they are based, and the values they are intended to protect. section 3 reviews the cases at issue in light of those laws and proposes that the divergence in laws between the eu and us stems primarily from opposing interpretations of anti-dilution laws. this divergence then triggers different interpretations regarding the way in which trademark law should intersect with comparative advertising law. section 4 suggests that the max planck institute’s study on the overall functioning of the european trade mark system indicates that in the future, the eu laws are likely to align more closely with their us counterparts, if certain proposals made by the institute are implemented by the european commission. 1 comparative advertising in the united states and the european union: an overview 1.1 united states 1.1.1 united states code: title 15 comparative advertising in the us is defined as ‘advertising that compares alternative brands on objectively measurable attributes or price, and identifies the alternative brand by name, nordic journal of commercial law issue 2012#1 2 illustration or other distinctive information.’1 foundationally, us comparative advertising law stems from title 15 of the united states code, primary federal legislation which covers commerce and trade. title 15 gives the federal trade commission (ftc) oversight over business practices. title 15 specifically prohibits ‘[u]nfair methods of competition in or affecting commerce, and unfair or deceptive acts or practices in or affecting commerce.’2 it also prohibits false advertising.3 the lanham act, which sets out federal protection and registration standards for trademarks and is codified in title 15, forbids ‘[f]alse designations of origin, false descriptions, and dilution.’4 prior to the ftc’s codification of us comparative advertising law, claimants often relied upon the lanham act for relief. 1.1.2. statement of policy regarding comparative advertising the current state of us comparative advertising law has been shaped and defined by the ftc’s statement of policy regarding comparative advertising. this policy statement, in effect since 1979, emphasizes that the ftc not only tolerates, but actively encourages, truthful, nondeceptive comparative advertising.5 prior to this clarification, advertising that compared different brands and identified them had been discouraged by both broadcasters and selfregulation entities.6 the ftc’s stated viewpoint, however, was that such advertising offers important information to consumers and promotes product improvement and innovation.7 the judiciary will defer to agency regulations interpreting a provision of the united states code, provided the regulations are a ‘permissible construction’ of that provision.8 the ftc’s regulation codifying its comparative advertising policy statement has withstood the test of time: it was cited approvingly in a judicial opinion as recently as september 19, 2011.9 1 statement of policy regarding comparative advertising, 16 c.f.r. § 14.15(b) (2012). 2 15 u.s.c. § 45. 3 15 u.s.c. §§ 52-54. 4 15 u.s.c. § 1125. 5 statement of policy regarding comparative advertising, 16 c.f.r. § 14.15(b) (2012). 6 john e. villafranco, ‘the law of comparative advertising in the united states’, ip litigator, jan.-feb. 2010, at 1,1. 7 statement of policy regarding comparative advertising, 16 c.f.r. § 14.15(a)-(c) (2012). 8 chevron, usa, inc. v. nat. resources defense council, inc., 467 u.s. 837, 843 (1984). 9 ashley furniture indus. inc. v. am. signature, inc., no. 2:11-cv-00427, 2011 wl 4383594, at *4 (s.d.ohio. sept. 19, 2011). nordic journal of commercial law issue 2012#1 3 the ftc, when determining whether a certain advertisement is authorized, will consider ‘whether or not the advertising has a tendency or capacity to be false or deceptive.’10 the ftc emphasizes the benefits to the consumer, not the rights of the companies making the products, when conducting its analysis. 1.2 european union 1.2.1 directive 2006/114/ec concerning misleading and comparative advertising comparative advertising in the eu is defined as ‘any advertising which explicitly or by implication identifies a competitor or goods or services offered by a competitor.’11 directive 2006/114/ec of the european parliament and of the council of 12 december 2006 concerning misleading and comparative advertising establishes this definition and also lays down uniform general principles so as to harmonize the conditions of use of comparative advertising in the eu member states.12 it is a directive, and not a regulation; therefore, it allows eu member states to choose the form and appropriate method by which to attain those objectives in their own national laws.13 similar to the parallel us law, eu law on comparative advertising is essentially a supplement to earlier existing laws on misleading advertising. council directive of 10 september 1984 relating to the approximation of the laws, regulations and administrative provisions of the member states concerning misleading advertising (84/450/eec) was amended by the october 1997 directive so as to include comparative advertising (97/55/ec). it was then subsequently repealed and codified by directive 2006/114/ec on misleading and comparative advertising (hereinafter the ‘comparative advertising directive’).14 like the ftc in the us, the parliament and council acknowledge that truthful comparative advertising ‘can be a legitimate means of informing consumers of their advantage’15 and ‘can also stimulate competition between suppliers of goods and services to the consumer’s advantage.’16 as regards protection of consumers against misleading advertising, however, there is crossover with another recent directive. 10 statement of policy regarding comparative advertising, 16 c.f.r. § 14.15(c)(2) (2012). 11 directive 2006/114/ec, oj l 376 at 22, art. 2(c). 12 directive 2006/114/ec, oj l 376 at 21, para. 6. 13 directive 2006/114/ec, oj l 376 at 22, para. 20. 14 directive 2006/114/ec, oj l 376 at 26, annex i, part a. 15 directive 2006/114/ec, oj l 376 at 22, para. 8. 16 directive 2006/114/ec, oj l 376 at 21, para. 6. nordic journal of commercial law issue 2012#1 4 according to article 1 of 84/450/eec, its purpose was to ‘protect consumers, persons carrying on a trade or business or practising a craft or profession and the interests of the public in general against misleading advertising and the unfair consequences thereof.’ however, the comparative advertising directive specifies that its purpose is to ‘protect traders against misleading advertising and the unfair consequences thereof and to lay down the conditions under which comparative advertising is permitted.’ (emphasis added) this change in focus from consumers to traders as regards misleading advertising is due to the adoption of the unfair commercial practices (ucp) directive in 2005. the ucp directive regulates the commercial practices of business to consumers (b2c), so its misleading advertising rules replaced the b2c rules in what is now the comparative advertising directive.17 it is worth noting that there is no such division regarding comparative advertising. when claims regarding unlawful comparative advertising simultaneously include claims regarding advertising that misleads consumers, the provisions of both directives are therefore implicated. 1.2.2 implementation of comparative advertising rules the only primary sources of eu law are the treaties that create the european union, to which all eu member states are signatories and from which all eu institutions derive their authority.18 secondary sources of law include regulations and directives. regulations promulgated by eu institutions are directly binding on the member states and become part of national laws with no additional steps necessary. the language of regulations is verbatim law. directives, on the other hand, are binding only as to the result: member states are responsible for drafting national legislation to reach that result. because comparative advertising law in the eu is based on a directive, not a regulation, there are variations in national laws. 1.2.3 directive 2008/95/ec relating to trademarks eu trademark law is directly implicated in comparative advertising law. the trademark directive is mentioned in the recitals paragraphs 13 through 15 of the comparative advertising directive, where it is acknowledged that, despite trademark owners’ right to prevent third parties from using their mark on identical or similar products or services, comparative advertising cannot be effective if a competitor’s goods or services cannot be identified. while recitals do not constitute the law, they do reflect underlying policy objectives behind the law. 17 the european commission web site pages on consumer protection: http://ec.europa.eu/consumers/ cons_int/safe_shop/mis_adv/index_en.print.htm (last accessed may 25, 2011) 18 sources of european union law: http://europa.eu/legislation_summaries/institutional_affairs/ decisionmaking_process/l14534_en.htm (last updated august 18, 2010; last accessed may 25, 2011); with the entry into force of the treaty of lisbon on december 1, 2009, eu primary law also includes the charter of fundamental rights of the european union. http://ec.europa.eu/consumers/cons_int/safe_shop/mis_adv/index_en.print.htm http://ec.europa.eu/consumers/cons_int/safe_shop/mis_adv/index_en.print.htm http://europa.eu/legislation_summaries/institutional_affairs/decisionmaking_process/l14534_en.htm http://europa.eu/legislation_summaries/institutional_affairs/decisionmaking_process/l14534_en.htm nordic journal of commercial law issue 2012#1 5 the use of trademarks in comparative advertising is pivotal in l’oréal v. bellure, the european court of justice (ecj) case at issue here.19 1.2.4 case law the l’oréal v. bellure ruling was handed down by the ecj, the eu’s highest court. however, unlike the us, the eu legal system is primarily based on civil law principles, which traditionally have not included the common law doctrine of precedent. the europa website labels ecj case law as ‘supplementary;’20 that is, judicial opinions constitute neither primary nor secondary law. it is nonetheless significant that the l’oréal v. bellure decision was made in response to a preliminary ruling, a procedure whereby national courts question the ecj on the interpretation or validity of european law.21 such a process is ‘not a recourse taken against a european or national act, but a question presented on the application of european law.’22 the ecj’s interpretations of eu law, when formulated in response to a preliminary ruling, are binding on all member states’ national courts as well as the court of the member state that requested the ruling.23 there is no formal doctrine of stare decisis, or binding precedent, in the eu, but the ecj does tend to follow its own decisions even though it is not obligated to do so.24 consequently, while the ecj did not “decide” the case in the same way a us court would, the ecj’s interpretation of the eu laws implicated in l’oréal v. bellure nonetheless impacts the interpretation of those laws in all the eu member states and in future ecj decisions. 1.3 smith v. chanel in the us and l’oréal v. bellure in the eu more than forty years after the us ninth circuit court of appeals (ninth circuit) handed down its decision in smith v. chanel, the ecj issued a preliminary ruling in l’oréal v. bellure in 2009. the factual similarity between these two cases is remarkable, although the context of the decisions is different. despite the passage of time, smith v. chanel remains binding precedent in 19 the l’oréal v. bellure decision was reached under earlier versions of the laws discussed here, but the relevant provisions remained consistent. 20 http://europa.eu/legislation_summaries/institutional_affairs/decisionmaking_process/l14533_en.htm (last updated august 20, 2010; last visited may 10, 2011). 21 http://europa.eu/legislation_summaries/institutional_affairs/decisionmaking_process/l14552_en.htm (last updated october 1, 2010; last visited april 22, 2012). 22 id. 23 id. 24 juha raitio, the principle of legal certainty in ec law 86 (kluwer acad. publishers 2003); see also hans w. micklitz, the politics of judicial co-operation in the eu 121 (cambridge u. press 2005). http://europa.eu/legislation_summaries/institutional_affairs/decisionmaking_process/l14533_en.htm http://europa.eu/legislation_summaries/institutional_affairs/decisionmaking_process/l14552_en.htm nordic journal of commercial law issue 2012#1 6 the us; in fact, it has been referenced in other judicial opinions more than 575 times since its publication, most recently in august, 2011.25 however, in light of certain proposals outlined in the recently issued max planck institute study on the overall functioning of the european trademark system, it remains to be seen whether l’oréal v. bellure will continue to provide accurate guidance on interpretation of the intersection of trademark law and comparative advertising law in the eu, or whether future changes to the applicable laws will render this case moot. 1.3.1 smith v. chanel, inc. 1.3.1.1 facts26 smith created a fragrance called ‘second chance’ as a duplicate of chanel, inc.’s fragrance ‘chanel no. 5’ at a fraction of the latter’s price. he advertised this and other ‘smell-alike’ perfumes in a trade journal directed to wholesale purchasers, claiming that his perfumes ‘duplicate 100% perfect the exact scent of the world’s finest and most expensive perfumes and colognes at prices that will zoom sales to volumes you have never before experienced!’ this advertisement also contained an order blank with a ‘comparison list’ presenting each smith fragrance along with the name of the well-known fragrance it purportedly duplicated. below ‘second chance’ appeared ‘(chanel no. 5)’ with an asterisk referring to a statement at the bottom of the form reading ‘registered trade name of original fragrance house.’ chanel, inc. filed suit against smith claiming violation of us trademark laws, 15 usc. §§ 1051 et seq. ‘without regard to the truth or falsity of the statements made in defendant's advertisement and notwithstanding the fact that the plaintiffs' toilet preparations are not protected by the patent laws,’27 the trial court held that smith infringed chanel, inc.’s trademarks and that irreparable harm would result if the infringements continued. chanel, inc. was therefore granted a preliminary injunction prohibiting any reference to chanel no. 5 in the promotion or sale of smith’s ‘smell-alike’ perfumes. smith appealed. 25 according to westlaw citing references, apr. 24, 2012. 26 all facts are drawn from smith v. chanel, inc., 402 f.2d 562, 562-63 (9th cir. 1968), and chanel, inc. v. smith, 151 u.s.p.q. 685 (n.d.cal. 1966). 27 chanel, inc. v. smith, 151 u.s.p.q. 685, 687 (n.d.cal. 1966). nordic journal of commercial law issue 2012#1 7 1.3.1.2 decision the ninth circuit reversed the trial court’s decision. noting that both parties agreed that 1. smith had the right to copy chanel’s perfume; 2. smith’s copy was indeed equivalent to chanel’s original, and 3. the packaging and labeling of ‘second chance’ was not misleading or confusing,28 the court framed the issue as ‘whether one who has copied an unpatented product sold under a trademark may use the trademark in his advertising to identify the product he has copied.’29 stating that such use was allowed, the ninth circuit held that a manufacturer of a perfume may market its perfume as a duplicate of a trade-mark perfume which was not patented so long as the manufacturer does not misrepresent or create a reasonable likelihood that purchasers would be confused as to source, identity, or sponsorship of manufacturer's product.’30 the ninth circuit’s reasoning will be discussed further in section 3. 1.3.2 l’oréal sa v. bellure nv 1.3.2.1 facts31 bellure produced and marketed ‘smell-alike’ perfumes, using a comparison list for retailers that indicated the word marks of the luxury brands to which the smell-alike product corresponded. some of the luxury brands, such as trésor and anais anais, were owned by l’oréal. bellure’s cheaper perfumes included ‘coffret d'or’ and ‘la valeur,’ which bellure’s comparison lists identified as sharing characteristics, specifically smell, with certain of l’oréal ’s luxury perfumes. l’oréal filed suit against bellure in the high court of justice of england and wales (chancery division), claiming that bellure’s similar packaging and comparison lists showing which products corresponded to which l’oréal perfume infringed l’oréal’s registered trade marks for those perfumes. l’oréal claimed that the reputations of its well-known luxury perfumes were harmed by the cheaper imitations. the packaging issue was later resolved, so this discussion will focus on the comparison list claim. dissatisfied with the high court’s ruling, l’oréal appealed and the case reached the court of appeal of england and wales (civil division). the appeals court stayed the proceedings and, 28 smith v. chanel, inc. at 563. 29 id. 30 id. 31 all facts are drawn from case c-487/07, l’oréal v. bellure [2009] ecr i-5185, paras. 14-26. the facts are simplified somewhat here (particularly as regards the parties’ names) in the interests of brevity. nordic journal of commercial law issue 2012#1 8 in a reference for a preliminary ruling, sought guidance on the inter-relationship of the trademarks directive and the comparative advertising directive. 1.3.2.2 decision the ecj’s interpretation of the directives gave the uk court no choice but to rule that bellure’s use of l’oréal’s registered marks in its comparison lists constituted trademark infringement and unlawful comparative advertising. in its reference for a preliminary ruling, the uk court had specifically asked whether article 5(1)(a) of the trademark directive (prohibiting use of an identical mark for identical goods) was implicated when the trader uses registered marks in a way that such use plays a significant role in the promotion of the trader’s product, but does not cause confusion, harm the sales or reputation of the well-known product, or jeopardize the registered marks’ essential function. then, if so, was there a defense under the comparative advertising directive that the comparison lists were lawful, and did the use of the marks in the comparison lists infringe article 5(2) of the trademark directive by taking unfair advantage of the reputation of the marks?32 the ecj, in answering the questions, addressed the last question first, holding that unfair advantage under article 5(2) of the trademark directive does not require a likelihood of confusion or detriment to the distinctive character of the repute of the mark or to its proprietor.33 the court also ruled that article 5(1)(a) of the trademark directive allows the proprietor of a registered trademark to prevent a third party’s use of the mark in a comparative advertisement when that advertisement does not satisfy all the conditions of the comparative advertising directive.34 further, the court ruled that an advertiser who explicitly or implicitly states in comparative advertising that his product is an imitation of a product bearing a wellknown trademark violates article 3a(1) of the comparative advertising directive and takes unfair advantage of the mark.35 the ecj’s reasoning will be discussed further in section 3. 32 case c-487/07, l’oréal v. bellure, paras. 27-30. 33 id., para. 50. 34 id., para. 65. 35 id., para. 80. nordic journal of commercial law issue 2012#1 9 2 comparative advertising and trademark law in the us and the eu: foundations and protected values two cases, almost identical facts, laws complying with international obligations – so why such opposite outcomes? an understanding of the foundations for those laws, as well as the values they protect, is crucial to an analysis of their interpretation. 2.1 united states in the us, comparative advertising law developed primarily from judicial interpretations of certain aspects of trademark law. 2.1.1 trademarks 2.1.1.1 constitutional basis of trademark law trademarks are considered intellectual property (ip) and therefore are generally grouped with copyrights and patents, but in the united states, congress’s authority to regulate trademarks is derived from a different constitutional clause than these other two primary forms of ip. congress’s power to set federal trademark law stems from the commerce clause, which gives congress power to regulate commerce between the states and with foreign nations.36 ip laws, however, stem from the copyright clause, which gives congress the power to ‘promote the progress of science and useful arts, by securing for limited times to authors and inventors the exclusive right to their respective writings and discoveries.’37 this distinction signifies that the policy rationales for these types of ip differ. copyright and patent protection is afforded to stimulate innovation for the common good. trademark protection, on the other hand, has its foundation in regulation of commerce. of course, innovation in the arts and sciences intersects with commerce, but the two areas have very different considerations: copyright and patent law rewards creativity, while that is not the primary purpose of trademark law. the focus of us trademark law may have fluctuated in the past few centuries, but its foundation has not. ultimately, this commercial foundation has determined the direction in which trademark law, and the case law interpreting it, has developed in the us. 36 u.s. const., art. 1, § 8, cl. 3. 37 u.s. const., art. 1, § 8, cl. 8. nordic journal of commercial law issue 2012#1 10 2.1.1.2 history, development and judicial interpretation of the lanham act attempts to pass federal trademark laws were made starting in 1870, but all were considered inadequate prior to the adoption of the federal trademark act of 1946, known as the lanham act. for the first time, congress passed a law creating substantive, as well as procedural, rights in trademarks and unfair competition.38 the law was not without its opponents. the department of justice expressed a number of strong concerns, including the assertion that trademarks are monopolistic and the law would favor ‘big business’ and encourage violation of antitrust laws.39 however, in support of the new law, the senate committee on patents implied that these fears were overstated, noting that ‘the protection of trademarks is merely protection to good will, to prevent diversion of trade through misrepresentation, and the protection of the public against deception.’40 the committee also pointed out that the new law was necessary to align us law with its international obligations. us failure to carry these out meant that industrialists had been ‘seriously handicapped in securing protection in foreign countries.’41 it appears that, at least initially, the ‘protection to good will’ cited by the senate committee translated into protection of the rightsholder’s investment. us trademark law as codified in the lanham act was (according to some) intended to serve the dual goals of protecting both consumer and rightsholder. in a report accompanying the lanham act in 1946, the senate said the purpose underlying any trade-mark statute is twofold. one is to protect the public so it may be confident that, in purchasing a product bearing a particular trademark which it favorably knows, it will get the product which it asks for and wants to get. secondly, where the owner of a trade-mark has spent energy, time, and money in presenting to the public the product, he is protected in his investment from its misappropriation by pirates and cheats. this is the well-established rule of law protecting both the public and the trade-mark owner.42 perhaps in response to the doj’s initial fears, however, us case law interpreting the lanham act has since emphasized the consumer protection aspect. 38 4 mccarthy on trademarks and unfair competition, § 5:4 (4th ed.). 39 id. 40 s. res. no. 1333, 79th cong. 2d. sess (1946), u.s.c.c.a.n. at 1277, as cited in mccarthy on trademarks and unfair competition, § 5:4. 41 id. 42 s. rep. no. 1333, 79th cong., 2d sess., 3 (1946). nordic journal of commercial law issue 2012#1 11 consumer protection is not, however, the sole focus of us trademark law. the federal trademark dilution revision act (ftdra) protects a rightsholder’s investment in a trademark that has become ‘famous’ even when there is no consumer confusion. under the ftdra, [t]he owner of a famous mark that is distinctive…shall be entitled to an injunction against another person who…commences use of a mark or trade name in commerce that is likely to cause dilution by blurring or dilution by tarnishment of the famous mark, regardless of the presence or absence of actual or likely confusion, or competition, or of actual economic injury.43 with the incorporation into the lanham act of the ftdra, us legislation has at least acknowledged the initial dual goals of trademark law by creating a separate area of the law recognizing the private rights of certain trademark owners. the ftdra places limits on those rights, limits that reflect an ongoing emphasis on consumer protection. the dilution provision tilts the balance more towards rights holders, but the exception for comparative advertising focuses the emphasis back on the consumer: a third party’s use “in connection with advertising or promotion that permits consumers to compare goods or services” is not actionable as dilution.44 in certain situations, then, a deciding body will not even reach an analysis of harm before determining that a use is not actionable as dilution. use of even a famous mark for the purposes of comparative advertising is specifically designated as fair. 2.1.2 comparative advertising in the united states, maximizing consumer welfare and encouraging a free and competitive economy have been the guiding objective and keystone of governmental attitude towards business for over a century.45 consequently, truthful and non-deceptive comparative advertising, including the right to use a competitor’s trademark to describe a legal imitation, has long been lawful in the us – in fact, it pre-dates the creation of the lanham act. in 1910, the us supreme court upheld the right of a seller of mineral water to use a competitor’s trademark to truthfully tell the public that he was selling water which was identical in content to the ‘trademarked’ water.46 in 1917, the eighth circuit court of appeals (eighth circuit) followed the supreme court’s guidance in holding that reproduction of another manufacturer's medicines, and sale under representations that they were the same article, did 43 15 u.s.c. 1125(c)(1). 44 15 u.s.c. 1125(c)(3). 45 charlotte j. romano, ‘comparative advertising in the united states and in france’, 25 nw. j. int’l l. & bus. 371, 377 (2005). 46 saxlehner v. wagner, 216 u.s. 375 (1910). nordic journal of commercial law issue 2012#1 12 not constitute unfair competition, if the medicines were not sold as the goods of such other manufacturer.47 such use was ‘properly descriptive’ and did not constitute a ‘deceptive imitation.’ despite the judiciary’s consistency in its approval of lawful comparative advertising, an ftc investigation revealed that, in reality, industry self-regulation often limited such advertising.48 the ftc’s policy statement was issued to correct this tendency. in strong language, this statement emphasized that ‘comparative advertising, when truthful and non-deceptive, is a source of important information to consumers’, ‘encourages product improvement and innovation’ and ‘can lead to lower prices in the marketplace.’ it warned that restraints upon use of comparative advertising would be subject to challenge by the ftc. later cases reveal the extent to which these policies have been integrated into us judicial approaches to comparative advertising claims involving trademark use. in a 1995 case that is particularly applicable to smith v. chanel and l’oréal v. bellure, the eighth circuit refused to issue a preliminary injunction against an imitator’s use of the trademark ‘obsession’ in a claim for a perfume advertised as ‘our version of obsession,’49 citing ‘the strong public interest in the lowest possible prices’ as well as ‘the interest in avoiding monopolies and in encouraging, not stifling, competition.’50 there are, of course, limits on what is acceptable. for example, comparative advertising will not be allowed if it is likely to confuse buyers as to exactly what they are getting.51 if the claims therein are not completely true and accurate, there may be liability for false advertising or trade disparagement.52 it is indisputable, however, that ‘if a seller has the right to copy public domain features of his competitor’s goods, then, as a corollary, he must have the right to inform the public of this fact.’53 47 viavi co. v. vimedia co., 245 f. 289 (8th cir. 1917). 48 statement of policy regarding comparative advertising, 16 c.f.r. § 14.15(a) (2012). 49 calvin klein cosmetics corp. v. lenox laboratories, inc., 815 f.2d 500 (8th cir. 1995). 50 id. at 505. 51 4 mccarthy on trademarks and unfair competition, § 25:52 (4th ed.). 52 id. 53 id., citing geisel v. poynter prods., inc., 295 f. supp. 331 (s.d.n.y. 1968). nordic journal of commercial law issue 2012#1 13 2.2 european union 2.2.1 trademarks 2.2.1.1 legislative foundation and functions of trademark law in the european union, three sources of law govern trademarks: the trademark directive harmonizing national trademark laws; the community trademark regulation (ctm regulation); and ecj case law.54 the trademark directive was created pursuant to the internal market provisions of the treaties.55 the ctm regulation sets out a system for a centralized european community trademark (as opposed to national trademarks granted individually by member states). its rules broadly match those contained in the directive. it also contains procedural and administrative rules, but ‘does not replace the laws of the member states on trade marks.’56 two systems therefore essentially exist side by side: national laws and the eu laws (including the ctm) with which the national laws must not conflict. this paper will focus on the eu laws, and more specifically, the trademark directive and ecj cases. according to the trademark directive, the function of the registered trade mark is ‘in particular to guarantee the trade mark as an indication of origin.’57 as one commentator (keeling) points out, the inclusion of the words ‘in particular’ suggests that the origin function is not the only function58 and then goes a step further to insist that ‘it is certainly important to avoid taking an excessively narrow view of the origin function of trademarks.’59 and indeed, extended protection to marks with a reputation has been granted by eu legislation. article 5(2) of the trademark directive contains what is essentially an anti-dilution provision, as discussed further in section 3. it allows member states to give the proprietor of a trademark with a reputation the right to prevent another using in the course of trade any sign which is identical with, or similar to, the trade mark in relation to goods or services which are not similar to those for which the trade 54 bryan harris, intellectual property law in the european union 51-52 (william s. hein & co. 2005). 55 directive 2008/95/ec, oj l 299 at 25, para. 2. 56 council regulation 207/2009, oj l 78 at 1, para. 6. 57 directive 2008/95/ec, oj l 299 at 26, para. 11. 58 david t. keeling, intellectual property rights in eu law, vol. i – free movement and competition law 159 (oxford u. press 2003). 59 id. at 149. nordic journal of commercial law issue 2012#1 14 mark is registered ... where use of that sign without due cause takes unfair advantage of, or is detrimental to, the distinctive character or the repute of the trade mark. in the case of a mark with a reputation, therefore, the goods and services need not even be similar in order to trigger the right to protection. such a provision broadens the scope of the protection right.60 since an unauthorized use cannot be lawfully prevented if it does not impinge upon a trademark’s function, broadening the scope of protection essentially constitutes a broadening of the functions of the trademark. 2.2.1.2 ecj case law ecj case decisions reflect such a broadening of function. while not precedential, they have nonetheless developed to take into consideration not only the origin function of trademarks, but also what keeling calls ‘ancillary functions’ such as goodwill, quality and publicity. early ecj decisions were dismissive of trademark rights, and therefore viewed trademark functions narrowly. in 1971, the court stated that ‘interests protected by other rights of industrial and commercial property are usually more important, and merit a higher degree of protection, than the interests protected by an ordinary trademark.’61 subsequent cases demonstrate a shift in approach to trademark protection. in 1990, the advocate general of the ecj62 emphasized a trademark owner’s right to protection by noting that ‘trademarks reward the manufacturer who consistently produces high-quality goods…’63 seven years later, in parfums christian dior sa v evora bv, case c-337/95, the ecj considered whether the function of a trade mark may include protection of investment in advertising or promotion. in this christian dior case, dior opposed the use of its trademark by a reseller for advertising purposes. the ecj held that such opposition would normally not be permissible, but made an exception for situations where serious damage would be caused to the reputation of the trademark. while this case involved parallel imports, not the use of a mark on a legal imitation, the potential repercussions on comparative advertising issues were significant, since the ecj essentially acknowledged the advertising function of a trademark. as mentioned above, with recognition of the function come the associated rights. here, the ecj recognized that the 60 case c-487/07, l’oreal v. bellure, para. 34. 61 case 40/70, sirena v. eda, [1971] ecr 69, para. 78. 62 advocate generals present opinions on the cases brought before the ecj, which is not obligated to follow them. http://europa.eu/about-eu/institutions-bodies/court-justice/index_en.htm 63 keeling, supra note 58 at 157, citing opinion of ag jacobs in case c-10/89, cnl sucal v. hag gf [1990] ecr i–3711. http://europa.eu/about-eu/institutions-bodies/court-justice/index_en.htm nordic journal of commercial law issue 2012#1 15 value of this function to the rightsholder could be protected through allowing a trade mark owner to prevent advertising detrimental to the image of the trade mark. similarly, in bmw v. deenik, case c-63/97 (1999), the ecj concluded that, although generally a proprietor of a mark may not prohibit use of its mark by another to inform the public as to repairs and maintenance of the product associated with the mark, an exception will be made if the mark is used in a way that may create the false impression that there is a commercial connection between the user of the mark and the mark owner.64 consistent with this reasoning, the ecj clarified in gillette v. la laboratories, case c-228/03 (2005) that a third party’s use of another’s mark is lawful when such use is necessary to indicate the intended purpose of a product marketed by the third party, and such use is necessary where it “constitutes the only means of providing the public with comprehensible and complete information on that intended purpose.”65 as in dior and bmw v. deenik, the court noted exceptions in cases where the use discredited or imitated the mark, affected the value of a well-known mark, or gave the false impression of a commercial connection.66 these cases, wherein the ecj acknowledges the consumer’s right to information (and, implicitly, a trader’s right to impart that information) while reiterating the power of a trademark owner to restrict certain forms of advertising, lay the groundwork for ecj comparative advertising cases. 2.2.2 comparative advertising the eu faced a number of challenges in implementing comparative advertising laws. variations in national laws made harmonization efforts difficult, and this difficulty was reflected in subsequent requests for preliminary rulings. 2.2.2.1 varying national laws a major challenge to the creation and implementation of the comparative advertising directive in the eu was the initial variation – even conflict – in outlook on the subject among the eu member states. this caused problems with the internal market, for cross-border advertisements originating in a member state where they were lawful would have to be accepted on the territory of other member states to comply with ecj case law regarding free movement of goods and services.67 additionally, member states with liberal comparative advertising laws could have 64 case c-63/97, bmw v. deenik [1999] ecr i-905, summary, para. 8. 65 case c-228/03, gillette v. la laboratories [2005] ecr i-2337, para. 39. 66 id., para. 49. 67 jules stuyck, ‘regulating comparative advertising in the european community’, european advances in consumer research, vol. 1, 1993, at 565. nordic journal of commercial law issue 2012#1 16 a competitive advantage over states with tighter controls, resulting in distortions in competition.68 the comparative advertising directive was created to correct this imbalance.69 prior to the implementation of this directive, for example, belgium, luxembourg, france, italy, and germany essentially prohibited comparative advertising. in denmark, ireland, portugal and the uk, comparative advertising was authorized unless it was misleading or unfair. some countries, such as spain, greece and the netherlands, lacked an express statutory provision but case law founded in unfair competition was evolving from a system of prohibition to a system of authorization.70 some of the countries that banned or restricted the practice often did so on cultural grounds, considering it to be in bad taste or unnecessarily violative of the competitor.71 others considered it an infringement of trademark rights, and still others felt it encouraged misrepresentation or gave adverse press to competitors.72 in fact, objections to comparative advertising were so strong that an initial attempt to authorize it in the directive 84/450/eec on misleading advertising was rejected and the commission dropped it from that directive.73 a second attempt was more successful, and directive 97/55/ec, amending the misleading advertising directive to include comparative advertising, did ultimately pass – but more than a decade after its initial attempt, the commission still encountered difficulties in obtaining consensus among the member states regarding comparative advertising. it was in this conflictual environment that the comparative advertising directive was implemented. 2.2.2.2 case law despite the resistance in many instances to the practice of comparative advertising, the ecj was obligated, with the passage of the directive, to recognize its importance to the internal market, and rule accordingly. case decisions over the past ten years have addressed, among other issues, the definition of comparative advertising and when the use of trademarks in comparative advertising amounts to trademark infringement. while the latter may seem the most directly 68 t. prime, european intellectual property law 124 (dartmouth publishing co. ltd. 2000). 69 directive 2006/114/ec, oj l 376 at 21, para. 6. 70 stuyck, supra note 67, at 565 (footnote applicable to all preceding sentences in the paragraph). 71 s.m. kirmani, ‘cross-border comparative advertising in the european union’, 19 b.c. int’l & comp. l. rev. 201, 201 (1996). 72 id. at 204-5. 73 id. at 203. nordic journal of commercial law issue 2012#1 17 relevant in the context of this paper, cases dealing with other issues have laid a foundation for subsequent decisions. in toshiba europe gmbh v. katun germany gmbh, case c-112/99 (2001), katun sold spare parts and consumables used in toshiba photocopiers. it copied toshiba's product numbers in its catalogues so as to identify which spare parts could be used with which toshiba product. toshiba filed suit. in response to the german court’s referral for a preliminary ruling, the ecj set the tone by noting that ‘the conditions required of comparative advertising must be interpreted in the sense most favourable to it’,74 thereby acknowledging that comparative advertising is to be encouraged. it held that the use of another person's trademark may be legitimate where it is necessary to inform the public of the nature of the products or the intended purpose of the services offered. nevertheless, it held that a third party's use of a trademark may not take unfair advantage of the distinctive character or the reputation of the mark or be detrimental to it. in a factually similar case, siemens ag v vipa, case c-59/05 (2006), vipa manufactured and sold components compatible with siemens products. siemens filed suit, claiming vipa used an identification system for its products that was virtually identical to siemens’. the ecj pointed to the recitals of directive 97/55 which stated that the purpose of comparative advertising is also ‘to stimulate competition between suppliers of goods and services to the consumer's advantage’ and concluded that the benefit of comparative advertising to consumers was a relevant factor to consider. an advertiser cannot be regarded as taking advantage of the reputation of distinguishing marks if effective competition requires a reference to those marks. the ecj continued in this direction in o2 holdings limited v. hutchinson 3g uk limited, case c-533/06 (2008). 3g, the mobile phone service provider, had launched a uk television advertising campaign comparing 3g's services with those of o2. 3g referred to o2 using images of bubbles. o2 claimed that 3g's use of this imagery infringed certain of o2’s registered trademarks. in response to a reference for a preliminary ruling to clarify the relationship between the trademark directive and the comparative advertising directive, the ecj held as a matter of general principle that the proprietor of a registered trademark cannot prevent the use by a third party of a sign identical with, or similar to, his mark, in a comparative advertisement which satisfies all the conditions of the comparative advertising directive.75 however, if the use of the trademark would cause confusion, it would not be lawful. the ecj noted that in the circumstances at hand, 3g’s use of imagery similar (but not identical) to o2’s trademarks did not give rise to a likelihood of confusion and therefore o2 was not entitled to prevent use of the bubble imagery by 3g in comparative advertising. 74 case c-112/99, toshiba europe gmbh v. katun germany gmbh, [2001] ecr i-7945, para. 37. 75 case c-533/06, o2 holdings limited v. hutchinson 3g uk limited, [2008] ecr i-0000, paras 45-49, 51, operative part 1. nordic journal of commercial law issue 2012#1 18 such was the state of eu comparative advertising law prior to l’oréal v. bellure. 3 comparative application of us and eu laws to smith v. chanel and l’oréal v. bellure the application of the legislation and case decisions discussed above to the cases at issue brings to the forefront the key areas of divergence between them. us law’s current emphasis on consumer rights as the primary purpose of trademark law76 manifests a departure from the senate’s stated original policy rationale behind the lanham act, which emphasized not only the consumer’s right to information but also the property rights of ip holders. us comparative advertising laws reflect the current emphasis on consumer rights. in contrast, particularly after the l’oréal v. bellure decision, current eu law has evolved in directions that maintain the ip holders’ property rights. the divergence in interpretation is due primarily to conflicting developments in case law, as opposed to major foundational differences in the rationale behind the laws’ creation. 3.1 differences in the laws using the registered trademark of a well-known product to describe another product that lawfully imitates the better-known one, when such use is truthful and not misleading or deceptive, is unlawful in the eu and lawful in the us. the discrepancies in judicial opinions stem from this fundamental divergence. a closer review of both jurisdictions’ trademark laws reveals that the heart of this divergence lies in opposing interpretations of anti-dilution laws. 3.1.1 anti-dilution and comparative advertising a primary purpose of general trademark law is to protect against a likelihood of consumer confusion.77 trademark anti-dilution laws, in contrast, protect a rightsholder’s investment in a trademark that has become ‘famous’ (in the us) or ‘has a reputation’ (in the eu) even when there is no consumer confusion. the concept of trademark dilution is therefore particularly important in the context of comparative advertising generally and even more so in the context of these two cases specifically, since the divergence of outcome in these two cases arises out of 76 ‘the only legally relevant function of a trademark is to impart information as to the source of sponsorship of the product.’ smith v. chanel inc. 402 f.2d 562 at 566. 77 directive 2008/95/ec, oj l 299 at 26, para. 11; case 102/77, hoffmann-la roche v. centrafarm, [1978] ecr 1139 (eu); august storck k.g. v. nabisco, inc., 59 f.3d 616 (7th cir., 1995) ‘trademarks designate origin and quality of products, thus, use of rival's mark that does not engender confusion about origin or quality is permissible.’ (us) nordic journal of commercial law issue 2012#1 19 the different emphasis the two courts place on the parties’ respective rights. simply put, the ecj comes down on the side of the rightsholder; the us on the side of the consumer. generally speaking, both the us and the eu laws provide protection against trademark dilution. under us law, the owner of a famous mark that is distinctive, inherently or through acquired distinctiveness, shall be entitled to an injunction against another person who, at any time after the owner’s mark has become famous, commences use of a mark or trade name in commerce that is likely to cause dilution by blurring or dilution by tarnishment of the famous mark, regardless of the presence or absence of actual or likely confusion, of competition, or of actual economic injury.78 ‘dilution by blurring’ is defined as “association arising from the similarity between a mark or trade name and a famous mark that impairs the distinctiveness of the famous mark.”79 ‘dilution by tarnishment’ is “association arising from the similarity between a mark or trade name and a famous mark that harms the reputation of the famous mark.”80 in eu legislation, the word ‘dilution’ does not actually appear in the trademark directive, but commentators consider articles 4(4)(a) and 5(2) to be anti-dilution laws.81 although optional, every pre-2004 eu member state incorporated the provisions of these articles into national law.82 article 4(4)(a) gives member states latitude to prohibit registration of a mark identical or similar to an earlier mark even when the goods or services are not similar, where the earlier trade mark has a reputation in the member state concerned and where the use of the later trade mark without due cause would take unfair advantage of, or be detrimental to, the distinctive character or the repute of the earlier trade mark. article 5(2) allows member states to provide that the proprietor [of an earlier mark] shall be entitled to prevent all third parties not having his consent from using in the course of trade any sign which is identical with, or similar to, the trade mark in relation to goods or services which are not similar to those for which the trade mark is registered, where the latter has a 78 15 u.s.c. § 1125(c)(1). 79 15 u.s.c. § 1125(c)(2)(b). 80 15 u.s.c. § 1125(c)(2)(c). 81 j.t. mccarthy, ‘dilution of a trademark: european union and united states law compared’, 94 trademark rep. 1163, 1164 (2004). 82 id. at 1163. nordic journal of commercial law issue 2012#1 20 reputation in the member state and where use of that sign without due cause takes unfair advantage of, or is detrimental to, the distinctive character or the repute of the trade mark. the advocate general, in his opinion for the 2003 adidas case, defined ‘dilution’ as ‘detriment to the distinctive character of a trademark’83 and went on to incorporate therein the concept of ‘free riding’, stating that ‘the concepts of taking unfair advantage of the distinctive character or repute of the mark must be intended to encompass instances where there is clear exploitation and free-riding on the coattails of a famous mark.’84 85 ‘free-riding’ is a key concept in the l’oréal case, and one of the bases upon which the ecj found advantage unfairly taken by bellure. article 4 of the comparative advertising directive lays down the conditions under which comparative advertising is allowed. it contains no ’without due cause‘ qualifier in its prohibition on misleading advertising, denigration of others’ marks, taking unfair advantage, or presenting goods as replicas. in the eu, therefore, anti-dilution laws may be used to limit comparative advertising. however, in the us, a dilution claim may not be the basis for an attack on the use of a mark in comparative advertising. the lanham act dictates that use of trademark in lawful comparative advertising is considered fair use: any fair use, including a nominative or descriptive fair use, or facilitation of such fair use, of a famous mark by another person other than as a designation of source for the person’s own goods or services, including use in connection with advertising or promotion that permits consumers to compare goods or services’ is not actionable as dilution.86 the use of the word ‘descriptive’ in the anti-dilution provisions of the lanham act is key, particularly since the right to use well-known trademarks to describe a product as an imitation of the well-known product is not specifically laid out in the statute. rather, the right to do so is found in case law. the exclusion of ‘descriptive fair use’ from the scope of the lanham act’s anti-dilution provisions implicitly allows advertisers to describe their product as an imitation of 83 opinion of ag jacobs, 10 july 2003, case c-408/01, adidas salomon ag and adidas benelux bv v fitnessworld trading ltd, para. 37. 84 id., para. 39. 85 here, the ag uses the word ‘famous’, mirroring the language in the us’s ftdra as opposed to the ‘has a reputation’ language in the trademark directive. 86 15 u.s.c. § 1125 (c)(3)(a)(i). nordic journal of commercial law issue 2012#1 21 another without risking an anti-dilution action. indeed, ‘descriptive fair use’ is in essence how bellure framed its actions.87 bellure’s arguments were not without precedent in the eu. the ecj acknowledged that ‘certain uses for purely descriptive purposes are excluded from the scope of application of article 5(1) of directive 89/104, because they do not affect any of the interests which that provision is intended to protect and accordingly do not constitute ‘use’ within the meaning of that provision.’88 the ecj, however, disagreed that bellure’s use in these circumstances was ‘for purely descriptive purposes’, finding instead that ‘the word marks belonging to l’oréal are used in the comparison lists not for purely descriptive purposes, but for the purpose of advertising.’89 the ecj then reasoned that, in the context of advertising, use of the marks in the comparison lists constituted presenting an article as a replica, in contradiction of the comparative advertising directive. article 4(g) specifies that ‘comparative advertising shall, as far as the comparison is concerned, be permitted when … it does not present goods or services as imitations or replicas of goods or services bearing a protected trade mark or trade name.’ in finding only advertising use, and not descriptive use, the ecj ignores a salient point made by the us supreme court in 1910 in saxlehner v. wagner, when the copied product was a ‘bitter water’ sold under the name ‘hunyadi janos.’ the lower court had allowed the defendants to use the mark to identify the plaintiff’s water as the product the defendants were copying. in affirming that there was no unfair competition and no fraud in allowing such use, the court noted that the copiers ‘are not trying to get the good will of the name, but the good will of the goods.’ 90 the distinction is a narrow one, but particularly significant in l’oréal, since the product in question was perfume, which, when worn, has no visible identifying features. consumers would buy bellure’s products because they like the smell of the copied product (the goodwill of the goods), not because they are relying on the reputation of l’oréal’s marks (the goodwill of the name). in direct contrast to us courts, the ecj considered bellure’s attempts to ‘get the good will of the goods’ to amount to unfair competition. 87 see l’oreal v. bellure, u.k. high court of justice, chancery division [2006] ewhc 2355 (ch). 88 case c-487/07, l’oréal v. bellure, para. 61. 89 id., para. 62. 90 saxlehner v. wagner, 216 u.s. 375 at 380-81. nordic journal of commercial law issue 2012#1 22 3.1.2 unfair competition because of the two jurisdictions’ opposing views regarding use of trademarks to describe copies, what constitutes unfair competition will also be different, as seen above in the advocate general’s incorporation of free-riding into his definition of dilution. article 10bis (2) of the paris convention defines unfair competition as ‘any act of competition contrary to honest practices in industrial or commercial matters.’ the difference in the two jurisdictions’ interpretations arises here from a divergence of opinion on what constitutes an ‘honest practice.’ in the us, a competitor who produces low-priced substitutes for better known, name-brand items, and uses the name-brand to truthfully tell consumers what has been copied, does not compete unfairly.91 on the other hand, in the eu, ‘comparative advertising which presents the advertiser’s products as an imitation of a product bearing a trademark is inconsistent with fair competition…any advantage gained by the advertiser through such advertising will have been achieved as the result of unfair competition and must, accordingly be regarded as taking unfair advantage of the reputation of that mark….’92 part of this variation in approach is due to the difference in emphasis on the expenditures made by rightsholders to build and maintain their brand. in the us, such expenditure does not, in itself, create additional rights (although, as discussed above, rightholders’ expenditures were initially considered when creating the lanham act). in the eu, however, it does. the ninth circuit in smith v. chanel stated definitively that ‘a large expenditure of money does not in itself create legally protectable rights’ and that chanel was ‘not entitled to monopolize the public’s desire for the unpatented product, even through they themselves created that desire at great effort and expense.’93 subsequent courts have confirmed this statement. the northern district of california, in sykes laboratory, inc. v. kalvin, noted that ‘one consequence of the rule announced in smith v. chanel is that the copyist may freely capitalize on the goodwill and product recognition developed at great cost by the trademark owner.’94 the ecj in l’oréal v. bellure stated unequivocally that ‘riding on the coat-tails of a mark’ is unfair competition when it involves exploitation ‘of the marketing effort expended by the proprietor of the mark in order to create and maintain the mark’s image.’95 this statement 91 4 mccarthy on trademarks and unfair competition, § 25:52 (4th ed.). 92 case c487/07, l’oréal v. bellure, para. 79. 93 smith v. chanel, inc. at 568. 94 sykes laboratory, inc. v. kalvin, 610 f.supp. 849 at 854 (c.d. cal. 1985). 95 case c-487/07, l’oréal v. bellure, ruling, para. 1. nordic journal of commercial law issue 2012#1 23 reflects the eu’s expansion of both the trademark directive’s stated function for the protection of marks generally – to guarantee the trademark as an indication of origin96 – and the protection of marks with a reputation under its anti-dilution provisions. since it is not codified in the trademark directive, the groundwork for such expansion must have been laid primarily through ecj case law. as the advocate general notes in his opinion, ‘neither the trademark directive nor … the case-law of the court has provided a list or a description of the functions of a trade mark other than that as a guarantee of origin.’97 in its l’oréal decision, the ecj accepts the advocate general’s implicit invitation and provides such a list, citing ‘communication, investment or advertising’ as additional trademark functions. in fact, the ecj draws this list directly from the advocate general’s opinion, which provides further reasoning: ‘communication, investment, or advertising functions…arise from the fact that the investment in the promotion of a product is built around the mark and are, therefore, values which deserve protection as such, even when there is no abuse arising from misrepresentations about either origin or quality.’98 the ecj’s specific inclusion of protection of a mark owner’s investment in a list of trademark functions reflects an adoption of another advocate general’s view that it was ‘simplistic reductionism to limit the function of the trade mark to an indication of trade origin.’99 here, the ecj goes in the opposite direction of us courts. in smith v. chanel and subsequent cases, the ‘dual goals’ of us trademark law have been narrowed to the single primary one of preventing consumer confusion (with anti-dilution provisions simply a narrow exception to this purpose). in the eu, on the other hand, the ecj’s condemnation of ‘free-riding’ clearly strengthens the legal protection afforded the trademark owner’s investment. 3.2 reasons for the differences 3.2.1 historical development eu trademark and comparative advertising laws were created primarily in response to the founding treaties’ requirements of facilitating the internal market, even though intellectual 96 directive 2008/95/ec, oj l 299 at 26, para. 11. 97 opinion of ag mengozzi, case c-487/07, l’oréal v. bellure, para. 50. 98 id., para. 51 (citing opinion of ag jacobs in parfums christian dior). 99 as cited in opinion of ag mengozzi, case c-487/07, l’oréal v. bellure, para. 52. nordic journal of commercial law issue 2012#1 24 property was not specifically mentioned in those treaties.100 indeed, this silence initially led to wide variations in member states’ prior laws, with the consequence that eu legislation was sometimes at odds with the rules it was intended to replace or harmonize. parallel us laws, however, grew out of more gradual developments in policy. put another way, us law developed in a more organic fashion, while eu law was created to forcibly harmonize conflict. this means the public and the judiciary have had time to gradually adjust to developments in the us law. its longer history means it is also more familiar to them. in fact, in the us, allowing use of a mark to describe a copy has a more established history than does use of a competitor’s mark to disparage the competitor. prior to the creation and codification of the ftc’s policy statement, neither us industries nor broadcasters favored comparative advertising when it disparaged the competitor,101 while use of a mark to describe a legitimate copy has been permitted for over a century, as discussed in section 2.1.2. the concept of comparative advertising is relatively new to the eu, however, as discussed in section 2, and therefore less established. comparative advertising has not been part of cultural mores for decades, as it has in the us. in fact, in the years immediately following the implementation of the comparative advertising directive, referrals to the ecj highlighted the uncertainty that surrounded this directive, particularly in countries where, historically, comparative advertising was largely prohibited.102 as a practice with only recent, as opposed to long-term, acceptance, it is more likely to be viewed as suspect, particularly when the acceptance was so difficult to obtain. this uncertainty is reflected in the conflict of the ecj’s l’oréal decision with earlier ecj case law. in siemens, the ecj said an advertiser does not take advantage of the reputation of distinguishing marks if effective competition requires a reference to those marks. in allowing vipa’s use of siemens’ numbers, ecj stated that the only way vipa could effectively compete was by using siemens’ marks. the l’oréal decision is at odds with this statement. effective competition means that manufacturers are encouraged to try to make an equally good product for less and pass the savings on to the consumer. this is exactly what bellure did. in l’oréal, for bellure to compete effectively, it had to reference the l’oréal marks; there was no other way to accurately identify 100 a. jolly and j. philpott, the handbook of european intellectual property management 4 (kogan page ltd 2d ed. 2009). 101 statement of policy regarding comparative advertising, 16 c.f.r. § 14.15(c)(1) (2012). 102 patty kamvounias, ‘comparative advertising and the law: recent developments in the european union’, 2010 eabr & etlc conference proceedings, dublin, ireland, 620, 623. nordic journal of commercial law issue 2012#1 25 the product. simply calling it ‘perfume’ does not adequately inform the public of the product’s characteristics. the ecj’s statement that an advertiser does not take advantage of the reputation of distinguishing marks if effective competition requires a reference to those marks also conflicts with the l’oréal decision’s interpretation of unfair competition. vipa’s replacement parts could be viewed as ‘riding the coat-tails’ of siemens’ efforts to promote its products just as bellure was considered to be ‘riding the coat-tails’ of l’oréal’s investment. to create demand for its own product, vipa was relying upon the demand for siemens’ original product, a demand siemens undoubtedly created by investing in advertising and marketing. this is no different from the situation in l’oréal for which bellure was censured by the ecj. bellure created a product that competed with l’oréal’s, and, by inviting comparison, relied upon the demand l’oréal had created for its product. both vipa and bellure ‘exploited, without paying any financial compensation, the marketing effort expended by the proprietor of the mark in order to create and maintain the mark’s image.’103 the ecj notes in l’oréal that ‘it is irrelevant … whether the advertisement indicates that it relates to an imitation of the product bearing a protected mark as a whole, or merely the imitation of an essential characteristic of that product.’104 however, if this were truly the case, siemens and toshiba, discussed above, would have been resolved differently. for what is a spare part, but an imitation of an essential characteristic of a product? these conflicts reflect a shift in the balance of interests on the part of the ecj, towards an emphasis on the private, as opposed to public, rights. 3.2.2 different perspectives on the balance of interests article 17 of the trips agreement states that parties ‘may provide limited exceptions to the rights conferred by a trademark, such as fair use of descriptive terms, provided that such exceptions take account of the legitimate interests of the owner of the trademark and of third parties.’ as discussed above, the us and the eu agree in general terms on what constitutes legitimate interests – that is, protection of consumers and protection of the property rights of the trademark owners. in 1990, the ecj’s advocate general wrote that ‘trade marks find their justification in a harmonious dovetailing between public and private interests.’105 103 case c-487/07, l’oréal v. bellure, para. 50. 104 id., para. 76. 105 opinion of ag jacobs in cnl sucal v. hag gf, case c-10/89 (1990), cited in keeling, supra note 58 at 157. nordic journal of commercial law issue 2012#1 26 while acknowledging the need for a balance of interests,106 us courts have nonetheless agreed that ‘protection of trademark values other than source identification would create serious anti-competitive consequences with little compensating public benefit,’107 and noted that ‘courts have generally confined legal protection to the trademark’s source identification function for reasons grounded in the public policy favoring a free, competitive economy.’108 here, the divergence of us and eu laws as illustrated in the two cases at issue lies in the respective weight accorded those interests. the advocate general viewed those interests as ‘dovetailing.’ however, commentators have noted an increase in the potential for conflicts between laws prohibiting unauthorized use of another’s mark and the right to freedom of expression,109 citing in particular anti-dilution laws, which protect famous marks regardless of likelihood of confusion. as discussed above, us trademark law protects free speech by exempting from dilution liability the fair use of another’s mark ‘other than as a designation of source’ in comparative advertising.110 in an impassioned opinion, justice jacob, of the u.k. court that had requested the preliminary ruling in l’oréal v. bellure, directly confronted the free speech issues arising out of the ecj’s decision. justice jacob made it quite clear he applied the ecj’s guidelines only because he was obligated to, not because he respected them. calling the ecj decision a ‘muzzle’ on freedom of expression, justice jacob wrote, ‘my own strong predilection, free from the opinion of the ecj, would be to hold that trade mark law did not prevent traders from making honest statements about their products where those products are themselves lawful.’111 further, justice jacob spoke to the corollary rights of consumers to be informed, pointing out that ‘the right of free speech extends not only to those who wish to tell the truth, but also those who would wish to hear it…in terms of the market place the hearer’s right to receive information translates into the right of the consumer to make an informed choice about products on the market.’112 106 ‘involved in the instant case is a conflict of values which necessarily arises in an economy characterized by competition and private property.’ dior case, 299 f.2d at 37. 107 see the court’s support for its reasoning in smith v. chanel, inc., at 566-67. 108 see the court’s support for its reasoning in smith v. chanel, inc., at 566. 109 lisa p. ramsey, ‘free speech and international obligations to protect trademarks’, 35 yale j. int’l law 405, 406 (2010). 110 15 u.s.c. § 1125(c)(3)(a)(i). 111 l’oréal v. bellure, u.k. court of appeals, [2010] ewca civ 535, para. 8. 112 id., para. 12. nordic journal of commercial law issue 2012#1 27 the ecj was not unaware of these issues when it crafted its ruling in l’oréal, but it presented them very narrowly when it described the comparative advertising directive’s objective as reconciling …the interest of the proprietor of the mark in benefiting from protection of his exclusive right, on the one hand, and the interest of the proprietor’s competitors and of consumers in having effective comparative advertising which objectively highlights the differences between the goods or services offered.113 after making a point of its obligation to broadly define ‘comparative advertising’ in siemens and toshiba,114 the ecj in l’oréal subsequently limits its definition of effective comparative advertising to that which ‘objectively highlights the differences between the goods or services offered.’ yet in toshiba, the court said the display of toshiba’s product numbers alongside katun’s own order numbers was permissible because it ‘constituted a positive statement that the two products have equivalent technical features.’115 however, such a statement does not ‘objectively highlight the differences.’ by narrowing its definition of lawful comparative advertising, the ecj also narrows advertisers’ free speech rights and the rights of the consumer to be informed. 4 conclusion after the ecj’s decision in l’oréal v. bellure, it appears that the only kind of lawful comparative advertising in the eu involves implicitly or explicitly unfavorable comparisons, at least where marks with a reputation are concerned. a favorable comparison with a well-known mark is likely to be considered as ‘riding the coattails’ of that mark, in contravention to the prohibition against unfair advantage in article 4(f) of the comparative advertising directive. if the product advertised is essentially the same as the well-known product to which it is being compared, it risks being deemed a replica, in contravention to article 4(g). this risk is not merely theoretical, as recognized in the max planck institute’s ‘study on the overall functioning of the european trade mark system’ (the study). this study, produced in response to a request from the european commission, examines procedural and substantive 113 case c-487/07, l’oréal v. bellure, para. 71. 114 additionally, in both cases, the systems used to allow consumers to identify the corresponding products constituted comparative advertising, yet it highlighted similarities, not differences. 115 case c-112/99, toshiba europe gmbh v. katun germany gmbh, [2001] ecr i-7945, para. 37. nordic journal of commercial law issue 2012#1 28 aspects of eu trademark law and makes recommendations with the ultimate goal of assisting the commission in a future review of eu trade mark laws.116 if the commission follows the study’s recommendations, which is deemed likely, it may result in significant changes to these laws.117 notably, many of the proposals ‘radically depart from developments in the law arising from references to the ecj.’118 the study acknowledges that, ‘in addition to indicating origin, marks may acquire intrinsic value as business assets’ with the economic rationale being that ‘reputation enjoyed by a mark is regularly the fruit of intensive investments, for which further incentives are provided by the additional protection granted.’ it then warns that ‘for competition, however, the phenomenon is not without risks…which have to be considered for the balancing of interests…’119 (emphasis added). this conclusion recalls the us court’s concerns that ‘protection of trademark values other than source identification would create serious anticompetitive consequences with little compensating public benefit.’120 the study’s concerns as to anti-competitive behavior are particularly significant in any discussion of unfair advantage, since the ecj relied upon a finding that bellure was ‘riding the coat-tails’ of l’oréal’s investments in its determination that bellure took unfair advantage of l’oréal’s marks. the study suggests clarifying the law so that it is more difficult to make out an unfair advantage than it is under current eu law, which incorporates l’oréal v. bellure. the related issue of allowing manufacturers to copy a product, but not allowing them to describe their products as such, is addressed in the section on comparative advertising. the study declares ‘it appears appropriate to make provision for a broader clause exempting ‘honest referential use’ from infringement, i.e. cases where the protected trade mark is used as a reference to the proprietor’s goods or services.’121 this recalls justice jacobs’s insistence that ‘trade mark law did not prevent traders from making honest statements about their products where those products are themselves lawful’122 and the us courts’ statement that ‘if a seller has 116 max planck institute’s ‘study on the overall functioning of the european trade mark system’,15 feb., 2011 (full text available at the european commission’s website at http://ec.europa.eu/internal_market/indprop/ docs/tm/20110308_allensbach-study_en.pdf) at 1. 117 hiroshi sheraton and leigh j. smith, ‘european commission publishes max planck institute study on european trade mark system,’ mcdermott newsletters, mar. 22, 2011, available online at http://www.mwe.com/publications/unientity.aspx?xpst=publicationdetail&pub=5095 118 id. 119 max planck study, supra note 116, at 52. 120 see the court’s support for its reasoning in smith v. chanel, inc., at 566-67. 121 max planck study, supra note 116, at 121. 122 l’oréal v. bellure, u.k. court of appeals, supra note 111, para. 8. http://ec.europa.eu/internal_market/indprop/docs/tm/20110308_allensbach-study_en.pdf http://ec.europa.eu/internal_market/indprop/docs/tm/20110308_allensbach-study_en.pdf http://www.mwe.com/publications/unientity.aspx?xpst=publicationdetail&pub=5095 nordic journal of commercial law issue 2012#1 29 the right to copy public domain features of his competitor’s goods, then, as a corollary, he must have the right to inform the public of this fact.’123 this right ties into fair use exceptions, which the study recommends clarifying to include free speech, through incorporation of a new proposed provision regulating use for purposes other than distinguishing goods or services in the course of trade.124 noting that these issues cannot be viewed solely in the context of trade mark law (the subject of the study), the max planck institute referenced a workshop discussion wherein participants pointed out that ‘it is not for trade mark law alone to provide a full and satisfactory catalogue of limitations and exceptions…this also depends on the contents of adjacent regulations, such as the comparative advertising directive.’125 this directive incorporates trade mark laws,126 however, and while it can provide a different context for their interpretation, it cannot be in conflict with those laws. the study is non-binding on the commission, but it is understood that consultations took place between the max planck institute and the commission during its drafting, indicating a greater likelihood that the commission will follow the study’s recommendations.127 the commission is currently preparing a communication on the comparative advertising directive, to be based in part on a public consultation that closes in mid-december 2011.128 this communication will “identify any problematic issues in the interpretation or application of the directive and explore options for its possible review.”129 in 2012, the commission is expected to announce proposed legislation and other changes as a result of the study and additional assessments such as the public consultation. it therefore appears possible that the area of eu law where trademarks and comparative advertising intersect will in the near future align more closely with its us counterparts. 123 4 mccarthy on trademarks and unfair competition, § 25:52 (4th ed.), citing geisel v. poynter prods., inc., 295 f. supp. 331 (s.d.n.y. 1968). 124 max planck study, supra note 116, at 122-23. 125 id. at 103. 126 directive 2006/114/ec, oj l 376 at 22, paras. 13-15. 127 sheraton, h. et al, supra note 117. 128 the european commission web site pages on consumer and marketing law: http://ec.europa.eu/justice/ newsroom/consumer-marketing/opinion/111021_en.htm (last visited november 25, 2011). 129 id. http://ec.europa.eu/justice/newsroom/consumer-marketing/opinion/111021_en.htm http://ec.europa.eu/justice/newsroom/consumer-marketing/opinion/111021_en.htm nordic journal of commercial law issue 2012#1 30 bibliography legislation united states 15 u.s.c. §§ 45 et seq. – unfair methods of competition unlawful; prevention by commission 15 u.s.c. §§ 1051 et seq. – lanham act code of federal regulations, title 16, chapter 1: 16 c.f.r. § 14.15 – in regard to comparative advertising. european union directive 2006/114/ec of the european parliament and of the council of 12 december 2006, oj l 376, 27.12.2006, pages 21-27 (comparative advertising directive). directive 2008/95/ec of the european parliament and of the council of 22 october 2008 (codified version), oj l 299, 08.11.2008, pages 25-33 (trademark directive). council regulation (ec) no. 207/2009 of 26 february 2009 (codified version), oj l 78, 24.3.2009, pages 1-42 (ctm regulation). international agreements paris convention for the protection of industrial property agreement on trade-related aspects of intellectual property rights (trips agreement) judicial opinions united states calvin klein cosmetics corp. v. lenox labs, inc., 815 f.2d 500 (8th cir. 1995). chanel, inc. v. smith, 151 u.s.p.q. 685 (n.d.cal. 1966). chevron, usa, inc. v. natural resources defense council, inc. 467 u.s. 837 (1984). saxlehner v. wagner, 216 u.s. 375 (1910). sykes laboratory, inc. v. kalvin, 610 f.supp. 849 (c.d. cal. 1985). smith v. chanel, inc., 402 f.2d 562 (9th cir. 1968). societe comptoir de l’industrie contonniere etablissements boussac v. alexander’s dept. stores, inc., 299 f.2d 33 (2d cir. 1962). european court of justice case c-63/97, bmw v. deenik [1999] ecr i-905. nordic journal of commercial law issue 2012#1 31 case c-228/03, gillette v. la laboratories [2005] ecr i-2337. case 102/77, hoffmann-la roche v. centrafarm [1978] ecr 1139. case c-487/07, l’oréal sa v. bellure nv [2009] ecr i-5185 case c-533/06, o2 holdings limited v. hutchinson 3g uk limited [2008] ecr i-4231. case c-337/95, parfums christian dior sa v. evora bv [1997] ecr i-6013. case c-59/05, siemens ag v. vipa [2006] ecr i-2147. case 40/70, sirena v. eda [1971] ecr 69. case c-112/99, toshiba europe gmbh v. katun germany gmbh [2001] ecr i-7945. united kingdom l’oréal v. bellure, u.k. court of appeal [2010] ewca civ 535. l’oréal v. bellure, u.k. high court of justice (chancery division) [2006] ewhc 2355 (ch). advocate general opinions opinion of advocate general jacobs, delivered on 10 july 2003, case c-408/01, adidas salomon ag and adidas benelux bv v fitnessworld trading ltd. opinion of advocate general mengozzi, delivered on 10 february, 2009, case c-487/07, l’oréal sa, lancôme parfums et beauté & cie, laboratoire garnier & cie v. bellure nv, malaika investments ltd, starion international ltd. books, articles and treatises harris, b., intellectual property law in the european union, william s. hein & company, 2005, pages 51-66. jolly, a. and philpott, j., the handbook of european intellectual property management, 2d ed., kogan page ltd., 2009. kamvounias, p., ‘comparative advertising and the law: recent developments in the european union’, 2010 european college teaching & learning (etlc) and european applied business research (eabr) conference proceedings, dublin, ireland, pages 620-631, available at http://www.cluteinstitute.com/ proceedings/2010_dublin_eabr_articles/article 479.pdf . keeling, d.t., intellectual property rights in eu law, volume i – free movement and competition law, oxford university press, 2003, pages 147-242. kirmani, s.m., ‘cross-border comparative advertising in the european union’, boston college international and comparative law review, volume 19, issue 1, article 6, 1996, pages 201-215. mccarthy, j.t., ‘dilution of a trademark: european union and united states law compared’, the trademark reporter, volume 94, november-december 2004, pages 1163-1180. mccarthy, j.t., mccarthy on trademarks and unfair competition, fourth edition, thomson reuters/west, 2011, various sections. micklitz, h.w., the politics of judicial co-operation in the eu, cambridge university press, 2005, page 121. http://www.cluteinstitute.com/proceedings/2010_dublin_eabr_articles/article%20479.pdf nordic journal of commercial law issue 2012#1 32 petty, r.d., ‘advertising law in the united states and european union’, journal of public policy and marketing, volume 16(1), spring 1997, pages 2-13. prime, t., european intellectual property law, dartmouth publishing company limited, 2000, pages 75-136. raitio, j., the principle of legal certainty in ec law, kluwer academic publishers, 2003, page 86. ramsey, l.p., ‘free speech and international obligations to protect trademarks’, yale journal of international law, volume 35, summer 2010, pages 405-464. romano, c.j., ‘comparative advertising in the united states and in france’, northwestern journal of international law and business, volume 25, winter 2005, pages 371-414. sheraton, h. and smith, l.j., ‘european commission publishes max planck institute study on european trade mark system’, mcdermott newsletters, march 22, 2011, available online at http://www.mwe.com/publications/unientity.aspx?xpst=publicationdetail&pub=5095. stuyck, j., ‘regulating comparative advertising in the european community’, european advances in consumer research, volume 1, 1993, pages 565-568. villafranco, j.e., ‘the law of comparative advertising in the united states’, ip litigator, january/february 2010, vol. 16, number 1, pages 1-7. villafranco, j.e., ‘practice note: comparative advertising law in the us,’ published by practical law company on its law department web service at http://us.practicallaw.com/3-503-3503. studies and reports max planck institute for intellectual property and competition law, ‘study on the overall functioning of the european trade mark system’, 15 february, 2011, full text available at the european commission’s website at http://ec.europa.eu/internal_market/indprop/docs/tm/20110308_ allensbach-study_en.pdf united states senate report no. 1333, 79th congress, second session, page 3 (1946). abbreviations ag advocate general of the european court of justice cfr code of federal regulations (united states) comparative advertising directive directive 2006/114/ec of the european parliament and of the council of 12 december 2006 concerning misleading and comparative advertising and all prior versions. ctm regulation council regulation (ec) no. 207/2009 of 26 february 2009 on the community trade mark and all prior versions. doj department of justice (united states) ecj european court of justice ftc federal trade commission (united states) ftdra federal trademark dilution revision act ip intellectual property http://www.mwe.com/publications/unientity.aspx?xpst=publicationdetail&pub=5095 http://us.practicallaw.com/3-503-3503 http://ec.europa.eu/internal_market/indprop/docs/tm/20110308_allensbach-study_en.pdf nordic journal of commercial law issue 2012#1 33 max planck study ‘study on the overall functioning of the european trade mark system’, max planck institute for intellectual property and competition law, munich, 15.02.2011. ninth circuit united states court of appeals, ninth circuit policy statement federal trade commission’s statement of policy regarding comparative advertising trademark directive directive 2008/95/ec of the european parliament and of the council of 22 october 2008 to approximate the laws of the member states relating to trademarks and all prior versions. trips agreement on trade-related aspects of intellectual property rights introduction 1 comparative advertising in the united states and the european union: an overview 1.1 united states 1.1.1 united states code: title 15 1.1.2. statement of policy regarding comparative advertising 1.2 european union 1.2.1 directive 2006/114/ec concerning misleading and comparative advertising 1.2.2 implementation of comparative advertising rules 1.2.3 directive 2008/95/ec relating to trademarks 1.2.4 case law 1.3 smith v. chanel in the us and l’oréal v. bellure in the eu 1.3.1 smith v. chanel, inc. 1.3.1.1 facts 1.3.1.2 decision 1.3.2 l’oréal sa v. bellure nv 1.3.2.1 facts 1.3.2.2 decision 2 comparative advertising and trademark law in the us and the eu: foundations and protected values 2.1 united states 2.1.1 trademarks 2.1.1.1 constitutional basis of trademark law 2.1.1.2 history, development and judicial interpretation of the lanham act 2.1.2 comparative advertising 2.2 european union 2.2.1 trademarks 2.2.1.1 legislative foundation and functions of trademark law 2.2.1.2 ecj case law 2.2.2 comparative advertising 2.2.2.1 varying national laws 2.2.2.2 case law 3 comparative application of us and eu laws to smith v. chanel and l’oréal v. bellure 3.1 differences in the laws 3.1.1 anti-dilution and comparative advertising 3.1.2 unfair competition 3.2 reasons for the differences 3.2.1 historical development 3.2.2 different perspectives on the balance of interests 4 conclusion bibliography legislation abbreviations microsoft word rehman_hafiz_aziz_ur.doc nordic journal of commercial law issue 2011#1 wto, compulsory export licences and indian patent law by hafiz aziz ur rehman * * hafiz aziz ur rehman is currently a phd candidate at anu college of law, the australian national university, australia. he is an assistant professor at the faculty of shariah & law, international islamic university, islamabad. he holds masters in european intellectual property law (llm) degree from stockholm university, sweden. he can be reached at: azeez.rehman@gmail.com. i am specifically thankful to my supervisor, dr. matthew rimmer, for his valuable comments and suggestions. all errors and omissions are, however, mine nordic journal of commercial law issue 2011#1 1 injurious commissions also include severely restrictive – and inefficient – trade barriers that curb exports from poorer countries. amartya sen, identity and violence1 i. introduction a 2005 publication of unaids, aids in africa: three scenarios to 2025, contains several moving stories about hiv/aids in africa, describing how the aids epidemic in africa could evolve over the next 20 years.2 the scenarios set out to answer one central question: over the next 20 years, what factors will drive africa’s and the world’s responses to the aids epidemic, and what kind of future will there be for the next generation? amongst the various aspects of the problem, access to and uptake of aids treatment is discussed and highlighted throughout the document. the publication highlights how crucial indian pharmaceutical exports are for the treatment of the hiv/aids epidemic in africa. african nations and many other developing countries require access to essential medicines to address public health concerns. the creation of a safe, secure and reliable access to an essential medicines regime depends upon a number of factors ranging from mobilisation of resources to administration of drugs to those who badly need them in extreme poverty situations. factors such as resources prioritisation, adequate procurement policies, supporting infrastructure and trained personnel are definitely very crucial for any successful essential drugs program. however, the most critical factor is the very availability of the medicines which could then be provided to those who need them. the most crucial and the daunting barrier increasingly faced in this regard is the accessibility to safe and affordable medicines to keep up the life expectancy trajectory of millions of poor patients around the world. according to available research, indian generic pharmaceutical companies provide a major portion of pharmaceutical products which are procured by various international and regional organisations for their treatment projects related to hiv/aids, malaria and tuberculosis.3 the 1 amartya sen, identity and violence (new york: w.w. norton & company, 2006) 140. 2 united nations programme on hiv/aids (unaids), aids in africa: three scenarios to 2025, 2005 at http://www.unaids.org/unaids_resources/images/aidsscenarios/aids-scenarios-2025_report_en.pdf. 3 padmashree hehi sampath, ‘economic aspects of access to medicines after 2005: product patent protection and emerging firm strategies in the indian pharmaceutical industry’ (accessed on july 12, 2009) institute of new technologies, united nations university at http://www.who.int/intellectualproperty/studies/ padmashreesampathfinal.pdf. nordic journal of commercial law issue 2011#1 2 following table shows the list of top ten suppliers of antiretroviral (arv) drugs under the global fund’s procurement program. table 1.1: top ten suppliers of arvs under global fund in terms of consignments (june 2003-jan 2006) manufacturer total no. of consignments cipla ltd. 342 aspen pharmacare 221 bristol myers squibb 158 glaxosmithkline ltd. 144 abbott laboratories 88 merck 73 ranbaxy laboratories 45 hetro drugs ltd. 35 roche 32 boehringer ingelheim 25 source: global fund as cited by biswajit dhar4 table 4.1 shows that although four indian firms are among the top ten suppliers by volume, in terms of value only two appeared in the top ten, because of their lower prices.5 another source cites the data of global fund’s suppliers in terms of brand names and generics. it shows that in 2004, brand name, patented, manufacturers supplied 40.7% of total procurements by volume but their share in expenditure terms was around 53%, whereas, generic manufacturers supplied almost 59.3% of the volume of total drugs with only a 47% share of expenditures.6 other international humanitarian agencies like unicef and the clinton foundation rely heavily on importing affordable drugs from india. indeed 84% of the arvs that médecins sans frontières prescribes to its patients worldwide come from indian generic companies.7 there has been much debate as to whether india will be able to continue to be such a dominant supplier of generic medicines, in an era where it must be compliant with the trips 4 biswajit dhar and k.k. gopakumar, ‘post-2005 trips scenario in patent protection in the pharmaceutical sector: the case of generic pharmaceutical industry in india’ (2006), unctad, idrc and ictsd, 57 at http://www.measwatch.org/autopage/file/monmarch2009-14-25-16-indianindustry.pdf. 5 ibid. 56. 6 kenneth c. shalden, ‘the political economy of aids treatment: intellectual property and the transformation of generic supply’ (2007) 51 international studies quarterly 559-581, 564. 7 gustavo capdevila, ‘indian court rejects novartis’ drug patent suit’ asia times online, 8 august 2007, http://www.atimes.com/atimes/south_asia/ih08df01.html. nordic journal of commercial law issue 2011#1 3 agreement 1994. several studies consider whether compulsory licensing will be an effective tool to maintain the current level of supplies from indian generic manufacturers.8 we can see four different strategies bearing on the relevancy and usefulness of compulsory licensing as a means of providing access to medicines. first of all, multinational brand-name pharmaceutical companies represented by pharmaceutical research and manufacturers of america (phrma) have favoured a narrow and limited scope for compulsory licensing mechanisms. accordingly, this industry is largely comfortable with the waiver decision 2003 and the way in which limitations and restrictions are imposed on the issuance of compulsory licences. second, a number of academics and commentators contend that the compulsory licensing arrangements under the waiver decision 2003 will have a positive impact on pharmaceutical export mechanisms. scholars like frederick abbott and jerome h. reichman belong to this group when they argue that export mechanisms can be boosted through a well-designed implementation strategy.9 third, civil society groups such as médecins sans frontières (msf) and knowledge ecology international (kei) hold critical positions about the negative implications of the waiver decision 2003 on export mechanisms. they argue that the complicated and cumbersome procedure envisaged under the waiver decision 2003 will inevitably limit the ability of export markets to meet the demands of poor and developing countries. finally, there is a group of commentators who contend that the waiver decision 2003 has a symbolic significance, even though its practical, tangible impact is negligible. employing the themes of rule complexity and regulatory ritualism, professor peter drahos has highlighted the limitations of the waiver decision 2003 to show the futility of outcome.10 this chapter contends that the compulsory licensing mechanism for exports under the waiver decision 2003 lacks efficacy. it argues that the indian compulsory licensing regime fails to facilitate affordable drug supply to other developing countries, because of the rigidity and complexity of treaty rules; economic considerations; technological constraints and capacity; and a fickle lack of political commitment. the main hypothesis extended is that without a viable, affordable and continuous generic supply from india, the success of doha declaration 2001 8 see for example: biswajit dhar and k.k. gopakumar, ‘post-2005 trips scenario in patent protection in the pharmaceutical sector: the case of generic pharmaceutical industry in india’ (2006), unctad, idrc and ictsd, 56; alka chadha, ‘product cycles, innovation and exports: a study of indian pharmaceuticals’ (2005), department of economics, national university of singapore working paper no. 0511 at http://www.fas.nus.edu.sg/ecs/pub/wp/wp0511.pdf. also see: padmashree gehl sampath, ‘economic aspects of access to medicines after 2005: product patent protection and emerging firm strategies in the indian pharmaceutical industry’ institute of new technologies, united nations university at http://www.who.int/intellectualproperty/studies/padmashreesampathfinal.pdf. 9 frederick m. abbott and jerome h. reichman, ‘the doha round public health legacy: strategies for the production and diffusion of patented medicines under the amended trips provisions’ (2007) 10(4) journal of international economic law 921-987, 941. 10 peter drahos, ‘four lessons for developing countries from the trade negotiations over access to medicines’ (2007) 28(11) liverpool law review 39 at http://www.anu.edu.au/fellows/pdrahos/pdfs/ 2007fourlessonsfordevcountries.pdf. nordic journal of commercial law issue 2011#1 4 would be substantially compromised. part ii of this chapter deals with the key provisions in the trips agreement 1994 dealing with the exports of pharmaceutical drugs. part iii considers the doha declaration 2001 and the subsequent waiver decision 2003. part iv considers the various species of compulsory licensing under indian patent law. part v considers the first indian compulsory licensing instance under the new law and the natco’s application for the grant of compulsory licences of erlotinib and sutent. ii. the trips agreement 1994 and pharmaceutical exports before the adoption of the trips agreement 1994, developing countries were largely free to determine the scope, term and availability of patent protection as a part of their overall industrial and public health policy objectives. although many developing countries were members of the paris convention for the protection of industrial property of 1883 (paris convention 1883), they retained the flexibility to legislate on domestic pharmaceutical production and access to essential medicines. in terms of substantive rule-making, patentable subject matter, local usage and enforcement measures, the paris convention 1883 leaves considerable space for member states to devise and implement their own patent systems. indeed, it even allows member states to deny protection for certain subject matters such as pharmaceutical products. however, under the trips agreement 1994, all member states are now required to comply with the minimum standards set out in the treaty. the obligations of the trips agreement 1994 include the extension of patent protection to all qualifying inventions without the discrimination of any field of technology and origin of subject matter.11 thus the developing countries were obligated to extend patent protection to pharmaceutical products pursuant to the requirements of the trips agreement 1994. since the expiry of the limited transition period in 2005, the situation has radically changed in developing countries and they have introduced new laws and governing regulations dealing with the patentability of medicines and related components. in 1994, india decided to take advantage of the transitional period allowed under the trips agreement 1994 for developing countries, which ultimately ended in 2005. the trips agreement 1994 recognises the right of member countries to issue compulsory licences subject to procedural requirements laid down in article 31. however, the option of invoking article 31 flexibilities to meet public health objectives had no real meaning for many developing and least developing countries because they lacked any local pharmaceutical manufacturing capabilities. the problem is directly linked with the language of article 31(f) of the trips agreement 1994 which, after initially allowing the grant of a compulsory licence, restricts the operation of this option by stating: 11 article 27.1 of the trips agreement 1994. nordic journal of commercial law issue 2011#1 5 (f) any such use shall be authorized predominantly for the supply of the domestic market of the member authorizing such use; however, in practice, many developing and least developing countries lacked sufficient manufacturing capacity for the production of highly advanced and technologically sophisticated medicines to address public health epidemics. they did not have even a possibility of getting cheaper medicines from india, china or brazil under a compulsory licence because any such production in these countries was supposed to be predominantly for the supply of the local market and only a fraction of total produce was allowed to be exported to the countries which mainly needed these drugs. the wto ministerial conference adopted the doha declaration 200112 in november 2001. this was the product of an extensive lobbying effort of international humanitarian organisations, ngos and the governments of developing and least developing countries. the doha declaration 2001 reaffirmed the flexibilities built into the trips agreement 1994, including the right of member states to issue compulsory licences on public interest grounds.13 the declaration then specifically addressed the problem of member states lacking the capacity to manufacture cheaper generic substitutes and which are otherwise not capable of exploiting the flexibilities under the existing article 3(f) requirement. paragraph 6 of the doha declaration 2001 mandated the relevant wto body to work out a suitable solution, keeping in view the limitations of such countries with an aim to ensure access to essential medicines.14 after almost two years of extensive discussions at wto a solution, initially embodied in the form of a waiver, was reached on 30 august 2003 (waiver decision 2003).15 in the light of various proposals and discussions, it was decided that this waiver decision 2003 would be rendered as permanent in the form of an amendment to the trips agreement 1994 as article 31bis.16 the ratification of the proposed amendment is still pending while member states consider their options. meanwhile the waiver reached on 30 august 2003 is effective and would continue to operate. the waiver decision 2003 and the protocol amending the trips agreement 1994 are summarised in the following section along with a brief analysis of some provisions. 12 doha declaration on the trips agreement and public health, wto doc wt/min(01)/dec/2 (14 november 2001) at http://www.wto.org/english/thewto_e/minist_e/min01_e/mindecl_trips_e.htm. 13 ibid. paragraph 5(b). 14 bid. paragraph 6. 15 implementation of paragraph 6 of the doha declaration on trips agreement and public health, wto doc wt/l/540 (30 august 2003) (decision of the general council of 30 august 2003) at http://www.wto.org/english/tratop_e/trips_e/implem_para6_e.htm. 16 wto general council decision of 6 december 2005 amendment of the trips agreement, wt/l/641, (8 dec. 2005) (protocol amending the trips agreement’ with annex setting out article 31bis) at http://www.wto.org/english/tratop_e/trips_e/wtl641_e.htm. nordic journal of commercial law issue 2011#1 6 iii. the waiver decision and proposed article 31bis in 2001, paragraph 6 of the doha declaration 2001 recognised that the countries with limited or virtually no manufacturing capacity in the pharmaceutical sector had difficulties in invoking the compulsory licensing mechanism set out in article 31 of the trips agreement 1994. subsequently based upon the mandate of the doha declaration 2001, the wto general council’s waiver decision 2003 paved the way to allow countries with sufficient manufacturing capacity to make and export pharmaceutical products to countries which require such medicines for public health needs. this objective is achieved through a mechanism whereby restriction of article 31(f) is waived for the exporting countries (by relaxing the requirement of manufacturing predominantly to the supply of domestic market), and restriction of article 31(h)17 is waived for importing countries. proposed article 31bis essentially reflects the terms of the waiver decision 2003 by establishing the waiver of certain obligations of the trips agreement 1994 as mentioned earlier. a. scope and coverage of diseases paragraph 1 of the waiver decision 2003 defines ‘pharmaceutical product’ broadly without limiting application of the solution to certain specific diseases. it reads: (a) “pharmaceutical product” means any patented product, or product manufactured through a patented process, of the pharmaceutical sector needed to address the public health problems as recognized in paragraph 1 of the declaration. it is understood that active ingredients necessary for its manufacture and diagnostic kits needed for its use would be included.18 the definition is sufficiently broad as active pharmaceutical ingredients (apis) and diagnostic kits are expressly covered. the definition is also sufficiently broad to cover vaccines because vaccines are ‘products of the pharmaceutical sector’. the negotiations prior to the adoption of waiver decision 2003 were quite extensive with regard to the scope and coverage of diseases to be covered under the proposed mechanism. the united states proposed to restrict the candidate list of diseases to hiv-aids, malaria, tuberculosis and a relatively small group of infectious diseases. the us proposal also sought to limit the countries that would benefit from the solution and considered it to be the ministers’ 17 remuneration requirement is explicitly waived. this aspect is discussed further hereafter. 18 implementation of paragraph 6 of the doha declaration on trips agreement and public health, wto doc wt/l/540 (30 august 2003) (decision of the general council of 30 august 2003) paragraph 1 at http://www.wto.org/english/tratop_e/trips_e/implem_para6_e.htm. nordic journal of commercial law issue 2011#1 7 intention at doha.19 at some later stage of negotiations, the ec had demonstrated a relatively more flexible approach and suggested that the solution be confined to grave public health problems and a potential role of who was also mentioned to identify such grave situations.20 on 28 january 2003, india together with several developing countries submitted that they would not accept the usa and ec proposals as they would narrow down the scope of paragraph 1 of the doha declaration.21 india’s position prevailed. paragraph 1 of the doha declaration 2001 does not mention any limitation on the application of the declaration to certain specific diseases or medicines and the position of developing countries was finally reflected in the waiver decision 2003. the proposed article 31bis mirrors this stance. b. notification requirement and eligible countries both the waiver decision 2003 and the proposed article 31bis contemplate two important notification requirements. the first is a general notification of intent which is required from all member countries that use the system, other than least developing countries.22 the group of members belonging to least developing countries are thus free to invoke the mechanism without any notification of intent. both the instruments also provide that any member state may notify the trips council that it does not intend to use the system as an importing country or that it only intends to use it in a limited way. almost all oecd countries have practically opted out by notifying their intention not to use the system or to use it in a limited way.23 a number of member states (hong kong, china, israel, kuwait, macao chian, mexico, qatar, singapore, chinese taipei, turkey and the united arab emirates) notified their intention to use the system only in cases of national emergency or other circumstances of extreme urgency.24 by analogy, one can construe that other non-notifying member states may then use the system liberally in situations other than national emergency or circumstances of extreme urgency. 19 cecilia oh, ‘developing countries criticise attempts to limit scope of diseases in paragraph 6 negotiations’, update on 5 feb 2003 informal meeting of trips council and background to the negotiations on para 6, page 4. at http://www.twnside.org.sg/title/trips-feb5.doc. 20 ibid. 21 ibid. 3 22 paragraph 1(b), wto general council decision of 6 december 2005 amendment of the trips agreement, wt/l/641, (8 dec. 2005) (protocol amending the trips agreement’ with annex setting out article 31bis) at http://www.wto.org/english/tratop_e/trips_e/wtl641_e.htm. 23 ibid. footnote 3 to paragraph 1(b). 24 duncan matthews, ‘wto decision on implementation of paragraph 6 of the doha declaration on the trips agreement and public health: a solution to the access to essential medicines problem?’ (2004) 7(1) journal of international economic law 73-107, 95. nordic journal of commercial law issue 2011#1 8 on 19 july 2007, rwanda became the first wto member state which notified its intention to use the system to import some 260,000 packs of triavir, a fixed-dose combination product of zidovudine, lamivudine and nevirapine, from a canadian pharmaceutical firm apotex, inc.25 it is pertinent to note that rwanda had no obligation to notify as such being a designated least developing country and it was eligible to use the system without following any procedural formalities. however, a notification requirement is imposed upon the potential exporting wto member states pursuant to paragraph 2(c) of the waiver decision 2003. in response to the request of rwanda, the canadian government notified the trips council of the terms of the export licence it had issued in this regard.26 some commentators have criticised the elaborate and lengthy procedural notification procedure in the canadian regime. c. determination of manufacturing capacity according to article 31bis least developing countries are automatically eligible to import medicines under the system envisaged in this regard. in addition to this, any country making a determination that it has insufficient or no manufacturing capacity of a particular pharmaceutical product, can also become an eligible importing state.27 this article further provides that the determination of manufacturing capacity in this regard by the importing country excludes the production facilities which are owned or controlled by the patent holders. it states: where the member has some manufacturing capacity in this sector, it has examined this capacity and found that, excluding any capacity owned or controlled by the patent owner, it is currently insufficient for the purposes of meeting its needs. when it is established that such capacity has become sufficient to meet the member’s needs, the system shall no longer apply.28 the language of the article 31bis about the definition of pharmaceutical product and determination of manufacturing capacity would be helpful for a developing country that wants to use this system merely to import pharmaceutical products to manufacture medicines locally for justified public health needs. 25 rwandanotification under paragraph 2(a) of the decision of 30 august 2003 on the implementation of paragraph 6 of the doha declaration on the trips agreement and public health, ip/n/9/rwa/1 (19 july 2007) at http://www.wto.org/english/tratop_e/trips_e/public_health_notif_import_e.htm. 26 canada-notification under paragraph 2(a) of the decision of 30 august 2003 on the implementation of paragraph 6 of the doha declaration on the trips agreement and public health, , wto doc ip/n/10/can/1 (18 october 2007) at http://www.wto.org/english/tratop_e/trips_e/public_health_notif_export_e.htm. 27 paragraph 2(a) (ii), wto general council decision of 6 december 2005 amendment of the trips agreement, wt/l/641, (8 dec. 2005) (protocol amending the trips agreement’ with annex setting out article 31bis) at http://www.wto.org/english/tratop_e/trips_e/wtl641_e.htm. 28 ibid. appendix to annexure. nordic journal of commercial law issue 2011#1 9 d. licensing scheme both the waiver decision 2003 and proposed article 31bis detail the procedural and substantive requirements that deal with the issuance of compulsory licences by importing and exporting countries. as an importing country, members from least developing countries are entitled to use the system without meeting any notification requirement. thus, these countries can use the system without issuing domestic compulsory licences which is otherwise required under the scheme. likewise, any other member state, where the desired medicine is not patented, can also use the system without issuing a compulsory licence. in all other cases, countries which are willing to use this system must issue a compulsory licence prior to importation and it must notify the trips council of such intention.29 the conditions which are generally set out in article 31 of the trips agreement 1994 should be complied with while the countries consider the option of issuing compulsory licence. so the solution evolved through the waiver decision 2003 and the proposed article 31bis should be construed and applied in conjunction with other substantive requirements of the trips agreement 1994 unless specifically waived. the issuance of a compulsory licence itself entails several procedural and administrative complications within the overall scheme of the trips agreement 1994 and it has yet to be seen how developing countries will overcome those legal and administrative barriers to implement the waiver decision 2003 in an effective and efficient way. however, article 31 does not attempt to limit in any way the grounds upon which compulsory licences may be issued and its procedural requirements can be incorporated in domestic legislation in a way which would supplement the flexibilities designed under article 31bis. article 31bis also suggests some disclosure obligations on importing country in terms of identification of product(s) and expected quantities to be imported. this should be notified to the trips council.30 this aspect has been specifically criticised by some commentators for being too restrictive and inhibitive as an exact determination of expected quantity can be unviable both practically and economically. furthermore, no model exists to satisfy such procedural requirements and it may put the willing member states in an unending exercise of monitoring and evaluation.31 some commentators do not consider it a critical obstacle and suggest that the proposed article 31bis does not demand a particular fixed formula, and there are various possibilities for complying with this obligation in efficient and innovative ways.32 in order to facilitate the usage of complex notification and determination procedure, a world bank study 29 ibid. paragraph 2(a) (iii). 30 ibid. paragraph 2(a) (1). 31 rohit malpani and mohga kamal-yanni, ‘patent versus patients: five years after the doha declaration’, oxfam briefing paper (95) at http://www.oxfam.org/en/policy/briefingpapers/bp95_patentsvspatients_061114. 32 frederick m. abbott and jerome h. reichman, ‘the doha round public health legacy: strategies for the production and diffusion of patented medicines under the amended trips provisions’ (2007) 10(4) journal of international economic law 921-987, 941. nordic journal of commercial law issue 2011#1 10 in 2005 developed some model forms which rwanda had used in 2007 to notify the wto about its intention of using waiver decision 2003.33 the proposed article 31bis and the waiver decision 2003 would also regulate the conditions for issuing a compulsory licence for exporting member states.34 the authorised manufacturer from the exporting country can only manufacture and export the required quantities which the importing country has notified earlier.35 on the insistence of developed countries, the so called safeguards against diversion are also enumerated in this regard which requires that the product should be clearly identified as having being produced under this system. this may involve special packaging, labelling, special shaping or colouring provided that the distinctions are feasible and do not significantly affect price.36 further conditions are put on the licensees to post destination and identification information on a website.37 non-governmental organisations, international humanitarian organisations and academics have criticised the bureaucratic approach of the waiver decision 2003 and the article 31bis.38 a 2006 report of médecins sans frontières (msf) notes: prolonged prior negotiations severely limit the ability to use the august 30th decision and act as a disincentive to manufacturers to participate in the process … anti-diversion measures that generic companies must comply with are onerous and are further disincentives to their participation in the process.39 highlighting the need for a viable and robust supply of pharmaceutical drugs, the report also considered the challenging task of manufacturing and supplying under compulsory licensing arrangement. in this regard, the msf report complains that ‘the decision flies in the face of the practical reality of managing a health programme, where flexibility and rapidity of response to 33 frederick m. abbott and rupolph van puymbroeck, ‘compulsory licensing for public health, a guide and model documents for implementation of the doha declaration paragraph 6 decision, world bank working paper no. 61 (2005). 34 paragraph 2(b) (i), wto general council decision of 6 december 2005 amendment of the trips agreement, wt/l/641, (8 dec. 2005) (protocol amending the trips agreement’ with annex setting out article 31bis) at http://www.wto.org/english/tratop_e/trips_e/wtl641_e.htm. 35 ibid. paragraph 2(b) (i). 36 ibid. paragraph 2(b) (ii). 37 ibid. paragraph 2(b) (iii). 38 médecins sans frontières, doha derailed, a progress report on trips and access to medicines (switzerland: msf campaign for access to essential medicines, 27 august 2003) and médecins sans frontières, neither expeditious, nor a solution: the wto august 30th decision is unworkable: an illustration through canada’s jean chrétien pledge to africa (prepared for the xvi international aids conference, toronto august 2006), and oxfam international, patents versus patients, five years after the doha declaration, oxfam briefing paper 95, november 2006. 39 médecins sans frontières (msf), neither expeditious, nor a solution: the wto august 30th decision is unworkable: an illustration through canada’s jean chrétien pledge to africa, prepared for the xvi international aids conference, toronto, august 2006, 3 nordic journal of commercial law issue 2011#1 11 ever-changing circumstances are vital’.40 some commentators have suggested that procurements strategies can incentivise the potential supplier and such policies can be used to overcome the problem of limited demand.41 e. remuneration and non-authorised importation article 31bis provides that adequate remuneration need only be paid in the country of export by taking into account the economic circumstances of the importing country.42 the system requires the importing countries to take reasonable and proportionate measures to prevent diversion or re-exportation of medicines supplied under this arrangement.43 the proposed article 31bis obligates member states to enable patent holders to protect themselves against unauthorised importation of pharmaceutical products manufactured under the system, but no additional legislative or administrative measures are required in this regard.44 f. regional arrangements as the group of least developing countries from africa was quite instrumental behind the development and adoption of the doha declaration 2001 because of limited drugs manufacturing capacity within the region, the final solution addresses the need of such countries in a somewhat specialised and preferential way. the proposed article 31bis contains a special provision for member states that belong to regional trade agreements of which at least half the members are currently least developing countries.45 for such a regional group, a relaxation is designed with regard to re-exportation to a member country once the product is manufactured and exported to one country under the compulsory licence. however, importing countries have not been discharged from the obligation of issuing separate compulsory licences where otherwise applicable.46 40 ibid. 4. 41 frederick m. abbott and jerome h. reichman, ‘the doha round public health legacy: strategies for the production and diffusion of patented medicines under the amended trips provisions’ (2007) 10(4) journal of international economic law 921-987, 943. 42 paragraph 2, wto general council decision of 6 december 2005 amendment of the trips agreement, wt/l/641, (8 dec. 2005) (protocol amending the trips agreement’ with annex setting out article 31bis) at http://www.wto.org/english/tratop_e/trips_e/wtl641_e.htm. 43 ibid. paragraph 3. 44 ibid. paragraph 4. 45 ibid. paragraph 3. 46 ibid. nordic journal of commercial law issue 2011#1 12 g. implementation and ratification the waiver decision 2003 was adopted after much deliberation and difficult negotiations and it was hoped that it would open a window of opportunities for least developing countries to boost their public health coverage programs. with the finalisation of the protocol of amendment in the form of article 31bis, commentators were keen to look at the practical aspects of the new system as there were a number of concerns regarding the cumbersome nature of the proposed solution. to date, thirty-one countries including european communities have notified their acceptance of the proposed amendment of the trips agreement 1994.47 however, the export scheme was not used until july 2007 when one least developing country, rwanda, notified its intention to benefit from the scheme set out initially in the waiver decision 2003.48 the proposed article 31bis would be rendered permanent in the form of an amendment to the trips agreement 1994 once it is ratified by two-thirds of wto members. by the december 2007 deadline, only 13 of 151 wto countries had ratified it. the wto pushed back the ratification deadline to december 2009 and in the meanwhile, the 2003 waiver remains in effect. with thirty-one countries accepting the proposed amendment in september 2010, it is anticipated that the article 31bis would not be included into the trips agreement 1994 in the wake of growing criticism and opposition of civil society organisation, and the situation may continue to be governed under the waiver decision 2003.49 moreover, there is some confusion about the status of the acceptance notification of the european communities and individual community members have yet to notify their intentions.50 47 these countries include united states (17 december 2005), switzerland (13 september 2006), el salvador (19 september 2006), rep. of korea (24 january 2007), norway (5 february 2007), india (26 march 2007), philippines (30 march 2007), israel (10 august 2007), japan (31 august 2007), australia (12 september 2007), singapore (28 september 2007), hong kong, china (27, november 2007), china (28 november 2007), european communities (30 november 2007), mauritius (16 april 2008), egypt (18 april 2008), mexico (23 may 2008), jordan (6 august 2008) brazil (13 november 2008) morocco (2 december 2008) albania (28 january 2009) macau, china (16 june 2009) canada (16 june 2009) bahrain (4 august 2009) colombia (7 august 2009) zambia (10 august 2009) nicaragua (25 january 2010) pakistan (8 february 2010) former yugoslav republic of macedonia (16 march 2010) uganda (12 july 2010); and mongolia (17 september 2010). see: world trade organization, members accepting amendment of the trips agreement (updated 17september 2010) at http://www.wto.org/english/tratop_e/trips_e/amendment_e.htm. 48 world trade organization, members accepting amendment of the trips agreement (17 december 2010) at http://www.wto.org/english/tratop_e/trips_e/amendment_e.htm. 49 ibid. 984. 50 matthew kennedy, when will the protocol amending the trips agreement enter into force? (2010) 13(2) journal of international economic law 459-473. nordic journal of commercial law issue 2011#1 13 most of the non-governmental organisations, humanitarian agencies and independent experts consider the system is defective in its design and modalities and it is extremely difficult for potential member states to invoke it to meet their public health needs.51 they maintain that conditions associated with the issuance of licences, notification requirements, the so-called safeguard clause and anti-diversion measures have unnecessarily over-burdened the system and it is very hard for least developing countries to overcome these barriers. james love of the consumer project on technology wrote about the waiver decision 2003: ‘the new agreement has very modest benefits, and it has very substantial costs, risks and uncertainties.’52 this view is further augmented by the european generic medicine association (ega) declaring that wto compulsory licensing system is unworkable and will not improve access to medicine. mr greg perry, director general of the ega expressed his views recently at the wto public forum 2008 and said: ‘the wto’s 2003 august 30 decision concerning compulsory licenses is complicated, unworkable and unable to deliver any significant improvement in access to medicines.’53 however, frederick abbott and jerome reichman construe the terms of the new system in a positive way suggesting that a better trade-off deal was practically not possible given the political and structural environment of trade negotiations at that time. they consider that most of the procedural requirements set out in the new system can be intelligently managed within national laws and willing member states can overcome potential problems through pooled procurement strategies and innovative decision-making.54 however, in the light of theoretical analysis and the two cases (rwanda and india), it is hard to construe the waiver decision 2003 as a positive measure which can solve the problem of access to medicine. the decision is cumbersome and rigid and beyond its textual constraints, it also restricts the economic incentive which is essential to maintaining a manufacturing base. 51 msf access to medicines campaign, doha derailed, a progress report on trips and access to medicines, 27 august 2003 and neither expeditious, nor a solution: the wto august 30th decision is unworkable: an illustration through canada’s jean chrétien pledge to africa, prepared for the xvi international aids conference, toronto, august 2006, and oxfam international, patents versus patients, five years after the doha declaration, oxfam briefing paper 95, november 2006. 52 james love, ‘cptech statement on wto deal on exports of medicines’, august 30, 2003 at http://www.cptech.org/ip/wto/p6/cptech08302003.html. 53 european generic medicine association, ‘wto compulsory licenses system is unworkable and will not improve access to medicines’ (press release 25 september 2008, brussels at http://www.egagenerics.com/pr-200809-25.htm 54 frederick m. abbott and jerome h. reichman, ‘the doha round public health legacy: strategies for the production and diffusion of patented medicines under the amended trips provisions’ (2007) 10(4) journal of international economic law 921-987, 941. nordic journal of commercial law issue 2011#1 14 iv. indian compulsory licensing regime after the series of sporadic amendments, india finally brought its patent law into conformance with the trips agreement 1994 through the patents (amendment) act 2005 (india). it is important to see that india has incorporated the spirit of the waiver decision 2003 in its domestic law to facilitate the smooth flow of generics export to other countries. the waiver decision 2003 is merely an international instrument and its real potential will be demonstrated once put into operation under domestic laws and regulations. through the patents (amendment) act 2005 (india), india has supposedly provided some robust and strong compulsory licensing avenues which yet need to be tested practically to judge its effectiveness. the principal provisions dealing with compulsory licensing consist of section 84, section 92 and section 92a of the patents act 1970 (india). in addition to this, section 11a also provides a mechanism for automatic compulsory licensing in certain cases. here, i am focusing on the compulsory licensing provision relevant to pharmaceutical exports. a. section 92a: doha style compulsory licence the patents (amendment) act 2005 (india) introduces a third compulsory licensing avenue which reflects the wto waiver decision 2003 in domestic law. section 92a provides for compulsory licences to enable exports of pharmaceutical products to those countries with no manufacturing capacity of their own. it states that: compulsory licence shall be available for manufacture and export of patented pharmaceutical products to any country having insufficient or no manufacturing capacity in the pharmaceutical sector for the concerned product to address public health problems, provided compulsory licence has been granted by such country or such country has, by notification or otherwise, allowed importation of the patented pharmaceutical products from india. the controller shall, on receipt of an application in the prescribed manner, grant a compulsory licence solely for manufacture and export of the concerned pharmaceutical product to such country under such terms and conditions as may be specified and published by him.55 this section also defines the term ‘pharmaceutical product’ in line with the language of the waiver decision 2003 and the proposed article 31bis and includes ‘any patented product, or product manufactured through a patented process, of the pharmaceutical sector needed to address public health problems and shall be inclusive of ingredients necessary for their 55 section 92a(1) and (2) of the patents act 1970 (india). nordic journal of commercial law issue 2011#1 15 manufacture and diagnostic kits required for their use.’56 an application for the grant of a compulsory licence under this section can be filed at any time after a patent has been issued.57 section 92a provides a relatively flexible and fast track doha style licensing mechanism in view of the waiver decision 2003 and the adoption of subsequent national laws in many member states such as canada, china, norway and the european union. it necessarily reflects the spirit of the waiver decision 2003 and employs a less restrictive language and procedural requirements to issue a compulsory licence. for instance, indian law does not explicitly require as a precondition that an importing country should have issued a licence before indian law comes into action, and it merely puts the condition of a notification or otherwise to allow exportation of patented medicines. this provision was first introduced through the patents ordinance 2004 (india) and at that time it required that the exporter obtain a compulsory licence from the importing country as well.58 however, this requirement was later dropped to accommodate situations where no such patent exists in the importing country and a notification would suffice in such cases. the section is completely silent about the requirements of specifying the amount of pharmaceutical products that will be manufactured under compulsory licence which is an important procedural aspect of the waiver decision 2003. likewise, no requirements are mentioned with regard to separate packaging, colouring or shape. it is important to note that no such guidelines are currently under consideration when the indian patent office is finalising its manual of patent practice and procedure.59 this particular section was scrutinised recently when the indian generic manufacturer natco applied for a compulsory licence for roche’s patented medicine, erlotinib, for export to nepal. b. section 11a: automatic compulsory licences india was among those developing countries which opted to enjoy the full transition period allowed under the trips agreement 1994. thus until 2005, india was not granting product patents for pharmaceutical and agro-chemical products and, in lieu, it had established a mailbox mechanism to determine priority matters in the post-2000 scenario. by virtue of this mailbox facility, applications would be judged for ‘novelty’ on the basis of the filing date and 56 ibid. explanation. 57 ibid. no post grant waiting period is maintained under this section unlike section 84 of the act. 58 shamnad basheer, ‘indian tryst with trips: the patents 9amendment) act 2005’ (2005) 1(1) the indian journal of law and technology 15-46, 28. 59 intellectual property india, draft manual of patent practice and procedure at http://www.patentoffice.nic.in/ipr/patent/draftpatent_manual_2008.pdf nordic journal of commercial law issue 2011#1 16 not with reference to 2005, the year in which product patents were first incorporated into the patent regime. the patents (amendment) act 2005 (india) provides that where a patent is granted to any of those mailbox applications, an automatic compulsory licence would issue to those generic companies that made a ‘significant investment’ and were ‘producing and marketing’ a drug covered by the mailbox application prior to 2005. such licence is subject to the payment of a reasonable royalty.60 there has been much discussion about the indian compulsory licensing regime and a range of positions can be identified in this regard. first, the pharmaceutical research and manufacturer of america (phrma) in its 2008 submission to ustra termed the indian compulsory licensing provisions as one of the most damaging provisions of the indian patent law.61 second, some commentators consider that the indian export oriented compulsory licensing regime is the broadest in scope when compared with other jurisdictions and thus ‘widespread use of the section 92a avenue for compulsory licensing to export patented medicines appears likely’.62 however, i would argue here that the indian compulsory licensing provisions under section 92a should be understood and analysed both in a legal and factual context. a study undertaken for who shows that very few indian pharmaceutical companies think that the indian patent law provides an economically lucrative option for them to retain their export sales. of the 103 firms, only 25 firms thought it was an economically lucrative option, whereas 78 firms did not think so. it is important to note that out of 25 firms which responded positively, only 6 firms have a strong technological base to meet export market demand on a sustainable basis.63 v. tarceva and sutent compulsory licences the indian compulsory regime has been tested by two separate compulsory licence applications for anti-cancer medicines involving erlotinib and sutent. 60 section 11a proviso of patents act 1970 (india). 61 pharmaceutical research and manufacturer of america, ‘special 301 submission 2008’, february 11, 2008, 68, at http://www.ustr.gov/assets/trade_sectors/intellectual_property/special_301_public_submissions_2008/ asset_upload_file109_14495.pdf 62 janice m. mueller, ‘the tiger awakens: the tumultuous transformation of india’s patent system and the rise of indian pharmaceutical innovation’ (2007) 68 university of pittsburgh law review 491-641, 604 at http://lawreview.law.pitt.edu/issues/68/68.3/mueller.pdf 63 padmashree hehi sampath, ‘economic aspects of access to medicines after 2005: product patent protection and emerging firm strategies in the indian pharmaceutical industry’ institute of new technologies, united nations university at http://www.who.int/intellectualproperty/studies/padmashreesampathfinal.pdf nordic journal of commercial law issue 2011#1 17 a. erlotinib hydrochloride erlotinib which is marketed by genentech, osi pharmaceuticals and roche in different parts of the world under the brand name tarceva, is prescribed for the treatment of non-small cell lung cancer and pancreatic cancer. it is basically a small molecule human epidemic growth factor type 1/epidermal growth factor receptor inhibitor which was approved in november 2004 by the u.s. food and drug administration (fda).64 the drug is primarily developed by osi pharmaceuticals and later business and marketing partnerships were developed with genentech and roche. now osi pharmaceuticals and genentech are marketing the tarceva brand in the united sates, and elsewhere it is marketed by roche. after its marketing approval in 2004, tarceva did quite well in the global oncology market by generating substantial revenue for marketing companies. in its business report 2007, the roche group declared tarceva among its top selling pharmaceutical products with sales of 1,062 million swiss francs. the report indicates a 31% annual increase in sales.65 genentech markets this drug jointly with osi pharmaceutical and in 2007 it reported us $417 million sales with a steady annual growth since 2006.66 for osi pharmaceuticals, tarceva stands as the single most important drugs for business and revenue purposes. in 2007, it reported revenues of $340 million (up 41% on the prior year) and it was observed: the business continues to be anchored around our flagship anti-cancer therapy tarceva® which, just three years after the november 2004 approval in non-small cell lung cancer (nsclc), exited the year with fourth quarter global sales of $250 million – an annualized run-rate of $1 billion, the recognized industry-wide metric of a blockbuster.67 b. tarceva patents osi pharmaceuticals and roche secured the patents of erlotinib (the active pharmaceutical ingredient of tarceva) in the united states, europe, japan, and number of other countries. indeed, roche claimed in india that patents related to tarceva had already been filed in more 64 u.s. food and drug administration consumer information at http://www.fda.gov/cder/ consumerinfo/druginfo/tarceva.htm. 65 roche, annual report 2007: we innovate healthcare (switzerland: 2007), 19 at http://www.roche.com/gb07e.pdf. 66 genentech, annual report 2007: in business for life (california: 2007) 23, at http://www.gene.com/gene/ about/ir/historical/annual-reports/2007/2007annualreport.pdf 67 osi pharmaceuticals, annual report 2007 (new york: 2007) 1, at http://media.corporateir.net/media_files/irol/70/70584/2007_osip_annual_report.pdf nordic journal of commercial law issue 2011#1 18 than 80 countries and in almost 50 countries it was granted.68 in the united states, the orange book data shows two patents related to tarceva which would respectively expire on march 30, 2015 (patent no. 5747498) and november 9, 2020 (patent no 6900221).69 in addition to this, osi pharmaceuticals was granted patent term extension certificates which extend the united states patent to november 2018 and a corresponding patent in europe to march 2020.70 further patenting activity is expected around erlotinib given its emerging importance and ongoing research regarding the possibility of future use of the same molecule for pipeline products. osi pharmaceuticals states in this regard: we are also currently pursuing u.s. and international patents for new inventions concerning various other formulations of erlotinib and related intermediate chemicals and processes in an effort to enhance our intellectual property rights in this compound. we have obtained a patent covering a key polymorphic form of tarceva in the united states, which expires in 2020. we are also currently seeking patent protection for additional methods of use for tarceva, including the use of tarceva in combination with other compounds.71 in india, pfizer inc. usa and osi pharmaceuticals jointly filed an erlotinib patent application on 30th march 1995. the invention claimed in the patent application was related to ‘quinazoline derivatives compounds and composition thereof’ with initially 27 claims.72 it is worthwhile mentioning that the corresponding us patents showed a broader claim strategy where 79 claims were made under united states patent no. 6,900,221.73 the other us patent related to erlotinib contains 32 claims.74 however, realising the very broad scope of claims made in patent no. 5,747,498 which may become ultimately susceptible to challenge under 68 f. hoffmann-la roche ltd v cipla (i.a 642/2008 in cs (os) 89/2008) dated march 19 2008, paragraph 65, full text is available at: http://courtnic.nic.in/dhcorder/dhcqrydisp_j.asp?pn=1031&yr=2008. 69 approved drug products with therapeutic equivalence evaluations in electronic orange book at http://www.accessdata.fda.gov/scripts/cder/ob/docs/patexclnew.cfm?appl_no=021743&product_no=001&tabl e1=ob_rx 70 osi pharmaceuticals annual report 2007, 12, at http://media.corporate-ir.net/media_files/irol/ 70/70584/2007_osip_annual_report.pdf 71 ibid. 72 decision of assistant controller of patents and designs in the matter of patent application no. 537/del/1996 at https://210.210.88.164/patentdecisionsearch/display_uploaded.asp?application_number=537-del-1996-154 73 norris, timothy et al (2005), ‘stable polymorph on n-(3-ethynylphenyl)-6, 7-bis (2methoxyethoxy)-4quinazolinamine hydrochloride, methods of production, and pharmaceutical uses thereof’, us patent no: 6,900,221 at http://patft.uspto.gov/netacgi/nphparser?sect1=pto1&sect2=hitoff&d=pall&p=1&u=%2fnetahtml%2fpto%2fsrchnum.htm&r=1&f=g&l =50&s1=6,900,221.pn.&os=pn/6,900,221&rs=pn/6,900,221 74 schnur, rodney caughren (1998), ‘alkynyl and azido-substituted 4-anilinoquinazolines’ united states patent no: 5,747,498 at http://patft.uspto.gov/netacgi/nphparser?sect1=pto1&sect2=hitoff&d=pall&p=1&u=%2fnetahtml%2fpto%2fsrchnum.htm&r=1&f=g&l =50&s1=5747498.pn.&os=pn/5747498&rs=pn/5747498 nordic journal of commercial law issue 2011#1 19 paragraph iv procedure of the drug price competition and patent term restoration act (hatchwaxman act), osi pharmaceuticals filed an application in february 2008 to the united states patent and trademark office to correct certain claims by deleting surplus compounds from the claims.75 the indian patent office had already raised these objections with regard to the erlotinib patent application and on 22 january, 2006, eleven preliminary objections were raised in the first examination report of the indian patent office including the lack of novelty and the inventive step.76 these objections were later removed and finally the applicants managed to secure a patent on the following two claims: 1. a novel [6,7-bis(2-methoxyethoxy)quinazolin-4-yl]-(3-ethynylphenyl) amine hydrochloride compound of the formula a, and 2. a process for preparing the compound as claimed in claim 1.77 c. pre-grant opposition by natco pharma after the case was put for the final grant of patent, natco pharma ltd., a local generic manufacturer, filed an opposition to the grant of patent on 10th april 2007. this application was made under section 25(1) of the patents act 1970 (india) which deals with pre-grant opposition proceedings. the grounds on which pre-grant opposition may be based include virtually all patentability criteria including anticipation, lack of inventive step and noninvention.78 in its opposition petition, natco pharma mainly raised concerns about whether the application was non-obvious, and whether there had been sufficient disclosure of the invention in the specifications.79 in view of these objections, the indian patent office examined the question of the novelty and inventive step again in the light of prior art citation ep 0566226, published on 20.10.93 and ep 0520722 published on 30.12.92. in the end, it decided that none of the citations were specific for the claims made under the patent application. the opponent maintained that the 75 osi pharmaceuticals annual report 2007, 12, at http://media.corporate-ir.net/media_files/irol/70/ 70584/2007_osip_annual_report.pdf 76 decision of assistant controller of patents & designs in the matter of patent application no. 537/del/1996, 11. full text available at https://210.210.88.164/patentdecisionsearch/display_uploaded.asp?application_number=537del-1996-154. 77 ibid. 13. 78 section 25 (1) a-k of the patents act 1970 (india). 79 decision of assistant controller of patents & designs in the matter of patent application no. 537/del/1996, 14. full text available at https://210.210.88.164/patentdecisionsearch/display_uploaded.asp?application_number=537del-1996-154. nordic journal of commercial law issue 2011#1 20 claimed invention was an obvious derivative derived from 4-anilinoquinazoline nucleus and ‘the combination of simple functional groups like alkoxy, alkyl, alkynyl, halo to already known basic nucleus or compound is obvious to a person of ordinary skill in the art’.80 applicants also survived the attack on their claims on the basis of section 3(d) of the patents act 1970 (india) by showing the data regarding survival rate increase by the use of drug. the patent office decided in favour of applicants and the patent was granted accordingly against two claims agreed during the proceedings. during the hearings, the parties could not agree on the nature of opposition proceedings with natco considering it as a pre-grant opposition under section 25(1) and osi pharmaceuticals and others as a post-grant opposition under section 25(2). this confusion basically arose because of an earlier decision by the patent office on its own objections and the subsequent order for the grant of patent which was delayed due to internal processes. this distinction is important from the point of view of the possibility of filing a post-grant opposition, though natco could not succeed in its pre-grant opposition. on this point, the patent office decided that the proceeding was a pre-grant opposition.81 the success in pre-grant opposition was an important victory for osi pharmaceuticals and other parties and its annual report 2007 states: ‘a patent corresponding to the u.s. composition of matter patent for tarceva was granted in february 2007 in india and we, along with our collaborator roche, successfully opposed a pregrant opposition by natco pharma, ltd. of mumbai, india in july 2007.’82 d. sunitinib malate sunitinib malate is prescribed for the treatment of renal cell carcinoma, a type of kidney cancer. it is manufactured and marketed by pfizer under the brand name sutent and also used for the treatment of gastrointestinal stromal tumour (gist). gist is a cancer of the stomach and bowels which is caused by the uncontrolled growth of cells in the wall of the stomach or bowel. sutent was the first medicine approved by the u.s. food and drug administration (fda) simultaneously for two indications. while approving the drug in january 2006, steven galson, director of fda’s center for drug evaluation and research, observed: ‘today’s approval is a major step forward in making breakthrough treatments available for patients with rare and difficult to treat forms of cancer.’83 80 ibid. 19. 81 ibid. 26. 82 osi pharmaceuticals annual report 2007, 13, at http://media.corporate-ir.net/media_files/irol/70/ 70584/2007_osip_annual_report.pdf 83 u.s food and drug administration, ‘fda approves new treatment for gastrointestinal and kidney cancer’, january 26, 2006, p06-11 at http://www.fda.gov/bbs/topics/news/2006/new01302.html nordic journal of commercial law issue 2011#1 21 in pfizer’s product portfolio, sutent is still categorised as one of the new medicines which is performing very well with an increase of 166% in sales revenue during 2006.84 sutent’s sales revenue increased to us$581 million in 2006 and that was mainly because of its widespread and speedy marketing approval in europe and many asian countries. e. sutent patents in the united states, three patents were granted for sunitinib malate which would expire on february 15, 2021 (patent no. 6573293 and patent no. 7125905) and december 22, 2020 (patent no. 7211600). in addition to this, a new chemical entity (nce) exclusivity protection is also applicable until january 26, 2011.85 a pct application (application no. pct/us1999/012069) was also filed in 1999 and the patents were granted in several designated countries between 2001 and 2005.86 the parallel indian patent application was filed on august 9, 2002 under the title of pyrrole substituted 2-indolinone protein kinase inhibitors and a patent was granted on august 31, 2007.87 this patent (patent no. 209251) was granted jointly to sugen inc. and pharmacia & upjohn company. sugen was a small california based biotechnology company which was acquired by pharmacia & upjohn company in the late 1990s and subsequently pharmacia & upjohn company was acquired by pfizer in 2003. however, pfizer kept using these distinct business identities as a business strategy.88 patent protection is central in pfizer’s business strategy and one of its foremost business strategies is to refocus and optimise its patent protected portfolio.89 in its annual review of 2007, pfizer declared: ‘we are refocusing and optimizing our patent-protected portfolio to speed up the flow of new products, invest more in areas of strength, and deliver greater value to customers and patients.’90 in this context, an attempt to secure compulsory licences for these two drugs was really seen as an offensive move by the patent owners and both applications were fiercely contested in the patent office. 84 pfizer, annual review 2007 (new york: 2007) 7 http://media.pfizer.com/files/annualreport/2007/annual/review2007.pdf 85 approved drug products with therapeutic equivalence evaluations in electronic orange book at http://www.accessdata.fda.gov/scripts/cder/ob/docs/patexclnew.cfm?appl_no=021938&product_no=001&tabl e1=ob_rx 86 tang, peng cho et al (filed in 1999), ‘pyrrole substituted 2-indolinone protein kinase inhibitors’, pct application no: pct/us1999/012069 at http://www.wipo.int/pctdb/en/wo.jsp?wo=1999061422&ia= us1999012069&display=status 87 government of india, controller general of patents designs and trademarks at https://124.124.220.66/patentgrantedsearch/(s(k3gh1m55vis3y1rkuwtxcx55))/grantedsearch.aspx. 88 pfizer annual review 2007, 14, http://media.pfizer.com/files/annualreport/2007/annual/review2007.pdf. 89 ibid. 4. 90 ibid. 12. nordic journal of commercial law issue 2011#1 22 f. natco’s compulsory licence application notwithstanding the unsuccessful attempt to block the erlotinib patent through a pre-grant opposition procedure, natco pharma ltd. applied for compulsory licences under section 92a of the patents act 1970 (india). as mentioned earlier in this chapter, section 92a provides the avenue for the grant of a doha style compulsory licence solely for export purpose. in early january 2008, latha jishnu of the business standard reported that: [t]he first application for a compulsory licence filed in india, has put a key provision of the indian patents (amendment) act, 2005 under the scanner. the application has been filed by natco pharma of hyderabad for roche’s erlotinib (brand name tarceva), which is used in the treatment of lung cancer.91 in its application to the patent office for the grant of a compulsory licence under section 92a, natco asked for permission to manufacture 30,000 tablets of tarceva for export to nepal against a fixed royalty of 5%. later, it was also reported that natco applied for a compulsory licence of sunitinib against the same terms and conditions.92 g. nepal: public health profile and access to medicines nepal is a least developing country in south asia having boundaries with china in the north and india in the south. with a population of 27,641,000 its gross national income per capita is us$1,010.93 the share of annual health expenditure as a percentage of the national budget was 5.1% in 2001-03. nepal’s rank in terms of the undp human development index (hdi) is 142 among 177 countries.94 there have been a number of estimates of cancer incidence in nepal. some estimates show that the incidence of cancer is approximately 120 per l00,000 head of population, and it is assumed that there are 35,000 to 40,000 cancer sufferers in the country.95 the incidence of cancer is thought to be rising every year. the hospital based statistics showed that there were 23% cases with malignancies in 1993 compared to 19% in 1989. the five most common malignant 91 latha jishnu, ‘cancer drug puts licence, patent rules to test’, business standard, january 16 2008, at http://in.rediff.com/money/2008/jan/16drug.htm 92 tatum anderson, ‘india considers compulsory licences for exportation of drugs’, intellectual property watch, 20 february 2008, at http://www.ip-watch.org/weblog/index.php?p=933 93 world health organization country statistics at http://www.who.int/countries/npl/en/ 94 world health organization, ‘2007/2008 human development index rankings’ at http://hdr.undp.org/en/statistics/. 95 sunil kumar joshi, ‘occupational cancer in nepal – an update’ (2003) 1(2) kathmandu university medical journal 144-151, 144 at http://member.wnso.org/drsunilkj/occupationalcancer.pdf nordic journal of commercial law issue 2011#1 23 diseases in nepal are bronchial cancer, breast cancer, cervical and ovarian cancer, stomach and colorectal cancer and leukaemia.96 the nepal pharmaceutical industry is largely dependent upon the indian market and most of local manufacturers are importing their raw materials from india and china (see table 4.2) table 1.2: top 15 suppliers to nepal rank company origin value (in crore) market share (%) 1 nepal pharma nepal 13.2 3.85 2 lomus pharma nepal 11.8 3.47 3 aristo indian 11.4 3.31 4 deurali janata nepal 10.7 3.08 5 knoll pharma mnc 9.6 2.78 6 dabur indian 9.1 2.65 7 lupin indian 8.7 2.50 8 national health care nepal 8.6 2.50 9 hoechst mnc 8.1 2.35 10 alkem indian 7.8 2.27 11 ranbaxy indian 7.4 2.14 12 cadila pharma indian 6.3 1.84 13 cadila health care indian 6.3 1.83 14 e merck mnc 6.0 1.75 15 novartis mnc 5.6 1.64 source: dr r. k. srivastava97 nepal joined the wto on april 23, 200498 and it is regarded as at least a developing country for implementation and enforcement of various treaty related obligations including the trips agreement 1994. historically, nepal had domestic intellectual property laws but it had to amend those laws in the light of obligations of the trips agreement 1994 by january 1, 2006.99 this is 96 ibid. 97 dr r. k. srivastava, ‘nepal-new emerging pharma market’ (undated) http://www.p-mc.com/pmc%20web%20_articles/nepal%20new%20emerging%20pharma%20market.doc 98 world trade organization, ‘member information: nepal and wto’ (accessed on september 13, 2010) at http://www.wto.org/english/thewto_e/countries_e/nepal_e.htm 99 world trade organization, ‘wto ministerial conference approves nepal’s membership’ (accessed on september 13, 2010) at http://www.wto.org/english/news_e/pres03_e/pr356_e.htm nordic journal of commercial law issue 2011#1 24 of course subject to the doha declaration’s extended deadline for least developing countries to apply provisions on pharmaceutical patents until 1 january 2016.100 as a least developing country, nepal has as yet no obligation to protect pharmaceutical products under patent law. according to the patent, design and trademark act 1965 (nepal), a patent is defined as ‘any useful invention relating to a new method or process of manufacture, operation or publicity of any material or a combination of materials, or that made on the basis of a new theory or formula’.101a patent is valid only for 15 years after registration.102 there has been a little patenting activity in nepal and only 49 patents were registered until 2002.103 natco’s compulsory licensing applications have generated substantial debate in india and elsewhere but surprisingly there is complete silence from nepal. though these compulsory licenses were intended to be used for export to nepal but we can see virtually no debate in nepal about this issue. with the status of a least developing country, nepal has no obligation to respond to this situation with a domestic compulsory license and its mere notification should suffice in the given circumstances. in fact, there is no compulsory licensing related provision in the patent, design and trademark act 1965 (nepal). however, for a successful outcome of natco’s application in india, at least two factors are important in nepal. first, nepal should determine and establish its public health need with regard to products which natco is attempting to manufacture under compulsory license. second, nepal should notify the wto about its intention to invoke the waiver decision 2003, much like rwanda natco’s attempt looks half-hearted and apparently it rushed to the patent office without adequate preparation. these points were justifiably highlighted by the patentees before the patent office and played a decisive role in the final outcome. the matter is further discussed in subsequent sections. pfizer’s presence in nepal and its pricing policy there is another aspect of this debate which is not discussed by the commentators. aiming clearly to counter natco’s compulsory licensing application, pfizer announced the launch of a free sutent access program in nepal.104 the decision was first revealed in april 2008, much later than the filing of the compulsory licensing applications in india. 100 world trade organization, ‘the doha declaration explained’ (accessed on september 13, 2010) at http://www.wto.int/english/tratop_e/dda_e/dohaexplained_e.htm 101 section 2(a) of the patent, design and trade mark act, 1965 at http://www.vakilno1.com/ saarclaw/nepal/patentandtrademarkact/chapter1.htm 102 section 8 (1) of the patent, design and trade mark act, 1965 at http://www.vakilno1.com/saarclaw/ nepal/patentandtrademarkact/chapter1.htm. 103 sirjana sharma, ‘intellectual property law’ on nepalese lawyers in the us (january 11, 2008) at http://anlus.wordpress.com/2008/01/11/article-intellectual-property-law/ 104 c.h. unnikrishnan, ‘pfizer to launch free sutent access programme in nepal; the wall street journal, april 3, 2008 at http://www.livemint.com/2008/04/03004838/pfizer-to-launch-free-sutent-a.html?d=1 (note that ‘the move may upset indian generic drug maker natco pharma ltd’s efforts to secure a compulsory licence for exporting copy-cat versions of the drug’.) nordic journal of commercial law issue 2011#1 25 h. procedural requirements in contrast to the doha declaration 2001 and the waiver decision 2003, section 92a adopts a straightforward and relatively fast track mechanism to issue a compulsory licence for export purposes. this provision does not stipulate the requirement of issuance of two back-to-back compulsory licences in importing and exporting countries along with separate notification obligations. in fact, the provision is silent about the royalty payment and no formula is referred for its calculation. however, the patent controller is authorised under the relevant provision to determine the terms and conditions of such licence. despite the gaps in section 92a, it is important to note that the whole scheme is designed to meet the obligations of the doha declaration 2001 and any interpretation of this section should be construed against this background. in light of the doha declaration 2001 and related provisions of indian law, natco’s application can be analysed in the following way. according to the doha declaration 2001, an importing country is obliged to notify the council for trips about the name and expected quantity of the drug which it intends to import under the scheme. the declaration further requires that the member state must establish beforehand that it has virtually no, or a very limited, manufacturing capacity with regard to the drug which it wants to import and it should issue a compulsory licence if the product is patented in that importing country. in this case, nepal is a least developing country and it does not need to establish its insufficient manufacturing capacity pursuant to the doha declaration 2001. given that nepal has no product patent regime, issuing a compulsory licence has no relevance. however, general notification of intent to the council for trips is required which nepal has not made. in the very first doha-style compulsory licensing case, rwanda had notified its intention to use the mechanism of the doha declaration 2001.105 it is unclear how the indian patent office will operate in the absence of such a notification to the council for trips. nepal has only reportedly issued an import letter in favour of natco. the contents of this letter which was issued from the nepalese ministry of health are not yet known so its adequacy in terms of satisfying the procedural requirement of doha declaration 2001 is yet to be established. this point was precisely raised by the patentees during a hearing before the patent office and an objection was raised as following: counsel for patentees further argued that the “notice” by the nepal government that natco was relying upon was insufficient to amount to a formal notification of an intent to import drugs produced under a compulsory licence. he alleged that natco, in its application for a compulsory licence, had merely submitted a letter from the nepal government recommending that one consignment of erlotinib be approved for import 105 rwandanotification under paragraph 2(a) of the decision of 30 august 2003 on the implementation of paragraph 6 of the doha declaration on the trips agreement and public health, ip/n/9/rwa/1 (19 july 2007) at http://www.wto.org/english/tratop_e/trips_e/public_health_notif_import_e.htm nordic journal of commercial law issue 2011#1 26 from india during the period 2006-2007. he argued that this was insufficient to demonstrate nepal’s intent to utilise the 30 august mechanism to import drugs produced under a compulsory licence. in contrast, he pointed to the formal notification provided to the wto by rwanda of its intent to utilise the paragraph 6 implementation.106 setting aside the procedures of the doha declaration 2001 for a moment, natco can argue that indian law does not prescribe the requirement of notification to the council for trips and any document establishing the intent of the importing country should be considered satisfactory. indeed, a bare reading of section 92a supports this assertion as it states: compulsory licence shall be available for manufacture and export of patented pharmaceutical products to any country having insufficient or no manufacturing capacity in the pharmaceutical sector for the concerned product to address public health problems, provided compulsory licence has been granted by such country or such country has, by notification or otherwise, allowed importation of the patented pharmaceutical products from india.107 (emphasis added) once the importing member country fulfils the requirement, then the exporting country can issue a compulsory licence under its domestic law. in this case natco has applied to the patent office after securing a letter from nepal stating its intent, the name of the product, required quantities and a royalty offer. this licence is necessary in india given the existence of a valid patent by osi pharmaceuticals and pfizer. in the absence of any notification from nepal, it is difficult to determine the prevalence of a public health problem and its nature. paragraph 1 of the doha declaration 2001 clearly spells out the intent by linking it with public health problems. it is not necessary for nepal to show a national emergency before importing drugs from india under the indian compulsory licence but such an action should definitely be related to a public health problem. the relevance of an anti-cancer drug contrary to an hiv/aids treatment may become a contentious point as we have already seen this line of argument the case of thailand.108 106 chan park, ‘natco’s application for cl for export – hearing in the delhi patent office’ on commons-law blog (march 20, 2008) at http://commonslaw.freeflux.net/blog/archive/2008/03/20/commons-law-natco-s-applicationfor-cl-for-export-hearing-in-the-delhi-patent-office.html 107 section 92a(1) and (2) of the patents act 1970 (india). 108 jonathan burton-macleod, ‘tipping point: thai compulsory licences redefine essential medicines debate’ in thomas pogge, matthew rimmer and kim rubenstein (eds), incentives for global public health: patent law and access to essential medicines (cambridge university press: 2010) 77. also see: office of the united states trade representative, 2009 special 301 report (april 30, 2009) 21 at http://www.ustr.gov/sites/default/files/full%20version%20of%20the%202009%20special%20301%20rep ort.pdf nordic journal of commercial law issue 2011#1 27 i. the right to a hearing in response to natco’s application, pfizer approached the patent office to contest the matter both on its merits and on procedural grounds. indeed, the patent office itself identified some lacunas in natco’s application and those were communicated to the applicant. natco responded to those points and maintained that patentees had no right to be heard in this case. on the questions of maintainability of this application and the patentees right to become a party, two hearings were held and finally the patent office resolved this matter to the extent of a hearing right in favour of patentees. it is pertinent to note that section 92a of the patents act 1970 (india) is silent on the question of a patent holder’s right to a hearing and relevant rules along with draft manual of patent practice and procedure are equally unhelpful in this regard. natco interprets it as a fast track compulsory licensing avenue unlike other provisions and asserts that a hearing right would unnecessarily delay the licence issuance process. patent holders believe that their right to a hearing is inherent and based upon natural justice and several provisions of patent law. this question arose in discussion during the first two hearings when deliberations on the merit of the application were set aside for a while and parties argued their position on this preliminary hiccup. the parties raised several crucial points in their submissions. to resolve this matter and decide about the stay petition of natco, the delhi patent office held a hearing on march 19, 2008. this hearing was attended by the parties and representatives of the lawyers collective, the hiv/aids unit and the msf access campaign. the latter two parties attended the proceedings as observers and the counsel of patentees raised objections about their presence asserting the proceedings as a private hearing. however, it was finally resolved that the observers could attend the proceedings with the objection of patentees placed on the record.109 in favour of their position, patentees relied both on statutory and common law grounds to establish the right to hearing before a compulsory licence was issued. the patentee argued that under the notion of ‘natural justice’ and ‘due process’, a hearing opportunity was fundamental before any decision adverse to their right was considered. further reliance was made on section 80 of the patents act 1970 (india) and rule 129 of the patents rules 2003 (india). a joint reading of section 80 and rule 129 suggest that the patent controller is required to grant a patent applicant, or any party to a proceeding, a hearing before exercising any discretionary power adversely. thus, it was argued, the patentees had a right to be heard before the grant of compulsory licence.110 pfizer also relied upon a number of indian cases to establish its position 109 chan park, ‘natco’s application for cl for export – hearing in the delhi patent office’, commons-law blog at http://commonslaw.freeflux.net/blog/archive/2008/03/20/commons-law-natco-s-application-for-cl-for-exporthearing-in-the-delhi-patent-office.html 110 ibid. nordic journal of commercial law issue 2011#1 28 on the right to be heard and in this regard reliance was made on audi alterum partum.111 the same principle was upheld in several other cases such as union of india v. t.r. verma112, basudeo tiway v. sido kanhu uni113 and udit narayan singh v. additional member board of revenue.114 in response to such assertions, the applicant (natco) maintained that section 92a was clear in its language and intention and such hearing was deliberately avoided at the time of amendments in the law. section 92a was a clear response to the mandate of the doha declaration 2001 and the legislature intentionally adopted a fast track and efficient mechanism to meet the public health challenges in importing countries. thus, a clear distinction was made between the general compulsory licensing provisions (sections 84-92) and this provision (section 92a). domestic compulsory licensing provisions clearly provide a hearing opportunity and section 92a is deliberately silent on this point to expedite the procedure. natco insisted that section 92a could be construed in the light of the doha declaration 2001 which prompted the need for rapid response in the case of a public health crisis. natco maintained that: on analysis of the section 92 (a) of the indian patents act, it is clear that law specifically excludes any interference or intervention or even participation by the patentee. therefore, the question of contesting the grant of license does not arise. the entire mechanism is a departure from the usual procedure of grant of compulsory license and is aimed at giving effect to and fulfilling the objectives of said doha declaration which emphasizes on the rapid response to the urgent needs of the least developed countries or developing countries for immediate access to patented medicines.115 natco also referred to the relevant canadian legislation (section 21.14) where no such right was incorporated in the law before the issuance of a compulsory licence.116 in response to the patentees’ position that certain matters could only be determined with the assistance of patentees, natco relied on the joint publication of who/undp which could be used to work out adequate remuneration in such circumstances without the involvement of the patentees.117 111 maneka gandhi v union of india (1978) 1 scc 248. 112 union of india v t.r. verma air 1957 sc 882. 113 basudeo tiway v sido kanhu uni (1998) 8 scc 194. 114 udit narayan singh v additional member board of revenue air 1963 sc 786. 115 delhi patent office, government of india, no. pod/hk/2008-09012942 dated july 4, 2008 at https://124.124.220.66/patentdecisionsearch/display_uploaded.asp?application_number=in-pct-2002-00785del-167 116 ibid. 117 in fact reference was made to: james love, ‘remuneration guidelines for a non voluntary use of a patent on medical technologies, undp-who health economic and drugs tcm series no. 18 (who/tcm/2005.1), (2005). nordic journal of commercial law issue 2011#1 29 it further argued that the common law doctrine of natural justice could not be applied in an absolute manner and it had always been regulated under different situations and in view of the unambiguous language of section 92a, general rules could not be attracted. the patent office finally resolved the matter of the hearing controversy on july 4, 2008. in his decision, hrdev karar, assistant controller of patents and design, dismissed the interlocutory petition of natco and allowed the patentees to become parties to proceedings before the patent office in the matter under section 92a. the patent office decision is important in view of future applications of section 92a and it would eventually pave a way towards elaborative and lengthy proceedings before the grant of a compulsory license. the decision is mainly about the patentee’s right to participate in proceedings held under section 92a and several other points were also discussed by the assistant controller regarding the maintainability of natco’s application. for instance, it is noticed that natco could not substantiate its application for the grant of a compulsory licence by producing a notification from the government of nepal. the letter which natco had attached along with its original application was declared insufficient in the light of legislative requirement. natco did not submit proof to suggest that there was a public health emergency in nepal due to the lack of availability of the drug. the assistant patent controller, therefore, stated in his order that one of the reasons for the ‘hearing’ was to ensure that the provisions of 92 (a) were not ‘abused’. the participation of patentees and their hearing right are recognised in the decision in purview of section 92a and the applicant’s submission on this point was turned down. agreeing with the patentees’ arguments on this point, the assistant controller of patents and design said: it may be observed that the requirements as mentioned in section 92a and rules made thereunder impliedly demands the presence of the patentee, therefore the doctrine “necessary implication or the maxim expression ‘unius est exclusio alterius’ need not to be applied. the principle audi alteration partem would be more beneficial for proper administration of justice. therefore, the patentee is required to be invited to the hearing in respect of proceedings of section 92(a).118 the hearing controversy is now resolved by this decision and the remaining matter is to be decided on its merits. this initial controversy raised important procedural questions which have the potential to stall a compulsory licence application for a considerable time. an unrestricted and full-fledged hearing right may hamper the development of a standard working procedure which can be later employed by other generic companies to apply for compulsory licences under section 92a. this first case is highly important not only for indian manufacturers but also for the rest of the developing world as the placement of a quick and efficient mechanism in india would help them activate their domestic regulations to important 118 ibid. 13. nordic journal of commercial law issue 2011#1 30 cheaper drugs from generic resources. obviously any unnecessary delay or cumbersome procedure should be considered against the legislative intent and procedural requirements under section 92a. j. withdrawal of application by natco after this decision, it was expected that the matter would shift to normal proceedings and the patent office would decide about the grant of compulsory licence after hearing both parties. though the decision was disappointing for natco it was expected that natco would strongly push its case on the merits for the grant of a compulsory licence. however, in september 2008, natco requested the controller of patents to withdraw its applications for compulsory licenses for export of the generic anti-cancer drugs sunitinib and erlotinib.119 apparently it was an unexpected move although some commentators noted that it was anticipated after patent office’s decisions on natco’s interlocutory petition. shamnad basheer observed that: [p]atent office was concerned that the doha cl process ought not to be abused by generic manufacturers that wished to make a quick buck. therefore, the best way to ensure this was to hear the other side as well … natco’s decision to withdraw its application may have stemmed from a fear that it would lose on merits.120 the outcome is indeed disappointing for a variety of reasons. first, this case was a good chance for indian generic companies to test the application of export oriented compulsory licences. second, the decision of the patent office was unreasonable in that it had indeed determined the outcome of natco’s application beforehand. the decision expressed serious doubts about the maintainability of a compulsory licensing application at a stage when there was controversy about the hearing matter. natco had also apparently rushed into this matter without completing its homework in nepal, and it could not substantiate its case for the grant of compulsory licence on public health grounds. 119 c.h. unnikrishnan, ‘natco withdraws plea on making patented cancer drugs’, mint: the wall street journal, sep 28 2008 at http://www.livemint.com/2008/09/28214903/natco-withdraws-plea-on-making.html 120 shamnad basheer, ‘breaking news: natco withdraws “doha” compulsory licence application’ on spicyip (september 28, 2008) at http://spicyipindia.blogspot.com/2008/09/breaking-news-natco-withdraws-doha.html nordic journal of commercial law issue 2011#1 31 vi. conclusion in conclusion, one possible way of maintaining indian exports at their current level is through the strategic use of compulsory licensing provisions which are incorporated in indian law. i have analysed this potential in the light of early compulsory licensing instances. natco’s application for a compulsory licence highlights the ambiguities in the law and procedure. contrary to the general assumptions, the system did not work efficiently in this first case for a variety of reasons which could be attributed to the patent office, patent law, the applicant and patent holders. however, the main reasons were procedural ambiguities and the lack of appropriate homework by the applicant i have argued that both the international framework (wto waiver decision 2003) and the domestic rules (indian compulsory licensing provisions) will not help in achieving the objectives of the doha declaration 2001. four main reasons are cited here to support this position. first, the complexity of rules is a vital constraint and it operates both on the levels of treaty law and domestic regulation. second, pharmaceutical firms view the export potential in terms of market size and the profits involved in such supply. because of the complexity of rules, and fragmented markets, the firms may be less inclined to engage in export oriented production if their commercial expectations are largely unmet. third, the chances of supplies being available becomes more unlikely especially if the firms have to make specific technological investments to produce the drugs required for a limited time in a restricted territory. such technological investment is essential to the manufacture of new drugs which are constantly in demand in most of the african countries. fourth, the indian government lacks the political will or enthusiasm to engage in the wide scale use of section 92a.121 the indian government has a vested interest in integrating into the global economy and trading network. 121 sanjeev choudhary and khomba singh, ‘government may use compulsory licensing for drug companies only in emergency’, the economic times, 3 april 2008, at http://economictimes.indiatimes.com/ news/news_by_industry/healthcare__biotech/healthcare/govt_may_use_compulsory_licensing_for_drug_com panies_only_in_emergency/articleshow/2921237.cms nordic journal of commercial law issue 2011#1 32 figure 4.1 four modes of compulsory licensing under the patents act 1970 (india) as amended at 2005 section 11a section 92 section 84 section 92a after grant any time after grant three years after grant any time after grant notification by central government availability of compulsory licence. if a patent granted on mail box application the subject to some conditions. form 17 with rs. 1500(natural person)/rs. 6000others immediate grant of compulsory licence under section 92(3) in the circumstances of national emergency or extreme urgency or public noncommercial use including public health crises relating aids hiv tuberculosis, malaria or epidemics section 92(1) opposition for the settlement of terms & conditions prima facie case made out under section 87 refusal after hearing within one month if no prima facie case advertisement of the application and applicant to serve copies to the patentee opposition by the patentee, if desired with in two months from the date of publication grant compulsory licence automatic compulsory licence immediate grant of compulsory licence for export of patented pharmaceutical products to the countries having insufficient or no manufacturing capacity to address public health problems contracts, risks and management = contractual risk management nordic journal of commercial law issue 2012#2 conceptual fallacies behind the idea of unprotected intellectual works by yoshiyuki tamura* * professor of law and director of the research institute for information law & policy, hokkaido university graduate school of law. the author would like to express his thanks for their comments and suggestions to antonina bakardjieva engelbrekt, katja lindroos, nari lee, toshihide watabe, branislav hazucha and participants in the “4th annual conference on innovation and communications law” organized by the university of turku faculty of law may 24-25, 2012. nordic journal of commercial law issue 2012#2 1 1 introduction in the midst of the global pervasive proliferation of intellectual property protection, an ‘if there exists unprotected intellectual works, it is a bad thing’ -type argument can be observed in several ways. actually, in legal theory, as well as in the enforcement of intellectual property rights, we often hear suggested that there is an area without any protection of intellectual works or if there is any legal protection, it is deemed to be insufficient with regards to protection of certain intellectual works. in this essay, i will use the term “intellectual works” which broadly refers to all those intangibles which are the result of human intellectual, creative or inventive labor. when someone says that there is an area with insufficient or lacking protection of intellectual works, i think that there are three types of assumptions behind this expression. the first assumption is that there is a “thing” or object that embodies an intellectual work. the second assumption is that if there is no or insufficient protection over this type of intellectual work as an object, it will cause tensions or frictions in society, since such object belongs to its creator. the third assumption is that the protection of such intellectual works should be provided for in the form of law. 2 pitfalls in the conceptualization of intellectual works in this regard, i would like to point out several conceptual fallacies behind the idea that there exists an area with insufficient or no protection of intellectual works. first of all, i will enquire whether intellectual works per se do actually exist. peter drahos introduces two lines of thinking concerning intellectual works as objects in legal and political philosophy. one line argues that intellectual works do exist as real entities. the second line suggests that they only exist as constructs of the mind. in this line of thinking, intellectual creations or works are deemed to be artificial concepts based on mental constructs.1 regardless of which line is actually adopted as the correct one, another problem which needs to be dealt with in our endeavor is whether we can distinguish intangible objects from the act of their usage. in theory, the objects of intellectual creations and the acts of their usage are often thought of separately. a separation of this kind is based on the idea that it is possible to distinguish an actual act of human conduct from the object of an action. however, this distinction is only relative. we can consider an act of transmitting a computer program through the digital network as an example. copyright law distinguishes between a computer program that is a copyrighted work—an intangible object—and an act of its 1 peter drahos, a philosophy of intellectual property (ashgate 1996) at 18. nordic journal of commercial law issue 2012#2 2 transmission to the public which is deemed as an act of using such copyright work. by contrast, the assessment of the entire situation may be seen differently from the point of view of patent law where all depends on the particular claims written in the granted patent. if a method of transmitting the given computer program through the digital network is claimed as an invention, it is viewed as an intangible object under patent law and not only as a use of an intangible good. this example clearly illustrates that the identification of what exactly is an “intangible object” and what exactly is an “action”—the use of such object—is actually a matter of the degree of abstraction in individual branches of intellectual property law due to the differences in their objects of protection. accordingly, from the act of the public transmit of a program through a digital network, an action — human conduct — and an intangible object constructed as a computer program, exist separately in copyright protection. if we go even further in this abstraction, the actual intangible object becomes the method of transmitting the program as was the case in the abovementioned case under patent law. from this example, one can learn that the distinction between human behavior and intangible objects is simply fiction. the reason is that all concepts of intangible objects are based on rather relative degrees of conceptualization. wendy gordon puts it succinctly. she suggests that the way of regulating intangible objects is simply the regulation based on certain similarities in patterns of human behaviors which are called intangible objects.2 if we take this relativistic position of human action and intangible objects, the concept of rights over intellectual creation is problematic as well. behind this idea of intellectual creation, there is a strong metaphor that assumes that there is a “thing” or there is an object of intellectual creation that can be distinguished from human beings’ actions, and that one can institute a right over that object. this metaphor hides the fact that the relativistic concepts of human actions and intangible goods actually cause restriction of human actions by granting a right over intellectual works. for instance, it is often suggested that intellectual property laws deal with a right over information. although i have no substantial objection against the concept of a right over information, it is important to point out that this concept is also one type of metaphor which is somewhat problematic in my opinion. i think that information does not exist per se. it cannot be distinguished from the respective human activity. this metaphor thus obscures the difficulties with the possible distinction between an intangible object and human action. a similar objection can be found in gordon’s work,where it is suggested that instead of calling this right an intellectual property right over information, it would be more adequate to refer to it as a right restricting a certain pattern of human action. 2 wendy j. gordon, ‘intellectual property’ in peter cane and mark tushnet (eds), the oxford handbook of legal studies (oup 2003) at 621-622. nordic journal of commercial law issue 2012#2 3 one might argue that the same argument applies to the use of tangible things and the property rights to them. what is then the difference between property rights to tangible things and intellectual property rights? to answer this question, i will refer to immanuel kant’s writings. it is often suggested that it was kant who proposed to distinguish the use of intangible things from the right to ownership. although the right of ownership over tangibles contains also rights to use such object, in the case of the rights over tangibles, the focal point is a physical contact between a tangible thing and the respective way of its use.3 due to the physical focal point, there is limited danger that this type of property rights would be extended indefinitely to the degree that it would broadly restrict the other persons’ actions.4 property rights over tangible things can thus be easily distinguished from property rights over intellectual works. although drahos doesn’t use the expression “focal point”, the analysis used in this speech stems from the ideas presented in his philosophy of intellectual property. as there are no physical focal points in the case of intellectual property rights, the lack of clear conceptual limitations allows the granting of rights that can significantly and broadly restrict other persons’ activities due to their artificial creation. another problem is that a high economic value is attached to intellectual property rights. intellectual property rights are thus likely to become the object of lobbying by interested groups such as multinational enterprises and the like. the negative outcome of such activities is that the intellectual property rights become unnecessarily broad and ubiquitous.5 3 from monistic theories towards a pluralistic theory to justify intellectual property so far, i have talked about the distinctions between intellectual works as intangible objects and their actual use, now i am going to talk a bit about the idea of unprotected intellectual works. the ideas that intellectual works should be protected stems from two main justificatory theories: the natural rights theory and the incentive theory. although the grant of intellectual property rights and their extension are often justified by using the lockean labour theory6, it is heavily debated whether john locke himself thought his theory can be applied to the 3 immanuel kant, die metaphysic der sitten (the metaphysics of morals) (benzion kellermann ed, verlag dr. h. a. gerstenberg 1973) at 72-73. 4 drahos (1996) at ch 7. 5 peter drahos & john braithwaite, information feudalism: who owns knowledge economy? (earthscan pub. 2002) at ch 4; peter drahos, ‘intellectual property industries and the globalization of intellectual property: pro-monopoly and anti-development?’ (2004) 3 intellectual property l. & policy j. 65, available at < http://www.juris.hokudai.ac.jp/coe/pressinfo/journal/vol_3/3_4.pdf> accessed 4 september 2012; peter k. yu, the international enclosure movement’ (2007) 82 indiana l. j. 827. 6 john locke, two treatises of government (peter laslett ed, cup 1988) at 286 288-289. http://www.juris.hokudai.ac.jp/coe/pressinfo/journal/vol_3/3_4.pdf nordic journal of commercial law issue 2012#2 4 justification of intellectual property rights. the same applies to hegel’s geistiges eigentum with regard to applying his mental property theory7 to the justification of intellectual property rights. as pointed out above, intellectual property rights are rights that restrict the other person’s liberty and freedom. the idea that a person should own the intellectual works that he creates can therefore hardly justify any restrictions on another person’s freedom alone.8 hence, the justification of intellectual property rights requires other additional justifying factors. for this purpose, i will rely on a japanese scholar, susumu morimura, who uses in his theory of ownership various arguments stemming from libertarianism.9 accordingly, i think that the justification of intellectual property rights should not be based only on their benefits to an individual right holder’s private interests, but they should be designed in a way that the majority of people can benefit from them. it leads me to relying on an efficiency argument to a certain degree. by restricting some types of free-riding activities, it is possible to prevent the underproduction of concerned intellectual works. the public can then benefit from the protection of some intellectual works by access to a variety of intellectual works which would not otherwise be created or invented.10 contrary to the abovementioned theories, i advocate a more pluralistic approach. it is hard to completely ignore the rhetoric of the natural rights theories. if one follows only the incentive theory, intellectual property rights can be deemed as rights that can restrict another persons’ freedom for the benefit of the entire society.11 in this regard, the incentive theory might be a bit weak due to its pure utilitarianism. one needs to engage in more research into utilizing the teachings from constitutional, public choice and other theories. as noted before, the fact that a person created something––the act of creation––can hardly be the only reason for the justification of its proprietary rights to the results of his intellectual labor. at the same time, relying on the incentive theory as the sole way of justifying intellectual property is also weak. in particular, if one uses efficiency as the justification for such restrictions, for example, in order to prevent the free-riding problem, their justification becomes quite problematic because of emerging difficulties with measuring or verifying the improved efficiency by adopting a certain type of intellectual property institution.12 however, if one 7 g. w. f. hegel, elements of the philosophy of right (allen w. wood ed, h. b. nisbet tr, cup 1991) at 74-75 86-88 95 97-101. 8 yoshiyuki tamura, ‘a theory of the law and policy of intellectual property’ [2009#1] nordic journal of commercial law <http://www.njcl.utu.fi/article.php?issue=1_2009&n=1> accessed 4 september 2012. 9 susumu morimura, zaisanken no riron (a theory of property rights) (kobundo 1995) at 121 241-261. 10 tamura (2009). 11 jeremy waldron, ‘from authors to copiers: individual rights & social values in ip’ (1993) 68 chicago-kent l. rev 841, at 862-864. 12 nari lee, ‘toward a pluralistic theory on efficacious patent institution’ (2007) 6 john marshall rev. of intellectual property l. 224, available at <http://ssrn.com/abstract=936893> accessed 4 september 2012. http://www.njcl.utu.fi/article.php?issue=1_2009&n=1 http://ssrn.com/abstract=936893 nordic journal of commercial law issue 2012#2 5 considers the idea of efficiency with regard to granting intellectual property rights, the fact that a person created something can become a passive justification to restrict the freedom of another person.13 from my previous observations, the main point i wanted to make thus far is that the restriction of freedom is not always necessary. it is necessary to distinguish the occasion where the restriction is necessary and where it is not. intellectual property rights do not constitute protection over an “intangible thing”—an intellectual work—but they are rights that restrict the freedom of persons who are not right-holders. consequently, we can conclude for now that if the lack of intervention into human activities by the law does not cause any harm to improving efficiency, it is probably better to leave such area of human activities without any regulation. 4 policy making process as a justification for legitimacy clearly the conclusion that intervention by law is not necessary in any case is contradictory to the third assumption behind the need to sufficiently protect all intellectual works, which i have raised at the beginning of this essay. the question thus arises whether this third assumption that intellectual works must be always protected is correct. and if not, whether there are any alternatives to the legal protection of intellectual works. my argument here is based on nari lee’s work14 where she argues that regulation by law is effective mainly in cases where the idea of intellectual works has some connection with the physical, material world. if there is no such connection, there is no need to always regulate any exploitation of such intellectual works. as i have already noted several times before, it is very difficult to distinguish the act of use from the intangible object itself. in terms of regulation, the connecting point often becomes a person’s act of use. but the connecting point which is the subject of regulation does not always have to be the actual use of an intellectual work, especially since it can hardly be sufficiently clearly determined. if the distinction between an intangible object and an act of its use is just a relative point, it is possible for the legislature to choose which connecting point should be the point of regulation. it might thus be assumed that there is a certain freedom to choose such a connecting point. accordingly, it is important to explore further the notion of a connecting point of regulation–– the point of equilibrium where efficiency can be achieved as much as possible but at the same time, the encroachments on other people’s liberty are kept at the minimum level possible. 13 tamura (2009). 14 nari lee, ‘the patent subject matter reconfiguration and the emergence of proprietarian norms: the patent eligibility of the business methods’ (14 october 2002) <http://ssrn.com/abstract=400100> accessed 4 september 2012. http://ssrn.com/abstract=400100 nordic journal of commercial law issue 2012#2 6 there are different types of regulatory regimes. for instance, antonina bakardjieva engelbrekt, among others, puts forward four types or methods of regulations and institutional arrangements: market, legislation, administration and judiciary.15 based on the traits or nature of individual institutions, it is possible to make an institutional choice with regard to the respective method of regulation. as i have pointed out several times elsewhere, if it is very difficult to verify the efficiency of choosing a particular institution from all available ones, it is not important only to strive for legitimacy of the substance of such regulation, but it is more crucial to explore the possibility of seeking its legitimization by the process of its adoption. at the same time, it should be pointed out that institutional choice has several problems. one of them faced by the democratic decision-making process is a so-called collective action problem. neil komesar identifies two main collective action problems: the minoritarian bias and the majoritarian bias.16 in addition to them, the democratic decision-making process––put in other words, the legislative procedure––also has to face other particular problems. although it has not been used so many times in the japanese academic circles, i agree with komesar that the market is also one significant method of democratic participation, similar to the legislative, administrative and judiciary procedures.17 one of the reasons why i am going now to focus quite a lot on the idea of market as one of possible participation methods is that the market has been largely ignored in academic circles with regard to the need to protect intellectual property rights. although i might sound too pro-market oriented, i am doing so just to introduce the idea of using the market in this context. i borrow this idea from friedrich von hayek. he suggests that the principle of the market is always inevitably accompanied by the idea of liberty.18 put in other words, if the market choice functions properly, the decision-making process does not get controlled by a specific individual or group of people. therefore, the individuals are free of any dominance and control by other persons. in this sense, the concept of liberty is inherently embodied in the principles of the market. returning to intellectual property rights, i think that their conceptualization as rights to intellectual creations is accompanied with severe risks. as stressed several times before,intellectual property rights are rights that restrict other persons’ freedom. due to their freedom-restricting or sometimes even freedom-inhibiting character, the property institutions and the grant and extension of property rights over intellectual works have to be modest and 15 antonina bakardjieva engelbrekt, ‘copyright from an institutional perspective: actors, interests, stakes and the logic of participation’ (2007) 4(2) rev. of economic research on copyright issues 65. 16 neil k. komesar, imperfect alternatives: choosing institutions in law, economics, and public policy (university of chicago press 1994) at ch 3. 17 komesar (1994) at 7-8. 18 f. a. hayek, ‘liberalism’ in new studies in philosophy, politics, economics and the history of ideas (routledge & kegan paul ltd 1978) at 136-137. nordic journal of commercial law issue 2012#2 7 cautious. one result of minoritarian bias in intellectual property policy making is that the rights tend to be extended or to become excessively strong. in this regard, e.g. the collecting societies play a significant role in keeping and expanding the exclusive rights they manage. however,attention also needs to be drawn to the fact that once the institutions are formed, extended or strengthened, they often stay that way for a long time. 5 advantages of a market-driven approach to intellectual property laws based on all the previous observations, i will try to argue for a market-driven approach towards intellectual property regulation. one conclusion based on the above is that intervention by law can be allowed, even if it restricts the freedom of others, as long as the interference is kept at a minimum. as the distinction between the intangible object and its use are only relative, the connecting point of regulation does not necessarily need to be static. there is, therefore, a certain room to choose between connecting points that could constitute the points of regulation. it is not necessary to tie the use of intellectual works or legal protection to the intellectual work itself. furthermore, the market plays a significant role of participation in the decision-making process just like the legislation, administration and judiciary. if all the four points are taken into consideration, it is not the act of use or the object of intellectual creation which should be regulated by law, but the market environment where such intellectual creation emerges and is exploited. regulation of that market environment could be one possible alternative. the regulation of the market environment is often viewed as the domain of competition (antitrust) law. in japan, antitrust law belongs under the authority of the fair trade commission. nevertheless, one of the recent trends which can also be observed in japan is that many entities attempt to enforce antitrust law violations through private litigation. this can lead to the emergence of an interfacing area between antitrustlaw and intellectual property law type of enforcement. that is also the reason why i employ a slightly flexible categorization of law concerning particular competitive activities, including those regulated under intellectual property law, unfair competition law, antitrust law and civil law. accordingly, intellectual property laws should be divided to two types. the first one is an incentive-creating type of property law, since it creates incentives that do not exist on the market.19 however, it should be noted that there exists another type of intellectual property laws that does not simply create the necessary incentives, but which also supports the incentives already existing on the market. this type of intellectual property laws should also be taken into consideration. 19 yoshiyuki tamura, chiteki zaisan hō (intellectual property law) (5th ed, yuhikaku 2010) at 16-21. nordic journal of commercial law issue 2012#2 8 as an example of the second type of intellectual property law—the incentive-supporting type of intellectual property law—i will give you an example of regulation by the trademark and unfair competition prevention laws in japan. although some might think—and common sense might lead you to presume this to be the case—that the aim of trademark law is the protection of marks, the law itself does not protect the process or development of marks, contrary to copyright or patent law with regard to the work of authorship or invention respectively. one can look at trademark law as the second type of intellectual property law—the incentive-supporting type of intellectual property law. by regulating the acts of passing off, it supports the cluster of incentives that already exist in the market, such as an incentive for quality control including the improvement of service quality, or the improvement in general. hence, trademark law and passing off can also be characterized in this way. in this case, what the law aims to promote is not the mark as an object of protection, i.e. an intangible object, but the general improvement and maintenance of quality in terms of goods or services. the law therefore does not interfere with the market. it is left to the market to decide exactly what type of product or service should be developed under the goodwill and the incentives created and supported by law. engelbrekt argues that the traditional copyright protection is horizontal protection, since it does not distinguish between individual types of protected intellectual works. she also points out that when the protection is horizontal, it does not easily become the target of lobbying activities.20 therefore, if some incentive-creating intellectual property laws can be designed as horizontal protection regulations, the incentive-supporting type of intellectual property laws must be seen as horizontal even on a broader level, because what the law aims to regulate is something completely different from what the law actually protects. another example can be the ban on a slavish imitation of product configuration.21 i guess that this regulation is rather less horizontal because it focuses on more concrete and specific information. one of the reasons why i use the slavish imitation regulation as an example is that it is a bit different from the usual kinds of intellectual property laws, where the subject matter of protection is the same thing—what the law protects is the same thing as what law aims to protect. in the case of slavish imitation regulation in japan, what law protects and what the law aims to protect are two different things. slavish imitations do not require a creative value of commercial products at all. the protection against slavish imitation is granted regardless of any creative value of the actual products. the objective of the law is not to support the incentives based on the monopoly, which already 20 eengelbrekt (2007) at 73-74. 21 yoshiyuki tamura, ‘shōhin keitai no deadcopy kisei no dōkō (trends of regulation against imitating the configuration of goods)’ (2009) 25 intellectual property l. & policy j. 33, available at <http://www.juris.hokudai.ac.jp/gcoe/journal/ip_vol25/25_2.pdf> accessed 4 september 2012. http://www.juris.hokudai.ac.jp/gcoe/journal/ip_vol25/25_2.pdf nordic journal of commercial law issue 2012#2 9 exists on the market, by regulating or prohibiting the slavish imitation or exact copying of commercial products regardless of the type of commercial product. conversely, the law protects the incentives to acquire market share. it protects and supports such incentives. what the law wants to promote is not the intangible object, which would be the actual configuration of commercial product. what the law actually aims to promote is the actual act of its development. again, the law here does not interfere with what exactly gets developed under this incentive system. it is left to the market to decide. one of the legal scholars, shigeaki mitsuda, heavily criticized this law.22 he argued that the logic of the law did not make any sense at all from the then contemporary legal concepts. my belief was that the main consideration made by the law did not focus on the individual interests of would-be plaintiffs and defendants, since their interests could considerably differ from one case to another. on the contrary, by regulating an actual act of slavish imitations, the long-term benefits to society could be gained. the law’s aim was based exactly on these considerations.23 returning back to mitsuda’s criticism, his criticism was actually on point. the law did not make any sense as part of the contemporary legal concepts referred to by mitsuda. now i would like to summarize the types of regulations that support the incentives. as already mentioned several times, the connecting point of regulation is a remote from the actual intellectual creation or intellectual work as an intangible object in the case of this type of intellectual property laws. the result is that the actual creative works or certain types of creative works that get developed are all decided by the market. the merit in this type of regulation is that instead of lobbying during the legislative process, the decision-making is done by the market, where there is no such thing as lobbying. my approach presented here might be criticized on grounds that it is too market-oriented and can thus lead to some kind of market absolutism. but i would like to point out that my approach is, instead, market-driven. it considerably differs from the traditional market-oriented approaches. for example, a famous law-and-economics scholar, frank h. easterbrook, argues that if the right to property is created, the market will achieve efficiency24. however, i think that already at the time when the idea of granting the property rights to certain things is molded in the law and policy-making process, the biases exist in these processes. furthermore, once the property institutions are established, the actual transaction costs never equal zero. the actual extent of 22 shigeaki mitsuda, ‘sekai no chitekizaisanken no harmonization no dōkō kara mita konkai no kaisei no ichiduke (symposium: the new unfair competition act examined in light of the harmonizing tendencies of national, foreign and international unfair competition law development)’ (1994) 18 annual of industrial property l. 65. 23 yoshiyuki tamura, ‘tanin no shōhin no mohōkōi to fuseikyōsōbōshihō (imitation of others’ commercial goods and unfair competition prevention law’ (1993) 1018 jurist 24. 24 frank h. easterbrook, ‘cyberspace and the law of the horse’ (1996) 1996 university of chicago legal forum 207, 209-210. nordic journal of commercial law issue 2012#2 10 transaction costs can significantly affect the efficiency of redistributing the granted rights by the market. consequently, the market-driven approach discussed above considers the cost of instituting the property institution itself, and the division of roles between the market and the legislation. the inherent searching for an adequate and proper division of roles between the market and the legislation entirely supports the idea of amarket-driven approach. 6 conclusion it is generally argued that the actual active justification for intellectual property rights should be based on an improvement in efficiency. as it is often difficult to verify efficiency, the actual substantive improvement of efficiency by the law should not be the only basis of law and policymaking, but the main aim should be that the actual process of policy making will lead to the improvement in efficiency. improving the actual process may be even a better way of achieving the legitimacy of the whole intellectual property law system. however, due to the biases in the law-making process, to overcome this ambivalence between the law and policy-making process and the substance of the law should be one of the main targets of any research on the justification of intellectual property laws. although this essay has mainly focused on the division of roles between the law and the market and on the legitimization of the law and policy-making process, it should be pointed out that there are still the administration and judiciary which have a huge impact on the operation, implementation and enforcement of law. this might be the case of patentability requirements in patent law, where the legislation only sets up the standard’s scope in general terms. it is left to administrative agencies and the judiciary to concretize the actual legal requirements through interpretation. in cases of this sort, the crucial point is to choose an institution that is not susceptible to lobbying activity, such as an administrative agency or the judiciary. contracts, risks and management = contractual risk management nordic journal of commercial law issue 2012#2 the treatment of cisg article 79 in german courts: halting the homeward trend by peter mazzacano nordic journal of commercial law issue 2012#2 1 1. introduction the un convention on contracts for the international sale of goods (“cisg”)1 has played a preeminent role in german jurisprudence. this is a fortunate development towards the harmonization of international sales law. this development bucks the “homeward trend” which has plagued a number of signatory states.2 this is a small, but important, step towards a conceptual goal of functional uniformity in a body of international commercial law. as a review of german case law demonstrates, while excuses for non-performance in article 79 may have developed out of variants of similar domestic legal principles, it ultimately stands alone as an autonomous international doctrine under the cisg. this suggests that the unique development of article 79 in separate and distinct legal jurisdictions, such as germany, may ultimately evolve into an autonomous international norm. it further supports the notion that article 79 is capable of creating relative uniformity within the context of the cisg’s goal for a sales law that is transnational in design. article 79 states: (1) a party is not liable for a failure to perform any of his obligations if he proves that the failure was due to an impediment beyond his control and that he could not reasonably be expected to have taken the impediment into account at the time of the conclusion of the contract or to have avoided or overcome it or its consequences. (2) if the party's failure is due to the failure by a third person whom he has engaged to perform the whole or a part of the contract, that party is exempt from liability only if: (a) he is exempt under the preceding paragraph; and (b) the person whom he has so engaged would be so exempt if the provisions of that paragraph were applied to him. (3) the exemption provided by this article has effect for the period during which the impediment exists. (4) the party who fails to perform must give notice to the other party of the impediment and its effect on his ability to perform. if the notice is not received by the other party within a reasonable time after the party who fails to perform knew or ought to have known of the impediment, he is liable for damages resulting from such non-receipt. (5) nothing in this article prevents either party from exercising any right other than to claim damages under this convention. 1 united nations convention on contracts for the international sale of goods, april 11, 1980, 1489 u.n.t.s. 3, 19 i.l.m. 671, hereinafter cited as the “cisg” or “convention.” 2 the “homeward trend” is that tendency of jurists to project domestic law and national legal concepts onto the international provisions of the cisg. the homeward trend has been especially noticeable in the states of belgium, canada, russia, and the united states. nordic journal of commercial law issue 2012#2 2 2. the evolution of excuses for non-performance: from wegfall der geschäftsgrundlage to an international norm the theory of excuse for contractual non-performance has a long history in germany. this development in law reflects the history and fate of that nation, as well as its civil law tradition. under the influence of roman law, many european states came to recognize the principle of initial impossibility, impossibilium non est obligato.3 in continental europe in the seventeenth and eighteenth centuries, legal scholars further developed this principle, and contracts were to be considered concluded under the implied condition that there would be no fundamental change in the circumstances under which the agreement had been completed.4 this became known as the doctrine of an implied clausula rebus sic stantibus, and was codified in certain jurisdictions.5 over the course of the nineteenth century, the doctrine of implied conditions experienced a number of modifications, but the most substantial revision occurred in 1921, under the influence of the currency inflation crisis.6 at that time, the former reichsgericht applied the doctrine of changed circumstances (rebus sic stantibus) to cases of economic hardship in longterm contracts when inflation threatened to prove disastrous for parties in the aftermath of world war i.7 in 1923, rebus sic stantibus and the concept of the lapse of the contractual basis were codified into the legal doctrine of wegfall der geschäftsgrundlage, which was then used by german courts to decide cases of hardship and impracticability.8 in the civilian tradition, courts had the option of either terminating or revising contracts when the balance of the contract had significantly changed due to unforeseeable events. in the revised german civil code of 2002, bgb section 313 has modified slightly the doctrine of wegfall der geschäftsgrundlage. under the modified title of storung der geschäftsgrundlage, which means “interference with the basis of the contract”, bcb s. 313 now incorporates the principles of rebus sic stantibus, which amounts to hardship, as well as the doctrine of absolute impossibility.9 this extended the existing doctrines beyond the sphere of frustration or impossibility, to situations where unexpected changes in circumstances had simply made performance more onerous for one party. in this respect, bcb s. 313 bares some semblance to cisg article 79. the liberal approach towards excuses for nonperformance under german law may also explain why jacob ziegel stated that article 79 is 3 e.j. cohn, “frustration of contract in german law” (1946) 28 j. comp. legis. & int’l l. 3d 15 at 15. 4 ibid. at 19. 5 ibid. at 19-20. 6 leo m. drachsler, “frustration of contract: comparative law aspects of remedies in cases of supervening illegality” (1957) 3 n.y.l.f. 50 at 71. 7 christoph brunner, force majeure and hardship under general contract principles (the netherlands: wolters kluwer, 2009) at 79 [brunner]. 8 ibid. 9 ibid. nordic journal of commercial law issue 2012#2 3 “more civilian than common law in its conception”.10 however, this is a simplification. while german law is thought to be generally in harmony with some of the most liberal articles of the cisg, other civilian jurisdictions, such as france, employ relatively strict rules to excuse nonperformance. 11 as suggested by the historical development in german law, the approach to the principle of excuses for contractual non-performance is relatively liberal, even by civilian standards. for example, a strict application of the rule of pacta sunt servanda is rarely invoked.12 this flexible approach is partially the result of the german historical experience of the last century. during that time, the country has been subjected to severe social and political upheavals. its economy has been ravaged by two major wars, it had witnessed rampant currency inflation and revaluation, and it has had to reabsorb and restructure the economic system of the former german democratic republic. under such conditions, the certainty and dependability of commercial contractual performance was often in doubt. impossibility of performance, hardship, or frustration, have been constant risks in the commercial life of the modern german nation. not surprisingly, these events have had a profound influence on the development and legal treatment of excuses for contractual non-performance in that nation. 3. article 79 in germany: general observations there are some interesting facts concerning the evolution of article 79 case law in germany. with the exception of arbitral cases from cietac, even though germany has reported more article 79 cases than any other cisg signatory state, this amounts to only 18 cases from that country that are considered in this article. an overview of article 79 demonstrates that parties may frequently resort to this provision as a defence, but they are rarely successful.13 this may 10 jacob s. ziegel, “analysis from a provincial common law perspective” in ziegel and claude samson, report to the uniform law conference of canada on convention on contracts for the international sale of goods, (toronto: uniform law conference, 1981) 33-167.at “article 79” para. 2. ziegel’s statement, however, detracts from the approach taken by article 79, which stands as a compromise between the different legal approaches taken towards excuses for non-performance in civil law and common law. 11 dionysios p. flambouras, “the doctrines of impossibility of performance and clausula rebus sic stantibus in the 1980 vienna convention on contracts for the international sale of goods and the principles of european contract law: a comparative analysis” (2001) 13 pace int’l l. rev. 26 at 262 [flambouras, “the doctrines of impossibility”]. 12 joern rimke, “force majeure and hardship: application in international trade practice with specific regard to the cisg and the unidroit principles of international commercial contracts” in pace int’l l. rev., ed., pace review of the convention on contracts for the international sale of goods (1999-2000), (boston: kluwer law international, 2001) at 207 [rimke]. 13 according to cisg-ac opinion no. 7, “exemption of liability for damages under article 79 of the cisg” at 4: “article 79 has been invoked in litigation and arbitration by sellers and buyers with limited success”. rapporteur: professor alejandro m. garro, columbia university school of law, new york, n.y., usa. see also united nations commission on international trade law (uncitral), uncitral: nordic journal of commercial law issue 2012#2 4 suggest that the standards established under article 79 are set relatively high, particularly relative to equivalent domestic law. for example, of the 18 german cases involving article 79 considered here,14 there is only one instance where the successful party invoked that provision to its advantage.15 even in that case, article 79 was not the primary cisg article relied upon by the party; rather, it used article 79 only to excuse it for a delay in payment.16 it ultimately won digest of case law on the united nations convention on the international sale of goods (new york: un, 2008) at 253: “article 79 has been invoked with some frequency in litigation, but with limited success” [uncitral: digest of case law]. 14 in chronological order, from the most recent german case to the earliest, these are: oberlandesgericht [olg] [appellate court] brandenburg, 18 november 2008, 6 u 53/07 [beer case], online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/081118g1.html>; oberlandesgericht [olg] [appellate court] münchen, 5 march 2008, 7 u 4969/06 [stolen car case], online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/080305g1.html>; oberlandesgericht [olg] [appellate court] hamburg, 25 january 2008, 12 u 39/00 [café inventory case], online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/080125g1.html>; bundesgerichtshof [bgh] [federal supreme court], 27 november 2007, x zr 111/04 [glass bottles case], online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/071127g1.html>; oberlandesgericht [olg] [appellate court] dresden, 21 march 2007, 9 u 1218/06 [stolen automobile case], online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/070321g1.html>; oberlandesgericht [olg] [appellate court] zweibrücken, 2 february 2004, 7 u 4/03 [milling equipment case], online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/040202g1.html>; landgericht [lg] [district court] freiburg, 22 august 2002, 8 o 75/02 [automobile case], online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/020822g1.html>; bundesgerichtshof [bgh] [federal supreme court], 9 january 2002, viii zr 304/00 [powdered milk case], online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/020109g1.html>; oberlandesgericht [olg] [appellate court] hamm, 12 november 2001, 13 u 102/01 [memory module case], online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/011112g1.html>; bundesgerichtshof [bgh] [federal supreme court], 24 march 1999, viii zr 121/98 [vine wax case], online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/990324g1.html>; oberlandesgericht [olg] [appellate court] hamburg, 4 july 1997, 1 u 143/95 and 410 o 21/95 [tomato concentrate case], online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/970704g1.html>; oberlandesgericht [olg] [appellate court] hamburg, 28 february 1997, 1 u 167/95 [iron molybdenum case], online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/970228g1.html>; oberlandesgericht [olg] [appellate court] köln, 21 may 1996, 22 u 4/96 [used car case], online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/960521g1.html>; landgericht [lg] [district court] ellwangen, 21 august 1995, 1 kfh o 32/95 [spanish paprika case], online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/950821g2.html>; amtsgericht [ag] [lower court] alsfeld, 12 may 1995, 31 c 534/94 [flagstone tiles case], online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/950512g1.html>; landgericht [lg] [district court] berlin, 15 september 1994, 52 s 247/94 [shoes case], online: pace law school cisg database <http://www.cisg.law.pace.edu/cases/940915g1.html>; landgericht [lg] [district court] münchen, 2 august 1994, 13 hko 17330/93 [copper and nickel cathodes case], online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/940802g1.html>; and landgericht [lg] [district court] aachen, 14 may 1993, 43 o 136/92 [hearing aid case ], online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/930514g1.html>. 15 the successful invocation of article 79 in germany was in the shoes case, supra note 14. 16 ibid. http://cisgw3.law.pace.edu/cases/081118g1.html http://cisgw3.law.pace.edu/cases/080305g1.html http://cisgw3.law.pace.edu/cases/080125g1.html http://cisgw3.law.pace.edu/cases/071127g1.html http://cisgw3.law.pace.edu/cases/070321g1.html http://cisgw3.law.pace.edu/cases/040202g1.html http://cisgw3.law.pace.edu/cases/020822g1.html http://cisgw3.law.pace.edu/cases/020109g1.html http://cisgw3.law.pace.edu/cases/011112g1.html http://cisgw3.law.pace.edu/cases/990324g1.html http://cisgw3.law.pace.edu/cases/970704g1.html http://cisgw3.law.pace.edu/cases/970228g1.html http://cisgw3.law.pace.edu/cases/960521g1.html http://cisgw3.law.pace.edu/cases/950821g2.html http://cisgw3.law.pace.edu/cases/950512g1.html http://www.cisg.law.pace.edu/cases/940915g1.html http://cisgw3.law.pace.edu/cases/940802g1.html http://cisgw3.law.pace.edu/cases/930514g1.html nordic journal of commercial law issue 2012#2 5 the case based upon receipt of the seller’s non-conforming goods (in violation of cisg article 35).17 another interesting point is that the plaintiffs’ won 13 of the 18 cases.18 this suggests that plaintiffs commence cisg litigation only where the likelihood of success weighs in their favour. based on these cases, a defendant’s prospect for a successful article 79 defence would appear to be small. indeed, of the 27 article 79 cases recorded in the uncitral digest,19 only four parties successfully utilized article 79 to limit their damages.20 it also appears that disputes involving non-conforming goods and article 79 are a common theme in this jurisprudence. perhaps this should not come as a surprise, as most sale of goods disputes arise over the issue of whether the product conforms to the contract description.21 six of the 18 german cases analyzed involve a primary dispute over non-conforming goods, in addition to the article 79 defence.22 of course, issues of non-conforming goods exist in some of the remaining german cases, but product non-conformity is not central to those disputes. 4. the pre-eminent treatment of article 79 in germany german courts have been pre-eminent in their treatment of the cisg. many of the decisions were the first in which a supreme court of a signatory state has ruled on specific cisg provisions.23 not surprisingly, therefore, courts in other cisg states have often relied on german rulings.24 as magnus notes, “decisions of the bundesgerichtshof [federal supreme court] 17 ibid. 18 the 13 successful plaintiff actions are: electronic hearing aid case, cathodes case, flagstone tiles case, chinese goods case, used automobile case, iron molybdenum case, vine wax case, powdered milk case, used automobile ii case, milling equipment case, stolen automobile case, stolen car case, and the beer case. ibid. 19 supra note 14. 20 according to uncitral, the four successful parties were two sellers and two buyers. they are, in respective order: tribunal de commercial [trib. com.] besançon, 19 january 1998, flippe christian v. douet sport collections, online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/980119f1.html> [flippe christian]; handelsgericht [hg] [commercial court] zürich, 10 february 1999, hg 970238.1 [art books case], online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/990210s1.html>; tribunal of international commercial arbitration, russian federation chamber of commerce and industry, 22 january 1997, award 155/1996 [butter case], online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/970122r1.html>; and, shoes case, supra note 14. 21 see e.g. john o. honnold, uniform law for international sales under the 1980 united nations convention, 4th ed., harry flechtner, ed., (netherlands: kluwer law international, 2009) at 328 [honnold, uniform law for international sales under the 1980 united nations convention]. honnold states: “most sales controversies grow out of disputes over whether the goods conform to the contract”. 22 the six cases are: shoes case, spanish paprika case, used automobile i case, vine wax case, powdered milk case, and the milling equipment case, supra note 14. 23 ulrich magnus, “cisg in the german federal civil court” in franco ferrari, ed., quo vadis cisg? (munich: sellier european law publishers, 2005) 143 at 211 [magnus, “cisg in the german federal civil court”]. 24 ibid. at 3ff. magnus provides three case examples, from the united states, switzerland, and italy. http://cisgw3.law.pace.edu/cases/980119f1.html http://cisgw3.law.pace.edu/cases/990210s1.html http://cisgw3.law.pace.edu/cases/970122r1.html nordic journal of commercial law issue 2012#2 6 have internationally paved the way in the interpretation and application of the cisg”.25 overall, the country is the most active adjudicator of cisg issues. according to unilex,26 germany has played a leading role in the interpretation of the cisg, ruling on 205 cases since the convention’s inception.27 this represents more than one-quarter (just over 26 percent) of cisg case law world-wide.28 switzerland is the next largest adjudicator of the cisg, having ruled on 80 cases.29 magnus similarly notes that “[n]o wonder, that the first cisg cases published by uncitral in its databank clout [case law on uncitral texts] were seven german decisions […] and in 2000 one third of the 600 clout cases were of german origin”.30 germany has also played a leading role in cases that touch on article 79 issues. the pace law school cisg website database records a total of 128 cases from a variety of signatory states and arbitral panels that mention article 79.31 some of these cases only touch upon article 79 in a marginal manner. however, of all the article 79 cases listed on the pace cisg database, germany leads in article 79 jurisprudence, having decided 18 of these cases. uncitral cites only 27 cases from all jurisdictions (signatory state courts and arbitral decisions) in its 2008 digest of article 79 case law.32 however, the pace cisg database is more current and comprehensive in scope. its only disadvantage is that it also includes cases that mention article 79 in a minor or peripheral manner. based on the pace cisg database, excluding arbitral decisions, german courts lead other signatory states in their interpretation of this article, having decided 18 cases.33 as in cisg case law generally, switzerland is the second-largest adjudicating state following germany, with nine decisions involving article 79.34 it is 25 ibid. at 211. 26 unilex is database of international case law and bibliography on the cisg and the unidroit principles of international commercial contracts. it is operated by the centre for comparative and foreign law studies, which is a joint venture between the italian national research council, the university of rome i “la sapienza”, and the international institute for the unification of private law (unidroit). see unilex online: <http://www.unilex.info>. 27 unilex online: <http://www.unilex.info/dynasite.cfm?dssid=2376&dsmid=13354&x=1> (as of december 3, 2010). note that the unilex database lags significantly behind the pace law school cisg database on reported cases. 28 as of december 3, 2010, the total number of cisg cases reported by unilex is 784. 29 unilex, online: <http://www.unilex.info/dynasite.cfm?dssid=2376&dsmid=13354&x=1> (as of december 3, 2010). 30 ulrich magnus, “general principles of un-sales law” in franco ferrari, ed., the cisg and its impact on national legal systems, (1997) 3 int’l trade & bus. l. ann. 33 at 143 [magnus, “general principles of un-sales law”]. 31 as of june 10, 2010, according to the pace law school cisg database, online: <http://www.cisg.law.pace.edu/cisg/text/case-annotations.html>. 32 uncitral: digest of case law, supra note 13 at 252-261. these cases are listed at supra 14. 33 ibid. not all of these cases have english translations, and some only refer to article 79 in minor ways. for a list of the 18 german cases see supra, note 14. 34 ibid. http://www.unilex.info/ http://www.unilex.info/dynasite.cfm?dssid=2376&dsmid=13354&x=1 http://www.unilex.info/dynasite.cfm?dssid=2376&dsmid=13354&x=1 http://www.cisg.law.pace.edu/cisg/text/case-annotations.html nordic journal of commercial law issue 2012#2 7 noteworthy that certain arbitral organizations have also been active in article 79 adjudication. the china international economic and trade arbitration commission (cietac) has considered 26 cases35 on the article, and in russia, 25 arbitral cases36 have decided issues that have dealt with article 79 to some degree. 35 china international economic and trade arbitration commission (cietac) arbitration award, may 2007 [cisg 2007/06] [hammer mill case], online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/070500c1.html>; cietac arbitration award, 7 december 2005 [cisg/2005/05] [heaters case], online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/051207c1.html>; cietac arbitration award, 25 may 2005 [cisg 2005/09] [iron ore case], online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/050525c1.html>; cietac arbitration award, 17 september 2003 [cisg 2003/14] [australia cotton case], online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/030917c1.html>; cietac arbitration award, 26 june 2003 [cisg 2003/10] [alumina case], online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/030626c1.html>; cietac arbitration award, 21 october 2002 [cisg 2002/16] [engraving machine case], online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/021021c1.html>; cietac arbitration award, 9 august 2002 [cisg 2002/21] [yellow phosphorus case], online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/020809c1.html>; cietac arbitration award, 4 february 2002 [cisg 2002/17] [steel bar case], online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/020204c2.html>; cietac arbitration award, 25 december 2001 [cisg 2001/04] [dvd hifi case], online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/011225c1.html>; cietac arbitration award, 31 may 1999 [cisg/1999/27] [indium ingot case], online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/990531c1.html>; cietac arbitration award, 15 december 1998 [cisg/1998/09] [shirt case], online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/981215c1.html>; cietac arbitration award, 31 december 1997 [cisg/1997/37] [lindane case], online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/971231c1.html>; cietac arbitration award, 30 november 1997 [cisg/1997/33] [canned oranges case], online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/971130c1.html>; cietac arbitration award, 29 september 1997 [cisg/1997/28] [aluminium oxide case], online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/970929c1.html>; cietac arbitration award, 25 june 1997 [cisg/1997/16] [art paper case], online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/970625c1.html>; cietac arbitration award, 7 may 1997 [cisg/1997/11] [sanguinarine case], online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/970507c2.html> cietac arbitration award, 31 december 1996 [cisg/1996/58] [high carbon tool steel case], online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/961231c2.html>; cietac arbitration award, 30 july 1996 [cisg/1996/33] [ferro-molybdenum alloy case], online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/960730c2.html>; cietac arbitration award, 2 may 1996 [cisg/1996/21] [“femo” alloy case], online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/960502c1.html>; cietac arbitration award, 14 march 1996 [cisg/1996/14] [dried sweet potatoes case], online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/960314c1.html>; cietac arbitration award, 30 january 1996 [cisg/1996/05] [compound fertilizer case], online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/960130c1.html>; cietac arbitration award, 28 april 1995 [cisg/1995/08] [rolled wire rod coil case], online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/950428c1.html>; cietac arbitration award, 10 march 1995 [cisg/1995/04] [wool case], online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/950310c1.html>; cietac arbitration award, 17 june 1994 [cisg/1994/08] [warm rolled steel plates case], online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/940617c1.html>; cietac arbitration award, 7 august 1993 [cisg/1993/11] [semi-automatic weapons case], online: pace law school cisg database http://cisgw3.law.pace.edu/cases/070500c1.html http://cisgw3.law.pace.edu/cases/051207c1.html http://cisgw3.law.pace.edu/cases/050525c1.html http://cisgw3.law.pace.edu/cases/030917c1.html http://cisgw3.law.pace.edu/cases/030626c1.html http://cisgw3.law.pace.edu/cases/021021c1.html http://cisgw3.law.pace.edu/cases/020809c1.html http://cisgw3.law.pace.edu/cases/020204c2.html http://cisgw3.law.pace.edu/cases/011225c1.html http://cisgw3.law.pace.edu/cases/990531c1.html http://cisgw3.law.pace.edu/cases/981215c1.html http://cisgw3.law.pace.edu/cases/971231c1.html http://cisgw3.law.pace.edu/cases/971130c1.html http://cisgw3.law.pace.edu/cases/970929c1.html http://cisgw3.law.pace.edu/cases/970625c1.html http://cisgw3.law.pace.edu/cases/970507c2.html http://cisgw3.law.pace.edu/cases/961231c2.html http://cisgw3.law.pace.edu/cases/960730c2.html http://cisgw3.law.pace.edu/cases/960502c1.html http://cisgw3.law.pace.edu/cases/960314c1.html http://cisgw3.law.pace.edu/cases/960130c1.html http://cisgw3.law.pace.edu/cases/950428c1.html http://cisgw3.law.pace.edu/cases/950310c1.html http://cisgw3.law.pace.edu/cases/940617c1.html nordic journal of commercial law issue 2012#2 8 <http://cisgw3.law.pace.edu/cases/930807c1.html>; and cietac arbitration award, 6 june 1991 [date claim filed] shenzhen [cysteine monohydrate case], online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/910606c1.html>. 36 tribunal of international commercial arbitration, russian federation chamber of commerce and industry, 13 may 2008, award 13/2007, online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/080513r1.html>; tribunal of international commercial arbitration, russian federation chamber of commerce and industry, 15 november 2006, award 30/2006, online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/061115r2.html>; tribunal of international commercial arbitration, russian federation chamber of commerce and industry, 21 november 2005, award 42/2005 [equipment case], online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/051121r1.html>; tribunal of international commercial arbitration, russian federation chamber of commerce and industry, 9 april 2004, award 129/2003, online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/040409r1.html>; tribunal of international commercial arbitration, russian federation chamber of commerce and industry, 16 june 2003, award 135/2002, online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/030616r1.html>; federal arbitration court for the moscow region [appellate court], 4 february 2002 (rimpi ltd v. moscow northern customs department), online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/020204r1.html>; tribunal of international commercial arbitration, russian federation chamber of commerce and industry, 30 july 2001, award 198/2000, online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/010730r1.html>; tribunal of international commercial arbitration, russian federation chamber of commerce and industry, 6 june 2000, award 406/1998, online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/000606r1.html>; tribunal of international commercial arbitration, russian federation chamber of commerce and industry, 24 november 1998, award 96/1998, online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/981124r1.html>; tribunal of international commercial arbitration, russian federation chamber of commerce and industry, 6 october 1998, award 269/1997, online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/981006r1.html>; tribunal of international commercial arbitration, russian federation chamber of commerce and industry, 10 june 1998, award 83/1997, online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/980610r1.html>; high arbitration court of the russian federation, 16 february 1998, [information letter no. 29] [onions case], online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/980216r1.html>; tribunal of international commercial arbitration, russian federation chamber of commerce and industry, 12 january 1998, award 152/1996, online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/980112r1.html>; high arbitration court of the russian federation, 1997, [ruling no. 4, case 4], online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/970000r2.html>; tribunal of international commercial arbitration, russian federation chamber of commerce and industry, 11 june 1997, award 255/1994, online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/970611r1.html>; tribunal of international commercial arbitration, russian federation chamber of commerce and industry, 13 may 1997, award 3/1996, online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/970513r1.html>; tribunal of international commercial arbitration, russian federation chamber of commerce and industry, 11 may 1997, award 2/1995, online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/970511r1.html>; tribunal of international commercial arbitration, russian federation chamber of commerce and industry, 22 january 1997, award 155/1996 [butter case], online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/970122r1.html>; tribunal of international commercial arbitration, russian federation chamber of commerce and industry, 10 february 1996, award 328/1994, online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/960210r1.html>; tribunal of international commercial arbitration, russian federation chamber of commerce and industry, 13 december 1995, award 364/1994, online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/951213r1.html>; and tribunal of international commercial arbitration, russian federation chamber of commerce and industry, 1 december 1995, award 369/1994, online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/951201r1.html>. tribunal of international commercial arbitration, russian federation chamber of http://cisgw3.law.pace.edu/cases/930807c1.html http://cisgw3.law.pace.edu/cases/910606c1.html http://cisgw3.law.pace.edu/cases/080513r1.html http://cisgw3.law.pace.edu/cases/061115r2.html http://cisgw3.law.pace.edu/cases/051121r1.html http://cisgw3.law.pace.edu/cases/040409r1.html http://cisgw3.law.pace.edu/cases/030616r1.html http://cisgw3.law.pace.edu/cases/020204r1.html http://cisgw3.law.pace.edu/cases/010730r1.html http://cisgw3.law.pace.edu/cases/000606r1.html http://cisgw3.law.pace.edu/cases/981124r1.html http://cisgw3.law.pace.edu/cases/981006r1.html http://cisgw3.law.pace.edu/cases/980610r1.html http://cisgw3.law.pace.edu/cases/980216r1.html http://cisgw3.law.pace.edu/cases/980112r1.html http://cisgw3.law.pace.edu/cases/970000r2.html http://cisgw3.law.pace.edu/cases/970611r1.html http://cisgw3.law.pace.edu/cases/970513r1.html http://cisgw3.law.pace.edu/cases/970511r1.html http://cisgw3.law.pace.edu/cases/970122r1.html http://cisgw3.law.pace.edu/cases/960210r1.html http://cisgw3.law.pace.edu/cases/951213r1.html http://cisgw3.law.pace.edu/cases/951201r1.html nordic journal of commercial law issue 2012#2 9 from the outset of cisg jurisprudence in germany, the courts of that state have displayed a remarkable sensitivity to the interpretive requirements of the convention. this is no easy task. as enderlein and maskow stated, “the existence of different national legal systems impedes the development of international economic relations with complicated problems arising from the conflict of laws”.37 however, in germany, when the cisg was ratified in 1991, it did not represent an entirely new type of law. german courts already had practical experience with the predecessor laws to the cisg, the 1964 hague conventions, which had governed international sale of goods transactions there since 1974.38 rather than reflexively invoking domestic legal concepts, such as the national equivalent to article 79—the principle of wegfall der geschäftsgrundlage39—courts in germany have gone to great lengths to divorce themselves from the idiosyncrasies of domestic jurisprudence. as magnus stated, in a recent decision the german “federal supreme court felt the need to repeat the maxim of an international and autonomous interpretation of the cisg and underpinned that this kind of interpretation generally does not allow any redress to concepts developed under national law”.40 in doing so, they have assisted in the development of a separate, international legal doctrine into an autonomous principle. this is a small, but important, step towards a conceptual goal of functional uniformity in a body of international commercial law. in this way, the unique development of article 79 in separate and distinct legal jurisdictions may ultimately evolve into an autonomous international norm. german jurisprudence in commerce and industry, 17 october 1995, award 123/1992 [automatic diffractameter equipment case], online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/951017r1.html>. tribunal of international commercial arbitration, russian federation chamber of commerce and industry, 15 may 1995, award 321/1994, online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/950515r1.html>. tribunal of international commercial arbitration, russian federation chamber of commerce and industry, 16 march 1995, award 155/1994 [metallic sodium case], online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/950316r1.html>. tribunal of international commercial arbitration, russian federation chamber of commerce and industry, 17 november 1994, award 493/1993, online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/941117r1.html>. 37 fritz enderlein & dietrich maskow, international sales law (dobbs ferry ny: oceana publications, 1992) at 1, online: pace law school cisg database <http://www.cisg.law.pace.edu/cisg/biblio/enderlein.html#pref>. 38 convention relating to a uniform law on the international sale of goods, 834 u.n.t.s 107 (july 1, 1964) [hereinafter, ulis] and convention relating to a uniform law on the formation of contracts for the international sale of goods, 834 u.n.t.s 169 (july 1, 1964) [ulf]. 39 according to chengwei liu, wegfall der geschäftsgrundlage can be translated into english as “disappearance of the basis of the transaction”. see changed contract circumstances [2nd edition: case annotated update (april 2005)], online: pace law school cisg database <http://www.cisg.law.pace.edu/cisg/biblio/liu5.html>. similarly, theo rauh translates wegfall der geschäftsgrundlage into “destruction of the basis of the contract”. see “legal consequences of force majeure under german, swiss, english and united states’ law” (1996-1997) 25 den. j. int’l l. & pol’y 151 at 152. 40 magnus, “cisg in the german federal civil court”, supra note 23 at 156. http://cisgw3.law.pace.edu/cases/951017r1.html http://cisgw3.law.pace.edu/cases/950515r1.html http://cisgw3.law.pace.edu/cases/950316r1.html http://cisgw3.law.pace.edu/cases/941117r1.html http://www.cisg.law.pace.edu/cisg/biblio/enderlein.html%23pref http://www.cisg.law.pace.edu/cisg/biblio/liu5.html nordic journal of commercial law issue 2012#2 10 support of this proposition indicates that there has developed a generally cohesive body of case law exemplifying a functionally uniform and autonomous doctrine of excuses for nonperformance. this is substantiated by general consistency in the application of excuses for nonperformance, as well as by judicial deference to international case law and scholarly opinion when those courts decide cases under the cisg in general, and article 79 in particular. this is not to suggest, however, that all german court decisions are to be held as exemplary jurisprudential models of the proper application of the cisg. scrutiny of any jurisdictions’ case law will invariably reveal certain imperfections, and certainly, german jurisprudence is no exception. even magnus, in his assessment of the treatment of the cisg in german courts, noted that “in the first years after the cisg entered into force in germany a certain homeward trend of the lower courts could be observed which partly imported concepts of german domestic law into the interpretation of the cisg”.41 the context of the domestic legal environment can never be completely eradicated. as murray noted, any national court finds it difficult to “transcend its domestic perspective and become a different court that is no longer influenced by the law of its own nation state”.42 what is to be commended is an approach that results in functional uniformity of the convention, rather than absolute or strict uniformity, which is a practical impossibility.43 in this respect, german jurisprudence on the cisg generally succeeds. 5. article 79(1) impediments and non-conforming goods of all the cisg cases that find their way to court or arbitration, disputes concerning the nonconformity of goods are the most common.44 it is not surprising, therefore, to find case law at the juncture of non-conformity of goods and excuses for non-performance. as a prerequisite to an exemption, article 79(1) requires that a party’s failure to perform under the contract be due to an “impediment” that was beyond the party’s control, and that the party could not have reasonably taken it into account at the time of the conclusion of the contract. the issue of whether a party is successfully able to invoke article 79 when it has sold non-conforming goods 41 ibid. at 156. 42 j.e. murray, “the neglect of cisg: a workable solution” (1998) 17 j.l. & com. 365 at 367. 43 “functional uniformity” must be differentiated from “absolute” or “strict uniformity.” it is closer to the concept of “harmonization” in that the goal is to lessen the legal impediments to international trade. see larry a. dimatteo et al., the interpretive turn in international sales law: an analysis of fifteen years of cisg jurisprudence, 34 nw. j. int’l l. & bus. 299, 309-10 (2004). see also charles sukurs, harmonizing the battle of the forms: a comparison of the united states, canada, and the united nations convention on contracts for the international sale of goods, 34 vand. j. of transnat’l l. 1481, 1500-503 (2001) (sukurs utilizes the term “vertical uniformity,” which is similar to the concepts of “functional uniformity” or “harmonization”). 44 magnus, “general principles of un-sales law”, supra note 30 at 223, states: “delivery of non-conforming goods is the most common and frequent violation of sales contracts”. nordic journal of commercial law issue 2012#2 11 has been a matter of much scholarly debate.45 at one end of the debate is a liberal doctrine of excuse that attempts to seek fairness in the allocation of the costs of the unforeseen event between the parties.46 excuse for non-performance in german national law is closer to this liberal perspective.47 at the other end of the spectrum is a strict construction analysis that provides for very few conditions that will serve to excuse a party from performing.48 this latter approach is closer to the traditional pacta sunt servanda doctrine, and more consistent with the relatively rigid approach found in common law jurisdictions. there are also middle positions in this dichotomy, which attempt to apply various approaches, such as the “transaction test”, the “litigation test”,49 or the “better loss-bearer” approach.50 these intermediate approaches attempt to balance contractual justice with predictability and security of transactions. the earliest german case involving article 79 also concerned alleged non-conforming goods and an attempt to invoke article 79. the 1993 case51 involved the sale of hearing aids by a german seller (plaintiff) to an italian buyer (defendant). the latter party had refused to take delivery of the products, even though the seller had allowed the buyer an additional period of time to perform.52 from the outset of the court’s decision, it was unequivocal in its rejection of domestic law as governing the contract.53 the court held that the cisg was comprehensive enough in scope to cover all of the substantive issues under consideration. more importantly, it noted that the convention precluded recourse to domestic law, an approach that is mandated in article 7(1). accordingly, cisg articles 31(b)(c) and 60(b) dictated that the buyer was under an obligation to take delivery of the goods.54 that the buyer failed to do so entitled the seller to claim damages under articles 61(1)(b), 63, and 74-77. this was the correct approach. in terms of excuses for non-performance, the buyer invoked the domestic rules of impossibility, frustration, and hardship, which are all incorporated under the german principle of wegfall der geschäftsgrundlage, and attempted to apply these rules as a defense from the acceptance of non 45 see generally ronald a. brand, “article 79 and a transactions test analysis of the cisg” in franco ferrari, harry flechtner, & ronald a. brand, eds., the draft uncitral digest and beyond: cases, analysis and unresolved issues in the u.n. sales convention (munich: sellier european law publishers, 2004) at 395-397 [brand]. 46 ibid. . brand notes that john henry schlegel is representative of the “liberal” approach. 47 ibid. 48 ibid. brand sees harold j. berman as representative of the “strict” approach. 49 the “transaction test” and “litigation test” are discussed by brand, ibid. 50 for an overview of the “economic analysis of frustration” and the “better loss-bearer” approach, see generally michael g. rapsomanikas, “frustration of contract in international trade law and comparative law” (1980) 18 duq. l. rev. 551 at 568-570 [rapsomanikas]. 51 hearing aid case, supra note 14. note that german case citations do not name the parties to the proceedings. 52 ibid. at para. 4. 53 ibid. at para. 2(d), 54 hearing aid case, supra note 14 at paras. 2, 3 and 4. nordic journal of commercial law issue 2012#2 12 conforming goods.55 more specifically, the buyer attempted to avoid the contract by claiming that the hearing aids were not suitable for resale because a domestic regulation banned the sale of the products in question.56 in domestic law the modification or avoidance of a contract owing to wegfall der geschäftsgrundlage is connected to the notion of good faith.57 it would be considered bad faith to require a party to perform when the circumstances surrounding the basis of the contract have become highly unbalanced. however, the temptation of the court to apply a domestic rule over article 79 was avoided. the court was resolute in its application of the cisg. in rendering its decision, the court determined that “hardship” was covered by article 79, and the issue was, in its opinion, settled in the convention. accordingly, the court had no reason to look beyond the text of cisg to either domestic law or elsewhere in order to fill possible gaps in the convention. it rejected the more liberal domestic rule of wegfall der geschäftsgrundlage. instead, the court stated that “[r]ules of frustration or economic hardship (wegfall der geschäftsgrundlage) under domestic law or domestic law challenges having to do with mistake as to the quality of the goods are irrelevant, because the cisg fills the field in these areas”.58 it is noteworthy that the court’s reference to the impediment under article 79 negated an analysis under the domestic concepts of “frustration” and “economic hardship”. the implication is that article 79 stands alone, and is differentiated from similar domestic concepts, and is uniquely able to address the matter in question.59 a number of other german cases involved the alleged delivery of non-conforming goods and article 79. in the shoes case, the defendant buyer ordered shoes from an italian seller.60 the buyer refused to pay the full amount of the invoice on the basis that a portion of the goods were defective and non-saleable. the seller commenced an action for the balance due plus interest. ruling in favor of the buyer, the lower court61 noted that the defendant had given proper notice of the defective goods in accordance with cisg article 39(1), and denied the seller’s claim. the appeal court upheld the decision.62 both courts analyzed the facts of the case within the context of the cisg without any explicit references to domestic law. both courts agreed that the buyer was entitled to declare partial avoidance of the contract in accordance 55 ibid. at para. 2(d). 56 vivian grosswald curran, “the interpretive challenge to uniformity” (1995) 15 j.l. & com. 175 at 181 [curran]. 57 denis tallon, “article 79” in bianca-bonell, eds., commentary on the international sales law (milan: dott. a giuffre editore, s.p.a., 1987) at 593-594 [tallon]. 58 shoes case, supra note 14 at para. 2(d). 59 contra scott d. slater, “overcome by hardship: the inapplicability of the unidroit principles’ hardship provisions to cisg” (1998) 12 fla. j. int’l l. 231 at 257 [slater]. 60 shoes case, supra note 14. 61 amtsgericht [ag] alsfeld, see ibid. 62 landgericht [lg] [district court] berlin, supra note 14. nordic journal of commercial law issue 2012#2 13 with cisg articles 49(1)(a) and 51(1), as the non-conformity of part of the goods sold constituted a fundamental breach of the contract by the seller. the appeal court further held that the buyer’s offer to make restitution of the goods was an unmistakable declaration of its intention to avoid the contract, per cisg article 26.63 its attempt to try to resell the defective goods after the declaration of partial avoidance was considered to be an attempt to mitigate the damages in accordance with article 77, and not as an implicit waiver of its right to rely on the lack of conformity. considering this relatively sophisticated analysis of the cisg, at the end of its judgment, the lower court invoked article 79 in a peculiar manner. one must question whether the court made a typographical error, but if it did, the appeal court did not make a correction. the lower court stated that “[p]ursuant to art. 79(1) cisg, the buyer is not liable for the delayed payment as it could not reasonably be expected to pay immediately for defective goods the seller did not want to take back without either an agreement in this respect or without having tested the possibility of selling the goods despite their described defects”.64 this reference to article 79 appears to be out of context. equally perplexing is the court’s next statement that “[t]he buyer has also communicated to the seller the reason for its late payment (art. 79(4) cisg)”.65 article 79(4) requires that a party who fails to perform give notice to the other party of the impediment, and its effect on its ability to perform. if the notice is not received by the other party within a reasonable time after the party who fails to perform knew, or ought to have known, of the impediment, the non-performing party is liable for damages resulting from the failure of the notice to be received by the other party. considering the context of this reference, the court’s invocation of article 79 does not appear to be an error. it is possible that the buyer relied on article 79 to some extent in its submissions to the court. however, there is no reference in the decision to the buyer’s argument that it had relied on article 79 as an excuse for its delayed partial payment, and notice of such, to the seller. rather, the buyer refused to pay the full purchase price because the goods were defective, and it could not re-sell them. it likely invoked article 79 without realizing that it was not the appropriate provision for this argument. in any event, the seller refused to accept a return of the non-conforming portion of the shipment. these are the reasons addressed in the court’s decision; there is no mention of a failure to pay due to an “impediment” beyond the buyer’s control. the spanish paprika case also involved an argument over non-conforming goods, partial nonpayment, and the invocation of article 79.66 the seller brought an action against the buyer for 63 article 26 states: “a declaration of avoidance of the contract is effective only if made by notice to the other party». 64 landgericht [lg] [district court] berlin, supra note 14. both the english translation of the judgment and the german version make this reference to cisg article 79. for the original language (german) decision see: cisgonline.ch <http://www.cisg-online.ch/cisg/urteile/399.htm>; and, unilex database <http://www.unilex.info/case.cfm?pid=1&do=case&id=218&step=fulltext>. 65 ibid. 66 spanish paprika case, supra note 14. http://www.cisg-online.ch/cisg/urteile/399.htm http://www.unilex.info/case.cfm?pid=1&do=case&id=218&step=fulltext nordic journal of commercial law issue 2012#2 14 payment for a partial consignment of paprika pepper powder. the buyer counterclaimed for damages for breach of contract. it contended that some of the goods delivered were not fit to be sold in germany. according to an expert’s analysis, the pepper contained approximately 150 percent of the maximum concentration of ethyl oxide admissible under german food and drug law. however, courts will not usually make a seller liable for knowing and complying with the national laws and regulations in the buyer’s country. the court found that the seller had prior knowledge of the laws and, therefore, could not argue that it was ignorant of the requirement that the goods comply with the german laws. the court held that since the paprika contained more ethylene oxide than permitted under german law, the goods failed to conform to the contract and specifically failed to meet the buyer’s purpose that had been made known to the seller. this amounted to a fundamental breach as it deprived the buyer of what it was entitled to expect from the contract as per cisg articles 35(1)67 and 25,68 thereby making the seller liable for damages under cisg articles 7469 and 75.70 before the litigation commenced, the seller agreed to take back the goods and admitted that they were non-conforming under german food law. it stated it would deliver substitute goods, but failed to perform within the additional period of time for performance fixed by the buyer. it later argued that it should be exempt from having to pay damages under article 79. the reason for invoking article 79 is not made explicit in the court’s judgment, but it appears that the seller tried to convince the court that the contamination of the pepper was beyond its control. the court correctly noted that the seller “is responsible for the performance of its contractual obligations (art. 79 cisg) independently of whether the goods were contaminated with ethylene oxide through a treatment in the plant of the [seller] or in any different way. in the latter case, [the seller] was able to examine the goods before delivering them to the 67 see united nations convention on contracts for the international sale of goods, 11 april 1980, 1489 u.n.t.s. 3, 19 i.l.m. 671. article 35, infra, note 74 [cisg]. 68 cisg article 25 states: “a breach of contract committed by one of the parties is fundamental if it results in such detriment to the other party as substantially to deprive him of what he is entitled to expect under the contract, unless the party in breach did not foresee and a reasonable person of the same kind in the same circumstances would not have foreseen such a result”. ibid. at art. 25. 69 cisg article 74 states: damages for breach of contract by one party consist of a sum equal to the loss, including loss of profit, suffered by the other party as a consequence of the breach. such damages may not exceed the loss which the party in breach foresaw or ought to have foreseen at the time of the conclusion of the contract, in the light of the facts and matters of which he then knew or ought to have known, as a possible consequence of the breach of contract. ibid. at art. 74. 70 cisg article 75 states: “if the contract is avoided and if, in a reasonable manner and within a reasonable time after avoidance, the buyer has bought goods in replacement or the seller has resold the goods, the party claiming damages may recover the difference between the contract price and the price in the substitute transaction as well as any further damages recoverable under article 74”. ibid. at art. 75. nordic journal of commercial law issue 2012#2 15 [buyer]”.71 indeed, non-conformity of goods is almost always deemed to be within the seller’s sphere of control, even if the non-conformity was caused by the seller’s supplier or producer. however, not all commentators agree with this approach—particularly those from civil law jurisdictions. one french court has, in fact, granted an article 79 exemption to a seller that delivered non-conforming goods,72 but this case appears to be an exception. as fletchtner has noted, scholars from the civil law tend to see article 79 as providing some scope for exempting a seller from damages for delivering non-conforming goods.73 for example, stoll and gruber are of the view that an exemption under article 79 “is also possible in principle if the seller fails in his obligation under article 3574 to supply goods conforming to the contract”.75 their view reflects an exception to the common law strict liability rule that was incorporated in article 79. it also reflects a rejection of the strict common law view of pacta sunt servanda by allowing for altered circumstances to exempt a seller’s reasonable efforts to supply goods that are prima facie conforming. in their view, even though the cases may be rare, where a latent defect exists in goods at the time of the conclusion of the contract, a “seller must […] be permitted the defense that the defect was hidden and could not have been discovered by methods which a reasonable person in the seller’s position could have reasonably have been expected to adopt”.76 also in their view, cases of an insuperable event that caused the defect, such as a natural catastrophe, or an act of sabotage, should allow the seller an exemption under article 79. stoll and gruber 71 spanish paprika case, supra note 14 at para. iii a. 72 see tribunal de commercial [trib. com.] besançon, 19 january 1998, flippe christian, supra note 20. this decision is problematic and its approach to article 79 (and article 39) can be criticized. see infra. 73 see harry flechtner, “article 79 of the united nations convention on contracts for the international sale of goods (cisg) as rorschach test: the homeward trend and exemption for delivering non-conforming goods” (2007) 19 pace int’l l. rev. 29 [flechtner]. 74 article 35, in its entirety, states: (1) the seller must deliver goods which are of the quantity, quality and description required by the contract and which are contained or packaged in the manner required by the contract. (2) except where the parties have agreed otherwise, the goods do not conform with the contract unless they: (a) are fit for the purposes for which goods of the same description would ordinarily be used; (b) are fit for any particular purpose expressly or impliedly made known to the seller at the time of the conclusion of the contract, except where the circumstances show that the buyer did not rely, or that it was unreasonable for him to rely, on the seller's skill and judgment; (c) possess the qualities of goods which the seller has held out to the buyer as a sample or model; (d) are contained or packaged in the manner usual for such goods or, where there is no such manner, in a manner adequate to preserve and protect the goods. (3) the seller is not liable under subparagraphs (a) to (d) of the preceding paragraph for any lack of conformity of the goods if at the time of the conclusion of the contract the buyer knew or could not have been unaware of such lack of conformity. 75 hans stoll & georg guber, “article 79” in schlechtriem & schwenzer eds., commentary on the un convention on the international sale of goods (cisg) ), 2d ed. (new york: oxford university press, 2005) 812 at 828 [stoll & guber]. 76 ibid. . nordic journal of commercial law issue 2012#2 16 concede, however, that a seller is always responsible for the sale of generic goods, or for defects that occur in the typical course of manufacturing, and where this occurs, “the question of fault is irrelevant”.77 product non-conformity and article 79 has also been invoked in the used car case78 and the milling equipment case.79 the court’s reference to article 79 was indirect in the used car case, where it simply noted that damages would only be recoverable if they could have been “classified as unforeseeable”. in that case, where the buyer claimed damages from the fraudulent seller for a defective used automobile, damages were clearly warranted.80 similarly, in the milling equipment case, the plaintiff buyer claimed the partial refund of the price it paid when it discovered that the milling components it received from the defendant seller were not the same as those specified in the contract.81 the seller attempted an article 79 defense on the basis that it could not obtain the specified milling components as offered by the original producer, and thus, was forced to use substitute parts of a foreign origin. it was aware of this non-conformity, but did not disclose this fact to the buyer. as this could not be deemed an unforeseeable impediment within the meaning of article 79, the court rejected this argument. 6. product non-conformity as an impediment?: 6.1 the vine wax case the german federal supreme court has also provided guidance on the issue of non-conformity of goods and excuses for non-performance. in the vine-wax case, a case that has been considered a landmark in cisg jurisprudence,82 the supreme court demonstrated an advanced and sophisticated understanding of the convention’s interpretative methodology.83 schlechtriem viewed the decision with optimism: 77 ibid. at 829. 78 used car case, supra note 14. 79 milling equipment case, supra note 14. 80 used car case, supra note 14. 81 milling equipment case, supra note 14. 82 peter schlechtriem, “uniform sales law in the decisions of the bundesgerichtshof” 50 years of the bundesgerichtshof: a celebration anthology from the academic community, online: pace law school cisg database <http://www.cisg.law.pace.edu/cisg/biblio/schlechtriem3.html> [schlechtriem, “uniform sales law in the decisions of the bundesgerichtshof”]. 83 vine wax case, supra note 14. http://www.cisg.law.pace.edu/cisg/biblio/schlechtriem3.html nordic journal of commercial law issue 2012#2 17 [t]he decision of the bundesgerichtshof in the “vine-wax case” brought needed clarity [in this area of law…] and is furthermore a “liberation” […]. in its treatment of the legal issue as well as in its reasoning, the decision is not only a welcome movement towards the point of view of other legal systems regarding seller’s liability, which is extremely important for the preservation of a uniform interpretation of the convention, but is also in two ways guiding for the future legal developments in internal german sales law and the convention.84 the 1999 case involved the sale of vine wax used to protect vines from drying out, and to reduce the risk of infection. the buyer (plaintiff), from austria, claimed that the vine wax was defective. the seller (defendant), from germany, had obtained the vine wax from a third-party manufacturer. the buyer that took delivery in the original packaging directly from the manufacturer, gave notice of the non-conforming wax to the seller, and complained of major damage to vines treated with the wax. it also demanded damages from the seller. the latter party refused to provide any compensation. it not only attributed the alleged damages to frost, but argued that it was exempt from any liability as an intermediary pursuant to article 79. because it only acted as an “agent” in the transaction, and purchased the product from a third party supplier, it argued that the reasons for the damages were beyond its control. the seller’s invocation of article 79 reflects a broader interpretation of excuses for nonperformance that tends to be more widespread in the civil law jurisdictions of europe.85 in german law, this would entail a determination as to whether or not physical performance was still possible for the promisor.86 if performance was possible, a case for delay may be made. in such a situation, specific performance would still be available, and damages for the delay may be awarded.87 this allowance provides a greater scope for an aggrieved party to perform. in harmony with the pacta principle, the common law takes a much more restrictive view of the doctrine.88 for the doctrine of impossibility to apply, for example, performance must be physically impossible.89 in addition, the events surrounding the failure to perform must be beyond the control of the non-performing party. some academics also suggests that the delivery of non-conforming goods should not fall within the scope of article 79, as the term “impediment” assumes the prevention of the delivery of goods.90 indeed, harry flechtner has recently argued that “those who have drafted the [cisg] text did not intend article 79 to apply 84 schlechtriem, “uniform sales law in the decisions of the bundesgerichtshof”, supra note82. 85 j. barrigan marcantonio, “unifying the law of impossibility” (1985) hastings int’l & com. l. rev. 41 at 49-50 [marcantonio]. 86 ibid. at 49. 87 ibid. 88 ibid. at 50. see also stoll & guber, supra note 75 at 810-811. 89 marcantonio, supra note 85 at 50. 90 stoll & guber, supra note 75 at 810. nordic journal of commercial law issue 2012#2 18 to deliveries of non-conforming goods”.91 unfortunately, that intention was not clearly expressed in article 79(1), as it states that it applies to “a failure to perform any […] obligation”.92 the bundesgerichtshof therefore considered impediments that might excuse a party from damages based on the non-performance attributable to third-party contractor. the court stated: “because the seller has the risk of acquisition […] he can only be exempted under cisg article 79(1) or (2) (even when the reasons for the defectiveness of the goods are—as here—within the control of his supplier or his sub-supplier) if the defectiveness is due to circumstances out of his own control or out of each of his suppliers’ control”.93 in analyzing the facts of the vine wax case, the bundesgerichtshof identified a discord among scholars as to whether article 79 “encompasses all conceivable cases and forms of nonperformance of contractual obligations creating a liability and is not limited to certain types of contractual violations and, therefore, includes the delivery of goods not in conformity with the contract because of their defectiveness”, or “whether a seller who has delivered defective goods cannot rely on article 79 cisg at all”.94 the court did not deem it necessary to resolve this conflict stating that, “in any case, the defectiveness of the [goods] was not outside [the seller’s] control. [the seller] is, therefore, responsible for the consequences of a delivery of goods not in conformity with the contract”.95 however, the court appeared to leave open the question that article 79 might in some other circumstances exempt a seller for delivery of non-conforming goods. although that was not the case in this instance, the court suggested that if defective goods had been caused by the seller’s supplier, the seller would be exempt from that situation under article 79 only if the defect was beyond its control as well as the control of the seller’s suppliers. while the court did not provide a definitive answer on this question, this suggests, according to dicta from the german federal supreme court, that a seller could escape liability for damages under article 79 for supplying non-conforming goods. such an approach would allow for fault-based liability, which is recognized in german law, to creep into article 79. recall that article 79 does not follow the civil law, which bases solutions to impediments on the doctrine of fault. according to honnold, who represents the scholarly view from a common law perspective, article 79 is simply inapplicable when a seller supplies non-conforming goods.96 such a development, should it occur, would undermine the objective of the cisg to create an internationally uniform sales 91 flechtner, supra note 73 at 36. 92 cisg, supra note 67 at art. 79(1). 93 ibid. at art. 79(1). 94 vine wax case, supra note 14 at s. ii. para. 2(a). 95 ibid. 96 flechtner, supra note 73 at 41. nordic journal of commercial law issue 2012#2 19 law. for this reason, while the vine wax case is an admirable addition to cisg jurisprudence, theoretically, it does leave open the possibility of divergence in the case law on article 79 in national courts. 6.2 the powdered milk case three years later, product non-conformity and article 79 was also again addressed by the supreme court in the powdered milk case.97 a german firm sold powdered milk to a company in the netherlands. the buyer sampled the product at the time of delivery, and the test results failed to disclose any problems with the milk. the buyer then exported the goods to customers in algeria and aruba. these customers, however, claimed that some parts of the powdered milk were contaminated, so the buyer sought compensation from the seller. while the seller agreed that defects existed, and offered to take back the powdered milk, it declined to pay damages as requested by the buyer. the seller first claimed that its performance should be excused because the bacterial infestation occurred after the milk had been delivered, and therefore, the goods as delivered had conformed to the contract. secondly, it argued that under the german civil code, no damages could be claimed. one of the conflicting terms was a force majeure clause in the seller’s order confirmation. at the appeal court,98 the seller argued that this contractual provision trumped the cisg as the convention was derogated by a clause in its standard forms. the appeal court ruled that the force majeure clause was not part of the contractual relationship as it was not agreed to by the buyer. the supreme court also confirmed that neither the buyer’s nor the seller’s standard forms could be included in the contractual agreement.99 while the contract was deemed to be valid, the conflicting terms from the parties’ standard forms were declared void, and were to be replaced by the provisions of the cisg that regulated the respective subject matter, including article 79. as for the non-conformity, both the appeal court and supreme court were of the view that, in this case, the seller was not exempt from liability under article 79(1). the appeal court noted that the seller failed to comply with its burden to demonstrate that it was exempt from liability for damages under article 79(1).100 the seller had not demonstrated that the product nonconformity “originated from outside of its sphere of control” and remarked that “[t]his proof 97 powdered milk case, supra note 14. 98 oberlandesgericht [olg] [appellate court] germany 23 october 2000 appellate court dresden (powdered milk case) online: pace law school cisg database <://cisgw3.law.pace.edu/cases/001023g1.html> [powdered milk case, appellate court]. 99 powdered milk case, supra note 14. 100 ibid. at s. 2.5.1.2.c. nordic journal of commercial law issue 2012#2 20 […] is critical in order to argue in favor of an exemption from liability”.101 it was unequivocal on this point, noting that the seller was “obliged […] to pay damages because [the] powdered milk lacked conformity with the contract”, therefore, there was “no exemption from liability in accordance with art. 79 cisg”.102 the supreme court agreed with this view to some extent, but also appeared to be unemphatic from denying a seller’s non-conforming goods an exemption under article 79. in this respect, it appeared to leave open the possibility that a seller might, in certain cases, be excused from liability for damages for supplying defective goods under article 79. the decision lacks clarity on this important issue. in this respect, it referred back to the vine wax case “as art. 79 also applies to the delivery of goods that do not meet the requirements of the contract”.103 it elaborated on this point and ruled that if the existence of the infestation prior to the transfer could not be excluded, the seller’s success under article 79 would depend on the seller proving that the contamination would not have been detectable with the best possible testing method and, further, that any infestation had occurred outside of its sphere of control.104 the supreme court then remanded the case for further fact finding on the timing of the contamination. the supreme court did not explain from where this test had originated, but it appears to have been based on its interpretation of the language of article 79. it is also in harmony with the civil law tradition that is more accommodating to an unforeseen change in circumstances, i.e. rebus sic stantibus. the court’s first condition for excusing the seller—that the non-conformity would be undetectable with the best possible methods of testing—arguably echoes the words of article 79’s requirement that the failure to perform be out of the seller’s control. however, this perspective also appears to reflect the civilian fault-oriented position. the problem is that this perspective may be due to an ingrained familiarity with domestic law, but this view is not supported by the drafting history of the article.105 in the official records of the conference it was made clear that a “seller was not to be held free of responsibility for defects in the goods he supplied, even if he had not been at fault in regard to his own manufacturing process. it was also understood that […] there would be no ‘impediment’ if a seller instead of doing the manufacturing himself, bought goods from a supplier and those goods proved defective”.106 as honnold and flechtner have noted, this position reflects a “lack of sympathy with the no-fault approach to liability for damages adopted 101 ibid. at s. 2.5.1.2.c.aa. 102 ibid. at s. 2. 103 powdered milk case, supra note 14 at s. iii. 104 ibid. 105 honnold, uniform law for international sales under the 1980 united nations convention, supra note 21 at 618. 106 united nations, united nations conference on contracts for the international sales of goods, vienna, 10 march-11 april 1980, official records, un doc. a/conf.97/19 (new york: un, 1991) at 410. nordic journal of commercial law issue 2012#2 21 in the cisg”.107 yet according to the supreme court, if “the best possible testing” failed to detect the defect, the seller could not have discovered and cured it, nor could he have taken it into account or overcome its consequences. the result of this approach is a situation where a seller delivering non-conforming goods would not be liable in damages. this reasoning bears a close resemblance to the approach taken in civil law. unfortunately, should this line of reasoning continue to develop in civilian courts, it could lead to significant differences in the outcomes of article 79 cases in various jurisdictions. to complicate matters, the supreme court’s second requirement that the seller prove that the infestation was caused by something “outside its sphere of control” appears to restate article 79’s “beyond the seller’s control” test. indeed, there is nothing in the language of article 79 that might unambiguously limit its scope, and forbid its application to cases of non-conforming goods. this was only made explicit during the drafting of the convention, but express terms were not incorporated into the cisg. perhaps this was a drafting oversight. the provision does state in subpart (1) that it applies to “a failure to perform any […] obligation”.108 however, when read within the context of other articles in the cisg, an argument can be made that a party delivering non-conforming goods was not to be entitled to an article 79 defense. this is particularly evident when considering the cisg’s approach to each parties’ contractual obligations and its unitary approach to remedies for breach. for example, article 35(1) states that a “seller must deliver goods which are of the quantity, quality and description required by the contract”, and article 45(1) provides that “[i]f the seller fails to perform any of his obligations under the contract or this convention” which includes the seller’s obligations under article 35(1)(b), “the buyer may […] claim damages”.109 a similar provision for a breach by the buyer exists under article 61(1)(b). the cisg is, thus, based on a no-fault unitary contractual principle that all parties are obliged to perform their obligations, and will be held responsible for damages. this differs to some extent from certain legal systems, particularly from civil law jurisdictions, that take a more liberal approach to the concept of fault when dealing with liability for damages for a contractual breach. the approach taken by the supreme court, thus, appears to reflect its ingrained familiarity with domestic law, and would seem to be a sensible and obvious interpretation of the cisg. however, such a result could lead to divergent interpretations of the convention, and reflects the sometimes subtle, but insidious, nature of the homeward trend. 107 honnold, uniform law for international sales under the 1980 united nations convention, supra note 21 at 620. 108 cisg, supra note 67 at art. 79(1). 109 ibid. at arts. 35(1) and 45(1)(b). nordic journal of commercial law issue 2012#2 22 7. the impediment requirement under article 79(1) as a prerequisite to an exemption, article 79 (1) requires that a party’s failure to perform be due to an “impediment” that was beyond the control of the party, and that the party could not reasonably be expected to have taken it into account at the time of the conclusion of the contract, or to have avoided it or its consequences.110 the english wording in article 79(1), “beyond his control” is more precise than the general wording found in the german language (aufserhalb ihres einflufsbereichs).111 in order to determine whether the impediment was beyond the party’s control, courts must undertake a risk analysis to establish whether the risk of the occurrence of the impediment was something within that party’s sphere of control. in other words, a court is required to assess the risks that a party claiming exemption assumed when it concluded the contract. it must have regard to the allocation of risk that was incorporated in the contract, as well as any trade usages or practices that might be relevant (according to cisg article 9). in the absence of any force majeure-type agreement, recourse must be made to the cisg. generally, a party’s sphere of control is extensive. there will rarely be impediments that are deemed to be beyond its control. the most common examples for such cases are unforeseen events, such as natural catastrophes (storms, flooding, fire, earthquakes, disease epidemics, etc.), war or terrorist attacks, and governmental measures affecting trade (export or import bans, embargoes, etc.).112 the unforeseen event must also be exceptional. thus, in the tomato concentrate case, the seller was not exempted from liability under article 79, even though heavy rainfall had reduced the production of tomatoes.113 according to the hamburg appellate court (olg), even though the french seller claimed “force majeure”, the crop of tomatoes was not entirely destroyed, and the supply was not exhausted, thus, performance was still possible. the reduction of the tomato crop, and the resultant increase in the market price of tomatoes were burdensome, but not impediments that the seller could not overcome. the supply, although restricted, was deemed be within the seller’s sphere of control.114 in the same year as the tomato concentrate case, that same court had made a similar ruling in the iron molybdenum case.115 an english buyer and a german seller had entered into a contract for the supply of iron molybdenum from china in 1994. the goods were never delivered to the 110 the full text of article 79(1) states: “a party is not liable for a failure to perform any of its obligations if he proves that the failure was due to an impediment beyond his control and that he could not reasonably be expected to have taken the impediment into account at the time of the conclusion of the contract or to have avoided or overcome it or its consequences.” cisg, supra note 67. 111 stoll & guber, supra note 75 at 814 para. 14. 112 ibid. 113 tomato concentrate case, supra note 14. 114 ibid. 115 iron molybdenum case, supra note 14. nordic journal of commercial law issue 2012#2 23 buyer because the seller had not itself received delivery of the goods from its own chinese supplier. the buyer then concluded a substitute transaction with a third party and sued the seller for the difference between the price paid and the price under the contract. the seller claimed that is was exempt from liability under a force majeure clause in the contract, as well as under article 79, as the market price for the product had tripled since the time of the conclusion of the contract. the court held that the buyer was entitled to damages under article 75 of the cisg. it stated that it was incumbent upon the seller to bear the risk of increasing market prices.116 the court made the additional point that a seller has to make greater efforts where the transaction had a speculative character, as in this case, so the fact that the market price had tripled was not sufficient to exempt the seller. where the seller has sold generic or commodity goods, such as tomato paste or iron molybdenum, it will have to bear the acquisition or procurement risk, assuming there is no agreement to the contrary. failure to do so is not considered an “impediment”. recall that the german federal supreme court also made this point in the vine wax case. it noted that the seller normally bears the risk that its supplier might breach, and that the seller will not generally receive an exemption when its failure to perform was caused by its supplier’s default.117 where other sources of supply exist, even if more expensive than the one from which the seller intended to purchase the goods, the seller must obtain the goods from any available source. failure to do so will deprive that party from a defense under article 79. also, from the perspective of the buyer, it is often irrelevant how the seller obtains the goods, or whether the goods by-pass the seller, and come directly from the seller’s supplier or producer. if a seller does not want to assume the acquisition risk, it should ensure that an exemption clause is included in the contract with the buyer exempting it from liability for failure to perform by its supplier or producer. there do appear to be limits to the extent to which the seller must bear all of the risk of acquisition. for example, if the contract provided that the seller was to supply the goods from a specific source, or if the seller promised to deliver the goods provided that it received the product from its supplier, then a failure of the intended source, or a failure by the supplier to deliver, will normally exempt the seller from having to perform.118 furthermore, even if no specific source of goods was identified in the contract, the court in the iron molybdenum case suggested that a post-contract market rise could become so extreme and unreasonable so as to entitle a seller to claim an exemption under article 79.119 it stated, however, that “[f]or parties doing business in a sector that has a very speculative aspect the limits of reasonability are very 116 ibid. 117 vine wax case, supra note 14 at s. ii. para. 2(a). 118 peter huber & alastair mullis eds., the cisg: a new textbook for students and practitioners (germany: sellier european law publishers, 2007)at 261-262. 119 iron molybdenum case, supra note 14. nordic journal of commercial law issue 2012#2 24 high”.120 considering the speculative nature of the industry and the contract, it was not commercially unreasonable to justify an exemption under article 79. 8. miscellaneous article 79 issues in german case law the remaining german cases concern a variety of issues, many of which touch upon article 79 in only a marginal manner. in one early case, the copper and nickel cathodes case, for example, which dealt with contract formation, article 79 was cited, but it otherwise had no other application in the case.121 similarly, in the flagstone tiles case the court referred to article 79 by noting that the buyer had to accept certain foreseeable risks by paying an unauthorized sales agent, rather than directly remitting the payment to the seller.122 in this respect, the court noted that by the buyer’s conscious act of paying an agent instead of the seller, the buyer had to bear the consequences of the possibility that the agent might cash the cheque without handing over the purchase price to the seller. if the buyer commissioned the agent to transmit the purchase price to the seller, it had to bear the risk of that transmission. in the court’s view, this was a risk that fell under article 79, even though this provision of the cisg is not explicit on this subject. the reference to article 79 was, thus, inappropriate, but it is possible that the buyer attempted to use this provision as a defense, and the court was, thus, obliged to respond. unfortunately for this buyer, non-payment has never been deemed to be an unforeseeable supervening event in cisg jurisprudence. the court correctly noted that the failure to pay the seller was, in this case an issue governed by cisg articles 53123 and 57(1).124 non-payment was also the main issue in the memory module case.125 there, the chinese seller sued the german buyer for payment of the purchase price for delivered memory modules, as well as for reimbursement of its legal fees. the district court ruled in the seller’s favour, and the buyer appealed. it argued that it had rightfully avoided the contract under cisg article 49, and that the legal fees were not recoverable by the seller. it also must have made an argument under article 79 to support its position on contract avoidance. the court noted, however, that contrary to the buyer’s view, the contract was not properly avoided under article 49 as there was no fundamental breach by the seller. 120 ibid. 121 copper and nickel cathodes case, supra note 14. 122 flagstone tiles case, supra note 14. 123 cisg article 53 states: “the buyer must pay the price for the goods and take delivery of them as required by the contract and this convention”. cisg, supra note 67 at art. 53. 124 cisg article 57(1) states: “if the buyer is not bound to pay the price at any other particular place, he must pay it to the seller: (a) at the seller’s place of business; or (b) if the payment is to be made against the handing over of the goods or of documents, at the place where the handing over takes place”. cisg, supra note 67 at art. 57(1). 125 memory module case, supra note 14. nordic journal of commercial law issue 2012#2 25 in its only reference to article 79, the court stated that “[i]t is irrelevant according to art. 79(5) cisg whether or not the seller is responsible for the failure to perform”.126 this cryptic reference to article 79(5) appears peculiar. the article itself states: “[n]othing in this article prevents either party from exercising any right other than to claim damages under this convention”.127 by this reference, the court simply acknowledged that a party who fails to perform a contract owing to an impediment that meets all the requirements set forth in article 79(1) is not liable for damages, but the exemption of a party from damages does not prevent the other party from claiming other remedies. for example, since article 79 does not prevent the other party from exercising any right other than to claim damages, a serious delay by one party will entitle the other party to put an end to the contract by reason of a fundamental breach. because delayed delivery and payment were issues in this case, it can only be surmised that the buyer attempted to use, to a limited degree, an article 79 defense, but was unsuccessful. in the german courts’ interpretations of article 79, it is important to consider the extent to which they have remained true to the interpretive mandate in cisg article 7(1) and promoted uniformity in their court decisions. for the most part, german courts have been relatively sensitive to this requirement. as ulrich magnus has noted, it is his “impression that german courts today do neither directly nor indirectly on a subconscious level follow the homeward trend. as far as the interpretation of the cisg is concerned the courts and in particular the federal supreme court try to avoid any interpretation which merely imports the domestic solution into the cisg”.128 the remaining german cases on article 79 appear to underpin the need for an autonomous interpretation of the cisg that negates any recourse to law and legal concepts of a purely domestic nature. in the automobile case, for example, the plaintiff buyer of a vehicle with a defective title attempted to rely on s. 306 of the bgb to avoid the contract for reason of impossibility of performance.129 it argued that under german domestic law regarding the legal consequences of an impossibility of a contractual performance, the seller was unable to properly transfer the ownership of the car to the buyer. the seller made a similar argument under article 79(1), as it sold the automobile to the buyer without realizing that the vehicle was stolen property. it, thus, attempted to rely on an exception to its duty to perform under article 79(1), arguing that the failure to properly transfer property (and title) was due to an impediment beyond its control. the freiburg district court (landgericht) invoked numerous articles of the cisg, which it deemed to govern the dispute. it disregarded the inapplicable references that the parties made to domestic law, and determined that the buyer’s claim was justified. it awarded the buyer reimbursement of the purchase price under article 81(2) cisg, and of all its expenses on 126 ibid. at s. iii.1. 127 cisg, supra note 67 art. 79(5). 128 magnus, “cisg in the german federal civil court”, supra note 23 at 156. 129 automobile case, supra note 14. nordic journal of commercial law issue 2012#2 26 under article 74. in making this award, the court noted that the seller could not rely on exceptions under article 79(1). it held that the seller’s failure to properly transfer the property was not due to an impediment beyond its control. on the contrary, it was the responsibility of the seller to inquire into the background of the car. in addition, according to cisg article 41, the seller was liable for any defects in title. if it had undertaken a proper examination, the seller would have discovered that the car had been stolen and, thus, would have refrained from reselling it. this was within the seller’s sphere of control. in addition to the automobile case,130 german courts have made similar rulings in two other cases that involve stolen vehicles and article 79. what is also interesting is that it is apparent that these courts have had little difficulty in applying the cisg articles in a sophisticated manner. the stolen automobile case involved a buyer of an automobile from belarus, who purchased the car “without warranty” from a german seller.131 shortly after taking delivery, the car was seized by belarusian authorities based on an alleged theft. the buyer immediately informed the seller that the vehicle had been seized, and the seller agreed to reimburse the buyer for the purchase price on condition that the car be returned. as the car was impounded by the authorities, the buyer was unable to return it to the seller. as the buyer had not been able to make restitution to the seller, the latter argued that it had been relieved of its obligation to perform. the court noted, however, that the buyer was relieved from his obligation to return the car “because the impossibility to do so is not due to his act or omission”.132 in the alternative, the seller utilized an article 79 defense by claiming it was unaware that it had sold stolen property. in ruling against the seller, the court noted that it was not relieved from its obligation to reimburse the purchase price and to pay damages according to article 79(1). in the words of the court, “[t]his article provides that a party is not liable for a failure to perform any of his obligations if he proves that the failure was due to an impediment beyond his control and that he could not reasonably be expected to have taken the impediment into account at the time of the conclusion of the contract”.133 as the seller should have been aware that a separate vehicle identification number had been spot-welded on top of the original plate, it was the seller who bore the burden of proof in this case, and he had not demonstrated he could not have noticed the attached plate. damages were thus awarded to the buyer under cisg article 74. similar facts and arguments were also present in the stolen car case in the following year.134 a german car dealer sold a vehicle to an italian buyer, who was also a professional in the trade. 130 automobile case, supra note 14. 131 stolen automobile case, supra note 14. 132 ibid. at s. 2(f). 133 ibid. at s. 2(d). emphasis in the original. 134 oberlandesgericht [olg] [provincial appellate court] münchen, 5 march 2008, 7 u 4969/06 [stolen car case], online: pace law school cisg database <http://cisgw3.law.pace.edu/cases/080305g1.html> [stolen car case, provincial appellate court]. not to be confused with the stolen automobile case, ibid. http://cisgw3.law.pace.edu/cases/080305g1.html nordic journal of commercial law issue 2012#2 27 the seller had purchased the car from another automobile dealer and had submitted the vehicle registration document to local authorities for a preliminary check. although nothing was revealed by this check, it later turned out that the car had been stolen prior to its sale. consequently, the italian police confiscated the car and returned it to its original owner. in the interim, the buyer, having resold the car to a third party, had to return the funds received as payment for the car. the buyer then filed a suit against the seller claiming breach of contract plus damages and lost profits. the seller requested the dismissal of the claim, alleging that it had acted in good faith, as it had conducted due diligence on the title prior to the sale. the court of first instance had dismissed the claim, holding that, according to article 79(1), the seller was not liable. this appears to be an unusual determination, as the court also seemed to be of the view “that article 79 cisg had to be interpreted in a very restrictive way”.135 in that court’s view, the seller had demonstrated that its breach of contract—its failure to discern that the car was stolen property—was due to an impediment beyond its control, and it could not reasonably be expected to have taken the impediment into account at the time of the conclusion of the contract, or to have avoided or overcome it or its consequences. such a ruling, rather than restricting the scope of article 79, appears to broaden it considerably. it must be questioned whether the court of first instance was subconsciously influenced by its own domestic laws, in particular, bgb section 313’s more liberal doctrine of wegfall der geschäftsgrundlage. relying on its erroneous interpretation of article 79, the buyer appealed the court’s ruling, the munich court of appeal partially reversed the decision of the court of first instance, and found that the seller had failed to perform its obligation, namely the transfer of ownership of the car to the buyer. in this respect, the court of appeal undertook a more sophisticated analysis of the cisg. after pointing out that while the cisg was the law applicable to the merits of the dispute, as per article 4(b), it did not govern the effects of the contract on the property in the goods sold. as a consequence, this was a matter governed by domestic law. the court, thus, correctly applied german law, which prohibits the acquisition of stolen property, even by those who act in good faith. furthermore, in contrast to what the court of first instance had affirmed, the court of appeal held that the seller could not be exempted from liability under article 79, since such an exemption implies the occurrence of objective circumstances preventing the fulfillment of the contractual obligations, while in this case the alleged circumstances were of a subjective nature. in the words of the court, “[a]ccording to article 79 cisg, an exemption of the seller from the consequences of a breach of obligation is only possible if the breach cannot reasonably be attributed to him”.136 moreover, the argument that the alleged impediment could not reasonably be expected to have been taken into account at the time of the conclusion of the 135 quote is from the judgment of the munich court of appeal, stolen car case, provincial appellate court, ibid. 136 stolen car case, provincial appellate court, supra note 134. nordic journal of commercial law issue 2012#2 28 contract was not convincing. based on the facts of the case, including the low price of the car, the mileage, and the disparities in the owner’s registration document, this should have led the seller to be suspicious regarding the ownership of the vehicle. as the court stated, “the obligation to inquire whether a seller is entitled to transfer property of a car dealer of used cars does not meet the requirements of article 79”.137 in consequence, the buyer was entitled to damages under cisg articles 45(1)(b) and 74. the remaining three cases138 from germany contain very little content on article 79. the glass bottles case, which was an appeal case to the supreme court, involved a german seller and a greek buyer who had entered into a contract for the manufacture and supply of bottles that were to be resold to the buyer’s customers in russia.139 due to the difficulties of selling bottles in russia caused by the ruble’s decline, the buyer informed the seller of its intention to accept only the goods already produced. it also asked the seller for the return of its moulds, which the buyer had financed with a loan from the seller. the seller refused, and the buyer brought an action against it claiming, inter alia, repayment of the loan. the seller counterclaimed with a claim for compensation of lost profits it had allegedly suffered as a result of early termination of the contract. both the court of first instance and the court of appeal dismissed the buyer’s claims, but the supreme court reversed these two decisions in part, noting that the seller was entitled to set-off because the buyer had failed to perform its contractual obligations under the cisg. the buyer attempted an article 79 defense, apparently first under german domestic law. it claimed that there had been a disruption of the “equivalence mandate” (aquivalenzstorung), which is a domestic rule that stipulates that the duties of both contractual parties remain approximately the same. the aquivalenzstorung rule bears a close resemblance to wegfall der geschäftsgrundlage, which is the german rule concerning the destruction of the basis of the contract. the supreme court acknowledged that although the ruble’s value fell, resulting in a disruption of sales on the part of the buyer, “the buyer bears the risk whether the purchased object can be resold for a profit”.140 while the court referred to previous bundesgerichtshof jurisprudence and cited bcb s. 313, it correctly noted that cisg article 79 was the governing provision. that the buyer was not able to sell the bottles because of a decline of the ruble exchange rate did not entitle the buyer to terminate the contract. at most, article 79(1) simply “releases the debtor only from damages claims by the creditor”.141 otherwise, the buyer’s obligations to perform the contract remained unaffected. 137 ibid. 138 these are: beer case, supra note 14; café inventory case, supra note 14; and glass bottles case, supra note 14. 139 glass bottles case, supra note 14. 140 ibid. at para. 30(b). 141 glass bottles case, supra note 14 at para. 31. nordic journal of commercial law issue 2012#2 29 the café inventory case similarly raised only a minor point on article 79.142 the court held that the buyer’s assignees were entitled to recover a contractual penalty for the seller’s partial nonperformance (in supplying defective equipment). in so doing, the court left open the problem as to whether an exemption from the obligation to pay the contractual penalty should be decided on the basis of cisg, or on the basis of domestic law. with respect to cisg, the court noted that an exemption for the seller’s non-performance would only be allowed if proper installation of the equipment at the buyer’s premises had been impossible due to an unforeseeable impediment beyond the seller’s control, as per article 79(1), or through conduct by the buyer, in accordance with article 80.143 while the buyer did not leave its premises in an ideal condition to enable the seller to properly install the equipment, the seller’s complete failure to install the equipment deprived it from a right to rely on articles 79 and/or 80. this decision, while limited in scope, appears to be a correct application of the facts with regard to article 79. the beer case was primarily concerned with contract avoidance, fundamental breach, and damages.144 the dispute concerned two breweries with reciprocal claims involving contracts for the manufacturing of a plant and the bottling of beer for the buyer. when the buyer failed to purchase all the beer manufactured for the venture, the relationship between the parties deteriorated. the buyer attempted to argue that a distortion of the parties’ implicit contractual purpose occurred, which is a principle recognized in german law (under wegfall der geschäftsgrundlage). this principle is often compared to force majeure, frustration, and cisg article 79. however, the court was quick to dismiss this argument, and stated that “[t]he cisg does not contain this legal principle”.145 while article 79 did not apply to these changed circumstances, the court noted that cisg article 7(1) provides that the principle of good faith is inherent to the convention.146 as such, it could construe the principle of good faith in a way that when circumstances change, an aggrieved party could demand an adjustment of the obligations under a contract. so while article 79 could not be used to broaden the scope of excuses for non-performance when new situations arise, the court appeared to open the door for article 7(1) to be used in claims for contract adjustment at least in some situations. however, in this case, the court found that good faith was not a relevant factor, and dismissed this line of argumentation. 142 café inventory case, supra note 14. 143 article 80 states: “a party may not rely on a failure of the other party to perform, to the extent that such failure was caused by the first party’s act or omission». 144 beer case, supra note 14. 145 ibid. at s. “position of [seller]”. 146 ibid. at s. iii. 3. nordic journal of commercial law issue 2012#2 30 9. conclusion germany has a long history in efforts to unify international sales law, and it is likely that this experience has assisted jurists in that country to treat the cisg in a sensitive and sophisticated manner.147 this should not be surprising as german courts have had experience in applying ulis and ulf from 1974 to 1990. the relatively large number of cisg cases coming from that country also speaks to the relative popularity and success of the convention in germany. indeed, this review of article 79 in german courts indicates that jurists there take the cisg very seriously. most of the german decisions demonstrate that courts have a nuanced understanding of both the cisg’s general principles as well as its specific provisions, such as article 79. while there has been a tendency to make a distinction between “normal” domestic sales law, and the cisg as a unique law for international sales, there is little evidence that german courts have interpreted article 79 in a manner that shows a bias for the homeward trend. the german cases interpreting article 79, although not always perfect, have gone to great lengths to avoid any interpretation that might import domestic law into the cisg. this is the case even though german courts have not quoted foreign case law on article 79. this practice is common in german courts, as they rarely invoke the decisions of foreign courts unless there is a specific international matter at stake.148 as a civil law country, this also reflects the lack of reliance on precedent, which is widespread in common law jurisdictions. nevertheless, the cisg calls for a uniform interpretation and application across signatory states, and german courts have managed to pay heed to this requirement. 147 see generally, martin karollus, “judicial interpretation and application of the cisg in germany 19881994” in cornell j. int’l l., eds., cornell review of the convention on contracts for the international sale of goods (cisg) 1995 (new york: kluwer law international, 1996) 51. see also, magnus, “general principles of un-sales law”, supra note 30 at 143ff. 148 magnus, “general principles of un-sales law”, supra note 30 at 155. microsoft word finaltarjalleehlers_andreas.doc nordic journal of commercial law issue 2014#1 blaming the unblameable? on the liability of mediators by andreas ehlers* 1 *1 assistant professor at the faculty of law centre for enterprise liability (cevia) at the university of copenhagen, denmark. nordic journal of commercial law issue 2014#1 1 1 introduction the purpose of the present article is to examine the legal basis for establishing claims for pure economic loss against persons acting as mediators in private (out-of-court) disputes.1 mediation can be defined as a voluntary process in which a neutral third party (the mediator) helps conflicting parties find a satisfactory solution to a given problem. the role of the mediator, who will often be a professional such as a lawyer, an architect, a psychologist, an accountant, a consultant or a medical doctor, is to lead the dispute resolution process by supporting the parties in developing and examining their own proposals for a settlement. during the course of mediation, the mediator usually performs a variety of different services ranging from the overall structuring of the mediation to concrete services pertaining to the substance of the conflict. inter alia this involves deciding how meetings should be set up, who should be present at meetings, what should be discussed, what advice should be given, and what experts (if any) should be consulted. by interfering with disputes regarding the rights and duties of other parties, the mediator, like any other negotiator or advisor, risks that his conduct in some way causes detriment to one or more of the parties to the mediation. several damage scenarios can be imagined but most importantly perhaps, the mediator’s conduct may cause the parties to settle on unfavourable terms or not settle at all. further, the mediator may cause damage to the parties by revealing their commercial secrets and he may also cause harm to their persons (e.g. emotional distress).2 furthermore, damage to parties not even involved in the mediation may ensue. in danish law there are no special rules applicable to the liability of mediators acting out of court.3 this means that the well known requirements of contract law and tort law need to be satisfied in order for the parties to recover against the mediator:4 first, the mediator must have acted in contravention of the liability standard applicable to the mediation. this standard is 1 at present pure economic loss is to be understood in what i understand to be its traditional sense, i.e. as a loss, which does not flow from initial injuries to the person or damage to property. 2 see michael moffitt, ‘suing mediators’ (2003) 83 boston university law review 182. 3 recently special rules have been adopted for mediations conducted at the danish courts, cf. the administration of justice act (consolidated act no. 1139 of 24 september 2013) chapter 27. in a recent article by lise dyrby nielsen published in the danish law report for commercial law (2013) (in danish: erhvervsjuridisk tidsskrift) at 49 it is suggested that legislation on out-of-court mediation is being enacted as soon as possible in order to promote the practice of such mediation. in sweden, for example, legislation on out-of-court mediation was enacted in 2011, see lag (2011:860) om medling i vissa privaträttsliga tvister. for a commentary on this piece of legislation, see dan engström, lag om medling i vissa privaträttsliga tvister – en kommentar (2011). 4 it has been argued by certain anglo-american legal scholars that mediators can become liable for breach of fiduciary duties also, see e.g., (anonymous author), ‘the sultans of swap: defining the duties and liabilities of american mediators’ (1986) 99 harvard law review 1879ff and arthur a. chaykin, ‘mediator liability: “a new role for fiduciary duties?”’ (1984) 53 university of cincinnati law review 731ff. however, several scholars firmly reject that mediators can become liable as fiduciaries, see e.g. andrew lynch, ‘”can i sue my mediator?” finding the key to mediator liability’ (1995) australian dispute resolution journal 117-119. liability for breach of fiduciary duties under common law will not be dealt with further in the article. nordic journal of commercial law issue 2014#1 2 determined pursuant to the basic rule of culpa. second, there must be a certain nexus between the negligent conduct of the mediator and the loss suffered by the aggrieved party. this requirement is traditionally split in a requirement for factual causation and a requirement for adequacy. the former requires that a factual causal nexus can be established, whereas the latter requires that certain normative criteria and policy considerations make it reasonable to award damages. for many good reasons said requirements have long standing in the law. perhaps the most apparent one is their inherent flexibility, which enables them to adapt to developments and trends in society. the significant developments in the past 200 years evidence this very well and on that basis there are also goods reasons to believe that they are capable of dealing with mediation in a satisfactory way. however, this does not mean that the conduct of mediators is easily assessed according to above requirements. on the contrary each of them seems to pose serious difficulties to anyone contemplating suing a mediator. this should become apparent from the present examination. the article focuses on the liability of mediators under danish law. due to the lack of danish case law (as well as other authoritative sources of law such as legislation) on the matter, also foreign law will be looked at in order to extrapolate pertinent arguments for and against imposing liability. this will make the article interesting to foreign lawyers also. part 2 offers a global outlook on court cases concerning the liability of mediators and in part 3 it is discussed on what legal basis liability claims against mediators can be raised. in part 4 it is examined what it takes to establish that the mediator has acted wrongfully. this makes it necessary to do two things: first, it must be determined what standard of care is applicable to mediators and second, it must be examined what it takes for the mediators’ conduct to contravene this standard. in parts 5 and 6 respectively the feasibility of establishing factual causation and adequacy is examined and in part 7 it is discussed to what extent liability can be disclaimed by the mediator.. 2 the concept of mediator liability 2.1 mediator liability is sui generis as adumbrated above mediation can be defined as a voluntary dispute resolution process in which a neutral third party, the mediator, helps disputants settle certain conflicts. in private mediations the conflicts may regard any issue which can be handled out-of-court, including, inter alia, commercial matters (concerning e.g. contracts, personal injury and relationships between landlord and tenant), matters pertaining to the relationship between employer and employee and disputes between public authorities and private persons or entities. mediations may be conducted in several different ways but roughly it seems fair to say that the two most common and distinct ways are the so-called facilitative mediations and the substantive mediations. in the former way, the role of the mediator is to help the parties by, inter alia, leading the dispute resolution process, structuring the dialogue, and resolving dead locks by coming up with alternative solutions and employing empathy. in the latter way, in addition to nordic journal of commercial law issue 2014#1 3 these measures, the mediator may to some extent interfere with the substance of the conflict. if, for example, the mediator is a practicing lawyer he may offer his opinion on matters of law and if he is an architect, he may explain how a certain structure, which has collapsed, should have been properly built. in the literature the said two ways of conducting mediations are correctly perceived as being fundamentally different but as will become apparent below, a mediator may well shift from one way or model of mediation to another during the mediation process.5 hence, the boundaries between said schools may be somewhat blurred in practice. what makes mediation a special kind of dispute resolution is, first and foremost, its voluntary and collaborative nature. thus, unlike court proceedings or in the performance of traditional advisory services, the disputants have voluntarily and explicitly agreed to solve the disputed matter by way of collaboration. second, as already pointed out, mediations can be conducted by a variety of different professionals such as lawyers, accountants, consultants, architects, and doctors. or even by non-professionals. this is, of course, also a sui generis feature of mediation. third, in contrast to what applies to most other dispute resolution services, in most countries there is no legislation or other firm rules on how mediations should be conducted. the said special traits of mediation are exactly what make mediation particularly interesting in a liability context. how does one, for example, establish what the standard of care is when so many different kinds of professionals and non-professionals conduct mediations and when there is no legislation or other rules setting out what they should and should not do? and how much should be required of the breach of standard in order to establish blameworthiness when it – inter alia due to said heterogeneity of the mediators’ backgrounds – is difficult to say whether mediation is to be regarded as a proper profession in a liability context? further, how is it at all possible to establish causation between the conduct of the mediator and the loss suffered by a client when the hallmark of mediation is that it is the parties themselves who determine the outcome of the settlement? thus, if it is indeed the parties’ own agreement at least it will require a special structuring of one’s argument to persuade a court that it was in fact the mediator who caused the relevant damage. furthermore, when the principal role of the mediator is to help the parties find their own solution, generally it will not be an easy task to establish that the mediator should have reasonably foreseen that his conduct could cause detriment to one or more of the disputants. when assessing the liability of e.g. court judges and advisors such as lawyers and consultants one may face some of the above difficulties.6 for example, the duties of said advisors are often difficult to ascertain.7 however, in such cases it is uncommon that practically all of the basic liability requirements will give rise to problems as will most often be 5 see e.g. the below mentioned australian case in tapoohi v. lewenberg no 2 [2003] vsc 410 (21 october 2003) where the mediator himself gave legal advice on the substance of the conflict in question even though he had contracted with the parties to conduct a facilitative mediation. 6 on the liability of danish court judges, see vibe ulfbeck, erstatningsretlige grænseområder (2nd edn, 2010) at 279286. for an illustration of the case law on this issue, see e.g. a case decided by the danish supreme court in 1963 (published in the danish weekly law report the same year at 767). 7 on the duties of lawyers under danish law, see mads bryde andersen, advokatretten (2005). nordic journal of commercial law issue 2014#1 4 the case with regard to claims made against mediators. to some extent this sui generis nature of mediator liability is also evidenced by that fact that e.g. lawyers and consultants are frequently sued and held liable for losses incurred by their clients, while no mediator has so far been held liable for damages in a court of law. 2.2 a global outlook on court cases concerning mediator liability mediation is becoming increasingly popular and today a staggering amount of disputes are resolved in this way. in spite of this and the apparent potential of the mediators’ conduct to cause loss not a single danish court case deals with the liability of mediators and the same seems to be true in the other nordic countries. the lack of judicial guidance in the case law of the nordic legal family makes it relevant to look at the jurisprudence of other legal systems as well, but even on the global level the number of cases is extremely small.8 moreover, it seems that almost every case that does deal with the issue was decided on summary judgment and this of course reduces their value significantly. the most illuminating cases that could be found are three u.s. cases in lange v. marshall,9 lehrer v. zwernemann10 and chang’s imports, inc. v. srader11 and the australian case in tapoohi v. lewenberg12 (even though liability was not imposed in any of them).13 first, in lange, a lawyer, mr marshall, had undertaken to mediate a dispute regarding the dissolution of a marriage between mrs lange and mr lange. he advised both parties that he would not represent one against the other but that he would represent them jointly and prepare the papers necessary to effectuate the dissolution.14 at a time where the claimant, mrs lange, was admitted to the psychiatric ward at a hospital suffering from lupus eryethemathosis, the 8 the little effort to sue mediators is rather surprising but on close scrutiny there seem to be at least a few good reasons for this. one seems to be that the parties do not really know what to expect of the mediator and this makes it difficult to assess whether he performed well. another could to be the existence of a pro-settlement inclination on behalf of parties participating in mediation in the first place, cf. michael moffitt, ‘suing mediators’ (2003) 83 boston university law review 152. the most important reason, however, seems to be that apparently it is very difficult to successfully sue a mediator. 9 622 sw 2d 237 mo ct app (21 september 1981). 10 14 sw 3d 775 (17 february 2000). 11 216 f. supp. 2d 325 (20 august 2002). 12 no 2 [2003] vsc 410 (21 october 2003). 13 see also the u.s. case in re joint eastern and southern districts asbestos litig.737 f. supp 735 (e.d.n.y. 16 may 1990) and the new zealand case in mcgosh v williams [2003] nzca 19 (12 august 2003). 14 in fact therefore, he seems to have acted as a mediator for the parties rather than as a lawyer for one of the parties. this appears also to have been accepted by the court: ‘the parties disagree as to the nature of the obligation defendant undertook. it is clear that he advised both parties that he would not represent either as an advocate. although the terms “arbitrator” and “negotiator” were used also in the parties’ conversations, “mediator” would appear to be the proper term to apply to defendant’s role.’ nordic journal of commercial law issue 2014#1 5 mediator helped the parties negotiate a settlement which was signed by both parties and filed to the court (together with a petition for dissolution). however, before the judgment was entered, mrs lange had second thoughts concerning the settlement and sought legal counsel. mr lange did the same and the mediator withdrew from the case. the matter was taken off submission from the court and 10 months later mrs and mr lange entered into a settlement, which was more favourable to the former. mrs lange then sued the mediator alleging that he had failed to inquire as to the financial state of mr lange and negotiate a better settlement for her. moreover, she alleged that he had failed to advice her that she could get a better settlement if she litigated the matter and that he had not fully and fairly disclosed her rights as to marital property, custody, and maintenance. the mediator contented that he had no duty to do either of the alleged things because he had undertaken to represent the parties as a mediator. the court found for mr marshall alleging that, even if he had acted negligent, mrs lange had failed to establish any damages proximately caused by mr marshall.15 second, in the lehrer case, mr lehrer had sued his former attorneys for malpractice. this dispute was mediated by mr zwernemann and a settlement agreement was subsequently entered into. however, lehrer became dissatisfied with the settlement and sued mr zwernemann alleging that he had failed to disclose a certain conflict of interest. inter alia mr lehrer based his claim on negligence, breach of contract, and breach of fiduciary duty. the court briefly held that mr lehrer had not produced sufficient evidence to establish that mr zwernemann had caused any ‘legal injury’.16 third, in chang, a mediator,17 mr rubin, had agreed to help settle a dispute between a trademark licensor, chang, and a licensee, srader. after signing the settlement agreement the parties consulted separate accountants to review the relevant records, in accordance with the terms of the settlement agreement, but they did not agree on the amounts owed between the parties. this led chang to sue mr rubin for the amount he believed was due according to the settlement agreement.18 chang alleged first that mr rubin was in a position of conflict of interest and that he therefore should not have mediated the agreement.19 further, chang alleged that the mediator’s conduct fell below the standard of care owed by him. the court found that mr rubin had satisfied his duties as a mediator because he managed to bring the 15 for more on the lange case and the reasoning by the court, see below at 5. 16 for more on the lehrer case and the reasoning by the court, see below at 4.2. 17 the mediator was also an attorney but the court found that he was not acting as such for either party in negotiating and drafting the settlement agreement. rather, the court found that he was acting as a neutral mediator and therefore he had not violated new york law in representing two clients with conflicting interests. 18 chang also sued srader but these proceedings were referred to arbitration. 19 even though both parties had in fact been informed about said conflict of interest and signed a letter agreeing to waive any claim in that respect. nordic journal of commercial law issue 2014#1 6 parties together and successfully drafted an agreement which was executed by both of them. chang’s allegations were therefore dismissed.20 fourth, in tapoohi, the mediator was asked to settle a dispute between two sisters concerning the estate of their late mother.21 during the mediation both sisters were represented by lawyers.22 the meditator was appointed verbally by the parties and for that reason there was no firm or elaborate written basis on which his duties could be established. however, it did follow from his letter of acceptance that he was to assist the parties in reaching a result rather than dictating or imposing a settlement on them.23 dissatisfied with the settlement agreement reached between the sisters, tapoohi first attempted to set it aside in court. then she added a claim against her former solicitors whom by way of a third party notice sought contribution from, inter alia, the mediator pursuant to the wrongs act 1958 (vic).24 the claim made against the mediator, which he vigorously disputed, was based on breach of contractual and tortious duties. in its summary judgment the court found that it was ‘not beyond argument that some at least of the breaches of the contractual and tortious duties might be made out’ and allowed the case to proceed to trial.25 the said common law cases of course do not have an immediate precedential value for danish law but for at least two reasons the arguments put forward here seem relevant to us also. first of all, out-of-court mediations seem to be practiced in largely the same way throughout the western countries and therefore, the disputes, which ensue between the mediator and the clients must be expected to be similar also. second, as will become apparent below, ascertaining what the law is on the present issue is most of all about extrapolating legal arguments from the basic normative structure of tort and contract law and on that level, the rules of common law and danish law do not seem to differ much. this appears also from the fact that most of the legal reasoning of the common law courts in said cases could well be applied by danish courts in future cases.26 20 for more on the chang case and the reasoning by the court, see below at 4.1. and 4.2. 21 in this case the person sued was a queen’s counsel but during the negotiations he acted as a mediator for both parties. 22 as noted also by melinda shirley and tina cockburn it is a peculiar fact of this case that mrs. tapoohi was herself a qualified lawyer and that mrs. lewenberg was represented by a law firm (lewenberg & lewenberg) in which her daughter and husband were both principals, cf. melinda shirley and tina cockburn, ‘when will a mediator operating outside the protection of statutory immunity be liable in negligence’ (2004) 32 university of western australia law review 84. 23 the content of the letter of acceptance is discussed further below. 24 see section 23b of the wrongs act 1958 (victoria). 25 unfortunately for present purposes, for other reasons the case never went to trial. for more on the tapoohi case and the reasoning by the court, see below at 4.1., 4.2., and 5. 26 all of the said common law cases are dealt with further below. nordic journal of commercial law issue 2014#1 7 3 the basis for establishing liability claims against mediators it is neither in danish law, nor in any other legal system, entirely clear how claims against mediators for pure economic loss should be designated.27 as regards danish law this is hardly surprising given the fact that the boundaries among several different branches of the law are blurry. to foreign lawyers this lack of clarity may seem odd and in some respects perhaps it is. for example, to some extent it is odd that in danish law it is still disputed whether claims for personal injury made by employees against employers should be regarded as contractual or tortious. however, to a danish lawyer accustomed to the pragmatic nordic approach to the law, the said lack of clarity is not necessarily perceived as a flaw or as a lack of stringency in the law. in fact, many modern commentators see this open nature of the danish legal system as a way of promoting justice because care is taken to handle claims with due regard to the legal norms, which are most pertinent, instead of the norms applicable due to the designation of a certain claim under a certain heading.28 even though it is not clear on what specific grounds a mediator may be sued under danish law, it is clear that the claim must be established in contracts or torts. it is common for mediators to enter into a contract with the parties on how the mediation is to be conducted and sometimes the provisions of such contracts may themselves pave the way for establishing a claim. however, mediation contracts have certain characteristics which often make it difficult to base claims on the contracts as such. first of all, in the vast majority of the contracts the role of the mediator is only sparsely described and the provisions that actually do address what he should and should not do concern mostly procedural matters of a very general nature.29 for example, it is often specified that the mediator should be impartial, lead the case without deciding it, and ensure that the parties are treated equally.30 further, clauses on disclosure of conflicts of interest and confidentiality are common. in certain circumstances some of these provisions may be relevant in a liability context but they do not deal with the duties of the mediator in regard to the substance of the mediation (i.e. the disputed issue). for example, it is rarely specified to what extent (if any) the mediator should give advice on the merits of the dispute (e.g. how he understands the facts of the dispute) or how a certain regulatory framework should be construed. the latter could, for example, concern the interpretation of rules on accounting, on building a bridge or some other rule relevant to the 27 at common law this is e.g. reflected by the writings of andrew lynch and melinda shirley and tina cockburn, see the former author in ‘”can i sue my mediator?” finding the key to mediator liability’ (1995) australian dispute resolution journal 113. for the latter authors, see ‘when will a mediator operating outside the protection of statutory immunity be liable in negligence’ (2004) 32 university of western australia law review 83. 28 see e.g. ole hansen, det entrepriseretlige hjemmelsproblem (2008). 29 see michael moffitt, ‘suing mediators’ (2003) 83 boston university law review 163-164. 30 see further below part 4.1. nordic journal of commercial law issue 2014#1 8 dispute.31 second, the provisions in mediation contracts are normally quite vague and this also makes it difficult to ascertain what the legal implications of the contracts are. the little focus on the duties of the mediator in the contracts probably owes to the fact that the parties often do not consider it relevant to sue him for damages. perhaps most parties to mediations are not even aware of this feasibility.32 the failure to specify the duties of the mediator in the contracts may be problematic for an aggrieved party because it leaves merely a feeble contractual basis for raising a claim. however, it does not necessarily mean that the parties are precluded from raising claims in contract since such duties can be made clear by supplementing the contract with norms not expressly agreed upon by the parties. roughly, such norms can be inferred from the (hypothetical) will of the parties (i.e. what the parties in the circumstances would have agreed to) or some external source of law.33 the former way of inferring norms is most frequently used when there is something in the contracts (or in the prior negotiations) indicating what the intentions of the parties were, when they agreed upon them.34 if, for example, there is a preamble to the contract it may contain useful interpretative guidelines as to how a certain ambiguity should be settled.35 the same applies to the language of the contract, e.g. the parties’ use of headlines or certain words in certain contexts.36 the latter way of inferring norms is usually employed when there are no useful guidelines in the contract as to how a certain matter should be dealt with. in such cases the courts may apply norms, which do not stem from the parties themselves so to speak. this could be, for example, basic legal norms derived from legislation, case law, custom or literature.37 in a mediation context custom and literature seem particularly important sources of 31 the main reason for this is probably that most mediators (at least most danish mediators) consider themselves to be merely facilitators and not advisors as the facts or the rules applicable to a certain dispute. however, as we shall see below, sometimes the mediator transgresses the facilitative role set out in the agreement with the parties and somehow interferes with the substance of the dispute, cf. below at 4.1. regarding the tapoohi case. 32 see further michael moffitt, ‘suing mediators’ (2003) 83 boston university law review 151. 33 much has been written in nordic literature about this fundamental issue of contract law, see e.g. jan ramberg og christina ramberg, allmän avtalsrätt (8th edn, 2009) 153-156, jo hov og alf petter høgberg, alminnelig avtalerett (2009) 249ff, geir woxholth, avtalerett, (7th edn, 2009) 395ff and mads bryde andersen, grundlæggende aftaleret, (3rd edn, 2008) 315ff and 342ff. 34 see bernhard gomard, forholdet mellem erstatningsregler i og uden for kontraktforhold (1958) 64-65. 35 mads bryde andersen, grundlæggende aftaleret (3rd edn, 2008) 316. 36 the use of headings and perhaps a special use of certain words may indicate what the common will of the parties was when entering into the contract. but when it is not possible to establish that, the courts may choose to rely on an interpretation of the general semantics of the words employed in the contract. such interpretation is objective in the sense that it is based on what is commonly understood by the use of certain words as opposed what the parties meant by the them. on so-called linguistic interpretation, see mads bryde andersen, grundlæggende aftaleret ( 3rd edn, 2008) 320-322. 37 it is controversial whether literature is relevant in this respect. on the one hand, it is, of course, not a source of law in sensu stricto. but on the other hand it seems difficult to rule out that courts are sometimes persuaded by analysis or empirical research put forward in the literature. in the context of mediation, for example, it seems reasonable to assume that in order to ascertain what the customary behaviour of mediators is, the courts (to some extent) look at the existing literature on this particular issue. nordic journal of commercial law issue 2014#1 9 law in this regard. with respect to custom evidence of how mediators act can be derived from e.g. the many rules and standards adopted by (particularly) private organisations, cf. e.g. the rules for mediation adopted by the institute for mediation (danish: mediationsinstituttet)38 and the ethical guidelines of the association of danish lawyers acting as mediators (danish: danske mediatoradvokater).39 further, the extensive literature on how mediations are (and should be) conducted can be used to extrapolate relevant standards of behaviour. in most cases claims against mediators will probably be regarded as contractual. however, due to the special nature of the relationship between the mediator and the clients (including the fact that the mediator represents the interests of both parties) and the fact that the contractual basis from which the relevant legal norms can be extrapolated is usually very feeble, claims against mediators will often resemble claims in tort more than claims in contract. thus, for example, when the mediation contract (if there even is such a contract) is silent as to what the mediator should or should not do, the duties of the mediator will in most cases be determined in a way which is most familiar to tort law, i.e. on the basis of general societal norms of what good behaviour is. this is also reflected in below examination of the standard of care applicable to mediators which – due to the lack of pertinent norms in the contracts – is based on an approach which is most often used in torts (i.e. an approach where the relevant norms are inferred from different kinds of regulation and custom).40 due to the differences between contract law and tort law the question about the proper designation of claims raised against mediators (as either contractual or tortious) may be important in several respects.41 this is true with regard to e.g. the remedies available to the aggrieved party and the question of who bears the burden of proof.42 also, as will be further developed below, in some cases it makes a difference how a claim is designated when disclaimers are assessed.43 moreover, it is reasonable to say that liability is generally assessed more strictly way when the claim is considered to be contractual as opposed to tortious.44 however, due to said fact that normally only little relevant guidance on the duties of the mediator can be elucidated from the mediation contracts, in practice the precise designation of a certain claim will not make that much of a difference in 38 see http://www.mediationsinstituttet.dk/files/pdf/dk/mediationsinstituttets_regler.pdf. see further below at 4.1 39 see http://www.mediatoradvokater.dk/foreningen/etiske-regler.html. 40 see below at 4.1. 41 vibe ulfbeck, erstatningsretlige grænseområder (2nd edn, 2010) 27-28. 42 as a rule, in torts the burden of proof is on the claimant whereas in contracts it is often reversed, see e.g., torsten iversen, erstatningsberegning i kontraktsforhold (2000) 103 and vibe ulfbeck, erstatningsretlige grænseområder (2nd edn, 2010) 28. 43 vibe ulfbeck, erstatningsretlige grænseområder, (2nd edn, 2010) 28. 44 mads bryde andersen, advokatretten (2005) 761. nordic journal of commercial law issue 2014#1 10 most cases. at least not with regard to the fundamental requirements of liability to be examined here.45 4 mediator conduct and wrongfulness 4.1 the standard of care in regulation and custom 4.1.1 the standard of care if a claim against a mediator for pure economic loss is to succeed, first of all it is necessary to establish that he has somehow acted wrongfully. whether this is the case is determined according to the basic rule of culpa applicable in danish law. essentially, this makes it necessary to determine two things: first, it must be determined what standard of care that applies to mediators and second, it must be determined what it takes for the mediators’ conduct to contravene this standard in a way that triggers liability. as already pointed out, mediation contracts rarely specify the duties of the mediator in a way that affects how culpa is measured. this means that in most cases culpa will be determined pursuant to norms found in external sources of law rather than the contract. it is commonly accepted that the applicable standard of care can be determined in a subjective and an objective way.46 the two ways of measuring the standard are fundamentally different, but can be applied at the same time. in that way they can both support and contradict each other and the standard so set, may well be an eclectic product of the two.47 the subjective test is based on an assessment of what a reasonable person would do (or refrain from doing) in a given situation. thus, if a reasonable person would have anticipated that a certain conduct would cause damage such conduct is normally deemed wrongful.48 in this way the subjective test for culpa is an introspective and retrospective examination of what an ideal person would have done in a certain situation. there is no allowance for inexperience or any other subjective 45 however, as noted by iversen the requirement for adequacy may be interpreted less strict when there is a contract between the parties involved in a certain dispute, cf. torsten iversen, erstatningsberegning i kontraktsforhold (2000) 100-104. as rightly pointed out by iversen the basic reason for this is that the existence of a contract adds a certain proximity to the relationship between the parties which makes it reasonable to extent the limits of liability further than in tort law. 46 see bo von eyben og helle isager, lærebog i erstatningsret (7th edn, 2011) 86-87 and 88-106. 47 earlier it was generally accepted that both the subjective and the objective requirement had to be met in order for the tortfeasor to be held liable. however, perhaps due to the fact that tort law and criminal law are not as intimately connected as they were previously, today the two requirements seem to be alternative rather than cumulative. this appears from e.g. bo von eyben og helle isager, lærebog i erstatningsret, (7th edn, 2011) 86-87 where the authors speak of a traditional way of determining culpa as well as a modern way. see also andreas bloch ehlers, om adækvanslæren i erstatningsretten (2011) 53-65. 48 bo von eyben og helle isager, lærebog i erstatningsret (7th edn, 2011) 86-87. nordic journal of commercial law issue 2014#1 11 deficits for that matter.49 however, if the mediator positively professes to be or acts as if he is an expert in a particular area, a higher standard may be expected.50 pursuant to the objective test the standard of conduct is fixed on the basis of norms laid down in some kind of regulation or custom.51 such regulation can be derived from norm-giving institutions (such as legislation, ministerial orders, and government circulars) or from private parties. examples of the latter could be standards of conduct for mediators or ethical guidelines adopted by various organisations. in this way the standard of care is determined according to actual rules of conduct, which can be identified by examining said regulation. sometimes rather detailed norms for what acceptable behaviour is, can be extrapolated on this basis. this appears from, for example, the danish road traffic act52, which comprises meticulous rules on how e.g. motorised vehicles should be operated.53 when said act applies it is often uncomplicated to ascertain what is right and wrong behaviour. for example, it appears from section 21(1) that normally cars should be overtaken from the left hand side and failure to observe this rule will in far the most cases be wrongful. when the norms are derived from legislation often the courts will apply them immediately (i.e. without inquiring whether they actually do express the relevant standard of behaviour). this is not the case when the norms are based on private regulation. in such cases the courts may well require more (or less) of the conduct of the promisor or tortfeasor. this shows that also the objective test is a legal standard and not a mere sociological product of certain norms applicable in society. the basic rule of culpa does seem to offer some useful guidance for assessing the standard of care applicable to mediators. this applies particularly to the objective test, whereas the subjective test in many cases seems too vague to give concrete directions in practice.54 the value of the objective test lies in its ability to explain how a variety of different norms stemming from different kinds of sources impact on how the standard of care is determined. as already said, in a mediation context the most important such sources seem to be regulation (either public or private) and custom (i.e. established practices of mediation). the feasibility of extrapolating relevant norms from these two sources is examined below. 49 see e.g. henry ussing, skyld og skade (1914) 42 and andreas bloch ehlers, om adækvanslæren i erstatningsretten (2011) 55. 50 see stig jørgensen, erstatningsret (2nd edn, 1972) 76. 51 bo von eyben og helle isager, lærebog i erstatningsret (7th edn, 2011) 88-106. 52 consolidated act no 1047of 24 october 2011. 53 see andreas bloch ehlers, om adækvanslæren i erstatningsretten (2011) 60 and bo von eyben og helle isager, lærebog i erstatningsret (7th edn, 2011) 89. 54 on the difficulties of applying a subjective test to determine the limits of liability, see andreas bloch ehlers, om adækvanslæren i erstatningsretten (2011) 118-147. much of the critique launched here is applicable to the subjective test employed to determine the standard of care. nordic journal of commercial law issue 2014#1 12 4.1.2 regulation as already said, in danish law there is no domestic legislation setting out rules of conduct for mediators acting out of court. however, there are several rules and codes of conduct, which can help determine the standard of care in accordance with the objective test. these rules emanate from the supranational level as well as the national level. with respect to the former the european parliament and the council of the european union have adopted a directive on certain aspects of mediation in civil and commercial matters.55 further, a european code of conduct for mediators has been adopted by the eu.56 the purpose of the directive is to establish a predictable legal framework for mediation57 and better access to justice by promoting adequate dispute resolution processes for individuals and businesses (in cross border disputes).58 article 3 (b) of the directive comprises a definition of what a mediator is and in article 4 certain provisions for ensuring the quality of mediation is set out. with respect to the latter it appears, among other things, that ‘member states shall encourage, by any means (…) the development of, and adherence to, voluntary codes of conduct by mediators and organisations providing mediation services, as well as other effective quality control mechanisms concerning the provision of mediation services.’59 further, it appears that initial and further training of mediators should be encouraged in order to ensure that the mediation is conducted in an effective, impartial, and competent way in relation to the parties. the said code of conduct contains provisions regarding (i) the competence and appointment of mediators, (ii) their independence and impartiality, and (iii) the procedure. section 1(1) sets out that mediators must be competent and knowledgeable in the process of mediation. this necessitates proper training and continuous updating of their education and practice in mediation skills, having regard to any relevant standards or accreditation schemes. according to section 1(2) the mediator must verify that he has the appropriate background and competence to conduct a mediation before accepting the appointment. upon request, any information concerning their background and experience must be disclosed to the parties. with respect to independence and neutrality it appears that if there are any circumstances that may, or may be seen to, affect a mediator’s independence or give rise to a conflict of interests, he must disclose those circumstances to the parties. such circumstances, it appears, may be a personal or business relationship with one or more of the parties or financial or other interests in the 55 directive 2008/52/ec of the european parliament and of the council of 21 may 2008. the directive is not applicable to danish law, cf. article 1(3) of the directive. for further information see also the ministry of justice’s paper of 23 february 2005 on the (then merely proposed) directive at http://www.euo.dk/upload/application/pdf/780271ac/20040718_1.pdf. even though the directive does not apply to danish law it is interesting that on the eu level also efforts are made to enhance access to justice by promoting mediation as a dispute resolution mechanism. 56see preamble of above directive at 17. the code of conduct is available at http://ec.europa.eu/civiljustice/adr/adr_ec_code_conduct_en.pdf. 57 see the preamble to said directive at 7. 58 see article 1 (1) of the directive. 59 see article 4 (1) of the directive. nordic journal of commercial law issue 2014#1 13 outcome of the mediation. the same applies if the mediator (or a member of his firm) has previously conducted a mediation for any of the parties. further, it is specified that a mediator shall at all times act, and endeavour to be seen to act, with impartiality towards the parties and be committed to serve all parties equally with respect to the process of mediation. regarding procedure, it is, inter alia, set out that the mediator must ensure that all parties have adequate opportunities to be involved in the process. further, he must inform the parties (and he may terminate the mediation) (i) if a settlement is being reached that appears unenforceable or illegal or (ii) if the mediator considers that continuing the mediation is unlikely to result in a settlement. furthermore, the mediator must take all appropriate measures to ensure that any agreement is reached by all parties through knowing and informed consent, and that all parties understand the terms of the agreement. the parties may withdraw from the mediation at any time without giving any justification. last, the mediator must, upon request of the parties and within the limits of his competence, inform the parties as to how they may formalise the agreement and the possibilities for making the agreement enforceable. with respect to the national level both private and public initiatives to furnish rules on the conduct of mediators can be identified. among the former, the ethical guidelines of the association of danish lawyers acting as mediators are important.60 for present purposes the most relevant provisions concern (i) the role and neutrality of the mediator, (ii) the duty of confidentiality, (iii) the drafting of the agreement, and (iv) the termination of the mediation. pursuant to section 1 regarding the basic principles of the mediation the mediator’s role is to help the parties resolve the dispute at hand without deciding about the case. further, it appears that the mediator is not obliged to address strengths or weaknesses in the factual assertions or legal argumentation of the parties. nor is he obliged to interfere if the parties reach a settlement, which does not correspond to the most likely outcome of court proceedings or arbitration.61 all information received by the mediator during the mediation (including at separate meetings) is confidential.62 from section 5 it appears, inter alia, that the mediator must abide by the law and that he must have completed a certain special training in dispute resolution.63 moreover, in the organisation of the process the mediator must pay due consideration to making progress in resolving the dispute. section 2 lays down certain provisions on neutrality, impartiality and independence. inter alia, it appears that the mediator must inform the parties of any circumstances, which could influence his neutrality, impartiality or independence. finally, section 3 contains provisions concerning the parties’ rights be assisted by their respective lawyers in the mediation. as a rule the parties may be assisted by lawyers and they may at any time consult with them. among other private initiatives the rules 60 see above at part 3 (fn 30). 61 see section 1 (5). 62 see section 1 (2). 63 see sections 4 (1) and 4 (5). nordic journal of commercial law issue 2014#1 14 for mediation adopted by the above mentioned institute for mediation.64 these rules largely contain provisions similar to above-mentioned ethical guidelines adopted by the association of danish lawyers acting as mediators. the same applies to the public initiatives, which include the new ethical rules for court appointed mediators65 and the rules on mediation 2010 of the danish institute of arbitration.66 the regulatory framework outlined above provides a good overall idea of what mediators are expected to do. further, the high degree of convergence in the contents of the rules suggests that most of them are generally accepted in the mediation community and perhaps even society at large. this makes it likely that the courts will take them into consideration when laying down the applicable standard of care. for example, it seems clear that the prevalent rules on the mediator’s role, competence, impartiality, and confidentiality will be taken into consideration. however, for several reasons the potential of the regulatory framework for determining the standard of care seems limited. first and foremost the scope of the rules is limited. this appears from the fact that they almost exclusively deal with the limited range of issues mentioned above. thus, similar to the provisions of the mediation contracts, the rules mostly deal with procedural matters whereas the mediator’s duties in respect of the substance of the conflict are ignored. for example, it is not specified in any detail how (and to what extent) he should interfere with the substance of the conflict e.g. by sharing his opinion on the facts of conflict or giving advice on pertinent rules. in at least some mediations the mediator will in some way (deliberately or not) deal with the substance of the conflict and therefore, an important part of what mediation is about is not dealt with.67 this is of course problematic and as a consequence what the duties of the mediators are in this respect must be established on a different basis (i.e. primarily custom, cf. below). second, the rules that actually do appear from the regulatory framework are defined rather vaguely. for example, it appears, from the ethical guide lines of the association for danish lawyers acting as mediators that the mediator’s role is to help the parties resolve the dispute at hand and advance the resolution process as quickly as possible.68 this very broadly stipulates what the role of the mediator is but it says little about his concrete duties. it appears that he should not decide the case but this merely reiterates the (obvious) fact that it is ultimately for the parties to agree on a settlement and therefore, it is difficult to see how it can 64 see above part 3. 65 this set of rules was drafted by a working group of court-appointed mediators. thus, this set of rules, which applies to court mediation conducted in pursuance of chapter 27 of the administration of justice act (consolidated act no 1139 of 24 september 2013) only, also contains provisions on inter alia (i) the role of the mediator, (ii) neutrality and impartiality, (iii) duty of confidentiality, and (iv) termination of the mediation process. 66 see http://www.voldgiftsinstituttet.dk/en/menu/mediation 67 mediators subscribing to the facilitative tradition will probably deny that such interference with the substance is taking place and in most cases perhaps rightly so. however, as evidence by the tapoohi case, in which (as will become apparent below) the mediator claimed to be merely a facilitator in his letter of acceptance, at least in some cases it will be difficult even for facilitative mediators not to interfere with the substance of the dispute to some extent. 68 see sections 1(1) and 4(2). nordic journal of commercial law issue 2014#1 15 contribute to setting the applicable standard of care. it seems that almost any way of conducting mediations may correspond with said rule. the same applies to several of the other rules. third, some of the rules do not in any case appear relevant in a liability context. for example, it is doubtful if what is said about the mediator having to complete certain training is relevant.69 of course it indicates that he must possess a certain level of proficiency but failure to complete a certain training program will not itself give rise to liability. what is relevant in that respect is how he actually conducts himself in the mediation.70 last, even though the rules reflect duties that seem to be broadly accepted, it should be borne in mind that most of them stem from private organisations and not the legislature. 4.1.3 custom the limited potential of regulation to specify the standard of care makes it necessary to look for other ways to establish what the mediator should and should not do. in the literature, it has been suggested that, when there is no firm regulation, the standard of care can be determined on the basis of how reasonable mediators actually behave (i.e. according to custom).71 this way of determining the standard is of course well known but due to the stylistically varied and complex nature of mediation (including the many different schools of mediation) it seems difficult to extrapolate clear guidance on this basis.72 to overcome this problem it has been suggested to differentiate or break down the standard of care to reflect the different models of mediation.73 the rationale is that it is possible to ascertain the duties of the mediator more precisely by exploring the customary behaviour of each model. for example, it has been argued that the duties should be established taking into account whether the mediation is facilitative or evaluative.74 schulz gives the following example of this: ‘if it is the custom of all mediators of a certain school, such as facilitative mediation, in a specific practice area, such as small claims court mediation, not to mediate cases involving violence between intimate partners and a mediator of that school and practice area mediates such a case, that mediator has breached the 69 see section 4(5) of the ethical guidelines of the association for danish lawyers acting as mediators. 70 see below at 4.2 regarding breach of the standard of care. 71 jennifer l. schulz, ‘mediator liability: using custom to determine standards of care’ (2002) 65 saskatchewan law review 163ff. 72 the stylistically varied and complex nature of mediation is evidenced well by the large amount of literature on what mediation is or should be, see e.g. hans boserup, konfliktvindere (1993), cyril chern, dispute resolution guides. international commercial mediation (2008), hans boserup og susse humle, mediationsprocessen i praksis (2nd edn, 2012) and vibeke vindeløv, konfliktmægling. en refleksiv model (3rd. rev. edn, 2013). 73 see jennifer l. schultz, ‘mediator liability: using custom to determine standards of care’ (2002) 65 saskatchewan law review 163, 66, and 169. 74 very broadly it seems to be generally accepted in the literature that there are two major approaches to mediation; the facilitative and the evaluative. roughly, the facilitative model is process-oriented and focuses on interest-based problem solving. in this model the main role of the mediator is merely to promote the negotiation process and to encourage the parties to create a settlement that reflects mutual interests. conversely, the evaluative model is of a more substance-oriented nature in that the mediator interferes with the dispute as such. nordic journal of commercial law issue 2014#1 16 customary standard of care.’75 breaking down the standard of care may certainly help clarify the duties of the mediator and therefore, this way of dealing with the issue deserves support. that being said it should be borne in mind that it is difficult to establish what the customary behaviour of even a particular model of mediation is. in the abstract certainly useful distinctions can be made between e.g. facilitative and evaluative mediation but it seems folly to believe that clear guidelines can be extrapolated from this bipartition of the practice of mediation.76 further, there are many more models (or schools) of mediation and an even greater number of special settings in which mediations take place and this of course makes it even harder to lay down accurate standards. schulz argues that this multiplicity of mediation is not problematic because it “is acceptable to have more than one standard of care when there is more than one practice being evaluated.”77 but this is not entirely persuasive. it is true that standards of care need to be differentiated according to the area of practice in question. indeed this is a common place way of clarifying standards of care in tort law. for example, there are different standards for people working in the field of law and medicine and even within these fields differentiations are made. this is also pointed out by schulz who notes that e.g. different standards apply to doctors and chiropractors even though they both work within the field of medicine. however, this does not cart off the fact that what is acceptable behaviour for professionals such as lawyers, doctors, and chiropractors is much better established than what is acceptable within certain kinds of mediation. moreover, the demarcations among said professions seem much more robust than the corresponding demarcations among the different models of mediation. the most important reasons for this are probably the long standing of these professions and the strong body of regulation applicable to them. another reason why it is difficult to establish clear standards even within the different models of mediation is that in practice a competent mediator must be expected to always adapt his services to the circumstances of the actual dispute. all of his actions therefore, can rarely be fitted into a particular model or school of mediation. for example, some actions may be “facilitative”, others may be “evaluative” and sometimes the mediator could probably even shift completely from one school to another. this is also a feature of mediation, which does not apply to the same extent to above professions. not even within the same field. for example, a chiropractor may only perform a limited number of services also provided by doctors. the point in question is well illustrated by the facts of the tapoohi case.78 in an initial letter to the parties, the mediator explained the mediation process and his role as follows: 75 jennifer l. schulz, ‘mediator liability: using custom to determine standards of care’ (2002) 65 saskatchewan law review 172. 76 see also andrew lynch, ‘“can i sue my mediator?” – finding the key to mediator liability’ (1995) australian dispute resolution journal 121. 77 jennifer l. schulz, ‘mediator liability: using custom to determine standards of care’ (2002) 65 saskatchewan law review 173-174. 78 no 2 [2003] vsc 410 (21 october 2003). nordic journal of commercial law issue 2014#1 17 ‘i confirm that the aim of the mediation conference is to assist the parties in reaching a settlement of their dispute by the involvement of an impartial mediator. it is not the role or function of a mediator to impose a settlement on the parties. it is up to the parties to arrive at their own resolution of the dispute. the purpose of the mediator is to assist the parties to define the issues, eliminate obstacles to successful communication, explore settlement alternatives, and generally work with the parties to achieve a negotiated resolution.’79 this definition much resembles the definition of facilitative mediation, where the main role of the mediator is to conduct the process and to maintain a constructive dialogue between the parties. however, the mediator clearly exceeded the stipulated facilitative role by undertaking to dictate the terms of the settlement agreement and insisting that the agreement be signed before the mediation was adjourned. from the affidavit given by one of ms tapoohi’s legal advisors, mr shiff, it appears that the mediator said such things as: ‘you have got to stay, you have got to do the terms of settlement tonight. no, we are doing it now. we are signing up tonight as that is the way that i do it, that’s how i conduct mediations. given the acrimony between these two sisters we must go away with something that is written. it is in the interests of all the parties to sign up tonight.’80 ‘we will now put together the terms of settlement and i will dictate them.’81 further, the mediator expressed his legal view on stamp duty issues relating to the transfer of certain properties and suggested that for tax purposes the consideration for certain shares to be transferred from ms tapoohi to ms lewenberg should be fixed at one dollar.82 as it appears, due to, among other things, the acrimony between the sisters, the mediator deviated from the facilitative starting point expressed in his letter and adopted a highly evaluative approach by dictating the settlement agreement and giving advice on tax issues. therefore, the tapoohi case is a good example of how the stylistically varied nature of the mediator’s role adds to the problems of laying down accurate standards of care. some further attempts have been made to find a feasible way of specifying the duties of the mediator. for example, it has been sought to identify certain “core” duties applicable to mediators and to some extent this approach seems to have been employed in chang where it was said that ‘[t]he role of a mediator is often that of the honest broker who must suggest a solution giving advantage to both sides and minimizing the 79 no 2 [2003] vsc 410 (21 october 2003) at 16. 80 no 2 [2003] vsc 410 (21 october 2003) at 27. 81 no 2 [2003] vsc 410 (21 october 2003) at 29. 82 no 2 [2003] vsc 410 (21 october 2003) at 24 and 31. nordic journal of commercial law issue 2014#1 18 price that each must pay.’83 however, this way of dealing with the problem seems susceptible to largely the same criticisms as above. this appears also from said quote of the chang court, which basically merely reiterates what is quite obviously the overall role of the mediator. in fact what is said here seems to follow almost immediately from what is denoted by the word “mediation”. in sum, at least at this stage it does not seem feasible to lay down a predetermined and conclusive standard of care for mediators. rather, in each case the courts must set the standard by taking into account the unique circumstances at play. this seems also to be the conclusion of the court in chang, who noted that “[t]here is almost no law on what the appropriate standard of care is, if any, for a mediator who helps negotiate a settlement between parties.”84 admittedly, this makes it difficult to assess and predict how the mediator should conduct himself in order not to be exposed to liability and of course this lack of transparency in the law is unsatisfactory. 4.2 breach of the standard of care what has been said about the standard of care pertains to what behavioural norms the mediator must observe. the problem to be examined here concerns what it takes for the mediator’s conduct to contravene the applicable standard in a way that allows for liability to ensue. this problem is strictly speaking fundamentally different from the former. it is the firm rule of danish law that the promisor or tortfeasor should somehow be to blame for contravening a certain norm in order to be liable. this applies to norms derived from the will of the parties (e.g. norms based on a contract) as well as norms derived from other sources such as regulation and custom. with respect to contraventions of the former norms this appears e.g. from section 42 (2) of the domestic danish sale of goods act85 which sets out that the seller is liable to pay damages, if the lack of conformity of specific goods was caused by his neglect or fraudulence.86 the said rule constitutes a basic tenet of danish contract law which is applicable by default, unless otherwise indicated by legislation or case law. thus, it applies – mutatis mutandis to many other areas than the sale of goods such as for example the liability of service providers and advisors. due to the lack of special rules for mediators it will apply to this area also. with respect to violations of the latter norms, the requirement for blameworthiness (in shape of either negligence or intent) appears from the rule of culpa laid down in case law.87 83 216 f. supp. 2d 325 (20 august 2002) at 333. the chang court said this with reference to the decision in re joint eastern and southern districts asbestos litig., 737 f. supp. 735, 739 (e.d.n.y. 1990). 84 216 f. supp. 2d 325 (20 august 2002) at 332. 85 consolidated act no 237 of 28 march 2003. 86 in said section it is also specified that the buyer can claim damages if the goods lacked qualities warranted by the seller. 87 se e.g. andreas bloch ehlers: om adækvanslæren i erstatningsretten (2011) 53-65. nordic journal of commercial law issue 2014#1 19 above it has been examined how the standard of care is laid down according to this rule, but this is not all it does. also it contains a subjective requirement. this means that a mediator (in the outset) can be held liable only if (i) he has violated the applicable standard of care and (ii) such violation is somehow intended or negligent. what has just been said is still the firm rule of danish law. however, in recent years (particularly with respect to violations constituting a tort) there has been a development in case law towards what is usually called an objectification of the rule of culpa.88 essentially, this means that the subjective requirement has been relaxed and in some cases even eliminated. sometimes, therefore, the courts may require only little of the blameworthiness of the tortfeasor’s behaviour and in rare cases they may require nothing at all. in the latter case the mere contravention of the applicable standard is sufficient to constitute liability.89 with respect to the liability of mediators what constitutes a breach of the standard of care first of all depends on how courts perceive the practice of mediation as such. more specifically it is important whether it is perceived as a proper profession (equivalent to e.g. lawyers, accounts, and doctors) or not. if the former is the case, as a rule the courts will not ask much, if anything, of the mediator’s fault to find liability.90 thus, within this area the development towards an objectified rule of culpa has been prevalent. the areas in which the courts have relaxed the subjective requirement have several common features. first, the professionals in question supposedly possess a certain knowledge or skill typically offering them a position which is superior to that of their clients.91 for example, it is often difficult for the average patient to comprehend everything a doctor is saying or doing and this is a (good) reason to incite the doctor to make efforts not to cause damage. it is probably fair to say that to some extent mediators do hold such superior knowledge. at least with respect to what they are supposed to do and that is what is relevant here. different people make use of mediation, but the average client probably does not know much about what a mediator is expected to do. further, some of the time probably the client will not even know what the mediator is doing (e.g. when he is having a separate meeting with another party). this makes him even more inferior in the present respect. second, said areas are characterised by having a special tradition and often quite comprehensive and well defined standards of behaviour. with respect to doctors, for example, there is a long standing tradition of how certain operations should be performed and what medicine should 88 see bo von eyben og helle isager, lærebog i erstatningsret (7th edn, 2011) 88-89 and 105-106 and andreas bloch ehlers, om adækvanslæren i erstatningsretten (2011) 59-65. 89 in such cases the subjective requirement is completely eliminated, see andreas bloch ehlers, om adækvanslæren i erstatningsretten (2011) 59-65. 90 vibe ulfbeck, erstatningsretlige grænseområder (2nd. edn, 2010) 32. 91 bernhard gomard, forholdet mellem erstatningsregler i og uden for kontraktforhold (1958) 365 and mads bryde andersen, advokatretten (2005) 752. nordic journal of commercial law issue 2014#1 20 be prescribed in certain situations. further, there is a detailed web of express rules on how doctors should conduct themselves. strictly speaking mediation is an old practice as well but it has not become popular as a method of dispute resolution in modern society until fairly recently. for that reason there has not been the same centripetal development in the understanding of how mediations should be conducted, as has been the case with e.g. the practice of medicine. furthermore, in the area of mediation, there is not a strong institutional edifice similar to that of many other professional settings. in particular, there are no institutions with a mandate to issue binding rules or guidelines as to how mediations should be carried out. neither is there one set of rules applicable to all kinds of mediation. this is not surprising since the practice of mediation is not as homogenous as for example above professions. the existence of a firm tradition and a clear and generally applicable regulatory framework seems to be a necessary prerequisite for the courts to relax the requirements for blameworthiness and adopt an objectified interpretation of the rule of culpa. the main reason for this is that the justification for adopting such interpretation lies in the very existence of more or less firm rules clarifying what the professional should and should not do. further, it seems difficult to even establish an objectified application if there is in fact no (or only few) appropriate rules with which the conduct of the professional can be compared. due to the lack of both traits (i.e. a strong tradition and an appropriate regulatory framework) it seems unlikely that the court will transplant the objectified interpretation of the rule of culpa to mediation. consequently, it must be assumed that the courts will require some amount of fault of behalf of the mediator to establish liability. in fact (as will be further developed below) probably in many cases the courts will be prone to require quite a lot in this regard. what is required of the subjective element of the rule of culpa could depend also on what appears from the (potential) contract entered into by the mediator and the parties. whether or not the contract is relevant in this regard depends first on how the pertinent claim is qualified. if it is qualified as a contractual claim, as a rule the parties will be entitled to agree on whatever the wish.92 save for, inter alia, when liability is attached to professionals but, as developed above, mediators are unlikely to be qualified as such. conversely, if the claim in question is qualified as a claim in torts the legal rights and duties of the parties are determined according to external norms founded in e.g. regulation or custom. in such cases the rule is that liability is not subject to any contractual provisions.93 pursuant to what has been already said, if there is indeed a contract probably most claims will regarded as contractual. this means that in the outset mediators are able to contract on what should constitute a breach of a certain standard. however, it is important to note that many claims will not be based on violations of express contractual provisions, but externally founded norms characteristic to the normative framework of torts. accordingly, a great deal of the rights and duties of the parties will be fixed not by the 92 vibe ulfbeck, erstatningsretlige grænseområder (2nd edn, 2010) 37. 93 vibe ulfbeck, erstatningsretlige grænseområder (2nd edn, 2010) 37. nordic journal of commercial law issue 2014#1 21 will of the parties, but by said norms. this makes it likely that the courts will be somewhat hesitant to subject their interpretation of the rule of culpa to the contract. at least if the contract is not clear on this matter. further, it should be borne in mind that the subjective element of the rule of culpa (notwithstanding the recent development towards objectification) represents a basic tenet of law. thus, normally there will be an inclination to impose liability when a promisor or a tortfeasor has acted with fault. of course, this inclination will vary with the pertinent amount of fault. it is important to take the above considerations into account when the effectiveness of contractual provisions are assessed. as it appears the courts are not likely to transplant the objectified interpretation of the rule of culpa to the liability of mediators. further, in many cases probably they will be likely to interpret any contractual provisions to the opposite effect, narrowly. this means that normally the courts will require some amount of blameworthiness on behalf of the mediator. many different kinds of behaviour qualify as sufficiently blameworthy to this effect. for example, the mediator simply may not have made sufficient efforts to structure the negotiations and pave the way for a settlement. or he may have lacked the skill to do this. perhaps he did not have sufficient knowledge on a certain matter or he did not acquire the necessary information from someone else. further, he may have lacked the skill to apply a certain knowledge or piece of information properly to the situation at hand94 or he may have drafted the settlement agreement ambiguously. exactly how much will be required of the mediators neglect is a difficult question to answer. it could be argued that even though mediation cannot be qualified as a proper profession, its quasi-professional nature (due to the mediator’s supposed superior knowledge) still counts as argument for lowering the requirements for fault. however, this argument is not a particularly good one and indeed there seem to be better arguments to the opposite effect. first, the significant doubts as to how mediators should conduct their business is likely to influence the courts. thus, at least when the courts are uncertain as to how the mediator should have behaved in a certain situation they will be inclined to require a somewhat greater degree of fault. second, it should be borne in mind that the claims in question are claims for pure economic loss. in contract law most claims are of this kind and it is of course not controversial that they can be recovered. however, as developed above, many claims against mediators have traits that resemble claims in tort more than claims in contract (first and foremost because of nature of the applicable normative framework) and this may prompt the courts to require more of the fault of the mediator than usual. the reason for this is that danish courts, similar to most other civil law courts and indeed the common law courts, are somewhat reluctant to award damages for pure economic loss in tort. as in apparently most other jurisdictions this is based on a concern for not extending liability too far and to counter this, recovery for pure economic loss usually requires special reasons. with respect to mediators such a reason could well take the form of a greater requirement for fault. third, there are certain considerations regarding particularly contributory negligence which 94 see bernhard gomard, forholdet mellem erstatningsregler i og uden for kontraktforhold (1958) 400. nordic journal of commercial law issue 2014#1 22 may influence the courts assessment in said way but this discussion is better left to the below discussion about causation in fact. for the said reasons, in most cases a breach of the standard of care must be somehow qualified in order for the mediator to become liable. this appears also from most of the cases on mediator liability. for example, in chang, where the claimant alleged, inter alia, that the mediator had failed to investigate critical facts and drafted the settlement agreement in a way that allowed the defendant to contest the amounts owed according to, the court found that the mediator’s duty was merely to find an amicable solution to the conflict at hand and the mediator did not fail to satisfy this duty as he brought the parties together and successfully drafted an agreement that was executed by them.95 thus, even though the mediator should have probably drafted the settlement agreement more clearly, the court required more than this. also, the case is a good example of the importance of what the court considers to be the duties of the mediator. chang seems to suggest that as long as the mediator brings the parties together and achieves a settlement, the parties will have a difficult time claiming damages. the same follows from lehrer where the court noted that ‘the evidence proves that zwernemann fulfilled his primary obligation as a mediator to facilitate a settlement. in fact, as a result of the mediation, appellant entered into a voluntary settlement agreement, in which he agreed to dismiss his legal malpractice claims against his attorneys. in return, his attorneys dismissed their counter-claims against him for unpaid attorneys’ fees.’96 so in this case also, the mediator had performed his primary duty of achieving a settlement, which was signed by the parties. however, as evidenced by the tapoohi -case, the mediator does risk liability if he exceeds the role of the facilitator and somehow interferes with the substance of the dispute at hand. thus, in tapoohi the mediator interfered by (i) putting pressure on the clients to sign, (ii) dictating the settlement agreement, and (iii) expressing his views on stamp duty and how the agreement should be set up to minimise taxes. this led the court (habersberger j) to conclude that it could not be ruled out that mrs tapoohi could claim against the mediator: ‘i have reached the conclusion that it is not beyond argument that some at least of the breaches of the contractual and tortious duties might be made out. i consider that it is possible that a court could find that there was such a breach constituted by the imposition of undue pressure upon resistant parties, at the end of a long and tiring mediation, to execute an unconditional final agreement settling their disputes where it was apparent that they, or one of them, wanted to seek further advice upon aspects of it, or where it was apparent that the agreement was not unconditional, or where the agreement was of such 95 see 216 f. supp. 2d 325 (20 august 2002) at 332: ‘(…) the parties explicitly retained rubin [the mediator] not to provide legal assistance but rather to “assist [the parties] in finding an amicable resolution to [their] differences relating to the trademark margaret jerrold (…). there can be no claim that rubin failed to satisfy this duty because rubin did assist in bringing these parties together and did successfully draft an agreement that was executed by both parties and that settled their dispute.’ 96 14 s.w. 3d 775 (17 february 2000) at 777. nordic journal of commercial law issue 2014#1 23 complexity that it required further consideration. i emphasise that it is not for me to conclude that any of these things occurred in the present case and i do not do so. it is sufficient that i conclude, as i do, that on the evidence before me such a contention is not plainly hopeless.’97 even though tapoohi was merely decided in a interlocutory decision and never went to trial, the court’s findings show that it is at least possible to claim against a mediator. however, it seems to show also that it will require the mediator to exceed the mandate given by the clients to a considerable extent. 5 causation in fact to establish a claim, the client must demonstrate that there is a certain (normally referred to as factual) causal nexus between the mediator’s breach of the standard of care and the loss in question. the point of departure for the causal assessment therefore is the breach of standard. as already said such breaches may occur in many different ways. for example the mediator may have made insufficient efforts or lacked the skill to structure the negotiations and pave the way for an amicable solution. or he may simply have offered one or more of the parties poor advice or failed to obtain sufficient advice elsewhere. of course any contravention of the mediator’s duties may constitute a breach and thus many more examples can be conjured up. the mediator could e.g. exceed the mandate set out in the mediation agreement, as was the case in tapoohi. he could make mistakes in the drafting of the settlement or fail to observe his duties regarding neutrality and confidentiality. the loss suffered by the client will usually be some kind of pure economic loss. for example (and perhaps most importantly) a client may suffer an economic loss due to non-settlement or settlement on unfavourable terms. further, a client may suffer loss of earnings or good will (e.g. if the mediator leaks confidential information to someone). as a rule, the establishment of a sufficient causal nexus between the breach of standard and the loss requires that the former was a necessary condition of the latter. there is (still) general agreement that this is decided pursuant to the conditio sine qua non -rule laid down in case law.98 97 no 2 [2003] vsc 410 (21 october 2003) at 86. 98 however, it is worth noting that the american scholar, richard w. wright, has formulated an alternative to the conditio sine qua non-test, the so-called ness-test, which seems to be accepted in the literature to a still greater extent. on the ness-test see richard w. wright, ‘causation, responsibility, risk, probability, naked statistics, and proof: prunning the bramble bush by clarifying the concepts’ (1987-1988) 73 iowa law review 1001ff and ‘once more into the bramble bush: duty, causal contribuiton, and the extent of legal responsibility’ (2001) 54 vanderbilt law review 1071ff. in the nordic literature the primary proponent of the ness-test seems to be mårten schultz who has examined it at length in kausalitet: studier i skadeståndsrättslig argumentation (2007). further, the ness-test seems to appear more and more frequently in recent nordic literature, see e.g. mia carlsson, arbetsskada (2008) 386ff. nordic journal of commercial law issue 2014#1 24 at the outset this means that acts (or omissions) are regarded as a relevant cause of a certain loss, if this loss would not have occurred but for said acts (or omissions). this was the central issue in lehrer where the claimant merely stated that he would not have agreed to permit mr zwernemann to act as mediator had he been aware of the conflict of interest. however, he did not state that he would not have entered into the settlement agreement if he had been aware of said conflict and therefore, no causal nexus could be found between the alleged negligent conduct of the mediator and the alleged loss. as it appears the sine qua non -rule constitutes a counterfactual test, whereby the sufficiency of the causal nexus is assessed by testing the actual causal event against a hypothetical event. further, the minimalist counterfactual requirement, which makes any cause having somehow contributed to the damage legally relevant, means that in most cases there may be several different causes to a certain event. strictly speaking, as observed by von bar, a simple car crash may in principle – in addition to the driver’s failure to break – be caused by ‘the weather, the drivers’ breakfast, the programme broadcast on the radio, or the drivers’ spouse’s tempers.’99also, many different kinds of causes can be relevant in this way. this includes not only physical manifestations but also psychological factors such as instigation and advice.100 the minimalist requirements of the sine qua non -rule means that, as a rule, the courts will not require much to find that a certain breach of standard is a relevant cause, for which the mediator may be held liable. however, for a couple of reasons to be explained further below, the idiosyncrasies of the mediation set up may often supply the client with good arguments to the contrary effect. for example, the raison d’être of mediation is that ultimately the settlement is reached by the parties themselves and of course this makes it relevant to consider whether the mediator’s contribution to the loss in question should be deemed relevant in comparison with the parties’ own contribution. the following analysis will focus on the two damage scenarios that seem most important and unique to mediation. the first scenario is when the parties fail to reach a settlement and the second is when the parties settle on unfavourable terms. in the former scenario in order to establish causation, first a client must demonstrate that the mediator caused the parties not to settle (i.e. that the parties would have actually settled “but for” the negligent conduct of the mediator). at the outset to establish this causal link poses formidable problems as it involves constructing a hypothetical scenario on a highly speculative basis. most importantly perhaps, some cases simply cannot be mediated.101 for example the parties may have had better alternatives to a mediated agreement or perhaps the acrimony between the parties was too vocal to be overcome. in other cases, the failure to settle may be due to strategic or tactical decisions beyond the influence of the mediator.102 in this regard it is important to remember that the hallmark of mediation is that 99 christian von bar, the common european law of torts (2000) 459. 100 see e.g. andreas bloch ehlers, om adækvanslæren i erstatningsretten (2011) 47. 101 see michael moffitt, ‘suing mediators’ (2003) 83 boston university law review 176. 102 see michael moffitt, ‘suing mediators’ (2003) 83 boston university law review 176. nordic journal of commercial law issue 2014#1 25 the settlement is reached by the parties – not the mediator.103 this means that even a perfectly conducted mediation may result in a non-settlement. notwithstanding said obstacles sometimes a party may successfully establish the required causal nexus. this could e.g. be the case when the mediator has acted extraordinarily incompetently by basing the negotiations on an incorrect assumption made by himself. the mediator may, for example, have wrongfully set off the negotiations on the assumption that a certain piece of legislation allowed the parties to do something – such as tearing down a building or deducting a certain expense in taxes – which later proved impossible. another example of this could be neglect of the mediator’s duties to remain impartial and keep information confidential. in such cases – for example if the mediator reveals an important business secret of one party to another party – it could well be imagined that a non-settlement could be traced back to the conduct of the mediator as set out by the sine qua non -rule. thus, it is not impossible to establish that the mediator caused the non-settlement. establishing that the mediator somehow caused the parties not to settle is a necessary requirement for a party to recover. however, it is not sufficient. also, the aggrieved party must demonstrate that the (hypothetical) settlement would have been economically advantageous to him. if not, he cannot be said to have suffered a relevant loss. this seems to involve even greater problems, because it requires the mediator to specify on what particular terms the (hypothetical) settlement would have been reached. further, it involves a difficult comparison of the economy of the hypothetical settlement and the non-settlement. in this way a party could e.g. be required to show that “but for” the mediator’s wrongful conduct the other party would have agreed to a particular price and that the (whole) economy of the hypothetical settlement therefore would have been more advantageous than not settling. even when there are merely two parties to the mediation it would prove difficult to establish the exact terms of a hypothetical settlement, and when there are multiple parties involved in some cases it probably borders on the insurmountable. in the scenario where a client is dissatisfied with the outcome of the settlement, it must be demonstrated that the mediator caused him to settle on less favourable terms than he could have settled on. establishing such connection is also not uncomplicated. first of all, the fact that the party has agreed to the outcome makes it problematic to argue that the mediator should be responsible for it. particularly, if the mediator has duly explained the contents of the settlement to the parties and invited them to read it before signing it. in such cases, the parties have consented to the agreement on a fully informed basis and any subsequent dissatisfaction will in most cases be at their own risk.104 however, when this is not the case the client may have a chance to argue that the mediator was responsible for the unfavourable outcome. it could be 103 andrew lynch, ‘“can i sue my mediator?” – finding the key to mediator liability’ (1995) australian dispute resolution journal 120 and 123-124. 104 see michael moffitt, ‘suing mediators’ (2003) 83 boston university law review 178. nordic journal of commercial law issue 2014#1 26 imagined, for example, that the mediator has somehow acted coercively or even fraudulently105 by not informing one or more of the parties of a certain matter important to the settlement.106 if the mediator did not wrongfully influence a client’s decision to settle, the argument must be structured differently. more specifically he must argue that the mediator had a duty to secure an outcome that was “fair”.107 however, this raises several issues. first, it is difficult to demonstrate that a settlement is unfair when the party has actually agreed to it. second, “fairness” is a highly elusive concept, which means different things to different people in different contexts. for example, a settlement may include terms, which are valuable to a certain party but cannot be appreciated by the courts (e.g. an apology).108 the present question was raised in lange,109 where the aggrieved party, mrs lange, claimed that the mediator had failed to negotiate an agreement that was “fair” to her. the court dismissed mrs lange’s claim,because the necessary causal link between the mediators’ conduct and the outcome could not be proved. since the parties had freely agreed on the settlement, it could not be said that the damage was caused by the mediator. further, it could not be proven that the other party to the mediation, mr lange, would have agreed to a more favourable settlement had the mediator performed his duties better at the mediation. the lange court, inter alia, noted as follows: ‘there is no evidence in the record that had defendant done the things plaintiff contends he did not do that these items of expense would not have been incurred in order for plaintiff to achieve the settlement she considered proper. there is no evidence that ralph lange would have voluntarily agreed to a settlement acceptable to plaintiff had the defendant done the things he admittedly did not do. (…) it is the rankest conjecture and speculation to conclude that ralph lange’s willingness to settle the marital affairs without litigation on the basis of the original settlement established his willingness to settle without litigation at a higher figure acceptable to plaintiff. plaintiff states in her brief that it is “obvious” that upon proper representation by defendant she would have received a far more beneficial settlement in a non-contested dissolution.’110 from what has been said it is clear that in most cases it will be difficult to establish a sufficient causal nexus between the mediator’s breach of the standard of care and the loss in question. however, as has also been made clear, it is not entirely unfeasible. further, the courts may be inclined to relax the requirements for causation if, for example, the mediator has acted grossly 105 see further michael moffitt, ‘ten ways to get sued: a guide for mediators’ (2003) 8 harvard negotiation law review 122-225. 106 see michael moffitt, ‘suing mediators’ (2003) 83 boston university law review 178. 107 see michael moffitt, ‘suing mediators’ (2003) 83 boston university law review 178-179. 108 see michael moffitt, ‘suing mediators’ (2003) 83 boston university law review 180. 109 lange v marshall 622 sw 2d 237 mo ct app (1981). 110 622 sw 2d 237 mo ct app (21 september 1981) at 239. nordic journal of commercial law issue 2014#1 27 negligently or perhaps even intentionally.111 at least the courts have done so in other areas of tort and contract law and there is good reason to believe that the inclination to find causation when policy considerations support such finding can be transferred to the mediation context. the significance of policy considerations is considered further below. 6 adequacy elsewhere i have argued at length that the requirement for adequacy can be described best as a test of fairness.112 essentially, this involves perceiving the assessment as an argumentative process based on a variety of different criteria (rather than a deductive process based on one criterion such as foreseeability) founded in the normative framework applicable to tort and contract law. in addition to the traditional criteria such as foreseeability it involves considering several policy criteria, which do not (at least not in the first place) pertain to the causal nexus as such.113 as is well known it is often very difficult to decide whether a certain loss is adequate in the present sense and the cases concerning mediation are certainly no exception to this. for that reason it is not an easy task to lay down clear guidelines for when this criterion is satisfied. however, as it appears from above cases concerning mediation also, it does seem clear that in general the claimants will struggle to convince the courts that their losses can be qualified as adequate. as noted above, courts are reluctant to award damages when the loss in question is a pure economic loss. of course it can be argued that this does not apply to damage claims in contracts, but the dominant tortious nature of most claims made against mediators is likely to make it difficult for the claimants recover. the main reason for the reluctance to accept claims for pure economic loss, is of course the concern that too many claims can be made by too many people in too many scenarios.114 a concern that is deeply rooted in most civil law and common 111 see e.g. two decisions by the danish supreme court published in the danish weekly law report (2000) 521 and (2002) at 2000. 112 see andreas bloch ehlers, om adækvanslæren i erstatningsretten (2011). 113 see andreas bloch ehlers, om adækvanslæren i erstatningsretten (2011) chapters 6, 8, and 9. in swedish literature andersson has developed an approach to adequacy whereby the limits of liability in torts are fixed on the basis of an interpretation of the scope of the rule of conduct, which has been violated, see håkan andersson, skyddsändamål och adekvans (1993). this approach may be helpful in many respects but it seems difficult to apply to the question of liability of mediators due the unclear nature of the applicable rules of conduct. 114 in anglo-american literature and case law as well as (fairly) recent literature from the nordic countries this argument is know as the floodgate argument. for nordic literature on the floodgade argument, see bjarte thorson, erstatningsrettslig vern for rene formuetap (2011) 66, bo von eyben og helle isager, lærebog i erstatningsret (7th edn, 2011) 329, jan kleineman, ren förmögenhetsskada (1987) 377, håkan andersson, trepartsrelationer i skadeståndsrätten (1997) 38ff, mårten schultz, kausalitet. studier i skadeståndsrättslig argumentation (2007) 553ff, morten kjelland, særlig sårbarhet i personskadeerstatningsretten (2008) 189 and 400 and andreas bloch ehlers, om adækvanslæren i erstatningsretten (2011) 224-225. nordic journal of commercial law issue 2014#1 28 law systems. perhaps most clearly this is evidenced by the well-known “exclusionary rule” which applied even when the loss was perfectly foreseeable and could reasonably have been avoided.115 with the emergence of modern society, however, in most legal systems there has been a development towards an increased understanding of the need to impose liability for pure economic loss. in english law this development was instituted by the prominent case of hedley byrne & co ltd v heller & partners ltd,116 which deals with liability for misstatements in negligence, and since hedley the courts have several times confirmed that in certain circumstances pure economic losses may be recovered. despite the recent developments in society and law, it seems clear that the claimant in any case must convince the court that special reasons make it fair to award damages. if the claimant can establish that the mediator clearly could foresee that his conduct would cause a certain loss, he may have a case. for example, this could be the case if the mediator in an evaluative mediation makes important assertions of fact which are untrue or if the fails to disclose a close personal connection with one of the parties. but in many cases the voluntary and unpredictable nature of the mediation process will probably make it difficult to establish foreseeability. this has been argued also by lynch, who contends that foreseeing damage is an almost impossible task since the mediator has only very little idea as to how the mediation will proceed until it is actually underway.117 moreover, lynch argues that a reasonable mediator will not be able to foresee any damage in most cases, as the whole idea of mediation is that it is the parties who are responsible for the mediated outcome.118 a claimant may also have a chance to recover if the conduct of the mediator can be qualified as grossly negligent (culpa lata). thus, several danish and foreign cases show that liability is more likely to ensue and is extended further when gross negligence can be established.119 if the loss was inflicted intentionally it would seem to be the rule that the mediator would be held liable provided that the loss was a cause in fact of the intentional conduct.120 obviously, this is based 115 see p. benson, ‘the problem with pure economic loss’ (2009) 60 south carolina law review 823. 116 [1964] ac 465. 117 see andrew lynch, ‘”can i sue my mediator?” – finding the key to mediator liability’ (1995) australian dispute resolution journal 113. 118 see andrew lynch, ‘”can i sue my mediator?” – finding the key to mediator liability’ (1995) australian dispute resolution journal 113. 119 see e.g. two cases from the danish high courts (western and eastern division) published in the danish weekly law report (1963) 629 and (1967) 945 respectively. i discuss these cases in andreas bloch ehlers, om adækvanslæren i erstatningsretten (2011) 239. 120 see christian von bar in the common european law of torts (2000) 477 where he contends that ‘vorsätzlich herbeigeführte tatfolgen sind immer adäquat.’ moreover see petl article 2:102 (5) which sets out that ‘[t]he scope of protection may also be affected by the nature of liability, so that an interest may receive more extensive protection against intentional harm than in other cases.’ nordic journal of commercial law issue 2014#1 29 on the fundamental moral repugnance against such conduct and the commonly accepted aim of tort and contract law to deter losses. 7 disclaimers probably the safest way for a mediator to avoid liability is to get the parties to the mediation to sign a disclaimer to that effect. as a rule such disclaimer will be upheld in court, but there are a number of things that the mediator should take note of in this respect.121 first, as developed above,122 many claims against mediators will be of a quasi-contractual or tortious nature and this may impact on the courts’ readiness to accept the disclaimer. this is because the courts may in certain cases have doubts as to whether a tortious claim should be covered by the disclaimer or if it pertains exclusively to claims that are (clearly) contractual. ultimately, this will depend on whether the mediator and the client can be said to have contemplated such claims when signing the disclaimer and therefore, it would be prudent to set out as clearly as possible what potential claims are disclaimed. and it should be expressly noted that it does not matter how such claims are designated (e.g. as contractual or tortious). in this way the mediator can also avoid other claims than the ones dealt with here such as claims for physical or mental harm to the person (e.g. emotional distress). second, the readiness to accept disclaimers will depend on the relative strength of the mediator and the client. if the relative strength is symmetrical the courts will be inclined to accept the disclaimer, whereas the opposite is true if it is asymmetrical. the clients are often medium or even large companies and when that is the case it can be argued that the mediator is the weaker party who deserves protection by the law. however, not only economic strength is relevant in this respect. rather, what is probably more important are the criteria relevant to deciding whether mediation is considered a proper profession in the eyes of the law. as already said, in most cases the mediator is unlikely to be subjected to the rather strict form of liability attached to certain professionals such as lawyers123 and accountants but the practice of mediation does have some of the same traits. e.g. the mediator is trained in what he does and possesses knowledge, which is (presumably) superior to that of the client.124 these traits may make it somewhat more difficult for the courts to accept disclaimers by mediators. at least if it pertains to one or more of the basic duties of the mediator such as the duty to remain impartial and work for an agreement in the mutual interest of the parties. 121 see günther j. petersen, ansvarsfraskrivelse (1957) 28-32. 122 see above at part 3. 123 if the mediator is actually a lawyer he should carefully inform the parties that he is not acting as such during the mediation. otherwise it may impact on the assessment of liability, including the feasibility of disclaiming liability. on the effect of disclaimers made by lawyers, see mads bryde andersen, advokatretten, (2005) 758-759. 124 see further above at part 4.2. nordic journal of commercial law issue 2014#1 30 however, as was the case in chang, it is probably possible for the mediator to disclaim a conflict of interest as long as he is capable of working for a mutually beneficial agreement. in this judgment both clients had signed an agreement, which said, inter alia, that ‘i have advised you that you should be represented by different attorneys. however, you have represented to me that you are both aware of the conflict of interest issue and still desire me to assist you in finding a common resolution of your difficulty and structuring a settlement. please sign below to evidence your waiving any claim of conflict of interest, your request that i act for both of you and your consent to my doing so with regard to this matter.’125 the court accepted the disclaimer finding that the letter of agreement clearly disclosed the fact that the mediator would be acting as a mediator and that the parties explicitly waived any conflict of interest issue by signing the letter. third, in order for a disclaimer to be upheld, it is important that it is carefully drafted and properly communicated to the parties (e.g. not written on the back side of the disclaimer with small letters) to satisfy the court that the parties actually were aware of what exactly was disclaimed. this appears also from chang where the court explicitly noted that the agreement “clearly disclosed” the mediator’s role and the conflict of interest in question.126 with respect to the necessity for clarity in drafting and communication of the disclaimer it is important also how far reaching the disclaimer is. if it merely regards claims that would appear normal for the mediator to disclaim the courts will not require much in this respect while, of course, the opposite is true if he wishes to preclude claims that the reasonable client would always expect he could make. fourth, and last, the mediator should be aware that it is not possible to disclaim losses which have been inflicted intentionally and in the far most cases the courts will not allow disclaimers for losses inflicted grossly negligently either.127 the reason for this is obviously that it is an important goal of the law to deter losses inflicted in that manner. therefore, even with a clearly drafted and well communicated disclaimer, the mediator cannot guard himself from all kinds of claims. 8 conclusion in this article the legal basis for establishing claims against professional mediators for pure economic loss has been examined. the examination has shown that all the basic requirements of contract and tort law are difficult to satisfy when it comes to placing blame on mediators. 125 216 f. supp. 2d 325 (20 august 2002) at 329. 126 216 f. supp. 2d 325 (20 august 2002) at 332. 127 in some cases even an unqualified degree of negligence (culpa levis) will be sufficient to set aside a disclaimer, cf. vibe ulfbeck, ‘fortolkning af ansvarsfraskrivelsesklausuler. eksempler fra traditionel og utraditionel transportret’, in boel flodgren et al (eds.) avtalslagen 90 år (2005) 485-488. nordic journal of commercial law issue 2014#1 31 first, it is difficult to say how claims against mediators are to be designated. some seem to have a contractual nature whereas others are probably better designated as claims in tort. second, it is difficult to determine what the applicable standard of care is since the sources of law relevant to answering this question do not yield clear answers. one can ask what the reasonable mediator would have done in a certain situation but this important standard does not apply well to the dynamic and stylistically varied practice of mediation. further, one can examine the pertinent regulation and look at custom in order to ascertain how mediators should conduct themselves. these sources do give some answers but the sparse amount of regulation and the inherent difficulties in determining the customary behaviour of mediators are serious obstacles here. third, it is difficult to establish what is required of the breach of the applicable standard of care in order for the mediator to become liable. this depends, inter alia, on whether the practice of mediation can be qualified as a proper profession. it seems most likely that it cannot. therefore, to find a breach of standard the courts will require more than they do of other professionals such as accountants and lawyers. this is also evidenced by the cases dealing with the liability of mediators. they show that even though the mediator could have performed better (e.g. drafted the settlement agreement more clearly), as a rule he will not be held liable as long as he has successfully brought the parties together and achieved a settlement agreement. if liability is to be imposed, in most cases the aggrieved party will have to show that the mediator has somehow put undue pressure of on the parties in the negotiation process or interfered wrongfully with the substances on the dispute. fourth, in most cases it poses formidable problems to establish the necessary causal link between the breach of standard of the mediator and the loss of the client. the main reason for this is that there can be numerous causes to a non-settlement and even a perfectly conducted mediation may not cause the parties to agree on how the disputed matter should be resolved. further, if the client’s claim is based on dissatisfaction with the outcome of the settlement, he will have a difficult time showing that the mediator caused him to settle on less favourable terms than could have been agreed upon. fifth, in order to establish adequacy, in most cases the client must to show that the mediator could clearly foresee that his conduct would cause a loss to him or that his conduct can be qualified as grossly negligent. due to said difficulties the mediator rarely needs a disclaimer. however, if he wishes an even better defense against claims made by the clients, it may be prudent to invoke one even so. if the mediator choses to do this there are, however, a number of things he should take note of. most importantly perhaps, in order to satisfy the courts that the clients are fully aware of what they are agreeing to, the disclaimer should be drafted carefully (taking into account that the potential claims may be of a contractual as well as a tortious nature) and communicated clearly. as it appears neither of the requirements that are necessary to establish a claim in contract or tort is easily applied to mediation and at the end of the day it will be very difficult for a client to bring a successful claim against a mediator. whether this is fair is a difficult question to answer. on the one hand, it can be argued that it would be a paradox to allow claims against mediators nordic journal of commercial law issue 2014#1 32 to a greater extent because the very raison d’être of mediation is exactly the opposite of creating (more) litigation. further, it could be argued that a greater exposition to liability will deter certain persons from acting as mediators and performing a service, which is beneficial to the parties involved and society as a whole. on the other hand, it can be argued that mediators interfere with the rights and duties of other people just like any other negotiator or advisor and therefore, the opportunity of claiming against them should be improved. these are, of course, political questions that are not to be answered here but this notwithstanding, i believe we can all agree that it would be helpful if the law on the liability of mediators was somehow clarified. by way of legislation, for example, at least some of the difficult issues could be settled. nordic journal of commercial law issue 2014#1 33 bibliography mads bryde andersen, grundlæggende aftaleret, (3rd edn, 2008) mads bryde andersen, advokatretten (2005) håkan andersson, trepartsrelationer i skadeståndsrätten (1997) christian von bar, the common european law of torts (2000) p. benson, ‘the problem with pure economic loss’ (2009) 60 south carolina law review 823 hans boserup, konfliktvindere (1993) hans boserup og susse humle, mediationsprocessen i praksis (2nd edn, 2012) mia carlsson, arbetsskada (2008) arthur a. chaykin, ‘mediator liability: “a new role for fiduciary duties?”’ (1984) 53 university of cincinnati law review 731 cyril chern, dispute resolution guides. international commercial mediation (2008) andreas bloch ehlers, om adækvanslæren i erstatningsretten (2011) bo von eyben og helle isager, lærebog i erstatningsret (7th edn, 2011) dan engström, lag om medling i vissa privaträttsliga tvister – en kommentar (2011) bernhard gomard, forholdet mellem erstatningsregler i og uden for kontraktforhold (1958) jo hov og alf petter høgberg, alminnelig avtalerett (2009) torsten iversen, erstatningsberegning i kontraktsforhold (2000) stig jørgensen, erstatningsret (2nd edn, 1972) morten kjelland, særlig sårbarhet i personskadeerstatningsretten (2008) jan kleineman, ren förmögenhetsskada (1987) andrew lynch, ‘”can i sue my mediator?” finding the key to mediator liability’ (1995) australian dispute resolution journal 113 michael moffitt, ‘suing mediators’ (2003) 83 boston university law review 147 michael moffitt, ‘ten ways to get sued: a guide for mediators’ (2003) 8 harvard negotiation law review 81 lise dyrby nielsen, ‘hvorfor ignorerer lovgiver udenretlig mægling?’ (2013) erhvervsjuridisk tidsskrift 49 günther j. petersen, ansvarsfraskrivelse (1957) jan ramberg og christina ramberg, allmän avtalsrätt (8th edn, 2009) melinda shirley and tina cockburn, ‘when will a mediator operating outside the protection of statutory immunity be liable in negligence’ (2004) 32 university of western australia law review 83 jennifer l. schulz, ‘mediator liability: using custom to determine standards of care’ (2002) 65 saskatchewan law review 163 mårten schultz, kausalitet: studier i skadeståndsrättslig argumentation (2007) bjarte thorson, erstatningsrettslig vern for rene formuetap (2011) vibe ulfbeck, erstatningsretlige grænseområder (2nd edn, 2010) vibe ulfbeck, ‘fortolkning af ansvarsfraskrivelsesklausuler. eksempler fra traditionel og utraditionel transportret’, in boel flodgren et al (eds.) avtalslagen 90 år (2005) 481 henry ussing, skyld og skade (1914) vibeke vindeløv, konfliktmægling. en refleksiv model (3rd. rev. edn, 2013). geir woxholth, avtalerett, (7th edn, 2009) richard w. wright, ‘causation, responsibility, risk, probability, naked statistics, and proof: prunning the bramble bush by clarifying the concepts’ (1987-1988) 73 iowa law review 1001 richard w. wright, ‘once more into the bramble bush: duty, causal contribuiton, and the extent of legal responsibility’ (2001) 54 vanderbilt law review 1071 (anonymous author), ‘the sultans of swap: defining the duties and liabilities of american mediators’ (1986) 99 harvard law review 1876 1 directors’ duties and corporate social responsibility under german law – is tort law litigation changing the picture? peter rott* * professor for civil law, european private law and consumer law, university of kassel, germany. directors' duties and csr under german law 10 1. introduction ..................................................................................... 11 1.1. two strands of directors’ duties .................................. 12 1.2. the legality principle ........................................................ 12 1.2.1. control of subsidiaries ........................................... 12 1.2.2. the transnational dimension .............................. 13 1.2.3. the practical relevance of the legality principle ......................................................................... 14 1.2.4. the extent of and limitations to the legality principle ......................................................................... 15 1.2.5. summing up ..................................................................... 16 1.3. the benefit of the company ............................................. 16 2. changes through tort law litigation? ................................ 18 2.1. novelties in tort litigation ........................................... 18 2.1.1. tort law liability in corporate structures .. 18 2.1.2. supply chain liability ............................................... 23 2.2. impact on directors’ duties? ............................................ 25 2.3. limitations ............................................................................... 26 3. legal uncertainty .......................................................................... 26 4. conclusion .......................................................................................... 27 njcl 2017/1 11 abstract this article discusses the right and a potential duty of directors to pursue csr policies under german law. it first explains the two main duties of directors: to make sure that the company complies with its legal obligations, which has been broadly interpreted in germany to include the duty to extend to domestic and foreign subsidiaries’ compliance with the law, and to act for the (economic) benefit of the company. csr policies will often only come under the second duty, which means that they can be pursued if they are economically beneficial. however, acting in order to benefit the company also means the avoidance of unnecessary risk, including the risk of tort law liability. this article discusses how recent tort law development towards a duty of care of parent companies for employees of their subsidiaries, and perhaps even victims of their subsidiaries’ operations, as triggered by the english landmark case of chandler v cape, has created risks for parent companies that affect the duty of their directors to establish a corporation-wide system of prevention. it is argued that those liability risks are substantive in amount but uncertain due to the early state of case law, with a number of relevant cases pending at this moment; which allows directors a certain margin of appreciation. the article concludes that the tort law development has certainly strengthened the right of directors to pursue a csr policy that avoids liability, while a corresponding duty of directors may arise and intensify with the influx of more transnational tort law cases and, in particular, with judgments in favour of victims of torts committed in the course of operations of transnational corporations in developing countries. 1. introduction the discussion on directors’ duties and corporate social responsibility (csr) has come a long way. at the outset, it centred around the question of whether or not the directors of a company were allowed to pursue csr although this might be less profitable than ruthless (but lawful) behaviour. in the meantime, the tone has shifted towards a potential duty of directors to pursue csr goals. in this article, several developments in german law (and beyond) shall be discussed, which together may have changed, or have the potential to change, the picture: case law relating to directors’ duties under the legality principle, in particular in the context of transnational corporations with subsidiaries in developing countries, and developments in tort law that may have an impact on the duty to avoid unnecessary risks for the benefit of the company. combined, they have the potential not only to justify the pursuance of csr but they may even pave the way towards a duty to include at least aspects of csr into the policy and operations of the corporation. directors' duties and csr under german law 12 1.1. two strands of directors’ duties directors’ duties are duties that are owed to the company, not to third parties. thus, a breach of directors’ duties does not normally lead to external liability but to a claim of the company against the director. that claim must, of course, be based on the damage that the company suffered from the breach, and that damage may consist of liability towards victims of a tort. it could, however, also be damage that consists in fines for unlawful behaviour. directors’ duties are legally defined for the public limited company (aktiengesellschaft). under § 93 para. 1 aktiengesetz (aktg), in conducting business, the members of the management board shall employ the care of a diligent and conscientious manager. they shall not be deemed to have violated the aforementioned duty if, at the time of taking the entrepreneurial decision, they had good reason to assume that they were acting on the basis of adequate information for the benefit of the company. in the following, the article deals with two types of directors’ duties: the legality principle and the duty to act for the benefit of the company. 1.2. the legality principle regardless of the potential economic benefit of unlawful behaviour, directors always have the duty to comply with legal obligations.1 this would, of course, include legal obligations relating to corporate social responsibility. for example, bribery would be a breach of directors’ duties even if the bribe in question secures beneficial business.2 the legality principle has seen significant development in recent years that is of great relevance in the context of transnational corporations. 1.2.1. control of subsidiaries the legality principle has two elements: first, the directors themselves are required to act in accordance with the law, and second, they have to ensure compliance with the law by their subordinates; which triggers the question of whether the directors and staff of subsidiaries are subordinated to the directors of the parent company.3 in principle, the 1 see german federal supreme court (bundesgerichtshof; hereinafter: bgh) njw 2010, 3458, 3460. see also dirk a verse, ‘compliance im konzern’ [2011] zeitschrift für das gesamte handelsrecht und wirtschaftsrecht 401, 405. 2 see lg munich i, neue zeitschrift für gesellschaftsrecht 2014, 345, 346; eike bicker, ‘compliance – organisatorische umsetzung im konzern’ [2012] die aktiengesellschaft 542; gerald spindler, ‘§ 93’ in wulf goette, mathias habersack and susanne kalss (eds), münchener kommentar zum aktiengesetz, 4th ed (ch beck 2014) margin notes 91ff. for an outdated view in a slightly different context see bgh njw 1985, 2405. 3 on the related controversial discussion see uwe h schneider and sven h schneider, ‘konzern-compliance als aufgabe der konzernleitung’ [2007] zeitschrift für wirtschaftsrecht (zip) 2061 vs. verse, supra note 1, at 411ff. njcl 2017/1 13 majority of authors agree with such a corporation-wide coverage of the directors’ duties and argue that the directors of the parent company are required to establish a corporation-wide compliance system; whereas the details of such a system may differ from one corporation to the next and be subject to some discretion. this is despite the recognition of the legal separation of the parent company and its subsidiaries, and the reason for the duty to establish a corporation-wide compliance system may also be seen in the risk that a breach of law by the subsidiary may affect the assets of the parent company.4 moreover, one may refer to the voluntary german corporate governance code (deutscher corporate governance kodex),5 which presents essential statutory regulations for the management and supervision of german listed companies and contains, in the form of recommendations and suggestions, internationally and nationally acknowledged standards for good and responsible corporate governance, formulated under the heading ‘management board’: ‘the management board ensures that all provisions of law and the enterprise’s internal policies are abided by and works to achieve their compliance by group companies (compliance).’6 1.2.2. the transnational dimension arguably, the duty to establish a corporation-wide compliance system extends to foreign subsidiaries. this was confirmed in the neubürger decision of the landgericht munich i.7 mr neubürger was the financial director of siemens ag, the parent company of innumerable subsidiaries worldwide. during his term of service, a corporation-wide system of corruption existed, in the context of which a nigerian subsidiary of siemens ag won government contracts through bribery. the discovery of that system led not only to an immense loss of reputation but also to fines imposed on siemens ag by the united states securities and exchange commission (sec). moreover, siemens ag paid an estimated €474 million to the law firm they had commissioned to investigate the 4 see, e.g., holger fleischer, ‘corporate compliance im aktienrechtlichen unternehmensverbund’ [2008] corporate compliance zeitschrift 1, 6. see also verse, supra note 1, at 407ff., who however argues that the duty to ensure compliance with the law of subsidiaries does not stem from the legality principle but from the duty to act to the benefit of the company; which would mean that the directors could decide to let the subsidiary engage in unlawful activities if they are to the benefit of the company; ibid., 411ff. 5 the german corporate governance code is referred to in § 161 aktg. it follows the principle of comply or explain. thus, listed corporations do not have to follow the recommendations and suggestions but they have to lay open if they do not do so and explain why they choose not to adhere to particular recommendations and suggestions. 6 germancorporategovernancecode,2005, <www.dcgk.de//files/dcgk/usercontent /en/download/code/2015-0505_corporate_governance_code_en.pdf, principleg 4.1.3.> accessed 1 september 2017. 7 lg munich i, supra note 2. directors' duties and csr under german law 14 details of the corruption system. of that amount, siemens ag reclaimed a part of €15 million from mr neubürger, arguing that he breached his duties under § 93 para. 2 aktg, thereby causing damage to siemens ag, and siemens ag succeeded in the landgericht munich i. the court argued that the directors' duties include the establishment of a supervision system by which breaches of the law are prevented. the details of that requirement depend on the type and size of the enterprise, the relevant legal provisions, the geographical situation and previous suspicious situations. in the instant case, the court held that the directors, amongst them mr neubürger, had not taken any measures to improve the compliance management system of siemens ag despite repeated hints towards its lack of effectiveness, and the lacking reliability of the regional compliance officer but rather covered the responsible members of staff and misled the supervisory board. the decision was the subject of a controversial debate in academic literature.8 mr neubürger appealed but reached an out-of-court settlement with siemens before the trial started (and committed suicide shortly after). thus, the decision was never overruled, and it would not be wise for a director to ignore it. 1.2.3. the practical relevance of the legality principle as mentioned above, a breach of the directors’ duties does not give rise to damage claims by external victims9 but only by the company itself, which means that they will only influence the behaviour of directors if there is a risk that the company will enforce the claim. the relevant body is the supervisory board (aufsichtsrat). here, another landmark decision has increased that risk drastically. in the case of arag v garmenbeck, the bgh decided that the members of the supervisory board who do not bring such a claim on behalf of the company incur liability for breach of their own duties.10 that decision has changed the picture in that claims against directors have been brought more frequently ever since.11 for example, the supervisory board of volkswagen ag is currently considering to sue 8 for critique, see gregor bachmann, ‘anmerkung zum urteil des lg münchen i vom 10.12.2013 5 hk o 1387/10 zur haftung des vorstands für mängel des compliancesystems’ [2014] zeitschrift für wirtschaftsrecht 579; walter g paefgen, ‘"compliance" als gesellschaftsrechtliche organpflicht?’ [2016] wertpapier-mitteilungen 433. 9 in particular, § 93 aktg is not a statute whose breach would give rise to the tort of breach of a statutory duty under § 823 para. 2 bgb, see, e.g., spindler, supra note 2, margin note 309. 10 bgh, njw 1997, 1926. 11 see tim drygala, marko staake and stephan szalai, kapitalgesellschaftsrecht (springer 2012) § 21 margin note 97. in academic writing, in contrast, there seems to be a trend to weaken the meaning of arag v garmenbeck and to allow the supervisory board some discretion. for an overview of the debate see jens koch, ‘die schleichende erosion der verfolgungspflicht nach arag/garmenbeck’ [2014] neue zeitschrift für gesellschaftsrecht 934. njcl 2017/1 15 the directors of volkswagen ag and audi for at least negligent omission to prevent ‘dieselgate’.12 moreover, it should be mentioned that coverage of directors' and officers' (d&o) insurance has been restricted in 2009. under § 93 para. 2 sent. 3 aktg, insurance contracts must provide for a director’s contribution of at least 10% of the damage up to at least 1.5 times the fix annual salary. this was explicitly meant to create incentives for directors to act responsibly.13 1.2.4. the extent of and limitations to the legality principle (a) statutory obligations liability under the legality principle requires a breach of law, which in transnational situations may often mean the breach of the law of the host state of the subsidiary.14 thus, the legality requires the directors of parent companies to ensure compliance with local laws; which, often do not require ‘socially responsible’ behaviour. it should, however, be noted that some of the ‘classical’ csr issues, such as the lack of a working fire protection system, as in the case of the ali enterprises factory fire,15 are in breach of local laws. moreover, a number of developing countries avail of modern environmental laws16 (which are, however, often not enforced). in contrast, there is little doubt that soft law, and even international soft law, does not count as ‘law’ in this sense but would rather be classified as an emanation of ‘good morals’; and clearly, there is no obligation under german company law to comply with good morals.17 thus, there is no duty to comply with csr instruments such as the oecd guidelines,18 the global compact19 or the 'protect, respect and remedy framework'20 12 see kristina gnirke, ‘winterkorn und stadler droht millionenforderung’ (spiegel online, 4 april 2017) <www.spiegel.de/wirtschaft/unternehmen/volkswagen-martin-winter korn-und-rupert-stadler-droht-millionenforderung-a-1141287.html> accessed 14 june 2017. 13 see the report of the legal committee (bericht des rechtsausschusses), printed matters of the german bundestag (bundestags-drucksache) 16/13433, 11 14 see also michael kort, ‘gemeinwohlbelange beim vorstandshandeln’ [2012] neue zeitschrift für gesellschaftsrecht 926, 927. 15 on which see infra, at 3.1.2. 16 see, e.g., the case of vedanta, infra at 3.1.1., that was concerned with the breach of zambian environmental legislation; which caused harm to neighbouring communities. 17 kort, supra note 14, at 929; wolfgang hölters, ‘§ 93 aktg’ in wolfgang hölters (ed), aktiengesetz, 2nd ed (ch beck 2014), margin note 70. 18 oecd guidelines for multinational corporations as first adopted in 1976, <http://mneguidelines.oecd.org/text> accessed 1 september 2017. 19 “homepage | un global compact” (homepage | un global compact) <www.unglobalcompact.org> accessed august 15 2017. 20 john ruggie, ‘protect, respect and remedy: a framework for business and human rights’, (un doc a/hrc/8/5, 7 april 2008) <www.reports-and-materials.org/ruggiereport-7-apr-2008.pdf> accessed 1 september 2017. directors' duties and csr under german law 16 and the 'guiding principles on business and human rights'21 as such, that is, if they have not found entry into the law, for example, through openended norms,22 or into the internal regulation of the corporation, in particular due to subscription to, for example, the global compact. (b) internal regulation in the context of directors’ duties, the notion of ‘legal obligations’ goes beyond obligations stemming from statutory law. it also includes the internal regulation of the corporation, thus the ‘law of the company’.23 the directors are bound by the by-laws as far as the subject of the enterprise and the aims and objectives of the corporation are concerned. this may of course include the aim to be a social and environmentally friendly corporation, which may be expressed in the adoption or signature of soft law instruments, such as codes of conduct. thus, compliance with codes of conduct to which the corporation has signed up would seem to come within the scope of the legality principle. the same applies to compliance with internal guidelines that have been adopted or consented to by the competent bodies of the corporation, as compliance with such regulation is in the interest of the corporation. in contrast, the directors would not be forced, under the legality principle, to enforce guidelines that they have set up themselves but which have not become part of the internal regulation of the corporation. again, breach of internal regulation will only be actionable if it caused damage to the corporation. 1.2.5. summing up the legality principle is able to cover csr issues that are expressed in legal obligations, including those established in the host states of subsidiaries. in contrast, it has no significance for any duty or right of directors to pursue csr policies beyond the law, including the internal regulation of the company. 1.3. the benefit of the company where there is no legal obligation, the directors have the duty to act for the benefit of the company. here, they enjoy the discretion that is 21 john ruggie, ‘guiding principles on business and human rights: implementing the united nations “protect, respect and remedy” framework’, (un doc a/hrc/17/31,31march2011) <www.ohchr.org/documents/issues/business/a.hrc.17.31.pdf> accessed 1 september 2017. 22 on which, see carola glinski, ‘the ruggie principles, business human rights selfregulation and tort law: increasing standards through mutual impact and learning’ (2017) 15 nordic journal of human rights 15, concerning the relationship between the ruggie framework and guiding principles, tort law and transnational private regulation, with further references. 23 see holger fleischer, ‘§ 93 aktg’, in gerald spindler and eberhard stilz (eds), kommentar zum aktiengesetz, 3rd ed (ch beck 2015) margin notes 21f. njcl 2017/1 17 commonly referred to as the business judgment rule. actually, the second sentence of § 93 para. 1 aktg, according to which the directors shall not be deemed to have violated the aforementioned duty if, at the time of taking the entrepreneurial decision, they had good reason to assume that they were acting on the basis of adequate information for the benefit of the company, has not always formed part of german law. it was introduced in 2005 in the aftermath of the above-mentioned arag decision of the bgh24 in order to clarify that directors are not liable for the lack of success of the company but only for imprudent decisions in breach of the business judgment rule.25 the business judgment rule was meant to be a codification of the arag decision. although it was only explicitly codified in the law on public limited companies, the same principles apply for private limited companies under § 43 gesetz betreffend die gesellschaften mit beschränkter haftung (gmbhg) and other companies, as the legislator has mentioned expressly in the explanations on the draft legislation.26 csr strategies will often have the potential benefit the company, an issue that is commonly discussed as the ‘business case of csr’.27 key words are market advantages through advertising with csr, employees’ satisfaction leading to reduced fluctuation, good relationship with government and the avoidance of scandals that might lead to loss of reputation or consumer boycotts.28 the latter aspect is currently gaining momentum through the csr reporting directive 2014/95/ec,29 which will force big corporations to lay open their csr policies.30 in connection with the business judgment rule, such potential advantages of socially responsible behaviour may often justify a csr policy;31 although this is not necessarily the case, for example, where there are no end-users involved, as in the extraction industry, or where endusers are insensitive to the well-being of people in the host states of the 24 and a follow-on decision in the case of siemens ag v nold, bgh njw 1997, 2599. 25 see spindler, supra note 2, margin note 8. 26 see printed matters of the german bundestag 15/5092, 12. see, e.g., bgh njw 2010, 3458. 27 on which see, e.g., dennis j aigner, ‘corporate social responsibility and financial performance’ in ronny manos and israel drori (eds), corporate responsibility (palgrave & macmillan 2016) 11. 28 examples for financial loss resulting from scandals are nike and shell (in the context of the oil platform brent spar), see, e.g., menno t kamminga, ‘company reponses to human rights reports: an empirical analysis’ [2016] business and human rights journal 95, 101. 29 directive 2014/95/eu amending directive 2013/34/eu as regards disclosure of nonfinancial and diversity information by certain large undertakings and groups, oj 2014 l 330/1. 30 see, e.g., peter hommelhoff, ‘nichtfinanzielle ziele in unternehmen von öffentlichem interesse’ in reinhard bork, godehard kayser and frank kebekus (eds), festschrift für bruno m. kübler zum 70. geburtstag (ch beck 2015) 291. 31 see, eg, hölters, supra note 17, margin note 70. directors' duties and csr under german law 18 production.32 if there is no possible benefit, most authors would deny the directors’ right to pursue a csr policy.33 certainly, it would be difficult to argue in favour of a duty to act socially responsibly for the benefit of the company (given the undeniable costs of csr), unless in the individual case, it is obvious that pursuing a csr strategy – to what extent? – will be more beneficial to the corporation than not caring about csr. another aspect of the duty to act for the benefit of the company is the duty to avoid unnecessary risks, including the unnecessary liability to third parties.34 the duty to avoid unnecessary liability risks requires consideration of the extension of the risk and the likelihood of its materialisation.35 thus, special care is required where a business decision puts the whole enterprise at risk.36 2. changes through tort law litigation? tort law litigation against transnational corporations and even against the dominant purchaser in a supply chain is the topic of the day, and corporations from, for example, the oil business and the extracting industry are facing litigation by victims of human rights abuses and environmental degradation in several jurisdictions; which may lead to high damage payments that affect the success of the corporation. thus, in the following, the recent development in tort litigation is analysed and put into context with the directors’ duty to avoid unnecessary risk. it should be mentioned that liability risks may also stem from other areas of law, for example from securities law or from unfair commercial practices law, where a corporation does not keep its csr promises. these are, however, not subjects of this article. 2.1. novelties in tort litigation 2.1.1. tort law liability in corporate structures tort law litigation related to – broadly speaking the parent company’s liability for damage suffered by employees and neighbours of 32 on loss of reputation that may or may not lead to financial loss, see lars klöhn and klaus ulrich schmolke, ‘unternehmensreputation (corporate reputation)’ [2015] neue zeitschrift für gesellschaftsrecht 689. 33 see, eg, kort, supra note 14, at 929. for a deviating position, see olaf müller-michaels and wiebke ringel, ‘muss sich ethik lohnen?’ [2011] die aktiengesellschaft 101. 34 see, eg, spindler, supra note 2, margin note 67; olg jena, neue zeitschrift für gesellschaftsrecht 2001, 86 35 dirk kocher, ‘zur reichweite der business judgment rule’ [2009] corporate compliance zeitschrift 215, 217. on the criterion of likelihood, see olg jena, neue zeitschrift für gesellschaftsrecht 2001, 86; egon kust, ‘zur sorgfaltspflicht und verantwortlichkeit eines ordentlichen und gewissenhaften geschäftsleiters’ [1980] wertpapier-mitteilungen 758, 761. 36 see spindler, supra note 2, margin notes 54f. njcl 2017/1 19 subsidiaries in developing countries has been discussed in academic writing for a long time37 but has been fuelled by the english landmark case of chandler v cape;38 although, ironically, the case was purely domestic as both the parent company and the subsidiary were domiciled in england. nevertheless, the case was seen as a breakthrough in imposing liability on parent companies for problems that occurred in the realm of the subsidiary, and academics as well as practitioners immediately made the link to the classical problems of corporate liability for disasters in developing countries. the case concerned an english worker, mr. chandler, who during work for cape products over a longer period of time was exposed to asbestos dust. cape products was a wholly owned subsidiary of cape plc. both companies were situated in the uk. cape plc had control over the asbestos business carried out by the subsidiary in the sense that the products were manufactured in accordance with cape’s product specifications. the separate administration of cape products was originally approved of by cape plc on the condition that cape products would be run ‘in accordance with company policy’. cape plc had a group medical advisor employed, who was responsible for the health and welfare of all employees within the corporation (a ‘flying’ doctor) and also a scientific officer who was responsible for trying to find methods to suppress asbestos dust. cape plc knew that the system of work at cape products was defective. when mr. chandler became ill, cape products no longer existed. consequently, mr. chandler sued the parent company, cape plc, instead. the court found cape plc liable towards mr. chandler under the tort of negligence, relying on a wide interpretation of the concept of ‘assumption of responsibility’. summarising the judgment, arden lj stated: ‘in appropriate circumstances the law may impose on a parent company responsibility for the health and safety of its subsidiary’s employees. … (1) the businesses of the parent and subsidiary are in a relevant respect the same; (2) the parent has, or ought to have, superior knowledge on some relevant aspect of health and safety in the particular industry; 37 see, eg, halina ward, ‘towards a new convention on corporate accountability? some lessons from the thor chemicals and cape plc cases’ [2001] yearbook of international environmental law 105; carola glinski, die rechtliche bedeutung der privaten regulierung globaler produktionsstandards (nomos 2010) 332ff; ead., ‘corporate selfregulation: moral or legal obligation?’ in doreen mcbarnet, aurora voiculescu and tom campbell (eds), the new corporate accountability: corporate social responsibility and the law (cambridge university press 2007) 119. 38 [2012] ewca civ 525. for detailed analysis, see martin petrin, ‘assumption of responsibility in corporate groups: chandler v cape plc’ (2013) 76 mlr 589, 603ff.; siel demeyere, ‘liability of a mother company for its subsidiary in french, belgian, and english law’ [2015] european review of private law 385, 402ff. directors' duties and csr under german law 20 (3) the subsidiary’s system of work is unsafe as the parent company knew, or ought to have known; and (4) the parent knew or ought to have foreseen that the subsidiary or its employees would rely on its using that superior knowledge for the employees’ protection. for the purposes of (4) it is not necessary to show that the parent is in the practice of intervening in the health and safety policies of the subsidiary. the court will look at the relationship between the companies more widely. the court may find that element (4) is established where the parent has a practice of intervening in the trading operations of the subsidiary, for example production and funding issues.’39 in the aftermath of chandler v cape, courts in england but also in the netherlands have seen an influx of cases relating to transnational corporations and their operations in developing countries. royal dutch shell is facing litigation regarding the operations of its nigerian subsidiary spdc in the netherlands40 as well as in england.41 the english company vedanta is being sued in england, together with its zambian subsidiary kcm, in relation to environmental damage caused by the copper mine that is operated by kcm.42 germany has not seen a transnational case dealing with human rights violations of corporations in recent years,43 although in a recent empirical study, german corporations ranked number 5 among the countries whose companies most frequently received reports on human rights infringements abroad, after us american, british, canadian and chinese corporations.44 all these cases are still pending at the time of writing, at different stages, and a variety of issues, or barriers to the claims of victims, are subjects of controversial debates, amongst them prominently jurisdiction, the applicable law, and most crucially, substantive law. jurisdiction of eu member states’ courts for claims against parent companies that are domiciled in the relevant member state is not normally a problem any longer, as under article 4(1) of the brussels ia regulation 39 chandler v cape plc [2012] ewca civ 525 [80]. 40 see, eg, district court of the hague, 30/1/2013, fidelis ayoro oguru et al. v royal dutch shell plc et al, <https://milieudefensie.nl/publicaties/bezwaren-uitspraken/finaljudgment-oguru-vs-shell-oil-spill-goi> accessed 14 june 2017. see also liesbeth enneking, ‘the future of foreign direct liability? exploring the international relevance of the dutch shell nigeria case’ (2014) 10 utrecht law review 44; nicola mcp jägers and marie-jose van der heijden, ‘corporate human rights violations: the feasibility of civil recourse in the netherlands’ (2008) 33 brooklyn journal of international law 833. 41 see okpabi v royal dutch shell plc [2017] ewhc 89 (tcc). 42 see lungowe and others v (1) vedanta resources plc (2) konkola copper mines plc [2016] ewhc 292 (tcc). 43 see miriam saage-maaß and maren leifker, ‘haftungsrisiken deutscher unternehmen und ihres managements für menschenrechtsverletzungen im ausland’ [2015] betriebsberater 2499, 2501. 44 see kamminga, supra note 28, at 101 f. njcl 2017/1 21 (eu) no. 1215/2012,45 defendants can be sued in the courts of the member states where they are domiciled. in the case of owusu,46 the anglo-saxon doctrine of forum non conveniens, under which courts had been allowed to deny and had denied jurisdiction for reasons such as the impracticality of collecting evidence, political economy,47 or even the workload of courts,48 was rejected by the european court of justice (ecj) as being non-compliant with the provisions of eu law, namely, the brussels i regulation (ec) no. 44/2001,49 the predecessor of regulation (eu) no. 1215/2012. english courts have accepted that decision ever since,50 and current controversies concerning jurisdiction do not relate to the parent company but to the question whether or not the foreign subsidiary, who is not domiciled in an eu member state, can nevertheless be sued together with the parent company, due to the connection between the claims, although the eu member states’ courts would clearly not have jurisdiction for these claims as, even in a multinational corporation, the individual legally independent companies have to be treated separately.51 a connection of the claims has been accepted by the dutch first instance court in oguru v shell,52 and by the english high court in the vedanta case,53 whereas it has been rejected in the okpabi case where the first instance judge held that he saw no prospect of the claim against the parent company,54 which would be a necessary precondition for the connection with the claim against the subsidiary. the applicable law is to be determined in accordance with the provisions of the rome ii regulation (ec) no. 864/2007.55 under article 4(1), the law applicable to a non-contractual obligation arising out of a tort/delict shall be the law of the country in which the damage occurs irrespective of the country in which the event giving rise to the damage occurred and irrespective of the country or countries in which the indirect consequences of that event occur. in essence, this means that it is normally 45 oj 2012 l 351/1. 46 case c-281/02 andrew owusu v n.b. jackson and others, ecli:eu:c:2005:120. 47 see in re union carbide corporation gas plant disaster at bhopal, india, 1984, 634 f supp. 842 (sd ny 1986). 48 see rockware glass v macshannon [1978] ac 795. 49 oj 2001 l 12/1. 50 see, eg, the overview of cases in okpabi, supra note 41, [67]. 51 see gerhard wagner, ‘haftung für menschenrechtsverletzungen’ (2016) 80 rabels zeitschrift für ausländisches und internationales privatrecht 717, 733. 52 see district court of 's-gravenhage, 30.12.2009, fidelis ayoro oguru et al. v royal dutch shell plc et al, ecli:nl:rbsgr:2009:bk8616, <http://deeplink.rechtspraak.nl/uitspraak?id=ecli:nl:rbsgr:2009:bk8616> accessed 14 june 2017. 53 see vedanta, supra note 42, [168]. 54 on which see infra. 55 regulation (ec) no. 864/2007 on the law applicable to non-contractual obligations, oj 2007 l 199/40. directors' duties and csr under german law 22 the law of the developing country where the subsidiary operates and where the victims suffered damage that applies. in many instances, the tort law systems of these countries belong to the common law world; which triggers the interesting question of whether or not the recent development of english common law with the case of chandler v cape applies. in oguru v shell, the district court of the hague regarded chandler v cape plc to be a part of nigerian law.56 english courts have been less bold until now, and in vedanta as well as in okpabi, the first instance judges heard experts from the relevant countries about their views of the application of chandler v cape in zambian and nigerian law respectively. unsurprisingly, expert evidence supplied by the claimant and by the defendant differed, and the judges have not reached a conclusion yet on which opinion to follow.57 therefore, the following considerations first of all depend on the application of the chandler v cape criteria as part of the laws of the countries where the subsidiaries operate; which shall be assumed hereinafter. in substantive law, one important distinction relates to the claimants: in the dutch shell cases as well as in vedanta and in okpabi, the claimants are not employees of the subsidiaries, as in chandler v cape, but neighbours that have been harmed by the pollution of the environment through oil and mining operations. until now, courts have not entirely excluded the application of chandler v cape to this type of claimants. the first instance judge in vedanta said this: ‘for obvious reasons, such a claim is more likely to succeed if advanced by former employees .... however, depending on the facts, claims made by residents, rather than former employees, are still arguable.’58 another problem of fact is the comparability of the corporate structures at issue. as mentioned above, under the second chandler v cape criterion, the parent has, or ought to have, superior knowledge on some relevant aspect of health and safety in the particular industry. in contrast, in the case of thompson v renwick,59 liability of the parent company was denied because the parent company merely held shares in the subsidiary and did not possess superior knowledge in the field of business that the subsidiary was in. thus, potential liability of the parent company heavily depends on the relationship between the parent company and the subsidiary. for example, the first instance judge in okpabi argued that royal dutch shell did not have any operations in nigeria or anywhere; that it did not have any infrastructure in nigeria; and that there was simply no evidence of a high level of oversight or high degree of control and direction, or indeed of any appreciable level of oversight or control either. 56 see oguru, supra note 40, [4.30] and [4.34ff]. the appeal court of the hague has not decided on that issue yet. 57 see okpabi, supra note 41, [58] f.; vedanta, supra note 42, [123]. 58 see vedanta, supra note 42, [115]. 59 [2014] ewca civ 635. njcl 2017/1 23 thus, he could not see the chandler v cape criteria satisfied.60 in contrast, the first instance judge in vedanta saw a realistic chance to find that vedanta has taken significant control over the operations of its subsidiary kcm.61 following chandler v cape, a scholarly debate has also started in germany, where authors discuss a potential duty to organise the corporation including its subsidiaries in such a manner that employees and other third parties do not suffer harm. that debate is by and large fictitious, as far as activities of german parent companies in developing countries are concerned, as german law will not apply to torts that cause damage in the host states62 (although some authors try to bring german law to application, for example, as ‘rules of safety and conduct’ in the terms of article 17 of the rome ii regulation63 or through the ordre public rule of article 26 of the rome ii regulation, in particular if otherwise the law of an unjust state applied).64 a number of authors have argued towards an extension of the duty to organise the enterprise (betriebsorganisationspflicht) to a duty to organise the corporation (konzernorganisationspflicht).65 generally speaking, german authors are cautious but recognise a general development towards greater responsibility for the activities of subsidiaries.66 2.1.2. supply chain liability the idea of supply chain liability is even more recent than the idea of the parent company’s liability for its impact on the performance of subsidiaries. it has also been fuelled by the case of chandler v cape. in fact, the court in chandler v cape did not refer in any way to ownership of the parent company in the subsidiary but rather to dependence and control. in the aftermath, academic authors have argued that a comparable ‘relationship of control’, 'prior conduct that creates a situation of peril', 'superior knowledge' and a situation in which the 'injured party relies on 60 see okpabi, supra note 41, [99]. 61 see vedanta, supra note 42, [121]. 62 see also wagner, supra note 51, at 739ff. 63 see saage-maaß and leifker, supra note 43, at 2502. 64 see axel halfmeier, ‘menschenrechte und internationales privatrecht im kontext der globalisierung’ (2004) 68 rabels zeitschrift für ausländisches und internationales privatrecht 653, 671ff.; marc-philippe weller, luca kaller and alix schulz, ‘haftung deutscher unternehmen für menschenrechtsverletzungen im ausland’ (2016) 216 archiv für die civilistische praxis 387, 394ff., for serious human rights violations. 65 se, eg, glinski, supra note 37, at 343ff.; saage-maaß and leifker, supra note 43, at 2502ff. 66 see, eg, wagner, supra note 51, at 767; weller, kaller and schulz, supra note 64, at 401ff. directors' duties and csr under german law 24 the defendant' and his superior knowledge or resources may also exist in the relationship between suppliers and their purchasers.67 following spectacular disasters, in particular in the garment industry in pakistan and bangladesh, the first cases relating to supply chain responsibility have reached the courts. in germany, four victims of the ali enterprises factory fire in karachi have sued the garment discounter kik, the main customer of ali enterprises, for damages.68 outside eu jurisdictions, victims of the rana plaza collapse in bangladesh have initiated a class action in the us against several retailers,69 and a similar law suit has been filed in ontario.70 in terms of jurisdiction, no problems arise in eu member states. in particular, victims would not normally try to sue the suppliers together with the purchasers as the suppliers lack relevant funds. in fact, if suppliers are large enough to be attractive defendants, the level of control of the purchaser over the supplier is likely to be insufficient to justify supply chain liability. the applicable law is again the law of the country where the damage occurred. thus, in the german kik case, the applicable law is the law of pakistan;71 and therefore, again, chandler v cape may be relevant, as the lg dortmund may find that case to be part of pakistani law. in rahaman, the superior court of delaware applied bangladeshi law to the issue of prescription but not to the employer’s liability claim.72 in terms of substantive law, courts would need to be prepared to apply the chandler v cape criteria to supply chains, as proposed above. in rahaman, the superior court of delaware applied the general rules (of the law of delaware) regarding an employer’s liability for the employees of an independent contractor without mentioning chandler v cape at all; which also the claimants apparently have not pleaded. the action was dismissed. 67 see peter rott and vibe ulfbeck, ‘supply chain liability of multilateral corporations?’ [2015] european review of private law 415. see also andrew sanger, ‘crossing the corporate veil: the duty of care owed by a parent company to the employees of its subsidiary’ (2012) 7 clj 478, 480; cees van dam, ‘tort law and human rights: brothers in arms’ (2011) 2 journal of european tort law 221, 251; demeyere, supra note 38, at 390. 68 lg dortmund, 7 o 95/15. for details, see philipp wesche and miriam saage-maaß, ‘holding companies liable for human rights abuses related to foreign subsidiaries and suppliers before german civil courts: lessons from jabir and others v kik’ (2016) 16 human rights law review 370, 372ff. 69 delaware superior court, abdur rahaman et al. v jcpenney corp. inc. et al., c.a. no. n15c-07-174 mmj. 70 das v george weston limited, no. cv-15-526628 (ont. superior ct. filed apr. 22, 2015). 71 lg dortmund, press statement of 30/8/2016, <www.lg-dortmund.nrw.de/behoerde /presse/pressemitteilungen/pm-kik_docx.pdf> accessed 14 june 2017. 72 see rahaman, supra note 69. njcl 2017/1 25 german scholars are also discussing supply chain liability under german tort law, and reluctance is even greater than with regard to organisational duties in corporate structures.73 2.2. impact on directors’ duties? as explained above, the duty to avoid unnecessary liability risks requires consideration of the extension of the risk and the likelihood of its materialisation. looking at the degree of damage caused by subsidiaries in developing countries and the number of people affected, the extension of the risk is significant. for example, in bodo communities, the shell petroleum development company of nigeria paid £55 million in settlement.74 in okapbi and others v rds and spdc, the claimant chiefs of the ogoni people represent around 42,000 people. the vedanta law suit concerns 1,826 claimants. in the kik case, four test claimants claim €30,000 each. shortly after the admission of the claim and the grant of legal aid, kik agreed to pay us-$5.15 mio. to the victims.75 the rana plaza factory collapse, which was subject to the rahaman litigation, claimed 1,130 deaths and injured 2,500. in the das case pending in ontario $2 billion are at stake.76 law firms have sent messages to their transnational corporations clients warning them against the new liability risks.77 the likelihood of the materialisation of the risk, in contrast, is difficult to estimate as all the law suits are still pending, and until now, almost no parent company has been successfully sued; in the case of bodo communities, it was the subsidiary spdc who paid £55 million in settlement. academic authors are also divided about the prospects of the claims as well as about the desirability of any duties of parent companies related to the activities of subsidiaries in developing countries. thus, it is clearly not possible to argue that passivity on part of the parent company concerning the subsidiaries’ operations will lead to tort law liability, whereas it might lead to tort law liability. the same applies to supply chain liability where, intuitively, the idea of liability arising from supply chain control appears to be even more remote. litigation is still at an early stage, and the best one can say at this 73 see, eg, wagner, supra note 51, at 771ff. 74 the bodo community and others v the shell petroleum development company of nigeria ltd [2014] ewhc 1973 (tcc). 75 see ecchr, ‘der preis der katastrophen in der textilindustrie südasiens’, <www.ecchr.eu/de/unsere-themen/wirtschaft-undmenschenrechte/arbeitsbedingungen-in-suedasien/pakistan-kik.html> accessed 14 june 2017. 76 see michelle chen, ‘a western company could finally be held accountable for the rana plaza disaster’ (the nation, 29 april 2016) <www.thenation.com/article/awestern-company-could-finally-be-held-accountable-for-the-rana-plaza-disaster> accessed 14 june 2017. 77 see birgit spießhofer, ‘wirtschaft und menschenrechte – rechtliche aspekte der corporate social responsibility’ [2014] njw 2473. directors' duties and csr under german law 26 time is that the claims of subsidiaries’ employees have not been struck out immediately, and that legal aid has been granted in germany; which means that the court does not deny the possibility of a successful claim (predominantly due to lack of knowledge of the law of pakistan). application of chandler v cape to supply chains has not been tested in the failed rahaman litigation in delaware. 2.3. limitations tort law of course has its own limitations in that it usually requires physical damage, whereas liability for non-pecuniary damage is by and large excluded. thus, tort law may impose liability on transnational corporations where insufficient health and safety precautions and environmental protection lead to physical damage and consequential loss of employees and neighbours, or where there is responsibility for human rights violations committed by security personnel in the neighbourhood. in contrast, it would seem impossible to catch other csr issues such as, in particular, minimal wages, excessive working hours (unless they lead to health problems), or obstruction of workers’ associations. 3. legal uncertainty of course, the law is not always clear. legal uncertainty is a problem that arises both with regard to the duty to avoid unnecessary risks and with the legality principle. in principle, these situations need to be distinguished, as the appreciation of business risks, including liability risks, come under the business judgment rule whereas the legislator has made it clear that the business judgment rule does not apply to compliance with legal obligations under the legality principle. nevertheless, it has been argued in academic writing that the criteria that are to be applied to the business judgment rule may also apply in situations of legal uncertainty, as in such situations, there will also be some margin of appreciation.78 how do directors deal with this legal uncertainty? clearly, directors will have to investigate the legal situation.79 this will normally require them to seek professional advice,80 in particular when it comes to the application of foreign law.81 whether or not asking the internal legal department of the company suffices depends on the circumstances, such as the time that is available for the decision, but also the risk. here, it should be recalled, that in csr matters such as health and safety and environmental degradation the extension of the risk might be quite significant. the courts lean towards a duty to seek external advice,82 and even then, directors should be wary that in long-term relationship with an external, 78 see spindler, supra note 2, margin note 75; kocher, supra note 35, at 217. 79 see spindler, supra note 2, margin note 77. 80 see bgh neue zeitschrift für gesellschaftsrecht 2011, 1271. 81 see kocher, supra note 35, at 220. 82 see olg stuttgart, neue zeitschrift für gesellschaftsrecht 2010, 141. njcl 2017/1 27 independence may suffer over time.83 quite obviously, the external professional must possess the relevant expertise,84 or his or her selection may trigger director’s liability.85 if the director can derive from professional advice that the courts may interpret the law in favour of the company, he does not act in breach of his duty if he acts on the basis of such favourable interpretation.86 this would mean that in the current situation of legal uncertainty about a transnational corporation’s liability for damage that occurs in the country where the subsidiary or the supplier operates, the director would not be under the general duty to do everything to avoid that damage to occur; although it would seem that, again, the closer the situation to the chandler v cape criteria, and therefore, the greater the risk of liability, the more likely it is for a court to find a breach of duty. at the same time, there should be no doubt that the recently increased risk of liability in corporate structures and even in supply chain situations give directors the right to integrate risk avoidance measures in their decisions. certainly, they have to follow the legal development, in particular the pending litigation, closely.87 4. conclusion pursuing corporate social responsibility goals as such is surely not a duty of directors under german law. the directors’ duties under the legality principle only apply to existing legal obligations or to selfcommitments of a company, through its competent bodies, to csr soft law or private regulation. directors, however, also have to avoid unnecessary risks, under the business judgment rules. here, the increasing risk of tort liability in the aftermath of chandler v cape, with the influx of cases in several jurisdictions, may lead to the duty but surely to the right of directors to organise the transnational corporation or the supply chain in such a way that damage is avoided, even if this is more costly than the often ruthless business policy of the past. 83 see spindler, supra note 2, margin notes 78 and 80. 84 see olg stuttgart, neue zeitschrift für gesellschaftsrecht 2010, 141. 85 for an overview, see holger fleischer, ‘vorstandshaftung und vertrauen auf anwaltlichen rat’ [2010] neue zeitschrift für gesellschaftsrecht 121. 86 see spindler, supra note 2, margin note 83. 87 see also liisa-julia voß, ‘saage-maaß, miriam/leifker, maren – haftungsrisiken deutscher unternehmen und ihres managements für menschenrechtsverletzungen im ausland, in: bb 2015, s. 2499 – 2504’ [2015] newsdienst compliance 42101. contracts, risks and management = contractual risk management nordic journal of commercial law issue 2012#1 consid eration of ethical and legal aspects of corporate social responsibility: the issue of multi-national corporations and sust ainabl e devel opment brian-vincent ikejiaku* * the author, dr. brian-vincent ikejiaku is a lecturer in law and politics at the british institute of technology & e-commerce (bite), london uk, e-mail: brian@bite.ac.uk or ike.bvo06@yahoo.com. dr. ikejiaku visits as a senior lecturer in international law in the madonna university nigeria; he served as an interim head of department of international law in the first quarter of 2012. much appreciation is expressed to the bite, for providing the necessary support during the preparation of the manuscript of this paper. the author also thanks prof. mathias siems (director of research norwich law school uea uk) for reading through and, commenting on the first draft of the manuscript. many thanks go to katja lindroos, the editor njcl for the final recommendations he made for improving on the paper. finally, profound appreciation goes to rev. sister purisima of the madonna university for all her moral support. mailto:brian@bite.ac.uk mailto:ike.bvo06@yahoo.com 1 nordic journal of commercial law issue 2012#1 1 introduction trend of events over the last ten years have shown that the world has witnessed widespread business failures and even collapses. 1 these failures and collapses have been devastating and tragic to the global economy. 2 within this period, corporations have claimed to promote corporate social responsibility (csr) and be committed to sustainable development, while at the same time perpetrating harmful business practices in the communities in which they operate. 3 unethical behaviour and illegal practices (such as cheating, greed and deceit) on the part of the executives of the corporations are the major causes of these crashes. 4 the primary motivating factor to cheat in the business world is financial gain. however, cheating in any sense, be it greed, deceit, unethical conduct, acts of illegality or illegal practices, though detrimental to the sustainable development of the communities in which corporations operate their businesses, eventually in some occasions end up causing the executives of these multi-national corporations (mncs) problems. 5 the issue is topical, because csr continues to be one of the most important and controversial aspects of global business receiving much attention from all circles – business managers, lawyers, government leaders and academics in different fields. while continuing to increase in prominence, there are many aspects and many approaches evolving surrounding this global phenomenon. csr of business is actually impacting on the people at this point-in-time, locally, nationally, regionally and globally. the financial crisis has provided a number of examples of firms that have engaged in practices that create systemic risk to the economy, but the issue is not confined to the financial sector. virtually all firms are deemed to be sufficiently strategic in their undertakings in the local, 1 for example, besides enron and andersen debacle, there have been collapses of other global companies – allco finance group in nov. 2008, ebs international a digital media in nov. 2008, environinvest agribusinesses in sept. 2008, gmc a manufacturing power tool maker global machinery company dec. 2008, mida in jan. 2009, and lehman brothers, available at http://www.smartcompany.com.au/strategy/20090212-25-corporate-collapsesand-the-lessons-learnt.html (10/04/2011). 2 for example, see maniam, b., & teetz, h. (2005). current realities of ethical issues in corporate america: how does ethics effect the financial arena: journal of legal, ethical and regulatory issues, vol. 8, no. 2. 3 see mcdonald's corporation csr information, available at http://www.mcdonalds.com/usa/good/report.html (19/12/10). 4 for example a one-year probe into the collapse of lehman brothers found credible evidence that top executives, including the former chief dick fuld, approved misleading financial statements and used an accounting gimmick and manipulation to flatter results. there is also further and enough evidence that ernst & young, lehnam’s auditors, failed to qusetion and challenge improper or inadequate disclosures in the firm’s result, see guerrera, f., bullock, n., & sender, h. (2010). lehman report blames top executive at www.ft.com 5 see maniam, b., & teetz, h. (2005) supra. lehman and enron cases are very instructive here. the ‘bear strearns’ hedge fund collapse convinces us on how deadly mix of greed and leverage cost investors millions. http://www.smartcompany.com.au/strategy/20090212-25-corporate-collapses-and-the-lessons-learnt.html http://www.smartcompany.com.au/strategy/20090212-25-corporate-collapses-and-the-lessons-learnt.html http://www.mcdonalds.com/usa/good/report.html http://www.ft.com/ 2 nordic journal of commercial law issue 2012#1 national, regional and global community. actions desired by the society may differ from those undertaken by the firm in order to make reasonable profits in their business. thus, firms may adopt different (positive or/and negative) strategies to maximise impact on society for their benefit. however, business strategy also affects the likelihood of harm to the society as a whole (though, with the level of impact differing on developed and developing societies). 6 it is argued that csr initiatives of mncs are all about cover-up and pretence. 7 most of the legal authoritative works on csr, which analyse company csr, primarily focus on developed areas, and therefore overlook or discuss only briefly the csr situations in developing countries that more clearly demonstrate the box-ticking mentality of companies. 8 the few works that focus on developing areas reveal that in developing countries almost all the corporations are involved in box-ticking; as this paper will demonstrate. in light of the harm caused by firms globally, the hypothesis of this paper is that the undertakings or business activities of most large global firms (i.e. mncs) must have impacted heavily on the sustainable development of the society, particularly the communities where they operate their businesses and, especially in the developing countries. it is therefore important for this paper to consider the ethical and legal aspects of csr of mncs and their business impact on sustainable development of the wider community. this paper primarily examines the contribution of csr of mncs to the sustainable development of the communities in which the corporations operate their businesses; this is approached from the context of practice argued through the three chosen empirical cases, 9 and supported with theoretical analysis. this paper provides a separate sub-section for the consideration of various definitions or/and meaning of csr. 10 however, the working definition for the purpose of this paper is that csr is about 6 for example the impact of environmental damage because of the oil spillage of the shell british petroleum in the us and nigeria is not the same; equally the response and attention given to these oil-spillages in these societies are different. 7 many companies used csr as a kind of corporate pr or make-believe rather than as genuine attempt or practical move to change the way they intermingle with the society. instead of addressing the real issue at stake, csr merely put up camouflage, thereby distracting public attention away from the corporate ills. csr never tells the audience what happened behind the scene, i.e. what is really going on inside the company; see ying, f. (2005). ethical branding and corporate reputation, available at http://www.emeraldinsight.com/researchregister (12/04/10). 8 horrigan’s (2010) work for example that highlights among other things, the major recent global developments in corporate social responsibility already this century, focus especially on europe, the uk, north america, and australasia. 9 as stated earlier, this paper uses three giant multinational corporations in three different legal regimes for brief empirical illustrations: enron in the united states of america, macdonald’s in the united kingdom and shell b.p in nigeria (africa). 10 this paper also provides brief explanations of the important concepts in understanding csr that will be helpful in the analysis, such as sustainable development, social responsibility, corporate governance, corporate citizenship, and corporate accountability. http://www.emeraldinsight.com/researchregister 3 nordic journal of commercial law issue 2012#1 the sensitivity of an organisation to ethical and legal practices, and beneficial responsiveness that promote sustainable development in the community. thus, while this paper recognises the importance of the success of business activities regarding what goes inside the corporations (i.e. internality-the inner circle), it is more concerned on the impacts of the activities of corporations on the communities or environments in which they operate their businesses (i.e. externality-the outer circle). this focus is on how csr of an organisation contributes to the sustainable development of the wider community. section 2 primarily looks at the various definitions or/and meaning attached to the term csr, and briefly explains the central concepts helpful in the understanding of csr as used in this paper, such as sustainable development, social responsibility, corporate governance, corporate citizenship, corporate accountability, triple-bottom-line, and box-ticking mentality; as well as looks at the difference between ethics and legality. section 3 presents the three empirical case studies identified; these are enron, north america (usa); macdonald’s, uk (europe); and shell, nigeria (africa); it also made comparative remarks of csr in uk (europe), north america (usa), and nigeria (africa). the empirical cases form the basis of analysis in the other sections of this paper within the framework of the contribution of csr of mncs in the sustainable development of the communities in which they operate their businesses. this includes: consideration of the ongoing heated debate within the academic circles whether csr is voluntary or mandatory (section 4); the issue of box-ticking and its implementation on a practical level (section 5); it concludes in section 6 that the neglect of the ethical and legal aspects of csr, though detrimental to the sustainable development of the communities in which corporations operate their businesses, eventually in some occasions end up in causing the executives of these multinationals or/and the corporations problem. 2 central concepts 2.1 definition and meaning attached to csr one of the inevitable questions about csr, is what it means? 11 it is therefore necessary to consider some of the definitions and meanings of csr, as well as briefly look at the central concepts helpful in understanding it. there are many definitions rendered by scholars and institutions on the meaning of corporate social responsibility (csr). 12 the european commission green paper (ecgp of 2001), which has one of the 11 though the working definition for this paper is that csr is about the sensitivity of an organisation to ethical and legal practices, and beneficial responsiveness that promotes sustainable development in the community; it is helpful to consider other different csr definitions and their conceptual meaning. 4 nordic journal of commercial law issue 2012#1 most frequently cited definitions on csr, for example, defined csr as “a concept whereby companies decide voluntarily to contribute to a better society and a cleaner environment”. 13 lazear defines csr as a company’s voluntary commitment to address the ethical, social, and environmental factors associated with all aspects of its operations. 14 in ward’s view “csr or cr are about maximising the positive impacts or contributions of business activity to society, while minimising the negatives. in this broad sense, both agendas are sometimes understood as synonymous with business and sustainable development agenda, which incorporates recognition of a need to balance economic, social and environmental considerations”. 15 while csr according to dti in its 2001 document, summarily is associated with reputation, competitiveness and risk. 16 csr has also been viewed as a concept that suggests that commercial corporations have a duty of care to all of their stakeholders in all aspects of their business operations. it is basically the notion that business has a symbiotic relationship to society, which is firmly entrenched and extends beyond the economic criteria. 17 holme and watts defined csr as ”the continuing commitment by business to behave ethically and contribute to economic development while improving the quality of life of the workforce and their families as well as the local community and society at large”. 18 most of these definitions emphasise the voluntary nature of csr, although a few others suggest that csr is mandatory. 19 this has caused heated debate in academic circles on whether csr is mandatory or voluntary. before considering the debated positions or views that will help address the research question of this paper, other central concepts helpful to understanding csr will be explained and the empirical case studies that will assist the analysis in this paper, will be presented. 12 due to such divergent views in the meaning, it has also become a common issue whether csr can still really be considered as a mere voluntary act or not; this has incited a debate in the academic circles. 13 commission (2001). promoting a european framework for corporate social responsibility. green paper com (2001) 366 final, luxembourg: oopec, p. 5. 14 lazear, e. (2009). the global society: content and limits of corporate social responsibility: global economic symposium. 15 see ward, h. (2005). corporate social responsibility and the business of law. globalt assvar, swedish partnership for global responsibility, p.2 16 see dti, in deakin, s. and hobbs, r. (2006). false dawn for csr? shift in regulation policy and the response of the corporate and financial sectors in britain. centre for business research: university of cambridge working paper no. 333. 17 see prandtl, l. (2008). a brifing paper on corporate social responsibility: mandatory or voluntary? http://www.mydd.com/users/louisprandtl/posts/a-briefing-paper-on-corporate-social-responsibility (11/05/2011). 18 holme, l. and watts, r. (2000). ‘making good business sense’. world business council for sustainable development, p.1. 19 for example, while the ecgp (2001) and lazear (2009) see csr from the voluntary context, prandtl (2008) and holm and watts (2000) suggest the mandatory csr. these works are cited above. http://www.mydd.com/users/louisprandtl/posts/a-briefing-paper-on-corporate-social-responsibility 5 nordic journal of commercial law issue 2012#1 2.2 definition of the central concepts related to csr as employed in this paper sustainable development: sustainable development is an elusive and widely contested concept, with vast array of different conceptualizations and definitions. 20 within the context of this paper, it refers to development that addresses social problems such as poverty, crime, environmental protection, equal rights, human rights, public health and improving education as a result of the socially responsible acts of mncs in the communities in which the corporations operate their businesses. social responsibility: this concept reflects the ethical aspect that an entity (in this paper, mncs) has an ethical (rather than legal) obligation to act responsibly by providing sustainable development benefits within the communities in which they operate. 21 corporate citizenship: this concept is used to describe a company’s role in, or responsibilities towards society, 22 and here relates to the role of mncs in taking socially responsible action aimed towards ensuring the sustainable development of the communities in which they operate. corporate governance: this concept broadly refers to the rules, processes, or laws by which businesses are operated, regulated, and controlled. in this paper, it refers to the rules that guide or regulate the business operation of mncs in order to enforce or structure their csr activities for the sustainable development benefits of communities in which they operate. 23 corporate accountability: this is the obligation of mncs to account for, accept responsibility for, and disclose the results of their csr activities in a transparent manner that will help to contribute to the sustainable development of the communities in which they operate. triple bottom line: triple bottom line (tbl), which is also known as ‘people, planet, and profit or the three pillars’ is a wide spectrum or an expanded range of values and criteria for measuring mncs success and commitment to csr by way of contributing to the sustainable development of the communities in which they operate. 20 for example, the more general definition of the concept is that rendered by the wced, as development that ‘meets the needs of the present without compromising the ability for the future generations to meet their own needs’ – see the world commission on environment and development (1987). our common future. oxford university press, p9. 21 in the context of this paper the issue remains whether most corporations see the ethical notion of providing sustainable development benefits to communities in which they operate their businesses as obligation – in other words are mncs social responsible to the communities they carry on businesses. 22 based on this, corporate citizenship may be used interchangeably with the more common concept ‘corporate social responsibility’; in reality, many companies such as noavarities, microsoft, pfizer, and ibm etc have used it in this way to describe their social initiatives, see matten, d. crane, a. and chapple, w. (2003). ‘behind the mask: revealing the true face of corporate citizenship’ journal of business ethics, 45, 1 / 2: 109-120. 23 that is by adhering to accepted ethical standards and best practices, as well as to formal laws that will lead to csr of mncs contribution to sustainable development. 6 nordic journal of commercial law issue 2012#1 box ticking mentality: this is fake willingness or pretence by most companies to be ethical and legal responsible, in order to promote sustainable development of the communities in which they operate. however, in reality or practice, the activities of most corporations seem not to make this profound impact on the communities. 24 2.3 difference between ethical and legal there is a case for the more influence of laws (as differs to that of ethics) on csr regarding responsiveness or sensitivity to contribute in the sustainable development of communities. the yardstick established by laws, obligatory rules and regulations, whereas they may not instantaneously be turned into action in any real sense of global organisational practice, have a particularly strong influence on establishing social expectations about responsible corporate behaviour, as opposed to ethics. the social expectations (that involve contribution to development activities) subsequently act as a hub upon which corporations organise their behaviour in the communities where they operate their businesses. 25 the enacted laws and policies promulgated by governments as well convey an effective warning sign about the crucial nature of a matter; a warning indication, as regards csr, is augmented by the business culture in the country, consumers’ interests, institutional investors’ actions, the corporate governance regime, ngos’ effectiveness and civil society’s conducts. 26 whereas, these laws serve as a regulatory framework over the corporations’ activities, they also provide a sense of direction and confidence to the corporations on the direction they could operate. more so, once the social expectation is created as a result of the criteria laid down by law, a number of other forces, including consumer demands, institutional investor demands, ngo demands and particularly community demands interact to create incentives for corporations to meet the standards set out in the law, whether ‘enforcement’ is a realistic cause or a mere threat, 27 depends on whether it is purely ethical or legal. the ethics of csr is equally crucial, particularly in ensuring corporations’ responsiveness to sustainable development of the community – when csr is infused with ethics, it helps to guide corporate activities, and practically goes on to maintain a moral course that favours the larger public. 24 only quite a minority communicate a clear sense of the values that differentiate them from their competitors – the co-operative bank, cadbury, schweppes are good cases to mention. 25 mcadams, r. and nadler, j. (2005). testing the focal point theory of legal compliance: the effect of third-party expression in an experimental hawk/dove game. journal of empirical legal studies, 87-123. 26 williams, c. and aguilera (2007). corporate social responsibility in comparative perspective. spi publishers delhi. 27 see kagan, r., gunningham, n. and thornton, d. (2003). explaining corporate environmental performance: how does regulation matter? law and society review, 37: 51-90. 7 nordic journal of commercial law issue 2012#1 this is particularly important during times of change and intense pressure when often no just range is in place to regulate and direct corporations through complex conflicts about what is right or wrong. 28 it is therefore relevant to consider the difference between ethics and legality. ethical simply means – moral, principled, right, fair, decent or just. it is derived from the term ‘ethics’, which generally refers to moral rules or principles of behaviour for deciding what is right and wrong. 29 legality means – lawful, officially permitted or authorised. it is derived from the concept ‘law’, which refers to codified principles and regulations that describe how people (including corporations) are required to act. 30 ethics is a very complex subject; for example it is different from legality, but at the same time it is difficult to distinguish between ethics and legality, and ethical values vary between individuals and organisations, and between different cultures; and they are changing over time. 31 corporations for example, may face legal action for failing to adhere to the ethics incorporated in its csr. ethics incorporated in csr could be viewed as a promise protected by legal contract. corporations can be subjected to suit for breach of contract for failure to comply with any promise it made (that is the failure for complying with the ethics inbuilt in its csr). thus, the gap between stated corporate ethos and actual practice has crucial legal, as well as ethical implications; 32 so there is a philosophical issue involved in understanding ethical conduct. according to orsini and mcdouglas, ‘ethics is a broad and murky area and the workplace is full of ethical dilemmas and issues’. 33 or as treviño and nelson put it, ethics is where ‘values are in conflict’. 34 and as harvard professor lynn sharp paine notes earlier, ‘what is ethical problem today may become a legal problem tomorrow’. 35 28 see wallace, d. and pekel, j. (of the twin cities-based fulcrum group), available at http://www.managementhelp.org/ethics (18/03/2010). 29 see the thesaurus free english dictionary (online) www.macmillandictionary.com/ (7/03/2010). 30 see the thesaurus free english dictionary (online), ibid. 31 berg, j. (1991). moral rights: a legal, historical and anthropological perspective, intellectual property journal, vol. 6, september. 32 drake, b. and drake, e. (1988). ethical and legal aspects of managing corporate cultures. california management review, vol. 16, pp107-123. 33 orinsi, b. and mcdouglas, d. (1999). fraudbusting ethics, cma management, cited in maniam, b. and teetz, h. (2005), supra p. 83. 34 treviño, l. and nelson, k. (2007). managing business ethics; straight talk about how to do it right, wiley & sons: new york, p.3 35 see paine, l. (1994). ‘law ethics and managerial judgement’: the journal of legal studies in education, vol. 12. no.2, 155, 165, 167. http://www.managementhelp.org/ethics http://www.macmillandictionary.com/ 8 nordic journal of commercial law issue 2012#1 really, ethical standards appear to be confused or muddled with what legal requirements are governing the situation at any point in time. being ethical is more than obeying the law and avoiding harm. there are codified principles and regulations that describe how people or corporations are required to act legally, but these legal stipulations cover behaviours or activities not necessary covered by ethical standards and values. 36 the ethics of a particular act of corporation is many times determined independently of the legality of the conduct. in fact, decisive answers or responses cannot always be provided for many ethical issues because enforceable standards or reliable theories for resolving ethical conflicts are lacking. 37 3 empirical illustrations: three multinational corporations in three different legal regimes these examples illustrate the conflict between csr policy and mnc actions and goes to the heart of the csr-debate. corporations that have claimed to promote csr and to be committed to sustainable development, while at the same time engaging in harmful business practices in the communities in which they operate challenge the whole concept and meaning of csr. the brief empirical case illustrations here, demonstrate the extent in which the activities of three large multinational corporations contribute to the sustainable development of the communities in which they operate. it shows the practical problem of disproportionality of csr activities to the overall activities of the respective mncs. however, the illustration also shows that unethical conduct and acts of illegality, though detrimental to the sustainable development of the communities, on some occasions end up causing the executives of the mncs or/and the mncs themselves, problems. 3.1 enron in the united states of america (north america) traditionally in the us, the definition of csr has been based on a philanthropic model; companies are allowed to make profit largely unhindered (that is operating on a moral space) but are then expected to donate a certain percentage of the profits to charitable causes. 38 companies have moral spaces, and as well, owe moral obligations to those whom they come up against. operating within these apparently undefined moral terrains is not simple. thus, since the 1930s academic debate about the obligations that us companies owe to shareholders and to society at large. 39 based on the 36 see maniam, b. and teetz, h. (2005) supra, pp.83-98. 37 see di lorenzo, v. (2004). ‘the influence of law on business ethics’, paper presented at the annual meeting of the law and society association, renaissance hotel, chicago, illinois, may. 38 the law society (2002) supra 39 kagan, r., gunningham, n. and thornton, d. (2003) supra 9 nordic journal of commercial law issue 2012#1 traditional model, most companies in the us have abused the freedom because only very small shares of profits are actually channeled to charitable causes. for example, according to a recent harvard university study, “u.s. companies avoid paying tax on nearly $300 billion in income in 1998… in 1940, companies and individuals each paid about half the federal income tax collected; now the companies pay 13.7% and individuals 86.3%”. 40 recently, however, the us government amended the us sentencing guidelines which effectively reshaped the debate by requiring corporate boards to ensure that their companies have organizational cultures that promote ethical conduct. 41 if companies fail to do so, they could face increased risk of prosecution, increased penalties following conviction, or the possibility of shareholder suits for breach of fiduciary duty. despite the availability of statutes, regulations, cases, and legions of lawyers to interpret them, it is hard for companies to decipher what is legal and illegal, and to say the least, to decode what is normatively ethical and unethical. yet, it would be unwise for companies to assume that for purposes of the guidelines, the standard for corporate ethical conduct is soft, subjective, and nebulous. if this were the case, enron could have met the requirement, 42 but it did not, because the guidelines on corporate ethical conduct set forth a normative threshold or acceptable standard. enron indeed displays one of the most elaborate csr policies recorded in recent years, before it met its collapse. before its demise, enron had been on the list of the 100 best companies to work for in america and received six environmental awards in 2000. enron emphasized activities that promote sustainable development of society and issued a triple bottom line report. it had great policies on climate change, human rights, and anti-corruption. its ceo gave speeches at ethics conferences and put together a statement of values emphasising ‘communication, respect, and integrity’. the company’s stock was included in many social investing mutual funds, when it collapsed. 43 by the end of 2000, it became known that enron over several years had engaged in clandestine activities involving non-ethical conduct and illegal practices – which has recently been described as ‘an illusion of smoke and mirrors created by its upper management echelon’. 44 enron, through its executives and most senior officials, involved itself in cleverly designed conspiracy, impersonation, forgery, over estimation of its financial statement and deception. in fact, the ceo jeffery skilling answered arrogantly and derogatorily to the initial questioning about the company’s transparency and initial doubts about the veracity of the financial statements of the company instead of answering 40 see nanette, b. and lavelle, l. (2003). ‘special report: the corporate tax game – how blue-chip companies are paying less and less of the nation’s tax bill. business week, march 31, 2003, 79-87. 41 united states sentencing commission, federal sentencing guidelines manuals available at http://www.ussc.gov/guidelin.htm (12/04/10) 42 see sherman, j. (2007) supra. 43 see kelly, m. (2002). ‘the next step for csr: building economic democracy’, business ethics, summer issue 44 maniam, b. and teetz, h. (2005) supra, p.89. http://www.ussc.gov/guidelin.htm 10 nordic journal of commercial law issue 2012#1 the questions posed to him. this attitude likely added to the injury initiating even greater scrutiny by market actors into the reputation of the company. in consequence, enron’s stock, previously valued at about eighty dollars fell drastically to selling for twenty-six cents a share. now, some of its executives are facing criminal charges – for example ben gilson, jr., the former treasurer of enron, is serving a five year sentence, and the former ceo jeffery skilling is facing indictment concerning the reasons leading to the crumbling of enron. 45 ceo jeffery skilling has been quoted “my job as a businessman is to maximise returns to shareholders. it is the government’s job to step in if the product is dangerous” 46 now the government including the courts have done so and former mnc enron including its executives are no longer, as they sink into limbo. 3.2 mcdonalds in the united kingdom (europe) in the uk model, the csr – focus rests on operating the core business in a socially responsible way, balanced by investment in communities for genuine business reasons, for example, douglas alexander, the former uk minister for csr, has remarked that a company with a csr policy in practice should;  realise that its activities have a wide impact on society;  in response, vigorously manage the economic, social, environmental and human rights impact of its global activities; and  seek to accomplish these benefits by working closely with other groups and organisations. 47 in the same vein, the corporation of london in its policy statement on csr has observed that csr concerns the recognition by business and other organisations, whether in the private or public sector, of their responsibilities to society in which they operate. 48 therefore, the uk model, as compared to the philanthropic model in the us, is at least in theory more oriented towards reaching sustainable results. 45 for more on enron’s scandal, see thomas, c. and morris, t. (2003). enron and beyond: what’s the world coming to? the cpa journal, vol. 73 issue 1. p8; maniam, b. and teetz, h. (2005), supra. 46the observer (2002), cited in ying, f. (2005) supra. 47 see ‘argument against csr’ at http://www.mallenbaker.net/csr/against.php (02/04/10). 48 for the views of alexander and corporation of london, see the law society (2002) supra, p.3. it is important to note that apparently, the new uk government no longer appoints ministers for csr, available at http://www.fabianpattberg.com/2010/06/csr-minister-post-disappears-devaluation-uk-leadership-responsiblebusiness-practice/ (19/03/2012). http://www.mallenbaker.net/csr/against.php http://www.fabianpattberg.com/2010/06/csr-minister-post-disappears-devaluation-uk-leadership-responsible-business-practice/ http://www.fabianpattberg.com/2010/06/csr-minister-post-disappears-devaluation-uk-leadership-responsible-business-practice/ 11 nordic journal of commercial law issue 2012#1 it is documented that the administration of prime minister tony blair is exemplary as a government leadership that emphasises and encourages the promotion of csr. one example of its policy encouragement was that the u.k. government was persuaded that extractive industry revenue transparency would help to promote government accountability, political stability and reduced poverty in many resource rich, yet poor countries. 49 in 1996, the blair administration promulgated regulations that require the trustees of occupational pension funds to adopt statements of investment principles (sip) specifying the way social and environmental information is taken into account in constructing investment portfolios. other countries such as, belgium, france, germany and the netherlands have adopted similar initiatives. 50 it is believed that this regulation has had an important impact on most uk companies towards acting in a socially responsible way. 51 macdonald’s is one such company, which is well known in the uk/europe for its csr programmes concerning environmental, labour and sustainable development practices. since the 1970s, the mcdonald’s corporation in association with ronald mcdonald house has been viewed as the leading csr and relationship marketing. more recently, as csr has become the mainstream in global trends, the company has further emphasized its csr programs related to its labour, environmental and other practices. 52 the company’s corporate social responsibility department provides corporate staff leadership, coordination and support for global corporate social responsibility policies, programs and reporting. the corporate responsibility committee acts in an advisory capacity to the company’s management, regarding policies and strategies that affect mcdonald’s role as a socially responsible organisation, such as issues related to product safety, workplace safety, employee opportunities and training, diversity and particularly the environment and sustainable supply chain initiatives. essentially, mcdonald’s csr initiatives seem to be founded on the deliberate inclusion of public interest into corporate decision-making, and the honouring of a triple bottom line: people, planet, and profit (ppps). 53 however, mcdonald’s csr policies left much to be desired regarding sensitivity to unethical and illegal conduct that seem to affect its level of responsiveness to sustainable development of the society. the two primary ethical challenges faced by mcdonald’s in recent years (that have 49 see williams, c. and aguilera (20008) supra. 50 williams, c. and conley, j. (2005). an emerging third way?: the erosion of the anglo-american shareholder value construct. cornell international law journal, 38(2): 493-551. 51 for example it has been argued that based on uk’s leadership role in promoting and encouraging csr, it is not startling that comparative works demonstrate that companies in the u.k possess higher rates of ‘stakeholder engagement and social reporting’ than companies in all other european countries, but norway; yet evaluating on these metrics, the european companies lead globally, see welford, r. (2005). corporate social responsibility in europe, north america and asia. journal of corporate citizenship, 17: 13-52. 52 mcdonald's corporation csr information, available at http://www.mcdonalds.com/usa/good/report.html 53 sound ethics and good governance are priceless, available at http://www.aboutmcdonalds.com/mcd/csr/report/corporate_ethics.html (09/04/10). http://www.mcdonalds.com/usa/good/report.html http://www.aboutmcdonalds.com/mcd/csr/report/corporate_ethics.html 12 nordic journal of commercial law issue 2012#1 subsequently resulted to law suits), concern issues of health and nutrition, and demeaning pay and working conditions of its workers. 54 critics claim that a diet of fast food has been a major contributor to escalating rates of obesity, and the social responsibility of mcdonald’s as the world’s leading fast food company, has been questioned. there is a claim that 'if one eats enough mcdonald's food, one's diet may well become high in fat etc., with the very real risk of heart disease.' 55 the company’s recent report on csr reveals that it is at a low-water mark for the concept of sustainability and the promise of corporate social responsibility has remained unfulfilled. the report asks, whether: a corporation that has been severely stung by bad publicity, poor service, dirty restaurants, and declining earnings…. it presupposes that we can continue to have a global chain of restaurants that serves fried, sugary junk food produced by an agricultural system of monocultures, monopolies, standardization and destruction, and at the same time find a path to sustainability… 56 there was an initial lawsuit (with great publicity in 2002) brought against the company on behalf of two new york children. it was alleged that the company has failed to provide a balanced menu; rather it provides insufficient nutritional information and guidance that actively encourages consumers (especially children) to make unhealthy choices. although this initial lawsuit was dismissed, elements regarding deceptive advertising were reinstated as admissible following appeal in 2005. 57 in europe, the governments have equally reacted; for example the uk government initiated a commons health committee inquiry into obesity that brought executives from mcdonald’s and other food companies to give evidence, and there is further action aimed at tackling obesity anticipated in the near future. 58 mcdonald’s is not better off concerning workers pay 54 the issue here lies on whether it is socially responsible to sell unhealthy or sub-standard products to the consumers, and the level of standard required from the various mncs on their products. this contrasts reasonably from the illegal or unethical behaviours of executives, for example, as was the case of enron. however, it should be noted that certain level of neglect or lack of reasonable response to the duty of care owned to the public, may still be a ground to bring legal suit against mnc. 55 see habisch, a., jonker, j., wegner, m., and schmidpeter, r. eds., (2005). corporate social responsibility across the europe. heidelberg: springer. 56 see the view of hawken, p. on mcdonald's 'report on corporate social responsibility’ in mcdonald’s and corporate social responsibility, available at http://www.ethicalcorp.com/content.asp?contentid=85 april 14 (06/04/10). 57 see big mac under attack (iii): a big fat problem with health and nutrition in mcdonald’s and corporate social responsibility, available at http://www.ethicalcorp.com/content.asp?contentid=85 (06/04/10). there are fears that food companies could come under the similar sort of legal attacks that threatened the tobacco industry in the 1990s. 58 see big mac under attack (iii): a big fat problem with health and nutrition in mcdonald’s and corporate social responsibility. http://www.ethicalcorp.com/content.asp?contentid=85 http://www.ethicalcorp.com/content.asp?contentid=85 13 nordic journal of commercial law issue 2012#1 package and general working conditions, as what are obtainable in terms of general duty of care owned to its workers is below the required standard. 59 3.3 shell b.p. in nigeria (africa) on the matter of multinational corporations’ csr and sustainable development; african countries and other developing countries face a dilemma. on the one hand, foreign investment is a key to economic growth, prosperity and sustainable development. on the other hand, governments of these countries were unwilling to give up control over precious economic resources to those they perceived as agents of foreign economic interests. 60 some governments of developing countries that have decided to allow foreign investment are promulgating laws requiring higher standards of responsible environmental or social conduct in order to compete for foreign capital and institutional investment. however, these governments also compete on adopting favorable rules on issues of contract and property law rights, financial transparency, intellectual property and consumer protection, and reduced government corruption or more general adherence to the rule of law. 61 yet, one prevalent csr concern in developing countries is that governments will ignore corporate irresponsibility or refuse to enforce protective labour or environmental standards in the law, as an inducement to foreign investment. 62 it is the result of the strategy of mncs to seek out areas with low production costs, poor working conditions, and abundant and easily exploitable resources, where profits can be maximised and repatriated without legal constraints, where political leadership is weak, corrupt, and ready to enter into deals or compromises. mncs invest handsomely in countries that meet these criteria, and most african countries, including nigeria fall within this category. nigeria’s vast resources (especially oil), cheap labour, large population, and expanding markets are crucial targets to the mncs, particularly oil companies. 63 therefore, many multinational oil companies such as, chevron, mobil, total, shell and exxonmobil, elf etc have investments in nigeria, and all claim to promote sustainable development in nigeria through their csr programmes. 59slapps, online, available at http://www.environmentcrimes.com/corporations/slapps.htm (08/01/10). in fact, it is instructive to know that in the case of mcdonald’s restaurant v. morris and steel, the court presided over by justices pill, may and keane held that it was right or fair comment to say that md employees globally perform badly on the issue of pay and working conditions. 60 see zerk, j. (2006) supra. 61 see hebb, h. and wojcik, d. (2004). global standards and emerging markets: the institutional investor value chain and calpers’ investment strategy. university of oxford working paper 04-05. 62 see aman, a. (2001). privatisation and the democracy problem in globalisation: making markets more accountable through administrative law. fordham urban journal, 28: 1477-1506. 63 see dare, s. (2001) supra. http://www.environmentcrimes.com/corporations/slapps.htm 14 nordic journal of commercial law issue 2012#1 shell in particular, which dominates the lucrative nigeria oil fields has a much-publicised csr policy and was a pioneer in triple bottom line reporting. a sustainable development approach for csr that is becoming widely accepted is community-based development projects. shell has been involved in many projects across the world, including a partnership with marks and spencer (uk) in three flower and fruit-growing communities across africa such as, the shell foundation’s involvement in the flower valley, south africa. here they have set up an early learning centre to help educate the community's children, as well as develop new skills for the adults. 64 in nigeria, shell undoubtedly has contributed immensely to the sustainable development of local communities in its areas of operation. as a foremost employer of labour, about 12,000 persons (skilled and unskilled) are employed in shell’s activities. one of the strong evidence of shell’s csr activities is in its community development programmes in the local communities. through the community development programmes for example, shell contributes to the development of education by awarding primary, secondary/post primary and university scholarships to local people. shell also builds classrooms, provides equipment and occasionally pays the salaries of secondary school teachers. 65 however, some of the activities of shell in nigeria suggest that the company falls short of ethical and legal standards; 66 most communities in nigeria, particularly the niger delta, see shell’s oil investment in nigeria as a curse and the niger delta has been in constant conflict with both the nigerian government and the shell oil corporation. the niger delta communities contend that shell, in collaboration with the nigerian government, have been exploiting their oil wealth without giving much of it back to the oil communities in the form of sustainable development. 67 niger delta, a flourishing of mangrove swamps, rainforests and swampland is the site of rich oil and natural gas reserves in nigeria. 68 despite being the richest geopolitical region in terms of natural resource endowment, the niger delta’s potential for sustainable development however remains unfulfilled, and is now increasingly threatened by environmental devastation and worsening economic conditions. in spite of the enormous wealth accrued from their land, the people continue to live in pristine conditions in the absence of electricity, pipe borne water, hospitals, housing and schools. 64 available at http://www.fairtrade.org.uk/work/case_studies/read_a_case_study/default.aspx?id=40 (16/02/10). 65 tuodolo, f. (2009). corporate social responsibility: between civil society and oil industry in the developing world. acme: an international e-journal for critical geographies, 8 (3), 530-541. 66 there is the need to promote social justice and environmental protection in nigeria, and most other developing countries but this is lacking. as amaeshi, et al puts it, the niger delta region of the country, and indeed the entire nigerian nation has up to today continued to seek social justice and environmental protection but the oil politics is restlessly driven by powerful interests – the government and the oil firms. the nigerian oil sector is dominated by mncs; see amaeshi, et al (2006). corporate social responsibility in nigeria: western mimicry or indigenous influences? 67 onyeiwu, s. (2004). on the economic determinants of violent conflict in africa; preliminary evidence from nigeria, helsinki: finland. 68 oil accounts for about 90 per cent of nigerian exports and more than 80 per cent of government revenue. http://www.fairtrade.org.uk/work/case_studies/read_a_case_study/default.aspx?id=40 15 nordic journal of commercial law issue 2012#1 the late environmentalist and minority rights crusader, ken saro-wiwa described the pitiable situation of his 500,000 ogoni people in the niger delta to have been relegated to slavery and extinction. 69 in 1993 when saro wiwa was arrested as a rebellion leader, because of protest against the exploitation of oil and pollution of ogoni community, human rights groups urged shell to use its influence on the nigerian government to prevent them from executing him. it has been argued that the shell group chairman herkströter had claimed that the corporation as an economic actor had no licence to meddle with political processes and that shell chose to remain politically unbiased. 70 yet, other sources state that when ken saro-wiwa and eight other activists were hanged for crusading against the government and the oil company; officials at royal dutch shell admitted in a press statement that the company could have stopped the hangings, if it had so desired. shell executives also publicly confessed to purchasing arms for the nigerian state police, who have attacked community residents and activists. 71 in addition, the criss-crossing shell oil pipelines in the front and back premises of private residences should raise the duty of care placed on shell regarding its operations. 72 instead, some local groups have engaged in hostage taking, hijacking and kidnapping of expatriate oil company workers and demand of ransom, and repeated invasion and blockading of oil installations. 73 violence in the niger delta has been spearheaded mainly by ‘restive, and often unemployed,’ youths, who blow up oil pipelines; kidnap expatriate workers of oil corporations, assassinate law enforcement officers guarding oil facilities, as well as community members that collaborate with oil companies and the federal government. 74 69 see onduku, a. (2001). environmental conflicts: the case of the niger delta; a paper presented at the one world fortnight programme organised by department of peace studies, university of bradford, uk, nov., 2001. 70 see livesey, s. (2001). eco identity as discursive struggle: royal dutch/shell, brent spar, and nigeria. journal of business communication, 38 (1): 58-91. 71 see dare, s. (2001) supra. 72 see onduku, a. (2001) supra. 73 onduku, a. (2001) ibid. in 1993 for instance, it is claimed that, the operations and activities of shell were disrupted by about a hundred communal disturbances, leading to the loss of some 12 million barrels of crude oil worth about 369 billion naira. 74 onyeiwu, s. (2004) supra. there were the kidnappings of 2 expatriates in 2006; both included british nationals and involved officials and ministers; more information available at http://www.publications.parliament.uk/pa/id200405/idhansrd/pdvn/ids06/text/60418-1... (07/02/2007). because the conflict wane the peace of the nation, the federal government had to organise a ‘peace workshop’ in april 2004 that included the major youth organisations in the niger delta. coordinated by academic associates peace works – a ngo involved in the conflict resolution – the workshop sought to ‘preach peace among youths of the niger delta’; the nigerian guardian, 2004; in onyeiwu, s. (2004) supra. president obasanjo addressed the workshop. http://www.publications.parliament.uk/pa/id200405/idhansrd/pdvn/ids06/text/60418-1 16 nordic journal of commercial law issue 2012#1 in 2004 it was reported that shell had misreported oil reserves, which seriously damaged its reputation. in may 2008 four nigerian fishermen and farmers from the village of oruma, in the niger delta region, together with friends of the earth-netherlands and friends of the earth-nigeria, filed a lawsuit against shell in the district court of the hague, netherlands, where the company has its international headquarters. the plaintiffs allege that shell was negligent in its clean-up of oil spills in nigeria and that their health was adversely affected by the oil spills. the plaintiffs claim that shell had failed to adhere to international standards of ‘good field practice’ in its nigerian oil operations. they also seek damages for loss of fishponds and livelihood. 75 now, shell faces a lawsuit in the netherlands over alleged oil pollution in nigeria, the ecumenical council for corporate responsibility (eccr), considers how the operations of shell’s nigerian subsidiary, the shell petroleum development company (spdc), affect the human rights and living conditions of niger delta communities. based on case studies researched and written by five civil society organisations working in the niger delta, there are concerns about shell’s operations in relation to international social and environmental standards, pollution levels, communities’ health and livelihoods, and the right of local people to have a say in decisions that affect their lives. 76 human rights and corporate responsibility advocates argue that the activities of shell negate the provisions in the international covenant on civil and political rights and the covenant on the economic, social and cultural rights of the united nations, both of which nigeria is a signatory. 77 3.4 conclusions for csr the three empirical illustrations above show that the csr contributions of mncs to the sustainable development of the communities in which the corporations operate their businesses seem trifling or insignificant in relation to the overall activities, resulting (irreparable) harm and profits of the mncs. this seems to reflect that largely voluntary rather than mandatory csr regulation in reality leaves much to be desired for the goal of achieving sustainable development in affected communities. this implies that though mncs have made some positive contributions to sustainable development of some communities; however, these are not commensurate to the benefits they accrue. there is a case for csr of mncs; as a result of globalisation, particularly the spread of mncs to developing countries, has resulted in the increase of global capital, which has been a dynamic instrument of 75 see case profile: shell lawsuit (re oil pollution in nigeria), at http://www.businesshumanrights.org/categories/lawlawsuits/lawsuitsregulatoryaction/lawsuitsselectedcases/shelllawsuitreoilpolluti oninnigeria (13/04/10). 76 see the ecumenical council for corporate responsibility (2010). shell in the niger delta: a framework for change, available at http://sndden.wordpress.com/2010/03/23/shell-can-improve-impacts-in-the-niger-delta-saysnew-report/ (11/04/10). 77 for example see eccr report (2009) supra; onduku, a. (2001) supra. http://www.business-humanrights.org/categories/lawlawsuits/lawsuitsregulatoryaction/lawsuitsselectedcases/shelllawsuitreoilpollutioninnigeria http://www.business-humanrights.org/categories/lawlawsuits/lawsuitsregulatoryaction/lawsuitsselectedcases/shelllawsuitreoilpollutioninnigeria http://www.business-humanrights.org/categories/lawlawsuits/lawsuitsregulatoryaction/lawsuitsselectedcases/shelllawsuitreoilpollutioninnigeria http://sndden.wordpress.com/2010/03/23/shell-can-improve-impacts-in-the-niger-delta-says-new-report/ http://sndden.wordpress.com/2010/03/23/shell-can-improve-impacts-in-the-niger-delta-says-new-report/ 17 nordic journal of commercial law issue 2012#1 growth, creating avenues for diverse opportunities in terms of goods and services, creating employment and, boosting government revenues. 78 this has proved beneficial in few cases; for example in south africa and nigeria, gold mining and oil companies have brought new technology, attracted subsidiary industries in the home country, and facilitated the acquiring of skills by indigenous personnel. 79 in november 2002, the british american tobacco (bat) nigeria established a british american tobacco foundation, the role of which is to identify and implement community enhancement programmes across nigeria. the foundation has commenced series of poverty reduction projects for unemployed youths in different states of nigeria. the foundation is also working with the international institute of tropical agriculture to provide improved maize seedlings and cassava cuttings to farmers from communities of production. 80 shell also currently runs competitive internship programme open to university students, and sabbatical programme for senior academic staff of universities. shell, in partnership with marks and spencer (uk), embaked on projects in three flower and fruit-growing communities across africa, including shell foundation’s involvement in the flower valley, south africa – where they set up early learning centre to provided education to the community's children, and develop new skills for the adults. 81 in nigeria, shell is foremost employer of labour; about 12,000 persons (skilled and unskilled) are employed in shell’s activities. 82 in latin america, csr is seen by many as the hope for positive change in the face of persistent poverty, environmental degradation, corruption, and economic stagnation. 83 however, any such benefits are far outweighed by activities that deplete local resources, stifle local or indigenous industry, subvert the fragile democratic process, and abuse children on hard labour in developing countries. based on the impact of their operations, csr-policies should be re-tailored and re-channelled in a meaningful way that has practical sustainable impact; and this should not just be on ad hoc basis. 78 dare, s. (2001) supra 79 ibid 80 amaeshi, et al (2008), supra. 81 available at http://www.fairtrade.org.uk/work/case_studies/read_a_case_study/default.aspx?id=40 (16/02/10). 82 tuodolo, f. (2009), supra. 83 see schmidheiny, s. (2006). ‘a view of corporate citizenship in latin america’. journal of corporate citizenship, 21, spring: 21–4. http://www.fairtrade.org.uk/work/case_studies/read_a_case_study/default.aspx?id=40 18 nordic journal of commercial law issue 2012#1 brief comparative remarks of csr in uk (europe), north america (usa), and nigeria (africa) the distinct character of csr activities of mncs in the three different regimens empirically presented becomes clearer with brief evaluative comparative remarks of the british model to the us model and, african state of affairs. developing countries of africa present typical forms of csr challenges which are quite different to those faced in the developed world such as uk and usa. due to poverty, poor social amenities, and philanthropic cultural traditional value in most african countries, csr practically suggests more the economic and philanthropic aspects, rather than legal and ethical responsibilities that are more common in the usa and uk. 84 just as amaeshi et al suggest csr in nigeria (like most other poor developing countries) specifically aims at addressing the socio-economic development challenges of the country, including poverty alleviation, health-care provision, infrastructure development, and education. 85 this, contrast largely to usa and uk csr priorities that emphasis consumer protection, fair trade, green marketing, climate change concerns, or socially responsible investments. 86 the legal framework in the uk highly influences the philanthropic responsibility, which is contrary to discretionary acts of successful companies or rich capitalists as in the united states. 87 developing countries of africa appear to identify more with the american model in this direction. in african countries, legal responsibilities generally have a lower priority than in developed countries; primarily as result of far less pressure for good conduct. this is because, in most african countries, adequate legal regulation instruments are lacking, and where they are adequately available, there are weak regulations comparable to uk and usa. for example, the case presented in this paper on the impact of environmental damage because of the oil spillages of the shell british petroleum in the us and nigeria, and the different responses and attentions given to the oil-spillages in these societies support this view. similarly ethical responsibilities are given more attention in the uk than in the united states. 88 in developing countries of africa, however, ethics seems to have the least influence on the csr agenda. though, south africa, have been toeing an exemplary line in favouring an ‘inclusive approach’; king iii in particular emphasises: social responsibility, stakeholder relationships, 84 see visser, w. (2006). revisiting carroll’s csr pyramid. in: e.r. predersen and huniche, m. (eds), corporate citizenship in developing countries, the copenhagen centre. 85 amaeshi et al (2006), supra. 86 ibid 87 see aguilera, r., williams, c., conley, j., and ripp, d. (2006). corporate governance and social responsibility: a comparative analysis of the uk and the us. corporate governance volume 14 number 3 may. 88 crane, a., and matten, d. (2007). business ethics, 2nd edn. oxford: oxford university press. 19 nordic journal of commercial law issue 2012#1 corporate citizenship, and sustainability principles, as salvaging concepts for achieving a new role for business in society. 89 the three empirical cases provide crucial ‘legal food for thought’. 90 therefore, whether csr should be taken to be mandatory or voluntary, is analysed in the following sections. 4 mandatory or voluntary csr? while csr has gradually continued to move away from that vague and imprecise concept that it has been for many years, 91 what is very clear is that up to now csr has been something more of voluntary than anything else, as the three empirical cases above suggest. however, there is an ongoing heated debate in the academic circles whether csr should remain voluntary or become mandatory, there is yet no consensus in this respect. 4.1 arguments in favour of mandatory csr most who argue in favour of mandatory csr, for example adhere to the view that the limitation of the co2 in atmosphere emissions will not stop unless there is a legal duty attached to it. 92 in this respect, scholars emphasise that csr initiatives should not only benefit the companies financially, 89 miles, l. and jones, m. (2009), supra. 90 legally speaking; shell, enron and macdonald’s are from three different planets both in what they “cause”, the type of “harm” and whether they are complying with existing rules or not: (a) what the executives did in enron was a crime, and the company is bankrupt and executives in jail – public response = zero tolerance; (b) what shell does is dangerous and environmentally hazardous for innocent bystanders, therefore it can be argue that the obligations to give back to communities are expected to be higher. – public response = give more money or contribute more to the communities; and (c) macdonald’s sells a legal product to willing buyers. whether its activities are socially responsible can be debated, but it is a far way from questioning whether the company can ever live up to csr standards – public response = change your product, and practicalise responsible advertising etc. 91 some suggest that it is just about glossy reports and public relations. some see it as a source of business opportunity and improved competitiveness. some see it as no more than sound business practice. others see it as a distraction or threat. is it a framework for across the board regulative of all of the relationships between the business and the rest of society, nationally and globally? is it just about the activities of north american and european multinationals in developing countries? is it relevant and useful to companies of all sages no matter where they are based and operate? lively debate will continue on these and many other questions. see mullerat, r. (2006). social corporate responsibility: new trends: american bar association section of international law. 92 mullerat, r. (2006) ibid, p.1. 20 nordic journal of commercial law issue 2012#1 but also benefit workers and communities socially and environmentally. the inclusion of a range of guiding principles in relation to regulation, profit strategies, governance and political responsibilities concerning csr, have been suggested. 93 it has been argued that the issue at stake is not to proclaim that companies are socially responsible, but rather that the law now weighs in to give substance, meaning, and accountability for csr undertakings. 94 the csr -movement in recent times has developed the notion of corporate governance as a vehicle for asserting on management to put into consideration wider ethical issues. the csr-movement has therefore, joined the political endeavours to make corporations more responsive to public, environmental, and social needs by pursuing corporate governance as a framework for boards and managers to treat not only employees, consumers and communities similarly to, if not the same as, shareholders, but also to contribute in the sustainable development of the communities in which they operate businesses. 95 mandatory csr: national and international legal system there has been increasing demonstration of tendencies by both national and international legal systems to require some more mandatory corporate social conscience. 96 a similar view is that information pertaining to all environmental, social, and governance (esg) activities of a company, are not only standardised and government mandated, but also independently reviewed and audited as well, just like financial reports. 97 there are various relevant instruments which have provided some mandatory regulatory procedures or guidelines for companies. 98 nations and regions as diverse as china, united kingdom, the middle east, america, south africa, have taken equally remarkable and 93 for example see coleman, g. (2002). ‘gender, power and post-structuralism in corporate citizenship: a personal perspective on theory and change’, journal of corporate citizenship 5, spring, pp. 17–25. 94 weissbrodt, d (2010) supra. 95 stefan, a. (2008). "realizing the potential: global corporations and human rights": article: corporate governance as social responsibility: a research agenda; riesenfeld symposium. 96 this becomes necessary considering the csr activities of enron, macdonald’s and shell b.p, as presented in this paper. 1 97 robinson, r. (2010). a call for mandatory corporate social responsibility reporting. http://english.alrroya.com/node/44794 (12/05/2010). 98 this includes, oecd, guidelines for multinational enterprises (1976/2000); ilo, tripartite declaration of principles concerning multinational enterprise and social policy (1971/2001); un global compact: corporate citizen in the world economy (2000); eu commission, green paper promoting a european framework for corporate social responsibility (2001) unchr, norms on the responsibilities of transnational corporations and other business entities with regard to human rights (2003); and eu commission, communication “implementing the partnership for growth and jobs: making europe a pole of excellence on corporate social responsibility (2006) etc. see enrst, p. (2009). corporate social responsibility from a legal perspective acc europe, corporate counsel symposium antwerp, march 5. http://english.alrroya.com/node/44794 21 nordic journal of commercial law issue 2012#1 systematic steps towards to introducing more mandatory elements into their corporate governance and csr systems. as horrigan clarifies, countries in the anglo-american and anglo-commonwealth tradition (and even within corporate regulatory systems) have been more explicit in sensitising a regime of corporate laws consideration beyond the shareholders to become more inclusive. 99 according to a recent report on csr: three countries stand out with regard to csr regulations. the first is denmark, which was the first western country to require non-financial (i.e. csr) information in their largest companies’ and annual financial reports. the second is indonesia, which has taken a global lead by passing a law requiring all public companies to issue csr reports; and third, perhaps the biggest impetus for csr reporting, came in january 2010, when the u.s. security exchange commission (sec) asked all u.s. public companies to regularly disclose climaterelated risks in their annual reports to investors. there is little doubt that we will have near universal government mandated csr reporting for all public companies sometime in the next five to ten years. 100 the higgs review and its proposal for changes in the boardroom provides for an operating and financial review (ofr) included in the company’s annual report, containing information on the company’s relations with stakeholders on areas such as – corporate governance, risk management, and environmental and community impact. it is envisaged that this will lead to a formulation and development of “best practices” intended to have persuasive effect on csr in the uk. 101 similarly, in south africa, there is active support from the government as well as domestic and foreign companies in promoting csr. for example, the 2005 response to a survey carried out by trialoge of more than 100 stock exchange-noted companies in south africa, shows that 73.5% of those surveyed take corporate citizenship ‘very seriously’ and 24.5% take it ‘seriously’. since 1994, political change and the efforts to balance out the unequal distribution of wealth that was inherited from the apartheid periods have driven csr forward. 102 the legal sphere in south africa provides specific legislation which compels companies to take the interests of certain stakeholders into 99 horrigan, b. (2010). corporate social responsibility in the 21st century debates, models and practices across government, law and business; see also horrigan, b. (2007). 21st century corporate social responsibility trends – an emerging comparative body of law and regulation on corporate responsibility, governance, and sustainability. mqjbl vol 4, 85-122; electronic copy available at http://ssrn.com/abstract=1087133 100 robinson, r. (2010) supra. 101 thomson, s. (2011). uk takes step towards csr reporting, http://www.stuartthomson.co.uk/articles/csr/ (13/05/2011). there are signs that the introduction of ofrs may be the first giant step towards mandatory csr reporting in the uk. 102 coetzee, s. (2005). csr towards a new paradigm, at http://www.csrweltweit.de/en/laenderprofile/profile/suedafrica/index.nc.html (09/6/11). http://ssrn.com/abstract=1087133 http://www.stuartthomson.co.uk/articles/csr/ http://www.csr-weltweit.de/en/laenderprofile/profile/suedafrica/index.nc.html http://www.csr-weltweit.de/en/laenderprofile/profile/suedafrica/index.nc.html 22 nordic journal of commercial law issue 2012#1 account. this is, for example evident in the labour relations act 66 of 1995; the promotion of access to information act 2 of 2000; and the broad based black economic empowerment act 53 of 2003. 103 the current corporate governance regime in south africa imposes a legal duty on directors to adopt an ‘inclusive approach’ in managing their business and to reiterate the value of good corporate citizenship and responsibility. the series of kings reports (1994, 2002 and 2009 in south africa) 104 on corporate governance follow the same line in favouring an inclusive approach; king iii in particular concentrates on: social responsibility, stakeholder relationships, corporate citizenship, and sustainability principles, as salvaging concepts for achieving a new role for business in society. 105 the effect of new south african companies act 71 2008, especially sections 7, 76(2b) and 72(4) also suggests that csr has ceased to be a mere voluntary act. 106 4.2 arguments for voluntary csr in spite of all these and other measures 107 that support mandatory over voluntary csr, and which aim to eliminate concerns over the impact of mnc operations in environmentally sensitive areas, particularly in economically developing areas, in order to ensure more commitment of mncs responsiveness to sustainable development. the three cases above show that the csr of shell b.p in nigeria is poorer compared with those of enron and macdonald’s in usa and uk respectively. some experts maintain that one of the major challenges of using the concept of csr in effectively promoting corporate accountability and community responsibility so far has been and still remains 103 esser, i. and dekker, a (2008). the dynamics of corporate governance in south africa: broad based black economic empowerment and the enhancement of good corporate governance principles: journal of international commercial law & technology, vol. 3, issue 3. see also hodes, l. (1983). ‘the social responsibility of a company’. 100 south african law journal 468–495. 104 it should be noted however that king’s report ii did not support for a legislative regime that mandates companies to comply with its recommendations, rather it recommended for self regulation. 105 miles, l. and jones, m. (2009). ‘the prospects for corporate governance operating as a vehicle for social change in south africa’ (2009) 14(1) deakin law review at 71. making reference to ‘principle 2.2’ miles and jones argued that, king iii is of the view that for a company to be seen as a good corporate citizen, it must be that with comprehensive policies and practices which enable it to make decisions and conduct its operations ethically, meet legal requirements and show consideration for society, communities and the environment. 106 the new act which came into effect in 2010 is making giant stride in putting more regulatory steps on csr in south africa; see companies act (no 71 of 2008) at http://www.polity.org.za/article/companies-act-no-71-of2008-2009-05-13 (12/05/2011). nigeria and other african countries should borrow a leaf from south africa’s bold step towards more regulatory csr. 107 some scholars have seen this number of measures as an emergence of csr movement in the 20th and 2nd centuries; see for example zerk, j. (2006). multinationals and corporate social responsibility: limitations and opportunities in international law 15-29. http://www.polity.org.za/article/companies-act-no-71-of-2008-2009-05-13 http://www.polity.org.za/article/companies-act-no-71-of-2008-2009-05-13 23 nordic journal of commercial law issue 2012#1 the urge for a binding regulatory framework, since there has been strong resistance to a binding regulatory code for the activities of mncs. 108 many corporations also favour only voluntary csr commitments, however, a legal regime ‘with some’ mandatory or binding rules will surely bring more improvement. since there are claims that corporations have used the concept of csr as a ploy for ‘public relations’ or simply a box-ticking, ‘some level’ of mandatory and binding rules might help to expose whether the csr activities of corporations are seriously honest or not. boeving argues: even if companies are honestly committed to csr, legally binding rules may work to overcome the classic collective action problem arises when no individual corporation has an incentive to bind itself to a given norm if other corporations are free to ignore it. thus, legally binding rules may “push” companies to adopt more robust commitments and to add commitments not previously adopted. this would have the effect, according to some scholars, of restor[ing] what is presently an unequal bargaining power in which [multinational corporations] enjoy substantially more leverage over the environmental policies of developing countries. 109 the sort of legal regime needed, therefore, is such that would improve csr, and in turn improve environmental, human rights and other activities of sustainability in place in most developing countries. law, corporate law in particular at first acknowledges the relative lack of progress of the csr movement during the past few decades. 110 since socially responsible business should respect human rights and consider whether both the social and environmental effects of their actions have gained broad acceptance and signification in the eyes of the communities they operate; 111 there is the need for csr to be voluntary. this is particularly important when it is appreciated that a prerequisite of csr is willingness by organisations to look beyond their legal requirement, commercial concentration and business appeal to take account of social and environmental factors in the communities in which they operate. csr is therefore about going further than the law requires, rather than simply complying with it and, it is only a voluntary approach to csr that will practically accommodate this principle. 112 108 emeseh, e. et al (2010). corporations, csr and self-regulation: what lessons from the global financial crisis? 11 german l.j. 230, 237. 109 boeving, j. (2005). half full…or completely empty?: environmental alien tort claims post sosa v. alvarexmachain 18 geo. international environmental law review. 109, 114. 110 nina, b., murray, r., and villiers, c. (2008). perspectives on corporate social responsibility. edward elgar publishing: london review by lowe, k. (2009). web journal of current legal issue, http://webjcli.ncl.ac.uk/2009issue4/lowe4.html (29/03/10). 111 see weissbrodt, d. (2010). corporate social responsibility: a legal analysis: human rights quarterly, volume 32, no. 1, february, pp. 207-215 ‘review’. 112 see for example lea, r. (2002). ‘corporate social responsibility: iod member opinion survey’ the institute of directors, uk, november. http://webjcli.ncl.ac.uk/2009issue4/lowe4.html 24 nordic journal of commercial law issue 2012#1 another problem of a mandatory approach to corporate social responsibility remains the want of viable and subtle law that will ensure companies take their csr seriously. 113 this points to another problem associated with csr of mncs in contributing to sustainable development of communities that is the ‘box-ticking’ syndrome – this will be examined generally and, with more reference to developing countries. 5 csr in practice 5.1 box-ticking and csr implementation on a practical level since corporate social responsibility (csr) is concerned with the relationship between corporations and society, it goes to the heart of the sustained co-existence of business and contemporary society; the role which corporations or business are supposed to play has become more fundamental to the society. there are three underlying reasons; 1. the more obvious negative impacts such as financial scandals, environmental and human rights violations, accusations of complicity in corruption and collaboration with oppressive state power (common in developing countries); 2. the subtle impacts of the changing role of the private/public divide in the provision of goods and services; and 3. the active engagement of multinational corporations and business organisations at the international level. 114 all of the above have led to a gradual, but radical change in ideology behind regulation both within the areas of global governance and corporate governance in the context of csr of mncs and sustainable development of communities. csr regulation of business generally could be viewed in two ways; the ‘conviction or value-led csr’ and ‘the compliance csr’. 115 as the discussion so far in this paper shows, in recent times a gradual 113 see csr & legality section in this paper . 114 okeye, a. (2008). stream: regulation, governance and csr. socio-legal studies association (slsa) annual conference, available at http://www.manchester.ac.uk/aboutus/news/events/slsa2008/documents (09/6/11). 115 the first views csr as conviction or value-led, and is the expression of a company’s purpose and values in all its relationship. this view if taken by companies would provide a kind of marketplace in corporate personality, in which companies are free to disclose what they stood for and what their aim is, regarding contribution to the society. stakeholders will then be invited to join them in evaluating how effectively they have performed on these intentions and lived up to their own corporate values. even though companies will not have the same level of http://www.manchester.ac.uk/aboutus/news/events/slsa2008/documents 25 nordic journal of commercial law issue 2012#1 but more critical debate in favor of mandatory regulation over business or corporations’ csr is taking place with heightened sensitivity and dynamism in most countries and regions at various levels. 116 horrigan argues that the 21 st century is already bearing witness to transformational changes in csr thinking, regulation, and practice. 117 powerful global bodies such as the g8 leaders have equally called for a new csr with suitable standards that goes beyond simply emphasising the desirability of voluntary csr initiatives: ‘(w)e call on private corporations and business organisations to adhere to the principles in the oecd guidelines for multinational enterprises’, ‘(w)e invite corporations from the g8 countries, emerging nations and developing countries to participate actively in the global compact and to support the worldwide dissemination of this initiative’, and ‘(w)e invite the companies listed on our stock markets to assess, in their annual reports, the way they comply with csr standards and principles’. taken at face value, these commitments extend beyond generic rhetorical support for csr, and position it anew within contemporary international policy priorities. in short, the 2007 g8 summit declaration not only places csr in the top tier of international policy concerns and initiatives, and signals clear roles and responsibilities of the private sector in addressing such shared geopolitical problems as climate change, underdeveloped economies, and unsustainable development, but also urges progression to the next stage of global csr dialogue, framework-building, and standard-setting. 118 due to the serious nature of this campaign for more robust csr regulatory actions and policies, most corporations are now more willing than ever to respond to being csr accountable. however, this corporate willingness to be accountable can easily degenerate into telling the stakeholders what they want to hear in order to pacify them. this is because this willingness for csr compliance is not necessarily genuine or honest, but as goyder points out is driven by external pressures, such as the need to appease the company’s critics or the threat of legal repercussions, and risks creating if commitment to society, but there would be no pretending; as companies would have the freedom to say that they care for no one except their shareholders if that is want they want. this will make the process of reporting and dialogue non cumbersome, however, it would clearly expose those companies that show their conscience without having the deeds to match. the second (compliance csr) sees it as a process by which companies are required by social pressures to comply with a widening range of social expectations. if all companies were to subscribe to this view, csr would become like a fashion parade, where companies would win applause for wearing the right clothes and saying the right things in their reports, but where actually meaning what they said would not be important and csr would be well isolated from genuine business activity; goyder, m. (2003). redefining csr: from the rhetoric of accountability to the reality of earning trust; available at http://www.tomorrowscompany.com/uploads/redf_csrintro.pdf (11/6/11). 116 it is important to highlight that the level of csr regulation is most of the developing countries are weak. 117 horrigan, b. (2007). 21st century corporate social responsibility trends – an emerging comparative body of law and regulation on corporate responsibility, governance, and sustainability. mqjbl vol. 4, 85-122. 118 ibid http://www.tomorrowscompany.com/uploads/redf_csrintro.pdf 26 nordic journal of commercial law issue 2012#1 companies’ totally neglect ethical compliance. the case of enron, macdonald’s and shell b.p demonstrate the problem of “fake” willingness at different level – that is a simple and passive boxticking syndrome. 119 thus, much of the effort that goes into the campaign for a more robust csr will not make a long-term impact on the sustainable development of the communities in which companies operates their businesses. 120 this fake willingness (i.e. a mere box-ticking mentality), as demonstrated by enron, macdonalds and shell bp in this paper that their csr responds to sustainable development of the communities, could also be notably seen or easily read in many ways in other companies. for example, one mnc used the accommodating language to describe their willingness and involvement: community initiatives, community development and community engagement. also the integration of citizenship initiatives into business strategy as a way of responding to community needs is communicated regularly within most of the global company reports of mncs. for example: exxonmobil directly states: “exxonmobil applies a rigorous approach to corporate citizenship in all aspects of our business, everywhere we operate. citigroup echoes this sentiment writing that they integrate “citizenship initiatives into our business. aig states that citizenship efforts are “essential to (their) long-term business objective. at general electric they make good citizenship “a way of life at ge. wal-mart acknowledges their responsibility to society though they do not speak explicitly of being a good citizen.121 similarly, another mnc communicates their commitment to citizenship and environmental ‘sustainability’ in their csr reporting as follows: citigroup demonstrates reporting that they are “evaluating environmental and social challenges, what we call sustainability issues,” into their mission and they focus on building sustainable communities. conocophillips refers to itself as a “responsible global energy company committed to sustainable development.” chevron suggests that their community engagement initiatives not only contribute to the economic prosperity and improvement of the sustainability of the communities where they operate, but that in doing so, it establishes them “as a partner of choice in the region.”122 however, in reality or practice, the activities of most corporations seem not to make this profound impact on society. 123 the ethics of csr need to not only rest on paper, thought, word or mere 119 this suggests the inherent contradictory nature of ‘corporate will’ and ‘csr’. 120 goyder, m. (2003) supra. 121 merrill, n. (2009). doing good in society: a comparative study of the communication of the ethical aspects of corporate social responsibility in germany and the us: ccg p.33. 122 ibid, p34. 123 only quite a minority communicate a clear sense of the values that differentiate them from their competitors – the co-operative bank, cadbury, schweppes are good cases to mention. 27 nordic journal of commercial law issue 2012#1 intention, but should be practicalised in deed, action and activities. 124 rather than adopting relevant ethical and legal practices that will benefit stakeholders, particularly the promotion of sustainable development of the communities, mncs seem to have willingly championed the move to avoid or remove legal obligations and regulations that seem to obstruct their business, as well as ignore the ethical norms and policy that guide their business undertakings. 125 it is common therefore that mncs pursue the sole business objective or follow legal advice that claims that it is unlawful to pursue any other goal than delivering profits to the company/shareholders. 126 based on this belief, most mncs practically ignore the interests of the community in which they operate. 127 therefore to its critics, 128 as argued in the beginning of this paper, csr initiatives of mncs are all about cover up and pretence. 129 csr policy ideally, would function as a built-in, self-regulating mechanism whereby business would monitor and ensure its adherence to law, ethical standards and the relevant domestic and international norms. that is to say, business would benefit its stakeholders and practically promote the public interest, by encouraging community growth and development, and voluntarily eliminating practices that harm the public sphere or wider society without regard to legality. 130 however, the issue at stake is that only very few corporations are socially responsible. 131 despite worries over the box-ticking syndrome and impact of multinational corporations in environmentally sensitive areas, particularly their poor contribution to sustainable development of communities; some scholars take the position that the corporate social performance of mncs has 124 corporations, on one hand demonstrate their neglect to ethics in the sense that it is those corporate decisions which encompass both ethical and legal issues that directly affect the business activities of corporations that are given immediate and proper attention by corporations because the corporations are left with no other option, since the choice is both ethically and legally wrong. on the other hand, those decisions that are not within this combined terrain (that is, matters that have only ethical implications and, do not affect the corporations’ business activities directly) or that concern matters that affect solely the sustainable development of the community are not attended to, or are given improper attention; see hamed, p. and sutliff, k. (2003) supra. 125 see for example plesch, d. (2005). corporate social responsibility: questions of equality before the law, property rights and de-regulation. accountancy business and the public interest, vol. 4, no. 2. 126 see plesch, d. (2005), ibid. 127 the cases of shell bp in nigeria, particularly in the niger-delta areas and the anglo american gold illegal exploitation and consequential environmental harzards in drc should be noted. 128 it is important to point out that this paper takes a critical view of csr of multinationals. 129 see ying, f. (2005), supra. 130 please, see for example ward, d. (1991). corporate social performance revisited. the academy of management review, vol. 16, no. 4 oct. 131 only quite a minority communicate a clear sense of the values that differentiate them from their competitors – the co-operative bank, cadbury, schweppes are good cases to mention. 28 nordic journal of commercial law issue 2012#1 been surprisingly favourable to date. 132 for example, the activities of mncs encourage technology transfer from the developed to the developing world, and the wages paid to multinational employees in developing countries are generally above the national average, as exemplified in the case of shell b.p in africa. kotler and nancy in their 2005 work also suggest that charitable giving has risen from $9.6b in 1999 to $12,19b. 133 there is equally a view that the business case for the importance of socially responsible business activity is now commonly accepted. an award winning article from the 2006 harvard business review emphasises a smooth running between business and social value. 134 5.2 box-ticking mentality and developing regions as argued in the beginning of this paper, most authoritative works on csr, analyse company csr from the context of developed areas, and therefore overlook or briefly discuss the csr situations in developing countries that more glaringly demonstrate companies box ticking syndrome. 135 the few works that focus on developing areas reveal that in developing countries almost all the corporations are involve in box-ticking. akyildiz points out that the reason why mncs choose particularly developing countries has been studied under two themes: so called “dirtying companies” choose the countries that do not have severe legal rules and, countries where the public opinion is unconscious of the harms that economical activities do to the environment. 136 prieto-carrón, et al also contend that debating whether companies should go beyond their legal obligations and voluntarily adopt csr initiatives makes little sense in many developing countries where box-ticking thrives. the nature of things in developing countries or situational challenges facing developing regions are such that call for sensitivity to csr by mncs in the sustainable development of communities in which they operate. this is reiterated by the un millennium development visionary target refined in 2000: “a world with less poverty, hunger and disease, greater survival prospects for mothers and their infants, better educated children, equal opportunities for women, and a healthier environment”. 137 however, unfortunately, the ethical and legal responses of mncs to sustainable development in the 132 see tuodolo, f. (2009). corporate social responsibility: between civil society and oil industry in the developing world. acme: an international e-journal for critical geographies, 8 (3), 530-541; kotler, p. & lee, n. (2005). corporate social responsibility: wiley. 133 kotler, p. & nancy, l. (2005). corporate social responsibility: wiley. 134 porter, m. and kramer, m. (2006). strategy and society: the link between competitive advantage and corporate social responsibility. 84 harvard business review 78. 135 see horrigan (2010), supra. 136 akyildiz, f. (2006). "the failure of multinational companies in developing countries in sharing environmental responsibilities: the case of turkey", social responsibility journal, vol. 2 issue: 2, pp.142 – 150. 137 un. (2006). millennium development goals report 2006. brussels: united nations. 29 nordic journal of commercial law issue 2012#1 communities they operate, suggest that these global aspirations remain far from being met in many developing countries today. in some countries, for example india, pakistan, nigeria and the drc, mncs demonstrate box-ticking. 138 drc offers one good instructive example of companies csr box-ticking mentality – a country since the end of mobutu’s era in 1997 has been describes as a scene of organised looting of a sovereign state not seen in any part of the globe in recent times. every type of wealth in the country has been impacted upon by structures set up and imposed by power from above. stockpile of extracted minerals (coltan, gold, diamond, cassiterite, etc) were seized and taken away as loots to rwanda, uganda and burindi. there is indication that these minerals are exploited to supply multinationals in their need of raw materials – a transparent neglect of csr that has incited call for a world wide campaign to boycott end products (laptops, cell phones, jewels, etc) made from these minerals. the situation is such that for nearly two decades un institutions and international justice system are being used or manipulated by western powers because of their selfish polices and interest. 139 in some of the developing countries in asia, nike factories have been making great wealth at the expense of the people that is, by contributing little to the sustainable development of the communities it operates. it is so open that, nike factories were even criticized for extremely poor working conditions and, for employing young children who suppose to be attending schools. similarly, in africa, nestle received criticism in relation to its’ practices including marketing and utilizing a supply chain that use child bonded labour. 140 the continuous exploitation of resources in the niger-delta by the mncs with the fake promises to contribute in the sustainable development of the community has resulted in serious environmental damage, developmental neglect, human-rights 138 in africa in particular, rather than contributing to the sustainable development of the communities in which they operate; many multinational corporations (mncs) have acted as economic predators in africa, gobbling up national resources, distorting national economic policies, exploiting and changing labor relations, committing environmental despoliation, violating sovereignties, and manipulating governments and the media. in order to ensure uninterrupted access to resources see dare, s. (2001). a continent in crisis, africa and globalization. dollars and sense magazine, july/august. also available at http://www.thirdworldtraveler.com/africa/continent_crisis.html (27/03/12). 139 see ending illegal exploitation of democratic republic of congo mineral and other resources, available at http://therisingcontinent.worldpress.com/2010/11/24/ending-illegal-exploitation-of-democratic-republic-of-congominerals-and-other-resources/ accessed (21/11/2011). 140 see kercher, k. (2007). corporate social responsibility: impact of globalisation and international business. corporate governance e-journal, 4-2. bond university faculty of law. the use of children is for the main purpose of reducing cost of labour, as the children receive menial pay and, they cannot complain. it is presented in the pretence as if these companies are offering employment to these children – a mere box-ticking mentality. the use of children in such labour is internationally legally prohibited; for example, it is against the ilo convention against the worst forms of child labor otherwise known as convention no. 182, and the un convention on the rights of the child. http://www.thirdworldtraveler.com/africa/continent_crisis.html http://therisingcontinent.worldpress.com/2010/11/24/ending-illegal-exploitation-of-democratic-republic-of-congo-minerals-and-other-resources/ http://therisingcontinent.worldpress.com/2010/11/24/ending-illegal-exploitation-of-democratic-republic-of-congo-minerals-and-other-resources/ 30 nordic journal of commercial law issue 2012#1 abuses, economic oppression, and inequitable resource allocation. these abuses, and the need for redress, are at the heart of the conflict in this community. 141 it is the rule rather than the exception that companies do not comply with existing legal frameworks related to corruption, payment of taxes, fair trade practices, and respect for human rights, customer services, and environmental protection. 142 this suggests that csr-contributions of mncs to sustainable development in developing communities are poor. as companies pretend to take csr more seriously now, the campaigns or regulatory proposals for csr transformation (which emphasize that companies should operate in a more ethically or environmentally friendly way) is increasingly influential. in reality, mncs have continued to show cosmetic embellishments to their csr and this is not beneficial in relation to: practical community development, citizenship initiative, stakeholders’ engagement, and societal responsibility, which are all relevant to promoting and contributing to the sustainable development of the communities in the developing countries. the case of shell discussed above, largely gives credence to this position. waller also concur that something substantial is being lost in this direction, “call it what you like – the personality, the authenticity, the soul and character of the company is masked by pro forma statement”, 143 which weakens their csr activities. this in turns impacts negatively on the sustainable development of the communities in which corporations operate their businesses. 5.3 addressing mnc box-ticking mentality in developing countries in order to have a more practical implementation of csr that will contribute to sustainable development, particularly in the developing countries; this paper specifically suggests that there is the need to first address the political ideological orientation underpinning csr of business. it can be argued that the current csr regulation in place in the developing global south is deliberately fashioned, manipulated and used by the powers that be in the developed global north (which institutionalise both the global political norms and legal rules) to control and protect their 141 dare, s. (2001), supra. 142 prieto-carrón, m., lund-thomsen, p., chan, a., muro, a., & bhushan, c. (2006). critical perspective on csr and development: what we know, what we don’t know, and what we need to know: international affairs 82: 5, 977987. 143 waller, m. (2003). much corporate responsibility is box-ticking: times july 8. waller points out that most companies may claim they comply with the expectations of society; “enron, for example, was a great ‘compliance csr’ company.” but only a minority communicates a clear sense of the values that differentiate them from their competitors. “the co-operative bank and cadbury schweppes are good examples here.” 31 nordic journal of commercial law issue 2012#1 multinational businesses scattered all over the developing regions. the csr activity of shell in developed and developing regions is a very good practical example. 144 when this political ideological issue is addressed, then, it will become more practicable for ‘certain salient csr issues’ (such as illegal or/and unethical activities of mncs over mineral resource exploitations and, the use of children for cheap labour) in the developing countries to be ‘distinctly’ mandatory regulated, while other non-salient csr issues, such as sponsoring a ‘genuine’ political party or candidate in election or grooming flower garden, as was the case in shell partnership with marks and spencer (uk) in three flower and fruit-growing communities across africa (which is country or regional specifically applicable) 145 should be allowed to remain voluntary. this will help reduce box-ticking in this region and also allow corporations to function properly for the sustainable development of the communities. this is because the present csr in place shows that the distinction between companies’ voluntary and mandatory action is most times blurred in the developing world. as graham and woods clarify, voluntary initiatives may have mandatory aspects and national regulatory frameworks may incorporate the use of voluntary instruments. 146 however, there must be a clear distinct dividing line between the voluntary instruments and national regulatory frameworks, as well as between ethical and legal issues to achieve practical csr goals. this will not only involve putting stringent regulatory laws in place, but also there should be practical move to make the implementation of the regulatory rules active and enforceable; in order to ensure that mncs contribute to sustainable development in the communities in which they operate. one key suggestion is that there should be an agreed blueprint on a minimum csr requirement, in the form of contribution to sustainable development expected from mncs every three years in each community, which they operate. 147 this minimal expectation should serve as a legal pendulum; while any contribution above the required minimus 144 the environmental pollution of oil-spill in the deepwater horizon of the gulf of mexico, which killed 11 workers because of the oil-pipe line spill of the shell british petroleum (the same oil company that has been doing environmental havoc and killing hundreds of people in the third world countries because of their poor csr) made headlines around the world, since it is described as the worst environmental disaster in us history. the us has even went ahead to sue the shell b.p and eight other subsidiaries alleging that the cause of the 20 april oil explosion in the us was due to violations of safety and operational regulations that implicate the csr of the shell b.p. this is one of the many clear cases where companies are hold responsible for their poor csr in western developed global north (because of their powerful control of both global political and legal norms) as opposed to the poor csr activities in the global north. 145 what may be taken as salient csr issues in many developing countries, may not be the same in developed countries, and vice versa. 146 graham, d., and woods, n., (2006). making corporate self-regulation effective in developing countries: world development 34: 5, 868-883. 147 this will be a practical step, as each company will be expected to meet its minimum requirement, or face legal action. 32 nordic journal of commercial law issue 2012#1 will be seen as ethical. the minimal expected contribution must not be imposed; rather it must be agreed between the concerned mnc and community. this will make it enforceability practical and active. 6 conclusion society needs mncs to progress, but mncs have contributed very little to the continued sustainable development of the communities in which they operate because the business operations of most corporations negate most of the common ethical and legal practices incorporated in their csr programmes. the problem arises when corporations interpret the grey areas of the law and ethics underlining csr to suit their own interests, purposes, whims and caprices at the detriment of sustainable development of the communities. however, sometimes, this may backfire against the corporation, as the cases of enron, macdonald’s and shell illustrated in this paper. the deceptive and illegal business activities of enron in america had serious consequences on the american public who invested in the illegitimate investment of the company. enron paid a higher price at the end, in the form of its collapse and the criminal indictment against its executives. similarly, mcdonald’s in the uk has endangered the health of individuals, particularly children, because it provides insufficient nutritional information and unhealthy food. yet, the company has been affected, since it has been confronted with bad publicity, declining earnings and series of law suits, which threatens its very existence. in the same vein, shell has contributed immensely in the environmental devastation and deteriorating economic conditions of nigeria, and in the niger delta conflicts and loss of lives. however, shell has experienced great losses and menace of its officials by the restive niger delta people and a series of pending law suits. it stands to justify that the neglect of the ethical and legal aspects of csr, though detrimental to the sustainable development of the communities in which corporations operate their businesses, eventually in some occasions end up causing the executives of these mncs problem (for example, through the loss of money, threat to the officials, loss of employment and even ultimate collapse). it will therefore, benefit the corporations and the society if there is sensitivity and adherence to both ethically and legally sustainable practices. this will have more positive impact on csr in relation to all the stakeholders, particularly on the sustainable development of the wider community. relying on the view that mncs amass so much wealth and possess enormous power to transform the world political economy, it is crucial that further research should be carried out to specifically examine the impact of mncs in the current global financial and economic downturn. in conclusion, it is more practicable for ‘certain salient csr issues’ to be ‘distinctly’ mandatory regulated, while other non-salient csr issues should be allowed to remain voluntary. the dividing line between what should be taken as salient csr issues and, non-salient csr issues should depend on the activities of mncs within the context of each individual country/region. 1 the transnational dimension of statutory interpretation – tragically overlooked in a global commercial environment bruno zeller* & camilla andersen** * dr. bruno zeller is a professor of transnational law in the law school at the university of western australia, perth; adjunct professor, school of law, murdoch university perth and the sir zelman cowen centre, victoria university, melbourne; fellow of the australian institute for commercial arbitration, panel of arbitrators – mlaanz; visiting professor humboldt university berlin, and visiting professor aalborg university, denmark. ** dr camilla baasch andersen is a professor of international commercial law, university of western australia, cand jur, university of copenhagen, phd, university of aarhus. transnational dimension of statutory interpretation 6 1. introduction ....................................................................................... 7 2. interpretation of statutes and contracts ........................... 10 3. interpretation of contracts ..................................................... 14 4. conclusion ......................................................................................... 18 njcl 2019/1 7 1. introduction recently, we came across a very well written and thoroughly researched article by dharmananda and firios entitled “interpreting statutes and contracts: a distinction without a difference?”.1 the article made many excellent points and was very thought provoking – but it overlooked an aspect of legal interpretation which is central to the modern legal landscape, namely internationalisation. in all areas of law – arguably, especially in our field of commercial regulation – the regulatory effects of globalisation and harmonisation necessitate a different perspective on both statutory and contractual interpretation.2 we do not disagree with the paper’s overarching conclusion that there are important parallels between contractual and legislative interpretation – but we posit that in the formula to establish this point it becomes increasingly important to include the international dimension. not all domestic statues should be seen in a solely domestic light. the reason for this is not purely academic. sadly, the phenomenon of overlooking this in scholarship and judicial application is very common, so the authors feel compelled to address this, and to emphasize the significance of the interpretive variations which are the result of the internationalisation of law. model laws, legal transplants/legal diffusions and conventions have found their way into our legal system and form part of the australian legal landscape. importantly, many of the international documents include their own interpretive mandate and hence cannot be interpreted with the same tools as those who are entirely drafted by domestic legislators, thus creating a modern dualism of legal principles. parliament is, in essence, the surrogate of the international diplomatic conference and hence parliament’s supremacy is subrogated.3 as corney put it, “the intent is to create an independent legal regime that transcends national boundaries and applies uniformly among state parties”.4 the conclusion is that a dual system of interpretative approaches exists in australia in order to give internal legal effect to all laws currently in force in australia. but shared international laws, in convention format or springing from model laws, do not come just from parliament but from a shared international comity 1 jacinta dharmananda and leon firios, ‘interpreting statutes and contracts: a distinction without a difference?’ (2015) 89(8) australian law journal 580. 2 camilla baasch andersen, ‘a new challenge for commercial practitioners: making the most of shared laws and their ‘jurisconsultorium’’ (2015) 38(3) university of new south wales law journal 911, 912. here andersen emphasises the necessity for commercial lawyers to consider the application of law in different contexts in order to keep up with the increasing trend of globalisation. 3 graham corney, ‘mutant stare decisis: the interpretation of statutes which incorporate international treaties into australian law’ [1994] 18 university of queensland law journal 50, 51. 4 ibid 50. transnational dimension of statutory interpretation 8 of states. shared laws, like all things shared, have to be interpreted with an eye to how others are applying and interpreting them, so this cannot happen purely in domestic settings. this point has been raised in previous research on the global jurisconsultorium of shared laws.5 applying such an angle to these unique forms of law would be to lend them a so-called “homeward trend” in interpretation, which frequently leads to non-uniform results6 and therefore inconsistency in application on the transnational scale for which these laws are designed. the frequency with which this added dimension of international interpretive aspects is overlooked in scholarship such as this is also mirrored in the legal profession and in the judiciary, which do not seem to appreciate the subtle differences in the interpretive mandate. introspective and domestic interpretational guidelines become especially moot in the light of transnational conventions and model laws adopted into domestic legislation. in australia, examples of shared laws built on model laws are many, both at state level (like the west australian commercial arbitration act, which like many other state acts in this field is an adoption of the unictral model law) and the cross-border insolvency act 2008 (cth).7 but we also see shared laws in the forms of implemented or adopted conventions, such as the cisg. hence in many statutes the authors' subjective intent is relevant such as in the cisg. spiegelman – when defending the textual approach – did concede that “a business like” interpretation is an acceptable constraint on contractual interpretations.8 this inclusion of shared international laws in the domestic legal framework truly challenges any view that “the interpretative task is an objective one”.9 the inclusion of model laws into domestic legislation further strengthens the international perspective of a less objective task. 5 camilla baasch andersen, above n 2. 6 ibid 916. 7 commercial arbitration act 2012 (wa) based on the uncitral model law on international commercial arbitration, ga res 40/72, un gaor, 40th sess, 11th plen mtg (11 december 1985) amended in 2006 ga res 61/33, un gaor, 6th comm, 61st sess, 64th plen mtg, agenda item 77, un doc a/res/61/33 (18 december 2006) and cross-border insolvency act 2008 (cth) based on the model law on cross‑border insolvency of the united nations commission on international trade law, ga res 52/158, un gaor, 6th comm, 52nd sess, 72nd plen mtg, agenda item 148, un doc a/res/52/158 (30 january 1998) annex i (‘model law on cross-border insolvency of the united nations commission on international trade law’). 8 hon james spigelman, ‘from text to context; contemporary contractual interpretation,’ (2007) 81 australian law journal 322, 330. 9 jacinta dharmananda and leon firios, above n 1, 581. njcl 2019/1 9 the starting point is the observation made by the house of lords in fothergill v. monarch airlines10 interpreting the warsaw convention. lord diplock rejected the plain meaning approach and stated: it should be interpreted, as lord wilberforce put it in james buchanan & co., ltd v. babco forwarding & shipping (u.k.) ltd. [1978] a.c. 141, 152, unconstrained by technical rules of english law, or by english legal precedent, but on broad principles of general acceptation.11 he went on to say that "the language […] has not been chosen by an english draftsman. it is neither couched in the conventional english legislative idiom nor designed to be construed exclusively by english judges."12 lord scarman sums it all up when he states: rules contained in an international convention are the outcome of an international conference; if, as in the present case, they operate within the field of private law, they will come under the consideration of foreign courts; and uniformity is the purpose to be served by most international conventions, and we know that unification of the rules relating to international air carriage is the object of the warsaw convention. it follows that our judges should be able to have recourse to the same aids to interpretation as their brother judges in the other contracting states, the mischief of any other view is illustrated by the instant case. to deny them this assistance would be a damaging blow to the unification of the rules which was the object of signing and then enacting the convention. moreover, the ability of our judges to fulfill the purpose of the enactment would be restricted, and the persuasive authority of their judgments in the jurisdictions of other contracting states would be diminished.13 this paper will demonstrate that interpretive rules do not all the time depend on the domestic rules but depend on the interpretive mandate which is included in many model laws and conventions. hence due care must be taken to follow the mandate and avoid an ethnocentric approach. it will be demonstrated that good faith and the subjective approach do play an important role and simply cannot be ignored. in addition, this paper will also argue that depending on the subject matter there is a difference between the rules of interpretation of statutes and contracts. 10 [1980] 2 all er 696. 11 ibid 706. 12 ibid. 13 ibid 715. transnational dimension of statutory interpretation 10 2. interpretation of statutes and contracts as justice kirby observed; the work of judges and lawyers involves the interpretation of statutes and contracts.14 dharmananda and firios note that professor carter said that “the time has been reached where reliance on cases interpreting statutes is rarely necessary or helpful when construing contracts.”15 on the other hand, justice kirby noted that there are: “differences between the way in which judges approach the construction of written contracts and the way that they approach the interpretation of legislation”16 it is argued that justice kirby’s astute observation is correct. there are two situations where the application of purely domestic law is disturbed. hence we challenge the four broad propositions put forward by dharmananda and leon firios; the objective approach that the text is paramount, that purpose and context inform the meaning of the text and that courts can fill gaps in the text, are not in every case applicable.17 a soon as transnational legal texts are to be interpreted, the propositions change, firstly in transplantations and secondly with model laws and conventions. the first situation is best explained by kirby j in air link pty ltd v paterson.18 the civil aviation (carriers’ liability) act 1959 (cth) in essence is nearly identical to the warsaw convention and hence is a transplant. kirby j noted: in accordance with established principles of interpretation governing australian legislation, designed to give effect to the language of international law to which australia has subscribed, the expression in the carriers’ act must, if possible, be given the same interpretation as has been adopted by equivalent courts of other states parties. no differentiation could be drawn on the basis that it was not obligatory for australia to apply the language of the warsaw convention to domestic carriage by air within australia. having elected to do so, it must be assumed that an interpretation consistent with any given to the treaty provisions should be adopted, in so far as the treaty language was borrowed.19 kirby j noted that to give effect to the language of the warsaw convention, as it is enacted in the carriers’ act, the purposive approach 14 hon michael kirby, “towards a grand theory of interpretation: the case of statutes and contracts” (2003) 24(2) statute law review 95. 15 jw carter, the construction of commercial contracts (hart publishing, oxford, 2013) [154]. 16 hon michael kirby, above n 14, 106. 17 jacinta dharmananda and leon firios, above n 1, 581. 18 [2005] hca 39. 19 ibid [49] (kirby j). njcl 2019/1 11 must be taken by also relying on lord diplock’s statements in fothergill v monarch airlines ltd.20 tellingly, kirby j noted that the error of the court of appeal was in effect, the error of the court of appeal, in concluding otherwise, was the result of failing to give the language of s 34 a purposive construction. particularly so when its origin, and operation, within the warsaw convention language is to be considered, in all of its differing applications in different countries by different decisionmakers.21 in sum, it is argued that the interpretation of transplanted statutes is not only different from domestic statutory interpretation, but may also challenge the theory that it is essentially the same as interpreting contracts. the interpretation of a statute is an essential element in the judging of a contract, but it will first require conflicts of laws analysis to ensure the correct contractually interpretive framework is applied. a far as model laws or conventions are concerned, the clearest distinction is supplied by the cisg which not only includes an article to interpret the convention but also how to interpret the contract. article 7 – interpreting the convention notes: “(1) in the interpretation of this convention, regard is to be had to its international character and to the need to promote uniformity in its application and the observance of good faith in international trade.”22 the text of this article is clear; it talks about the interpretation of the convention and supplies two principles under which the cisg must be interpreted; namely to promote uniformity and the interpretation of any contract under the cisg must be guided by observing the principle of good faith. this interpretive rule is used in a number of uncitral model laws and instruments, and not just the cisg, as an interpretive tool which assures uniform and international applications of law.23 both ahead of their time in 1980, lord diplock and lord scarman displayed their understanding of the principle of uniformity when commenting on the question of how a convention must be interpreted. specifically, lord diplock stated that an interpretation of international documents must be “unconstrained by technical rules of english law, or by 20 ibid [78]-[79] (kirby j). 21 ibid [84] (kirby j). 22 united nations convention on contracts for the international sale of goods, opened for signature 11 april 1980, 1489 unts 3 (entered into force 1 january 1988) (hereby referred to as the united nations convention on contracts for the international sale of goods). 23 see, for instance, the uncitral model law on international commercial arbitration (mal) and its interpretive guideline. the success of this is analysed extensively in dean lewis, the interpretation and uniformity of the uncitral model law on international commercial arbitration (alphen aan den rijn, the netherlands kluwer law international, 2016). transnational dimension of statutory interpretation 12 english legal precedent.”24 the significance of article 7 of the cisg is demonstrated by the fact that it has found its way into many other conventions and model laws. as an example, the cape town convention notes in article 5: “in the interpretation of this convention, regard is to be had to its purposes as set forth in the preamble, to its international character and to the need to promote uniformity and predictability in its application.”25 the cross-border insolvency act similarly notes in article 8: “in the interpretation of the present law, regard is to be had to its international origin and to the need to promote uniformity in its application and the observance of good faith.”26 there is no doubt that many conventions and model laws incorporated an article setting out the interpretative requirements which do not involve ethnocentric considerations at all. simply put, a court or legal practitioner must be aware of the application of good faith when required, but foremost, any interpretation of the text must be made “unconstrained by technical rules of [domestic law] or by [domestic] legal precedent.”27 a further problem arises as several instruments are at the judge’s disposal when interpreting statutes which are international in character but are not devised by domestic draftsman. generally speaking, there is the vienna convention on the law of treaties, specifically articles 31 and 32;28 the statute specific interpretative article and the domestic law, such as the acts interpretation act and the parol evidence rule. they all have a place within the interpretative landscape but must be used in a correct and appropriate manner. a good example to illustrate this point is the cross-border insolvency act. the court in ackers and others v saad investments company ltd and another29 clearly demonstrates that there was a lack of understanding around the interpretative mandate. rares j had to interpret an article within the model law and he correctly noted the importance of article 8; the interpretative article. the court did question if extrinsic material can be used to assist in the interpretation of ambiguities.30 however, rares j proceeded to rely on the vienna convention by noting “[it] is an authoritative statement of customary international law for the 24 fothergill v. monarch airlines [1980] 2 all e.r. 696, 706. 25 convention on international interests in mobile equipment, opened for signature 16 november 2001, 2307 unts 285 (entered into force 1 march 2006) ch 24 available at http://dgca.nic.in/int_conv/chap_xxiv.pdf. 26 cross-border insolvency act 2008 (cth) sch 1. 27 fothergill v. monarch airlines [1980] 2 all e.r. 696, 706. 28 the application of the vienna convention on the law of treaties to issues of private law instruments is debated by some, but see bruno zeller, four-corners the methodology for interpretation and application of the un convention on contracts for the international sale of good (19 may 2003) cisg database <http://www.cisg.law.pace.edu/cisg/biblio/4corners.html>. 29 [2010] fca 1221. 30 ibid. njcl 2019/1 13 purposes of construing a convention.”31 although this may be correct, the model law is not a convention. the model law has its own interpretative article and hence recourse to the vienna convention is not allowed. it must be noted that rares j did arrive at the correct result as he did consult the travaux préparatoires. logan j in tannenbaum v tannenbaum32 incorrectly noted that: […] even where an international convention or model law is adopted by parliament in an australian enactment, that enactment and the adopted convention or model law must be interpreted in accordance with australian principles of statutory construction.33 the point is that the model law must be interpreted using article 8. however, the domestically drafted part of the cross-border insolvency act indeed must be interpreted in accordance with australian principles of statutory interpretation. simply put, the vienna convention is not to be used, as it only deals with the interpretation of convention.34 if we turn our attention to the cisg article 7, the matter is different. again, the convention must be interpreted using article 7. however, if article 7 should be interpreted – as it cannot interpret itself – recourse to the vienna convention will resolve the issue which will point to the use of travaux préparatoires. a comment must be made in relation to the vienna convention, specifically article 31.35 it describes the rule of interpretation of a treaty, which was put correctly by corney as follows: the terms of article 31 indicate a moderate textualist approach with supplementary teleological assistance. it is not exclusively textualist in that it allows consideration of contemporaneous and subsequent related documentation as well as object and purpose. it has thus avoided the difficulties associated with an extreme plain meaning interpretation while at the same time properly emphasising the centrality of text.36 in sum, the interpretation of statutes which contain model laws or are the result of the ratification of a convention domestic interpretative tools have no place in determining the meaning of the statute. professor goode put it succinctly by stating: “the first point to note is that international interest [as defined by the cape town convention] is the creature of the convention 31 ibid [295]. 32 [2012] fca 904. 33 ibid [37]. 34 for further elaboration on this point see bruno zeller, ‘statutory interpretation – the two step approach,’ (2014) 1 curtin law and taxation review 36. 35 united nations convention on contracts for the international sale of goods art 31. 36 graham corney, see above n 3, 60. transnational dimension of statutory interpretation 14 and in principle does not derive from or depend on national law.”37 it follows that applying the cape town convention and any other convention for that matter by australian domestic law courts will by definition be subject to different interpretive tools. in essence, justice kirby was correct on this point, namely that the interpretation of statutes and contracts require different tools. hence it is not possible to interpret transnational statues objectively as manifested by the words used in the document and not search for the actual or subjective intention of the author.38 the use of travaux préparatoires is an essential part of the interpretative process as applied by kirby j in air link and rares j in ackers and others v saad investments company ltd and another.39 3. interpretation of contracts the first point to make is that the purpose of contract interpretation is to elicit evidence which supports a party’s arguments, to ascertain the true intention and to assess the parties' basis for the bargain struck. the issue again is; does the instrument, namely the statute, contain rules as to the interpretation of contracts? in common law based contract law, the common law has mandated that the parol evidence rule is to be applied if a term is ambiguous.40 however, under the cisg the situation is different. in addition to article 7, article 8 of the cisg states: (1) for the purposes of this convention statements made by and other conduct of a party are to be interpreted according to his intent where the other party knew or could not have been unaware what that intent was. (2) if the preceding paragraph is not applicable, statements made by and other conduct of a party are to be interpreted according to the understanding that a reasonable person of the same kind as the other party would have had in the same circumstances. (3) in determining the intent of a party or the understanding a reasonable person would have had, due consideration is to be given to all relevant circumstances of the case including the negotiations, any practices which the 37 roy goode, ‘international interests in mobile equipment: a transnational juridical concept’ (2003) 15 bond law review 9, 12. 38 jacinta dharmananda and leon firios, above n 1, 581. 39 camilla baasch andersen, above n 2, 915. professor andersen mentions how the available travaux préparatoires of the cisg have expressed the need to interpret conventions with the ‘goal of uniformity’. 40 royal botanic gardens and domain trust v south sydney council (2002) 186 alr 289. njcl 2019/1 15 parties have established between themselves, usages and any subsequent conduct of the parties.41 as it can be seen, article 8 is structured in two ways, first the subjective approach is to be used and only if it does not yield any result will the court use the objective approach. in essence, the parol evidence rule is at odds with the contract interpretation of the cisg.42 the first question is; how do articles 7 and 8 interrelate? as indicated above, article 7 cisg is, in cases of uncertainties, interpreted with the aid of the vienna convention. however, article 8 is only subject to article 7. the debate is whether article 7 therefore also includes the interpretation of the conduct of the parties. there are two main views on this matter. first that article 7 does not inform on the conduct of the parties43 and the second view argues that at least impliedly the two articles are linked.44 the reason is that article 7 mandates that good faith must be applied. good faith is a general principle of the cisg and hence will also influence article 8. this mandate is explained in article 7(2) which states: (2) questions concerning matters governed by this convention which are not expressly settled in it are to be settled in conformity with the general principles on which it is based or, in the absence of such principles, in conformity with the law applicable by virtue of the rules of private international law.45 as the cisg is not a code, gaps as noted in article 7(2) must be filled by domestic law. hence, a court must resort to domestic rules of interpretation on that issue only but must also be careful not to overstep “the mark”, as otherwise article 7 and 8 would be breached. however, the problem in australia is not how the dual system coexists but the lack of understanding how article 8 influences the gathering of evidence to support claims form the parties in the dispute. a very good example is fryer holdings v liaoning mec group.46 the question was whether the goods were fit for the purpose and what damages can be claimed. the court did mention article 35 cisg but neglected to consult article 74 in relation to damages. the problem was twofold, first article 7 was not 41 united nations convention on contracts for the international sale of goods art 8. 42 see generally bruno zeller, ‘the parol evidence rule and the cisg – a comparative analysis’ (2003) 36 comparative and international law journal of south africa 308. 43 see john felemegas, the united nations convention on contracts for the international sale of goods: article 7 and uniform interpretation (5 november 2002) cisg database <http://www.cisg.law.pace.edu/cisg/biblio/felemegas.html>. 44 see bruno zeller, four-corners – the methodology for interpretation and application of the un convention on contracts for the international sale of goods (19 may 2003) cisg database <http://www.cisg.law.pace.edu/cisg/biblio/4corners.html>. 45 united nations convention on contracts for the international sale of goods art 7(2). 46 [2012] nswsc 18. transnational dimension of statutory interpretation 16 consulted, otherwise the court would have realised that to rely on domestic jurisprudence and domestic law is wrong. in para 19 the court stated: were the goods fit for purpose? the test which has been applied in this country is that fitness for purpose equates to being of merchantable quality. see, for example, castel electronics pty ltd v toshiba singapore pte ltd [2010] fca 1028 at [123]. it seems to me that i should follow that test, particularly since it has been applied in other common law jurisdictions.47 to compound the error, the court noted in para 20: the test of merchantable quality requires that the goods should be in such an actual state that a buyer fully acquainted with both latent and patent defects within them, and not limited to their apparent condition, would buy them without abatement of the price that would be paid if they were in fact in reasonably sound order and condition. see dixon j in australian knitting mills ltd v grant [1933] hca 35.48 to start with the cisg, article 35 does not include merchantability and even then, the test applied by common law jurisdictions is not to be used pursuant to article 7. in his article on statutory interpretation involving international treaties, corney argued correctly that: a particular english word used in an international convention may have a meaning different from the same word used in a domestic statute. it is not appropriate to apply prior domestic meaning to a word in a convention.49 to put it differently, the mandate of “international character” and to “promote uniformity” has been interpreted by international jurisprudence as not reverting to domestic principles and jurisprudence but to consult international jurisprudence, which can be found on the cisg pace website.50 the problem with australian jurisprudence is the fact that most of the australian decisions are not correct but via the principle of precedent the errors have persisted,51 as also evidenced by the castel case below. 47 ibid [19]. 48 ibid [20]. 49 graham corney, above n 3, 58 at fn 3. 50 see pace law school institute of international commercial law, albert h. kritzer cisg database, <http://www.cisg.law.pace.edu/> (last updated29 january 2016). 51 camilla baasch andersen, above n 2, 932; the point is made as to whether cisg cases heard in australia often cite us cases either to pertain to the international character of the cisg pursuant to article 7. otherwise, it may simply be the case of following ‘the common law tradition of sharing persuasive precedents among the njcl 2019/1 17 reverting back to castel electronics pty ltd v toshiba singapore pte ltd,52 the argument by counsel in relation to damages indicates that the interpretive mandate has not been grasped, which is astonishing, as a simple reading of article 74 would already have alerted that the following stamtent is not correct. counsel argued: counsel argued castel’s expectation of the profit to be derived by it from sales of each consignment of goods should have been ascertained objectively at the time of the “conclusion” of the sales contract related to that consignment.53 article 74 clearly notes that the party in breach foresaw or ought to have foreseen at the time of the conclusion of the contract, in the light of the facts and matters of which he then knew or ought to have known, as a possible consequence of the breach of contract. this suggests that article 8 needs to be consulted and a cursory read would also lead to the conclusion that the phrase “knew or ought to have known” would at least suggest that either the subjective approach is to be used or an argument must be mounted that the subjective approach does not yield a result and hence the objective approach is to revert to article 8. unlike the australian courts, the new zealand high court have understood the interrelationship of the application of the cisg and hence the interpretative mandate. in rj & am smallmon v. transport sales limited and grant alan miller54 french j noted that the cisg applies but that “counsel for both parties nevertheless sought to rely on domestic sale of goods law. however, in my view, recourse to domestic law is prohibited by article 7”.55 french j went on to explain that: the requirement imposed by article 7(1) namely to have regard ‘to the international character of the convention and to the need to promote uniformity in application’ is generally accepted as establishing what has been called a principle of autonomous interpretation. that means the convention must be applied and interpreted exclusively on its own terms, having regard to the principles of the convention and commonwealth’ and whether this is just incidental in the pursuit of international uniformity. 52 source. 53 castel electronics pty ltd v toshiba singapore pte ltd [2011] fcafc 55, [202]. 54 rj & am smallmon v. transport sales limited and grant alan miller [2011] nzca 340 (30 july 2010). 55 ibid. transnational dimension of statutory interpretation 18 convention-related decisions in overseas jurisdictions. recourse to domestic case law is to be avoided.56 the court also referred to academic writing57 and was right to correct counsel who attempted to justify the use of domestic law by referring to article 7(2). french j correctly stated that article 7(2) “only authorises reference to domestic law in order to fill gaps in interpretation”.58 as there is no gap, domestic law is not applicable and in applying article 35 the court relied on article 8. the case went on appeal to the court of appeal59 which dismissed the case. of real interest is the fact that the court relied on academic writing and jurisprudence from many countries. it is indeed a model of how the cisg needs to be interpreted and applied. 4. conclusion this paper has demonstrated that the transnational interpretive mandate in general has not yet been understood in australia; the prerequisite paradigm shift has not yet eventuated. the effects of relying on learned domestic principles in isolation is one which does not accord with harmonisation, uniform laws and the increasing role of internationalisation. an ethnocentric approach, or ‘homeward trend,’60 is far too prevalent. despite a promising start, specifically in the area of the cisg, no judgement has been delivered where either counsel or the courts were aware and hence applied the correct interpretive tool.61 the issue is that a convention does not only bind nations internationally, “it is also necessary for the treaty to have internal legal effect.”62 this paper has also demonstrated that corney was correct when already in 1994 made the observation that: 56 ibid. 57 peter schlechtriem, requirements of application and sphere of applicability of the cisg (2005) 36 victoria university of wellington law review 781, 789-790. 58 rj & am smallmon v. transport sales limited and grant alan miller [2011] nzca 340 (30 july 2010). 59 ibid. 60 camilla baasch andersen, above n 2, 916. 61 ibid 931 as mentioned earlier, it is still uncertain whether the courts follow established cisg case law out of respect of following the tradition of commonwealth common law or whether there is truly the goal of uniform application of the convention in mind. whatever the case, it is still too early to tell without further jurisprudence. furthermore, with the availability of online databases such as the pace law school institute of international commercial law, albert h. kritzer cisg database, available at < http://www.cisg.law.pace.edu/> there is no need for practicing counsel or even courts to ignore the international jurisprudence and information they have at their fingertips at any given moment. 62 graham corney, above n 3, 50. njcl 2019/1 19 the executive and legislative branches, having fulfilled their respective roles by concluding the treaty and enacting its terms, have signalled to the judiciary the need to restock its interpretative armoury to meet a hitherto seldom confronted challenge. if the judiciary fails to develop the means to interpret treaties, the attempt to create an international regime will flounder for want of a basic tenet: uniform application of uniform laws.63 63 ibid 51. microsoft word lahteenmaki_uutelafinal _2_.doc nordic journal of commercial law issue 2009#2 chinese law on foods and medicines by anu lähteenmäki-uutela nordic journal of commercial law issue 2009#2 2 i. foundations of chinese food and medicine law 1.1 global agreements and standards china joined the wto in 20011. if we look at foodstuffs and medicines from a consumer viewpoint, the most important wto agreements are the technical barriers to trade agreement (tbt agreement) and the agreement on sanitary and phytosanitary measures (sps agreement). the tbt agreement covers all mandatory and voluntary technical regulations and standards, including testing and certification procedures. the aim of the agreement is that these technical measures do not create unnecessary obstacles to trade.2 the sps agreement defines the rights and obligations of members with respect to application of sanitary and phytosanitary measures. this means laws and standards on food safety, animal health and plant health. basically, the sps agreement defines how food is to be regulated in order to maintain tbt agreement goals3. the tbt agreement also applies to medicines4. disputes arise when trade restrictions are justified by somewhat ambiguous goals such as human health. the most famous food disputes resolved by the wto dispute settlement body are the ‘hormones in beef case’5 of 1998 and the ‘sardine case’6 of 2002. ec banning beef hormones was not justified according to the sps agreement, because it was not based on codex alimentarius standards. ec restricting the use of the term ‘sardine’ was not justified according to the tbt agreement, because the restrictions were not based on the codex.7. here we see the connection between codex standards and wto disputes: codex rules are specifically referred to in the tbt agreement8 and the sps agreement9, and are therefore used as a reference in 1 this happened after lengthy discussions with the most important trading partners. as a non-member, china’s exports were often the subject of discriminatory treatment in overseas markets. by adjoining, china gained new market access opportunities and new legal protections against discrimination. gong 2005. 2 wanhua 2002, 316. 3 hollo 2008, 26. 4 for example in the november 2007 meeting of the technical barriers to trade committee, columbia raised a concern on argentina’s regulations for pharmaceuticals. these regulations involved for example application of tariffs or fees for undertaking verification visits to plants located in the countries of origin. world trade organisation. committee on technical barriers to trade. specific trade concerns relating to access of pharmaceuticals to the argentine market. communication from colombia. g/tbt/w/280. 30 october 2007. 5 ec measures concerning meat and meat products (hormones), wt/ds48/ab/r of 16 january 1998. (ab-1997-4). 6 wt/ds231/r of 29 may 2002. 7 poli 2004, 615-616. 8 the tbt agreement covers all mandatory and voluntary technical regulations and standards, including testing and certification procedures. the aim of the agreement is that these technical measures do not create unnecessary obstacles to trade. wanhua 2002, 316. 9 the sps agreement defines the rights and obligations of members with respect to application of sanitary and phytosanitary measures. this means laws and standards on food safety, animal health and plant health. nordic journal of commercial law issue 2009#2 3 trade disputes at the wto.10 codex alimentarius is an international organization governing foodstuffs and operating under united nations organizations fao11 and who12. china is a member. codex documents are global food law13: codex alimentarius pursues to protect the health of consumers and to promote fair international food trade.14 the codex alimentarius commission is the highest decision-making body, where the representatives of the approximately 18015 member states meet every year. the codex alimentarius commission is the most important global actor drafting food standards. codex documents are in the forms of standards, codes of practice, guidelines, principles, recommendations, etc. standards often relate to product features and can be very precise, setting for example mrls (maximum residue levels) for pesticides or medicinal substances in foods. there is for example a standard for canned baby food and a standard for frozen spinach. codes of practice guide procedure as regards production, preparation, transport and storage, including haccp16 systems. guidelines exist for example on nutrition and health claims17. principles are more general and relate for example to import and export certificates. the division between different document types is not important as none of the codex documents are directly binding on food industry operators. all of the above-mentioned document types are listed under ‘standards’ on the codex web page18. it is important for china to defend their interests in codex, particularly as a member of the wto. the role of the codex commission is to provide a political forum to debate issues. the role of wto dispute settlement body is to ultimately resolve issues that cannot be agreed upon. as regards to china, the absence of wto disputes against china is seen as a sign of china’s reasonably effective implementation of the wto rules19. the worst possible scenario is that china would disrupt the whole wto process that is based on consensus20. trade partners expect china to comply with the spirit of the wto agreements and to develop into a “more responsible member of the international community”21. foreign businesses expected to benefit from a more 10 world health organisation web page. biotech: 20 questions. http://www.who.int/foodsafety/publications/biotech/20questions/en/. 11 food and agriculture organization. 12 world health organization. 13 codex alimentarius means food law. 14 www.codexalimentarius.net. 15 counted on codex web page http://www.codexalimentarius.net/web/members_area.jsp?lang=en, april 2007. 16 hazard analysis and critical control points. 17 cac/gl 23. 1997. revised 2004, amended 2008. 18 codex alimentarius web page at: http://www.codexalimentarius.net/web/standard_list.do?lang=en. 19 mertha 2008, 1. 20 qingjian 2002, vi. 21 kobayashi 2008, 1. nordic journal of commercial law issue 2009#2 4 transparent and predictable business environment in china22. according to the us-china business council in 2008, china has gone a long way in fulfilling its wto obligations, but there are still problems related to the principle of national treatment in particular. this means that foreign companies experience adverse treatment compared to chinese companies. discrimination comes in the form of stricter regulations and their enforcement. in addition, application procedures and license approval procedures are more stringent, time consuming or costly for foreign companies, foreigners are excluded from standards setting processes, and there is bias towards domestic goods in government procurement.23 according to peerenboom, some of the areas listed by foreign investors are actually required of china by the wto, while others are just wishful thinking seeking to further foreign interests24. besides factors related to the chinese legal culture, employment and income levels of the chinese people will determine whether china will fulfil its wto obligations25. the tbt agreement recommends the recourse to international standards wherever possible while drafting technical regulations. besides codex standards, iso/iec26 standards are particularly referred to in the tbt agreement27. iso is the international organisation for standardisation, and has published several standards related to the food industry. iso is a nongovernmental organization “forming a bridge between the public and private sectors”. iso is a network of the national standards institutes of its 157 member countries. many of the member institutes are part of the governmental structure of their countries, while others have been set up by national partnerships of industry associations.28 legal description of the iso standards is difficult. they are not agreements between states as with codex standards, and they are not selfregulation as governments are involved. they are followed voluntarily, although abiding by a standard might be required in practice. in any case, iso standards can be defined as soft law. on medicines, the who is involved in developing international medicinal products law. they develop international norms, standards and guidelines, and provide guidance, technical assistance and training to support countries in adopting these standards on medicinal products.29 the who also organizes international conferences of drug regulatory authorities, where medicinal products law is discussed. the outcome of these meetings are “recommendations”, in which various areas of medicinal products law are discussed. they are 22 qingjiang 2002, v. 23 us-china business council 2008, 10. 24 peerenboom 2008 b, 8. 25 qingjiang 2002, 308. 26 “the international electrotechnical commission is the international standards and conformity assessment body for all fields of electrotechnology.” http://www.iec.ch/. 27 annex 1 of the agreement. 28 iso web page. http://www.iso.org/iso/about.htm. 29 who web page. http://www.who.int/medicines/areas/quality_safety/regulation_legislation/en/index.html. nordic journal of commercial law issue 2009#2 5 in the form “member states should…”i.e. adoption is not mandatory. in 2006, it was agreed for example that member states should support clinical studies of herbal medicines30, and seek efficient sanctions for false drug advertising, particularly internet advertising31. china is involved in the who discussions and drafting the recommendations on medicinal products law. china also works bilaterally on issues of medicine law. for example between china and the eu, the agreement on a “consultation and cooperation mechanism” was signed in 2008. in 2009, the chinese sfda32 met with the director general enterprise of the ec in the first annual high-level working conference under the “mechanism”.33 1.2 from rule of man to rule of law it has been said that the chinese legal system cannot really be called ‘legal’ or ‘system’. that is why investigating chinese law is challenging for a european lawyer. legal systems can be divided in western and non-western systems, where western systems are individual-centered and nonwestern systems are community-centered. western systems can be further divided in common law and romano-germanic civil law. non-western legal systems can be divided in religious and non-religious systems. non-religious systems include asian law and traditional law. asian law relies on the confucian principle of mediation and avoiding disputes, which means courts and lawyers are not in a central role.34 in this division, chinese law is a member of the asian family. for the past 30 years, the chinese have put focus on “socialist justice” and legality. a lot of legislative work has been done, particularly economic reforms including modern legislation.35 today, chinese law shares many of the characteristics of the romano-germanic system. the legislation reflects a structural similarity to countries in the civil law family, and chinese jurists value legal doctrines and hold written law in esteem. concrete judicial decisions are not officially considered a source of law.36 however, particularly the supreme people’s court is influential in practice. its decisions are in practice used as a guideline in the lower courts, when the provision of law is obscure.37 according to jones, china has succumbed to western arguments and built a european-style legal system, but has never been entirely convinced38. the 30 icdra. 12th international conference of drug regulatory authorities. recommendations. page 5. 31 icdra. 12th international conference of drug regulatory authorities. recommendations. page 8. 32 state food and drug administration. china. 33 sfda web page at: http://former.sfda.gov.cn/cmsweb/webportal/w43879541/a64029996.html. 34 husa 2009, 126-127. 35 huotari – seppälä 2005, 132-133. 36 this can be attributed to the europeanization in china in the end of the 19th century and the beginning of the 20th century, and is also based on chinese tradition: statutes or codes were highly valued already by the qin dynasty in 221-207 bc. liu 2000. 37 liu 2000. 38 jones 2003, 8. nordic journal of commercial law issue 2009#2 6 chinese legal system is closely linked to the economy: china is still balancing between market economy and socialism. the need to balance market efficiency and social stability has left administrators considerable discretion, which has resulted in legal and practical uncertainty as regards the roles of government vs. markets39. on the surface, chinese statutes and institutions of food and medicine law are rather similar to the european ones. however, china is still heavily influenced by tradition. the most important trace of chinese history is in the close connection between strong central government (previously headed by emperor) and the administration40. in the history, the emperor had all the power. each dynasty had its own legal code. there could be no discussion on separation of powers: local officials carried out all government functions at the bottom level41. separation between legislation, its execution, and adjudication still sounds strange to the chinese. when discussing chinese law, we cannot presume that concepts such as state, law, or court mean the same as in europe. the history and contemporary understanding of law in the chinese society is different from ours. donald c. clarke has described methods for comparing chinese law to western, particularly american law. firstly, the naive ignorance approach sees the two legal systems as similar and looks at legal texts only. this approach is to be avoided. we could also compare chinese reality to an ‘ideal western legal order’.42 an alternative would be to see the ‘errors’ as normal features of the chinese legal system43. a ‘disciplinary model’ might be fruitful in understanding the chinese legal system. this model is based on the assumption of state as emperor.44 an outright hostility towards law in a western sense is inherent in chinese history and culture. according to confucius himself, the goal is a situation with no legal cases45. china started to create a legal system and law in a western sense in the end of 1970’s, in conjunction with its new open-door policy. in china, law was traditionally seen as an instrument of governance for the rulers, and ‘rule of man’ was applied instead of ‘rule of law’46. there was law, but it was occupied with implementing the emperor’s orders, and did not have anything to do with 39 peerenboom 2008 a, 3. 40 jones 2003, 8-9. this system of government developed over 2000 years ago and remained similar until the 20th century. 41 jones 2000, 9. 42 a sophisticated researcher with this approach will notice features of the chinese legal system that do not fit the western model, but still see them as errors. if we try to understand chinese law and where it is going, we cannot simply presume it is going towards ideal western legal order. clarke 2003, 99-100. 43 clarke 2003, 100. 44 clarke 2003, 102. 45 jones 2003, 7. here jones cites bodde – morris 1967. 46 kobayashi 2008, 3. nordic journal of commercial law issue 2009#2 7 agreements or disagreements between citizens, or rights of citizens. there was in fact no such thing as citizen: people were subordinates. as stated above, china has created large volumes of legislation in the past 30 years. however, laws are void without implementation. after writing the necessary legal texts, china has to create legal institutions to make law work in practice. the legal reform is closely connected to the economic transition. government agencies are no longer primarily responsible for managing economic entities or planning their economic transactions. in the new economic order, it is enterprises and individuals and their relationships that are important. private actors must believe that they will be held to their legal obligations, and that their legal rights will be protected. as the government can no longer command market actors to make economic decisions, it needs the ability to use administrative sanctions, and the ability to resort to courts.47 instead of command, the market now needs to be guided through law. this leads us to the above-mentioned concept ‘rule of law’. the discussion on modern chinese law revolves around this concept. several scholars are discussing the development, current level, and future direction of rule of law in china48. building the rule of law has been on the party agenda since mid-1990s, and the constitution was amended in 1999 to include the concept49. it says in the constitution that all organs, administrators and enterprises must abide by law, all acts in violation of the law must be investigated, and that no one is above the law50. these are rather familiar concepts to us europeans, but novel to the chinese. there are narrow and wide concepts of rule of law. the narrow concept is rather formal and requires the very basic parts of the legal system to exist. this means meaningful restraints on the use of powers, supremacy of law, and equality of citizens before the law. in a society governed by rule of law, laws need to be general, public, prospective, clear, consistent, capable of being followed, stable, and enforced. some insist the rule of law must include liberal democracy and human rights, and wider theories add political, social, and economic concepts. some writers are of the view that china fulfils the narrow criteria. some argue that china is a country of rule by law at best: law is used by the non-democratic state as an instrument for social control.51 47 lichtenstein 2003, 287. 48 see for example the rule of law in china programme at the foundation for law, justice and society, a thinktank affiliated with oxford university's centre for socio-legal studies. the scholars in this program have written several articles in english on rule of law in china, both generally and as regards certain legal areas such as employment or intellectual property. see foundation for law, justice and society at http://www.fljs.org. see rule of law in china publications at http://www.fljs.org/section.aspx?id=607. 49 wikipedia: http://en.wikipedia.org/wiki/chinese_law. 50 article 5 of the constitution. 51 qingjian 2002, 301, uses the words “rule through law”. see also wikipedia: http://en.wikipedia.org/wiki/chinese_law. wikipedia article sites randall peerenboom: china’s long march toward rule of law, cambridge university press 2002, and albert huhg-yee chen: an introduction to the legal system of the people’s republic of china, 1992. nordic journal of commercial law issue 2009#2 8 peerenboom sees china as following the ‘east asian model’, where economic growth, legal reforms, democratization, and constitutionalism follow each other, in this order52. according to critics, china has a long way to go towards the rule of law. the congress needs to be strengthened as legislator, the constitution should be enforced, and the judiciary should be independent. corruption is common among public officials: personal favours, bribery, and taking of public monies happen at all levels of government. the legal profession has also been inadequate and china is now putting effort in training competent judges and attorneys.53 the legal reform revolves around taking some of the powers away from administrators, which up until now have been the legislators, the executors, and the judges. according to peerenboom, china’s performance on rule of law might be best judged in relation to other countries in its income class54, and china seems to be doing reasonably well by that measure55. there is also critique on the whole discussion on the rule of law in china. according to jerome cohen, the problem with westerners is that we never go beyond that primitive stage we call the rule of law. according to him, china has always known that law is not enough to govern a society, and still knows it.56 according to qingjiang, guanxi (social connections) and mianzi (face) do still affect implementation of laws in china57. we are of the view that mere existence of laws, even laws of technically high quality, is not a goal in itself and guarantees nothing more than clarity on paper. the content, the substance of law, is what matters. laws need to address the needs of companies and individuals. it is therefore integral that stakeholder voices are heard before making laws. it is also integral that laws are implemented in practice. disputes need to be fairly resolved, whether by courts or by other means such as mediation58. 52 peerenboom 2008, 6. 53 wikipedia: http://en.wikipedia.org/wiki/chinese_law. article sites randall peerenboom: china’s long march toward rule of law, cambridge univeristy press 2002, and albert huhg-yee chen: an introduction to the legal system of the people’s republic of china, 1992. 54 wealth is highly correlated with good governance indicators, human rights, and other indicators of human weelbeing. 55 peerenboom 2008 a, 5. 56 cohen according to jones 2003. 57 guanxi can work both ways: it can either assist in enhancing law enforcement, or be used to avoid compliance of law. similarly, law enforcement may also be related to the psychological assessment of saving face or losing face of the persons against whom law is enforced. qingjiang 2002, 301. 58 lichtenstein 2003, 288. nordic journal of commercial law issue 2009#2 9 1.3 national and local laws we are now turning to the questions of who makes the law in china. the question of legislative competence of central government versus the competence of provinces and cities reminds us of the discussion of the competence of the eu vs. its member states. in china, the constitution is not a very important piece of law. according to clarke, it does not constitute anything, and is perhaps the least important document in the entire legal system59. in reality, the government does not work in the way described in the constitution. in theory, the chinese central government is strong with powerful instruments at its disposal. all the powers of localities stem from the centre60. the central government decides who controls the provinces: it appoints the government top officials and the party top officials in the provinces. the central government also controls key economic resources like scarce raw materials, government investments, foreign loans and budgetary subsidies. unity of the nation and thus strong central government is also culturally favoured: the han majority of people want to see china as one.61 in practice, chinese localities have been given powers and resources to administer the state economy in the localities. driven by local interests, local leaders have gradually become less obedient to the centre, and centrally promulgated laws are unevenly implemented at local level.62 officially, the highest organ in china is the parliament, the national people’s congress (npc). the amount of representatives has fluctuated between 2000 and 3500 members. representatives are chosen by indirect election. local congresses elect the members of provincial congresses, and provincial congresses elect the members of the national congress. the authorities of the parliament are extensive. the parliament enacts the national laws and appoints the prime minister, other ministers, and the president. the npc also decides on the state economic plans and budgets.63 the role of the parliament has increased in the recent years. the npc chooses among itself a standing committee. the standing committee convenes the parliament, issues regulations, interprets laws, and oversees government activities. the chairman of the standing committee acts as the chairman of the parliament.64 the national congress appoints the members of the state council, which is the highest executive organ in china, as well as the highest organ of state administration65. it is led by the prime 59 clarke 2003, 103. 60 qingjiang 2002, 305. 61 ren 2000, 102-103. 62 qingjiang 2002, 305. 63 huotari – seppälä 1993, 128-129. 64 huotari – seppälä 1993, 129. 65 official web page of the central people’s government of the people’s republic of china. http://english.gov.cn/2008-03/16/content_921792.htm. nordic journal of commercial law issue 2009#2 10 minister. the position of the party has normally been decisive in choosing the members of the state council66. according to the constitution the government and the communist party work together to rule the country. since the birth of the people’s republic in 1949, the chinese communist party (zhongguo gongchandang) has played a central role in state affairs.67 officially and formally, there are also other parties and citizen organizations in china, but their influence is not significant.68 the real locus of central political power in china lies in the leadership of the communist party, which exercises power largely through the state council. the party has inherent authority to make rules about anything, and now chooses to make certain rules through the national people’s congress.69 the party has a leading role in central and local government, army, and economy. party organs make decisions and issue them to state organs for implementation. the same people work for the state and the party: party representatives have leading positions also in the government70. china’s size and diversity have led the government to use a system of local autonomy. below the central level, there are both geographically defined provincial authorities and sectorally defined ministries.71 because of the geographically and sectorally separated actors, legal and economic integration of china can not be realized at once. the chinese have created economic zones as a type of regional economic experiments.72 the establishment of these zones is to encourage economic cooperation by promoting division of labour and competition.73 these are first steps towards integration of the chinese economy. according to weixin, the successful realization of regional integration in china requires institutional arrangements similar to those of the eu. interests of the whole economy and the individual economies need to be coordinated.74 in environmental issues, the resistance of local and provincial governments is a serious obstacle to sustainable development policy. similar problems relate to regulation of foodstuffs and medicines. the chinese food hygiene law of 1995 declared that precise food safety standards are to be decided locally. standards vary, and national and local standards contradict one another. implementation and control of the rules differs among provinces and cities. it is not possible for the central government to be aware of all the day-to-day decisions and actions of 66 huotari – seppälä 1993, 130. 67 preamble of the constitution, see also amendment 2 of 1993 and amendment 3 of 1999. huotari – seppälä, 124. 68 huotari – seppälä 1993, 123. 69 clarke 2003, 111. 70 huotari – seppälä 1993, 124. 71 weixin 1992, 48-49. 72 weixin 1992, 88. 73 weixin 1992, 91. 74 weixin 1992,86. nordic journal of commercial law issue 2009#2 11 localities. local officials might see national laws as obstacles to their cities’ growth and personal promotion, and hence readily defy them. promotions are often based on meeting economic targets, and cooperation with other provinces or cities is not rewarded. this enhances local protectionism.75 distrust in food and medicine markets describes consumer attitudes in china. geographically, china is divided into provinces76, autonomous regions77, special administrative regions78, and municipalities directly under the central government79. provinces and autonomous regions are further divided into autonomous prefectures, counties, autonomous counties and cities, and counties are divided into towns and townships.80 local and provincial legislation is given by local and provincial congresses. according to the constitution and the 2000 act of legislation, the npc standing committee oversees local regulations, and can annul any local regulations contravening the constitution or national laws81. in practise, however, this responsibility is far from being realised, and a large number of local regulations contravene national laws82. the sectoral planning hierarchy also fragments the market. all sectors within the economy are organized vertically and headed by ministries under the state council. ministries include for example the ministry of health, the ministry of agriculture, and the ministry of science and technology83. the ministry of health is the most relevant in regulating foodstuffs and medicines. also the state food and drug administration (sfda)84, founded in 2003, has its 75 lam 2006. 76 hebei, shanxi, liaoning, jilin, heilongjiang, jiangsu, zhejiang, anhui, fujian, jiangxi, shandong, henan, hubei, hunan, guangdong, hainan, sichuan, guizhou, yunnan, shaanxi, gansu, qinghai, and taiwan. 77 inner mongolia autonomous region, guangxi zhuang autonomous region, tibet autonomous region, ningxia hui autonomous region, and xinjiang uygur autonomous region . 78 hong kong special administrative region and macao special administrative region. 79 beijing, tianjin, shanghai, and chongqing. 80 weixin 1992, 47. 81 jian 2003, 506-507. 82 jian 2003, 508. 83 there are altogether 28 ministries and commissions under the state council. in addition, there are at least 36 other organisations and institutions directly under the state council. these include for example the customs, the bureau of statistics, and the intellectual property office. governments official web portal: http://english.gov.cn/links.htm#1. see plans on restructuring the state council at gov.cn: tuesday, march 11, 2008. http://english.gov.cn/2008-03/11/content_916738.htm. 84 the state food and drug administration was founded according to the restructuring plan of the state council, approved by the first plenary session of the 10th national people's congress, and "the state council notice on government structuring", no.8.2003. the new authority replaced the former state drug administration. http://www.sfda.gov.cn/cmsweb/webportal/w43879538/index.html. nordic journal of commercial law issue 2009#2 12 role in drafting various guidelines related to safety and efficacy of foodstuffs and medicines85. the sfda is at the moment directly under the state council86, but will be transferred under the ministry of health in the upcoming government restructuration, described in detail below. an important step towards centralisation is that currently all food and medicine pre-market authorisations are under the competence of the sfda. this has eliminated the conflicting standards that previously prevailed among provincial government agencies. regulations that can be enacted by ministries are called guizhang. these regulations tend not to be results of comprehensive planning or strategy. they are rather reactions to problems arisen. within the areas of food and medicines, several different government agencies have competence to regulate and supervise the entrepreneurs. when giving guizhang regulations, administrative organs do not necessarily check whether their guizhang is in agreement with laws or former regulations by the same administrative organ or another administrative organ. thus, conflicts between guizhang provisions are not rare.87 this is naturally confusing both to regulation targets and those that are supposed to supervise them. 1.4 administrative regulations and court interpretations today, the question of hard law vs. soft law is relevant also in china. first of all, there are laws enacted by the national people’s congress. then there are regulations and directives given by the state council, which is the highest administrative body in the nation. in reality, it is the state council that decides on important law. in addition, there are regulations and directives given by various departments under the state council. these departments include the ministry of health and the state food and drug administration.88 we stated above, that administrators previously had the imperial power and acted as legislators, executors, and judges. administrative regulations were not seen as any kind ‘soft law’, as the simply were ‘the law’. according to article 90 of the chinese constitution, “the ministries and commissions issue orders, directives and regulations within the jurisdiction of their respective departments and in accordance with the statutes and the administrative rules and regulations, decisions and orders issued by the state council”. the ministry of health has the official competence to legislate on the area of foodstuffs and medicines. the state food and drug administration (sfda), on the other hand, does not have hard-law legislative power. however, the sfda’s department of policy and regulations, more precisely its division of regulations, has the following tasks: 85 the sfda has control over foods, medicines, and cosmetics. its domain of is thus similar to that of the fda in united states. in europe, food and medicine administration is divided under two separate agencies at the eu level and also in most of eu member states. 86 http://www.sfda.gov.cn/cmsweb/webportal/w43879538/index.html. 87 bian 2004. 88 lists of chinese food, drug and cosmetics laws in 2007 at: http://www.chinafdc-law.com/laws/index_1.html. nordic journal of commercial law issue 2009#2 13 ‘studying and drafting legislation program and annual plan for food and drug administration; participating in, and/or organizing the drafting of medicine administration laws and regulations; organizing relevant authorities to draft laws and regulations for safety management of food, health food and cosmetics organizing and carrying out review, coordination and issue of administrative provisions; interpretation of the related laws and regulations in accordance with law’.89 this means the sfda is at the moment involved in both important stages of food and medicine law: preparing the laws and implementing the laws. the sfda plans and drafts legislation, which is promulgated by the state council of ministeries. the authority also gives its own administrative regulations, and interprets laws and regulations. the division of work between the ministry of health and the sfda will be restructured in the future. according to information on the central government’s website in march 2008, china is upgrading the ministry of health to better monitor the safety of foodstuffs and medicines. the sfda will be transferred under the ministry of health (moh). the “new moh” will be authorized to coordinate food safety management, organize investigations into serious food safety incidents, and give “due punishment”. the moh is responsible for the constitution of the national food and medicine laws. the sfda, after the reform, is responsible for food sanitation permits, monitoring food businesses, and monitoring the safety of medicines including their research, production, circulation, and use. 90 this means that in the future, the moh will be giving all the laws on foodstuffs and medicines, not the sfda. the task of the sfda will be to more efficiently monitor the businesses. in china, the court system has traditionally not been separated from administration. cases have been handled as police or administrative issues.91 this is still the case also with foodstuff and medicine administration. the ministry of health and the sfda are entitled to carry out various executive punishments stipulated in the food safety law and the medicine administration law. in the new food safety law, fines range from 2,000 yuan to ten times the value of the commodity in question. this means there are no maximum fine amounts for offences affecting large volumes of foods. the new law is similar the old one in stating that business licenses can be revoked in serious cases, and illegal gains shall be confiscated. in addition to administrative penalties, violating the food safety law may lead to civil responsibility. for causing a serious food poisoning accident or putting poisonous raw materials 89 sfda web page. http://www.sfda.gov.cn/cmsweb/webportal/w44993659/index.html. 90 gov.cn tuesday, march 11, 2008 . http://english.gov.cn/2008-03/11/content_916856.htm. 91 huotari – seppälä 2005, 131. nordic journal of commercial law issue 2009#2 14 to foods, also criminal responsibility is possible.92 with medicines, the pre-market and postmarket control is under the competence of the sfda. administrative enforcement agencies are not willing to hand over their cases for criminal prosecution, because administrative penalties enhance their own operating budgets93. the autonomy of courts and the enforcement of judgments are by many scholars considered problematic in china94. the judicial system as a whole is weak and under the control of the communist party95. finally, we have to note that courts in china often act like legislative bodies. they make law by issuing interpretations of laws that are binding on the courts. every year the supreme people’s court (spc) issues interpretations, regulations, notices, replies, opinions, and policy statements. most are binding on the courts, others are highly persuasive and likely to be followed. the ‘interpretations’ range from general statements to specific replies to inquiries from lower courts96, and fill in the void left by inexistent or vague laws. the biggest problem with this distribution of work between the national people’s congress and the spc is that the spc is not adhering to recent process reforms to increase transparency and public participation. the spc has started to respond to this criticism. the questions of legislative hierarchy still remain.97 1.5 ngo regulation and self-regulation the chinese government is calling for the participation of consumers, ngos98, and food companies in establishing food safety standards. in a document submitted to the world health organization in 2002, china called for increased participation on the part of “consumers, food industry and other stakeholders”. china has stressed on increasing consumer awareness by hosting an annual “food hygiene law education week” and implementing other educational programs on the importance of sanitary food handling.99 this way some of responsibility can be shifted onto the shoulders of consumers themselves, and the large numbers of food poisoning incidents caused by chinese consumers themselves can be lowered. 92 for more information on pre-market, post-market control, and penalties as regards the law on foodstuffs and medicines, see our doctoral thesis. 93 mertha 2008, 2. 94 see seppänen 2005 on how empirical evidence is missing on these issues. 95 mertha 2008, 2. 96 the latter means the supreme people’s court acts similarly to the europen court of justice, which can decide how law is to be interpreted in a case that is held by a member state court. 97 peerenboom 2008 c, 1. 98 the term “ngo”, non-governmental organization, means organizations outside of state systems, including advocacy organizations, non-profit service-providing institutions, religious groups, and social welfare organizations. ma, 2002. 99 li 2005, 30. nordic journal of commercial law issue 2009#2 15 the civilian consumer protection group system also plays an important role in chinese food regulation. consumer groups, such as the chinese consumer association, obtain licenses from local government authorities to independently regulate and inspect food production facilities and plants. they also hear complaints and comments from consumers and report back to local government officials.100 these groups are important in protecting people’s rights. in addition, self-regulation by the industry itself exists: various chambers of commerce recommend their own voluntary standards to food producers. these standards cover many areas of food production. more and more food producers are adopting voluntary standards in order to achieve better market success.101 the new food safety law urges both the industry organisations and social groups to be more involved. according to article 7, food industry organisations shall tighten industry selfdiscipline, and guide producers and traders in complying with the law. in article 8, the state encourages social and community groups to conduct educational activities as regards food safety laws. article 8 also urges the media to publicise laws for free, and to provide oversight on acts that violate the law. it is interesting that also media is given responsibility on food safety. there seems to be a trend of shared responsibility that can be noted also for example in the european and american discussions on who is responsible for obesity. voluntary approaches have been criticized for not being sufficient, and greater government involvement has been demanded. china must build the capacity to oversee food production within its borders. several severe food safety scandals have been the result of unsafe or inferior ingredients in processed foods, or chemical and pesticide residues.102 these problems cannot be resolved through self-regulation or consumer awareness only. food safety must also be a priority of the government, not just by consumers, their organisations, and the food industry. ii. chinese law on foods and medicines 2.1 food or medicine? functional foods often comprise of materials that are used in traditional chinese medicine. the legal difference between health foods and medicines is that health foods have a special health function, but are not for curing a disease. the categorisation decision (medicine vs. nonmedicine) is legally important. however, the chinese classification rules are not clear and the 100 li 2005, 30-31. 101 bian 2004 102 li 2005, 30. nordic journal of commercial law issue 2009#2 16 sfda has not published any guidelines on the subject. companies are consulting the sfda on a case-by-case basis. 103 in the chinese medicine administration law, pharmaceuticals are defined as articles intended for use in the prevention, treatment or diagnosis of human diseases, or intended to effect the purposive regulation of human physiological functions, for which indications or major functions, usage and dosage are prescribed. they include raw traditional chinese medicinal materials, traditional medicines prepared in ready-to-use forms, and other prepared chinese medicines, medicinal chemicals and their preparations, antibiotics, biochemical medicines, radioactive drugs, serums, vaccines, blood products, diagnostic aids, etc.104 traditional chinese medicines are particularly mentioned in the definition. the chinese want to emphasize the fact that modern and traditional medicine are treated as equal. the new food safety law makes a distinction between foodstuffs and medicines in article 50: “medicines can not be added to food, unless the added substance is traditionally considered both food and chinese medicine.” this means that foods must not contain medicinal substances, but can contain materials that have traditionally served as both food and medicaments. the same plant can be used as nutrition for healthy people and as medicine for sick people. the catalogue of substances that are traditionally considered both as food and as chinese medicine will be published by the executive department of health under the state council. this kind of catalogue will offer valuable guidance to producers and marketers. the major implication of a product being classified as a medicine is that it imposes higher requirements for producers and sellers. for example, manufacturers of medicines must hold a gmp certificate, and wholesale and retail enterprises must hold a gsp certificate. the implications of the categorisation decision on marketing are also important. only medicines can bear medicinal claims. this means claims of preventing, treating or curing a disease. only health foods can bear health claims. article 11 of the health food regulation separates health foods and medicines from each other: “any medicinal product approved by the government should not apply for the certificate of approval on health food”. this way the health food category separates health foods from regular foods in the other end, and medicines in the other end. the function and the claim resolve the foodstuff vs. medicine -issue, not the raw material as such. regular foods can bear nutrition claims, which means claims of the type “low-fat” or “high in fibre”. 103 tsoi 2007. 104 article 102. nordic journal of commercial law issue 2009#2 17 2.2 structure of food law in china, food law is given by the npc, the state council, or authorities under the state council. previously, food hygiene law of 1995 was the basic piece of food law in china. since june 2009, the basic piece of food law is the food safety law. the standing committee of the national people’s congress passed the new food safety law on february 28th 2009, and it went into effect in the beginning of june 2009. based on the new law and its future implementing regulations, chinese food law and particularly its implementation and control will be developed. the new law uses western terminology in promoting safety “from farm to table”. the new law is more comprehensive in spelling out who is responsible for what, focusing on the critical points where there have been problems in the past. the main structure and content of the two laws are similar, though. the new food safety law has ten chapters105. the food hygiene law of 1995 already was a modern food law similar to the codex alimentarius model. the food hygiene law was enacted for the purpose of ensuring food hygiene, preventing food contamination and harmful substances from injuring human health, safeguarding the health of the people and improving their physical fitness.106 other national food laws were based on the food hygiene law. examples of chinese food regulations based on the food hygiene law are the additive regulation, the novel food regulation, the gmo food regulation, and the health food regulation107. for example on health foods, the national health food regulation by the ministry of health is the basic law on health foods. in addition, health foods are governed by over 20 other rules or notifications by the ministry of health or the state food and drug administration. these include for example the “interim regulations for the registration of health foods”, “provisions for health food labelling”, “general hygiene requirements for health foods” and the “notification on preparing for censoring health food advertisements”. 108 for clarity reasons, combining these in one piece of law might be considered in the future. if the state has not formulated standards for a certain food, the people's governments of the provinces, autonomous regions, or municipalities directly under the central government may establish local standards for that food and report them to the administrative department of public health under the state council and the competent standardization administration department under the state council for the record.109 local standards are plentiful, and the 105 chapter one: general provisions. chapter two: surveillance and assessment of food safety risks. chapter three: food safety standards. chapter four: food production and trade. chapter five: inspection and testing of food. chapter six: food import and export. chapter seven: response to food safety incidents. chapter eight: supervision and administration. chapter nine: legal liabilities. chapter ten: supplementary provisions. 106 article 1. 107 kan and zhang (2002) use the term ’management measures’ of these pieces of law. 108 list of chinese food, drug and cosmetic laws at http://www.chinafdc-law.com/laws/list_1-27_5-118_1.html. 109food hygiene law, article 15. nordic journal of commercial law issue 2009#2 18 delegation of more specific food hygiene legislation to local legislators has led to inconsistent standards and confusing licensing requirements110. for example in hong kong, there is a whole body of local food law. a general food and medicine code is complemented by legislation on specific matters111. existing principles of legislative competence are upheld by the 2009 food safety law112. when drafting new food regulations, central and regional government, businesses, associations, ngos, and internet are consulted113. according to kan and zhang, factors considered in formulating food standards are: feasibility of standards on the basis of research, current and future risk evaluation, international food law codes and standards of other countries, and industrial standards.114 as means to better food legislation, kan and zhang urge that law shall be based on science, and regulators must look at the food chain from farm to table. food law must emphasize the responsibility of food producers and sellers to guarantee food safety: food business operators must have effective in-house control, using haccp115 based systems. the businesses are responsible for taking dangerous products off the market. the government should do its share by reducing over-detailed regulation and emphasizing coordination.116 the chinese views on how to develop food law sound similar to the european approach, where food law is legally based on scientific risk analysis, global harmonization is considered important from free trade perspectives, and industry is always consulted when drafting new legislation. in china, there is not a particular authority (like efsa in europe) responsible for scientific risk assessment as regards food law. instead, risk assessment is performed by the ministry of health and the sfda, which will in the near future be transferred under the ministry. 2.3 challenge of food safety food safety is today a top concern in china. it is important both for chinese food export and for chinese domestic markets117. this increased weight on food safety is due to several serious 110 li 2005, 29. 111 hong kong government web page. http://www.fehd.gov.hk/safefood/foodlaw_list.html#part5. 112 according to article 24 of the new law, local food laws can be developed in the absence of national laws. 113 kan – zhang 2002. 114 kan – zhang 2002. 115 hazard analysis and critical control points. 116 kan – zhang 2002. 117 since the 1990s, china has been an important exporter of food products such as vegetables, apples, shrimp, and poultry. however, china has recently had problems with food export because chinese food has failed to meet stringent food safety standards in japan, europe, and other countries. also chinese consumers are more and more interested in food safety because of some domestic food contamination scandals. nordic journal of commercial law issue 2009#2 19 food scandals where dozens of people have died. food safety efforts are more advanced in the export sector118, and more recent in the domestic sector. it is not rare that developing countries have, to promote their exports, stricter standards for exported food. according to calvin et al., “china’s efforts are an important case study of a country’s striving to elevate standards in its food and agriculture sector to international food safety standards”.119 export industry is has been regulated stricter because the export industry is easier to regulate because it is smaller than the general food industry, and because the export industry is a more motivating target as the exports generate considerable revenue, and china wants to keep up its international reputation.120 the chinese system was created as a response to bans of chinese food in foreign countries. the export-oriented system monitors food products from exporting companies at every step, from the pesticides and chemicals used on farms to food processing facilities to packaging plants. exporting food companies must obtain special licenses from the exportoriented system administration.121 the approach taken resembles the european farm-to-table approach. the new food safety law covers food safety evaluation, monitoring, recall, and information release. in addition to the basic law, the government promised to stipulate or update more than 7,700 national standards for the safety of foodstuffs, medicines, and other consumer goods in 2008. the government states that after the current reform, all the requirements and testing methods should “comply with international standards”. legislators have promised to include the general public in the process law formulation, and to publicly post all the drafts.122 besides the central government, also local governments have been active in promoting safer food.123 the general aim of food safety legislation is protecting consumers from unhealthy products, encompassing biological and chemical hazards. according to calvin et al, many of china’s food safety problems can be traced back to the farm level. it is difficult to standardize and monitor production practices of the chinese food production sector, which is composed of 200 million farm households. important issues include both chemical and biological hazards. chinese farmers must rely on heavy use of fertilizers to get production out of intensively cultivated soils. chinese farmers also use many 118 chinese food must meet the international food safety standards, and the increased costs of achieving these standards might have an effect on growth of chinese food exports. chinese foods have been rejected because of excessive antiobiotic residues (eu rejected schrimp 2001,eu and japan rejected poultry 2001, and eu rejected honey 2002), excessive pesticide residues ( japan rejected frozen spinach in 2002-2003, eu and japan rejected tea 2002) and parasites (south korea rejected fermented cabbage in 2005). calvin et al. 2006, 18. news reports of product rejects compiled by usda, economic research service. 119 calvin et al. 2006, 17. 120 li 2005, 30. 121 li 2005, 30. 122 gov.cn saturday, march 8, 2008. http://english.gov.cn/2008-03/08/content_914117.htm. 123 calvin et al. 2006, 20. nordic journal of commercial law issue 2009#2 20 highly toxic pesticides. some farmers have little understanding of correct chemical use. they may harvest right after applying a pesticide, which results in excessive residues in the harvested product. antibiotics are widely used to control disease in livestock, poultry, and aquaculture products. industrialization and lax environmental controls have also led to concern about heavy metals in food products. untreated human and animal waste in fields and water raises the risk of microbial contamination.124 besides the farms, the chinese system of food trade is a challenge to safety monitoring. millions of chinese small food businesses often keep no record of what they buy and sell. ensuring traceability is difficult when there are millions of growers and buyers dealing with small volumes, like in china.125 the chinese food companies are now promoting approaches to gain greater vertical control over the food chain.126 chinese food safety efforts at the farm level are primarily concerned with chemical residues in spite of the fact that food poisonings and deaths from microbial contamination exceed those from farm chemical exposure. china is developing good agricultural practice guidelines, chinagaps, which will address minimizing the risk of microbial contamination.127 the ministry of agriculture is the lead agency promoting food safety at the farm level. the ministry has created standards intended to guarantee that foods are free of contaminants. the “pollution-free program” and the “green food program” have standards specifying tolerances for harmful materials in soil, water, and air.128 they also regulate the use of fertilisers and pesticides, and set maximum residue levels. the programs include certified production areas and trademarked symbols for use on consumer products. packaged products carry information on the firm, which is a step towards a traceability system. compliance is enforced by regular testing of soil, water, and air, and random testing of final products for residues.129 the above-mentioned programs are voluntary, and not yet commonly followed. in 2005, about 6 percent of the volume of agricultural production met the pollution free standard, and 1 percent the green standard, which is stricter.130 the decision to produce green or pollution-free food is usually made by local officials or agribusiness enterprises, not the individual farmers131. 124 calvin et al. 2006, 18. 125 calvin et al. 2006, 18. 126firms have used a model in which the company leases land and controls production directly, and a model in which they use production contracts with growers that specify chemical use and production methods. good agricultural practices (gaps) and use of a type of hazard analysis and critical control point (haccp) are promoted. calvin et al. 2006, 19. 127 calvin et al. 2006, 20-21. 128 more specifically, the green food program defines two categories of green food. aa green food is equal to organic food, and a green food is between normal food and organic food. a green food is more realistic in china, as chinese land is already heavily polluted. gmos can be used in a but not aa green food. 129 calvin et al. 2006, 20. 130 calvin et al. 2006, 20. 131 calvin et al. 2006, 21. nordic journal of commercial law issue 2009#2 21 the trend is inevitably towards green food, though. this is because exports require adherence to rather strict rules anyway, and because also chinese consumers are becoming more aware and cautious. bian sees green food as a suitable compromise between organic food and normal food, particularly for developing countries. following the green food standard does not make food too expensive, but use of fertilisers and pesticides is still heavily restricted. according to huang, the measures taken have improved food safety in recent years. the general situation of food security concerning vegetables, meat, grains, fruits, dairy products, aquatic products and other food has turned better. however, supervision over food security is still weak in suburbs and rural areas, and about 8 percent of domestic food cannot reach the national food safety standards.132 china will need equally strict food safety control for its domestic consumers than it already has in place for exports. the milk and dairy scandal discovered in september 2008 shows that china still has a long way to go. in addition to food safety, food marketing is also now at focus in china. until recently, nutrition claims have not been regulated in china. in november 2007, the chinese ministry of health issued administrative measures on food nutrition labelling133. the measures are applicable from 1st may 2008. nutrition labelling and nutrition claims are regulated by one single instrument. the new regulation stipulates the definition of food nutrition labelling and its scope, nutrition declaration and nutrition claim. the three technical annexes stipulate definition of nutrition ingredients, rounding rules, nutrients reference values, the conditions and terms of nutrition claims.134 guideline daily amounts (gda) are used as a guide for consumer. companies are not allowed to say their products are high in calcium, iron or low in fat unless they meet certain strict criteria. they must not make false claims nor exaggerate the nutritional benefits of the product. the prohibition of medicinal claims is also repeated: labels must also not make direct or indirect claims of curing illness.135 2.4 health food regulations as stated above, additives, health foods, novel foods, and gmo foods are regulated separately in china. all have their separate pre-market authorisation procedures. the chinese category for health foods covers a wide range of different products and includes the european categories 132 huang hai, assistant minister of commerce. july 19 2005. press conference reported by china internet information center. 133 22 pages, in chinese. 134 wto tbt/sps notification. http://www.tbt-sps.gov.cn/sites/english/news/lists/news/dispform.aspx?id=60. 135 reuters beijing january 11 2008. nordic journal of commercial law issue 2009#2 22 of food supplements136, fortified foods, and dietetic foods. here we take a closer look at the regulations on health foods.137 health foods are foods which have a specific health function, are suitable for a certain group of people, and which are not for therapeutic purposes. safety and efficacy of health foods are evaluated in a single procedure. we will not discuss the details of the application process here138. the new food safety law states basic rules on health foods in its article 51. it is first stated that “the state executes strict regulations on health foods”. health foods may not pose acute, subacute or chronic hazard to human body. labels and instructions may not refer to disease treatment or prevention, all information and claims must be truthful, and the product must correspond to the information given. more precise rules on health foods are given by the health food regulation of 1996139 and its subsequent amendments. the health food regulation was enacted to strengthen the administration and supervision of health foods, ensuring the quality of health foods140. the regulations focus on evaluation and approval of health foods, and are as such directed more at authorities than at entrepreneurs. however, there are also sections regulating production and marketing of health foods. the regulations establish minimum safety and efficacy requirements for health foods as follows: raw materials and final products must comply with food hygiene requirements and shall not cause any acute, subchronic, or chronic harm to human body, necessary animal and/or human tests must have confirmed a clear and stable health effect, formulation and dosage must be based on scientific evidence (the functional ingredient should be identified but when that is impossible, at least the raw materials that cause the effect shall be listed), therapeutic effects shall not be claimed in labelling or advertising.141 besides general hygiene rules, safety of health foods in controlled via controlling the choice of raw materials. a separate notification from 2002142 governs the raw materials of health foods. 136 there is no specific legislation on food supplements in china and food supplements thus do not form a separate legal category. the pre-market authorisation requirements depend on whether the supplement contains vitamins, minerals, or something else, and whether or not health claims are presented on the product. as stated above, only health foods are allowed to bear health claims in china. this applies to foods in food form and food supplements. 137 we will leave additives, novel foods, and gmo foods out of this article. chinese regulations on these products have been discussed in our doctoral study. 138 we have discussed the topic in our doctoral thesis. 139 ministry of health: administrative regulations on health food, order no. 46 (promulgation date: 1996-0315; effective date: 1996-06-01.) 140 article 1. 141 health food regulation, article 4. huang – lapsley 2005, 266. nordic journal of commercial law issue 2009#2 23 first of all, the notification aims to clear the situation of overlapping pieces of legislation. novel foods are a separate issue from health foods. if a health food has novel ingredients, the novel food regulation shall be followed. further, if the health food uses food additives, additive law applies. there are also particular rules on fungal health foods143, probiotic health foods144, and nuclei acid type of health foods145. these products should follow these procedures respectively.146 if health foods involve protected wild animals or plants, they should be applied according to notification of restraining the produce of health food using wild animal and plants as raw materials of ministry of public health of the notification of 5th july 2001 restraining the use of certain single materials147 that have anti-desert function in the wild.148 other health food raw materials are regulated by three lists given by the annexes of the health food raw material regulation: list i includes materials that can be used either as foods or medicines. list ii includes materials that can be used as health food materials. list iii includes materials that are prohibited as health food materials. the bit complicated rules are given by point 5 of the raw material notification: 142 ministry of health: notification on further standardising the management of raw materials for health food (directive, document no.:weifajian[2002]51, promulgation date: 2002-02-28. 143 regulation on evaluation and examination of fungal health foods, valid from march 23rd 2001. fungal health food means food with specific health function, which uses edible macro-fungi and carpophores and filaments or filament macro-fungi. fungal health food must be safe and dependable, i.e. safe for eating, non-toxic and not harmful. the strains used in production must have clear and stable characteristics of biology, genetics and functionality. article 3. only certain fungus species are permitted as health food ingredients. the permitted fungus species are the following: saccharomyces cerevisae, candida atilis, kluyveromyces lactis, saccharomyces carlsbergensis, paecilomyces hepiali chen et dai, sp. nov, hirsutella hepiali chen et shen, ganoderma lucidum, ganoderma sinensis, ganoderma tsugae, monacus anka, monacus purpures. huang – lapsley 2005, 266. if an entrepreneur wants a fungus to be added on the list, an application to the sfda has to be made. 144 regulation on evaluation and examination of probiotic health foods, valid from march 23rd 2001. probiotic health food means preparation which promotes ecological balance of bacterial colony in intestine and is beneficial to human health. article 2. the probiotic strains must belong one of normal bacterial colonies in human body. it is allowed to use live or dead bacteria and bacterial metabolites. the probiotic health food must be safe and dependable, i.e. safe for eating with no adverse reactions. the strains used in production must have clear and stable characteristics of biology, genetics and functionality. only certain probiotic bacteria are allowed as health food raw materials. the permitted probiotics are the following: bifidobacterium bifidum, bifidobacterium infantis, bifidobacterium longum, bifidobacterium breve, bifidobacterium adolescentis, lactobacillus bulgarius, lactobacillus acidophilus, lactobasillus casei subsp. casei, streptococcus thermophilus. huang – lapsley 2005, 266. if an entrepreneur wants a probiotic to be added on the list, an application to the sfda has to be made. 145 this means health foods using dna or rna as raw material. the purity of dna or rna must be above 80 percent, and the recommended dosage for nuclei health foods should be 0,6g-1,2g per day. huang – lapsley 2005, 266. 146 points 1, 2, and 3 of the notification. 147 wild licorice, saussurea involucrate, xxx and xxx. there is no english word for the latter two. 148 point 4 of the notification. nordic journal of commercial law issue 2009#2 24 first of all, if health foods involve products (or materials) of animals or plants, the number of products (or materials) of animals or plants can not exceed 14. if health foods use products (or materials) that are not listed in the list of materials which are used as either foods or medicines, the number of products or materials of animals or plants can not exceed 4. if health foods use products (or materials) of animals or plants not listed in the list of materials which are used as either foods or medicines and neither in list of materials which can be used in health foods, the number of products (or materials) of animals or plants can not exceed 1. the other way round: if you want to use a material outside both lists, you can only use one. the one cannot be on the third list of forbidden materials. if you want to use materials on the first and the second list, or merely on the second list, you can use four materials altogether. if you can settle with the materials listed in the first list, then you can have 14 materials. normal food materials are not included in this number: it only concerns materials with health effects. category i includes approximately 90 materials, for example hawthorn fruit (fructus crataegi), barbary wolfberry fruit (fructus lycii), lotus leaf (folium nelumbilis), lotus seed (semen nelumbilis), hemp seed (fructus cannabis), ginkgo seed (semen ginkgo), oyster shell (concha ostreae), honey (apis melifera), peppermint (herba menthae), peach seed (semen persicae), and tangerine peel (citrus reticulata).149 some products made of these materials will be classified as traditional medicines. whether a product is a health food or a traditional medicine will depend on functions and marketing claims of the product. category ii includes approximately 110 materials, for example ginseng root, leaf and fruit (radix ginseng, folium ginseng, fructus ginseng), deer embryo (fetus cervi), deer bone (fel cervi), white peony root (radix paeoniae alba), red peony root (radix paeoniae rubra), aloe vera (herba aloe), magnolia flower (flos magnoliae), tortoise shell (carapax et plastrum testudinis), and ginkgo leaf (folium ginkgo).150 category iii includes approximately 60 materials, for example poppy capsule (pericarpium papaveris), quicksilver (mercury), chinese azalea flower (flos rhododendri mollis), lily of the valley grass (herba convallariae majalis), mung bean blister beetle (lytta caraganae pallas), and blowfish (globefish, tetraodontiforms syn. plectognathi).151 149 see complete list by huang – lapsley 2005, 267-269. 150 see complete list by huang – lapsley 2005, 269-272. 151 see complete list by huang – lapsley 2005, 272-274. nordic journal of commercial law issue 2009#2 25 in addition to complying with the lists, the product must pass toxicological safety assessment. there is a ministry of health standard152 establishing requirements for toxicological testing. animal tests requirements vary from no need for toxicological testing to four tiers of tests (tier i: acute toxicity; tier ii: genetic toxicity; tier iii: sub-chronic toxicity; tier iv: chronic toxicity).153 the test requirements depend on the categories of the raw materials. if the product is made of common foods and category i ingredients, and processing and consumption of the food are traditional, no tests are required on raw material of finished products. however, if the product is processed and consumed so that dosage is greater than regular, tests are needed on final products. for foods made of category ii ingredients, tests on the final product are always needed. for those other ingredients that are not common foods nor category i or ii ingredients, tests are always needed both on the raw material and the finished product. the strictest requirements apply if the raw material has no historical human consumption data at all.154 for food supplements that contain authorised vitamins or minerals, there is a special procedure under the health food regulation. they need to get an “approval certificate for health food” prior to production, but clinical tests on safety and efficacy of the vitamin or mineral are not required. the producer still needs to show hygiene, stability, etc. other supplements such as those containing dietary fibres, proteins, or amino acids, are considered common foods where no pre-market control applies. for common foods, health claims are not allowed. if health claims are wanted, the supplement must undergo the whole health food process.155 next, we turn to marketing of health foods. in article 23 of the food hygiene law, misleading advertising of health foods was prohibited. article 51 of the new food safety law states the same rules in new words. the content of the product description shall be accurate. the functions and ingredients of the product shall be identical with the information given in the product description and there shall be no false information. claims that refer to prevention or treatment of disease (medicinal claims) are prohibited on health foods. suitable and unsuitable user groups of the health food must be given, as also the functional ingredients and their content. there is certain mandatory information that must be given to consumers on health foods. according to the health food regulation156, the label and specification of health food must contain the following details: role of the product in health protection, suitable user groups, optimal dosage, storage method, name and quantity of effective components157, order number of health food 152 ministry of health: technical standards for testing and assessment of health food. promulgation date 14 february 2003, effective 1 may 2003. 153 huang – lapsley 2005, 274-275. 154 huang – lapsley 2005, 275. 155 huang – lapsley 2005, 266. 156 article 21. 157 if components of effective function can not be determined under present conditions, names of major raw materials having a health protection function should be listed. nordic journal of commercial law issue 2009#2 26 certificate, and the health food symbol. names of health foods should be accurate, scientific, and should not use names of peoples, names of places, names that are misleading or exaggerating, or names of minor effective components158. there shall be no referrals to therapeutic effects. it is also forbidden to use superstition in health food advertisement.159 it is important to notice that in china, only health foods can bear health claims. regular foods cannot bear health claims. on the other hand, health foods cannot bear medicinal claims. this way the health food regulation separates normal foods from health foods, foodstuffs from medicines, and food advertising from medicine advertising. to make the separate functions clear, health foods must bear the advice: ‘this product cannot substitute any medicine’160. the verb “assist” is now used in 6 health claims. for example, one cannot say that a product lower hypertension; instead it is allowed to say that it assists in hypertension alleviation. this approach is similar to the european rules on health claims: one has to remind the consumer of the lifestyle factors. there are currently 27 possible functions and claims for health foods, with other functions not accepted161. the chinese health claim categories cover many of the important claims that are 158 health food regulation, article 22. 159 health food regulation, article 23. 160 functional ingredients december 2005 china news. available at www.functionalingredientsmag.com. 161 1. enhancing immune function 2. assisting in blood lipids reduction 3. assisting on blood sugar reduction 4. anti-oxidation (delay of aging) 5. assisting in memory improvement 6. reducing eye fatigue 7. facilitating lead excretion 8. thinning throat mucus (moistening of throat) 9. assisting in hypertension (blood pressure) reduction 10. enhancing sleep 11. promoting lactation 12. alleviating physical fatigue 13. enhancing anoxia endurance 14. assisting protection against irradiation hazard 15. weight reduction 16. enhancing child growth and development 17. increasing bone density 18. alleviating nutritional anemia 19. assisting in protection against liver chemical injury 20. alleviating acne 21. eliminating skin pigmentation 22. improving skin moisture 23. improving skin oil content 24. regulating gastrointestinal flora 25. facilitating digestion 26. alleviating constipation 27. assisting in protection against gastric mucosa injury. ministry of health notification 2003, point a. nordic journal of commercial law issue 2009#2 27 interesting to functional food developers. the ministry of health revised the procedures for efficacy evaluation in 2003, when the current list of 27 functions/claims came into force. cosmetic claims were separated into four different claims instead of just one. similarly, gut health claims were separated into four different claims.162 two important claim types are prohibited: claims related to cancer, and claims related to sexual functions. it is not possible to market an all-purpose health food: a health food with same recipe is not allowed to apply for more than two functions.163 the list of allowed claims would not give much guidance without rules on scientific substantiation of the claims. according to the current rules on health food efficacy, animal trials are required for 22 of the 27 claims.164 human feeding trials are now required for 20 claim categories165. if both animal and human tests are required, human tests are done after getting a positive result with animal tests. before a human feeding trial can be started, it must receive approval from an ethical committee. the regulations do not give precise requirements on how effective a product must be. similarly to the european rules on claims, the regulations only give the scientific criteria that are used in the evaluation of the application. whether the product is effective enough is a question that the sfda will have to evaluate on a case by case basis. in 2002, 60 percent of so far authorised health foods were focused on three functions: immune regulation, regulating blood pressure, and anti-fatigue. health foods were not often in regular food form, instead they were primarily in the form of oral liquid, capsule, tablet, or powder. it is noteworthy, that in about 90 percent of health foods, the active ingredients of the products were related to traditional chinese medicine.166 today, also other types of health foods are emerging, for example probiotic products are gaining interest. in 2002, 90 percent of health foods were marketed by chinese companies, 10 percent were imported167. 162 huang – lapsley 2005, 264. 163 ministry of health notification 2003, points b and c. animal trials are not required for claims on: alleviating eye fatigue, and cosmetic claims: alleviating acne, eliminating skin pigmentation, improving skin moisture, and improving skin oil content 164 huang – lapsley 2005, 277-281. 165 human trials are not required for claims on: enhancing immune function, enhancing sleep, alleviating physical fatigue, enhancing anoxia endurance, assisting in protection against irradiative hazard, increasing bone density, and assisting in protection against liver chemical injury. huang – lapsley 2005, 277-281. 166 wang et al. 2003. 167 huang – lapsley 2005, 263. nordic journal of commercial law issue 2009#2 28 2.5 structure of medicine law the basic chinese law on medicines is the medicine administration law along with its implementing regulations. the law itself was enacted by the national people’s congress in 2001, and the implementing regulations were given by the state council in 2002. more detailed information on what is required is to be found in the ‘registration measures’ given by the sfda in 2007168. similarly to the regulation of foodstuffs, the basic laws on medicines are complemented by several pieces of administrative regulations given by the sfda. this material could be defined as soft law as it is given by the sfda or its predecessor, the sda. the sfda has an important role as a formulator of laws and administrative regulations on medicines. the regulations include rules on manufacturing licences, certification for good manufacturing practice, good clinical practice, good supply practice, distribution, labelling and packaging, advertising, pricing, import-export, etc. medicine marketing was in 2007 regulated in a stricter and more detailed manner because of the problems and scandals related to false advertising. medicine advertising is under pre-market control. in china, there are basically two different kinds of medicinal products on the market: modern medicines and traditional chinese medicines. as regards modern medicines, there are general standards, and specific standards for narcotics, psychotropic substances, toxic drugs for medicinal use, and radioactive medicines169. the specific standards shall not be discussed here. traditional chinese medicine (tcm) remains a recognised and valued source of treatment170. a separate law on scientific evaluation of traditional medicines is also on the way, as the chinese intend to be a global leader in bringing herbal medicine into the 21st century by establishing modern standards. the law has not been accepted yet, because it has caused controversy. local government authorities have enacted their own medicine regulations which may supplement and modify some of the national regulations. local rules exist particularly on labelling. the chinese rules on medicine marketing of 2007 aim to clean up medicine advertising mainly by two means: defining the prohibited marketing methods more precisely, and hardening punishments. 168 the sfda promulgated the latest “measures for the administration of drug registration” on july 10 2007, and they entered into force in october 1, 2007. 169 based on medicine administration law, article 35. 170 china-britain business council. china-britain business review archive. nordic journal of commercial law issue 2009#2 29 the 2007 rules on therapeutic claims are the same for modern and traditional medicines.171 there are no special categories for medicines without proven therapeutic efficacy. however, the scientific criteria for efficacy of traditional medicines are not yet legally established. 2.6 law on modern medicine in the past few years, china has significantly modernized its legislation on medicines, in order to guarantee their safety, efficacy, and quality. china has simultaneously enhanced intellectual property protection, which is particularly important to the medicine industry.172 the chinese rules on medicines currently resembles for example the eu rules. compared to food safety, medicine safety is more relative to the efficacy of the product, whereas food safety is more of an absolute requirement, the risk/benefit ratio is applied to medicines. all effective medicines have some side-effects and should only be used if needed. 173 medicine safety is guaranteed by strict procedures on tests and trials, scientific risk assessment, pharmacovigilance, and by comprehensive user information. with herbal medicines, safety assessment is affected by nature: the plants vary as to where they grow. the central government authority responsible for medicine control is the state food and drug administration. a new medicine can be put into production only after the sfda has approved it and issued a registered document of approval174. a new medicine which has completed its clinical tests and been approved after appraisal shall be issued a certificate of new medicine by the sfda175. 171 according to the new chinese standards and measures on medicine advertising (2007), claims on the curative effects of medicines in advertisements must be scientific and accurate and may not contain any of the following content: unscientific assertion or guarantee of efficacy; claims of curative rate or efficiency; comparison of effects and safety with other medicines; explicit or implicit suggestion that the drug can heal all diseases and is good for all symptoms in contravention of the rules of science; suggestion that the medicine is "safe with no toxic side-effect" or has "very little toxic side-effect"; for proprietary chinese medicine, explicit or implicit suggestion that it is "natural" and guaranteed safe; explicit or implicit suggestion that the medicine is essential for normal daily life and for the treatment of diseases; explicit or implicit suggestion that the medicine can help one cope with the tension of modern life, studies or examination, and can help boost academic performance, energy, competitiveness, height and intelligence; other unscientific terms or suggestions such as "the latest technology", "state-of-the-art science" and "the most advanced methods of preparation". 172 tsoi 2007. 173 kwak – jukes 2000a, 105. 174 medicine administration law, article 31. 175 medicine administration law, article 29. nordic journal of commercial law issue 2009#2 30 production and sale of fake medicines is prohibited176. production and sale of medicines of inferior quality is prohibited. this refers to medicines whose components do not conform to state pharmaceutical standards.177 these standards are the "pharmacopoeia of the people's republic of china" and the pharmaceutical standards promulgated by the sfda.178 import of medicines whose curative effects are uncertain or poor, or which produce adverse reactions or have other harmful effects on people's health is prohibited179. 2.7 law on traditional chinese medicine traditional chinese medicine is an ancient chinese system of medicine that includes meditation, herbal and nutritional therapy, restorative physical exercises and massage, and acupuncture180. here we are mainly interested in herbal medicines181. medicines of plant origin form the main part of traditional chinese medicine. their species, habitat, collection season, collection method, and storage are thus important factors determining their quality and efficacy. for example, some plants need to be collected when flowers are in full bloom, others when flowers are still in bud. medicines from fruits are usually collected when the fruits are ripe, medicines from roots in late autumn or spring, and medicines from bark in early summer.182 beginning in the 1920’s, traditional chinese medicines have been investigated in terms of modern medical science. chemical ingredients and fractions have been isolated from herbs, 176 a fake medicine has any one of the following characteristics: (1) its components do not comply with state pharmaceutical standards. (2) a non-medical substance is passed off as a medicine, or one medicine is passed off as another. a medicine is legally a fake medicine in any of the following cases: (1) where the use of the medicine has been prohibited by the sfda; (2) where the medicine is produced and imported without a legal approval or sold without being inspected according to the law; (3) where the medicine has deteriorated; (4) where the medicine has been contaminated; (5) where the medicine has been produced of medicinal materials without obtaining a registration document of approval for the materials. (6) where the indications or the functions marked on the label do not fall within the prescribed scope. medicine administration law, article 48. 177a medicine shall be handled as medicine of inferior quality also in any of the following cases: (1) an expiry date is not indicated or is altered; or (2) a registration number is not indicated or is altered; or (3) the medicine has passed its expiration date; or (4) the packages and containers which have direct contact with pharmaceuticals have not obtained approval; or (5) the medicine has been added presumptuously with colour or preservative additives, spice, disguising odour or supplementary materials; or (6) the medicine fails to meet the prescribed standards in other respects. medicine administration law, article 49. 178 medicine administration law, article 32. 179 medicine administration law, article 38. 180 spondylitis association of america. web page at: http://www.spondylitis.org/patient_resources/glossary.aspx. 181 according to a survey from a few years ago, the number of traditional chinese medicines is close to 13 000. of these, over 11 000 are of plant origin; the rest are animal or mineral origin. this means traditional chinese medicine often means herbal medicine. the essentials of traditional chinese herbal medicine 2003, 1. 182 the essentials of traditional chinese herbal medicine 2003, 3. nordic journal of commercial law issue 2009#2 31 and their actions studied. since the 1950’s, the chinese government has paid a lot of attention to the development of traditional chinese medicine. colleges focused on the subject have been established in every province and autonomous region, hospitals and research institutes have been set up at national, provincial, municipal and even county level. new chemical ingredients are isolated. new forms of herbal remedies are instant powders, tablets, injections and capsules.183 herbal medicines are processed before being taken as medicines. sometimes the purpose of processing is increasing potency, and hence effectiveness. sometimes it is minimizing or eliminating side effects or toxicity. sometimes processing makes drugs easier to prepare or store. methods of processing can be divided into physical processing, liquid processing, fire processing and processing by both water and fire. side effects are often reduced by boiling or steaming.184 diseases are classified into two major categories: cold and hot. medicines to counteract these diseases are either cool, cold, warm or hot. in terms of yin and yang, cool and cold belong to yin, and warm and hot belong to yang. hot diseases are ones where body temperature, blood pressure, respiratory rate, and salive secretion are high. cold diseases are the opposite. hot diseases are treated with cold medicines and the other way around. hot or warm medicines stimulate the central nervous system, promote the metabolid system and so on. cold and cool medicines tranquilize, sedate, and have anti-microbial and anti-inflammatory actions.185 the taste of a medicine is related to its therapeutic capability.186 in terms of safety or toxicity, traditional chinese medicines can be classified as non-toxic, slightly toxic, moderately toxic and extremely toxic. even some extremely toxic herbs thus have their medical uses. according to ancient literature, it is stated that no medicine is non-toxic if taken in excessive doses or for too long a period of time. when using traditional chinese medicines, the properties, actions and toxicity are weighed against one another. medicines are chosen according to the syndrome, and the doctor must look at the situation as a whole. 187 dosage and method and time of administration are determined simultaneously188. for mild diseases and for children and other weak persons, dosage is smaller189. when discussing medicine safety, interactions of substances have to be taken into account. this includes medicine-medicine interactions and medicine-food interactions. 183 the essentials of traditional chinese herbal medicine 2003, 2. 184 the essentials of traditional chinese herbal medicine 2003, 4-5. 185 the essentials of traditional chinese herbal medicine 2003, 5-6. 186 the essentials of traditional chinese herbal medicine 2003, 6. 187 the essentials of traditional chinese herbal medicine 2003, 8. 188 the essentials of traditional chinese herbal medicine 2003, 10-11. 189 the essentials of traditional chinese herbal medicine 2003, 10. nordic journal of commercial law issue 2009#2 32 in clinical practice, traditional chinese medical doctors usually prescribe around ten or more herbs to make the best possible mixture in each individual case of symptoms. the medicines in a mixture can be classifed into four categories: the principal medicine(s) provides the principal curative action, the adjuvant medicine(s) strengthens this action and treats secondary symproms, the auxiliary or correctant medicine(s) relieves secondary symptoms or tempers the action of the principal medicine, the conductant medicine(s) directs the action to the right part in the body.190 medicines in a prescription can either reinforce each other, weaken each other, neutralize side effects of each other, counteract each other (resulting in no therapeutic action), or are totally incompatible, where two medicines put together will result in enhanced side effects or toxicity.191 there are lists of counteracting and incompatible medicines available to doctors. there are eighteen incompatible medicaments and nineteen medicaments of mutual restraint. for example, if radix veratri nigri (lilu) is put together with radix ginseng, there will be serious side effects. if radix ginseng is put together with faeces trogopterorum (wulingzhi), ginseng neutralizes the effect of trogopterum. the mechanisms of these actions are not clear.192 as there are 11 000 medicinal herbs in use, and only a couple of dozen are mentioned in the above mentioned incompatibility list, it is evident that a lot more research is needed on herbal interactions. there is also a list of herbs that should not be used during pregnancy, as they might harm the fetus or cause abortion. drugs that are prohibited or should be used with great caution during pregnancy are those that have a drastic action or are very toxic. these are for example flos genkwa and radix euphorbiae pekinensis. also drugs that are very warm or purgative should be avoided.193 there are also guidelines on unwanted medicine-food interactions. uncooked or cold food is not suitable for a person suffering a cold syndrome. hot and greasy food is not suitable for persons with a hot syndrome: for example no chillies for insomniacs. some medicaments do not work well together with for example chinese green onion, garlic and radish. peppermint counteracts turtle flesh, honey counteracts scallions, and so on.194 after discussing the tradition of traditional medicine, we will now turn to law on traditional medicine. in china, traditional chinese medicine is under the administration of state administration of traditional chinese medicine and pharmacology, which is under the ministry of health. national strategies, laws and regulations governing traditional chinese 190 the essentials of traditional chinese herbal medicine 2003, 8-9. 191 the essentials of traditional chinese herbal medicine 2003, 9. 192 the essentials of traditional chinese herbal medicine 2003, 9. 193 the essentials of traditional chinese herbal medicine 2003, 9. 194 the essentials of traditional chinese herbal medicine 2003, 9. nordic journal of commercial law issue 2009#2 33 medicine are in place to guide and promote the research and development in the industry.195 also the ministry of science and technology has initiated a program that has ambitious goals related to traditional chinese medicine. they have a program called “international traditional chinese medicine program for cooperation in science and technology”. the aim is to facilitate integration of traditional medicine with western medicine all over the world. according to of the chinese medicine administration law196, “the state shall develop both modern and traditional medicines and encourage their role in the prevention and treatment of diseases and in health care”. further, “the state shall protect the resources of wild medicinal resources and encourage the domestic cultivation of chinese traditional medicinal crops”.197 traditional medicine is given clearly more weight compared to the european law on medicines. the national regulations on traditional chinese medicine have been effective as of october 2003198. these regulations do not specify rules on safety, efficacy and marketing of traditional medicines. instead, the regulations are focused more on attitudes towards and roles of traditional medicine. the objectives of the regulations include: the development of the science of traditional chinese medicine, the promotion of the development of undertakings engaged in traditional chinese medicine, and the protection of public health.199 the regulations apply to institutions and individuals engaged in healthcare involving traditional chinese medicines, as well as to education, research and international cooperation related to the subject. the objectives of the state are to protect, support, and develop traditional chinese medicine. the aim is to lay equal stress on traditional chinese medicine and western medicine and encourage development and integration of both schools.200 as stated above, the regulations on traditional chinese medicine do not include criteria on product safety, efficacy and marketing. product development, production, marketing, use, 195 chinese symbols web page. http://www.chinese-symbols.com/chinese-medicine/chinese-medicine.html. 196 the medicine administration law of the people's republic of china, revised at the twentieth meeting of the standing committee of the ninth national people's congress on february 28, 2000. the revised law entered into force as of december 1, 2001. 197 article 3. 198 regulations of the people's republic of china on traditional chinese medicine. adopted at the third executive meeting of the state council on 2 april 2003. promulgated by decree no. 374 of the state council of the people's republic of china on 7 april 2003. (gazette of the state council of the people's republic of china, 30 may 2003, issue no. 15, serial no. 1086.) 199 summary of the chinese regulations on traditional chinese medicines by who’s “international digest of health legislation”. available on the who web page at: http://www.who.int/idhl-rils/frame.cfm?language=english. 200 summary of the chinese regulations on traditional chinese medicines by who’s “international digest of health legislation”. available on the who web page at: http://www.who.int/idhl-rils/frame.cfm?language=english. nordic journal of commercial law issue 2009#2 34 supervision, and administration with respect to traditional chinese medicines must comply with the medicine administration law of the people's republic of china. it is stated in article 6, that the preparation of chinese medicines shall be in accordance with the "pharmacopoeia of the people's republic of china", or in accordance with the "preparation standards" laid down by the department administering health in that province, autonomous region or municipality under the direct control of the central government. many of the safety problems with traditional chinese medicines are due to poor quality. this means the plant itself might be safe, but due to heavy metal contamination or adulteration with prescription drugs, the product is dangerous. there may also be quantitative variations in constituents, which affects safe use of the product.201 a regulation on good agricultural practice of traditional chinese medicines exists since 2002. this regulation is interim and given by the sda, the predecessor of the sfda. as stated above, the law does not specify criteria on traditional medicines yet. the safety of traditional medicines is guaranteed by the traditional guidelines described above. in the beginning of 2007, the chinese ministry of health completed the drafting of law on traditional chinese medicine, which was submitted to the state council. the drafting of the law had drawn considerable attention from the national people's congress (npc) and government departments.202 the goal of the chinese government is to strengthen supervision on the sources of chinese medicines, improve the administrative system for good chinese medicine production practice (gcmp), push forward the implementation of gcmp and ensure the production quality of chinese herbal medicines.203 improving the legal framework on traditional medicine is among the important goals set by the chinese government for the next few years. the goal is to establish and improve a system of chinese traditional medicine standards. a comprehensive classification system of chinese medicine is needed. technical pre-market evaluation criteria shall be set, followed with postmarket control criteria. to strengthen the knowledge base, research guiding principles of reference materials will be formulated, and a chinese medicine library for standard materials will be established. china will actively advocate for the establishment of international standards for traditional medicines.204 201 barnes 2003. 202 people’s daily online. january 17 2007. available at: http://english.people.com.cn/200701/14/eng20070114_341062.html 203 five-year plan for food and drug safety. april 2007. page 12. 204 five-year plan for food and drug safety. april 2007. pages 12-13. nordic journal of commercial law issue 2009#2 35 iii. conclusions china has in recent years created and considerably strengthened its food and medicine legislation. this process was related to china’s entry to the wto in 2001. the new food safety law focuses on implementation and control, and the strict 2007 rules aim to clean up medicine advertising. as regards functional food products, the health food regulation was important in setting common national rules. the proposed national law on traditional herbal medicines will strengthen patient confidence in china, and also promote acceptance of herbal medicine in foreign countries. the problem is not with legislation: china must now focus on the execution of laws, and particularly at the local level. independent agencies such as the sfda are valuable in resolving scientific issues based on science, not politics. scientific risk assessments and issuance of scientific guidelines are the most suitable tasks for foodstuff and medicine agencies. if the sfda is to perform impartial risk assessments based on science, its independence from political actors must be guaranteed. the chinese government has in food hygiene issues promoted self-regulation and regulation by consumer organisations. the chinese are also campaigning to make consumers more responsible in food safety issues. although important, these approaches will not suffice. because it is an enormous task in china to officially control the whole food chain, the government wishes the food business operators and consumers could manage by themselves. in our opinion, foodstuffs and medicines are way too important for the government to step aside. self-regulation has proven useful in certain minor questions where the industry as a whole is motivated in following common rules that often supplement hard-law norms. even though chinese legal rules and institutions are more and more similar to the western ones, legal culture will change slowly205. the chinese tend to trust neither the law nor the companies. in china, the difference between legal system surface and legal reality is a wider cultural phenomenon. it is related to the notion of ‘rule by man’, the reliance to family and friends in the first place, and the confusian principle of conflict avoidance. in the chinese legal culture, the administrator long had all the (imperial) power. the ‘rule by man’ tradition runs counter to rule of law. the separation of powers is new to the chinese. reliance to social connections, guanxi, is deeply rooted and also runs counter to the establishment of rule of law206. legal culture, including consumer trust in regulation, is not a stable phenomenon but changes through time. the roles of governments and other governance regimes are constantly in flux. consumers will have to learn the most basic assumptions on a given legal culture: 205 according to jones, chinese legal system may some day be what it now is on paper. he suspects this will not happen soon, if ever. he thinks the surface will be similar to western legal systems, but the legal culture will continue to be influenced by history. jones 2003, 40. 206 kubayashi 2008, 6. nordic journal of commercial law issue 2009#2 36 what can be expected of regulators, what can be expected of companies, and what is under their own responsibility. from consumer viewpoint, there is not a big difference between who regulates the companies: whether it is governmental bodies or non-governmental bodies. from business viewpoint, there is a difference between law, co-regulation and self-regulation. as the scope of business law widens, the room for business ethics becomes narrower. and vice versa: if business ethics is highly developed, law is supposedly not needed. confucius relied on moral rather than legal rules; now rule of law is gaining importance in china. reverting to legal proceedings is new in china and something that confucius wanted to avoid. in china, legal institutions are needed because of the transition from planned economy to market ecocomy. this transition is not complete, which makes it difficult for the chinese and others to know the roles of state vs. markets in china207. according to qingjiang, there is no turning back china's progress into a market-oriented economy and rule-based society208. at the same time, rule of law is being discussed in europe, as legislation is increasingly replaced by co-regulation, standards, and self-regulation. a new understanding of law is emerging. this means that when china accepts rule of law, rule of law might not be the same anymore. references official sources chinese legislation 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(zhao 1996.) contracts, risks and management = contractual risk management nordic journal of commercial law issue 2012#2 treaty conflicts in investment arbitration by ahmad ali ghouri review by stephan schill* * dr. stephan schill of max planck-institut für ausländisches öffentliches recht und völkerrecht appointed opponent by the faculty of law at the university of turku. final report on the doctoral thesis by candidate ahmad ali ghouri. nordic journal of commercial law issue 2012#2 1 i. international investment law and investment arbitration are becoming increasingly important in a global market economy. what is critical in cases of foreign investment is that foreign investors place their investment, a factory being built abroad, or a big infrastructure project, under the control of a foreign law and the sovereignty of a foreign state, whose administration, courts, and legislator may not always be docile vis-à-vis foreigners and may not always offer comparable domestic institutions and safeguards to the ones the investor is used to from home. in the worst case, a foreign government may even expropriate foreign investors without compensating them. to mitigate this political risk and to offer independent dispute settlement in the relations between foreign investors and host states is the object and purpose of international investment law and investment arbitration. in fact, international investment law has grown tremendously over the past two decades with now more than 3,000 international investment treaties in place and more than 450 disputes that have ensued under these treaties. the european commission, for example, considers international investment law as the “new frontier for the common commercial policy” (com(2010)343 final (7 july 2010) at 2). what is more, international investment law is not only of relevance to protect our investors abroad; it also protects foreign investors at home and restricts our governments in their executive, legislative, and judicial activities and binds them to the substantive standards contained in international investment agreements. these standards, on top, are critically vague and amiguous in requiring “fair and equitable treatment”, “full protection and security”, protection against “mesaures tantamount to expropriation”, “national treatment”, “mostfavored-nation treatment”, etc. these standards have sometimes been interpreted very broadly by investment treaty tribunals and investors are creative in bringing claims against a large number of host state measures that go to the heart of how a political community intends to order its public affairs. germany, to take an example, is now facing a claim under the energy charter treaty in connection with its nuclear power phase out; in australia and uruguay, philipp morris is challenging legislation on tobacco labeling by arguing that plain-packaging, or extreme health-warnings, constitute unfair and inequitable treatment and an expropriation, thus demanding millions in damages. it therefore comes as no surprise that there is now wide-spread criticim of this branch of international law because it puts fundamental values of constitutional law in question, when foreigners are allowed to settle disputes in by-passing domestic courts, in demanding protection against the application of domestic law, and when arbitrators interpret the vague standards in nordic journal of commercial law issue 2012#2 2 international investment treaties in a creative fashion without having a democratic mandate as law-makers. in addition, arbitral tribunals are not interpreting investment treaties in a uniform manner but create an increasing number of inconsistent decisions, not only when it comes to irreconcilable interpretations of one and the same treaty standard, but even with contradicting decisions on identical questions of fact. states, non-governmental organizations, and international organizations start to react, by withdrawing from international investment treaties or by changing their content so as to ensure more transparency and that states have sufficient space to pursue policies to serve and protect public interests. in addition, writings on international investment law constitute one of the growth areas in th literature on international law and dispute settlement, making it increasingly difficult to navigate the field. ii. in this maze of literature, ahmad ali ghouri makes his voice heard. his thesis on “treaty conflicts in investment arbitration” goes to the heart of the debate about the legitimacy of international investent law and investment arbitration and about the relationship between investment protection and the protection of non-investment concerns, such as the protection of the environment or human rights. in his thesis, which consists of a summarizing chapter that sets out the problématique, the methodology used, and the solutions reached, and five already published articles, mr. ghouri assesses one of the core problems arising in international investment law, namely the conflicts that international investment treaties may create with other international agreements and how these conflicts should be resolved. this topic is so important because investment treaties are primarily bilateral and single issue treaties that do not clarify how they relate to international agreements that protect interests that may compete with those of foreign investors. tensions exist, inter alia, between international investment law and other branches of international law, such as human rights, international environmental law, and eu law. these tensions are exacerbated by the apparantly fragmented nature of international investment law as a law governed by several thousand bilateral treaties. ultimately, the problems of fragmentation may put the legitimacy of international investment treaties and investor-state arbitration into question because they may result not only in incompatible results but also in an overemphasis on investment protection to the detriment of competing concerns. differently from other authors that criticize international investment law fundamentally and advocate for institutional change, mr. ghouri proposes, as a solution to the fragmentation nordic journal of commercial law issue 2012#2 3 problem, to go back to the principles of general international law relating to international treaties and to the law of sources. he does not attempt a “reconceptualization of international legal obligations, but [an] elaborati[on of] the implications for states and foreign investors of other international obligations arising from non-investment treaties.”1 he stresses that international investment law cannot be seen in isolation from the rest of international law, that principles of treaty interpretation mandate taking into account other international legal obligations under article 31(3)(c) of the vienna convention on the law of treaties, and that investor-state arbitral tribunals should make use of balancing as an interpretative technique to deal with conflicting rights and interests under different international treaties. balancing is necessary, in mr. ghouri’s view, because the rules of the vienna convention often do not provide clear or satisfactory answers on which of two treaties shall prevail in the circumstances of a case, primarily because the content of investment treaties consists largely of principles not of precise rules, that could be overwritten by a later rule to the contrary. accordingly, this “requires tribunals to realign their interpretative methodologies and practices in order to establish investor-state arbitration as a legitimate system of rights adjudication.”2 furthermore, for mr. ghouri, treaty conflicts are essentially value conflicts that require decision-makers to engage in balancing and establish ad hoc hierarchies among competing values.3 iii. cumulative theses are still an unusual format for a doctoral dissertation in law, where the classical format of writing a monograph still prevails. this is different from other fields in the natural sciences, but also empirical social sciences, and economics, where article dissertations are becoming more and more common. this raises the question as to the standards to be applied to an article dissertation in law, in particular as regards the coherence of the articles submitted. as regards quality, by contrast, it is clear that no difference can exist as compared to a classical monograph, in terms of novelty of ideas, quality of the research, methodology used, 1 see ahmad ali ghouri, treaty conflict in investment arbitration (2012) 6. 2 ibid. 3 see, in particular, ahmad ali ghouri, ‘determining hierarchy between conflicting treaties: are there vertical rules in the horizontal system’, 2 asian. j. int’l l. 235 (2012). nordic journal of commercial law issue 2012#2 4 originality in the planning and execution of the research, mastery of the field of research, and familiarity with the relevant literature, as well as the manner of presentation and style. in my view, it is appropriate to analyze, in a first step, each submitted article separately (with the important caveat that the examination of the thesis is not bound by the decision of even a peer-reviewed journal to have published any of the articles in question), and in a second step to examine the introduction of the thesis that embeds the articles into a larger research framework, describes and analyzes the overarching problems fueling the research, draws connections between the articles, reflects on the methodology and audience of the research, fills gaps that may exist when solely looking at the articles alone, and draws conclusions flowing from the cumulated research undertaken in the separate articles. in this process, minor overlaps between the submitted articles, as well as gaps between articles, will have to be disregarded in examining the thesis, because the nature of an article-by-article dissertation requires that every piece can function as a self-standing article. iv. mr. ghouri lays out his thesis in the summarizing introduction and five attached articles. he builds up his analysis by analyzing in article 1 how the investment arbitration system has evolved, in articles 1, 2, and 3 what the normative functions of investment treaties are, in articles 2 and 3 the policy options for arbitral tribunals to address legitimacy concerns in investment arbitration, in particular as regards balancing between competing rights and interests, and in articles 4 and 5 the relationship between investment treaties and other systems of international law and the question whether there is a hierarchy between them. article 1 is an accurate analysis of the historic development of international investment law which shows both the multitude of arbitral institutions (including varying arbitral rules) and the multitude of treaties involved in this regime. mr. ghouri also shows, by briefly addressing wto law, that there is no uniform international economic legal regime. article 1 is a largely descriptive piece that unfortunately provides no specific angle on the historic development. it is also not entirely clear why he chose to focus on the overlaps between investment and trade law and not overlaps with other legal regimes. while this article is not original in the arguments it brings, it serves the purpose of elucidating the framework in which treaty conflicts play out in international investment law and provides an impeccable analysis of treaty practice and institutions. this is the kind of chapter that would also figure in a nordic journal of commercial law issue 2012#2 5 monograph thesis as one of the introductory chapters. it is very well written and concise in introducing readers into the history and functioning of international investment law. article 2 is a shorter piece that offers solutions to how to counter the problem of internal fragmentation in international investment law and external fragmentation in relation to other international legal regimes by introducing the notion of international investment law and arbitration as a “collective value system”. this provides an overarching framework within which to develop investment law and its relations to other regimes. while the focus of article 2 is on the question of whether investment law constitutes a system, it does not well develop how this system brings to bear collective values and how the notion of investment law as a “collective value system” can be used to resolve treaty conflicts. article 2 therefore introduces a strong concept and illustrates mr. ghouri sense for innovation in doctrinal reconstruction but falls short of explaining the implications of this concept in the article itself. the concept, in connection with the idea, that investment treaty tribunals are bound to live up to the requirements of international justice, however, is picked up in the introductory chapter and further explained. as a self-standing piece, article 2 leaves too many questions open. yet, its strength is the vision it develops for international investment law and investment treaty arbitration. article 3 analyzes the structure and nature of investment treaty obligations and contains an interesting analysis of different ways to conceptualize investment treaties (as sovereign acts, sovereign contracts, sovereign decrees, and special laws). it provides an intriguing normtheoretic background to problems of conflicts between investment treaties and competing rights and interests. in addition, article 3 sensibly introduces the notion of balancing as a concept to resolve conflicts of competing rights and interests. what is highly original and innovative in this context, is how mr. ghouri develops balancing against the norm-theoretic background of the nature of investment treaties. this has not been done in this fashion before. on the downside, article 3 does not further develop the contours of the concept of balancing clearly, nor does mr. ghouri address how this method has played, will play out, and should play out in arbitral jurisprudence. in fact, there is are several arbitral decisions that engage in balancing but that are not further discussed in article 3, such as tecmed v. mexico or saluka v. czech republic. in addition, mr. ghouri could have drawn on the existing literature on balancing and proportionality analysis in investment arbitration, for example, by stone sweet, investor-state arbitration: proportionality’s new frontier, 4(1) law and ethics of human rights 47 (2010) and kingsbury/schill, investor-state arbitration as governance: fair and equitable treatment, proportionality and the emerging global administrative law, iilj working paper 2009/6. nordic journal of commercial law issue 2012#2 6 moreover, what could have been added as a further conceptualization of investment law is the view of investment law as a public law discipline, in particular as mr. ghouri states at the beginning of article 3 that there is a certain “parallelism” between international investment law and domestic public law. article 4 addresses the rules on conflicts under the vienna convention on the law of treaties and suggests that they are insufficient to deal with the roblems in international investment law regrading treaty conflicts. furthermore, in an insightful way and with strong arguments that also critically reflect on positions taken by martti koskenniemi and jean d’aspremont, mr. ghouri explains that at the heart of conflicts of treaties are conflicts of values and hence that a formal view on the problem will fall short of providing convincing solutions. article 4 is a very ambitious and engaged piece that moves beyond the kelsenian view on treaty conflicts and that mandates international lawyers to look beyond the positivistic form and to deal with values. this is, in my view, the strongest and most insightful piece among the articles forming part of the dissertation; it shows mr. ghouri’s mastery of the theoretical debates in international law. it is highly original and argues that international lawyers need to look at the societal values behind legal rules, in particular when there are conflicts between rules and values. somewhat surprisingly, article 4 does not address article 31(3)(c) of the vienna convention and remains silent on how international courts and tribunals, in particular in the investment context, should determine hierarchy between values concretely and on what basis. in addition, in the context of the whole thesis, the connection to investment law remains could have been made clearer. article 5, finally, addresses the conflict between bits and eu law. this chapter is insightful for the topic of treaty conflicts because it shows different conflict solutions techniques as applied in the eu context (namely ex-article 307 ec) and under the vienna convention. this shows how treaty-makers can address conflicts and thereby avoid unpredictable solutions in dispute settlement. this piece contains convincing legal arguments and doctrinal construction in the field of eu external relations law. when published, in november 2010, it was at the heigths of the debate at the time. the further developments in the field of eu investment policy have added additional debates, policy papers, and arbitral and court decisions. notwithstanding, article 5 even today is an instructive read because the conflict issues it discusses are expounded in a most clear manner. nordic journal of commercial law issue 2012#2 7 in terms of quality, legal craftmanship, mastery of literature, and originality of ideas, the five articles taken together are all worthy of being included in an article-by-article dissertation and attest to the qualities needed for being awarded a doctorate in law. v. the introduction of the thesis finally sets the themes that overarch the individual articles. here, mr. ghouri introduces the central problem of treaty conflicts and its importance for the legitimacy of the system. he also sets out his core argument that the treaty conflict problems in investment arbitration can be resolved based on existing positive law, in particular the methods of treaty interpretation and the principle of systemic integration contained in the vienna convention on the law of treaties. this is all done is a clear and analytically strong fashion and with convincing arguments regarding the solution mr. ghouri proposes to use to deal with treaty conflicts in investment treaty arbitration. there are only a few critical points, i would like to mention. first, what could have been developed more clearly, in my view, is the concept of conflict. at times, mr. ghouri seems to focus on hard conflicts, meaning the inability to meet two international legal obligations at the same time; but more centrally he distinguishes between explanatory and supervisory crossfertilisation which does not necessarily involve conflicts but cross-fertilisation and partly is not about the conflict of treaties, but the conflict of different decision-making institutions (as is the case with the review by the british columbia supreme court of the metalclad arbitration), or the conflict of different objects and purposes (for example as regards the notion of “investment” in bilateral investment treaties and the icsid convention in section iii of the introduction). likewise, mr. ghouri does not only focus on conflicts between international treaties but on interactions between competing interests and treaties more generally. one sometimes wonders therefore whether treaty conflict is the central concept or whether mr. ghouri is not more interested in cross-fertilisation. why the concept of conflict was used, i suspect, is that it connects better to the current debate in international investment law, and more generally the fascination of lawyers with conflicts rather than harmony. in that perspective, the use of the conflict terminology is a clever way to market ideas and solutions, such as balancing in the present context. second, how balancing between investment and non-investment concerns can and should work, and how it actually already works in arbitral jurisprudence could have been addressed in more depth. this refers above all to the now quite wide-spread use by investment nordic journal of commercial law issue 2012#2 8 treaty tribunals of the concept of proportionality to balance investment protection and competing interests in the context of applying the concept of indirect expropriation or the fair and equitable treatment standard. the practice that already exists makes one wonder about mr. ghouri’s argument that investor-state arbitral tribunals need to “realign” their jurisprudence. as an argument for that need he refers mainly to cases from the first years of investment treaty jurisprudence, including above all metalclad v. mexico and santa elena v. costa rica. but one wonders if these cases and their interpretative methodology have not been labor pains of investment treaty arbitration and have now been overhauled by much more sophisticated interpretative methodology that include balancing and proportionality analysis. it is for this reason, that the reader is sometimes unclear whether there are any more recent cases in arbitral jurisprudence mr. ghouri targets when he says that “investor-state tribunals … fall short on their determination of applicable international law to resolve treaty conflicts” (p. 73). finally, mr. ghouri rightly analyzes the problem of conflicts between treaties (and competing interests more generally) as value conflicts and advocates that resolving such conflicts requires the development of spontaneous value hierarchies. yet, mr. ghouri does not develop on which grounds arbitral tribunals should accord higher value to one and not the other value. who decides, and on what basis, which value prevails in a given situation of conflict? and how does this work in an international community where universal values are regularly cast into doubt? this problem would have merited further analysis. vi. notwithstanding these critical points, the articles as well as the introduction are very well written, clearly structured, and extensively referenced. they show good familiarity with international law and international economic law more generally and an intimate familiarity with the law, practice, and scholarship on international investment law. they also show mr. ghouri’s ability to apply the scientific methods of international legal research independently, in particular as regards the analysis of arbitral jurisprudence and treaty practice and the doctrinal reconstruction of the field. he also sets innovative accents in how he deals with treaty conflicts in international investment law by proposing new conceptual and methodological approaches for investment treaty tribunals and treaty-makers. his work reflects critically on existing practice and scholarship and advances the thinking about international investment law and arbitration. the thesis and the suggestions that ahmad ali ghouri makes are important and timely. he aims at guiding decision-makers in how to deal with conflicts of interests and conflicts of nordic journal of commercial law issue 2012#2 9 treaties on the basis of positive international law. it is therefore an important contribution to one of the pressing debates in international economic law and international dispute resolution. above all, mr. ghouri’s thesis is strong and visionary in developing concepts for the future development of international investment law. this is particularly the case with concepts such as his idea that international investment law and its relationship with other international legal regimes can be reconceptualized as a “collective value system” and that a guidepost for arbitral tribunals are the “requirements for maintenance of justice in international law” (p. 4). he also shows a keen sense in unmasking debates about conflicts of rules as conflicts of values and thereby poses the important question of how the clash of values can be resolved. he is engaged and optimistic that investment treaty tribunals are able and willing to live up to the ambitious task of not only settling individual disputes but to function as a system of rights adjudication that is able both to protect foreign investors and to help bring competing interests to fruition. mr. ghouri is certainly idealistic in his ambitions for investment law and investment arbitration, but is clever in showing that his ambitions are in line with positive international law. vii. overall, i can therefore recommend to the faculty of law of turku university to accept mr. ghouri’s dissertation as part of the requirement for being granted a doctorate in law. 1 a time-limit running wild? article 39(2) cisg and domestic limitation periods* ulrich schroeter ** * an earlier version of this article was published in mb andersen and rf henschel (eds), a tribute to joseph m. lookofsky (djøf publishing 2015) 335ff. the text and footnotes have been updated in order to reflect case law and scholarly writings that have appeared since then, but the contribution’s festschrift style has been maintained. the author thanks his research assistant till maier-lohmann for his excellent assistance in updating the contribution. ** professor of private law, faculty of law, university of basel, switzerland. njcl 2017/2 153 1. introduction .................................................................................. 154 1.1. tracing the borderline between the cisg and domestic law ....................................................................... 155 1.2. fixed time-limits for the buyer’s rights in cases of non-conforming goods as a borderline issue ..... 156 1.2.1. the cut-off period in article 39(2) cisg ...... 156 1.2.2. the limitation (prescription) under domestic laws ............................................................................... 157 2. the cut-off period in article 39(2) cisg and shorter domestic limitation periods: the prevailing view ........ 159 2.1. the alleged incompatibility between article 39(2) cisg and shorter domestic limitation periods ... 160 2.1.1. case law ...................................................................... 160 2.1.2. scholarly writings ................................................ 162 2.1.3. domestic legislators ............................................. 163 2.1.4. summary ....................................................................... 166 2.2. the assumed incompatibility’s effect on the application of domestic statutes of limitation .. 166 2.2.1. extension of the limitation period (“geneva approach”) .................................................................. 167 2.2.2. postponing the commencement of the limitation period (‘berne approach’) ............. 167 3. challenging the prevailing view: why the cut-off period in article 39(2) cisg is compatible with shorter domestic limitation periods .................................................... 168 3.1. technical nature or doctrinal characterisation of time-limits as the decisive issue? ........................... 169 3.1.1. article 39(2) cisg’s technical nature ........... 169 3.1.2. doctrinal characterisation of time-limits 170 3.2. protection of the seller’s (and not the buyer’s) interests as article 39(2) cisg’s sole purpose ....... 172 3.2.1. article 39(2) cisg’s purpose ................................ 172 3.2.2. article 39(2) cisg as a supplement to article 39(1) cisg ..................................................................... 174 3.2.3. summary ....................................................................... 175 3.3. the ‘reasonable time’ under article 39(1) cisg as the only rule in the cisg potentially affecting domestic statutes of limitation ................................. 176 3.3.1. source of the conflict potential ................... 176 3.3.2. ‘reasonable time’ v. ‘bref délai’: a possible case of conflict ....................................................... 177 4. conclusion ....................................................................................... 178 a time-limit running wild? 154 abstract article 39(2) of the united nations convention on contracts for the international sale of goods of 11 april 1980 (cisg) imposes a cut-off period on the buyer's remedies for the delivery of non-conforming goods, depriving the buyer of all remedies under the cisg if he has not given notice of non-conformity to the seller within two years after the goods were handed over. despite the fact that the cisg itself contains no rules on the limitation of actions (prescription), courts in various jurisdictions have held that article 39(2) cisg pre-empts the application of limitation periods under domestic laws that are shorter than two years – a practically relevant scenario, because a significant number of domestic laws throughout the world know relatively brief limitation periods. the present article challenges this approach and argues that the prevailing interpretation of article 39(2) cisg inter alia overlooks the provision's systematic function as a mere supplement to article 39(1) cisg, with its cut-off rule applying only where the defect remained undetectable for the buyer. even more importantly, the prevailing opinion misunderstands article 39(2) cisg’s purpose of exclusively protecting the seller’s interests, and not the buyer’s – if the provision is (mis-)construed as displacing limitation periods that would otherwise prevent buyers’ claims from being exercised, article 39(2) cisg is turned into a rule that protects the buyer’s interest, thereby violating its purpose. the article therefore concludes that no conflict exists between the cisg's two-year cut-off rule and shorter domestic limitation periods. 1. introduction professor joseph lookofsky, in whose honour the present contribution was written, has devoted a significant part of his oeuvre to the united nations convention on contracts for the international sale of goods of 11 april 1980 (cisg). having published his first article on the cisg very soon after the convention had been adopted,1 he has since authored contributions on almost every interpretative issue under the cisg and has also actively accompanied new developments in international sales law, as the recent withdrawals of the nordic declarations under article 92 cisg and their consequences.2 in doing so, 1 his first contribution listed in the bibliography of the albert h kritzer cisg database is j lookofsky, ‘cisg: the basis of liability. a comparative analysis of the fault and nofault theories of contractual liability pursuant to the danish sale of goods act, the american uniform commercial code and the united nations convention on contracts for the international sale of goods’ (1981) 4(5) justitia copenhagen, 1–72. 2 see j lookofsky, ‘the rise and fall of cisg article 92’ in p mankowski and w wurmnest (eds), festschrift für ulrich magnus (sellier 2014), 243ff as well as the papers in j lookofsky and mb andersen (eds), the cisg convention and domestic contract law: harmony, cross-inspiration, or discord? (djøf / juristog økonomforbundet 2014). njcl 2017/2 155 he has greatly contributed to the quest for an interpretation of the cisg’s provisions which is both practically sensible and internationally uniform (see article 7(1) cisg). while one part of this quest, namely the convention’s interpretation by courts in the various contracting states, has been likened to an orchestra without conductor,3 the related discussions between cisg commentators resemble a global academic town hall meeting, with a free exchange of ideas in search for the best solution. in this spirit, the following pages will similarly be dedicated to the identification and discussion of a question that arises, because ‘the cisg is not always understood by all arbiters and commentators in an identical way’, and that professor lookofsky has aptly characterised as ‘anomalies, particularly as they impact on merchants (and their lawyers) in the real cisg world’.4 1.1. tracing the borderline between the cisg and domestic law a general issue that features particularly prominently in professor lookofsky’s writings is the delimitation of the cisg’s sphere of application and the relationship between the convention and domestic law.5 in this context, he has cautioned against ‘running wild with the cisg’,6 warning that ‘those who run wild with the cisg – stretching its borders to solve controversial problems it was not designed to solve – might unwittingly provide commercial certainty-seekers with an excuse to opt out of the convention regime altogether’.7 the point is well taken. and although i suspect that i may well qualify as a cisg academic running wild in the eyes of some, given the positions that i have advocated elsewhere on the relationship between the cisg and domestic remedies for misrepresentation8 or on the ‘validity exception’ in article 4 sentence 2(a) cisg,9 i will in the following join those who argue in favour of a 3 p schlechtriem, ‘einheitskaufrecht in der rechtsprechung des bundesgerichtshofs’ in c-w canaris and others (eds), 50 jahre bundesgerichtshof: festgabe aus der wissenschaft, vol. 1: bürgerliches recht (ch beck 2000) 407, 408. 4 j lookofsky, understanding the cisg (5th edn, kluwer 2017) xi. 5 see eg j lookofsky, ‘cisg case commentary on preëmption in geneva pharmaceuticals and stawski’ [2003–2004] review of the convention on contracts for the international sales of goods 115ff. 6 j lookofsky, ‘not running wild with the cisg’ (2011) 29 jl & com 141. 7 ibid 144. 8 ug schroeter, ‘defining the borders of uniform international contract law: the cisg and remedies for innocent, negligent or fraudulent misrepresentation’ (2013) 58 villanova law review (vill l rev) 553. 9 ug schroeter, ‘the validity of international sales contracts: irrelevance of the ”validity exception” in article 4 vienna sales convention and a novel approach to determining the convention’s scope’ in i schwenzer and l spagnolo (eds), boundaries and intersections: the 5th annual maa schlechtriem cisg conference (eleven international a time-limit running wild? 156 narrower construction of the convention, as far as one borderline issue is concerned. 1.2. fixed time-limits for the buyer’s rights in cases of nonconforming goods as a borderline issue the borderline issue to be discussed in the present contribution is the application of fixed time-limits to the buyer’s rights arising from a delivery of non-conforming goods (article 45 cisg). in his seminal book on the cisg, professor lookofsky merely touches upon this matter in passing, inviting the reader in a footnote to ‘compare’ a decision by a swiss court10 in which the problem was first addressed.11 accepting this invitation, the following remarks will try to compare the position adopted by courts and academic writers12 with an alternative view to be developed below.13 1.2.1. the cut-off period in article 39(2) cisg the only time-limit in the cisg that takes the form of a fixed period (and not a flexible period, as notably the ubiquitous ‘reasonable time’14) is found in article 39(2).15 article 39 cisg reads: ‘(1) the buyer loses the right to rely on a lack of conformity of the goods if he does not give notice to the seller specifying the nature of the lack of conformity within a reasonable time after he has discovered it or ought to have discovered it. (2) in any event, the buyer loses the right to rely on a lack of conformity of the goods if he does not give the seller notice thereof at the latest within a period of two years from the date on which the goods were actually handed over to the buyer, unless this time-limit is inconsistent with a contractual period of guarantee.’ at the vienna diplomatic conference, the two-year cut-off period in article 39(2) cisg was one of the most contentious issues in the entire convention,16 variously described by commentators as ‘probably the most publishing 2014) 95; ug schroeter, ‘contract validity and the cisg’ (2017) 22 uniform law review 47. 10 cour de justice genève 10 october 1997, cisg-online 295, schweizerische juristenzeitung (sjz) 1998, 146, to be further discussed below at 2.2.1. 11 j lookofsky, ‘understanding’ (n 4) §4.10; similarly j lookofsky, convention on contracts for the international sale of goods (cisg) (2nd edn, wolters kluwer 2016) 136. 12 see 2. below. 13 see 3. below. 14 throughout its text, the cisg uses the term ‘reasonable time’ no less than fifteen times (in arts 18(2), 33(c), 39(1), 43(1), 46(2), (3), 48(2), 49(2)(a), (b), 64(2)(b), 65(1), (2), 73(2), 75(2) and 79(4) cisg). 15 this statement only takes into account time-limits directed at the parties to international sales contracts. in addition, part iv of the cisg contains some fixed periods applicable to declarations under public international law made by contracting states to the cisg. 16 p schlechtriem, uniform sales law – the un convention on contracts for the international sale of goods (manz 1986) 70; i schwenzer in i schwenzer (ed), schlechtriem & schwenzer njcl 2017/2 157 heatedly debated’ provision17 or ‘one of the most dramatic debates’ of the conference.18 professors enderlein and maskow explain: ‘latent defects, which in spite of an examination at the time of the taking over of the goods could not be discovered, can become visible while the goods are being used. the later the defects are discovered, the more difficult it is to decide whether they were caused by a breach of an obligation of the seller or by outside influence after the passing of the risk, eg wrong use by the buyer or normal wear and tear. therefore, a maximum period of two years after the taking over of the goods is laid down in the convention. […] this exclusive period was greatly disputed during the preparation of the convention […]. after long discussions, a two-year exclusive period was stipulated in the cisg because at a later date difficulties would almost inevitably arise with regard to evidence on the status of the goods at the time of delivery, and the seller would no longer be in a position to take action against his suppliers (of the goods themselves or of the material needed for their manufacture). a period that would be equally suitable for all goods cannot be established. whether or not the two-year period is too short or too long depends on the goods in question [...].’19 1.2.2. the limitation (prescription) under domestic laws by contrast, the cisg contains no statute of limitations, because time-limits for bringing legal actions (limitation or prescription) are generally considered to be a matter not governed by the convention.20 when the cisg was drafted, questions relating to the limitation of actions were intentionally left to ‘uncitral's first-born’,21 the convention on the limitation period in the international sale of goods that was first commentary on the un convention on the international sale of goods (cisg), (4th edn, oup 2016) art 39 para 2. 17 k sono in cm bianca and mj bonell (eds), commentary on the international sales law (rothman 1987) art 44 para 1.2. 18 g eörsi, ‘a propos the 1980 vienna convention on contracts for the international sale of goods’ (1983) 31 american journal of comparative law 333, 350. 19 f enderlein and d maskow, international sales law (oceana 1992) art 39 cisg para 6, citing k sono in cm bianca and mj bonell (n 17) art 39 para 1.11. 20 icc arbitration case no 11333 of 2002, (2006) 31 yearbook commercial arbitration (yb comm arb) 117, 124–25; cour d’appel (court of appeals) de versailles 13 october 2005, cisg-online 1433; us nonwovens v pack line corp, supreme court of the state of new york, 12 march 2015, cisg-online 2676; jo honnold and hm flechtner, uniform law for international sales under the 1980 united nations convention (4th edn, kluwer 2009) § 254.2; p schlechtriem and ug schroeter, internationales un-kaufrecht (6th edn, mohr siebeck 2016) para 200. only very rarely has opposition been voiced by academic writers, see a williams, ‘limitations on uniformity in international sales law: a reasoned argument for the application of a standard limitation period under the provisions of the cisg’ (2006) 10 vindobona journal of international commercial law and arbitration (vj) 229, 244–59. what is less clear are the precise consequences of the cisg not governing prescription; see 3.1.2. below. 21 see h smit, ‘the convention on the limitation period in the international sale of goods: uncitral’s first-born’ (1975) 23 am j comp l 337–62. a time-limit running wild? 158 adopted in new york on 14 june 1974 and subsequently modified during the 1980 diplomatic conference in vienna in order to make it compatible with the new cisg. therefore, it was probably the limitation convention’s four-year limitation period (article 8 limitation convention) which was primarily present in the cisg drafters’ minds when article 39(2) cisg was discussed, given that the coexistence between these two different-but-related time-limits did not seem to adversely affect the cisg’s two-year cut-off period.22 the situation can be different whenever article 39(2) cisg has to coexist with a domestic limitation period that is shorter than two years. the laws of a surprisingly large number of cisg contracting states impose such relatively brief limitation periods on buyers’ claims, an approach that often can be traced back to roman law under which a buyer’s actio redhibitoria or actio quanti minoris had to be brought within short time-limits.23 currently, limitation periods that run for less than two years from the handing over of the goods can e.g. be found in the domestic laws of african states (madagascar, morocco and tunisia – thirty days; egypt – sixty days, six months or one year; algeria, libya and syria – six months or one year), of american states (brazil – thirty days; peru and venezuela – three months; bolivia – one year; mexico – six months; argentina, chile, colombia, ecuador and el salvador – six months or one year), of asian states or territories (taiwan – six months; cambodia – one year), of european states (spain – six months; italy – one year) and of middleeastern states (lebanon – thirty days; united arab emirates – sixty days or six months; bahrain, kuwait, qatar and yemen – six months or one year).24 in addition, many african states (benin, burkina faso, cameroon, central african republic, chad, congo, cote d’ivoire, gabon, guinea, mali, niger and togo) as well as belgium and luxembourg have maintained the rule formerly contained in article 1648 french civil code, according to which an action for a hidden defect must be brought within a short time (bref délai). furthermore, a number of european states until not too long ago also had short limitation periods for buyers’ action for defects, but have since replaced them either in the course of implementing the 1999 eu consumer sales directive (which requires a two-year limitation period for 22 compare eg secretariat’s commentary in united nations conference on contracts for the international sale of goods, vienna 10 march – 11 april 1980, official records: documents of the conference and summary records of the plenary meetings and the meetings of the main committees (united nations 1981) art 37 para 6, p 35; i schwenzer (n 16) art 39 para 31. 23 see r zimmermann, the law of obligations: roman foundations of the civilian tradition (oup 1996) 305, 317–18, 327–28. 24 i schwenzer, p hachem and c kee, global sales and contract law (oup 2012) para 51.27; e muñoz, modern law of contracts and sales in latin america, spain and portugal (eleven international publishing 2011) 524ff. njcl 2017/2 159 consumer sales)25 or in unrelated domestic law reforms. examples include germany and greece, which until 2001/2002 respectively had a limitation period of six months,26 as well as switzerland, which in 2013 replaced its traditional one-year limitation period for buyers’ claims for nonconformity with a two-year period.27 it was primarily those three rather brief limitation periods (now all abolished) that in the past gave rise to discussions about the relationship between article 39(2) cisg and shorter domestic limitation periods. however, the topic is of general importance and continuing practical relevance, given the numerous similar limitation laws cited above.28 2. the cut-off period in article 39(2) cisg and shorter domestic limitation periods: the prevailing view while the ‘prevailing view’ upon a given interpretative question may sometimes be difficult to identify,29 such a difficulty hardly arises in the present context: as will be demonstrated in the following section,30 courts from a number of cisg contracting states, academic writers from various countries as well as the domestic legislators that have addressed the question almost unanimously agree that limitation periods of less than two years are incompatible with the cut-off period in article 39(2) cisg. in contrast, there is significantly less agreement about the precise effect that the alleged incompatibility has upon the application of domestic limitation laws.31 25 directive 1999/44/ec of the european parliament and of the council of 25 may 1999 on certain aspects of the sale of consumer goods and associated guarantees [1999] oj l171/12, art 5(1). 26 § 477 bürgerliches gesetzbuch (german civil code) as in force until 31 december 2001 contained a six-months limitation period for the buyer’s rights which commenced with the handing-over of the goods. since 1 january 2002, the new § 438(1) no 3 german civil code instead provides for a two-year limitation period; see in more detail 2.1.3.1. below. similarly, greece amended art 554 of the greek civil code through law no 3043/2002 (which entered in force on 21 august 2002) and replaced the former limitation period of six months with a two-year limitation period. 27 see further 2.1.3.2. below. 28 see in this sense also i schwenzer, p hachem and c kee (n 24) para 51.31: ‘although this problem arises in many civil law legal systems – especially in latin america – up to now it has been discussed in germany and switzerland only’. 29 compare the critical remarks by j lookofsky, ‘running wild’ (n 6) 143 on the oblique use of the term ‘prevailing opinion’ by german authors (like myself). 30 see 2.1. below. 31 see 2.2. below. a time-limit running wild? 160 2.1. the alleged incompatibility between article 39(2) cisg and shorter domestic limitation periods 2.1.1. case law in case law under the convention, courts have almost uniformly held that the two-year cut-off period in article 39(2) cisg is ‘incompatible’ or ‘in conflict’ with shorter limitation periods. maybe most prominently, the swiss federal supreme court described the underlying reasoning as follows: ‘pursuant to article 210 or [obligationenrecht – swiss law of obligations], a buyer’s claims arising out of a lack of conformity of the goods become time-barred one year after the goods have been delivered to it by the seller. in certain cases, an application of this one-year limitation period (article 210 or) to contracts governed by the cisg will be problematic: it might happen that claims arising out of a lack of conformity of the goods would already be time-barred although the period for notification under article 39(2) cisg has not even expired. as stated earlier, the buyer loses the right to rely on a lack of conformity of the goods in accordance with article 39(2) cisg if he does not give the seller notice thereof at the latest within a period of two years from the date on which the goods were actually handed over to the buyer. therefore, legal scholars tend to argue that article 210 or should be inapplicable to sales contracts governed by the cisg. the court holds that this is an appropriate solution. the one-year limitation period provided for in article 210 or cannot be applied at least to those cases where it would subject a claim to limitation even before the two-year notification period of article 39(2) cisg has expired. otherwise, there would be a violation of provisions of public international law.’32 in addition to various earlier decisions by swiss courts of first and second instance which had considered the one-year statute of limitation under the former article 210(1) or to be incompatible with article 39(2) cisg,33 at least two greek courts adopted the same position with respect to the former article 554 greek civil code and its six-months limitation period, expressly referring to the discussion in switzerland and following 32 bundesgericht (swiss federal supreme court) 18 may 2009, cisg-online 1900, (2008) 8 internationales handelsrecht (ihr) 27 para 10.3, referring to art 210 or as in force until 31 december 2012 and citing c brunner, un-kaufrecht – cisg (stämpfli 2004) art 4 para 25; f dasser in basler kommentar, internationales privatrecht (2nd edn, helbing & lichtenhahn 2007) art 148 iprg para 3; h honsell, schweizerisches obligationenrecht, besonderer teil (8th edn, stämpfli 2006) 154; m keller and d girsberger in zürcher kommentar zum iprg (2nd edn, schulthess 2004) art 148 iprg para 7; t koller, ‘die verjährung von ansprüchen des käufers aus der lieferung nicht vertragskonformer ware im spannungsfeld zwischen un-kaufrecht (cisg) und nationalem partikularrecht’ (2003) 21 recht 41, 47ff; m will, ‘zum wiener unkaufrecht/verjährung’ (1998) 94 sjz 146ff. this decision was later approvingly referred to in bundesgericht 16 july 2012, cisg-online 2371, entscheidungen des schweizerischen bundesgerichts (bge) 138 iii 601 para 7.5. 33 see 2.2. below. njcl 2017/2 161 its reasoning.34 an italian court similarly declared the one-year limitation period in article 1495(3) italian civil code to be incompatible with article 39(2) cisg.35 in comparison, french courts have demonstrated a range of approaches when addressing article 39(2) cisg’s relationship with domestic laws on limitation. for example, the lyon court of appeal36 applied the former article 210(1) or to a cisg contract without even mentioning article 39(2) cisg.37 after the french supreme court had reversed the decision for procedural reasons and remanded the case to the paris court of appeal,38 the latter court ruled that article 210(1) or as then in force violated french public policy, since its one-year period could elapse before the last seller could take recourse against earlier sellers in the chain.39 in doing so, the court looked only at the ’black letter’ of swiss law, without taking into account its flexible interpretation by the swiss courts (to be addressed below).40 a mere 20 days later, the bordeaux court of appeal explicitly rejected the same public policy argument when it was raised against article 1495(1) italian civil code.41 in an earlier case, the same court had seen no conflict between these two bodies of law in the first place, because it had interpreted the cisg as entirely pre-empting the limitation period in article 1495(3) italian civil code.42 as the court had furthermore found the time-limits of article 39 cisg to be inapplicable 34 monomeles protodikio larisa (single-member court of first instance of larissa) case no 165/2005, reported by e zervogianni, ‘greece’ in f ferrari (ed), the cisg and its impact on national legal systems (sellier 2008) 172ff; polimeles protodikio athinon (multimember court of first instance of athens) case no 4505/2009, cisg-online 2228, para 2.2.6. 35 tribunale di bolzano (district court bolzano) 27 january 2009, cisg-online 2344, (2012) 12 ihr 42, 43. but see hof van beroep (belgian appellate court) ghent 17 may 2004 – noma bvba v misa sud refrigerazione spa, cisg-online 990, para. 6.2, where the court applied art 39(2) cisg and art 1495(3) italian civil code concurrently (given that a full seven years had passed since the delivery of the goods and six years since the discovery of the defect, the relationship between the two time-limits arguably did not matter in this case, as both periods had clearly expired). 36 cour d’appel de lyon 22 june 2010, docket no 08/08864. 37 the decision has been criticised by c witz and b köhler, ’der neueste beitrag der französischen gerichte zur auslegung des cisg (2012–juli 2013)’ (2014) 14 ihr 89, 94. 38 cour de cassation, chambre commerciale (french supreme court, commercial chamber) 13 february 2013 – société solodem v soctiété codefine, cisg-online 2435. 39 cour d'appel de paris 10 april 2015, cisg-online no 2708. 40 see on the ’geneva approach’ 2.2.1 and on the ’berne approach’ 2.2.2. below. criticising the paris court of appeal’s decision in this regard c witz and b köhler, 'panorama: droit uniforme de la vente internationale de marchandises (janvier 2015– juillet 2016)’ (2017) recueil dalloz (d) 613, 620. 41 cour d'appel de bordeaux 30 april 2015, cisg-online 2707; approving discussion by c witz and b köhler, 'panorama’ (n 40) 620-21. 42 cour d'appel de bordeaux 12 september 2013 – sociéte ceramiche v société bois, cisgonline 2552. a time-limit running wild? 162 due to article 40 cisg, the claim concerned was effectively free from any time-limits. the french supreme court reversed the judgment and held limitation periods to be outside of the cisg’s scope, but did not address their possible incompatibility with article 39(2) cisg.43 2.1.2. scholarly writings mirroring the cisg case law mentioned earlier, academic writers almost uniformly agree that domestic limitation periods of less than two years are incompatible with article 39(2) cisg.44 in doing so, they also frequently echo the swiss supreme court’s view that an application of such statutes of limitation would constitute a violation of public international law.45 only exceptionally have authors argued in favour of a different position (among them the author of the present contribution).46 43 cour de cassation, chambre commerciale 2 november 2016 – société bois v société cermiche, cisg-online 2804; critical remarks on the reasoning c witz and b köhler, 'panorama’ (n 40) 619. 44 f enderlein and d maskow (n 19) art 39 cisg para 6; p tannò, die berechnung der rügefrist im schweizerischen, deutschen und un-kaufrecht (dike 1993) 288; v heuzé, traité des contrats: la vente internationale de marchandises – droit uniforme, (lgdj 2000) para 313; j-m joerin, ‘discrepancies between lack of conformity notification requirements in cisg 39(2) and the statute of limitations in co 210(1): gap filling by arbitral tribunals or prerogative of legislator?’ (2000) 18 asa bull. 82, 83; m will, ‘“meine großmutter in der schweiz…”: zum konflikt zwischen verjährung und rügefrist nach un-kaufrecht’ in t rauscher and h-p mansel (eds), festschrift für werner lorenz zum 80. geburtstag (ch beck 2001) 623, 626; a janssen, ‘das verhältnis nationaler verjährungsvorschriften zur ausschlussfrist des art. 39 abs. 2 cisg in der schweiz’ [2003] praxis des internationalen privatund verfahrensrechts (iprax) 369, 370; t koller, (n 32) 47; d girsberger, ‘the time limits of article 39 cisg’ (2005-06) 25 j l & com 241, 249; i schwenzer and s manner, ‘“the claim is time-barred”: the proper limitation regime for international sales contracts in international commercial arbitration’ (2007) 23 arb. int. 293, 305; p hachem and f mohs, ‘verjährung von ansprüchen des käufers wegen nichtlieferung und lieferung vertragswidriger ware aus cisg nach internem schweizer recht: zugleich eine urteilsanmerkung zum entscheid des bundesgerichts vom 18. mai 2009, cisgonline 1900’, (2009) 18 aktuelle juristische praxis (ajp) 1541, 1547; st kröll in st kröll, l mistelis and p perales viscasillas (eds), un convention on contracts for the international sale of goods (cisg) commentary (ch beck 2011) art 39 para 121; f ferrari in f ferrari and others (eds), internationales vertragsrecht (2nd edn, ch beck 2012) art 39 cisg para 34; i schwenzer, p hachem and c kee (n 24) para 51.31; c witz, ’panorama: droit uniforme de la vente internationale de marchandises (janvier 2012–juillet 2013)’ (2013) recueil dalloz (d.) 2874, 2877; t murmann and m stucki in c brunner (ed), un-kaufrecht – cisg, (2nd edn, stämpfli 2014) art 4 para 23; c witz and b köhler, ‘auslegung des cisg 2012-2013’ (n 37) 94; c witz and b köhler, 'panorama’ (n 40) 619. 45 m will (n 44) 635; t koller (n 32), 47; p hachem and f mohs (n 44) 1547; t murmann and m stucki (n 44) art 4 para 23; c witz and b köhler, ‘auslegung des cisg 20122013’ (n 37) 94. 46 a mullis in p huber and a mullis, the cisg – a new textbook for students and practioners (sellier 2007) 163; p schlechtriem and ug schroeter (n 20) para 428; r gildeggen and njcl 2017/2 163 2.1.3. domestic legislators furthermore, it is instructive to consider the view of domestic legislators in some cisg contracting states who have also identified an incompatibility between article 39(2) cisg and their brief statutes of limitation. the reason why their position is mentioned last in the present context lies in the inherent risk to the international character of the convention and the need to promote uniformity in its application, which are both listed in article 7(1) cisg as interpretative goalposts:47 with the ratification of the cisg, the legislative organs of ratifying states relinquish their influence on the content of the convention48 and leave all interpretative power to the community of courts in cisg contracting states.49 any guidance from a contracting state about the ‘correct’ interpretation of cisg provisions – may it be in form of an interpretative declaration50 or a domestic law51 – therefore constitutes a threat to article 7(1) cisg’s principles and should be avoided. against this background, domestic legislators’ opinion about the issue discussed here must similarly be viewed through an article 7(1) cisg lens. as far as could be ascertained, there are in any case only two states in which the domestic legislator has specifically addressed the relationship between article 39(2) cisg and the local statute of limitation: a willburger, ‘art. 39 abs. 2 cisg als problem bei internationalen einkaufsvertra ̈gen’ (2016) 16 ihr 1, 3; p hachem, ‘the cisg and statute of limitation’ in i schwenzer (ed), 35 years cisg and beyond (eleven international publishing 2016) 151, 163; p hachem, ‘verja ̈hrungsund verwirkungsfragen bei cisg-vertra ̈gen’ (2017) 17 ihr 1, 16. 47 compare hm flechtner, ‘uniformity and politics: interpreting and filling gaps in the cisg’ in p mankowski and w wurmnest (n 2) 193, 197ff, who convincingly points out that the two interpretative principles should not be equated with each other. 48 although the text of the cisg was fixed when the convention was adopted in vienna on 11 april 1980, individual states retained the possibility to declare one or more of the reservations authorized in arts 92–96 cisg, thereby influencing the text version to be applied; see hm flechtner, ‘the several texts of the cisg in a decentralized system: observations on translations, reservations and other challenges to the uniformity principle in article 7(1)’ (1998) 17 journal of law and commerce 187, 194. see also j basedow, ‘uniform private law conventions and the law of treaties’ (2006) 11 uniform law review 731, 735: ‘with the exception of reservations permitted in the convention, the binding treaty only leaves national legislators a choice between ”yes” and ”no”.’ 49 ug schroeter, ‘backbone or backyard of the convention? the cisg’s final provisions’ in cb andersen and ug schroeter (eds), sharing international commercial law across national boundaries: festschrift for albert h. kritzer on the occasion of his eightieth birthday (wildy, simmonds and hill 2008) 425, 455. 50 as eg the hungarian declaration on art 90 cisg or the german declaration on art 1(1)(b) and art 95 cisg; see ug schroeter, ‘final provisions’ (n 49) 452–54. 51 as eg the laws interpreting art 6 cisg enacted by many canadian provinces; see j ziegel, ‘canada prepares to adopt the international sales convention’ (1991) 18 canadian business law journal 1, 3. a time-limit running wild? 164 germany when the ratification of the cisg was prepared in the federal republic of germany in 1988, the staff in the federal ministry of justice noticed the discrepancy between the then six-months limitation period in § 477 of the german bgb and the two-year cut-off period in article 39(2) cisg. the explanations to the parliamentary act of ratification therefore explain that an unfettered application of § 477 bgb could lead to ‘problems’ if the buyer did not and could not identify the non-conformity with these six months, as his rights would then be affected by limitation, although article 39(2) cisg gives him the right to rely on a nonconformity until two years have passed since the goods were actually handed over.52 ‘in order to not erode’ the latter provision through the short limitation period in § 477 bgb,53 a special provision was introduced in article 3 of the act implementing the cisg into german law (vertragsgesetz)54 according to which the limitation period only began to run in case of cisg contracts at the moment the buyer had given notice of non-conformity in accordance with article 39(1) cisg. in doing so, the german legislator removed every potential for conflict between § 477 bgb and article 39(2) cisg, because the limitation period only ever commenced once a notice of non-conformity had been given by the buyer, while article 39(2) cisg concerns situations in which no notice under article 39(1) cisg was given. notwithstanding this effective legislative solution, it is interesting to note that the travaux préparatoires remain surprisingly vague when it comes to the question whether there was, legally speaking, a conflict of norms looming between the two provisions, or whether it was merely an unfortunate practical effect the german legislator sought to avoid. the non-legalistic terms employed in the parliamentary materials (‘problems’ (‘könnte allerdings zu problemen führen (…)’), avoiding an ‘erosion’ of the two-year cut-off period (‘um diese regelung nicht durch die (…) kurze verjährungfrist auszuhöhlen’)) hardly support the assessment of a true conflict between § 477 bgb and article 39(2) cisg, so that the german legislator should arguably not be counted among those that regard the cisg’s cut-off period and shorter limitation periods as legally incompatible. 52 deutscher bundestag (german federal parliament), 11. wahlperiode, entwurf eines gesetzes zum übereinkommen der vereinten nationen vom 11. april 1980 über verträge über den internationalen warenkauf sowie zur änderung des gesetzes zu dem übereinkommen vom 19. mai 1956 über den beförderungsvertrag im internationalen straßengüterverkehr (cmr) of 7 october 1988, drucksache 11/3076, 7. 53 ibid. 54 gesetz zum übereinkommen der vereinten nationen vom 11. april 1980 über verträge über den internationalen warenkauf sowie zur änderung des gesetzes zu dem übereinkommen vom 19. mai 1956 über den beförderungsvertrag im internationalen straßengüterverkehr (cmr) of 5 july 1989, bundesgesetzblatt (german federal legal gazette) 1989 ii, 586. njcl 2017/2 165 the rule in article 3 of the german vertragsgesetz remained in force until 31 december 2001, when the provision was changed in connection with a fundamental overhaul of the german law on limitation periods. in this context, § 477 bgb was replaced by a two-year period of limitation, which generally (including in case of cisg contracts) starts to run with the delivery of the goods.55 the legislative materials on the modification of article 3 vertragsgesetz explain that postponing the beginning of the limitation period was viewed as ‘no longer necessary’, given the significant extension of its length from six months to two years.56 switzerland in switzerland, where the cisg’s ratification was prepared soon after it had been in germany, the time gap between article 39(2) cisg and the local one-year limitation period (article 210(1) or) was equally noticed. the swiss government’s explanations accompanying the parliamentary act of ratification pointed out that an ‘unsatisfactory solution’ could be the result for buyers wanting to bring an action in a swiss court after a year has passed.57 contrary to the german legislator, the swiss parliament nevertheless at first took no steps to remedy the situation, but left it to the parties to solve the problem by contractually harmonising the two time-limits, merely noting that both article 39(2) cisg’s cut-off period and the swiss statute of limitation are subject to contrary party agreements.58 the passive approach adopted by the swiss legislator was soon criticized for merely shrugging the problem off,59 and the resulting conflict of norms was even referred to as ‘absurd’.60 the swiss authorities took this criticism to heart and later expressly acknowledged the incompatibility with the cisg when the limitation period of article 210(1) or was extended in 2013.61 55 § 438(1) no 3, (2) bgb as in force since 1 january 2002. 56 deutscher bundestag, 14. wahlperiode, entwurf eines gesetzes zur modernisierung des schuldrechts of 14 may 2001, drucksache 14/6040, 284. 57 botschaft betreffend das wiener übereinkommen über verträge über den internationalen warenkauf of 11 january 1989, bundesblatt (swiss federal gazette) 1989, 745, 793: ‘(...) eine unbefriedigende lösung (...)’. 58 ibid. 59 m will (n 44) 631: ‘achselzuckender hinweis’. 60 p widmer, ‘droits et obligations du vendeur’ in lausanne colloquium, the 1980 vienna convention on the international sale of goods: lausanne colloquium of november 19–20, 1984 (schweizer institut für rechtsvergleichung 1985) 91, 102: ‘résultat peu convaincant – pour ne pas dire absurd –’. 61 eidgenössisches justizund polizeidepartement, bundesamt für justiz, obligationenrecht (revision des verjährungsrechts), bericht zum vorentwurf (august 2011) 34: ‘die allgemeinen verjährungsregeln sind wkr-konform. dies im unterschied zum geltenden recht. (...)’. a time-limit running wild? 166 2.1.4. summary in summary, courts in various cisg contracting states, the overwhelming majority of academic writers as well as domestic legislators all agree: according to them, the borderline issue of fixed time-limits for buyers’ rights under cisg contracts is marked by an incompatibility between article 39(2) cisg and domestic limitation periods with a length of less than two years. 2.2. the assumed incompatibility’s effect on the application of domestic statutes of limitation what is less clear are the legal consequences to be drawn from this incompatibility. in other words: who should do what about it? there is general agreement that the cisg must ‘prevail’,62 i.e. that the alleged conflict of norms needs to be resolved in favour of the cisg. support can be found in the general law of treaties, where it has long been recognized as a rule of customary public international law that ‘[a] party [i.e. a state] may not invoke the provisions of its internal law as justification for its failure to perform a treaty’:63 since the application of a domestic statute of limitation in spite of its incompatibility with article 39(2) cisg would constitute a partial failure to perform the treaty (through non-application of article 39(2) cisg), such a step would be a violation of treaty law. however, neither the general law of treaties nor the cisg specify how the full application of the cisg’s provisions can be achieved in a situation in which a domestic statute of limitation, similarly equipped with the force of law, on its face also demands to be applied. when the incompatibility issue addressed above was discussed at an academic conference in lausanne in 1985, professor loewe (who had acted as chairman of the first committee during the 1980 vienna diplomatic conference) described the two generally available ways of solving the difficulty: in such a situation, a contracting state has to resolve the conflict either through legislature or through judicature.64 presented with these options, only the german parliament tried to remedy the situation through an express tailor-made provision,65 while legislators in 62 tribunale di bolzano 27 january 2009 (n 35) 43; d girsberger (n 44) 249: ‘no doubt’; st. kröll (n 44) art 39 para 121; f ferrari (n 44) art 39 cisg para 34; i schwenzer, p hachem and c kee (n 24) para 51.32. 63 article 27 first sentence vienna convention on the law of treaties (adopted 22 may 1969, opened for signature 23 may 1969 and entered into force 27 january 1980) 1155 unts 331. this provision codifies a rule of customary law; see me villiger, commentary on the 1969 vienna convention on the law of treaties (brill 2009) art 27 para 1; k schmalenbach in o dörr and k schmalenbach (eds), vienna convention on the law of treaties (springer 2012) art 27 para 4. 64 r loewe, ’discussion’ in lausanne colloquium (n 60) 106: ‘hier müsse ein solcher staat eine lösung zur vereinbarung dieser beiden fristen durch gesetzgebung und judikatur finden.’ accord f enderlein and d maskow (n 19) art 39 cisg para 6. 65 see on the former art 3 vertragsgesetz 2.1.3.1. above. njcl 2017/2 167 all other states left it to the courts to handle the situation. in the resulting case law,66 two approaches can be distinguished:67 2.2.1. extension of the limitation period (“geneva approach”) the first approach consists in an extension of shorter domestic limitation periods to a period of two years. it was adopted by the court of justice geneva in a 1997 decision68 based on the authorization granted to swiss courts in article 1(2) swiss civil code to act modo legislatoris;69 it has therefore become known as the ‘geneva approach’. many academic writers agree with this solution.70 2.2.2. postponing the commencement of the limitation period (‘berne approach’) the second approach does not focus on the length of the limitation period, but rather its beginning, which under many domestic limitation statutes is the moment the goods are handed over (or ‘delivered’) to the buyer. by instead letting the limitation period commence only with the receipt of the notice of non-conformity given in accordance with article 39(1) cisg,71 the commercial court of the (swiss) canton berne chose an alternative path towards removing the presumed incompatibility (the ‘berne approach’). in doing so, it relied on article 1(2) swiss civil code (as the geneva court had done), but followed the solution implemented by the german legislator in the then article 3 german vertragsgesetz. the 66 note that the swiss federal supreme court explicitly left open how the incompatibility should be resolved; see bundesgericht (n 32) 27 para. 10.3. 67 in addition, commentators have suggested yet different approaches, as eg the application of a longer, ‘general’ limitation period (where available); see s marchand, les limites de l’uniformisation matérielle du droit de la vente internationale (helbing & lichtenhahn 1994) 291ff; v heuzé (n 44) para 313. 68 cour de justice genève 10 october 1997 (n 10). 69 art 1(2) swiss civil code (zivilgesetzbuch) reads: ‘in the absence of a provision, the court shall decide in accordance with customary law and, in the absence of customary law, in accordance with the rule that it would make as legislator’; see ae von overbeck, ‘some observations on the role of the judge under the swiss civil code’ (1977) 37 louisiana law review 681, 688ff. the court of first instance (tribunal geneva 14 march 1997, cisg-online 89) had instead applied the general limitation period of ten years (art 127 swiss or). 70 p tannò (n 44) 288; j-m joerin (n 44) 89ff (reporting an unpublished icc arbitral award in which the sole arbitrator adopted this solution); m will (n 44) 638; t koller (n 32) 53; d girsberger (n 44) 250; d akikol, die voraussetzungen der sachmängelhaftung beim warenkauf (schulthess 2008) 36; g benedick, die informationspflichten im un-kaufrecht und ihre verletzung (stämpfli 2008) para 635ff; p hachem and f mohs (n 44) 1548; t murmann and m stucki (n 44) art 4 para 23. 71 handelsgericht des kantons bern (commercial court of the canton berne) 30 october 2001, cisg-online 956, [2002] schweizerische zeitschrift für internationales und europäisches recht (szier) 142; handelsgericht des kantons bern 17 january 2002, cisg-online 725, (2003) 21 recht 48. a time-limit running wild? 168 two greek courts mentioned earlier adopted the same approach when applying the former article 554 greek civil code to cisg contracts.72 a few authors agree.73 3. challenging the prevailing view: why the cutoff period in article 39(2) cisg is compatible with shorter domestic limitation periods given the impressive cross-border uniformity displayed by courts and commentators when it comes to the relationship between article 39(2) cisg and shorter statutes of limitation, one might wonder whether it is worthwhile, or indeed admissible, to challenge the prevailing view. after all, article 7(1) cisg aims at uniformity in the convention’s application, and this goal would clearly be much easier reached by the few remaining sceptics joining the almost uniform ranks, than through a further extension of the discussion. luckily, article 7(1) cisg’s uniformity goal is not quite as strict, and should not be read as stymieing an academic exchange of ideas.74 (from a formal perspective, it could be pointed out that article 7(1) cisg’s principles are legally binding only for courts in cisg contracting states,75 but are a mere inspiration to academic writers.) maybe more importantly, professor flechtner has noted that attempts to apply the uniformity principle in a rigid or absolutist fashion are generally unjustified by the convention.76 and quite similarly, professor lookofsky has reminded us that the command of article 7(1) cisg even to courts ‘does not mean that a given cisg majority view is necessarily persuasive, let alone “right”’, and that ‘numbers should not count for much, especially if the reasoning of the (first-in-time) majority is unpersuasive.’77 thus encouraged, i will try to demonstrate that the prevailing view in fact has it wrong. my disagreement in this context is not with the general position that the cisg should prevail over domestic law in case of an incompatibility78 (with this, i do agree), but rather with the assumption 72 monomeles protodikio larisa, case no 165/2005, reported by e zervogianni (n 34) 172ff; polimeles protodikio athinon (n 34) para. 2.2.6. 73 a janssen, ‘verhältnis’ (n 44) 371; f ferrari (n 44) art 39 cisg para 34. 74 see already 1. above. 75 see j lookofsky, ‘digesting cisg case law: how much regard should we have?’ (2004) 8 vj 181, 184: ‘article 7(1) contains a clear (public international law) command to all cisg contracting states and their courts (…)’. 76 hm flechtner, ‘several texts’ (n 48) 188. 77 j lookofsky, ‘case law’ (n 75) 188 (emphases in the original). 78 see 2.2. above. njcl 2017/2 169 that article 39(2) cisg and shorter statutes of limitation are incompatible:79 in my opinion, no such incompatibility or conflict exists.80 3.1. technical nature or doctrinal characterisation of timelimits as the decisive issue? a first possible reason why the cisg’s cut-off rule and domestic limitation periods are not in conflict could be that both time-limits belong to different categories, from either a technical or a doctrinal perspective. in my opinion, such a reasoning should not be followed, irrespective whether the focus is on the technical nature or the doctrinal character of the time-limits concerned: 3.1.1. article 39(2) cisg’s technical nature as to their technical nature, it has frequently been stressed that limits on the time for instituting legal proceedings are technically distinct from the cut-off period in article 39(2) cisg.81 this distinctness appears first and foremost in the steps that are needed in order to comply with the respective time-limits: while limitation periods require the introduction of an action at law as defined in the respective statute of limitation, article 39 cisg merely requires a notice of non-conformity to be given to the seller, without court action being involved.82 the distinctness further manifests itself in a number of technical features that are present in article 39(2) cisg (notably that the cut-off period has to be observed ex officio,83 and that it cannot be interrupted or suspended84), but presumably not in limitation periods. the latter assumption must nevertheless not necessarily be true for all domestic limitation regimes, because of the technical 79 see 2.1. above. 80 see already p schlechtriem and ug schroeter (n 20) para. 428; support in recent scholarly writings by r gildeggen and a willburger (n 46) 3; p hachem, ‘statute of limitations’ (n 46) 163; p hachem, ‘verjährungsund verwirkungsfragen’ (n 46) 16. 81 d girsberger (n 44) 248; jo honnold and hm flechtner (n 20) § 261.1; st kröll (n 44) art 39 para 119; j lookofsky, ‘convention’ (n 11) 134; i schwenzer (n 16) art 39 para 30; k sono in cm bianca and mj bonell (n 17) art 39 para 1.9. see also the secretariat’s commentary (n 22) art 37 para 6, p 35, stressing that the obligation under art 39(1) cisg to give notice ‘is a completely separate obligation from that to commence judicial proceedings under the prescription convention’. 82 cour d’appel de versailles 29 january 1998, cisg-online 337. 83 oberlandesgericht (austrian court of appeals) linz 24 september 2007, cisgonline 1583, (2008) 8 ihr 28, 30; u magnus in h honsell (ed), kommentar zum unkaufrecht (2nd edn, springer 2010) art 39 para 29; st kröll (n 44) art 39 para 94; i schwenzer (n 16) art 39 para 24; c witz and b köhler (n 37) 93; doubting whether this holds true outside of europe p hachem, ‘verjährungsund verwirkungsfragen’ (n 46) 2. 84 cour de cassation, chambre commerciale 13 february 2007, cisg-online 1562; cour de cassation, chambre commerciale 27 october 2012, cisg-online 2403; p hachem (n 79) 1; f enderlein and d maskow (n 19) art 39 cisg para 6; a janssen, ‘verhältnis’ (n 44) 369; u magnus (n 83) art 39 para 29. a time-limit running wild? 170 differences between the ways in which different domestic laws construct the instrument of prescription.85 these differences in turn mean that the technical construction of limitation laws cannot in itself be decisive for article 39(2) cisg’s relation toward them, simply because such an influence of domestic legal orders would be irreconcilable with the cisg’s international character (article 7(1) cisg).86 3.1.2. doctrinal characterisation of time-limits the doctrinal characterisation of the concurring rules is another potential point of reference, as it at first sight indeed appears possible to distinguish between limitation periods on one hand and cut-off rules like article 39(2) cisg on the other hand, using normative, theoretical categories.87 in legal writings, article 39(2) cisg’s two-year period has therefore variously been qualified as not a limitation period, but a period of exclusion,88 a statute of repose,89 a verwirkungsfrist,90 a präklusionsfrist91 or an ausschlussfrist.92 however, these characterisations should neither determine the relationship between article 39(2) cisg and rules of domestic law, because the categories used are once more categories of domestic legal systems and not of the cisg. this alone is a sufficient reason not to rely on time-limits’ character in legal doctrine or ‘domestic law ideology’93, as the resulting (albeit indirect) influence of domestic law and jurisprudence is – again94 – disfavoured by article 7(1) cisg. 85 see r zimmermann (n 23) 769; see also m müller-chen in schlechtriem & schwenzer commentary, (n 16) art 1 limitation convention para 7. 86 see ug schroeter, ‘defining the borders’ (n 8) 562ff. 87 see cour de cassation, chambre commerciale 3 february 2009 – société novodec / société sigmakalon v. soctiétés mobacc et sam 7, cisg-online 1843: ‘attendu qu’en statuant ainsi, alors que le délai de deux ans de l’article 39 de la convention de vienne est un délai de dénonciation du défaut de conformité et non un délai pour agir, la cour d'appel a violé le texte susvisé (...)' (thereby reversing and remanding the decision of a lower court that had treated article 39(2) cisg as a limitation period); cour de cassation, chambre commerciale 21 june 2016 – caterpillar energy solutions gmbh v a allianz iard, cisg-online 2742 (again reversing a decision of a lower court); cour de cassation, chambre commerciale 2 november 2016 – société bois v société ceramiche, cisg-online 2804; a janssen, ‘verhältnis’ (n 44) 371; p hachem and f mohs (n 44) 1541;. 88 f enderlein and d maskow (n 19) art 39 cisg para 6. 89 cp gillette and sd walt, the un convention on contracts for the international sale of goods: practice and theory (lexisnexis 2014) § 5.03[5]. 90 t koller (n 32) 44. 91 h honsell (n 32) 150; p hachem and f mohs (n 44) 1541;. 92 oberster gerichtshof (austrian supreme court) 19 december 2007, cisgonline 1628 (2008) 8 ihr 106; a janssen, ‘verhältnis’ (n 44) 369; u magnus in j von staudinger’s kommentar zum bürgerlichen gesetzbuch, wiener un-kaufrecht (cisg) (sellier – de gruyther 2012) art 39 cisg para 63; p hachem, ‘verjährungsund verwirkungsfragen’ (n 46) 2. 93 this expression is used by hm flechtner, ‘several texts’ (n 48) 200. 94 see already 3.1.1. above. njcl 2017/2 171 the decisive question is therefore whether article 39(2) cisg, when interpreted in accordance with article 7(1) cisg, aims at displacing concurring statutes of limitations in part or entirely, or rather wants to leave rules of prescription untouched. the limitation convention, sister convention to the cisg,95 specifically addresses this question of legislative intent in its article 1(2), where it provides that ‘[t]his convention shall not affect a particular time-limit within which one party is required, as a condition for the acquisition or exercise of his claim, to give notice to the other party or perform any act other than the institution of legal proceedings’.96 in explaining the term ‘shall not affect’, the official commentary states that the limitation convention ‘is not applicable’ to time-limits as article 39(2) cisg and ‘has no effect’ on such rules.97 what is not entirely clear is whether this lack of applicability and effect is a specific result of article 1(2) limitation convention or would have been the case anyway, as the limitation convention is at the outset not concerned with time-limits for notices of non-conformity. it is furthermore interesting to note that the cisg does not include a counterpart to article 1(2) limitation convention addressing its relationship with statutes of limitation. the secretariat’s commentary on the draft cisg contains somewhat contrary indications, in that it stresses that ‘the principles which lie behind [article 39(2) cisg and articles 8, 10 limitation convention] are the same’, only to add that the obligation under article 39(1) cisg to give notice ‘is a completely separate obligation from that to commence judicial proceedings under the prescription convention’.98 arbitral decisions have stressed the latter point.99 by contrast, commentators have argued that it might be difficult to reconcile the policies underlying the two conventions,100 and have even spoken of a 95 see 1.2.2. above. 96 art 1(2) limitation convention refers to time-limits as those imposed by art 39 cisg (f enderlein and d maskow (n 19) art. 2 limitation convention para. 8). 97 k sono, ‘commentary on the convention on the limitation period in the international sale of goods, done at new york, 14 june 1974 (a/conf.63/17)’ (1979) x uncitral yearbook 145, 149. 98 secretariat’s commentary (n 22) art 37 para 6, p 35. 99 icc arbitration case no 7565 of 1994, cisg-online 566, (november 1995) icc international court of arbitration bulletin (icc bull) 63: art 39(2) cisg ‘has nothing to see with claims or other means of action in justice. it just deals with notice of a lack of conformity which must take place within two years from the delivery of the goods. it leaves entirely open the matter of the time during which, after that notice, a claimant may or may not file its claim within a court or an arbitral tribunal. this matter depends on the proper law of limitation (...)’; icc arbitration case no 7660 of 1994, (november 1995) icc bull 69. 100 k sono in cm bianca und mj bonell (n 17) art 39 para 1.10. during the preparatory work on the cisg within uncitral, the conflict between the different policies was frequently noted and discussed; see (1973) iv uncitral yearbook 13, 48, 49, 66–67 and (1975) vi uncitral yearbook 99–100. a time-limit running wild? 172 ‘clash of policies’ between the two time-limits.101 these concerns in turn support the view that notice requirements like those of article 39 cisg and limitation periods, while belonging to doctrinally separate categories of rules, may still collide where results of their respective application interfere. to the present author, the correct answer to the above question is not obvious. given the complexity of the problem and the fact that it does not merely arise in the context discussed here, but is of a more general nature, the present contribution is not a suitable place to attempt a solution. rather, this must be left for another day. for the remaining part of the contribution, i will therefore proceed under the assumption that statute of limitations can be incompatible with rules on notices of nonconformity at least where they interfere with the intended functioning of such rules,102 thereby accepting arguendo an assumption (implicitly) underlying the prevailing view. 3.2. protection of the seller’s (and not the buyer’s) interests as article 39(2) cisg’s sole purpose the decisive factor must therefore be the interpretation of article 39(2) cisg, which has to elucidate whether the concurrent application of a shorter limitation period to a buyer’s rights is really incompatible with the two-year cut-off rule. it is submitted that the answer is in the negative: 3.2.1. article 39(2) cisg’s purpose as a starting point, it must be noted that in order to be able to conflict with any shorter time-limit, article 39(2) cisg would have to be read as fixing a two-year minimum period for giving notice. and the prevailing view103 indeed interprets article 39(2) cisg variously as granting the buyer two years within which to give notice that the goods were non-conforming,104 as essentially protecting the buyer from hidden defects during two years105 or as providing the buyer with a duty, but also with a right to give notice of non-conformity within two years after 101 k sono in cm bianca and mj bonell (n 17) art 39 para 1.12. 102 whether such an interference really exists in case of art 39(2) cisg will be investigated in 3.2. below. 103 see in detail 2.1. above. 104 sky cast, inc v global direct distribution, llc, us district court (eastern district of kentucky) 18 march 2008, cisg-online 1652: ‘assuming the light poles were nonconforming because of the delay in shipments, under article 39, it appears that global [i.e. the buyer] had two years from the date of delivery of the light poles to the construction project within which to give sky cast [i.e. the seller] notice that the goods were non-conforming.’ but see the critical remarks about this judgment by i bach, ‘neuere rechtsprechung zum un-kaufrecht’ [2009] iprax 299, 303 (‘geht doppelt fehl’), by i schwenzer (n 16) art 39 para 30 n 159 (‘incorrect’) and by cp gillette and sd walt (n 89) § 5.03[5]. 105 u magnus (n 83) art 39 para 29: ‘die vorschrift [art 39(2) cisg] schützt den käufer damit im ergebnis für zwei jahre vor verborgenen sachmängeln.’ njcl 2017/2 173 handing over of the goods.106 it is submitted that it is with this understanding of article 39(2) cisg that the prevailing view goes wrong: the construction just described is for once at odds with the wording of article 39(2) cisg, which makes no positive statement whatsoever about the time for giving a notice granted to the buyer; the provision in contrast only stipulates a further reason (‘in any event, (…)’) why the buyer loses his right to rely on a lack of conformity of the goods. its common description as a ‘cut-off rule’ points in the same direction. in addition, article 39(2) cisg’s purpose makes amply clear that the provision is of no help to the buyer, but only to the seller.107 the secretariat’s commentary describes the purpose as: ‘to protect the seller against claims which arise long after the goods have been delivered. claims made long after the goods have been delivered are often of doubtful validity and when the seller receives his first notice of such a contention at a late date, it would be difficult for him to obtain evidence as to the condition of the goods at the time of delivery, or to invoke the liability of a supplier from whom the seller may have obtained the goods or the materials for their manufacture. paragraph (2) recognizes this interest by requiring the buyer to give the seller notice of the non-conformity at the latest two years from the date the goods were actually handed over to him.’108 in the same vein, courts applying the convention have held that the provision serves to provide the seller with certainty that he no longer needs to reckon with claims after a certain point in time, and that he may finally regard the transaction as finished.109 finally, the drafting history of article 39(2) cisg indicates the protection of the seller as its sole designated purpose. in fact, concerns were raised at the 1980 vienna diplomatic conference that buyers ‘might be unduly penalized’110 by article 39(2) cisg, and the provision was criticised as ‘draconian’ from the buyer’s point of view.111 more recently, article 39(2) cisg has even been challenged for allegedly violating the buyer’s right to a fair trial as guaranteed by article 6 of the 1950 european convention on human rights.112 on the contrary, nobody seems to have 106 a janssen, ‘verhätltnis’ (n 44) 369: ‘dass der käufer grundsätzlich die pflicht, aber auch das recht hat, vertragswidrigkeiten der ware innerhalb von zwei jahren ab übergabe anzuzeigen’. 107 see also st kröll (n 44) art 39 paras 7, 12: ‘the primary purpose of art 39 is to protect the interests of the seller in the finality of transactions.’ on the purpose of art 39(2) cisg in particular, see already f enderlein and d maskow (n 19); a janssen, ‘chapter 16: examination and notice of non-conformity’ in la dimatteo and others (eds), international sales law: contract, principles & practice (nomos 2016) 429, 459 para 82. 108 secretariat’s commentary (n 22) art 37 paras 5–6, p 35. 109 oberster gerichtshof 19 december 2007 (n 91), cites i schwenzer in p schlechtriem and i schwenzer (eds), kommentar zum einheitlichen un-kaufrecht (4th edn, ch beck 2004) art 39 para 22. 110 delegate date-bah (ghana) in official records (n 22) 320, no 32. 111 delegate o’flynn (united kingdom) in official records (n 22) 320, no 35. 112 see cour de cassation, chambre commerciale 16 september 2008 – société industrielle et agricole du pays de caux (siac) v agrico cooperatieve handelsvereiniging voor a time-limit running wild? 174 considered the cut-off rule as potentially helpful for the buyer’s position, as it was never designed to be. against this background, it is unconvincing to draw from article 39(2) cisg a minimum two-year notice period in favour of the buyer, which could be disturbed by the application of shorter domestic limitation periods. 3.2.2. article 39(2) cisg as a supplement to article 39(1) cisg it is furthermore necessary to take into account article 39(2) cisg’s systematic position within the convention. the provision supplements article 39(1) cisg,113 which in turn positively defines the time frame available to the buyer for giving notice, namely ‘a reasonable time’ after he has discovered the non-conformity or ought to have discovered it. the supplementary function of article 39(2) cisg has equally been neglected by the proponents of the prevailing view, thereby contributing to the misunderstanding about the cut-off rule’s purpose and effect: it is article 39(1) cisg which – first – provides that the buyer only has to give notice of non-conformity if he has discovered the nonconformity or ought to have discovered it, and – second – thereafter grants the buyer a ‘reasonable time’ for giving notice (instead of requiring notice to be given ‘promptly’, as the predecessor in article 39(1) ulis did), with the time’s reasonability inter alia being influenced by the buyer’s skill (or lack thereof).114 article 39(1) cisg accordingly also protects the buyer’s interests through these two requirements,115 although the notice requirement primarily serves the seller’s interest.116 article 39(1) cisg does not, however, guarantee that the buyer’s opportunity to give notice remains undisturbed for two years, but merely for a reasonable time. to this scenario, article 39(2) cisg adds its two-year cut-off rule which ‘[i]n akkerbouwgewassen ba, cisg-online 1821, d 2009, 1568 with note by c witz. (the french supreme court rejected the argument for procedural reasons.) 113 j lookofsky, ‘convention’ (n 11) 134. 114 oberlandesgericht (german court of appeals) munich 11 march 1998, cisgonline 310: ‘a thorough and expert examination of the goods can be expected from a business of [buyer]’s size, which owns various retail stores (...)’; shuttle packaging systems v tsonakis, us district court (western district of michigan) 17 december 2001, cisgonline 773: ‘the [buyer]’s employees lacked the expertise to inspect the goods and needed to rely on [seller]’s engineers even to use the equipment (...)’; gerechtshof [dutch appellate court] arnhem 18 july 2006, cisg-online 1266, para. 5.7: ‘when determining a reasonable time for notice of defects, it is finally relevant, that [buyer] is a professional and – facing the amount of compensation requested – a large scale manufacturer’; miami valley paper, llc v lebbing engineering & consulting gmbh, us district court (southern district of ohio) 26 march 2009, cisg-online 1880; st kröll (n 44) art 39 para 76. 115 see u magnus (n 92) art 39 cisg para 4; i schwenzer (n 16) art 39 para 1. 116 j lookofsky, ‘understanding’ (n 4) §4.9: purpose underlying art 39(1) cisg ’is to provide the seller with a reasonable and timely opportunity to consider and perhaps refute a given non-conformity claim, as well as an opportunity to cure an existing defect. etc.’; st kröll (n 44) art 39 paras 7, 12 (citation in n 107). njcl 2017/2 175 any event’ takes away the buyer’s right to rely on a lack of conformity once two years have passed since the goods were actually handed over, notwithstanding the fact that the buyer could at no point in time discover the respective non-conformity.117 article 39(2) cisg accordingly does not give the buyer any time at all; it only takes away rights that other provisions in the cisg have given him. if one were to liken article 39 cisg to a ‘good cop, bad cop’ scenario with the buyer as the subject, article 39(1) cisg would occupy the role of the (to a limited extent) good cop, with article 39(2) cisg resembling the aggressive, purely negative colleague. this role once more excludes any potential for conflict with concurring limitation periods if it arises from the aim to preserve the buyer’s rights. article 39(2) cisg’s merely supplementary function has yet another effect on its relation to statutes of limitation, albeit only an indirect one: as the cut-off rule only applies to cases in which the reasonable time for giving notice under article 39(1) cisg has not yet expired118 (most often because the non-conformity has remained hidden, so that the reasonable time has not even started to run), article 39(2) cisg’s alleged pre-emptive effect could similarly only apply in situations in which the reasonable notice period has not passed. in case law following the prevailing view,119 this was sometimes overlooked, with short domestic limitation periods being treated as displaced although the cut-off rule did not even apply in the particular case, given that the buyer had to comply with article 39(1) cisg.120 article 39(2) cisg’s pre-emptive effect accordingly reached further than the scope of the provision – a further sign of the prevailing view’s weaknesses. 3.2.3. summary contrary to the currently prevailing opinion, article 39(2) cisg is not incompatible with limitation periods of less than two years of length, because the cisg’s cut-off rule neither according to its wording and legislative history nor to its purpose and systematic position within the 117 see oberster gerichtshof 19 december 2007 (n 91) 108; p schlechtriem (n 16) 70 who speaks of ’the absolute exclusion of all claims after two years, whether or not the defects were discoverable during that time’; u magnus (n 92) art 39 cisg para 63. 118 oberster gerichtshof 19 may 1999, cisg-online 484; audiencia provincial (spanish appellate court) de pontevedra 8 february 2007, cisg-online 1802; oberster gerichtshof 19 december 2007 (n 92) 108; see also i schwenzer (n 16) art 39 para 23: art 39(2) cisg applies furthermore where the buyer has a reasonable excuse in accordance with art 44 cisg. 119 see 2.1.1. above. 120 cour de justice genève 10 october 1997 (n 10) 146: notice given by buyer within reasonable time (art 39(1) cisg), but statute of limitation (former art 210(1) swiss or) nevertheless held to be displaced by art 39(2) cisg; tribunale di bolzano 27 january 2009, (n 35) 43: notice given by buyer within reasonable time (art 39(1) cisg), but statute of limitation (art 1495(3) italian civil code) nevertheless held to be displaced by art 39(2) cisg. a time-limit running wild? 176 convention aims at granting the buyer two years for giving notice of nonconformity. correctly understood, article 39(2) cisg protects exclusively the interests of the seller, and not the buyer; it can therefore not be in conflict with statutes of limitations which give the buyer less than two years’ time for commencing legal proceedings. 3.3. the ‘reasonable time’ under article 39(1) cisg as the only rule in the cisg potentially affecting domestic statutes of limitation accepting the non-prevailing interpretation of article 39(2) cisg suggested here121 does nevertheless not mean that all potential for conflict between article 39 cisg and brief domestic limitation periods is removed. but the conflicting provision within article 39 cisg is a different one: instead of the cut-off rule in article 39(2) cisg, it is the rule in article 39(1) cisg governing the details of the required notice of non-conformity, in particular its time-frame (‘within a reasonable time after he has discovered it or ought to have discovered it’) that may be incompatible with brief domestic statutes of limitation. 3.3.1. source of the conflict potential the reason is that the ‘within reasonable time’ requirement in article 39(1) cisg – as noted earlier122 – is indeed supposed to protect the buyer’s interests, insofar as it no longer requires the notice to be given ‘promptly’ and takes into account the buyer’s skills. in case a domestic limitation period expires before the ‘reasonable time’ under article 39(1) cisg has passed, domestic law may therefore indeed infringe upon the buyer’s rights as given to him by the convention, if one accepts the assumption that time-limits for giving notice of non-conformity and limitation periods can conflict at all.123 in order to determine whether such a conflict exists, one cannot resort to an abstract, numerical comparison of the notice period under article 39(1) cisg and the respective limitation period, because the timelimit of article 39(1) cisg is fact-specific, requiring an assessment according to the circumstances of each particular case.124 it is accordingly necessary to determine when the ‘reasonable time’ granted to the buyer has passed under the circumstances at hand, and whether the applicable domestic limitation period has expired before this point in time. if it has, we are faced with a conflict of norms, which has to be resolved in favour 121 see 3.2. above. 122 see 3.2.2. above. 123 see 3.1.2. in fine above. 124 see miami valley paper (n 114); cp gillette and sd walt (n 89) § 5.03[1]. njcl 2017/2 177 of the convention’s time-limit in line with one of the approaches developed by courts under article 39(2) cisg.125 3.3.2. ‘reasonable time’ v. ‘bref délai’: a possible case of conflict in view of the experience with the interpretation of article 39(1) cisg’s ‘reasonable time’ and notwithstanding the ‘crazy decisional quilt’126 that has developed in this context, courts have relatively rarely concluded that a period of more than one or two months was still reasonable for giving notice of non-conformity,127 although such cases have occasionally occurred.128 this raises the question whether there is a relevant likelihood of domestic limitation periods falling short of article 39(1) cisg’s period. such situations will probably be rare, though at least three possible constellations come to mind: first, a few domestic laws know limitation periods which only run for thirty or sixty days,129 thereby using a fixed time-limit that may occasionally be briefer than article 39(1) cisg’s ‘reasonable time’. second, statutes of limitation not infrequently let their limitation begin to run with the delivery of the goods, irrespective of the non-conformity’s recognisability: in cases of hidden defects (i.e. the ones also governed by article 39(2) cisg), such limitation periods may well expire before the reasonable notice period, which under article 39(1) cisg only commences once the buyer ought to have discovered the nonconformity. and third, the bref délai for actions in cases of hidden defects modelled on the former article 1648 french civil code130 may collide with article 39(1) cisg – a conflict potential that deserves closer consideration. commencing with the plain language of bref délai rules (‘within a short time’), it may at first appear that such limitation periods will frequently expire earlier than the ‘reasonable time’ of article 39(1) cisg. the legislative history of article 38 cisg seems to support this expectation, given that a (similarly framed) ‘short period’ was clearly regarded as shorter than a ‘reasonable time’.131 in practice, however, the former article 1648 french civil code was often construed more generously, so that the conflict potential between the bref délai requirement and article 39(1) cisg may be narrower than it first appears: on one hand, the french courts have predominantly ruled that the bref délai only 125 see 2.2. above; in agreement p hachem, ‘statute of limitations’ (n 46), 164; p hachem, ‘verjährungs und verwirkungsfragen’ (n 46) 17. 126 j lookofsky, ‘case law’ (n 75) 193. 127 see u magnus (n 92) art 39 cisg para 41. 128 see p schlechtriem and ug schroeter (n 20) para 414. 129 for examples, see 1.2.2. above. 130 see 1.2.2. above. 131 compare the extensive discussions about a canadian proposal (un doc. a/conf.97/c.1/l.118) to modify the wording of today’s art 38(1) cisg accordingly; see official records (n 22) 106 (proposal) and 310–12 (discussion). a time-limit running wild? 178 begins to run once the defect is discovered by the buyer, and not already on the moment of delivery.132 and on the other hand, the ‘short’ (bref) period has often been measured rather tolerantly, with actions brought after two133 or more than three years134 having been accepted as still meeting the bref délai requirement. on at least one occasion, the former article 1648 french civil code has even been interpreted in light of article 39(2) cisg and its two-year period.135 in addition to the generous interpretation of bref délai rules, the scope of such rules has often been narrowly construed within domestic limitation laws. buyers’ actions under cisg contracts have therefore frequently been subjected to (longer) general limitation periods instead of bref délai rules,136 as the latter are usually designated for certain categories of defects only, as notably the vices rédhibitoires of article 1648 french civil code. due to the construction of these limitation rules in practice, their conflict potential with article 39(1) cisg turns out to be relatively small. however, there remains the possibility that a bref délai will in some circumstances expire before the ‘reasonable time’ for giving notice under the convention has passed. it is submitted that in such circumstances, the bref délai-style limitation periods that remain in force today, as eg those in belgium, benin, congo, gabon, guinea and luxembourg as well as in a number of non-cisg contracting states in francophone africa,137 should be regarded as pre-empted, in order to preserve the time for giving notice of non-conformity that the convention grants the buyer through article 39(1) cisg. 4. conclusion the time-limits applicable to the buyer’s rights under the cisg in cases of non-conforming goods are a borderline issue, in that the convention’s rules compete with domestic laws on the limitation 132 cour de cassation, chambre commerciale 22 november 1965, bulletin des arrêts des chambres civiles de la cour de cassation (bull civ) iii, no 593; cour de cassation, chambre commerciale 18 february 1992, bull civ iv, no 82; see also v heuzé (n 44) para 313. slightly different j ghestin and b desché, traité des contrats: la vente (lgdj 1990) para 737, who focus on the defect’s decoverability. note that since its reform in 2005, art 1648 french civil code explicitly specifies the beginning of the period (‘(...) à compter de la découverte du vice’). 133 cour appel de paris 26 june 1980 – savie v logabax, cited in j ghestin and b desché (n 132) para 737. 134 ibid. 135 icc arbitration case no 8453 of october 1995, cisg-online 1275 (fall 2000) icc bull 55 (although the arbitral tribunal ruled that the cisg was inapplicable to the contract at hand). 136 icc arbitration case no 11333 of 2002 (n 20) 126 (applying the ten-year limitation period of art 189bis french commercial code); v heuzé (n 44) para 313: ‘la seule solution raisonnable’. 137 see 1.2.2. above. njcl 2017/2 179 (prescription) of actions.138 the prevailing view among courts, academic writers and domestic legislators regards the perceived incompatibility between the two-year cut-off period in article 39(2) cisg and shorter domestic limitation periods as the main area of conflict, eventually arguing that article 39(2) cisg must prevail over domestic law.139 the present contribution has tried to demonstrate that this prevailing view misunderstands the purpose of the cut-off period in article 39(2) cisg, resulting in its time-limit indeed ‘running wild’. a more convincing construction leads to a parallel application of the two-year cut-off period and shorter limitation periods.140 there nevertheless remains an area of conflict between uniform international and domestic time-limits, namely between the ‘reasonable time’ in article 39(1) cisg and short domestic limitation periods:141 if a limitation period exceptionally expires while the buyer’s reasonable time for giving notice of non-conformity is still running, the domestic statute of limitation must be regarded as pre-empted by article 39(1) cisg. as this effect on domestic laws is restricted to situations in which there is an actual discrepancy between the two time frames under the circumstances of the case at hand, incompatibilities will be much less frequent than under the prevailing view, which compares the fixed length of the two time-limits in an abstract manner. in consequence, the approach presented here may well depart from an (almost) uniformly held view on the matter, but promises to deliver a more convincingly defined scope of the convention in return. 138 see 1.2. above. 139 see 2. above. 140 see 3.1., 3.2. above. 141 see 3.3. above. microsoft word abbas_riaz_korjattu.doc nordic journal of commercial law issue 2013#1 flexibilities under trips: implementation gaps between theory and practice by muhammad zaheer abbas* shamreeza riaz*** *mailto:m.zaheer@iiu.edu.pk. muhammad zaheer abbas is a phd scholar and research associate at the department of law, faculty of shariah & law, international islamic university islamabad. **shamreeza riaz is a phd scholar and research associate at the department of law, faculty of shariah & law, international islamic university islamabad. the authors are grateful to dr. hafiz aziz-ur-rehman, assistant professor, for his guidance, invaluable comments, suggestions and insights. the authors also owe a debt of gratitude to mr. shamnad basheer, ministry of human resource development chaired professor in ip law, the west bengal national university juridical sciences, kolkatta, india, for his long distance research assistance and to dr. katja lindroos, editor-in-chief, nordic journal of commercial law for her valuable comments and suggestion on earlier draft. the authors, however, remain personally responsible for any errors or omissions. nordic journal of commercial law issue 2013#1 1 1 introduction agreement on trade related aspects of intellectual property (hereinafter trips) aimed at fostering innovation and developing a system based on innovation-oriented national economies. trips could have enabled all member states to achieve economic development had the enforcement mechanisms been properly implemented. but owing to varying level of development of the member states, the system lacked balance and its implementation was open to abuse.1 when trips agreement was concluded, the problems faced by the third world countries, especially due to outbreak of epidemics and pandemics, were not foreseen and public health concern was not given due importance. instead of having mechanisms in favor of access to essential medicines in its main provisions, the trips included them as exceptions. compulsory licensing2 and parallel importation3 are two such flexibilities provided to the lowincome countries.4 1 n. ayse odman, ‘using trips to make the innovation process work’, 2 http://papers.ssrn.com/sol3/papers.cfm?abstract_id=238988, accessed 20 jan 2013. 2 compulsory license is a non-voluntary license issued by the state to a third party without authorization of the patent holder on the condition of payment of a reasonable royalty to the patentee. the concept, though in conflict with the exclusive right of the patent holder, was introduced in the u.k in the statute of monopolies 1623 as a safeguard to prevent abuses of monopoly rights. since then, this concept has been endorsed by all important international conventions and treaties on the subject. the birth of the concept of compulsory licenses is linked to the obligation, introduced by the united kingdom (uk) statute of monopolies in 1623. compulsory licensing has been reported to be popular in britain as early as 1850s. later it was recognized by the international community through paris convention of 1883. for details visit doi:http://www.legislation.gov.uk/aep/ja1/21/3/contents, accessed 13 feb, 2012. 3 a parallel import is a non-counterfeit product imported from another country without the permission of the intellectual property owner. parallel imports are often referred to as ‘grey product’. the practice of parallel importing is often advocated in case of software, music, printed texts, and electronic products and occurs for several reasons. it involves bringing in products from a third party in another country at relatively inexpensive price. the companies set different prices for the same product in different countries. the purchaser from a third party other than the manufacturer can take advantage from this fact. for instance, according to a study in 1998, the price of smithkline beechman’s version of armoxil was $8 in pakistan, $14 in canada, $16 in italy, $22 in new zealand, $29 in the philippines, $36 in malaysia, $40 in indonesia, and $50 in germany. certainly, the actual production cost is same for any market but the logic of price difference is to allow an elevated price to recover costs of research and development from the developed world. there may be various other reasons for price difference in different countries. for more details, see black’s law dictionary (6th ed. 1990), 1143 4 trips, however, does not explicitly establish compulsory licensing rules. article 31 indirectly authorizes compulsory licensing by allowing ‘other use of the subject matter of patents without authorization of the right holder’. full text of trips agreement is accessible at http://www.wto.org/english/docs_e/legal_e/27-trips.pdf accessed 13 jan3,2013. nordic journal of commercial law issue 2013#1 2 trips agreement –one of the most comprehensive treaties on intellectual property rights introduced a strict legal regime for the protection of iprs. prior to trips, pharmaceuticals were excluded from patent protection in domestic laws of about fifty countries. even many of the present world’s developed countries excluded pharmaceutical products from patent protection prior to trips.5 trips agreement provided protection to patents6 in all fields of technology, including pharmaceuticals, for a period of twenty-years.7 higher price of drugs due to monopoly provided to the patent holders became a common concern of developing countries considering stronger iprs protection.8 compulsory licensing safeguard initially provided under trips had no practical significance for least developed countries (hereinafter ldcs) which lacked manufacturing capacity of their own because the pharmaceutical products manufactured under compulsory license could only be used for domestic use. with the outbreak of epidemics and pandemics like hiv/aids in africa, the outcry by ngos and human rights activists succeeded to draw attention of the world community towards practical problems faced by the ldcs (lacking manufacturing capacity) despite the flexibilities provided in the trips. changes were made in the existing system under doha declaration 20019, and wto10 waiver decision 200311 to address the 5 germany excluded pharmaceuticals from patent protection until 1968, switzerland until 1977, italy until 1978, norway, portugal and spain until 1992, finland until 1995. see f m scherer: jayashree watal, ‘post-trips options for access to patented medicines in developing countries’, commission on macroeconomics and health, (2001), 4,last accessed date march 23,2012, doi:http://www.icrier.org/pdf/jayawatal%20.pdf. 6 a grant of right to exclude others from making, using or selling one’s invention and includes right to license others to make, use or sell it. black’s law dictionary (6th ed. 1990), 1125. a patent is a form of intellectual property. it consists of a set of exclusive rights granted by a sovereign state to an inventor or their assignee for a limited period of time in exchange for the public disclosure of an invention. 7 twenty years term of protection is under article 33 of trips agreement. full text of trips agreement is accessible at. http://www.wto.org/english/docs_e/legal_e/27-trips.pdf accessed 20 20 jan, 2013. see more sandra bartelt, ‘compulsory licences pursuant to trips article 31 in the light of the doha declaration on the trips agreement and public health’, (2003), 6 jwip 2, 283, doi:http://onlinelibrary.wiley.com/doi/10.1111/j.17471796.2003.tb00202.x/pdf, accessed 20 jan 2013. 8 richard p. rozek, ‘the effects of compulsory licensing on innovation and access to health care’,(2000), 3 jwip 6,892, doi:http://onlinelibrary.wiley.com/doi/10.1111/j.1747-1796.2000.tb00158.x/pdf, accessed 20 march 2012. 9 the november 2001 doha declaration on the trips agreement and public health was adopted by the wto ministerial conference of 2001 in doha on november 14, 2001. it reaffirmed flexibility of trips member states in circumventing patent rights for better access to essential medicines. 10 the world trade organization (wto) is the only global international organization dealing with the rules of trade between nations. it intends to supervise and liberalize international trade. the organization officially commenced on january 1, 1995 under the marrakech agreement, replacing the general agreement on tariffs and trade (gatt). for details visit http://www.wto.org/.accessed20 jan, 2013. nordic journal of commercial law issue 2013#1 3 problems of the ldcs by allowing export of generics produced under compulsory licensing to these countries. whether the changes were substantial or cosmetic and to what extent the third world countries have been able to use these flexibilities and mechanisms is a debatable issue. purpose of this work is to explore the practical implications faced by the poorer countries in availing the legitimate flexibilities provided under trips and to discuss the implementation gaps between theory and practice of compulsory licensing. 2 impediments in the implementation of trips flexibilities trips agreement is criticized by many for protecting the interests of the rich countries and giant pharmaceutical companies without giving due consideration to the costs of implementing trips for low and middle economy countries with weak innovation capacity and improper legal, administrative and enforcement infrastructure. owing to weak innovation capacity of their own, majority of patent owners in the third world are foreign inventors; most of the benefits of stringent patent laws therefore flow out into foreign pockets.12 access to essential drugs, due to limited purchasing power of masses in the third world, is also a major concern and a much debated issue. keeping in view the situation of poorer countries, some flexibilities were provided, under the doha declaration, within trips agreement like ‘compulsory licensing’ and ‘parallel importation’. the doha declaration is not self-executing and requires changes in the national laws for its implementation.13 most of the third world countries have updated their intellectual property laws in order to conform with trips obligations14 and to avail the flexibilities afforded by the trips agreement. 11 full text of wto’s general council’s waiver decision of august 30, 2003 is available online at <http://www.wto.org/english/tratop_e/trips_e/implem_para6_e.htm>, accessedmay 26, 2012. 12 travis j. lybbert, ‘on assessing the cost of trips implementation’, (2002), world trade review310, doi:http://journals.cambridge.org/action/displayfulltext?type=1&pdftype=1&fid=142116&jid=wtr&volumeid =1&issueid=03&aid=142115, accessed 20 march 2012. 13 south bulletin, ‘the doha declaration on trips: the state of implementation’, 6doi:http://www.southcentre.org/index.php?option=com_content&view=article&id=1657%3asb58&catid=144 %3asouth-bulletin-individual-articles&itemid=287&lang=en, accessed 20 march 2012. 14 assafa endeshaw, ‘asian perspectives on post-trips issues in intellectual property’,(2008), 8 jwip 2,234, doi:http://onlinelibrary.wiley.com/doi/10.1111/j.1747-1796.2005.tb00247.x/pdf, accessed 23 feb 2012. nordic journal of commercial law issue 2013#1 4 the issue is, however, of implementation of these laws and the costs of availing these flexibilities. firstly, the procedure for availing these flexibilities is unnecessarily complicated and burdensome. the procedure is time-consuming, involves substantial financial expense, and holds no guarantee of success.15 secondly, there are various practical implications for third world countries owing to which the flexibilities are, in many instances, only provided in the statute books and do not serve the desired practical purpose. some of the implications for the developing world are briefly discussed here. 2.1 foreign direct investment (fdi)16 the growth of local industry in developing countries is heavily dependent on investment that comes from outside the country.17 developing states may have to pay a heavy price for providing affordable access to medicines to their citizens by invoking compulsory licensing provisions. the pharmaceutical companies may mistrust the promises made by such nations to protect and enforce patent rights. if a nation is lacking security of intellectual property rights, pharmaceutical companies would think twice before making investments in that country. therefore, a country may lose a potential source of economic growth by issuance of compulsory licenses.18 the patent holding pharmaceutical companies may withdraw from the states not fulfilling their commitments of patent protection; at least, they may withhold their new drugs.19 stringent patent protection on the other hand may lead to greater foreign direct investment. 15 south bulletin, ‘the doha declaration on trips’, 8 16 foreign direct investment, in its classic definition, is defined ‘as a company from one country making a physical investment into building a factory in another country. it is an investment abroad, usually where the company being invested in is controlled by the foreign corporation. it is a firm’s transfer of assets from one country to another country in order to generate wealth for the owner of the assets’. in other words, it is a firm’s transfer of assets from one country to another in order to generate wealth for the owner of the assets. an example of fdi is an american company taking a majority stake in a company in china. passive investment through instruments such as notes, debt securities and bonds does not generally constitute fdi activities. for details visit <http://www.goingglobal.com/articles/understanding_foreign_direct_investment.htm> accessed april 26, 2012). 17 frederick m. abbott, ‘compulsory licensing for public health: a guide and model documents for implementation of the doha declaration paragraph 6 decision’, (2000), quaker uno160, doi:http://wwwwds.worldbank.org/external/default/wdscontentserver/wdsp/ib/2005/08/30/000012009_20050830130225 /rendered/pdf/334260rev0pub.pdf, accessed 23 feb 2012. 18 cahoy, ‘the impact of compulsory licensing’,284. 19 jerome h. reichman, ‘compulsory licensing of patented pharmaceutical inventions: evaluating the options, journal of law’, (2009), 37 medicine & ethics 2, doi:http://web.ebscohost.com/ehost/ pdfviewer/pdfviewer?vid=34&hid=122&sid=b06a26af-6028-4687-93e0-06fa097c0197%40sessionmgr13, accessed 23 feb 2012 nordic journal of commercial law issue 2013#1 5 thus, there is a straightforward relationship between foreign direct investment and intellectual property protection.20 for instance, egypt, a middle-economy country with great potential for economic growth, has faced the consequences of its mishandled efforts to provide affordable access to pharmaceuticals to its citizens. in spite of its relatively high literacy rate, high english language proficiency of its citizens, liberal investment laws, relatively transparent tax system21 and cheap labor force, egypt has a suffered a continuous decline in foreign direct investment from ‘$948 million in 1987 to $598 million in 1995 to $428.2 million in 2001-2002’22 because of its broad and ambiguous compulsory licensing provisions23 and poor record of intellectual property protection. in 2002, for example, egyptian government first provided full patent protection to renowned pfizer drug ‘viagra24’ but only after two months, egyptian government granted unlimited compulsory license in response to domestic pressure especially from local pharmaceutical manufacturers.25 as a reaction to this decision, pfizer cancelled its plan to construct an additional production facility in egypt.26 moreover, in the wake of the same issue, the pharmaceutical research and manufacturers association of america (hereinafter phrma27) 20 jamie feldman, ‘compulsory licenses: the dangers behind the current practice’, 160, doi:http://www.hofstrajibl.org/media/blogs/a/compulsory%20licenses%20the%20dangers%20behind%20the %20current%20practice.pdf, accessed 23 march 2012accessed 21 robert bird and daniel r. cahoy, ‘the impact of compulsory licensing on foreign direct investment: a collective bargaining approach’, (2008), 45 ablj,2, 20, http://papers.ssrn.com/sol3/ papers.cfm?abstract_id=1092577, accessed 20 jan 2013. 22 cahoy, ‘the impact of compulsory licensing’,301. 23 cahoy, ‘the impact of compulsory licensing’, 23. 24 viagra is the brand name for sildenafil citrate, and is used for treating erectile dysfunction and pulmonary arterial hypertension. originally developed by scientists in great britain, it was brought onto the market by pfizer inc., a us pharmaceutical company. for details visit doi:http://www.medicalnewstoday.com/articles/232912.php, accessed 27 april, 2012. 25 bird, ‘developing nations’, 211. 26 matthews, ‘renewing healthy competition’,133. 27 pharmaceutical research and manufacturers of america (phrma), founded in 1958, ‘is a trade group representing the pharmaceutical research and biopharmaceutical companies in the united states. phrma's stated mission is advocacy for public policies that encourage the discovery of new medicines for patients by pharmaceutical and biopharmaceutical research companies’. for details visit <http://www.phrma.org/>, accessed 27 april, 2012. nordic journal of commercial law issue 2013#1 6 told egyptian representatives that pharmaceutical companies had cancelled their plans to invest $300 million in egypt owing to weak intellectual property laws of the country.28 the developing countries may act collectively with other nations having similar problems and attempt to use compulsory licenses strategically through the use of collective action mechanism in order to minimize the loss of fdi through enhanced bargaining power. 2.2 unilateral trade sanctions the advanced countries have the tendency to ensure implementation of trips in the developing world by their own unique mechanisms. for instance, the ‘special 30129’ mechanism of the united states is used as an economic leverage to speed up the implementation of trips agreement in the developing world and to pressure the poorer countries to go beyond what is required under trips. initially, under section 30130 of the trade act of 1974, the us president was authorized to impose economic sanctions on states that burden or restrict us commerce.31 under trade and tariff act 1984 and omnibus trade and competitiveness act 198832, section 301 was amended to expand the scope of the provision to intellectual property. 28 s. aziz, ‘linking intellectual property rights in developing countries with research and development, technology transfer, and foreign direct investment policy: a case study of egypt’s pharmaceutical industry’,(2003), 10 ilcl 1, 27 april,doi:https://litigationessentials.lexisnexis.com/webcd/app?action =documentdisplay&crawlid=1&srctype=smi&srcid=3b15&doctype=cite&docid=10+ilsa+j+int%27l+%26+co mp+l+1&key=4bdb9af0b546c12bf48dd5833eaf6ac1, accessed 27 april 2012. 29 the u.s, and western pharmaceutical companies have routinely used the special 301 ‘mechanism for authorizing trade sanctions and lawsuits at the wto and in domestic courts to oppose policies implemented by other countries that are unfavorable to pharmaceutical company interests’. see generally sarah boseley, ‘how the u.s. wields a big stick for big pharm’, (2003), guardian, doi:http://www.guardian.co.uk/world/2003/ feb/18/aids.sarahboseley4, accessed27 27 april, 2012. 30the full text of the section can be accessed at <http://en.wikisource.org/wiki/trade_act_of_1974>, accessed20 20 jan, 2013. 31 sean m. flynn, ‘special 301 of the trade act of 1974 and global access to medicines’, (2010), 25 wclr, 5, http://ssrn.com/abstract=1654011. accessed 20 jan 2013. 32 full text of the omnibus trade and competitiveness act 1988 is accessible at http://gsi.nist.gov/global/docs/ omnibus.pdf. accessed 20 20 jan, 2013. nordic journal of commercial law issue 2013#1 7 present provision authorizes the office of the united states trade representatives (hereinafter ustr33) to review laws and practices of the us trading partners with regards to protection of intellectual property rights of united states citizens and companies34 and prepare an annual special 301 report35 on the basis of which sanctions can be imposed36 on the countries that are non-serious in trips compliance and have not revised their intellectual property laws.37 ustr is authorized to place the states with inadequate intellectual property protection in ‘watch list’ or ‘priority watch list’ or ‘priority foreign country category’38 rendering them liable to face import restrictions.39 these provisions provide for a ‘fast track system’ as ustr is required to decide within six months on what retaliatory action should be taken.40 ustr is empowered to impose unilateral trade sanctions if demands of the us are not met.41 trade pressure is thus 33 the office of the united states trade representative (ustr) is the united states government agency responsible for developing and recommending united states trade policy to the president of the united states for details visit <http://www.ustr.gov/>, accessed 27 april, 2012. 34 daniel j gervais, ‘intellectual property and human rights: learning to live together’, (2008), iphr, 4. 35 it is analyzed that ‘the special 301 report is prepared annually by the office of the united states trade representative (ustr) under section 182 as amended of the trade act of 1974. the reports identify trade barriers to us companies and products due to the intellectual property laws in other countries. each year the ustr must identify countries which do not provide adequate and effective protection of intellectual property rights or fair and equitable market access to united states persons that rely upon intellectual property rights’. for details visit <http://www.ustr.gov/about-us/press-office/reports-and-publications/2011/2011-special-301report>, accessed 27 april, 2012. 36 the economic leverage applied by the us through section 301 was in violation of article xx(d) of the general agreement on tariffs and trade (gatt) which provided signatory states flexibilities with regards to practices which ustr was addressing. obama administration pledged to promote access to affordable drugs in the third world, but the reports released under obama administration do not suggest departure from previous us policy on trade and access to medicines. full text of gatt is accessible at http://www.wto.org/english/ docs_e/legal_e/gatt47_e.pdf accessed january 13, 2013. 37 jillian clare cohen-kohler and lisa forman, ‘addressing legal and political barriers to global pharmaceutical access: options for remedying the impact of the agreement on trade-related aspects of intellectual property rights (trips) and the imposition of trips-plus standards, health economics’, (2008), 3 policy and law, 241,accessed february 13, 2012, doi:http://journals.cambridge.org/action/displayfulltext?type=1&pdftype=1&fid =1914284&jid=hep&volumeid=3&issueid=03&aid=1914276 38 michael a. santoro, ‘human rights and human needs: diverse moral principles justifying third world access to affordable hiv/aids drugs’, 5, http://ssrn.com/abstract=1269367. accessed 20 jan 2013. 39 andreas rahmatian, ‘neo-colonial aspects of global intellectual property protection’,(2009), 12 jwip 1, 48, doi:10.1111/j.1747-1796.2008.00349.x. accessed 20 jan 2013. 40 heinz klug, ‘law, politics, and access to essential medicines in developing countries’, (2008), 1094 lsrp, 36(2), 213 , http://ssrn.com/abstract=1464872, accessed 20 jan 2013. 41 flynn, ‘special 301 of the trade act of 1974’, 4. nordic journal of commercial law issue 2013#1 8 exerted on developing countries under the threat of sanctions under the ‘special 301’ mechanism. for instance, this mechanism was used against south africa when in 1997, after the outbreak of the hiv/aids epidemic, it attempted to authorize parallel importation of affordable medicines through amendment in its patent law42. the united states tried to put pressure with a threat to impose unilateral trade sanctions against south africa if the proposed legislation was passed.43 the united states, however, had to withdraw trade pressure in this instance due to outrage around the world from the general public, human rights groups, aids activists and consumer advocates44 that caused significant damage to the election campaign of al gore, the presidential candidate in the 2000 presidential elections in the us.45 in 2007, when thailand announced use of compulsory license to improve access to drugs needed to treat heart diseases and aids, it was included in the ‘priority watch list’.46 more recently, the ‘special 301 reports’ issued in 2009 and 2010 pressed developing countries like thailand and india to limit compulsory licenses for essential medicines and to restrict their freedom to define the scope of patentability.47 therefore, the fear of potential vulnerability to unilateral trade sanctions from the united states48 prevents developing and least developed countries from exercising the flexibilities, exceptions and safeguards provided under trips agreement.49 in 1999, use of section 301 was reviewed by wto dispute settlement panel and 42 section 15c was inserted into the south african medicines and related substances control act (mrsca). the primary purpose of this amendment was to enable south africa to benefit from lower prices abroad for the same drugs. for details visit http://www.ncbi.nlm.nih.gov/pubmed/19555268, accessed 27 april, 2012 43 a. p. valach, ‘trips protecting the rights of patent holders and addressing public health issues in developing countries’, (2005), 4 chicago. jip 2, 27 april.doi:https://litigationessentials.lexisnexis.com/webcd/app?action= documentdisplay&crawlid=1&doctype=cite&docid=4+chi.kent+j.+intell.+prop.+156&srctype=smi&srcid=3b15 &key=d5661df69a048447176c9a6a2dbef3c8, accessed 27 april, 2012. 44 forman, ‘addressing legal and political barriers’,241. 45 third world network, ‘trips, drugs and public health: issues and proposals’, (2001), 2 iprs 26, , http://www.twnside.org.sg/title2/ipr/pdf/ipr02.pdf. accessed 13 feb 2012. 46 flynn, ‘special 301 of the trade act of 1974, 42. 47 ‘human rights groups to challenge special 301’, doi:http://a2knetwork.org/human-rights-groups-challengespecial-301, accessed 27 april, 2012). 48 colleen chien, ‘cheap drugs at what price to innovation: does the compulsory licensing of pharmaceuticals hurt innovation?’, (2003), 18 btlj 895, http://digitalcommons.law.scu.edu/cgi/viewcontent.cgi?article=1019&context=facpubs&seiredir=1&referer=http%3a%2f%2fscholar.google.com.pk%2fscholar%3fq%3dcompulsory%2blicensing%2bof %2bpatents%26hl%3den%26btng%3dsearch%26as_sdt%3d1%252c5%26as_sdtp%3don#search=%22comp ulsory%20licensing%20patents%22, accessed 3 april 2012. 49 islam, ‘the generic drug deal’, 690. nordic journal of commercial law issue 2013#1 9 it held that without going through wto dispute settlement process, us was not authorized to impose unilateral trade sanctions.50 the continuation of special 301 program is a blithe disregard for the mandate of the wto dispute settlement panel and stands in stark contrast to the commitments made by the us under doha declaration. powerful countries like the united states should not be allowed to use the economic leverage through section 301to deny legitimate flexibilities to the third world countries or to promote ‘trips plus’ policies by pressing poorer countries to adopt stringent intellectual property rules that are not required under any international treaty or agreement. council for trips may take notice of any such practices which are not in conformity with the provisions of the trips agreement. the us may be asked to bring special 301 program into compliance with the wto. 2.3 bilateral free trade agreements while the developing world is facing practical problems in implementing trips agreement, the european union and the united states of america have set new intellectual property standards going even further than trips agreement.51 under regional and bilateral free trade agreements with over 60 countries, the us has decided to implement trips-plus52 intellectual property standards. central american free trade agreement (cafta), north american free trade agreement (nafta), u.s.-jordan free trade agreement (jusfta)53, u.s.-singapore free trade agreement, u.s.-chile free trade agreement, u.s.-australia free trade agreement, u.s.-morocco free trade agreement, u.s.-malaysia free trade agreement, and u.s.-korea free trade agreement are just a few examples.54 these agreements extend patent life beyond twenty years limit set by the trips agreement, limit use of compulsory licensing, 50 flynn, ‘special 301 of the trade act of 1974, 13. 51 puymbroeck, ‘basic survival needs’ , 537. 52 many developing countries have been coming under pressure ‘to enact or implement even tougher or more restrictive conditions in their patent laws than are required by the trips agreement – these are known as ‘trips plus’ provisions. countries are by no means obliged by international law to do this, but many states have had no choice but to adopt these, as part of trade agreements with the united states or the european union. these have a disastrous impact on access to medicines’. for further details visit <http://www.msfaccess.org/content/trips-tripsplus-and-doha>, accessed 27 april, 2012). 53 see generally 54 chuan-feng wu, ‘raising the right to health concerns within the framework of international intellectual property law’, 156, http://ssrn.com/abstract=1578865, accessed 20 jan 2013. nordic journal of commercial law issue 2013#1 10 prohibit parallel imports, and discourage market entry of generics even after the expiration of patent protection.55 it might be surprising to note that many of these countries are developing countries already facing the issues of availability of necessary drugs. governments of poorer countries consent to enter into these agreements because they prefer economic growth over access to health care.56 in return of these agreements that impair public health, the third world countries get access to western investment, access to large industrialized country markets, low tariffs on particular goods, and foreign aid. another reason behind willingness of third world countries to enter into such agreements may be threat of bilateral trade sanctions which deprives developing countries of any bargaining power during negotiations and hardly leaves any room for poorer countries to say no to such agreements.57 these additional trade-enforced restrictions -outside wto and wipofurther aggravate the public health situation in third world countries.58 the u.s. government uses the aforementioned special 301 program to promote these trips-plus policies.59 the situation may become grimmer if the generic drug suppliers like india and thailand bow to foreign pressure and enter into trips-plus agreements that prohibit the use of non-voluntary licenses for export.60 the economic coercion in the form of bilateral and regional trips-plus agreements, therefore, undermines the existing trips safeguards, exceptions, and flexibilities.61 international institutions like wto and wipo may play their role to maintain a balance between intellectual property rights and public health because there is an asymmetric power relationship between developed and developing world. 55 forman, ‘addressing legal and political barriers’, 241. 56 lisa forman, ‘trade rules, intellectual property, and the right to health’, 342, http://onlinelibrary.wiley.com/doi/10.1111/j.1747-7093.2007.000103.x/pdf, accessed 20 jan 2013. 57 ibid. 343. 58 gervais, ‘intellectual property and human rights’, 20. 59 flynn, ‘special 301 of the trade act of 1974’, 15. 60 ibid. 61 south bulletin, ‘the doha declaration on trips’, 7. nordic journal of commercial law issue 2013#1 11 2.4 external transit control of generics confiscation of legitimate generics by customs officials has become another hurdle in the access to drugs. the powerful countries encourage their border officials to seize any products that allegedly infringe intellectual property rights. out of twenty shipments of generic medicines seized by border officials of countries like france, germany and netherlands since late 2008, nineteen were lawfully manufactured in india and legally exported to poorer countries.62 these medicines were not intended for consumption in the eu countries; they were only passing through these countries and there was no evidence of the fraudulent diversion of these medicines to the national markets of eu countries63, even then they were confiscated for allegedly violating territorial patents of eu countries.64 similarly, in march 2009, a shipment funded by unitaid65 was stopped by dutch border officials under eu regulation 1383/200366 for allegedly containing counterfeit drugs. according to unitaid, the medication ‘abacavir’ was not counterfeit and confiscation was unlawful.67 generic producers like india and brazil consider external transit control of generics inconsistent with trips and doha declaration and an impediment for access to drugs.68 wto member states are required to adopt border measures under article 51 to 60 of the trips but these provisions apply to only ‘counterfeit trademark and pirated copyright goods’69. these provisions do not cover other forms of intellectual property rights such as patents.70 moreover, article 51 is confined to ‘importation of counterfeit trademark or pirated copyright goods’. from language of article 51 it is not clear whether or not border measures required under trips 62 medicines that were confiscated included losartan –a cardiovascular disease medicineintended for brazil and abacavir, a key anti-retroviral medicine intended for nigeria. see generally flynn, ‘special 301 of the trade act of 1974’, 47. 63 micara, ‘trips-plus border measures and access to medicines’, 77. 64 flynn, ‘special 301 of the trade act of 1974’, 47. 65 unitaid is an international drug purchase facility that was founded in 2006 on the initiative of france and brazil to provide sustainable and long term funding for access to drugs for the treatment of malaria, tuberculosis and hiv/aids in the third world. for details visit http://www.unitaid.eu/. accessed 19 jan, 2013. 66 full text of eu regulation 1383/2003 is accessible at http://www.wipo.int/wipolex/en/details.jsp?id=1455. accessed 19 jan, 2013. 67 micara, ‘trips-plus border measures and access to medicines’ 73. 68 ibid, 74 69 text from article 51 of trips . similarly, article 61 mentions ‘cases of wilful trademark counterfeiting or copyright piracy on a commercial scale’. full text of trips is accessible at <http://www.wto.org/english/tratop_e/trips_e/t_agm0_e.htm> accessed 19 jan, 2013. 70 henning grosse ruse-khan, ‘china—intellectual property rights: implications for the trips-plus border measures’, (2010), 13 jwip 5, 623, doi:10.1111/j.1747-1796.2010.00405.x, accessed 20 jan 2013. nordic journal of commercial law issue 2013#1 12 extend to infringing exports.71 in 2009, wto dispute settlement panel confirmed that ‘there is no obligation to apply the requirements of article 59 to goods destined for exportation’.72 moreover, text of article 59 also confirms the same as in its second sentence it refers to ‘reexportation’ of the infringing goods and not ‘exportation’. if border measures are extended to patent infringements going beyond what is required by trips, there is a fair chance that most of the confiscations under the suspicion of patent infringement may be wrongful because violations patent rights cannot be determined by border officials or police from mere appearance of products. moreover, external transit control of generics is in contrast with the objectives of trips stated in article 773 of trips. it was claimed by india that ‘the seizures run counter to the spirit of the trips agreement and the resolution 2002/31 of the commission on human rights on the right to enjoy the highest standards of physical and mental health’.74 international institutions should not allow powerful countries to threaten lives of people and impede legitimate trade of generic drugs on the basis of their mere suspicion or speculation. 71 ibid, 624. 72 dispute settlement reports, ( 2009), 7.224,. 2172 , http://books.google.com.pk/books?id=6wpudidyebec&pg=pa2172&lpg=pa2172&dq=there+is+no+obligation +to+apply+the+requirements+of+article+59+to+good+destined+for+exportation&source=bl&ots=xy5ugawjzr& sig=mw4lfk1iyksthi-2j-1nhtzbdy&hl=en&sa=x&ei=thh7upljk8hdhafzroaq&sqi=2&ved=0cckq6aewaa#v=onepage&q=there%20is %20no%20obligation%20to%20apply%20the%20requirements%20of%20article%2059%20to%20good%20dest ined%20for%20exportation&f=false. accessed 20 jan, 2013. 73 article 7 of trips stipulates: ‘the protection and enforcement of intellectual property rights should contribute to the promotion of technological innovation and to the transfer and dissemination of technology, to the mutual advantage of producers and users of technological knowledge and in a manner conducive to social and economic welfare, and to a balance of rights and obligations’. full text of trips is accessible at <http://www.wto.org/english/tratop_e/trips_e/t_agm0_e.htm> accessed 19 jan, 2013. 74 swarna latha soppadandi, ‘new hurdles for access to medicines: a human rights perspective of the ecregulation 1383/2003 and the generic drug seizure cases’, (2010), auw col. of law.5, http://works.bepress.com/cgi/viewcontent.cgi?article=1000&context=swarna_latha_soppadandi, accessed 20 jan 2013 nordic journal of commercial law issue 2013#1 13 2.5 the risk of retaliatory action political pressure exerted by developed countries prevents developing and least developed countries from exercising their rights under trips agreement.75 faced with the risk of retaliatory action from developed countries, their giant corporations, and industry lobbies, the third world countries do not feel free to enact policies and laws on parallel imports and compulsory licensing for essential life-saving drugs.76 they have been provided rights under trips but the decision to make use of these rights is plagued by political considerations.77 for instance, in 2002, when south korea decided to grant compulsory license for gleevec, the us government pressured her not to do so. similarly, in 2006, pfizer pressured philippine when she decided to parallel import a generic version of norvasc.78 in the same year, when thailand79 granted compulsory license for efavirenz, the united states, with the threat of high tariffs for thai exports80, exerted pressure on thailand to ban parallel imports and to revoke the compulsory license and negotiate with merck.81 the pharmaceutical industry also reacted strongly against the thai government’s efforts to provide affordable access to necessary drugs.82 the giant pharmaceutical companies are not only well funded but also well organized; they are supported by powerful governments like the united states and the european union83, and are, 75 for instance, in the summer of 2007, the government of bangladesh got letters from european union trade commissioner peter mandelson and u.s. ambassador to thailand, ralph boyce, after it announced plans for a compulsory license for hiv drugs. for details visit <http://www.worldcrunch.com/drug-companies-battle-against-indian-pharmaceuticalpirates/4890>, 76 third world network, ‘trips, drugs and public health’, 26. 77 south bulletin, ‘the doha declaration on trips’, 7. 78 forman, ‘trade rules, intellectual property’, 342. 79 government of thailand issed order, ‘citing the high drug prices and its obligation to provide access to essential medicines, thailand issued government use (gu) orders for three drugs on the national essential medicines list: efavirenz (november 2006), lopinavir/ritonavir (20 jan07), and clopidogrel, a heart disease drug marketed as plavix by bms (20 jan07). the patent holders were entitled to a royalty of 0.5% of the total sales of the generic product. the gu authorised the governmental pharmaceutical organisation (a thai state-owned enterprise) to import or produce generic versions of these products for non-commercial use in the public health sector. initially the gu was used for importation’. for details visit <http://www.keionline.org/content/view/90/1>, accessed 27 april, 2012. 80 third world network, ‘trips, drugs and public health’, 26. 81 south bulletin, ‘the doha declaration on trips’, 7. 82 ‘compulsory licensing and the anti-competitive effects of patents for pharmaceutical products: from a developing countries’ perspective’, 56. 83 bird, ‘developing nations’, 214. nordic journal of commercial law issue 2013#1 14 therefore, fully capable of exerting formidable pressure on third world countries.84 the international federation of pharmaceutical manufacturers association (ifpma) openly condemns issuance of non-voluntary licenses.85 developing countries may show unity for their common concerns irrespective of their geographical variation and difference in level of development. moreover, they may form alliances with developed states and even with international health organizations and nongovernmental organization (ngos) to constrain extra-legal pressure. through unity, coordinated behavior, and adoption of collaborative position, developing countries may extract more fair prices from patent holders through collective bargaining. further, effective use of media and mobilization of non-governmental organizations and human rights activists can be very useful in instances where global powers and giant multinational pharmaceutical companies try to place corporate interests above the grave medical concerns during a health crisis. media and human rights activists may present the issue of access to drugs as an issue of ordre public86 or morality in order to shape public opinion in favor of poor countries. multi-national corporations (mncs) are normally very much concerned about public opinion and their reputation or perception among consumers because any negative impression about these companies has an adverse effect on sale of their products. furthermore, developing countries may use the forum of wto’s dispute settlement body (dsb87) to resolve disputes relating to compulsory licensing of patents. developed states, owing 84 for instance, when thailand issued a compulsory license for kaletra, an aids medication produced by abbot, the u.s. drug maker responded by denying thai patients access to its other life-saving drugs. for details visit <http://www.worldcrunch.com/drug-companies-battle-against-indian-pharmaceutical-pirates/4890>, accessed june 4, 2012. 85 muhammad asif awan, ‘pakistani pharmaceutical industry in wto regime-issues and prospects’, (2005), 1 jqtm 9, doi:http://pu.edu.pk/images/publication/ppi_in_wto_%20regime-issues_and_prospects.pdf, accessed 4 june 2012. 86 the public policy doctrine or ordre public concerns the body of principles that underpin the operation of legal systems in each state. this addresses the social, moral and economic values that tie a society together. laws are most likely to be effective when they are consistent with the most generally accepted societal norms and reflect the collective morality of the society. ordre public encompasses the protection of public security and the physical integrity of individuals as part of society. for details visit <http://www.iprsonline.org/unctadictsd/docs/rb2.5_patents_2.5.3_update.pdf> accessed june 2, 2012. 87 the dispute settlement body (dsb) of the world trade organization (wto) makes decisions on trade disputes between governments that are adjudicated by the organization. the dsb is, in effect, a session of the general council of the wto: that is, all of the representatives of the wto member governments, usually at ambassadorial level, meeting together. it decides the outcome of a trade dispute on the recommendation of a dispute panel. for details visit <http://en.wikipedia.org/wiki/dispute_settlement_body> accessed june 2, 2012. nordic journal of commercial law issue 2013#1 15 to the risk of a binding negative decision, are normally reluctant to use the dsb forum; they rather rely on political and economic pressure to achieve their desired results in such disputes. 2.6 technology transfer article 66, paragraph 2 of the trips agreement stipulates: ‘developed country members shall provide incentives to enterprises and institutions in their territories for the purpose of promoting and encouraging technology transfer to leastdeveloped country members in order to enable them to create a sound and viable technological base.’88 moreover, paragraph 7 of the declaration on trips agreement and public health (doha declaration adopted on 14 november 2001) ‘reaffirms the commitment of developed-country members to provide incentives to their enterprises and institutions to promote and encourage technology transfer to least-developed country members pursuant to article 66.2’89 of the trips agreement. everyone has a right to benefit from scientific inventions and technological advancements.90 more importantly, economic development of third world countries, especially those with adequately developed technology infrastructure and a strong base of human capital, relies heavily on transfer of technology from industrialized economies who almost enjoy a monopoly on the development of new knowledge and high-level technologies. no intellectual property rights protection poses a threat of imitation or reverse engineering91 of high-technology imported products. stringent patent protection, on the other hand, can cause inordinate delay in technology transfer to the developing world92 because the patent holder enjoying monopoly over the new technology excludes all others rendering the invention beyond the reach of poor 88 article 66, paragraph 2 of the trips agreement. full text of trips agreement is available online at <http://www.wto.org/english/tratop_e/trips_e/t_agm0_e.htm> accessed may 5, 2012. 89 paragraph 7 of the declaration on trips agreement and public health. full text of doha declaration is available at <http://www.wto.org/english/thewto_e/minist_e/min01_e/mindecl_trips_e.htm> accessed may 5, 2012. 90 islam, ‘the generic drug deal’, 688. 91 reverse engineering is the process of discovering the technological principles of a device, object, or system through analysis of its structure, function, and operation and to apply the findings to produce something similar. for details visit <http://en.wikipedia.org/wiki/reverse_engineering> accessed may 5, 2012. 92 dilip k. das, ‘intellectual property rights and the doha round’,(2005), jwip, 43doi:http://onlinelibrary.wiley.com/doi/10.1111/j.1747-1796.2005.tb00236.x/pdf, accessed 13 feb 2012. nordic journal of commercial law issue 2013#1 16 masses in the third world.93 edwin mansfield94, an american professor of economics, concluded that: the strength or weakness of a country’s system of intellectual property protection seems to have a substantial effect, particularly in high-technology industries, on the kinds of technology transferred by many u.s firms to that country.95 trips agreement was expected to give due importance to the issue of transfer of technology from developed to underprivileged countries. but trips agreement did not create mandatory obligations for transfer of technology.96 a corresponding obligation was created under aforementioned article 66.2 of the trips agreement, but practically advanced nations did not comply with article 66.2. this corresponding obligation was reaffirmed in 2001 in doha declaration, again without producing desired results. again, the trips council, in 2003, adopted a decision on implementation of article 66.2 and devised a reporting mechanism under which developed nations were supposed to submit reports to the trips council on actions taken or planned by them to fulfill their commitments under article 66.2. again, this mechanism could not produce desired results because most of the reports submitted failed to meet the reporting criteria.97 this attitude of developed nations is against the objectives of the trips that are set down in article 7 of the trips agreement. article 7 of trips clearly stipulates that: the protection and enforcement of intellectual property rights should contribute to the promotion of technological innovation and to the transfer and dissemination of technology, to the mutual advantage of the producers and users of technological knowledge and in a manner conducive to social and economic welfare, and to a balance of rights and obligations.98 93 islam, ‘the generic drug deal’, 688. 94 edwin mansfield (1930–1997) was a professor of economics at university of pennsylvania from 1964 and until his death. from 1985 he was also a director of the center for economics and technology. edwin mansfield is best known for his scientific results concerning technological change / diffusion of innovations, and also for his textbooks on microeconomics, managerial economics, and econometrics. for details visit <http://en.wikipedia.org/wiki/edwin_mansfield> accessed may 5, 2012. 95 rozek, ‘the effects of compulsory licensing’,901. 96 islam, ‘the generic drug deal’, 688. 97 south bulletin, ‘the doha declaration on trips’, 10. 98 full text of trips agreement is available online at http://www.wto.org/english/docs_e/legal_e/27-trips.pdf accessed january 13,2013. nordic journal of commercial law issue 2013#1 17 in the absence of mandatory obligations for transfer of technology, the developing countries may develop their patent regime in such a manner as to strike a balance between iprs protection and their economic development goals. compulsory licenses can therefore be used as one of the channels to improve flows of technology to the third world remaining within the flexibilities provided under trips agreement. advanced states may be asked to fulfill their commitments made under article 66.2 of the trips agreement. trips may be revised to include mandatory obligations for transfer of property. developing countries may compose themselves into a homogeneous group in the wto to raise a common voice for their concerns if the provisions safeguarding their legitimate interests are not complied with by the technologically advanced states. 2.7 lack of technical expertise in order to use flexibilities provided under trips agreement and doha declaration, member states need to review and amend their national laws. lack of technical expertise in the field of intellectual property in the underprivileged countries has been an impediment in fully availing the flexibilities provided under trips by incorporating them in the national laws.99 trips agreement’s provisions especially those regarding compulsory licenses and parallel importation, are coupled with conditions which make them difficult to invoke effectively and speedily. the countries which do not have adequate technical expertise face difficulties in interpretation and implementation of the trips provisions that lack legal clarity and common understanding.100 necessary technical assistance should therefore be provided to developing countries in relation to intellectual property in order to enable them to reform their legal and administrative systems. trips agreement provides for this technical cooperation. article 67 of the trips agreement stipulates: in order to facilitate the implementation of this agreement, developed country members shall provide, on request and on mutually agreed terms and conditions, technical and financial cooperation in favor of developing and least-developed country members….101 99 south bulletin, ‘the doha declaration on trips’, 16. 100 third world network, ‘trips, drugs and public health’, 125. 101 article 67 of the trips agreement. full text of trips agreement is available online at <http://www.wto.org/english/tratop_e/trips_e/t_agm0_e.htm> accessed may 5, 2012. nordic journal of commercial law issue 2013#1 18 in 1996, trips council agreed that the developed country members would provide annually information about the steps taken by them to fulfill their commitments made under article 67. in addition to individual member states, intergovernmental organizations like world intellectual property organization (wipo) and world trade organization (wto) may undertake capacity building work to ensure technical assistance to developing countries that lack the capacity to reform their domestic iprs regimes to avail trips-compatible flexibilities.102 2.8 high litigation costs the cost of patent litigation is not trivial.103 owing to high litigation costs, third world countries are extremely reluctant to become party to patent litigation.104 drug and health patents are the most litigated patents105 and developing and least developed countries can hardly be expected to have significant capacity and economic incentive to litigate claims against authorization of parallel importation and grant of non-voluntary licenses. in the aforementioned case of south africa, for instance, when in 1997, after the outbreak of the hiv/aids epidemic, south african government attempted to authorize parallel importation of affordable medicines through a controversial legislative proposal,106 it triggered reaction of pharmaceutical companies. thirty nine multinationals, being the stakeholders in this matter, moved the high court of south africa whereby they challenged the constitutionality of the proposed amendment.107 102 south bulletin, ‘the doha declaration on trips’, 11. 103 in december 1998, the new york times reported that the median cost of u.s patent litigation was $1.2 million per side, whereas costs of litigation in complex cases were much higher. the largest component of these costs is attorney’s fee but it also includes expert witness fees, travel costs, and document management and production costs. for details visit <http://www.harborlaw.com/newsletters/november.pdf> accessed may 5, 2012. 104 james love, ‘compulsory licensing: models for state practices in developing countries, access to medicine and complince with the wto trips accord’, (2004), 5, doi:http://www.twnside.org.sg/title2/ipr/pdf/ipr06.pdf, accessed 20 march 2012. 105 ibid, 4. 106 section 15c was inserted into the south african medicines and related substances control act (mrsca). the primary purpose of this amendment was to enable south africa to benefit from lower prices abroad for the same drugs. for details visit <http://www.ncbi.nlm.nih.gov/pubmed/19555268>, accessed 27 april, 2012. 107 ‘ofeibea quist-arcton, south africa: battle against pharmaceutical giants continues’, 2001. for details visit <http://allafrica.com/stories/200104170346.html> accessed may 23, 2012. nordic journal of commercial law issue 2013#1 19 in this case, the multinationals had to drop their case due to outrage around the world from the general public, human rights groups, aids activists and consumer advocates108; otherwise one can imagine the potential litigation cost in this case. thirty-nine multinational pharmaceutical companies, including giants like bristol-myers squibb109 could easily afford the litigation cost but the governments of developing countries do not see much economic incentive in bearing such heavy costs of corporate litigation. in addition to the legal fee, such disputes impose considerable time costs on developing countries.110 although challenge was withdrawn in the aforementioned case due to intense public pressure, the potential threat of similar challenges still exists.111 governments of third world countries may therefore be reluctant to invoke compulsory licensing provisions keeping in view the considerably high potential costs of patent litigation and time costs. this consequently restricts the use of compulsory licensing. the giant multinational pharmaceutical companies have money and legal firepower to put a pressure on third world countries. in order to avoid spending huge amounts on costly patent litigation, the poor countries should do their homework and comply with national and international law on the issue before invoking compulsory licensing provisions. they should try their best to know and perform their obligations before resorting to compulsory licensing. they should enhance their technical expertise in the field of intellectual property laws to know the nitty gritty of the compulsory licensing mechanism and the legal ramifications involved in its use. 2.9 insufficient progress during transition period the trips agreement came into effect on 1st of january in 1995. the third world countries were, however, provided extended period for compliance with trips agreement keeping in view their technical, administrative, financial, and economic constraints.112 developing 108 third world network, ‘trips, drugs and public health’, 25. 109 bristol-myers squibb, is a pharmaceutical company, headquartered in new york city. the company was formed in 1989, following the merger of its predecessors bristol-myers and the squibb corporation. squibb was founded in 1858 in new york, while bristol-myers was founded in 1887 also in new york for further details visit <http://en.wikipedia.org/wiki/bristol-myers_squibb>,accessed may 23, 2012. 110 bird, ‘developing nations’, 213. 111 third world network, ‘trips, drugs and public health’, 26. 112 wto and the trips agreement. available online at <http://www.who.int/medicines/areas/policy/wto_trips/en/index.html> accessed may 24, 2012. nordic journal of commercial law issue 2013#1 20 countries were granted an extended period up to january 1, 2000. the least developed countries were given an initial extended period up to january 1, 2006. in november 2005, however, the wto member countries granted further transition period until july 1, 2013.113 later, the deadline for least developed countries was further extended to january 1, 2016.114 during the transition period, developing and least developed countries were exempted from the obligation of patent protection and data protection with regards to pharmaceutical products.115 the purpose behind granting this extended period was to provide time to these countries to make their national legislation and local practices compatible with the trips provisions and to develop their technological base before full compliance with the trips obligations. the transition period is even more significant from a public health perspective.116 these countries were provided time to develop their local pharmaceutical manufacturing capacity to avoid various practical implications of trips. but the third world especially the least developed countries failed to fully utilize the transition period. financial constraints may be an obvious reason for not achieving the fundamental objectives of the transition period. the united states’ annual expenditure on its patent and trademark office is about $1 billion.117 other developed countries also spend huge amounts of money on their patent examination mechanism. third world countries, especially least developed countries, can hardly afford to allocate huge sums in this regard. moreover, third world countries were dependent on the developed world to achieve objectives of the transition period because technology transfer was an integral component of the extended period. according to article 66, paragraph 2 of the trips and paragraph 7 of the doha declaration, the technologically advanced states are obligated to provide incentives to encourage transfer of technology to the least developed countries.118 it has been shown by the 113 richard j. hunter: hector r. lozada: frank giarratano and daniel jenkins, ‘compulsory licensing: a major ip issue in international business today?’, european journal of social sciences – volume 11, number 3 (2009), 372, last accessed date march 21, 2012, doi:http://www.eurojournals.com/ejss_11_3_03.pdf., 114 bird, ‘developing nations’, 211. 115 united nations industrial development organization, ‘transition period for least developed countries’, available online at <http://www.local-pharma-production.net/index.php?id=98> , accessed may 24, 2012. 116 south perspectives, ‘the use of flexibilities in trips by developing countries: can they promote access to medicines?’, (2006), last accessed date march 23,2012. http://www.southcentre.org/index.php?option=com_content&view=article&id=70%3athe-use-of-flexibilities-intrips-by-developing-countries-can-they-promote-access-to-medicines&catid=41%3ainnovation-technology-andpatent-policy&itemid=67&lang=en. 117 love, ‘compulsory licensing: models for state practices’, 4. 118 south bulletin, ‘the doha declaration on trips’, 10. nordic journal of commercial law issue 2013#1 21 available evidence that technologically advanced states failed to comply with article 66, paragraph 2 of the trips agreement.119 thus, not only third world countries but also the developed countries are equally responsible for not achieving the fundamental objectives of the transition period because they too did not meet their commitments made under article 66.2 of the trips agreement. article 68 of the trips agreement envisages establishment of ‘council for trips’ with the duty to monitor the operation of trips and compliance of member states with the provisions of the agreement.120 council for trips should make sure that legitimate interests of the poorer countries are protected and provisions of the trips are complied with by the powerful states. 2.10 risk of counterfeit drugs121 although, so far, the focus has been on implications which restrict poor countries from availing the flexibilities provided under the trips agreement, third world countries face certain problems even if they successfully invoke the compulsory licensing provisions despite all economic and political pressure. risk of falsely labeled substandard counterfeit drugs with little or no therapeutic value is one such issue associated with the use of compulsory licensing in the third world countries. purpose of granting a compulsory license by government of a poor country may be to promote access to affordable drugs for its citizens with low purchasing power, but this sometimes results in 119 unaids , ‘implementation of trips and access to medicines for hiv after 20 jan16: strategies and options for least developed countries’, (2011), 11,doi:http://www.unaids.org/en/media/unaids/contentassets/ documents/unaidspublication/2011/jc2258_techbrief_trips-access-medicines-ldc_en.pdf , accessed 20 march 2012. 120 odman, ‘using trips to make the innovation process work’, 27. 121 counterfeit drugs are products that are presented in such a way as to look like legitimate or genuine products although they are not that product. a counterfeit drug may contain inappropriate quantities of active ingredients, may contain ingredients that are not on the label, or may be supplied with inaccurate or fake packaging and labeling. for further details visit <http://en.wikipedia.org/wiki/counterfeit_medications> accessed may 24, 2012. nordic journal of commercial law issue 2013#1 22 prevalence of fake or counterfeit drugs. this mixing of fake and generic medicines122 undermines access to necessary medicines for underprivileged masses in the developing world. most of the african countries lack the capacity to manufacture drugs. they therefore import generic medicines from generic producers and are particularly concerned about falsified substandard drugs. according to a survey conducted by world health organization (who), about 30 percent of the sampled medicines for curing malaria taken from ethiopia, kenya, ghana, cameroon, nigeria, and tanzania did not meet international quality standards.123 the situation is not much different in the rest of the third world. world health organization (who) estimated that 25 percent of the total medicine consumed in the third world countries is counterfeit or substandard.124 the buyers in the low income countries can hardly distinguish between the generic copies of the patented drugs and the counterfeit or fake drugs. they purchase the falsified drugs which may prove silent killers because the counterfeit medicines are not only devoid of effect but may also contain toxic substances. consequently, anti-counterfeit laws are being proposed or enacted by many poor countries; kenyan anti-counterfeit act of 2008125 is just one example. efforts are being made at international level as well to curb global trade of fake products. in october 2011, for instance, developed countries including australia, new zealand, japan, canada, and the united states 122 generic medicines are legitimately produced medicines that are the same as original brand name products with the same active ingredients but that are manufactured without a license from the innovator company and marketed after the expiry date of the patent or other exclusive rights. although they may not be associated with a particular company, generic drugs are subject to the regulations of the governments of countries where they are dispensed. generic drugs are labeled with the name of the manufacturer and the adopted name (nonproprietary name) of the drug. since generic manufacturers do not bear any research and development cost but only the manufacturing cost, the drug produced under the compulsory license will almost always be cheaper than the patented drug. for details visit <http://en.wikipedia.org/wiki/generic_drug> accessed may 24, 2012. 123 ibid 2. 124world health organization, ‘‘substandard and counterfeit medicines’’, (2003doi:http://www.who.int/mediacentre/factsheets/2003/fs275/en/, accessed 24 may 2012. 125 in 2010, the high court of kenya suspended implementation of the act ‘in as far as it applies to generic medicines.’ the case was filed by three people living with hiv challenging sections 2, 32 and 34 of the act as unconstitutional. for details visit <http://afro-ip.blogspot.com/2010/04/kenyas-anticounterfeit-lawsuspended.html> accessed may 24, 2012. in august 2010, the kenyan anti-counterfeit act of 2008 was replaced by the kenyan anti-counterfeit regulations 2010. for details visit <http://www.coulsonharney.com/lawarticles/documents/the%20kenyan%20anticounterfeit%20regulations%202010%20-%2026102010.pdf> accessed may 24, 2012. nordic journal of commercial law issue 2013#1 23 signed a new international treaty called the anti-counterfeiting trade agreement (acta).126 in january 2012, the european union and 22 member countries of the european union also signed this treaty. practically, so far, developing world has not been able to curb the prevalence of falsified counterfeit drugs. some critics of compulsory licensing even suggest that instead of relying on compulsory licensing to gain access to drugs, governments of developing countries should buy patented products directly from the manufacturers at negotiated prices.127 risk of illness or death from the use of falsely labeled substandard counterfeit drugs with little or no therapeutic value can be reduced to some extent through consumer education about identification and hazards of counterfeit drugs. a consumer is less likely to buy a fake drug if he is familiar with his medicine and knows about side effects of the bogus drug. moreover, governments of developing countries may acquire and use modern technologies to identify the counterfeit drugs from genuine drugs because both may look exactly the same to the naked eye. further, manufacturers of branded drugs may use distinguishable features –like unique stickers which cannot be imitated easilyon packaging to help the consumer distinguish between fake and genuine drugs. furthermore, the law enforcement agencies should take action against laboratories manufacturing counterfeit drugs and pharmacies selling these fake drugs. 2.11 reducing incentives to innovate reduction in incentives to innovate is yet another drawback of non-voluntary licensing faced by third world countries. not only use but also the predictability of compulsory licensing has a negative impact on pharmaceutical innovation. the drugs can be divided into two broad categories: first, ‘global drugs’ like cancer drugs and hiv/aids vaccines that are primarily created for rich markets but are also needed by the developing world. second, the drugs that are needed only by poorer countries like drugs to treat tuberculosis or malaria.128 the drugs specific to third world are not priority of multinational pharmaceutical companies because of less financial gain. threat of non-voluntary licensing in the developing world further adds to the concerns of the multinationals rendering them extremely reluctant to initiate and carry out 126 dg expo policy department, ‘the anti-counterfeiting trade agreement (acta): an assessment’, (2008), european parliament, 8, doi:http://www.europarl.europa.eu/committees/en/studiesdownload.html?language document=en&file=43731, accessed 20 march 2012. 127 ‘fake drug progress in kenya and compulsory licensing’, (2010), available online at <http://afroip.blogspot.com/2010/09/fake-drug-progess-in-kenya-and.html> , accessed may 24, 2012. 128 chien, ‘cheap drugs at what price’, 892. nordic journal of commercial law issue 2013#1 24 research and development investment on pharmaceutical products specific to the poorer countries. when the multinationals are not willing to invest in poverty-related diseases because they do not consider it a profitable investment, private research-based pharmaceutical companies of the developing countries may play a vital role. but unnecessary use of non-voluntary licensing by the developing countries may adversely affect the private research-based pharmaceutical industry of the country.129 by establishing an appropriate correlation between profit and risk through careful use of compulsory licensing, developing countries may encourage their private researchbased pharmaceutical companies to invest in the third world specific ailments in the hope of monetary gain.130 appropriate laws and regulations should therefore be adopted by developing countries to make use of trips flexibilities. courts and patent offices of poor countries should act as vigilant stewards of public interest. no doubt developing countries can invoke compulsory licensing provisions to improve access to essential life-saving medicines, but this is a short term and emergency solution to public health crisis. developing countries should use it carefully to avoid undesirable potential consequences. developing countries should use all other available options to promote greater access before resorting to compulsory licensing only in grave situations of public health crisis. for instance, tariff barriers have effect on the prices of products imported into the country. high import tariff and other trade barriers raise the price of drugs and consequently have a disastrous effect on access to drugs. states faced with the public health crisis may lower tariffs on necessary medicines to reduce prices of such medicines. similarly, governments of developing countries may negotiate with the patented pharmaceutical manufacturers and request them to lower the prices on humanitarian grounds in situations of public health crisis. if the pharmaceutical companies are willing to help, governments of developing countries may buy patented products directly from the manufacturers at negotiated prices. 3 conclusion though wto, under trips, provided flexibilities to developing and under developed countries and over the period of time tried to facilitate the poorer countries to use such 129 reichman, ‘compulsory licensing of patented’, 7. 130 ibid, 4. nordic journal of commercial law issue 2013#1 25 flexibilities, still a lot of steps need to be taken to facilitate the member countries to effectively use the safeguards provided under trips in order to improve availability of necessary drugs at affordable prices. no doubt, compulsory licensing and parallel importation are effective legitimate tools in the hands of developing and least developed nations to provide essential drugs to their citizens; in order to avoid costly and needless litigation and to minimize negative effects, this tool should be used with extreme caution only after giving due consideration to compliance with municipal and international law and keeping in view the external political, social, and economic conditions. use of trips flexibilities may generate undesirable long-term effects on the economic development of the country. the reaction of the owners of a patent may be so serious that a developing or under developed country may face economic consequences. the pharmaceutical companies may mistrust such states and decide not to engage in foreign direct investment (fdi). this loss of foreign investment may be a heavy blow for the economic growth of a poorer country. thus, a state may have to pay quite a heavy price for improving access to needed medicines for its masses. to sum up, there are implementation gaps between theory and practice of trips flexibilities; wto member states have been provided flexibilities under trips agreement but third world countries are not able to avail the flexibilities due to numerous practical implications which restrict them from availing the legitimate flexibilities. the flexibilities are, in many instances, only provided in the statute books and do not serve the desired practical purpose. microsoft word bu_qingxiu.doc nordic journal of commercial law issue 2014#2 is it a new era of anti-bribery enforcement in china? by qingxiu bu* 1 *1 dr., senior lecturer sussex law school university of sussex, uk; adjunct professor, centre of transnational legal studies, georgetown university. nordic journal of commercial law issue 2014#2 abstract bribery harms the global playing field as it distorts fair completion, undermines honest practices and increases transactional costs, which results in significant uncertainty in transnational business. the chinese ministry of public security (mps)’ crackdown on the pharmaceutical company glaxosmithkline (gsk)’s bribery and corruption, signals a broad trend toward elevated scrutiny of all foreign corporations operating in china. the case of gsk serves as a timely wake-up call indicating that china’s anti-bribery law has shown its teeth against foreign multinational companies (mncs). gsk’s bribery may also invoke anticorruption enforcement across multiple major jurisdictions including both the u.s. and uk, as well as, china. the more global approach of enforcement agencies should incentivise greatly mncs to design and implement anti-bribery compliance programmes commensurate with their risk of corruption, with a particular regard to china’s unique business and legal culture. nordic journal of commercial law issue 2014#2 1 1 introduction bribery damages the long-term interests of both host and home countries as well as business itself. since china’s entry into the global anti-corruption enforcement arena, there has been a significant change in the enforcement landscape of its anti-bribery laws.1 china has enacted new laws aimed at targeting corporate bribery in the wake of a global crackdown on overseas corporate corruption.2 due to the increased allegations of fraudulent behaviour and ethical misconduct on the part of multinational companies (mncs), china has been targeting highprofile foreign mncs on multiple fronts with harsh enforcement against bribery.3 such an approach forces mncs to defend their reputation in china where international brands often have a valuable edge over local competitors in terms of public trust.4 part i introduces the contextual circumstances of china’s lucrative but corrupt business environment, which includes arbitrary enforcement as well as a general campaign against bribery and corruption. the case of gsk serves as an epitome of the current anti-bribery campaign against foreign mncs . part ii looks at china’s anti-bribery legal and regulatory framework, including the anti–unfair competition law (aucl 1993) and the the chinese communist party (ccp) disciplinary system, with a particular regard to an supreme people's procuratorate (spp) & supreme people’s court (spc)-jointly issued judiciary interpretation 2012 based on the criminal law of china.5 part iii examines the remit of the us foreign corrupt practices act (fcpa), clarifying some controversial issues like the scope of foreign officials, foreign issuers, affirmative defences and exceptions. it also partly explains whether gsk should be liable under the fcpa’s accounting and anti-bribery provisions. part iv moves to the uk bribery act 2010, widely perceived as the most stringent act in the anti-bribery arena. however, doubt is cast as to whether an adequate procedure could shield the firm covered from its strict liability under section 7 under uk bribery act 2010. part v challenges gsk’s internal compliance procedures and argues that gsk may not rely on the “rogue employee defence” established in the case of morgan stanley, in which vigorous compliance programmes have averted the us enforcement actions against the firm. before 1 p.r. china ratified the united nations convention against corruption (uncc) in january 2006; elizabeth k. spahn, ‘multijurisdictional bribery law enforcement: the oecd anti-bribery convention’ (2012) 53 (1) virginia journal of international law 1, 52: “although china is not yet an oecd convention member state, it enacted domestic laws criminalizing bribery of foreign officials abroad in 2011.” 2 bribery act 2010; the foreign corrupt practices act of 1977, as amended, 15 u.s.c. §§ 78dd-1, et seq 3 michael martina, ‘glaxosmithkline routed china bribes through travel agencies–police’ reuters (15 july 2013) 4 cong dai and min jiang, ‘gsk executives admit to bribery and tax crimes, china claims’ british medical journal (18 july 2013) <http://www.bmj.com/content/347/bmj.f4541/rr/654217> 5 on 26 december 2012, the spc and spp jointly promulgated the interpretation of several issues concerning the application of law for handling bribery cases ( interpretation 2012) which became effective on 1 january 1 2013. the judicial interpretation includes significant provisions regarding entities who offer bribes as well as monetary thresholds for criminal prosecution. nordic journal of commercial law issue 2014#2 2 turning to the general conclusion, part vi explores how a foreign multinational could make its global compliance programmes compatible in china’s unique business environment. among other things, it is indispensable for the mncs to undertake risk-based due diligence on overseas third parties as well as their subsidiaries. 2 context 2.1 a most lucrative pharmaceutical market as one of the most important markets for future growth, china is too lucrative a market to resist. building personal relationships (guanxi), which is tantamount to bribery, is critical for successfully doing business in china, and thus engrained in chinese business culture.6 business courtesies constitute a grey area and the complexities of china's hospital and pharmaceutical network make it particularly thorny for foreign mncs to navigate.7 in addition, china’s healthcare system is controlled and owned by the state, along with a rooted practice of government patronage and gift-giving.8 the pharmaceutical manufacturers are more likely to encounter corruption, as such an area is characterised by a high preponderance of state-owned customers.9 more contentiously, china prefers discretionary administrative policy to predictability, opacity to transparency and decentralised enforcement of the law, which provides incentives for rent-seeking behaviour.10 previously, much foreign anti-bribery enforcement did not trigger an investigation in china. with the chinese agencies reshaping its enforcement landscape, a number of world’s largest pharmaceutical companies have been facing corruptions investigation over claims of bribery. china, being one of the fastest growing emerging markets is expected to overtake japan as the world's second biggest pharamceutical market behind the united states by 2016.11 sales of 6 benjamin shobert and damjan denoble, ‘compliance after china’s healthcare bribery scandals’ china business review (10 october 2013) 7 seung ho park and wilfried r. vanhonacker, ‘the challenge for multinational corporations in china: think local, act global’ mit sloan management review (1 july 2007) 8 ‘glaxo looks into alleged bribery of chinese doctors’ shanghai business review (13 june 2013) 9 r. christopher cook, ‘the foreign corrupt practices act: enforcement trends in 2010 and beyond’ (january 2010) <http://www.jonesday.com/the-foreign-corrupt-practices-act-enforcement-trends-in-2010-and-beyond-01-122010/> 10 nathan bush, ‘corruption & fraud in china: challenges for us companies & investors’ (29 august 2011) <http://www.law.berkeley.edu/13597.htm> 11 kazunori takada, ‘china to launch fresh pharmaceutical bribery probe’ cnbc (14 august 2013) nordic journal of commercial law issue 2014#2 3 pharmaceuticals in china reached $82 billion in 2012, up 18.2% from 2011.12 china’s health costs are expected to double and the demand for drugs will boom, which is projected to rocket from $357 billion in 2011 to $1 trillion in 2020.13 china is an increasingly important market for international pharmaceutical companies drug makers, such as gsk, which rely on growth in emerging markets to offset slower sales in western markets with the loss of patent protection for key treatments.14 gsk earned $1.42 billion from china in 2012, and has five manufacturing plants in the country employing 5000 people. although it generates only 3% of gsk’s global revenues, china represents one of the fastest-growing drug markets.15 its revenue in china rose 17% in 2012 to nearly $1.2 billion, compared with growth rates of 11% in latin america and 10% in india.16 however, it is important to be aware of the unique chinese business environment where the giant pharmaceutical firm has generated this impressive growth. 2.2 a corrupt business environment? 2.2.1 the pervasive corruption in the chinese market bribery and corruption are rampant in china.17 personal relationships are indispensible in china which is different from other jurisdictions, and the concept of business ethics is an oxymoron.18 corruption is thought to be endemic in wide swaths of the chinese health industry, and is perceived as a cost of doing business.19 the line is often blurred between what is appropriate and what is perceived as bribery.20 the acquiescence to china’s corrupt environment, however, can be a double-edged sword in that foreign mncs’ agents may view 12 laurie burkitt and jeanne whalen, ‘china targets big pharma’ the wall street journal (16 july 2013) 13 ‘big pharma in a little trouble in china’ economist (12 july 2013) 14 ian walker, ‘glaxosmithkline profit slips, too early to quantify china impact’ the wall street journal (24 july 2013); ‘glaxosmithkline executives in china confess to bribery and tax violations’ guardian (11 july 2013) 15 leslie hook and andrew jack, ‘gsk is test case in china’s rules laboratory’ financial times (15 july 2013) 16 gsk, ‘gsk delivers 2012 core eps of 112.7p and returns £6.3 billion ($10.2billion) to shareholders’ (6 february 2013) <http://www.gsk.com/content/dam/gsk/globals/documents/pdf/investors/quarterly-results/2012/q4-2012results-announcement.pdf>; david barboza, ‘glaxosmithkline is investigated in china’ the new york times (1 july 2013); michael martina, ‘compliance the buzzword for foreign firms in china after glaxo’ reuters (17 july 2013) 17 jamil anderlini and tom mitchell, ‘bribery built into the fabric of chinese healthcare system’ financial times (24 july 2013) 18 stanley lubman, ‘business in china: what does ‘playing by the rules’ mean?’ the wall street journal (22 december 2009) 19 virginia harrison, ‘china scandal takes toll on glaxo’ cnnmoney (23 october 2013) 20 steven r. salbu, ‘transnational bribery: the big questions’ (2001) 21 (2) northwestern journal of international law & business 435, 470 nordic journal of commercial law issue 2014#2 4 bribery as endemic to chinese business, and therefore tend to tolerate insufficient compliance with chinese and foreign anti-bribery laws.21 although foreign mncs may need to adapt to the local environment, they must retain their own values.22 it is worth identifying certain social, economic and institutional factors that contribute to the corrupt environment in china. business courtesies constituting a customary fixture of normal business conduct can present challenges in china, where relationship building drives successful business developments.23 as a result, china is a high-risk country where offering cash bribes and kickbacks are widespread; bribery and business go hand-in-hand in china.24 transparency international (ti) ranked china the 80th out of 176 countries in its 2012 corruption-perceptions index (cpi), which reflects how outsiders perceive levels of corruption in china.25 arguably, chinese doctors do not swear the hippocratic oath, and their motivations for professional assistance are financially driven rather than being based upon a moral creed.26 the bribing of doctors by pharmaceutical companies is an "open secret" in china.27 chinese patients must have a doctor’s prescription to buy regulated medicine, and pharmaceutical sales persons meet regularly with doctors to promote their products.28 it is common practice for pharmaceutical firms to offer doctors and hospitals bribes to have their products used. one of the primary concerns for mncs is to balance the embedded and pervasive culture of gift-giving in china with foreign anticorruptionlaws.29 foreign mncs must renew their focus on strengthening global compliance programmes to ensure that they are not exposed to such vulnerabilities.30 apart from the fertile 21 michael martina ‘compliance the buzzword for foreign firms in china after glaxo’ reuters (17 july 2013) 22 kirk o. hanson and stephan rothlin, ‘taking your code to china’ (2010) 3 (1) journal of international business ethics 69, 80 23 f. joseph warin, michael s. diamant and jill m. pfenning, ‘fcpa compliance in china and the gifts and hospitality challenge’ (2010) 5 virginia law & business review 33, 35 24 feng jing, ‘combating commercial bribery’ beijing review (25 may 2006); “in china’s pharmaceutical industry, kickbacks for pharmaceuticals alone approach ¥rmb772 million $126million) of state assets every year, an amount equivalent to approximately 16% of the tax revenue for the whole pharmaceutical industry.” 25 transparency international ‘corruption perceptions index 2012’ (december 2012) <http://www.transparency.org/cpi2012/results> 26 dezan shira, ‘why corruption is inevitable in china’s pharmaceutical industry’ caijing (25 july 2013) 27 hongyi wang and zhenghua wang, ‘gsk corruption claims trigger wider concerns’ china daily (3 july 2013) 28 christopher matthews and jessica hodgson, ‘glaxe probes china bribe claims’ fidelity (12 june 2013) 29 susan rose-ackerman, ‘corruption: greed, culture, and the state’ (2010) 120 the yale law journal online 125, 140 30 samer korkor and nicole saleem, ‘enforcement of the foreign corrupt practices act in the healthcare industry and foreign bribery’s adverse consequences for patients’ (2013) 74 ohio state law journal furthermore 23, 40 nordic journal of commercial law issue 2014#2 5 soil for corruption in the pharmaceutical industry, the chinese fragmented drug licensing system provides ample opportunity for rent seeking.31 2.2.2 institutional framework: a highly-regulated market corruption in the drugs business is a direct result of the regulatory landscape controlling the sale and prescription of drugs.32 the government control of china’s health-care system increases the risks for foreign companies.33 drug prices are set by the chinese authorities, which dictate the margin structure for the state-controlled distributors as well as sub-distributors and hospitals.34 some chinese officials often solicit or expect a “facilitation payment” merely for doing their routine job.35 the direct or indirect extortion put foreign mncs in a dilemma, that is, either taking the risk of prosecution or refusing to pay or risk adverse consequences for the business. as local entities are not similarly constrained by stringent anti-bribery laws, a western firm may incur significant costs to avoid the risk of their home law, which arguably puts western companies at a disadvantage.36 in an era when the chinese market is increasingly important, some over-eager mncs may be tempted to bend the rule of zero tolerance for corruption so as to avoid being left out of business opportunities.37 this may, to some extent, explain why gsk has failed to make its global compliance procedures compatible to china’s more challenging business environment. 2.3 arbitrary prosecution: protectionism or politically-driven prosecution? mncs may complain that they have been penalised selectively. it is worth ascertaining whether the investigations are driven politically or in a protectionist way. nationalism and protectionism have played a part which should not be overestimated. first, foreign mncs may feel like scapegoats, in part, in reaction to the economic downturn and, in part, in an attempt to deflect attention from 31 leslie hook, ‘unorthodox injections sustain china’s healthcare system’ financial times (16 july 2013) 32 dezan shira, ‘why corruption is inevitable in china’s pharmaceutical industry’ caijing (25 july 2013) 33 samuel rubenfeld, ‘chinese health-care system rife with corruption risks’ the wall street journal (2 may 2012); hannah beech, ‘how corruption blights china’s health care system’ time (2 august 2013) 34 ‘china’s bitter medicine for foreign drug companies’ <http://knowledge.wharton.upenn.edu/article/chinas-bitter-medicine-foreign-drug-companies/> 35 emily n. strauss, ‘easing out” the fcpa facilitation payment exception’ (2013) 93 (1) boston university law review 235, 273 36 irina sivachenko, ‘corporate victims of "victimless crime": how the fcpa's statutory ambiguity, coupled with strict liability, hurts businesses and discourages compliance’(2013) 54 (1) boston college law review 393, 431 37 richard mcgregor, the party: the secret world of china's communist rulers (harper perennial, 2012) 122 nordic journal of commercial law issue 2014#2 6 china’s own domestic drug concerns.38 the slower economic growth may serve to fuel the public resentment toward those foreign multinationals that are scooping substantial profit. with china’s accession to the world trade organisation (wto), some of the more flagrant barriers imposed against foreign mncs trying to compete on a very uneven playing field have been softened.39 as a result, chinese pharmaceutical companies often find themselves put at a disadvantage against their foreign counterparts with world-known brands and reputations.40 second, china has achieved its goals of accumulation of capital. it is a transformative period for the country to upgrade its technology and improve governance capacity. it is also the time for china to realise its vast economic potential primarily by stimulating its domestic consumption instead of relying heavily on exports and investment.41 the time has passed since china had to queue up to attract mncs, with super-national treatments; such as the offering of tax breaks. in this vein, mncs need china more than china needs them.42 when looking for easy targets to fulfil their quotas of corruption-bashing, local officials may find it simpler to pick on foreign firms than on local ones that have interwoven connections with local or national politicians.43 although an element of nationalism and even protectionism cannot be rooted out, it would not be wise to attribute bribery to such an excuse. the judicial system in china is highly politicised.44 the chinese communist party (ccp) has effectively institutionalised an entire ecosystem of crony capitalism, which renders business and politics tightly intertwined.45 the chinese government is keen to cut the prices of medicines whilst trying to provide universal access to healthcare. the rising cost of pharmaceuticals and medical devices have been sparking widespread frustration, with national healthcare expenses expected to reach $1 trillion annually by 2020.46 cost-effective health care represents a critical and challenging 38 simon denyer, ‘amid attacks by chinese government and media, foreign companies get mixed signals’ the washington post (9 august 2013) 39 dezan shira, ‘why corruption is inevitable in china’s pharmaceutical industry’ caijing (25 july 2013) 40 shubha ghosh and brad luo, ‘protection and enforcement of well-known mark rights in china: history, theory and future’ (2009) 7(2) northwestern journal of technology and intellectual property 119, 161 41 mj deen and nicholas ward, ‘china pivots its growth strategy to focus on domestic consumption’ financial post (21 february 2012) 42 james moore, ‘multinationals, like gsk, now need china more than china needs them.’ the independent (16 july 2013) 43 ‘glaxosmithkline in china: bitter pill’ the economist (20 july 2013) 44 victor nee and sonja opper ,’on politicized capitalism’ in victor nee and richard swedberg (eds.) on capitalism (stanford, stanford university press, 2007) 93-127 45 david barboza and sharon lafraniere, ‘princelings in china use family ties to gain riches’ the new york times (17 may 2012) 46 franck le deu, rajesh parekh, et al., ‘healthcare in china: entering uncharted waters’ (september 2012) <http://www.mckinseychina.com/wp-content/uploads/2013/04/mckinsey-healthcare-in-china.pdf> nordic journal of commercial law issue 2014#2 7 policy objective, thus, the government’s legitimacy would be jeopardised were it not to deliver affordable and accessible healthcare.47 2.4 crack-down on bribery: a toothless watchdog? there has been more enforcement by the u.s. agencies under the fcpa against western firms operating in china than by the chinese government itself.48 the u.s. department of justice (doj) has aggressively pursued the pharmaceutical industry for violating the fcpa. some multinational pharmaceutical giants were penalised for alleged fcpa violations based on their bribery in china. for instance, pfizer inc., johnson & johnson and eli lilly, have all reached fcpa settlements in recent years.49 although the corrupt business practices of the pharmaceutical giants were heavily penalised by the securities and exchange commission (sec) as well as the department of justice (doj), most of the incidences of the high profile china-related fcpa cases have turned up no parallel chinese investigations, and have gone unpunished by the chinese enforcement agencies.50 the chinese authorities have focused more on punishing bribe recipients than bribe givers,51 resulting in few actions against foreign mncs paying bribes in china. they have finally escaped scrutiny largely because the antibribery agencies have typically not prosecuted non-chinese companies for violations of law 47 michael martina, ‘compliance the buzzword for foreign firms in china after glaxo’ reuters (17 july 2013) 48michael b. runnels and adam m. burton, ‘the foreign corrupt practices act and new governance: incentivising ethical foreign direct investment in china and other emerging economies’ (2012) 34 cardozo law review 295, 327 49 doj, ‘pfizer h.c.p. corp. agrees to pay $15 million penalty to resolve foreign bribery investigation’ (7 august 2012) <http://www.justice.gov/opa/pr/2012/august/12-crm-980.html>; sec, ‘sec charges pfizer with fcpa violations’ (7 august 2012) <http://www.sec.gov/news/pressrelease/detail/pressrelease/1365171483696#.ugo2itjaze0>: in pfizer/wyeth, employees allegedly used bribes to influence doctors at state-owned hospitals to recommend wyeth nutritional products, ensure that the products were made available to new mothers at the hospitals. pfizer paid a $60 million fine in 2012 to settle allegations of making improper payments to government officials and physicians in china. sec, ‘sec charges johnson & johnson with foreign bribery: j&j to pay $70 million to settle cases brought by sec and criminal authorities’ (7 april 2011) <http://www.sec.gov/news/press/2011/2011-87.htm>; sec, ‘sec charges eli lilly and company with fcpa violations’ (20 december 2012) <http://www.sec.gov/news/pressrelease/detail/pressrelease/1365171487116#.ufe2qm3f2um>:employees from the company’s china subsidiary had “falsified expense reports in order to provide gifts and cash payments to government-employed physicians,” which resulted in a settlement that eli lilly had agreed to pay a $29 billion fine. 50 rachel beller, ‘whistleblower protection legislation of the east and west: can it really reduce corporate fraud and improve corporate governance? a study of the successes and failures of whistleblower protection legislation in the u.s. and china’ (2011) 7 new york university journal of law and business 873, 929 51 ‘former head of chinese drug watchdog appeals death sentence’ people’s daily (12 june 2007); one of the most striking cases in the pharmaceutical industry was that xiayu zheng, former director of china’s state food & drug administration (sfda). he was executed in 2007 after being convicted of taking bribes of ¥rmb 6.49 million $1.06million) in return for approving hundreds of new medicines, some of which proved to be dangerous. nordic journal of commercial law issue 2014#2 8 involving corruption of public officials.52 as transparency international observed, “the ineffectiveness of government regulation was initially caused by china’s sole emphasis on fighting the “demand side of corruption,” which involved close regulation of public officials but ignored the actions of the private sector “suppliers of corruption.”53 despite rampant corruption, the chinese government has not efficiently prosecuted and punished such conduct. the lack of enforcement against foreign violators left observers thinking that the chinese antibribery laws were little more than a “legal sleeping dog.”54 this imbalance has begun to change in recent years with the chinese government launching a campaign to crack down on foreign mncs’ bribery activities.55 the scrutiny of the mncs operating in china has been heightened.56 multinational pharmaceutical companies in china face increasing challenges given that corruption is rampant in china’s health system. although the crackdowns should be seen in a broader context and as a manifestation of developments in the legal arena,57 the chinese enforcement agencies are likely to take a hard line with foreign firms and show the teeth of its anti-bribery laws, especially in those markets that have a direct and immediate nexus to chinese consumers.58 the case of gsk represents a notable development because it reshaped china’s traditional corruption investigations, demonstrating that the enforcement agencies will target bribers as well as officials receiving bribes.59 52 daniel chow, ‘the interplay between china’s anti-bribery laws and the foreign corrupt practices act’ (2012) 73 (5) ohio state law journal 1015, 1037 53 transparency international, ‘global corruption report 2009: corruption and the private sector 254; rachel beller, ‘whistleblower protection legislation of the east and west: can it really reduce corporate fraud and improve corporate governance? a study of the successes and failures of whistleblower protection legislation in the u.s. and china’ (2011) 7 new york university journal of law and business 873, 929 at 885 54 matthew shabat, ‘sec regulation of attorneys under the foreign corrupt practices act: decisions on efficiency and their role in international anti-bribery efforts’ (1999) 20 (4) university of pennsylvania journal of international law 987, 999 55 benjamin olken and rohini pande, ‘corruption in developing countries’ (2012) 4 annual review of economics 479, 509 56 tom fox, ‘gsk in china, a game changer in compliance’ corporate compliance insights <http://www.corporatecomplianceinsights.com/gsk-in-china.pdf> 57 david b. wilkins and mihaela papa, ‘the rise of the corporate legal elite in the brics: implications for global governance’ (2013) 54 (3) boston college law review 1149, 1184 58 kirk o. hanson and stephan rothlin, ‘taking your code to china’ (2010) 3 (1) journal of international business ethics 69, 80 59 freshfields and bruckhaus deringer, ‘anti-bribery and corruption: frontier market and global enforcementan update on legislative and enforcement developments, 2013’ (september 2013) nordic journal of commercial law issue 2014#2 9 3 ministry of public security (mps) v glaxosmithkline (2013) 3.1 does gsk have clean hands? gsk has been involved in widespread bribery between 2004 and 2010,60 during which gsk's china sales staff provided doctors with speaking fees, cash payments, lavish dinners and allexpenses-paid trips in return for prescribing medication. despite gsk’s guarantee of operating ethically and with high standards of integrity, the chinese ministry of public security (mps) charged gsk for breaching the anti-bribery laws based on substantial evidences that the firm had used travel agencies as vehicles to commit the flagrant and repeated bribery. the charges against gsk resemble those leveled at other pharmaceutical mncs by the sec and doj,61 which have been looking into possible violations of the u.s. foreign corrupt practices act (fcpa) relating to sales in china since 2010. gsk paid $3 billion according to a healthcare fraud settlement on 2 july 2010.62 the penalty illustrates the upward trend toward increased enforcement and harsh penalties.63 gsk has been seeking to repair its corporate image after multibillion-dollar settlements with u.s. regulators tied to drug-marketing tactics, where the company admitted that its marketing practices relating to some of its drugs were illegal.64 it is also executing a five-year corporate integrity agreement, requiring major changes in the way its sales force does business.65 it seems that gsk has not been snagged in law that creates a double standard for its business practices. just one year after the criminal and civil charges of its off-label marketing and related unlawful promotion of prescription drugs,66 gsk has allegedly uncovered bribery involving $450 million that had been funnelled through more than 700 travel agents and other third parties during the last six years.67 it has used bribes, kickbacks and other fraudulent means to bolster drug sales in china. on 11 july 2013, the ministry of public security (mps) lodged a new investigation into the firm. the acceptance of kickbacks from the travel agents or other 60 laurie burkitt and jeanne whalen, ‘china targets big pharma’ the wall street journal (16 july 2013) 61 peter j. henning, ‘be careful what you wish for: thoughts on a compliance defence under the foreign corrupt practices act’ (2012) 73 (5) ohio state law journal 883 62 doj, ‘glaxosmithkline to plead guilty and pay $3 billion to resolve fraud allegations and failure to report safety’ (2 july 2012 <http://www.justice.gov/opa/pr/2012/july/12-civ-842.html> 63 robert c. blume and j. taylor mcconkie, ‘navigating the foreign corrupt practices act: the increasing cost of overseas bribery’ (1997) 36 (8) the colorado lawyer 91, 100 at 97 64 doj, ‘glaxosmithkline to plead guilty and pay $3 billion to resolve fraud allegations and failure to report safety data’ (2 july 2012) <www.justice.gov/opa/gsk-docs.html>; jeanne whalen, devlin barrett and peter loftus, ‘glaxo in $3 billion settlement’ the wall street journal (3 july 2012) 65 wayne m. carlin, ‘white collar and regulatory enforcement: emerging trends and what to expect in 2013’ the harvard law school forum on corporate governance and financial regulation (30 january 2013) 66 duff wilson, ‘glaxo settles cases with u.s. for $3 billion’ the new york times (3 november 2011) 67 peter henning, ‘lessons from the glaxo case in china’ the new york times (29 july 2013) nordic journal of commercial law issue 2014#2 10 third parties by such executives has constituted another violation of chinese criminal law (ccl), since the payment or benefit far exceeded the threshold value of ¥rmb 5,000 ($816).68 gsk’s reputation has been substantially tarnished. it may be worth examining how much of this allegation has been driven by anti-bribery efforts and how much of it is politicallymotivated.69 however, it is not well-justified that the case against gsk represents the targeting of foreign companies in competition with domestic industry, rather than an overarching crackdown on corrupt practices. nevertheless, challenging the anti-bribery prosecution will make little sense. “when in rome, do as the romans”, constitutes quite a weak defence in criminal proceedings anywhere. despite bribery being widely considered as a most common practice in china’s hyper-competitive pharmaceutical markets, it does not mean that foreign mncs should engage in it. a better practice would be that the foreign mncs strengthen their global compliance programmes to ensure that they are not exposed to similar vulnerabilities in the increasingly stringent anti-bribery environment. 3.2 parallel prosecutions as possible parallel investigations unfold, mncs will have to pay more attention to their bribery risk management under chinese anti-bribery law, which presents some unique challenges. the charges against gsk may again lead to serious penalties. gsk’s holdings and business are under the jurisdiction of the fcpa and the uk bribery act 2010, as well as china’s anti-corruption laws. the breadth of gsk’s activities could make the company vulnerable to enforcement action by both the uk's serious fraud office (sfo) and the us department of justice (doj), which can levy heavy penalties under their sweeping respective anti-bribery laws if they find evidence of wrongdoing.70 the charges of bribery make the gsk case the highest profile probe in china since four executives of mining giant rio tinto plc were jailed in march 2010 for taking bribes and stealing commercial secrets.71 the current prosecution of gsk is apparently the first such parallel investigation undertaken by the chinese government. it provides further evidence that extraterritorial enforcement of anticorruption laws is not limited to u.s. government actions. this does not only signal the end of that inaction era and the beginning of an industry-wide enforcement sweep, but also signal an 68 ccl article 163 69 susan rose-ackerman, ‘international actors and the promises and pitfalls of anti-corruption reforms’ (2013) 34 (3) university of pennsylvania journal of international law 447, 489 70 kathrin hille and john aglionby ‘china accuses gsk of bribing officials’ financial times (11 july 2013) 71 david barboza, ‘china sentences rio tinto employees in bribe case’ new york times (29 march 2010); the four executives received jail terms of between seven and 14 years after being found guilty of getting information from confidential strategy meetings of the body representing china's steel industry in negotiations with iron ore suppliers. nordic journal of commercial law issue 2014#2 11 inclination by the chinese government to affirmatively pursue anti-bribery cases.72 foreign mncs should wake up and accept such a reality that china’s anti-bribery agencies do not turn a blind eye to flagrant breaches of its anti-bribery laws any more. to join the global fight against corruption, china has updated its laws to reflect the developing global standard in anticorruption enforcement. a brief overview of anti-bribery laws in china is next. 4 the anti-bribery framework in china 4.1 the chinese criminal law on anti-bribery the flagrant bribery and corruption have posed a fundamental challenge to the legitimacy of the chinese communist party (ccp),73 which could cause “the collapse of the ccp” and the downfall of the state.74 in response, china has instituted complex anti-bribery laws from criminal and administrative penalties to disciplinary regimes for ccp members to the standard adjudication process. the system consists of two main parts: the principal piece of chinese criminal law (ccl) and the anti-unfair competition law (aucl 1993). the latter prohibits business parties from engaging in "commercial bribery" by giving money or property to another business operator or individual for the purpose of selling or purchasing goods.75 firms are forbidden to give ‘money or property’ for the purpose of gaining a competitive advantage.76 a bribery case under the aucl 1993 is investigated by the state administration of industry and commerce (saic).77 in addition, it appears that the ccp regulations on disciplinary penalties prohibit any official from accepting ‘any gift that might affect his impartial exercise of a public function’ without registering receipt of the gift and surrendering it to the state.78 the perceived lack of specificity and guidance in the ccl confers considerable discretion to chinese enforcement agencies.79 the spc and the spp jointly promulgated a judicial interpretation on 72 amy l. sommers and matt t. morley, ‘multinational executives detained in china due to bribery concerns’ legal insight (26 july 2013) 73 michael j. boskin, ‘the global stake in china’s anti-corruption reform’ project syndicate (10 september 2013) 74 jaime a. florcruz, ‘corruption as china’s top priority’ cnn (7 january 2013) 75 aucl 1993 article 8 76 the aucl was adopted in the 3rd session of the standing committee of the 8th national people’s congress (npc) on 2 september 1993 and came into effect on 1 december 1993. 77 aucl 1993 article 3 78central commission for discipline inspection (ccdi), ccp regulations on disciplinary penalties (18 february 2004) <http://news.xinhuanet.com/weekend/2004-02/18/content_1320429.htm>; patrick norton, ‘the foreign corrupt practices act: a minefield for us companies in china’ china law & practice (november 2004) 79 irina sivachenko, ‘corporate victims of "victimless crime": how the fcpa's statutory ambiguity, coupled with strict liability, hurts businesses and discourages compliance’(2013) 54 (1) boston college law review 393, 431 nordic journal of commercial law issue 2014#2 12 several issues concerning the specific application of the law in the handling of criminal cases of bribery on 26 december 2012 (spc & spp interpretation 2012).80 there are a number of provisions incorporated under the ccl that relate to bribery of public officials for an improper interest.81 it constitutes a crime for a person to give "money or property”82 to a state functionary for the purpose of obtaining an undue advantage.83 the ccl defines ‘state functionaries’ as individuals of government agencies who are engaged in public service.84 pursuant to interpretation 2012, the threshold for a bribe to a state functionary that will trigger a criminal investigation is ¥rmb 10,000 ($1632).85 more specifically, the threshold for bribery to constitute an offence is ¥rmb 10,000 ($1632) where committed by an individual,86 and ¥rmb 200,000 ($32639) by companies.87 the ccl does not contain an exception for facilitation payments.88 china has updated its criminal laws to reflect the developing global standards in anti-bribery enforcement.89 given these rather general standards and broad prosecutorial discretion, fashioning a set of compliance rules that are not only effective in avoiding the legal pitfalls, but also practical and realistic as a business matter will be difficult.90 80 the interpretation 2012 was adopted respectively by the spc trial committee decree 1547 on 14 may 2012 and spp procurator committee decree 77 on 21 august 2012. it came into force on 1 january 2013. 81 ccl articles 389-393 82supreme people’s court (spc) and the supreme people’s procuratorate (spp), opinion on some issues concerning the application of the law in criminal commercial bribery cases (20 november 2008): the concept of “property” in the crime of bribery under the ccl was clarified to include any “property interest” that can be quantified with a monetary value. 83 ccl articles 389 84 ccl article 93 85 spc&spp interpretation 2012 article 1; ccl article 390 86 ccl articles 164, 389 87 ccl article 391; spp, the threshold for criminal prosecution in bribery cases (22 december 2000) 88 the amendments to the criminal law of the people’s republic of china (viii) was promulgated by the standing committee of the national people’s congress on 25 february 2011, and became effective on 1 may 2011. <http://www.npc.gov.cn/huiyi/cwh/1119/2011-02/25/content_162 5618.htm>; bribery act 2010 s6 89 the newly enacted amendment of prc criminal law adds a second provision to article 164 that criminalizes bribes given to foreign public officials or officials of an international public organization, which came into effect on 1 may 2011. 90 william l. rosoff and yuanming wang, ‘recent developments in chinese anti-bribery laws and enforcement’ (6 august 2013) <http://cdn.akingump.com/images/content/2/4/v2/24261/recent-developments-in-chineseantibribery-laws-and-enforcement..pdf> nordic journal of commercial law issue 2014#2 13 4.2 spc & spp judicial interpretation 2012 under the ccl, the severity of punishment of individuals for bribing government officials depends on the degree of culpability.91 the interpretation 2012 sets out some factors and financial thresholds that will determine the level of ‘seriousness’ of the bribery offence, with associated penalties for each categorisation from ‘serious’,92 to ‘extraordinarily serious’.93 the crime of bribery is “extraordinarily serious” if the amount proffered is more than ¥rmb 1 million ($163,192);94 or if the amount proffered is more than ¥rmb 500,000 ($81,596), but less than ¥rmb1 million($163,192,95 and the defendant has paid bribes to (i) more than three people;96 (ii) to government officials who are responsible for supervising and administering matters in relation to food, pharmaceuticals, manufacturing safety or the environment, etc. that endanger public health or the security of public property;97 (iii) to a judicial or administrative authority, thereby interfering with administrative law enforcement and judicial justice;98 or (iv) the bribes are sourced from the offender’s illegal gains.99 for instance, individuals found to have engaged in “extraordinarily serious” bribery face lifetime imprisonment. 100 the chinese enforcement agencies usually charge individuals, largely because of complex pre-conditions for charging an enterprise.101 although the prosecution of companies, as opposed to individuals, has been far less frequent for various evidentiary and technical reasons, the government has now fully implemented a database that documents all cases of convictions for bribery and lists all parties involved, whether or not those parties have been criminally pursued.102 this makes greater sense because it is much easier for foreign 91 ccl article 390: (i) payment of bribes is punishable by imprisonment of one month to five years; (ii) if the circumstances are severe or if severe damage has been caused to the interests of the state, punishment is increased to between 5 and 10 years of imprisonment; and (iii) if the circumstances are extraordinarily severe, the defendant is subject to imprisonment of more than 10 years or life imprisonment and all of his/her property may also be confiscated. 92 spc&spp interpretation 2012 article 2 93 spc&spp interpretation 2012 article 4 94 spc&spp interpretation 2012 article 4 (1) 95 spc&spp interpretation 2012 article 4 (2) 96 spc&spp interpretation 2012 article 4 (2) (i) 97 spc&spp interpretation 2012 article 4 (2) (iii) 98 spc&spp interpretation 2012 article 4 (2) (iv) 99 spc&spp interpretation 2012 article 4 (2) (ii) 100 ccl article 390 101 daniel chow, ‘china under the foreign corrupt practices act’ (2012) 2 wisconsin law review 573, 607 102 spp, centralizes database of bribery convictions (16 february 2012) nordic journal of commercial law issue 2014#2 14 mncs to undertake their risk assessment to avoid potential successor liability. furthermore, «major loss to the national interest»103 shall be deemed to have been caused to the interests of the state if the direct economic losses are more than ¥rmb1million ($163,192).104 the interpretation 2012 clarifies a number of key terms and issues under the ccl with respect to paying bribes and the consequence of the criminal liability. it provides long-awaited guidance and fills gaps in the ccl, with precise financial thresholds and specified aggravating circumstances to assist the courts in producing fair and predictable decisions. 4.3 implication from the distinction between the ccl and the interpretation 2012 despite the lack of separation of powers in china, the spc plays a pivotal role in china’s judicial practice, with a particular regard to its indispensable guidance in the judicial enforcement.105 arguably, the spc is not constitutionally mandated with the power to interpret the law, but issues statute-like judicial interpretations only when the npc delegates it the power to do so.106 generally, interpretation 2012 is equivalent to law, although it cannot make new rules without the existing legal ground.107 the interpretation 2012 does provide significant insight into how chinese judicial organs interpret key principles of anti-bribery laws. the more detailed guidance allows lower-level courts to make more consistent and predictable decisions. in this vein, the judicial interpretation helps to insure national standards of justice. furthermore, judicial interpretation enables the court to adapt promptly to legal developments without necessarily revising the relevant laws through the npc.108 given china’s long standing civil law jurisdiction, however, the interpretation 2012 may impede judges to exercise their discretions in making a decision. keith and lin observed that the spc’s interpretation has “narrowed the function of the court to a more tightly disciplined judicial role as well as for plugging the holes in legal process and structure by creating guiding case law and supporting the freedom of judge’s decision making.”109 such a unique approach in china’s judicature 103 ccl 390 104 spc&spp interpretation 2012 article 3 105 the organic law of people’s court article 33; the decision of the standing committee of the national people’s congress on strengthening legal interpretation (1981) article 2 : “issues of applying laws and regulations in court proceedings shall be interpreted by the supreme people’s court” 106 constitution of the prc article 67; prc law on legislation article 42; randall peerenboom, china's long march toward rule of law (cambridge, cup, 2002) 317 107 chengguang wang, ‘law-making functions of the chinese courts: judicial activism in a country of rapid social changes’ (2006) 3 frontiers of law in china 29 108 björn ahl, ‘retaining judicial professionalism: the new guiding cases mechanism of the supreme people’s court’ (2014) 216 the china quarterly 1-19 109 ronald keith and zhiqiu lin, ‘judicial interpretation of china’s supreme people’s court as “secondary law” with special reference to criminal law’ (2009) 23 (2) china information 223, 256 at 229 nordic journal of commercial law issue 2014#2 15 mechanism may be arguably referred to as codification of spc’s judicial interpretation.110 this may result in the discretion of local procuratorate and court to be further restricted. in the pursuit of rule of law and the judicial independence,111 it remains a long-standing controversy as to whether the current approach would strike a balance between the facilitation of judicial efficiency and the enhancement of the judges’ description in the decision making. 5 the anti-bribery framework in the united states: the remit of foreign corrupt practices act (fcpa) 5.1 american and foreign companies under the fcpa the foreign corrupt practices act (fcpa) is a far-reaching statute which is aggressively enforced.112 it forbids bribing foreign government officials to gain illicit interests. the antibribery provision of the fcpa prohibits u.s. ‘issuers,’ and their officers, directors and agents from bribing foreign officials with ‘anything of value’ to corruptly influence an official decision or to obtain a business benefit.113 it is illegal for companies with significant u.s. operations to bribe foreign officials in exchange for business.114 the fcpa imposes certain accounting requirements on foreign issuers in the u.s,115 which provision is designed to ensure corporate accountability.116 maintaining an effective compliance programme will not only mitigate a firm’s exposure to fcpa liability, but also minimise the risk of enforcement action in case of a systematic failure to prevent a violation. foreign firms registered with the sec must comply with u.s. securities laws and rules, including requirements that the issuer maintains certain books and records.117 the fcpa’s anti 110 ronald keith and zhiqiu lin, ‘judicial interpretation of china’s supreme people’s court as “secondary law” with special reference to criminal law’ (2009) 23 (2) china information 223, 256 at 224 111 taisu zhang, ‘the pragmatic court: reinterpreting the supreme people’s court of china’ (2012) 25 (1) columbia journal of asian law 1, 61 112 mike koehler, ‘the foreign corrupt practices act in the ultimate year of its decade of resurgence’ (2010) 43 indiana law review 389, 421 113 the foreign corrupt practices act of 1977, as amended, 15 u.s.c. §§ 78dd-1, et seq 114 h. lowell brown, ‘the foreign corrupt practices act redux: the anti-bribery provisions of the foreign’ corrupt practices act’ (1994) 12 (2) berkeley journal of international law 260, 290 115 15 u.s.c. § 78m(b)(2) (2006) 116 15 u.s.c. § 78m; sec, ‘sec sanctions statoil for bribes to iranian government official’ (13 october 2006) <http://www.sec.gov/news/press/2006/2006-174.htm> 117 sec and doj, a resource guide to the fcpa u.s. foreign corrupt practices act (14 november 2012) 42-45; stuart h. deming, ‘the potent and broad-ranging implications of the accounting and record-keeping provisions of the foreign corrupt practices act’ (2006) 96 (2) journal of criminal law and criminology 465, 502 nordic journal of commercial law issue 2014#2 16 bribery provisions prohibit issuers118 from giving anything of value to a foreign official for the purpose of influencing the official’s actions or decision-making.119 designed to operate in tandem with the anti-bribery provisions,120 the fcpa requires companies whose securities are listed in the u.s. to meet its accounting provisions, requiring the company covered to (a) make and keep books and records that accurately and fairly reflect the transactions of the corporation; and (b) devise and maintain an adequate system of internal accounting controls.121 the issuers are responsible for ensuring that their consolidated subsidiaries and affiliates comply with the accounting provisions,122 reflecting the breadth and complexity of the fcpa’s extraterritorial reach. for instance, it is illegal for foreign issuers in the nyse to bribe foreign officials in exchange for business,123 even if it may be common practice in china. since the term "issuer" covers any business entity that is registered124 or required to file reports,125 a foreign firm whose american depository receipts (adrs) are listed on a u.s. exchange is recognised as an "issuer”, too. it demonstrates that the government has a commitment to vigorously enforce the fcpa against all international business whose conduct falls within such a wide scope.126 it is no wonder that many foreign subsidiaries of u.s. issuers based in china have been charged with conspiring to violate the fcpa.127 although gsk is a multinational company based in the uk, its extensive holdings in the u.s. make it subject to u.s. law no matter where the bribery actually takes place. in this vein, the gsk bribes in china fall within the jurisdiction for purposes of the fcpa. 118 15 u.s.c. § 78dd-1(a) 119 15 u.s.c. §§ 78dd-1(a), 78dd-2(a); 78dd-3(a) 120 the foreign corrupt practices act of 1977, as amended, 15 u.s.c. §§ 78dd-1, et seq 121 15 u.s.c. § 78m 122 sec and doj, a resource guide to the fcpa u.s. foreign corrupt practices act (14 november 2012) 43 123 united states v. statoil, asa, 1:06-cr-00960-rjh-all (s.d.n.y.2006); doj, ‘u.s. resolves probe against oil company that bribed iranian official’ (13 october 2006) <http://www.usdoj.gov/opa/pr/2006/october/06_crm_700.html> 124 15 u.s.c. § 78l 125 15 u.s.c. § 78o (d) 126 robert c. blume and j. taylor mcconkie, ‘navigating the foreign corrupt practices act: the increasing cost of overseas bribery’ (1997) 36 (8) the colorado lawyer 91, 100 at 97 127 united states v. daimlerchrysler china ltd., no. 10-cr-66 (d.d.c. 2010); united states v. alcatel-lucent france, s.a., no. 10-cr-20906 (s.d. fla. dec. 27, 2010) nordic journal of commercial law issue 2014#2 17 5.2 broader interpretation of foreign official under the fcpa, a foreign official includes any officer or employee of a foreign government or any instrumentality.128 the definition has been further clarified in a doj & sec jointly-issued guide that any employee of a foreign-government instrumentality, including state-owned hospitals, is a foreign official, in light of their ownership, control, status and function.129 consistently, the term "state functionaries" is widely defined in china to include not only public officials, but also employees in state-owned enterprises and other state institutions and persons who perform public services authorised by the state.130 an entity is unlikely to qualify as an instrumentality if a government does not own or control a majority of its shares, minoritystate-owned entities are "instrumentalities" only in exceptional circumstances.131 the doj and the sec take an expansive view and consider doctors who are employees of overseas stateowned hospitals to be "foreign officials".132 according to pfizer, government officials included doctors who held positions on registration committees and other employees of “hospitals, clinics, and pharmacies in countries with national healthcare systems.”133 in this regard, the majority of chinese companies are state-owned/controlled or are instrumentalities of the government.134 conceptually, all employees of state-run hospitals should fall within the remit of the term of foreign officials.135 128 15 u.s.c. § 78dd-2(h)(2)(a) 129 doj & sec, a resource guide to the u.s. foreign corrupt practices act (14 november 2012) 19-21 130 ccl article 93 131 united states v. alcatel-lucent france, s.a., no. 10-cr-20906 (s.d. fla. dec. 27, 2010); sec and doj, ‘a resource guide to the u.s. foreign corrupt practices act’ (14 november 2012) 21 132 sec and doj, a resource guide to the fcpa u.s. foreign corrupt practices act (14 november 2012); doj, ‘pfizer h.c.p corp. agrees to pay $15million penalty to resolve foreign bribery investigation’ (7 august 2012) <http://www.justice.gov/opa/pr/2012/august/12-crm-980.html> 133 united states of america v pfizer h.c.p. corporation (7 august 2012) district court for columbia <www.justice.gov/criminal/fraud/fcpa/.../pfizer/2012-08-07-pfizer-dpa.pdf>; u.s. securities exchange committee v pfizer inc. (2012) district court for columbia <www.sec.gov/litigation/complaints/2012/comp-pr2012-152-pfizer.pdf > 134 court e. golumbic and jonathan p. adams, ‘the “dominant influence” test: the fcpa's “instrumentality” and “foreign official” requirements and the investment activity of sovereign wealth funds’ (2011) 39 (1) american journal of criminal law 1, 51 135 mike koehler, ‘why compliance with the us foreign corrupt practices act matters in china’ (february) 2008 china law & practice 54, 56 nordic journal of commercial law issue 2014#2 18 5.3 exceptions and affirmative defences 5.3.1 the narrow formulation of the facilitation payment exception the contours of the fcpa's facilitating payments exception have been long debated,136 which provides an exception for payments made to further “routine governmental action.”137 it would not constitute an fcpa violation in the context of “reasonable” and “bona fide” expenditures directly related to promotional or performance functions.138 one exception to the anti-bribery provisions is the ‘facilitation/grease payment’ exception, which is exempt from fcpa liability.139 the sole exception is for “facilitating or expediting payments” to government officials who perform “routine governmental action”,140 which refers to actions that are ordinarily and commonly performed by the foreign official and do not entail any decision making or discretion.141 it has been typically defined in terms of "non-discretionary acts," but court decisions and the statute's terms have left significant ambiguity as to what qualifies.142 there is no universally accepted standard of what constitutes a permissible facilitation payment. the conception remains unclear with particular regard to how a company should treat gift-giving as a deep-rooted tradition exists in china’s cultural contexts.143 it is safer to reinforce the narrow formulation of the facilitation payments exception.144 5.3.2 affirmative defences the first affirmative defence applies where the payment at issue “was lawful under the written laws and regulations of the foreign official’s country.”145 notably, common conduct, such as the 136 andrew brady spalding, ‘four unchartered corners of anti-corruption law: in search of remedies to the sanctioning effect’ (2012) 2 wisconsin law review 661, 688 137 15 u.s.c. § 78dd-1(b) 138 15 u.s.c. §§ 78dd-1(c)(2), -2(c)(2), -3(c)(2) (2006) 139 15 u.s.c. §§ 78dd-1(b) and (f)(3) [section 30a of the securities & exchange act of 1934] 140 15 u.s.c. §§ 78dd-1(b), 78dd-2(b), and 78dd-3(b) 141 15 u.s.c. § 78dd-1(f)(3) 142 irina sivachenko, ‘corporate victims of “victimless crime”: how the fcpa's statutory ambiguity, coupled with strict liability, hurts businesses and discourages compliance’(2013) 54 (1) boston college law review 393, 431 143 michael b. runnels and adam m. burton, ‘the foreign corrupt practices act and new governance: incentivising ethical foreign direct investment in china and other emerging economies’ (2012) 34 cardozo law review 295, 327 144arthur f. mathews, ‘defending sec and doj fcpa investigations and conducting related corporate internal investigations: the triton energy/indonesia sec consent decree settlements’ (1998) 18 (2) northwestern journal of international law & business 303, 456 145 15 u.s.c. §§ 78dd-1(c)(1), 78dd-2(c)(1), and 78dd-3(c)(1) nordic journal of commercial law issue 2014#2 19 overwhelmingly pervasive practice of gift-giving, is insufficient to satisfy this requirement.146 this virtually refutes the unlawful approach in china, that is, “ in rome, do as the romans do”.147 despite the chinese culture of gift-giving, chinese law explicitly bars government officials from accepting lavish gifts.148 second, the expenditures "will not give rise to prosecution only if they are reasonable, bona fide and directly related to the promotion, demonstration, or explanation of products or services or the execution or performance of a contract."149 regardless of the guide, many companies are grappling to address where to draw a line between “reasonable and bona fide” payments and those that may constitute a violation of the law.150 the fcpa contains no de minimis for prohibited gifts or payments, including both tangible and intangible benefit.151 the applicability of the affirmative defence for reasonable and bona fide expenditures necessarily requires a fact-specific analysis.152 in practice, doj and sec have focused on small payments and gifts only when they comprise part of a systemic or longstanding course of conduct that evidences a scheme to corruptly pay foreign officials to obtain or retain business."153 notably, the tension between china’s aims of preventing corruption whilst not penalising modern business practices, such as legitimate corporate hospitality for a bona fide business purpose, creates a significant grey area.154 as to the evidential requirement, a defendant bears the burden of proof that the payment falls within one of the above two categories.155 it is illustrative to look into gsk’s compliance programmes before determining whether its conduct could trigger the fcpa violations. 146 alejandro posadas, ‘combating corruption under international law’ (2000) 10 duke journal of comparative & international law 345, 414 147 chen weihua, ‘multinationals under scrutiny for corruption’ china daily (8 september 2010) 148 ccl article 389 149 sec and doj, ‘a resource guide to the u.s. foreign corrupt practices act’ (14 november 2012) 24 150andrew brady spalding, ‘unwitting sanctions: understanding anti-bribery legislation as economic sanctions against emerging markets’ (2010) 62 (2) florida law review 351, 427 151 sec, a resource guide to the u.s. foreign corrupt practices act (14 november 2012) 15 152 sec and doj, ‘a resource guide to the u.s. foreign corrupt practices act’ (14 november 2012) 24 153 sec and doj, ‘a resource guide to the u.s. foreign corrupt practices act’ (14 november 2012) 15 154 margaret ryznar and samer korkor, ‘anti-bribery legislation in the united states and united kingdom: a comparative analysis of scope and sentencing’ (2011) 76 (2) missouri law review 415, 453 155 barbara black, ‘the sec and the foreign corrupt practices act: fighting global corruption is not part of the sec's mission’ (2012) 73 (5) ohio state law journal 1093, 1119 nordic journal of commercial law issue 2014#2 20 5.4 compliance programmes under the fcpa the doj and sec‘s enforcement of the fcpa has been extraordinarily aggressive, which represents a primary compliance concern facing most mncs.156 a competent compliance programme is usually considered as a mitigating factor in determining whether to charge a company and the extent of any penalty.157 the sec & doj’s joint guide provides a useful resource for evaluating an effective compliance programme, in which the enforcement agencies provide appropriate credit to corporate compliance efforts. the guide illustrates a roadmap of doj and sec’s expectations regarding corporate compliance programmes.158 both enforcement agencies have been reluctant to create a formal compliance defence, arguing that the adequacy of the procedures utilised by the company is assessed in casu in the actual process.159 a company may still be held liable for an fcpa violation even if it has conducted a due diligence check of a third party as part of its corporate compliance programmes.160 this may seem contradictory to the concept of both reasonableness and foreseeability which are firmly rooted in law of due process.161 despite the lack of a guaranteed formal defence, the rigorous anti-bribery compliance programmes reduce the likelihood of acts of bribery and can serve to mitigate the severity of any penalty imposed under the fcpa.162 furthermore, doj and sec provide that “in a global marketplace, an effective compliance programme is a critical component of a company’s internal controls and is essential to detecting and preventing fcpa violations.”163 while the guide did not adopt an absolute compliance defence to corporate liability,164 it seems that sec and doj are truly committed to giving meaningful credit to corporate compliance 156 jessica tillipman, ‘a house of cards falls: why “too big to debar” is all slogan and little substance’ (2012) 80 fordham law review res gestae 49, 58 at 53 157 james barta and julia chapman, ‘foreign corrupt practices act’ (2012) 49 (2) american criminal law review 825, 862 158 sec and doj, a resource guide to the fcpa u.s. foreign corrupt practices act (14 november 2012) 159 mike koehler, ‘revisiting a foreign corrupt practices act compliance defence’ (2012) (2) wisconsin law review 609, 659 160 daniel j. grimm, ‘the foreign corrupt practices act in merger and acquisition transactions: successor liability and its consequences’ (2010) 7 (1) nyu journal of law & business 247, 331 161 rosalie berger levinson, ‘reining in abuses of executive power through substantive due process’ (2008) 60 (3) florida law review 519, 587 at 523 162 rashna bhojwani, ‘deterring global bribery: where public and private enforcement collide’ (2012) 112 columbia law review 66, 111 163 sec and doj, a resource guide to the fcpa u.s. foreign corrupt practices act (14 november 2012) 56 164 thomas gorman and william mcgrath, jr., ‘the new era of fcpa enforcement: moving toward a new era of compliance’ (2012) securities regulation law journal 369, 370 nordic journal of commercial law issue 2014#2 21 efforts in the fcpa context.165 when appropriately designed and effectively implemented, a robust compliance programme presents a real opportunity to prevent questionable conduct before it occurs. this stance is perfectly enshrined in the guide that enforcement agencies “place a high premium on self-reporting, along with cooperation and remedial efforts, in determining the appropriate resolution of fcpa matters."166 even so, the guide does not provide a bright-line rule on whether companies could use compliance programmes as a defence against criminal prosecution.167 both sec and doj view a company’s prompt response to the discovery and immediate self-reporting as commendable.168 it is imperative that companies implement robust fcpa compliance programmes which are well-designed and tailored to the companies’ specific business operations, geography and areas of corruption risk and that they are enforced.169 5.5 evaluation of the actions of gsk under the fcpa provisions: the interplay between the two provisions? 5.5.1 anti-bribery provisions gsk’s headquarters are in the uk, but it meets the definition of an «issuer» in the us. therefore it is also subject to the fcpa,170 which makes it potentially liable to penalties under the us anti-bribery laws. criminal penalties for violations of the fcpa have been increased, under which the antibribery fine for a firm was raised from $1 million to $2 million and for individuals from $10,000 to $100,000.171 the maximum imprisonment for bribery for an individual remained 165 lauren giudice, ‘regulating corruption: analyzing uncertainty in current foreign corrupt practices act enforcement’(2011) 91(1) boston university law review 347, 378 166 sec and doj, a resource guide to the fcpa u.s. foreign corrupt practices act (14 november 2012) 54 167 kayla feld, ‘controlling the prosecution of bribery: applying corporate law principles to define a “foreign official” in the foreign corrupt practices act’ (2013) 88 (1) washington law review 245, 280 168 sec and doj, a resource guide to the fcpa u.s. foreign corrupt practices act (14 november 2012) 54-55; arthur f. mathews, ‘defending sec and doj fcpa investigations and conducting related corporate internal investigations: the triton energy/indonesia sec consent decree settlements’ (1998) 18 (2) northwestern journal of international law & business 303, 456 169 keith m. korenchuk, samuel m. witten and mauricio j. almar, ‘emerging global standard for effective anticorruption compliance: meeting the expectations of governments worldwide’ bloomberg bna (21 february 2013) <http://www.bna.com/emerging-global-standard-n17179872475/> 170 15 u.s.c. § 78dd-1 (2006); drury d. stevenson and nicholas j. wagoner, ‘fcpa sanctions: too big to debar?’ (2011) 80 (2) fordham law review 775, 820 171 h. lowell brown, ‘the foreign corrupt practices act redux: the anti-bribery provisions of the foreign’ corrupt practices act’ (1994) 12 (2) berkeley journal of international law 260, 290 nordic journal of commercial law issue 2014#2 22 five years.172 the fcpa also provides for civil penalties of up to $10,000 for violations of the bribery provisions.173 as a foreign issuer, gsk could only be subject to the fcpa’s anti-bribery provisions to the extent a “means or instrumentality of interstate commerce” were used in connection with any improper payment scheme.174 gsk certainly would violate the fcpa if it evinced a corrupt intent,175 which includes conscious disregard and deliberate ignorance.176 the term of “knowing” is defined broadly as basically being aware that a payment will raise red flags and not taking any avoidable measures.177 in this case, gsk knowingly gave cash and some other monetary incentives to state-owned hospitals, and kept the money in its coffers rather than truthfully recording it in its accounts,178 gsk could, on principle, be criminally liable for bribing doctors. despite china’s pervasive customary gift-giving, gsk could not refer to the affirmative defence that “its payment is lawful under the laws of the foreign country”,179 because china criminalises the kind of payment identified as bribery.180 5.5.2 accounting provisions the ‘books and records and internal control” fcpa provisions, together known as the accounting provisions, are enforced by the sec and apply to any company listed on a u.s. stock exchange.181 the guide makes it clear that an issuer’s books and records include those of its consolidated subsidiaries and affiliates.182 thus, gsk’s obligations under the fcpa extend to ensuring that its consolidated subsidiaries and affiliates in china comply with the fcpa’s accounting provisions. since bribery is often disguised on a company’s books and rerecorded through mischaracterisation, gsk should under the accounting provisions of the fcpa have ensured that costs and expenses had been accurately recorded in the company’s books and 17215 u.s.c. § 78dd-2(g); michael v. seitzinger, ‘foreign corrupt practices act (fcpa): congressional interest and executive enforcement’ (october 21, 2010) <https://www.fas.org/sgp/crs/misc/r41466.pdf> 173 15 u.s.c. § 78dd-2(g) 174 the foreign corrupt practices act of 1977, as amended, 15 u.s.c. §§ 78dd-1, et seq; issuers refer to a company listed on a securities exchange in the u.s. either stock or american depository receipts, or the company’s stock traded in the over-the-counter market in the u.s. 175 sec and doj, ‘a resource guide to the u.s. foreign corrupt practices act’ (14 november 2012)18 176 15 usc §§ 78dd-1(f)(2)(a) 177 patricia brown holmes, valarie hays and schiff hardin, ‘corporate officials beware: knowledge may no longer be required for fcpa liability’ (2010) 3 (4) bloomberg law report: risk & compliance <www.schiffhardin.com/binary/hays-holmes_bloomberg_april2010.pdf > 178 bruce w. klaw, ‘a new strategy for preventing bribery and extortion in international business transactions’ (2012) 49 (2) harvard journal on legislation 303, 371 179 15 u.s.c. §§ 78dd-1(c)(1), -2(c)(1), -3(c)(1) (2006) 180 ccl article 389 181 15 u.s.c.§ 78m 182 sec and doj, a resource guide to the u.s. foreign corrupt practices act (14 november 2012) 42-45 nordic journal of commercial law issue 2014#2 23 records which fairly reflected the issuer's transactions.183 failure to maintain accurate books and records may result in both civil and criminal liability.184 engaging in systemic efforts to falsify its corporate books and records and knowingly failing to enforce and circumventing existing internal control would violate the accounting provisions. notably, a payment that does not violate the anti-bribery provisions may nonetheless violate the accounting provisions if inaccurately recorded or attributable to an internal control deficiency.185 in reality, the accounting provisions may provide a secondary offence for prosecution charges,186 and violations thereof may include commercial bribes that would typically fall outside of the ‘foreign official’ caveat otherwise needed for liability.187 accounting provisions violations may result in fines of up to $25 million for a company, and $5 million and/or imprisonment of up to 20 years for culpable individuals.188 thus, in theory, the sec could invoke the accounting provisions against gsk for bribery of its chinese subsidiary, because the payments were not accurately and sufficiently recorded, and because gsk and its subsidiary lacked reasonable controls to prevent, detect or correct such corrupt conduct.189 in order to limit legal exposure, it is imperative for gsk to implement and enforce an effective compliance programme. charges by the chinese mpc potential charges by the doj and sec could, if proven, put gsk also at risk of prosecution under the bribery act of 2010 in the uk. 6 the anti-bribery framework in the united kingdom: the uk bribery act 6.1 a new strict liability corporate offence the uk bribery act 2010 represents a most significant reformulation of the uk’s anti-bribery laws.190 it adds a set of compliance requirements parallel but not identical to those of the fcpa 183 section 13(b) (2) (a) of the securities exchange act of 1934 [15 u.s.c. §78m] 184 united states v. siemens ag, no. 08-cr-367-rjl (d.d.c. dec. 12, 2008) <http://www.justice.gov/criminal/fraud/fcpa/cases/siemens/12-15-08siemensakt-plea.pdf> 185 thomas p. cimino, jr., junaid a. zubairi et al., ‘foreign corrupt practices act trends’ the national law review (7 april 2011) 186 lauren giudice, ‘regulating corruption: analyzing uncertainty in current foreign corrupt practices act enforcement’(2011) 91(1) boston university law review 347, 378 187 lauren ann ross, ‘using foreign relations law to limit extraterritorial application of the foreign corrupt practices act’ (2012) 62 (2) duke law journal 445, 485 188 15 u.s.c. § 78ff(a); michael v. seitzinger, ‘foreign corrupt practices act (fcpa): congressional interest and executive enforcement’ (october 21, 2010) <https://www.fas.org/sgp/crs/misc/r41466.pdf> 189 sec and doj, a resource guide to the u.s. foreign corrupt practices act (14 november 2012) 57 190 margaret ryznar and samer korkor, ‘anti-bribery legislation in the united states and united kingdom: a comparative analysis of scope and sentencing’ (2011) 76 (2) missouri law review 415, 453 nordic journal of commercial law issue 2014#2 24 that affect mncs doing business overseas.191 to invoke a defence, a company must have adequate procedures in place designed to prevent persons associated with it from committing bribery.192 unlike the controversial exception under the fcpa, there is no exemption for facilitation payments which can constitute bribery of another person,193 or bribery of a foreign public official194 and can trigger the failure to prevent bribery offences.195 the bribery act 2010 creates a new criminal offence for failure to prevent bribery by a person associated with the organisation, which aims to be an even more stringent anti-bribery act than the fcpa.196 the uk bribery act 2010 makes it illegal to either pay or receive an advantage to/from another person with the intent to: i) induce a person to perform improperly a relevant function or activity;197 or ii) reward a person for the improper performance of a relevant function or activity.198 the bribery act 2010 essentially makes it a crminal offence for a person to bribe a foreign public official,199 which also applies to a company associated with a person who bribes.200 bribes carried out by third party associates may not constitute grounds for a defence of ignorance by the covered company because it may be assumed that such a company will have appropriately vetted its partners before engaging in business.201 prosecutors do not have to demonstrate prior knowledge, or ‘corrupt intent’ on the part of the company or its officials to charge them under the bribery act 2010.202 191 lauren ann ross, ‘using foreign relations law to limit extraterritorial application of the foreign corrupt practices act’ (2012) 62 (2) duke law journal 445, 485 192 ba 2010 s7(2); michael w. johnson, ‘the uk bribery act and beyond–preparing for change’ the world financial review <http://www.worldfinancialreview.com/?p=244> 193 ba 2010 s1 194 ba 2010 s6 195 ba 2010 s7 196 ba 2010 s7 197 ba 2010 s1 (1) (b) (i) 198 ba 2010 s 1 (1) (b) (ii) 199 ba 2010 s6 200 ba 2010 s7 201 ministry of justice, ‘the bribery act 2010 guidance’ (march 2011): government policy and section 7 of the bribery act-section 7: failure of commercial organisations to prevent bribery 16-18, §§37-43 <http://www.justice.gov.uk/downloads/legislation/bribery-act-2010-guidance.pdf> 202 cecily rose, ‘the uk bribery act 2010 and accompanying guidance: belated implementation of the oecd anti-bribery convention’ (2012) 61 (2) international and comparative law quarterly 485, 499 nordic journal of commercial law issue 2014#2 25 the bribery act 2010 does not include a carve-out for facilitation payments, which, although exempt from the fcpa, are prohibited under the bribery act 2010.203 the serious fraud office (sfo) guidance reaffirms the zero tolerance -approach to facilitation payments irrespective of their size and frequency.204 nevertheless, reasonable corporate hospitality is not something that is prohibited. bona fide hospitality, promotional or other legitimate business expenditure is recognised as an established and important part of doing business.205 notably, bribes may sometimes be disguised as legitimated business expenditure.206 any concerns about criminalising reasonable corporate hospitality would be addressed in the prosecutorial discretion.207 a broad test used is: whether it is likely to influence someone to make a decision that they might not otherwise make.208 the anti-bribery enforcement actions often involve overseas third parities making improper payment on behalf of a company.209 potential liability of gsk under the uk bribery act 2010 results from its extraterritorial effect, the extent to which gsk has instigated a review of all third party relationships appears vital.210 any company, wherever incorporated, which “carries on a business, or part of a business” in the uk falls within the bribery act’s remit.211 a corporate offence can be committed irrespective of whether the acts or omissions which form part of the offence take place in the uk or elsewhere.212 prosecutors will be able to tackle the overseas operations of any company that conducts commerce in the uk, seeking unlimited fines for those suspected of bribing foreign public officials or buying influence of commercial counterparts and pursuing company executives with the threat of up to 10 years in prison.213 203 michael s. diamant and jesenka mrdjenovic, ‘don’t you forget about me: the continuing viability of the fcpa’s facilitating payments exception’ (2012) 73 ohio state law journal furthermore 19, 26 204 ministry of justice, ‘the bribery act 2010 guidance’ (march 2011) <http://www.justice.gov.uk/downloads/legislation/bribery-act-2010-guidance.pdf> 205 sfo & dpr, bribery act 2010: joint prosecution guidance of the director of the serious fraud office and the director of public prosecutions <http://www.sfo.gov.uk/bribery--corruption/the-bribery-act/business-expenditure.aspx> 206 sfo, the revised policies on facilitation payments, business expenditure (hospitality) and corporate self-reporting (9 october 2012) <http://sfo.gov.uk/press-room/latest-press-releases/press-releases-2012/revised-policies.aspx> 207‘letter from lord tunnicliffe to lord henley, house of lords, (14 january 2010) <http://www.justice.gov.uk/publications/docs/letter-lord-henley-corporate-hospitality.pdf> 208 richard tyler, ‘bribery act: lord goldsmith says look to the us’ telegraph (5 january 2011) 209andrew brady spalding, ‘unwitting sanctions: understanding anti-bribery legislation as economic sanctions against emerging markets’ (2010) 62 (2) florida law review 351, 427 210 ‘developments in the law-extraterritoriality’ (2011) 124 (5) harvard law review 1226, 1304 211 ba 2010 s7(5) (a) 212 ba 2010 s12(7) 213 ba 2010 s11(1)(b) nordic journal of commercial law issue 2014#2 26 6.2 statutory defence to the corporate offence: law in place ≠ law in practice the bribery act 2010 contains the strictest laws against corruption, but enforcement has been minimal since it was passed in 2010.214 arguably, it consists of a safe harbour provision for a corporation, that is, it has instituted in place “adequate procedures” to prevent such bribes from occurring.215 a company will not be liable if it can prove, on the balance of probabilities, that adequate procedures were in place to prevent persons associated with the company from paying bribes.216 this is in contrast to the u.s. approach where compliance procedures are evaluated as part of the charging process, not as a defence.217 the statutory defence appears to soften the enivsioned “strict liability” for all company operations.218 it seems that by putting such an affirmative defence in place, companies may well go down the paper compliance defence route and not dedicate the time and resources to make it compatibly effective.219 in respect to the charges against gsk in china, an irrefutible point is that gsk admittedly has not followed its own stated protocols.220 gsk may try to defend itself by attributing to its compliance which has been challenged by the scale of the company's growth in china.221 if gsk could prove that it "had in place adequate procedures designed to prevent persons associated with [the company] from undertaking such conduct",222 it could escape a criminal prosecution, although this is quite a high hurdle to overcome. it remains ambiguous as to what “adequate procedures”223 can be put in place as a defence against the corporate offence of failing to prevent bribery. even so, a prerequisite condition for gsk to rely on the statutory 214 jon jordan, ‘recent developments in the foreign corrupt practices act and the new uk bribery act: a global trend towards greater accountability in the prevention of foreign bribery’ (2011) 7 (2) nyu journal of law & business 845, 871 215 ba 2010 s7(2) 216 sfo & dpp, bribery act 2010: joint prosecution guidance of the director of the serious fraud office and the director of public prosecutions <http://www.cps.gov.uk/legal/a_to_c/bribery_act_2010/> 217 howard sklar, ‘against an fcpa compliance defence’ forbes (18 october 2011) 218r. zachary torres-fowler and kenneth anderson, ‘the bribery act’s new approach to corporate hospitality’ (2011) 52 virginia journal of international law digest 39, 53; cheryl l. evans, ‘the case for more rational corporate criminal liability: where do we go from here?’ (2011) 41 stetson law review 21, 39; bruce w. bean and emma h. macguidwin, ‘expansive reach-useless guidance: an introduction to the u.k. bribery act 2010’ (2012) 18 ilsa journal of international and comparative law 323, 346 219 thomas fox, ‘glaxosmithkline and the death knell for the compliance defence’ corporate compliance insight (25 july 2013) 220thomas fox, ‘the grim reaper, glaxosmithkline and the death knell for the compliance defence’ lexisnexis legal newsroom corporate (2 august 2013) 221 elvira n. loredo, karlyn d. stanley and michael d. greenberg, ‘anti-corruption regulations in emerging and expeditionary markets: new markets, new challenges’ (rand centre for corporate ethics and governance, 2012) <http://www.rand.org/content/dam/rand/pubs/conf_proceedings/2012/rand_cf304.pdf> 222 ba 2010 s7(2) 223 ba 2010 s7(2) nordic journal of commercial law issue 2014#2 27 defence is that it must prove that gsk has not only put adequate procedures in place, but also has effectively enforced them.224 7 gsk’s dysfunctional internal compliance regimes 7.1 internal compliance mechanism: a code on the books but not in practice mncs usually have strict internal controls, such as limits on gift value to doctors, entertainment fees, or a number of days limit for organising overseas trips for doctors so that gift giving or entertaining is not defined as bribery.225 indeed, gsk’s code of conduct states explicitly that: “the gsk attitude towards corruption in all its forms is simple: it is one of zero tolerance, whether committed by gsk employees, officers, complementary workforce or third parties acting for or on behalf of the company… gsk has an active system of internal management controls to identify company risks, issues and incidents with appropriate corrective actions taken….provides the framework for these internal controls, to ensure significant risks are escalated to the proper levels of senior management.” 226 the above code should, in principle, be aimed at identifying potential compliance risks with embedded preventive measures before serious problems arise, such as massive fines, longrunning monitor-ships and harm to reputation.227 assumingly, the compliance programme could enable the company to detect wrongdoings in response appropriately to flagrant and systematic bribery. 228 in reality, gsk hq received information about widespread bribery in china in january 2013. however, just a week before the chinese government detained the gsk employees, gsk hq official stated that they had investigated and found no evidence of bribery and corruption.229 224michael peterson, ‘amending the foreign corrupt practice act: should the bribery act 2010 be a guideline?’ (2013) 12 richmond journal of global law and business 417, 431 225 xinyuan wang, ‘pharma giant gsk investigated for bribery’ global times (12 july 2013) 226 gsk, ‘the code of conduct: one company one approach’ <http://www.gsk.com/content/dam/gsk/globals/documents/pdf/policy-code-conduct.pdf> 227nicholas elliott, ‘alixpartners survey shows multinationals building anti-bribery compliance, but resourceconstrained’ wsj blogs (26 march 2012) 228 stephen a. fraser, ‘placing the foreign corrupt practices act on the tracks in the race for amnesty’ (2012) 90 (4) texas law review 1009, 1040 229kathrin hille and john aglionby, ‘china accuses glaxosmithkline of bribing official over prices’ financial times (11 july 2013) nordic journal of commercial law issue 2014#2 28 many uk companies would not stand detailed scrutiny should they be investigated. much worse, they are notoriously defensive in response to any claim, challenge or allegation. the structural inefficiency ensures much time and energy is expended and heavy costs incurred trying to maintain an artificial separation “on the books” for what is, in reality, a single organization.230 as sophisticated as they are, such an internal compliance mechanism is in place, but surprisingly futile.231 gsk found no evidence of wrongdoing after completing a fourmonth investigation into a whistle-blower’s claims of corruption and bribery, which clearly indicates a lack of immediate remediation in response to an emergent crisis.232 gsk should have ensured that it had implemented effective anti-bribery compliance systems. however, gsk has not adequately addressed applicable anti-bribery and corruption rules, neither has it conducted an adequate anti-bribery risk assessment.233 7.2 the corporate rogue employees defence to fcpa liability as an additional enforcement tool, a non-prosecution agreement (npa) has been used in connection with morgan stanley’s anti-bribery efforts.234 sec and doj have declined to pursue charges against the company, where one of its executives “used a web of deceit” to evade the investment bank’s efforts to maintain adequate anti-corruption internal controls.235 the case involved a chinese state-owned enterprise (soe), which is at the heart of a growing number of 230 dezan shira, ‘why corruption is inevitable in china’s pharmaceutical industry’ caijing (25 july 2013) 231 philip m nichols, ‘the psychic costs of violating corruption laws’ (2012) 45 (1) vanderbilt journal of transnational law 145, 210 232 benjamin w. heineman, jr., ‘wal-mart bribery case raises fundamental governance issues’ harvard law school program on corporate governance and harvard kennedy school of government <http://blogs.law.harvard.edu/corpgov/2012/04/28/wal-mart-bribery-case-raises-fundamental-governance-issues/> 233 ministry of justice, bribery act 2010 guidance (march 2011) 15-19 <http://www.justice.gov.uk/downloads/legislation/bribery-act-2010-guidance.pdf> 234 david m. zornow , charles f. walker et al., ‘the united states foreign corrupt practices act: sec and doj enforcement trends’ (22 april 2013) <http://www.law.yale.edu/documents/pdf/cbl/skadden_fcpa_sec_and_doj_enforcement_trends.pdf> 235 sec and doj, a resource guide to the fcpa u.s. foreign corrupt practices act (14 november 2012) 56-58, 61; doj, ‘former morgan stanley managing director pleads guilty for role in evading internal controls required by fcpa’ (25 april 2012) <http://www.justice.gov/opa/pr/2012/april/12-crm-534.html>; sec, sec charges former morgan stanley executive with fcpa violations and investment adviser fraud (25 april 2012); the compliance programmes included “a robust compliance department with direct reporting lines to morgan stanley's board of directors; significant compliance training for asia-based personnel; regular monitoring and auditing of particular transactions, employees, and business units; extensive due diligence for all new business partners; annual employee certifications regarding adherence to morgan stanley's code of conduct; and a regular review and update of the compliance program.” nordic journal of commercial law issue 2014#2 29 fcpa enforcement actions.236 peterson, a former managing director based in shanghai, bribed a chinese government official to illegally win business. peterson has been characterised as a “rogue” employee, whose deceptions circumvented morgan stanley’s robust internal control. ignoring his fiduciary duties, peterson made every effort to enrich himself and the chinese government official millions of dollars through a matrix of off-shore shell companies and unknowing payment by morgan stanley. the sec and doj found no wilful blindness on the part of morgan stanley. given the bank’s adequate compliance programme, along with its voluntary disclosure of the misconduct and cooperation with the u.s. government’s investigation, no fcpa enforcement action has been taken against the bank. this decision has profound implications for cases involving executives and foreign officials charged with fcpa violations, which is also instructive for multinational companies in several respects. in peterson, a rigorous compliance programme protected morgan stanley from the actions of an employee that violated the fcpa.237 self-reporting has particularly been one of the significant factors weighted in the agencies’ exercise of prosecutorial discretion. morgan stanley had maintained a system of internal controls and enforced its anti-bribery polices consistently, which provided reasonable assurances that its employees were not bribing government officials.238 doj and sec gave the bank unusual credit for its longstanding and comprehensive fcpa compliance programmes, voluntary reporting of the matter and its extensive cooperation with the agencies’ investigations. it should be noted that "the existence and effectiveness" of the compliance program, and "the company's remedial actions”, where the source of credit.239 in april 2012, the doj charged peterson with violations of the fcpa’s anti-bribery provisions.240 peterson pled guilty to one count of conspiring to circumvent the system of internal controls that the bank maintained to prevent violations of the fcpa.241 the sec also charged him with violating the fcpa and securities laws for investment advisors.242 the peterson settlement with the sec included surrendering a $3.4 million interest in shanghai real estate and $250,000 in damages, a permanent bar from the securities industry and 9 months in a u.s. 236 sec and doj, a resource guide to the fcpa u.s. foreign corrupt practices act (14 november 2012); states v carson no. 8:09-cr-00077 (c.d. cal. april 8, 2009) 237laura fraedrich and jamie a. schafer, ‘what is in it for me: how recent developments in fcpa enforcement affect the voluntary disclosure calculus’ (2013) 8 (9) global trade and customs journal 257, 264 238 doj, former morgan stanley managing director pleads guilty for role in evading internal controls required by fcpa (25 april 2012) <http://www.justice.gov/opa/pr/2012/april/12-crm-534.html> 239 sec and doj, a resource guide to the fcpa u.s. foreign corrupt practices act (14 november 2012) 56 240 section 13(b) (5) of the securities exchange act of 1934, et al 241 united states v. peterson, cr. no. 12-224 (jbw) (e.d.n.y. april 25, 2012) 242 sec v. peterson, no. 12-2033 (jbw) (e.d.n.y. april 25, 2012) nordic journal of commercial law issue 2014#2 30 jail.243 due to the bank’s robust and well-enforced system of internal controls, neither the doj nor sec charged morgan stanley itself, highlighting the bank's effective ethics and compliance programme as the primary basis for the decision.244 this provides a perfect example to confirm the value of well-formulated and meticulously implemented corporate compliance policies in deflecting the results of fcpa enforcement actions at the entity level.245 the assessment of risk is fundamental to developing a strong compliance programme.246 the compliance programme is designed to effectively militate against violations, along with its rigorous periodic review. paradoxically, it would be difficult to monitor all sales practices. no compliance program can ever prevent all criminal activity by a corporation’s employees.247 there will always be employees who decide to take matters into their own hands, and even the best compliance program may not stop fraud or corruption from occurring.248 morgan stanley not only discovered the violations and reported it, but also cooperated fully in the investigation by the sec and doj. it is the bank’s pre-existing ethics and compliance programme that made a decisive difference for the doj and sec not to prosecute it. this case underscores the importance of establishing adequate and effective internal anti-bribery controls for global companies in protecting both the entity and individual personnel from such enforcement. the morgan stanley case illustrates that an effective compliance program can provide companies facing fcpa enforcement actions with tangible benefits in the form of a more favourable settlement term.249 could the morgan stanley rule apply to gsk? enforcement agencies can give meaningful credit to a company which in good faith applies a comprehensive and risk-based compliance programme,250 on the condition that the company did devote greater resources in higher-risk 243 section 15(b) (4) (c) of the exchange act, 15 u.s.c.§78o; a court injunction allows the sec to permanently bar a defendant from the securities industry, if it finds such sanction in the public interest; 30a(g) and 13(b)(5) of the securities exchange act of 1934; investment advisers act 1940 s206(1) (2); sec, ‘sec charges former morgan stanley executive with fcpa violations and investment adviser fraud’ (25 april 2012) <http://www.sec.gov/news/pressrelease/detail/pressrelease/1365171488702> 244 wayne m. carlin, ‘white collar and regulatory enforcement: emerging trends and what to expect in 2013’ the harvard law school forum on corporate governance and financial regulation (30 january 2013) 245 mike koehler, ‘revisiting a foreign corrupt practices act compliance defence’ (2012) (2) wisconsin law review 609, 659 246 house of representatives, sub-committee on crime, terrorism, and homeland security, committee of the judiciary, foreign corrupt practices act (washington, dc., 14 june 2011) <http://judiciary.house.gov/hearings/printers/112th/112-47_66886.pdf> 247 ministry of justice, the bribery act 2010 guidance (march 2011) 15; mike koehler, ‘revisiting a foreign corrupt practices act compliance defence’ (2012) (2) wisconsin law review 609, 659 248 jessica tillipman, ‘a house of cards falls: why “too big to debar” is all slogan and little substance’ (2012) 80 fordham law review res gestae 49, 58; howard sklar, ‘against an fcpa compliance defence’ forbes (18 october 2011) 249 sec and doj, a resource guide to the fcpa u.s. foreign corrupt practices act (14 november 2012) 56, 75 250 sec and doj, a resource guide to the fcpa u.s. foreign corrupt practices act (14 november 2012) 59 nordic journal of commercial law issue 2014#2 31 areas, such as china. in this vein, the quality and effectiveness of the compliance programme plays a vital role for the agencies to determine whether the company could be given credit despite a confirmed violation. it remains uncertain as to whether gsk could use the defence against the failure to prevent the actions of its employees in china.251 gsk may raise a defence by showing that it has taken reasonable steps to prevent wrongdoing, although it is ultimately powerless if somebody really wants to break the law. gsk seems to have adequate systems in place for supervising adherence to those rules. the practical challenges of effectively implementing such programmes, however, should not be underestimated.252 it appears that having a best practices compliance program without effective implementation did not lead to gsk doing business more ethically. as stated above, gsk conducted a four month internal investigation which yielded no evidence of bribery. this is indicative of a dysfunctional compliance system. gsk may encounter two challenges: proving rigorousness of its earlier investigation and giving reasons why the internal procedures failed to detect the flagrant and systemic violations.253 the likely inability to meet the first challenge and excusing the resulting inaction will make gsk vulnerable to enforcement action by the uk’s serious fraud office (sfo) and the u.s. department of justice (doj) and securities exchange commission (sec), both of which can levy severe penalties under their sweeping anti-bribery laws, i.e. bribery act 2010 and the fcpa.254 while the authorities have discretion, it is more likely in the public interest to prosecute cases where there has been a systemic and major breach of corruption laws.255 after all, a parent is liable for bribery by a subsidiary’s employees on the ground that it has sufficient knowledge and control of its subsidiary’s actions.256 since gsk has confessed to authorising and participating 251 irina sivachenko, ‘corporate victims of "victimless crime": how the fcpa's statutory ambiguity, coupled with strict liability, hurts businesses and discourages compliance’(2013) 54 (1) boston college law review 393, 431 252susan rose-ackerman, ‘governance and corruption’ in bjørn lomborg, (ed.) global crises, global solutions (cambridge, cambridge university press, 2004) 301-362 253 brent t. white, ‘putting aside the rule of law myth: corruption and the case for juries in emerging democracies’ (2010) 43 cornell international law journal 307, 363 254 ba 2010 s7; 15 u.s.c. § 78dd-1(a): issuers include (i) companies that have securities registered on a national exchange or listed on the nasdaq or (ii) that are required to file reports under section 15(d) of the exchange act 15 u.s.c. § 78m.; sec and doj, resource guide to the u.s. foreign corrupt practices act (14 november 2012) <http://www.justice.gov/criminal/fraud/fcpa/guidance/ > and <http://www.sec.gov/spotlight/fcpa/fcpa-resourceguide.pdf> §10: the guide explains when a company is an “issuer” for purposes of the fcpa: the company is listed on a national securities exchange in the united states (either stock or american depository receipts); or the company’s stock trades in the over-the-counter market in the united states and the company is required to file sec reports. 255 mike koehler, ‘the foreign corrupt practices act under the microscope’ (2012) 15 (1) university of pennsylvania journal of business law1, 63 at 55 256 sec and doj, a resource guide to the fcpa u.s. foreign corrupt practices act (14 november 2012) 42-43 nordic journal of commercial law issue 2014#2 32 in systemic bribery in china,257 it will have more difficulty in proving that it had sufficient controls to prevent corruption. it appears that gsk has knowingly and wilfully failed to implement anti-bribery compliance measures and reaped financial gains from prohibited activities.258 for its lack of due diligence, gsk could be held liable for failure to oversee its subsidiary.259 8 make global compliance programmes compatible in china 8.1 challenges arising from jurisdictional gaps in the new era of growing international enforcement, many mncs have been involved in longrunning fcpa investigations covering multiple locations around the world.260 the increased cooperation between foreign governments will further expose companies to potential liability in multiple jurisdictions.261 it is never enough to emphasise the significance of implementing adequate and effective compliance programmes. despite the bribery act 2010 and fcpa’s extraterritorial reach, the anti-bribery laws may not put anglo-american companies at a disadvantage.262 instead, the tough anti-bribery laws may help them compete in china. the western firms would gain a reputation for not paying bribes, which ultimately reduce costs for all concerned.263 although an ethical company incurs significant costs to avoid the risk of possible liability, the compliance to anti-bribery laws may prevent real and lasting advances in anti-bribery,264 as chinese entities are not similarly constrained. in addition, there is a great need to cultivate a dynamic and strong culture of compliance, which should encourage "ethical conduct and a commitment to compliance with the law" and help "prevent, detect, remediate, and report misconduct."265 rigorous due diligence procedures should also be used to assess the adequacy of a company's compliance programme in dealing with overseas third parties as well as 257ccl 2011 article 390 (2): self-disclosure may lead to a more favourable settlement with enforcement agencies. gsk could benefit from leniency measures linked to voluntary disclosure given its full confession of bribes. 258 heidi l. hansberry, ‘in spite of its good intentions, the dodd-frank act has created an fcpa monster’ (2012) 102 (1) journal of criminal law and criminology195, 226 259 sec v magyar telekom plc and deutsche telekom, ag, (u.s. district court south district of new york, 20 december 2011) <http://www.sec.gov/litigation/complaints/2011/comp22213-co.pdf> 260 drury d. stevenson and nicholas j. wagoner, ‘fcpa sanctions: too big to debar?’ (2011) 80 (2) fordham law review 775, 820 261 rashna bhojwani, ‘deterring global bribery: where public and private enforcement collide’ (2012) 112 columbia law review 66, 111 262 lauren giudice, ‘regulating corruption: analyzing uncertainty in current foreign corrupt practices act enforcement’(2011) 91(1) boston university law review 347, 378 263 bob davies, ‘when the anti-corruption official comes calling’ the wall street journal (8 february 2012) 264 sec and doj, a resource guide to the fcpa u.s. foreign corrupt practices act (14 november 2012) 265 sec and doj, a resource guide to the fcpa u.s. foreign corrupt practices act (14 november 2012) 56 nordic journal of commercial law issue 2014#2 33 its subsidiaries.266 it remains questionable how gsk has localised its global anti-bribery compliance programmes in china. given the extent of gsk’s systemic and egregious malpractices, china and the u.k. would seem to have a greater and more direct interest in the conduct at issue compared to the u.s. accusations by the chinese ministry of public security (mps), the american doj and sec could, if proven, put gsk at risk of prosecution by u.k. authorities under the bribery act 2010 at home, despite its incorporation and the bribes that have taken place in china. the uk, u.s. and china are parties and are subject to the united nations convention against corruption (uncc),267 which, among other things, stipulates legal and investigative cooperation in combating bribery. the start of the first such parallel investigation indicates that china may be embarking on a more active and cooperative path.268 most mnc’s holdings and business are under the jurisdiction of the fcpa, the bribery act, and china’s anti-corruption laws.269 the fcpa only prosecutes against the bribery of foreign officials, although the definition of ‘foreign official’ remains very vague,270 but under chinese and british laws, an mnc’s senior executives could also be charged for accepting bribes.271 it should be noted that a corporate compliance policy which has satisfied the fcpa may not be sufficient for compliance with the u.k. adequate procedures guidance published by the sfo.272 it is likely that the gsk case will set a precedent for the future interplay of multinational anti-corruption law.273 it remains to be seen whether china enforcement agencies will draw on the wealth of bribery evidence and admissions generated in most doj, sec and sfo enforcement actions, or vice versa, and whether gsk marks the establishment of a cross-border anti-corruption cooperation, which may render it possible to exchange bribery evidence between the enforcement agencies. it is worth 266 eugene r. erbstoesser, john h. sturc and john w.f. chesley, ‘the fcpa and analogous foreign anti-bribery laws—overview, recent developments, and acquisition due diligence’ (2007) 2 (4) capital markets law journal 381, 403 267 unodc, ‘united nations convention against corruption’ <http://www.unodc.org/unodc/en/treaties/cac>: china ratified the united nations convention against corruption (uncc) on october 27 in 2005 and came into force on 14 december 2005 268 henry chen, ‘pharma bribe probe points to china parallel prosecutions’ fcpa professor blog (11 july 2013) 269 emily flitter and ben hirschler, ‘exclusive: u.s. prosecutors add china bribe allegations to gsk probe’ reuters (6 september 2013) 270 sec and doj, a resource guide to the fcpa u.s. foreign corrupt practices act (14 november 2012) 19-21; joel m cohen, michael holland and adam wolf, ‘under the fcpa, who is a foreign official anyway?’ (2008) 63 (4) the business lawyer 1243, 1274 271 ba 2010 s1; sec and doj, a resource guide to the fcpa u.s. foreign corrupt practices act (14 november 2012) 8; ccl article 385 272 serious fraud office (sfo), ‘revised policies’ (9 october 2012) <http://www.sfo.gov.uk/press-room/latest-press-releases/press-releases-2012/revised-policies.aspx> 273 daniel chow, ‘the interplay between china’s anti-bribery laws and the foreign corrupt practices act’ (2012) 73 (5) ohio state law journal 1015, 1037; andrew b. spalding, ‘four uncharted corners of anti-corruption law: in search of remedies to the sanctioning effect’ (2012) 2 wisconsin law review 661, 688 nordic journal of commercial law issue 2014#2 34 looking into an intriguing question as to whether the multiple enforcement agencies will at some point develop coordinated enforcement program and share information about their respective investigations.274 8.2 risk-based due diligence on overseas third parties and subsidiaries 8.2.1 keep abreast of china’s national prioritised objective in a political & judicial context operating in china generally entails the use of local partners and agents, whose dealings with the government officials are typically not in the foreign investor’s hand but lie within the chinese partners.275in the increasingly complicated environment, the majority of prosecutions and enforcement actions involve corrupt payment made indirectly through intermediaries.276 due diligence efforts should be conducted on a regular basis, which may help detect and deter the third parties’ misconduct.277 gsk illustrates the importance of recognising red flags associated with third-party intermediaries and embracing more sophisticated compliance mechanisms.278 the allegations against gsk came at a time when regulators were reviewing the prices and production costs of major chinese and global drug companies in what appeared to have been an effort to lower drug prices.279 such a kind of approach is normally politically-driven, at least, implicitely. this holds particularly true in china’s health-care sector that is mired in systemic and pervasive corruption,280 which is deemed as a major impediment to government health-care reform initiatives. the chinese healthcare reform is accompanied by a shifting regulatory regime as new laws and decrees take effect against bribery.281 the growing drug costs appear to have provided the chinese government with the motivation to widen the probe into the 274 jon jordan, ‘the need for a comprehensive international foreign bribery compliance program, covering a to z, in an expanding global anti-bribery environment’ (2012) 117 (1) penn state law review 89, 137 275 patrick norton, ‘the foreign corrupt practices act: a minefield for us companies in china’ china law & practice (november 2004) 276lucinda a. low, thomas k. sprange and milos barutciski, ‘global anti-corruption standard and enforcement: implications for energy companies’ (2010) 3 (2) journal of world energy law and business 166, 213 277 sec and doj, a resource guide to the fcpa u.s. foreign corrupt practices act (14 november 2012) 60, 62; rashna bhojwani, ‘deterring global bribery: where public and private enforcement collide’ (2012) 112 columbia law review 66, 111 278 brian p. loughman and richard a. sibery, bribery and corruption: navigating the global risks (john wiley & sons, 2011) 69 279 natasha khan, ‘china probes 60 drug-makers in effort to curb drug prices’ bloomberg (5 july 2013) 280 daniel chow, ‘china under the foreign corrupt practices act’ (2012) 2 wisconsin law review 573, 607 281 benjamin shobert and damjan denoble, ‘compliance after china’s healthcare bribery scandals’ china business review (10 october 2013) nordic journal of commercial law issue 2014#2 35 activities of multinational pharmaceutical giants.282 the case of gsk indicates that the drug giant lacks proper sensitivity in china’s current political and judicial context and ignores the policy and economic repercussions of anti-bribery regulations.283 apparently, china is currently prioritising the issue of addressing the problems relating to the disproportionally high prices of pharmaceutical products as well as infant milk with world-known brands. unfortunately, gsk has failed to respond properly to this national campaign targeting relevant foreign mncs. the accusation against gsk reflects, again, the long-standing issues of serious deficiencies of multinationals’ strategies of localisation.284 8.2.2 cultivate a culture of compliance an mnc is expected to comply with applicable laws and regulations of each jurisdiction where it operates and promote a culture of high ethical standards in addition to legal compliance.285 it is essential for mncs to take active steps to maintain a strong compliance culture, which will maximise the chances of addressing problems internally and solving them before they become serious.286 it must be ensured that a company has the proper “tone at the top,” including a compliance and ethics program that is tailored to the company’s risks, applied in good faith, and effective.287 a proper “tone at the top” should include unambiguous communication from senior management about the compliance requirements that is “scrupulously followed” and disseminated throughout the organisation.288 the guide specifically obligates senior management to set a strong, ethical culture, "inspire" their colleagues to adhere to that culture, and articulate the procedures and standards that underpins that culture.289 such a culture should encourage "ethical conduct and a commitment to compliance with the law" and help "prevent, detect, remediate, and report misconduct."290 however, the as discovered relating to 282 josé p. sierra, ‘enemy at the gates: bribery charges in china getting worse for gsk’ (10 july 2013) <http://pharmarisc.com/2013/07/enemy-at-the-gates-bribery-charges-in-china-getting-worse-for-gsk/> 283 u myint, ‘corruption: causes, consequences and cures’ (2000) 7 (2) asia-pacific development journal 33, 58 284 seung ho park and wilfried r. vanhonacker, ‘the challenge for multinational corporations in china: think local, act global’ mit sloan management review (1 july 2007) 285 keith m. korenchuk and samuel m. witten, ‘emerging global standard for effective anti-corruption compliance: meeting the expectations of governments worldwide’ bloomberg bna's corporate accountability report; bloomberg bna's world securities law report (18 january 2013) 286 wayne m. carlin, ‘white collar and regulatory enforcement: emerging trends and what to expect in 2013’ the harvard law school forum on corporate governance and financial regulation (30 january 2013) <http://blogs.law.harvard.edu/corpgov/2013/01/30/white-collar-and-regulatory-enforcement-emerging-trends/> 287 keith m. korenchuk, marcus a. asner and samuel m. witten, ‘responding to anti-corruption compliance challenges in china: the way forward in light of the ongoing investigations in the pharmaceutical industry’ pharmaceutical compliance monitor (26 september 2013) 288 sec and doj, a resource guide to the fcpa u.s. foreign corrupt practices act (14 november 2012) 57 289 sec and doj, a resource guide to the fcpa u.s. foreign corrupt practices act (14 november 2012) 57 nordic journal of commercial law issue 2014#2 36 the bribery prosecution of the minstry of public security concern may be raised that a culture of compliance may not be as strongly embedded in gsk, or, at least, such a culture is not perceived as strongly embedded.291 8.2.3 corrupt payment by intermediaries of subsidiaries: parental-subsidiary liabilities with regard to parent-subsidiary liability, a subsidiary’s actions are imputed to the parent if an agency relationship exists.292 a long-standing issue always turns on whether the officers and agents of the parent had control over the actions of the subsidiary.293 there is an increased trend that parent companies will be held responsible for the actions of local employees and partners.294 foreign subsidiaries are a frequent source of concern for companies subject to the fcpa, although it remains to be clarified about the issues of liability for minority-owned entities in which a parent may have a substantial stake, but no ostensible control.295 an increasingly common issue concerns the appropriate degree of oversight that a parent issuer is required to exercise over a minority-owned subsidiary.296 enforcement agencies may consider the formal relationship between the two entities as well as the "practical realities of how the parent and subsidiary actually interact.”297 despite the seminal doctrine of the separate legal entity and piercing the corporate veil,298 parent companies are likely to be held responsible for the actions of local employees, which underscores the importance of due diligence on 290 sec and doj, a resource guide to the fcpa u.s. foreign corrupt practices act (14 november 2012) 56 291 glenn engelmann, john kocoras et al., ‘observation on a milestone bribery investigation and increased security of foreign companies in china’ <http://www.mwechinalaw.com/news/2013/cla0713b.htm> 292 justin f. marceau, ‘a little less conversation, a little more action: evaluating and forecasting the trend of more frequent and severe prosecutions under the foreign corrupt practices act’ (2007) 12 (2) fordham journal of corporate & financial law 285, 310 293 travis robert-ritter, ‘using second circuit precedent to fundamentally change multinational corporations' global foreign corrupt practices act internal investigations’ (2012) 8 international law & management review 89, 110 294 sec and doj, a resource guide to the fcpa u.s. foreign corrupt practices act (14 november 2012) 27; h. lowell brown, ‘the foreign corrupt practices act redux: the anti-bribery provisions of the foreign’ corrupt practices act’ (1994) 12 (2) berkeley journal of international law 260, 290 295 sec and doj, a resource guide to the fcpa u.s. foreign corrupt practices act (14 november 2012) 27-28; 296 david m. zornow , charles f. walker et al., ‘the united states foreign corrupt practices act: sec and doj enforcement trends’ (22 april 2013) <http://www.law.yale.edu/documents/pdf/cbl/skadden_fcpa_sec_and_doj_enforcement_trends.pdf>; stuart h. deming, ‘the potent and broad-ranging implications of the accounting and record-keeping provisions of the foreign corrupt practices act’ (2006) 96 (2) journal of criminal law and criminology 465, 502 297 sec and doj, a resource guide to the fcpa u.s. foreign corrupt practices act (14 november 2012) 27 298 kayla feld, ‘controlling the prosecution of bribery: applying corporate law principles to define a “foreign official” in the foreign corrupt practices act’ (2013) 88 (1) washington law review 245, 280 nordic journal of commercial law issue 2014#2 37 prospective third parties.299 in china’s more increasingly complicated business environment, foreign mncs must strengthen their efforts in due diligence and transparency to ensure that ethics at the corporate level are translated to ground floor business practices.300 8.2.4 localise gsk’s global compliance programmes global compliance measures superimposed on china’s unique business environment are not enough.301 foreign mncs should truly localise their global compliance programmes to specifically address their local operations in china. thus, having a robust home compliance programme makes limited sense, unless it is effectively compatible in china’s social and legal settings.302 gsk should always be aware of the degree of risk attributed to particular locations, like china, where an agent may present bigger risks for gsk than the same type of agent in another country.303 a truly effective compliance program for china needs to be one that identifies and addresses the issues arising out of local business and legal culture.304 such efforts are helpful in minimising risk and potential consequences, including reputational damage. mncs operating in china should understand the potential consequences of alleged violations of the chinese anti-bribery laws, regularly assess their risk profile, and highlight hallmarks of adequate compliance programmes to account for local variations in enforcement standards.305an effective compliance programme “constantly evolves” to reflect the changes to the company’s business over time, including changes to the environment in which the company operates, the nature of its customers and the laws that govern the company’s actions.306 299 jennifer quartana guethoff, marie-josée bérubé, et al., ‘good practice guidelines on conducting third-party due diligence’ (geneva, switzerland, world economic forum, 2013) <http://www3.weforum.org/docs/wef_paci_conductingthirdpartyduediligence_guidelines_2013.pdf> 300 ron cai, jeffrey b. coopersmith and elizabeth chen, ‘chinese probe into gsk—media reports and legal analysis’(29 july 2013) <http://www.dwt.com/chinese-probe-into-gskmedia-reports-and-legal-analysis-07-29-2013/> 301 sec and doj, a resource guide to the fcpa u.s. foreign corrupt practices act (14 november 2012) 63 302 david kennedy and dan danielsen, “busting bribery: sustaining the global momentum of the foreign corrupt practices act (new york, open society foundations, 2011) ; f. joseph warin, michael s. diamant and veronica s. root, ‘somebody’s watching me: fcpa monitorships and how they can work better’ (2011) 13 (2) university of pennsylvania journal of business law 321, 381 303 wendy wysong, ‘third-party intermediaries in china: mitigating a necessary risk’ corporate compliance insights (29 august 2011) 304glenn engelmann and john kocoras, ‘observations on a milestone bribery investigation and increased scrutiny of foreign companies in china’ mcdermott will & emery china law alert (26 july 2013) 305 sec and doj, a resource guide to the fcpa u.s. foreign corrupt practices act (14 november 2012) 8, 52, 57 306 sec and doj, a resource guide to the fcpa u.s. foreign corrupt practices act (14 november 2012) 61-62 nordic journal of commercial law issue 2014#2 38 most significantly, gsk should consider undertaking more due diligence to ensure that existing compliance programs are properly implemented in china.307 it is paramount to have a robust compliance program covering all critical functions, including sales and marketing personnel as well as legal compliance.308 sales in the uk through legal and compliant channels may warrant less scrutiny from a compliance program than gsk’s deals in china, by way of engaging those high-risk chinese third party sales agents.309 the risk-based compliance approach is only effective if the company in question is realistic about the locale in which it is dealing.310 gsk should have devoted more resources, like increasing its budgets, to ensuring compliance with the anti-bribery laws and regularly assess risks and to review and update their policies to reflect evolving best practices.311 8.2.5 overseas third parties: identify “red flags” “red flags” are simply warning signs that a violation may have occurred or may be about to occur.312 since third parties are commonly used to conceal the payment of bribes to foreign officials,313 the requisite level of scrutiny of a prospective third party depends on the “red flags” identified through the due diligence process.314 both the fcpa and bribery act 2010 impose liabilities on companies for payments made by any third parties acting on its behalf, even if the company was not aware of the third party’s conduct.315 it is indispensable to have periodical, thorough due diligence reviews of third-party business partners, including but not limited to: agents, distributors, consultants and travel agents. mere negligence is insufficient to impose 307 philip urofsky, hee won moon and jennifer rimm, ‘how should we measure the effectiveness of the foreign corrupt practices act? don’t break what isn’t broken-the fallacies of reform’ (2012) 73 (5) ohio state law journal 1145, 1179 308 dezan shira, ‘china's criminal law tackles bribery of foreign officials’ caijing (5 august 2013) 309 ‘fcpa: increased enforcement in china could result in large fines in us and uk’ policy & medicine (16 august 2013) <http://www.policymed.com/fcpa> 310 rodriguez, peter, klaus uhlenbruck and lorraine eden, ‘how corrupt governments matter: strategies of multinationals under corrupt regimes’ (2005) 30 (2) academy of management review 383, 396 311 united nations office on drugs and crime, ‘the united nations convention against corruption: a strategy for safeguarding against corruption in major public events’ (new york, united nations, september 2013) <http://www.unodc.org/documents/corruption/publications/2013/13-84527_ebook.pdf> 312 charles kenny and maria musatova, ‘‘red flags of corruption’ in world bank projects: an analysis of infrastructure contracts’ (the world bank sustainable development department finance, economics and urban division, march 2010) <http://elibrary.worldbank.org/doi/pdf/10.1596/1813-9450-5243> 313 emily n. strauss, ‘easing out” the fcpa facilitation payment exception’ (2013) 93 (1) boston university law review 235, 273 314 oecd, oecd due diligence guidance for responsible supply chains of minerals from conflict-affected and high-risk areas (2nd ed., 2012) <http://www.oecd.org/daf/inv/mne/guidanceedition2.pdf> 315 margaret ryznar and samer korkor, ‘anti-bribery legislation in the united states and united kingdom: a comparative analysis of scope and sentencing’ (2011) 76 (2) missouri law review 415, 453 nordic journal of commercial law issue 2014#2 39 liability under the statute's third-party payment provision.316 however, proof of conscious avoidance, wilful blindness, and deliberate ignorance are sufficient to satisfy the third-party payment provision's knowledge requirement.317 there should be policies and procedures relating to the risks associated with third parties, including the capacity for on-going monitoring and the ability to address any “red flags” that may surface during the course of the third party relationship.318 individual companies have different compliance needs and there is no “one-size-fits-all” formula to an effective model, but a "common-sense and pragmatic approach to evaluating compliance programs."319 this leaves it to the company to determine what reasonable internal controls are. an effective compliance program is one that is appropriately tailored to meet the needs of the company. the adequacy of a company's compliance "staffing and resources" depends on the "size, structure, and risk profile of the business."320 gsk’s compliance programme must be tailored to the size and nature of the business and the particular risks associated with its global location. gsk should have evaluated what type of compliance programme would fit it best. due to the failure to conduct due diligence on the agent responsible for the bribes, gsk must identify high-risk activities while concentrating compliance efforts on mitigating potential violations of law.321 emphasising a risk-based approach, gsk may need to tailor its programme to take into account its size, product and sensitivity with a particular regard to high-risk areas with “red flags”.322 when the “red flags” were raised, gsk had an affirmative duty to investigate the suspicious circumstances and took steps to determine whether the anti-bribery laws have been violated. if red flags cannot be justified, gsk may run the risk of having had knowledge that would make the bribery a violation of anti-bribery laws.323 a mere declaration of its innocence would not insulate it from liability. in the wake of the us and chinese 316jer monson, ‘bribery boom or bust: a practitioner’s primer for differentiating between bribes and legitimate exceptions in the foreign corrupt practices act’ (2012) 5 (2) journal of business, entrepreneurship and the law 403, 426 317 united states v. kozeny 582 f. supp. 2d 535 (s.d.n.y. 2008) 318 sec and doj, a resource guide to the fcpa u.s. foreign corrupt practices act (14 november 2012) 60-61 319 sec and doj, a resource guide to the fcpa u.s. foreign corrupt practices act (14 november 2012) 56 320 sec and doj, a resource guide to the fcpa u.s. foreign corrupt practices act (14 november 2012) 58 321 dean giampietro, ‘fcpa and uk bribery act updates: whistleblower effects’ whistleblower security (13 june 2013) 322 robert c. blume and j. taylor mcconkie, ‘navigating the foreign corrupt practices act: the increasing cost of overseas bribery’ (2007) 36 the colorado lawyer 91 323 emily flitter and ben hirschler, ‘exclusive: u.s. prosecutors add china bribe allegations to gsk probe’ reuters (6 september 2013) nordic journal of commercial law issue 2014#2 40 governments’ increasingly rigorous stance on enforcement, foreign multinationals should act with more caution in dealing with their foreign agents and business partners.324 9 conclusion the recent enforcement of chinese anti-bribery laws against gsk highlights the compliance challenges faced by foreign companies operating in china and the importance of the maintenance of high legal and ethical standards. critical to a compliance programme is making integrity and ethics a part of the overall evaluation process, which provides incentives for compliance. gsk represents china’s highest profile bribery investigation of a foreign company since the new bribery rules came into effect in 2013, reflecting broad concerns about the challenges of doing business in china. as a milestone for chinese agencies to impose far more rigorous enforcement of analogous anti-bribery laws, it is advisable that mncs should not underestimate the implications of china’s willingness to subject foreign companies to bribery prosecutions. gsk sends a strong message of deterrence to domestic and foreign actors, and improves china’s overall anti-corruption standing in the world. gsk has a particular far-reaching impact on the pharmaceutical firms, which are expected to re-examine their internal controls and be more legally compliant. it is also imperative that foreign mncs implement robust anti-bribery compliance programmes which are well-designed and tailored to the companies’ specific highrisk areas. more meaningfully, the first parallel gsk case may set a precedent for the future interplay of multinational anti-bribery law. given that the bribery act 2010 and china’s laws are relatively untested, the landmark case serves an instrumental role in demonstrating how the transnational criminal codes apply to real world issues. in the increasingly complicated environment of multinationals and their foreign subsidiaries, mncs must strengthen efforts in due diligence to ensure that ethics at the global corporate level are translated to ground floor business practices. 324 oecd, convention on combating bribery of foreign public officials in international business transactions and related documents (2011) <http://www.oecd.org/daf/anti-bribery/convcombatbribery_eng.pdf> microsoft word magnea_lilly_fridhgeirsdottir_lopullinen.docx nordic journal of commercial law special edition 2011 google’s liability under eu law for trademark infringements committed through the adwords system by magnea lillý friðgeirsdóttir 1 nordic journal of commercial law special edition 2011 1 introduction trademarks represent one of the fundamental elements of maintaining an active competition on the market. therefore, it is natural that trademark protection should be under constant reconstruction and amendment in accordance with changes and developments in the business world. the most extensive development over the past years occurred through the rise of the internet, which resulted in a changed focus point for trademark protection as well. while general exclusive rights retain their importance, new challenges have surfaced with the rise of the internet. these problems have called for a re-interpretation of trademark laws, new legislation and an evaluation of conflicting rights and interests in light of business developments. even though current legislation has been improved and is increasingly fitted to this new environment, the internet still challenges trademark protection. one of the more troubling conflicts which have arisen is manifested in the google search engine and the operation of advertisement software connected to the search engine. through its function as a global search engine, google has managed to attract a vast number of advertisers by selling search terms, or keywords, through a software called adwords. the adwords program has, however, been greatly criticised by trademark owners claiming it is an infringement tool. the alleged infringements that have been committed through the google adwords software have raised concerns by trademark proprietors that with the internet, they are vulnerable to attacks on their marks and that without proper reaction by the courts, their rights will be severely diminished. on the other hand, the adwords cases have been marked as an attempt of trademark holders to expand their rights even further and have raised concern that extended trademark protection would be established at the cost of restrictions on freedom of expression and commerce. as google adwords has caused considerable debate, it does not come as a surprise that several cases regarding its legality have been presented in national courts, with many of them reaching the european court of justice (ecj) for a preliminary ruling. however, most of the cases have been restricted to the question of whether advertisers using the adwords software are committing trademark infringements and thus have not considered the liability of google as an internet service provider (isp). until now, only three cases specifically discussing isp liability in connection with the adwords system have been referred to the ecj. in the following text, these three cases regarding google’s liability will be discussed, addressing the liability question from both a primary and a secondary infringement point of view. furthermore, european union (eu) legislation and directives will be examined, and light will be shed on the conflicts of interest between parties. european national courts have delivered diverse opinions on the matter, and it is clear that the ecj will have decisive effect on the future of electronic use of trademarks, as the ecj’s judgement is binding on national courts. furthermore, the ecj will have decisive effect on the future of google as well as the future of other comparable isps, as its judgements will serve as precedent for similar trademark uses. the article will therefore emphasise google’s position 2 nordic journal of commercial law special edition 2011 under eu laws and the guidelines provided by the ecj. the aim will be to answer the question whether the use by google of keywords corresponding to trademarks in its adwords advertising system constitutes an infringement of those marks. relevant sources regarding the legality of the adwords system under eu law are scarce, as the ecj judgement is quite recent. therefore, the judgement itself as well as legislation are at the centre of the following discussion. 2 what is google adwords? before a discussion on the legality of google’s adwords software can commence, it must first be established what google adwords is, what its function is and how it is connected to the natural operation of the google search engine. google’s function revolves around the operation of a global search engine. each time an internet user types a search word(s) into the search engine, a list of websites is displayed which consists of the sites which best correspond with the search term. the resulting sites are ranked according to relevance. this function of the search engine is objective and provides what is called a ‘natural’ result of the search.1 in addition to this basic function, google also offers a paid referencing service called adwords. adwords is a software program which enables advertisers to promote their product or service on google’s website. the software requires that advertisers select one or more search terms that their own website will thenceforth be linked to. in addition, advertisers are required to make a short commercial text which will appear along with the website’s link. after this process has been completed, the advertisement will appear whenever a search for the chosen term(s) is initiated.2 the advertisement appears on a yellow banner under the heading ‘sponsored links’, which is displayed either at the top of the search results above the natural results or on the right-hand side of the screen.3 google has set up an automated process for the selection of keywords and the creation of ads, however; advertisers select the keywords, draft the commercial message and input the link to their site themselves.4 in principle, an advertiser can choose any given sign for a keyword. however, when a registered trademark belonging to someone other than the advertiser is chosen, a question regarding the legitimacy of that choice arises.5 1 ecj 23 march 2010 in the joined cases c-236/08 to c-238/08, paragraph 22. 2 http://adwords.google.com/support/aw/bin/static.py?hl=en&topic=21901&guide=21899&page=guide.cs& answer=148648. retrieved 25 july 2011. 3 ecj 23 march 2010 in the joined cases c-236/08 to c-238/08, paragraphs 23–24. 4 ibid., paragraph 27. 5 bechtold, stefan. ‘google adwords and european trademark law: is google violating trademark law by operating its adwords system?’, 54 communications of the acm (2011), p. 30. 3 nordic journal of commercial law special edition 2011 google collects revenue from adwords on a price-per-click basis, i.e. based on the number of times that a sponsored link is clicked on calculated with the maximum price per click, which is negotiated beforehand by google and the advertiser.6 multiple advertisers can select the same search term as a keyword for their advertisements. the order in which the advertisements appear is in accordance to the maximum price per click that the advertisements have, the number of times each advertisement has been clicked on and the quality of the ad as assessed by google. the same applies in case there is not room to display all the advertisements connected to the keyword that has been entered into the search engine. an advertiser can, at any given time later on, improve his ranking by simply raising the maximum price per click or by increasing the quality of his advertisement.7 3 the ecj cases seeing that the adwords software offers advertisers the possibility of connecting their products or services with protected trademarks owned by third parties without the owner’s permission, the software has understandably created great conflicts. although european union legislation provides national courts with guidelines for a uniform approach to the problem, it has proven insufficiently clear. during the past year, a judgement has been issued by the ecj providing additional interpretation on how the conflict of google adwords may be approached. this judgement was the result of the first case law to come before the ecj, which consisted of three cases referred to the court by the french cour de cassation. all three cases involved google france and were joined together for a collective judgement. each case will be summarised individually in the following text in order of the case number. 3.1 case summary in the case of google france and google inc. (will be referred to hereafter collectively as google) v louis vuitton malletier (c-236/08), vuitton brought proceedings against google france claiming that its trademark rights had been infringed. in early 2003, vuitton discovered that google was offering keywords matching protected community and national trademarks owned by vuitton, as search terms in its adwords software. in addition to offering keywords matching vuitton’s trademarks, google also offered advertisers the ability to choose a combination of the protected trademarks and terms suggesting imitation or copy. when french internet users entered keywords constituting vuitton’s trademarks into google’s search engine, links were displayed which, if clicked on, directed the user to sites offering imitation versions of vuitton’s products. 6 ecj 23 march 2010 in the joined cases c-236/08 to c-238/08, paragraph 25. 7 ibid., paragraph 26. 4 nordic journal of commercial law special edition 2011 google was found guilty of infringing on louis vuitton’s trademarks in national courts but appealed to the cour de cassation, which referred questions to the ecj for a preliminary ruling.8 the second case, google france sarl v viaticum sa, luteciel sarl (c-237/08), entailed the use of the french trademarks ‘bourse des vols’, ‘bourse des voyages’ and ‘bdv’ registered to viaticum. the second party to the case, luteciel, is an information technology service provider for travel agencies, such as viaticum, which published and maintained viaticum’s internet site. viaticum and luteciel brought proceedings against google france after finding that google had, through the software adwords, sold the use of the trademarks in question for advertising purposes. thus, on account of the adwords service, an advertisement for viaticum’s competitors appeared each time a search for viaticum’s trademarks was made by internet users. national courts found google guilty of trademark infringement and accessory to infringement, and google was ordered to compensate viaticum and luteciel for the losses which they had suffered. google brought an appeal before the cour de cassation, which referred questions to the ecj.9 the third and last case of the joint judgement, google france sarl v centre national de recherche en relations humaines (cnrrh) sarl, pierre-alexis thonet, bruno raboin and tiger sarl (c238/08), regarded the unauthorised use of the trademark ‘eurochallenges’. the trademark, which belongs to mr thonet and is licensed to cnrrh, was used by competitors of cnrrh, mr raboin and mr tiger to promote their own websites by having a link presented each time an internet user made a google search for the trademark. the unauthorised use was implemented by use of the adwords software, which specifically offered advertisers the possibility of selecting ‘eurochallenge’ as a keyword. mr raboin, tiger and google were all found guilty of trademark infringement by french national courts. google later lodged an appealed to the cour de cassation, which referred questions to the court.10 3.2 arguments to begin with, it must be emphasised that trademark holders do not possess, within their exclusive rights, the right to prevent all use of their mark by unauthorised parties. on the contrary, the rights conferred by a trademark are clearly defined as a right to prevent unauthorised third-party use of a protected trademark in the course of trade for goods or services which are identical to those for which the mark is registered. additionally, proprietors may prevent unauthorised use of an identical or similar mark which is being used for identification on identical or similar goods or services where there exists a likelihood of confusion on the part of the 8 ecj 23 march 2010 in the joined cases c-236/08 to c-238/08, paragraphs 28–32. 9 ecj 23 march 2010 in the joined cases c-236/08 to c-238/08, paragraphs 33–37. 10 ibid., paragraphs 38–41. 5 nordic journal of commercial law special edition 2011 public, including association.11 furthermore, member states may provide proprietors of wellknown marks with the right to prevent a use of the mark, or of a similar mark, on dissimilar goods or services if such use would constitute taking unfair advantage of the reputation of the mark or would be damaging to the mark’s repute or distinctive character.12 corresponding provisions apply to community trademarks.13 the question is then whether the keyword advertising as conducted through the adwords program constitutes use by google in the course of trade of identical or similar marks to those of the parties to the cases for identification on identical or similar products or services. as it can easily be established, louis vuitton is a well-known mark. therefore, a use on dissimilar goods or services would suffice for an infringement to have occurred. since the liability of google for possible infringements committed by advertisers when selecting keywords is the only issue being discussed here, all arguments regarding the advertisers’ own liability will be disregarded except certain discussion which is needed for the purpose of establishing secondary liability. according to the trademark directive, what may be prohibited by trademark proprietors is affixing the trademark to goods or packaging, offering the goods or putting them on the market under the sign as well as offering or supplying services using the mark. additionally, importation and exportation of goods identified by the mark or the use of the mark on business papers and in advertising can be prohibited.14 furthermore, the use of a sign identical or similar with a trademark ‘constitutes use in the course of trade where it occurs in the context of commercial activity with a view to economic advantage and not as a private matter’.15 it is clear that storing for clients keywords which constitute or are similar to protected trademarks owned by third parties and arranging for the display of advertisements based on those keywords in return for payment cannot be considered as a private matter but rather a commercial activity with a view to economic advantage.16 however, this inevitably brings attention to the fact that google does not use the mark itself to promote any product or service. the trademarks which are used for keyword advertising also do generally not appear in the sponsored ad itself (only in google v louis vuitton was that the case). the unauthorised use simply consists of an advertisement, containing a link, which appears with the natural search results whenever the trademark is entered into google’s search engine.17 google cannot, therefore, be held liable for 11 directive 2008/95/ec, article 5(1) and agreement on trade-related aspects of intellectual property rights, part ii, section 2, article 16. 12 directive 2008/95/ec, article 5(2). 13 council regulation (ec) no. 40/94, article 9. 14 directive 2008/95/ec, article 5(3). 15 ecj 23 march 2010 in the joined cases c-236/08 to c-238/08, paragraph 50. 16 ibid., paragraph 53. 17 ibid,. paragraph 55. 6 nordic journal of commercial law special edition 2011 direct infringement of exclusive trademark rights, as it has not violated the conditions of article 5 of the trademark directive.18 however, by briefly looking at the advertiser’s liability, it is quickly evident that the requirements of trademark and product similarity or identical features are met in all three cases. in fact, if this would not be the case, the act of choosing a particular mark as a keyword would be pointless, as it is the aim of the advertisers to achieve a higher level of exposure to consumers by buying competing trademarks as keywords. therefore, it can be stated that most likely in all cases of unauthorised use of trademarks as keywords, there exists a similarity between the marks and the goods or services or they are identical. but is it a use in the course of trade? according to article 5(3)(d) of the trademark directive, a preventable use in trade is amongst other things ‘using the sign on business papers and in advertising’19. although the mark itself is not displayed as a part of the advertisement in a sponsored link, the mark is used, in exchange for payment, to trigger the display of an advertisement for a competitor or a seller of counterfeited goods and therefore for commercial purposes and not as a private matter. thus, it would be reasonable to argue that this is indeed use in the course of trade. we must therefore once again consider the possibility of google being liable for violating trademark law, this time for an indirect attributive infringement. as has already been stated, google’s role in the possibly infringing activities does not suffice for it to be held directly liable. nonetheless, it is clear that all possible and actual infringements through the use of adwords are committed only because google enables it. in addition to providing the technical conditions for adwords functionality, it has been established that google does not restrict the selection of protected trademarks as keywords to those who actually hold the right to those marks.20 in fact, google does quite the opposite, making all trademarks equally accessible to all advertisers. trademarks may even be selected by numerous parties. it is not debated that google collects a substantial part of its annual revenue from its advertisement services, thereof mostly from payments for the use of the adwords system. google does therefore clearly benefit from the operation of adwords, including the infringements which are committed with the help of the software. in order to determine, however, whether or not google carries secondary liability, it must be established whether it falls within the provisions of the e-commerce directive providing limited liability for isps, also known as safe harbour provisions. according to the e-commerce directive, the information society services which are subject to the directive are ‘any service normally provided for remuneration, at a distance, by electronic means and at the individual request of a recipient of services’.21 as it is clear that google 18 ibid., paragraph 58. 19 directive 2008/95/ec, article 5(3)(d). 20 ecj 23 march 2010 in the joined cases c-236/08 to c-238/08, paragraph 54. 21 directive 2000/31/ec, article 2(a). 7 nordic journal of commercial law special edition 2011 transmits information at the request of the advertisers who are also the service recipients, over a communication network and stores certain data, including the keywords selected by the advertisers as well as the link and commercial messages, it must be concluded that google falls within this definition.22 furthermore, it has been established that although google’s search engine is provided free of charge, it is provided in the expectation of remuneration under the adwords system.23 section 4 of the e-commerce directive establishes the possibility of restricted liability for three types of isps. in all three cases laid by the cour de cassation before the ecj, a question was referred regarding whether google might be considered as falling within the scope of the third type found in article 14 of the e-commerce directive24 referred to as ‘hosting’. hosting applies to information which is provided by and stored at the request of the recipient of the service. there are, however, two conditions that must be met in order for this article to apply. first, google may not have actual knowledge or be aware of any illegal activity or information that is being stored.25 second, should it be established that google has already obtained such knowledge or awareness, it is under obligation to immediately remove or disable access to the information.26 the adwords system in its essence transmits information gathered from the recipient of the service, that is the advertiser, […] over a communications network accessible to internet users and stores, that is to say, holds in memory on its server, certain data, such as the keywords selected by the advertiser, the advertising link and the accompanying commercial message, as well as the address of the advertiser’s site.27 thus, google is likely to fall within the article. however, for the exemption to be applicable, google may, according to recital 42, only provide a service ‘of a mere technical, automatic and passive nature, which implies that the information society service provider has neither knowledge of nor control over the information which is transmitted or stored’28. whether google, as a service provider, meets these requirements is for the national courts to decide, as they are in the best position to assess the actual terms on which the service in these cases is supplied.29 nonetheless, it must be borne in mind that the court declared that google’s 22 ecj 23 march 2010 in the joined cases c-236/08 to c-238/08, paragraph 110. 23 opinion of advocate general poiares maduro delivered on 22 september 2009, joined cases c-236/08, c237/08 and c-238/08, paragraph 131. 24 ibid., paragraphs 32, 37 and 41. 25 directive 2000/31/ec, article 14(1)(a). 26 directive 2000/31/ec, article 14(1)(b). 27 ecj 23 march 2010 in the joined cases c-236/08 to c-238/08, paragraph 111. 28 directive 2000/31/ec, recital 42. 29 ecj 23 march 2010 in the joined cases c-236/08 to c-238/08, paragraph 119. 8 nordic journal of commercial law special edition 2011 remuneration and the fact that google sets payment terms and provides general information to the advertisers cannot cause google to be deprived of the exemption from liability provided in article 14 of the e-commerce directive.30 furthermore, the function of the adwords system of connecting keywords selected by the advertiser and the search term entered into the google search engine is not sufficient for google to be considered to have ‘knowledge of, or control over, the data entered into its system by advertisers and stored in memory on its server’31. 3.3 ecj judgement to summarise, the ecj found, in its joint judgement, that google was not using the rightholders’ marks, in a manner covered by european trademark law, by operating the adwords software. on the contrary, google was merely ‘operating a service that may enable advertisers to engage in trademark violations. google does not decide which trademarks to use as keywords, but merely provides a keyword selection service.’32 this was not considered sufficient to justify an action for direct trademark infringement. although the court established that google had not committed direct infringement, there was still the question of whether google might be held liable for indirect infringement. the adwords software enables third-party advertisers to infringe on the exclusive rights of trademark holders and also collects revenue for google. there are, therefore, clearly great interests at stake for google. however, the e-commerce directive provides restrictions regarding the liability of isps for infringing activities of third parties, in this case the advertisers. according to the judgement of the ecj, the question of whether google is subject to secondary liability or whether it falls within the safe harbour provisions of the e-commerce directive depends on whether the google adwords system is a mere automatic and passive system or whether google played such an active role that it can be considered to have knowledge of, or control over, the information that was stored. in addition, if google is deemed to have failed to act expeditiously to remove or to disable access to the information upon having obtained knowledge of its unlawful nature, it cannot fall within the limitation provision. final evaluation regarding this can, however, only be conducted by the national courts, which must evaluate these issues compared to the facts of the case.33 30 ibid., paragraph 116. 31 ibid., paragraph 117. 32 bechtold, stefan. ‘google adwords and european trademark law: is google violating trademark law by operating its adwords system?’, 54 communications of the acm (2011), p. 31–32. 33 ecj 23 march 2010 in the joined cases c-236/08 to c-238/08, paragraph 121(3). 9 nordic journal of commercial law special edition 2011 4 further discussion although the findings of the ecj are apparent, it can still be debated whether the court’s approach is the most favourable one for society as a whole. furthermore, there still remains the need to discuss arguments not presented or dealt with by the court, both legal and non-legal. even though the ecj judgement will weigh heavily when national courts take their final stand regarding the liability of google, there is still room for varying interpretations. 4.1 conflict of interests the conflict surrounding google adwords may at first seem like a regular infringement dispute, but in fact, the outcome of the conflict will have significant effect on the future prospects of all affected parties. from the proprietors’ perspective, there are substantial advantages tied to the possibility of google being held liable as a service provider for third-party infringing activities. if google is found to be liable, proprietors no longer need to file suit against numerous individual advertisers which are using their trademarks in advertisements. instead, with a single lawsuit against google, all keyword-related trademark violations will be stopped. the same applies for preventing the use of a trademark to advertise websites containing counterfeited goods, as was the case in google france v louis vuitton. this would be a substantial improvement for trademark proprietors, as it can be extremely difficult to determine ownership regarding such sites, jurisdictional forum as well as the applicable legislation. additionally, new infringing sites can quickly and easily take the place of those removed through judicial processes.34 proprietors would thus no longer need to sue each product imitator individually but could instead have the obligation effected on google as a service provider to remove all infringing material and even incur a permanent monitoring obligation. a development like this would inevitably save trademark holders a great deal of time and money. what is more, if google is found liable of secondary infringement for making a selection of keywords corresponding to protected trademarks available, then the scope of trademark protection has been extended to such degree that proprietors may prevent the use of their marks in adwords regardless of whether the marks are used by sites offering counterfeited goods or for advertising legitimate versions sold by retailers. 35 google, on the other hand, has tremendous interests in not being held liable in cases such as those concerning adwords. google’s main source of revenue is collected from advertisement services, where google adwords is considered the biggest factor.36 the advertisement profits 34 opinion of advocate general poiares maduro delivered on 22 september 2009, joined cases c-236/08, c237/08 and c-238/08, paragraph 115. 35 ibid., paragraph 49. 36 http://investor.google.com/financial/tables.html. retrieved 5 may 2011. 10 nordic journal of commercial law special edition 2011 are then used to maintain and improve features such as the google search engine which is one of the most widely used search engines worldwide. it is evident that if all unauthorised uses of trademarks in adwords become infringing, google will be forced to prevent such activity. keywords corresponding with trademarks are innumerable, and google would be required to go to extreme lengths in order to reduce the risk of liability with accompanying litigation costs. in fact, it is most likely that ‘the nature of the internet and search engines as we know it would change’.37 thus, a great deal may depend on whether google is found liable for indirect infringement. although isp liability may thus appear to be the solution to online infringements such as in the case of google adwords, arguments have also been raised demanding protection for the necessary preservation of the internet as well as the need to protect the possibility of further development. for instance, isps’ willingness to provide their necessary services would be dramatically affected if they would be in danger of being held liable for infringing material which is put on their internet facilities by third parties. moreover, it would be extremely difficult for isps to monitor the vast amount of material they transfer and store, and should isps be obligated to perform such monitoring, it would result in higher costs of access to basic server users.38 4.2 the future of isp liability when the e-commerce directive was originally tailored, its objective was to create a legal order to deal with the regulation of the new global business sphere of the internet. however, in 2000, the european commission found it necessary to assemble rules providing limited liability.39 on the following grounds: the limited liability regime of intermediaries ... was considered indispensable to ensure the provision of basic services that safeguard the continued free flow of information in the network and the provision of a framework that allows the internet and e-commerce to develop.40 however, the goal of these provisions has not been achieved. while the e-commerce directive seemingly provides clear provisions on limited liability for isps, the interpretation of those provisions has been varying and increasingly ignoring the aim of providing safe harbour for isps. 37 opinion of advocate general poiares maduro delivered on 22 september 2009, joined cases c-236/08, c237/08 and c-238/08, paragraph 122. 38 eecke, patrick v. & ooms barbara. ‘isp liability and the e-commerce directive: a growing trend toward greater responsibility for isps’, 11 journal of internet law (2007), p. 3. 39 ibid., p. 3. 40 ibid., p. 3. 11 nordic journal of commercial law special edition 2011 articles 12–14, which specify the three types of isps subject to limited liability, all have the common element of not in any way affecting the possibility for a court or an administrative authority to require the isp to terminate or prevent an infringement.41 what this means is that although isps may be free from liability under articles 12–14, they can still be subject to injunctions requiring them to react to infringements that occur through the use of their services. this factor has caused considerable uncertainty since the term ‘prevent’ is used in the provisions. the issuance of preventive injunctions upon isps could easily result in an obligation to monitor, and that has already been the case in several national judgements, see inter alia rolex v ebay decided by the german federal supreme court.42 in contradiction to permitting preventive injunctions, article 15 of the directive clearly states that member states are not permitted to impose a general obligation on isps which fall under articles 12–14 ‘to monitor the information which they transmit or store, nor a general obligation actively to seek facts or circumstances indicating illegal activity’43. monitoring obligations may thus only be imposed in specific cases.44 however, to add even further complications, recital 48 of the directive states that member states may require isps to ‘apply duties of care, which can reasonably be expected from them and which are specified by national law, in order to detect and prevent certain types of illegal activities’ 45, thus seemingly contradicting article 15. the e-commerce directive thus provides provisions prohibiting general monitoring obligations while simultaneously declaring instances where those exact obligations may be implemented. on the grounds of these inconsistencies and contradictions found within the e-commerce directive, member states are rendered confused and without the proper guidelines to create a uniform approach regarding monitoring obligations of isps. this uncertainty has left isps in darkness regarding their future, and only time will tell how this will affect their operating services. it is, however, clear that should google be found liable for indirect infringement based on the function of the adwords system, it would become subject to monitoring obligations such as those which are both prohibited and permitted in the e-commerce directive. 4.3 finding the right balance as trademark rights do not confer a complete exclusive right over a mark or a sign, trademark proprietors cannot prevent all use of their mark, for example comparative advertising46 and use 41 directive 2000/31/ec, article 12(3), 13(2) and 14(3). 42 bgh case i zr 304/01. 43 directive 2000/31/ec. article 15(1). 44 ibid consideration 47. 45 ibid consideration 48. 46 case c-533/06 o2 holdings and o2(uk) [2008] ecr i-4231, paragraphs 41-45 12 nordic journal of commercial law special edition 2011 of a mark for purely descriptive purposes47. use for descriptive purposes and comparative advertising has been found by the court to be excluded from the protective scope of article 5(1)(a) and (b) of directive 89/104 and thus do not affect a trademark proprietor’s interests regarding the trademark’s functions. the exclusive rights conferred by trademark protection are thus only justifiable within the limits of these articles and for the purpose of protecting the aim of the provisions.48 this applies equally to trademarks with a reputation.49 it is therefore evident that as long as an unauthorised use by a third party does not affect the function of a trademark, it cannot be prevented by the proprietor. although google’s use of trademarks does not fall within either of the above mentioned categories, it can be argued that it should be construed as falling outside proprietors’ monopoly powers for the same reason. in a similar manner as descriptive purposes and comparative advertising, google adwords creates a link of information to consumers using a protected mark without creating consumer confusion.50 google adwords’ use is twofold: it allows the selection of a certain trademark as a keyword, and it activates the display of the ad. both of these uses create a link in order for consumers to obtain information about specific trademarks. use of protected trademarks in the adwords ads and on websites that are advertised in adwords is, however, not connected to google’s use of the trademarks.51 therefore, it is not a question of whether google’s use of keywords corresponding to protected trademarks affects their essential function, but rather a question of whether google’s use affects other functions, such as whether the use takes unfair advantage of the trademarks or is detrimental to the distinctive character or repute of the marks.52 when consumer confusion exists, a trademark infringement has always been committed. however, based on the nature of google’s use, as it is strictly consisting of making information available, google can hardly be considered to be confusing consumers. therefore, it is open to interpretation whether or not google has committed a trademark infringement. adwords does, in fact, take less advantage of the trademarks used than comparative advertising and descriptive use, as adwords does not take part in the display of the trademarks in the ads in adwords nor on the sites advertised, while both comparative advertising and descriptive use consist of the display of a protected mark and affiliation with it in order to convey information 47 case c-2/00 hölterhoff [2002] ecr i-4187, paragraph 16 48 case c-206/01 arsenal football club [2002] ecr i-10273, paragraphs 52-54. 49 case c-487/07 l‘oréal and others [2009] ecr i-0000, paragraph 62. 50 opinion of advocate general poiares maduro delivered on 22 september 2009, joined cases c-236/08, c237/08 and c-238/08, paragraph 106. 51 opinion of advocate general poiares maduro delivered on 22 september 2009, joined cases c-236/08, c237/08 and c-238/08, paragraphs 106-107. 52 directive 2008/95/ec, article (2). 13 nordic journal of commercial law special edition 2011 regarding the quality or kind of service or product. this supports strongly that google’s use should not be found to infringe trademark rights. 53 in the case of google adwords trademark proprietors are trying to have their rights extended to cover google’s actions regardless of consumer confusion and reaching beyond clear trademark infringements. these claims are supported by arguments that trademark proprietors have invested heavily in their marks to build up a certain reputation and should alone be free to reap the benefits of that investment. although these are valid arguments, we must keep in mind the need for balance between necessary trademark protection, on one hand, in order to incentivise innovation and commercial investment and, on the other hand, protecting the public domain in order to leave room for further innovation. it is necessary to provide protection in the form of private ownership over investments and innovations that are made in order for the effort to be fruitful, such as the time and monetary commitment made to build up a trademark. nonetheless, if the protection is too strong and a complete monopoly over words and signs is created, then the selection left in the public domain for future trademark creations is continuously diminished. hence, excessive protection would, in fact, prevent further innovation and investments, which goes against the original aim of trademark protection. trademark rights can therefore not be construed as classic rights enabling the trademark proprietor to exclude any other use. the transformation of certain expressions and signs – inherently public goods – into private goods is a product of the law and is limited to the legitimate interests that the law deems worthy of protection.54 therefore, an equal balance must be found between the two interests, and both interests have to be taken into account when trademark infringements are evaluated. consequently, it is imperative that adwords is not found to infringe upon trademark rights, because once the monopoly rights have been extended beyond the requirement of possible consumer confusion, trademark proprietors have, in fact, been granted an absolute monopoly over their mark as keywords. ‘such an absolute right of control would cover, de facto, whatever could be shown and said in cyberspace with respect to the good or service associated with the trade mark.’55 here, we must remember that adwords is not only used to promote counterfeited goods or authentic goods sold in an illegal manner, but is also used to advertise legitimate retailers and private and public parties selling legally obtained legitimate versions of the good. nonetheless, if adwords is found to be infringing, trademark proprietors could 53 opinion of advocate general poiares maduro delivered on 22 september 2009, joined cases c-236/08, c237/08 and c-238/08, paragraph 107. 54 opinion of advocate general poiares maduro delivered on 22 september 2009, joined cases c-236/08, c237/08 and c-238/08, paragraph 103. 55 opinion of advocate general poiares maduro delivered on 22 september 2009, joined cases c-236/08, c237/08 and c-238/08, paragraph 108. 14 nordic journal of commercial law special edition 2011 prevent advertisements from these parties as well since they would be based on keywords corresponding to their trademarks. regulating the internet to this extent by allowing private control over specific keywords would impede the internet in its general operation and thus its further growth, as keywords are the fundamental instrument of allowing transportation of information and access between consumers and the material sought after.56 the importance of the balance between incentives and safe guarding freedom of expression and commerce to maintain stimulation in competition and future innovation has been repeatedly confirmed by the court itself.57 in order to follow that precedent and protect the balance against exclusive trademark rights, the use by google adwords of protected marks should be exempted from liability. 5 conclusion google represents one of the giant isps and has become an integral part of everyday life for many people. the european court of justice has already adopted an official position on google’s liability as an internet service provider by leaving room for final assessment by national courts of whether google’s role in the infringement is sufficient to be deemed an indirect infringement. however, given the growing trend of national courts towards increased isp liability, it is probable that the final judgement will not be in google’s favour. when all facts and arguments are considered, it is still debateable whether google should be held liable for third-party infringements committed through the use of adwords. many conflicting arguments are relevant to this issue, and the consequences will be substantial regardless of the outcome of the adwords cases. if google were to be found liable, this would, in fact, subject google to monitoring obligations, although these are strictly prohibited under the e-commerce directive. to avoid any future findings of liability, google would have to remove all terms from the adwords selection that could possibly correspond to trademarks or reserve the use of such words for trademark proprietors. this would leave little scope for proper operation of the software, which in turn would likely lead to economic hardships for google, affecting its entire operation. the move of intellectual property owners towards demanding stronger and extended protection for their rights has been growing continuously in the past years. trademark proprietors have justified their efforts as necessary to incentivise investment and innovation. in many cases, these efforts have been successful. however, the internet clearly provides incredible possibilities 56 opinion of advocate general poiares maduro delivered on 22 september 2009, joined cases c-236/08, c237/08 and c-238/08, paragraphs 109 – 110. 57 for instance case c-533/06 o2 holdings and o2(uk) [2008] ecr i-4231, paragraphs 38-40, and case c487/07 l‘oréal and others [2009] ecr i-0000, paragraph 68. 15 nordic journal of commercial law special edition 2011 both in business and in private life. furthermore, the countless opportunities of future developments within the internet world carry great potential. the internet and its essential function must therefore be safeguarded from the attacks of proprietors and preserved for the future benefit of society as a whole. determining whether google is liable as an internet service provider is clearly one of the largest issues awaiting resolution regarding isp liability, which will set a major precedent for future isp liability cases. given the tremendous influence restrictions to this extent would have on the function of isps as well as on society as a whole, i am of the view that extending trademark rights to prevent all unauthorised use in adwords cannot be justified. other means must be found to ensure continuing natural and necessary functions of trademarks online. 16 nordic journal of commercial law special edition 2011 bibliography legislation agreement on trade-related aspects of intellectual property rights directive 2000/31/ec directive 2008/95/ec regulation (ec) no. 40/94 cases and opinions bgh case i zr 304/01 ecj 23 march 2010 in the joined cases c-236/08 to c-238/08 ecj 18 june 2009 case c-487/07 ecj 12 june 2008 case c-533/06 ecj 14 may 2002 case c-2/00 ecj 12 november 2002 case c-206/01 opinion of advocate general poiares maduro delivered on 22 september 2009, joined cases c236/08, c-237/08 and c-238/08 journals bechtold, stefan. ‘google adwords and european trademark law: is google violating trademark law by operating its adwords system?’ 54 communications of the acm (2011), 30–32. eecke, patrick v. & ooms barbara. ‘isp liability and the e-commerce directive: a growing trend toward greater responsibility for isps’, 11 journal of internet law (2007), 3–9. internet sources: http://adwords.google.com/support/aw/bin/static.py?hl=en&topic=21901&guide=21899&page=guide .cs&answer=148648. retrieved 25. july 2011. http://investor.google.com/financial/tables.html. retrieved 5. may 2011. microsoft word yajie_zhao.doc nordic journal of commercial law issue 2014#2 what bothers innovation in china: is it only a question of counterfeits? by yajie zhao* * doctoral candidate/ll.m of european intellectual property. university of helsinki, faculty of law. nordic journal of commercial law issue 2014#2 1 abstract starting with a comparison of litigation data between western litigants and chinese officials on both public and private level, this article stands in the shoes of the foreign intellectual property (ip) right holders asking why a sound made by western society resonates so differently in china? this is done through the eyes of the chinese adjudicators and the system as a whole: where, how long and with what results. it briefly lists various characteristics of each litigation phase that foreign ip right holders will confront, when choosing the chinese judiciary (private litigation) to enforce their ip rights, especially patents. insum, this article offers a picture, from the perspective of aprivate party, of procedural peculiarities of chinese courts, the time limit system and compensation rules. even though the chinese government, at the federal level, is workiing very hard to introduce a positive image relating to private enforcement of ip rights, this article emphasizes that the negative attitude towards foreign right holders, , is caused by a normative chain effect. it is neither only about law nor only about policy. nordic journal of commercial law issue 2014#2 2 1 introduction counterfeit goods, i.e. illegal copies of trademarked goods, remains a controversial issue worldwide. however, debate on the issue is remarkably different in the eastern and western world. the unique encounter of counterfeits and innovations in the chinese market has become a distinctive phenomenon. this phenomenon reveals very well when contrasting data published in the west and in china. from the chinese perspective, carrying the stigma of the world biggest maker of counterfeits, yet the chinese government claims that it is successfully fighting counterfeits of all kinds at all levels. at the -administrative level, the problem of counterfeits has gathered attention of the chinese authorities for a long time. for example, according to data published by the ministry of public security of china, , chinese officials carried out 15 000 anti-counterfeiting cases, cracked down on 212 criminal gangs involving a total value of rmb 870 million (approximately $10million) from january to may in 2012. 1 a shy estimate for the year of 2012, china removed counterfeits with a value around $25 million from the market. however, at the judicial level, not counting administrative anti-counterfeit cases, the amount of ip-related civil trials is not large. according to the 2012 supreme people's court (spc) report to the people’s congress on the work of the ipr trial courts, , there were 226 753 ip cases handled by the people’s courts in total, and among which 208 653 were concluded (2008-2012).2 the data published in the west tells another story. taking 2012 as an example, the conflict is obvious. according to data published by the european commission, china remains the country where most of the suspected ipr infringing goods originateand accounted for 77.09% of the total value of all counterfeit goods in the eu in 2012. 3data published by the u.s. customs and borders protection states that: in fiscal year 2012, there were 22,848 intellectual property rights seizures with a manufacturer’s suggested retail value of $1.26 billion. goods from china accounted for 72% of the total manufacturer’s suggested retail value for all ipr 1 ministry of public security of china. “全球反假冒机构向公安部经济犯罪侦查局颁发2012年度执法部门最高贡献奖(global anti-counterfeiting group awards the chinese ministry of public security for its greatest contribution for anti-counterfieting acts in 2012).” accessed may 2, 2014. http://www.mps.gov.cn/n16/n1237/n1342/n803715/3328221.html. 2王胜俊. 最高人民法院关于知识产权审判工作情况的报告—— 2012年12月25日在第十一届全国人民代表大会常务委员会第三十次会议上 (wang shengjun, supreme people’s court, report to the people’s congress on the work of the ipr trials of 2012). http://www.npc.gov.cn/npc/xinwen/2013-01/06/content_1750233.htm. 3 report on eu customs enforcement of intellectual property rights results at the eu border 2012. taxation and customs union of european commission. accessed may 2, 2014. http://ec.europa.eu/taxation_customs/resources/documents/customs/customs_controls/counterfeit_piracy/statis tics/2013_ipr_statistics_en.pdf. nordic journal of commercial law issue 2014#2 3 seizures.4 when comparing the data on ip counterfeits thatare captured inside china and at the western borders, despite chinese declarations of intensive anti-counterfeit actions, the data indicates that counterfeits in china is rampant. compared to the share amount of counterfeits, ip-related trials with a foreign party, not counting administrative anti-counterfeit cases, are actually very rare.. data published by the spc shows that between 2008 and 2012, there were a total of 5670 foreign-related ip trials in chinese courts.5 even though china has been labeled as a country of imitations, china is trying very hard to be a country of innovations. china has set a strategic goal to be an innovative country by 2020. indeed, china is already a significant market for innovations. according to data published by the state intellectual property office (sipo), by the end of 2013, the number of effective domestic and foreign patents that are authorized by the sipo is 1,034,000, measuring a growth of 12.8% compared to 2012. not including hong kong, macao and taiwan, there are 4 patents for every 10 000 chinese. this rate is 0.7 patents higher than the 3.3 patent possession goal stated in the twelfth five-year plan for national economic and social development of china. companies have 352,000 valid patents. universities have 116,000 patents, and research institutions own 47,000 patents. excluding hong kong, macao and taiwan, the top five regions with effective domestic patents are guangdong (95,000), beijing (85000), jiangsu (62,000), shanghai (48,000) and zhejiang (43000).6 coincidentally, before china had listed the top five innovative regions, dahman, a western scholar had spotted at least five major wholesale distribution markets for counterfeit goods in china: nansantiao market in shijia zhuang in hebei province; linyi market in linyi, shandong province; hanzhen jie in wuhan city, hubei province; china small commodities city in yiwu city, zhejiang province; and wuai market in shenyang, liaoning province.7 these five counterfeit-intense regions are either geographically within the radiation circle of the top innovative regions or even inside the same province. when counterfeits encounter innovations, the problem of counterfeiting does not only take away market shares of private 4 fact sheet of intellectual property rights. u.s customs and border protection. accessed may 2, 2014. http://www.cbp.gov/sites/default/files/documents/ipr_fact_sheet_2.pdf. 5王胜俊. 最高人民法院关于知识产权审判工作情况的报告—— 2012年12月25日在第十一届全国人民代表大会常务委员会第三十次会议上 (wang shengjun, supreme people’s court, report to the people’s congress on the work of the ipr trials of 2012). http://www.npc.gov.cn/npc/xinwen/2013-01/06/content_1750233.htm. 6 state intellectual property office of the people’s republic of china. “知识产权局：我国平均每万人拥有4件发明专利(sipo: each 10000 chinese own 4 pieces of innovation patents).” accessed january 17, 2014. http://www.gov.cn/jrzg/2014-01/17/content_2569164.htm. 7 dahman, samir b. “protecting your ip rights in china: an overview of the process.” entrepreneurial business law journal 1 (2006): 63. nordic journal of commercial law issue 2014#2 4 companies, it is estimated that 15% to 20% of all products by well-known brandsin china are counterfeits.8 at the federal level, china is very optimistic about achieving the set goal of an innovationcentered country. although china offers both administrative as well as judicial remedies, right holders still have no confidence in the ip enforcement system. foreign right holders discover that it is very easy to buy a counterfeit item at a cheap price in china, but it costs a lot of time and money to enforce registered rights. some non-chinese litigants even claim that intellectual property protection does not exist in china, since the country’s legal system does not offer any sufficient remedies or private ip right enforcement in courts. with the conflicting sounds from the western and chinese side in mind, thisarticle will step into the shoes of foreign right holders and take an insider’s view from the perspective of chinese adjudicators working within the civil court system as a whole. . 2 courts of china for ipr generally speaking, chinese courts have been divided according to the national administrative and geographical divisions of government. the level of the court follows from the level of its local government.9 china has one supreme people’s court (spc), 32 higher courts, 409 intermediate courts and 3117 basic courts. 10according to the court organization law (col), chinese courts are divided in three categories: (1) various levels of the local courts, which are the higher people’s courts, intermediate courts, and basic people’s courts; (2) military courts and other specialized courts; and (3) the spc. col states the jurisdiction of the courts at each level and also stipulates the administrative relationship among them. the basic people’s courtshandle the first instance of civil and criminal trials, unless otherwise stipulated by law. basic people’s courts can request to transfer accepted cases to the intermediate court, if necessary. apart from handling first instance cases, the basic people’s courts have jurisdiction over civil disputes that do not require a trial and minor criminal cases.11 8 dahman, samir b. “protecting your ip rights in china: an overview of the process.” entrepreneurial business law journal 1 (2006): 63. 9 shao, wei. patent litigation practices in mainland china. taiwan ministry of economic affaris, intellectual property office, 2011. 10 the superme people’s court of china. “人民法院简介（introduction of the people’s courts).” accessed may 2, 2014. http://www.court.gov.cn/jgsz/rmfyjj/. 11 art. 20, art. 21 of the col. nordic journal of commercial law issue 2014#2 5 currently, basic courts have no jurisdiction over patent infringement cases. however, based on the regional development and the ability of the courts, with the spc’s authorization, certain basic courts can have jurisdiction on contract issues, which involve patent matters. the spc has also authorized a few courts have jurisdiction for infringement cases of utility models and designs. since 2009, the spc has authorized yiwu court of zhejiang provience, kunshan court of jiangsu and haidian regional court of beijing to conduct, at first instance, civil trials regarding utility model patents and designs. the intermediate courts hear cases at first instance, if the laws and/or regulations decree so. intermediate courts also have jurisdiction over cases, which are transferred from the basic courts, and hearsappeals and protest cases regarding the basic courts judgments. according to the trial supervision procedure, protest cases from the people's procuratorate are also within the jurisdiction of the intermediate courts. courts at this level can request to transfer accepted cases to higher courts, if necessary. 12 intermediate courts are the first instance for patent infringement proceedings. intermediate courts are situated in the capital cities of the provinces, the autonomous regions, and the municipalities directly under the control of the central government.13 art. 27 col regulates that the higher people’s courts handle the first instance of trials, if the laws and/or regulations decree so. higher courts also have jurisdiction over the cases, which are transferred from the intermediate courts, as well as appeals and protest cases regarding the intermediate court’s judgments. according to the trial supervision procedure, protest cases from the people's procuratorate are also within the jurisdiction of the higher courts. court at this level cannot request to transfer accepted cases to a higher level, which would be the spc. art. 29 col cements the role of the spc at the highest level of the court system and its supervising power regarding the work of the lower courts. based on art. 31 col, the spc handles the first instance of trials, if the laws and/or regulations decree so, or if the spc considers it necessary. its jurisdiction also covers appeals and protest cases regarding the higher courts’ and special courts’ judgments. according to the trial supervision procedure, protest cases from the supreme people's procuratorate are also under the jurisdiction of the higher courts. art. 32 of the col regulates that the spc interprets the application of laws. for complicated patent cases or cases which claim large amounts of compensation, the first instance of the trial will be heard at the level of the higher courts or even the spc. with the booming development of the chinese market, the number of ip cases is growing. the cases are getting more and more complicated and specialized. according to spc’s annual report 12 art. 22 of the col. 13 duncan, jeffrey m., michelle a. sherwood, and yuanlin shen. “comparison between the judicial and administrative routes to enforce intellectual property rights in china. a.” john marshall review of intellectual property law 7 (2008 2007): [i]. nordic journal of commercial law issue 2014#2 6 2013, there were 114 075 ip cases at first and second instances in 2013.14 the chinese state council in its 12-year strategy from 2008 outlines that: “we should improve the trial system for intellectual property-related cases, optimize the allocation of judicial resources and simplify remedy procedures. we should consider setting up special tribunals to accept civil, administrative or criminal cases involving intellectual property.” 15 under the current administration «three-in-one» pilot courts that handle civil, administrative and criminal ip cases within existing courts have been established in different provinces. by the end of 2013 7 higher courts, 79 intermediate courts and 71 basic courts had the three-inone ip bench. 16 so far, however, the practice differs from one province to another, but the main practices follow one of five models: (1) the pudong model (or also known as shanghai model): is a trial model, which unifies all civil, administrative, and criminal ip cases into one specialized tribunal under a basic people’s court. (2) the nanshan model (or known as shenzhen model): is a trial model that the civil, administrative and criminal ip cases are still respectively under the jurisdiction of each original tribunal. but it requires a collegial panel that is consisted of ip judges from civil, administrative and criminal tribunals. (3) the fujian model: is unifying civil and administrative ip cases into one tribunal, criminal ip cases still separately heard in criminal court. in practice, fuzhou intermediate people's court, and quanzhou intermediate people's court hears the first instance of ip civil and administrative cases, and the higher court in fujian hears the second instance. (4) the wuhan model: is hearing the first instance of civil, administrative and criminal ip cases inside the qualified basic courts. and the second instance will be heard in its intermediate courts. (5) the chongqing model: is the model that, unless otherwise specified, the first instance of the three types of ip cases will be heard in the qualified regional court, yiyu district court. meanwhile, it requires the collegial panel, for the administrative or criminal ip cases, shall be consisted with ip judges from civil, administrative and criminal tribunals or/and people's assessors. the second instance will be heard at chamber no.3 of the chongqing fifth intermediate people's. for the second instance of administrative or criminal ip cases, the 14 2013年中国法院知识产权司法保护状况(chinese courts’ judicial protection status of intellectual property 2013) , april 25, 2014. http://www.chinacourt.org/article/detail/2014/04/id/1283299.shtml. 15 the state council. notice of the state council on issuing the outline of the national intellectual property strategy, 2008. para 45. 16易继明. “为什么要设立知识产权法院.” 人民法院报, (yi jiming, why establish ip court, people’s court news), june 18, 2014. nordic journal of commercial law issue 2014#2 7 collegial panel shall jointly consist of ip judges from civil, administrative and criminal tribunals. the chamber no.3 of the higher people’s court of chongqing has the authority of supervision and guidance. on 31 august 2014, the standing committee of the national people's congress of china published a decision on the establishment of intellectual property court in beijing, shanghai, guangzhou (the decision).17according to the art. 3 and art.4 of the decision, ip courts are intermediate courts. the ip courts are under the supervision of the spc and the high people’s court of its region. 18 as a legislative matter, it is still being discussed, which level the ip court shall be at and how it shall be organized. this does not only recquire an administrative decision, but also an update of the current legislation in col. moreover, there also exists a legislative gap for the basis of the ‘three-in-one’ model. 19 meanwhile, the jurisdiction of ip courts so far is strictly limited to beijing, shanghai and guangzhou, even though it is possible to develop these courts into circuit courts, which would have jurisdiction in other provinces. it means the current ‘three-in-one’ model is maintained in some jurisdictions, and so are the general rules in undeveloped provinces, which employ none of the mentioned models of ip tribunals. will the spc will keep on authorizing qualified regional courts to have jurisdiction over patent cases the same way it did in 2009 or establish more ip courts as in beijing, shanghai and guangzhou in the future? based on art.7 of the decision, the establishment of ip courts in china is still an experiment and the implementation of the decision will be reported to the standing committee after three years. so far, there is no clear national-wide picture on what the ip enforcement landscape will look like yet. it also remains unclear how the different regional practices will be unified nationally. according to art. 1 of the decision, the ip courts may be arranged differently in beijing, shanghai and guangzhou based on the types and number of ip cases. details of organization will be decided by the spc. according to the state council’s strategy in 2008, the legal reform shall be possibly completed nationally in 2020.20 the first ip tribunal was established in china in 1993, and so far china 17全国人民代表大会常务委员会关于在北京、上海、广州设立知识产权法院的决定(standing committee of the national people’s congress decision on the establishment of intellectual property court in beijing, shanghai, guangzhou), 2014. http://npc.people.com.cn/n/2014/0901/c14576-25581035.html. 18 art.5 of the decision. 19胡淑珠. “论知识产权法院（法庭）的建立——对我过知识产权审判体制改革的理性思考.”(hu shuzhu, discussions on the establishment of ip court) 知识产权(intellectual property) , no. 2010年第4期 (n.d.): 37. 20 the state council. notice of the state council on issuing the outline of the national intellectual property strategy, 2008. nordic journal of commercial law issue 2014#2 8 has established more than 420 ip tribunals within intermediate and basic courts.21 all things considered, and although it still takes time to see a clear picture of the ip courts, the development of the chinese ip legal system is very fast. the fast development is a positive sound from the state level.. the spc states in its annual report: “we are keenly aware that there are still many problems and difficulties in the work of the people's courts. first, some cases are judged with unfairness and inefficiency, which harms the benefits of the parties involved and judicial credibility. second, it remains difficult for case－filing, litigation and judgment enforcement in some people's courts, with a gap in meeting people's judicial requirements. third, more efforts are needed to improve the system and mechanism guaranteeing people's courts to independently and fairly exercise the judicial power according to the law. fourth, some courts are under heavy administrative management, which affects the quality and efficiency of trials. fifth, some court officials are under heavy impacts of bureaucracy and special privilege, resulting in irregular and crude judicial acts, indifference, insolence, prevarication, deliberately creating obstacles, and extortion to concerned parties. some even commit illegalities for personal gains, pervert justice for a bribe, to the discontent of the public. sixth, people's courts experienced heavy workload with the sustainable growth of caseloads. some people's courts have more cases but fewer staff, with serious brain drains and unreasonable personnel structure. some people's courts in the western region, remote and border areas, and ethnic minority areas need further improve working conditions.”22 for private parties, the non-unified practice and fast changes lead to different levels of protection from one province to another. will it enhance the already existing problem of varying geographical protection? i carried out face-to-face interviews in various domestic businesses inside china in the summer of 2013. the results show that for those who enforced their patent rights through the judicial process, the right holders all more or less experienced the variances in geographical protection in a way or other. in extreme cases, one interviewee even commented that running patent cases is a competition about networks. in practice, the fast development at governmental level could lead to a lack of predictability and even more serious forum shopping concerns, which reduces the sufficiency and efficiency of judicial remedies. moreover, because of the problems relating to the current court system in combination with rampant counterfeiting, chinese right holders prefer to sue foreign actors instead of (chinese) makers of counterfeits, due to the fact that foreign parties are relatively clearer targets. that 21袁定波. “最高法解密知产法院因何选中北上广.”(yuan dingbo, the supreme people’s court of china decrypts reasons of establishing the intellectual property courts in beijing, shanghai and guangzhou) 法制日报(legal daily), august 27, 2014. http://epaper.legaldaily.com.cn/fzrb/content/20140827/articel05006gn.htm. 22 zhou, qiang. report on the work of the supreme people’s court (2013-2014). spc official report delivered for the second session of the twelfth national people’s congress. supreme people’s court, march 10, 2014. http://www.china.org.cn/china/2014-05/08/content_32331522.htm. nordic journal of commercial law issue 2014#2 9 local business strategy also experiences a relatively better rate of enforcement of the judgments.the judgments can also be used as negotiation support for later business. 3 the time limit system chinese law regulates a time limit for civil trials. if the parties are chinese citizens or legal entities, the first instance of a civil case shall be completed within six months. the second instance of a civil case shall be completed within three months. in practice, courts are allowed to prolong the processing time on various legal grounds. for example, for patent cases, the processing time for both first and second trials is, on average, around a year.23 according to art. 270 of the chinese civil procedure law, foreign related civil cases have been excluded from the time limit system. hence, foreign related ip cases are excluded from the time limit system as well. if one of the parties is not chinese, then there will be no time limit for the processing time. the official reason why all foreign related cases are excluded from the time limit system is because foreign related cases are more complicated than normal civil cases. judges may have limited knowledge or information of the related subject matter. having a limited period for such trials cannot be supported for judges to have a clear view of the facts of the case. it is reasonable to exclude those trials in order to ensure procedural and substantial justice for nonchinese parties. according to art. 20 and 21 of the spc supervisions on strictly executing the time limit system, the time limit system has been treated as a matter of court management and shall be supervised by the court itself. this provision leaves its implementation to the discretion of judges. unfortunately, chinese law does not offer any means for the parties to safeguard that judges deal with cases actively. the exclusion made by art. 270 of the civil procedural law leaves a gray area and it is used as a legal umbrella for some judges to mishandle cases. for example, foreign ip right holders, although they are holding valid chinese trademarks or patents, often find themselves running cases for years.likewise, foreign defendants may also find themselves running cases for years just because of its foreign elements. back in1991 the limited information at hand and the lack of expertise are what distinguished normal civil cases from foreign-related civil cases. however, with improved information sources in china and the extended knowledge of judges, is this separation still necessary? especially for ip cases, does the exclusion still make sense? although foreign related cases can take longer than normal cases in practice, it should not be used as a reason for the court to extend the processing time for ip cases further. 23 art.135, civil procedural law of china. nordic journal of commercial law issue 2014#2 10 moreover, there are some other circumstances that will notcount towards the time limit of trials. according to the supervisions of the supreme court on strictly execute the time limit system, periods that shall not be counted into the time limit of trials are times caused by: 1) announcement and identification, 2) argument on jurisdiction, 3) professional audit, evaluation and liquidation of the subject matter, 4) suspension of proceedings or enforcement; 5) restart of proceedings or enforcement; 6) settlement of the enforcement between parties or suspension of enforcement due to property assurance; 7) suspension based on the higher court’s decision; and 8) auction, sale , seizure and detention. the time limit system does not offer legal means for parties to safeguard that judges actively process cases and the supervision is limited to the court itself and under the control of its higher level court. at this moment, the time limit system for foreign-related ip cases is not actually a normative issue, but more a court management problem. judges are encouraged to implement judicial powers actively and efficiently to offer a solid base for both procedural and substantial justice. however, there exists no guarantee of actual implementation for private parties in reality. the general practice of exclusion leads to difficulties for foreign right holders in enforcing their patent rights inside china and offers an unfair opportunity for local business to occupy the market in bad faith. although foreign right holders hold equal rights to chinese right holders to enforce their legal ip rights, the endless trials and great case costs create a bad impression of chinese ip protection. moreover, the exclusion from the time limit system, becomes a haven for counterfeits. the slow proceeding offers time for counterfeit manufactures to transfer their copied goods to other formats or brands. 4 amount for compensation another claim often presented by right holders, is that: the chinese legal system does not offer sufficient remedies or recovery of costs for ip right enforcement. this is primarily because: (1) the administrative procedure doesn’t offer any compensation for damage, and (2) in addition to the long running court trials, the amount of compensation is very limited. so far, chinese nordic journal of commercial law issue 2014#2 11 courts only award compensation for direct damages. there is no evidentiary discovery system in china.24 the chinese patent law doess not include set statutory civil remedies for patent infringements. art. 65 of the patent law regulatescompensation as follows: ‘the amount of compensation for patent right infringement shall be determined according to the patentee’s actual losses caused by the infringement. if it is hard to determine the actual losses, the amount of compensation maybe determined according to the benefits acquired by the infringer through the infringement. if it is hard to determine the losses of the patentee or the benefit acquired by the infringer, the amount of compensation may be determined according to reasonably multiplied amount of the royalties of that patent. the amount of compensation shall include the reasonable expenses paid by the patentee for putting an end to the infringement. if the losses of the patentee, benefits of the infringer, or royalties of the patent are all hard to determine, the people’s court may, on the basis of the factors such as the type of patent right, nature of the infringement, and seriousness of the case, determine the amount of compensation within the range from 10,000 to 1,000,000 yuan.’ art. 65 of the patent law does not clearly indicate what kind of losses are actual losses. the related interpretations published by the spc in 2001 and 2009 have no clear definition either. in theory, although art. 65 spells out a few legal references on calculating the amount, the deciding court has discretion to utilize any established method on calculating the amount of compensation.25 however, in practice, many judges are avoiding the new method for calculating compensation (art. 65) and using conservative methods instead. 26 art. 20(3) of the spc interpretations concerning the application of law in the trial of patent infringement dispute cases (2001) concerns the benefits acquired by the infringer through the infringement. it is indicated that such benefits could be divided into operating profit and sales profit. in real cases, judges are counting such profit based on the audit report of accountants. this method of interpretation has divided the infringers into two categories. the first group consists of the general infringers and the other group consists of infringers from the infringement industry. for the general infringer, the benefits acquired by the infringer through the infringement are normally calculated based on the operating profits. for the infringers from the infringement industry, the calculation will be based on the sales profits. 24 dahman, samir b. “protecting your ip rights in china: an overview of the process.” entrepreneurial business law journal 1 (2006): 63. see also duncan, jeffrey m., michelle a. sherwood, and yuanlin shen. “comparison between the judicial and administrative routes to enforce intellectual property rights in china. a.” john marshall review of intellectual property law 7 (2008 2007): [i]. 25 ibid 26 shao, wei. patent litigation practices in mainland china. taiwan ministry of economic affaris, intellectual property office, 2011. p233. nordic journal of commercial law issue 2014#2 12 however, the spc’s interpretation does not clearly define an ‘infringer from infringement industry’. in real cases, if the infringers conduct other business apart from business based on patent infringement, then such infringers are only general infringers.27 art. 21 of the spc interpretations concerning the application of law in the trial of patent infringement dispute cases (2001) also includes guidance on the reasonably multiplied amount of the royalties of the infringedpatent. the reasonably multiplied amount is regulated to 1-3 times of the royalties. the interpretation does not detail standards on how to apply such levels in real cases, so judges have discretion in applying this interpretation.28 some commentators claim that the interpretation actually introduces punitive damages, which is presently being discussed. 29 since 2011 recent discussions on patent law amendment, which concentrates on improving patent protection, has recognized that the current compensation system is not sufficient to prevent malicious infringements and repeated infringements. most likely, china will soon implement punitive compensation in its new patent law. the courts can award compensation up to 3 times of actual damages. if a right holder can prove the infringement plot, scale and consequences of the damage, then it is possible for the right holder to get punitive damages. such claim may also require that the right holder prove that the infringement is carried out (with malicious) intent, e.g., the infringer conducts repeated infringements and has already been held liable for infringement once in similar circumstances.30 art. 65 of the patent law also regulates statutory compensation, which applies when the losses of the patentee, benefits of the infringer, or royalties of the patent are all difficult to determine. however, in reality, the courts still ask the right holders to prove the damages, but employ a relatively low requirement of the strength of the evidence. it means that th right holders do not need to prove a specific amount of damages. moreover, as revealed by studies from patent agents, the chinese courts are, nevertheless, applying statutory compensation in most patent cases. 27 shao, wei. patent litigation practices in mainland china. taiwan ministry of economic affaris, intellectual property office, 2011. 28 spc (2005) civil chamber 3, no.1 judgment. 29 see zhang guangliang, civil remedy of intellectual property infringement, china law press 2003, p154. see also, cui guobing, patent law theories and cases, peking university press 2012, p731. 30 hong, wang. “chinese patent law amendment ongoing and punitive damages could be possible.” legal evening news, may 7, 2014. nordic journal of commercial law issue 2014#2 13 in practice, maximum statutory damages are often requestedbecause the plaintiff frequently finds it difficult to prove the amount of plaintiffs’ losses, defendant's benefits, or license fees or royalties.31 despite the complex, yet limited compensation, so far, right holders have a heavy burden of proof. they need not only present evidence of ownership and validity of the claimed right, as well as, evidence showing the infringement of that right, but right holders must also present evidence to support the amount of the claimed compensation. 32although large compensation awards are possible, it may still take a long while before the situation gets easier. it has been claimed that ‘the chinese judicial system seems overly cumbersome and under-compensatory in resolving cases of ip infringement. thus, the majority of ip rights owners settle for simply stopping infringement and swallowing the losses or writing off lost profits.’ 33 5 conclusion: imitation or innovation? china as a developing country is facing a juncture in ip protection. after joining the world trade organization (wto), china reformed its ip regime to adjust its market to the global market. on the other hand, ip protection also involves public interests that impact its economic reforms as well as social welfare. 34 there is no doubt that imitation supports technological growth and development in the short run. however, it raises the cost of conducting business in china and also discourages domestic innovation, which are a long-term drivers of economic growth.35 the chinese government obviously wants to transform chinese industry from labor-intensive to technology and capital-intensive markets. the aims of the chinese ip strategy 2020 is “establishing a comprehensive ip system,” “promoting creation and 31 duncan, jeffrey m., michelle a. sherwood, and yuanlin shen. “comparison between the judicial and administrative routes to enforce intellectual property rights in china. a.” john marshall review of intellectual property law 7 (2008 2007): [i]. see also shao, wei. patent litigation practices in mainland china. taiwan ministry of economic affaris, intellectual property office, 2011. p233. 32 duncan, jeffrey m., michelle a. sherwood, and yuanlin shen. “comparison between the judicial and administrative routes to enforce intellectual property rights in china. a.” john marshall review of intellectual property law 7 (2008 2007): [i]. 33 dahman, samir b. “protecting your ip rights in china: an overview of the process.” entrepreneurial business law journal 1 (2006): 63. 34 liu, wenqi. “intellectual property protection related to technology in china.” technological forecasting and social change 72, no. 3. managing emerging technologies in asia (march 2005): 339–48. doi:10.1016/j.techfore.2004.08.009. 35 gregory k., leonard, and stiroh lauren j. economic approaches to intellectual property: policy,litigation and management. thomson/west, 2006.p11.403 nordic journal of commercial law issue 2014#2 14 utilization of ip,” “enhancing ip protection,” “preventing abuse of ip rights,” and “fostering a culture for ip rights” are well-aligned with this overall economic strategy.36 after all, the current problem is not only a matter of law or policy at the government level. the promises of short-term gain, coupled with political as well as economic concernns keep on sacrificing the effectiveness of law.37 despite the the different levels of development in different regions, achieving stronger protection for ip will require a massive administrative effort of judicial implementation and enforcement. it will raise the cost of labor shifting within the industry,38 and may also widen the gap between well-developed and developing regions. moreover, it will raise the prices of goodsas well as the costs for domestic technological development. the infringements occur in many types of chinese enterprises, e.g., (1) individually-owned enterprises, (2) hong kong invested companies, (3) state-owned enterprises, (4) trading companies, (5) import and export companies, and (6) domestic wholesalers and retailers.39 the practical market reality is more complicated, and the compromise between law, policy and other considerations is very difficult one to make. although it is clear that the degree of ip protection is closely related to the level of technological development, and the openness of markets, china still has a long way to go. 40 it is worth mentioning that the concept of counterfeit is not unambiguous. a one-size-fits-all solution at the government level may no longer be sufficient. indeed, for simple cases, the chinese government can carry out efficient actions at the administrative level. incomplicated cases, such as those involving technology or pharmaceutical patents, it may not be easy to decide, which product is counterfeit without technical expertise, and the mass administrative action procedure may be unsuitable. civil trials may also lack both legal and technical expertise in addition to other inefficiencies of operation. despite future difficulties and current problems, the agenda set by the chinese government is promising. in the latest annual report of the spc, strengthening ipr adjudication was 36 state councile of people’s republic of china. national intellectual property strategy outline, june 5, 2008. http://www.gov.cn/gongbao/content/2008/content_1018942.htm. 37 liu, wenqi. “intellectual property protection related to technology in china.” technological forecasting and social change 72, no. 3. managing emerging technologies in asia (march 2005): 339–48. doi:10.1016/j.techfore.2004.08.009. see also, gregory k., leonard, and stiroh lauren j. economic approaches to intellectual property: policy,litigation and management. thomson/west, 2006. p11.404. 38 gregory k., leonard, and stiroh lauren j. economic approaches to intellectual property: policy,litigation and management. thomson/west, 2006. p11.405. 39 dahman, samir b. “protecting your ip rights in china: an overview of the process.” entrepreneurial business law journal 1 (2006): 63. 40 j. ginarte, w. park, determinants of patent rights: a cross-national study, res. policy (1997) 283 – 301. see also, liu, wenqi. “intellectual property protection related to technology in china.” technological forecasting and social change 72, no. 3. managing emerging technologies in asia (march 2005): 339–48. doi:10.1016/j.techfore.2004.08.009. nordic journal of commercial law issue 2014#2 15 emphasized at the twelfth national people's congress “the people's courts protected the patent rights, copyrights and trademark rights according to law, intensified judicial protection of internet intellectual properties rights, cracked down unfair competition and monopoly according to law, to maintain a sound market environment for fair competition, and to promote the construction of the national innovation system. the people's courts at various levels concluded 100,000 cases of first instance on intellectual properties. the courts were also actively involved in the specific action of cracking down on infringement of intellectual properties, and manufacturing and selling of counterfeit goods, published white paper and typical cases on judicial protection of intellectual properties, and established a sound image of china in judicial protection of intellectual properties.”41 on the other hand, to a country such as china, where people are used to imported technology, have a weak awareness of ip protection in general, and have various and easy access to low-cost imitations in the market, there is still a long way to go in establishing consumer awareness of the importance of ip protection in china. all efforts of the government of china cannot alone solve the real problems on the grass root market. stronger ip protection in practice requires more than just policy and law. the western predictions may remain until comprehensive legal reform is carried out throughoutthe central and local government , including access to the judiciary in civil litigation. 41 zhou, qiang. report on the work of the supreme people’s court(2013-2014). spc official report delivered for the second session of the twelfth national people’s congress. supreme people’s court, march 10, 2014. http://www.china.org.cn/china/2014-05/08/content_32331522.htm. 1 platforms as private governance systems – the example of airbnb clement salung petersen*, vibe garf ulfbeck** & ole hansen*** * professor, centre for enterprise liability (cevia), faculty of law, university of copenhagen. ** professor, centre for enterprise liability (cevia), faculty of law, university of copenhagen. *** professor, centre for enterprise liability (cevia), faculty of law, university of copenhagen. platforms as private governance systems 38 1. introduction ..................................................................................... 39 2. airbnb contractual setup ........................................................... 41 2.1. the user contract – b2c or b2b ..................................... 42 2.2. the rental contract – c2c, b2b, c2b or b2c ............ 42 2.3. a contractual triangle .................................................... 43 3. airbnb as a private governance system ................................. 46 3.1. airbnb as regulator ............................................................ 46 3.2. airbnb as implementer......................................................... 47 3.3. airbnb as dispute resolver ............................................... 49 4. airbnb and the undermining of state governance ......... 50 4.1. governing law ...................................................................... 51 4.2. state governance of the airbnb-user relationship . ............................................................................................ 53 4.2.1. enforcing the user contract through the state legal order ..................................................... 53 4.2.2. enforcing statutory law through the state legal order ................................................................. 54 4.3. state governance of relations between users ...... 56 4.3.1. enforcement of contractual rights in the state legal order ..................................................... 56 4.3.2. enforcement of statutory law in the state legal order ................................................................. 57 5. conclusion ......................................................................................... 59 njcl 2018/1 39 abstract online platforms create legal systems that can best be described as private governance systems. by private governance we refer to the fact that a private actor can take on the roles as regulator, implementer and dispute resolution body, thereby mirroring the classical roles of the state and potentially replacing state governance with an alternative, private legal order. as an example, the airbnb platform (www.airbnb.com) regulates the rights and duties between users of the platform (hosts and guests), it implements these rights and duties by facilitating supervision mechanisms such as ratings and reviews, and it provides dispute resolution mechanisms for the users. the increasing societal role and impact of online platforms makes it pertinent to consider to what extent these private governance systems can safeguard the public values and interests which state legal orders seek to promote and protect. in this article, we use the concept of private governance to make a case study of the private legal order of airbnb. our analysis shows that the private governance system created by airbnb is concerned not only with commercial matters, but also with public values as known in state legal orders. however, it also shows that the private governance system created by airbnb can have an undermining effect on state legal orders. 1. introduction it is well-known that private actors can create their own private legal orders. private actors can thus, to a large extent, establish their own rules and standards of behavior and play a significant role in the implementation and enforcement of such private rules and standards. in this way, private actors can take on the role of the state as both regulator, implementer and dispute resolution body, and replace state governance with private governance. online platforms, which facilitate transactions between their users (“peers”), are a very clear example of the phenomenon of such private governance.1 for instance, the core function of the airbnb platform is to act as an intermediary between platform users who wish to offer accommodation services (“hosts”) to other platform users (“guests”).2 in this connection, airbnb regulates the main rights and duties of hosts and guests, it implements these rights and duties by facilitating supervision mechanisms such as ratings and reviews, and it provides dispute resolution mechanisms for the 1 for an overview of these platforms, see e.g. pierre hausemer and others, exploratory study of consumer issues in online peer-to-peer platform markets – final report (european commission, 2017). 2 see www.airbnb.com for details. in fact, hosts may also offer other kinds of services on the airbnb platform such as, for instance, guided tours and other “events”. in this article, we focus on the accommodation services offered on the airbnb platform. platforms as private governance systems 40 parties.3 other examples of such online platforms include ebay and uber. platforms often see themselves as creators of private legal orders with their own visions and political agendas, to a wide extent detached from state legal orders. for example, the ebay website includes a section on “government relations”, which includes the following statements: “we focus on providing buyers and sellers with the ability to move goods via the internet with minimal legislative interference” and “we envision a world of technology-enabled commerce that is open, diverse and inclusive for all”.4 the website also includes a section on “responsible business” with the following statement: “we have created a trusted, transparent marketplace based on the strong ethical values we follow as a business.” airbnb’s website includes similar statements. for example, airbnb states in its “nondiscrimination policy” that “while we do not believe that one company can mandate harmony among all people, we do believe that the airbnb community can promote empathy and understanding across all cultures”. furthermore, “we commit to do more than comply with the minimum requirements established by law” and finally: airbnb’s members bring to our community an incredible diversity of background experiences, beliefs, and customs. by connecting people from different backgrounds, airbnb fosters greater understanding and appreciation for the common characteristics shared by all human beings and undermines prejudice rooted in misconception, misinformation, or misunderstanding.5 it is clear from those statements that the platforms are striving to create their own private legal orders that are as unaffected by state law as possible.6 the platforms also draw up a picture of their platforms as representing a different and “better world” which the users become part of by using the platforms. thus, not only can there be commercial advantages by using the platforms but the users also acquire a “do good”identity. in this regard, the platforms apparently seek to govern not only the commercial aspects of their activities but also to ensure 3 see section 3. 4 see ‘government relations’ (ebay inc) <www.ebayinc.com/ourcompany/government-relations/> accessed 11 october 2018. 5 see ‘nondiscrimintion policy’ (airbnb inc) <www.airbnb.com/terms/nondiscrimination_policy> accessed 11 october 2018. 6 the airbnb terms of service emphasize that “hosts alone are responsible for identifying, understanding, and complying with all laws, rules and regulations that apply to their listings and host services”, see ‘terms of service’ (airbnb inc, 16 april 2018) <www.airbnb.com/terms> accessed 11 october 2018. njcl 2018/1 41 certain public values such as consumer protection and nondiscrimination. through the lens of the concept of private governance, this contribution provides a case study of the private legal order of airbnb.7 the aim of our study is two-fold. first, we will show that the airbnb platform provides a system of private governance that is concerned not only with commercial matters but also with public values as known from state legal orders, in particular consumer protection and nondiscrimination (section 3). secondly, we will show that the airbnb platform challenges the applicability and effectiveness of statutory consumer protection and nondiscrimination laws, and that it can hereby have an undermining effect on state governance (section 4). we begin with an analysis of the contractual setup established by airbnb (section 2). 2. airbnb contractual setup the airbnb “terms of service” describe the nature of the services provided by airbnb:8 1.1 the airbnb platform is an online marketplace that enables registered users (“members”) and certain third parties who offer services (members and third parties who offer services are “hosts” and the services they offer are “host services”) to publish such host services on the airbnb platform (“listings”) and to communicate and transact directly with members that are seeking to book such host services (members using host services are “guests”). 1.2 as the provider of the airbnb platform, airbnb does not own, create, sell, resell, provide, control, manage, offer, deliver, or supply any listings or host services, nor is airbnb an organiser or retailer of travel packages under directive (eu) 2015/2302. hosts alone are responsible for their listings and host services. when members make or accept a booking, they are entering into a contract directly with each other. airbnb is not and does not become a party to or other participant in any contractual relationship between members, nor is airbnb a real estate broker or insurer. airbnb is not acting as an agent in any capacity for any member, except as specified in the payments terms. these and other provisions in the terms of service make it clear that use of the airbnb platform establishes (principally) two different 7 for another case study of airbnb focusing on private law perspectives and challenges for european consumer and market law, see vanessa mak, ‘private law perspectives on platform services’ eucml (2016) 19. 8 terms of service (n 6). platforms as private governance systems 42 contractual relationships:9 one between airbnb and a registered user (which we will refer to as “the user contract”) and one between a host and a guest (which we will refer to as “the rental contract”). 2.1. the user contract – b2c or b2b to use the airbnb platform for offering or booking accommodation, the user must register on the airbnb platform in order to become a “member”. in this connection, the user must accept the airbnb terms of service, which in the preamble incorporate by reference several other terms and policies into the agreement, including the “payments terms of service”, “nondiscrimination policy”, “airbnb privacy policy”, “host guarantee terms and conditions” and “airbnb guest refund policy”.10 the user can read the content of these terms and policies by clicking on links provided by airbnb but can also accept the terms and policies without clicking on any of these links. users are required to provide only limited information about their identity and, in general, airbnb does not request them to verify their identity.11 whereas airbnb is undoubtedly acting in a commercial capacity, the users (guests as well as hosts) may be acting for private purposes or for purposes relating to their trade, business or profession. in principle, a user may interchangeably use the airbnb platform for both private and commercial purposes. currently, the user contract does not require hosts or guests to provide information about the purpose of their transactions. this has implications for the applicability of statutory consumer protection laws to the legal relationship between airbnb and its users, which we will analyze further in section 4.12 2.2. the rental contract – c2c, b2b, c2b or b2c the rental contract governs transactions between a guest, who has made a booking, and a host, who has accepted this booking. the booking system provides two types of booking procedures, namely 9 other provisions in the terms of service also emphasize these separate contractual relationships, including section 7.1.7 addressing terms specific for hosts: “when you accept or have pre-approved a booking request by a guest, you are entering into a legally binding agreement with the guest and are required to provide your host service(s) to the guest as described in your listing when the booking request is made.” see also section 8.1.2 addressing terms specific to guests: “upon receipt of a booking confirmation from airbnb, a legally binding agreement is formed between you and your host, subject to any additional terms and conditions of the host that apply, including in particular the applicable cancellation policy and any rules and restrictions specified in the listing.” see also section 3. 10 terms of service (n 6). 11 terms of service (n 6) and section 1 of the ‘privacy policy’ (airbnb inc, 16 april 2018) <www.airbnb.com/terms/privacy_policy> accessed 11 october 2018, section 2.4. 12 it may also have implications for other areas of law, including tax law. njcl 2018/1 43 “normal booking” and “instant booking”. under the normal booking procedure, a potential guest shall submit a booking request to the host, who may choose to accept or reject the booking request. under the instant booking procedure, the host has already accepted any booking request from potential guests in advance. the host can restrict the availability of such instant booking so that it is only available to 1) guests who meet airbnb’s requirements or 2) guests who meet airbnb’s requirements and also have a) provided a government issued id and/or, b) recommendation from other hosts. as mentioned, the user contract presupposes that a host and a user will enter into a separate rental contract and dictates, to a large extent, the main terms and conditions of the rental contract. however, the user contract does not require users to enter into any explicit (written) agreement. as mentioned, the user contract requires users to provide only limited information about their identity to airbnb, which airbnb generally does not verify. also, when guests and hosts (de facto) enter into rental contracts, airbnb does not ensure that they obtain verified information about each other. consequently, the airbnb platform generally does not ensure that users, who enter into a rental contract, will have credible information about the identity of their contractual counterpart. since users of the airbnb platform may be acting for private and/or commercial purposes, the rental contract may govern both c2c, b2b, b2c or c2b transactions. as mentioned, the user contract does not require hosts and guests to provide information about the purpose of their transactions and this has implications for the applicability of statutory consumer protection laws to the legal relationship between airbnb and its users, which we will analyze further in section 4. 2.3. a contractual triangle a closer examination of the contractual setup may require a more nuanced understanding of the contractual relations: the terms of the user contracts dictate, to a large extent, the main terms and conditions of rental contracts as well. for instance, section 7 of the terms of service contains detailed rules for hosts listings, such as rules on the minimum information about the host, the use of pictures, animations and videos, requirements of deposits, etc.13 further, section 7.2.3 contains a clause, according to which hosts “present a warrant” (towards airbnb), that they will not breach the terms of the rental contract.14 further, the airbnb platform offers some surveillance with contract compliance as well as some sanctions in case of breach. thus, the full 13 see also, e.g., section 8 of the terms of service (n 6) on “terms specific for guests”. 14 in section 7.1.3 of the terms of service (n 6), it is stated that “(a)ny terms and conditions included in your listing, in particular in relation to cancellations, must not conflict with these terms.” platforms as private governance systems 44 picture of the contractual setup that forms the basis for a specific transaction seems to take the shape of a contractual triangle with three contractual relations:15 under the terms of service (section 1.2), it reads “airbnb is not and does not become a party to or other participant in any contractual relationship between members.” this attempt to avoid involvement in the contractual relation between hosts and guests is further supported by the explicit disclaimers of liability contained in section 17 of the terms of service. the viability of this construction can be questioned. when taking the actual involvement of airbnb in the contractual relation between hosts and guests into consideration, it could be considered whether airbnb is not subject to some kind of responsibility for the performance of the rental contract and if so, whether the general disclaimer in section 17 in the given circumstances can be set aside as unconscionable or as an unfair contract term. 16 further, in the light of airbnb’s overall business model, the contractual triangles take the character of a contractual cluster or a network. in such networks, one may observe an increased contractual duty of loyalty between the participants17 and a tendency to lower the bar for direct actions and tort law claims.18 15 the picture of the contractual triangle – or “a tripartite relationship” – is also used by vassilis hatzopoulos, the collaborative economy and eu law (oxford: hart publishing, 2018), chapter 2, where five different platform models are identified for the purpose of examining market acces and consumer protection issues. see also christiane wendehorst, ‘platform intermediary services and duties under the e-commerce directive and the consumer rights directive”, eucml (2016) 30. 16 in this contribution we do not pursue this question further. on the platform’s liability for illegal content on the platform, see n 63. 17 see for instance emily m. weitzenboeck, a legal framework for emerging business models (edward elgar publishing 2012), 186-243 and hugh collins ‘introduction’ in gunther teubner, networks as connected contracts (hart publishing 2011), 14-15. 18 see for instance matthias e. storme, ‘a civilian perspective on network contracts and privity’, [2017] vol. 85 no. 6 the george washington law review 1739-1776 and njcl 2018/1 45 leaving aside these more fundamental considerations as to the strict “separation” of the three contractual relations in the triangular setup, it is the clear starting point under the principle of privity of contract that a contract between two parties does not have effect for a third party. this means that as a general rule, the contract between airbnb and the host cannot be relied upon by the guest and the contract between airbnb and the guest cannot be relied upon by the host. in particular, it is clear that a contract between two parties cannot impose burdens on a third party. however, one may may ask if the established contractual setup may confer rights on a third party under the doctrine of third party beneficiary law. in other words, it could be asked whether the guest can be regarded a third party beneficiary of the contract between airbnb and the host and whether the host can be regarded a third party beneficiary of the contract between airbnb and the guest. several jurisdictions recognize the concept of the third party beneficiary contract.19 quite clearly and as the above mentioned reference shows, by entering into the user contract, the user undertakes to live up to certain obligations that will in fact benefit the other user. however, in order for the user to be able to base a legal claim on the contract, three requirements must be fulfilled.20 firstly, the contractual parties must intend to confer a right on the third party. secondly, the parties must confer a specific right on the third party. thirdly, the third party must be identifiable. normally, it is not a requirement that the third party existed or was identified at the time of entering into the contract,21 but the third party must be identifiable, for instance, as belonging to a specific group or class.22 it seems doubtful whether the airbnb contractual setup fulfills these requirements. in particular, it must be presumed that it will often be difficult to show the required intention on (from the origin of this line of theory) john n. adams and roger brownsworth, ‘privity and the concept of a network contract’, vol 10, iss. 1 legal studies, 12-18. see also vassilis (n 15) 61 on the connection between the tripartite relationship and tort law issues. these matters are not further pursued in this contribution. 19 see for instance for german law: bürgerliches gesertzbuch (bgb) 328, french law: code civil (cc) art. 1121, english law: the third party beneficiary rights act and for us law: the restatement second § 302 ff. the concept is also recognized in scandinavia, torsten iversen, ‘tredjemandsaftaler’, [1994] tidsskrift for retsvidenskab 12. also in what could be called “general international contract law”, the concept of the third party contract is recognized as reflected in articles 5.2.1.-5.2.6 of the unidroit principles, article 6:110 of the pecl, article 78 of the cesl and the dcfr article 9:301. 20 see katerina p mitkidis, sustainability clauses in international business contracts (eleven international publishing 2015) 197. 21 see dcfr 9.301 where this is specified. 22 mitkidis (n 20) 198. platforms as private governance systems 46 the part of the user to confer a right on the other user to hold it responsible for infringements of the contract with airbnb. 3. airbnb as a private governance system as described in section 1, platforms like airbnb have become powerful societal players, which take on roles that from a constitutional law perspective are recognizable as regulators, implementers and dispute resolution bodies. in this section, we will explore whether the airbnb platform as a system of private governance is also concerned with public values as known from state legal orders, in particular consumer protection and non-discrimination. we will focus in particular on the extent to which such values become part of the relation between the host and the guest with airbnb acting in the role of a “state”. 3.1. airbnb as regulator the airbnb contractual setup described above aims to govern activities on the airbnb platform. interestingly, airbnb regulates not only commercial aspects of these activities but also aspects of general public interest such as consumer protection and nondiscrimination. with regard to consumer protection, some elements of the airbnb concept aim at protecting the guest against misconduct of the host. as an example, guests are required to pay in advance, but airbnb holds the funds in escrow until 24 hours after the guest has checked in.23 another example of a rule that arguably provides some protection of the guest against misuse (forgery) concerns the content of the “listing” of a host:24 when creating a listing through the airbnb platform you must (i) provide complete and accurate information about your host service (such as listing description, location, and calendar availability), (ii) disclose any deficiencies, restrictions (such as house rules) and requirements that apply (such as any minimum age, proficiency or fitness requirements for an experience) and (iii) provide any other pertinent information requested by airbnb. this duty of disclosure is comparable to article 5 of the eu directive on consumer rights.25 however, it expands this duty of disclosure beyond the scope of eu consumer law.26 23 ‘payment terms of service’ (airbnb inc, 16 april 2018) <https://www.airbnb.com/terms/payments_terms> accessed 11 october 2018, section 7.2. 24 terms of service (n 6) section 7.1.1. 25 council directive 2011/83/eu of 27 june 2002 on consumer rights amending council directive 93/13/eec and directive 1999/44/ec of the european parliament and of the council and repealing council directive 85/577/eec and directive njcl 2018/1 47 with regard to nondiscrimination, airbnb has a separate nondicrimination policy.27 in this policy, airbnb presents itself as “at its core, an open community dedicated to bringing the world closer together by fostering meaningful, shared experiences among people from all parts of the world”, and lays down and explains two “foundational principles” that apply to hosts and guests, namely “inclusion” and “respect”.28 the nondiscrimination policy provides “specific guidance for hosts” in the form of a number of rules about what hosts may or may not do. according to the rules, it is prohibited for a host to reject a guest or impose special terms on a guest based on race, skin color, ethnicity, nationality, religion, sexual orientation, sexual identity or marital status. it is also prohibited to discriminate on the basis of sex unless the host shares rooms with the guest. in contrast, it is permitted for the host to reject guests for other reasons. for instance, hosts can reject smokers to keep the home a non-smoking area. in europe, these private rules find parallels in the state legal orders which will be described in section 4.29 3.2. airbnb as implementer airbnb has also created systems that fill out the role of supervision, control and enforcement of the contractual setup. the fundamental tool in this regard is the review system, which primarily is of a non-legal nature and based on reputation of users. like many other platforms, airbnb “outsources” core implementation tasks to the customers themselves while the platform primarily takes on the role of facilitator of exchange and disclosure of relevant information: within a certain timeframe after completing a booking, guests and hosts can leave a public review (“review”) and submit a star rating (“rating”) about each other. any ratings or reviews reflect the opinion of individual members and do not reflect the opinion of airbnb.30 in practice, both guests and hosts review each other, and airbnb posts detailed reviews on listings and member profiles. based on 97/7/ec of the european parliament and of the council text with eea relevance [2002] oj l304/64. 26 see section 4.2.2. 27 nondiscrimination policy (n 5). 28 ibid. 29 non-discrimination is a fundamental right and goal throughout europe, see, in particular, teu articles 2 and 3(3), article 14 of the european convention on human rights, articles 20-26 of the eu charter on fundamental rights, and the eu directives implementing the principle of equal treatment (directives 2000/43/ec, 2000/78/ec, 2004/113/ec and 2006/54/ec). 30 terms of service (n 6) section 10.1. platforms as private governance systems 48 reviews, each member builds its reputation on the platform. airbnb supports the reputational effect by granting hosts the position of “super-hosts”, which is displayed for guests or to withdraw this badge. reviews are also used as a tool in the booking system so that hosts can choose to only rent out to guests who have previously been well reviewed by their previous hosts. apart from facilitating this review system, airbnb may also undertake a more active role as implementer. airbnb emphasizes that it has no obligation to monitor the access to or use of the airbnb platform by any member (…), but has the right to do so (…)”.31 in this regard, airbnb may use several means to enforce its rules and policies on the platform. most severely, airbnb may terminate the contractual relationship with the user and/or stop providing access to the airbnb platform.32 airbnb reserves the right to do this in three situations: first, if the user has materially breached his obligations under the user contract. secondly, if the user has “violated applicable laws, regulations or third party rights”. thirdly, if “airbnb believes in good faith that such action is reasonably necessary to protect the personal safety or property of airbnb, its members, or third parties (for example in the case of fraudulent behavior of a member).33 airbnb may also take other measures against a user, including refuse to surface, delete or delay any listings, ratings, reviews, or other member content; cancel any pending or confirmed bookings; limit your access to or use of the airbnb platform; temporarily or permanently revoke any special status associated with your airbnb account; temporarily or in case of severe or repeated offenses permanently suspend your airbnb account and stop providing access to the airbnb platform.34 if a host cancels a booking, airbnb may publish an automated review on the listing cancelled by the host indicating that a booking was cancelled”. in addition, “airbnb may (i) keep the calendar for the listing unavailable or blocked for the dates of the cancelled booking, and/or (ii) impose a cancellation fee, unless the host has a valid reason for cancelling the booking pursuant to airbnb’s extenuating 31 terms of service (n 6) section 14. 32 see terms of service (n 6) section 15.4 and the nondiscrimination policy (n 5). 33 ibid. 34 see terms of service (n 6) section 15.5 and the nondiscrimination policy (n 5). njcl 2018/1 49 circumstances policy or has legitimate concerns about the guest’s behavior.35 whereas airbnb can use the review system and system of sanctions mentioned above as important means of implementing its rules and policies, the airbnb booking system (described in section 2.2) can challenge the implementation of the nondiscrimination policy.36 for hosts, their first name and their profile photo are part of their public profile page.37 accordingly, the airbnb platforms requires hosts to accept that their sex, race and ethnic origin are publicly available. airbnb thus invites potential guests to consider this information before making a booking request, which may make the host a victim of discrimination. for hosts, it will generally be very difficult to prove such discrimination. under the normal booking procedure, a potential guest shall submit a booking request to the host, who may choose to accept or reject the booking request. in this connection, airbnb will share certain information about the guest with the host, which includes the full name of the guest, the full name of any additional guests, and other information that the guest agrees to share.38 apparently, this may also include a profile picture.39 again, potential hosts may consider the provided information about sex, race and ethnic origin of the potential guest(s), which may make the guest a victim of discrimination, and again, such discrimination might be difficult to prove. 3.3. airbnb as dispute resolver airbnb has created its own system for solving certain types of disputes between its users (the “resolution center”). in particular, users can use the resolution center to send or request money for refunds (e.g. in cases of cancellation) or to send or request money for damage claims related to bookings.40 the terms of service describes the dispute resolution procedure for damage claims as follows:41 if a host escalates a damage claim to airbnb, you will be given an opportunity to respond. if you agree to pay the 35 see terms of service (n 6) section 9.3. 36 this topic has attracted significant attention in recent legal scholarship in the us. see, inter alia, jamilla jefferson-jones ‘shut out of airbnb: a proposal for remedying housing discrimination in the modern sharing economy’ [2016] vol. xliii fordham urban law journal, www.ssrn.com/abstract=2772078 accessed 11 october 2018, and nancy leong and aaron belzer ‘the new public accommodations: race discrimination in the platform economy’ [2017] 105 georgetown law journal 1271 <www.ssrn.com/abstract=2687486> accessed 11 october 2018. 37 see privacy policy (n 11) section 3.3. 38 ibid section 3.2. 39 ibid section 1.1. 40 terms of service (n 6) sections 9.8 and 11. 41 ibid section 11.2. platforms as private governance systems 50 host, or airbnb determines in its sole discretion that you are responsible for the damage claim, airbnb payments will collect any such sums from you and/or against the security deposit (if applicable) required to cover the damage claim pursuant to the payments terms. airbnb also reserves the right to otherwise collect payment from you and pursue any remedies available to airbnb in this regard in situations in which you are responsible for a damage claim, including, but not limited to, in relation to any payment requests made by hosts under the airbnb host guarantee. it is not mandatory for hosts to use the resolution center to pursue damage claims, whereas the guest cannot oppose to the procedure. the procedure allows airbnb not only to make a decision but also to enforce this decision and collect the sum from the user and/or from the security deposit.42 with regard to damage claims, the function of the resolution center is clearly to help the host get “access to justice”. airbnb may also facilitate the resolution of other types of disputes between users, including violations of the nondiscrimination policy or applicable statutory laws, e.g. concerning consumer protection and nondiscrimination. however, airbnb has no obligation to do so.43 we are unaware of any publicly available empirical data about the use of the airbnb resolution center to resolve such other types of disputes. obviously, the resolution center’s decision is not binding, but the guest will need to take legal action against the host (and/or airbnb) to recover. we will return to this aspect in section 4. the private dispute resolution system completes the private legal order, which, taken as a whole, is a comprehensive system of private governance. it parallels the state legal order by offering “services” with regard to both regulation, implementation and dispute settlement and by being concerned not only with commercial matters but also with matters of general public interest such as consumer protection and antidiscrimination. 4. airbnb and the undermining of state governance if a user is unsatisfied with the private governance mechanisms offered by airbnb, the user may instead seek to use traditional state governance mechanisms to enforce his contractual rights (under the user contract and/or the rental contract) as well as to enforce his rights under 42 a host can require a security deposit, see terms of service (n 6) section 7.2.2 for details. 43 in section 1.3 of the terms of service (n 6), airbnb states: “while we may help facilitate the resolution of disputes, airbnb has no control over and does not guarantee (i) ..., (ii) ..., or (iii) the performance or conduct of any member or third party.” njcl 2018/1 51 applicable statutory laws. in this section, we will show that the airbnb platform challenges the applicability and effectiveness of traditional state governance mechanisms when it comes to the obligations of airbnb and its users. we will limit our analysis in this section to situations where the host offers its accommodation services within the eu, and both the host and the guest have their residence in the eu. 4.1. governing law airbnb offers its platform services to users in the eu from a subsidiary incorporated under the laws of ireland, except for payment services, which airbnb offers (so far) through a subsidiary incorporated under the laws of the uk.44 the hosts often have their domicile in the country where they provide their services, whereas guests generally come from all over the world. consequently, the law applicable to the contractual relationships between airbnb, hosts and guests can be of material importance. the rome i regulation will govern the law applicable to the contractual setup presented in section 2, when both the host and the guest have their residence in the eu.45 with regard to the user contract, the terms of service include the following provision on applicable law for users with residence in the eu:46 if your country of residence is outside of the united states and china, these terms will be interpreted in accordance with irish law. the application of the united nations convention on contracts for the international sale of goods (cisg) is excluded. the choice of law does not impact your rights as a consumer according to the consumer protection regulations of your country of residence. the rome i regulation generally allows the parties to choose the law applicable to their contract. article 3 of the regulation requires that such a choice is made expressly or is clearly demonstrated by the terms of the contract or the circumstances of the case. the assessment of this requirement is subject to an autonomous interpretation of the choice of law agreement, which is not restrained by national rules of interpretation.47 in our view, the above provisions are sufficiently clear to constitute a choice of law agreement for the contractual relationships between each of the two airbnb subsidiaries and its users. this means 44 see the terms of service (n 6) and the payment terms of service (n 22). 45 regulation (ec) 593/2008 of the european parliament and of the council of 17 june 2008 on the law applicable to contractual obligations (rome i) [2008] oj l177/6. however, this regulation does currently not apply in denmark. 46 the payments terms of service (n 22) include a similar provision. 47 franco ferrari (ed): rome i regulation (sellier european law publisher 2015) 95. platforms as private governance systems 52 that, as a starting point, irish law applies to the contract between airbnb and users with residence in the eu. however, article 6 of the rome i regulation includes a special rule on consumer contracts, i.e. contracts concluded by a natural person for a purpose which can be regarded as being outside his trade or profession (the consumer) with another person acting in the exercise of his trade or profession (the professional).48 under article 6, a choice of law provision in a consumer contract may not have the result of depriving the consumer of the protection afforded to him by provisions that cannot be derogated from by agreement by virtue of the law which, in the absence of choice, would have been applicable to the contract.49 apart from such mandatory consumer protection law, a choice of law clause in a consumer contract that meets the requirements under article 3 of the rome i regulation is binding on the consumer. consequently, although irish law applies to the contract between airbnb and the consumer, mandatory consumer protection law in the consumer’s country of residence will also be applicable to the contract and may override the written terms of the contract. the above-mentioned clause in the terms of service (“the choice of law does not impact your rights as a consumer according to the consumer protection regulations of your country of residence”) is in line with this.50 with regard to the rental contract, some of its terms may be dictated by the user contracts. however, the user contract does not define the law applicable to the rental contract. under the rome i regulation, a host and a guest may choose the law applicable to their contract and, if they do not make such a choice, the law of the country where the property is situated shall govern the rental contract.51 this means that if the host and the guest have not made a specific choice of law, the law of the country where the rented property is located will apply. in practice, this will often be the law of the country where the host has its place of residence. the special provision on the law applicable to consumer contracts in article 6 of the rome i regulation does not apply to the 48 article 6 does not apply to certain types of consumer contracts; see article 6(4). 49 rome i regulation (n 45) article 6(2). 50 actually, the clause appears to go even further, since the wording of the clause seems to refer to any national consumer protection law, whether mandatory or not. however, since the clause merely states that “the choice of law” does not “impact” statutory consumer protection laws, other provisions in the user contract may still deprive consumers of non-mandatory consumer rights. to what extent the user contract derogates from non-mandatory consumer protection laws in the country, where the consumer has his habitual residence, will depend on a comprehensive legal analysis. it falls outside the scope of this paper to conduct such an analysis, but it is noteworthy that airbnb does not guide consumers about how the terms affect their statutory consumer rights. 51 rome i regulation (n 45) article 3. njcl 2018/1 53 rental contract.52 as mentioned in section 2.2, airbnb does not encourage users to enter into an explicit (written) rental contract. thus, it seems fair to assume that most rental contracts will not include an agreement on the applicable law.53 consequently, the law applicable to the rental contract will normally be the law of the country where the property is situated. in sum, with regard to the user contract, consumer users will maintain (at least) their mandatory consumer rights under the statutory laws of the eu member state in which they have their residence. the law applicable to the rental contract will normally be the laws of the eu member state where the host offers the accommodation service, and statutory consumer protection laws will normally apply to b2c rental contracts (and, to some extent, to c2b rental contracts), but not to c2c rental contracts.54 since statutory consumer protection laws differ across the eu member states, we will use a part of the eu consumer law acquis in our analysis below to illustrate the role of statutory consumer protection laws without taking into account the specific transposition of this eu law acquis into national law in specific member states. for the same reason, we will generally not include other statutory consumer protection laws in our analysis. 4.2. state governance of the airbnb-user relationship 4.2.1. enforcing the user contract through the state legal order the user contract stipulates that users have a number of obligations with regard to their transactions on the airbnb platform, and the user contract also provides airbnb with significant means to act in order to ensure that users comply with these obligations (as described in section 3). however, airbnb does not take upon itself a general obligation to use these means to ensure that users comply with their obligations.55 as mentioned, the user contract also explicitly stipulates that airbnb is generally not liable for anything related to transactions between users.56 thus, the wording of the user contract does not provide users with a 52 ibid article 6(4)(c). 53 in the same vein, see hatzopoulos (n 15) 173. 54 on the different types of rental contracts, see section 2.2. 55 see, in particular, terms of service (n 6) section 1.3: “while we may help facilitate the resolution of disputes, airbnb has no control over and does not guarantee (i) the existence, quality, safety, suitability, or legality of any listings or host services, (ii) the truth or accuracy of any listing descriptions, ratings, reviews, or other member content (as defined below), or (iii) the performance or conduct of any member or third party. airbnb does not endorse any member, listing or host services.” 56 see, in particular, terms of service (n 6) sections 1, 14, 16 and 17. for details about the contractual setup, see section 2. platforms as private governance systems 54 basis for raising and enforcing a claim against airbnb concerning their transactions with other users.57 4.2.2. enforcing statutory law through the state legal order as mentioned in section 4.1, statutory consumer protection laws will often apply to the relationship between airbnb and users acting for purposes not relating to their business, trade or profession.58 within the eu, these include national laws transposing the eu consumer law acquis, which include, in particular, the directive on unfair commercial practices, the directive on consumer rights and the directive on unfair contract terms.59 the scope of the obligations that the eu consumer law acquis imposes on commercial platforms is subject to some legal uncertainty.60 as an example, airbnb is required to act with a degree of professional diligence commensurate to its specific field of activity, and to avoid misleading its users by either action or omission. in particular, airbnb may have an obligation to enable commercial hosts to comply with applicable laws and consumer guests to clearly understand with whom they are possibly concluding contracts.61 however, these requirements do not apply to private (non-commercial) hosts under the eu law consumer acquis.62 in addition, statutory law does not impose on airbnb any general obligation to monitor content provided by users (such as the hosts’ listings) or to carry out fact-finding.63 in general, the unclear status 57 on the legal uncertainty related to this contractual triangle, see section 2.3. 58 see section 2. 59 directive 2005/29/ec of the european parliament and of the council of 11 may 2005 concerning unfair business-to-consumer commercial practices in the internal market [2005] oj l149/22, directive 2011/83/eu of the european parliament and of the council of 25 october 2011 on consumer rights [2011] oj l304/64, and council directive 93/13/eec of 5 april 1993 on unfair terms in consumer contracts [1993] oj l95/29. 60 see, in particular, commission (n 1). more specifically about the implementation and application of directive 2005/29/ec on unfair commercial practices (n 59), see commission, ‘staff working document guidance on the implementation/application of directive 2005/29/ec on unfair commercial practices’ (secretariat-general) com [2016] 163 final. 61 see the directive on unfair commercial practices (n 59) in particular articles 2, 5, 6 and 7, and commission staff working document (n 60) 114. 62 some eu member states impose such requirements even on private hosts under their national statutory laws. as an example, see section 2(3) of the danish consumer contract act. 63 see article 15(1) of council directive directive 2000/31/ec of the european parliament and of the council of 8 june 2000 on certain legal aspects of information society services, in particular electronic commerce, in the internal market ('directive on electronic commerce') [2000] oj l178/1 and commission staff working document (n 58). interestingly, the eu commission has recently presented a proposal for a legislative package, which, if adopted, will introduce certain new transparency njcl 2018/1 55 of the platform’s contractual partner may make it difficult to assess the applicability of consumer protection laws. statutory nondiscrimination laws aim to provide effective, proportionate and dissuasive remedies to victims of discrimination.64 however, it is not clear from these laws whether airbnb has any obligations (or can incur any liability), if a user of the airbnb platform discriminates against another user on the basis that airbnb has contributed to such discrimination. on the one hand, the airbnb platform provides a system under which discrimination based on sex, race and ethnic origin can easily happen (as mentioned in section 3.2). on the other hand, airbnb, by its antidiscrimination policy, clearly seeks to prevent any kind of discrimination between users, and airbnb clearly waives any liability for anything related to the transactions between users. against this background, it is not unlikely that the platform setup under which airbnb has not actively exercised discrimination itself will have as a consequence that airbnb escapes the reach of applicable statutory nondiscrimination laws in the eu. since airbnb offers its services in the eu from companies in ireland and the uk, public authorities in other eu member states generally have no jurisdiction to enforce the law against airbnb. the scope for action of the authorities will be limited to giving guidance to the users about their rights and obligations, supporting users in filing a claim to a competent public authority in ireland or the uk, or encouraging legal action against airbnb. in general, the platform setup is demanding in terms of the degree of cooperation between public authorities in different member states that may be necessary in this regard.65 requirements on platforms such as airbnb, see commission, ‘communication from the commission to the european parliament, the council and the european economic and social committee, a new deal for consumers’ (com(2018) 183 final), and the proposals for two new eu directives (com(2018) 184 final and com(2018) 185 final). on the need to adjust the current consumer protection regime in the eu to accommodate the particular needs emerging from the platform economy, see also christoph bush and others, ‘the rise of the platform economy: a new challenge for eu consumer law?’, eucml (2016) 3, and research group on the law of digital services, ‘discussion draft of a directive on online intermediary platforms’, eucml (2016) 164. 64 the relevant directives are mentioned in more detail in section 4.3.2. 65 with regard to consumer protection, see, in particular, council regulation (ec) 2004/2006 on cooperation between national authorities responsible for the enforcement of consumer protection laws [2004] oj l364/1 (the regulation on consumer protection cooperation). regulation (eu) 2017/3494 will replace this regulation from 17 january 2020. the european commission has recently announced that it intends to step up coordination with partners outside the eu, see commission, a new deal for consumers (n 61) 10. with regard to nondiscrimination (equal treatment) laws, the eu directives have established a network of bodies for the platforms as private governance systems 56 when consumer protection laws are not enforced by public authorities, the user may be left with the option to turn to dispute resolution. however, even if the user can establish a claim against airbnb, the user agreement contains an arbitration clause, a “no class actions or representative proceedings” clause and a “jury trial waiver” clause, which will probably prevent users from any effective access to the us public civil justice system.66 in the eu, the arbitration clause will not be binding on the users to the extent they are qualified as consumers but will rule out court proceedings in other situations.67 representative proceedings are currently only available in some eu member states under their national laws, and it will require a detailed analysis of each jurisdiction to assess whether the “no class actions or representative proceedings” clause constitutes a valid waiver of a right to use such collective redress mechanism.68 in sum, a user wishing to rely on a state legal order to pursue rights against the platform will face several challenges, many of which are due to the fact that the platform setup escapes the reach of national statutory regulation and thereby undermines its effectiveness. 4.3. state governance of relations between users 4.3.1. enforcement of contractual rights in the state legal order the contractual obligations of a user vis-a-vis another user may follow, in particular, from the contractual setup (described in section 2 above). however, the airbnb contractual setup generally does little to promotion of equal treatment. see, inter alia, article 13 of council directive 2000/43/ec of 29 june 2000 implementing the principle of equal treatment between persons irrespective of racial or ethnic origin [2000] oj l180/22, and article 12 of council directive 2004/113/ec of 13 december 2004 implementing the principle of equal treatment between men and women in the access to and supply of goods and services [2004] oj l373/37. 66 see terms of service (n 6) section 19. on the validity of such dispute resolution clauses, see also hatzopoulos (n 52) 180-183. 67 see, in particular, council directive 93/13/eec of 5 april 993 on unfair terms in consumer contracts [1993] oj l95/29. in several jurisdictions, national arbitration acts also explicitly provide that an arbitration agreement is not binding for a consumer. see e.g. danish arbitration act section 7(2). 68 however, see directive 2009/22/ec of the european parliament and of the council of 23 april 2009 on injunctions for the protection of consumers’ interests [2009] oj l110/30, which has not been a success in practice, and the proposal in commission, ‘proposal for a directive of the european parliament and of the council on representative actions for the protection of the collective interests of consumers, and repealing directive 2009/22/ec’ com(2018) 184 final for a directive on representative actions for the protection of the collective interests of consumers, and repealing directive 2009/22/ec. njcl 2018/1 57 support such contractual claims between users. the user contract (which each user enters into with airbnb) includes a catalogue of rights and obligations of users, but it does not ensure a clear contractual basis for one user to raise a claim against another user.69 for instance, although the concept of third party beneficiary law is familiar in many state legal orders, it is highly uncertain whether it would be possible for the guest to enforce the user contract’s consumer protection provisions and airbnb’s antidiscrimination policy against the guest on this basis.70 moreover, the user contract presupposes the existence of the rental contract, but airbnb does very little to ensure that users actually enter into an explicit (clear) rental contract. consequently, it is reasonable to presume that the contractual regulation governing transactions between two specific users (a host and a guest) will often be unclear, and it will thus be difficult to establish a (clear) contractual basis for a claim that can be enforced either by public authorities or by courts. in some jurisdictions, it may not be possible to enforce contractual obligations that implement public law rules aiming to safeguard matters of general public interest.71 4.3.2. enforcement of statutory law in the state legal order with regard to statutory consumer protection laws, the airbnb platform does not ensure that users disclose the purpose of their transactions, i.e. whether they are acting in a commercial or private capacity. this can make it difficult to assess whether statutory consumer protection laws apply to a specific transaction.72 as an example, it can be difficult for a guest to know whether the host is acting for commercial or private purposes (which will usually determine whether consumer protections laws apply to their legal relationship). currently, airbnb does not require users to provide and share the relevant information in this regard. also, airbnb does not currently provide an easily accessible link to the online dispute resolution (odr) platform on its website with relevant information related to dispute resolution pursuant to the eu regulation on consumer odr applies.73 69 see section 2.3. 70 ibid. 71 under danish law, this follows from the principle that the executive generally has a monopoly to enforce such types of public law rules, unless explicitly provided for by the law. this also affects the arbitrability of such disputes under danish law, see the danish supreme court’s decision reported in the danish weekly law reports as u 1999.829 h. 72 as discussed in section 2. the legislative package recently proposed by the eu commission (n 63) includes a proposal for new disclosure requirements in this regard. see also the recent developments mentioned in section 5. 73 regulation (eu) no 524/2013 of the european parliament and of the council of 21 may 2013 on online dispute resolution for consumer disputes, [2013] oj l165/1. this is about to change, see section 5. platforms as private governance systems 58 with regard to statutory nondiscrimination laws, regulation exists both at the eu level and at the national level.74 however, also in this respect, traditional distinctions such as the distinction between private affairs and public enterprise may render inapplicable fundamental nondiscrimination regulation to the user relation. for instance, it is subject to legal uncertainty whether private hosts must comply with directive 2004/113/ec implementing the principle of equal treatment between men and women in the access to and supply of goods and services. this directive applies to all persons who provide goods and services, which are available to the public irrespective of the person concerned as regards both the public and private sectors, including public bodies, and which are offered outside the area of private and family life and the transactions carried out in this context.75 is it thus unclear, whether the directive applies to a private person renting out a single room in his/her private home.76 public authority implementation and enforcement of statutory laws against the users may also face difficulties. the airbnb regulation does not ensure adequate and correct information about the users’ identities, and it is subject to legal uncertainty to what extent applicable statutory consumer protection laws impose an obligation on airbnb to obtain and share such information.77 a commercial host is probably subject to such an obligation vis-a-vis consumer guests.78 since airbnb does not ensure that hosts fulfil this requirement, and since the requirement does not apply to consumer hosts, there is a significant risk that many guests may not know the full (true) identity of their host. thus, the lack of information about the identity of users (and, for consumer protection, about the purpose of specific transactions between users) can undermine the opportunities for public enforcement of statutory laws against users. the lack of an obligation to disclose the identity of the user may also short circuit the general principle of access to justice, since in order to raise a claim against another user, it is crucial to know the identity of that user. in sum, also with regard to the relationship between the users, the reach of the state legal order may be limited due to the special platform 74 see n 29. furthermore, many eu member states have adopted comprehensive national legislation to implement the principle of equal treatment. 75 council directive 2004/113/ec of 13 december 2004 implementing the principle of equal treatment between men and women in the acces to and supply of goods and services [2004] oj l373/37, article 3(1). 76 the preparatory works to the danish act transposing the directive into danish law assume that the directive will generally not apply to such a transaction. 77 see section 4.1. 78 under the directive on unfair commercial practices (n 59). the directive on consumer rights (n 25), which includes specific disclosure requirements in article 5, does not apply to contracts for rental of accommodation for residential purposes, see article 3(3)(f) of the directive. njcl 2018/1 59 setup, which thereby also to some extent has an undermining effect on the state legal order. 5. conclusion as described in section 3, airbnb offers a private governance system that, on the face of it, may seem to be a complete parallel to the state governance system comprising regulation, implementation and dispute resolution and addressing not only commercial but also public values. however, it is difficult to assess the effectiveness of this private governance system. the user contract generally does not require airbnb to enforce the contractual rights and obligations of its users. we are unaware of any publicly available information about airbnb practices in this regard. furthermore, since airbnb generally does not verify the identity of its users, it will properly be quite easy for a suspended user to register again as a new user of the airbnb platform.79 it is unclear, whether the reputational schemes (user reviews and ratings) provide users with a general incentive to comply with airbnb rules and policies. thus, to a large extent the protection granted under the private governance system may be more apparent than real. at the same time, as described in section 4, turning to enforcement by state legal orders can be complicated. first of all, the airbnb system is based on a complicated triangular contractual setup and the extent to which state legal orders can give effect to rights and duties within this framework may be limited and require the use of third party constructions or other network lines of reasoning not familiar to traditional, national legal systems. secondly, the private governance system challenges the state legal order in even more fundamental ways. at the general level it does so by blurring basic dichotomies as business/consumer, public/private, transnational/local, transparency/anonymity. the result can be said to be an undermining effect on the state legal order. for example, the platform operates a peerto-peer system that does not fit into the classical distinctions between business and consumer. this makes it difficult to assess the applicability of consumer protection laws. also, the applicability of other statutory protective laws such as antidiscrimination laws may become uncertain because of the blurring of the line between what is private and what is public. moreover, the (often) transnational character of the contractual relationship between the host and the guest challenges public authority implementation of protective statutory law, since public authorities are generally limited to exercise their jurisdiction within territorial boundaries. the limited role that public authorities can potentially play may push the user in the direction of dispute resolution mechanisms. however, the potential for using a national court system (as well as alternative dispute resolution) is to some extent undermined by the fact 79 as described in section 2.1. platforms as private governance systems 60 that airbnb facilitates contracting with effectively unknown contractual parties, since there is no identity disclosure requirement in the system. this short circuits the potential role played by national courts and arbitrators which would be the last resort for a user trying to pursue rights in the state legal order. on 16 july 2018, the european commission and eu consumer authorities officially called on airbnb to align their terms and conditions with eu consumer rules and be transparent on their presentation of prices.80 the call included a requirement that airbnb shall clearly identify if an offer is made by a private host or a professional host, as the consumer protection rules differ, and a requirement that airbnb should provide an easily accessible link to the eu odr platform pursuant to the eu odr regulation.81 it is worth noting that the commmision does not require airbnb to disclose the identity of hosts. on 20 september 2018, the european commission announced that airbnb has committed to comply with these demands before the end of 2018.82 based on our analysis above, we expect that this will hardly be enough to accommodate the need to safeguard the public values related to consumer protection. 80 european commission, press release ip/18/4453. 81 see n 73. 82 european commission, press release ip/18/5809. microsoft word ogwezzy_michael_c final.doc nordic journal of commercial law issue 2013#2 common court of justice and arbitration: a supranational institution for the administration of commercial disputes in africa by michael. c. ogwezzy*1 *1 ph.d, ll.b, (ibadan) b.l, ll.m, (nigeria) ml.d, (delsu) masio/ll.m, (zh/switzerland), lecturer i, department of public international law, faculty of law, lead city university, ibadan, oyo state-nigeria, email: ogwezzym@yahoo.com nordic journal of commercial law issue 2013#2 1 1. introduction due to the expansion of business transaction across the globe, the private sector demands an adequate legal framework that is sufficiently clear, modern, predictable and transparent to permit investment with a sense of security. the organisation for the harmonisation of business law in africa (organisation pour l’harmonisation en afrique du droit des affaires) is generally known by its french acronym ohada. as long-standing idea, the foundation of the ohada treaty was first laid during a meeting of finance ministers of the members of the franc cfa1 area held in ouagadougou, burkina faso, in april 1991. a group of experts, led by senegalese justice keba mbaye, was appointed to conduct a feasibility study on a form of legal collaboration designed to promote economic integration and attract investments.2 identifying low investment as a major obstacle to economic growth, keba mbaye presented his report to the french-speaking african summit in libreville, gabon, in october 1992, recommending the creation of a supranational organization comprising the entire franc area. the recommendation was adopted and a steering committee of three experts were appointed and tasked with drafting an international instrument as well as identifying the areas of law to be harmonized. the ohada was established through the treaty of port louis in mauritius on 17th october, 19933 the treaty is open to any member state of the organization of african unity (au) as well as any other non-member of the au invited to join with the common agreement of all the member states.4 the ohada has progressively become the common business law in anglophone and francophone african countries, taking the best from the civil law and the common law systems.5 the ohada provides its member states with 1) a single, modern, flexible and reliable business law adapted to each country’s economy; 2) arbitration as an appropriate and trustworthy way to settle disputes; and 1 cfa is the acronym for the communauté financière africaine. the cfa franc is the name of two currencies used in africa that are guaranteed by the french treasury: the west african cfa franc (xof) and the central african cfa franc (xaf). 2martin kirsch, “historique de l’ohada,” revue penant 827 (1998) at 129; barry walsh, in search of success: case studies in justice sector development in sub-saharian africa (washington, dc: world bank, 2010), 44. 3 the ohada treaty has been amended once, in quebec (canada), on 17th october, 2008. 4the treaty creating the “organization for the harmonization of business law in africa”, was signed by14 african heads of state in port louis, mauritius on 17 october, 1993 and entered into force on 18 september, 1995, and amended in quebeccanada, on 17th october, 2008 came into force on 21st march, 2010. it now numbers 17 member states. (note that the provisions of the revised treaty is applicable in the course of this research irrespective of the use of the term “ treaty or revised treaty”) 5martha simon tumnde, et. al, unified business laws for africa: common law perspectives on ohada, london: gmb publishing company, 2009, at 69-70 nordic journal of commercial law issue 2013#2 2 3) an opportunity for training judges and judicial staff and ensuring their specialisation. in may 2003, the uniform ohada business law came into force in the sub-saharan african states of benin, burkina faso, cameroon, central african republic, comoros, congo, ivory coast, gabon, guinea, guinea bissau, equatorial guinea, mali, niger, senegal, chad, togo and later the democratic republic of the congo. the ohada treaty secures a legal framework for the conduct of business in africa.6 pursuant to article 53 of the ohada treaty, any member state of the african union may become a member, if it wishes to do so.7 many countries are currently giving active consideration to joining the ohada common system of business law.8 most of the countries have a french colonial heritage, with the exception of the democratic republic of the congo (former belgian colony), guinea-bissau (former portuguese colony), equatorial guinea (former spanish colony), and togo and cameroon (formerly under partly british and partly french colonial rule). french is also an official language in most of the countries and many ohada sources are only available in french. 9 it is interesting to know that the council of ministers of the ohada organisation which is the legislative organ of the organisation have adopted the following uniform business law: the general commercial laws, corporate laws and rules concerning different types of joint ventures, laws concerning secured transactions, debt recovery and enforcement laws, bankruptcy laws, arbitration law, accountability law, and law regulating contract for the carriage of goods by 6the seventeen member states are: benin, burkina faso, cameroon, comoros, congo, the democratic republic of the congo, ivory coast, gabon, guinea-bissau, guinea, equatorial guinea, mali, niger, the central african republic, senegal, chad and togo, available at: http://www.ohada.com/etats-membres.html, accessed 20 july, 2013 7under article 52(2) of the treaty, it was provided that the treaty shall enter into force sixty (60) days after the date of deposit of the seventh instrument of ratification. the instruments of ratification and accession shall be deposited with the senegalese government, which is the depositary government, and which issues a copy to the permanent secretariat. the depositary government will register the treaty with the secretariat of the african union and with that of the un in accordance with article 102 of the united nations charter and issue a registered copy to the permanent secretariat. on 18 september, 1995, the number of ratifications required for entry into force of the treaty was fulfilled after the deposit by the niger of its instrument of ratification, thus the ohada treaty entered into force in accordance with article 52. 8m.t. ladan., introduction to ecowas community law and practice: integration, migration, human rights, access to justice, peace and security, kaduna: ahmedu bello university press limited, 2009, at 34 9 alexa tiemann , “ohada membership and business reforms:a driver for growth?” university of st. gallen draft version as of december 2012”, at. 3. available online at http://dial2013.dauphine.fr/fileadmin/ mediatheque/dial2013/documents/papers/146_us_tiemann.pdf, accessed 11 june, 2013 nordic journal of commercial law issue 2013#2 3 roads.10 the ohada treaty established the common court of justice and arbitration (ccja) which is a supranational11 judicial institution based in abidjan, ivory coast.12 2. the ccja as an arbitral institution 2.1 history of arbitration as a means of dispute settlement arbitration is a method of dispute resolution involving one or more neutral third parties, agreed upon by the disputing parties and whose decision the parties recognize as binding.13 arbitration is an alternative to litigation which dates back to the 13th century where english merchants sought to have their disputes resolved according to their own customs rather than by public law. in contemporary arbitration, the parties turn over the decision-making power to a private individual with stature, experience, and standing who can exercise authority similar to a judge in a court room. the decision is final, the proceedings are private, and decisions are typically made at a faster pace than in the court system with lower costs to all involved.14 though, according to song and samassekou, private arbitration predates the establishment of modern economic courts and arbitral tribunals. arbitration began as an extrajudicial mechanism for resolving disputes. the ancient sumerians, persians, egyptians, greeks and romans all had a tradition of arbitration. in roman law, arbitration agreements were admissible as a reflection of the recognized principle of freedom of contract. in arbitrations dating back to the oxyrhynchus papyri from 427 ad, merchants accepted as final the decisions of fellow merchants with knowledge and expertise in the related field. arbitration has, for that 10 ibid. these ohada uniform acts came into force between january, july, 1998, january 1999, january 2001 and january, 2004. available online at http://www.ohada.com/fichiers/newsletters/811/ohada-and-ecowastreaties-as-tools-for-final.pdf, accessed 22 july, 2013 11 supranationalism is a politico-legal concept which embodies but is not limited to the following core elements: decisional autonomy (in particular the rule of the voting majority as opposed to consensus), the binding effect of the laws of international organisations (where member states are precluded from enacting contradictory laws), the institutional autonomy of an organisation from its member states, and the direct binding effect of laws emanating from regional organisations on natural and legal persons in member states. (see b. fagbayibo, “common problems affecting supranational attempts in africa: an analytical overview” (2013) per 3,at. 33. see also hay, “federalism and supranational organisation”, 69 and pescatore law of integration 51-52.) 12antonia menezes, “the last frontier arbitrating in africa where shall we go?, “geneva, 13 april, 2012, at 10. the organization for the harmonization of business law in africa (ohada) was created by the treaty on the harmonization of business law in africa signed on october 17th, 1993 in port-louis and amended in quebec canada, on 17th october, 2008. available online at http://www.uihj.com/en/ressources/21548/50/ newsletter_janvier_2011_-_en.pdf, accessed 13 june, 2013 13bryan a. garner (ed), black’s law dictionary, st paul minn: west publishing co., 7th edn 2000, at. 62. 14 rozdeiczer and alejandro alvarez de la campa, alternative dispute resolution manual implementing commercial mediation, washington dc: the world bank group, 2006 nordic journal of commercial law issue 2013#2 4 reason, historically functioned as an independent adjudicative dispute resolution mechanism. it is characteristic that arbitration was perceived as superior for resolving price or damages disputes. trade exchanges compel states to modernize their legal system. it has become vital for states to develop an appropriate legal framework for an open economy and competitive market by establishing patterns of prevention and effective resolution of disputes.15 as regards to the ccja it does not settle disputes itself, but instead, like other international arbitration centres, provides the institutional procedures for arbitration.16 it controls the proceedings by appointing or confirming the arbitrators. in order to resolve the dispute, the parties may appoint a sole arbitrator or three arbitrators who will be confirmed by the ccja. it also intervenes in the appointment of arbitrators where the parties have agreed to appoint a sole arbitrator but fail to agree on the person of the arbitrator within thirty days from the date of notification of the request for arbitration to the other party. in that case the arbitrator shall be appointed by the ccja and where the parties have agreed that the dispute shall be decided by three arbitrators: each party shall appoint one, and the third, who shall chair the arbitral tribunal, is appointed by the court, unless the parties have agreed that the arbitrator will be designated by the two other arbitrators. however, failing agreement between the two arbitrators on the third person, and at the expiration of a time limit fixed either by the parties or by the court, the third arbitrator is appointed by the ccja.17 2.2 establishment of the common court of justice and arbitration (ccja) the ohada treaty provided for the creation of four institutions to carry out the treaty’s objectives: 1) the common court of justice and arbitration (ccja); 2) the council of ministers of justice and finances, which meets once a year to adopt “the uniform acts” applicable in each internal law of the member states; 3) the permanent secretariat, attached to the council of ministers and responsible for the preparation of all the acts and the annual program of harmonization of business law, with its headquarters is in yaoundé, cameroon; and 15lianbin song and mamoudou samassekou, “effectiveness and remedies of arbitral awards in ohada (1)’s system and in the people’s republic of china”, journal of politics and law, vol. 4, no. 1; march 2011 at 63. 16 paige berges and robert sentner, “doing business in africa — new regional institutions bring international arbitration to sub-saharan africa”, international arbitration alert, a publication of nixon peabody llp, 4 february, 2013 at 5 17 alhousseini mouloul, “understanding the organization for the harmonization of business laws in africa (o.h.a.d.a.)”, 2nd edn, june 2009, at 37-46, available online at http://www.ohada.com/fichiers/newsletters/ 1556/comprendre-l-ohada-en.pdf, accessed 26 of july, 2013. nordic journal of commercial law issue 2013#2 5 4) the higher regional school of judges (ersuma) as the regional training centre for legal officers of the ccja.18 the ccja could be described as both an arbitration institution and a judicial court, with jurisdiction covering all the ohada states. the treaty revisions signed in québec on october 17, 2008, completed the institutional framework with a fifth component, the conference of heads of state and government. the revised treaty came into force on march 21, 2010. 19 the preamble to the ohada treaty provides its vision: “determined to accomplish new progress on the road to african unity and to establish a feeling of trust in favour of the economies of the contracting states in a view to create a new centre of development in africa; mindful of the fact that the realisation of those objectives demands an application in the contracting states of a business law which is simple, modern and adaptable; in order to facilitate companies’ activities..., desiring to promote arbitration as an instrument to settle contractual disputes; determined to participate in common new efforts to better the training of judges and representatives of the law. ”....20 those who drafted the treaty firstly elected to lay down known, uniform and modern laws and secondly to create the ccja in order to respond to concerns in relation to the reliability of the legal system. the ccjafacilitates the administration of disputes among ohada members .21under article 14 of the ohada treaty: “the common court of justice and arbitration will rule on, in the contracting states, the interpretation and enforcement of the present treaty, on such regulations as laid down for their application and on the uniform acts”. the ohada 18leo netten, the ohada: an example of harmonization, newsletter – january 2011, available online at http://www.uihj.com/en/ressources/21548/50/newsletter_janvier_2011_-_en.pd, accessed 15 june, 2013. establishment of the ccja; on 4 april, 1997, installation of the official ccja, abidjan (ivory coast), from 4 to 10 april 1997: first session of the ccja; approval of the uniform act on general commercial law. 19renaud beauchard and mahutodji jimmy vital kodo, can ohada increase legal certainty in africa? , justice and development working paper series17/2011, washington, dc: the international bank for reconstruction and development / the world bank, 2011, at 10. see ohada newsletter, available online at http://www.ohada.com/newsletter.php?newlang=english&news=04032010-848#. accessed 26 of july, 2013. 20treaty on the harmonisation of business law in africa, signed on the 17th october, 1993 and entered into force on the 18th october, 1995. on 17 october 2008, the conference of heads of state and government of the ohada revised the treaty of port louis and the conditions under which the ohada treaty may be revised. see articles 61 and 63. 21norton rose, “managing the successful reforms of the business environment in africa”, the regional consultative conference in africa, accra, ghana, 5 7 november, 2007, at. 4 nordic journal of commercial law issue 2013#2 6 treaty provides for two routes to arbitration: institutional arbitration under the auspices of the ccja; and private arbitration under the uniform act on arbitration.22 it is pertinent to state that the ohada was established through a treaty with the objective of improving the abidance to rule of law in the private sector. in many member states, business and commercial laws dated back to colonial times without major revisions, the legal frameworks were outdated and not suitable for modern business, and were often fragmented or after limited amendments even contradictory in themselves. the ccja, in view of the importance of economic growth and investments, sought to develop and adopt a common framework for business law in order to promote growth and development in west and central africa and also building on enhanced regional integration to uniformly interpret the treaty and its uniform act for arbitration.23 accordingly, the ccja started functioning in line with the provisions in chapters iii and iv of the ohada treaty with the official adoption of rules of procedure by the council of ministers at n’djamena, chad on the 16 april, 1996 and the rules of arbitration adopted in ouagadougou, burkina faso on the 11 march, 1999 respectively.24 2.3 composition and election of the judges of the ccja the ccja is composed of nine judges;25 however, the council of ministers might, taking into account the needs of the service and the financial possibilities, set a higher number of judges. judges of the common court of justice and arbitration are elected for a non-renewable term of seven years, from among the nationals of the contracting parties through a secret ballot by the council of ministers.26 the court sits in chambers of three judges.27 the operating procedures of the ccja are to first ensure guarantee of judicial independence and security. the treaty did not specify that there must be a judge from a member state. in addition, the 22benefits of uniform act : harmonized approach to arbitration., especially if parties are from different countries, each of them may prefer disputes to be handled by a neutral body rather than by the national courts of the other party gives parties unfettered access to the benefits of arbitration, including: lower costs, avoidance of unnecessary publicity, neutral and impartial adjudication, access to the expertise of arbitrators in specific fields and certain level of control over the procedure. 23alexa tiemann , “ohada membership and business reforms: a driver for growth?” university of st. gallen draft version as of december 2012”, at. 3-4. available online at http://dial2013.dauphine.fr/fileadmin/ mediatheque/dial2013/documents/papers/146_us_tiemann.pdf, accessed 11 june, 2013 24boris martor, “business law in africa: ohada and the harmonization process”, london: kogan page publishers ltd, 2002, at.11 25article 31(1) of the revised treaty on the harmonisation of business law in africa, adopted on the 17 of october, 2008 in quebec, canada. available online at http://www.ohada.com/traite-revise.html accessed 23 july, 2013 26see also alhousseini mouloul, above note 16 at 37-46. see also, boris martor, above note 24 27 see norton rose, above note 21, at. 8 nordic journal of commercial law issue 2013#2 7 ccja has set itself the internal regulation that a judge must withdraw if the decision against which the appeal is brought was returned in his state of origin.28 before the election of the judges of the ccja, the permanent secretary invites each state to submit its candidates29. one state cannot have two justices seated in the court but can nominate or submit two candidates out of whom one could be selected. under article 31 of the ohada treaty,the personal requirements for candidates can be divided in three categories: judges with at least fifteen years of professional experience who possess the qualifications required to occupy the highest judicial office in their respective countries;30 lawyers that are members of the lawyer’s association or professional legal body or association of one of the states parties and with at least fifteen years of professional experience; and law professors with at least fifteen years of professional experience. one third of the judges of the ccja must belong to the categories of lawyers and law professors.31 following the reception of the application, the permanent secretary lists all the candidates in alphabetical order, and communicates that list to all member states at least one month before the election32. the council of ministers, before proceeding to the election, will take into account that the court cannot include more than one national of any member state 33. once elected, members of the ccja enjoy diplomatic privileges and immunities,are irremovable and cannot hold any political or administrative function. however, they can have gainful activity after having been authorized by the court. in case of vacancy of a seat, for death or resignation of a judge, the judge will be replaced according to the renewal procedure. the members of the court elect among themselves a president and two vice -presidents for a term of three years and six months.34 28 ibid. 29 this must be done at least four months before the date fixed for the election. 30article 31(2) of the revised treaty on the harmonisation of business law in africa, adopted on the 17 of october, 2008 in quebec, canada 31martha simon tumnde, et. al, above note 5, at 49 32the election of the members of the court are made according to the articles 1st and following of the rule of procedure of the ccja. 33article 31(3) of the revised treaty on the harmonisation of business law in africa, adopted on the 17 of october, 2008 in quebec, canada 34the elections are made according to the articles 37 and 38 of the treaty and 6, 7, 8 of the rule of procedure. nordic journal of commercial law issue 2013#2 8 3 the powers of the ccja 3.1 jurisdiction and powers of the ccja the ccja is both an arbitral institution and a judicial court, with jurisdiction covering all the ohada states.35 one of the particularities of ccja institutional arbitration is the double role of the ccja: administrative and jurisdictional. the administrative function consists of that of an arbitration centre. in its jurisdictional function it is a supreme court which rules on appeals made against arbitration decisions (review, third party proceedings, request for enforcement of foreign decisions, opposition to foreign decisions).36 the jurisdiction of the court can be traced to the provisions of articles 13-18 of the ohada treaty which grants the ccja three main areas of jurisdiction.37 the ccja performs the judicial functions of interpretation and review as a supranational court, consults and advises on draft uniform acts that the permanent secretariat has submitted for comments and administers and monitors arbitral proceedings within provision of article 21 of the treaty.38 first, the ccja is the supra-national court of the ohada states. it ensures the common interpretation and application of the ohada treaty and the uniform acts that harmonize african commercial law (including the uniform act on arbitration). as part of its judicial function, it has the power to review the decisions rendered by the high courts and court of appeals of member states in cases involving the application of the ohada treaty. after enshrining the supranationality and the primacy of ohada law, those who drafted the treaty created judicial supranationality within its geographic area.39 second, the preamble of the ohada treaty shows that the signatory states are willing to promote arbitration as a means of resolving contractual disputes. hence, the uniform act on arbitration law and the rules of arbitration of the ccja was adopted.40 35ohada january 2010 arbitration in africa, available online at www.nortonrose.com, accessed on 20 july, 2013 36 see norton rose, above note 20, at. 7. for a detailed examination of ohada arbitration, see mbaye mayatta ndiaye, l’arbitration ohada : réflexions critiques , memorandum prepared under the supervision of professor fadlallah ibrahim, june 2001, beda, bibliothèque de droit africain. 37see articles 13-18 of the revised ohada treaty. 38martha simon tumnde, et. al, above note 5, at 49 39 d. abarchi, la supranationalité de l’organisation pour l’harmonisation en afrique du droit des affaires (ohada) , revue burkinabé du droit, no. 37, 2000, ohadata d-02-02 ; eugène assepo assi, la cour commune de justice et d’arbitrage de l’ohada : un troisième degré de juridiction ?, revue internationale de droit comparé, 4-2005, ohadata d-06-23. see norton rose, above note 20 at.8 40 by the council of ministers of ohada, at a meeting in ouagadougou (burkina faso) on 11 march 1999. nanette pilkington and søbastien thouvenot “the innovation of ohada in the field of arbitration” , la semaine juridique n 44 of 28 october 2004, supplement no 5, at 28 . see also alhousseini mouloul, above note 16 at 43-44. nordic journal of commercial law issue 2013#2 9 according to beauchard and vital kodo, “the ccja also acts as an arbitration forum but there is a difficulty, in distinguishing between the ccja as an arbitration tribunal and an ad hoc arbitration body subject to the uniform act dealing with arbitration. as an institutional arbitration tribunal, the ccja plays the occasional role as an arbitration center. 41the ccja conducts, controls the procedure to be conducted before the arbitral tribunal, and administers the arbitration procedure in accordance with the treaty and the rules of arbitration. as an ad hoc arbitral body, the ccja is governed by the uniform act on arbitration law, however, when the parties are allowed to derogate from these provisions, they are allowed to determine the proceedings.42 however, ccja arbitration must be specifically agreed on between the parties, with the consequence that the proceedings are subject not to the uniform act on arbitration but to ccja rules; in addition, the parties must use the ccja to administer the arbitration proceedings. ccja arbitration, wherever the seat of the arbitration proceedings is located, is institutional arbitration.”43 the ccja also plays a role in arbitrations governed by the ccja arbitration rules subject to the provision of article 21 which provide that, “in applying a arbitration clause or an out of court settlement, any party to a contract may, either because it has its domicile or its usual residence in one of the member states, or if the contract is enforced or to be enforced in its entirety or partially on the territory of one or several member states, refer a contract litigation to the arbitration procedure provided in this section. the ccja does not itself settle such disagreements. it names and confirms the arbitrators, is informed of the progress of the proceedings, and examines decisions in accordance with article 24”.44 the ccja does not act as an arbitral tribunal per se and does not settle disputes itself. the ccja’s decisions are administrative (in its arbitral capacity). it is not required to provide reasons for its decisions and they cannot be challenged by the parties.45 only contractual disputes with a sufficient link to one or various ohada states can be referred to the ccja.46 41 renaud beauchard and mahutodji jimmy vital kodo, above note 19 at 12 42alhousseini mouloul, above note 15 at 43-44. joseph issa-sayegh, jacqueline lohoues-oble, ohada harmonisation du droit des affaires, ed. bruylant juriscope, 2002, no 492, at 198-199 43 renaud beauchard and mahutodji jimmy vital kodo, above note 19 44 title iv, arbitration, article 21 of the revised treaty on the harmonisation of business law in africa, adopted on the 17 of october, 2008 in quebec, canada. article 24 provides that, “before signing a partial or final award, the arbitrator shall submit the proposed decision to the common court of justice and arbitration, which may suggest any formal amendments to such a decision”. 45reference arbitrating across the regions norton rose group, at 15, available online at www.nortonrosefulbright.com/files/arbitration-reference-26054.pdf accessed 23 july, 2013 46 ibid., nordic journal of commercial law issue 2013#2 10 3.2 contentious and advisory jurisdiction of the ccja as a supranational court, it has both contentious and advisory jurisdiction. at the contentious level, the ccja is the court of cassation for all the disputes related to the uniform law. national courts are familiar, at first instance and on appeal, with disputes relating to the application of the uniform acts. by way of appeal, the court shall rule on the decisions pronounced by the appellate courts with the exception of decisions applying criminal sanctions.47 it is seized either directly by one of the parties to the proceeding or on referral of the national court.48 the seizing of the court suspends all judicial proceedings before a national court with the exception of the enforcement procedures on penal sanction. the ccja may also be seized by the government of a state party or by the council of ministers of ohada. this in summary means that, on jurisdictional matters, the ccja gives its opinion on decisions taken on appeal in member states on any affair bordering on the application of uniform rules and regulations (except decisions involving penal sanctions). this is because the ccja has equaljurisdiction to recall and give a ruling when a dispute is brought to its attention. its decisions are binding on the entire territory of the member state.49 article 14(1) of the revised treaty provides that, “the ccja is responsible for the uniform interpretation and uniform application of the treaty, of the regulations promulgated to further the treaty's implementation, of the uniform acts, and of other actions”. that is the ccja ensures the interpretation and application of the treaty and the regulations taken for its implementation, the uniform acts and the decisions”. the article 14 specifically provides that: “the ccja will rule on, in the contracting states, the interpretation and enforcement of the present treaty, on such regulations as laid down for their application, and on the uniform acts. the court may be consulted by any contracting state or by the council of ministers on all questions falling within the field of the preceding paragraph. the right to request the advice of the court, as herein before mentioned, is recognised by the national courts hearing a case or litigation regarding the implementation of uniform acts 50 is settled in the first instance and on appeal within the courts and tribunals of the contracting states.”51 by virtue of article 20 of the ohada treaty, the judgments of the ccja are final and conclusive and their execution and enforcement shall be ensured by the member states on their respective territories. in no case may a decision contrary to a judgment of the ccja be lawfully executed in a territory of a member state. therefore the decisions of ccja have the 47article 14(3) of the revised treaty 48article 15 of the revised treaty 49 west african power sector regional regulation project diagnostic report on the institutional and regulatory of the ecowas regional electricity regulatory authority, july 2008 at 15-16 available online at www.erera.arrec.org/explainerdctemplatesite/.../downloadfile.aspx?...accessed, 19 july, 2013 50council of ministers of ohada, meeting in ouagadougou (burkina faso) on 11 march, 1999 adopted the uniform act on arbitration law and the rules of arbitration of the ccja. 51article 14(1) of the revised ohada treaty of october, 2008 nordic journal of commercial law issue 2013#2 11 flavour and authority of a final judgement of an international judiciary capable of immediate enforceability in each member state.52 the ccja therefore has the final and ultimate power as far as interpretation and application of the uniform acts are concerned, with the exception of judgements applying criminal sanctions of penalties which are governed by national laws of member states.53 though once a judgement is delivered, it is res judicata and no counter ruling on the matter may be executed in the territory of a contracting state.54 this means that the domestic authorities tasked with enforcement cannot go beyond the verification of the authenticity of the instrument presented for enforcement.55 it is observed that since the ccja decision is final, there is loss of judicial sovereignty by the member states. undeniably the supreme courts of the member states are technically bypassed in ohada matters when parties leapfrog from the courts of appeal to the ccja. indeed the national supreme courts have not taken this phenomenon kindly as evidence have it that some ohada cases are taken to the national supreme courts and neither these courts or the parties to the litigation are systematically referring such cases to the ccja.56 regarding the modality of the seizing of the ccja, an author wrote that, “it is through the preliminary ruling mechanism that national courts should seize the court”.57 the ccja has jurisdiction of final appeal with regard to all matters of business law falling within ohada’s scope of application except for criminal penalties, for which the national courts retain exclusive jurisdiction. this jurisdiction can be exercised only once the regular appeal proceedings have been exhausted before the national or domestic courts. an appeal to the ccja can be made in three different situations: the parties can directly file an appeal before the ccja against a decision of a domestic court once the regular appeal proceedings available in the domestic legal order have been exhausted. the appeal must be lodged within two months of service of the challenged decision. if the ccja overrules the decision of the national court, the case is remanded for de novo review(evocation a de novo). the parties can apply to the ccja to annul a decision of a domestic court that they suspect fell within the exclusive jurisdiction of the ccja. if the ccja decides that the domestic court lacked jurisdiction, its decision will be annulled by the ccja. the supreme court of a member state can stay the proceedings and refer the case to the ccja for a decision on subject-matter jurisdiction.58 if the ccja finds that it has no 52in each state party the enforcement seal is affixed to the judgments of the ccja, after checking the authenticity of the title, by an authority designated by the state government concerned. however, extraordinary remedies may be exercised against the judgments of the ccja; it concerns the third-opposition, the request for interpretation of the ruling or the request for review of the ruling. 53martha simon tumnde, et. al, above, note 5, at 49 54 ibid 55 renaud beauchard and mahutodji jimmy vital kodo, above note 19 at 12 56ibid, at 50. see also revised ohada treaty, articles, 14, 15 and 18 relating to the authority of the ccja. 57tristan gervais de lafond., “the treaty on the harmonization of business law in africa”, g. p. 20, and 21/09/1995, at. 2 58 articles 14, 18 and 15 of the revised ohada treaty nordic journal of commercial law issue 2013#2 12 jurisdiction to hear the case, the proceedings will resume before the domestic court but if the ccja quashes the decision of the national court, it performs through a process known as evocation a de novo review over the case meaning that the case will have to start all over under the ccja jurisdiction and issues raised will be considered afresh on it merit.59 the ccja, like many other regional judicial institutions, also provides advisory opinions upon request. the ccja can be seized for advisory opinions in three situations. it reviews draft uniform acts before the council of ministers votes on them. any member state or the council of ministers may request it to review the interpretation or an application of the treaty, regulations for applying the treaty or the uniform acts. again, a lower national court hearing a case regarding the application of ohada law or its interpretation can request an advisory opinion to assist it.60 article 14(2) of the treaty establishes the advisory role of the court. 4. challenges for the ccja the ccja has been described as unique in the world and no other court, not even the european union court of justice has as many powers and prerogatives as the ccja.61 on the african continent, such powers have been theoretical in nature and have not always translated into reality or practical application. in its judicial function the ccja is unique in this regard as well, while its arbitral function has been less successful.62 there are however significant problems that may undermine the exercise of its powers. first, the ccja is said to be severely understaffed despite a constant increase in its caseload63. as a result, the court has to deal with a significant backlog of cases hence the ccja, the council of ministers at its meeting in june 2011 tasked the permanent secretariat with finding external financial assistance and consulting with the national supreme courts to find a solution to the backlog problem.64 ohada institutions still face considerable budgetary constraints that hamper their ability to fulfill their function to apply the treaty’s uniform laws. 59renaud beauchard and mahutodji jimmy vital kodo, above note 19 at 13-14 60african international courts and tribunals (aict), “ohada ccja: court of justice of the organization for the harmonization of african business law”, available online at http://www.aictctia.org/courts_subreg/ohada/ohada_home.html, accessed 20 july, 2013 61 project of international courts and tribunals, “the common court of justice and arbitration (ccja) of the organization for the harmonization of business law in africa (ohada)”, available online at, http://www.pictpcti.org/courts/ohada.htm, accessed 27 july, 2013 62ibid 63renaud beauchard and mahutodji jimmy vital kodo, above, note 19, at 19 64ibid., see minutes of the meeting of the council of ministers of 16–17 june, 2011, available online at http://web.ohada.org/actualite-cm/fr/cmfj/actualite/3574,compte-rendu-de-la-reunion-du-conseil-des-ministres-de lohada-juin-2011.html. accessed 22 july, 2013 nordic journal of commercial law issue 2013#2 13 the total budget of ohada institutions for the year 2011 for example amounted to 4,257,612,181 cfa francs (about us$9.3 million), a budget that appears insufficient to fully support the existing bodies including the ccja across the board.65 the increase in caseload should also lead to a reconsideration of the budgetary procedures within ohada, taken in the aggregate, the fact that the court has rendered 500 to 600 judgments in the 12 years that the uniform acts have been in existence, also suffers from backlog issues points to some significant organizational flaws and performance problems that should be addressed by means other than simply requesting external assistance.66 second, making the ccja the cour de cassation instead of the member states’ supreme courts on all ohada issues has led to difficulties in administrative manageability and made backlogs an unavoidable problem. this choicedid remove the final interpretation of ohada law from the national judiciaries, which are often accused of capture by political forces and extractive interests, and of solving conflicts of interpretation of ohada provisions even before states review the matters. there is however a risk of causing jurisdictional conflict with domestic supreme courts which hampers the ccja’s manageability, and given the scarcity of resources becomes a critical problem.67 third, the rules of procedure contain no provision for fast-tracking or disposing off a case by a nonreasoned decision if it were to deem that the appeal, which is limited to a matter of legal interpretation, did not raise interpretative issues requiring a ccja decision. instead, article 26 of the rules of procedure requires that as soon as an appeal is lodged, the ccja president must appoint a judge to follow up the case management and report to the court. this is a provision under the rules of procedure that will encourage a build-up of large backlogs of cases instead of quick dispensation of such cases.68 fourth, according to beauchard and vital kodo, another problem regarding the success of the ccja may lie in the geographical origins of the appeals before the court, since an overwhelming number of appeals come from ivory coast, the seat of the ccja. for example, from its inception in 1998 to august 2003 the ccja in its supranational guise received 162 cases, with 57 from one year alone. in that time, the court issued 44 decisions and seven opinions. of the 162 cases, 116 were from the ivory coast.69 this can be explained in part by the consideration that côte d’ivoire is the most important economy among the member countries, with the likely corollary that business activity is a more important source of litigation there than in other member states. however, this statistics also suggests that many other potential litigants may be reluctant to pursue their claims due to the perceived cost of removing 65ibid 66 renaud beauchard and mahutodji jimmy vital kodo, above, note 19, at 20 67 ibid 68 ibid 69 project of international courts and tribunals, above, note. 59 nordic journal of commercial law issue 2013#2 14 the final appeal to the ccja in abidjan.70 beauchard and vital kodo further criticize that the procedure before the ccja is essentially a written and an oral hearing is very rare.71 appealing before the ccja requires residence in abidjan for the duration of the proceedings, including possibly for the attorney representing a non-ivorian party and/or a pro hac vice72 representation by an ivorian attorney.73 apart from the problems linked to its location the member states’ national courts are at times reluctant to accept the ccja’s supranational jurisdiction. lastly, the reluctance of attorneys to bring cases to the ccja from their home jurisdictions, is also due in part to the inadequate legal understanding of the workings of the ohada treaty, the ccja and the uniform act. therefore there is the need to educate attorneys and others in the legal community of the workings of the ccja, the uniform acts and the treaty. in dealing with this challenge, the ohada has also created a regional training center for legal officers (ersuma).74 ersuma trains judges and other legal officers, including lawyers, notaries and bailiffs, as well as academics and businessmen in ohada law. with this training, the use of the ccja should be expanded as members of the legal communities outside of the ivory coast become more familiar with the ccja and its jurisprudence and this has become a significance of the ccja in developing awareness about the ohada law.75 70 see claire moore-dickerson, “harmonizing business laws in africa, ohada calls the tune,” columbia journal of transnational law 44, no. 1 (2005): 57–58 71 see article 34 of the regulation organizing the proceedings before the ccja, available online at http://www.institut-idef.org/-chapitre-iii-de-la-procedure-orale-.html. accessed 22 july, 2013 72 latin for "this time only," the phrase refers to the application of an out-of-state lawyer to appear in court for a particular trial, even though he/she is not licensed to practice in the state where the trial is being held. the application is usually granted, but sometimes the court requires association with a local attorney. (see the free dictionary, available online at http://legal-dictionary.thefreedictionary.com/pro+hac+vice, accessed 23 july, 2013). it is a latin phrase "for this occasion" or "for this event" (literally, "for this turn"), is a legal term usually referring to a lawyer who has not been admitted to practice in a certain jurisdiction but has been allowed to participate in a particular case in that jurisdiction. 73 article 23 section 1 rules of procedure provides that representation by an attorney is mandatory. article 28(3) provides that the parties must elect domicile where the court has its seat. 74 article 41, revised treaty on the harmonisation of business law in africa, adopted on the 17 october, 2008 in quebec, canada. available online at http://www.ohada.com/traite-revise.html accessed 23 july, 2013 75renaud beauchard and mahutodji jimmy vital kodo, above, note 19, at 20 nordic journal of commercial law issue 2013#2 15 5. the role of the ccja in africa 5.1 the significance of the ccja despite the challenges encountered by the ccja in its almost two decades of existence, the court has also made some significant progress in advancing the concept of regional integration in africa. the court have assisted in the development of uniform business law among the contracting state parties through ohada treaty; it has served as an alternative avenue for the settlement of commercial disputes apart from the national court and serves as the supreme court in all cases involving the interpretation and application of ohada treaty among the contracting state parties. the interpretation of the ohada treaty and uniform act of arbitration have led to the development of uniform business in law in ohada member states. the decisions of the court will help to encourage uniformity in the law applicable in member states as regards private business investment and contract law. this is exemplified in the court’s advisory opinion no. 002/99/ep of october 13, 1999, where the ccja confirmed the principle of direct applicability and the repealing effect of the treaty and unified acts over domestic law by asserting that article 16 of the malian bill derogates from article 39 of the unified act because it enacts new, compulsory and restrictive requirements for the debtor to benefit from the grace period and is therefore contrary and inconsistent with article 39 of unified act on simplified recovery procedures and enforcement measures. the court has been able to assert the supremacy of ohada law over national law in order to ensure uniformity in its application in member states. the ccja has afforded and opportunity of an alternative arbitration avenue for settlement of commercial disputes apart from relying on national courts of justice. this is because the parties to a contract have the opportunity to choose to submit their dispute to the ccja provided at least one of them is domiciled in an ohada member state, or the relevant contract provides for its partial or entire execution within one or several ohada member state(s). in this case, the seat of the arbitration must not necessarily be located within an ohada member state. this reinstates confidence among business men and investors as to legal security and certainty of their transactions in member states of ohada. as a follow up to the above advantage, when acting in it arbitral capacity, the ccja will for instance be in charge of appointing or revoking arbitrators and examining arbitration awards, and of verifying the compliance of the arbitration with the ohada arbitration regulation. arbitral awards rendered accordingly are nordic journal of commercial law issue 2013#2 16 enforceable in any ohada member state subject to the granting of an execution judgement by the ccja which has sole competence in this matter.76 one of the greatest successes of the ccja, is that it serves as the supreme court in supranational capacity and as the court of final arbiter or last resort for the ccja members states after which no further appeal will lie on the interpretation and application of ohada business law. in describing the function of the ccja, article 14(1) and (2) of the ohada treaty states: «the common court of justice and arbitration will rule, in the contracting states, on the interpretation and enforcement of the present treaty, on such regulations as laid down for their application, and on the uniform acts"...., to realize such a function: the court may be consulted by any contracting state or by the council of ministers on all questions falling within the field of the preceding paragraph. the right to request the advice of the court, as herein before mentioned, is recognised to the national courts” “when hearing a case in first or second instance where the application of ohada law is concerned.77 with reference to the authority of the ccja jurisprudence; article 20 states: the judgments of the common court of justice and arbitration are final and conclusive. in no case may a decision contrary to a judgment of the common court of justice and arbitration be lawfully executed in a territory of a contracting state. “the most significant characteristic of the ccja can be found in the last paragraph of article 14 which state, "while sitting as a court of final appeal, the court can hear and decide points of fact".78 as stated earlier, the ccja has been described “as unique in the world and that no other court, not even the european court of justice has as many powers and prerogatives as the ccja”.79 the ccja is a supranational judicial body with jurisdiction over the courts of appeal in member states, its decisions overriding even those of national supreme courts. it is, moreover, the final authority on the interpretation and enforcement of the ohada treaty. the ccja therefore plays a vital role in the uniform application of ohada laws.80 76norton rose fulbright, “the democratic republic of congo joins ohada july,” http://www.nortonrosefulbright.com/knowledge/publications/69441/the-democratic-republic-of-congo-joinsohada, accessed 23 july, 2013 77 mancuso, salvatore, "the new african law: beyond the difference between common law and civil law," annual survey of international & comparative law: vol. 14: iss. 1, article 4. 2008, at 50-51. available online at:, http://digitalcommons.law.ggu.edu/annlsurvey/vol14/iss1/4 accessed 26 july, 2013 78 ibid. 79project of international courts and tribunals, above, note 62 80sherif el saadani, “communication : ohada, a continent-wide perspective”, at 487, available online at http://www.unidroit.org/english/publications/review/articles/2008-1&2/485-488.pdf, accessed 26 july, 2013 nordic journal of commercial law issue 2013#2 17 5.2 innovative modes of appeal not common to other regional judiciaries the ccja has an enviable three avenues of appeal not common with other sub regional economic court. an appeal to the ccja can be made in three different situations: first, the parties can directly file an appeal before the ccja against a decision of a domestic court once the regular appeal proceedings available in the domestic legal order have been exhausted.81 secondly, the parties can also apply to the ccja to annul a decision of a domestic court that they suspect fell within the exclusive jurisdiction of the ccja.82 if the ccja decides that the domestic court lacked jurisdiction, its decision will be annulled by the ccja. thirdly, the supreme court of a member state can stay the proceedings and refer the case to the ccja for a decision on subject-matter jurisdiction.83 if the ccja finds that it has no jurisdiction to hear the case, the proceedings will resume before the domestic court. these modes of appeal are innovative and truly rare.84 with the adoption of ohada treaty and the creation of the ccja, legal professionals have propagated ohada norms to the applicable african society essentially through the intermediary of the legal profession. the mechanisms through which lawyers have brought the knowledge and changes of ohada law to the society have to do with the regular application of law namely through consulting clients in their contractual relations and through preparing legal briefs based on ohada law for presentation on behalf of the clients at the ccja. finally both of these have led to a general formalisation of business relations that entails an increase in legal certainty and business trust.85 the creation of the ccja has led to the stability of the judicial system among the ohada member states because the courts of first instance and courts of appeal have primary responsibility in application of ohada treaty while the ccja has the supreme responsibility of supervising the interpretation and application of community laws uniform acts, on which the national supreme courts cannot rule. moreover, the possible over ruling or upturning of the judgements handed down by national courts of appeal by the ccja will discourage these national courts of member states from derogating in applying treaty provisions and its uniform 81 article 14 of the revised ohada treaty 82article 18 of the revised ohada treaty 83 article 15 of the revised ohada treaty 84 renaud beauchard and mahutodji jimmy vital kodo, above, note 19, at 11-12 85 gustav kalm , building legal certainty through international law: ohada law in cameroon, the roberta buffett center for international and comparative studies northwestern university working paper series no. 11005 october 2011at. 18. available online at http://www.cics.northwestern.edu/ documents/workingpapers/buffett_11-005_kalm.pdf, accessed 24 july, 2013 nordic journal of commercial law issue 2013#2 18 act. the ohada therefore ensures a certain reliability of the judicial system in member states through the activism of the judges of ccja.86 apart from the general assertion that the ccja has helped in the development of uniform business law in member states, akin akinbote has noted a positive impact on arbitration among ohada and ecowas87 states, which also fills the gap created by the absence of an ecowas arbitration tribunal. he suggested that the harmonisation of the functions of these judicial institutions is achievable and should be part of harmonisation process of business laws in ecowas states. co-operation between the various institutions of the two organisations is essential if any meaningful achievement is to be made in this regard. even where the functions overlap, it should not lead to usurpation of the functions of one by the other.88 6. conclusion since its adoption the ohada treaty has worked to realise the unification of business law in the member states and removed fear of uncertainties from business investors. also the several uniform acts which have been adopted and entered into force, have set new rules of law for economic activities among ohada states and have also formed what is now part of the legal corpus of each member state. the ccja is very important and innovative mechanism which lies at the heart of the ohada system. the supranational nature of the court has made it to play an invaluable role in realising the aims and objectives of the founding fathers of the organisation. the adoption of modern, known and unified laws, as well as the creation of a common supreme court, has certainly made it possible to considerably improve the legal and judicial environment for business within the ohada zone in favour of international investors. national persons before the courts are also benefiting considerably from this improvement.89 since its establishment, the court has passed through several challenges but these challenges 86see norton rose, above note 20, at.8.the reliability of the judicial system under the ccja can for example be illustrates by the protection given by ohada to international investors. in a civil case decided by the court of appeal in ndjamena, the national creditors had carried out debt seizures on the bank account of a foreign investor. these accounts had previously been secured in favour of international financial institutions. the seizures therefore threatened the financial equilibrium of a major project. by application of the provisions of the uniform act on securities law, the court of appeal upturning the ruling by the court of first instance ordered the reversal of these seizures by virtue of the principle that duly registered pledge contracts are opposable vis-à-vis third parties the court hence applied the uniform act on securities in favour of international investors and financiers over the uniform act on enforcement measures, the application of which would have benefited the nationals. (see the civil decision of the court of appeal of ndjamena, no. 001/05 of 28 january 2005). 87 economic community of west african states currently with 15 member states available at http://www.ecowas.int/?lang=en, accessed 2 january, 2014. 88akin akinbote, “ohada treaty and law by anglophone states”, available online at, http://www.nigerianlawguru.com/articles/international%20law/ohada%20treaty%20and%20law%20 by%20anglophone%20states.pdf, accessed 27 july, 2013 89see norton rose, above note 21, at.10 nordic journal of commercial law issue 2013#2 19 have been surmounted by the successes recorded as a result of foresight and wisdom of the treaty drafters and the vibrant activities of the judges appointed to adjudicate over disputes instituted in this court over the years. to sum it up, out of the four institutions established by the ohada treaty, the ccja is the one that best encapsulates the organisations ambitious goals by virtues of the scope and specificity of its jurisdictional powers. it occupies a strategic position in the overall process of legal and judicial reforms for business development among the member states.90 90rudolf v. van puymbroeck, (ed), comprehensive legal and judicial development: towards an agenda for a just and equitable society in the 21st century, washington dc: world bank, 2001, at. 419 microsoft word hoffren_mia.doc nordic journal of commercial law issue 2011#1 contractual rights and third parties: a unified perspective of the law of property and the law of delict by mia hoffrén nordic journal of commercial law issue 2011#1 1 1 introduction 1.1 a conflict in this article i will discuss a conflict between two persons who – at first – had nothing to do with each other. let us call them promisee and transferee. their conflict arose because they were interested in the same piece of property and consequently they had dealings with the same third person, the owner of the said piece of property. promisee was there first. promisee had entered into a contract with the above mentioned third person – promisor. the contract concerned an object that promisor owned. according to the contract, promisee had a right in that property. his contractual right might be, e.g., a right of use or a right of pre-emption. after entering into the contract with promisee, the promisor sold the piece of property to transferee, who – at the time of the sale – knew of promisor’s duties arising from the contract with promisee. after the sale, promisee wanted to exercise his contractual right – e.g., to use the object or to buy it according to the terms of his right of pre-emption – while transferee, as owner of the object, was not willing to let him do it. is promisee entitled to exercise his contractual right in the property despite the subsequent sale to transferee? if not, is promisee entitled to a monetary compensation from transferee for the right which he has lost due to the sale?1 1.2 the traditional view a traditional answer to a conflict of rights concerning the same piece of property is to classify rights as property rights on the one hand and personal rights on the other. according to the traditional theory, property rights are binding on third parties, while mere personal rights are not. if the promisor’s right is a property right, it is enforceable against transferee. if it is not, it will not affect transferee, even if he knew of it at the time of the transfer.2 giving priority to transferee might be rational, if he did not know of promisee’s prior right at the time of the transfer. however, if transferee knew of promisee’s right, this traditional rule 1 the issue is discussed in detail in hoffrén (2008). 2 see, e.g., terré & simler (2002), 52–54 and fikentscher (1985), 42–46. nordic journal of commercial law issue 2011#1 2 leads to outcomes that are neither efficient nor fair. why should we give priority to the transferee, while the promisee was there first and the transferee was the one who would have been able to prevent the conflict of rights? 1.3 a fair and efficient solution given the lack of efficiency and fairness of the traditional rule, it is not a surprise that this rule is not strictly followed in finland or in other european jurisdictions. roughly, the alternatives to this traditional rule can be divided in three. first, the traditional rule can be kept as a main rule and then exceptions to it can be made. second, the core of the traditional rule can be kept, but its details altered. third, the traditional rule can be rejected. german law is a model example of the first alternative. property rights (dingliche rechte) are good against all, while mere personal rights (forderungen) do not have effect on third parties. there are two kinds of exceptions to this rule: first, some obligatory rights are, according to specific legislation, protected against third parties. for instance, a tenant of a rented apartment is protected against a transferee (bgb § 566), and certain personal rights can be registered in order to achieve protection against third parties (bgb § 883). second, under some circumstances, third parties have been held liable for damages if they interfere with a contract between a promisee and a promisor. according to bgb § 826, a person who, in a manner contrary to public policy, intentionally inflicts damage on another person is liable to the other person to make compensation for the damage.3 however, as a rule, third parties are not required to take other people’s contracts into account.4 liability in damages is an exception restricted to cases where, taking into account all circumstances, the conduct of the interfering party is considered as immoral. for example, an agreement to indemnify the promisor for liability that she might incur in breaking her earlier contract is an element that could be indicative of immoral conduct.5 in france, the traditional rule has been altered. art 1165 code civil provides that contracts have effect only between parties to them and that they impose no burdens on third parties.6 in 1800’s, courts did not find interference with contract culpable.7 this stand started to change 3 ”wer in einer gegen die guten sitten verstoßenden weise einem anderen vorsätzlich schaden zufügt, ist dem anderen zum ersatz des schadens verpflichtet.” 4 see, e.g., larentz & canaris (1994), 405 and palandt (2006), 1280. 5 bgh njw 1981, 2184. 6 “les conventions n'ont d'effet qu'entre les parties contractantes; elles ne nuisent point au tiers, et elles ne lui profitent que dans le cas prévu par l'article 1121.” 7 see, e.g., palmer (1992), 304–305. nordic journal of commercial law issue 2011#1 3 when an employer was held liable in damages for hiring away another’s employee.8 after that, similar decisions were given also in disputes concerning other types of contract.9 nowadays, it is commonly accepted that third parties can not ignore legal consequences of contracts. knowingly interfering with an existing contract is actionable.10 in finland, a sharp division between property rights and personal rights has been rejected. rights can be binding on some third parties and not binding on others.11 according to legislation, registrable rights to real property bind subsequent buyers of the property, even if they are not registered, if the buyer knew or should have known of them at the time of the purchase.12 even rights that are not registrable will bind a purchaser who knew of them at the time of the transfer.13 rules for movable property are not so clear, since they are not laid down in legislation. on the one hand, the supreme court has given some decisions in which contractual rights are not considered binding on subsequent purchasers with knowledge of them.14 on the other hand, a rule, according to which a contractual right should bind a transferee who knows of it at the time of the transfer, has gained support in legal literature.15 all the above-mentioned alternatives have something in common. there exists a number of rights – call them property rights or not – which are effectively protected against subsequent transferees. other rights enjoy a more limited protection. in this article, this starting point is taken as given and not called into question. furthermore, rules of defining which types of rights are property rights and which are not, vary from one jurisdiction to another and are not considered in this article. here, it is assumed that a number of contractual rights which are not prima facie binding on subsequent transferees exist and that promisor’s right belongs to that group. this article concerns the protection of rights which are not prima facie binding on transferees, specifically their protection against transferees who have knowledge of them. consequently, protection of contractual rights against transferees who do not know of them at the time of the transfer falls outside the scope of the article. as seen above, the conditions and the scope of protection differ in different european countries. conditions differ in that sometimes mere knowledge of a 8 cour de cassation, chambre civile, 27 mai 1908. 9 see, e.g., palmer (1992), 303. 10 see, e.g., terré & simler (2002), 55, terré, simler & lequette (2002), 484–485 and wiederkehr (2004), 1008. 11 see, e.g., zitting (1951), 83 and tuomisto (1993), 45–47. 12 maakaari (code of real estate) 3:7.1 and 13:3 §§. 13 maakaari (code of real estate) 3:8 §. 14 most recent cases are kko 1999:111 and kko 2002:58. 15 see, e.g. tuomisto (1993), 127–136, tammi-salminen (2001), 180–182 and niemi (2002), 6–7. it has been suggested that protection should be denied only from rights that are considered undesirable from a social and economic perspective. nordic journal of commercial law issue 2011#1 4 previous contractual right is deemed sufficient for protecting it, and sometimes more is required. the scope of protection differs in that the prior right can be binding on the transferee or the transferee may only be liable to pay damages if he interferes with the prior right. in this article, i will discuss the appropriate conditions and scope of the protection independently from specific statutory rules of any jurisdiction. i will suggest a resolution of the conflict described above, which is both efficient and fair. first, in section 2, i will introduce the theoretical framework used. in section 3, i will argue that there are no grounds for denying promisee protection, if transferee knew of promisee’s contractual right at the time of the transfer. therefore, contractual rights should be protected against transferees with actual knowledge of them. in section 4, i will point out some problems that enforcing a contractual right against a transferee who is not a party to the contract could present. due to these problems, the best way to protect promisee’s contractual right in most cases is to hold transferee liable in damages for interfering with the contract. the results are summarized in section 5. 2 the law of property and the law of delict from a unified perspective 2.1 different fields of law consider different questions as a rule, the law of property and law of delict are conceptually separate. those interested in the law of property and those interested in the law of delict may sometimes search answers to same conflicts – but find different answers, because the answers to be found on a given issue in these different areas of law are different. in order to find the best answers, these two subject areas have to be unified. i have described a conflict between a contract promisor and a transferee. facing this conflict, a scholar interested in the law of property – at least a finnish one – asks: is promisee’s right binding on transferee? one interested in the law of delict might ask if transferee is liable to damages for interfering with the contract. the problem with asking these questions separately is that the answers to these questions should be interdependent. it is easy to see that if the right is binding on transferee, there is usually no need for liability for interference, because promisee suffers no harm due to the transfer. a less obvious observation is that the interdependency works also the other way around: if there is liability in damages, it is not so crucial for promisee that his right is binding on transferee. therefore, the two questions raised by this conflict should be discussed from a unified perspective. we should not ask separately, if the right is binding on the transferee and if the transferee is liable in damages. if we do, we find separate answers which may be incompatible. to find an answer to the problem instead of answers to two separate questions, we need better questions. to find better questions, i will utilize a framework created by calabresi and melamed. nordic journal of commercial law issue 2011#1 5 2.2 property rules and liability rules calabresi and melamed have pointed out that in any given dispute between two people with conflicting interests it has to be decided (1) which party is to be favored and (2) what kind of protection is to be granted to the favored party’s entitlement. an entitlement can be protected by a property rule, a liability rule or an inalienability rule. since the inalienability rule16 is not relevant here, only the property rule and the liability rule will be elaborated below. if an entitlement is protected by a property rule, its holder can lose it only through a voluntary transaction. if it is protected by a liability rule, it can be taken away against holder’s consent if an objectively determined value is paid to the holder.17 in our setting, the first question (“which party to favor”) means asking if promisee has any remedy against transferee. answered in the affirmative, the second question (“what kind of protection”) means asking if transferee must permit promisee to exercise his right according to the contract despite the transfer (property rule) or if promisee is denied the exercise of his right, but entitled to a payment of damages by transferee (liability rule). this situation can be illustrated with an example. promisee and promisor have agreed that promisee has a right to use the object for a fixed period of time. promisor sells the object to transferee. if we decide to favor transferee, transferee can prevent promisor from using the object and promisee can do nothing about it. if we decide to favor promisee, we still need to decide how to protect his entitlement. if we choose a property rule, promisee can use the object despite the fact that it has been sold to ttransferee. if we choose a liability rule, transferee can prevent promisee from using the object, but transferee will be liable for damages. answering two questions gives us a solution to the conflict in question: (1) is promisee protected against transferee who has knowledge of his contractual right and, answered in the affirmative, (2) should promisee be protected by a property rule or a liability rule. below, in sections 3 and 4, the questions are answered. 3 why protect promisee’s right? 3.1 why not? as noted above, favouring transferee who knows of promisor’s pre-existing right at the time of the purchase seems to be neither fair nor efficient. however, there are arguments in favour of 16 the inalienability rule means that the sale of the entitlement in question is not allowed (calabresi–melamed 85 harv. l. rev. 1089 (1972), 1111–1115). 17 calabresi–melamed 85 harv. l. rev. 1089 (1972), 1092. nordic journal of commercial law issue 2011#1 6 not protecting all contractual rights in property against subsequent transferees. in short, it has been argued that (1) promisee does not need protection against transferee; (2) promisee does not deserve protection against transferee; (3) protecting promisee would have undesirable effects; and (4) protecting promisee would create undesirable incentives. below, i will discuss these arguments and demonstrate why they are not sufficient grounds for denying the promisee protection against a transferee with actual knowledge of his right. 3.2 promisee needs protection promisee’s need for protection against transferee has been called into question. first, it has been argued that promisor is responsible for complying with the terms of the contract between him and promisee, and that promisor’s liability provides for sufficient protection for promisee.18 second, those rights which fall outside the category of property rights are considered to be of little importance.19 third, it has been suggested that it is not worthwhile protecting a right against one person if the right is not protected against all.20 these arguments are not convincing. it is true that promisor is liable for breach of contract, if promisee can not exercise his contractual right due to the sale of the object to transferee. however, promisor’s liability is inadequate. it is highly probable that, despite promisor’s liability, promisee will not receive any compensation from him. promisor might be insolvent or at least reluctant to pay. given the circumstances – promisor has entered into inconsistent contracts – promisor does not seem to be a very reliable debtor. even if promisee was to receive compensation from promisor, the compensation might not cover all his losses. due to the transfer of the object, the promisor is incapable of specific performance and promisee is merely able to sue him for damages. true, the aim of contract damages for breach is to put the promisee in the position in which he would have been had the promisor fulfilled his contractual obligations. due to both legal and practical reasons, the compensation is likely to fail to achieve that aim. first, all disadvantages for promisee are not considered as compensable damage. second, promisee might not be able to prove the damage in court.21 18 see, e.g., hemmo (1998), 107, perlman 49 u. chi. l. rev. 61 (1982), 92–93 and cane (1996), 124–125. 19 see, e.g., hessler (1973), 82. 20 see, e.g., lohi (2003), 201 and håstad (2000), 441. 21 see, e.g., calabresi–melamed 85 harv. l. rev. 1089 (1972), 1108, schwartz 89 yale l. j. 271 (1979), 275–276, epstein 16 j. legal stud. 1 (1987), 37–38 and craswell 61 s. cal. l. rev. 629 (1988), 637. nordic journal of commercial law issue 2011#1 7 of course, if transferee was – according to a liability rule – merely liable for damages, the liability of transferee would not solve the problem of damages being inadequate. still, protection against transferee could provide for compensation if promisor was insolvent. there is a fundamental weakness in the argument which suggests that all rights of importance are already protected as property rights and rights falling outside that category do not need protection. that argument is based on a static view of exchange and contracts. it seems to assume that all relevant contractual rights have been taken into consideration when legislation has been given and rights have been classified as property rights or other rights. such a view fails to acknowledge that new types of contractual rights can and do arise, and it is very difficult to take these rights into account in advance, before conflicts have already arisen. even after it has been noted, that a specific right has become both significant and widely used, legislator might not act immediately – or at all.22 furthermore, a suggestion that contractual rights should be protected either merely against the promisor or against the world can be supported by claiming that if a promisee would be protected against the promisor and transferees with knowledge, the protection would be so weak and uncertain that it is not at all worthwhile.23 true, promisee would still risk losing his contractual right due to promisor’s insolvency or a transfer to a bona fide transferee. however, this does not mean that promisee does not need protection against transferees with actual knowledge. if conflict between promisee and transferee has arisen, it is important for promisee to be protected in that particular relation. if promisee loses the conflict, he will find no comfort in the fact that he could have lost his right also in promisor’s insolvency.24 3.3 promisee deserves protection despite promisee’s need for protection, it has been claimed that he does not deserve protection because he has knowingly and perhaps negligently taken a risk of losing his right. his dealings are risky since 22 a good example is a leasing contract. leasing contracts have become widely used, are often long-term and involve considerable economic interests. still, the legislator has not granted protection against third parties to the rights arising from a leasing contract. this problem has been noted both in finland and in sweden. see, e.g., tepora (1999), 287–291, hessler (1973), 300–303 and håstad (2000), 434–438. 23 see, e.g., lohi (2003), 201 and håstad (2000), 441. 24 see, e.g., forssell (1976), 113. nordic journal of commercial law issue 2011#1 8 (1) he has chosen to enter into a contract, even if he knows (or should know) that his contractual right is not binding on third parties and can thus be lost due to a subsequent transfer25; (2) he has failed to protect his contractual right in an appropriate way26; or (3) he has chosen an unreliable contracting party27. the first argument can be dismissed as circular reasoning: promisee has entered a contract despite the fact that his contractual right will not be protected against third parties. if we decide for a rule according to which contractual rights are in fact protected against third parties, this statement becomes false. when promisee’s right is protected, the same circular reasoning could be applied to transferee: transferee has purchased the object despite the fact that promisee’s right will be binding on him. the claim that promisee has failed to protect his right requires some elaboration. in some cases, rights are binding on subsequent transferees only if they are registered or some other measures have been taken to make them public. e.g. in finland, an agreement of a real estate lien is binding between the parties, but the lien will become complete and protected against all other people only after certain legal formalities have been met.28 it has been discussed if an agreement of a lien should be protected against transferees with knowledge even if the lien is not yet complete. the answer according to the legislation is negative: if a creditor is so careless that he lends money before the formalities are fulfilled, he is not protected against third parties.29 there is some sense in not protecting someone who has acted carelessly. it is a part of the basic structure of private law that those who have acted negligently should suffer the consequences of their own negligence. negligence of an injured party is often a sufficient reason for eliminating or at least limiting the liability of a tort-feasor.30 however, to estimate the consequences of promisee’s assumed negligence we will have to look into the actions of transferee. transferee knew of promisee’s right at the time of his dealing with promisor. he knowingly and willingly entered into a sales contract which was to give rise to a conflict. it is often suggested in legal literature that the negligence of an injured party should lack significance, if the wrong-doer 25 see, e.g., kartio xxx oikeustiede–jurisprudentia 152 (1997), 159–163. 26 see, e.g., kaisto (1997), 19, jokela, kartio & ojanen (2004), 482 and tammi-salminen (2001), 172. 27 see, e.g., hemmo (1998), 108 and howarth m. l. rev. 68 (2005) 195, 206. 28 a real estate lien is raised by creating a mortgage over the real estate and handing the mortgage instrument over to the creditor as security for a debt (maakaari (code of real estate) 15:2.1). 29 this argument, brought up in the preparatory works for legislation (he 120/1994, 111), has been vigorously criticized by erkki havansi, according to whom bad faith should not be favoured (see, havansi (1996), 93–97). 30 according to vahingonkorvauslaki (tort liability act) 6:1, “if there has been a contribution to the injury or damage from the side of the person sustaining it – – the damages may be adjusted as is reasonable”. (translation at http://www.finlex.fi/fi/laki/kaannokset/) nordic journal of commercial law issue 2011#1 9 has caused damage willfully.31 this is reasonable, since the negligence of the injured party only gives the wrong-doer an opportunity to cause damage, and he is free to decide if he causes damage or not. the same is not true if the wrong-doer is only negligent: then the negligence of both parties increases the probability of damage, and it can not be said that only one of them caused it. thus, in a conflict between promisee who has acted carelessly and a transferee who has acted willfully, it is fair to protect the one who has been “only” careless. despite the carelessness of promisee, transferee could have chosen not to enter into an incompatible sales contract. had he not known of the pre-existing right, the situation would have been different: then he would not have chosen to cause a conflict of rights but it would have arisen accidentally. moreover, since transferee knew of the pre-existing right, it becomes irrelevant, that the right was not appropriately made public. the purpose of registration of rights is to make them visible to affected third parties and to prevent unpleasant surprises that could arise if secret rights were binding on subsequent purchasers and other third parties. in this case, the pre-existing right was visible to transferee and the conflict of rights was not a surprise to him. the purpose of registration is in fact met in our setting, so the defect in formalities should not have relevance. the argument based on choosing an unreliable contract party can be criticized on the same grounds as the argument based on failing to fulfill formalities. even if promisee has chosen an unreliable contracting party, transferee’s intentional interference is more blameworthy. furthermore, promisor’s breach of contract would not have beem so detrimental to promisee had the transferee not interfered. without the transfer, promisee would have been able to claim specific performance from promisor. only after the transfer did it become impossible. in sum, even negligent promisee deserves protection against transferee who knowingly interferes with his contract with promisor. 3.4 protection does not necessarily have undesirable effects protection against transferee could have harmful effects since contractual terms which have been negotiated between promisee and promisor would not be appropriate between promisee and transferee. the harm for transferee for being bound by promisee’s right could exceed the harm that promisee would suffer if he was to lose his right. in such cases, enforcement of promisee’s contractual right against transferee would lead to an inefficient outcome. one conceivable solution to this problem is a contract between promisee and transferee. if promisee’s right would be so harmful to transferee and not so important to promisee, 31 see, e.g., saxén (1975), 126, hemmo (2005), 208 and epstein 16 j. leg. stud. 1 (1987), 28–29. nordic journal of commercial law issue 2011#1 10 transferee could buy out the promisee.32 however, achieving an agreement could be difficult in such a conflict since transferee would try to negotiate as low a price as possible. negotiations are made more difficult by the fact that there is a bilateral monopoly: neither promisee nor transferee needs to be afraid for competition, if they do not reach an agreement. both parties have thus incentives to use resources to reach as good a deal as possible.33 the problem with avoiding the above-mentioned problems by denying the promisee protection is that we can not know in advance, how important a certain right is to promisee and how harmful to transferee. thus, if we decide not to protect any other rights than rights in rem, we end up denying protection also from rights which benefit promisee more than they harm transferee. then, transferee and promisee would again have to reach an agreement in order to achieve an efficient outcome. this shows us that an efficient outcome can not be reached simply by denying protection from all rights which fall outside the category of rights in rem. luckily, the problem can be avoided by choosing a suitable way to protect promisee. if transferee is not bound by promisee’s right but is only liable in damages, the problem described above does not emerge. if transferee has to compensate promisee for his losses, he will accept promisee’s right as binding on him if he would have to pay more compensation than what it is worth to him not to be bound by it. respectively, transferee would prevent promisee from exercising his right, if and only if, losses caused to promisee and compensable by transferee would be inferior to transferee’s gain. i will return to this possibility below in section 4. 3.5 protecting promisee creates good incentives last, i will consider incentives that protecting promisee would create. it is commonly held that protection of pre-existing rights against transferees can make exchange more difficult and increase transaction costs. if transferees were bound by pre-existing contractual rights, they would need to use time and other resources to find out about other people’s rights before they could enter into sales contracts. besides generating these costs, protecting contractual rights against third parties would prevent so-called efficient breaches, i.e. breaching a contract when promisor would gain from the breach more than promisee would lose.34 the argument on transaction costs is not plausible when we discuss rules in conflicts where transferee knew of the prior contract at the time of the purchase. undoubtedly, even then it 32 this solution goes back to coase who has emphasized the possibility to modify legal rights by market transactions (3 j. law & econ. 1 (1980)). 33 see, e.g., epstein 106 yale l. j. 2091 (1997), 2094 and krier & schwab 70 n.y.u.l. rev. 440 (1995), 460–462 34 see, e.g., posner (1998), 145–146 and perlman 49 u. chi. l. rev. 61 (1982), 82–83. nordic journal of commercial law issue 2011#1 11 could prove costly to find out the precise terms of the contract between promisor and promisee. however, this is not a sufficient ground for denying promisee protection, since these costs are ultimately borne by promisor and thus internalized. this needs elaboration. on economic terms, transaction costs caused to third parties due to a contract between two people are a problem since they are external costs and the contracting parties do not have incentives to avoid them. merril and smith have illustrated this with an example of “monday watches”. monday watch is a watch which its owner is allowed to use on every day of the week but monday. on mondays, right of use belongs to an other right-holder. if people dealing with watches know that there are monday watches on the market, they would have to find out about owner’s exact right every time they purchase a watch. this extra transaction cost would affect the price of all watches and thus everyone who is trying to sell a watch – not only those, who actually sell monday watches. this is a sound reason for not protecting third party rights against bona fide purchasers.35 the same does not apply, if the right-holders’ right is only binding on those transferees who know that they are buying a monday watch. that rule would not generate external costs because people who are not (or do not know that they are) dealing with monday watches would not have to be afraid of secret third-party rights and use resources to make sure that such rights do not exist. only those who knowingly buy monday watches would incur transaction costs for investigating the details of third-party rights. these transaction costs would affect the price of monday watches and thus be borne by those who own monday watches, i.e. people who have given away “monday rights” to their watches.36 were these people rational, these internalized costs would affect their decision to sell monday rights and thus affect also the price of monday rights. if transaction costs would be too high, monday rights would not exist. since the transaction costs are internalized, they do not cause a problem of two people being able to burden others by their contract. efficient breach is a controversal issue. some scholars argue that legal rules should encourage efficient breaches i.e. breaching a contract when promisor’s gains from breach outweight losses promisee incurs. for example, a certain object which a owns is worth 90 € to a and 110 € to b. a and b have entered into a sales contract for a price of 100 €, but the object has not been delivered to b. after that, c is willing to buy the object from a and pay 150 €. proponents of efficient breach theory suggest that a should be allowed to breach the contract with b, sell to c and compensate for b’s losses since this would lead to an efficient allocation of resources: all parties involved would be at least as well off as they would have been had the contract not been breached. a and c would be better off because a got more money and c got the object he 35 merrill & smith 110 yale l. j. 1 (2000), 27–34. 36 merrill & smith 110 yale l. j. 1 (2000), 30. nordic journal of commercial law issue 2011#1 12 wanted. b would be in the same position as if he had gotten the object according to the contract if he receives full compensation for his losses.37 there is an evident shortcoming in the theory. why should a and c have all the gains from the breach? should not c go to the first buyer, b, and buy the object from him? a contract between b and c is a more efficient and more fair solution than a breach of contract between a and b and a new contract between b and c. it is more efficient because it does not generate transaction costs which would follow from dispute over a’s breach of contract.38 it is more fair because it gives gains from the latter transaction to b. after all, when contracting of the sale and sales price with a, b has assumed the risk of changes in prices. if the price of the object had sunk, b would still have paid the contract price to a. if the price had risen – as it in this case did – b should have the gain. however, the theory of efficient breach is somewhat more plausible if b and c are not interested in the exactly same right. for example, a owns an object, b has a right to use it and c is willing to buy it and use it himself. in such a setting, c would not be able to contract with b since b does not own the object. if b’s use right would be binding on transferee, c would have to reach an agreement with both a and b in order to become owner and be allowed to use the object. if b’s right was not binding on a transferee, the transaction would be easier: c would have to negotiate only with a. as noted above, in a bilateral monopoly like this between new owner c and right-holder b, it could prove difficult to reach an agreement even though it would be beneficial to both parties. luckily, this too is a problem which can be solved by choosing an appropriate remedy. i will return to this issue in section 4. favouring efficient breaches by not protecting promisee against transferee would create problems since under some circumstances also “inefficient breaches” would be encouraged. parties are encouraged to efficient breaches if and only if promisee is to receice full compensation for his losses. if promisor and transferee were to gain 100 € and promisee lose 50 €, it would be advantageous for promisor to breach and pay compensation. if promisee was to lose 150 € and be fully compensated, the breach would not be efficient and rational promisor would not breach. such a mechanism does not work if – for some reason, e.g. promisor’s insolvency – promisee is not going to be compensated by promisor. in such cases the liability of transferee would guarantee that inefficient breaches would not occur: if promisee could not receive compensation from promisor, he could receive it from transferee, and thus promisor and transferee would have a stronger incentive to take into account the losses caused to promisee. 37 see, e.g., posner (1998),145–146 and perlman 49 u. chi. l. rev. 61 (1982), 82–83. 38 see, e.g., bevier 76 va. l. rev. 877 (1990), 921–922 and mcchesney 28 j. legal. stud. 131 (1999), 148–151. nordic journal of commercial law issue 2011#1 13 3.6 summary in this section we have seen that promisee should be protected against transferee who has actual knowledge of his right. however, we have noted a problem with this solution. if promisee’s right is binding on transferee, it is possible that promisee maintains his right even when his gains from maintaining his right are less than the disadvantage caused to transferee by being bound by promisee’s right. this should be taken into account when discussing the appropriate remedy. 4 why a liability rule? 4.1 differences between property rules and liability rules as mentioned before, the topic of this article is often discussed solely in the context of the law of property or the law of delict. at least in finland, this restricts possible outcomes. from the point of view of the law of property, the outcome can be either that transferee is bound by promisee’s right or that he is not. from the point of view of the law of delict, transferee can be liable in damages or not. isolated discussion does not permit comparison between possible remedies: which one is better? in the following, the choice is made on the basis of fairness and efficiency, not on the formal ground of deciding first the field of law and after that the remedy typical to that field. to make a choice between property rules and liability rules, we have to consider their differences, especially the different consequences that these rules have. if a property rule is used, promisee maintains his right concerning the property in question. if a liability rule is used, a sum of money is taken away from transferee and given to promisee. consequently, a property rule means an “all-or-nothing” resolution, while applying a liability rule involves deciding the amount of damages to be paid. a property rule is more advantageous for promisee. he is allowed to maintain his right, or if he is willing to part with it, he can negotiate for a suitable price. respectively, a liability rule is more advantageous for transferee. he can have the property in its entirety for himself by paying a certain amount of money. if he does not want to pay, but is willing to tolerate promisee’s right, he is free to accept the right as binding on him. in short, a property rule gives the right to decide, and consequently, more bargaining power to promisee, while a liability rule favours transferee. after we have decided to protect promisee, we are facing the question of how strong a protection we want to grant him. another issue to be observed are the problems characteristic of each rule. a property rule might lead to a long-term relationship between promisee and transferee. exact terms of that relationship would have to be decided, and it would have to be ensured that both parties comply with these terms. when applying a liability rule, the correct amount of damages to be paid would have to be decided. nordic journal of commercial law issue 2011#1 14 4.2 preventing unfair advantage as noted in section 3, it is possible that promisee’s right is inefficient so that its value to promisee is less than disadvantages it causes to transferee. this problem would not appear, if promisee was protected by a liability rule. even if promisee was protected by a property rule, promisee and transferee may reach an agreement according to which promisee’s right will be terminated. in such case, promisee is in a better position than if his right was protected merely by a liability rule. according to a liability rule, he would receive compensation equal to his losses for losing the right. in voluntary negotiations, he could receive more. is this fair or not? let us return to monday watches to illustrate the setting. promisor owns a valuable watch that he does not need on mondays. promisor enters into a contract with promisee. according to the contract, promisee is allowed to use the watch every monday. after entering into the contract, promisor faces financial difficulties and needs to sell the watch. there is a potential buyer, but he is not interested in a watch that someone else is entitled to use on mondays. he needs a watch every day and, in addition, lives so far away from promisee that it would be very difficult to deliver the watch to him for use every monday. besides him, there is no one interested in buying the watch. if promisee was protected by a property rule, he could negotiate quite a high price from promisor or transferee for giving up his monday right in the watch. the price could be much more than what the monday right is actually worth for promisee. this does not seem fair, since the purpose of the contract between promisor and promisee has probably been to give promisee a right to use the watch while promisor does not need it, not to give him opportunity to take advantage of promisor’s financial difficulties. from this point of view, liability in damages seems to be a more appropriate remedy. the same applies also when a pre-existing right becomes an obstacle for using the object in a new, more profitable way. it is often fair to give profits gained from a more profitable use to someone who invented that the property can be used in that way – not to someone, who happens to be able to prevent it unless he is bought out.39 here, we can distinguish between two types of conflicts. one is a conflict where promisee has a use right or another limited right in the object and transferee wants to buy the object to use it in its entirety. another possible setting is that promisee has a right to become the owner of the thing – e.g. he has a right of pre-emption or a right to buy the object according to a pre-contract of sale. when promisee has only a limited right, the above-said applies: most probably the purpose of the contract between promisor and promisee has not been to give promisee part of the profits that can be obtained by using the property in its entirety in a more efficient way. it is 39 see, e.g., yorio 82 colum. l. rev. 1365 (1982) 1401–1402. nordic journal of commercial law issue 2011#1 15 different when the right of promisee is a right to become owner. one essential feature of ownership is the right to profit from increases in the value of the property. if promisee is entitled to become owner, he should be the one who gains from the new opportunities which make the object more valuable. 4.3 preventing practical problems finally, we have to consider practical problems typical of both remedies. one characteristic problem in applying a liability rule is that it is not easy to decide a proper amount of compensation to be paid. it is often claimed that the parties themselves know best how valuable a certain right is to them, and they should have to part with it solely through voluntary exchange.40 true, as described in subsection 3.1, there is always the risk of not compensating promisee’s losses in full. however, a property rule is not so simple either. to decide the dispute between promisee and transferee, we would have to find out what the exact content of the contract between promisor and promisee is. after that, we would have to decide if all the terms of the contract can be applied in the relationship between promisee and transferee. can transferee be obligated to active behaviour or is the burden on him only negative so that he must not prevent promisee from exercising his right? even though the terms of the relationship between promisee and transferee could be set in a satisfactory manner, it would have to be ensured that both parties comply with these terms. in a long-term relationship this could prove difficult – at least more difficult than simply transferring a certain amount of money from transferee to promisee. moreover, contractual terms which have been negotiated between promisee and the promisor might not be appropriate between promisee and transferee. they could, for instance, be influenced by promisor’s personal capabilities and needs. in subsections 3.3 and 3.4, it has been noted that problems of enforcing rights which are less important to promisee than harmful to transferee can be solved by choosing a liability rule. a liability rule seems to have more advantages than a property rule. there is one exception. problems of long-term relationship between promisee and transferee do not occur if promisee has a right of pre-emption or some other right which entitles him, and not transferee, to become owner of the property. if promisee becomes owner, transferee is left with no right in the property, and there is no long-term relationship between promisee and transferee. 40 see, e.g., epstein 106 yale l. j. 2091 (1997), 2093–2096 nordic journal of commercial law issue 2011#1 16 5 summary and conclusions we have seen above that both fairness and efficiency seem to suggest a similar solution to a conflict between promisee and transferee. there are no grounds for denying promisee protection if transferee knew of promisee’s contractual right at the time of the transfer. therefore, contractual rights should be protected against transferees with actual knowledge of them. since enforcing a contractual right against a transferee who is not a party to the contract can present a variety of problems, it is, as a rule, better to employ a liability rule than a property rule. a property rule is more suitable if promisee’s right is a right to become owner. it is certain that there are contractual rights which, for instance on social grounds, should be protected by a property rule. the rule proposed here leaves this choice to the legislator. for example in finland, a tenancy agreement is binding on a buyer of an apartment if the tenant has the apartment in his possession before the sale. the rule stated in this article is a default rule, a rule to be applied to those rights the protection of which has not been considered by the legislator. nordic journal of commercial law issue 2011#1 17 references bevier, reconsidering inducement, 76 va. l. rev. 877 (1990) calabresi & melamed, property rules, liability rules, and inalienability: one view of the cathedral 85 harv. l. rev. 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(government bill for the code of real estate) hemmo, sopimus ja delikti, tutkimus vahingonkorvausoikeuden vastuumuodoista, kauppakaari (1998) hemmo, vahingonkorvausoikeus, wsoypro (2005) hessler, allmän sakrätt, om det förmögenhetsrättsliga tredjemansskyddets principer, p. a. norstedt & söners förlag (1973) hoffrén, tieto ja sivullissuoja, suomalainen lakimiesyhdistys (2008) howarth, against lumley v gye, m. l. rev. 68 (2005) håstad, sakrätt avseende lös egendom, upplaga 6:9 med supplement mars 2000, norstedts juridik (2000) jokela, kartio & ojanen, maakaari, 3., uudistettu painos, talentum (2004) kaisto, “tiesi tai olisi pitänyt tietää”, varallisuusoikeudellinen tutkimus perustellun vilpittömän mielen vaatimuksesta kk 11:4 ja 12:4:n sekä vkl 14 §:n mukaan, suomalainen lakimiesyhdistys (1997) kartio, sopimus ja kolmas, xxx oikeustiede–jurisprudentia 152 (1997) krier & schwab, property rules and liability rules. cathedral in another light, 70 n.y.u.l. rev. 440 (1995) larentz & canaris, lehrbuch des schuldrechts. beck (1994) lohi, ositus, tasinko ja sivullissuoja, suomalainen lakimiesyhdistys (2003) mcchesney, tortious interference with contract versus “efficient” breach: theory and empirical evidence, 28 j. legal. stud. 131 (1999) niemi, maakaaren järjestelmä i. kiinteistön kauppa ja muut luovutukset, toinen, uudistettu pianos, wsoy lakitieto (2002) palandt, bürgerliches gesetzbuch, 51., neuarbeitete auflage, beck (2006) palmer, a comparative study (from a common law perspective) of the french action for wrongful interference with contract, 40 am. j. comp. l. 297 (1992) perlman, interference with contract and other economic expectancies. a clash of tort and contract doctrine, 49 u. chi. l. rev. 61 (1982) posner, economic analysis of law, fifth edition, aspen law & business (1998) saxén, skadeståndsrätt, åbo akademi (1975) schwartz, the case for specific performance, 89 yale l. j. 271 (1979) tammi-salminen, sopimus, kompetenssi ja kolmas, varallisuusoikeudellinen tutkimus negative pledge lausekkeiden sivullissitovuudesta, suomalainen lakimiesyhdistys (2001) tepora, irtaimen esineen vuokralleottajan sivullissuojasta. in ruokonen, sundblad & ylöstalo (eds.), juhlajulkaisu jukka peltonen 60 vuotta, pp. 275–293, helsinki (1999) terré & simler (2002), droit civil, les biens, 6e edition, dalloz (2002) terré, simler & lequette, droit civil, les obligations, 8e edition, dalloz (2002) tuomisto, tyyppipakosta aikaprioriteettiin, näkökohtia esineoikeudellisen sivullissuojan perusteista, suomalainen lakimiesyhdistys (1993) wiederkehr, code civil, 103 e edition, dalloz (2004) yorio, in defence of money damages for breach of contract, 82 colum. l. rev. 1365 (1982) zitting, omistajanvaihdoksesta silmällä pitäen erityisesti lainhuudatuksen vaikutuksia, suomalainen lakimiesyhdistys (1951) 1 book review: gustavo moser, rethinking choice of law in cross-border sales (eleven international publishing 2018) luca g. castellani* * legal officer, uncitral secretariat, vienna, austria. the views expressed herein are those of the author and do not necessarily reflect the views of the united nations. njcl notes that book reviews are not subject to double blind peer review. review: rethinking choice of law in cross-border sales 2 the current global trend in commercial and non-commercial matters is for states to grant ever greater freedom to parties in choosing the law applicable to their transactions. in the commercial field, such freedom may go as far as allowing the choice of non-state law, thus completing the process of detachment of business transactions from national provisions, even if the pitfalls of the mandatory application of public order rules may remain. in any case, the broader trend is clear and accommodates the ever-increasing global mobility of goods, services, funds and persons. with more choice comes more accountability, and hence it is expected that as freedom increases greater diligence would be required when choosing the appropriate legal regime, especially when the choice is based on professional legal advice. elements traditionally taken into consideration for that choice include the features of the transaction, the contractual power of the parties involved and existing usages and practices. such generic elements may be relevant for transactions as diverse as a contract for the sale of cotton between a burkinabe seller and a bangladeshi buyer and a sudden marriage in las vegas. a comprehensive and structured analysis of choice of law matters is necessary to appreciate the grounds for current decisions and the need, if any, to provide better options or additional guidance. this analysis may be carried out according to a quantitative approach based on the compilation of data and a qualitative approach based on identifying and explaining the underlying arguments. the outcome may lead to an assessment of the rationality of decision-making processes. with respect to international commercial law, this discussion has taken place with respect to the actual use of the united nations convention on contracts for the international sale of goods, 1980, known as “cisg”, which represents one of the most significant uniform law texts both with respect to substantive content and to participation of states. the cisg being based on the principle of freedom of contract means that parties may opt out of its application, except for the use of the written form for those states that have lodged the corresponding declaration. the rate of opting out and underlying reasons have generated an interesting literature, in which different data has been explained with significantly varying arguments that range from the modest relevance of the cisg in ordinary business transactions to the limited awareness of the cisg by contractual parties and their legal counsels. the truth probably lies in the middle, is rather complex and is not crystallised. in general, it seems that traders and, at times, their legal counsels do not pay sufficient attention to the choice of the law applicable to their contracts for the sale of goods. for example, they may neglect to adequately consider the specific features of the contract, including by failing to account for the interaction between choice of law and choice of forum. such negligence may have significant economic consequences on traders and may expose counsels to malpractice claims. njcl 2019/1 3 the book of gustavo moser on “rethinking choice of law in cross-border sales” provides a comprehensive and timely contribution to this discussion. the book deals primarily with cisg matters, though several considerations may apply more generally to international commercial law. statements and conclusions are supported by solid bibliographical references. the author starts with an overview of existing research, which has increased in frequency and sophistication over the years to the point that studies before the year 2008 are qualified as “pioneering” and studies after that year as “innovative”. the overview then discusses in detail the “global survey on choice of law”, a major endeavour led by ingeborg schwenzer. that survey considered choice of law and cisg exclusion not only from a legal perspective but also from a psychological and economic one. the results provide a vast and significant dataset that is useful for several reasons, including in identifying the various motives parties may have for opting out of the cisg. significantly, the survey results highlight the nexus between choice of law, choice of forum and availability of enforcement mechanisms. chapter 2 of the book provides a description of cognitive processes relevant to choice of law, including heuristics. the discussion is conducted along the lines of the juxtaposition between rational and intuitive responses and explains the reasons for the latter ones by identifying three classes of intuitive decision-makers: (pre)-judgmental, experiential and herd followers. chapter 3 offers an illustration of economic considerations relating to transaction costs, in particular those arising from information asymmetry and difference in bargaining power. these are two matters closely related to the justification for a broader use of uniform law. with respect to costs arising from learning a new law, one may wonder whether those costs are the legacy of times where individuals were in charge of providing legal advice as opposed to the current prevalence of law firms where knowledge is shared and learning processes are ongoing. chapter 4 discusses the interplay between choice of law and choice of forum issues, which are defined in a broad sense to include alternative dispute resolution methods. the practical importance of the matter may not be overstated. the fact that the current landscape may be changing in light of recent treaties and other texts aimed at facilitating the cross-border recognition and enforcement of decisions by national courts (including those specialised in international trade) and of mediation settlements is also taken into account. the discussion usefully covers certain details such as the consequences of the choice of the seat of arbitration. the interaction between the hague convention on choice of court agreements and the cisg is discussed in terms of synergy. chapter 5 aims at concluding the discussion on choice of law and uniform law by matching the concerns of the legal counsels, as compiled review: rethinking choice of law in cross-border sales 4 in the global survey on choice of law, and the features of uniform law, namely the cisg. the resulting catalogue is a reminder of the benefits associated with uniform law. it could be possible to add a discussion of commonly chosen national laws and explain advantages and disadvantages arising from each of them. this may reinforce the case for the use of uniform law. the fact that the cisg is not presented as the only possible solution to the legal needs of international trade, but as one of the possible solutions – actually, one of the few modern ones specifically designed for cross-border transactions – is in line with the current approach that favors freedom of choice of law, provided sound legal reasoning based on factual analysis informs that choice. the author also identifies the “commitment to freedom of contract” of the cisg as one of its main benefits: indeed, even if parties opt out, in some jurisdictions the cisg may be the main, if not the only, gateway to upholding a choice of law other than national law. while the main focus of moser’s book is on the important question of choice of law and dispute resolution, greater treatment of the equally important issue of dispute prevention by proactive contract management would also be welcome. the general conclusion of the book is that uniform law – namely the cisg – is often excluded because it is simply not liked by traders and their legal advisors and that the reasons for this dislike are unclear and may be unrelated to rational legal arguments. this is a dangerous approach that does not serve commercial interests and may expose involved lawyers to professional liability. hence, this conclusion highlights the importance of capacity-building. universities and bar associations could do much in that respect. at the international level, the ongoing joint effort of the hague conference on private international law, uncitral and unidroit in drafting a legal guide on international commercial contracts (with a focus on sales) should be noted. given the significant amount of work carried out in the field of uniform international contract law, the guide aims at providing an illustration of the interaction among existing uniform law legal texts. its draft will be widely circulated for comments so as to benefit from the feedback of the intended users. in the longer run, and from a different angle, the use of artificial intelligence agents in automated contract conclusion may assist in providing a more structured and coherent approach to choice of law and forum matters. overall, moser’s book provides relevant information to those interested in learning how to make efficient decisions with respect to choice of law in international commercial contracts or to improve existing decision-making processes. it is also a valuable reference work for those concerned with assessing and improving the practical relevance of uniform law in commercial transactions across borders. 1 digital collaborative platforms: a challenge for social partners in the nordic model annamaria westregård * * associate professor and senior lecturer in business law, department of business law at school of economics and management, lund university, ole römers väg 6, se 223 00 lund, sweden, annamaria.westregard@har.lu.se digital platforms & the nordic model 92 1. introduction ..................................................................................... 93 2. online collaborative platforms and umbrella companies ................................................................................................................. 96 3. employee or self-employed ......................................................... 98 3.1. introduction .......................................................................... 98 3.2. theory of dispositive facts ............................................... 99 3.3. evidentiary facts in labour law ................................... 100 3.4. evidentiary facts in tax law .......................................... 101 3.5. the concept of employment in a digital economy 102 4. work and employment protection ......................................... 104 5. collective agreements for crowdworkers ........................ 106 5.1. introduction ........................................................................ 106 5.2. the parties ............................................................................. 107 5.3. who is covered by collective agreements? ............. 109 5.4. are the parties ready for new collective agreements? .......................................................................... 110 6. social insurance for crowdworkers ..................................... 111 7. concluding remarks .................................................................... 113 njcl 2018/1 93 abstract crowdworkers—workers in the new digital economy—face new employment situations not covered by the existing legislation. this paper focuses on the specific problems in the labour and social security legislation as it relates to crowdworkers, analysing their place in labour markets, and especially in the collective agreements which are the standard means of regulating working conditions in the nordic model. exactly how the concept of employment should be framed when someone works for an online platform depends entirely on the platform’s business model, which can vary from closely managed, vertically integrated businesses to service-only crowdsourcing agencies, so it is not easy to make general statements about crowdworkers’ status. this paper analyses whether the concept of an ‘employee’ can be applied to crowdworkers, looking at both labour and tax law (the latter being especially important in the handling of social security and unemployment benefits). under labour law the concept of an employee is a matter of interpretation, and the swedish labour court would probably hold many crowdworkers to be employees, but equally a considerable number, being self-employed, would not be. the law on working and employment conditions offers only limited protection of those on short, fixed-term contracts; instead, it is social partners that have improved crowdworkers’ conditions in some industries by using collective bargaining. however, there are no collective agreements in the digital economy, or indeed for platform entrepreneurs. the complications of the parties’ positions will be analysed, especially as platforms do not consider themselves to be employers, but rather coordinators of the selfemployed. particularly significant for the crowdsourcing economy are the regulations that give the same employees’ rights to ‘dependent contractors’ who have employee-like status to organize and enter into collective agreements, while many crowdworkers are in a grey area, being neither employees, ‘false self-employed’, assignment workers, nor selfemployed. legislatures are reviewing the situation at the national and eu levels in order to strengthen the rules for those in atypical forms of employment. this may lead social partners to finally acknowledge that they will have to introduce collective bargaining into the digital economy. 1. introduction new technology brings new forms of work in the digital economy, or gig economy as it is often known. gig is a term borrowed from the music industry, where a gig is a musician’s temporary, one-off assignment for others. those who take these ‘gigs’ are often called crowdworkers. this term refers to the fact that work tasks are offered to a large number of people, the ‘crowd’. the terminology of the digital platforms & the nordic model 94 collaborative economy is new, and is used in different ways depending upon the context. there are many different kinds of crowdwork, and there is no legal definition. here it is used for the performing party (service producer) in the digital economy.1 online collaborative platforms or digital sharing platforms (hereafter platforms) are now a standard business model where a third party brings together two others—the service provider (crowdworker) and the service consumer— and enables a transaction between them.2 eurofound has studied and mapped the new forms of employment and work that have emerged in europe since the turn of the millennium.3 work in the digital economy is ‘new’ either in the sense that it did not exist before, being the result of digitization and the collaborative economy, or because it has become far more prevalent thanks to the new technology. what is common to all these new forms of work is that they are seldom a question of traditional, full-time, permanent employment. on the contrary, it is almost always work done by the self-employed or those in short-term fixed-term employment.4 according to eurofounds report, ict-based mobile work is new or of increasing importance in all nordic countiers. ict-based mobile work means the use of new technology to carry out work wherever and whenever the worker wishes – outside of normal working hours or workplaces. this form of work is relevant for both employees and the self-employed. in denmark and norway, portofolio work (sole proprietors work for many clients, carrying out small, short-term assignments for each client) has emerged and in denmars crowd employment (where many workers are gathered for an assignment via an online platform) has also 1 annamaria westregård, `collaborative economy – a new challenge for the social partners´ in kerstin ahlberg (ed.) vänbok till niklas bruun (iustus 2017). 2 see also sou [government white paper] 2017:26 delningsekonomin på användarnas villkor, 64, 191–2. 3 see eurofound, new forms of employment, publications office of the european union (2015). 4 see also annamaria westregård, `precarity of new forms of employment under swedish labour law´ in precarious work. the challenge for labour law in europe, eds. izabela florczak, jeff kenner and marta otto, 2018, edward elgar publishing, forthcoming; sou (government white paper) 2017:24 ett arbetsliv i förändring—hur påverkas ansvaret för arbetsmiljön? chap 7,9,10 and 11; samuel engblom and jacob inganäs atypiska företagare – om relationen mellan företagare och deras uppdragsgivare tco (the swedish confederation of professional employees) rapport 1 2018; about denmark see steen scheuer, atypisk beskæftigelse i danmark om deltidsansattes, midlertidigt ansattes og soloselv-stændiges vilkår lo-dokumentation nr. 1/2017. njcl 2018/1 95 increased. in sweden, specially umbrella companies (see section 2) are of increasing importance.5 the purpose of this article is to highlight the legal problems associated with platform-based work that are seen in the nordic model. i will focus on conditions in sweden, with some comparisons with the other nordic countries. in the nordic countries there are many similarities in how the labour market is organized, but equally there are considerable dissimilarities, to the point where it might even be correct to talk of five distinct nordic models.6 by nordic model, i here mean the situation in which the state holds back from detailed labour legislation, and limits itself to providing a legal framework for the social partners, in the expectation that they will regulate wages and working conditions in collective agreements. in sweden, the collective agreement coverage is high: in the public sector, 100 per cent of employees are covered by collective agreements, while for private individuals the figure is approximately 85 per cent. this high level of coverage is largely thanks to the fact that employers are organized in employers’ organizations, and are thus included in the industry-wide agreements. the employees’ degree of organization is relatively high, being on average about 70 per cent.7 i begin with a synoptic owerview of the digital economy and umbrella companies (section 2). the definitions of employee and selfemployed are analysed with focus on crowdworkers (section 3). an important consequence if crowdworkers are regarded as self-employed instead of employed is that they are not covered by labour law, and thus not collective bargaining. the nature of the working and employment conditions stipulated in the swedish legislation as it applies to crowdworkers who are employees and on fixed-term contracts are detailed (section 4). in the nordic model, working conditions are above all be governed by collective agreements. i analyse parties to actions under collective labour law, focusing on the digital economy and the ways in which the swedish term for ‘dependent contractor’ is applied when collective agreements regulate terms for certain categories of selfemployed, and similarly the possibilities for social partners to regulate working conditions for crowdworkers and other in the digital economy 5 eurofound 2015 chap 6,8,9 and 10 6 see niklas bruun, den nordiska modellen för facklig verksamhet i den nordiska modellen fackföreningarna och arbetsrätten i norden—nu och i framtiden, (liber 1990), 17 ff; niklas bruun ‘the future of nordic labour law’ (2002) scandinavian studies in law 43, 375–85. 7 avtalsrörelsen och lönebildningen år 2017 medlingsinstitutets årsrapport, 224–5. digital platforms & the nordic model 96 (section 5). another factor in the nordic model is the financial security it offers in the shape of the social security regulations for performing parties if their work falls through. the crowdworkers' precariousness stems not only from their working conditions, but also from their poor social security benefits and unemployment benefits, where they are eligible at all. the particular difficulties crowdworkers encounter in the social security system are highlighted (section 6). finally, i round off with some concluding remarks (section 7). 2. online collaborative platforms and umbrella companies in sweden as elsewhere, online platforms have a variety of business models, but with that said, two main types can be distinguished. either they specialize in local, physical work, or in completely digital work where the parties never meet one another.8 the platform can serve to bring together service producers and service consumers, and nothing more. it can also be part of a business model with a far more structured organization, where all contact between service producers and consumers goes via the platform, which also has a clear set of rules for how services should be provided, price-setting, and so on. the platform provides the service, which the service producer then performs. the nature and workings of online platforms have been described at length elsewhere, so i will not dwell on the subject here.9 a new business model that has been rapidly adopted in sweden, keeping pace with the rise of the collaborative economy, is a variant of the umbrella company and the platforms that use umbrella companies as middlemen.10 the umbrella companies have a special design; the performing party bids for work and, if successful, arranges both the work and the remuneration with the client. the performing party then makes sure the client has signed a contract with the umbrella company. the client is invoiced by the umbrella company, which in turn employs the performing party for the duration of the assignment. once the client 8 sou 2017:24, 197. 9 valerio de stefano, `the rise of the ‘just-in-time workforce: on-demand work, crowdwork and labour protection in the “gig-economy”´ ilo, conducion of work and employment 71 (2016), 1; communication from the commission to the european parliament, the council, the european economic and social committee and the committee of the regions, a european agenda for the collaborative economy, brussels 2 june 2016 com (2016), 356 final; de stefano 2016. 10 sou 2017:24, 167. according to the branch organization, the number of umbrella companies employees grew from 4,000 in 2011 to 44,000 in 2017, and increased by 31 per cent in 2016, http://www.egenanstallning.org/index/news > accessed 30 july 2018. njcl 2018/1 97 has paid the umbrella company, the performing party is credited, after deductions for tax, social security contributions, and the umbrella company’s commission.11 the parties rarely meet in real life, with all contact between them conducted electronically. swedish umbrella companies have a trade organization, where membership is predicated on companies taking responsibility for the performing parties for the time they are working.12 umbrella companies are similar to temporary work agencies in their operations, with the difference that a temporary employee works when the employer decides, while the performing party of an umbrella company decides when to work and then ‘hires’ an employer. the question of whether umbrella companies are covered by the agency work act (2012:854) depends on the interpretation of the definition of temporary work agencies in section 5 (1). umbrella companies scarcely existed in sweden in 2012 when the law was passed, and they were not mentioned in preparatory work for the bill.13 by law, temporary agency work is when a company employs temporary agency workers in order to assign them to work for users, under their supervision and direction. if a company instead places its employees to do a particular job under its direction for another company, then that is contract work, which is not covered by the law.14 any decision whether a company is a temporary work agency or not must also correspond to the interpretation under the temporary agency work directive.15 where an umbrella company is judged to be termporary work agency, the consequence is that its employees are entitled to the basic working and employment conditions set down in the end-user’s collective agreements and other binding general provisions.16 there have been no cases in the swedish labour court that concern crowdworkers in the collaborative economy, or that indicate whether the performing parties in an umbrella company should be considered employees, or whether umbrella companies are temporary 11 see sou 2017:24, 161 ff, 198; the swedish tax agency, https://www.skatteverket.se/privat/skatter/arbeteochinkomst/inkomster/egenanstalln ing > accessed 30 july 2018; eurofound, new forms of employment, publications office of the european union (2015), 120. 12 http://www.egenanstallning.org/ > accessed 30 july 2018. 13 sou 2011:5 bemanningsdirektivets genomförande i sverige; proposition [government bill] prop. 2011/12:178 lag om uthyrning av arbetstagare. 14 sou 2011:5, 55; see also labour court ruling 2006 nr 24 on contract versus agency work. 15 directive 2008/104/ec of the european parliament and the council of 19 november 2008 on temporary agency work. 16 sections 5 (3) and 6 the 2012 agency work act (2012:854). digital platforms & the nordic model 98 work agencies in the meaning of the 2012 agency work act. since the parties themselves say that the performing party is an employee—and that the umbrella company has all the responsibilities of an employer—it is possible that the labour court would judge it to be employment. it is not self-evident, however, that the rules for employees’ unemployment insurance apply to the performing party. the degree of independence determines whether it is employment in the sense used for unemployment insurance in the administrative court of appeal.17 it is these construals of employment that mean the term’s meaning shifts according to the legislation, as is discussed in the following sections. 3. employee or self-employed 3.1. introduction swedish labour law is a binary system in which someone is either employed or self-employed.18 there is no intermediate category, and nothing to indicate that the government is planning to legislate for one, 19 largely out of fear of the new boundary issues that would arise, and the risk that groups previously held to be employees would end up in the new intermediate category. performing parties can be platform employees, perhaps even the service consumer’s employees, or the work is done by someone who is self-employed and has their own company, a sole trader (enskild firma) or owner of a limited company (aktiebolag). if the work is occasional and 17 judgement from administrative court of appeal in gothenburg 11 may 2010 (case no. 3059–09); judgement from administrative court of appeal in gothenburg 17 february 2015 (case no. 911–15); see also the swedish unemployment insurance board (iaf) appeal to the supreme administrative court in the judgement from administrative court of appeal in gothenburg 11 may 2010 (case no. 3059–09) review not granted (case no. 4218–10). see also uppdragstagare i arbetslöshetsförsäkringen, 2016:3, 15–16, about the particular difficulties relating to the self-employed. 18 see annamaria westregård, ‘the notion of “employee” in swedish and european union law: an exercise in harmony or disharmony?’ in laura carson, örjan edström and birgitta nyström (eds.) globalisation, fragmentation, labour and employment law—a swedish perspective (iustus 2016); se also ole hasselbalch, arbejdsretten, (11th edn, djøf forlag 2013, revise oktober 2017 available through schultz arbejdsretsportalt, arbejdsretsnøglen) section iii, section 1.1. and comments on the danish binary system; see also marianne jenum hotvedt, `arbeidstaker-quo vadis? den nyere utviklingen av arbeidstakerbegrepet´ (1/2018) tidsskrift for rettsvitenskap vol 131, 42-103 about norway. 19 in the latest review of the concept of employment in 2002, the legislators made it clear that there are no plans to introduce a third category of party in addition to employee and self-employed; see legislative inquiry ds. 2002:56, 133. njcl 2018/1 99 small-scale, which is common in the digital economy, this is done often by an assignment worker (uppdragstagare). an assignment worker is someone who takes on work without being employed or having their own business. the terms employee and worker could have various meanings, e.g. in the uk. in sweden, an employee (as the term is used here) is virtually the same as both an employee and a worker.20 the definitions of employee and self-employed are important to decide the scope of the labour legislation and the collective agreements as they, whith some exceptions, only apply to employees.21 it is also important in social security legislation to decide the nature of the performing party as different regulations apply to employees and selfemployed. the legislation has special difficulties to handle assignment workers and decide whether the legislation for employee or selfemployed apply in different situations. 3.2. theory of dispositive facts when judging whether someone is an employee or not, in the nordic countries the assessment is based on the relevant circumstances or criteria. in denmark and norway in particular, the purpose of a legislation is important for its area of application.22 according to källström and malmberg, in sweden too the parties to an action and type of dispute determine the weight given to various criteria in the overall assessment, although that approach is not accepted there.23 in his theory of dispositive facts,24 axel adlercreutz identifies the set of relevant circumstances (legal facts) that must all be present for it to count as employment. there has to be ‘contract that a performing party 20 uk legislation distinguishes between employee and worker, with worker being the far broader term, see the employment rights act 1996, 230 (1)–(3); jeff kenner ‘inverting the flexicurity paradigm: the united kingdom and zero hours contracts’ in ales et al. (eds) core and contingent work in the european union, a comparative analysis (hart publishing 2017), 153–83. 21 see also hasselbalch 2013 (2017) section iii, section 1.1. 22 ruth nielsen, ‘arbejdstagerbegrebet i et arbejdsmarked under forandring—et komparativt perspektiv’ (2002) arbejdsretslig tidsskrift, 152–75, 157; hotvedt 2018, 59ff; kent källström, ‘employment agreements and contract work in the nordic countries’ (2002) scandinavian studies in law 43, 77–86; källström and malmberg anställningsförhållandet—inledning till den individuella arbetsrätten (4th edn, iustus 2016), 26 n. 13 and 28 n. 18. 23 källström and malmberg 2016, 28–9. 24 the term dispositive facts (rättsfakta) has a variety of translations, here in the sense that facts decide a legal question. digital platforms & the nordic model 100 must personally perform work on behalf of another party’.25 to this different circumstances or evidentiary facts of varying degrees relevance are added, depending on which law is applied.26 examples of evidentiary facts are the degree of independence in relation to the principal; whether the performing party has more than one client or was previously employed by the principal; what the parties’ intent was; the scope of the work; whether remuneration was paid; who owned any equipment; trade practices, etc. although the relevant circumstances in the concept of employment are the same, the evidentiary facts are assessed differently depending on the legislation. here, the focus is on how the concept of employment is judged in labour law and tax law. the manner in which ‘employee’ is assessed in tax law is also significant for access and methods of calculating social security benefits and unemployment benefits, which are based on the notion of a tax-based workforce.27 this also means that a performing party could be regarded as an employee in labour law but as self-employed in the social security legislation. it is difficult for crowdworkers to foresee their classification and to calculate their social security benefits and that is a disadvantage. 3.3. evidentiary facts in labour law in order to determine whether an employment relationship is covered by the 1982 employment protection act (1982:80), the degree of independence is assessed, along with whether the performing party is under the principal’s direction and part of that company’s activities. all this indicates that an employment relationship exists.28 if there is only one client, it is an indication that it is a matter of employment, especially if the performing party was previously employed by the principal. a substantial change in working conditions is required for it to be regarded a contract of employment thereafter.29 in labour law, the concept of the employee is a sufficient imperative that even when the parties agree on a contract of employment and that the performing party is self-employed, 25 axel adlercreutz, arbetstagarbegreppet (norstedt 1964), 186, 276 ff; ds. 2002:56 hållfast arbetsrätt för ett föränderligt arbetslivs, 111, n. 63; westregård 2016. 26 adlercreutz 1964, 187–8. 27 2010 social insurance code (sfs 2010:110); 1997 unemployment insurance act (sfs 1997:238). 28 tore sigeman and erik sjödin arbetsrätten—en översikt (7th edn wolter kluwer 2017), 27. 29 källström and malmberg 2016, 28; labour court rulings ad 2012 no. 24 and ad 2005 no. 16. njcl 2018/1 101 so the performing party may well be held to be an employee by the labour court. very brief, occasional work can be held an employment relationship.30 although where the parties have agreed there would be no wage because it was an internship, the labour court took the comprehensive view that there was a position, and the employer was obliged to pay wages according to the current collective agreement.31 the labour court also adheres to what is considered as customary in the industry. one example is how for journalism the labour court followed the collective agreement’s provisions on what constitutes a freelance worker is under the freelance agreement.32 the collective agreement’s definition is industry praxis. according to this agreement (and industry practice), a performing party may be regarded as self-employed, even when in an assessment of evidentiary fact—such as only one principal, regular hours or work for extended periods time, the principal providing equipment and tools etc.—in an ‘ordinary’ case it would be considered a worker.33 were the social partners to arrive at a collective agreement for crowdworkers, the contract’s construal of the concept of employment would thus be important as a trade practice according to the labour court. 3.4. evidentiary facts in tax law in tax law, the weighting and assessment of evidentiary facts is somewhat different. new rules were introduced in 2009 to make it easier for individuals to obtain approval for swedish business tax certificiate (godkänd för f-skatt).34 as before, it is based on broad evaluation of the same set of circumstances used in labour law, looking at whether the performing party is sufficiently independent for business tax certificiate approval and to be counted self-employed; the difference is in the fact that certain evidentiary facts taken from the wording of the acts are accorded greater importance. one criterion mentioned in the legislation is the extent to which an assignment worker is dependent on the employer and is part of their business. the fact that the employer decides how, when, and where the work is to be done—including on its 30 sigeman and sjödin 2017, 32; källström and malmberg 2016, 27; labour court rulings ad 2013 no. 92 and ad 2005 no. 33. 31 labour cour ruling ad 2003 no. 1; see also källström & malmberg 2016, 27. 32 § 2 kollektivavtal mellan svenska tidningsutgivareföreningen och svenska journalistförbundet för frilansarbetare 1994. 33 labour court rulings ad 1987 no. 21, ad 1994 no. 104 and ad 1998 no. 138; see also ds. 2002:56, 121. 34 see chap 13 section 1 of the 1999 income tax law (1999:1229). digital platforms & the nordic model 102 premises and with its tools—according to the preparatory works this does not automatically mean that the assignment worker is under the direction of the employer. according to the preparatory works, it is also standard for a former employer to be the new company’s first and only client, yet even so the business must be considered independent. in addition, particular attention must be paid to the parties’ intent, while the number of clients is less important.35 from this example, it is clear that evidentiary facts are assessed differently in labour law and tax law. a performing party should thus be thought an employee under the 1982 employment protection act, but self-employed under the income tax act (1999:1229), and thus qualify for approval for business tax certificiate. business tax certificiate approval or not adds little of weight, when the concept is assessed under labour law.36 were the swedish tax agency to go over in a case to considering the performing party to be an employee, this would have consequences for the principal, who would duly be required to pay social security contributions and taxes to the swedish tax agency, which may amount to significant sums. predictability is therefore important.37 the problem, that the rules for business tax certificiate approval can result in more people being hired as sole traders, even though they are actually employed—the so-called `false self-employed´—as was brought to the attention of the ministry of finance, which appointed an inquiry to look at possible alterations to the legislation.38 in the government white paper, (sou 2018:49) the commissioner was specifically critical towards the fact that the former employer can be the new company's only client. here, some changes in the legislation will probably be suggested to avoid the `false self-employed´.39 3.5. the concept of employment in a digital economy how should the concept of employment be applied to crowdworkers in the collaborative economy? the answer depends on which businessmodel the platform has, which country´s concept of 35 prop. 2008/09:62 f-skatt åt fler, 26–7. 36 källström and malmberg 2016, 31; in denmark and norway seems the established practice in tax law follow the established concept of employment in labour legislation; hasselbalch 2013 (2017) section iii, section 1.2.1; hotvedt 2018, 51, 58 and 64. 37 see also westregård 2016. 38 dir. 2017:108 översyn av f-skattesystemet. 39 sou 2018:49 f-skattesystemet-några särskilt utpekade frågor, 211 f. njcl 2018/1 103 employment and which legislation that is applied, so it is very difficult to make any precise statements.40 a more general guide is a model put together by the european commission for assessments of collaborative platforms.41 the first question is whether the platform really provides services, or if it is only a middleman. criteria for determining whether a collaborative platform provides a service include price, other key contractual terms and ownership of key assets. the next question is whether the performing party is self-employed or an employee. here the commission stipulates three criteria.42 it is the criterion of subordination. it requires that the platform leads the crowdworker’s work by determining the choice of activity, remuneration and working conditions. the mere transfer of payment does not mean that remuneration is determined by the platform. next criterion is the nature of work, which requires the existence of an actual business activity with an economic value according to the commission, conditions such as short work duration do not preclude an employment relation. the last criterion, remuneration shall primarily distinguish ordinary work from volunteer work. to determine whether a relationship is one of employment, an assessment shall be carried out using all three criteria. the criteria are based on the definition of the term ‘worker’, established by the court of justice of the european union, cjeu, in their settled case law.43 however, the swedish concept of employment is more extensive. criteria such as remuneration and the duration of the work are not among the necessary prerequisites, in order for it to be considered employment.44 considering this, if the model is adapted for 40 see annamaria westregård, ‘delningsplattformar och crowdworkers i den digitaliserade ekonomin—en utmaning för kollektivavtalsmodellen’ in birgitta nyström, niklas arvidsson and boel flodgren (eds) modern affärsrätt (wolters kluwer 2017); hasselbalch 2013 (2017) section iii, section 3.4.; marianne jenum hotvedt, ‘utfordringene i formidlingsökonomien: arbetsgiverplikter for uber’ in festskrift till stein evju (universitetsforlaget 2016), 327–38. 41 communication from the commission to the european parliament, the council, the european economic and social committee and the committee of the regions—a european agenda for the collaborative economy, brussels 2 june 2016 com (2016) 356 final, 5 and 11; see westregård, vänbok till niklas bruun, 2017, 427 ff. how the model is used on the concept of employment in sweden. 42 com (2016) 365, 12 ff. 43 com (2016) 356 final, 5 and 11; judgements in lawrie-blum v land baden-württemberg c–66/85 ecli:eu:1986:284 para 16–17; levin v staatssecretaris van justitie c–53/81 ecli:eu:1982:105; birgitta nyström eu och arbetsrätten (5th edition wolter kluwer 2017), 139–40; källström and malmberg 2016, 28 and westregård 2016. 44 sigman and sjödin 2017, 32. digital platforms & the nordic model 104 the concept of employment in the present country, it could be used as a help to define the concept of employment for performing parties in the collaborative economy. 4. work and employment protection in sweden, anyone who is an employee is subject to labour law but this legislation does not, with some exemptions, apply to the selfemployed.45 many of the performing parties in atypical employments, as well as many self-empoyed, are in a precariuos situation. the regulations for the protection of working and employment conditions in the 1982 employement protection act concentrate on those in permanent or long-term employment. in the case of redundancy, both permanent and fixed-term employees (those who have worked fewer than twelve months) are entitled to be rehired if their employer begins to recruit within nine months of the employee being laid off. this is an important rule for long-term, fixed-term employees in sweden. when someone is employed on a fixed-term contract, it converts into permanent employment once the total time worked exceeds two years in a five-year period.46 this and the rehiring regulations apply to crowdworkers on fixed-term contracts if they have worked long enough for the platform to qualify. it is the actual form of employment that is converted from fixed term to permanent; the act is silent on the conditions that should apply, only stating that the conditions are a matter of negotiation between the parties.47 employees in the collaborative economy are in most cases on short fixed-term contracts—they are only employees for the hours they actually work. there is no legal barrier to repeatedly employing someone for short jobs as long as the employer and employee agree on the form of employment in advance each time.48 it falls to the employer to prove that it is not a question of permanent employment. for each job opening the employee has the right to turn it down and can instead work for 45 in principle, the 1977 work environment act (arbetsmiljölagen 1977:1066) does not apply to the self-employed, except for certain regulations about technical arrangements and dangerous substances, chap 3 section 5 (2). 46 sections 5 a and 25 of the 1982 employment protection act 47 for earlier work on the regulation of automatic conversion, prop. 2005/06:185 förstärkning och förenkling – ändringar i anställningsskddslagen och föräldraledighetslagen, 52; prop. 2006/07:111 bättre möjligheter till tidsbegränsad anställning, m.m. 28; lars lunning and gudmund toijer, anställningsskydd: en lagkommentar (11th edn wolters kluwer 2016), 258. 48 labour court ruling 2008 no. 81. njcl 2018/1 105 another platform. one question is whether a performing party can be on hold with several (possibly competing) apps or platforms at once, ignoring the rest if there is an assignment with one of them. the rules on fixed-term employees are optional law in their entirety,49 and, as befits the nordic model, social partners in some industries have reached collective agreements on working conditions— some better, some worse—for those with short, temporary positions. one collective agreement of interest here is the recent white-collar employee agreements50 between the white-collar trades union, unionen, and the employers’ organization for the swedish service sector, almega, which covers most white-collar workers in private sector service companies, including temporary work agencies. the collective agreements do not cover umbrella companies or platforms, although it is likely that service companies of that sort will join almega if they do choose to join an employers' organization. the collective agreements are examples of how social partners agree to and change working and employment conditions where the legislation offers little protection.51 the opportunity to take on workers on a sequence of short, fixedterm positions can explain why ‘no minimum hours working arrangements’52 or zero-hour contracts53 are not more widespread in sweden. another reason may be the limit on extra hours for part-time workers under in the 1982 work time act. part-time workers are not 49 section 2 (3) the 1982 employment protection act. 50 collective agreement between unionen and almega concerning tech and media companies for the period 1 may 2017 to 30 april 2020. the regulations are in § 2.2. temporary employment is valid from 1 november 2017. the regulation is the same in all almega’s 22 collective agreements for white-collar workers. 51 § 2.3 which applies from 1 november 2017. there is a special regulation for fixedterm employment, which means it must exceed a minimum employment period— which is missing from the law—of seven days, unless the employer and the employee specifically agree on a shorter period. if unionen takes the view that employers are abusing their freedom of contract by repeatedly recruiting workers for shorter periods of time, even though the needs of the business could be met by offering longer fixedterm or permanent contracts, it can invoke the restrictions in the agreement. the regulations for automatic conversion to permanent employment are extended to a total period of three years—one year more than the law requires—in a five-year period. 52 see abi adams, mark freeland and jeremias prassl ‘the “zero-hours contract”: regulating casual work, or legitimating precarity?’ legal research paper series paper no 00/2015 university of oxford, 19. 53 in the sense that there is permanent employment without a legal minimum number of fixed working hours. digital platforms & the nordic model 106 allowed to work more than 200 hours a year, and in exceptional cases an additional 150 hours, over the contractually agreed number.54 it is possible to have a collective agreement for a form of employment where someone is permanently employed, but this only works when they are called on to do so by the employer, but that is very unusual. on-call work, which comes under the security industry agreement, is an example of how social partners solved an existing problem.55 thus, there is a difference in employee vulnerability between long and short fixed-term employment. occupational protection legislation does not offer those employed in numerous short-term positions any special protection for their working and employment conditions, whether as minimum guaranteed working hours, or guarantees of continued work or minimum wages, as such things are only governed by collective agreements in accordance with the nordic model. crowdworkers in the collaborative economy, where they are considered employees in the first place, largely fall into this category. the problem with brief, temporary, fixed-term employment has been noted by parliament, and an inquiry has been appointed to revisit the protections offered to employees in intermittent employment.56 5. collective agreements for crowdworkers 5.1. introduction the nordic model thus relies on the regulation of the most important working conditions being arranged through collective 54 section 10 (2) of the 1982 work time act (1982:673). 55 § 1 moment 4 behovsanställning in the security industry collective agreement between security companies and the transport workers’ union, 1 june 2017–31 may 2020. on-call employment means that working hours are not determined in advance and employers only offer work when staff are needed. employees can at any time refuse the work offered, and they are paid by the hour. there are rules for the order in which work has to be offered, and the point at which employees convert automatically to another form of employment. the reason for the regulations is unusual: private security guards must be licensed by the county administrative board (decree (1989:149) under regulations on security companies (förordning 1989:149 om bevakningsföretag m.m.), which can be difficult to arrange for fixed-term employees called in at short notice to help with a major incident, for example. those who take oncall work often have other jobs where they decide their own schedules, such as students or farmers (interview with jonas milton, former ceo and current senior adviser, almega, the employers’ organzation for the swedish service sector, 8 february 2018). 56 dir. 2017:56 trygghet och utveckling i anställningen vad gäller arbetstid och ledighet, 13, to be revised at latest 31 january 2019. njcl 2018/1 107 agreements, and not in the legislation. there are thus no rules on minimum wages, overtime pay, guaranteed minimum working hours, and so on. other important regulations on fixed-term employment, conversion rules, and rehiring in the 1982 employment protection act are semi-discretionary rules.57 the result is that the legislation can be derogated from collective agreements at the industry level, but not at the local level or by personal contracts. if there is no collective agreement in a workplace, the employer is free to agree with its employees as it sees fit on all the unregulated issues, including wages, but otherwise it must comply with the legislation without the deviations agreed by the social partners in their collective agreements. in sweden, there are currently no collective agreements for crowdworkers or umbrella companies. there is a nordic example of a collective agreement for crowdworkers, however: denmark, where a one-year trial agreement between 3f and hilfr (a cleaning company) will come into force on 1 august 2018. it holds the performing party to be an employee, but without a duty to work other than the assignments they have been contracted to do. there is a fixed minimum wage in the agreement.58 5.2. the parties a collective agreement is a written contract that governs working conditions and the relationship between employers and employees, agreed between employers or an employers’ organization and an employees’ organization.59 in sweden it is always a trades union that is party to the agreement for the employees. some white-collar and academic trades unions (unionen and jusek among them) are interested in recruiting the selfemployed, and they also want to attract crowdworkers. unionen has a vision of social partners collaborating through industry-wide collective agreements, going on to create a system for the regulation of crowdwork.60 57 section 2 (3) the 1982 employment protection act. 58 https://fagbladet3f.dk/artikel/rengoeringsplatform-indgaar-aftale-med-3f > accessed 30 july 2018. 59 section 23 of the 1976 co-determination act. 60 see the union’s report unionen om plattformsekonomin och den svenska partsmodellen (unionen 2016) 97; joint declaration by ig metall, germany, and unionen, sweden, signed 8 june 2016 about cooperation in regulatory and policy matters for work in the field, and to share experiences in union recruitment of crowdworkers. digital platforms & the nordic model 108 in the collaborative economy, determining who can be party to a collective agreement from the employees’ side is nothing compared to deciding who should be party to it from the employer’s side. the legal definition of an employer is usually fixed with reference to the concept of employment. section 1 in the 1982 employment protection act states which employees are covered by the act, and section 1 (2) in the 1976 co-determination act (1976:680) defines an employer as the party that the employee works for. the problem at present is that the platforms’ representatives claim that platform employees are self-employed. since they argue they are not employers and thus have no employers’ responsibilities, they also have no interest in joining employers’ organizations or regulating working conditions in collective agreements. prassle and risak have analysed uber and taskrabbit, looking at the platforms’ business models in order to identify the employer in a collaborative economy. looking at various employer responsibilities, they find that uber’s business model fulfils all the functions of an employer, while taskrabbit only exercises some, leaving others to be shared between the performing parties, the platform, and the users.61 marianne jenum hotvedt has analysed uber’s business model, and specifically the norwegian concept of the employee, and, finding that the business model is a grey area, argues that the employer’s responsibility in the collaborative economy does not necessarily have to be all or nothing.62 ilsö and weber madsen analyse a number of platforms operating in denmark, and find that employers are yet to organize to any significant extent.63 there is no nordic case about performing parties and platforms, but in one case in the uk uber has been found to be the employer of its drivers.64 the collaborative economy is an industry that differs greatly from what is customary in the nordic model, where collective agreements are 61 jeremias prassle and martin risak ‘uber, taskrabbit & co platforms by employers? rethinking the legal analysis of crowd work’ (2016) comparative labour law and policy journal 37, 619–51. the five criteria are inception and termination of the employment relationship; receiving labour and its fruits; providing work and pay; managing the enterprise–internal market; and managing the enterprise–external market. 62 hotvedt 2016, 337. 63 anna ilsö and louise wever madsen, industrial relations and social dialogue in the age of collaborative economy (irsdace) 2018 national report denmark, employment relations research centre department of sociology university of copenhagen; see also more generally about the concept of the employer in hasselbalch comments about danish law, hasselbalch 2013 (2017) section iii, section 2. 64 employment appeal tribunal uber bv and others v mr y asiam & others (2017) ukeat/0056/17da (eat), 10 november 2017. njcl 2018/1 109 the self-evident and most important regulatory instrument. until the employers take on a more organized form, there will be no collective agreements. it seems likely that those least averse to collective bargaining, despite the lack of clarity about their position as parties to an action, are the umbrella companies, for they already have a trade organization and say they are meeting their responsibilities as employers.65 5.3. who is covered by collective agreements? given the broadest definition, the concept of ‘employee’ would certainly apply to a good many crowdworkers. where a crowdworker is judged to be an assignment worker rather than an employee, it is very likely this falls under the term ‘dependent contractor’ in section 1 (2) the 1976 co-determination act (1976:580), and the same could be true of a self-employed crowdworker too. the conflicts that can arise if the self-employed take employees’ jobs by working for less than the wages agreed in the collective agreement were settled some time back in swedish law by the term 'dependent contractor'. that is someone ‘who works for another and at that time is not employed by them, but has a position that in essentials is the same as an employee’s’.66 källström argues that the reason why the 1976 co-determination act also covers some of the self-employed is that they can negotiate and enter into collective agreements without affecting the application of other labour laws, such as the 1982 employment protection act.67 the consequence of crowdworkers being accounted employed or ‘dependent contractors’ is that they are protected by the 1976 codetermination act’s regulations on the right to join a trades union, to negotiate, to engage in collective bargaining and enjoy its legal effects, to strike, etc.68 social partners can enter into a collective agreement on their behalf, or apply the workplace’s existing collective agreements, on the assumption that the performing parties’ work comes within the scope of the collective agreement.69 when social partners collectively bargain for those who are not employees or those the cjeu term the ‘false self-employed’, the 65 egenanställningarden svenska partsmodellens ingenmansland 2017:1 furion tco:s (federation of white-collar workers) think tank. 66 section 1 (2) of the 1976 co-dermination act. 67 kent källström löntagarrätt, (juristförlaget jf ab 1994), 70–1. 68 sections 7–9, 10, 26–7, 41 of the 1976 co-determination act. 69 section 26 of the 1976 co-determination act. digital platforms & the nordic model 110 question is whether it conflicts with eu competition legislation. this will not be discussed further here.70 5.4. are the parties ready for new collective agreements? given the way social partners have handled new situations previously, the answer has to be a cautious yes. consider how the social partners handled temporary work agencies, a brand new service industry in sweden in the early 1990s.71 almega and lo, the blue-collar trades union,72 and again almega and the white-collar trades unions,73 arrived at a collective agreement for staff working for temporary work agencies in around 2000. what was interesting about the two collective agreements in question is that they cover the entire private sector, meaning that a temporary work employee can work in any of the sectors covered by the collective agreement and enjoy the same collective agreement and conditions. the exact detail of the agreements differ, but the principles are the same—both cover all temporary work employees, regardless of the industry they are hired out to.74 the upshot is that temporary work 70 see moor in westregård 2016; westregård 2017, how ‘dependent contractor’ relates to eu competion law in the cjue judgement in fnv kunsten informatie en media, c– 413/13, eu:c:2014:2411. 71 ronnie eklund, ‘temporary employment agencies in the nordic countries’ (2002) scandinavian studies in law 43, 311-33. 72 the collective agreement on general employment conditions for temporary work blue-collar workers between temporary work agencies almega (bemanningsföretagen almega) and the blue-collar unions fastighetsanställdas förbund, gs—facket för skogs, träoch grafisk bransch, handelsanställdas förbund, hotell och restaurang facket, if metall, seko—serviceoch kommunikationsfacket, svenska byggnadsarbetareförbundet, svenska elektrikerförbundet, svenska kommunalarbetareförbundet, svenska livsmedelsarbetareförbundet, svenska musikerförbundet, svenska målareförbundet, svenska pappersindustriarbetareförbundet and svenska transportarbetareförbundet, for 1 may 2017 to 30 april 2020. 73 the collective agreement on general employment conditions for temporary work white-collar workers and professionals between temporary work agencies almega and the white-collar workers and professionals unions unionen and the academic alliance. the swedish association of graduate engineers is the representative for the academic alliance. the academic alliance includes a variety of professions, including as university lecturers, physiotherapists, scientists, and engineers, such as akademikerförbundet ssr, civilekonomerna, dik, sveriges arbetsterapeuter, fysioterapeuterna, jusek, naturvetarna, sveriges farmaceuter, sveriges ingenjörer, sveriges psykologförbund, sveriges skolledarförbund, sveriges universitetslärarförbund and sveriges veterinärförbund, for 1 may 2017 to 30 april 2020. 74 the collective agreement for white-collar workers and professionals has one set of conditions used throughout the temporary work industry. the blue-collar agreement has the same regualations for salary (§ 4–5) and working hours (§ 7–9) in the industry njcl 2018/1 111 agencies and their employees are now considered to be a service industry in their own right.75 just which solutions the social partners might choose in order to regulate the collaborative economy are hard to gauge. were a collective agreement to define the concept of employee for crowdworkers, that would be taken into account by the labour court when assessing the concept of employment in the digital economy, in much the same way as happened for journalists (see section 3.3). however, the concept of employment is not optional law in the sense that all social partners are free to determine its content by means of collective agreements, but the collective agreements’ definition may be taken into account as an evidentiary fact—industry practice—in an overall assessment.76 6. social insurance for crowdworkers77 inherent to the nordic model is the idea that if someone's employment ceases or they are incapacitated, the social security system will step in with unemployment benefit, sickness benefit, and the like. the challenge the nordic countries face is applying the existing social security regulations to crowdworkers. the most important issues for crowdworkers include access to social insurance and the methods for calculating their benefits. the protection offered by social security and unemployment benefits was designed for permanent employees in regular, full-time work; for temporary employees who have irregular working hours and incomes, or who have more than one employer, problems arise. the official inquiry into social insurance found in 2015 that there are shortcomings in the weighting system for remuneration, and that workers with multiple temporary work employments are at a disadvantage.78 for example, it is almost impossible to know in advance how much benefit will be paid. several new, precarious forms of work in where the person works for the moment. other conditions such as holiday pay and insurance (§ 10–22) are the same for temporary work employees, regardless of the industry. 75 see especially the blue-collar workers’ collective agreement (3) and the social partners’ common declaration of intent; see also the agreement’s importance for temporary work in sou 2011:5 bemanningsdirektivets genomförande i sverige, chap 6.5-6. 76 lunning 2016, 25. 77 see annamaria westregård, ‘social protection for workers outside the traditional employment contract—a swedish example’, in mies westerveld and marius olivier (eds.) social security outside the realm of the employment contract (edward elgar, forthcoming). 78 sou 2015:21 mer trygghet och bättre försäkring, 316 ff., 322 ff. digital platforms & the nordic model 112 the digital economy are thus firmly in the benefits grey zone, and crowdworkers fail to cross the social insurance threshold, or their benefits are calculated in a way that leaves them at a disadvantage. it has proved particularly difficult for unemployment benefit funds to decide whether those working for umbrella companies are employed or selfemployed.79 some reforms were made or initiated in 2018 with the aim of improving the social insurances and employment protection for precarious workers including crowdworkers. 80 it is similarly difficult to pin down who is responsible for the payment of social insurance contribution and tax—the platform, the service consumer, or the crowdworkers themselves (if they are held to be self-employed). in social insurance the dividing line is not, as in labour law, between self-employed and employee, but between those considered to have their own businesses (who must pay their social insurance contribution themselves) and those who are self-employed and do not carry out work independently, for whom the principal has to pay social insurance contribution, just like an employer has to pay its employees’ social insurance contribution.81 the problem, as the official inquiry into social security noted, is that the assumption is that employers are ‘in the system’, and that all taxes and social security contributions are reported and paid correctly. income that is not accounted for is not included in the calculation of social benefits, which are based on declared income. the result is that the entire informal sector falls outside sweden's social and unemployment insurance system. the swedish tax agency has identified a number of tax issues with the new collaborative economy. its primary concern has been who should be responsible for paying social security contributions and handling tax credits for everyday services and transport services.82 it can 79 see the swedish unemployment insurance board (iaf), uppdragstagare i arbetslöshetsförsäkringen, 2016:3. 80 a legal change in sfs 2018:670 and prop. 2017/18:168 stärkt försäkringsskydd för studerande och företagare; proposal for legal changes in sou 2018:49 f-skattesystemet – några särskilt utvalda frågor; inquiry for new legislation in kommittédirektiv dir. 2017:56 trygghet och utveckling i anställning vad gäller arbetstid och ledighet; kommittédirektiv dir. 2018:8 en ny arbetslöshetsförsäkring för fler, grundad på inkomst; kommittédirektiv dir. 2018:54 ett tryggare företagande i ett förändrat arbetsliv – för tillväxt och innovation. 81 chap 2 the 2000 social insurance contribution act (2000:980); see also kent källström, ‘employment and contract work’ (1999), comparative labour law & policy journal 21/1, 162. 82 skatteverkets rapport dnr 1 31 129651–16/113 delningsekonomi. kartläggning och analys av delningsekonomins påverkan på skattesystemet 2016. njcl 2018/1 113 be difficult in a collaborative economy83 to judge whether it is the client or the platform that is renumbering the performing party, and thus is responsible for paying tax and social insurance contributions if the performing party does not have business tax certificiate approval. where the platform determines the nature of the service, its price, and the contract between the provider and the client, it is a clear indication that the performing party is subordinate to the platform. the platform, and not the client, will then be responsible for paying the performing party and for paying tax and social security contributions. if instead it is the performing party who decides when to do the work and the price, etc., they are then independent of the platform, which is only a means of communication between the service producer and the service consumer. in that case it is the service consumer who pays the performing party, and thus is responsible for paying taxes and social security contributions. this can be administratively difficult because it is often only the platform that has the performer’s personal information. another catch is that a great many performing parties work for a large number of assignment workers, and often have only low, sporadic incomes. the swedish tax agency has found that it is far more common to have undeclared income, and in larger quantities, in the collaborative economy than in other comparable traditional service industries.84 7. concluding remarks it is interesting to see how the new technology has brought brand new business models as the digital economy has matured. if nothing else, it affects conditions for how work is done and by whom. the legislature is often several steps behind, while social partners tend to grasp the new situations faster. the exact interpretation of the concept of employment as it pertains to crowdworkers working for a platform will depend largely on the platform’s business model. there are a considerable variety of models, and it is therefore unwise to make any general pronouncements. the swedish concept of ‘employee’ is a broad one, and many crowdworkers certainly fall into that bracket. the statutory protections for someone’s working and employment conditions if they are on a short, fixed-term contract are limited, while social partners in the service sector have reached collective agreements that have improved the conditions for those in short-term employment; however, there are no 83 see sou 2017:26, 62. 84 skatteverkets rapport 2016, 25, 29–34. digital platforms & the nordic model 114 collective agreements in sweden yet that specifically concern crowdworkers in the digital economy. this is because there are still question marks. is there an employer, and, if so, who? the swedish regulation of ‘dependent contractors’ looks to be particularly interesting for the collaborative economy, where many crowdworkers are caught in the grey zone between employee, the ‘false self-employed’, assignment workers, and self-employed. there are presently two official inquiries into possible legislative measures, one looking at the fiscal definition of employee and whether it has led to greater numbers of the ‘false self-employed’,85 and the other looking at precarious employment on short, fixed-term contracts (intermittent employees).86 the findings of both inquiries will impact on crowdworkers. the directives state that the social partners’ collective bargaining should not be obstructed by possible changes to the legislation, which is in line with the nordic model. when social partners make collective agreements in the traditional manner, the legislator normaly does not go in and regulate the same issue in law or if they do the legislation is made semi-discretionary and allow the social parners to make other agreements in collective agreements. there are also moves to legislate on the matter at the eu level within the european commission’s proposed european pillar of social rights.87 the proposal for an update to the written statement directive,88 promises e.g. several innovations that may be of interest to crowdworkers, including a definition of ‘employees’, new basic rights in an ‘information package’, minimum employment conditions such as a maximum length for trial periods, rules on parallel employment, the right to convert to another form of employment, and training.89 the swedish parliament has said immediately a firm no to the commission’s proposal, fearing it goes too far in its detailed regulation at the eu level of 85 dir 2017:108; sou 2018:49 86 dir 2017:56. 87 european commission brussels 26.4.2017 com(2017) 250 final communication from the commission to the european parliament, the council, the european and social committee and the committee of the regions establishing a european pillar of social rights. 88 council directive 91/533/eec of 14 october 1991 on employers’ obligations to inform employees of the conditions applicable to the contract or employment relationship; see also commission staff working document refit evaluation of the ‘written statement directive’ (directive 91/533/eec). 89 proposal for a directive of the european parliament and of the council on transparent and predictable working conditions in the european union com (2017) 797. njcl 2018/1 115 questions that the swedish parliament believes should be regulated nationally, and preferably through collective agreements in accordance with the nordic model.90 these legislative initiatives may be a factor in the social partners organizing and, finally, coming to the negotiating table and conclude a colletive agreement for digital collaborative platforms. another related issue is the social security system’s difficulties with crowdworkers. in some respects, social insurance and pensions are in the scope of the collective agreements. yet when it comes to social insurance and unemployment insurance, it is the responsibility of the swedish legislature to ensure it is brought up to date to reflect the realities of the new collaborative economy. 90 the decision of parliament 1 march 2018, utlåtande 2017/18:au11. 1 jurisdictional clauses in platform work contracts: a danish perspective asger lund-sørensen* * phd-fellow, department of law, university of aarhus, denmark. jurisdictional clauses in platform work contracts 262 1. introduction ................................................................................... 263 1.1. the platform economy and work ................................. 264 1.2. the platforms ....................................................................... 266 1.2.1. clickworker ............................................................... 266 1.2.2. taxify ............................................................................ 266 2. jurisdiction, agreements and platform work .................... 267 2.1. agreeing ................................................................................. 267 2.2. relevance .............................................................................. 268 2.3. legal instruments .............................................................. 268 2.4. application ............................................................................ 270 2.4.1. clickworker ............................................................... 270 2.4.2. taxify ............................................................................ 276 3. conclusion ....................................................................................... 282 4. epilogue ............................................................................................ 283 njcl 2018/1 263 abstract recent technological developments have increased the need for a restatement of some of the prescriptive concepts in labour law, consumer law, completion law, contract law as well as in other areas. many researchers have increased their scrutiny of these concepts, and for this special issue of the nordic journal of commercial law, this article tries to deal with what might be an overarching legal issue the issue of where to solve potential disputes. this paper is both investigative and exploratory in nature. using doctrinal research method, and two examples, the author examines the possible legal approaches to disputes arising from work contracts entered into by individuals and platform companies. the analysis of two different jurisdictional clauses takes into account the character of the subject in the main contract, and finds potential difficulties and consequences in applying the current pil regime to the sui generis contracts of the platform economy. following the conclusions, while based on inductive reasoning, it could be hypothesized that there is a need for a restatement of some concepts in pil. this paper argues, based on two examples, that jurisdictional agreements in platform work contracts, and the rules governing them, cause uncertainty and unpredictability. further studies need to be done to support this. 1. introduction most contracts of work involve parties located in the same country, wherefore the question of jurisdiction does not need much consideration. however, in contracts with an international aspect these questions can be of great importance, and jurisdictional agreements can create predictability in the legal relationship. that the standardized patterns of both the social and economic regulation of labour are changing can hardly be contested.1 the prevalence of standard employment contracts as the means of engaging in remunerated work, is declining around the world.2 in recent years a new phenomenon, the platform economy, has introduced a new international aspect to the world of work. the digital nature of the platform economy opens up the possibility of cross-border work contracts different from the ones we know. 1 alain supiot (ed), beyond employment (oup 2001) 2. 2 katherine v.w. stone, ‘the decline in the standard employment contract: evidence from ten advanced industrial countries’ (2012) ssrn <https://ssrn.com/abstract=2181082> accessed may 29th 2018. jurisdictional clauses in platform work contracts 264 1.1. the platform economy and work the platform economy has been debated, publicly and scientifically, for around a decade. in short, a platform is a digital location, where users of different characteristics can obtain information and interact, socially or economically.3 the platform economy is a term used to encapsulate the economic transactions and business models that unfold within the framework of the platforms. the platforms of interest in this article are the ones that provide access to labour, as opposed to the ones that provide access to capital goods. there is no consensus on what exactly comprises ‘platform work’. neither in the political/media discourse or in the academic debate is the term used systematically.4 this conceptual confusion blurs the debate, but for the purpose of this article the concept of platform work is seen as a specific manifestation of the broader online platform economy, more precisely one involving the provision of labour.5 the labour can be of a digital or manual nature but the platform has to be involved in some way other than by presenting static information on a website. the platform can play a role in either the organisation of the work in the production process and/or in the provision of the labour itself.6 this article focuses only on platforms where labour is the principal service, which clearly distinguishes them from the capital platforms. in this article work platforms are exemplified by the cases of clickworker7 and taxify8 that are both described below. the two examples have been chosen because they both include jurisdictional clauses in their terms and conditions of use (t&c) and because clickworker is, and taxify aims to be, available in denmark. for the purpose of this article the term service providers covers the individuals performing the labour. the term platform is used to describe the company that connects the labourer and the entity that is in need of labour – the latter covered by the terms user or customer. 3 sacha garben, ‘protecting workers in the online platform economy: an overview of regulatory and policy developments in the eu’ (european agency for safety and health at work 2017), 9 (garben: protecting workers) <https://osha.europa.eu/en/tools-and-publications/publications/regulatingoccupational-safety-and-health-impact-online-platform> accessed may 29th 2018. 4 cristiano codagnone and bertin martens, ‘scoping the sharing economy: origins, definitions, impact and regulatory issues’ (2016) institute for prospective technological studies digital economy working paper 2016/01 <https://ssrn.com/abstract=2783662> accessed may 29th 2018. 5 garben: protecting workers, 11. 6 ibid. 7 clickworker <www.clickworker.com> accessed may 29th 2018. 8 taxify <www.taxify.eu> accessed may 29th 2018. njcl 2018/1 265 as far as the nordic research agenda on platform economy is concerned, the scholarly angles have been vastly different.9 a common denominator in much of the international research and a critical factor in any labour law debate is the classification issue concerning the ‘service providers’. are they independent contractors, employees or something in-between? as trebor schulz writes, ‘the question of misclassification might seem overly technical, inessential, or even esoteric … ’, 10 for the uninitiated, but as this article will show, the question can have far-reaching implications for the parties involved – not just in a labour law context. in most member states, the lack of an employment relationship means that labour law is inapplicable.11 the platforms have been accused of misclassifying their service providers as independent contractors to avoid labour law obligations.12 the response from the platforms has mainly referred to the contracts that state that the service providers are not employees and that the platforms only provide a technology service. to rectify a potential classification issue through litigation, the question of jurisdiction must first be answered. when a service provider enters into a contract as an independent contractor, he often accepts terms that potentially reduce his chances of successful litigation, by reducing the number of jurisdictions available to him. the validity of such jurisdictional clauses is therefore interesting. as this article will show, the question of jurisdiction depends on the outcome of a ‘classification debate’ as well. as long as there is doubt regarding the classification, there will be doubt as to the validity of the jurisdictional clauses, which will be a source of unpredictability instead of predictability. this article examines what issues member state judges, in casu a danish judge, must consider, what instruments and principles are applicable and how the validity of the clauses will be assessed. 9 see for example marie jull sørensen, 'private law perspectives on platform services' (2016) journal of european consumer and market law, volume 5, issue 1, 15, jane bolander, ‘deleøkonomi og skat’ in peter møgelvang-hansen (ed), liber amicorum (ex tuto 2016), and marianne jenum hotvedt, ‘arbeidsgiveransvar i formidlingsøkonomien? tilfellet uber’ (2016), lov og rett, volume 56, issue 8, 484. 10 trebor scholz, uberworked and underpaid (polity press 2017) (scholz 2017), 129. 11 garben: protecting workers, 15. 12 the labour court in paris decided that uber and their service providers were bound by no employment contract, in the judgement of january 29th 2018 in the case f 16/11460 florian menard v uber < www.diritto-lavoro.com/wpcontent/uploads/2018/02/sentenza-del-29-gennaio-2018.pdf> accessed may 31st 2018 (english translation); the employment appeal tribunal in london reached a different conclusion, and considered the service providers to be ‘workers’ in a british context, see uber b.v. and others v mr y aslam and others [2017] ukeat/0056/17/da. jurisdictional clauses in platform work contracts 266 1.2. the platforms this section presents the two example platforms, which represent two of the archetypes of the platform economy, crowdsourced digital work and transport services. 1.2.1. clickworker clickworker is a german platform that ‘utilizes the knowledge of the crowd’.13 the concept, in short, is based on a database of service providers (clickworkers), willing to work, and a line of customers with tasks to be solved. prior to offering any tasks, the platform collects information on the service providers’ skills, knowledge and interests.14 the platform has a full-service solution and a self-service solution, each indicating a different level of engagement from them. both products involve breaking down large and complex tasks into microtasks that can be solved by an individual. microtasks may vary from translating longer texts to performing one simple search on google.com and reporting the results. after the service provider has completed the task, the platform ensures the quality by different means, including statistical process control, audits and peer review. if the work performed is ‘inadequate and unsatisfactory’ no payment is made.15 the service provider is offered tasks at a piecemeal rate and the platform handles the remuneration. 1.2.2. taxify taxify is an estonian platform with an international transportation network. the concept is based on a smartphone application, an app, which allow people to request personal transportation services.16 a user in need of the service can enter a request in the app and the platform then searches for an idle service provider. the platform then offers the task to the assigned service provider and if accepted he is dispatched. the service provider picks up the user in his own car and drives to the destination after which the payment is made. the service providers are considered to be independent contractors.17 the platforms collect information on the service providers’ activity level, rate of acceptance 13 clickworker, ‘about clickworker’ <www.clickworker.com/about-us> accessed may 29th 2018. 14 clickworker, ‘our crowd – the clickworkers’ <www.clickworker.com/aboutus/clickworker-crowd> accessed may 29th 2018. 15 clickworker, ‘general terms and conditions (clickworkers)’ <https://workplace.clickworker.com/en/agreements/10123> (clickworker t&c), 3.1. 16 the business model is very similar to that of uber, which has become notorious around the world. for a thorough analysis of the business model, that covers everything from philosophy, ethics, economy, business and law, see henry schneider, uber: innovation in society (palgrave macmillan 2017) (schneider: uber). 17 taxify, ‘general terms for drivers’ <https://taxify.eu/da/legal/terms-for-drivers> (taxify t&c), para 10.4 njcl 2018/1 267 and location, which together with the users’ ratings are used for suspending underperformers, temporarily or permanently. 2. jurisdiction, agreements and platform work the issue of jurisdiction is usually the first one to present itself in a transnational case.18 the eu commission estimates that almost 70 % of european cross-border contracts on goods and services involve a jurisdictional agreement.19 allowing the parties to choose the jurisdiction creates legal certainty and predictability and party autonomy is therefore of paramount importance in international private law. 20 an exclusive agreement can either concern prorogation or derogation, by expressly pointing out that proceedings must or must not be brought in a specific forum. a non-exclusive agreement points out a specific forum, but does not restrict the parties, retaining some flexibility, at the expense of predictability. if a service provider located in denmark works via a digital platform with its base in germany, there is a possible conflict of interest. both parties might wish to pursue litigation in a specific forum. most probably, each party will prefer to pursue litigation in his home country, as there are usually several obvious advantages over litigating in a foreign system. 2.1. agreeing in the platform economy, the business model is reliant on the streamlined infrastructure of a strong and experienced actor for it to be able to reach its goals of lower transaction costs and thereby profit.21 oftentimes, the platform’s strongest bargaining chip is the access to the market, in other words, taxify’s passengers are only available through taxify’s platform.22 if the platforms holds the key to a market with large access costs, this places them on top in the negotiation process. the service providers, on the other hand, regardless of their legal status, are alone. they presumably do not have a team of legal experts advising them, and they might not have the competencies to understand the boilerplate language in a standard contract. as many of the service 18 ketilbjørn hertz and joseph lookofsky, transnational litigation and commercial arbitration (4th edn, djøf 2017) (hertz & lookofsky 2017) 471. 19 commission, ‘staff working paper, impact assessment’, sec (2010) 1547 final, 29. 20 peter arnt nielsen, ‘exclusive choice of court agreements and parallel proceedings’ in the permanent bureau of the hague conference on private international law, a commitment to private international law. essays in honour of hans van loon (intersentia 2013) 409. 21 scholz 2017, 43. 22 taxify connects two groups of people and thereby creates the market. the first group has idle capacity and would like to exchange it on the market, and the other group has a demand for the capacity and would like to pay for it, cf. schneider: uber, 29ff. jurisdictional clauses in platform work contracts 268 providers are oftentimes working through the platforms only to supplement their income,23 they are possibly inclined to accept terms they otherwise would not, when the contract is offered as one of adhesion, in the sense that it is presented on a “take it or leave it” basis. this could mean that the ones that rely solely on the platform to make a living, are forced to accept the same terms. 2.2. relevance whether or not the parties can rely on the jurisdictional agreement is in itself important as the purpose is to ensure a high degree of legal certainty and predictability. furthermore, a binding jurisdictional agreement can have the effect that a party is prevented from relying on mandatory rules that would have been applied, if another court had jurisdiction. this is especially relevant in the borderline territory of labour law, where most of the rules cannot be derogated from to the detriment of an employee. if the status of a service provider is unclear, the question arises as to what provisions govern the validity of the jurisdictional agreement, and therefore according to which law the existence of a relationship is going to be assessed. a service provider might be considered an employee in one member state and an independent contractor in another. as will be shown below, the jurisdictional regime assumes inequality in the employment relationship, wherefore protective measures apply.24 2.3. legal instruments in assessing jurisdictional agreements, the first step is to decide which legal instrument to apply.25 denmark’s national rules on territorial jurisdiction are found in part 22 of the administration of justice act.26 however, following paragraph 247, the act’s international jurisdictional rules yield for the brussels i regime. denmark recently ratified the 2005 hague convention on 23 anna ilsøe and louise w. madsen, ‘faos research paper 163’ (2018) irsdace – national report denmark, 4.2.1.2. <https://faos.ku.dk/publikationer/forskningsnotater/fnotater-2018/fnotat_163__industrial_relations_and_social_dialogue_in_the_age_of_collaborative_economy_ _irsdace_.pdf> accessed may 29th 2018. 24 hertz & lookofsky 2017, 110. 25 alameda c., alfonso et al., ‘choice-of-court agreements under brussels i recast regulation’, escuela judicial (spain), 3. <www.ejtn.eu/documents/themis%20luxembourg/written_paper_spain1.pdf> accessed may 29th 2018. 26 lbkg nr. 1101 af den 22. september 2017, retsplejeloven [the administration of justice act]. njcl 2018/1 269 choice of court agreements.27 jurisdictional agreements relating to contracts of employment are expressly excluded from the scope of the convention.28 the convention does not, however, change the state of the law relating to intra-eu cases, wherefore it will not be discussed further in this article. the brussels i regulation governs issues of jurisdiction and the recognition and enforcement of judgments in civil and commercial matters. 29 denmark is opting out from the community cooperation in a number of areas, including the field of justice, wherefore the regulation as such does not apply. however, due to a bilateral agreement between eu and denmark, the rules of the regulation apply regardless. this distinction will not be examined further, and the regulation will be applied in a danish context as is. the general principle of brussels i is that jurisdiction is dependent on the domicile of the defendant. 30 article 4 states that a defendant, whatever his nationality, can be sued in the courts of the member state in which he has his domicile. the objective of the domicile jurisdiction, and of the regulation, is inter alia, to: “ … ensure legal certainty and avoid the possibility of the defendant being sued in a court of a member state which he could not reasonably have foreseen.”31 if the dispute regards certain matters, including insurance, consumers or employment, it is for the plaintiff to choose either the general or a special jurisdiction.32 article 25 governs jurisdictional agreements and has two purposes: giving the parties freedom to choose and limiting that power, reasonably.33 to make sure that the jurisdictional agreements strike the right balance, certain conditions of validity are put in place,34 and it is a prerequisite for the validity of a jurisdictional agreement that it satisfies all formal and material conditions in article 25.35 27 lov nr. 670 af den 8. juni 2017, lov om ændring af retsplejeloven, lov om bruxelles i-forordningen m.v. og forskellige andre love [act amending the administration of justice act and various other laws]. 28 hague conference on private international law, hague convention on choice of court agreements, june 30th 2005, art 2(1)(b). 29 council regulation (ec) 1215/2012 of 12 december 2012 on jurisdiction and the recognition and enforcement of judgments in civil and commercial matters (recast) [2012] oj l351/1 (brussels i). 30 brussels i, art 4. 31 brussels i, recital 16. 32 peter mankowski, ’article 7’ in ulrich magnus and peter mankowski (eds), brussels ibis regulation: volume i (verlag dr. otto schmidt 2016) (m&m: brussels ibis), note 1. 33 ulrich magnus, ’article 25’ in m&m: brussels ibis, note 1. 34 case 25/76 galeries segoura sprl v. société rahim bonakdarian (1976) ecr 1851, para 6. 35 magnus (n 34), note 75. jurisdictional clauses in platform work contracts 270 2.4. application this section presupposes a dispute between a service provider located in denmark and the two platforms, clickworker36 and taxify.37 the service provider is presumed to institute proceedings in denmark. 2.4.1. clickworker clickworker uses the following clause in its standard terms: “insofar as this is legally permissible, essen shall be the exclusive venue for any legal disputes arising out of the business relationship between clickworkers and clickworker”38 from the wording of the clause, it is safe to presume that the intention is to confer exclusive jurisdiction to the courts of essen, germany. for the danish court to assess the jurisdictional clause, it first has to decide whether the dispute falls within the scope of the brussels i regulation. article 1(1) of the regulation states that it applies in civil and commercial matters. the definition of such matters is not given in the regulation itself, but it is generally accepted in both the literature and case law of the european court of justice (ecj), that all litigation between private parties fall within the scope of the regulation, except when the case is excluded by subject matter.39 employment law is specifically included as there are special provisions on the matter in section 5. next, the court has to assess whether the courts of a member state have exclusive jurisdiction following article 24 of the regulation. exclusive jurisdiction bypasses all other general and special rules of jurisdiction and cannot be derogated from by agreement.40 the case at hand is not subject to exclusive jurisdiction. 36 not only is clickworker accessible from denmark, they have actively sought out workers here as well by placing job ads online, cf. jobindex, ‘internet research/dataindsamling’ <www.jobindexarkiv.dk/cgi/showarchive.cgi?tid=h683856> and jobindex, ‘tekstforfattere og korrekturlæsere’ <www.jobindex.dk/vis-job/h669070> both accessed may 30th 2018. 37 taxify is not currently active on the danish market but they are present in several european countries, e.g. austria, czech republic, hungary, poland and the baltic countries. taxify has stated that they are looking to enter the danish market following uber’s goodbye, cf. the copenhagen post, ‘taxify eyeing denmark following uber’s demise’ (march 31st 2017) <http://cphpost.dk/news/business/taxify-eyeing-denmarkfollowing-ubers-demise.html> accessed may 30th 2018. 38 clickworker t&c, para 8.3. 39 pippa rogerson, ‘article 1’ in m&m: brussels ibis, note 16. 40 luís de lima pinheiro, ‘article 24’ in m&m: brussels ibis, note 3, cf. brussels i, art 25(4). njcl 2018/1 271 the next matter at hand is to examine whether the claimant falls within one of the protected categories in brussels i. these protected categories are comprised of what is seen as weaker parties in the need of protection from standard clauses in contracts.41 the protection consists of provisions placing the ‘weaker party’ in an intermediate position between the exclusive nature of article 24 and the ‘total’ freedom of article 25.42 in relation to platform work and international contracts on the provision of labour the relevant ‘weaker party protection regime’ to consider is the one found in section 5 of the brussels i regulation, namely the one concerning individual contracts of employment. that the contract classifies the relationship as a ‘business relationship’43 carries in itself no decisive meaning. section 5 governs jurisdiction in matters relating to individual contracts of employment according to article 20(1) of the brussels i. as with the general scope, the regulation does not include a definition of the concept of an ‘individual contract of employment’. as such a concept has different meaning in different member states, the ecj has intervened and developed an autonomous interpretation of the concept.44 the concept has been developed in both case law and in the jenard/möller report45 accompanying one of the brussels i predecessors, the lugano convention.46 according to the ecj in the case of shenavai v kreischer, a contract of employment is characterized by a durable relation between individual and company, a lasting bond, which brings the worker, to some extent, within the organizational framework of the business.47 the contract also has to be linked to the place of performance, which determines what mandatory rules and collective agreements are to be applied.48 it has however been suggested that the precedent value of the ruling, in a brussels i context, is suboptimal due to the fact that employment contracts were not separately regulated at the time.49 furthermore, the jenard/möller report introduced the concept of subordination to the equation, following which an employment contract 41 geert van calster, european private international law (2nd edn hart publishing 2016) (van calster: epil), 89. 42 van calster: epil, 106. 43 clickworker t&c, para 3.4. 44 van calster: epil, 109. 45 paul jenard and gustav möller, ‘report accompanying the convention on jurisdiction and the enforcement of judgments in civil and commercial matters done at lugano on 16 september 1988’ (jenard/möller report), oj [1990] c189/57. 46 convention 88/592/eec on jurisdiction and the enforcement of judgments in civil and commercial matters [1988] oj l 319. 47 case 266/85 hassan shenavai v klaus kreischer [1987] ecr 239, para 16. 48 ibid. 49 van calster: epil, 110. jurisdictional clauses in platform work contracts 272 presupposes a relationship of subordination of the employee to the employer.50 in the case of holterman v spies51, ag cruz villalòn specified that the purpose of the assessment is to distinguish the employment contracts from other contracts involving the provision of services.52 to do this, the ecj looks towards the concept of a worker in the context of article 45 tfeu and other legislative acts, since it has been developed more and continues to be.53 in such a context, the essential feature of an employment relationship is that a person, for a certain period of time, performs services for and under the direction of another, in return for which remuneration is paid.54 the test that the court applies is used both to establish the concept of a worker and to distinguish workers from independent contractors. in the case of ruhrlandklinik, the court asserted that restricting the concept of a worker to those that have a tangible employment contract was liable to undermine the effectiveness of the underlying directive in an inordinate and unjustified way.55 the term worker must be given a broad interpretation, and any exceptions to and derogations from, on the other hand, must be interpreted strictly.56 when distinguishing workers from independent contractors, the ecj does not shy away from reclassifying the relationship, if the independence is merely notional.57 but where do they draw the line? the ecj delimits negatively by stating that: “since the essential characteristic of an employment relationship . . . is the fact that for a certain period of time a person performs services for and under the direction of another person in return for which he receives remuneration, any activity which a person performs outside a relationship of subordination must be classified as an activity pursued in a self-employed capacity . . . ”58 50 jenard/möller report, point 41. 51 case c-47/14 holterman ferho exploitatie bv and others v f.l.f. spies von büllesheim [2015]. 52 ibid, opinion of ag cruz villalòn, para 27. 53 case c-47/14 holterman ferho exploitatie bv and others v f.l.f. spies von büllesheim [2015], para 41. 54 case 66/85 deborah lawrie-blum v land baden-württemberg [1986] ecr 2121, paras 16 and 17; for the context of the council directive (ec) 92/85, see the judgment in case c-232/09 dita danosa v lkb līzings sia [2010], para 39. 55 case c-216/15 betriebsrat der ruhrlandklinik ggmbh v. ruhrlandklinik ggmbh [2016], para 36. 56 case 139/85 r. h. kempf v. staatssecretaris van justitie (1986), ecr 1741, para 13. 57 case c-256/01 debra allonby v accrington & rossendale college [2004] ecr 873, para 71. 58 case c-268/99 aldona malgorzata jany and others v. staatssecretaris van justitie [2001] ecr 8615, para 34. njcl 2018/1 273 even though the ecj has developed the concept, it is for the national courts, in casu the danish court, to apply the criteria in practice.59 as to the durability criteria, the relationship between the service provider and the platform, in the case of clickworker, can hardly be characterized as a lasting bond per se. the service providers are entitled to delete their accounts at any time on their own initiative,60 and some might do so after performing a limited amount of work. some might however depend on the income from the platform as an important or necessary component of their budget, as suggested by a qualitative survey.61 it can be helpful to draw upon the case law of the ecj in the context of the free movements, as it treats a similar issue, namely when a work activity can be viewed as so marginal and ancillary that it excludes the performer from the concept of worker and thus from the protection of the treaty. in the case of fenoll did the fact that the worker was paid substantially less than a guaranteed national average not mean that he was excluded from worker classification and the accompanying protection.62 some do not pursue activities on the clickworker-platform as anything else than a distraction, but the 41% that depend on the platform assumedly maintain a stronger bond with the platform, which could be considered as bringing them within the scope of the employment relationship in a brussels i context. that the platform denotes the service providers as ‘our clickworkers’ could be seen as an indication that they are, to some extent, brought within the organizational framework of the platform. the users are considered the customers of the platform and not of the service providers. as to the link to a place of performance criteria, the t&c stipulates that the platform itself, in concreto its websites, are to be considered ‘the workplace’. 63 this author argues that the notion of ‘place’ in relation to the ‘workplace’ and the ‘place of performance’ is becoming increasingly 59 van calster: epil, 110, cf. case c-337/97 c.p.m. meeusen v. hoofddirectie van de informatie beheer groep [1999], ecr 3289, para 16. 60 clickworker t&c, para 2.7. 61 the survey, which suggests that 41 % of clickworker’s service providers are dependent on the income, was made by the german organisation fair crowd work, that collects information about platform work from the perspective of workers and unions, cf. fair crowd work, ‘clickworker’ <http://faircrowd.work/platform/clickworker> accessed may 30th 2018. 62 case c-316/13 gérard fenoll v. centre d’aide par le travail [2015], para 33. 63 clickworker t&c, para 1.1. jurisdictional clauses in platform work contracts 274 obsolete.64 in the holterman v spies ruling, the ecj abstained from emphasizing exactly this part of the shenavai v kreischer test.65 the subordination criteria must be assessed on the basis of all of the factors and circumstances characterising the relationship between the parties.66 in the clickworker t&c, ‘projects’ are presented as invitations to submit an offer, an ‘invitatio ad offerendum’.67 technically, this means that the platforms’ posting of a job to the list does not constitute a binding offer. however, in practice are service providers only ‘offered’ jobs that correspond to their ‘qualification profile’ and the work itself can begin immediately after clicking on it.68 after the customer has made a request to clickworker, the platform creates tasks that can be performed by individual service providers. the conditions of a specific project are set by the customer and/or the platform, and the remuneration is non-negotiable. the prerequisite qualifications for service providers to accept a specific task and the criteria for subsequent acceptance of the performance are also set by the platform. if either a temporal or material condition is not met, the service provider will receive no compensation. when the service providers’ performance is ‘inadequate or unsatisfactory’, he will, if the customers’ deadline allows it, have three days to revise or rectify the defective work product. the platform expressly states that the service provider is prohibited from ‘subcontracting or outsourcing’ projects.69 if the service provider violates either the t&c or any other obligation arising from the contractual relationship, the platform reserves the rights to delete the user account.70 the data needed to make such a decision are collected seamlessly whenever the service provider accesses any part of the clickworker website.71 in this way, the platform can both supervise the performance of work and subsequently discipline poor performance. as the ecj in the holterman v spies ruling, for the first time, directly considered the meaning of ‘individual contract of employment’, in the context of brussels i, it is worth noting that ag cruz villalón sees ‘the power of management and instructions’ as the defining factor of a subordinate 64 miriam a. cherry, ‘a taxonomy of virtual work' georgia law review (2011) 951– 1013, ii, d. 65 case c-47/14 holterman ferho exploitatie bv and others v f.l.f. spies von büllesheim [2015], para 45. 66 ibid, para 46. 67 clickworker t&c, para 3.1. 68 this author created a profile on clickworker, accepted a task and performed the service, without further offer/acceptance formalities. 69 clickworker t&c, para 3.3. 70 clickworker t&c, para 2.7. 71 clickworker, ‘terms of data privacy’, paras 1 and 3, <https://workplace.clickworker.com/en/agreements/10124> accessed may 30th 2018. njcl 2018/1 275 relationship.72 this, and the fact that the ecj referenced the case law regarding article 45 tfeu, suggests that a wide definition of employment should be applied.73 there is an imbalance between the platform and the service provider. the platform has the power of management, e.g. when they assign a task to a specific service provider and subsequently monitor the performance, under the threat that non-compliance can lead to exclusion. even though the overall description of the project comes from the customer, it is the platform who divides it into smaller tasks and instructs the service providers in the performance of them. these factors point towards an employment relationship. that the service provider can choose when to work and what tasks to do does however point in the opposite direction. on the other hand, the notion of flexibility does not negate an employment relationship per se, since all factors and circumstances in each case has to be assessed. as shown above, numerous conditions are imposed on the service providers and control is exerted both during and after the performance. section 5 in brussels i is essentially a protection of the weaker party, the employee. to assess the relationship, one must first accede to the wide definitions of the ecj and take into account that the danish courts traditionally take a dynamic and teleological approach to the defining concepts of labour law.74 for all of the above mentioned reasons, provided that the specific dispute involves a service provider that depends on the income from the platform and moreover that the facts of the relationship perfectly align, it is not completely unwarranted to expect a danish court to consider the service provider and the platform to be in an employment relationship, and therefore section 5 of the regulation to be applicable. the service provider, for a certain period of time, performs a service for and under the direction of the platform in return for remuneration. the question of whether the jurisdictional agreement is valid in this specific example therefore has to be answered in the context of section 5, including article 23, which states that the protective provisions may only be departed from by agreement if said agreement is concluded after the dispute has arisen, or if the agreement gives the employee access to 72 case c-47/14 holterman ferho exploitatie bv and others v f.l.f. spies von büllesheim [2015], opinion of ag cruz villalòn, para 28. 73 louise merrett, ‘the contract of employment in its international and european law setting’ in mark freedland (ed) the contract of employment (oup 2016), 632ff. 74 ole hasselbalch, den danske arbejdsret i-iii (schultz arbejdsretsportal, online), section iii, 1.1, cf the ruling of june 24th 1986 søog handelsretten [the maritime and commercial court of copenhagen] in the case f-79/85, where a finishing artist at an ad agency, hired on a piecemeal basis, was considered to be an employee in the context of the legislation on sickness benefit but not in the context of the legislation on sick pay. jurisdictional clauses in platform work contracts 276 other jurisdictions than those indicated in the section itself.75 as the agreement obviously was entered into before the dispute arose, it is necessary to examine what jurisdiction(s) section 5 appoints. the brussels i regulation distinguishes between disputes where the employee is the plaintiff and those where the employer is the plaintiff. as the case at hand, and the majority of labour law suits,76 is initiated by the ‘employee’, the relevant provision is article 21. the general rule of jurisdiction in the defendant’s domicile is found in article 21(1)(a) as well. employers may however also be sued in the courts for the place where or from where the employee habitually carries out his work, according to article 21(1)(b)(i). this is the main factor of the protective design of section 5, as it allows the weaker party, the employee, to commence, or defend himself against, court proceedings in the place ‘where it is least expensive’.77 the habitual workplace is, according to the ecj, to be understood as the place that is the effective centre of the working activities and where the essential parts of the duties vis-à-vis the employer are performed.78 there are no provisions in the contract between the platform and the service provider as to where, geographically, the work has to be performed, but only that it has to be performed in the area they call the ‘workplace’.79 for the purpose of this analysis, the assumption is that the work is performed in denmark, wherefore the habitual workplace leads to danish jurisdiction, according to article 21(1)(b)(i) of the brussels i regulation. the words of the jurisdictional agreement ‘essen shall be the exclusive venue‘ implies the prorogated exclusive jurisdiction of the court, which means that the effect of the clause would be that the service provider is barred from suing in denmark. the jurisdictional agreement conflicts with article 23(2) of the brussels i regulation, in this specific example, thus voiding it, according to article 25(4). 2.4.2. taxify taxify’s standard terms contain the following dispute settlement clause: “any dispute that may arise in connection with this agreement, whether with respect to its existence, validity, interpretation, performance, breach, termination or otherwise, shall be settled by way of negotiations. if the respective dispute resulting from this agreement could not be settled by the negotiations, then the dispute will be finally solved in 75 brussels i, arts 23(1) and (2). 76 carlos esplugues mota, ‘article 21’ in m&m: brussels ibis, note 1. 77 case c-125/92 mulox ibc ltd v hendrick geels [1993], ecr i-4075, para 19, cf. mota (n 768), note 13. 78 case c-383/95 petrus wilhelmus rutten v cross medical ltd [1997], ecr i-57, para 23. 79 clickworker t&c, para 1.1. njcl 2018/1 277 harju county court kentmanni court house in tallinn, republic of estonia.“80 as can be seen from the quote, the taxify t&c require initial ‘negotiation’ as a dispute settlement mechanism. however, for the purpose of this article, this negotiation-clause is treated as legally nonbinding on the basis of uncertainty.81 the danish courts have not determined specific criteria regarding the enforceability of such clauses, but seem to allow the parties to initiate litigation regardless of even welldefined mediation clauses.82 the taxify t&c negotiation-clause is however not well-defined. even though mandatory language as the word ‘shall’ is used, the clause contains neither deadlines nor specification of the negotiation participants, which is essential for the enforcement of multi-tier resolution clauses.83 for the remaining part of this article, it is presumed that the intention of the clause is to confer exclusive jurisdiction to the harju county court in talinn, estonia. this court is located in the same county as the registered offices of the platform, taxify. the article takes the view that the dispute falls within the scope of brussels i, according to article 1, and that no court has exclusive jurisdiction, according to article 24. next is the matter of whether the claim relates to an individual employment contract. the fact that the parties have expressly agreed that the relationship is not an employment relationship,84 carries in itself no decisive meaning. the same criteria as used for the analysis of the clickworkerrelationship has to be applied, in order to determine the nature of the relationship in the context of brussels i. whether or not the relation between the platform and the service provider is durable and brings the worker within the organizational framework of the business may vary greatly. the taxify t&c allow both individuals and ‘fleet companies’ to register. individuals may only perform transportation services themselves, whereas fleet companies may simply use the platform’s software as a dispatching system.85 for the purpose of this article only the individual agreements are considered. 80 taxify t&c, para 15.2. 81 neil andrews, arbitration and contract law (springer 2016), 36. 82 see for example the ruling of january 20th 2015 søog handelsretten [the maritime and commercial court of copenhagen] in the case h-41-10. 83 dan terkildsen, “denmark” in multi-tiered dispute resolution clauses (international barassociation 2015), 60 <https://www.ibanet.org/lpd/dispute_resolution_section/litigation/multitiereddis puteresolution.aspx> last accessed july 25th 2018. 84 taxify t&c, para 10.4. 85 taxify t&c, paras 2.5 and 2.6. jurisdictional clauses in platform work contracts 278 the agreement allows the service provider to receive requests from users interested in transportation services, which the service provider may ‘accept or ignore at [his or her] choosing’.86 the service provider is free to, at any point, delete the account.87 while providing transportation services, the service provider is obliged to have all the necessary licenses, certifications and registrations, and the platform has a right to control these. the service provider is also obliged to perform the services in ‘a professional manner’ in accordance with the business ethics ‘applicable to providing such services’, including, but not limited to, taking the route least costly for the user and not having other passengers in the car.88 the compliance with these ethics is enforced through a rating system, which allows the users to rate and give feedback upon completion of services. the ratings are published and linked to the service provider’s account, just as an ‘activity score’, based on the habits of the service provider, is calculated. both parameters have to exceed a minimum level, set by the platform.89 if a service provider, after being notified by taxify, does not increase the parameter levels within a prescribed period of time, his or her account will be deactivated automatically, temporarily or permanently, at the discretion of the platform.90 the platform is generally entitled to terminate the agreement, at its own discretion.91 the characteristics of the individuals that use the taxify platform may vary as much as in the case of clickworker. the characteristics of the services performed on the clickworker platform vary greatly within a certain genre, whereas the taxify services are specifically limited to transportation. in this case, where the service provider is not affiliated with a taxi company or other dispatchers, the threshold for being brought within the framework of the platform’s organisation is juxtapose to the threshold for more traditional taxi drivers. as the service provider is legally bound to the ethics and standards of the platform and furthermore given labels and tags to affix to the car, a court may very well consider that a service provider performing services for taxify is brought within the organizational framework of the platform. however, this criteria, as well as the ‘place of performance’ criteria, are not sufficient to point to an employment relationship, also due to their ‘builtin obsolescence’.92 assessing the subordination criteria involves examining whether the service provider performs his services under the direction of another, in return for remuneration. when a user sends a request for transportation services to the platform, the platform presents the service 86 taxify t&c, para 4.5. 87 taxify t&c, para 11.2. 88 taxify t&c, para 4.4. 89 taxify t&c, paras 8.1 and 8.2. 90 taxyfi t&c, para 8.3. 91 taxify t&c, para 13.4. 92 text to n 66. njcl 2018/1 279 provider with the possibility to accept or decline. technically, the choice is the service provider’s, though declining is equal with a lowered activity score, which is equal to the risk of being deactivated.93 the service provider is entitled to charge a fare for each service provided, and a fare is automatically calculated and suggested after the trip.94 the service provider may lower the fare, but in reality this seems unlikely, as the ‘taxify fee’ that the service provider has to pay, is based on the suggested price. the service provider may only charge a higher fee, if he is a licensed taxi driver and in that capacity legally obliged to use a physical taximeter. the platform can ‘adjust’ the fare after the trip, for example if the user believes the service provider took a longer route than necessary.95 to assess a claim from a user, the platform may use any of the personal data it has collected, including the location based information that is transmitted constantly via the smartphone application while active.96 to sum up: taxify controls key information, the contact details and location of the user, it determines the ‘right’ route and the ‘right’ price and it reserves the power to unilaterally change the t&c and/or terminate the relationship. taxify solicits feedback, sets the relevant performance levels, and makes decisions based on the users’ feedback – just as employers do.97 does that mean it is an employment relationship? the threat of termination in case of misbehaviour does not in itself help distinguish the relationship from other commercial transactions.98 what selfemployed carpenter or gardener is impervious to ratings on google, facebook or trustpilot? the service providers do have a relatively high degree of freedom, as they for example decide when, where and if at all to work. they might be sanctioned if they are active on the platform and do not accept tasks, but they are not sanctioned if they do not activate the platform to begin with. the service provider accepts the risk of losses. if the user does not pay, or the transaction is cancelled due to the service providers’ non-compliance with the t&c, the losses fall on the service provider, not the platform. the platform does not receive payment either, but nor did it invest capital or labour in the specific transaction, at least to a significant degree. the service provider is obliged to, at his own expense, provide and maintain all equipment and the means necessary to perform the services.99 the question is, how 93 taxify t&c, para 13.6. 94 taxify t&c, para 4.7. 95 taxify t&c, para 4.8. 96 taxify t&c, 11.1. 97 benjamin sachs, ‘uber and lyft: customer reviews and the right-to-control’ (onlabor, may 20th 2015) <https://onlabor.org/uber-and-lyft-customer-reviews-andthe-right-to-control> accessed may 30th 2018. 98 guy davidov, ‘the status of uber drivers: a purposive approach’, spanish labour law and employment relations journal, 1-2, vol. 6, november 2017, 12. 99 taxify toc, para 4.6. jurisdictional clauses in platform work contracts 280 these freedoms and responsibilities measure against the factors that point towards a subordinate relationship. employment relationships are characterized as suffering from a ‘democratic deficit’.100 this imbalance is what labour law regulation, in this case the weaker party protection provisions in brussels i, seek to even out. one thing that particularly distinguishes the taxify-platform from the clickworker-platform is that to provide services through taxify one must acquire operational capital of significant value, i.e. a car compared to a personal computer. comparing the size of the parties’ investment in the agreement might put some perspective on the imbalance and help decide whether the dispute at hand arises from an employment relationship. considering the size of the investment, which on the platforms’ side is the same no matter what, the service provider, who uses a bought and paid for family car to supplement her income, will not necessarily fall into the same category as the young entrepreneurial spirit, who takes out a loan to buy a car, and if applicable a permit, with the intention of performing transportation services as his main profession. the latter might, at some point, want to buy additional cars, hire drivers herself and use taxify as a dispatcher, or maybe she maximises her profits by working via different transportation platforms simultaneously and thereby advertises her services on several different markets. as the service providers may vary greatly, and the formalities of the contract alone will take us only so far, it is hard to reach a conclusive analysis without limiting it to an actual case with actual facts.101 to explore the differences in the legal regimes applicable to jurisdictional agreements concerning platform workers, regardless of their employment status, this article hereinafter considers the possibility that the plaintiff is an independent contractor, in the context of the brussels i regulation, thus not encompassed by section 5. the jurisdictional agreements validity therefore has to be assessed under article 25 of the regulation, including the requirements on form, certainty and fairness.102 article 25 regulates international jurisdiction 100 davidov (n 101), 14. 101 the ecj has yet to rule in a dispute concerning the employment status of ‘a platform worker’, but in the recent ruling in case c-434/15 asociación profesional elite taxi v uber systems spain sl [2017], paras 37-40, the court notes that the platform, in casu uber, is more than an intermediation service, namely a part of a transportation service, over which they exercise decisive influence. the court gives no answers, but their assessment of the factors, such as uber setting the price, handling the payment and controlling aspects of the quality regarding both the vehicle and the conduct of the service provider, resembles the assessment one would have to do in the context of an employment relationship. 102 mukarrum ahmed, the nature and enforcement of choice of court agreements (hart publishing 2017), 4, iii, a. njcl 2018/1 281 agreements conclusively, within the scope of the regulation.103 however, as it has already been established that the agreement does not contradict articles 23 and 24 this issue will not be further examined. the material, territorial, temporal and personal scope of article 25 will not be discussed either. the certainty requirement, following the wording ‘disputes which have arisen or may arise in connection with a particular legal relationship’, serves to avoid doubts and disputes over the competent court and to prevent a party from forcing a weaker party to litigate in foreign jurisdictions.104 as such, this rules out catch all-clauses which cover all present and future disputes between two parties.105 the agreement between the platform and the service provider pertain to ‘the respective dispute resulting from this agreement’, whereas it clearly limits itself to one legal relationship. article 25 furthermore requires that the specific dispute is connected to the relationship for which the jurisdictional agreement is concluded. this requirement is met already due to the fact that the dispute arises from the same contract which contains the jurisdictional agreement.106 lastly, the certainty requirement demands that the prorogated court is designated with sufficient certainty. in the case at hand, the agreement clearly designates harju county court in tallinn, whereby the requirement is met. another central criteria when applying article 25 is that the parties have agreed that their disputes are to be litigated in a certain place.107 the ecj has affirmed the importance of this criteria several times, e.g. in the case of galeries segoura sprl v. société rahim bonakdarian (25/76).108 the agreement in this context is an autonomous concept in eu-law and it must be appraised only in relation to the requirements in the article itself.109 if the agreement lacks true consensus, the jurisdictional agreement is invalid and has no effect.110 the criteria are: (a) the agreement must be in writing or evidenced in writing or (b) the form of the agreement must comply with either the practices of the parties or in international relationships with a usage which the parties are or ought to have been aware of.111 in assessing the ‘in writing’-criteria112 the salient point is whether both parties have expressed their consent in written form.113 the criteria 103 magnus (n 33), note 15. 104 ibid, note 65. 105 ibid, note 66. 106 ibid, note 69. 107 ibid, note 75. 108 (1976) ecr 1851, para 6. 109 case c-116/02 erich gasser gbmh v. misat srl (2003) ecr i-14693, para 51. 110 magnus (n 33), note 77. 111 brussels i, art. 25 (1). 112 brussels i, art. 25 (1) (a), 1st alt. 113 magnus (n 33), note 95. jurisdictional clauses in platform work contracts 282 can be met by means of electronic communication, as stated in (2) of the article. that the taxify jurisdictional agreement is contained in the general terms and conditions is therefore, in itself, without significance for the validity of the clause. when a potential service provider creates an account, he accepts the platforms’ terms of service and privacy policy, and is provided with a link to both.114 the ecj has established a set of conditions validating jurisdictional clauses in standard contract terms, for the purpose that a jurisdictional clause should not ‘slip a reasonable party’s attention’.115 what the conditions, in general terms, prevent are hidden clauses that are printed on the back of the contract or on separate papers.116 where a party specifically signed that he had ‘read and accepted’ the t&c, the formal requirements of the criteria were held to have been complied with.117 this leads to the conclusion that the taxify jurisdictional agreement, prima facie, complies with the requirements of article 25. even though the agreement is an autonomous concept in this context, there are situations where national law must be considered, even in the case of an otherwise valid agreement. 118 these situations, including the issues that may rise as a result of estonian contract law, choice of law provisions and possible reverse lis pendens effects, fall outside the scope of this article. 3. conclusion the clickworker t&c contain, at least for this purpose, an invalid jurisdictional agreement. if danish courts, contrary to the agreement, categorize the contract as an employment relationship, the jurisdictional agreement is void and unenforceable, according to article 25(4) of the brussels i regulation in that it is contrary to article 23. the danish courts may therefore continue proceedings. the taxify t&c contain, at least for this purpose, a valid jurisdictional agreement. a danish court must therefore, of its own motion, reject the proceedings as inadmissible, according to article 25(1) of the brussels i regulation. 114 this method is called click-wrapping. websites often refer to terms and conditions that are located behind ‘a click’ on a link to a subpage. in effect, this means that there is no guarantee that the signee has in fact seen the t&c he agrees to. however, the ecj accepts this practice in commercial relationships, as long as the method allows for the t&c’s to be saved and/or printed before the conclusion of the contract, see case c322/14 jaouad el majdoub v carsontheweb.deutschland gmbh (2015), para 40. 115 ibid, note 97. 116 case 24/76 estasis salotti di colzani aimo and gianmario colzani v. rüwa polstereimaschinen gmbh (1976) ecr 1831, para. 9. 117 magnus (n 33), note 99. 118 ibid, note 79a. njcl 2018/1 283 4. epilogue this last section is part impact analysis and part perspectival reflections. the individuals’ motivation for entering into contracts online, crossing virtual borders, have traditionally been found within the consumers’ sphere. the possibility of concluding contracts of work on an online platform gives both companies and individuals new possibilities. when contracts are entered into, the parties’ bargaining powers are hardly ever equal. however, through negotiations compromises are made, and different terms and conditions benefit different parties. an unfavourable jurisdictional clause can be mitigated by a favourable price, or maybe even a favourable choice of law. contractual freedom is the reason that brussels i focuses on the agreement or consensus and only limits it reasonably, as mentioned above (section 2.3). the validity criteria for jurisdictional agreements emphasize an informed consent. these criteria are put in place to distinguish voluntary and coerced agreements. the weaker party protection rules are also put in place to assure reasonableness, as there are categories of people whom we assume to be weak and thus in need of protection. companies actively target service providers in other countries, as mentioned above, by posting job ads on danish websites or announcing their arrival in mass media outlets. the risks of not protecting the weaker party is, that they are being taken advantage of by stronger parties, whom after having ‘coerced’ a jurisdictional agreement into the contract can rest surely knowing that the weaker party de facto has no access to justice. milana karayanidi describes it as letting “[t]he will of one part . . . entirely dominate the transaction to the point that it crushes the autonomy of the other party.”119 are these service providers necessarily the weaker party? the service providers’ themselves have sought out an international business partner, when they could have picked a local. they actively chose to sign up with a multinational enterprise, maybe because they have more clients, customers or users, thus increasing the potential amount of work for the service providers. the prospect of forcing platform companies to litigate in forums all over the world might however make them seem weak. some have even predicted their ‘death by litigation’, without them having to worry about jurisdiction.120 take clickworker, who has over 1 million service providers. according to themselves, 35% of them are from the united states, 15% from germany, 25% from the rest of the 119 milana karayanidi, ‘reassessing the approach to jurisdiction in civil and commercial matters: party autonomy, categorical equality and sovereignty’ (dphil thesis, trinity college dublin 2018) 121. 120 sarah kessler, ‘the gig economy won’t last because it’s being sued to death’ (fast company february 17th 2015) <www.fastcompany.com/3042248/the-gigeconomy-wont-last-because-its-being-sued-to-death> accessed 31st may 2018. jurisdictional clauses in platform work contracts 284 eu, and the rest are from all over the world, including canada, australia and south america.121 litigating in exotic jurisdictions will likely entail expenses, which will be passed on to the users and remaining service providers, and legal obstacles can ultimately push the platforms out of the market and force them to leave the country. who benefits from the end of the platforms? the 41% that depend on the income,122 and probably the most likely to dispute their employment status, would lose an important source of income. in a platform economy context, the european regime governing jurisdictional agreements seem to provide not legal certainty and predictability but uncertainty and unpredictability. this author therefore subscribes to the view that the european private international law is characterized by a lack of coherence and conceptual vision,123 for my part at least in the field of work contracts in the platform economy. applying the autonomous concepts of the ecj can sometimes feel like being handed a square peg and being asked to choose between two round holes, as famously expressed by district judge vince chhabria in the cotter v lyft case.124 the judge continued, stating that the 20th century tests for classifying workers were not helpful in addressing a 21st century problem. even though derived from a case from california, this point might prove valid in the eu as well. just as across the atlantic, the 20th century tests will have to suffice in the absence of legislative action or judicial pronouncement. this article does not provide alternative regulatory approaches, nor does it intend to suggest that the balance has shifted in favour of anyone in particular. this article does however intend to emphasize that the current balance of power in work contracts is not alone determined by the market, but also an outcome of political decisions. 121 clickworker, ‘our crowd – the clickworkers’ <www.clickworker.com/aboutus/clickworker-crowd> accessed may 31st 2018. 122 see n 62. 123 giesela rühl, ‘the protection of weaker parties in the private international law of the european union: a portrait of inconsistency and conceptual truancy’ (2014), journal of private international law, volume 10, no 3, 358. 124 cotter v lyft, inc., united states district court, n.d. california. jan 1, 201560 f. supp. 3d 1067 (n.d. cal. 2015), 19, 8-9. 1 public service compensation in the aviation sector: the swedish airports state aid cases michele giannino* * italian qualified lawyer, llm (leicester), pdd (lond) dip(itm). i would like to express my sincere gratitude to dr. federich romby (italian qualified lawyer llm (lse)) for his precious suggestions and insightful comments on the previous drafts of the article. public service compensation in the aviation sector 210 1. introduction .................................................................................. 211 2. the relevant eu regulatory framework for public service compensation to airports .......................................... 214 2.1. the altmark doctrine ...................................................... 215 2.2. the relevant state aid sgei rules for pso compensation to airports ............................................... 216 3. the facts of the swedish state aid airport cases ............ 218 4. the application of the altmark doctrine ......................... 219 5. the application of the state aid rules for sgei ............. 220 5.1. the qualification of public tasks entrusted to airports as sgei .................................................................. 221 5.2. the compatibility conditions regarding compensation and overcompensation ....................... 222 5.3. the compatibility condition of compliance with eu public procurement rules ................................................ 223 5.4. the other relevant compatibility conditions ...... 224 6. conclusive remarks ...................................................................... 226 6.1. finding that public tasks of beneficiary airports are genuine sgei ........................................................................ 226 6.2. meeting the compatibility conditions in the state aid rules on sgei ................................................................ 228 njcl 2017/2 211 abstract for those eu airports whose catchment area is sparsely populated, it may be difficult to achieve the necessary air traffic volume that generates sufficient revenues to cover operating losses. public financial support is often crucial to keep these airports operating, though it may be considered incompatible state aid under article 107(1) tfeu. to have such public aid cleared by the european commission, two options are open to national authorities. either they invoke the compatibility conditions for operating aid to airports recently introduced by the commission’s 2014 aviation guidelines on state aid to airports and airliners or they claim that the aided airports constitute sgei and that compensation granted to airports for the provision of such services meet the compatibility conditions, laid down by the 2011 sgei decision or the sgei framework adopted by the commission. the article deals with the second option based on the state aid rules for sgei. it delves into how the commission has applied these rules in the aviation sector, looking in particular at the cases of kalmar airport, sundsvall timra airport, skelleftea airport. these three swedish state aid airport cases are noteworthy because they illustrate what the commission expects from national authorities to demonstrate that airport aid complies with the sgei rules. arguably, on applying the criteria laid down by the 2014 aviation guidelines, the commission has crafted a two-limb test for the qualification of airports as sgei, revolving around the isolation condition and the market failure condition. after reviewing the commission’s decisional practice on the administration of this test, it can be submitted that small airports located in scarcely inhabited areas struggling to make profits are more likely to be considered by the commission as sgei. national authorities should bear this point in mind either when drafting public service compensation arrangements for airports or when defending the commission’s objection that such arrangements constitute incompatible state aid in the context of article 107 tfeu enquiries. national authorities should also make sure that the entrustment acts satisfy the formal and substantive requirements included in the compatibility conditions laid down by the commission’s 2011 sgei decision and sgei framework. a shoddy compliance is likely to result in the commission finding that the national measures under scrutiny are outside the safe harbours provided by the 2011 sgei decision and sgei framework with the ensuing risk that the compensation may be viewed by the commission as incompatible state aid. 1. introduction regional airports are sometimes located in sparsely populated areas and achieve small traffic figures. unsurprisingly, they are likely to struggle to generate enough revenues to cover their operating losses and earn a public service compensation in the aviation sector 212 profit. support through public funds is then often crucial to keep these airports opened, but it may trigger the regulatory intervention of the european commission to ascertain whether this kind of support constitute state aid under article 107(1) tfeu. european commission’s 2014 aviation guidelines indicate that, under certain conditions, the management and running of an airport can be considered as services of general economic interest (hereinafter sgei)1. when an airport qualifies for sgei, it it may fall within the scope of application of the sgei exception in article 106(2) tfeu2. as a result, public financial sustain granted to such an airport can be found to be compatible with the internal market on the basis of article 106(2) tfeu. to clarify under which conditions this exception applies, the commission has adopted the so-called sgei package to enact new state aid rules for sgei3. the sgei package includes hard-law and soft-law instruments 1 communication from the commission, guidelines on state aid to airports and airliners, ojeu 2014 c99/3, point 72 that reads that: ‘as far as airports are concerned, the commission considers that it is possible for the overall management of an airport, in well-justified cases, to be considered an sgei. in the light of the principles outlined in point 69, the commission considers that this can only be the case if part of the area potentially served by the airport would, without the airport, be isolated from the rest of the union to an extent that would prejudice its social and economic development. such an assessment should take due account of other modes of transport, and in particular of high-speed rail services or maritime links served by ferries. in such cases, public authorities may impose a public service obligation on an airport to ensure that the airport remains open to commercial traffic. the commission notes that certain airports have an important role to play in terms of regional connectivity of isolated, remote or peripheral regions of the union. such a situation may, in particular, occur in respect of the outermost regions, as well as islands or other areas of the union. subject to a case-bycase assessment and depending on the particular characteristics of each airport and the region which it serves, it may be justified to define sgei obligations in those airports’. 2 article 106(2) tfeu lays down that: ‘undertakings entrusted with the operation of services of general economic interest or having the character of a revenue-producing monopoly shall be subject to the rules contained in the treaties, in particular to the rules on competition, in so far as the application of such rules does not obstruct the performance, in law or in fact, of the particular tasks assigned to them. the development of trade must not be affected to such an extent as would be contrary to the interests of the union’. 3 nicola pesaresi, adinda sinnaeve, valérie guigue-koeppen, joachim wiemann, madalina radulescu, ‘the new state aid rules for services of general economic interest (sgei): the commission decision and the framework of 20 december 2011, available at http://ec.europa.eu/competition/publications/cpn/2012_1_11_en.pdf, last visited 5 september 2018. njcl 2017/2 213 and namely the sgei communication4, the 2011 sgei decision5, the 2011 sgei framework6 and the de minimis regulation7. member states can defend the commission’s objections that airport aid constitutes incompatible state aid under article 107(1) tfeu by invoking the rules in the sgei package. by the same token, member states can also forestall such objections by shaping financial aid packages for airports in accordance with the state aid rules for sgei. reliance on these rules, which in the context of this article will be labelled as the sgei strategy, may be an effective way for public authorities to financially support lossmaking airports that play a relevant role for local communities. since the enactment of the 2014 aviation guidelines, the european commission has approved public service compensation for airports on the basis of the sgei exception in the swedish cases of kalmar airport8, sundsvall timra airport9, skelleftea airport10. these decisions will be referred throughout this article as the swedish airports state aid cases. the commission considered the legality of airport aid in the form of public service compensation in a further case concerning a swedish airport, västeras airport11. however, public aid in this case was approved on the 4 communication from the commission on the application of the european union state aid rules to compensation granted for the provision of services of general economic interest, ojeu 2012, c 8/4, available at http://eur-lex.europa.eu/legalcontent/en/txt/pdf/?uri=celex:52012xc0111(02)&from=en, visited 5 september 2017. 5 commission decision of 20 december on the application of article 106(2) of the treaty on the functioning of the european union to state aid in the form of public service compensation granted to certain undertakings entrusted with the operation of services of general economic interest, ojeu 2012, l7/3, available at http://eurlex.europa.eu/legal-content/en/txt/pdf/?uri=celex:32012d0021&from=en, visited 5 september 2017. 6 communication from commission, european union framework for state aid in the form of public service compensation , ojeu 2012 c8/15, available at http://eurlex.europa.eu/legalcontent/en/txt/pdf/?uri=celex:52012xc0111(03)&from=en, visited 5 september 2017. 7 commission regulation no. 360/2012 on the application of articles 107 and 108 of the treaty on the functioning of the european union to de minimis aid granted to undertakings providing services of general economic interest, ojeu 2012 l 114/8, available, http://eur-lex.europa.eu/legal-content/en/txt/pdf/?uri=celex:32012 r0360&from=en, visited 5 september 2017. 8 commission decision of 2 december 2016, case sa.43964 – kalmar öland airportentrustment of a service of general economic interest, c(2016) 7781 final. 9 commission decision of 19 january 2016, case sa.38892sundsvall timra airportentrustment of a service of general economic interest, c(2016) 133 final. 10 commission decision of 19 january 2016, case sa.38757-skelleftea airport-.entrustment of a service of general economic interest, c(2016) final. 11 commission decision of 1 october 2014, case sa.18857, alleged aid to västeras airport and ryanair ltd, case sa.18857. public service compensation in the aviation sector 214 basis of the compatibility conditions in the 2014 aviation guidelines. incidentally, the sgei exception was accepted by the commission also in angoulême airport12 and inverness airport13, which were determined before and after the swedish airports state aid cases, respectively. whether and when, in the decisional practice of the commission, financial aid granted to airports entrusted with public tasks can be considered as a compensation for sgei is the issue addressed by this article. compensation granted to airports for performing public service obligation (pso) does not constitute state aid if it satisfies the four cumulative conditions set out in the altmark doctrine14. the focus of this article is, however, on the different scenario where public aid does not meet the requirements for the application of the altmark doctrine and its legality is assessed on the basis of the state aid rules for sgei. more precisely, this article examines the findings of the commission in the swedish airports state aid cases. these cases well illustrate the decisional practice developed by the commission for the application of the state aid rules for sgei in the aviation sector given that in these cases the sgei strategy was the main defensive argument invoked by the national authorities. in that regard, the article gives readers an insight into which facts and circumstances public authorities have to submit in support for their sgei-related claims to have the airport aid cleared by the commission. the remaining structure of the article is as follows. first, the article introduces readers to the relevant eu regulatory framework for airport aid in the form of public service compensation. second, the article describes the facts of the kalmar airport, sundsvall timra airport, skelleftea airport, distinguishing them from those in västeras airport. third and fourth, the article considers how the commission administered the altmark test and applied the state aid rules for sgei to the above swedish airports state aid cases. lastly, the article draws some conclusions. 2. the relevant eu regulatory framework for public service compensation to airports member states planning to give financial support to regional airports, which are ailing because revenues are lower than expenses, can argue that such financial sustain covers the operating losses of the beneficiary and then invoke the compatibility conditions for operating aid set out in the 2014 aviation guidelines15. when these public aid measures meet the above compatibility conditions they are approved by the 12 european commission, decision of 23 july 2014 (sa.33963) concerning aéroport d'angoulême. 13 europan commission, decision of 18 july 2017 (sa.45692) concerning airport of inverness. 14 european court of justice, case c-280/00, altmark trans gmbh,regierungspräsidium magdeburg v nahverkehrsgesellschaft altmark gmbh, [2003] ecr i-7747. 15 points 112-137 of the 2014 aviation guidelines, above note n. 1. njcl 2017/2 215 commission. it should be borne in mind, however, that the compatibility conditions for operating aid to airports will be available only throughout the 10-year transitional period, which started on the date of the enactment of the 2014 aviation guidelines16. alternatively, public authorities can rely on the sgei strategy, arguing that the pso imposed on airports have the nature of an sgei. as said above, point 72 of the 2014 guidelines expressly says that in welljustified cases the overall management of an airport can be considered as sgei. it is submitted that what differentiate sgei from pso is a quid plus,17 as reflected by the fact that sgei have special characteristics if compared to other economic activities. typically, the notion of sgei comprises services addressed to citizens or are supplied in the interest of society as a whole. such services are not and cannot be satisfactorily provided by the market ‘under conditions such as price, objective quality characteristics and access to the service consistent with the public interest, as defined by the state’.18 the power to determine which public tasks constitute sgei and sett the compensation to which the services suppliers are entitled is within the competences of the member states. these powers, however, are not unfettered as member states have to exercise them in compliance with the eu relevant provisions and case law. the measures enacted by member states are subject to the scrutiny of the commission that has to check whether the former have made no manifest errors in the definition of sgei19. 2.1. the altmark doctrine the underpinning for the altmark doctrine is that the public service compensation awarded to the airport is not state aid due to the lack of an economic advantage for the recipient. for article 107(1) tfeu to apply, several cumulative conditions must be fulfilled by the national measures alleged to constitute state aid, among which the award of an economic 16 point 112 of the 2014 aviation guidelines, above note n. 1. 17 caroline wehlander, ‘services of general economic interest as a constitutional concept’ (asser press -springer, the hague 2016) 200. on the relevance of the concept of sgei in state aid cases, see also erika szyszczak,’altmark assessed’in erika szyszczak (ed.) research handbook on european state aid law (edward elgar, cheltenham 2011), 248. 18 see, for example, european commission, ‘the new state aid package for sgei’, available at http://ec.europa.eu/competition/state_aid/overview/presentation_sgei_de_minimis_e n.pdf, visited 5 september 2017. 19 see point of the 2011 sgei decision, above note n 5, according to which ‘… it is clear from the case-law that, in the absence of sectoral union rules governing the matter, member states have a wide margin of discretion in the definition of services that could be classified as being services of general economic interest. thus the commission’s task is to ensure that there is no manifest error as regards the definition of services of general economic interest’. public service compensation in the aviation sector 216 advantage to the beneficiary. in the seminal altmark judgment20 the court of justice of the eu (hereinafter cjeu) has developed a four-limb test to establish whether the compensation paid to the supplier of a public service is an economic advantage under article 107(1) tfeu.21 a national measure that meets all the four cumulative conditions required by the altmark test does not constitute a state aid and need not to be notified to the commission. 2.2. the relevant state aid sgei rules for pso compensation to airports where an airport public service compensation failed the altmark test, thereby falling within the reach of article 107(1) tfeu, it can nevertheless be found to be compatible with the internal market if it satisfies the criteria laid down by the state aid rules for sgei. the criteria set by the 2011 sgei decision and the sgei framework are of particular relevance for the purpose of this article. the 2011 sgei decision is a hard law instrument, being binding in its entirety22. it applied to public service compensation schemes meeting some quantitative and qualitative criteria23. as far as the aviation sector is concerned, the 2011 sgei decision applies to smaller airports with an average annual traffic not exceeding 200,000 passengers over the duration of the sgei entrustment period24. public service compensation granted to such airports is exempt from the obligation of prior notification to the commission under article 108(3) tfeu and can be cleared if it fulfils the compatibility conditions laid down by the 2011 sgei decision25. in practice, the 2011 sgei decision lays down a set of de minimis rules for public service compensation. more importantly, it provides for a safe 20 see above note n.14. 21 the four conditions of the altmark test are as follows: i) the recipient undertaking is actually required to discharge public service obligations and those obligations have been clearly defined; ii) the parameters on the basis of which the compensation is calculated have been established beforehand in an objective and transparent manner; iii) the compensation does not exceed what is necessary to cover all or part of the costs incurred in discharging the public service obligations, taking into account the relevant receipts and a reasonable profit for discharging those obligations; iv) where the undertaking which is to discharge public service obligations is not chosen in a public procurement procedure, the level of compensation needed has been determined on the basis of an analysis of the costs which a typical undertaking, well run and adequately provided with means of transport so as to be able to meet the necessary public service requirements, would have incurred in discharging those obligations, taking into account the relevant receipts and a reasonable profit for discharging the obligations. 22 on the legal nature of decisions adopted by the european commission, see article 288 tfeu. 23 the criteria are laid down in article 2 of the 2011 sgei directive. 24 article 2(e) of 2011 sgei decision, above note n. 5. 25 article 1 of 2011 sgei decision, above note n. 5. njcl 2017/2 217 harbour for the eligible airports whereby pubic authorities can award public service compensation to these airports without being subject to the commission’s regulatory scrutiny. on the contrary, public service compensation for larger airports having more than 200,000 passengers per year falls outside the 2011 sgei decision and have to be assessed on the basis of the rules in the 2011 sgei framework. though not legally binding, the sgei framework is however of great practical relevance as it states how the commission applies in practice the state aid rules for sgei rules26. unlike the 2011 sgei decision, public service compensation under the sgei framework have to be notified to the commission. the compatibility conditions laid down by the sgei framework also differ from those in the 2011 sgei decision in other aspects, thereby requiring a more thorough analysis27. the sgei framework stipulates that the responsibility for the provision of sge must be entrusted to the undertaking concerned by way of one or more acts28. these acts have to specify the entrusted sgei by indicating the following elements: a) the content and duration of the pso; b) the undertaking and the territory concerned; c) the nature of any exclusive special rights awarded to the undertaking; d) the methods for calculating compensation; and e) the arrangements for preventing and recovering any over-compensation29. the other basic compatibility conditions in the sgei framework are as follows: a) duration of the entrustment which should be set by reference to objective criteria30; b) the compensation amount must not exceed the net cost of discharging the pso inclusive of a reasonable profit31; c) periodic overcompensation checks during the entrustment period and at the end of it32; and d) compliance with the transparency directive 2006/111/ec33. additional compatibility conditions include: a) public consultation to weight interests of users and providers34; b) compliance with the eu public procurement rules35; c) no discrimination to determine 26 the commission often relies on soft law instruments to clarify its approach to certain matters in the field of competition and state aid law. see, alison jones and brenda sufrin, ‘eu competition law (5th edition,oup 2014), p. 118. 27 nicola pesaresi, adinda sinnaeve, valérie guigue-koeppen, joachim wiemann, madalina radulescu, above note n. 3. 28 point 15 of the sgei framework, above note n. 6. 29 point 16 of the sgei framework above note n. 6. 30 point 17 of the sgei framework, above note n. 6 . 31 point 21 of the sgei framework, above note n. 6 . 32 point 49 of the sgei framework, above note n. 6. 33 point 18 of the sgei framework, above note n. 6. 34 points 14 and 60 of the sgei framework, above note n. 6 . 35 point 19 of the sgei framework, above note n. 6. public service compensation in the aviation sector 218 compensation36; d) incentives for the efficient provision of sgei37; e) careful assessment for serious competition distortions expected from compensation38. sections 5.1, 5.2 and 5.3 of the article delves into the approach followed by the commission to assess compliance of the national measures under scrutiny with the compatibility conditions to which the commission appeared to have attached more weight in assessing whether the aid was lawfully granted to the airports of kalmar, sundsvall timra and skelleftea. in addition to the clear entrustment of sgei, such compatibility conditions have been identified in those concerning the methods for the determination of compensation and avoiding overcompensation, compliance with eu public procurement rules. section 5.4, instead, has a brief look at the other compatibility conditions considered in the state aid to swedish airports cases. 3. the facts of the swedish state aid airport cases before starting the analysis of the findings of the commission in the swedish airports state aid cases, it may be helpful having a quick look at the financial aid provided by the challenged national measures. in that regard, it can be said that the public aid measures in kalmar airport, sundsvall timra airport and skelleftea airport are rather different from those considered in västeras airport. kalmar airport, sundsvall timra airport, skelleftea airport all concerned financial arrangements put in place by the contracting authorities as a compensation for the provisions of the sgei entrusted to the beneficiary airports. the measures by which the swedish authorities entrusted the sgei to the airports of kalmar, sundsvall timra and skellftea, which will be referred to in this article as the entrustment acts, were similarly worded and imposed on airports similar duties and obligations39. the subject matter of the entrustment acts was to give the addressees the task to keep the airports open to commercial air links. accordingly, the airports had to supply carriers with all the services that were necessary for the operation of commercial traffic. the entrustment acts provided for the compensation of the net costs incurred by the airport to discharge their public tasks. it also included an efficiency mechanism whereby the airport had to supply key indicators for the efficiency (kpi). if the kpi showed that the airport was less efficient than comparable swedish airports, the airport had to give an acceptable explanation. when no explanation was 36 point 20 of the sgei framework, above note n. 6. 37 point 39 of the sgei framework, above note n. 6. 38 points 51-59 of the sgei framework, above note n. 6. 39 the terms of the entrustment acts are reported in the decisions of the commission. see, in particular, skelleftea airport, above note n. 10, paras. 7-17; sundsvall timra airport, above note n. 9, paras. 9-19; kalmar airport, above note n. 8, paras. 4-16. njcl 2017/2 219 given, the compensation must not exceed the net cost incurred by the airport if it were as efficient as the comparison airports. as hinted before, the factual context in västeras airport was rather dissimilar as national authorities granted different types of public financial aid caught by the scope of article 107(1) tfeu40. the commission enquiry not only targeted the airport charges and the marketing incentives applied by the airport manager (vfab) to ryanair but also to the public financial sustain directly granted to vfab. to cover the long-standing losses from which vfsb was suffering, the local public authorities crafted and implemented a package of financial aid. this package included contributions by public authorities to the equity capital of vfab and operating support granted to vfab under the local airport scheme over the 2001-2010 period. to dispel the commission’s concerns that aid granted to vfab infringed article 107(1) tfeu, sweden argued that the majority of the activities of the västeras airport were not economic in nature. as the airport hosted flight schools and an aero club that did not perform economic activities, the airport services provided to those entities, so the argument run, did not have an economic nature41. rather, the services supplied by the airport to them had to be qualified as sgei. hence, sweden claimed that the financial aid given to vfab had the nature of an sgei compensation and did not constitute state aid. 4. the application of the altmark doctrine all the aid measures considered in kalmar airport, sundsvall timra airport, skelleftea airport and västeras airport failed the four-limb altmark test because they did not satisfy the fourth condition. this condition, which is arguably the most problematic for national authorities to be met, comes into play when the firm on which the pso is imposed is chosen outside a competitive tender procedure. to satisfy this condition, national authorities must show that the pso compensation was determined on the basis of the analysis of the costs that a typical well-run undertaking would have incurred in the provision of the public service plus a reasonable profit.42 yet, in kalmar airport, sundsvall timra airport, skelleftea airport and västeras airport the swedish authorities failed to correctly discharge this burden of proof. no analysis showing that the costs structure of the aided airport corresponded to that of an efficient comparable airport was provided. as a result, the commission took the view that the 40 vasteras airport, above note n. 11, paras. 13-36. 41 vasteras airport, above note n. 11, paras. 89-92. 42 vasteras airport, above note n. 11, para. 109; skelleftea airport, above note n. 10, para. 33; sundsvall timra airport, above note n. 9, para.35. public service compensation in the aviation sector 220 compensation for the airports was not determined on the basis of the costs of an efficient firm.43 the aid package reviewed in västeras airport also breached the first and second conditions of the altmark test. it infringed the first altmark condition because neither the entrustment act nor the by-laws of vfab, clearly defined the pso with which the airport was tasked. in the commission’s view, the bylaws of the airport manager made no reference to the pso imposed on the airport of västeras but only contained a general description of the corporate object of vfab.44 the second altmark condition requires that the entrustment act sets out in advance in an objective and transparent manner the parameters for the calculation of the pso compensation. considering the lack of a clear act of entrustment of an sgei to vfab, the commission concluded that there was no evidence of an ex ante definition of the pso compensation but rather only of ex post compensation of unanticipated losses.45 this element was not sufficient to consider the national measures compliant with the second altmark condition. 5. the application of the state aid rules for sgei at this point the arguments submitted by the swedish authorities employed in västeras airport diverged from those relied on in kalmar airport, sundsvall timra airport, skelleftea airport. though the västeras airport, with less than 200,00 annual passengers, was within the scope of application of the 2011 sgei decision, sweden did not go on with the sgei strategy but rather it relied on the provisions in the 2014 aviation guidelines. this change turned out to be successful as the commission held that the financial support granted to the airport satisfied the compatibility conditions for operating aid.46 on the contrary, in kalmar airport, sundsvall timra airport and skelleftea airport sweden still pursued the sgei strategy. because the annual passengers of the airports exceeded the 200,000 thresholds, whether the sgei exception applied to them had to be assessed in accordance with the rules in the sgei framework. the article now focuses on how the commission applied the rules in the sgei framework. 43 kalmar airport, above note n.8, paras. 24-32; sundsvall timra airport, above note n. 9, paras. 27-38; skelleftea airport, above note n. 10, paras. 25-36; västeras airport, above note n. 11, para. 109. 44 västeras airport, above note n. 11, para. 108. 45 västeras airport, above note n. 11, para. 109. 46 for the sake of completeness, the commission ruled that also the financial measures in favour of the airport that had the nature of investment aid met the compatibility conditions for the investment aid in the 2005 aviation guidelines and were accordingly declared compatible with the internal market. njcl 2017/2 221 5.1. the qualification of public tasks entrusted to airports as sgei logically the first issue to be considered to ascertain whether a pso compensation awarded to airports does not breach eu law is whether such pso constitute genuine sgei. as said above, the clear entrustment of sgei to the beneficiary airport is enlisted as compatibility conditions for aid by both the 2011 sgei decision and the sgei framework47. the 2014 guidelines provide for guidance on which factors and economic evidence can be relied on to demonstrate that the recipient is amongst the well justified cases in which the overall management of an airport can be considered as genuine sgei.48 in that regard, national authorities have to consider whether, absent the aided airport, its catchment area would be in such a situation of isolation, taking also into account alternative modes of transport, to prejudice the economic and social development of this area. applying these criteria, the commission considered the public tasks entrusted to the airports of kalmar, sundsvall timra airport and skelleftea airport as being a genuine sgei for the following reasons. first, the aided airports played a very important role in ensuring accessibility to their catchment areas from the main swedish and eu destinations. competing airports did not represent an acceptable alternative for passengers because they were at more than 100 km away from the aid recipient and a travelling distance of at least 90 minutes49 or because they lacked the necessary infrastructure for the operation of a sufficient level of commercial traffic.50 moreover, the travelling distance from some parts of the catchment areas of the recipients could be even longer,51 especially during winter time due to rough weather conditions.52 neither the maritime and rail links to/from the catchment areas of the airports of kalmar, sundsvall timra and skelleftea were satisfactory nor 47 see above at section 2.2 of this article. 48 point 72 of the 2014 aviation guidelines, above note n. 1. 49 kalmar airport, above note n. 8, paras. 59-66; skelleftea airport, above note n. 10, paras. 61-71; sundsvall timra airport, above note n. 9, paras. 62-64. 50 sundsvall timra airport, above note n. 9, para. 63. 51 in kalmar airport, above note n. 8, paras. 64-65, the commission observed that the airports of växjö and ronneby, were at an approximately 3h travelling time from the island of öland that was comprised within the catchment area of the airport of kalmar. therefore, especially for the inhabitants of the island of öland it was impossible to fly out to stockholm and return on the same day without an overnight stay at växjö or ronneby. these airports, then, could not ensure the needed connectivity between stockholm and the catchment area of the airport of kalmar, especially the island of öland. 52 skelleftea airport, above note n. 10, paras. 62 and 69; being the airport in the far north of sweden, close to the article circle, travelling time may be significantly prolonged by severe winter weather conditions. public service compensation in the aviation sector 222 they could be seen as an effective alternative to flying.53 therefore, the commission considered that the lack of acceptable connections would harm the standard of living of the inhabitants and the business prospective of the firms in the catchment areas of the aided airports, thereby prejudicing the social and economic development of those areas.54 the second reason on which the qualification of the airports of kalmar, sundsvall timra and skelleftea as sgei was grounded was that the airports would cease operating without the sgei compensation. all these airports were located in sparsely populated and remote areas, whereas the airports of sundsvall timra and skelleftea were close to the arctic zone.55 the aided airports also implemented the basic airport concept, which is a management tool that can boost the efficient use of the airports’ resources. notwithstanding that, the airports were unable to generate enough profit to cover their operating losses and without public support, in the form of an sgei compensation, they were likely to exit the market.56 after having established that the public authorities have correctly qualified the public tasks of the aided airports as sgei, the commission went on to assess whether the national measures under scrutiny also met the other compatibility conditions in the sgei framework. 5.2. the compatibility conditions regarding compensation and overcompensation the sgei framework requires an entrustment act to specify the pso and the methods to determine compensation57. the commission found that the entrustment acts were officially adopted by the contracting authorities and that such acts clearly indicated the content, the duration of the pso, the firm upon which the pso is imposed, the methods for calculating compensation and the arrangements for avoiding and recovering overcompensation. the compensation to be paid to the airports covered only the net costs of the sgei, as calculated on the basis of the observed factual operating losses suffered by the airport over a given year. to prevent overcompensation, the entrustments acts correctly laid down that the profits generated by the non-commercial 53 kalmar airport, above note n. 8, para. 68; skellfetea airport, above note n. 10, para. 73; sundsvall timra airport, above note n. 9, para. 65. 54 kalmar airport, above note n. 8, para. 69; skellfetea airport, above note n. 10, para. 74; sundsvall timra airport, above note n. 9, para. 66. 55 skellfetea airport, above note n. 10, paras. 78-79; sundsvall timra airport, above note n. 9, paras. 69-71 56 skellfetea airport, above note n. 10, paras. 79-81; sundsvall timra airport, above note n. 9, paras.71-73. 57 see section 2.8 of the 2011 sgei framework, above note n. 6. njcl 2017/2 223 activities outside the sgei have to be used to reduce the sgei compensation.58 from the sgei framework it emerges that the commission’s favourite approach to calculate the compensation for sgei is the net avoided cost methodology59. however, the application of this methodology to the airports of kalmar, sundsvall timra and skelleftea was inappropriate. the net avoided cost methodology requires the determination of the costs and revenues of the provider of the sgei in a hypothetical scenario where there are no sgei. since all the commercial activities of the airports outside the entrustment acts depended on the existence of the sgei, a hypothetical scenario where only the non-sgei activities are conducted could not be envisaged. for this reason, the commission employed the alternative methodology of the cost allocation, according to which the net cost for sgei corresponds to the difference between the costs and revenues for the provider of sgei. considering the reports delivered by the aided airports before the closing of each financial year, the compensation granted to them did not exceed the net costs of the sgei. for the above reasons, the commission concluded that the proper application of the net costs methodology based on the actually incurred costs prevented possible overcompensation.60 5.3. the compatibility condition of compliance with eu public procurement rules according to the sgei framework, the provider of the sgei must be selected in accordance with the eu public procurement rules61. prior to establishing that the entrustments acts complied with these rules, the commission had to assess whether the objected national measures fell within the scope of the eu public procurement legislation. the entrustment acts were qualified as service concession contracts because the major source of revenues for airports was the sgei compensation. next, the commission took the view that the mode for the provision of the entrusted sgei chosen by the contracting authorities was the in-house model in the sense of the teckal judgment.62 in teckal the cjeu ruled that when the provider of public services is controlled by the public authorities to which the major part of its activities are directed it must be considered as an in-house service provider in relation to the controlling public 58 skelleftea airport, above note n. 10, paras. 85-90; sundsvall airport, above note n. 9, paras. 77-81; kalmar airport, above note n. 8, paras. 76-79. 59 see, point 24, and especially, point 27 of the sgei framework, above note n. 6, which states that the commission regards the net avoided cost methodology as the most accurate method for determining the cost of a pso. 60 skelleftea airport, above note n.10, paras. 117-119; sundsvall airport, above note n. 9, paras. 107-109; kalmar airport, above note n. 8, paras. 96-103. 61 section 2.6 of the 2011 sgei framework, above note n. 6. 62 european court of justice, case c-107/98, teckal srl v comune di viano and azienda gas-acqua consorziale (agac) di reggio emilia, [1999] i ecr 08121. public service compensation in the aviation sector 224 authorities. hence, the provision of public service under the in-house model is outside the reach of the eu public procurement rules. that said, the commission went on to apply these rules to the facts of the swedish airports state aid cases. it observed that the managers of the aided airports were indirectly controlled by the contracting authorities and the main activity of the airport managers was to run the airports in the concession contracts concluded with the public authorities. the result of the qualification of the relationship between the contracting authorities and the airports as ‘in-house provision of services’ was that such relationship was outside the scope of the eu public procurement rules. hence, the commission concluded that the acts by which the beneficiary airports were entrusted with the sgei were exempt from the eu public procurement rules. the important consequence of this finding was that the compatibility condition of compliance with eu public procurement rules could not apply to the aid received by the airports of skelleftea, sundsvall and kalmar63. 5.4. the other relevant compatibility conditions this section of the article briefly discusses the compatibility conditions that apparently played a minor or no role in the line of reasoning followed by the commission in the swedish airports state aid cases. the absence of discrimination compatibility condition requires that in cases in which the same sgei were entrusted to several undertakings, the same methodology must be used to calculate the related compensation for all the suppliers of such services64. because the management of the airports of kalmar, sundsvall timra and skelleftea was assigned only to one undertaking, this principle was not applicable in the state aid to swedish airports cases65. to meet the public consultation compatibility condition, member states have to publish on the internet or by alternative appropriate means the pieces of information enlisted by the sgei framework66. the commission considered that sweden submitted a report with a socioeconomic cost estimate for the aided airports prepared before the 63 skelleftea airport, above note n. 10, paras. 101-106; sundsvall airport, above note n. 9, paras. 92-97; kalmar airport, above note n. 8, paras. 88-93. 64 point 20 of the sgei framework, above note n. 6. 65 skelleftea airport, above note n. 10, para. 122; sundsvall airport, above note n. 9, para. 112; kalmar airport, above note n.8, para. 110. 66 according to point 60 of the sgei framework, above note n. 6, these data are as follows: the results of the public consultation concerningthe interests of users and suppiers; (b) the content and duration of the public service obligations; (c) the undertaking and, where applicable, the territory concerned; (d) the amounts of aid granted to the undertaking on a yearly basis. njcl 2017/2 225 adoption of the sgei entrustment acts67. sweden also reported to the commission that the airports of kalmar, sundsvall timra and skelleftea carried out frequent surveys on travel needs in the region and customer satisfaction. the results of these surveys would be published on the airports’ websites68. lastly, sweden informed that the public has access to all the relevant documents on the basis of the principle of public access to documents enshrined in the swedish constitution.69 considering the submissions made by sweden, the commission reached the conclusion that the challenged national measures fulfilled the transparency compatibility condition. the commission was also satisfied that the entrustment acts met the compatibility condition of efficiency incentives. under the sgei framework this compatibility condition comes into relevance when appraising the criteria laid down by the contracting authorities for the determination of the compensation for the sgei supplier70. the commission considered that the efficiency mechanisms in the entrustment acts complied with the requirement in the sgei framework to introduce incentives for the efficient provision of sgei. more specifically, the commission positively viewed the duty for the aided airports to submit an annual report on kpi, as well as the obligation of airports and national authorities to take action in case, the kpi show a decrease in efficiency. it also believed that the implementation of the ‘basic airport’ concept was instrumental in achieving the required efficiency71. a further compatibility condition is that sgei suppliers comply with directive 2006/111/ec on the transparency of financial relations between member states and public undertakings72. though the sgei in question were entrusted to the airport managers that were fully owned by the contracting authorities, the provisions of directive 206/111/ec, however, could not apply to the cases of skelleftea airport, sundsvall airport, and kalmar airport. indeed, the airports did not meet the financial threshold triggering the application of the directive, which was a total net turnover of at least eur 40 million over the financial years preceding the payment of the compensation for the provision of the sgei73. 67 skelleftea airport, above note n. 10, paras. 107-108; sundsvall airport, above note n. 9, paras. 98-99; kalmar airport, above note n.8, paras. 94-95. 68 skelleftea airport, above note n. 10, para. 123; sundsvall airport, above note n. 9, para. 113; kalmar airport, above note n.8, para. 111. 69 skelleftea airport, above note n. 10, para. 125; sundsvall airport, above note n. 9, para. 114; kalmar airport, above note n.8, para. 113. 70 sgei framework, above note n. 6, especially points 39-43. 71 skelleftea airport, above note n. 10, paras. 117-119; sundsvall airport, above note n. 9, paras. 113-115; kalmar airport, above note n.8, paras. 105-106. 72 point 18 of the 2011 sgei framework, above note n. 6. 73 skelleftea airport, above note n. 10, paras. 91-96; sundsvall airport, above note n. 9, paras. 88-91; kalmar airport, above note n. 8, paras. 84-87. public service compensation in the aviation sector 226 lastly, the sgei framework also sets out the compatibility condition that the length of entrustment must be justified by reference to objective criteria74. the entrustment acts determined the duration of the entrustment period in 10 years. the commission took the view that the 10-year period is objectively justified as it refers to the 10-year maximum depreciation period chosen by the aided airports. indeed, such a long period of time is appropriate for the depreciation of the many tangible assets that are normally used by an airport.75 6. conclusive remarks the examination of the commission’s decision on the swedish state aid airport cases has shown that reliance on the altmark doctrine is frayed with difficulties. this legal argument was rejected in all the cases in which it was invoked because the national measures failed to satisfy the highly controversial fourth condition of the altmark test. similarly, public authorities intending to draft aid packages for airports in accordance with the altmark doctrine, so to put these measures beyond the reach of article 107(1) tfeu, should be aware that that may not be the best available option. difficulties in correctly fulfilling the fourth altmark condition may result in breaching this criterion with the ensuing risk of a state aid enquiry being opened by the commission. on the other hand, the sgei strategy looks more promising, as reflected by the higher success rate with which this argument was invoked in the swedish airports state aid cases. 6.1. finding that public tasks of beneficiary airports are genuine sgei the first issue to be considered when the public authorities played the card of the sgei strategy is to demonstrate that the aided airport is tasked with an sgei. the commission has crafted a two-limb test to establish whether a pso imposed on airports constitute an sgei. under the test, it must be established that, absent the aided airport, its catchment area would be isolated; and that there is a market failure in the sense that, without public financial support to the airport, no market economy operator would be ready to take up the provision of the sgei in question. the isolation criterion is assessed by the commission with a counterfactual. the question is whether, in a scenario where the aided airport is absent, its catchment area is in such a situation of isolation to prejudice its economic and social development. in kalmar airport, sundsvall timra airport and skelleftea airport the commission established that, had the aided airport left the market, their catchment areas would be isolated due to the poor or no connections other than the air links ensured by the 74 point 17 of the 2011 sgei framework, above note n. 6. 75 skelleftea airport, above note n. 10, paras. 97-100; sundsvall airport, above note n. 9, paras. 82-87; kalmar airport, above note n. 8, paras. 81-83. njcl 2017/2 227 aid recipients76. from that the commission reached the conclusion that the lack of connections would negatively affect persons and business in the catchment areas. and all that would harm the social and economic development of these areas. it can be said that it is the isolation of the catchment areas to be the key factor in the counterfactual. from the hypothetical scenario of isolation of the catchment areas, the commission seemed to infer a deterioration of the welfare of individuals and businesses with the resulting prejudice of the local social and economic development. no discussion of the causality links between the condition of isolation of the catchment areas and the prejudice suffered by the social and economic development of those areas was, however, made by the commission. turning to the market failure requirement, what public authorities have to do to meet this condition was well illustrated in sundsvall timra airport and skelleftea airport77. the commission found that in these cases the concerned airports were unable to obtain a significant increase in revenues and, accordingly, to survive without continuous cost compensation because an increase in air traffic was unlikely due to the scarce population in their catchment areas. the efficiency measures implemented by the airports with the view of cutting costs where possible were not enough to cover the operating losses suffered by them in the provision of the sgei. these cases then highlight the importance for public authorities to demonstrate that, due to structural conditions such as the geographical position or scarcely populated catchment areas, the aided airport has limited prospects to attract a significant passenger traffic. the implementation of efficiency measures, like the basic airport concept in these cases, may also help to convince the commission about a market failure affecting the aided airports. also in kalmar airport, the swedish authorities contended that the airport was unable to function without sustainable financial support despite the adoption of the basic airport concept78. the commission did not discuss these arguments, neither did it explicitly reject them. thus, it can be argued that the commission considered that the market failure condition was satisfied also in kalmar airport. in sum, the key factor here is the hypothetical isolation of the catchment area of aid recipients that occurs due to the lack of acceptable alternative domestic and international connections. this proof was reached in kalmar airport, sundsvall timra airport and skelleftea airport where all the concerned airports were located in remote sparsely populated areas. incidentally, the airports of skelleftea and sundsvall timra were in an outermost region close to the arctic circle. it should also be observed that the airports of kalmar, sundsvall timra and skelleftea were all small regional airports with a limited air traffic, comprised between 200,000 and 76 see section 5.1 of the article. 77 ibidem. 78 kalmar airport, above note n.8, paras. 52-53. public service compensation in the aviation sector 228 700,000 annual passengers, thereby falling under the “b” category of the 2014 guidelines classification79. a further element that the airports of kalmar, skelleftea and sundsvall timra had in common was that they were all suffering from operational losses notwithstanding the implementation of management tools aimed at improving the efficient use of airport resources. the take home lesson for public authorities is that the commission appears ready to consider as sgei airports that find themselves in a factual and geographical context similar of those of the airports of kalmar, skelleftea and sundsvall timra80. the above factors and circumstances should be taken into great consideration by public authorities. in order to successfully invoke the sgei strategy to lawfully grant financial sustain to airports, public authorities should employ this legal argument only in relation to small regional airports serving scarcely inhabited areas. the acts entrusting the sgei should also provide detailed reasons why the contracting authorities believe that, in the absence of the aided airport, its catchment area would be isolated and that, without public aid, the airport would leave the market. by the same token, the commission will accept the sgei strategy as defense in the context of state aid investigations if the public authorities can prove to the requisite standard that the aid airports constitute sgei on the basis of the criteria of isolation and market failure. 6.2. meeting the compatibility conditions in the state aid rules on sgei in addition to correctly qualifying the aided airports as genuine sgei, contracting authorities also have to make sure that the related entrustment acts comply with the substantive and formal requirements included in the compatibility conditions laid down by the 2011 sgei decision and the sgei framework. the decisional practice developed by the commission in the application of such conditions is a remainder for public authorities of the importance of carefully drafting the entrustment acts. not only the national contracting authorities have to correctly define a genuine sgei but they also have to draft the entrustment acts in such a manner to comply with the sgei rules regarding the methodologies for the determination of compensation, the need to avoid overcompensation, compliance with the eu public procurement rules and the presence of 79 points 89 and 118 of the 2014 aviation guidelines, above note n. 1. 80 similar factors were found in relation to the public service compensation granted to the airport of angouleme, that is the only other case in which the commission accepted the sgei strategy. in comparison with the swedish airports, the airport of angouleme was much smaller, falling within the category “a” of the 2014 guidelines with a volume of air traffic lower than 200,000 passengers per year. see angouleme airport, above note n. 12. njcl 2017/2 229 efficiency incentives. several lessons can then be drawn from the commission’s findings on these issues. first, to determine the compensation of the sgei, the commission may be willing to accept the alternative methodology based on cost allocation instead of the application of its favoured net avoided cost methodology where this approach is not appropriate. second, the reimbursement to the airport of a reasonable profit is acceptable provided that the profit does not go beyond the margin determined in the sgei framework, which is the relevant swap rate plus a premium of 100 basis point81. third, an acceptable length of the entrustment should be that corresponding to the maximum depreciation period applied by the aided airport. fourth, a claw back provision imposing the obligation on airports to pay back the portion of compensation received in excess of the net cost of the sgei was considered by the commission as a suitable tool to combat overcompensation. fifth, mechanisms, such as those framed by the swedish authorities imposing efficiency targets and linking the calculation of compensation to the meeting of such targets, were found to be appropriate efficiency incentives for the purpose of the sgei framework. sixth, the commission drew a line of distinction between public aid granted for compensation of an sgei, on one hand, and aid to promote certain economic activities or rescue aid awarded to ailing firms, on the other hand. the commission also highlighted that these instruments pursue different policy goals and are subject to different legal regimes. seventhly and finally, as required by point 73 of the 2014 guidelines82, for an activity entrusted to an airport to be qualified as an sgei it must not cover the development of commercial air transport services. consistently with this requirement, in kalmar airport, sundsvall timra airport and skelleftea airport sweden confirmed that car parks and services consisting in renting premises to restaurant and café services and other sales outlets did not receive any public support83. having that said, it may be worth noting before concluding that also the efta surveillance authority (esa) has adopted guidelines on state aid to the aviation sector (the efta aviation guidelines), which are similar to the european commission’s 2014 aviation guidelines84. the 81 point 36 of the 2011 sgei framework, above note n. 6. 82 point 73 of the 2014 aviation guidelines, above note n. 1, provides that ‘in the light of the specific requirements attached to public service obligations for air transport services and in view of the complete liberalisation of air transport markets, the commission considers that the scope of public service obligations imposed on airports should not encompass the development of commercial air transport services’. 83 skelleftea airport, above note n. 10, paras. 82-83; sundsvall airport, above note n. 9, paras. 74-75; kalmar airport, above note n. 8, paras. 73-74. 84 efta surveillance authority no. 216/14/col of 28 may 2014, amending for the 96th time the procedural and substantive rules in the field of state aid by adopting new guidelines on state aid to airports and airlines [2016/2051], available at http://eurlex.europa.eu/legalpublic service compensation in the aviation sector 230 efta aviation guidelines allow national authorities to qualify certain economic activities of airports as sgei and provide compensation for discharging such services85 and give guidance on which factors to be considered to qualify airports as sgei86. the esa has also enacted a set of state aid rules for sgei similar to the correspoinding eu rules by adopting the framework for state aid in the form of public service compensation87 and a communication on sgei compensation88. as of the time of writing, the esa has not yet applied the efta sgei rules in the aviation sector89. bearing in mind the similarities between the eu and content/en/txt/?uri=uriserv:oj.l_.2016.318.01.0017.01.eng&toc=oj:l:2016:318 :toc, visited 5 september 2017. 85 efta aviation guidelines, above note n.68, point 69. 86 similarly to point 72 of the 2014 aviation guidelines of the commission, point 72 of the efta aviation guidelines state that: ‘as far as airports are concerned, the authority considers that it is possible for the overall management of an airport, in well-justified cases, to be considered an sgei. in the light of the principles outlined in point 69, the authority considers that this can only be the case if part of the area potentially served by the airport would, without the airport, be isolated from the rest of the eea to an extent that would prejudice its social and economic development. such an assessment should take due account of other modes of transport, and in particular of high-speed rail services or maritime links served by ferries. in such cases, public authorities may impose a public service obligation on an airport to ensure that the airport remains open to commercial traffic. the authority notes that certain airports have an important role to play in terms of regional connectivity of isolated, remote or peripheral regions of the union. such a situation may, in particular, occur in respect of the outermost regions, as well as islands or other areas of the eea. subject to a case-by-case assessment and depending on the particular characteristics of each airport and the region which it serves, it may be justified to define sgei obligations in those airports. 87 available at http://www.eftasurv.int/media/state-aid-guidelines/part-vi--framework-for-state-aid-in-the-form-of-public-service-compensation.pdf, visited 5 september 2017. 88 application of the state aid rules to compensation granted for the provision of services of general economic interest, available at http://www.eftasurv.int/media/state-aidguidelines/part-vi---compensation-granted-for-the-provision-of-services-of-generaleconomic-interest.pdf, visited 5 september 2017 89 the only state aid case so far determined by the esa in which sgei-related arguments have been submitted was hurtigruten in the maritime sector (esa decision no. 070/17/col of 29 march 2017 on coastal agreement on hurtigruten maritime service 2012-2019, available at http://www.eftasurv.int/media/esa-docs/physical/finaldecision-non-confidential-version---formal-investigation---alleged-unlawful-aid-incoastal-agreernent-for-hurtigruten-maritime-services-2012-2.pdf, visited 5 september 2017). this case was about a pubic aid granted to a ferry operator for providing maritime links between the coastal town of bergen and kirkenes in norway over the 2012-2019 period under a coastal agreement concluded with the norwegian public authorities. the esa took the view that the pso imposed on the aided ferry operator constituted genuine sgei. the public financial support granted to the ferry operator was considered as a compensation for discharging such sgei. hence, the aid was cleared by the esa. njcl 2017/2 231 the efta state aid rules for sgei, it can be argued that should the esa open a state aid enquiry into pso compensation to airports, it might follow an approach similar to that of the european commission to assess the legality of the objected national measures. microsoft word ehlers_andreasfinal.doc nordic journal of commercial law issue 2013#2 establishing a uniform interpretation of the cisg: a case study of article 74 by andreas ehlers*1 *1 assistant professor at the faculty of law, centre for enterprise liability (cevia) at the university of copenhagen, denmark. nordic journal of commercial law issue 2013#2 1 1 introduction the debate on whether a satisfactory degree of uniformity in the interpretation of the un convention on contracts for the international sale of goods (cisg or convention) is being achieved seems more relevant than ever. thus, more than 30 years after the adoption of the convention it is still doubtful whether the aim of establishing uniform rules for the international sale of goods as set out in article 7(1) is being achieved and this raises the question if it ever will be. in a recent article published in the danish weekly law report,1 joseph lookofsky, a prominent cisg scholar, shows that danish courts do not take much note of the sources of law relevant to the cisg when dealing with matters pertaining to it. such an approach is in direct contravention of article 7(1) and if it applies to the courts and arbitral tribunals in the other cisg jurisdictions as well, it is clear that we are dealing with a serious problem. the purpose of this article is to address the question of whether said aim of establishing a uniform interpretation of the cisg is being achieved. this is done by doing essentially two things: first, it is examined what potential each of the internationally recognised sources of law pertaining to the convention has for contributing to bringing about a uniform interpretation. this should give a good indication as to the theoretical feasibility of establishing uniformity. second, in order to show to what extent said sources of law help achieve uniformity in practice, an extensive case study of article 74 is conducted. in order to embark further on what seems to be a much needed empirical work, one could have wished to conduct case studies of all the articles of the cisg, but this has not been possible within the limits of this article. this is, of course, an important caveat but the study of the unifying potential of the sources of law and the case study of article 74 do in fact seem to provide a good basis for commenting on the question at hand. parts two and three are devoted to a general introduction to the cisg and the command for uniformity laid down in article 7(1). part four critically analyses the potential of the wording of the convention for establishing uniformity. this part discusses a number of weaknesses related to the cisg as an international convention and certain inherent linguistic flaws and the general lack of convergence of legal terms are also dealt with,. part five discusses the quality of the travaux préparatoires as an interpretative guide and part six examines the capability of cisg precedents to create uniformity. in part seven the potential of scholarly writings for contributing to uniformity is examined. part eight is dedicated to said case study of article 74. as will become apparent the study shows that many of the (general) problems pertaining to the relevant sources of law (examined in parts four to seven) apply to the important issue of 1 see the danish weekly law report 2012, at 281ff. nordic journal of commercial law issue 2013#2 2 measuring damages and it does not seem that uniformity is being achieved to an acceptable extent. 2 an introduction to the cisg throughout modern history the world has experienced a tremendous increase in the volume of trade among nations. in a legal perspective, this development has created a need for uniform rules governing the rights and obligations of the actors on the global market. with respect to international sale of goods, this need was accommodated in 1980 when the cisg was adopted at a diplomatic conference in vienna.2 the cisg is a legally binding piece of legislation, which applies to sale of goods between parties whose places of business are in different states provided that the states are contracting states or that the rules of private international law lead to the application of the law of a contracting state.3 according to the preamble of the convention its overall purpose is to reduce the legal barriers in international trade by laying down uniform rules for the exchange of goods. there are many advantages associated with such rules. first and foremost, a uniform set of rules, which is applied fairly consistently, enables the parties to more accurately predict and allocate the legal and economic risks connected with the international sale of goods. prior to the coming into force of the cisg, the parties had to rely on the rules of private international law to determine the applicable substantive law (lex causae). this almost invariably led to uncertainty since many rules of private international law are rather elusive. moreover, the rules of private international law would often enable the parties to shop between forums with different choice of law rules. in some cases this enabled a party to choose which substantive law should apply.4 this was and still is a great weakness of the rules of private international law as a tool for determining the choice of law in international disputes. prior to the entering into force of the cisg, the parties were obviously able to diminish above problems pertaining to the rules of private international law by including choice of law clauses in the contracts. however, it is a matter of fact that such clauses are often not included in commercial contracts due to either carelessness or the fact that the parties are not able to agree on them. secondly, such choice of law clauses do not rule out the problem of legal uncertainty 2 the cisg entered into force in 11 states on 1 january 1988, see further baasch andersen, camilla, ”the uniform international sales law and the global jurisconsultorium” journal of law and commerce 24 (2005) at 161. today a total of 78 states have adopted the convention, see http://www.cisg.law.pace.edu/ cisg/countries/cntries.html. 3 see art. 1(1) of the convention. according to art. 6 the parties may choose to opt out of the convention and choose another set of rules to govern the contract, e.g. the rules of the forum. 4 if a party can sue another party in more than one state, he will be able to choose between different substantive laws (lex causae) if the rules of private international law of the relevant states lead to different lex causae. the possibility of a party choosing a certain lex causae is problematic because it may cause the dispute to be settled by rules not contemplated by the parties when entering into the contract. there is a great deal of literature on the issue, see e.g. bell, andrew s. “forum shopping and venue in transnational litigation” oxford university press 2003. nordic journal of commercial law issue 2013#2 3 and unpredictability entirely. thus, if the domestic law of party “a” is chosen as the governing law, party “b” will have to familiarise himself with the domestic law of party “a” in order to assess his legal rights and obligations in the event of a dispute.5 undoubtedly, the cisg has brought along many advantages for parties involved in international exchange of goods. however, in order for the convention to meet its full potential for creating legal transparency and reducing the risks of cross-border trade, it is crucial that it is interpreted uniformly by the adjudicators6 of the contracting states. 3 article 7(1) and the command for an international and uniform interpretation the cisg deals with the important question of how it should be interpreted in article 7(1) which provides that: ‘in the interpretation of this convention, regard is to be had to its international character and to the need to promote uniformity in its application and the observance of good faith in international trade.’ as it appears, the convention provides that it shall be interpreted with regard to its “international character” and the need to promote “uniformity”.7 a plain literal interpretation of the words “is to be had” indicates that article 7(1) contains a command for the adjudicator to interpret the convention in accordance with the aims set out in its provisions.8 the reference to the “international character” indicates that the adjudicator must have regard to the origin and unique nature of the convention. in fact, said wording seems to imply that the convention should be perceived and interpreted as a self-contained, autonomous body of law.9 this means that domestic sources of law or strictly domestic principles of interpretation should not be applied when dealing with matters within its sphere of application. the command that regard 5 the parties may, of course, choose the rules of a neutral jurisdiction to govern the contract but this means that both parties will have to familiarise themselves with foreign rules. 6 for purposes of convenience, throughout this article the term adjudicator is used as a collective term for both court judges and arbitrators. 7 further, it appears that in the interpretation of the cisg regard is to be had to the observance of “good faith” in international trade. this requirement will not be dealt with further in the present article since it is not necessary to answer the question at hand. for research on the requirement of good faith, see e.g. keily, troy, “good faith and the vienna convention on contracts for the international sale of goods” vindobona journal of international commercial law and arbitration 3 (1999), at 15 and klein, john, “good faith in international transactions” liverpool law review 15 (1993), at 115. 8 lookofsky, joseph, “digesting cisg case law: how much regard should we have?” vindobona journal of international commercial law and arbitration 8(2004) at 183. 9 schlechtriem, peter & schwenzer, ingeborg, “commentary on the un convention on the international sale of goods (cisg)” 3rd ed. (2010) oxford university press at 123. nordic journal of commercial law issue 2013#2 4 must be had to the need to promote “uniformity” is a natural consequence of the general unificatory aim upon which the whole convention rests10 and achieving such uniformity appears to correspond well with and reinforce the aforementioned need for an autonomous and self-contained jurisprudence of the cisg. thus, a uniform interpretation presupposes that a certain consensus is established among the adjudicators of the various contracting states as to how it should be applied. article 7(1) does not elaborate on how such autonomous and international jurisprudence should be established. the overall aims for the interpretation of the convention are clear but essentially it fails to specify how they should be attained. this means that the adjudicator is left with little authoritative guidance as to how to comply with the directives of article 7(1). of course, this is a weakness of the convention and an impediment to achieving uniformity. even though it is not clear how the jurisprudence of the cisg should be crafted, it is clear that an interpretation, which is to be both international and uniform, must be based on the internationally recognised sources of law pertinent to the convention. below it is examined how and to what extent these sources of law can contribute to establishing an internationally oriented interpretation of the convention. 4 the language of the convention the most notable achievement of the cisg is that it lays down a set of uniformly worded provisions governing the international sale of goods. indeed, this appears to be a necessary first step on the way towards legal uniformity and predictability in international commerce and therefore, it is clear that the wording of the convention must serve as the obvious starting point when dealing with matters within its sphere of application. sometimes legal disputes may even be resolved simply by looking up the relevant provision(s). however, for at least two reasons the uniform wording of the convention does not automatically lead to a uniform interpretation. first, the cisg does not appear in a single original language text. there are six official versions that are equally authentic and for that reason no canonical version can be visited in order to resolve interpretative issues. this gives rise to certain problems: consider, for instance, the notorious article 3(1) which provides that: 10 see further bonell, michael j., “article 7” in bianca c. m. & bonell michael j. “commentary on the international sales law” giuffré: milan (1987) at 71-74 and schlechtriem, peter & schwenzer, ingeborg, “commentary on the un convention on the international sale of goods (cisg)” 3rd ed. (2010) oxford university press at 122-127. nordic journal of commercial law issue 2013#2 5 ‘contracts for the supply of goods to be manufactured or produced are to be considered sales unless the party who orders the goods undertakes to supply a substantial part of the materials necessary for such manufacture or production.’11 as it appears, the english version requires that a “substantial part” of the materials is supplied by the buyer for a contract not to be a sale under the convention. conversely, the french version provides that the materials must qualify as “une part essentielle”. this terminological difference gives rise to important concerns. thus, the english word “substantial” and the french word “essentielle” seem to carry different meanings and this may well have the effect that in certain cases a contract is qualified as a sales contract under the english version but not under the french version.12 imagine for instance a contract stipulating that a buyer is to provide the seller with a component which is rather insignificant in terms of size and price compared to the final product as a whole. in general, such component, which could be a computer chip,13 will not be qualified as “substantial” but if the chip is absolutely necessary to the functioning of the end product (perhaps the seller cannot manufacture the product without the component?) it may be regarded as “essentielle”. in that case the contract would not be a sales contract under the french version.14 schlechtriem and schwenzer argue that discrepancies among the various official language texts should be resolved by consulting the english or occasionally the french version as they reflect the intentions of the legislature of the cisg more accurately. this is allegedly true because the negotiations at the vienna conference were carried out in those languages and because the 11 article 3(1) has been dealt with in detail by several cisg-scholars; see e.g. schlechtriem, peter & schwenzer, ingeborg, “commentary on the un convention on the international sale of goods (cisg)” 3rd ed. (2010) oxford university press at 64-73 with further references. 12 see schlechtriem, peter & schwenzer, ingeborg, “commentary on the un convention on the international sale of goods (cisg)” 3rd ed. (2010) oxford university press at 64-66. further, bruno zeller has noted that the german translation, which employs the word “wesentlich”, corresponds neither with the english nor the french translation; cf. zeller, bruno, “international trade law – problems of language and concepts?” journal of law and commerce 23 (2003) at 43. 13 see schlechtriem, peter & schwenzer, ingeborg, “commentary on the un convention on the international sale of goods (cisg)” 3rd ed. (2010) oxford university press at 66 where it is argued that a computer chip can even, in some cases, be regarded as ‘… so essential for the objects to be manufactured that it is more substantial than the tin and plastic of the machines that run on it, even though the latter materials may have cost more.’ see also schroeter, ulrich g., “vienna sales convention: applicability to “mixed contracts” and interaction with the 1968 brussels convention” vindobona journal of international commercial law and arbitration 5 (2001) at 74-75. 14 essentially three tests have been proposed in order to determine whether a certain portion of the materials is “substantial” pursuant to article 3(1); (i) the economic value-test, (ii) the volume/quantity-test and (iii) the importance/essentiality-test, see schlechtriem, peter & schwenzer, ingeborg, “commentary on the un convention on the international sale of goods (cisg)” 3rd ed. (2010) oxford university press at 64-66. see also schroeter, ulrich g., “vienna sales convention: applicability to “mixed contracts” and interaction with the 1968 brussels convention” vindobona journal of international commercial law and arbitration 5 (2001) at 74-75. nordic journal of commercial law issue 2013#2 6 english language was used by the drafting committee.15 however, these arguments do not appear persuasive since the apparent political unwillingness to adopt a single authentic version must be respected. otherwise, english, and to a lesser extent french, would be the only authentic languages de facto and this would be in direct contravention of the resolution to adopt six equally authentic versions.16 second, there are certain inherent problems regarding the incongruence of legal terms and interpretative principles in the international forum which may impact on the feasibility of creating legal uniformity.17 thus, well-known legal terms employed by the convention such as “foreseeability”, “loss” and “possible consequence”18 do not have universal and objective meanings which can be readily ascertained by the adjudicators. on the contrary, they already carry certain domestic prejudices and, as we shall see, this is prone to influence on the interpretation of the convention. with respect to local biases on legal terms and interpretation, particular note should be taken of the dichotomy between the common law and the civil law since these legal schemes represent different approaches to the law.19 for instance, in the common law, statutes are normally interpreted narrowly because they are generally perceived as exceptions to the common law. by contrast, in civil law jurisdictions, statutes are generally the most important source of law and thus often subjected to expansive interpretation. now, if these different legal approaches are applied by civiland common law adjudicators, respectively, uniformity is unlikely to be achieved. therefore, and this is one of the main purposes of article 15 see schlechtriem, peter & schwenzer, ingeborg, “commentary on the un convention on the international sale of goods (cisg)” 3rd ed. (2010) oxford university press at 130. 16 further, as will be developed below, one must always be cautious in attempting to discern the will or intention of the legislature for purposes of interpretation, see part 5. 17 the 1969 vienna convention on the law of treaties contains rules on the interpretation of treaties in articles 31-33 and therefore, it could be argued that it should be applied in the interpretation of the cisg. however, the vienna convention seems to have only little relevance for the interpretation of the cisg, as the former, according to article 1, applies solely to obligations that states have undertaken to each other. the contracting states are (of course) obliged to give effect to the rules set out in particularly parts i-iii of the cisg but said rules are not concerned with rights and obligations of states. rather, they apply to the relationship between parties to an international sale of goods and as such they are to be interpreted according to the rules on interpretation set out in e.g. article 7 of the cisg, cf. honnold, john o, “uniform law for international sales under the 1980 united nations convention” (4th edn, 2009) kluwer law international at 148-149. in all, therefore, the vienna convention solely applies to the part iv of the cisg (“final provisions”) which contains certain obligations of the contracting states. one scholar, bruno zeller, claims that the principles of interpretation laid down in the vienna convention may in fact contribute toward creating a uniform interpretation of the cisg even though the former convention is not directly applicable, cf. zeller, bruno, ”fourcorners – the methodology for interpretation and application of the un convention on contracts for the international sale of goods” (may 2003) [visited at pace law school at http://www.cisg.law.pace.edu/cisg/biblio/4corners.html on 1 april 2013] at chapter 3, 3(b). looking at articles 31-33 of the vienna convention it is, however, difficult to see how these principles can contribute to said end. 18 see article 74 and below part 8. 19 on the differences and similarities of common law and civil law, see e.g. markesinis, basil (ed), “the clifford chance millenium lectures. the coming together of the common law and the civil law” (2000). nordic journal of commercial law issue 2013#2 7 7(1), the adjudicators must set aside their domestic legal idiosyncrasies and adopt an international approach. however, certainly it is not an easy task for the adjudicators to disregard the legal tradition and methodology they are accustomed to and have practiced throughout perhaps their entire careers. the draftsmen of the cisg apparently realised that the language could cause serious difficulties. hence, the wording of the various provisions appears to have been chosen with great care and abstract legal concepts have been avoided where possible. instead, as observed by honnold, the convention generally employs a “plain” language referring to ‘… things and events for which there are words of common content in the various official languages’.20 articles 15 and 31 regarding formation of the contract and delivery of goods illustrate this point well. thus, article 15 provides that an offer becomes effective when it “reaches the offeree” and article 31 provides that the seller’s obligation to deliver consists – if the contract of sale involves carriage of the goods – in “handing the goods over” to the first carrier. further, in article 24 it is even specified what is exactly meant by the term “reaches” referred to in article 15. due to the strong domestic prejudices carried by certain legal concepts, the extensive use of plain language deserves support. however, the impact of this must not be overestimated. even plain language leaves room for interpretation and other problems may ensue from using essentially non-legal language.21 5 the travaux préparatoires when the wording of the convention does not provide sufficient guidance as to how a certain question should be decided, the adjudicator may find interpretative support in the travaux préparatoires (tp). the tp of the cisg comprise three legs: the first leg includes the deliberations of the uncitral working group which was established in 1969. the working group was given a mandate to prepare a draft convention for the international sale of goods and by 1977 the working group had produced two draft conventions; a draft convention on sales and a draft on formation of the sales contract.22 the second leg covers the review of the salesand formation drafts by a full uncitral-commission23 which was assembled in 1977. the commission united the two drafts into one document (which came to be known as the 1978 draft convention on contracts for international sale of goods) and recommended that 20 see honnold, john o, “uniform law for international sales under the 1980 united nations convention” (4th edn, 2009) kluwer law international at 118. 21 see honnold, john o, “uniform law for international sales under the 1980 united nations convention” (4th edn, 2009) kluwer law international at 118. 22 see honnold, john o, “documentary history of the uniform law for international sales” (1989) kluwer law and taxation publishers at 3. 23 the full commission consisted of 36 states, cf. honnold, john o, “documentary history of the uniform law for international sales” (1989) kluwer law and taxation publishers at 3. nordic journal of commercial law issue 2013#2 8 a diplomatic conference would be convened in order for the document to be finalised and adopted. the third leg contains the proceedings at the vienna conference held in 1980.24 the volume of the tp is comprehensive and they are easily accessible through the official records of the proceedings in vienna and the uncitral year books. prima facie this makes them well-suited for determining how the convention should be properly interpreted according to its legislature. however, there are a few issues that must be taken into consideration when assessing the interpretative value of the tp. first of all, some courts have traditionally not even recognised them as a relevant source of law. this view has been maintained particularly in the common law jurisdictions,25 where many courts argue that the interpretation of the text itself must determine the scope of the legislation.26 further, said view has been supported by a number of judges and scholars such as, for example, steyn, who contends that it is ‘a fairy tale to think that the subjective views of members of parliament, sitting in two separate chambers, can be determined’.27 the dismissive attitude towards the tp of common law courts has long standing but for some time now it has been at least somewhat relaxed. for example in the context of international treaties, in the landmark english case of fothergill v monarch airlines,28 the house of lords (cautiously) appreciated that the common law approach to statutory interpretation should not apply to an international instrument such as the warsaw convention. lord wilberforce said that: «… i think that it would be proper for us, in the same interest, to recognise that there may be cases where such travaux préparatoires can profitably be used. these cases should be rare, and only where two conditions are fulfilled, first, that the material involved is public and accessible, and secondly, that the travaux préparatoires clearly and indisputably point to a definite legislative intention.”29 24 see honnold, john o, “documentary history of the uniform law for international sales” (1989) kluwer law and taxation publishers at 3; honnold, john o, “uniform law for international sales under the 1980 united nations convention” (4th edn, 2009) kluwer law international at 119. 25 an important exception to this is the united states where the legislative history is commonly recognised as a source of law, cf. honnold, john o, “uniform law for international sales under the 1980 united nations convention” (4th edn, 2009) kluwer law international at 120. 26 see, honnold, john o, “uniform law for international sales under the 1980 united nations convention” (4th edn, 2009) kluwer law international at 121. 27 see steyn, johan, “interpretation. legal texts and their landscape” in markesinis, basil (ed), “the clifford chance millenium lectures. the coming together of the common law and the civil law” (2000) at 85. 28 [1981] a.c. at 251. 29 [1981] a.c. at 278. nordic journal of commercial law issue 2013#2 9 in the same case, lord wilberforce cited james buchanan & co. ltd. v babco forwarding & shipping (u.k.) ltd. 30 where his lordship said that an international convention “should be interpreted unconstrained by technical rules of english law, or by english legal precedent, but on broad principles of general acceptation.” in fothergill v monarch airlines their lordships31 further held that the tp should be examined in order to ascertain the meaning of the word “damage”. in this connection lord diplock stated: »so i think the case is one where it is right to have recourse to the minutes of the conference at the hague to see if they confirm or contradict or contain nothing capable of affecting the prima facie view which consideration of the terms of the convention itself has led your lordships to form as to the meaning which the expression “damage” in art 26 was intended to bear.»32 in the context of uk legislation, in the equally important case of pepper v hart33 the house of lords confirmed the incipient recognition of the interpretative value of the tp by accepting that parliamentary debates were relevant to statutory interpretation.34 lord griffiths recapitulates the development as follows: «the courts now adopt a purposive approach which seeks to give effect to the true purpose of legislation and are prepared to look at much extraneous material that bears upon the background against which the legislation was enacted. why then cut ourselves 30 [1978] a.c. 141, 152 31 only lord fraser of tullybelton found that the tp should not be taken into account, cf. [1981] a.c. at 287-289. 32 [1981] a.c. at 283. 33 pepper v hart [house of lords] [1993] a.c. at 593. 34 however, according to lord browne-wilkinson, who gave the leading speech, this applies only if ‘the legislation is ambiguous or obscure, or leads to an absurdity; the material relied upon consists of one or more statements by a minister or other promoter of the bill together if necessary with such other parliamentary material as is necessary to understand such statements and their effect, and the statements relied upon are clear.’ nordic journal of commercial law issue 2013#2 10 off from the one source in which may be found an authoritative statement of the intention with which the legislation is placed before parliament?»35 with the increased recognition of the interpretative value of the tp even in the common law jurisdictions, it is probably safe to say that this source of law enjoys a widespread acceptance within the cisg area. this means that the tp must be taken seriously in the interpretation of the convention. the mere recognition of the tp does not, however, say anything about the extent to which they may contribute to elucidating the meaning and purpose of the various articles of the convention. indeed, there is extensive legal history pertaining to several articles and in some cases the tp certainly are helpful to clarifying doubts as to how the convention should be interpreted. yet, in many cases it seems a rather unhelpful task to establish for what reasons the contracting states collectively decided to adopt a certain article (or provision) in its present shape. this is true for several reasons but perhaps most importantly because the negotiations do not always expose a unified and clear intent which can be readily applied. rather, on close scrutiny, the tp reveal great controversy and disagreement as to the scope of several articles and the final wording often represents a compromise among different legal systems and traditions.36 further, it must be appreciated that the tp are merely historic manifestations of opinions and intentions, which may not correspond well – or perhaps at all – with the current interests of the contracting states. thus, the negotiations reflected in the tp were carried out more than 25 years ago and subsequent changes in society could possibly mean that they no longer represent the positions of the contracting states. as noted by zeller the demise of the eastern bloc is a good example of this.37 for example, the views expressed by the eastern countries prior to the fall of the iron curtain are most likely of only little relevance today since the political context has changed (remarkably) in these jurisdictions. and even if major, political reforms have not 35 pepper v hart [house of lords] [1993] a.c. at 617. also see lord carswell in harding v wealands35, referring to another house of lords case: ‘pepper v hart has been out of judicial favour in recent years (no doubt largely because there were some instances of its over-use, though there have been some trenchant and irreconcilable critics), and courts have constantly striven to avoid resorting to it. i do consider, however, that the principle has a place in statutory interpretation. as lord nicholls of birkenhead remarked in r (jackson) v attorney general [2006] 1 ac 262, 291-292, para 65, it would be unfortunate if pepper v hart [1993] ac 593 were now to be sidelined, as there are occasions when ministerial statements are useful in practice as an interpretative aid, perhaps especially as a confirmatory aid. i would simply remark myself that it would be wilful blindness for courts to deprive themselves of its assistance in proper cases. the conditions for the application of the pepper v hart principle have been authoritatively stated in a number of cases and do not require repetition.’ see further the several expressions by lord nicholls of birkenhead in r v secretary of state for the environment, transport and the regions, ex p spath holme [2001] 2 ac 349 at 396-399, wilson v first county trust ltd (no 2) [2004] 1 ac 816 at 840-841, paras 56-59 and r (jackson) v attorney general [2006] 1 ac 262 at 291-292, paras 65-66. 36 see also felemegas, john (eds), “an international approach to the interpretation of the united nations convention on contracts for the international sale of goods (1980) as uniform sales law” cambridge university press 2007 at 19. 37 zeller, bruno, ”four-corners – the methodology for interpretation and application of the un convention on contracts for the international sale of goods” (may 2003) [visited at pace law school at http://www.cisg.law.pace.edu/cisg/biblio/4corners.html on 1 april 2013] at chapter 3, 3(c). nordic journal of commercial law issue 2013#2 11 occurred, the interests of the contracting states may have changed due to modern trends such as globalisation and the emergence of e-commerce.38 last, even though the tp are generally quite comprehensive, they do not provide sufficient guidance on many key issues. this point is developed further below.39 6 case law on the convention 6.1 the precedent value of cisg case law as the only source of law which shows how the convention is actually interpreted, case law is perhaps the most important vehicle for establishing uniformity. however, due to first and foremost the international character of the convention, the use of case law raises several questions. first, it must be clarified what overall approach to case law the courts and arbitral tribunals of the contracting states must adopt. the cisg is an international convention but in contrast to several other conventions, an international court of law vested with the power to authoritatively decide issues pertaining to it, has not been established. rather, convention related issues are decided by the various domestic courts and arbitral tribunals which are competent in accordance with either the rules of private international law or an agreement deciding on the forum. the lack of an established court hierarchy makes it necessary to ascertain to what extent the adjudicators should have regard to foreign precedents. the convention does not deal expressly with the issue but the command of article 7(1) that regard should be had to its “international character” and the need to promote “uniformity” indicates that the adjudicator should – at least – consider foreign court decisions.40 since the exact scope of the duty to consider foreign court decisions cannot be elucidated from the convention itself, it seems necessary to look for an appropriate approach in the domestic law of the contracting states. overall, two different approaches can be identified; the common law and the civil law approach. in the common law the doctrine of stare decisis applies but if this were transplanted mutatis mutandis – to the convention, in certain circumstances the domestic courts would be legally bound by foreign court decisions. this would be quite radical and such an expansive interpretation of article 7(1) does not seem to have bearing in the wording of the cisg or the tp. further, as a matter of public international law, such duty cannot be imposed on the domestic courts without an express and clear agreement to this effect 38 zeller, bruno, ”four-corners – the methodology for interpretation and application of the un convention on contracts for the international sale of goods” (may 2003) [visited at pace law school at http://www.cisg.law.pace.edu/cisg/biblio/4corners.html on 1 april 2013] at chapter 3, 3(c). 39 see part 8.3. 40 lookofsky, joseph, “digesting cisg case law: how much regard should we have?” vindobona journal of international commercial law and arbitration 8 (2004) at 182-183. nordic journal of commercial law issue 2013#2 12 among the contracting states.41 for these reasons it is not conceivable that domestic courts, including the common law courts, will be or consider themselves bound by foreign court decisions. it is well known that the approach of the civil law jurisdictions is somewhat different. here, court decisions, even those handed down by courts at the highest level of the court hierarchies, are not binding. however, the decisions do have persuasive value and in practice the courts often have regard to decisions delivered by superior courts or even courts at the same level. this is indeed a more flexible approach to the binding force of precedent which allows the courts to disregard decisions which are outdated or perhaps even erroneous.42 moreover, it is not in contravention of public international law and appears to correspond somewhat better with the purpose of article 7(1). most commentators and an increasing number of courts appear to agree on this.43 for example, hackney has observed that: «when interpreting the convention, a court should look to other courts’ interpretations of the convention, including the interpretations of courts from other countries. these interpretations, however, would not be binding, but only persuasive. the use in the u.s. of case law to interpret the uniform commercial code (ucc) can serve as a model for courts using case law to interpret the convention. no state within the u.s. is bound by an interpretation of the ucc from another state, but the interpretations of the ucc from other jurisdictions are extremely persuasive.»44 furthermore, cases from, inter alia, the u.s. and italy such as medical marketing international, inc. v. internazionale medico scientifica, s.r.l.45 and al palazzo s.r.l v. bernardaud di limoges s.a.46 evidence that foreign decisions, when considered, are actually considered as being merely persuasive. this also follows from the bulk of cases reviewed in the case study of article 74 conducted below.47 it seems clear that the command to have regard to foreign cases should be understood in accordance with the civil law approach. however, this approach does not itself make it clear what value foreign cases have and when they should be taken into account. for example, it is not clear what the adjudicators should do if the relevant cisg case law is 41 see further baasch andersen, camilla,”the uniform international sales law and the global jurisconsultorium” journal of law and commerce 24 (2005) at 167. 42 whether a precedent is applied or not thus depends entirely on the cogency of the reasoning by relevant the courts, see for instance lookofsky, joseph, “digesting cisg case law: how much regard should we have?” vindobona journal of international commercial law and arbitration 8 (2004) at 184. 43 for further references, see baasch andersen, camilla, ”the uniform international sales law and the global jurisconsultorium” journal of law and commerce 24 (2005) at 167. 44 hackney, philip, “is the united nations convention on the international sale of goods achieving uniformity?” louisiana law review 61 (2001) at 479. 45 decided on 17 may 1999 by u.s. district court, eastern district of louisiana (case no. 99-0380), see http://cisgw3.law.pace.edu/cases/990517u1.html. 46 decided on 26 november 2002 by tribunale di rimini (case no. 3.095), see http://cisgw3.law.pace.edu/cases/021126i3.html. 47 see part 8 (in particular part 8.4). nordic journal of commercial law issue 2013#2 13 ambiguous or contradictory on a certain matter. further, in practice the discrepancies in the procedural law of the various contracting states may deter the adjudicators from applying foreign cases even when they are relevant prima facie. 6.2 contradictions in cisg case law in two recent articles mazzacano argues that, with respect to the interpretation of article 79, we are experiencing an increased consistency in case law.48 if this analysis is accurate it is indeed an encouraging development. however, as a matter of fact much of the case law dealing with the convention is contradictory and in some areas rather consistent divergences have emerged. this is, of course, an impediment to achieving uniformity and it makes it difficult for the adjudicators to ascertain what interpretation of the convention should be adopted. article 39(1), which provides that notice should be given by the buyer within “reasonable time” in cases of non-conformity, serves as a good example of an area where a consistent interpretative divergence has emerged among the courts of two different legal systems. thus, in several decisions the austrian supreme court has interpreted “reasonable time” as being a period of 14 days49 whereas the german federal supreme court has set the limit at one month.50 at first, this may seem insignificant but only minor discrepancies as to the interpretation of such key articles may harm the pursuit of uniformity and cause the parties to speculate where legal proceedings should be instigated. for example, a buyer who seeks legal redress against a seller for non-conformity may be inclined to try to swap forums from the austrian courts to the german courts if his notice is not given within two weeks and this is certainly not what is intended by the convention. due to the lack of a central and authoritative court, it is difficult to see how such divergent interpretations should be overcome. perhaps it could be argued that the adjudicator should merely keep in mind the command of article 7(1) and extrapolate the proper interpretation from all relevant international case law on the disputed matter. however, this is not easily done and if case law (together with the additional sources of law discussed in the present article) truly does not provide any clear guidance, the adjudicator may find himself in an interpretative deadlock. it is disputed how such deadlocks should be resolved. bonell, argues that, in cases of insurmountable divergences, the only possible response is to fall back on the rules of private 48 see mazzacano, peter j. “the treatment of cisg article 79 in german courts: halting the homeward trend” nordic journal of commercial law (2012#2) at 1-30 and “force majeure, impossibility, frustration & the like: excuses for non-performance; the historical origins and development of an autonomous commercial norm in the cisg” nordic journal of commercial law (2011#2) at 1-54. 49 schlechtriem, peter & schwenzer, ingeborg, “commentary on the un convention on the international sale of goods (cisg)” 3rd ed. (2010) oxford university press at 631. 50 schlechtriem, peter & schwenzer, ingeborg, “commentary on the un convention on the international sale of goods (cisg)” 3rd ed. (2010) oxford university press at 633. nordic journal of commercial law issue 2013#2 14 international law. in this way, bonell argues, the adjudicator should employ the interpretation applicable according to the designated lex causae.51 on the other hand felemegas, argues that this alternative ”should be avoided by anyone who believes that uniformity is a goal that is worth pursuing”52 and that such an approach would jeopardise the “a-national” frame of mind which is the ultimate goal of the convention. instead, felemegas insists that the problem should be solved by a ”… careful consideration of foreign experience”.53 regrettably, neither of said propositions is persuasive. bonell’s approach is in direct contravention of article 7(1) and felemegas merely reiterates the command for an international and uniform interpretation without specifying how the deadlock should be resolved. moreover, in practice, it seems unlikely, at least in the danish jurisdiction, that a court would revert to the rules of private international law in order to find substantive rules of interpretation, perhaps from distant jurisdictions such as cuba and mongolia, which could be applied in the interpretation of the convention. thus, it must be appreciated that divergent interpretations do occur and sometimes there will be deadlocks which cannot be resolved by simply referring to the command of article 7(1) or the rules of private international law. 6.3 procedural discrepancies there are many differences in the procedural law of the various contracting states which may impact how and to what extent foreign case law is applied by the courts and arbitral tribunals. all of these cannot be dealt with here but (again) it is possible to identify two different approaches to procedural law among the contracting states: the civil lawand the common law approach. according to the former, the courts normally have an ex officio duty to discover and apply the law, including case law, which is pertinent to the matter at hand. this is also known as the jura novit curia approach.54 such duty does not exist (to the same extent) in most of the common law, where the review of the courts is based more firmly on the pleadings of the parties.55 in this regardfentiman has noted that ”the english judge has not traditionally been regarded, as he might be in many non-common-law jurisdictions, as a custodian of a body of 51 bonell, michael j., “article 7” in bianca c. m. & bonell michael j. “commentary on the international sales law” giuffré: milan (1987) at 92. 52 felemegas, john, “the united nations convention on contracts for the international sale of goods: article 7 and uniform interpretation” [visited at pace university law school at http://cisgw3.law.pace.edu/ cisg/biblio/felemegas.html on 1 april 2013] at 6 (a). 53 felemegas, john, “the united nations convention on contracts for the international sale of goods: article 7 and uniform interpretation” [visited at pace university law school at http://cisgw3.law.pace.edu/cisg/biblio/ felemegas.html on 1 april 2013] at 6 (a). 54 see further, salung petersen, clement, “treaties in domestic civil litigation: jura novit curia? nordic journal of international law 80 (2011) at 369-402. 55 see also baasch andersen, camilla, ”the uniform international sales law and the global jurisconsultorium” journal of law and commerce 24 (2005) at 171. nordic journal of commercial law issue 2013#2 15 rules which morality and public policy require him to apply. traditionally, he is perceived more as an umpire, whose task is to adjudicate in the dispute between the parties before him on the terms they have set for themselves.”56 the civil law approach seems to facilitate best the aim of establishing a uniform interpretation of the convention. thus, the duty of the court to actively identify the law (including pertinent case law) will obviously – other things being equal – increase the likelihood of cisg precedents being considered. further, the impartiality of the adjudicator ensures that the case law, which is considered by the court, is selected in an unbiased way for the sole purpose of laying down the law. the common law approach, on the other hand, seems to involve a considerable risk that important precedents are ignored since it is primarily for the parties and their respective lawyers to produce them. thus, lawyers are always arguing a case from the client’s point of view and obviously precedents will be ignored if they do not support his case. the discrepancies in the procedural law of the contracting states make it difficult for the adjudicators to ascertain the exact circumstances under which foreign decisions have been delivered. this is problematic because an adjudicator who is unsure and perhaps even uncomfortable with the proceedings of a foreign case is less likely to consider it persuasive. in fact, it does not seem unlikely that he would disregard a case entirely on this basis. therefore, it must be assumed that said discrepancies have an adverse effect on the pursuit of uniformity and unfortunately this seems to be a systemic weakness which is difficult to overcome. at least it does not seem possible to mend it in a manifest way (e.g. by law) unless major amendments were made to the cisg regime. 7 scholarly writings since scholarly writings do not originate from an authoritative source it is debateable whether they should be regarded as a source of law at all. traditionally, particularly in the common law jurisdictions, it seems to have been the position that this was not the case.57 however, for quite some time this restrictive attitude has been relaxed in most common law jurisdictions.58 a good example isthe case of fothergill.59 as mentioned above this case concerned the interpretation of the warsaw convention but most commentators seem to agree that its ultima ratio applies to 56 see fentiman, richard, “foreign law in english courts” 108 law quarterly review (1992) at 143. 57 a prominent exception to this is the united states, cf. honnold, john o, “uniform law for international sales under the 1980 united nations convention” 4th edn, (2009) kluwer law international at 130. 58 this includes, for example, the usa, cf. honnold, john o, “uniform law for international sales under the 1980 united nations convention” 4th edn, (2009) kluwer law international at 123-124. 59 [1981] a.c. at 251. nordic journal of commercial law issue 2013#2 16 the interpretation of treaties in general.60 in fothergill the house of lords expressly recognised that recourse may be had to literature as aid to the interpretation of the legislative text. inter alia, lord wilberforce noted that ”… the text-books and articles, however, do take the matter further”.61 also, his lordship referred to various scholarly writings showing a consensus as to the meaning of the term “avarie” (“damage”).62 moreover, lord diplock made the following important statement: «to a court interpreting the convention subsequent commentaries can have persuasive value only … it may be that greater reliance than is usual in the english courts is placed upon the writings of academic lawyers by courts of other european states where oral argument by counsel plays a relatively minor role in the decision-making process. the persuasive effect of learned commentaries, like the arguments of counsel in an english court, will depend upon the cogency of their reasoning.»63 above all lord diplock’s statement must be construed as an unequivocal recognition of scholarly writings as a source of law in international contexts. the reservation concerning the cogency of the reasoning in such writings seems rather unsurprising and common place. thus, for many reasons, including obvious democratic ones, the point of view that scholarly writings can be persuasive only (as opposed to binding) seems to be accepted in most jurisdictions (including the common law jurisdictions). this means that the differences between the approaches to literature as a source of law in the contracting states are at a minimum. 60 see e.g. felemegas, john, “the united nations convention on contracts for the international sale of goods: article 7 and uniform interpretation” kluwer law international at 132 and honnold, john o, “uniform law for international sales under the 1980 united nations convention” 4th edn, (2009) kluwer law international at 123-124. see also [1981] a.c. 251 at 270 per lord wilberforce: “it [the appeal] does, in addition, require discussion of some important issues concerned with the interpretation of treaties.” 61[1981] a.c. at 274. 62 [1981] a.c. at 272-275. 63 [1981] a.c. at 284. see also per lord scarman: ‘i come now to consider to what aids our courts may have recourse in interpreting an international convention.... rules contained in an international convention are the outcome of an international conference; if, as in the present case, they operate within the field of private law, they will come in the consideration of foreign courts; and uniformity is the purpose to be served by most international conventions, and we know that unification of the rules relating to the international air carriage is the object of the warsaw convention. it follows that our judges should be able to have recourse to the same aids to interpretation as their brother judges in the other contracting states.... to deny them this assistance would be a damaging blow to the unification of the rules which was the object of signing and then enacting the convention. moreover, the ability of our judges to fulfil the purpose of the enactment would be restricted, and the persuasive authority of their judgments in the jurisdictions of the other contracting states would be diminished. we know that in the great majority of the contracting states the legislative history, the “travaux préparatoires”, the international case law (“la jurisprudence”), and the writings of jurists (“la doctrine”) would be admissible as aids to the interpretation of the convention. we know also that such sources would be used in the practice of public international law. they should, therefore, also be admissible in our courts: but they are to be used as aids only. aids are not a substitute for the terms of a convention: nor is their use mandatory. the court has a discretion.’ nordic journal of commercial law issue 2013#2 17 the appreciation of scholarly writings as a source of law in the cisg area seems to be a necessary precondition for them to help bring about uniformity. however, the mere appreciation does not tell us to what extent they are actually capable of doing this. basically, scholarly writings are carefully prepared documents giving well-informed and easily accessible opinions on various legal issues of the convention. this makes them well-suited for clarifying what the law is and several commentators agree that the increasing volume of literature on the cisg will provide good help on the way towards achieving uniformity.64 the said positive attitude towards literature as a vehicle for creating uniformity is certainly not unfounded. yet, it must be borne in mind that the literature on the cisg is not a consensual body of opinions. rather, as will be further examined below, there is much controversy among cisg scholars as to how many issues should be dealt with and in such cases literature does not take us much further. 8 uniformity and the measurement of damages: a case study of article 74 8.1 preliminary remarks the above analysis has shown that there are many obstacles to achieving a uniform interpretation of the cisg. the purpose of this part is to examine how these obstacles impact on achieving uniformity with respect to the important issue of measuring damages set out in article 74. in part 8.2. the purpose and content of article 74 is explained and in part 8.3. three obstacles to achieving uniformity are dealt with. in part 8.4. it is examined what effect cisg case law has on the interpretation of article 74. this is done by examining to what extent courts and arbitral tribunals actually have regard to foreign decisions when deciding matters pertaining to article 74. in part 8.5. it is discussed to what extent uniformity is being achieved with respect to article 74. 8.2 the purpose and content of article 7465 the purpose of the foreseeability doctrine laid down in article 74 is to provide a mechanism for measuring damages in contracts governed by the cisg.66 the article reads: 64 see e.g hackney, philip, “is the united nations convention on the international sale of goods achieving uniformity?” louisiana law review 61 (2001) at 476. 65 there is extensive commentary on article 74, see e.g. schlechtriem, peter & schwenzer, ingeborg, “commentary on the un convention on the international sale of goods (cisg)” 3rd ed. (2010) oxford university press at 999-1026 with further references. see also kröll, stefan, mistelis, loukas & viscasillas, pilar perales: un convention on contracts for the international sale of goods (cisg) at 990-1011 with further references and zeller, bruno, “damages under the convention on contracts for the international sale of goods” 2nd ed. (2009) oxford university press at 113127. nordic journal of commercial law issue 2013#2 18 ‘damages for breach of contract by one party consist of a sum equal to the loss, including loss of profit, suffered by the other party as a consequence of the breach. such damages may not exceed the loss which the party in breach foresaw or ought to have foreseen at the time of the conclusion of the contract, in the light of the facts and matters of which he then knew or ought to have known, as a possible consequence of the breach of contract.’ article 74 is based on the principle of full recovery. thus, the aggrieved party is to be placed in the same position he would have been in had the contact been duly performed. this applies to claims made by both sellers and buyers.67 the principle of full recovery is, however, subject to an important limitation since the amount of damages cannot exceed ”the loss which the party in breach foresaw or ought to have foreseen at the time of the conclusion of the contract, in the light of the facts and matters of which he then knew or ought to have known, as a possible consequence of the breach of contract.” as it appears, the article provides for both a subjective and an objective test of foreseeability.68 the former is concerned with the actual foresight of the aggrieved party and takes into account, for example, any special claims made about potential losses at the time of the conclusion of the contract. the latter provides for a test which is based on the reasonable expectations of the aggrieved party.69 this makes it a normative test. article 74 is obviously of great importance and therefore, it is essential that it is interpreted homogenously by the courts and arbitral tribunals of the contracting states. if not, the purpose of having a uniform rule for measuring damages seems to collapse as the parties are unable to ascertain what they are entitled to in cases of breach. 66 on the calculation of damages according to cisg articles 75 and 76, see e.g. cisg-ac opinion no. 8, calculation of damages under cisg articles 75 and 76. rapporteur: professor john y. gotanda, villanova university school of law, villanova, pennsylvania, usa. adopted by the cisg-ac following its 12th meeting in tokyo, japan, on 15 november 2008. available at nordic journal of commercial law (2009#1) at http://www.njcl.utu.fi/1_2009/ commentary1.pdf. 67 see further schlechtriem, peter & schwenzer, ingeborg, “commentary on the un convention on the international sale of goods (cisg)” 3rd ed. (2010) oxford university press at 1002. 68 schlechtriem, peter & schwenzer, ingeborg, “commentary on the un convention on the international sale of goods (cisg)” 3rd ed. (2010) oxford university press at 1019-1020. see further kröll, stefan, mistelis, loukas & viscasillas, pilar perales: un convention on contracts for the international sale of goods (cisg) at 1003. 69 schlechtriem, peter & schwenzer, ingeborg, “commentary on the un convention on the international sale of goods (cisg)” 3rd ed. (2010) oxford university press at 1019-1020. nordic journal of commercial law issue 2013#2 19 8.3 three obstacles to a uniform interpretation of article 74 the introduction of a uniform mechanism for measuring damages in article 74 is, of course, an important first step towards achieving a homogenous interpretation in practice. however, there are at least three obstacles that impede upon such interpretation being achieved by the courts and arbitral tribunals. the first obstacle has to do with the vagueness of article 74. thus, some important questions are left unanswered and this makes a lot of room for interpretational discrepancies. for example, the article does not designate a clear method for calculating “the loss (…) suffered by the other party as a consequence of the breach.”70 this is problematic because a number of important specifics regarding calculation of losses thereby remain murky. of course this is an inherently difficult question and no matter how such a basic limitation mechanism is drafted it will leave room for interpretation and dissent. but perhaps more could have been done to deal with some of these controversial questions. the second obstacle, which is closely related to the first, has to do with the many prejudices pertaining to article 74. thus, the limitation mechanism laid down in the article carries significant local prejudices and this makes it likely for the courts and arbitral tribunals to revert to lex fori when assessing damages. this is a problem because losses are calculated differently in the various contracting states (even among the european states). for example, in english law damages are measured pursuant to the well-known principles laid down in the landmark case of hadley v baxendale from 1854. in this case the court held that damages are recoverable only if the loss has been “such as may reasonably be supposed to have been in the contemplation of both parties, at the time they made the contract, as the probable result of the breach of it.” in denmark and several other states damages are measured according to the doctrine of adequate causation.71 this doctrine used to be construed in accordance with the concept of “objective probability” laid down in von kries’ article “über den begriff der objektiven möglichkeit und einige anwendungen desselben”72 but today most scholars seem to agree that it comprises a variety of different considerations such as (i) foreseeability, (ii) causal proximity, and (iii) the purpose of the contract in question.73 even though it is difficult to pin down the exact contents of the doctrine of adequacy, it is probably safe to say that it differs somewhat from the hadleyrule. this is also emphasised by, among others, lookofsky, who argues that the “kind of 70 see below part 8.5. for more examples. 71 see e.g. ehlers, andreas bloch “om adækvanslæren i erstatningsretten” (2011) at 77-182. 72 see kries, johannes von: über den begriff der objektiven möglichkeit und einige anwendungen desselben, 12 vierteljahrsschrift für wissenschaftliche philosophie (1888) at 179. 73 see e.g. ehlers, andreas bloch “om adækvanslæren i erstatningsretten” (2011) at 118-147, 81-117 and 148-180. there is quite a lot of literature on this topic, see e.g. hart, h.l.a. og honoré, tony: causation in the law, 2nd. ed. (1985), lookofsky, joseph, “consequential damages in comparative context” juristog økonomforbundets forlag (1989), green, leon: the causal relation issue in negligence law, 60 michigan law review (1961-1962) at 543, foreseeability in negligence law, columbia law review 61 (1961) at 1401 and the rationale of proximate cause, (1930). nordic journal of commercial law issue 2013#2 20 conceptual thinking” embodied by hadley does not correspond entirely with the doctrine of adequate causation laid down in danish law.74 the third obstacle concerns the quality of the tp. as developed above in some cases this source of law may give helpful support as to how concrete issues should be decided. with respect to article 74 one could, for example, expect them to reveal how the above issue regarding the calculation of loss should be dealt with and how the foreseeability limitation should be properly understood. perhaps one could even expect them to deal with more specific questions such as how non-pecuniary loss should be assessed. however, the tp do not give any clear guidance as to how these questions, or any other questions for that matter, should be dealt with. rather, they reveal significant disagreement as to how the article should be understood. already in the working group there was disagreement about the proper understanding of the principle of full compensation. most speakers in the group agreed that some restriction on consequential damages was necessary but some were concerned that the foreseeability test of the ulis was not sufficiently objective.75 certain representatives expressed the opinion that the foreseeability limitation was not even necessary.76 further, some representatives, including the ussr, preferred that full damages for all proven loss be allowed.77 the working group took note of these reservations but decided to adopt the following version of the foreseeability doctrine: “such damages cannot exceed the loss which the party in breach foresaw or ought to have foreseen at the time of the conclusion of the contract, in the light of the facts and matters which he then knew or ought to have known, as a possible consequence of the breach of contract.»78 before the commission it was proposed that the foreseeability doctrine, as adopted by the working group, was replaced by the following paragraph: «such damages shall not include compensation for loss of a nature which the party in breach could not reasonably have foreseen at the time of the conclusion of the contract 74 lookofsky, joseph, “consequential damages in comparative context” juristog økonomforbundets forlag (1989) at 176. 75 honnold, john o, “documentary history of the uniform law for international sales” (1989) kluwer law and taxation publishers at 190. 76 honnold, john o, “documentary history of the uniform law for international sales” (1989) kluwer law and taxation publishers at 190. 77 honnold, john o, “documentary history of the uniform law for international sales” (1989) kluwer law and taxation publishers at 238 and 253. 78 honnold, john o, “documentary history of the uniform law for international sales” (1989) kluwer law and taxation publishers at 190. nordic journal of commercial law issue 2013#2 21 or of an extent which would be excessive in relation to the price, the ability of the party in breach to foresee or prevent the loss as well as other circumstances of the case.»79 this proposal was supported by arguments alleging that the text prepared by the working group ‘contained a limitation on the amount of damages which was hypothetical and gave little effective guidance in practice’. however, there was only little support for this proposal since it was considered to introduce too many difficulties. thus, the commission found that no substantial change was necessary and gave the working group’s proposal its unanimous approval with only minor editorial amendments.80 this proposal was incorporated into the 1978 draft convention.81 from the proceedings at the diplomatic conference it appears that pakistan proposed to amend the foreseeability doctrine to the effect that damages could not exceed the “reasonable expectation of” loss.82 the purpose of this amendment was presumably to clarify that ‘damages for loss of profit could not be claimed automatically when, for example, the party in breach could not reasonably have foreseen the risk of loss.’83 however, this proposal was rejected and the foreseeability doctrine laid down in the present article 74 was adopted by 48 votes to none84 on the 10th plenary meeting.85 thus, no amendments were made to the foreseeability doctrine at the diplomatic conference.86 the tp of the foreseeability doctrine evidence well the general problems pertaining to their usefulness as a source of law. first of all, comments on the doctrine are sparse and this makes it difficult to discern clear guidance as to the extent of liability under the convention. for example, it is not specified how essential concepts such as “loss”, “foreseeability”, and “possible 79 honnold, john o, “documentary history of the uniform law for international sales” (1989) kluwer law and taxation publishers at 352. 80honnold, john o, “documentary history of the uniform law for international sales” (1989) kluwer law and taxation publishers at 352. 81 honnold, john o, “documentary history of the uniform law for international sales” (1989) kluwer law and taxation publishers at 352 and 404. further, the commission asked the secretary-general to prepare a commentary on the various provisions of the draft. this document, which is known as the “secretariat commentary”, reflects the secretary-general’s impression of the commission’s work and it is the closest one comes to an official commentary on the convention. however, despite the complexity and importance of the foreseeability doctrine, the secretariat commentary seems to contribute with merely one clarifying note on its applicability, see ibid at 404. thus, it is made clear that the foreseeability-limitation on the principle of full compensation applies even in cases of fraud; see ibid at 449-450. 82 honnold, john o, “documentary history of the uniform law for international sales” (1989) kluwer law and taxation publishers at 615 and 703. 83 honnold, john o, “documentary history of the uniform law for international sales” (1989) kluwer law and taxation publishers at 615. 84 there were two abstentions, cf. honnold, john o, “documentary history of the uniform law for international sales” (1989) kluwer law and taxation publishers at 756. 85 honnold, john o, “documentary history of the uniform law for international sales” (1989) kluwer law and taxation publishers at 356. 86 compare ibid at 352 and 756. nordic journal of commercial law issue 2013#2 22 consequence” should be construed or if the doctrine as such should be interpreted expansively or narrowly in comparison with e.g. the hadley rule or the doctrine of adequate causation. we can observe the genealogy of the doctrine but the deliberations carried out at the various stages of its genesis do not clarify how far liability for breach of contract should be extended. second, the comments that actually do concern the doctrine fail to set out unified and unequivocal guidelines as to how it should be properly understood. rather, they contain mostly abstract observations on the vagueness of the doctrine and unfeasible proposals regarding the extent of liability. for example, we can learn that some representatives criticised the doctrine for providing too little effective guidance and that some wished to allow for all proven loss to be recovered. furthermore, most proposals to amend the doctrine were firmly rejected by the working group and the commission respectively, so even if they had been instructive on certain points they would not have been of much help. in all, therefore, the only useful piece of information seems to be the secretary general’s commentary on the applicability of the foreseeability doctrine in cases of fraud. the said obstacles to uniformity seem to leave the pursuit of uniformity almost entirely to the adjudicators and the legal scholars. below it is examined to what extent case law and literature contribute to achieving uniformity with respect to the calculation of damages. 8.4 the effect of cisg case law: is regard actually being had? it is a basic presupposition for achieving uniformity that the adjudicators actually do have regard to foreign case law when measuring damages pursuant to article 74. if they fail to do so each state is prone to develop its own (domestic) understanding of the article. it is not an easy task to examine whether such due regard is being had. the main reason for this is that there are no rules or principles providing clear guidance as to when foreign decisions should be taken into account. rather, this is highly controversial and therefore it is difficult to say when a certain adjudicator should apply the ratio of a foreign decision in order to solve a particular problem.87 further, the only empirical data available to test this are the transcripts of cisg cases. the transcripts are indeed helpful but they do not reveal everything that has been said and done during the cases and for that reason it can hardly be assumed that all foreign cases, having in some way affected the courts’ or arbitral tribunals’ decisions, appear from them. to the extent this is true, it is, of course, impossible to ascertain what influence foreign cases may have had. furthermore, official (or at least reliable) translations are not always available for cisg cases. this may also exclude valuable data from the examination. last, it is important to note that in some jurisdictions courts do not, by tradition, refer to foreign case law (or other 87 this is not to say that there are not cases where the courts obviously should have considered foreign case law. for a good example of this, see henschel, rené franz “danske domstoles anvendelse af fremmed retspraksis som set i sager om mangler i internationale køb reguleret af cisg”, erhvervsjuridisk tidsskrift (2006) at 134. nordic journal of commercial law issue 2013#2 23 sources of law for that matter) when interpreting international instruments but this does not necessarily mean that such sources are disregarded. due to said difficulties it cannot be answered unequivocally whether foreign cases are being duly considered. however, this need not lead to some kind of methodological defeatism since there are indeed some ways to test this. first, it can be examined to what extent foreign case law is actually being cited by the various courts and arbitral tribunals in the cisg area. below this nordic journal of commercial law issue 2013#2 24 is done by way of a systematic review of cisg cases decided in the period from 2005 to 2013.88 second, by looking at the said cases, it can be ascertained to what extent domestic case law is 88 in the present review a total of 107 cases dealing with article 74 have been examined. the cases have been identified by searching the cisg database at pace law school which contains a comprehensive collection of cases on article 74 decided from the entering into force of the convention to the present. the review comprises cases decided from january 2005 to february 2013 only. unfortunately, the transcripts are not always sufficiently comprehensive or detailed to ascertain how article 74 has been construed. in such cases the transcripts have been excluded from the review (save for some cases where it has been possible to obtain the original case transcript from the local jurisdiction in question). further, to this author it has only been possible to examine case transcripts in danish, german, english, and spanish. the reviewed cases, which are all available at http://www.cisg.law.pace.edu/cisg/text/digest-cases-74.html, are: decision by bundesgerichtshof of 26 september 2012 (no viii zr 100/11), decision by bundesgerichtshof of 18 july 2012 (no viii zr 337/11) decision by bundesgericht of 17 april 2012 (no 4a_591/2011), al hewar environmental & public health establishment v. southeast ranch, llc and joel gutierre (decision by u.s. district court, southern district of florida of 7 november 2011 (no 10-80851)), semi-materials co., ltd. v memc electronic materials, inc., et al. (decision by u.s. district court, eastern district of missouri, eastern division of 10 january 2011 (no 4:06cv1426 frb)), decision by lg lübeck of 30 december 2010 (no 6 0 160/10, decision by juzgado nacional en lo comercial de buenos aires of 5 october 2010 (no 5), decision by cámara nacional de apelaciones en lo comercial de buenos aires of 7 october 2010 (no unavailable), decision by hg zürich of 22 november 2010 (no hg070223/u/dz), decision by olg hamm of 30 november 2010 (no 19 u 147/09), castel electronics pty. ltd. v toshiba singapore pte. ltd. (decision by federal court of australia, victoria district registry, general division of 28 september 2010 (no vid 141 of 2008)), decision by audiencia provicial de murcia of 15 july 2010 (no 439/10), ecem european chemical marketing b.v. v the purolite company (decision by u.s. district court, eastern district of pennsylvania of 29 january 2010 (no 05-3078)), decision by bundesgericht of 17 december 2009 (no 4a_440/2009), decision by lg stuttgart of 29 october 2009 (no 25 0 99/09), decision by foreign trade court of arbitration attached to the serbian chamber of commerce of 19 october 2009 (no t-6/08), decision by lg stuttgart of 15 october 2009 (no 39 0 31/09 kfh), doolim corp. v r doll, llc, et al. (decision by u.s. district court, southern district of new york of 29 may 2009 (no 08 civ. 1587 (bsj) (hbp)), decision by audiencia provicial de alicante of 24 april 2009 (no 72/2009), barbara berry, s.a. de c.v. v ken m. spooner farms, inc. (decision by u.s. district court, western district of washington at tacoma of 3 april 2009 (no c 05-5538fdb)), decision by olg hamm of 2 april 2009 (no 28 u 107/08), decision by audiencia provicial madrid of 10 march 2009 (no 759/2008), decision by obergericht of 3 march 2009 (no zor.2008.16/eb), decision by tribunal contonal du valais of 28 january 2009 (no c1 08 45), decision by rechtbank breda of 16 january 2009 (no 197586/kg za 08-659), decision by polymeles protodikio athinon of 2009 (no 2228/2009), decision by multi-member court of first instance of athens of 2009 (no 4505/2009), decision by kantonsgericht zug of 27 november 2008 (no a3 2004 112), decision by olg brandenburg of 18 november 2008 (no 6 u 53/07), decision by supreme court of the slovak republic of 28 october 2008 (no obo 250/2007), decision by rechtbank rotterdam of 15 october 2008 (no 295401/ha za 07-2802), norfolk southern railway company v power source supply, inc. (decision by u.s. district court, western district of pennsylvania of 25 july 2008 (no 07-140-jjf)), decision by foreign trade court of arbitration attached to the sertian chamber of commerce of 15 july 2008 (no t-4/05), decision by cour d’appel de rennes of 27 may 2008, decision by kantonsgericht st. gallen of 13 may 2008 (no bz.2007.55), decision by olg stuttgart of 31 march 2008 (no 6 u 220/07), decision by olg münchen of 5 march 2008 (no 7 u 4969/06) decision by olg hamburg of 25 januar 2008 (no 12 u 39/00), decision by foreign trade court of arbitration attached to the serbian chamber of commerce of 23 january 2008 (no t-9/07), decision by judicial board of szeged of 22 november 2007 (no gf.i.30.372.2007/3), decision by bundesgericht of 13 november 2007 (no 4a_362/2007), macromex srl v globex int’l inc (decision by the international centre for dispute resolution of the american arbitration association of 23 october 2007 (no 50181t 0036406)), annika gustavsson v lrf n.v. (decision by københavns byret of 19 october 2007), decision by supreme court of denmark of 17 october 2007 (no 56/2006), decision by foreign trade court of arbitration attached to the serbian chamber of commerce of 1 october 2007 (t-8/06), decision by china international economic and trade arbitration commission of october 2007 (no 2007/03), decision by regional court in nitra of 17 september 2007 (no 16 cbm/30/2004), decision by kontonsgericht zug of 30 august 2007 (no a3 2006 79), decision by ag freiburg of 6 july 2007 (no 4 c nordic journal of commercial law issue 2013#2 25 4003/06), decision by olg köln of 2 july 2007 (no 16 u 5/07), decision by china international economic and trade arbitration commission of 30 june 2007 (no 2007/04), decision by handelsgericht des kantons zürich of 25 june 2007 (no hg 050430/u/ei), decision by handelsgericht aargau of 19 june 2007 (no hor.2005.83/ds/tp), decision by pretore del distretto di lugano of 19 april 2007 (no oa.2000.459), decision by olg dresden of 21 march 2007 (no 9 u 1218/06), decision by audiencia provincial de madrid of 20 february 2007 (no 683/2006), decision by hov van beroep of 22 january 2007 (no 2004/ar/1382), decision by tribunal of international commercial arbitration at the russian federation chamber of commerce and industry of 29 december 2006 (no 54/2006), decision by obergerict zug of 19 december 2006 (no og 2006/19), decision by lg coburg of 12 december 2006 (no 22 0 38/06),decision by obergericht des kantons thurgau of 12 december 2006 (no zbr.2006.26), decision by china international economic and trade arbitration commission of december 2006 (no 2006/05), decision by tribunal of international commercial arbitration at the russion federation chamber of commerce and industry of 15 november 2006 (no 98/2005), decision by zivilgericht basel-stadt of 8 november 2006 (no p 2004 152), decision by olg münchen of 19 october 2006 (no 23 u 2421/05), decision by lg berlin of 13 september 2006 (no 94 0 50/06), decision by china international economic and trade arbitration commission of september 2006 (no 2006/09), decision by olg köln of 14 august 2006 (no 16 u 57/05), teevee toons, inc. (d/b/a) tvt records) & steve gottlieb, inc. (d/b/a biobox) v. gerhard schubert gmbh (decision by u.s. district court, southern district of new york of 12 august 2006 (no 00 civ 5189 (rcc))), decision by china international economic and trade arbitration commission of 3 august 2006 (no 2006/15), decision by china international economic and trade arbitration commission of august 2006 (no 2006/13), decision by china international economic and trade arbitration commission of 25 july 2006 (no 2006/22), decision by rechtbank arnhem of 19 july 2006 (no 125903/ ha za 05-682), decision by ag landsberg am lech of 21 june 2006 (no 1 c 1025/05), decision by china international economic and trade arbitration commission of 31 may 2006 (no 2006/01), decision by tribunal cantonal valais of 23 may 2006 (no c1 06 28), decision by tribunal of international commercial arbitration at the russian federation chamber of commerce and industry of 19 may 2006 (no 122/2005), decision by china international economic and trade arbitration commission of may 2006 (no 2006/18), decision by tribunal of international commercial arbitration at the russian federation chamber of commerce and industry of 13 april 2006 (no 105/2005), decision by olg köln of 3 april 2006 (no 16 u 17/05), decision by china international economic and trade arbitration commission of april 2006 (no 2006/21), decision by rechtbank arnhem of 1 march 2006 (no 125903/ha za 05-682), decision by olg köln of 13 february 2006 (no 16 u 1705), decision by tribunal of international commercial arbitration at the russian federation chamber of commerce and industry of 13 february 2006 (no 102/2005), decision by olg karlsruhe of 8 february 2006 (no 7 u 10/04), decision by foreign trade court of arbitration attached to the serbian chamber of commerce of 24 january 2006 (no t12/04), decision by olg linz of 23 january 2006 (no 6 r 160/05z), decision by regional court in trnava of 12 january 2006 (no 36 cbm/6/2003), american mint llc, goede beteiligungsgesellschaft, and michael goede v gosoftware, inc. (decision by u.s. district court, m. d. pennsylvania of 6 january 2006 (no civ.a. 1:05-cv-650)), decision by china international economic and trade arbitration commission of 26 december 2005 (no 2005/21), decision by handelsgerich zürich of 22 december 2005 (no hg 04 0374/u/ei), decision by china international economic and trade arbitration commission of december 2005 (no 2005/23), decision by china international economic and trade arbitration commission of 9 november 2005 (no 2005/04), decision by cour d’appel versailles of 13 october 2005 (no 04/04/128), decision by audiencia provincial de palencia of 26 september 2005 (no 227/2005), decision by new pudong district people’s court of shanghai of 23 december 2005 (no (2004) pu min er (shang) chu zi di no. 3221), decision by ogh of 8 november 2005 (no 4 ob 179/05k), decision by rechtbank van koophandel hasselt of 20 september 2005 (no a.r. 04/3568), decision by china international economic and trade arbitration commission of 22 august 2005 (no 2005/13), decision by tribunal of international commercial arbitration at the russian federation chamber of commerce and industry of 27 may 2005 (no 95/2004), decision by ho turku of 24 may 2005 (no s 04/1600), decision by china international economic and trade arbitration commission of 10 may 2005 (no 2005/02), decision by china international economic and trade arbitration commission of 7 april 2005 (no 2005/01), decision by audiencia provincial de valencia of 31 march 2005 (no unavailable), decision by tribunal of international commercial arbitration at the russian federation chamber of commerce and industry of 16 march 2005 (no 75/2004), decision by tribunal of international commercial arbitration at the russian federation chamber of commerce and industry of 24 january 2005 (no 68/2004), decision by alexandria center for international arbitration of 16 nordic journal of commercial law issue 2013#2 26 applied in the interpretation of article 74. basically, the application of domestic case law is not in contravention of the convention. however, if the courts and arbitral tribunals apply such case law only each contracting state may end up having its very own interpretation of the convention and therefore, a proclivity towards such cases is problematic. further, it is problematic if the courts apply domestic case law dealing with domestic pieces of legislation (e.g. a domestic sale of goods act) to solve matters pertaining to the cisg. third, it can be tested to what extent domestic doctrines on the measurement of damages (such as the hadley-rule or the doctrine of adequate causation) are employed in the interpretation of article 74. as adumbrated above, article 74 leaves a lot of questions unanswered and therefore, it seems reasonable to expect that the adjudicators rely heavily on case law (including foreign case law) in order to find appropriate answers. however, the review clearly shows that this is not the case. in fact, among the 107 cases reviewed, there do not appear to be a single case in which a foreign decision is employed in order to ascertain the scope of article 74. even though references to foreign cases are generally rare,89 this finding is rather surprising and alarming and it is difficult to see how an internationally-oriented interpretation can be established on this basis. of course it can be argued that in some cases there is no need to look at foreign case law but this does not account for said (complete) disregard. with respect to domestic case law the review shows a somewhat greater willingness to be persuaded on behalf of the adjudicators. a total of six cases where a court or an arbitral tribunal employed domestic case law in the interpretation of article 74 were found. in four of these cases the domestic case law, which was referred to, dealt with the interpretation of article 74, cf. norfolk southern railway company v. power source supply, inc.90, american mint llc, goede beteiligungsgesellschaft, and michael goede v gosoftware, inc.,91 semi-materials co. ltd. v memc electronic materials, inc., et al,92 and decision 4505/2009 by the multi-member court of first instance athens.93 january 2005 (no 6/2003), decision by china international economic and trade arbitration commission of 2005 (no 2005/25), decision by tribunal of international commercial arbitration at the ukraine chamber of commerce and trade of 2005 (no 2005/48). 89 see e.g. henschel, rené franz:”the conformity of goods in international sales. an analysis of article 35 in the united nations convention on contracts for the international sale of goods (cisg)” 2005 at 38 (with further reference). 90 cf. decision by u.s. district court, western district of pennsylvania of 25 july 2008 (no 07-140-jjf) available at http://cisgw3.law.pace.edu/cases/080725u1.html. 91 cf. decision by u.s. district court, m. d. pennsylvania of 6 january 2006 (no civ.a. 1:05-cv-650) available at http://cisgw3.law.pace.edu/cases/060106u1.html. 92 cf. decision by u.s. district court, eastern district of missouri, eastern division of 10 january 2011 (no 4:06cv1426 frb) available at http://cisgw3.law.pace.edu/cases/110110u2.html. 93 available with extensive editorial remarks by dionysios p. flambouras at http://cisgw3.law.pace.edu/ cases/094505gr.html. see further commentary on said case in flambouras, dionysios p., “case law of greek courts for the vienna convention (1980) for international sale of goods”, nordic journal of commercial law (2009#2) available at http://www.njcl.fi/2_2009/flambouras_dionysios.pdf. nordic journal of commercial law issue 2013#2 27 in the norfolk case, a buyer from canada (power source supply, inc.) and a vendor from the u.s. (norfolk southern railway company) had entered into a contract for the sale of locomotives. subsequently, the buyer refused to pay the (full) purchase price as specified in the contract claiming, among other things, that delivery had not been made on time. this led the vendor to sue the buyer for damages. the court found that the vendor had duly performed the parties’ agreement and awarded damages pursuant to article 74. with respect to the interpretation of article 74, the court referred to the case of delchi carrier s.p.a. v rotorex corp.94 where it was said that the article is “designed to place the aggrieved party in as good a position as if the other party had properly performed the contract”. on that basis the vendor was due the outstanding balance of the contract of $784,315. however, the court did not find that article 74 allowed the vendor’s attorneys’ fees to be recovered. this finding was based on the ratio of the case of zapata hermanos sucesores, s.a. v. hearthside baking company, inc. d/b/a maurice lenell cooky company.95 in that case the u.s. circuit court of appeals (7th cir.) found that, for a number of reasons, attorneys’ fees were not recoverable under article 74. first of all the court emphasized the need to distinguish between substantive and procedural law.96 further, it found that the question of reimbursement of attorneys’ fees was a question of procedural law not covered by the cisg.97 second, the court found no evidence in the drafting history of the convention that such fees should be recoverable. accordingly, the court reverted to domestic law to answer the question. in the american mint case, the vendor, a u.s. software company, had sold software to another u.s. company which was a subsidiary of a german firm. the software was installed at the place of business of the buyer’s parent company in germany but allegedly it did not function 94 see decision by u.s. circuit court of appeals (2d. cir.) of 6 december 1995 (no 95-7182, 95-7186) available at http://cisgw3.law.pace.edu/cases/951206u1.html. 95 see decision by u.s. circuit court of appeals (7th cir.) of 19 november 2002 (no 01-3402, 02-1867, 02-1915) available (with editorial remarks) at http://cisgw3.law.pace.edu/cases/021119u1.html. 96 inter alia the court said that “the convention is about contracts, not about procedure. the principles for determining when a losing party must reimburse the winner for the latter's expense of litigation are usually not a part of a substantive body of law, such as contract law, but a part of procedural law. for example, the "american rule," that the winner must bear his own litigation expenses, and the "english rule" (followed in most other countries as well), that he is entitled to reimbursement, are rules of general applicability. they are not fieldspecific.” 97 inter alia the court supported this finding by saying that “article 74 of the convention provides that "damages for breach of contract by one party consist of a sum equal to the loss, including loss of profit, suffered by the other party as a consequence of the breach," provided the consequence was foreseeable at the time the contract was made. (…) there is no suggestion in the background of the convention or the cases under it that "loss" was intended to include attorneys' fees, but no suggestion to the contrary either. nevertheless it seems apparent that "loss" does not include attorneys' fees incurred in the litigation of a suit for breach of contract, though certain prelitigation legal expenditures, for example expenditures designed to mitigate the plaintiff's damages, would probably be covered as "incidental" damages. sorenson v. fio rito, 413 n.e.2d 47, 50-52 (ill.app.1980); cf. tull v. gundersons, inc., 709 p.2d 940, 946 (colo.1985); restatement (second) of contracts § 347, comment c (1981).” on the recoverability of litigation costs, see schlechtriem, peter & schwenzer, ingeborg, “commentary on the un convention on the international sale of goods (cisg)” 3rd ed. (2010) oxford university press at 1010f. nordic journal of commercial law issue 2013#2 28 properly due to its incompatibility with certain german numeric standards. this led the buyer, the parent company, and the person in charge of the german parent (mr. michael goede) to sue the seller for breach of contract and damages. the damages comprised lost profits and attorneys’ fees (incurred as a result of the litigation). the buyer argued that the case should be decided in accordance with the cisg but this argument was rejected because the court did not find that the immediate parties to the contract were located in different contracting states as set out in cisg article 1(1). in this respect the court expressly noted that the german parent company could not be regarded as a party to the contract. consequently, the cisg did not apply to the contract but in obiter dictum the court made some interesting remarks which correspond well with above dictum in norfolk. thus, the court noted that attorneys’ fees were not recoverable under article 74 as part of the “foreseeable loss”. this finding was supported by references to the above case in zapata and in chicago prime packers, inc. v northam food trading co.98 in the latter case, the u.s. district court briefly noted that “the term “loss” in article 74 of the cisg does not include attorneys’ fees incurred in the litigation of a suit for breach of contract.” in the semi-materials case, which concerned a u.s. vendor and a korean buyer, the court found that in a case of breach of contract (where there is no avoidance of the contract by either party), only article 74 (not article 76) applies. this finding was based on the case of macromex srl v globex int’l inc.99 which concerns the interpretation of article 74. the case before the multi-member court of first instance of athens100 concerned the sale of bullet-proof vests from a vendor in the netherlands to a buyer in greece. the basic question of the case was whether the bullet-proof vests were in conformity with the contract entered into by the parties. both the vendor and the buyer raised a number of claims against each other. inter alia the vendor claimed damages for loss of professional reputation and clientele due to the alleged wrongful avoidance of the contract by the buyer. since it does not follow (immediately) from article 74 whether such loss is recoverable the question was considered carefully. first, the court found that ‘the criterion for the affirmation of subjective foreseeability is the ability to foresee of the “ideal promisor”, i.e., of the prudent and “reasonable” representative of the circle of transactions in which the breaching promisor belongs, also in the light of the purpose of the specific sales contract’. this finding was supported by reference to two domestic cases also dealing with article 74, cf. case 22513/2003 decided by the multi-member court of first instance thessalonika101 and case 63/2006 decided by the court of appeals of lamia.102 98 see decision by u.s. district court, northern district of illinois, eastern division of 21 may 2004 (no 01 c 4447) available at http://cisgw3.law.pace.edu/cases/040521u1.html. 99 see decision by the international centre for dispute resolution of the american arbitration association of 23 october 2007 (no 50181t 0036406) available at http://cisgw3.law.pace.edu/cases/071023a5.html. 100 see op. cit. at fn 86. 101 for a brief editorial remark on this case by eleni zervogianni, see http://cisgw3.law.pace.edu/ cases/030513gr.html. 102 for a brief editorial remark on this case by dionysios p. flambouras, see http://cisgw3.law.pace.edu/ cases/060001gr.html. nordic journal of commercial law issue 2013#2 29 moreover, references were made to literature published by prominent greek scholars. second, the court found that ‘the object of the foreseeability is the nature [type] and extent of the damage as a possible consequence of the contractual breach, but not the contractual breach itself. therefore, the breaching promisor is not liable for just any damage; instead his liability under cisg is limited to the foreseeable damage, even if the promisor has intentionally breached his contractual obligations.’ the said findings finally made the court conclude that ‘non-material damage is not compensated, as well as damage suffered by the party to his professional reputation and damage from loss of clientele due to the non-conformity [of the goods] by the counter-party to the terms of the sales contract, since the said damage is not, as s general rule, considered to be foreseeable.’ in the remaining two cases the courts referred to domestic cases dealing with domestic law only, cf. castel electronics pty. ltd. v. toshiba singapore pte. ltd.103 and ecem european chemical marketing b.v. v. the purolite company.104 in castel, an australian wholesaler and distributor, castel electronics pty ltd, had contracted to buy certain electronic products from a toshiba subsidiary in singapore (toshiba singapore pte ltd. (tsp)). the main issues before the federal court of australia were whether the products were in conformity with the contract and whether castel was entitled to damages. first the court noted that ‘… australia and singapore, at all material times, [had] been “contracting states” within the meaning of the cisg. that has the effect that the cisg governs the rights and liabilities of castel and tsp under each sales contract to the exclusion of any operation which the goods act might otherwise have’. then the court went on to discuss the questions of breach of contract and damages. with respect to the latter the court held that castel was entitled to damages for expectation interest and reliance interest.105 the court observed correctly that article 74 was applicable but when measuring the recoverable amount of damages it relied on domestic common law cases only. when measuring the expectation interest, for example, the court found that ‘a difficulty in apportioning expenses, which have clearly been incurred, between amount properly allowable as damages and those which are not does not excuse a court from making the apportionment.’ this finding was based on the following ratio laid down in enzed holding ltd v. wynthea pty ltd.:106 ‘if the court finds damage has occurred it must do its best to quantify the loss even if a degree of speculation and guess work is involved. furthermore, if actual damage is suffered, the award must be for more than nominal damages. we should add that we can see no reason why 103 see decision by federal court of australia, victoria district registry, general division of 28 september 2010 (no vid 141 of 2008) available at http://cisgw3.law.pace.edu/cases/110420a2.html. 104 see decision by u.s. district court, eastern district of pennsylvania of 29 january 2010 (no 05-3078) available at http://cisgw3.law.pace.edu/cases/100129u1.html. 105 in the amount of $6,097,543. a deduction of $3,484,406, which toshiba singapore pte. ltd. had already paid in part compensation, was made from this sum. thus, the judgment for castel was made in the sum of $2,613,137. 106 1984 fca 373. nordic journal of commercial law issue 2013#2 30 this principle should not apply in cases under the trade practices act as well as in cases at common law. we emphasize, however, that the principle applies only when the court finds that loss or damage has occurred. it is not enough for a plaintiff merely to show wrongful conduct by the defendant.’ in order to further substantiate its finding on the measurement of the expectation interest the castel court referred to a number of other australian cases, cf. callaghan v. william c lynch pty ltd,107 commonwealth v. cornwell,108 ginza pte ltd v. vista corp pty ltd,109 and playcorp pty ltd v. taiyo kogyo ltd.110 in ecem a company based in the netherlands, ecem european chemical marketing b.v., had agreed to sell “styrene monomer”, an essential ingredient in products used to remove impurities from water and other liquid and gas media, to a buyer in the u.s. (the purolite company). the case arose from the the purolite company’s alleged failure to pay for five shipments of styrene monomer received in the last quarter of 2004. with respect to the interpretation of article 74, as in castel, the key question concerned the degree of certainty required in order for a plaintiff to claim damages. by reference to the domestic case of kituskie v. corbman,111 the u.s. district court held that ‘damages are considered remote or speculative only if there is uncertainty concerning the identification of the existence of damages rather than the ability to precisely calculate the amount or value of damages.’ another important question considered by the court was whether overhead was recoverable. this was accepted by the court with reference to the domestic case of vitex mfg. corp. v. caribtex corp decided by the united states court of appeals third circuit.112 in ecem also, no foreign cases were considered. it is a well-known fact that courts and arbitral tribunals sometimes apply domestic doctrines on the measurement of damages or domestic legislation in order to decide matters rightly pertaining to article 74. perhaps the most prominent example of this is the case of delchi carrier, s.p.a. v rotorex corp.113 in this case, delchi, an italian manufacturer of units for air conditioning, purchased 10,800 compressors from a u.s. vendor, rotorex. the compressors were to be delivered in three instalments by 15 may 1988. on 26 march 1988 the first instalment was successfully delivered. however, when the second instalment was in transit, delchi discovered that the first instalment of compressors was not in conformity with the contract. delchi suffered a loss and successfully sued rotorex for damages pursuant to the 107 1962 nswr 871. 108 2007 hca 16. 109 2003 wasc 11. 110 2003 vsc 108. 111 682 a. 2d 378 pa: superior. 112 377 f.2d 795, 798, 6 v.i. 166 (3d cir. 1967). 113 see decision by the united states court of appeals for the second circuit of 6 december 1995 (no 95-7182, 95-7186) available at http://cisgw3.law.pace.edu/cases/951206u1.html. the case was decided in the first instance by united states district court for the northern district of new york on 9 september 1994, cf. http://cisgw3.law.pace.edu/cases/940909u1.html. nordic journal of commercial law issue 2013#2 31 cisg. the court rightly observed that the convention should be interpreted with regard to ‘its international character and … the need to promote uniformity in its application and the observance of good faith in international trade’. subsequently, however, the court employed a line of arguments which eliminated entirely the possibility of achieving such international interpretation. with respect to article 74 the court found that ‘… the cisg requires that damages be limited by the familiar principle of foreseeability established in hadley v. baxendale …’ this is problematic because, as discussed above, the hadley-rule is not identical with the foreseeability doctrine laid down in the convention.114 fortunately, the present review shows that it is not common for the courts to refer to domestic doctrines in order to solve matters pertaining to article 74. in fact, only two examples of this could be found, cf. teevee toons, inc & steve gottlieb, inc v. gerhard schubert gmbh115 and decision of 15 october 2009 by the landgericht of stuttgart.116 in teevee, the plaintiffs claimed, inter alia, damages for breach of contract alleging that a certain packaging system delivered by the defendant was malfunctioning. in its reasoning on the foreseeability of the damages incurred by the plaintiff, the u.s. district court said that the foreseeability requirement ‘is identical to the well-known rule of hadley v. baxendale … such that relevant interpretations of that rule can guide the court’s reasoning regarding proper damages.’ here the court employed the same erroneous interpretation of article 74 as in delchi. the case before the landgericht of stuttgart concerned the sale of a printing machine from a german vendor to a hungarian buyer. the buyer claimed that the printing machine was not in conformity with the contract and sued the vendor for an amount of eur 244,276. the vendor rejected this claim and launched a counterclaim for costs of repair in the amount of eur 14,696.93. the court found that the dispute was governed by the cisg. this meant that the buyer was required to give notice within “reasonable time” about the lack of conformity pursuant to article 39(1) of the convention. in this respect the court noted that ‘according to jurisprudence and the leading doctrine, the gross average is approximately one month’. since almost three months lapsed between the buyer’s discovery of the lack of conformity and his notice, the court rejected the claim. with respect to the vendors counterclaim it was accepted in full by the court. however, although the court found that the cisg was applicable, this claim was measured pursuant to article 632 bgb (rather than article 74 cisg). there does not seem to be a good reason why the court reverted to domestic german legislation in order to deal with this particular issue. 114 see part 8.3. 115 see decision by u.s. district court, southern district of new york of 12 august 2006 (no 00 civ 5189 (rcc) available at http://cisgw3.law.pace.edu/cases/060823u1.html. 116 see decision by lg stuttgart of 15 october 2009 (no 39 0 31/09 kfh) available at http://cisgw3.law.pace.edu/cases/091015g1.html. nordic journal of commercial law issue 2013#2 32 in sum, the review shows that courts only rarely consider cisg case law when interpreting article 74. this is highly problematic because it may undermine the whole idea of having an international convention on the sale of goods. in particular, the disregard of foreign case law is a problem and the somewhat greater willingness to apply domestic cases does not seem to do much to rectify this. first of all it is not likely that a uniform interpretation can be achieved by application of domestic case law only. rather, in this way a sui generis interpretation of article 74 is likely to arise in each contracting state. second, in two out of the six domestic cases found, the courts referred to case law which did not even deal with article 74. such approach seems to undercut the possibility of establishing a uniform interpretation of article 74. the only encouraging finding of the review seems to be that there were merely two cases in which a domestic liability doctrine or a domestic piece of legislation was employed in the interpretation of article 74. however, this does not help much to achieve uniformity. 8.5 to what extent is uniformity being achieved? article 74 regulates a very complex and ambiguous issue and for that reason it is unfortunate that said sources of law do not provide much clarification as to how it should be interpreted. thus, as developed above, the wording of the article is vague and the tp contain hardly any interpretative guidelines which can be employed to ascertain how it should be understood. further, as evidenced by the empirical study of cases decided from 2005 to 2013, the adjudicators only seldomly apply case law to ascertain how article 74 should be interpreted. and when they actually do so, it is most often domestic cases dealing with impertinent domestic legislation or doctrines on the measurement of damages which are employed. as a consequence of the lack of guidance in the relevant sources of law and the adjudicators’ failure to make use of case law most of the central concepts of article 74 have not been made sufficiently clear. first, it is not entirely clear how the basic principle of the article, i.e. the principle of full compensation, should be construed.117 from the wording of the article it appears merely that damages consist of a sum equal to the loss (including loss of profit) suffered as a consequence of a breach of contract. this leaves undecided how certain fundamental problems on the measurement of damages should be dealt with and what kinds of losses are covered by the principle of full compensation. with respect to the former problem it is, for example, not clear if (and how) loss suffered by the claimant is to be set off with gains he may have had.118 with respect to the latter it is, for example, not settled to what extent a claimant may recover for costs 117 see further schlechtriem, peter & schwenzer, ingeborg, “commentary on the un convention on the international sale of goods (cisg)” 3rd ed. (2010) oxford university press at 1001 who note that “while the principle of full compensation is undisputed, its precise meaning it yet to be determined.” 118 schlechtriem, peter & schwenzer, ingeborg, “commentary on the un convention on the international sale of goods (cisg)” 3rd ed. (2010) oxford university press at 1016-1017. nordic journal of commercial law issue 2013#2 33 incurred in pursuing his rights.119 in particular, it is debated to what extent extra-judicial costs (such as costs incurred in order to retrieve the claim) can be reimbursed under article 74. even though it seems to be generally accepted that attorney’s fees can be recovered only if the applicable procedural law allows for it,120 the above empirical study shows that the question is still litigated upon cf. e.g. the norfolk case and the american mint case. in the former case the court found that the principle of full recovery is ‘designed to place the aggrieved party in as good a position as if the other party had properly performed the contract’. however, the court did not find that this allowed for attorney’s fees to be reimbursed. in the latter case the ratio of norfolk was supported in an obiter dictum. also, it is not entirely clear to what extent compensation for non-material loss is allowed. this applies to e.g. loss of goodwill where apparently three different interpretations have been launched.121 according to perhaps the most dominant interpretation such loss can be compensated if it amounts to a concrete financial loss but according to another interpretation this is not always a necessary condition. on the third interpretation damages for loss of goodwill seems to be ruled out ipso facto due to lack of foreseeability, cf. the above decision of the multi-member court of first instance of athens where the court held that “damage from loss of clientele” could not, as a general rule, be considered “foreseeable”. second, it is not clear how the foreseeability limitation should be interpreted. since this basic limitation mechanism is relevant to many cases this is a significant problem. it appears from the wording of article 74 that both a subjective and an objective test may be applied but these tests can be construed in several different ways. for example, what does it take for a certain subjective expectation to justify an award for damages and how is the exact amount of such damages to be calculated? and how is the objective test to be interpreted? does one, for example, need to employ a bonus pater or a vir optimus standard when assessing the limits of liability? and to what extent may the adjudicators consider other criteria such as the purpose of the contract, the allocation of risk, and basic notions of fairness? further, if it is indeed allowed to consider a variety of different criteria, how are these criteria to be weighed and balanced? these questions are important to clarify and a large number of cases show that the courts make great efforts to try to achieve a better understanding of them. this appears also from the above empirical study, cf. the case before the multi-member court of first instance of athens which 119 schlechtriem, peter & schwenzer, ingeborg, “commentary on the un convention on the international sale of goods (cisg)” 3rd ed. (2010) oxford university press at 1010-1012. 120 see further schlechtriem, peter & schwenzer, ingeborg, “commentary on the un convention on the international sale of goods (cisg)” 3rd ed. (2010) oxford university press at 1011. 121 see schlechtriem, peter & schwenzer, ingeborg, “commentary on the un convention on the international sale of goods (cisg)” 2nd ed. (2005) oxford university press at 753. in the third edition of said publication the authors argue that the controversy about damages for loss of goodwill has diminished, see schlechtriem, peter & schwenzer, ingeborg, “commentary on the un convention on the international sale of goods (cisg)” 3rd ed. (2010) oxford university press at 1013. nordic journal of commercial law issue 2013#2 34 held that the foreseeability standard is that of an “ideal promisor”. accordingly, damages were measured on the basis of the foresight of the “prudent and “reasonable” representative of the circle of transactions in which the breaching promisor belongs”. third, it is not entirely clear what the object of the foreseeability test is and what degree of probability that is to be applied when assessing whether there is a relevant loss. with respect to the former problem, it is necessary that the object of the foreseeability test is fixed before the assessment of probability can be made. otherwise it is not clear what it is (exactly) the promisor needs to foresee as a consequence of the breach of contract and this seems to make it impossible to carry out even a rough an assessment of probability.122 that this is indeed a real problem, which must be considered by the courts, is evidenced also by above empirical study, cf. the case before the multi-member court of first instance of athens where the court (among other things) observed that ‘the object of the foreseeability is the nature [type] and extent of the damage as a possible consequence of the contractual breach, but not the contractual breach itself.’123 the lack of clarity as to how the basic concepts of article 74 should be interpreted is problematic because it makes it difficult to see how uniformity and predictability can be established with respect to the measurement of damages. this jeopardises the whole purpose of the convention and it could be argued (with some credence) that the parties are better off choosing the law of a well-known and well-established legal system (such as e.g. english or german law) to govern the contract. certainly the law of such legal systems is also not entirely settled on the matter in question but a more homogenous legal tradition and legal culture, well established court hierarchies, and many more decisions do make it more clear what the law is. in particular it seems that a well-established court hierarchy is necessary to furnish a clear understanding of the complex problem of measuring damages. 9 conclusion the article has shown that neither of the internationally recognised sources of law provides clear an unequivocal guidance as to how the cisg should be interpreted. in fact, they are all susceptible to serious criticisms and a high degree of uniformity seems unlikely to be achieved in the imminent future. some scholars believe that the ever increasing amount of case law and literature will solve many of these problems. however, it is not certain that such centripetal development will occur. in fact, the inevitable disagreement among adjudicators and legal scholars appear to be a good breeding ground for dissident and inconsistency. this is supported also by the study of article 74. it is – at least to the present author – quite surprising how little 122 see further ehlers, andreas bloch “om adækvanslæren i erstatningsretten” (2011) at 124-127 and at 137-144. 123 see above part 8.4. nordic journal of commercial law issue 2013#2 35 relevant interpretative data that can be elucidated from the sources of law pertaining to this article. this applies first and foremost to the tp and case law. the former is almost completely silent as to how said article should be interpreted and the latter shows a remarkable disregard for case law, including particularly foreign case law. thus, not a single case could be found where the ratio of a foreign decision was applied and this reduces significantly the value of case law as a source of law. the little interpretative guidance of the sources of law and the disregard of case law pose a serious obstacle to achieving uniformity and this raises the question of what can be done to improve the situation. the immediate answer would be to set up some sort of supranational court of appeals with the capacity to authoritatively decide on matters pertaining to the convention. but this does not appear to be politically or practically realistic and perhaps not even desirable since it would inevitably draw out the cases to the detriment of the parties. moreover, such a drastic measure is perhaps not even necessary since much progress could be made already within the present framework. most importantly, it seems clear that the lawyers, the arbitrators, and the court judges could make much better efforts to confer with and employ the rich body of easily accessible cisg case law when arguing and deciding cases pertaining to the convention. this would ensure that in each case the relevant cisg case law is at least considered. microsoft word benjamin_j_richardson_lopullinen.docx   nordic journal of commercial law issue 2011#2 sovereign wealth funds and the quest for sustainability: insights from norway and new zealand by benjamin j. richardson*   *  professor  and  canada  research  chair   in  environmental  law  and  sustainability,  university  of  british   columbia.         1   nordic journal of commercial law issue 2011#2 1 introduction an impressive trend in global financial markets is the growth of sovereign wealth funds (swfs), some of which purport to invest ethically by considering the social and environmental impact of their financing. yet, like private investors, these funds primarily view themselves as financial institutions interested in enhancing investment returns. a significant tension, therefore, may emerge between the ethical and financial expectations of swfs. this article investigates two contrasting cases, the norwegian government pension fund global (ngpf-g) and the new zealand superannuation fund (nzsf), in order to evaluate how they address any tensions between being both virtuous and prosperous. these swfs have legislative mandates to invest ethically, and have been hailed by some researchers as having among the most progressive approaches in this area.1 but neither fund yet manages its entire portfolio comprehensively to promote sustainable development. increasingly, nation-states are establishing swfs in a trend that seemingly defies an era in which many governments have sought to deregulate or otherwise limit their hand in the market.2 in their governance, formally swfs are public institutions but functionally they are generally expected to be private actors. they invest large pools of state-owned assets in the market to meet macro-economic policy objectives,3 such as to buffer the sponsoring state’s budget and economy against swings in international markets, or to build savings to meet future financial burdens such as pension payments. swfs are typically funded through either commodity-based earnings, such as from a country’s natural resources sector, or by noncommodity-based resources, such as foreign exchange reserves and general taxation revenue.4 the ngpf-g is a commodity-based fund, built on norway’s large oil reserves, while the nzsf is supported by non-commodity financing. such concentration of wealth has made swfs, an institutional phenomenon that began in the mid-1950s, influential actors in the global economy.5 according to the sovereign wealth fund   1 united nations environment program – finance initiative (unep-fi) asset management working group and uk social investment forum (uksif), responsible investment in focus: how leading public pension funds are meeting the challenge (unep-fi, 2007), 7. 2 ashby h.b. monk, sovereignty in the era of global capitalism: the rise of sovereign wealth funds and the power of finance (school of geography, oxford university, 2010); roland beck and michael fidora, “the impact of sovereign wealth funds on global financial markets,” intereconomics (2008) 43(6): 349. 3 adrian blundell-wignall, yu-wei hu and juan yermo, “sovereign wealth and pension fund issues,” oecd working papers on insurance and private pensions (2008) 14: 4. 4 rumu sarkar, “sovereign wealth funds as a development tool for asean nations: from social wealth to social responsibility,” georgetown journal of international law (2010) 41: 621, at 623. 5 ibid., 631.       2   nordic journal of commercial law issue 2011#2 institute, as of may 2011 there were 52 swfs worldwide, with assets of some us$4.3 trillion.6 a recent survey by the monitor group, published in july 2011, put norway’s swf as the largest (with us$560 billion in assets), while new zealand’s was ranked 20th (valued at us$15.8 billion).7 with swfs’ assets expected to at least double within the next decade,8 and growing awareness of their economic clout and capacity to project state political power, international efforts to create voluntary behavioural codes for such funds have grown. the principal achievement to date is the santiago principles,9 which emphasise transparency, clarity, and equivalent treatment with private funds similarly operated. in addition to these issues, the socially conscious goals of some swfs has stirred debate about the wisdom of mixing ethical investment with wealth maximisation goals, and attempting to influence corporate social and environmental behaviour.10 swfs share several characteristics which might lead them more than private sector financiers to invest in sustainable development. their ownership or control by a state can enmesh them in the machinery of government, and thereby render them instruments of public policy. further, because of their sheer size and government backing, swfs tend to have higher risk tolerances and might therefore bear investment strategies eschewed by private financiers. thirdly, swfs tend to have longer-term financial considerations than the private sector, which may encourage investing that is mindful of threats such as climate change. however, few states so far have obliged swfs to invest ethically. while regulations to encourage socially responsible investment (“sri,” as ethical investment is sometimes known) in the private sector are appearing, such as taxation incentives and corporate governance reforms, explicit duties to practice sri have only been imposed on public financial institutions.11 the first precedents were adopted in the 1980s by some states and municipalities in the united states, which restricted government pension funds from investing in firms operating in the   6 sovereign wealth fund institute, http://www.swfinstitute.org. 7 monitor group, “swf assets under management” (7 july 2011), http://www.monitor.com/tabid/202/l/enus/default.aspx. in local currency, the nzsf valued its assets as nzs18.8 billion in march 2011 (see http://www.nzsuperfund.co.nz/index.asp?pageid=2145855927), while the ngpf-g valued its at nok 3,007 trillion (norges bank investment management (nbim), annual report 2010 (nbim, 2010), 1). 8 international monetary fund, “norway’s oil fund shows the way for wealth funds,” imf survey magazine: policy (9 july 2008). 9 international working group of sovereign wealth funds, sovereign wealth funds, generally accepted principles and practices: santiago principles (october 2008), available at http://www.iwg-swf.org/pubs/gapplist.htm. 10 gordon l. clark and ashby monk, “the norwegian government pension fund: ethics over efficiency,” rotman international journal of pension management (2010) 3(1): 14, 17; larry c. backer, “sovereign wealth funds as regulatory chameleons: the norwegian sovereign wealth funds and public global governance through private global investment,” georgetown journal of international law (2010) 41(2): 425. 11 benjamin j. richardson, socially responsible investment law: regulating the unseen polluters (oxford university press, 2008), 303-75.       3   nordic journal of commercial law issue 2011#2 discriminatory milieu of south africa12 or northern ireland.13 since 2000, the swfs of sweden, norway, new zealand and france have been subject to legislative direction to invest ethically, with more comprehensive and ambitious obligations than the american precedents. ethical investment by swfs is controversial. some observers believe that investment should be based only on economic and financial grounds and, especially in the case of swfs, there is further concern that sri could be a means for sponsoring states to insinuate their social and environmental policies globally.14 for instance, a 2009 survey of 146 asset managers having routine dealings with swfs reported that most “did not think governments should have any influence over investment decisions despite the fact that swfs are managing governments’ money.”15 but such concerns misunderstand the changing rationale and aims of sri. a long-standing movement that once had few adherents,16 sri is attracting investors who are reassessing the financial relevance of social and environmental behaviour. no longer is sri pursued largely as a matter of ethical compulsion, as in the 1970s divestment campaign led by religious groups against south africa’s apartheid regime,17 and their earlier admonitions against investment in tobacco, alcohol and other “sin” stocks.18 rather, many social investors today, in both the institutional and retail sectors, take a more comprehensive view of business conduct through the lens of sustainable development. sustainable development (or “sustainability” as the concept is sometimes known) is an ideal widely endorsed in theory as a goal of states, international bodies and businesses, and has been enshrined as an objective of the european union treaty.19 it seeks to curb unfettered economic   12 patricia mccarroll, “socially responsible investment of public pension funds: the south africa issue and state law,” review of law and social change (1980-81) 10: 407; grace jubinsky, “state and municipal governments react against south african apartheid,” university of cincinnati law review (1985) 54: 453. 13 see christopher mccrudden, “human rights codes for transnational corporations: what can the sullivan and macbride principles tell us?” oxford journal of legal studies (1999) 19(2): 167; neil j. conway, “investment responsibility in northern ireland: the macbride principles of fair employment,” loyola of los angeles international and comparative law review (2002) 24: 1. 14 clark and monks, supra note 10; backer, supra note 10. 15 gordon l. clark and ashby monk, “the oxford survey of sovereign wealth funds' asset managers,” (school of geography and the environment, university of oxford, 2009), 1. 16 in western europe and north america, some surveys estimate that between 10 to 20% of all investment portfolios are now managed for ethical, social and environmental purposes, although these surveys use very broad definitions and certainly over-estimate the amount of effective sri: european social investment forum (eurosif), european sri study (eurosif, 2010); us social investment forum (sif), socially responsible investing trends in the united states (sif, 2010). 17 christopher coons, “divestment steamroller seeks to bury apartheid,” business and society review (1986) 57: 90. 18 russell sparkes, socially responsible investment: a global revolution (john wiley & sons, 2002), 71. 19 art. 11, consolidated version of the treaty on the functioning of the european union, o.j. c 83/47 (30 march 2010), (2008) o.j. c 115/47, states: “environmental protection requirements must be integrated into the definition and implementation of the union policies and activities, in particular with a view to promoting       4   nordic journal of commercial law issue 2011#2 exploitation of nature by ensuring consumption of renewable resources within their rate of regeneration, limiting waste and pollution to the assimilative capacity of the biosphere, and conserving the biodiversity of the planet.20 some investors recognise the financial materiality of sustainability, such as when corporate polluters create financial risks or, conversely, firms pioneer innovative environmental technologies and services.21 although, often the nexus between environmental and financial returns is misunderstood or overlooked by financiers. for large institutional investors, including swfs, the sustainability imperative has mostly fluently been theorised through the concept of the “universal owner.” hawley and williams hypothesise that institutional investors who invest widely across the market will benefit financially by taking into account the social and environmental externalities in their portfolios.22 as economy-wide investors, they should “have no interest in abetting behavior by any one company that yields a short-term boost while threatening harm to the economic system as a whole.”23 acting as a universal investor implies that any “externality” at the level of an individual company may result in a costly “internality” for an investor’s global portfolio. such sentiments have underpinned the proliferation of codes of conduct for sri,24 such as the united nations principles for responsible investment (unpri)25 and the equator principles.26 although adherence to such benchmarks is ostensibly voluntary, they have garnered many signatories, including the ngpf-g and the nzsf, and thereby helped standardise and   sustainable development.” on the lack of consistency between the european treaty and the level of secondary law in company and business law, see beate sjåfjell, towards a sustainable european company law: a normative analysis of the objectives of eu law (kluwer law, 2009). 20 herman daly, “toward some operational principles of sustainable development” ecological economics (1990) 1: 1: marie-claire segger and ashfaq khalfan, sustainable development law: principles, practices, and prospects (oxford university press, 2005). 21 matthew j. kiernan, investing in a sustainable world: why green is the new color of money on wall street (amacom books, 2009). such sentiments are reflected in reports of the influential united nations environment programme – finance initiative (unep-fi), such as: show me the money: linking environmental, social and governance issues to company value (unep-fi asset management working group, 2006). 22 james hawley and andrew williams, the rise of fiduciary capitalism: how institutional investors can make corporate america more democratic (university of pennsylvania press, 2000). 23 stephen davis, jon lukomnik and david pitt-watson, the new capitalists. how citizen investors are reshaping the corporate agenda (harvard business press, 2006), 18. 24 see kate miles, “targeting financiers: can voluntary codes of conduct for the investment and financing sectors achieve environmental and sustainability objectives?” in critical issues in environmental taxation, volume 5, eds nathalie chalifour, et al. (oxford university press, 2008), 947; deborah leipziger, the corporate responsibility code book (greenleaf publishing, 2003). 25 http://www.unpri.org. 26 http://www.equator-principles.com.       5   nordic journal of commercial law issue 2011#2 disseminate sri norms and practices.27 some interesting research has begun to measure the cost of environmental externalities to universal investors. a report prepared for the unpri secretariat evaluated the price of environmental damage worldwide to which the companies in a representative investment portfolio contribute, and estimated these in 2008 to be us$6.6 trillion or 11% of global gdp.28 the report expects such costs by 2050 to grow to us$28.6 trillion (18% of projected global gdp).29 the rest of this article takes up these themes by examining the sri policies and practices of the norwegian and new zealand swfs. in comparing how they attempt to reconcile their ethical and financial aspirations, the article highlights the importance of governance frameworks. while there are some salient differences in how each swf is governed, each has, especially in their early years, focused on avoiding complicity in unethical conduct or social and environmental harm. this stance represented a rather narrow approach to ethical investment, which limited the capacity of these swfs to promote environmentally sustainable development. more recently, both funds have begun to accept the business case for sri, and reconceptualised ethical investment as a means of promoting long-term financial returns. but neither the ngpfg nor the nzsf is mandated to actively promote sustainable development or to seek improvements in corporations’ sustainability performance. in the future evolution of swfs, the creation of explicit duties to invest in sustainability is perhaps the next logical step if they are to influence benignly the global economy. 2 norwegian government pension fund global (ngpf-g) 2.1 institutional and legal structure the ngpf-g (statens pensjonsfond – utland) is a sovereign fund that invests proceeds from norway’s petroleum industry that has prospered since oil was discovered in the north sea in 1969. originally known as the petroleum fund, it was established in 1990 through the act of the government petroleum fund (lov om statens petroleumsfond). the fund did not receive any capital until 1996, when a sufficient government budget surplus arose. the fund’s statutory framework was overhauled in december 2005,30 which resulted in it being renamed the “government pension fund – global,” to reflect that it is intended to meet future pension costs (although it does not yet directly have any such liabilities). the accompanying regulations   27 benjamin j. richardson, “financing sustainability: the new transnational governance of socially responsible investment,” yearbook of international environmental law (oxford university press) (2007) 17: 73. 28 principles of responsible investment (pri) association and unep-fi, universal ownership: why externalities matter to institutional investors (pri association and unep-fi, 2010), 2. 29 the majority of these costs are attributed to greenhouse gas emissions and unsustainable use of water. 30 act of the government pension fund (lov om statens pensjonsfond), no. 123 (2005).       6   nordic journal of commercial law issue 2011#2 for governance of the ngpf-g have periodically been revised, most recently in march 2010.31 while the government mandates the ngpf-g to operate like a private investor, it is expected to fulfill two broad policy goals of the state. firstly, as a vehicle for long-term savings, the fund should ensure that a reasonable share of norway’s petroleum wealth benefits future generations of norwegians. secondly, it should avoid investments that would make it complicit in unethical or harmful social and environmental practices. investing only in foreign assets so as to avoid overheating the domestic economy, the ngpf-g has grown immensely to reach almost nok 3,100 billion at the beginning of 2011.32 its sister fund, the government pension fund norway, invests just in norway and other scandinavian countries. in contrast to some swfs including new zealand’s, the ngpf-g is closely tied to the government. its administration is divided among three governmental entities. the norwegian ministry of finance retains ultimate responsibility for the policy and management of the ngpfg, including ethical investment decisions such as to exclude a company. the norges bank (norway’s central bank) has operational control, and through its ownership rights in companies it handles corporate engagement. the bank has devolved many of its responsibilities to norges bank investment management (nbim)33 and external fund managers. thirdly, a governmentappointed council on ethics advises on ethical investment decisions relating primarily to the exclusion of companies. the activities of all three entities are overseen by the norwegian parliament (storting), which approves the ngpf-g’s investment strategy, and scrutinises annual reports of the ministry of finance and its ethical investment guidelines. while the ngpf-g functions under a legal framework that reflects a “public commitment to procedural democracy,”34 and which encourages practices that are broadly reflective of the values of norwegian society, the general public itself has few opportunities to participate directly in the fund’s governance except circuitously through their elected storting representatives. the ngpf-g decision-making, at least, is highly transparent. all recommendations of the council are publicly disclosed, with detailed reasons.35 the norges bank consults with the public before submitting to the ministry its plans for exercise of active   31 the regulations are consolidated as the management mandate for the government pension fund, available at http://www.regjeringen.no/upload/fin/statens%20pensjonsfond/mandat_spu_eng.pdf. 32 norwegian ministry of finance, the management of the government pension fund in 2010 (report no. 15 (20102011) to the storting, 2011), 20. 33 see http://www.nbim.no. 34 clark and monk, supra note 10, at 15. 35 the council’s guidelines oblige it to justify its recommendations, including “the council’s assessment of the specific basis for exclusion and any comments on the case from the company”, and it shall, insofar as possible, rely on evidence that “can be verified”: guidelines for observation and exclusion from the government pension fund global’s investment universe (2010), s. 5(4); available at: http://www.regjeringen.no/en/sub/styrer-rad-utvalg/ ethics_council/ethical-guidelines.html?id=425277.       7   nordic journal of commercial law issue 2011#2 ownership in the ngpf-g’s portfolio companies,36 and it must inform the public about its work in active ownership and integration of environmental and social issues.37 another transparency mechanism is the annual reporting by the ministry of finance to the storting on the operations and performance of the ngpf-g.38 while no citizen may judicially challenge a decision of the council or the ministry (exclusion of a company is not open to judicial appeal), procedures allow public input into their decisions. the council meets annually with nongovernmental organisations to discuss its policies and practices; attendance is on an invitational basis, but is routinely granted to groups that have been in recent contact with the council. informal channels of complaint also exist, including that any individual or group may write to the council or the ministry to voice concerns.39 2.2 the turn to ethical investment the ngpf-g lacked any sri mandate until 2001. the norwegian government then established on a three-year trial a dedicated “environment fund” within the larger petroleum fund (as it was then known) for investing in companies in emerging economies that met environmental performance criteria.40 concomitantly, because it is a swf, with the potential for its decisions or omissions to be attributed to norway as a matter of state responsibility under international law, the fund as a whole would sometimes consider issues of human rights or environmental protection. its first ethical screenings were guided by an advisory commission on international law appointed by the ministry of finance in 2001.41 the commission responded to enquiries from the ministry regarding whether specific investments might conflict with norway’s international legal obligations. for example, in april 2002 the ministry directed the fund to divest from singapore technologies engineering because of its links to production of anti-personnel mines, contrary to norway’s obligations under the ottawa convention on anti-personnel mines.42   36 guidelines for norges bank’s work on responsible management and active ownership of the government pension fund global (2010), s. 2(3), available at: http://www.regjeringen.no/en/dep/fin/selected-topics/the-governmentpension-fund/responsible-investments/guidelines-for-norges-banks-work-on-responsible-management-and-activeownership-of-the-government-pension-fund-global-gpfg.html?id=594253. 37 ibid., s. 4. 38 see, e.g., norwegian ministry of finance, the management of the government pension fund in 2009 (report no. 10 (2009-2010) to the storting, 2010). 39 one example is when the rainforest action group lobbied the ngpf-g to exclude some extractive industries. 40 in 2004, the environment fund was integrated into its parent fund, whose entire investment portfolio became subject to an ethical mandate. 41 the advisory commission was replaced by the council on ethics in 2004. 42 the petroleum fund advisory commission on international law, memorandum to the ministry of finance: question of whether investments in singapore technologies engineering can imply a violation of norway’s international       8   nordic journal of commercial law issue 2011#2 in 2002 norway moved to develop regulations to create a normatively and procedurally clearer approach to ethical investment by the fund. it appointed a committee chaired by professor hans peter graver for this purpose.43 while the graver committee did not believe the fund should have an overriding mission to leverage its resources to improve corporate social and environmental behaviour, it stressed “sustainable economic development is essential to a longterm return on a broad-based financial portfolio.”44 thus, the committee concluded: the requirement for a long-term return gives rise to ethical obligations in relation to the requirement for sustainable development in a longer-term perspective. sustainable development is a precondition for return on the petroleum fund’s financial investments in the long term.45 in addition, the graver committee rationalised ethical investment on the ground that the fund should avoid complicity in gross or systematic breaches of ethical norms relating to human rights and the environment: even though the issue of complicity raises difficult questions, the committee considers, in principle, that owning shares or bonds in a company that can be expected to commit gross unethical actions may be regarded as complicity in these actions. the reason for this is that such investments are directly intended to achieve returns from the company, that a permanent connection is thus established between the ... fund and the company, and that the question of whether or not to invest in a company is a matter of free choice.46 in identifying a broad, democratic basis to support sri decisions, the graver committee sought to rely on international agreements on environmental protection and human rights that norway supports, rather than defining a separate basis rooted in norwegian culture or national   obligations (22 march, 2002), citing the ottawa convention, which stipulates that states parties should not “assist, encourage or induce, in any way, anyone to engage in any activity prohibited to a state party under this convention.” the ottawa convention is officially known as the convention on the prohibition of the use, stockpiling, production and transfer of anti-personnel mines and their destruction, i.l.m. (1997) 36: 1507. 43 norwegian ministry of finance, the report from the graver committee (2003), available at: http://www.regjeringen.no/en/dep/fin/tema/statens_pensjonsfond/ansvarligeinvesteringer/graverutvalget/report-on-ethical-guidelines.html?id=420232. 44 ibid., s. 1. 45 ibid., s. 3.1. 46 ibid., s. 2.2.       9   nordic journal of commercial law issue 2011#2 policy.47 the committee reasoned that while most international legal obligations apply only to states, companies may aggravate or facilitate human rights and environmental violations committed by states, and the ngpf-g might contribute to companies’ misdeeds through its stock ownership. while excluding companies from the ngpf-g might influence their behaviour, in addition to any influence achieved by corporate engagement, the graver committee focused on exclusion as a means of avoiding the fund’s own complicity in ethically problematic activities. by contrast, the former environment fund was conceived as a mechanism to promote sustainable development and leverage environmental improvements in the targeted economies. in november 2004, regulations inspired by the graver committee were adopted and a council on ethics took charge to evaluate potential investments for compliance.48 the five members of the council on ethics, each appointed by the ministry of finance, blend practical and theoretical expertise. presently, it comprises two academics, a former government diplomat, a professional scientist and an investment manager. the council submits recommendations to the ministry, which makes final decisions on exclusion of companies. the council nearly always makes its recommendations on a consensual rather than majoritarian basis. it has wide discretion in passing judgement on serious human rights violations, gross corruption, severe environmental damage and general violations of fundamental ethical norms. in assessing investments on these grounds, it relies not only on international treaties ratified by norway, but also soft law standards approved by norway such as the un global compact and the oecd guidelines for corporate governance and for multinational enterprises.49 2.3 ngpf-g’s revised ethical guidelines the ngpf-g’s current ethical guidelines were adopted in 2010 following a major review in 2008 of the legal mandate and practices of the council on ethics conducted by the ministry of finance. the review included a separate commissioned report, written by the albright group and professor simon chesterman.50 the results were mainly procedural rather than normative   47 norwegian ministry of finance, the report from the graver committee (11 july 2003), available at: http://www.regjeringen.no/en/dep/fin/selected-topics/the-government-pension-fund/responsible-investments/ the-graver-committee---documents/the-graver-committee-and-ethical-guideli.html?id=434926. 48 regulations on the management of the government pension fund – global (forskrift om forvaltning av statens pensjonsfond utland (2006), s 8(1). 49 un global compact: http://www.unglobalcompact.org. oecd guidelines for corporate governance and for multinational enterprises: http://www.oecd.org/dataoecd/56/36/1922428.pdf. 50 the albright group and simon chesterman, assessment of implementation of articles 3 and 4 of the ethical guidelines for the government pension fund – global (report submitted to the norwegian ministry of finance, may 2008).       10   nordic journal of commercial law issue 2011#2 changes. the review concluded that the ethical guidelines had proven to be generally robust, but recommended more engagement with companies, particularly with firms under scrutiny.51 it also recommended that tobacco production be singled out as a new criterion for investment exclusion. the albright and chesterman report recommended greater collaboration between the council and nbim, more attention to climate change, more opportunities for public submissions and dialogue with companies, and improved disclosure of implementation of the ethical guidelines.52 consequently, in march 2010 the ministry of finance issued two standards that were accepted by the storting: the guidelines for observation and exclusion from the government pension fund global’s investment universe53 (hereafter guidelines i), and the guidelines for norges bank’s work on responsible management and active ownership (hereafter guidelines ii).54 the norwegian ministry of finance also initiated a complementary programme for active environmental-related investment, focusing on firms pioneering climate-friendly energy efficiency, carbon capture and storage, water technology, and waste and pollution management. the programme is worth about nok 20 billion (equivalent to less than 1% of the value of the ngpf-g portfolio) invested between 2010 and 2015.55 many of these targeted investments are in environmental bonds for financing eco-friendly projects, such as the world bank’s green bonds.56 the guidelines continue the exclusion mechanism for companies that engage in unethical activities, and strengthen the ngpf-g’s use of active shareholding and exertion of responsible influence in its portfolio companies with a view to promoting sustainable development. guidelines i allow the ministry, on the advice of the council on ethics, to exclude companies from the ngpf-g portfolio: if there is an unacceptable risk that the company contributes to or is responsible for: a) serious or systematic human rights violations, such as murder, torture, deprivation of liberty, forced labour, the worst forms of child labour and other child exploitation; b) serious violations of the rights of individuals in situations of war or conflict; c) severe environmental damage;   51 norwegian ministry of finance, on the management of the government pension fund (gpf) in 2008 (report no. 20 (2008-2009) to the storting, 2009). 52 the albright group and chesterman, supra note 50, at 5-7. 53 see supra note 35. 54 see supra note 36. 55 norwegian ministry of finance, supra note 51, at 11. 56 world bank green bonds, http://treasury.worldbank.org/cmd/htm/worldbankgreenbonds.html.       11   nordic journal of commercial law issue 2011#2 d) gross corruption; e) other particularly serious violations of fundamental ethical norms.57 from the yardstick of sustainable development, however, the guidelines’ threshold of “severe environmental damage” is too high. much environmental degradation such as climate change is piece-meal and only significant cumulatively. consequently, the ngpf-g must rely on other mechanisms if it wishes to address environmental issues more comprehensively. the guidelines i elaborate factors that the ministry may take into consideration, which include “the probability of future violations of ethical norms, the severity and extent of the norm violations, the connection between the norm violations and the company in which the fund is invested, and whether the company does what may reasonably be expected to reduce the risk of future violations of norms within a reasonable time frame.”58 positive actions taken by a company to safeguard the environment may also be taken into account,59 and companies excluded may be readmitted to the fund if their behaviour improves. the guidelines i also require, on the advice of the council, exclusion of companies that produce tobacco, produce weapons that violate fundamental humanitarian principles, or sell weapons or military material to pariah states.60 importantly, the ministry may use other measures before excluding a company, such as active engagement or close observation of a firm.61 companies proposed for exclusion must be warned and given reasons, with an opportunity to respond.62 the revised guidelines also contain provisions to improve communications between the council on ethics and the norges bank to ensure any contact with companies is coordinated.63 guidelines ii, which is directed to the work of the norges bank, reflects assumptions of the “universal investor” thesis, in which long-term financial returns hinge on maintenance of healthy social and environmental returns.64 thus, while guidelines ii requires norges bank to manage the ngpf-g in order to achieve the “highest possible return,”65 this objective is qualified as “dependent on sustainable development in economic, environmental and social terms [and] well-functioning, legitimate and effective markets.”66 relatedly, guidelines ii obliges   57 guideline i, s. 2(3). 58 ibid., s. 2(4). 59 ibid., s. 2(5). 60 ibid., s. 2(1)-(2). 61 ibid., s. 3. 62 ibid., s. 5(3). 63 ibid., s. 6. 64 the norwegian ministry of finance has explicitly endorsed this thesis: supra note 38, at 133-36. 65 guideline ii, s. 1(1). 66 ibid.       12   nordic journal of commercial law issue 2011#2 the bank to integrate good corporate governance, environmental and social issues in its investments,67 and to contribute actively to good international standards in responsible management and active ownership.68 as a result of the 2010 revisions to the ngpf-g’s governance, with more emphasis on the economic case for ethical investing, the criticisms of some commentators that “the process supporting the ethical mandate actually constrains the fund’s functional efficiency,” and that it “may pay a high price for its ethical policies over the long-term,”69 are perhaps less valid, if ever they were. the ngpf-g achieved average annual returns in the decade since january 2000 of 3.02%, above the government’s expected benchmark investment performance of 2.40% per year.70 while many sri practitioners believe that engagement is preferable to exclusion, as both a means of retaining a properly diversified portfolio and to retain influence within targeted companies as a shareholder or bondholder,71 the ngpf-g shows that these strategies are not mutually exclusive. corporate engagement can occur in the lead-up to exclusion, and afterwards; for example, after rio tinto was excluded it sought re-admission and began dialogue with the ngpf-g about how it could redeem itself. 2.4 norwegian ethical investment in practice traditionally, the primary strength of the ngpf-g’s approach to ethical investment has been its ability to scrutinise individual companies meticulously and to inflict tangible sanctions. but targeting individual entities is necessarily highly selective in a portfolio of over 8,000 companies, and thus does not ensure a systematic, portfolio-wide approach. the ngpf-g has recently diversified its tools for promoting sri, as a result of several initiatives including: changes to the fund’s governing regulations, its new program for positive environmental investment, publication of its “expectations” documents on climate change and other concerns, and greater collaboration with other institutional investors. the ngpf-g therefore has, in theory, become better positioned to take a more comprehensive approach to sustainable development.   67 ibid., s. 1(2). 68 ibid., s. 3. 69 clark and monk, supra note 10, at 14 and 17. 70 norges bank investment management, nbim performance results (nbim, 2010), 8, available at http://www.nbim.no/global/reports/2010/gips%20report/gips%20report%20final_update%2020100811.p df. 71 doug watt, “why sri funds aren’t a monolithic group,” morningstar (23 april 2009), available at http://www.morningstar.ca/globalhome/industry/news.asp?articleid=288065 (referring to the policy of ethical funds).       13   nordic journal of commercial law issue 2011#2 in making recommendations to the ministry, the council on ethics follows a sequence of procedures for gathering information, reviewing evidence and applying ethical guidelines. in considering specific cases, the council may act on its own volition or at the request of the ministry. the council is not a legal tribunal and is not bound by rules of evidence or other judicial-like formalities, although its recommendations resemble rudimentary court judgements in their evaluation of evidence and justification of decisions.72 it uses a “quasi-legal” process, following its precedents and allowing companies to hear allegations and respond to them.73 but the council is not obliged to prove occurrence of an environmental violation or other wrong to recommend exclusion of a company. indeed, much of its work addresses the “unacceptable risk of breaches taking place in the future,” rather than ongoing or past breaches.74 the council’s advice is generally persuasive, as nearly always the minister for finance accepts its recommendation.75 so far, the minister has rejected the council’s advice only twice. one involved the german company siemens, which is suspected of corruption, and remains on the council’s watch list. the second case involved monsanto, which through its subsidiaries allegedly exploits child labour in india’s cotton seed industry. the ministry and the norges bank opposed singling our monsanto for exclusion, favouring instead an engagement process that would involve many companies in this troubled economic sector.76 with a support staff of eight and an annual budget of nok 11 million (as at the end of 2010),77 the council is able to scrutinise closely just a small fraction of the ngpf-g’s investment portfolio. such “resource constraint[s],” suggest some commentators, “forces it to make subjective decisions about ethical targets.”78 to overcome such hindrances, the council increasingly relies on external consultants to monitor companies and provide it with monthly reports, which it uses for selecting firms for investigation.79 the nbim also plays a key role in discharging the ngpf-g’s ethical investment policy, as it exercises the fund’s ownership rights through sponsoring and supporting shareholder resolutions, proxy voting, and informal corporate engagement. in 2007, for example, the nbim voted on more than 38,000   72 simon chesterman, “the turn to ethics: divestment from multinational corporations for human rights violations – the case of norway’s sovereign wealth fund,” american university international law review (2008) 23: 577 at 605. 73 ibid, 594. 74 recommendation from the norwegian ministry of finance, the petroleum fund’s council of ethics on total s.a. (14 nov. 2005), s. 3.3 75 clark and monk, supra note 10, at 16. 76 john acher, “norway fund drops rio tinto on ethical grounds,” reuters (9 september 2008), http://www.reuters.com/article/2008/09/09/us-norway-fund-riotinto-idusl872852220080909. 77 council of ethics for the government pension fund global, annual report 2010 (2010), 8. 78 clark and monk, supra note 10, at 17. 79 ibid., 7.       14   nordic journal of commercial law issue 2011#2 shareholder proposals in more than 4,200 companies.80 but, as with the council, the nbim has limited institutional capacity and has elected to engage mainly with the largest (but not necessarily the most problematic) companies. the ngpf-g investment regulations do not instruct how to resolve any trade-offs between ethical and financial considerations, although they postulate that a long-term synergy between financial returns and sustainable development exists.81 in practice, the ngpf-g is increasingly governed on the premise that it can be both virtuous and prosperous.82 the norwegian ministry of finance affirmed in its 2010 annual report that “[s]olid financial returns over time depend on a sustainable development in economic, environmental and social terms,”83 and it regards the ngpf-g as a “universal owner” exposed to environmental and social externalities that should be addressed.84 nonetheless, the norwegian ministry of finance has acknowledged that: in some cases, the concerns of ensuring long-term financial returns and taking widely shared values into account will coincide, but not always. for example, the fund will not invest in companies that are in gross breach of fundamental ethical norms, regardless of the effect this will have on returns.85 the ngpf-g presently screens companies using the services of several consultancy firms. from this information, the council on ethics maintains a short-list of some 200 300 companies that warrant greater scrutiny. it pays close regard to international law in judging companies, although its ethical guidelines mandate it to go beyond international law. a company thus does not have to formally breach any international treaty to be recommended for exclusion; indeed, as companies are not true international legal personalities who can be prosecuted in an international court, instances of companies incurring international legal sanctions are very rare. thus, the council routinely looks for other evidence of ethical violations, including breaches of national law and disregard for soft law standards such as the un global compact.   80 anita m. halvorssen, addressing climate change through the norwegian sovereign wealth fund (swf) using responsible investments to encourage corporations to take esg issues into account in their decision-making (university of oslo faculty of law legal studies, research paper series, no. 2010-06), 29. see also anita m. halvorssen, “the norwegian sovereign wealth fund’s ethical guidelines: a model for investors,” european company law (2011) 8(2-3): 88. 81 guidelines ii, s. 1. 82 norwegian ministry of finance, supra note 38, at 11, 16; see also secretary general tore eriksen, “the norwegian petroleum sector and the government pension fund – global” (ministry of finance, june 2006), 23; available at http://www.regjeringen.no/upload/fin/statens%20pensjonsfond/the_norwegian_petroleum_ sector_te.pdf. 83 norwegian ministry of finance, supra note 32, at 3. 84 ibid., 12. 85 norwegian ministry of finance, supra note 38, at 15.       15   nordic journal of commercial law issue 2011#2 based on recommendations of the council on ethics, the ngpf-g has divested from companies producing cluster bombs (eg, lockheed martin) and nuclear weapons components (eg, boeing), breaching human rights and labor standards (eg, walmart), and causing severe environmental damage (freeport-mcmoran copper & gold). one of its most publicised divestments was us$400 million of wal-mart shares in march 2006, which led to protests from the us ambassador to norway.86 as of may 2011, the ngpf-g had divested from or excluded 51 companies, a tiny number compared to the some 8,300 companies currently in its portfolio.87 the fund has also excluded one state, myanmar (burma), by refusing to buy its government bonds. divestment has usually occurred after dialogue and engagement strategies have failed.88 the ngpf-g has also occasionally readmitted formerly excluded companies following new evidence presented by the council of improved behaviour.89 whereas the mandate of the council on ethics is to recommend exclusion of companies, engagement rests with norges bank. exclusion tends be applied against the worst offenders, while companies whose behaviour needs improvement and is considered redeemable may be engaged. the ngpf-g presently has an average ownership stake of about 1 per cent in its 8.300 companies,90 and only engages with a miniscule fraction of its portfolio at any one time. engagement may occur as a prelude to recommending exclusion. when the council envisions recommending exclusion, it sends a draft recommendation to the company’s management for response.91 this process may trigger some dialogue with the firm, and persuade it to make changes (eg, selling-off part of the business or cancelling a project) in order to avoid exclusion.92 in 2009, the norges bank picked six strategic priority areas for corporate engagement and other forms of active ownership, of which three are explicit sustainability issues: climate change, water management and children’s rights.93 climate change, the gravest environmental threat, presents a moral dilemma for ngpf-g managers. black-listing companies that contribute to global warming would put norway in an awkward position as the ngpf-g has been financed from proceeds of the country’s fossil fuels. the council on ethics believes that since virtually   86 mark landler, “norway keeps nest egg from some u.s. companies,” new york times (4 may 2007), available at http://www.nytimes.com/2007/05/04/business/worldbusiness/04norway.html. 87 norwegian ministry of finance, “companies excluded from investment universe,” http://www.regjeringen.no/en/dep/fin/selected-topics/the-government-pension-fund/responsible-investments/ companies-excluded-from-the-investment-u.html?id=447122. 88 norges bank investment management, annual report 2006 (norges bank, 2007), s. 4.2. 89 norwegian ministry of finance, supra note 38, at 75. 90 ibid., 65 91 gro nystuen, “etikk og kritikk,” dagens naeringsliv (11 september 2006), 4. 92 this option is not available for companies liable to be excluded because of the very nature of their business (eg, producing tobacco) rather than the way they operate. 93 norwegian ministry of finance, supra note 38, at 125.       16   nordic journal of commercial law issue 2011#2 everyone is a contributor to climate change in a world that ubiquitously depends on fossil fuels, climate change itself is unsuitable as a rationale to exclude any specific entity. therefore, instead of excluding oil and coal businesses as demanded by some environmental groups, the nbim has released an “expectations” document on companies' management of risk factors relating to climate change.94 the expectations include having: strategies for managing both physical and economic climate effects, to measure its emissions and set targets for reducing them, to explore and exploit opportunities to develop new products and services that will help the transition to a low-carbon economy, and to develop a strategy for dealing with climate change risk in the supply chain.95 such measures, in turn, should enable the ngpf-g to manage its own climate change risks, which the ministry of finance recognises as “a long-term investor with a broad portfolio.”96 the ministry has also collaborated in an international research project with other major institutional investors to foster a deeper understanding of the financial risks of climate change.97 unusually, the norges bank has also written to some american companies to express its concerns how they campaigned against the imposition of carbon caps.98 together, these strategies to address companies and issues on a portfolio-wide basis could provide important means for the ngpf-g to act as an ethical, universal owner.99 3 new zealand superannuation fund (nzsf) 3.1 legislative and institutional framework new zealand (nz), renowned for some of the most progressive environmental and social legislation in the world,100 has, like norway, begun to consider whether and how to use public   94 norges bank investment management, nbim investor expectations: climate change management (norges bank, 2008). see generally, halvorssen, supra note 80. 95 as summarised by the norwegian ministry of finance, supra note 38, at 126. 96 ibid., 126. 97 norwegian ministry of finance, supra note 32, at 15. 98 norges bank investment management, government pension fund – global annual report 2008 (norges bank, 2009), 54. 99 scholars have advocated such measures: see, e.g., ola p.k. gjessing and henrik syse, “norwegian petroleum wealth and universal ownership,” corporate governance: an international review (2007) 15(3): 427. 100 notable examples include the environment act, 1987 and the resource management act, 1991.       17   nordic journal of commercial law issue 2011#2 financial institutions to promote sustainable development and ethical policy. the new zealand superannuation fund (nzsf) is the country’s first major step towards this goal. the nzsf was established in 2001 to ease the future financing burden of the country’s pension payments. nz’s retirement income scheme is financed from general taxation revenue, where residents over the age of 65 receive a pension irrespective of their personal wealth. because the country’s population is ageing, there is significant pressure on public revenue to sustain nz superannuation.101 the fund was created by the new zealand superannuation and retirement income act of 2001 to invest nz government contributions to address this growth in demand for pensions. since the fund began operations in september 2003, it has grown rapidly to about nz$19 billion of assets, as of early 2011,102 with investments principally in shares in global and nz companies, real estate, commodities, and fixed interest. the legislative framework prescribes arrangements for the management and operation of the nzsf in order to limit political interference. the fund is administered by a separate entity called the guardians of new zealand superannuation,103 which enjoys a broad plenary power to invest subject only to specified statutory restrictions.104 while the nzsf holds assets belonging to the nz government, the legislation declares that the guardians “are not a trustee.”105 the effect of this rider presumably is to avoid implying any common law fiduciary standards in the management of the fund, and to limit its governance strictly to the terms of the enabling legislation. however, the guardians are presumably still subject to judicial review, which would enable courts to issue remedies to ensure that the nzsf is administered in accordance with its legislative mandate and procedures. the guardians’ board consists of between five to seven members, appointed by the cabinet on the recommendation of the minister of finance, after nominations from an independent nominating committee and consulting with representatives of other political parties.106 only persons with “substantial experience, training, and expertise in the management of financial   101 see k. dunstan and n. thomas, demographic aspects of new zealand's ageing population (statistics new zealand, 2006). 102 nzsf, “investment performance,” http://www.nzsuperfund.co.nz/index.asp?pageid=2145855927. 103 section 48(1). 104 section 49(4), with specified restrictions in ss 58, 59 and 64. while the minister of finance can give directions to the guardians in regard to the government's expectations to the fund's performance, the minister cannot give any direction that is “inconsistent with the duty to invest the fund on a prudent, commercial basis” (s. 64(1)). 105 section 51(2). 106 sections 54(1), 56.       18   nordic journal of commercial law issue 2011#2 investments” may be board members.107 while the guardians exercise overall control over the fund, they have, like the ngpf-g, outsourced much work to external fund managers.108 the act includes a qualified obligation to invest ethically, which is considerably less prescriptive than norway’s regulations. the guardians’ primary duty is to: invest the fund on a prudent, commercial basis … in a manner consistent with (a) bestpractice portfolio management; and (b) maximising return without undue risk to the fund as a whole; and (c) avoiding prejudice to new zealand's reputation as a responsible member of the world community.”109 the legislation does not define this terminology, and offers no guidance on reconciling any conflicts between these goals. while the guardians therefore have ample discretion to implement their mandate, they must prepare a statement of investment standards and procedures which, inter alia, “cover … ethical investment, including policies, standards, or procedures for avoiding prejudice to new zealand’s reputation as a responsible member of the world community,”110 and the “retention, exercise, or delegation of voting rights acquired through investments.”111 the fund must report annually to the nz government on its performance.112 in governance arrangements, the nz approach to ethical investment diverges from norway’s in several interesting ways. firstly, the ethical investment duty is comingled with other legislative goals relating to financial considerations. by contrast, norway’s ethical screening guidelines are placed in separate instrument to which compliance is not constrained by or conditional on the ngpf-g adhering to other legal norms. while guidelines ii relating to the norges bank’s active ownership obliges it to seek “the highest possible return,” this objective is stated to be “dependent on sustainable development in economic, environmental and social terms.”113 secondly, the nzsf lacks an ethics council to provide advice; decisions about ethical investment are ultimately the responsibility of the guardians’ board, a body without special expertise in such matters. thirdly, while the nzsf must avoid prejudicing nz’s reputation internationally, active consideration of social and environmental issues, and promotion of improved corporate behaviour, is not explicitly required. indeed, the legislation has been   107 section 55(1)(a). 108 controller and auditor-general, guardians of new zealand superannuation: governance and management of the new zealand superannuation fund (new zealand government, may 2008), para. 5.8. 109 section 58(2)(c). 110 section 61(d). 111 section 61(1). 112 section 68(e)-(f). 113 section 1(1).       19   nordic journal of commercial law issue 2011#2 interpreted by nz treasury staff as simply requiring the nzsf “to have a policy regarding ethical investment: it does not prescribe any particular approach to or emphasis on ethical investment.”114 this laissez-faire approach contrasts with other nz legislation relating to natural resources management and environmental protection115 that is much more prescriptive regarding sustainable development and related goals. 3.2 guardians’ ethical investment policies and practices the guardians’ broad discretion to determine the nzsf’s ethical investment has enabled it to establish a range of processes and policies. a responsible investment committee was appointed to draft ethical policies, monitor their implementation and generally to advise the guardians’ board on sri matters. but it was disestablished in october 2009 when the board assumed direct oversight of ethical policies as part of an avowed commitment to embed sri considerations throughout its decision-making.116 its responsible investment policy is a relatively brief document that sketches the nzsf’s main ethical standards and methods.117 the guardians rely on external agencies such as innovest strategic value advisors and institutional shareholder services to monitor the majority of the nzsf’s portfolio for compliance with its ethical policy. as in the norwegian approach, the guardians rely on both exclusion and active ownership as means of ethical investment. lately, they have also incorporated environmental and social risk analysis into their due diligence procedures and, like the ngpf-g, initiated positive investment measures to deliver “strong environmental or social returns in addition to sufficient investment returns.”118 in practice, however, there are some marked differences between these swfs’ approaches. the guardians were slow to fulfill their ethical mandate, being initially for two years without in-house sri experts and lacking a formal policy. their current policy of exclusion is mainly determined by a company’s economic sector rather than its individual practices. while the ngpf-g also excludes sectors, such as tobacco producers, its ethical mandate also requires   114 brian mcculloch and jane frances, “governance of public pension funds: new zealand superannuation fund,” in public pension fund management: governance, accountability, and investment policies. eds a.r. musalem and r.j. palacios (world bank, 2004), 157, 189. 115 e.g., the resource management act, 1991, s. 5. 116 guardians of new zealand superannuation, annual report 2010 (guardians of new zealand superannuation, 2010), 133. 117 nzsf, statement of responsible investment policies, standards and procedures (guardians of new zealand superannuation, october 2009). 118 ibid.       20   nordic journal of commercial law issue 2011#2 evaluation of firms’ specific conduct. the guardians have adopted policies since 2006 to exclude entities involved in whaling, the manufacture of tobacco, cluster mines or antipersonnel mines, and the production and testing of nuclear explosives.119 as of june 2009, it had ousted 12 companies that manufacture such mines or nuclear explosives, and excluded one whaling business and 20 tobacco companies.120 the guardians rationalise any exclusion decisions on considerations of international law, and nz law and government policy. for instance, the guardians’ exclusion of producers of cluster mines was triggered by the nz government’s pending ratification of the convention on cluster munitions.121 another ostensible difference between norway and nz is that the guardians’ sri strategy focuses “on acting as a responsible shareholder and fostering transparent corporate governance rather than necessarily excluding shares or securities.”122 in the 12 months until june 30, 2010, the guardians had engaged on 345 occasions with companies concerning various social and environmental issues.123 share exclusion is considered “a last resort for the guardians,” only used if they “cannot bring about a positive outcome through exercising their shareholder rights.”124 however, in practice to date, the guardians have used exclusion only for entities in a few designated economic sectors and not only as a “last resort.” although environmental matters are encompassed in its responsible investment policy, in april 2009 the guardians released a separate environmental policy statement and action plan that champions four issues: minimising waste, efficient use of energy, green procurement, and reducing greenhouse gas emissions.125 much of this effort centres on reducing the environmental footprint of the nzsf’s in-house operations (eg, use of physical offices and staff travel), in addition to addressing any environmental impacts and risks from its portfolio companies.126 as for the ngpf-g, the economic threat posed by climate change has galvanised some action in nz. in the 12 months to june 30, 2010, the guardians engaged on 250 occasions with companies on climate change issues, representing the substantial majority of its corporate   119 ibid., 138. 120 see the guardians’ responsible investment in practice reports, available at http://www.nzsuperfund.co.nz/index.asp?pageid=2145855970. 121 nzsf, responsible investment in practice report (guardians of new zealand superannuation, 2009), 10. the text of the convention is at ilm (2009) 48: 354. 122 controller and auditor-general, supra note 108, at para. 3.62. 123 guardians of new zealand superannuation, supra note 116, at 134. 124 ibid., para. 3.67. 125 nzsf, responsible investment in practice report (guardians of new zealand superannuation, 2009), 12. 126 nzsf, supra note 117, at 140.       21   nordic journal of commercial law issue 2011#2 engagement activity.127 as a signatory to the carbon disclosure project (cdp), the nzsf is able to collaborate with institutional investors including the ngpf-g to advocate corporate disclosure of climate-related impacts and policies.128 in 2008 the guardians wrote to every company in the nzx 50 index (nz’s premier stock market index) to encourage replies to cdp disclosure requests. according to the guardians, the response-rate increased to 50% from 38% in the previous year, partly as a result of the fund’s presence.129 furthermore, the guardians see their participation in the cdp as “important in raising awareness amongst nz companies that investors globally are interested in the economic impacts of climate change and its potential effect on long-term shareholder value.”130 the nzsf is also a member of the investor group on climate change, a club of 20 australian and nz investors concerned about the potential financial impact of global warming.131 while the nzsf has made great strides in its ethical investment policy and practices since 2006, it still tends to trail its norwegian counterpart and has been dogged by criticisms for alleged complicity in some unethical or unsustainable businesses. some criticisms have been rationalised on the basis that the nzsf continues ties with companies blacklisted by norway.132 some of the most vituperative objections have come from investment watch aotearoa, a national network campaigning for ethical investment to be a duty of all nz public funds.133 it once accused the nzsf of “invest[ing] large amounts of our taxpayer money in companies who … prop up murderous regimes and commit mass environmental destruction,”134 and more recently has excoriated the nzsf for allegedly investing in corporations “complicit in the israeli occupation” of asserted palestinian territories.135 in august 2011 the nzsf was accused of investing in a chinese tobacco producer, contrary to the fund’s policies.136 also, the nzsf’s reluctance to use the divestment option more widely has troubled the green party,137 a growing political force in nz politics. when the green party denigrated the nzsf for investing in   127 ibid., 133. 128 cdp: https://www.cdproject.net/en-us/pages/homepage.aspx. 129 nzsf, responsible investment in practice report (2009), 9. 130 ibid. 131 ibid., 9-10. 132 russel norman, betting the bank on the bomb (green party of aotearoa, 2007), 3. 133 investment watch: http://investmentwatch.wordpress.com. 134 investment watch, “nz super fund invests our money in mass murder,” (18 march 2007), http://www.indymedia.org.nz/article/73329/nz-super-fund-invests-our-money-mass-mur. 135 investment watch, “nz ngos call for superfund divestment from israeli war crimes,” (3 december 2009), http://investmentwatch.wordpress.com. 136 daniel brooksbank, “nz super fund facing questions over stake in tobacco-linked chinese conglomerate,” responsible-investor.com (12 august 2011). 137 green party of new zealand, “super fund must stop investing our taxes in nuclear bombs” (9 february 2007).       22   nordic journal of commercial law issue 2011#2 exxonmobil, a company derided by many as a “climate change skeptic,”138 then nzsf chief executive, paul costello, retorted that there was no basis to exclude it because his fund’s policy was to divest only from those companies whose products or activities are illegal in nz.139 robert howell, head of the nz council for socially responsible investment (nzcsri), has also criticised the ambiguity of the world reputation clause in the governing legislation as failing to prevent the nzsf from investing in “companies with unacceptable or questionable human rights behaviour or environmental impacts, such as nike, walmart, bj services (operating in myanmar), and exxon mobil.”140 the nz government’s own auditor-general has weighed into the debate, with its 2008 report concluding that “overall, the guardians have taken an appropriate and pragmatic approach to responsible investment,” but “a number of challenges still face the guardians in managing their responsible investment risk.”141 these include that, because “the fund is not a substantial shareholder in any entity in its own right,” and the guardians depend on collaboration from other investors whose decisions “are consistent with their ‘avoid prejudice’ requirement.”142 the auditor-general further cautioned that “[i]dentifying which companies to exclude can present challenges and requires a specialist screening agency (for example, checking for a company’s involvement in landmine manufacture),” and “it is not always possible for the fund to identify all activities in pooled investment structures such as unit trusts.”143 the auditorgeneral also found that the guardians’ investment screening process is limited to equity positions and sovereign securities held by the fund, thus exposing it to ties to an excluded entity through other financial relationships such as by holding corporate bonds.144 4 becoming marathon investors for sustainability both the norwegian and new zealand swfs resemble institutional chameleons in the conflicting expectations they face. they operate like private investment vehicles for maximising shareholder value, while encumbered with public responsibilities to fulfil the ethical policies of   138 david adam, “exxonmobil continuing to fund climate sceptic groups, records show,” the guardian (1 july 2009). 139 “greens urge super fund to dump exxon,” new zealand herald (6 october 2006). 140 robert howell, “the new zealand crown financial institutions’ non-financial investment criteria” (presentation to the nzcsri conference, reward, risk and reputation rethinking the investment role of crown financial institutions in new zealand’s growth, auckland, 2 december 2005), 1. 141 controller and auditor-general, supra note 108, at paras. 3.68, 3.73. 142 ibid. 143 ibid. 144 ibid, para. 3.74.       23   nordic journal of commercial law issue 2011#2 their state. while ethical considerations of course are not necessarily only public in nature, and indeed a vibrant sri market has evolved in recent years while states have increasingly opted for business-friendly policies,145 in the private realm ethical considerations have tended to be more vulnerable to usurpation by market pressures. some commentators thus see tensions between swfs’ financial and non-financial ambitions, and fear some swfs might “serve as a covert mechanism for extending state power.”146 socially responsible investment does not necessarily entail any irresolvable trade-offs between public and private interests, or financial and ethical goals. while commercial considerations do not always coincide with ethical ones, over the very long-term they should given ecological constraints to infinite economic growth. in the near term, countervailing business motivations to fund unethical behaviour certainly can prevail because of underlying market and regulatory failures, or because investors perceive no financial value in ecological assets such as biodiversity that cannot be monetised.147 in the long-term, meaning at least several decades, the economic case for environmentally sustainable development solidifies. take climate change, for example. the uk’s stern report of 2007 calculated that global warming if left unabated will by the middle of this century cut world gdp by between 5 to 10% annually, but only 1 to 2% of gdp if we act expeditiously.148 other commentators such as monbiot, flannery, and homer-dixon predict even grimmer economic costs if business-as-usual continues.149 financial markets can make investors myopic and inclined to ignore future costs, such as because institutional fund management is commonly devolved to specialists hired on short range contracts and financial accounting metrics heavily discount distant costs and benefits. to become marathon investors, the norwegian and new zealand swfs must not only avoid companies that harm the environment or violate human rights, they should actively promote sustainable development. traditionally, the notion of complicity has been a touchstone for their ethical investment policies. the albright group’s and chesterman’s review of the ngpf-g observed that a “central tension within the guidelines is the question of whether they are intended simply to avoid norwegian complicity or influence the behaviour of others. the   145 see, e.g., ronen shamir, “corporate social responsibility: towards a new market-embedded morality?” theoretical inquiries in law (2008) 9(2): 371; robert hahn and robert stavins, “economic incentives for environmental protection: integrating theory and practice,” american economic review (1992) 82: 464. 146 backer, supra note 10, at 176. 147 benjamin j. richardson, “keeping ethical investment ethical: regulatory issues for investing for sustainability,” journal of business ethics (2009) 87(4): 555, 556-57. 148 nicholas stern, stern review on the economics of climate change (h.m. treasury, 2007). 149 george monbiot, heat: how to stop the planet burning (harpercollins, 2005); timothy flannery, the weather makers (atlantic monthly press, 2006); thomas homer-dixon, the upside of down: catastrophe and renewal and the renewal of civilisation (alfred a. knopf, 2006).       24   nordic journal of commercial law issue 2011#2 former is closer to the truth.150 some of the council on ethics’ recommendations view divestment as necessary in order avoid the complicity of the fund (and thus norway) from human rights violations or environmental damage committed by companies in which the fund invests.151 somewhat similarly, the nzsf’s legislation, which obliges it to avoid “prejudice to new zealand's reputation,”152 implies avoiding the stigma of profiting from unethical companies.153 and commentators and activists who have scrutinised the nzsf’s investments often couch their concerns in this language.154 neither swf, however, relies on a strict legal conception of complicity,155 but rather views complicity in an ethical and pragmatic sense. complicity is not a sufficient yardstick for promoting sustainability. firstly, in the context of resource constraints that limit comprehensive screening, an ad hoc rather than a portfolio-wide approach consistent with universal ownership may disappointedly ensue. secondly, it places the threshold for divestment too high, such as gross violation of human rights or severe environmental damage; however, much social injustice and ecological damage stems from incremental actions or omissions that viewed in isolation might seem trivial. thirdly, complicity as an ethical and legal concept is conceptually confusing and imprecise regarding the degree of necessary knowledge or assistance required to trigger consequences.156 while a commitment to sustainability sanctions divestment from the worst businesses, it requires other strategies. these include positive investment in companies that are environmental leaders, broad portfolio-wide policies on key sustainability issues such as climate change, biodiversity conservation and pollution management, and public policy advocacy to promote better social and environmental regulation at national and global levels. while the ngpf-g   150 the albright group and chesterman, supra note 50, at 11. the nbim rejected that such tension exists and believes both goals are equally valid and achievable simultaneously through divestment and engagement strategies: nbim, “comments on the report by the albright group and simon chesterman on the implementation of the ethical guidelines” (nbim, 6 june 2008). 151 chesterman, supra note 72, at 607. 152 new zealand superannuation and retirement income act, s. 58(2)(c). 153 while the fund’s legislation and policies do not refer to “complicity,” as a supporter of the un global compact which does, the nzsf has indirectly endorsed this stance: principle 2 of the global compact expects signatories to “make sure they are not complicit in human rights abuses”. 154 see, e.g., auckland university students for justice in palestine and global peace and justice auckland, “nz taxpayer funded murder results in protests at rakon agm,” media release (31 august 2006). 155  regarding  legal  conceptions  of  “complicity”  for  international  wrongs,  see  james  g.  stewart,  “the end of ‘modes of liability’ for international crimes,” leiden journal of international law (2012): forthcoming, 156 complicity, as a legal principle, can be defined in various ways in order to attribute liability to actors, such as direct complicity (where an actor knowingly assists another to commit a legal violation) and beneficial complicity (where an actor benefits directly from the violation committed by someone else): see sanford h kadish, “complicity, cause and blame: a study in the interpretation of doctrine,” california law review (1985) 73: 323; see also stewart, ibid       25   nordic journal of commercial law issue 2011#2 and nzsf undertake some of these measures, they are not done comprehensively; for example, less than 1% of the ngpf-g’s portfolio is earmarked for positive environmental investment, and both only engage with a miniscule fraction of companies in their vast portfolios. fundamentally, both funds are biased to seeing how sustainability contributes to investment value, rather than how investment value may contribute to sustainability. conceivably, if each swf made sustainability a priority, they would be justified in divesting from a vast number of entities. yet, because very few companies in the world presently meet rigorous sustainability standards,157 such an approach would be unworkable for the swfs. therefore, rather than divesting, they would need to rely mainly on a mix of corporate engagement and positive investment in environmental programs. such strategies allow maintenance of a broadly diversified portfolio without compromising financial returns. but they would only be influential if undertaken on a much larger scale, and by swfs acting in concert and with other investment institutions to achieve a critical mass of influence. legislative change is likely needed to spur such a change, coupled with additional resources to allow screening, risk assessment, engagement and positive investment on a much greater scale. legislation could minimise fund managers’ discretion to deviate from sustainability goals and to promote a cultural shift in their decision-making. such reform has already been proposed in nz, but without success. in 2006 and 2010 the nz parliament debated a private member’s bill, which sought to strengthen the ethical investment framework of the nzsf and apply similar standards to other nz crown financial institutions.158 the bill included a duty on the nzsf guardians “to promote socially responsible and environmentally sustainable development,”159 and that investment policies must take into account international norms and conventions supported or ratified by the new zealand government.160 such an ambitious duty would have needed supplementary rules to provide meaningful direction regarding sustainability indicators and investment time-frames, as well as more administrative resources to enable effective implementation. nz already has similar duties in its environmental and planning legislation, and a substantial body of judicial case law and administrative practice, which could help guide elaboration of a sustainability goal for investment purposes.161 reforming the governance of the ngpf-g and nzsf alone is unlikely to be sufficient to make either a role model for marathon investing. halvorssen argues that “sustainable development   157 paul shrivastava and stuart hart, “creating sustainable corporations,” business strategy and the environment (1995) 4: 154, 163. 158 ethical investment (crown financial institutions) bill, 2006. it was reintroduced to the nz parliament in 2010, but was voted against. 159 ibid., s. 9. 160 ibid., s. 10. 161 claire freeman, “sustainable development from rhetoric to practice? a new zealand perspective,” international planning studies (2004) 9(4): 307.       26   nordic journal of commercial law issue 2011#2 needs to be incorporated into the swfs’ general accepted principles and practices (santiago principles or gapp).”162 she recommends that the principles should explicitly require swfs to take into account climate change as a key environmental issue. such a reform would render the santiago principles ahead of some of the existing sri international codes such as the unpri. a formal international treaty for swfs that prioritises sustainability might be even more beneficial, but of course faces greater political hurdles. without further legislative changes, the ngpf-g will likely remain ahead of the nzsf in promoting ethical investment owing to several institutional and structural differences between the funds. the nzsf is managed solely by the guardians who enjoy relatively broad discretion in interpreting and implementing their ethical mandate. the ngpf-g is supported by a council on ethics, whose institutional separation from the norges bank and ministry allows the council to focus purely on ethical issues without being distracted about the financial implications of its recommendations. in administering the ngpf-g, the ministry and norges bank are subject to ethical guidelines that are much more extensive and detailed than those of the nzsf’s. the nzsf perhaps faces greater pressure to meet financial returns,163 as it must provide for the future funding of nz pension payments, which are forecast to grow substantially; by contrast, the norwegian fund invests abundant surplus oil wealth without any overt or indirect financial liabilities.164 the ngpf-g is also considerably larger than the nzsf, giving it greater leeway to “indulge” in ethical issues alongside financial returns. finally, the ngpf-g only invests outside its national borders, while the nzsf invests both abroad and domestically. because it would problematic for the nzsf to exclude nz companies’ on the basis of their social and environmental practices, which are already subject to nz regulation, it faces greater constraints to making its own judgements regarding ethical behaviour. both the ngpf-g and nzsf have much to gain by engaging with one another and collaborating with other socially conscious swfs and institutional investors. in recent years, there have been periodic meetings and consultations among swfs and other major institutional investors such as calpers165 and dutch pension funds to promote sri. as one of the world’s preeminent swfs, and with the resources on the ground to check how companies behave, the ngpf-g is best placed to exert leadership on sri. companies excluded or engaged   162 halvorssen, supra note 80. 163 the nzsf is expected to exceed the risk-free rate of return (the interest rate on nz treasury bills) by at least 2.5% per year over rolling 20 year periods: nzsf, “our expected rate of return,” http://www.nzsuperfund.co.nz/index.asp?pageid=2145855927. the ngpf-g is expected over the long term to achieve an annual real return of 2.7% on its bond investment, 3.5% on real estate and 5.0% of equities: norwegian ministry of finance, supra note 38, at s. 8. 164 that oil wealth, of course, is not ever-lasting and the industry is subject to market fluctuations and potential constraints in a future low carbon economy. 165 the california public employees' retirement system (calpers) is the largest pension fund in the united states: http://www.calpers.ca.gov.       27   nordic journal of commercial law issue 2011#2 by the ngpf-g are more likely to subsequently be treated similarly by other funds interested in sri. the urgency of the need for change is growing. basic assumptions of our development path and the impact of financial markets must be reconsidered for the sake of the planet and thus humanity’s own long-term prosperity. in 2005, the millennium ecosystem assessment board warned “human activity is putting such strain on the natural functions of the earth that the ability of the planet’s ecosystems to sustain future generations can no longer be taken for granted.”166 ethical investment, if practiced widely by swfs, could help alleviate such problems.   166 millennium ecosystem assessment board (meab), living beyond our means: natural assets and human well-being. statement from the board (meab, 2005), 5. microsoft word njcl_2011.dot nordic journal of commercial law issue 2011#1 can soft clauses in letter of credit transactions be considered letter of credit fraud in china? by yanan zhang* * the author has recently gained her phd from department of law, university of eastern finland. she currently works as a lecturer and researcher in law at the university of eastern finland. this article is largely taken from her phd dissertation “approaches to resolving the international documentary letters of credit fraud issue’, which is lately published by university of eastern finland in jan. 2011 (publications of the university of eastern finland, dissertations in social sciences and business studies no 15). she is very thankful to her phd supervisor professor soili nystén-haarala, and to ms. katja weckström, editor-in-chief of the nordic journal of commercial law for her valuable suggestions and comments of this article. the author can be contacted at yanan.zhang@uef.fi or yanan2@hotmail.com. nordic journal of commercial law issue 2011#1 1 1 introduction 1.1 letter of credit: a payment system documentary credit (also letter of credit, or more formally documentary letter of credit), which was created in trade and business several hundred years ago, is a well known financial method for international trade parties nowadays. letter of credit has a long history and has been stated as “the life blood of international commerce” by english judges1. it is considered as an instrument that reconciles the interests of the seller and the buyer, thus providing security both to the buyer and seller.2 the terms and conditions governing letter of credit transactions are almost always to be found in uniform customs and practice for documentary credits (ucp) issued by the international chamber of commerce (icc)3. in commercial practice, letter of credit4 is a letter issued from a bank promising payment where the recipient of the letter (known as the beneficiary of letter of credit) presents to the bank the stipulated documents during a specific time period.5 the buyer (known as the applicant) is the person who applies for a letter of credit for the beneficiary from a bank. these documents presented by the beneficiary of the letter of credit (also the seller of the sales contract) will then be passed on by the bank to the buyer. thus, a letter of credit also signifies an agreement in which a bank acts for its customer and assures payment against presentation of the specified documents by the beneficiary. 1 d’arcy, leo (2000), schmitthoff’s export trade the law and practice of international trade, london: sweet & maxwell, 10th ed., p. 166. 2 further analysis, see llewellyn, k. n. (1929), ‘some advantages of letters of credits’, journal of business of the university of chicago, vol. 2, no. 1, jan., pp. 1-16. 3 ucp have six versions since they were first promulgated in 1933; ucp 400 came into effect on 1 oct., 1984, and ucp 500 on 1 jan., 1994, and the latest version is ucp 600, which came into effect on 1 july, 2007. the icc is a private body made up of the union of national chambers of commerce, the world business organisation based in paris and established in 1919, the global leader in the development of standards, rules and reference guides for international trade. the lawmaking process is argued to be a bottom-up approach. for further discussion see levit, janet koven (2005), ‘a bottom-up approach to international lawmaking: the tale of three trade finance instruments’, yale journal of international law, vol. 30, p. 125. 4 further discussion about the theory about the legal feature of letter of credit: contract theory or debt theory, see e.g. deng, xu (2006), pp. 193-196. 5 dalhuisen, j. h. (2004), dalhuisen on international commercial, financial and trade law, oxford: hart publishing, 2nd ed., p. 463. nordic journal of commercial law issue 2011#1 2 in the letter of credit system, two fundamental principles are the autonomy of the credit (also the independence principle) and the doctrine of strict compliance.6 the independence principle of the letter of credit is clear and is accepted worldwide.7 according to the autonomy principle, a letter of credit is separate from and independent of the underlying contract of sale or other transactions involved.8 the strict compliance doctrine, which accords with the first autonomy principle of the letter of credit, means that the beneficiary must strictly comply with the documentary requirements laid down in the letter of credit. in brief, the letter of credit has its documentation character, and the two fundamental principles of it allow letter of credit payment in international trade to operate in an efficient manner. in an international letter of credit transaction, a letter of credit usually involves four different and independent contracts between different parties. some scholars9 have accepted the idea of the letter of credit as a contract between the bank and the beneficiary, although several theories have been advanced to explain the judicial basis of the letter of credit itself10. in this paper, contract theory is employed to explain different legal relationships in letter of credit transactions. 1.2 introduction to letter of credit fraud the character of the letter of credit facilitates international transactions, but makes it easy to be abused by fraudsters. the phenomenon of fraud is timeless and universal, and is found both in the east and west. according to the unctad report, four kinds of letter of credit fraud have been popular: 1) where the cargo is non-existent, the documents are falsified by the beneficiary in order to obtain payment from the bank; 2) where the goods are of inferior quality or quantity; 3) where the same goods are sold to two or more parties; 4) where bills of lading are 6 d’arcy, leo (2000), p. 170; see also gao, xiang & buckley, ross p. (2003), ‘the unique jurisprudence of letters of credit: its origin and sources’, 4 san diego international law journal 91, pp. 119-124; regal, dorothea w. (2003), ‘basic principles of letters of credit’, 847 practising law institute 13 (commercial law and practice course handbook series), february. 7 see e.g. ortego, joseph j. & krinick, evan h. (1998), ‘letters of credit: benefits and drawbacks of the independence principle’, 115 banking l.j. 487 (may); see also chatterjee, charles & lefcovitch, anna (2003), ‘the principle of autonomy of letters of credit is sacrosanct in nature’, journal of international banking regulation, sep., vol. 5, no. 1, p. 72; wang, saisai (2007), ‘discussion on letter of credit independence principle’, times finance, vol. 7, pp. 31–33. 8 for analysis from the legal perspective and contractual engagement, see goode, roy, chapter 9 ‘abstract payment undertakings’, in cane, peter & stapleton, jane (eds.) (1991), essays for patrick atiyah, oxford: clarendon press, pp. 217-220. 9 for example, raymond, jack (1993), documentary credits –the law and practice of documentary credits including standby credits and demand guarantees, london & carlsbad & calif: butterworths, 2nd ed., chapter 5, pp. 78-79. 10 penn, g. a. (1987), the law and practice of international banking banking law, vol. 2, london: sweet & maxwell, pp. 295-303. nordic journal of commercial law issue 2011#1 3 issued twice for the same goods.11 it can be seen that in the most common letter of credit fraud scheme, the victims are the buyers. besides letter of credit against applicants, banks sometimes can also be the target.12 the unctad report mentioned that fraudsters could invest large sums of money for many years in creating a pattern of international activity though nothing exists; and they attempt to defraud paper-obsessed bankers.13 letter of credit fraud happens quite often in china (china refers to the people’s republic of china (prc)) during its international trade. before the 1990s most letter of credit fraud was involved in the importing sector.14 businessmen in foreign countries, being the seller, often forged required documents, received the payment for goods and then disappeared. either there were no goods at all, or sometimes the delivered goods were merely rubbish. after the 1990s, with the development of the economy in china and a sharp increase in foreign trade, letter of credit fraud began to happen not only in the importing trades but also in the exporting trades, with variant types of letter of credit fraud taking place. several typical types of letter of credit fraud in china will be discussed.15 firstly, the most common type of letter of credit fraud in china is when the beneficiary presents the fraudulent documents to the bank to demand payment.16 fraudulent documents could be a forged bill of lading, where there are no delivered goods, or the delivered goods are rubbish, or in a very small quantity. sometimes, the beneficiary and the carrier conspire to defraud letter of credit payment. 11 the unctad report (2003), prepared by the unctad secretariat, ‘a primer on new techniques used by the sophisticated financial fraudsters with special reference to commodity market instruments’ (unctad/ditc/com/39), 7 mar., 2003, p. 7, available at http://www.unctad.org/en/ docs/ditccom39_en.pdf, accessed 29 july, 2009. 12 letter of credit fraud can also be connected with the crime of money laundering, see ellen, eric (1998), ‘complex letter of credit frauds put banks at risk’, dci (icc), winter, vol. 4, no. 1, p. 1. 13 the unctad report (2003), p. 7. 14 gu, xiaorong & ni, ruiping (eds.) (2005), research on internationalization of punitive regulations on financial crimes, peking: law press china, 1st ed., p. 225. 15 there have also been several new types of letter of credit fraud deriving from old types in recent years, such as forging the amendement of letter of credit, forging confirming letter of credit, using revocable letter of credit, see cao, yuanfang (2006), ‘new trend and corresponding solutions to letter of credit fraud’, practice in foreign economic relations and trade, no. 11, 51, pp. 51-52. 16 this point is discussed in various literature, see e.g., jin, saibo (2002), prc letter of credit law and comments on typical cases, peking: university of international business and economics press, pp. 94-95; wu, guoping (2005), ‘letter of credit documentary fraud and relief of bank’s responsibility of payment and questions’, business consultation, practice in foreign economic relations and trade, no. 5, 25, p. 26; wang, jingen (2009), ‘seller’s letter of credit fraud against buyer and prevention’, practice in foreign economic relations and trade, no. 12, 64, pp. 64-65. nordic journal of commercial law issue 2011#1 4 secondly, the buyer and the seller conspire to defraud the issuing bank by presenting forged documents.17 this is a common phenomenon in letter of credit transactions in china; and was especially so during the 1990s.18 the applicant and beneficiary collude to sign a sales contract first, and then apply for a letter of credit from a bank. after presenting the forged documents, they obtain payment through the issuing bank. once the fraud succeeds, the applicant and beneficiary will then quickly disappear.19 quite often the applicant has a small percentage of deposit or no deposit in the issuing bank, and thus the bank cannot attach any properties of the applicant.20 the third type is to use a false or a blank-out letter of credit, or to obtain letter of credit through deceitful means.21 this type of letter of credit fraud used to be rampant in china.22 however, nowadays it is much easier to identify whether a letter of credit itself is authentic through the banking internal system. fourthly, the issues on back-dated bl, ante-dated bl and re-issued bl23 deserve attention. both antedating and re-issuing bl are serious maritime frauds24, but whether they are letter of credit 17 jin, saibo (2002), p. 96; see also li, xiaoyong (1998), p. 161; cheng, zhengyun (1997), p. 150; wang, linxia (2006), ‘brief analysis of letter of credit fraud and prevention’, hlj foreign economic relations & trade, no. 8 (serial no. 146), 59, pp. 59-60; li, jian (2005), ‘study on the legal problem of letter of credit fraud in international trade’, market modernisation, dec. (1st issue) (sum. no. 451), 46. 18 see e.g. zhao, limei (2000), guide to letter of credit operations, vol. 2, peking: china economy press, pp. 12011202. 19 see e.g. guo, xiaojie (2005), ‘risk and countermeasures of letter of credit fraud’, market modernisation, dec. (1st issue) (sum. no. 451), 39, p. 40. 20 jin, saibo (2002), p. 97; see also yang, ming (2001), ‘certain risks and prevention in usance letter of credit transaction’, south china finance, no. 2, 45. 21 sui, qingjun (2006), theory and practice of dealing with financial fraud cases, peking: china agriculture university press, 1st, 2006, pp. 125-126; see also, tan, xinghua (2005), ‘discussion on letter of credit fraud types, forms, and preventive measures’, journal of dalian university, vol. 26, no. 5, oct., 74, p. 76. 22 for features and cases of such type of letter of credit fraud, see chen, yulong & lin, hong (1995), international financial fraud identification and countermeasures, peking: peking economic college press, 1st ed., pp.142-143; sun, dingjie (1995), combating non-criminal financial fraud and criminal financial fraud, peking: chinese prosecutor press, 1st ed., pp. 644-650. 23 for further explanation and case examination on these issues which are considered as letter of credit fraud, see gu, xiaorong & ding, muying (2000), pp. 184-189, for cases in this type of letter of credit fraud, see gu, min (1993), international trade fraud and prevention, peking: university of international economics and business press, pp. 59-62; particularly about anti-dated bl fraud, see liu, yuliang (2006), ‘beware of cheat trap in global trade’, china economy and trade, view & commercial observation, (june), 78, pp. 79 -80. nordic journal of commercial law issue 2011#1 5 fraud is debatable. most prc court cases confirmed that they are letter of credit fraud; whereas some court cases demonstrated that antedating or backdating bill of lading does not always constitute letter of credit fraud. furthermore, some academics argue that the bill of lading is itself real and authentic, from the theoretical and practical point of view;25 and these behaviours do not necessarily result in criminal liabilities and transactions may still continue26. the fifth category is called letter of credit soft clauses fraud, in which the buyer takes advantage of some clauses in the letter of credit to defraud the seller.27 this is commonly considered as one type of letter of credit fraud by the banking and commercial community in china.28 however, it is complicated and controversial issue, which will be discussed further. 1.3 letter of credit soft clauses issue in china there is no internationally acceptable definition for the term “soft clauses”; neither is such a term mentioned in ucp 600. some practitioners in hong kong, china, considered such an 24 for further discussion about the concept of maritime fraud and its legal problems and judicial remedy in china, see zhang, xianwei (2002), ‘several legal issues and maritime judicial remedy of maritime frauds’, published on 28 may, available at www.ccmt.org.cn/hs/explore/exploredetial.php?sid=133, accessed 15 july, 2008; yin, xiyang (2007), ‘current situation analysis and countermeasures of international maritime fraud’, law and society, vol. 8, 173; zhang, xianglan (2000), ‘study on legal problem of international maritime fraud’, law review (bimonthly), vol. 1, 107; about the jurisdiction and applicable law, li, feng (2000), ‘the jurisdiction and applicable law of international maritime fraud’, tianjin sailing, vol. 1, 39; about prevention, zhang, meisheng & du, ming (2005), ‘prevention and control and international maritime fraud’, crime study, no. 1, 15; also zhang, xianglan & wang, huaiyu (2000), ‘studies on the legal mechanism of prevention and control of international maritime fraud’, modern law science, vol. 22, no. 4, august, 112. 25 sui, qingjun (2006), p. 102. 26 chen, li (2006), theory and practice of economic crime, xiamen: xiamen university press, 2nd ed., p. 98. 27 it is also possible that the buyer will conspire with the issuing bank to defraud the seller, see li, xiaoyong (1998), pp. 164-165; chen, zhengyun (ed.) (1999), distinguish and deal with economic fraud crime, peking: china fangzheng press, p. 406; for concrete letter of credit soft clause cases and analysis, see e.g. jiang, xianling (chief ed.) (2005), international trade settlement practice and cases, peking: university of international economy and business press, pp. 273-278. 28 this opinion is so widely accepted in china, see li, ziping & hu, xiangfu (2005), new comments on financial crimes, people press, 2005, p. 303; zhou, ying (2003a), ‘dilemma in preventing documentary credit fraud’, economy professional, vol. 5, pp. 46-47; bai, jianjun (1994), financial fraud and prevention, peking: chinese legal press, pp. 33-34; there are quite a number of letter of credit fraud cases concerning soft clauses, see e.g. chen, yu (2002), ‘guarding against letter of credit soft clauses pitfall: comment on jiaxing letter of credit fraud case’, international business study, no. 2, 64; tu, yonghong (2006), ‘case analysis on letter of credit soft clauses fraud’, new finance and economics, no. 3, 116. nordic journal of commercial law issue 2011#1 6 issue as ‘built-in discrepancy’.29 according to the statistics from the bank of china, the fraud of letter of credit soft clauses has led to a loss of millions of dollars since 1992.30 the term soft clauses can be discussed by comparing them with normal clauses in the letter of credit. according to the independence principle of the letter of credit, the only condition for a paying bank to decide on whether to honour a letter of credit payment is that the documents presented by the beneficiary conform to the letter of credit itself. in an ordinary letter of credit, the beneficiary who honestly performs the sales contract is able to obtain the required documents. such clauses that can be satisfied through the beneficiary’s performance are normal clauses.31 however, sometimes there are other letter of credit clauses, in which some special documents are required to be presented by the beneficiary, such as the buyer’s receipt of goods, inspection of goods issued by the buyer, or the letter of credit will take effect under some conditions.32 with such clauses, whether the beneficiary can get specified documents or whether the stipulated conditions can be satisfied, partially or entirely depends on the buyer or other parties, rather than the beneficiary’s performance of contract; such clauses can be regarded as soft clauses in the letter of credit.33 soft clauses are commonly abused by dishonest businessman as a tool for committing fraud, breach of contract or dishonour; thus letter of credit soft clauses can make a beneficiary’s obtainment of the letter of credit payment risky and uncertain.34 very often letter of credit soft clauses are connected with the applicant’s intention to deceive a prepaid performance deposit, a letter of credit issuance deposit and so forth from the beneficiary.35 once the applicant has received such a prepaid deposit, the applicant would find faults with the quality of goods, refuse to issue an inspection certification, and finally achieve the fraudulent purpose. the risk of such 29 fung, king tak (2005), extract of some cases discussed in leading court cases on letters of credit, published by dc-pro, 18 jan., 2005; in this extract, fung argues that although the bank may refuse letter of credit payment because of a discrepancy under the letter of credit, it does not discharge the payment obligation of the buyer to the seller under the sales contract. 30 cai, lei & liu, bo (1997), international trade fraud and prevention, peking: law press china, p. 278; this type of letter of credit fraud still happens nowadays, see e.g. chen, qian (2007), ‘international fraud trial hangs on credit letters’, shanghai daily, 04 august. 31 xu, donggen (2005), p. 299. 32 zhang, zongliang (2005), p. 215. 33 yu, jingsong (chief ed.) (2003), current issues of international economic law, wuhan: wuhan university press, 1st ed., pp. 231-232; see also dong, guoshu & li, dejun (2006), ‘discussion on letter of credit risk and prevention’, market modernisation, jan. (2nd issue), (sum. no. 456), 14. 34 zhao, limei (2000), guide to letter of credit operations, vol. 2, peking: china economy press, p. 1199. 35 cai lei & liu, bo (1997), international trade fraud and prevention, peking: law press china, p. 278; see also shi, zheng (2006), ‘value evaluation of letter of credit in international trade’, enterprise economy, no. 4 (sum. no. 308), 174, p. 176. nordic journal of commercial law issue 2011#1 7 a clause is that the applicant can take advantage of it by refusing to appoint someone to inspect goods or they can simply reject the goods in times when the market falls or the importer finds cheaper goods.36 thus the financial payment of the letter of credit guaranteed by the credit of the bank in a way becomes a commercial payment depending on the credit of one trading party.37 however, soft clauses of a letter of credit do not always mean fraud, as sometimes soft clauses in a letter of credit can be accepted due to different business customs in different countries or agreements between trading parties.38 identifying which clauses are letter of credit soft clauses and which clauses are reasonable requirements from the buyer can be difficult. the forms of letter of credit soft clauses are various and changeable; sometimes they can be formulated in a very obscure way.39 therefore, it is sometimes difficult for the beneficiary to notice and understand them. the problem of soft clauses seriously affects the beneficiary’s legal rights and further deteriorates the value and function of the letter of credit as a payment method in international trade.40 are letter of credit soft clauses a kind of letter of credit fraud? to answer this question, we will start by discussing the main types of letter of credit soft clauses. 2 various categories of letter of credit soft clauses in china soft clauses in a letter of credit take on various forms, as the forms and expressions of a letter of credit issued by different banks are different.41 but it is still helpful to explain the problem by classifying different types of soft clauses so as to find out the common features of this problem. 36 see xu, junke (2007), pp. 97-98. 37 see e.g. ma, guobing & weng, di (2005), ‘discussion on risk of fraud and prevention under letter of credit’, hlj foreign economic relations & trade, no. 5 (serial no. 131), 61, pp. 61-62. 38 liu, debiao & yu, youyan (2003), international business cases selection, peking: international economy and business university press, p. 95; leng, hanbing & jiang, xiaochun (2000), ‘soft clauses and forgery – two means of letter of credit fraud’, china foreign exchange management, 5, p. 33; see also xu, junke (2007), p. 99. 39 see e.g. qi, hongwei (2003), ‘analysis and countermeasure on letter of credit fraudulent soft clauses’, jiangsu business view, no. 10, 39. 40 xu, xin & mao, xuegang & guo, yu (2009), ‘discussion on letter of credit soft clauses: from a letter of credit dispute case’, theory research, no. 5 (general no. 179), 127, p. 128. 41 the categories are different under different opinions, see e.g. hu, yuexiu (2007), ‘letter of credit soft clauses and risk prevention’, market modernisation, august (2nd issue), 295, pp. 295-296; zhang, zongliang (2005), ‘letter of credit soft clauses analysis and prevention’, market modernisation, december (2nd issue), 215, pp. 215-216. nordic journal of commercial law issue 2011#1 8 2.1 soft clauses that create conditions for a valid letter of credit the first type of soft clauses in a letter of credit in essence makes an irrevocable letter of credit become a conditional letter of credit.42 a normal letter of credit is effective and valid when the beneficiary receives it. however, some letter of credits are valid with some conditions43 and the specified conditions can be controlled by the buyer, or controlled by a third party in the buyer’s country such as an authorised certificate from the importer’s government, or certification of approval from the foreign exchange office in the importer’s country.44 in particular, such a type of soft clauses can be written for example as, “this credit will be effective only after receiving further instruction”, or “this credit will become an effective instrument with confirmation from the applicant”45. some other soft clauses can become more complicated where the condition of a valid letter of credit is reflected in the letter of credit amendment.46 if the buyer does not give any further notice or instructions on shipping date or vessel, then it can result in great loss to the seller where part of the performance of the sales contract has been done. thus, with such clauses, the buyer decides whether or not a letter of credit will be effective. but how one defines the legal nature of such a clause is a debatable issue in theory. should such an amendment clause belong to the preconditions of an effective letter of credit or should it be considered as an amendment agreement clause later?47 two concrete case examples are provided in order to illustrate such a problem. the first case can demonstrate the problem of this type of letter of credit soft clauses, in which some conditions are controlled by the buyer. one seller in china concluded a contract with kam wa enterprises inc. usa; then it received an irrevocable letter of credit with the letter of 42 see qu, xinjiu (2003), finance and financial crime, peking: citic publishing house, 1st ed., pp. 340-341; see also li, jinze (2004), letter of credit and legal problems in financing of international trade, peking: china finance press, pp. 19-20. 43 see e.g. wu, cuihua (2005), ‘risk and prevention of letter of credit soft clauses’, economic forum, no. 12, 32; yuan, hui (2005), pp. 91-92. 44 wang, xitong (2007), p. 77. 45 xu, donggen (2005), study on letter of credit law and practice, peking: peking university press, p. 301. 46 for example, such clauses may read that the “carrying vessel of shipment, date of shipment and destination port shall be informed by the issuing bank in the form of letter of credit amendment upon receipt of the notification from applicant”, “the goods will be shipped upon receipt of shipping advice issued by opener of letter of credit appointing the name of vessel, which will be issued by way of an amendment to this credit by the issuing bank” (see tang, jinlong (2005), p. 177), or “the goods will be shipped upon the appointing of the vessel by the applicant of letter of credit and adding a cable/telex amendment of letter of credit by issuing bank to advising bank, which should be negotiated accompanied with the original documents” (see chen, yan & liu, ling (2007), ucp 600 and letter of credit essentials, peking: university of international business and economics press, p. 203); see also jia, qinghong (2003), ‘letter of credit fraud, prevention and treatment’, international economy cooperation, no. 5, 48, pp. 48-49. 47 further discussion, see fang, shuangfu (2003), ‘the legal character and judicial remedy of letter of credit soft clauses’, people’s justice, no. 5, 28. nordic journal of commercial law issue 2011#1 9 credit amount of 1, 9 million dollars.48 one term of the letter of credit was that, “shipment can only be effected upon receipt of applicants’ shipping instructions through letter of credit issuing bank nominating the name of carrying vessel by means of subsequent credit amendment”.49 the chinese seller shipped all the goods to dalian port in china before the valid period of shipping, waiting for further specific notice from the buyer. the buyer nominated a deputy to inspect the goods before shipping, but the deputy refused to give notice of shipping date and the name of the vessel. subsequently, the transaction could not continue and the chinese seller could not draw on the letter of credit. but the chinese exporter also paid 2, 6 million rmb (chinese currency) as the quality guarantee to the deputy of the buyer, after receiving the letter of credit. thus, the deputy of the usa buyer drew out the chinese seller’s prepaid deposit, and disappeared.50 the second case illustrated the problem of such a type of letter of credit soft clauses, in which some condition is controlled by a third party in the buyer’s country. company a in china concluded a contract with company b in canada, paid by an irrevocable letter of credit.51 company b applied for bank c in canada to issue 5 letter of credits from july to october 1991. however, the letter of credit payment is effective only after the issuing bank receives the notice of approval of importing such goods by the canadian government. after the goods arrived at the destination port, company b did not present the inspection certification issued by the agriculture department of canada to the bank. then bank c notified the bank of china that all the issued letters of credit were invalid and they would not honour the payment.52 in this case, according to the contract, the letter of credit was irrevocable, but in fact it was conditional. the purpose of inserting such clauses most probably was to obtain the goods first and then to avoid payment. generally, such clauses are not valid unless some conditions are satisfied; thus, they provide no guarantee to the beneficiary. 2.2 soft clauses that place obstacles to obtaining documents the second type of letter of credit soft clause in essence creates obstacles for the beneficiary to obtain the required documents under the letter of credit. under such a soft clause, the letter of 48 gao, jie (2006), international settlements cases analysis, peking: university of international business and economics press, 1st ed., pp. 59-61. 49 ibid. 50 he, xie & zhang, xikui (2002), financial crime cases – experience and techniques of preventing financial crime, peking: economy daily press, pp. 247-248. 51 gu, xiaorong & ding, muying (2000), pp. 203-204. 52 later company a applied for arbitration to the international commercial arbitration certre in canada, claiming the payment for goods. however, company b was in debt long ago, and had already signed agreements with all its creditors to discharge 1/4 of its debts by reason of bankruptcy. finally, this arbitration case ended up with company a obtaining only 1/4 of the payment. nordic journal of commercial law issue 2011#1 10 credit documents presented by the beneficiary need to include an inspection certificate or cargo receipt signed by the letter of credit applicant or the person appointed by the applicant (the agent).53 the issuance of an inspection certificate by the applicant violates the commercial customary rule, as inspection of goods usually is conducted by a third independent institution (authoritative, qualified, professional institution) excluding trading parties.54 sometimes such an inspection certificate or other documents are required to be certified by the issuing bank or advising bank.55 it is argued that such clauses obviously violate customary practice of international trade, as banks shall not engage in trade according to ucp, but such clauses involve banks in a trading business.56 in addition, an applicant can leave one person’s specimen in the issuing bank, but appoint another person to sign.57 when the market rises, the applicant may issue the inspection certification; however, once the market falls at the time of honouring payment, the applicant may collude with the bank to refuse to pay on the grounds of the incompliant documents.58 the problem is that the beneficiary knows nothing about the seal or specimen left by the applicant in the issuing bank.59 thus, the beneficiary cannot ensure their presented documents conform to the letter of credit, and thus there is no guarantee for the seller to obtain the payment under the letter of credit. 53 see chen, li (2006), p. 101; see also li, qiujuan (2003), ‘typical letter of credit soft clauses forms and harm’, economist, no. 10, 48; see also liu, aie (2009), ‘main forms and preventive measures of letter of credit soft clauses’, commercial accounting, vol. 11, no. 21, 33, pp. 33-34. 54 song, jie (2010), ‘features and risk prevention of letter of credit soft clauses in foreign trade’, commercial times, no. 10, 38. 55 hu, meilun (2006), ‘letter of credit fraud and risk legal study’, exploration, no. 12, 117; several examples of such type of soft clauses are provided below: a) “cargo receipt and signed by xxx and the signature must be in strict compliance with that of our file” b) “the certificate of inspection would be issued and signed by the authorized agent of the applicant of letter of credit before shipment of cargo and the signature will be inspected by the issuing bank”c) “commercial invoice in triplicate, all duly signed and counter-signed by mr. xx and whose signatures must be in conformity with the specimen signatures(s) held in xx bank” d) “quality confirmation issued and signed by authorized person(s) of applicant (whose signature must be conformed with that hold in your file), certifying that goods are in good condition, and stating date, value, quantity of goods and dated”, see chen, yan & liu, ling (2007), p. 203. 56 jin, saibo (2002), p. 99. 57 xu, junke (2007), study on international trade law special topics: new development under wto framework, peking: china legal publishing house, p. 99. 58 ibid. 59 li, qiujuan (2003), p. 48. nordic journal of commercial law issue 2011#1 11 2.3 other types of soft clauses in letters of credit there are some other different types of soft clauses in the letter of credit;60 and conflicting clauses are sometimes stipulated in the sales contract and the letter of credit.61 sometimes, different types of soft clauses may be combined together in one letter of credit. for example, the xiamen branch of the bank of china received one letter of credit issued by one bank in singapore, for the amount of 1 million dollars in 1993.62 in this letter of credit, one clause was that “shipment can only be effected after the letter of credit applicant has nominated the carrying vessel by way of subsequent tested telex amendment to this credit via opening bank to advising bank, the tested telex amendment must accompany original documents presented for negotiation”, which seems to fall in the first type of letter of credit soft clauses as discussed earlier. the other clause was that “inspection certificate to be issued prior to shipment and signed by authorized signatories of applicant whose signatures must be verified by letter of credit issuing bank”, which falls into the second type of letter of credit soft clauses. with these two letter of credit clauses, the buyer controlled the transaction by nominating a ship, and controlled the letter of credit payment by issuing an inspection certificate. in this case, the beneficiary seller was required to pay the deposit of performance of contract in advance, with the amount of 5 -10 percent of the whole contracting amount, in order to get a letter of credit issued. after 10 million rmb remitting to the bank account instructed by the buyer, the deputy of the buyer immediately withdrew it from the bank. thus the buyer intended to deceive the performance deposit from the seller by taking advantage of inserting such letter of credit soft clauses. the discussed letter of credit soft clauses can either make the letter of credit ineffective, or the applicant can in fact control the letter of credit payment. it is also possible that the applicant colludes with the issuing bank, or advising bank to delay or avoid payment. in fact, with such letter of credit soft clauses, the letter of credit payment, which is guaranteed by a bank, has already been changed to a kind of conditional commercial payment, which is controlled by one party. thus, the beneficiary’s rights and interests can be seriously harmed. it is strongly recommended that the sellers pay careful attention to such a kind of clauses in letter of credit transactions.63 60 gu, xiaorong & ding, muying (2000), letter of credit, credit card and foreign bills – cognizance and sanctions, peking: taihai press, 1st ed., p. 203. 61 yuan, hui (2005), ‘how foreign trading company will identify and prevent letter of credit soft clauses’, international business – periodical of university of international business and economics, no. 1, p. 91; see also bai, jianjun (1994), p. 28; yang, yishi (2007), ‘identification and types of letter of credit frauds’, business weekly, may 5, 84, p. 86. 62 sun, dingjie (1995), pp. 653-654. 63 wang, xitong (2007), ‘reflection on letter of credit soft clauses and countermeasures’, decision exploration, no. 3 (1st issue), 78, p. 79. nordic journal of commercial law issue 2011#1 12 3 soft clauses in letters of credit in practice 3.1 how soft clauses in letters of credit are viewed in england? soft clauses in letters of credit seem to be a serious problem in china. however, whether such problem is frequent in other countries is unclear. literature and academic discussions in western countries concerning such issue are rarely seen. judith autié, a consultant from france, raised the discussion of such problem on letter of credit requiring documents to be issued by buyers (applicants) in an international conference organized by the icc austria on 28 may 2008. however, no exact term concerning such letter of credit clauses has been discussed in england. thus, it seems that such letter of credit clauses have not been clearly recognised as ‘letter of credit soft clauses’ by the courts in england. the principles of contract were applied when letter of credit cases were dealt with by courts in england64. the english case law concerning letter of credit has shown rigid attitudes of the courts towards the autonomy principle and the strict compliance doctrine of letter of credit. it would be interesting to explore the english courts’ attitude towards them, according to current theory and practice of letter of credit in england. whatever soft clauses are called, they are part of clauses in letter of credit. according to the party autonomy principle widely accepted either by courts or scholars in england, the courts would regard the arrangement of opening letter of credit as offer and acceptance between applicant and issuing bank, and the letter of credit clauses as the result of mutual agreement between issuing bank and beneficiary. upon the requirement of applicant the issuing bank opens a letter of credit containing soft clauses, which may be merely considered as an offer. the beneficiary has the right to put forward objection, either asking for amendment or reissuing a new letter of credit. if the beneficiary does not articulate any points against the letter of credit after the issuance of letter of credit, then it is a silent acceptance. thereafter the beneficiary should present conforming documents required by letter of credit. if the beneficiary cannot make themselves submit compliant documents with letter of credit, then definitely the issuing bank is entitled to dishonour the payment according the doctrine of strict compliance. occasionally, the english courts may issue an order to enforce the buyer to complete the document so that the beneficiary could present the document to the bank for payment or it could order a third party, who most probably is the officer of the court, to perform the document on behalf of the buyer.65 however, such a document may be refused by the paying bank on the grounds of incompliant documents under the letter of credit. 64 here are some examples: donald h.scott & co., ltd v. barclays bank, ltd. [1923] 2 k.b. 1 p. 14; midland bank ltd. v. seymour [1955] 2 lloyd’s rep. 147 p. 166; malas (hamzeh) & sons v. british imex industries ltd. [1958] 2 q.b. 127, p. 129. 65 raymond, jack (1993), para 9.42, p. 231. nordic journal of commercial law issue 2011#1 13 the astro exito navegacion sa v. southland enterprise co. ltd (no. 2) (chase manhattan bank na intervening) case illustrated the problem of such clauses.66 in this case, the sales transaction was financed through a letter of credit by a london bank. there was a clause requiring the notice of readiness to be signed and accepted by the buyer’s agent for an amendment of the letter of credit, but the buyer refused to sign it. the judge ordered that the buyer or the buyer’s agents should sign the notice by noon of 28 october, since the letter of credit would expire on 30 october; and if the buyer failed to do this, a master of the supreme court was to sign the notice on the basis of the supreme court act 1981, section 39. eventually, the seller tendered the documents including the required notice signed by a master of the supreme court. however, the bank refused to pay because the documents were not compliant with the credit of their face value. such clauses inserted in letter of credits require some cooperation and performance from the buyer. as for the situation where such clauses are inserted and documents such as an inspection certification from the buyer are required, but the buyer refuses to sign or issue such documents, the beneficiary is not able to present compliant documents to obtain the letter of credit payment. certainly the beneficiary will face huge losses resulting from such letter of credit clauses, and this is a common phenomenon in china. in china, letter of credit soft clauses sometimes can be misused as a way for conducting fraud. the banking and commercial community mostly consider letter of credit soft clauses as a crime (letter of credit fraud). however, what is the attitude by the courts in china towards this issue? 3.2 the approach of the courts in china towards letter of credit soft clauses some cases concerning letter of credit soft clauses have been decided by the courts in china. in the case of tsaolian v. china agriculture bank hunan branch67, the buyer hulong company applied for a letter of credit through china agriculture bank hunan branch. the branch issued a 90 days usance letter of credit with the tsaolian material corporation limited as the beneficiary, and hong kong south pacific commercial bank as the advising bank. article 48a.3 of this letter of credit stated that “the signature of the applicant on the receipt of goods shall be in compliance with the signature specimen held by the issuing bank”. this is a typical letter of credit soft clause falling in the second type. the beneficiary had the receipt from the applicant, but the signature on the receipt was different from the specimen held in the issuing bank. thus the issuing bank did not honour the payment. then the beneficiary sued the issuing bank in the hunan high court with the cause of action that the issuing bank broke its credit obligation. 66 [1983] 2 ac 787. 67 the spc, civil court, the 4th tribunal (2006), selected court cases of letter of credit disputes, peking: china democracy and legal press, pp. 40-42. nordic journal of commercial law issue 2011#1 14 the first instance court decided that the beneficiary should perform according to the terms and conditions of the credit since the beneficiary had accepted the letter of credit.68 the issuing bank has the right to refuse the payment in accordance with the strict compliance doctrine, because tsaolian presented one incompliant document. tsaolian appealed to the spc. the spc held that the beneficiary should understand the specific condition in the letter of credit before he accepted it.69 the acceptance of the credit showed that the beneficiary and applicant mutually agreed on this contract about the letter of credit. based on the contract autonomy, the court should respect the agreement. the documents presented by the beneficiary were not compliant with the letter of credit, thus the issuing bank has the right to dishonour payment. as a result, the spc approved the judgment of the first instance court.70 the case sanhe bank shenzhen branch v. china communication bank changsha branch71, decided by the spc, also shows the same attitude as in the case discussed above towards soft clauses in a letter of credit. one of the documents in the letter of credit was the receipt of goods to be signed by the applicant, and the signature of the receipt should conform to the specimen in the issuing bank. the spc decided that the “soft clause” in the letter of credit should bind on the relevant parties to the credit as a result of the willingness of all parties.72 furthermore, due to the incompliance of the signature on receipt with the requirements of the letter of credit, the issuing bank is entitled not to reimburse the negotiating bank.73 three points can be identified concerning the spc’s attitude towards letter of credit soft clauses. firstly, the cases involving the letter of credit soft clauses were dealt with under the principle of contract law. secondly, the validity of the letter of credit soft clauses was confirmed by regarding it as an agreement between parties. thirdly, the courts in civil cases did not show any tendency of considering soft clauses in the letter of credit as a way of letter of credit fraud. however, letter of credit soft clauses issue is considered differently under criminal law. in 1997 china had its new version of criminal law74 and the crime of letter of credit fraud is listed separately under the subtitle of financial crime in the new criminal law. in article 195 on the crime of letter of credit fraud, it provides that the following acts are criminalised: (1) using a forged or altered letter of credit or any of its attached bills or documents; (2) using an 68 ibid. 69 ibid. 70 for further comment on this case, see tang, jinlong (2005), new version of case study: financial law, peking: china renmin university press, 1st ed., pp. 172-177. 71 sanhe bank shenzhen branch v. china communication bank changsha branch, judgment of december 31, 2000, (1999) series no. 86, the spc. 72 ibid. 73 ibid. 74 the criminal law of prc was revised at the 5th meeting of the standing committee of the 8th national people’s congress of prc on 14 march, 1997, and came into force on the same date. nordic journal of commercial law issue 2011#1 15 invalidated letter of credit; (3) obtaining letter of credit fraudulently; (4) other types of letter of credit fraud. the article 195 (4) – other types of letter of credit fraud is explained as the fraud of soft clauses in the letter of credit by legislature.75 in both criminal law theory and judicial practice in china, it is very common that a crime is approached by analysing four elements subject, subjective element, object, and objective element.76 according to criminal law 1997, the subjects who may commit letter of credit fraud include natural persons and legal persons77. natural persons include not only natural persons with chinese nationality, but also foreigners and those without nationality.78 the subjective element for this crime is the intention of illegally possessing the properties of others under the letter of credit; intention only refers to direct intention, rather than indirect intention or negligence.79 the object of letter of credit fraud is widely accepted as the harm to the national administering system of the letter of credit and public and private property rights.80 the objective element of letter of credit fraud crime is the behaviours of committing letter of credit fraud, and it seems to include both presenting forged documents and acting fraudulently in underlying sales transactions.81 it can be seen that there is a conflicting judicial view between civil law and criminal law. some argue that soft clauses in a letter of credit are not a kind of 75 other types of letter of credit fraud usually refer to ‘letter of credit soft clauses’ fraud; for further explanation and concrete circumstances for each type of letter of credit fraud, see zhao, bingzhi (ed.) (2000), judicial countermeasure to distinguish financial crime, jilin: jilin people press, 1st ed., pp. 359-362; see also wei, dong & tang, lei (2001), pp. 276-279. 76 see e.g. zhao, bingzhi (2007), introduction to criminal law, peking: renmin university of china press, 1st ed., pp. 140-144; see also wang, zuofu (2007), criminal law, peking: renmin university of china press, 3rd ed., pp. 60-61; zhang, mingkai (2007), criminal law, peking: law press china, 3rd ed., pp. 96-98; liu, xianquan & yang, xingpei (2007), topics of criminology, peking: peking university press, 1st ed., pp. 92-93. 77 prc criminal law, article 200, provides the sanctions of letter of credit fraud conducted by legal persons. 78 prc criminal law, article 8. 79 this is considered as a fundamental feature of the subjective element of letter of credit fraud, see sui, qingjun (2006), theory and practice of dealing with financial crime cases, peking: china agriculture university press, 1st ed., pp. 130-133, see also chen, li (2006), pp. 102-104; zhao, bingzhi & zhou, jiahai (2001), ‘discussion on ‘illegal possession intention’ the essential condition of letter of credit fraud’, people’s procuratorial monthly, vol. 3, 5; but it is an arguable issue, as some academics and judges consider that such an intention is not necessary in order for it to constitute letter of credit fraud, see yan, renpeng & chen, guangxiu (2003), ‘comments on letter of credit fraud subjective element – ‘illegal possession’’, contemporary law, (10), p. 44. 80 see wei, dong & tang, lei (2001), financial crime identification and investigation, peking: people publishing house, p. 275. 81 for further discussion on the features of the objective element; see hou, fang (2005), research on crimes concerning letters of credit and credit card, peking: law press china, 1st ed., pp. 27-65. nordic journal of commercial law issue 2011#1 16 letter of credit fraud;82 and it is wrong for criminal law to regulate such a type of letter of credit fraud and it should be amended.83 in judicial practice, there are criminal cases which constituted fraud by the way of stipulating soft clauses in the letter of credit. however, it should be pointed out that in some cases the criminal could be accused as having committed fraud, instead of letter of credit fraud.84 as some examples have shown earlier, with letter of credit soft clauses, either the sellers’ performance deposit was deceived, or the seller’s goods were taken but without letter of credit payment. in such cases the buyers have intended to deceive deposit or goods from the sellers by misusing the instrument of letter of credit, which can be analyzed from the criminal law perspective. nevertheless, if the subjective element is the intention of deceiving some amount of deposit rather than the full amount of letter of credit payment, the kind of act can be considered as a kind of fraud but not letter of credit fraud. therefore, whether letter of credit soft clauses is a civil law case handled under contract law, or is a letter of credit fraud dealt with under criminal law is not a clear-cut issue. it depends on not only the facts of cases, but also on which legal perspective one approaches such issue. due to the difficulty the letter of credit soft clauses has raised to the legal field, it is necessary and helpful for sellers to consider some measures to avoid such kind of problem in commercial practice. 4 preventive and proactive measures to solve soft clauses problems in commercial practice 4.1 choose a credible partner choosing a credible trading partner is the best way of avoiding fraud or falling into a harmful situation. a well-known letter of credit expert pointed out that the buyer who employs letter of credit to pay should be very careful and must clearly know who the trading party is.85 this suggestion is also relevant to the seller. a common channel by which to investigate the credibility of new customers is through the bank and those professional institutions that 82 yang, jianhong (2002), ‘clarifying soft clauses in letter of credit’, journal of southwest university for nationalities, philosophy and social sciences, vol. 23, no. 12, dec., pp. 190-192. 83 jin, saibo & li, jian (2004), the law of letters of credit, peking: law press china, 1st ed., p. 766. 84 see one case example li, hua (south african), fraud, 2005, cited from tu, yonghong (2006), pp. 166-167. 85 zhou, xianshun & liang, lan (2006), ‘risk prevention measures of exporters under letter of credit’, science information, vol. 4, 176. nordic journal of commercial law issue 2011#1 17 provide credibility investigation.86 if the trading partner is a middleman, then it is much more important to find out its credibility including its economic strength and its past record of implementing contracts.87 4.2 draft international sales contract carefully usually letter of credit clauses in a letter of credit agreement are essentially based on an underlying international sales contract. therefore, the whole sales contract, especially contracting clauses on the various documents should be drafted as clearly as possible.88 it would be preferable if the various required documents including bill of lading, insurance policy, commercial invoice, inspection certification, certificate of origin and other possible documents are stipulated clearly in the sales contract. if contingent conditions in the future are possible to predict and are stipulated in the sales contracts, then the possibility of inserting soft clauses into letter of credit agreements would be reduced. 4.3 check letter of credit after it is received the seller needs to carefully and promptly check the letter of credit after it is received, so as to leave sufficient time if any amendment is necessary and to avoid the failure of not having the conforming documents.89 there are two main aspects requiring attention when the letter of credit is checked. firstly, the seller needs to check the validity of the letter of credit itself, including the credibility of the issuing bank, the terms of honouring payment, and the 86 gu, xiaorong & ni, ruiping (eds.) (2005), p. 237; see also zhou, qinghua (2001), ‘discussion on preventive measures and judicial remedy to letter of credit fraud’, contemporary law review, no. 12. 68, pp. 68-69; cheng, songliang & xiao, xiao (2008), ‘discussion on letter of credit fraud’, pioneering with science & technology monthly, no. 8, 131, p. 132. 87 sun, dingjie (1999), financial fraud and legal countermeasures, peking: people’s court publishing house, p. 176; see also yang, zhengming (ed.) (1999), financial crime and legal control, peking: linxin accounting press, 1st ed., p. 215. 88 gu, xiaorong & ding, muying (2000), p. 213-214; see also cai, lei & liu, bo (1997), pp. 323-325; shi, donglian (2005), ‘letter of credit fraud and risk prevention of exporters’, market modernisation, sep. (2),no. 444, 90, p. 91. zhu, min (2006), ‘the causes and risk prevention of letter of credit soft clauses’, finance and accounting journal (integrated), no. 3, 35, p. 36; hong, tao (2009), ‘letter of credit fraud and preventive measures in international trade’, modern business, no. 11, 89, p. 91. 89 li, xiaoyong (1998), financial crime and prevention, hangzhou: hangzhou university press, 1st ed., p. 17; see also bai, jianjun (1994), p. 31; this is only one small part in managing documentary credits on the side of exporters; for a detailed discussion see ‘vincent o’brien with some personal tips for exporters who receive a letter of credit’, dci (icc), autumn 1997, vol. 3, no. 4, pp. 21-22. nordic journal of commercial law issue 2011#1 18 appropriateness of period of validity.90 secondly, the seller needs to check whether the letter of credit terms comply with the clauses of the sales contract.91 once the seller identifies soft clauses in the letter of credit, the seller must immediately require the applicant to amend; at the same time, the seller sets forth the time limit for the buyer to amend or provide other guarantees, and clearly points out that the buyer should extend the validity of the letter of credit due to the delay of amendment.92 if the buyer refuses to amend the letter of credit afterwards, the seller may claim that the contract is terminated and can require the buyer to provide a valid guarantee, and further preserves the right to claim for compensation as the buyer breaks the sales contract due to the failure of opening the letter of credit. 4.4 establish a set of effective criterion of soft clauses the key of preventing soft clause problems in letter of credit transactions is to establish a set of effective criterion that could help to identify various letter of credit soft clauses.93 through such criterion, when one soft clause is in a letter of credit, it is possible to identify which type of soft clause it is, what effect it can bring to the seller, and what protective measures can be taken. unfortunately, there is no standard criterion for it as letter of credit soft clauses are different and variable. preventing soft clause becomes feasible, if the seller is aware of possible soft clauses in each stage of a letter of credit transaction.94 before solving the problem of letter of credit soft clauses in a letter of credit, the seller must not impatiently ship the goods in order to avoid more loss. concerning problematic soft clauses in a letter of credit, on the one hand, we emphasise preventing including such clauses; on the other hand, we recommend the sellers make use of contractual provisions to protect themselves. 90 wang, haizhi & ma, youxin (2000), p. 213; this point is also closely related to the prevention of letter of credit soft clauses, see li, xiaoyong (1998), p. 176. 91 hu, yuexiu (2007), ‘soft clause of letter of credit and risk prevention’, market modernisation, no. 512, august (second), p. 296; concrete contractual terms that need to be checked, see also li, xiaoyong (1998), p. 176. 92 see e.g. lu, jingsheng (2003), legal security study and measures in business operations, peking: china economy press, p. 299; see also chen, zhenhang (2007), ‘the risk and its prevention in international letter of credit transactions by exporters’, science and educational innovation, march, no. 6, 220, p. 221. 93 xu, donggen (2005), p. 310; see also wang, xiaodong (ed.) (2006), research on prevention of modern financial crime, jinan: shandong people press, p. 79; jin, xiaohua & zheng, shuhua (2005), ‘analysis of letter of credit soft clauses’, market modernisation (academic), no. 7, 70. 94 there are several stages such as the stage of letter of credit taking effect, inspecting goods, shipping goods and accepting goods, liu, zhiyong (2006), ‘analysis of letter of credit fraud’, academic journal of shanxi provincial committee party school of c.p.c., vol. 29, no. 3, june, 107, pp. 108-109; see also wu, renbo (2009), ‘identification and prevention of letter of credit soft clauses’, practice in foreign relations and trade, no. 8, 56, p. 57. nordic journal of commercial law issue 2011#1 19 4.5 cooperate with internal units and banks it is important for the seller to make efforts to cooperate between different units inside the company and cooperate with banks.95 it is clear that sellers need to have sufficient knowledge not only of their business but also of letter of credit transactions. letter of credit is in itself complicated and risky, thus once a letter of credit transaction is involved, it is essential not only for each unit of a company to do its own work well, but also to cooperate with each other through effective communication. in addition, the seller must cooperate with the advising bank in its home country96 by seriously taking on board the bank’s advice on some terms in the letter of credit. to sum up, the sellers in international sales transactions certainly have to be able to choose a credible commercial partner, to identify soft clauses when manipulating the payment method of the letter of credit and inform the buyers to amend it without delay, and to cooperate with internal departments and banks, so as to solve such soft clauses problem at an early stage. nevertheless, it is up to the sellers to decide whether to accept such soft clauses or not, depending on the particular customer and trading business. 5 conclusion from the above discussion, we can see that the issue of soft clauses in the letter of credit is indeed complex and debatable. on the one hand, in some particular circumstances, designing and inserting soft clauses in the letter of credit is a kind of protective measure taken by the buyer against letter of credit fraud committed by the seller. letter of credit soft clauses could be influenced by several elements, such as trading practice, features of the goods and the buyer’s market; not all soft clauses in the letter of credit are unreasonable and tricky. thus, considering the balance of rights and interests of both parties, it is impossible to entirely prohibit letter of credit soft clauses. on the other hand, soft clauses in the letter of credit can be abused by the buyer to conduct deceitful behaviours or even to commit fraud with intention, such as defrauding goods without payment or deceiving deposit of performance of contract or guarantee of the letter of credit issuance. 95 see wang, xiaodong (ed.) (2006), p. 81; see also li, xiaoyong (1998), p. 176; bai, jianjun (1994), p. 32; cooperation with banks may prevent the false letter of credit, ensure the creditability of the issuing bank, avoid letter of credit soft clause fraud, transferring letter of credit fraud, and so forth, see yang, zhengming (ed.) (1999), pp. 216-217; xie, ying & zhu, zhiyong (2003), ‘discussion on letter of credit fraud and prevention’, international economics and trade research, vol. 19, no. 5, oct., 41, p. 44. 96 wu, cuihua (2005), ‘risk and avoidance of soft clauses in letter of credit’, economy forum, no. 12, p. 33; similarly, establishing a platform for exchanging information for business enterprises and banks is also recommended, see zhang, xianglan (1999), ‘discussion on letter of credit fraud and countermeasures’, law review (bimonthly), no. 2 (sum. no. 94), 78, p. 82. nordic journal of commercial law issue 2011#1 20 in england, where some documents issued by they buyer are required, and if the buyer refuses to issue or sign such documents, the court may order the buyer or third party on behalf of the buyer to do so. however, a problem arose where a third party on behalf of the buyer is ordered to sign or issue such documents. the paying bank may consider such documents as not being compliant documents and refuse to honour the letter of credit payment. thus, the solution of the english court still would not be able to protect the seller against the problem of obtaining the letter of credit payment. in summary, letter of credit soft clauses issue can be considered either from contract law perspective or from criminal law perspective. the letter of credit soft clauses can take various forms; and the most important thing for the sellers is to take preventive and proactive measures to reduce the risk resulting from soft clauses to the lowest degree. contracts, risks and management = contractual risk management nordic journal of commercial law issue 2012#1 anticipatory avoidance of contract: cisg and egyptian law compared by amin dawwas* * professor of private law at arab american university – jenin, palestine. 1 nordic journal of commercial law issue 2012#1 1 introduction the united nations convention on contracts for the international sale of goods (the convention or cisg) was signed in vienna in 1980 and became effective on january 1, 1988. cisg applies to contracts for the international sale of goods, i.e. contracts concluded between parties whose places of business or habitual residences are in two different states. the convention aims at promoting international commerce by removing legal barriers in sale of goods transactions between international traders. to date, 77 states have adopted the cisg. 1 this convention entered into force in egypt on january 1, 1988. contracts for the sale of goods are also regulated by egyptian law. there are two kinds of such contracts under the present egyptian law, civil (non-commercial) and commercial contracts. the former egyptian commercial code for the year 1883 had no provision relating to the sale of goods contract. therefore, the egyptian civil code governed both non-commercial and commercial sale of goods contracts. the new egyptian commercial code (ecc) no. 17 for the year 1999 has reformed the field. in articles 88-118, it governs the commercial sale contract: articles 88-103 include general rules and articles 104-118 govern special types of sales contracts, including the supply contract. however, ecc is not all inclusive. according to ecc article 2, the civil code shall apply in absence of a commercial rule in the commercial code. accordingly, the non-commercial sale of goods contract is entirely governed by the civil code. in addition, the commercial sale of goods contract is basically governed by the (new) commercial code; and, in absence of any rule in this code, resort shall be made to the civil code. cisg deals with anticipatory avoidance of contract. in general, if prior to the date for performance of the contract it is clear that one of the parties will commit a fundamental breach of contract, the other party may – under cisg article 72 declare the contract avoided. the party intending to declare the contract avoided must give reasonable notice to the other party, in order to allow him to provide adequate assurance of his performance. nevertheless, such notice is not necessary, if time does not allow for providing it, or if the other party has declared that he will not perform his obligations. cisg also particularly governs anticipatory avoidance of installment contracts. ‘the contract calls for the delivery by instalments if it requires or authorizes the delivery of goods in separate lots’. 2 cisg article 73(2) clearly says: ‘if one party's failure to perform any of his obligations in respect of any 1 see the united nations commission on international trade law (uncitral), at: http://www.uncitral.org/uncitral/en/uncitral_texts/sale_goods/1980cisg_status.html. 2 the secretariat commentary on the [1978] draft convention on contracts for the international sale of goods (document a/con.97/5, article 64, para. 1, available at: http://www.uncitral.org/pdf/a_conf.97_5-ocred.pdf). http://www.uncitral.org/uncitral/en/uncitral_texts/sale_goods/1980cisg_status.html http://www.uncitral.org/pdf/a_conf.97_5-ocred.pdf 2 nordic journal of commercial law issue 2012#1 instalment gives the other party good grounds to conclude that a fundamental breach of contract will occur with respect to future instalments, he may declare the contract avoided for the future, provided that he does so within a reasonable time.’ 3 in its article 223, the egyptian draft civil code explicitly regulated the anticipatory avoidance of contracts. it stated: ‘in synallagmatic contracts, if one of the parties suffers a decrease in his assets after the contract is concluded, or his creditworthiness is reduced so that there are fears that he will not be able to perform his obligation, the other party – if he has to perform first – may not perform until the first party performs what he undertook or provides adequate assurance for such performance. where this obligation is not performed or the assurance is not provided within a reasonable time termination of the contract may be requested’. 4 however, the present egyptian civil code does not recognize the anticipatory avoidance doctrine. 5 generally, given the inherent uncertainty in assessing future events, it is impossible to know with certainty prior to the time of performance that the party in difficulty will commit a breach. 6 as a result, the egyptian legislator explicitly recognizes termination of contracts on the ground of actual breach only. article 157(1) of the egyptian civil code says: ‘in synallagmatic contracts, if one of the parties fails to perform his obligation, the other party may, after serving a warning upon him, request performance of the contract or its termination, with damages in either case if needed’. according to the general rules of the civil code, the creditor must not himself be in default and must be able to restore the status quo ante, too. 7 nevertheless, the egyptian civil code includes some provisions that indirectly cover anticipatory breach of contract. article 220 governs situations in which a party declares that he will not perform his obligation. articles 220 and 273 deal with circumstances in which a party will not be able to 3 in cases of anticipatory breach, cisg (article 71) also entitles the aggrieved party the right to suspend performance of his obligations. 4 see: sami, asma’ medhat, al-faskh ka-jaza’ lil-ikhlal bel-eltizam fi a’qd attawreed wifqa leqanoun ettijarah [avoidance as a penalty for the failure to perform the obligation in the supply agreement under commercial code in arabic], al-muhamah [legal profession journal, issued by the egyptian bar association], issue no. 2 (2002), 602-612, at 608. 5 abd el-hamid, khaled ahmad, fask' a'aqd al be' al dawli lel badae' wefkan le itefakeyet vienna l'am 1980 [the avoidance of the contract for international sale of goods according to the vienna convention 1980 in arabic], doctoral thesis cairo university, 2d ed., 2001, notes 193, 201, also available at: http://www.cisg.law.pace.edu/cisgarabic/middleast/abd_el_hamid.htm. 6 von ziegler, alexander, the right of suspension and stoppage in transit (and notification thereof), 25 journal of law and commerce (2005-06), 353-374, at 358, also available at: http://www.cisg.law.pace.edu/cisg/biblio/ziegler.html. 7 islam, muhammad wohidul, dissolution of contract in islamic law, arab law quarterly, vol. 3 no. 4 (1998), at 336-368, at 359-360. amkhan, adnan, termination for breach in arab contract law, 10 arab law quarterly (1995), 17-30, at 20-22. sami, supra note 4, at 606-609. http://www.cisg.law.pace.edu/cisgarabic/middleast/abd_el_hamid.htm http://www.cisg.law.pace.edu/cisg/biblio/ziegler.html 3 nordic journal of commercial law issue 2012#1 perform his obligation in due date. this paper will clarify whether the aggrieved party may avoid the contract in such cases or not. the new egyptian commercial code has reformed the anticipatory avoidance ("termination", in the context of ecc) of the sale of goods contract, in that it has put an end to halting future performance. like cisg, ecc governs the contract for the sale of goods by installments. concerning the anticipatory avoidance of installment contract, ecc article 97 says in part: ‘if it is agreed that the thing sold shall be delivered by installments, the buyer may request termination if the seller fails to perform one of the deliveries in the time agreed upon’. 8 ecc article 117 deals, in a clearer way, with the concept of anticipatory avoidance with respect to the supply contract. it states in toto: ‘if either party fails to perform his obligations relating to one of the periodic supplies, the other party may not terminate the contract unless such failure to perform causes gross harm to him or weakens confidence in the ability of the defaulting party to continue performing subsequent supplies on a regular basis’. ecc differentiates between local and international commercial sale of goods contracts. ecc article 88/2 subjects the international commercial sale of goods contract to international conventions effective in egypt, i.e. cisg, and international commercial practice. the local commercial sale of goods contract is governed by the ecc rules as augmented with civil code rules. according to the ecc’s memorandum, cisg was one of the instruments with which ecc has been influenced. 9 the aim of this paper is to see to which extent do articles 97 & 117 ecc plainly harmonize with cisg with respect to anticipatory avoidance. all respective rules of the egyptian civil code (e.g. articles 220 & 273) will also be tackled. in accordance, this paper will examine the requirements for anticipatory avoidance in section two and all legal effects resulting from meeting such requirements under both cisg and egyptian law, in section 3. 2 requirements for anticipatory avoidance cisg article 72 entitles an aggrieved party to anticipatorily avoid the contract for the sale of goods in general, regardless of whether it is a single delivery or an installment contract. furthermore, cisg article 73 includes special rules on anticipatory avoidance of installment contracts. thus, with regard 8 it further says: ‘… such termination does not apply to deliveries already performed unless the separation of the thing sold would cause gross harm to the buyer’. this provision is comparable to cisg article 73(3) which clearly says: “a buyer who declares the contract avoided in respect of any delivery may, at the same time, declare it avoided in respect of deliveries already made or of future deliveries if, by reason of their interdependence, those deliveries could not be used for the purpose contemplated by the parties at the time of the conclusion of the contract.” 9 sami, supra note 4, at 602. 4 nordic journal of commercial law issue 2012#1 to an installment contract, the aggrieved party might avoid the contract as to future installments, either by virtue of cisg article 72 or 73. this has also been emphasized in the real praxis. according to the zürich chamber of commerce, switzerland, for instance, ‘[f]or the arbitral tribunal it is clear that [seller's] deliberate stop of supplies to [buyers] was a fundamental breach by the seller under art. 30 vienna convention, namely an anticipatory repudiation of an installment contract under arts. 49, 72 and 73 vienna convention’. 10 ecc does not address the anticipatory avoidance of single delivery contracts. it only covers the anticipatory avoidance of installment contracts, particularly the supply contract which is dealt with by ecc as a special type of (commercial) sale of goods contract. ecc articles 97 & 117 explicitly allow anticipatory termination of contract as to future installments or supplies. besides, the egyptian civil code governs some aspects of anticipatory breach of contract. anticipatory avoidance under cisg article 72 requires: a. a breach of contract by party becomes clear prior to the date for performance, and b. such breach shall be fundamental in nature. this paper will now address these requirements under the cisg (articles 72 & 73(1)) in comparison with the egyptian law. 2.1 clarity of anticipatory breach 2.1.1 degree of clarity of anticipatory breach cisg article 72/1 lays down the principal prerequisite for a rightful anticipatory avoidance of contract: it must be ‘clear’ prior to the date for performance that the debtor (buyer or seller) will commit a fundamental breach. on one hand, ‘[a] mere suspicion, even a well-founded one, is not 10 award no. zhk 273/95, 31 may 1996, available at: http://cisgw3.law.pace.edu/cases/960531s1.html. see also: helsinki court of appeal, decision no. s 96/1215, 30 june 1998, available at: http://cisgw3.law.pace.edu/cases/980630f5.html, ‘[i]t is the understanding of the [buyer] that also article 72(2) cisg is applicable in this case. through non-conforming delivery, the [seller] has given the [buyer] grounds to assume that also the forthcoming deliveries in installments would constitute a fundamental breach of contract. the [buyer] was clearly entitled to declare the contract avoided as defined in cisg article 73.’ schiedsgericht der börse für landwirtschaftliche in wien (arbitral court of the market for farm products – vienna), austria, award no. s 2/97, 10 dec. 1997, available at: http://cisgw3.law.pace.edu/cases/971210a3.html#vii, '[t]he regulations of the cisg are contained in arts. 72 and 73, which both provide for anticipated breach of contract as a reason for the avoidance of contract’. http://cisgw3.law.pace.edu/cases/960531s1.html http://cisgw3.law.pace.edu/cases/980630f5.html http://cisgw3.law.pace.edu/cases/971210a3.html#vii 5 nordic journal of commercial law issue 2012#1 sufficient.’ 11 further, it does not suffice if ‘it becomes apparent’ that the debtor will commit a (fundamental) breacha standard that would suffice under cisg article 71. 12 on the other hand, a complete certainty of a fundamental breach is not required; 13 a very high probability that there will be a fundamental breach would rather suffice in this field. 14 in the words of the landgericht berlin, kammer für handelssachen 99, germany, ‘[z]war sind an die offensichtlichkeit einer zukünftigen vertragsverletzung hohe anforderungen im hinblick auf den grad ihrer wahrscheinlichkeit zu stellen. doch ist eine an sicherheit grenzende wahrscheinlichkeit nicht erforderlich. vielmehr bedarf es einer sehr hohen naheliegender wahrscheinlichkeit, die allgemein einleuchtet’. 15 unlike cisg article 72, cisg article 73(2) entitles the aggrieved party to avoid the contract with respect to future performance of an installment contract even if it is not ‘clear’ that there will be a 11 liu, chengwei, suspension or avoidance due to anticipatory breach: perspectives from arts. 71/72 cisg, the unidroit principles, pecl and case law, [2nd edition: case annotated update (may 2005)], 4.4, available at: http://www.cisg.law.pace.edu/cisg/biblio/liu9.html#cciv. von ziegler, supra note 6, at 359. abd elhamid, supra note 5, note 209. seliazniova, tasiana, prospective non-performance or anticipatory breach of contract (comparison of the belarusian approach to cisg application and foreign legal experience), 24 j. l. & com. 2004-2005, 111-140, , at 128, also available in: heinonline. 12 bennett, trevor, in: bianca-bonell, commentary on the international sales law, giuffrè: milan (1987), 525-530, at 528. eiselen, sieg, remarks on the manner in which the unidroit principles of international commercial contracts may be used to interpret or supplement articles 71 and 72 of the cisg, september 2002, para. g., available at: http://www.cisg.law.pace.edu/cisg/principles/uni71,72.html#er. rowley, keith a., a brief history of anticipatory repudiation in american contract law, 69 university of cincinnati law review (winter 2001), at 565-639, at 634, also available at: http://www.cisg.law.pace.edu/cisg/biblio/rowley.html. 13 schlechtriem, peter, uniform sales law the un-convention on contracts for the international sale of goods, manz, vienna: 1986, at 96, also available at: http://www.cisg.law.pace.edu/cisg/biblio/schlechtriem.html#a71. schnyder, a. k. / straub, r. m., vorweggenommene vertragsverletzung und vertrӓge über aufeinander folgende lieferungen, in: honsell, h. (ed.), “kommentar zum un-kaufrecht. übereinkommen der vereinten nationen über verträge über den internationalen warenkauf (cisg)” [commentary on the cisg article by article in german] [ by c. brunner, t. dornis, w. ernst, b. gsell, c. hurni, t. koller, r. lauko, u. magnus, w. melis, a. k. schnyder, h. schönle, k. siehr, r. m. straub, r. h. weber], springer-verlag berlin heidelberg, 2nd ed. (2010), at 879. liu, supra note 11, 4.4. 14 abd el-hamid, supra note 5, note 206. 15 decision no. 99 o 123/92, 30 sept. 1992, available at: http://www.cisg-online.ch/cisg/urteile/70.htm. http://www.cisg.law.pace.edu/cisg/biblio/liu9.html#cciv http://www.cisg.law.pace.edu/cisg/principles/uni71,72.html#er http://www.cisg.law.pace.edu/cisg/biblio/rowley.html http://www.cisg.law.pace.edu/cisg/biblio/schlechtriem.html#a71 http://www.cisg-online.ch/cisg/urteile/70.htm 6 nordic journal of commercial law issue 2012#1 fundamental breach of the contract in the future. 16 the schiedsgericht der börse für landwirtschaftliche produkte wien (arbitral court of the market for farm products – vienna), austria, concluded that ‘a less strict standard is to be applied to the level of probability with which equal fundamental breaches of contract are to be expected on future installments after the breaches of duty so far, as is demanded in the case of art. 72 cisg’; ‘the term "good grounds" in art. 73(2) presupposes the least level of probability for the assumption of a future breach of contract, it suffices when for the reasons ascertained a defect in the performance of the future installments will occur with "predominant probability"’. 17 the authority of this award might also be persuasive to other arbitral tribunals and domestic courts. the test of the right to anticipatory avoidance under cisg article 73(2) is whether a failure to perform in respect of an installment gives the other party good reason to fear that there will be a fundamental breach in future installments. ‘the test does not look to the seriousness of the current breach. this is of particular significance where a series of breaches, none of which in itself is fundamental or would give good reason to fear a future fundamental breach, taken together does give good reason for such a fear.’ 18 this (subjective) criterion is much more flexible than the (objective) one adopted by cisg article 72. cisg article 73(2) – contrary to cisg article 72 – deals with a situation of an actual breach of contract. 19 in its award no. vb/94124, 17 nov. 1995, the hungarian chamber of commerce and industry court of arbitration pointed out that ‘die bankgarantie als eine sicherung, zu deren beibringung die beklagte partei … verpflichtet war. da sie aber dieser pflicht nicht nachgekommen ist, war die klagende partei aufgrund des art. 71.1.b. berechtigt, ihre lieferungspflichten auszusetzen. demzufolge kann man in dieser beziehung nicht von vertragsverletzung der klagenden partei sprechen. durch dieses vereinbarungswidrige verhalten der beklagten partei war auch die 16 secretariat commentary, supra note 2, article 64, para. 5, ‘[i]t should be noted that article 64(2) [draft counterpart of cisg article 73(2)] permits the avoidance of the contract in respect of future performance of an instalment contract even though it is not "clear" that there will be a fundamental breach of the contract in the future as would be required by article 63 [draft counterpart of cisg article 72].’ see also: bridge, michael g., issues arising under articles 64, 72 and 73 of the united nations convention on contracts for the international sale of goods, 25 journal of law and commerce (2005-06), 405-421, at 420, also available at: http://www.cisg.law.pace.edu/cisg/biblio/bridge1.html#art72. koch, robert, the concept of fundamental breach of contract under the united nations convention on contracts for the international sale of goods (cisg), review of the convention on contracts for the international sale of goods (cisg) 1998, kluwer law international (1999), 177–354, at 310, also available at: http://www.cisg.law.pace.edu/cisg/biblio/koch.html. 17 award no. s 2/97, 10 dec. 1997, available at: http://cisgw3.law.pace.edu/cases/971210a3.html#vii 18 secretariat commentary, supra note 2, article 64, para. 6. 19 honnold, john o., uniform law for international sales under the 1980 united nations convention, 3rd ed., deventer: kluwer law international (1999), at 442. azeredo da silveira, mercédeh, anticipatory breach under the united nations convention on contracts for the international sale of goods, nordic journal of commercial law, issue 2005 #2, , at 45, also available at: http://www.njcl.utu.fi/2_2005/article1.pdf. http://www.cisg.law.pace.edu/cisg/biblio/bridge1.html#art72 http://www.cisg.law.pace.edu/cisg/biblio/koch.html http://cisgw3.law.pace.edu/cases/971210a3.html#vii http://www.njcl.utu.fi/2_2005/article1.pdf 7 nordic journal of commercial law issue 2012#1 vertragskündigung der gegenpartei … aufgrund des art. 73.2. berechtigt’. 20 the seller was entitled to declare the contract avoided according to art. 73(2) cisg; the buyer's actual breach of his obligation to issue a bank guarantee gave the seller good reasons to conclude that the buyer would not pay with respect to future deliveries. whereas cisg article 73(2) gives both buyer and seller the right to declare the anticipatory avoidance of contract, 21 ecc article 97 explicitly gives such right to the buyer only. ecc article 117 authorizes only the importer to anticipatorily avoid the contract, too. however, ecc also governs a situation of (non-anticipatory) termination of supply contract for actual non-performance that occurs after the performance deadline; here, it applies to both parties of the contract. if either party (supplier or importer) already failed to perform any of his obligations relating to one of the periodic supplies at the due time, the other party might request termination of the contract provided that such failure causes him gross harm. 22 in either case, the right to avoid / terminate the contract by the buyer / importer prior to the date of performance is preceded with an actual failure by the seller / supplier to perform. under ecc article 97, the mere fact that the seller failed to give a certain delivery in the time agreed upon authorizes the buyer to terminate the contract for the future deliveries. however, under the surface, this entails that such failure to perform by the seller makes the buyer suspicious about the future deliveries. under ecc article 117, the failure by the supplier to deliver any periodic supply does not per se entitles the importer to anticipatorily terminate the supply contract. rather, this articleexplicitly states that such a failure weakens confidence in the supplier’s ability to continue performing subsequent supplies on a regular basis. otherwise, the importer cannot terminate the contract. since ecc articles 97 and 117 do not deal with the single delivery contract, both are well comparable to cisg article 73(2). with regard to installment contracts, both cisg (article 73(2)) and ecc obviously require that the right of anticipatory avoidance of contract be preceded by an actual breach. still, the aggrieved party may – under cisg article 72 anticipatorily avoid the contract even if no actual breach is committed. as we have already said, with regard to an installment contract, the aggrieved party might avoid the contract as to future installments, either by virtue of cisg article 72 or 73(2). 23 under cisg article 73(2), it suffices if one party fails to perform any of his obligations with respect to any installment, be it non-performance, late performance or non-conformity. under ecc article 117, 20 available at: http://www.unilex.info/case.cfm?id=217. 21 schlechtriem, supra note 13, at 96, ‘[t]his provision is concerned with successive deliveries, not instalment payments. by analogy, however, article 73(2) can also apply to missed payments if they coincide with instalment deliveries. otherwise, the entire contract may be avoided under article 72. article 73(2) is also applicable to other breaches by the buyer, such as not taking delivery of an instalment’. 22 article 117. 23 see supra note 10 and the accompanying text. http://www.unilex.info/case.cfm?id=217 8 nordic journal of commercial law issue 2012#1 by contrast, the supplier’s failure to perform shall be in the form of non-delivery of any periodic supply. in this case, late or non-conforming delivery will not suffice. 24 like cisg article 73(2), ecc article 117 adopts a subjective criterion, i.e. the supplier’s failure to perform one of the periodic supplies weakens confidence in his ability to continue performing subsequent supplies on a regular basis. thus, the importer shall establish that the supplier’s failure to perform a periodic supply is a proof of a serious deficiency in the supplier's creditworthiness; i.e., the supplier will not be able to perform future supplies. this serious deficiency in the supplier's creditworthiness does not however mean insolvency or bankruptcy. 25 under article 273 of the egyptian civil code which is applicable to both noncommercial and commercial sale contracts, declaring the supplier insolvent or bankrupt renders all outstanding supplies due. under article 157(1) of the egyptian civil code, the importer may immediately request the performance of the contract or its termination and, in either case, damages if needed. 2.1.2 causes leading to the clarity of anticipatory breach cisg article 72, contrary to cisg article 71, does not stipulate that the anticipated breach be clear as a consequence of any particular conduct or circumstances. 26 the most important element of cisg article 72 is that a fundamental breach will be committed, whatever the cause of clarity would be. 27 such clarity might – just like cisg article 71 result from ‘(a) a serious deficiency in [the debtor’s] ability to perform or in his creditworthiness; or (b) his conduct in preparing to perform or in performing the contract’. 28 still, it can also be a consequence of any other circumstances. a party is found to be entitled to anticipate breach of contract when confronted with the following circumstances: the non-performance by the buyer of his obligations under prior contracts; 29 the 24 sami, supra note 4, at 607. 25 ibid, at 608. 26 bennett, supra note 12, at 528. liu, supra note 11, 2.2. 27 schnyder / straub, in : honsel, supra note 13, at 876. azeredo da silveira, supra note 19, at 26. liu, supra note 11, 2.2. 28 abd el-hamid, supra note 5, note 207. liu, supra note 11, 4.4. 29 in its decision no. 11 o 210/92, 28 april 1993 (available at: http://www.unilex.info/case.cfm?id=85), the landgericht krefeld, germany concluded that the seller had the right to declare the second contract avoided under art. 72(1) and (2) cisg, since the buyer had not yet performed under the prior contract although the seller had requested several times to do so and had even commenced a legal action, a thing that made it clear that the buyer would not pay the purchase price under the second contract and would thereby commit a fundamental breach of contract. this ruling has been affirmed by the oberlandesgericht düsseldorf in its decision no. 17 u 146/93, 14 jan. 1994, available at: http://www.unilex.info/case.cfm?id=84. http://www.unilex.info/case.cfm?id=85 http://www.unilex.info/case.cfm?id=84 9 nordic journal of commercial law issue 2012#1 buyer's refusal to establish a letter of credit; 30 the buyer's serious delays in payment of the price; 31 the seller's deliberate stop of supplies to buyers; 32 the seller's delayed delivery of defective samples; 33 and the loss of either party's creditworthiness due to being subject to an insolvency proceedings. 34 obviously, insolvency is one of the circumstances that may – under cisg indicate that there will be a fundamental breach prior to the date for performance. the egyptian law also deals with the situation in which a contracting party is declared insolvent or bankrupt. according to article 273 of the egyptian civil code which is applicable to both non-commercial and commercial sale contracts, if the debtor adjudged insolvent or bankrupt, he shall lose his right in the maturity period. this maturity period is originally given to the debtor based on trust in his creditworthiness. 35 thus, the creditor logically expect that the insolvent debtor will not be able to perform his obligation when it is due under the contract. this is an obvious situation of anticipatory breach of contract. the aggrieved 30 in its decision no. civil jurisdiction 10680 of 1996, 17 nov. 2000 (available at: http://www.unilex.info/case.cfm?id=472), the supreme court of queensland, australia, stated that ‘[t]he refusal to establish a timely letter of credit was clearly a fundamental breach within the meaning of article 25 and article 64(1)(a) of the convention. … such a failure would also justify termination [under article 72 cisg]’. 31 in its decision no. ar 3641/94, 1 mar. 1995 (available at: http://www.unilex.info/case.cfm?id=269), the rechtbank van koophandel, hasselt – belgium pointed out that the buyer's serious delay in payment, namely over seven months, could reasonably lead to the suspicion that it would not perform in the future. likewise, in its decision of 20 february 2007 (available at: http://www.unilex.info/case.cfm?id=1186), the cour de cassation chambre commerciale, france concluded that the buyer’s previous serious delays in payment and its belonging to a seriously indebted group had led the seller reasonably to believe that the other party would not perform in the future. 32 in its award no. zhk 273/95, 31 may 1996 (available at: http://www.unilex.info/case.cfm?id=396), the zürich handelskammer concluded that ‘it is clear that [seller's] deliberate stop of supplies to [buyers] was a fundamental breach by the seller under art. 30 vienna convention, namely an anticipatory repudiation of an installment contract under arts. 49, 72 and 73 vienna convention’. likewise, in its decision no. 2 ob 328/97t, 12 feb. 1998 (available at: http://www.unilex.info/case.cfm?id=385), the oberster gerichtshof, austria pointed out that ‘[e]in schwerwiegender mangel der kreditwürdigkeit, wie er hier von der klagenden partei geltend gemacht wird, ist etwa gegeben, wenn … der schuldner seine zahlungen oder lieferungen eingestellt hat’. 33 in its award no. 8786 of january 1997 (available at: http://www.unilex.info/case.cfm?id=463), the icc court of arbitration – zurich concluded that ‘with its delayed delivery of defective samples claimant has itself caused the impossibility of delivery of the products at the date agreed upon. by informing defendant that it would not meet the delivery deadline claimant committed an anticipatory and fundamental breach of contract’. 34 in its decision no. 2 ob 328/97t, 12 feb. 1998 (available at: http://www.unilex.info/case.cfm?id=385), the oberster gerichtshof, austria pointed out that ‘[e]in schwerwiegender mangel der kreditwürdigkeit, wie er hier von der klagenden partei geltend gemacht wird, ist etwa gegeben, wenn über das vermögen des schuldners ein insolvenzverfahren eröffnet worden ist’. 35 abd el-hamid, supra note 5, note 199. http://www.unilex.info/case.cfm?id=472 http://www.unilex.info/case.cfm?id=269 http://www.unilex.info/case.cfm?id=1186 http://www.unilex.info/case.cfm?id=396 http://www.unilex.info/case.cfm?id=385 http://www.unilex.info/case.cfm?id=463 http://www.unilex.info/case.cfm?id=385 10 nordic journal of commercial law issue 2012#1 creditor may immediately request (specific) performance by the debtor of his obligations. 36 he may also demand immediate termination of the contract; i.e. before the time originally agreed upon. with regard to installment contracts, cisg and ecc define the cause of anticipatory breach. 37 the actual non-performance of an installment ‘gives the other party good grounds to conclude that a fundamental breach of contract will occur with respect to future instalments’ 38 or ‘weakens confidence in the ability of the defaulting party to continue performing subsequent supplies on a regular basis’. 39 2.2 fundamental non-performance with respect to the breach anticipated by either party, the convention distinguishes between the right of an aggrieved party to anticipatorily avoid the contract under cisg article 72 and the right to suspend his obligations under cisg article 71. in order to suspend either party’s performance, it suffices that ‘the other party will not perform a substantial part of his obligations’. 40 in order to anticipatorily avoid the contract by the aggrieved party, by contrast, it shall be clear that the other party ‘will commit a fundamental breach of contract’. thus, ‘a promisee's prospective failure to perform a "substantial part" (in art. 71) of its obligations, although obviously significant, is presumably intended to denote something less than a "fundamental breach" (in art. 72)’. 41 under both articles of the cisg, however, the minor breach anticipated by a contracting party does entitle the other party neither a right of suspension of performance nor anticipatory avoidance of contract. 42 36 in addition, the failure by the debtor to provide the debt securities agreed upon or decrease of such securities by his own deed or for a cause not related to him (but not by the creditor's deed, see: decision of the court of cassation, egypt, no. 67 for the judicial year 35, 11 feb. 1969, available (in arabic) in the arab legal network at: http://www.eastlaws.com/ahkam/ahkamhokmsearch.aspx) constitute themselves situations of anticipatory breach of contract. therefore, article 273 of the egyptian civil code equates these situations with the case of the debtor's bankruptcy or insolvency. 37 koch, supra note 16, at 311. 38 article 73/2 cisg. 39 article 117 ecc. 40 decision of the landgericht berlin, germany, no. 52 s 247/94, 15 sept. 1994, available at: http://www.unilex.info/case.cfm?id=218, ‘danach [dh, nach artikel 71 cisg] kann eine vertragspartei die erfüllung ihrer pflichten aussetzen, wenn sich nach vertragsabschluß herausstellt, daß die andere partei einen wesentlichen teil ihrer pflichten nicht erfüllen wird, was sich aufgrund des verhaltens bei der vorbereitung der erfüllung oder bei der erfüllung des vertrages ergeben kann. dazu bedarf es nicht notwendig einer wesentlichen vertragsverletzung im sinne des art. 25 cisg’. 41 liu, supra note 11, 2.2. 42 ibid, 1. http://www.eastlaws.com/ahkam/ahkamhokmsearch.aspx http://www.unilex.info/case.cfm?id=218 11 nordic journal of commercial law issue 2012#1 according to cisg article 71(3), ‘[a] party suspending performance … must immediately give notice of the suspension to the other party and must continue with performance if the other party provides adequate assurance of his performance.’ failure to provide such adequate assurance may not in itself authorize the aggrieved party to declare the contract avoided under cisg article 72. 43 however, if this failure makes it clear that the suspected breach is fundamental, the contract can be avoided on the ground of anticipatory breach. 44 cisg article 73(1) authorizes a party to declare a contract avoided with regard to a single installment where the other party has committed a fundamental breach in respect of that installment. cisg article 73(2) further provides that the failure of one party to perform any of his obligations under the contract in respect of any installment can give the other party good grounds to conclude that a fundamental breach will occur with respect to future installments. consequently, the other party may declare the contract avoided with regard to these future installments. to sum, the convention entitles the aggrieved party to declare the contract avoided when the anticipated breach is fundamental in the sense of cisg article 25. 45 this is completely concordant with the right to avoid in cases of actual breach of contract under cisg articles 49 & 64. it should however be noted that, whereas avoidance based on actual breach of contract occurs after the date of performance, the anticipatory avoidance is declared by the aggrieved party prior to the date of performance. in its decision no. viii zr 18/94, 15 feb. 1995, the bundesgerichtshof, germany, stated that the right to anticipatory avoidance may be exercised up until the date for performance. yet since the machine had been delivered to the buyer, the court concluded that buyer was entitled to avoid the contract only under the prerequisites stipulated in cisg articles 45 & 49. 46 by making avoidance conditional on fundamental breach of contract, whether anticipatory or actual, the convention makes avoidance a remedy of last resort. 47 that is to say, the keeping the contract 43 schlechtriem, supra note 13, at 96, ‘the refusal of the obligor to provide "adequate assurance" following a notice under article 71(3) should not in itself be regarded as "clear" evidence of an impending breach of contract’. strub, gilbey, the convention on the international sale of goods: anticipatory repudiation provisions and developing countries, 38 international and comparative law quarterly (1989), 475-501, at 498, also available at: http://www.cisg.law.pace.edu/cisg/biblio/strub.html, ‘[a] failure to respond to a request for assurances is too vague to merit avoidance under the text of article 72’. contra: bennett, supra note 12, at 524, ‘a failure to provide an adequate assurance will justify a conclusion that a fundamental breach will be committed and avoidance for anticipatory breach will be possible.’ 44 compare: honnold, supra note 19, at 436, ‘b’s failure to respond with assurances of performance may make it ‘clear’ that b will commit a fundamental breach of contract – a ground for avoiding the contract under article 72’. 45 it says: ‘a breach of contract committed by one of the parties is fundamental if it results in such detriment to the other party as substantially to deprive him of what he is entitled to expect under the contract, unless the party in breach did not foresee and a reasonable person of the same kind in the same circumstances would not have foreseen such a result.’ 46 available at: http://www.unilex.info/case.cfm?id=107. 47 schlechtriem, supra note 13, at 95. http://www.cisg.law.pace.edu/cisg/biblio/strub.html http://www.unilex.info/case.cfm?id=107 12 nordic journal of commercial law issue 2012#1 intact is a principle upon which cisg is based. accordingly, the zürich chamber of commerce, switzerland, in its award no. zhk 273/95, 31 may 1996, concluded that ‘the failure by a buyer to perform one installment (i.e., paying the price for one installment) gives the seller the right to avoid the contract only where the buyer's breach is a fundamental breach ….’ 48 pursuant to ecc article 117, the anticipatory termination suggests that the supplier’s failure to perform one of the periodic supplies weakens confidence in his ability to continue performing subsequent supplies on a regular basis. though this provision does not include the term ‘fundamental breach’, the inability by the supplier to continue performing subsequent supplies on a regular basis means that the importer will be deprived of what he reasonably intended to get under the contract. 49 under ecc article 97, the failure by the seller to perform any installment gives the buyer the right to terminate the contract for future installments, too. such a failure gives the buyer reasons to expect a fundamental breach of contract by the seller, i.e. fear of non-performance of coming installments. 50 in addition, in order to terminate the contract for (actual) breach under the egyptian civil code, the breach shall have a certain degree of seriousness. in order to decide whether or not the breach at issue is serious enough to warrant termination, the court shall take into account the initial intent of the parties when the contract was concluded as well as all the circumstances relating to this contract. thus, the court shall consider, inter alia, the nature of the contractual obligation breached (whether a subsidiary or essential one) and the significance of the part of contract not performed. 51 obviously, this egyptian civil code test compares well to the fundamental breach test of cisg article 25. 3 legal effects once the prerequisites mentioned in cisg articles 72 & 73(2) or ecc articles 97 & 117 are met, the aggrieved party may avoid / terminate the contract prior to the date for performance. beside avoidance / termination of contract, this paper will show in the following pages whether or not the 48 available at: http://cisgw3.law.pace.edu/cases/960531s1.html. 49 sami, supra note 4, at 607. 50 amkhan, supra note 7, at 24-25. 51 in principle, a judicial judgment is required for effecting termination as a remedy of (actual) breach of contract (see: amkhan, supra note 7, at 23. sami, supra note 4, at 610). however, the judge enjoys a wide margin of discretion in this regard; ‘the judge may reject the request for termination if that which the debtor has failed to perform is of little importance in relation to the obligation as a whole’ (article 157(2) of the egyptian civil code). besides, the contracting parties may deprive the judge of his discretionary powers in deciding upon termination; ‘the parties may agree that in case of non-performance of the contractual obligations, the contract will be terminated ipso facto without a judicial judgment. such an agreement does not release the parties from the obligation of serving a warning, unless the parties explicitly agree that such a warning will be dispensed with’ (article 158 of the egyptian civil code). http://cisgw3.law.pace.edu/cases/960531s1.html 13 nordic journal of commercial law issue 2012#1 aggrieved party has to give an advanced notice of his intent to avoid or terminate the contract. it will also demonstrate whether or not the other party can evade avoidance / termination of contract through providing adequate assurance of performance. 3.1 avoidance of the contract prior to the date for performance cisg articles 72 & 73(2) authorize the aggrieved party to declare the contract avoided when the suspected breach is fundamental. the aggrieved party may exercise this right to anticipatory avoidance up until the date for performance. in the words of the bundesgerichtshof, germany, ‘[d]amit war die vertragserfüllung durch beide parteien auf die zeit ende november 1991 festgesetzt, so daß die beklagte ihr sich aus art.72 cisg ergebendes aufhebungsrecht auch nur bis zu diesem zeitpunkt geltend machen konnte.’ 52 unlike cisg articles 49(2) & 64(2), cisg article 72 itself does not explicitly provide for a certain period of time during which anticipatory avoidance should be declared. nevertheless, such an avoidance shall happen within a reasonable time. the notice of avoidance must give the other party the time necessary for providing adequate assurance. 53 ‘fundamental’ is more severe than ‘substantial’ 54 which is the standard stated in cisg article 71 for suspension of performance. 55 thus, if it is clear that a fundamental breach of contract is going to occur, the aggrieved party may choose either to avoid the contract or to suspend performance of his obligations. 56 according to the oberster gerichtshof, austria, ‘[d]as aussetzungsrecht gemäß art 71 unk besteht unabhängig neben dem recht zur aufhebung des vertrages in bezug auf teillieferungen 52 decision no. viii zr 18/94, 15 feb. 1995, available at: http://www.unilex.info/case.cfm?id=107. 53 schnyder / straub, in : honsel, supra note 13, at 889. 54 karton, joshua d. h., contract law in international commercial arbitration: the case of suspension of performance, available at: http://works.bepress.com/joshua_karton/5/, 1 46, at 28. 55 according to article 161 of the egyptian civil code, if in contracts obligatory on both parties the mutual obligations shall be due for fulfillment each of the two contracting parties may refrain from performing his obligation if the other contracting party does not perform his obligation. thus, contrary to cisg article 71, the invocation of the suspension right given to each contracting party by article 161 of the egyptian civil code is limited to the time of performance rather than in advance. 56 schnyder / straub, in : honsel, supra note 13, at 923. eiselen, supra note 12, para. d. von ziegler, supra note 6, at 356. http://www.unilex.info/case.cfm?id=107 http://works.bepress.com/joshua_karton/5/ 14 nordic journal of commercial law issue 2012#1 eines sukzessivlieferungsvertrages; die vertragstreue partei kann zwischen der geltendmachung des einen oder des anderen rechtsbehelfs wählen’. 57 under cisg article 77, however, ‘[a] party who relies on a breach of contract must take such measures as are reasonable in the circumstances to mitigate the loss’. thus, if the requirements of anticipatory avoidance of contract are satisfied, the aggrieved party should immediately declare the contract avoided where an avoidance mitigates the loss. 58 under these circumstances, the aggrieved party might not suspend performance of his obligations. 59 with regard to anticipatory breach in installment contracts, cisg article 73(2) (contrary to cisg article 72) does not authorize the aggrieved party to declare the entire contract avoided. rather, it allows the aggrieved party to do so only for the future. likewise, ecc articles 97 & 117 entitle the buyer / importer to terminate the contract for future installments or deliveries only. under both instruments (namely, cisg article 73(3) and ecc article 97), however, such termination could also apply to deliveries already performed if the item sold is inseparable. in all events, the right of anticipatory avoidance requires suspected fundamental breach of contract, whether under cisg articles 72 & 73(2) or ecc articles 97 & 117. whereas this prerequisite is explicitly provided for in the cisg, it is concluded under egyptian law from the augmentation of ecc articles 97 & 117 with the civil code rules, as clarified earlier. 60 accordingly, if the aggrieved party declares the contract avoided without a fundamental breach of contract by the other party being anticipated, the avoidance is ineffective and the aggrieved party 57 decision of no. 2 ob 328/97t, 12 feb. 1998, available at: http://www.unilex.info/case.cfm?id=385. see also: decision of the u.s. district court, southern district of new york, no. 08 civ. 1587 (bsj)(hbp), 29 may 2009, available at: http://www.unilex.info/case.cfm?id=1451, ‘[plaintiff] permissibly withheld delivery of the november and surplus garments to [defendant] because it became apparent that [defendant] would not be able to make any payments for those garments. cisg art. 71(1). … [plaintiff] also permissibly cancelled the contract and permanently withheld delivery of the november garments and the surplus garments because [defendant’s] persistent failure to pay for the garments it ordered demonstrated that it was unable or unwilling to pay the agreed upon price for these garments. cisg art. 72’. 58 secretariat commentary, supra note 2, article 63, para. 4, ‘[w]here it is in fact clear that a fundamental breach of contract will occur, the duty to mitigate the loss enunciated in article 73 [draft counterpart of cisg article 77] may require the party who will rely upon that breach to take measures to reduce his loss, including loss of profit, resulting from the breach, even prior to the contract date of performance’. bridge, supra note 16, at 417. bennett, supra note 12, at 529. contra: schnyder / straub, in : honsel, supra note 13, at 890, ‘art. 77 zwingt die vertragstreue partei nicht dazu, die aufhebungserklӓrung unverzüglish nach eintritt des anfangstermins abzugeben. … da art. 77 die ersatzfӓhigkeit eines eingetretenen schadens beschrӓnkt – und damit allein die folge, nicht aber die grundlage der ausübung eines rechtsbehelfs – kann sich aus dieser vorschrift keine einschrӓnkung der geltendmachung des rechts zur vertragsaufhebung ergeben’. 59 azeredo da silveira, supra note 19, at 19. liu, supra note 11, 4.1. 60 see, above, 2.2. http://www.unilex.info/case.cfm?id=385 http://www.unilex.info/case.cfm?id=1451 15 nordic journal of commercial law issue 2012#1 himself becomes the one committing the fundamental breach. 61 both parties are not released from their obligations under the contract. the other party is not compelled to restitute under cisg article 81. in such a case, the other party may choose to compel the aggrieved party to accept his performance. 62 under the contract, the other party may also ask the aggrieved party to perform his obligations. 63 furthermore, since cisg article 72 – contrary to ecc articles 97 & 117 applies to both parties, the other party may declare the contract avoided prior to the date for performance. 64 the aggrieved party might be liable to the other party for damages, too. 65 cisg articles 75 & 76 makes the measures of damages available to the aggrieved party after the contract has been declared avoided. both articles also permit the avoiding party to claim further damages recoverable under cisg article 74. the duty of the other party to mitigate the loss under cisg article 77 might be significant. under cisg article 80, the aggrieved party “may not rely on a failure of the other party to perform, to the extent such failure was caused by the first party’s ]the aggrieved party’s[ act or omission”. though article 220 of the egyptian civil code does not explicitly recognize the doctrine of anticipatory avoidance, it still regulates situations comparable to anticipatory breach. article 220 covers, inter alia, performance of the obligation that might become impossible or non-beneficial by the debtor's act. in principle, the creditor may ask the debtor to perform his contractual obligation, whether per se or in equivalent monetary compensation as an alternative. under articles 218 & 203/1 of the egyptian civil code, the creditor must first of all serve upon the debtor a warning by official means, e.g. commencement of judicial proceedings. 66 with regard to commercial contracts, however, a registered letter, fax or telex may constitute sufficient warning according to ecc article 58. 61 secretariat commentary, supra note 2, article 63, para. 3, ‘[i]f at the time performance was due no fundamental breach would have occurred in fact, the original expectation may not have been "clear" and the declaration of avoidance itself be void. in such a case, the party who attempted to avoid would be in breach of the contract for his own failure to perform.’ liu, supra note 11, 2.2. 62 azeredo da silveira, supra note 19, at 29. 63 schnyder / straub, in : honsel, supra note 13, at 893. 64 rowley, supra note 12, at 635. liu, supra note 11, 4.1. 65 liu, supra note 11, 4.4. u.s. district court of illinois, decision no. 99 c 5153, 7 dec. 1999, available at: http://www.unilex.info/case.cfm?id=423. 66 amkhan, supra note 7, at 22. http://www.unilex.info/case.cfm?id=423 16 nordic journal of commercial law issue 2012#1 this warning basically aims at placing the defaulting debtor legally in breach. 67 if the debtor’s obligation becomes impossible or non-beneficial by his own act (e.g. if the seller destroys the thing sold), the creditor (the buyer) may claim damages without having to serve a warning upon the debtor. 68 the buyer must, however, file his suit claiming damages when or after the time of performance agreed upon is due, 69 though he might not request termination of contract under such circumstances. contrary to cisg, article 273 of the egyptian civil code does not explicitly recognize the right of anticipatory avoidance in situations of insolvency or bankruptcy. rather, it authorizes the aggrieved party to react prior to the date for performance only. the insolvent debtor loses his right in the maturity period and his obligation will now be due. the creditor may therefore request performance by the debtor of his obligation immediately. 70 he does not need to wait until the time of performance, originally agreed upon, is due. the creditor may also request termination of the contract if the debtor fails to perform his obligation immediately. thus, termination of the contract may happen before the time originally agreed upon. this is clearly close to anticipatory avoidance under cisg. 71 3.2 advanced notice of intent to avoid in order not to abuse his right of anticipatory avoidance, 72 the aggrieved party intending to declare the contract avoided should – under cisg article 72(2) give reasonable notice to the other party. 73 according to cisg article 27, if such ‘notice … is given … by means appropriate in the circumstances, a delay or error in the transmission of the [notice] or its failure to arrive does not deprive that party 67 amkhan, supra note 7, at 22. decision of the court of cassation, egypt, no. 2092 for the judicial year 57, 6 mar. 1989, available (in arabic) in the arab legal network at: http://www.eastlaws.com/ahkam/ahkamhokmsearch.aspx. 68 this right of creditor has been emphasized in many decisions of the court of cassation in egypt. see, for instance: decision no. 243 for the judicial year 37, 1 june 1972; decision no. 497 for the judicial year 57, 28 mar. 1990; decision no. 1556 for the judicial year 56, 26 mar. 1989; decision no. 388 for the judicial year 57, 12 dec. 1989; and decision no. 3238 for the judicial year 71, 26 dec. 2002, all of them are available (in arabic) in the arab legal network at: http://www.eastlaws.com/ahkam/ahkamhokmsearch.aspx. 69 abd el-hamid, supra note 5, note 194. 70 ibid, note 195. 71 ibid, note 199. 72 honnold, supra note 19, at 440. liu, supra note 11, 2.1. 73 see also: helsinki court of appeal, finland, decision no. s 96/1215, 30 june 1998, available at: http://cisgw3.law.pace.edu/cases/980630f5.html. hof van beroep [appellate court] ghent, belgium, decision no. 2003/ar/2603, 11 oct. 2004, available at: http://cisgw3.law.pace.edu/cases/041011b1.html. http://www.eastlaws.com/ahkam/ahkamhokmsearch.aspx http://www.eastlaws.com/ahkam/ahkamhokmsearch.aspx http://cisgw3.law.pace.edu/cases/980630f5.html http://cisgw3.law.pace.edu/cases/041011b1.html 17 nordic journal of commercial law issue 2012#1 of the right to rely on the [notice]’. thus, what counts is that the notice is sent properly, no matter it is received or not. 74 this notice aims at giving the other party the opportunity to provide adequate assurance of his obligation. 75 the aggrieved party has the right to demand adequate assurance. for instance, the mere fact that the seller made defective deliveries to other buyers with similar needs does not authorize the buyer to request assurance. however, if the cause of seller's defective deliveries to other buyers was the result of using a raw material from a particular source, the seller's conduct in preparing to use the raw material from the same source would give the buyer the right to demand adequate assurance. 76 nonetheless, the aggrieved party is not obliged to demand adequate assurance. in its award no. 8786, jan. 1997, the icc court of arbitration – zürich, switzerland, concluded that ‘[b]ecause claimant itself declared that it would not meet the delivery deadline defendant was under no obligation to ask for a bond from claimant in accordance with art. 72 para. 2 cisg (art. 72 para. 3 cisg), as claimant has alleged’. 77 this notice is also advantageous to the aggrieved party intending to declare the contract avoided. it will ‘establish whether it is in fact «clear» that the fundamental breach will be committed, thereby removing the risk of liability arising in consequence of an invalid declaration.’ 78 however, such notice is not required if time does not allow to give a notice (cisg article 72(2)). yet, with modern means of communication, it is difficult to imagine circumstances in which a prior notice could not be given by the aggrieved party. 79 it has to be kept in mind, however, that ‘to comply with the paragraph the notice must be «reasonable» in order to permit the other party time to provide adequate assurance of his performance.’ 80 thus, if the agreed upon date of performance is so near that the other party will not be able to provide adequate assurance, there is no need to notify the other party 81 . in such a case, the notice is unreasonable. similarly, the advanced notice is not required ‘if the other party has declared that he will not perform his obligations’ (cisg article 72(3)). as providing adequate assurance becomes unattainable in a 74 liu, supra note 11, 5.1. 75 eiselen, supra note 12, para. k. 76 secretariat commentary, supra note 2, article 62, para. 6. 77 available at: http://www.unilex.info/case.cfm?id=463. 78 bennett, supra note 12, at 530. see also: liu, supra note 11, 5.1. azeredo da silveira, supra note 19, at 29. 79 liu, supra note 11, 5.1. abd el-hamid, supra note 5, note 215. 80 bennett, supra note 12, at 529-530. 81 schlechtriem, supra note 13, at 95. schnyder / straub, in : honsel, supra note 13, at 885. strub, supra note 44, at 500. http://www.unilex.info/case.cfm?id=463 18 nordic journal of commercial law issue 2012#1 timely manner, the need for giving a notice must fall away. 82 in its decision no. 99 c 5153, 7 dec. 1999, 83 the u.s. district court of illinois pointed out that seller declared that he would ‘no longer feel obligated’ to perform and would ‘sell the material elsewhere’; hence, the buyer has the right to avoid the contract. ‘[t]his exception also covers the frequent cases in which a demand for new terms or alleged contract violations by the other side [is] used as a pretext for not performing one's own obligations’. 84 this exception includes the case of the seller who makes delivery dependent on an additional counterperformance not agreed upon. for instance, it includes the situation in which the seller makes delivery of the second installment conditional on payment for all buyer's outstanding debts. according to the award of the schiedsgericht hamburger freundschaftliche arbitrage, germany, 29 dec. 1998, ‘[u]m eine solche unberechtigte erfüllungsverweigerung handelt es sich auch dann, wenn die verkäuferin nach vereinbarung einer vorkasselieferung ihre lieferung von der bezahlung anderweitiger forderungen abhängig macht wie hier. …. 85 likewise, in its decision no. 99 c 5153, 7 dec. 1999, the u.s. district court of illinois concluded that the seller's threat not to perform his contractual obligations if the letter of credit was not amended amounted to an anticipatory fundamental breach of contract under cisg article 72. 86 in such cases, if the aggrieved party ‘does not respond to repudiation by declaring the contract avoided, he may be obliged to accept performance if the party who repudiated the contract changes his mind.’ 87 on the other hand, the aggrieved party may declare the contract avoided without giving of prior notice, ‘and, hence, without the obligation to resume performance if and when the promisor provides adequate assurances’. 88 cisg article 73 does not require the aggrieved party to give prior notice of anticipatory avoidance to the other party. as this other party has already committed an actual breach, he does not deserve an opportunity to provide adequate assurance of his obligation. in its decision no. s 96/1215, 30 june 1998, the helsinki court of appeal, finland, concluded that ‘[t]hrough non-conforming delivery, the [seller] has given the [buyer] grounds to assume that also the forthcoming deliveries in installments would constitute a fundamental breach of contract. the [buyer] was clearly entitled to declare the 82 eiselen, supra note 12, para. l. 83 available at: http://www.unilex.info/case.cfm?id=423. 84 schlechtriem, supra note 13, at 95. 85 available at: http://www.unilex.info/case.cfm?id=394. 86 available at: http://www.unilex.info/case.cfm?id=423. 87 azeredo da silveira, supra note 19, at 27. see also: strub, supra note 44, at 497. abd el-hamid, supra note 5, note 207. 88 rowley, supra note 12, at 634. http://www.unilex.info/case.cfm?id=423 http://www.unilex.info/case.cfm?id=394 http://www.unilex.info/case.cfm?id=423 19 nordic journal of commercial law issue 2012#1 contract avoided as defined in cisg article 73. giving of prior notice of avoidance is not required in article 73’. 89 nevertheless, the aggrieved party should use this right of avoidance ‘within a reasonable time’ 90 as from ‘the failure to perform’. 91 it makes no difference here whether anticipatory avoidance is based on cisg article 72 or 73(2). 92 in its decision of 3 nov. 1997, the audiencia provincial de barcelona, spain, concluded that the 48-hour period within which the buyer avoided following delivery of the last late installment received was deemed to be a ‘reasonable time’ to declare the contract avoided in accordance with cisg articles 49 & 73. 93 like cisg articles 49, 64 & 26, the declaration of anticipatory avoidance must be communicated by the aggrieved party to the other party. this requirement of cisg article 26 also applies to anticipatory avoidance due to the refusal to provide adequate assurance. 94 ecc articles 97 & 117 do not themselves require the aggrieved party to give an advanced notice of intent to request termination of contract. 95 nevertheless, the buyer / importer may not request termination of contract unless he serves a warning upon the debtor according to article 218 of the egyptian civil code. this warning aims at placing the defaulting debtor legally in breach. obviously, under cisg, giving of advanced notice by the party intending to avoid aims at giving the other party the opportunity to provide adequate assurance of his obligation. under egyptian law, by contrast, serving of warning aims at establishing the debtor's fault in performing his contractual obligation. this first step will enable the creditor to ask for contract termination. besides, the egyptian civil code regulates the declaration by the debtor that he will not perform his obligationa situation comparable to anticipatory breach under cisg. under article 220 of the egyptian civil code which is applicable to both commercial and non-commercial contracts, 89 available at: http://cisgw3.law.pace.edu/cases/980630f5.html. 90 article 73/2 cisg. 91 secretariat commentary, supra note 2, article 64, para. 5. bennett, supra note 12, at 534 contra: azeredo da silveira, supra note 19, at 44, ‘the reasonable period of time starts running when the creditor of the obligation has acquired ”good grounds” indicating that a fundamental breach will be committed’. 92 bridge, supra note 16, at 420. 93 available at: http://www.unilex.info/case.cfm?id=313. 94 icc court of arbitration, award no. 8574, sept. 1996, available at: http://www.unilex.info/case.cfm?id=521. 95 contra: sami, supra note 4, at 608. http://cisgw3.law.pace.edu/cases/980630f5.html http://www.unilex.info/case.cfm?id=313 http://www.unilex.info/case.cfm?id=521 20 nordic journal of commercial law issue 2012#1 declaration by the debtor in writing that he does not intend to perform his obligation exempts the creditor from serving a warning upon the debtor. 96 according to the egyptian civil code rules, the creditor may not in principle claim damages unless he serves a warning upon the debtor. if the debtor declares in writing that he will not perform his contractual obligation, the creditor may logically claim damages without serving a warning upon the debtor. clearly, under cisg, repudiation of contract by the debtor can be in any form. by contrast, this shall be in writing under egyptian law. it is interesting to notice, however, that while cisg article 72 entitles the aggrieved party the right to avoid the contract prior to the date for performance, article 220 of the egyptian civil code only discharges the creditor from his duty to serve a warning upon the debtor. the egyptian civil code does not recognize the right of anticipatory avoidance in such a situation. it does not even authorize the aggrieved party to react prior to the date for performance. rather, the aggrieved party shall file his suit (to claim damages) when or after the time for performance agreed upon is due. 97 3.3 provision of adequate assurance the purpose of the advanced notice of intent to avoid required under cisg article 72(2) is to allow the other party an opportunity to provide adequate assurance of performance. in its award no. 8574 of sept. 1996, the icc court of arbitration stated that ‘[w]ith respect to anticipatory breach, cisg invests the potentially prejudiced party with a has right of suspending (article 71) or terminating avoiding in the parlance of cisg (article 72) the contract. however, in order for the party to suspend or terminate his performance, he must give immediate or reasonable, respectively, notice of the suspension or termination. … these requisites … [are] obviously motivated by a concern that the other party is made clear of the position of its counter party, placing him in a position to provide assurance that he will in fact perform and thereby defeating the assumption of anticipatory breach and the concomitant threat to the orderly fulfillment of the contract.’ 98 therefore, giving this prior notice assures that cisg considers (anticipatory) avoidance of contract a remedy of last resort. 99 96 this right of the creditor has been emphasized by many decisions of the court of cassation in egypt. see, for instance: decision no. 222 for the judicial year 33, 14 feb.1967; decision no. 3238 for the judicial year 71, 26 dec. 2002, both of them are available (in arabic) in the arab legal network at: http://www.eastlaws.com/ahkam/ahkamhokmsearch.aspx. 97 abd el-hamid, supra note 5, note 194. 98 available at: http://www.unilex.info/case.cfm?id=521. 99 azeredo da silveira, supra note 19, at 24. http://www.eastlaws.com/ahkam/ahkamhokmsearch.aspx http://www.unilex.info/case.cfm?id=521 21 nordic journal of commercial law issue 2012#1 cisg itself does not prescribe the form the assurance must take. instead, the adequate assurance varies depending on the circumstances of each case, 100 particularly the nature of the event that creates the uncertainty as to the debtor’s ability and willingness to perform his obligations. 101 ‘for such an assurance to be "adequate", it must be such as will give reasonable security to the first party either that the other party will perform in fact, or that the first party will be compensated for all his losses from going forward with his own performance.’ 102 issuance of a letter of credit or a guarantee by a reputable bank would normally constitute an adequate assurance. 103 in all events, adequate assurance must be provided by the other party prior to the date of his performance. still, ‘the assurance may promise performance after the contractual performance date but not so late as to amount to a fundamental breach’. 104 likewise, ‘an assurance of imperfect performance should preclude avoidance under art. 72 as long as the performance that is assured would not constitute a fundamental breach’. 105 if the failure to provide adequate assurance of performance suggests that a fundamental breach of contract is going to occur, 106 the aggrieved party may declare the contract avoided. 107 according to the oberlandesgericht düsseldorf, the seller was entitled to declare the contract avoided under cisg article 72 due to the buyer's failure to provide security for performance of his obligation to pay the price. 108 on the other hand, if the other party provides adequate assurance of performance, the aggrieved party shall refrain from declaring the contract avoided. he shall also continue performing his obligations. 109 100 liu, supra note 11, 5.1. abd el-hamid, supra note 5, note 219. 101 koch, supra note 16, at 305-306. liu, supra note 11, 5.2. 102 secretariat commentary, supra note 2, article 62, para. 13. see also: koch, supra note 16, at 306. liu, supra note 11, 5.2. von ziegler, supra note 6, at 370. seliazniova, supra note 11, at 131. 103 koch, supra note 16, at 306. seliazniova, supra note 11, at 131. 104 bridge, supra note 16, at 418. see also: abd el-hamid, supra note 5, note 220. 105 liu, supra note 11, 5.2. see also: abd el-hamid, supra note 5, note 220. seliazniova, supra note 11, at 132. 106 secretariat commentary, supra note 2, article 63, para. 2, “[t]he failure by a party to give adequate assurances that he will perform when properly requested to do so under article 62(3) [draft counterpart of cisg article 71(3)] may help it "clear" that he will commit a fundamental breach”. bennett, supra note 12, at 528. liu, supra note 11, 4.4. koch, supra note 16, at 305. 107 abd el-hamid, supra note 5, note 218. von ziegler, supra note 6, at 370. koch, supra note 16, at 303. seliazniova, supra note 11, at 133. contra: rowley, supra note 12, at 638, “[t]he cisg … does not spell out the promisee's options if the promisor refuses to provide adequate assurance”. 108 decision no. 17 u 146/93, 24 jan. 1994, available at: http://www.unilex.info/case.cfm?id=84. for a similar conclusion, see also: landgericht berlin, decision no. 99 o 123/92, 30 sept. 1992, available at: http://www.unilex.info/case.cfm?id=79. 109 bennett, supra note 12, at 529. liu, supra note 11, 5.2. abd el-hamid, supra note 5, note 219. http://www.unilex.info/case.cfm?id=84 http://www.unilex.info/case.cfm?id=79 22 nordic journal of commercial law issue 2012#1 by contrast, cisg article 73(2) and ecc articles 97 & 117 do not stipulate for the possibility of providing adequate assurance of performance. 110 the feared fundamental breach is, in this case, preceded by an actual failure to perform an installment. thus, the aggrieved party might not rely anymore on the commitment of the defaulting party. rather, the aggrieved party may declare the contract avoided with respect to future installments even if the defaulting party provides adequate assurance of performance. 111 4 conclusion evidently, cisg covers anticipatory avoidance of both single delivery and installment contracts. by comparison, ecc regulates anticipatory termination of installment contracts only, particularly with regard to the supply contract. both cisg and ecc require the anticipated breach be a fundamental one. whereas cisg explicitly provides for this prerequisite (articles 72 & 73(2)), it is concluded under egyptian law from the reading of ecc articles 97 & 117 as augmented with civil code rules. besides, both cisg (article 73(2)) and ecc (articles 97 & 117) require that non-performance by a party of an installment makes the other party suspicious about the performance of future installments, i.e. the fear that a fundamental breach of contract will be committed. by contrast, with regard to single delivery contracts, cisg (article 72) does not stipulate that the anticipated fundamental breach be clear as a consequence of any particular conduct or circumstances; it rather suffices whatever the cause of clarity of such a breach. both cisg (article 73(2)) and ecc also require that the right of anticipatory avoidance of installment contract be preceded by an actual non-performance. accordingly, both instruments do not require the aggrieved party intending to declare the contract avoided to give an advanced notice to the other party. under both instruments, the aggrieved party may also declare the contract avoided with respect to future installments even if the other party provides adequate assurance of performance. again, under both instruments, such avoidance would apply to deliveries already made if the item sold is inseparable. 110 contra, without any legal justification: sami, supra note 4, at 608. 111 azeredo da silveira, supra note 19, at 46. koch, supra note 16, at 311. contra, bridge, supra note 16, at 421, according to him the rule of adequate assurance in cisg article 72 might be considered a general principle upon which the convention is based in the sense of cisg article 7/2; this principle can be used to fill the gap in cisg article 73/2. 1 allocation of the right to tax income from digital intermediary platforms – challenges and possibilities for taxation in the jurisdiction of the user louise fjord kjærsgaard* & peter koerver schmidt** * louise fjord kjærsgaard is phd scholar at copenhagen business school and associate at corit advisory: lfk.law@cbs.dk. ** peter koerver schmidt, phd, is associate professor at copenhagen business school and academic advisor at corit advisory: pks.law@cbs.dk. njcl 2018/1 147 1. international tax law and the digital challenge ...... 148 2. digital intermediary platforms and current tax principles .......................................................................................... 151 2.1. lack of taxation in the jurisdiction of the user . 151 2.2. the interaction between platform enterprises and users ......................................................................................... 153 2.2.1. transactions relevant for tax purposes ...... 153 2.2.2. classification for tax treaty purposes.......... 161 3. policy challlenges and options ............................................ 164 3.1. unilateral and oecd reactions ................................. 164 3.2. the eu proposal on significant digital presence ..... .......................................................................................... 166 4. conclusions ..................................................................................... 170 allocation of the right to tax income 148 abstract the authors analyse the current (lack of) possibilities for userjurisdictions to tax the value generated by the increased use of digital intermediary platforms. focus is on analysing the possibilities for userjurisdictions to tax the remuneration received by a foreign enterprise owning a digital intermediary platform and on disucussing whether the users’ provision of personal data in exchange for access to the platform could be considered a barter transaction for tax purposes in the userjurisdiction. among other things, it is concluded that user-jurisdictions, pursuant to current international tax treaties, will normally be precluded from taxing the income of foreign platform enterprises, as the platform enterprises are often able to deliver their digital services remotely. against this background, a number of tax policy challenges and options of relevance for taxing platform enterprises are discussed, in particular the proposed directive on significant digital presence recently put forward by the european commisssion. it is concluded that the proposal may prove to be an adequate step towards taxation in the userjurisdictions, even though the proposal needs further work in order to become sufficiently clear and targeted and the scope may be limited. 1. international tax law and the digital challenge in recent years, it has become clear that the increasing digitalisation of the economy poses challenges with respect to international taxation, as current international tax law and its underlying principles have not kept pace with the changes in global business practices, including practices based on the intensified use of information and communications technology.1 accordingly, as the current international tax framework was originally designed to deal with “brick and mortar” businesses, it may be argued that the framework is not sufficiently equipped to address modern, digitalised business practices, where physical presence in the market jurisdictions is no longer necessary.2 policymakers have discussed these challenges at least since the late 1990s,3 but the attention has dramatically increased in later years. in particular, the oecd/g20 project aimed at mitigating base erosion and 1 marcel olbert and christoph spengel, ‘international taxation in the digital economy: challenge accepted?’ (2017) 9 world tax journal 1. 2 georg kofler et al., ‘taxation of the digital economy: quick fixes or long-term solution?’ (2017) 57 european taxation 12. see also the same authors, ‘taxation of the digital economy; a pragmatic approach to short term measures’, (2018) 58 european taxation 4. 3 see e.g. oecd, taxation and electronic commerce – implementing the ottawa taxation framework conditions (oecd publishing 2001). for more on the earlier policy initiatives see e.g. peter koerver schmidt, ‘den digitale økonomi som skatteretlig udfordring’ in børge dahl et al. (eds), liber amicorum peter møgelvang hansen (extuto 2016). njcl 2018/1 149 profit shifting (beps) has attracted interest.4 the project focuses on aggressive tax planning carried out by multinational enterprises,5 and one of the deliveries consisted of a report specifically dealing with the tax challenges of the digital economy.6 among other things, the report highlighted some key features of the digital economy that was seen as particularly relevant from a tax law perspective. these features for example included increased mobility, reliance on data, network effects and the spread of multisided business models. as such, the features of the digital economy were not considered to generate unique beps risks, but it was acknowledged that these features could exacerbate the risks.7 the report also addressed a number of broader tax challenges raised by the digital economy, and a number of policy options were considered, however, without reaching an agreement on whether any of the options should be adopted.8 after the release of the report, the oecd/g20 has continued its work, and in march 2018 a new interim report was made publicly available.9 the new report further elaborates on the tax issues raised by digitalisation and concludes that, overall, there is support for undertaking a coherent and concurrent review of two key aspects of the existing tax framework, namely nexus rules and profit allocation rules.10 4 oecd, adressing base erosion and profit shifting (oecd publishing 2013) and oecd, action plan on base erosion and profit shifting (oecd publishing 2013). 5 for more on the background of the beps project see yariv brauner, ‘beps: an interim evaluation’ (2014) 6 world tax journal 1. 6 oecd/g20, adressing the tax challenges og the digital economy – action 1 final report (oecd publishing 2015). 7 ibid p. 11-12. 8 ibid p. 99 and p. 136-139. 9 oecd/g20, tax challenges arising from digitalisation – interim report (oecd publishing 2018). also academia has showed a massive interest in the tax challenges raised by the digital economy. hence, several contributions in the academic literature have recently addressed the broader issues. besides the contributions already mentioned see for example ina kerschner and maryte somare (eds.), taxation in a global digital economy (linde verlag 2017), yariv brauner and pasquale pistone, ‘adapting current international taxation to the new business models: two proposals for the european union’ (2017) 71 bulletin for international taxation 12, joachim englisch, ‘beps action 1: digital economy – eu law implications’ [2015] british tax review 280, maarten de wilde, ‘tax jurisdiction in a digitalizing economy; why online profits are so hard to pin down’ (2015) 43 intertax 12, miranda stewart, ‘abuse and economic substance in a digital beps world’ (2015) 69 bulletin for international taxation 6/7, aleksandra bal and carlos gutiérrez, ‘taxation of the digital economy’ in madalina cotrut (ed), international tax structures in the beps era: an analysis of anti-abuse measures (ibfd 2015), walter hellerstein ‘jurisdiction to tax in the digital economy: permanent and other establishments’ (2014) 68 bulletin for international taxation 6/7, and arthur cockfield et al., taxing global digital commerce (wolters kluwer 2013). 10 oecd/g20 (2018) [footnote 9], p. 212-213. it is contemplated that a final report should be published in 2020. allocation of the right to tax income 150 in light of the topic of this article, it is particularly interesting that the interim report further elaborates on the significance of userparticipation in the value creation process of certain highly digitalised business models, including business models relying on digital intermediary platforms. thus, even though consensus was not reached, the interim report reflects that a number of countries are of the opinion that the current international tax regime fails to recognise the contribution and importance of user participation in the value creation process of these highly digitalised businesses, as the existing nexus rules and profit allocation rules do not result in an appropriate alignment between the location in which profits are taxed and the location in which value is created.11 against this background, the authors of this article analyse the current (lack of) possibilities for user-jurisdictions to tax the value generated by the increased use of digital intermediary platforms.12 in this regard, it should be acknowleged that applicaple domestic tax laws often will provide sufficient legal basis for taxing the payment received by a user providing a service to another user through a digital intermediary platform, even though it might be difficult to enforce the tax in practise. for example legal basis often exists for taxing the proceeds received by an uber-driver or the proceeds received by the letter of an apartment through airbnb but enforcement may be difficult. however, these issues will not be addressed in this article.13 instead, focus will be on analysing the possibilities for user-jurisdictions to tax the remuneration received by the enterprises owning the digital intermediary platform (hereinafter: the platform enterprises), and on disucussing whether the users’ provision of personal data in exchange for access to the platform could be considered a barter transaction for tax purposes in the user-jurisdiction. 11 ibid p. 171-172. it is not the purpose of this article to discuss whether the view of these countries is actually appropriate or not. for a critical discussion see for example eric c.c.m. kemmeren, ‘should the taxation of the digital economy really be different’ (2018) 27 ec tax review 2 and werner haslehner, taxing where value is created in a post beps (digitalized) world, kluwer international tax blog <http://kluwertaxblog.com/2018/05/30/taxing-value-created-post-beps-digitalizedworld/> (24 august 2018). 12 only issues concerning direct taxation will be dealt with. 13 instead, see for example giorgio beretta, ‘taxation of individuals in the sharing economy’ (2017) 45 intertax 1, and same author ‘the taxation of the sharing economy’ (2016) 70 bulletin for international taxation 11, nangel kwong, ‘the taxation of sharing economy activities’ in ina kerschner and maryte somare (eds.), taxation in a global digital economy (linde verlag 2017), p. 61 et seq., shu-yi oei and diane m. ring, ‘can sharing be taxed?’ (2016) 93 washington university law review 4, roberta a. kaplan and michael l. nadler, ‘airbnb: a case study in occupancy regulation and taxation’, (2017) 82 university of chicago law review online 1, and jane bolander, ‘deleøkonomi og skat’ in børge dahl et al. (eds.), liber amicorum peter møgelvang hansen (extuto 2016), p. 29 et seq. njcl 2018/1 151 the analysis is divided in two main parts. the first main part contains an analysis and discussion of the possibilities for taxing the value creation in the user-jurisdiction under current tax regimes (section 2). the second main part discusses a number of tax policy challenges and options of relevance for taxing platform enterprises, in particular the proposed directive on significant digital presence recently put forward, as part of the european commisssion’s digital tax package (section 3).14 finally, the article contains a section which recaptures the main conclusions (section 4). 2. digital intermediary platforms and current tax principles 2.1. lack of taxation in the jurisdiction of the user in short, increased digitalisation – including the widespread use of the internet and mobile devices – has expanded the possibility of sharing goods and services beyond individuals’ social networks and immediate surroundings.15 in this context, digital intermediary platforms such as uber and airbnb have been able to turn the collaborative model into profitable, global businesses.16 thus, the fact that digital intermediary platforms have significantly widened the possibilities for sharing property and services, including across national borders, has created new opportunities for both consumers and entrepreneurs and has raised issues with regard to the application of existing legal frameworks, including the tax framework.17 from a tax perspective, sharing economy transactions may be divided into different kinds of transactions, one of which is cash transactions, where users of the network share personal goods or provide services on a peer-to-peer basis via digital intermediary platforms for a fee.18 in short, the business model of such digital intermediary 14 proposal for a council directive laying down rules relating to the corporate taxation of a significant digital presence, com(2018) 147 final, and proposal for a council directive on the common system of a digital services tax on revenues resulting from the provision of certain digital services, com(2018) 148 final. 15 vassilis hatzopoulos and sofia roma, ‘caring for sharing? the collaborative economy under eu law’ (2017) 54 common market law review, p. 81-128. 16 for more on the business models of uber and airbnbp including related private law issues see marie jull sørensen, ‘private law perspectives on platform services: uber – a business model in search of a new contractual legal frame?’ (2016) 5 journal of european consumer and market law 1, and vanessa mak, ‘private law perspectives on platform services: airbnb – home rentals between ayor and nimby (2016) 5 journal of european consumer and market law 1. 17 communication from the commission on a european agenda for the collaborative economy, com(2016) 356 final. and giorgio beretta, ‘the european agenda for the collaborative economy and taxation’ (2016) 56 european taxation 9. 18 for more on the different transaction types see beretta (2017) [footnote 13]. allocation of the right to tax income 152 platforms relies on a three-party relationship between the platform, the providing users and the buying users. accordingly, the platform creates value by matching end-users for example drivers and passengers so that they can complete a ride on a pay-as-you-go basis. consequently, such business models rely on a mediation technology which creates value by linking users of the network, as well as organise and facilitate the exchange between users, and ensure transaction quality using a review system whereby users have the option of rating the quality of the interaction. the activities performed by the platform enterprise thus generally include: 1) network promotion and contract management activities, for example related to inviting potential users to join the network, 2) service provisioning activities, for example related to matching the users, facilitating the supply of goods or services and the payment, and 3) network infrastructure operation activities related to maintaining and running a physical and information infrastructure.19 in exchange for providing the mediation technology (typically in the form of an app-based market place), the platform enterprise takes a fee. for example, uber takes a portion of the gross fares generated by partners (usually up to 20%, depending on the market), and airbnb charges the hosts a fee of 3% on every booking plus an additional service fee paid by the guests up to 20%.20 it is publicly known that some of the larger platform enterprises enjoy low effective taxation of their worldwide income, due to their taxefficient and often rather complex corporate structures that include entities in low tax jurisdictions.21 one element in this tax planning is to avoid establishing a taxable presence (nexus) in the jurisdictions where the users are located (hereinafter: the user-jurisdiction).22 for example, in the case of uber, a subsidiary in the netherlands processes the worldwide payments for all rides.23 moreover, even though uber has established subsidiaries in a number of countries where it operates, these subsidiaries do normally not attract a lot of taxable income, as they only 19 oecd/g20 (2018) [footnote 9], p. 38-40 and p. 66-73. please see the report itself for a more elaborate description of such business models. 20 <https://www.airbnb.dk/help/article/1857/what-are-airbnb-service-fees> (24 august 2018), and oei and ring (2017) [footnote 13], p. 1002. 21 carrie brandon elliot, ‘taxation of the sharing economy: recurring issues’ (2018) 72 bulletin for international taxation 4a. 22 ibid. for more on the lack of a taxable nexus in the user-jurisdiction in the form of a permanent establishment see section 2.2.2 below. 23 even though the fees received are taxable, the effective taxation is low, among other things because the subsidiary in the netherlands can deduct intra-group royalty payments. njcl 2018/1 153 provide low-risk support services that generally are remunerated on a cost plus-basis.24 the fact that highly digitalised enterprises can provide their services without obtaining a taxable nexus in the user-jurisdictions has caused intense debate. thus, it has been argued that even though data may be collected from the users without monetary consideration, these data constitute a key resource of highly digitalised businesses.25 accordingly, it may be argued that the users become a kind of “virtual workers” for these digital enterprises and that it is troubling if these enterprises do not contribute with tax revenues to the jurisdictions where their users live and “work” for them.26 as the collaborative business models are characterised by high user participation intensity, this argument may also be made with respect to the contributions provided by users of digital intermediary platforms.27 against this background, section 2.2 takes a closer look at the interaction between the platform enterprise and its users. in this regard, it is discussed whether it is correct to consider the interaction between the platform enterprises and the users as one pure cash transaction, which is the payment of a service fee that can generally only be taxed in the user-jurisdiction if a taxable nexus is established there, or whether the interaction in addition contains some kind of barter transaction (section 2.2.1). subsequently, issues concerning classification and allocation of the right to tax are analysed (section 2.2.2). 2.2. the interaction between platform enterprises and users 2.2.1. transactions relevant for tax purposes before it is relevant to classify payments and allocate the taxing right for tax treaty purposes, it must be analysed whether and how the interaction between the platform enterprise and the users should be recognised for domestic tax purposes. nevertheless, as it is outside the scope of this article to undertake a comprehensive comparative study of various domestic tax regimes, the analysis below is limited to outlining 24 elliot (2018) [footnote 21], who states that airbnb uses a setup similar to uber’s. see also brian o’keefe ‘how uber plays the tax shell game’ (2015) fortune magazine (22 october). 25 hm treasury, corporate tax and the digital economy: position paper update (2018), p. 7 et seq. 26 nicolas colin and pierre collin, task force on taxation of the digital economy (2013), p. 2. see also raffaele petruzzi and svitlana buriak ‘addressing the tax challenges of the digitalization of the economy – a possible answer in the proper application of the transfer pricing rules?’ 72 bulletin for international taxation 4a, who argue that users who generate valuable data serve as “unconscious” contributers and/or employees. 27 oecd/g20 (2018) [footnote 9], p. 56-59. users must often disclose their preferences to access the services. moreover, the users of digital platforms may be seen to bear the burden of verifying the product quality, e.g. by giving a rating or writing a review. allocation of the right to tax income 154 the basic features of the interaction, based on the fact that no income tax systems appear to focus exclusively on cash compensation.28 in other words, in most income tax systems at least some non-cash barter transactions are considered to posess a taxable component.29 as an example, the main principles in danish tax law could briefly be considered. according to section 4 of the danish state tax act, the main rule is that all income is taxable whether in money or in kind, unless the income consists of a gain from the disposal of private property, pursuant to section 5 of the danish state tax act. in the case of provision of services, the provider will be taxable, if a payment is received in return for the service. in this respect, not only cash payments must be included but also payments in kind that objectively have economic value. this also applies if one service is traded in exchange for another service. for instance, if person a paints person b’s living room in exchange for person b repairing person a’s car, both services should in principle be valued and taxed. however, services may be so insignificant and the connection between them so weak that no taxation takes place.30 yet, the borderline between a non-taxable interaction and a taxable barter transaction is not clear.31 even though national tax regimes are diverse, the following analysis and discussion of interactions between the platform enterprise and its users will be based on the working hypothesis that the general features of many tax systems are somewhat similar to the danish tax regime when considering barter transactions for tax purposes.32 in addition, it is assumed that the underlying rationale for treating (some) barter transactions as taxable events is often founded in (explicit 28 beretta (2016) [footnote 13], who argues that this is the case no matter whether the domestic tax regime in question is a so-called global system or a scheduler system. 29 kwong (2017) [footnote 13], p. 66. 30 bolander (2016) [footnote 13], pp. 30-31. see also the report from the danish ministry of taxation;, rapport om vennetjenester/sort arbejde, eget arbejde, forbrug af egne varer, produkter og ydelser samt personalegoder (2002), in which it was stated that so-called taxexempt acts of friendship could be defined as customary non-commercial services between family, friends and the like caused by ordinairy helpfulness, generosity or social involvement. 31 in 2012, the danish legislator tried to elucidate when favours between friends and family are not taxable by introducing section 7 å of the danish tax assessment act. for more on the traditional perception of the income concept in danish tax law see jan pedersen et al., skatteretten 1 (karnov group 2015), p. 208 et seq., aage michelsen et al., lærebog om indkomstskat (juristog økonomforbundets folag 2017), p. 147 et seq., and thøger nielsen, indkomst beskatning i (juristforbundets forlag 1965), p. 172. 32 it is recognised that for example jurisdictions relying on old uk doctrines may be different as the judicial concept of income under those doctrines excludes benefits in kind that cannot be converted to cash. see lee burns and richard krever ‘individual income tax’ in victor thuronyi (ed), tax law design and drafting (kluwer law 2000), pp. 507-508. njcl 2018/1 155 or implicit) neutrality considerations,33 broadly understood as the aim that taxes should not affect economic behaviour.34accordingly, based on these assumptions, the economic substance of the interaction between the users and the platform enterprise will now be analysed and compared to how interactions similar in economic substance are normally treated for domestic tax purposes. it seems straightforward that the cash payment made by the user to the platform enterprise for the provision of various digital services shall be recognised for tax purposes. accordingly, the cash payment will normally constitute taxable income in the hands of the recipient platform enterprise in the jurisdiction where the platform enterprise is resident according to domestic tax rules (unless the recipient enterprise is located in a tax haven). moreover, the provisions on limited tax liability in the tax code of the user-jurisdiction may prescripe that tax, for example a withholding tax, shall be levied on the payment in the user jurisdiction (however, as explained in section 2.2.2. below the applicaple tax treaty will typically preclude taxation in the user-jurisdiction of payments from a user to a foreign platform enterprise).35 in contrast to cash payments, there seems to be no consensus between countries on whether data collection from users as well as their participation and provision of content (for example trust generating reviews of other users of the platforms, user profile data, user locations in real time, credit card data and bank information) in return for access to the digital intermediary platform should be recognised as barter transactions between the users and the platform enterprise.36 in the tax literature, barter transactions have recently experienced renewed topicality in relation to the raise of virtual currencies and cryptocurrencies in respect to whether these new currencies constitute means of payment or means of exchange.37 however, up until now, no 33 ibid, pp. 507-508. see also robert i. keller ‘taxation of barter transaction’ (1982) 67 minnesota law review 411, where the author argues that ’[a]ll taxpayers who engage in barter transactions are in the same economic position they would have been had they received cash for their goods or services in an amount equal to the value of the goods or services actually received and used that cash to purchase goods or services from the other party to the exchange.’. 34 the broad definition of neutrality used in simon james and christopher nobes the economics of taxation (prentice hall 1998), p. 306. 35 according to chang hee lee and ji-hyun yoon, ‘general report’ in international fiscal association (eds), cahiers de droit fiscal international volume 103 b: withhiolding tax in the era of beps, civs and the digital economy (sdu 2018), p. 236, every country covered in the branch reportsrely on a withholding system to collect a number of taxes concerning non-residents. 36 oecd/g20 (2018) [footnote. 9], p. 38-40. 37 see for example aleksandra bal ’stateless virtual money in the tax system’ (2013) 53 european taxation 7 and the same author ‘blockchain, initial coin offerings and other developments in the virtual currency market’ (2018) 20 derivatives & financial allocation of the right to tax income 156 relevant analysis of the distinction between barter transactions and other interactions, which neither constitute a money transaction nor a taxable barter transaction, seems to have been conducted for direct tax purposes.38 no generally accepted definition of a barter transaction exists but one could be: ‘transactions whereby products or services are directly exchanged between two suppliers without using money as a medium of exchange’.39 four cumulative conditions in order for a transaction to be regarded a barter transaction can be derived from this definition. first, the articles exchanged should be regarded as products or services. this should most likely be broadly interpreted as to include almost anything that may be controlled and offered for attention, acquisition, use or consumption etc. in this context, it seems difficult to argue that the supply of data by users of a platform, as well as the access to the platform provided by the platform enterprise, cannot be considered within the scope.40 second, the products or services should be exchanged, which in respect of barter transactions may be defined as: ‘the barter of the comparatively superfluous for the comparatively necessary’.41 this only seems to require that some right, for example to own or use a product, is given or some service is provided. that will likely include a platform enterprise’s right to collect user data, as well as the right for the users to access the platform.42 in respect of the term comparatively, this is a subjective measure and, consequently, it is challenging to determine whether the data and access to the platform are comparatively superfluous and necessary to the users and the platform enterprise. however, as the users instruments 2 and louise fjord kjærsgaard and katja dyppel weber ‘skattemæssig behandling af virtuelle valutaer’ [2018] tidskrift for skatter og afgifter, 2. 38 piergiorgio valente ‘digital revolution – tax revolution?’ (2018) 72 bulletin for international taxation 4a, lists the following question as one of the questions that are still pending: ‘should consumers/users be taxed in respect of the deemed benefits derived from the transition of data owned?’ however, the author does not provide an answer. in the literature on vat sebastian pfeiffer ’vat on free electronic services?’ (2016) 27 international vat monitor 3, has discussed whether electronic services are subject to vat where the consideration consists of personal data provided by the users. 39 julie rogers-glabush, ibfd international tax glossary (ibfd 2009), p. 35. 40 it has been debated how to classify personal user data collected by enterprises. for example, colin and collin (2013) [footnote 26] discuss how to qualify data collected from users given that such data are not per se an intangible asset owned by the collecting enterprise. 41 w. stanley jevons ’money and the mechanism of exchange’ [1896] the international scientific series, p. 8 42 for example in respect of uber, both the driver and the passenger must sign an agreement which entails that a wide spectrum of driver and passenger data may be collected and used by uber. njcl 2018/1 157 and the platform enterprise are generally unrelated, it seems reasonable to assume that this is the case.43 third, it has to be an exchange between two suppliers. again, this seems to be a broad concept that may include most situations where a person provides products or services that people want or need, especially over a long period of time.44 in direct tax law, it is rarely necessary to discuss whether a given taxpayer should be seen as a “supplier”, as this is normally not decisive for the taxation. however, within other legal disciplines, it is a central question to answer. accordingly, interpretive aid may perhaps be found in other fields such as indirect tax law and private international law. for vat purposes, it has been discussed in the literature whether a highly digitalised business such as a platform enterprise is the only supplier of a service, or whether both the platform enterprise and the users should be considered taxable suppliers. the strongest arguments seem to support that the users of a platform should not be considered suppliers in a vat context. this is based on the fact that users allegedly cannot be viewed as carrying out economic activities (economic exploitation with the purpose of obtaining income) and that the provision of personal data in order to gain access to the platform could constitute a mere form of payment similar to crypto currencies, which is accepted as a mean of payment for vat purposes. however, uncertainty exists, as it could also be argued that the link between the service (access to the platform) and the consideration (provision of user data) is too weak to cause that the consideration could constitute a mere payment.45 as crypto currencies are typically regarded as properties and not a mean of payment for direct tax purposes, it could be argued that the principles from vat cannot be directly relied on in the analysis of whether the interaction between the users and the platform enterprise should be recognised as a barter transaction.46 43 see keller (1982) [footnote 33], where it is stated ‘[…] that in most taxable exchanges the same basis figure would result whether the taxpayer used the value received or the value given up theory of cost, since generally the value of two exchanged in an arms length transaction are either equal in fact, or are presumed to be equal.’. 44 see for example the general definition of supplier in cambridge dictionary <https://dictionary.cambridge.org/>. 45 pfeiffer (2016) [footnote 38]. even though vat law may provide some inspiration, it should be kept in mind that there are fundamental differences between the underlying principles of direct tax law and indirect tax law. see karina kim egholm elgaard, interaktion mellem momsretten og indkomstskatteretten (jurist& økonomforbundets folag 2016), p. 131 et seq. 46 bal (2013) [footnote 37], kjærsgaard and weber (2018) [footnote 37] and administrative practice from the danish tax council, decision of 9 march 2018, skm2018.104.sr, decision of 3 april 2018, skm2018.130.sr, decision of 31 august 2017, skm2017.520.sr, and decision of 1 april 2014, skm2014.226.sr. allocation of the right to tax income 158 in private international law, emphasis is often put on who provides the characteristic performance of the transaction with respect to determining the applicable law in the absence of choice. in this regard, where a party enters into a contract in the course of his trade or profession, it is rebuttably presumed that this is the party that provides the characteristic performance which again means that the other party is considered a buyer and not a supplier.47 nevertheless, if it is not possible to identify a single party that provides the characteristic performance of a transaction, the presumption does not apply.48 accordingly, if relying on these principles from international private law, the interaction between the platform enterprise and the users could only be viewed as a barter transaction if none of the parties can be seen as the party providing the characteristic performance. fourth, money cannot be used as a means of payment in the transaction; hence, barter transactions should be distinguished from sale and purchase of products and services in which money is exchanged. even though a fee is typically paid by the user for acquiring a service through a digital intermediary platform, it should be noted that the recipient of the fee will not necessarily be the same group entity as the entity collecting the user data, and that it may be possible to split the overall interaction into a monetary transaction, as well as a non-monetary transaction.49 moreover, it is typically possible to access the platform without actually acquiring anything, and even in that case, user data is collected and used. correspondingly, in a number of situations, personal data seems to be exchanged for access to the platform. although, no generally accepted definition of money exists for tax purposes, neither of the articles exchanged between the users and the platform enterprise have the general characteristics of money known from economic theory, that is something which can be used as a medium of exchange, a measure of value, a standard value, and storage of value.50 47 article 4 (2) of the convention on the law applicable to contractual obligations (adopted 19 june 1980, entry into force 1991) (hereinafter: the rome convention). see richard plender and michael wilderspin, the european private international law of obligations (sweet & maxwell 2009), p. 169. 48 ibid. 49 as mentioned in section 2.1. above, in the case of uber a subsidiary in the netherlands processes the worldwide payments for all rides, whereas the data seems to be collected and used by the headquarter entity, see oecd/g20 (2018) [footnote 9], p. 67. 50 jevons (1896) [footnote 41], pp. 13-18. in danish administrative practice, the danish tax council has stated that from a danish domestic tax law perspective for an article to be regarded as money it must be: (1) regulated by the global currency market, (2) subject to regulation by a central bank, (3) redeemable, and (4) affiliated with a jurisdiction or currency area. see decision of 25 march 2014, skm2014.226.sr, regarding the qualification of bitcoins, and decision of 22 august 2017, skm2017.520.sr regarding the qualification of bookcoins. njcl 2018/1 159 if the interaction can be viewed as a barter transaction, the interaction could potentially give rise to income taxation on both sides of the transaction, depending on the applicable domestic tax law. the underlying reason is that splitting the interaction in two separate supplies in consideration for money does not change the economic substance of the transaction.51 however, generally, tax systems accept that various kinds of interactions are not relevant for tax purposes. an example could be the social interaction between two colleagues discussing an issue. this discussion may be of mutual benefit if both colleagues thereby gain new insights. nevertheless, typically, such interactions are viewed as social, everyday interactions where the link between the interaction and the creation of economic value are considered too weak to be recognised for tax purposes. accordingly, if the interaction between the users and the platform enterprise can be considered similar to such social, everyday interactions, it normally implies that the interaction is not relevant for tax purposes for any of the parties. altogether, there does not seem to be a clear and general answer to how the interaction between the users and the platform enterprise shall be viewed, among other things because all interactions between users and the various platforms are not completely alike and since the existing tax regulations have not been drafted with such digital transactions in mind.52 however, it seems far-fetched to compare the interactions between the users and the platform enterprise to social, everyday interactions, as at least the platform enterprise has a clear commercial rather than social motive. further, there seems to be a clear link between the collection and use of data and the creation of economic value for the platform enterprise.53 in addition, as most users would probably not allow the collection of user data or would not spend time on writing reviews etc. without getting something in return, it seems reasonable to presume that the users’ access to the platform provides some kind of (economic) value for the users, for which the users might otherwise would have been willing to pay for in cash. consequently, for direct tax purposes, it could be argued that the non-monetary part of the interactions between the platform enterprise and the users appear to have quite strong similarities with a recognisable 51 keller (1982) [footnote 33] 67 minnesota law review 411, where the author argues that ‘[a]ll taxpayers who engage in barter transactions are in the same economic position they would have been had they received cash for their goods or services in an amount equal to the value of the goods or services actually received and used that cash to purchase goods or services from the other party to the exchange.’ 52 apart from viewing the interaction as either a barter transaction or a social, everyday event some intermediary outcomes could also be considered. for example, it could be considered whether the platform should be seen as the only part providing a service, and the users as a “pure” buyer paying in kind, or vice versa. 53 oecd/g20 (2018) [footnote 9], p. 29. allocation of the right to tax income 160 barter transaction. this may, at least in theory, give rise to income taxation on both sides of the transaction, if the applicable domestic tax legislation has similarities with the main principles of the danish regime and an applicable tax treaty allocates the right to tax the user of such income to the user-jurisdiction, for example as ‘business income’ or ‘other income’. nevertheless, even though it may be possible for the userjurisdiction to find legal basis in current tax regulations for taxing resident users of the receipt of a payment in kind (in the form of access to the platform), no jurisdictions are, to our knowledge, currently enforcing such taxation.54 one reason for this could obviously be that taxpayers, tax authorities, and courts do not agree or are not (yet) aware that such legal basis may be found in the applicable domestic tax legislation. however, in practice, it may also play a role that enforcing such taxation would entail severe practical challenges, inter alia, because of difficulties with valuation of the payments in kind.55 further, there seems to be a risk that the costs associated with controlling and collecting such taxes will be significant compared to the tax revenue collected, as the value of each barter transaction is likely to be low, whereas the volume of barter transactions could be massive.56 finally, the taxation of users on the access to digital intermediary platforms would conflict with a number of other principles underpinning most tax systems. for example, it must be expected that individual taxpayers will have a hard time understanding and accepting being taxed, just because they obtain access to a platform.57 as a consequence of the fact that user-jurisdictions in practice are not levying tax on users receiving a payment in kind in the form of access to a platform, the following section on classification for tax treaty purposes will only address issues related to the payment from users to a foreign platform enterprise. in other words, the section below will only 54 it is generally recognised that income tax systems struggle to capture transactions where money is not used as a medium of payment on either side of the transaction see oecd/g20, (2018) [footnote 9]. 55 oecd, exploring the economics of personal data: a survey of methodologies for measuring monetary value (oecd publishing 2013). further, it seems impossible to distinguish how much value is associated with the data of a specific user, as this depends on inter alia the scale and quality as well as the specific business model adopted by the enterprise, see also olbert and spengel (2017) [footnote 1]. less debated, though equally challenging, is the valuation of the access provided to the users. 56 oecd/g20, (2015) [footnote 6], p. 100. 57 carrying out such taxation of a potentially very high number of low value user transactions could in practice conflict with underlying objectives such as simplicity, administrability, fairness and efficiency. for a general and critical discussion of the various objectives see louis kaplow, the theory of taxation and public economics (princeton press 2008), p. 37 et seq. njcl 2018/1 161 consider the allocation of taxing rights with respect to the income received by the platform enterprises (not by the users). 2.2.2. classification for tax treaty purposes the development and wide spread use of the oecd model tax convention on income and on capital (hereinafter: the oecd model) has supported the so-called ‘classification and assignment of sources method’ which means that income is classified under a number of categories and taxing powers are assigned to each state for each category of income.58 however, as described and analysed above, the digitalisation has enabled monetisation in new ways that raise questions regarding both the rationale behind the existing classifications of income and the consistency of the treatment of similar types of transactions.59 in regard to the classification of payments in digital transactions, the technical advisory group concluded in its report from 2001 (hereinafter: the tag report)60 that one of the most important classification issues were the distinction between business income and royalties corresponding to article 7 and 12 of the oecd model, assuming that all payments are received in the course of carrying on a business.61 this distinction is also of importance with respect to the classification of payments from the users to the platform enterprise, as it potentially affects the allocation of the right to tax. the reason is that numerous bilateral tax treaties allow the source state (the userjurisdiction) to withhold a tax on royalty payments, whereas the right to tax business income is exclusively granted to the domicile state unless the income should be allocated to a taxable permanent establishment (hereinafter: pe), located in the source state, pursuant to article 7 of the oecd model (2017).62 in other words, so-called nexus is needed in the user-jurisdiction, in order for the user-jurisdiction to be able to tax the income of a foreign platform enterprise. 58 chang hee lee, ‘impact of e-commerce on allocation of tax revenue between developed and developing countries’ in reuven avi-yonah (ed), international tax law vol. 1 (edward elgar publ. 2016) and michael j. graetz and michael m.o’hear ‘the original intent of u.s. international taxation’ in reuven avi-yonah (ed), international tax law vol. 1 (edward elgar publ. 2016), with reference to david rosenbloom and stanley i. langbein ‘united states tax treaty policy: an overview’ (1981) 19 columbia journal of transnational law 359, who view the choice of classification and assignment as the basic structure for virtually all current bilateral tax treaties. 59 oecd/g20 (2015) [footnote 6], p. 98 et seq. 60 oecd technical advisory group on treaty characterisation of electronic commerce payments, tax treaty characterisation issues arising from e-commerce (1 february 2001 and adopted by the oecd council in july 2002). 61 ibid, p. 4. 62 lee and yoon (2018) [footnote 35], p. 238. see also hanna litwinczuk ‘poland: payments for copyrights of computer software as royalties’ in michael lang et al. (eds) tax treaty case law around the globe (ibfd 2011), pp. 288-299. allocation of the right to tax income 162 according to the main rule in article 5(1) of the oecd model (2017), a pe means a fixed place of business through which the business of an enterprise is wholly or partly carried on. however, as physical presence is required in order to create a pe, digital enterprises have the possibility of providing their services in the user-jurisdiction remotely without establishing a pe. for example, platform enterprises provide their services remotely through digital intermediary platforms and thereby generally avoid establishing a pe in the user-jurisdiction. moreover, as the number of matches made by the platform between end-users are only limited by computer power, the scale and geographical scope of the platform enterprises’ activities may be comprehensive, even though no taxable nexus is established.63 recently, amendments have been made to the pe-definition in the oecd model (2017) and its commentaries.64 however, as physical presence is still used as the nexus-defining criterium, many digital business models, including platform enterprises, will still be able to provide their digital services without establishing a pe in the userjurisdictions.65 nevertheless, it should be recalled that article 7 is secondary to article 12 of the oecd model (2017) if an enterprise does not carry on its business through a pe in the source state (the user-jurisdiction). accordingly, it must initially be considered whether the payment 63 oecd/g20 (2018) [footnote n. 9], p. 70-71. 64 the amendments were prescribed in oecd/g20, preventing the artificial avoidance of permanent establishment status – action 7 final report (oecd publishing 2015). a number of bilateral tax treaties will incorporate these changes through the adoption of the multilateral convention to implement tax treaty related measures to prevent base erosion and profit shifting, (signed on 7 june 2017, entry into force on 1 july 2018). 65 peter hongler and pasquale pistone, blueprints for a new pe nexus to tax business income in the era of the digital economy, ibdf working paper 20 january 2015, and kofler et al. (2017) [footnote 2]. the 2017-amendments to article 5 of the oecd model with commentary included an expansion of the dependent agent-test, a tightening of the independent agent criteria, and a narrowing of the pe-exemptions for preparatory and auxiliary activities. however, several countries that have signed the multilateral instrument have chosen not to apply the amended pe definition. no analysis of the (amended) pe definition will be conducted in this article, as several other contributions in the literature have already done this. see for example vishesh dhuldhoya, ‘the future of the permanent establishment concept’ (2018) 72 bulletin for international taxation 4a, peter blessing, ‘preventing the artificial avoidance of pe in base erosion and profit shifting (beps) – impact for european and international tax policy’ in robert danon (ed.), base erosion and profit shifting (beps) – impact for european and international tax policy (schulthess, 2016), daniel w. blum ‘permanent establishments and action 1 on the digital economy of the oecd base erosion and profit shifting initiative – the nexus criterion redefined’ 69 bulletin for international taxation 6/7, and anders nørgaard laursen, ‘ændringer af fast driftsstedsdefinitionen afledt af beps-projektet’, [2018] sr-skat, p. 111 et seq. njcl 2018/1 163 received by the platform enterprise constitutes a royalty. in this respect, it should be noted that the definition of royalties varies in bilateral tax treaties, though it is often inspired by the definition of royalties included in article 12 (2) of the oecd model (2017): the term ‘royalties’ as used in this article means payments of any kind received as a consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work including cinematograph films, any patent, trade mark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience. the word ‘payment’, as used in the definition, should be interpreted broadly and only requires the fulfilment of an obligation to put funds at the disposal of the creditor in the manner required by contract or by custom.66 consequently, a payment does not need to be in cash to be within the scope of the definition.67 hence, the cash fee as well as the data provided by the users of a platform (if presumed that the data also forms part of the taxable part of the remuneration to the platform), could potentially be classified as royalties. however, the classification of payments between the users and the platform enterprise shall be based on a thorough analysis of the facts on a case-by-case basis. nonetheless, it must be expected that the payment, as a starting point, could often be considered a payment related to a mixed contract.68 according to the tag report and the commentaries to article 12(2) of oecd model (2017), a payment in consideration for knowhow and copyrights concerning software shall only in relatively rare cases be classified as royalties. this is based on the understanding that such payments are generally for the provision of services using underlying copyrights or know-how and not for the right to use or be imparted in the copyrights or knowhow.69 this also seems to be the case with respect to 66 para. 8.3 of the commentaries to article 12 of the oecd model (2017). 67 matthias valta, ‘income from royalties’ in ekkehart reimer and alexander rust (eds), klaus vogel on double taxation conventions (wolters kluwer 2015), p. 993. 68 such mixed contracts should be broken down, on the basis of the information contained in the contract or by means of a reasonable apportionment and classified separately except if; (i) one part of what is being provided constitutes by far the principal purpose of the contract, and (ii) the other parts are only of an ancillary and largely unimportant character. in such cases, the classification of the principal part should generally be applied to the whole amount of the consideration, according to para. 11.6 (know-how) and 17 (software) of the commentaries to article 12 of the oecd model (2017). 69 oecd technical advisory group on treaty characterisation of electronic commerce payments (2001) [footnote 60], p. 5 and 7. see also para. 11-11.6 (knowhow) and 12-17.4 (software) of the commentaries to article 12 of the oecd model (2017). allocation of the right to tax income 164 the payment made to a platform enterprise, as the users are not given information on the ideas and principles underlying the platform, such as the logic, algorithms, programming languages or techniques.70 consequently, the payment should typically be classified as business income, according to article 7 of the oecd model (2017) which entails that the user-jurisdiction will not be entitled to tax the income, if the platform enterprise does not have a pe in the user-jurisdiction. it should be mentioned that some bilateral tax treaties contain an expanded royalty definition which also includes payments for the provision of technical services and that the scope of ‘technical’ is disputed. the prevailing understanding, however, seems to be that making data and software, or functionality of that data or software, available for a fee does not constitute a service of a technical nature.71 on this basis, it could be argued that even with an expanded definition of royalties, the payments from the users to the platform enterprise (whether in cash or in personal data) shall typically be classified as business income and shall therefore not be taxable in the userjurisdiction, assuming that no pe of the platform enterprise is established. consequently, if the user-jurisdiction cannot tax the income of the platform enterprise and in practice cannot either carry out taxation of the users, the user-jurisdiction will be left with nothing to tax with respect to value generated in the interaction between the platform enterprise and the users.72 on this basis, it is a fact that some countries wish to explore other opportunities for establishing a taxing right in the user-jurisdiction. some of these initiatives will be discussed further in section 3. 3. policy challlenges and options 3.1. unilateral and oecd reactions currently, and as explained above, user-jurisdictions are normally not entitled to tax the income of a foreign platform enterprise, if the enterprise does not have physical presence in the user-jurisdiction in the form of a pe. moreover, even though it may be possible for the userjurisdiction to find legal basis for taxing resident users of the receipt of a 70 for illustrative examples see para. 11.5 and 14.3 in the commentaries to article 12 of the oecd model (2017). 71 oecd technical advisory group on treaty characterisation of electronic commerce payments (2001) [footnote 60], p. 15. whether ‘technical’ should be understood strictly in the context of know-how, industrial ip and secrets, or as to having a wider meaning is debated in international tax literature, see for example matthias valta (2015) [footnote 67], p. 1019-1021, where the author summarises and discusses the various views. 72 obiously, the providing user of a platform will typically be taxable in the userjurisdiction depending on the applicable domestic tax law. however, this is outside the scope of this article, as explained en section 1. njcl 2018/1 165 payment in kind (in the form of access to the platform), no jurisdictions are, to our knowledge, currently enforcing such taxation. against this background, and because similar challenges occur in relation to other digital business models, it is not surprising that some countries have made an effort to explore new opportunities for establishing a taxing right in the user-jurisdiction. a part of these efforts has been made under the auspices of the oecd. thus, besides the targeted initiatives that were agreed upon in the course of the beps project,73 a number of broader tax policy options, enabling (some) taxation in the user-jurisdiction, have been discussed, including; 1) a new nexus in the form of a significant economic presence, 2) a withholding tax on certain types of digital transactions, and 3) an equalisation levy. however, for various reasons, none of the options were agreed upon and recommended.74 even though no agreement was reached with respect to the broader tax challenges, the beps report on action 1 stated that countries could introduce any of these three options in their domestic laws or tax treaties as additional safeguards against beps (provided they respect existing treaty obligations).75 perhaps as a consequence of this, a number of countries have taken such unilateral action.76 india, hungary, and italy have for example adopted rules that (will) impose equalisation levies on certain kind of digital services, and both the uk and australia have introduced a so-called diverted profits tax. moreover, israel has introduced rules that create a taxable nexus in israel if the foreign enterprise has a digital pe there. finally, and of particular interest for the topic of this article, it should be mentioned that slovakia has introduced a new broad pe concept to encompass ride and room-sharing intermediation services.77 as already mentioned, it is understandable that some countries feel a need to take action in order to protect their tax bases from the challenges caused by highly digitalised business models. however, the proliferation of unilateral approaches may have severe adverse impacts 73 including the amendments to the pe definition mentioned in section 2.2.2. 74 oecd/g20 (2015) [footnote 6], p. 13 and p. 97 et seq. for elaborate proposals on how the pe concept could be extended and how to use withholding taxes to address the challenges raised by the digital economy see peter hongler and pasquale pistone, (2015) [footnote 65] and yariv brauner and andrés baez, withholding taxes in the service of beps action 1: address the tax challenges of the digital economy, working paper of 2 february 2015 (ibfd 2015) . 75 oecd/g20 (2015) [footnote 6], p. 13 and p. 97 et seq. 76 the lack of consensus is also reflected in the interim 2018-report, even though the report states that continued work is undertaken in order to reach a consensus-based solution by 2020. see oecd/g20 (2018) [footnote 9], p. 212-213. 77 for a recent overview of the various unilateral initiatives see lee sheppard, ‘digital permanent establishment and digital equalization taxes’ (2018) 72 bulletin for international taxation 4a. allocation of the right to tax income 166 on investment and growth, inter alia, due to the increased risk of double taxation, as well as increased interpretational complexity. this concern is also shared by the european commission which is of the opinion that the adoption of unilateral and divergent approaches by member states could be ineffective and fragment the single market by creating national policy clashes, distortions and tax obstacles for businesses in the eu. accordingly, the european commission finds that coordinated initiatives are needed.78 3.2. the eu proposal on significant digital presence for quite some time, the eu has been engaged in discussions and initiatives addressing the tax challenges raised by highly digitalised businesses, including the challenges caused by the increased use of digital intermediary platforms.79 in continuation of these efforts, the european commission has recently proposed two new directives. the first directive proposal is laying down rules that should enable member states to tax income generated in their territory if the taxpayer is considered to have a significant digital presence in the member state (even without having physical presence).80 moreover, the second directive introduces an interim solution enabling member states to levy a tax of 3% on revenues from certain types of digital services (digital services tax), where the main value is created through user participation.81 below, the proposal laying down rules relating to a significant digital presence is analysed in further detail. particular focus will be on the elements of relevance for platform enterprises, despite the fact that the directive has a broader scope. the proposal on a digital services tax is not addressed. the reasons for focusing on the first proposal are, among other things, that the digital service tax is only proposed as an interim measure, it is not a tax on income (but on turnover), the digital services tax has already received severe criticism by academic scholars,82 and the whole idea seems to lack substantial support from member states.83 78 directive proposal com(2018) 147 final [footnote 14], p. 5. 79 european commission, commission expert group on taxation of the digital economy – report (2014). see also bjørn westberg, ‘taxation of the digital economy – an eu perspective’ (2014) 54 european taxation 12, and paolo centore and maria teresa sutich, ‘taxation and the digital economy: europe is ready’ (2014) 42 intertax 12. 80 directive proposal com(2018) 147 final [footnote 14]. 81 directive proposal com(2018) 148 final [footnote 14]. 82 johannes becker and joachim english, eu digital services tax: a populist and flawed proposal, kluwer international tax blog <http://kluwertaxblog.com/ 2018/03/16/eu-digital-services-tax-populist-flawed-proposal/> (24 august 2018), and eric c.c.m. kemmeren (2018) [footnote 11]. 83 in a questionnaire sent to the member state’s tax authorities, only 9 respondents answered that they believe that a digital services tax would solve the current problems. see commission staff working document, swd(2018) 81 final/2, p. 94. njcl 2018/1 167 the basic idea behind the first proposal is to extend the currently applied pe-concept in order to include a significant digital presence84 and to set out new principles for attributing income to such significant digital presence, as new attribution rules are needed in order to better capture the value creation of highly digitalised business models.85 according to article 2, the proposed directive shall apply only for purposes of corporate tax in each member state and should apply to entities irrespective of where they are resident for tax purposes.86 however, in order to not violate the member states’ tax treaties with third countries, it follows that the directive should not apply to entities resident in third countries if the member state has concluded a tax treaty with that third state and the treaty does not include provisions similar to the proposed provisions on significant digital presence.87 this exception is obviously necessary in order to not cause treaty override, but it may entail a significant reduction of the scope of the new rules if the member states are not successful or sufficiently interested in re-negotiating their tax treaties with third countries. according to article 4(1), a pe will be considered to exist if a significant digital presence exists through which a business is wholly or partly carried on. the phrase ‘through which a business is wholly or partly carried on’ is also used with respect to the existing pe-rule set out in article 5(1) of the oecd model (2017). however, in that context, the phrase is usually meant to indicate that persons who, in one way or another, are dependent on the enterprise (personnel) conduct the business of the enterprise in the state in which the fixed place is situated.88 given that a significant digital presence of for example a platform enterprise may exist, even if no personnel is carrying on 84 accordingly, it follows from article 4(2) of the proposed directive that the new concept must be viewed as an addition that does not affect or limit the application of any other test under eu law or national law for determining a pe. 85 as a consequence of the scope and focus of this article (allocation of the right to tax), the profit allocation rules proposed in article 5 are not further analysed. for more on how profits could be attributed to a digital pe see yariv brauner and pasquale pistone, ‘some comments on the attribution of profits to the digital permanent establishment’ (2018) 72 bulletin for international taxation 4a. 86 the encompassed corporate taxes are listed in annex i to the directive proposal. 87 however, the commission has adopted a recommondation which recommends that member states negotiate the necessary adaptions to their tax treaties with third countries, so as to bring provisions on significant digital presence into effect. see comission recommendation of 21 march 2018 relating to the corporate taxation of a siginicant digital presence, c(2018) 1650 final. moreover, as set out in the directive proposal com(2018) 147 final [footnote 14], p. 1-4, the intention is that the proposal should contribute to the ongoing efforts of the oecd and that similar provisions eventually should become part of the oecd model, as well as the commission’s preferred overall solution; the common consolidated corporate tax base (ccctb). 88 para. 6 in the commentaries to article 5(1) of the oecd model (2017). allocation of the right to tax income 168 business in the user-jurisdictions, because no or limited human intervention is needed, it makes little sense to interpret the phrase in line with its traditional understanding. despite this, the proposal does not contain any material guidance on how to interpret this phrase. pursuant to article 4(3), a significant digital presence shall be considered to exist in a member state if the business carried on through it consists wholly or partly of the supply of digital services through a digital interface and one or more of three conditions is met.89 before dealing with the three conditions, it is worth taking a closer look at the concepts of digital services and digital interface. starting with the last concept, digital interface is briefly defined in the proposal’s article 3(2) as any software, including a website or a part thereof and applications, including mobile applications accessible by users. this definition is very broad and seems to cover most, if not all, digital interfaces currently used for digital intermediary platforms. a more elaborate definition is provided in article 3(5) with respect to the concept of digital services.90 accordingly, digital services should be understood as services delivered over the internet or an electronic network and the nature of which renders their supply essentially automated and involving minimal human intervention and impossible to ensure in the absence of information technology. it should be noted that ‘minimal human intervention’ means that the services involve minimal human intervention on the side of the platform enterprise without any regard to the level of human intervention on the side of the users (which may be substantial). in this regard, a digital intermediary platform must also be regarded as requiring minimal human intervention in situations where the platform enterprise initially sets up the system, regularly maintains and updates the system, or repairs it in cases of problems linked with its functioning.91 however, it is important to note that the mere sale of services facilitated by using a digital intermediary platform is not regarded as a digital service for the providing user (for exampel the uber-driver or the lettor of an apartment on airbnb). in other words, it is the platform enterprise that gives access to the digital intermediary 89 whether the conditions are met should be evaluated with respect to the entity carrying on that business, taken together with the supply by each of that entity’s associated enterprises in aggregate. the term “associate enterprise” is defined in art. 3(9). 90 article 3(5) includes a list of services which in particular are considered digital serives. these examples further underline the broad scope of the concept and makes it even clearer that also the services supplied by a digital intermediary platform in a member state may constitute a significant digital presence. these examples are complemented by a list of encompassed digital services in annex ii to the directive proposal. annex iii provides a list of services that are not included. 91 directive proposal com(2018) 147 final [footnote 14], p. 6-9. the definition corresponds to the definition of “electronically supplied services” in article 7 of the council implementing regulation (eu) no 282/2011 of 15 march 2011. njcl 2018/1 169 platform for remuneration (for example uber or airbnb) which is considered to provide digital services.92 as mentioned above, a significant digital presence of a platform enterprise should only be considered to exist if one or more of the following three conditions are met; (a) the proportion of total revenues obtained in that tax period and resulting from the supply of digital services to users located in that member state in that tax period exceeds eur 7,000,000; (b) the number of users of one or more of digital services who are located in that member state in that tax period exceeds 100,000; or (c) the number of business contracts for the supply of any such digital service that are concluded in that tax period by users located in that member state exceeds 3,000. with respect to condition (a) article 3(6) prescribes that ‘revenues’ basically means all proceeds of sale and of other transactions net of vat and other taxes and duties, whether of a monetary or non-monetary nature. the proportion of total revenues in a member state shall, pursuant to article 4(7), be determined in proportion to the number of times that devices are used in a tax period by users located anywhere in the world to access the digital intermediary platform. with regard to both condition (a) and (b), a user shall, according to article 4(4), be deemed to be located in a member state in a tax period, if the user uses a device in that member state in that tax period to access the digital intermediary platform. moreover, the member state where a user’s device is used shall be determined by reference to the internet protocol (ip) address of the devices or, if more accurately, any other method of geolocation. even though condition (a) and (b) might seem relatively simple to apply, practical and interpretive difficulties must be expected to arise. for example, in practice, it might be difficult to delineate revenues obtained from the supply of digital services from other (related) kinds of revenue. in addition, it might not be particularly easy to keep sufficient track of the often vast numbers of users and their locations and at the same time preserve the privacy of the users.93 finally, with respect to condition (c), it is stipulated that a contract shall count as a business contract if the user concludes the contract in the course of carrying on business. it seems that this could include contracts concluded by “providing users” acting sufficiently frequently and professionally. however, it may be difficult for the platform 92 directive proposal com(2018) 147 final [footnote 14], p. 6-9. 93 article 8 of the proposed directive states that the data collected shall be limited to data indicating the member state in which the users are located, without allowing for identification of the user. anyway, concern has been raised about the compatibility with eu privacy rules. see cristiano garbarini, six questions plus one about the eu directive on the taxation of a significant digital presence, kluwer international tax blog <http://kluwertaxblog.com/2018/04/20/six-questions-plus-one-proposed-eudirective-taxation-significant-digital-presence/> (24 august 2018). allocation of the right to tax income 170 enterprise to know and control whether this is in fact the case. in addition, it is stated in article 4(5) that such users shall be deemed to be located in a member state in a tax period if the user is resident for tax purposes in that member state in that tax period or the user is resident for corporate tax purposes in a third country but has a pe in that member state in that tax period. as the domestic tax rules for determining residence vary between member states, this link to domestic tax legislation may cause additional complexity. overall, the proposed directive on significant digital presence is not without some merit. it addresses a legislative and political need to preserve member states’ tax bases in a time where the new digital business models, including digital intermediary platforms, challenge the existing international tax regime. correspondingly, the new concept enables the user-jurisdictions to tax (parts of) the profits generated by the interaction between the users and a foreign platform enterprise.94 furthermore, a uniform eu approach seems preferable to the proliferation of member states’ unilateral approaches. however, some limitations of the proposal have to be emphasised. for example, and as identified above, a number of the terms used in the directive contain interpretive uncertainties, and in general the current proposal appears to need further work in order to become sufficiently clear and targeted. in addition, it may be questioned whether the thresholds are set at appropriate levels and whether the criteria are at risk of ring-fencing certain digital activities (too much). further, it does not seem clear how enterprises relying on both a digital and a physical presence would be affected.95 finally, and from a more political perspective, it should be factored in that it may not be easy to persuade non-eu treaty partners to alter the tax treaties in order to introduce a provision on significant digital presence.96 should this be the case, it might cause a flow of digital business from the eu to other non-eu jurisdictions.97 4. conclusions as physical presence is still used as the nexus-defining criterium, platform enterprises are often able to provide their digital services without establishing a pe in the user-jurisdiction. this entails that userjurisdictions will normally be precluded from taxing the income of 94 however, if the new concept should be able to address the challenges it is crucial that appropriate attribution rules are adopted, in order to capture the value creation of the digital business models. 95 this concern has also been raised with respect to the significant economic presence concept contemplated by the oecd. see olbert and spengel (2017) [footnote 1]. 96 see also kofler et al. (2017) [footnote 2], who argues that the appropriateness of different standards within and outside the eu is highly questionable. 97 garbarini (2018) [footnote 93]. njcl 2018/1 171 foreign platform enterprises, as the income should typically be classified as business income, pursuant to article 7 of the oecd model (2017), and since the platform enterprises are often able to deliver their digital services remotely. taking a closer look at the interaction between the platform enteprises and the users, it may be possible to argue that some kind of barter transaction takes place, as the users of the digital intermidiary platform provide vital data to the platform enterprise in exchange for getting “free” access to the platform. however, even though it may be possible for some user-jurisdictions to find legal basis in existing tax legislation for taxing resident users of the receipt of a payment in kind (in the form of access to the platform), this does not seem to be a viable option in practice. as a consequence of the current lack of possibility for taxation in the user-jurisdictions, the european commission’s recent proposal for a directive laying down rules relating to a significant digital presence seems to be particularly interesting, as it will enable user-jurisdictions within the eu to tax (parts of) the profits generated by foreign platform enterprises. accordingly, even though the proposal needs further work in order to become sufficiently clear and targeted, and the scope may be limited in order not to cause treaty override, it may prove to be a step in the right direction, if adopted. * this publication provides information and comments on legal issues and developments of interest. the foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. readers should seek specific legal advice before taking any action with respect to the matters discussed herein. ** sarah earned her law degree from the university of copenhagen and is an assistant attorney at danders & more where she advises a number of national and international companies and organisations. intellectual property & security interests: a us perspective* by sarah troelsen** nordic journal of commercial law issue 2007#2 nordic journal of commercial law issue 2007 #2 1 i. introduction it is no secret that intellectual property can be a valuable business asset. as i.b.m.’s ceo, samuel palmisano, said, “ [i]ntellectual property is the crucial capital in a global knowledge economy.” 1 expressing the same sentiment, a recently published article states that the “ driving force behind many of the mergers and acquisitions completed during the past decade has been the acquirer’s desire to obtain the target’s ip assets. now, more than ever, the full financial potential of ip is being realized as an additional source of funding to facilitate research and development, acquisitions, and other commercial transactions.” 2 despite this, a basic business transaction involving intellectual property, a secured loan, has many traps for the imprudent attorney or lender. the american bar association task force on security interests in intellectual property concluded that “ [t]he current state of the law governing security interests in intellectual property is unsatisfactory. there is uncertainty as to where and how to file, what constitute notice of a security interest, who has priority, and what properly is cover by a security interest.” 3 reform of american laws has been long advocated in order to reduce uncertainty, but progress has been slow. as such, this article intends to inform foreign attorneys of the basic problems when securing a loan with intellectual property collateral under united states law. ii. security interests basics the two most basic but important principles of secured lending is attachment and perfection. a security interest must ‘attach’ to the collateral to be enforceable against the debtor and be ‘perfected’ to have, among other advantages, constructive notice and superior rights to the secured collateral in relation to all non-secured creditors. thus, when perfected, the secured creditor can avoid the otherwise potent powers of a trustee-in-bankruptcy. the method of attaching and perfecting a security interest is usually governed by state law, which is modeled after article 9 of the uniform commercial code (ucc). to accomplish attachment, a debtor usually signs a security agreement, which identifies the creditor and the debtor, describes the 1 steve lohr, hoping to be a model, i.b.m. will put its patent filings online, n.y. times, september 26, 2006, at c5. 2 scott j. lebson, trade secrets as collateral: a us perspective, journal of intellectual property law & practice, 2007, vol. 2, no. 11. 3 task force on security interests in intellectual property, business law section, american bar association, preliminary report 1 (june 1, 1992). nordic journal of commercial law issue 2007 #2 2 collateral, and contains a grant by the debtor of a security interest to the creditor.4 the debtor must also have received something of value in exchange for the security interest and have rights to the collateral.5 in most cases, perfection is accomplished by filing a ucc-1 financing statement in the appropriate state office, usually the state where the debtor or the collateral is located.6 a financing statement is required to name the debtor and creditor and describe the collateral.7 a creditor can simply use the phrase, “ all of the debtor’s general intangibles,” to take a blanket lien on all of a debtor’s intellectual property and need not identify the individual intellectual property assets.8 “ general intangibles” is a catch-all phrase that covers any type of collateral not specifically categorized by article nine, such as intellectual property.9 unfortunately, perfection is not so easily achieved with intellectual property collateral. because federal law govern many aspects of intellectual property, the state rules concerning perfection may be preempted when federal laws require filing a security interest (or other instruments) with a federal records office. this article will detail the contours of preemption in relation to perfecting security interests, the potential problems it presents for the creditor, and possible solutions. as explained below, in general, the safest way to secure intellectual property collateral is to file a financing statement in both the appropriate state and federal offices. iii. patents although patents can be potentially the most valuable form of a company’s intellectual property, the “ best” way to perfect a security interest in patent collateral is not clear. us case law, however, has consistently held that filing a ucc-1 financing statement with the appropriate state office will assure priority over other lien creditors (i.e. non-title holders).10 problems arise when subsequent bone fide11 purchasers (bfps) or mortgagees are considered. more specifically, a creditor who records only a ucc-1 financing statement in a state office may have no way of preventing the debtor from selling or mortgaging the patent out from under it, free of its security interest.12 i use ‘may’ as there has yet to be a case deciding priority between a secured party and a bfp or mortgagee, but several courts have considered the issue in dicta.13 one court opined that if a 4 see ucc § 9-203. 5 id. 6 ucc § 9-301. 7 ucc §§ 9-516 & 9-504. 8 ucc § 9-504. 9 ucc § 9-106. 10 see generally in re phoenix systems & components, inc., 47 b.r. 264 (d. neb. 2007); in re cybernetic servs., 252 f.3d 1039 (9th cir. 2001); city bank & trust co. v. otto fabric, inc. 83 b.r. 780 (d. kan. 1988); in re transportation design & tech., inc., 48 b.r. 635 (bankr. s.d. cal. 1985). 11 in this context, bone fide means that the purchaser or mortgagee had no knowledge of an existing security interest. 12 alice haemmerli, insecurity interests: where intellectual property and commercial law collide, 96 colum. l. rev. 1645, 1703. 13 in re transportation design, 48 b.r. at 640 (“ and because § 261 [of the patent act] provides that only an ‘assignment, grant or conveyance shall be void’ as against subsequent purchasers and mortgagees [who take title], nordic journal of commercial law issue 2007 #2 3 secured creditor wishes to claim priority over a subsequent bfp or mortgagee, the secured creditor must bring its security interest within the patent act’s section 261,14 which governs title transfer.15 accordingly, this means that a security interest must be a title interest as section 261 records only title transfers. further, even filing a title interest with a state office is not sufficient for perfection as a subsequent bfp will divest title if the creditor fails to record its title interest with the us patent and trademark office (pto). in part, section 261 states that an “ assignment, grant or conveyance16 shall be void as against any subsequent purchaser or mortgagee . . . unless it is recorded in the patent and trademark office within three months from its date or prior to the date of such subsequent purchase or mortgage.” although section 261 seems to specify as one way an assignment, grant, or conveyance may be voided, courts have interpreted it as specifying the only way an assignment, grant or conveyance may be voided by a competing interest.17 for example, a previous bfp who failed to record a title transfer with the pto will have superior rights than a subsequent secured lender who does not take title. this is so even if the creditor diligently searched the pto files and found no recorded interests in the patent collateral and records its security interest with the pto because only a title interest may trump another titleholder’s claim.18 similarly, even though a secured creditor files his non-title interest in both the appropriate state office and the pto, a subsequent bfp (who takes title through a conveyance from the debtor) may take a patent free of the previous security interest without even recording the title transfer with the pto. without title, a secured creditor does not obtain constructive notice when filing with the pto. the common advice in avoiding such troubles simply states, “ file in both the state and federal offices,” 19 and while this is certainly sound advice, unless the security interest has a title interest, filing in the pto may be legally ineffective. complicating matters more, authorities are split as to only transfers of ownership interests need to be recorded with the pto.” ); but see in re peregrine entertainment, ltd, 116 b.r. 194, 204 (c.d. cal 1990) (the court believed that the patent act fully preempts the ucc, and thus all ownership and security interests should be recorded with the pto.). 14 35 u.s.c. §261. 15 in re transportation design, 48 b.r. at 640. 16 courts define the terms “ assignment, grant, and conveyance” as they were in 1870, when the language of section 261 was drafted. “ the historical meanings of the three terms all involved the transfer of an ownership interest. specifically, a patent “ assignment” referred to a transaction that transferred a patent’s title. a “ grant” also referred to a transfer of an ownership interest in a patent, but only as to a specific geographic area. a “ conveyance” was defined as “ to transfer the legal title from the present owner to another.” xuan-thao nguyen, security interest in intellectual property and licenses and the revised article 9, 11 the licensing journal 9 (may 2003) (citing cybernetic servs. 252 f.3d at 1050.). 17 see weinar v. rollform inc., 744 f.2d 797, 807 (fed. cir. 1984); see also bailey v. chattem, inc., 684 f.2d 386, 392 (6th cir. 1982) (“ the law in this circuit is that recording does not affect the validity of a patent assignment expect as to subsequent purchasers or mortgagees without notice.” ); john truman & sons, inc. v. basse, 113 f.2d 928 (2d cir. 1940) (the patent recording statute “ does not require recording to support the validity of an assignment, except as to subsequent purchasers or mortgagees without notice, and by implication recognizes its validity as to all others.” ). 18 id. 19 reagan harris fibbe, perfecting security interests in ip (2007), http://www.bakerbotts.com/ infocenter/publications/ (last visited sept. 14, 2007); henry j. huelsberg, iii and kevin a. white, is your secured loan really “ secure” ? perfecting security interests in ip (2005), http://www.willcoxsavage.com/nep/articles.php (last visited sept. 14, 2007); paul j.n. roy et al., security interests in technology assets and related intellectual property, the computer lawyer, august 1999, at 3. http://www.bakerbotts.com/ http://www.willcoxsavage.com/nep/articles.php nordic journal of commercial law issue 2007 #2 4 whether the potential risks of the creditor being a titleholder outweigh the gains.20 one risk for the creditor is being named a party for patent invalidity actions.21 a consequence for the debtor is that while it can sue for infringement and seek equitable remedies, the debtor might not be allowed to seek legal damages such as loss profits without naming the creditor as a co-plaintiff.22 thus, there is no singular “ best” way to perfect a security interest in a patent. rather the underlying deal should guide whether or not to perform a title assignment. the risks created by a creditor not holding title are based on the possibility of the debtor committing a fraudulent transfer. if there is no perceived risk of this happening, then perhaps an assignment is not necessary. and in fact, transactions occur both ways. if a title transfer is deemed appropriate, a conditional assignment may be best. that is, a debtor will hold title until default, in which title passes to the creditor. such an assignment is treated as an absolute assignment by the pto for purposes of filing and thus receives section 261 protection.23 this also results in creditor being a titleholder in name only and debtor enjoying most of the substantive rights of patent ownership, barring, though, suing for legal damages. the assignment should clearly state that this is the parties’ objective and put the burden on patent maintenance (payment of fees to the pto and other duties) on the debtor. a similar decision is to be made when drafting the financing statement. again, depending on the transaction, a creditor may file a blanket lien with the pto that simply states, “ all of debtor’s past and future patents and patent applications are subject to creditor’s security interest,” or file a financing statement that identifies the patents individually by the number the pto assigns a patent. although the latter necessitates filing a financing statement for each new patent application and patent issued, listing the patent numbers is safer as patents are organized by number, and thus every creditor knows to search the pto records by patent number. however, an electronic search can find pto records by a creditor’s name as well. iv. trademarks “ unlike patents or copyrights, trademarks are not separate property rights. they are integral and inseparable elements of the goodwill of the business or services to which they pertain.” 24 because of this, an assignment of a trademark is void (i.e. an assignment in gross) unless it includes the “ goodwill” of the underlying business associated with the mark.25 although, a security interest in a trademark has repeatedly been held not to be an assignment, problems can arise if a creditor attempts to foreclose without obtaining a business’s goodwill.26 20 bramson, intellectual property financing in asset-based financing: a transactional guide (h. ruda ed.) § 31.02[3] (advises to assigning title to creditor); raymond t. nimmer, commercial asset based financing § 22.05 (callaghan 1988) (same); but see william c. hillman, documenting secured transactions: effective drafting and litigation, § 3:11.1 (“ in most cases, however, this price is small [of risk of fraudulent transfer by debtor] compared to exposure to patent invalidity actions.” ); roy, supra note 20, at 10 (believes that an assignment of title to a lender are risky.). 21 hillman, supra note 21, at § 3:11.1. 22 haemmerlli, surpa note 13, at 1712. 23 37 c.f.r. 3.56 (2005). 24 visa, u.s.a., inc. v. birmingham trust nat'l bank, 696 f.2d 1371, 1375 (fed. cir. 1982). 25 j. thomas mccarthy, mccarthy on trademarks and unfair competition § 18.01[7]. 26 see li’l red barn, inc. v. red barn system, inc., 322 f. supp. 98 (n.d. ind. 1972); marshak v. green 746 f.2d 927 (2d cir. 1984); clark & freeman corp. v. heartland co. ltd., 811 f. supp. 137 (s.d.n.y. 1993). nordic journal of commercial law issue 2007 #2 5 a prudent creditor has several ways to avoid such a risk if foreclosure is necessary. first, a security interests may include all goodwill associated with the mark as collateral too. by filing a financing statement that states a creditor has a security interest in all of a debtor’s “ general intangibles,” it should cover both trademarks and related goodwill.27 second, a creditor may also take a security interest on “ related assets associated with the products marketed under the trademark, such as accounts receivable, to make certain that in the event of foreclosure, the mere act of assignment would not in and of itself destroy the value of the collateral.” 28 this technique is supported by case law as courts have traditionally viewed the transfer of tangible business assets as reflecting “ goodwill.” 29 unlike the case in patents, it is not recommended that a creditor structure the security interest as a condition assignment, that is, where a creditor would take title of the trademark upon default of the debtor. while this necessitates recording with the pto to maintain validity, the real cause of concern is “ by recordation, the conditional assignment is deemed, by law, a present transfer of title.” 30 as such, “ the lender must use the trademark in order to maintain the rights in the trademark, and if the lender licenses the trademark back to the borrower, the lender must actively monitor and control the borrower’s use of the trademark.” 31 thus, a security interest that lacks a title interest is preferred. the question remains as to where to file a financing statement. just as with patents, the safest way is to file in both state and federal offices. filing with the appropriate state office is mandatory in order to assert rights in the trademark collateral superior to other lien creditors.32 at the federal level, assignments of trademarks, like patents, are recorded with the pto to give notice to subsequent purchasers; however, unlike patents, trademarks do not have to be filed with the pto to be legally recognized. their creation and substantive rights are dictated by state law and arise out of a business’s use of a mark with its goods and services. the federal law pertaining to trademarks, the lanham act, creates few substantive trademark rights, but establishes a registration system to record assignments and provides benefits to registrants such as constructive notice.33 although case law has clearly held that a security interests are distinct from assignments,34 the pto will nevertheless accept filing of instruments other than assignments vis-à-vis trademarks.35 it is thus advisable to do so in order to cut-off any potential rights of subsequent bfps or assignees. 27 roy, supra note 20, at 12. 28 scott j. lebson, security interests in intellectual property in the united states: (are they really secure?), http://www.ladas.com/ipproperty/ipprop_securityinterests.html (last visited sept. 14, 2007) citing matter of roman cleanser co., 802 f.2d (6th cir. 1986). 29 j. thomas mccarthy, trademarks and unfair competition §18:10 (2001). 30 deborah ruff, navigating uncharted waterstaking security interests in united states trademarks, http://www.securitization.net/knowledge/transactions/waters.asp (last visited sept. 14, 2007). 31 id. 32 see trimarchi v. together dev. corp., 255 b.r. 606, 612 (d. mass. 2000); in re roman cleanser co., 43 b.r. 940 (bank. e.d. mich. 1984). 33 15 u.s.c. § 1022 34 see, e.g., in re roman cleanser co., 802 f.2d 207, 210 (6th cir. 1986). 35 roy, supra note 20, at 12 (citing in re ellison publications, inc., 182 uspq 498.). http://www.ladas.com/ipproperty/ipprop_securityinterests.html http://www.securitization.net/knowledge/transactions/waters.asp nordic journal of commercial law issue 2007 #2 6 v. copyright although the copyright act and case law interpreting the act create a federal registry for security interests in copyright collateral,36 filing a financing statement in a state office may be necessary as well. the copyright act requires that any transfer of copyright ownership to be recorded with the copyright office.37 although a security interest is not normally an ownership interest, the copyright act defines a “ transfer of copyright ownership” as an “ assignment, mortgage, exclusive license, or any other conveyance, alienation or hypothecation of a copyright . . . .” 38 black law’s dictionary defines hypothecate as “ to pledge (property) as security or collateral for a debt, without delivery of title or possession.” 39 under this definition courts have held that perfection of security interests with copyright collateral is accomplished by filing with the copyright office.40 however, a wrinkle (and dispute among courts) is caused because copyrights come into existence at the moment a work is fixed in a tangible medium of expression.41 thus, while filing with the copyright office is necessary to enforce a copyright,42 its creation is instantaneous. this presents two problems. first, how does a creditor perfect an interest in an unregistered copyright? second, how does a creditor perfect an interest in subsequent modifications of a registered copyright as modifications are regarded as a new and thus unregistered work under copyright law? to the first question, the courts are split. one side holds that it is impossible to hold a security interests in a copyright without first registering the work.43 the other side holds that since the copyright act is silent as to unregistered copyrights and security interests, state law governs.44 thus, a creditor must file with the appropriate state office. the split also answers the second question. the first line of decisions would require both a registration of each modified work and an accompanying financing statement, while the second would allow for either a work-bywork filing with the copyright office or simply a blanket lien in all of debtor’s general intangibles to be filed at the appropriate state office. thus, to get both the broadest scope of protection available and avoid the courts’ discrepancies, filing at both the state and federal level is necessary. 36 see in re avalon software inc., 209 b.r. 517, 521 (bank. d. ariz. 1997) (“ under federal copyright law, the grant of a security interest is defined as a ‘transfer of copyright ownership,’ because within copyright law that term includes mortgages or other forms of hypothecation.” ). 37 17 u.s.c. § 205(a). 38 17 u.s.c. § 101. 39 (8th ed. 2004). 40 e.g. in re avalon software, inc., 209 b.r. 517 (bankr. d. ariz. 1997). 41 17 u.s.c. § 101. 42 17 u.s.c. § 411. 43 avalon software, 209 b.r. 517; in re aeg. acquisition corp., 127 b.r. 34 (bankr. c.d. cal. 1991). 44 in re world auxiliary power co., 244 b.r. 149 (bankr. n.d. calif. 1999). all of the courts in the split cited in re peregrine entertainment ltd., 116 b.r. 194 (c.d. cal.1990) as support for their rulings. nordic journal of commercial law issue 2007 #2 7 vi. trade secrets on the periphery of the intellectual property landscape are trade secrets. due to their very nature, trade secrets are of unknown length, must be maintained in confidence, and are not registered in a state or federal office. thus, “ this fundamental principle of maintaining secrecy suggests the need to proceed with extreme caution when negotiating, creating, and perfecting security interests in trade secrets.” 45 a blanket lain in a debtor’s intellectual property is likely perfected with a financing statement containing “ language to the effect of ‘all general intangibles now owned or hereinafter acquired by the debtor.’” 46 that is, the ucc does not require a financing statement to specifically identify separate intellectual property rights that fall under the general intangibles category when taking a blanket lien on a debtor’s general intangibles.47 however, if a creditor is taking an interest in only specific trade secrets, the financing statement should identify the trade secret without breaching its confidentiality. “ it has also been suggested that the trade secret be held in escrow for the benefit of the secured party.” 48 vii. domain names to date, there are two well known cases that have addressed whether domain names are property. if domain names are recognized as property or an analog of property, it would lend credence to the idea that a security interests can be obtained in them. in kremen v. cohen, the ninth circuit court of appeals found domain names are property.49 in contrast, the virginia supreme court in umbro v. 3263851 canada inc., held that ‘‘a domain name registration is the product of a contract for services between the registrar and registrant” in which a domain name, like a telephone number, does not exist separately from “ its respective service that created it and that maintains its continued viability.’’50 as such, one article advises: [b]ecause of the uncertainty in this area, a lender may want to make a state ucc-1 filing where the borrower’s business is located and also in the state where the host server is located. if the domain name is particularly valuable, a lender may also want to have the debtor transfer the domain name into escrow along with a power of attorney in favor of the lender so that the lender can control the domain name in the event of the borrower’s default.51 viii. conclusion if trademarks, copyrights, or patents are identified as collateral in a security agreement, the financing statement should be filed in both the appropriate state and federal offices. in the same vein, a creditor must perform a proper search in these offices to make sure that the debtor 45 lebson, supra note 3. 46 id. 47 id. 48 id. 49 325 f.3d 1035 (9th cir. 2003). 50 259 va. 759, 529 s.e.2d 80 (va. 2000). 51 huelsberg, supra note 20, at 3. nordic journal of commercial law issue 2007 #2 8 is the titleholder and for other encumbrances. counsel should also be aware of the various issues when choosing how to structure a secured transaction (conditional assignment, leaseback, etc… ) vis-à-vis the underlying intellectual property collateral. particular care should be taken with trade secrets and domain names as authority and case law on the subject is scarce. whether structuring a loan for a creditor or conducting due diligence for an acquisition, these issues should be addressed to save headaches in the future. 1 csr and the law of the wto – the impact of tuna dolphin ii and ec–seal products carola glinski* * postdoctoral fellow researcher at the centre for enterprise liability (cevia), faculty of law, university of copenhagen, denmark, email: carola.glinski@jur.ku.dk. njcl 2017/1 121 1. introduction .................................................................................. 122 2. setting the scene: extraterritoriality – or admissibility of non-product-related production requirements ... 124 2.1. non-discrimination under gatt ............................... 126 2.1.1. article iii:4 gatt ................................................... 126 2.1.2. article xx gatt ..................................................... 130 2.2. the tbt agreement .......................................................... 134 2.2.1. the scope of application ....................................... 134 2.2.2. discrimination of ‘like products’ under the tbt agreement ........................................................ 136 2.2.3. interim conclusion on the extraterritoriality issue .................................... 137 3. attribution of private or voluntary csr measures to the state ................................................................................................... 138 3.1. the discussion ...................................................................... 138 3.2. the impact of tuna dolphin ii: mandatory vs. voluntary ............................................................................. 140 3.3. conclusion ............................................................................ 142 4. csr regulation as ‘international standards’ ................. 143 4.1. the discussion ..................................................................... 145 4.2. the impact of tuna dolphin ii ...................................... 146 5. conclusion and prospects ......................................................... 147 csr and the law of the wto 122 abstract this article deals with wto law as a possible obstacle to pursue csr policies. drawing in particular from the reports in tuna dolphin ii and ec – seal products, it discusses the three main issues within wto law related to the hybrid character of csr regulation between private and public and between national and international: first, the general admissibility for the importing state to address socially and/or environmentally responsible production standards abroad and thus – from its perspective – extraterritorial situations (so-called ‘non-product-related production measures’); second, the attribution of (more or less) private csr regulation to the importing state; and third, the question whether and under which conditions private (transnational) csr standards can be regarded as ‘international standards’ under the law of the wto. 1. introduction this article deals with the relation between ‘corporate social responsibility’ (csr) regulation and the law of the wto. csr regulation has gained new momentum in the aftermath of the rana plaza collapse in bangladesh and the fire in the ali enterprises factory in pakistan, with academic discussion1 and pending litigation on corporate liability of multinational corporations or supply chain liability, for example, in germany2 and canada.3 at the same time, these disasters have led to new private csr initiatives such as the so-called ‘bangladesh accord’4 but also to new public-private csr governance structures such as (national and international) ‘csr alliances’ like the german ‘bündnis für nachhaltige textilien’ (alliance for sustainable garment).5 in fact, csr regulation comes in a great variety of forms, including: purely private business selfregulation; agreements between business and labour organisations or ngos that have been adopted by certain or a considerable number of corporations nationally, eu-wide or internationally; private standards and labels, again nationally, eu-wide or internationally developed and/or adopted; and forms of public promotion of or state involvement in the setting of csr standards like round tables for the development of csr standards and labels, the adoption of legal minimum standards for 1 see, for example, c. van dam, ‘tort law and human rights: brothers in arms’ (2011) 2 journal of european tort law 221; p. rott and v. ulfbeck, ‘supply chain liability of multilateral corporations?’ (2015) european review of private law 415. 2 lg dortmund, 7 o 95/15. for details, see p. wesche and m. saage-maaß, ‘holding companies liable for human rights abuses related to foreign subsidiaries and suppliers before german civil courts: lessons from jabir and others v kik’ (2016) 16 human rights law review 370. 3 das v. george weston limited, no. cv-15-526628 (ont. superior ct. filed apr. 22, 2015). 4 accord on fire and building safety in bangladesh, <http://bangladeshaccord.org> accessed 29 may 2017. 5 <www.textilbuendnis.com/de> accessed 29 may 2017. njcl 2017/1 123 voluntary labels or state based voluntary labels, agreement based ‘csr alliances’, and csr standards in public procurement or in public support schemes. other state based csr mechanisms could be the mandatory use of certain certificates, mandatory product related minimum production requirements or csr reporting duties. csr regulation usually encompasses certain minimum production standards concerning environmental protection, human rights, labour and employment issues, health and safety issues, and bribery within the whole production chain. it is based on the idea that corporations are responsible for their impact on workers, the environment or neighbourhoods in situations or states with weak legal protection standards or weak enforcement mechanisms. thus, csr regulation is of particular importance with regard to transnational production chains where protection standards vary greatly between states. in turn, the law of the wto, namely the gatt6 and the tbt agreement,7 are concerned with the promotion of free trade through the obligation not to treat foreign products less favourable than ‘like products’ of national origin (‘national treatment’, article iii gatt) or less favourable than products originating from other countries (‘most favoured nation treatment’, article i gatt), the prohibition of unnecessary restrictions to trade (article xi gatt) and the requirement to base product regulation, labels and standards on international standards (articles 2.4 and 2.5 tbt). due to its regulatory impact on internationally traded products, their market access and competitive opportunities, csr regulation is often thought to be in conflict with the law of the wto; whereas it might also provide for international standards that national regulation can be based upon. three main issues within wto law related to the hybrid character of csr regulation between private and public and between national and international can be identified: first, the general admissibility for the importing state to address socially and/or environmentally responsible production standards abroad and thus – from its perspective – extraterritorial situations (so-called ‘non-product-related production measures’); second, the attribution of (more or less) private csr regulation to the importing state; and third, the question whether and under which conditions private (transnational) csr standards can be regarded as ‘international standards’ under the law of the wto. all these aspects have been unsettled until now. this article first provides an overview of the long-standing discussions related to these aspects. it then analyses to what extent the two recent rulings of the wto 6 general agreement on tariffs and trade. 7 agreement on technical barriers to trade. csr and the law of the wto 124 dispute settlement bodies in tuna dolphin ii8 and ec – seal products,9 which deal not only with environmental but also with ethical concerns, further concretise the responsibility of the state for voluntary measures and the procedural fairness requirements for international standards, contribute to the solution of csr related problems. 2. setting the scene: extraterritoriality – or admissibility of non-product-related production requirements the extent to which the law of the wto permits members to take (regulatory) action dealing with situations beyond member’s borders, has been discussed for long amongst wto lawyers and members. this discussion has also been led under the heading of the admissibility of socalled ‘non-product-related process and production methods’ (‘nprppms’), which might negatively restrict importation or marketing chances of goods produced abroad. nprppms mean production requirements for certain products which cannot be traced in the physical characteristics of the product itself, for example, environmental, labour or health and safety standards for production processes. proponents of the admissibility of csr regulation and production related standards argue that they are an important means to socially embed transnational markets, which can bridge the boundaries of state based law.10 their argument is that transnational trade is inevitably linked to the issue of exploitation of the environment and vulnerable parts of the population. the wto members should take reasonable measures to encourage corporations to pursue csr objectives and/or adopt related standards. without the possibility to link trade policies with production standards, in particular where internationally accepted minimum standards exist, the wto would undermine social and environmental protection in the international arena and would put its own legitimacy at risk.11 8 us – measures concerning the importation, marketing and sale of tuna and tuna products, wt/ds/381/ab/r (hereinafter: tuna dolphin ii). 9 ec – measures prohibiting the importation and marketing of seal products, wt/ds/400/ab/r, wt/ds 401/ab/r (hereinafter: ec– seal products) 10 see e.g. the un framework (john ruggie, ‘protect, respect and remedy: a framework for business and human rights’, un doc. a/hrc/8/5 of 7/4/2008), and the guiding principles for business and human rights (john ruggie, ‘guiding principles on business and human rights: implementing the united nations “protect, respect and remedy” framework’, un doc. a/hrc/17/31 of 31/3/2011) which are based upon the idea to embed global liberalism, prominently developed by k. polanyi, the great transformation (farrar and rinehart, new york, 1944). see also j. ruggie, ‘taking embedded liberalism global: the corporate connection’, in d. held and m. koenig-archiburgi (eds), taming globalization: frontiers of governance (cambridge university press, cambridge, 2003) 93. 11 see e.g. s. bernstein and e. hannah, ‘non-state global standard setting and the wto: legitimacy and the need for regulatory space’ (2008) 11 journal of international economic law 575; c. vidal-léon, ‘corporate social responsibility, human rights and njcl 2017/1 125 opponents of production related requirements argue that they would produce external effects on the territory of the exporting states and interfere with their sovereignty, in particular when imposed unilaterally by the importing state. thus, they could be regarded as coercion or imperialism or at least as paternalism to the detriment of comparative (cost-price) advantages of developing countries which impose additional costs upon poor producers and which thus constitute disguised protectionist or discriminatory practices. this position is particularly prominent amongst developing countries and has gained much attention in relation to environmental standards and environmental labelling.12 furthermore, developing countries are strictly opposed to link trade and (core) labour standards, arguing that they are intrinsically linked to (disguised) protectionist practices.13 again, proponents argue that, strictly speaking, production requirements do not regulate extraterritorial situations as such but only requirements for products to be brought into the importing state and thus a domestic issue. csr standards address rules for the importer’s own behaviour and the issue of contributing to or benefitting from production practices regarded as immoral, socially inacceptable or detrimental to the environment via one’s own consumption. also, regarding economic effects abroad, there is said to be no principal difference to product requirements.14 proponents of csr regulation base their arguments on the fact that a distinction between product or production related measures has no founding in the wording of the gatt and the fact that there is no adopted ruling of a dispute settlement body concerning csr related production methods to the contrary. opponents of production based regulation base their legal arguments on early case law like the (never adopted) panel the world trade organisation’ (2013) 16 journal of international economic law 893, with further references. 12 see in particular, m. joshi, ‘are eco-labels consistent with world trade organization agreements?’ (2004) 38 journal of world trade 69, at 72, who refers, among others, to a study of the wto committee on trade and environment on discriminatory effects of environmental labelling. see also vidal-léon (n. 11), at 899 ff., who refers to several studies on the effects of csr codes of conduct on international trade. 13 see e.g. vidal-léon (n. 11), at 898 ff. with further references; m. du, ‘permitting moral imperialism? the public morals exception to free trade at the bar of the world trade organisation’ (2016) 50 journal of world trade 675, at 694 ff. 14 see, e.g., r. howse and d. regan, ‘the product/process distinction – an illusory basis for disciplining ‘unilateralism’ in trade policy’ (2000) 11 european journal of international law 249, at 269 ff., who for the latter explicitly refer to environmental standards as opposed to labour standards which are more likely to be protectionist, except for those based on generally accepted core minimum requirements like the ilo core conventions. csr and the law of the wto 126 decisions in tuna dolphin i15 where the panel argued that a distinction between dolphin-friendly and dolphin-unfriendly caught tuna constituted discrimination.16 in legal terms, this dispute relates to the legal character of the wto and to the question whether wto agreements, namely the gatt and the tbt agreement, only create a negative right of states not to be discriminated against by differentiating products on the basis of their national origin, or whether they create a general positive right of market access which can only be denied for certain codified or accepted reasons.17 doctrinally, this dispute affects the interpretation, in particular, of articles iii:4 and xx gatt, and the applicability and interpretation of the tbt agreement; which we turn to hereinafter. 2.1. non-discrimination under gatt 2.1.1. article iii:4 gatt (a) the discussion article iii:4 gatt requires imported products to be treated ‘no less favourable than … like products of national origin in respect of all laws, regulations and requirements affecting their internal sale …’.18 this requirement has been interpreted not only as a prohibition of discrimination on the basis of the national origin of the product (de jure discrimination) but also as encompassing de facto discrimination, which results from origin-neutral requirements.19 this translates into the question whether physically identical products have to be considered as ‘like products’ or may be considered as ‘unlike’ on the basis of differences in the way they were produced. or, if they are regarded as like products, the question would be to what extent reduced competitive opportunities of imported products due to origin-neutral production requirements necessarily lead to legally relevant de facto discrimination. authors have suggested that the question of likeness should not be decided by physical identity but by the ordinary legal approach as to whether a product differs in a relevant respect that justifies different treatment in a non-protectionist regulatory policy.20 15 us – restrictions on imports of tuna (1991) 30 ilm 1594; us – restrictions on imports of tuna (1994) 33 ilm 936 (not adopted). 16 see infra, 2.1.1. 17 for an encompassing analysis, see howse and regan (n. 14), at 269 ff., 276; see also s. charnovitz, ‘the law of environmental “ppms” in the wto: debunking the myth of illegality’ (2002) 27 yale journal of international law 59. 18 similar requirements are imposed by the ‘most favoured nation’ treatment standard in article i:1 gatt in relation to products originating from any other country. 19 see, e.g., l. ehring, ‘de facto discrimination in world trade law: national and mostfavoured nation treatment’ (2002) 36 journal of world trade 921. 20 see in particular howse and regan (n. 14), at 261 f. njcl 2017/1 127 in contrast, early decisions by the gatt and wto dispute settlement bodies, such as the panel decisions in tuna dolphin i21 where the panel ruled that a distinction between dolphin-friendly and dolphinunfriendly caught tuna constitutes a discrimination amongst like products as well as a few other early rulings, however unrelated to csr policies, such as us – malt beverages22 where the panel considered beer produced by large breweries not unlike beer produced by small breweries; us – taxes on automobiles23 where a fleet averaging method was regarded as not relating to the product (car) but to the producer; us – gasoline24 where the panel held that it was not admissible to differ on the basis of characteristics of the producer and the nature of the data held by it; suggested that a regulatory distinction on the basis of production or producer characteristics would be inadmissible. instead, since japan – alcoholic beverages,25 the appellate body emphasised a competition-focused determination of whether products are ‘like’ which is based on ‘four categories of “characteristics” that the products involved might share: (i) the physical properties of the products; (ii) the extent to which the products are capable of serving the same or similar end-uses; (iii) the extent to which consumers perceive and treat the products as alternative means of performing particular functions in order to satisfy a particular want or demand; and (iv) the international classification of the products for tariff purposes’, and on the question whether the measure modifies the conditions of competition to the detriment of imported ‘like’ products in order to establish de facto discrimination. in this approach the potentially legitimate and nonprotectionist objective of a regulation, be it product or production related, was of no relevance at all. this strict competition-based approach, however, was opened up to some extent in subsequent rulings such as ec – asbestos: here, the appellate body held that although the ‘determination of “likeness” under article iii:4 is, fundamentally, a determination about the nature and extent of a competitive relationship between and among products,’26 significant health risks (of building materials containing asbestos as opposed to other building materials) could be of relevance for two of the criteria, namely for differences in the physical characteristics of the product and for differences in consumer preferences. thus, they might not be ‘like’ one 21 n. 15. 22 us – measures affecting alcoholic and malt beverages, bisd 39 (1992) 206. 23 us – taxes on automobiles (1994) 33 ilm 1397 (not adopted). 24 us – standards for reformulated and conventional gasoline, wt/ds2/r. 25 japan – taxes on alcoholic beverages, wt/ds8/ab/r, wt/ds10/ab/r, wt/ds11/ab/r, paras 19 ff. 26 european communities – measures affecting asbestos and asbestos-containing products, wt/ds135/ab/r, para. 99. csr and the law of the wto 128 another although they compete on the same market.27 the appellate body further held that in case products have been determined to be like products, this does not necessarily imply that members may not draw any regulatory distinctions.28 in thailand – cigarettes, the appellate body further clarified that there must be a ‘genuine relationship’ between the measure at issue ‘and its adverse impact on competitive opportunities for imported versus like domestic products to support a finding that imported products are treated less favourably’.29 nevertheless, it remained unclear from these decisions whether and under what conditions de facto discrimination of a competition modifying measure could indeed be excluded on the basis of legitimate regulatory intent and whether this could also apply to production related requirements.30 this question was of particular relevance for the potential application of us – clove cigarettes,31 which applied a two steps inquiry in order to define de facto discrimination under article 2.1 tbt agreement; a provision which requires, in addition to the question whether the measure modifies the conditions of competition, also the finding that the detrimental impact on competitive opportunities indeed reflects discrimination.32 27 ec – asbestos, wt/ds135/ab/r, para. 113. although ‘[t]he kind of evidence to be examined in assessing the 'likeness' of products will, necessarily, depend upon the particular products and the legal provision at issue. when all the relevant evidence has been examined, panels must determine whether that evidence, as a whole, indicates that the products in question are 'like' in terms of the legal provision at issue.’; ibid., paras 101–103. 28 in ec – asbestos, wt/ds135/ab/r, para. 100, the appellate body found that a member may draw distinctions between products which have been found to be 'like', without, for this reason alone, according to the group of 'like' imported products 'less favourable treatment' than that accorded to the group of 'like' domestic products. 29 thailand – customs and fiscal measures on cigarettes from the philippines, wt/ds/371/ab/r, para. 134. 30 in favour of the relevance of the regulatory intent: howse and regan (n. 14); sceptical charnovitz (n. 17), at 91. 31 us – measures affecting the production and sale of clove cigarettes, wt/ds/406/ab/r, paras 161 ff. 32 see r. howse, j. langille, k. sykes, ‘pluralism in practice: moral legislation and the law of the wto after seal products’ (2015) new york university school of law, public law and legal theory research paper series, working paper no. 15-05, april 2015, 81, at 126 ff.; see also r. howse, j. langille and k. sykes, ‘sealing the deal: the wto’s appellate body report in ec – seal products’ (2014) 18(12) american society of international law; <www.asil.org/insights/volume/18/issue/12/sealing-dealwto%e2%80%99s-appellate-body-report-ec-%e2%80%93-seal-products> accessed 1 september 2017. for the tbt agreement, see infra, 2.2.2. njcl 2017/1 129 (b) the impact of ec – seal products ec – seal products33 concerned a european importation and marketing ban on seals products, motivated by european moral concerns about seal killing (methods) but accompanied by an exception for indigenous subsistence hunting.34 in fact, this ban affected the vast majority of canadian and norwegian seal products, which derive from commercial hunting, whereas the european (indigenous greenlandic) seal products fell under the exception. thus, the appellate body had to deal exactly with the question in how far (a distinction based on) a legitimate regulatory intent might exclude discrimination in the terms of articles i:1 and iii:4 gatt, and whether a production related restriction could be regarded as informed by a legitimate regulatory intent. the appellate body, however, held that the decisive question was solely whether the measure had a detrimental impact on competitive opportunities of imported products. the relevance of the regulatory intent was rejected as there was no basis for the latter in the wording of article iii.4.35 consequently, the fact that the measure impacted far more on canadian and norwegian seal products than on european products was regarded as sufficient to establish less favourable treatment in terms of article iii:4.36 as a consequence, any change in the competitive relations to the disadvantage of (certain) imported ‘like products’37 which is caused by a governmental measure could be regarded as de facto discrimination in terms of article iii:4, no matter how legitimate the governance issue.38 a discriminating measure could only be justified under article xx if it was necessary to pursue one of the listed legitimate policy objectives. actually, it has been doubted that the appellate body really meant to take such a rigorous stance, as this would mean that very many legislative measures by wto members would be prima facie illegal under wto law; an outcome which has been regarded to be ‘extreme and hard to reconcile with the intent and text of gatt’.39 33 ec – measures prohibiting the importation and marketing of seal products, wt/ds/400/ab/r, wt/ds 401/ab/r. 34 on the background and the relevant eu law, see j. beqiraj, ‘the delicate equilibrium of eu trade measures: the seals case’ (2013) 14 german law journal 279. 35 ec – seal products, wt/ds/400/ab/r, wt/ds 401/ab/r, para. 5.90. 36 ibid., paras 5.94, 5.105, 5.110. 37 the question of ‘likeness’ was not discussed in ec – seal products. 38 ec – seal products, wt/ds/400/ab/r, wt/ds 401/ab/r, para. 5.125. for detailed analysis, see howse, langille and sykes, ‘pluralism in practice’ (n. 32), at 127 ff. 39 see howse, langille and sykes, ‘sealing the deal’ (n. 32). for detailed analysis, see howse, langille and sykes, ‘pluralism in practice’ (n. 32), at 132 ff., 146. csr and the law of the wto 130 2.1.2. article xx gatt (a) the discussion with this rigorous approach to article iii.4 gatt, article xx gatt is conferred upon the role of protecting policy space for legitimate regulatory measures. under article xx gatt, a potential infringement of article iii:4 gatt – and also of article xi gatt which prohibits (quantitative) trade restrictions evoked by a (production related) csr measure can be justified in case it is necessary to pursue legitimate policy objectives such as (a) the protection of public morals, (b) the protection of human, animal or plant life or health or (g) relate to the conservation of exhaustible natural resources. here again, the question whether these policy objectives can also be related to activities or situations outside the importing state’s territory has been the subject of a controversial debate. opponents of an extraterritorial application in particular of article xx(a) and (b) still base their opinion on the early tuna dolphin i rulings where the panel held that article xx(b) does not cover extra-territorial measures such as the protection of dolphins outside us territory. proponents of the admissibility of csr regulation related to situations abroad, invoke in particular us shrimp-turtle40 where the appellate body regarded the us importation requirement that shrimps have to be harvested under conditions that do not adversely affect sea turtles (an endangered species) to be justified under article xx(g) as long as good faith efforts were undertaken with a view to the adoption of an international standard in this regard. the appellate body stated that it would not ‘pass upon the question of whether there is an implied jurisdictional limitation in article xx(g), and if so, the nature or extent of that limitation’ as in the specific circumstances of that case, there was ‘a sufficient nexus between the migratory and endangered marine populations involved and the united states for purposes of article xx(g)’.41 thus, as the appellate body referred to the fact that the protected turtles also traversed us waters, strictly speaking, the ruling did not concern a (purely) extraterritorial issue.42 moreover, the protection of exhaustible resources under article xx(g) has generally been interpreted as less restrictive than the other justifications.43 as the very idea of the us measure was the preservation of an endangered species as such and not of domestic turtles, this decision has nevertheless been interpreted as permitting extraterritorial production measures at least as far as environmental protection is concerned; which has been regarded as being in line with the fact that environmental degradation or pollution is a globally interrelated and transboundary 40 us – import prohibition of certain shrimp and shrimp products, wt/ds58/ab/r. 41 ibid., para. 133. 42 for detailed analysis of case law and discussions, see in particular charnovitz (n. 17), at 92 ff., 99 ff. see also howse and regan (n. 14). 43 see charnovitz (n. 17), at 92 ff. njcl 2017/1 131 issue.44 in contrast, the potential justification of csr standards relating to purely domestic health and safety issues or the protection of human and labour rights under article xx (a) or (b) remained contested.45 (b) the impact of ec-seal products in ec seal products, the european union initially justified the importation and marketing ban on seals products with public concerns about seal killing (methods) under article xx(a) and (b). the appellate body, however, considered only article xx(a). it upheld the panel’s finding that the eu regulation was necessary to protect public morals within the meaning of article xx(a) although the public morals were (also) concerned with the protection of extraterritorial seals. with regard to the exterritorial issue, the appellate body held that ‘[a]s set out in the preamble of the basic regulation, the eu seal regime is designed to address seal hunting activities occurring "within and outside the community" and the seal welfare concerns of "citizens and consumers" in eu member states. the participants did not address this issue in their submissions on appeal. accordingly, while recognizing the systemic importance of the question of whether there is an implied jurisdictional limitation in article xx(a), and, if so, the nature or extent of that limitation, we have decided in this case not to examine this question further.’46 the general approach towards article xx(a) is first, to examine whether the objective of the measure falls within the scope of protection of public morals and second, whether it is necessary, which includes a weighing and balancing of the relative importance of the interests at stake, the contribution of the measure to meeting the objective, and the trade restrictive impact of the measure; also, alternative measures to achieve the same objective are analysed. with regard to the highly contested issue whether the european ban falls within the scope of public morals (and prevents harm to european citizens), the panel had held that ‘members should be given some scope to define and apply for themselves the concepts of “public morals” in their respective territories, according to their own systems and scales of values. … [w]e are nevertheless persuaded that … animal welfare is an issue of ethical or moral nature in the european union. international doctrines and measures of a similar nature in other wto members … illustrate that animal welfare is a matter of ethical responsibility for human beings in general.’47 this wide interpretation of public morals was upheld by the appellate body: ‘members have the right to determine the level of protection that they consider appropriate. … members may set different 44 see howse, langille and syke, ‘pluralism in practice’ (n. 32), 124 ff. 45 on these, see mj trebilcock and r howse, ‘trade policy & labour standards’ (20042005) 14 minnesota journal of global trade 261. 46 ec – seal products, wt/ds/400/ab/r, wt/ds 401/ab/r, para 5.173. 47 ec – seal products, wt/ds/400/r, wt/ds 401/r, para. 7.409. csr and the law of the wto 132 levels of protection even when responding to similar interests of moral concern … [w]e do not consider that the european union was required by article xx(a), as canada suggests, to address such public moral concerns [slaughterhouses and terrestrial wildlife hunts] in the same way.’48 thus, the appellate body was convinced ‘that the principal objective of the eu seal regime is to address eu public moral concerns regarding seal welfare, while accommodating ic [indigenous communities] and other interests so as to mitigate the impact of the measure on those interests.’49 the panel – upheld by the appellate body also regarded the highly trade restrictive importation and marketing ban as necessary, due to the consideration that the protection of public morals is of highest importance and that ‘[t]o the extent that such seal products are prohibited from the eu market, we find that the ban makes a material contribution to the objective of the measure’ ‘by reducing, to a certain extent, the global demand for seal products and by helping the eu public avoid being exposed to seal products … derived from seals killed inhumanely.’50 also, potential alternative less trade restrictive measures, namely labelling requirements certifying compliance with animal welfare standards, had been dismissed as they would not effectively address the moral concerns and pose significant difficulties in terms of monitoring and compliance.51 what remains is the so-called chapeau in article xx, which provides for a safeguard that ‘such measures are not applied in a manner which would constitute a means of arbitrary or unjustifiable discrimination between countries where the same conditions prevail, or a disguised restriction on international trade’ aims at ensuring that a trade restrictive measure which can invoke one of the exceptions is applied in ‘good faith’ and not misused for protectionist purposes. often, the chapeau is used to address inconsistencies in the measure. in ec – seal products, the appellate body found inconsistencies with the exception of indigenous hunts which it held to amount to arbitrary or unjustifiable discrimination and thus not to meet the requirements of the chapeau. in particular, the exception did not address animal welfare issues of indigenous hunts and did not safeguard sufficiently that no commercial hunts could fall under the exception. moreover, access of canadian inuit to the exception should be facilitated.52 (c) public morals and human rights and labour standards although ec – seal products dealt with animal welfare, its (potential) significance for csr regulation, in particular human rights and labour standards, seems obvious. the relevance of the public moral exception in 48 ec – seal products, wt/ds/400/ab/r, wt/ds 401/ab/r, para. 5.200. 49 ibid., para 5.167. 50 ec – seal products, wt/ds/400/r, wt/ds 401/r, para. 7.637. 51 ibid., paras 7.496 ff. for detailed analysis, see howse, langille and sykes, ‘pluralism in practice’ (n. 32). 52 ec – seal products, wt/ds/400/ab/r, wt/ds 401/ab/r, para. 5.337. njcl 2017/1 133 article xx(a) for the protection of human rights and labour rights has always been highlighted by authors like charnovitz who regarded internationally recognised human rights standards as a classical application of the concept,53 or trebilcock and howse who state that a ‘conception of public morals or morality that excluded notions of fundamental rights would simply be contrary to the ordinary contemporary meaning of the concept’ and that article xx(a) should thus ‘extend to universal human rights, including labor rights’.54 this approach now seems, in principle, to be uncontested also with authors that are concerned about the trade restricting effect of csr approaches: ‘if we agree that human rights are more important than animal welfare in our value scale, internationally recognized human rights norms and standards should definitely come within the scope of the “public morals”’.55 also, following ec – seal products, the extraterritoriality of protected subjects seems to no longer be an obstacle, at least for article xx(a). although the appellate body did not address this issue fundamentally, the fact that the measure aimed at the protection of moral concerns of european citizens and consumers was regarded as sufficient.56 the challenge now relates to striking the balance between the protection of extraterritorial concerns and its misuse as a ‘catch all justification’ for concerns that are otherwise (potentially) not permitted57 or for protectionist purposes.58 indeed, article xx provides for legal safeguards against the misuse of alleged csr aims for protectionist purposes, namely the necessity to provide evidence for the high national value of the particular csr concern, the necessity of the measure, and the chapeau.59 although ec – seal products dealt with a specific european concern which was neither established with reference to an internationally recognised standard nor 53 s. charnovitz, ‘the moral exception in trade policy’ (1998) 38 virginia journal of international law 689, 717 742. 54 trebilcock and howse (n. 45), at 290. 55 du (n. 13), at 695. see also p. serpin, ‘the public morals exception after the wto seal products dispute: has the exception swallowed the rules?’ (2016) columbia business law review 217, at 245 ff. 56 para 5.173. for detailed analysis, see howse, langille and sykes, ‘pluralism in practice’ (n. 32), at 124 et seq., who argue that the measure is exactly concerned about the conduct of eu citizens and consumers who do not want to create a market for cruelly killed seals or become accomplices to these practices. 57 ‘[i]t is simply a shift from protecting foreign seals to eu citizens’ feelings about the seals’, see du (n. 13), at 689. 58 ‘[w]hy couldn’t the us government claim that the us citizens have legitimate moral concerns on gender equality in saudi arabia, human rights in myanmar and labour standards in china?’, see du (n. 13), at 695. 59 see serpin (n. 55). csr and the law of the wto 134 necessarily consistent with (all) other animal treatment concerns,60 for establishing a legitimate csr concern, it might be helpful to refer to internationally recognised human rights or core labour standards61 and to pursue a consistent policy in this regard. similar considerations would, in principle, apply for compliance with the chapeau. here, it would be of particular relevance whether a csr measure does not target specific countries, as opposed to other countries where similar conditions exist.62 with regard to the element of necessity, it is noteworthy that the panel and the appellate body both did not regard a labelling requirement as an alternative, less restrictive instrument; and this was not only because of monitoring and verification problems but also because a mere labelling requirement would not effectively meet the relevant moral concerns.63 2.2. the tbt agreement 2.2.1. the scope of application the tbt agreement is applicable to ‘technical regulations’ and ‘standards’. a technical regulation is defined as a ‘[d]ocument which lays down product characteristics or their related processes and production methods, including the applicable administrative provisions, with which compliance is mandatory. it may also include or deal exclusively with terminology, symbols, packaging, marking or labelling requirements as they apply to a product, process or production method.’ as opposed to a technical regulation, compliance with a standard is voluntary.64 art. 2.1 tbt lays down most-favoured nation and national treatment requirements for like products that are, in principle, similar to those of the gatt.65 article 2.2 tbt prohibits technical regulations from being more trade restrictive than necessary to fulfil a legitimate objective which includes the prevention of deceptive practices, the protection of human 60 see howse, langille and sykes, ‘pluralism in practice’ (n. 32), at 114 ff., who argue that the appellate body did not require philosophical consistency with other moral concerns; at 117 ff., they also argue that the protection of public morals can less be addressed by international standards and principal and instrumental consistency. 61 see also charnovitz (n. 53), at 742. 62 trebilcock and howse (n. 45), at 290; howse, langille and sykes, ‘pluralism in practice’ (n. 32), at 117 ff. 63 see supra, 2.1.2. (b). 64 tbt agreement, annex i 1. a standard is defined in annex i 2. as a ‘[d]ocument approved by a recognized body, that provides, for common and repeated use, rules, guidelines or characteristics for products or related processes and production methods, with which compliance is not mandatory. it may also include or deal exclusively with terminology, symbols, packaging, marking or labelling requirements as they apply to a product, process or production method.’ 65 see infra, 2.2.2., although the appellate body does regard the scope and content of these provisions not to be entirely identical, see e.g. tuna dolphin ii, wt/ds381/ab/r, para. 405. njcl 2017/1 135 health or safety, animal or plant life or health, or the environment. the list is non-exhaustive. for example, the appellate body has also accepted consumer protection and fair competition as legitimate objectives.66 (a) the discussion here, it had been discussed for long whether or not the tbt agreement is applicable to (extraterritorial) production methods at all (or whether they fall under the gatt instead). the opponents of an inclusion of ‘nprppms’ into the tbt agreement argued with the wording of annex i 1., which refers to product characteristics or ‘their related’67 processes and production methods whereas ‘related’ was interpreted as traceable within the physical characteristics of the concrete product. a subsequent question was whether labelling requirements would also have to relate to the physical characteristics of the product, as the second sentence of annex i 1. does not explicitly contain this reference.68 (b) the impact of tuna dolphin ii tuna dolphin ii69 dealt with us provisions which only allow the use of a ‘dolphin-safe’ label or any other form of description as ‘dolphin-safe’ for tuna caught in the eastern tropical pacific ocean (etp) on the us market if dolphins are not intentionally chased, encircled or netted during an entire tuna fishing trip and if this is confirmed by an independent observer thus with an extraterritorial fishing method. neither the panel nor the appellate body discussed a (potential) distinction between product related and non product related process and production methods at all. the panel regarded the us labelling provisions as product related as they ‘apply to a product’ without even considering the fact that the label deals with ‘dolphin-safe’ fishing methods, which cannot be traced in the tuna (products).70 this finding remained uncontested. the appellate body even regarded the us regulation as more encompassing than a mere labelling requirement, because it laid down comprehensively the use of the term ‘dolphin-safe’, and thus as a technical regulation within the meaning of the first sentence in annex i.1. again without even mentioning a 66 see european communities – trade description of sardines, wt/ds231/ab/r, para. 287. 67 emphasis added by the author. 68 see e.g. joshi (n. 12), at 74 f. with reference to the negotiation history of the agreement. see also s. puth, wto und umwelt – die produkt-prozess-doktrin (duncker & humblot, 2003), at 217 ff.; c. tietje, ‘voluntary eco-labelling programmes and questions of state responsibility in the wto/gatt legal system’ (1995) 29(5) journal of world trade 123, at 135. for deviating views see e. vranes, trade and the environment, fundamental issues in international law, wto law and legal theory (oxford university press, oxford, 2009), at 319 ff., 342 ff.; c. conrad, process and production methods (ppms) in wto law – interfacing trade and social goods (cambridge university press, cambridge, 2011), at 385 ff. 69 united states – measures concerning the importation, marketing and sale of tuna and tuna products, wt/ds381. 70 tuna dolphin ii, wt/ds381/r, paras 7.71 ff. csr and the law of the wto 136 potentially required relation to the physical characteristics of the product.71 it held that ‘the us measure prescribes in a broad and exhaustive manner the conditions that apply for making any assertion on a tuna product as to its "dolphin-safety", regardless of the manner in which that statement is made. as a consequence, the us measure covers the entire field of what "dolphin-safe" means in relation to tuna products. for these reasons, we find that the panel did not err in characterizing the measure at issue as a "technical regulation" within the meaning of annex 1.1 to the tbt agreement.’72 thus, according to that ruling, the tbt agreement covers all (technical) product requirements, be they product related or production related.73 accordingly, authors have already claimed the ‘end of the ppm distinction’.74 2.2.2. discrimination of ‘like products’ under the tbt agreement similar considerations as under the gatt apply to the feasibility of a different treatment of ‘like products’ based upon different production methods under the tbt agreement. as opposed to the latest ruling under the gatt in ec – seal products, however, the appellate body in tuna dolphin ii followed the line of reasoning set up in us clove cigarettes75 that it takes two steps to define de facto discrimination. in addition to the question whether the measure modifies the conditions of competition, it must be established that the detrimental impact on competitive opportunities reflects discrimination. the latter translates into the question whether the measure pursues legitimate objectives and could be regarded as ‘calibrated’ and ‘even-handed’.76 again, the legitimacy of addressing fishing methods which adversely affect animals (dolphins) which are neither endangered nor present inside us territory was not questioned at all. however, the labelling requirement reduced competitive opportunities of mexican tuna products considerably, because the mexican fleet was still setting on dolphins in order to catch the tuna. the panel had found that it was not the us measure as such, which made it impossible or difficult for mexican tuna producers to comply with, but the persisting fishing and purchasing choices of the mexican producers 71 tuna dolphin ii, wt/ds381/ab/r, paras 190 ff. 72 ibid., para 199. 73 for detailed analysis, see r. howse and m.a. crowley, ‘tuna-dolphin ii: a legal end economic analysis of the appellate body report’ (2014) 13 world trade review 321, at 325 ff. 74 j. pauwelyn, ‘tuna: the end of the ppm distinction? the rise of international standards?’, <worldtradelaw.typepad.com/ielpblog> accessed 29 may 2017. 75 us clove cigarettes, wt/ds/406/ab/r, para 161 et seq. 76 tuna dolphin ii, wt/ds381/ab/r, para. 215: ‘whether that technical regulation is even-handed’, ‘panel must further analyse whether the detrimental impact on imports stems exclusively from a legitimate regulatory distinction rather than reflecting discrimination against the group of imported products.’ njcl 2017/1 137 themselves and thus it was ‘not persuaded that … the united states affords mexican tuna products “less favourable treatment” than that afforded to tuna products originating in the united states or in any other country …’.77 the appellate body, however, did not regard the measure as even-handed, mainly due to the fact that the labelling requirements did not include comparable requirements for tuna caught outside the crucial maritime area where the tuna/dolphin gatherings occurred (eastern tropical pacific).78 thus, as opposed to article iii:4 gatt, in principal, a governmental measure which leads to a change in competitive relations does not necessarily constitute an infringement of article 2.1 tbt as long as it can be based upon a legitimate regulatory distinction and is applied in a ‘calibrated’ and ‘even-handed’ manner. to this end, it is legitimate to distinguish on the basis of production methods which are concerned with the protection of at least certain extraterritorial objects or subjects, such as animals. 2.2.3. interim conclusion on the extraterritoriality issue both rulings, tuna dolphin ii and ec – seal products, dealt with animal welfare. nevertheless, they provided for some clarification of the admissibility of csr production requirements, which could be summarised as follows: first, the wto provides for no principal obstacle to a measure dealing with extraterritorial situations. although there are doctrinal differences concerning the national treatment requirements in gatt and tbt, these differences are not related to the extraterritoriality of a measure, and the protection of extraterritorial animals has been regarded as a legitimate policy aim under both agreements, at least as long as it related to the sale of products on the domestic market of the regulating state. second, the impact, at least of ec – seal products, is not delimited to animal welfare, as the same moral considerations all the more apply to human welfare as laid down in many human rights or core labour rights oriented csr standards. third, although the previous rulings justified extraterritorial production requirements ‘only’ with articles xx(a) and (g) gatt and legitimate policy aims under the tbt agreement, there is no reason not to extend this extraterritorial approach also to article xx(b) gatt, which protects human, animal or plant life or health and which could be invoked for health and safety at workplace requirements. ec – seal products addressed moral perceptions about animal welfare, and tuna dolphin ii animal welfare as such, while both 77 tuna dolphin ii, wt/ds381/r, paras 7.319., 7.377., 7.375 and 7.378. 78 tuna dolphin ii, wt/ds381/ab/r, paras 228 ff., 282 ff. for critical analysis of the application of the evenhandedness test in this ruling, see in particular, howse and crowley (n. 73), 328 ff, who argue that in order for an origin neutral requirement to be not evenhanded it requires not a random effect on marketing shares but a regulatory specific obstacle for foreign products such as e.g. a requirement for a very specific technology. csr and the law of the wto 138 species, seals and dolphins, were not endangered. thus, the measures were not related to the protection of global exhaustible resources as mentioned in article xx(g) gatt but simply protected the welfare of extraterritorial animals, which constitutes a classical article xx(b) gatt situation. thus, although there seem to be no more fundamental obstacles to the pursuance of csr goals, they have to be drafted carefully in order not to be regarded as disguised protectionist measures (in particular under the chapeau of article xx gatt). the devil will be in the details of the concrete case. 3. attribution of private or voluntary csr measures to the state 3.1. the discussion as mentioned above, most csr measures, however, are not imposed upon corporations by compulsory state law requirements but range from purely private (self-)regulation to various forms of state incentives. the law of the wto, however, is, in principle, concerned with trade restrictive measures of member states, not of private actors. for example, the gatt speaks in article iii:1 and iii:4 of ‘laws, regulations and requirements’ of a ‘contracting party’, and in article xi of ‘measures’ by a ‘contracting party’ or of ‘governmental measures’. the tbt agreement refers to ‘technical regulations’ or ‘labelling requirements’. nevertheless, one line of argument is based upon the observation that the de facto practice of private market actors can be as trade restrictive and as coercive as mandatory state law requirements. for example, it is argued that de facto adherence to a voluntary label could render the related voluntary requirements de facto mandatory and should thus be an issue of wto law.79 in fact, private activities have already been discussed under the umbrella of wto law, however with regard to the question of what types of state involvement in private actions are necessary to trigger wto rules. both panels in japan – restriction on imports of certain agricultural products80, which concerned a non-legally binding agricultural programme, and in japan – trade in semiconductors,81 which concerned a voluntary export limiting scheme which private producers adhered to, found that a governmental ’measure’ in the terms of article xi gatt encompasses more than a ‘law or regulation’. also, both rulings focused on the effectiveness of the measure, not on its legal character. however, two criteria were set up in order for a private measure to be attributed to the state and thus to constitute a governmental measure: there have to be sufficient state incentives for the measure to take effect, and the measure 79 see e.g. vidal-léon (n. 11), at 898 ff. 80 japan – restrictions on imports of certain agricultural products, bisd 35s/163 (1988). 81 japan – trade in semiconductors, bisd 35s/116 (1988). njcl 2017/1 139 has to be essentially dependant on government action or intervention.82 in eec – dessert apples,83 the panel regarded a privately administered apple marketing scheme, which had been established by an eec regulation and the operation of which was based upon eec decisions and public financing, as a governmental measure.84 japan – kodak/fuji85 concerned a private self-regulatory code of conduct of the japanese photographic film and paper industry which was accompanied by private enforcement councils and which impacted upon the competitive opportunities of us producers. the government was involved in the drafting of the code and approved the final code. the panel regarded this involvement as sufficient to qualify as a governmental measure, in particular, in order to prevent wto disciplines to be circumvented through a member’s delegation of quasi-governmental authority to private enforcement bodies.86 korea – beef87 concerned a korean so-called ‘dual retail’ scheme which required retailers to choose between either selling domestic or selling foreign beef only. although the decision of the private retailers on what to sell was completely voluntary, the appellate body held that ‘[t]he legal necessity of making a choice was, however, imposed by the [governmental] measure itself’.88 this ruling has also been confirmed by the appellate body in us – cool89 dealing with origin labelling requirement.90 in canada – automobiles,91 the appellate body regarded a canadian voluntary ‘valueadded content’ scheme which led to importation duty exceptions as mandatory. within the field of csr measures, the public-private, mandatoryvoluntary distinction has gained particular attention in the area of voluntary (eco-) labels. here, one line of argument considers voluntary labels as a means of market-based self-regulation regardless of whether the label is privately or publicly administered, at least as far as no concrete compliance incentives are included which does not invoke wto disciplines. moreover, voluntary labels are considered as less trade restrictive than other measures which aim at the protection of legitimate 82 for detailed analysis, see r.j. zedalis, ‘when do the activities of private parties trigger wto rules?’ (2007) 10 journal of international economic law 335, at 340 ff. 83 eec – restrictions on imports of dessert apples-complaint by chile, gatt doc. l/6491, 36s/93 bisd (1990). 84 see zedalis (n. 82), at 343 ff. 85 japan measures affecting consumer photographic film and paper, wt/ds44/r. 86 for detailed analysis, see zedalis (n. 82), at 344 ff. 87 korea – measures affecting import of fresh, chilled and frozen beef, wt/ds161/ab/r and wt/ds169/ab/r. 88 ibid., para 146. 89 us – certain country of origin labelling (cool) requirements, wt/ds/384/ab/r, wt/ds/386/ab/r. 90 ibid., para 291. 91 canada – certain measures affecting the automotive industry, wt/ds139/ab/r, wt/ds142/ab/r. csr and the law of the wto 140 goals.92 others argue that the de facto practice of private market actors can be as coercive as mandatory requirements.93 thus, the de facto adherence to e.g. a voluntary label can render the respective voluntary requirements de facto mandatory. the situation becomes even more complicated when state measures provide for certain incentives to comply with a voluntary (labelling) requirement.94 3.2. the impact of tuna dolphin ii: mandatory vs. voluntary under the tbt agreement, the full state responsibility for product or labelling requirements translates to the question whether compliance with these requirements is mandatory.95 tuna dolphin ii dealt with mandatory minimum requirements for a voluntary ‘dolphin-safe’ label or any other voluntary ‘dolphin-safe’ description. hitherto, the great majority of authors had categorised this type of regulation, which lays down (mandatory) requirements for a voluntary label, as voluntary.96 the panel, however, regarded the labelling requirement as mandatory. the panel admitted that there was ‘a basic distinction between a "requirement", which refers to the conditions or criteria to be fulfilled in order to comply with a document, and the notion of "mandatory" requirement as a condition made compulsory by law.’97 thus, the characterisation ‘must be based on considerations other than, or beyond, the mere fact that such document establishes criteria for the use of a certain label.’98 it then, however, focussed on the fact that ‘[i]n particular, the measures prescribe "in a negative form" […] that no tuna product may be labelled dolphin-safe or otherwise refer to dolphins […] if it does not meet the conditions set out in the measures, and thus impose a prohibition (‘in a binding and exclusive manner’ ‘subject to specific enforcement measures’99) on the offering for sale in the united states of tuna products 92 e.g. h.r. trüeb, umweltrecht in der wto (schulthess, 2001), 453. joshi (n. 12), at 69 ff., sees no sufficient relation between a voluntary eco-label and a national measure – regardless of whether the label is privately or publicly administered. from japan – measures consumer photographic film and paper, wt/ds44/r, and canada – certain measures affecting the automobile industry, wt/ds139/ab/r, wt/ds142/ab/r, results that a relation between compliance with the label and a national benefit is necessary. 93 see e.g. vidal-léon (n. 11), at 898 ff. 94 for an overview of the discussion, see e.g. e. vranes, ‘climate labelling and the wto’ (2011) 2 european yearbook of international economic law 205, at 207 f.; joshi (n. 12), at 69 ff.; j. pauwelyn, ‘recent books on trade and environment: gatt phantoms still haunt the wto’ (2004) 15(3) european journal of international law 575. 95 see annex 1.1 of the tbt agreement. 96 see, e.g., vranes (n. 94), at 209 ff.; joshi (n. 12), at 70 ff.; puth (n. 68), at 40, 217; trüeb (n. 92), at 448; conrad (n. 68), at 382 ff. 97 tuna dolphin ii, wt/ds381/r, para vii.116. 98 ibid., para vii.117. 99 ibid., paras vii.127 ff. njcl 2017/1 141 bearing a label referring to dolphins and not meeting the requirements that they set out.’100 although the appellate body admitted that the fact of a (mandatory) ‘requirement’ (for a voluntary label) does not in itself render a measure a technical regulation,101 it upheld the findings of the panel with regard to the particular circumstances of the case, and especially to the fact that legislation by state authorities that contains specific enforcement mechanisms lays down exclusive requirements for the broad subject of dolphin safety.102 in detail, the appellate body considered ‘whether the measure consists of a law or a regulation enacted by a wto member, whether it prescribes or prohibits particular conduct, whether it sets out specific requirements that constitute the sole means of addressing a particular matter, and the nature of the matter addressed by the measure.’103 it held that ‘the us measure prescribes in a broad and exhaustive manner the conditions that apply for making any assertion on a tuna product as to its "dolphin-safety", regardless of the manner in which that statement is made. as a consequence, the us measure covers the entire field of what "dolphin-safe" means in relation to tuna products. for these reasons, we find that the panel did not err in characterizing the measure at issue as a "technical regulation" within the meaning of annex 1.1 to the tbt agreement.’104 thus, at least this type of exclusive and encompassing requirements for a specific subject addressed by a voluntary label or description laid down by state regulation can be regarded as a technical regulation for which the respective state is fully responsible, although this has been highly criticised in the literature.105 100 ibid., para. vii.131. 101 tuna dolphin ii, wt/ds381/ab/r, paras 187 f. 102 ibid., paras 188 ff., 193. hereby, the appellate body highlights the ruling in ec – sardines, wt/ds231/ab/r, para. 176, that a regulation must apply to an identifiable product or group of products, it must lay down characteristics of the product, and ‘compliance with the product characteristics must be mandatory’. according to the appellate body the situation in both cases is similar: whereas in ec – sardines other species of sardines could be marketed on the ec market, provided they are not called ‘sardines’, here, tuna products could be marketed, provided they are not called ‘dolphinsafe’ (!). on this see also the amicus curie submission by r. howse, <www.worldtradelaw.net/amicus/howsetunaamicus.pdf> accessed 29 may 2017 , at 4 ff., who highlights the point that it depends on the relevant ‘identifiable product’ if a regulation could be regarded as mandatory. in ec – sardines, the relevant product was ‘sardines’ whereas here the relevant product in tuna dolphin ii was defined as ‘tuna’ or ‘tuna products’, not as ‘dolphin-safe tuna’ (!). 103 ibid., para. 188. 104 ibid., para. 199. 105 see e.g. howse and crowley (n. 73), at 324, who regard this characterization as a ‘fundamentally erroneous finding’. csr and the law of the wto 142 3.3. conclusion from the above, a certain likelihood of csr measures to be attributed to the state can be deduced. mandatory production requirements for certain products, such as the turtle extruder in shrimp catching in us-shrimps-turtles, are clearly regarded to be state measures. this applies equally to potential csr measures such as an importation and marketing ban for carpets knotted by children or garments not produced under certain minimum fire safety conditions. although less intrusive, mandatory certification requirements, for example the requirement to put a label on carpets either declaring ‘knotted without child labour’ or ‘knotted by children’ would also be regarded as compulsory and thus attributable to the state. the same should apply to reporting duties, such as those laid down in the new eu csr reporting directive 2014/95/eu,106 which require certain big companies to report on their csr activities or to declare that they do not have any csr policies in place, and which are also meant to inform and influence market actors. other examples are sec. 1502 of the us dodd frank act107 or the proposed eu regulation on conflict minerals.108 this can be derived from korea – beef and us – cool, which also dealt with the legal necessity to make a decision and to declare. also, minimum requirements for voluntary certificates as a precondition for either support schemes, such as those laid down in the eu renewable energy directive for biofuels109, or for public procurement, would likely be regarded as state based. considerable financial support or public supply contracts, the conditions of which are codified in domestic legislation, could be regarded as ‘sufficient state incentives for the measure to take effect, and the measure to be essentially dependant on government action’ as referred to in japan – trade in semiconductors and other decisions. even without state incentives, encompassing mandatory minimum requirements for a certain type of voluntary label, thereby excluding alternative labels as in tuna dolphin ii, evoke full state responsibility. in contrast, although it is not entirely clear, the reasoning in tuna dolphin ii suggests that mandatory minimum requirements for a state based voluntary label which, however, do not exclude alternative labels, might not be regarded as (technical) regulation but merely as voluntary 106 directive 2014/95/eu amending directive 2013/34/eu as regards disclosure of non-financial and diversity information by certain large undertakings and groups, [2014] oj l 330/1. 107 dodd–frank wall street reform and consumer protection act. 108 proposal for a regulation setting up a union system for supply chain due diligence self-certification of responsible importers of tin, tantalum and tungsten, their ores, and gold originating in conflict-affected and high-risk areas, com(2014) 111 final. 109 directive 2009/28/ec on the promotion of the use of energy from renewable sources [2009] oj l 140/16. njcl 2017/1 143 standards. furthermore, there is no indication in wto dispute settlement reports of state responsibility for purely private standards, even if they create a de facto obstacle to trade.110 similarly, the political promotion of voluntary csr standards, the organisation of round tables with business representatives (and ngos) in order to set up csr standards and other assistance in the drafting or implementation of standards like national ‘alliance for sustainable garment’ would not be characterised as state based as long as resulting private csr schemes provide for no indication that they in fact constitute a delegation of quasi-governmental authority to private bodies and thereby try to circumvent state responsibility (as was the situation in eec – dessert apples or japan – kodak/fuji).111 in order to approach this distinction, zedalis has suggested to refer to the general rules of state responsibility under public international law where state planning, direction and support or control are regarded to be necessary, thus a relatively high threshold.112 instead, voluntary standards would come under article 4 of the tbt agreement which requires member states to ‘ensure that their central government standardizing bodies … take such reasonable measures as may be available to them to ensure that … non-governmental standardizing bodies within their territories … [accept and comply] with the code of good practice’, that is, the code of good practice for the preparation, adoption and application of standards in annex 3 to this agreement. the code of good practice, in principle, requires standardisation bodies to ensure that their standards do not create unnecessary obstacles to trade, treat products from one country no less favourable than others and, in particular, to base their standards on international standards as far as appropriate. with regard to transnational private csr standardisation activities, however, it would seem difficult to attribute their activities to a particular state that might then be required to take reasonable measures to influence them.113 4. csr regulation as ‘international standards’ rather than being an obstacle to trade, private csr regulation could in fact play a positive role in constituting ‘international standards’ under the tbt agreement, which could justify national csr approaches based upon these standards. the tbt agreement aims at achieving international 110 although it was argued that in situations where a small number of retailers account for a high proportion of market share ‘the distinction between private voluntary standards and mandatory ‘official’ or ‘public’ requirements can blur.’ see private standards and the sps agreement: note by the secretariat, committee on sanitary and phytosanitary measures, 24 january 2007, g/sps/gen/756, para 9. 111 see also zedalis (n. 82), at 345 ff. 112 zedalis (n. 82), at 356 ff. 113 see also vidal-léon (n. 11), at 903 ff., who has spotted this problem with a view to the drafting of technical regulations. csr and the law of the wto 144 harmonisation of technical regulations including marking and labelling standards through the recognition of international standards. to this end, article 2.4 requires member states to base their technical regulation on international standards. vice versa, those national measures that are based on an international standard are (rebuttably) justified as not being arbitrary, discriminatory or unnecessarily protective and thus in conformity with the tbt agreement, article 2.5 tbt. according to annex 1, point 2 tbt a ‘standard’ is a ‘[d]ocument approved by a recognised body that provides, for common and repeated use, rules, guidelines and characteristics for products and related processes and production methods, with which compliance is not mandatory. it may also include or deal exclusively with … labelling requirements as they apply to a product, process or production method’. a standard constitutes an international standard, when it is adopted by an international ‘[b]ody or system whose membership is open to the relevant bodies of at least all members’, annex 1, point 4. a ‘standardizing body’ is defined as a ‘body that has recognised activities in standardization’.114 therefore, an ‘international standard’ has to be approved ‘by an “international standardizing body”, that is, a body that has recognised activities in standardization and whose membership is open to the relevant bodies of at least all members.’115 annex 3 of the tbt explains that its requirements are open for acceptance for all standardising bodies, be they governmental or non-governmental, local, national, regional or international. a nongovernmental body is defined as one ‘which has legal power to enforce a technical regulation’, annex 1 point 8.116 the tbt committee’s decision on principles for the development of international standards (‘committee decision’)117 adds the procedureoriented principles of transparency, openness, impartiality and consensus, effectiveness, relevance and coherence, and of addressing the concerns of developing countries for the development of international standards. 114 iso/iec guide 2: 1991. 115 tuna dolphin ii, wt/ds381/ab/r, paras 349 ff, in particular at 359. here, the appellate body also clarified that a ‘body’ (‘legal or administrative entity that has specific tasks or composition’ (iso/iec guide 2: 1991, 4.1)) is enough to enact an international standard; it is not necessary to have an ‘organization’ (‘body that is based on the membership of other bodies or individuals and has an established constitution and its own administration’ (iso/iec guide 2: 1991, 4.2)), ibid, at 351 ff. 116 see also j. pauwelyn, ‘non-traditional patterns of global regulation: is the wto ‘missing the boat’?’ in c. joerges and e.-u. petersmann (eds), constitutionalism, multilevel trade governance and international economic law (hart publishing, oxford, 2011) 199, at 210. 117 decision of the committee on principles for the development of international standards, guides and recommendations with relation to articles 2, 5 and annex 3 of the agreement, second triennial review of the operation and implementation of the agreement on technical barriers to trade, annex iv, g/tbt/9, 13 november 2000, sec. a. 24-26. njcl 2017/1 145 4.1. the discussion there is no doubt that private organisations, such as the international organization for standardization (iso), can be international standardisation bodies. the question is, however, whether it is necessary for an international standardisation body to be composed of ‘national bodies’ or whether purely private stakeholder driven systems, which adhere to fair and inclusive procedures, could also be regarded as ‘international bodies’.118 on the one hand, an organisation that is composed of national bodies guarantees far better the necessary international consensus, given that it is the national bodies which have to implement the international standards in their national norms. on the other, private csr standards which have been directly negotiated in line with procedural fairness between the relevant interests – for example, industry, environmental protection and consumer interests including industry and civil society from developing countries – could reflect a more direct and inclusive consensus between the concerned different protection interests and could be more flexible with regard to local particularities.119 pauwelyn has characterised this conflict as ‘thin (state driven) consent’ vs. ‘thick (stakeholder driven) consensus’.120 the principles of the committee decision have not solved the conflict as now delegations and a fair inclusive procedure are mentioned. indeed, there is an increasing amount of encompassing private transnational csr standard setting systems which systematically adjust their structure and procedures to the above mentioned requirements of the annex to the tbt agreement, such as the ‘forest stewardship council’, the ‘marine stewardship council’ or ‘fair trade’ labels.121 at the 118 for details of the discussion, see h. schepel, the constitution of private governance: product standards in the regulation of integrated markets (hart publishing, oxford, 2005), 185 ff. 119 see, e.g., schepel (n. 118), at 28, 35. see also e. meidinger, ‘multi-interest selfgovernance through global product certification programmes’ in o. dilling, m. herberg and g. winter (eds), responsible business: self-governance and the law in transnational economic transactions (hart publishing, oxford, 2007) 259; k. bizer, ‘kooperative umweltpolitik im internationalen kontext – global law making am beispiel nachhaltiger forstwirtschaft’ in b. hansjürgens, w. köck and g. kneer (eds), kooperative umweltpolitik (nomos 2003) 57 regarding the ‘forest stewardship council’. 120 see j. pauwelyn, r. a. wessel and j. wouters, ‘informal international lawmaking: an assessment and template to keep it both effective and accountable’, in id. (eds), informal international lawmaking (oxford university press, oxford, 2012) 500, at 524 ff. for procedural requirements in the ‘standardisation community’ see schepel (n 118), at 101 ff.; h. schepel, ‘the empire’s drains: sources of legal recognition of private standardisation under the tbt agreement’ in c. joerges and e.-u. petersmann (eds), constitutionalism, multilevel trade governance and international economic law (hart publishing, oxford, 2011) 397, at 399 f. 121 see also bernstein and hannah (n. 11). csr and the law of the wto 146 same time, increasingly, national csr regulation refers to these programmes or to their contents.122 4.2. the impact of tuna dolphin ii in us – tuna dolphin ii, the appellate body rejected the panel’s finding, that a dolphin-safe label set up by an international organisation, the ‘interamerican tropical tuna commission’, was the relevant ‘international standard’ in terms of the tbt agreement because it was not ‘open to the relevant bodies of at least all members.’123 a possible membership to that commission was based on the requirements of either having a coastline bordering the eastern tropical pacific ocean (etp) or having vessels fishing for tuna in the etp or being otherwise invited to join the agreement, and thus did not provide for the inclusion of (members pursuing) other interests than fishing. instead, the appellate body clarified that for a standardisation ‘body’ it is not necessary to have an ‘organization’which is defined as a ‘body that is based on the membership of other bodies or individuals and has an established constitution and its own administration’124 but the development of a single standard could be enough.125 it further emphasised the tbt committee’s procedure-oriented principles of transparency, openness, impartiality and consensus, effectiveness, relevance and coherence, and of addressing the concerns of developing countries for the development of international standards126 and highlighted that standards development must ‘take place transparently and with wide participation’ of ‘all interested parties’ which also aims at stakeholders127 and ‘must not privilege any particular interests.’128 this emphasis on (fair and inclusive) procedures where ‘all interested parties’ have the chance of giving input instead of on (state based) organisation can be regarded as a considerable step into the direction of recognition of private transnational csr standards as ‘international standards’ in case they meet the relevant legitimacy requirements. thus, 122 see bernstein and hannah (n. 11). in bolivian law and brazilian administrative practice, enterprises which have been certified by the ‘forest stewardship council’ are assumed to manage their forests in in a sustainable way in accordance with the legal requirements. for brazil, see c. derani and j.a. fontoura costa, ‘state and private sector in a cooperative regulation: the forest stewardship council and other product labels in brazil’ in dilling, herberg and winter (n. 119) 301; for bolivia, see e. meidinger, ‘forest certification as environmental law making by global civil society’ in e. meidinger, c. elliott and g. oesten (eds), social and political dimensions of forest certification (kessel, 2003) 315. for more details see meidinger (n. 119), at 275 ff. 123 tuna dolphin ii, wt/ds/381/ab/r, para. 386. 124 iso/iec guide 2: 1991, 4.2. 125 tuna dolphin ii, wt/ds/381/ab/r, paras 349 ff., in particular para 359. 126 committee decision (n. 114), sec. a. 24-26. 127 tuna dolphin ii, wt/ds/381/ab/r, para. 379. 128 ibid., para. 384. njcl 2017/1 147 they can play an increasingly important role in defining whether or not a (national) concern is legitimate and whether or not a country has acted in a non-discriminatory manner.129 5. conclusion and prospects the two appellate body rulings in tuna dolphin ii and ec – seal products provide for a complex and mixed picture as to the admissibility of csr measures. on the one hand, in ec – seal products the appellate body applied a very broad concept of (de facto) discrimination, with the consequence that every csr regulation which impacts negatively on the competitive opportunities of imported products would be regarded prima facie as an infringement of article iii:4 gatt, which would have to be justified under article xx gatt. thus, this decision supports a broad interpretation of wto law as creating a general positive right of market access which can only be delimited for certain legitimate codified or accepted reasons, an opinion which is primarily pursued by opponents to csr regulation. on the other hand, the pursuance of extraterritorial protection aims was accepted in both decisions as a legitimate policy goal under article xx gatt and under the tbt agreement without further discussion. the protection of domestic moral perceptions (ec – seal products) and the relation to domestically marketed products (tuna dolphin ii) have been regarded as sufficient territorial nexus,130 an argument put forward by those who favour a narrow interpretation of wto law, focusing on non-discrimination. second, while the extraterritoriality of csr protection aims is not a fundamental hurdle to their admissibility under wto law, the devil is within the details, and csr measures, in particular those which aim at the protection of health and safety and labour standards, will have to be drafted carefully in order to not constitute a protectionist and disguised discriminatory measure. third, tuna dolphin ii has extended state responsibility slightly by including mandatory legal requirements for the voluntary use of a label or declaration into the concept of technical regulations. however, there is no indication from the reasoning in tuna dolphin ii or from other case law as 129 see also j. pauwelyn, ‘rule-based trade 2.0? the rise of informal rules and international standards and how they may outcompete wto treaties’ (2014) 17 journal of international economic law 739, at 742 ff.; see further n. hachez and j. wouters, ‘a glimpse at the democratic legitimacy of private standards: assessing the public accountability of global g.a.p.’ (2011) 14 journal of international economic law 677; for extensive discussion, see c. glinski, ‘competing transnational regimes under wto law’ (2014) 30(78) utrecht journal of international and european law 44. 130 on a suggestion on how to balance these two approaches, in particular consumer preferences and producer needs, see i. cheyne, proportionality, proximity and environmental labelling in wto law (2009) 12 journal of international economic law 927. csr and the law of the wto 148 to whether states should be held responsible for purely private csr measures beyond those enshrined in article 4 tbt that states should take reasonable and available measures to ensure that also voluntary standardisation activities within their territories are based upon international standards and do not create unnecessary or discriminatory obstacles to trade. tuna dolphin ii has increased the likelihood for procedurally fair and inclusive (private) transnational csr standards to be accepted as ‘international standards’ under the law of the wto. those private standards would in turn legitimise national csr measures based upon them. this option indeed seems to be an incentive for a variety of private or public-private csr initiatives to adopt their standards in the required inclusive (in particular with regard to the needs of developing countries) and procedurally fair manner. building upon this incentive also seems to be the way forward with regard to a non-protectionist social embedding of transnational markets instead of trying to discipline even private csr decisions with state responsibility.131 131 in this direction, see also bernstein and hannah (n. 11). 1 regulating equity crowdfunding service providers an innovation-oriented approach to alternative financing elif härkönen* * dr. elif härkönen (docent), associate professor at linköping university, sweden. equity crowdfunding service providers 202 1. introduction ................................................................................... 203 2. the regulatory framework covering crowdfunding platforms .......................................................................................... 206 2.1. the evolution of financial services regulation in the european union .......................................................... 206 2.2. the rise of crowdfunding as a business model ..... 208 2.3. a new alternative financing form for small and medium-sized companies .................................................. 209 2.4. nordic approaches to the regulation of digital platforms in equity crowdfunding ........................... 212 3. a modest proposal for harmonization of the european crowdfunding market................................................................ 216 3.1. a harmonized european regulation on crowdfunding service providers ................................ 216 3.2. using an opt-in regulatory technique-achieving a single financial services market? .............................. 219 4. is the legal environment important for the development of crowdfunding? ............................................ 221 4.1. is the regulation of crowdfunding service providers decisive for the development of the alternative finance market? ....................................... 221 4.2. is the regulation of crowdfunding project owners decisive for the development of the alternative finance market?.................................................................. 223 5. conclusion ....................................................................................... 228 njcl 2018/1 203 abstract in recent years the advancements in technology have led to an upheaval in many markets. in the financial sector, technological innovations have led to the emergence of technology-enabled financial services, ranging from new product offerings to new business concepts. in this article, the regulatory challenges facing online intermediary platforms, and in particular equity-based crowdfunding platforms, are discussed more in detail. an integral part of crowdfunding is the prevalence of actors who provide crowdfunding services, operating digital crowdfunding platforms, where the business funding interest of investors and companies is matched. equity-based digital platforms have over the past few years become an important financing alternative, especially for small and medium-sized growth companies. however, such platforms have only recently attracted the attention of regulators. in this article, the regulatory framework covering equity-based crowdfunding platforms in the nordic countries is discussed in detail. it is concluded that the nordic countries have very different approaches to regulating crowdfunding platforms, hindering the development of a pan-nordic market in equity crowdfunding. the proposal for a pan-european opt-in legislation covering crowdfunding service providers (csps) is likely to complicate the regulatory framework in the nordic countries even further. although the nordic countries have chosen different paths in regulating equity-based csps, the regulatory regime each country has chosen for the registration or authorization of csps does not seem to be decisive of the success of local equity crowdfunding markets. this does not mean that regulation of the sector is irrelevant for the success of an alternative finance market. on the contrary, the regulatory requirements on crowdfunding project owners seem to have a significant effect on the development of the market. it is suggested in the article that the dismal development of equity crowdfunding in norway and denmark is likely to be caused by the restrictions on offers in private company shares on online intermediary platforms in the two countries, and not by the admittedly burdensome authorization requirements applicable to csps. the legal environment is thus of importance for the development of equity crowdfunding in individual nordic countries, although not in the way it is usually perceived to be of importance. 1. introduction in recent years, the advancements in technology have led to an upheaval in many traditional markets.1 in the financial sector, cutting 1 this paper builds on previous research on equity-based crowdfunding published by the author, see elif härkönen, ‘crowdfunding and the small offering exemption in european and us prospectus regulation– striking a balance between investor protection and access to capital?’ (2017) 14 eur comp and fin l rev 121; elif härkönen, ‘investeringsbaserad gräsrotsfinansiering– en expanderande marknad utan equity crowdfunding service providers 204 edge innovations fuel the emergence of technology-enabled financial services, forming part of a growing fintech sector. the growth of crypto-assets, block chain technology, cloud services and other fintech products presents regulatory challenges both at the european and national level. at the same time as it is important to encourage financial innovation, which can provide consumers with more choices as well as better suited or more accessible products, it is necessary to ensure a high level of investor protection and integrity in the financial system.2 the digitalization of products and services has been instrumental to the development of the “platform economy”. companies that form part of the platform economy use online platforms to reach their customers. from a legal perspective, the challenge lies in regulating a triangular relationship, involving the supplier of the goods or services and the platform, as well as the platform and the customer. the platform is not usually part of the contract between the supplier and the customer but is often in some sort of legal relationship both with the supplier and the customer.3 the platform economy covers companies in such diverse sectors as car transport services (uber, lyft), accommodation services (airbnb, homestay) and food delivery services (ubereats, delivery hero). the challenges with regulating the platform economy have been discussed to some extent in legal circles, with particular attention paid to consumer law aspects, circumvention of labor law and competition law issues.4 in this article, the focus is on the financial services sector and the regulatory challenges facing equity-based crowdfunding platforms. crowdfunding can be described as an “open call via the internet for the provision of funds by the public at large to support specific initiatives by typically small fundraisers.”5 equity-based crowdfunding involves an individual or institutional investor who purchases an equity security issued by a company. an integral part of crowdfunding is the reglering’ (2016–2017) 3 juridisk tidskrift 674; elif härkönen, ‘investerarskyddet vid gräsrotsfinansiering– om intressekonflikter, asymmetrisk information och effektiva marknader’ (2017) 1 nordisk tidsskrift for selskabsret 45. 2 commission, ‘fintech action plan: for a more competitive and innovative european financial sector’ (communication from the commission to the european parliament, the council, the european central bank, the european economic and social committee and the committee of the regions), com (2018) 109 final, 2–3. 3 christoph busch, hans schulte-nölke, aneta wiewiórowska-domagalska, frydryk zoll, ‘the rise of the platform economy: a new challenge for eu consumer law?’ (2016) 5 eucml 3, 4. 4 see for example the contributions by several authors in the thematic issue on platform services in (2016) 5 eucml 1. 5 commission, ‘impact assessment accompanying the document proposal for a regulation of the european parliament and of the council on european crowdfunding service providers for business and proposal for a directive of the european parliament and of the council amending directive 2014/65/eu on markets in financial instruments’ (commission staff working document) swd (2018) 56 final, 7. njcl 2018/1 205 existence of actors who provide crowdfunding services, so called crowdfunding service providers (csps), operating digital crowdfunding platforms, where the business funding interests of investors and companies are matched.6 these digital platforms have become an important financing alternative, especially for small and medium-sized enterprises (smes).7 by creating innovation-oriented business models, csps have managed to disrupt the traditional market for business financing. online intermediary platforms have only recently attracted the attention of regulators. at the european level, a proposal for model rules on such platforms was published in 2016 under the auspices of the european law institute. the model rules are intended to cover contracts for the supply of goods, services or digital content that are concluded between a supplier and a customer, with the help of an online intermediary platform.8 furthermore, after an initial observation period, the european commission has decided to take a more active stand in regulating the platform economy. in april 2018, it published two regulatory acts; a decision on setting up a group of experts for the observation of the online platform economy and a proposal for a regulation on promoting fairness and transparency for business users of online intermediation services. a business user is in the regulation defined as a natural or legal person who offers goods or services to consumers through online intermediation services.9 neither the model rules nor the european commission proposal for a regulation is particularly helpful when navigating the triangular relationship present between actors on equity-crowdfunding platforms. the model rules exclude financial services from the scope of the rules and the european commission regulation is not intended to affect the application of relevant rules in the financial services area.10 6 commission, ‘proposal for a regulation of the european parliament and of the council on european crowdfunding service providers (ecsp) for business’ com (2018) 113 final, art. 3. 7 in this article, the european union definition of an sme is used, see commission, ‘recommendation of 6 may 2003 concerning the definition of micro, small and medium-sized enterprises’ [2003] oj l124/36. 8 research group on the law of digital services, ‘discussion draft of a directive on online intermediary platforms’ (2016) 5 eucml 164. 9 commission, ‘proposal for a regulation of the european parliament and of the council on promoting fairness and transparency for business users of online intermediation services’ com (2018) 238 final; commission, ‘commission decision of 26.4.2018 on setting up the group of experts for the observatory on the online platform economy’, c (2018) 2393 final. 10 research group on the law of digital services, ‘discussion draft of a directive on online intermediary platforms’ (2016) 5 eucml 164 (art. 1(2)); com (2018) 238 final (n 9) recital 32. equity crowdfunding service providers 206 at present, there is no pan-european legislation specifically covering csps, allowing for a diversified approach at national level in the european union (eu) member states. some countries have decided that csps are covered by pan-european securities regulation, while others argue that national authorities retain the authority to enact their own regulation covering such platforms. in addition, some countries have decided to not take any regulatory action at all. the regulation of equity crowdfunding platforms has thus for years been in a flux in the eu member states. this article sets to discuss the divergent approaches taken by the nordic countries when regulating equity-based crowdfunding platforms.11 is equity-based crowdfunding held back by excessive regulation in some/all of the nordic countries? recently, the european commission proposed an opt-in regulation for european crowdfunding providers, allowing csps to either opt-in to the paneuropean regulation or continue to be regulated at the national level.12 an assessment is therefore also made of the pros and cons of the proposed pan-european framework for participatory platforms. particular emphasis in the paper is placed on the relationship between fintech innovations and regulation. are digital innovations, and particularly equity-based crowdfunding platforms, disrupting the regulatory status quo in the nordic countries? 2. the regulatory framework covering crowdfunding platforms 2.1. the evolution of financial services regulation in the european union although the topic of the paper is nordic regulatory approaches to digital platforms in equity crowdfunding, the financial services sector is largely harmonized at the eu-level, why an analysis of nordic law takes its starting point in eu-level regulation. one of the fundamental goals of the eu is to establish an internal market among the member states of the “ever closer” union.13 in the early days of european co-operation, the focus was on creating an internal market for goods and remove fundamental barriers to trade, such as customs tariffs.14 in the financial services sector, the harmonization of the european market started in earnest with the introduction of the financial services action plan in 11 in the following, the discussion is limited to denmark, finland, norway and sweden. the author is well aware that iceland is part of the nordic countries. however, insufficient knowledge of icelandic limits the author’s access to icelandic regulatory sources. 12 com (2018) 113 final (n 6). 13 consolidated version of the treaty on european union [2016] oj c202/1, art. 1, 3(3). 14 case c-26/62 van gend en loos v. nederlandse administratie der belastingen eu:c:1963:1. njcl 2018/1 207 1999.15 a number of regulatory initiatives were introduced as part of the action plan in 2003 and 2004. for example, the markets in financial instruments directive (mifid) created a harmonized financial market structure and introduced a european passporting regime for investment firms, consisting of a freedom to provide investment services and activities in other member states.16 during this period, it was not always clear whether a legislative initiative was aimed at fully harmonizing the affected area or if there was still room for national initiatives. the relationship between national and eu-regulation of financial services was further complicated by the practice to adopt minimum and maximum harmonization directives.17 minimum harmonization directives set a minimum threshold for standards in all member states, while maximum harmonization directives precluded both less and more restrictive provisions in national law.18 the same financial services directive could contain both maximum and minimum harmonization articles. in combination with the common practice of member states to engage in so called gold-plating, the result was a partly harmonized, partly fragmented internal market for financial services.19 more recently, the european commission has updated most of the core financial services directives introduced in the financial services action plan. increasingly, the amended legislative acts are in the form of regulations, directly binding in their entirety in all member states.20 as 15 commission of the european communities, ‘implementing the framework for financial markets: action plan’ (communication), com (1999) 232 final. 16 directive 2004/39/ec of the european parliament and of the council of 21 april 2004 on markets in financial instruments amending council directives 85/611/eec and 93/6/eec and directive 2000/12/ec of the european parliament and of the council and repealing council directive 93/22/eec [2004] oj l145/1 (directive 2004/39/ec) (no longer in force), art. 6(3). 17 according to the lisbon treaty, regulations have general application, are directly applicable in the member states and binding in their entirety. directives are binding as to the result to be achieved but leave to the member states the choice of form and methods, see consolidated version of the treaty on the functioning of the european union, [2016] oj c202/1, art. 288. 18 luca enriques & matteo gatti, ‘is there a uniform eu securities law after the financial services action plan?’ (2008) 14 stan. j. l. bus. fin. 43, 49. 19 carsten gerner-beuerle, ‘united in diversity: maximum versus minimum harmonization in eu securities regulation’ (2012) 7 cap. markets l. j., 317 (the author discusses the drive in the united kingdom to abolish gold-plating). gold-plating can be defined as an effort by national legislators to create a more attractive financial environment than in other member states, for example by adopting additional investor protection rules when implementing a directive. 20 see for example regulation (eu) no 596/2014 of the european parliament and of the council of 16 april 2014 on market abuse (market abuse regulation) and repealing directive 2003/6/ec of the european parliament and of the council and commission directives 2003/124/ec, 2003/125/ec and 2004/72/ec [2014] oj l173/1; equity crowdfunding service providers 208 part of its efforts to further integrate the capital markets in the eu, the european commission introduced an ambitious action plan in 2015 aimed at creating a fully integrated capital markets union between the member states by 2019. an integral part of the new action plan is to develop financing opportunities for smes, by opening up the public capital markets as well as by creating a thriving seed and venture capital sector.21 equity-based crowdfunding as an alternative financing model fits into the european commission’s plan by contributing to deeper external capital markets for smes. 2.2. the rise of crowdfunding as a business model crowdfunding, as it is known today, is closely connected with the technological revolution of the past decades. however, crowdfunding as a concept was known much earlier. one of the earliest accounts of crowdfunding is the much-publicized crowdfunding effort by joseph pulitzer, who in 1885 raised funds for the building of a base to the statue of liberty. by an open call in his newspaper, new york world, he urged the people of new york to donate money to the project. in return, donors would get their name printed in his newspaper. most of the donations were small, ranging from a couple of cents to a couple of dollars.22 in more recent history, the financing of the us tour of the rock band marillion in the late 1990s is often mentioned in crowdfunding circles as a precursor to the projects which are today marketed on digital crowdfunding platforms.23 crowdfunding projects are usually divided into donation-, lending and equity-based models, where only the last model is of interest in this article. equity-based crowdfunding models can in their turn be divided into entrepreneur-led and investor-led models. entrepreneur-led models are characterized by a call for investors made by a project owner through the digital platform. swedish crowdfunding platforms fundedbyme and tessin are two examples of nordic platforms using an entrepreneur-led model. investor-led models are headed by professional investors, who put their own money into the project. the project is then marketed on regulation (eu) 2017/1129 of the european parliament and of the council of 14 june 2017 on the prospectus to be published when securities are offered to the public or admitted to trading on a regulated market, and repealing directive 2003/71/ec (regulation (eu) 2017/1129) [2017] oj l168/12; regulation (eu) no 600/2014 of the european parliament and of the council of 15 may 2014 on markets in financial instruments and amending regulation (eu) no 648/2012 [2014] oj l173/84. 21 commission, ‘action plan on building a capital markets union’ (communication) com (2015) 468 final. 22 geneva daily gazette (geneva, n.y., 17 apr. 1885) 3; the evening gazette (port jervis, n.y., 13 june 1885) 1. 23 see for example martin edwards, ‘the big crowd and the small enterprise: intracorporate disputes in the close-but-crowdfunded firm’ (2018) 122 penn st. l. rev. 411, 420. njcl 2018/1 209 the platform, and crowd investors are allowed to join the project under the same terms as the lead investor. this business model is used, among others, by the finnish platform innovestor. in both models, investors get access, often for free, to sales pitches by different companies on a digital platform. before investing in a crowdfunding company, most csps require potential investors to register with the platform. the platform then acts as an intermediary between the crowd investors and a business venture. in many equity-based crowdfunding business models, the project owner issues a security, often in the form of a share in a private company, and the investor makes a direct investment by buying an equity interest in the business venture. some csps have instead chosen to introduce a business model, where the investor makes an investment in a special purpose vehicle or a collective investment scheme. the special purpose vehicle or collective investment scheme will in its turn hold securities in the project, and the investor gets indirect exposure to the project through ownership in the investment vehicle.24 the swedish csp pepins group ab for example has a business model where the project owner issues shares to a holding company, which in its turn issues shares to the investors in a specific project. a shareholder agreement is drafted between the holding company and the original owners of the marketed project in an effort to protect the crowdfunding investors.25 many csps offer additional services, such as taking care of the stock ledger of companies promoted on the platform or providing advice after a successful crowdfunding round. others offer an even more diverse selection of services in connection to their crowdfunding services. the finnish platform innovestor for example manages venture capital funds, organizes networking events, has auto-bid features for investors and provides mentoring for start-ups, in addition to co-investing with crowd investors.26 2.3. a new alternative financing form for small and medium-sized companies small and medium-sized enterprises are of great importance for the economy. in the nordic countries, the absolute majority of all companies are categorized as smes.27 they provide around 60 percent of total employment and between 50 and 60 percent of value added in 24 european securities and markets authority, advice, investment-based crowdfunding (advice), esma/2014/1560, ¶ 17. 25 pepins group ab, ‘pepins explains’ < www.pepins.com/pepins-explains> accessed 30 may 2018. 26 innovestor group <www.innovestorgroup.com> accessed 30 may 2018 (the innovestor group consists of several companies under the same brand). 27 oecd, ‘financing smes and entrepreneurs 2018, an oecd scorecard’ (oecd publishing 2018) 3, 126, 130, 164, 182. equity crowdfunding service providers 210 the oecd area. although the output of smes is imperative for the economic performance of a country, such companies often find it more difficult than larger companies to get access to the financing needed for investments and growth. compared with the u.s., europe has a stronger tradition of bank financing for businesses. more than 75 percent of the external financing used by european smes is supplied by banks.28 after the 2007–09 financial crisis, banks faced new requirements on capital and loan portfolios, leading to lower availability of bank loans to smes.29 although the availability of bank financing has improved in recent years, such financing is often not an appropriate option for innovative fastgrowing start-ups.30 banks are reluctant to loan funds to newly incorporated businesses, given their short financial history and high riskreturn profile. furthermore, innovative smes often lack collateral or own intangible assets, which are difficult to value correctly, complicating the securitization of loans. for such companies, external equity sources of financing are often a more appropriate alternative.31 in comparison with other eu member states, the nordic countries have a relatively well-developed venture capital sector, providing equity capital to seed, start-up and early stage development of enterprises.32 they also have a high concentration of mixed-finance smes, i.e., firms that use a range of different financial instruments for financing and expansion. mixed-finance smes tend to be newly established businesses, with innovative business ideas and high future growth expectations.33 however, when comparing the nordic countries with the united states, canada and israel, venture capital investment as percentage of gdp is still considerably lower, why there is room for improvement.34 this is even more true, when comparing with a cross section of eu member states. the european commission estimated in 2015 that if the eu 28 com (2015) 468 final (n 21) 7. 29 duygan-bump et al., ‘financing constraints and unemployment: evidence from the great recession’ (2014) feds working paper no. 2014-92; european central bank, ‘survey on the access to finance of small and medium-sized enterprises in the euro area: second half of 2009 10–11’ (16 feb. 2010). 30 european central bank, ‘survey on the access to finance of enterprises in the euro area, april to september 2017’, (2017) 9–10. 31 kris boschmans & lora pissareva, ‘fostering markets for sme finance’ (2017) oecd sme and entrepreneurship papers no. 6, 9. 32 there are considerable differences between the nordic countries when it comes to attitudes to equity financing. according to the european commission survey on the access to finance, a majority of swedish firms had either issued equity or considered equity capital as a relevant source of financing in 2017, while less than quarter of danish and finnish smes did the same, see ton kwaak et al., ‘survey on the access to finance of enterprises (safe)’ (2017) european commission analytical report 30. 33 demary markus et al., ‘sme financing in the eu: moving beyond one-size-fits-all’ (2016) iw-report 11/2016, 8. 34 oecd, ‘entrepreneurship at a glance 2017’ (oecd publishing 2017) 125. njcl 2018/1 211 venture capital markets would have been as deep as in the us, an additional €90 billions could have been provided to european smes.35 in an effort to revitalize the european capital markets, the commission has made it a top priority to build stronger capital markets as well as to provide better access to investment finance to smes and mid-size companies.36 an important aspect, when trying to develop deeper venture capital markets, is the impact of technology on such markets. the digital revolution of the past decades has provided for an alternative finance market based on innovations in asset-backed financing, venture capital investment and crowdfunding.37 in recent years, the growth of alternative finance has been exponential, with china as the market leader, followed by the united states (us) as a distant second.38 the european alternative finance market is much smaller than both the chinese and the us market. it is also geographically concentrated. much of the activity in europe is focused to the united kingdom (uk), which makes up 73 percent of the total european market value of €7.671 billions.39 consumer and business lending platforms dominate the sector, while equity-based crowdfunding platforms have a lower market share. only one tenth of total volume in mainland europe is attributed to equitybased models.40 still, equity-based crowdfunding contributes substantially to seed and venture capital investment in countries with developed alternative finance markets. for example, in the uk, equity-based crowdfunding platforms provided for almost 20 percent of total seed and venture equity capital investment in the country in 2016.41 35 com (2015) 468 final (n 21) 4; see also demary markus et al., (n 33) 6. 36 commission, ‘an investment plan for europe’ (communication) com (2014) 903 final, 5, 14. 37 oecd (n 27) 3. 38 the alternative finance market in mainland china is estimated to more than $243 billion in 2016, see kieran garvey et al., ‘cultivating growth, the 2nd asia pacific region alternative finance industry report’ (2017) cambridge centre for alternative finance & australian centre for financial studies 24, while the u.s. market is estimated to $34.5 billion, see tania ziegler et al., ‘hitting stride, 2017 the americas alternative finance industry report’ (n.d.), cambridge centre for alternative finance & polsky center for entrepreneurship and innovation & the university of chicago booth school of business 27. the overall european market, including the uk, expanded by 41 percent annually. when excluding the uk, mainland europe transaction volumes increased by 101 percent between 2015 and 2016, see tania ziegler et al., ‘expanding horizons, the 3rd european alternative finance industry report’ (n.d.), cambridge center for alternative finance 21. 39 ziegler et al., ‘expanding horizons’ (n 38) 21. 40 ziegler et al., ‘expanding horizons’ (n 38) 28. 41 bryan zhang et al., ‘entrenching innovation, the 4th uk alternative finance industry report’ (2017) cambridge centre for alternative finance 59. equity crowdfunding service providers 212 2.4. nordic approaches to the regulation of digital platforms in equity crowdfunding during the past decade, the revolution in the fintech sector has not only led to new opportunities for alternative financing, but also to new challenges from a regulatory perspective. the diversity in services provided as well as the diverse business models used by crowdfunding platforms makes it difficult to place csps under existing financial services regulation. furthermore, the evolving business models of equity-financing platforms make it difficult to draft a relevant regulatory framework. as many as 57 percent of european equity-based csps reported significant changes to their business model in 2016.42 as mentioned, the legislative status of csps at the eu-level is unclear at the moment. there has not been any clear indication at the eu-level as to whether crowdfunding is covered under mifid rules, other applicable eu legislation, such as the payment services directive (psd2) or the alternative investment fund managers directive (aifmd), or fall outside eu legislation.43 psd2 might become applicable depending on how funds are transferred from an investor to the promoted business venture and aifmd might become applicable for certain csps using investment vehicles as part of their business model. the commission noted in may 2016 that given the local nature of crowdfunding, there was no need for eu-level action at that point in time.44 the lack of a targeted legislative approach in relation to crowdfunding has led to a variety of legislative approaches in different member states. although both psd2 and aifmd are of importance for some equity-based csps, the platforms (and member states) need to primarily position themselves in relation to the mifid regulatory framework.45 in order to fall under the mifid framework an actor has to both provide investment services and provide those services in relation to mifid financial instruments.46 a csp carrying out mifid services in relation to mifid 42 ziegler et al., ‘expanding horizons’ (n 38) 43. 43 directive (eu) 2015/2366 of the european parliament and of the council of 25 november 2015 on payment services in the internal market, amending directives 2002/65/ec, 2009/110/ec and 2013/36/eu and regulation (eu) no 1093/2010, and repealing directive 2007/64/ec [2015] oj l337/35; directive 2011/61/eu of the european parliament and of the council of 8 june 2011 on alternative investment fund managers and amending directives 2003/41/ec and 2009/65/ec and regulations (ec) no 1060/2009 and (eu) no 1095/2010 [2011] oj l174/1. 44 commission, ‘crowdfunding in the eu capital markets union’ (commission staff working document) swd (2016) 154 final, 31. 45 parts of the following discussion on mifid and crowdfunding has been previously published in swedish by the author, see härkönen, ‘investeringsbaserad gräsrotsfinansiering’ (n 1). 46 directive 2014/65/eu of the european parliament and of the council of 15 may 2014 on markets in financial instruments and amending directive 2002/92/ec and njcl 2018/1 213 financial instruments has to be authorized as an investment firm, unless it meets conditions to be exempted. an authorization is only obtained if the actor fulfills stated requirements on starting capital, organizational structure, internal guidelines and supervision.47 mifid financial instruments are in the directive defined as transferable securities, moneymarket instrument, units in collective investment undertakings, options, futures, swaps as well as other derivative instruments.48 in some member states, such as austria, belgium, germany and sweden, certain forms of participatory instruments which are not classified as mifid financial instruments have become popular on digital crowdfunding platforms, thus leaving them outside the scope of mifid.49 in sweden, platforms have concentrated their services to shares in private limited liability companies.50 since the swedish companies act contains a restriction on public offers in private limited liability companies, shares in such companies are not considered to be transferable financial instruments.51 in july 2016, the rise of crowdfunding platforms in sweden prompted the swedish government to establish a committee tasked with investigating the potential for new legislation covering crowdfunding.52 the committee published its report in february 2018, proposing a new swedish crowdfunding law.53 the law would introduce new organizational and ownership requirements on platforms offering securities in private limited liability companies which fall outside the mifid framework. offers of securities in public limited liability companies would, just as before, be covered by mifid regulation.54 digital platforms marketing both private and public companies would only need to apply for authorization as investment firms according to national mifid legislation, thus eliminating the need for platforms to apply for two different authorizations.55 furthermore, the proposal includes requirements on csps to disclose information on investments marketed on the platform to potential investors as well as similar but less directive 2011/61/eu [2014] oj l173/349 (directive 2014/65/eu), art. 4, annex i, section a and c. 47 directive 2014/65/eu (n 46), art. 5–16. 48 directive 2014/65/eu (n 46), art 4.1(2), annex i, section c. 49 esma, ‘investment-based crowdfunding’ (opinion), esma/2014/1378, ¶ 45. 50 there is some confusion regarding the term “limited liability company”. in this article the term is meant to refer to a corporation, not to be confused with the ”limited liability company” (llc), which is a different business association altogether. 51 swedish companies act ch 1 § 7; prop 2006/07:115 p 281–282 (swedish preparatory works); see also prop 2005/06:158 p 68 (swedish preparatory works). 52 dir 2016:70; dir. 2017:112 (swedish preparatory works). 53 sou 2018:20 (swedish preparatory works). 54 sou 2018:20 p 244, 358 (swedish preparatory works). 55 sou 2018:20 p 378 (swedish preparatory works). equity crowdfunding service providers 214 arduous requirements as in mifid to know your customer.56 if the proposal is adopted, sweden would in addition to mifid legislation have a separate crowdfunding framework based on national law. although some member states have determined that securities traded on crowdfunding platforms are not financial instruments falling under the scope of mifid, in other member states, the shares transferred on crowdfunding platforms are deemed to be mifid financial instruments. in those jurisdictions, it becomes important to determine if the platforms provide investment services, the second requirement under mifid. the three services falling under the scope of mifid, which most closely resemble the services provided by csps are reception and transmission of orders, placing of financial instruments without firm commitment basis and providing investment advice.57 in its 2014 opinion, esma noted that the question of which services are being carried out has to be answered on a case-by-case basis, due to the different business models used by the crowdfunding platforms.58 although many platforms have in the past argued that they only operate bulletin boards, where the platform assists in collecting and transmitting expressions of interest, esma has noted that there “would have to be a real, substantive distinction between the expression of interest and something which could be considered as an order” for the platform to be able to operate outside the mifid framework.59 the author of this article has previously argued that the business models of most nordic platforms are likely to qualify under the definition of the investment service “reception and transmission of orders”, considering the expansive interpretation made by esma.60 if a crowdfunding platform fulfills both conditions, i.e., it provides investment services in relation to mifid financial instruments, it will fall under the scope of mifid regulation. in the nordics, the financial supervisory authority (fsa) of norway has clarified that the position of the authority is that an activity where a csp receives and transfers orders falls under national mifid-legislation. alternatively, csps can be covered by national aifmd-legislation.61 investment services can only 56 förslag till lag om viss verksamhet med förmedling av finansiering (a proposal for a crowdfunding law), ch 3 § 3–4, in sou 2018:20 p 33–34. compare with directive 2014/65/eu (n 46), art. 25. 57 directive 2014/65/eu (n 46), art 4.1(2) and annex i, section a. 58 esma (n 49) ¶ 47–48. 59 esma (n 49) ¶ 49. 60 see härkönen, ‘investeringsbaserad gräsrotsfinansiering’ (n 1). 61 letter from the financial supervisory authority of norway to the ministry of finance, regulering av folkefinansiering 7–8, 17, ref no 16/11774 (1 feb 2017). compare with the definition of investment services in the norwegian securities trading act, see lov av 29 juni 2007 nr 75 om verdipapirhandel, ch 2 § 1–2. recently, the possibility of a norwegian crowdfunding regulatory framework has been put forward in preparatory works, see nou 2018:5 p 92 (norwegian preparatory works). see however siv jensen, department of finance, brev till stortinget, om et norsk njcl 2018/1 215 be offered after authorization by the norwegian fsa.62 similarly, danish mifid legislation requires that persons who are interested in starting a digital platform, where investors are put in contact with project owners who offer them shares, shall apply for authorization as an investment firm.63 several countries in the eu have instead of applying all provisions in mifid, adopted national bespoke regimes under the exemption for national legislation allowed in mifid.64 according to the exemption, member states may choose to regulate certain investment activities at the national level. persons covered by the mifid exemption are only allowed to provide a limited number of investment services, such as receiving and transferring orders in transferable securities and units in collective investment undertakings and the providing investment advice in relation to such financial instruments. any persons acting under the exemption have to include a third party such as an investment firm or a credit institution in their business model, since they are only allowed to transmit orders to certain third parties, such as investment firms and credit institutions. also, actors operating under the exemption are not allowed to hold client funds or securities in their possession. the article 3 exemption is strictly local in nature. actors relying on national legislation enacted under the exemption are not allowed to use the european passporting regime, consisting of a cross-border right to offer financial services in other member states for investment firms authorized in one member state. furthermore, they still need to follow many of the mifid requirements concerning authorization, on-going supervision and conduct of business operations.65 with the introduction of mifid ii, article 3 was amended to include new requirements on authorization as regelverk for crowdfunding/folkefinansiering, doc no 8:37 s (2017–2018) (15 nov 2017), where the minister of finance dismisses the proposal to introduce bespoke regulation. 62 the power is delegated from the ministry of finance, see lov av 29 juni 2007 nr 75 om verdipapirhandel, ch 9 § 1 (norwegian securities trading act). 63 bekendtgørelse af lov om finansiel virksomhed, ch 3, § 9, bilag 4, afsnitt a (danish financial business act). 64 see for example legislative decree no 58 of 24 february 1998 consolidated law on finance pursuant to articles 8 and 21 of law no. 52 of 6 february 1996, art 50quinquies, art 100-ter (italy); regulation on “the collection of risk capital via on-line portals”, commissione nazionale per le società a la borsa (consob) resolution no 18592 of 26 june 2013, amended by resolutions no 19520 of 24 february 2016, no 20204 of 29 november 2017 and no 2264 of 17 january 2018) (italy); code monétaire et financier, art l548-1–l548-9 (version of 3 jan 2018); l´ordonnance no. 2014-559 du 30 mai 2014 relative au financement participatif (consolidated version of 11 june 2018) (france); ley 5/2015 de 27 abril, de fomento de la financiación empresarial, título v (spain); see also härkönen, ‘investerarskyddet vid gräsrotsfinansiering’ (n 1) 46 (with more examples from different european union member states). 65 directive 2014/65/eu (n 46), art. 3. equity crowdfunding service providers 216 well as more stringent investor protection rules covering actors operating under the exemption.66 finland is the only nordic country which has so far opted to introduce national bespoke legislation under the article 3 exemption. the country already had several csps operating under the mifidframework, when it in 2016 decided to adopt national bespoke regulation covering digital platforms.67 the finnish crowdfunding law adopted under the mifid exemption covers both loan and equity-based crowdfunding and includes rules on authorization, organization of the platform, investor protection and sanctions.68 the aim of the law is to introduce a less onerous legal framework than the mifid-framework in an effort to accommodate the differing needs and risks with digital platforms.69 the nordic countries have thus decided to apply the mifid framework in very different ways to the same phenomena, regardless of similarities in cultural, economic and legal framework. the development in the nordic countries clearly illustrates the difficulty in creating an appropriate legal framework for new innovations that do not fit into established legislative structures. 3. a modest proposal for harmonization of the european crowdfunding market 3.1. a harmonized european regulation on crowdfunding service providers despite the fact that crowdfunding as an alternative finance model has exhibited exponential growth in europe during the past years, there is cause for concern in the fragmented approach to regulation in the member states. the different legislative approaches by member states create a barrier for cross-border activity, at the same time as the concentration of crowdfunding to certain member states hinders the development of an internal market.70 less than 10 percent of the inflows and outflows in equity-based crowdfunding in europe occur across national borders.71 in an effort to create clear and consistent rules for crowdfunding platforms across the eu, a legislative proposal on european crowdfunding service providers was published in march 2018. the regulation is set to cover both lendingand equity-based 66 compare directive 2014/65/eu (n 46), art. 3 with directive 2004/39/ec (n 16) art. 3. 67 rp 46/2016 rd p 22, 63–64 (finnish preparatory works). 68 joukkorahoituslaki, 25.8.2016/734 (finnish crowdfunding law). 69 rp 46/2016 rd p 65–67 (finnish preparatory works). 70 com (2018) 113 final (n 6) 1–2. the proposal was published as the first targeted action of the commission’s fintech action plan, published at the same time, see com (2018) 109 final (n 2) 5–7. 71 ziegler et al., ‘expanding horizons’ (n 38) 46. njcl 2018/1 217 csps, covering crowdfunding services consisting of either the facilitation of granting of loans, the placement without firm commitment of transferable securities issued by project owners and the reception and transmission of client orders with regard to those securities.72 an important limitation is that only csps for business are covered by the regulation. the regulation thus does not cover any crowdfunding services that are provided to project owners that are consumers.73 csps that are authorized as investment firms are also exempted from the scope of the proposed regulation.74 although the legislative act is in the form of a regulation, implying maximum harmonization and preclusion of national legislative acts in the regulated area, the csp-regulation is a voluntary opt-in regulation. the regulation is not applicable to services provided in accordance with national law, thus allowing csps to choose if they want to opt-in to the pan-european legislation by applying for authorization at the eu-level.75 an authorization allows a csp to offer its services cross-border in all eu-member states, in line with other european passports in the regulatory framework for financial services.76 one of the most criticized sections of the proposed csp regulation is the monetary threshold on eligible crowdfunding offers.77 the current proposal does not cover crowdfunding offers of more than €1m, calculated over a period of 12 months.78 according to the recital to the crowdfunding regulation, the threshold is aligned to the new prospectus regulation, where a similar “mandatory” threshold exists for prospectuses.79 however, the monetary threshold in the prospectus 72 com (2018) 113 final (n 6) art 3(a). it is proposed in a draft report by a european parliament committee that service providers facilitating initial coin offerings should also be covered by the regulation, see european parliament, committee on economic and monetary affairs, ‘draft report on the proposal for a regulation of the european parliament and of the council on european crowdfunding services providers (ecsp) for business’ (2018) 2018/0048 (cod). 73 com (2018) 113 final (n 6) art. 2.2(a). 74 com (2018) 113 final (n 6) art. 2.2(b). 75 com (2018) 113 final (n 6) art. 2.2(c). 76 com (2018) 113 final (n 6) art. 10. 77 see for example fg lawyers b.v., letter to the european commission, feedback on the prospectus regulation, f11569 (11 may 2018) (netherlands); italiafintech, letter to the european commission, feedback on the prospectus regulation, f11566 (may 11, 2018) (italy); financement participatif france, proposal for a regulation on european crowdfunding service providers (ecsp) for business, position paper fpf , f11554 (11 may 2018) (france); but see european savings and retail banking group, ‘esbg position paper on the european commission “have your say” consultation on its proposal for a regulation of the european parliament and of the council on european crowdfunding services providers for business’ (2018) f11562 (belgium). 78 com (2018) 113 final (n 6) art. 2.2(d). 79 com (2018) 113 final (n 6) recital, p. 12. the prospectus regulation covers offers of €1m or more, while the csp regulation covers offers of €1m or less, which would imply that offers of €1m are covered by the csp regulation and the prospectus equity crowdfunding service providers 218 regulation is more flexible than the reference to a mandatory threshold suggests. it is correct that member states are not allowed to require a prospectus for public offers falling beneath the €1m threshold according to the prospectus regulation. they may however still “require other disclosure requirements at national level to the extent that such requirements do not constitute a disproportionate or unnecessary burden”.80 member states are also allowed, according to the prospectus regulation, to exempt offers where the total consideration does not exceed €8m over a period of 12 months.81 the prospectus thresholds thus allow for diversification based on the national market and need for investor protection, determined by national legislatures.82 the nordic countries have all opted for different prospectus thresholds. in denmark and norway offers of less than €1m are exempted.83 many member states have however opted for a higher monetary threshold. in sweden, offers not exceeding €2.5m are exempted from prospectus requirements.84 in finland, a specific exemption exists for crowdfunding offers, according to which crowdfunding offers of less than €5m are exempted.85 the proposed 1m€ threshold on crowdfunding offers would limit the potential of scaling up csp business models to include larger financing rounds. in the united kingdom, the average deal size in 2016 was £807,214, corresponding to around €1m, depending on the currency exchange rate.86 admittedly, the average deal sizes in mainland europe are lower, at €324,608. however, the nordic countries seem to have at least some projects with higher deal values, more in line with the united kingdom.87 the proposed threshold is thus likely to limit the activities in regulation. the exact wording of the csp regulation is however likely to be modified at a later stage before adoption. 80 regulation (eu) 2017/1129 (n 20), art. 1(3). 81 regulation (eu) 2017/1129 (n 20), art. 3(2) (b); see also swd (2018) 56 final (n 5) 33–34. 82 the author of this article has previously noted that the prospectus thresholds hardly enhance harmonization efforts between the member states. instead, they are likely to lead to further fragmentation of the internal market, see härkönen, ‘crowdfunding and the small offering exemption’ (n 1). 83 bekendtgørelse af lov om værdipapirhandel m.v., lbk nr 251 af 21/03/2017, ch 12, § 43–44 (danish securities trading law); lov om verdipapirhandel (verdipapirhandelloven) § 7–2 (norwegian securities trading act). 84 lag (1991:980) om handel med finansiella instrument, ch 2 § 4 p 5 (swedish securities trading act). 85 joukkorahoituslaki § 11, 25.8.2016/734 (finnish crowdfunding law). compare with the threshold of 2.5m€ for other types of offers, see arvopaperimarkkinalaki, ch 4, § 3, 14.12.2012/746 (finnish securities markets act). 86 zhang et al., (n 41) 59. 87 ziegler et al., ‘expanding horizons’ (n 38) 35. see also fundedbyme crowdfunding sweden aktiebolag (publ.), ‘annual report 2016’ (2016) (where at least two funding njcl 2018/1 219 more mature alternative finance markets, such as finland and sweden. furthermore, it creates an inconsistent regime of investor protection in countries that have opted for a higher prospectus threshold. for example, in finland and sweden, offers of €1m or less on crowdfunding platforms falling under the csp-regulation would be covered by more advanced investor protection measures than offers of €2.5m or less made through banks or other intermediaries or offers of less than €5m made on finnish crowdfunding platforms operating under national bespoke regulation. in a recently published draft report by the committee on economic and monetary affairs of the european parliament, a higher threshold of €8m is proposed.88 there is thus a possibility that the disparity between the proposed csp-regulation and the prospectus regulation will be remedied at a later stage of the legislative process. 3.2. using an opt-in regulatory technique-achieving a single financial services market? as mentioned, the regulation of the financial services sector has evolved from minimum harmonization in the 1990s to the current stage, where the aspiration is to create a capital markets union by 2019. considering the general development in financial services regulation from directives to directly binding regulations, it is surprising that the commission in its proposal for a csp-regulation has chosen a legislative technique allowing for a diversified approach. the legislative technique of having parallel national and eu-legislation has been used sparingly in financial services legislation. instead, member states are often allowed to exempt certain services from the scope of eu-legislation. for example, member states can exempt certain investment services from the scope of mifid ii as well as introduce additional disclosure requirements for offers that are not covered by the prospectus regulation.89 the exempted services or products are usually less complicated services or services of a local character. furthermore, the decision to exempt certain services from the scope of eu-legislation is made by member states and not the actors involved. although not common, the concept of opt-in regulation is not unheard of in financial services regulation. for example, a similar regulatory technique is adopted in the regulation on european venture capital funds, laying down uniform requirements for managers of alternative investment funds that wish to use the designation rounds, involving the platform itself and uniti, approached or exceeded the €1m threshold). 88 european parliament (n 72). 89 directive 2014/65/eu (n 46) art. 3; regulation (eu) 2017/1129 (n 20), art 1(3). equity crowdfunding service providers 220 “euveca” when marketing their funds to investors in the eu.90 the regulation does not apply to managers that do not wish to use the euveca designation, creating a similar opt-in regulation for investment fund managers as the new csp regulation creates for csps.91 it can be discussed if the opt-in legislative technique will create an integrated crowdfunding market. in countries which have introduced bespoke regulation, the same activity could in the future be covered by three different laws; national bespoke regulation, the csp regulation and mifid. in other countries, csps with mifid authorization might be reluctant to opt-in to the csp regulation if they already fulfill the conditions required for mifid authorization. in the nordics, danish and norwegian csps without any mifid authorization will probably gain from the adoption of the csp regulation, regardless of if they plan to be involved in cross-border activities or not, due to the strict rules in place in national law. finnish and swedish csps involved in crossborder activities might also gain from opting-in to the regulation, due to the european passport, which forms part of the regulation. however, the exemptions from prospectus requirements are more generous both in finland and sweden, why some platforms might prefer to continue to be governed by national legislation (or mifid), despite the fact that growth opportunities are limited in countries with small home markets. there are indications that the proposal, as it stands now, is not an attractive choice for european csps. for example, only about 27 percent of french platforms were interested in opting-in to the new regulation according to an industry survey.92 a mandatory regulation would have achieved the aim of an integrated european market better, as well as reduced transaction costs for csps operating under different regimes. however, from a political perspective, a mandatory proposal would have been difficult to reach consensus about, considering the fact that most member states have adopted national csp legislation recently. in that sense, the wait-and-see approach adopted by the commission earlier has backfired, when member states decided to take action instead. 90 regulation (eu) no 345/2013 of the european parliament and of the council of 17 april 2013 on european venture capital funds (regulation no 345/2013) [2013] oj l115/1. 91 regulation 345/2013 (n 90) recital, p. 10, art. 1. 92 financement participatif france (n 77) 2. njcl 2018/1 221 4. is the legal environment important for the development of crowdfunding? 4.1. is the regulation of crowdfunding service providers decisive for the development of the alternative finance market? technology-enabled financial innovations are transforming the financial services sector, introducing new concepts, challenging traditional actors in the sector as well as disrupting established regulatory frameworks. many countries have embraced the change by taking steps to foster innovation and competition in the fintech sector, for example through the introduction of financial sandboxes or innovation hubs at the national level.93 innovative business models are, in addition to innovation support, dependent on a proportionate regulatory framework, why it is important to eliminate unnecessary regulatory hurdles. administrative burdens or burdensome authorization requirements can create unnecessary transaction costs to companies interested in alternative financing. at the same time, it is important to create a legal framework that increases transparency and strengthens consumer and investor protection. in an environment of regulatory competition, it is important for a country to adopt a regulatory structure that is internationally competitive.94 more than 40 percent of equity-based csps in europe have noted that the current regulatory framework is excessive and too strict for their platform activities.95 there is thus a real need for a simpler regulatory framework. the lack of an appropriate regulatory framework can also deter the development of new financial products if entrepreneurs are forced to operate in a “grey” zone, where the applicability of certain rules is unclear. the european commission has noted that “[o]ptimal framework conditions for business across the single market are essential to unlock the full potential of investment in europe. the regulatory framework, at national as well as european level, needs to be simple, clear, predictable and stable to incentivize investments with a longer term horizon”.96 93 svein andresen, secretary general, financial stability board, ‘cambridge centre for alternative finance conference on navigating the contours of alternative finance, regulatory and supervisory issues from fintech’ (remarks) (29 june 2017) 5. 94 in the late 1990s, several controversial european court of justice judgments opened up for regulatory competition in europe, see case c-212/97 centros ltd. v. erhvervsog selskabsstyrelsen eu:c:1999:126; case c-208/00 überseering bv v. nordic construction company baumanagement gmbh (ncc) eu:c:2002:632; case c-167/01, kamer van koophandel en fabrieken voor amsterdam v. inspire art ltd. eu:c:2003:512. 95 ziegler et al., ‘expanding horizons’ (n 38) 54. 96 european commission, ‘an investment plan for europe’ (2014) com (2014) 903 final, 13. equity crowdfunding service providers 222 there seems to be a correlation between growth of the financing form and a regulatory structure that is perceived as adequate by csps. this suggests that regulation should be amended to facilitate growth of the financing form rather than enacted when volumes have grown large enough.97 the nordic alternative financing market has experienced an exponential growth during the past years. it is now the second largest market for alternative financing in mainland europe, after france but before germany, the baltics and the benelux countries. although the volumes in the nordic market as a whole seem to indicate welldeveloped opportunities to use crowdfunding as an alternative financing form, there are huge differences between the nordic countries. in iceland and norway, the market is almost non-existent, with a total estimated value of €1 million in iceland and €5 million in norway. on the other hand, the danish and the swedish markets are valued at more than €80 million each and the market leader, finland has an alternative financing market with an estimated value of more than €140 million. equity-based crowdfunding in the nordic countries grew by an astonishing 493 percent from 2015 to 2016, but it is only two countries, finland and sweden, which have established markets for equity-based crowdfunding. equity-based crowdfunding volumes in norway, denmark and iceland are non-existent.98 admittedly, denmark has one actor, crowdinvest, engaged in equity-based crowdfunding, but there is no reported data from any money raised through the platform. in norway, the only activity is associated with foreign platforms.99 it could be argued that the differences in which regulatory regime each country has chosen for the registration or authorization of csps is decisive of the success of the local crowdfunding market.100 however, evidence from the nordic countries does not support this hypothesis. it does not seem to matter if a country has left the area unregulated, even if such uncertainty forces csps to operate in a “grey” area. both the swedish and the finnish markets have large equity crowdfunding markets, irrespective of if they have introduced national bespoke legislation or not. it therefore does not seem to be a decisive factor if a country has introduced specific crowdfunding regulation as in finland, or lack a regulatory framework, as in sweden. admittedly, the imposition of the full range of mifid requirements on csps in norway and denmark raises administrative costs and can deter new entrepreneurs from entering the market, why it 97 ziegler et al., ‘expanding horizons’ (n 38) 54. 98 ziegler et al., ‘expanding horizons’ (n 38) 75–76. 99 vækstfonden & dansk crowdfunding forening, det danske crowdfunding marked anno 2017 (15 jan 2018) 24; the financial services authority of norway, letter to the royal norwegian ministry of finance, regulering av folkefinansiering (1 feb 2017) 6, ref. no. 16/11774. 100 nou 2018:5 p 91–92 (norwegian preparatory works). njcl 2018/1 223 might seem to be more advantageous to choose to regulate crowdfunding under the article 3 mifid exemption. however, with the new requirements on companies providing services under the article 3 exemption introduced in mifid ii, operating under the article 3 exemption is not as attractive as it used to be. the introduction of mifid ii has for example forced the finnish authorities to amend their national crowdfunding law, in line with the more burdensome requirement on member states who use the article 3 exemption. the changes include new requirements on authorization for crowdfunding platforms as well as more burdensome investor protection requirements.101 the differences between operating under the full mifid regulatory framework or under an article 3 exemption are currently only marginally more burdensome for digital platforms operating under mifid.102 for example, platforms operating under article 3 exemptions are required to transfer the orders to an authorized third party under mifid, while csps operating in countries with mifid requirements need to operate under an authorization. digital platforms operating in countries with the more burdensome mifid requirements have easily seemed to be able to circumvent the cost of the rules, by establishing strategic partnerships with actors who already have the required authorizations. for example, the danish crowdfunding platform crowdinvest has established a strategic partnership with the bank merkur.103 it is therefore not likely that the dramatic difference in the finnish crowdfunding market on one hand and the norwegian and danish markets on the other hand is caused by the latter requiring full mifid compliance from csps. 4.2. is the regulation of crowdfunding project owners decisive for the development of the alternative finance market? if the applicability of mifid on csps is not the decisive factor between the different developments in the nordic countries, then what is? one theory is that the company laws in some of the nordic countries pose a hurdle in the development of equity crowdfunding. what seems to be important is which categories of companies are granted access to the digital platforms. the nordic countries have similar company law structures, with a division between private and public limited liability 101 joukkorahoituslaki, § 1, § 9–10 (finnish crowdfunding act); he 151/2017 vp, p 84–86 (finnish preparatory works). 102 an important difference is however that platforms operating under article 3 are constrained to their national markets, while platforms operating under mifid are included in the european passport regime, thus allowing them to operate in other member states with the authorization acquired in their home state. 103 merkur andelskasse, ‘crowdfunding kan blive en finansiel folkebevægelse’ (press release) (19 oct 2016) on file with author. equity crowdfunding service providers 224 companies. in denmark, finland and sweden, the two company forms are regulated in the same law, while each company form is regulated in a separate law in norway.104 the countries have, regardless of the similarities in their company laws, applied them very differently when it comes to crowdfunding platforms. the majority of all securities offered on equity-based crowdfunding platforms in finland and sweden are shares in private limited liability companies. sweden, which is the market leader in the nordics, as well as one of top-three countries when comparing crowdfunding volumes in europe, has taken a peculiar stance on the legal status of the shares offered on swedish equity-based crowdfunding platforms. an offer of shares in a private limited liability company is restricted in the swedish companies act. no advertising of share offers is allowed. furthermore, no solicitation of an offer to more than 200 persons is allowed, unless the solicitation is directed at persons who have previously announced that they are interested in such offers and the lots on offer do not exceed 200 lots.105 the exemption from the solicitation ban is aimed at covering solicitations and offers to professional investors, although no such restriction is placed in the law.106 the shares are also “restricted” in the sense that they cannot be sold on regulated markets or other organized marketplaces.107 when mifid was implemented in sweden, shares in private limited liability companies were deemed to fall outside the scope of the directive. shares in private limited liability companies could not be considered “transferable securities” due to the restrictions placed on transfers in swedish company law.108 according to swedish preparatory 104 in denmark, the two forms are called anpartsselskaber or aps (private limited liability companies) and aktieselskaber or a/s (public limited liability companies), see bekendtgørelse af lov om aktieog anpartsselskaber (selskabsloven), §1–2, lbk no 1089 af 14/09/2015 (danish companies act). in sweden the two forms are called privata aktiebolag (private limited liability companies) and publika aktiebolag (public limited liability companies), see aktiebolagslag (2005:551), § 2. in finland, the two forms are called yksityinen osakeyhtiö (private limited liability company) and julkinen osakeyhtiö (public limited liability company), see osakeyhtiölaki, 21.7.2006/624, § 1 (finnish companies act). in norway the two forms are called aksjeselskaper (private limited liability companies) and allmennaksjeselskaper (public limited liability companies), see lov om aksjeselskaper (aksjeloven), § 1–1, lov 1997-06-13-44 (norwegian private limited liability companies act), lov om allmennaksjeselskaper (allmennaksjeloven), § 1–1, lov 1997-06-13-45 (norwegian public limited liability companies act). 105 an exemption is also made for advertising and solicitations, where the total number of buyers will not exceed ten persons, or the company is a community interest corporation (in swedish bolag med särskild vinstutdelningsbegränsning). 106 prop. 1993/94:196 p 143 (swedish preparatory works). 107 swedish companies act, ch 1 § 8. 108 compare with the definition in directive 2014/65/eu (n 46), art. 4(1)(44). njcl 2018/1 225 works, it is not enough that a share is transferable, but the conditions must be such that a share, at least in principle, can be bought by anyone as a financial placement. the share must be negotiable on the capital market, and an investor must be able, at least in theory, to exchange the share for cash.109 this has led to an uneasy compromise, where shares in private limited liability companies are allowed on crowdfunding platforms, but do not fall under the mifid protective framework, since they are not considered transferable securities. with the expansion of the equity-based crowdfunding market in sweden, the distinction becomes harder and harder to justify. swedish csps are marketing the shares of private limited liability companies as “the best investment deals” and urge investors to create a “diversified portfolio” of investment deals.110 there are also several existing secondary markets for swedish crowdfunding shares, why investors can, at least in theory, easily sell their shares.111 at the same time, the shares are not transferable securities according to law. in some business models, csps use a special purpose vehicle, which can be structured as a public company or a foreign business entity. in those cases, the restrictions on transfer of shares are not applicable. however, if investors directly invest in the crowdfunded company, the transfer restrictions become problematic. it has been argued that the registration process with csps, which investors must undertake before they can invest in a crowdfunding company, might be enough to place csps under the exemption for offers, where investors have previously announced that they are interested in such offers.112 it is however doubtful if the registration in itself is considered a “previous” show of interest, when it is so closely connected to the investment procedure.113 furthermore, it is important to understand that the registration procedure is in no way connected to any investor protection measures.114 the registration process at one of the leading swedish csps takes for example less than 30 seconds to complete, and an investor is only required to provide a username, password, country of origin and an e 109 prop. 2006/07:115 p 282 (swedish preparatory works). 110 see <www.fundedbyme.com/en/for-investors/> accessed 1 june 2018). 111 for example, the company pepins group ab runs a platform where crowdfunding shares are traded, see pepins group ab, ‘annual report 2016’ (2016). 112 sou 2018:20 p 317–218 (swedish preparatory works). 113 the danish industry organization for crowdfunding actors has stated that such a procedure is probably not considered a ”closed” round of funding according to danish law, see regina m andersen, dansk crowdfunding forening, ‘10 hurtige q&a’s om udbud af værdipapirer i forbindelse med crowdfunding’ (17 nov 2015) <www.danskcrowdfundingforening.dk/10-hurtige-q-as-om-udbud-af-vaerdipapirer-iforbindelse-med-crowdfunding/> on file with author. 114 sou 2018:20 p 317 (swedish preparatory works). equity crowdfunding service providers 226 mail address.115 a private limited liability company or a csp involved in equity-based crowdfunding might also violate the advertising prohibition in the swedish company law. in the swedish proposal for a new crowdfunding law, it is noted that the question of a possible violation of the transfer restrictions in swedish company law should be solved in case law, and not by legislators. it is however noted that there have never been any cases, where the restrictions on transfer of private limited liability companies on crowdfunding platforms have been tried. nor are there any pending cases.116 the situation in sweden will be further complicated when the previously mentioned eu-regulation on csps is adopted. the regulation covers csps that offer crowdfunding services, defined as “the matching of business funding interest of investors and project owners through the use of a crowdfunding platform” which consists of the placing without firm commitment of transferable securities issued by project owners and the reception and transmission of client orders with regard to those transferable securities.117 considering the swedish classification of shares in private limited liability companies as non-tradable shares, it is doubtful if swedish csps fall under the regulation. even if the proposed swedish bespoke regulation would make an exemption for csps covered by the eu-regulation, the latter does not per se cover the trade in nontransferable securities. an exemption in the national bespoke law would therefore need to cover such shares, for example by allowing csps under the eu-regulation to follow the requirements in the regulation when marketing private limited liability company shares. finland has a very similar company law framework as in sweden. however, finnish law was modified in the early 2000s, and most of the restrictions on the transfer of shares in private limited liability companies were repealed.118 it was seen as important to develop different types of financial instruments in an effort to create a diversified financial services sector. to become successful in an international setting, it was paramount to have an innovative and diversified financial sector.119 finnish equity-based crowdfunding platforms are therefore free to market shares in private limited liability companies on their platforms. denmark has similar rules as sweden on the restriction of public offers in private limited liability companies.120 however, instead of allowing private limited liability companies to offer shares on digital 115 see fundedbyme, <www.fundedbyme.com/en/accounts/register/businessinvestor/?button=register&from=header> accessed 1 june 2018. 116 sou 2018:20 p 319 (swedish preparatory works). 117 com (2018) 113 final (n 6) art 2, 3. 118 laki osakeyhtiölain muuttamisesta 1524/2001 (28 dec 2001) (amendment of the finnish companies act). 119 he 184/2001 vp. p 13–14 (finnish preparatory works). 120 bekendtgørelse af lov om aktieog anpartsselskaber (selskabsloven), §1, lbk no 1089 af 14/09/2015 (danish companies act). njcl 2018/1 227 platforms outside the mifid framework, as in sweden, danish platforms are prohibited from offering shares in the two danish forms of private limited liability companies, anpartsselskaber and iværksætterselskaber. mifid-compliant digital platforms are only allowed to offer shares in public limited liability companies and financial instruments which are similar to shares in such companies, for example participatory instruments in limited liability partnerships with more than ten partners.121 in norway, offers of private limited liability company shares on crowdfunding platforms are not prohibited per se, but considering that there is limited transferability of such shares according to norwegian company law, such offerings are highly unlikely.122 furthermore, the fsa clearly states that the activities of many crowdfunding platforms are closely connected to investment services regulated under norwegian mifid-regulation.123 since the activities of csps are already covered by financial services regulation, the fsa does not see any need for a separate bespoke regulation in norway. a national bespoke regulation in norway would, according to the fsa, instead risk creating a two-tier system for csps. such a system would lead to an unclear legal position for csps and inconsistent regulation of similar activities.124 however, several actors have instead noted that the uncertainties in regulation of crowdfunding existing today in norway have hindered the development of such funding alternatives in the country.125 when comparing the crowdfunding sectors in the nordic countries with the actual restrictions placed on the transfer of shares in private limited liability companies, there is a correlation between allowing shares in such companies on crowdfunding platforms and the development of 121 finanstilsynet, notat, orientering om samspillet mellem alternativ finansiering og den finansiella regulering 9 (18 nov 2013) (denmark). see also bekendtgørelse af lov om kapitalmarkeder, § 4(1)(a), lbk no 12 af 08/01/2018 (danish capital markets law); bekendtgørelse af lov om finansiel virksomhed, annex 5, lbk no. 1140 af 26/09/2017 (danish financial business act); bekendtgørelse af lov om aktieog anpartsselskaber (selskabsloven), §1, lbk no. 1089 af 14/09/2015 (danish companies act). 122 lov om aksjeselskaper (aksjeloven), § 4-15–4-23, lov 1997-06-13-44 (norwegian private limited liability companies act). 123 depending on the business model, they might also be covered by norwegian aifmd-regulation. 124 the financial services authority of norway, letter to the royal norwegian ministry of finance, regulering av folkefinansiering (1 feb 2017) ref. no. 16/11774, 7–8, 17; see also lov av 29. juni 2007 nr. 75 om verdipapirhandel, § 2–1 (norwegian securities trading act); lov av 20. juni 2014 nr. 28 om forvaltning av alternative investeringsfond, § 1–2 (norwegian aifm act). 125 nou 2018:5 p 89–92 (norwegian preparatory works); see also letter from finans norge to the royal norwegian ministry of finance, ‘regulering av folkefinansiering (”crowdfunding”) i norge’ (30 nov 2017) ref. no. 16–1123. equity crowdfunding service providers 228 equity-based crowdfunding in the country. the companies that use crowdfunding platforms are usually innovative but cash-strapped companies with a short financial history. furthermore, they often have a negative cash flow and few assets, which can be securitized. as mentioned, such companies do not have access to bank financing, which can limit the growth of potentially successful companies. crowdfunding possesses an alternative financing form with low transaction costs at the same time as the high risk in such companies is spread between a number of investors.126 it is imperative that crowdfunding platforms are able to offer their services to these companies. considering that most innovative businesses start their existence as private limited liability companies, it is likely that the danish and norwegian restrictions on offering shares in private limited liability companies on crowdfunding platforms severely restrict the development of equity-based crowdfunding.127 in order to incorporate as a public limited liability companies, a business needs a starting capital of nok1m in norway and dkk500k in denmark.128 businesses in need of seed capital usually do not have these kinds of funds in the corporation, preventing them from incorporating as public limited liability companies. although it cannot be determined with certainty that the restrictions on transfer of shares in private limited liability companies are hindering the development of equity-based crowdfunding, the manner in which a country has regulated share transfers seems the most likely determinant of the success of equity-based crowdfunding in the nordic countries. 5. conclusion the nordic countries are characterized by similar cultural, economic and regulatory frameworks. however, when it comes to equity-based crowdfunding, the countries have taken different paths, both when it comes to regulating the sector as well as the volumes raised on alternative seed and venture capital crowdfunding platforms. sweden has decided to regulate equity-based csps outside the mifid regulatory framework, while denmark and norway have decided to impose the full range of mifid requirements on danish and norwegian csps. finland has chosen a middle ground, by adopting national bespoke regulation, within the exemption allowed in the mifid framework. in this article, the different approaches of the nordic countries have been analyzed in relation to the performance of equity-based csps. it is argued that the 126 nou 2018:5 p 87–88 (norwegian preparatory works). 127 see also sou 2018:20 p 322 (swedish preparatory works). 128 bekendtgørelse af lov om aktieog anpartsselskaber (selskabsloven), § 4, lbk no 1089 af 14/09/2015 (danish companies act); lov om allmennaksjeselskaper (allmennaksjeloven), § 3–1, lov 1997-06-13-45 (norwegian public limited liability companies act). njcl 2018/1 229 regulatory differences in regulating crowdfunding platforms have at most a marginal effect on the development of the sector. this does not mean that regulation of the sector is irrelevant for the success of an alternative finance market. quite the contrary, it is argued that the restrictions on marketing shares in private limited companies are likely to have contributed to the dismal performance of danish and norwegian equitybased crowdfunding markets. furthermore, the fact that csp-regulation is not the likely determinant of the success of the alternative equity finance market does not mean that csps should be left unregulated. csp-regulation is important in achieving transparency in the sector as well as in achieving proportionate investor protection regulation. as the alternative financial market matures, it could become an important source for seed and venture capital in europe. with a larger market share of the venture capital funding market, it could also become systematically important for the european economy. in an effort to avoid systematic market failures, regulation and supervision of csps is imperative. however, it cannot be concluded that the csp-regulation in the nordic countries is the determining factor of the current disappointing performance/success of equity-based crowdfunding in individual nordic countries. in addition to the regulatory structure in the nordic countries, the pros and cons of the pan-european csp-regulation have been discussed in this article. all of the nordic countries are limited by their small home markets. the lack of harmonization of crowdfunding regulation has limited cross-border crowdfunding growth. although the majority of nordic crowdfunding platforms have indicated their plans to internationalize their business and cater to international clients, the fragmented regulatory framework in the nordic countries and the eu makes it difficult to expand outside national markets.129 a harmonized regulation is therefore likely to be beneficial for the nordic countries. already, some nordic csps have used the european passport rights in mifid to expand their business cross-border.130 the introduction of a harmonized csp regulation would allow a further integration of the nordic markets and the introduction of crowdfunding as an alternative financing model in denmark and norway, which have been underserved by csps. however, the legislative technique, with an opt-in regulation, is likely to further diversify the sector, creating several different regimes in the member states as well as inside a country. there is also a great risk that such a regulatory technique will increase transaction costs for csps as well as contribute to an unclear regulatory structure. the vision of a european capital markets union, or even a nordic capital markets 129 ziegler et al., ‘expanding horizons’ (n 38) 83. 130 invesdor, press release, ‘invesdor launches in norway’ (press release) (17 feb 2016) on file with author. equity crowdfunding service providers 230 union, is still some years away from becoming a reality, at least when it comes to the regulation of equity-based crowdfunding. microsoft word salminen_jaakko_henrik.doc nordic journal of commercial law issue 2011#1 the different meanings of international commercial conciliation by jaakko henrik salminen nordic journal of commercial law issue 2011#1 1 1 introduction the meanings of legal textual objects, such as laws, legal principles, concepts, and judgments, change over time. new meanings are proposed by legislators, courts, lawyers, and other legal actors, and are then argued over in courts. in this article, based on my 2011 master’s thesis, i discuss some of the different meanings proposed for conciliation1 in the context of international commercial dispute resolution. on the basis of contemporary legislative material, caselaw and jurisprudence, i identify three distinct legal meanings. the first meaning is that of a blanket denial of any legal effect of conciliation agreements. under this meaning, courts simply leave conciliation agreements unenforced. the second meaning is that of applying a restrictive interpretation on conciliation agreements. under this meaning, conciliation agreements must be drafted in a particular form and any deficiency in them may cause the agreement to be denied legal meaning. the third meaning is that of applying a liberal interpretation to conciliation agreements. under this meaning, any clearly expressed intention to conciliate is given independent legal effect, if necessary through a constructive interpretation that overcomes deficiencies in form. lacking any binding international legislation on conciliation, i reflect on these three different meanings of conciliation in light of the brocard pacta sunt servanda; agreements must be kept. a key problem is that no single content can be identified for pacta sunt servanda itself; courts use this brocard to represent not only different interpretive paradigms, but also the more general principles of equity. agreements are enforced to the extent that their content is understandable and acceptable to the relevant legal system. discourse over this acceptability takes place through the principle of pacta sunt servanda and all the concepts and ideas used to clarify that principle. thus, identifying the true motives of courts that apply different kinds of meaning to conciliation agreements is difficult. therefore, i argue that the only meaning that can reasonably be attributed to conciliation in the international commercial context is that of a liberal interpretation seeking to assign legal effect to all agreements to conciliate. doing so would alleviate paradigmatic confusion when courts interpret conciliation agreements and better protect the true intentions of the parties. another compelling reason for adopting a liberal interpretation of conciliation agreements is the inherent value of conciliation for international dispute resolution in general. it has been recognised by business actors, international dispute resolution institutes, international and national legislation, and courts of law. in practice, while leading authorities view preparing for a restrictive interpretation of conciliation agreements as a “safe choice”, business actors should 1 in this article, the words conciliation and mediation are used interchangeably to refer to a consensual method of dispute resolution under the guidance of a neutral third party. nordic journal of commercial law issue 2011#1 2 also acknowledge that courts have increasing possibilities for applying a liberal interpretation to conciliation agreements. thus, business actors should avert negative consequences, for example in relation to the validity of arbitral awards, by acting to uphold any contractual intention to conciliate prior to commencing litigation. section 2 provides an overview of the legal and practical contexts of international commercial conciliation. in section 3, i review a number of legal instruments and caselaw on conciliation and, based on these, identify three different meanings given to conciliation in different legal contexts. finally, in section 4, i evaluate the three different meanings of conciliation in light of their legal and practical implications. section 4.4 provides an overview of the key findings on a general level and particularly in relation to finnish law. 2 contexts of conciliation from the point of view of abstract legal norms, societal phenomena can be framed in a multitude of ways. in this section i sketch a theoretical framework to examine the practical and legal contexts of international commercial conciliation. in particular, i argue that conciliation should not be viewed separately as a novel form of dispute resolution in itself, but as an integral part of existing forms of litigious dispute resolution. thus, the same ideas and principles that are used in evaluating the method underlying dispute resolution, such as arbitration or court proceedings, should also apply to conciliation. similarly, any legal meanings afforded to conciliation should necessarily take into account the greater context of international commercial dispute resolution. 2.1 general legal-theoretical framework this article is based on the underlying position that law is a discourse that not only directs societal practice, but also necessarily reflects upon it. every time a provision, a legal principle, a decision, or some other legal textual object is applied, the circumstances of that application nordic journal of commercial law issue 2011#1 3 build upon and change the meaning of the legal textual object in question.2 this discourse between legislators, judges, scholars, and other users of law changes and challenges our understanding of what is considered expected behaviour in particular circumstances and under particular ideas of law. in order to study that discourse successfully it needs to be set into a framework that can highlight meaningful differences in the types of argumentation used by different actors. the framework used in this article is the traditional nordic concept of sources of law.3 however, i propose that this concept needs to be expanded. any idea of law depends on the point of view adopted as regards to context. despite any possibly increased textual stability that law brings to legal textual objects, interpreting law is in the end a process of contextualisation, de-contextualisation and re-contextualisation of a particular justification in different circumstances. discussing emily dickinson’s poems from the perspective of textual criticism marta werner notes that:4 …the editor…is charged with the task of re-making dickinson in the image of the present critical and cultural age. of particular interest here will be the ways in which [the edition] responds to recent readings of dickinson—many feminist and poststructuralist in orientation—that challenge, among other things, the “hierarchies of traditional textual components (e.g., truth and error, reading and variant, center and margin),” and that are clearly antithetical to masterpiece theories of art. 2 the changing meanings of textual objects and the relationship of this meaning to perceptions of context are discussed for example by derrida (1988) and foucault (2009). for law in particular, see e.g. amstutz (2007) and (2008) on swiss codification and interpretive methodology and votinius (2004) on the general principle of pacta sunt servanda in a nordic context. latour (2009) sees “law” affect the meaning of legal textual objects as a system of discourse and translation through which various kinds of input from society interact with each other in order to determine what is “right”, the relevancy of societal input being identified by its nature as so called “value objects”. these ideas are universal for all legal systems based on human language. whether one talks about the interpretation of statutes or the creation of new caselaw, the underlying discoursive process is the same. law redefines the meaning of legal textual objects through the discourse through which they are applied into societal circumstances. 3 in effect, “the sources of law” form a list of legitimate sources of arguments for creating normative reasoning and identifying what is just in a society (e.g. tolonen 2003 p. 169). from a nordic point of view, tolonen identifies as valid sources of law in a somewhat descending order of hierarchy legislation, travaux préparatoires, caselaw, legal principles and jurisprudence, custom, and factual consideration (2003 p. 103 ff.). the actual relationship of these different sources of law under particular circumstances is often unclear, especially where law provides no “obvious” solution for example in situations where legislation is lacking or where laws contradict each other or some more general perception of “justice”. some general rules for interpreting the relationship of sources of law have nonetheless been proposed. for example, under traditional finnish legal theory the value of travaux préparatoires as an indication of the legislator’s intent is typically seen as great when a new law is promulgated. over time, the importance of the travaux préparatoires wanes and is replaced by judicial interpretations in the form of caselaw (tolonen 2003 p. 116). thus, a number of general structuring principles are used to organize the discourse network formed by these various legal arguments. 4 werner 1998 p. 256. nordic journal of commercial law issue 2011#1 4 a similar process of re-evaluation of the possible contemporary readings of a justification as interpreted in relation to previous readings creates various voices that propose different kinds of argument. gradually, new voices gain momentum and replace older voices as the more or less agreed upon default reading of law. a key question is how exactly this happens. latour has tried to identify all the different value objects that affect decisionmaking in the french supreme administrative authority, the conseil d’état.5 one of latour’s main findings was that law as a system cannot be diluted to what are seen as traditional doctrines of sources of law such as the nordic concept that lies at the foundations of this article.6 instead, law is much more complex and requires at least all the different value objects identified by latour to make it possible for courts to translate societal phenomena into legal output. similarly, in the nordic context pöyhönen has criticized the present finnish system of contract, property, and tort for being locked into an old-fashioned legal paradigm that cannot adequately reflect in its argument structures the plurality of different factual circumstances caused by societal development.7 the discrepancy between the legal and the societal causes a severe strain on courts, in particular by making it difficult to create absolutely coherent legal arguments that also reflect changing views on equity. the result is that law is a systemic framework that highlights the difficulties and open-ended nature of legal argument; no hierarchy of argument seems to be able to provide a single viewpoint on what is just. this point of view has been recently noted by the swiss federal supreme court that has declared that it no longer can convincingly interpret every aspect of law in a unitarian and authoritative manner with the traditional legal argumentative tools they have at hand.8 how then, can the forces that affect the course of law be portrayed in judgments in such a manner that legislators can more effectively remedy any perceived problems in law and that citizens can better understand, discuss and criticize the contents of law? the uncertain nature of law as a process of translating societal expectations that arise in individual situations into the abstract and general language of law has the power to conceal more than it reveals. a number of proposals have been made to overcome this democratic deficiency, for example by increased reliance on the context of individual cases and different technologies to systematize these contexts.9 i try to take this into account in this article. in short, law should respect the context more, and openly take into account how different actions can be perceived in different ways depending on how things are looked at. therefore, in addition to trying to cover the traditional sources of law listed by tolonen this article tries to place conciliation into a particular context, that of international commercial dispute resolution in general, and to evaluate the legal aspects of conciliation from within this context. 5 latour 2009. 6 latour 2009 p. 194–5. 7 pöyhönen 2000. 8 see steinauer 2009 and amstutz 2008 for viewpoints criticizing and lauding this approach. 9 pöyhönen 2000 p. 140ff., p. 159ff. nordic journal of commercial law issue 2011#1 5 2.2 practical contexts of conciliation in his treatise on international commercial arbitration, born duly notes the adage that a “contract means no more than what it is interpreted to say”.10 a contract can be interpreted in a number of ways. one is to have the parties themselves negotiate a common interpretation for the contract. another possibility is having some third party such as a court of law or an arbitral tribunal do the interpretation. yet another possibility is that the parties reach a common interpretation with the help of a third party such as a conciliator or mediator. but why would the parties choose one over the other? in section 2.2.1, i explore this question in light of the benefits associated with arbitration in relation to proceedings in national courts and by comparing conciliation to the perceived benefits of arbitration. in section 2.2.2, i highlight the benefits and problems of conciliation especially when coupled with another form of dispute resolution such as arbitration or litigation. in doing so, i place conciliation in the context of international commercial dispute resolution and hope to underline not only the similarities in the objectives of conciliation and arbitration, but especially the intertwined nature of these two forms of dispute resolution. in effect, section 2.2.3 reaches the outcome that, from the point of view of international dispute resolution agreements, it is more useful to conceive of arbitration and conciliation not as separate individual dispute resolution mechanisms, but as two integral aspects of a single dispute resolution mechanism. 2.2.1 arbitration and conciliation according to born, objectives for international arbitration come down to having a forum that is as equal and efficient as possible for the parties and one that provides for internationally effective judgments.11 specifically, some factors can be identified as prominent including having; a neutral and centralized dispute resolution forum; enforceable agreements and awards; final decisions; tribunals with adequate commercial competence and expertise; the possibility for party autonomy and procedural flexibility; benefits of cost and speed; confidentiality; and facilitating amicable settlement. the neutrality of the dispute resolution forum is enhanced by the parties’ mutual agreement on the composition, location and procedure of the arbitral tribunal. a centralized dispute resolution forum helps avoid jurisdictional and choice of law difficulties that might result in the fragmentation of the dispute and thereby increasing transaction costs. any award ordered by an arbitral tribunal is useless unless it can be effectively enforced. similarly on the question of enforceability, the finality of a decision relates to transaction costs and legal certainty in the sense of to what extent decisions can be taken up for review by national courts. the possibility 10 born 2009 p. 64. 11 born 2009 p. 72 ff. nordic journal of commercial law issue 2011#1 6 of agreeing on choosing their own arbitrators may help the parties ensure the tribunal’s commercial competence and expertise instead of having to rely on generalist judges struggling with caseloads that have little relation to the subject matter at hand. further, the procedural flexibility brought in by the principle of party autonomy may help the parties tailor a procedure that is not only more efficient, but also more just. confidentiality and privacy are typically easier to achieve through arbitration than through national courts, which are often obligated to publicity. the cost and speed of arbitration is greatly variable and depends on the other factors such as choices made regarding forum and procedure.12 finally, born claims that the procedural cooperation required by arbitration and “the prospect of a competent, expert decision by a commercially-sensible tribunal often facilitates the settlement process”.13 on the other hand, all these factors are relative. any neutrality in choice of procedure is subject to the relative equality of the parties.14 as noted in section 2.1, law is a process of translating societal circumstances into the legal; the arbitrators’ possibilities to use their expertise in assessing what is just in a concrete situation are limited by the requirement that the ensuing award must retain its enforceability and finality when the award is reviewed by judges operating in national legal systems. even under the new york convention15 the enforceability of arbitral awards is not guaranteed and problems in enforcement may be used as a means of coercing settlement.16 organizing arbitration in an efficient and flexible way requires additional effort in 12 bühring-uhle’s questionnaire study found that practitioners typically experience arbitration as faster but not less expensive than court litigation (2005 p. 38ff.). born reflects factors such as arbitrators’ and institutional fees and the logistical costs of organizing an arbitral process, all these increasing if the process lingers on (2009 p. 84). on the other hand, transaction costs at national courts may similarly be considerable for example in cases of appeal. regarding speed, born estimates that arbitration is “usually less slow” with meaningful commercial disputes often taking 18–36 months before a final award is reached, though this again depends on how well the agreed arbitration procedure fits the dispute at hand (2009 p. 85). from a finnish perspective, ovaska estimates that arbitration and ordinary court proceedings face roughly equal costs but that arbitration would on average be clearly faster due to the lack of appeals and taking into account the “attention that chambers of commerce pay on expeditiousness” for example with the one year time limit for arbitrations issued by the finnish central chamber of commerce (2007 p. 376, p. 387). 13 born 2009 p. 87–88. 14 e.g. ben-shahar and white 2006. 15 united nations 1958: convention on the recognition and enforcement of foreign arbitral awards. 16 pricewaterhousecoopers 2008. nordic journal of commercial law issue 2011#1 7 the drafting phase, and even then, one size rarely fits all.17 if the parties’ relationship has deteriorated, bespoke arbitration procedures intended to ensure swift resolution of disputes may become prime objects of dispute themselves.18 finally, while the institutionalisation of arbitration also has its benefits, the interaction that has ensued between the arbitral and the judicial has lead to arbitration becoming more and more like “normal” litigation with potentially rigid procedure legislated nationally and internationally and further defined by caselaw.19 in short, increased procedural intricacy and increased involvement of judicial systems bring arbitration closer and closer to formal judicial procedure, a starting point from which arbitration traditionally has tried to distance itself. conciliation is defined by hill as a “voluntary, non-binding” process “using a neutral to guide the parties towards a mutually beneficial resolution of their dispute”.20 a conciliator cannot impose a decision on the parties like a judge or arbitrator, but only “helps the parties to decide for themselves whether to settle and on what terms”.21 thus, in conciliation the objectives of arbitration mentioned above are of somewhat different weight. instead of guaranteeing a final decision for the parties, the non-adjudicatory procedure tries to facilitate a mutually acceptable settlement. amicable settlement is emphasised to such an extent that if settlement cannot be reached, the procedure results in no decision at all. either party may decline the proposed 17 see e.g. berger (2008) on fast-track arbitration. how institutionalisation has turned into increased drafting, contract-management and co-operation requirements becomes clear from o’neil’s presentation of arbitration from a commercial client’s perspective (2008). however, achieving o’neil’s objectives for a fast and cost-efficient process may become impossible once a dispute has escalated (2008 p. 73): • appoint a tribunal that has the necessary expertise, availability and reputation of being expeditious, be they one or three arbitrators. • co-operate in agreeing to an expeditious programme. • prepare submissions that are concise, use simple language and clearly identify the key issues… • make use of party autonomy—encourage and assist the arbitrator to limit discovery, the number of experts and the size of submissions. • make sure arbitration does not become litigation under another name. • agree on a process to narrow the issues if possible. • control of costs is all-important. clients hate being ambushed with large unexpected legal bills– provide us with a budget for approval in advance and if it looks like being blown tell us that well in advance, because it may affect our decision. 18 as is seen in the swiss federal supreme court case 4a_18/2007 discussed in section 3.2.3. 19 e.g. brower 2007 p. 181, p. 184. increased procedural intricacy is clear from the great interest on various procedural issues such as disclosure. a recent example on the relationship of arbitration to european law is the 2009 allianz spa (formerly riunione adriatica di sicurta spa) v. west tankers inc decision on anti-suit injunctions. the ecj ruled that anti-suit injunctions based on arbitration agreements are not compatible with council regulation (ec) 44/2001 on jurisdiction and the recognition and enforcement of judgments in civil and commercial matters. arbitration is thus increasingly intertwined with judicial procedure: even when arbitration is specifically left outside the scope of council regulation (ec) 44/2001 (see article 2), the ecj nevertheless found itself competent to rule on the use of anti-suit injunctions in arbitration. 20 hill 1998 p. 175. 21 hill 1998 p. 175. nordic journal of commercial law issue 2011#1 8 solution without any harm to its rights. volition is thus one of the most important aspects of conciliation.22 the heavy emphasis on volition changes the balancing of objectives of arbitration, so that in conciliation, there is no guarantee of a final decision. apart from the lack of guaranteed decisions, conciliation seems to better fulfil those objectives, than arbitration. there is no fixed procedure, unless the parties agree to such. in this, conciliation seems similar to the arbitration of yore: a relatively free procedure that is not cluttered by procedural restraints unless the parties wish so. once a conciliator has been appointed, they are free to conduct the proceedings as they see fit.23 the parties are free to choose a conciliator they see as competent and expert on the matter in question and they are also free to formulate their conciliation agreement and procedure as required. the dispute resolution forum is even more neutral than in arbitration as parties have equal power over whether any ensuing decision is accepted. the dispute resolution forum is as centralized as the parties wish, as the parties may include in their settlement any disputes they want to, even ones that have no direct relevance to each other. while the parties have no obligation to accept a settlement proposed in conciliation, the outcome of the process, if accepted, can be a final and binding agreement; an arbitral tribunal or court may even be requested to turn the settlement agreement into an enforceable decision. the transaction costs of conciliation with regard to time and money are lower than in arbitration or court proceedings as the parties need not invest as much in a legal process that attempts to subordinate the other side’s arguments at all costs. as seen in section 2.2.2 below, the procedure has potential to maximize the circulation of dispute-related information even while maintaining overall confidentiality. by emphasising volition over everything else and by avoiding the tribulations of adversarial procedure, conciliation helps further amicable relationships between disputing parties. the questions remaining, then, are whether a procedure with no guarantee of resolving a dispute can work and whether it can and should be imposable on parties as a binding obligation. the question of whether and how a non-binding procedure such as conciliation does work is examined in section 2.2.2 below. the latter question is addressed in detail in section 4 below. 22 e.g. sanders 1999 p. 355. 23 for example, according to article 6(2) of the uncitral model law on conciliation: failing agreement on the manner in which the conciliation is to be conducted, the conciliator may conduct the conciliation proceedings in such a manner as the conciliator considers appropriate, taking into account the circumstances of the case, any wishes that the parties may express and the need for a speedy settlement of the dispute. redfern and hunter describe conciliation as a kind of scuttling back and forth between the parties that the conciliator undertakes while trying to pinpoint the essence of a dispute and any middle ground (2004 p. 44). a more detailed example of how a conciliation process may take place is provided for example in aaa’s guide to mediation and arbitration for business people (2007 p. 10–14). nordic journal of commercial law issue 2011#1 9 2.2.2 how conciliation works and how it doesn’t the theoretical foundations of non-adjudicatory dispute resolution have been examined for example by hill.24 hill notes the essential distinction between interests and rights.25 interests are “defined by a party in interaction and are the things that that party is interested in”, with examples such as money, physical goods, and recognition, while rights are “given by an external framework” such as laws or agreements. the key difference between litigation (including arbitration) and conciliation is that the first attempts to settle disputes in relation to parties’ rights while the latter attempts to settle disputes in relation to parties’ interests.26 interest-based conciliation, hill argues, is a non-zero-sum game aiming at a solution that tries to guarantee both parties’ interests, whereas rights-based litigation is zero-sum due to the restrictions of litigation, which typically require that the rights of one party are given precedence over the rights of another.27 in light of the discussion in section 2.1 above, interests thus reflect real world situations in particular circumstances while rights reflect abstractions of justice translated over time from real world circumstances. in litigation or arbitration, interests would have to be approximated and translated into rights through the legal system, while conciliation can directly try to tackle the underlying interests of a dispute. conciliation is therefore of fundamental interest not because it is more efficient time-wise and cost-wise than litigation, but because it can be more effective by allowing solutions that better reflect both parties’ interests than rights-bound judicial decisions or arbitral awards ever can.28 furthermore, conciliation allows for conflict-avoidance; unlike litigation, parties may be able to find a solution that does not force them to cross swords at all. according to hill, what makes conciliation work as a non-zero-sum game are factors such as, confidential information exchange, interweaving of information exchange, characteristic matching, de-conflicting, and the mere fact that solutions are not judicially constrained.29 24 hill 1998. 25 hill 1998 p. 173 26 while purely facilitative conciliation concentrates solely on interests, evaluative conciliation tentatively sketches the parties’ respective rights positions in order to facilitate a settlement. thus, evaluative conciliation is akin to litigation but with the key difference that it only attempts to identify probable rights positions without having the capacity of definitively fixing them. even tentative information about each other’s respective power positions may change the parties’ actual power positions in negotiations. hill notes that litigation itself is often also used as an expensive version of evaluative conciliation on the results of which settlement negotiations are based. similarly, redfern and hunter conclude that an arbitral award may often be only the beginning of settlement negotiations and especially so with the added risks of enforcement difficulties or appeals on the arbitral process (2004 p. 560). 27 hill 1998 p. 176. 28 hill 1998 p. 174. 29 hill 1998 p. 175. nordic journal of commercial law issue 2011#1 10 confidential information exchange is important because parties typically weaken their own bargaining positions, if they disclose relevant information to each other. a neutral conciliator, on the other hand, may be able to access the relevant information without weakening the bargaining position of either party. the interweaving of information exchange is important as in litigation parties typically communicate through a fixed procedure that is limited to rigid and formal exchanges of documents, statements and pleadings.30 in conciliation, however, information exchange can be more fluid and responsive with one party providing the other with a piece of information and proceeding further only after the other party has sufficiently responded to the first request by directly acknowledging or challenging the information or with new information. characteristic matching refers to the increased possibility of a conciliator to identify the common denominators in parties’ interests.31 for example, in technically complex disputes the mere requirement that each party presents complex cases to the conciliator in an understandable manner may lead to the dispute being broken down into more manageable entities. de-conflicting directs parties away from the absolutely-right-or-absolutely-wrong frame of reference of law, based on what either party sees as supposedly provable facts and supposedly clear interpretations of law, to the more relativistic frame of reference of extra-legal reality. instead of winning a legal claim parties can for example concentrate on how a particular resolution to the dispute affects the parties’ image, financial positions, and future sales and profits. drafting from such a relativistic frame of reference may help identify the actual interest of the dispute from the abstract legal framework of rights that may be distanced from the actual problem. finally, that solutions are not bound by judicial constraints is important due to the limitations of litigation with regard to the above-mentioned divide between abstract rights and concrete interests.32 judges and arbitrators are constrained by the parties’ claims and the limits of law. conciliation is not limited by such bounds. parties are free to settle as they wish, even by compromising their potential rights positions in order to secure their interest positions. from a game-theoretical perspective as presented by hill, one of the basic ideas behind conciliation is that if one party cooperates but the other does not, then the cooperating party may weaken its bargaining position by revealing useful information to the other side without gaining anything in return. if neither does, then either both parties stand to lose or the result is uncertain. this is the case for example in rights-centred litigation, where one party wins acknowledgment of its rights position while the other party loses such acknowledgment. in particular in cases with complex legal issues it may be impossible to know beforehand which party will prevail and the ensuing legal battle will be akin to the classic example of auctioning a twenty dollar bill. if both parties, however, overcome any one-sided views of their bargaining positions, then the ensuing result may be better for both due to lesser transaction and image 30 hill 1998 p. 177. 31 hill 1998 p. 178–9. 32 hill 1998 p. 181. nordic journal of commercial law issue 2011#1 11 costs and the possibility for more equal decisions than those possible through litigation. but due to the information blackout often associated with legal bargaining, it may be nearly impossible for disputants to reach such settlement without outside help. with regard to using information positions and the possibilities for proposing different types of settlements, there is a major difference between negotiation, conciliation and litigation. between free-for-all negotiation and rigid litigation procedure, conciliation offers middle ground on which a conciliator has the possibility to make maximum use of both parties’ information positions with neither party having to fear losing bargaining power. further, as a neutral evaluator, the conciliator is in the best position to use this advanced information position for characteristic matching in order to propose de-conflicting solutions, even beyond what would be judicially possible. especially in escalated disputes all this may only be achievable through an experienced conciliator and a binding conciliation procedure. if both parties see the conciliator as trustworthy, he or she may be able to identify and propose solutions that the parties could not achieve due to the locked-in status of their negotiations. unlike hill, in their treatise on international arbitration redfern and hunter concentrate on what they see as the five key limits of conciliation33. first off, they point out what they see as the cultural specificity of conciliation. this is their belief that conciliation works best when all parties and the conciliator share the same cultural and legal background. to an extent this is true; as seen above with regard to the discussion on the objectives of arbitration and conciliation, parties in dispute most certainly wish for a competent and expert conciliator who can take into account the particularities of their respective fields and backgrounds. it is well within the scope of party autonomy to try to decide on a conciliator or arbitrator suitable also in this regard. beyond this, in an increasingly global world i argue that cultural specificity will increasingly cease to be an issue for capable conciliators. another issue raised by redfern and hunter is that in some cases one party can simply be seen to be wholly right about its rights position and the other wholly wrong. redfern and hunter claim that compromise in brokering a deal in such situations may not be morally justifiable and may have a poor impact on fairness in general.34 then again, party autonomy with regard to the possibility of settling on whatever grounds is a key principle of private law. parties are typically free to settle cases, whether or not an ensuing settlement might be seen by some to be morally questionable or not, and neither does conciliation impose any obligation to settle. further, from other perspectives accepting a smaller settlement instead of a full reparation that is attainable only through time-consuming litigation may be justifiable with regard to minimising transaction costs both on the parties themselves and the judiciary. redfern and hunter themselves note that the result of litigation may be perceived as merely the starting point for 33 redfern and hunter 2004 p. 53. 34 redfern and hunter 2004 p. 53. nordic journal of commercial law issue 2011#1 12 settlement proceedings on the basis of “a bird in the hand is worth two in the bush”.35 finally, whether or not conciliation is futile in such situations is difficult to judge beforehand. it is not atypical for disputing parties to see their rights positions as “right” prior to litigation, only to see the same rights positions change during the legal process, as noted for instance by the english justices discussing the effects of declining court-proposed conciliation on cost-awards.36 third, redfern and hunter note that conciliation may be used as a tactical ploy by a party that, while not willing to negotiate, nevertheless claims to be so up to the point at which it turns down the suggested settlement. the use of law as a tactical measure for achieving goals foreign to the meaning of law is of course a very real possibility. however, the possibility of abuse of rights exists with regard to almost any legal measure. any courts that assess whether for example interim measures for securing assets are justified during conciliation proceedings or whether pre-arbitral procedure as a condition precedent for further dispute resolution has been complied with should take this possibility into account under relevant doctrines on abuse of law. the two remaining issues discussed by redfern and hunter are more pertinent to the nonbinding nature of conciliation. fourth, they acknowledge that conciliation aims at a compromise, a situation in which both parties win or at least do not lose as bad as they would under litigation. however, all issues cannot be compromised. one example are clauses in standard form that, depending on their interpretation, may affect numerous other contracts in which the same standard form is used. in such cases, and in others where a legal precedent is sought, a final decision on the interpretation of the clause may be required instead of an in casu compromise. fifth and finally, redfern and hunter note that even with genuine effort, conciliation does not always work. the conciliating parties are free to decline any proposed settlement as they wish. in such a case, conciliation would according to them only have been an obstacle towards reaching a final result to the dispute, incurring additional costs and delays to the parties involved. thus, out of the five issues raised by redfern and hunter only the last two seem to be particularly pertinent to conciliation. these issues are neatly summed up by the english court of appeals in the 2004 halsey decision:37 35 redfern and hunter 2004 p. 560. this position is also supported by a pricewaterhousecoopers study conducted among major corporations engaged in international arbitration, according to which “56% of the participating corporate counsel who had negotiated a settlement after an award indicated they did so in order to avoid the time or costs involved in embarking on recognition, enforcement and execution proceedings in a foreign jurisdiction” and that for 19% maintaining a relationship with the non-prevailing party was a major incentive to settle (pricewaterhousecoopers 2008 p. 3). further, corporations relatively seldom manage to recover the full award for example due to lack of funds, problems in identifying recoverable assets or local enforcement and execution proceedings (ibid.). 36 see e.g. susan dunnett v railtrack plc. 37 halsey para 17. nordic journal of commercial law issue 2011#1 13 even the most ardent supporters of adr acknowledge that the subject-matter of some disputes renders them intrinsically unsuitable for adr. the commercial court working party on adr stated in 1999: “the working party believes that there are many cases within the range of commercial court work which do not lend themselves to adr procedures. the most obvious kind is where the parties wish the court to determine issues of law or construction which may be essential to the future trading relations of the parties, as under an on-going long term contract, or where the issues are generally important for those participating in a particular trade or market. there may also be issues which involve allegations of fraud or other commercially disreputable conduct against an individual or group which most probably could not be successfully mediated.” other examples falling within this category are cases where a party wants the court to resolve a point of law which arises from time to time, and it is considered that a binding precedent would be useful; or cases where injunctive or other relief is essential to protect the position of a party. but in our view, most cases are not by their very nature unsuitable for adr. however, the fact that some legal issues are not solvable through conciliation does not in itself necessarily make conciliation useless. mackie and allen claim that even when conciliation has led to trial or appeal instead of settlement “preparation work that will have been needed to be done anyway is done at an earlier stage than otherwise, and the issues thereby usefully defined and limited” and that because of this “mediators tend to talk not of failed mediations but mediations which did not settle the claim immediately or at all”.38 similarly, lightman notes that conciliation is always a good exercise for stepping into the shoes of the other party, i.e. “opening the eyes of parties to the merits of the opponent’s case, the issues involved, the risks and costs of litigation and the attractions of a settlement”.39 even where no settlement is reached directly through the conciliation process, parties (and indirectly the judiciary) benefit from the case analysis that parties undertake during conciliation. the american arbitration association sums up these possible benefits of conciliation in “plain talk”, noting that even when not resulting in a settlement, conciliation can:40 • reduce the hostility between the parties and help them to engage in a meaningful dialogue on the issues at hand; • open discussions into areas not previously considered or inadequately developed; • communicate positions or proposals in understandable or more palatable terms; • probe and uncover additional facts and the real interests of parties; 38 mackie and allen 2009. 39 lightman 2007 p. 401. 40 aaa 2007 p. 7. nordic journal of commercial law issue 2011#1 14 • help each party to better understand the other party’s view and evaluation of a particular issue, without violating confidences; • narrow the issues and each party’s positions, and deflate extreme demands; • gauge the receptiveness for a proposal or suggestion; • explore alternatives and search for solutions; • identify what is important and what is expendable; • prevent regression or raising of surprise issues; and • structure a settlement to resolve current problems and future parties’ needs. 2.2.3 best of both worlds? because it cannot guarantee a final resolution to a dispute, conciliation is not used as the sole method of dispute resolution in international commercial contracts. instead, it is typically used as one tier of a multi-tiered dispute resolution clause and accompanied by some form of litigation or arbitration.41 parties typically start their contractual dispute resolution process with voluntary methods such as negotiation and conciliation and only use litigation or arbitration in case other methods fail to resolve the dispute. as seen in the previous section, conciliation may not be capable of offering an ideal solution to all cases. however, as also seen in the previous section, neither does conciliation harm the parties’ interests; on the contrary, it eases the burden of litigation if conciliation has more precisely narrowed down the nature of the dispute than what would be possible under litigation. conciliation does not need to provide a final solution in order to facilitate litigious dispute resolution. the question is rather of having the possibility of conciliation as a first step before more costly methods of dispute resolution.42 conciliation itself should be seen less as an independent method of dispute resolution and more as pre-arbitration or pre-litigation that helps carry the burden of litigation, with the added bonus that the first step may be able to prevent litigation completely. thus, there seems to be little need to consider conciliation as a 41 pryles describes multi-tiered dispute resolution clauses as clauses designed to deal with future disputes that are multifarious in nature; they are “likely to contain, in one tier or another, a procedure appropriate for a particular dispute” (2001 p. 158–159). such clauses typically escalate from a negotiation tier to a conciliation tier to a litigation tier, and do not, as a rule, make a differentiation between what kinds of disputes are resolved with which method (see, for example, dobbins 2005). 42 as with all ex ante agreements on the resolution of future disputes, it is impossible to know the exact nature of future disputes beforehand. there seems to be no way of realistically determining in advance whether conciliation, litigation or some other method would be optimal under particular circumstances. hill’s discussion of conflict system design provides an example of a dispute resolution mechanism in which there is a case-by-case ex post decision over what dispute resolution method from a number of alternatives is used (1998 p. 182–3). in such cases the power to decide the appropriate methods of dispute resolution would be relegated to an external party, in hill’s example to the dispute resolution advisers used in the construction industry in hong kong. having such a third party on standby of course requires considerable resources. nordic journal of commercial law issue 2011#1 15 fully independent dispute resolution system. instead, it should be seen as an integral and effective part of arbitration or litigation, a kind of pre-arbitral or pre-judicial procedure that parties should agree on in order to increase the efficiency of their dispute resolution process. in general, settlement is by far the most common way to solve commercial disputes and most probably as old as the very idea of dispute.43 civil courts have also been susceptible to settlement for long.44 this also applies to procedures that assist reaching settlement.45 it is beyond the scope of this article to reflect on the exact history of helping people settle their disputes without resorting to litigation, but it seems that conciliation as assisted settlement does not lag far behind from the reputation of settlement in general. conciliation seems to be increasingly gaining the favour of business.46 also institutions organising conciliation proceedings are very positive about their results. mackie and allen, representing the uk organisation cedr, note that in 2009: the investment [into conciliation] pays off in anything from 60-90% of cases, depending on the sector, the mediator, and on the willingness of the parties to buy up the risks in their respective cases. many which do not settle on the mediation day settle later and as a direct result of the shifts in thinking produced by the mediation. the aaa claims not only that “85% of commercial matters and 95% of personal injury matters” that are conciliated end up in “written settlement agreements”, but also that conciliation is successful on an extremely broad spectrum of disputes:47 43 born 2009 p. 70. 44 see also the frequent evocations of settling disputes outside courts in sachs’ analysis of the practice of medieval courts in relation to modern perceptions of lex mercatoria (e.g. 2006 p. 721–722). for example in the 1302 decision darlington v. burser reported by sachs, the st. ives fair court, instead of issuing a general ruling, “granted permission to settle”. 45 according to roebuck’s research (in particular 2006 p. 102–3; 2007 p. 115), conciliation has been a prime method of dispute resolution in all kinds of cultures and throughout the ages, from prehistoric times to our own. 46 pricewaterhousecoopers’ 2006 survey international arbitration: corporate attitudes and practices studied the attitudes of 103 “leading corporations” towards transnational litigation, international arbitration, and conciliation and other forms of adr. the study found that the preferred dispute resolution method for international disputes were multi-tiered dispute resolution procedures combining arbitration and adr for 44% of the respondents, international arbitration for 29% of the respondents, international conciliation and other adr for 16% of the respondents, and transnational litigation for 11% of the respondents (pricewaterhousecoopers 2006 p. 5). while the study does not give a clear picture on the prevalence of conciliation, one may assume that conciliation, which is seen as the default adr method for example by the uncitral conciliation model law and the icc adr rules, is well represented by the almost two thirds of the respondents who mention adr either alone or in conjunction with arbitration as their preferred method of dispute resolution. further, the study indicated a trend toward the development of “more sophisticated dispute resolution policies” that will “[i]ncreasingly… take the form of escalating, multi-tiered dispute resolution procedures” (pricewaterhousecoopers 2006 p. 22). 47 aaa 2007 p. 2; aaa 2009. nordic journal of commercial law issue 2011#1 16 [i]t is widely acknowledged that the majority of disputes submitted to mediation result in a settlement agreement. however, there is no one specific answer to this question because of the diversity of issues submitted to mediation and the various fields in which mediation is practiced, e.g. family, community, commercial, employment, international, etc. 2.3 legal contexts of international commercial conciliation in this section i study the relevance to conciliation of various legal instruments on international commercial dispute resolution. conciliation will be approached from the perspective of the more extensive legal material available on international arbitration. section 2.3.1 provides an overview of international regulation and section 2.3.2 discusses the effects and potential of this regulation on the enforceability of arbitration and conciliation agreements. finally, instead of concentrating on regulation solely aimed at conciliation, section 2.3.3 proposes identifying international commercial dispute resolution as the relevant legal context from which to examine the meaning and effects of conciliation agreements. 2.3.1 international regulation this discussion on regulating international commercial conciliation starts with a detour through the most generally accepted legal instrument on international commercial arbitration, the 1958 new york convention. the new york convention provides a widely accepted international basis for the evaluation of arbitration agreements.48 it does not, however, provide much regulation on what arbitration agreements look like or how the actual arbitration process should proceed. further, the new york convention does not directly state how arbitration agreements should be interpreted; the assessment of whether an agreement to arbitrate exists is primarily left to national laws of contract. nevertheless, because the majority of the nations in the world adhere to the new york convention, international arbitration is well established and recognised by law. there is no such international law on conciliation. international regulation on conciliation consists primarily of non-binding soft law instruments. for example uncitral, in connection with its work on arbitration, decided in 1978 to take steps in providing a common legal framework for conciliation.49 this resulted in the 1980 uncitral conciliation rules and the 2002 uncitral model law on international commercial conciliation (“uncitral 48 see in general born 2009 for the new york convention and its interpretive effect. 49 according to the travaux préparatoires, one of the priority items of the new work programme adopted at the eleventh session of uncitral was, under the general heading of international commercial arbitration, “conciliation of international trade disputes and its relation to arbitration and to the uncitral arbitration rules” (uncitral 1979). this programme eventually led to the uncitral conciliation rules. nordic journal of commercial law issue 2011#1 17 conciliation model law”). while these are non-binding, they nevertheless have some institutional support in that they have been promulgated by uncitral as models for international commercial conciliation. further, the uncitral conciliation model law may be adopted by states as the basis for binding national legislation on conciliation and the uncitral conciliation rules may be similarly incorporated into a contract. however, as will be seen in section 3.1.1 below, even when incorporated into legislation or a contract these instruments retain a curiously non-binding nature unless they are extensively modified. nonetheless, both instruments serve as an international model for the legislation and interpretation of conciliation. they provide a basic benchmark for conciliation procedure, thus helping promote the uniformity of international conciliation. they have also gained a level of international acceptance as binding national legislation. according to the uncitral website, as of august 2010 legislation based on the uncitral conciliation model law has been enacted in seven countries.50 further, ten us states and the federal district of washington have adopted the uniform mediation act, which is claimed to be influenced by the uncitral conciliation model law.51 sanders notes that some national conciliation legislation based on the uncitral conciliation rules have also been enacted.52 further international soft law on conciliation is available through international dispute resolution institutions that have established their own conciliation rules. some of the betterknown regulations are the adr rules of the international chamber of commerce (“icc adr rules”), the international mediation rules of the international centre for dispute resolution (“icdr mediation rules”) and the mediation rules of the world intellectual property organization (“wipo mediation rules”). these constitute non-binding soft law that may be seen as even less official than the uncitral conciliation model law and conciliation rules, lacking the general institutional basis of the uncitral. however, similarly to the uncitral regime, they nevertheless serve as additional competing models on how to understand conciliation. parties are free to incorporate such rules in their contract for which purpose the rules provide a number of model clauses, ranging from optional clauses requiring parties only to consider alternative dispute resolution to clauses specifying mandatory adr procedures. as is seen in section 3.1.2, such non-uncitral regulations more clearly provide for binding conciliation. the key difference between international regulations on arbitration and conciliation is thus that with regard to conciliation there is no clear international authority that would require national courts to recognize and enforce agreements to conciliate. instead, there are merely non-binding models on how an agreement to conciliate might be construed. whether or not an 50 uncitral 2010b. 51 uncitral 2010b. 52 sanders 1999 p. 358 ff., pp. 371–2. nordic journal of commercial law issue 2011#1 18 agreement to conciliate in fact exists is thus ultimately left to national laws of contract.53 this position is not all too different when compared to arbitration. despite the new york convention, which requires courts to recognize and enforce foreign arbitration agreements, it is ultimately up to national contract law to decide whether or not an agreement to arbitrate exists. born, for example, notes that international arbitration conventions do not and national arbitration legislations only very rarely do prescribe specific rules governing the interpretive process of arbitration agreements.54 thus, the overall presumption made in this thesis that the enforceability of conciliation clauses is in general subject to national contract law is basically identical to arbitration agreements. the only major difference is that there is no overriding international legal instrument that would outright compel courts to uphold international conciliation agreements as the new york convention does. 2.3.2 the greater juridical contexts of arbitration and conciliation as seen in section 2.3.1, it is up to national contract law to evaluate whether or not a valid conciliation or arbitration agreement exists. besides the requirement to uphold valid arbitration agreements imposed by the new york convention, international and national regulation on arbitration and conciliation primarily provides a procedural framework through which to support any arbitration or conciliation process that does take place on the basis of an agreement. with regard to such procedural frameworks, arbitration is clearly in a more favourable position than conciliation. the international and national law on arbitration has two major effects on the enforceability of arbitration clauses. first of all, the new york convention and other international arbitration conventions are seen to contain a distinct pro-arbitration bias requiring courts to recognize international arbitration agreements.55 for example, article v(1)a of the new york convention does not require a court to deny recognition of an arbitral award based on an arbitration agreement that is found to be invalid “under the law to which the parties have subjected it”; 53 conciliation has in general been recognised in numerous jurisdictions by granting enforceability at least to what for example dobbins calls “properly crafted mandatory mediation clauses” (2005 p. 169). see e.g. berger (2006 pp. 6–9) on germany, france, england, new south wales, ireland, and the usa and jolles (2006 pp. 329–334) for switzerland, germany, usa, england, and the icc. dobbins notes that in the usa “state and federal courts are willing to recognize the strong public policy favouring alternative dispute resolution proceedings” (2005 p. 169). in some cases noted by dobbins, such as the seventh circuit’s 1987 devalk lincoln mercury and an ohio federal district court’s 1993 bill call ford, parties have even lost their right of access to court due to the annulment of judgments made prior to proper conciliation and the consequent running out of limitation periods. similar conclusions, though with less severe consequences due to policy disfavouring the loss of limitation periods, have been made for example in germany (bgh decision viii zr 344-97 of 18 november 1998) and austria (ogh wien decision 8 oba 28/08p of 2 september 2008). 54 born 2009 p. 1060. 55 born 2009 p. 1060. nordic journal of commercial law issue 2011#1 19 instead, the court may refuse such recognition. this pro-arbitration bias has led to liberal rules for the construction of international arbitration agreements. typically, arbitration agreements are in cases of doubt seen as enforceable rather than not even to the extent that meaning is sought for an arbitration clause even when that clause contains discrepancies or omissions. this is done on the basis of the apparent intent of the parties to arbitrate as expressed by their arbitration clause.56 second, national legislations on arbitration such as the finnish arbitration act, the us federal arbitration act and the over 70 national laws based on the uncitral model law on international commercial arbitration57 provide a framework for the arbitral process that often allows for suplementing imperfect arbitration clauses. for example, if arbitration has been agreed to under finnish law but the parties have not agreed on the specifics of the arbitral procedure they wish to follow, the finnish arbitration act provides for a basic arbitral procedure starting with the constitution of the arbitral tribunal and, under article 23, bestowing upon that tribunal the power to decide any procedural issues not agreed upon by the parties on the basis of the finnish arbitration act, and principles of equality and procedural efficiency. these two features leave very little demands on arbitration agreements. for example, simple statements in international contracts such as “arbitration, finland” or “arbitration, finnish law” are probably enforceable as agreements to arbitrate. even between disputing parties not able to agree on anything at all, the arbitral procedure can be filled out with the help of the finnish arbitration act and the new york convention provides additional motivation to enforce the agreement even if it for some reason would be seen as open to interpretation.58 at first glance there seems to be relatively little regulatory support for conciliation agreements. there is no widely accepted and binding international law convention requiring courts to recognize and enforce conciliation agreements. individual legislations on international conciliation based for example on the uncitral conciliation model law and the uncitral conciliation rules do exist, as noted in section 2.3.1 above. however, the extent of these is not as far-reaching as that of relevant legislation on international arbitration. thus agreements such as “conciliation, finland” or “conciliation, finnish law” would quite possibly be good for nothing due to the apparent lack of a specific legal framework on conciliation in finland. lacking such a framework, agreements such as these typically lack necessary substance 56 see generally redfern and hunter 2004 p. 197 ff. and the more extensive analysis of born 2009 p. 654 ff., p 1066 ff., p. 2710 ff., and passim; for a critique acknowledging the considerable extent of the pro-enforcement bias see auchie 2007; born extends this pro-enforcement view also to for example the uncitral arbitration model law (2009 p. 287). 57 uncitral model law on international commercial arbitration (1985, amended in 2006). for a current list of national laws based on the uncitral arbitration model law, see uncitral 2010a. 58 for similar examples from caselaw from different jurisdictions and more generally, see born 2009 p. 656 ff. nordic journal of commercial law issue 2011#1 20 and certainty to be enforceable. thus, whereas arbitration is institutionalised to the point that very little is required in relation to arbitration agreements, conciliation is not. furthermore, in order for a conciliation agreement to be enforceable, that agreement would seemingly need to take into consideration the conciliation procedure in far greater detail than an agreement to arbitrate. to what extent, then, can and should national courts give meaning to international agreements to conciliate? the procedural requirements for an enforceable conciliation agreement and to what extent these requirements, if lacking, can and should be filled out by courts is open to question. one possible solution is using existing international soft law instruments, such as the uncitral regime, as a basis for filling out imperfect conciliation agreements. another is using legislation and legal principles related to arbitration by analogy to support conciliation agreements. both ideas find support in national contexts.59 59 in the united kingdom, the commercial court made mention of both filling out the duties of an agreement to conciliate and the analogy between arbitration and conciliation in the 2002 decision cable & wireless v. ibm: 34. before leaving this point of construction i would wish to add that contractual references to adr which did not include provision for an identifiable procedure would not necessarily fail to be enforceable by reason of uncertainty. an important consideration would be whether the obligation to mediate was expressed in unqualified and mandatory terms or whether, as is the case with the standard form of adr orders in this court, the duty to mediate was expressed in qualified terms – “shall take such serious steps as they may be advised”. the wording of each reference will have to be examined with these considerations in mind. in principle, however, where there is an unqualified reference to adr, a sufficiently certain and definable minimum duty of participation should not be hard to find. … 36. the reference to adr is analogous to an agreement to arbitrate. as such, it represents a free-standing agreement ancillary to the main contract and capable of being enforced by a stay of the proceedings or by injunction absent any pending proceedings. the jurisdiction to stay, although introduced by statute in the field of arbitration agreements, is in origin an equitable remedy. … 38. on the face of it, there can be no doubt that [claimant] has declined to participate in any adr exercise. as such it is in breach of clause 41.2. [defendant] is thus at least prima facie, entitled to the enforcement of the adr agreement. however, given the discretionary nature of the remedy it is important to consider what factors might also be relevant to the way in which the court’s discretion should be exercised. analogously to enforcement of a reference to arbitration, strong cause would have to be shown before a court could be justified in declining to enforce such an agreement. for example, there may be cases where a reference to adr would be obviously futile and where the likelihood of a productive mediation taking place would be so slight as not to justify enforcing the agreement. even in such circumstances adr would have to be a completely hopeless exercise. … according to roebuck, legal-historical research shows that the analogy argument has prominent roots (2007 p. 115). in the 2003 fisher case, the us 6th circuit district court noted that “[as the cases listed] indicate, federal policy favors arbitration in a broad sense, and mediation surely falls under the preference for non-judicial dispute resolution”. an analogy can also be made with regard to the enforcement of settlement agreements resulting from conciliation and arbitral awards (sanders 1999 p. 362). for an example from legislation, according to section 1297.491 of the california code of civil procedure: if the conciliation succeeds in settling the dispute, and the result of the conciliation is reduced to writing and signed by the conciliator or conciliators and the parties or their representatives, the written agreement shall be treated as an arbitral award rendered by an arbitral tribunal duly constituted in and pursuant to the laws of this state, and shall have the same force and effect as a final award in arbitration. nordic journal of commercial law issue 2011#1 21 2.3.3 towards a uniform interpretation of international dispute resolution in addition to the possibility of an analogous interpretation mentioned in section 2.3.2 above, there is a further interesting nexus between arbitration and conciliation on an international level. this is that of multi-tiered dispute resolution clauses, which typically contain a requirement to conciliate as a prerequisite to litigation60. in such circumstances, arbitral tribunals in principle have the competence to assess their own jurisdiction under the doctrine of competence competence61. this assessment also entails evaluation of the validity and effect of any conciliation clause that serves a prerequisite to arbitration. therefore, the pro-enforcement bias of international arbitration agreements affects international conciliation agreements under such circumstances. but what is the effect of this arbitrational pro-enforcement bias on conciliation in multi-tiered dispute resolution agreements? should conciliation give way when faced by the pro-enforcement bias of arbitration, or should conciliation be included under the umbrella of the pro-enforcement bias of a dispute resolution agreement culminating in arbitration? the validity of arbitration agreements is typically governed by the new york convention, which sets the legislative standard for effective arbitration agreements by requiring that if no valid arbitration agreement exists, then an arbitral award does not need to be enforced or recognised. according to article ii(1): each contracting state shall recognize an agreement in writing under which the parties undertake to submit to arbitration all or any differences which have arisen or which may arise between them in respect of a defined legal relationship, whether contractual or not, concerning a subject matter capable of settlement by arbitration. the typical understanding of this article is that all material terms of an agreement to arbitrate should be recognized.62 but if there is no such valid agreement, then grounds for arbitration under the new york convention can be contested. thus, whether or not parties can arbitrate is clearly grounded on principles of contractual interpretation, i.e. whether or not a valid agreement to arbitrate exists, as according to article v: 1. recognition and enforcement of the award may be refused…[if] (a) the parties to the agreement referred to in article ii were, under the law applicable to them, under some incapacity, or the said agreement is not valid under the law to which the parties have subjected it or, failing any indication thereon, under the law of the country where the award was made… 60 e.g. dobbins 2005. 61 jones 2009. 62 born 2009 p. 2734. nordic journal of commercial law issue 2011#1 22 if the conciliation clause within a multi-tiered dispute resolution clause is seen as a procedural prerequisite to arbitration, a valid agreement to arbitrate may not exist before the requirement to conciliate is fulfilled. scholars typically acknowledge this position on the basis of caselaw.63 clearly, parties agreeing to conciliation as a mandatory prerequisite to arbitration have expressly wished to agree that no agreement to arbitrate exists until the requirement to conciliate has been fulfilled. this already makes a conciliation clause an integral part of an ensuing agreement to arbitrate. on the other hand, in multi-tiered dispute resolution agreements any requirement to conciliate should in my opinion be construed as a material term of the overall dispute resolution agreement that includes the agreement to arbitrate. the very idea of a multi-tiered dispute resolution clause entails that any single element of the clause, such as a last tier requirement to arbitrate, should not be forcibly separated from the whole. the traditional doctrine of the severability of an arbitration clause from the rest of a contract should be seen as separating the dispute resolution mechanism of a contract from that contract and not just a part of the dispute resolution mechanism.64 for example in westacre inv. inc, the english queen’s bench found that: [a]n agreement to arbitrate within an underlying contract is in origin parasitic. it is ancillary to the underlying contract for its only function is to provide machinery to resolve disputes as to the primary and secondary obligations arising under that contract. thus, conciliation as an integral part of a dispute resolution clause should not be separable from the rest of the clause and therefore should fall under the pro-enforcement bias of any arbitration tier also included in such a clause. either way, any requirement to conciliate should be upheld under relevant international law on arbitration as an integral part of an agreement to arbitrate. similarly, the pro-enforcement bias should cover any agreement to conciliate as already argued on a more general level in section 2.3.2 above. the new york convention is also seen to set a common standard of interpretation for its provisions and therewith for arbitration agreements.65 thus, caselaw on multi-tiered dispute resolution agreements containing international arbitration as one tier, also sets a requirement of uniform interpretation on conciliation agreements and, as argued above, on international dispute resolution agreements in general. a broader requirement of uniform interpretation of international conciliation agreements in particular is supported by the idea that international contract law should in general be interpreted uniformly. this principle is recognised for 63 e.g. jolles 2006, boog 2007. 64 on severability in general, see born 2009 p. 315 ff. 65 born 2009 pp. 99–100. nordic journal of commercial law issue 2011#1 23 example by cisg article 7, the existence of collections of general principles of international contract law such as the unidroit principles, and in particular article 2 of the uncitral conciliation model law, which specifically states the uniformity of application as a basis for its interpretation. while there is no overriding law governing international conciliation, there is general precedence for the uniform interpretation of conciliation agreements internationally. 2.4 summary—conciliation and adversarial dispute resolution intertwined the general practical and legal context of international commercial conciliation agreements was presented above. in sum, conciliation seems to be a beneficial stage of most dispute resolution procedures even when it does not directly lead to settlement. the lack of having to translate to and be limited by the language of law and other legal constraints provide better possibilities for disputing parties to explore and understand the actual interests and positions underlying their dispute. this is especially important when conciliation is contrasted with arbitration or litigation before ordinary courts, both being procedures which tend to distance the actual dispute from an abstraction that does not always reflect the parties’ aspirations. courts and tribunals should recognize the usefulness of conciliation for helping understand and resolve disputes. even as a non-binding means of dispute resolution, conciliation at the very minimum serves to alleviate the problems of litigation and arbitration. because conciliation, if it fails, necessarily leads to litigation or arbitration, conciliation should not be seen as a fully independent method of dispute resolution, but as a form of pre-litigation procedure that parties may specifically agree to. this point of view receives support from the regulatory frameworks of arbitration and conciliation. conciliation should be seen as a part of the whole dispute resolution procedure, typically a multi-tiered dispute resolution agreement, and not as an independent agreement separate from the other tiers of a dispute resolution agreement. this supports the reasoning that conciliation should, due to the similarity of their legal and operative contexts, be likened to arbitration. international legislative objectives, such as the proarbitration bias mentioned above, and the supportive legislative framework of arbitration, should thus apply also to international commercial conciliation, at least when conciliation is coupled with arbitration. the same should apply with regard to other forms of litigation when conciliation is used in conjunction with these. despite this, a key problem for international commercial conciliation is the lack of any binding international legislation that would absolutely require courts to recognize and enforce agreements to conciliate. the existence of an agreement to conciliate persists as the sine qua non for international commercial conciliation. arbitrators and courts may advice parties to nordic journal of commercial law issue 2011#1 24 conciliate even in the absence of such an agreement, however, conciliation imposed by a court or arbitral tribunal without prior agreement, can not be seen as equitable even when it would have positive effects on the dispute.66 this is due to the principle of party autonomy and the materiality of the dispute resolution agreement as recognised by international law on dispute resolution. but if the parties have expressed an intention to conciliate, how much is in practice inferred from this expressed wish? section 3 below discusses different meanings given by international regulation and caselaw for different kinds of expressions of an intention to conciliate. these different meanings are then evaluated in section 4 in light of the context of international commercial dispute resolution that was provided by this section. 3 the different meanings of conciliation in this section i examine what conciliation agreements entail in light of international conciliation regulation, caselaw and scholarly writing. it is difficult to give a single overriding definition for conciliation due to the freedom of parties to agree on different kinds of conciliation proceedings and, absent such an agreement, the freedom of conciliators in conducting the proceedings as they feel best. therefore, i instead study conciliation by asking the question “what kind of conciliation agreements are given legal effect by courts”. litigation necessarily results in a decision being imposed on the parties by a court or tribunal. courts can thus define litigation, including arbitration, by its outcome; a binding judgment. with regard to conciliation, this outcome-centred perspective does not work. as a general rule, while successful conciliation can be defined by its end product, a settlement agreement, unsuccessful conciliation proceedings are much more difficult to define for the lack of any such end product. as seen in section 2.2.1 above, it is in the very nature of conciliation that a decision cannot be forced upon the parties, but must instead be reached in a voluntary manner. if a settlement cannot be reached, at what point, then, should conciliation be judged to be so futile that courts should declare the obligation to conciliate fulfilled? most importantly, it was further argued in section 2.2.1 that conciliation should be seen as a successful form of prelitigation procedure even when it does not directly result in a tangible end product in the form of a settlement agreement. thus, the success or failure of conciliation as a process should be judged through other means than those used for final litigation. the question of how to define conciliation as a process is crucial in order for courts to be able to give legal effect to conciliation agreements as such and not just to their tangible outcome. therefore, this section concentrates on what kind of a process conciliation is considered by 66 for example at the threat of losing a costs award as may be done in a national context under the english court procedure rules; see e.g. the susan dunnett and halsey cases. nordic journal of commercial law issue 2011#1 25 legislators, courts, and scholars. on the basis of this analysis, i arrive at three different general meanings attributable to international commercial conciliation. 3.1 international regulation of conciliation as noted in section 2.3.1 above, legislation on international commercial conciliation is scarce. in this section i discuss in detail the process of conciliation identified by uncitral soft law and the conciliation rules of three different international dispute resolution institutes. these three are the international chamber of commerce (icc), the international centre for dispute resolution (icdr), and the world intellectual property organization (wipo). even when constituting non-binding soft law in itself, the uncitral regime is the only truly international effort at legislating conciliation and therefore merits discussion on its own. the three dispute resolution institutes discussed here have been chosen because of two reasons. first, their relative reputation in the field of dispute resolution is high in europe, north america and also internationally.67 icc and icdr represent dedicated international dispute resolution centres. while icc is a purely international organization, icdr is the international counterpart of the american arbitration association (aaa) and the conciliation rules of aaa and icdr are practically identical; the ideology behind the icdr rules also reflects that of aaa and therefore a viewpoint that seems generally more open towards conciliation.68 wipo, on the other hand, represents a more particular form of international dispute resolution relating to intellectual property. however, the wipo rules are of special interest due to their extensive scope and their background as a set of rules adopted by a special agency of the united nations, thus arguably having an additional degree of international acceptance. additionally, the wipo conciliation rules also provide useful background to the analysis of a swiss case on international conciliation in section 3.2.3 below. second, these three in my opinion best describe the different kinds of regulatory approaches to conciliation. this notion will be described in more detail in section 3.1.3 below. 3.1.1 conciliation in light of uncitral soft law due to their similarity, the 1980 uncitral conciliation rules (“conciliation rules”) and the 2002 uncitral conciliation model law (“model law”) are here discussed side by side. as seen in the following, both instruments have been based on a non-binding commitment to conciliate. while a number of national legislations have adopted either of the uncitral 67 born 2009 p. 146 ff. 68 visible for example in the ample material on conciliation available on icdr’s and aaa’s websites. nordic journal of commercial law issue 2011#1 26 instruments as the basis of their conciliation laws69, in some if not all of these cases there has been a tendency to give more binding meaning to conciliation.70 this, however, does not change the notion of conciliation in the uncitral instruments. according to article 2 of the model law, the general interpretive basis of the model law is formed by its international origin, the need for uniformity in its application, and good faith. thus, even if adopted into national legislation, the model law cannot be interpreted solely in light of the local context but must instead aim at a harmonized interpretation on an international level.71 good faith is, similarly to for example cisg article 7, only used as a basis for interpreting the model law itself. with regard to the substance of individual cases, the model law specifically distances itself from imposing any requirement of good faith between the parties. even when the model law guide to enactment acknowledges that parties may agree on a requirement to conciliate in good faith, the model law itself does not deal with the consequences of a breach of such an obligation.72 in contrast to the model law, the conciliation rules contain no regulation on their interpretation; however, the interpretive basis is most probably similar to that of the model law. dore, who compares the uncitral arbitration rules to the conciliation rules, contends that the former are not binding without prior agreement and the latter are “even less binding”.73 for example, article 1 of the conciliation rules does not require the parties to conciliate any dispute, but only to apply the conciliation rules if they decide to conciliate; thus, any reference in the contract to conciliation under the conciliation rules is not in itself enough to obligate the parties to conciliation. this non-binding nature becomes even clearer from the model clause attached to the conciliation rules. as in article 1 of the conciliation rules, the only commitment required by the model clause is the use of the rules themselves and even this only if the parties wish to conciliate ex post. thus, if either party does not wish to conciliate after a dispute has arisen, then there will be no conciliation: where, in the event of a dispute arising out of or relating to this contract, the parties wish to seek an amicable settlement of that dispute by conciliation, the conciliation shall take place in accordance with the uncitral conciliation rules as at present in force. (the parties may agree on other conciliation clauses.) 69 see section 2.3.1. 70 e.g. sanders 1999 p. 358 ff., for a particular case see also canadian bar association 2005 p. 3 ff. 71 uncitral 2002, paras 40–41. 72 e.g. uncitral 2002, paras 46 and 76. 73 dore 1986 p. 15. nordic journal of commercial law issue 2011#1 27 the drafting commission for the conciliation rules did propose a more binding alternative. this was to be an alternative model clause included in the conciliation rules that would require one of the parties to at least send a proposal to conciliate74, and contemplated a third alternative that would have been even more binding.75 however, dore notes that the alternative clauses were rejected by the drafting commission which decided “not to draw the attention of the parties to the possibility of a binding commitment to conciliate”.76 dore quotes uncitral as fearing that more binding clauses would create uncertainty and “that a commitment to conciliate would ‘not be consistent with the voluntary concept underlying the rules’”.77 the conciliation rules, if not modified by the parties, are thus completely noncommittal. so is the model law, as noted for example by sanders.78 however, as seen below, underneath its textual surface the model law does more actively take into account alternatives that allow for a somewhat more binding conciliation procedure. suppose that, unlike under the model clause of the conciliation rules, both parties have bindingly committed themselves to conciliation under either uncitral instrument. even in such a case, both instruments provide numerous exit possibilities. these exit possibilities are discussed in the following and contrasted to the possibility of providing for more binding conciliation under the uncitral instruments. both the model law and the conciliation rules provide for the possibility of terminating conciliation right away at its onset by not accepting a request to conciliate within 30 days of its receipt or within any other time limit the parties may have agreed to: 74 commentary on revised draft uncitral conciliation rules, para 94. 75 ibid., para 96. 76 dore 1986 p. 16. 77 dore 1986 p. 16. 78 sanders 2004 p. 234. nordic journal of commercial law issue 2011#1 28 uncitral conciliation model law uncitral conciliation rules article 4. commencement of conciliation proceedings 1. conciliation proceedings in respect of a dispute that has arisen commence on the day on which the parties to that dispute agree to engage in conciliation proceedings. 2. if a party that invited another party to conciliate does not receive an acceptance of the invitation within thirty days from the day on which the invitation was sent, or within such other period of time as specified in the invitation, the party may elect to treat this as a rejection of the invitation to conciliate. commencement of conciliation proceedings article 2 (1) the party initiating conciliation sends to the other party a written invitation to conciliate under these rules, briefly identifying the subject of the dispute. (2) conciliation proceedings commence when the other party accepts the invitation to conciliate. if the acceptance is made orally, it is advisable that it be confirmed in writing. (3) if the other party rejects the invitation, there will be no conciliation proceedings. (4) if the party initiating conciliation does not receive a reply within thirty days from the date on which he sends the invitation, or within such other period of time as specified in the invitation, he may elect to treat this as a rejection of the invitation to conciliate. if he so elects, he informs the other party accordingly. according to the model law’s guide to enactment, the possibility to evade conciliation by not replying to an invitation to conciliate is not intended to mean that a party would have an “opportunity to disregard its contractual obligation”.79 instead, the drafters have intended to leave the consequences of any intentional disregard of contractual obligations to the general law of obligations and only to “provide certainty in a situation where it is unclear whether a party is willing to conciliate … irrespective of whether that failure is or is not a violation of an 79 uncitral 2002, para 46. nordic journal of commercial law issue 2011#1 29 agreement to conciliate under the general law of obligations”.80 thus, a binding agreement to conciliate is in effect detached from any real requirement to conciliate under the model law, at least from a procedural point of view. this is criticized by sanders: “in spite of the agreement to conciliate a second agreement is required to enter in conciliation proceedings when a dispute has arisen”.81 already from this it is clear that the legislative setting of the model law highly stresses procedural certainty over the agreement of the parties. this echoes the close proximity of conciliation and arbitration under the uncitral regime. legislation on conciliation arose under the auspices of uncitral’s efforts at institutionalizing international arbitration and thus as subsidiary to it.82 the model law has clearly been designed to offer, in case of any lack of volition, a smooth transgression from the procedural uncertainty of conciliation as a nonfinal means of dispute resolution to the finality of arbitration. also the older conciliation rules overtly allow the party receiving the conciliation invitation to break any agreement to conciliate and to reject the invitation. as already noted above, the underlying position of the conciliation rules, however, is somewhat different from that of the model law. the travaux préparatoires of the conciliation rules simply point out the fact that conciliation is not possible unless all parties are willing to participate.83 unlike under the model law, there is no mention about the possibility that the parties’ agreement might lead to even substantive repercussions if the parties do not engage in a conciliation process. in addition to termination of conciliation already in the invitation stage, both the model law and the conciliation rules allow any party involved in conciliation to unilaterally terminate conciliation once it has been initiated: 80 ibid. 81 sanders 2004 p. 211 82 commentary on draft uncitral conciliation rules a, paras 1–2. 83 commentary on draft uncitral conciliation rules b, para 30. nordic journal of commercial law issue 2011#1 30 uncitral conciliation model law uncitral conciliation rules article 11. termination of conciliation proceedings the conciliation proceedings are terminated: (a) by the conclusion of a settlement agreement by the parties, on the date of the agreement; (b) by a declaration of the conciliator, after consultation with the parties, to the effect that further efforts at conciliation are no longer justified, on the date of the declaration; (c) by a declaration of the parties addressed to the conciliator to the effect that the conciliation proceedings are terminated, on the date of the declaration; or (d) by a declaration of a party to the other party or parties and the conciliator, if appointed, to the effect that the conciliation proceedings are terminated, on the date of the declaration. termination of conciliation proceedings. article 15 the conciliation proceedings are terminated: (a) by the signing of the settlement agreement by the parties, on the date of the agreement; or (b) by a written declaration of the conciliator, after consultation with the parties, to the effect that further efforts at conciliation are no longer justified, on the date of the declaration; or (c) by a written declaration of the parties addressed to the conciliator to the effect that the conciliation proceedings are terminated, on the date of the declaration; or (d) by a written declaration of a party to the other party and the conciliator, if appointed, to the effect that the conciliation proceedings are terminated, on the date of the declaration. according to sanders, no reason needs to be given for such unilateral termination.84 again, despite the similarity of the texts, a slight difference exists in the legal contexts of the articles. the model law’s guide to enactment is clear to state that any obligation to conciliate in good faith is separate from the right to terminate under article 11 and that “the model law does not deal with [obligations to conciliate in good faith]”.85 even if the parties have added 84 sanders 2004 p. 225–6. 85 uncitral 2002, para 76. nordic journal of commercial law issue 2011#1 31 further weight to their agreement to conciliate, such as a requirement to conciliate in good faith, the effects of such further obligations are not procedural in light of the model law. not abiding with a good faith negotiation requirement cannot stop a party from proceeding to arbitration from a procedural perspective. the travaux préparatoires of the conciliation rules simply denounce that the rules would attach a binding effect to a submission to conciliate, such as an obligation to conciliate until a set period of time or the rejection of a settlement proposal.86 instead, the termination clause is “inspired by the absolute freedom of the parties” and “based on the premise that a policy compelling parties to continued participation … would not, in all circumstances, lead to a genuine settlement”.87 the freedom of contract of parties, with regard to agreeing to conciliation ex-ante, is clearly a relative concept dependent on the adopted notion of conciliation. the notion of conciliation under the conciliation rules reflects a point of view that does not take into account the possibility of conciliatory procedure that might turn the heads of initially unwilling parties or that might be otherwise useful in light of any litigation that were to follow conciliation. the notion of conciliation under the model law reflects a point of view where such conciliatory procedure is acknowledged but not given procedural weight in itself. to this extent, the parties themselves can according to the model law specify a “period of time” or “event” that terminates any requirement to conciliate. when expressly stated, such specification would prevent the dispute from progressing to arbitration under the model law. no such possibility is made explicit under the conciliation rules: 86 commentary on the revised draft of uncitral conciliation rules b, para 72. 87 ibid. nordic journal of commercial law issue 2011#1 32 uncitral conciliation model law uncitral conciliation rules article 13. resort to arbitral or judicial proceedings where the parties have agreed to conciliate and have expressly undertaken not to initiate during a specified period of time or until a specified event has occurred arbitral or judicial proceedings with respect to an existing or future dispute, such an undertaking shall be given effect by the arbitral tribunal or the court until the terms of the undertaking have been complied with, except to the extent necessary for a party, in its opinion, to preserve its rights. initiation of such proceedings is not of itself to be regarded as a waiver of the agreement to conciliate or as a termination of the conciliation proceedings. resort to arbitral or judicial proceedings article 16 the parties undertake not to initiate, during the conciliation proceedings, any arbitral or judicial proceedings in respect of a dispute that is the subject of the conciliation proceedings, except that a party may initiate arbitral or judicial proceedings where, in his opinion, such proceedings are necessary for preserving his rights. again, the model law stresses procedural certainty by maintaining that any derogation from its systematisation must be expressly pronounced by the parties (emphasis added): where the parties have agreed to conciliate and have expressly undertaken not to initiate during a specified period of time or until a specified event has occurred arbitral or judicial proceedings with respect to an existing or future dispute… if this is not done, under the model law either party may terminate conciliation at its will without suffering any procedural setbacks, such as the inadmissibility of an arbitration clause. an agreement to conciliate is thus separate from an agreement not to litigate. parties can terminate conciliation at will while nevertheless being barred from litigation if they have expressly agreed not to litigate until a particular time or event that does not coincide with the termination of conciliation. taking into account that the model law does not include a good faith obligation , a requirement to conciliate in good faith does not constitute an event that forbids a party from using its unilateral right to terminate conciliation. from a procedural point of view, conciliation is fully detached from litigation. any barriers to litigation are construed as agreements separate from the agreement to conciliate. nordic journal of commercial law issue 2011#1 33 sanders states that he much prefers the formulation of the conciliation rules to that of article 13 of the model law.88 the conciliation rules tie the litigation bar only to the duration of the conciliation proceedings, stating that the parties may not initiate litigation “during the conciliation proceedings, except [when necessary for preserving their rights]”. the travaux préparatoires refer only to the possibility of either party unilaterally terminating the proceedings at will, and no binding effect is given to the fact that conciliation has started.89 further, the travaux préparatoires emphasise that, instead of an objective requirement, only either party’s subjective view is necessary for proceeding to litigation “in order to avoid controversy as to whether the initiation of adversary proceedings is justified”.90 thus, under the conciliation rules, either party can litigate at will despite having initiated conciliation if either of them unilaterally terminates the conciliation proceedings. in sum, in light of the uncitral instruments the possibility to terminate conciliation proceedings takes precedence over the agreement to conciliate or, for example, the situation assessment of an appointed conciliator. even when parties have agreed that they will attempt to conciliate prior to other forms of dispute resolution, this requirement may be reduced to a minimal procedural detour as conciliation may be unilaterally terminated by either party immediately. the only requirement is that any party first commences, or tries to commence, proper conciliation in accordance with the conciliation rules or the model law. this removes the instruments from party autonomy in the sense that the parties’ mutual agreement to conciliate can be reduced to the minimal procedural detour of initiating and then terminating conciliation. there is a certain progression in the notion of conciliation when one compares the conciliation rules of 1980 to the model law of 2002. the conciliation rules, while emphasising party autonomy in conciliation, do not overtly acknowledge the possibility that parties might have agreed on a more fixed kind of conciliation than the one presented by the conciliation rules.91 in effect, conciliation according to the conciliation rules is necessarily such that parties cannot bindingly agree to conciliate, unless one understands with conciliation the initiation and possibly instantaneous subsequent termination of a procedure; if the other party refuses to reply to the invitation to conciliate, then even termination is unnecessary. doing otherwise would require a complete revision of not only the model clause of the conciliation rules but also of, at least, their articles 2, 15 and 16. this idea of conciliation as 100% dependent on the willingness of all parties to negotiate is not in line with the modern concept of conciliation presented in section 2.2 above. neither are the conciliation rules, if 88 sanders 2004 p. 230. 89 commentary on draft uncitral conciliation rules b, para 75. 90 commentary on draft uncitral conciliation rules b: para 76. 91 dore 1986 p. 16, fn. 29. nordic journal of commercial law issue 2011#1 34 read in this light, in line with the concept of party autonomy, unless the modern notion of conciliation is discarded in favour of the notion of conciliation presented by the conciliation rules: agreeing on binding conciliation only to have the opposing party terminate the proceedings right away. thus, the agreement to conciliate amounts to almost nothing at all. the model law, on the other hand, does acknowledge the possibility of parties agreeing on a set time or event before which they cannot refer a dispute to litigation. this would, however, require an additional express agreement that the forbidding the parties to proceed to other dispute resolution mechanisms until a particular event or point of time has been reached. further, the model law makes it clear that a mere requirement to conciliate in good faith does not suffice to strip parties of their unilateral power to terminate conciliation. interestingly, while a lack of conciliation in good faith cannot deter the parties from continuing to litigation under the model law, it could, however, be subject to the substantive provisions for breach of contract under national legislation. the uncitral instruments have clearly been drafted having in mind an antecedent for arbitration. this is reflected in the smooth progression from conciliation to arbitration provided by both; at default, even if the parties have agreed to conciliate, conciliation can be unilaterally terminated in favour of arbitration without any procedural side effects. while the model law does acknowledge the possibility for a more binding form of conciliation, this is not the default rule, but it is subject to additional drafting requirements. further, even the model law does not allow a mere requirement to conciliate in good faith to hinder the easy procedural progression from conciliation to arbitration. sanders discusses the model law’s approach that allows parties to reject an invitation to conciliate. in particular, while he sees the possibility for unilateral termination in itself as “an essential element of conciliation”, he opposes the possibility that a party may avoid its contractual obligation to conciliate by not responding at all to the invitation to conciliate.92 instead, he proposes that an agreement to conciliate should present a clear obligation to participate in conciliation at least until a conciliator has been nominated and has commenced his or her task. after that, the parties could freely terminate the proceedings on the basis of the voluntary nature of conciliation. sanders’ emphasis is very similar to that of the icc adr rules discussed in the following subsection. 92 sanders 2004 p. 226. nordic journal of commercial law issue 2011#1 35 3.1.2 conciliation in light of institutional rules in this section i discuss conciliation under the icc adr rules, the icdr international mediation rules, and the wipo mediation procedure.93 all three present a more independent understanding of conciliation than the uncitral instruments. the 2001 icc adr rules are an instrument provided by the international chamber of commerce to govern the use of all kinds of non-judicial dispute resolution mechanisms in contracts. parties may opt-in to the rules as they wish. as per article 5(1), the different dispute resolution mechanisms covered by the icc adr rules include conciliation, neutral evaluation, mini-trial, and any other adr technique or combination of techniques. however, according to article 5(2), conciliation is the default in case parties cannot agree to a specific method of adr. terminating conciliation under the icc adr rules is relatively similar to uncitral. according to sanders, the approach to termination in icc’s earlier 1988 rules of conciliation was exactly the same as that adopted in uncitral’s model law and conciliation rules.94 the newer icc adr rules that replace the 1988 icc rules of conciliation, however, add an additional twist. first of all, article 2a of the icc adr rules requires that parties cannot avoid conciliation simply by not replying to an invitation to conciliate. even if a request to conciliate is made unilaterally to the icc, article 2a requires a third party “neutral” to be nominated to initiate conciliation. according to the icc adr guide, this provision “preserves the parties’ intention to agree to icc adr, by obligating them to evaluate the potential of the icc adr proceedings together with the neutral”.95 thus, instead of the need for two agreements under the uncitral regime, where an extra agreement is necessary to bar the initiation of litigation until a particular event or point of time, the icc adr rules actually guarantee individual effect to an agreement to conciliate. parties who have agreed to conciliation under the icc adr rules are required by article 6(1)b to participate in a preliminary discussion before they can unilaterally terminate the proceedings (emphasis added): adr proceedings which have been commenced pursuant to these rules shall terminate upon the earlier of: … b) the notification in writing to the neutral by one or more 93 see icc 2001b for the icc adr rules, in force as of 1 july 2001, icdr 2009 for the icdr mediation rules, contained in international dispute resolution procedures, as amended and effective of june 1, 2009, and wipo 2009 for the wipo mediation rules, contained in the 2009 wipo arbitration, mediation and expert determination rules and clauses. 94 sanders 2004 p. 211. 95 icc 2001a p. 7. nordic journal of commercial law issue 2011#1 36 parties, at any time after the discussion referred to in article 5(1) has occurred, of a decision no longer to pursue the adr proceeding… this procedural obstacle is, however, a small one. article 5(1) of the icc adr rules only requires the parties to participate in a discussion on the procedure of the dispute resolution with the neutral: the neutral and the parties shall promptly discuss, and seek to reach agreement upon, the settlement technique to be used, and shall discuss the specific adr procedure to be followed. whether the requirement of a preliminary discussion as a prerequisite for termination under the icc adr rules is a major change in relation to the uncitral instruments is debatable. according to the icc adr guide, there are few requirements for the preliminary discussion between the parties and the neutral.96 the parties need not meet live, as pretty much any form of meeting such as “telephone conference, videoconference or any other suitable means” will suffice. further, there is no requirement to consider the substantive issues of the dispute. the first discussion is primarily meant to identify the procedure that the parties see best fit for the dispute at hand. of course, discussing appropriate procedure probably cannot avoid discussion on substantive issues. nonetheless, there is no concrete requirement for the neutral to conduct, for example, a preliminary evaluation of the dispute before the parties are allowed the procedural right to terminate conciliation. the icc adr rules include what the guide to icc adr specifically claims are not model clauses but suggestions for conciliation clauses.97 what the difference between model clauses and mere suggestions is remains unclear, but perhaps hints at the lesser interpretive weight of the suggestions. in any case, the first suggestion makes conciliation fully optional.98 the second obligates the parties to consider conciliation; they must “discuss and consider submitting the matter to settlement proceedings”. the third suggestion obligates the parties to pursue conciliation for 45 days, while the fourth is similar to the third but incorporates icc arbitration in case conciliation fails. what is important is that the third and fourth “suggested clauses” refer to time limits despite the icc adr rules giving parties the possibility to terminate conciliation only after a specific event, the preliminary discussion mentioned in article 5(1). such a time limit seems to override article 5(1) of the icc adr rules as the time limit “allows the parties to know precisely when they are no longer obligated to continue the proceedings”.99 in order to prevent any abuse of 96 icc 2001a p. 11 ff. 97 icc 2001a p. 18; for a discussion on these clauses see e.g. jimenéz figueres 2003. 98 icc 2001b p. 4. 99 icc 2001a p. 18. nordic journal of commercial law issue 2011#1 37 rigid time limits, the parties are expected to apply such a time limit in “good faith”.100 thus, while the icc adr rules provide for a more binding conciliation procedure than uncitral, they nevertheless contain a clear reference to uncitral’s system of two agreements; one to conciliate and another to bar litigation. in any case, the icc adr rules incorporate by default one example of what article 13 of the uncitral model law calls an event prior to which litigation cannot be commenced. thus, even if only a small step for effective conciliation in individual cases, and even if supplemented by an express time limit in the suggested conciliation clauses, the requirements of the icc adr rules are nevertheless a step towards establishing content to the idea of independent conciliation procedure. the 2009 icdr international mediation rules go further than the icc adr rules. under article 12 of the international mediation rules, pending successful settlement, the mediator’s understanding that the situation is hopeless, or the agreement of the parties to terminate mediation, the proceedings may be terminated only: when there has been no communication between the mediator and any party or party's representative for 21 days following the conclusion of the mediation conference. the mediation conference mentioned in the rules may be an extensive procedure. under article 7, the mediator has relatively free hands to communicate with the parties together or separately prior to, during, and after the conference. for example, the mediator may request: the exchange of memoranda on issues, including the underlying interests and the history of the parties’ negotiations. information that a party wishes to keep confidential may be sent to the mediator, as necessary, in a separate communication with the mediator. further, under article 8, both parties are required to participate in this procedure: the parties shall ensure that appropriate representatives of each party, having authority to consummate a settlement, attend the mediation conference. prior to and during the scheduled mediation conference(s) the parties and their representatives shall, as appropriate to each party's circumstances, exercise their best efforts to prepare for and engage in a meaningful and productive mediation. thus, under the icdr international mediation rules, a party may unilaterally terminate mediation only after having participated with their best efforts in a mediation procedure culminating in a mediation conference. lacking agreement between the parties, the actual 100 icc 2001a p. 18. nordic journal of commercial law issue 2011#1 38 extent of proceedings is up to the mediator. in any case, the parties must participate in that procedure also with regard to the substance of the issue. this approach is radically different from that of the uncitral and icc instruments. further, there is no mention at all of rigid time limits prior to which litigation is barred, as opposed to the uncitral model law or the suggested clauses of the icc adr rules. instead, any time limit starts running only after a set event, e.g. the mediation conference. this mediation conference is much more demanding on the parties than the “procedural meeting” required under the icc rules, both in that it may deal with the substance of the issue and that the parties are required to participate with their best efforts and, further, in that the mediator may engage in mediation even before the mediation conference. as the third and final example, the wipo mediation rules can be positioned somewhere between the icc adr rules and the icdr international mediation rules in their understanding of conciliation. as under the icdr international mediation rules, under the wipo mediation rules the conciliator has relatively free hands to organise the proceedings as they wish (articles 11–12) and the parties to conciliation have an obligation to cooperate in good faith (article 10). as under the icc and icdr regulations, the conciliation may be terminated only after attending a “first meeting” (article 18). this first meeting depends greatly on the conciliator’s efforts but seems to be closer to the more extensive and substantive procedure required under the icdr international mediation rules than the procedural discussion under the icc adr rules. however, similarly to the conciliation clauses suggested by icc adr rules, the wipo mediation rules also include in their combined conciliation and arbitration clause by default a 60 or 90 day time limit for barring arbitration. while such time limits are not included in the “conciliation only” clause, the wipo mediation rules nevertheless seem to share the understanding that conciliation clauses should contain two agreements: one to conciliate and another to delay arbitration. in the swiss federal supreme court decision discussed in section 5.2.3 the court, in relation to a contract referring to wipo mediation without a clear time limit for delaying arbitration, did not seem to view such a time limit as explicitly required but merely as typical and expected when binding conciliation is agreed upon. thus, the wipo mediation rules, while portraying an independent view of conciliation similar to that of the icdr mediation procedure, nevertheless contain traces of the thinking prevalent under the uncitral and icc adr regimes. 3.1.3 legislation and institutional rules—a summary the instruments provided by uncitral, icc, wipo, and icdr create a continuum of increasingly strong legal meaning attributable to conciliation clauses. the unmodified uncitral instruments provide practically no legal meaning to an agreement to conciliate, instead requiring a specific, additional agreement to delay arbitration in case the parties want to prohibit the possibility of overriding an agreement to conciliate and proceeding directly to arbitration. this position is of course modifiable; national legislations adopting either of the uncitral instruments have tended to give conciliation a stronger, more independent meaning so that parties cannot simply opt out of their agreement. nevertheless, under the nordic journal of commercial law issue 2011#1 39 default uncitral instruments, conciliation agreements have little independent legal meaning; if one party does not want to conciliate, this unilateral lack of volition overrides the conciliation agreement. the other instruments, on the other hand, provide for increasingly extensive and intricate meanings. the icc adr rules require parties at least to participate in a discussion on conciliation procedure. the independent meaning of conciliation agreements finds its culmination in the icdr international mediation rules, which require parties to engage in best efforts conciliation over substantive issues. thus, as opposed to the uncitral instruments, the icdr international mediation rules clearly provide for an independent meaning to conciliation agreements in the sense that substantial conciliation efforts must have been undertaken before an agreement to conciliate is seen to be fulfilled and the parties may proceed to litigation. these efforts consist precisely of negotiations with the other party, via the help of an appointed conciliator, regarding the substance of a dispute at hand, and not just the procedural discussion proposed by the icc adr rules. the conciliation process required under the icdr international mediation rules gives conciliation agreements independent meaning whereby conciliation agreements in themselves are enough to block litigation. no additional agreement on barring litigation is necessary, contrary to the notion of conciliation under the uncitral rules and the more blurry, hybrid distinction under the icc and wipo instruments. international regulation on conciliation is clearly dependent on different kinds of notions of what it means to conciliate and how these notions are reflected in regulation: whether conciliation is seen as an end result based on volition that cannot be agreed upon in advance, as under the uncitral regulations, or whether it is seen as a process that must be gone through for the benefit of the parties even when a concrete end result cannot be guaranteed, as under the icdr regulation. 3.2 caselaw on conciliation in this section, i provide a brief look at caselaw on international commercial conciliation. due to the extent of such caselaw, i will in section 3.2.1 discuss three perspectives on caselaw provided in scholarly literature. in section 3.2.2 i look at a particular continuum of argumentation on non-binding dispute resolution from the common law jurisdiction of new south wales in australia. through that analysis, i will try to point out some of the phases that new south wales courts have gone through in their migration from a volition-based point of view on conciliation towards a process-based point of view on conciliation. i hope that this examination will prove useful for argumentation for conciliation on a practical level, even when it in name deals with conciliation from a national perspective. finally, in section 3.2.3 i analyse a recent swiss federal supreme court case on what it means to agree on international commercial conciliation. nordic journal of commercial law issue 2011#1 40 3.2.1 scholarly perspectives on caselaw jolles examines whether the non-fulfilment of a pre-arbitration tier in a multi-tiered arbitration clause can be seen as a procedural prerequisite that prevents parties from proceeding to arbitration.101 the alternative would be to treat them either as non-issues or as substantive issues that may merit contractual remedies but which do not stop parties from proceeding to arbitration. examining swiss, german, us, uk, and icc positions on the topic, jolles concludes that the non-fulfilment of pre-arbitration tiers should be considered a procedural prerequisite for arbitration.102 jolles states two requirements that should be met in order for a tribunal to consider a request for arbitration as inadmissible when an agreement to conciliate has not been fulfilled.103 first, the parties should have agreed in a “binding and unequivocal manner” to pursue conciliation before arbitration. second, “the commitment should be limited in time and the tier mechanism should be defined to precisely determine the stage at which the efforts will be considered exhausted and the pre-arbitral requirements satisfied”. these requirements are, according to jolles, necessary so that a party is not precluded from access to court for an indeterminate amount of time. jolles’ requirements are identical to the items mentioned by the uncitral conciliation model law as requirements for delaying litigation in face of conciliation. jolles also cites the uncitral conciliation model law when evaluating whether or not the failure to satisfy a conciliation requirement affects an arbitral tribunal’s jurisdiction and thus it seems that jolles’ argument is based on a conception of conciliation stemming from the uncitral conciliation model law.104 in his monograph on arbitration, born examines the same situation as jolles but with a more extensive discussion of caselaw.105 his discussion spans cases in support of both situations in which contractual procedural requirements have been found to constitute a jurisdictional prerequisite for arbitration and situations in which they have not. born argues for example that courts and tribunals not only have been but continue to be “reluctant to conclude that compliance with contractual procedural requirements is a jurisdictional condition for commencing an arbitration” for example in situations where a “party resisting jurisdiction was partially or entirely responsible for the failure or non-exhaustion of a negotiation process” and where “dispute resolution provisions do not state that negotiation or mediation is a condition 101 jolles 2006. 102 jolles does mention the possible exception of “non-determinative” procedures such as negotiation and mediation under english law, however, this position has changed; after the cable & wireless plc v ibm united kingdom ltd decision, non-determinative adr procedures are typically seen as procedural obstacles for litigation; see lye (2004). 103 jolles 2006 p. 336. 104 jolles 2006 p. 335. on a similar point see boog (2007 p. 105, fn. 6) who cites jolles’ article. 105 born 2009 p. 840 ff. nordic journal of commercial law issue 2011#1 41 precedent to arbitration”.106 however, “if dispute resolution clauses expressly provide that negotiations or other procedural steps are a condition precedent to arbitration, courts sometimes require compliance with those provisions”.107 with regard to the last situation, born emphasizes that a claimant’s failure to comply with procedural requirements for arbitration may constitute a jurisdictional defect precluding arbitration and that this:108 …is particularly true where the provision in question is drafted in a mandatory fashion (“the parties shall meet and negotiate”) and the right to arbitrate is arguably conditioned on compliance with this requirement (“only if the parties are unable to resolve their dispute through good faith negotiations after 30 days, then either party may refer the dispute to arbitration …” according to born, both a provision in mandatory language and a requirement that arbitration is conditioned on compliance with that provision are required for precluding arbitration. however, there is no mention of a time limit or specific event for the expiration of the prerequisite even when the example clause he uses contains a 30-day time limit. with regard to requirements to negotiate or conciliate in particular, born notes that these have often been seen as “unenforceably vague or indefinite” and, according to born, courts have generally upheld such agreements only when there are reasonably clear substantive and procedural guidelines for the relevant conciliation or negotiation procedure to be upheld.109 the definiteness of an agreement to negotiate or conciliate would arise, for example, from the limited duration of negotiation or conciliation, a specified number of negotiation sessions, specified participants for negotiations, or conciliation under specified rules or a specified dispute resolution institute.110 berger specifically aims at systematizing the possible “points of failure” of non-judicial dispute resolution such as conciliation.111 berger examines what he sees as the possible points at which conciliation can be seen to have failed so that parties may proceed with other dispute resolution mechanisms. on the basis of the uncitral and icc instruments and german scholarly literature, berger recommends that parties should include in their conciliation agreement objectively definable criteria on exactly when conciliation can be terminated. these criteria could for example be similar to those in articles 11 and 13 of the uncitral conciliation model law discussed above. where the parties have not agreed on any clear guidelines on how the point of failure of conciliation should be identified, berger maintains that the lack of any 106 born 2009 p. 841, my emphasis. 107 born 2009 p. 842, my emphasis. 108 born 2009 p. 841, emphasis in original. 109 born 2009 p. 846–7. 110 born 2009 p. 847. 111 berger 2006 p. 10 ff. nordic journal of commercial law issue 2011#1 42 overt criteria or reference to a dispute resolution institute means that the power to define whether an agreement to conciliate has been adequately fulfilled is in the hands of the tribunal or court that rules on the admissibility of the dispute. in such cases, berger argues that the criteria for fulfilling an agreement to conciliate should be that of a reasonable attempt to conciliate. as an example berger uses icc award 6276, where the parties had agreed to attempt amicable settlement before other forms of dispute resolution under the following dispute resolution clause:112 any differences arising out of the execution of the contract shall be settled friendly and according to mutual goodwill between the two parties; if not, it shall be settled in accordance with clause 63 of the general conditions of contract [first through an engineer’s decision and, that failing, arbitration]. the tribunal, seated in switzerland, found that there existed enough grounds to show that the requirement to attempt amicable settlement had in fact been satisfied. however, instead of providing any specific general criteria through which to judge this, the tribunal argued that:113 with regard to prior resort to amicable settlement, … there are no objective criteria making it possible to declare that the means of amicable settlement have been actually exhausted. these means cannot be identified in absolute terms and do not obey any preestablished and stereotyped rules. everything depends on the circumstances and chiefly on the good faith of the parties. what matters is that they should have shown their good will by seizing every opportunity to try to settle their dispute in an amicable manner. they will only be discharged of this duty when they arrive in good faith at the conviction that they have reached a persistent deadlock. the tribunal came to the conclusion that the requirement to attempt an amicable settlement as having been fulfilled. it drew this conclusion on the grounds that one party had made genuine efforts at negotiating a solution based on the length of the elapsed time, that “a variety of contacts” were undertaken during that time, and that the contacts aimed at finding a solution to the dispute between the parties. while emphasising that parties should try to objectively identify when any requirement to conciliate has been fulfilled, berger concludes that, lacking any clearly expressed criteria for the exhaustion of conciliation, courts and tribunals can require from parties an “honest, reasonable and conscientious effort” at solving their dispute.114 the only concrete requirements that can be imposed on a party would be the initiation of dispute resolution and a reasonable attempt at reaching an amicable solution. this could be done for example in the manner of the arbitral 112 icc award 6276. 113 icc award 6276. 114 berger 2006 p. 12. nordic journal of commercial law issue 2011#1 43 tribunal in icc 6276 that based its evaluation on factual circumstances regarding how the parties had attempted to pursue amicable dispute resolution. thus, it seems that a continuum somewhat similar to that presented in relation to conciliation regulation can also be formed between jolles, born and berger. jolles and born stress both the mandatory language of any prerequisite to arbitration and procedural clarity in the form of a clearly defined point of time at which the prerequisite expires. born adds to this other possible options for satisfactory definitiveness, such as and in particular definitions of successful conciliation under particular institutional rules. as seen in section 3.1 above, some institutional rules acknowledge conciliation agreements as having independent meaning even when the rules (or the conciliation agreement) do not provide an absolutely defined time limit for the conclusion of conciliation. finally, while arguing that parties should aim at a clear agreement on when any requirement to conciliate has been fulfilled, berger emphasises that when such an agreement does not exist it should be up to a court or tribunal to assess, on the basis of the circumstances of the case, whether an agreement to conciliate has been fulfilled. in the next section, i examine new south wales caselaw to highlight these positions in practice. 3.2.2 progression of national caselaw: the new south wales continuum in their respective articles, pryles and chapman concentrate on the legal situation of multitiered dispute resolution clauses in a single common law jurisdiction, that of new south wales in australia.115 this discussion is particularly interesting for this thesis as it concentrates on how notions of what it means to conciliate have gradually evolved from a result-oriented perspective towards an increasingly process-oriented perspective. it also serves to highlight problems of the position that conciliation agreements should clearly define the limits of unsuccessful conciliation. 3.2.2.1 conciliation for a major part of his article, pryles concentrates on the question of whether all stages of dispute resolution agreements, and in particular negotiation and conciliation agreements, are enforceable.116 his starting point is the 20th century english notion that because negotiation and conciliation are essentially reliant on the volition of parties they are in effect “agreements to agree” and as such cannot be subjected to judicial enforcement. this starting point, which essentially denies conciliation agreements any legal meaning, has been changed and elaborated on in three cases of the new south wales supreme court. 115 pryles 2001, chapman 2010. 116 pryles 2001. nordic journal of commercial law issue 2011#1 44 in the first of these cases, the 1992 hooper bailie associated ltd v. natcon group pty ltd, giles j extensively reviewed english and australian authorities and came to the conclusion that “[w]hat is enforced [in conciliation agreements] is not co-operation and consent but participation in a process from which co-operation and consent might come” and that “[i]f the terms of the conciliation agreement were sufficiently certain the court could require the parties to participate in the process”. in the case at hand, the court found the terms of the conciliation agreement to be sufficiently certain and therefore enforced the agreement to conciliate. giles j returned to the same subject matter in the 1995 elizabeth bay developments pty ltd v. boral building services pty ltd case. here, however, the outcome was different as the judge concluded that the conciliation agreement in question was not enforceable. while restating the value of conciliation, giles j noted that “agreements to mediate should be recognised and given effect in appropriate cases”. it seems that in elizabeth bay the enforcement of the conciliation agreement would, according to giles j, have led to considerable uncertainty on behalf of the parties regarding their contractual obligations and therefore be contrary to the certainty doctrine of common law.117 the multi-tiered dispute resolution clause in the case had required the parties to “endeavour to settle the dispute by mediation administered by the australian commercial disputes centre (acdc)”. giles first contended that this clause did not expressly incorporate the acdc mediation guidelines. however, both parties made the concession that the acdc mediation guidelines had indeed been intended. it seems that if that had not been the case, giles j would have come to the conclusion that only naming a conciliation institute in a conciliation agreement does not constitute sufficient certainty for enforcing that agreement as required by hooper bailie; instead, the rules under which conciliation would be administered would have to be explicitly referred to: the concession [that the parties in fact intended to use the acdc mediation guidelines] … makes it unnecessary to express any view upon whether a mediation clause having no greater content than an agreement to settle the dispute by mediation administered by a named person or body would require of the parties participation in a process of mediation of sufficient certainty for legal recognition of their agreement. it may be that a conclusion favourable to incorporation or sufficient certainty would not be warranted, and that acdc should give further consideration to its suggested mediation clause. giles j now had to manoeuvre around the acdc mediation guidelines, and did so by noting that the acdc mediation guidelines required the parties to sign a mediation agreement, but not necessarily an acdc mediation agreement, thus making the obligation too broad and vague to be enforceable. the certainty requirement was further pickled by giles j by noting that even if the agreement were to be construed as meaning precisely the acdc mediation 117 for which see e.g. mckendrick 2000 p. 57 ff. nordic journal of commercial law issue 2011#1 45 agreement, that agreement in itself had intrinsic uncertainty. clause 11 of the acdc mediation agreement charged the parties with a “commitment to attempt in good faith to negotiate toward achieving a settlement of the dispute”. this clause contained for giles j too much compound uncertainty when analysing it from the perspective that the parties had, long before any dispute, agreed that in case of a dispute they would sign a mediation agreement that required them to “commit” to an “attempt” to “negotiate” in “good faith”. thus, in any case the effects of the clause would not have been certain enough to fulfil the certainty requirement established in hooper bailie and therefore the mediation clause could not be enforced. in the 1999 judgment aiton v. transfield, einstein j took his turn at interpreting a conciliation agreement in the new south wales supreme court. this time around, the key problem in the dispute resolution clause was seen to be twofold. despite noting that it “is trite to observe that parties ought be bound by their freely negotiated contracts” (para 25), giles j’s view on certainty in hooper bailie was again taken up. quoting authority on dispute resolution, einstein j ends up arguing that any stage of a dispute resolution clause should satisfy the following set of requirements (para 69): it must be in the form described in scott v avery [a case from 1856 acknowledging arbitration agreements under the common law]. that is, it should operate to make completion of the mediation a condition precedent to commencement of court proceedings. the process established by the clause must be certain. there cannot be stages in the process where agreement is needed on some course of action before the process can proceed because if the parties cannot agree, the clause will amount to an agreement to agree and will not be enforceable due to this inherent uncertainty. the administrative processes for selecting a mediator and in determining the mediator's remuneration should be included in the clause and, in the event that the parties do not reach agreement, a mechanism for a third party to make the selection will be necessary the clause should also set out in detail the process of mediation to be followed—or incorporate these rules by reference. these rules will also need to state with particularity the mediation model that will be used. on the basis of these requirements, einstein j argued that the dispute resolution clause in the case at hand lacked necessary certainty with regard to conciliation because the clause (which is extremely extensive and elaborate, taking up over two pages of the tightly formatted judgment and thus implying the parties’ careful drafting of their intent to conciliate—author’s note) does not contain any agreement on how the costs of conciliation should be apportioned. einstein j argues that it cannot be implied, for example, that the costs of conciliation should be split between the parties, as is often the case, or that the conciliator could decide on the apportionment, as is the case with the expert mentioned later on in the same dispute resolution clause. this is because neither implication would be “so obvious as to go without saying”, einstein j claims, precisely because both of these two different implications exist, one from the nordic journal of commercial law issue 2011#1 46 outside world and one from another part of the dispute resolution clause that concentrates on a different dispute resolution method (paras 66–67). einstein’s stance seems curious with regard to costs of voluntary procedures typically being split even.118 following this, einstein j acknowledges that in part because of the parties’ ability to determine when the procedure provided by the agreement has concluded (para 78) and in part because even the notion of good faith in the dispute resolution clause is sufficiently certain (para 153), the rest of the dispute resolution clause is worthy of legal recognition. thus, because there is no agreement on the apportionment of conciliation costs in an over two-page long dispute resolution clause, almost a half of that clause loses its enforceability and any legal meaning and effect it may have (para 78). the result has raised eyebrows.119 in sum, the progression of the three cases outlined by pryles seems logical on the one hand. there are differences in the facts of the cases, which, little by little, discuss and elaborate what exactly is a conciliation agreement that courts are willing to grant legal meaning to. but one can nevertheless not help but feel slightly bothered. why cannot the dispute resolution clause in elizabeth bay be interpreted as a valid agreement to conciliate, especially since both parties confirmed that they indeed had had a common intention to refer to the acdc mediation guidelines? why did the extremely extensive and elaborately crafted dispute resolution clause in aiton v. transfield lose all meaning with regard to its section on conciliation just because the judge in question felt that the parties should have explicitly apportioned (but not quantified) their costs beforehand? einstein j himself noted that the parties’ agreement should bind them. what is at work here that undoes the bounds of parties’ intentions to conciliate? as always, one can speculate on the circumstances of the cases. in hooper bailie, the only one of these cases in which conciliation was actually enforced, arbitration had already been initiated when the parties, on mutual agreement, decided to adjourn the proceedings and instead opt for conciliation. thus, the issue in that case was not about the interpretation of a multi-tiered dispute resolution clause entered into by parties ex-ante, but instead an ex-post subsumption to change the method of dispute resolution into conciliation. further, in that conciliation certain determinations by the conciliator were to be binding on the parties; this is emphasised by giles j as showing that there was a clear, agreed upon structure to the proceedings. the conciliation was only cut short when a provisional liquidator was appointed to the defendant. it was the provisional liquidator who required continuation of the arbitration proceedings, which motion was then denied by giles j who instead enforced the agreement to conciliate. thus, the parties 118 e.g. aaa 2007 p. 14. 119 e.g. boulle et al. (2000 p. 70), who note that: interestingly, there was no problem with the lack of reference to the quantum of the mediator’s fees, presumably on the basis that this would be determined by the mediator. with the apportionment of the mediator’s fees, however, the parties would have to reach their own agreement, thus rendering this an unenforceable agreement to agree. nordic journal of commercial law issue 2011#1 47 had agreed to adjourn arbitration and enter into conciliation and only afterwards did the provisional liquidator of the plaintiff try, unsuccessfully, to force a return to arbitration. elizabeth bay and aiton, on the other hand, both concern intricate multi-tiered dispute resolution clauses attempting to make, ex-ante, a binding commitment to conciliate. in elizabeth bay, it seems from his argumentation that giles j is deliberately looking for a reason not to enforce the conciliation clause, even when the parties in that case acknowledged that they had common intentions with regard to that clause. in aiton, it seems clear that the defendants tried to use the enforcement of conciliation as a delaying tactic.120 in both cases, the argument with which conciliation is denied enforceability seems trifling, especially when it has to be weighed against the parties’ express (and elaborate) intentions of conciliation. pryles does not explicitly state it, but he does seem to refer to einstein’s argument of extreme formality with some bewilderment.121 there seems to be at least some indication that the formality argument is used in elizabeth bay and aiton as a pragmatic detour for arriving at an equitable solution for individual cases instead of a systematic and consistent stance on dispute resolution. 3.2.2.2 good faith negotiations almost ten years after pryles, chapman discusses the readiness of australian courts to enforce an obligation to negotiate in good faith.122 chapman writes from the opposite perspectives adopted by english and australian courts, the first according to pryles rejecting such obligations, the latter now binding parties to such agreements. the key issue he discusses, however, is universal. how should an obligation to negotiate in good faith be defined if such an obligation cannot be defined through a successful end product such as a judgment? from this point of view and the similarities between defining the failure of negotiation and conciliation123, chapman’s discussion of the supreme court of new south wales’ court of appeals’ 2009 decision in united group rail services limited v rail corporation new south wales is of interest to the discussion on conciliation agreements in the previous subsection. in that decision, the court presided by allsop p upheld the validity of a dispute resolution clause that contained a requirement for “senior representatives” to “meet and undertake genuine and good faith negotiations with a view to resolving the dispute or difference” as a prerequisite for arbitration (para 15, clause 35.11). in upholding the enforceability of this clause, the court overruled the view that good faith negotiations are akin to agreements to agree and therefore 120 e.g. aiton v. transfield para 22. 121 pryles 2001 p. 165. 122 chapman 2010. 123 e.g. born 2009 p. 847, discussed in section 3.2.1. nordic journal of commercial law issue 2011#1 48 generally unenforceable.124 this viewpoint will not be further discussed here. instead, of interest are the arguments used by the court to overrule the previous blanket unenforceability of good faith negotiation agreements. these reasons are similar to those already used with regard to conciliation clauses in the previous subsection. first, agreements to negotiate in good faith are not seen by allsop p as agreements to agree but instead as agreements to negotiate in a particular manner (paras 71– 74). whatever this manner is depends on the circumstances: “what the phrase “good faith” signifies in any particular context and contract will depend on that context and that contract” (para 70). the difficulty of proving whether or not negotiations have been undertaken in a particular manner “does not mean that this is not a real obligation with real content” (para 74). second, effect should be given on the parties’ express intentions (para 74): if business people are prepared in the exercise of their commercial judgment to constrain themselves by reference to express words that are broad and general, but which have sensible and ascribable meaning, the task of the court is to give effect to, and not to impede, such solemn express contractual provisions. chapman analyzes how exactly an obligation to good faith should be defined.125 he first notes that the united group judgment denounced any overriding definition of good faith. in that case, allsop p noted that even self-interested activities may be conducted with an air of honesty and genuineness and gives some examples of what this might mean under particular circumstances:126 a party, for instance, may well not be entitled to threaten a future breach of contract in order to bargain for a lower settlement sum than it genuinely recognises as due. that would not, in all likelihood, reflect a fidelity to the bargain. a party would not be entitled to pretend to negotiate, having decided not to settle what is recognised to be a good claim, in order to drive the other party into an expensive arbitration that it believes the other party cannot afford. if a party recognises, without qualification, that a claim or some material part of it is due, fidelity to the bargain may well require its payment. that, however, is only to say that a party should perform what it knows, without qualification, to be its obligations under a contract. nothing in cl 35.11 prevents a party, not under such a clear appreciation of its position, from vindicating its position by self-interested discussion as long as it is proceeding by reference to an honest and genuine assessment of its rights and obligations. 124 chapman 2010 pp. 91–92. 125 chapman 2010 p. 95. 126 united group para 72. nordic journal of commercial law issue 2011#1 49 in order to further concretise what this obligation boils down to, chapman refers to other authorities for a variety of examples. one of these is alan berg, who suggests that an undertaking to negotiate in good faith might mean:127 “an obligation to commence negotiations and to have some minimum participation in them” as well as “an obligation to have an open mind in the sense of: (i) a willingness to consider such options for the resolution of the dispute as may be proposed by the other party [and] (ii) a willingness to give consideration to putting forward options for the resolution of the dispute… [and] “not to take advantage, in the course of negotiations, of the known ignorance of the other side” and “not to withdraw giving a reason which is untrue”. in the end, chapman emphasises the difficulty of identifying any clear overriding meaning for good faith negotiations as opposed to allsop p’s general idea of a context-based understanding. however, the notion of good faith is always sensitive to its context. the key point in united group seems to be that the parties have agreed on the use of a particular clause, and this clause must be understood and given effect through the particular context of the case. the meaning of good faith in negotiations does not arise from some overriding, universal meaning of good faith, but rather, as seen in section 2.1, from its application into the particular factual circumstances of a case. thus, the supreme court of new south wales has come a long way from the decisions mentioned with regard to conciliation in the previous subsection. the court has confessed that it may be possible to find enforceable meaning in all agreements made by reasonable businessmen, even apparently uncertain ones. thus, courts can give meaning to negotiation clauses even when such clauses have little procedural description on how negotiations should be undertaken. the same reasoning should also apply to conciliation, as there clearly are reasonable meanings that can be given to the concept. 3.2.3 international commercial conciliation and the swiss federal supreme court in its decision 4a_18/2007, the swiss federal supreme court dismissed a complaint claiming that the conciliation requirement of a dispute resolution agreement had been skipped in favour of arbitration. the reasoning provided by the court is worth discussion here. in that case, a french company, “y”, holding a number of patents related to coffee machines, licensed these patents to the hong kong subsidiary, “x”, of a germany based group of companies engaged in the manufacture and import of electric machinery. the agreement contained as article 10 a 127 chapman 2010 p. 97, quoting berg. nordic journal of commercial law issue 2011#1 50 dispute resolution clause.128 according to the judgment, the parties’ relationship deteriorated for diverse reasons. this was followed by various attempts to resolve their disputes, but as these failed y’s counsel proposed arbitration. following this, x immediately terminated the licensing agreements for which it also requested partial damages from y. y then requested arbitration from the wipo arbitration centre. x replied that conciliation, as required by their contract, had not been undertaken and that therefore the arbitration tribunal lacked jurisdiction. the tribunal nevertheless declared itself competent and ruled over the case, finding primarily in benefit of y, but holding that each party bear their own costs and half the arbitration costs. x appealed the award in the swiss federal supreme court, which, as already noted, found that conciliation had not been required in the particular case. the court presented two key arguments for its decision denying the appeal and for awarding costs relating to the appeal to y. the first had to do with the interpretation of the dispute resolution clause and the second with the conduct of the parties. in interpreting provision 10.2 in light of “general principles of contract law” the court found it to be “sibylline” (section 4.3.2 of the judgment, third paragraph). nonetheless, in the end the court interpreted the clause as not requiring mandatory conciliation. this was first of all due to the court finding the statement “on-going negotiations in no case constitute an impediment to commencing arbitration”129 difficult to understand if the conciliation requirement also included in provision 10.2 would be construed as mandatory. the court refused to accept the appellant’s statement that this clause, identically to article 65 of the wipo arbitration rules, only referred to negotiations initiated after arbitration had commenced. instead, the court noted that the parties seemed to want to emphasise that all disputes not resolved amicably would go to arbitration even when they favoured amicable dispute resolution “with or without a mediator”. second, the court accepted the arbitral tribunal’s notion that because there was no time limit in the dispute resolution clause barring arbitration for a specified time, which is 128 titled droit applicable et arbitrage, the relevant content of the clause according to the swiss federal supreme court was: 10.1 le présent contrat et tous les rapports de droit qui en découlent sont soumis exclusivement au droit suisse. 10.2 toute controverse et tout différend en rapport avec le présent contrat et qui ne pourront être résolus à l'amiable (y compris la conciliation selon les règles de l'ompi) devront être soumis à un tribunal arbitral qui sera seul compétent pour décider définitivement, à l'exclusion des tribunaux ordinaires. au surplus, le tribunal arbitral sera seul compétent pour statuer sur tout différend concernant l'applicabilité de cette clause d'arbitrage. des négociations en cours ne constitueront en aucun cas un empêchement à l'engagement de la procédure arbitrale. 10.3 l'arbitrage sera tenu sous les règles de conciliation et d'arbitrage de l'ompi et le chapitre 12 de la loi suisse sur le droit international privé. les parties désignent expressément genève (suisse) comme siège du tribunal arbitral... 10.5 les parties demandent expressément au tribunal arbitral d'accomplir sa tâche avec la plus grande diligence et de statuer dans les plus brefs délais. … 129 my translation of “[d]es négociations en cours ne constitueront en aucun cas un empêchement à l'engagement de la procédure arbitrale”. nordic journal of commercial law issue 2011#1 51 “usual practice internationally”, the parties had not intended conciliation as a mandatory condition precedent. the court further noted that the model clauses of the wipo mediation rules do contain such time limits. thus, the court could not establish that the reference to conciliation in provision 10.2 indeed was intended as an obligatory precondition to arbitration. following this, the court in its second key argument took up the notion of abuse of law (section 4.3.3 of the judgment). the court first noted the conduct of the parties and especially the attempts made at settlement prior to the arbitration proceedings. the court came to the conclusion that it was doubtful whether the parties could be reconciled, even under a neutral third party, as was alleged by the appellant. more importantly, however, if the appellant really wished amicable settlement, they should also have acted thus according to the court. the court noted that under wipo rules conciliation is possible also during arbitration. while the appellant did inform the arbitral tribunal that it felt that the tribunal lacked jurisdiction, the appellant did not request the tribunal to suspend proceedings in favour of conciliation. instead, the appellant participated actively in the arbitration proceedings and then, after the arbitral award had been issued, invoked the lack of conciliation as a procedural deficiency. further, the court did not accept the appellant’s view that initiating conciliation would have been the duty of the plaintiff. ultimately, the court found that such behaviour on part of the appellant cannot constitute good faith and therefore cannot be awarded legal protection. thus, the swiss federal supreme court provides two reasons for why the conciliation agreement was not upheld. because of there being two reasons, it is frustrating to follow the reasoning of the court; what tipped the scale against the appellant? how much did the “sibylline” drafting of the dispute resolution clause weigh? or was the tipping of the scales primarily due to appellant’s bad faith, only that there conveniently happened to be available additional material on which to ground the judgment so that bad faith would not have to be relied upon alone? the decision seems to help little with regard to giving a meaning to conciliation, even when latour would probably argue that the vagueness of the decision is an important value object in itself by allowing for multiple interpretations. in the end, the court need not stress the requirements of conciliation clauses. in the abovementioned elizabeth bay and aiton judgments, courts stressed a rigid interpretation of the certainty doctrine with regard to what appeared as inconsequential details, apparently in order to perform an equity-based evaluation. here, however, the swiss court had abundant additional material at its use. but this material is not used convincingly. definite time limits were seen by the swiss court to be typical, but not necessarily obligatory, elements of mandatory conciliation clauses and the court did not stress that they need be present. further, the last sentence in clause 10.2 discusses negotiation, not conciliation. besides, the parties had agreed to a dispute resolution clause that contained a clear reference to conciliation. it seems probable that had the parties, when agreeing on this clause, really intended conciliation to be voluntary, they would have taken care to mention such a fact. finally, there is no escaping that the court itself pointed out that conciliation could have been possible even during arbitration by suspending the arbitration proceedings. by doing this, the court itself seems to accept that conciliation really was intended by the parties. nordic journal of commercial law issue 2011#1 52 thus, it seems that the court primarily wished to stress the appellant’s conduct under the particular circumstances of the case as the primary reason on why conciliation was not required in this particular case even when it might be required in general. the german bgh explicitly stated in its november 18, 1998 decision viii zr 344/97 that a treuwidrigkeitseinwand might override agreed conciliation procedure. according to boog, the swiss federal supreme court’s decision similarly shows that bad faith may override normal conciliation procedure. it would thus be the parties’ conduct in fulfilling an agreement to conciliate that counts.130 on the other hand, it also seems curious that the arbitral tribunal itself did not stay the proceedings and revert the parties to conciliation, which would easily have cured any procedural deficiency. here, the swiss court would have had a perfect possibility to reprimand the tribunal. of course, such a reprimand would have seemed excessive with regard to the substance of the case at hand and the decision already made by the arbitral tribunal. as a policy consideration it might nevertheless have served a purpose. then again, probably even the present judgment has enough pedagogic effect so that any arbitral tribunal should be careful enough to propose a stay for conciliation in order to ensure that its eventual award would not appealed on similar grounds. 3.2.4 caselaw—a summary in analysing caselaw on international commercial conciliation, jolles and born propose drafters a careful and conservative perspective similar to that of the uncitral model law; parties should, in addition to a conciliation agreement, include in their dispute resolution clause another mechanism that bars access to litigation for a limited period of time. thus, there would be no need for parties to rely on an agreement to conciliate that is possibly meaningless for a court that does not accept a more liberal interpretation of conciliation. such a point of view does have its practical benefits, as is clear from the series of cases on conciliation from the new south wales supreme court. while claiming to be acceptant of conciliation in general, that court nevertheless adopted in the elisabeth bay and aiton judgments a restrictive interpretation of conciliation that overrode clear mutual intentions to conciliate. instead of having a fixed policy on interpreting conciliation agreements, it seems that in those judgments the courts were primarily looking for pragmatic solutions to individual cases. despite its apparent benefits, the safety-first method of drafting proposed by jolles and born altogether skips the relevant question of whether conciliation can be attributed independent legal meaning. berger answers this question in the affirmative, arguing that courts should give 130 boog et al. 2008 p. 109. nordic journal of commercial law issue 2011#1 53 meaning to dispute resolution agreements even when they do not exactly fit into traditional models. berger’s argument receives further support from the english cable and wireless decision referred to in section 2.3.2, where the court noted that “[i]n principle… where there is an unqualified reference to adr, a sufficiently certain and definable minimum duty of participation should not be hard to find”.131 berger’s approach is also consistent with the new south wales supreme court’s reasoning in the united group case with regard to negotiation. in all these cases, the reasoning used follows the lines of argument in section 2.1 by stressing that the factual circumstances in light of the context of a case should weigh more than an abstract interpretive paradigm that may not fit into the same circumstances. this position also has its likeness in the icdr international mediation procedure. there is thus precedent for not only a denial of independent meaning to conciliation, but also for a restrictive interpretation of conciliation agreements based solely on the parties agreement and a more liberal interpretation requiring courts to locate the relevant legal meaning to the parties’ agreement not from within the contract itself but from the greater context of which the contract is an indicator. none of these interpretations is useful, however, if the reasoning behind them is not clear. in the swiss federal supreme court decision 4a_18/2007, it seems clear that the factual circumstances of the case were thoroughly balanced by the court. unfortunately, due to the vagueness of the decision and the multiple possible objectives of the court in making it, the relation of the different factors of the decision is unclear. one cannot be sure whether or not the court embraced a restrictive or liberal interpretation of conciliation, both of which could be supported by the text of the decision. 3.3 summary—the three meanings of conciliation underlying the 1980 uncitral conciliation rules is the premise that conciliation must rely on the parties’ volition to such an extent as to be wholly noncommittal, even if ”agreed to” in advance. this premise is somewhat moderated under the 2002 uncitral model law which provides for the possibility of a time limit or event that can be used to define the extent of conciliation. further, the 2001 icc adr rules tie conciliation to the attendance of a meeting on conciliation procedure. still, none of these instruments as such provides much substance to conciliation itself. the 2009 icdr international mediation rules, on the other hand, are much more demanding on the parties, imposing upon them a requirement of best efforts conciliation before the agreement to conciliate is fulfilled. unlike the time limits and the mere attendance of an event, an adequate attempt at the substantive best practice conciliation required by the icdr international mediation rules can only be defined by courts on the basis of an evaluation of relevant factual circumstances. 131 cable & wireless v. ibm para 34. nordic journal of commercial law issue 2011#1 54 similar ideas are traceable also in discussions of caselaw. the approach to drafting conciliation agreements proposed by jolles and born is a careful and conservative one similar to that of the uncitral model law; parties should, in addition to a conciliation agreement, include in their dispute resolution clause another agreement that bars access to further dispute resolution mechanisms for example for a limited period of time. thus, there would be no need for the parties to rely on any agreement to conciliate possibly being meaningless for a court disinclined to the more liberal interpretations of conciliation. berger, on the other hand, argues that when the parties have not defined when an attempt to conciliate is fulfilled, courts should, based on the factual circumstances of each case, identify whether or not adequate attempts at conciliation have been undertaken. broadly speaking, three different kinds of meaning attributable to conciliation can be distilled from the above. the first is a blanket denial of legal meaning to agreements to conciliate, represented by the unmodified uncitral instruments that give either party the possibility to walk away from an agreement to conciliate without further ado. jolles’ and born’s recommendations for drafting enforceable conciliation agreements also take into account the possibility of such a blanket denial interpretation. second, there is a restrictive interpretation of the parties’ agreement, which position in principle allows legal meaning to conciliation agreements but only to the extent to which this is precisely defined in the parties’ agreement. this interpretation is represented by the recommendations of jolles and born and the three new south wales supreme court decisions on conciliation, all of which emphasise a drafter’s liability for creating a meaningful conciliation agreement. this second interpretation is also reflected in the strict requirements of conciliation agreements that bar litigation in the uncitral instruments. third and finally, there is a liberal pro-conciliation interpretation under which courts try to enforce any express intention to conciliate by giving that intention meaning in light of the factual circumstances of the case. this is done even when the agreement to conciliate might be seen to be lacking in the regard that it does not provide what is seen as a full and certain agreement covering all aspects of conciliation, as may be required under the restrictive interpretation. thus, under this interpretation courts fill out any missing details in the conciliation agreement in light of the factual context of the case. this viewpoint is reflected in the cable & wireless, icc award 6276 and united group decisions. it is also reflected to an extent in the swiss federal supreme court decision 4a_18/2007 that does not explicitly deny meaning to what is claimed to be an unclear conciliation clause. it also finds expression in the icdr international mediation rules, which stress the actual process of conciliation over rigid formalities. nordic journal of commercial law issue 2011#1 55 as is clear from the different international instruments and caselaw on conciliation, there are numerous different ways to understand the content of a single conciliation agreement. this is problematic. boog notes that:132 in summary, an analysis of the rather scarce case law [on the enforceability of conciliation clauses] shows that the focus has often been less on issues of doctrine and strict legal concepts than on finding pragmatic solutions to individual situations. insofar as a general rule can be established, a procedural approach [i.e. seeing unfulfilled conciliation clauses as a bar to arbitration] would seem to be the preferable solution, since it is likely to better meet the parties' expectations than a substantive approach. the confusion caused by such a pragmatic viewpoint on the interpretation of conciliation clauses is evident in the three new south wales supreme court judgments on conciliation above and also in the swiss federal supreme court decision 4a_18/2007. 4 towards a conclusion—interpretive alternatives for conciliation agreements as seen in section 3 above, at least three legal meanings are identifiable for conciliation agreements: • a blanket denial of any legal meaning to conciliation; • a legal meaning of conciliation defined through a restrictive interpretation of the parties’ agreement; and • a legal meaning of conciliation defined through a liberal interpretation of the parties agreement, where, if necessary, a clear intention to conciliate is given meaning through the greater context of international commercial dispute resolution as discussed in section 2 above. the effect of these different legal meanings of conciliation on contracting is discussed in this section. the interpretation of conciliation agreements is closely related to two questions. the first is whether or not conciliation has a legal meaning of its own and what the exact scope of this legal meaning is. the second is whether and how any deficiencies in a conciliation agreement should be filled in. this section concentrates on the first of these two questions. with regard to the latter question, it is argued in section 2 above that the interpretation of conciliation agreements should not be seen as separate from other forms of international commercial dispute resolution. instead, conciliation should be seen as an integral part of the entire dispute resolution agreement, thus bridging any contextual or interpretive gap between different forms of dispute resolution, such as conciliation and arbitration. 132 boog 2008 p. 107. nordic journal of commercial law issue 2011#1 56 4.1 blanket denial of legal meaning to conciliation agreements the position of blanket denial categorically denies any legal meaning to and thus also the legal effect or enforceability of conciliation clauses. this idea seems radical in light of the benefits of conciliation identified in section 2.2 above. nonetheless, as seen in section 3.1.1 above, such a viewpoint is reflected for example in the unmodified uncitral conciliation rules and uncitral conciliation model law. these two instruments stress the volition of the parties as the key feature of conciliation to such an extent as to allow parties to walk out of conciliation before it begins or anytime after it has begun. thus, under such a viewpoint there exists no real obligation to conciliate, not even where the parties have seemingly agreed to conciliate under their contract. one view of the blanket denial position stresses volition at the moment of conciliation as something that overrides any ex ante agreement of the parties to submit their disputes to conciliation. in light of present understandings of conciliation this position is not sustainable. first of all, the idea of a contract that is outright denied legal meaning is against the principle of pacta sunt servanda, according to which party autonomy in the form of contracts should be recognised and enforced by courts. even when contracts that are denied legal effect do exist, these should be limited to cases that are clearly against the ideals of a particular legal system. it is difficult to see conciliation agreements as contrary to the ideals of any legal system. conciliation is a procedure that helps bring disputing parties closer to each other and reach a mutual understanding of the nature of their dispute, potentially also solving it. this is something not readily available under other kinds of legal proceedings such as arbitration and litigation. because of the nature of conciliation as an aid to litigation, it is difficult to imagine situations in which conciliation would be a complete waste of resources for parties. these would primarily seem to be limited to cases where an abuse of law doctrine should suffice to protect relevant interests. a blanket denial of legal meaning to conciliation could clarify the legal situation in the sense that dispute resolution mechanisms such as arbitration and court proceedings would receive more attention. conciliation would remain as something that the parties might undertake alongside or in addition to such mechanisms but without any overt support from courts. in such a situation, courts would not need to bother with interpreting conciliation agreements and could right away dismiss them in favour of litigation. but as seen in section 2.2 above, all the ills of litigation, such as time and cost related constraints and the argumentative difficulties and boundaries caused by the limits of law, cannot be easily corrected. this is visible also in the support given to conciliation by the business community, as noted in section 2.2.3. business clearly wants to provide conciliation a recognised status. not recognising such input would be a violation of pacta sunt servanda, as noted among others by allsop p in united group: the task of courts is to give effect to express contractual provisions that reflect the exercise of commercial judgment and which have a sensible and ascribable meaning. conciliation has such a sensible and ascribable meaning and should thus be given legal effect. nordic journal of commercial law issue 2011#1 57 finally, under the blanket denial ideology, additional agreements are required in order to give a conciliation agreement a chance of any practical legal effect. for example under the uncitral instruments discussed in section 3.1.1, an agreement not to initiate litigation for a set period of time or until a particular event is required in addition to the actual agreement to conciliate, giving rise to a type of hybrid agreement combining these two different elements. this confusion of different kinds of agreements cannot be seen as helpful for contract law. for example in light of the reasoning of the swiss federal supreme court in decision 4a_18/2007, the confusion of ideologies on what it actually means to conciliate muddles the idea of pacta sunt servanda in relation to conciliation agreements and also offers a poor example for the interpretation of other kinds of agreements novel to legislation by moving focus away from the process of conciliation to events, such as arbitrary time limits, that have little to do with conciliation itself. as seen in section 2.1 and as exemplified in the progression of cases in new south wales discussed in section 3.2.2, i argue that in order to avoid such contractual confusion courts should adopt a more flexible understanding of contracting in general. in relation to conciliation agreements, this understanding is reflected in the liberal interpretation of conciliation agreements as contrasted with a more restrictive interpretation in the following two subsections. 4.2 the problems with a restrictive interpretation of conciliation clauses what i see as a tendency towards a restrictive interpretation of conciliation agreements is closely related to the notion of a blanket denial of any legal meaning to conciliation agreements. as seen in section 4.1 above, the blanket denial of legal meaning to conciliation agreements creates a category of subpar agreements that require another agreement to give them any legal effect. the restrictive interpretation of conciliation agreements seems like an outgrowth of these subpar agreements. because conciliation agreements are in general denied legal meaning under the blanket denial position, business actors have tried to create conciliation agreements that overcome this deficiency through better drafting for example by modifying arbitration agreements in order to delay their onset once a dispute arose in order to provide an incentive to conciliate. similar techniques seem to have become an integral part of conciliation agreements. all the rules governing conciliation discussed in this article, save for the icdr international mediation rules, contain remnants of such a blanket denial ideology. the model clauses accompanying these instruments recommend the use of set time limits in order to ascertain that any conciliation agreement effectively bars litigation at least for the set period of time, apparently in case the agreement to conciliate is not otherwise given legal effect. the same line of thought is also evident in caselaw. as seen in section 3.2.1, jolles and born recommend the use of clearly defined transitions from conciliation to other forms of dispute resolution, such as set time periods. the blanket denial position has merged conciliation agreements with agreements barring access to litigation to such an extent that the two seem inseparable. because the barring of litigation is seen as an integral part of conciliation agreements, the two different notions have nordic journal of commercial law issue 2011#1 58 also become confused in legal argument. this is visible for example in the swiss federal supreme court decision 4a_18/2007 discussed in section 3.2.3 above, where the court noted the lack of any time limit for conciliation as possible indication of the non-binding nature of the conciliation agreement, even when in the end the court seemed to argue that it was the conduct of the plaintiff that led to the unenforceability of the conciliation agreement. in light of section 3, a restrictive interpretation of conciliation agreements seems typical at present. this results in a restrictive construction of conciliation agreements under which conciliation agreements are given legal effect only to the extent that their meaning can be construed through the conciliation agreement. in order for conciliation to have legal meaning, conciliation agreements must therefore be as self-sufficient as possible; parties should explicitly agree on all open issues for example by stating that the appointed conciliator may rule over any issues not agreed upon by the parties. in other words, courts cannot fill out the meaning of international commercial conciliation with regard to individual conciliation agreements. most importantly, courts cannot decide whether or not conciliation has been fulfilled unless clear criteria are provided for this examination. as long as courts do not recognise any general meaning for conciliation, this would come down to setting an objectively definable moment at which any requirement to conciliate is fulfilled. this moment of fulfilment could be for example a unilateral or bilateral proclamation, the elapsing of a set period of time, or the accomplishment of an action such as a meeting between the parties. problems with such a restrictive interpretation are obvious. trying to establish an explicit meaning for conciliation in a manner that would be easily applicable to all possible cases necessarily far removes conciliation from an in-context assessment of whether or not parties to a conciliation agreement have in fact tried to conciliate. such an assessment of conciliation relies on events that may have nothing at all to do with the process of conciliation itself. these events, such as proclamations, time periods, or individual meetings, are not tied to the process of conciliation itself but instead to acts that are traditionally regarded as relatively easy to verify from an objective standing point. in a sense, a claimed efficiency of interpretation overrides any independent legal meaning that could be attributed to conciliation. it could of course be argued that as long as there is no standard legal meaning for conciliation, courts cannot apply any particular legal meaning to conciliation agreements. instead, under the principle of party autonomy they would be reliant on any legal meaning of conciliation provided to them by the parties’ agreement. this, however, may lead either to unequitable demands on the drafting of conciliation agreements, as seen in section 3.2, or to a notion of conciliation that fails to see conciliation as the useful pre-litigation process described in section 2.2. most importantly, such a restrictive interpretation based on the parties’ agreement overrides the principle of pacta sunt servanda. if the parties have undertaken to conciliate their dispute, they should try to do so instead of just waiting for a set time limit to elapse. moving towards a contextual assessment of whether or not conciliation has taken place might prima facie seem to increase litigation due to the problems of attributing when exactly a requirement to conciliate has been fulfilled. however, the problems of such an attribution of nordic journal of commercial law issue 2011#1 59 meaning must be weighed against the parties’ intent in agreeing to conciliate in the first place. under the principle of party autonomy, the task of courts is to enforce parties’ agreements. as argued in section 2.2, there is no reason not to enforce conciliation agreements, as these are a useful means for making the overall dispute resolution process smoother and more effective. further, in section 2.2.2 a brief framework of the inner workings of conciliation procedure was outlined from two different points of view; the more theoretical perspective of hill and the “plain talk” version of the american arbitration association. courts have no excuse for not knowing how conciliation works and what could be seen as reasonable steps for trying to conciliate. there is thus no reason for courts not to emphasise the particular circumstances of each case in relation to their understanding of conciliation. in doing so courts could also take into account other factors, such as the fundamental freedom of access to court or also to apply the extensive international and national frameworks created for the interpretation of dispute resolution agreements in general, as argued in section 2.3. finally, neither is litigation over conciliation agreements out of the question under a restrictive interpretation of conciliation. even under a restrictive interpretation of conciliation agreements, parties would have to argue over whether or not their conciliation agreements can be attributed a legal meaning, as happened in elizabeth bay, aiton and the swiss federal supreme court judgments discussed in section 3.2. a restrictive interpretation of conciliation agreements cannot in general be said to make courts more effective by easing their task of interpretation. however, what can be said is that a restrictive interpretation of conciliation agreements is undesirable for legal argumentation in general. arguing whether or not an agreement to conciliate is valid distracts discussion from what could be considered equitable conduct under particular circumstances in relation to conciliation. this seems to have also confused the reasoning of the swiss federal supreme court in its decision 4a_18/2007. instead of concentrating solely on the behaviour of the parties in light of a potentially valid conciliation agreement, the court in that case also discussed the matter of whether or not the conciliation agreement itself was valid. with regard to this, the court seemed to reach no clear conclusion. a simpler and more elegant approach would certainly have been to uphold the validity of the conciliation agreement and instead argue the case only based on the parties’ conduct in relation to a tentatively enforceable agreement to conciliate. argumentation over the validity of conciliation agreements has a tendency of hiding the real arguments used by courts to solve cases as noted in section 2.1 and as is visible for example in the transfield, aiton and the swiss federal supreme court judgments. contractual interpretation should not and cannot be used as a fix-it for all kinds of problems. if the courts in these three cases really had, as it seems, primarily equity-based motives for their resolutions, the contractual reasoning nevertheless used by them twists the law in the wrong direction. arguments may be hidden behind the veil of contractual interpretation, giving little chance for any viewpoint that the intention of the parties as understood for example by a reasonable businessman under similar circumstances should instead bear weight. thus, under the nordic journal of commercial law issue 2011#1 60 restrictive interpretation, conciliation agreements risk being used for what courts perceive as in casu equity, thus confusing any doctrinal viewpoints on contractual interpretation in general. finally, the restrictive interpretation point of view places the risk of the enforceability of a conciliation agreement heavily on the drafter. the agreement to conciliate would have to be foolproof so that courts would not be susceptible of misinterpreting it for whatever cause. on the one hand businesses seem ready for such endeavours; for example, following the aiton judgment drafting guidelines for conciliation clauses were duly updated.133 on the other, such extensive requirements on drafting constitute considerable transaction costs on business, especially when coupled with the potential for ensuing litigation on the interpretation of the same agreements. instead of encouraging parties to dispute their dispute resolution agreements, courts should encourage parties to conciliate. 4.3 towards a liberal interpretation of conciliation clauses above in section 4.2 it was argued that courts should adopt a liberal interpretation of conciliation agreements. this would not only be more respective of the parties’ intention in drafting an agreement to conciliate, but would also alleviate the need to litigate on whether or not a valid agreement to conciliate actually exists. attention could be directed towards the more important issue of what kind of efforts at conciliating are appropriate in particular circumstances. courts could thus concentrate on clarifying any equity-based arguments in particular cases without having to hide them behind the veil of contractual interpretation. thus, the third possible legal meaning of conciliation discussed here is such that courts themselves are able to provide the basic meaning of conciliation in relation to the context of the dispute at hand. instead of full reliance on the parties’ agreement to conciliate, that agreement is only to supplement the core meaning of conciliation. instead of a case by case assessment based solely on the parties’ agreement, conciliation receives a general legal meaning of its own that is only adjusted in light of the particular circumstances of the case at hand, such as the parties’ conduct and case-specific contractual stipulations. the meaning of conciliation is not reliant on such representations but instead has an intrinsic core of its own that is recognised and accepted by the judiciary. this meaning is defined by the ongoing discussion on what it means to conciliate, including the article of hill, aaa’s list of the objectives of conciliation, and the other opinions discussed in section 2.2.2. this meaning is further defined by the framework provided by the evolving regulation of international dispute resolution and regulations and caselaw specific to conciliation. however, the primary value of conciliation agreements should be their interpretation through application into the particular circumstances 133 boulle et al. 2000 p. 70. see also boog (2007 p. 110) discussing the effect of the swiss federal supreme court decision 4a_18/2007 on the drafting of conciliation clauses. nordic journal of commercial law issue 2011#1 61 of a case, as emphasised in section 2.1. the meaning of conciliation is malleable and changes with the circumstances of each case. nonetheless, this meaning is simultaneously concrete in that courts should use and spread the meaning of conciliation as reliant on the liberal interpretation proposed here. the key question then is how to define the limits of such a liberal interpretation. certainly conciliation must not become an insurmountable obstacle for a binding decision. one key starting point that must be taken into account is the safeguarding of parties’ access to court, especially with regard to possible limitation periods and interim measures. otherwise, the parties’ own conduct in trying to resolve their dispute is crucial, as for example in the swiss supreme court decision 4a_18/2007, icc award 6276, and the australian united group decision. such malleable contextuality could be given form on a more general level for example under the attempt to systematize context proposed by pöyhönen.134 on a more practical level, these general principles must be compared to expectations of conciliation such as those found in the aaa conciliation objectives mentioned in section 2. these, and other relevant soft law and regulations, together form a general starting point for deciphering the extent of conciliation in a particular case. the key agenda of this article is that such an attribution of legal meaning to conciliation agreements is not only more equitable than the other interpretive options both from an in casu and overall systemic perspective, but also realistically achievable. 4.4 postscript or the ongoing negotiation of the legal meaning of conciliation businesses include conciliation mechanisms in their dispute resolution agreements in order to make the resolution of disputes more effective. dispute resolution centres vie to create and update more efficient concepts of conciliation. conciliation has rightfully caught the eye of the judiciary through these legal impulses. but what meaning should courts give to these impulses? are they worthy of recognition under pacta sunt servanda? legislators and courts have at first rejected the idea of giving binding legal effect to conciliation as a procedure with an end result, the resolution of a dispute, that is reliant on the volition of participants. thus, conciliation agreements were almost categorically denied legal effect. focus then shifted away from the aspect of volition towards the principle of pacta sunt servanda in the sense that caselaw emphasised the parties’ will not to litigate until some attempt at conciliation is made. this led courts to accept that the process of conciliation might be allowed some legal recognition if the conciliation procedure is sufficiently certainly defined in relation to the rest of the dispute resolution procedure, for example with regard to the point of time after which litigation could commence. finally, recent scholarly writing highlights the positive effects of the 134 pöyhönen 2000, especially p. 140ff. and p. 159ff. for contextual assessment. nordic journal of commercial law issue 2011#1 62 process of conciliation even when no direct settlement is reached. thus, the next step to be taken is to provide an independent meaning for conciliation that is not reliant on the rest of the parties’ dispute resolution agreement for its enforceability but is instead independently definable. to this end, conciliation should be defined by courts in light of the circumstances of particular cases in relation to a common understanding of what it means to conciliate. this common understanding is defined through scholarly writings, business practice and caselaw and ensures that conciliation agreements can be given appropriate legal effect in all conditions. the process of development of legal meaning over time through an interplay of legislative, judicial and business practise related arguments continues to redefine not only what it means to conciliate but also the paradigm of pacta sunt servanda in relation to conciliation agreements and agreements in general. from a de lege lata point of view, it seems that the risk of successfully defining the meaning of conciliation still lies in the hands of the drafter of a conciliation agreement. the drafter should ensure the viability of a conciliation clause by clearly stating that litigation is barred until an objectively definable event or time limit is reached. despite this, increasingly less emphasis is put on the details of the conciliation agreement and instead more on the conduct of the parties in fulfilling an agreement to conciliate. it seems that conciliation agreements are about to mature from agreements related to something else than conciliation, such as agreements barring litigation for a set period of time, into true agreements that reflect the parties’ actual intention to undertake a process of conciliation prior to engaging in litigation. this is a reasonable goal and should therefore be embraced by courts to the full; by the courts, precisely, as the question relates more to the interpretation under general contractual principles of the parties’ intentions in agreeing to conciliate rather than the interpretation of any existing law. as seen above, these intentions can be given meaning through evolving conceptions of conciliation visible in business practice and institutional rules and increasingly also in regulation and caselaw. as shown for example by the recent swiss federal supreme court decision 4a_18/2007, the maturation of conciliation into a type of agreement recognised as such as bearing legal meaning and effect is by no means complete. for example in finland the different interpretations of conciliation agreements presented in this thesis live on and thus potentially remain at the use of courts of law. it could be argued that hemmo’s general commentary on finnish contract law represents the blanket denial approach. on the basis that parties are not obliged to accept a settlement proposed in conciliation, hemmo argues that conciliation probably could not form a procedural prerequisite to arbitration or court proceedings, thus echoing the volition-based position of the uncitral instruments referred to in section 3.1.1 above.135 this is in contrast with savola, who primarily on the basis of party autonomy argues that a different point of view is merited under finnish law.136 nonetheless, on the basis of international caselaw savola 135 hemmo 2005 p. 367. 136 savola 2006. nordic journal of commercial law issue 2011#1 63 stresses the requirements imposed by a clearly restrictive interpretation of conciliation agreements by claiming that drafters should pay particular attention to how they define the point at which conciliation can be ceased and arbitration or litigation begun.137 both hemmo and savola can be contrasted with the perspective of this article, that is, a fluid understanding of conciliation based on the conciliatory intent of the parties and reflecting that intent in light of both the conduct of parties within a particular dispute resolution context and scholarly writing and legal practice on accepted standards of conciliation. i argue that the latter view best reflects the principles of pacta sunt servanda and party autonomy by allowing courts to give meaning to conciliation agreements and also best allows courts to concentrate on arguing the substantive issue of what it actually means to conciliate under particular circumstances. thus, instead of concentrating on issues of contract construction, courts should direct parties to utilise the beneficial process of conciliation to the best possible extent as must be in line with the intentions behind any agreement to conciliate. according to savola there is no clear finnish precedent for a particular type of interpretation of conciliation agreements. on the basis of section 3 above, it seems that the same applies on an international scale. however, in order to avoid unnecessary litigation on whether or not 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[2002] app.l.r. 10/11 darlington v. burser (st. ives fair ct. 1302), available for example in gross, charles (ed. & trans.) 1908: select cases concerning the law merchant 5. selden society 23. susan dunnett v railtrack plc [2002] adr.l.r. 02/22. halsey v milton keynes general nhs trust [2004] adr.l.r. 05/1. westacre inv. inc. v. jugoimport-sdpr holdings co. ltd [1998] 4 all e.r. 570 (q.b.). united states: bill call ford v. ford motor co., 830 f. supp. 1045, 1047-48 (d. ohio 1993). devalk lincoln mercury, inc. v. ford motor co., 811 f.2d 326, 328 (7th cir. 1987). fisher v. ge medical sys., 276 f. supp. 2d 891, 894 (m.d. tenn. 2003). abbreviations aaa american arbitration association adr alternative dispute resolution bger schweizerisches bundesgericht (swiss federal supreme court) bgb bürgerliches gesetzbuch (german civil code) bgh bundesgerichtshof (german federal court of justice) cedr centre for effective dispute resolution (uk) cisg united nations convention on the international sale of goods (1980) ecj court of justice of the european union (“european court of justice”) icc international chamber of commerce icdr international centre for dispute resolution new york convention united nations convention on the recognition and enforcement of foreign arbitral awards (1958) ogh oberster gerichsthof (austrian supreme court of justice) uncitral united nations commission on international trade law uncitral arbitration model law uncitral model law on international commercial arbitration (1985, as amended in 2006) uncitral conciliation model law uncitral model law on international commercial conciliation (2002) uncitral conciliation rules uncitral conciliation rules (1980) unidroit international institute for the unification of private law unidroit principles unidroit principles of international commercial contracts (2004) wipo world intellectual property organization 1 sustainability requirements in eu public and private procurement – a right or an obligation? marta andrecka* and kateřina peterková mitkidis** * assistant professor at the centre for enterprise liability (cevia), faculty of law, university of copenhagen, denmark, e-mail: marta.andrecka@jur.ku.dk the article is a contribution to the author’s research project funded by the carlsberg foundation and a contribution to cevia’s project on public-private enterprise liability funded by the danish research council for independent research. ** assistant professor at the international and transnational tendencies in law (intralaw) centre, department of law, aarhus university, denmark, e-mail: katpe@law.au.dk. both authors are members of sustainable market actors for responsible trade (smart) (smart.uio.no). smart has received funding from the european union’s horizon 2020 research and innovation programme under grant agreement no 693642. sustainability requirements in eu procurement 56 1. introduction ..................................................................................... 57 1.1. the sustainability concept in private and public procurement ........................................................................... 61 2. sustainability requirements in public and private contracts ............................................................................................ 63 2.1. scope – coverage – topics .................................................. 63 2.2. link to the subject-matter of a contract ................. 65 2.3. procurement process ........................................................... 69 3. rights or obligations? .................................................................. 73 3.1. drivers of inclusion of sustainability issues into procurement processes ....................................................... 73 3.2. a right or an obligation to consider sustainability within procurement processes? ...................................... 77 3.3. legal risks associated with inclusion or avoidance of sustainability issues ....................................................... 83 4. conclusion .......................................................................................... 87 njcl 2017/1 57 abstract procurement is no longer just about buying the cheapest possible supplies or services. rather, it is understood as a process whereby organisations meet their needs in a way that achieves value for money on a lifetime basis and allows delivering aspects beyond savings, so-called sustainable procurement. this is true both for the public and private sectors. however, there is only limited legal regulation of sustainable procurement, which causes many uncertainties in respect to the possibility to include sustainability concerns into procurement processes as well as consequences of (not) doing so. the article thus focuses on the questions whether pursuing sustainability goals through procurement is an organisation's right or obligation and whether there are any risks of liability associated with pursuing or ignoring sustainability goals. these questions are analysed from the two perspectives of public and private procurement and similarities and differences between the sectors are identified. we find that in both sectors sustainability topics (i) are increasingly considered and implemented into contracts; (ii) deal with similar issues in both contexts; (iii) cover issues that are linked to the subject matter of a contract, including issues that relate rather to production process than the physical qualities of the delivered goods as such; and (iv) proliferate through all stages of the procurement process. however, the drivers of sustainability procurement and the legal regulation differ substantially. still, it is found that while there is a right to include sustainability considerations into both public and private procurement processes, there are only contours of the legal obligation to do so. in respect to private procurement, the right to give considerations to sustainability issues is not expressly stated by the applicable law as it is in respect to public procurement (though limitations apply there as well). in fact, in both sectors the right mostly stems from the fact that there is no regulation forbidding this. quite counter-intuitively then, there seem to be more legal risks associated with the inclusion of sustainability requirements into the procurement process (and inadequate enforcement thereof) rather than with ignoring them. 1. introduction throughout the last decades, sustainability has become a goal to be achieved both in the public and private spheres. it has been influencing various policies and processes, one of them being procurement. the latter is understood as an organisation’s activity of purchasing the goods and services in order to carry out its functions. nowadays, procurement is no longer just about buying the cheapest possible supplies or services but rather it is understood as a process whereby organisations meet their needs in a way that achieves value for money on a lifetime basis and allows delivering aspects beyond savings. consequently, there is an expectation both on private (companies) and public (entities) organisations to sustainability requirements in eu procurement 58 implement sustainability considerations and criteria into their procurement processes. while in many aspects public and private procurements are similar – for example, they constitute a strategic development of an organisation – there are several differences – most obvious in relation to the applicable legal framework, and these become palpable when speaking about sustainability considerations in procurement processes. in respect to the legal framework, it could be argued that in the private sector doing more than the bare minimum required by law is often down to voluntary engagement.1 although there are those pushing for increased hard law regulation of corporate social responsibility (csr), this remains limited. most of csr regulation dealing with private procurement has the form of soft law2 or meta-regulation.3 this is quite different in the public procurement context, where there is more hard law to lean on. there is no doubt that governments are bound by international treaties to uphold certain sustainability standards and actively prevent law violations such as forced labour, child labour and/or corruption. however, at the same time, in the context of international procurement regimes, sustainable regulatory objectives are often referred to as ‘horizontal’ or ‘secondary’ policies of the procurement process, in addition to the primary objective of achieving the best value for money in the acquisition of the goods and services that comprise governmental necessities.4 in light of the common demand to include sustainability criteria in procurement processes in both private and public spheres on the one hand, and the differences outlined above on the other, several questions arise. firstly, what is the legal status of such requirements; are they enforceable and actually enforced? secondly, what are the regulatory effects of such requirements? are they able to affect behaviour of the contractual parties? thirdly, does the legal environment and framework within which procurement takes places actually support or allow the pursuit of sustainability goals or not? are the private and public entities legally required to pursue sustainability goals throughout procurement processes? or can they in fact face a legal liability for doing so? while the 1 this presumption is problematized in section 3.2 below. 2 we adopt the definitions of hard and soft law presented by abbott and snidal (hard law means “…legally binding obligations that are precise (or can be made precise through adjudication or the issuance of detailed regulations) and that delegate authority for interpreting and implementing the law.” soft law comprises all regulation that is weakened in one or more of the three respects: obligation, precision, and delegation.) see kenneth w abbott and duncan snidal, ‘hard and soft law in international governance’ (2009) 54(3) int’l org. 421, 422. 3 meta-regulation is understood as regulation that supports companies’ self-regulation. 4 reference to sustainable consideration may be found in: european public procurement directives 2014, wto governmental procurement agreement 1994 (and revised version) and in uncitral model law on public procurement 2011, see further below section 1.1. njcl 2017/1 59 issues of the legal status of sustainability requirements, their enforceability and effects have throughout the last decade been in the focus of legal scholars mostly from the private, but increasingly also from the public procurement perspective,5 the issue of the legal framework has been addressed only partly within the discourse on the voluntary/mandatory nature of.6 moreover, to the authors’ surprise, a comparative perspective between public and private purchasing theory and practice in connection 5 for private procurement see e.g. michael p vandenbergh, ‘the new wal-mart effect: the role of private contracting in global governance’ (2007) 54 ucla l. rev. 913; carola glinski, ‘corporate code of conduct: moral or legal obligation?’ in doreen mcbarnet, aurora voiculescu and tom campbell (eds) the new corporate accountability: corporate social responsibility and the law (cup 2007) (hereinafter ‘mcbarnet, voiculescu and campbell, the new corporate accountability’); li-wen lin, ‘legal transplants through private contracting: codes of vendor conduct in global supply chains as an example’ (2009) 57 am.j.comp.l. 711; fabrizio cafaggi, ‘the regulatory functions of transnational commercial contracts: new architectures’ (2013) 36 fordham int’l l.j. 1557; paul w j verbruggen, ‘regulatory governance by contract: the rise of regulatory standards in commercial contracts in ‘regulatory governance’’ (2014) 35 recht der werkelijkheid 79; anna beckers, enforcing corporate social responsibility codes: on global self-regulation and national private law (oxford: hart publishing 2015), chapter 3; katerina peterkova mitkidis, sustainability clauses in international business contracts (eleven international publishing 2015); louise vytopil, contractual control in the supply chain (eleven international publishing 2015); cristina poncibò, ‘the contractualisation of environmental sustainability’ (2016) 12 ercl 335; a claire cutler and thomas dietz (eds), the politics of private transnational governance by contract (routledge 2017). for public procurement see e.g. christopher mccrudden, ‘corporate social responsibility and public procurement’ in mcbarnet, voiculescu and campbell, the new corporate accountability; antti palmujoki, katriina parikka-alhola and ari ekroos, ‘green public procurement: analysis on the use of environmental criteria in contracts’ (2010) 19 review of european, comparative & international environmental law 250; phoebe bolton, ‘protecting the environment through public procurement: the case of south africa’ (2008) 32 natural resources forum 1; dacian c dragos and bogdana neamtu, ‘sustainable public procurement in the eu: experiences and prospects’ in francois liche ̀re, roberto caranta and steen treumer (eds), modernising public procurement: the new directive (djøf 2014); peter trepte, ‘the contracting authority as purchaser and regulator: should the procurement rules regulate what we buy?’ in christina d tvarnø, grith skovgaard ølykke and carina risvig hansen (eds), eu public procurement modernisation, growth and innovation discussions on the 2011 proposals for procurement directives (djøf 2012); roberto caranta, ‘the changes to the public contract directives and the story they tell about how eu law works’ (2015) 52 common market law review 391, 2.2 and 2.3; a special issue of the european procurement & public private partnership law review on sustainable procurement, ipppl 1-13 (2013). 6 see e.g. doreen mcbarnet, ‘corporate social responsibility beyond law, through law, for law’ in mcbarnet, voiculescu and campbell, the new corporate accountability, at 12; halina ward, ‘legal issues in corporate citizenship’ (2003) global ansvar swedish partnership for global responsibility, london: international institute for environment and development; jennifer a zerk, multinationals and corporate social responsibility: limitations and opportunities in international law (cambridge university press 2006) 33-36. sustainability requirements in eu procurement 60 to sustainability requirements is largely missing in academic literature.7 the separate treatment of sustainable procurement in the private and public spheres does not reflect the reality that organisations in both sectors face, such as similar questions and obstacles when implementing sustainability requirements into their procurement processes. the new iso20400 sustainable procurement guidance reflects this, as it is to be used by all organisations, both public and private.8 thus, while there might be some obstacles to the endeavour to compare the public and private in this respect, such as the understanding of sustainability requirements in their connection to the subject matter of a contract,9 the authors believe that there is a relevance in this exercise and that the results have the potential to improve the practice by pinpointing the areas where the two spheres can learn from each other and understand the legal theory behind sustainable procurement. the paper thus focuses on the question whether pursuing sustainability goals through procurement is a right or an obligation of public and private organisations and whether there are any risks of liability associated with pursuing or ignoring sustainability goals. in order to answer these questions, the paper firstly analyses the concept of sustainability with the purpose to identify whether the concept is understood similarly or differently in both public and private spheres (1.1). secondly, sustainability requirements in public and private contracts are examined from the perspective of their scope and topics that they cover (2.1). further, the paper analyses whether sustainability requirements are connected to the subject matter of a contract and what this actually means (2.2), and identifies where in the procurement process sustainability requirements come into play (2.3). the paper, then shifts the focus to analyse the character of the right and/or obligation to include sustainability criteria into procurement processes (3.2). in order to give a better understanding, it firstly discusses the drivers and legal frameworks of using sustainability requirements in public and private procurement spheres (3.1). the last section concludes the paper, by identifying the similarities and differences between the spheres, and shares some recommendations. 7 for a discussion on how public procurement can benefit from the private sphere see anna beckers, ‘using contracts to further sustainability?’ in anja wiesbrock and beate sjåfjell, sustainable public procurement under eu law (cambridge university press 2015). for comparison in the us context, see sarah e light and eric w orts, ‘parallels in public and private environmental governance’ (2015) 5 michigan journal of environmental and administrative law 1, namely at 46-50. 8 iso 20400:2017, sustainable procurement – guidance < www.iso.org/standard /63026.html> accessed 17 may 2017. 9 see section 2.2 below. njcl 2017/1 61 1.1. the sustainability concept in private and public procurement while omnipresent in the public and legal discourse, the concept of sustainability does not have a globally accepted legal definition. national legal systems are not better either; since they have a difficulty delineating the confines of the concept, they often provide either multiple definitions or no definition at all. the concept of sustainability is a sister to the concept of sustainable development. the most cited definition of sustainable development comes from the brundtland commission as a development ‘that (…) meets the needs of the present without compromising the ability of future generations to meet their own needs.’10 the core idea of this definition lies in integrating three areas of development: environmental, social and economic. despite the further evolution of the sustainability concept,11 it is the triple-bottom line definition that has inspired a wide range of national, international and supranational legal instruments as well as private-made law. for example, article 3(3) of the treaty on european union (teu) reads as follows: ‘it [the union] shall work for the sustainable development of europe based on balanced economic growth and price stability, a highly competitive social market economy, aiming at full employment and social progress, and a high level of protection and improvement of the quality of the environment.’12 the obligation of the eu to aim for sustainable development is further underlined, in the europe 2020 strategy for sustainable and inclusive growth, which aims to develop an economy based on knowledge and innovation, to promote a low-carbon, resource-efficient and competitive economy, and to foster a high-employment economy delivering social and territorial cohesion.13 according to the commission, public procurement plays a key role in the europe 2020 strategy, as it is one of the market-based instruments for the realisation of smart, 10 un, report of the world commission on environment and development: our common future, 20 march 1997, transmitted to the ga as an annex to document a/42/427 development and international cooperation: environment, para 27. 11 a major contribution in this respect is the development of the ‘planetary boundaries’ concept, see johan rockström et al., ‘planetary boundaries: exploring the safe operating space for humanity’, (2009) 14 ecology and society 32; and will stephen et al., ‘planetary boundaries: guiding human development on a changing planet’ (2015) 347(6223) science. 12 consolidated version of the treaty on european union (teu) [2016] oj c 202/13 (emphasis added). see also the charter of fundamental rights of the european union [2012] oj c 326/391, preamble (‘[the union] seeks to promote balanced and sustainable development …’ , emphasis added) and art. 37 (‘a high level of environmental protection and the improvement of the quality of the environment must be integrated into the policies of the union and ensured in accordance with the principle of sustainable development’, emphasis added). 13 european commission europe 2020 on a strategy for smart, sustainable and inclusive growth, brussels, com (2010) 2020 final. sustainability requirements in eu procurement 62 sustainable and inclusive growth while ensuring the most efficient use of public funds. reference? the preamble to the directive 2014/24/eu on public procurement (hereinafter the public sector directive) states that ‘[t]his directive clarifies how the contracting authorities can contribute to the protection of the environment and the promotion of sustainable development, whilst ensuring that they can obtain the best value for money for their contracts.’14 consequently, it can be argued that governments can and are encouraged to do business responsibly, take a leadership position in community and consider sustainable issues relevant to its own business operations (including those of its supply networks), and be transparent about their actions in these areas. it is not only public entities that are encouraged to align their purchasing decisions with the sustainability concept. private actors, and especially companies are in fact expected to do the same. in the private sphere, we will more often hear about the concept of csr rather than sustainability.15 csr usually refers to conducting business in such a manner where environmental and social interests are protected without undermining the economic prosperity of a company.16 despite having independent origins, the concepts of sustainability and csr have a close connection.17 they are both based on the triple-bottom line balancing economic, social and environmental interests, though at different levels. csr is focused on individual business units, approaching the issue from a microeconomic perspective and, thus, constituting one aspect of sustainable development that takes the macroeconomic point of view. inclusion of sustainability requirements in suppliers’ selection and commercial contracts became one of the wide-spread csr tools.18 under the pressure of public policies and increasing legal regulation (through both hard and soft law, international and national law, and public 14 directive 2014/24/eu on public procurement, oj 2014 l 94/65 [hereinafter public sector directive], recital 91. 15 other concepts have developed that comprise the same or similar business activities/strategy, e.g. corporate citizenship or business ethics. 16 archie b carroll, ‘corporate social responsibility evolution of a definitional construct’ (1999) 38 business & society 268 (describing the development of the definition of csr). 17 their mutual relationship is the subject of a separate academic discussion with no clear conclusion. for a list of academic articles on the relationship between sustainable development and csr (until 2006) see daniela ebner and rupert j baumgartner, ‘the relationship between sustainable development and corporate social responsibility’ (2006), conference paper presented at the corporate responsibility research conference 2006, 4th-5th september, dublin, table 2: overview of reviewed articles, 10-11. <http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.485.5912&rep=rep1&typ e=pdf >accessed 26 april 2017. 18 mitkidis, supra note 5, at 13-14. njcl 2017/1 63 and private regulation) organisations are expected19 to make sure that not only they alone conduct business in a sustainable manner, but so do all their business partners, including suppliers and sub-suppliers. that is why private companies are concerned with traditionally public interests, such as labour issues, human rights, environmental protection or anti-bribery activities, and include relevant requirements in their procurement processes and business agreements, and why public procurers do the same in procurement processes concerning contracts which are preliminary commercial ones and as such they are meant to achieve the best value for money.20 2. sustainability requirements in public and private contracts 2.1. scope – coverage – topics the topics that are covered within both contexts are similar: labour issues (such as minimum wage and occupational health and safety), human rights protection (such as ban of child and forced labour and freedom of association), environmental protection (such as limitation of water use and the ‘ecologic’ origin) and business ethics issues (such as bribery, fair trade labels and conflict of interest). while the catalogue of the covered issues is basically the same within the public and private spheres, the different topics were introduced in the two spheres under varying imperatives and motivations.21 in the public sphere, eu law sets out minimum harmonised public procurement rules to create a level playing field for all businesses across europe. the application of the principles of the internal market (in particular the transparency, equality and open competition) to public contracts ensures better allocation of economic resources and more rational use of public funds. therefore, it can be noted that public procurement has a strong emphasis on economic benefits for the public budget, awarding contracts based on the highest available quality at the best price under the broadest possible competition. however, public 19 the word ‘expected’ is preferred here as a neutral term not implying a legal obligation. that is because a fierce discussion has divided both public and academia into proponents of voluntary and mandatory character of csr, see supra note 6. 20 public procurement origins may be accounted to governments’ provision of goods and services in their public dominium and as such, it supplements the role of a government as a protector of public interest. however, with the development of governments’ participation in commercial markets as buyers; the privatization of governmental services and the increased role of outsourcing as well as the establishment of international trade (particularly eu internal market), public procurement is seen as commercial contracting. nevertheless, it is impossible for governments to renounce their obligation to protect public interests. consequently, the sustainability agenda in public contracting is given an increased attention over the last decade. 21 the motivations are further analysed in section 3.1. sustainability requirements in eu procurement 64 procurement at the national level has throughout history been consistently used as a policy tool for different purposes, such as achieving equal pay for men and women or fighting unemployment.22 for a long time, there was no special label associated with the use of public procurement for achieving broader policy goals. when public entities started to consider environmental protection in their purchasing, the concept of green procurement was born and it then paved the way for a more comprehensive concept of sustainable procurement that we see nowadays. in brief, we may say that public procurement may be used to support and implement wider policy goals – often referred to as horizontal policies – and to lead by example.23 it is possible to identify a wide range of contractual clauses which encapsulate the sustainable approach for example an anti-corruption clause: the contractor undertakes in the fulfilment of the contract to refrain from bribe or otherwise improperly influence government officials, courts and / or private parties. the contractor must also undertake to promptly and fairly inform the client of all circumstances and relationships which may appear as a conflict of interests.24 a work conditions clause: the contractor must ensure that the employees of the contractor and any subcontractors in denmark that helps to fulfil the contract, are guaranteed salaries (including benefits), working hours and other working conditions, which are not less favourable than those established for work of the same kind under the union’s collaborative agreements in denmark, and which are applied throughout danish territory. the contractor must ensure that the employees of the contractor and any subcontractors inform employees about the labour conditions.25 sustainable procurement is understood very broadly and may cover not only all the issues noted above (environmental, human and labour rights, business ethics), but also issues of promotion of innovation or smes (small and medium enterprises). in comparison, private procurement has traditionally been tied to the protection of contractual parties’ business interests. companies started to insert the various sustainability issues into business contracts as a response 22 christopher mccrudden, buying social justice: equality, government procurement and legal change (oxford university press, 2007) 37-48; for historical development see christopher mccrudden, ‘using public procurement to achieve social outcomes’ 28 natural resources forum 257-267. 23 mccrudden, supra note 5, at 94; sue arrowsmith, ‘a taxonomy of horizontal policies in public procurement’ in sue arrowsmith and peter kunzlik (eds), social and environmental policies in ec procurement law: new directives and new directions (cambridge: cambridge university press, 2009) 108–46. 24 ski’s (danish central purchasing body’s) clause from the annex on csr applicable to all their public procurements. <http://csr-indkob.dk/wp-content/uploads/2013/06 /bilag-h-csr.pdf> accessed 26 april 2017 (authors’ translation). 25 ibid. njcl 2017/1 65 to stakeholders’ pressure instigated by the attention of the media and the public to ethical issues in business conduct. that is why the visible problems – such as child labour or local pollution came into focus first, while the attention to invisible, abstract problems – such as co2 – has been picked up slower, often as a result of a (threat of a) legislative action at the national or international level. an example of a sustainability clause from a private contract can be found on the supplier management portal of deutsche telekom (dt).26 the dt’s corporate social responsibility and anti corruption clause is 1,5 page long, this shows the complexity and importance of the issue to the company.27 the provision requires dt’s suppliers to follow the company’s code of conduct and social charter next to not only applicable law, but also ‘rules’ on ethical behaviour, including those on ‘human rights, environmental protection, sustainable development and bribery’. according to the provision, the company reserves the right to audit the supplier’s and any sub-supplier’s compliance with this provision. if a non-compliance is discovered, the supplier should remedy it within a 30-days timeframe, otherwise the contract may be terminated. this type of relational enforcement – in contrast to enforcement through a legal procedure at a court or an arbitral tribunal is a typical treatment of sustainability issues in supply agreements concluded by european companies.28 2.2. link to the subject-matter of a contract sustainability concerns have found their firm position both in the public and private procurement activities. however, their understandings and related discourses have developed differently in the two contexts. while in the private sphere, sustainability contractual clauses were defined as ‘provisions [in commercial contracts] covering social and environmental obligations that are not directly connected to the subject matter of a specific contract …,’29 the understanding within public procurement is narrower. in fact, contracting authorities may require special conditions – innovation, environmental, social – relating to the performance of a contract, only if these are ‘linked to the subject-matter’ of the contract.30 while the possibility of establishing special conditions for the performance of a public contract under eu procurement regime 26 <www.suppliers.telekom.de/irj/portal/smp/aeb> accessed 26 april 2017. 27 such a long sustainability clause is not common, but also not unusual. the length and specificity of such clauses will depend, among others, on the type of the company, its overall sustainability strategy, the type of contract and the location of the supplier. 28 while sustainability has its place in purchasing contracts across the globe, the practice differ in various geographical regions. for comparison between european and us companies see mitkidis, supra note 5, at 231. 29 ibid, at 75. 30 public sector directive, arts 67(3) and 70. sustainability requirements in eu procurement 66 is not something new – this possibility existed already under directives from 2004 – it is a novelty introduced with the 2014 directives for the requirements for these conditions to be ‘linked to the subject-matter’ of the contract.31 the concept of the ‘link to the subject-matter’ has been developed by the court of justice of the european union (cjeu) in its case law regarding award criteria for public contracts. in the court’s first judgment in this area, the concordia case, where the public entity used environmental considerations, namely the emissions of nitrogen oxide and noise amongst the criteria for the contract award, the cjeu established that: ‘[w]here the contracting authority decides to award a contract … it may take criteria relating to the preservation of the environment into consideration, provided that they are linked to the subject-matter of the contract ….’32 these criteria also need to not confer an unrestricted freedom of choice on the public entity; be explicitly mentioned in the contract notice or tender documents; and comply with the fundamental treaty principles, in particular non-discrimination.33 further case law development in this area included the challenge of the awarding criteria when public entity had allocated 45 per cent of the award for bidders' ability to produce renewable electricity in amounts which exceeded the volume required under the contract (evn and wienstrom case).34 the cjeu ruled that the focus on capacities of electricity which exceeded the public entity’s requirements doomed the criterion to not be linked to the subject matter of the contract. the concept of the ‘link to the subject-matter’ in public procurement has been subject to criticism, as it practically disables an effective pursuance of the sustainability goals.35 that is due to the fact that the requirement makes it impossible to include general csr policies to the extent that these address matters beyond the specific needs of the public entity. what it means in practice? it seems that a requirement for a contractor to invest in the local community outside of the specific contract might not be contested on this basis.36 however, contract performance clause directly linked to the activities carried out under the contract, such 31 see directive 2004/18/ec on the coordination of procedures for the award of public works contracts, public supply contracts and public service contracts, oj 2004 l 134/114, art 26, and directive 2004/17/ec coordinating the procurement procedures of entities operating in the water, energy, transport and postal services sectors, oj 2004 l 134/1, art 38. 32 case c-513/99 concordia bus finland [2002] ecr i-3609, para 64. 33 ibid. 34 case c-448/01 evn and wienstrom [2003] ecr i-14527. 35 abby semple, ‘the link to the subject matter: a glass ceiling for sustainable public contracts?’ in beate sjåfjell and anja wiesbrock (eds), sustainable public procurement under eu law new perspectives on the state as stakeholder (cambridge university press 2016) chapter 3. 36 abby semple, a practical guide to public procurement (oxford university press 2015) 197204. njcl 2017/1 67 as obtaining a recycling rate over x per cent of materials disposed during building works; powering a festival only with renewable energy; releasing in open source whatever intellectual property was developed in the contract development, shall be permissible.37 it is worth noting that the understanding of the ‘link to the subject matter’ concept has expanded systematically from its establishment in the concordia case. during the time of redrafting procurement directives, cjeu dealt with the milestone dutch coffee case.38 the public entity wanted to include award criteria for a supply contract of tea and coffee vending machines to relate to their organic and fair trade character. in its ruling cjeu confirmed that non-economic criteria which relate to a particular means of production (e.g. organic character) or distribution (e.g. fair trade labels) could be considered to be linked to the subject-matter of a contract.39 in this judgment cjeu expanded the concept of ‘link to subjectmatter’ of a contract by underlining that there was no requirement for award criteria to relate to a core characteristic of a product or something which alters its material substance. the newest developments in this area come from the 2014 public sector directive, where, among other things, a definition of the concept can be found which nota bene has been influenced by the dutch coffee case. accordingly, to article 67: award criteria shall be considered to be linked to the subject-matter of the public contract where they relate to the works, supplies or services to be provided under that contract in any respect and at any stage of their life cycle, including factors involved in: a) the specific process of production, provision or trading of those works, supplies or services; or b) a specific process for another stage of their life cycle, even where such factors do not form part of their material substance it is important to read article 67 in combination with recital 97 of the public sector directive, which includes certain limitations: [t]he condition of a link with the subject-matter of the contract excludes criteria and conditions relating to general corporate policy, which cannot be considered as a factor characterising the specific process of production or provision of the purchased works, supplies or services. contracting authorities should hence not be allowed to require tenderers to have a certain corporate social or environmental responsibility policy in place. consequently, combined article 67 and recital 97 emphasise that matters considered a public procurement process, and subsequently the contract, must relate to the goods, services or works that are being 37 public contracts regulations (2015) commentary, regulation 70 – conditions for performance of contracts, <http://pcr2015.uk/regulations/regulation-70-conditionsfor-performance-of-contracts/> accessed 26 april 2017. 38 case c-368/10 commission v. kingdom of the netherlands [2012] ecr i-284. 39 ibid, paras 89–92. sustainability requirements in eu procurement 68 purchased, and cannot concern matters, which fall outside of the scope of procurement relationship and the public contract itself. the discourse on the link to or disjunction of sustainability requirements from the subject matter of a contract in the private sphere takes a substantially different starting point – the principle of freedom of contract. private parties are in general not limited in what they can include in their commercial contracts.40 including sustainability provisions, dealing with environmental, human rights, labour or bribery issues, is thus from a contract law perspective not anyhow restricted. however, this does not mean that they will all be enforceable under national and/or international law of contracts. their enforceability will largely depend on the level these requirements are connected to the subject matter of a contract. if they do not expressly specify the quantity, tangible quality, or manufacturing procedure for the product in question, the enforcement of the provisions via traditional remedies, i.e. specific performance41 and damages,42 is hindered.43 legal scholars have noted that commercial contracts contain a growing amount of sustainability provisions that are disconnected from the contract’s subject matter44 and that their aim is rather regulatory than contractual.45 this has led to increased focus on such provisions, as their characteristics have been raising many questions both from contract law theory and practice, and eventually distinguishing those as ‘sustainability contractual clauses’.46 this being said, not all sustainability requirements in commercial contracts are disconnected from the contract’s subject matter. for example, there are provisions that require compliance with a specific production process in order for the delivered goods to be marketed under a specific label (e.g. fair trade) or specific reporting and other obligations to be sold on the eu market (e.g. the reach 40 subject to relatively few mandatory provisions. this is not the same in respect to consumer contracts, where more limitations exist. 41 ingeborg schwenzer and benjamin leisinger, ‘ethical values and international sales contracts’, in ross cranston, jan ramber and jacob ziegel (eds), commercial law challenges in the 21st century: jan hellmer in memoriam, (stockholm centre for commercial law, juridiska instituionem 2007) 265. 42 peter schlechtriem, ‘non-material damages – recovery under the cisg?’ (2007) 19 pace international law review 89; mitkidis, supra note 5, at 226-230. 43 eva kocher, ‘private standards between soft law and hard law: the german case’ (2002) 18 international journal of comparative labour law and industrial relations 265, 270 (pointing out that the courts have been reluctant to recognize csr production methodrelated requirements as product characteristics in consumer cases, and it can be expected that the same would happen in business cases as well). 44 lin, supra note 5, at 717; fabrizio cafaggi, ‘transnational private regulation and the production of global public goods and private “bads”’ (2012) 23 ejil 695, 711. 45 caffagi, supra note 5, at 2. 46 poncibò, supra note 5, at 345; mitkidis, supra note 5. njcl 2017/1 69 regulation).47 in these cases, non-compliance with the sustainability criteria would affect the further marketing of the goods and would result in goods’ non-conformity, thus they would have to be considered directly linked to the subject matter of the contract. to reconcile the position of public and private procurement to ‘the link to the subject-matter’ issue, we may conclude that the two spheres are possibly closer than it seems on the first look.48 on the one hand, the definition of sustainability contractual clauses as disconnected from the subject matter of a contract in the private procurement sphere is used only to enable discourse over the issues arising when we experience such disjunction, however, it is not a term coming from legislation. in practice, we experience an increasing amount of sustainability requirements in commercial contracts that are both connected and disconnected from the subject matter of a contract, each bringing a set of legal challenges, some specific to one of the categories, some common to all sustainability requirements. on the other hand, the concept of ‘the link to the subjectmatter’ in the public procurement sphere has been expanding to include e.g. requirements related to the production processes, thus requirements that do not stipulate material qualities of the purchased goods. in sum, we experience convergence between the types of sustainability requirements that can and are included in private and public contracts. 2.3. procurement process when speaking about sustainability considerations in procurement processes, we certainly do not speak only about contractual clauses. such considerations may appear in all four phases of the procurement process: the pre-engagement phase, where the organisation defines and specifies what it requires to satisfy its needs (in public procurement that is the pretender stage while in private sphere this can be described as the ‘planning phase’);49 the acquiring phase (in public context, in majority of cases, a competitive tender process; in private context the contract negotiation or pre-contractual phase); the contract execution (concluding/signing the actual contract); and contract implementation (contractual parties carrying out their obligations under the contract).50 all phases are present in respect 47 regulation (ec) no 1907/2006 concerning the registration, evaluation, authorisation and restriction of chemicals (reach) oj 2006 l 396/1. 48 beckers, supra note 7, at 213. 49 the ‘planning phase’ is here understood as company’s identification of its needs and process of specifying of what and how is going to be purchased (formulating the corporate procurement strategy). 50 the iso20400 sustainable procurement guidance works with four different stages: planning (art 7.2); integrating key elements of sustainable procurement (art 7.3); selecting suppliers (art 7.4) and managing the contract (art 7.5). it does divide what we call the preengagement (planning) phase in two, while it does not distinguish contract execution as a separate phase. see also the chartered institute of purchasing & supply (cips), ethical sustainability requirements in eu procurement 70 to every contract. however, the attention to sustainability requirements differs through all of them depending on whether we are talking about public or private contexts. while in the public procurement law, major focus is given to the tender process, in the private contract law, it is the contract execution and implementation that is the centre of attention. in the public context, the public sector directive provides several opportunities to include sustainable considerations throughout the procurement process. these factors may firstly be considered when specifying the terms and conditions for participation in a public tender. at this qualification stage, bidders may be excluded from participation in a procurement procedure where it can be demonstrated by any appropriate means that a violation of applicable obligations referred to in article 18(2) of the public sector directive occurred. article 18(2) refers to obligations in the fields of environmental, social and labour law established by union law, national law, collective agreements or by the international environmental, social and labour law provisions listed in annex x to the directive.51 the question is whether establishment of such terms is not superfluous. a contracting authority may be unable, on the basis of national laws, to award a contract to a company that is in a breach of laws in the first place. it could potentially deem the contract unlawful irrespective of the fact if compliance with specific laws is included or not in a tender as minimum standard for participation in the public tender. consequently, it may be the case of reinforcing obligations which already rest on the contractor. another option is to include as terms or conditions of participation requirements a higher than the minimum legal standard, such as the obligation to ensure liveable wages or the demand of employment of at least one third of the company’s capacity by rehabilitated convicts. of course, all of these terms and conditions must be ‘linked to subject-matter’ of the contract; therefore requiring general csr policies is not permitted. in addition, an establishment of too narrow terms for participation in a tender may hinder competition. consequently, it is advisable to rather implement these elements in the form of a contract performance clause rather than limiting the access to public procurement. secondly, sustainability may be implemented in tender specifications by using functional characterisation of what is needed, leaving an open door for tenderers to propose new innovative, ‘green’, socially responsible solutions to the public entity’s needs. a practical example may be a functional description stating that a solution is needed to connect point a with point b, without specifying if that shall be a bridge or a tunnel or a ferry connection. it is left for the contractors to define which of the aforementioned solutions, under the specific circumstances of the and sustainable procurement report, 2013, <www.cips.org/documents /about%20cips/cips_ethics_guide_web.pdf> accessed 12 august 2017. 51 art 18.2 is also referred to as a basis for refusal of awarding a contract to a bidder who is found to be in violation of before mentioned provisions. njcl 2017/1 71 contract, will represent the best quality-price ratio. another example may be the requirement that products are produced using recyclable materials. thirdly, sustainable factors may be defined as a part of the most economically advantageous tender (meat) award criteria, where they would be weighted in addition to the price offered.52 a further approach to the award criteria may include the application of life cycle costing to determine the total cost for purchase, operation, maintenance and finally disposal of a good/ termination of a service.53 lastly, it is possible to consider sustainability in the contract performance clauses discussed in the previous section. however, the only sustainability related mandatory provision in public sector directive regards public entity obligation to reject an abnormally low tender, where it has been established that the tender is abnormally low because it does not comply with applicable obligations referred to in article 18(2). similarly, in the private contract law context, sustainability considerations have been spotted and analysed in the different stages of the contractual process. it is not uncommon that sustainability requirements are present in the pre-contractual phase, as a part of potential suppliers’ screening criteria or as a request to potential suppliers to sign a type of code of conduct.54 this can be connected with the requirement imposed on businesses by various soft law instruments to conduct due diligence and mitigate any negative impacts in respect to sustainability issues as soon as possible. for example, the un guiding principles state that: ‘human rights due diligence should be initiated as early as possible in the development of a new activity or relationship, given that human rights risks can be increased or mitigated already at the stage of structuring contracts or other agreements (…).’55 52 public sector directive, article 67. 53 public sector directive, article 68; dacian c dragos and bogdana neamtu, ‘life-cycle costing for sustainable public procurement in the european union’ in beate sjåfjell and anja wiesbrock (eds), sustainable public procurement under eu law new perspectives on the state as stakeholder (cambridge university press 2016). 54 an empirical study of 56 multinational companies seated in the usa and europe has found that about one fourth of the studied companies required their suppliers to commit to sustainability requirements in writing prior to entering into an actual supply agreement, see mitkidis, supra note 5, at 154-155. 55 human rights council, report of the special representative of the secretary general on the issue of human rights and transnational corporations and other business enterprises, john ruggie: guiding principles on business and human rights: implementing the united nations “protect, respect and remedy” framework, u.n. doc. a/hrc/17/31, 21 march 2011 (hereinafter ‘guiding principles’), para 17; oecd guidelines on multinational enterprises, 2011 edition, commentary on general policies, para 17. it is worth noting that the guiding principles are also applicable to public procurement. they affirm that the “state duty to protect” human rights extends to business-related human rights abuses. guiding principles 5 and 6 clarify that this duty sustainability requirements in eu procurement 72 however, the legal effects of such pre-contractual requirements, actions and statements may vary according to the governing law of the final contract. while in civil law jurisdictions, the pre-contractual phase plays an important role in a case of any dispute between the parties helping to establish the intent in respect to the contractual content, in common law countries the parol evidence rule as a starting point precludes relying on pre-contractual negotiations and dealings when establishing the content of a contract.56 this is possibly a determining factor for the empirical observation that written documents on sustainability considerations appear in the pre-contractual phase more often in the european than in the us context.57 when supply agreements are executed between european companies and their suppliers, in the majority of the cases sustainability provisions are included in the final text of the contract. a study conducted in 2010 by the pace university and the international association for contract and commercial management reported that almost 80 per cent of the investigated companies stated that they had previously imposed sustainability related requirements upon their business partners.58 however, sustainability provisions differ significantly in respect to their inclusion in the contractual text (express provisions, incorporation by reference to codes of conduct or soft law instruments), topics they cover (social, environmental, ethical) and the level of their specificity (vague or specific language). these differences translate into different legal effects and possible risks. for example, it is easier to establish that an express provision forms an integral part of a contract then if a requirement is incorporated by a reference to another document, since such a reference must fulfil some additional formal requirements.59 the contract implementation phase is probably the most important, but also the most problematic for all parties involved. companies extends to situations where governments enter into commercial relationships, including through public procurement. 56 ucc § 2-202 (amended 2002); restatement (second) of contracts § 213 (1981). the parol evidence rule is however not applied in a consistent manner throughout the usa, but differences exist among the states. for an overview of these differences, see a schwartz and re scott, ‘contract interpretation redux’ (2010) 119 y. l. j. 926. 57 mitkidis, supra note 5, at 155. 58 pace university school of law and iaccm, 2010, the triple bottom line: the use of sustainability and stabilization clauses in international contracts, available at <www.iaccm.com> for the association’s members (nb the results are based on a survey conducted with companies representing various industries from north america, middle east, africa, europe, asia and pacific and include all areas of csr). 59 for example, according to the proposal for a regulation of the european parliament and of the council on a common european sales law, 11.10.2011, com (2011) 635 final (cesl), art 70(1) the obliged contractual party must be ‘aware of them’, or the party supplying them must take ‘reasonable steps to draw the other party's attention to them, before or when the contract was concluded.’ njcl 2017/1 73 imposing sustainability requirements on their suppliers have to choose whether and how to enforce them. suppliers have to choose whether to comply or not. and third parties, which are often the subjects protected by the provisions, may consider enforcing these provisions based on various legal standings, such as third party beneficiaries or false advertising claims.60 the public contract implementation phase has been identified as the one which needs much more attention than it has been given over the years. that is due to the fact that while sustainability criteria find their way into public contracts, they are often not (similarly in respect to private contracts) properly enforced. therefore, the inclusion of sustainability terms and conditions in public procurement gained an infamous name, ‘a ticking box process’,61 where there is no follow up upon compliance with them in the contract implementation phase. 3. rights or obligations? before discussing whether the inclusion of sustainability criteria into public and private procurement processes is a legal right and/or obligation, the drivers for doing so are introduced in section 3.1. this drivers’ introduction provides a background for the understanding of the relevant legal regulation or a lack thereof. 3.1. drivers of inclusion of sustainability issues into procurement processes public procurement in itself is a complex system of activities that lead to the purchase of works, services and goods. to be able to conduct a good procurement, not only a legal provisions have to be adhered to but also a sound business decision needs to be made, while at the same time the governmental policy pressures, such as sustainability agenda, need to be considered. further, focusing solely on the legal setting of public procurement, it needs to be underlined how complex it is. the governing setting is shaped by international law, eu law, national laws, governmental policies as well as choices and practices of individual contracting authorities. on the one hand, public procurement is preliminarily set on economic premises and as such is referred to in national financial acts.62 emphasis is given to efficient spending of tax payers' money through the achievement of value for money in public contracting. at the eu level, 60 beckers, supra note 5, chapters 3-5. 61see: mark plant, ‘iso 14001 an end to box ticking culture for sustainable procurement or just more red tape’ (ecodesk, 14 may 2014) <www.ecodesk.com/media /blog/2014/05/19/iso14001-an-end-to-box-ticking-culture-for-sustainableprocurement-or-just-more-red-tape> accessed 1 september 2017. 62 see e.g. the financial management and accountability act 1997 no. 154, 1997 as amended (australia). sustainability requirements in eu procurement 74 the total public expenditure in procurement amounts to 2.400 billion euro, which accounts to 19.7 per cent of the yearly gdp of the union.63 the high value of public procurement is a reason for economic interest in it at the eu level. therefore, the main purpose of establishing eu procurement law is to support the eu internal market and hence the facilitation of an open competition, transparency and non-discrimination. on the other hand, public procurement carries a delivery of governmental administrative tasks which includes to a certain degree the protection of public interest.64 as it was indicated in the previous sections, public procurement has been used for decades as a tool to deliver governmental policies at the national level. similarly, at the eu level, the sustainable agenda in public procurement gained wider recognition as a part of further eu development, and as such it was identified by the european commission as a strategic instrument to achieve the eu’s objective of a smart, sustainable and inclusive growth.65 this led to the modernisation of the eu procurement regime in 2014 with new directives providing for a broader than ever before sustainable procurement toolbox. both the european and national agendas are underlining the need to strike a balance between an efficient spend of public money and environmental protection and social developments.66 it is commonly acknowledged that for the eu’s economies to bounce back from the financial crisis, new innovative and cost efficient solutions for spending public money have to be established, jobs need to be created and climate change has to be addressed. furthermore, motivations for the inclusion of sustainability considerations into public procurement processes sprung not only from governmental policies but time and time again it has been shown that sustainable procurement is actually a good business where saving can be achieved, for example on the basis of considering life cycle costs of goods and services. 63 european commission, public procurement indicators 2010, 4 november 2011. 64 the subject matter of public procurement includes amongst others high value and high public importance tasks such as services in regards to welfare and health, water and energy, municipal waste and/or infrastructure. 65 communication from commission, europe 2020: a strategy for smart, sustainable and inclusive growth, com (2010) 2010 final. 66 united nations environment programme (unep), sustainable consumption and production branch (2012) <www.unep.fr/scp/procurement/whatisspp/> accessed 26 april 2017; european commission, sustainable public procurement <http://ec.europa.eu/environment/gpp/glossary_en.htm> accessed 26 april 2017; ga a/68/970, report of the open working group of the general assembly on sustainable development goals, 12 august 2014; defra, procuring the future: sustainable procurement national action plan: recommendations from the sustainable procurement task force (defra 2006), at 10; european commission, buying social: a guide to taking account of social considerations in public procurement, ip/11/105, 28 january 2011. njcl 2017/1 75 some of the drivers for the inclusion of sustainability concerns into public procurement processes are observed also in respect to private procurement. first of all, the eu’s policies not only drive the actions of the eu, but also of the business sector. policies can be turned into laws (both hard and soft). such a threat of future regulation together with existing national, eu and international law, or a lack thereof, can be subsumed under the headline of regulatory drivers.67 from existing regulation, we may note the csr reporting directive, under which large companies are expected to report annually on their csr performance.68 while the directive does not specifically ask the companies to report on the inclusion of sustainability criteria into their procurement processes, it is one aspect that companies regularly report on. an example of driving sustainability conduct through a lack of regulation can be any area that is regulated by international law, such as the ban of child labour, which is not fully implemented and/or enforced by states on the one hand and does not bind private parties operating across borders on the other.69 in fact, this is the situation in the most discussed csr areas such as human rights or bribery. in regard to expectation of new regulation, carbon labelling has been perceived by some companies as a driver for implementing demands for reduction and/or reporting of co2 emissions levels by their suppliers.70 however, laws and regulation can also be felt as a barrier to private sustainable procurement. especially, the tension between corporate supply chain sustainability policies and free trade provisions is often highlighted.71 as in the case of public procurement, cost saving is seen as an important driver for sustainable private procurement. it has been argued and observed that by successful implementation of sustainability criteria into procurement processes, companies may achieve cost savings in respect to operational and material flows.72 another resources related driver concerns companies’ reputation. by implementing sustainability 67 andrew j hoffman, competitive environmental strategy: a guide to the changing business landscape (island press 2000) part ii, chapter 2. 68 directive 2013/34/eu on the annual financial statements, consolidated financial statements and related reports of certain types of undertakings, oj 2014 l182/19 (directive 2013/34/eu), art 19a. 69 this has been described as ‘regulatory gaps’ or ‘governance deficit’, see e.g. peter newell, ‘managing multinationals: the governance of investment for the environment’ (2001) 13 journal of international development 907, 908. 70 olga chkanikova and oksana mont, ‘corporate supply chain responsibility: drivers and barriers for sustainable food retailing’ (2015) 22 corporate social responsibility and environmental management 65, 76. 71 see the contribution of carola glinski in this issue. see also united nations environment programme and the world trade organisation, report: trade and climate change, 2009, 99; mark a cohen and michael p vandenbergh, ‘the potential role of carbon labelling in a green economy (2012) 34 energy economics s53, s59-s60. 72 chkanikova and mont, supra note 70, at 76. sustainability requirements in eu procurement 76 requirements into procurement processes and reporting on the same, companies are boosting their image as ethical and sustainable companies.73 as such, private companies may become more competitive on both private and public markets. sustainable procurement may thus both save costs and escalate incomes of companies. market drivers are then often cited as the most urgent ones for the inclusion of sustainability concerns into private procurement processes. they include customers’ and peer pressure. firstly, there is a presumption among businesses that consumers demand sustainable behaviour in the production chain and will punish the companies if they find otherwise, e.g. by boycotting their products. in order to satisfy this demand, companies often seek to attach a specific sustainability label to their products.74 in order to ensure that the products fulfil the requirements set by the specific labelling scheme, companies must pass appropriate requirements on their suppliers and this most often happens within procurement processes.75 secondly, customers' sustainability policies may be seen as another driver. if a company is a tier of another company’s supply chain, it can be expected that it will be asked not only to act responsibly itself, but also to pass the requirements on its own suppliers.76 quite naturally then, public sustainable procurement is a driver for implementing sustainable concerns within private spheres. if a company has the ambition to become a contractor to a public entity, it (and arguably its sub-suppliers) must live up to the requirements imposed by the public institution within the public procurement process. finally, sustainability requirements come into private procurement processes under the peer pressure. csr as competitive advantage or otherwise referred to as ‘strategic csr’ has been widely discussed by academia and practitioners.77 peer pressure can however materialise not only through the effort of getting a competitive advantage, but also through regulatory efforts at the industrial level. various industry self-regulatory initiatives, such as the bangladesh accord,78 expect the participating companies to consider sustainability issues throughout their procurement processes. while such industrial regulation is based on a voluntary basis, participation is often a precondition for membership in an industrial or relevant business association. the final set of drivers for the inclusion of sustainability concerns into both public and private procurement processes, can be labelled as 73 mark rowe, ‘reputation, relationships and risk: a csr primer for ethics officers’ (2006) 111 business and society review 441. 74 e.g. fair trade label or ecologic origin label. 75 cafaggi, supra note 5, at 1561. 76 iaccm, supra note 58. 77 michael e. porter and mark r. kramer, ‘the link between competitive advantage and corporate social responsibility’ (2006) 84 harvard business review 78. 78 the accord on fire and building safety in bangladesh, <http://bangladeshaccord.org> accessed 26 april 2017. njcl 2017/1 77 ‘social drivers’. these might include ngos’ campaigns, media attention (negative publicity) and pressure exerted by science and new knowledge. it is especially the first two that influence the adoption of the sustainable procurement attitude by both sectors. ngos’ campaigns often lead to negative publicity in respect to unethical behaviour within international supply chains.79 by adoption of the sustainability approach in procurement activities, companies and public entities try to protect themselves from such negative attention. 3.2. a right or an obligation to consider sustainability within procurement processes? this part of the article focuses on the regulatory drivers and barriers for the inclusion of sustainability concerns into procurement processes in order to answer two questions: do organisations have the right to include sustainability requirements into their procurement processes? and do they have the obligation to do so? in respect to the first question, the answer in both public and private spheres is a definite ‘yes’. there is no doubt at this point in time that the inclusion of sustainable considerations in public procurement is not only permitted but also highly promoted by numerous wide spread policies and revamped eu procurement directives as well as established cjeu case law.80 consequently, it can be stated that it is a right of contracting authorities – within the limits of the ‘link to subject-matter’ of a contract – to consider sustainability in public procurement.81 similarly, as national 79 danwatch exposed human rights violations and forced labour in it supply chains, at electronics factories that produce servers for brands danish universities (public buyers) most often used see: danwatch & goodelectronics, servants of servers: rights violations and forced labour in the supply chain of ict equipment in european universities (2015), <www.danwatch.dk/en/undersogelse/servants-of-servers/?chapter=1> accessed 1 september 2017; plastic gloves purchased through public procurement in the health-care sector in denmark have been documented to contain rubber from plantations relying on forced labour see: danwatch,<https://www.danwatch.dk/en/undersogelse/har-duhusket-gummiet/> accessed 1 september 2017. 80 beate sjåfjell and anja wiesbrock (eds), sustainable public procurement under eu law new perspectives on the state as stakeholder (cambridge university press 2016); roberto caranta and martin trybus, the law of green and social procurement in europe (djøf 2010); sue arrowsmith, ‘the purpose of the eu procurement directives: ends, means and the implications for national regulatory space for commercial and horizontal procurement policies’ (2012) 14 cambridge yearbook of european legal studies 1; peter kunzlik, ‘neoliberalism and the european public procurement regime’ (2013) 15 cambridge yearbook of european legal studies 283. 81 even though there are opinions that sustainable policies have no place in eu contracts, it could be argued that their numbers are decreasing. for a critique see: albert sánchez graells, ‘truly competitive public procurement as a europe 2020 lever: what role for the principle of competition in moderating horizontal policies?’, uaces 45th annual sustainability requirements in eu procurement 78 and international law of contracts is based on the principle of contractual freedom, private parties may freely (subject to a limited number of mandatory provisions) decide on what they want to include in their contract. and as in the public sphere, considering sustainability issues in commercial contracts is not only allowed, but also advised by various policy and soft law instruments.82 the answer to the second question whether on the basis of existing law organisations are obliged to pursue sustainable objectives within their procurement processes – is not as straightforward and the answer differs for the two spheres. in the context of public procurement, it is necessary to investigate the legal status of sustainability in eu law. in the context of private procurement, the topic relates closely to the voluntary/mandatory basis of csr. the lisbon treaty identifies sustainable development as an overarching objective that shall be applied as a guiding principle for all areas of eu law and policy as well as it establishes a wide understanding of an internal market which is to serve non-economic objectives too.83 both article 3(3) teu as well as the treaty’s preamble express the eu’s and its member states’ determination to pursue sustainable development. even though it is often agreed that article 3 teu is more than a mere policy objective, as well as the fact that there is a growing recognition of sustainable development as a general principle of international law, it would be too farfetched to derive a positive obligation of pursuing sustainability goals in the context of public procurement.84 at this point, it is relevant to distinguish between the legal status of two aspects of sustainable development, namely the social considerations and environmental protection. that is due to the fact that they hold different legal statuses in eu law in general and in the context of public procurement in particular. while environmental considerations are seen as more objective and therefore easier to justify in the context of public procurement, social considerations are seen as a potential smoke screen for preferential treatments of local suppliers. in regard to environmental protection, it can be said that there is a stronger legal bite to it. that is conference, bilbao, spain, september 2015 <http://papers.ssrn.com /sol3/papers.cfm?abstract_id=2638466> accessed 26 april 2017. 82 see for examples infra notes 103-107 and accompanying text. 83 teu, arts 3 and 21; consolidated version of the treaty on the functioning of the european union (tfeu) (2016) oj c 202/47, arts 11 and 191; and charter of fundamental rights of the european union, oj 2016 c 202/389, art 37. 84 important factor is also that the provisions are addressed to the union and not to individual member states. see david grimeau, ‘the integration of environmental concerns into ec policies: a genuine policy development?’ (2000) 9 european envtl. l. rev. 216; christina voigt, ‘article 11 tfeu in the light of the principle of sustainable development in international law’ in beate sjåfjell and anja wiesbrock, the greening of european business under eu law: taking article 11 tfeu seriously (routledge 2015). njcl 2017/1 79 mainly due to the legally binding obligation of article 11 tfeu which states that: ‘environmental protection requirements must be integrated into the definition and implementation of the union’s policies and activities, in particular with a view to promoting sustainable development.’85 nevertheless, there is a significant ambiguity as to the precise scope and effects of the obligations arising from this provision and unfortunately there is no further clarification provided by other provisions in the eu’s treaties or cjeu case law.86 since article 11 tfeu is addressed to the eu institutions, it has been argued that the eu legislator is bound by the obligatory requirements of environmental integration when setting the secondary legislation and policies (including public procurement), while the legal implications for the member states are less explicit.87 the eu legislator already made it obligatory on several occasions to apply green procurement in areas such as the energy and transport sectors.88 similarly at the national level, some member states have made environmental purchasing of specific categories of goods and services (or even all purchases) obligatory for their central governments, but such provisions are generally solely recommendations for local authorities.89 however, it seems doubtful that the eu legislator has to introduce environmental standards as an obligation to all public procurements. this is due to the fact that, firstly, it would not seem in line with the requirement of an integrated approach to the triple bottom line sustainable development. secondly, it would prioritise environmental policy over other facultative policies (social considerations) and procurement principles such as equal treatment and open competition, rather than balancing the various facultative considerations. finally, from a practical perspective, public procurement market significantly differs in its types, sizes and composition and, thus, applying the mandatory approach would be just unfitting and inappropriate in general. wiesbrock argues that article 11 tfeu potentially obliges eu legislators to ensure that contracting authorities in their procurement will not entirely ignore the 85 tfeu, art 11 (emphasis added). 86 anja wiesbrock, ‘an obligation for sustainable procurement? gauging the potential impact of article 11 tfeu on public contracting in the eu’ (2013) 40 legal issues of economic integration 105, 105. 87 ibid, at 109. 88 directive 2006/32/ec on energy end-use efficiency and energy services, oj 2006 l 114/64; regulation (ec) no 106/2008 on a community energy-efficiency labelling programme for office equipment (recast version), oj 2008 l 39/1; directive 2009/28/ec on the promotion of the use of energy from renewable sources, oj 2009 l 140/16; directive 2010/31/eu on the energy performance of buildings, oj 2010 l 153/13; directive 2009/33/ec on the promotion of clean and energy-efficient road transport vehicles, oj 2009 l 120/5. 89 european commission, national gpp action plans (policies and guidelines), <http://ec.europa.eu/environment/gpp/action_plan_en.htm > accessed 26 april 2017. sustainability requirements in eu procurement 80 issues of environmental policy.90 this could be done by applying a general rule requiring contracting authorities to consider environmental factors and if it is decided that they do not have a place in a tender, contracting authority would need to provide an explanation in the tender documents. still, this is not the case under the current status of law, even though the same methodical approach is applied in the context of the division of contracts into lots with the aim to promote the participation of smes at the eu level, or in the context of application of meat at the national level, for example in netherlands.91 in comparison to environmental considerations, social considerations in eu public procurement are often perceived through a negative lens, as a type of considerations that on the one hand are contradictory to the economic objectives of the eu procurement system and smoke screens for preferential treatment, and on the other hand are too burdensome on contracting authorities, limiting their flexibility and requiring a disproportionate amount of resources.92 that can be seen through the fact that out of 253 amendments tabled by the eu parliament, mostly from a social protection angle, the council and the commission rejected the majority of these in the process of modernising the eu procurement directives. consequently, social considerations in eu public procurement are almost fully facultative. article 18(2) of the public sector directive binds member states to ‘take appropriate measures to ensure that in the performance of public contracts economic operators comply with applicable obligations in the fields of environmental, social and labour law established by union law, national law, collective agreements or by the international environmental, social and labour law provisions listed in annex x .’93 even though article 18(2) provides a very general duty, it is a basis for more detailed rules. in regard to the latter, the directive creates a set of facultative options, for example a discretion for a contracting authority to reject a tender which does not comply with laws referred to in article 18(2).94 the solo obligation present in the context of social considerations under the directive that is addressed to contracting authorities is the obligation to reject abnormally low tender, where the low price or cost is due to non-compliance with the laws referred to in article 18(2), and explanation has been sought from the contractor in question.95 two further obligations are addressed to a) member states to ensure that where national law provides for joint liability between main contractors and 90 wiesbrock, supra note 86, at 109. 91 aanbestedingswet 2012, art 2.115. 92 anja wiesbrock, ‘socially responsible public procurement’ in beate sjåfjell and anja wiesbrock (eds), sustainable public procurement under eu law new perspectives on the state as stakeholder (cambridge university press 2016) 91. 93 it is worth noting that the article also includes the environmental protection aspect. 94 public sector directive, art 56(1), but also discretions under art 57(4) and art 71(6)(b). 95 public sector directive, art 69(3). njcl 2017/1 81 subcontractors, the relevant rules are applied in compliance with the laws mentioned in article 18(2);96 and b) a competent national authority to ensure compliance by subcontractors with laws from article18(2).97 as article 18(2) is a vaguely worded provision addressed to member states, it means that progress and enforceability of this provision will depend on the political will and incentives in national implementation.98 in the private sphere, the principle of contractual freedom again dictates the answer, which must instinctively be ‘no’, there is no positive legal obligation requiring companies to include sustainability requirements in their procurement processes. however, the answer is not as simple and obvious as it may seem on the first glance, but follows from the discussion on the nature of csr. csr was traditionally defined as voluntary business measures going beyond law. for example, in its green paper on csr from 2001, the eu stated: ‘most definitions of corporate social responsibility describe it as a concept whereby companies integrate social and environmental concerns in their business operations and in their interaction with their stakeholders on a voluntary basis.’99 this understanding has been increasingly questioned and criticised as being inaccurate and even misleading.100 there are several reasons to support this. firstly, most issues generally subsumed under the csr umbrella, for instance bribery or child labour are already regulated by international law.101 while international law is in general not directly applicable to companies, the rules are simply not new and have been internalised also by the private sphere. as a result, practices such as the use of child labour clearly fall out of what is considered moral behaviour. furthermore, defining csr as voluntary activities beyond law is impractical. it assumes that there is a clear definition of law and that all 96 public sector directive, art 71(6)(a). 97 public sector directive, art 71(1). the competent national authorities may include labour inspection agencies or environment protection agencies. 98 for example, poland, in its transposition of the public sector directive, has obligated its contracting authorities to require from their contractors and subcontractors to conclude employment contracts with the persons involved in the execution of the public contract. the purpose of this is to stop the practice of entering into civil law contracts where the person involved has a less favorable legal status (e.g. due to the lack of entitlement to holiday, lack of protection of wages, liability for compensation etc.). 99 commission of the european communities, green paper: promoting a european framework for corporate social responsibility, 18.7.2001com (2001) 366 final (emphasis added). 100 for early criticism see supra note 6. 101 doreen mcbarnet and marina kurkchiyan, ‘corporate social responsibility through contractual control? global supply chains and ‘other-regulation’’ in mcbarnet, voiculescu and campbell, the new corporate accountability, at 67 (‘as one interviewee put it: ‘99 per cent of our requirements are legal requirements; they are not set by us. they are included in our code, 99 per cent or even 100 per cent of them are legal requirements that should be observed anyway’’). sustainability requirements in eu procurement 82 legal obligations are of a binding nature. that is however not always true. hard law can have soft content and soft law may produce hard obligations.102 there is plenty of soft csr initiatives that may not expressly require companies to include sustainability issues into their contracting practice, but in fact impliedly rely upon the same. for example, while the guiding principles do not mention contractual control as a tool to be used, professor ruggie elaborated on the same in several accompanying documents.103 similarly, the commentary to the oecd guidelines for multinational enterprises state that ‘enterprises can also influence suppliers through contractual arrangements such as management contracts, pre-qualification requirements for potential suppliers.’104 the iso 26000 then works more clearly with contracts as a tool to influence suppliers’ behaviour. it refers to the possibility of a company to decide with whom to conduct business,105 setting sustainability contractual provisions106 and in general integrating ‘ethical, social, environmental and gender equality criteria, and health and safety, in [their] purchasing, distribution and contracting policies and practices to improve consistency with social responsibility objectives.’107 while all these csr related regulations (and those are merely a fragment of all existent ones) are only in the category of soft law, they create a significant pressure on companies to use their procurement processes in the quest for global sustainability. also, while we may discuss whether the substance is voluntary, the operationalisation of csr cannot do without law. companies are in fact obliged by law to implement csr 102 e.g. regulation (ec) no 1221/2009 on the voluntary participation by organisations in a community eco-management and audit scheme (emas), oj 2009 l 342/1 is based only on voluntary participation, while the un global compact <https://www.unglobalcompact.org> accessed 26 april 2017, has aspects of reporting and enforcement that are often perceived by participating companies as ‘hard’. 103 un ga, human rights council, report of the special representative of the secretary-general on the issue of human rights and transnational corporations and other business enterprises, john ruggie: promotion and protection of all human rights, civil, political, economic, socila and cultural rights, including the right to development: clarifying the concepts of “sphere of influence” and “complicity”, u.n. doc. a/hrc/8/16, 15 may 2008; un mandate of the special representative of the secretary-general on human rights and transnational corporations and other business enterprises, the corporate responsibility to respect human rights in supply chains, 10th oecd roundtable on corporate responsibility, discussion paper, 30 june 2010. 104 oecd guidelines for multinational enterprises, 2011 edition, commentary on general policies, para 21. 105 international organisation for certification, iso 26000:2010, guidance on social responsibility (iso 26000), paras 5.2.3 and 6.3.5.2. 106 iso 26000, para 7.3.3.2. 107 iso 26000, para 6.6.6.2. njcl 2017/1 83 into different procedures. csr reporting and obligations in respect to products’ labelling can serve as examples here.108 looking at these legal arguments combined with the factual drivers for csr, it has become simply redundant to discuss the voluntary/mandatory nature of csr. this is also reflected in the change of the eu’s csr definition. in the renewed strategy for csr from 2011 states: ‘the commission puts forward a new definition of csr as “the responsibility of enterprises for their impacts on society”. respect for applicable legislation, and for collective agreements between social partners, is a prerequisite for meeting that responsibility.’109 based on the above, it could be argued that it is a legal right and a morally based obligation to include sustainability requirements into private procurement processes and that the obligation is becoming increasingly legalised despite the principle of contractual freedom that governs the area of law of contracts. 3.3. legal risks associated with inclusion or avoidance of sustainability issues as the previous section indicates, under the current status of eu procurement law and commercial contract law, there is no positive obligation to include sustainability considerations in either public or private procurement processes. therefore, from a legal standpoint there will be no (direct) legal risks associated with the avoidance of such considerations. for example, even though there is a risk of divergent interpretation of what is an ‘appropriate measure’ under article 18(2) of the public sector directive, the legal consequences are unclear. the commission could potentially bring an action against a member state for noncompliance with article 18(2), but it is highly doubtful that a private entity could bring a case against a contracting authority on this basis. it seems that the only door open for a disgruntled contractor – against a contracting authority – that may be associated with sustainable considerations, is in a case of abnormally low tender. that is if the contracting authority will not reject abnormally low tender where the low price or cost is due to noncompliance with the environmental, social and labour law and collective agreements applicable under article 18(2), and explanation has been sought from the contractor in question. under such circumstances, a 108 see directive 2013/34/eu, art 19a; and directive 2010/30/eu on the indication by labelling and standard product information of the consumption of energy and other resources by energy-related products, oj 2010 l 153/1. 109 communication from the commission, a renewed eu strategy 2011-14 for corporate social responsibility, com (2011) 681 final, 3.1. sustainability requirements in eu procurement 84 disgruntled contractor may sue for damages on the basis of the remedies directive.110 companies may then face liability for omitting to include sustainability requirements into their private procurement processes only indirectly. as already mentioned, in order to publicise the adherence to certain sustainability standards, companies attach specific labels to their products (such as a fair trade label) or seek to obtain a relevant certification (such as emas). such labelling and certification schemes require the company to assure that its products are produced in a specific way or that a set of standards are observed by the company and all its suppliers. in order to legally secure compliance with these requirements, companies have to include adequate sustainability requirements into their procurement processes and contracts. if they fail to do so, they might face a liability stemming from the certification agreement.111 similarly, this may happen if a company participates in an industrial association or agreement, such as the bangladesh accord112 or the business social compliance initiative.113 while they do not specifically require the participants to use contracts to further sustainability goals, they speak about procurement processes, and namely about the process of suppliers’ selection. second consideration must be given to legal risks associated with the inclusion of sustainability considerations within procurement processes. while there is a clear right to pursue sustainability goals through procurement, this may expose organisations to multiple legal risks. in the public sector, if a contracting authority exercises its right and includes sustainability considerations at any step throughout public procurement, these considerations will be scrutinise against the ‘link to the subject-matter’ of the contract as discussed in previous sections. if there is any doubt upon their ‘link to subject-matter’, the contractors participating in the tender may challenge the contracting authority based on the remedies directive, which may lead to the cancelation of the procurement process, invalidity of the concluded contract or pay out of damages. another risk that is associated with the inclusion of sustainability considerations relates to limited possibilities of a future contract amendment under the eu public procurement rules. that is not an issue specifically linked to sustainability contractual clauses or considerations, but an issue applicable to a need for substantial changes to the awarded contract in general. for example, a contracting authority may wish to change the contractor to whom a public contract was awarded. this may 110 directive 2007/66/ec amending council directives 89/665/eec and 92/13/eec with regard to improving the effectiveness of review procedures concerning the award of public contracts, oj 2007 l 335/31. 111 cafaggi, supra note 5, at 1601. 112 supra note 78. 113 business social compliance initiative <www.bsci-intl.org> accessed 26 april 2017. njcl 2017/1 85 be due to the fact that the contractor is unreliable and does not respect the sustainability terms and conditions originally agreed on. this can be a problem from a procurement perspective, as the rules may affect the situation again and trigger a requirement for a fresh competition. under the eu procurement law, a substantial change of a contract will as a general rule require its retendering. therefore, any change to already awarded contract, that is a change associated with the inclusion of sustainability contract performance clauses, will need to be scrutinised against article 72 of the public sector directive on contract modifications and concept of substantial change included therein.114 in the private sphere, due to the principle of contractual freedom, there is no direct legal risk associated with the inclusion of sustainability considerations at any point during the procurement process. however, many efforts have been made to establish various types of legal liability, if companies impose sustainability requirements on their suppliers and afterwards do not enforce those or a breach occurs. as will be seen below, although this liability in theory exists, it has only been possible to establish such liability in a very limited number of cases in the eu and worldwide.115 first of all, companies may face liability for false advertisement. in april 2010, the german retailer lidl was taken to court for using the following statement in its advertising: ‘we trade fairly! every product has a story. it is important to us who writes this story. lidl advocates fair working conditions on a global scale. therefore, at lidl, we contract our non-food orders exclusively to selected suppliers and producers that are willing to comply with and can demonstrate their social responsibility (…).’116 while the company indeed imposed sustainability contractual requirements on its suppliers, a number of breaches in the company’s supply chains were disclosed. the case was settled out of court. lidl had to retract the statements from its advertising (which is hardly an adequate sanction and does not solve the issue of unfair working conditions in the retailer’s supply chain).117 in this respect, it will be interesting to see if new disclosure oriented legal requirements imposed by eu law as well as some national laws on certain types of companies in respect to their sustainability related activities in supply chains, such as the non-financial disclosure directive, 114 the definition of what is a substantial modification follows from the pressetext case and is now codified in public sector directive, art 72(4). 115 from the latest cases from outside of eu, see e.g. monica sud v costco wholesale corporation, et al.. original claim <www.cpmlegal.com/media/news/222_ costco%20prawns%20complaint.pdf> accessed 17 april 2017. 116 hamburg consumer protection agency’s case against lidl, <www.ecchr.eu /en/our_work/business-and-human-rights/working-conditions-in-south-asia/ bangladesh-lidl.html> accessed 4 april 2017. 117 for a prominent case from the us jurisdiction on the same, see nike, kasky v. nike, inc., 45 p.3d 243 (cal. 2002) and nike, inc. v. kasky, 539 u.s. 654 (2003). sustainability requirements in eu procurement 86 the dk reporting act or the uk modern slavery act ok, will lead to more litigation. while none of them explicitly prescribe how companies should implement sustainability into their operation, using contracts to further the goals of these legal acts is a natural tool to use. in this regard, some law and consultancy firms warn companies to guard what is exactly disclosed, as this could be picked up by activists and consumers to base their claims on.118 second possibility of legal risks connected with the use of sustainability requirements in private procurement is opening up to third party beneficiaries claims. however, these claims are rarely successful in general, and to the authors’ knowledge there has been no success of such claims in respect to sustainability requirement.119 this limited applicability of third party beneficiaries doctrine stems from the fact that contract law treats a contract as a discreet agreement between the contractual parties and only allows the interference of a third party if it has a strong relation to the contract. while differences exist between jurisdictions, there are features of the third party beneficiaries doctrine that are common to most. the contractual parties must intend to confer a specific right to a third party and such third party must be identified or identifiable.120 although these conditions prove to be difficult to be fulfilled in respect to sustainability requirements,121 companies often take preventive steps and include a nothird-party-beneficiary clause into their contracts.122 another effort to establish legal liability in respect to sustainability requirements tried to use the unilateral contract doctrine. usually, this would come into question where there are no clear sustainability contractual clauses, but a suppliers' code of conduct or a sustainability report covering the issue of a supply chain’s sustainability. third parties, 118 for example, similarly in the us, law firms warn companies in the same way in respect to the california supply chains transparency act. see e.g. squire patton boggs, ‘wakeup call to supply chain managers and compliance officers of companies doing business in the usa’, <www.squirepattonboggs.com/~/media/files/insights/publications /2015/08/significant-conflict-minerals-ruling-and-recent-california-transparency-insupplychains-act/conflict-mineralscalifornia-transparency-act.pdf> accessed 26 april 2017; (stating ‘be careful: all supply chain transparency and ethic sourcing disclosures to the public, to customers, and to suppliers will receive increased scrutiny by ngos, consumers, activists, and plaintiffs’ law firms going forward.’) 119 third party beneficiaries claim was discussed within the us case doe v. wal-mart stores, inc., 572 f.3d 677 (9th cir. 2009). 120 principles of european contract law, art 6:110, and cesl, art 78 (nb cesl proposal has been withdrawn). 121 beckers, supra note 5, at 3.2.3. 122 such clause may for example read: ‘no third party beneficiaries. this agreement shall not confer any rights or remedies upon any person other than the parties and their respective successors and permitted assigns.’ the example taken from <www.lawinsider.com/clause/miscellaneous/no-third-party-beneficiaries> accessed 17 april 2017. njcl 2017/1 87 such as employees of a supplier could then claim that a contract was concluded between them and the sourcing company based on such unilateral statement. this tactic was tested in the usa, but did not succeed due to vagueness of a suppliers code resulting in an absence of a clear promise.123 in the european context, it can be expected that it would be even harder to establish an existence of a unilaterally made contract, as plaintiffs would have to prove not only the existence of a clear promise, but also the intention of the company to be bound by the statement.124 as a final point in this section, it must be stated that a major risk connected with both pursuance and avoidance of sustainability requirements in private procurements processes is rather reputational (and arguably consequently also financial) than legal. though, such other risks are outside the scope of this paper, possible reputational (and financial) risks may turn into legal risks through the liability of companies’ directors. if a company is found to ignore sustainability issues or to breach its due diligence duties under a legal rule or a soft-law instrument by not considering sustainability requirements in its procurement processes, and consequently suffers a financial loss, the directors may be found to be in breach of their duty of care towards shareholders. however, the same may happen if a company pursues sustainability goals through its procurement processes and this turns to be too costly or one of the legal risks described above materialises. 4. conclusion sustainability topics in public and private procurement (i) are increasingly considered and implemented into contracts; (ii) deal with similar issues in both contexts; (iii) cover issues that are linked to the subject matter of a contract, including issues that relate rather to the production process than the physical qualities of the delivered goods as such; and (iv) proliferate through all stages of the procurement process. consequently, it may be noted that the two spheres are possibly closer to each other than it seems at the first look. at the same time, the drivers for inclusion of sustainability consideration into public and private procurement processes come from different sources and the legal framework regulating the two spheres substantially differs. while the acknowledgment of sustainability issues within procurement processes have been steered by different development, the drivers in both public and private spheres can be classified into four categories: regulatory (policy), resource, market and social drivers.125 most importantly for this paper, the two spheres obviously influence each other in respect to sustainability 123 doe v. wal-mart stores, inc., supra note 119. 124 see study group on a european civil code and the research group on ec private law (acquis group), 2009, principles, definitions and model rules of european private law, draft common frame of reference (dcfr), outline edition, art 4.301. 125 hoffman, supra note 67. sustainability requirements in eu procurement 88 topics. public procurement acts as one natural driver for the development of private procurement, as private contractors must live up to public procurement rules and requirements if they want to supply to public institutions. private procurement then has developed an intricate best practice in respect to implementation and enforcement of sustainability requirements, which serves as an inspiration to the public sphere, where the focus has until now been on the pre-award phase.126 further, as described in the introduction to this article, the focal concern of this article with regard the questions of whether pursuing sustainability goals through procurement is a right or an obligation of public and private organisations and whether there are risks of liability associated with either pursuing or ignoring sustainability goals in procurement processes. in summary, it may be concluded that while the right to include sustainability concerns in procurement processes stands firm both in the public and private areas, the authors can only see contours of the legal obligation to do so. there seems to be a slow but consistent push from various stakeholders to establish such a legal obligation. however, in the view of the economic and business needs that are the driving forces in procurement, the position of the public contracting authorities balancing multiple public interests, and the overarching principle of contractual freedom in commercial contracting, it does not seem plausible to directly legally require either public or private organisations to include sustainability requirements into their procurement processes. an indirect legal push is, however, a possibility, which is increasingly used by various regulators.127 when it comes to the risks of liability, looking at the discussions from both the sectors, it seems that more legal risks are in fact associated with the inclusion of sustainability requirements into procurement process (and inadequate enforcement thereof) rather than with ignoring them. considering the lack of a positive legal obligation in this respect, this is a counter-intuitive conclusion. surprisingly, this fact has not discouraged organisations from exercising their contractual control over their suppliers to further sustainability goals, this showing to the power of resources related and market drivers of sustainable procurement. the legal framework of public procurement and commercial contracts should aim for ‘giving teeth’ to sustainability regulations (mostly soft law) and for the enforcement of organisations’ promises in respect to sustainability issues, while making sure that those organisations following the trend of inclusion of sustainability concerns into procurement processes are not punished but supported through law. it might thus be necessary, rather than establishing a legal obligation to 126 beckers, supra note 7, at 217. 127 an example here can be the us foreign corrupt practice act (the foreign corrupt practices act of 1977, as amended, 15 u.s.c. §§ 78dd-1, et seq.) or the uk 2015 modern slavery act. njcl 2017/1 89 include sustainability issues into procurement processes, to provide new solutions to their legal enforcement. microsoft word gurwinderfinaledit.doc nordic journal of commercial law issue 2009#2 the wto perspective on subsidies in international trade; by gurwinder singh nordic journal of commercial law issue 2009#2 1 i. introduction not long after the end of the second world war economists and policy makers started considering free trade as a method of maximizing welfare, and also as a means of finding solutions to social and political problems. after the formation of the gatt in 1947 and wto in 1995, governmental policies of the member states have continued moving forward to a system of free trade. the majority of nations have started following liberal trade policies, both in their pursuit of domestic economic objectives and while contributing to world trade. when government policies start inducing a system of liberal market economy, they have to modify the underlying economic concepts of government, and further make it suitable to cotemporary cross border trade requirements. first, government has to agree not to increase the existing levels of tariffs and second, when existing tariffs are lowered, it is likely that an even greater number of industries (domestic and foreign) will face the need to adjust to the competitive market situations. with the newly developed market conditions, nations start competing with each other for profitable international business. consequently, they resort to policies of granting aid and subsidies, so as to maintain a dominant position in the market. as far as obligations under the wto are concerned, all members are automatically bound by all the multilateral trade agreements, including the “agreements on agriculture and subsides and countervailing measures (ascm),” as well as the “understanding on rules and procedures governing the settlement of disputes (dsu)”.1additionally, member states, while framing domestic policies, should ensure that wto subsidy provisions are not breached. in so oing it is also necessary for wto members to bear in mind the provisions of article 31(1) of the vienna convention on the law of treaties.2 in practice, there is invariable use of subsidies by nations even for minor reasons. over time this practice is substantiated by legal precedent, ironically, indifferent to the vagueness of their purpose. the indiscriminate use of subsidies is contrary to the basic objectives of the wto and enhanced legal complexities follow. it has led to the demand for broader legal support for various other subsidies with unclear objectives. to understand the far reaching effects of subsidies in international trade, we start with discussing state aid. 1 marc benitah. (2001). p.3, the law of subsidies under the gatt/wto system. great britain:kluwer law international. 2 article31 (1) of the vienna convention provides “ a treaty shall be interpreted in good faith with the ordinary meaning to be given to the terms of treaty in their context and in the light of its object and purpose.” nordic journal of commercial law issue 2009#2 2 the impact of subsidies and state aid in international trade can be divided in two stages. a noticeable aspect of such aid and subsidies is that they improve the initial conditions of an enterprise and later, these aids and subsidies act as a factor for export promotion. in order to understand market practices better, it is necessary to distinguish between state-aid and subsidy. although, the two terms are different they have some commonness also. more significantly, the legal approach towards these two terms varies. 1.1 state-aid and subsidy a subsidy can generally be viewed as the opposite of tax. from the broader perspective of industrial and trade production, it is a payment by government to consumers or producers, which makes the factor costs received by the producers greater than the market price charged by them. there can be several reasons for giving subsidies, for instance subsidies may be given on the grounds of income distribution or to supplement the incomes of producers or consumers.”3 the subsidies that are provided to consumers and producers are not restricted to financial or fiscal benefits, but may also include para fiscal aid (for example, by adopting export promotion policies), provided from public and private accounts. these kinds of concessions often result in externalities and finally end up as subsidies either in explicit or implicit form. for comprehensive understanding of the term “subsidy” in relation to trade practice, and its effects, it is necessary to consider terms such as “aid”, “bounty” and “grant” on a collinear basis.4 as per the practice in general, the term “subsidy” can be construed as conforming the very broad meaning, inclusive of bounty or grant, primarily depending upon the conditions, and objectives of the policies. the mere conferral of most kinds of benefits to producers would qualify as a subsidy, since as soon as it is (legally) established that a “generous gift” has been given, a subsidy would exist.5 as a matter of fact, such a wide interpretation is commonly not used to determine trade distortion (distortion as defined under the wto treaty provisions) in international trade. while attempting to differentiate between state-aid and subsidy, one realizes the legal complexities, because the motive behind the aid can be elusive and with vague legal justification. from the perspective of wto law, state-aid is not invalid as such, but its precise proportions, when validity ceases, is difficult to ascertain, as market forces are influenced by many hidden factors. the wto ascm does not differentiate between state aid and subsidy. 3 john black. (2004). p. 451,oxford dictionary of economics, new delhi: oxford university press. 4 webster’s new world dictionary defines “grant” as “something granted” (or given) and “bounty” as “something given freely as a generous gift.” 5 webester’s new world dictionary. p587 (3d college ed 1988). reference quoted from. e. kwaku andoh. (jul. 1992). p. 1519 vol. 44, no. 6. countervailing duties in a not quite perfect world: an economic analysis, stanford law review. nordic journal of commercial law issue 2009#2 3 therefore, in an attempt to elaborate on the relationship between state-aid and subsidy, reference can be given of articles 87 and 88 of the ec treaty provisions6. some authors are of the view that ec institutions have consistently differentiated the notion of aid in ec law from the notion of subsidy in wto agreements.7 the most common justification for providing state-aid is “social necessity.” in practice, there are situations where aid is given to support policy measures, which is in the larger interest of society. in these cases, the social benefit can overshadow the prohibition against subsidies based on the use of funds from public accounts. since the wto does not have any specific human rights agreements, it is necessary to refer to some basic aspects of sociological jurisprudence in order to substantiate the legal justification for state-aid.8 sociological jurisprudence is concerned with speculating about society in the light of factual and observational data and with making and administering law with reference to the needs of society. 9 relevant here would be to apply roscoe pound’s idea of social engineering and ihering’s idea in his book der zweck im recht translated into english as (“law as a means to an end”). an instance of judicial justification for state-aid on social grounds can also be noted in the case of preussen elektra a.gv schleswag,10 where the validity of aid given by a state was challenged. 6 article 87 and 88 of the ec treaty (ex article 92-93 ec) set rules on state-aid that distort trade between the ec member states. article 87, (1). save as otherwise provided in this treaty, any aid granted by a member state or through state resources in any form whatsoever which distorts or threatens to distort competition by favouring certain undertakings or the production of certain goods shall, in so far as it affects trade between member states, be incompatible with the common market. article 88 the commission shall, in cooperation with member states, keep under constant review all systems of aid existing in those states. it shall propose to the latter any appropriate measures required by the progressive development or by the functioning of the common market. 7 marco.m. slotboom. (2002).p.518, subsidies in wto and in ec law broad and narrow definitions. journal of world trade. netherlands. see also, j.f.beseler & a.n.williams, (1986). anti –dumping and anti-subsidy law. the european communities. london: sweet &maxwell, at s.5.2.2 .see for a differentiation between the two notions after the entry into force of wto agreements t-55/99,cetm v. commission [2000] ecr, ii-3207, at s.50, where the court of first instance of the ec (the “ecfi”) observed without any further explanation, “the reference to the concept of ‘subsidy’ within the meaning of the wto agreement on subsidies and countervailing measures has, as the commission submits, no relevance whatsoever to the classification of the measure in question as state aid within the meaning of community law.” 8 wto follows basic human rights principles, that are part of international law and are also within the domain of vienna convention on the law of treaties. we can draw this analogy from the trade sanctions being applied to save human rights. vienna convention on the law of treaties, “article 53” ‘a treaty is void if, at the time of its conclusion, it conflicts with a peremptory norm of general international law. for the purpose of the present convention a peremptory norm of general international law is a norm accepted and recognized by the international community of states as a whole as a norm from which no derogation is permitted and which can be modified only by a subsequent norm of general international law having the same character’. 9 dias r.w.m. (1964), p. 442. jurisprudence, london: butterworths & co (publishers) ltd. 10 see case c-379/98, preussen elektra v schleswag ag, [2001] ecr i2099. nordic journal of commercial law issue 2009#2 4 the court in this case justified the statutory provisions of member states of (eu) that require private electricity suppliers to purchase electricity produced from renewable energy sources and later distribute the financial burden between the electricity suppliers and a private network of electricity operators.11 the commission in fact, maintains that state aid which can render competition rules ineffective is prohibited. this also includes adoption or enactment of any policy instrument by the legislative bodies. “in this case, aid is provided for the use of renewable energy source that is producing electricity and promoting protection of environment by reduction in the emission of greenhouse gases. so, the policy is designed mainly to achieve the environment objectives rather than tampering with fair competition. this illustrates the extent of legality for state aid, and its distinction from a subsidy; which is signified here as trade distorting.” although, this ruling supports grant of aid by the government, specifically on social grounds, the overall effects on trade because of aid, subsidies or any public measure adopted or followed by the government, cannot be ignored. there can be social, political, cultural economical and several other reasons for these kinds of aids, but they have also some limitations. despite social justifications, we also have to bear in mind that public measure that has the effect of conferring a selective advantage on an undertaking or sector is not relieved of its quantity as an aid by the reason of the fact that it was adopted for a social purpose.12 1 in french republic v commission of european communities13 it was concluded that “the social character of assistance is not sufficient 11 para 63 the commission maintains that, in order to preserve the effectiveness of articles 92 and 93 of the treaty, read in conjunction with article5 of the ec treaty (now article10ec), it is necessary for the concept of stateaid to be given in such a way as to include a support measure which, like those laid down by the amended stromeinspeisungsgesetz, (stromeinspeisungsgesetz is a german term in english, it is electric transmission act) are decided upon by the state but financed by private undertakings. it draws that argument by analogy from the case law of the court of justice to the effect that article 85 of the ec treaty (now 81ec), read in conjunction with article 5 of the treaty, and prohibits members from introducing measures, even of a legislative or regulatory nature, which may render the competition rules applicable to undertakings ineffective. para 73 the use of renewable energy sources for producing electricity, which a statute such as the amended stromeinspeisungsgesetez is intended to promote, is useful for protecting the environment in so far as it contributes to the reduction in emissions of greenhouse gases, which are amongst the main causes of climate change which the european community and its members states have pledged to combat. para 74 growth in that use is amongst the priority objective which the community and its member states intend to pursue in implementing the obligations which they contracted by the virtue of united nations framework convention on climate change, approved on behalf of the community by council decision 94/69/ec of 15 december 1993(oj1994 l33, p.11), and by virtue of protocol of the third conference of the parties to that convention, done in kyoto on 11december 1997, signed by the european community and its member states on 29april 1998 see inter alia council resolution 98/c198/01 of 8 june 1998 on renewable sources of energy (oj 1998 c 198,p.19, and decision no 646/2000/ec of the european parliament and of the council of 28 february 2000 adopting a multiannual programme for the promotion of renewable energy sources in the community (altener) (1998 to 2002) (oj 2000 l79,p.1) 12 case c-241/94, france v commission, ‘ kimberly clark’, [1996] ecr i-4551 paragraph 21; case-75/97, belgium v commission, [1999] ecr i3671, paragraph 25; case c-251/97, france v commission, [1999] ecr i –6639, paragraph 37. 13 case c-241/94french republic v commission of european communities. nordic journal of commercial law issue 2009#2 5 to exclude it from categorisation as state aid for the purpose of article 92(1) of the treaty. the main criteria to draw the distinction between justifiable state aid and unjustifiable, is the effect of it rather than its aims and objectives.14 in the case of italy v commission,15 the european court of justice, in reply to primary italian claims,16 stated that aid granted by states or through state resources that affect or can affect competition is incompatible with the common market.17 although, the basic elements for state-aid and subsidy are the same, stateaid cannot be confined to positive benefits only. it also covers other measures with similar characteristics. the concept of aid is wider than that of a subsidy, as it embraces other indirect benefits, such as to mitigate the expenses which are normally included in the budget of an undertaking. when establishing the basis for aid or subsidy, legislative bodies need to bear in mind mainly the consequences in the context of international trade. with the intensification of competition in international trade, the tendency to grant, state-aid and subsidies is higher. this further complicates the investigation and analysation of the practice followed by member nations of the wto. legal doctrines solely, are not enough to derive objective conclusions, hence economic concepts are used. 1.2 economic aspects it is well said, that for trade to be fair, there must be evidence about domestic costs and prices. economic concerns about subsidies relate to the fact that they can distort trade and prevent markets from attaining optimal resource allocation. for better allocation of resources, market conditions should not be biased. countries basically engage in international trade for two basic reasons. first, countries trade because they are different from each other. nations, like individuals, can benefit from their differences by reaching an arrangement in which each does 14 in this case “kimberley clark, company whose main business was to manufacture and processing of cellulose wadding. as a part of restructuring operation, the company decided to concentrate solely on the manufacture of paper handkerchiefs and to modernize its industrial equipment, which led to the reduction of workforce from 465 to 207. an agreement was concluded between the state i.e. fne (national employment fund) and kimberly clark, to fund the part of the cost of this new plan. para5, “the commission decided that the fne intervention constituted state aid, since such agreements are negotiated with undertakings encountering employment problems. the fne contributions, which is financed out of the state budget is determined case by case depending to the financial situation of the undertaking. it also stated that such aid was liable to distort competition and to affect the trade between member states, there by failing within the scope of article 92 (1) of the ec treaty.” 15 see c-6/97, italy v commission [1999] 1 cmlr 1357, paragraph 61. 16 see c-6/97 italy v commission, para 10, judgment of the court (sixth chamber) 1999.the italian republic claims that the tax -credit scheme does not constitute state-aid in compatible with the common market, since there is no allocation direct or indirect of state resources which distort or threatens to distorts competition by affecting intra-community trade. 17 c-6/97, italy v commission, [1999] 1 cmlr 1357paragraph 14, 15. nordic journal of commercial law issue 2009#2 6 the things it can do relatively well. second, countries trade to achieve “economies of scale” in production. that is, if each country produces only a limited range of goods, and specializes, it can produce each of these goods on a larger scale and hence more efficiently than if it tried to produce everything.18 for a better understanding of the impact of subsidies, a distinction needs to be drawn between export subsidies and domestic subsidies. domestic subsidies have some legal justification so long as it is within the legal parameters of state aid and are meant not for any profit-oriented trade. it is also noticeable, that in several instances domestic and export subsidies are either convergent or complement each other. an export subsidy has a direct impact on the terms of trade because it counters, in whole or in part, the tariffs levied on the product by the importing nation. at later stages, it also has the effect of capturing the domestic market of the importing countries. a domestic or production subsidy, on the other hand, is one granted to a firm regardless of exports. this type of subsidy has less of an impact on trade.19 it could be that these domestic subsidies reduce the factor cost and in a way help increase exports, so that they converge to attain the same objective. the main concern about subsidy in international trade is the market distortions caused by resorting to subsidies in trade practices. this goes contrary to the principle of free-tradethrough-fair-trade –rule.20 the two prominent distortions are: (1) for the country importing the subsidized product, there is unfair competition between the imports (that are cheaper due to a subsidy) and the competing unsubsidized (domestic) products of domestic producers. the reduced price of imported products due to a subsidy may injure domestic producers and workers. the subsidy could demonstrably cause serious injury to competing domestic producers. these issues fall mainly within the subject area of microeconomics. (2) the economic case of currency-value-devaluation (c.v.d) is mainly one of macroeconomics. economists have observed that, “an undervalued currency has an effect similar to an import tax, a tariff, or to export subsidies.”21 this is so because under valuation (or an artificially cheap 18 paul r.krugman &maurice obstfeld.(1999). p.11, fifth edition . international economics (theory and policy), u.s.a: addison-wesley publishing company. 19 mitsuo matsushita, thomas j.schoenbaun & petros c.mavroidis.(2003).p.261,first ed, the world trade organization law practice and policy. great britain: oxford university press. 20 the main aim of the wto is to promote free trade. although fair trade principles, not the part of prevalent trading concepts in wto agreements, but act as complementary to free trade principles. subsidies and dumping practices do not hamper free trade but effect fairness in trade practices to the extent that it can effect the basic objectives of wto. to derive legality of action against subsidies and dumping, fairness in trade act as a yard stick so that it does not effect the competition agreed between the parties. 21 dominick salvatore,.(1987). p.13, the new protectionist threat to world welfare. new york: elsevier science publishing co, inc. nordic journal of commercial law issue 2009#2 7 currency) of a currency makes exports cheaper, which, in turn, could make governments impose higher tariffs on imports. persistent currency under valuation induces import competition and export promotion. the example of the china-us trade relationship is relevant here. it is believed by most researchers that china has kept the value of its currency artificially cheap, thus implicitly subsidizing its exports and taxing imports. “this view is bolstered by china’s large accumulation of official us dollar reserve.”22 in support of this argument, we can analyse the trade statistics of china, and notice that exports have grown faster than imports. in comparison, us imports have grown faster than exports, resulting in a trade deficit.23 when devaluation is viewed as a policy instrument that switches demand from foreign to domestic goods, and with the latter, from tradable to non-tradable, and as a policy that switches output from supplying to the domestic market to exports, then tariffs, tighter import quotas, export subsidies, and so forth can be considered substitutes for devaluation.24 economic analysis reveals also another aspect. a framework of perfect competition in the domestic market makes it difficult for undertakings engaged in international trade to always respond strategically in their own favour. in such situations, markets yield to the conditions of imperfect competition. imperfect competition is characteristic both of industries in which there are only a few major producers, and of industries in which each producer’s product is viewed by consumers as strongly differentiated from those of rival firms. in imperfect competition, undertakings are aware that they can influence the prices of their products and that they can sell more only by reducing their price. under these circumstances, each firm views itself as a price setter, choosing the price of its product, rather than being a price taker.25 in a perfectly competitive market, monopoly profits are competed away. usually, it is imperfect competition that prevails in the market and in that case large firms usually have an advantage over smaller ones, thus the markets tend to be dominated either by one firm (monopoly) or by few firms i.e. oligopoly. when increasing returns enter trade practice, then, markets usually become imperfectly competitive in the long run. 22 on 21 july 2005, chinese government announced that it would no longer peg the yuan to the u.s dollar. for reference see, chad p.bown, meredith a.crowley, rachel mc culloch & daisuke j. nakajima., (2005),p.5 4 q. the us trade deficit made in china.,economic perspectives, federal reserve bank of chicago. 23 for reference see, united nations conference on trade and development. dispute settlement wto 3.7 subsidies and countervailing measure, p. 3, us merchandise trade deficit with china alone accounted for about $162 billion in 2004, or nearly onequarter of the total u.s trade deficit, up from a negligible in mid 1980s. 24 supra .p. 48, note 19 25 paul r.krugman & maurice obstfeld. international economics (theory and policy). (2000). p.122, fifth edition usa: addison-wesley publishing company. nordic journal of commercial law issue 2009#2 8 where oligopoly prevails, it can be assumed that undertakings in a country are symmetric,26 as well as, asymmetric since most industries consist of a few large undertakings and a great number of smaller undertakings. as helpman and krugman suggest, “there is a need for models of strategic trade policy under asymmetric oligopoly that allow firms within a country to have a different marginal cost of production.”27 the analysis of strategic trade policy under asymmetric oligopoly was pioneered by collie (1993), who extended the brander and spencer’s (1985) model of profit-shifting export subsidies to allow for cost differences between undertakings within a country.28 with cost asymmetries, a selective export subsidy scheme that discriminates between undertakings would be superior to a uniform scheme, if it were feasible. collie notes, that if the government could use a selective policy then it would be optimal to subsidize the most efficient undertaking and impose a prohibitive tax on all the others.29 there are certain welfare effects linked to tariffs and subsidies. under oligopoly, as brander and spencer (1984) have shown, tariffs can be used to extract rent from foreign firms and to shift profits from foreign to domestic firms.30 furthermore, a subsidy could increase the welfare of a country by improving its terms of trade, if it leads to a reduction in price. since the price exceeds the marginal cost in the oligopolistic industry, a subsidy will increase the domestic country’s welfare by shifting profits to increases the domestic producer’s surplus by increasing the output of the domestic industry. basically, it improves the terms of trade by reducing the cost of production. subsidy will enhance trade and welfare by shifting profits. this will induce the producer to increase production for exports. 26 symmetric is used to refer that all firms within a country have identical costs of production, for details see “tariffs and subsidies under asymmetric oligopoly: ad valorem versus specific instruments”by david r.colle cardiff business school, cardiff university. vol 74 no.3 (june 2006). p. 314, uk: the manchester school. blackwell publishing ltd. 27 ibid. p.314 note 24. 28 ibid. p.315.note 25. 29 ibid.p.316.note 26. 30 ibid.p.322.note 27. nordic journal of commercial law issue 2009#2 9 figure representing how subsidy increases domestic monopoly profits.31 in the above figure, where d is foreign demand, mr is marginal revenue from foreign sales, and the intersection between mc and mr determines the profit-maximizing quantity of exports, q. price is set at p, and monopoly profit per unit is the difference between p and mc along the price axis. total monopoly profits extracted from foreign market are the shaded area. a specific export subsidy (government subsidy of x dollars per unit of output) to the local monopoly firm lowers its marginal costs to (mcs), reduces the export price from p to (ps) (in other words, “our” terms of trade deteriorate) and raises quantity to (qs). economic profit appropriated from foreign markets increases to the rectangular area bounded by points (mcs), to (ps), a, b. the subsidy cost to the government is the rectangular area bounded by mc, mcs, a, c. it is smaller than the gain in monopoly profit. the difference between the gain in monopoly profit and the cost of the subsidy is the net gain to the country. its size depends on the shape of the demand curve. again, information on the cost structure and the demand elasticity is needed to determine the optimal size of the subsidy, the subsidy that would maximize the excess of appropriated profits over subsidy cost. as the differences between state-aid and subsidy are narrow, analysing the production function can be extremely helpful. the production function can be separated into two stages. in the first stage, intermediate inputs and a primary composite of capital and labour are used in fixed proportion to the output. in the second stage, capital and labour are combined through a ces (constant elasticity of substitution) function to form the primary composite depending upon 31 the figure, from, the new protectionist threat to world welfare dominick salvatore.(1987). p.321new york: elsevier science publishing co, inc . nordic journal of commercial law issue 2009#2 10 the profit.32 with the help of subsidy one can get these factors at a cheaper price and that can help export promotion. so far as support is given for the production function to subsist and that also categorized on certain basis, it can be brought under the term aid. one has to analyze the intrusive character of this support. defining and identifying a trade-distorting subsidy is, however, only the first step. the next step would be to decide, if the trade distorting subsidy should be removed. the criteria that can be used to determine if a subsidy is trade-distorting can primarily be based on the efficiency principle of economics. [in the mentioned figure, it is assumed that export subsidies and import substitution subsidies are trade-distorting. in fact, they are prohibited under article 3 of the subsidies agreement]. however, the debate on subsidies and their removal is a slightly more complex process and one which needs relativity to positive and negative externalities. ii. subsidies under the gatt and the wto 2.1 subsidies during the gatt period the issue of subsidy was given great significance in the current wto negotiations where as, it was not very widely discussed in the gatt. nowhere, in article xvi of gatt 1947, is the term “subsidy” defined. there is only a general description about subsidies as trade practice.33 32 drusilla k. brown, alan v.deardorff & robert m. stern. (january 23, 2001). p.3, discussion papers no 468.cge modeling and analysis of multilateral and regional negotiating options, university of michigan. research seminar in international economics. school of public policy. university of michigan. http://www.spp.umich.edu/rsie/workingpapers/wp.html. 33 article xvi section asubsidies in general. 1)if any contracting party grants or maintains any subsidy, including any form of income or price support, which operates directly or indirectly to increase export of any product from, or to reduce imports of any product into, its territory, it shall notify the contracting parties in writing of the extent and nature of the subsidization, of the estimated effect of the subsidisation on the quantity of the effected effect of the subsidization on the quantity of the affected product or products imported into or exported from its territory and of circumstances making the subsidization necessary. in any case in which it is determined that serious prejudice to the interest of any other contracting party is caused or threatened by any such subsidization, the contracting party granting the subsidy shall, upon request discuss with the other contracting or parties concerned, or with the contracting parties, the possibility of limiting the subsidization. section b additional provisions on export subsidies 2)the contracting parties recognize that the granting by a contracting party of a subsidy on the export of any product may have harmful effects for other contracting parties, both importing and exporting, may cause undue disturbance to their normal commercial interests, and may hinder the achievement of the objectives of this agreement. 3) accordingly, contracting parties should seek to avoid the use of subsidies on the export of primary products. if, however, a contracting party grants directly or indirectly any form of subsidy which operates to increase the export of any primary product from its territory, such subsidy shall not be applied in a manner which results in that contracting party having more than an equitable share of world export trade in that product, account being taken of the shares of the contracting parties in such trade in the product during a previous representative period, and any special factors which may have affected or may be affecting such trade in products. nordic journal of commercial law issue 2009#2 11 the two leading trade blocks influencing gatt policies; the ec and the us, may serve as examples in order to explain the practice of subsidy. wide ambiguities between the ec and us on the interpretation of this article made it impossible to define the term during the tokyo round. in the absence of the definition of subsidies, the us, on the one hand, and the ec and other gatt contracting parties, on the other hand, had divergent opinions, regarding the question of whether or not government measures involving a charge on the public account exclusively, were to be considered subsidies.34 although not specifically from the wto, we can further analyze the differences with reference to some cases, where the issue is discussed: for instance in the case of zenith radio corp.v. united states.35 the petitioner in this case, contended that certain imported products benefited from bounties or grants paid by japan. japan imposes a commodity tax (an indirect tax) on those products when they are sold in that country but “remits” the tax when the products are exported, and also refunds any tax paid on the shipment of a product on subsequent exportation. relying on, downs. v. united states,36 the customs court ruled in the petitioner’s favour. the court of customs and patent appeals reversed the decision. in the case of fediol, the ecj observed that37: it should be pointed out that the concept of subsidy in article 3 of eec regulation no 2176/8438 is not expressly defined, either in that regulation or in other community measures. however, an “illustrative list” of export subsidies, referred to in article 3(2) of the regulation, is annexed to the regulation. it also follows from article 3(3) of said regulation, which expressly excludes from the concept of subsidy the exemption of a product from certain export charges or taxes, that the concept of a 4) further, as from 1january 1958 or the earliest practicable date thereafter, contracting parties shall cease to grant either directly or indirectly any form of subsidy on the export of any product other than primary product which subsidy results in the sale of such product for export at a price lower than the comparable price charged for the like product to buyers in the domestic market. until 31december 1957no contracting party shall extend the scope of any such subsidization beyond that existing on 1stjanuary 1955 by the introduction of new, or the extension of existing, subsidies. 5)the contracting parties shall review the operation of the provisions of this article from time to time with a view to examining its effectiveness, in the light of actual experience, in promoting the objectives of this agreement and avoiding subsidization seriously prejudicial to the trade or interests of contracting parties. 34 marco m slotboom. (2002). p.518, subsidies in wto and in ec law broad and narrow definations. journal of world trade. kluwer law international. netherlands. 35 zenith radio corp.v. united states, 437 us. 443(1978). 36 downs. v. united states, 187 us 496. 37 case 188/85, para 12and 13 38 council regulation eec no 2176/84 was amended by council regulation eec no 1761/87.on 11th july 1988 the eec council adopted regulation eec no 2423/88 which replaced council regulation eec no 2176/84 as amended. nordic journal of commercial law issue 2009#2 12 charge covers not merely cases in which the state advances funds, but also those in which it waives recovery of tax debts thereby introducing an exception to a generally applicable rule of taxation.39 comparing this situation, with that in the us, the us employs a broader definition for the term subsidy. it disregards the question whether a reuirement of a charge on the public account was involved, and focused on the benefit provided by the disputed measure to its recipient. under us law, an export subsidy may be roughly defined as any government programme or practice that increases the profitability of sales by export, but which does not necessarily increase the profitability of sales for domestic consumption. “government practice that cannot be characterized as export subsidies are countervailable under us law only if they satisfy the statutory definition of a domestic subsidy.”40 this means that a domestic subsidy, that is otherwise not countervailable, can be challenged if it is indirectly meant for the promotion of export. in other words, regardless of whether a government measure represented a charge on the public account, the us would consider a measure of another gatt contracting party, countervailable, if the measure confers a benefit to a specific industry.41 it must provide some advantage to the producer that was otherwise not available. the way, the issue was handled in these cases shows both definitional and procedural inconsistencies in settling on a definition of subsidies. however, the ec (and other gatt contracting parties) took the position that “as far as international trade is concerned, the crucial characteristic of a subsidy is that it should involve a financial contribution by the government. the list annexed to regulation (eec) no 2176/84 makes it clear that any subsidy must involve a charge on the public account.”42 39 article 3(2) subsidies bestowed on exports include, but are not limited to, the practice limited in the annex. article 3(3) the exemption of a product from import charges or indirect taxes, as defined in the notes to the annex, effectively borne by the like product and by materials physically incorporated therein, when destined for the consumption in the country of origin of export, or the refund of such charges or taxes, shall not be considered as a subsidy for the purposes of this regulation. 40a. sykes. u.s.c.a§ 1677(5)(west 1980 & supp .4 dec 1988). p.203. countervailing duty law: an economic perspective. 89 columbia law review. (the identification of export subsidies may prove quite troublesome in practice. see generally g.hufbauer & j.erb, subsidies in international trade (1984). p45-88 (identifying and describing types of export duties.) 41ibid, p. 204. (the targeting criterion –commonly known as the “specificity test” or the “general availability test”ensures that many of the familiar activities of the governments are not characterized as “subsidies”. for example, public education, government-financed highway and railway systems, national telecommunications networks, and even national defence activities provide economic benefits to domestic producers, but these benefits ordinarily accrue to a wide range of industries. thus, such activities usually are not countervailable. in contrast, a special programme to educate workers in the semiconductor industry or a special rail rate for the coal industry might well be countervail able. 42 see case 188/85, fediol v commission, eec regulation no2176/84.(supra note. 35) nordic journal of commercial law issue 2009#2 13 drawing parallel between us and eu law on subsidies, it seems that under us law any kind of government support for export promotion can lead to subsidy, whereas under ec law financial support should be from public fund so as to be considered as subsidy. leaving aside the us rules on subsidies, practically speaking, any type of government programme can confer a domestic subsidy if it meets two criteria; it must be sufficiently targeted “to a specific enterprise or industry, or group of enterprises or industries,” and second, it must provide some opportunity or advantage to the targeted producers that would not otherwise be available to them in the marketplace. 2.2 describing subsidies in relation to the wto as in previous gatt conferences, talks about subsidies ended, without developing a comprehensive definition therefore. consequently, another attempt was made to achieve detailed rules that would be applicable to all wto members during the uruguay round. the agreement establishing the world trade organization incorporates several annexes containing various wto agreements. annex 1a, encompasses the multilateral agreements on trade in goods. one of these agreements is the ascm. this agreement deals with the issue of subsidies very widely. however, the policy making bodies of member states are also bound by the vienna convention on the law of treaties, article 26 and article 27 for the adoption and implementation of ascm.43 the ascm sets forth the rules and certain conditions that wto members are able to invoke in case of injuries due to the practice of granting subsidies.44 moreover, it provides detailed rules on the concept of subsidies, actionable subsidies and defines the material injuries caused. the ascm serves two main purposes: 1) it tries to discipline the use of subsidies and 2) it gives legal competency and regulates the actions countries can take to counter the effects of subsidies. subsidies and countervailing agreement of the wto plays a vital role in achieving the basic objective of free trade, supported by fair trade principles.45 so far as remedies are concerned, the ascm, which is binding on all wto members, is divided into xi parts and vii annexes.46 part 1 sets out the definition of subsidy and introduces the key concept of “specificity;” the test 43 article 26 of the vienna convention on the law of treaties. “every treaty in force is binding upon the parties to it and must be performed by them in good faith.” article 27 “a party may not invoke the provisions of its internal law as justification for its failure to perform a treaty.” 44 for detail reference see, articles 7 and 11 of the ascm .article 7, deals with remedies. article 11 deals with initiation and subsequent investigation to determine the existence , degree and effects of any alleged subsidy. 45 supra note.18 46 for reference see, www.wto.org. subsidies and countervailing duties. nordic journal of commercial law issue 2009#2 14 of which is whether the subsidy is available only to an enterprise or industry or group of enterprises and industry.47 article 1.1 of the ascm defines subsidy.48 it spells out the elements that the concept covers. generally, a subsidy is deemed to exist, if there is a financial contribution by a government or any public body and if a benefit is thereby conferred. thus, there are two separate basic elements. the first element of this definition is concerned with whether the government made a “financial contribution”, as defined in article 1.1(a). the focus of the first element is on the action of the government in making the “financial contribution”. that being so, it seems logical that the second element in article 1.1 is concerned with the “benefit…conferred” on the recipient due to that government action. thus, subparagraphs (a) and (b) of article1.1 define “subsidy” in two different contexts: first, the action of granting authority and second, to what is conferred on the recipient.49 the term benefit is very wide. to know if there exist some relationship between benefit and subsidy, it is imperative to consider whether the financial contributions place the recipient in a more advantageous position. what is significant here is its relationship with the export. export orientation, is relevant and a significant factor, when considering a subsidy that distorts international trade principles under the wto. further, a subsidy under ascm is classified as: 1) non-actionable, 2) actionable and 3) prohibited.50 even though, subsidy is well classified, there are differences of opinion between developing and developed countries on this issue; an issue that follows the north-south divide. 47 mitsuo matsushita, thomas j. schoenbaun &petros c.mavroidis. (2003). first ed. p264, the world trade organization law practice and policy.great britain: oxford university press. 48 article 1 definition of subsidy 1.1 for the purpose of this (wto) agreement, a subsidy shall be deemed to exist if: (a) (1) there is a financial contribution by a government or any public body within the territory of a member (referred in this agreement as “government”), i.e. where: (i) a government practice involves a direct transfer of funds (e.g., grants, loans, and equity infusion), potential direct transfers of funds or liabilities(e.g. loan, and guarantees); (ii) government revenue that is otherwise due is foregone or not collected (e.g, fiscal incentives such as tax credits);48 (iii) a government provides goods or services other than general infrastructure, or purchases goods; (iv) a government makes payments to a funding mechanism, or entrusts or directs a private body to carry out one or more of the type of functions illustrated in (i) to (iii) above which would normally be vested in the government and the practice, in no real sense, differs from practices normally followed by governments; or (a) (2) there is any form of income or price support in the sense of article xvi of gatt1994; and (b) a benefit is thereby conferred. 49 appellate body report, canada-measures affecting the export of civilian aircraft (canada-aircraft),wt/ds 70/ab/ r, para 156. 50 for detail reference see www.wto.org. nordic journal of commercial law issue 2009#2 15 iii. the north -south divide on “subsidies” more than two hundred years ago, adam smith highlighted the benefits of free trade and david ricardo in the early nineteenth century elaborated the theory of comparative advantage. this was a distinct shift from the mercantilist philosophy that emphasized the desirability of nations achieving a favourable balance in terms of trade an export surplus, that is impossible for all to accomplish simultaneously and this has acted as a latent factor for subsidies being a contentious issue between developed and developing countries. even though, the ascm recognizes exceptions for infant industries, national defence and other exigencies, there are stll many issues of contention between developed and developing member states of the wto. considering the wide differences in the economic conditions of the member states of wto, there are provisional grounds for the relaxation of subsidies. article 27 of the ascm gives special and differential treatment to developing countries. article 27 is divided into 15 clauses, but the focus here will be on the first five clauses, as they outline the concessions for developing nations. clause 1 of article 27, specifically recognizes the role of subsidies in economic development. creating opportunities for economic development is one of the key objectives of wto. clause 2, explicitly exempts the developing and least developed countries from the general prohibitions mentioned in article 3 of ascm. this exemption undoubtedly has reasonable justification. during the time when wto came into existence, most of the developing and least developed country economies were based, by and large on the agriculture and cottage industries. this consentration acted like a structural hurdle in the process of industrialisation. promoting rapid industrialisation required strong policy support for a certain period of time. this exemption is supported for the period of five years in case of developing countries and eight years in case of least developed countries. clause 4 of article 27 allows, after consultation with the committe, extension of the period of exemption depending upon such like requirement. however, to maintain the balance between rule-based free trade, and extra privileges given to developing and least developed economies, the latter should be time bound. in case the member state seeking the exemption, has acquired market competency in an exporting product, it can phase out the export subsidy for that product as per the process mentioned in clause 5 of article 27. phasing out a subsidy, after obtaining market competitiveness is significant, as otherwise it can lead to the practice of dumping. in addition, it is necessary to mention article 29 sub-paragraphs 1, 2 and 4 because they cover flexibilities for countries-in-transition.51 s51 article 27(1) members recognize that subsidies may play an important role in economic development programmes of developing country members. article 27(2) the prohibition of paragraph 1(a) of article 3 shall not apply to (a) developing country members referred to in annex vii (b) other developing country members for a period of eight years from the date of entry into force of the wto agreement, subject to compliance with the provisions in paragraph 4 nordic journal of commercial law issue 2009#2 16 in comparing the reasons for providing subsidies between the developed and developing nations, one of the significant reasons for the use of subsidies among developing nations, is an attempt to overcome market imperfections. it is highly probable that the domestic industry (of a developing nation) will have to face already existing market domination, because of economies of scale and other externalities, while competing with multinational firms. developed countries, on the other hand, try to solve their economic problems such as unemployment, lagging growth, industrial outsourcing by sometimes imposing restrictions on imports and by subsidizing exports. 3.1 doha conference 2001 the fourth wto ministerial conference was held in doha. wto members remained deeply divided. the issue of the subsidy for agriculture was a major bottleneck between developed and developing countries.52additionally, there was also a proposal from developing countries that article27.(3) the prohibition of paragraph 1(b) of article3 shall not apply to developing country members for a period of five years, and shall not apply to at least developed country members for a period of eight years, from the date of entry into force of wto agreements. article 27.(4 )any developing country member referred to in paragraph 2(b) shall phase out its export subsidies within the eight –year period, preferably in a progressive manner. however, a developing country member shall not increase the level of its export subsidies, and shall eliminate them within a period shorter than provided for in this paragraph when the use of such export subsidies is in consistent with its development needs. if a developing country members deem it necessary to apply such subsidies beyond the 8 year period, it shall not later than one year before the expiry of this period enter into consultation with the committee, which will determine whether an extension of this period is justified, after examining all the relevant economic, financial and development needs of the developing country member in question. if no such determination is made by the committee, the developing country member shall phase out the remaining export subsidies within two years from the end of the last authorized period. article 27.(5) a developing country member which has reached export competitiveness in any given product shall phase out its export subsidies for such product(s) over a period of two years. however, for a developing country member which is referred to in annex vii and which has reached export competitiveness in one or more products, export subsidies on such products shall gradually be phased out over a period of eight years. article 29.1 members in the process of transformation from centrally –planned into a market, free-enterprise economy may apply programmes and measures necessary for such a transformation. article 29.2 for such members, subsidy programmes falling within the scope of article 3, and notified according to paragraph 3, shall be phased out or brought into conformity with article 3 within a period of seven years from the date of entry into force of the wto agreements. in such a case, article 4 shall not apply. in addition during the same period :(a) subsidy programmes falling with in the scope of paragraph 1(d) of article 6shall not be actionable under article 7; (c) with respect to other actionable subsidies, the provisions of paragraph 9 of article 27 shall apply. 29(4) in exceptional circumstances members referred to in paragraph 1 may be given departures from their notified programmes and measures and their time frame by the committee if such departures are deemed necessary for the process of transformation. 52 the inclusion of developing country members in the wto list is based on recent data from the world bank on gnp nordic journal of commercial law issue 2009#2 17 they should not have to face countervailing measures or other actions in case of subsidies for basic development necessities. these can be described as subsidies with “legitimate development goals.” this includes support for regional growth, technology research and development, production diversification, development and implementation of an environmentally friendly method of production. developing nations also showed their serious concern regarding new commitments. they found these commitments, not giving enough “policy space” to them according to the respective situation and circumstances of the member states. it was emphatically pointed out that developed nations have gone through several stages before reaching their present status. developing nations proposed that subsidies which are provided for technological improvement and for the eradication of poverty, social and environmental problems should be considered inline with sustainable development and hence, should not be considered trade distorting. the conference finally ended up agreeing on some relaxations. ministers affirmed that the governments of the least developed countries be allowed, to pay subsidies that are essential for basic industries. this relaxation covers actionable subsidies, and consequently both developing and developed countries thus have the flexibility to finance their exporters, consistent with their specific development needs. members also agreed that more time should be given to some developing countries to phase out their export contingent subsidies. finally, ministers instructed the subsidies committee to give some of the developing countries more time to phase out subsidies; those are based on the requirement to export according to the procedures in a committee document. 3.2 the hong kong conference in 2005 besides other issues, trade subsidy was also discussed during the hong kong conference. ministers affirmed the decisions and declarations accepted during the doha conference. agriculture subsidies were again a primary matter of discussion. there were proposals by some of the members that exemptions, to the general prohibitions on the use of subsidies, needed to be phased out. member states agreed to eliminate most of the subsidies by the end of december 2013. the policy measures that were indirectly connected to export subsidies were also discussed in detail. these issues relate to e.g. export credits and insurance programmes. one suggestion was to strictly define these policies so as to avoid supporting export promotion. as the main policy objective of wto is to promote free trade, so to maintain consistency between policy and practice, was the prevalent reason to hold the opinion restricting the role of state trading enterprises during this conference. these state trading enterprises have influential per capita. annex vii of subsidies and countervailing measure agreement allows some developing nations to pay export subsidies to a certain extent. among them is a group which is eligible so long as their gnp stays below u.s $ 1000 per capita. this is subject to the agreement among the member states regarding the method of calculation. nordic journal of commercial law issue 2009#2 18 market status in most of the developing countries. state trading enterprises supported by government policies, such as tax concessions and other forms of aid that reduces the costs of factors of production, in a way cumutatively lead to export subsidies. restricting the further increase in proportion of subsidies was agreed between the member states, but providing special aid for food in certain areas, or dealing with an emergent situation was supported overwhelmingly. additionally, subsidies on cotton products was also discussed this resulted in quota free access to cotton exports from least developed economies. the structural reforms for african cotton producers and exporters were also widely supported. as continuing practice, the importance of special and differential treatment was recognised and reaffirmed. flexibilities provided to small economies also seek the support of the majority of the member states during this conference. 3.3 practice followed by developing and developed countries. when it comes to applying or interpreting the subsidyrelated provisions, the perspectives of developed and developing countries also differ. this can be observed in the case below. in the case of india –quantitative restrictions on import of agricultural, textile and industrial products53 the us claimed that india had been unjustifiably maintaining quantitative restrictions on imports of products falling under 2714 tariff lines at the eight-digit level of hs96. in reply, india claimed the balance-of-payment crisis justification, as its economy had been almost totally closed to imports 15 years previously. it has not been possible for india to make an assessment of the exact amount of demand for imports. regarding the foreign-currency reserve crisis, india made the point that the reserve problem for developing hinders the economic development programmes. the foreign reserves held by india vary according to its development policies. in reply to queries by the parties, the imf finally concluded that “macroeconomic policy measures would need to be complemented by structural measures. in general, the benefits of tradepolicy reforms are greater when accompanied by domestic economic reforms …”recently, the general council of the wto has made a change in article 27.4(ascm) that deals with special and differential treatment of developing country members. we will now consider the practice followed by developed nations for the sake of comparison and getting the picture from the other side. developed countries often use the subsidies that 53 india –quantitative restrictions on import of agricultural, textile and industrial products: (wt/ds90/r). the case was decided, not in india’s favour, [we have found that india’s balanceofpayments situation was not such as to allow the maintenance of measures for balance-of payments purposes under the terms of article xviii: 9 that india was not justified in maintaining its existing measures under the terms of article xviii: 11 and that it does not have a right to maintain or phase out these measures on the basis of other provisions of article xviiib which it invoked in its defence. we therefore conclude that india’s measures are not justified under the terms of article xviiib] nordic journal of commercial law issue 2009#2 19 fall under the heading of non-actionable subsidies. article 8, of the ascm widely covers nonactionable subsidies, also known as green-light subsidies. we may refer to article 87(3) of the ec treaty. article 87(3) supports aid for economic development, execution of an important project of common european interest, development of economic activities or of a certain economic interest. apart from these, stateaid is partially given to instruments such as the common agricultural policy funds; aid granted by supranational organizations, such as the european space agency; and defense and public works. these aid provisions serve as an institutional infrastructure for economic promotion. even though these aids are meant for economic development, one cannot ignore these aids effects on the markets. as there is no strict line of demarcation between state-aid and subsidy, stateaid is used as an instrument to support industries. in the eu, several forms of subsidies are used to directly promote targeted economic activities – especially, regional development, since new eu members are at lower levels of development when they first join. the most relevant subsidies from the eu structural funds are as mentioned. european commission (ec) budgeted € 196 billion to the structural funds for 2000 to 2006, of which €26.2 billion were used in 2003.the structural funds reserved €13 billion for research infrastructure and networks, innovative business start-ups, and technical up grading of smes.54 we can also use the practice followed by the us, the most developed economy as an example. the us has a long history of providing financial support for research development and energy sectors. this includes not only direct financial support, but also para-fiscal support through the provisions of legislative acts. legislation very much reflects the objectives of the government, for example the price anderson act55. the main purpose of the price-anderson act is to ensure the availability of a large pool of funds (currently about $ 10 billion) to provide prompt and orderly compensation to members of the public who incur damage from a nuclear or radiological incident no matter who might be liable. the act provides “omnibus” coverage, that is, the same protection available to a covered licensee or contractor extends through indemnification to any persons who may be legally liable, regardless of their identity or relationship to the licensed activity. as the act channels the obligation to pay compensation for damages, a claimant need not sue several parties, but can bring their claims to the licensee or contractor. additionally, there are several investment tax credits and production credits designed to benefit renewable technologies. these include the investment energy tax credit, 54francisco aguayo,ayala, & kevin p.gallagher.p.18.preserving policy space for sustainable development. . international institute for sustainable development, by program on science, technology and development, el colegio de mexico. 55 the price –anderson act was enacted into law in 1957and has been revised several times. it constitutes section 170 of the atomic energy act .the latest revision was enacted through the “energy policy act of 2005” and extended it through december 31, 2025. nordic journal of commercial law issue 2009#2 20 established by the energy tax act of 1978, and the production tax credit (ptc), authorized under energy policy act.56 it really seems difficult to achieve the basic objectives of the wto, if nations already in an advantageous position try to take advantage under the heading of green-light subsidies. the green-light subsidies get exempted by the provisions of article 8 of the ascm. as an example article 8.2 (a) immunizes subsidies given for research activities conducted by firms or higher educational or research establishment. article 8.2(b) supports government assistance to disadvantageous regions. the developed nations already have an export surplus and these supports will put them into further advantageous situations. as far as agricultural subsidies are concerned, this question is very crucial for african nations. by providing subsidies to their own farmers, developed nations try to dominate the agricultural market. this practice very much affects the african continent because agriculture, along with raw materials are their main exports. the foreign exchange earned through those exports helps them get technology. these issues are crucial and are often raised in the conferences. some midway agreeable to both sides needs to be evolved to resolve the crisis. iv. conclusions even though it is clear that subsidies and stateaid affect competition, we cannot ignore the fact that there are occasions when subsidies and state aids may be necessary. there seems a need to exempt several kinds of aids and subsidies. the most plausible argument for this being, the fact that the economic inequalities are very wide among the member states. here, we also have to ensure that these concessions are not abused. first, while making comparative discussion between subsidy and stateaid one can realize the analogous properties. it becomes the inherent responsibility of the member states to follow the principle of good faith. to cover the gap, some legal checks and balances are provided by the ascm, for example, annex vi, provides procedures for on the spot investigation. it is also obligatory for legislative bodies of the member states, to follow the line of reasoning behind granting flexibilities under the enacted provisions. here, critics of the wto may raise their concern about the sovereign values of domestic policies, but one has to keep in mind the international norms and their implicit and explicit justifications as well. nowadays, there is a growing tendency among the developed nations to restrict import from developing nations. it is quite obvious that if indebted developing countries are to meet their economic interests obligations and to repay their debt they must be allowed to increase their export. an effect of continued protective policies adopted by developed nations might be the revival of protectionist sentiment in the developing nations. 56 marshall golberg.research report, federal energy subsidies not all technologies created equal, july 2000.no11 p.14. nordic journal of commercial law issue 2009#2 21 considering the fundamental economic realities, we cannot deny the need for subsidy, but it has to be allocated in a disciplinary manner and with the wto as an institution acting as a control mechanism. those favouring the ideology of free trade have always criticized subsidies as a means of government control that eventually effects competition. certainly, there is some truth in this argument but we cannot ignore the economic logic behind the government interference. when the market fails, policy instruments are deployed to correct the distortions. so, we can also consider subsides as a tool to correct market distortions. a government intervention in the case of negative externalities is also justified, such as in case of pollution, overproduction etc. the main point of contention, quite often remains export subsides, (whether direct or in direct). as already mentioned in the text, it improves the relative business position of the exporting nations. there is a need to think constructively and objectively about the reasons behind these relaxations, whether they are for developing or developed nations. the principles of free trade along with fair trade should go together. in the wake of globalization, people have undoubtedly, become outward looking, but we cannot ignore the ethics and principles that have laid the foundation for the socio -economic and political structure of the nations. microsoft word finaltarjallemitkidis_katerina_peterkova_kpmmu (2).doc nordic journal of commercial law issue 2014#1 sustainability clauses in international supply chain contracts: regulation, enforceability and effects of ethical requirements by katerina peterkova mitkidis1 1 phd, ll.m. katerina peterkova mitkidis is a research assistant at the department of law and the arctic research center at the school of business and social sciences, aarhus university, denmark. she is further a board member and newsletter editor of the corporate social responsibility legal research network (http://law.au.dk/forskning/projekter/csr-lrn/). this article is an abstract of some few of the most important points in the author’s phd dissertation titled sustainability clauses in international business contracts defended in january 2014 at aarhus university (forthcoming as a monograph, eleven international publishing, 2014). nordic journal of commercial law issue 2014#1 1 abstract our current society is not successful in mitigation of global social and environmental challenges. states lack legal tools, and sometimes also the will, to secure social and environmental interests transnationally and the existing soft and private regulation is criticized for its weak legitimacy, effectiveness and enforcement. regardless of this regulatory gap, companies who do not comply with the globally accepted sustainability standards run reputational risks that can lead to long-term negative economic effects. moreover, stakeholders expect companies not only to follow the standards themselves but also to do business exclusively with socially responsible partners. unawareness, either intentional or negligent, of unethical behaviour within a company’s supply chain may lead to an assumption that the company is complicit in such a conduct. the paper discusses a hypothesis that sustainability contractual clauses (sccs) in international supply chain agreements may help to overcome the regulatory gap in relation to global sustainability while concurrently protect companies against potential social, economic and legal risks threatening in connection to unethical behaviour of their suppliers. as parts of enforceable business contracts, sccs are considered to overcome the heavily criticized softness of other csr regulation and, therefore, to be more successful in fostering ethical behaviour of suppliers who are legally independent but often in economic and business terms dependent on the sourcing companies. however, this hardening function is questionable faceto-face the lack of case law or another proof of sccs’ formal enforcement. this article aims to shed a light on the question whether sccs can be the efficient regulatory solution for global challenges we are looking for or whether they are yet another corporate social responsibility tool ‘without teeth’. the central questions are: why sccs are presumed to be effective regulatory means for global sustainability, how these clauses are seen through the lenses of international contract law and whether they can actually contribute to a positive change in suppliers’ social and environmental performance. based on the analysis of sccs’ features and the underlying regulatory framework, the author concludes that while sccs would not be enforceable by courts in most cases, they can still be successful in regulating global sustainability. their positive effects on suppliers’ behaviour will depend on how companies draft and use such clauses. it is suggested that the full potential of private contracting could be triggered by adequate governmental regulation. nordic journal of commercial law issue 2014#1 2 1 introduction the primary purpose of business is to strive for profit within the applicable legal framework. despite this, today we witness companies increasingly engage under the imperative of corporate social responsibility (csr),2 in the promotion of social and environmental standards, an activity that was traditionally in the sole responsibility of states.3 as governmental regulation of transnational social and environmental issues is failing, public and private actors have developed various other tools implementing csr into daily business operations. many of these tools (such as csr reporting or labelling) and their legal regulation have been widely discussed by legal scholars.4 this article examines one of the csr tools that has received much less academic attention,5 although it is extensively used in practice:6 social and environmental clauses in international supply chain contracts (hereinafter sustainability contractual clauses or sccs). as parts of business contracts, sccs are considered to overcome the heavily criticized softness of other csr regulation. however, this hardening function can be questioned because there is a lack of case law or other proof of sccs’ formal enforcement. thus, this article aims to shed a light on the question whether sccs can be the efficient regulatory solution for global challenges we are looking for or whether they are yet another csr tool ‘without teeth’. the promotion of social and environmental objectives and their balanced development has always belonged to the states’ competence and responsibility. however, despite intensive international efforts to reach sustainable development, an increasing number of national regulations and social pressure on companies to limit their socially and environmentally 2 for the purpose of this article csr is defined as business measures consistent with law and ethical standards under which companies accept the responsibility for the effects their activities have on the environment and society. 3 un hrc, ‘report of the special representative of the secretary-general on the issue of human rights and transnational corporations and other business enterprises, john ruggie: protect, respect and remedy: a framework for business and human rights’, un doc a/hrc/8/5, 7 april 2008 (hereinafter the protect, respect and remedy framework), part ii., par. 27-50. 4 for literature review on csr reporting see e.g. rüdiger hahn, michael kühnen, ‘determinants of sustainability reporting: a review of results, trends, theory, and opportunities in an expanding field of research’ (2013) 59 journal of cleaner production; for legal aspects of csr reporting see e.g. daniel gergely szabo, ‘mandatory corporate social responsibility reporting in the eu’ (phd thesis, aarhus university 2013); for csr labeling see e.g. mark a. cohen, michael p. vandenbergh, ‘the potential role of carbon labeling in a green economy’ (2012) 34 energy economics. 5 doreen mcbarnet, aurora voiculescu and tom campbell (eds) the new corporate accountability: corporate social responsibility and the law (cup 2009) 59. 6 michael p. vandenbergh, ‘the new wal-mart effect: the role of private contracting in global governance’ (2007) 54 ucla l. rev. 913; pace university school of law and iaccm report [2010] ‘the triple bottom line: the use of sustainability and stabilization clauses in international contracts’ (hereinafter iaccm report); katerina peterkova, ‘sustainability clauses in international business contracts’ (phd thesis, aarhus university 2014) 148-149. nordic journal of commercial law issue 2014#1 3 harmful activities, contemporary society is not successful in mitigation of global challenges, such as climate change or securing safe working conditions. continuous melting of ice in the arctic or the recent fires in bangladeshi garment factories serves asproof. unequal development and clashing social and economic interests of developed and developing countries lie in the midst of the regulatory conundrum and prevent us from reaching international consensus and viable solutions.7 moreover, while states generally have the competence to enforce compliance with national and international social and environmental standards against companies within their jurisdictions, they lack legal tools to secure the same compliance on their companies’ business partners abroad. on the one hand, private parties are not subject to international law and, on the other hand, the applicability of national law is geographically and personally limited. thus, while governments in developed countries adopt various regulations to limit socially and environmentally harmful activities of subjects under their jurisdiction, they indirectly create incentives for these subjects to outsource their activities to countries with weaker laws.8 the situation is further exacerbated as some developing countries do not fulfil their international obligations, i.e. they do not enforce international law within their territory, either because they lack the institutional capacity or because they fear an outflow of foreign investment.9 they may even purposefully relax their social and environmental regulation in order to create competitive advantage for their domestic companies.10 in this way a legal gap is created where private parties may escape from the legal consequences of the fact that their cross-border activities are not aligned with globally recognized social and environmental standards.11 this regulatory gap needs to be closed if we aim for effective solutions to global challenges. since states are not able or willing to meet their obligations in the environmental and social area, other actors, including non-governmental organizations, industrial associations and 7 michael p. vandenbergh and mark a. cohen, ‘climate change governance: boundaries and leakage’ (2010) 18 n.y.u.envtl.l.j. 221, 222. 8 ibid at 262 et seq; commission communication, 26 may 2010, com(2010) 265, oj 2011 c 121/15, s 4. 9 protect, respect and remedy framework, para 14. 10 this phenomenon is known as ‘race to the bottom’. while this topic is relevant to the article, it is not central to the main discussion and is not further followed here. from the vast amount of literature concerning this topic, see e.g. ian sheldon, ‘trade and environmental policy: a race to the bottom?’ 57 journal of agricultural economics 365. 11 alice de jonge, ‘transnational corporations and international law: bringing tncs out of the accountability vacuum’, (2011) 7 critical perspectives on international business 66, 67-68; andré sobczak, ‘are codes of conduct in global supply chains really voluntary? from soft law regulation of labour relations to consumer law’ (2006) 16 business ethics quarterly 167, 168. nordic journal of commercial law issue 2014#1 4 companies themselves, have taken on the task.12 they develop various types of soft and private regulations. companies, who do not comply with these legally non-binding regulations, run reputational damage risks that can lead to public shaming in media, drop in demand for their products, outflow of financing and loss of competitive advantage against their peers.13 moreover, the general public and other stakeholders, such as national governments or investors, expect companies not only to follow the standards themselves, but also to do business exclusively with socially responsible partners. companies are thus asked by their stakeholders, although they have no formal legal responsibility to do so,14 to act as global regulators and replace in this function states that have no available legal means to enforce rules on social and environment concerns internationally. unawareness, either intentional or negligent, of unethical behaviour within a company’s supply chain may lead to an assumption that the company is complicit in such a conduct. the case of technology giant apple inc. (apple) can serve as an example. in 2011, inhumane labour conditions at apple’s supplier foxconn in china were revealed. after the issue was discussed in media extensively, apple pledged to strengthen its suppliers’ audits.15 however, last year more issues were uncovered and apple was again at the centre of attention accused of lying.16 therefore, in order to protect themselves when engaged in cross-border activities that are not covered by state-based hard regulation and enforcement, companies employ various tools to control potential social, economic and legal risks in a manner that fits with both their business strategies and public expectations. most common csr tools include an articulation of corporate csr statements, adopting suppliers’ codes of conduct, participation in voluntary csr initiatives and csr reporting.17 however, these csr tools are voluntary, non-binding and unilateral activities and, thus, do not provide companies with sufficient coercive power over their business partners. some scholars have argued that the lack of factual leverage can be 12 ingeborg schwenzer and benjamin leisinger, b., ‘ethical values and international sales contracts’, in ross cranston, jan ramberg, jacob ziegel, j. (eds) commercial law challenges in the 21st century: jan hellmer in memoriam (iustus forlag 2007) 249. 13 from vast literature, see e.g. doreen mcbarnet, ‘corporate social responsibility beyond law, through law, for law: the new corporate accountability’, in mcbarnet, voiculescu and campbell, supra note 5. 14 similarly karin buhmann, ‘corporate social responsibility: what role for law? some aspects of law and csr’ (2006) 6 corporate governance: the international journal of effective board performance 188, 190. 15 apple supplier responsibility 2012 progress report <http://images.apple.com/supplierresponsibility/pdf/apple_sr_2012_progress_report.pdf> accessed 25 february 2014. 16 jim armitage, ‘'even worse than foxconn': apple rocked by child labour claims’ (the independent, 30 july 2013) <http://www.independent.co.uk/life-style/gadgets-and-tech/even-worse-than-foxconn-apple-rocked-by-child-labourclaims-8736504.html> accessed 13 february 2014. 17 paul hohnen, (author), jason potts, j. (ed), corporate social responsibility: an implementation guide for business (international institute for sustainable development 2007) <http://www.iisd.org/publications/pub.aspx?id=884> accessed 13 february 2014. nordic journal of commercial law issue 2014#1 5 overcome by imposing sustainability contractual obligations on business partners.18 with the backup of judicial enforcement, contracts give to soft law and self-regulatory csr instruments a hard law edge and may, therefore, be more successful in fostering ethical behaviour of suppliers who are legally independent but often in economic and business terms dependent on the sourcing companies. if that is correct, then many questions arise. why do governments not simply oblige companies to include sustainability clauses in all their business contracts? why is there no case law, when media reveal many breaches of contracts in this area? if contracts are not enforced through courts,19 how do they differ from unilateral tools, such as codes of conduct? can international supply chain contracts help to achieve sustainable development? these are some of the questions that are addressed in this article with the overall aim to investigate if contractual form indeed imparts hard law edge to social and environmental requirements and thus enhance global sustainability. the central questions are: why sccs are presumed to be effective regulatory means for global sustainability; how are these clauses seen through the lenses of international contract law; and whether they can actually contribute to a positive change in suppliers’ social and environmental performance. 2 sustainability contractual clauses before entering deeper into the topic, it is first necessary to define what sustainability contractual clauses are and how do they differ from other contractual content. sccs are provisions in business contracts that cover social and environmental issues which are not directly connected to the subject matter of the specific contract. this means that they do not specify the physical quality of the delivered goods,20 but rather prescribe how the parties should generally behave when conducting business.21 an example is a requirement to avoid child labour or to reduce emissions in the production process. the most common issues covered by sccs include the protection of human rights, labour conditions, environmental protection and anti-bribery provisions.22 when a supplier does not follow these standards, the product 18 see e.g. fabrizio cafaggi, ‘new foundations of transnational private regulation’ (2011) 38 j. law & soc. 20; eva kocher, ‘private standards between soft law and hard law: the german case’ (2002) 18 int.j.comp.l.l.i.r. 265, 266. 19 doreen mcbarnet and marina kurkchiyan, ‘corporate social responsibility through contractual control – global supply chains and ‘other regulation’’, in mcbarnet, voiculescu and campbell, supra note 5, at 79; fabrizio cafaggi, ‘the architecture of transnational private regulation’ (2011) eui working paper law 2011/12, european university institute, 9; li-wen lin, ‘legal transplants through private contracting: codes of vendor conduct in global supply chains as an example’ (2009) 57 am.j.comp.l. 711, 725. 20 lin, ibid at 717. 21 iaccm report, supra note 6, at 24. 22 ibid at 29. nordic journal of commercial law issue 2014#1 6 delivered may not suffer from any physical damage in the sense of lower usability or functionality, but may still have a lower market value.23 the breach, if discovered, may further damage the sourcing company’s reputation and thus have an impact on its long-term economic results. the list of covered issues shows that sccs protect rather general public interests than private interests of the contractual parties. the protected subjects are then third parties external to the specific deal, such as the suppliers’ employees.24 this does not correspond to the common understanding of a contract as a framework for a private transaction stipulating the rights and obligations of the parties to facilitate a specific exchange.25 moreover the protected economic interests are of long-term character (e.g. reputation building) rather than maximizing benefits of the specific exchange. overall, we can see that if sustainability requirements are cut out, the contract can still exist and the main objective can be carried out. the use of contracts for other than private exchange related purposes also shifts the notion of contract as such. from enforceable exchange of promises, contracts are becoming relational tools.26 from frameworks of private transactions, they move towards regulation of behaviour in general.27 from contracts between independent parties, they come closer to a type of organization.28 these shifts can be observed in a number of international business contracts. but it is in sustainability requirements that all of them are present at once. although sccs can appear in many different types of contract,29 this article focuses only on supply agreements concluded between a multinational company from a developed country and its suppliers from developing countries. the reason for this is not only to keep the research in a feasible extent, but mostly because supply chains of western-based multinationals are highly sensitive to unethical behaviour as shown in the example of apple. 23 schwenzer and leisinger, supra note 12, at 265. 24 joe phillips, suk-jun lim, ‘their brothers' keeper: global buyers and the legal duty to protect suppliers' employees’ (2009) 61 rutgers l.rev. 333, 369; james j. brudney, ‘envisioning enforcement of freedom of association standards in corporate codes: a journey for sinbad or sisyphus?’ (2012) 33 comp.lab.l.& pol'y j. 555, 580. 25 fabrizio cafaggi, ‘transnational private regulation and the production of global public goods and private ‘bads’’ (2012) 23 ejil 695, 711. 26 ian r. macneil, the new social contract: an inquiry into modern contractual relations (yale university press 1980); paul j. gudel, ‘relational contract theory and the concept of exchange’ (1998) 46 buff.l.rev. 763. 27 e.g. hugh collins, regulating contracts (oup 1999, reprinted 2005); fabrizio cafaggi (author), horatia muirwatt (ed), making european private law: governance design (edward elgar 2008) 2. 28 e.g. george s. geis, ‘the space between markets and hierarchies’ (2009) 95 va.l.rev. 99, 101-102; geunther teubner, networks as connected contracts (hart publishing 2011). 29 vandenbergh, supra note 6. nordic journal of commercial law issue 2014#1 7 3 why sustainability contractual clauses can be effective 3.1 an ineffective regulatory framework looking at the specifics of sccs in supply chain contracts acting on the background of ‘failing states’30 and continuous global challenges, we have to ask what gives us the confidence that sccs can be an effective means for global sustainability. the indications, suggesting that sccs could indeed be successful where other regulation fails, are several. first indication is the already mentioned lack of transnational binding regulation.31 while the legal vacuum is filled in by soft and private csr regulation, such regulation suffers from several shortcomings. csr regulation varies extensively in regards to the type of the regulating entity (public, public-private, private), the form (e.g. guidelines, codes of conduct), the content (e.g. general or industry specific requirements) and the scope of governed subjects (e.g. all companies or members of an initiative). yet, we can observe a similarity among these diverse regulations in regards to sccs. basically, all the regulations approach sccs as a tool to ‘harden’ their own soft nature and, thus, to overcome their deficiencies in respect to legitimacy, effectiveness and enforcement. the legitimacy of national and international law is derived from the state’s authority vested in it by the governed subjects.32 an alternative to such an authority is, however, missing at the transnational level.33 the uncertain legitimacy of transnational csr regulation leads to its lower effectiveness, which is furthermore undermined by a lack of verifiable reporting and monitoring systems.34 csr audits, the most common monitoring tools, are conducted without any connection to public authorities and the auditing entities have no formal power to enforce the findings. finally, transnational private and soft regulation is not generally subject to review by the national and international courts. the deficiencies characterize csr regulation as based on voluntary participation with questionable legitimacy and effectiveness and lacking formalized and consistent enforcement. hence, in order to secure and validate its role, the csr regulation needs means to remedy the 30 schwenzer and leisinger, supra note 12 at 249. 31 for the purpose of this article, transnational regulation is understood as all regulation which governs actions or events between or involving private entities that transcends (i.e. is applicable regardless) national frontiers. this includes both private regulation and governmental regulation. 32 deirdre curtin and linda senden, ‘public accountability of transnational private regulation: chimera or reality? (2011) 38 j. law & soc. 163, 164-165. 33 ibid; tineke elisabeth lambooy, corporate social responsibility: legal and semi-legal frameworks supporting csr (kluwer 2010) 256 et seq. 34 de jonge, supra note 11, at 72. nordic journal of commercial law issue 2014#1 8 deficiencies and drive compliance among business community and international supply chains. using the position of companies to insert csr regulation or requirements into their supply chain contracts is one of such few available means. international contracts are results of negotiation between contractual parties, thus the question of legitimacy does not arise here. while this is theoretically true, practice may appear different, since a majority of contracts concluded within international supply chains may not be products of negotiation but rather unilaterally imposed rules by economically stronger parties.35 moreover, sustainability requirements do not affect only the contractual parties but directly influence the life of third parties; global citizens.36 thus, we could discuss whether contractual parties have the authority to govern these issues. i argue that this should not be an issue, because unlike private regulatory regimes, contracts impose obligations only on parties who agree to them. they cannot oblige external subjects to adhere to a bilateral arrangement; these subjects may only benefit from the results. however, this opinion is valid only in the case where contracts are not the only regulation in the area, when states do not entirely pass the regulation onto private parties. contractual clauses and their enforcement are vulnerable and can easily be influenced by the economic interests of the contractual parties, and therefore although they contribute to positive changes, they should be rooted in a broader regulatory system. nevertheless, they are generally enforceable by courts, thus their effectiveness and enforcement is normatively secured. in the light of the foregoing, it seems that contracts can be the answer to the problems of csr regulations. this understanding is confirmed throughout the text of the main csr regulations and their accompanying documents. the articulation ranges from more subtle references to contracts to express requirements that contractual leverage is used. the best-known csr initiative,37 united nations global compact (ungc), requests its participants to extend their influence in the areas of child labour and environmental protection throughout their supply chains.38 the ungc practical guide on supply chain sustainability advises companies to clearly formulate their csr expectations towards their suppliers in a code of conduct and subsequently implement the code through its ‘integration … into supplier contracts’.39 a similar approach, when the regulation does not directly request companies to include sccs into their contracts, but the same can be found in the related documents, is used 35 mcbarnet and kurkchiyan, supra note 19, at 86-88; friedrich kessler, ‘contracts of adhesion – some thoughts about freedom of contract’ 43 colum.l.rev. 629, 640. 36 lin, supra note 19, at 742-742. 37 caroline schimanski [2013] an analysis of policy references made by large eu companies to internationally recognised csr guidelines and principles, european commission (directorate-general for enterprise and industry), at 7. 38 ungc, commentary to principle 5 and principle 8. 39 un global compact office and business for social responsibility [2010] supply chain sustainability: a practical guide for continuous improvement, at 23. nordic journal of commercial law issue 2014#1 9 in the protect, respect, remedy framework40 and the oecd guidelines for multinational enterprises (2011).41 a more direct request to use sccs is articulated in the iso 26000 guidance on social responsibility (iso 26000) that expects companies not to contract with risky partners42 and to influence their suppliers by imposing sccs upon them.43 an even stronger position towards the use of contracts for sustainability goals can be found in some business driven private initiatives, for example the business social compliance initiative (bsci).44 when becoming a member, each company has to commit and sign that it will ‘ensure’ that its subcontractors will comply with the requirements of the bsci code of conduct and make compliance with it a condition of all supply agreements. overall, the regulators realize that soft and private csr regulation does not effectively substitute missing governmental hard law. therefore, to fortify the csr regulation’s effects, they require companies to use contracts, as hard legal tools, to influence behaviour in their supply chains. 3.2 the growing regulatory power of companies the next suggestion for the success of contracts in regulating global sustainability is the constantly growing power of multinational companies. the concept of a company as a legal entity was originally established to make profit for its owners while providing goods and services to society at large.45 however, in the current global economy, companies are no longer merely legal concepts, but also strong economic, and therefore also political and regulatory, actors. according to the world investment report of the un conference on trade and development, there were approximately 82,000 transnational corporations worldwide in 2009. their economic power was demonstrated by the fact that the 100 largest of them accounted for about 4 % of world gdp.46 moreover, from the 100 world largest economies in 2000, only 49 were 40 un ga, a/hrc/8/16, 15 may 2008; un mandate of the special representative of the secretary-general on human rights and transnational corporations and other business enterprises (srsg), the corporate responsibility to respect human rights in supply chains, 10th oecd roundtable on corporate responsibility, discussion paper, 30 june 2010. 41 oecd, oecd guidelines for multinational enterprises (oecd pub 2011), commentary on general policies, paras 18, 19 and 21. 42 iso 26000, paras 5.2.3 and 6.3.5.2. 43 iso 26000, para 7.3.3.2. 44 <https://www.bsci-intl.org/> accessed 24 february 2014. 45 archie b. carroll, ‘the pyramid of corporate social responsibility: toward the moral management of organizational stakeholders’ (1991) 34 business horizons 39, 40-41. 46 unctad [2009] world investment report, vol. 1, transnational corporations, agricultural production and development, chapter 1 (b), at 17. nordic journal of commercial law issue 2014#1 10 countries and 51 are corporations.47 general motors, as the largest company, was ranked above economies such as those of norway and denmark.48 with their strong economic power and transnational reach, companies have the means to influence political and legislative processes (most obviously by lobbying, sponsoring and signing bilateral investment agreements with national governments) as well as the everyday life of people worldwide (through e.g. the environmental effects of their operations and employment policies) and other business entities, especially those in their supply chains. from being governed they are evolving into governing entities,49 yet without being subjected to international law obligations.50 3.3 widespread use of sustainability contractual clauses the third indication of the effectiveness of sccs is the fact that they are not a sporadic but widespread phenomenon. they can be found in the majority of business contracts concluded in recent years. a study from 2007 found that over 50 % of the sample companies include one or more types of environmental requirements in their business contracts.51 a later study from 2010 showed a rapid increase in these contractual practices, whereby almost 80 % of the sample companies stated that they had previously imposed sustainability requirements upon their business partners.52 finally, a study of self-reported information in sustainability reports and corporate websites from 2013 revealed that companies use four types of commitments to impose sustainability requirements upon suppliers.53 first, just over 50 % of the investigated companies report inserting the requirements directly into their supply chain contracts. about 35 % report demanding of their suppliers that they comply with certain sustainability requirements, although they do not speak of a binding form. 25 % of the sample companies report that they request their suppliers to commit in writing to sustainability standards prior to entering into a contract. finally, approximately 13 % of the sample companies only recommend to their suppliers to follow sustainability practices, but do not make it a condition of the mutual business relationship at any level. 47 sarah anderson and john cavanagh [2000] top 200: the rise of corporate global power, institute for policy studies. 48 ibid. 49 protect, respect and remedy framework, para 2. 50 see alice de jonge, transnational corporations and international law: accountability in the global business environment (edward elgar publishing 2011); de jonge, supra note 11. 51 vandenbergh, supra note 6. 52 iaccm report, supra note 6, at 26. 53 peterkova, supra note 6, at 148-149. nordic journal of commercial law issue 2014#1 11 the widespread use of sustainability contractual clauses means that certain best practice has or is developing in this respect. thus, it is easier to build upon an already started trend than to impose new obligations upon companies. 3.4 enforceability through contract law the final indication of sccs’ potential is their normative enforceability through international contract law rules. a contract for the sale of goods is one of the oldest legal instruments in the world.54 although differences exist between individual jurisdictions, many principles of contract law are similar across the globe; these include the principle of contractual freedom, the underlying moral imperative pacta sunt servanda and the enforceability of contracts through public legal institutions. the legal system of contracts’ enforcement copes rather well with the growing number of interand transnational private transactions. where parties do not choose applicable law, default law will be determined according to the international private law rules, often leading to the applicability of the convention on contracts for the international sale of goods (cisg) as a part of the applicable national law.55 when adopting cisg, the aim of the legislators was to agree on uniform rules applicable to contracts for sale of goods concluded between parties situated in different states, without recourse to international private law rules. there is no reason per se why the cisg should not apply to sccs that form part of a contract if the applicability requirements are met.56 once applicable, cisg may help to answer the question of whether sustainability requirements have become a valid part of a contract, how they should be interpreted, whether or not their breach causes a non-conformity in the delivered goods and what remedies parties may claim in the event of breach. however, we should bear in mind that many countries, which are considered problematic from the csr perspective, are not the contracting states to cisg.57 not only because of this reason also other instruments of international contract law, although of soft nature, may become relevant and applicable. these instruments include the unidroit principles of international commercial contracts 2010 (upicc) and the principles of european contract law (pecl). both upicc and pecl 54 richard a. posner, ‘creating a legal framework for economic development’ (1998) 13 world bank research observer 1, 2. 55 united nations convention on contracts for the international sale of goods, (adopted 10 march to 11 april 1980, entered into force 1 january 1988) 1489 unts 3. 56 cisg arts 1, 2 3, 4, 5, 6 and 7(2). 57 cf bsci risk countries list (<http://www.bsci-intl.org/resources/rules-functioning> accessed 26 february 2014) and cisg contracting states (<http://www.uncitral.org/uncitral/en/uncitral_texts/sale_goods/1980cisg_status.html> accessed 26 february 2014). nordic journal of commercial law issue 2014#1 12 were prepared by groups of experts with the aim of re-stating international contract law in the form of non-binding instruments. the soft character allowed covering also those issues that were excluded from cisg, e.g. third parties’ rights.58 as soft law instruments, the applicability of upicc and pecl is more complex than in the case of cisg. they do not constitute a part of national legal systems, but may be still applied by courts and other dispute resolution bodies in certain situations.59 they might also be used to interpret or fill in gaps in other applicable international and national laws, including cisg.60 as in the case of cisg, there is no formal barrier to upicc and pecl being applied to sccs, although they were not drafted with this purpose in mind. the two soft-law instruments may soon be accompanied yet by another one – the eu regulation on a common european sales law (cesl).61 however, for now, cesl remains only a proposal for a legislative act. despite some inherent flaws of the international law of contracts,62 the system is pretty clear, accessible to private parties and tailored for international business relations. therefore, provided that sccs do not prescribe anything illegal or impossible, they should be enforceable under the international law of contracts.63 4 enforceability of sustainability contractual clauses 4.1 form from the presented preconditions it appears that contracts can be successful where other regulation fails. however, this conclusion must be critically assessed. while the ineffective 58 michael joachim bonell, ‘the cisg and the unidroit principles of international commercial contracts: two complementary instruments’ (2008-2009) 10 international law review of wuhan university 100, 103. 59 upicc, preamble. 60 see e.g. anukarshan chandrasenan, ‘unidroit principles to interpret and supplement the cisg: an analysis of the gap-filling role of the unidroit principles’ (2007) 11 vindobona journal of international commercial law and arbitration 65; for the opposite view, see lucia carvalhal sica, ‘gap-filling in the cisg: may the unidroit principles supplement the gaps in the convention? (2006) 1 njcl. 61 commission legislative proposal on a common european sales law, 11 october 2011, com(2011) 635, oj 2012 c 37/04; jan smits ‘the common european sales law (cesl) beyond party choice’ (2012) 20 zeup 904. 62 unified interpretation and application is one of the most problematic issues; see e.g., frank diedrich, ‘maintaining uniformity in international uniform law via autonomous interpretation: software contracts and the cisg’ (1996) 8 pace int'l l.rev. 303. 63 schwenzer and leisinger, supra note 12. nordic journal of commercial law issue 2014#1 13 regulatory framework, widespread use of sccs and growing power of multinational enterprises are undeniable facts, the enforceability of sccs through applicable contract law raises some concerns, especially facing the lack of case law. therefore, it is necessary to examine if and how the features of sccs influence their enforceability. first of all, a sustainability clauses must become a valid part of a contract in order to be enforced. companies and their suppliers should be aware that csr standards may become an integral part of a contract not only by their direct implementation into the contractual text, but also by reference to another document, such as a code of conduct or a soft law instrument.64 while express provisions do not pose any formal problems, the incorporation by reference can sometimes raise concerns as to whether the referenced document becomes validly a part of the contract. we can find guidance in international rules regarding standard terms and conditions. basically, a code of conduct or any other csr document may qualify as standard terms and conditions,65 if it is drafted by one party only in advance of the contract and intended for general and repeated use.66 in order to establish if a referenced document became a part of a contract we have to look into the form and content of the reference. international contract law does not provide any specific rules in this respect; therefore, the general rules on interpretation of the parties’ intentions will apply. the reference must be made in such a form and language that a reasonable person would comprehend that the mentioned document is intended to form part of the contract.67 it does not need to be in writing or signed.68 furthermore, it does not need to be placed directly in the contractual text, but it can be for example made clear during pre-contractual negotiations.69 thus, signing a code of conduct by a supplier in the pre-contractual phase, which states that the buyer intends to cooperate only with suppliers fullfilling therein-stipulated requirements, may be interpreted as incorporation of the code as standard terms and conditions into the contract.70 moreover, it is necessary that suppliers become aware of the content of the 64 vandenbergh speaks of ‘embedded agreements’, see michael p. vandenbergh, ‘the private life of public law’ (2005) 105 colum.l.rev. 2029, 2045. 65 louise vytopil, ‘contractual control and labour-related csr norms in the supply chain: dutch best practices’ (2012) 8 utrecht law review 155, 166. 66 upicc art 2.1.19; pecl art 2.209 (3); cesl art 2 (b); the cisg does not contain a special provision on standard terms and conditions. 67 ingeborg schwenzer (ed), schlechtriem & schwenzer commentary on the un convention on the international sale of goods (cisg) (3rd edn, oup 2010), art 14, para 37. 68 ibid. 69 stefan vogenauer and jan kleinheisterkamp (eds), commentary on the unidroit principles of international commercial contracts (picc) (oup 2009), art 2.1.19, para 13. 70 ibid art 2.1.19, para 13. nordic journal of commercial law issue 2014#1 14 referenced csr documents.71 a mere statement that a supplier must fullfil requirements stipulated in a code of conduct is not sufficient;72 he must be also able to access the text.73 except for express provisions or incorporation by reference, some authors argued that sustainability requirements become part of international contracts impliedly, without the necessity of contractual parties expressly acknowledging them. 74 this may happen through the concepts of practices that the parties have established between themselves or international trade usages.75 a practice between parties can be established in a repeated or long-lasting business relationship.76 in the csr context, a practice may for instance emerge in relation to monitoring and enforcement of sustainability requirements. this may happen when a company adopts a suppliers’ code of conduct stating the possibility of compliance monitoring through third-party audits, but does not incorporate it in its supply agreements. then, if a supplier repeatedly allows the audits to take place and consequently accepts and follows eventual corrective action plans, we could assume that the compliance monitoring became an established practice between the parties. parties are also bound by trade usages that are widely known and regularly observed by traders involved in the particular trade and of which the parties knew or ought to have known.77 schwenzer and leisinger suggest that observance of ethical standards constitutes such an international trade usage.78 however, i argue that the scope of csr obligations that would fall under the usage is not clearly established. we may compare all the public and private csr initiatives and derive the common standards from them. however, the fact that there are some standards that a majority of companies agree would be good to follow does not mean that they are actually followed.79 for example, while we could accept that the ban of child labour is theoretically accepted standard, the practice is different as breaches are common. thus, i argue that we cannot consider general sustainability requirements to form an international trade usage as yet. however, sets of rules specific to individual industries may be found to function as 71 cisg and upicc derive the obligation from the rules on the contract formation; cesl art 70(1). 72 it may be sufficient if the supplier has ‘an actual and positive knowledge’ of the code, see schwenzer, supra note 67, art 14, para 39. some domestic legal systems are less strict; see vogenauer and kleinheisterkamp, supra note 69, art 2.1.19, para 17. 73 machinery case (bgh, 31 october 2001, viii zr 60/01). 74 schwenzer and leisinger, supra note 12. 75 cisg art 9; upicc art 1.9; pecl art 1:105; cesl art 67. 76 schwenzer, supra note 67, art 9, para 8. 77 schwenzer, supra note 67, art 9, para 16. 78 schwenzer and leisinger, supra note 12, at 264. 79 schimanski, supra note 37 (the study found that only 32 % of companies refer to the ungc; however, the ungc was still the initiative referred to most often). nordic journal of commercial law issue 2014#1 15 trade usage if they are not only proclaimed by the majority of traders in those industries but also observed by the parties. 4.2 content of sustainability clauses the content of sccs varies greatly in relation to the topic and protected interests as well as the style, length and specificity of language, and hence may influence their enforceability. next to substantive rules, international contracts also contain certain implied terms on the parties’ obligations regarding their mutual relationship. such additional terms can be derived from the principle of good faith.80 this principle has a general character, underlying all international contracts, as well as specific applications, such as the parties’ duty to cooperate and the ban on inconsistent behaviour. the duty to cooperate implies that parties should render to each other reasonable cooperation to perform their contractual obligations.81 suppliers could for example argue that a buyer did not cooperate enough if he requests that the suppliers act in socially responsible manner, but in reality thwarts compliance by other contractual terms (typically low prices or last-minute changes in orders).82 the principle that the parties should not act inconsistently then for example implies that if a buyer implements a code of conduct into a contract by reference, but does not enforce it for a span of several years, he should not be able to enforce it suddenly without giving to the supplier prior notice.83 moreover, it was already stated above that sccs are disconnected from the subject matter of a contract. such separation from the core of a business agreement may complicate assessment of supplier’s compliance and also the enforcement of the provisions via traditional remedies.84 the final theme to mention in relation tothe content of sccs, and also one of the most difficult features of sccs to grasp, is the level of language specificity. the used language may influence the understanding and interpretation of a provision by the contractual parties and, thus, the scope of parties’ obligations and available remedies. it is therefore important for companies to choose such a level of specificity that the contractual provisions bind suppliers to the extent that the companies require. it is not an easy task to find appropriate language in the csr area, where regulation is quickly changing, a certain level of non-compliance is often 80 upicc arts 1.7 and 5.1.2; pecl art 6:102; cesl art 68. in cisg, good faith is considered a general principle of the convention, see ulrich magnus, ‘comparative editorial remarks on the provisions regarding good faith in cisg article 7(1) and the unidroit principles article 1.7’, in john felemegas (ed.), an international approach to the interpretation of the united nations convention on contracts for the international sale of goods (1980) as uniform sales law (cup 2007); vogenauer and kleinheisterkamp, supra note 69, art 1.7, para 2. 81 upicc art 5.1.3. 82 mcbarnet and kurkchiyan, supra note 19, at 88. 83 vogenauer and kleinheisterkamp, supra note 69, art 1.8, para 11. 84 see s 4.4.2 below. nordic journal of commercial law issue 2014#1 16 expected and the provisions have to balance relationship and risk management.85 thus, although the conventional economic rationale of commercial contracts pushes the parties towards avoiding the costs and risk of litigation by formulating contractual terms as precisely as possible,86 there are reasons why companies choose to adopt vague contractual terms. they may do so if they have low negotiation power, their csr strategy is not strong enough, they wish to retain flexibility of the contract,87 it is hard to control and measure the compliance, they wish to communicate goals and values to their business partners rather than to future judges88 or there is no concrete statutory sanction threatening.89 leaving sccs vague may be beneficial for the parties and may be more helpful in reaching the objective of sustainable development. however, vague terms open up room for ambiguous interpretations, which may cause problems, especially in the event of their enforcement through review by the courts. the courts will have to apply the rules on contract interpretation, looking into parties’ intentions and behaviour, the circumstances of the contract (including the preliminary negotiations), usages and practices, the nature and purpose of the contract, the common meaning of the terms and possibly good faith.90 using vague terms may thus cast doubts on the applicability of the underlying contract law and the enforceability of the terms. such doubts undermine the notion of sccs’ binding nature, which is an important incentive for compliance even if the parties do not intend actually to use the formal enforcement mechanisms.91 4.3 third parties 4.3.1 rights of third parties another aspect of sccs to examine is their influence over out-of-contractual subjects. according to the principle of privity of contract, a contract may confer rights and impose 85 tim coltman et al., ‘supply chain contract evolution’ (2009) 27 european management journal 388, 389. 86 george g. triantis, ‘the efficiency of vague contract terms: a response to the schwartz-scott theory of u.c.c. article 2’ (2002) 62 la.l.rev. 1065, 1067; karen eggleston, eric a. posner; richard zeckhauser, ‘the design and interpretation of contracts: why complexity matters’ (2000) 95 nw.u.l.rev. 91, 104-106. 87 mcbarnet and kurkchiyan, supra note 19, at 70; collins, supra note 27, at 167 et seq. 88 triantis, supra note 86, at 1073. 89 eggleston, posner and zeckhauser call this reason ‘political economy’ (supra note 86, at 105); louis kaplow, 1992, ‘rules versus standards: an economic analysis’ (1992) 42 duke l.j. 557, 559-560. 90 cisg art 8; upicc ch 4; pecl ch 5; cesl ch 6. 91 cf. glinski, supra note 135, at 123. nordic journal of commercial law issue 2014#1 17 obligations only on the contractual parties.92 however, under some circumstances, this principle will be relaxed and third parties may accrue certain rights.93 there are two situations where third parties are relevant to sccs’ enforcement: firstly, when third parties try to enforce the contract between the buyer and the supplier, and secondly, when the buyer tries to extend the applicability of sccs beyond first tier suppliers. corporate csr policies have always been criticized for their ‘greenwashing’ purposes, low effectiveness and soft nature.94 proponents of csr as well as subjects influenced by ethically tainted behaviour have tried to find creative ways to ensure that companies keep to what they pledge. they have used the claim of false advertisement, breach of unilateral promises and other third party beneficiaries’ claims. false advertising cannot be used directly to enforce sccs as contracts are addressed to suppliers. however, it can be claimed in order to enforce companies’ public statements that sustainability standards are part of supply agreements, whose compliance is monitored by the company in question.95 therefore it is crucial for companies to make good choices as to what they include in their sustainability reports or websites. the possibility to claim breach of unilateral contracts, i.e. unilateral statements that create contractual relationships, depends on the specific jurisdiction. european contract law instruments suggest that a unilateral statement may be enforceable if the person making it intends to create binding effects.96 the intention is to be determined from how the addressee would reasonably understand it.97 in the usa, courts have developed the doctrine of ‘unilateral contract’, under which unilateral statements can have a contractual character although the subjects making them do not intend to extend a contractual offer to the addressees.98 the 92 justinian’s institutes, 3 19 19; see jan hallebeek, ‘contracts for a third-party beneficiary : a brief sketch from the corpus iuris to present-day civil law’ (2007) 13 fundamina: a journal of legal history 11, 12. 93 ingeborg schwenzer and mareike schmidt, ‘extending the cisg to non-privity parties’ (2009) 13 vindobona journal of international commercial law & arbitration 109, 109. 94 see e.g. subhabrata bobby banerjee, ‘corporate social responsibility: the good, the bad and the ugly’ (2008) 34 critical sociology 51; igor m. alves, ‘green spin everywhere: how greenwashing reveals the limits of the csr paradigm’ (2009) 2 journal of global change & governance 1; for new perspective of the criticism of csr see gerard hanlon, peter fleming, ‘updating the critical perspective on corporate social responsibility’ (2009) 3 sociology compass 937. 95 a landmark case is kasky v. nike, inc., 45 p.3d 243 (cal. 2002); nike, inc. v. kasky, 539 u.s. 654 (2003). see also european center for constitutional and human rights and the clean clothes campaign against the german retailer lidl (heilbronn district court, germany). 96 pecl art 2:107; study group on a european civil code and the research group on ec private law (acquis group), principles, definitions and model rules of european private law, draft common frame of reference (dcfr) (outline edition, selier 2009), art 4:301. 97 cf dcfr art 4.302. 98 pine river state bank v. mettille, 333 n.w.2d 622, 115 l.r.r.m. 4493 (minn. 1983); see also brudney, supra note 24, at 577. nordic journal of commercial law issue 2014#1 18 walmart case99 however showed that the language used and the method of dissemination will be absolutely essential in establishing the existence of such a contract. finally, external subjects may pursue rights as third party beneficiaries. with some differences, the general conditions for creation of a third party right under international contract law instruments are similar.100 as a starting point, the contractual parties must intend to confer such a right. the intention can be either expressed or implied in the contract.101 normally, a third party’s right will not be found if a third party benefitted from the contract only incidentally.102 it has been argued that this cannot happen in the csr area as the essential goal of buyers’ codes is to benefit workers or other parties such as people living in the vicinity of suppliers’ factories.103 however, some also claim that the right can only arise from promissory obligations to benefit others and not from obligations not to harm others, which is relevant especially in relation to environmental and anti-corruption issues.104 furthermore, the conferred right must be specific. if there is no clear right, for example because vague language is used, there can be no breach. lastly, the third party must be identified with adequate certainty, at least as a member of a specific group.105 this requirement can be especially complicated in relation to breaches of a contractual duty of care where there is an indefinite number of third party beneficiaries,106 such as in relation to carbon emissions that have global consequences.107 while the various third parties’ strategies have not hitherto been successful at courts,108 they have not been entirely rejected either. the success of such claims will largely depend on the formulations of sccs. companies are aware of this ‘open door’ and try to minimize the possible risks by the inclusion of disclaimers in their contracts.109 however, we can see positive indirect effects of these strategies; the negative advertising connected to any formal proceeding force companies to change their csr strategies, namely to become more transparent and 99 doe v. wal-mart stores, inc., 572 f.3d 677 (9th cir. 2009) (walmart case). 100 upicc ch 5 s 2; pecl art 6:110; cesl art 78. cisg does not provide for third party beneficiaries’ rights, see art 4. cf schwenzer and schmidt, supra note 93, at 114. 101 vogenauer and kleinheisterkamp, supra note 69, art 5.2.1, para 11. 102 walmart case. 103 phillips and lim, supra note 24, at 369; brudney, supra note 24, at 580. 104 stephen a. smith, ‘contracts for the benefit of third parties: in defence of the third-party rule’ (1997) 17 oxford journal of legal studies 643, 646. 105 vogenauer and kleinheisterkamp, supra note 69, art 5.2.2, paras 3-5. 106 a duty to care is a legal obligation, under which a subject is obliged to exercise reasonable care in performing actions that could result in harm to others. 107 george s. geis, ‘broadcast contracting’ (2012) 106 nw.u.l.rev. 1153. 108 most cases being dismissed or settled out of court. 109 for example, art 15.8 of the product and service supply agreement of verizon australia pty. limited, version pssa –australia_051010-2 <www.verizonenterprise.com/resources/legal/au-vzb-pssa_en_xg.pdf> accessed 26 february 2014. nordic journal of commercial law issue 2014#1 19 honest about them. therefore, the third parties’ actions can be seen as more of a ‘stakeholder tactic’, rather than a personal attempt by the plaintiffs to gain compensations for their losses. 4.3.2 extension of sccs beyond first-tier suppliers implementation of csr issues into international supply contracts is a positive step towards global sustainability; however, it may lead nowhere if the provisions are not enforced throughout the whole supply chain.110 this remains a major issue in csr, since buyers may force compliance on their direct suppliers, but face difficulties in achieving compliance of further supply chain tiers with whom they have no direct legal relationship.111 looking at this conundrum, one possibility would be to treat sccs as a kind of warranty. implied warranties of merchantability and fitness for a particular purpose are in some jurisdictions automatically transferred with the goods’ ownership on each subsequent buyer.112 a sub-buyer then enforces the warranty via a direct contractual claim against the original seller. however, as sccs do not influence the tangible quality of goods, they can hardly create such claims. moreover, although the extension of implied warranties to subsequent buyers is well established in some jurisdictions, it is still unknown in others.113 hence a question arises as to which law is applicable to decide the admissibility of the claim.114 if we take international contract law as the applicable legal framework, such claim would not most probably be admissible.115 since the legal enforcement of contracts between two upstream subjects in a supply chain is not realistic, the regulators expect that companies will couple the contractual chain of csr requirements with due diligence processes.116 however, the buyers will find themselves in exactly the same situation: able to control their direct suppliers but unable to control the execution of due diligence by sub-suppliers. so, although such requirements strengthen the pressure on direct suppliers, they may not secure greater confidence of buyers in relation to further tiers of their supply chains. yet, extending the applicability of sccs up the supply chain 110 margaret m. blair, cynthia williams and li-wen lin, ‘the new role for assurance services in global commerce’ (2008) 33 j.corp.l. 325, 337 et seq. 111 fabrizio cafaggi (ed), enforcement of transnational regulation: ensuring compliance in a global world (edward elgar 2012) 6. 112 schwenzer and schmidt, supra note 93, at 111-113; nicolas carette, ‘direct contractual claim of the sub– buyer and international sale of goods: applicable law and applicability of the cisg’ (2008) 16 erpl 583, 586. 113 carette, supra note 112, at 589. 114 donald j. smythe, ‘the road to nowhere: caterpillar v. usinor and cisg claims by downstream buyers against remote sellers’ (2011) 2 george mason j.i.c.l., 123. 115 caterpillar, inc. v. usinor industeel, 393 f. supp 2d 659 (n.d.ill. 2005). 116 srsg, supra note 40, at 5-6. nordic journal of commercial law issue 2014#1 20 remains one of the few available tools to cope with the imposed duty to manage sustainability throughout the whole supply chain. 4.4 remedies 4.4.1 three-step best practice: monitoring, relational enforcement, contract termination the last feature to consider when assessing the enforceability of sccs under the international contract law is the range of available remedies and other enforcement tools. an extension of sccs beyond first-tier suppliers is a complex issue, but not even a direct legal relationship ensures that sustainability requirements will or even can be effectively monitored and enforced. on the one hand, companies may not intend to do that, if they merely use sccs as a part of their ‘greenwashing’ strategy. on the other hand, companies sincerely pursuing sustainability goals may encounter a lack of enforcement tools or suppliers’ resistance to cooperate. before analysing various enforcement tools, the meaning of ‘enforcement’ should be briefly discussed. enforcement is not always of a formal legal character. even better results can, and often are, achieved through informal processes, such as reputation effects. the latter predominates in relation to sccs. companies do not start formal enforcement procedures, but rather choose informal ways to secure suppliers’ compliance.117 one reason is that formal proceedings have a major drawback they have a remedial character, while the character of sccs is preventive, aiming at avoiding negative impacts of corporate behaviour on third parties,118 assuring suppliers’ compliance with sustainability objectives and managing business and legal risks in the case a breach occurs.119 for this purpose, companies have developed a three-step best practice. the first step of sccs’ enforcement preventive monitoring is essential, because noncompliance is not detectable after the goods are delivered.120 for example, we cannot see from the goods’ appearance that children were used to produce it. the majority of companies use suppliers’ self-assessment to start with. it is often required during the suppliers’ selection 117 lin, supra note 19, at 724. 118 ibid at 726. 119 mcbarnet and kurkchiyan, supra note 19, at 75; fabrizio cafaggi, ‘the regulatory functions of transnational commercial contracts: new architectures’ (2013) 36 fordham int'l l.j. 1557, available through < http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2153096&download=yes> accessed 26 february 2014, at 29. 120 schwenzer and leisinger, supra note 12, at 265. nordic journal of commercial law issue 2014#1 21 process as a part of risk assessment and due diligence as well as during the contractual term. as a cheap although highly subjective alternative, self-assessments can be conducted often and commonly serve as detecting ‘red flag’ issues, which are then further followed up by suppliers’ audits.121 a variety of audits exists, including internal and external, announced and unannounced audits on site, audits coordinated among groups of firms and according to different audit standards. each type has some associated positives and negatives, but all of them face a common criticism pointing towards unreliable and subjective results and corruption practices.122 in response to the criticism, companies are becoming more transparent about the audit results.123 this information, despite its possible incompleteness, is absolutely essential for implementing any practical change in suppliers’ behaviour through various soft and hard remedial strategies. if non-compliance is discovered, the buyer will usually work with the supplier to find solutions. the most common tool that companies use is a so-called corrective action plan, under which the parties agree what the supplier must do to remedy the breach. sometimes, the buyer will even provide a supplier with capacity building resources, such as training or assistance. the aim of these relational strategies is to secure compliance with sustainability requirements in a collaborative manner and avoid disputes. it is common that buyers expect a certain level of noncompliance among their suppliers and thus do not break off cooperation if a supplier is willing to improve. in addition to the positive relational enforcement tools, companies may also rely on name-andshame strategies. an increasing number of csr initiatives establish a database of compliant suppliers.124 a supplier, who is erased from such a database or, worse still, listed as noncompliant can no longer be used by members of the specific initiative. relational enforcement tools are essential for the effectiveness of sccs as they aim to actually change behavioural patterns in supply chains. however, although neither companies nor regulators stress it, the effectiveness of the relational tools is grounded in the threat of formal legal sanctions.125 this reliance on the indirect enforcement power of formal legal sanctions is 121 e.g. johnson&johnson responsibility report 2011 <https://www.jnj.com/sites/default/files/pdf/2011responsibilty-report.pdf> accessed 26 february 2014, at 27. 122 clean clothes campaign report [2005] looking for a quick fix: how weak social auditing is keeping workers in sweatshops, at 17-31; mcbarnet and kurkchiyan, supra note 19, at 77-78. 123 e.g. nestlé creating shared value report 2011 <http://www.nestle.com/assetlibrary/documents/library/documents/corporate_social_responsibility/2011-csv-report.pdf>, at 145. 124 e.g. icti care program in the toy industry <http://www.icti-care.org/e/content/cat_page.asp?cat_id=211> accessed 26 february 2014. 125 yehuda adar and moshe gelbard, ‘the role of remedies in the relational theory of contract–a preliminary inquiry’ (2011) 7 ercl 399, 405-406; robert a. kagan, neil gunningham and dorothy thortnton, ‘fear, duty and regulatory compliance: lessons from three research projects’, in christine parker and vibeke lehmann nielsen (eds) explaining compliance: business responses to regulation (edward elgar publishing 2011) 41. nordic journal of commercial law issue 2014#1 22 evident from the frequent reservation of the right to terminate a contract if the supplier’s noncompliance is not remedied. contract termination play an important role; a refusal to source from a supplier is considered as the most severe punishment.126 although contract termination is a remedy provided to a buyer under all international contract law instruments,127 it is most often executed outside of any formal enforcement proceedings; a company may simply stop placing orders to the supplier.128 if it comes to a formal disagreement about the right to terminate, the court would have to establish whether the breach in question amounted to a fundamental breach.129 this is easy if the contract states that non-compliance with sccs constitutes a fundamental breach,130 but much more difficult if it does not. usually, a fundamental breach is found when the main obligation under a contract is not fulfilled.131 a breach of ancillary obligations can also result in a fundamental breach, but most probably not if those obligations were not connected to the goods’ non-conformity.132 a fundamental breach must also be foreseeable according to the general rules on contract interpretation. the main aspect to examine in this respect will once again be the language of the sccs and/or the manner in which the supplier was informed of the buyer’s csr standards.133 at the end, it should be stressed that termination of a relationship with a non-compliant supplier is not an effective way of using sccs for sustainability goals. on the contrary; contract termination means that the supplier will not change its behaviour or, perhaps more relevantly, that the buyer does not help the supplier to change its behaviour. therefore, it can be concluded that the possibility of contract termination plays an important role in the use of sccs, but the role relates more to the deterrence function of such a provision than its actual use. in this sense, underlying contract law is crucial in allowing multinational buyers to exert legal pressure over their suppliers. 126 collins, supra note 27, at 101. 127 cisg art 49; upicc ch 7 s 3; cesl ch 11 s 5; pecl ch 9 s3. 128 kocher, supra note 18, at 268. 129 cisg art 25; upicc art 7.3.1(2); cesl art 87(2)(a); pecl art 8:103. schwenzer and leisinger, supra note 12, at 268. 130 e.g. boeing research and technology (br&t) non-government general terms & conditions (10/12/2010), <http://www.boeingsuppliers.com/terms_conditions/rd_gp_10-12-10.pdf> accessed 26 february 2014, at 11-12. 131 schwenzer, supra note 67, art 25, paras 57-58. 132 vogenauer and kleinheisterkamp, supra note 69, art 7.3.1, para 87. 133 on foreseeability see schwenzer, supra note 67, art 25, paras 26-33. nordic journal of commercial law issue 2014#1 23 4.4.2 specific performance and damages a brief note should address the other two typical contractual remedies next to contract termination specific performance and damages although they are not used in the enforcement practice of sccs. specific performance actually cannot be used in relation to sccs, since these requirements do not relate to the physical product quality.134 the courts have been reluctant to recognize csr production method-related requirements as product characteristics in consumer cases, and it can be expected that the same would happen in business cases as well.135 in order to claim damages under international contract law the buyer then has to prove a breach, damage that was foreseeable and a causal relationship between the two.136 all may pose problems in relation to sccs. firstly, a breach can occur only where there is a binding obligation. as discussed earlier, the binding nature of sccs is dependent on the relevant provision’s form and specificity. secondly, if an scc is breached, most likely a non-pecuniary damage occurs, usually a reputational harm. whereas upicc and pecl expressly provide for the possibility of recovering non-pecuniary loss,137 the same is the subject of an academic discussion and contradicting court decisions under cisg138 and it is expressly excluded in relation to reputational loss by cesl.139 finally, the causal relationship between breach of an scc and relevant damage will often be ‘a matter of speculation and guesswork’.140 and it will be even harder if a buyer claims a future loss, which must be proved with reasonable certainty.141 it may be impossible to reach reasonable certainty, unless the buyer for example faces litigation by third parties due to the breach in question and expects to lose it. in the light of the foregoing, it seems that awarding damages for breaches of sccs under international contract law it is not feasible. although theoretically not impossible, the practical limitations appear to be simply too complex. 134 supra note 20. 135 kocher, supra note 18, at 270; carola glinski, ‘corporate code of conduct: moral or legal obligation?’ in mcbarnet, voiculescu and campbell, supra note 5, at 125. 136 cisg art 74; upicc arts 7.4.2 and 7.4.4; pecl ch 9 s 5; cesl arts 159 and 161; schwenzer, supra note 67, art 74, para 64. 137 upicc art 7.4.2(2); pecl art 9:501(2)(a). 138 schwenzer and leisinger, supra note 12, at 269; peter schlechtriem, ‘non-material damages – recovery under the cisg?’ (2007) 19 pace int'l l.rev. 89. 139 cesl, regulation proposal art 2(c). 140 schlechtriem, supra note 138, at 94. 141 upicc art 7.4.3(1); pecl art 9:501(2)b); cesl art 159(2). in regards to cisg, see cisg-ac opinion no. 6, calculation of damages under cisg article 74, rapporteur: professor john y. gotanda, villanova university school of law, usa, para 3.19. nordic journal of commercial law issue 2014#1 24 5 hardening of soft law effects 5.1 soft law and legalization looking back on all the features of sccs, these provisions would not in most cases be held enforceable by courts since: their inclusion into a contract is not always done in an appropriate manner; they are often vague to an extent that no clear obligation can be deduced from them; third parties have limited enforcement powers; and contract law remedies are not particularly suitable to formally enforce sccs. this leads to the quick conclusion that international contract law rather hinders than supports the use and effects of sccs. in other words, that the contractual form does not actually imparts hard law edge on soft sustainability requirements. however, the conclusion could be impetuous. as this article examines the contribution of sccs towards global sustainability rather than the protection of contractual parties’ interests, the main questions are whether the contractual form of the clauses manages to change suppliers’ behaviour towards more sustainable one and whether it can help other soft and private regulations to overcome their deficiencies. these effects may be achieved by the theoretical subjection of sccs to international contract law, without the need to formally enforce them. a major contribution of formal contract law lies in the legalization of csr, which was traditionally perceived as an area of voluntary action. it has been argued that legalization leads to greater cooperation and compliance of actors at the international level.142 legalization, understood as a ‘move to law’,143 does not necessarily mean that contractual form transforms legally unenforceable soft requirements into legally enforceable hard ones, but rather transforms soft regulation into less soft. abbott et al. define legalization as a multidimensional continuum oscillating around three dimensions: obligation, precision and delegation.144 at one end of the spectrum lies typical hard law with all three dimensions maximally legalized, at the other end is a complete absence of legalization, meaning no law in any sense.145 any regulation that is weakened around one or more of the dimensions constitutes soft law.146 global csr regulation is dominated by soft law instruments. by insertion of sustainability requirements into supply chain agreements the requirements are hardened to certain extend 142 miles kahler, ‘conclusion: the causes and consequences of legalization’ (2000) 54 int'l org. 661, 673 et seq. 143 louis bélanger and kim fontaine-skronski, ‘‘legalization’ in international relations: a conceptual analysis’ (2012) 51 soc.sci.inf. 238, 239. 144 kenneth w. abbott et al., ‘the concept of legalization’ (2000) 54 int'l org. 401, 401. 145 ibid at 402. 146 kenneth w. abbott and duncan snidal, ‘hard and soft law in international governance’ (2009) 54 int'l org 421, 422. nordic journal of commercial law issue 2014#1 25 around each of the dimension. however, it is important to bear in mind that the legalization effect primarily depends on the parties’ will to implement sccs into their business contracts. thus, although contracts can be seen as creating binding obligations, they cannot fully substitute governmental regulation.147 5.2 obligation obligation is the notion of binding force of a commitment or a rule; it lies deep in our conceptual understanding of what we consider as binding. the obligation dimension of sustainability requirements may be influenced in several ways by the contractual form and/or the standardization of the csr area. using the form of a binding commitment, even though the undertaking may not be legally enforceable, is a signal of its seriousness towards suppliers.148 it has been suggested that the increased credibility of commitment through the use of binding language might compensate for the low possibility of non-compliance detection.149 ‘…(t)urning a promise into a contract means that the promise is to be believed, accepted and relied upon’.150 the reliance is moreover created not only between the contractual parties, but also to third subjects. by signature the requirements furthermore gain the character of agreed terms.151 such formal and conscious acceptance of the terms as a part of a business deal is likely to increase the internalization of the values and goals by the supplier. this may also explain why companies insist on signing their codes of conduct by suppliers even without the intention to create a contract. by taking on the contractual form the csr standards also come under the moral imperative of pacta sunt servanda.152 a signature may seem unimportant if the incorporated standards are drafted in vague terms; but it makes a clear, almost symbolic demarcation of what is considered a part of the deal and, therefore, ethically binding.153 a general consensus exists that a legally 147 see also section 3.1 above. 148 cf rosalinde klein woolthuis, bas hillebrand and bart nooteboom [2002] trust and formal control in interorganizational relationships, erim report series research in management; see also abbott and snidal, supra note 146, at 422. 149 abbott and snidal, supra note 146, at 428-429. 150 denise rousseau, psychological contracts in organizations: understanding written and unwritten agreements (sage pub1995) 18. 151 cf. rousseau, supra note 150, at 9-10. 152 richard hyland, ‘’pacta sunt servanda’: a meditation’ (1993-94) 34 va.j.int'l l. 405, 427. 153morris r. cohen, ‘the basis of contract’ (1933) 46 harv.l.rev. 553, 582. nordic journal of commercial law issue 2014#1 26 valid contract imposes moral obligations on a promisor; thus, a supplier will probably feel obliged to comply with the standards, irrespective of their actual legal force.154 some authors also speak about the formalization of csr requirements and regulation.155 csr regulations occupy an unclear position within the hard legal framework. bestowing a contractual form on these regulatory forms allows us to place them within the established conceptual frameworks of binding and non-binding rules. a consistent and widespread use of sccs also contributes to the standardization of the area. it leads to the development of best practice for csr in international supply chains,156 where legal regulation is missing.157 it provides companies with practical guidance on what stakeholders expect of them and how to fullfil those expectations,158 and a benchmark for comparison with their peers.159 it also creates pressure on companies who lag behind. with more subjects implementing best practice, the perception of participation as an obligation strengthens.160 the use of sccs could even evolve into a trade usage if it becomes widely known and regularly observed by contractual parties in a particular trade.161 this level of legalization is of great importance, because it strengthens the obligation considerably, transforming soft best practice into hard trade usage that can be interpreted and applied by courts or arbitral tribunals. finally, it is not always necessary to enforce the law in order to give it effect. making a statement through law or private contracts may alone change our social norms and behaviour.162 this phenomenon is known as the expressive function of law.163 international supply contracts will lead to different expressive effects in different jurisdictions. where the contractual content conforms to the local social norms, it will be easily internalized by suppliers and vice versa. local cultural and social norms can be very strong and hard to change through 154 for a literature review on the empirical evidence, see ben depoorter and stephan tontrup, ‘how law frames moral intuitions: the expressive effect of specific performance’ (2012) 54 ariz.l.rev. 673, 706, fn 141. 155 collins, supra note 27, at 174 et seq. 156 iaccm report, supra note 6, at 23-24. 157 glinski, supra note 135, at 129. 158 see e.g. stephen brammer et al. [2011] managing sustainable global supply chains: framework and best practices, network for business sustainability report. 159 christopher e. bogan and michael j. english, benchmarking for best practices: winning through innovative adaptation (mcgraw-hill 1994). 160 kahler, supra note 142, at 680. 161 see s 4.1 above. 162 cass r. sunstein, ‘on the expressive function of law’ (1996) 144 u.pa.l.rev. 2021, 2025; kenneth w. abbott and duncan snidal, ‘values and interests: international legalization in the fight against corruption’ (2002) 31 jls s141, s151; abbott and snidal, supra note 146, at 425. 163 robert cooter, ‘expressive law and economics’ (1998) 27 jls 585, 587. nordic journal of commercial law issue 2014#1 27 international law. a bottom-up approach through private contracts may thus be more successful. to sum up, sccs change the perception of obligation not only on the part of the contractual parties but also on the part of a broader audience. the extra-contractual effects may lead to hardening of obligations all the way from the soft to the hard end, potentially leading to a change in social norms or the creation of a trade usage that becomes impliedly included in all business contracts for the sale of goods. 5.3 precision the precision of language used in sccs has already been discussed in relation to the link between the language specificity and sccs’ enforceability. the discussion here moves to the question whether the precision dimension is legalized by the inclusion of soft csr requirements into hard international supply contracts. csr regulations are mostly drafted in general to vague language that has to be clarified through their implementation and enforcement. this vagueness has been the subject of strong criticism for years now164 and appears despite the fact that precision of language is considered an aspect of csr regulation directly linked to the compliance level of the regulated subjects. precision is closely connected with the delegation dimension of legalization. a vague regulation may become precise in adjudication.165 since we have no decision-making authority at the transnational level, it seems that precision in the language of csr regulation is even more important, in order to limit inappropriate and self-serving interpretations.166 at first, it seems that the contractual form cannot change the precision of csr regulations; this is especially true when it comes to express provisions. however, the situation may be different when speaking about incorporation by reference, because we have to check the language of both the standards themselves and the reference. vagueness of csr standards will not be remedied by their inclusion into a contract, regardless if the text of the reference is vague or precise. however, if precisely drafted sustainability standards are included in a contract through a vaguely drafted reference, for example a provision stating that ‘suppliers should support and 164 andreas rasche, ‘’a necessary supplement’: what the united nations global compact is and is not’ (2009) 48 business & society 511, 522-524; surya deva, ‘global compact: a critique of the u.n.’s “public-private” partnership for promoting corporate citizenship’ (2006) 34 syracuse j.int'l l.& com. 107, 129. 165abbott and snidal, supra note 146, at 421. 166 similarly in relation to international law, kern alexander, ‘the role of soft law in the legalization of international banking supervision: a conceptual approach’ (2000) esrc centre for business research, university of cambridge, working paper no. 168, 6; or abbott et al., supra note 144, at 414. nordic journal of commercial law issue 2014#1 28 respect the company’s code of conduct’, such a reference may undermine the precisely described obligation in the referred document.167 overall, the contractual form does not enhance precision in the same way as in relation to obligation. the vagueness of regulation cannot be remedied through a mere change of legal form and on the contrary a vague contractual provision may impede the effects of high precision in incorporated regulation. 5.4 delegation delegation means that third parties have been granted authority to implement, interpret and apply the rules.168 this dimension raises the most concerns in relation to transnational csr regulation that is based on voluntary participation. national and international courts do not have the jurisdiction to decide disputes in this area169 and there is no official executive power to overview compliance. the compliance monitoring and enforcement is thus performed by companies themselves or by third party auditors. no connection to public authorities and no formal enforcement power of these subjects and their findings result in doubtful quality and effectiveness of the transnational csr regulation.170 the question is whether this deficiency can be cured by using contracts. in the implementation and monitoring phases, the contractual form does not really assist the delegation dimension. as parts of private contracts, sccs are implemented and monitored by the contractual parties. although the contractual parties may assign this task to a third party (e.g. an external auditor), this does not mean that the delegation is strengthened, because the third party usually does not have the authority to carry through enforcement of its findings in a binding manner.171 with regard to the enforcement phase, by taking the form of a contract, the delegation is hardened as sccs become subjected to the underlying law of contract. thus, at least theoretically, their enforcement can be carried out through courts or arbitral tribunals that have 167 cf the hp’s supplier social & environmental responsibility agreement <http://www.hp.com/hpinfo/globalcitizenship/environment/pdf/supagree.pdf> accessed 26 february 2014 and hp’ general specification for the environment <http://www8.hp.com/us/en/hp-information/globalcitizenship/society/general-specification-for-the-environment.html> accessed 26 february 2014. 168abbott et al., supra note 144, at 401. 169 courts or tribunals may however refer to transnational csr regulation or enforce it indirectly, using other legal instruments, such as advertising law (supra note 95) or labor law (see e.g. andré sobczak, ‘corporate social responsibility: from labour law to consumer law’ (2004) 10 eur. rev. of labour and research 401). 170 david l. owen et al., ‘the new social audits: accountability, managerial capture or the agenda of social champions?’ (2000) 9 european accounting review 81. 171 cf. ibid at 415. nordic journal of commercial law issue 2014#1 29 the jurisdiction to decide international disputes according to the applicable contract law.172 however, only contractual parties, or eventually third party beneficiaries, can seek enforcement. if they do not, the possibilities of indirect enforcement by extra-contractual parties are only limited.173 moreover, as described earlier, international contract law may not be suitable to enforce social and environmental requirements, as the available remedies may not correspond to the underlying purpose of the csr policies and there are unlikely to be remedies for all affected subjects. nevertheless, the fact that there is rarely enforcement through formal proceedings and that contract law remedies are not ideal does not erase the existing possibility of courts to sanction non-compliance. given the foregoing, the conclusion must be that even the theoretical possibility of seeking formal enforcement strengthens the delegation dimension of soft csr regulation considerably, since it formally transfers the right to interpret sccs and resolve any disputes to independent parties (courts) that interpret and apply international contract law. 6 conclusion the aim of the article was to explore the general assumption that contractual form imparts hard law character to soft social and environmental requirements and thus contributes to global sustainability. three issues were addressed to tackle the problem: preconditions for sccs’ effectiveness in regulating transnational sustainability, their enforceability according to the international contract law instruments and their legalization effects. the examination of the background that sccs operate on provides the answer to the initially posed research question: these provisions could indeed be the regulatory solution to global challenges we are desperately seeking. the power of multinational companies allows them to develop and implement sustainability requirements within their spheres of influence that transcend national boundaries. these requirements may possibly substitute missing or inefficient states’ regulation and cure the deficiencies of transnational soft and private initiatives. the presumed success of sccs is rooted in the understating that as parts of business contracts, sccs are ultimately enforceable by courts according to the applicable contract law. however, as it stands the majority of current sccs would not be formally enforceable due to their unclear contractual form, frequent vagueness and disconnectedness from the subject matter of the contract. still, as the discussion on legalization effects of sccs showed, the reliance on international contract law framework is not groundless. opposite so; the inclusion of a requirement into a contract triggers psychological (e.g. internalization of values, moral 172 for contract enforcement mechanisms’ overview, see michael trebilcock and jing leng, ‘the role of formal contract law and enforcement in economic development’ (2006) 92 va.l.rev. 1517. for sccs’ enforcement mechanisms’ overview see lin, supra note 19, at 723 et seq. 173 see s 4.3.1 above. nordic journal of commercial law issue 2014#1 30 obligations) as well as legal (e.g. standardization, development of new trade usage) processes that have hardening effects. the contractual form thus strengthens suppliers’ perception of the agreed terms as binding, although they may not be originally enforceable, and hence enhances the level of suppliers’ compliance. the conclusion therefore is that sccs have the potential to be an effective form of transnational regulation for achieving global sustainable development. the question is how to make sure that the potential is used and maximized. some results are already achieved by the mere act of sccs’ inclusion into contracts. for example, the expressive function of contracts will work regardless of the parties’ intention. however, the positive effects of sccs on suppliers’ social and environmental performance can furthermore be enhanced by modification of sccs’ features. with stronger contractual commitment, more precise language and use of the three-step best practice in sccs’ enforcement combining formal with informal means, sccs can become formally enforceable and achieve stronger hardening effects. this optimal use of sccs can be influenced by the contractual parties as well as by the underlying public and private regulations. therefore, the findings of this article may firstly serve as an inspiration for companies to focus the improvement of their supply chain strategies, whether in order to achieve sustainable development goals or to better protect their own interests. understanding when sccs are actually enforceable or what extra-legal effects they may cause is essential for their successful design and use. however, more importantly, the author calls for more attention of both public and private regulators to the use of sccs. as states are unable to reach solutions to transnational social and environmental challenges on the international level, it could be easier for them to adopt policies, laws and regulations supporting corporate activities such as sccs that may have the necessary transnational reach, but mean lower negotiation costs for states. these regulations could take the form of extending the csr reporting obligation to the usage of sccs, building institutional help with enforcement by third parties or offering assistance in drafting sccs (e.g. through official guidelines) or even their pre-approval. such governmental regulations would also strengthen the legitimacy of sccs. the thoughts indicated above in relation to public regulators can be similarly applied to private regulators. although the range of private csr regulations is overwhelming, most of them do not provide any rules on sccs. as shown above, they do require or recommend to companies to use contracts as a tool to implement csr strategies, but do not provide any guidance as to how, in what form and with what content sccs should be implemented and enforced. private regulators should focus more on this practical side of sccs’ use and possibly develop more precise guidelines and rules than has hitherto been the case. with the conscious use of underlying contract law and csr regulation for the optimal use of sccs, we could be one step closer to effective regulation of global social and environmental issues. nordic journal of commercial law issue 2008#1 cisg advisory council opinion no. 7 i. exemption of liability for damages under article 79 of the cisg by alejandro m. garro nordic journal of commercial law issue 2008#1 2 to be cited as cisg-ac opinion no. 7, exemption of liability for damages under article 79 of the cisg, rapporteur: professor alejandro m. garro, columbia university school of law, new york, n.y., usa. adopted by the cisg-ac at its 11th meeting in wuhan, people’s republic of china, on 12 october 2007. reproduction of this opinion is authorized. this opinion is dedicated to the memory of professor peter schlechtriem, our dear friend, colleague and teacher, who passed away on 23 april 2007. jan ramberg, chair eric e. bergsten, michael joachim bonell, alejandro m. garro, roy m. goode, john y. gotanda, sergei n. lebedev, pilar perales viscasillas, ingeborg schwenzer, hiroo sono, claude witz, members loukas a. mistelis, secretary1 1 the cisg-ac is a private initiative supported by the institute of international commercial law at pace university school of law and the centre for commercial law studies, queen mary, university of london. the international sales convention advisory council (cisg-ac) is in place to support understanding of the united nations convention on contracts for the international sale of goods (cisg) and the promotion and assistance in the uniform interpretation of the cisg. at its formative meeting in paris in june 2001, prof. peter schlechtriem of freiburg university, germany, was elected chair of the cisg-ac for a three-year term. dr. loukas a. mistelis of the centre for commercial studies, queen mary, university of london, was elected secretary. the cisg-ac has consisted of: prof. emeritus eric e. bergsten, pace university; prof. michael joachim bonell, university of rome la sapienza; prof. e. allan farnsworth, columbia university school of law; prof. alejandro m. garro, columbia university school of law; prof. sir roy m. goode, oxford; prof. sergei n. lebedev, maritime arbitration commission of the chamber of commerce and industry of the russian federation; prof. jan ramberg, university of stockholm, faculty of law; prof. peter schlechtriem, freiburg university; prof. hiroo sono, faculty of law, hokkaido university; prof. claude witz, universität des saarlandes and strasbourg university. members of the council are elected by the council. at subsequent meetings, the cisg-ac elected as additional members, prof. pilar perales viscasillas, universidad de la rioja, prof. ingeborg schwenzer, university of basel, and professor john y. gotanda, villanova university. at its 11th meeting in wuhan, people’s republic of china, professor eric bergsten from pace university school of law, was elected chair of the cisg-ac and professor sieg eiselen, from the department of private law of the university of south africa, was elected secretary. for more information please contact <eiselgts@unisa.ac.za>. mailto:eiselgts@unisa.ac.za nordic journal of commercial law issue 2008#1 3 opinion 1. article 79 exempts a party from liability for damages when that party has failed to perform any of its obligations, including the seller’s obligation to deliver conforming goods. 2.1 if the non-performance or defective performance results from a third person’s failure to perform, article 79 sets forth different requirements for establishing an exemption, depending on the nature of the engagement of the third person with the contracting party. 2.2 article 79(1) remains the controlling provision even if a contracting party has engaged a third person to perform the contract in whole or in part. (a) in general, the seller is not exempted under article 79(1) when those within its sphere of risk fail to perform; for example, the seller’s own staff or personnel and those engaged to provide the seller with raw materials or semi-manufactured goods. the same principle applies to the buyer in relation to the buyer’s own staff or personnel and those engaged to perform the obligations of the buyer under the contract. (b) in exceptional circumstances, a contracting party may be exempted under article 79(1) for the acts or omissions of a third person when the contracting party was not able to choose or control the third person. 2.3 article 79(2) applies when a contracting party engages an independent third person to perform the contract in whole or in part. in such a case, the contracting party claiming an exemption must establish that the requirements set forth in article 79(1) are satisfied both in its own regard and in regard to that third person. 3.1 a change of circumstances that could not reasonably be expected to have been taken into account, rendering performance excessively onerous (“hardship”), may qualify as an “impediment” under article 79(1). the language of article 79 does not expressly equate the term “impediment” with an event that makes performance absolutely impossible. therefore, a party that finds itself in a situation of hardship may invoke hardship as an exemption from liability under article 79. 3.2 in a situation of hardship under article 79, the court or arbitral tribunal may provide further relief consistent with the cisg and the general principles on which it is based. nordic journal of commercial law issue 2008#1 4 comments introduction and scope of this opinion article 79 grants buyers and sellers an exemption from performance if they can establish that nonperformance was due to an “impediment” beyond their control which they could not reasonably have been expected to take into account when the contract was made and which, or the consequences of which, they could not reasonably have been expected to avoid or overcome. the second paragraph of article 79 provides that a third person’s failure to perform may constitute grounds for exemption when the requirements for exemption under the first paragraph are satisfied with respect to both the party claiming exemption and the third person. a party failing to perform is required under the fourth paragraph of article 79 to provide timely notice of the impediment and its effect on his ability to perform and, according to the previous third paragraph, the effect of the exemption is limited to the period of time during which the impediment subsists. the fifth and last paragraph of article 79 does not restrict either party from claiming relief other than damages. at the time this opinion is issued, article 79 has been invoked in litigation and arbitration by sellers and buyers with limited success. overall, sellers made only slightly more claims of exemption than buyers. the types of “impediments” claimed as an exemption by sellers have been as varied as those claimed by buyers, a variety matched by the types of goods involved in the transactions. any survey of reported decisions is to be read with caution, because the number of cases decided at this point do not allow but a few tentative conclusions regarding interpretative trends on cisg article 79. thus, whereas sellers have succeeded in claiming an exemption in some cases,2 in many others their claims were denied.3 reported decisions also indicate that 2 an indicative list of meaningful cases where sellers qualified for relief under article 79 includes: tribunal de commerçe de besançon, france, 19 january 1998, available in english translation at <http://cisgw3.law.pace.edu/cases/980119f1.html> (excusing a seller, who was found to have acted in good faith, on account of defective goods manufactured for seller’s supplier) [hereinafter cited as ”tribunal de commerce besancon, 1998”; handelsgericht des kantons zurich, switzerland, 10 february 1999, clout case no. 331, available in english translation at <http://cisgw3.law.pace.edu/cases/990210s1.html> (seller excused for paying damages for late delivery due to carrier’s failure to meet a guarantee that the goods would be delivered on time); tribunal of international commercial arbitration at the russian federation chamber of commerce and industry, russian federation, 16 march 1995, clout case no. 140, available in english translation at <http://cisgw3.law.pace.edu/cases/950316r1.html> (seller excused due to an emergency halt to production by seller’s supplier); schiedsgericth der handelskammer hamburg, germany, 21 march 1996, clout case no. 166, available in english translation at <http://cisgw3.law.pace.edu./cases/960321g1.html>. 3 in two cases decided by germany’s supreme court, subsequently addressed in this opinion, sellers were held to be conceivably excused on account of their failure to deliver conforming goods, but such exemption was denied on the specific facts of those cases. see, bundesgerichtshof, civil panel viii, germany, 24 march 1999, clout case no. 271, available in english translation at <http://cisgw3.law.pace.edu/cases/990324g1.html> [hereinafter referred to as the ”vine wax case”]; bundesgerichtshof, germany, 9 january 2002, available in english translation at <http://cisgw3.law.pace.edu/cases/020109g1.html> [hereinafter the ”powder milk case”] http://cisgw3.law.pace.edu/cases/980119f1.html http://cisgw3.law.pace.edu/cases/990210s1.html http://cisgw3.law.pace.edu/cases/950316r1.html http://cisgw3.law.pace.edu./cases/960321g1.html http://cisgw3.law.pace.edu/cases/990324g1.html http://cisgw3.law.pace.edu/cases/020109g1.html nordic journal of commercial law issue 2008#1 5 buyers were granted exemptions under article 79,4 their excuses having been rejected in many other cases.5 there is considerable room for judicial appraisal and divergent interpretation of several words used in, and issues raised by, article 79. however, the decisions reported to date do not bear out concerns that courts or arbitral tribunals might too readily excuse a party to perform, or initial fears that some civil law judges may reintroduce the requirement of fault by allowing a seller to show that defects were beyond its control,6 or that some courts would rely too much on their domestic legal systems’ concepts of force majeure and hardship with resulting diverging interpretations.7 quite to the contrary, the bulk of judicial decisions and arbitral awards touching on article 79 focus, by and large, on the standards for exemption that may qualify as excuses under the guise of “impediments”. however, not every decision identifies facts that may become relevant to draw some tentative conclusions (e.g., the nationality of the parties, the type of goods involved or other details of the transaction), while others are incomplete in the sense that they merely state that the conditions of article 79 have not been met. for example, a court finding a party exempted under article 79 may be presumably satisfied that the alleged impediment was beyond the control of that party, yet one finds not much discussion in the available judicial decisions as to when that 4 an indicative list of meaningful cases where buyers qualified for relief under article 79 includes: tribunal of international commercial arbitration at the russian federation chamber of commerce, 22 january 1997, available in english translation at <http://cisgw3.law.pace.edu/cases/970122r1.html> (buyer excused to pay damages for failure to take delivery due to state official’s refusal to permit importation into the buyer’s country) [hereinafter cited as ”arbitration. russian federation chamber of commerce, 1997”]; amtsgericht charlottenburg, germany, 4 may 1994, available in english translation at <http://cisgw3.law.pace.edu/ cases/940915g1.html#cx> (buyer excused on account of seller’s delivery of non-conforming goods) [hereinafter cited as ”amtsgericht charlottenburg, 1994”]. 5 the following may be listed among the cases in which the buyer’s alleged impediment did not result in the tribunal granting excuse under article 79: tribunal of international commercial arbitration at the russian federation chamber of commerce and industry, russian federation, 17 october 1995, available in english translation at <http://cisgw3.law.pace.edu/cases/951017r1.html> (buyer not excused to pay the purchase price on account of inadequate reserves of convertible currency), clout case no. 142; bulgarian chamber of commerce and industry, bulgaria, 12 february 1998, available in english translation at <http://cisgw3.law.pace.edu/ cases/980212bu.html> (buyer not excused due to negative market developments and problems relating to storage of the goods). 6 for an opinion echoing this fear, see john honnold, uniform law for international sales under the 1980 united nations convention § 423.3 (3rd ed. 1999), available at <http://cisgw3.law.pace.edu/ cisg/biblio/honnold.html>. 7 for a comprehensive list of cases until 2004, where buyers and sellers were held to be excused and not excused under article 79, see the uncitral digest of case law on the united nations convention on contracts for the international sale of goods, a/cn.9/ser.c/digest/cisg/79, 8 june 2004 [hereinafter ”uncitral digest”] article 79 (published in june, 2004, and referring to 27 cases) available at <http://cisgw3.law.pace.edu/cisg/text/digest-art-79.html>. for a constantly updated chronological list of cases on article 79, see article 79. uncitral’s digest cases plus added cases, available at <http://cisgw3.law.pace.edu/cisg/text/digest-cases-79.html>. see also, peter winship, exemptions under article 79 of the vienna sales convention, rabelsz (2004) 495-510; ronald a. brand, the draft uncitral digest and beyond. article 79, in 1 cile studies 392-407 (2005); sonja a. kruisinga, ”(non-)conformity in the 1980 un convention on contracts for the international sale of goods: a uniform concept?”, intersentia (2004) 123-154. http://cisgw3.law.pace.edu/cases/970122r1.html http://cisgw3.law.pace.edu/ http://cisgw3.law.pace.edu/cases/951017r1.html http://cisgw3.law.pace.edu/ http://cisgw3.law.pace.edu/ http://cisgw3.law.pace.edu/cisg/text/digest-art-79.html http://cisgw3.law.pace.edu/cisg/text/digest-cases-79.html nordic journal of commercial law issue 2008#1 6 requirement should be deemed to have been met. similarly, few cases have focused expressly on the requirements to be met for a party to claim successfully that the impediment could not have been reasonably taken into account at the time the contract was concluded. in the absence of decisions providing these type of guidelines it is not possible to assess whether courts and arbitral tribunals are relatively in harmony in their interpretation of article 79. however, that at this point in time courts and arbitral tribunals have failed to provide firm guidelines does not make those requirements less important for an excuse to be found under article 79. but this state of affairs explains why this opinion focuses on a limited number of issues that are likely to provoke differences in interpretation in different jurisdictions. there are issues under article 79 that, either as a result of flexibility in the language of the provision and an unusual level of ambivalence in its drafting history, leave courts and arbitrators with significant leeway when applying article 79 to the facts before them. this opinion focuses on those issues because they are the most likely to be treated in light of the arbitrator’s or judge’s national law; or at least the most susceptible to provoke divergent approaches. one of those issues is whether a seller that has delivered non-conforming goods is eligible to claim an exemption under article 79. a second issue, this time with a rather confusing drafting history, concerns the requirements to be met under the first and second paragraph of article 79 by a seller that claims to be excused due to an impediment suffered by a third-party supplier or manufacturer to whom the seller looked as a source for supplying the goods. a third issue that is likely to reveal divergence in the approaches of judges and arbitrators is whether hardship may qualify as an “impediment” under article 79 and, if so, what type of relief may be granted to the aggrieved party. divergent interpretations on or about article 79 may be discerned and continue to come up, but those issues may be the subject of future advisory opinions. 1. article 79 exempts a party from liability to pay damages for failing to perform any of its obligations, including the seller’s obligation to deliver conforming goods. comments whether a seller delivering non-conforming goods may claim exemption of liability for damages under cisg article 79 was an issue addressed at the hague conference in 1964, in connection with the drafting of article 74 of ulis (the counterpart to cisg article 79). at that time, some delegates from common-law jurisdictions favoring a “warranty-based” liability in contract law raised concerns that the prevailing view in civil law jurisdictions, to the effect that contractual liability is based on proof of fault, might unduly influence civil-law judges or nordic journal of commercial law issue 2008#1 7 arbitrators too ready to allow sellers to escape liability for defective performance, pleading events beyond their control that could not have been taken into account.8 concerns with filtering in a fault-based concept of liability prompted some legal commentators to question whether delivery of defective goods may ever qualify as an impediment under article 79. thus, it has been argued that the choice of the word “impediment” was intended to denote an event external to the seller and to the goods, excluding the possibility that the seller’s liability for defects in the goods could ever be excused under article 79.9 in contrast, for those who approach liability for non-conforming goods from the standpoint of fault, a defect present in the goods at the time of the conclusion of the contract may conceivably constitute an impediment to the seller’s obligation to deliver conforming goods under cisg article 35. indeed, to the extent that delivery of conforming goods is expressed as a contractual obligation under the cisg (rather than in terms of warranties or guarantees), it stands to reason that a breach of the obligation to deliver conforming goods amounts to a seller’s failure to perform 8 the discussion of this issue at the hague conference was centered on the choice between the word ”obstacle” as opposed to ”circumstances.” the latter word carried the day at the hague on the assumption that a seller could be conceivably exempted from liability if the defects could not possibly have been detected at the time the contract was concluded. see honnold, uniform law for international sales under the 1980 united nations convention § 427 (3rd ed., 1999), available at <http://cisgw3.law.pace.edu/cisg/biblio/honnold.html>. the issue was revived when, years later, the uncitral working group decided to adopt the word ”impediment” in what later became article 79 of the cisg. commentary on the draft convention on contracts for the international sale of goods, uncitral secretariat, official records, united nations, new york, 1981, § 21 at 378 and § 36 at 380, also available at <http://cisgw3.law.pace.edu/cisg/text/secomm/secomm-79.html> 9 see barry nicholas, impracticability and impossibility in the u.s. convention on contracts for the international sale of goods in nina m. galston & hans smit eds., international sales: the united nations convention on contracts for the international sale of goods, matthew bender § 5.02 at 5-10, available at <http://cisgw3.law.pace.edu/cisg/biblio/nicholas1.html> (stating that the choice of the word ”impediment” resulted from the widely shared view that a seller could not be exonerated of liability for non-conforming goods). nicholas explains that for a common law lawyer, whose point of departure is strict liability under an implied warranty of merchantability, it comes as something of a surprise that impossibility may be regarded as an excuse for breach of this warranty. see nicholas, impracticability and impossibility, op. cit. supra, § 5.02 at 5-13 (”the common law lawyer does not, i think, see a warranty in the traditional sense as a promise of performance which is capable of becoming impossible or impracticable or of being frustrated. it is not a promise of a performance, but a guarantee of a fact and it is of the essence of a guarantee that impossibility is irrelevant to it.”). http://cisgw3.law.pace.edu/cisg/biblio/honnold.html http://cisgw3.law.pace.edu/cisg/text/secomm/secomm-79.html http://cisgw3.law.pace.edu/cisg/biblio/nicholas1.html nordic journal of commercial law issue 2008#1 8 “any of his obligations.” accordingly, this type of breach may conceivably be excused due to an impediment of the kind described in article 79.10 cases in which a seller may be exempted of liability for delivering non-conforming goods are extremely rare. for example, goods that are unique and the subject of the contract may have already perished at the time of the conclusion of the contract and before the risk of loss passed to the buyer. in this exceptional case, article 79 may apply as long as the seller had no knowledge of the prior destruction and could not reasonably have been expected to take the destruction of the goods into account at the time of the conclusion of the contract.11 indeed, sellers have invoked article 79 to claim exemption from liability for their failure to deliver conforming goods and for late delivery -but with very limited success.12 more importantly, fear that extending the exemption to delivery of non-conforming goods might reintroduce the principle of liability for fault through the “backdoor” has been allayed by the german federal supreme court. in the “vine wax case,” a seller agreed to supply vine wax to be used by the buyer to protect grafts of grape vines from drying out and from the risk of infection.13 the seller had acquired the wax from his supplier, which manufactured the wax in part with raw materials provided by a hungarian supplier the seller had not used in previous years. the seller forwarded the wax from his supplier without opening the package, the wax did not protect the vines as it was supposed to, and the buyer brought suit against the seller. the intermediate appellate court found the seller liable for delivering goods below prevailing industry standards. stating that in 10 as noted before, the view that a seller delivering defective goods cannot find refuge under article 79 appears to derive from questionable inferences regarding the adoption of the word “impediment,” at least whenever this term is read against the common law background of the warranty-based liability in contract. see honnold, op. cit. supra, at 427; nicholas, op. cit. supra, § 5.02. however, the seller’s obligation to deliver goods under the cisg is not established in terms of a warranty, but rather in terms of a general obligation to deliver goods free from defects, which includes an obligation to deliver substitute goods or repair the goods (cisg art. 46(2) and 46(3)). therefore, an insuperable impediment to deliver conforming goods may be able to excuse the seller. see hans stoll & georg gruber, in peter schlechtriem & ingeborg schwenzer, commentary on the un convention on the international sale of goods (cisg) article 79, at 812-13 (2d ed., oxford university press, 2005) (hereinafter ”schlechtriem & schwenzer, commentary on the cisg”) (questioning the inference that the adoption of the word ”impediment” meant a return to the notion of ”obstacle”, which had been discarded for article 74 of ulis, as if this choice of words were to suggest that a seller could find no excuse under cisg article 79 for delivering non-conforming goods). 11 but see denis tallon, in bianca-bonell, commentary on the international sales law at 577-78, available at <http://cisgw3.law.pace.edu/cisg/biblio/tallon-bb79.html> (”… the absence of the subject matter raises a problem of validity which is not governed by the convention (see article 4(a) …”. see also, commentary on the draft convention on contracts for the international sale of goods, uncitral secretariat, official records, united nations, new york, 1981, at 406, also available at <http://cisgw3.law.pace.edu/cisg/text/secomm/secomm-79.html>. 12 in one case a french court exempted a seller for damages for failure to deliver conforming goods, and in another case a swiss court found a seller exempt for late delivery. but in at least nine other cases the uncitral digest reports a seller’s claim for an exemption to have been denied. see uncitral digest and cases cited in notes 13 and 14, available at <http://cisgw3.law.pace.edu/cisg/text/anno-art-79.html>. 13 olg zweibrücken 31 march 1998, clout no 272. http://cisgw3.law.pace.edu/cisg/biblio/tallon-bb79.html http://cisgw3.law.pace.edu/cisg/text/secomm/secomm-79.html http://cisgw3.law.pace.edu/cisg/text/anno-art-79.html nordic journal of commercial law issue 2008#1 9 principle a seller could claim exemption when delivering non-conforming goods, the regional appeal court of zweibrücken held the seller liable on the ground that he failed to inspect the wax before sending it to the buyer. affirming the seller’s liability on different grounds, the federal supreme court germany (“bgh”) did not find it necessary to make a general pronouncement on whether a seller could ever be exempt when delivering non-conforming goods. disagreeing with the reasoning of the lower appellate court, the bgh held that, unless the parties otherwise agree (and in this case they did not), the seller undertakes the risk of acquiring conforming goods when he does not manufacture them himself. this line of reasoning suggests that the seller’s liability under the cisg is one of guarantee, irrespective of fault, hence the irrelevance of the seller’s failure to inspect.14 the bgh did not find it necessary to expressly address whether a party’s failure to perform “any of his obligations” under the contract might include the failure of the seller or any of his suppliers to deliver conforming goods. yet, resorting to an explanation why the seller could not be exempted from his failure to deliver conforming goods suggests that, in the opinion of the german supreme court, article 79 might conceivably be applied to excuse a seller’s failure to deliver conforming goods.15 this reading of article 79 conforms to what appears as the “plain meaning” of article 79. both the language (“... any of his obligations...”) and the location of this provision in the cisg (chapter v: “provisions common to the obligations of the seller and of the buyer”) suggests that the delivery of non-conforming goods amounts to a failure to perform an obligation within the meaning of article 79 and chapter v. thus, there is no reason to exclude this obligation from the broad range of obligations whose failure to perform may be excused under article 79. in a subsequent case decided by the bgh, the “powder milk case”,16 a buyer of powdered milk found the milk spoiled by lipase. the seller sought refuge in article 79 arguing and even establishing that inactive lipase could not have been detected by application of any of the available and current testing techniques. the bgh was not satisfied with this excuse, holding that it was not enough for the seller to prove that properly administered testing techniques would not have detected lipase. the case was remanded to the lower court, which was instructed to ascertain whether the introduction of the lipase could have actually escaped the seller’s control during the whole manufacturing process of the powdered milk (i.e., either by the seller’s whole milk suppliers or during the seller’s own processing of that milk). thus, although recognizing that 14 the bgh made profuse citations to conflicting scholarly opinions as to whether by referring to an impediment capable of exonerating the obligor from ”any of his obligations,” article 79 could be relied upon to excuse the seller’s obligations, and those of their suppliers, to deliver conforming goods. 15 the bgh remanded the case to the lower appellate court for a determination on mitigation of damages and on whether the german buyer had used the goods for a purpose other than the one intended by the contract. more significant to the purposes of establishing the seller’s liability squarely under the first paragraph of article 79, rather than on the ”double force majeure” scenario of the second paragraph, is the court´s finding that the defects originated with the seller’s ‘sphere of influence,” so those defects could have been foreseen and prevented by the seller. 16 bgh, 9 january 2002, available in english translation at <http://cisgw3.law.pace.edu/cases/020109g1.html>. http://cisgw3.law.pace.edu/cases/020109g1.html nordic journal of commercial law issue 2008#1 10 finding an excuse remains theoretically possible for a seller failing to deliver conforming goods, this judicial decision stresses once again the extremely heavy burden of proof faced by a seller seeking an excuse under article 79 for delivering non-conforming goods. even if those decisions by the bgh fall short of an express pronouncement as to whether the seller may be exempt for delivering defective goods, the possibility for sellers to be exempted from liability under article 79 for delivering non-conforming goods is reduced to a few marginal circumstances. assume, for example, the case of a seller bound to deliver frozen goods which, due to a blackout or power failure occurring before the transfer of risk to the buyer but after the seller parted with the goods, arrive in a decomposed state at the place of delivery. article 79 may apply in this case only if the seller succeeds in establishing that he did not know of the blackout and that the power failure was totally beyond his control. the seller would not be exempted of liability for damages if he reasonably could have been expected to take the possibility of a power failure into account at the time of the conclusion of the contract. there are indeed very few chances for the seller to find an excuse for delivering non-conforming goods, for it is generally and correctly considered that sellers implicitly assume the risks involved in the procurement of the goods they sell. however, in the absence of an express or implicit warranty, the seller should not be deemed to guarantee, absolutely and unconditionally, that the goods are free from defects. article 79 will gain in certainty and fairness if this straightforward interpretation is adopted, thus precluding dubious distinctions between excuses for failure to comply with the obligation to deliver conforming goods and those that may exonerate a party’s failure to comply with other obligations arising out of the contract (e.g., failure to pack the goods in accordance with the contract under article 35(2)(d)). 2.1 if the non-performance or defective performance results from a third person’s failure to perform, article 79 sets forth different requirements for establishing an exemption, depending on the nature of the engagement of the third person with the contracting party 2.2 article 79(1) remains the controlling provision even if a contracting party has engaged a third person to perform the contract in whole or in part. (a) in general, the seller is not exempted under article 79(1) when those within its sphere of risk fail to perform; for example, the seller’s own staff or personnel and those engaged to provide the seller with raw materials or semi-manufactured goods. the same principle applies to the buyer in relation to the buyer’s own staff or personnel and those engaged to perform the obligations of the buyer under the contract. (b) in exceptional circumstances, a contracting party may be exempted under article 79(1) for the acts or omissions of a third person when the contracting party was not able to choose or control the third person. 2.3 article 79(2) applies when a contracting party engages an independent third person to perform the contract in whole or in part. in such a case, the contracting party claiming an exemption must establish that the requirements set forth in article 79(1) are satisfied both in its own regard and in regard to the third person. nordic journal of commercial law issue 2008#1 11 comments the exemption under article 79 would hardly become operative to relieve the seller from the obligation to deliver conforming goods in those cases in which the goods were produced, manufactured, and delivered by the seller or his own personnel, or in those cases where the buyer is to take delivery and pay without relying on any intermediate agent. but when the failure to deliver conforming goods, pay the price, or undertake any of the obligations arising under the contract result from the activities or omissions of the seller’s secondary suppliers and sub-contractors, or by intermediate agents engaged by the buyer to take delivery or pay the price, the question arises whether such failure should be imputed to contracting parties under paragraph (1) or paragraph (2) of article 79. although article 79(2) applies to both sellers and buyers seeking an excuse on account of a third person’s failure to perform, this part of the opinion focuses on the conditions under which a seller could claim an exemption due to failure to perform by a third person. several courts and arbitral tribunals have addressed the question whether the seller may be excused due to an impediment allegedly beyond the control of a supplier to whom the seller looks to procure or produce the goods. in a handful of cases, the seller’s plea to be excused has been granted, but in the majority of cases it has been held that the requirements of article 79 have not been satisfied, even when the supplier’s failure to deliver conforming goods was totally unforeseeable to the seller. decisions vary, however, as to the analysis used by the courts to reach their conclusions. some courts place the analysis of whether the seller qualifies for such an exemption under paragraph (1) of article 79;17 other tribunals prefer to examine the seller’s exoneration under paragraph (2);18 and still others opt for deciding the issue on the basis of article 79 in the abstract.19 whether the seller’s claim of exemption falls under one or the other paragraph is relevant for the purpose of determining where to place the burden of proof. the key issue is whether a supplier, subcontractor or third person to whom the seller looks for performance fits the phrase of article 79(2) “a third person whom [the party claiming exemption] has engaged to perform the whole or part of the contract.” article 79(2), where it applies, makes it more difficult to succeed in claiming an excuse because it demands that the requirements for exemption under article 79(1) be satisfied with respect to both the party claiming exemption and the third person. it is not self-evident who are the “third persons” referred to in the second paragraph of article 79, whose wording seems to result from 17 oberlandesgericht hamburg, germany, 28 february 1997, cisg-online 261, available in english translation at <http://cisgw3.law.pace.edu/cases/970228g1.html>; hamburg chamber of commerce, partial award of 21 march 1996, riw, 1996, at 766 et seq., available in english translation at <http://cisgw3.law.pace.edu/cases/960321g1.html>. 18 international chamber of commerce, award 8128/1995, unilex j.d.i. 1996, 1024 et seq., available in english translation at <http://cisgw3.law.pace.edu/cases/958128i1.html> 19 chamber of commerce of the russian federation, award 155/1994, 16 march 1995, clout no. 140; available in english translation at <http://cisgw3.law.pace.edu/cases/950316r1.html> http://cisgw3.law.pace.edu/cases/970228g1.html http://cisgw3.law.pace.edu/cases/960321g1.html http://cisgw3.law.pace.edu/cases/958128i1.html http://cisgw3.law.pace.edu/cases/950316r1.html nordic journal of commercial law issue 2008#1 12 a misunderstanding, among those who fought for the introduction of the second paragraph, regarding the meaning of the previous first paragraph. no one disputes that under article 79(1) the seller bears the risk of non-conformity owed to its own personal circumstances and to those employed by him to perform the contract and whose work the seller is to organize, coordinate, or supervise. the problem sought to be addressed more specifically in article 79(2) is when the nonperformance or defective performance is due to the act or omission of a person or legal entity separate and distinct from the seller. there are least two different types of “third persons,” but only one type is sought to be covered by article 79(2). the first identifiable group of “third persons” is composed of those who, while not entrusted with the performance of the contract vis-à-vis the buyer, nevertheless enable, assist, or create the preconditions for the seller’s delivery of conforming goods. these “third persons” may be distinct and separate from the seller, such as suppliers of raw materials, subcontractors of semimanufactured parts and other “ancillary” or “auxiliary” agents whose performance is a precondition to the seller’s obligation to deliver conforming goods. these third-party suppliers or subcontractors, to whom the seller turns as a source for the supply of goods, are not the type of “third persons” contemplated in article 79(2). there is a consistent line of decisions suggesting that the seller normally bears the risk that third-party suppliers or subcontractors may breach their own contract with the seller, so that at least in principle the seller will not be excused when the failure to perform was caused by its supplier’s default.20 article 79(1) remains the controlling provision to ascertain the liability of the seller for the acts or omissions of that type of “third persons” whose default cannot be invoked by the seller to excuse his own failure to deliver conforming goods. an exception should be allowed, however, for those very exceptional cases in which the seller has no control over the choice of the supplier or its performance, in which case the supplier’s default may be established as a genuine impediment beyond the control of the seller.21 the second group of “third persons” identifiable under article 79(2) is composed by those who are “independently” engaged by the seller to perform all or part of the contract directly to the buyer. it is not easy to ascertain the precise meaning of “... a third person whom [the party claiming exemption] has engaged to perform the whole or part of a contract ...”, but the expression seems to point to those third persons who, unlike third-party suppliers or subcontractors for whose performance the seller is fully responsible, are not merely separate and 20 see uncitral digest, article 79, text accompanying note 56 and cases cited therein. 21 hans stoll & georg gruber, in peter schlechtriem and ingeborg schwenzer eds., commentary on the un convention on the international sale of goods (cisg) article 79, at 819-22 (2d ed., oxford university press, 2005). nordic journal of commercial law issue 2008#1 13 distinct persons or legal entities, but also economically and functionally independent from the seller, outside the seller’s organizational structure, sphere of control or responsibility.22 in cases where the defects result from a failure of this genuinely “independent” third person, the prerequisites for exemption under article 79(2) have to be met cumulatively by both the seller and the third person. in this particular case, the seller’s liability stretches to answer for the conduct of such an independent “third person”, unless the impediment was insuperable for the seller and, additionally, the independent third person would qualify for exemption under article 79(1) if such third person had been the seller. thus, article 79(2) is meant to increase the seller’s liability, for it makes the seller in principle responsible for defective performance incurred by independent third persons as if it were the seller’s own conduct.23 of course the seller’s liability is not unconditional, for in exceptional cases he may be able to establish that he had no control over the choice of such third person, either because the third person enjoys a monopoly in the supply of goods or services, or if the third person was chosen by the buyer, or if the seller may otherwise establish that default by the third person was actually beyond his control. to the extent that the circumstances of the case allow a distinction between the two types of “third persons,” it is clear that it would be more difficult for the seller to be exempted from liability for the acts of an “independent” third person under article 79(2), than to be exonerated for the delivery of non-conforming goods procured from or manufactured by a supplier to whom the seller has resorted to deliver the goods. however, the drafting history of article 79(2) reflects confusion by some delegates, to whom the policy of making it more difficult for the seller to be exempted of liability on account of the conduct of a genuinely independent “third person” was not so clear. those delegates sought unsuccessfully to expressly include suppliers, subcontractors, and any person working independently for the seller under article 79(2).24 22 see denis tallon, in commentary on the international sales law: the 1980 vienna sales convention (ed. by m. bianca and m.j. bonell, milan, 1987) at 545, available at <http://cisgw3.law.pace.edu/cisg/biblio/tallon-bb79.html>. 23 according to uncitral’s official records, tightening the conditions under which a seller could claim exemption sought to avoid, among other consequences, ”that a party should be exempted from liability because he had chosen an unreliable supplier ...”. commentary on the draft convention on contracts for the international sale of goods prepared by uncitral’s secretariat, official records, united nations, new york, 1981 [hereinafter ”commentary on the 1978 draft convention”] § 23 at 379 par. 23 (motion by denmark) and § 35 at 380 (comment by norwegian delegate). 24 see a. vischer, provisions common to the obligations of the seller and of the buyer, in the 1980 vienna convention on the international sale of goods 179 (lausanne colloquium, november 19-20, 1984). if the explicit inclusion of suppliers would have been carried into paragraph (2) of article 79, it would have eliminated the possibility of exemption for the seller in cases of non-conformity, because the suppliers and sub-suppliers who manufactured the goods could never qualify for the exemption. but the rejection of the proposal to include the suppliers explicitly into paragraph (2) of article 79 does not necessarily lead to the conclusion that the seller’s potential exemption of liability for non-conforming goods is to be placed under paragraph (1) of article 79. http://cisgw3.law.pace.edu/cisg/biblio/tallon-bb79.html nordic journal of commercial law issue 2008#1 14 if anything, article 79(2) and its legislative history suggests that the phrase “a third person whom [a party] has engaged to perform the contract” should be given a narrow scope, covering cases such as those in which the seller turns over to a third person the seller’s obligation to manufacture the goods according to specifications given by the buyer, or whenever the seller delegates to a third person the seller’s obligation to procure the goods and deliver them to the buyer. in either case, the seller can succeed on a claim to be exempted for damages for failure to perform only if the seller can establish that the third person was himself prevented to perform by an impediment qualifying as an excuse under article 79(2).25 this interpretative approach appears to be consistent with a sound allocation of risks arising from nonconformity of the goods. although a seller who depends on ancillary suppliers cannot always control the conformity of the goods, it seems fair to assign to the seller the risk of non-conformity and resulting damages for non-conformity as part of the overall procurement risk borne by sellers. even though the first and second paragraphs of article 79 provide for different requirements for a party to be excused on account of another person’s failure to perform, for all practical purposes most cases are likely to be resolved under article 79(1). this is, indeed, the conclusion reached by the german supreme court (bgh) in the “vine wax case” referred to in connection with the question whether a seller could ever be exempt under article 79 for delivering non-conforming goods. in that case, an austrian seller invoked an exemption from liability under article 79(1) on the ground that it played the role of a mere intermediary in a contract to supply vine wax to a german buyer, which vine wax the seller had manufactured with raw materials acquired from a hungarian supplier. the seller’s central argument was that it was exempted from liability under article 79 on the grounds that the alleged defects were caused by the supplier and were, therefore, “beyond his control.” the bgh held that it makes no difference under article 79(1) whether the defect could be imputed to the seller or to its suppliers or sub-suppliers. according to the court, the existence of the defects should in any event be imputed to the seller, for even if caused by the suppliers or sub-suppliers, such defects are deemed to be within the seller’s “sphere of influence.” in a subsequent case, also touching upon article 79, the “powder milk case”,26 the bgh once again suggested that it is “all the seller’s fault” even in cases where the failure to perform appears to be blamed on the seller’s suppliers. since the seller was unable to establish whether the lipase that spoiled the powdered milk had been introduced by his whole milk suppliers or during the seller’s processing of the milk, the bgh reversed a lower court judgment with instructions to ascertain whether the spoiling of the powdered milk had been actually beyond the seller’s control. 25 john o. honnold, uniform law for inernational sales under the 1980 united nations convention 546-46 (kluwer international, 2d ed., 1999). 26 bgh 9 january 2002, available in english translation at <http://cisgw3.law.pace.edu/ cases/020109g1.html>. http://cisgw3.law.pace.edu/ nordic journal of commercial law issue 2008#1 15 attributing to the seller the responsibility for the supplier’s actions under article 79(1) appears consistent with a sound policy of placing the risks involved in non-conformity on the party who is in the best position to avoid or minimize those risks. the seller may be exempted from liability in some extreme and exceptional cases, such as when the supplier is the only available source of supply, or when other supplies are unavailable due to unforeseeable and extraordinary events, or in situations in which the defects in the goods are unconnected with the typical procurement risks assumed by the seller. 3.1 a change of circumstances that could not reasonably be expected to have been taken into account, rendering performance excessively onerous (“hardship”), may qualify as an “impediment” under article 79(1). the language of article 79 does not expressly equate the term “impediment” with an event that makes performance absolutely impossible. therefore, a party that finds itself in a situation of hardship may invoke hardship as an exemption from liability under article 79. 3.2 in a situation of hardship under article 79, the court or arbitral tribunal may provide further relief consistent with the cisg and the general principles on which it is based. comments under a variety of legal doctrines, most of which can be traced back to the doctrine of rebus sic stantibus developed by the roman preaetor, unforeseeable and extraordinary change of circumstances rendering a contractual obligation extremely burdensome though not absolutely impossible, may entail the avoidance or even the revision or “adaptation” of the contract or one of its clauses. the variety of national laws and legal doctrines (e.g., imprévision, frustration of contract, commercial impracticability, wegfall der geschäftsgrundlage, eccesiva onerosita sopravvenuta), coupled with the amplitude of the term “impediment” in article 79, provides a fertile ground for judges and arbitrators to take divergent approaches to the question whether a party whose performance has turned extraordinarily burdensome (in economic terms or otherwise, hereinafter identified as “hardship”).27 not surprisingly, scholarly opinions are divided on whether this situation of hardship, short of impossibility, is governed by article 79. whereas some consider that the wording of article 79 is sufficiently flexible to include an extreme 27 see tallon, article 79, in commentary on the international sales law. the 1980 vienna sales convention § 3.1 at 592 (1987), available at <http://cisgw3.law.pace.edu/cisg/biblio/tallon-bb79.html> ; hans stoll & georg gruber, in schlechtriem & schwenzer, commentary on the u.n. convention, op. cit. supra, article 79, § 39, at 82226. see also honnold, uniform law, op. cit. supra, at 434 (suggesting the adoption of a ”comparative law approach” towards the notion of impediment under article 79, taking into account the ”prevailing patterns and trends of modern domestic law”). http://cisgw3.law.pace.edu/cisg/biblio/tallon-bb79.html nordic journal of commercial law issue 2008#1 16 situation of unexpected hardship within the meaning of “impediment”,28 others opine that there is no place in the cisg for any relief on account of economic hardship.29 concerns for the word “impediment” employed in article 79 and its proper interpretation have been voiced by commentators from a broad spectrum of legal systems. according to one scholarly opinion the word “impediment” is “vague and imprecise,”30 another pointed to several “contradictions and ambiguities” in the use of that term,31 and a third characterized the word “impediment” as a “chameleon-like” example of “superficial harmony which merely mutes a deeper discord.” 32 the legislative as well as the drafting history of article 79 is not conclusive enough to warrant a conclusion that the hardship problem was meant to be excluded or included within its scope. as to the legislative history of article 79, there is ample support for the proposition that the convention does not favor an easy exemption from nonperformance and that the notion of “impediment” under article 79 points to an insurmountable obstacle that is unrelated to the more flexible notions of hardship, impracticability, frustration, or the like.33 however, that background is insufficient to warrant the conclusion that cisg article 79 cannot exempt a 28 see, e.g., denis tallon in commentary on the international sales law article 79 at § 3.2 (1987) (”[t]he judge will have a natural tendency to refer to similar concepts in his own law. thus, the judge of a socialist country will have a restrictive approach to force majeure... on the contrary a common lawyer will feel inclined to refer to the more flexible notions of frustration and impracticability. in the roman-german system, the judge will reason in terms of force majeure...”). see also m. j. bonell, force majeure e hardship nel diritto uniforme della vendita internazionale, in diritto del commercio internazionale 590 (1990) (observing that by requiring that the obligor ”could not reasonably be expected ... to have avoided or overcome [the impediment] or its consequences” suggests that, at least in principle, the possibility should be entertained that performance has become so onerous that it would be unreasonable to enforce it). 29 see, e.g., barry nicholas, who observed that exemption of liability on account of unexpected and excessive economic hardship was ”out of place” in a sales law. progress report of the working group on the international sale of goods on the work of its fifth session (a/cn.9/87, annex iii, reprinted in uncitral yearbook v:1974 (1975) at 66. 30 b. nicholas, impracticability and impossibility in the u.n. convention on contracts for the international sale of goods, in international sales: the united nations convention on contracts for the international sale of goods § 5.02 at 5-4 (parker school of foreign and comparative law, columbia university, ed. nina m. galston & hans smit, 1984), available at <http://cisgw3.law.pace.edu/cisg/biblio/nicholas1.html>. 31 d. tallon, commentary to article 79, in commentary on the international sales law. the 1980 vienna sales convention 594 (giuffre, milan, 1987), available at <http://cisgw3.law.pace.edu/cisg/biblio/tallon-bb79.html>. 32 e. a. farnsworth, perspective of common law countries, in la vendita internazionale 19 (congress at s. margherita ligure, sept. 1980, giuffre, 1981). 33 article 79 was drafted in response to the criticism of article 74 of the 1964 uniform law on international sales, to the effect that ”a party could be too readily excused from performing his contract.” but the criticism that ulis article 74 was insufficiently clear and subjective lead to the substitution of the word ”impediment” for ”circumstances,” so that the conditions for exemption are more narrowly and objectively identified. it is on record that one of the reasons for the uncitral’s working group’s adoption of the term ”impediment” in article 79 was to exclude the scenario, envisioned under article 74 of ulis, in which the obligor could escape liability when performance had become unexpectedly difficult for reasons beyond his control. http://cisgw3.law.pace.edu/cisg/biblio/nicholas1.html http://cisgw3.law.pace.edu/cisg/biblio/tallon-bb79.html nordic journal of commercial law issue 2008#1 17 party from performing its obligations, in whole or in part, when the impediment is represented by a totally unexpected event that makes performance excessively difficult. as to the drafting history of this provision, isolated discussion of proposals that were dismissed or the comments by some delegates may lead one to conclude that there was some type of consensus among the members of the working group against the doctrine of “hardship.”34 in fact, some passages of the travaux préparatoires appear to indicate that the choice of the word “impediment” was made for the purpose of adopting a unitary conception of exemption with the intention of setting aside the theory of rebus sic stantibus, imprévision, or hardship theories based on “changed circumstances.” thus, according to some legal commentators, the exclusion (rectius: rejection) of hardship from the scope of article 79 would emerge from its drafting history.35 following the successive drafts preceding what finally became article 79, the working group of uncitral considered but rejected a proposal allowing a party to claim avoidance or adjustment of a contract whenever facing unexpected “excessive damages”.36 yet, a closer look at this passage reveals that after briefly setting out the arguments in support of the proposal, the report simply stated that it was not adopted, not reappearing in subsequent discussions.37 other commentators have seized upon the rejection of a norwegian proposal linked to a passage of what later became article 79(3) in order to infer a rejection of the position that article 79 may extend its application to a situation of genuine hardship. thus, when the issue of temporary impediment came up for discussion at the diplomatic conference, the norwegian delegation suggested the inclusion of an additional provision to the effect that the temporary exemption from performing may turn into a permanent exemption if, after the impediment ceases to exist, the circumstances had so changed that performance would become manifestly unreasonable.38 the proposal gained significant support from other delegations, but the french delegate raised his concerns that introducing such a provision may be regarded as an acceptance of doctrines such as imprévision, frustration of purpose, and the like. although the recollection of the discussions among the participant delegates, or what should be made out of those 34 see the discussion in john honnold, documentary history of the uniform law for international sales 185, 252 (1989) (hereinafter honnold, documentary history). 35 see honnold, documentary history, at 252. 36 see honnold, documentary history, op. cit. supra, at 350, recalling that a proposal aimed at incorporating an article allowing a party to ”claim an adequate amendment of the contract or its termination” on account of ”excessive difficulties” was expressly rejected by uncitral’s working group. 37 report of committee of the whole i relating to the draft convention on the international sale of goods (a/32/17, annex i, paras. 458-60), reprinted in uncitral yearbook viii:1977 (1978), 57. see also john honnold, documentary history at 350. 38 see a/conf.97/c.1/sr.27 at 10. the norwegian proposal lead to the deletion of the word ”only” in article 79(3), so that even if the initial and temporary impediment vanishes, the resulting change of circumstances, which may well be of an economic nature, may turn into another impediment leading to that party’s exemption from liability. nordic journal of commercial law issue 2008#1 18 discussions, is far from uniform, the rejection of the norwegian proposal did not settle the issue of economic hardship because it was actually not discussed as such. if it is accepted that the drafting history has any controlling role to play which is a debatable issue such history evidences that the discussions were not conclusive on this question.39 several court decisions have rejected the possibility that negative market developments constitute an impediment within article 79(1). indeed, as of the time of the drafting of this opinion, no court has exempted a party from liability on the grounds of economic hardship. as to noticeable case-law developments, a german court of first instance is reported to have stated in dicta that the german doctrine of wegfall der geschäftsgrundlage does not apply because the cisg “fills the field in this area” and therefore forces out the otherwise applicable domestic law.40 an italian court of first instance, in a decision reported in the same year, in a case that was not governed by the cisg, considered but ultimately refused to apply the doctrine of “supervening excessive onerousness,” as adopted in article 1467 et seq. of the italian civil code.41 according to the italian court in monza, this variation on the doctrine of “hardship” could not conceivably find its way into the vienna sales convention, because hardship is not expressly excluded under article 4 of the cisg, thus being an issue left unsettled in the cisg.42 39 speculation about what the intention of the drafting group might have been with regard to the scope of application of cisg article 79 is unlikely to be too accurate, especially when we are left to our inferences from fragments in the travaux préparatoires. indeed, the dismissal of a proposal which did not even address whether hardship should be given any space within the convention is no proper foundation upon which to build an argument on the ”intention of the legislator”. 40 lg aachen, germany, unilex, no. 43 0 136/92 (may 14, 1993) (the case involved a german seller of acoustic prosthetics against an italian buyer who refused to take delivery of the goods under the contract). 41 nuova fucinati, s.p.a., v. fondmetall international a.b., tribunale di monza, italy, 14 january 1993, clout no. 54, reproduced in english translation 15 j.l. & com. 153 (1995), available at <http://cisgw3.law.pace.edu/cases/930114i3.html>. in this case, the italian seller’s (nuova fucinati) failed to deliver 1,000 tons of metal that a swedish buyer, fondmetall, had contracted to purchase. faced with a courtimposed injunction sought by fondmetall, nuova fucinati alleged that delivery of the 1,000 tons of metal was impossible due to fondmetall’s refusal to take delivery of another load of metal ordered at the same time. the italian seller also sought to avoid its obligation to the swedish buyer arguing that, prior to delivery of the 1,000 tons of metal, the price of the goods on the international market had risen so swiftly and unexpectedly that the fundamental equilibrium of the performances had been significantly altered, to the point of justifying the termination of the contract under article 1467 of the italian civil code. 42 the italian court’s discussion as to the applicability of article 79 to an ”impediment” that makes performance short of impossible was pure dicta, because the court decided that cisg was not applicable. according to the court of monza, the cisg could not apply under article 1(1)(a) because the cisg had not entered into force in sweden at the time the contract was concluded and it was not applicable under article 1(1)(b) because, in the opinion of the court, such a provision applies only in the absence of an express choice of law by the parties. for a critical view on this approach to applicability of the cisg, see ferrari, uniform law of international sales: issues of applicability under private international law, 15 j. l. & com. 159, 161 (1995), available at <http://cisgw3.law.pace.edu/cisg/biblio/ferr1.html>. http://cisgw3.law.pace.edu/cases/930114i3.html http://cisgw3.law.pace.edu/cisg/biblio/ferr1.html nordic journal of commercial law issue 2008#1 19 there are not many cases dealing with situations of hardship in which courts have found it fair to provide relief, and no cases have been found at the time this opinion is drafted in which a court has provided well-grounded reasons explaining why a change in circumstances was unpredictable or why one type of relief was more appropriate than others. to this date, there are no reported decisions whereby a court exempted a party from liability on the ground of hardship. this state of affairs is not inconsistent with the admission, by a majority of legal commentators, that a fair legal system should admit some flexibility within the general principle of pacta sunt servanda to account for a genuine situation of hardship. the question to be raised then is what type of factual scenario may be proposed for an exceptionally “hard” case of hardship that would merit relief. resorting to the type of scenarios designed in the comments accompanying unidroit principles article 6.2.2, one may envision a situation where a buyer “a”, domiciled in state x, concludes a contract of sale with a seller “b”, domiciled in state y. payment is agreed to be made in state z within three months, upon delivery of the goods, in the currency of state z. let us imagine that within a month of the conclusion of the contract a totally unpredictable political and economic crisis, which the parties could not have reasonably taken into account, leads to a massive devaluation of 80% of z’s currency. as a result of this totally unanticipated and massive devaluation of the currency, the sale turns out extremely burdensome for the buyer “a” and a gross windfall for the seller “b”.43 assuming then that the cisg applies to a contract subject to a situation of hardship such as the one previously described, the question is whether the aggrieved party should be entitled to find relief under the terms of the cisg by reading the word “impediment” in article 79 to include hardship or by concluding that there is a gap within the cisg to be filled by some underlying general principle via the “governed-but-not-settled” gap-filling technique promoted by cisg art. 7(2). if the cisg applies, then it naturally preempts other, potentially applicable domestic rules dealing with hardship. but if the hardship question cannot be thus settled, there is no alternative other than resorting to domestic legal rules, hoping that the applicable law would provide for some risk-share allocation of remedies. the alternative of resolving the hardship problem within the four corners of the cisg is more palatable than the other, because leaving the question to the conflict of law rules of the forum leads to a great diversity of potentially applicable legal doctrines. it is submitted that the interpreter who takes seriously the cisg’s confessed purpose of unifying the law of sales, as 43 admittedly, it is not easy to ascertain whether the change in circumstances could not have been reasonably foreseen. it is not an easier task to distinguish between the risk of loss that every contracting party should be deemed to have assumed and the extraordinary disastrous economic disadvantages amounting to a ”limit of sacrifice” (because there is indeed such a limit), beyond which the obligor should not be expected to perform the contract as written. for an enlightening discussion of a ”true hardship problem” based on a factual scenario in which a deal unexpectedly turned into a ”nightmare” for one party and a ”steal” for the other, see joseph lookofsky, walking the article 7(2) tightrope between cisg and domestic law, 21 journal of law and commerce 87 (2005). nordic journal of commercial law issue 2008#1 20 articulated in article 7(1), will probably exhaust all technically available means to respond to the hardship problem within the “four corners” of the convention, rather than resorting to the application of potentially disparate domestic legal rules and doctrines. before proceeding to examine the type of relief that may be found under the cisg for a true hardship problem, it is important to recall that termination or adjustment of a contract on grounds of hardship may be regarded in some legal systems as a validity-related issue, so that it may be argued that the hardship issue is excluded from the scope of application of the cisg by virtue of article 4.44 the argument deserves careful consideration, because it has been reported that in some scandinavian legal systems the issue of hardship is approached as an issue of validity.45 in this case, there is something to be said in favor of granting the defaulting party the benefit of finding appropriate relief by choosing among competing domestic doctrines of hardship. but this approach does not sound convincing or persuasive. unlike a situation of unconscionability (usury, lésion or gross disparity of the performances at the time the contract is concluded), which clearly falls under the rubric of validity, the hardship problem tends to be associated in most legal systems with force majeure or impossibility of performance, that is, a situation of exoneration or mitigation of liability due to events subsequent to the conclusion of the contract, more than as a case of nullity or avoidance due to infirmities or flaws affecting the contract from its inception.46 moreover, every benefit potentially obtained from allowing national doctrines of hardship to compete for its application is more than offset by the high price in terms of uniformity that is to be paid under this approach. 44 see j. lookofsky, understanding the cisg in the usa (2d ed., 2004) § 2.6 and joseph lookofsky, the limits of commercial contract freedom under the unidroit ‘restatement’ and danish law, 46 am. j. comp. law 485, 496 (1998), also available at <http://cisgw3.law.pace.edu/cisg/biblio/lookofsky6.html>, referring to the hardship provisions in the general clause of the danish contracts act, authorizing a court to refuse enforcement or to adjust ”any unreasonable contract or term, and that includes a term which becomes unreasonable after the contract is made”. professor lookofsky also refers to dutch civil code article 6.258(1) as an illustration of a provision that appears to question the ”validity” of a contract (”upon the demand of one of the parties, the court may modify the effects of a contract or it may set it aside; in whole or in part, on the basis of unforeseen circumstances of such a nature that the other party, according to standards of reasonableness and fairness, may not expect the contract to be maintained in unmodified form. the modification or setting aside may be given retroactive effect.”). 45 see, e.g., tom southerington, impossibility of performance and other excuses in international trade, publication of the faculty of law of the university of turku, private law publication series b:55, available at <http://cisgw3.law.pace.edu/cisg/biblio/southerington.html>. southerington refers to section 36(1) of the finnish contracts act, which the author considers as a rule of validity akin to unconscionability. 46 a much criticized 1993 decision by the tribunale civile di monza entered (unnecessarily for the purposes of the case before the court) to examine the legal nature of hardship under italian law and its relationship with the cisg. the italian court stated that ”... hardship is not a matter expressly excluded in article 4 of the cisg. dissolution of the contract for supervening excessive onerousness affects neither the validity of the contract nor ownership over the goods ...”). tribunale civile di monza, 14 january 1993, clout case 54, reproduced in english in <http://cisgw3.law.pace.edu/cases/930114i3.html>. http://cisgw3.law.pace.edu/cisg/biblio/lookofsky6.html http://cisgw3.law.pace.edu/cisg/biblio/southerington.html http://cisgw3.law.pace.edu/cases/930114i3.html nordic journal of commercial law issue 2008#1 21 if it is accepted that a situation of genuinely unexpected and radically changed circumstances, in truly exceptional cases, may qualify as an “impediment” under article 79(1), it deserves a legal response under the convention that would preempt the application of domestic rules on hardship. it is certainly not possible or even convenient to attempt a definition of hardship, beyond accepting that the impediment may entail a situation of “economic impossibility” which, while short of an absolute bar to perform, imposes what in some legal systems is conceptualized as a “limit of sacrifice” beyond which the obligor cannot be reasonably expected to perform. in most cases market fluctuations are not to be considered an “impediment” under cisg article 79, because such fluctuations are a normal risk of commercial transactions in general. whether wild and totally unexpected market fluctuations in goods or currency could ever become an “impediment” is another matter. indeed, the theoretical possibility of such radical and unexpected changes admits the application of article 79 in those rare instances as the one exemplified above. the next issue to tackle is to ascertain the contours of the remedial guidelines that may be followed to grant the most appropriate remedy or relief after hardship has been found to exist. one may infer from the obligation to interpret the convention in good faith a duty imposed upon the parties to renegotiate the terms of the contract with a view to restore a balance of the performances. in case negotiations fail, there are no guidelines under the convention for a court or arbitrator to “adjust,” or “revise” the terms of the contract so as to restore the balance of the performances. even if one were not ready to stretch the principle of good faith buried in cisg article 7(1) in order to find a balance of the performances,47 cisg article 79(5) may be relied upon to open up the possibility for a court or arbitral tribunal to determine what is owed to each other, thus “adapting” the terms of the contract to the changed circumstances. 47 a suggestion by peter schlechtriem to this effect may be found in transcript of a workshop on the sales convention, in 18 journal of law and commerce 191-258, 236-37 (1999), available at <http://cisgw3.law.pace.edu/cisg/biblio/workshop-79.html>. http://cisgw3.law.pace.edu/cisg/biblio/workshop-79.html nordic journal of commercial law issue 2009#1 cisg advisory council opinion no. 9. consequences of avoidance of the contract by prof. michael badge nordic journal of commercial law issue 2009#1 2 to be cited as: cisg-ac opinion no. 9, consequences of avoidance of the contract, rapporteur: professor michael bridge, london school of economics, london, united kingdom. adopted by the cisg-ac following its 12th meeting in tokyo, japan on 15 november 2008. reproduction of this opinion is authorized. eric e. bergsten, chair michael joachim bonell, michael g. bridge, alejandro m. garro, roy m. goode, john y. gotanda, sergei n. lebedev, pilar perales viscasillas, jan ramberg, ingeborg schwenzer, hiroo sono, claude witz, members sieg eiselen, secretary * * the cisg-ac is a private initiative supported by the institute of international commercial law at pace university school of law and the centre for commercial law studies, queen mary, university of london. the international sales convention advisory council (cisg-ac) is in place to support understanding of the united nations convention on contracts for the international sale of goods (cisg) and the promotion and assistance in the uniform interpretation of the cisg. at its formative meeting in paris in june 2001, prof. peter schlechtriem of freiburg university, germany, was elected chair of the cisg-ac for a three-year term. dr. loukas a. mistelis of the centre for commercial law studies, queen mary, university of london, was elected secretary. the founding members of the cisg-ac were prof. emeritus eric e. bergsten, pace university school of law; prof. michael joachim bonell, university of rome la sapienza; prof. e. allan farnsworth, columbia university school of law; prof. alejandro m. garro, columbia university school of law; prof. sir roy m. goode, oxford, prof. sergei n. lebedev, maritime arbitration commission of the chamber of commerce and industry of the russian federation; prof. jan ramberg, university of stockholm, faculty of law; prof. peter schlechtriem, freiburg university; prof. hiroo sono, faculty of law, hokkaido university; prof. claude witz, universität des saarlandes and strasbourg university. members of the council are elected by the council. at subsequent meetings, the cisg-ac elected as additional members prof. pilar perales viscasillas, universidad de la rioja; professor ingeborg schwenzer, university of basel; prof. john y. gotanda, villanova university; and prof. michael g. bridge, london school of economics; prof. jan ramberg served for a three-year term as the second chair of the cisg-ac. at its 11th meeting in wuhan, people's republic of china, prof. eric e. bergsten of pace university school of law was elected chair of the cisg-ac and prof. sieg eiselen of the department of private law of the university of south africa was elected secretary. nordic journal of commercial law issue 2009#1 3 opinion 1.1 rights to damages for non-performance against a party not exempted from liability under article 79 survive avoidance of the contract, whether they have accrued prior to avoidance or arise from future non-performance. 1.2 provisions of the contract survive its avoidance if they assist in the winding-up of the contract or are intended by the parties to survive avoidance. 1.3 an agreement to avoid the contract is governed by its terms and by the convention. 1.4 the convention does not deal with the proprietary aspects of restitution. 2.1 the right to restitution of performance on avoidance derives from the contract of sale and the convention. 2.2 restitution of the goods takes place at the buyer's premises or at the agreed place of delivery or at the place where the buyer acting reasonably has warehoused the goods, according to the case. 2.3 restitution of the price takes place at the buyer's premises or at a bank of the buyer's choice. 2.4 restitution of the price should be made in the currency of payment. 2.5 additional costs arising after restitution are recoverable as damages from an unexempted non-performing party but not from a party whose non-performance is exempted under article 79. 2.6 restitution of performance by seller and buyer should take place within a reasonable time. 2.7 where the buyer's restitutionary duty includes an account of money as a substitute for original goods, the seller may set off the corresponding portion of the price against this amount. 3.1 restitution of benefits derived from the goods and of interest on the price should take place concurrently. 3.2 the concurrent restitution of benefits and interest should normally take place separately from the concurrent restitution of the goods and the price. 3.3 monetary benefits flowing from the goods and interest on the purchase payable by the seller may be made the subject of a set-off. 3.4 interest on the purchase price is normally determined by the commercial investment rate prevailing at the seller's place of business. 3.5 interest runs from the date the seller receives the price to the date that repayment is made to the buyer. 3.6 it is irrebuttably presumed that the seller has earned interest on the price. 3.7 the seller has to prove that the buyer has derived benefits derived from the goods. nordic journal of commercial law issue 2009#1 4 comments introduction where a contract is avoided, it is in the interests of both parties for the avoidance process to be carried out as quickly as possible with a minimum of cost, loss and delay. the restitution of the goods and the price is based on a modified resale of the goods to the seller, drawing upon the rules in the convention dealing with the original sale. because the convention does not make provision for property rights in the goods or the price, avoidance takes place concurrently in the interest of mutual security of the parties. for that reason, concurrency should also be required for the restitution of interest and benefits. the question whether a contract is avoided retrospectively or prospectively has divided legal systems but is not an issue that needs to be considered under the convention, given the explicit way that the convention sets out the effects of avoidance. in determining the effects of avoidance, courts and tribunals should clearly separate restitutionary questions and damages questions. drafting history the first sentence of article 81(1) cisg is more or less identical to the whole of article 78(1) of the uniform law on the international sale of goods (ulis) and article 81(2) cisg is substantially the same as article 78(2) ulis. there is nothing in ulis that corresponds to the provision in article 81(1) cisg dealing with contractual provisions that survive avoidance. ulis does, however, contain in its article 81 provisions corresponding to article 84 cisg, dealing with restitution by the buyer of benefits received from the goods and by the seller of interest on the price. the working group on the international sale of goods1 considered a proposal that, where the contract has been avoided in part, the rule in article 81(1) should be expressly limited to the relevant part of the contract.2 this proposal was not adopted in the 1977 draft of uncitral's committee of the whole3. at the 1980 diplomatic conference, concerns were expressed that the rule of restitution in article 81 might be seen as giving rise to in rem consequences, affecting 1 established at the second session of uncitral. 2 fifth session (geneva 1974), a/cn.9/87, para 143. see also report of the secretary-general (1975), a/cn.9/100, annex iv, para 44. 3 report (1977), a/32/17, annex 1 para 461. nordic journal of commercial law issue 2009#1 5 domestic bankruptcy legislation. a proposal was therefore made for a new paragraph stating that the seller's rights should not interfere with those of third parties or creditors in the buyer's bankruptcy, but the proposal was withdrawn after failing to gain the necessary support.4 the working group decided to adopt the ulis provision (article 81) dealing with the restitution of benefits flowing from the price and the goods on avoidance of the contract, but extended it also to cases where the buyer had required substitute goods to be delivered. at the diplomatic conference, a number of amendments were proposed to specify the rate of interest that the seller had to pay but were later withdrawn.5 interpretation general remarks avoidance of the contract under article 81 of the cisg (hereinafter the convention) is determined by articles 49 (avoidance by the buyer) and 64 (avoidance by the seller) and can arise in two cases: first, where a fundamental breach has occurred and the party entitled to performance elects to avoid the contract; and secondly, where one party has served a time notice on the other, the other has failed to perform within the additional time prescribed in that notice, and the first party elects to avoid the contract. in either case, avoidance may occur where the non-performing party is not liable in damages as a result of an impediment beyond his control.6 aa) effects of avoidance the basic effect of avoidance is that both parties are released from their primary performance obligations7 and are no longer entitled to perform those obligations.8 the primary obligations of the parties include the seller's obligations to make delivery and transfer ownership9 and the 4 33rd meeting (2 april 1980), a/conf.97/c.1/sr.33, paras 75-84. 5 j honnold, uniform law for international sales under the 1980 united nations convention (3rd ed, 1999), 709-10. 6 article 79. 7 oberlandesgericht frankfurt (germany), 17 september 1991, unilex, translated at <http://cisgw3.law.pace.edu/cases/910917g1.html>; bundesgerichtshof (8th civil panel) (germany), 25 june 1997, translated at <http://cisgw3.law.pace.edu/cases/970625g2.html>; bezirksgericht saane (switzerland), 20 february 1997, translated at http://cisgw3.law.pace.edu/cases/970220s1.html. 8 . in a related way, avoidance of the contract of sale has been held to prevent a seller from drawing down a bank letter of credit: oberster gerichtshof (austria), 19 january 1999, translated at <http://cigw3.law.pace.edu/cases/990119a3.html>. 9 article 30. http://cisgw3.law.pace.edu/cases/910917g1.html http://cisgw3.law.pace.edu/cases/970625g2.html http://cisgw3.law.pace.edu/cases/970220s1.html. http://cigw3.law.pace.edu/cases/990119a3.html nordic journal of commercial law issue 2009#1 6 buyer's obligations to pay the price and take delivery.10 other related obligations may also be avoided, such as maintenance and service agreements. rights to damages that may have accrued by the time of avoidance remain in existence, even as against the avoiding party. where avoidance occurs after unexempted non-performance by one of the parties, the liability of that non-performing party includes damages for future non-performance prevented by the avoidance of the contract.11 avoidance may nevertheless occur as a result of exempted non-performance, where neither party is liable in damages for future non-performance.12 bb) surviving provisions of the contract provisions of the contract designed to govern the rights and obligations of the parties after or notwithstanding avoidance nevertheless survive avoidance of the contract. in this regard, dispute settlement provisions are specifically mentioned in article 81(1). these include jurisdiction clauses and should also include arbitration clauses,13 though these may be regarded as separate contracts and thus capable of surviving independently of article 81(1).14 the identity of other surviving clauses will depend upon the interpretation of the contract, but should normally include choice of law clauses, provisions for penalty and related payments,15 force majeure clauses,16 exclusion and limitation clauses and clauses making provision for the return of the goods.17 these are all clauses that assist in the winding-up of the avoided contract. 10 article 53. 11 this follows from articles 75-76. 12 article 79. 13 federal district court new york (united states), 14 april 1992 (filanto v chilewich), available at <http://cisgw3.law.pace.edu/cases/920414u1.html>; tribunal of international commercial arbitration at the russian federation chamber of commerce and industry, no 280/1999, 13 june 2000, translated at <http://cisgw3.law.pace.edu/cases/000613r1.html>. 14 uncitral model law on international commercial arbitration 1985 (amended in 2006) (article 16(1); uncitral arbitration rules (article 21(2)) ('an agreement independent of the other terms of the contract'); tribunal of international commercial arbitration at the russian federation chamber of commerce and industry, no 161/1994, 25 april 1995, translated at <http://cisgw3.law.pace.edu/cases/950425r3.html>. 15 icc court of arbitration, award no 9978, march 1999, unilex, cisg on-line; icc court of arbitration, award no 9887, august 1999, unilex; tribunal of international commercial arbitration at the russian federation chamber of commerce and industry, no 280/1999, 13 june 2000, translated at <http://cisgw3.law.pace.edu/cases/000613r1.html>; tribunal of international commercial arbitration at the russian federation chamber of commerce and industry, no 160/1997, 5 march 1998, translated at <http://cisgw3.law.pace.edu/cases/980305r2.html>; tribunal of international commercial arbitration at the russian federation chamber of commerce and industry, no 95/2004, 27 may 2005, translated at <http://cisgw3.law.pace.edu/cases/050527r1.html>. 16 tribunal of international commercial arbitration at the russian federation chamber of commerce and industry, no 280/1999, 13 june 2000, translated at <http://cisgw3.law.pace.edu/cases/000613r1.html> 17 oberster gerichtshof (austria), 29 june 1999, unilex, translated at <http://cisgw3.law.pace.edu/ cases/990629a3.html>. http://cisgw3.law.pace.edu/cases/920414u1.html http://cisgw3.law.pace.edu/cases/000613r1.html http://cisgw3.law.pace.edu/cases/950425r3.html http://cisgw3.law.pace.edu/cases/000613r1.html http://cisgw3.law.pace.edu/cases/980305r2.html http://cisgw3.law.pace.edu/cases/050527r1.html http://cisgw3.law.pace.edu/cases/000613r1.html http://cisgw3.law.pace.edu/ nordic journal of commercial law issue 2009#1 7 certain other clauses, such as confidentiality clauses, might also survive avoidance if the intention of the parties, determined by interpreting the contract, is that they should do so. the survival of these clauses should turn upon the circumstances of non-performance and the interpretation of the particular contract of sale. for example, where the buyer avoids the contract because of the seller's non-performance, a put option allowing the seller to supply more goods is less likely to survive avoidance than a call option in favour of the buyer. if the buyer's call option did not survive, the buyer would have a claim for damages against the seller for future non-performance, which would not be the case if the non-performing seller's put option failed to survive. the survival of the buyer's call option gives the parties a chance to perform which would avoid a dispute and damages assessment. the seller's non-performance, however, which led to the avoidance of the contract of sale, gives the buyer good reason to doubt that the seller would perform any future contract of sale brought into existence by the exercise of that seller's put option. cc) related contracts once a contract of sale has been avoided, the convention takes no express position on the survival of related contracts. the issues here bear some resemblance to those concerning the survival of options. related contracts are not to be assimilated with the contract of sale to produce a single contract, so that they are avoided along with the contract of sale. in principle, they should survive the avoidance of the contract of sale. some related contracts, for example, framework and master agreements, may not be governed by the convention, so that the question of their avoidance would be a matter for their applicable laws. in cases where related contracts are governed by the convention, there may be scope for the rules on contractual suspension and anticipatory repudiation if the behaviour of a party to a contract of sale raises serious concerns about its willingness or ability to perform related contracts.18 finally, the parties themselves, however, may make provision for avoiding related contracts by means of cross-default clauses in those contracts. dd) termination agreements where the parties consensually terminate the contract, the position is governed by their termination agreement19 in accordance with the convention.20 to the extent that they are not 18 articles 71 (as extended with the aid of article 7(2)) and 72. 19 tribunal of international commercial arbitration at the russian federation chamber of commerce and industry, case no 82/1996 of 3 march 1997, unilex, translated at <http://cisgw3.law.pace.edu/cases/ 970303r1.html>; oberster gerichtshof (austria), 29 june 1999, unilex, translated at <http://cisgw3.law.pace.edu/ cases/990629a3.html>. 20 article 29(1) (which refers to termination rather than avoidance). http://cisgw3.law.pace.edu/cases/ http://cisgw3.law.pace.edu/ nordic journal of commercial law issue 2009#1 8 displaced by conflicting terms in the termination agreement itself,21 nevertheless, the provisions of article 81 will also apply to supplement the termination agreement.22 ee) proprietary consequences of avoidance nothing in article 81 deals with the existence of property rights in the goods or money subject to the restitutionary process. the convention does not deal with the effect that the contract may have on the property in the goods sold.23 in view of the way that the convention ought to be interpreted and the gaps in its coverage filled,24 it should also be regarded as not dealing with the property in the goods returned to the original seller under the restitutionary process and with the existence of proprietary rights in the price that the seller must repay to the buyer. the restitutionary process in the convention amounts to a type of reverse sale of the goods back to the original seller. in the event of avoidance of the contract, the effect of a reservation of title clause is a matter for the applicable law governing proprietary matters and not for the convention. similarly, a seller's right to recover the goods on avoidance is subject to relevant property and insolvency laws.25 a buyer prevented by such laws from making restitution of the goods will, because of the concurrent restitution rule (see below), be unable to require the seller to repay the price. furthermore, where the buyer has acquired the property in the goods, the buyer is contractually bound to restore the seller to its original property rights.26 the proprietary effect of the buyer's efforts to do so will be determined by the applicable law for proprietary matters. restitution of performance aa) nature of restitutionary relationship as seen above, the avoidance of the contract does not mean the avoidance of all provisions of the contract. in addition, the convention at the point of avoidance introduces new rights and duties to give effect to avoidance by transforming the original contractual relationship into a 21 article 6. 22 oberlandesgericht düsseldorf (germany), 28 may 2004, translated at <http://cisgw3.law.pace.edu/cases/040528g1.html>; oberlandesgericht münchen (germany), 19 october 2006, translated at <http://cisgw3.law.pace.edu/cases/061019g1.html>. aliter, tribunal of international commercial arbitration at the russian federation chamber of commerce and industry, case no 82/1996 of 3 march 1997, unilex, translated at <http://cisgw3.law.pace.edu/cases/970303r1.html>. 23 article 4(b). 24 see article 7(2). 25 federal district court illinois (united states), 28 march 2002 (usinor industeel v leeco steel products), available at <http://cisgw3.law.pace.edu/cases/020328u1.html> . 26 see articles 30 and 41, which should be brought into play in line with article 7(2). http://cisgw3.law.pace.edu/cases/040528g1.html http://cisgw3.law.pace.edu/cases/061019g1.html http://cisgw3.law.pace.edu/cases/970303r1.html http://cisgw3.law.pace.edu/cases/020328u1.html nordic journal of commercial law issue 2009#1 9 winding-up or restitutionary relationship.27 where the agreement has been executed on both sides, restitution involves the return of the goods to the seller and the return of the price to the buyer.28 if only one party has performed, then restitution takes place unilaterally. the requirement of restitution binds both parties, and not just the party whose non-performance led to avoidance.29 the rights of the parties arising on avoidance are contractual and are not based on the unjust enrichment rules of any applicable law.30 this restitutionary relationship does not foreclose rights to damages for breach of the contract of sale. the convention calls for what is in effect a resale of the goods from the buyer to the seller but it leaves unstated the rules concerning the place and costs of restitution and the allocation of risk under that resale. there are, however, rules concerning the preservation and disposal of the goods after avoidance.31 it has also been decided that a buyer has an actionable right for the seller to take redelivery of the goods.32 this should be so whether it is the seller's or the buyer's non-performance that led to the avoidance of the contract. the receipt of the price is unlikely to raise the same practical problems but the principle is the same. bb) exactness of restitution in relation to the goods, restitution means the redelivery of the very goods supplied.33 repaying the price is a different matter, compounded by currency issues. repayment of the price should presumptively be in the currency of account and payment, where these are the same34 and 27 landgericht düsseldorf (germany), 11 october 1995, translated at <http://cisgw3.law.pace.edu/cases/951011g1.html>; handelsgericht st gallen (switzerland), 3 december 2002, translated at <http://cisgw3.law.pace.edu/cases/021203s1.html>. see also p schlechtriem and i schwenzer, commentary on the un convention on the international sale of goods (2nd (english) edn, 2005), 855-56. 28 the austrian supreme court appears in one case concerning jurisdiction to have ruled that the restitution of advance payments made by the buyer is not governed by the convention: oberster gerichtshof, 10 march 1998, translated at <http://cisgw3.law.pace.edu/cases/980310a3.html>. there is no good reason to distinguish advance payments made by the buyer to the seller from other payments made by the buyer. 29 see secretariat commentary on article 66 (which was later renumbered article 81), para 9. 30 icc court of arbitration, award no 9978, march 1999, unilex, cisg-online.ch no. 708. but note that the convention does not apply in the case where a seller mistakenly restores to the buyer a price that the buyer in fact has not paid and now seeks reimbursement from the buyer: oberlandesgericht münchen (germany), 28 january 1998, translated at <http://cisgw3.law.pace.edu/cases/980128g1.html>. restitution of this money is governed by the relevant applicable law. 31 articles 86-88. 32 landgericht krefeld (germany), 24 november 1992, unilex, translated at <http://cisgw3.law.pace.edu/cases/921124g1.html>. in this case, there was an agreement on the avoidance of the contract. 33 so far as the avoiding buyer is excusably unable to do this, the buyer must account for the benefits instead of the goods that cannot be redelivered: article 84(2)(b). 34 this was the result in a case dealing with interest: china international economic and trade arbitration commission, 10 march 1995, translated at <http://cisgw3.law.pace.edu/cases/950310c2.html>. http://cisgw3.law.pace.edu/cases/951011g1.html http://cisgw3.law.pace.edu/cases/021203s1.html http://cisgw3.law.pace.edu/cases/980310a3.html http://cisgw3.law.pace.edu/cases/980128g1.html http://cisgw3.law.pace.edu/cases/921124g1.html http://cisgw3.law.pace.edu/cases/950310c2.html nordic journal of commercial law issue 2009#1 10 should be in the currency of payment if this is different from the currency of account.35 it has nevertheless been held in one case that, if the buyer is truly to be restored to the pre-contractual position, the buyer must receive repayment in the currency which it expended to effect performance in the contract of sale. if the buyer therefore expended us dollars to acquire the roubles needed to pay the seller, this would mean that the buyer would be entitled to restitution in dollars.36 this is incorrect. the restitution process is designed to reverse gain and not to compensate for loss. since the seller's obligation under article 81 is a restitutionary one, it would therefore be more appropriate if a buyer suffering currency losses made a claim for damages for such losses under article 74. cc) partial restitution restitution under article 81 need not necessarily be bilateral but can instead be unilateral restitution. this will be the case if only the seller or the buyer has performed. in addition, restitution may for various reasons be partial. a buyer avoiding the contract may not be able fully to restore the goods to the seller, for the goods or some of them may have been sold on to sub-buyers or transformed by a manufacturing or similar process into goods of a different kind. although the buyer loses the right to avoid the contract if unable to restore the goods 'substantially' in the condition in which they were received, in exceptional cases the buyer may still avoid the contract.37 first, the impossibility of making restitution may not be due to the act or omission of the buyer.38 secondly, restitution in full may not be possible because of the buyer's examination of the goods.39 thirdly, and most importantly, the goods may have been sold on, consumed or transformed before the buyer discovers that they are non-conforming. where goods in these cases cannot be redelivered, the rules regarding the restitution of benefits in article 84 come into play in place of the basic duty to redeliver the goods under article 81. where performance has been executed on both sides, each party has some security for the return of performance by the other (see below). this will be more or less adequate from the buyer's point of view according to the quality and condition of the goods delivered. in addition, if only one party has performed, the question arises whether the non-performing party is entitled to some assurance that the other party will return performance, especially where the 35 where the contract fails to state the currency of payment, the unidroit principles of international commercial contracts (article 6.1.10) prescribe the currency of the place where payment is due. this rule is not appropriate for a restitutionary obligation to repay money. 36 tribunal of international commercial arbitration at the russian federation chamber of commerce and industry, no 2/1997, 11 may 1995, translated at <http://cisgw3.law.pace.edu/cases/970511r1.html>. 37 article 82(2). 38 for example, the goods may have perished and the seller may have committed a fundamental breach: see article 70. 39 under article 38. http://cisgw3.law.pace.edu/cases/970511r1.html nordic journal of commercial law issue 2009#1 11 contract has been avoided for that party's fundamental breach. in such cases, the device of contractual suspension in article 72, pending the receipt of adequate assurance of performance by means, for example, of a performance bond or standby letter of credit, may not usefully be extended. the party seeking restitution in these circumstances is not seeking to suspend the resale of the goods. furthermore, no useful purpose would be served by requiring adequate assurance to be given, followed by an award of damages in the event of it not being given. dd) concurrent restitution article 81(2) requires restitution between seller and buyer to be concurrent.40 the seller may not object to restitution in those cases under article 82 where the avoiding buyer is excusably unable to redeliver all the goods.41 otherwise, the requirement of concurrent restitution applies in all cases. the concurrence of the parties' obligations means that each party has a type of security in not having to give credit to the other. if restitution by one party is prevented by national laws dealing with bankruptcy or currency restrictions, for example,42 the party who is not prevented by these laws from making restitution is protected by the concurrency rule from having to make restitution. ee) place of restitution the place of restitution is not dealt with expressly by the convention but it is a matter governed by the convention and so is to be determined by the general principles on which the convention is based.43 taking first redelivery of the goods, suppose that the contract of sale calls for delivery at the seller's premises. if it is the buyer who avoids the contract for the seller's unexempted non-performance, requiring the buyer to redeliver to the seller's premises would give rise to an additional damages liability of the seller under article 74. furthermore, nothing in article 81 would allow the buyer to insist on reimbursement of these carriage costs before handing the goods over. concurrence goes to the reversal of delivery and payment and not to damages. the avoidance of economic waste may be seen as a general principle underlying the convention.44 a requirement of redelivery at the buyer's premises, even if the contract is 40 kantonsgericht schaffhausen (switzerland), 27 january 2004, <http://cisgw3.law.pace.edu/cases/040127s1.html> ('reciprocally and simultaneously'). 41 landgericht freiburg (germany), 22 august 2002, <http://cisgw3.law.pace.edu/cases/020822g1.html>. for the operation of the concurrency rule in this case, see below. 42 see secretariat commentary on article 66 (which was later renumbered article 81), para 10. 43 oberster gerichtshof (austria), 29 june 1999, unilex, translated at <http://cisgw3.law.pace.edu/cases/990629a3.html>. cf cour d'appel de paris (france), 14 january 1998, unilex, translated at <http://cisgw3.law.pace.edu/cases/980114f1.html> (applying rules of private international law under article 7(2) so that the place of repayment was the debtor's (i.e., the seller's) residence). 44 see articles 25 (the rule of fundamental breach does not lightly permit avoidance) and 77. http://cisgw3.law.pace.edu/cases/040127s1.html http://cisgw3.law.pace.edu/cases/020822g1.html http://cisgw3.law.pace.edu/cases/990629a3.html http://cisgw3.law.pace.edu/cases/980114f1.html nordic journal of commercial law issue 2009#1 12 avoided for the buyer's non-performance (see below), would allow for disposal of the goods in the local market and thus minimise the costs of the restitutionary process. in addition, redelivery at the buyer's premises avoids the complications of allocating risk in transit. it would also delay the process of restitution if the buyer had to hand over the goods at the seller's premises, thus adding further to the cost of restitution. redelivery at the buyer's premises is therefore the general rule and is supported by cases where the seller is the non-performing party.45 it can be seen as flowing also from the convention rules on delivery, since the avoiding buyer, as part of the winding-up process, may be seen as reselling the goods to the seller. these delivery rules presumptively call for delivery at the seller's premises.46 this result is preferable to requiring restitution to be made at the place of performance of the original primary obligations.47 two exceptional cases should however be considered. if the contract calls for delivery of the goods at another place, then this place should be the place of redelivery. if the buyer acting reasonably has warehoused the goods at another place still, then the warehouse should be the place where the goods are to be redelivered, though any warehouse warrant or similar document that has to be produced to release the goods should be the subject of transfer at the buyer's premises. in addition, if it is the seller who avoids the contract for the buyer's unexempted nonperformance, it is less clear that redelivery should be required at the buyer's premises. if redelivery did take place there, the seller would have an action for damages against the buyer under article 74 for any consequent costs of carriage. nevertheless, the likely cause of a seller avoiding the contract is where the buyer fails to pay for the goods, in which case the seller would have a practical interest in taking an active position and expediting the redelivery process. this points to the efficacy of a clear rule in all cases, including cases where the contract is avoided for exempted non-performance, that redelivery should take place at the buyer's premises. the place of repayment of the purchase price is also not dealt with expressly by the convention. treating the seller as the buyer of the redelivered goods, the price should be 45 landgericht krefeld (germany), 24 november 1992, unilex, translated at <http://cisgw3.law.pace.edu/cases/921124g1.html>; kantonsgericht valais (switzerland), 21 february 2005, translated at <http://cisgw3.law.pace.edu/cases/050221s1.html>. but see p schlechtriem and i schwenzer, commentary on the un convention on the international sale of goods (2nd (english) edn, 2005), 860-61, for the view that the place of redelivery should be an exact reversal of the place of delivery. this would mean that goods delivered carriage paid to the buyer's premises should be redelivered carriage paid to the seller's premises. 46 article 31. 47 with the assistance of the austrian civil code, this was the result in oberlandesgericht wien, 1 june 2004, detailed abstract available at <http://cisgw3.law.pace.edu/cases/040601a3.html>. http://cisgw3.law.pace.edu/cases/921124g1.html http://cisgw3.law.pace.edu/cases/050221s1.html http://cisgw3.law.pace.edu/cases/040601a3.html nordic journal of commercial law issue 2009#1 13 repayable at the original buyer's premises.48 this obligation of the seller should not be interpreted too literally since the means of payment and repayment also have to be considered. if payment under the contract of sale has been made by a bank transfer, repayment by the same method to a bank of the buyer's choice represents the most practical method of effecting restitution. requiring restitution of the goods and the purchase price in different places is not as such inconsistent with the rule of concurrency of restitution, though exact concurrency may be hard to achieve in all cases where redelivery and repayment occur in different places. ff) costs of restitution even though restitution may have taken place in full, with redelivery of the goods at the buyer's premises, there will frequently be additional costs arising out of the subsequent disposal of the goods. any such additional costs of restitution should be borne by the unexempted nonperforming party.49 if for example goods already delivered to the buyer have to be shipped back to the seller, the cost of carriage should be borne by the unexempted buyer, if the seller avoided the contract, and by the unexempted seller, if the buyer avoided the contract. the unexempted buyer would be liable for the cost of carriage under article 74; the unexempted seller would bear the cost of carriage on its own account.50 in the latter case, if the buyer actually paid the cost of carriage back to the seller, it is arguable that this is a consequence of the seller's nonperformance and that therefore the cost would be recoverable by the buyer as damages under article 74.51 if the goods can more efficiently be disposed of or used in a local market, then the requirement of mitigation of loss will limit a claim for damages against an unexempted buyer under article 74 for the cost of carriage back to the seller52 the complication of an article 74 damages claim having to be made by the avoiding seller would of course not arise if the cost of carriage were paid by the unexempted buyer.53 in those cases where avoidance follows exempted 48 article 57(1)(a); landgericht giessen (germany), 17 december 2002, translated at <http://cisgw3.law.pace.edu/cases/021217g1.html> (departing from the contrary decision under the ulis of the bundesgerichtshof, bghz 78, 257). see also p schlechtriem and i schwenzer, commentary on the un convention on the international sale of goods (2nd (english) edn, 2005), 860, for apparent support for this rule, treating the buyer restoring the goods as the seller and relying on oberlandesgericht düsseldorf (germany), 2 july 1993, translated at <http://cisgw3.law.pace.edu/cases/930702g1.html>, which asserts the existence of a general rule in the convention that payment in all cases takes place at the seller's premises. 49 see secretariat commentary on article 66 (which was later renumbered article 81), para 11; cm bianca and mj bonell, commentary on the international sales law (1987), 605 (tallon). 50 see p schlechtriem and i schwenzer, commentary on the un convention on the international sale of goods (2nd (english) edn, 2005), 861. 51 the alternative approach, where this is done at the request of the seller, is to treat the seller's liability as a matter of express or implied contract between the parties consequent upon the avoidance of the contract. this would seem to be a matter for the law applicable to the contract. 52 article 77. 53 no practical purpose would be served by inferring a separate rule with the aid of article 7(2) that these costs should in the first instance be paid by the non-performing party. http://cisgw3.law.pace.edu/cases/021217g1.html http://cisgw3.law.pace.edu/cases/930702g1.html nordic journal of commercial law issue 2009#1 14 non-performance,54 the cost of carriage back to the seller should not be borne by the exempted buyer, who is exempt from liability for in damages non-performance in article 79. this exemption is expressed in general terms as an exemption from paying damages under the convention, and not in special terms as an exemption from paying damages for the nonperformance that led to avoidance of the contract.55 since restitution is plainly a matter governed by the convention, along with exemption, there is no room for the cost of carriage or of disposal of the goods to be allocated to another applicable law. gg) time of restitution the convention does not state when mutual restitution of performance has to take place but performance within a reasonable time may be inferred as a general principle under article 7(2),56 in the absence of an agreed time, upon or after avoidance of the contract. since the duty to make restitution is a contractual one, any unexempted delay in effecting restitution, giving rise to loss suffered by the receiving party, should be compensable in damages in accordance with article 74. loss is more likely to arise where it is the seller who delays in making restitution, since the buyer may incur costs in warehousing or handling the goods when unable to put them to productive use. if the buyer is late in making restitution, so that the seller holds back the purchase price together with interest on the purchase price, the seller will not be incurring loss in holding the money but will indeed be earning interest on money not yet paid back to the buyer. hh) risk prior to restitution requiring restitution of the goods at the buyer's premises minimises complications stemming from the allocation of the risk of loss. apart from loss or destruction of the goods arising out of their defective state upon delivery,57 there remains a need to allocate risk in the period between avoidance and redelivery. in principle, the question of whose fault led to the avoidance of the contract ought not to be relevant, or indeed whether there was fault at all, since the allocation of risk pertains to the identity of the party better able to take out loss insurance. that person is the buyer as the party in possession.58 the cost of insuring the goods in very many cases will be negligible or non-existent: the buyer's insurance may cover all goods in its possession. if the 54 article 79 is likely to be applied infrequently to cases where goods have been delivered. 55 paragraph (5). see also cm bianca and mj bonell, commentary on the international sales law (1987), 605 (tallon). 56 deriving from article 33(c). 57 article 70 in substance would leave the risk with the seller where the seller commits a fundamental breach of the contract. 58 it is assumed that the buyer in possession will have an insurable interest under the relevant law. nordic journal of commercial law issue 2009#1 15 contract is avoided because of the seller's unexempted non-performance, the buyer should be able to claim damages for the cost of insurance or safeguarding the goods under article 74. if the contract is avoided for the seller's exempted non-performance, then article 79 precludes transferring the cost of insurance to the seller by means of a damages claim. in those cases where the seller is at fault in making timely restitution, there is a case for transferring the risk to the seller in order to give an incentive to complete the restitutionary process. the better view, on balance, however, is that the reasons for allocating risk to the buyer remain valid for this case. the additional cost of insuring and safeguarding the goods beyond the due restitution date if the seller has failed to participate in a timely way in the process of restitution are recoverable as damages under article 74. restitution of the fruits of performance aa) general after the contract has been avoided, article 84 imposes correlative duties on the seller to pay interest to the buyer, if the price has to be refunded, and on the buyer, to account to the seller for benefits derived from the goods. these duties apply where restitution in full occurs, but they may also be brought into play in cases of partial restitution, whether or not partial restitution occurs further to article 82. they apply in favour of each party to the avoided contract, whether or not that party was a performing party, an exempted non-performer or an unexempted nonperformer.59 the mutual restitution of interest and benefits will usually be financial on both sides. mutual restitution raises a number of questions. the first question is whether the rule of concurrency expressed in article 81 for the goods and money, but not referred to in article 84, nevertheless applies in the latter case to benefits. if concurrency does apply, the second question is whether restitution under article 84 is to be integrated with restitution under article 81 or is separate. the third question is whether set-off takes place with respect to the two article 84 payments, so as to leave only one payment to be made representing the balance. the fourth question, if setoff is permissible, is whether payments to be made under articles 81 and 84 can be the subject of a consolidated set-off. 59 bezirksgericht saane (switzerland), 20 february 1997, translated at <http://cisgw3.law.pace.edu/cases/970220s1.html>. where non-performance, due to the inexact description of the goods, was held to be the fault of neither party, a chinese tribunal incorrectly halved the rate of interest that the seller had to pay when repaying the buyer: china international economic and trade arbitration commission, 23 april 1997, translated at <http://cisgw3.law.pace.edu/cases/970423c2.html>. http://cisgw3.law.pace.edu/cases/970220s1.html http://cisgw3.law.pace.edu/cases/970423c2.html nordic journal of commercial law issue 2009#1 16 bb) separation of articles 81 and 84 the process of calculating interest and benefit under article 84 may in some cases be difficult and time-consuming. the avoidance of business disruption and economic waste may fairly be inferred from the convention as principles on which it is based. if these losses are to be kept to a minimum, then restitution under article 81 should be effected as quickly as possible and indeed before any complex calculations required by article 84 are completed. nevertheless, in those cases where the buyer has to return benefits in lieu of the original goods, a one-sided concurrency would arise under article 81 if the seller's repayment of the price were made in return for only part of the goods delivered to the buyer. the most practical solution, if the seller is unwilling in these circumstances to return the price in full, is to prorate the price so as to match the quantity of goods that the buyer is able to return.60 the remainder of the price would then become concurrently repayable when the buyer accounted for the benefits received from the missing goods. by this means, the process of restitution under article 81 is kept as separate as is possible from the process of restitution under article 84. cc) concurrency concurrency is the means by which mutual restitution can take place under the convention without account having to be taken of proprietary considerations. although the principle of concurrency is not expressed in article 84, consistency therefore requires it also to be the rule under article 84 following on from the general principle laid down in article 81.61 dd) set-off issues although there are numerous decisions stating that set-off is not dealt with by the convention,62 there are many different ways in which set-off or something akin to set-off might arise between a buyer and a seller. consequently, a general denial of set-off as a subject dealt with by the convention is too widely stated. set-off, broadly understood to include permissible deductions, is explicitly permitted in one case where a buyer avoids the contract. where a buyer is permitted to sell the goods for one of the reasons stated in article 88, the expenses of preserving the goods and selling them may be deducted from the proceeds of sale, prior to their remittance to the seller. so far as there has to be concurrency in making restitution, and so far 60 because it is simpler, this solution is preferable to the alternative of requiring such a buyer to account for the benefits received from the missing goods at the time of concurrent restitution under article 81. these benefits may take time to calculate, which would delay the article 81 restitution process if this approach were adopted. 61 article 7(2). see also article 58(1). 62 for example, bundesgerichtshof (switzerland), 20 december 2006, translated at <http://cigw3.law.pace.edu/cases/061220s1.html>; landgericht münchen (germany), 20 march 1995, translated at <http://cisgw3.law.pace.edu/cases/950320g1.html>. http://cigw3.law.pace.edu/cases/061220s1.html http://cisgw3.law.pace.edu/cases/950320g1.html nordic journal of commercial law issue 2009#1 17 as payments have to be made by both buyer and seller as part of the restitutionary process, then concurrency is most effectively promoted by permitting set-off.63 set-off serves the purpose of minimising business disruption and avoiding economic waste. to the extent, however, that the process of restitution under article 81 needs to be implemented before the calculations are made under article 84, it follows that set-off in respect of amounts that will or might fall due under the article 84 process ought not to be allowed as against payments to be made under article 81. various claims for damages might arise under or pursuant to the contract of sale, either before or during the implementation of the restitutionary process. this opinion does not take a view on whether set-off might take place between a restitutionary claim and a damages claim. ee) commencement of interest the seller's duty to pay interest under article 84 runs from the date that payment is made. in the case of a seller who fails to deliver, it does not run from the time that the seller was in breach of contract for failing to deliver.64 if payment is made on the buyer's behalf by a third party, the seller's duty to pay interest runs from this date.65 the convention does not define when payment is made but the purpose underlying the restitutionary provisions of the convention is best served by treating payment as having occurred when the seller is able to start earning interest on the money paid by the buyer. if, for example, a transfer of funds is made to an account nominated by the seller, then payment should in principle be treated as occurring when the seller is able to draw on the account with incurring interest charges to the bank. ff) rate of interest the convention does not state from where the rate of interest is to be derived: seller and buyer will usually be located in different countries. interest is payable by the seller whether in fact interest has been earned or not, according to the use that the seller could have made of the 63 in favour of set-off, further to article 7(2), where there are two reciprocal claims arising under the convention, see oberlandesgericht hamburg (germany), 26 november 1999, translated at <http://cisgw3.law.pace.edu/cases/991126g1.html>; landgericht mönchengladbach (germany), 15 july 2003, translated at <http://cisgw3.law.pace.edu/cases/030715g1.html>. a deduction for the cost of goods disposed of by the buyer against the buyer's claim for the return of the price was allowed in oberlandesgericht köln (germany), 14 october 2002, translated at <http://cisgw3.law.pace.edu/cases/021014.html>. 64 tribunal of international commercial arbitration at the russian federation chamber of commerce and industry, no 135/2002, 16 june 2003, translated at <http://cisgw3.law.pace.edu/cases/030616r1.html>. 65 cour d'appel aix-en-provence (france), 21 november 1996, translated at <http://cisgw3.law.pace.edu/cases/961121f1.html>; cour de cassation (france) 26 may 1999, translated at <http://cisgw3.law.pace.edu/cases/990526f1.html>. http://cisgw3.law.pace.edu/cases/991126g1.html http://cisgw3.law.pace.edu/cases/030715g1.html http://cisgw3.law.pace.edu/cases/021014.html http://cisgw3.law.pace.edu/cases/030616r1.html http://cisgw3.law.pace.edu/cases/961121f1.html http://cisgw3.law.pace.edu/cases/990526f1.html nordic journal of commercial law issue 2009#1 18 money paid by the buyer.66 the seller's duty to pay interest therefore is based on an irrebuttable presumption that the seller has invested the money in an interest-bearing account or has benefited from the money in some other way. this presumption avoids any inquiry into the actual use made by the seller of the money paid by the buyer and thus also avoids difficult questions arising out of tracing the money through the seller's commercial activities.67 because of this presumption, and because the seller's duty to account for interest is a restitutionary one, the commercial investment rate current at the seller's place of business should normally be applied.68 in the majority of cases, the rate at the seller's place of business has been arrived at by applying the forum's rules of private international law.69 a preferable justification is to infer the 66 icc court of arbitration, no 6653 of 25 march 1993, translated at <http://cisgw3.law.pace.edu/cases/936653i1.html>; handelsgericht zürich, 5 february 1997, translated at <http://cisgw3.law.pace.edu/cases/970205s1.html>. 67 there is an argument that a seller in receipt of revolving credit may have benefited more from payment of the price than the amount recoverable according to the commercial investment rate. the benefit would be the commensurate avoidance of the higher borrowing rate that the seller would otherwise have had to pay its bank under the revolving credit facility. an inquiry into the amount of such benefit would be time-consuming and expensive, and would unduly complicate the process of effecting restitution. 68 see p schlechtriem and i schwenzer, commentary on the un convention on the international sale of goods (2nd (english) edn, 2005), 885-86. the unidroit principles of commercial contracts (article 7.4.9), in the different case of failing to pay a sum of money when it falls due, refer to the "average short-term lending rate to prime borrowers prevailing for the money of payment at the place of payment". failing the existence of such a rate, they turn to the same rate in the state of the currency of payment or some other rate fixed by the law of that same state. this approach is inappropriate for a restitutionary obligation. 69 oberlandesgericht celle (germany), 24 may 1995, translated at <http://cisgw3.law.pace.edu/ cases/950524g1.html>; landgericht landshut (germany), 5 april 1995, translated at <http://cisgw3.law.pace.edu/cases/950405g1.html>; the oberlandesgericht karlsruhe (germany), 19 december 2002, translated at <http://cisgw3.law.pace.edu/cases/021219g1.html>; the icc court of arbitration, award no 9978, march 1999, unilex, cisg on-line; tribunale d'apello lugano/ticino (switzerland), 15 january 1998, translated at <http//cisgw3.law.pace.edu/cases/980115s1.html>; bezirksgericht saane (switzerland), 20 february 1997, translated at <http://cisgw3.law.pace.edu/cases/970220s1.html>; tribunal of international commercial arbitration at the russian federation chamber of commerce and industry, no 175/2003, 28 may 2004, translated at <http://cisgw3.law.pace.edu/cases/040528r1.html>; oberlandesgericht frankfurt am main (germany), 18 january 1994, translated at <http://cisgw3.law.pace.edu/cases/940118g1.html>; kantonsgericht schaffhausen (switzerland), 27 january 2004, <http://cisgw3.law.pace.edu/cases/040127s1.html> although it conceded that the buyer's entitlement to interest derived from the cisg, the same approach was adopted by the oberlandesgericht münchen (germany), 8 february 1995, translated at <http://cisgw3.law.pace.edu/ cases/950208g1.html>. in one case, the rate was determined according to the applicable law, which was neither the law of the seller's nor of the buyer's place of business: icc court of arbitration, no 7660, 23 august 1994, translated at <http://cisgw3.law.pace.edu/cases/947660i1.html>. http://cisgw3.law.pace.edu/cases/936653i1.html http://cisgw3.law.pace.edu/cases/970205s1.html http://cisgw3.law.pace.edu/ http://cisgw3.law.pace.edu/cases/950405g1.html http://cisgw3.law.pace.edu/cases/021219g1.html http://cisgw3.law.pace.edu/cases/970220s1.html http://cisgw3.law.pace.edu/cases/040528r1.html http://cisgw3.law.pace.edu/cases/940118g1.html http://cisgw3.law.pace.edu/cases/040127s1.html http://cisgw3.law.pace.edu/ http://cisgw3.law.pace.edu/cases/947660i1.html nordic journal of commercial law issue 2009#1 19 rate at the seller's place of business directly from article 84 itself.70 a minority of tribunals have favoured the rate of interest prevailing at the buyer's place of business,71 which is inconsistent with the restitutionary character of the seller's duty to pay interest. one tribunal has held that the interest rate should accord with the currency in which restitution of the price has to be made, since it should reflect the use that the creditor (the buyer) could have made of the money.72 this approach seeks to indemnify the buyer for the loss of use of its money and is again inconsistent with the restitutionary character of the seller's duty to pay interest.73 in some 70 see secretariat commentary on article 69 (which was later renumbered article 84), para 2; handelsgericht zürich (switzerland), 5 february 1997, translated at <http://cisgw3.law.pace.edu/ cases/970205s1.html>. the view advanced in this opinion rejects is contrary to the landgericht landshut (germany), 5 april 1995, translated at <http://cisgw3.law.pace.edu/cases/950405g1.html> expressly rejected the drawing of general restitutionary principles by analogy from articles 31 et seq of the convention. the source of the rule that the rate at the seller's residence should apply was left open in oberlandesgericht düsseldorf (germany), 28 may 2004, translated at <http://cisgw3.law.pace.edu/cases/040528g1.html>. the seller was italian and the result would have been the same whether an italian interest rate was inferred directly from article 84 or applied by virtue of private international rules, since italy was the place of business of the characteristic performer (the seller). 71 tribunal of international commercial arbitration at the russian federation chamber of commerce and industry, no 99/2002, 16 april 2003, translated at <http://cisgw3.law.pace.edu/cases/030416r1.html>; china international economic and trade arbitration commission, 30 november 1998, translated at <http://cisgw3.law.pace.edu/cases/981130c1.html>; tribunal of international commercial arbitration at the russian federation chamber of commerce and industry, no 133/1994, 19 december 1995, translated at <http://cisgw3.law.pace.edu/cases/951219r1.html> (but rate not proved by the buyer); tribunal of international commercial arbitration at the russian federation chamber of commerce and industry, no 1/1993, 15 april 1994, unilex; hof van beroep gent (belgium), 11 september 2003, noted at <http://cisgw3.law.pace.edu/cases/030911b1.html>. that same law would also have been applied but for the absence of a russian rate of interest for indian rupees in tribunal of international commercial arbitration at the russian federation chamber of commerce and industry, no 100/2002, 19 may 2004, translated at <http://cisgw3.law.pace.edu/cases/040519r1.html>. the tribunal applied instead the unidroit rule (article 7.4.9(2)), namely, the average short-term lending rate for prime borrowers in the place of payment, failing which, in the place of the currency of repayment. a hamburg arbitral tribunal has also applied the local law in the case of a german buyer and czech seller: schiedsgericht hamburger freundschaftliche arbitrage (germany), 29 december 1998, translated at <http://cisgw3.law.pace.edu/cases/981229g1.html>. 72 icc court of arbitration, no 6653 of 25 march 1993, translated at <http://cisgw3.law.pace.edu/cases/936653i1.html> (basing the award of interest on the london inter-bank offered rate (libor)). this part of the award was later reversed on the ground that the parties had not been properly heard on the subject of interest: cour d'appel paris (france), 6 april 1995, translated at <http://cisgw3.law.pace.edu/cases/950406f1.html>. 73 a case that is hard to classify is icc court of arbitration no 7585 of 1992, translated at <http://cisgw3.law.pace.edu/cases/927585i1.html>, where the tribunal selected the currency most closely related to the financial aspects of the contract of sale. http://cisgw3.law.pace.edu/ http://cisgw3.law.pace.edu/cases/950405g1.html http://cisgw3.law.pace.edu/cases/040528g1.html http://cisgw3.law.pace.edu/cases/030416r1.html http://cisgw3.law.pace.edu/cases/981130c1.html http://cisgw3.law.pace.edu/cases/951219r1.html http://cisgw3.law.pace.edu/cases/030911b1.html http://cisgw3.law.pace.edu/cases/040519r1.html http://cisgw3.law.pace.edu/cases/981229g1.html http://cisgw3.law.pace.edu/cases/936653i1.html http://cisgw3.law.pace.edu/cases/950406f1.html http://cisgw3.law.pace.edu/cases/927585i1.html nordic journal of commercial law issue 2009#1 20 cases, by default, the rate of interest prevailing under the local law has incorrectly been applied.74 gg) currency of interest payment of interest should presumptively be in the currency of account and payment, where these are the same,75 and should be in the currency of payment if this is different from the currency of account. since the seller's duty to pay interest is a restitutionary one, interest should be paid in the currency in which the seller earned the interest if this differs from the currency of payment. hh) cessation of interest the convention does not state when the seller's duty to pay interest should cease. in principle, the restitutionary character of the seller's duty ought to mean that interest runs until the buyer has been reimbursed,76 but it has been held in one case, incorrectly, to run to the date of commencement of the proceedings.77 a difficult case arises where restitution is unduly delayed by the buyer. one argument favours allowing the seller to retain the interest accruing after the due date of restitution, in order to give an incentive to the buyer to effect timely restitution, but the better view is that the seller should account for interest even in this case since the seller has incurred no loss arising from the buyer's delay.78 74 the approach that seems to have been adopted in tribunal of international commercial arbitration at the russian federation chamber of commerce and industry, no 53/1997, 25 december 1997, translated at <http://cisgw3.law.pace.edu/cases/971225r1.html>; tribunal of international commercial arbitration at the russian federation chamber of commerce and industry, no 439/1995, 29 may 1997, translated at <http://cisgw3.law.pace.edu/cases/970529r1.html>; tribunal of international commercial arbitration at the russian federation chamber of commerce and industry, no 72/1995, 25 april 1996, translated at <http://cisgw3.law.pace.edu/cases/960425r1.html>; tribunal of international commercial arbitration at the russian federation chamber of commerce and industry, no 22/1995, 1 december 1995, translated at <http://cisgw3.law.pace.edu/cases/951201r2.html>; juzgado de primera instancia tudela (spain), 29 march 2005, translated at <http://cisgw3.law.pace.edu/cases/050329s4.html>. an award of interest, incorrectly, as damages has led also to the buyer's law: käräjäoikeus kuopio (finland), 5 november 1996, translated at <http://cisgw3.law.pace.edu/cases/961105f5.html> 75 this was the result in china international economic and trade arbitration commission, 10 march 1995, translated at <http://cisgw3.law.pace.edu/cases/950310c2.html>. 76 as decided by tribunal of international commercial arbitration at the russian federation chamber of commerce and industry, no 1/1993, 15 april 1994, translated at <http://cisgw3.law.pace.edu/ cases/940415r1.html>; pretura circondariale parma (italy), 24 november 1989, translated at <http://cisgw3.law.pace.edu/cases/891124i3.html>. 77 tribunal of international commercial arbitration at the russian federation chamber of commerce and industry, no 100/2002, 19 may 2004, translated at <http://cisgw3.law.pace.edu/cases/040519r1.html>. 78 if the seller did incur a loss, it would have a claim for damages against the buyer (article 74). http://cisgw3.law.pace.edu/cases/971225r1.html http://cisgw3.law.pace.edu/cases/970529r1.html http://cisgw3.law.pace.edu/cases/960425r1.html http://cisgw3.law.pace.edu/cases/951201r2.html http://cisgw3.law.pace.edu/cases/050329s4.html http://cisgw3.law.pace.edu/cases/961105f5.html http://cisgw3.law.pace.edu/cases/950310c2.html http://cisgw3.law.pace.edu/ http://cisgw3.law.pace.edu/cases/891124i3.html http://cisgw3.law.pace.edu/cases/040519r1.html nordic journal of commercial law issue 2009#1 21 ii) benefits flowing from the goods 3.28 the buyer's duty to account for benefits received under article 84, unlike the seller's duty to pay interest, is based on actual benefits and not notional benefits. these benefits should also be net benefits, after the cost of using or enjoying the goods has been taken into account.79 there will be many cases where a buyer, despite delivery having occurred long before avoidance, will have received no measurable benefits. an example is where the goods have been sold on to a domestic sub-buyer who has eventually rejected them or who may yet reject them.80 any money derived from that sub-buyer does not count as a benefit under the head contract of sale if it has to be returned to the sub-buyer, since article 84 concerns only retained benefits.81 the burden of proof is on the seller to show that the buyer has obtained benefits.82 there may be difficult cases arising out of the supply of durable machines and similar goods that yield profits over a lengthy term. the calculation of benefits in such cases would require a close examination of the buyer's business and a calculation of its profit margin and its fixed and variable overhead. there are no decided cases quantifying benefits that the buyer must restore to the seller. the buyer's duty to account for benefits is stated to apply not only in cases of avoidance. it applies also where the buyer has required the seller to deliver substitute goods.83 the meaning of this provision is obscure. the buyer's duty to account for benefits is the counterpart to the seller's duty to pay interest on money received by the buyer, and no mention is made of the any duty of the seller to pay interest in cases where the buyer requires substitute goods. if substitute goods are delivered, perhaps some time after the first delivery, the seller will have had the use of the buyer's money in the meantime. the provision appears to contemplate goods with a limited commercial life where the buyer gets value from the rejected goods, despite the existence of a fundamental breach,84 in excess of the seller's value derived from payment and in a way that replicates the value stemming from the substitute goods. this provision has not given rise to any decided cases and is unlikely to do so. 79 p schlechtriem and i schwenzer, commentary on the un convention on the international sale of goods (2nd (english) edn, 2005), 889. 80 oberlandesgericht oldenburg (germany), 1 february 1995, translated at <http://cisgw3.law.pace.edu/ cases/950201g1.html>. 81 landgericht freiburg (germany), 22 august 2002, translated at <http://cisgw3.law.pace.edu/ cases/020822g1.html>. 82 ibid. the seller was able to prove a sub-sale by the buyer in compromex arbitration (mexico), 4 may 1993, translated at <http://cisgw3.law.pace.edu/cases/930504m1.html>. 83 article 84(2)(b). 84 article 46(2). http://cisgw3.law.pace.edu/ http://cisgw3.law.pace.edu/ http://cisgw3.law.pace.edu/cases/930504m1.html nordic journal of commercial law issue 2009#1 22 addendum: cases cited austria oberster gerichtshof, 10 march 1998. note 28 oberster gerichtshof 19 january 1999 (coat hanger case). note 8 oberster gerichtshof 29 june 1999 (wall panels case). notes 17, 19, 43 belgium hof van beroep gent 11 september 2003 (digital archive case). note 71 china china international economic and trade arbitration commission polyethylene film case of 10 march 1995. notes 34 and 75 automobile case of 23 april 1997. note 59 glassware case of 30 november 1998. note 71 finland käräjäoikeus kuopio 5 november 1996 (butter case). note 74 france cour de cassation 26 may 1999 (karl schreiber v thermo dynamique). note 65 cour d'appel de paris 6 april 1995 (thyssen stahlunion v maaden). note 72 cour d'appel de paris 14 january 1998 (société productions v roberto faggioni). note 43 cour d'appel de aix-en-provence 21 november 1996 (karl schreiber v thermo dynamique). note 65 germany bundesgerichtshof 25 june 1997 (stainless steel wire case). note 7 oberlandesgericht celle 24 may 1995 (used printing press case). note 69 oberlandesgericht düsseldorf 2 july 1993 (veneer cutting machine case). note 48 oberlandesgericht düsseldorf 28 may 2004 (tv sets case). notes 22, 70 oberlandesgericht frankfurt 17 september 1991 (shoes case). note 7 oberlandesgericht frankfurt 18 january 1994 (shoes case). note 69 oberlandesgericht hamburg 26 november 1999 (jeans case). note 63 oberlandesgericht karlsruhe 19 december 2002 (machine case). note 69 oberlandesgericht köln 14 october 2002 (designer clothes case). note 63 oberlandesgericht münchen 8 february 1995. note 69 oberlandesgericht münchen 28 january 1998 (automobiles case). note 30. oberlandesgericht münchen 19 october 2006 (auto case). note 22 oberlandesgericht oldenburg 1 february 1995. note 80 landgericht düsseldorf 11 october 1995 (generator case). note 27 landgericht freiburg 22 august 2002 (automobile case). notes 41, 81 landgericht giessen 17 december 2002 (vehicle safety device case). note 48 landgericht krefeld 24 november 1992 (shoes case). notes 32, 45 landgericht landshut 5 april 1995 (sport clothing case). notes 69, 70 landgericht mönchengladbach 15 july 2003 (filters case). note 63 landgericht münchen 20 march 1995 (frozen bacon case). note 62 schiedsgericht hamburger freundschaftliche arbitrage 29 december 1998 (cheese case). note 71 icc court of arbitration award no 7585 of 1992 (foamed board machinery case). note 73 award no 6653 of 26 march 1993 (steel bars case). notes 66, 72 award no 7660 of 23 august 1994 (battery machinery case). note 69 award no 9978 of march 1999. notes 15, 30, 69 award no 9887 of august 1999 (chemicals case). note 15 italy pretura circondariale parma 24 november 1989 (foliopack v daniplast). note 76 nordic journal of commercial law issue 2009#1 23 mexico compromex arbitration 4 may 1993 (josé luis morales v nez marketing). note 82 russian federation tribunal of international commercial arbitration at the russian federation chamber of commerce and industry case no 1/1993 of 15 april 1994. notes 71, 76 case no 161/1994 of 25 april 1995. note 14 case no 2/1997 of 11 may 1995. note 36 case no 22/1995 of 1 december 1995. note 74 case no 133/1994 of 19 december 1995. note 71 case no 72/1995 of 25 april 1996. note 74 case no 82/1996 of 3 march 1997. notes 19, 22 case no 439/1995 of 29 may 1997. note 74 case no 53/1997 of 25 december 1997. note 74 case no 160/1997 of 5 march 1998. note 15 case no 280/1999 of 13 june 2000. notes 13, 15, 16 case no 99/2002 of 16 april 2003. note 71 case no 135/2002 of 16 june 2003. note 64 case no 100/2002 of 19 may 2004. notes 71, 77 case no 175/2003 of 28 may 2004. note 69 case no 95/2004 of 27 may 2005. note 15 spain juzgado de primera instancia tudela 29 march 2005 (bricks case). note 74 switzerland bundesgerichtshof 20 december 2006 (machines case). note 62 tribunale d'apello lugano/ticino 15 january 1998 (cocoa beans case). note 69 kantonsgericht schaffhausen 27 january 2004 (model locomotives case). notes 40, 69 kanstonsgericht valais 21 february 2005 (cnc machine case). note 45 handelsgericht st. gallen 3 december 2002 (sizing machine case). note 27 handelsgerich zürich 5 february 1997 (sunflower oil case). notes 66, 70 bezirksgericht saane 20 february 1997 (alkohol royal feinsprit liquor case). notes 7, 59, 69 united states federal district court new york 14 april 1992 (filanto v chilewich). note 13 federal district court illinois 28 march 2002 (usinor industeel v leeco steel). note 25 * ph.d, ll.m, lawyer with prudentum attorneys at law, the representative office of holland & knight llp, finland, helsinki arbitration under new rules of the international commercial arbitration court in moscow by roman o. zykov* nordic journal of commercial law issue 2006 #1 nordic journal of commercial law issue 2006 #1 2 abstract this article is a review of new rules of the international commercial arbitration court in moscow, effective since march 1, 2006. the rules observed the latest developments in international commercial arbitration aiming promotion of an effective and speedy arbitration in russia. it is natural, that together with the growth of russian international business transactions the number of commercial disputes has increased accordingly. having a long history and extensive experience the icac has become one of the top venues for international commercial arbitration. it is noted that the number of disputes between non-russian parties has risen immensely during the last decade. the author trusts that in the light of the existing economic cooperation between finland and russia the article will be useful for students, scholars, and practicing attorneys. 1. legislation international commercial arbitration in russia is governed by the federal law on international commercial arbitration (‘law’) of july 7, 1993. the law is based on the uncitral model law on international commercial arbitration, adopted by the united nations commission on international trade law on 21 june 1985. the appendices to the law lay down the statute of the international commercial arbitration court in moscow and the statute of the maritime arbitration commission. it is a rather unique construction, when the status of an arbitration institute is set out by national legislature. however, as we will see below, both arbitration institutes remain entirely independent from the russian state. it is essential to note, that the russian federation, as a successor state of the ussr, is a party to the new york convention on recognition and enforcement of foreign arbitral awards (1958), ratified in 1960. 2. international commercial arbitration court in moscow 2.1. legal status and structure the international commercial arbitration court in moscow (icac) originates in 1932 when the central executive committee and council of people’s commissars of the ussr passed the directive establishing the foreign trade arbitration commission (ftac) under the national chamber of commerce. in 1987 the ftac was renamed into the arbitration court at the chamber of commerce and industry of the ussr. and finally, in 1993 upon the adoption of the nordic journal of commercial law issue 2006 #1 1 official web site of the icac: http://www.tpprf-mkac.ru/ 3 law “ on international commercial arbitration” the icac was established in its current legal capacity. the icac is an independent entity within the structure of the chamber of commerce and industry of the russian federation (ccirf).1 the icac is not a legal person. there are two organs in the icac: the presidium and the secretariat. the presidium’s major roles are to study arbitration case law, including that of the icac, to promote the icac arbitration, to represent the icac internationally, to prepare the list of arbitrators for approval of the ccirf, and others. the presidium is elected for a 5 year term by the general meeting of the listed arbitrators. the presidium is led by its chairman. at the time of this writing, the chairman of the icac presidium is professor komarov a.s. the secretariat is the “ executive” organ of the icac, whose authority includes daily management, paper work for submitted and considered claims, communication to parties, and others. the secretariat is headed by the secretary general, who is also present at the meetings of the presidium. additionally, for each case the secretariat appoints a rapporteur, whose main responsibility is to keep the minutes of the meetings, execute the instructions of arbitrators, and other managerial responsibilities. 2.2. commencement of arbitration the icac arbitration commences with filing of a statement of claim, where a claimant substantiates the jurisdiction of the icac, presents its claims, facts, evidence, amount in dispute and calculations for each claim. it should also be noted, that the total amount of a claim includes a compensation of neither arbitral costs nor related costs. a statement of claim shall be duly signed by a claimant, or a person authorized by the claimant. in practice, a sufficient proof of authorization would be a power of attorney or the by-laws of a company, vesting such authority into one of its employees, which is usually its managing director. the rules require the claimant to be precise about the claim in order to facilitate the proceedings without unnecessary delays. additionally, in the event a panel of three arbitrators is formed, the claimant may nominate his arbitrator and a substitute. at this stage all document submissions are done through the secretariat in five copies, in case the tribunal consists of three arbitrators or in three copies if there is a sole arbitrator. needless to say, that in multi-party arbitration the number of copies increases accordingly. the secretariat may ask the claimant to correct mistakes in the statement of claim within a reasonable period of time, but not more than one month. should the claimant fail to comply with the request for correction of mistakes within the prescribed time the icac renders an award or a resolution on termination of the proceedings. the secretariat communicates a copy of the statement of claim to the respondent, and asks to submit the statement of defense within thirty days. in the statement of defense, the respondent http://www.tpprf-mkac.ru/ nordic journal of commercial law issue 2006 #1 4 may raise a counter claim. the rules foresee consequences for not meeting the deadline. should the respondent fail to meet the submission deadline, extra costs of the claimant are to be covered by the respondent. as well as the statement of claim, the statement of defense shall be duly signed by the respondent or a person authorized to do so. the secretariat communicates documents to the parties to their post addresses. it is crucial that the parties keep their contact information actual, and inform the icac of any changes. the parties communicate their submissions by sending registered letters, and the rest might be sent by regular mail, telefax, e-mail and by other means, which may confirm sending. both the statement of claim and the statement of defense can be supplemented or altered before the beginning of the first hearing, unless such action delays the proceedings. in these circumstances the tribunal has powers to limit the parties’ time for the introduction of changes. the tribunal may attribute related procedural extra costs on a delaying party, as well as reject the introduced changes in the statement in case of an unreasonable delay. 2.3. arbitration costs together with the rules, the ccirf adopted the schedule for arbitration costs (‘schedule’). the arbitration costs are comprised of the registration fees, arbitrator’s fees, administrative fees, and any extra fees. upon the commencement of arbitration the claimant pays the non-refundable registration fees of usd 1.000; otherwise, the request is not considered as submitted. the claimant deposits the arbitration costs, calculated on the basis of the schedule. the same rules apply to the counter claim. the paid registration fees are credited in the total arbitration costs. the schedule foresees different tables for calculation of the arbitration costs, depending on the currency of the claim – russian rubles or any foreign currency. for claims in foreign currency the arbitration costs are calculated in the us dollars. however, it is in the discretion of the icac to allow variations in the currency of payment. the arbitration costs are calculated according to the schedule predicated on the size of the claim. to make it clearer, the author suggests the following calculation examples for the claims of usd 100.000 and usd 1.000.000. the arbitration costs for a claim of usd 100.000 are usd 7.770, where usd 3.330 is the arbitrator’s fee. the arbitration costs for a claim of usd 1.000.000 are usd 21.420, where usd 9.180 is the arbitrator’s fee. a few remarks shall be given in this respect. the icac may increase the arbitration costs if a case appears to be complicated and therefore, requires additional time and work. the icac may also reduce the arbitration costs in several circumstances. in particular, if a case is held by a sole arbitrator the arbitration costs are reduced by 20%. if the arbitration is terminated prior to the first session by a motion of the claimant, the arbitration costs are reduced by 50%. if the arbitration is terminated at the first session without rendering an award the arbitration costs are reduced by 25%. in any circumstance, the registration fees are not subject to reduction. the icac may also request the party(s) to deposit money for extra costs. for example, if one of the nordic journal of commercial law issue 2006 #1 5 parties appoints an arbitrator who resides in a place other than the place of arbitration, that party shall make a deposit for the corresponding expenses (traveling, accommodation, visa, etc.). the arbitration costs, unless otherwise agreed by the parties, are attributed to the losing party. however, if the claim is satisfied only partially, the costs are attributed proportionally between the parties according to the arbitral award. a winning party may also ask the tribunal to impose its legal and other related costs on the losing party. additionally, for promotion of a speedy dispute resolution, the schedule adopted the rule where a party delaying the proceedings is accountable for extra costs of the other party. 2.4. arbitrators and constitution of the tribunal the rules support commonly accepted requirements of impartiality and independence of arbitrators. for the practical implementation of the requirements, the rules impose an obligation on each appointed arbitrator to inform the icac, at any stage of the proceedings, of any circumstances which may influence his decision making. each arbitrator also produces a biographical sketch describing the education, work experience, and other relevant facts. the icac makes this information available to the parties. as a prerequisite for acting as arbitrator, each appointed person gives within 15 days from the date of appointment a written consent to act as arbitrator under the rules. the icac makes up a list of arbitrators for a period of 5 years, containing the following information: the names of arbitrators, their education, current employment, research achievements, field of expertise, and working languages. the list names around 200 professionals from different jurisdictions. however, the parties are free to appoint an arbitrator(s) other than from the list. unless otherwise agreed by the parties, a panel of three arbitrators is appointed to resolve a dispute. however, it is always in the discretion of the parties to agree on the number of arbitrators. as an exception to the rule, if a case is not complicated, or the amount in dispute is less than usd 25.000, the icac may exercise its right of appointment of a sole arbitrator, even though the parties agreed to constitute a panel of three arbitrators. if the parties agreed to submit their dispute to a sole arbitrator, it would be for the icac to appoint the arbitrator and a substitute. when a panel of three arbitrators is formed, each party appoints its own arbitrator and the substitute, and the icac appoints the chairman of the panel and the substitute. the claimant has to exercise his right within 15 days from the day when the icac accepts the statement of claim. the respondent appoints the arbitrator within 15 days after receiving the icac’s notification that the claimant appointed the arbitrator (the name of the claimant’s arbitrator is also disclosed). if any of the parties fails to appoint their candidates within the said period, the icac appoints a party’s arbitrator on its own notion. nordic journal of commercial law issue 2006 #1 6 2.5. proceedings needless to say, that the rules adhere to the principle of the adversary proceedings between equal parties. confidentiality is another corner stone principle resembled in the rules. generally, the proceedings take place in moscow. yet, if the parties agree and are ready to cover extra costs, the proceedings can be conducted in any other place. the arbitral tribunal may also decide to hold some sessions out of moscow if necessary. it should be noted here, that even if the actual place of the icac arbitration is outside russia, the place of arbitration is considered de jure moscow. the sole purpose of that is to subjugate the arbitral proceedings to the russian law on arbitration, and define the «nationality» of the award. it is a general understanding, that speedy proceedings are a fundamental feature of arbitration. the average duration of the proceedings prior to adoption of the new rules did not exceed nine months. the new rules reduced the duration, imposing on the arbitral tribunal a 180-day term obligation for rendering an award, beginning from the day when the tribunal was composed. in fact, the duration requirements are not always observed due to many reasons. therefore, the rules foresee a possibility of granting an extension by the icac upon a request of the arbitral tribunal. one of the important novelties of the rules is the right of the parties to choose the language of the entire proceedings. written submissions, though, are filed in the language of the original documents, or might be translated into the language of the proceedings. as a matter of fact, the old rules provided only for the language of the hearings, skipping in silence the other stages of the proceedings. in the new rules this deficiency was eliminated. the parties to a dispute usually state their case in the oral pleadings. the tribunal may also consider the case solely on the basis of the documents, if the parties so agree. for each session the minutes are kept, which are also available for the parties’ insight. if necessary, the parties may request the tribunal to adjourn or suspend the proceedings. the tribunal grants such motion by passing a resolution. the dynamic growth and acceptance of arbitration worldwide puts the question of clear understanding of interim measures of protection on the agenda. the importance of interim measures of protection in arbitration becomes even more apparent if we consider how fast the today’s business is. clearly, it requires adequate fast and flexible measures to protect interests of businesses. as a matter of fact, interim measures of protection in arbitration are actively discussed in the legal community nowadays. for instance, the work of the uncitral working group ii on article 17 of the model law is a clear evidence of that. among the open issues are: the security by a requesting party to cure possible damages of the respondent; forms and types of interim measures; an extent of cooperation between judiciary and arbitral tribunals, and many others. in the absence of the legislative clarity on this question in russia, the icac rules address some of mentioned matters: a requesting party may be asked to provide a security to cure possible damages of a respondent; the measures are rendered in the form of an interim award; the requesting party is bound to inform the tribunal of any measures taken by the state courts in relation to the subject matter of the arbitration. nordic journal of commercial law issue 2006 #1 2 official statistical data of the icac. 7 2.6. arbitral award the provisions of the rules regarding arbitral awards are similar to those in many international arbitration rules, therefore we will only give a brief overview of them. final awards are passed by the majority of votes of the arbitral tribunal. a dissenting arbitrator may give a statement in a separate opinion, which is attached to the final award. the arbitral tribunals are also enabled to render partial awards in relation to some parts of the claim, or deciding upon some of the issues. if during the proceedings the parties reach a settlement, upon a joint request of the parties the tribunal may record it in an arbitral award. before signing an award a tribunal communicates a draft award to the secretariat. the secretariat checks the draft award for mistakes and deficiencies as to its form, but is not authorized to give its opinion on the merits of the case. awards are signed by all arbitrators, and if not, the chairman of icac witnesses this fact, and notes the reasons of absence of a signature(s). the parties may within a reasonable time after receiving an award ask the tribunal to rectify the award. the tribunal has to comply with a 30 day term to introduce its corrections. additionally, the parties within 30 days may request the tribunal to supplement and interpret the award. the tribunal has 60 days from the date when the request received to issue a supplementary award. arbitral awards of the icac are confidential, and therefore are not published in their original form. yet, subject to deleting the names of parties and other confidential information, arbitral awards might be disclosed. in particular, professor rosenberg (a member of the presidium icac) compiles yearbooks of the icac awards, some of the awards are also discussed in several russian arbitration journals. additionally, cisg related icac arbitral awards can be found in english in the cisg database of the pace law school institute of international commercial law. 3. activities of the icac in figures finally, there are some statistics for illustration of the activities of the icac in the recent years.2 according to the icac there were 210 claims submitted in 2003, 162 in 2004, and 148 claims in 2005. at the same time, a clear tendency that there was the increase of the disputes between nonrussian parties submitted to icac is remarkable. there were 9 claims relating to the agreements between non-russian companies in 2002, 17 in 2003, and 30 claims in 2004. in 2005 there were 5 claims where one party was a company from a nordic country (denmark -2 claims, finland, norway, and sweden – 1 claim each). the types of the matters in disputes remain relatively steady. in 2005, 107 claims (73%) arose out of international sales-purchase agreements, 13 claims (8,5%) out of service agreements, 13 claims (8,5%) out of credit and loan agreements, 5 claims (3,5%) out of construction agreements, another 5 claims (3,5%) out of transport agreements, and the rest 5% out of agency, insurance and lease agreements. the largest amount in dispute in 2004 was usd 91.590.122 (claimant – polish, respondent russian); and usd 26.880.000 in 2005 (claimant – luxembourgian, respondent russian). 1 victoria university melbourne is the ship's rail really significant? by reannon hemmings 1 nordic journal of commercial law issue 2005 #2 nordic journal of commercial law issue 2005 #2 1 international commercial terms ‘incoterms’ (2000). 2 gabriel, h. contracts for the sale of goods,: a comparison of domestic and international law, (2004) oceana press, at 241. 3 john levingston, ‘a commentary on incoterms 2000fob contracts’ (january 1999) findlaw australia database, <http://www.findlaw.com.au/articles/default.asp?task=read&id=4156&site=gn> cited at 14-04-05. 4 bergami, r., international trade: a practicaliintroduction, (2004), eruditions publishing: melbourne, at 135. 2 i. introduction the development of containerisation has not only simplified the carriage of goods but has also changed the legal relationship between seller and buyer. as a consequence some of the incoterms 2000 such as free on board (fob) are now often used incorrectly. traders instead should make use of the more suitable multimodal term, namely free carrier (fca). a comparison of the two terms on the basis of risk transfer indicates that differences occur and significant implications arise if parties incorporate the ‘wrong’ term into their contract. for instance, fob’s risk transfer point of the ‘ship’s rail’ is synonymous with shipping and should not be misapplied to transactions involving containerisation where the risk transfer is not the ‘ship’s rail.’ the risk transfers when the first carrier takes charge of the goods. this simple fact alone requires a clear understanding of the two terms in order to avoid unnecessary legal complications in case of lost or damaged cargo. it is common knowledge that an incorporation of any incoterms 2000 1 term into an international contract requires specific reference in the contract. the main functions of incoterms, being a code of acronyms, are to facilitate intentional trade by eliminating uncertainties and differences in interpretation of trade or shipping terms. 2 however merely agreeing to transact under incoterms is not enough to finalise a transaction. incoterms do not cover all aspects of the sale of goods contract and to facilitate a smooth transaction, parties should include provision as to transfer of title of the goods, remedies for breaching the contract, exception or limitation clauses, exemptions from liability, and any other duties the parties may wish to include in the sale contract. 3 parties further have the choice of incorporating an incoterm as well as making additional provision in the sales contract for ‘the export customs clearance, carriage from warehouse (works) to port of export, contract of affreightment (carriage), contract of insurance, import customs clearance, and local delivery in country of import’. 4 this paper will compare the operation of fob and fca, two frequently used international commercial terms. the question of risk transfer from seller to buyer is used to demonstrate the significance of the ‘ship’s rail’, and the consequences of choosing the wrong term. http://www.findlaw.com.au/articles/default.asp?task=read&id=4156&site=gn nordic journal of commercial law issue 2005 #2 5 mo, j., international commercial law, (2000), butterworths: new south wales. p11. 6 sanson, m., essential international trade law, (2002), cavendish publishing: new south wales. p79-80. 7 gabriel. h. above n 2, at 249. 8 (1954) 2 qb 402. 9 the el amira & el amina [1982] 2 lloyds rep 28, 32. 10 [1913] 3 k.b. 743. 11 t o d d , p . , ‘ p y r e n e v . s c i n d i a n a v i g a t i o n c o . l t d . ’ ( d e c e m b e r 1 9 9 8 ) o u r w o r l d d a t a b a s e , http://ourworld.compuserve.com/homepages/pntodd/cases/cases_p/pyrene.htm cited at 21-03-05. 12 ibid. 13 (1839) 7 er 824, at 627. 3 ii. salient features of fob f group terms in essence require the seller to deliver goods to a carrier which has been appointed by the buyer. the terms are; fca (free carrier), fas (free alongside ship) and fob (free on board). the element of the f terms is that the main carriage is unpaid by the seller, and the risk is passing to the buyer at the point where the goods are delivered to a named carrier. 5 the fob term enjoys wide usage in the international shipping of goods, being originally developed to clarify responsibilities and liabilities for parties to the transaction. 6 english law and american law did not give the same meaning to the fob term which was considered to be a general delivery term. 7 in england devlin j, in pyrene v scindia 8 defined the existence of three variations of the fob contract, depending on the intent of the parties. the classic fob contract occurs when the seller draws up the contract of carriage, with the buyer nominating a vessel. as explained in el amira & el amina 9 it is also possible under fob that the seller acts as the principal shipper. furthermore in wimble sons v rosenberg and sons 10 the possibility has been confirmed that occasionally the seller ‘ships’, not because he is obliged to do so, but as a favour to the buyer. the second variation of fob is explained as obliging the seller to make the shipping and insurance arrangements for the buyer’s account, with the seller nominating a suitable ship. thirdly the most common form that fob exists in today occurs with the buyer nominating the vessel and making the contract of carriage. 11 consequently if the buyer fails to nominate a ship within the contractually stipulated time, the contract is effectively repudiated. the seller may then sell goods to a third party, recovering any losses from the buyer. the incoterms definition of fob is based on the buyer being the shipper as demonstrated in the pyrene 12 with the buyer nominating the vessel. the buyer commonly makes the contract of carriage today because of the lack of options the seller had in recovering damages or loss against the carrier in the nineteenth century. dunlop v lambert 13 established that because property and risk had transferred to the buyer on delivery and because the buyer would most likely sue for losses or damages, the buyer was the party that needed to make the contract of carriage: where there is a delivery to a carrier to deliver to a consignee, he is the proper person to bring the action against the carrier should the goods be lost; yet that if the consignor made a special contract with the carrier, and the carrier agreed to take the goods from him, and to deliver them to any particular person at any particular place, the special contract supersedes the necessity of showing the ownership in the goods; http://ourworld.compuserve.com/homepages/pntodd/cases/cases_p/pyrene.htm nordic journal of commercial law issue 2005 #2 14 dunlop v. lambert (1839) 7 er 824, at 627. 15 (1839) 7 er 824. 16 1855 (uk), section 1. 17 gleeson, a.m., ‘pr i vi t y o f c o n t r a c t a n d ma r i t i m e l a w ’ ( j a n ua r y 1 9 9 3 ) findlaw australia database, <http://www.findlaw.com.au/article/4734.htm> cited at 06-06-2005. 18 bergami, above n 4, at 147. 19 i n t e r n a t i o n a l c h a m b e r o f c o m m e r c e , ‘ i n c o t e r m s 2 0 0 0 ’ . ( 2 0 0 0 ) i c c p u b l i c a t i o n 5 6 0 . <http://www.iccwbo.org/incoterms/preambles/pdf/fob.pdf> cited at 10-03-05. 20 todd, above n 11. 4 and that, by the authority of the cases of davis v. james (1770) 5 burr 2680 and joseph v. knox (1813) 3 camp 320, the consignor, the person making the contract with the carrier, may maintain the action, though the goods may be the goods of the consignee. 14 interestingly, this case asserted that even where the ‘consignor’ doesn’t hold the risk liability (or property) he might still recover damages from the carrier. stemming from the developments of dunlop v. lambert, 15 the bills of lading act 16 made it possible for the seller to make the contract for carriage because unlike previously thought, the contract wasn’t transferred with the bill of lading: the main problem was that a buyer of goods, whether or not there had been a transfer of a document of title, and even though the buyer was at risk in relation to the goods, was unable to sue or to be sued on a contract of carriage to which the buyer was not a party. section 1 of the 1855 act sought to deal with this problem by providing that the transfer of a bill of lading also affects the transfer of the contract of carriage. a consignee named in a bill of lading, and an endorsee to whom the property in the goods passes upon or by reason of consignment or endorsement, has the same rights, and the same liabilities, as if an original party to the contract. 17 this was an early attempt to equalise buyer and seller’s rights in the transaction. a) the correct usage of fob fob’s prominent status today is a result of its inclusion in most contracts over the past two centuries. fob was the usual way of conducting international trade and it can be argued that it took on the mantle of “ customary law” . as with all enshrined practices and customs, implementing changes is problematic. traders are reluctant to use another term when formulating their contracts and as a result, fob is often incorrectly incorporated into contracts to indicate any point of delivery, for instance fob factory or fob plant. 18 the international chamber of commerce specifically states in the explanatory notes to the incoterms that fob means ‘free on board’ and should be used in that manner only in the contract. 19 fob, besides being a term of choice, can at times serve a specific purpose, for instance where the buyer requires a particular type of vessel or where currency restrictions exist and carrier and buyer are the same nationality. in this latter example, fob is the best and most correct term to apply to the transaction, as fob prices are lower than cif prices. 20 http://www.findlaw.com.au/article/4734.htm http://www.iccwbo.org/incoterms/preambles/pdf/fob.pdf nordic journal of commercial law issue 2005 #2 21 icc, above n 19, at 14. 22 [1954] 2 qb 402. 23 pyrene & co. v scindia steam navigation co [1954] 2 qb 402, at 419. 24 national australia bank, finance of international trade, (1996), nab: australia. p44. 25 zaritski, j., ‘international commercial terms.’ (2002) australian export online, <http://www.export61.com.au/export-tutorials.asp?ttl=tict> cited at 20-02-05. 26 bergami, above n 4, at 147. 5 despite the widespread and effective use of fob, the risk transfer point at the ‘ship’s rail’ has been criticised for not reflecting the current situation at seaports. arguments were advanced to abolish fob but because many port customs and commercial practices have developed as a result of the term and therefore fob was retained in incoterms 2000. 21 furthermore fob is still applicable in certain instances were cargo is not shipped in containers. iii. risk transfer: significance of the ship’s rail the use of fob in contracts, whilst common, is not applied correctly in all cases. frequently when goods are containerised parties misuse fob, most likely mistaking it for the more appropriate fca term. this misapplication could result in complications in situations where goods are damaged during loading. in relation to risk transfer crossing the ‘ships rail’ is of significance and requires some commentary. in pyrene & co v scindia steam navigation co, 22 the plaintiff pyrene co ltd was able to recover ^200 from the defendant carrier, after the carrier was found to be negligent in loading the goods which caused damage prior to the goods crossing the ‘ship’s rail’. pyrene raises questions of liability if the damage occurs at any point other than after crossing the ‘ship’s rail’. devlin j stated that if the goods are damaged during loading, whether that damage occurs on either side of the ‘ship’s rail’, then the carrier’s liability for negligence would have to extend to cover the damages: only the most enthusiastic lawyer could watch with satisfaction the spectacle of liabilities shifting uneasily as the cargo sways at the end of the derrick across a notional perpendicular projecting from the ship's rail. 23 the problem that emerged from the early ‘ship’s rail’ cases and the judgement in pyrene is: who bears the responsibility if the goods sway back over the ‘ship’s rail’ and fall on the wharf? however it still stands that in general fob holds the seller/exporter responsible for delivering the exportcleared goods to a named port and loading them onto a vessel. as the goods pass over the ‘ship’s rails’ the risk of loss or damage to the goods is transferred from the seller to the buyer. 24 in sum, the buyer assumes all peril of loss or damage after the goods passed the ‘ship’s rail.’ if, as the goods are being loaded they fall on the wharf or water, then the seller bears the loss. if however, the goods fall on the deck or any point over the ‘ship’s rails’, the buyer bears the loss. 25 the risk transfer point at the ‘ship’s rail’ is very specific and should not be misapplied to situations where it contains no adequate purpose, as is too often the case with containerised traffic and roll on-roll off traffic. 26 fob should only be applied in a shipping capacity, in reference to ocean or inland waterway transport, though the term is frequently used to describe inland movement of http://www.export61.com.au/export-tutorials.asp?ttl=tict nordic journal of commercial law issue 2005 #2 27 ibid. 28 cowas-jee v thompson (1845) 3 moore ind. app. 422, 430, 18 er 560, 563 (pc). 29 (1859) 4 h. & n. 822. 30 bills of lading act 1855, section 1. 31 (1885) 10 app. cas. 263. 32 [1970] 1 lloyds rep 499, at 504. 33 [1921] 3 kb 302. 34 ibid at 307 35 [1981] 1 lloyds rep 200. 36 the international convention for the unification of certain rules relating to bills of lading (1924) 37 carriers and innkeepers act (1958) vic, convention on the contract for the international carriage of goods by road (cmr) geneva, 19 may 1956. 6 cargo. 27 fob would be best suited for bulk commodity cargo such as oil or grain, where it is imperative that the goods pass the ‘ship’s rail’. a) developments in case law the concept of delivery being effected as the goods pass the ‘ship’s rail’ is not a new development, however the confusion surrounding the concept has never been laid totally to rest, as demonstrated by case law spanning the p ast three decade s. early forms of fob saw the property (and consequently risk) transfer at the ‘ship’s rail’, with the ship being treated as the buyer’s floating warehouse. 28 brown v hare 29 established that the point of delivery and property transfer was also the point of risk transfer. the principle that property and risk would transfer together was anchored in legislation. 30 inglis v stock 31 clarified that risk always passed on shipment that is crossed the ships rail, even when property passes at a later date. in frebold and sturznickel (panda ohg) v. circle products ltd, 32 widgery l.j made specific mention of delivery being at the ‘ship’s rail’. however in colley v oversees exporters 33 , it appears that the judge held property and risk to pass once loading is complete: i need only deal with f.o.b. contracts. the presumed intention (see s. 18 of the act) of the parties has been settled. it seems clear that in the absence of special agreement the property and risk in goods does not in the case of an f.o.b. contract pass from the seller to the buyer till the goods are actually put on board. 34 when parties fail to understand the intricacies of the ‘ship’s rail’ concept, conflicts can arise. thermo engineers ltd v. ferry masters limited 35 , illustrates this point well. the english seller of a heat exchanger entered into an fob contract with a buyer located in copenhagen. the heat exchanger was carried by trailer onto the vessel, at which point the lower deck of the vessel was damaged. uncertainty arose as to where the responsibility would fall – as technically the trailer had crossed the line of the stern, hence ‘the ship’s rail’. the damage was ultimately covered by virtue of the hague rules. 36 if the damage had occurred prior to the crossing of the ‘ship’s rails’, it would have been governed by road provisions instead 37 . thermo engineers acts as a warning to parties when entering transactions with incorrect incoterms. the transfer of risk can vary depending on the chosen terms and therefore it is imperative that parties clearly understand the terms which will indicate where their liabilities begin and end. nordic journal of commercial law issue 2005 #2 38 levingston, above n 3. 39 see the international convention for the unification of certain rules relating to bills of lading (1924) 40 zaritski, above n 25, 41 national australia bank, 1996, finance of international trade. nab, australia. p45. 42 pinka, v., ‘incoterms 2000’ (2002) airkargo database, <http://www.airkargo.sia.iv/incoterms2000.htm> cited 04-02-05. 7 iv. development of fca if the parties intend to apply an incoterm to the contract and intend to govern the risk transfer at a point other than ‘the ship’s rail’. fca – that is free carrier provides the best alternative. of importance is that this term is suitable for all modes of transport including multimodal transport. as defined in the incoterms 2000, fca: means that the seller delivers the goods, cleared for export, to the carrier nominated by the buyer at the named place. it should be noted that the chosen place of delivery has an impact on the obligations of loading and unloading the goods at that place. if delivery occurs at the seller's premises, the seller is responsible for loading. if delivery occurs at any other place, the seller is not responsible for unloading. 38 the development of containerisation meant that fob failed to address the increasing multimodal transport requirements international trade. as pointed out above, fob means that the risk passes once goods cross the ships rails. this is a vital concept because if not careful, the seller will remain liable for the goods, even after ‘delivering’ them to the carrier. when the seller remains liable beyond the point of delivery, the seller is responsible for goods that are under the control of the carrier. as such, a gap emerges in liability, from the point of delivery to the point somewhere down the line where the goods cross the ‘ship’s rail’. by way of solving the emerging gap i n liab ility, the fca te rm wa s intro duced wi th the incoterms 2000. the development of the free carrier (fca) incoterm was necessary to offer an alternative to the usage of the free on board (fob) term. the introduction of the fca term in the incoterms 1990 resulted from the narrowing of some of the previous terms that were specific to a particular mode of transport, namely, free on rail/truck as well as free airport. the 13 terms in the 1990 version also saw a name change of free carrier from frc to fca. 39 free carrier (fca) denotes the seller/exporter’s responsibility over all risks and costs, until the goods are ‘delivered to the named place and collected by the carrier nominated by the buyer’. 40 a carrier is defined as: any person whom in a contract of carriage, undertakes to perform or to procure the performance of carriage by rail, road, sea, air, inland waterway or by a combination of such modes. the buyer must give the seller in time the necessary instructions for despatch and take responsibility of the goods from the time when they have been delivered into the custody of the named carrier. 41 fca is a term that can be used for all modes of transport, including multimodal. fca has particular use with containers and roll on-roll off traffic by trailers and ferries. 42 the development of containerisation paved the way for the introduction and implementation of the fca term, often now being used to replace the more outdated fob term. fca is based on the same principle as fob, except the risk transfer point stops with the first carrier at the named place, not the ‘ship’s http://www.airkargo.sia.iv/incoterms2000.htm nordic journal of commercial law issue 2005 #2 43 ibid. 44 icc, above n 19, at 14. 45 bid at 26. 46 gabriel, h., ‘the international chamber of commerce incoterms 1990 a guide to their usage’ (1999), cisg database, pace, <http://www.cisg.law.pace.edu/cisg/biblio/gabriel1.html> cited at 21-02-05. 8 rail’. 43 it is only by considering the risk transfer point of fob and fca that the critical differences in the terms emerge. the significance of shifting liability at the ‘ship’s rail’ can have dire consequences if not incorporated correctly into the contract of sale. v. consequences of choosing the wrong term? since the 1960’s, growth in containerisation and changed cargo handling patterns has meant that fob puts undue pressure on the seller as the goods are prepared and stowed in containers before the arrival of the ship. 44 as such fob should not be used unless the goods specifically transfer to the carrier at the ship’s rails. when considering an fob contract, this point of the ‘ship’s rail’ means prior to that point the buyer has no insurable interest. likewise, after that point the seller has no insurable interest. hence, the seller in the fob transaction remains liable until this point, which means that if the parties incorrectly use fob instead of fca the seller remains at risk even after the goods have been handed over to the first carrier. the seller has no control over the goods from this point, as the buyer usually nominates the carrier: normally, sellers have general insurance arrangements (so called open cover) which protects them in such cases. however, a seller who fails to cover himself adequately in these situations will no not normally benefit from the buyer’s insurance, even if that insurance contains a so-called transit clause to the effect that the insurance protection lasts from warehouse to warehouse, thereby covering the period before loading the goods on board. there are two reasons for this: first, the fob-seller is not a contracting party to the fob-buyer’s insurance contract; and second, the fob-buyer has no insurable interest before the goods have passed the ship’s rail. 45 however, incorporating fca into the contract of sale benefits the seller as the risk transfer point occurs when goods transfer to the first carrier. the buyer is put in a clearer position than if trading under fob, because he now bears responsibility from the point in which the first carrier takes charge of the goods. the third major party in a standard transaction is the carrier that agrees to transfer the goods from the seller’s hand to the buyer’s. fca further benefits the seller because the liability of the carrier extends to cover the loading of the goods, which was previously completed to the point of the ship’s rail, with the seller bearing the risk. vii. conclusion first published in 1936, the incoterms are uniform rules defining costs, risks and obligations of buyers and sellers in international transactions. incoterms, if expressly provided for, will govern the sales contract. other law applies to transactions, for instance, international conventions such as the cisg, hague-visby rules and domestic laws. when used correctly, the incoterms allow ‘prudent and efficient’ allocation of duties and risks in agreement. 46 incorrect use of the http://www.cisg.law.pace.edu/cisg/biblio/gabriel1.html nordic journal of commercial law issue 2005 #2 47 sanson, above n 6, at 79. 48 mo, above n 5, at 19. 49 united nations convention on the carriage of goods by sea, hamburg, (1978), article 4.(1). 50 parliament of australia, parliamentary library, ‘carriage of goods by sea amendment bill 1997’, (1997), bills digest (no.15), <http://www.aph.gov.au/library/pubs/bd/1997-98/98bd015.htm> cited at 06-06-05. 9 terms may bind parties to obligations that are not only beyond their understanding, but also beyond their capabilities. the operation of fob and fca terms differ dramatically, best evidenced by comparing the risk transfer point in the transaction. where the contract for sale of goods was entered into on an fob basis, the seller is required to deliver the goods via the named vessel, to the named port, place and time stipulated in the contract. the risk transfer point changes from buyer to seller as the goods cross over the ship’s rail, up until this point the seller bears all risk pertaining to loss or damage. ultimately, once the appropriate goods cross the ‘ship’s rail’ on the named vessel, the seller is free from further liability; all that remains is for the seller to endorse the bill of lading to the buyer when the goods are onboard the ship. 47 the buyer must also meet a number of obligations under an fob sales contract. the buyer assumes all risks of loss or damage from the point of risk transfer, the ‘ship’s rail’. the concept of risk transfer at the ‘ship’s rail’ is confusing, and often misused in practice. fca is the appropriate multimodal term that should be applied to situations where the containers used for shipping do not pass the ‘ship’s rail’. 48 where the contract for sale of goods was entered into on an fca basis, the seller effects delivery by either delivering the goods to the named carrier (freight forwarded etc), or by making the goods available at the seller’s premises to the first carrier. the seller is responsible for the goods until one of the above delivery methods is accomplished. the buyer must also meet a number of obligations under an fca sales contract; the buyer assumes all risks of loss or damage from the point of risk transfer, where the goods are delivered to the first carrier. the consequences of using the wrong term in the transaction can be problematic. it could involve the seller in unnecessary legal expenses as – transacting under fob with containers instead of fca – the seller remains liable until the goods cross the ‘ship’s rail’. in practice, this often occurs after the carrier has taken possession of the goods and they have been stowed at the carrier’s facility. if the seller had instead transacted under the fca term, then the seller’s liabilities and responsibilities would conclude the moment the carrier takes delivery of the goods, either via truck at the seller’s premises or at the named place. when fob is incorrectly used, a gap emerges where it is difficult to assign liability if the goods are damaged before the risk transfer point of the ‘ship’s rail’. the hague-visby rules provide that the carrier is only liable from the point that the goods are loaded onto the ship. consequently, these widely accepted rules do not solve the problem of assigning liability to fill the gap. the hamburg rules, although not widely accepted and not binding on australian contracts, bind the carrier with liability from ‘the moment the carrier is in charge of the goods at the port of loading’. 49 the hamburg rules, if adopted, would successfully solve the problem of assigning liability to parties that don’t have control over the goods. unfortunately, the hamburg rules are problematic, particularly in regards to the effect their adoption would have on the uniformity of the law governing carriage of goods by sea. 50 http://www.aph.gov.au/library/pubs/bd/1997-98/98bd015.htm nordic journal of commercial law issue 2005 #2 10 the cisg is also not helpful as it only offers default rules. despite the fact that article 67(1) in essence mirrors the fca term articles 8 and 9 oblige a tribunal or court to take either the subjective or objective intent of the parties into consideration or pursuant to article 9 the “ usage to which they have agreed.” hence a term such as fob will “ trump” article 67(1) and will be enforced. in sum, fob, whilst enjoying widespread usage, is often inaccurately applied to the sale of goods contract. the fob contract undoubtedly has a place in commercial transactions, but where containerisation is involved, parties need to choose fca, as otherwise the risk management of the transaction is not properly executed. microsoft word ahmad_ali_ghouri.doc nordic journal of commercial law issue 2010#1 the law and regulation of otc derivatives: an anglo-american comparison and lessons for developing countries by ahmad ali ghouri* * the author is a doctoral scholar at the university of turku, finland and a lecturer in law at the university of the punjab (gujranwala campus), pakistan. he is very thankful to ms. katja weckström, editor-in-chief of the nordic journal of commercial law for her detailed review of this article with helpful suggestions and comments. the author can be contacted at ahmgho@utu.fi or ghouri_ali@hotmail.com. nordic journal of commercial law issue 2010#1 1 1. introduction based on different underlying assets and instruments, derivatives are traded in the absence of clearing houses and organised markets. since they are not exchange-traded, derivatives are not widely understood. in over-the-counter (otc) markets, counterparty default risk generates a network of interdependencies among market actors, promotes risk volatility and results in systemic risk. the largest bankruptcy in the us, lehman brothers holdings inc., was the result of derivatives financing.1 the same otc financing caused the failure of the barings bank in 1990s.2 presently, an estimated amount of us$604.6 trillion is outstanding from otc derivatives contracts,3 which is roughly more than ten times of the world gdp (us$57.53 trillion). the inherent lack of transparency in otc markets impairs price discovery and obviates the efficient markets hypothesis, i.e., the otc derivatives and the risks associated with them may be priced incorrectly. the aim of this article is to examine the threat of systemic risk posed by speculative otc derivative financing to financial institutions and the efforts made by the regulators to reduce such risk. a critical and comparative analysis of the anglo-american approach to regulate otc derivatives is endeavoured, in order to evaluate how these advanced economies have proven effective in achieving the ultimate objectives of financial stability, certainty and predictability. the article examines how the financial regulators of these advanced economies have responded to the vociferous public debate about the threats that otc derivative financing may have on the overall stability of contemporary financial systems. while the threat is the same, there are substantial differences in regulatory approaches and conclusions. the article concludes by showing how otc derivatives regulations of advanced economies can be applied to emerging financial markets in order to both increase market efficiency and attain financial stability. in addition to the introduction and conclusion this article is divided into four main parts where each part has its own introduction and conclusions. chapter 2 begins with an introduction to financial derivatives; the derivatives products (contracts) viz. forwards, swaps and options are introduced and their possible uses, i.e., arbitrage, hedging and speculation are explored. chapter 3 investigates different types of risks associated with derivatives financing and the legal nature of derivatives contracts and concludes with an analysis of the different regulatory approaches adopted for otc derivatives. 1see online at http://online.wsj.com/article/sb122166095912947875.html?keywords=lehman+ brothers+holdings+inc 2a. s. bhalla; collapse of barings bank: case of market failure; (economic and political weekly); vol. 30, no. 13 (apr. 1, 1995), pp. 658-662 3 see online at http://www.bis.org/statistics/otcder/dt1920a.pdf nordic journal of commercial law issue 2010#1 2 chapter 4 gives a detailed analysis of and compares the otc regulation in the united kingdom (the uk) and the united states of america (the us). the purpose is to identify any similarities and differences in these two regulatory approaches that deal with the identical problem of systemic risk posed by otc derivatives. chapter 5 begins with the assessment of potential benefits of otc derivates. after outlining the potential benefits and also the potential risks of the otc derivatives for the developing economies, the article gives concrete solutions for the developing economies to regulate their otc financial markets. 2. an introduction to financial derivatives contracts 2.1 derivatives contracts in general this chapter describes the nature of a derivative transaction. after exploring the difference between exchange traded and “over the counter” (otc) derivatives, some important derivatives products like forwards, options and swaps, are evaluated. it also looks at the rationale of derivative financing and the driving force that has lead the financial markets to invent derivatives. in this context, concepts like hedging, speculation and arbitrage, are discussed. it concludes that derivatives financing, whether driven by hedging or speculation, is inherently open to certain kinds of risks. a derivative is a transaction originating from an underlying instrument and it derives its value from that underlying instrument. derivatives underlyings include corporate bonds, payment obligations under a loan agreement, shares, commodities, indexes, interest rate, but this list is by no means exhaustive. a derivative contract is purely financial in its nature. in both financial contracts and contracts for real goods and services, the contract requires that the underlying security or good be delivered either immediately or later on an agreed date.4 this, however, is not the case with a derivative contract. in a financial derivatives contract, the parties at the outset of the contract intend no actual delivery of the underlying instrument or asset. this is the factor that converts an ordinary futures contract into a derivative contract.5 in a derivative futures contract the delivery is intended to be settled by payment of a single lump sum, or some other special arrangement.6 the underlyings from which derivatives derive their value are called derivative products. derivative contracts can be transacted in one of two ways. first, it can be transacted on an exchange. this is generally referred to as an exchange-traded derivative contract and is subject to the rules governing transactions on the exchange. the clearinghouse of the exchange 4 don m. chance; an introduction to options and futures; (the pryden press chicago 1989), p.3 5 cf. simon james; the law of derivatives; (llp1999), p.3 6 as we will discuss later the buyer and seller ‘closeout’ the contract by taking off-setting positions nordic journal of commercial law issue 2010#1 3 interposes itself between the buyer and the seller, and acts as a central counterparty of all derivative deals. to protect itself from insolvency, the clearinghouse requires traders to deposit an initial margin. additional margin calls are also made on the basis of movements in derivative prices. most of the terms of an exchange-traded derivative are standardized.7 alternatively, derivatives contracts can be entered as ‘over the counter’ (otc). an otc derivative contract is separately negotiated and a tailor-made contract as compared to a standard and readymade exchange-traded derivatives contract and parties can enter into the terms of their own choice, including the maturity date and contract volume. parties, if they desire, can make an otc derivatives contract subject to exchange rules. the eminent backdrop for otc derivatives is the absence of formally organised market (e.g. an exchange for exchange-traded derivatives) and channelled counterparty risk assessment.8 since otc derivatives remain the main focus of discussion in this article, identifying the specialised otc derivatives products is next on the agenda. 2.2 derivatives products 2.2.1. forwards contracts as said earlier, a derivative derives its value from an underlying instrument or asset where there is no exhaustive list of such underlyings. the spectrum of these underlyings can, however, be condensed by dividing them according to the nature and form of the transaction involved. these transactions are, in other words, the building blocks of a derivatives contract. the most popular type of derivatives contracts is a forwards contract. forwards contracts can be either ‘financial forwards’ or ‘commodity forwards’, depending on the underlying asset. principally, a forwards contract is an agreement to deliver in the future at the price agreed upon now. a financial forwards contract, as compared to commodity forwards contracts, calls for the delivery of a security not a commodity at a future date. a forwards contract is converted into a derivatives contract when it is agreed that the physical delivery of the underlying will not actually take place and that the contract will be concluded by the payment of the sum of money i.e., the difference between the contract price and the market price at the relevant time.9 at that time, the contract is said to be closed out,10 and the total gain 7 cf. charles good hart; the emerging framework of financial regulations; (central banking publications 1998), p.293 8 cf. c. good hart; op. cit. p.293 9 s. james; the law of derivatives;(llp1999), p.4 10 the term signifies the settlement of contract as cash settlement rather than physical settlement and sometimes the contract is closed out by the buyer selling another contract to the seller of the base contract or entering into another equal but opposite contract, with a third party. cf. simon james; op. cit. p.4 nordic journal of commercial law issue 2010#1 4 or loss of the counterparty is the change in the futures price between the time the original contract was entered into and the time it was closed out. forwards contracts, when traded on an exchange are called futures contracts, and are subject to exchange rules and regulations and will also be interposed by a clearinghouse. this removes the counterparty risk from the futures contract. in the absence of a clearinghouse as mandatory counterparty with margin requirements imposed to cushion losses, forwards are highly risky transactions. the process of forwards pricing entails consideration of different costs like storage, commissions and spreads. the prices are calculated on a ‘cash & carry’ basis and are not merely predictions.11 the forwards market operates through informal communications among major financial institutions. for example, there is a healthy forwards market for foreign currencies that gives individuals or companies the opportunity to buy or sell foreign currency at a later date at an exchange-rate agreed upon today. the absence of an organised market in forwards also makes them less standardised and, consequently, its extent and volume is not precisely known. 2.2.2. swaps contracts in a swaps contract, two counterparties agree to exchange streams of payments over time on predetermined terms. in fact, the parties exchange less favourable obligations for more favourable obligations. there are two main types of swaps, interest rate swaps and currency swaps. the principle behind a swaps contract is that of comparative advantage. for example, in interest rate swaps, a party due to its higher credit rating than another party can get loans at lower interest rates as compared to the other party. the parties can enter into a swaps contract and the party with lower credit ratings (low franchise/ high risk profile) and the party with higher credit ratings (high franchise/ low risk profile) can both benefit. swaps are also used for risk management against adverse market movements. interest rate swaps are the most common example of risk management-oriented swaps contracts. with interest rate swaps, two parties exchange interest payment obligations on debts denominated in the same currency, whereas in a currency swap parties exchange interest payment obligations on debts denominated in different currencies. another difference between interest rate and currency swaps is that in an interest rate swap there is no exchange of payment obligations of the principal amount, while in currency swaps, the principal amounts are also exchanged at 11 s. james; op. cit. p.6 nordic journal of commercial law issue 2010#1 5 maturity at an exchange-rate agreed in advance.12 interest rate swaps are generally used in a combination of floating and fixed rate.13 equity swaps are another kind of swaps agreement in which a party exchanges the performance of a share owned by it in an exchange for the performance of another share owned by another party in a different exchange. parties then pay the difference of appreciation or depreciation in the exchanged shares. in this way parties can enjoy the benefit of the shares in a particular company without buying them and thus avoid buying costs. however, swaps agreements expose a party to credit and currency risks. for this reason financial institutions usually work as intermediaries and efforts continue to be made to standardise swaps contracts.14 2.2.3. options contracts an option is the right, without the obligation, to buy or sell a thing at a later date at a price agreed upon today. in return for the extra flexibility an option gives, and unlike forwards and swaps contract, the buyer of an option pays the seller a premium in return for the risk associated with it. an option to buy something is referred to as a ‘call’ and an option to sell something is called a ‘put’. in broad terms, many financial arrangements like lines of credit, loan guarantees and insurances are forms of options. moreover, stocks themselves constitute an option on a firm’s assets.15 options are symbolically known as european, american, asian or bermudan depending upon the nature and time of the exercise of the right created by an options contract.16 to control interest rate exposures, borrowers can buy a put option for a fee paid to a lender or an investment bank (writer). if the interest rate rises above a particular rate the borrower only pays up to that particular rate and the writer pays the excess. this is called a ‘cap’. the borrower may agree that if the rate falls below a particular rate, it will still pay that particular rate. this is known as the ‘floor’. when options are used in a cap and floor combination the arrangement is termed ‘collar’. obviously, collar costs much less than cap. beside the counterparty risk, the market risk and legal risks are transparent in options contracts. another element of risk in the options contracts is that there is no solid economic equation or mathematical formula to calculate the exact price for an option.17 most of the options trading occur in organised exchanges. 12 denis petkovic; derivativessome fundamental contracts and concepts; (international banking and financial law 1996), p.102 13 s. james; op. cit. p.6-7 14 on international level, international swaps and derivatives associations (isda) 15 don m. chance, op. cit. p.3 16 for detailed view, see denis petkovic, op. cit, p.103 17 black-scholes equation is most popular to calculate the price of a european option but still it does not guarantee the ‘right’ price. nordic journal of commercial law issue 2010#1 6 2.3 why have derivatives? 2.3.1. market volatility movements in interest rates, exchange rates, commodities and securities prices are generally called market volatility. derivatives financing is not only originated from market volatility but it can also create market volatility.18 large swings in market volatility in one way or the other is always alarming for regulators since it can cause systemic risks. systemic risk is the risk where the failure of one or more counterparties causes the failure of other counterparties and ultimately threatens to cause failure to the overall financial system. the general function of derivatives is to allow individual parties to transform risk arising out of market volatility. when used for risk management, derivatives can effectively reduce the risk associated with the individual user. this, however, as we will see later in this chapter, does not mean that they cannot cause systematic risk. the aim of derivatives transactions in the early 1990’s was to avoid exchange-control regulations.19 however, the derivatives market today is motivated by a variety of reasons. derivatives, it has been suggested, are analogous to electricity in many ways since electricity also is simply a powerful tool that can be used for good or bad.20 derivatives can amplify risk not only for the individual user but also for the overall financial system when traded for sole speculation. however, derivatives can be traded for arbitrage, hedging and speculation. 2.3.2. the difference between arbitrage, hedging and speculation the principle working behind derivatives financing is that of comparative advantage. arbitragers use a derivative product to benefit from the potential comparative advantage between competing financial markets. arbitrage can take place in a variety of situations to achieve a variety of objectives. a company may have a comparative advantage in borrowing from another capital market than its native market. a company can borrow from that other market and enter into a currency swap contract to arbitrage between its comparative costs of funding. an arbitrager in this way can simply be a speculator, making profit from market differences, or it can be a hedger lowering its cost of funding due to market abnormalities.21 18 r. kelly & a. hudson; hedging our future: regulating the derivative market (fabian society 1994) discussion paper no. 18; p. 2 19 alastair hudson, op. cit, p.8 20 eric bettelheim, helen parry & william rees, swaps and off-exchange derivatives trading: law and regulation (ft law and tax 1996), p.xxxvi 21 ibid nordic journal of commercial law issue 2010#1 7 different financial markets have different tax and regulatory requirements and therefore call for different costs on the same transactions. an arbitrager makes profit out of these differences. sometimes a market does not respond quickly to changes in other related markets and an arbitrager makes profit out of the time period a market allows before it responds to changes in other markets. strategic use of derivatives can position market participants to acquire assets or cash settlements when such market mismatches arise, rather than waiting for the actual physical market to move.22 adverse movements in financial markets remain a major concern for market participants. when hedging, derivatives work as a shield against the risk of adverse market conditions. a us court described hedging, as “safeguarding one’s self from loss on a bet or speculation by making compensatory arrangements on the other side.”23 in hedging, the hedger transfers a particular defined risk to the derivatives provider. for instance, for lenders lending on a fixed interest rate, future movements in the interest rate is always a major concern. an adverse movement in the interest rate can result in loss. with the help of a derivatives product (e.g. an interest rate swap agreement) the lender can hedge against the rising interest rate. derivatives hedging strategies has made it possible for banks to offer fixed-rate house-financing spread upon long periods.24 derivatives allow the user to buy or sell in the future on a price agreed upon today. obviously, if market volatility goes in favour of the user, he has made a profit. the adverse market volatility will result in loss. the magic of derivatives is that they allow this process without obliging the user to actually purchase the underlying asset or instrument. participants can simply settle the contract by paying the difference between the agreed price and the actual market price.25 speculation in otc derivatives is attractive since there are no initial margin requirements. equity swaps, as discussed earlier,26 are a lowest cost method to explore share markets without incurring regulatory or other costs. derivatives speculation is, therefore, a cheap and fast manner to magnify the market exposure of the speculator. it has been argued that derivatives should only be allowed for hedging and not for speculation.27 since we are dealing with systemic risk caused by derivatives financing, it is important to analyse the difference between hedging and speculation. both the hedger and the speculator try to benefit from future changes in a market position. the difference lies in their 22 a. hudson; op. cit. p. 12 23 whorley v. patton-kjose co. 90 mont.461, 5 p.2d 210,214 24 cf. eric-bettelheim op. cit. p.xxxviii 25 cf. eric c-bettelheim; op. cit. p.xxxvii 26 see swaps contracts at para 1.1.2.2 above. also hull, j.c an introduction to futures and options markets 3rd ed. (prentice hall 1998), p.8-9, alastair hudson, op. cit. p.10 27 r. kelly & a. hudson; op. cit; p. 12 nordic journal of commercial law issue 2010#1 8 intended objectives. hedging is a tool for risk management, whereas speculation occurs for the sole purpose of profit-making. for instance, a manufacturing company is hedging risk when it uses a forwards agreement to limit the impact that exchange rate fluctuations might have on an international trade deal. the same company would be speculating if it were to invest heavily in a foreign currency forward agreement solely in the assumption that a certain currency will move sharply in one direction or the other. in hazell v. hammersmith and fulham lbc28 lord templeman tried to distinguish between hedging and speculation by saying that the key in determining whether a derivatives trade is a hedge or a speculation from the viewpoint of a particular counterparty is the intention of the trader concerned. however, it is uncertain whether the test to determine such intention is subjective that is, dependent upon the declared animus of the participant, or objective that is, derived from all the surrounding indicators of the intention.29 it has been suggested that since the reason to enter into a trade is insolubly linked to the individual judgement of the trader, the subjective test is more practicable.30 two issues arise at this point: firstly, the declared animus of the participants can be misleading because accountancy, tax, capital adequacy and other motives lead the participants to designate them as hedging; and secondly, it is not possible for an outsider to effectively assess the actual objective that a participant intends to achieve.31 the subjective test is, therefore, not practicable for either the market participant, whose focus is to assess the potential counterparty; or the regulator, whose focus is to gauge the overall structure of the market. 2.4. should hedging be compulsory?32 hedging strategies are recognised as efficient tools for risk management. some us courts have held that fiduciaries, like corporate directors and trustees, are under a duty to mitigate risk arsing from exposures to interest and foreign-exchange rates and commodity prices. the court of appeals for the 10th circuit in hoye v. meek33, found that the director of a company had breached its fiduciary duty (his duty of care and loyalty to look out for the best interest of the company) by failing to respond to the increasing exposures of his company, in its ginnie mae investments, as the interest rate rose. by maintaining that “ignorance is not a basis for escaping liability”, the court imposed on the director, not only a duty to enquire into the risk exposure 28 [1992] 2a.c.1, 24b, 31f 29 alastair hudson, op. cit. p.157 30 steven edwards; legal principles of derivatives ;(j.b.l. 2002) 31 cf. c. good hart; op. cit; p. 298 32 cf. a. hudson, op. cit. p.57 33 795 f.2d 893 (10 cir. 1986) nordic journal of commercial law issue 2010#1 9 of the company, but also a duty to do something about it. in brane v. roth34 shareholders of a grain cooperative claimed that the directors breeched their fiduciary duties by failing to protect the cooperatives profits through hedging in the grain futures market. the court agreed and awarded the shareholders over us$ 400,000 in damages. a washington state court of appeals in baker boyer national bank v. garver35 found that a trustee breeched its fiduciary duty by failing to hedge a portfolio that was concentrated in tax-exempt bonds. the courts, however, do not observe a distinction between hedging in organised derivatives exchanges and hedging in otc derivatives market. 2.5 interim conclusions when used for hedging derivatives products are intended to increase predictability of exposures and reduce volatility in anticipated revenues. hedging strategies, i.e., the numerical equations designed to measure and price volatility and risk in financial markets, can themselves expose financial markets to systemic risk when they fail to produce the intended result.36 in the otc derivatives market, a floating rate borrower company will purchase a derivative instrument to defend itself against the risk of an increasing interest rate. the company will enter into an interest rate swap and borrow at a fixed rate. this amounts to hedging against the risk that the interest rate will rise, the bet being on the performance of the floating-rate indicator compared to fixed-rate indicator. unfortunately, if the rate does fall, the company will lose the potential gains if it had not entered into a swaps contract. the company will then make another arrangement and purchase another derivative with a third party that will result in profit, if the first one will result in loss. this second transaction will be the reverse and opposite of the first transaction (called a perfect hedge). in case of a perfect hedge, the company will remain in the same position as it was before entering into the market since both transactions have opposite effects and the company is going to lose in one, if it earns in the other. therefore, it can be concluded that a company has no commercial interest in entering into a perfect hedge, except when hedging the base contract (borrowing on a floating interest rate). still, the company is exposing itself to the counterparty risk, because the counterparty maybe transacting for sole speculation. it can rightly be said that in each swaps transaction, the risk is transferred to a counterparty, which will in turn hedge its risk with other market participants, thus creating a nexus of contracts interlinking market 34 590 n.e.2d 587 (ind. ct. app.1992) 35 719 p.2d 583 (wash. ct. app.1986) 36 e.g. metallgesellschaft; see christopher l. culp and merton h. mille; hedging, a flow of commodity deliveries with futures: lesson from metallgesellschaft; derivatives quarterly (vol. 1 no. 1 fall 1994) also, ruth kelly and a. hudson; et. al. hedging our future: regulating the derivative market (fabian society 1994) discussion paper no. 18 nordic journal of commercial law issue 2010#1 10 participants to each other.37 hedging used to insure against risk can provoke a chain of transactions, which are systemically unstable.38 the use of derivatives in hedging strategies, therefore, do not eliminate risk, rather the risk is fragmented into smaller amounts, and redistributed among existing participants more willing to bear them.39 the danger of systemic risk can arise in such a situation by any of three occurrences: the default of a major market player; a large market movement that whips out a trader; or the inability of market participants to match obligations.40 the detailed analysis of these and other kinds of risks associated with otc derivatives financing, is made in the next chapter. 3. associated risks and regulatory approaches for otc derivatives markets 3.1 introduction growth in otc derivatives in the past few years has been phenomenal. according to the statistical release by the bank of international settlements in may 2000, the total estimated notional value of outstanding otc contracts relating to only major banks and dealers in g10 countries was us$ 88.2 trillion. where the otc market has attracted a large number of market participants to hedge their risks arising from market volatilities, it has also attracted sole speculators due to, inter alia, low cost investment opportunities. this major shift to unorganised business has raised legal and regulatory issues. financial innovation has given birth to new complex instruments and has resulted in more complex and less reliable quantitative techniques to measure and price risk. initially intended and designed to mitigate risk of individual market participants, derivatives have the potential to expose the entire financial market to systemic risk. first, different kinds of risks associated with derivatives financing, including legal, equity, credit and other associated risks are discussed. we will look at the manner in which the otc derivatives market might give rise to systemic risk. in other words, regulation of otc derivatives markets is justified by economic parameters, i.e., when manifest harm or its 37 e.g. in hazell v. hammersmith fulham; op. cit. hammersmith fulham swapped hundreds of times with lots of different institutions 38 r. kelly and a. hudson; op. cit. p. 10 39j. board; derivatives regulations; lse financial markets group special paper no. 70 40 r. kelly and a. hudson; op. cit. p. 10 nordic journal of commercial law issue 2010#1 11 potential is present, expressed in terms of externalities imposed on other market participants or in terms of market failure.41 second, an introduction to regulating the otc derivatives market is given along with a discussion on the legal nature of derivatives contracts and the legal area to which derivative instruments fit into. the discussion also includes some of the regulatory tools available to regulators in fighting the risks associated with otc derivatives, and surveys different regulatory approaches adopted by the regulators of the otc derivatives market. the purpose of this part is not to introduce new semantic distinctions into the regulatory debate, but to highlight the existing discussions at all levels,from institutional to academic focusing on why it is we regulate the otc derivative market and how can we do so effectively. 3.2. risks associated with derivatives contracts 3.2.1. generally on risks knowledge of probable risk on an investment over a given time is the most desired piece of information in the business world. the exact equation of revenues and costs is the only means to forecast the required margin. in economic terms, revenues and costs are divided into fixed and variable terms. adequate measurements and exact pricing of the economic risk such as whether commodity prices, interest rates or exchange rates will rise or fall, are the prime concerns for market participants. derivatives are commonly used to remove economic risks, and transfer them on other market participants who are more willing to accept them. it might be argued that there is no difference between profit making (speculation) and risk management in economic terms since both result in an increase in anticipated revenues. it is, however, suggested that risk management is an endeavour to mitigate risk arising from speculation and is different from speculation because speculation does not result in profit in all circumstances.42 risk management tools are effective means to alleviate risk posed to individual market participants arising out of speculative profit making business activity. this is why some us courts have held that a fiduciary is under a duty to hedge risks effectively.43 the use of derivatives is not limited to risk management only and it also includes speculation itself. derivatives, whether used to hedge risks or for speculation are not immune to certain risks like all other business activities. following are some of the risks arising out of derivative financing. 41 c. goodhart; the emerging framework of financial regulation; (cbp 1998), p.291 42 as discussed earlier, (para.1.3) a perfect hedge may in all circumstances, give the desired result. 43 see supra para. 1.2.1.3.2. nordic journal of commercial law issue 2010#1 12 3.2.2. legal and operational risks in essence derivatives are rights or obligations to receive or pay sums of money according to the movement in the underlying indicator.44 since a derivative agreement consists of rights or obligations; entering into a derivative transaction raises legal questions, whether these rights or obligations are validly created in law and whether or not they achieve (in legal terms) what they were intended to achieve or whether these rights or obligations are enforceable under the law without undue delay and undue cost.45 a derivative transaction can be unenforceable because of insufficient documentation, incapacity of a counterparty (ultra vires), uncertain legality or unenforceability due to bankruptcy or insolvency.46 another legal risk arises out of the recharacterisation of a derivative transaction; i.e. a court re-characterises the transaction. this kind of legal risk is particularly relevant in the case of the english law credit support annex within which an outright transfer might be viewed as a security interest, taking the form of the transaction into account, and therefore void due to want of registration. english academics have accepted that it is almost impossible to avoid the recharacterisation risk for even the best-drafted transaction or statute must use words, and words inevitably engender some uncertainty.47 legal risk and its ancillaries are dealt in with in detail in the later part of this chapter while dealing with the legal nature of derivatives. there are many other kinds of risks associated with derivatives that cannot be measured and predicted by plain calculations. precisely these risks may arise when systems and managerial understanding does not keep pace with market and business opportunities.48 due to the inquantifiable nature of such risk, it is very difficult to protect against it. market participants hit by such operational risks have systemic externalities, when their exposures are relatively high. barings bank can be one of the examples, where a market participant fell prey to operational risk due to the same person working in both back and front offices. operational risks project other kinds of risks and can induce systemic melt down. 3.2.3. liquidity risk liquidity is the status or condition of a business in terms of its ability to convert assets into cash.49 liquidity risk arises when cash flows of a business are insufficient to cover is payment obligations. liquidity risk is divided into two types: market liquidity risk and funding liquidity 44 r. kelly and a. hudson; op. cit. p.12 45 for analysis of legal risk see trust and harris; (bjibfl 1997); p.291 46 global derivatives of group of thirty; derivatives: practice and principles; p.51 47 s. james; the law of derivatives; (llp 1999); p. 15 48 speech given by clifford smout published in c. goodhart; op. cit. p. 331 49 blacks law dictionary; (sixth edition); (west publishing co. us); p. 931 nordic journal of commercial law issue 2010#1 13 risk.50 ‘market liquidity risk’ is the risk that a large transaction in a particular instrument could have an adverse impact on its market price. it, therefore, depends upon the market condition of the product/instrument, the size of the position (contract size) and also the creditworthiness of the counterparty.51 the risk that sudden volatility may make it difficult for a market participant to hedge or unwind a losing position including a derivative position is another related market liquidity risk. ‘funding liquidity risk’ is the risk that mismatches in the cash flow and payment obligations of a business may result in contractual non-performance. liquidity funding plans and additional internal funding reserves to avoid such cash-flow mismatches are traditional responses to mitigating funding liquidity risk. in an illiquid derivative market dealers will try to either cover their uncovered otc positions by taking off-setting positions in an exchange traded instrument or by synarticleing such a position through “dynamic hedging”, a process which often mandates either the sale of the underlying, when its price falls or its purchase when its price rises.52 these mandated transactions could trigger a large number of purchase or sale orders into an already illiquid market for the underlying security.53 as the international capital markets report54 suggests “the resulting illiquidity may (at the time of crisis) even violate the assumptions underlying the models used to construct these portfolios at precisely the time when the hedges are mostly needed.”55 to avoid intervention of credit departments due to full utilisation of credit lines by banks and other financial institutions, dealers use collateral and/or margin requirements, which require a counterparty to transfer collateral to a bank or financial institution when its exposure to that counterparty crosses a certain limit.56 the collateral is retransferred to the counterparty if the market moves the other way and the parties can continue to deal despite their credit lines are full.57 this arrangement, however, gives rise to three liquidity issues:58 a. if the limit to call additional collateral depends upon the credit-worthiness of the counterparty being calculated by rating system, the lower-rated illiquid counterparty might be asked to transfer additional collateral at the nick of the time it starves for it 50 basle committee on banking supervision; recommendations for public disclosure of trading and derivative activities of banks and securities firms; (october 1999) 51 edward sunderland; derivatives-risky business; journal of international banking law 2001); p. 58 52 r. kelly and a. hudson; op. cit. p. 11 53 ibid 54 part 1-exchange rate management and international capital flows; imf; (august 1993) 55 also quoted by r. kelly and a. hudson op. cit. p. 11 56 edward sunderland; op. cit. p. 59 57 ibid 58 ibid nordic journal of commercial law issue 2010#1 14 itself. this will result in loss of more liquidity and ultimately in default by such counterparty. b. a counterparty may use the collateral received from another counterparty to create a reverse hedge. in this arrangement such counterparty might be required to transfer the collateral to a third counterparty under the reverse hedge even before it receives it from its first counterparty due to difference in limits, which result in calling for the collateral. this may result in liquidity problems for that counterparty. c. if, in the commodities market, a counterparty has hedged its future revenues under a collar (combination of put and call option: see para. 1.1.2.3 supra) arrangement, such counterparty might face loss of liquidity as the purchaser of the put option exercises its put when the commodity price falls unpredictably. liquidity loss might also arise in case of a sudden and unexpected rise in the commodity price where the purchaser of “call” exercises its right to call. the illustrations above make it clear how some risk mitigating techniques adversely affect it and may result in liquidity risk. loss of liquidity results in the inability to receive payments by counterparties, which adds to systemic risk.59 3.2.4. credit risk as said earlier, a derivative transaction is typically an obligation to pay or receive sums of money at a certain future date. the financial market yields participants with different franchise sizes and different credit-ratings. since one or the other counterparty is under an obligation, each party in a derivative transaction is concerned with the credit rating of its counterpart. a credit rating simply reflects the ability and past performance of a business or a person in paying debts.60 the probability that the counterparty might default in its payment obligations is called credit risk. in its report, principles for the management of credit risks, the basle committee described credit risk as “the potential that a bank borrower or counterparty will fail to meet its obligations in accordance with the agreed terms.” while credit rating agencies are performing a very good job in assessing the credit worthiness of market participants, individual counterparties usually conduct private investigations before entering into a derivative transaction. the balance sheet, obviously, is the first thing to be enquired into. because of the fact that certain exposures, especially in otc derivatives markets, are kept off the balance sheet, balance sheet enquiries are not conclusive evidence of credit worthiness. since payment obligations in a derivatives transaction arise at a future date, the transaction maturity date, the lack of an upfront cash commitment by the parties may also obscure the eventual monetary significance of the obligations of the parties. 59 a. hudson; swaps, restitutions and trusts; (sweet and maxwell 1999); p. 66 60 blacks law dictionary (6th edition) op. cit. p. 369 nordic journal of commercial law issue 2010#1 15 market participants, especially those with high franchise and more sophisticated management (e.g. banks and major financial institutions) have generated their own internal risk control systems to ascertain their value at risk (var) in the ordinary lending market from the very start of the transaction. var indicates the expected loss from an adverse market movement with a specified probability over a particular period of time. as compared to the ordinary lending market, it is far more difficult to give an accurate var in the derivative field due to the continually fluctuating value of the instrument. though, more sophisticated methods to calculate var (e.g. j. p. morgans’ “riskmatrix” methodology) are now available, these do not help the regulators due to the risk-sensitive nature of required regulatory capital under capital adequacy frameworks. higher risk attracts higher capital to be set aside to cushion that risk. internal var calculations are, therefore, unreliable and can be biased in favour of the entity. it is equally difficult to rely on the marking-to-market methods of derivatives value fluctuations. marking-to-market means the calculation of var on a derivative instrument on a continual/daily basis. there is, however, no marking-to-market model, which convincingly explains the kind of relationship between the scope and degree of marking-to-market on the one hand, and the degree of systemic stability on the other.61 there are two types of credit risks: market risk and settlement risk. market risk is the kind of credit risk, which, arises out of the market volatility. var models are actually intended to calculate and ascertain specifically the market risk. market risk is a doubleedged sword, i.e., even if the market moves in favour of the participant, ultimately it moves against the counterparty and adds to counterparty risk. an unexpected flash of market volatility, therefore, increases the overall market risk regardless of the way it moves.62 settlement risk, as opposed to market risk, is a kind of credit risk that arises out of the default of the counterparty. this default can be the result of many incidents, i.e., a counterparty in an exchange rate swaps contract, may default because it could not access the necessary currency to be paid under the contract; because it failed to instruct properly how to pay (operational failure) or even by the introduction of exchange rate controls by the country whose currency was to be paid (country risk).63 settlement payments in foreign exchange contracts, swaps and repurchase agreements (also known as a repo that allow a borrower to use a financial security as collateral for a cash loan at a fixed rate of interest) are usually made by a small number of financial institutions. a large amount of the settlement payments represent funds, which the recipient needs in order to fulfil its own payment obligations due on the same date. if, on the settlement date, a major market player (financial institution) defaults, a situation may arise where many related counterparties 61 christian de boissieu; derivatives market and systemic risk: some reflections; in c. goodhart; op. cit. p. 334 62 cf. e. sunderland; op. cit. p. 58 63 cf. ibid nordic journal of commercial law issue 2010#1 16 are unable to make payments due to non-receipt from the defaulting financial institution(s). this follow-on effect goes on and on to other connected counterparties and non-payment ripple out through the system.64 different schemes of netting like payment netting which occurs during the life of the transaction and close-out netting which occurs on the happening of some other event,65 have been introduced to cope with the settlement risk. netting has its own legal and regulatory issues and is not unanimously allowed under the insolvency laws in all jurisdictions. 3.3. the legal nature of derivatives contracts 3.3.1. derivatives from a legal standpoint derivatives are not conveniently confined to a particular area of law and their study requires knowledge of contract, company, commercial property, insurance and corporate insolvency law.66 in the broadest legal sense, derivatives are rights or obligations to receive or pay sums of money according to the movement in the underlying indicator.67 there is no exhaustive list of derivative underlyings. some important underlyings include currencies, interest rates, equities, commodities, treasury bills and bonds.68 some commentators have suggested that derivatives agreements create personal relationships between parties and hence should be regulated under the law of contract.69 others argue that the term derivative is descriptive of a large number of choices in action and therefore should be categorised as specific items of property and consequently be regulated by property institutions.70 in derivatives business practice, however, the generic term “derivatives” has no meaning without specific mention of the particular derivatives product like options, futures, forwards or swaps. though, the derivation of value is their common feature, every derivative product has its own specific features and create distinct legal rights and obligations. furthermore, there are different licensing and other regulatory requirements for each product in different jurisdictions. this mandates the proper identification and separate analysis of each derivative product.71 64 cf. schuyler k. henderson; regulation of swaps and derivatives: how and why? (journal of international banking law 1993); p. 357 65 cf. a. hudson; the law of financial derivatives; op. cit. p. 293 66 steven edwards; legal principles of derivatives; (jbl 2002); p. 1 67 r. kelly and a. hudson; op. cit. p.12 68 a. giles; the regulation governing derivatives; an international guide; (international financial law review special supplement 1992); p. 4 69 henry t.c. hu; misunderstanding derivatives: the causes of informational failure and the promise of regulatory instrumentalism; (yale law journal 1993); p. 102 70 a. hudson; money as property in financial transactions; (jibl 1999); p. 170 71 tony ciro; the regulation and market organisation of financial derivatives: an australian prospective: part 1; (jibl 2002); p. 93 nordic journal of commercial law issue 2010#1 17 derivative contracts are arguably a series of executory contracts, as payment obligations usually remain to be performed on both sides.72 trading is ordinarily conducted by telephone in the otc derivatives market and the oral/informal contract is binding on the parties, provided it fulfils the essential criteria for the creation of a contract.73 if, however, parties use tape recording as evidence of the contract the recording party must notify the other party that the telephone call is being taped.74 the international swaps and derivatives association (isda) has contributed a great deal in standardising the otc derivatives contracts.75 in our present legal scrutiny of derivatives products, we will also discuss some of the isda master agreement approaches. 3.3.2. the legal nature of swaps contracts woolf l. j in hazell v. hammersmith fulham76 described an interest rate swap in the following terms: “an interest rate swap is an agreement between two parties by which each agrees to pay the other on a specified date or dates an amount calculated by reference to the interest which would have occurred over a given period on the same notional principle sum assuming different rates of interest each payable in each case. for example, one rate maybe fixed at 10 percent and the other rate maybe equivalent to the six months london inter-bank offered rate (libor). if the libor rate over the period of swap is higher than the 10 percent than the party agreeing to receive ‘interest’ in accordance with libor will receive more than the party entitled to receive the 10 percent. normally neither party will in fact pay the sums which it has agreed to pay over the period of the swap but instead will make a settlement on a ‘net payment basis’ under which the party owing the greater amount on any day simply pays the difference between the two amounts.” the definition was approved by lord templeman on appeal to the house of lords.77 this definition raises a number of classification issues,78 i.e., are swaps to be classified as a series of executory contract considered as one single agreement made up of a matrix of obligations? (executory contract theory) or are all the swaps simply reciprocal payments constructed in from of mutual debts? (mutual debt theory) executory contract theory (also called the single agreement 72 philip r. wood; title finance, derivatives, securitization, set-off, and netting; (1995); para. 10-10 73 cf. s. james; op. cit. p. 175 74 ventouris v. mountain, the italia express; (no. 2) [1992] 2 lloyds’ rep. 281 75 see isda; master agreement 1992 76 [1990] 2 q.b. 697 at 739 77 hazell v. hammersmith and fulham lbc [1991] 1 all e. r. 545 at 550 78 a. hudson; the law of financial derivatives; (sweet and maxwell 2nd edition 1998); p. 65 nordic journal of commercial law issue 2010#1 18 approach) is proposed by the isda master agreement,79 and primarily based upon the single payment method under payment netting. the approach suggests that it makes no difference how many contracts have been entered by the parties since the payment in the end is set-off against each contract and is netted to only one payment. therefore, all the contracts should be treated as one single agreement. the single agreement approach has been criticised on the basis of the different economic functions intended to be served by each swaps contract, and because they may have been entered on different dates with different counterparties and have different termination dates.80 the criticism was approved by evans l. j, in kleinwort benson v. birmingham cc,81 where the hedging agreements were said to be “separate and independent contracts.”however, they were not governed by an isda master agreement. the single agreement approach under the isda master agreement was motivated by the need to avoid cherry-picking, that is, the power of an insolvency practitioner to disclaim unprofitable contracts under section 178 (3)(a) of the insolvency act of 1986, whilst affirming contracts that are beneficial to the insolvent party.82 rejection of the single agreement approach by the courts would enable cherry-picking of derivatives contracts.83 the mutual obligations theory views each swap payment as a distinct contractual debt obligation.84 each and every payment made pursuant to a swap agreement is made independently and hence has no nexus with other payments.85 though affirmed by kleinwort benson this theory is not supported by market participants. it has been suggested that the parties would continue to trade in derivatives in pursuit of profit notwithstanding any defective legal foundation of the single agreement approach.86 an important question emerged in morgan grenfell v. welwyn halfield dc,87 where it was contended that an interest rate swap agreement, under a proper construction would be construed as gaming. section 18 of the gaming act of 1845 provides that all contracts by way of gaming or wagering are null and void. section 1 of the same act provides that a promise to pay any money in respect of such contracts is unenforceable. the nature of a gaming contract is 79 see sec. 3 of isda multicurrency master agreement (1992) 80 a. hudson; the law of financial derivatives; op. cit. p. 65 81 [1996] 4 all e.r. 733, 738g 82 cf. steven edwards; legal principles of derivatives; (jbl 2002); p. 4 83 cf. a. hudson; swaps, restitutions and trusts; (sweet and maxwell 1999); p. 46 84 a. hudson; the law of financial derivatives; op. cit. p. 68 85 see note 16 above; also tony ciro; op. cit. p. 96 86 s. edwards; op. cit. p. 5 87 [1995] 1 all e.r.1 nordic journal of commercial law issue 2010#1 19 elaborated in carlill v. carbolic smoke ball co.88 where two people with opposite views on a uncertain future event, enter into an agreement that one shall pay to the other a sum of money depending upon the determination of that event, they are entering into a wagering contract. in morgan grenfall, the courts stated that the purpose of the parties to enter into a derivative contract was the deciding element, i.e., if the speculative element is coincidental to the purpose of the contract, then wagering is not the purpose of the derivative contract. in city index v. leslie,89 derivative speculation was held lawful only when it was carried out for business purposes. this is also provided by section 63 of the financial services act of 1986 and sched.1, para. 12 thereto that derivative contracts are not unenforceable on the ground of gaming, if entered into by way of business and constitute offering or agreeing to offer, the buying, selling, subscribing for or underwriting of an investment in morgan grenfall, business activity is considered as an ordinary person would understand it, that is, an organisation involved in the capital market that regularly deals in interest rate swaps agreements is doing so in the form of business activity rather than on a casual or isolated basis. 3.3.3. the legal nature of forwards contracts the basis for legal analysis of a forwards contract is that it may be classified as a futures contract. the significance of the classification is that if a contract is construed as a futures contract, it is void since it fails to fulfil the regulatory requirements attached to a futures contract. for example, in the us, the commodity exchange act of 1936 (the cea) provides inter-alia that trade in futures contracts must be through brokers registered with the commodity futures trading commission (the cftc). in a number of cases, us courts have held that certain forwards contracts are in fact futures contracts subject to regulatory oversight.90 the conflict is not unique to the us and persists in other jurisdictions, including the uk.91 us courts have taken the mode of settlement in a particular forwards contract as a key to determine its actual nature. the fact that futures contracts are cash settled and are off-set by the parties, all forwards contracts that are cash settled rather than settled by actual delivery, should be categorised as futures.92 in mg ref. & marketing inc.93 the court held that an energy forwards 88 [1892] 2 q.b. 484 at 490-491 89 [1992] 1 q.b. 98 90 see for e.g. re mg ref. & mktg, inc. and futures, inc. no. 95-14 cftc lexis 190 (cftc july 27, 1995); transnor (berm) v. bpn. am petroleum 738f. supp. 1472 91 see larussachigi v. cs first boston; unreported 18 dec 1997, where forwards contract has been compared with so-called contract for differences. 92 mg ref. & marketing inc. op. cit 93 ibid nordic journal of commercial law issue 2010#1 20 contract was in fact a futures contract since it provided an opportunity for off-set, even though the contract is actually for the delivery of the underlying. this conclusion alarmed market participants for the test applied would also render swaps agreements as futures contracts.94 the cftc disagreed with the courts findings and decided that the contracts were forwards because they contained terms that provided for the delivery of the underlying, even though the parties routinely settle the contracts without delivery.95 several attempts have been made in the us to remove the uncertainty e.g. the enactment of the futures trading practices act in 1992 and the issuing of a number of policy statements exempting certain otc transactions from provisions of the cea but uncertainty persisted till the passing of commodity futures modernisation act 2000 (cfma 2000). 3.3.4. the legal nature of options contracts courts have given different meanings to options and there is no precise definition of an options contract. at common law, in mackay v. wilson96 jordan cj described options as “nearly always a ticklish thing”. options have attracted two contrary views:97 one is that an option to purchase is ‘a contract for valuable consideration’; viz. to sell the property (or whatever the subject matter maybe) upon the condition that the other party shall, within the stipulated time, bind itself to perform the terms of the offer embodied in the contract (the irrevocable offer theory). the other view is that ‘an option given for value is an offer’; together with a contract that the offer will not be revoked during the time, if any, specified in the option (the conditional contract theory). it has been suggested that the controversy has little significance from a regulatory point of view, since on either theory options would be regulated unless specifically exempted.98 furthermore, there are a number of different kinds of options with varied uses and different subject matter, which has resulted in confusion and uncertainty as to the nature of options.99 lack of a generic legal definition suitable for all options, and absence of a unified legal relationship created by different kind of options suggest different regulatory modes and standards for each kind of option.100 94 tony ciro; op. cit. p. 97 95 ibid 96 [1947] 47 nswsr. 315 at 318 97 braham v. walker [1974] 132 clr 57 98 financial services and markets act 2000 make it illegal to carry on investment business in uk unless authorised or exempted under the act and options fall under the category of investment business provided by the act. cf. tony ciro op. cit. p. 94 99 tony ciro; ibid 100 ibid nordic journal of commercial law issue 2010#1 21 3.4. otc derivatives and systemic risks: is regulation justified? systemic risk is recognised as the most valid reason for financial regulation. systemic risk is not a very well-defined concept, compared to other risks across the financial world. though the term is not very well defined, we all know what a systemic crisis is, when it occurs.101 it has been suggested that systemic disturbances can be thought of in two stages.102 initially, it consists of an ‘event’ of some description that affects at least one financial institution adversely due to e.g. a sharp market move or a decline in the credit-worthiness of a key group of customers. this ‘event’ is sufficient to cause systemic problems if it simultaneously affects a large number of institutions. the second stage comes when such an ‘event’ results in the non-settlement by the affected institutions. the follow-on situation is called ‘contagion’.103 a ‘contagion’ situation is the more dangerous, where institutions are interconnected in the very area of activity affected. on the same grounds, economics justifies regulation only when there is manifest harm or its potential expressed in terms of externalities imposed on other participants or in terms of market failure.104 it has been argued that otc derivatives do not create any new or unique risk.105 the argument is based on the fact that though the increased use of otc derivatives is new, they are composed of financial instruments and arrangements that have been around for decades. credit, market, liquidity, operational and legal risks are, therefore, not a speciality of otc derivatives only and are regularly faced by market participants in their traditional business. it is, however, not the type of risk which is alarming but the increased size of the risk caused by otc derivatives.106 otc derivatives can accelerate systemic risk by any or all of the following:107 first derivatives have altered either the likelihood or the severity of an adverse ‘event’. secondly, widespread use of derivatives increases the correlation of default among financial contracts. in other words, otc derivatives have made ‘contagion’ more likely. thirdly, if risk is borne by more investors than before, more participants will be affected by the underlying shocks to the economy arising out of the adverse ‘event’.108 the externality of risk extends not only to other individual 101 william r. white; systemic risk and derivatives: can disclosure help? in c. goodhart op. cit. p. 314 102 speech given by clifford smout published in c. goodhart; op. cit. p. 325 103 see supra para 2.1.3.2 104 c. goodhart; op. cit. p. 291 105 speech given by clifford smout published in c. goodhart; op. cit. p. 326 106 ibid 107 ibid 108 haluk unal; benefits, risks and regulations of derivatives markets available online at http://www.rhsmith.umd.edu/finance/hunal/courses/bmgt745/topic8.doc. nordic journal of commercial law issue 2010#1 22 investors but also to the economy as a whole when it strikes in the major market place. after all, even firms that do not use otc derivatives will also be affected by such strikes.109 otc derivatives financing is more prone to systemic risk because of 1) the complexity of the products, 2) comparatively less transparency and disclosure by the market participants, and 3) due to increased linkage between market segments and individual financial institutions.110 3.5. how to regulate otc derivatives? otc derivatives regulation has been subject to vociferous public debate in recent years. this article is not intended to contribute new theoretical regulatory structures or to introduce an unprecedented regulatory strategy for otc derivatives. in fact, this article compares and contrasts existing regulatory regimes in the perspective of developing countries with an objective to help them improve their own financial market conditions by increasing market efficiency and financial stability. the regulatory challenge for otc derivatives is to assess 1) the associated risk itself, 2) the benefits offered by the instruments and 3) the potential costs of regulatory interference.111 there exists a tendency to overstate the risk of otc derivatives which leads to proposals that would significantly raise the costs of derivative instruments. the challenge, however, is to limit the risks while preserving the efficiency of the capital markets.112 there are two approaches classified according to subject matter, to regulating otc derivatives financing.113 on the one hand, there is ‘institutional’ regulation, i.e., regulation of different kinds of enterprises involved in the financial markets and intermedation. on the other hand, there is ‘functional’ regulation i.e. regulation of financial instruments and markets according to the underlying functions they perform. since there is a large variety of otc derivative market participants and products, either regulatory approach can be complex.114 109 ibid 110 see supra. para. 1.3 111 h. unal; op. cit. p. 22 112 ibid. 113 christopher l. culp and robert j. mackay; regulating derivatives: the current system and proposed changes: available online at http://www.cato.org/pubs/regulation/reg174b.html. 114 cf. ibid nordic journal of commercial law issue 2010#1 23 there is another approach; a hybrid between functional and institutional derivatives regulation. the hybrid regulatory approach provides for the regulation of institutions both institutionally and functionally.115 on the institutional level, derivatives regulation could have the following elements:116 1. it specifies the ‘permissible activities’ in which an institution may engage; 2. it provides ‘regulatory oversight’ of the institutions engaged in permissible activity; 3. it provides rules for capital adequacy to ensure the financial stability of each financial institution; 4. it enforces prudential regulations to ensure compliance with regulatory requirements; and 5. it requires the end-users to periodically report the market value of their derivative positions. on the functional level, derivatives regulation works by: 1. providing definitions of permissible financial products; 2. requiring compulsory licensing to deal in a lawful product; 3. requiring certain products to be traded only on-exchange; 4. providing margin requirements for certain products; and 5. necessitating registration, documentation or other regulatory requirements for a product. there is a tendency to prefer functional regulation to institutional regulation especially in the us. the view is taken on the basis that functions of the financial system are more stable than the institutions that provide those functions at any given time.117 another benefit of functional regulation is that it provides a set of functions to the financial system that are defined exclusively, and mutually exhaustively. regulatory overlap is minimized, i.e., one function should not be regulated by more than once agency.118 functional regulation also precludes regulatory avoidance since institutions are run by people who can opt into another category to avoid regulations.119 functional regulation, however, is not without its costs. functional regulations are implemented as financial products (in the shape of defining permissible financial products) and market regulation. although different functions of a financial system can be defined mutually exclusively, functions provided by particular financial products cannot be so defined. another 115 cf. christopher culp; derivatives regulations: problems and prospects; available online at http://www.cei.org/gencon1005,01275.cfm. 116 christopher l. culp and robert j. mackay; op. cit 117 christopher culp; op. cit 118 ibid 119cf. ibid nordic journal of commercial law issue 2010#1 24 disadvantage of functional regulation is that it greatly increases compliance costs for institutions, which are engaged in multiple financial products by subjecting them to multiple regulators. defining highly complex financial products is also a challenge for functional regulation. no jurisdiction has, however, observed strict boundaries of functional or institutional regulation in its financial regulatory framework. even the us, which is a leading advocate of the functional approach employs, as we will see in the next chapter, a hybrid form of derivatives regulation. 3.6. regulatory approaches to combat systemic risk arising out of otc derivatives systemic risk arsing out of otc derivatives has alarmed regulators and different regulatory responses and suggestions have emerged to preclude systemic externalities of otc failures. the first and most common regulatory response is invoking the rules for capital adequacy. capital adequacy rules are instructions issued by regulators to ensure that financial institutions have sufficient capital to cover their investment activities.120 this efficiently internalise the risk arisen during the course of business of an institution. the difficulties with capital adequacy requirements are that it is very difficult to define and price every kind of risk faced by a conglomerate financial market participant. the second problem is that there is no risk-pricing or var calculation formula, which is suitable for all market participants, regardless of franchise size. another problem with capital adequacy rules is whether internal var calculations should be relied upon for required regulatory capital or external var calculations made by the regulators are necessary. the second most common response is to introduce disclosure requirements. since otc transactions are off the balance sheet, they need to be subjected to mandatory disclosures as the parties should be able to judge counterparty risk. additional disclosure of otc positions along with the traditional disclosures is required and a periodic reporting system based on an internal risk-management system has been suggested in this regard.121 disclosure can bring comparability and help in strengthening external and internal market discipline.122 the third regulatory response is in the form of providing mandatory clearing of the otc derivatives like the clearing of exchange-traded derivatives.123 this can effectively reduce the counterparty risk. for mandatory clearing, clearing houses would be required to be made insolvency remote to avoid the situation of the failure of the clearing-house, which can cause great danger to financial system. another regulatory suggestion is that otc derivatives should be allowed only for hedging purposes and not for speculation. this, again, brings to the 120 c. goodhart; op. cit; p. 296 121 ibid p. 299 122 c. goodhart; op. cit; p. 325 123 cfma. us. sec. nordic journal of commercial law issue 2010#1 25 difficult task of distinguishing between hedging and speculation from a counterparty stand point.124 yet another suggestion is that all otc derivatives should be brought to exchanges, i.e., derivatives should only be allowed to be traded on an exchange.125 flex options are the most recent example. still, the problem is that specialised products cannot be traded on an exchange. financial innovation also continuously demands more specialised products.126 others prefer stricter internal control; the introduction and strict observation of market participants, according to the sophisticated nature of their business, allowing only more sophisticated persons to deal in otc derivatives and introduction of rules of consumer protection for otc derivatives and users are also a subject to discussion in regulatory circles. 3.7. interim conclusions otc derivatives have posed financial markets to systemic risk in the past decades. one particular example is barings bank as there are suggestions that its failure almost led to some systemic externalities.127 though derivatives financing might not be the only cause of barings failure, it was no doubt the major cause. study of risks associated with derivatives has revealed their potential to pose threat to financial systems. there is a need to speed up regulatory response which is not only provides incentive for innovation but also keeps pace with such innovation since channelled innovation is recognised as beneficial for financial productivity and stability. another challenge for regulators is to introduce regulation, which is cost efficient for both regulators when they force regulatory interventions; and for the regulated when they are compelled to regulatory compliances. keeping in view the standards set forth, we will be better able to evaluate the efficiencies of derivatives regulations in some advance jurisdictions in our next part. 4. regulation of otc derivatives in advanced jurisdictions 4.1. introduction the aim of this part is to provide a comparative analysis of regulatory regimes for otc derivatives existing in advanced economies e.g. the uk and the usa. we will begin with the uk regulatory regime. for the purpose of better analysis and to give a proper critical treatment to latest regulatory changes carried out in the form of financial services and markets act 2000 124 see para. 1.2.1.3.1 supra 125 cf. c. goodhart; op. cit; p. 293 126 ibid 127 c. goodhart; op. cit; p. 295 nordic journal of commercial law issue 2010#1 26 (fsma 2000), a comparison will be preferred between fsma and its predecessor financial services act 1986 (fsa 1986). after taking a precise overview of present regulatory structure, we will discuss the specific otc derivative related provisions of fsma 2000. then we will move on to the us regulations for otc derivatives and again our analysis will be in a comparative mode between the latest developments and the preceding regulatory structure. 4.2. introduction to the uk financial regulatory structure128 4.2.1. the fsa and the fsma the uk financial regulatory structure has been greatly reformed by fsma 2000. fsma 2000 can rightly be designated as a revolutionary step towards the creation of a single regulator, i.e., financial services authority (fsa) regulating the entire financial conglomerate. the fsma has abolished all the previous regulators for different kinds of financial activities like the securities and investment board (sib) and all the self-regulatory organisations (sro’s). the new fsa is empowered to regulate all the categories of financial business; deals with the official listing of securities, controlling insurance business and banking transfers, overseeing the regulations of lloyds of london, combating market abuse, recognising and supervising investment exchanges and clearing-houses, regulating competition scrutiny, and overseeing the compensation schemes and the ombudsman scheme. the fsa has the objective of maintaining confidence in the uk financial system; the promotion of public understanding of the financial system including the promotion of public awareness of the risks and benefits of investment; to secure consumer protection by considering the degree of risk and experience that a consumer may possess and their need for accurate information; and the reduction of financial crime. in this regard, the fsa is required to make sure that regulated businesses are aware of the risks of their business being used in the commission of financial crime and to make sure that the necessary steps are taken to monitor, detect and prevent financial crime. the parliamentary committee and the treasury have power to scrutinize the powers exercised by fsa. under fsma (the act), the regulatory structure more likely fits into the category of institutional regulation since after giving a very detailed list of regulated activities129, it requires anyone who deals in such activities to seek authorisation.130 the act provides for certain qualification and other requirements for authorisation and then provides for strict regulation of an authorised person in accordance with its objectives. only the relevant provisions of fsma and the instruments provided thereunder relating to otc derivatives will be discussed here. 128 cf. butterworths financial regulatory services; vol. 1 div. a 129 sec. 22 and regulated activities order 2001/544 130 sec. 19 nordic journal of commercial law issue 2010#1 27 4.2.2. otc derivatives regulation under fsma2000 4.2.2.1. general requirements the uk financial markets are founded on the principle of freedom of contract and even an oral contract is binding on the parties without formalities. this creates a perfect environment for otc contracts, where transactions are usually made by telephone. there are no specific laws governing otc derivatives and transactions are generally subject to all the normal principles of common law and equity. general principles of formations and proof of contract, breach of contract, negligence, mispresentation, negligent misstatement, fiduciary duties etc., are applicable to otc transactions and remedies available for other commercial disputes are all available in otc derivative transactions.131 otc derivatives regulation is in practice subject to light or non-existent regulation132 and the analysis calls for the following tests: a. what derivatives products fall under the category of regulated activities? b. if a product falls under a regulated activity, what are the requirements to deal in such products? 4.2.2.2. regulated derivatives products under the fsma 2000 the act prohibits any one carrying out investment business in the uk, unless that person is authorised or exempted.133 ‘investment’ includes any asset, right or interest134 covered by any of the articles falling under the regulated activities order 2001/544.135 as far as derivatives are concerned, articles 83 to 85 are relevant. (see appendix ‘a’ for full text of the articles) articles 83 to 85 aim to identify financial transactions rather than commercial ones in order to overcome the uncertainties relating to the applicability of section 18 of gaming act 1845.136 in a case dealing with financial services act 1986 part 1 of schedule 1 paragraph 7-9, which contained the similar provisions as to the fsma 2000 article 84 (3) and (4), it was held that these particular provisions amount to mandatory deeming.137 the other provisions are merely an indication as to whether the transaction falls on the commercial or financial side.138 under 131 e. bettelheim, h. parry & w. rees; swaps and off-exchange derivatives trading: law and regulation; (ft law and tax 1996); p. 15,16 132 ibid 133 sec. 19 134 sec. 22 (4) 135 see online at http://www.opsi.gov.uk/si/si2001/20010544.htm#83 136 cf. s. james; the law of financial derivatives; (llp 1999); p. 125 137 laurssa-chigi v. cs first boston (unreported 18 dec 1997) 138 cf. s. james; op. cit. p. 125 nordic journal of commercial law issue 2010#1 28 article 4 ‘a transaction delivery’ seems to be the deciding factor in rendering a contract a future. under fsa 1986 provisions139 it was possible to run a foreign exchange book outside the scope of the provisions, as long as the contract provided for delivery within seven days.140 this is now precluded by article 84 (4) of the fsma 2000, by providing an objective test to construe the actual nature of the transaction, where there exists an understanding regardless of the express terms of the contract; that the delivery would not be made within seven days. article 84 attempts to distinguish between a commercial and investment purpose, to ensure that the act does not cover genuine commercial transactions, which also commonly provide for delivery in the future. in fact, it is not always the case even in financial transactions that the delivery is not made and the contract is closed-out by another transaction. transactions carried on, e.g. at london metal exchange, may sometimes also be concluded by delivery. this may be very unusual, but not impossible.141 this however, does not mean that the act will not apply to such transactions and art. 84 (3) clearly states that the transaction is to be regarded as made for investment purposes if it is made or traded on a recognised investment exchange. another enquiry into art 84 could be whether it covers only ‘futures’ contracts or is also applicable to ‘forwards’ contracts. the words “or made otherwise than on a recognised investment exchange but is expressed to be as traded on such exchange or on the same terms as those on which an equivalent contract would be made on such an exchange” are clear enough. the article also covers forwards transactions. contracts for differences cover a wide category of contracts. contracts for differences under fsa 1986 schedule 1 para. 9 covered interest rate swaps since their purpose or pretended purpose is to secure a profit or avoid a loss by reference to fluctuations in the value or price of property.142 for the same reason currency, equity, commodity and total return swaps were also likely to be contracts for differences.143 the position may have been changed now by providing article 85 (2) (b): “rights under a contract under which money is received by way of deposit on terms that any interest or other returns or other returns to be paid on the sum deposited will be calculated by reference to fluctuations in an index or other factor”. this seems to exclude certain interest rate swaps where net payments are made. the scope of options under article 3 of the fsma seem broader than fsa 1986 options that were limited to the options expressly provided for by it, like currency options, and gold, palladium, platinum and silver options, and did not cover the options to buy e.g. copper.144 139 note 3 para 8 of schedule 1 part 1 140 cf. ibid 141 ibid 142morgan grenfall v. welwyn hatfield [1995] 1 all er 1,12 143 s. james; op. cit. p. 127 144 ibid nordic journal of commercial law issue 2010#1 29 fsma article 83 starts with providing a sweep up provision, i.e., options to acquire or dispose off…(a) a security or contractually based investment (other than one of the kind specified by this article); and then specifically mentions some of the options, including the currency of the uk or any other country or territory. the sweep up provision brings every kind of options, which is a ‘contractually based investment’ within the scope of article 83, regardless of the mode of settlement. a credit swaps option which gives the buyer the right to transfer the underlying asset will also be considered a contractually based investment. the position is clearer where the underlying asset is a security. 4.2.2.3. requirements to deal in a regulated derivatives product in our discussion of regulated derivative products above, it is evident that a large number of derivative products whether on or off-exchange fall within regulated activities. if an otc product or other derivative activity falls within the regulated activities, it becomes subject to all regulatory requirements provided for in investment business. the act makes it a criminal offence if a person carries on activities in breach of the general prohibition stated in sec. 19 of the act.145 although a person who commits such criminal offence is subject to the maximum of two years imprisonment and an unlimited fine, it is a defence for a person to show that he took all reasonable precautions and exercised due diligence to avoid committing the offence.146 breach of the general prohibition may also result in the agreements being unenforceable (sec. 26-29 of the act). under sec. 22 of the act, for an activity to be a regulated activity it must be carried on ‘by way of business’. the business element differs depending upon the activity in question.147 it is a question of judgement whether or not an activity is carried on by way of business. elements include degree of continuity, the existence of a commercial element and the proportion which the activity bears to other unregulated activities carried on by the same person.148 the salient features of the present uk regulatory approach can be summarised as follows: 1. it takes a liberal approach as to what otc activities are taken and focuses on who is doing the activity; 2. when an activity falls under a regulated activity, it provides strict authorisation requirements; 3. when an authorised person is engaged in otc activities, it provides strict rules for consumer protection, thus focuses on with whom the business is done. 145 sec. 23 of the act (contravention of the general prohibition) 146 butterworths financial regulation service; op. cit. vol. 2 para. 2.2.1 147 fsma 2001 (carrying on regulated activities by way of business) order 2001 s1 no. 1177. 148 butterworths financial regulation service; op. cit. vol. 2 para. 2.3.3 nordic journal of commercial law issue 2010#1 30 from the perspective of risk, the regulatory approach requires strict capital adequacy rules. uk capital adequacy rules provide a required capital ratio that imposes both triggered and targeted capital to the total risk weighted assets.149 it provides principles of business integrity; due skill, care and diligence; standards of reasonable care to organise and control with adequate risk management systems; financial prudence; proper standards of market conduct; consumer protections; clear and fair customer information; management of conflict of interest; and open coordination with the regulator.150 4.3. otc derivatives regulation in the united states 4.3.1. the commodity futures modernization act of 2000 (cfma 2000) derivatives regulation in the us was a mixture of banking, securities and bankruptcy laws. the situation created conflicts, complexities and ambiguities of jurisdiction and applicable law when multiple areas of law and regulation came together. the need to overhaul derivative regulation was long felt and as a result the commodity futures modernization act of 2000 (cfma/the act) was signed into law by president clinton on december 21, 2000.151 the cfma 2000 replaced the commodity exchange act of 1936 (cea) and amended securities, banking and bankruptcy laws. the cfma 2000 addresses uncertainties regarding the status of otc derivatives and hybrid instruments under the cea by providing a number of exclusions and exceptions. the cfma 2000 also modernises the regulatory structure and clarifies the legal status of certain derivative products like non-retail swaps.152 the most important provisions of the cfma 2000 relate to the authorisation of the clearing of otc derivatives and establishment of a framework for the regulation of clearing organisations. before the passing of the cfma 2000 all trading of ‘contracts for future delivery’ were required by cea to be carried on in exchanges. although commodity futures trading commission (the cftc) had exempted a number of transactions from the application of the cea, a large number of derivative transactions could not fit into the statuary exclusions or exemptions provided by the cftc. the exemptions only covered some specific financial products related to futures and swaps. the result of this was a comparative disadvantage and fleet of business to 149 c. goodhart; the emerging framework of financial regulation; (cbp 1998); p. 1 150 butterworths financial regulation service; op. cit. vol. 1 para. 6 151 the act was adopted as part of the consolidated appropriation act of 2001 (hr 5457) 152 cf. remarks of thomas. j. erikson; commissioner commodity futures trading commission (santa clara, california july 16, 2002) available online at http://www.cftc.gov/opa/speaches02/opacricks-13.htm. nordic journal of commercial law issue 2010#1 31 more flexible overseas markets.153 the otc derivatives related provisions of the cfma will now be discussed and the regulatory infrastructure provided therein revealed. section 2 of the cfma 2000 state the purposes of the act, which are, inter alia, to eliminate unnecessary regulation for the commodity futures exchanges and other entities regulated under cea; to bring jurisdiction clarity of cftc; to provide a statuary and regulatory framework for allowing the trading of futures on securities; to promote innovation for futures and derivatives and to reduce systemic risk by enhancing legal certainty in the market for certain futures and derivative transactions; to reduce systemic risk by providing clearing facilities of transactions in otc derivatives, through appropriately regulated clearing organisations. for otc derivatives the cfma 2000 has two main features: a. it brings legal certainty for otc derivatives; b. it allows clearing facilities for otc derivatives through recognised clearing exchanges. 4.3.2. legal certainty for otc derivatives before the passing of cfma 2000, there was a great deal of uncertainty regarding the legal status and enforceability of otc derivatives transactions. the cfma 2000 brings legal certainty by providing that no contract shall be unenforceable under the cea or any other provisions of federal or state law, based on a failure to comply with any exemptions or exclusions provided by cea.154 a broad range of swaps agreements and otc derivatives agreements have been brought outside the application and jurisdiction of the cea and cftc respectively. the cfma 2000 provides for a specific category of participants, which are ‘eligible contract participants’,155 and then provides that the transactions involving any commodity (other than an agricultural commodity) that is not executed on a ‘trading facility’ is excluded from the cea application, if they are entered into by eligible contract participants (ecps) and are subject to individual negotiations.156 the term ecps includes natural persons with more than 5,000000 us$ in assets, who enter into the related transactions for risk management purposes. it also includes non-us regulated insurance companies and banks and their us branches and agencies; participants acting as brokers, agents, investment advisers or fiduciaries; and financial institutions such as a large proportion of federally or stately regulated institutions. numerous provisions of the cfma 2000 apply to ‘agreements, contracts or transactions’. swaps exemption 153 cf. testimony of patrick m. parkinson before the subcommittee of financial and hazardous material of the committee of commerce us to the us house of representatives; (july 12, 2000) available at world wide web at http://www.federalreserve.gov/boarddocs/testimony/2000/20000712.htm. 154 amendment provided by the act of sec. 22 of cea by adding a new clause (4) at the end of sec. 22 (a) 155 sec. 1a (12) 156 sec. 2 (d)(1) nordic journal of commercial law issue 2010#1 32 provided by the cftc in 1993 was applicable to only ‘swap agreements’ and required a swap to meet certain tests of being a certain type of agreement to be excluded from cea.157 the enhanced application of the act clearly makes it applicable to all types of swaps.158 a trading facility is defined as a person providing a facility in which multiple persons have the ability to execute or trade contracts by accepting bids and offers from multiple participants. an organised exchange is, inter alia, a trading facility that permits trading by or on behalf of persons who are not ecps. the swap exemptions (part 35 of cftc regulations) contains four elements:159 1. the swap agreement is entered into between eligible swap participants; 2. the swap agreement is not part of a fungible class of agreements that are standardised as to their material economic terms; 3. the creditworthiness of the parties is a material consideration in entering into or determining the terms of swaps agreement; and 4. the swap agreement is not entered into or traded through a multilateral transaction execution facility. the new sec. 2 (d)(1) is broader than the old swaps exemption because first, a statuary exclusion that can only be modified by congress is inherently more robust than a regulatory exemption that can be modified by agency action. secondly, sec. 2 (d)(1) applies to any transaction and not merely to ‘swap agreements’. thirdly, ‘eligible contract participants’ is broader than ‘eligible swaps participants’, fourthly, both the non-fungibility and credit worthiness requirements in swaps exemptions have been dropped; and finally, sec. 2 (d)(1) replaces ‘multilateral transaction execution facility’ with only ‘trading facility’.160 another provision with legal certainty is sec. 2 (d)(2) which states that nothing in cea (except the provisions relating to derivatives clearing organisations) governs or applies to a transaction of an ‘excluded commodity’, if the transaction is: 1. entered into on a principal-to-principal basis by parties trading for their own account or; 2. by parties trading as an authorised investment manager or fiduciary; 3. between ecps (other than while acting as brokers); 4. executed or traded on an electronic trading facility. 157 memorandum for isda members; cfma 2000; prepared by cravath, swaine & moore; (january 5, 2001); p. 14 158 ibid 159 ibid; p. 23 160 cf. ibid; p. 24 nordic journal of commercial law issue 2010#1 33 this makes it clear that the transactions entered into by ecps on a principal-to-principal basis are exempt. but what is the principal-to-principal basis? this is said to include: “any transaction whereby a party to a transaction books the transaction for parties’ own account. it includes ‘riskless principal’ transactions whereby one party enters into a transaction and thereafter contemporaneously enters into an off-setting transaction so that the risk or payments under the transactions net out. the fact that the party has entered into off-setting transactions in no way alters the principle to principle nature of the transaction and any party which has entered into a riskless principal transaction maybe assured that its contracts remain legally enforceable and excluded or exempted from the jurisdiction of the cftc and/or sec as applicable.”161 sec. 2 (g) provides for the ‘excluded swap transactions’. swaps on all commodities other than agricultural commodities are excluded by sec. 2 (g) from the application of cea subject to similar conditions required to be satisfied for the application of sec, 2 (d)(1) except that sec. 2 (g) also requires that the agreement be ‘subject to individual negotiations’. while sec. 2 (g) applies to all commodities except agricultural commodities, it clearly covers commodities like metals, chemicals and energy products that are not traded on a trading facility and are entered into by ecps subject to individual negotiations. further sec. 2 (h)(1) provides that (subject to certain exceptions) nothing in cea applies to an ‘exempt commodity’, if carried on by ecps at the time they enter into the transaction and is not entered into on a trading facility. the exemptions to sec. 2 (h)(1) general exclusions are sec. 5b and 12 (e)(2)(b) and certain provisions relating to fraud and manipulation of market price. cfma 2000 also provides for exclusions of certain swap agreements that fall under the definition of ‘covered swaps agreements’, from the jurisdiction and application of cftc or cea when offered, entered into or provided by a bank.162 a covered swaps agreement is a ‘swap agreement’ including a credit or equity swap based on a commodity other than an agricultural commodity enumerated in sec. 1a (4) of the cea, if the swap agreement: 163 a. is entered into by ecps; b. not executed or entered into on a trading facility. such a ‘swap agreement’ is an agreement defined under sec. 206 (b) of gramm-leach-bliley act, which states: “the term swaps agreements means any individually negotiated contract, agreement, warrant, note or option that is based, in whole or in part, on the value of, any interest in, or any quantitative measure or the occurrence of any event relating to, one or more 161 floor statement released by congressman james a. leach (december 15, 2000); s11867-8 (2000) also quoted by ibid. 162 cfma 2000 part 4 sec. 407 163 sec. 402 (d) of cea nordic journal of commercial law issue 2010#1 34 commodities, securities, currencies, interest or other rates, indices, or other assets, but not included any other identified banking product as defined in paragraphs (1) through (5) of subsection (a).” this clarifies the status of swaps agreements and the new definition covers all interest, currency, credit, equity, commodity, weather or other derivatives contracts. for this purpose, swaps agreements do not include transactions involving the purchase or sale of a security or a put, call or option on a security since the definition of ‘security’ in sec. 2 (a)(1) of 1933 act and sec. 3 (a)(10) of 1934 act has been amended by the act by providing that ‘security’ does not include any swaps agreements. the new provisions effectively remove any confusion about the status of swaps under us securities laws that existed before the act. title 3 of the act provides a distinction between ‘security based’ and ‘non-security based’ swaps agreements. the former is a swaps agreement of which a material term is based on the price, yield, value or volatility of any security or any group or index of securities and the later means any swaps agreement that is not a security-based swap agreement.164 the act makes security-based swaps agreements subject to anti-fraud, antimanipulation and anti-insider trading provisions of the 1933 act and 1934 act. it is, however, not clear whether the sec has regulatory authority over security-based swap agreements.165 the act establishes two categories of clearing organisations for derivative products: “derivatives clearing organisations” that are subject to regulations of the cftc and “multilateral organisations” that are subject to banking or securities regulation.166 otc derivative transactions eligible for exclusion may be cleared through a multilateral clearing organisation and not through derivative clearing organisations. it is, however, not mandatory for an otc derivative to be cleared, but when it is cleared, it must be cleared by a multilateral clearing organisation. to be registered as a clearing organisation a statement must be submitted that it complies with the core principles. the core principles address matters like financial resources, participant and product eligibility, risk management, settlement procedures; treatment of funds, default rules and procedures, rule enforcement, system safeguards, reporting, record keeping, public information and information sharing.167 otc transactions may also be cleared by a securities clearing agency regulated by sec under the 1934 act, or certain foreign clearing organisations approved by the sec, cftc or federal banking regulators. a multilateral clearing organisation is defined as a system used by more than two participants where the bilateral credit exposures of participants are effectively eliminated and replaced by a system of guaranteed, insured and mutualised risk of loss. 164 cf. memorandum of isda members; op. cit. p. 41 165 cf. ibid. 166 the commodity futures modernization act of 2000: watershed legislation for derivatives; may 2001 available at: http://www.mfcafe.com/pantry/ls_0501.html. para iv 167 ibid nordic journal of commercial law issue 2010#1 35 4.4. interim conclusions we have seen that although the us cfma 2000 generally focuses on the regulation of products and markets it also provides core principles regulating intermediaries. under the act the cftc is also required to review and report the possible replacement of intermediary or institutional regulation addressing inter alia the “core principles” and “interpretation of acceptable business practices”. this clarifies the hybrid regulatory approach adopted by cfma by providing the regulation of institutions both institutionally and functionally. in contrast, the uk regulatory regime set forth by fsma 2000 connotes an institutional approach. it imposes a general prohibition to engage in investment business and then provides regulatory oversight into regulated investment business. the investment business under fsma covers a large number of otc transactions with certain swap exemptions. the us otc regulation has been generally subjected to deregulation by cfma 2000 where a large number of swaps and other otc derivatives have been exempted or excluded from the application of the cea and the regulations of the cftc. the emphasis shifted to ecp’s (eligible contract participants). for a natural person to qualify as an ecp, he is required to have more than 5,000,000 us$ in assets and enter into the related transaction for risk management purposes. this again brings into question the blurred distinction between risk management and speculation.168 other ecps include regulated banks and companies. an optional clearing facility for otc derivatives is a positive step. the number of market participants opting to avoid optional clearing facilities with obvious clearing costs and other requirements will by no means be attractive and a large number of participants will opt not to avail the facility. core principles required to be observed by clearing organisations are efficient enough to prevent its failure, is another inquiry. a comparison between us ecps and uk authorised persons, us cfma exemptions and exclusions and uk fsma regulated activities reveal that the uk otc derivatives regulation is more relaxed for some swaps and other otc transactions.169 the result is that in the uk certain swaps are accessible to more market participants than in the us, with virtually no regulatory requirements. however, the institutional nature of the regulation requiring prudential standards and customer protection make it advent that all business activities are organised and channelled. furthermore, under the present regulatory structure, it is not possible in the us for other than ecps to use swaps agreements. under cfma 2000 sec 105 (c) the board of governors of the federal reserve is required to conduct a study of issues relating to the potential use of swaps agreements by non-ecps’. the uk imposes no restrictions on offering otc derivative 168 see supra para 1.2.1.3.1 169 see supra para 1.2.1.3.1 nordic journal of commercial law issue 2010#1 36 products to persons who are not authorised under fsma. this freedom is fenced by requiring a high level of customer and consumer protection and setting prudential standards since the relationship is still governed by fsma where one of the parties is an authorised person. hitherto, we have developed a good knowledge of otc derivatives financing, its associated risks, and the regulatory approaches adopted by uk and us financial regulators. in the light of uk and us regulatory approaches, an attempt is made to reveal the role that otc derivatives can play in developing countries, and how regulators can use this monster in a useful manner. 5. benefits, suitability and regulatory challenges for developing economies 5.1. benefits this concluding part of the article will focus on the role of otc derivatives in developing economies. we will deal with the questions like: are there any benefits of otc derivatives? are they suitable for developing economies? if yes: what are the regulatory challenges for developing economies to use otc derivatives to increase market efficiency without jeopardizing financial stability? while dealing with these questions we will discuss the role of otc derivatives in developing countries generally and in pakistan particularly where it is necessary and appropriate. after ever-increasing use of otc derivatives in the past three decades, there are still apprehensions about derivatives. one such apprehension is that derivatives do not serve any economic purpose, only increases speculation and market volatility and cause instability for institutions and the system. there is, however, a tendency to overstate the associated risks and ignore the economic role played by otc derivatives. there are mainly two categories of otc participants, i.e., end users or dealers. end users are government entities, institutional investors, financial institutions and corporations. the dealers include highly rated and large banks; highly rated insurance companies and securities firms. dealers act as intermediaries who quote bids and offers and commit capital to satisfy customer demand for derivatives.170 numerous studies conducted by international and national organisations have revealed that otc derivatives provide several benefits to end users.171end users benefit from the lowest funding costs and more diversified funding sources by swaps; for example, a company can borrow in the cheapest capital market, even across border, without regard to the currency in 170 christopher l. culp and robert j. mackay; regulating derivatives: the current system and proposed changes; available at http://www.cato.org/pubs/regulation/reg174b.html 171 cf. ibid nordic journal of commercial law issue 2010#1 37 which the debt is denominated or the fixed or floating interest rate payment mode. end users can also benefit from derivatives by hedging their exposures against risks arising from price and interest rate fluctuations. it is because of interest rate swaps that banks are able to offer long term funding, like mortgages with short term liabilities that re-price frequently, such as certificates of deposits; and better manage their asset liability mismatches. commodity swaps are used by airlines and oil refineries to hedge their exposures to fluctuating oil prices. some users like institutional investors and portfolio managers may use derivatives to enhance asset yield. the case settlement benefit of derivatives enables institutions to exchange cash flow on one asset to cash flow of another asset like an exchange rate. where securities are poorly traded for an undesirable feature, derivatives can provide a synthetic instrument to neutralize the undesirable element, thus, creating a higher yield instrument as compared to a traditional instrument of equal credit quality. derivatives are an efficient tool for asset liability management. borrowers can use interest rate swaps to raise the proposition of fixed rate to floating rate coupons for fixed rate coupons, thus alleviating the need to actually sell any of its securities. derivatives also benefit dealers in many ways.172 derivatives have increased both the average credit quality and the diversity of credit risk to which dealers are exposed. derivatives also provide profitable income streams that help the dealers reconstruct their capital bases, and diversify their sources of income. with the help of derivatives dealers are improving their risk management techniques arising in traditional business practices. the risk management techniques originally developed for derivatives are also being applied to risk management and has resulted in the improved safety and profitability of these institutions. innovation is recognised as beneficial for the economy173 derivatives, as discussed earlier, reduce funding costs and diversify funding sources for market participants. an efficient derivative market can help boost the competitiveness of an economy in global economic uprising. derivatives provide new and efficient tools to manage exposures to interest rates, foreign exchange rates and commodity prices; with an organised derivatives market an economy will have better exposure management capability and will attract the international business investors and large market participants. the lower cost funding provided by derivatives, help large capital formations increase business activity in spot markets and stimulate economic growth. 5.2. are otc derivatives suitable for developing economies? otc derivatives have been frequently criticized for the scale of their associated risks and high levelled leverage. the issue whether otc derivatives are suitable for developing economies may 172 cf. ibid 173 cf. ibid nordic journal of commercial law issue 2010#1 38 be address by inquiring into the following two questions: firstly; can otc derivatives fit into any financial system? secondly, to what extent is the regulatory initiative plausible to introduce otc derivatives in a developing economy? there are two aspects of the first question: the regulatory aspect and the philosophical aspect. from the regulatory aspect of a financial system, we have observed in the preceding part while discussing the regulations of otc derivatives in the uk and the us that the otc derivatives market is doing well in both financial systems, regardless of opposite regulatory approaches. in the uk any otc activity is allowed without regulatory requirements, unless the concerning activity falls under one of the regulated activities provided by the regulatory activities order; whereas in the us no otc derivatives activity is allowed, unless exempted or excluded from regulation by cfma 2000 or other related regulatory enactments. it is however, submitted that from the perspective of developing countries, the us approach would be more suitable. it is the strong institutional and judicial background and principles long established, followed and carried out in the uk that allow uk regulators to adopt such a liberal approach, and such are scarce in developing countries. furthermore, ever-increasing innovation in the otc derivatives market calls for checks and appropriate risk assessment before a new instrument is introduced in a developing market since the regulatory framework may not keep pace with the changing financial atmosphere. a ustype general prohibition, followed by approvals in the form of exemptions and exclusions after proper assessment of an otc instrument is, therefore, more plausible for developing countries. the philosophical aspect of financial systems calls for appropriate scrutiny of any developing country and a relatively close scrutiny, especially in the context of pakistan. in principle, every financial system is meant for active participation in economic growth and welfare of the society at large. the objectives of a financial system are no different around the globe, regardless of its philosophical background. pakistan being conservative economy with mixed capitalist and islamic philosophy may face difficulties in introducing an innovative financial device. nevertheless, the present situation where standard derivatives products, like forwards and options, already exist and are allowed by the state bank of pakistan and where the rupee-dollar forward already has a liquid market, the introduction of more derivative products would not be a new prodigy. furthermore, the otc derivative trading in shares of small companies in the karachi stock exchange have already been approved by the securities and exchanges commission of pakistan.174 174 approval dated 17 may 2002; details are available at: http://www.pakistaneconomist.com/issue2001.issue32/ f&m2.htm nordic journal of commercial law issue 2010#1 39 it might be argued that otc derivatives are complex, exotic instruments and, thus, that participants in developing country markets will have difficulties in understanding them.175 in fact, trading in standard derivative products like forwards and options is not new in for example india and pakistan and related derivative products already exist in various markets including equity markets. to what extent is then the regulatory initiative plausible to introduce otc derivatives in a developing economy? the fact is that the otc derivative market has emerged and grown in an unregulated atmosphere. regulation of otc derivatives emerged when their potential to cause financial meltdown was felt in some disastrous failures, many of which were directly or indirectly caused by derivative financing. the regulatory approach in the last century was to prohibit otc derivatives for their same potential, but the regulatory approach in 21st century is to allow otc derivatives financing channelled in a systemically stable way because of their positive potential in mitigating risks arising out of traditional business with resulting financial stability and economic growth. this is the reason why the otc derivatives market has gone through a large scale de-regulation in us. now the economies that do not have systems of derivatives hedging are believed to be deprived of the benefits of a beneficial financial instrument and are in a comparative disadvantage. benefits of exchange trading of derivatives are not denied a tailor-made-low-cost otc instrument is highly effective if the dangerous elements like illiquidity and undisclosed positions are removed. it is not necessary for financial innovation to originate from market participants. initiatives in developing countries can be taken by the regulator and introduce new instruments with specific regulatory requirements; instruments that can attain the ultimate objectives. otc derivatives are, no doubt risky and highly leveraged instruments. this might form the basis for arguments against the introduction of otc derivatives in developing countries. banks and other financial institutions and corporations are less sophisticated in both technique and technology, so the risk element will be more prominent. it is, however, suggested that though the risks associated to otc derivatives have caused great alarm, they are now well defined and comprehensively elaborated. techniques like clearing, facilities for otc derivatives and capital adequacy requirements and an increased emphasis on skilled and prudential management have proved effective to keep the otc market well liquid and coping with other risks. regulatory initiatives can ab initio curtail legal uncertainty. furthermore as alan greenspan the chairman of federal reserve board of the us has rightly said, “there are some who would ague that the role of the bank supervisor is to minimise or even eliminate bank failure; but this view is mistaken in my judgement. the willingness to take risk is essential to the growth of a free market economy. [i]f all savers and their financial intermediaries invested only in risk free assets, the potential for business growth would be never realised.” 175 cf. nina mehta; myths behind derivatives; available at http://www.blonnet.com/businessline/iw/2000/ 06/11/stories/0811ho17.htm nordic journal of commercial law issue 2010#1 40 5.3. regulatory challenges for developing economies 5.3.1. financial integrity and the reduction of systemic risk since derivatives are risky and highly leveraged instruments, developing economies that intend to introduce or have already allowed otc transactions in different areas of financial activity have to combat certain regulatory challenges. developing economies may not be strong enough to sustain defaults of large number of major market participants. protection against systemic risk is therefore the biggest regulatory challenge for developing countries. regulatory challenges for developing countries may be discussed under the following headings. integrity of the investment market is essential for the promotion of orderly raising of capital. developing economies need to establish framework for the free operation of the market, establishing rules of conduct designed to improve the flow of information and the confidence of market participants. otc derivative financing is required to be brought under the general heading of investment business and required to be authorised like credit institutions and investment firms. once otc derivatives are recognised as investment business subject to authorisation, other requirements like capital adequacy, minimum standards of prudential management and standards of internal control can also be applied. capital adequacy requirements are recognised efficient tools to internalising credit and other kinds of risks. the risk sensitive nature of the required capital, i.e., depending upon and increasing along with the nature and degree of the risk, would be more suitable for developing economies. capital requirements may also be made adjustable depending upon the nature, size or sophistication of a firm. there is a corresponding need to establish systems to monitor compliance of capital requirements. depending upon the regulatory model, capital compliance may be monitored by different regulators than the one that monitors compliance with conduct of business rules.176 influence can be taken from the guidelines of the ‘basle capital adequacy accord’ (1993) and the ‘ec own funds and solvency ratio directive’ adopted in 1993. one of the major challenges, however, for capital adequacy rules is to design a usable method for calculating total risk that is suitable for all market participants.177 because of the inter-linkage among financial institutions, close co-operation is necessary among regulators of different sectors of the national financial systems to assure the financial integrity of authorised financial institutions, prevent conflict of interest and to reduce systemic risk. this is the reason that leads to a single financial regulator in uk. the free flow of information and close co-operation among different regulators is highly important in the absence of a single financial regulator. to prevent systemic crisis, firms engaging in otc activities should also be 176 working paper on national laws regulating to otc derivatives transactions and the public policy objectives of financial regulation; office of inter-affairs; us. cftc; issued july 2000 177 cf. c. goodhart; emerging framework of financial regulation; (cbp. 1998); p.26 nordic journal of commercial law issue 2010#1 41 made subject to minimum standards of prudential regulation and internal control. the fact that otc derivatives can be complex and difficult to understand presents a need for skilled management capable of understanding and managing risks associated with such exotic instruments. an appropriate settlement and clearing system also helps to reduce systemic risk arsing out of otc derivatives. the us has already taken an initiative to provide a clearing facility for otc transactions. certain institutions, like banks, securities houses and insurance companies are regarded as central to a financial system. since they are given a monopoly in certain products and certain kinds of activities, they are usually regulated by specialised regulators (except in the uk), who exercise detailed supervisory authority over their activities.178 in the context of otc derivatives regulations two issues arise; should a monopoly on otc derivatives be given to specialised institutions or should otc activity of regulated institutions be specially regulated.179 the proponents that suggest that specialised institutions should be given the monopoly over otc derivatives hold that this will enable the regulator to closely monitor and control the developments of otc derivatives.180 this kind of regulation is termed ‘ring fencing’.181 ring fencing necessarily provides that institutions should be restricted to their own specialized activities e.g. deposits-taking may be limited to banks that are then subject to disclosure and prudential requirements and securities dealing may be restricted to registered brokers/dealers, who are subject to requirements as to disclosure to customers and making determinations as to suitability of certain types of instruments for customers. by ring fencing, otc derivatives can be restricted to only one type of institution, which can be closely regulated. in return for monopoly over a product, control can be placed on these regulatory institutions, designed to control their solvency and conduct of business in the form of prudential management requirements. ring fencing may also make possible the achievement of certain policy considerations relating to otc derivatives. for instance, if it is determined to regulate swaps offered to the general public, one approach might be to limit the offering of swaps to the public to offers by institutions whose solvency and conduct of business is supervised.182 ring fencing, is however, criticized on the grounds that the focus should be on how to control an institutions’ involvement in derivatives business rather than on forbidding it.183 the second issue i.e. should otc activity of regulated institutions be specially regulated is evidenced by us otc derivatives regulations. as discussed in the preceding part, us otc 178 cf. s. k. henderson; regulation of swaps and derivatives: how and why? ; (jibl 1993); p. 353 179 cf. ibid 180 s. k. henderson; op. cit. p.354 181 cf. c. goodhart; op. cit. p. 297 182 cf. ibid 183 c. gaoodhart; op. cit. p. 292 nordic journal of commercial law issue 2010#1 42 derivative regulation mainly focuses on individual otc products. the system provides definitions of otc products and clarifies the capacity to deal in those products. in recent years there has been a tendency towards specific derivatives legislations184 developing economies should be required to clarify questions as to capacity, i.e., whether or not a regulated institution should be permitted to enter into otc activities and also the circumstances under which such activity is permitted or prohibited. such clarifications may be necessary both to enable the institution to have access to the swap market and to protect the otc market from potentially serious losses from a finding that the counterparty lacked capacity.185 5.3.2. legal certainty and protection of less sophisticated persons186 certain issues with respect to the legal certainty of otc derivatives transaction demand particular attention. firstly, developing economies need to enhance legal certainty relating to enforceability of otc derivative transactions under certain circumstances and between certain counterparties. for example, in some jurisdictions certain otc products may fall under the laws relating to the prohibition of gambling. removal of this uncertainty is vital. secondly, there should be legal certainty as to the enforceability of bilateral contractual arrangements that are intended to govern the use of collateral, and the close out or liquidation of derivative positions in the event of a default or insolvency. isda provides legal certainty in this context by providing essential close out netting. in the absence of close-out netting and legal certainty regarding the enforceability of bilateral collateral arrangements otc derivatives will always be exposed to legal risk. another challenge for developing countries will be the protection of the less sophisticated person or average citizen from the depredations of somewhat greedy and untrustworthy large institutions. the protection of less sophisticated persons may be achieved by any of the following ways: by excluding less sophisticated persons from the otc derivatives market, and limiting the use of otc derivative product to institutions and individuals which are subject to the regulations regarding dealing with the general public.187 this approach is adopted by the us, where otc products are limited to eligible contract participants (ecps). ecps are those market participants, which fulfil certain requirements and meet certain financial tests.188 secondly the protection is achieved on the pattern of the uk wholesale market regime, by regulating the conduct of businesses providing capital adequacy requirements for those market 184 see for example australian securities commission, report on otc derivatives markets (canberra, australian government publishing services 1994); p. 6 185 s. k. henderson; op. cit. p. 354 186 cf. working paper, op. cit. p. 99 187 cf. s. k. henderson; op. cit. p. 354 188 see part 3, para. 3.4.1.1 supra nordic journal of commercial law issue 2010#1 43 participants who are authorised in dealing with the general public in investment business including otc products. the uk regulatory framework imposes a higher degree of disclosure and standard fiduciary obligations on market participants offering investments to the general public .189 developing economies also need to prepare customer protection laws where the customers are protected from misleading, fraudulent and abusive practices. full disclosure is required for customers making informed investment or risk management decisions. customers’ assets also need protection from defalcation on intermediary insolvency.190 there are certain other regulatory challenges, which according to market conditions could appear in a developing economy in otc derivative regulation. for example, a government may wish to regulate the price of certain commodities (e.g. agricultural commodities), which it deems central for the proper functioning of its economy.191 it may, therefore chose to regulate otc instrument that affect the price or marketability of those commodities. some jurisdictions especially developing, have systems like exchange controls intended to protect the domestic economy or monetary systems, to protect the integrity of the local currency, to manage the local interest rate, to restrict capital outflows or to protect domestic institutions from foreign competition.192 regulation of certain otc products, e.g. swaps, would be important for the effectiveness of such protections. 6. final conclusions otc derivatives are no doubt very risky and highly leveraged instruments. at the same time, they can serve numerous financial purposes and participate in economic growth and prosperity. as far as the risks associated with otc derivatives are concerned, we have seen that these risks are well identified and comprehensively defined. legal liquidity, credit and market risks are exhaustively investigated and known by both financial regulators and market participants. secondly, these risks are not special to otc derivatives, but are also faced by market participants in traditional investment business. it is true that otc derivatives increase linkage between market segments and individual financial institutions. this linkage can cause contagion in case of failure and can ignite systemic meltdown, but certain regulatory tools like capital adequacy, increased disclosure requirements, and clearing facilities have proved to be effective to internalise these risks and prevent systemic externalities of such failures. with the 189 s. k. henderson. ibid 190 iosco objectives and principles of securities regulation. 191 s. k. henderson. op. cit. p. 356 192 cf. ibid nordic journal of commercial law issue 2010#1 44 help of regulatory tools the financial market regulators in both the us and the uk has made of otc derivatives market very reliable and productive. otc derivatives are equally beneficial for end users, dealers and the economy at large. end users benefit from lowest funding costs and more diversified funding sources by the use of otc derivatives. hedging of risks arising out of traditional investment business is important and according to some us courts it is even compulsory. otc derivatives hedging has proved itself an efficient instrument to hedge against different kinds of risks arising out of traditional business activities. dealers can generate activities profitable income stream, reconstruct their capital basis and diversify their sources of income. with an organised otc derivative market, an economy will have increased financial activity with better exposure management capability and will also attract international investment and large market participants. these are the benefits, which are longed for by any financial market regardless of nature or size. contemporary economies that prohibit derivatives hedging are deficient in a beneficial economic income source, and are at a comparative disadvantage. the ability to use otc derivatives to unbundled financial risk into separate components is an important step in the direction of creating more complete and efficient financial markets. worries related to otc derivatives are that they fail to perform as expected in the times of stress when major firms are at risk of suffering loss and many other smaller institutions are at risk of illiquidity, if not insolvency. the fact is that otc derivatives can give rise to systemic instability due to their dynamic nature of gross credit exposures, the absence of necessary information to market participants, their effects on available aggregate credit and market liquidity, and for their enlarged market size. inadequate counterparty assessment, limited understanding of market dynamics and liquidity risk assessments, and legal and regulatory uncertainty are also major factors that participate in otc derivatives market precariousness. furthermore, the otc market is dominated by internationally active large institutions and the failure of single such institution can bring global financial meltdown. increased market discipline with symmetric information mechanisms and increased cooperation between the regulator and the regulated is required to fight against these problems. the mechanism that makes mandatory the disclosure of the minimum information necessary for useful market discipline and effective official supervision and surveillance is essential. prudential regulations and particularly capital adequacy requirements are also vital in this regard. a u.s-type clearing facility available for otc transactions can effectively remove liquidity risks. secondly, for the better and smooth function of the otc derivatives market, developing economies are required to provide higher degree of legal and regulatory certainty. enforceability of otc derivatives and bilateral collateral arrangements and the recognition of close-out netting are major areas in this context. in addition to these challenges, developing countries wishing to introduce derivatives may face some peculiar challenges as well according to the individual circumstances and their financial and economic conditions. there might be policy considerations like the protection of the domestic economy or monetary system, protection of the market/price nordic journal of commercial law issue 2010#1 45 of certain commodity that can be affected by otc activities, or protection against capital outflows, which can necessitate regulation of certain otc products, for example swaps, in a particular fashion. the us type functional approach with general restrictions followed by exemptions to deal in certain product after proper risk and regulatory assessments is believed feasible in such circumstances. microsoft word villa_seppo.doc nordic journal of commercial law issue 2008#1 creditor protection and the application of the solvency and balance sheet tests under the company laws of finland and new zealand by seppo villa nordic journal of commercial law issue 2008#1 2 i. introduction creditor protection in the recently adopted finnish limited liability companies act (fllca)1 has gone through structural changes compared to the preceding finnish limited liability companies act of 19782. novelties in the creditor protection of the fllca is that asset distribution is tied to maintaining the solvency of the company and contrary to the 1978 act, creditor protection now covers also the company’s distributable reserves of unrestricted equity. consequently, assets may be distributed only if the company has adopted a financial statement,3 which indicates the amount of the company’s reserves of unrestricted equity that may be distributed,4 unless otherwise ensues from a solvency test. the solvency requirement is set forth in chapter 13, section 2 of the fllca: “assets shall not be distributed, if it is known or should be known at the time of the distribution decision that the company is insolvent or that the distribution will cause the insolvency of the company.” it is important to notice that the solvency test applies not only to the distribution of reserves of unrestricted equity, but also to restricted equity even when the creditors have consented to its distribution in accordance with the creditor protection procedure laid down in chapter 14 of the fllca. 1 finnish limited liability companies act (624/2006). 2 finnish companies act (734/1978). 3 in accordance with an amendment (461/2007) adopted on 1 july 2007, chapter 13, section 3 of the limited liability companies act will be as follows: the distribution of assets shall be based on the latest adopted financial statement. if so provided in this act or the articles of association, the company must select an auditor and the financial statement must be audited. the essential changes in the financial position of the company after the completion of the financial statement shall be taken into account in the distribution. 4 in accordance with chapter 13, section 5 of the limited liability companies act, unless otherwise ensues from the application of chapter 13, section 2 therein, the company may distribute its reserves of unrestricted equity, less the assets that are to be left undistributed under the articles of association. in addition to possible articles of association, the distribution of a company’s reserves of unrestricted equity is limited by the shares that have been purchased or redeemed by the company or that are in its possession, which shall be included in the reserves of unrestricted equity as a negative item. under section 17, subsection 3 of the act on the entry into force of the limited liability companies act (625/2006), if the company balance sheet has active incorporation and research expenses which have been removed by 31 december 2004 in accordance with the provisions of the accounting act in force (1336/1997), a corresponding amount shall, in the application of chapter 13, section 5 of the limited liability companies act, be taken into account as an undistributed item. nordic journal of commercial law issue 2008#1 3 the aim of this paper is to discuss the solvency test and the balance sheet test5 in chapter 13, section 5 of the fllca respectively, and assess how they should be carried out as well as what should be taken into account when doing so. moreover, as an example i will compare the tests to creditor protection in the new zealand companies act (nz ca)6, with a special focus on whether the solvency test therein could help in the application or practical development of the solvency and balance sheet tests in finland. the extreme distance of new zealand to finland and the fact that the common law system differs in both history and content from the finnish legal system, were not the only reasons for selecting this creditor protection system as the point of comparison. it was chosen as an example of how two legal systems with different historical backgrounds and in two countries far apart can end up with rather similar mechanisms for solving conflicts of interest between creditors and shareholders, with the aim to prevent the opportunism of insiders, i.e. management and controlling shareholders. the comparison also serves as a tool for examining the control mechanisms of basically dispositive company legislation ex ante. the 1993 nz ca reform is a valid reference point also in other respects, because its ideas and goals for modernisation were similar to those prevailing in the reform process of the fllca. accordingly the nz ca aims: “to encourage efficient and responsible management of companies by allowing directors a wide discretion in matters of business judgment while at the same time providing protection for shareholders and creditors against the abuse of management power.”7 in their extensive commentary of the nz ca reform, ross grantham and charles rickett maintain that the act should 1) be understood as a model agreement between different interest groups in a company, 2) prevent any opportunistic behaviour of management and controlling shareholders, 3) in its extent and nature correspond to the risk of abuse of controlling positions and not prevent financial activities, and 4) be sufficiently simple and not too detailed.8 5 chapter 13 section 5 of the fllca. 6 new zealand companies act 1993 no 105, nz ca. 7 the preparatory work for the limited liability companies act (government proposal 109/2005) states that the new act is more transparent and comprehensive than the previous one. the act would increase companies’ scope of activity and guarantee sufficient protection for minority shareholders and creditors. nordic journal of commercial law issue 2008#1 4 thus it is no surprise that both the fllca and the nz ca include provisions on creditor protection based on the maintenance of company solvency in addition to the traditional balance sheet test now used for determining the amount of net assets. the adoption of the solvency test also required reform of the regulation of modern limited liability companies and their activity. the traditional balance sheet and share capital-oriented creditor protection cannot be considered a sufficient means of meeting the requirements of good and efficient company legislation that protects all interest groups. the purpose of the solvency test is very simple. it aims to ensure the allocation of creditors in terms of assets and liabilities, by preventing such distribution of assets that would endanger the timely payment of receivables to creditors in the proper amount. under nz ca the solvency test is applied not only to the protection of creditors, but to fixed preferential returns on shares ranking ahead of those in respect of which a distribution is made.9 technically, this entails that in the application of the solvency test under nz ca the above-mentioned shares are considered debt according to their financial character. ii. background of the solvency test in finland, creditor protection has traditionally been connected to the amount of capital invested in a company in the form of shares, and the permanence of its other reserves of restricted equity (the capital maintenance doctrine). this was apparent in the finnish limited liability companies act of 1978, which provided that for each subscription to a share, the par value or its counter value for accounting purposes was to be credited to the share capital and the rest to the share premium reserve. in addition, subscriptions to shares could not be made without crediting the par value of the share price, or its counter value, to the share capital for each subscription price paid or other balance assets. under the finnish limited liability companies act of 1978, the share capital and share premium reserve were, along with the legal 8 ross grantham & charles rickett: company and securities law commentary and materials. brookers ltd 2002 (grantham & ricket), pp. 38-39. for further details on the aims of the new zealand companies act reform, see new zealand law commission, report 9, 1989 and especially pp. 1-2. comparing the aims of the new zealand companies act reform and the finnish limited liability companies act reform – legislation that is more transparent, flexible, guaranteeing a more extensive scope of action for companies, improving the operational preconditions, competitiveness and employment possibilities of both large and small companies – we must acknowledge that the similarities are remarkable. both acts are based largely on dispositive provisions, subject to mandatory provisions on the company institution’s essential parts. this is understandable because both reforms have been influenced by e.g. the american model business corporations act. 9 nz ca, section 52, subsection 4. see e.g. mike ross: the statutory solvency test. company law writings: a new zealand collection 2002, pp. 177-202, (ross), p. 189. nordic journal of commercial law issue 2008#1 5 and revaluation reserves, the company’s restricted equity, which could not be distributed without observing the creditor protection procedure in accordance with chapter 6 of the act.10 the provisions of the finnish companies act on the permanence of capital and the distribution of assets corresponded to the requirements of the second company law directive (77/91/eec). as the directive required, the finnish limited liability companies act of 1978 tied the distribution of assets solely to the amount of unrestricted equity indicated in the balance sheet.11 under article 15 (1) (a) of the directive, except for cases of reductions of subscribed capital, no distribution to shareholders may be made when on the closing date of the last financial year the net assets as set out in the company’s annual accounts are, or following such a distribution would become, lower than the amount of the subscribed capital plus those reserves which may not be distributed under the law or the statutes. under article 15 (1) (c) the amount of a distribution to shareholders may not exceed the amount of profits at the end of the last financial year plus any profits brought forward and sums drawn from reserves available for this purpose, less any losses brought forward and sums placed to reserve in accordance with the law or the statutes. pursuant to article 15(1)(d) the expression “distribution” used in these provisions includes in particular the payment of dividends and of interest relating to shares. the content of the solvency test is currently influenced by the reformed capital system, which, within the limits of the minimum share capital requirement, allows crediting the subscription price paid for a share to the reserves of unrestricted equity. other influences are legal problems relating to the implementation of international financial statement standards, and especially valuation problems in accounting related to the traditional balance sheet test. these problems involve taking into account unrealised changes in value because such changes are taken into consideration in different balance sheet tests only to a certain extent.12 10 the revaluation reserves under the 1978 finnish companies act could not be distributed, but they could be used to increase the capital stock through reserve issue and new subscriptions in mixed issue. under the new limited liability companies act, however, the use of reserves to increase the capital stock is not possible. revaluation reserves under chapter 8, section 1, subsection 1 are absolutely undistributable. 11 see the finnish companies act, chapter 12, section 2, under which profit distribution was not to exceed the sum total of the profit confirmed in the balance sheet for the latest entire financial period and the company’s other reserves of unrestricted equity, less the losses indicated in the balance sheet and other undistributable items which were defined in section 2, subsection 1, paragraphs 1, 1 a, 2 and 3. 12 a working group for the development of corporate taxation, appointed by the ministry of finance in 2005, has proposed that only unrealised increases in value entered into the accounting records of financial instruments credited in accordance with the resulting income and expenses to the fair price of the share should be taxed income and unrealised value decreases tax-deductible expenses. unrealised value increases of financial instruments credited directly to equity would not be taxed income and similar unrealised depreciation would not be deductible. see verotus, tilinpäätös ja yhtiöoikeus 2006, pp. 38, 40-42, 61-63, 76 and 80. nordic journal of commercial law issue 2008#1 6 in the non-nominal value capital system under the fllca, shares have no nominal value. the link between a share and the share capital has also been removed. consequently, crediting the subscription price of a share to the corresponding items in the balance sheet – the share capital and reserves of invested unrestricted equity – is in the establishment of the company connected to the provisions of the memorandum of association, and in subsequent share issues to the contents of the decision to issue shares or to the articles of association. pursuant to the fllca, unless otherwise provided on crediting the subscription price, crediting is carried out as follows: the subscription price shall be credited to the share capital, unless it is provided in the memorandum of association or articles of association that a part of it is to be credited to the reserve for invested unrestricted equity, or unless it is otherwise provided in the accounting act.13 under chapter 9, section 6.2 of the fllca, the situation may be inversed, depending on whether the share issue involves new shares or ones already in the company’s possession. provisions on the subscription price of shares allow new subscriptions to them to be credited entirely to the reserve of invested unrestricted equity. iii. the contents of the balance sheet and solvency tests in finland and new zealand iii. a finland – the fllca chapter 13, section 5 of the fllca corresponds to article 15 of the second company law directive. pursuant to this section, unless the assets are to be left undistributed under the articles of association or after application of the solvency test, the company may distribute its reserves of unrestricted equity14. hence, the fllca limits the distribution of unrestricted equity with the balance sheet test,15 the solvency test16 and the requirement that the distribution of assets shall be based on the latest adopted (and audited) financial statement17. 18 in addition, 13 fllca chapter 2 section 4. 14 the articles of association may order, for example, that half of the profit from the financial year shall not be distributed. 15 pursuant to chapter 13, section 5. 16 pursuant to chapter 13, section 2. 17 in chapter 13, section 3. 18 according to the second sentence of chapter 13, section 3. nordic journal of commercial law issue 2008#1 7 essential changes in the financial position of the company after the completion of the financial statement shall also be taken into account in the distribution.19 as the fllca enables crediting subscription prices to unrestricted equity, and as unrestricted equity has traditionally been based on the free disposition by shareholders20, it is rather clear that contemporary creditor protection was designed to prevent opportunistic share holderbehaviour at the expense of creditors. as indicated by the collocation of creditors21, it is in the creditors’ interest that the company is able to pay its liabilities. more specifically it should be able to do so in accordance with agreements, at the proper time, in the proper amount and it is also in the company’s interest that the transfer of funds to customers does not endanger the activity of the company. the balance sheet test and the solvency test are connected to each other. before distribution of company assets e.g. the distribution of dividends and the reserve of unrestricted equity, it is necessary to test whether distribution is, in fact legally possible.22 based on the solvency test, one must verify whether it is necessary to decrease the amount distributed. it is illegal to distribute assets in contravention to the solvency test. such a violation results in a refund obligation.23 the balance sheet test makes a distinction between the company law concepts of restricted and unrestricted equity and liabilities. the fllca defines equity and divides it into two types: restricted and unrestricted24. restricted equity consists of share capital, as well as of the fair value reserve and revaluation reserves under the accounting act. unrestricted equity consists of other reserves, as well as of profit from the current and the previous financial periods. 19 the provision can be interpreted based on the traditional duty of care. the provision refers in particular to a decline in the financial situation of the company after the conclusion of the financial statement. decreases in the reserve of unrestricted equity after the preparation of the financial statement must be taken into account in the distribution of dividends and in the estimation of the unrestricted equity available for distribution. similar increases in unrestricted equity cannot be taken into account without the adoption of the new financial statement because distribution must always be based on an adopted (and audited) financial statement. 20 under the limited liability companies act, chapter 13, section 6, subsection 4, unrestricted equity may, on the consent of all shareholders, also be distributed in a manner other than referred to in section 1, subsection 1 above, unless otherwise provided in the articles of association. 21 pursuant to the limited liability companies act, liabilities take precedence over equity in the distribution of funds. it is a question of collocation between equity and liabilities or different financial instruments. the order is based on the idea that returns paid on liabilities or other related expenses are dealt with in the company's profit and loss account as deductible expenses and they always decrease the company’s distributable assets. see mähönen, jukka & villa, seppo: osakeyhtiö ii. pääomarakenne ja rahoitus. wsoypro helsinki 2006. mähönen & villa 2006 ii), p. 21. 22 for further information on distributable unrestricted equity, see mähönen & villa 2006 ii, p. 322. 23 chapter 13, section 4 of the fllca. 24 chapter 8, section 1, subsection 1. nordic journal of commercial law issue 2008#1 8 the revaluation and fair value reserves refer to reserves of the same name in the chapter 5 of the accounting act. the company law concept of a fair value reserve covers also the part of equity that consists of changes in value credited directly to equity based on the international accounting standard (ias) 39. according to ias 16 and ias 38, the changes should be credited directly to equity under a revaluation reserve, if the carrying amount of a tangible or intangible asset is increased or decreased as a result of revaluation. according to ias 39, investment real estate and agricultural goods credited to the fair value are not provided for in the fllca. consequently, the profit indicated in the profit and loss account for the financial period may include unrealised increases in value. in terms of company legislation, the profit for a financial period can in total be considered unrestricted equity regardless of whether it includes realised profits or not. the finnish parliament’s commerce committee has considered it necessary that provisions on the distribution of unrealised value increases are prepared separately in cooperation with the ministry of justice and the ministry of finance and that a separate government proposal be issued thereon.25 hence, the test is twofold. only the sum indicated by the balance sheet test may be distributed, and the distribution is possible only within the frames set by the solvency test. in consequence, the solvency test sets the limits for distributing assets with the aim of ensuring that the distribution is not carried out in contravention to the collocation of those having invested capital in the company in different forms and ways. in this connection, i wish to point out that the solvency test concerns the distribution of both restricted and unrestricted equity equally. this provision shall be applied irrespective of whether creditor protection under chapter 14 of the fllca has been applied to the distribution. iii.b. new zealand – the nz ca creditor protection in the new zealand has been arranged with a solvency test similar to the solvency and the balance sheet tests of the fllca. pursuant to nz ca section 4, subsection 1: distribution depends on the company's ability to pay its debts (the liquidity limb of the solvency test) and the company’s assets being greater than its liabilities after distribution (the balance sheet limb of the solvency test). management is obligated to assess the amount of the company’s assets and liabilities, their nature and proportion based on the latest financial statement, which has been prepared in accordance with the financial reporting act of 1993. under nz ca, section 4, subsection 1, a company passes the solvency test if: 25 see the memorandum of the commerce committee tavm 7/2006 vp and government proposal he 109/2005 vp. p. 5. the government proposal has not yet been issued to the parliament. nordic journal of commercial law issue 2008#1 9 the company is able to pay its debts as they become due in the normal course of business; and the value of the company's assets is greater than the value of its liabilities, including contingent liabilities. one of the characteristics of the nz ca is that the company directors may, without special authorization,26 distribute the company’s assets as they see fit, provided that they can, on reasonable grounds, be sure that the company fulfils both requirements of the solvency test based on an assessment carried out immediately after the distribution.27 pursuant to nz ca, section 52, subsection 1: the board of a company that is satisfied on reasonable grounds that the company will, immediately after the distribution, satisfy the solvency test may, subject to section 53 of this act and the constitution of the company, authorise a distribution by the company at a time, and of an amount, and to any shareholders it thinks fit. 28 as the quote above demonstrates the nz ca gives directors extensive rights to distribute the company’s assets as they see fit without the disposition of shareholders. for the protection of both passive shareholders and creditors, it is understandable that passing the solvency test must be essentially connected to the preparation of a directors’ certificate immediately after the distribution of assets.29 in the certificate, directors must affirm that the statutory solvency test has been satisfied and explain in minute detail the information on which they base their statement.30 failure to provide such a certificate has also been sanctioned.31 under the companies act 1955, which preceded the companies act 1993, the traditional approach to the permanence of a company’s capital did not allow the distribution of dividends from the capital invested in the company. only the company’s cumulative income could be distributed. the system was based on the idea that 26 see christopher i. haynes: the solvency test: a new era in directorial responsibility. auckland university law review 1996, (pp. 126-141), p. 126. (haynes). 27 according to the preparatory work on the new zealand companies act, the solvency test is an essential provision aiming to protect creditors and passive shareholders and may be used to limit the distribution of a company’s funds to shareholders. its purpose is to act as a counterforce to the directors' right to distribute the company's funds as they see fit. see new zealand law commission, report 9, 1989, p. 78. 28 the contents of the provision resembles chapter 13, section 6, subsection 4 of the finnish limited liability companies act, under which shareholders may unanimously distribute the company’s assets as they see fit. nz ca section 52, subsection 1 and the limited liability companies act, chapter 13, section 6, subsection 4 are an accurate description of the systematic differences between shareholders and directors in the two company law systems. 29 see nz ca section 52, subsection 2. 30 see haynes 135-137. 31 see nz ca section 373, subsections 1 and 4. nordic journal of commercial law issue 2008#1 10 companies should have a capital buffer to protect creditors.32 hence the distribution of dividends was completely prohibited if the net assets of the company were smaller than the amount of capital invested in the company by shareholders.33 the structure of the 1955 nz companies act and its doctrine on the permanence of capital, led to a nearly similar result as the finnish limited liability companies act of 1978 and its provisions on the permanence of equity invested in a company. the permanence of capital invested into a company in the form of a subscription price was protected in order to protect the receivables of creditors, and in practice, only unrestricted equity from profit could be distributed.34 the permanence of capital was de-emphasised in the nz ca of 1993 by highlighting instead the importance of the solvency test. as grantham & rickett state, the enactment of the nz ca significantly streamlined the distribution of assets and the requirements for permanence of capital, by allowing the company directors to distribute assets, such as dividends, as they see fit, provided that the company is solvent and remains so after the distribution.35 in addition, the distribution of assets is naturally limited by nz ca, which requires that the value of a company's assets must be greater than the value of its liabilities.36 iii c. comparison the finnish solvency test applies to all distribution of assets, not only the distribution of dividends or capital from the company’s reserve of unrestricted equity. it must be applied e.g. when a company acquires or redeems its own shares or reduces its share capital. however, it is not applied when a company’s assets are distributed in connection with its dissolution.37 one should also note that the application on the solvency test is not limited to situations referred to 32 if shareholders paid a premium exceeding the nominal value in the share subscription, the premium was dealt with similarly to the nominal value in terms of permanence. see also ross, p. 178: “where shareholders paid a premium over par, the share premium was treated as if it were nominal capital.” 33 see grantham & rickett, p. 855. 34 the obligation under the finnish companies act, chapter 13, section 2 to liquidate the company and prevent the continuance of its activity at the risk of the creditors based on the low ratio between the equity and share capital should be considered as a special characteristic of creditor protection in swedish and finnish limited liability company legislation. 35 see grantham & rickett, p. 855. 36 nz ca section 4, subsection 1, paragraph b. 37 in the dissolution of a company, creditor protection is based on the repayment of debts and distribution of assets provided in chapter 20, section 15 of the limited liability companies act. in accordance with the first sentence of the section, once the due date of the public summons to the creditors of a company has passed and all known debts have been repaid, the liquidators shall distribute the assets of the company. pursuant to the third sentence of the section, shareholders shall have the right to a share in the distribution of the net assets of the company in proportion to their shareholding, unless it is otherwise provided in the articles of association. nordic journal of commercial law issue 2008#1 11 in chapter 13, section 1, subsection 1 of the fllca38, but it may also be extended to the distribution of assets of companies with a purpose other than producing profit to company shareholders, as well as to so-called continuous distribution of companies operating on the absorption principle.39 the scope of the solvency test under the nz ca corresponds to the solvency and the balance sheet tests in the fllca, which are applied to all distribution of assets within a company, not only dividends.40 the nz ca solvency test also concerns all distributions. it is also applied when company assets are used to provide financial assistance for purchasing company shares.41 the nz ca defines distribution as the direct or indirect transfer of money or property to, or for the benefit of the shareholder, or the incurring of a debt to or for the benefit of the shareholder.42 this division requires that assets be distributed to shareholders in proportion to the shares they hold. haynes has interpreted the wording “in relation to shares held by that shareholder” rather loosely because channelling assets or financial profit to controlling shareholders based on other than shares held, may be prejudicial to minority shareholders or creditors. haynes has also discussed whether the payment of wages in closely held companies should be interpreted as distribution and thus a measure requiring a solvency test. he concludes that the solvency test should also be applied to the payment of wages, if the company's result is made negative by paying wages to shareholders in the company, especially if the wages differ from market-based wages. 43 the most important creditor protection provision in the nz ca44 is also structurally very similar to the solvency and balance sheet tests of the fllca. both legal systems measure the distribution of assets by the assets indicated in the balance sheet and by the company’s solvency, which measures the financial status at a more general level. one of the essential differences involves the content of the capital system relating to the permanence of assets. according to the fllca share capital credited to restricted equity, and legal and share premium reserves 38 in accordance with chapter 13, section 1, subsection 2 of the limited liability companies act, company funds may be distributed to shareholders only as provided in the act on: 1) the distribution of profit (dividends) and funds from the reserve of unrestricted equity; 2) the decrease in share capital referred to in chapter 14 of the limited liability companies act; 3) the acquisition and redemption of the company's own shares, referred to in chapters 3 and 15 of the limited liability companies act; and 4) the dissolution and deregistration of the company in chapter 20 of the limited liability companies act. 39 see government proposal he 109/2005 vp. p. 124. 40 see new zealand law commission, report 9, 1989, p. 79: “the solvency test is applied in the draft act to all distributions, including share repurchase as well as dividends.” see also ross, p. 177. 41 nz ca section 77, subsection 1. financial assistance granted by a company for buying its own shares is not considered as the company’s assets (receivables) in assessing whether the company passes the solvency test. 42 nz ca section 2, subsection 1, paragraphs a) and b). 43 see haynes, p. 127. 44 section 4, subsection 1. nordic journal of commercial law issue 2008#1 12 pursuant to the finnish limited liability companies act of 1978 may be distributed only by observing a special creditor protection procedure. other items of equity (the valuation reserve, fair value reserve and revaluation reserve) are absolutely undistributable. the nz ca does not divide equity into restricted and unrestricted, but defines company financing in terms of capital invested in the company, assets and liabilities. the application of the solvency test pursuant to the nz ca has caused problems similar to those that must be solved in the application of the solvency and the balance sheet tests in the fllca. according to ross, practical problems are encountered with cash flow timing, the valuation of assets and liabilities, and basing the assessment of solvency on a statutory or other financial statement. the meaning that can be assigned to the opinion of accountants and other professionals on the solvency of the company has also proven problematic.45 iv. the practical significance of the solvency test one of the purposes of the solvency test is to ensure that a company does not distribute its assets in a way that endangers its solvency when it according to the solvency test is possible due to unrealised increases in the value of unrestricted equity. the solvency test limits the abuse of management power and protects creditors.46 the solvency test also avoids the unreliable aspects of the balance sheet test, in relation to e.g. intangible assets, or other goods47 with valuation problems. in new zealand, one of the strongest arguments for adopting the solvency test and abandoning the sole use of the balance sheet test was the difficulty in valuating and representing balance sheet items.48 one incentive to carrying out the solvency test is connecting it to the directors’ potential liability in damages to creditors. if acting in violation of the test is damaging to a creditor, a 45 see ross, p. 180. 46 ”the solvency test --is pivotal to the scheme of the act. it applies to all transactions which transfer wealth from the company to the prejudice of creditors and, where some shareholders only receive benefit, to the prejudice of non-participating shareholders. the test is designed to be a substantial constraint in such circumstances because they are those in which limited liability and management power are most open to abuse.” new zealand law commission, report 9, 1989, p. 78. 47 the preparatory work of the limited liability companies act mentions company acquisitions as an example, where the valuation of balance sheet items may be affected by the commercial value of the company acquired as well as by other possible benefits, such as synergy and economies of scale. see government proposal he 109/2005 vp. pp. 125-126. see also airaksinen, manne & pulkkinen, pekka & rasinaho, vesa: osakeyhtiölaki ii. talentum. helsinki 2007 (airaksinen & pulkkinen & rasinaho ii) p. 20. 48 see ross, pp. 190-191. ross states that in new zealand, company directors may, within the frames of the financial reporting act 1993 and the securities regulations 1993, somewhat freely decide which items should be presented as assets or liabilities in the balance sheet, and which of them may be left out. nordic journal of commercial law issue 2008#1 13 board member or the managing director may be liable in damages for losses.49 shareholders may also be held responsible for any loss that they, contributing to a violation of the act or the articles of association, have deliberately or negligently caused to the company, another shareholder or a third party.50 assets received from the company in contravention of the act or the articles of association are refunded, if the recipient knew or should have known of the violation.51 a member of the board of directors or the supervisory board and the managing director shall likewise be liable in damages for a loss that he or she, in violation of other provisions of the act or the articles of association, has in office deliberately or negligently caused to the company, a shareholder or a third party.52 a key point is that in such cases, a presumption of fault is applied, unless the liable person does not prove that he or she has acted with due care.53 such a situation may be at hand when the distribution of assets has led to insolvency, based on which the company is declared bankrupt and the creditors cannot be fully paid. an essential factor in determining liability, and thus in the application of the solvency test, is what was or should have been known when making the decision to distribute assets. information available for the test based on the course of subsequent events is irrelevant. according to the preparatory work for the fllca, the fact that a company becomes insolvent within a relatively short period of the distribution of assets does not yet indicate that the solvency test was violated.54 the formulation "should have known" contained in the provision should be interpreted similarly to presumption provisions in general. airaksinen, rasinaho and pulkkinen maintain that this expression brings a certain objectivity to the assessment of the situation. if the actor did not know of the insolvency, he or she is not discharged from liability solely on those grounds. instead, what the person in his or her position should have known is also assessed.55 the connection to the duty of care posed in chapter 1, section 8 of the fllca, and the importance of the business judgement-rule seems obvious.56 49 in accordance with chapter 22, section 1, subsection 2 of the fllca. 50 according to chapter 22, section 2, subsection 1 of the fllca. 51 under chapter 13, section 4 of the fllca. 52 according to chapter 22, section 1, subsection 2 of the fllca. 53 under chapter 22, section 1, subsection 3 of the fllca. 54 see government proposal he 109/2005 vp. p. 125. for further information on the definition of the concept of insolvency, see e.g. airaksinen, pulkkinen & rasinaho ii, p. 21 and erkki k. laine: maksukyky uuden osakeyhtiölain mukaan. tilintarkastus 5/2006, (laine 2006) p. 9-14. 55 see airaksinen & pulkkinen & rasinaho ii, p. 22. 56 for more details on the so-called fiduciary duties of management, see mähönen, jukka & villa, seppo: osakeyhtiö i. wsoypro helsinki 2006 (mähönen & villa i) p. 107. nordic journal of commercial law issue 2008#1 14 a similar system is in use in new zealand. according to the nz ca, a distribution made to a shareholder at a time when the company did not, immediately after the distribution, satisfy the solvency test may be recovered by the company from the shareholder.57 however, the shareholder's refund obligation is limited. distributed assets cannot be recovered if a) the shareholder received the distribution in good faith and without knowledge of the company's failure to satisfy the solvency test, b) the shareholder has altered his or her position in reliance on the validity of the distribution, and if c) it would be unfair to require repayment in full or at all.58 pursuant to the nz ca, a director of a company is personally liable to repay the company so much of the distribution as is not able to be recovered from shareholders.59 in addition to the supplementation obligation and liability in damages, company directors may also be sanctioned for violating the solvency test.60 directors in favour of a distribution are liable to a fine not exceeding 5 000 new zealand dollars if they have failed to sign the certificate concerning the solvency test61 or have neglected to state the grounds on which, in their opinion, the company would satisfy the solvency test after the distribution. if a director has signed the certificate fully aware of it being fraudulent or misleading, he or she may be sentenced to a fine of up to 200 000 new zealand dollars or five years of imprisonment. v. how is solvency assessed? v.a. solvency or insolvency? there are at least four key questions related to defining the contents of a solvency test. one must establish, 1) whether it is a question of assessing insolvency or solvency, 2) when the test must be conducted, 3) which information serves as the basis for the solvency assessment, and 4) how far into the future the solvency test must extend. 57 nz ca section 56, subsection 1. 58 haynes considers it difficult to fulfil the refund criteria because fulfilment of paragraph b) requires active measures from the shareholder. see haynes, p. 139. in comparing the national provisions, an interesting observation is that the refund obligation is assessed also on grounds of equity. 59 nz ca section 56, subsection 2. 60 nz ca section 56.2, subsection 2. see also haynes, pp. 126 and 139. 61 in accordance with nz ca section 52, subsection 5: “[t]he directors who vote in favour of a distribution must sign a certificate stating that, in their opinion, the company will, immediately after the distribution, satisfy the solvency test and the grounds for that opinion”. nordic journal of commercial law issue 2008#1 15 even though these questions are seemingly separate and independent of each other, they are nevertheless connected to investigating one and the same matter. therefore, they should also be considered as overlapping and intertwined. in finland, solvency tests must be based on the latest adopted financial statement, which must be evaluated along with other information affecting solvency, taking also into account the business forecasts of the company. the preparatory work on the fllca recognises the difficulty of determining insolvency, and it does not aim for an exhaustive explanation concerning insolvency or the contents of the insolvency test.62 in fact, the questions above cannot be answered unequivocally; they always depend on the context and actors involved. therefore, the ambiguity of the concept of solvency and the open-endedness of the solvency test are susceptible to criticism. interpretative guidance can only be obtained from subsequent legal practice. pursuant to nz ca63, a company is solvent, if it is able to pay its debts as they become due in the normal course of business,64 if the value of its assets is greater than the value of its liabilities. in new zealand, there has been discussion especially concerning the meaning of the phrase "ability to pay debts as they become due" and how company solvency is measured. haynes has analysed legal cases, and based on them, listed five points which may be of assistance in interpretation. first, it is imperative to assess solvency based on the date of payment and to some extent also on the recent past and near future. second, attention should be paid to the total amount of debts. third, the date of payment refers to liabilities becoming legally due. fourth, assets must be assessed base on their liquidity, and lastly, the solvency test must be carried out objectively. however, mike ross maintains that the test focuses on estimating future cash flows. nonetheless, there are no guidelines on how far into the future the directors should gaze, but the directors make the decision based on their ability to evaluate the company's business activities and solvency in a professional manner.65 insolvency in the fllca is not the same kind of insolvency that is referred to in, for instance, the finnish act on recovery to an estate in bankruptcy.66 nonetheless, interpretation of the 62 see government proposal he 109/2005 vp. pp. 125-126. 63 nz ca section 4, subsection 1, paragraph a and b. 64 the sentence has been interpreted as meaning that the company must be able to pay its debts as they become due from the viewpoint of normal business activities. the payment of debts that are not expected to fall due does not need to be taken into account in the test. see haynes, p. 130. 65 as the assessment period for cash flows, ross recommends the business cycle following the date of comparison, which most likely means the planning period for the following financial period. see ross, p. 182. naturally, the planning may focus on a period other than the financial period. 66 finnish act on recovery to an estate in bankruptcy (758/1991). nordic journal of commercial law issue 2008#1 16 concept may be aided by other provisions which contain the concept of insolvency.67 one should, however, bear in mind in the interpretation that the fllca refers not only to the assessment of insolvency, but also that of future solvency. the concept of insolvency adopted in the act on recovery to an estate in bankruptcy should therefore not be applied as such to company law and in particular to the distribution of assets, because the fllca constitutes special legislation in relation to the act on recovery to an estate in bankruptcy.68 the interpretative rule of lex specialis thus governs; a general law can only be used to the extent the specialized law is silent. v.b. when should solvency be assessed? insolvency should be assessed at the moment assets are distributed, or at least as close to it as possible.69 “assets shall not be distributed, if it is known or should be known at the time of the distribution decision that the company is insolvent or that the distribution will cause the insolvency of the company.” the chosen wording supports the interpretation that the test should be carried out as close as possible to the actual distribution decision. it is common company practice that the directors carry out the test in connection with proposing a distribution to the general meeting. on the other hand, it is the duty of the board of directors to implement the decisions of the general meeting, and the directors may not comply with a decision by the general meeting or the board of directors which is contrary to the fllca or the articles of association. such decisions are inherently void, and thus the board of directors must always verify that any decision it makes on the distribution of assets is, in fact, in accordance with the fllca even at the time of implementation.70 if the board of directors observes that the solvency of the 67 the concept of insolvency can be found at least in the bankruptcy act (120/2004), the penal code (39/1889), the restructuring of enterprises act (47/1993), the execution act (37/1895), the pay security act (866/1998) and the act on financial supervision (587/2003). erkki k. laine has analysed the contents of the concept of insolvency based on legislation. see erkki k. laine: maksukyky uuden osakeyhtiölain mukaan. tilintarkastus 5/2006 pp. 8-17 (laine). 68 see airaksinen, pulkkinen & rasinaho ii, p. 23 and especially ahti kaarenoja & seppo suontaus: maksukyvyttömyys ja osakeyhtiön varojenjako. defensor legis 2007, pp. 239-256 (especially pp. 246-248). (kaarenoja & suontaus 2007). 69 see government proposal he 109/2005 vp. pp. 125-126. 70 the prohibitive provision in the limited liability companies act, chapter 6, section 2, subsection 2 concerns all decisions made by the company’s organs that require implementation measures. before implementation, the board of directors or its individual members have the duty to examine whether the decision is legal in both form and content. if the decision to be implemented is in violation of the limited liability companies act or the articles of association, and thus invalid, the board of directors shall not comply with it. nordic journal of commercial law issue 2008#1 17 company has decreased to the extent that there is a risk of insolvency, if the decision is implemented, the board of directors71 is obligated not comply with the decision.72 the duties of the board of directors are not affected by whether the company was solvent at the time of the distribution decision but insolvent at the time of implementation, or whether the board knew or should have known that a distribution would lead to insolvency. the board of directors is considered to have a constant obligation to update and examine the solvency test as it implements the general meeting decision.73 similarly, the director is always responsible for performing the solvency test and it applies to all distribution of assets in new zealand. the directors must also prepare a certificate regarding solvency74 when it distributes the company’s assets.75 v.c. what information serves as the basis for the assessment? the assessment of solvency should be based on all available information on the company’s financial status. thus, it is not merely a question of the latest adopted and audited financial statement, but of all information produced in connection with the company’s business-related information flows, describing and measuring the company's financial status. therefore, it is a question of a constantly augmenting information flow. the latest adopted (and audited) financial statement does, however, play a pivotal role. firstly, it indicates the amount of unrestricted equity which may be distributed.76 secondly, it lists the items related to a company’s solvency, such as the amount, form and type of assets, the liquidity of assets, the amount of liabilities and its division into short-term and long-term liabilities. 71 pursuant to chapter 6, section 19, subsection 1 of the limited liability companies act, the same applies to the managing director as to members of the board of directors under chapter 6, section 2, subsection 2 of the same act with regard to invalid decisions. 72 if the solvency of a company is in critical condition and it is not certain at the time of deciding on the distribution of dividends that the company would remain solvent after the distribution, a recommendable measure would be for the general meeting to authorise the board of directors to decide on the distribution of dividends. the board may then schedule the distribution for a time when the solvency test, which is under its responsibility, will indicate that the solvency of the company is sufficient. 73 the same is required if the board of directors distributes assets based on an authorisation from the general meeting. the board must be sure as it distributes assets that the distribution is not in violation of the solvency test pursuant to chapter 13, section 2 of the limited liability companies act. 74 nz ca section 52, subsection 2: “the directors who vote in favour of a distribution must sign a certificate stating that, in their opinion, the company will, immediately after the distribution, satisfy the solvency test and the grounds for that opinion”. 75 this is natural since under nz ca section 52, subsection 1, the board of directors is entitled to decide on distributions as it sees fit: “[t]he board of a company that is satisfied on reasonable grounds that the company will, immediately after the distribution, satisfy the solvency test may, subject to section 53 of this act and the constitution of the company, authorise a distribution by the company at a time, and of an amount, and to any shareholders it thinks fit”. 76 in accordance with chapter 11, section 1 and chapter 13, section 5 of the fllca. nordic journal of commercial law issue 2008#1 18 the solvency ratio may be characterised as a concept describing the financial standing of the company, which cannot be measured with individual parameters. it is described by analysing a combination of several parameters, the nature and conditions of fundraising, the focus and contentual quality of the use of funds. based on this overall analysis, a company can be declared solvent, or certain financial measures involving the company, such as selling shares or changing short-term debts to long-term or lowest priority debts, may be stated to strengthen the company’s solvency.77 solvency assessments based on balance sheets are connected with a company's static solvency. they assess the relation of the company’s short-term liabilities and liquid assets.78 static solvency simply measures whether a company has sufficient liquid assets to repay its liabilities according to its financial obligations timely and in the proper amount as they fall due.79 if the payments cannot be made, the company must be considered insolvent.80 the assessment of solvency based on the company financial statement is tied to the financial status at a specific point in time, when the company's assets and liabilities are compared according to the conditions at that time.81 the point-wise measurement of financial statement information provides information on the recent history, but not necessarily on whether the company is solvent at them moment of measurement or will be in the near future. founding the company’s solvency assessment on static solvency alone is not sufficient. a balance sheet assessment is an examination of a single point in time and therefore does not provide a comprehensive picture on the company’s ability to repay its liabilities. in addition, the assessment should include dynamic solvency. dynamic solvency means that the company has 77 see seppo villa: pääomalaina. a study on company legislation and obligations involving equity loans in finland, jyväskylä 1997, pp. 67-69, which states e.g. that assessments of a company's solvency should be understood as tools provided by business studies that investigate financial operation. these tools provide further grounds for decisions concerning a company's financial, investment or other decisions. 78 traditional solvency parameters include the quick ratio (liquid assets/short-term debts), the current ratio (current and liquid assets/short-term debts) and the amount of liquid assets. comparing the proposed distribution of dividends to liquid assets is one way of documenting the maintenance of solvency after the distribution. however, all of the above-mentioned parameters are static, balance sheet based parameters tied to a specific point in time. as mike ross states: “financial ratios are of limited benefit in assessing future solvency because they are based on historical data. --nevertheless, they are widely used by financial institutions and security analysts, in the absence of any alternative. they reflect a company’s ability to pay debts as they fall due in the normal course of business out of working capital”. ross, p. 184. 79 erkki k. laitinen considers that a company’s insolvency means the company’s inability to repay its financial obligations as they become due. erkki k. laitinen: yrityksen maksukyvyttömyyden arvioiminen taloustieteen näkökulmasta, lakimies 1996, p. 1169. see also yrjö tuokko: maksukyvyttömyydestä ja pysyvästä maksukyvyttömyydestä. defensor legis 1995, p. 290. 80 for further information on the contents of the concept of insolvency, see kaarenoja & suontaus 2007, pp. 239-256. 81 see e.g. risto koulu: yrityssaneerausmenettelyn aloittaminen. vammalla 1994, p. 239. nordic journal of commercial law issue 2008#1 19 sufficient revenue to pay its current expenses. in the words of ross: “there must be sufficient cash available to meet the company’s existing commitments.”82 the going concern in a company is based on positive cash flow, which may consist of both the capital investments received by the company and funds generated from operations. solvency should be at a level that allows the company to repay its financial obligations in both the short and the long term. a key criterion in assessing a company’s solvency and maintaining it regardless of distributions, is the company’s cash flow forecasts, which take into account future revenue and payments that are based on both cash flow and capital financing.83 in carrying out the assessment, one should, however, bear in mind that the assessment is connected to future events, which are liable to change. since the solvency test under the fllca has an element focused on the future, it is somewhat difficult to assess how and to what extent the company management should be able to assess future solvency. the third sentence of chapter 13, section 3 of the fllca requires that essential changes in the financial position of the company after the completion of the financial statement shall be taken into account in the distribution. naturally, these changes will not be indicated in the latest financial statement, which means that other tools must be used. as the company’s profitability affects both solvency and cash flow; low profitability is a strong indicator that the company's solvency at the moment of distribution and in the future must be determined using other tools. in their publication on insolvency and the distribution of assets in a limited liability company, kaarenoja and suontausta come to the conclusion that a distribution proposal should be based consistently on reports on the current status and future forecasts.84 dividends that have not been distributed, but have fallen due according to a decision by the general meeting can be credited as the company’s debt to shareholders. however, the financial nature of the dividends will not take on the financial nature of debt, which could be paid without regard to the solvency test. however, this kind of situation has its problems. the normal financing of a company entails that the distribution of dividends can also be financed by new debt. in such cases, of course, cash flow forecasts must be updated to include the repayment and interest on the new loan in order to show that the company has maintained its solvency despite the additional debt. accordingly, the board of directors must, make sure that they do not compromise the solvency of the company, because the company must remain 82 ross, p. 183. 83 kaarenoja and suontaus conclude that the essential going concern and solvency assessment criterion are the company’s cash flow forecasts. see kaarenoja & suontaus 2007, p. 256. 84 see kaarenoja & suontausta, p. 255. in an uncertain situation, the board of directors should carefully examine the current status of the company: assess the static and dynamic solvency. in addition to the current state, the directors should sufficiently forecast future trends. nordic journal of commercial law issue 2008#1 20 solvent both when a decision to distribute dividends is made and when dividends-based liabilities are repaid.85 obviously, the fllca does not specify how the company management should determine that the company is and will remain solvent after a distribution decided on by the management.86 it is up to the company management to decide how it carries out the solvency test related to the distribution of assets. the key point is that management is aware of its responsibility to conduct the test and understands that neglecting to perform it, or performing it without due care, may lead to personal liability for damages. the fllca, chapter 1, section 8, lays down a duty of care and loyalty.87 management is required to act with due care in performing the solvency test, which may in practice be assessed to the extent required by the business judgement rule88. the way how the solvency test is carried out is also affected by the presumption of fault in the fllca.89 a loss shall be deemed to have been caused negligently, insofar as the person liable does not prove that he or she has acted with due care.90 similarly, the company management must base the solvency test on the company’s most recent financial statements in new zealand and they may rely on valuations of assets or estimates of liabilities therein. in addition to the information in the balance sheet, the directors must take into account all other circumstances that they ought to know of91 and that affect or may affect the amount of the company’s assets or liabilities. the liabilities also include contingent liabilities.92 in the assessment of balance sheet-based information, the completion of the nz ca solvency test does not differ from the solvency and balance sheet tests under the fllca. the assessment must take into account the operation of the company: 85 in accordance with chapter 1, section 8 of the fllca. 86 see also airaksinen & pulkkinen & rasinaho 2007, p. 23, which states that the provision lays down no requirements that the board of directors or the general meeting should prepare e.g. a statement on the sources and uses of funds to support the distribution unless there are special grounds for it. special grounds might include low profitability, or a poor financial standing or result, or the management knowing that the company may have difficulties in repaying liabilities due in the near future in the proper amount and time. 87 for further information, see e.g. mähönen & villa 2006 i, p. 107. 88 see mähönen & villa 2006 i, pp. 112-115, and in this connection especially kaarenoja & suontausta, pp. 254-255. 89 under chapter 22, section 1, subsection 3 of the fllca. 90 for further information on the presumption of fault, see e.g. mähönen, jukka & villa, seppo: osakeyhtiö iii. corporate governance. wsoypro. helsinki 2006, p. 290. (mähönen & villa 2006 iii). 91 in accordance with nz ca section 4, subsection 2, paragraph a, subparagraph i, and with section 4, subsection 2, paragraph b. similar to the formulation of chapter 13, section 2 of the limited liability companies act: “is known or should be known at the time of the distribution decision”. the provision requires careful consideration and a “professional” approach to the assessment of the company’s financial status. 92 nz ca section 4, subsection 2, paragraph a, subparagraph ii. nordic journal of commercial law issue 2008#1 21 1) whether the assessment is carried out with an eye on the “going concern” situation or the dissolution of the company, 2) whether the cash flow of the company consists of the employees’ work contribution when the balance is low, and 3) whether balance sheet items have special financial characteristics.93 especially the financial characteristics may be connected with e.g. the valuation of subordinated loans and taking into account contingent liabilities. the nz ca specifically requires that the solvency test must take into account, not only items in the most recent financial statement, but also contingent liabilities on the company's financial status. the assessment of the value and liquidity of assets and due debts is obviously difficult and tied to each assessor's subjective views. in conducting the solvency test, the management may use financial material produced by the company itself. in addition they may use assessments on the company’s solvency at the time of distribution, and in the future, from financial advisers and persons responsible for budgeting and reporting. nz ca section 138 specifically secures the right of the management to rely on financial data and statements supplied by outside financial advisers, such as: a) an employee of the company whom the director believes on reasonable grounds to be reliable and competent in relation to the matters concerned: b) a professional adviser or expert in relation to matters, which the director believes on reasonable grounds to be within the person's professional or expert competence. this kind of information is acceptable for the purposes of conducting the solvency test on the condition that the directors act in good faith, make proper inquiry where the need for inquiry is indicated by the circumstances, and have no knowledge that such reliance is unwarranted. in addition, the directors’ general duty of care in handling company affairs is applicable.94 a director may avoid personal liability if he or she has; taking the conditions into consideration, relied on information supplied by a reputable adviser and has had no reason to suspect that the information is fraudulent. the use of an outside adviser does not, however, absolve the management from responsibility, but it does have weight in evaluating whether a director has acted with due care. 93 see haynes, pp. 131-132. 94 nz ca section 137, subsection 1 provides the general duty of care of management. the provision states the following: [a] director of a company, when exercising powers or performing duties as a director, must exercise the care, diligence, and skill that a reasonable director would exercise in the same circumstances taking into account, but without limitation a) the nature of the company; b) and the nature of the decision; and c) the position of the director and the nature of the responsibilities undertaken by him or her. this is similar to the limited liability companies act, chapter 1, section 8, under which the company management shall act with due care and promote the interests of the company. nordic journal of commercial law issue 2008#1 22 vi. certificate on satisfying the solvency test the nz ca is dispositive, and it provides management with an extensive authority to, for instance, distribute company assets. thus, it is understandable that special attention has been paid to the lawful distribution of assets. one such feature, with no equivalent in the fllca, is the obligation of directors, who vote in favour of a distribution, to provide a certificate concerning the solvency test.95 the certificate must state that, in the opinion of the undersigned, the company will, immediately after the distribution, satisfy the solvency test in terms of amount of net assets available and liquidity.96 in addition, the certificate must state the grounds for the opinion of the undersigned. failure to provide such a certificate is sanctioned.97 according to haynes, the fulfilment of the balance sheet and liquidity tests required for the solvency test must be presented separately. he also maintains that the certificate should indicate that the conclusions were drawn on reasonable grounds after detailed consideration. in haynes’ opinion, the certificate should include at least the directors’ 1) estimation on by how much the company's assets exceed its liabilities, 2) statement that nothing has occurred after the latest financial statement that would obligate changing the financial status indicated in the financial statement, 3) report that the financial statement was analysed with care, taking into account all of the known valuation questions involving the assets and liabilities in the balance sheet, 4) report on adviser statements on ambiguous valuation questions, 5) account on the essential risks involved in the company's activity and financial status, 6) account on the reasonable grounds for the directors' assessment, 7) account on whether the company is able to repay its liabilities as they fall due in the normal course of business, and 8) account on the company's contingent liabilities and their assessment methods. 98 vii. conclusions after comparing the solvency and balance sheet tests of the fllca to the solvency test under the nz ca, it can be concluded that they are very similar, despite minor substantive differences. in comparing the two, it is especially notable that the capital systems pursuant to 95 the directors may sign the same certificate or separate ones in the same terms (nz ca section 394). 96 in accordance with nz ca section 52, subsection 2. 97 see nz ca section 52.5, subsection 2. 98 see haynes, pp. 135-136. nordic journal of commercial law issue 2008#1 23 the nz ca and the fllca have some structural differences. no minimum amount is set for share capital, nor are assets divided into restricted and unrestricted equity in the nz ca, as they are in the fllca. a significant difference between the systems is that the board of directors is authorised to distribute company assets to shareholders as it sees fit and to the extent it considers appropriate in new zealand. in both systems, the tests apply to all distribution of assets – that is, the distribution of profit or repayment of capital invested in the company. as a condition for the distribution of assets, the systems specify that the latest adopted financial statement must indicate that the company does, in fact, have assets that it can distribute to shareholders. the nz ca specifically requires that distributions must be based on the latest financial statement, which has been drawn up in accordance with legislation in force concerning financial statements.99 according to the fllca100, distributions must be based on the latest adopted financial statement, and the company must select an auditor and the financial statement must be audited.101 the nz ca, the distribution of assets presupposes that the company's assets exceed its liabilities, and the fllca presupposes that the company has unrestricted equity for the distribution without resorting to the creditor protection procedure. the rather modern solutions in the nz ca of 1993, which largely resemble the american model business corporations act (mbca), aim to ensure, firstly, that only assets that exceed the amount of liabilities are distributed, and secondly, that the company maintains its solvency despite the distribution.102 in the measurement or assessment of company solvency, there are no significant differences. satisfying the tests presupposes that the company is, despite the distribution, able to repay its liabilities in the proper amount as they fall due. in both systems, conducting the test is the management’s responsibility. fulfilling the requirements of the tests includes that the management must assess not only the solvency at the 99 in accordance with the financial reporting act, section 10 (obligation to prepare financial statements): (1)the directors of every reporting entity must ensure that, within 5 months after the balance date of the entity or, where the entity is required by any other act to prepare financial statements or accounts within a shorter period after the end of its financial year or balance date, within that period, financial statements that comply with section 11 of this act are: (a) completed in relation to the entity and that balance date; and (b) dated and signed on behalf of the directors by 2 directors of the entity, or, if the entity has only 1 director, by that director. (2) the directors of every exempt company must ensure that within 5 months after the balance date of the company or, if all the members or shareholders of the company agree, within 9 months after the balance date of the company, financial statements that comply with section 12 of this act are: (a) completed in relation to the company and that balance date; and (b) dated and signed on behalf of the directors by 2 directors of the company, or, if the company has only 1 director, by that director. 100 chapter 13, section 3 of the limited liability companies act enters into force in this form on 1 july 2007 (see 461/2007). 101 if so provided in the fllca or the articles of association. 102 in this respect, the solvency test also satisfies the requirement under article 15, paragraph 1, subparagraph a of the second company law directive that only net assets may be distributed. nordic journal of commercial law issue 2008#1 24 moment of distribution, but the effect of the distribution on the company's financial status in the near future, by taking into account the repayment of liabilities to interest groups. the nz ca requires that the solvency test be applied also to the company’s obligation to distribute dividends to holders of preferred shares. the systems differ especially in that the directors are required to sign a certificate stating that the company has satisfied the solvency test under the nz ca. the certificate is the directors’ assurance to interest groups on the fact that the company is and will remain solvent despite the distribution. the certificate must also state the grounds on which the directors consider the solvency test satisfied. the fllca solvency test may be criticised of an ambiguous content and of providing insufficient information on how solvency should be assessed. in addition, interest groups do not, in the absence of specific provisions obligating the company thereto, receive information on whether the test has been carried out, how, and based on what information. requiring a certificate or assurance similar to the one under nz ca, would undoubtedly improve the position of interest groups and their possibilities to consider their own risks in relation to those involving the company. the adoption of this kind of a provision must be considered recommendable de lege ferenda as a factor that strengthens legal certainty. haynes aptly comments on the connection between the liberalisation of company legislation and the solvency test: ”while directorial freedom is expanded under the regime, the solvency test operates as a significant restriction, enhancing scrutiny of directors’ activities and providing greater transparency of company distributions”.103 however, the importance of the solvency test should not be overemphasised. the provision in chapter 13, section 2 of the fllca is to be applied similarly to other provisions in the act. for instance, if a company becomes insolvent relatively shortly after a distribution, it does not necessarily mean that the test was not carried out with due care or was neglected completely, since it is common knowledge that business involves both known and hidden risks. thus, the management is not expected to foresee “a bolt out of the blue”, and the provision should not be applied as an afterthought. although "reasonable grounds" should, in principle, be interpreted objectively, it involves a subjective element that concerns each actor, according to which a director is not responsible for what he or she did not or was not expected to know.104 103 haynes, p. 141. 104 see haynes, p. 138. microsoft word kyllonen_sanna.doc nordic journal of commercial law issue 2010#1 the legal framework for the responsibility of international organizations by sanna kyllönen nordic journal of commercial law issue 2010#1 1 i. introduction when states cooperate in order to form an international organization, they authorize it to have the power to perform certain functions with legal consequences. while performing these functions, an international organization may incur responsibilities to third parties. these third parties may be states, other organizations, individuals or legal persons. all the different possibilities regarding the status of the third party cause situations that differ greatly from each other. the main rule is that international organizations are responsible for the consequences of the acts performed by them.1 the capacity of international organizations to be held responsible under international law corresponds to their respective capacities to operate under international law. the responsibility of international organizations varies according to the scope of their legal personality. the responsibility will depend on their legal status vis-à-vis both member and non-member states, and will differ from organization to organization.2 with the increasing number of international organizations executing tasks with highly injurious potential, the responsibilities need to be defined clearly. the efforts to provide international organizations with the status of international legal subjects with a responsibility of their own have proved only partially successful. the law on the responsibility of international organizations is unclear.3 the two principal aims of the law of international responsibility in both domestic common law and civil law systems are: i) to prevent or minimize breaches of obligations prescribed by law; and ii) to provide remedies for those subjects whose legal rights have been infringed due to such violations. a general examination of the evolution of the law in both international and national systems in recent decades shows a change of perspective. there used to be a tendency to stress the limitations of the obligations of the potential wrongdoer, but the emphasis has shifted and now tends to be on the rights of the injured parties.4 1 amerasinghe, c. f.: principles of the institutional law of international organizations, cambridge university press, united kingdom 2005, p. 408. 2 ginther, konrad: international organizations, responsibility, in: r. bernhardt (ed.), encyclopedia of public international law, volume ii, north-holland 1991, p. 1336. 3 ginther (1991) p. 1339. 4 hirsch, moshe: the responsibility of international organizations toward third parties: some basic principles, martinus nijhoff publishers, dordrecht 1995, p. 8. nordic journal of commercial law issue 2010#1 2 recently, international organizations in general and the united nations (un) in particular, have been placed under greater scrutiny.5 it is also noteworthy that the obligations of international organizations towards their member states have recently received some attention especially with regard to international financial institutions, such as the international monetary fund and the world bank.6 in academia, this shift towards a more critical approach is reflected in the decision of the international law association (ila) to create an international research committee on the 'accountability of international organizations'.7 the current possibilities to bring international organizations to account for their actions are limited when compared to existing possibilities with respect to states. in the absence of effective legal remedies against international organizations directly, attempts to file claims against member states continue. the view of many international law experts is that member states of an international organization do not incur legal responsibility for the acts of the organization by virtue of their membership in it. however, some writers accept that member state responsibility might be in order, if effective remedies against international organizations are lacking.8 two basic questions are raised. whether and under what conditions are international organizations obliged to comply with obligations under international law? what are the legal consequences of non-compliance, in particular regarding the responsibility of international organizations for damage caused in violation of the above-mentioned obligations? in theory, four alternatives can be offered as answers to these questions. the answers have also partly been followed in practice: i) only the member states are held responsible, be it jointly, or severally and jointly; ii) the organization and the member states are held severally and jointly responsible; 5 wilde, ralph: enhancing accountability at the international level: the tension between international organization and member state responsibility and the underlying issues at stake, 12 ilsa journal of international & comparative law, 395 – 415, spring 2008, p. 399 and international law association, final report of the committee on the accountability of international organizations (2004) and resolution no. 1/(2004) both available at http://www.ila-hq.org/en/committees/index.cfm/cid/9 (last visited on 11 march 2010). 6 darrow, mac: between light and shadow: the world bank, the international monetary and international human rights law, hart publishing, oxford/oregon 2003, p. 132 an interesting curiosity about the world bank is that it has established an inspection panel. the purpose of the panel is to make sure that the bank is acting in compliance with its own operational policies, i.e. not with obligations arising from general international law. the inspectional panel is an internal organ of the world bank and can only recommend an investigation on other measures. for more on the topic, please see shihata, ibrahim f.i.: the world bank inspection panel: in practice, oxford university press, 2000, p. 56 and roos, stefanie-ricarda: the world bank inspection panel, max planck united nations law yearbook 5, pp. 479-521, 2001, p. 482. 7 wilde (2008) p. 399 and international law association, final report of the committee on the accountability of international organizations (2004) and resolution no. 1/(2004) both available at http://www.ilahq.org/en/committees/index.cfm/cid/9 (last visited on 11 march 2010). 8 wilde (2008) pp. 400-401. nordic journal of commercial law issue 2010#1 3 iii) the organization is held primarily responsible and the member states only secondarily responsible; or iv) the international organization is held exclusively responsible.9 the aim of this article is to examine the responsibility of international organizations, from a procedural perspective as a contextual perspective. it touches upon the question of member state responsibility and the phenomenon of 'piercing the corporate veil'.10 four concrete steps of improvement, which could be taken in order to improve the situation regarding international responsibility and to increase accountability, are proposed. ii. the legal foundation for international organizations 2.1 constituent documents the basis of the legal order of an international organization is its constituent document. the constituent document, the constituent treaty, represents the top of the hierarchy of legal rules of the international organization.11 the constituent treaty differs from international treaties in general. for example, the purpose of constituent treaties is to create a new subject of law, which possesses certain autonomy. the constituent treaty forms the backbone of the international organization and aids in the process of identifying and organizing the competences of the organization.12 the constituent treaty determines the legal nature of the instruments of an international organization, and the ways those instruments are created. however, the constituent treaty may be too vague or even if it is clear (as the treaty of rome), cases, where the instrument does not fit into the scope of the treaty may be presented in practice.13 often the objectives of normative texts are to authorize various bodies, especially international organizations, to contribute to the preservation of a harmonious international order. in this regard, the texts must offer clarity in defining the specific duties and jurisdiction of these bodies in order to avoid any straying from the true objectives of the organization. straying from the 9 ginther (1991) p. 1336. 10 while referring to international organizations, the 'corporate veil' means the same type of limited responsibility of the member states, as exists for the share holders of a limited liability company. 'piercing the veil' -situation thus refers to a situation, where member state responsibility is invoked. 11 schermers, henry g. & blokker, niels m.: international institutional law, kluwer law international, the netherlands 1995, p. 1195, para. 1899. 12 diez de velasco vallejo, manuel: les organisations internationales, economica, paris 2002, p. 107. 13 klabbers, jan: an introduction to international institutional law, cambridge university press, united kingdom 2005, p.197. nordic journal of commercial law issue 2010#1 4 objectives can result in violations of law and cause harm to third parties.14 unsuccessfully directed involvement by international organizations may blur the distinction between their positive value and unreasonable, regulatory involvement that has a negative effect on the international order. that is why the roles of international organizations must be clear. that is also why the normative texts providing the justification and authority for these roles must be as clear as possible. the texts that international organizations themselves produce and apply in the execution of their responsibilities, must also be drafted and interpreted with extreme care, taking into consideration the juridical instruments on which the work relies. these texts provide legitimacy for the acts of the organization.15 the general starting point, when examining issues of responsibility of international organizations is the text of the constituent treaty in each case.16 international organizations can be regarded as subjects of international law. three indicators can be used to define an international subject. the first indicator is whether the subject in question has the right to enter into international agreements. the second is whether it has the right to send and receive delegations, and the third is whether it can file and receive international claims. however, even though an organization would not fulfil one of these requirements, it could still be regarded as an organization, and the list is not a comprehensive description of subjects of international law.17 to be able to attain the aims presented in the constituent documents, international organizations need the attribution of competences, a legal personality, organs and financial and personnel resources.18 in order to operate in the guidelines provided to the international organization, it also needs the capacity to create legal instruments.19 14 araujo, robert john (2005): objective meaning of constituent instruments and responsibility of international organization. in maurizio ragazzi (ed.), international responsibility today, pp. 343 – 353, koninklijke brill nv, the netherlands 2005, p. 346. 15 araujo (2005) p. 347. 16 brownlie, ian: the responsibility of states for the acts of international organizations. in maurizio ragazzi (ed.), international responsibility today, pp. 355 – 362, koninklijke brill nv, the netherlands 2005, p. 359. 17 klabbers (2005) p. 44. 18 colliard, claude-albert – dubouis, louis: institutions internationales, dalloz, paris 1995, p. 172. 19 klabbers (2005) p. 197. note that the generic term ‘instruments’ includes but is not limited to international agreements. it covers also other legal documents, such as rules and decisions, which can also be seen as rather generic categories. the core of the matter is that any problem can be solved provided that the right tools exist, and by the term ‘instruments’, it is meant to express that international organizations need the capacity to create these tools. nordic journal of commercial law issue 2010#1 5 2.2 international legal personality the notion of 'legal personality' is originally a concept of private law. it was designed to enable a group of persons to function as an autonomous entity in pursuit of a certain goal. the legal personality of these entities is derived from the individuals who form the entity. therefore, the theoretical distinction sometimes made between original and derivative legal persons was born.20 the international legal personality of an international organization means that it possesses rights, duties, powers and liabilities distinct from its members or its creators on the international plane and in international law. the question what these powers are, is a harder one to answer, as the international legal personality is rarely explicitly mentioned in the constituting acts of organizations.21 unlike most domestic legal orders, international law does not have a code or a statute, which contains the requirements for obtaining legal personality or capacities that result from it.22 the international personality of international organizations has evolved, and it can be said that they have a legal personality that is distinct from their member states. the organizations not only have the capability to possess rights or obligations in international relations, but also when they operate in the territory of a state.23 the fact that little doctrinal work on the subject of the legal personality of international organizations has appeared after the beginning of the 1970s, may be seen as evidence of the fact that the international system has evolved to a point where the legal personality of international organizations as such is no longer an issue.24 2.3 domestic legal personality every domestic legal system is free to develop its own requirements for a legal personality to exist. this does not mean that these various differing requirements would be unrelated. many constituent treaties of international organizations also have provisions regarding their legal 20 muller, a.s.: international organizations and their host states, aspects of their legal relationship, kluwer law international, the netherlands 1995, p. 72. 21 amerasinghe, c.f.: local remedies in international law, cambridge university press, united kingdom 2004, p. 78, 22 muller (1995) p. 72. 23 diez de velasco vallejo (2006) p. 14. the articles of the constituting acts of certain international organizations defining the international legal personality: european community (ec) art. 281; european coal and steel community (ecsc) art. 6; united nations educational, scientific and cultural organization (unesco) art. xii; world meteorological organization (wmo) art 27; international maritime organization (imo) art. 49; organization of american states (oas) art. 139. articles defining the domestic legal personality: un art. 104; ec art. 282 indian ocean commission (ioc) art. 3.2. 24 muller (1995) p. 73. nordic journal of commercial law issue 2010#1 6 personality under the domestic law of their member states. these provisions, naturally, can only affect the organization’s position within its member states – states that are not members define the legal status of the organization in accordance with their national law. this often depends on the government's opinion regarding the organization’s status in general – whether it has recognized the organization or not. the domestic legal personality of an organization may extend to its various organs, and even its subsidiary bodies.25 the acquisition of legal personality under international law does not depend on the inclusion of a specific provision in the constituent instrument. however, all the better if such a provision can be found, as, for example article 104 of the united nations charter, which reads as follows: “the organization shall enjoy in the territory of each of its members such legal capacity as may be necessary for the exercise of its functions and the fulfilment of its purposes.” the purpose of this type of provision in the constituent instrument or the headquarters agreement is to impose on the member states or the host state an obligation to recognize the legal personality of the organization under national law. 26 in addition to the constituent treaty, a particularly important source for answers regarding the domestic legal personality of an international organization is the headquarters agreement, concluded between the organization and the host state. this agreement determines the immunities and privileges of the organization and creates a particular legal status that derogates from the automatic application of national law.27 on the international level there are two ways to lay down the parameters for the national legal personality of international organizations. firstly, there are those provisions that state that the organization: shall enjoy in the territory of its member states 'the legal capacity necessary to exercise its functions'. this is a functional description of the concept. the second way explicitly indicates what capacities the national legal personality includes. according to one 'model description', the international organization shall have the capacity to: i) contract; ii) to acquire and dispose of immovable and movable property; and iii) to institute legal proceedings. there is no substantial difference between the two abovementioned ways of determining domestic legal personality, although both organizations and states tend to prefer one of the two.28 25 klabbers (2005) pp. 49-52. 26 see official records of the general assembly fifty-eight session, supplement no. 10(a/58/10) (2003) pp. 29 – 54, report of the international law commission (ilc), 55th session (5 may – 6 june and 7 july – 8 august 2003) p. 41. 27 colliard – dubouis (1995) p. 174. 28 muller (1995) pp. 89-90. muller presents as an example the fact that financial institutions seem to have a preference for the model description. nordic journal of commercial law issue 2010#1 7 2.4 attributed, implied and inherent powers in order to be able to operate, international organizations need legal competence, i.e. legal powers. the possible origins of this competence or these powers are not as clear as their necessity. the debate between attributed, implied and inherent powers is interesting, and as it is necessary to know what exactly the existing powers are for us to be able to define an act beyond these powers, the three possibilities of origin are shortly presented below. attributed powers basically mean that international organizations are only authorized to do things they are empowered to do. the principle of attribution faces at least two problems. firstly, the whole idea of creating international organizations loses ground, if these organizations are nothing more than spokespersons of their member states. the second problem relates to the fundamental idea of an international organization. as they are considered dynamic and living creatures that are in constant development, their founding members can hardly envisage their future completely. this creates a major practical problem, if attributed powers are considered the only powers an organization can have.29 the doctrine of implied powers was first developed in order to solve the division of power between central government and local authorities in the context of federal states. there are two ways in which implied powers can be considered to exist. the first way supposes that implied powers flow from a rule of interpretation that treaty rules must be interpreted so as to guarantee their fullest effect. the second version suggests that a power is implied in the functions and objectives of the organization. the latter version has been criticised, but is often thought to have prevailed.30 as both of the above-mentioned doctrines have their problems, a third one has been presented. according to the third alternative, established organizations would possess inherent powers to perform all those acts, which they need to perform in order to reach their goals, simply because they are inherent in being an organization.31 usually, when important powers, as in the above-mentioned situations, have been attributed to international organizations, parliamentary and judicial organs have also been established. these structures are needed to provide necessary checks and balances.32 29 klabbers (2005) pp. 63-67. 30 klabbers (2005) pp. 67-73. 31 klabbers (2005) p. 75. 32 schermers – blokker (1995) p. 1193 para. 1897. nordic journal of commercial law issue 2010#1 8 iii. governing laws and supervisory mechanisms 3.1 the governing law the law governing the relations between international organizations and states is generally international law. therefore, in states’ relations with organizations as members the constituent instrument would basically be applicable as an international treaty, subject to international law. there may also be relationships between states and organizations which involve separate agreements governed by international law. examples of these agreements would be headquarter agreements and peacekeeping agreements.33 however, there may be direct relations between international organizations and states, which are governed by national or by international law. as an example, the supply of gas or electricity by a state to an international organization will generally be governed by the national law of that state. responsibility of states to international organizations may in the appropriate situation and circumstances, for example, if armed forces or police damage the property of an organization, be governed by international law. the converse situation regarding the responsibility of an organization to a state, may also be governed by international law, for example, when an official of an organization in the performance of his duties damages state property. the ownership of immovable property and the rights and duties relating to it, are generally governed by the national law of the state, where the property is located (lex situs). therefore, the un, the international monetary fund (imf) and the international bank for reconstruction and development (ibrd), for example, have registered the ownership of the buildings they own in the usa in the appropriate registry. it is understood that the consequences of ownership in terms of rights, derive from the national law concerned.34 it must be stated that international organizations also have diverse relations with entities other than states, such as natural persons and corporations, and these relations are governed by either national or international law. there is a wide range of choices regarding the law of contracts or agreements, and if no expressed choice is made, principles of private international law apply to determining the proper law applicable to the contract.35 the mechanisms of bringing international organizations to account for their actions are limited when compared to such mechanisms existing with respect to states.36 a major issue is the question whether and to what extent the application of systems of public order can be evaded by the claim that it was not the member states, but the organization that was involved in the activities concerned. one such case, serbia and montenegro v. belgium concerned the legality of 33 amerasinghe (2005) p. 387. 34 amerasinghe (2005) p. 387. 35 amerasinghe (2005) p. 388. 36 wilde (2008) p. 400. nordic journal of commercial law issue 2010#1 9 use of force. in 2004 three of the respondent states contended at the preliminary objections phase at the international court of justice (icj) that because the north atlantic treaty organization (nato) possesses legal personality, it is the organization and not the individual member states that should bear the responsibility.37 concerning member state responsibility, in the case of waite and kennedy v. germany in 1999, the grand chamber of the european court of human rights (ecrthr), in an article 6 case, observed that: “the court is of the opinion that where states establish international organizations in order to pursue or strengthen their cooperation in certain fields of activities, and where they attribute to these organizations certain competences and accord them immunities, there may be implications as to the protection of fundamental rights. it would be incompatible with the purpose and object of the convention, however, if the contracting states were thereby absolved from their responsibility under the convention in relation to the field of activity covered by such attribution. it should be recalled that the convention is intended to guarantee not theoretical or illusory rights, but rights that are practical and effective. this is particularly true for the right of access to the courts in view of the prominent place held in a democratic society by the right to a fair trial….”38 while the case concerned human rights, the principle applied would seem to be a general one. a state cannot escape responsibility by creating an international organization. it is also clear that responsibility for violations of the european convention on human rights (echr) is itself a form of state responsibility.39 the decisions of deliberative, legislative or executive organs of organizations may need to be interpreted and legally examined either by the organs themselves, by other organs or by international or national tribunals. as an example, the decisions of the general assembly or the security council of the un relating to peace-keeping may fall into this category. in 1982 a resolution of the general assembly relating to the un council for namibia was brought before an organ of the un for interpretation. the legal counsel of the un gave an opinion in which he advised that because the resolution conferred a representative function on the council, it had the power to conclude contracts on behalf of namibia. his opinion was followed.40 37 legality of use of force (serbia and montenegro v. belgium) (2004), judgment of the international court of justice, 15 december 2004. commented by brownlie (2005), see the preliminary objections of france, italy and portugal, available at www.icj-cij.org applications submitted in 1999 (last visited 14 march 2010). 38 see as recent authority, aït-mouhoub v. france (case no 103/1997/887/1099) (28 october 1998, unreported) (p. 52) referring to airey v. ireland (1979) 2 ehrr 305 at 314-315) waite and kennedy v. germany (application no. 26083/94), 118 international law reports (ilr) (2001), 121, at 135 (p. 67). 39 brownlie (2005) p. 361. 40 amerasinghe (2005) pp. 61 and the opinion of the legal counsel of the un of 14 april 1982: united nations juridical yearbook (unjy) (1982) pp. 164-165. nordic journal of commercial law issue 2010#1 10 3.2 supervisory mechanisms 3.2.1 the international court of justice the icj is the principal judicial organ of the un. it is one of the six major organs of the organization and the successor to the permanent court of international justice (pcij) established by the league of nations (ln). the statute of the court is an integral part of the un charter, and as a government ratifies the charter, the ratification includes automatically the acceptance of the statute. however, the compulsory jurisdiction of the court further requires an acceptance by the state41. in addition to hearing contentious cases, the icj is authorized to issue advisory opinions on legal questions. the un charter provides that the un general assembly and the security council may request such opinions and that the general assembly may authorize other organs and the specialized agencies to request opinions on legal questions within the scope of their activities. the economic and social council (ecosoc), the trusteeship council, and all the specialized agencies except the universal postal union have been granted general authority of this kind.42 the icj hears cases that are referred to it by the contending parties. the court may, however, determine that the case, because of its nature, is not subject to judicial determination or that the parties have no legal right to submit the case to the icj. only states are entitled to bring cases before the icj.43 no state is required to submit any case (filed, for example, by another state) for hearing and decision. this lack of compulsory jurisdiction is a major deficiency of the international legal system as contrasted with national legal systems.44 the freedom to choose whether or not the states will submit any particular case for judicial determination is a feature of sovereignty that states refuse to surrender to international authority. after agreeing to submit a case to the court, the state is bound by the principles of international law to accept and carry out the decision, although there is no satisfactory means for enforcement of decisions, and refusal to comply has occurred on more than one occasion.45 article 36 of the statute of the icj includes a partial attempt to overcome the lack of compulsory jurisdiction. the article 36 section 2 provides that any party to the statute may 41 unlike the league arrangement in which the pcij and its membership were independent of the league, bennett, leroy a.: international organizations, principles and issues, prentice-hall inc., new jersey 1995, p. 75. 42 bennett (1995), p. 76. 43 bennett (1995) p. 76 and the statute of the international court of justice, see for example www.icj-cij.org (last visited 14 march 2010). 44 bennett (1995) p. 76. 45 bennett (1995) p. 187. nordic journal of commercial law issue 2010#1 11 declare, that it recognizes as compulsory, in relation to any other state accepting the same obligation, the jurisdiction of the court in all legal disputes concerning: i) the interpretation of a treaty; ii) any question of international law; iii) the existence of any fact which, if established, would constitute a breach of an international obligation; and iv) the nature or extent of the reparation to be made for the breach of an international obligation. article 36 section 2 was an attempt to build a bridge between the principle of sovereignty and that of compulsory jurisdiction. the intention was to open an area in which a degree of international order could be established through the judicial process.46 this 'optional clause' described above has not resulted in the submission of a wide range of disputes over legal questions to the court for settlement. several states have attached reservations to their acceptance of the compulsory jurisdiction of the court. the broadest of these reservations was made by the united states (us) in the connally amendment, which specified that the jurisdiction of the court would not apply to “disputes with regard to matters which are essentially within the domestic jurisdiction of the us as determined by the united states of america”. not only did this reservation practically nullify the compulsory jurisdiction clause by allowing the us to decide unilaterally that any case it wished not to submit was 'essentially' one of domestic jurisdiction, but it also allowed, under the legal principle of reciprocity, any other party to a case involving the us to invoke the same privilege. the jurisdiction of the court in contentious matters is by no means limited to the 'optional clause' of its statute and the voluntary submission of cases by parties to disputes. hundreds of bilateral and multilateral treaties contain clauses agreeing that the parties will submit disputes arising under the terms of each treaty to the icj. the most recent cases submitted to the court have in fact been based on such treaty agreements.47 the reformation of the role of the icj could serve to facilitate the enforcement of international responsibility. in order to achieve this improvement, the international organizations would need to be allowed to become parties to cases before the court. the ila committee acquired detailed proposals regarding the issue, drawn up by one of its co-rapporteurs. the views of the members differed on the substantive merits of these proposals; some members were strongly in favour, as others doubted whether these proposals would prove to be practicable, or even desirable.48 46 bennett (1995) p. 187. as an example, russia has not declared that it recognizes ipso facto the courts jurisdiction in accordance with article 36(2). thus relating to the crisis in georgia in august 2008, georgia had to file a case against russia on the basis of article 36(1), which states that the court has jurisdiction (regardless of a specific declaration by a un member state) in all matters specially provided for in the charter of the un or in treaties and conventions in force. georgia filed an application to the court claiming that russia had violated the provisions of the international convention on the elimination of all forms of racial discrimination (cerd). please see georgia v. russian federation, press release on 12 august 2008 (2008/23), www.icj-cij.org (last visited on 14 march 2010). 47 bennett (1995) pp. 187-188. 48 international law association final report, berlin conference, committee on accountability of international organizations, 2004, p. 49. nordic journal of commercial law issue 2010#1 12 due to their permanent cooperation with international organizations through membership links or otherwise, states have a greater risk than non-state operators of finding themselves opposed to an international organization in a dispute or a difference, but cannot bring a claim against an international organization before the icj as a result of the wording of article 34(1) of the court’s statute. a judicial remedy from the international court of justice for the tortuous and/or organizational responsibility of an international organization might be obtained in either a direct or an indirect way – by allowing more flexibility regarding advisory opinions or by clearly amending article 34(1) to read as follows: “states and international organizations, duly authorized by their constituent instrument, may be parties in cases before the court.”49 3.2.2 internal remedies and national courts exhaustion of local or internal remedies regarding the relationship between states and international organizations (or between international organizations themselves) and in regard to the employment relationship between international organizations and their staff can be discussed. since international organizations are a comparatively recent phenomenon, the rule of local remedies, which has a much longer history than the life of international organizations, cannot be regarded as intrinsic to the law of international organizations. if the rule is to be applicable in any way in this area, it will be by analogy or on the basis that in specific situations it may be appropriate to apply the rule itself or a similar rule in a different form. what must be discussed then is how far the law of international organizations, in terms of its policies and objectives, requires that the rule of local or internal remedies or an analogous rule be applied to certain situations which arise in the functioning of such organizations. the position is somewhat complicated, because there seem to be no judicial decisions or agreed or accepted practice in the area of the relations between organizations and states. in the area of employment relations, on the other hand, the situation is different, as the relevant basic premises are distinct.50 in the case of the relationship between states and international organizations, it is only since the international legal personality of such organizations was formally recognized in the reparation for injuries case51 that the question was seriously asked whether it was proper that the rule of local or internal remedies be applied in that area. the question may be asked both 49 ila final report (2004) pp. 51-52. 50 amerasinghe (2004) p. 366. for an interesting case regarding an employment relationship please see boivin c. la france et la belgique et 32 autres etats membres du conseil de l’europe, (application no. 73250/01, decision only available in french) ecrthr, 9 september 2008. 51 reparation for injuries suffered in the service of the united nations, advisory opinion of the international court of justice, 11 april 1949. nordic journal of commercial law issue 2010#1 13 where the international organization is a claimant on behalf of an individual against a state and where a state claims on behalf of a national or individual against an international organization. a third situation which has involved the exhaustion of internal remedies is where a staff member brings a claim against an organization under the internal law of the organization in regard to his employment relationship. this situation concerns a relationship which is entirely internal to the organization.52 regarding the implementation of responsibility of international organizations, jurisdictional immunity remains a decisive barrier to remedial action for non-state claimants. this could be corrected by the availability of adequate alternative remedial protection mechanisms within international organizations.53 since the reparation for injuries case, it has been established that international organizations such as the un have the capacity at international law to bring claims, particularly against states in situations in which a right relating to a staff member and vested in the organization has been violated. this followed the recognition of the international personality of the un in the same case. after the decision in this case, it was suggested that the rule of local remedies should be applied, apparently without qualification, to claims on behalf of staff members, because it would save the un much trouble and give to the respondent state an opportunity to repair through its own means the injury caused by it.54 in the proceedings before the icj in the reparation for injuries case, the counsel for the secretary general of the un stated that, in the context of claims by the un against states for injuries to its officials, there was ‘room for consideration’ whether the rule of local remedies was applicable. however, in the memorandum of the secretary general to the general assembly, explaining what procedures should be taken pursuant to the case, no mention was made of the rule. consequently, no reference is made to the rule in the resolution of the general assembly dealing with the matter. however, it has been submitted subsequently that, where a staff member of the organization has been threatened with a private nuisance, he or she should first have recourse to local remedies, no waiver of immunity being necessary because the acts are of a private character over which local courts would have jurisdiction in any case. it has also been suggested in this connection that after exhausting remedies a staff member of an international organization should be able to seek the protection of the organization which he serves rather 52 amerasinghe (2004) p. 367. 53 gaillard, emmanuel – pingel-lenuzza, isabelle: international organizations and immunity from jurisdiction: to restrict or to bypass, international & comparative law quarterly (iclq) vol. 51 no. 1 (january 2002), pp. 1-15. cambridge university press, p.2. 54 amerasinghe (2004) p. 367 nordic journal of commercial law issue 2010#1 14 than that of his national state, because of the primary allegiance which he owes to the organization.55 there are several problems connected with the view that the rule of local remedies applies to claims by international organizations on behalf of their staff members. first, it must be recognized that in the reparation for injuries case what the icj acknowledged was that as a result of the fact that international organizations such as the un may carry international responsibility; such organizations had the right to bring claims on behalf of their staff members for injuries suffered in the performance of their official functions.56 the court made a clear distinction between a staff member acting in his official capacity and the treatment of such a staff member in his personal capacity.57 it would seem that where a staff member is injured while performing his official duties, the organization would have the exclusive right of protection. then again, where the injury takes place when he or she is in his private capacity or in his or her private life, his or her national state would have the right of protection. some may believe that it is undesirable that a staff member should have to rely on his or her national state for protection in his private life. however, if he or she is to be able to maintain his or her independence in the performance of his official duties, the better view, in the light of the reparations for injuries case, seems to be that the organization has the right of protection only where the staff member is acting in an official capacity.58 the opposite situation, where the international organization is the respondent in a case involving the protection of a national, raises different problems. the question is whether, where the international organization does provide internal means of settling disputes between such persons and itself, they have an obligation to exhaust such remedies before their national states may exercise diplomatic protection.59 immunity of the un, for example, often sets a barrier for the use of national courts. as an example, a national court in the netherlands declared on 10 july 2008 it had no competence to hear an action instituted against the un. the judgment was delivered in the incidental proceedings in the civil case brought by the association ‘mothers of srebrenica’ and ten individual plaintiffs against the state of the netherlands and the un. the basis of the claim was that the association considered the un and the netherlands to be responsible for the murder of 8.000-10.000 citizens of bosnia-herzegovina in 1995. the association represented the interests of the victims’ relatives. central to the issue of whether a dutch court had 55 amerasinghe (2004) p. 368. 56 amerasinghe (2004) p. 368. 57 amerasinghe (2004) p. 369. 58 amerasinghe (2004) p. 369. 59 amerasinghe (2004) p. 371. nordic journal of commercial law issue 2010#1 15 jurisdiction in this case, was the question whether the case offered grounds or reasons to make an exception to the immunity enjoyed by the un under international law, in accordance with article 105 of the un charter and article ii, paragraph 2 of the convention on the privileges and immunities of the united nations (the privileges convention). the court concluded that in international law practice absolute immunity of the un is the standard and is respected, and that the interpretation of article 105 of the un charter offers no basis for restriction of the immunity of the un.60 3.2.3 arbitral tribunals the final report of the ila in 2004 stated that when concluding agreements with states or nonstate entities, international organizations should continue adding a clause providing for compulsory referral to arbitration of any dispute that the parties have been unable to settle through other means. the report further stated that international organizations should faithfully comply with their undertakings to resort to arbitration procedures.61 when inserting an arbitration clause into treaties concluded between them, states, international organizations and non-state entities should consider the compulsory arbitration provided for in such clauses to be governed by the 1996 optional rules for arbitration involving international organizations, drawn up by the permanent court of arbitration.62 there have been rare cases where international organizations have been reluctant to cooperate with the establishment of an arbitral tribunal. by agreeing to an arbitration clause the international organization waives its right to invoke its immunity before the arbitral tribunal, and this waiver has to be understood as including any means that a party, having accepted the principle of recourse to arbitration, may attempt to invoke in order to hinder the arbitral process.63 3.3 case law 3.3.1 reparation for injuries – a landmark case case law on international responsibility of or to international organizations is scarce. however, established practice since the creation of the ln, which no longer exists, and particularly after 60 please see association of mothers of srebrenica et. al v. the state of the netherlands and the united nations (case number 295247), district court in the hague, the netherlands, 10 july 2008, http://www.haguejusticeportal.net/ecache/def/7/766.html (last visited 23 may 2010). 61 ila final report (2004) p. 49. 62 ila final report (2004) p. 49. 63 gaillard – pingel-lenuzza (2002) p. 13. nordic journal of commercial law issue 2010#1 16 ww ii has rested on certain assumptions. the principal international judicial precedent relating to the subject of international responsibility is the reparation for injuries case64, brought before the icj.65 the advisory opinion of the court was a landmark in establishing the international personality of the un with attendant rights in international law. the icj ruled that the member states in setting up the un intended to confer upon it the capacity to operate on the international plane and to exercise rights and duties necessary to carry out its functions. its privileges are not necessarily identical with those of a state, but the organization must be deemed to have such powers, even if not expressly stated in the charter that are essential to the performance of its duties. this idea is a principle of implied powers that opens the door to a generous interpretation of the prerogatives of international organizations. in reconciling the un’s right to claim damages with the state interest involved, the court advised that neither party has priority and that any conflict of interest might be resolved by accommodation.66 the advisory opinion of the icj on the reparation for injuries case marks the beginning of the judicial recognition that the un has powers other than those expressly conferred by the member states in the constituent treaty.67 3.3.2 westland helicopters ltd. westland helicopters ltd. v. arab organization for industrialization arbitration by the international chamber of commerce (icc) in 1984 and the subsequent appeals in swiss courts are some of the most important cases regarding the responsibility of international organizations with relation to member state responsibility.68 the organization in question here was the arab organization for industrialization (aoi), which was founded by a treaty concluded between the united arab emirates, saudi arabia, qatar and the arab republic of egypt.69on 27 february 1978, westland helicopters ltd. (westland), a company subject to english law, and the aoi concluded a contract called the shareholder agreement, as an aim to create a joint stock company. 64 icj reports (1949) p. 174. 65 amerasinghe (2005) pp. 384-385. 66 bennett (1995) p. 201. 67 martin martinez, magdalena m.: national sovereignty and international organizations, kluwer law international, the netherlands 1996, p. 82. 68 westland helicopters v. arab organization for industrialization and others (international chamber of commerce, arbitral tribunal, case no 3879)), 80 international law reports (1989), (hereinafter westland case, icc (1984) and the subsequent cases in geneva court of justice (switzerland), 23 october 1987 and federal supreme court, switzerland, 19 july 1988. see also international legal materials (ilm) 23 (1984) p. 1071. 69 westland case, icc (1984) pp. 596-603 and hirsch (1995) p. 107. nordic journal of commercial law issue 2010#1 17 the aoi was to have 70 % of the shares and westland 30 %. the purpose of the company, the arab british helicopter company (abh) was to function as the legal base for the creation of a business to manufacture, overhaul, carry out quality control on and sell the lynx helicopters developed by westland. arab emirates, saudi arabia and qatar declared in may 1979 that they wished to liquidate the aoi, a liquidation committee would be set up, and that all investments in the armaments business in question would be discontinued. egypt held that the aoi was still in existence as a legal person. 70in june 1980, an arbitration request was filed by westland against the aoi, the four member states and the abh. westland claimed that the organization and its members were bound to pay under a joint and several liability the sum of 126.000.000 pounds sterling to the claimant. in october 1980, an arbitral tribunal of the icc was constituted.71 in the proceedings the question of member state responsibility arose and the arbitral tribunal concluded that in the absence of any specific provisions the member states were liable for the debts of the organization.72 the ruling was, however, overturned by the subsequent appeals in swiss courts, which found that the arbitral tribunal did not have jurisdiction over egypt in the absence of an arbitration agreement signed by egypt.73 in addition to this, the court of justice of geneva did not agree with the observation of the arbitral tribunal regarding the status of the aoi, and it stated that the aoi was “legally and financially, an organization independent of the founding states”. 74after the court of justice of geneva, the case went to the federal supreme court of switzerland. the federal court upheld the decision of the geneva court and approved its principal reasoning. in the reasoning of the federal court, it placed great significance on the constituent instruments of the aoi.75 in an analysis performed by hirsch, two main points arise regarding both sets of proceedings. in the arbitral award, the two main conclusions were that i) the doctrine of limited responsibility was rejected by the arbitral tribunal and that ii) the reasoning inclines to impose a secondary responsibility on the member states of international organizations. in the swiss courts, the two main principles were that i) the responsibility should be determined almost exclusively in accordance with the constituent instruments and that ii) when the constituent instrument shows that the organization is a legal entity separate from its member states, this separation will exempt the members from responsibility towards third parties.76 70 westland case, icc (1984) pp. 596-603. the details more thoroughly discussed by hirsch, pp. 107-112. 71 westland case, icc (1984) pp. 604-605 and hirsch p. 108. 72 westland case, icc (1984) pp. 600, 613. 73 westland case, icc (1984) p. 641. 74 westland case, icc (1984) pp. 641-646 and hirsch (1995) p. 110. 75 westland helicopters v. arab organization for industrialization and others (federal supreme court, switzerland (1980) 80 ilr, p. 652. 76 hirsch (1995) pp. 111-112. nordic journal of commercial law issue 2010#1 18 3.3.3 the international tin council another strong example of relevant case law in the field is the international tin council litigation in the 1980s.77 the itc was an international organization established by a treaty (the sixth international tin agreement) concluded in 1982 between 23 parties, including the uk and the eec. the agreement stated that the itc has a legal personality and that the executive chairman of the itc is responsible for the administration and operation of the agreement in accordance with the decisions made by the itc.78 the purpose of the itc was to regulate the international tin market, to adjust and balance world production and consumption of tin, and to maintain market prices stable by buying and selling tin on the international markets. due to an unexpected overproduction of tin and financial mistakes, the itc collapsed in 1985 and left behind numerous unpaid obligations. the creditors resorted to litigation mostly in english courts by bringing, inter alia, the claim that there was a subsidiary or complementary liability of member states.79 the main question was, whether the itc was itself alone responsible for the contracts it made or whether the member states were additionally or alone responsible, either as ‘partners’ or as principals of an agent.80 the constitutive treaty of the itc did not provide for any responsibility of the member states, nor was there a clause excluding the responsibility of the member states. the courts examined whether there was a general rule of international law which provided for a secondary responsibility of member states in this case. after thorough and elaborate court proceedings, where the judges reviewed the existing international case law and the writings of leading international law jurists, both the court of appeals and the house of lords concluded that there was no such rule and dismissed the claims.81 the court of appeals held that “nothing is shown of any practice of states as to the acknowledgement or acceptance of direct liability by any states by reason of the absence of an exclusion clause”.82 cases were also brought before the court of justice of the european communities, but were withdrawn before the judgment was rendered. the first question for the court to decide would have been the question of admissibility.83 77 maclaine watson & co ltd. v. international tin council, high court, chancery division, united kingdom 13 may 1987 (no. 2) and 9 july 1987, and court of appeal, united kingdom, 27 april 1988. 78 amerasinghe (2005) p. 410. 79 seidl-hohenveldern, ignaz: piercing the corporate veil of international organizations: the international tin council case in the englich court of appeals, 32 german yearbook of international law, pp. 43-54, 1989, p. 44. 80 lewis, charles j.: state and diplomatic immunity, lloyd’s of london press ltd. 1990, p. 173.. 81 hirsch (1995) pp. 115-121. 82 maclaine watson & co ltd. v. international tin council (no. 2), 80 ilr. pp. 110, 174. 83 hirsch (1995) p. 121. nordic journal of commercial law issue 2010#1 19 after the collapse of the itc the operation of a commodity agreement was added as a new testing ground for the responsibility of international organizations. in the debate on the responsibility of international organizations, the view that international organizations are endowed with an international legal personality, and with a responsibility for wrongful acts towards third parties irrespective of their prior recognition, started gaining ground.84 3.3.4 behrami and behrami v. france and saramati v. france, germany and norway a rather recent and interesting case on the topic was the behrami and saramati case in the ecrthr in 2007. based on the doctrine of attributability, and a movement from 'effective control' towards 'ultimate control', the ecrthr found in the case of behrami and saramati, that the un was itself responsible for the actions of unmik and kfor in kosovo, and not individual states carrying out the operations, and thus the echr could not be applied and the case was inadmissible in the ecrthr.85 the court stated that unmik was a subsidiary organ of the un created under chapter vii and kfor was exercising powers lawfully delegated under chapter vii of the charter by the security council. as such, their actions were directly attributable to the un, an organisation of universal jurisdiction fulfilling its imperative collective security objective.86 this attribution concerning unmik is clear, if we consider, for example the draft articles of the ilc on the responsibility of international organizations. these articles have not, however, been agreed upon by states and therefore are not, as such, binding codification. unmik is a subsidiary organ of the security council, and thus its conduct has to be considered as an act of the un under international law. the court considered the attribution to be possible also with regard to kfor, as a single chain of command ran from the security council through nato down to kfor and the individual national contingents making up the operation87 therefore, the ecrthr concluded that the applicants’ complaints must be declared incompatible ratione personae with the provision of the echr.88 84 ginther (1991) p. 1339. 85 behrami and behrami v. france and saramati v. france germany and norway (hereinafter behrami and saramati), grand chamber of the ecrthr, 2 may 2007, paras. 151-153. 86 behrami and saramati (2007) para. 151. 87 sari, aurel: jurisdiction and international responsibility in peace support operations: the behrami and saramati cases. in 8 human rights law review, pp. 151-170, oxford university press 2008, pp. 163-165 and un document a/62/10 (2007) art. 4 p. 187. the ecrthr has also faced criticism regarding the un’s unified command and control on kfor, whether such effective control actually existed. sari suggests, that the conduct of kfor should have been attributed either to the states contributing personnel to the operation or to nato, or possibly to both. 88 behrami and saramati (2007) para. 152. nordic journal of commercial law issue 2010#1 20 on admissibility grounds, the court removed the saramati application against germany from the docket and declared inadmissible the application of behrami and behrami as well as the remainder of the saramati application against france and norway.89 the reasoning of the court has been criticized for a number of reasons, even though even the critics admit that the applicants’ complaints should have been held inadmissible in any event.90 the most fundamental of these reasons is the ecrthr’s identification of the legal issues raised by the complaints. the ecrthr correctly underlined that one of the legal issues raised by the case concerned the court’s competence to review the conduct of national contributions to kfor and unmik. however, this did not entitle it to disregard whether the applicants came within the jurisdiction of the respondent states as article 1 of the echr presupposes. instead of addressing the issue of a jurisdictional link between the applicants and the respondent states, the court decided to investigate primarily, whether kfor and unmik operated in the framework of chapter vii of the charter, and secondly, whether their acts and omissions could be attributed to the un in accordance with the rules of international law governing the responsibility of international organizations.91 the above-mentioned critique recognizes the fact that the attributability in this case of the relevant acts and omissions to the un demonstrates that the un could in principle incur responsibility for the internationally wrongful conduct of kfor and unmik. however, this responsibility of the un does not exclude the possibility that the same conduct may also be attributable to the respondent states and may engage their international responsibility.92 the ecrthr has used the behrami and saramati cases as precedents regarding similar admissibility issues. this is troubling in light of the enhancement of international responsibility in general, and in taking into consideration the shortcomings of the court in the reasoning of the case.93 89 behrami and saramati (2007) para. 153. 90 sari (2008) p. 166. 91 sari (2008) p. 158. 92 sari (2008) p. 159. 93 the behrami and saramati case has already been used as reference for example in the case of beric and others v. bosnia and herzegovina case in the ecrthr, fourth section, on 16 october 2007, where the court declared the applications inadmissible. another decision of the ecrthr regarding inadmissibility was given in the case of boivin c. la france et la belgique, et 32 autres etats membres du conseil de l'europe (decision only available in french) on 9 september 2008. the court distinguished the case from the cases beer and reagan, waite and kennedy vs. germany, (application no. 28934/95, ecrthr, 18 february, 1999) and bosphorus (bosphorus hava yollari turizm ve ticaret anonim sirketi v. ireland, ecrthr, fourth section 13 september 2001 and grand chamber 30 june 2005), and made a comparison to the situation in the behrami and saramati case to find the case inadmissible. the behrami and saramati case has also been used as reference on the national level, in the case of al-jedda v. secretary of state for defence in the uk house of lords (ukhl) on 12 december 2007. however, reference was not made to find the case inadmissible. in the al-jedda case, the ukhl rejected the argument that the ecrthr used in the behrami and saramati case by distinguishing the facts of the al-jedda case from those of the behrami and saramati case and it found the case admissible. nordic journal of commercial law issue 2010#1 21 3.3.5 bankovi� and others v. belgium and 16 other contracting states another interesting case that relates to the echr is the bankovi� and others v. belgium, the czech republic, denmark, france, germany, greece, hungary, iceland, italy, luxembourg, the netherlands, norway, poland, portugal, spain, turkey and the united kingdom (hereinafter the bankovi� and others case) of 2001, where the ecrthr also held the application inadmissible. vlastimir and borka bankovi� and four other applicants had filed a complaint against 17 member states of the nato for the deaths and injuries of their close family members that occurred due to the nato missile attack against the rts television and radio station facilities in belgrade on 23 april 1999.94 the case was also used as reference later on in the behrami and saramati case. to summarize shortly the contents of the bankovi� and others case, the ecrthr found that it had no jurisdiction over the nato attacks on fry. it reasoned its conclusion on the grounds that article 1 of the echr limits the competence of the ecrthr to the cases concerning the duty of the high contracting parties to secure the rights and freedoms defined in the echr to everyone within their jurisdiction. the ecrthr concluded that the application of the echr cannot be extended to the aerial bombing of a non-member state’s territory, since it falls beyond the jurisdiction of the bombing state.95 the bankovi� and others case was in all its simplicity about the conduct of military forces of nato states that were under the full control and jurisdiction of the respondent states. it should be clear, under international law, that this is enough to hold a state responsible. the ecrthr’s reasoning is not clear enough to explain why general principles should not apply to the echr.96 iv. responsibility of international organizations 4.1 elements of responsibility 4.1.1 the conventional position in international law in article 3 of the ilc draft articles on the responsibility of international organizations, it is stated that every internationally wrongful act of an international organization is within the 94 bankovi� and others v. belgium and 16 other contracting states (nato member states) (bankovi� and others), grand chamber, 12 december 2001 paras. 9-11. 95 altiparmak, kerem: bankovi�: an obstacle to the application of the european convention on human rights in iraq. journal of conflict & security law 9, pp. 213-251, oxford university press 2004, p. 221 and the bankovi� and others case (2001). 96 altiparmak (2004) p. 226 and the bankovi� and others case (2001). nordic journal of commercial law issue 2010#1 22 responsibility of the international organization. there is an internationally wrongful act of an international organization when conduct consisting of an action or omission is i) attributable to the international organization under international law and it ii) constitutes a breach of an international obligation of that international organization. damage is not included in the elements, as it is not included in the ilc articles on state responsibility.97 once the existence of international personality of international organizations is recognized, it is natural that, organizations can demand responsibility of other international subjects because they have rights at international law. similarly they can also be held responsible to other international subjects because they have obligations at international law. states have international responsibility in general because their duties flow from the control they have over territory, airspace, persons etc. or from their relations with other international subjects. in comparison, international organizations have a limited amount of control. however, they have a certain amount of control over persons, and they enter into treaties, agreements and other relations with other international persons which could give rise to international obligations. these obligations could generate responsibility in the appropriate circumstances.98 the conventional approach to the law of international organizations disregards the tension between international organization and individual state responsibility. the conventional approach conceives responsibility for the acts of the organization exclusively in terms of the organization itself, not also in light of responsibility for the individual member states. a reflection of the idea of the separate distinct legal personality, which international organizations enjoy, is that the distinct legal person is responsible for the acts of the organization. if states perform acts as part of the structure of the international organization or act on behalf of the organization and in the organization’s name, these acts are as a matter of law acts of the organization and not the state.99 the current state of the law concerning the responsibility of international organizations leaves a number of problems unsolved. among them is the question of 'piercing the corporate veil', the distribution of responsibility between the organization and its member states. this question is of paramount importance. the ilc draft articles on the responsibility of international organizations have tried to answer this question in art. 29, which states that a state member of an international organization is responsible for an internationally wrongful act of that organization, if it has accepted responsibility of that act or it has led the injured party to rely on its responsibility. this responsibility is presumed to be subsidiary and exist without prejudice to other possible situations regulated in the articles, where the responsibility may exist due to 97 un document a/62/10, report of the international law commission, 59th session (7 may – 5 june and 9 july – 10 august 2007, official records of the general assembly, sixtieth session, supplement no. 10 pp. 178 – 220, 1 september 2007, article 3, p. 185. 98 amerasinghe (2005) p. 399. 99 wilde (2008) pp. 401-402. nordic journal of commercial law issue 2010#1 23 other reasons than simply due to the membership of the organization and acceptance of responsibility.100 another special legal problem as regards the implementation procedure concerns the question of whether international organizations are entitled to, and whether they should, set up remedial procedures which have to be exhausted before a third party is allowed to bring a claim against the organization under international law. does the law of state responsibility concerning the prior exhaustion of local remedies apply here mutatis mutandis? what is the law to be applied for assessing damages?101 regardless of the remaining unclarities, two starting point principles could be presented: i) international organizations are responsible for the consequences of all unlawful acts attributed to them under international law, whether the acts are committed within their competence or not; ii) where the incompetence of the organization to carry out the relevant act was manifest, and as a consequence the injured party was able to avoid the harmful results, the organization will not be held responsible toward this party.102 4.1.2 the obligations of international organizations article 9 of the ilc draft articles on the responsibility of international organizations states that an act of an international organization does not constitute a breach of an international obligation unless the international organization is bound by the obligation in question at the time the act occurs.103 summarizing the above-mentioned, international organizations are responsible for breach of international agreements. when for example the ibrd and the international development association (ida) enter into loan and credit agreements with states, which are international agreements governed by international law, the failure on the part of the ibrd or the ida respectively to carry out its obligations under such agreements would trigger their international responsibility. there are various other examples of agreements that could generate international responsibility in case the organizations failed to carry out their obligations under them.104 for example, in the world health organization (who) agreement case105, the question brought before the icj was, whether the who had violated its obligations under an agreement with egypt, 100 un document a/62/10 (2007) article 29, p. 194. 101 ginther (1991) pp. 1338 – 1339. 102 hirsch (1995) p. 16. 103 un document a/62/10 (2007) articles 8-9, p. 187. 104 amerasinghe (2005) p. 400. 105 interpretation of the agreement of 25 march 1951 between the who and egypt (1980) advisory opinion of the international court of justice, 20 december 1980, icj reports (1980) p. 67. nordic journal of commercial law issue 2010#1 24 there being no question that the who could have been responsible to egypt for the breach of its obligations under the agreement.106 as with regards to the responsibility of organizations under customary international law, possibly on the analogy of the law governing relations between states, international organizations can also have international obligations towards other international legal persons arising from the particular circumstances in which they are placed or from particular relationships. in the who agreement case the icj specifically referred to the existence of obligations at customary international law for international organizations.107 there are situations in which international organizations would be responsible under customary international law for the acts of their servants or agents, when they are acting in the performance of their functions, or of persons or groups acting under the control of the organizations, such as armed forces in the case of the un. there have been claims arising from the united nations operation in the congo (unoc) in the 1960s, brought against the un by states relating to injury to their nationals, which were based on violations of international law and which were settled by negotiations between the un and the states concerned.108 the content of the obligations of international organizations could easily be identified in the case of constitutive instruments, other treaties or agreements, depending on the interpretation and application of such instruments. regarding customary international law, as in the case of obligations owed to organizations, the obligations will be based on fault, risk or absolute liability, as the case may be, depending on the obligation and the content of the applicable customary international law.109 4.1.3 limits of organizational competence and the scope of control the recognition of the importance of international organizations in the international society should not blur the recognition of their limitations stemming from the nature of the relationship between the organizations and their members. the organizations are basically instruments for international cooperation and their operations are to a large extent prescribed by the governments of the member states.110 one example regarding problems that can be generated by international organizations is the world trade organization (wto). in the opinion of some commentators, this organization has had a tendency to stray from its constitutional aims and exercise influence in areas that 106 amerasinghe (2005) p. 400. 107 icj reports (1980) p. 90. 108 amerasinghe (2005) p. 400. 109 amerasinghe (2005) pp. 400-401. 110 hirsch (1995) pp. 4-5. nordic journal of commercial law issue 2010#1 25 seem outside the limits of its competence (ultra vires). this phenomenon has been described in legal literature as ‘linkage’. this ultra vires activity means that an expansionist-oriented organization has infiltrated an area that does not appear to be within the scope of its competence. another organization that has undergone recent criticism, in this respect, is the imf.111 international organizations have generally been found to be at fault in connection with damage resulting from conduct of their servants, agents, persons or groups under their control, such as armed forces. there may be delicate issues concerning who is responsible in some cases where persons are under the control of more than one international person, such as where armed forces belonging to a state participate in an operation sponsored by the un or pursuant to a decision of the un. however, in such cases the issue is one of attribution of responsibility on the basis of control. there is no reason why analogies should not be borrowed from the principle of imputability applied in the customary law of state responsibility, particularly, for injuries for aliens. similarly, in the area of the general responsibility of international organizations for acts of servants or agents, analogies from the law of state responsibility may be relevant in appropriate situations in determining imputability. the subject of imputability, where acts of organs, servants, agents or independent contractors are concerned, will depend on whether the organ or individual concerned was acting within the scope of ‘apparent authority’. this is particularly so in the case of acts performed outside the actual authority granted. thus, though the act may in fact be done without authority, it may engage the responsibility of the organization, because it is within the scope of apparent authority.112 questions of responsibility have arisen particularly in the case of armed forces engaged in un ‘controlled’ operations. in such cases the un has generally accepted responsibility for any illegal acts which may have been committed by armed forces (belonging to member states) acting under the un aegis. the un has acknowledged responsibility for activities carried out by both the united nations energy force (unef) and the unoc, for instance.113 the main issues that arise in these cases again are i) whether there has been an unlawful act or omission; and ii) whether such act is imputable to the organization. regarding the first issue, the un has refused to bear responsibility for damages caused by its lawful military operations or arising from military necessity – these acts are not unlawful. on the other hand, the un has accepted liability for all damage not justified by military necessity (e.g. as a result of destruction without necessity, murder, imprisonment, arbitrary expulsion and such acts). 114 111 araujo (2005) p. 346. 112 amerasinghe (2005) p. 401. 113 amerasinghe (2005) pp. 401-402. 114 amerasinghe (2005) p. 402. nordic journal of commercial law issue 2010#1 26 4.1.4 the element of attribution as international organizations are subjects of international law and capable of possessing rights and being subject to obligations under international law, the question is, whether and under which conditions internationally wrongful acts can be attributed to an international organization per se as to trigger its responsibility.115 the ilc draft articles on the responsibility of international organizations also touch the subject of attribution in articles 4-7. according to article 4, the conduct of an organ or agent of an international organization in the performance of functions of that organ or agent shall be considered as an act of that organization under international law, no matter what position the organ or agent holds in respect of the organization. article 5 states that the conduct of an organ of a state or an organ or agent of an international organization that is placed at the disposal of another international organization shall be considered under international law an act of the latter organization if the organization exercises effective control over that conduct. article 6 states that the organization cannot avoid responsibility even in a situation, where the conduct exceeds the authority of that organ or agent or contravenes instructions. according to article 7, even if the conduct is not attributable to an international organization, the organization may acknowledge and adopt the conduct in question as its own.116 4.2 recent developments 4.2.1 two key policy issues as stated above, there are two key policy issues regarding the relationship between the responsibility of international organizations and the responsibility of member states. the first key issue concerns the efficiency and independence of international organizations in their functions. the second relates to the applicability of the responsibility principle.117 the institut de droit international states a principle regarding the first issue: “support for the credibility and independent functioning of international organizations and for the establishment of new international organizations”.118 member state responsibility in a traditional sense is seen as undermining this principle. the potential problem caused by enforcing member state responsibility for the acts of international organizations is the paralysis within existing organizations, with consensus required for every decision. states might also be 115 ginther (1991) p. 1336. 116 un document a/62/10 (2007) articles 4-7, pp. 186-187. 117 wilde (2008) pp. 404-405. 118 institut de droit international, resolution ii, the legal consequences for member states of the non-fulfilment by international organizations of their obligations toward third parties, session of lisbon, annuaire de l’institut de droit international, vol. 66-ii 1995, art. 8. nordic journal of commercial law issue 2010#1 27 reluctant to create and support new international organizations in the future out of a fear of running the risk of responsibility for future acts they may not be able to control. such responsibility necessarily contradicts the nature of those international organizations conceived in a manner whereby all member states are not necessarily able to control all the acts and functions of the organization, for example when decisions are taken by the un security council.119 according to the responsibility principle, third parties should be protected against undue exposure to loss and damage that they have not themselves caused, in relationships with international organizations. the focus is thus on those affected by the actions of international organizations, who should be provided with legal redress, when such actions lead them to suffer harm or some other loss. this victim-orientated approach leads to the related violatororientated approach of avoiding impunity, which argues that a state cannot escape its liability under international law by entrusting to another legal person the fulfilment of its international obligations.120 this dual principle, that third parties affected by the acts of international organizations should be given redress, and that states should not be able to evade legal responsibility by transferring competences to international organizations – would clearly be supported if member states were made legally responsible for the acts of organizations of which they are a member.121 during its session of lisbon in 1995, based on the work of the rapporteur of the fifth commission, institut de droit international adopted a resolution on ‘the legal consequences for member states of the non-fulfilment by international organizations of their obligations toward third parties’. in its decision the institut took into consideration the tensions between the importance of the independent responsibility of international organizations on the one hand, and the need to protect third parties dealing with such international organizations, on the other hand. it also recognized the diversity of international organizations, and the fact that it may not be possible to accomplish a solution which could suit all organizations.122 the traditional position which excludes member state responsibility promotes the first policy objective of ensuring the effective functioning of international organizations. therefore the institut de droit international resolved that “important considerations of policy, including support for the credibility and independent functioning of international organizations and for the establishment of new international organizations, militate against the development of a general and 119 wilde (2008) p. 404-405. 120 wilde (2008) p. 405. 121 wilde (2008) p. 406. 122 resolution of the institut de droit international (1995) p. 1. nordic journal of commercial law issue 2010#1 28 comprehensive rule of liability of member states to third parties for the obligations of international organizations.”123 however, those supporting this position do not do so by disregarding the responsibility principle: they do not reason that the effective functioning trumps the need to ensure accountability. they rather seek to promote accountability through alternative means: better safeguards for third parties operating in relation to international organizations directly. the institut further concludes that “important considerations of policy entitle third parties to know, so that they may freely choose their course of action, whether, in relation to any particular transaction or to dealings generally with an international organization, the financial liabilities that may ensue are those of the organization alone or also of the members jointly or subsidiarily. accordingly, an international organization should specify the position regarding liability 1) in its rules and contracts; 2) in communications made to the third party prior to the event or transaction leading to liability; or 3) in response to any specific request by any third party for information on the matter.”124 when transactions are freely entered into, adequate remedies for third parties would not necessarily be required, the key requirement being transparency as to the nature of remedies. this way, an informed decision can be made. for transactions that are imposed, adequate remedies are arguably necessary. in the case of a failure to protect, being ‘on notice’ of a lack of responsibility is beside the point; the idea here is that there should be a responsibility to take effective action.125 the underlying rationale for the lack of member state responsibility in relation to the acts of international organizations has to be understood, then, in terms of a separate area of international law. this area concerns the responsibility of international organizations and the provision of remedies against these actors directly. when the two are taken together, both policy objectives seem to be supported: the functioning of international organizations is not compromised, nor is securing responsibility and redress.126 4.2.2 problems with the current situation as far as the law is concerned, it is relatively unclear whether and to what extent international organizations are subject to national and international law. no standing international court or tribunal has jurisdiction to hear complaints brought directly against international organizations, 123 resolution of the institut de droit international (1995) art. 8. 124 resolution of the institut de droit international (1995) art. 9. commented by wilde (2008) p. 407. 125 wilde (2008) p. 408 and report of the high-level panel, pp. 199-203. see also iciss report, at pp. 69-75. 126 wilde (2008) p. 408. nordic journal of commercial law issue 2010#1 29 and due to privileges and immunities such complaints are usually barred on the domestic level. even if it was clear that international organizations were capable of being legally responsible for their acts by virtue of their possession of international legal personality, uncertainties would remain.127 as an example presented by wilde, individuals complaining of a breach of their civil and political rights by a member state of the council of europe would be able to invoke the state’s obligations under the echr (provided the alleged breach took place within the state’s ‘jurisdiction’ for the purposes of the convention). if they were denied an effective legal remedy against that state in domestic courts, they would then be entitled to bring a case to the ecrthr.128 such individuals complaining of a breach of their civil and political rights by the un – as for example in kosovo, where the un is the governmental authority – such a breach is not regulated by the echr, domestic remedies are largely absent because of the enjoyment of legal immunities by the un and its officials, and there is no standing before the ecrthr to bring cases directly against the un as opposed to an echr contracting state. an ombudsman can hear complaints against the un but its decisions are purely recommendatory and it has no enforcement powers.129 this is also close to what happened in the behrami and saramati case presented above, where the ecrthr declared the case inadmissible. therefore, in general, there is a legal bar against remedies against the member states of international organizations flowing from the lack of responsibility on the part of member states. this legal bar is matched by the lack of remedies available against such organizations as a matter of fact. although states act through international organizations in a broad range of functions, the remedies obtainable against them or the organizations involved for breaches of international law are severely limited.130 127 wilde (2008) pp. 408 – 409. 128 european convention for the protection of human rights and fundamental freedoms, rome, art. 34, (4 november, 1950), 213 united nations treaty series (unts). 222: “the court may receive applications from any person, non-governmental organization or group of individuals claiming to be the victim of a violation by one of the high contracting parties of the rights set forth in the convention of the protocols thereto. the high contracting parties undertake not to hinder in any way the effective exercise of this right”. 129 wilde (2008) pp. 409 – 410. the ombudsman was established by the special representative of the secretary general in kosovo in june 2000. see ombudsperson institution in kosovo, unmik regulation 2000/38, 30 june, 2000, as amended by unmik regulation 2003/8 15 april, 2003. 130 wilde (2008) p. 410. nordic journal of commercial law issue 2010#1 30 4.2.3 the work of the international law commission in 2000, the ilc decided to include the responsibility of international organizations in its longterm programme of work.131 in december of the following year 2001, the general assembly of the un requested the ilc to commence its work on the topic.132 two developments in the background initiated the process of the work of the ilc on the subject. firstly, the ilc examines at regular intervals the full range of issues related to international law in order to identify matters that would be appropriate for codification. when the ilc began selecting possible topics during its session in 1998, it was in the final phase of elaborating draft articles on the international responsibility of states for wrongful acts. it was a success after forty years of work, and it encouraged the ilc to extend its discussion of responsibility to international organizations.133 secondly, the ilc had earlier worked on international organizations. its previous work resulted in 1975 in the adoption of the vienna convention on the representation of states in their relations with international organizations of a universal character. another convention that related to international organizations and developed out of the ilc’s work was the 1986 vienna convention on the law of treaties between states and international organizations. discussions regarding other subjects relating to international organizations were also held. the existence of international organizations and their growing importance has been and still is urging the ilc to take a closer look at legal questions relating to them.134 at its fifty-fourth session, the ilc decided, at its 2717th meeting held on 8 may, 2002, to include the topic in its programme of work and appointed mr. giorgio gaja as special rapporteur on the topic. the working group considered the following issues in its works: a) the scope of the subject, including the concepts of responsibility and international organizations; b) relations between the subject of responsibility of international organizations and the articles on state responsibility; c) questions of attribution, d) questions of responsibility of member states for conduct that is attributed to an international organization; e) other questions concerning when responsibility arises for an international organization; f) 131 un document a/55/10(supp), reports of the international law commission, 52nd session (1 may – 9 june and 10 july – 18 august 2000), official records of the general assembly, fifty-fifth session, supplement no. 10, pp. 726 – 728 and 729 (1), 1 january 2000 p. 292. 132 un document a/60/10(supp), reports of the international law commission, 57th session (2 may – 3 june and 11 july – 5 august 2005), official records of the general assembly, sixtieth session, supplement no. 10, pp.73 – 105, 23 september 2005, p. 73. 133 holder, william e.: can international organizations be controlled? accountability and responsibility, 97 american society of international law proceedings, pp. 231 – 240, 2003, p. 237 134 holder (2003) p. 237. nordic journal of commercial law issue 2010#1 31 questions on the content and implementation of international responsibility; g) settlement of disputes; and h) the question of what practice is to be taken into consideration.135 the working group recommended that the un secretariat approach international organizations and collect relevant materials, especially on questions of attribution and the responsibility of member states for conduct that is attributed to an international organization.136 the ilc adopted the report of the working group.137 the ilc has so far adopted 66 draft articles.138 many of the articles have been the object of comments after their provisional adoption, especially in the debates held in the sixth committee of the un on the report of the ilc and in written statements made by states and international organizations. certain articles have been examined in judicial practice.139 however, the draft articles have not yet been extensively tried in international legal proceedings or much in legal literature either, and their impact on the current situation is still somewhat uncertain. 4.2.4 the work of the international law association the international law association established a committee on the accountability of international organizations in may 1996, and its mandate was: “to consider what measures (legal, administrative or otherwise) should be adopted to ensure the accountability of public international organizations to their members and to third parties, and of members and third parties to such organizations. in particular, the committee may consider such issues as: a) the relations between member states, third parties and international organizations; b) redress by and against international organizations, including access to the international court of justice and other courts and tribunals, and related issues of procedure; c) the relations between different forms of accountability of international organizations (legal, political, administrative, financial) and d) the dissolution of international organizations and related questions of succession.”140 135 un document a/60/10(supp) (2005) p. 73. 136 un document a/57/10(supp), report of the international law commission, 54th session (29 april – 7 june and 22 july – 16 august 2002), official records of the general assembly, fifty-seventh session, supplement no. 10 pp. 10 (b), 18, 461 – 488, 517 and 519, 20 september 2002, pp. 465-488. 137 un document a/60/10(supp) (2005) pp. 73-74. see also un document a/57/10(supp) (2002) para. 464. 138 see http://www.un.org/law/ilc/ (last visited 11. march 2010). 139 articles 3 and 5 were considered by the ecrthr in recent decisions, first in behrami and behrami v. france and saramati v. france, germany and norway, decision of 2 may 2007, pp. 29-33 and 121, and then in beric and others v. bosnia and herzegovina, decision of 16 october 2007, pp. 8,9, and 28. 140 the final report of the ila committee (2004) p. 4. nordic journal of commercial law issue 2010#1 32 the first report of the committee was presented to the 68th conference of the ila at taipei, 1998, and it laid down the legal framework for accountability of international organizations. the second report was presented to the 69th conference at london, 2000, and it comprised a discussion of relevant general principles, to which was annexed a corapporteurs’ draft of recommended rules and practices (rrp). the third report, presented at the 70th conference at new delhi, 2002, contained a consolidated, revised and enlarged versions of rrps, and the final report, further categorizing the rrps was presented to the 71st conference at berlin, 2004.141 in its final report, the committee had decided not to discuss the concurrent or residual responsibility of member states for non-fulfilment by international organizations of their obligations toward third parties. the committee considered the question fully covered in the 1995 resolution of the institut de droit international: 'the legal consequences for member states of the non-fulfilment by international organizations of their obligations toward third parties'.142 those who endorse the general view of a lack of member state responsibility in a broader context have focused their attention on seeking to improve mechanisms for securing the responsibility of international organizations. the final report, for example, concluded that this regime should be enhanced.143 v. conclusion no such situation should arise, where an international organization would not be accountable to some authority for an illegal act attributable to that organization.144 a precondition for the responsibility of international organizations is a separate legal personality of these organizations, but this does not determine whether member states have a concurrent or residual responsibility or not.145 141 the final report of the ila committee (2004) pp. 4-7. 142 international law association: third report consolidated, revised and enlarged version of recommended rules and practices (‘rrp’s’), new delhi conference, committee on accountability of international organizations, 2002 p. 18. finally the committee considered the question fully covered in the 1995 resolution of the institut de droit international. final report of the ila committee (2004) p. 26. the resolution of the institut de droit which the committee considered to be exhausting is discussed under the following title. 143 wilde (2008) p. 410 and ila final report (2004). 144 ila final report (2004) p. 26. 145 higgins, rosalyn: the legal consequences for member states of the non-fulfilment by international organizations of their obligations towards third parties, annuaire de l’institut de droit international, vol. 66-i, 1995, p. 254. nordic journal of commercial law issue 2010#1 33 these are interesting times when it comes to the development of international responsibility. with the adoption of the ilc articles on the responsibility of international organizations, the increasing legal practice and the hopefully successful un reform, the time is now to focus on the issue of the relation between the responsibility of international organizations and the responsibility of their members. should the corporate veil of an international organization be pierced and the member state responsibility invoked? if yes, how do we still need to develop the current legal framework in order to establish this member state responsibility? if not, how do we look after the interests of third parties? how do we make sure that the international organizations can be held accountable for their actions? in europe, the times are also interesting due to the ratification of the lisbon treaty146. the treaty defines the legal personality of the european union, making it a stronger actor in its own right, within the international community and, for example, opens the possibility for the european union to accede to the echr. it is evident from the cases presented above that case law does not deliver a unified stance on the question of member state responsibility under international law. therefore, the existing legal practice has not created a customary norm regarding member state responsibility in international law.147 current legal practice has even produced detrimental precedents, as can be seen in the behrami and saramati case in the ecrthr, when it comes to the protection of human rights and the endorsement of international responsibility. if a principle of international responsibility is not clear to the courts, as was obvious in the bankovi� and others case (where full control and jurisdiction of the respondent states did not result in state responsibility), further academic debate is definitely needed. taking into consideration the efforts of non-state actors such as the ilc, ila and the institut de droit international, the problem is not necessarily so much the lack of academic efforts regarding questions of substance, but the lack of consistent jurisprudence, caused to a large extent by the procedural difficulties surrounding these cases. the aforementioned efforts, especially the ilc draft articles, should be accepted by states as binding international law. by adopting clear procedural rules and more easily subjecting international organizations to claims, the substantive guidelines on international responsibility can develop into practice. a great step forward could be attained by amending the role of the icj. the ila committee would not include its conclusions regarding the amendment of the icj statute in the main body of its final report, as it is a topic that divides academics and consequently, on which consensus is difficult to reach. nevertheless, further academic discussions are encouraged in 146 for more information on the lisbon treaty, please see http://europa.eu/lisbon_treaty (last visited 14 march 2010). 147 hirsch (1995) p. 124. nordic journal of commercial law issue 2010#1 34 order to make the topic of the icj statute and the general question of procedural barriers to finding international organizations responsible easier to approach. in conclusion, there remain four points of consideration for the future development of international responsibility. by taking on these four challenges, the harm from the remaining unclarities could be brought down to a minimum. the interests of third parties would be better protected and unwanted surprises regarding responsibility issues for member states, and also international organizations themselves, could be avoided. 1. removing procedural obstacles: the statute of the icj should be amended to accept international organizations as parties in cases before the court. this would not open the court to individuals, but it would enable the court to hear cases, where the injured third party and claimant or the respondent is an international organization. this would be a great step forward in the field of international responsibility. 2. improving existing structures: if and when jurisdictional immunity continues to form a barrier to remedial action for non-state claimants, adequate alternative remedial protection mechanisms within international organizations should be encouraged and developed. 3. increasing transparency and good faith: an international organization should specify the position regarding responsibility in its rules. organizations should also be encouraged to provide parties with the necessary information as to the allocation of responsibility between the organization and its member states. this information should be given prior to the conclusion of the agreement concerned, or at the start of the operational activity envisaged by the organization and its member states. 4. referring disputes to arbitration: if possible, when concluding agreements with states or non-state entities, international organizations should add a clause providing for compulsory referral to arbitration of any dispute that the parties have been unable to settle through other means. specifications and the contractual relationship: article 65 of the cisg in light of pecl article 7:105 by andrea l. charters* nordic journal of commercial law issue 2004 #2 nordic journal of commercial law issue 2004 #2 2 i. introduction article 65 of the convention on contracts for the international sale of goods (the ”cisg”)1, setting forth an opportunity for the seller to impose certain specifications in light of the buyer’s failure to do so, raises particular questions of interpretation given the principles of european contract law (the ”pecl”)2. cisg article 65 sets forth a mechanism for the seller to supply specifications for a sale of goods transaction where the buyer has failed to do so. the pecl, on the other hand, states a similar right of parties in a generalized fashion, not merely applying to a narrow context. these provisions are set forth below, in comparison, with emphasis added to heighten the contrast and the key provisions of each section: cisg article 65 pecl article 7:105 (1) if under the contract the buyer is to specify the form, measurement or other features of t h e g o o d s a n d h e f a i l s t o m a k e s u c h specification either on the date agreed upon or within a reasonable time after receipt of a request from the seller , the seller may, without prejudice to any other rights he may h a v e , m a k e t h e s p e c i f i c a t i o n h i m s e l f i n accordance with the requirements of the buyer that may be known to him. (2) if the seller makes the specification himself, he must inform the buyer of the details thereof and must fix a reasonable time within which the buyer may make a different s p e c i f i c a t i o n . i f , a f t e r r e c e i p t o f s uc h a communication, the buyer fails to do so within the time so fixed, the specification made by the seller is binding. (1) where an obligation may be discharged by one of alternative performances, the choice belongs to the party which is to perform, unless the circumstances indicate otherwise. (2) if the party which is to make the choice fails to do so by the time required in the contract, then: (a) if the delay in choosing is fundamental, the right to choose passes to the other party; (b) if the delay is not fundamental, the other party may give a notice fixing an additional period of reasonable length in which the party to choose must do so. if the latter fails to do so, the right to choose passes to the other party. thus, the cisg provision is limited to certain basic information about the goods, such as the: ”form, measurement or other features of the goods”, which have not been specified by the buyer where the contract calls for the buyer to do so by a certain date. the portion of the pecl which is more directly applicable is the second paragraph of article 7:105, which applies ”if the party which is to make the choice fails to do so by the time required in the contract . …” thus, the pecl does not delimit the remedy to basic choice of specifications pertaining to the goods. this approach of the pecl thus generalizes through the substantive provision of article 7:105, rather than through offer and acceptance provisions, as will be shown to be done in the cisg, which was drafted a decade and a half earlier.3 there is thus movement over time toward a more relationship based principle, away from the technical features of offer and acceptance. this legal history observation may be eclipsed, however, by recent developments, discussed in section iv, which may have greater practical effect. nordic journal of commercial law issue 2004 #2 3 ii. context for interpreting article 65 in light of principles of european contract law article 7:105 a. canonical interpretations show that the practical needs of traders require an article 65 provision practical needs of traders require an article 65 provision. article 65 of the cisg is clearly necessary to show that the contract is not void for vagueness and to prevent a ”hold up” by the buyer, who might force the seller to seek adjudication rather than negotiation in the face of declining demand or increasing supply for the product.4 certain features of the goods may be left to future choice by the buyer, such as color or style, even automobile option5 specifications. this should not, of course, extend to having the seller supply complex, scientific or technical specifications of custom goods for which a design supplied by the buyer is essential. the language of the cisg and past commentary agree on these issues.6 three factors would point away from application of article 65 in the context of custom engineered goods. first, a long series of exchanges about the goods would be likely. thus, the failure of the buyer to respond to a deadline for a specification would not be an abrupt failure to call for the goods. second, the custom nature of the contract could involve a service component to the contract, which might be supplied by another party. third, the countervailing feature of the risk of quality claims by an already dissatisfied or lackadaisical buyer would increase the risk of suit over quality. b. legislative history is sparse the legislative history of article 65 is sparse. significant disagreement about including the provision was raised, but it had an antecedent in the uniform law of international sales, the predecessor of the cisg, and the consensus of opinion was in favor of keeping a provision of this type.7 c. sparse case law does not obviate need for the provision the sparse case law does not obviate the need for this provision, although only two cases reported or digested in english, or in any language in a major, international source of cases, address article 65.8 the cases reaffirm what would be concluded based on the text of article 65. one 1996 german case, not available in translation into english, is cited in the draft uncitral digest as stating that where the seller has failed to make a specification, ”the buyer retains the right to make its own specification.”9 a 1995 german case, available in english, pertaining to options on standard bmw series 3 automobiles, involved no objection by the buyer to the specifications, and objection only to the dates of delivery.10 the lack of case law may reflect the operation of article 65 as law that allows parties to operate ”in the shadow of the law” without adjudication. this is particularly likely, since where a seller believes that a buyer is not likely to adhere to the contract, the seller will probably avail itself of other remedies that may be more swift, with fewer responsibilities on the seller. where there is a good nordic journal of commercial law issue 2004 #2 4 relationship between the parties, however, the seller might avail itself of article 65 procedures without any ensuing litigation. we shall return to this emphasis on the contractual relationship after a discussion of how four comparative issues may be resolved. iii. pecl article 7:105 supports an interpretation in light of the contractual relationship a. reading in light of the pecl: resolving four comparative issues four technical issues are raised by pecl article 7:105 in relation to cisg article 65: (1) whether the buyer retains the right to choose if the seller does not do so; (2) whether the pecl concept of fundamental delay influences the cisg provision; (3) whether pecl provisions regarding (a) currency matters and (b) a number issues related to each other, affect the cisg provision; and (4) whether usages may influence cisg rights and obligations. the pecl specifies that, ”if the [seller] fails to do so, the right to choose passes to the [buyer].”11 it is implicit in the language of the cisg, however, that the right to choose remains with the buyer if the seller does not avail itself of its article 65 rights, and it was reportedly so held, as digested in the draft uncitral digest regarding the 1996 german case.12 the pecl provides that failures to choose shall be divided into failures that are fundamental and those that are not, with those that are not fundamental requiring notice, as in the cisg.13 given the apparent reticence of parties to avail themselves of cisg article 65 in contentious situations, as evidenced by the sparse case law,14 it is difficult to imagine parties concluding that they could rely on the ”fundamental” delay provision of pecl article 7:105(2)(a), however. the ”fundamental” delay provisions of the pecl thus do not appear to influence cisg article 65. the pecl further provides that currency of payment matters shall be governed by article 7:108 and matters of performance of a number of obligations related to each other shall be governed by article 7:109.15 neither of these specialized provisions addresses the general issue of specifications of goods, provided for in cisg article 65. while the major english commentary to the pecl also suggests that usages may determine who shall make a choice,16 this suggestion is not relevant where the specifications of characteristics of goods issue clearly dictates the seller taking over this responsibility from the buyer, in article 65 of the cisg. the implementation of article 65, on the contrary, might be seen to benefit greatly from the insights of cisg article 8(3) circumstances and article 9 usages under the cisg. expert testimony or prior case experience might address these issues. b. reading in light of the pecl: relationship over offer and acceptance and knowledge the 1995 german case pertaining to delivery of bmw automobiles addressed the delivery date through cisg articles 18 and 29, pertaining to contract formation and offer and acceptance.17 there was apparently less recourse for the seller under article 65, the language of which points to nordic journal of commercial law issue 2004 #2 5 ”features of the goods.” in contrast, the pecl language, which does not so limit to specifications, could have included the delivery date of the goods under its article 7:105. this contrast in approach shows an important development in the law, creating a more relationship based provision, rather than an offer and acceptance provision. in the pecl, the substitution of choice provision is much broader than in the cisg. rather than leaving other matters, such as delivery of the goods,18 to the offer and acceptance provisions, the pecl adopts a more modern approach of handling substitution of choice through a relationship oriented provision, the broad article 7:105. while litigants could consider a pecl inspired approach to cisg article 65 if, in some cases, the offer and acceptance provisions were inadequate, the major observation here is that the pecl, a decade and a half more recently drafted, takes a more relationship based approach, rather than an offer and acceptance approach. in addition, cisg article 65 explicitly requires that the seller act on preferences of the buyer ”which may be known to him.” the pecl does not directly include such a provision, although the ”fundamental” delay requirement adverts to some knowledge requirements.19 although the more flexible language of the pecl again indicates a more modern drafting, the usefulness of this provision as a guide to interpretation of the cisg leaves the litigant with little to rely on. the knowledge requirements of the cisg are complex, subtle and varied20 and one is clearly included in article 65. iv. communications technology and cisg-ac opinion no. 1 hold the promise for more use of article 65 any reticence of sellers to avail themselves of the article 65 provisions, which require a ”reasonable time within which the buyer may make a different specification” after notice, may be reduced by the recent scholarship of cisg-advisory council opinion no. 1 on electronic communication under cisg,21 which clarifies the provisions required for a writing and thus, for written notice,22 which may be required by many contractual provisions. v. conclusion interpretation of cisg article 65 in light of pecl article 7:105 thus shows an historical progression in the drafting, but does not leave a litigant with much recourse to obtain strategic advantage, either in terms of flexibility in or tightening of the provisions. the articles seem to pass each other without contact. a bigger benefit for interpretation of article 65 seems to stem not from interpretation in light of the pecl, but from the practical advance of cisg-ac opinion no. 1, which i have recently argued is a great benefit to clarity in defining ”writing,”23 and thus, to notice related provisions generally. nordic journal of commercial law issue 2004 #2 6 * adjunct professor, washington university school of law, st. louis, missouri, u.s.a.; j.d. harvard law school, m.s.w. washington university, a.b. yale university. 1 united nations convention, adopted 1980, available at <http://cisgw3.law.pace.edu/cisg/text/treaty.html>. [hereinafter referenced in the text by article]. 2 principles of european contract law, complete and revised version 1998, available at <http://cisgw3.law.pace.edu/cisg/text/ textef.html>. [hereinafter referenced in the text by article]. 3 compare supra cisg, note 1, with supra pecl, note 2 (citing adoption dates). 4 see albert h. kritzer, international contract manual: international sales law reporter, guide to practical applications of the united nations convention on contracts for the international sale of goods at 519 -522 (1994) (as supplemented) (analyzing provisions of article 65, reviewing other commentaries and comparing with the uniform international sales law and uniform commercial code section 2-311(3)); john o. honnold, uniform law for international sales, 3d ed. (1999) 357-58, at 358 (arguing that wasteful production and failure to mitigate damages would be subject to ”commercial and legal hazards that are so serious that extreme cases are unlikely to arise”); gunter hager, article 65, in peter schlechtriem, ed., commentary on the international sale of goods (cisg) (1998) (geoffrey thomas, trans.) 497-499, at 498 (arguing that in cases of extreme refusal to supply specifications when asked, production of goods according to the seller’s own specifications is warranted, without a duty to mitigate loss)(citations omitted); and annotated text of cisg: article 60 (collecting sources on meaning of article 60 buyer’s obligation to take delivery, referred to in article 65, primarily as duty of cooperation, not specific performance), available at <http://cisgw3.law.pace.edu/ cisg/text/e-text-60.html>. but see jacob s. ziegel, report to the uniform law conference of canada on convention on contracts for the international sale of goods (1981) (”it is difficult to become excited over art. 65 one way or the other”) (referring to the debate over specific performance vs. damages) available at <http://cisgw3.law.pace.edu/cisg/text/ziegel165/html>. 5 see infra note 10 and accompanying text. 6 cisg, supra, note 1 at article 65 (”form, measurement, or other features of the goods”); kritzer, supra note 4 at 520 (analyzing example of 1,000 pairs of shoes). 7 see victor knapp, article 65, in c.m. bianca and m.j. bonell, eds., commentary on the international sales law: the 1980 vienna sales convention (1987) 475-482, at 476. 8 see infra notes 9 and 10 and sources cited therein. the pace cisg w3 database and the draft digest are the two major sources of collected cases and digests in english. see also ralph amissah, cross-references and editorial analysis, article 65, available at <http://cisgw3.law.pace.edu/cisg/text/cross/cross-65.html>. 9 franco ferrari, harry flechtner, and ronald a. brand, eds., the draft uncitral digest and beyond: cases, analysis and unresolved issues in the u.n. sales convention, (2004) at 749, note 1, citing landgericht aachen, germany, 19 april 1996, available on the internet at <http://www.jura.uni-freiburg.de/iprl/cisg/urteile/text/165.htm>. 1 0 o b er l a n d es ger i c h t [ p r o v i n c i a l c o u r t o f a p p e a l ] m ü n c h e n , 7 u 1 7 2 0 / 9 4 , 8 f e b r u a r y 1 9 9 5 , a v a i l a b l e a t <http://cisgw3.law.pace.edu/cases/950208g1.html>. (holding that notice of avoidance of the contract after 2 ½ years violated the principle of good faith, where the seller had been ready to deliver the automobiles a few months hence and that, in fact, there was not breach at all). 11 see pecl article 7:105, supra note 2 at paragraph (2)(b). 12 see supra note 9 and accompanying text. 13 compare pecl article 7:105, supra note 2 at paragraph (2)(a) and cisg article 65, supra note 1 at paragraph (1). 14 see supra notes 8-10 and accompanying text. 15 ole lando and hugh beale, eds. principles of european contract law, parts i and ii, combined and revised (2000), at article 7:105 commentary. 16 id. 17 supra note 10 at 15(bb); see generally peter schlechtriem, effectiveness and binding nature of declarations (notices, requests or other communications) under part ii and part iii of the cisg, cornell review of the convention on contracts for the international sale of goods (1995) 95-114 (discussing offer and acceptance, the ”receipt” rule and related subjects), reproduced and available at <http://cisgw3.law.pace.edu/cisg/biblio/schlecht.html>. 18 see kritzer, supra note 4 at 521-22 (discussing article 77 provisions re: selection of the vessel for shipment). 19 for a discussion of the ”fundamental” requirement in the context of a breach, rather than a delay, see the sources identified in the guide to article 65, available at <http://cisgw3.law.pace.edu/cisg/text/peclcomp65.html>, including pecl article 8:103, defining ”fundamental non-performance” to include a foreseeability requirement in one paragraph and ”intentional” nonperformance in another. see also principles of european contract law: knowledge and behavior of person for whom a party is responsible (discussing pecl article 1:305 on imputed knowledge and intentions), available at <http://cisgw3.law.pace.edu/ cisg/text/knowbeh.html.> (including reproducing lando & beale, supra note 15 at 134-136). 20 see article 8(3) of the cisg for a discussion of general guidance on the knowledge requirements; amissah, supra note 8 at definition of ”may be known to” (citations omitted); and annotated text of cisg: article 65 words and phrases – degrees of knowledge (cross referencing numerous knowledge requirements). 21 15 august 2003. rapporteur: professor christina ramberg, gothenburg, sweden, available at <http://cisgw3.law.pace.edu/ cisg/cisg-ac-op1.html>. (endnotes) nordic journal of commercial law issue 2004 #2 7 22 see id. 23 see andrea l. charters, growth of the cisg with changing contract technology: ”writing” in light of the unidroit principles and cisg-advisory council opinion no. 1, available at <http://cisgw3.law.pace.edu/cisg/biblio/charters.html>. 1 cisg advisory council* opinion no. 17 limitation and exclusion clauses in cisg contracts * ingeborg schwenzer, chair. yesim atamer, eric bergsten, m. joachim bonell, michael bridge, alejandro garro, roy goode, john gotanda, han shiyuan, sergei lebedev, pilar perales viscasillas, jan ramberg, hiroo sono, ulrich schroeter, claude witz, members. sieg eiselen, secretary. njcl 2017/2 233 1. opinion .............................................................................................. 235 2. comments .......................................................................................... 236 2.1. rule 1 ....................................................................................... 236 2.1.1. introduction ............................................................. 236 2.1.2. internal gap within the cisg ........................... 238 2.1.3. filling the gap ......................................................... 240 2.1.4. issues of subtantive validity excluded ........ 240 2.2. rule 2 ....................................................................................... 240 2.2.1. comparative overview .......................................... 240 2.2.2. general ....................................................................... 240 2.2.3. civil law systems ..................................................... 242 2.2.4. common law systems .............................................. 242 2.2.5. other jurisdictions ................................................ 242 2.2.6. european union law and soft law ................... 242 2.2.7. uniform law instruments ..................................... 243 2.2.8. the position of the cisg ...................................... 243 2.3. rule 3 ....................................................................................... 246 2.3.1. general ....................................................................... 246 2.3.2. form governed by article 11 cisg ................... 246 2.4. rule 4 ....................................................................................... 247 2.4.1. general ....................................................................... 248 2.4.2. rule 4(a) ....................................................................... 248 2.4.3. rule 4(b) ....................................................................... 250 2.5. annex 1 limitation and exclusion clauses in comparative perspective .................................................. 254 2.5.1. civil law systems ...................................................... 254 2.5.2. common law systems ............................................... 258 2.5.3. other jurisdictions ................................................. 260 2.5.4. european union law and soft law ................... 260 2.5.5. uniform law instruments ..................................... 262 cisg ac opinion no. 17 234 2.6. annex 2 limitation and exclusion clauses (examples) ............................................................................... 263 2.6.1. limitation of damages ........................................... 263 2.6.2. consequential loss ................................................ 264 2.6.3. limitation of remedies .......................................... 266 2.6.4. exclusion of liability ............................................ 266 2.6.5. modification of time-limits ................................. 268 2.7. annex 3 cases cited ......................................................... 269 3. footnotes ........................................................................................ 293 njcl 2017/2 235 introduction of the cisg-ac the cisg-ac started as a private initiative supported by the institute of international commercial law at pace university school of law and the centre for commercial law studies, queen mary, university of london. the international sales convention advisory council (cisgac) is in place to support understanding of the united nations convention on contracts for the international sale of goods (cisg) and the promotion and assistance in the uniform interpretation of the cisg. at its formative meeting in paris in june 2001, prof. peter schlechtriem of freiburg university, germany, was elected chair of the cisg-ac for a three-year term. dr. loukas a. mistelis of the centre for commercial law studies, queen mary, university of london, was elected secretary. the founding members of the cisg-ac were prof. emeritus eric e. bergsten, pace university school of law; prof. michael joachim bonell, university of rome la sapienza; prof. e. allan farnsworth, columbia university school of law; prof. alejandro m. garro, columbia university school of law; prof. sir roy m. goode, oxford, prof. sergei n. lebedev, maritime arbitration commission of the chamber of commerce and industry of the russian federation; prof. jan ramberg, university of stockholm, faculty of law; prof. peter schlechtriem, freiburg university; prof. hiroo sono, faculty of law, hokkaido university; prof. claude witz, universität des saarlandes and strasbourg university. members of the council are elected by the council. at subsequent meetings, the cisgac elected as additional members prof. pilar perales viscasillas, universidad carlos iii, madrid; professor ingeborg schwenzer, university of basel; prof. john y. gotanda, villanova university; prof. michael g. bridge, london school of economics; prof. han shiyuan, tsinghua university, prof. yesim atamer, istanbul bilgi university, turkey, and prof. ulrich schroeter, university of mannheim. prof. jan ramberg served for a three-year term as the second chair of the cisgac. at its 11th meeting in wuhan, people’s republic of china, prof. eric e. bergsten of pace university school of law was elected chair of the cisg-ac and prof. sieg eiselen of the department of private law of the university of south africa was elected secretary. at its 14th meeting in belgrade, serbia, prof. ingeborg schwenzer of the university of basel was elected chair of the cisgac. 1. opinion 1. the convention governs the incorporation and interpretation of clauses providing for the limitation and cisg ac opinion no. 17 236 exclusion of liability of the obligor for failure to perform a contract for the international sale of goods (“limitation and exclusion clauses”). 2. according to the principle of freedom of contract laid down in article 6 cisg the parties may derogate from the provisions of the convention by including limitation and exclusion clauses. 3. article 11 cisg preempts the application of form requirements for limitation and exclusion clauses provided for in the otherwise applicable law or rules of law. 4. (a) the convention does not preempt provisions for the protection of the obligee under the applicable law or rules of law, relying on notions such as intentional or willful breach, gross negligence, breach of an essential term, gross unfairness, unreasonableness, or unconscionability. (b) however, in the application of these provisions, the international character of the contract and the general principles underlying the cisg are to be observed, including the principles of freedom of contract and reasonableness. 2. comments 2.1. rule 1 1. the convention governs the incorporation and interpretation of clauses providing for the limitation and exclusion of liability of the obligor for failure to perform a contract for the international sale of goods (“limitation and exclusion clauses”). 2.1.1. introduction 1.1. generally defined, limitation and exclusion of liability clauses (“limitation clauses”, “exemption and limitation clauses”) are contract terms which directly exclude or limit the non-performing party’s liability in the event of non-performance or defective performance.1 in other words, such contractual agreements derogate from the legal regime otherwise applicable in the case of breach of contract.2 1.2. the most common remedies for breach of contract are monetary damages. this is why limitation and exclusion clauses usually target liability for damages. the remedy of damages varies from jurisdiction to jurisdiction but usually include: compensatory damages, restitution, punitive, consequential, and liquidated damages.3 1.3. because damages are difficult to measure in a precise manner before the contract is actually breached, the parties may wish to deal with this risk beforehand, i.e. at the stage of contract negotiations. njcl 2017/2 237 1.4. take for example a contract for the sale of machinery. the seller can mitigate its damages risks in a number of ways: (i) by training the buyer how to operate the machines so as to prevent hazardous situations; (ii) by transferring all risks to the buyer (by providing for an exclusion clause); (iii) by sharing the risks with the buyer (by providing for a limitation clause); or (iv) by purchasing an insurance policy in the marketplace. between the options above, limitation and exclusion clauses stand as a cost-efficient mechanism for allocating contractual risk for the seller. 1.5. limitation clauses may be expressed in different ways (e.g., fixed sum, ceiling or cap, percentage of the performance in question, deposit retained).4 not only may the parties limit their liability to a certain amount of money, but also to certain types of losses (e.g., direct damages), to certain types of conduct (e.g., negligent conduct, as opposed to grossly negligent conduct). they may also exclude liability for damages altogether by agreeing to an exemption clause. 1.6. moreover, a contract term providing that a party who does not perform is to pay a specified sum to the aggrieved party for such nonperformance (“agreed sums”)5 or “liquidated damages”) can also have the effect of limiting the compensation due to the aggrieved party. this will be the case whenever the agreed sum is fixed at a lower level than the expected damages. in this situation it is irrelevant whether the parties intended to limit the obligor’s liability, so long as the clause performs that limiting function.6 1.7. the parties may also limit or exclude remedies available for breach, other than damages. for example, in a contract governed by the convention they may limit the buyer’s rights under article 46 cisg: (1) to require performance by the seller of his obligations, (2) to require delivery of substitute goods by the seller, or (3) to require the seller to remedy the lack of conformity of the goods by repair. 1.8. in contrast to agreed sums, exclusion and limitation clauses do not attempt to induce the obligor to perform the contract. they are always stipulated for the obligor’s benefit. 1.9. it is generally assumed to be beneficial to economic activity that a party to a contract should not be subject to unlimited economic loss. this explains why, despite the principle of full compensation,7 the extent of damages is regulated by most legal systems, as it is by the cisg (article 74).8 more importantly, it explains why it is often self-regulated by the parties. self-regulation affords the parties more certainty in managing their contractual risks, allowing them to calculate and, where applicable, cisg ac opinion no. 17 238 minimize potential damages.9 the same rationale explains why the parties are free to tailor any remedy available to them besides damages. 1.10. as with other terms and conditions of a business contract, limitation and exclusion clauses are generally governed (and at the same time limited) by the fundamental principles of modern contract law, namely: a) the freedom of contract (party autonomy); b) good faith and fair dealing (reasonableness); and c) public policy (which include mandatory rules). in respect of cisg contracts, it is disputed whether the principle of good faith and fair dealing applies as such to the parties’ behavior and their agreement. on the other hand, public policy (“ordre public interne”) and mandatory rules of domestic origin (“lois d’ordre public interne”) only apply to cisg contracts to the extent that the cisg does not provide otherwise (article 4). 2.1.2. internal gap within the cisg 1.11. the limitation and exclusion of liability agreed to by the parties to a contract for the international sale of goods is a matter governed but not settled by the convention. 1.12. in spite of the limitations imposed by the cisg on the contractual liability of the parties, namely the foreseeability rule (article 74), the duty to mitigate (article 77) and the exemptions due to an impediment (article 79) or to other circumstances (article 80) 10 – there is no provision in the convention specifically addressing the parties’ agreement on the limitation or exclusion of liability for failure to perform the contract, in whole or in part. article 19(3) cisg, on the reply to an offer, qualifies the “extent of one party’s liability to the other” as a term that materially alters the offer, however it does not claim to govern limitation and exclusion clauses. 1.13. rule 1 expresses the undisputed view that agreements on the exclusion or limitation of liability, except for their substantive validity, are governed but not settled by the convention. 11 in other words, the regulation of such agreements constitutes an “internal gap” in the convention, as opposed to matters outside its scope or “external gaps”.12 1.14. the parties’ agreement on the limitation or exclusion of their own liability falls under the scope of the convention for two reasons. first, it is a matter connected with the rights and obligations of the buyer and seller arising from the contract, as envisaged by article 4, first sentence cisg.13 second, it deals with the scope of the buyer’s or seller’s remedies for breach of contract under the convention. 1.15. these remedies include not only damages, available for both the buyer and the seller under art. 45(1)(b) and art. 61(1)(b), respectively, njcl 2017/2 239 but also other remedies. buyer’s remedies, such as specific performance (art. 46(1)), delivery of substitute goods (art. 46(2)), repair of lack of conformity of the goods (art. 46(3)), price reduction (art. 50), and the remedy of avoidance (art. 49) may be limited or even excluded by agreement of the parties. likewise the seller’s remedies, namely: to require the buyer to pay the price, take delivery or perform other obligations14 (art. 62), and to avoid the contract (art. 64). 1.16. by reason of the limitation or exclusion clause, the obligee must not be placed in a position where it is left with no remedies at all.15 in other words, the parties’ agreement to limit or exclude one or more contractual remedies must not amount to a situation where the performance of the contract becomes optional, subject only to the will of the obligor.16 1.17. as regards claims to compensation for the breach of contractual obligations, which are primarily delineated by article 74 cisg, the parties are free to limit or exclude by agreement both the amount that can be claimed and the circumstances under which damages can be claimed.17 as to limiting other remedies available under the cisg, which seldom occurs in practice, the parties must not exclude all remedies in favor of the aggrieved party.18 1.18. in sum, the parties’ agreement on the exemption or limitation of liability under the sales contract modifies the remedies regime established in the convention. 1.19. rule 1 recognizes that the convention allows the parties to agree on the limitation or exclusion of their own liability under the international sales contract (article 6 cisg).19 on the same line of reasoning, it states that the convention governs the formation of such clauses (articles 14 – 24). 20 the parties may agree to a limitation or exclusion clause initially, at the conclusion of their contract, or subsequently, during the course of their contractual relationship (article 29). 1.20. where the limitation or exclusion of liability clause is contained in standard terms, its incorporation into the contract must be consistent with cisg-ac opinion no. 13 inclusion of standard terms under the cisg.21 1.21. the interpretation of exemption and limitation of liability clauses and their particular elements is subject to the provisions set forth in articles 8 and 9 cisg.22 thus, terms and conditions in cisg contracts are to be construed in light of both the subjective and objective intent of the parties, as envisaged by article 8. the parties’ obligations under the sales agreement are further determined by the practices established cisg ac opinion no. 17 240 between the parties and by the trade usages they have agreed to – article 9(1) –, or by those that the parties “knew or ought to have known and which in international trade [are] widely known and regularly observed” article 9(2). 2.1.3. filling the gap 1.22. since there is an “internal gap” in the convention relating to this type of contractual agreement, this gap is to be filled in accordance with article 7(2), first part, cisg. in other words, such questions are to be primarily settled in conformity with the general principles on which the convention is based. only in the absence of any general principle are gaps in the cisg to be settled in conformity with the otherwise applicable law or rules of law. 1.23. hence, in order to fill this “internal gap” of the convention it is necessary to find one or more general principles in the cisg that can support a uniform rule or approach to the regulation of limitation and exclusion of liability clauses in cisg contracts. rules 2 and 4 intend to build up these general principles. 2.1.4. issues of subtantive validity excluded 1.24. issues of substantive validity of exemption and limitation clauses are, however, not governed by the convention, as set forth in article 4, second sentence (a) cisg. 1.25. rule 4, below, specifically addresses situations where a provision under the applicable law or rules of law invalidates, with the purpose of protecting the obligee, the exclusion or limitation clause. while these issues are to be decided only by the otherwise applicable law or rules of law,23 the cisg provides the backdrop against which the limitation or exclusion clause has to be assessed under the applicable validity test.24 2.2. rule 2 2. according to the principle of freedom of contract laid down in article 6 cisg the parties may derogate from the provisions of the convention by including limitation and exclusion clauses. 2.2.1. comparative overview 2.2.2. general 2.1. limitation and exclusion of liability clauses permit contractual parties to preventively regulate the scope of the obligor’s liability should there be a breach of contract, thus modifying the legal regime of remedies njcl 2017/2 241 otherwise applicable. owing to the principle of freedom of contract, such clauses vary widely both in language and scope. for example, the parties may exclude any liability of the relevant party, agree on a cap on damages or limit the type of damages to be compensated (e.g,, by excluding indirect losses). they may also limit remedies other than damages, such as specific performance or avoidance of the contract. additionally, the parties may agree on the modification of time-limits and/or the reversal of the burden of proof.25 in some cases, an exemption or limitation of liability is a necessary condition to the performance of risky ventures. it is often required to make the risk insurable. it may also benefit the other party in the form of a price reduction.26 2.2. such clauses are found in all types of contracts, including sales contracts. they deal with the allocation of liability between the parties in a way that is functionally similar to clauses providing for the payment of agreed sums for failure to perform the contract (“agreed sums”).27 2.3. clauses that limit or exclude one party’s liability for nonperformance are subject to specific regulation in several legal systems. while preserving the freedom to contract and the full compensation principles, legal instruments and case law have attempted to protect the weaker party by the means of techniques designed to make it difficult to exclude liability under certain circumstances (e.g., in cases of personal injury or gross negligence). in particular, an agreement to limit or exclude the obligor’s liability for breach must not leave the obligee with no contractual remedies to enforce its rights under the contract.28 2.4. limitation and exclusion clauses contained in standard terms, 29 especially, are to be construed contra preferentem, i.e., against the proponent or the party seeking to benefit from it.30 they also subject to strict interpretation and, in some jurisdictions, to specifically prohibited terms.31 in addition, the proponent must give the other party a reasonable opportunity to take notice of the standard terms.32 2.5. the grounds for invalidation of exemption or limitation of liability clauses vary across regions and legal traditions. in some countries (e.g., england) the clause must satisfy a reasonableness test. in other countries, they are deemed null and void in explicit circumstances, namely, (a) where the non-performing party has willfully breached the contract (e.g., germany); (b) where non-performance results from gross fault or grossly negligent conduct (e.g., china); (c) where the clause limits or exempts liability for death or personal injury (e.g., quebec); and (d) where the clause contravenes mandatory norms, such as consumer protection rules (e.g., brazil). cisg ac opinion no. 17 242 2.2.3. civil law systems 2.6. exemption and limitation of liability clauses are permitted in most legal systems within the civil law tradition, including france, belgium, germany, italy, switzerland, spain, turkey, brazil, colombia, argentina, russia, china, japan and korea. such agreements may be voided under specific circumstances (see annex 1 for more details). 2.2.4. common law systems 2.7. in the common law tradition, agreements on the exemption and limitation of liability are generally accepted under the principle of freedom of contract.33 this is the case, for instance, in england, the united states, canada and australia. such clauses are usually referred to as “exculpation or exemption clauses”, or “limitation of liability” or “limitation of remedies”. similarly to civil law systems, such agreements may be voided where the non-performing party’s conduct was intentional or fraudulent. peculiar to the common law tradition is the notion of fundamental breach,34 or breach of a fundamental term, which for purposes of invalidating an exemption or limitation of liability clause is assimilated to gross fault (see annex 1 for more details).35 2.2.5. other jurisdictions 2.8. in mixed systems such as quebec (canada) and south africa, limitation and exclusions clauses are generally accepted, subjecting to the same kind of restrictions found in other jurisdictions, namely: exclusion of liability for willful conduct, for death or moral injury etc (see annex 1 for more details). 2.2.6. european union law and soft law 2.9. the cisg applies only to the sale of goods for business purposes. contracts for the sale of goods for personal use, which generally characterize consumer contracts, fall outside the scope of the convention (article 2(a) cisg).36 therefore, the european union instruments in the field of consumer protection dealing with the validity of exemption and limitation clauses are of little or no importance for comparative purposes (see annex 1 for more details). 2.10. the principles of european contract law (pecl) have resorted to a flexible standard. this soft law instrument allows for the exclusion or restriction of remedies for non-performance, “unless it would be contrary to good faith and fair dealing to invoke the exclusion or restriction”.37 njcl 2017/2 243 2.2.7. uniform law instruments 2.11. at the international level, a specific provision on exemption clauses has been included, since 1994, in the unidroit principles.38 while such clauses are generally valid, article 7.1.6 has retained the more flexible idea of “gross unfairness” as the standard for invalidity, thus introducing yet another approach to the common criteria indicated above. according to a commentator, the idea of “gross unfairness” comprehends those of “gross negligence” and “intentional conduct”.39 2.12. other international instruments, such as the 1999 montreal convention on the unification of certain rules for international carriage by air, establish limitations and exclusions of liability and, by the same token, invalidate any agreement to the contrary (see annex 1 for more details). 2.2.8. the position of the cisg 2.13. rule 2 of this opinion acknowledges that exemption and limitation of liability clauses are particularly common in international contract law and practice and constitute a usual feature of international sales contracts. 2.14. the parties’ freedom to limit and exclude the remedies available to the buyer and the seller under the cisg stems from the general principle of party autonomy recognized in article 6 cisg.40 2.15. this rule emphasizes the parties’ freedom to derogate from any of the cisg remedial provisions, as long as the obligee is not deprived of all remedies available under the convention. the obligee must retain at least a minimum adequate remedy.41 in other words, the limitation or exclusion of remedies must not amount to a situation where the fulfillment of the sales contract becomes optional, subject only to the will of the obligor.42 such a situation would contravene both the general principle of reasonableness,43 recognized as one of the most fundamental principles of the cisg, and the observance of good faith in international trade (article 7(1) cisg). 2.16. though frequently concerned with damages for breach in favor of the buyer (art. 45(1)(b)) and the seller (art. 61(1)(b)), these clauses may also limit or exclude other remedies available to the aggrieved party under the cisg. 2.17. these other remedies include: a) remedies available to the buyer: specific performance (art. 46(1)), delivery of substitute goods (art. 46(2)), repair of lack of conformity of the goods (art. 46(3)), price reduction (art. 50), and the remedy of avoidance (art. 49); and b) to the seller: specific performance of the buyer’s obligations (art. 62), and the cisg ac opinion no. 17 244 remedy of avoidance (art. 64). the seller’s right to cure (art. 48) may also be limited or excluded by agreement of the parties. 2.18. sometimes demand for a certain good is such that the seller may be in a position to impose the exclusion of one or more remedies available to the buyer. take for example the market of rare earth elements, which present a given country as a quasi-monopoly supplier. if the market creates a huge demand for this product, the seller may wish to exclude the buyer’s remedy of specific performance, and may also wish to limit its liability for damages in case of failure to deliver the goods. 2.19. in other situations, the goods are sold at such a low price that the seller may wish to limit its liability to the greatest extent possible. for example: a clothing wholesaler may wish to sell all of its old summer collection at very competitive prices. on the other hand, it may require buyers to agree to the exclusion of any remedies concerning the nonconformity of the goods, such as delivery of substitute goods (art. 46(2) cisg) and repair (art. 46(3) cisg). in addition, the seller may limit its liability to 50% of the contract price. 2.20. given the circumstances of the parties’ deal in the above examples, the agreed exclusion and limitation clauses referring to remedies other than damages seem perfectly reasonable and therefore enforceable. in contract practice, though, limitation and exclusion clauses concerning damages are way more frequent than those limiting other remedies under the cisg. 2.21. court decisions and arbitral awards have implicitly relied on article 6 cisg to enforce contract terms limiting or liquidating damages.44 on the issue of limiting the buyer’s right to damages under article 45(1)(b) cisg, a finnish court applied its domestic law and the cisg to validate the incorporation of the seller’s standard terms into the contract. these standard terms limited the seller’s liability in a manner that work, travel, freight, lay day or other indirect expenses were not to be compensated.45 on this same issue, a cietac arbitral award concluded that a post-breach agreement settling a dispute with respect to the seller’s non-performance had displaced the aggrieved party’s right to full compensation under article 74 of the convention.46 2.22. as to remedies other than damages, an austrian court has stated that even though the buyer has the right to avoid the contract under article 49(1), the parties may agree to derogate from this provision and restrict the buyer's rights. it asserted that such restrictions must be valid according to the applicable domestic law (article 4 cisg) and must not contradict the convention’s fundamental principles, namely the buyer’s right to avoid the contract, which the buyer must have as ultima ratio. njcl 2017/2 245 according to the court, if the buyer’s right to avoid the contract is restricted, at least it must have the right to damages.47 2.24. still on the same issue, a german court found that the buyer's declaration of avoidance was without effect, as the buyer had failed to act in accordance with the contractually established procedure, contained in the seller's general conditions of contract. the relevant clause provided that the buyer could only declare the contract avoided following an invitation to the seller to comply with the contract, and, even so, no sooner than 15 working days from the date the seller received such an invitation without complying with the contract.48 2.25. similarly, a polish court understood that the buyer’s right to avoid the contract in case of non-delivery had been excluded by a clause limiting the validity of the sale contract to 90 days after its conclusion. the court found that article 49(1)(b) could not be relied upon in the case at hand. it stated that under article 6 cisg the parties were free to shape the contract as they saw fit, which inter alia allowed them to introduce a provision for an automatic termination of the contract within a certain period of time. however, in light of article 7 cisg, which calls for the application of the general principles on which the convention is based, the rules governing the effects of the avoidance of contract must be considered. consequently, the court ordered the seller to reimburse the full price to the buyer and to pay interests, as required by article 84(1) cisg.49 2.26. the parties’ ability to derogate from or vary the effect of the remedies regime set out in the convention is based not only on the freedom of contract envisaged by article 6 cisg but also on the nonmandatory character of the cisg remedial provisions, namely articles 46, 49 and 50, which include the buyer’s remedies; articles 62 and 64, which include the seller’s remedies; article 48, which includes the seller’s right to cure; and articles 74 – 80 of the convention, which regulate damages, interest and exemptions.50 2.27. in the case of damages, the general principle of full compensation that derives from (but is also limited by) article 74 cisg51 can therefore be excluded or limited by a contract term or condition. the parties’ agreement notwithstanding, the principle of full compensation remains important and useful in establishing the effectiveness of any exclusion or limitation of liability clause under the otherwise applicable law or rules of law (lex causae).52 2.28. the parties’ agreement on the exemption or limitation of liability may as well reduce or eliminate the obligation on a party to pay interest on any sum that is in arrears set out in article 78 cisg.53 cisg ac opinion no. 17 246 2.29. the parties’ agreement on the exemption of liability may also modify the legal regime on exemptions set out in articles 79 and 80 cisg.54 2.3. rule 3 3. article 11 cisg preempts the application of form requirements for limitation and exclusion clauses provided for in the otherwise applicable law or rules of law. 2.3.1. general 3.1. rule 3 addresses the interplay of the convention’s fundamental principle of freedom from form requirements (article 11 cisg) and the rules invalidating sales contracts for lack of formal requirements set out in the otherwise applicable law or rules of law. 3.2. given the preeminent character of the principle embodied in article 11 cisg, the consequences of non-compliance with a form requirement under the otherwise applicable law (domestic law or rules of law) will not necessarily entail the invalidity of the limitation or exclusion clause. 2.3.2. form governed by article 11 cisg 3.3. though the wording of article 11 cisg addresses only the formation and evidence of an international sales contract, the principle of freedom of form is applicable to all legally binding acts within the cisg,55 including limitation and exclusion clauses. 3.4. rule 3 states that the formal validity of exemption and limitation clauses in cisg contracts is not governed by the provisions of the otherwise applicable law or rules of law. rather, it acknowledges that only article 11 cisg regulates the formal validity of international sales contracts. this provision constitutes an exception to the general rule set out in article 4 second sentence (a), cisg according to which questions of validity are excluded from the scope of the convention.56 3.5. article 11 cisg expresses the principle of freedom from form requirements and liberates cisg contracts from any such requirements regarding their conclusion, subsequent modification, or termination. thus the formal validity of cisg contracts is only subject to party autonomy, usages applicable pursuant to article 9 cisg, and the exception contained in article 12 cisg,57 which concerns the reservation provided in article 96 cisg.58 3.6. moreover, the convention does not require the contract to be evidenced by a particular form.59 it follows that the formal validity of njcl 2017/2 247 limitation and exclusion of liability clauses found in sales contracts is exclusively governed by the cisg and subject to the principle of freedom from form requirements. 3.7. some jurisdictions have established specific formal requirements to be met by exemption or limitation clauses. however, in accordance with rule 3 and the preemptive character of article 11 cisg, a contract governed by the convention must not comply with such formal requirements. 3.8. for instance, article 1341 of the italian civil code states that a limitation clause contained in standard conditions only binds the other party if, at the time of the contract conclusion, that party has expressly approved it in writing. the italian courts have characterized it as a formal requirement, which is met when the other party undersigns the relevant deed twice. 3.9. another example: under u.s. law, disclaiming an implied warranty may function as a limitation or exclusion clause.60 such a disclaimer seeks to limit the seller’s obligations concerning the product’s merchantability61 or fitness for a particular purpose.62 according to section 2-316 of the uniform commercial code the exclusion or modification of implied warranties in sales contracts (a) shall be in writing, (b) requires language mentioning “merchantability”, and (c) must show the exclusion or modification of the warranty conspicuously.63 requirements (a), (b) and (c) may be characterized, in a cisg contract, as form requirements concerning the validity of the warranty disclaimer. in accordance with this rule and the preemptive character of article 11 cisg, the absence of such form requirements cannot render the warranty disclaimer unenforceable.64 3.10. the convention must be uniformly interpreted and applied as required by article 7(1) cisg. therefore, the principle under article 11 cisg must not give way to domestic form requirements regarding the validity of limitation clauses.65 3.11. courts and arbitral tribunals have consistently reaffirmed the principle of freedom from form requirements established in article 11 cisg and its prevailing character over domestic form requirements.66 2.4. rule 4 4. (a) the convention does not preempt provisions for the protection of the obligee under the applicable law or rules of law, relying on notions such as intentional or willful breach, gross negligence, breach of an essential term, gross unfairness, unreasonableness, or unconscionability. cisg ac opinion no. 17 248 4. (b) however, in the application of these provisions, the international character of the contract and the general principles underlying the cisg are to be observed, including the principles of freedom of contract and reasonableness. 2.4.1. general 4.1. rule 4(a) addresses the interplay of the convention and the rules protecting the obligee contained in the otherwise applicable law or rules of law, which invalidate limitation and exclusion clauses under certain circumstances. it acknowledges the authority of such invalidating rules to govern limitation and exclusion clauses in cisg contracts. 4.2. on the other hand, rule 4(b) addresses the application of validity tests to limitation and exclusion clauses contained in cisg contracts under the otherwise applicable law or rules of law, as envisaged by rule 4(a). it establishes that in the application of such validity tests the general principles underlying the cisg are to be observed. 2.4.2. rule 4(a) freedom of contract and protection mechanisms 4.3 owing to the basic principle of freedom of contract, most domestic legal systems and international instruments recognize the validity of exemption or limitation clauses and their aptitude to derogate from the default liability regime provided by law.67 4.4 nevertheless, domestic legal systems and international instruments include control mechanisms to invalidate exemption or limitation clauses under certain circumstances. such legal mechanisms provide a special protection to the obligee, i.e., the party who, if not for the exemption or limitation clause, would be in a position to claim full compensation for damages caused by the obligor’s breach of contract, or exercise the remedy otherwise available. such mechanisms also nullify exemption and limitation agreements where their application results in unfair treatment of the performing party and an evident imbalance between the parties’ respective performances.68 they may vary according to their legal origin but, in general, result in unenforceability of the exemption or limitation. 4.5 as seen in the comments to rule 2, supra, the circumstances invalidating exemption or limitation clauses can be summarized as follows: i) exemption or limitation clauses are always invalid where the nonperformance is the result of fraudulent or willful breach on the part of the obligor.69 njcl 2017/2 249 ii) exemption or limitation clauses are sometimes invalid where the non-performance is the result of the obligor’s grossly negligent conduct.70 iii) exemption or limitation clauses are invalid where they concern the very substance of the obligation (obligation vidée de sa substance) or concern a major obligation (kardinalpflicht).71 iv) exemption or limitation clauses are invalid where they relate to the breach of obligations deriving from mandatory norms.72 v) exemption or limitation clauses are invalid when they are “unreasonable”.73 vi) exemption or limitation clauses are invalid when they concern the liability for death or personal injuries.74 vii) limitation clauses are subject to the “agreed sums” legal regime in cases where they also serve as liquidated damages clauses.75 ix) exemption or limitation clauses may be restricted by the general principles of legislation concerning “unfair terms”.76 x) exemption and limitation clauses included in standard terms or in adhesion contracts may have to meet the requirements imposed by some regulations on the validity of such contracts and the clauses they contain, and be interpreted restrictively or contra preferentem.77 xi) exemption and limitation clauses may not be invoked if it would be grossly unfair to do so, having regard to the contract.78 xii) exclusionary clauses are unenforceable if they are unconscionable.79 the perspective of the cisg 4.6. as per article 4, second sentence (a), the cisg is not concerned with the validity of the contract.80 it follows that protection mechanisms established by the otherwise applicable law or rules of law remain generally applicable to limitation clauses in contracts governed by the convention. thus, from the perspective of the cisg, all of these protection mechanisms affect the substantive validity of exemption and limitation of liability clauses. 4.7. what is considered to be a validity issue under the convention is not to be decided by the otherwise applicable law or rules of law, but by the cisg itself.81 4.8. as limitation and exclusion clauses fall under the cisg scope, their uniform interpretation is required under article 7(1) and governed by articles 8 and 9 cisg.82 therefore, cases involving a challenge to the validity of such clauses under the otherwise applicable law or rules of law call for an interpretation in accordance with the general principles on cisg ac opinion no. 17 250 which the cisg is based (article 7(2)). among such principles, the principle of reasonableness stands as the most important. case law 4.9. courts have applied protection mechanisms set out in the otherwise applicable law or rules of law in favor of the obligee, thus rendering unenforceable exemption or limitation of liability clauses.83 4.10. for example, a german court applied german law to render unenforceable the exemption of liability set out in the seller’s terms and conditions drafted in italian. it stated that the clause limited the liability to the exchange or repair of defective parts "escluso qualsiasi risarcimento di danni" ("excluding any compensation") and that the complete exclusion amounted to an inappropriate disadvantage for the plaintiff, and contradicted the legal provisions. therefore such a term had to be considered as compulsorily invalid according to section 9 agbg [standard terms of business act].84 4.11. while validating the exclusionary clause, a u.s. court has expressly stated that the validity and enforceability of such clause were governed by domestic law rather than by the cisg.85 2.4.3. rule 4(b) general 4.12. rule 4(b) addresses the application of validity tests to exemption and limitation of liability clauses contained in cisg contracts, under the otherwise applicable law or rules of law, as envisaged by rule 4(a). it stresses the need to apply such validity tests in accordance with an international standard (article 7(1) cisg) derived from the underlying principles of the cisg (article 7(2) cisg). this guideline intends to preserve the international character of the cisg, promote uniformity in its application and foster the observance of good faith in international trade, as envisaged by article 7(1). 4.13. as seen in the comments to rules 2 and 4(a), national laws and international instruments take different approaches to controlling the validity of exemption and limitation clauses. nevertheless, from a functional perspective these mechanisms generally render exemption and limitation agreements unenforceable where they: (a) exclude or restrict the obligor’s liability in cases of intentional or gross fault or gross negligence; (b) are unconscionable; (c) violate mandatory norms or the public policy of the relevant legal system; (d) exclude liability in case of a fundamental breach or breach of a fundamental term; and (e) concern the exclusion or limitation of liability for death or personal injury. njcl 2017/2 251 4.14. invalidation of the clause by the competent state court or arbitral tribunal is therefore the most common protection mechanism against abusive exemption or limitation of liability agreements. interpretation of validity tests under the cisg 4.15. where the convention has become applicable in a particular contracting state, it becomes part of the law of that state. more specifically, the cisg provisions become that part of state law which governs international sales contracts. in accordance with articles 1 through 6 cisg, issues concerning international sales contracts are then submitted to the convention rather than to another national, foreign or international body of rules.86 4.16. accordingly, the cisg is the prevailing governing instrument for international sales of goods in any given contracting state. the convention thus requires a harmonizing effort in those situations where a subsidiary set of rules is called upon to supplement the cisg regime. in other words, those rules supplementing the cisg, in spite of their different origin, must be interpreted and applied in accordance with international standards derived from the principles underlying the convention – article 7(1) and (2) cisg. 4.17. in particular, where the validity of a limitation or exclusion clause contained in a cisg contract is assessed against the rules of a domestic law, the standards usually employed in domestic cases must give way to international standards, developed from the underlying principles of the cisg. for example, a clause excluding the seller’s liability in case of breach of a cisg contract, found unconscionable and therefore unenforceable under washington law,87 is not necessarily invalid in an international context. the validity test to be applied must correspond to an international principle established by the cisg. 4.18. correspondingly, one or more international principles derived from the cisg must prevail over any other standard in assessing the validity of exemption or limitation clauses under domestic law notions such as intentional or willful breach, bad faith, gross fault, gross negligence, lack of proportionality, excessiveness, fundamental breach or breach of a fundamental term, unconscionability or unreasonableness. even the more flexible notion of gross unfairness found in the unidroit principles88 must be construed according to an international principle derived from the cisg. 4.19. in conclusion, it is the cisg that provides the background against which the validity of an exemption or limitation of liability clause must be assessed under the otherwise applicable law or rules of law. thus cisg ac opinion no. 17 252 the unfairness tainting the validity of a limitation clause must be determined in light of what is fair in international trade – and not in similar domestic transactions. the same reasoning applies to an exemption clause concerning the breach of a fundamental contract term: what exactly is a fundamental breach is to be determined in light of a principle established by the cisg. the principles underlying the cisg 4.20. determining the international principles derived from the cisg in cases involving the validity of exemption and limitation of clauses requires the application of interpretive standards of the convention under article 7(1) cisg. 4.21. first, regard is to be had to the international character of the cisg and, additionally, of the sales contract itself. the terms and concepts contained in the convention are to be interpreted autonomously, i.e., in the context of the cisg itself and not by reference to the meaning which might traditionally be attached to them by a particular domestic law.89 in general, the cisg employs neutral language for which a common understanding should be ideally reached. even in situations where the cisg has employed terms or concepts peculiar to one or more domestic legal systems (e.g., the foreseeability rule in article 74), the concept is to be interpreted autonomously considering its function within the context of the convention.90 4.22. second, the terms and concepts in the cisg are not to be construed in a strict and literal sense but in light of the main purpose of the convention, which is to provide a uniform framework for the international sale of goods. promoting the uniform application of the cisg provisions ensures that, in practice, these provisions are interpreted and applied to the greatest possible extent in the same way by courts of different contracting states or by arbitral tribunals. 4.23. last, but not least, the convention must be interpreted with a view to foster the observance of good faith in international trade (article 7 (1) cisg). while there is no consensus as to the direct application of the good faith principle to individual cisg contracts – much to the contrary – the principle exerts at least indirect influence on the contractual relationship between the parties.91 the principle of reasonableness 4.24. ‘reasonableness’ is not only a general principle of the cisg but one of the most fundamental principles on which the convention is based.92 njcl 2017/2 253 4.25. in different opinions, the cisg advisory council has referred to the principle of reasonableness in the context of the convention (e.g. – opinions no. 5, on the avoidance of the sales contract by the buyer; no. 6, on the calculation of damages under article 74; no. 8, on the calculation of damages under articles 75 and 76; no. 9, on the consequences of avoidance; no. 10, on agreed sums; and no. 13, on the inclusion of standard terms).93 4.26. the principle of reasonableness also appears under different labels in the convention. it is at the origin of the prohibition against abuse of rights and the prohibition against contradictory behavior (venire contra factum proprium), both stemming from article 7 cisg.94 4.27. regarding reasonableness as a fundamental principle of the cisg and reading it into every convention provision has been said to help tilt the scales in favor of filling the gaps in the convention by the means of its general principles rather than using the otherwise law applicable. a tilting of scales that is required by virtue of the good faith and uniformlaw mandate recited in article 7(1) cisg.95 interpretation of limitation and exclusion clauses under international principles 4.28. article 7(1) cisg requires that solutions developed to fill in the gaps in the convention be acceptable in a majority of legal systems belonging to different legal traditions.96 as seen in this opinion, the law largely recognizes the parties’ ability to exclude or limit their own contractual liability by agreement. as a result, the condition set forth in article 7(1) cisg is met. hence, the interpretation of the protection mechanisms set forth in the otherwise applicable law or rules of law must follow a comparative law approach. 4.29. additionally, as a fundamental principle of the cisg, reasonableness has a strong bearing on the proper interpretation of the protection mechanisms set forth in the otherwise applicable law or rules of law, which govern the substantive validity of limitation and exclusion agreements. 4.30. since freedom of contract is recognized as a general principle of the cisg,97 it must be determined whether the parties’ freedom in the context of international trade provides sufficient grounds for the interpretation of validity mechanisms concerning exemption and limitation of liability clauses. given the width of the parties’ freedom to allocate their risks and liabilities in a manner which modifies the remedies regime established in the convention (article 6 cisg), the interpretation of the protection mechanisms set forth in the otherwise applicable law or rules of law must follow the priority of freedom of contract. cisg ac opinion no. 17 254 4.31. in sum, the interpretation of the validity of protection mechanisms set forth in the otherwise applicable law or rules of law must observe the principles of reasonableness and freedom of contract underlying the cisg. 2.5. annex 1 limitation and exclusion clauses in comparative perspective 2.5.1. civil law systems exemption and limitation of liability clauses are permitted in most legal systems within the civil law tradition, including france, belgium, germany, italy, switzerland, spain, turkey, brazil, colombia, argentina, russia, japan and korea. see annex 1 for more details. (france) the french civil code is silent with respect to exemption and limitation clauses. nevertheless, they are generally valid under the principle of freedom of contract.98 in sales contracts, the legal regime governing exemption and limitation clauses is quite complex, as the civil code distinguishes between the seller´s warranty for hidden defects (garantie des vices cachés) (pejus), on the one hand, and the seller´s liability for delivery of non-conforming goods (aliud) on the other. under article 1645 of the civil code, the seller cannot exclude the warranty for those hidden defects that he knew at the time of the conclusion of the contract. furthermore, case law equates the professional seller’s warranty for hidden defects to that of a seller acting in bad faith, since the former is presumed to know all defects in the goods sold. clauses exempting or limiting the professional seller’s warranty for hidden defects are, nevertheless, admitted as between professionals of the same business sector. as regards the seller´s liability for non-conforming goods (aliud), the law is more flexible. french courts have admitted the exemption of the seller´s liability in cases where the goods delivered were of a different kind of those contracted for.99 accordingly, the courts only invalidate limitation and exemption clauses in case of willful breach or gross fault on the part of the seller, or in cases where the clause depletes an essential obligation under the sales contract (new art. 1170, civil code).100 in addition, the 2016 reform of the french civil code has introduced a particular regime concerning exclusion and limitation of liability in adhesion contracts (art. 1171).101 with regard to cisg contracts, doctrinal authorities advocate that the convention´s uniform treatment must prevail over the french domestic law distinction between the professional seller’s warranty for hidden defects and the ordinary seller´s liability for njcl 2017/2 255 non-conforming goods, even where the cisg does not specifically cover the specific aspect of the contract.102 (belgium) the belgian civil code is also silent with respect to exemption and limitation clauses. however, the case law has adopted a liberal approach that permits the exclusion of consequential damages even in case of gross negligence (but not in case of willful negligence).103 in addition, belgian law does not contain any restriction on the exemption and limitation of liability for personal injury.104 (germany) the german legal regime is more liberal towards limitation and exclusion agreements. hence, such clauses are valid in commercial contracts, save in cases where the obligor has intentionally breached the contract (section 276, bgb).105 in standard terms and adhesion contracts, exemption and limitation of liability clauses are deemed invalid in many circumstances, including where the breach of contract results from gross fault by the non-performing party.[9] some big german companies notoriously choose foreign laws, notably swiss law, to govern their international contracts in order to avoid the strict control on exclusion clauses in their standard terms which apply under german law.106 (italy) while this type of clause is generally valid under italian law, article 1229 of the civil code contains a specific provision invalidating the agreement where the breach of contract results either from willful or grossly negligent conduct, or from acts contravening public policy rules.107 in addition, exemption and limitation clauses contained in standard contract terms must be specifically approved by the adhering party (article 1341, civil code).108 (switzerland) in switzerland, article 100 of the code of obligations sets out a general rule validating, a contrario sensu, exemption and limitation clauses which do not exclude liability for unlawful intent or gross negligence.109 this provision also allows the court to invalidate the exclusion of liability for minor negligence under certain circumstances. swiss law makes no provision for control of standard terms in commercial contracts. (spain) similarly to france, the spanish civil code is silent on exemption and limitation of liability agreements. however, such clauses are generally valid under the principle of freedom of contract, save in cases where the breach results from intentional conduct or gross negligence, or the agreement contravenes good morals and public order (civil code, article 1102).110 the 1998 law on general contract conditions, which transposes eu directive 93/13/cee into spanish law, establishes a strict control on limitation and exclusion clauses contained in standard terms. it cisg ac opinion no. 17 256 applies not only to consumers but also to contracts between professionals. (turkey) under the 2012 turkish code of obligations, limitation and exemption agreements are valid, except in case of gross negligence (code of obligations, article 115). such clauses are also unenforceable where they contravene mandatory norms (article 27).111 in sale contracts, the exclusion or limitation of warranty is enforceable, except where the seller has acted intently or has been grossly negligent.112 (brazil) the brazilian civil code is also silent in relation to such clauses. nevertheless, exemption and limitation agreements are generally valid, under the principle of freedom of contract. they may be rendered null and void in situations where: a) they exempt the liability of the nonperforming party in cases of intentional conduct; b) they contravene a mandatory rule;113 c) they affect the very substance of the obligation or they concern a major obligation; and d) they concern liability for personal injury.114 in the case of standard contract terms, the proponent has to bring the existence of the exemption or limitation clause to the attention of the other party, as a result of the contra preferentem (article 423, civil code) and strict contract interpretation rules.115 (colombia) in colombia, the civil code permits the parties to exclude or restrict their liability for failure to perform the contract (article 1604, final sentence).116 the colombian courts have consistently validated exemption and limitation of liability clauses, including those contained in adhesion contracts. however, the supreme court has established that a party in breach is liable in case of willful misconduct or gross negligence, and invoked both the cisg and the unidroit principles in support of its understanding.117 while the validity of such clauses is not expressly addressed by the code, nullity (and not only unenforceability) seems to be the consequence of their being contrary to public policy rules (articles 1741 and 1742).118 the commercial code, like other laws (e.g., ley 80/93 on contracts with state entities), contains specific rules on exemption and limitation of liability. (argentina) the new civil and commercial code of argentina entered into force in 2015, unifying the rules on civil and commercial obligations.119 under the new regime limitation and exclusion clauses are valid, except where they exempt the obligor’s liability for willful conduct, contravene good faith and mandatory rules, or are abusive in nature (article 1743).120 (russia) article 421 of the russian civil code, enacted in the 1990’s, embraces the principle of freedom of contract.121 in addition, article 400 expressly allows the parties’ agreement to exclude or restrict their own njcl 2017/2 257 liability for failure to perform the contract.122 liability can thus be limited to (a) the reimbursement of actual damages (excluding loss of profits) or of only specific types of damages; (b) cases where non-performance is based on the party’s faulty conduct; (c) a cap, including a fixed amount. however, the clause is deemed null and void where the obligor has intentionally non-performed the contract (article 401).123 the russian civil code also governs the contract for the sale of goods, including agricultural products.124 article 461, for example, renders null and void the exemption of liability of the seller where the buyer has been dispossessed of the goods by a third party on grounds that already existed before the conclusion of the sales contract.125 (china) in china, the 1999 contract law mirrors the unidroit principles in many aspects, including the principle of freedom of contract.126 accordingly, it is possible to insert an exclusion or limitation of liability clause in most types of contracts, including sales contracts. this is qualified by the prohibition against excluding liability for bodily or personal injury (including death) and liability for damages if incurred deliberately or due to gross negligence. standard terms are subject to further restrictions, the violation of which may result in the standard term not being validly incorporated into the contract. according to article 39 of the 1999 contract law a party that provides standard clauses must draw the other party’s attention to limitations and exclusions of liability and provide adequate explanation upon request.127 the same provision prescribes that standard clauses, by sanction of nullity, must satisfy the fairness requirement. (japan) in japan, the principle of freedom of contract allows the parties to agree on limitation and exclusion clauses. the 1896 civil code, under reform since 2009,128 also permits the parties to agree on the amount of liquidated damages for the failure to perform an obligation (art. 420(1)). on the other hand, the civil code establishes the general principle of good faith (art. 1(2)) and public policy (art. 90).129 on the basis of these principles, courts have held that limitation and exclusion clauses do not release the obligor from liability if that liability was caused by an intentional act or by gross negligence. there are other specific statutory regulations as well. for example, concerning sales contracts, art. 572 of the civil code does not permit disclaimer of warranty if the seller knew of the defects. the japanese consumer contract act further establishes both general and specific provisions which restrict the scope of limitation clauses in consumer contracts.130 (korea) limitation and exclusion clauses are valid under korean law on the basis of the general principle of freedom of contract, as stated in cisg ac opinion no. 17 258 article 105 of the 1958 korean civil code (also know as civil act).131 on the other hand, such clauses are deemed unenforceable or invalid in cases of bad faith, intentional or grossly negligent conduct on the part of the obligor.132 in korea there are no specific rules governing limitation and exclusion clauses in standard terms. (sweden) in general, under swedish law the parties are free to make their own bargain, and the courts will not interfere or question whether or not the terms are unreasonable. this principle is however restricted in a number of ways. generally, a contract term cannot relieve, release or exonerate anyone from liability for breach of duty arising from his own fraud, willful misconduct, and gross negligence. the closest to codification of this principle is section 36 of the contracts act, which provides a general prohibition against unreasonable terms in contracts.133 2.5.2. common law systems in the common law tradition, agreements on the exemption and limitation of liability are generally accepted under the principle of freedom of contract.134 this is the case, for instance, in england, the united states, canada and australia. such clauses are usually referred to as “exculpation or exemption clauses”, or “limitation of liability” or “limitation of remedies”. similarly to civil law systems, such agreements may be voided where the non-performing party’s conduct was intentional or fraudulent. peculiar to the common law tradition is the notion of fundamental breach,135 or breach of a fundamental term, which for purposes of invalidating an exemption or limitation of liability clause is assimilated to gross fault. (united states) specific provisions on exemption and limitation of liability in sales contracts are found in section 2-719 of the american uniform commercial code.136 under this provision the parties may limit or alter the measure of damages recoverable under the relevant ucc provisions, as by limiting the buyer’s remedies to return the goods and repayment of the price or to repair and replacement of non-conforming goods or parts. the parties may also agree to establish a remedy as exclusive of all other remedies. where an apparently fair and reasonable clause because of circumstances fails in its purpose or operates to deprive either party of the substantial value of the bargain, it must give way to the general remedy provisions of part 7 of the ucc. clauses limiting or excluding the buyer’s remedies, liability for consequential damages or personal injuries may be challenged as unconscionable under section 2302 of the ucc.137 warranty disclaimers regulated by sections 2-314 and 2-315 of the ucc may function as a limitation or exclusion clause, given njcl 2017/2 259 that their purpose of limiting the seller’s obligations concerning the product’s merchantability138 or its fitness for a particular purpose.139 section 2-316 of the uniform commercial code requires that the exclusion or modification of implied warranties in sales contracts (a) must be in writing; (b) must use language mentioning “merchantability” and (c) must show the exclusion or modification of the warranty conspicuously.140 (england) the english unfair contract terms act of 1977 (ucta) regulates the exclusion and restriction of liability for breach of express and implied contractual obligations and the common law duty of care.141 it is not possible to exclude or restrict liability for death or personal injury resulting from negligence. in the case of other loss or damage resulting from negligence, liability can be restricted, but only insofar as the term or notice satisfies the ucta reasonableness test.142 as regards the breach or non-performance of a contract, section 3 of the ucta prevents the use of an exclusion clause under certain circumstances,143 unless it satisfies the reasonableness test. additionally, the english sale of goods act of 1979 and the supply of goods (implied terms) act of 1973 imply warranties as to title and quiet possession into contracts for the sale of goods and hire-purchase agreements which effectively confirm the seller's right to sell. under section 6(1) of ucta, liability for breach of these implied warranties cannot be excluded or restricted. likewise, similar warranties which are implied by the supply of goods and services act 1982 into other types of contract cannot be excluded.144 (canada) in the common law provinces of canada, a court shall refuse to give effect to an exclusion or a limitation of liability clause where it finds the clause unconscionable or concludes that it is contrary to public policy.145 (australia) under australian law limitation and exclusion agreements in business contracts are generally enforceable. there is no requirement for reasonableness in an exclusion clause. generally, there is no concept of gross negligence in australian law outside of particular legislative uses of the phrase. accordingly, it is possible to exclude liability for gross negligence subject to clear language being used to achieve this outcome. on the other hand, it is not possible to exclude liability for fraud or to contract out of relevant legislation. since the high court of australia decision in darlington futures ltd v. delco australia pty ltd (1986) 161 clr 500,146 exclusion clauses subject to australian law are to be interpreted according to their natural and ordinary meaning and read in light of the contract as a whole, looking at the context in which the clause appears. cisg ac opinion no. 17 260 thus, limitation and exclusion clauses are usually interpreted against the party for whose benefit it is intended to operate, and not in a manner that results in an absurd outcome or in a way that defeats the giving of consideration under a contract. a court may also take into consideration the relative bargaining power of the parties and whether there are any issues of unconscionability associated with the exclusion clause or disclaimer. in consumer and domestic transactions there are a number of statutory guarantees and implied conditions that cannot be excluded. 2.5.3. other jurisdictions in mixed systems such as quebec (canada) and south africa, limitation and exclusions clauses are generally accepted, subjecting to the same kind of restrictions found in other jurisdictions (exclusion of liability for willful conduct, for death or moral injury etc.). (canada) in quebec, article 1474 of the civil code forbids the exclusion or restriction of liability for material injury caused to another through an intentional or gross fault.147 under this same provision, it is not possible to exclude or limit liability for bodily or moral injury caused to another. as for contracts of sale, manufacturers and professional sellers are presumed to know of latent defects existing at the time of sale. therefore, an exclusion clause addressing latent defects is valid only if the seller or manufacturer can rebut the aforesaid presumption of knowledge (articles 1473 and 1733). as in canadian common law provinces, limitation and exclusion clauses are restrictively interpreted under the law of quebec. (south africa) south african law generally follows the common law approach. an exemption clause excluding liability for willful conduct or fraud is deemed to be against public policy and void and so is a clause which excludes liability for an intentional breach of contract. however, it is noteworthy that a clause excluding liability for ordinary and gross negligence is not against public policy.148 in contrast, doctrine and case law have developed a general presumption according to which, in case of doubt, the contracting parties’ intention was not to exclude liability for negligent acts. secondly, where the exemption clause is ambiguous, or the language used in the contract is capable of more than one meaning, the exemption clause is interpreted narrowly.149 2.5.4. european union law and soft law the cisg applies only to the sale of goods for business purposes. contracts for the sale of goods for personal use, which generally characterize consumer contracts, are excluded from the scope of the njcl 2017/2 261 convention (article 2(a) cisg).150 therefore, the european union instruments in the field of consumer protection that deal with the validity of exemption and limitation clauses are of little or no importance for comparative purposes (see annex 1 for more details). in the context of this opinion it is nevertheless worth mentioning two european union directives in the field of consumer protection law that deal with the validity of exemption and limitation clauses. as per the eu directive of april 5, 1993 on unfair terms in consumer contracts,151 such clauses may be considered “unfair”, thus non-binding on the consumer, where they are found to be “contrary to the requirement of good faith” or to cause “a significant imbalance in the parties’ rights and obligations arising under the contract, to the detriment of the consumer” (article 3.1). member states must provide that such clauses are not binding on the consumer (article 6). similarly, exemption or limitation clauses may be considered “ineffective” in consumer contracts, as per the eu directive of may 25, 1999 on the sale of consumer goods and associated guarantees.152 it provides that under conditions set out by domestic law, the consumer is not bound by “any contracted terms or agreements concluded with the seller before the lack of conformity is brought to the seller’s attention which directly of indirectly waive or restrict the rights resulting from this directive” (article 7). the 1999 eu directive has been incorporated into the more recent 2011 directive on consumer rights, which, however, does not deal directly with the validity of exemption or limitation of liability clauses.153 under the recent proposal for a common european sales law,154 which deals with both consumer and non-consumer contracts, the principle of freedom of contract plays a central role, as stated in article 1. however, “unfair contract terms”, such as those listed in article 84, are deemed not binding on the parties (article 79). the list of “unfair contract terms” include agreements on the exclusion or limitation of liability of the trader (a) for death or personal injury caused to the consumer; or (b) for any loss or damage to the consumer caused deliberately or as a result of gross negligence. in addition, may be deemed unfair any term excluding or hindering the consumer’s right to take legal action or exercise any other legal remedy, particularly by requiring the consumer to submit disputes exclusively to arbitration. the principles of european contract law (pecl) have resorted to a flexible standard, similar to the unidroit principles (see below), which allows for the exclusion or restriction of remedies for noncisg ac opinion no. 17 262 performance, “unless it would be contrary to good faith and fair dealing to invoke the exclusion or restriction”.155 2.5.5. uniform law instruments at the international level, a specific provision on exemption clauses has been included in the unidroit principles since their first edition (1994).156 while such clauses are generally valid, article 7.1.6 has retained the more flexible idea of “gross unfairness” as the standard for invalidity, thus introducing yet another approach to the other common criteria indicated above. in accordance with a commentator, the idea of “gross unfairness” comprehends those of “gross negligence” and “intentional conduct”.157 other international instruments, such as the 1999 montreal convention on the unification of certain rules for international carriage by air, establish limitations and exclusions of liability and, by the same token, invalidate any agreement to the contrary. the convention, which has replaced the 1929 warsaw convention, establishes several limitations and exemptions of liability of the international carrier.158 in addition, article 26 of the convention invalidates any contractual provision tending to relieve the carrier of liability or to fix a lower limit than that which is laid down in the convention. by contrast to other international instruments and most domestic laws, the 1956 united nations convention on the contract for the international carriage of goods by road has not embraced the principle of freedom of contract.159 while establishing several rules on the liability of the carrier (articles 17 to 29), the convention does not allow the parties to contract out of its provisions (article 41). it is also worth mentioning 2008 united nations convention on contracts for the international carriage of goods wholly or partly by sea, widely known as the rotterdam rules.160 though not yet in force, this instrument establishes a modern, comprehensive, uniform legal regime for the international maritime carriage of goods, updating, and in some cases replacing, many provisions in the hague rules, hague-visby rules and 1978 hamburg rules. as compared to the latter instruments, the rotterdam rules are much stricter with respect to the parties’ freedom to agree on exemption and limitation of liability clauses.161 njcl 2017/2 263 2.6. annex 2 limitation and exclusion clauses (examples) 2.6.1. limitation of damages (indirect and special damages excluded) contract for the sale and purchase of brazilian iron 11 liability 11.1 neither the seller nor the buyer shall be liable, whether in contract, tort or otherwise, for any indirect, punitive, consequential or special losses, damages or expenses of any kind directly or indirectly arising out of or in any way connected with the performance of this contract. the seller shall in no circumstances be liable for more than the difference between the contract price and the market price, based on the nearest available market, as the date of any breach of the contract. (damages limited to a cap) contract for the sale and purchase of brazilian iron 12.2. the maximum aggregate liability of one party to the other from all sources in relation to this contract or any other obligation, whether in contract, statute or regulation, tort (including negligence) strict liability or otherwise shall not exceed the amount of the contract year or such lesser amount as may be expressly provided for under the provisions of this contract, provided, however, that such limitation of liability shall not apply to liability resulting from fraud, willful misconduct or gross negligence by the parties (which shall not counted for the purposes of determining whether the maximum liability has been reached). in addition, neither of the parties have any liability to each other for indirect, incidental, special, moral or consequential damages or any kind arising from or attributable to this contract. (damages limited to a cap) contract for the acquisition of a brazilian company (quota purchase agreement) 5.5. the total amount of losses subject to indemnification by the seller under this section shall be limited to the aggregate amount of r$ 15,000,000.00 and the amount effectively received by the seller as earnout consideration calculated in accordance with schedule 3.3, and the purchaser recognises and agree that the limitation of liabilities set forth herein is an essential condition to seller to enter into this agreement. (damages limited to a cap, except in case of gross negligence) notwithstanding the above, the limit of cumulative liability under paragraph b shall not apply to seller’s liabilities arising from gross cisg ac opinion no. 17 264 negligence and willful acts of seller for which seller’s liability under contract shall be unlimited. (damages insured by purchaser and special, indirect, incidental and consequential damages excluded) contract for the sale of turbine spare parts add to clause 11.1 (seller’s standard terms – ece 188) [the seller] is not responsible for any damage which are insured by purchaser or for any special, indirect, incidental or consequential damages including but not limited to loss of profit, loss of power, loss of use, loss of revenue, cost of capital or costs due to interruption of power supply. (certain types of damages limited – short version) neither party shall be liable (whether in contract, tort (including negligence) or otherwise) for any loss of profit, loss of business or of revenues, loss of goodwill or reputation, whether caused directly or indirectly, or for any indirect, incidental, punitive or consequential loss, damage, cost or expense. (consequential loss defined) 2.6.2. consequential loss for the purposes of this article the expression “consequential loss” shall mean: (i) consequential or indirect loss under english law; and (ii) loss and/or deferral of production, loss of product, loss of use, loss of revenue, profit or anticipated profit (if any), in each case whether direct or indirect to the extent that these are not included in (i), and whether or not foreseeable at the effective date. notwithstanding any provision to the contrary elsewhere in the agreement and except to the extent of any agreed liquidated damages (including without limitation any predetermined termination fees) provided for in the agreement, the buyer shall save, indemnify, defend and hold harmless the seller group from the buyer group’s own consequential loss and the seller shall save, indemnify, defend and hold harmless the buyer group from the seller group’s own consequential loss, arising from, relating to or in connection with the performance or non-performance of the agreement. (excluded damages defined) (a) for purposes of this agreement's limitation(s) of liability, the term = excluded damages = refers to consequential, indirect, special, punitive, exemplary, or similar damages arising from any breach of this agreement. the term encompasses, for example, the following: (1) loss of profits == from collateral business arrangements ==; (2) damages from njcl 2017/2 265 business interruption; (3) loss of use; and (4) loss of data or privacy or confidentiality. (b) for the avoidance of doubt, the term = consequential damages = refers to damages that the breaching party could not reasonably have foreseen upon entering into this agreement; and (c) for the avoidance of doubt, the term = excluded damages = does not encompass incidental damages, namely reasonable expenses incurred by a party incident to a breach or delay by another party; that is to say, incidental damages are not excluded. (broad effect of limitation) the parties have specifically agreed that all limitations of liability set forth in this agreement are to apply: (1) to all claims for damages or other monetary relief, whether alleged to arise in contract, tort, or otherwise, and (2) even if the allegedly-liable party was advised, knew, or had reason to know of the possibility of excluded damages and/or of damages in excess of the relevant damages cap, if any; and (3) even if a limited remedy fails of its essential purpose. (parties’ liability not limited in case of fraud or willful misconduct) exclusive remedy – the indemnification provisions contained in this article 10 shall constitute the exclusive remedy of the parties in connection with this agreement and the transactions contemplated hereby other than claims arising out of willful misconduct or fraud by a party. (deposit retained) default by buyer: if buyer fails to perform the contract within the time specified, the deposits(s) made or agreed to be made by buyer may be retained or recovered by or for the account of seller as liquidated damages, consideration for the execution of the contract and in full settlement of all claims; whereupon all parties shall be relieved of all obligations under the contract; or seller, at his option, may proceed at law or in equity to enforce his rights under the contract. (earnest money deposit) horse sale agreement purchase price. 3.1 […] 3.2 the purchase price shall be paid as follows: buyer shall pay a non-refundable earnest money deposit of $___________________dollars in cash or readily available funds. it is expressly understood by the buyer that the nonrefundable earnest money deposit will be applied toward the purchase price if the purchase contingency is satisfied or waived. in the event the contingency is not satisfied, the seller shall retain the non-refundable earnest money deposit cisg ac opinion no. 17 266 in consideration for horse being unavailable for sale to another buyer during the inspection period. 3.3. […] 2.6.3. limitation of remedies (liability limited to replacement of goods) the company warrants only that all goods shall be of merchantable quality and in accordance with specifications. it will replace without charge f.o.b. point of destination, dominion of canada, all goods shown to be otherwise than as warranted. liability is limited to such replacement and the company shall in no case be liable otherwise or for indirect of consequential damages. (liability limited to repairing or replacing a defective part) our obligation under this warranty shall be limited to repairing a defective part, or at our option, refunding the purchase price or replacing such part or parts as shall be necessary to remedy any malfunction resulting from defects in material or workmanship as covered by this warranty. 2.6.4. exclusion of liability (exclusion of liability) contract for the supply of a remote network operations center service [...] neither party will be liable to the other for any damage to software, damage to or loss of data, loss of profit, anticipated profit, revenues, anticipated savings, goodwill or business opportunity, or for any indirect or consequential loss or damage. (supplier’s liability excluded) industrial machinery suppliers will not be liable for any loss or damage whatsoever which is due to late or defective delivery; defective, faulty or negligent workmanship; or defective or faulty material; or any act, default or omission of its employees, suppliers or subcontractors. (vendor’s liability excluded) the vendor shall not be under any liability to the purchaser for any defects in the goods or for any damage, loss, death or injury (other than death or personal injury caused by the negligence of the vendor) resulting from such defects or from any work done in connection therewith (seller’s liability excluded) the delivery times provided are merely indicative and depend on procurement opportunities. the delivery times will be respected to the extent possible. delays in delivery cannot be the basis for cancellation of njcl 2017/2 267 the order or for claims to compensation or damages. no penalty is applicable in the event of delay, regardless of any notice to the contrary. (seller’s liability excluded) b shall bear all liabilities, in contract, in torts (including negligence) or otherwise, for any damage whatsoever, to person or property, sustained during the period of time from the delivery of the prototype by a until restitution of the latter to a pursuant to article 6. accordingly, a shall bear no liability whatsoever for any kind of damage, given the fact that the prototypes are delivered “as such”, that no warranty whatsoever is granted by a with regard to the performance, quality or design of such prototypes and finally that b alone is responsible for installing the prototypes on its facilities and for the testing work to be performed therewith. (seller’s liability excluded) contract for the acquisition of a brazilian pharmaceutical company (quota purchase agreement). notwithstanding anything to the contrary in this agreement or under applicable law, the sellers’ obligations to indemnify under this article x shall be subject to the following restrictions and limitations: • survival. in no event shall the sellers be responsible to the purchaser for any obligation arising out of sections 10.2 (a) and 10.2 (b) in respect to which a third party claim is not underway as of the closing date or an indemnification notice is delivered later than: 1. the whole statutory period set forth in applicable law, with respect to the warranties granted under sections 8.1.11 (organization and powers), 8.1.2 (subsidiaries), 8.1.3 (capital stock and ownership of sold quotas), 8.1.4 (no violation), 8.1.5 (authorizations) and 8.1.6 (no litigation or other obligations on quotas) of exhibit 8.1; 2. six (6) years from the closing date, with respect to the warranties granted under sections 8.1.11 (tax issues; tax benefits) and 8.1.18 (safety, health and environmental laws) of exhibit 8.1; 3. three (3) years as from the closing date, with respect to the warranties granted under section 8.1.16 (civil and criminal litigation) of exhibit 8.1; and 4. two (2) years as from the closing date, with respect to the warranties not referred to in the foregoing items. • de minimis. except for any obligation arising out of sections 10.2(c), 10.2(d) and 10.2(e), the sellers shall have no cisg ac opinion no. 17 268 obligation to indemnify the purchaser under the present agreement for those losses that, on a unitary basis, do not exceed fifteen thousand reais (r$ 15,000.00). in other words, no loss involving an individual amount equal to or less that such threshold shall be indemnifiable by the sellers under this agreement, other than those referred to in sections 10.2(c), 10.2(d) and 10.2(e); (seller’s liability not excluded in case of fraud, bad faith or gross negligence) neither a, its employees, nor any affiliated company of a or its employees, will be responsible for losses or damages that may be incurred by b or any third party by reason of any action or omission by b, its employees or any third party even though said action or omission was based on technical information or advice furnished by a, its employees, any of its affiliated companies or its employees, in accordance with this agreement, except if such damages or losses were caused by fraud, bad faith or gross negligence on the part of a or its employees. (seller’s liability for environmental contingencies excluded) y shall not be liable for any corrective action required by third parties or for any fines or damages resulting from a situation or procedure which was identified as problematic in the conclusions of the environmental audit, and for which no corrective action has been required by y. (seller’s liability excluded by virtue of limiting the scope of its obligation) the technical assistance and the services which a undertakes to perform for b in accordance with this agreement will be of an advisory nature only, and due to this all of the responsibility for the utilization of the technical recommendations provided by a, its employees, its affiliates or their employees in accordance with this agreement, shall rest solely with b. (seller’s liability for timely delivery excluded) delivery dates are the technical assistance and the services which a undertakes to perform for b in accordance with this agreement will be of an advisory nature only, and due to this all of the responsibility for the utilization of the technical recommendations provided by a, its employees, its affiliates or their employees in accordance with this agreement, shall rest solely with b. 2.6.5. modification of time-limits the buyer agrees that any claim or lawsuit relating to the purchased goods must be filed no more than six (6) months after the delivery date. the buyer hereby waives any statute of limitations to the contrary. njcl 2017/2 269 2.7. annex 3 cases cited australia forum: darlington futures ltd v. delco australia pty ltd, high court of australia [supreme court]. case reference: 1986 161 clr 500 http://www.austlii.edu.au/au/cases/cth/hca/1986/82.html facts: darlington futures ltd. is a broker which engages in transactions on the commodity futures market. delco australia pty ltd. is an engineering company which earned large profits in the financial year ended 30 june 1981. as that year drew to a close delco's accountant, mr schultz, discussed with darlington’s mr kleemann means by which the expected profit might be postponed until the succeeding financial year for tax purposes. upon darlington’s advice, the parties executed a written contract dated 12 june 1981, according to which darlington would enter into tax straddle transactions on behalf of delco. a tax straddle is a trading mechanism which is not designed for the making of profits out of trading; it is intended to avoid, so far as possible, exposure to trading losses. its purpose is to enable a loss to be made in one financial year which is offset by a corresponding profit in the succeeding financial year. this is achieved by matching contracts to sell commodities with contracts to buy commodities. a provision in the contract authorizing darlington to operate a discretionary account on behalf of the respondent was crossed out. the contract provided that, unless the client's account was to be traded as a discretionary account by darlington, the client should be solely responsible for operating and controlling it (clause 9). initially the transactions were entered into by darlington in such a way that the risk of loss to delco was minimized, leaving it with no disadvantage except brokerage fees. in july 1981 delco decided to take some risks with a view to recouping the brokerage fees. delco’s executives instructed darlington to engage in day trading. day trading leaves the investor exposed to the market for one day in the hope of making profits. such day trade transactions generated heavy losses to delco. delco sued to recover $279,715.36 damages from darlington, claiming that this was the amount of the losses it sustained on contracts as a result of darlington's breach of duty in trading in futures contracts without the respondent's authority. decision: at first instance, the court found that delco’s exposure of the coffee contracts and the silver contracts to the risks of the market for a substantial period of time was outside the ambit of the general cisg ac opinion no. 17 270 instructions which had been given to darlington. it accepted the evidence that delco’s officials had not authorized these transactions and were unaware that delco was exposed to those risks. however, the court found for darlington on the ground that, notwithstanding that the relevant transactions were not authorized by the respondent, clause 6 of the written contract between the parties excluded the appellant's liability for any loss arising in any way out of any trading activity undertaken on behalf of the client whether pursuant to the contract or not. on appeal the full court of the supreme court of south australia considered that the exclusion clause should be construed strictly and that, in accordance with this approach, the last sentence in clause 6 had no application to the case because the relevant trading activity was unauthorized. the full court also held that clause 7, which capped the damages to be paid by darlington, did not apply. in particular it considered that, as the transactions were unauthorized, the claim did not fall with clause 7(c). although the primary judge was not satisfied that darlington had deliberately defied delco’s instructions, the full court thought that deliberate defiance of those instructions was the proper, if not the inevitable, inference to be drawn from the evidence. the high court affirmed in part the full court’s judgment, specially in respect of the inference drawn by the latter. when the critical transactions are viewed in this light, the failure to unlock the straddle by taking the final step on the same day, or within a day, was not a negligent performance of delco's instructions. it positively committed delco to a form of speculation quite beyond the ambit of the authority given to darlington. as to whether clause 6 protected darlington from the consequences of what otherwise would be breaches of contract, darlington argued, on the basis of the house of lords precedents, that exclusion clauses should be simply construed in accordance with their language and that they should not be subjected to a strained construction in order to reduce the ambit of their operation. the high court acknowledged that it had in past decisions authoritatively stated the approach to be adopted in australia to the construction of exclusion and limitation clauses, without relying on the doctrine of fundamental breach. it noted that the interpretation of an exclusion clause is to be determined by construing the clause according to its natural and ordinary meaning, read in the light of the contract as a whole, thereby giving due weight to the context in which the clause appears including the nature and object of the contract, and, where appropriate, construing the clause contra proferentem in case of njcl 2017/2 271 ambiguity. notwithstanding the comments of lord fraser in ailsa craig (at p.970; p.105 of all e.r.), the same principle applies to the construction of limitation clauses, which may be so severe in their operation as to make their effect virtually indistinguishable from that of exclusion clauses. turning to clause 6 of the contract, the high court examined whether the relevant losses arose "in any way out of any trading activity undertaken on behalf of the client whether pursuant to this agreement or not". it found that, read in context, these words plainly refer to trading activity undertaken by darlington for delco with the latter's authority, whether pursuant to the agreement or not. the court further noted that it could scarcely be supposed that the parties had intended to exclude liability on the part of darlington for losses arising from trading activity in which it presumed to engage on behalf of the respondent when the appellant had no authority so to do. finally, the high court examined whether darlington was protected by clause 7(c) of the contract, which limited the liability of the appellant to $100 in relation to claims of three kinds : (1) claims arising out of or in connection with the relationship established by the agreement; (2) claims arising out of or in connection with any conduct under the agreement; and (3) claims arising out of or in connection with any orders or instructions given by the client to the broker. as opposed to the full court, the high court found that it must not interpret must not place a more restrictive interpretation on the clause than its language would naturally bear. in particular, the clause is expressed to comprehend claims arising out of or in connection with the relationship established by the agreement. a claim in respect of an unauthorized transaction may nonetheless have a connection, indeed a substantial connection, with the relationship of broker and client established by the agreement. the court then found that it was unable to discern any basis on which clause 7(c) can be construed so as not to apply to such a claim. the present case is one in which delco's claim arises in connection with the relationship of broker and client established by the contract between the parties, notwithstanding the finding that the relevant transactions were not authorized. in the result clause 7(c) operates to limit the appellant's liability to $100 in respect of each of the unauthorized coffee and silver contracts. austria forum: oberster gerichtshof [supreme court] case reference: 7 september 2000 case no. 8 ob 22/00v unilex, available at http://www.unilex.info/ case.cfm?id=473 cisg ac opinion no. 17 272 facts: a german seller and an austrian buyer concluded a contract for the delivery of gravestones made of dark stone, as they had previously done. the price was to be paid by a bill of exchange. according to the seller's standard order form, written notice of non-conformity should be made within 24 hours. if the goods were not conforming, the seller had the right either to cure the defect, or to replace the goods or else to pay back the price. furthermore, the buyer did not have the right to withhold payment. a few weeks after delivery, white marks were detected on the gravestones. the marks could not have been detected upon delivery, since they developed later. the buyer phoned the seller, which sent for some of the stones for examination. it was never discussed if the seller should deliver new gravestones, or if the buyer should not pay the price. the terms of the standard order form were not discussed either. as the bill of exchange was dishonoured by non acceptance, the seller refused to continue negotiations with the buyer. the buyer then declared the contract avoided. the seller commenced action against the buyer, alleging that the latter had to pay the price since it did not have the right to withhold payment; moreover, the goods were conforming or at least the defects in the stones were of minor importance. the buyer contested the validity of the standard clauses, and stated furthermore that it did not have to pay the price, since it had the right to avoid the contract according to art. 49(1) cisg. according to the applicable german law, the standard terms including the restriction of the right to withhold payment were valid. this was not in contradiction with the fundamental principles of cisg, since the restriction of the right of retention did not reduce the buyers right to avoid the contract. therefore, the buyer had to pay the price, even though the matter of conformity was not settled. then, if the seller could not cure the defect or if he did not replace the goods, the question would be whether or not the buyer could avoid the contract or if it only had the right to a reduction of the price. decision: the court stated that even though the buyer, according to art. 49(1) cisg, has the right to avoid the contract under certain circumstances, the parties can agree to derogate from this provision and restrict the buyer's rights. these changes must be valid according to the applicable domestic law (art. 4 cisg). however, even if the changes are valid according to the rules of the applicable domestic law, such rules must not contradict the fundamental principles (grundwertungen) of the cisg. the court stated that one of cisg's fundamental principles is the right for the buyer to avoid the contract, which the buyer must have as njcl 2017/2 273 ultima ratio, if the seller after an additional period of time still has not delivered the goods, or if the goods in spite of the sellers remedies are still essentially useless. if this right to avoid the contract is restricted, at least the buyer must have the right to damages. forum: oberster gerichtshof [supreme court] case reference: 14 january 2002 case number: 7 ob 301/01t http://cisgw3.law.pace.edu/cases/020114a3.html clout case no. 541 (cooling system case) [principle of full compensation] facts: an austrian buyer ordered from the german seller a cooling device according to custom specifications for its special intended use in a water plant. the general terms of delivery and payment of the contract contained a choice of german law and special rules on the notice of lack of conformity. as the seller did not deliver on the agreed date, the equipment had to be delivered directly to the construction site and could not be tested, as originally planned, before it was set into place. due to a construction flaw, the cooler could be operated only provisionally and had later to be completely rebuilt by the buyer. the buyer notified the lack of conformity of the cooling device to the seller. the buyer also warned the seller that he would be held responsible for damages to the main contractor if the cooling device could not be made fully operational on schedule and that the repair of the cooler might be very expensive. in fact, the damages stemming from the malfunctioning of the cooling device considerably exceeded its price, and the buyer declared their set off with the price for other equipment delivered by the seller under a different contract. decision: both the court of appeal and the supreme court deemed the cisg applicable to the contract. in particular, the supreme court discussed three issues: whether the examination of the good was performed properly and timely; whether the notice of non-conformity was timely and sufficiently specific; and the amount of damages to be paid, with special regard to the circumstances and conditions under which the damages to be paid could exceed the price of the goods. among other issues, the supreme court stated that if the seller fails to repair the nonconforming goods within reasonable time, the buyer may do so and claim compensation from the seller for the related expenses, which amount to damages within the meaning of article 45(1)(b) cisg. the court added that the same mechanism applies when the seller cannot be expected to carry out a repair, but that the expenses for such a repair may be compensated only insofar as they are reasonable in relation to the intended use of the sold goods. taking into account all the circumstances of the case (urgency, time needed to replace the faulty device, claims from cisg ac opinion no. 17 274 the main contractor), the court held that the buyer could set off the damages against the full amount of the contractual price. finally, the supreme court noted that the right to damages under article 74 cisg follows the principle of foreseeability and full compensation, and that all losses, including expenses made in view of the performance of the contract and loss of profit, are to be compensated to the extent they were foreseeable at the time of the conclusion of the contract. according to the court, the foreseeability requirement is met if, all the circumstances of the case considered, a reasonable person could have foreseen the consequences of the breach of contract, even if not in all details and in their final amount (article 8(2) cisg). consequential loss may also be compensated, if not excluded by parties' agreement, as it was not in this case. forum: arbitral award internation ales schiedsgeri cht der bundeskam mer der gewerblich en wirtschaft wien case reference: 15 june 1994 sch-4366 http://www.unilex.info/ case.cfm?id=55 clout case no. 93 [citing article 74 for general principle within meaning of article 7 (2) cisg] facts: in 1990 and 1991 an austrian seller and a german buyer concluded contracts for the sale of rolled metal sheets. the initial contracts provided that the goods were to be delivered 'fob hamburg', by march 1991 at the latest. later, due to the buyer's financial difficulties, the seller allowed the buyer to take delivery in installments according to the possibilities of resale, and the buyer had to pay promptly after receiving each invoice and cover all storage costs. the buyer took delivery of some of the goods without paying, and refused to take delivery of other goods. pursuant to an arbitration clause, the seller commenced arbitral proceedings, demanding payment of the price. the seller further asked for damages, including those deriving from a substitute sale of the undelivered goods. decision: the sole arbitrator held that since the parties had chosen austrian law, the contracts were governed by cisg as the international sales law of austria, a contracting state (art. 1(1)(b) cisg). with regard to the goods delivered but not paid, the sole arbitrator found that the seller was entitled to payment of their price (arts. 53 and 61 cisg). regarding the cover sale made by the seller, the arbitrator observed that the seller had the right to make a cover sale, and presumably even a duty to do so because of the duty to mitigate damages (art. 77 cisg). the seller would be entitled to the difference between the contract price and the substitute sale price. njcl 2017/2 275 the sole arbitrator further held that interest on the price accrued from the date payment was due (arts. 78 and 58 cisg). since the parties' agreement required the buyer to pay after receiving each invoice, interest accrued from the date of such receipt, which should occur within 10 days after issuance of each invoice. the sole arbitrator held that the interest rate is a matter governed but not expressly settled by cisg. therefore, it must be settled in conformity with the general principles on which the cisg is based (art. 7(2) cisg). referring to arts. 78 and 74 cisg, the arbitrator found that full compensation is one of the general principles underlying cisg. in relations between merchants, it is expected that the seller, due to the delayed payment, resorts to bank credit at the interest rate commonly practiced in its own country with respect to the currency of payment. such currency may be either the currency of the seller's country, or any other foreign currency agreed upon by the parties. the arbitrator observed that this solution is stated also in art. 7.4.9 of the unidroit principles of international commercial contracts. the interest rate awarded, therefore, was the average prime rate in the seller's country (austria), with respect to the currencies of payment (us dollars and german marks. belgium forum: hof van beroep, gent date and reference: 15 may 2002 http://www.unilex.info/ case.cfm?id=940 [considers the good faith principle in the context of the cisg to establish the binding nature of the contract] facts: a belgian seller negotiated with a french buyer to produce the plastic holders for pagers and to insert the pagers in these. the results of the negotiations were set out in writing signed by the parties and entitled by them ‘letter of intent’. decision: when the buyer, after subsequent market changes, denied the existence of a binding contract the seller sued the buyer for breach of contract. the court of first instance denied its jurisdiction. the court of appeal reversed the decision and affirmed the jurisdiction of belgian courts. it based its decision on art. 5(1) of the 1968 brussels convention on jurisdiction and the recognition and enforcement of judgments in civil and commercial matters. the court determined the place of performance of the obligation in dispute (the payment of the price) in accordance with cisg, which was the law governing the contract since the parties had chosen french law as the applicable law and france was a contracting state to cisg. according to cisg ac opinion no. 17 276 art. 57 cisg, payment of the price should be made at the seller's place of business, i.e. in belgium. as to the merits the court decided in favor of the existence of a binding contract. the court pointed out that it was not always possible to identify clearly in practice a sequence of an offer and an acceptance as provided in cisg. in the case at hand it affirmed the existence of binding contract in the light of the circumstances and the principle of good faith (art. 7(1) cisg), despite the fact the title 'letter of intent' given by the parties to their writing. canada forum: tercon contractors ltd. v. british columbia (transportation and highways), supreme court of canada date and reference: 12 february 2010 2010 scc 4 [2010] 1 scr 69 case number: 32460 http://scccsc.lexum.com/scccsc/scccsc/en/item/7843/index.do (doctrine of fundamental breach) facts: the province of british columbia issued a request for expressions of interest (“rfei”) for the design and construction of a highway. six teams responded with submissions including tercon and brentwood. a few months later, the province informed the six proponents that it now intended to design the highway itself and issued a request for proposals (“rfp”) for its construction. the rfp set out a specifically defined project and contemplated that proposals would be evaluated according to specific criteria. under its terms, only the six original proponents were eligible to submit a proposal; those received from any other party would not be considered. the rfp also included an exclusion of liability clause which provided: “except as expressly and specifically permitted in these instructions to proponents, no proponent shall have any claim for compensation of any kind whatsoever, as a result of participating in this rfp, and by submitting a proposal each proponent shall be deemed to have agreed that it has no claim.” as it lacked expertise in drilling and blasting, brentwood entered into a pre‑ bidding agreement with another construction company (“eac”), which was not a qualified bidder, to undertake the work as a joint venture. this arrangement allowed brentwood to prepare a more competitive proposal. ultimately, brentwood submitted a bid in its own name with eac listed as a “major member” of the team. brentwood and tercon were the two short‑ listed proponents and the province selected brentwood for the project. tercon successfully brought an action in damages against the province. the trial judge found that the brentwood bid was, in fact, submitted by a joint njcl 2017/2 277 venture of brentwood and eac and that the province, which was aware of the situation, breached the express provisions of the tendering contract with tercon by considering a bid from an ineligible bidder and by awarding it the work. she also held that, as a matter of construction, the exclusion clause did not bar recovery for the breaches she had found. the clause was ambiguous and she resolved this ambiguity in tercon’s favour. she held that the province’s breach was fundamental and that it was not fair or reasonable to enforce the exclusion clause in light of the province’s breach. the court of appeal set aside the decision, holding that the exclusion clause was clear and unambiguous and barred compensation. for all defaults. decision: in respect of the doctrine of fundamental breach, the supreme court described it as follows: “… where the defendant had so egregiously breached the contract so as to deny the plaintiff substantially the whole of its benefit … the innocent party was excused from further performance but the defendant could still be held liable for the consequences of its ‘fundamental breach’ even if the parties had excluded liability by clear and express language. china forum: china internation al economic and trade arbitration commissio n (cietac) date and reference: 1 april 1993, arbitral award no. 75, unilex, available at http://www.unilex.info/ case.cfm?id=429 facts: a chinese seller and an us buyer concluded a contract for the sale of steel products. in view of the seller's impossibility to deliver a substantial part of the goods, both parties agreed to enter into further negotiations in order to terminate the contract and amicably settle their dispute. the seller took the initiative and declared itself willing to pay the penalty provided for in the contract for late delivery on the condition that the buyer would discharge it from any further contractual obligation; the buyer replied it would accept this proposal provided that the seller would also bear the insurance expenses. the seller then sent a fax to the buyer whereby it (1) expressly accepted the buyer's offer and (2) asked the latter to draft a formal termination agreement. after the seller paid its penalty, however, the buyer filed an arbitration suit claiming its entitlement to the full compensation of the harm sustained (invoking art. 19 of the law of the people's republic of china on economic contracts involving foreign interests together with art. 74 cisg): it argued that the afore-mentioned fax sent by the seller, amounted to a counter-offer which it had never accepted. cisg ac opinion no. 17 278 decision: with respect to the law governing the contract, the arbitral tribunal stated that it would apply both the law of the people's republic of china on economic contracts involving foreign interests (by virtue of the principle of closest relation with the contractual performance) and cisg (because china and the united states were both contracting countries). the arbitral tribunal rejected the buyer's claim. in its view, the fax sent by the seller amounted to an acceptance of the offer made by the buyer (art. 19 (2) cisg) rather than, as pleaded by the latter, to a counteroffer. the arbitral tribunal therefore concluded that the parties had reached a final agreement on the termination of the contract, whereby they had completely settled their dispute, and held that the buyer was not entitled to any compensation in addition to the contractual penalty. columbia forum: constitutional court date and reference: 9 december 2010 case number: c-1008 http://www.unilex.info/ case.cfm?id=1591 facts: colombian citizens challenged the constitutionality of article 1616 of the colombian civil code according to which, except in case of willful misconduct or gross negligence, a party in breach is liable for the harm it had foreseen or should have foreseen as a consequence of its nonperformance. they argued that such limitation violated, among others, the parties' fundamental right to full compensation. decision: the constitutional court rejected the claim. in so doing the court pointed out that not only was the provision in question neither irrational or arbitrary but was inspired by basic criteria of justice and contractual fairness, and moreover was in conformity with important international instruments such as the vienna sales convention (article 74) and the unidroit principles (article 7.4.4). england forum: hadley v. baxendale, court of exchequer date and reference: 1854 ewhc j70 9 exch. 341, 156 eng. rep. 145 facts: a shaft in hadley’s (plaintiff) mill broke rendering the mill inoperable. hadley hired baxendale (defendant) to transport the broken mill shaft to an engineer in greenwich so that he could make a duplicate. hadley told baxendale that the shaft must be sent immediately and baxendale promised to deliver it the next day. baxendale did not know that the mill would be inoperable until the new shaft arrived. njcl 2017/2 279 baxendale was negligent and did not transport the shaft as promised, causing the mill to remain shut down for an additional five days. hadley had paid 2 pounds four shillings to ship the shaft and sued for 300 pounds in damages due to lost profits and wages. decision: the jury awarded hadley 25 pounds beyond the amount already paid to the court and baxendale appealed. to determine the amount of damages to which an injured party is entitled for breach of contract, the court of exchequer held that an injured party may recover those damages reasonably considered to arise naturally from a breach of contract, or those damages within the reasonable contemplation of the parties at the time of contracting. the court held that the usual rule was that the claimant is entitled to the amount he or she would have received if the breaching party had performed; i.e. the plaintiff is placed in the same position she would have been in had the breaching party performed. under this rule, hadley would have been entitled to recover lost profits from the five extra days the mill was inoperable. the court held that in this case however the rule should be that the damages were those fairly and reasonably considered to have arisen naturally from the breach itself, or such as may be reasonably supposed to have been in the contemplation of both parties at the time the contract was made. the court held that if there were special circumstances under which the contract had been made, and these circumstances were known to both parties at the time they made the contract, then any breach of the contract would result in damages that would naturally flow from those special circumstances. damages for special circumstances are assessed against a party only when they were reasonably within the contemplation of both parties as a probable consequence of a breach. the court held that in this case baxendale did not know that the mill was shut down and would remain closed until the new shaft arrived. loss of profits could not fairly or reasonably have been contemplated by both parties in case of a breach of this contract without hadley having communicated the special circumstances to baxendale. the court ruled that the jury should not have taken the loss of profits into consideration. european union forum: alsthom atlantique sa v compagnie de constructio n mécanique sulzer sa, european court of justice, second chamber cisg ac opinion no. 17 280 date and reference: 24 january 1991 case number: c-339/89 reference for a preliminary ruling: tribunal de commerce de paris france. articles 2, 3(f), 34 and 85 (1) of the eec treaty liability for defective products. [liability for defective products and free movement of goods] facts: sulzer, involved in a claim for latent defects in two vessel engines provided to alsthom, was, according to french law, unable to rely on a clause that exempted its liability. a peculiar but consolidated case law of the cour de cassation interpreted the relevant provisions of the french civil code so as to allow clauses limiting liability only where the parties to the contract were engaged in the same specialized field (which was not the case). sulzer therefore claimed that such case law distorted competition and hindered, contrary to article 29 (formerly 34) ec, the free movement of goods by putting french undertakings at a disadvantage compared to the foreign competitors who were not subject to such stringent liability. decision: the ecj held that article 29 ec applied to restrictions on intracommunity trade which placed the export trade at a disadvantage for the benefit of domestic trade. accordingly, the fact that all traders subject to french law were at a disadvantage, without there being any advantage for domestic production, did not trigger the application of article 29 ec. in addition, parties to an international contract of sale are generally free to determine the law applicable to their contractual relations and can thus avoid being subject to french law. finland forum: utc gmbh v. s p ky, turku court of appeal date and reference: 12 april 2002 s 97/324 http://cisgw3.law.pace.e du/cases/020412f5.html (forestry equipment case) facts: the case involved a sale of components to be attached to forestry equipment between a german buyer (the plaintiff) and a finnish seller (the defendant). the questions in dispute included the relationship between a warranty term limiting recovery of damages and the provisions of the cisg. while the buyer argued alleged that the warranty clause had to be interpreted in a way that the terms relating to limitation of liability should be interpreted restrictively so as to apply manufacture defects only, and not to design or structural defects, the seller interpreted it in such a way that manufacturing included both the machinetooling and the design. decision: the court of appeal confirmed that the law applicable to the contract was the cisg. it also stated that the seller's njcl 2017/2 281 interpretation, the previous practice of the buyer, and wordfor-word interpretation of the warranty terms supported the interpretation that factory defects comprise both defects caused by machine tooling and design and, in connection with these, structural defects. the court concluded that the warranty terms were not unreasonable, even though they had strongly limited the seller's liability for nonconformities. however, the court of appeal stated that even though the parties had agreed upon the warranty term and that they were part of the contract, the buyer had a right to claim damages for the defects according to the cisg. france forum: cour de cassation, chambre civile 1 [supreme court] date and reference: 24 february 1993 case number: 91-13.940 https://www.legifrance. gouv.fr/affichjurijudi.do? idtexte=juritext00000 7028954 [validity in general of limitation clauses under french law] facts: in 1990 a french consumer ordered at fnac two extra copies of a vacation videocassette tape he had filmed during a trip to jordania. the client’s tape was misplaced in the shop premises and eventually lost. the consumer sued the shop for damages. the shop disputed the amount claimed by the client and offered to settle for 750 francs, on the basis of a limitation clause contained on the service order, which stated that the shop’s liability in case of nonrestitution or destruction of films, photos or videocassettes was limited to the value of a blank film or cassette. the limitation clause further stated that, in case of very important works, the client should make a declaration at the moment of handing the film or tape to the shop, “so as to facilitate mutual negotiations”. decision: the tribunal d’instance of paris found that the limitation clause was not enforceable in the case at hand because the tape had not been lost as a result of the shop’s service of film developing or copying tapes. accordingly, it awarded the plaintiff 4,000 francs in damages. the cour de cassation reversed the first instance judgment stating that limitation of liability clauses are generally valid under french law and can only be set aside in cases of willful misconduct or gross negligence of the obligor. forum: chronopost cour de cassation, chambre commerciale [supreme court] cisg ac opinion no. 17 282 date and reference: 22 october 1996 case number: 93-18632 https://www.courdecass ation.fr/img///co_arret 9318632_961022_en.pdf [unenforceability of limitation of liability clauses – failure to fulfill a main obligation arising from the contract] facts: the banchereau company entrusted, on two occasions, an envelope containing a tender submission to the chronopost company, which acquired the rights of the sfmi company. contrary to its undertaking, chronopost failed to deliver these envelopes before midday on the day following their posting. banchereau brought proceedings to recover compensation for loss from chronopost. in defence, chronopost relied on the clause in the contract limiting compensation for delay to the transportation costs paid by banchereau. decision: the court of first instance found that the limitation clause was unenforceable because it limited the obligor’s liability even in situations where it failed to fulfill its main obligation under the contract. on 30 june 1993, the rennes court of appeal reversed the first instance judgment and dismissed banchereau's claims. il held that while chronopost had failed to fulfil its obligation to deliver the envelopes before midday on the day following their posting, it had nevertheless not committed gross negligence debarring the limitation of liability in the contract. in 1996, the cour de cassation reversed the court of appeal judgment, holding that it violated article 1131 of the french civil code. it further noted that chronopost specialized in rapid transportation and guaranteed the reliability and swiftness of its service. as it had undertaken to deliver banchereau's letters within a set timeframe and failed to fulfill this essential obligation, the clause limiting liability in the contract, which denied the effect of the undertaking given, had to be deemed null and void. forum: faurecia v. oracle france, cour de cassation, chambre commercial e, financière et économiqu e [supreme court] date and reference: 29 june 2010 case number: 732 https://www.courdecass ation.fr/jurisprudence_2 /chambre_commerciale_ 574/732_29_16744.html [enforceability of limitation of liability clauses under french law] facts: the dispute arose from a group of contracts between oracle and its client, faurecia, for the license and maintenance of an erp software and related training. oracle first provided a provisional solution to its client, then failed to deliver the agreed software. consequently, the client stopped paying the installments due under the contract. the factoring company, which had bought oracle’s receivables, launched legal njcl 2017/2 283 proceedings for payment against faurecia. this latter called oracle into the proceedings and counterclaimed that the contracts should be held void for deceit and, alternatively, cancelled for contractual breach. decision: in 2005, the versailles court of appeal restricted the scope of oracle’s liability pursuant a limitation clause provided in the contracts. in 2007, the cour de cassation quashed this decision on the basis of the chronopost case law, and held that the limitation clause was not enforceable due to oracle’s failure to comply with its essential obligation under the contract, i.e., to provide the agreed software to faurecia. the case went to the paris court of appeal for determination of oracle’s liability and the court rejected the cour de cassation ruling, like the versailles court of appeal had done. on 29 june 2010, the cour de cassation finally agreed with the lower court’s decision to enforce the limitation clause contained in the contracts. consequently, oracle was ordered to pay 200,000 euros to faurecia (i.e., the maximum amount set forth by the liability cap under the contracts), while this latter was claiming 60 million euros in damages. the cour de cassation found that the limitation clause was balanced, inter alia, by the discount rate granted by oracle and the favored position of faurecia under the contracts. germany forum: amtsgericht nordhorn date and reference: 14 june 1994 case no. 3 c 75/94 unilex, available at http://www.unilex.info/ case.cfm?id=114 facts: an italian seller and a german buyer entered into a contract for the sale of shoes. the contract provided, in a space entitled 'approximate delivery without commitment', the handwritten provision: 'before holidays, not later'. in italy, this means before august. a first consignment of goods was sent to the buyer on 5 august 1993. the buyer paid the relating price on 30 november 1993. a second consignment was sent on 24 september 1993. on 28 september 1993 the buyer declared the contract avoided, by fax. the seller commenced action against the buyer claiming full payment of price plus interest, alleging that the buyer had no right to avoid the contract. the seller also claimed payment of an amount retained by the buyer the previous year following three declarations of partial lack of conformity, in respect of a previous sale. the buyer objected that a fixed term for delivery was provided in the contract and its violation by the seller entitled the buyer to declare the contract avoided. referring to the previous year's sale, the buyer alleged that the seller never contested cisg ac opinion no. 17 284 the belated declarations of lack of conformity and accepted the return of the nonconforming goods. the different attitude displayed in asking for the price of these goods to be paid therefore was contrary to good faith. decision: the court held that the contract was governed by cisg (art. 1(1)(a) cisg). the court stated that the seller was entitled to payment of the full price according to art. 62 cisg. the two consignments of goods had indeed been delivered after the agreed term had expired, but the buyer would have been entitled not to pay the price only if it had avoided the contract, according to art. 49 cisg. the court found that the buyer's declaration of avoidance was not made according to a provision contained in the seller's general conditions of contract, which were printed on the back of the contract form, and which the court found to have been incorporated in the contract. this clause provided that the buyer could only declare the contract avoided following an invitation to the seller to comply with the contract, and, even so, no sooner than 15 working days from the date the seller received such an invitation without complying with the contract. the court held that the question of validity of the seller's general conditions of contract fell outside the scope of cisg, according to art. 4(a), and had to be determined according to the law governing the contract, which, according to german rules of private international law, was italian law. the court found that the clause was valid under italian law. thus, it held that the buyer's declaration of avoidance was without effect, as the buyer had failed to declare the contract avoided according to the contractually established procedure. forum: oberlandes gericht celle [provincial court of appeal] date and reference: 2 september 1998 case number: 3 u 246/97 http://cisgw3.law.pace.e du/cases/980902g1.htm l clout case no. 318 (vacuum cleaners case) [validity of contract terms controlled by domestic law; term in seller’s general conditions limiting damages not validly incorporated into contract] facts: a dutch seller, plaintiff, delivered a batch of "noname" vacuum cleaners along with batches of branded vacuum cleaners to a german buyer, defendant. after having sold the vacuum cleaners, the buyer alleged that the vacuum cleaners did not perform up to standard, declared the contract avoided and asserted that as a result it had suffered damages. the buyer also refused to effect payment of the purchase price. the seller sued the buyer for the outstanding purchase price and the buyer sought set-off with damages for loss of profit. njcl 2017/2 285 decision: the first instance court allowed the claim and dismissed the set-off. the appellate court found that the seller was entitled to claim the purchase price under article 53 cisg in conjunction with articles 14, 15, 18 cisg, because the buyer had failed to return the vacuum cleaners. as to the admissibility of the buyer’s counterclaim for loss of profit, the court found that such claim was not excluded under § 7(b) of the seller's general terms and delivery conditions. under such term, the seller was not liable for damages and could, at its own choice, either cancel the entire contract or part of the contract, grant the buyer a corresponding credit, deliver substitute goods, or grant the buyer an adequate reduction in the purchase price (which the seller did). however, under the german law applicable [art. 27(1) egbgb], the seller's standard terms had not been validly incorporated into the contract. as a result, the exclusion of the cisg by § 10(c) of the standard terms was unenforceable. after admitting the counterclaim, the court dismissed it because the buyer had failed to properly prove its damages. the court held that under article 74 the plaintiff must exactly calculate its damages. under the circumstances, the loss of profit relied on was not properly substantiated. the court noted that, if it had been provided with the vacuum cleaners' current market price, an abstract calculation would have been admissible under article 76 cisg. in such case, the damages would have been calculated on the basis of the difference between the price fixed by the contract and the current market price at the time of the avoidance of the contract. however, as the current market price of the "no-name" vacuum cleaners was missing, damages could only be established on the basis of a specific calculation under article 74 cisg, which had not been provided by the buyer. the court found that the buyer had failed to mitigate the loss under article 77 cisg, as it had made only efforts to effect replacement purchases in its region, without taking into account other suppliers in germany or abroad. the court determined to grant to the buyer only reimbursement of the costs related to recovery of the goods and allowed set-off in the corresponding amount. forum: landgericht heilbronn [district court] date and reference: 15 september 1997 case number: 3 kfh o 653/93 http://cisgw3.law.pace.e du/cases/970915g1.htm l (film coating machine case) clout case no. 345 [validity of standard term excluding liability determined by domestic law, but reference in domestic law to cisg ac opinion no. 17 286 nonmandatory rule replaced by reference to equivalent convention provision] facts: a german seller, the defendant, delivered a film coating machine for kitchen furnishings to an italian leasing company for the use of an italian lessee, the plaintiff. the buyer paid the purchase price. when problems occurred with the machine, the lessee commissioned an expert report which concluded that the machine was defective. the buyer assigned its rights to the lessee, who declared the contract avoided. the lessee sued the seller for the reimbursement of the purchase price and damages. the contract negotiations had been conducted in italian. on 23 may 1990, the managers of the parties signed a seller’s form, headed "contratto di vendita", concerning the purchase of the machine. above the signatures and handwritten adjustments, the form also contained pre-formulated standard trading conditions in italian language. on 20 june 1990, the seller confirmed the order to the plaintiff on an order confirmation form, which, in addition to a detailed explanation of the machine, contained preformulated standard sale and delivery conditions (in german language). under these last general terms and conditions, the seller's liability was limited. a german seller, the defendant, delivered a film coating machine for kitchen furnishings to an italian leasing company for the use of an italian lessee, the plaintiff. the buyer paid the purchase price. when problems occurred with the machine, the lessee commissioned an expert report which concluded that the machine was defective. the buyer assigned its rights to the lessee, who declared the contract avoided. the lessee sued the seller for the reimbursement of the purchase price and damages. the contract negotiations had been conducted in italian. on 23 may 1990, the managers of the parties signed a seller’s form, headed "contratto di vendita", concerning the purchase of the machine. above the signatures and handwritten adjustments, the form also contained pre-formulated standard trading conditions in italian language. on 20 june 1990, the seller confirmed the order to the plaintiff on an order confirmation form, which, in addition to a detailed explanation of the machine, contained preformulated standard sale and delivery conditions (in german language). under these last general terms and conditions, the seller's liability was limited. decision: the court applied the cisg. it held that due to the defectiveness of the machine, the buyer was entitled to declare the contract avoided (art. 49 cisg), to claim reimbursement under art. 81(1), njcl 2017/2 287 art. 81(2) and art. 49(1) cisg and to claim damages under art. 74 [sentence one], 45(1) and 45(2) cisg. the court stated that the cisg had no special rules for the incorporation of general conditions. therefore these rules had to be interpreted according to art. 8 cisg. following the underlying principles of art. 8 cisg, general terms and conditions had to be drafted in the language of the contract, the italian language in this case, because the negotiations had been conducted in italian. consequently, the terms and conditions in german provided by the german seller were unenforceable and therefore the exclusion clause in german was also ineffective. to assess the validity of the seller's terms and conditions, drafted in italian, on the back of the contratto di vendita the court applied german law. the clause limited the seller’s liability to the exchange or repair of defective parts "escluso quasiasi risacrimento di danni” ("exclusion of any compensation"). the court found that complete exclusion amounted to an inappropriate disadvantage for the plaintiff, and contradicted the legal provisions. therefore such a term had to be considered as compulsorily invalid according to sect. 9 agbg [standard terms of business act]. in the assessment it replaced the reference to german non-mandatory rules by reference to the rules of the cisg, namely art. 74 [sentence two] cisg, and held that exclusion of liability in the terms and conditions to be void. forum: oberlandes gericht naumburg date and reference: 13 february 2013 case number: 12 u 153/12 http://www.unilex.info/ case.cfm?id=1697 [application of the principle of good faith under the cisg to consider that the mere reference to standard terms did not amount to their incorporation into a sales contract] facts: a german seller and swiss buyer concluded a contract for the supply of poppy seeds to be used in the production of various bakery products. soon after the first consignments, the buyer notified the seller that the seeds showed a strong, musty and rancid flavor and, as a result, it ceased production. upon examination by an analysis laboratory, the seeds turned out not to be marketable. the buyer brought an action against the seller claiming for damages. decision: the court of first instance dismissed the buyer’s claim. in so doing, it declared not to have jurisdiction over the case on account of an arbitration clause that had become part of the contract by virtue of incorporation of the netherlands association for the trade in dried fruit, spices and allied products general conditions of sale into the parties’ agreement (hereinafter: nzv general conditions). the buyer appealed. cisg ac opinion no. 17 288 the appellate court reversed the first instance decision. in so doing, the court asserted that the lower court had erroneously failed to declare that the contract between the parties was governed by cisg pursuant to its art. 1(1)(a). accordingly, the question as to whether the nzv general conditions had been incorporated into the contract had to be resolved according to cisg’s provisions dealing with contract formation and interpretation (arts. 8, 14 and ff. cisg). in this respect, the court noted that, although under german law a mere reference to standards terms can be sufficient in order for them to become part of the contract, and the same has been established by some foreign courts in relation to international disputes governed by cisg, under the convention the view should be preferred that the party relying on such terms must submit the relevant document to the other party, or make them sufficiently available for it. in fact, as already ruled by the german supreme court (see bundesgerichtshof, 09.01.2002, in unilex) it would counter to the principle of good faith enshrined in art. 7(1) cisg if the recipient were under a duty to investigate the content of the standard terms where the declaring party had failed to adopt sufficient steps to make them accessible to it. in the light of the above, also considering that the nzv general conditions were exclusively designed for dutch businessmen and therefore the buyer could not have expected them to be applicable to its contract with the seller, the court upheld the buyer’s claim but remanded the case to the first instance court for further consideration. poland forum: court of appeals of warsaw date and reference: 20 november 2008 case no. i aca 1258/07 unilex, available at http://www.unilex.info/ case.cfm?id=1721 clout case no. 1305 facts: a polish seller and a ukrainian buyer concluded a contract for the sale of a mercedes actros truck. the contract contained a clause according to which “it was valid until 8 august 2006”, which stood 90 days after its conclusion. the seller failed to deliver and refused to return the price paid by the ukrainian party, who sued before a polish court. decision: the court of first instance (district court) dismissed the claim as premature. it found that the buyer had not set an additional period of time as required by article 49(1)(b) cisg and had never declared the contract avoided. the court concluded that the parties were still bound by the contract and that the buyer could not yet request the reimbursement of the price. njcl 2017/2 289 the court of appeals reversed the decision and ordered the seller to reimburse the price. it found that article 49(1)(b) cannot be relied upon in the case at hand because of the express clause in the contract providing for its termination within 90 days from its conclusion. the court reasoned that the parties were entitled under article 6 cisg to shape the contract as they saw fit, which inter alia allowed them to introduce a provision for an automatic termination of the contract within a certain period of time. in the opinion of the court of appeals, the lower court wrongly assumed that the “90 days validity” clause had no meaning. conversely, it found that the clause was dictated by the ukrainian customs regulations, which require to complete any international business transaction within 90 days from the conclusion of the contract and which provide sanctions for violating that rule. thus, the parties, having been aware of the said regulation at the time of the conclusion of the contract, consciously established a period, after expiry of which the contract was to come to an end. the court of appeals further stated that the convention does not expressly govern the consequences of the termination of a contract as a result of the lapse of contractually established time limit. however, in light of article 7 cisg, which calls for the application of the general principles on which the convention is based, the rules governing the effects of the avoidance of contract must be considered. more specifically, the issue is regulated by article 81(2) cisg which provides that a party who has performed the contract may claim restitution of whatever it has paid under the contract to the other party. consequently, the court ordered the polish seller to reimburse the full price to the ukrainian buyer and to pay the interest from the date on which the price was paid, as required by article 84(1) cisg. russian federation forum: tribunal of internation al commercial arbitration at the russian federation chamber of commerce date and reference: 23 november 1994 arbitral award no. 251/93 http://www.unilex.info/ case.cfm?id=250 facts: the seller was to deliver certain goods for a sum which had been paid by the buyer in advance. the buyer received a smaller quantity of goods than had been agreed: 415 pieces of the goods were missing. the buyer requested the tribunal, with reference to art. 74 cisg, to order the seller to return the payment of the price of the undelivered goods and to award damages for the damage sustained by the buyer as a result of the seller's breach of the contract with regard to the time of deliver and to the cisg ac opinion no. 17 290 quality of the goods. damages included the loss of profit on the sale of these goods to the buyer's customers, mainly because the goods were of a seasonal nature. decision: the tribunal held that the buyer was entitled to be reimbursed the amount it had paid for the undelivered goods. as regards the claim for damages the tribunal came to the conclusion that the clause in the contract which stipulated the payment of a penalty in case of a delay in delivery was of an exclusive nature and did not provide for payment of damages in excess of the sum due in accordance with this clause. the tribunal decided to award damages for the delay only to the limited amount indicated in the penalty clause. the tribunal refused to award damages relating to the poor quality of the goods since the buyer had not been able to prove the amount of the loss sustained as a result of the poor quality of the goods. forum: tribunal of internation al commercial arbitration at the russian federation chamber of commerce date and reference: 4 april 1998 arbitral award no. 387/95 http://www.unilex.info/ case.cfm?id=377 facts: the russian seller contracted with a uk buyer to deliver 5,000 tons of coal at option up to 10,000 tons to be exercised within one month after signing of the contract. the payments under the contract had to be effected no later than of 90 days after the bill of lading date. the seller's obligations were considered to be fulfilled after delivery of the coal in the quantity stipulated by the contract and the buyer's after full payment of the price. at the same time the parties concluded a confidential agreement containing their intent not to claim from each other damages, fines and penalties concerning the contractual performance. in his claim the seller insisted on the buyer's payment for the coal delivered to him and interest. the buyer submitted a counterclaim asking for damages suffered as a consequence of the seller's failure to deliver the coal in the quantity required by the contract. in response the seller stated that the buyer had not exercised his right to the quantity option up to 10.000 tons of the goods. decision: the arbitral tribunal awarded the seller’s claim for payment of the coal shipped to the buyer. it held that the conduct of the buyer, who had made the payment for the goods conditional to the seller's guarantee for complete performance of the contract and had refused to pay for the goods, sharply contradicted the contract and provisions of the cisg (art. 53), under which the payment for the goods is an unconditional obligation of buyer. the buyer's breach of contract njcl 2017/2 291 amounted therefore to a fundamental breach pursuant to art. 25 cisg and provided the seller with a right to declare the contract avoided. the arbitral tribunal further held that the seller’s right to interests on the overdue sum had not been excluded by the parties’ confidential agreement. according to the arbitral tribunal, the seller’s right to interest was neither a penalty nor damages, but had an autonomous basis (art. 78 cisg). united states forum: barbara berry, s.a. de c.v. v. ken m. spooner farms, inc., federal district court [state of washington ] date and reference: 13 april 2006. case number: c055538fdb http://cisgw3.law.pace.e du/cases/060413u1.htm l> facts: the case involved a contract whereby ken m. spooner farms, inc. (spooner farms) agreed to provide viable raspberry roots to barbara berry s.a. de c.v. (barbara berry or berry) for the purpose of planting and producing commercial quality raspberry fruit in mexico. berry alleged breach of contract in that the product sold by spooner farms was defective and caused berry to incur damages. plaintiff berry is a corporation formed under the laws of mexico with its principal place of business located in los reyes, michoacan, mexico. defendant ken m. spooner farms, inc. (spooner farms) is a washington corporation with its principal place of business located in puyallup, washington. defendant spooner farms moved for summary judgment based on a written exclusionary clause that excluded spooner farms from all liability for berry's claim. berry disputed the claim contending that what was involved was an oral contract for the sale of raspberry roots, that the warranty disclaimer was not negotiated, was unknown to berry at the time the contract was formed, and was not delivered to berry until after the roots were paid for and delivered to mexico. berry also contended that the contract was governed by cisg rather than the uniform commercial code (ucc). decision: the court confirmed the application a disclaimer of liability that benefited the washington seller in a dispute with its mexican buyer. the court said that the validity of a disclaimer was not governed by the cisg citing article 4. the court held the disclaimer to be valid and granted summary judgment to the defendant seller. the court stated that the plaintiff asserted that an oral contract was formed that contained no disclaimers. furthermore, the plaintiff asserted "that the warranty disclaimer was not negotiated, was unknown to berry at the time the contract was formed, and was not delivered to berry until cisg ac opinion no. 17 292 after the roots were paid for and delivered to mexico." the court relied instead upon the following: "in washington, the consistent rule has been that the exchange of purchase orders or invoices between merchants forms a written contract, and the terms contained therein are enforceable." the court recited means to avoid disclaimers based upon substantive or procedural unconscionability. the court agreed that the disclaimer was consistent with industry standards. forum: norfolk southern railway company v. power source supply, inc., federal district court [pennsylva nia] date and reference: 25 july 2008 case number: 07-140-jjf http://cisgw3.law.pace.e du/cases/080725u1.htm l facts: a buyer from canada and a seller from the usa entered into a contract for the sale of locomotives. the parties’ dispute included the following issues (1) counter-offer and acceptance of offer; (2) timeliness of delivery; (3) damages and (4) interest on damages. decision: the court applied cisg articles 19(1), 33(c), 74 and 78, determining, in relevant part, that (1) the alleged verbal agreement for delivery was never incorporated into the contract; (2) the plaintiff acted within a reasonable time after the conclusion of the contract to deliver the goods to the defendant as there was no firm delivery date; (3) the final bill of sale materially altered the purchase order to exclude warranties, thereby constituting a counter-offer which was accepted via performance: (4) as delivery was timely, defendant was held liable for damages pursuant to article 74; and (5) plaintiff was entitled to prejudgment interest, the rate of which was to be decided by the united states court. it further held that that “[t]he validity of the disclaimer cannot be determined by reference to the cisg itself. cisg art 4(a). it is therefore necessary to turn to the forum's choice of law rules.” the court then discussed the validity of the clause, which disclaimed all warranties (except that of marketable title) and liability, and read as follows: “the equipment being sold on an "as, where is" basis and with all faults. except as set forth herein, the seller makes no representation or warranty, either express or implied, as to the condition of the equipment, including without limitation any implied warranty of merchantability or fitness for a particular purpose, and expressly disclaims liability and shall not be liable for lost profits or for indirect, incidental consequential or commercial losses of any kind.” njcl 2017/2 293 the court applied both alberta and pennsylvania laws – which, to that end, did not diverge – to consider the following elements of the disclaimer: "(1) the placement of the clause in the document; (2) the size of the disclaimer's print; and (3) whether the disclaimer was highlighted or called to the reader's attention by being in all caps ...." id. expressions such as "as is" or "with all faults" are approved by statute as language of exclusion. 13 pa c.s.a. § 2316(c)(1). after examining the final, executed bills of sale, under the standards set forth above, the court found the disclaimer to be valid. 3. footnotes 1 see e.g., article 7.1.6 of the unidroit principles (2010) (n. 163) [hereinafter also referred to as « upicc »] and its official comments, para. 2. this opinion does not consider exemption clauses that permit a party to render a performance substantially different from what the other party reasonably expected, referred to by article 7.1.6 of the upicc and section 3(2) (b) (i) of the english unfair contract terms act 1977. they appear to be incompatible with some of the main features of a contract for the international sale of goods governed by the cisg contract, which include legal certainty and a certain balance between the rights and obligations of the parties. 2 in this regard, see generally: fontaine, marcel and de ly, filip – drafting international contracts: analysis of contract clauses, ardsley, ny: transnational publishers (2006) [hereinafter referred to as « fontaine and de ly on contract clauses »]; ghestin, jacques (ed.) – les clauses limitatives ou exonératoires de responsabilité en europe – actes du colloque des 13 et 14 décembre 1990, paris: lgdj, (1990) [hereinafter referred to as « ghestin – actes du colloque »]; alpa, guido – droit italien, in ghestin – actes du colloque; beale, hugh – droit anglais, in ghestin – actes du colloque; fontaine, marcel – observations sur les clauses limitatives ou exonératoires de responsabilité en europe, in ghestin – actes du colloque; garcia-cantero, gabriel – droit espagnol, in ghestin – actes du colloque; reich, norbert – la transparence des clauses limitatives dans le droit allemand, in ghestin – actes du colloque; schmidt-salzer, joachim – droit allemand, in ghestin – actes du colloque; stauder, bernd – droit suisse, in ghestin – actes du colloque; yates, david – exclusion clauses in contracts, 2nd edition, london: sweet and maxwell (1982) [hereinafter referred to as « yates on exclusion clauses »]; lawson, richard – exclusion clauses and unfair contract terms, 5th edition, london: sweet and maxwell (1998) [hereinafter referred to as « lawson on exclusion clauses »]; prata, ana – cláusulas de exclusão e limitação de responsabilidade contractual, reimpressão, coimbra: almedina (2005); oliveira, nuno manuel pinto – cláusulas acessórias ao contrato: cláusulas de exclusão e de limitação do dever de indenizar e cláusulas penais, 2a. ed., coimbra: almedina (2005); ponzanelli, giulio – le clausole di esonero dalla responsabilità civile, studio di diritto comparato, milano: giuffrè (1984); adriano, germana carlotta – clausole di esonero e di limitazione della responsabilità civile, roma: aracne (2009); lata, natalia álvares – cláusulas restrictivas de responsabilidad civil, granada: comares (1998); larroumet, christian – droit civil, tome 3, les obligations – le contrat, 3e édition, paris : economica (1996) [hereinafter referred to as « larroumet »]; farnsworth, e. allan – contracts, 3nd edition, new york: cisg ac opinion no. 17 294 aspen law & business (1999) [hereinafter referred to as « farnsworth on contracts »; azevedo, antonio junqueira de azevedo – cláusula cruzada de não indenizar (cross waiver of liability), ou cláusula de não indenizar com eficácia para ambos os contratantes. renúncia ao direito de indenização. promessa de fato de terceiro. estipulação em favor de terceiros. in estudos e pareceres de direito privado, são paulo: saraiva (2004) [hereinafter referred to as « azevedo, antonio junqueira de azevedo – cláusula cruzada de não indenizar (cross waiver of liability) »]; fernandes, wanderley – cláusulas de exoneração e de limitação de responsabilidade, são paulo: direito gv – saraiva (2013) [hereinafter referred to as « fernandes – cláusulas de exoneração e de limitação »]. 3 “compensatory damages” are the most common breach of contract remedy. when compensatory damages are awarded, a court orders the person that breached the contract to pay the other person enough money to get what they were promised in the contract elsewhere. “restitution”: when a court orders restitution, it orders the person who breached the contract to pay the other person back. “punitive damages” are a sum of money intended to punish the breaching party, and are usually reserved for cases in which something morally reprehensible happened, such as a manufacturer deliberately selling a retailer unsafe or substandard goods. “liquidated damages” are those that the parties agree to pay in the event a contract is breached. 4 for examples of limitation of liability clauses in sale contracts see « fontaine and de ly on contract clauses » (n. 2), ch. 7, and annex 2 of this opinion. 5 for more information on “agreed sums clauses”, see cisg-ac opinion no. 10, agreed sums payable upon breach of an obligation in cisg contracts, rapporteur: dr. pascal hachem, bar & karrer ag, zurich, switzerland. adopted by the cisg-ac following its 16th meeting in wellington, new zealand on 3 august 2012. 6 tribunal of international commercial arbitration at the russian federation chamber of commerce, russian federation, 23 november 1994 (arbitral award no. 251/93, unilex, available at http://www.unilex.info/case.cfm?id=250 (accessed on 15 jan. 2015). the seller was to deliver certain goods for a sum which had been paid by the buyer in advance. the buyer received a smaller quantity of goods than had been agreed: 415 pieces of the goods were missing. the buyer requested the tribunal, with reference to art. 74 cisg, to order the seller to return the payment of the price of the undelivered goods and to award damages for the damage sustained by the buyer as a result of the seller's breach of the contract with regard to the time of deliver and to the quality of the goods. damages included the loss of profit on the sale of these goods to the buyer's customers, mainly because the goods were of a seasonal nature. the tribunal held that the buyer was entitled to be reimbursed the amount it had paid for the undelivered goods. as regards the claim for damages the tribunal came to the conclusion that the clause in the contract which stipulated the payment of a penalty in case of a delay in delivery was of an exclusive nature and did not provide for payment of damages in excess of the sum due in accordance with this clause. the tribunal decided to award damages for the delay only to the limited amount indicated in the penalty clause. the tribunal refused to award damages relating to the poor quality of the goods since the buyer had not been able to prove the amount of the loss sustained as a result of the poor quality of the goods. 7 the goal of damages provisions is to place the aggrieved party in the same economic position it would have been in had the breach not occurred. according to e. a. farnsworth (apud gotanda, john y., p. 991, n. 1, in : kroll, s. , mistelis, l. and viscasillas, pilar p. (eds.), un convention on contracts for the international sale of goods (cisg), munich/oxford: c.h. beck/ hart publishing (2011) [hereinafter referred to as « kroll, njcl 2017/2 295 mistelis and viscasillas on cisg ») such provisions are designed to give the aggrieved party the benefit of the bargain or its expectations/performance interest. 8 see cisg-ac opinion no. 6, calculation of damages under cisg article 74, rapporteur: prof. john y. gotanda, villanova university school of law , villanova, pennsylvania, usa. adopted by the cisg-ac at its spring 2006 meeting in stockholm, sweden; esp. at paragraphs 1.2 and 1.3. see also zeller, bruno – damages under the convention on contracts for the international sales of goods, 2nd edition, oxford: oxford university press (2009) [hereinafter referred to as « zeller on damages »], ch. 6, esp. p. 82. see also honnold, john o. (edited and updated by flechtner, harry m.) – uniform law for international sales under the 1980 united nations convention, 4th edition, alphen aan den rijn: kluwer law international (2009) [hereinafter referred to as « honnold on cisg »] para. 403. 9 zeller on damages (n. 8), p. 81. see also mackaay, ejan law and economics for civil law systems, cheltenham (u.k.) : edward elgar (2013) [hereinafter referred to as « mackaay on law and economics »] p. 442, on the topic of “risk allocation” between the contracting parties. 10 see article 74 cisg, zeller on damages (n. 8), p. 82, and gotanda, kroll, mistelis and viscasillas on cisg (n. 7), art. 74 cisg, paras. 4 and 37-73. there are other limitations on damages. under the cisg, damages: a) are limited to monetary relief; b) and to material loss (and do not include moral damages, as set forth in article 7.4.2. of the unidroit principles); c) do not permit the recovery of punitive damages; d) nor does it permit the recovery of damages for death and bodily injury (article 5 cisg). see also schwenzer, in : schwenzer (ed.), schlechtriem & schwenzer – commentary on the un convention on the international sale of goods, 3rd edition, oxford : oxford university press (2010) [hereinafter referred to as « commentary »], art. 74 cisg, para. 2 and 4557; and schlechtriem, p. and butler, p., un law on international sales – the un convention on the international sale of goods, berlin: springer-verlag (2009) [hereinafter referred to as « schlechtriem & butler », p. 209-16. 11 see article 4 cisg and schwenzer/hachem, commentary (n. 10), art. 4 cisg, paras. 17 and 43; and honnold on cisg (n. 8), art. 74, para. 408.1. see also djordjevic, kroll, mistelis and viscasillas on cisg (n. 7), art. 4 cisg, paras. 8 and 26. the same reasoning presented by the author in para. 26 applies to exemption and limitation of liability clauses. 12 see article 7(2) cisg and schwenzer/hachem, commentary (n. 10), art. 7, par. 2730, 34. see also viscasillas, kroll, mistelis and viscasillas on cisg (n. 7), art. 7 cisg, paras. 52-53. in accordance with article 7(2) cisg, matters governed by the convention that are not expressly provided for in it (internal gaps) are to be dealt with exclusively by the convention, despite their characterization under domestic law. once an internal gap is detected, the first step is to apply the specific provisions of the cisg directly, by way of analogy created by scholars and case law. if the gap cannot be filled, resort is to be had to the general principles on which the cisg is based (internal principles) or in their absence to other external principles. finally, if the gap still remains, domestic law may then be applied. 13 see article 4 cisg and schwenzer/hachem, commentary (n. 10), art. 4, par. 17 and art. 7, par. 30. see also djordjevic, kroll, mistelis and viscasillas on cisg (n. 7), art. 4 cisg, para. 8. 14 according to schlechtriem & butler (n. 10), par. 209, p. 157: “the cisg recognizes that the contract can stipulate further duties for the buyer (compare articles 61(1), 62 cisg “other obligations”); for example: to provide security, to obtain data, drawings, and technical specifications, to deliver certain materials or components, to comply with cisg ac opinion no. 17 296 export or re-import prohibitions etc. the agreement of incoterms can constitute another ancillary duty. article 54 cisg stipulates that necessary measures and formalities which are requirements for the payment are part of the duty to pay. specification of the goods can be part of the duty to accept the goods. however, article 65(1) cisg grants the seller a specific remedy in that regard.” 15 see schwenzer/hachem, commentary (n. 10), art. 4, par. 43. 16 in some jurisdictions such a situation qualifies as a purely potestative condition, i.e. a condition made in a contract the fulfillment of which is entirely in the control of one of the parties to the contract. it subjects the contract performance to the free will of one of the parties only. for example: there is a purely potestative condition where the buyer is left with the option to fix the price of the goods sold at its own will. not only are purely potestative conditions null and void under many domestic laws but also the underlying contracts where they have been included (e.g., art. 1174 of the belgian civil code; articles 122 and 489 of the brazilian civil code; article 1500 quebec civil code). 17 see article 74 cisg and schwenzer, commentary (n. 10), art. 74, and zeller on damages (n. 8), p. 102. 18 this corresponds to the common law maxim according to which: “for every right, there is a remedy; where there is no remedy, there is no right”, which also applies to the civil law and other contemporary legal traditions. 19 see article 6 cisg and schwenzer/hachem, commentary (n. 10), art. 6, par. 28. see also mistelis, kroll, mistelis and viscasillas on cisg (n. 7), art. 6 cisg, para. 8. 20 see article 4 cisg and schwenzer/hachem, commentary (n. 10), art. 4, par. 17. 21 cisg-ac opinion no. 13, inclusion of standard terms under the cisg, rapporteur: professor sieg eiselen, college of law, university of south africa, pretoria, south africa. adopted by the cisg-ac following its 17th meeting in villanova, pennsylvania, usa, on 20 january 2013. 22 see article 8 and 9 cisg and schmidt-kessel, commentary (n. 10), arts. 8 and 9. see also zuppi and viscasillas, respectively, mistelis, kroll, mistelis and viscasillas on cisg (n. 7), arts. 8 and 9 cisg; and honnold on cisg (n. 8), arts. 8 and 9, paras. 104-122. 23 in line with the modern approach to private international law rules, this opinion understands that the “otherwise applicable law” includes not only the otherwise domestic law applicable but also “rules of law”, which do not originate from formal state sources of law. for more information on this topic, see choice of law in international contracts, hague conference of private international law, esp. draft commentary on the draft hague principles on the choice of law in international contracts at http://www.hcch.net/upload/wop/princ_com.pdf (accessed on april 26, 2014). 24 see article 4 cisg and schwenzer/hachem, commentary (n. 10), art. 4, par. 38 and 43. 25 for examples of limitation of liability clauses in sale contracts see annex 2. 26 see generally fontaine and de ly on contract clauses » (n. 2), ch. 7. 27 for more information on “agreed sums clauses”, see cisg-ac opinion no. 10, agreed sums payable upon breach of an obligation in cisg contracts, rapporteur: dr. pascal hachem, bar & karrer ag, zurich, switzerland. adopted by the cisg-ac following its 16th meeting in wellington, new zealand on 3 august 2012. 28 see schwenzer/hachem, commentary (n. 10), art. 4, par. 43. 29 see, for example, sections 305 to 310 of the german civil code (bgb), which govern standard contract terms. those provisions have replaced the standard contract terms act (gesetz zur regelung des rechts der allgemeinen geschäftsbedingungen, agbgesetz). for an english translation, njcl 2017/2 297 see: http://www.iuscomp.org/gla/statutes/bgb.htm#b2s2 (accessed on april 27, 2014). see also cisg-ac opinion no. 13, inclusion of standard terms under the cisg (n. 21). 30 in this regard see article 4.6 of the unidroit principles (2010). 31 bgb, section 309. for more information on the german law of standard terms, see: zerres, thomas. principles of the german law on standard terms of contract, available at: http://www.jurawelt.com/sunrise/media/mediafiles/14586/german_standard_ter ms_of_contract_thomas_zerres.pdf(access on 5 sept. 2015). 32 for example, article 2.1.20 of the unidroit principles (2010) establishes that surprising terms in standard contract terms are not effective. 33 see farnsworth on contracts (n. 2), para. 4.26, in which the author states that “a number of cases support discharge of a duty to pay damages for partial breach of contract by renunciation, written or oral, by the obligee on acceptance from the obligor of some performance under the contract” and para. 9.1. see also yates on exclusion clauses (n. 2), p. 197 and lawson on exclusion clauses (n. 2). 34 the doctrine of fundamental breach started with a 1956 judgment of the english court of appeal. the supreme court of canada in tercon contractors ltd. v. british columbia (transportation and highways) (2010) described the doctrine as follows: “… where the defendant had so egregiously breached the contract so as to deny the plaintiff substantially the whole of its benefit … the innocent party was excused from further performance but the defendant could still be held liable for the consequences of its ‘fundamental breach’ even if the parties had excluded liability by clear and express language”. see annex 3 for more details. 35 in the past the english and us courts developed a criterion for the validity assessment of exemption clauses that rendered such clauses unenforceable where they compromised “the very core and essence of the contract”, which became known as “fundamental breach” or “breach of a fundamental term”. however, this validity requirement has lost its appeal more recently. on this topic, see fernandes – cláusulas de exoneração e de limitação (n. 2), p. 394-395. 36 see article 2(a) cisg and schwenzer/hachem, commentary (n. 10), art. 2, par. 4-7. 37 the pecl provision reads as follows: “article 8:109: clause excluding or restricting remedies remedies for non-performance may be excluded or restricted unless it would be contrary to good faith and fair dealing to invoke the exclusion or restriction.” see also a revised version of pecl, as presented by fauvarque-cosson, bénédicte and mazeaud, denis (eds.) – european contract law, materials for a common frame of reference: terminology, guiding principles, model rules, munich: sellier (2008), p. 603, which reads as follows: “article 9:109: clause excluding or restricting remedies remedies for non-performance may be excluded or restricted by a contractual clause. this clause is without effect if its implementation is contrary to good faith, for example in the case of non-performance which is deliberate or of particular gravity.” 38 for the full text of article 7.1.6 of the 2010 unidroit principles and the official comments, see annex 2. 39 see article 7.1.6 of the 2010 unidroit principles and the official comments. see also schelhaas, harriet, in vogenauer, stefan (ed.). commentary on the unidroit principles of international commercial contracts, 2nd ed., oxford: oup (2015) [hereinafter referred to as « commentary on the unidroit principles »], p. 858-863, esp. 861. cisg ac opinion no. 17 298 40 see article 6 cisg and schwenzer/hachem, commentary (n. 10), art. 6, par. 7 and 8. see also mistelis, kroll, mistelis and viscasillas on cisg (n. 7), art. 6, paras. 1, 7-10, 23; and honnold on cisg (n. 8), art. 6, para. 74. on the principle of freedom of contract in the cisg, see also cisg-ac opinion no. 16, exclusion of the cisg under article 6, rapporteur: doctor lisa spagnolo, monash university, australia. adopted by the cisg-ac following its 19th meeting in pretoria, south africa on 30 may 2014. 41 see schwenzer/hachem, commentary (n. 10), art. 74, par. 60. 42 see note 16 supra on “purely potestative condition”. 43 for overview comments on the principle of reasonableness and extensive doctrinal reference, see kritzer, a. h. at <http://cisgw3.law.pace.edu/cisg/text/reason.html#view> (accessed: 15 january 2015). specifically mentioned in thirty-seven provisions of the cisg and clearly referred to elsewhere in the convention, reasonableness is a general principle of the cisg, and one of the most fundamental principles on which the convention is based. the cisg does not contain a definition of reasonableness, which appears at article 1:302 of the principles of european contract law, as follows: “under these principles reasonableness is to be judged by what persons acting in good faith and in the same situation as the parties would consider to be reasonable. in particular, in assessing what is reasonable the nature and purpose of the contract, the circumstances of the case and the usages and practices of the trades or professions involved should be taken into account.” which is why it is said that such a definition also fits the manner in which this concept is used in the cisg. as a general principle of the cisg, reasonableness has a strong bearing on the proper interpretation of all provisions of the cisg. 44 see the reported decisions at the uncitral digest of case law on the united nations convention on contracts for the international sale of goods (2012 edition) [hereinafter referred to as « cisg digest 2012 »], p. 343, para. 6, n. 8 and n. 11, available online at: http://www.uncitral.org/pdf/english/clout/cisg-digest-2012e.pdf (accessed on april 27, 2014) 45 finland 12 april 2002 turku court of appeal (forestry equipment case) [translation available] 
 [cite as: http://cisgw3.law.pace.edu/cases/020412f5.html], reported at the cisg digest 2012 (n. 44) p. 343, para. 6, n. 8. 46 china international economic and trade arbitration commission, people’s republic of china, 1 april 1993, arbitral award no. 75, unilex, available at http://www.unilex.info/case.cfm?id=429 (accessed on april 27, 2014), reported at the cisg digest 2012 (n. 44) p. 343, para. 6, n. 11. 47 oberster gerichtshof, austria, 7 september 2000, case no. 8 ob 22/00v, unilex, available at http://www.unilex.info/case.cfm?id=473 (accessed on 15 jan. 2015). 48 amtsgericht nordhorn, germany, 14 june 1994, case no. 3 c 75/94, unilex, available at http://www.unilex.info/case.cfm?id=114 (accessed on 15 jan. 2015). 49 court of appeals of warsaw, poland, 20 november 2008, case no. i aca 1258/07, unilex, available at http://www.unilex.info/case.cfm?id=1721 (accessed on 15 jan. 2015). clout case 1305. 50 see articles 6 and 74 cisg and schwenzer, commentary (n. 10), art. 74, paras. 58, 60. see also honnold on cisg (n. 8), art. 74, para. 408.1. 51 see article 74 and schwenzer/hachem, commentary (n. 10), art. 7, para. 35, and art. 74, para. 3; and gotanda, kroll, mistelis and viscasillas on cisg (n. 7), art. 74, paras. 15. see also clout case no. 541 [oberster gerichtshof, austria, 14 january 2002] (see full text of the decision); clout case no. 93 [internationales schiedsgericht der njcl 2017/2 299 bundeskammer der gewerblichen wirtschaft-wien, austria, 15 june 1994] (citing article 74 for general principle within meaning of article 7 (2)), reported at the cisg digest 2012 (n. 44) p. 343, para. 5, n. 5. 52 see schwenzer, commentary (n. 10), art. 79, paras. 57-58, and art. 80, para. 2; atamer, kroll, mistelis and viscasillas on cisg (n. 7), art. 79, para. 89, 93; and honnold on cisg (n. 8), art. 79, para. 424. see also the reported decisions at the cisg digest 2012 (n. 44), p. 393, para. 23. 53 for the same reason, an exemption or limitation clause should impact the obligation to pay interest on the refund price set out in article 84 cisg. in this regard, see bacher, commentary (n. 10), art. 78, para. 1. while the right to interest (article 78) may be limited or excluded by agreement of the parties (ius dispositivum), an arbitral award has stated that it had not been excluded by the parties’ confidential agreement containing their intent not to claim from each other damages, fines and penalties concerning contractual performance. the tribunal held that the seller’s right to interest on the overdue sum was neither a penalty nor damages, but had an autonomous basis (art. 78 cisg) under which the creditor is entitled to interest, without prejudice to any claim for damages recoverable under art. 74 cisg (tribunal of international commercial arbitration at the russian federation chamber of commerce, russian federation, 04 april 1998 (arbitral award no. 387/95, unilex, available at http://www.unilex.info/case.cfm?id=377 (accessed on 15 jan. 2015)). 54 see schwenzer, commentary (n. 10), art. 79, paras. 57-58, and art. 80, para. 2; atamer, kroll, mistelis and viscasillas on cisg (n. 7), art. 79, para. 89, 93; and honnold on cisg (n. 8), art. 79, para. 424. see also the reported decisions at the cisg digest 2012 (n. 44), p. 393, para. 23. 55 schlechtriem & butler (n. 10), par. 64, p. 61. 56 see article 11 cisg and schlechtriem/schmidt-kessel, commentary (n. 10), art. 4, para. 29 and art. 11, par. 4; viscasillas, kroll, mistelis and viscasillas on cisg (n. 7), art. 11, paras. 1-10; and honnold on cisg (n. 8), art. 11, para. 127. 57 see comments and cases reported at the cisg digest 2012 (n. 44), art. 11, p. 73-76. 58 article 96 cisg authorizes a contracting state whose legislation requires contracts of sale to be concluded in or evidenced by writing to make a declaration in accordance with article 12 cisg. article 12 states that the freedom from form requirement does not apply where any party to a sales contract has its place of business in a contracting state which has made a declaration under article 96. in other words, article 96 reservation excludes the contracting state’s obligation to apply the convention’s freedom of form provisions. thus, the cisg no longer governs the formal validity of the international sales contract. currently only 8 out of the 83 cisg contracting states have made an article 96 reservation. these countries include: argentina, armenia, belarus, chile, hungary, paraguay, the russian federation and ukraine. for more information on reservations under articles 95 and 96 cisg, see the cisg-ac opinion no. 15, reservations under articles 95 and 96 cisg, rapporteur: professor doctor ulrich g. schroeter, university of mannheim, germany. adopted by the cisg-ac following its 18th meeting in beijing, china on 21 and 22 october 2013. 59 see article 11 cisg and schlechtriem/schmidt-kessel, commentary (n. 10), art. 11, par. 4, 6, 9. 60 a warranty is an assurance by a party of the existence of a fact upon which the other party may rely. the intended purpose is to relieve the party of any duty to determine facts independent from the warranty which is a part of the transaction. the seller tipically provides a warranty to the buyer. a warranty constitutes a promise to indemnify the other cisg ac opinion no. 17 300 party if the warrantied fact proves untrue (glower w. jones, warranties in international sales: un convention on contracts for the international sale of goods compared to the us uniform commercial code on sales, 17 international business lawyer (1989) p. 497-500). the word "warranty" typically refers to the “express warranty” mentioned in the ucc, which consists of affirmative promises about the quality and features of the goods being sold. these promises also include descriptions of the goods being sold or samples shown to the buyer. in addition to express warranties, the ucc also creates a second kind of warranty, called an "implied warranty", which is effective regardless of whether or not it is specifically mentioned. the implied warranty created by the ucc ended the old rule of ‘caveat emptor’("let the buyer beware"). the two implied warranties under the ucc are: (i) the warranty of "merchantability" of the goods being sold, and (ii) the warranty that the goods are "fit for a particular purpose." generally, a seller who wants to disclaim ucc warranties must do so specifically. a general statement that there are "no warranties, express or implied" is usually ineffective. just how express a disclaimer needs to be depends on the kind of warranty being disclaimed. section 2316(2) and (3) of the ucc articulate the requirements a seller must meet to effectively disclaim the implied warranties of merchantability and fitness for particular purpose. subsection 2 provides, generally, that to be effective, a disclaimer must be conspicuous, and in the case of the warranty of merchantability, it must mention ‘merchantability’. subsection 3 articulates other ways in which the implied warranties can be effectively disclaimed (i.e. – [a] through the use of language like “as is” or “with all faults” which is commonly understood to mean that the buyer assumes all risks related to the quality of the goods; [b] through the buyer’s inspection of the goods; and [c] through trade usage). the ucc also requires all disclaimers of implied warranties to be in writing. however, a warranty disclaimer hidden in the fine print of a three-page sales contract will not be enforced because the ucc also requires that a disclaimer be conspicuous. a section of a contract is conspicuous if it clearly stands out from the rest of the contract and draws the eye of the reader (e.g., bold type, different colored type, larger type, or in all capitals). for a distinction between “breach of contract” and “breach of warranties” under the ucc, see timothy davis, ucc breach of warranty and contract claims: clarifying the distinction, baylor law review vol. 61:3 (2009) p. 783-817. for a status of the enforceability of disclaimers of implied warranties, see cate . dover corp. 790 s.w.2d 559 (1990) decided by the texas supreme court, available at: http://www.leagle.com/decision/19901349790sw2d559_11296/cate%20v.%20do ver%20corp. 61 the language of article 35 cisg closely tracks the ucc provisions of the implied warranty of merchantability and the implied warranty of fitness for a particular purpose. section 2-314 of the uniform commercial code (ucc) reads as follows: “§ 2-314. implied warranty: merchantability; usage of trade. (1) unless excluded or modified (section 2-316), a warranty that the goods shall be merchantable is implied in a contract for their sale if the seller is a merchant with respect to goods of that kind. under this section the serving for value of food or drink to be consumed either on the premises or elsewhere is a sale. (2) goods to be merchantable must be at least such as (a) pass without objection in the trade under the contract description; and (b) in the case of fungible goods, are of fair average quality within the description; and (c) are fit for the ordinary purposes for which such goods are used; and (d) run, within the variations permitted by the agreement, of even kind, quality and quantity within each unit and among all units involved; and njcl 2017/2 301 (e) are adequately contained, packaged, and labeled as the agreement may require; and (f) conform to the promise or affirmations of fact made on the container or label if any. (3) unless excluded or modified (section 2-316) other implied warranties may arise from course of dealing or usage of trade.” 62 section 2-315 of the uniform commercial code (ucc) reads as follows: “§ 2-315. implied warranty: fitness for particular purpose. where the seller at the time of contracting has reason to know any particular purpose for which the goods are required and that the buyer is relying on the seller's skill or judgment to select or furnish suitable goods, there is unless excluded or modified under the next section an implied warranty that the goods shall be fit for such purpose.” 63 section 2-316 of the american uniform commercial code (ucc) reads as follows: “§ 2-316. exclusion or modification of warranties. (1) words or conduct relevant to the creation of an express warranty and words or conduct tending to negate or limit warranty shall be construed wherever reasonable as consistent with each other; but subject to the provisions of this article on parol or extrinsic evidence (section 2-202) negation or limitation is inoperative to the extent that such construction is unreasonable. (2) subject to subsection (3), to exclude or modify the implied warranty of merchantability or any part of it the language must mention merchantability and in case of a writing must be conspicuous, and to exclude or modify any implied warranty of fitness the exclusion must be by a writing and conspicuous. language to exclude all implied warranties of fitness is sufficient if it states, for example, that "there are no warranties which extend beyond the description on the face hereof." (3) notwithstanding subsection (2) (a) unless the circumstances indicate otherwise, all implied warranties are excluded by expressions like "as is", "with all faults" or other language which in common understanding calls the buyer's attention to the exclusion of warranties and makes plain that there is no implied warranty; and (b) when the buyer before entering into the contract has examined the goods or the sample or model as fully as he desired or has refused to examine the goods there is no implied warranty with regard to defects which an examination ought in the circumstances to have revealed to him; and (c) an implied warranty can also be excluded or modified by course of dealing or course of performance or usage of trade. (4) remedies for breach of warranty can be limited in accordance with the provisions of this article on liquidation or limitation of damages and on contractual modification of remedy (sections 2-718 and 2-719).” 64 contra. in 2008 a u.s. district court understood that “[t]he validity of the disclaimer cannot be determined by reference to the cisg itself. cisg art 4(a). it is therefore necessary to turn to the forum's choice of law rules.” the court discussed the validity of a clause contained in a cisg contract concluded between a canadian buyer and an american seller, which disclaimed all warranties (except that of marketable title) and liability. the clause read as follows: “the equipment being sold on an "as, where is" basis and with all faults. except as set forth herein, the seller makes no representation or warranty, either express or implied, as to the condition of the equipment, including without limitation any implied warranty of merchantability or fitness for a particular purpose, and expressly disclaims liability and shall not be cisg ac opinion no. 17 302 liable for lost profits or for indirect, incidental consequential or commercial losses of any kind.” the court applied both alberta and pennsylvania laws – which, to that end, did not diverge – to consider the following elements of the disclaimer: "(1) the placement of the clause in the document; (2) the size of the disclaimer's print; and (3) whether the disclaimer was highlighted or called to the reader's attention by being in all caps ...." id. expressions such as "as is" or "with all faults" are approved by statute as language of exclusion. 13 pa c.s.a. § 2316(c)(1). after examining the final, executed bills of sale, under the standards set forth above, the court found the disclaimer to be valid. united states 25 july 2008 federal district court [pennsylvania] (norfolk southern railway company v. power source supply, inc.), available at: http://cisgw3.law.pace.edu/cases/080725u1.html. 65 see, for example, lookofsky, j. the 1980 united nations convention on contracts for the international sale of goods – articles 11 and 12 no writing requirement for cisg contract; declaration in derogation. in j. herbots (ed.) r. blanpain (gen. ed.). international encyclopaedia of laws contracts, suppl. 29 (december 2000) 1-192, at <http://www.cisg.law.pace.edu/cisg/biblio/loo11.html> (accessed on 19 jan. 2015). the author states: “92. some legal systems require that (certain) sales contracts be in writing. dispensing with that kind of 'formal validity' requirement in the international sales context, article 11 of the cisg provides as follows: (…) relation to formal requirements under domestic law in most cisg contracting states, article 11 serves to override the formal validity requirements of domestic law. on the hand, it should be noted that the rule does not bar the parties from imposing formal requirements, nor does it necessarily negate certain regulations (and sanctions) in states which require a writing for purposes of administrative control or for enforcement of exchange control laws. declarations in derogation of article 11 just as the general rule in article 11 is that cisg sales contracts need not be in writing, other convention rules dispense with writing requirements as regards contract formation and contract modification. however, many states still attach great importance to requirements such as these, and in order to make the convention acceptable for those states, article 12 of the cisg provides as follows: (…).'’ 66 see comments and cases reported at the cisg digest 2012 (n. 44), art. 11, p. 73-76. see also the cases reported at unilex on article 11 cisg, at: http://www.unilex.info/dynasite.cfm?dssid=2376&dsmid=13356&x=1 (access on sept. 11, 2015). 67 see comments to rule 2 supra. 68 see, e.g., article 7.1.6 of the 2010 unidroit principles and the official comments and commentary on the unidroit principles (n. 39), p. 762-764. 69 fontaine and de ly on contract clauses (n. 2), p. 384-385. see, for example, article 1229 of the italian civil code. in some countries, the professional seller is presumed to have acted in bad faith, which affects the validity of clauses limiting liability. 70 fontaine and de ly on contract clauses (n. 2), p. 385. while the laws of italy, germany and france preclude the application of the clause in case of gross negligence, the laws of belgium and mexico enforce such clauses even in cases of gross negligence. 71 fontaine and de ly on contract clauses (n. 2), p. 385. in the past the english and us courts developed a criterion for the validity assessment of exemption clauses that rendered such clauses unenforceable where they compromised “the very core and njcl 2017/2 303 essence of the contract”, which became known as “fundamental breach” or “breach of a fundamental term”. however, this validity requirement has lost its appeal more recently. on this topic, see fernandes – cláusulas de exoneração e de limitação (n. 2), p. 256261. 72 e.g., article 1229 of the italian civil code. 73 fontaine and de ly on contract clauses (n. 2), p. 386. see, for example, section 2-316 of the american uniform commercial code, and section 3 of the 1977 united kingdom unfair contract terms act. 74 fontaine and de ly on contract clauses (n. 2), p. 386. see, for example, article 11 of the brazilian civil code, article 1474 of the quebec civil code, and the 1977 united kingdom unfair contract terms act. 75 fontaine and de ly on contract clauses (n. 2), p. 386. article 1152 of the french civil code empowers the judge not only to reduce an excessive penalty clause but also to increase one that would be manifestly insufficient to compensate for the loss. 76 in this regard, see the 1977 united kingdom unfair contract terms act. 77 german law, for example, expressly prohibits standard terms excluding liability for willful intent and gross negligence, as well as liability for death or injury to body and health caused by the issuer (bgb, section 309). for more information on the german law of standard terms, see: zerres, thomas. principles of the german law on standard terms of contract, available at: http://www.jurawelt.com/sunrise/media/mediafiles/14586/german_standard_terms _of_contract_thomas_zerres.pdf (access on 5 sept. 2015). 78 article 7.1.6 of the 2010 unidroit principles. 79 [79] see § 2-719 of the ucc (n. 143). under washington law, for example, a limitation of liability clause is enforceable unless it is unconscionable. there are two types of unconscionability in contracts in washington: (1) substantive unconscionability, involving those cases where a clause in the contract is "shocking to the conscience." and (2) procedural unconscionability, which relates to impropriety during the process of forming the contract. … with regard to "substantive unconscionability," the washington supreme court stated: "as an initial matter, it is questionable whether clauses excluding consequential damages in a commercial contract can ever be substantively unconscionable." mortenson. 140 wn.2d at 586. the court in mortenson cited tacoma boatbuilding co. v. delta fishing co., 28 u.c.c. rep. serv. 26, 35 (w.d. wash 1980) where the district court stated in rejecting an argument that the limitation clause therein was unconscionable: ‘comment 3 to [u.c.c.] § 2-719 generally approves consequential damage exclusions as "merely an allocation of unknown or undeterminable risks."’ thus, the presence of latent defects in the goods cannot render these clauses unconscionable. the need for certainty in risk-allocation is especially compelling where, as here, the goods are experimental and their performance by nature less predictable. with regard to "procedural unconscionability" in commercial transactions, the concern is that there is no "unfair surprise" to the detriment of one of the parties. puget sound financial, 146 wn.2d at 439-41. the washington supreme court uses a "totality of the circumstances" approach to making the determination of procedural unconscionability. mortenson, 140 wn.2d at 588. there is a non-exclusive list of factors for assessing the totality of the circumstances, which include: (1) the conspicuousness of the clause in the agreement, which includes whether the important terms were "hidden in a maze of fine print"; (2) the manner in which the parties entered into the contract, which includes whether the parties had reasonable opportunity to understand the terms of the contract; (3) the custom and usage of the trade; and (4) the course of dealing between the parties. cisg ac opinion no. 17 304 puget sound financial, 146 wn.2d at 442-44. source: united states 13 april 2006 federal district court [state of washington] (barbara berry, s.a. de c.v. v. ken m. spooner farms, inc.), at <http://cisgw3.law.pace.edu/cases/060413u1.html>. 80 see article 4 cisg and schwenzer/hachem, commentary (n. 10), art. 4, par. 43; djordjevic, kroll, mistelis and viscasillas on cisg (n. 7), art. 4, para. 26 (same reasoning applies to exemption and limitation of liability clauses); and honnold on cisg (n. 8), art. 4, para. 64. 81 determining what are ‘validity issues’ under the convention has been recognized as ‘complicated and uncertain’ due to the intricate language of article 4 cisg (see, e.g. schlechtriem & butler (n. 10), par. 36, p. 34). according to schwenzer/hachem – commentary (n. 10), art. 4, par. 31 –, the term “validity” must be interpreted autonomously, using a functional approach in deciding from the perspective of the convention whether it intends to govern the question in dispute. matters of validity are those where a contract is void ab initio (e.g., “initial impossibility”) by operation of law or rendered so either retroactively by a legal act of the state or of the parties, such as rescission form mistake or ‘withdrawal’ or ‘revocation’ of consent under special provisions, or by a ‘resolutive’ condition or a denial of approval of relevant authorities. on the other hand, a novel two-step approach based instead on the requirements of internationality and uniform interpretation set out in article 7(1) might be useful to delineate the convention’s reach. according to this approach, a domestic law rule is displaced by the convention if (1) it is triggered by a factual situation to which the cisg also applies (the ‘factual criterion’) and (2) it pertains to a matter that is also regulated by the cisg (the ‘legal criterion’). only if both criteria are cumulatively fulfilled will the domestic law provision be displaced in favor of the convention. on this novel approach, see schroeter, u. g. the validity of international sales contracts: the irrelevance of the ‘validity exception’ in article 4 vienna sales convention and a novel approach to determining the convention’s scope, in : schwenzer, i. and spagnolo, l. (eds.), boundaries and intersections: the 5th annual maa schlechtriem cisg conference, the hague: eleven international publishing (2014), p. 95-117. 82 where the otherwise applicable law or rules of law provide for restrictive or contra preferentem interpretation of the exemption or limitation clause contained in standard terms, cisg-ac opinion no. 13 on inclusion of standard terms under the cisg (n. 21) must be taken into consideration. 83 see clout case no. 318 [oberlandesgericht celle, germany, 2 september 1998] (term in seller’s general conditions limiting damages not validly incorporated into contract) (see full text of the decision); clout case no. 345 [landgericht heilbronn, germany, 15 september 1997] (validity of standard term excluding liability determined by domestic law, but reference in domestic law to non-mandatory rule replaced by reference to equivalent convention provision), reported at the cisg digest 2012 (n. 44), art. 74, p. 346, para. 4. 84 clout case no. 345 [landgericht heilbronn, germany, 15 september 1997] (validity of standard term excluding liability determined by domestic law, but reference in domestic law to non-mandatory rule replaced by reference to equivalent convention provision), reported at the cisg digest 2012 (n. 44), art. 74, p. 346, para. 4. 85 united states 13 april 2006 federal district court [state of washington] (barbara berry, s.a. de c.v. v. ken m. spooner farms, inc.), at <http://cisgw3.law.pace.edu/cases/060413u1.html>. the court stated, inter alia, that “the cisg does not govern the enforceability of the exclusionary clause pursuant to an express provision in the cisg. the cisg provides at article 4 in pertinent part …. njcl 2017/2 305 whether a clause in a contract is valid and enforceable is decided under domestic law, not the cisg. … in washington, the consistent rule has been that the exchange of purchase orders or invoices between merchants forms a written contract, and the terms contained therein are enforceable. … a limitation of liability clause is enforceable unless it is unconscionable.” see also united states 25 july 2008 federal district court [pennsylvania] (norfolk southern railway company v. power source supply, inc.) (n. 65), available at: http://cisgw3.law.pace.edu/cases/080725u1.html. 86 see article 1 cisg and schwenzer/hachem, commentary (n. 10), introduction to articles 1-6, par. 3, and art. 1, par. 35. 87 see note 80 supra. (washington law on the validity of limitation clauses) 88 see article 7.1.6 of the unidroit principles and its official comments, para. 2. 89 see article 7(1) cisg and schwenzer/hachem, commentary (n. 10), art. 7, paras. 79; viscasillas, kroll, mistelis and viscasillas on cisg (n. 7), art. 7, paras. 18-20; and honnold on cisg (n. 8), art. 7, paras. 85-93. 90 according to schwenzer/hachem, commentary (n. 10), art. 7, par. 9, n. 24, “examples include the notions of ‘stocks, shares, investment securities’ and ‘ships’ in article 2 cisg, as well as the foreseeability rule in article 74, sentence 2 which has its role model in the english case hadley v. baxendale [1854] 9 ex 341. 91 see article 7 cisg and schwenzer/hachem, commentary (n. 10), art. 7, paras. 6, 16 and 17. in favor of the direct application of the principle of good faith to the formation and performance of the contract, see viscasillas, kroll, mistelis and viscasillas on cisg (n. 7), art. 7, paras. 24-30. as to case law, see the unilex database, article 7, “good faith as a general principle of the convention”. in particular, see the judgment where the belgium’s hof van beroep in gent considered the good faith principle in the context of the cisg to establish the binding nature of the contract. decision of 15.05.2002 available at: http://www.unilex.info/case.cfm?id=940. see also the 2013 german oberlandesgericht naumburg’s decision that applied the principle of good faith under the cisg to consider that the mere reference to standard terms did not amount to their incorporation into a sales contract. it affirmed that the user was required under the principle of good faith in international trade (art. 7(1) cisg) to submit the relevant document or make such terms accessible in another way to the recipient. case 12 u 153/12, 13.2.2013, available at: http://www.unilex.info/case.cfm?id=1697. 92 for overview comments on the principle of reasonableness and extensive doctrinal reference, see kritzer, a. h. at <http://cisgw3.law.pace.edu/cisg/text/reason.html#view> (accessed: 15 january 2015). among the thirty-seven cisg provisions that mention reasonableness and those others that clearly refer to it, a definition of the principle is nowhere to be found, which is why the definition in article 1:302 pecl is said to fit the manner in which this concept is used in the cisg. the relevant pecl provision reads as follows: “under these principles reasonableness is to be judged by what persons acting in good faith and in the same situation as the parties would consider to be reasonable. in particular, in assessing what is reasonable the nature and purpose of the contract, the circumstances of the case and the usages and practices of the trades or professions involved should be taken into account.” 93 see e.g. cisg-ac opinion no. 5, the buyer's right to avoid the contract in case of non-conforming goods or documents 7 may 2005, badenweiler (germany). rapporteur: professor dr. ingeborg schwenzer, ll.m., professor of private law, university of basel; cisg-ac opinion no. 6, calculation of damages under cisg article 74 (n. 8); cisgac opinion no. 8, calculation of damages under cisg articles 75 and 76. rapporteur: cisg ac opinion no. 17 306 professor john y. gotanda, villanova university school of law, villanova, pennsylvania, usa. adopted by the cisg-ac following its 12th meeting in tokyo, japan, on 15 november 2008; cisg-ac opinion no. 9, consequences of avoidance of the contract. rapporteur: professor michael bridge, london school of economics, london, united kingdom. adopted by the cisg-ac following its 12th meeting in tokyo, japan, on 15 november 2008; cisg-ac opinion no. 10, agreed sums payable upon breach of an obligation in cisg contracts (n. 27); and cisg-ac opinion no. 13 on inclusion of standard terms under the cisg (n. 21). 94 see article 7 cisg and schwenzer/hachem, commentary (n. 10), art. 7, par. 32; and magnus, ulrich. general principles of un-sales law, in rabels zeitschrift for foreign and international private law hein kötz
 in honor of his 60th birthday,
 part i, volume 59 (1995) issue 3-4 (october), hamburg: max-planck-institute for foreign and international private law, available online at: http://www.cisg.law.pace.edu/cisg/biblio/magnus.html (accessed on april 27, 2014). “[t]he need to promote ... the observance of good faith in international trade" set out in article 7(1) cisg, read in conjunction with the gap-filling rule of article 7(2), which refers unsettled matters to the general principles on which the cisg is based, states at least a general prohibition against the abuse of rights (and a prohibition against contradictory behavior venire contra factum proprium). 95 see kritzer, a. h. at <http://cisgw3.law.pace.edu/cisg/text/reason.html#view> (accessed: 15 january 2015). 96 see article 7 cisg and schwenzer/hachem, commentary (n. 10), art. 7, para. 8; and viscasillas, kroll, mistelis and viscasillas on cisg (n. 7), art. 7, paras. 16-17. 97 see schlechtriem & butler (n. 10), par. 49, p. 53. 98 the author of this opinion would like to thank professor claude witz for his valuable comments and suggestions in respect of this topic. 99 see, e.g., cour de cassation, chambre civile 1, 20 décembre 1998, nº 87-16369 (delivery of kiwi plants of a different kind). 100 see, e.g., cour de cassation, chambre civile 1, 24 février 1993, d. 1993.ir.78, available at : https://www.legifrance.gouv.fr/affichjurijudi.do?idtexte=juritext000007028954 (access on 15.4.2016). in regard to exemption and limitation of liability clauses under french law, see larroumet (n. 2), paras. 694-695. the new article 1170 of the french civil code reads as follows: “toute clause qui prive de sa substance l´obligation essentielle du débiteur est réputée non écrite”. this provision codifies the famous chronopost (cass. com., 22 octobre 1996, nº 93-18632) and faurecia ii (cass. com., 29 juin 2010, nº 09-11841) cases. 101 article 1171 of the civil code now reads as follows : « dans un contrat adhésion, toute clause qui crée un déséquilibre significatif entre les droits et obligations des parties au contrat est réputée non écrite. l´appréciation du déséquilibre significatif ne porte ni sur l´objet principal du contrat ni sur l´adéquation du prix à la prestation. ». 102 for more information on this topic, see : witz, claude. « forces et faiblesses du droit interne français de la vente par rapport à la convention de vienne », in creda et philippe delebecque (dir.), l´entreprise et la vente internationale de marchandises. brussels : larcier , 2016, pp. 102 et. ss. 103 see fontaine and de ly on contract clauses (n. 2), p. 385. 104 idem, p.386. however, exemption and limitation of liability for damages caused by third parties, even in the event of a grossly negligent conduct, may be valid under a combination of articles 276 and 278 of the bgb. on this subject, see fernandes – cláusulas de exoneração e de limitação (n. 2), p. 383. njcl 2017/2 307 105 see, for example, sections 305 to 310 of the german civil code (bgb), which govern standard contract terms. those provisions have replaced the standard contract terms act (gesetz zur regelung des rechts der allgemeinen geschäftsbedingungen, agbgesetz). for an english translation, see: http://www.iuscomp.org/gla/statutes/bgb.htm#b2s2 (accessed on april 27, 2014). for more information on the german law of standard terms, see: zerres, thomas. principles of the german law on standard terms of contract, available at: http://www.jurawelt.com/sunrise/media/mediafiles/14586/german_standard_ter ms_of_contract_thomas_zerres.pdf(access on 5 sept. 2015). 106 vogenauer, s., commentary on the unidroit principles (n. 39), p. 26. 107 italian civil code, art. 1229 clausole di esonero da responsabilità “e' nullo qualsiasi patto che esclude o limita preventivamente la responsabilità del debitore per dolo o per colpa grave (1490, 1579, 1681, 1694, 1713, 1784, 1838, 1900). e' nullo (1421 e seguenti) altresì qualsiasi patto preventivo di esonero o di limitazione di responsabilità per i casi in cui il fatto del debitore o dei suoi ausiliari (1580) costituisca violazione di obblighi derivanti da norme di ordine pubblico (prel. 31).” on this subject, see fernandes – cláusulas de exoneração e de limitação (n. 2), p. 384. 108 italian civil code, art. 1341 condizioni generali di contratto “le condizioni generali di contratto predisposte da uno dei contraenti sono efficaci nei confronti dell'altro, se al momento della conclusione del contratto questi le ha conosciute o avrebbe dovuto conoscerle usando l'ordinaria diligenza (1370, 2211). in ogni caso non hanno effetto, se non sono specificamente approvate per iscritto, le condizioni che stabiliscono, a favore di colui che le ha predisposte, limitazioni di responsabilità, (1229), facoltà di recedere dal contratto(1373) o di sospenderne l'esecuzione, ovvero sanciscono a carico dell'altro contraente decadenze (2964 e seguenti), limitazioni alla facoltà di opporre eccezioni (1462), restrizioni alla libertà contrattuale nei rapporti coi terzi (1379, 2557, 2596), tacita proroga o rinnovazione del contratto, clausole compromissorie (cod. proc. civ. 808) o deroghe (cod. proc. civ. 6) alla competenza dell'autorità giudiziaria.” 109 swiss code of obligations, article 100 “1 any agreement purporting to exclude liability for unlawful intent or gross negligence in advance is void. 2 at the discretion of the court, an advance exclusion of liability for minor negligence may be deemed void provided the party excluding liability was in the other party’s service at the time the waiver was made or the liability arises in connection with commercial activities conducted under official licence. 3 the specific provisions governing insurance policies are unaffected.” on this subject see fontaine and de ly on contract clauses (n. 2), p. 383. 110 artículo 1102 “la responsabilidad procedente del dolo es exigible en todas las obligaciones. la renuncia de la acción para hacerla efectiva es nula.” on this subject, see fernandes – cláusulas de exoneração e de limitação (n. 2), p. 386. 111 turkish code of obligations (law no. 6098 of january 11, 2011). see also: schwimann, ceyda akbal. the turkish code of obligations, available at: http://www.specht-partner.com/wp-content/uploads/2012/11/spechtboehm-theturkish-code-of-obligations.pdf (access on 10.11.2015). 112 schwimann, ceyda akbal. the turkish code of obligations (n. 117), p. 3. 113 e.g. article 51, i, of the consumer protection code, which expressly forbids this type of clauses in consumer contracts. cisg ac opinion no. 17 308 114 in this regard see azevedo, antonio junqueira de azevedo – cláusula cruzada de não indenizar (cross waiver of liability) (n. 2) and fernandes – cláusulas de exoneração e de limitação (n. 2), ch. 5. 115 the reasons for subjecting exemption and limitation of liability clauses to strict construction are twofold: first, these clauses derogate from the legal liability regime set out in the brazilian civil code; second, in this type of agreement, the obligee relinquishes the right to full compensation in case of breach. in this regard, see fernandes – cláusulas de exoneração e de limitação (n. 2), p. 343. 116 the relevant provision of the colombian civil code reads as follows: “articulo 1604. responsabilidad del deudor. el deudor no es responsable sino de la culpa lata en los contratos que por su naturaleza solo son útiles al acreedor; es responsable de la leve en los contratos que se hacen para beneficio recíproco de las partes; y de la levísima en los contratos en que el deudor es el único que reporta beneficio. el deudor no es responsable del caso fortuito, a menos que se haya constituido en mora (siendo el caso fortuito de aquellos que no hubieran dañado a la cosa debida, si hubiese sido entregado al acreedor), o que el caso fortuito haya sobrevenido por su culpa. la prueba de la diligencia o cuidado incumbe al que ha debido emplearlo; la prueba del caso fortuito al que lo alega. todo lo cual, sin embargo, se entiende sin perjuicio de las disposiciones especiales de las leyes, y de las estipulaciones expresas de las partes.” 117 colombia constitutional court, case c-1008, enrique javier correa de la hoz et al., 09.12.2010, available at: unilex http://www.unilex.info/case.cfm?id=1591 (accessed on april 27, 2014). in a challenge of the constitutionality of article 1616 of the colombian civil code according to which, except in case of willful misconduct or gross negligence, a party in breach is liable on for the harm it had foreseen or should have foreseen as a consequence of its non-performance, on the ground that such limitation violates, among others, the parties' fundamental right to full compensation, the constitutional court rejected the claim. in so doing the court pointed out that not only was the provision in question neither irrational or arbitrary but was inspired by basic criteria of justice and contractual fairness, and moreover was in conformity with important international instruments such as the vienna sales convention (article 74) and the unidroit principles (article 7.4.4). 118 gual acosta, josé manuel – cláusulas restrictivas de responsabilidad – observaciones al régimen vigente y propuestas de reforma, univ. sergio arboleda. bogota ́ (colombia) 8 (15): 15-34, julio-diciembre de 2008, available online at: http://www.usergioarboleda.edu.co/civilizar/revista15/clausulas%20restricti vas.pdf (accessed on april 27, 2014). 119 law no. 26.994 of october 8, 1994. for the influence of the cisg in the new civil and commercial code of argentina, see garro, alejandro and zuppi, alberto l.. the new civil and commercial code of argentina (2015) and the vienna convention on contracts for the sale of goods, available at http://www.sbm.com.ar/assets/pdf/prensa/nuevo_codigo/final_the_new_cciv_co m_argentina_and_the_cisg4.pdf(access on sept. 5, 2015). 120 article 1743 of the new civil and commercial code reads as follows: “articulo 1743.dispensa anticipada de la responsabilidad. son inválidas las cláusulas que eximen o limitan la obligación de indemnizar cuando afectan derechos indisponibles, atentan contra la buena fe, las buenas costumbres o leyes imperativas, o njcl 2017/2 309 son abusivas. son también inválidas si liberan anticipadamente, en forma total o parcial, del daño sufrido por dolo del deudor o de las personas por las cuales debe responder. » 121 article 421 of the russian civil code reads as follows: “article 421. the freedom of the contract 1. the citizens and the legal entities shall be free to conclude contracts. compulsion to conclude contracts shall be inadmissible, with the exception of the cases, when the duty to conclude the contract has been stipulated by the present code, by the law or by a voluntarily assumed obligation. 2. the parties shall have the right to conclude a contract, both stipulated and unstipulated by the law or by the other legal acts. 3. the parties shall have the right to conclude a contract, in which are contained the elements of different contracts, stipulated by the law or by the other legal acts (the mixed contract). toward the relationships between the parties in the mixed contract shall be applied in the corresponding parts the rules on the contracts, whose elements are contained in the mixed contract, unless otherwise following from the agreement between the parties or from the substance of the mixed contract. 4. the contract terms (provisions) shall be defined at the discretion of the parties, with the exception of the cases, when the content of the corresponding term (provision) has been stipulated by the law or by the other legal acts (article 422). in the cases, when the contract provision has been stipulated by the norm, applied so far as it has not been otherwise stipulated by the agreement between the parties (the dispositive norm), the parties may by their own agreement exclude its application, or may introduce the provision, distinct from that, which has been stipulated by it. in the absence of such an agreement, the contract provision shall be defined by the dispositive norm." 122 article 400 of the russian civil code reads as follows: “article 400. limitation of the scope of liability by obligations 1. by the individual kinds of obligations and by those obligations, which are related to a definite type of activity, the right to the full compensation of the losses may be limited by the law (the limited responsibility). 2. the agreement on limiting the scope of the debtor's responsibility by the contract of affiliation or by another kind of contract, in which the creditor is the citizen, coming out in the capacity of the consumer, shall be insignificant, if the scope of responsibility for the given kind of obligations or for the given violation has been defined by the law and if the agreement has been concluded before the setting in of the circumstances, entailing the responsibility for the non-discharge or for an improper discharge of the obligation.” 123 articles 401 and 402 of the russian civil code reads as follows: “article 401. the grounds of responsibility for the violation of the obligation 1. the person, who has not discharged the obligation or who has discharged it in an improper way, shall bear responsibility for this, if it has happened through his fault (an ill intention or carelessness on his part), with the exception of the cases, when the other grounds of the responsibility have been stipulated by the law or by the contract. the person shall be recognized as not guilty, if, taking into account the extent of the care and caution, which has been expected from him in the face of the nature and the terms of the circulation, he has taken all the necessary measures for properly discharging the obligation. 2. the absence of the guilt shall be proven by the person, who has violated the obligation. 3. unless otherwise stipulated by the law or by the contract, the person, who has failed to discharge, or has discharged in an improper way, the obligation, while performing the business activity, shall bear responsibility, unless he proves that the proper discharge has cisg ac opinion no. 17 310 been impossible because of a force-majeure, i.e., because of the extraordinary circumstances, which it was impossible to avert under the given conditions. to such kind of circumstances shall not be referred, in particular, the violations of obligations on the part of the debtor's counter-agents, or the absence on the market of commodities, indispensable for the discharge, or the absence of the necessary means at the debtor's disposal. 4. an agreement on eliminating or limiting the liability for an intentional violation of the obligation, concluded at an earlier date, shall be insignificant.” “article 402. the debtor's responsibility for his employees the actions of the debtor's employees, involved in the discharge of his obligation, shall be regarded as those of the debtor himself. the debtor shall be answerable for these actions, if they have caused the non-discharge or an improper discharge of the obligation.” (available at http://www.russian-civilcode.com/parti/sectioniii/subsection1/chapter25.html) 124 articles 454 to 538 of the russian civil code. 125 articles 461 of the russian civil code reads as follows: “article 461. the liability of the seller in case of the withdrawal of goods from the buyer 1. if goods are withdrawal from the buyer by third persons on the grounds that arose before the execution of the contract of sale, the seller shall be obliged to compensate the buyer's losses, unless he proves that the buyer knew or should have known about these grounds. 2. the agreement of the parties thereto about the release of the buyer of the liability in case third persons reclaim the acquired goods from the buyer or about its restriction shall be null and void.” (available at http://www.russian-civilcode.com/parti/sectioniii/subsection1/chapter30.html) 126 an english version of the 1999 people’s republic of china contract law may be found at http://www.npc.gov.cn/englishnpc/law/2007-12/11/content_1383564.htm (accessed on april 17, 2014). for an overview of the prc contract law see zhang, yuqing and huang, danhan the new contract law in the people’s republic of china and the unidroit principles of international commercial contracts : a brief comparison – revue de droit uniforme / uniform law review, rome: unidroit, 2000-3, p. 429-440. 127 the supreme people’s court interpretation clarifies that this obligation of alerting and explanation is satisfied if the party who provides the standard clauses uses scripture, symbols, signs, or other means that sufficiently draw the other party’s attention to the limitation or exclusion clause. the party using standard terms bears the burden of proving that it has fulfilled this obligation of alerting and explanation. the interpretation provides that, if a party fails to comply with the obligation of alerting and explanation, the other party may petition a people’s court to void the relevant clause. the supreme people’s court has rendered two general (and binding) interpretations since the enactment of the 1999 prc contract law. 128 the japanese civil code was enacted in 1896. it was influenced not only by german and french law, but also by english law (see, e.g., the foreseeability rule on art. 416). while partial amendments on the guarantee system were legislated along with modernization of the language of the civil code in 2004, the contents of the law of obligations which are mainly compiled in the book iii remain basically intact. ministry njcl 2017/2 311 of justice, japan. civil code reform (law of obligations), available at: http://www.moj.go.jp/english/ccr/ccr_00001.html (access on 12 sept. 2015). for accounts of the reform process, see kamo, akira (2010). “crystallization, unification, or differentiation? the japanese civil code (law of obligations) reform commission and basic reform policy (draft proposals).” columbia journal of asian law 24: 171-212; uchida, takashi (2011). “contract law reform in japan and the unidroit principles.” uniform law review 2011: 705-717, available at : http://www.unidroit.org/english/publications/review/articles/2011-3/705-717uchida.pdf; ishikawa, hiroyasu (2013). “codification, decodification, and recodification of the japanese civil code." university of tokyo journal of law and politics 10: 61-80; sono, hiroo (2014). "integrating consumer law into the civil code: a japanese attempt at re-codification" in keyes, mary and therese wilson eds. codifying contract law: international and consumer law aspects, ashgate: 107-129; and kozuka, souichirou and luke nottage (2014), “policy and politics in contract law reform in japan” in adams, maurice and dirk heirbaut eds., the method of culture of comparative law, hart: 235-253. the author of this opinion would like to thank professor hiroo sono for his valuable comments and suggestions in respect of this topic. 129 for an english translation of the 1896 japanese civil code see: http://www.moj.go.jp/content/000056024.pdf (access on 12 sept. 2015). 130 on this topic see okino, masami (2012). “recent developments in consumer protection in japan”, ut soft law review 4: 10-18, available at : http://www.gcoe.j.utokyo.ac.jp/en/publications/utsoftlaw4.pdf; sono, hiroo (2012). "private enforcement of consumer law: a sketch of the japanese landscape" hokkaido journal of new global law and policy 16: 63-80, available at : http://lex.juris.hokudai.ac.jp/gcoe/journal/lpg_vol16/16_4.pdf; and sono, hiroo (2014). "integrating consumer law into the civil code: a japanese attempt at recodification" in keyes, mary and therese wilson eds. codifying contract law: international and consumer law aspects, ashgate: 107-129. more generally, see karaiskos, antonio (2010). “regulation of unfair contract terms in japan”, waseda bulletin of comparative law vol. 28: 13-44, available at: https://www.waseda.jp/flaw/icl/assets/uploads/2014/05/a02859211-00000280013.pdf (access on 12 sept. 2015). 131 the relevant provision of the civil act reads as follows: “article 105 (optional provisions) if the parties to a juristic act have declared an intention which differs from any provisions of acts or subordinate statues, which are not concerned with good morals or other social order, such intention shall prevail.” the author of this opinion would like to thank h. e. chang-ho chung, judge of the international criminal court for his valuable comments and suggestions in respect of this topic. 132 see, for example: act on the regulation of terms and conditions “article 7 (prohibition on exemption clause) a clause in terms and conditions concerning the liability of contracting parties that falls under any of the following subparagraphs shall be null and void: a clause which exempts an enterpriser from liability for intentional or gross negligence on the part of the enterpriser, his/her agents, or his/her employees.” see also: commercial act “article 659 (reasons for insurer's non-liability) cisg ac opinion no. 17 312 "if a peril insured against has occurred due to bad faith or gross negligence of a policyholder, the insured or beneficiary, the insurer is not liable to pay the insured amount.” 133 catarina af sandeberg. “exemption of liability – where to draw the line”, stockholm institute for scandinavian law 1957-2009 pp. 279-291, available at: http://www.scandinavianlaw.se/pdf/45-16.pdf (access on 14 april 2016). 134 see farnsworth on contracts (n. 2), para. 4.26, in which the author states that “a number of cases support discharge of a duty to pay damages for partial breach of contract by renunciation, written or oral, by the obligee on acceptance from the obligor of some performance under the contract” and para. 9.1. see also yates on exclusion clauses (n. 2), p. 197 and lawson on exclusion clauses (n. 2). 135 the doctrine of fundamental breach started with a 1956 judgment of the english court of appeal. the supreme court of canada in tercon contractors ltd. v. british columbia (transportation and highways) (2010) described the doctrine as follows: “… where the defendant had so egregiously breached the contract so as to deny the plaintiff substantially the whole of its benefit … the innocent party was excused from further performance but the defendant could still be held liable for the consequences of its ‘fundamental breach’ even if the parties had excluded liability by clear and express language”. 136 for the language contained in § 2-316 of the ucc (exclusion or modification of warranties), see n. 64 supra. § 2-719 of the ucc reads as follows: “§ 2-719. contractual modification or limitation of remedy. (1)subject to the provisions of subsections (2) and (3) of this section and of the preceding section on liquidation and limitation of damages, (a) the agreement may provide for remedies in addition to or in substitution for those provided in this article and may limit or alter the measure of damages recoverable under this article, as by limiting the buyer's remedies to return of the goods and repayment of the price or to repair and replacement of non-conforming goods or parts; and (b) resort to a remedy as provided is optional unless the remedy is expressly agreed to be exclusive, in which case it is the sole remedy. (2)where circumstances cause an exclusive or limited remedy to fail of its essential purpose, remedy may be had as provided in this act. (3) consequential damages may be limited or excluded unless the limitation or exclusion is unconscionable. limitation of consequential damages for injury to the person in the case of consumer goods is prima facie unconscionable but limitation of damages where the loss is commercial is not.” 137 see farnsworth on contracts (n. 2), para. 4.28. the provision of the ucc read as follows: “§ 2-302. unconscionable contract or clause. (1) if the court as a matter of law finds the contractor any clause of the contract to have been unconscionable at the time it was made the court may refuse to enforce the contract, or it may enforce the remainder of the contract without the unconscionable clause, or it may so limit the application of any unconscionable clause as to avoid any unconscionable result. (2) when it is claimed or appears to the court that the contractor any clause thereof may be unconscionable the parties shall be afforded a reasonable opportunity to present evidence as to its commercial setting, purpose and effect to aid the court in making the determination.” njcl 2017/2 313 138 for the language of § 2-314 of the ucc (implied warranty: merchantability; usage of trade), see n. 62 supra. 139 for the language of § 2-315 of the ucc (implied warranty: fitness for particular purpose), see n. 63 supra. 140 for the language of § 2-316 of the ucc (exclusion or modification of warranties), see n. 64 supra. 141 the unfair contract terms act 1977 is an act of parliament of the united kingdom that regulates contracts by restricting the operation and legality of some contract terms. it extends to nearly all forms of contract and one of its most important functions is limiting the applicability of disclaimers of liability. the terms extend to both actual contract terms and notices that are seen to constitute a contractual obligation. the act renders terms excluding or limiting liability ineffective or subject to reasonableness, depending on the nature of the obligation purported to be excluded and whether the party purporting to exclude or limit business liability is acting against a consumer. it is normally used in conjunction with the unfair terms in consumer contracts regulations 1999, as well as the sale of goods act 1979 and the supply of goods and services act 1982. 142 the five guidelines to interpreting "reasonableness" laid down in schedule 2 to ucta are, in summary: § the relative strengths of the parties' bargaining positions; § whether the customer received any inducement to accept the term; § whether the customer knew or should have known that the term was included; § in the case of a term excluding liability if a condition is not complied with, the likelihood of compliance with that condition at the time the contract was made; and § whether the goods were a special order. 143 that is, where the clause (a) excludes liability for breach of contract; or (b) claims to permit a contractual performance substantially different from what is expected; or (c) in respect of the whole or any part of a contractual obligation, claims to allow no performance at all (e.g. if a condition precedent is not satisfied); nless in each case the clause satisfies the reasonableness test. 144 for example, a seller who is unable to pass good title should therefore agree with the buyer to transfer only such title as it has, rather than purporting to transfer good title then trying to exclude liability for the breach. the sale of goods act 1979 (as amended by the sale and supply of goods act 1994) implies warranties as to the quality of goods into contracts for the sale of goods. similar terms are implied into hire-purchase contracts by the supply of goods (implied terms) act 1973. under section 6(2) of ucta, liability for breach of these implied terms cannot be excluded as against a consumer. it is, however, possible to exclude or restrict liability for breach against other persons, but only in so far as the clause in question satisfies the requirement of reasonableness. it is likely to be reasonable if the buyer is given the chance to inspect the goods or to provide input into their design and/or manufacture. 145 supreme court of canada. tercon contractors ltd. v. british columbia (transportation and highways) (2010). the court in tercon did not however set out what the unconscionability test should be. in titus v. william f. cooke enterprises inc. (2007), macpherson j. adopted the four-part test applied in an earlier alberta court of appeal decision: 1. a grossly unfair and improvident transaction; cisg ac opinion no. 17 314 2. the victim’s lack of independent legal advice or other suitable advice; 3. an overwhelming imbalance in bargaining power caused by victim’s ignorance of business, illiteracy, ignorance or the language of the bargain, blindness, deafness, illness, senility, or similar disability; and 4. the other party’s knowingly taking advantage of this vulnerability. 146 darlington futures ltd v. delco australia pty ltd (1986) 161 clr 500, available at: http://www.austlii.edu.au/au/cases/cth/hca/1986/82.html (access on 15 april 2016). 147 quebec civil code, article 1474 a person may not exclude or limit his liability for material injury caused to another through an intentional or gross fault; a gross fault is a fault which shows gross recklessness, gross carelessness or gross negligence. he may not in any way exclude or limit his liability for bodily or moral injury caused to another. 1991, c. 64, a. 1474. 148 lerm, henry – a critical analysis of exclusionary clauses in medical contracts, doctoral thesis, faculty of law, university of pretoria (2008), p. 809-810. available at: http://upetd.up.ac.za/thesis/available/etd-05252009215044/unrestricted/06chapter12.pdf (accessed on april 27, 2014). 149 idem at 810. 150 see article 2(a) cisg and schwenzer/hachem, commentary (n. 10), art. 2, par. 4-7. 151 official journal, april 21, 1993, l. 95/29. 152 official journal, july 7, 1999, l. 171/12. 153 directive 2011/83/eu of the european parliament and of the council of 25 october 2011 (accessed on april 17, 2014 at http://ec.europa.eu/justice/consumer-marketing/rightscontracts/directive/index_en.htm). 154 proposal for a regulation of the european parliament and of the council on a common european sales law (com/2011/0635 final 2011/0284 (cod)) (accessed on april 17, 2014 at http://ec.europa.eu/justice/contract/cesl/index_en.htm). specifically on the cesl provisions limiting the debtor’s liability, namely: foreseeability of loss, loss attributable to the creditor, and mitigation, see the in-depth analysis by zimmermann, reinhard, in limitation of liability for damages in european contract law. the edinburgh law review 18.2 (2014), p. 193-224. 155 the pecl provision reads as follows: “article 8:109: clause excluding or restricting remedies remedies for non-performance may be excluded or restricted unless it would be contrary to good faith and fair dealing to invoke the exclusion or restriction.” see also a revised version of pecl, as presented by fauvarque-cosson, bénédicte and mazeaud, denis (eds.) – european contract law, materials for a common frame of reference: terminology, guiding principles, model rules, munich: sellier (2008), p. 603, which reads as follows: “article 9:109: clause excluding or restricting remedies remedies for non-performance may be excluded or restricted by a contractual clause. this clause is without effect if its implementation is contrary to good faith, for example in the case of non-performance which is deliberate or of particular gravity.” 156 article 7.1.6 of the 2010 unidroit principles reads as follows: “(exemption clauses) njcl 2017/2 315 a clause which limits or excludes one party’s liability for non-performance or which permits one party to render performance substantially different from what the other party reasonably expected may not be invoked if it would be grossly unfair to do so, having regard to the purpose of the contract.” 157 see article 7.1.6 of the 2010 unidroit principles and the official comments. see also schelhaas, harriet, commentary on the unidroit principles (n. 39),, p. 858-863, esp. 861. 158 especially articles 17 to 28. the montreal convention (formally, the convention for the unification of certain rules for international carriage by air) is a multilateral treaty adopted by a diplomatic meeting of icao member states in 1999. the full text of the montreal convention is available at: http://www.jus.uio.no/lm/air.carriage.unification.convention.montreal.1999/26.html (accessed on april 17, 2014). 159 the cmr convention (full title convention on the contract for the international carriage of goods by road) is a united nations convention that was signed in geneva on 19 may 1956. it relates to various legal issues concerning transportation of cargo by road. it has been ratified by the majority of european states. as of 2013, it has been ratified by 55 states. for more information see: https://treaties.un.org/pages/viewdetails.aspx?src=treaty&mtdsg_no=xi-b11&chapter=11&lang=en (access on 14 april 2016) 160 for the text and status of the rotterdam rules, see the uncitral website at: http://www.uncitral.org/uncitral/en/uncitral_texts/transport_goods/2008rotterdam_r ules.html (accessed on april 27, 2014). 161 in this regard, see article 79 of the rotterdam rules : “validity of contractual terms article 79 general provisions 1 . unless otherwise provided in this convention, any term in a contract of carriage is void to the extent that it: (a) directly or indirectly excludes or limits the obligations of the carrier or a maritime performing party under this convention; (b) directly or indirectly excludes or limits the liability of the carrier or a maritime performing party for breach of an obligation under this convention; or (c) assigns a benefit of insurance of the goods in favour of the carrier or a person referred to in article 18. 2 . unless otherwise provided in this convention, any term in a contract of carriage is void to the extent that it: (a) directly or indirectly excludes, limits or increases the obligations under this convention of the shipper, consignee, controlling party, holder or documentary shipper; or (b) directly or indirectly excludes, limits or increases the liability of the shipper, consignee, controlling party, holder or documentary shipper for breach of any of its obligations under this convention. nordic journal of commercial law issue 2015#1 a comparative view on ‘battle of the forms’ under the cisg and in the german and us american experiences by kasper steensgaard* * doctor of philosophy, associate professor, aarhus university. a condensed version of this article for practitioners has been published as steensgaard k, `battle of the forms under the cisg one or more solutions?’ [2015] internationales handelsrecht (ihr) 89. nordic journal of commercial law issue 2015#1 2 abstract although the cisg has been in force more than 25 years, it does not have a uniform solution to the ‘battle of the forms’. the courts have had to resolve these battles using the general rules and principles of the convention. an analysis of cisg case law reveals that german courts and us courts approach the battle of the forms problem differently and, consequently, produce different outcomes. this article analyzes and compares the possible solutions to the battle of the forms. based on this analysis of cisg case law, it is submitted that the (more) correct interpretation of the cisg rules will lead to the last-shot solution. nordic journal of commercial law issue 2015#1 3 1 introduction this article addresses a much-debated issue: the so-called ‘battle of the forms’.1 just about any business worth its salt outlines its business practices in standard terms and conditions that it attempts to incorporate into its contracts. a ‘battle of the forms’ occurs when two parties negotiating to see if they can reach an agreement on a contract both seek to incorporate their respective standard terms but fail to agree on which party’s terms apply before they perform. that the parties do not agree on all terms creates a potential legal problem. the problem, however, often remains dormant until a conflict arises and one of the parties wants to invoke the terms of the contract. before such a dispute can be resolved, two underlying questions must be answered: (1) have the parties in fact formed a contract, and if so, (2) what is its content, that is, which party’s terms apply, if any? even though these questions are the identical in every jurisdiction, they may receive fundamentally different answers. this article focuses on the battle of the forms under the united nations convention on contracts for the international sale of goods 1980 (cisg).2 the problem is that the convention does not contain an express universal solution to the battle, and the courts have therefore had to decide cases using the cisg’s general rules and principles. this has resulted in non-uniform interpretations. the cisg case law appears to be split between the so-called ‘lastshot’ and the ‘knockout’ solutions, or ‘rules’. these two approaches, and to a lesser extent the ‘first-shot’ rule, are the most widely used solutions among the different jurisdictions of the world. although the cisg must be applied autonomously, it does not exist in a vacuum. this article therefore takes a comparative look at the solutions offered in different jurisdictions to shed light on the ‘normal’ understanding of the issue, as this may reflect on the understanding of the battle under the cisg. the article then focuses on the solutions that can exist under rules similar to those in the cisg, which offers a plain mirror image principle approach to offers and acceptances and, as mentioned, no express rules on the battle of the forms. in theory, only certain variants of the knockout and last-shot rules are conceivable under the convention. the circumstances leading to a battle of the forms and the legal understanding hereof are presented in section 2. different implementations of the three solutions in various jurisdictions are presented in section 3. section 4 focuses on battle of the forms under the cisg, and contains, inter alia, an analysis of case law from german and us courts. the solution to the battle of the forms under the cisg is discussed in section 5–both de lege lata and de lege ferenda. 1 see, e.g., gerhard dannemann, the “battle of the forms” and the conflict of laws, in lex mercatoria: essays on international commercial law in honour of francis reynolds 199 (francis rose ed., 2000), who notes that ‘one gains the impression that the number of learned articles exceeds the number of reported cases where such a “battle” has occurred’. 2 united nations convention on contracts for the international sale of goods, u.n. doc. a/conf.97/18 (1981) (opened for signature apr. 11, 1980) [hereinafter cisg]. a current table of contracting states is available at the uncitral website, http://www.uncitral.org/uncitral/en/uncitral\s\do5(t)exts/sale\s\do5(g) oods/1980cisg\s\do5(s)tatus.html (last visited aug. 15, 2015). nordic journal of commercial law issue 2015#1 4 2 breakdown of the battle of the forms 2.1 social norms–the behaviours leading to a battle battles of the forms result from how businesses contract with each other in practice.3 studies of commercial transactions show that businessmen interact with each other on the basis of social norms and often tend to ignore the requirements imposed by contract law.4 a business wants to signal that it is trustworthy and flexible, that it is one you would trust to do business with again; whereas focusing on legal issues sends the opposite signal.5 making legal demands during negotiations can come across as confrontational and may jeopardize the deal. a business that gains a reputation for being ‘difficult’ may find its future opportunities limited. self-interest, therefore, may motivate businesses to forgo making legal demands and focus on the commercial terms of the deal, such as price and quality–after all, a deal on uncertain terms can still be good business. although social norms take precedence, businesses will often try to use standard terms and conditions to secure a favorable legal position in the event of a dispute.6 they may only negotiate openly on the commercial terms and attempt to incorporate their respective standard terms by reference in their correspondence. aware that standard terms are not necessarily read, the parties apply this dual course of action in an attempt to keep the potentially troublesome legal issues off the radar during the negotiations.7 3 this section relies on studies of the contracting practices of manufacturers in wisconsin, usa, and bristol, uk, and the findings may therefore not necessarily transpose to sales contracts on a global scale. the interviewees in one of the studies, for example, repeatedly said ‘that they would take much greater care when contracting with relatively unknown parties’, hugh beale & tony dugdale, contracts between businessmen: planning and the use of contractual remedies, 2 brit. j. l. & soc’y 45, 47 (1975). similarly, some interviewees reported that they put more effort into the contract negotiations for deals that were big and complex, or where there would be significant negative consequences if something went amiss, stewart macaulay, non-contractual relations in business: a preliminary study, 28 am. soc. rev. 55, 57 (1963); see also daniel keating, exploring the battle of the forms in action, 98 mich. l. rev. 2678, 2695-704 (1999-2000); hugh collins, regulating contracts 136-40 (first published 1999, photo. reprint 2005). nevertheless, not only do these findings consistently show that businesses focus more on the commercial terms than on ensuring legal enforceability when negotiating a contract, they are also consistent with patterns that can be observed in the international cases. 4 see macaulay, non-contractual relations, supra note 3; beale & dugdale, supra note 3, at 50-51; collins, supra note 3, at 127-48; stewart macaulay, the real and the paper deal: empirical pictures of relationships, complexity and the urge for transparent simple rules, 66 mlr 44, 45-47 (2003); see also jonathan morgan, great debates in contract law 16 (2012), who, under english law, considers the studies ‘ample evidence that businesses making contracts give no thought to contract law’ (emphasis in original). 5 macaulay, non-contractual relations, supra note 3, at 61-5, 61: ‘you can settle any dispute if you can keep the lawyers and accountants out of it. they just don’t understand the give-and-take needed in business’; see beale & dugdale, supra note 3, at 47-9 and 52-9. 6 on the lawyers’ role in drafting standard terms, see collins, supra note 3, at 149-73; see also on the considerations of businesses in: grant g murray, a corporate counsel’s perspective of the ‘battle of the forms’, 4 can. bus. l. j. 290 (1979-80). 7 see beale & dugdale, supra note 3, at 49-50; accord ole lando, kampen om formularen, ugeskrift for retsvæsen b 1, 2 (1988). nordic journal of commercial law issue 2015#1 5 once the parties have reached an agreement on the openly negotiated terms, however, they may believe they have a fully formed and binding contract and commence performance–even though they have yet to settle the question of applicable standard terms. this creates an unfortunate legal uncertainty, but if the transaction goes smoothly, this uncertainty does not become a problem. problems only emeerge in the event of a dispute between the parties. if the dispute cannot be settled amicably and one or both parties decides to invoke its legal rights under the ‘contract’, it becomes necessary to determine whether the parties had actually formed a valid contract, and if so, on what terms. 2.2 the battle from a legal perspective in both attempting to incorporate their respective standard terms and at the same time acting as if they do not exist, the parties rely on a flexibility not found in the law. one of the cornerstones of contract formation is the so-called mirror image principle, which prescribes that a contract can only emanate from an offer that is met by complete mirrored assent. in other words, to form a legally binding contract, an acceptance must signal an unconditional acceptance of all the terms of the offer, both the individually negotiated terms and the standard terms.8 a purported acceptance of (standard) terms that are different from those in the offer will in most cases ‘break the mirror’;9 it therefore does not function as an acceptance, but operates instead as a rejection of the offer and a counteroffer on its own terms.10 although the parties may not perceive their negotiations as an exchange of counteroffers, that is, legally speaking, the consequence of applying the mirror image principle.11 parties that agree on the negotiated terms but also attempt to incorporate their respective standard terms into their agreement do not at any time express the required complete mirrored assent and have in principle failed to conclude a contract. when the parties initiate performance without settling the issue of conflicting standard terms, they may be acting on the basis of what they perceive to be a contract. however, in (strict) legal sense that contract may never have come into being–and it is, consequently, unenforceable. even 8 rudolf b schlesinger, formation of contracts: a study of the common core of legal systems, vol 1, 125-26 (1968); see also reinhard zimmermann, the law of obligations: roman foundations of the civilian tradition 559-69 (1996); arthur taylor von mehren, the formation of contracts, in international encyclopedia of comparative law, vol vii/i, ch 9, paras 157-60 (2008). 9 see infra note 42 on art 19 cisg. 10 see generally and comparatively hyde v. wrench, [1840] ewhc ch j90, (1840) 49 er 132; lov nr. 242 om aftaler og andre retshandler på formuerettens område [aftaleloven][contracts act], may 8, 1917, as amended, § 6(2) (den.); bürgerliches gesetzbuch [bgb][civil code], aug. 18, 1896, reichsgesetzblatt [rgbl.] 195, as amended, § 150(2); art 19(1) cisg; art 2:208 of the principles of european contract law; art 2.1.11(1) of the unidorit principles of international commercial contracts. 11 minor and insignificant deviations are in most cases tolerated under the various implementations of the principle. some legal systems have exempted conflicting standard terms from the mirror image principle; see infra sections 3.2 and 3.4. nordic journal of commercial law issue 2015#1 6 so, the existence of a contract can be difficult to dispute once performances have been exchanged. the content of this contract is not necessarily discernible outright, and may have to be determined by the courts; how that can be done is addressed in the following sections. 3 solving the battle 3.1 introduction we saw in section 2 that there is very little correlation between how businesses act and the legal understanding of their conduct. this discrepancy gives rise to the question; if the contract is a creation of the parties’ agreement, what happens if the parties believe they did agree but, in fact, never fully did? the answer must follow from the applicable law. the contract derives its enforceability from the law, and the courts are bound by the law; it is therefore not within the court’s discretion to simply pick any answer it considers preferable.12 a limited number of solutions and variations are operable under the laws of the various national jurisdictions. in practice, only three solutions are seen: the first-shot rule, the last-shot rule, and the knockout rule. these solutions also have variations that require varying degrees of special regulation to apply. 3.2 ‘first shot’ the first-shot rule prescribes that the terms of an offer prevail over those contained in a modified acceptance. a first-shot solution is, for example, prescribed in art 6:225(3) of the dutch civil code:13 ‘where offer and acceptance refer to different general [standard] conditions, the second reference is without effect, unless it explicitly rejects the applicability of the general conditions as indicated in the first reference’.14 12 examples of inapplicable solutions are for example found in suggestions that are based on considerations from law and economics: victor p goldberg, the ‘battle of the forms’: fairness, efficiency, and the best-shot rule, 76 or. l. rev. 155, 166-71 (1997); giesela rühl, the battle of the forms: comparative and economic observations, 24 u. pa. j. int’l econ. l. 189, 221-24 (2003); omri ben-shahar, an ex-ante view of the battle of the forms: inducing parties to draft reasonable terms, 25 int’l rev. l. & econ. 350, 357-63 (2005); as here, naudé in commentary on the unidroit principles of international commercial contracts (picc) art 2.1.22 para 13 (stefan vogenauer & jan kleinheisterkamp eds., 2009), who rightly points out that these solutions cannot be justified by interests of the parties either; see also keating, supra note 3, at 2710-11. 13 burgerlijk wetboek [bw][civil code]. 14 translation: mahé in the principles of european contract law and dutch law: a commentary 123 (danny busch et al. eds., 2002); see also id. at 123-5; naudé in commentary on the unidroit principles, supra note 12, at art 2.1.22 para 11; ingeborg schwenzer, pascal hachem & christopher kee, global sales and contract law para 12.29 (2012). nordic journal of commercial law issue 2015#1 7 a rule such as this negates the mirror-image principle by changing the effect of a modifying acceptance so that it does not operate as a rejection and a counteroffer, but rather actually functions to conclude the contract on the terms of the offer. this effect can only be avoided if the terms of the offer are expressly rejected by the acceptance. because the approach departs from the mirror image principle, it requires another (independent) legal basis or rule, like art 6:225(3) of the dutch civil code, to apply. such provisions are rare in practice, though, and that may explain the limited acceptance of the first-shot solution. the first-shot solution will not be addressed in further detail because the cisg does not establish independent basis for application of the rule in lieu of the mirror image principle. another example of a (possible) first-shot solution can arguably be found in section 2-207 of the united states’ uniform commercial code (ucc), which, along with section 2-206 ucc, establishes the effects of offers and acceptances in the formation of a contract.15 section 2-207 is, however, a hybrid of different solutions. depending on the circumstances, the parties, and the differences between the terms of the offer and acceptance, it may proviode for a first-shot, a lastshot, or a knockout result. section 2-207(1) ucc establishes the general conditions for contract conclusion, and states that a ‘definite and seasonable expression of acceptance’ operates as an acceptance, even if it contains terms that are additional to or different from those contained in the offer.16 the rule differs fundamentally from the mirror image principle by allowing modified acceptances to conclude a contract. section 2-207(2) defines the content of the resultant contract. if the parties are merchants, the additional terms in the acceptance become part of the contract if the offeror (1) did not expressly limit acceptance to the terms of the offer, (2) the additional terms do not change the terms of the offer materially, or (3) the offeror does not expressly object to the additional terms.17 in other cases, the additional material terms in the acceptance are to be construed as proposals for additions to the offer, and, therefore, only make their way into the contract if they are accepted by the offeror–if he does not, the acceptance is, nevertheless, still effective and the terms of the offer prevail (first shot).18 it is unclear, however, whether section 2-207(2) also applies to different or 15 see arthur taylor von mehren, the ‘battle of the forms’: a comparative view, 38 am. j. comp. l. 265, 277-90 (1990); mehren in international encyclopedia of comparative law, supra note 8, at paras 168-74; edward j. jacobs, the battle of the forms: standard term contracts in comparative perspective, 34 int’l comp. l. q. 297, 307-12 (1985); howard o hunter, modern law of contracts § 4:24 (2013th ed.); lary lawrence, lawrence’s anderson on the uniform commercial code §§ 2-207:2 and 5 (3rd ed.); see also sieg eiselen & sebastian k bergenthal, the battle of forms: a comparative analysis, 39 comp. & int’l l.j. s. afr. 214, 230-34 (2006). 16 the modifying acceptance can be made conditional on assent to the additional or different terms; see clayton p. gillette & steven d. walt, sales law: domestic and international 76-84 (2nd ed. 2009); e. allan farnsworth, farnsworth on contracts § 3.21 (3rd ed. 2004); hunter, supra note 15, at § 4:25; lawrence, supra note 15, at §§ 2-207:26-30. 17 see gillette & walt, supra note 16, at 79-83; see also in detail lawrence, supra note 15, at §§ 2-207:75-101. 18 see lawrence, supra note 15, at §§ 2-207:116-21; litton microwave cooking products v. leviton mfg co, inc, 15 f.3d 790 (8th cir. 1994); jacobs, supra note 15, at 311; farnsworth, supra note 16, at § 3.21; gillette & walt, supra note 16, at 78-79. nordic journal of commercial law issue 2015#1 8 modifying terms (as opposed to additional). the ucc official comment to section 2-207 favours a knockout solution in that case, while some scholars argue in favor of a first-shot solution.19 to complicate the situation even more, section 2-207(3) ucc establishes another possible means of contract formation. if sections 2-207(1) and (2) do not lead to a contract but both parties recognize the existence of one through their conduct, section 2-207(3) ucc holds a contract to be formed and stipulates a knockout rule to resolve which terms govern the contract.20 the applicability of section 2-207(3) depends on the concrete facts of the case and the view of the court, and thus may leave the legal position somewhat unclear.21 3.3 ‘last shot’ the last-shot rule follows the mirror image principle to the letter and constitutes the logical extension of the principle.22 when the battle of the forms, legally speaking, consists of a string of counteroffers, each met by and rejected by a modifying acceptance, there will be one non-rejected and operable (counter) offer at the end–this is the ‘last shot’.23 the counteroffer deemed to be the final offer is incorporated into the contract when the recipient either performs the contract (implying acceptance through its conduct) or fails to object to the modified terms. these two variants of the last-shot solution are discussed in the sections that follow. 3.3.1 acceptance of the last shot inferred from conduct the most widespread variant of the last-shot rule involves an implied acceptance. in this construct the final offer is deemed have to been accepted by the offeree through its conduct–typically through an act of performance, such as shipping the goods or paying the purchase price.24 for example, if a seller responds to an incoming order by shipping the goods ordered, that in itself will count as the seller’s acceptance of the terms in the buyer’s purchase offer. this variant of the 19 official comment to ucc § 2-207 para 6, reprinted in lawrence, supra note 15, at § 2-207:1; see also the discussion in james j white & robert s summers, uniform commercial code (5th ed. 2000) para 1-3(1) and (3); farnsworth, supra note 16, at § 3.21; mehren, battle of the forms, supra note 15, at 286-87; hunter, supra note 15, at §§ 4:29-30; lawrence, supra note 15, at §§ 2-207:102-13. 20 farnsworth, supra note 16, at § 3.21; hunter, supra note 15, at § 4:31; mehren, battle of the forms, supra note 15, at 287-90; lawrence, supra note 15, at §§ 2-207:134-6, 157-60; mehren in international encyclopedia of comparative law, supra note 8, at para 174; eiselen & bergenthal, supra note 15, at 234-35. 21 official comment to ucc § 2-207, supra note 19, at para 7. 22 henry deeb gabriel, battle of the forms: a comparison of the united nations convention for the international sale of goods and the uniform commercial code, 49 bus. law. 1053, 1054 (1993-1994); naudé in commentary on the unidroit principles, supra note 12, at art 2.1.22 para 2; similarly michael p van alstine, consensus, dissensus, and contractual obligation through the prism of uniform international sales law, 37 va. j. int’l l. 1, 67 (1996-1997); andrea fejós, battle of the forms under the convention on contracts for the international sale of goods (cisg): a uniform solution?, 11 vindobona j. int’l com. l. & arb. 113, 118 (2007). 23 see supra section 2.2. 24 the form of the implied acceptance is not important unless the contract is subject to form requirements. nordic journal of commercial law issue 2015#1 9 last-shot rule is therefore, in principle, based on the recipient’s consent rather than on the action of the offeror.25 an example can be found in english contract law.26 in british railroad v crutchley,27 the recipient of a shipment of whiskey stamped the seller’s delivery note with a stamp that included the recipient’s own terms, thereby making a counteroffer, which was deemed accepted by the seller when its driver subsequently handed over the goods to the recipient.28 in a later case, butler machine tool,29 the seller signed and returned a tear-off acknowledgment slip that was attached to the buyer’s order form and thereby accepted the offer it represented.30 more recently, the last-shot rule was reaffirmed in tekdata v amphenol,31 trebor v adt,32 and claxton v txm.33 however, even where the last-shot rule applies, acceptance of the final offer cannot be inferred from performance when there is concrete evidence of a contrary intention. see, for example, lidl v hertford34 and ghsp v ab electronic.35 in those cases, both parties expressly and repeatedly refused to contract under the other party’s standard terms, and the courts were therefore unable to attribute an implied acceptance to either party. the judges consequently ruled that no standard terms had been incorporated. 25 burghard piltz, standard terms in un-contracts of sale, 8 vindobona j. int’l com. l. & arb. 233, 242 (2004). 26 this variant is sometimes also called the common law approach, see jacobs, supra note 15, at 297; see also the discussion on english law in morgan, supra note 4, at 14-27. the last-shot rule also applies in scandinavian contract law, kasper steensgaard, standardbetingelser i internationale kontrakter § 6 paras 27-39 (2010). 27 british railroad services v. arthur v. crutchley ltd, [1968] 1 all er 811 (ca). 28 id. at 274, 281-82. edwin peel, treitel on the law of contract 2-20 (13th ed. 2011); also comparatively françois vergne, the ‘battle of the forms’ under the 1980 united nations convention on contracts for the international sale of goods, 33 am. j. comp. l. 233, 239-43 (1985); burt a leete, contract formation under the united nations convention on contracts for the international sale of goods and the uniform commerical code: pitfalls for the unwary, 6 temp. int’l & comp. l. j. 193, 209-10 (1992); gabriel, supra note 22, at 1055-56; jacobs, supra note 15, at 297-307. 29 butler machine tool co ltd v. ex-cell-o corporation (england) ltd, [1977] ewca civ 9, [1979] 1 wlr 401. 30 id. at 403. in his ratio, lord denning questioned the last-shot rule, but applied it nonetheless; id. at 404-5. compare peel, supra note 28, at para 2-021; and comparatively vergne, supra note 28, at 241-43; mehren, battle of the forms, supra note 15, at 272-74; rühl, supra note 12, at 193-96. a similar reasoning was expressed by in muirhead v. industrial tank specialities ltd, [1985] ewca civ 16, [1986] qb 507, 530 (goff lj): ‘strictly speaking, the [seller’s] form of acknowledgement constituted a counter-offer, which was accepted when [the buyer] took delivery of the pumps delivered pursuant to the order placed on the [seller]’. 31 tekdata interconnections ltd v. amphenol ltd, [2009] ewca civ 1209, [2010] 2 all er (comm) 302. 32 trebor bassett holdings ltd v. adt fire & security plc, [2011] ewhc 1936 (tcc), [2011] blr 661 [152][157] (coulson j); appeal on other grounds dismissed, trebor bassett holdings ltd v. adt fire & security plc, [2012] ewca civ 1158; but see also, however, the more flexible approach in j murphy & sons ltd v. johnston precast ltd (formerly johnston pipes ltd), [2008] ewhc 3024 (tcc) [80]-[89] (coulson j). 33 claxton engineering services ltd v. txm olaj-és gázkutató kft, [2010] ewhc 2567 (comm), [2011] 2 all er (comm) 38 [51]-[52] (gloster j). 34 lidl uk gmbh v. hertford foods ltd, [2001] ewca civ 938 [19]-[25] (chadwick lj). 35 ghsp inc v. ab electronic ltd, [2010] ewhc 1828 (comm), [2011] 1 lloyd’s rep 432 [35]-[38] (burton j). nordic journal of commercial law issue 2015#1 10 the last-shot rule is applicable under us common law.36 it has lost most of its impact today, however, because most sales contracts are now governed by the ucc 2-207 (see section 3.2).37 it can be problematic, though, to infer acceptance of a counteroffer from the performance of the recipient. while active conduct provides a very strong basis for concluding that a party indeed wants to contract, it does not necessarily establish an intention to also accept the other party’s standard terms. a performance act may, on the one hand, express assent to the terms in the counteroffer or it may, on the other hand, simply indicate that the party already considers itself bound by a valid complete contract and that it is simply fulfilling its obligations accordingly. the studies mentioned in section 2.1 confirm that businesses often regard agreement on the individually negotiated terms as a sufficient basis for performance, and then act under their perceived obligations. moreover, the mirror image principle presumes that the offeror read and understand all the terms of the purported acceptance. if, in practice, the recipient does not read the terms in the modified acceptance, it will not perceive it as a counteroffer and therefore cannot express assent to it. the act of performance is thus not necessarily conclusive evidence of that party’s acceptance of the counteroffer. the basis for the last-shot solution may therefore be specious in the concrete case.38 3.3.2 express rule–last shot by silence or inaction the other variant of the last-shot rule places the onus of rejecting a modified acceptance on the recipient. according to this variant, if a recipient who does not want to bound by the terms of a counteroffer remains silent, ie does not expressly object to its terms, those terms are, nevertheless, incorporated into the contract. while this variant avoids some of the problems associated with implied acceptances based on conduct, it requires a dedicated provision to give this effect to silence.39 36 restatement (second) of contracts §§ 57, 59 (1981); farnsworth, supra note 16, at § 3.21; hunter, supra note 15, at § 4:23; vergne, supra note 28, at 243; e.g. poel v. brunswick-balke-collender co of new york, 111 n.e. 1098 (1916); critical john e murray jr, the standardized agreement phenomena in the restatement (second) of contracts, 67 cornell int’l l. j. 735, 744-761. (1981-82); see also on the mirror image principle hunter, supra note 15, at §§ 4:11-3. 37 c itoh & co (america) inc v. jordan intern co, 552 f.2d 1228 (7th cir. 1977); litton microwave cooking products v. leviton mfg co, inc, 15 f.3d 790, 794 (8th cir. 1994); but see also the criticised roto-lith ltd v. f p bartlett & co, 297 f.2d 497 (1st cir. 1962); see mehren, battle of the forms, supra note 15, at 280-81; ved p. nanda & david k .pansius, litigation of international disputes in u.s. courts § 12:28 (2nd ed. 2005); eiselen & bergenthal, supra note 15, at 232. 38 see van alstine, supra note 22, at 66-79. 39 silence generally does not amount to an acceptance, see generally schlesinger, supra note 8, at 131-40; mehren in international encyclopedia of comparative law, supra note 8, at para 34, some general exceptions to the principle are described from a comparative point of view in paras 35-7; see also ernst rabel, das recht des warenskaufs: eine rechtsvergleichende darstellung vol 1, 94-101 (1936); see also art 18(1) cisg. nordic journal of commercial law issue 2015#1 11 the most clearcut example of a silence-based last-shot provision was found in sections 33(2) and (3) of the law on international commercial contracts40 of the former german democratic republic. this section states that if both parties employ standard terms and conditions, the terms introduced last and uncontested will apply.41 a (very) limited silence-based last-shot rule is also found in art 19(2) cisg, which provides that acceptances that alter the terms of the offer immaterially42 will determine the contract unless the recipient objects, orally or in writing, without ‘undue delay’.43 in the cisg, purported acceptances that materially differ from their corresponding offers are considered rejections and, consequently, counteroffers, as prescribed in art 19(1) (see section 4 below). 3.3.3 assessment because the last-shot rule is the logical extension of the long-established mirror-image principle, it is the traditional solution to the battle of the forms. but nowadays, businesses often disregard the classic offer and acceptance formulae of contract law, and so the last-shot rule does not always conform with modern contracting practices.44 if, for example, the parties reach an agreement through successive, point-for-point negotiations and/or jointly sign a document, it can be all but impossible to identify the individual offers and acceptances. and neither party can reasonably be said to have been the sole offeror of the entire agreement complex.45 as noted earlier, a weakness of the last-shot solution concerns the inference of acceptance from conduct. it can be problematic to infer an acceptance from conduct that does not unequivocally 40 gesetz über internationale wirtschaftsverträge [giw] [law on international commercial contracts], feb. 5, 1979. 41 see rudolph in gesetz über internationale wirtschaftsverträge § 33 paras 8-12 (dietrich maskow & hellmut wagner, eds., 3rd ed. 1984). 42 standard terms almost always contain provisions that regulate issues which are considered material in the sense of art 19. the examples of material terms enumerated in art 19(3) dovetail almost completely with those reported as ‘most used’ in a sociological survey of the use of standard terms in the netherlands; floor aj gras, standaardkontrakten: een rechtssociologische analyse 130 (1979). 43 commentary on the draft convention on contracts for the international sale of goods, prepared by the secretariat (mar. 14, 1979) un doc a/conf 97/5 [hereinafter secretariat commentary] art 17 paras 9-10. article 19(2) was for example applied in oberlandesgericht koblenz [olg][higher regional court] mar. 1, 2010, neue juristische wochenschrift-rechtssprechungs-report [njw-rr] 1004, 2010 (ger.), in which an offer to sell an asphalt machine was only altered immaterially, when the prospective buyer in its acceptance had written ‘non’ on top of a proposal to add a mobile storage tank to the order–this could also have been seen as a separate offer, though; see also landgericht baden-baden [lg][regional court] aug. 14, 1991, cisg-online no. 24, available at http://www.cisg-online.ch (last visited aug. 15, 2015) [hereinafter cisg-online]. 44 see supra section 2.1. 45 see also mehren, battle of the forms, supra note 15, at 270; eiselen & bergenthal, supra note 15, at 221-22. nordic journal of commercial law issue 2015#1 12 express assent.46 this concern is cured under the silence-based last-shot variant, but that rule requires an express legal basis, such as a dedicated rule, to ensure that silence can be construed as an acceptance. a related concern relates to agency. for example, an employee who physically receives and signs for the goods or who issues the payment may not have the authority to conclude contracts on the company’s behalf.47 the question is often whether a company is bound if the concluding action is performed by a non-management employee. such situations must be dealt with individually. the last-shot rule has also been criticised for producing unbalanced outcomes. both parties contribute to the legal uncertainty, but the last shot is an all-or-nothing approach that awards one party everything and the other party nothing.48 rather than accommodating the interests of both parties, the last-shot rule ensures one party’s legal security and makes its legal position under the contract predictable. while the rule does give each party an equal the ability to protect its legal position by insisting on having the last shot, such insistence may lead to a counterproductive ping-pong-like exchange of correspondence (though it may also motivate the parties to address the standard terms expressly and thereby end the battle before the performances commence).49 the last-shot rule may, consequently, produce arbitrary results, as it can be somewhat random which party makes the final offer before the contract is executed–although the seller’s order confirmation often constitutes the final offer in practice.50 3.4 ‘knock out’ the knockout solution is based on a completely different approach to contract conclusion than the ‘shot’ rules. the knockout rule does not require complete mirrored assent as long as there is agreement on the essential contract terms (essentialia negotii) and both parties have an intention to contract (animus contrahendi). in essence, the approach holds that when the parties are convinced that a contract exists and perform it, this in itself should be recognized as an enforceable basis for contract formation under the law–notwithstanding any unresolved issues. the content of the contract is determined from the common core of the offers and acceptances exchanged during 46 see supra section 3.3.1; see also mehren, battle of the forms, supra note 15, at 270-72; eiselen & bergenthal, supra note 15, at 222; kaia wildner, art. 19 cisg: the german approach to the battle of the forms in international contract law: the decision of the federal supreme court of germany of 9 january 2002, 20 pace int’l l. rev. 1, 6-7 (2008). 47 jacobs, supra note 15, at 302-3. 48 see john o honnold, uniform law for international sales under the 1980 united nations convention para 170.3 (harry m flechtner ed., 4th ed. 2009). 49 see schwenzer, hachem & kee, supra note 14, at para 12.28; eiselen & bergenthal, supra note 15, at 221; maría del pilar perales viscasillas, battle of the forms under the 1980 united nations convention on contracts for the international sale of goods: a comparison with section 2-207 ucc and the unidroit principles, 10 pace int’l l. rev. 97, 118 and 148 (1998); wildner, supra note 46, at 6-7. 50 see also perales viscasillas, battle of the forms, supra note 49, at 116-17. nordic journal of commercial law issue 2015#1 13 the negotiations, which the parties are deemed to agree on, and the non-conforming and conflicting terms are ‘knocked out’. the knockout solution is therefore retroactive in nature.51 once the parties have concluded a contract, the legal nature of the documents that were exchanged during the negotiations are redefined. the previously obsolete counteroffers transform into generic expressions of intent that the courts use to determine the common core and extent of the parties’ agreement. because the knockout rule sidesteps the mirror image principle, another basis for contract conclusion must be established. two variants manifest when we look comparatively at the different implementations of the knockout rule. one variant is for the applicable law to stipulate a dedicated rule on how conflicting standard terms are to be reconciled. the other way is to apply an alternative approach to contract formation and then decide the content of the contract through interpretation. these two possibilities are presented in the following sections. 3.4.1 as an express rule the prevailing trend in international contract law is to include an express knockout provision. this option is adopted in for example art 2.1.22 upicc,52 art 2:209(1) pecl,53 art 6:204 acqp, art ii.-4:209(1) dcfr,54 and art 39 of the proposed cesl.55 although the wordings of the different rules vary, their core message is the same: a contract is recognised to have been concluded even though it contains conflicting standard terms as the rule knocks out the conflicting terms. these provisions eliminate any concerns over whether an offer was actually accepted or not and whether an enforceable contract was formed. 51 see also ingeborg schwenzer & florian mohs, old habits die hard: traditional contract formation in a modern world, 2006 internationales handelsrecht [ihr] 239, 244, who note that application of art 19 is restricted to the negotiation phase. this would circumvent the effects of the provision and enable the application of a knockout rule once the contract has been executed. 52 naudé in commentary on the unidroit principles, supra note 12, at art 2.1.22 paras 7-9, 14; eiselen & bergenthal, supra note 15, at 227-30. 53 ole lando & hugh beale (eds.), principles of european contract law: parts i and ii, art 2:209, cmnt c (2000); mahé in the principles of european contract law and dutch law, supra note 14, at 122-23; see also maría del pilar perales viscasillas, battle of the forms, modification of contract, commerical letters of confirmation: comparison of the united nations convention on contracts for the international sale of goods (cisg) with the principles of european contract law (pecl), 14 pace int’l l. rev. 153, 156-58 (2002). 54 draft common frame of reference (dcfr): full edition art ii.-4:209, cmnt c (study group on a european civil code, research group on the existing ec private law (acquis group) eds., 2009). 55 evelyne terryn in common european sales law (cesl): commentary art 39 paras 6-7 (reiner schulze ed., 2012); caroline harvey & michael schillig, conclusion of contracts, in the common european sales law in context: interactions with english and german law 284-86 (gerhard dannemann & stefan vogenauer eds., 2013). nordic journal of commercial law issue 2015#1 14 express knockout rules are also found in section 2-207(3) ucc (see section 3.2) and in section 2-207 of the 2003 proposal for a revision of article 2 ucc, which did not gather sufficient support among the states and has now been withdrawn.56 3.4.2 consensus as an alternative means of contract formation the other variant of the knockout rules employs an alternative approach to contract formation. an example is the case of domestic german law. historically, section 150(2) of the german civil code,57 which expresses the mirror image principle, was considered to mandate a last-shot approach to the battle of the forms.58 this position was challenged, however. and, in a 1973 landmark decision, the german supreme court, ruled that it would violate good faith (‘treu und glauben’) to negate a contract that the parties not only agreed existed but already had performed, even though the parties still disagreed on some terms.59 after the decision, german courts do not resolve battles of the forms by trying to identify a decisive, final offer and its corresponding acceptance. instead, the courts attempt to ascertain whether the parties had a mutual intention to contract.60 under this approach, a ‘meeting of the minds’ is sufficient to conclude a contract. the approach is based on the consensus principle, which provides that the agreement of parties is the underlying basis for the creation of legally binding obligations.61 the principle entails that nothing but an agreement is required for a contract to come into existence; it does not prescribe how that consensus must be reached. the ‘offer and acceptance’ model is, in principle, just one possible way of arriving at an agreement. by applying the consensus principle directly, german law circumvents 56 e.g. nanda & pansius, supra note 37, at § 12:18. 57 bürgerliches gesetzbuch [bgb][civil code], aug. 18, 1896. 58 ludwig raiser, das recht der allgemeinen geschäftsbedingungen 224-25 (first published 1935, photo. reprint 1961); peter schlechtriem, the battle of the forms under german law, 23 bus. law. 655, 656-59 (1967-68); werner flume, allgemeiner teil des bürgerlichen rechts: das rechtsgeschäft vol ii, 672-77 (3rd ed. 1979); ernst a kramer, battle of the forms: eine rechtsvergleichende skizze mit blick auf das schweizerische recht, in gauchs welt: recht, vertragsrecht und baurecht: festschrift für peter gauch zum 65. geburtstag 495-96 (pierre tercier et al., eds., 2004); mehren, battle of the forms, supra note 15, at 290-94; rühl, supra note 12, at 201-05; horst locher, das recht der allgemeinen geschäftsbedingungen 54-55 (3rd ed. 1997); eiselen & bergenthal, supra note 15, at 236. 59 bundesgerichtshof sep. 26, 1973, 61 bghz 282; see also oberlandesgericht cologne mar. 19, 1980, 1980 der betrieb [db] 924; mehren in international encyclopedia of comparative law, supra note 8, at paras 175-6; rühl, supra note 12, at 202-4; eiselen & bergenthal, supra note 15, at 236-39; filippo ranieri, europäisches obligationenrecht: ein handbuch mit texten und materialien 364-66 (3rd ed. 2009). 60 e.g. schlosser in j. von staudingers kommentar zum bürgerlichen gesetzbuch: recht der schuldverhältnisse §§ 305-310; uklag (recht der allgemeinen geschäftsbedingungen) (2013) § 305 bgb paras 205-9. 61 this principle is the basic foundation for the creation of volitional obligations in most legal systems–though the individual expressions vary, see mehren in international encyclopedia of comparative law, supra note 8, at paras 5-8, 31-61. one exception is nordic contract law, in which the so-called promise theory holds offers to be binding one-sided promises in themselves, see rabel, supra note 39, at 70-71. nordic journal of commercial law issue 2015#1 15 the difficulties associated with the mirror image principle and disposes of the strict requirement of an unqualified acceptance.62 the content of the contract is subsequently determined by filling the gaps left by the knocked out terms with the relevant underlying rules, cf sections 154(1), 155, and 306(2) bgb.63 austrian law contains a similar solution. the battle of the forms is also perceived as a question of contract formation through consensus. when the parties go through with the deal, they express that they do not want their disagreement to hinder their contract; the conflicting terms are removed while the remainder live on as the contract (‘die restgültigskeitstheorie’).64 in swiss law, the prevailing opinion also appears to be knockout based on consensus.65 3.4.3 assessment the knockout rule appears more aligned with modern contracting practices as it reflects the parties’ actual conduct during and after negotiations.66 contract conclusion follows either from an express provision or by an alternative means of contract formation. establishing that a contract exists is largely a question of evidence and that is relatively unproblematic as long as there is a manifest animus contrahendo and an agreement on the essentialia negotii.67 determining the content of the contract, however, is less straightforward. whether the knockout rule is worded negatively (by providing that conflicting terms be knocked out) or positively (by providing that the terms common in substance make up the content), it leaves the court with a relatively wide discretion in its subsumption of the facts, which can be understood and applied in more ways. that leaves room for uncertainty. the first step in determining the content of the contract is to identify the overtly incompatible terms in the parties’ standard terms and knock them out. this can often be done expeditiously, especially if the knockout rule provides that the terms common in substance are incorporated into the contract. it is less easy to do, however, with provisions on issues that are regulated in only one set of terms. are they in or out? standard terms are drafted to derogate from the underlying law, so a drafter’s choice not to regulate an issue in standard terms can be interpreted either as an 62 see flume, supra note 58, at 676-77. 63 section 306 bgb was drafted with a consumer protective scope, but applies also to commercial contracts, § 310(1) bgb e.c. 64 oberster gerichtshof [ogh][supreme court] jun. 7, 1990, 1991 juristische blätter [öjbl] 120 (austria); see also ranieri, supra note 59, at 366-67; kramer, supra note 58, at 496-97. 65 marc p bührer, agb-kollisionen, ‘the battle of the forms’ und weitere probleme beim verweis auf allgemeine geschäftsbedingungen 55-56 (1987); bücher in basler kommentar: obligationenrecht i art 1 or, paras 66-9 (heinrich honsell, nedim peter vogt & wolfgang wiegand eds., 4th ed. 2007); kramer, supra note 58, at 503-6. 66 see supra section 2.1. 67 this is not the case, for example, if one party refuses to contract under other terms than its own. nordic journal of commercial law issue 2015#1 16 implicit incorporation of the underlying rule, or, as a waiver of weighing in on the issue, which in practice amounts to an implied acceptance of the other party’s term through silence. which it is must be decided in each case. second, when the existence of the contract rests on the parties’ ‘will to contract’, cancelling a term that one party considers essential does, in principle, jeopardize the entire contract by vitiating the animus contrahendo. this situation can arise if a party chooses to balance an unfavorable term with a favorable one in an effort to stay competitive. if a seller, for example, compensates for an exemption clause with a significant price rebate, and the former is knocked out by a conflicting provision in the buyer’s terms (for example a guarantee), then the seller’s low price and the default liability regime in the applicable law will apply. the resulting contract is one to which the seller would have never agreed to voluntarily. essentially, this means that the parties may not attribute equal weight to all the individual provisions, so knocking out certain terms may create a paradoxical solution in which removing a certain conflicting term eliminates the consensus on which the contract is based.68 what remains is to fill the gaps resulting from the knockouts.69 does the underlying law apply exhaustively as a gap filler, or may implied or hypothetical terms be extrapolated from the contract and circumstances? the knockout is presumed to produce more balanced outcomes, but the underlying law does not always balance the interests of the parties. this is for example the case if the parties are pulling in the ‘same direction’ away from the law’s (presumably balanced) position.70 to illustrate: if free on board (fob) and delivered duty paid (ddp) clauses knock each other out of a cisg contract, the risk will pass in accordance with art 31(a) cisg, and that might be earlier than under both clauses. the buyer may therefore be better off with the seller’s fob clause.71 the extent to which the knockout rule gives courts discretion to fill in the contract gaps through interpretation and, for example, to rule that the risk passes in accordance with the earliest possible time of the two clauses, is not regulated in the express rules mentioned in section 3.4.1. a similar issue may arise in relation to clauses that conform and conflict at the same time. take for example arbitration clauses that name different venues–the conflicting venue nominations are knocked out, but does the underlying agreement to arbitrate survive? compare for example lea tai textile v manning fabrics,72 in which the court knocked out both arbitration clauses under section 2-207(2)(c) ucc, and lory fabrics 68 e.g. naudé in commentary on the unidroit principles, supra note 12, at art 2.1.22 paras 8-9. 69 see also schroeter in commentary on the un convention on contracts for the international sale of goods (cisg) art 19 paras 38-51 (ingeborg schwenzer & peter schlechtriem eds., 3rd ed. 2010). 70 ben-shahar, supra note 12, at 355, notes that the background rules will often be significantly closer to the buyer’s forms than to the seller’s. 71 a similar situation may, for example, also arise in relation to shorter or longer notice periods and prices in fluctuating markets. this uncertainty is illustrated by an award from cietac, 25 may 2005, available in english at http://cisgw3.law.pace.edu/cases/050525c1.html (zheng xie & jing li) (last visited aug. 15, 2015), although the case was decided already on the fact that in the case, no record of an agreement satisfied the applicable writing requirement. 72 lea tai textile co, ltd v. manning fabrics, inc, 411 f.supp. 1404, 1406-7 (s.d.n.y. 1975). nordic journal of commercial law issue 2015#1 17 v dress rehearsal,73 in which the court found that only the issue of venue was conflicting and knocked that out, while the agreement to arbitrate survived because ‘arbitration was clearly intended’.74 so, the knockout rule aligns more with modern contract practices and avoids the possibility of a specious implied acceptance. it may to produce a reasonable and balanced solution to legal uncertainties which both parties have created by failing to negotiate standard terms and conditions75 it does, however, give rise to a number of issues that are not always adequately addressed in the applicable rules. moreover, the approach sacrifices legal security and predictability of the shot solutions by giving courts a wide discretion over contract content. under the knockout rule it can be all but impossible to determine the content of the contract before a court has had its say. 3.5 discussion: the fundamental differences among the solutions to the battle of the forms the last-shot solution and the knockout solution presented in this article appear at first glance to be distinguishable based on their outcomes. the shot rules incorporate a complete single set of terms, whereas the knock-out rule consolidates a set of ‘common’ terms. nevertheless, upon closer inspection, it becomes apparent that the differences among them are more deeply rooted. a good starting point for a comparison of the different solutions is perhaps found in the two questions that battles of the forms prompt: (1) has a contract been concluded, and if so (2) what is its content, that is, which party’s terms apply, if any? regardless of which solution is applied, the courts rule in favour of the the existence of a contract if the parties have exchanged performances. but, as explained earlier, the last-shot and knockout solutions operate with different understandings of contract formation; the concrete reasoning of the court is therefore determined by the solution being applied. these differences stand out, in particular, when we consider the two solutions based on the mirror image principle, namely ‘last shot based on an implied acceptance’ 73 lory fabrics, inc v. dress rehearsal, inc, 434 n.y.s.2d 359, 362-63 (1980). 74 the efficacy of arbitration clauses is also dependent on art ii of the new york convention, e.g. oberlandesgericht frankfurt jun. 26, 2006, cisg-online no. 1385, available in english at http://cisgw3.law.pace.edu/ cases/060626g1.html (jan henning berg and daniel nagel trans.) (last visited aug. 15, 2015); see also lando & beale, supra note 53, at art 2:209 cmnt c ill 2; j. clark kelso, united nations convention on contracts for the international sale of goods: contract formation and the battle of the forms, 21 colum. j. transnat’l l. 529, 554-5 (1982-1983), who argues that the last-shot solution at least would ensure the agreement to arbitrate; perales viscasillas, battle of the forms, supra note 49, at 120, who argues that the difference in venue would be immaterial in the sense of art 19(2) cisg; goldberg, supra note 12, at 161, who notes that an agreement to arbitrate could be discernible from the record, that would, however, in some cases fall short of the requirements under art ii(1) of the new york convention. 75 mehren, battle of the forms, supra note 15, at 292; naudé in commentary on the unidroit principles, supra note 12, at art 2.1.22 para 14. both citing oberlandesgericht cologne mar. 19, 1980, 1980 der betrieb [db] 924, in which both parties were found to have lost their right to rely on their respective terms as neither party had sought to clarify the situation; see also wildner, supra note 46, at 9-11. nordic journal of commercial law issue 2015#1 18 and ‘knock out through consensus’.76 both utilize the same facts to establish the existence of contract, but they do so for different reasons. an act of performance, for example, would under the last-shot rule constitute an implied acceptance, and under the knockout rule, the same act would operate as an expression of an intent to contract. this difference is a consequence of the different qualifications (characterizations) of the battle of the forms as a legal problem. is the battle of the forms a question of offer and acceptance or a question of an alternative means of contract formation through consensus? the qualification of the battle not only decides the means of contract conclusion to answer the first question, but also extends to the second question by establishing the basis for determining content. if the contract is concluded by an (implied) acceptance, the corresponding offer is adopted in full. this acceptance cannot later be redefined to be a generic expression of intent to contract on only some of the terms of the offer, and that rules out a knockout outcome. accordingly, if the contract arises from mutual expressions of intent to contract, its content is decided by the extent of the parties’ agreement. consequently, neither set of terms can be wholly incorporated at the expense of the other as is the case under the last-shot rule. consequently, qualification, contract conclusion, and determination of the content of the contract are interrelated. the qualification of battle of the forms determines the approach to contract conclusion–whether the court will look for assent or consensus. in turn, the means of contract conclusion dictates how the content of the contract is determined. the two questions asked at the beginning of this article are therefore not independent from each other, as they rest on the same underlying premise–and that premise is impliedly decided by the court’s approach to the problem.77 the qualification of the battle is in essence outcome-determinative. but how does one arrive at a qualification? that depends on the applicable law. and it appears from the foregoing analysis that when the mirror image principle applies, it points towards the last-shot rule, and that a separate basis, such as an express provision or another legal qualification, is required to reach another result. 76 see supra sections 3.3.1 and 3.4.2 respectively. 77 in fact, both these questions are answered simultaneously under the last-shot rule. nordic journal of commercial law issue 2015#1 19 4 battle of the forms under the cisg 4.1 an unregulated issue? i now turn to the battle of the forms under the cisg. the drafting history is not conclusive on what the cisg solution is, but it shows that the issue is governed by the convention.78 delegates at the diplomatic conference at which the convention was negotiated and finalized could not, however, agree on what the solution should be (and many wished the issue had been taken up earlier in the drafting process). a proposal to add a knockout solution to article 19 was rejected by a small margin. some delegates who opposed the proposal felt that it conflicted with basic contract law, and that articles 19 cisg already provided a solution to the battle of forms.79 whereas this may suggest that art 19 does indeed provide a last-shot solution, the drafting history arguably can also be read as showing that the drafters deliberately left the question open for the courts to decide. the absence of a dedicated provision on the battle of forms in the cisg means that the courts have to apply the cisg general rules and principles. this does not, however, empower judges to choose whichever rule they are able to construct and find preferable. the convention must be applied consistently in all the contracting states, cf art 7(1); all courts must apply a uniform solution. developing a uniform solution based on the principles underlying an international code is difficult, however. national courts are sometimes prone to read autonomous international codes in the light of domestic principles, which often gives rise to varying solutions within the international regime.80 the risk that domestic influences may gain traction is amplified when not only the text but also the underlying legal qualification determine the outcome–as is the case in the battle of the forms.81 the potential for the spillover of domestic solutions into the cisg case law is addressed later in this section. 78 see eiselen & bergenthal, supra note 15, at 218-19; maría del pilar perales viscasillas, contract conclusion under cisg, 16 j. l. & com. 315, 341. (1996-97); steensgaard, supra note 26, at § 6 para 73-119; magnus in j. von staudingers kommentar zum bürgerlichen gesetzbuch: recht der schuldverhältnisse wiener un-kaufrecht (cisg) (2012) art 19 cisg para 20; ferrari in un convention on contracts for the international sale of goods (cisg): commentary art 19 para 14 (stefan kröll, loukas mistelis & maría del pilar perales viscasillas eds., 2011); honnold, supra note 48, at 170.3-4. 79 official records, documents of the conference and summary records of the plenary meetings and of the meetings of the main committees, un conference on contracts for the international sale of goods (vienna 10 march-11 april 1980, 1981) un doc a/conf 97/19, 96 para 3(ix), 288-9. 80 this article does address the causes of the so-called homeward trend; see, e.g., ingeborg schwenzer, the application of the cisg in light of national law 2010 internationales handelsrecht [ihr] 45, 53-54; harry m flechtner, the several texts of the cisg in a decentralized system: observations on translations, reservations and other challenges to the uniformity principle in article 7(1), 17 j. l. & com. 187 (1997-98); franco ferrari, homeward trend: what, why and why not 2009 internationales handelsrecht [ihr] 8; karen halverson cross, parol evidence under the cisg: the ‘homeward trend’ reconsidered, 68 oh. st. l. j. 133 (2007). 81 see supra section 3.5. nordic journal of commercial law issue 2015#1 20 4.2 fencing the analysis: distinguishing actual from seeming battles cisg case law on the battle of the forms is scarce. the following analysis therefore focuses on case law from the united states and germany, the countries that have produced more than the occasional case, and, thus, may reveal discernible tendencies. the number of reported cisg battle of the forms cases is small, but nevertheless inflated. the term ‘battle of the forms’ denotes a specific legal problem that emerges when a contract is performed before the parties have resolved the issue of which standard terms apply. but it is sometimes used to describe any situation where two parties attempt to use standard terms–regardless of the underlying issue.82 the numbers are inflated because cases, in which the courts have ruled on whether a set of standard terms have been effectively incorporated into the contract or not, are wrongly labelled as ‘battle of the forms’ cases.83 although incorporation of standard terms cases may resemble battles, ‘incorporation’ is fundamentally a different legal problem. in these cases, the problem is whether the requirements for the incorporation of the standard terms into the contract are met in the concrete situation.84 82 see schroeter in commentary on the un convention, supra note 69, at art 19 paras 33-4. cases are not excluded from the analysis if the court itself categorizes the case as a battle of the forms. the value as precedent may suffer as a result of the mischaracterisation, but such cases can be factored in when identifying broader tendencies, as the court actually expresses how it would solve a battle. 83 the threshold for incorporation is determined pursuant to arts 8, 14(1) on a case-by-base basis, ulrich magnus, incorporation of standard contract terms under the cisg, in sharing international commercial law across national boundaries: festschrift for albert h kritzer on the occasion of his eightieth birthday (camilla b andersen & ulrich g schroeter eds., 2008); steensgaard, supra note 26, at § 8; burghard piltz, internationales kaufrecht: das un-kaufrecht in praxisorientierter darstellung 3-80 (2nd ed. 2008); piltz, standard terms in un-contracts of sale, supra note 25, at 233-39; sieg eiselen, the requirements for the inclusion of standard terms in international sales contracts, 14(1) potchefstroom elec. l. j. 2 (2011); see also cisg-ac opinion no. 13, inclusion of standard terms under the cisg, rapporteur: professor sieg eiselen, college of law, university of south africa, pretoria, south africa. adopted by the cisg advisory council following its 17th meeting, in villanova, pennsylvania, usa, on 20 january 2013, rules 2-7, available at http://www.cisgac.com/default. php?ipkcat=222&ifkcat=213&sid=222 (last visited aug. 15, 2015) [hereinafter cisg-ac opinion no. 13]; e.g. oberlandesgericht düsseldorf mar. 23, 2011, cisg-online no. 2218. 84 the battle of the forms may also be illusionary if both set of terms provide for the same solution. see, e.g., oberlandesgericht cologne may 24, 2006, 2006 internationales handelsrecht [ihr] 147, available in english at http://cisgw3.law.pace.edu/cases/060524g1.html (thomas arntz and todd fox trans.) (last visited aug. 15, 2015); on incorporation of incoterms, hanwha corp v. cedar petrochemicals, inc, 760 f.supp.2d 426, 431 note 2 (s.d.n.y. 2011). nordic journal of commercial law issue 2015#1 21 generally speaking, to be capable of incorporation, standard terms must be included in the offer or the offer must contain a sufficiently clear reference to them.85 the text of the terms must be reasonably available to the recipient.86 the terms must be in the language of the negotiations, the contract, or in a language that is comprehensible to the recipient.87 and the terms must be introduced prior to contract conclusion.88 to illustrate: if a seller introduces its terms subsequent to the contract conclusion, and the buyer fails to make a sufficiently clear reference to its terms, then neither set of terms are capable of incorporation and no terms will therefore make it into the contract. this outcome does not follow from a battle of the forms knock-out of the terms, however, but is a result of the fact that neither party took proper care to meet the threshold for incorporation.89 to adopt a metaphor: if either party is firing blanks, it is not engaged in battle, but rather waiting to see if the other party hits. ineffective attempts at incorporation during a (seeming) battle of the forms pre-empts the problems that would normally follow from the reciprocity of a battle. in these incorporation cases, a party has tried but failed to incorporate standard terms different from the 85 cour d’appel paris dec. 13, 1995, 1997 ii jcp g no 22772; tribunale di rovereto nov. 21, 2007, cisg-online no. 1590; landgericht hannover apr. 21, 2009, cisg-online no. 2298; oberlandesgericht zweibrücken mar. 31, 1998, cisg-online no. 481; partly reversing on other grounds bundesgerichtshof mar. 24, 1999, 1999 neue juristische wochenschrift [njw] 2440; requirement discussed in amtsgericht [ag][local court] nordhorn jun. 14, 1994, cisg-online no. 259; see also hof arnhem apr. 27, 1999, 1999 nederlands internationaal privaatrecht [nipr] no 245. 86 bundesgerichtshof oct. 31, 2001, 2002 neue juristische wochenschrift [njw] 37, arguably constructing a duty to communicate the terms; mansonville plastics (bc) ltd v. kurtz gmbh 2003 bcsc 1298, paras 71-72; oberlandesgericht munich jan. 14, 2009, cisg-online no. 2011; oberlandesgericht celle jul. 24, 2009, 2010 neue juristische wochenschrift-rechtssprechungs-report [njw-rr] 136; oberlandesgericht jena nov. 10, 2010, cisg-online no. 2216, (choice of court clause, but decided under the cisg); appeal denied bundesgerichtshof jul. 5, 2011, viii zr 314/10, available at www.bundesgerichtshof.de; in favor of a more flexible individual approach under art 8(2); steensgaard, supra note 26, at § 8 paras 15-30; compare this with the more balanced approach in oberlandesgericht zweibrücken mar. 31, 1998, cisg-online no. 481; landgericht neubrandenburg aug. 3, 2005, 2006 internationales handelsrecht [ihr] 26. 87 landgericht heilbronn sep. 15, 1997, cisg-online no. 562; amtsgericht kehl oct. 6, 1995, 1996 neue juristische wochenschrift-rechtsprechungs-report 565; command of language of the terms was held sufficient for incorporation in oberlandesgericht düsseldorf apr. 21, 2004, 2005 internationales handelsrecht [ihr] 24; chateau des charmes wines ltd v. sabaté usa inc 2005 carswellont 5271, para 12; conversely, in which an american buyer was bound by terms in italian, mcc-marble ceramic center v. ceramica nuova d’agostino, 144 f.3d 1384, 1387-88 (11th cir. 1998). 88 cour d’appel paris dec. 13, 1995, 1997 ii jcp g no 22772; hof’s-hertogenbosch oct. 16, 2002, available in english at http://cisgw3.law.pace.edu/cases/021016n1.html (patrick bout trans.) (last visited aug. 15, 2015); kantonsgericht zug dec. 11, 2003, 2005 internationales handelsrecht [ihr] 119; chateau des charmes wines, ltd v. sabaté usa, inc, 328 f.3d 528 (9th cir. 2003); landgericht trier jan. 8, 2004, 2004 internationales handelsrecht [ihr] 115; rechtbank arnhem mar. 17, 2004, available in english at http://cisgw3.law. pace.edu/cases/040317n1.html (vasiliki mitria trans.) (last visited aug. 15, 2015); landgericht neubrandenburg aug. 3, 2005, 2006 internationales handelsrecht [ihr] 26; see schroeter in commentary on the un convention, supra note 69, at art 19 para 40; larry a dimatteo et al., international sales law: a critical analysis of cisg jurisprudence 74-5 (2005), on the scope of art 19. 89 see cour d’appel paris dec. 13, 1995, 1997 ii jcp g no 22772; see also ag kehl, 1996 njw-rr 565. nordic journal of commercial law issue 2015#1 22 offer. the failed incorporation attempt, of course, fails to express the complete mirrored assent required to conclude a contract and effectively operates as a rejection and a counteroffer. but the content of this counteroffer does not–as it would in a normal battle of the forms case–encompass the (different) standard terms it references. the situation is then not a battle between forms; it is a question of whether the terms that actually meet the threshold for incorporation have made it into the contract. on the other hand, if a party introduces in the last communication before a contract is executed a previously unmentioned set of standard terms, the legal situation is somewhat comparable to a battle even if no competing standard terms exist. the problem is structurally identical to the battle of the forms cases: the parties perform the contract without having reached an agreement on the standard terms applicable to the contract. consequently, the courts’ approach in such cases may indicate the approach it would take in an actual the battle of the forms case. some cases are excluded from the following analysis because the outcome suffers from interference from parallel rules that operate with stricter requirements.90 for example, the form requirements for forum selection agreements under article 25 bruxelles i regulation (recast), for example, are stricter than the threshold for incorporation under the cisg.91 so while incorporation of a clause may be successful under the cisg, its efficacy could be denied under the regulation. drawing a conclusion on the interpretation of the cisg from cases where such outside factors pay a role could lead to the wrong results.92 4.3 case law from the united states of america the us courts have almost without exceptions applied the last-shot solution in cisg cases. in other words, us courts by tend to seek out the decisive, final offer and a corresponding, yet often implied, acceptance. the earliest reported battle of the forms case from the us, filanto v chilewich,93 concerned the applicability of an arbitration clause that one party had sought to incorporate through a reference to an external contract. the court identified the final counteroffer, which contained the reference to this external contract, and determined that the reveiving party’s conduct indicated 90 e.g. art 25 bruxelles i regulation (recast) on forum selection agreements, art 17 bruxelles convention and their counterparts in the lugano conventions; e.g. kantonsgericht zug dec. 11, 2003, 2005 internationales handelsrecht [ihr] 119. comparable from requirements are also found in other rules on choice of jurisdiction and arbitration; e.g. oberlandesgericht frankfurt jun. 26, 2006, cisg-online no. 1385. 91 the courts will most likely apply the knockout rule under art 25 bruxelles i regulation (recast), because there is no written agreement on jurisdiction, see steensgaard, supra note 26, at § 11 para 128-9; dannemann, supra note 1, at 210-5. 92 consider for example cour de cassation [cass.][supreme court for judicial matters] 1re civ, dec. 2, 1997, 1998 ds ir 20; cour de cassation, 1re civ, jul. 16, 1998, 3 int’l legal f. 86 (1998). 93 filanto spa v. chilewich international corp, 789 f.supp 1229 (s.d.n.y. 1992); appeal dismissed 984 f.2d 58 (2d cir. 1993) [cisg not mentioned]. nordic journal of commercial law issue 2015#1 23 that it had accepted the offer.94 in magellan v salzgitter,95 the court dissolved the parties’ negotiations to a string of offers and counteroffers and sought out the offer on the basis of which the contract was concluded. that was determined to be the offer that preceded the buyer’s opening of a letter of credit, which action, in turn, constituted an acceptance by conduct.96 in subsequent cases, the courts have also approached the problem as a question of offer and acceptance. these cases include norfolk v power source,97 css antenna v amphenol-tuchel,98 golden valley v centrisys,99 and belcher-robinson v linamar.100 although only norfolk concerned conflicting standard terms, the other cases concerned a comparable situation. in them, the parties had executed a perceived contract despite the fact that one party had introduced a set of standard terms in the final offer to which the other party had not explicitly assented.101 in all these cases, the courts examined the correspondence between the parties in order to determine the decisive offer and establish acceptance by conduct–in other words, the courts applied a last-shot reasoning. none of the courts qualified the contract formation as anything but a question of offer and acceptance or mentioned any alternative means of contract formation as a possibility. in the 2011 case, hanwha v cedar petrochemicals,102 it appears, at a first glance, that the court adopted a different approach. faced with one choice of law clause pointing to new york law (and excluding the cisg) and another to singapore law, the court knocked out both clauses. the legal basis for arriving at this result, however, appears to have been section 2-207 ucc, not the cisg. the court stated that ‘[c]aselaw interpreting analogous provisions of article 2 [ucc] may also inform a court where the language of the relevant cisg provisions track that of the ucc’, before it stated that the situation at hand is ‘not unlike the one contemplated by ucc § 2-207(b)’. the 94 id. at 1237-41, at 1238 the court even considered the recipient, in the light of the parties’ course of dealing, to be under an obligation to object against uninvited terms in the offer. see also gary kenji nakata, filanto s.p.a. v. chilewich int’l corp.: sounds of silence bellow forth under the cisg’s international battle of the forms, 7 transnat’l law. 141. 95 magellan international corporation v. salzgitter handel gmbh, 76 f.supp.2d 919 (n.d.ill. 1999). 96 id. at 925: ‘and at the very least, a jury could find consistently with magellan’s allegations that the required indication of complete (mirrored) assent occurred when magellan issued its lc’. 97 norfolk southern railway company v. power source supply, inc, 66 ucc rep.serv.2d 680 (w.d.pa. 2008). 98 css antenna, inc v. amphenol-tuchel electronics, gmbh, 764 f.supp.2d 745, 752-54 (d. md. 2011). incorporation of the seller’s forum selection clause failed because the reference was worded so vaguely that it could not be expected of the buyer that it would understand it. see also ann morales olazábal et al., global sales law: an analysis of recent cisg precedents in u.s. courts 2004-2012, 67 bus. law. 1351, 1360-62 (2012). 99 golden valley grape juice and wine, llc v. centrisys corp, no. cv f 09-1424 ljo gsa, 2010 wl 347897 (e.d.cal. jan. 22, 2010), in which the acceptance by conduct of a jurisdiction clause was established. 100 belcher-robinson, llc v. linamar corp, 699 f.supp.2d 1329, 1336-38 (m.d.ala. 2010). a jurisdiction clause had not been agreed to under art 19(1) nor (2). see also morales olazábal et al., supra note 98, at 1362; primewood, inc v. roxan gmbh & co veredelungen, no. a3-97-28, 1998 wl 1777501 (d.n.d. feb. 19, 1998), in which a jurisdiction clause was not agreed upon under § 2-207 ucc, and the court stated, that the cisg would yield the same result; compare also simar shipping limited v. global fishing, inc., 540 fed.appx. 565, 566 (9th cir. 2013). 101 same approach was applied in miami valley paper, llc v. lebbing engineering & consulting gmbh, no. 1:05-cv-00702, 2009 wl 818618 (s.d.ohio mar. 26, 2009), in which a request for summary judgment was denied, as the court found that the contract could have been formed on three possible dates. 102 hanwha corp v. cedar petrochemicals, inc, 760 f.supp.2d 426 (s.d.n.y. 2011). nordic journal of commercial law issue 2015#1 24 court then cited a case on 2-207 ucc to support its decision.103 thus, the court’s application of the knockout solution to this question appears to be heavily influenced by precedents in domestic law. on the merits of the case, however, the court faced another battle-like situation involving an exchange of counteroffers, to which it applied the cisg without citing domestic law. here, the court performed a test to determine the decisive offer in accordance with the last-shot rule. as it could not determine that the complete mirrored assent required by article 19 had occurred at any time, it found that the parties had not concluded a contract.104 the court in hanwha is, thus, not clear on either the legal basis or the solution; but the test the court used to rule on whether the contract was concluded does not appear to be influenced by the ucc and that points strongly towards the last-shot solution. in the latest reported battle of the forms case from the fall of 2013, the district court for the western district of pennsylvania read and understood the (german) case law as evidence that ‘article 19 embod[ies] a mirror image rule’, and consquently arrived at a last-shot result.105 however, as shown below, the courts in those german cases actually applied a knockout solution. to conclude, the us courts have consistently applied the last-shot solution. in all the abovementioned cases, the courts have sought out the decisive offer and determined whether or not it had been accepted. article 19 cisg is being applied as the natural rule in these situations–in all cases the consensual approach is not being mentioned, let alone applied. 4.4 case law from germany german case law, on the other hand, leans heavily towards the knockout solution. the positions taken by german courts were inconsistent until 2002. in 1992, the appellate court hamm applied the last-shot solution, as did the appellate court saarbrücken in 1993.106 in 1995, district court kehl indicated obiter that two conflicting liability clauses should be knocked out; by executing the contract, the parties had either waived their respective standard terms or made an implicit derogation from article 19. in any event, they had concluded a contract.107 in 1998, the 103 id. at 430-31. 104 id. at 431-33. 105 roser technologies, inc v. carl schreiber gmbh, no. 11cv302 erie, 2013 wl 4852314, at *4 (w.d.pa. sep. 10, 2013); see also vlm food trading international, inc v. illinois trading company et al, 748 f.3d 780, 78587 (7th cir. 2014). 106 oberlandesgericht hamm sep. 22, 1992, cisg-online no. 57; oberlandesgericht saarbrücken jan. 13, 1993, cisg-online no. 83. 107 amtsgericht kehl oct. 6, 1995, 1996 neue juristische wochenschrift-rechtsprechungs-report 565. nordic journal of commercial law issue 2015#1 25 appellate court munich found a clause prohibiting set-off in the seller’s counteroffer to have been accepted by the buyer when it ‘carr[ied] through with the contract’.108 the case law settled when germany’s supreme court argued in favor of and applied the knockout rule in 2002 in the so-called powdered milk case.109 the case concerned the extent of a seller’s liability for delivering defective milk powder.110 the battle of the forms that ensued was somewhat peculiar, though, because the seller was seeking to invoke a favorable limitation clause in the buyer’s terms!111 moreover, the court applied both the knockout and the last-shot rules–or at least professed to do so. the supreme court’s first step in the case was to establish the existence of a contract. it affirmed the previous court’s reasoning that the parties, by performing the contract, had expressed that they considered the differences between their terms to be immaterial in the sense of art 19.112 the facts show that the buyer had ordered the milk powder by telephone and that both sides had followed up on the phone conversations by sending letters of confirmation. but neither court explored in detail how and when the contract had been concluded.113 other courts have in comparable cases been prompted to examine the possibility that the parties concluded a full and binding contract during telephone conversations that precede an exchange of forms. the subsequent ‘confirmations’ will then constitute offers to change the already concluded contract and can therefore be disregarded unless 108 oberlandesgericht munich mar. 11, 1998, 1999 schweizerische zeitschrift für internationales und europäisches recht [szier] 199, available in english at http://cisgw3.law.pace.edu/cases/980311g1.html (ruth m janal trans.) (last visited aug. 15, 2015). the court supported the conclusion with a reference to rolf herber & beate czerwenka, internationales kaufrecht: kommentar zu dem übereinkommen der vereinten nationen vom 11. april 1980 über verträge über den internationalen warenkauf art 19 para 18 (1991), where the lastshot solution is dealt with. 109 see bundesgerichtshof jan. 9, 2002, 2002 neue juristische wochenschrift [njw] 1651, available in english at http://cisgw3.law.pace.edu/cases/020109g1.html (william m barron and birgit kurtz trans.) (last visited aug. 15, 2015). 110 bundesgerichtshof jan. 9, 2002, 2002 neue juristische wochenschrift [njw] 1651. 111 this should not, in a legal sense, affect the extent of consensus or who sent the last shot. 112 oberlandesgericht dresden oct. 23, 2000, cisg-online no. 1935; see also ag kehl, 1996 njw-rr 565; oberlandesgericht düsseldorf jul. 25, 2003, cisg-online no. 919, available in english at http://cisgw3.law. pace.edu/cases/030725g1.html (mariel dimsey trans.) (last visited aug. 15, 2015). 113 see the presentation of facts in the decision of the previous instance, olg dresden, cisg-online no. 1935. nordic journal of commercial law issue 2015#1 26 they are independently accepted.114 from the presentation of facts, this could have been relevant for the supreme court to examine.115 after establishing the existence of a contract, the supreme court went on to determine its content. it stated: ‘according to the (probably) prevailing opinion, partially diverging general [standard] terms and conditions become an integral part of a contract (only) insofar as they do not contradict each other; the statutory provisions apply to the rest’.116 the court found that the buyer’s standard limitation of liability clause, which capped the amount of damages the seller would pay, conflicted with a ‘rejection clause’ in the seller’s terms that functioned to exclude the buyer’s terms.117 the liability regime was, accordingly, knocked out. the court further stated that the seller should not be allowed to rely only on the favorable terms in the buyer’s standard conditions while rejecting the disadvantageous terms. the resulting gap was filled by dispositive statutory provisions.118 although the supreme court decided the case using the knockout rule, it also professed to test the facts under the last-shot rule. but instead of identifying the decisive offer and acceptance, as the rule requires, the court stated that it would be contrary to good faith under art 7(1) cisg to allow the seller to cherry-pick individual terms from the buyer’s terms–‘even insofar as it served its terms and conditions last’.119 this reasoning is not persuasive, however, because the court’s opinion did not conform with the premise underlying the last-shot solution, namely that the contract is established by an offer and a corresponding acceptance.120 the last-shot solution results the incorporation of all terms in the decisive offer–and that does not involve picking favorable provisions from the previously rejected terms, nor does it in itself violate good faith. 114 see, e.g., chateau des charmes wines, ltd v. sabaté usa, inc, 328 f.3d 528, 531 (9th cir. 2003); which was followed in c9 ventures v. svc-west, lp, 202 cal.app.4th 1483, 1501-2 (2012); solae, llc v. hershey canada, inc, 557 f.supp.2d 452 (d.del. 2008); cited obiter comerica bank v. whitehall specialties, inc, 352 f.supp.2d 1077, 1082-83 (c.d.cal. 2004); see also travelers property cas v. saint-gobain technical, 474 f.supp.2d 1075, 1083 (d.minn. 2007) (no summary judgement as an oral contract may have been formed before the exchange of purchase orders and invoices); btc-usa corporation v. novacare, no. 07-3998 adm/ jsm, 2008 wl 2465814, at *4 (d.minn. jun. 16, 2008) (acceptance by initialing the subsequent terms). the doctrine of kaufmännishes bestätigungsschreiben and similar principles are not recognized under the cisg and will need a separate legal basis to apply. 115 compare wildner, supra note 46, at 18. 116 bundesgerichtshof jan. 9, 2002, 2002 neue juristische wochenschrift [njw] 1651, at para ii.1.b. 117 the buyer had used the general trade terms of the dutch dairy trade association, which presumably strike a general balance between the interests of the average buyers and sellers within the industry. the seller’s rejection clause stated: ‘we sell exclusively pursuant to our general terms and conditions. contrary statutory conditions or contrary general terms and conditions of the buyer are expressly not acknowledged and are therefore not part of the contract’. given this compelling wording, it could have been relevant to consider the clause’s impact on the formation as well as its content. see on rejection clauses, steensgaard, supra note 26, at § 14; see also wildner, supra note 46, at 20-25; maría del pilar perales viscasillas, battle of the forms and burden of proof: an analysis of bgh 9 january 2002, 6 vindobona j. int’l com. l. & arb. 217, 224 (2002). 118 bundesgerichtshof, 2002 njw 1651, see quote supra at note 116. this result was reached, however, by citing only german doctrine and may be an example of the homeward trend. 119 id. 120 critical also wildner, supra note 46, at 18-9 and 23-6. nordic journal of commercial law issue 2015#1 27 schlechtriem, nevertheless, wrote about the case: ‘despite some opaque arguments and sentences, the core message of the supreme court of germany is clear: conflicting standard forms are entirely invalid and are replaced by cisg provisions, while the contract as such stays valid’.121 except for one later decision in 2002 in which the appellate court koblenz employed a last-shot approach, the knockout solution has been applied consistently in later cases.122 in a 2003 case, the appellate court düsseldorf expressed that knockout is the preferred solution; however, it also purported to apply the last-shot rule, which it, unconvincingly, found to produce the same result.123 a few years later, the appellate court cologne was faced with conflicting jurisdiction clauses.124 the court found the battle to be illusionary as both the seemingly conflicting clauses in fact conferred jurisdiction to the courts at the seller’s place of business. the forum selection court would therefore be effective under both the knockout rule and the last-shot rule, regardless of which approach was applicable. the court did not address how to solve the battle of the forms in general, and although it stated preference for the knockout rule, it did keep the door open for both solutions.125 later that year, the appellate court frankfurt applied the consensus principle as an alternative means of contract formation; and art 19(2) cisg to deny incorporation of an 121 peter schlechtriem, kollidierende geschäftsbedingungen im internationalen vertragsrecht: festgabe für rolf herber, in transportund vertriebsrecht 2000: festgabe für rolf herber (karl-heinz thume ed., 1999) note 16a (added in the english edition), available at, http://cisgw3.law.pace.edu/cisg/biblio/schlechtriem5.html (martin eimer trans.) (last visited aug. 15, 2015). 122 oberlandesgericht koblenz oct. 4, 2002, cisg-online no. 716, but the reasoning is unclear, as the court cited both the buyer’s silence under art 19(2) and payment of the purchase price as decisive factors. it appears that the court may have construed the buyer’s payment to express that it considered the difference to be immaterial in the sense of art 19(2), and its silence to be decisive under this provision. compare also oberlandesgericht hamburg oct. 11, 2010, cisg-online no. 2449, in which the factual circumstances showed that an agreement had not been reached. 123 oberlandesgericht düsseldorf jul. 25, 2003, cisg-online no. 919: ‘[u]pon receipt of the [seller]’s first invoice, the [buyer] could consequently no longer assume that the [seller] had consented to the [buyer]’s contradictory jurisdiction clause’. this reasoning suggests that the court reached its result more on the basis of a perceived practice to contract on the seller’s terms, in accordance with art 9, than the last-shot solution. previously rejected offers do not under the last-shot rule affect the possible acceptance of superseding counteroffers, and nor do subsequent invoices. 124 oberlandesgericht [olg] cologne may 24, 2006, 2006 internationales handelsrecht [ihr] 147. 125 see also shroeter in commentary on the un convention, supra note 69, at art 19 para 35 note 119. olg cologne, 2006 ihr, at 147: ‘pursuant to the provisions of the cisg . . . the interpretation of contracts with conflicting terms leads to the application of at least those provisions which do not differ. beyond this [german: “andernfalls”], the so-called “last-shot doctrine” applies, according to which the governing terms are those which were exchanged last . . . here, both alternatives lead to the result that the parties validly concluded a choice of forum agreement’. see also supra section 4.2 on the concerns regarding battles on choice of court clauses; in this instance, however, the court expressly applied the cisg to the question. nordic journal of commercial law issue 2015#1 28 arbitration clause found in one of the parties’ standard terms.126 in 2011, the appellate court stuttgart applied the knockout solution to conflicting delivery clauses.127 in conclusion, the german position today favours the knockout rule. since 2002, only one court has applied the last-shot.128 the use of the last-shot rule in other cases appears to be more of an effort to legitimize the results already reached under the knockout rule than to actually apply the last-shot rule. this is apparent from the fact that none of the courts performed the test of identifying the decisive offer and acceptance, but based their decicions on broader considerations, such as good faith and parties’ expectations.129 4.5 comparative analysis the foregoing analysis reveals that us courts subscribe to the last-shot solution, whereas german courts show a strong tendency towards the knockout solution. this dichotomy disrupts the uniformity within the cisg regime. the differences extend beyond the outcome of individual cases, as the courts rely on different qualifications of the issue to arrive at these different results.130 because the courts almost always take the qualification of a legal issue for granted, they seldom explain in detail why its understanding is appropriate and should apply. nevertheless, the approach the court takes in the concrete case reveals the underlying understanding of the legal problem. the few us cases in which the legal foundation for the last-shot has been addressed have considered the last-shot, as noted earlier, to be an extension of the mirror image principle. in filanto v chilewich, the court stated that ‘[art 19] reverses the rule of uniform commercial code § 2-207, and reverts to the common law rule . . . ’131 this resonated with the court in magellan v salzgitter, in which it declared: ‘art. 19(1) . . . reflects the common law’s “mirror image” rule that the ucc 126 oberlandesgericht frankfurt jun. 26, 2006, cisg-online no. 1385: ‘however, the apparent corresponding dissent does not hinder the validity of the contract under the notion of § 306 bgb as long as the parties moved on to execute the contract amicably’. but even though the court cited the bgb it relied primarily on cisg sources to arrive at this result. 127 oberlandesgericht stuttgart apr. 18, 2011, 2012 internationales handelsrecht [ihr] 38. see also supra section 4.2 on the possible interference from competing rules; in this case the new york convention. 128 see oberlandesgericht koblenz oct. 4, 2002, cisg-online no. 716. 129 bundesgerichtshof [bgh] jan. 9, 2002, 2002 neue juristische wochenschrift [njw] 1651; oberlandesgericht düsseldorf jul. 25, 2003, cisg-online no. 919. when the existence of a contract is already determined through the parties’ common intention, it becomes almost impossible to revert and start over with a loyal test of the last shot. that would require the contract to have been formed through a corresponding pair of offer and acceptance, which goes against the previous findings. this is probably why the courts base their last-shot tests on considerations other than the implied acceptance. 130 see supra section 3.5. 131 filanto spa v. chilewich international corp, 789 f.supp 1229, 1238 (s.d.n.y. 1992); see also keith a. rowley in modern law of contracts, supra note 15, at § 23:16. nordic journal of commercial law issue 2015#1 29 has rejected’.132 these statements are evidence that the battle is understood in the offer and acceptance frame. the reasoning appears to be that in the absence of a rule to direct otherwise, such as section 2-207 ucc, the mirror image principle, as it is known in common law, will lead to the last-shot rule.133 when faced with a battle of the forms, the first step for a us court is therefore to identify the decisive offer and its acceptance; a us court does not even consider the possibility that a contract could have been formed through consensus. the basis for the knockout solution applied in germany was most thoroughly addressed in the 2002 supreme court decision in the powdered milk case. the court found the contract to have come into existence as ‘. . . the parties have indicated by the execution of the contract that they did not consider the lack of an agreement between the mutual conditions of contract as essential within the meaning of art. 19 cisg’.134 the reason being that when contract formation is not prevented by art 19(1), but allowed under art 19(2), the parties may conclude a binding contract on the terms on which they agree–even though they may not have expressed complete mirrored assent. this argument rests on a flawed application of art 19(2), however, because this provision not only addresses contract formation, but simultaneously determines the content of the contract in accordance with the terms of the counteroffer. article 19(2) expressly states that the terms of the counteroffer prevail unless the recipient objects; it does not leave room for excluding certain terms, as would be the case in a subsequent knockout. the primary precedent for the german position, the 2002 supreme court ruling, appears to qualify the battle as a question of (partial) consensus, but it struggles to make that fit with the wording of the convention. later case law shows that german courts attempt to establish a mutual intention to contract–and go out of their way to disregard the offer and acceptance. all in all, it appears that the us and german courts operate with different qualifications of the battle as a legal problem, and that this has led to split positions within the convention regime. one possible cause may be found in the spillover effect from the each country’s domestic solutions, which seem to dovetail with the corresponding positions under the convention.135 some us courts recognize and apply in cisg cases what they call the ‘common law mirror image principle’, which suggests that they read the convention in light of the domestic law, at least to some extent.136 the german courts, on the other hand, approach the battle as a question of 132 magellan international corporation v. salzgitter handel gmbh, 76 f.supp.2d 919, 925 (n.d.ill. 1999); see also miami valley paper, llc v. lebbing engineering & consulting gmbh, no. 1:05-cv-00702, 2009 wl 818618, at * 4 (s.d.ohio mar. 26, 2009) (‘[t]he cisg applies the common law concept of mirror image’); supermicro computer inc v. digitechnic, sa, 145 f.supp.2d 1147, 1151 (n.d.cal. 2001) (‘[t]he cisg requires a “mirror-image” approach to contract formation’). 133 see supra section 3.3.1. 134 bgh, 2002 njw, at para ii.1.a; see also oberlandesgericht düsseldorf jul. 25, 2003, cisg-online no. 919, at para ii.3.a.aa.bbb.: ‘the latter follows from the fact that, in the case of a partial contradiction between the standard business terms respectively referred to by the contractual parties, a failure to conclude the contract within the meaning of art. 19(1) and (3) cisg due to a lack of a meeting of the minds can only be assumed if the parties would have regarded the lack of consensus as fundamental’; oberlandesgericht cologne may 25, 2012, cisg-online no. 2388. 135 see supra sections 3.3.1 and 3.4.2. 136 see also lawrence, supra note 15, at § 2-207:52. nordic journal of commercial law issue 2015#1 30 (partial) consensus but have not expressly addressed the underlying qualification. nevertheless, because lawyers and judges in germany have been trained to understand the battle as a question of consensus per their domestic contract law, they may have a natural inclination to approach the problem in the same way in an international context.137 thus, the split legal position may be a result of the homeward trend. another possible cause for the split legal position may be that the german courts are more susceptible to the voice from the doctrine than their american counterparts. not only is there a very strong academic preference for the knockout rule, german courts are also accustomed to reinterpreting written law. the now century-old german civil code, for example, has continuously had to be adapted to meet the changes in the society. the cisg, on the other hand, does not exist within a confined homogenous jurisdiction with an overarching authority to ensure alignment, so it is doubtful whether such domestic practices of fundamental reinterpretations can simply be transposed to the convention. 5 discussion and conclusion 5.1 the solution under the cisg–de lege lata this article has shown that at least two legal positions with respect to the battle of the forms have developed within the convention regime. this is probably to be expected. it is difficult to develop and maintain a uniform solution among all courts when the case law already is inconsistent and the legislative history is inconclusive.138 however, article 7(1) cisg not only requires a uniform application but also prescribes that the convention has to be applied autonomously and in good faith. it does not offer advice on interpretation in practice, and the primary approach is therefore a literal interpretation in accordance with the normal understanding.139 the natural starting point when looking for a solution to the battle of the forms in the convention is art 19, which expresses the ‘generally accepted rule that a purported acceptance which adds to, limits or otherwise modifies an offer is a rejection of the offer and constitutes a counteroffer’–that is the mirror image principle.140 in fact, art 19 contains two last-shot rules that are distinguished by the degree of divergence between the terms of offer and the acceptance.141 purported acceptances that only differ immaterially from the offer are governed by art 19(2), which 137 especially because the wordings of art 19 and § 150 bgb are comparable, so it may appear as if the legal basis is the same. 138 see supra section 4.1. 139 see sieg eiselen, literal interpretation: the meaning of the words, in cisg methodology (andré janssen & olaf meyer eds., 2009) 61-89; magnus in staudinger, supra note 78, at art 7 paras 30-7; perales viscasillas in un convention on contracts for the international sale of goods, supra note 78, at art 7 paras 33-4, with references; see also the principle in art 31 in the vienna convention on the law of treaties 1969. 140 report of the working group on the international sales of goods on the work of its eight session, viii uncitral y.b. 73 (1977), 82 para 107; see also secretariat commentary, art 17 para 2. 141 see supra sections 3.3.1 and 3.3.2. nordic journal of commercial law issue 2015#1 31 provides a silence-based last-shot rule. article 19(1) applies to all other situations and lays out a last-shot rule based on an implied acceptance.142 such assent could be for example inferred from the seller shipping the goods or the buyer paying the purchase price.143 nevertheless, if consensus is allowed to manifest in ways other than an exchange of offer and acceptance, the battle may also be resolved by knocking out the conflicting terms. the basis for a knockout rule can arguably be founded either directly in an alternative means of contract formation, in an implied derogation of art 19, in a perception that a ‘battle of the forms’ is not governed by art 19 but must be decided by the parties’ consensus as an underlying principle,144 by moving the moment of contract conclusion to the point in time at which the parties agreed on the essential terms and disregarding subsequent terms,145 or by considering the differences to be immaterial in the sense of art 19 when the parties execute the contract nevertheless.146 these solutions are more or less obvious possibilities, but the court could in any of these cases arguably find that a contract has been formed even though the parties have not agreed on any standard terms. the content can then be determined by the extent of the parties’ agreement, with the conflicting terms knocked out. 142 acceptance through conduct is recognised under art 18(1). article 18(3) is often cited, mistakenly, as the basis for implied acceptances, but it has a different scope, which is to allow the parties to dispose of the necessity to communicate the acceptance as required under art 18(2). see, e.g., oberster gerichtshof dec. 13, 2012, cisg-online no. 2438. 143 see, e.g., oberlandesgericht saarbrücken jan. 13, 1993, cisg-online no. 83; magellan international corporation v. salzgitter handel gmbh, 76 f.supp.2d 919 (n.d.ill. 1999); landgericht bamberg apr. 13, 2005, cisg-online no. 1402; oberlandesgericht bamberg oct. 18, 2005, cisg-online no. 1403, contract formation not considered in appeal, oberster gerichtshof aug. 31, 2005, 2006 internationales handelsrecht [ihr] 31; oberlandesgericht dresden nov. 10, 2006, cisg-online no. 1625; norfolk southern railway company v. power source supply, inc, 66 ucc rep.serv.2d 680 (w.d.pa. 2008); see also nanda & pansius, supra note 37, at § 12:16; restatement (second) of contracts, § 19(1); see comparatively mehren in international encyclopedia of comparative law, supra note 8, at paras 33-7. 144 this is less convincing, as there is nothing in the convention to suggest that modifying acceptances are excluded from art 19 just because they are on different standard terms. such an argument makes sense, when the battle of the forms is specially regulated in the law–but only because the drafters of the law have defined it to be a special problem. 145 nanda & pansius, supra note 37, at §§ 12:19-28; compare also andré corterier, a peace plan for the battle of the forms, 10 int’l trade & bus. l. rev. 195 (2006). 146 see stefan kröll & rudolf hennecke, kollidierende allgemeine geschäftsbedingungen in internationalen kaufverträgen, 2001 recht der internationalen wirtschaft [riw] 736, 742-43; schroeter in commentary on the un convention, supra note 69, at art 19 paras 41-6; verena ventsch & peter kluth, die einbeziehung von allgemeinen geschäftsbedingungen im rahmen des un-kaufrechts, 2003 internationales handelsrecht [ihr] 61, 62-64; jana hammerschmidt, kollision allgemeiner geschäftsbedingungen im geltungsbereich des un-kaufrechts 110, 86-90 (2004); jörg schultheiß, allgemeine geschäftsbedingungen im un-kaufrecht: eine vergleichende analyse des einheitsrechts mit dem recht deutschlands, österreichs, der schweiz, frankreichs und der usa 173-77 (2004); schwenzer, hachem & kee, supra note 14, at para 12.33, who all argue that the knockout rule can be deduced from art 8; see magnus in staudinger, supra note 78, at art 19 cisg para 24-5, who relies on an implied derogation of art 19 through art 6; see also van alstine, supra note 22, at 93-97, who argues on the primacy of ‘party autonomy’; similarly eiselen & bergenthal, supra note 15, at 224-27; wildner, supra note 46, at 7-8; see also van alstine, supra note 22, at 72-77. nordic journal of commercial law issue 2015#1 32 in consequence, both the last-shot and knockout solutions arguably conform with the convention regime, or at the very least are defendable as such.147 but only one solution can exist under art 7(1), and the uniform solution should not only be defendable, after constructive effort has been made to reach it, but also follow from a natural interpretation of the convention. applying the literal understanding is all the more important in an diverse setting such as under a convention with contracting states spread out over the world. and the comparative analysis in section 3 suggests that the normal understanding of the battle of the forms under such circumstances as offered by the cisg–the mirror image principle and no express provision to deal with the battle for the forms–leads to the last-shot rule.148 there are more reasons for this: firstly, the drafters of the convention made a conscious effort to avoid terms and concepts from domestic laws but nevertheless chose to include the established and well-known mirror image principle.149 it would therefore be reasonable to conclude that they actually intended the mirror image principle to apply.150 we know that a proposed knockout provision was rejected at the conference in vienna. whether that was because the proposal was unacceptable or because it was premature, at the end of the day, there is no knockout rule in the cisg.151 this starting point is 147 see piltz, standard terms in un-contracts of sale, supra note 25, at 240-41: ‘the . . . knock-out-rule . . . is principally not excluded by the cisg. it does require a considerable constructive effort, though, since the theory was rejected when the cisg was being discussed at the conference in vienna’. contra nanda & pansius, supra note 37, at § 12:20. 148 likewise ferrari in un convention on contracts for the international sale of goods, supra note 78, at art 19 para 15; ferrari in münchener kommentar zum handelsgesetzbuch (2013) art 19 paras 14-5; farnsworth, supra note 16, at § 3.21; gillette & walt, supra note 16, at 85-91; piltz, internationales kaufrecht, supra note 83, at paras 3-107-13; piltz, standard terms in un-contracts of sale, supra note 25, at 239-42; katharina s ludwig, der vertragsschluß nach un-kaufrecht im spannungsverhältnis von common law und civil law: dargestellt auf der grundlage der rechtsordnungen englands und deutschlands 339-40 (1994); perales viscasillas, battle of the forms, supra note 49, at 144-49; perales viscasillas, contract conclusion, supra note 78, at 340-42; perales viscasillas, battle of the forms, modification of contract, commerical letters of confirmation, supra note 53, at 156-58; rühl, supra note 12, at 196-98; but see references in note 146; schwenzer & mohs, supra note 51, at 244; honnold, supra note 48, at 170.3-4; wanting to apply pecl or upicc, fejós, supra note 22, at 127-28. 149 see quote supra at note 140. see also honnold, supra note 48, at art 7 para 87; bonell in commentary on the international sales law para 2.2.2 (cesare massimo bianca & michael joachim bonell eds. 1987) on the drafting choices. 150 see also the case law on the mirror image principle in cisg’s predecessor, ulis, see perales viscasillas, battle of the forms and burden of proof, supra note 117, at 222 note 11; magnus in staudinger, supra note 78, at art 19 cisg para 23. 151 see supra section 4.2; see also piltz, standard terms in un-contracts of sale, supra note 25, at 240-41. nordic journal of commercial law issue 2015#1 33 emphasized in the early doctrine following the diplomatic conference, which shows that the lastshot rule was generally accepted as the applicable solution.152 secondly, there are no clear indications in the convention itself to suggest that the mirror image principle, and consequently the last-shot solution, should not apply, and that must carry an almost decisive weight. there is no evidence in the convention or the drafting history that standard terms were seen to pose a special problem that must be resolved outside the general mirror image principle, or that the battle should be qualified as anything but a string of counteroffers. under the cisg, standard terms and conditions constitute part of an offer, the acceptance of which has to be assessed under the general rules. because the last shot is the most globally prevalent solution, the average businessman is likely to understand the battle of the forms as a question of offer and acceptance.153 once he identifies art 19 cisg and ascertains that there are no indications to the contrary, he will be likely to search for and eventually find or dismiss an (implied) acceptance of the decisive offer. this businessman is unlikely to give a second thought to other possible means of contract formation, especially if he or she is unfamiliar with the ‘german solution’.154 the principle underlying art 9(2) cisg–that parties are not bound by usages that they could not reasonably be aware of–could also be relevant in this case.155 the mirror image principle is widely recognised as leading to the last-shot rule, so giving it the almost polar opposite legal effects, as is the consequence of the german solution, should therefore require a firmer basis.156 moreover, the drafters of newer international codes on contract law have included a knockout provision to make that approach applicable. the absence of such a provision in the cisg could be taken as evidence of that the unaltered mirror image principle in art 19 should apply in full.157 152 kelso, supra note 74, at 553-55; leete, supra note 28, at 214; farnsworth in commentary on the international sales law, supra note 149, at art 19 paras 2.5 and 2.8; ludwig, supra note 148, at 427; implied by gyula eörsi, problems of unifying law on the formation of contracts for the international sale of goods, 27 am. jur. comp. l. 311, 322-23 (1979); gabriel, supra note 22, at 1057-58; more reluctant frans van der velden, uniform international sales law and the battle of forms: contributions en l’honneur de jean georges sauveplanne, in unification et le droit comparé dans la théorie et la pratique: contributions en l’honneur de jean georges sauveplanne (e. h. hondius, g. j. w. steenhoff & f. j. a. van der velden eds., 1984). 153 see schwenzer, hachem & kee, supra note 14, at para 12.28. 154 see supra section 3.4.2. 155 see also the similar principle in regulation 593/2008, of the european parliament and of the council of 17 june 2008 on the law applicable to contractual obligations (rome i), 2008 o.j. (l 177/6), art 10(2). 156 differently wildner, supra note 46, at 9-10, who argues that application of the convention rules (as the result of a knockout of conflicting terms) instead of the parties’ terms would ensure uniformity. but extending the scope of the convention does not equate uniformity, when there is no agreement as to when it should happen. 157 see infra section 3.3.1. nordic journal of commercial law issue 2015#1 34 in conclusion, the normal understanding of the wording of the convention suggests the last-shot rule should apply, as it is the logical extension of the mirror image principle that is expressed in art 19. there are not yet sufficient reasons to make a persuasive case that the knockout solution would be a ‘more normal’ understanding. none of the possible explanations above can obviously displace the mirror image principle, and neither doctrine nor case law unanimously supports such displacement. 5.2 –de lege ferenda the last-shot rule is not the ideal solution to the battle of the forms, though, and a majority of scholars seem to favor simply applying the knockout solution.158 the question is then whether the knockout solution should be applied on the existing basis.159 a recent example of scholars advocating knockout is ‘opinion no 13’ from the selfproclaimed ‘cisg advisory council’.160 the group states that ‘[i]t would seem that the knock-out rule is favoured by the majority of commentators and the case law although there is support of the last-shot rule’, and it concludes161 that ‘[t]he knock-out approach will apply to a battle of the forms situation’.162 but there is no such agreement on the knockout solution in case law, as the analysis in this article has shown. moreover, academic popularity should not be an overruling factor in determining the applicable law.163 the primary consideration in the assessment must be to accommodate the purpose of the convention; the interests of the users, that is the businesses whose contracts are subject to the cisg. for the cisg to be an attractive option for those businesses and their advisors, the legal position and consequences of applying the convention must be clear. as us supreme court justice antonin scalia once wrote: ‘there are times when even a bad rule is better than no rule at all’–and this may be one of the those times.164 when parallel legal positions develop, as has happened with the 158 see references in note 146. 159 as for example magnus in staudinger, supra note 78, at art 19 cisg para 24. 160 see cisg-ac opinion no. 13, supra note 83; on the value of the group’s opinions as legal source rolf herber, eine neue institution: der cisg advisory council 2003 internationales handelsrecht [ihr] 200, 201; see also more enthusiastically: joshua d. h. karton & lorraine de germiniy, battle of the forms under the convention on contracts for the international sale of goods (cisg): a uniform solution?, 13 vindobona j. int’l com. l. & arb. 71, 80-83 in particular (2009). 161 the distribution of votes on rule 10 has oddly enough been omitted from the tallies in cisg-ac opinion no. 13, supra note 83, at note 2. 162 id. at paras 10.6 and 8. 163 the conclusion is based almost exclusively on the german cases presented above cisg-ac opinion no. 13, supra note 83, at para 10.7. one decision from the cour de cassation, 1re civ, jul. 16, 1998, 3 int’l legal f. 86 (1998), is also cited, but is ambiguous on the solution to battle of the forms under the cisg at best, as it concerns conflicting jurisdiction clauses under the art 17 bruxelles convention and furthermore bases the principle of consensus on art 1134 french code civil. 164 antonin scalia, the rule of law as a law of rules, 56 u. chi. l. rev. 1175, 1179 (1989); see also honnold, supra note 48, at para 170.4, in fine. nordic journal of commercial law issue 2015#1 35 battle of the forms, it lends force to the arguments that speak in favor of derogating from and excluding the application of the convention. when the purpose of the convention is to provide a framework for international trade, that must take priority over academic popularity. the current situation almost resembles a legal version of ‘the tragedy of the commons’. the (well-meaning) efforts to advocate for the knockout rule, in essence, do the convention a disservice as they create confusion and give potential ‘users’ understandable incentives to opt out. as a practical matter, there is no overarching authority within the convention regime, so who can claim the political legitimacy to decide which circumstances warrant a new legal position or what the new ‘correct’ reinterpretation should be? can a reinterpretation be justified when there is disagreement on an issue? for example, virtually all scholars agree that the definition of ‘writing’ in art 13 cisg should be extended to include certain electronic communications,165 but a similar consensus does not exist on how to resolve the battle of the forms. moreover, there is no effective vehicle for communicating a new interpretation to the ‘users’. full penetration of a new approach would take time–leaving the legal position uncertain in the interim. as such, agreement on a uniform last-shot rule is preferable to the current confusion. the knockout rule may in many ways be a better rule, and it should be considered as an option in international contract law. but the way to introduce it is through a revision of part ii of the cisg–and not through the discrepant application seen today.166 165 e.g. magnus in staudinger, supra note 78, at art 13 cisg para 5. 166 proposal by switzerland on possible future work by uncitral in the area of international contract law, un doc a/ cn.9/758 (may 8, 2012), see e.g. annex section vi. a revision would also allow the uncertainties and concerns voiced supra in section 3.4.3. related to this solution to be addressed. cisg advisory council opinion no. 3 [1] parol evidence rule, plain meaning rule, contractual merger clause and the cisg [2] (by cisg advisory council) nordic journal of commercial law issue 2005 #1 nordic journal of commercial law issue 2005 #1 2 to be cited as: cisg-ac opinion no 3, parol evidence rule, plain meaning rule, contractual merger clause and the cisg, 23 october 2004. rapporteur: professor richard hyland, rutgers law school, camden, nj, usa. adopted by the cisg-ac on its 7th meeting in madrid with no dissent. reproduction of this opinion is authorized. the opinion is dedicated to the memory of our dear friend, colleague, and teacher allan farnsworth who passed away on 31 january 2005. peter schlechtriem, chair eric e. bergsten, michael joachim bonell, alejandro m. garro, roy m. goode, sergei n. lebedev, pilar perales viscasillas, jan ramberg, ingeborg schwenzer, hiroo sono, claude witz, members loukas a. mistelis, secretary opinion 1. the parol evidence rule has not been incorporated into the cisg. the cisg governs the role and weight to be ascribed to contractual writing. 2. in some common law jurisdictions, the plain meaning rule prevents a court from considering evidence outside a seemingly unambiguous writing for purposes of contractual interpretation. the plain meaning rule does not apply under the cisg. 3. a merger clause, also referred to as an entire agreement clause, when in a contract governed by the cisg, derogates from norms of interpretation and evidence contained in the cisg. the effect may be to prevent a party from relying on evidence of statements or agreements not contained in the writing. moreover, if the parties so intend, a merger clause may bar evidence of trade usages. however, in determining the effect of such a merger clause, the parties' statements and negotiations, as well as all other relevant circumstances shall be taken into account. nordic journal of commercial law issue 2005 #1 3 comments 1. introduction 1.1. interpretation and evidence under the cisg 1.1.1. the cisg provides norms and principles for the interpretation and evidence of international sales transactions. these include article 8, which generally permits all relevant circumstances to be considered in the course of contract interpretation, article 9, which incorporates certain usages into the contract, and article 11,[3] which indicates that a contract and its terms may be proved by any means, including by witnesses. these rules prevail over domestic rules on interpretation and evidence of contractual agreements. since these are default rules, article 6 permits the parties to derogate from them or vary their effect. 1.1.2. article 6 permits the parties to derogate from them or vary their effect, e.g., by merger clauses. this opinion considers some issues that arise when a court or tribunal is asked to determine whether the parties intended by a merger clause to derogate from the convention's norms governing contract interpretation. 1.2. the parol evidence rule 1.2.1. the parol evidence rule refers to the principles which common law courts have developed for the purpose of determining the role and weight to ascribe to contractual writings. the basic purpose of these principles is "to preserve the integrity of written contracts by refusing to allow the admission of [prior] oral statements or previous correspondence to contradict the written agreement."[4] in order to allow the intent of the writing to prevail, the judge may exclude what is known as extrinsic or parol evidence, particularly statements made during the negotiations. the parol evidence rule applies to the general law of contracts, including the sale of goods law of common law jurisdictions.[5] 1.2.2. the parol evidence rule is believed to have developed as a method for judges to prevent common law juries from ignoring credible and reliable written evidence of the contract.[6] the us legal system maintains the right to a jury trial in civil matters, and most civil jury trials take place in the united states.[7] as a result, the parol evidence rule has become more important in us law than in other common law systems. 1.2.3. the parol evidence rule comes into play when two circumstances meet. first, the agreement has been reduced to writing. second, one of the parties seeks to present extrinsic or parol evidence to the fact finder. extrinsic or parol evidence includes evidence of the negotiations or of agreements related to the contractual subject matter which was not incorporated into the written contract. a typical case involves representations made during the negotiations by seller or seller's representatives regarding the quality of the goods. under the parol evidence rule, seller nordic journal of commercial law issue 2005 #1 4 may ask the tribunal to bar introduction of evidence of any representations not incorporated into the written contract. 1.2.4. in english law, the parol evidence rule involves a rebuttable presumption that the writing was intended to include all the terms of the contract.[8] english courts first examine the writing to determine whether it was meant to serve as a true record of the contract.[9] thus, under english law, the party relying on a writing has the benefit that, when the writing appears to be complete, it is presumed to represent the complete contract, subject to the other party's right of rebuttal.[10] 1.2.5 in us law, the parol evidence rule operates in two steps.[11] a us court asks first whether the writing was "integrated," meaning whether the writing was intended to represent the final expression of the terms it contains. the parties' notes, or a mere draft of the agreement, for example, would usually be deemed not to be integrated. a writing signed by the parties and containing detailed specifications will usually be found to be integrated. if the writing is integrated, neither party may introduce parol evidence to contradict the terms of the writing. if the writing is deemed to be integrated, the second step is to determine whether it is "completely integrated," namely whether it was intended to represent the complete expression of the parties' agreement. if the writing is completely integrated, parol evidence may not be introduced either to contradict or to supplement the writing's terms. 1.2.6. different methods are used in us law to determine whether a writing is completely integrated.[12] some courts engage in a conclusive presumption that a writing fully incorporates the contract. other courts presume that the writing is completely integrated unless, by its terms, it refers to factors beyond its four corners. still other courts allow evidence of extrinsic circumstances, though not of the preliminary negotiations, when considering whether the writing is integrated. perhaps the most liberal method is that proposed by the restatement (second) of contracts--all extrinsic evidence, including the negotiations, may be considered when determining whether the parties intended the writing to be the complete and final statement of their obligations.[13] us sales law has adopted a similarly liberal approach.[14] 1.2.7. the parol evidence rule was designed to serve both an evidentiary and a channeling function, but its efficacy has often been challenged.[15] the evidentiary function serves to protect a contractual writing against perjured or unreliable testimony regarding parol terms. the channeling function excludes prior agreements that have been superseded or merged into the writing. despite its name, the parol evidence rule is a substantive rule of contract interpretation rather than a rule of evidence.[16] the parol evidence rule therefore applies when the substantive law governing the contract contains a parol evidence rule. 1.2.8. the civil law generally does not have jury trials in civil cases [17] and civilian jurisdictions usually do not place limits on the kind of evidence admissible to prove contracts between merchants. though the french civil code, for example, incorporates a version of the parol evidence rule for ordinary contracts,[18] all forms of proof are generally available against merchants.[19] in german law, no parol evidence rule exists for either civil or commercial contracts, though german law presumes that a contractual writing is accurate and complete.[20] this is also the case in other laws, e.g., japanese law[21] and scandinavian laws. nordic journal of commercial law issue 2005 #1 5 1.2.9. statements, agreements, and conduct that arise after the conclusion of the writing are treated differently in the different common law systems. in us law, they are not considered parol evidence and are therefore not barred by the parol evidence rule.[22] english law, on the contrary, attempts to avoid the situation in which a contract's meaning when concluded varies at a later date. therefore, english law does not permit evidence of the parties' statements or conduct after the conclusion of the contract to impact the issue of contract interpretation.[23] 1.3. the plain meaning rule even when the parol evidence rule bars parol evidence for purposes of contradicting or supplementing a contract's terms, parol evidence is generally still admissible for the purpose of interpreting terms found in the writing. nonetheless, a us law doctrine known as the plain meaning rule, where adopted, bars extrinsic evidence, particularly evidence of prior negotiations, for the purposes of interpreting a contract, unless the term in question has first been found to be ambiguous. in contrast to the parol evidence rule, the plain meaning rule concerns only contract interpretation and does not purport to bar contradictory or supplementary terms. the plain meaning rule is based on the proposition that, when language is sufficiently clear, its meaning can be conclusively determined without recourse to extrinsic evidence.[24] under the plain meaning rule, the preliminary analysis concerns whether the contract term in dispute is clear. only if the term is deemed ambiguous, may evidence of prior negotiations be admitted for purposes of clarification.[25] 1.4. merger clauses the parties may wish to assure themselves that reliance will not be placed on representations made prior to the execution of the writing. the merger or entire agreement clause (the "merger clause") has been developed to achieve certainty in this regard. the merger clause, which usually appears among the concluding terms of a written agreement, provides that the writing contains the entire agreement of the parties and that neither party may rely on representations made outside the writing.[26] 2. the parol evidence rule the parol evidence rule has not been incorporated into the cisg. the cisg governs the role and weight to be ascribed to contractual writing. 2.1. the cisg includes no version of the parol evidence rule. to the contrary, several cisg provisions provide that statements and other relevant circumstances are to be considered when determining the effect of a contract and its terms. the most important of these are articles 8 and 11. 2.2. article 11 sentence 2 provides that a party may seek to prove that a statement has become a term of the contract by any means, including by the statements of witnesses. article 8 concerns contract interpretation.[27] article 8(1) provides that, in certain circumstances, contracts are to be nordic journal of commercial law issue 2005 #1 6 interpreted according to actual intent. when the inquiry into subjective intent proves insufficient, article 8(2) provides that statements and conduct are to be interpreted from the point of view of a reasonable person. this evaluation according to article 8(3) takes into account all relevant circumstances of the case, including the negotiations, any course of conduct or performance between the parties, any relevant usages, and subsequent conduct of the parties. thus article 8 allows that extrinsic evidence may generally be considered when determining the meaning of a contractual term. in sum, the cisg indicates that a writing is one, but only one, of many circumstances to be considered when establishing and interpreting the terms of a contract.[28] 2.3. the convention's legislative history is in accord. a version of the parol evidence rule was proposed by the canadian delegate in vienna.[29] the proposal was justified as a means to limit admissible evidence in those cases in which the parties had chosen to reduce their agreement to writing.[30] the austrian representative indicated that his delegation opposed the amendment because it "was aimed at limiting the free appreciation of evidence" by the judge. to prevent a judge from reviewing all the evidence would violate a "fundamental principle of austrian law."[31] the representative from japan also opposed the amendment, which he characterized as a "restatement of the rule on extrinsic evidence which prevailed in english-speaking common-law countries."[32] the only other nation to speak in support of the proposal was iraq. the amendment received little support and was rejected.[33] 2.4. there were several practical reasons for not including a parol evidence rule in the cisg.[34] first, most of the world's legal systems admit all relevant evidence in contract litigation. secondly, the parol evidence rule, especially as it operates in the united states, is characterized by great variation and extreme complexity.[35] it has also been the subject of constant criticism.[36] 2.5. since the convention has specifically resolved questions governed by the common law parol evidence rule, there can be no question of a gap in the cisg, and no grounds for recourse to non-uniform domestic law.[37] the parol evidence rule therefore does not apply when the cisg governs a contract.[38] us courts have so held.[39] 2.6. the leading us case is mcc-marble ceramic center, inc. v. ceramica nuova d'agostino, s.p.a.[40] d'agostino, the italian seller, agreed to sell the buyer, mcc-marble, a florida company, the buyer's requirements in ceramic tile. after mcc-marble refused to make certain monthly payments, d'agostino refused to fill remaining orders. mcc-marble sued for breach. d'agostino defended on the basis of the payment default. d'agostino pointed to pre-printed terms on the verso of the written contract which gave d'agostino the right to cancel the agreement if mcc failed to make payment. at trial, mcc-marble sought to introduce evidence from the parties' negotiations to prove that the agreement did not include the pre-printed terms. the trial court applied the parol evidence rule and granted summary judgment for the seller. the eleventh circuit reversed, holding that the parol evidence rule does not apply when a contract is governed by the cisg. 2.7. though the parol evidence rule does not apply to contracts governed by the cisg, similar policy considerations are incorporated into the cisg itself. the principal purpose of the parol evidence rule is to respect the importance the parties may have accorded to their writing. under the convention as well, a writing constitutes an important fact of a transaction it must be presumed to fulfill a function, otherwise it would not have been employed. one of the goals of contract interpretation is to determine the role the writing was designed to play. the nordic journal of commercial law issue 2005 #1 7 commentators agree that a contractual writing will often receive special consideration under the cisg.[41] 2.8. the special role of a writing, however, must be construed in accordance with the general principles that govern the cisg. the parties' intent with regard to the role of their writing is due the same respect as any other element of their intent. the principles of article 8 are to be used to determine that intent. if the parties intended their writing as the sole manifestation of their obligations, prior negotiations and other extrinsic circumstances should not be considered during contract interpretation. however, articles 8 and 11 express the general principle that writings are not to be presumed to be "integrations".[42] 3. plain meaning rule in some common law jurisdictions, the plain meaning rule prevents a court from considering evidence outside a seemingly unambiguous writing for purposes of contractual interpretation. the plain meaning rule does not apply under the cisg. 3.1. the majority jurisdictions in the united states retain some version of the plain meaning rule in their common law, though it has been rejected by other of the united states as well as by the restatement (second) of contracts,[43] and the uniform commercial code.[44] the unidroit principles of international commercial contracts also reject the plain meaning rule, by providing that, even in the presence of a merger clause, prior statements or agreements may be used to interpret a writing.[45] 3.2. article 8 specifies the convention's method for contract interpretation. as a general rule, article 8 mandates that all facts and circumstances of the case, including the parties' negotiations, are to be considered during the course of contract interpretation. the writing constitutes one of those factors, and though always important, it is not the exclusive factor. words are almost never unambiguous.[46] moreover, the application of the plain meaning rule would impede one of the basic goals of contract interpretation under the cisg, which is to focus on the parties' actual intent. if contract terms are deemed to be unambiguous, the plain meaning rule would prevent presentation of other proof of the parties' intent.[47] 3.3. under the cisg, therefore, the fact that the meaning of the writing seems unambiguous does not bar recourse to extrinsic evidence to assist in ascertaining the parties' intent. 4. merger clause a merger clause, also referred to as an entire agreement clause, when in a contract governed by the cisg, derogates from norms of interpretation and evidence contained in the cisg. the effect may be to prevent a party from relying on evidence of statements or agreements not contained in the writing. moreover, if the parties so intend, a merger clause may bar evidence of trade usages. nordic journal of commercial law issue 2005 #1 8 however, in determining the effect of such a merger clause, the parties' statements and negotiations, as well as all other relevant circumstances shall be taken into account. 4.1. when the parties agree to a merger clause,[48] its effect may be to derogate under article 6 from norms of interpretation and evidence contained in the cisg. in this regard merger clauses have two objectives.[49] the first objective is to bar extrinsic evidence that would otherwise supplement or contradict the terms of the writing.[50] such merger clauses mainly derogate from article 11, which provides that a sales contract may be proved by any means, including witnesses. the second objective is to prevent recourse to extrinsic evidence for the purpose of contract interpretation. this objective would constitute a derogation from the convention's canons of interpretation incorporated in article 8. under the cisg the extent to which a merger clause accomplishes one or both of these purposes is a question of interpretation of this clause. 4.2. several issues in relation to merger clauses are dealt with in international uniform law instruments, such as the unidroit principles[51] and the principles of european contract law.[52] 4.3. the unidroit principles of international commercial contracts expressly recognize merger clauses. under the unidroit principles, though prior statements and agreements may not be used to contradict or supplement a writing that contains a merger clause, such statements and agreements may be used for purposes of interpreting the contract. 4.4. article 2:105 of the principles of european contract law distinguishes between merger clauses that result from individual negotiation and those that do not. if the merger clause is individually negotiated, prior statements, undertakings or agreements that are not embodied in the writing do not form part of the contract. if it has not been individually negotiated, the merger clause merely establishes a presumption that the prior statements and agreements were not intended to become part of the contract. the presumption may be rebutted.[53] furthermore, the european principles provide that a party may, by its statements or conduct, be precluded from asserting a merger clause to the extent that the other party has reasonably relied on those statements or that conduct. 4.5. the cisg does not deal with merger clauses and therefore does not contain similar distinctions. indeed, the dividing line may be blurred. under the cisg there is authority for the proposition that a properly worded merger clause bars the consideration of extrinsic evidence.[54] however, extrinsic evidence should not be excluded, unless the parties actually intended the merger clause to have this effect. the question is to be resolved by reference to the criteria enunciated in article 8, without reference to national law. article 8 requires an examination of all relevant facts and circumstances when deciding whether the merger clause represents the parties' intent. 4.6. under the cisg, a merger clause does not generally have the effect of excluding extrinsic evidence for purposes of contract interpretation. however, the merger clause may prevent recourse to extrinsic evidence for this purpose if specific wording, together with all other relevant factors, make clear the parties' intent to derogate from article 8 for purposes of contract interpretation.[55] nordic journal of commercial law issue 2005 #1 9 4.7. article 9 requires a court or tribunal to consider a number of factors when determining whether usages have been agreed or trade practices have been established between the parties. a merger clause generally will not be held to exclude trade usages relevant under article 9(1) or established practices concerning the implicit background of the transaction unless those usages and practices are specifically mentioned. footnotes 1. the cisg-ac is a private initiative supported by the institute of international commercial law at pace university school of law and the centre for commercial law studies, queen mary, university of london. the international sales convention advisory council (cisg-ac) is in place to support understanding of the united nations convention on contracts for the international sale of goods (cisg) and the promotion and assistance in the uniform interpretation of the cisg. at its formative meeting in paris in june 2001, prof. peter schlechtriem of freiburg university, germany, was elected chair of the cisg-ac for a three-year term. dr. loukas a. mistelis of the centre for commercial studies, queen mary, university of london, was elected secretary. the cisg-ac has consisted of: prof. emeritus eric e. bergsten, pace university; prof. michael joachim bonell, university of rome la sapienza; prof. e. allan farnsworth, columbia university school of law; prof. alejandro m. garro, columbia university school of law; prof. sir roy m. goode, oxford; prof. sergei n. lebedev, maritime arbitration commission of the chamber of commerce and industry of the russian federation; prof. jan ramberg, university of stockholm, faculty of law; prof. peter schlechtriem, freiburg university; prof. hiroo sono, faculty of law, hokkaido university; prof. claude witz, universität des saarlandes and strasbourg university. members of the council are elected by the council. at its meeting in rome in june 2003, the cisg-ac elected as additional members, prof. pilar perales viscasillas, universidad carlos iii de madrid, and prof. ingeborg schwenzer, university of basel. for more information please contact <l.mistelis@qmul.ac.uk>. 2. this opinion is a response to a request by the association of the bar of the city of new york committee on foreign and comparative law. the questions referred to the council were: "1. by holding that the cisg permits a court to abandon the parol evidence rule, which generally bars 'evidence of any prior agreement' (ucc 2-202), the eleventh circuit has introduced what may be an unnecessary degree of uncertainty in the drafting of contracts. if the mcc-marble rule prevails, there is no certainty that the provisions of even the most carefully negotiated and drafted contract will be determinative. 2. ... does the parol evidence rule apply under the cisg? although the rule is regarded as substantive, not evidentiary, and thus within the scope of the cisg, it is arguable that the rule deals with a matter 'not expressly settled' in the cisg. the applicable law would then be the law of the jurisdiction whose law would 'be applicable by virtue of the rules of private international law' (cisg art. 7(2)), and if such jurisdiction were an american or other common law jurisdiction the parol evidence rule would apply. ... nordic journal of commercial law issue 2005 #1 10 3. does the 'plain meaning rule' apply under the cisg? 4. would a merger clause invoke the parol evidence rule under the cisg, regardless of whether the rule would otherwise be applicable?" 3. unless a state has made a reservation under article 96. 4. larry dimatteo, the law of international contracting 212 (2000). 5. for example, the parol evidence rule has been incorporated into the sales law of the us uniform commercial code: "terms with respect to which the confirmatory memoranda of the parties agree or which are otherwise set forth in a writing intended by the parties as a final expression of their agreement with respect to such terms as are included therein may not be contradicted by evidence of any prior agreement or of a contemporaneous oral agreement but may be explained or supplemented (a) by course of performance, course of dealing, or usage of trade (section 1-303), and (b) by evidence of consistent additional terms unless the court finds the writing to have been intended also as a complete and exclusive statement of the terms of the agreement." ucc § 2-202. 6. charles mccormick, handbook of the law of evidence §§ 210-11 (1954). 7. edward j imwinkelried, "a comparative critique of the interface between hearsay and expert opinion in american evidence law, 33 boston college law review 1 (1991) at 34. 8. g. h. treitel, the law of contract, 192 (11th ed. 2003). 9. id. 10. id. at 193. 11. see e. allan farnsworth, contracts, § 7.3 (3rd ed. 1999). 12. peter linzer, "the comfort of certainty: plain meaning and the parol evidence rule," 71 fordham l. rev. 799, 805-06 (2002). 13. restatement (second) of contracts § 214 (1981). 14. for example, the fact that a writing contains detailed specifications does not create a presumption that it is completely integrated. "this section definitely rejects . . . [a]ny assumption that because a writing has been worked out which is final on some matters, it is to be taken as including all the matters agreed upon . . . ." ucc § 2-202 comment 1 (a). 15. john calamari & joseph perillo, contracts § 3.2 at 123 (4th ed. 1998). 16. see mcc-marble ceramic center, inc. v. ceramica nuova d'agostino, s.p.a., 114 f.3d 1384, 1388-89 (11th cir. 1998); e allan farnsworth, supra note 11, § 7.2 at 428-30. nordic journal of commercial law issue 2005 #1 11 17. max rheinstein, "comparative law--its functions, methods and usages," 22 ark. l. rev. 415, 422 (1968). 18. c.civ. (fr.) art. 1341 (1). see also italian codice civile art. 2722, but see also art. 1350. 19. see c.comm. (fr.) art. l. 110-3. 20. see otto palandt (helmut heinrichs), bürgerliches gesetzbuch, § 125 bgb rn. 15 (64th ed., munich 2005). 21. in japanese law, no parol evidence rule exists for either civil or commercial contracts. japanese law presumes that a contractual writing is accurate and complete. an authentic contractual writing has the evidentiary value of showing that a contract was concluded as written therein. see e.g, makoto ito, minjisoshoho [law of civil procedure] (3d ed.), 2004, p.266. (or any given commentary/treatise.)] 22. "[t]he course of actual performance by the parties is considered the best indication of what they intended the writing to mean." ucc § 2-202 comment 2. 23. g. h. treitel, supra note 8, at 195-6. 24. e. allan farnsworth, supra note 11, § 7.12 at 476. 25. see id. § 7.12. 26. a typical merger clause in a sales transaction reads as follows: purchaser agrees that the purchase order and sales contract relating to this transaction include all of the terms and conditions of this agreement and that this agreement cancels and supersedes any prior agreement and as of the date hereof comprises the complete and exclusive statement of the terms of the agreement relating to the subject matters covered hereby. purchaser further understands that verbal promises by sales representatives are not valid and any promises or understandings not herein specified in writing are hereby expressly waived by the purchaser. 27. most commentators agree that article 8, which expressly covers the interpretation of a party's statements and conduct, should also be used, mutatis mutandis, to interpret the terms of the contract. john honnold, uniform law for international sales § 105 (3rd ed. 1999). see also schlechtriem & schwenzer (schmidt-kessel), kommentar zum einheitlichen un-kaufrecht cisg -, 4. auflage, münchen 2004, n 3, 4 and 32-34; english edition: schlechtriem & schwenzer (schlechtriem), commentary on the un convention on the international sale of goods (cisg), art. 8 n 21 (2nd ed., oxford 2005). 28. j. von staudinger (ulrich magnus), kommentar zum bürgerlichen gesetzbuch, art. 8 cisg rn. 24 (neubearbeitung 1999). 29. "between the parties to a contract of sale evidenced by a written document, evidence by witnesses shall be inadmissible for the purposes of confuting or altering its terms, unless there is nordic journal of commercial law issue 2005 #1 12 prima facie evidence resulting from a written document from the opposing party, from his evidence or from a fact the existence of which has been clearly demonstrated. however, evidence by witnesses shall be admissible for purposes of interpreting the written document." united nations conference on contracts for the international sale of goods, official records, u.n. doc. a/conf./97/19, u.n. sales no. e.81.iv.3, at 90 (1981) [hereinafter uncisg official records], reprinted in john honnold, documentary history of the uniform law for international sales, 662 (1989). for a summary of the legislative history, see note, "the inapplicability of the parol evidence rule to the united nations convention on contracts for the international sale of goods," 28 hofstra l. rev. 799, 823-26 (2000). 30. "mr. samson (canada), introducing [this] amendment . . . said that the aim was to introduce a limitation on admissible evidence in cases where contracting parties had freely chosen to have a written contract. in the international context, it was important to ensure a minimum of protection for parties who had made such a choice. the amendment sought to exclude evidence by witnesses unless it was supported by other evidence resulting from a written document from the opposing party or circumstantial evidence. the amendment called for some degree of certainty as to facts which could be used to establish a prima facie case: for example, a clearly established material fact could be adduced as evidence of the existence of an agreement." uncisg official records, supra note 28, at 270, reprinted in john honnold, documentary history, supra note 29, at 491. 31. id. 32. id. 33. id. 34. see note, "mcc-marble ceramic center: the parol evidence rule and other domestic law under the convention on contracts for the international sale of goods," 1999 b.y.u. l. rev. 351, 360-62. 35. "few things are darker than this, or fuller of subtle difficulties. ... [a] mass of incongruous matter is here grouped together, and then looked at in a wrong focus." james thayer, "the 'parol evidence' rule," 6 harv. l. rev. 325, 325 (1893). 36. "the truth is that the [parol evidence rule] does but little to achieve the ends it supposedly serves." zell v. american seating co., 138 f.2d 641, 644 (2d cir. 1943) (frank, j.). 37. since the parol evidence rule does not apply when the cisg governs the contract, there is nothing to be gained, as some scholars have attempted, by deciding which of the various aspects of the parol evidence rule comport with the basic principles of the cisg. see, e.g., harry flechtner, "the u.n. sales convention (cisg) and mcc-marble ceramic center, inc. v. ceramica nuova d'agostino, s.p.a.: the eleventh circuit weighs in on interpretation, subjective intent, procedural limits to the convention's scope, and the parol evidence rule," 18 j. l. & com. 259, 284 (1999) ("some aspects of the parol evidence rule ... appear to remain valid under the convention"); note, "the parol evidence rule and the united nations convention on contracts for the international sale of goods: justifying beijing metals & minerals import/export corp. v. american business center, inc.," 1995 b.y.u. l. rev. 1347 (1995). nordic journal of commercial law issue 2005 #1 13 instead, the particular interpretive method of the cisg must be developed from the text and purposes of the cisg itself. 38. most commentators are in accord. see, e.g., larry dimatteo, supra note 4, at 21; john honnold, uniform law, supra note 27, § 110; schlechtriem & schwenzer (peter schlechtriem), commentary on the un convention on the international sale of goods (cisg), art. 11 n 13 (2nd ed., oxford 2005) (german edition, 4th edition 2004, art. 11 n 13); albert kritzer, guide to practical applications of the united nations convention on contracts for the international sale of goods 94 (1994) ; bernard audit, la vente internationale de marchandises 43 n. 3 (1990); note, supra note 33, 1999 b.y.u. l. rev. at 359; peter winship, "domesticating international commercial law: revising u.c.c. article 2 in light of the united nations sales convention," 37 loyola l. rev. 43, 57 (1991); john murray, "an essay on the formation of contracts and related matters under the united nations convention on contracts for the international sale of goods," 8 j. l. & comm. 11, 44 (1988) ("cisg rejects the parol evidence rule in the most frugal terms"). for the contrary view, see note, supra note 36, 1995 b.y.u. l. rev. at 1351. 39. see mcc-marble ceramic center, inc. v. ceramica nuova d'agostino, s.p.a., supra note 16, 114 f.3d at 1392-93 ("the cisg ... precludes the application of the parol evidence rule, which would otherwise bar the consideration of evidence concerning a prior or contemporaneously negotiated oral agreement"); shuttle packaging systems, llc v. tsonakis, 2001 wl 34046276 (w.d.mich. 2001) ("international sales agreements under the convention are not subject to the parol evidence rule"); mitchell aircraft spares, inc. v. european aircraft service ab, 23 f.supp.2d 915, 919-21 (n.d.ill. 1998); claudia v. olivieri footwear ltd., 1998 wl 164824 *5-6 (s.d.n.y.) ("contracts governed by the cisg are freed from the limits of the parol evidence rule and there is a wider spectrum of admissible evidence to consider in construing the terms of the parties' agreement"); filanto s.p.a. v. chilewich international corp., 789 f.supp. 1229, 1238 n. 7 (s.d.n.y. 1992), app. dismissed, 984 f.2d 58 (2nd cir. 1993) ("the convention essentially rejects ... the parol evidence rule"). contra: beijing metals & minerals import/export corp. v. us business center, inc., 993 f.2d 1178, 1183 n. 9 (5th cir. 1993) (in dictum (the court applied texas law)). 40. supra, note 16. 41. see schlechtriem & schwenzer (schlechtriem), kommentar zum einheitlichen un-kaufrecht cisg -, 4. auflage, münchen 2004, art. 11 n 13; english edition: schlechtriem & schwenzer (schlechtriem), commentary on the un convention on the international sale of goods (cisg), art. 11 n 13 (2nd ed., oxford 2005). ("that does not preclude the existence of a 'preference' for evidence of declarations in written form"); john honnold, uniform law, supra note 27, § 110 ("jurists interpreting agreements subject to the convention can be expected to continue to give special and, in most cases, controlling effect to detailed written agreements"). 42. harry flechtner, supra note 37, 18 j. l. & comm. at 278-79 ("the question whether the parties intended a writing to be an integration must be resolved like any other question of intent under the cisg, and without benefit of a presumption that the writing is an integration"). 43. "it is sometimes said that extrinsic evidence cannot change the plain meaning of a writing, but meaning can almost never be plain except in a context. ... any determination of meaning or nordic journal of commercial law issue 2005 #1 14 ambiguity should only be made in the light of the relevant evidence of the situation and relations of the parties, the subject matter of the transaction, preliminary negotiations and statements made therein, usages of trade, and the course of dealing between the parties. ... but after the transaction has been shown in all its length and breadth, the words of an integrated agreement remain the most important evidence of intention." restatement (second) of contracts § 212 comment b (1981). 44. "this section definitely rejects ... [t]he premise that the language used has the meaning attributable to such language by rules of construction existing in the law rather than the meaning which arises out of the commercial context in which it was used ... ." ucc § 2-202 comment 1 (b). 45. unidroit principles of international commercial contracts art. 2.1.17 (2nd sentence). 46. one can never preclude the possibility that, by agreement of the parties ,usages of trade or commercial sense, ordinary words are given a special meaning. for the same reason there cannot be any such thing as a wholly unambiguous contract term, despite the supposed rule that reference may be made to extrinsic evidence only where there is ambiguity. among bakers, apparently, a dozen means thirteen. more significantly, the house of lords in the antaios [1985] ac 191 upheld an arbitral award which construed "breach" as meaning "fundamental breach" to give commercial sense to the contract, even though "breach" is wholly unambiguous. 47. "when a contract is unambiguous, the court must ... give effect to the contract as written, the duty of the court being to declare the meaning of what was written in the instrument, not what was intended to be written." vol 11 samuel williston, a treatise on the law of contracts § 30:6 at 80-83 (richard lord ed., 4th ed. 1999). for a critique of the plain meaning rule, see vol 5 arthur corbin (margaret kniffen), contracts § 24.7 (rev. ed. 1998). 48. for an example see note 27 supra. 49. see, e.g., c. m. bianca & m. j. bonell (e. allan farnsworth), commentary on the international sales law art. 8 § 3.3 at 102 (1987). 50. for "writing" see cisg-ac opinion no 1 http://www.cisg.law.pace.edu/cisg/cisg-acop1.html 51. see unidroit principles of international commercial contracts article 2.1.17 52. see article 2:105. 53. "it often happens that parties use standard form contracts containing a merger clause to which they pay no attention. a rule under which such a clause would always prevent a party from invoking prior statements or undertakings would be too rigid and often lead to results which were contrary to good faith." principles of european contract law article 2:105 comment. 54. see, e.g., mcc-marble ceramic center, inc. v. ceramica nuova d'agostino, s.p.a., supra note 16, 114 f.3d at 1391 ("to the extent parties wish to avoid parol evidence problems they can do so by including a merger clause in their agreement that extinguishes any and all prior agreements and nordic journal of commercial law issue 2005 #1 15 understandings not expressed in the writing"); john honnold, uniform law, supra note 27, § 110 (1) ("contract terms (often called 'integration clauses') that any contemporaneous or prior agreement shall be without effect would be supported by article 6"); bernard audit, supra note 38, at 43 n. 3 (1990) ("la clause relativement fréquente selon laquelle seul l'écrit souscrit par les parties doit être pris en considération à l'exclusion de tout autre élément . . . devrait recevoir effet en vertu de l'art. 6"); larry dimatteo, supra note 4, at 215-16. 55. see john murray, supra note 38, 8 j. l. & comm. at 45 ("the typical merger clause familiar to american lawyers may be insufficient for this purpose. at least some explicit reference to the parties' intention to derogate from article 8(3) through article 6 would provide a safer course"). recoverability of the buyer's lost resale profit under cisg by magdalena raczynska nordic journal of commercial law issue 2007#2 nordic journal of commercial law issue 2007 #2 1 introduction it is a common conjuncture that the right to claim damages as a result of a breach of contract plays the most pivotal role among the remedies available to an aggrieved party.1 hence, the importance of taking a better look at damages that can be recovered for a particular type of loss. in this essay an attempt is made to identify some of the problems that arise before the courts when granting damages for buyer’s lost resale profit under the un convention on the contracts for the international sale of goods.2 the practice in the area seems to be far from clear or consistent and academic literature is not always lending a helping hand. the purpose of the first part of the essay is to sketch the notion of lost resale profit against a broader background of the law of damages. further and more detailed analysis will oscillate around three issues which in practice appear to be central to the recoverability of the lost resale profit by the buyer, namely the foreseeability, calculation and mitigation of that loss. it is fascinating to see how the concrete and abstract considerations, general principles and their detailed applications are all masterfully interwoven in the colourful fabric of the lost resale profit issue. the author hopes to shed some light on the various patterns embellishing this fine material and, if possible single out the most prominent strands. 1. loss of resale profit as a type of loss recoverable under art. 74 cisg before embarking on the more concrete analysis, it is important to bear in mind some basic propositions relating to the issue of damages under cisg. pursuant to art. 45(1)(b) cisg, if the seller fails to perform any of his obligations that he has under the contract or the convention, the buyer may claim damages as provided under arts. 74-77 cisg. it is irrelevant whether the obligations that the seller failed to perform are principal or ancillary.3 thus the seller’s liability may be triggered not only by his failure to deliver goods (arts. 30 and 31 cisg) but also by delivery of goods which do not conform to the contract (art. 35 cisg). 1 s. eiselen, measuring damages for the breach of contract: remarks on the manner in which unidroit principles on international commercial contracts mat be used to interpret or supplement article 74 of the cisg, in: an international approach to the interpretation of the united nations convention on the contracts for the international sale of goods (1908) as uniform sales law, ed. j. felemegas, cup 2007, at 211. 2 hereinafter referred to as the convention or cisg. 3 m. müller-chen, in p. schlechtriem/i. schwenzer, commentary on the un convention on the international sale of goods (cisg), oxford 2005, art. 45, p. 520. nordic journal of commercial law issue 2007 #2 2 the seller’s liability for performance of his obligations is objective, independent of fault or specific warranty of performance.4 he assumes that liability the moment he undertakes an obligation to perform under a contract governed by cisg. the recoverability of damages under the convention is determined by the following principles. first, the purpose of remedies of breach of contract is to provide relief to the aggrieved party rather than provide a mechanism to prevent the breach.5 therefore, for the buyer to recover damages there must be a failure on the part of the seller to perform any of his obligations under the contract or the convention6 and no exemption available under art. 79 or art. 80 cisg.7 in other words, damages are compensatory, not punitive, in nature.8 second, relief to the aggrieved party is to be measured by that party’s loss of “expectation interests”, also known as “the benefit of the bargain”.9 damages aim to put the party who suffered loss in the position which he would have enjoyed had the contract been performed10 although not in any better one.11 this is often said to be the principle of full compensation.12 it means that all types of losses are relevant under cisg.13 as p. huber pointed out, whilst various classifications of losses may turn out to be helpful in identifying types of loss that can be suffered, by no means should they serve as criteria of recoverability of loss under cisg. the basic philosophy of damages is, as stipulated in the secretariat commentary, to place the injured party “in the same economic position he would have been in if the contract had been performed”.14 4 m. müller-chen, in p. schlechtriem/i. schwenzer, commentary on the un convention on the international sale of goods (cisg), oxford 2005, art. 45, p. 528. 5 e. a. farnsworth, remedies and specific, 27 american journal of comparative law 1979, at 247. 6 see art. 45(1)(b) cisg. 7 p. huber, in: huber/mullis, the cisg. a new textbook for students and practitioners, sellier 2007, at 257. 8 g. h. treitel, remedies for breach of contract, p. 76; p. huber, in: huber/mullis, the cisg. a new textbook for students and practitioners, sellier 2007, p. 268; cisg advisory council opinion no 6, calculation of damages under cisg, article 74, para. 9.5. 9 e. a. farnsworth, remedies and specific relief, 27 american journal of comparative law 1979, at 247; g. h. treitel, remedies for breach of contract, at 82. german law refers to this interest as erfüllungsinteresse or positive interest, as opposed to vertrauensinteresse, i.e., negative interest, which is protected by compensating expenses and other losses incurred in reliance on the contract. the latter aims to put the aggrieved party in the position in which he would have been had the contract never been made. (treitel, ibidem, p. 83). 10 stoll, gruber, in: schlechtriem/schwenzer, commentary on the un convention on the international sale of goods, art. 74 (...); see also commentary to an earlier version of the convention, a/cn.9/116, annex ii, available at <http://www.uncitral.org/pdf/english/yearbooks/yb-1976-e/vol7-p96-142-e.pdf> and the sectretariat commentary on the 1978 draft, at <http://cisgw3.law.pace.edu/cisg/text/secomm/secomm-74.html>. 11 cisg advisory council opinion no 6, calculation of damages under cisg, article 74, para. 9. cf. p. huber, in: p. huber, a. mullis, the cisg. a new textbook for students and practitioners, sellier 2007, at 256 (although the statement has been made with regard to availability of various remedies, it remains valid for the present purposes): “... damages are not available where their award would lead to the buyer being overcompensated.” 12 cisg advisory council opinion no 6, calculation of damages under cisg, article 74, para. 1.1. 13 p. huber, in: p. huber, a. mullis, the cisg. a new textbook for students and practitioners, sellier 2007, p. 268. 14 commentary on the draft convention on contracts for international sale of goods prepared by the secretariat, doc a/conf.97/5, art. 29, no. 5 – united nations conference on contracts for the international sale of goods, official records, new york, 1981 (a/conf.97/19), 53. j. honnold, uniform law for international sales under the 1980 united nations convention, 3rd ed., kluwer law international 1999, http://www.uncitral.org/pdf/english/yearbooks/yb-1976-e/vol7-p96-142-e.pdf http://cisgw3.law.pace.edu/cisg/text/secomm/secomm-74.html nordic journal of commercial law issue 2007 #2 3 third, only loss suffered as a consequence of the breach of contract will be compensable. it appears that the test applicable to determine causation is the conditio sine qua non or the “but for” test.15 in order to avoid the so-called “adam and eve” causation trap, where everything would ultimately have the cause in the beginnings of the universe, a mechanism of limitation of damages needs to be in place. one of the mechanisms instated in the convention is the foreseeability test,16 which constitutes the next proposition. fourth, losses recoverable under art. 74 cisg have been confined only to those that “the party in breach foresaw or ought to have foreseen at the time of the conclusion of the contract, in the light of the facts and matters of which he then knew or ought to have known, as a possible consequence of the breach of contract”.17 fifth, damages should not include compensation for loss that might reasonably have been avoided.18 the requirement of avoidability has been expressed in art. 77 cisg, according to which a party relying on a breach of contract must take such measures as are reasonable in the circumstances to mitigate the loss, including loss of profit, resulting from the breach. as follows from the principle of full compensation and art. 74 cisg, the aggrieved party can claim damages for any loss that the party suffered, including loss of profit.19 whilst the actual loss has been defined as the reduction in the assets which existed when the contract was concluded, loss of profit is taken to mean any increase in the assets which the breach prevented.20 a cursory definition of profits referenced to in art. 74 cisg was laid down in the compound fertilizer case of 30 january 1996.21 anticipated profits were taken to mean net profits, i.e., anticipated gross profits less payable fees. a loss of resale profit is one possible type of lost profit situation and as such is fully compensable under art. 74 cisg, though clearly it may not lead to the overcompensation of the buyer. if the seller has not delivered at all or the delivered goods (or part of them) are nonconforming, the buyer is left unable to gain profit from the resale of the goods. if, however, he manages to mitigate the loss and resell the goods albeit for a lower price, he should only be able to recover the price difference between the two contracts as his lost resale profit. as f. enderlein and d. maskow state: "as to the loss of profit, there are several possibilities. it may be questioned whether the injured party is entitled to recover the loss of profit he actually 15 stoll/gruber, in: p. schlechtriem/i. schwenzer, commentary on the un convention on the international sale of goods, art. 74, para. 23; p. huber, in: p. huber, a. mullis, the cisg. a new textbook for students and practitioners, sellier 2007, p. 270. 16 d. saidov, methods of limiting damages under the vienna convention on contracts for the international sale of goods, <http://cisg3.law.pace.edu/cisg/biblio/saidov.html>. 17 for a more detailed analysis see below (“foreseeability”). 18 e. a. farnsworth, remedies and specific relief, 27 american journal of comparative law 1979, at 247. 19 art. 74 cisg: “damages for breach of contract by one party consist of a sum equal to the loss, including loss of profit, suffered by the other party as a consequence of the breach.” 20 stoll/gruber, in p. schlechtriem/i. schwenzer, commentary on the un convention on the international sale of goods (cisg), oxford 2005, art. 74, para. 22, p. 758. 21 china international economic and trade arbitration commission (cietac) proceeding of 30 january (compound fertilizer case), 1996 <http://cisgw3.law.pace.edu/cases/960130c1.html>. http://cisg3.law.pace.edu/cisg/biblio/saidov.html http://cisgw3.law.pace.edu/cases/960130c1.html nordic journal of commercial law issue 2007 #2 4 suffered, the exact profit he could have expected, or an average profit to be expected at a certain time in a certain place. it is unclear also for which period of time the loss of profit can be measured."22 in deciding whether the profit would have been made if the contract had been properly performed, the convention does not stipulate what degree of probability is necessary. it is generally submitted that the aggrieved buyer should prove the loss with reasonable certainty.23 2. foreseeability as mentioned above, losses are only recoverable if they have been foreseeable by the party in breach of the contract. foreseeability is a troublesome concept to define. it also appears to be the key principle applied by the courts when determining whether lost resale profit should be recoverable. the main issue considered by courts in determining sellers’ liability was whether the seller could foresee or ought to have foreseen the loss of buyer’s profit. this, however, begs further question: what is the standard of foreseeability applied in the case of lost resale profit? the wording of art. 74 cisg24 clearly suggests that the loss resulting from the breach of contract does not need to be actually foreseen.25 the breaching party may be held liable if the loss is foreseeable. it seems that the foreseeability of buyer’s lost resale profit has been ascertained in the jurisprudence by adopting one of the two different, if not contradictory, approaches. the courts have either required that the seller have the knowledge of the buyer’s resale contract, typically already upon the conclusion of the contract of sale, or it has been assumed that the seller should know that the buyer was to resell the goods. the first approach is illustrated in the india rapeseed case.26 it was held that the seller should not be liable for the loss of resale profit since the resale contracts (entered into on 27 august 2002) were signed after the conclusion of the contract between the buyer and the seller (dated 30 july 2002). therefore, the seller was unaware of the conclusion and the terms of the resale contract. the arbitration tribunal did not find sufficient evidence showing that the seller foresaw or ought to have foreseen the difference between the contract price and the resale price alleged by the buyer in the light of the facts which the seller then knew or ought to have 22 fritz enderlein & dietrich maskow. "international sales law", oceana (1992), p. 299. 23 cisg advisory council opinion no 6, calculation of damages under cisg, article 74, para. 2; p. huber, in: huber/mullis, the cisg. a new textbook for students and practitioners, sellier 2007, p. 276; cf “the competent judge should be convinced that the profit would actually have been made ... before relief for this type of loss is granted”, neumayer/ming, art. 74, note 1; weber, vertragsverletzungsfolgen, p. 196, cited from stoll/gruber, in p. schlechtriem/i. schwenzer, commentary on the un convention on the international sale of goods (cisg), oxford 2005, art. 74, p. 759. 24 “...the loss which the party in breach ... ought to have foreseen”. 25 j. lookofsky, the 1980 united nations convention on contracts for the international sale of goods, article 74, damages for breach, in: j. herbots editor / r. blanpain general editor, international encyclopaedia of laws contracts, suppl. 29 (december 2000), at 290, footnote 3, also available at <http://cisgw3.law.pace.edu/cisg/biblio/loo74.html>. 26 cietac china arbitration proceeding of 29 september 2004 (india rapeseed case), <cisgw3.law.pace.edu/cases/040929c1.html>. http://cisgw3.law.pace.edu/cisg/biblio/loo74.html nordic journal of commercial law issue 2007 #2 5 known, as a possible consequence of the breach of contract. similarly, in the tinplate case, it has been required that the buyer should inform the seller of a resale contract.27 the prerequisite of the seller’s knowledge raises some doubts when it comes to lost resale profit cases. in commercial practice the buyer and the seller are usually identifiable entities entering into transactions with known purposes. incidentally, if the buyer, being a shoe wholesaler, orders hundreds of pairs of shoes it is not unforeseeable that the goods would be resold. if then the seller does not deliver or delivers non-conforming goods, it seems evident that the buyer will suffer loss of profit that he could earn by resale. in addition, resale is one of the usual ways of dealing with goods and as such will usually be foreseeable.28 the relevance of commercial practice seems to have been taken into account by the austrian supreme court in a case involving a sale (and resale) of propane gas.29 in this case the german buyer and the austrian seller entered into an agreement for the delivery of 3000 mt of propane gas. on the same day the buyer resold the ordered quantity of gas to the dutch company onto the belgium market. the seller however did not obtain from his supplier a permission required for reselling the gas in benelux countries, as a result of which he did not deliver the gas to the buyer. the buyer let the sellers know that his customer already had made substitute purchases and that he was trying to sell the quantity already purchased in germany. on the same day, the sellers also told the buyer that the natural gas could not be sold to customers in the socalled benelux countries at all. the austrian buyer instituted proceedings against the seller claiming lost profit from the envisaged resale of the natural gas in belgium. the buyer claimed he suffered a loss of profit of $5 per ton, resulting in the total of $15,000. although the seller was generally considered to be liable for loss of profit only if he had to reckon with the buyer’s resale, it was held that “in case of the sale of commercial goods to a merchant, this can always be assumed without any further indications.” the approach taken by the austrian supreme court in this case appears to be in line with a previous decision delivered by the chinese arbitration tribunal in the art paper case of 12 february 1996.30 the tribunal held that since the buyer is a trading company, the seller “should have known that the buyer was not buying goods for his own use” but in order to resell them. in the judgment of 23 december 2004,31 a russian tribunal held that “the [seller], as a professional participant of the market (...), could not have been unaware of the fact that the [buyer] is not the consumer of the delivered goods and that it distributes them on the internal market of russia, that naturally includes transshipment (resale) of the purchased goods by the [buyer] to further customers.” the tribunal took into account not only the status of the seller but also the long-lasting business relations the parties were in, which additionally were reflected in a number of contracts concluded between them. 27 cietac china arbitration proceeding of 17 october 1996 (tinplate case), <http://cisgw3.law.pace.edu/cases/961017c1.html>. 28 p. huber, in p. huber/a. mullis, the cisg. a new textbook for students and practitioners, sellier, 2007, p. 273. 29 austria 6 february 1996 supreme court (propane case), <http://cisgw3.law.pace.edu/cases/960206a3.html>. 30 cietac china arbitration proceeding of 12 february 1996 (art paper case), <http://cisgw3.law.pace.edu/cases/960212c1.html>. 31 russia 23 december 2004 arbitration proceeding 97/2004, http://cisgw3.law.pace.edu/cases/041223r1.html. http://cisgw3.law.pace.edu/cases/961017c1.html http://cisgw3.law.pace.edu/cases/960206a3.html http://cisgw3.law.pace.edu/cases/960212c1.html http://cisgw3.law.pace.edu/cases/041223r1.html. nordic journal of commercial law issue 2007 #2 6 considering the above-cited case law, it seems that the test applied to ascertain foreseeability of lost resale profit is often an objective one, i.e., it does not refer to what the seller actually foresaw. on the other hand, however, there is no reference to the reasonable person standard either. foreseeability of lost resale profit seems to have been based on factors such as the nature of the goods involved (“commercial goods”) and the status of the buyer (“a trading company”, “not the consumer of the delivered goods”). it also means that the requirement of the loss being foreseeable at the time of the conclusion of the contract will normally be fulfilled. the standard of foreseeability under cisg remains however both subjective and objective. as early as in s 1979 ulis case,32 the federal supreme court of germany (bundesgerichtshof) concluded that “... ulis article 82 [a match-up article with article 74 cisg] 33 requires (...) that the test can conclusively be met by a showing of trade custom as to foreseeability, and that a survey of persons in the trade is a proper means of determining those facts”.34 in that case, a german cheese importer was reselling cheese to other customers concluded a contract with a dutch exporter. it turned out that 3% of the total delivery of the cheese was defective. the buyer sought damages for loss of profits alleging that four of his wholesale customers ceased doing business with him, which resulted in lost profits over four years. having taken into account the information from chambers of commerce and industry concerning the question of foreseeability, the court held that it was foreseeable that minor deficiencies in performance could lead to a loss of customers. the decision has been criticized for treating foreseeability in the factual context rather than as an element in the assessment of the degree of the seller's risk assumption at the time of the conclusion of the contract.35 commenting on the decision, p. schlechtriem noted that “liability with regard to customers (indemnification), however, should at least have been 'foreseeable' within the normative meaning of this criterion since it is to be expected in the usual course of delivery of defective goods to a middleman. these types of damages are ('quite simply') considered 'foreseeable' not only for goods delivered to a middleman for resale but also for products for further processing, whose defects create replacement obligations for the buyer/manufacturer with respect to its customers.” 32 bgh of 24 october 1979, riw 1980, 143 et seq., <http://cisgw3.law.pace.edu/cases/791024g1.html>. 33 it has been established on various occasions that ulis jurisprudence can be useful in interpreting the convention, see f.a. mann, uniform statutes in english law, 99 law quarterly review, 1983, p. 382; b. audit, the vienna sales convention and the lex mercatoria, in: thomas e. carbonneau ed., lex mercatoria and arbitration, juris publishing 1998, p. 188. 34 cf. eric c. schneider, measuring damages under cisg, <http://cisgw3.law.pace.edu/cisg/text/cross/cross74.html>, citing jeffrey s. sutton, measuring damages under the united nations convention on the international sale of goods, 50 ohio st. l.j. 743-744: “article 74 contains both an objective and subjective test, limiting damages to the "loss which the party in breach foresaw or ought to have foreseen at the time of the conclusion of the contract, in light of the facts and matters of which he then knew or ought to have known." 35 see weitnauer, nichtvoraussehbarkeit eines schadens nach art. 82 s. 1 des einheitlichen gesetzes über den internationalen kauf beweglicher sachen. comment to bgh of 24 october 1979, iprax 1981, 83, 84 sub iv. 1, cited after p. schlechtriem. http://cisgw3.law.pace.edu/cases/791024g1.html http://cisgw3.law.pace.edu/cisg/text/cross/crossnordic journal of commercial law issue 2007 #2 7 this view seems to be supported in the art paper case36 where it was held that since the buyer was a trading company, the seller should have known that the buyer was not buying goods for its own use. 3. calculation of lost resale profit there are two possible ways of calculating damages in a situation when a buyer lost his resale profit:37 a) calculating loss of profit as a price difference between the contract price and the price for reselling to the buyer’s customer b) calculating loss of profit based on the difference between market price and the contract price. the first method seems to have been applied in a majority of cases. one of the first cases where lost resale profit was successfully claimed by the buyer was the art paper case of 12 february 1996.38 the tribunal awarded damages for the buyer’s loss of profit calculated as the difference between the contract price and the price the buyer would be paid pursuant to the resale contract. it is not clear, however, whether the buyer had already concluded the resale contracts with its customers. in the german paperboard containers case,39 the buyer running a business for office organization systems concluded an annual framework contract for delivery of seller’s “archive-solid-boards”. in december 2002, the buyer refused to sign a follow-up contract proposed by the seller. seller declared immediate termination of the 1999 contract because of the alleged “systematic breaches of payment terms” by the buyer. the appellate court in köln found that the seller’s termination of the contract was unjustified. since throughout 2003 the buyer did not receive any deliveries from the seller, the buyer was unable to realize profits through resale of goods. the calculation of lost profits was based on the turnover expectation (of eur 115,000) which was actually stated by the seller itself in his letter in december 2002. the court found that the buyer properly assumed the profit margin of 30% and took into account cost savings of 10%. the margin of profit was proved by having submitted a comparison of purchase and resale prices. the seller was barred from successfully pleading ignorance as a means of challenging the buyer's margin of profit by stating that the seller had relied on a lower margin during contractual negotiations. the seller did not manage to specify which margin of profit had been proposed back and, in any case, his negotiation on the basis of too low figures appears to have been simply a tactic move. 36 cietac china arbitration proceeding of 12 february 1996 (art paper case), <http://cisgw3.law.pace.edu.cases/960212c1.html>. 37 cietac china arbitration proceeding of 29 september 2004 (india rapeseed meal case), <http://cisgw3.law.pace.edu/cases/040929c1.html>. 38 cietac china arbitration proceeding of 12 february 1996 (art paper case), <http://cisgw3.law.pace.edu/cases/960212c1.html>. 39 germany 12 january 2007 appellate court köln (paperboard containers case), <http://cisgw3.law.pace.edu/cases/070112g1.html>. http://cisgw3.law.pace.edu.cases/960212c1.html http://cisgw3.law.pace.edu/cases/040929c1.html http://cisgw3.law.pace.edu/cases/960212c1.html http://cisgw3.law.pace.edu/cases/070112g1.html nordic journal of commercial law issue 2007 #2 8 in the already cited compound fertilizer case,40 the seller argued that the buyer’s resale price was too high and the profit was exorbitant. although in this case the seller failed to provide sufficient evidence, it would, arguably, be against the principle of full compensation if the buyer could recover excessive profits under the convention.41 the second method of calculating lost resale profit was employed in a case of 27 may 2005 between a turkish buyer and a russian seller.42 the seller failed to deliver a prepaid installment of goods to the buyer, who sued the former for loss of profits. in granting the buyer this claim, the russian tribunal took into account the rate of profit existent on the turkish market, which could be gained from the resale of the goods. the market rate was evidenced by the buyer in a document. it was held that the seller “could not have failed to foresee the occurrence of this loss of the [buyer] in base of non-performance by the [seller] of its contractual obligations”. similarly, a ukrainian tribunal43 refused to accept buyer’s calculation of the lost profit on the basis of subtracting the contract price of the goods from the sum the buyer claimed it could have received as payment for the processed product. instead, the buyer was awarded a much smaller sum (us $897,000 instead of the initially claimed us $1,700,000) calculated on the basis of the difference between the market and contractual price. although it may not always be clear from the jurisprudence, it seems that calculation of lost resale profit can only be based on the difference between the resale contract price and the contract price when the buyer had concluded resale contracts. if there are no such resale contracts, even if the buyer regularly resells the goods to its customers, the loss should be calculated on the basis of market price. 4. mitigation of loss of resale profit by the buyer article 77 cisg imposes an obligation upon the buyer to mitigate his loss of profit. if he fails to do so, the party in breach may claim a reduction of the amount of the damages. 44 the principle underpinning the mitigation of loss is that the aggrieved party should not recover damages for loss that could reasonably have been avoided.45 it has been said to be the expression of good faith in international commerce.46 pursuant to art. 77 cisg, the aggrieved party is required to take measures that are reasonable in the circumstances, i.e., measures that under the circumstances of the individual case could 40 cietac china arbitration proceeding of 30 january 1996 (compound fertilizer case), <http://cisgw3.law.pace.edu/cases/960130c1.html>. 41 see also p. huber, in huber/mullis, the cisg..., p. 276. 42 russia 27 may 2005 arbitration proceeding, <http://cisgw3.law.pace.edu/cases/050527r1.html>. 43 ukraine 2005 arbitration proceeding, case no. 48, <http://cisgw3.law.pace.edu/cases/050000u5.html>. 44 p. huber, in p. huber/a. mullis, the cisg. a new textbook for students and practitioners, p. 289. 45 g. treitel, remedies for breach of contract: a comparative account, 1988, p. 179; knapp/bianca, bonell, pp. 559-560; stoll/gruber, in: schlechtriem, commentary on the un convention on the international sale of goods, p. 787. 46 stoll/gruber, in: schlechtriem, commentary on the un convention on the international sale of goods, p. 787 and literature cited there. http://cisgw3.law.pace.edu/cases/960130c1.html http://cisgw3.law.pace.edu/cases/050527r1.html http://cisgw3.law.pace.edu/cases/050000u5.html nordic journal of commercial law issue 2007 #2 9 have been expected in good faith.47 in one court’s view, the answer to the question of which measures would be reasonable and ought to be taken depends on how a reasonable creditor would have acted in the same situation.48 since the claim of the breach of the duty to mitigate damages is an exception leading to the loss of the claim for damages, it is the seller who needs to prove it. in the situation of lost resale profit, the seller will typically try to raise the argument that the buyer failed to conclude substitute contracts at an appropriate time and in an appropriate time framework according to art. 75 cisg.49 on the other hand, the buyer will counterclaim that he has taken reasonable measures to mitigate loss. repeated requests addressed to the seller to deliver the goods were found to be insufficient means to mitigate loss.50 analyzing the jurisprudence, it seems that the courts do not take the duty of the buyer to mitigate his loss seriously enough. it is often held that the buyer has a duty to take reasonable measures to mitigate his loss but rarely did the courts find the buyer falling short of this requirement. in the case of loss of resale profit it seems that the buyer will often be able to conclude substitute transactions to obtain the goods from elsewhere. whether in practice substitution will actually be feasible is an entirely different matter and depends on the circumstances of the individual case. it seems, however, that the courts did not give it sufficient thought and failed to consider whether mitigation of the buyer’s lost resale profit could have been mitigated in that way. in the india rapeseed meal case, for instance, the seller argued that the buyer could purchase domestic goods to substitute the goods in resale contract. the arbitration tribunal found, however, that “the seller’s allegations of purchasing substitute goods is not in accordance with the contract and lacks of sufficient reasons.” the decision in this respect is controversial. the duty of the buyer to mitigate his loss of resale profit by entering into substitute transactions should not be dependent on whether such an obligation has been stipulated in the contract itself. it is contained expressly in art. 77 cisg. 5. conclusion the analysis of the jurisprudence in the area of loss of resale profit by the buyer seems to contain a number of inconsistencies and controversies. in awarding damages for lost resale profit the courts have mainly focused on the issue of foreseeability, leaving the duty of the buyer to mitigate his loss almost on the side. whilst circumstances surrounding the conclusion of the contract, notably the knowledge of seller of buyer’s resale contracts, are of decisive relevance,51 it appears to be impossible to 47 austria 6 february 1996 supreme court (propane case), <http://cisgw3.law.pace.edu/cases/960206a3.html>; cf. von caemmerer/schlechtriem, art. 77 n. 9). 48 austria 6 february 1996 supreme court (propane case), <http://cisgw3.law.pace.edu/cases/960206a3.html>. 49 austria 6 february 1996 supreme court (propane case), <http://cisgw3.law.pace.edu/cases/960206a3.html>; cf. ukrainian arbitration tribunal, which held that what would be regarded as a sufficient means of mitigation would be the purchase of analogous goods with price information presented by buyer (case no. 48). 50 ukraine 2005 arbitration proceeding, case no. 48, <http://cisgw3.law.pace.edu/cases/050000u5.html>. 51 piltz, internationales kaufrecht, 1993, munich, p. 291. http://cisgw3.law.pace.edu/cases/960206a3.html http://cisgw3.law.pace.edu/cases/960206a3.html http://cisgw3.law.pace.edu/cases/960206a3.html http://cisgw3.law.pace.edu/cases/050000u5.html nordic journal of commercial law issue 2007 #2 10 establish a general rule that certain damages are only foreseeable if they have been expressly dealt with in the contractual negotiations52 or made known to the breaching party. in awarding damages for the loss of resale profit the courts should take account of the specific nature of that loss, in particular the commercial practice in which the buyer and the seller operate. 52 switzerland 28 october 1998 supreme court (meat case), <http://cisgw3.law.pace.edu/cases.981028s1.html>. http://cisgw3.law.pace.edu/cases.981028s1.html microsoft word peter_j_mazzacano_lopullinen.docx nordic journal of commercial law issue 2011#2 force majeure, impossibility, frustration & the like: excuses for non-performance; the historical origins and development of an autonomous commercial norm in the cisg by peter j. mazzacano* * adjunct professor, ph.d. (cand.), co-coach of vis moot team, osgoode hall law school, toronto, canada. 1 nordic journal of commercial law issue 2011#2 1 introduction this article considers the extent to which a problematic legal doctrine is an autonomous1 international commercial norm, and capable of relative uniformity within the context of the 1980 united nations convention on contracts for the international sale of goods (“cisg” or “convention”)2 and its goal for a sales law that is transnational in design. this norm, is commonly known as force majeure, an act of god, impossibility, frustration, the german wegfall der geschaftsgrundlage, the french imprevision, and the like, but embodied in cisg article 79 under the neutral wording of “failure to perform…due to an impediment beyond his control” in cisg. a premise to be explored is that while phrase “failure to perform…due to an impediment beyond his control” in cisg article 79 may have developed out of an amalgamation of similar national conceptions which, in turn, grew from the conflicting roman maxims pacta sunt servanda and rebus sic stantibus, article 79’s excuse for non-performance ultimately stands alone as an autonomous international doctrine under the cisg in private international law. it belongs to a private legal order and is part of the non-state commercial lexicon of the new lex mercatoria. this development plays a crucial role for uniformity in private international law generally, and specifically for international sales law. it supports the idea that in certain cases, particularly in international commercial transactions, individual domestic legal doctrines and norms—some of which evolved out of roman maxims— can transcend state-based law-making, and may ultimately coalesce into autonomous international principles, regardless of their distinctive development by way of positive law in state-based jurisdictions. such a development also questions the role of the state in the creation of legal orders. this paper argues that this development of an autonomous legal principle—“failure to perform…due to an impediment beyond his control”—is part of the international commercial lingua franca. further, this private law-making is also evidence of a growing autonomous global legal culture that is truly independent of any national sovereign. this development affects traditional (i.e. state-based) legal boundaries. the implications for transnational law and global governance is that, in the absence of a supranational legislator, the participants themselves, the international merchants and bankers, are needed—indeed, required—to determine their own legal norms. 1 “autonomous” comes from the greek words auto meaning “independent” and nomos meaning “law”. in this paper “autonomous” refers to a concept or action that is self-contained and undertaken or conducted without outside control—it exists and develops independently of the whole, and lives outside the environment of statebased law. 2 united nations convention on contracts for the international sale of goods, april 11, 1980, 1489 u.n.t.s. 3, 19 i.l.m. 671, hereinafter cited as the “cisg” or “convention.” 2 nordic journal of commercial law issue 2011#2 there is, thus, a greater role for industry practices, custom, and party autonomy in the modern globalized environment. 2 roman origins the concept of a legal excuse for the non-performance of an obligation due to an unforeseen event did not fully develop until trade began to flourish in the medieval mediterranean world. in many respects, it arose to meet the needs of a vibrant—and increasingly international— mercantile community. the principle was not explicitly recognized in the laws of ancient rome.3 the roman republic did not know the word impossibilis; the idea could be expressed, but only in greek.4 this is not surprising as early roman law did not have a comprehensive body of contract law.5 rather, roman law embodied various classifications of liability, but no comprehensive system of contractual responsibility.6 in many respects the laws of rome also failed to adequately address the needs of commerce. there was no separate court for the trial of mercantile disputes, and its commercial and maritime law was part of the general law.7 in the early days of the latin language there were no words to express sea terms, even though the commercial sea code of rhodes, a greek creation, came into existence in the second or third century b.c.e.8 even the term contractus retained a very restricted meaning, denoting lawful conduct that could give rise to liability.9 gaius does not even define the term in his commentaries.10 it was far removed from the modern concept of “contract”. only certain types of transactions were recognized, leaving many types of agreements to exist without legal validity. 3 j. toshio sawada, subsequent conduct and supervening events (tokyo: university of tokyo press, 1968) at 114. 4 w.w. buckland, “casus and frustration in roman and common law” (1932) 46 harv. l. rev. 1281 at 1281. see also d. 28.7.1.20. pr. 5 anthony jeremy, “pacta sunt servanda: the influence of canon law upon the development of contractual obligations” (2000) 144 law & just. christian l. rev. 4 at 4. 6 malcolm p. sharp, “pacta sunt servanda” (1941) 41 colum. l. rev. 783 at 785. 7 frederick rockwell sanborn, origins of the early english maritime and commercial law (new york: the century co., 1930) at 8. here, sanborn describes roman law, by way of contrast to other legal systems, as being unitary and much more “abstract” and “sharply defined” in nature. he concurs with francois morel and levin goldschmidt that such a separate mercantile law would have been “contrary to the centralizing genius of the roman law, and […] contrary to their tradition of its unity”. op. cit. see also francois morel, les juridictions commerciales au moyen-âge: etude de droit compare (paris: arthur rousseau, 1897), and levin goldschmidt, handbuch des handelsrechts, vol. i (stuttgart: f. enke, 1891). 8 ibid. at 5 and 8. 9 coenraad visser, “the principle pacta servanda sunt in roman and roman-dutch law, with specific reference to contracts in restraint of trade” (1984) 101 s.a.l.j. 641 at 642. 10 w.f. harvey, a brief digest of the roman law of contracts (oxford: james thornton, 1878) at 2. 3 nordic journal of commercial law issue 2011#2 in the classical period,11 parol contracts did not create a binding legal obligation, and the term nuda pacta (“bare pacts”) initially represented this array of unsanctioned agreements that were common, but not enforceable in law.12 they were unenforceable for want of an action at law to make them binding, and were simply thought to be “natural obligations”.13 like much of roman law, gaius’ discussion of the law of obligations is very narrow and focused. there was the verbal contract,14 the stipulatio, which consisted of a formalistic series of questions and answers.15 but this was valid only between roman citizens, thereby excluding foreigners. within the stipulatio, however, are the formative ideas that later evolved into more developed legal principles, such as force majeure, frustration, impossibility, hardship, and the cisg variant in article 79. for example, in his title on invalid stipulations, gaius tells us that “if any one stipulates for a thing which does not, or cannot exist, as for stichus, who is dead, but whom he thought to be living, or for a hippocentaur, which cannot exist, the stipulation is void”.16 while the notions of impossibility and non-performance are evident here, absent are other fundamental ideas, such as a supervening event and unforeseeability. these are necessary in the doctrine of excuses for non-performance. furthermore, there is also an absence of the concept of good faith, even though the idea of ex fide bona was a part of later roman contract law involving sales, hires, and partnerships. like the roman action of bona fidei judicium,17 good faith is implicit in the doctrine of excuse for non-performance, as it requires the parties to do, not what has been exactly promised, but rather that which is fair and reasonable under the circumstances. roman law rules of ex fide bona were initially concerned with jurisdictional matters, not those of an ethical nature or 11 circa 350 b.c.e. 12 jeremy, supra note 5 at 4-5. 13 ibid. at 6. 14 while a written agreement was not necessary to make a stipulatio valid, often one was drawn up to record the transaction. see thomas collett sandars, the institutes of justinian (chicago: callaghan & co., 1876) at 427. 15 charles sumner lobingier, the evolution of roman law, 2d ed. (n.p.: published by the author, 1923). in the institutes, gaius describes the stipulatio as follows: ‘a verbal contract is formed by question and answer, thus: “dost thou solemnly promise that a thing shall be conveyed to me”? “i do solemnly promise”. “wilt thou convey”? “i will convey”. “dost thou pledge thy credit”? “i pledge thy credit”. “dost thou bid me trust thee as guarantor”? “i bid thee trust me as guarantor”. “will thou perform”? “i will perform”.’ g. 3.92 (trans. thomas c. sandars). 16 g. 3.97 (title xix. “de inutilibus stipulationibus”). 17 the action of bona fidei judicium directed the judge of a dispute to found his judgment on the basis of good faith. in these cases the judge would order the defendant to render performance on the basis of good faith. in the action of bona fidei judicium, the judge was thus given authority to introduce a good faith formula, and take into account informal agreements that would normally be unenforceable in law. see jeremy, supra note 5 at 5. 4 nordic journal of commercial law issue 2011#2 moral responsibility.18 later, with the rise of commerce, and under the christian influence of justinian, the canonists would imbue ex fide bona with the ideals of conscience and equity, and urge litigants to do what good faith and conscience required.19 as baldus de ubaldis (13271400) noted, bare pacts among merchants became actionable at a very early stage, “since good faith is required in these contracts which are most frequently concluded, and in these respects a bare pact does not differ from a stipulation”.20 these became known as good faith agreements, and covered sales, hire, and partnerships. they allowed a judge to take into account implied terms, customs, and the unexpressed intent of the parties. in addition to the development of good faith, the concepts of a supervening event and unforeseeability would later evolve, as commerce expanded and legal rules adapted to more complex business transactions. while some scholars have attempted to discern the predecessor of the doctrine of excuses for non-performance in roman private law, there is little evidence to support this finding.21 as noted above, its beginnings are fractured in a variety of undeveloped legal maxims and ancient legal rules. the underpinning idea can be traced back to the code of hammurabi (2250 b.c.e.). for example, it stated that “the hirer of an ox is bound to return it safe and undamaged but he is excused from his liability for its death in two cases: the first is in s. 244 where the ox is devoured by a lion ‘in the open country’; the second is in s. 249 when a god has struck it”.22 there are also references to legal excuses for non-performance in ancient greek law, but these are only tenuous connections.23 all that existed were certain formative ideas, and these would require considerable historical and legal development and articulation before crystallizing into modern concepts such as force majeure, impossibility, frustration, and article 79’s excuses for non-performance. the closest ancient iteration containing certain aspects of the doctrine is evident in gaius’ discussion of cases in which a stipulatio would be deemed invalid. he stated: “[i]f any one stipulates for a thing sacred or religious, which he thought to be profane, or for a public thing appropriated to the perpetual use of the people, as a forum or 18 ibid. at 4. 19 ibid. 20 gloss ad d. 13.5.1. 21 sawada, supra note 3 at 114 fn. 30. 22 g.r. driver and john c. miles, eds. & trans., the babylonian laws (oxford: the clarendon press, 1952) at 438440. 23 ibid. at 114. 5 nordic journal of commercial law issue 2011#2 theatre, or for a free man, whom he thought to be a slave […] the stipulation is at once void”.24 these also included agreements, for example, imposing an impossible condition, such as a nonexistent or unattainable object,25 or a deceased26 or insane27 person. also void were illegal pacts, or those between persons who had no legal capacity to form agreements.28 otherwise, obligations were to be strictly enforced, in a similar fashion to the much later doctrine of pacta sunt servanda. over time even the nuda pacta became actionable, and was transformed into the pacta vestita (“clothed pacts”). not surprisingly, contract law began its slow development with the expansion of the roman merchant empire. while rome expanded rapidly by conquest following the first punic war,29 and foreigners, lured by commercial opportunities, flocked to the urban centres, the jus civile, the primary body of law which applied only to roman citizens, failed to address these new conditions.30 initially the jus gentium, which was considered to be a component of the jus civile, was limited to transactions between foreigners and roman citizens.31 eventually, the jus gentium adapted and became the body of law that governed all commercial matters, covering both citizens and foreigners. 3 the rise of pacta sunt servanda even though the word pactum is one of the oldest words in the latin language, the exact wording of the maxim pacta sunt servanda (“agreements must be honoured”) was not common in the days of the roman empire.32 however, the concept of the sanctity of contracts is universal: it is found in all legal systems, in all periods of history, in all cultures, and in all 24 g. 3.97. 25 “a condition is considered impossible of which nature forbids the accomplishment; as, if a person says, ‘do you promise if i touch the heavens with my finger’”? g. 3.98. 26 g. 3.100. 27 g. 3.106. 28 g. 3.104, 109. 29 from 264 to 241 b.c.e. 30 andrew stephenson, a history of roman law (boston: little, brown, & co., 1912) at 197. 31 lobingier, supra note 15 at 213. 32 richard hyland, “pacta sunt servanda: a meditation” (1994) 34 va. j. int’l law 405 at 412. 6 nordic journal of commercial law issue 2011#2 religions.33 for example, in 1292 b.c.e., a peace treaty was created between ramses ii and hatushill iii in which their respective gods were held to guarantee the sanctity of their agreement. although the pacta maxim, which has since been elevated to a recognized legal principle, has its roots in roman law, identical doctrines exist in hindu, buddhist, muslim, confucian, and in communist systems.34 it would appear that pacta sunt servanda has provided a standard of conduct for humanity from time immemorial. it is one of the world’s most important legal norms, and it enjoys a very long tradition in all national legal systems. as an arbitral panel the held in liamco v. libya, “[t]he principle of the sanctity of contracts [...] has always constituted an integral part of most legal systems. these include those systems that are based [on] roman law, the napoleonic code (e.g. article 1134) and other european civil codes, as well as anglo-saxon common law and islamic jurisprudence ‘shari’a’”.35 the pacta principle reflects not only natural justice, but also an economic necessity: commerce would not be possible without reliable promises. as a basic and universal principle, it is today recognized in article 1.3 of the unidroit principles,36 and codified in international law in article 26 (entitled “pacta sunt servanda”) of the vienna convention on the law of treaties.37 unquestionably, it is a paramount feature of contract law. the pacta maxim was first used in a slightly altered form in 348 ad in a consilium by the church involving a dispute between two bishops.38 it read: [p]acta quantumcunque nuda servanda sunt (“pacts, however naked, must be kept”).39 the full phrase is not found in justinian’s digest, even though an entire chapter is devoted to agreements, entitled de pactis.40 in the decretals of gregory ix, issued in 1234, it is found again in a modified form as a sub-heading to a chapter on agreements.41 the maxim as it is known today was likely first coined in the seventeenth century by the german jurist samuel von pufendorf (1632-1694).42 33 w. paul gormley, “the codification of pacta sunt servanda by the international law commission: the preservation of classical norms of moral force and good faith” (1969) 14 st. louis u. l.j. 367 at 373. 34 ibid. at 373-374. 35 april 12, 1977, y.b. comm. arb., (1981) 89 at 101. 36 unidroit, unidroit principles of international commercial contracts 2004, 2d ed. (rome: unidroit, 2004). 37 23 may 1969, 1155 u.n.t.s. 331 (entered into force 27 january 1980). the vienna convention on the law of treaties has been ratified by 111 states as of 16 june 2010. 38 hyland supra note 32 at 415-416. 39 ibid. 40 ibid. at 411-412. 41 ibid. at 415. 42 ibid. at 421-422. 7 nordic journal of commercial law issue 2011#2 4 legal abstraction and the introduction of rebus sic stantibus over the course of many centuries, excuses for non-performance did eventually develop into a recognized legal principle. this development was likely assisted by new scientific discoveries that forced academics to think in more abstract terms.43 without this level of abstraction, general legal principles would not evolve. instead, what would follow would be a series of legal rules (i.e. maxims) and their exceptions, as typically found in roman law.44 in this way, excuses for non-performance evolved out of two conflicting latin maxims: pacta sunt servanda45 and rebus sic stantibus (“assuming things remain the same”).46 individually, neither maxim adequately addressed the situation where unforeseen supervening events made contractual performance impossible. pacta sunt servanda would insist on performance in spite of the impossibility. alternatively, reliance on rebus sic stantibus provided too much uncertainty in contractual relations. as a result of this inherent conflict, each maxim presented a different vision of contractual relations. as david bederman stated: “[o]ne is harmonious, predictable, and stable; the other is dynamic, dangerous and uncertain”.47 this begs the question: how can a promise to perform a contractual obligation be reconciled with a fundamental change in circumstances? the development of the principle of an excuse for contractual non-performance, as in cisg article 79, seeks to address this apparent contradiction. however, prior to the adoption of the cisg, it took a number of centuries to resolve the conflict between these two competing principles. 5 medieval origins of the principle of excuse for non-performance the rigid position of pacta sunt servanda was based on ancient religious notions that developed long before the roman empire. the chaldeans of babylon, the ancient greeks, egyptians, and chinese, all believed that the gods participated in the creation of a contract—and the divine 43 ibid at 419. hyland uses the example of galileo’s discovery of the trajectory of a cannon shot. in finding that the cannon ball follows the outline of a parabola, he needed to separate the movement into its discrete parts. these distinctions are not empirically observable. rather, they force men to think in abstract terms, and visualize each part of the movement of the cannon ball along the plane and its free fall. the same approach is used to develop legal maxims into more sophisticated general legal principles. 44 ibid. 45 see hyland, ibid. and coenraad visser, “the principle pacta servanda sunt in roman and roman-dutch law, with specific reference to contracts in restraint of trade” (1984) 101 s.a.l.j. 641. 46 guenter treitel, frustration and force majeure, 2d ed. (london: sweet & maxwell, 2004) at 1. 47 david j. bederman, “the 1871 london declaration, rebus sic stantibus and a primitivist view of the law of nations” (1988) 82 am. j. int’l l. 1 at 2. 8 nordic journal of commercial law issue 2011#2 became guarantors of the commitment.48 in islam, pacta sunt servanda also has a religious foundation, and muslims are entreated to “abide by their stipulations”.49 the koran, for example, states “[b]e true to the obligations which you have undertaken [...] your obligations which you have taken in the sight of allah [...] for allah is your witness”.50 as guarantors of the contract, and under divine threat, the gods ensured that the parties would honour their agreements, regardless of subsequent unforeseen hardship or impossibility of performance. the violation of a promise, particularly an oath made under the gods, was a punishable spiritual offence.51 in this way, contractual promises and performance became entwined with ancient religious practices and customs.52 early christianity had a great impact on ideals concerning the sanctity of contracts. in the late fourth century, st. augustine (354-430) preached that individuals must always keep their word, even with enemies.53 thomas aquinas echoed this view regarding the performance of contracts with foes. however, in words that foreshadow the modern principle of excuses for nonperformance, aquinas also said that if the circumstances that existed at the time of contract formation had radically changed, non-performance of the contract would be excusable.54 this notion likely evolved from the philosophical writings of cicero (106-43 bce) and seneca (4 bce-65 ce) who acknowledged that promises and agreements could be adapted to unforeseen and extraordinary changes in circumstances.55 cicero used the example of a person who promised to store another’s sword, but argued that he was not obliged to return the sword if the depositor had subsequently become insane.56 seneca devoted a chapter on the subject of exceptions to promises. his opening statement sets the framework: “when i promise to bestow a benefit, i promise it, unless something occurs which makes it my duty not to do so”.57 the roman praetor also accepted this principle.58 these views were helpful to those who admitted that there were exceptions to the sanctity of contracts. this idea was one of the formative components that later led to the development of the maxim of clausa rebus sic stantibus. this 48 hans wehberg, “pacta sunt servanda” (1959) 53 am. j. int’l l. 775 at 775. 49 ibid. 50 passage is quoted in wehberg, ibid. 51 jeremy, supra note 5 at 8. 52 ibid. 53 wehberg, supra note 48 at 775-776. 54 ibid. at 777. reference is to aquinas’ summa theologica at 2, 2, q. 140. 55 ingeborg schwenzer, “force majeure and hardship in international sales contracts” (2008) 39 v.u.w.l.r. 709 at 710 fn. 3. 56 de officiis, 1.10.31 and 3.25.94-95. 57 de beneficiis, 4.35.1. 58 schwenzer, supra note 55 at 710 fn. 3. 9 nordic journal of commercial law issue 2011#2 maxim found its way into canon law in the fourteenth century as rebus sic se habentibus, and was first used as a principle in contract law in 1507.59 for the canonist lawyers of the early medieval period, a violation of a promise became a sin, regardless of whether the promise had been made under the strict legal formalities of secular law. the canonist angelus carletus put it in the following words: “the question is whether a man is bound by a naked pact. the answer is that he is so bound by canon law and in conscience, under pain of mortal sin”.60 to break a promise was, in the eyes of the canonists, perjury. in the eyes of god, even informal promises were to be as obligatory as those made under oath. the authority for this principle came from jesus himself.61 these religious notions eventually transformed the nuda pacta into the pacta vestita. from the belief that all agreements were binding, the canonists imbued the doctrine of pacta sunt servanda with the roman law notion of ex fide bona. in this way, the canonists infused the pacta sunt servanda principle with duties of conscience and equity, and directed the individual to do what good faith and conscience required.62 through this development, parol contracts of merchants and nuda pacta, which would previously have created no enforceable legal relationships, came to be recognized as bona fide negotia or “good faith agreements”.63 this type of agreement bound merchants to perform not exactly what had been promised, but rather what might reasonably be expected under the circumstances. conceptually, this laid the foundation to exceptions or legal excuses for the non-performance of contractual obligations. the canonists, in particular, christopher st. germain (1460–1540), had little difficulty in synthesizing these various—and sometimes conflicting—legal concepts. no doubt, scientific abstraction also played some role in the development of legal maxims into more elaborate legal principles. echoing the words of angelus carletus (1411-1495) in his summa angelica, st. germain tells us that binding promises must meet a number of criteria. these include, inter alia, that the promise is intentional, and that it may be disavowed if there is a material change in circumstances.64 st. germain’s criterion sets the stage for rebus sic stantibus. the influence of the canonists in the development of the law is clearly evident. the canonists’ proved decisive in developing the concept of pacta sunt servanda, even in the case of nuda pacta. this effect 59 ibid. at fn. 2 and fn. 3. schwenzer notes that the phrase rebus sic stantibus was used by jason de mayno (14351519). 60 angelus carletus, summa angelica quoted in jeremy, supra note 5 at 8. 61 “again you have heard that it was said to men of old, ‘you shall not swear falsely, but shall perform to the lord what you have sworn’”. matthew 5:33 (revised standard). 62 jeremy, supra note 5 at 4. 63 ibid. at 5. 64 paul vinogradoff, “reason and conscience in sixteenth-century jurisprudence” (1908) 24 l.q. rev. 373 at 382. the passage from st. germain is from his work the doctor and student circa 1530. 10 nordic journal of commercial law issue 2011#2 upon the nascent legal systems of europe was to be significant.65 in the west from the fifteenth century forward—roughly the era of galileo (1564-1642)—contracts were to be honoured, unless there was no intent to attach legal significance to them, or unless a supervening material event discharged the parties’ contractual obligations. an additional influence on the conceptualization of contractual obligations in europe was the adoption of pacta sunt servanda by the natural law lawyers and philosophers. one of the most prominent was hugo grotius (1583-1645). writing an entire chapter on the subject of promises,66 he viewed bona fides as being inextricably linked with pacta sunt servanda: “good faith [is] the foundation of justice […] god himself would act contrary to his nature if he did not make good on his promises. from this it follows that the obligation to perform promises arises from the nature of immutable justice”.67 pufendorf followed grotius’ perspective in this regard and held that the sanctity of a promise was one of the inviolable rules of natural law.68 a short time later, pacta sunt servanda was brought out in strong relief by emer de vattel (1714-1767). although his primary concern was to apply the principle to the laws of nations, vattel recognized its value in all contractual relationships. phrasing it in very human terms, he noted that “[i]t is a settled point in natural law, that he who has made a promise to any one, has conferred upon him a real right to require the thing promised—and consequently, that the breach of a perfect promise is a violation of another person’s right [...like] it would be to rob a man of his property”.69 in vattel’s view, rebus sic stantibus should only be used with the greatest of caution, and it was to play a subservient role to pacta sunt servanda.70 it would be unjust to have to have a contracting party take advantage of rebus sic stantibus to release it from its contractual obligations: “we ought to be very cautious and moderate in the application of the present rule [rebus sic stantibus]: it would be a shameful perversion of it, to take advantage of 65 according to harold d. hazeltine, “during the centuries when this long process (the growth of secular legal systems) of development was taking its course, the canon law, profoundly influenced by the renaissance of roman law, had slowly taken its place as a world wide system of jurisprudence”. see hazeltine, “roman and canon law in the middle ages” in j.r. tanner, c.w. previte-orton, & z.n. brooke, eds., the cambridge medieval history, vol. 5 (new york: the macmillan co., 1926) at 749. 66 hugo grotius, de jure belli ac pacis (1625), trans. by francis w. kelsey (buffalo: william s. hein & co. inc., 1995) at 328 (corresponding to book ii, chap. xi, “on promises”). 67 ibid. at 330-331 (corresponding to book ii, chap. xi). 68 wehberg, supra note 48 at 779. wehberg is referring to pufendorf’s de jure naturae et gentium (1672), book ii, chap. iii, s. 23 and book iii, chaps. iii, iv, ss. 1, 2 respectively. 69 emer de vattel, the law of nations (1758), trans. by [anonymous] (indianapolis: liberty fund, inc. 2008) at 342 (corresponding to book ii, chap. xii, s. 163). 70 ibid. at 430 (corresponding to book ii, chap. xvii, s. 296). 11 nordic journal of commercial law issue 2011#2 every change that happens in the state of affairs, in order to disengage ourselves from our promises”.71 all contracts are based on the idea that at the commencement of a contract, risks are allocated to each party. as such, these risks must not be later disturbed unilaterally by one of the parties, or revised by the courts. this is the foundation of the tenacious pacta sunt servanda principle. in contrast, rebus sic stantibus acts as a counter-principle to pacta sunt servanda. without pacta sunt servanda there would have been little need for the development of an exception to it, hence, reliance on rebus sic stantibus became dependent on the existence of pacta sunt servanda. indeed, the notion that rebus sic stantibus is a recognized legal doctrine has even been contested.72 some have viewed it as nothing more than a creation of political theory, born from the statecraft of cicero and machiavelli (1469-1527).73 regardless of its origins, as dubious as they may be, rebus sic stantibus has become a principle that is recognized today (albeit, in various guises) in every legal system. as an exception to pacta sunt servanda, rebus sic stantibus developed in the late medieval period to incorporate the premise that contractual terms are not absolute, but relative. in this respect rebus sic stantibus set the basis for the establishment of the modern doctrine of excuse for nonperformance. from this perspective was the notion that parties enter contracts with certain shared and implicit assumptions. however, a fundamental change in subsequent circumstances may destroy the basic assumptions upon which the contract was formed. the effect of this legal abstraction was to discharge a contract due to a supervening event that made performance excessively onerous or impossible. however, as an exception to contractual performance, the use of rebus sic stantibus was to be severely curtailed. from the outset, it was applied in a restrictive manner, not only in national courts, but also in arbitral practice. this approach continued into the modern era. thus, by 1971 the sole arbitrator in icc case no. 1512 could state: the principle ‘rebus sic stantibus’ is universally considered as being of strict and narrow interpretation, as a dangerous exception to the principle of sanctity of contracts. whatever opinion or interpretation lawyers of different countries may have about the ‘concept’ of changed circumstances as an excuse for non-performance, they will doubtless agree on the necessity to limit the application of the so-called ‘doctrine rebus sic stantibus’ (sometimes referred to as ‘frustration’, ‘force majeure’, ‘imprevision’, and the like) to cases where compelling reasons justify it, having regard not only to the 71 ibid. 72 bederman, supra note 47 at 8. this criticism of rebus sic stantibus has come primarily from publicists in the field of international public law. they view it as an illegitimate child of international law, as it provides states with an excuse to renege on their treaty obligations. 73 ibid. 12 nordic journal of commercial law issue 2011#2 fundamental character of the changes, but also to the particular type of the contract involved, to the requirements of fairness and equity and to all circumstances of the case.74 consequently, while the principle of rebus sic stantibus and concept of changed circumstances were widely recognized by arbitral tribunals and the courts of most jurisdictions, in practice the requirements were rarely met.75 6 origins of the principle of excuse for non-performance in common law the dichotomy posed by the conflict between the sanctity of the contract or its discharge by supervening events has, over time, received divergent treatment by the civil and common law systems. while both legal systems acknowledged in varying degrees the doctrines of pacta sunt servanda and rebus sic stantibus, they emphasized certain aspects of each doctrine, and they did so at various historical periods. to say that one legal system embraced one doctrine over the other is to simplify the rather complex interaction each system had with these doctrines over the centuries.76 rather than focus on the broader principles of pacta sunt servanda or rebus sic stantibus, each legal system placed greater emphasis on the extent of the available remedies, as well as the culpability or degree of “fault” embedded in each doctrine. the civil law tradition rejected the notion that a party could contract to do the impossible. this is stated in justinian’s digest: impossibilium nulla obligatio.77 civil law remedies are concerned primarily with performance, not damages. from this it follows that a party cannot be forced to do the impossible, even if this was promised in contract. conceptually in civilian legal systems, there can be no enforceability of an impossible obligation. in contrast, this concept was originally rejected in the common law tradition. it had little difficulty in holding such a party liable, at least in damages. while the obligation may be physically impossible to perform, it could be compensated for by way of a monetary judgment. holt j.c. put it in the following terms in 1706: “when a man will for valuable consideration undertake to do an 74 the arbitrator was prof. pierre lalive. the case involved an indian concrete company and a pakistani bank. see pieter sanders, ed., “award of 1971 in case no. 1512” (1976) 1 y.b. com. arb. 128 at 128-129 (italics are in the original). 75 according to christoph brunner, force majeure and hardship under general contract principles (the netherlands: wolters kluwer, 2009) at 417. 76 for example, friedrich kessler has noted that “[c]ivilians justify their system by reference to the maxim pacta sunt servanda”. 77 dig. 50.17.185. 13 nordic journal of commercial law issue 2011#2 impossible thing, although it cannot be performed, yet he shall answer in damages”.78 performance of an obligation may become physically impossible, but the payment of damages is always possible. in later common law jurisprudence, the common law came closer to acknowledging rebus sic stantibus as in the civil law approach. in one case it made the analogy with the civil law nullity of an impossible obligation, and ruled “the court does not compel a person to do what is impossible”.79 in such cases, the courts would not order specific performance, but such a refusal did not preclude the awarding of damages. unlike the initial common law approach, civil law could simultaneously acknowledge the existence of pacta sunt servanda, while stressing the importance and the flexibility provided in the principle of rebus sic stantibus. of course, this would be tempered with the principle that no contract could be formed to do the impossible (impossibilium nulla obligatio).80 in addition, the emphasis on pacta sunt servanda was treated in civil law as a self-evident legal norm, with ethical and moral characteristics, incorporating the notion of “fault”. not surprisingly, the canonists believed all promises to be binding, including those that had not yet been accepted.81 the moral imperatives of the church were to be carried over into promissory obligations. the prominence of rebus sic stantibus over pacta sunt servanda provided the civilian legal tradition with a differing view towards contractual obligations. assuming events remained unchanged, this view incorporated the notion that a party would be liable for contractual non-performance, but only if it could be demonstrated that the party was somehow at fault. by contrast, the common law tradition, at least initially, rejected the civil law position, and held parties liable to their contracts even where performance had become impossible.82 as hannes rosler has noted, “english law has never known the medieval clausa [rebus sic stantibus] doctrine”.83 pacta sunt servanda was to dominate; rebus sic stantibus was to play a subservient role. the earliest recorded evidence of this principle is from an unnamed case in the year books.84 reported in 1366, the case involved a defendant who had agreed to maintain the buildings on a property that he had leased from the plaintiff.85 the defendant was to return the buildings in the same condition as they had been in when they were initially leased. when the lease ended 78 thornborow v. whitacre (1706), 92 e.r. 270, 2 ld. raym. 1164 at 1165. 79 forrer v. nash (1865), 35 beav. 167 at 171. 80 ibid. at 1-2. 81 hyland, supra note 43 at 418. 82 ibid. at 2. 83 hannes rosler, “hardship in german codified private law – in comparative perspective to english, french and international contract law” (2007) 15 e.r.p.l. 483 at 497. 84 [anonymous] (1366), y.b. hil. 40 edw. iii, pl. 11, fol. 6. 85 ibid. 14 nordic journal of commercial law issue 2011#2 and one building was returned to the plaintiff in damaged condition, he sued for breach of contract. in defense, the defendant pleaded that the damage, a fallen wall, had been caused by a severe wind-storm. the plaintiff argued that this was still a breach of contract. the defendant responded that he was not obliged to repair damage caused by acts of god, which were beyond his control and unavoidable. the court ruled in favour of the plaintiff, upholding the pacta sunt servanda principle. strictly speaking, while the storm was a supervening event, returning the property in its original condition was not something that was impossible. rather, the promise was simply more onerous, but still capable of being performed, as the defendant could repair the damaged wall. thus, the defendant was liable if he did not perform. the court stated that “a man is liable to do a thing which is capable of being done by a man, thus when he bound himself to the lessor to repair them, even though it was knocked down by the wind, or by other sudden events, yet you are capable of repairing them, and can do this”.86 if the defendant sought to avoid liability for damage caused by acts of god, he should have protected himself by expressly providing for such an exclusion at the time of contracting. later english cases also upheld the primacy of pacta sunt servanda. many of these cases involved the carriage of goods by sea. in one case, the defendant promised to carry apples by a boat from greenwich to london, but the vessel sank in a “great and violent tempest”.87 the defendant pleaded an act of god, but the court ruled, “it was holden to be no plea in discharge of the assumpsit, by which the [defendant] had subject himself to all adventures”.88 in a similar case a few years later, it was held that the defendant was still liable in damages under a contract of carriage, even though the boat was overturned “by the violence of wind and water”.89 although the law on impossibility of performance in england was still developing at this time, the initial emphasis was on a strict reading of pacta sunt servanda. this principle became enshrined in the english doctrine of absolute contacts in the 1647 case of paradine v. jane.90 frequently cited in later court decisions, and still regarded by some jurists as good law,91 paradine has come to stand for the common law principle that an impossible supervening event will not necessarily discharge a party from its contractual obligations. in doing so the case is an implicit rejection in english common law of the principle rebus sics stantibus. 86 ibid. translation by john d. wladis, “common law and uncommon events: the development of the doctrine of impossibility of performance in english contract law” (1987) 75 geo. l.j. 1575 at 1582 note 36. 87 taylor’s case (1583), 4 leon 31, 74 e.r. 708. 88 ibid. 89 tompson v. miles (1591), i rolle’s abridgement, condition g.9. 90 aleyn 26, 82 e.r. 897 (k.b.) [paradine]. 91 treitel, supra note 46 at 19. 15 nordic journal of commercial law issue 2011#2 the action in paradine grew out of the english civil war. according to the judgment, “prince rupert, an alien born, enemy to the king and his kingdom, had invaded the realm with a hostile army of men” and took possession of land owned by the plaintiff, paradine.92 at the time, the land was under lease to the defendant, jane. the enemy army held the land for three years, and finally relinquished it in 1646. paradine sued jane for three years back rent, but jane argued that he was not in possession during the period as the land was in enemy hands. as such the defendant was prevented from taking profits from the use of the land. in other words, jane claimed to be without fault for his failure to pay the rent. the court held that jane was still liable for the rent. it ruled that “as the lessee is to have the advantage of casual profits, so he must run the hazard of casual losses”.93 jane assumed the risk that he would make a profit (or loss) from the use of the land. the court made a crucial distinction between cases where “the party by his own contract creates a duty” and “where the law creates a duty”.94 it reasoned that the parties had committed themselves to the terms of the lease, and if they had wanted to provide for the avoidance of liability in certain situations, they could have done so by redefining the terms of the contract. when a party creates “a duty or charge upon himself, he is bound to make it good, if he may, notwithstanding any accident by inevitable necessity, because he might have provided against it by his contract”.95 as the contract did not provide for any reallocation of the loss due to the foreign invasion, the loss remained where it fell. thus, without a contractual excuse for non-performance, jane had to follow his duty as a tenant and pay the rent. this was the case even though he was deprived of the property by an event for which neither he nor the property owner was responsible. paradine was followed in many later cases where it was similarly held that a tenant was not discharged for the payment of rent due to supervening events such as fire, flood, or enemy action.96 indeed, pacta sunt servanda, as enshrined in the english doctrine of absolute contracts triumphed for the next two centuries. not only did the principle prevail, it came to stand for the proposition that physical impossibility would never excuse performance. thus, in brown v. royal insurance company lord campbell, after paraphrasing the paradine principle, declared, “the fact that performance has become impossible is no legal excuse for [non-performance]”.97 92 paradine, supra note 90. 93 ibid. at para. 3. 94 ibid. 95 ibid. 96 treitel, supra note 46 at 23-26. 97 (1859), 1 e1. & e1. 853, 120 e.r. 1131 (q.b.). 16 nordic journal of commercial law issue 2011#2 the turning point for a strict reading of the pacta sunt servanda principle came in 1863 in the case of taylor v. caldwell.98 while the case did not overturn the pacta sunt servanda principle in common law, it did introduce the notion that there can be mitigating factors to discharge an otherwise absolute contract. in the case, the defendant, caldwell, contracted to permit taylor the use of a music hall for four days in exchange for £100 per day. the contract stated that the hall must be fit for a concert but there was no express stipulation regarding disasters. the hall was destroyed by fire just before the first concert. as the concerts could not be performed at any other location, taylor sued the music hall owner, caldwell, for breach of contract for failing to rent the hall, and for his expenses that were incurred for advertising the concerts. there was no clause within the contract itself which allocated the risk to the underlying facilities, except for the phrase “god’s will permitting” at the end of the contract. in taylor v. caldwell blackburn j. skilfully avoided a direct conflict with paradine. he acknowledged the well-established precedent and stated, “[t]here seems no doubt that where there is a positive contract to do a thing, not in itself unlawful, the contractor must perform it or pay damages for not doing it, although in consequence of unforeseen accidents, the performance of his contract has become unexpectedly burthensome or even impossible”.99 however, he dismissed taylor’s claim on the basis that “in contracts in which the performance depends on the continued existence of a given person or thing, a condition is implied that the impossibility of performance arising from the perishing of the person or thing shall excuse the performance”.100 furthermore, the destruction of the hall excused not only the defendant from performance, but also the plaintiff: “both parties are excused, the plaintiffs from taking the [music hall] and paying the money, the defendants from performing their promise to give the use of the [music hall]”.101 it is significant that blackburn j. noted that the destruction of the music hall was the fault of neither party, and that this fact rendered the performance of the contract by either party impossible. such a ruling went beyond what was necessary to decide the case. blackburn j. should have focused only on the liability of the defendant and the obligation to supply the music hall. however, he also excused the plaintiff from the obligation having to pay, even though the agreed payments were not impossible to make. the destruction of the subject matter in taylor, and the associated discharge of the obligation to pay for the destroyed hall, thus, provided for an exception to the doctrine of pacta sunt servanda as enshrined in paradine. over time, the exception, as initially formulated in taylor, would be developed further and extended to recognition of rebus sic stantibus and the doctrine of discharge through frustration, 98 3 b. & s. 826, 122 e.r. 309 (q.b.) [taylor]. 99 ibid. 100 ibid. 101 ibid. 17 nordic journal of commercial law issue 2011#2 impossibility, or hardship. through this progression, by the early 1900s, the law came to recognize and address the problem of loss allocation that arises in situations where contractual performance becomes impossible because of a supervening event for which neither party is responsible.102 the law did evolve to address this problem, particularly with a group of cases that arose when the coronation of king edward vii was postponed due to illness.103 it was in these coronation cases that the doctrine of frustration was recognized for the first time. variants of the frustration, such as impossibility, hardship, and impracticability, also developed to address the realities of the modern world. however, pacta sunt servanda never disappeared entirely from the legal landscape in the common law. the principle continues to exist primarily in cases that concern landlord and tenant law, as well as in other case law that follows the reasoning of paradine, including those that concern antecedent impossibility.104 while the common law has developed to recognize the doctrine of discharge (through frustration, impossibility, hardship, or impracticability) due to supervening events, in the interests of commercial certainty, the common law has come to attach greater importance to pacta sunt servanda. for this reason, in england the doctrine of discharge was severely restricted in scope after its initial development. the first world war did give rise to a number of cases that successfully relied upon the doctrine of discharge due to impossibility.105 however, by the second world war there were few reported cases of supervening impossibility.106 indeed, in the post-war era there was a distinct judicial reluctance to apply rebus sic stantibus to discharge a contract except in only the rarest of circumstances. as guenter treitel remarked, “this reluctance is primarily based on the importance now attached to the principle of sanctity of contract”.107 in this manner, excuses for non-performance of contractual obligations experienced a distinct evolution in the common law. this was to be different from the progression of excuses for non-performance as it evolved in civil law jurisdictions, and beyond, as incorporated in cisg article 79 as an autonomous principle. but as in civil law, the common law developed an array of related doctrines and principles to deal with a fundamental change in circumstances. 102 wladis, supra note 86 at 1599. 103 the cases are commonly known as the “coronation cases”, and include chandler v. webster, [1904] 1 k.b. 493, clark v. lindsay (1903), 19 t.l.r. 202, griffith v. brymer (1903), 19 t.l.r. 434, and krell v. henry, [1903] 2 k.b. 740. 104 treitel, supra note 46 at 50-55. treitel describes these as “historical survivals” and “survivals based on the reasoning of paradine v. jane”. 105 ibid. at 57-58. 106 ibid. at 58. 107 ibid. at 59. 18 nordic journal of commercial law issue 2011#2 7 frustration the common law has developed the doctrine of frustration to deal with three types of cases that concern excuses for non-performance because of a fundamental change in circumstances: these are i) impossibility; ii) frustration of purpose; and, iii) temporary impossibility.108 the first type of case is that where the frustrating event has rendered performance impossible.109 in this respect, impossibility in the common law is a sub-set of the broader doctrine of frustration. in addition, the term “impossibility” must be differentiated from “frustration” even though these words are sometimes used interchangeably.110 indeed, as john mccamus has observed, “the doctrines of impossibility and frustration were received as and continue to be regarded as two separate doctrines”.111 7.1 impossibility frustration in the common law provides a party with an excuse for non-performance of a contract because that party’s ability to perform has become severely compromised because of a supervening event. in many respects, it resembles the civilian doctrine of force majeure, but there are notable differences. while civil law never accepted that a party could contract to do the impossible, in the early stage of the development of the doctrine of frustration, the common law accepted that an impossibility was no excuse for failure to perform a contract.112 as treitel noted, generally, in most common law jurisdictions, there was no theory of impossibility.113 thus, as noted above, initially the common law adopted the strict doctrine of “absolute” contractual obligations. from this it followed that an impossibility to perform was generally not a legally recognized excuse. unlike the civil law, the common law was much more reluctant to allow for the termination of a contractual obligation because of a new, unanticipated event. however, there were some exceptions to the general rule of absolute contracts. the death of a promisor in a contract of personal service was one recognized exception; the other was the enactment of subsequent legislation that would make the performance illegal.114 apart from these narrow grounds, in 108 john d. mccamus, the law of contracts (toronto: irwin law, 2005) at 573. 109 ibid. 110 see e.g. g.h.l. fridman, the law of contract in canada, 5th ed. (toronto: thomson/carswell, 2006) at 576577. 111 mccamus, supra note 108 at 576-577. 112 see e.g. paradine v. jane, supra note 90. 113 treitel, supra note 46 at 1-4, under the sub-heading “no theory of impossibility”. 114 mccamus, supra note 108 at 568. 19 nordic journal of commercial law issue 2011#2 the common law pacta sunt servanda was to prevail over a contractual impossibility. as lord buckmaster of the privy council stated in 1920, “no phrase [is] more frequently misused than the statement that impossibility of performance excuses breach of contract. without further qualification such a statement is not accurate; and indeed if it were necessary to express the law in a sentence, it would be more exact to say that precisely the opposite was the real rule”.115 thus, in the common law where a party made an unqualified contractual promise, it had a prima facie duty to perform. if circumstances materially changed after contract formation, making performance impossible, the parties still remained bound to their obligations unless a term of discharge could be implied in the contract. more recently, martin c.j. of saskatchewan made this point when he stated, “[w]here a person by his own agreement creates a duty or charge upon himself, he is bound to carry it out notwithstanding that he is prevented from so doing by some accident or contingency which he ought to have provided against in his agreement”.116 the words of martin c.j. echo those found in the seventeenth century judgment of paradine: contractual performance was to be “absolute” to the extent that impossibility was not excusable, unless such a provision was provided for in the contract. over time, the common law became less strict in the application of the doctrine of absolute contractual obligations. the process of change began with blackburn j.’s decision in taylor v. cadwell.117 blackburn j. did not directly contradict the precedent in paradine in that impossibility could not apply to cases involving land, as the land could not be destroyed, and the remaining interests could survive.118 however, the accidental destruction of a building by fire on property that was to be leased could discharge a contract. blackburn j. made a similar ruling in appleby v. myers.119 that case concerned a contract for the manufacture and installation of machinery for a factory, and maintenance of the machinery for two years. the contract was held to be discharged when the factory was destroyed by fire prior to the installation of the machinery. blackburn j. also acknowledged the principle he laid down in taylor v. cadwell—that both parties were excused from their performance—but the plaintiffs could not recover for any work that had already been completed. the common law approach to frustration and discharge was that losses should lie where they fall at the time of the 115 grant, smith & co. v. seattle const. & dry dock co., [1920] a.c. 162 at 169 (u.k.). 116 mccuaig v. kilbach, [1954] 3 d.l.r. 117 at 119 (sask. c.a.). 117 supra, note 98. 118 fridman, supra note 110 at 633. 119 appleby v. myers, [1867] l.r. 2 c.p. 651. 20 nordic journal of commercial law issue 2011#2 frustrating event. this approach has also been adopted in canada where two early supreme court decisions applied taylor v. cadwell and appleby v. myers.120 as g.h.l. fridman noted, it was the decisions of blackburn j. in the cases of taylor v. cadwell and appleby v. myers that were instrumental in facilitating the development of the modern doctrine of frustration in the common law.121 according to fridman, “[t]he courts were attempting to extricate themselves from the straightjacket of the absolute theory of contracts”.122 treitel would appear to concur with this view by acknowledging that the judgment of blackburn j. in taylor v. cadwell “formulated the doctrine of discharge in a way which facilitated its development and expansion”.123 however, in discussing the development of frustration, treitel did so within the context of cases beginning with paradine that remain historical “[s]urvivals of the doctrine of absolute contracts”.124 the common law, in developing the modern doctrine of frustration, never abandoned the pacta principle. as lord shaw stated, “frustration can only be pleaded when the events and facts on which it is founded have destroyed the subject-matter of the contract, or have, by an interruption of performance thereunder so critical or protracted as to bring to an end in a full and fair sense the contract as a whole”.125 what lord shaw was alluding to is the implied-term theory, which plays a part in the development of the doctrine of frustration in the common law. indeed, it was blackburn j. who, in his ruling in taylor, articulated a concept that had been slowly evolving in english jurisprudence. this was the concept of an implied condition to a contract. even though a contract might not expressly provide for discharge in the event of the destruction of a building by fire, according to blackburn j., “a condition is implied that the impossibility of performance arising from the perishing of the person or thing shall excuse the performance […] [t]hat excuse is by law implied, because from the nature of the contract it is apparent that the parties contracted on the basis of the particular person or chattel”.126 this was a logical step from the decision in paradine which acknowledged the defense of an implied promise or a “legal incident”, for example, “if a house be destroyed by a tempest”.127 by way of contrast, an express covenant to repair the same house would make a tenant liable even “though it be burnt by 120 the cases were kerrigan v. harrison (1921), 62 s.c.r. 374 and canadian government merchant marine ltd. v. canadian trading co. (1922), 64 s.c.r. 106. see also fridman, supra, note 110 at 636-637. 121 fridman, supra, note 110 at 633. 122 ibid. 123 treitel, supra note 46 at 55. 124 ibid. at 50 (sub-heading). 125 lord strathcona steamship co. v. dominion coal co., [1926] a.c. 108 at 114 (u.k.). 126 taylor, supra, note 98 at 839. 127 paradine, supra note 90. 21 nordic journal of commercial law issue 2011#2 lightning”.128 in this way, blackburn j. viewed the contract in taylor as being subject to an implied condition that the owner be excused if the subject matter of the contract was destroyed: “looking at the whole contract, we find that the parties contracted on the basis of the continued existence of the music hall […] that being essential to their performance”.129 with the subject matter of the contract destroyed, it seemed reasonable to excuse the parties from performance. this solution, to blackburn j., must have been the presumed intent of the parties. thus developed the theory that performance might be dependent upon certain promises, but these same promises, in turn, might be dependent upon the performance of some other condition.130 as a result, it could be implied into a contract, even where it was not made explicit that a promise depended on the occurrence of a certain event, that this was intended, based on the reasonable person standard. hence, contracts could be subject to either a condition precedent or a condition subsequent. if the implied term where a condition precedent, it would not be a case of impossibility or frustration, but rather one from the older law that was based on dependency of performance (i.e. fulfillment of conditions precedent). alternatively, it was now recognized as an implied contractual term that performance could be dependent upon a condition subsequent, i.e, a supervening event. as such, the contract could be deemed “frustrated” and excused based on impossibility of performance. the concept of implied conditions became the basis for the english doctrine of frustration until the house of lords rejected it in a decision in 1981.131 the law reform (frustrated contracts act) 1943132 enshrined many of the legal consequences of frustration, but its primary aim was to prevent unjust enrichment.133 the act otherwise did little to change the common law in this regard, and it did not enshrine the concept of implied intent in contract interpretation.134 in addition, many types of contracts fell outside its scope.135 the problem with the implied intent theory was that the inquiry into intent did not concern the actual intent of the parties, but the presumed intent of them acting as reasonable persons. where the subject matter of the contract was destroyed, who can say with certainty that the parties would not have wanted to adapt or continue with the contract? as lord radcliffe was to later note, “there is 128 ibid. 129 taylor, supra, note 98 at 839. 130 fridman, supra note 110 at 633-634. 131 brunner, supra note 75 at 89. the decision was in national carriers ltd. v. panalpina (northern) ltd., [1981] a.c. 675 [national carriers]. 132 6 & 7 geo. 6, c. 40 (u.k.). 133 brunner, supra note 75 at 90-91. 134 ibid. 135 ibid. 22 nordic journal of commercial law issue 2011#2 something of a logical difficulty in seeing how the parties could even impliedly have provided for something which ex hypothesi they neither expected nor foresaw”.136 the inadequacy of implying contractual terms had been noted in earlier jurisprudence. in particular, a 1916 case involved the requisition of a ship from a charter party for the purpose of carrying troops during world war i.137 the owners claimed that the charter party had been discharged by the requisition. the charterers, who wished to continue with the contract, claimed that the government’s intervention was not sufficient to frustrate the contract. there, in using an implied-term approach to reconstruct the intent of the parties, a majority of the court ruled that no term could be implied in the charter party to excuse performance. thus, the contract had not been frustrated. in a dissenting opinion, and without referencing the intent of the parties or an implied contractual term, viscount haldane noted that the charter party could be dissolved on the basis that “[a]lthough the words of the stipulation may be such that the mere letter would describe what has occurred, the occurrence, itself, may yet be of a character and extent so sweeping that the foundation of what the parties are deemed to have had in contemplation has disappeared, and the contract itself has vanished with that foundation”.138 the problem with the implied term theory was that it left it to the courts to determine the true intent of the parties. the courts were forced to attempt to determine whether a supervening event had had such a negative effect on the contract that it would be unfair to hold parties to their bargain, in the absence of fault and of any assumption of the risk by either party. this left unanswered the question of what was the foundation of the contract, or what was fundamental to it, or what was the adventure or purpose of the contract. as lord hailsham l.c. remarked when the house of lords rejected the implied term theory, “[t]he weakness […] of the implied term theory is that it raises once more the spectral figure of the officious bystander intruding on the parties at the moment of agreement”.139 the theory preferred by lord hailsham l.c. and later courts was based on the construction of the contract. such a theory sought to discern the true meaning of the contract. 7.2 frustration of purpose “frustration of purpose” is the second type of case that falls under the doctrine of frustration. this type of case has broadened the notion of impossibility in english law. in many respects, 136 davis contractors ltd. v. fareham urban district council, [1956] a.c. 696 at 728 [davis contractors]. 137 tamplin steamship co. v. anglo mexican s.s. co., [1916] 2 a.c. 397 (h.l.) [tamplin steamship co.]. 138 ibid. at 406-407. 139 national carriers, supra note 131 at para. 13. 23 nordic journal of commercial law issue 2011#2 cases of frustration of purpose seek to reconstruct the fundamental basis or foundation of the contract. the implied intent of the parties is not the focus; rather, the court attempts to uncover, or “reconstruct” the true meaning of the contract. the common law concept of frustration of purpose appears to have originated with the early case of jackson v. union marine insurance co. ltd.140—at least that was the view of diplock l.j.141 in jackson, a ship, which was to be chartered, ran aground without the fault of either contractual party. this caused several months’ delay in the availability of the vessel. the court ruled that this event discharged the charter party. the ship could have been sent later, but by the time it would have been ready, the original purpose of the charter could not have been fulfilled. on this basis the case was decided, even though there was no physical impossibility or true frustration. instead, there was “practical” frustration, or frustration of purpose. giving credit to bramwell b. in this case, diplock l.j. noted that “it was recognized that it was the happening of the event and not the fact that the event was the result of a breach by one party of his contractual obligations that relieved the other party from performance of his obligations”.142 following jackson, english courts treated cases of this type as “frustrating” the contract, even though the contract could be performed at some point in the future. the rationale for extending the scope of frustration was the notion that the commercial purpose of the original contract had been frustrated. to continue with performance would be to bind the parties to a new arrangement, under new circumstances. this would be a radically different agreement than was originally agreed to. as lord radcliffe put it: “frustration occurs whenever the law recognises that without default of either party a contractual obligation has become incapable of being performed because the circumstances in which performance is called for would render it a thing radically different from that which was undertaken by the contract. non haec in foedera veni. it was not this that i promised to do”.143 140 (1874), l.r. 10 c.p. 125 [jackson]. according to bramwell b. at 147: ‘there are the cases which hold that, where the shipowner has not merely broken his contract, but has so broken it that the condition precedent is not performed, the charterer is discharged. why? not merely because the contract is broken. if it is not a condition precedent, what matters it whether it is unperformed with or without excuse? not arriving with due diligence or at a day named is the subject of a cross-action only. but not arriving in time for the voyage contemplated, but at such a time that it is frustrated is not only a breach of contract, but discharges the charterer. and so it should though he has such an excuse that no action lies.’ 141 in hong kong fir shipping co. v. kawasaki kisen kaisha ltd., [1962] 2 q.b. 26 at 68-69 [hong kong fir]. 142 ibid. 143 davis contractors, supra note 136 at 729. 24 nordic journal of commercial law issue 2011#2 the historical impetus for the expansion of the principle of frustration in the common law came from a series of cases144 that occurred as a result of the postponement of the coronation procession of king edward vii due to his illness. it appeared that the similar problems presented in these cases could not be easily resolved under the rigid common law rule of impossibility. as impossibility was never at issue, the courts felt compelled to expand the principle frustration to incorporate situations where the purpose of the contract failed or was defeated through a subsequent event that was not the fault of either party. in what became known as the coronation cases,145 they represented an innovative approach to frustration, and marked a clear departure from earlier decisions. the facts in these cases had a common element. numerous contracts had been made in anticipation of the coronation, such as the rental of rooms, the rental of seats in stands, etc. when the coronation had to be postponed, performance of these contracts did not become impossible. the leased rooms and seats could still be occupied on the contracted dates, but this would have been a superfluous exercise. the leading case was krell v. henry.146 the defendant, henry, had agreed to hire from the plaintiff some rooms to watch the coronation procession on 26 and 27 june, 1902. he paid £25 as a deposit and was to pay the balance of £50 on 24 june. when the king became ill and the coronation procession was postponed, henry refused to pay the balance, and the plaintiff brought a claim for the outstanding amount due. henry also counterclaimed to recover the £25 deposit he had paid. at trial, the court held that there was an implied term in the contract that the procession should take place. accordingly, darling j. gave judgment for the defendant on both the claim and the counterclaim. krell appealed, but the court of appeal dismissed the appeal, holding that the purpose of the contract had been frustrated. the court noted that the agreement made no reference to the coronation. however, the plaintiff was aware of the purpose for renting the rooms. in the court’s view, the postponement of the coronation destroyed the value of the contract for the defendant. referencing the taylor case, vaughan williams l.j. stated that the taylor rule had been expanded to include those “cases where the event which renders the contract incapable of performance is the cessation or non-existence of an express condition or state of things, going to the root of the contract, and essential to its performance”.147 in his view, the novel point in this case was whether the court should 144 chandler v. webster, [1904] 1 k.b. 493; clark v. lindsay (1903), 19 t.l.r. 202; griffith v. brymer (1903), 19 t.l.r. 434; herne bay steamboat co. v. hutton, [1903] 2 k.b. 68 [herne bay]; krell v. henry, [1903] 2 k.b. 740 [krell]. 145 krell, ibid. 146 ibid. 147 ibid. at 748. 25 nordic journal of commercial law issue 2011#2 consider circumstances that went beyond the terms in the contract in applying the rule that was established in taylor. he answered in the affirmative: you first have to ascertain, not necessarily from the terms of the contract, but, if required, from necessary inferences, drawn from surrounding circumstances recognised by both contracting parties, what is the substance of the contract, and then to ask the question whether that substantial contract needs for its foundation the assumption of the existence of a particular state of things. if it does, this will limit the operation of the general words, and in such case, if the contract becomes impossible of performance by reason of the non-existence of the state of things assumed by both contracting parties as the foundation of the contract, there will be no breach of the contract thus limited.148 although it was not stated in the court’s decision, such an approach would also honour the pacta principle. it was not that the contract became impossible to perform; the payment of money for the rent of a room is rarely an impossibility. rather, where the occurrence of an event becomes the basis of a contract—even though it may not be explicitly mentioned in the agreement—the parties may be discharged from their obligation if the event does not occur. it is not an impossibility that has prevented performance, but instead it is the failure of the purpose of the contract that has rendered performance superfluous. in this way, krell established a doctrine related to, but independent of, impossibility. as mccamus stated, “[b]y eliminating references to impossibility of performance and by formulating the rule in terms of a cessation or non-existence of a ‘state of things’ going to the root of the contract, the krell decision cast the rule in broad enough form to embrace all of the impossibility cases” as well as cases like krell “in which no question of impossibility arises”.149 the krell decision has been subject to some criticism for its theoretical ability to allow a party to be excused from a bad bargain as a result of an unfortunate subsequent event.150 as thomas roberts stated, “[t]o accept krell as a general precedent allowing frustration of purpose to be a valid ground for cancellation would however introduce into the law a principle at odds with the principle sanctity of contract”.151 however, the potential for the expansion of the doctrine of frustration of purpose has not been realized. as lord wright remarked of the krell decision, it “is certainly not one to be extended”.152 indeed, krell has been narrowly distinguished from 148 ibid. at 749. 149 mccamus, supra note 108 at 576. 150 see e.g. treitel, supra note 46 at 320-321; mccamus, supra note 108 at 577; and fridman, supra note 110 at 635. 151 thomas roberts, “commercial impossibility and frustration of purpose: a critical analysis” (2003) 16 can. j.l. & juris. 129 at para. 30. 152 martime national fish ltd. v. ocean trawlers, [1935] a.c. 524 at 529. 26 nordic journal of commercial law issue 2011#2 similar cases. in another of the coronation cases, herne bay,153 decided in the same year as krell by the same panel of judges, the defendant’s contract to hire a boat to watch the king at a naval review was not discharged from the agreement by the cancellation of the coronation. herne bay begs the question: why was a contract to rent a room for viewing the coronation wholly frustrated by the cancellation of the coronation, but a contract to hire a boat to watch the naval review was not frustrated? even though the naval review was part of the coronation activities, vaughan williams l.j. felt that the object of the voyage was not limited to the naval review, but also extended to “taking them round the fleet”.154 the fleet was still in place, and so the tour could still proceed in spite of the cancellation of the naval review. as treitel has noted, the herne bay case demonstrates a common feature of the cases on frustration of purpose, in that it shows that the approach of the common law to partial frustration of purpose diverges from the method that has been adopted to cases of partial impossibility.155 “in cases of partial impossibility”, he stated, “a contract can be discharged if its main purpose can no longer be achieved; but in cases of frustration of purpose the courts have applied the more rigorous test of asking whether any part of the contractual purpose […] could still be achieved: if so, [the courts] have refused to apply the doctrine of discharge”.156 the court of appeal in both cases also considered the “common purpose” of the parties, and made a noteworthy distinction. in krell, the “common purpose” was for the rooms to be used for the viewing of the procession and this purpose was frustrated when the coronation was postponed. there was no such common purpose in herne bay. romer l.j. considered that, the “statement of the objects of the hirer of the ship would not [. . .] justify him in saying that the owner of the ship had those objects just as much in view as the hirer himself”.157 this meant that, although the postponement had frustrated the defendant’s purpose in entering into the contract to hire the ship, it had not the frustrated plaintiff’s purpose, which was presumably to provide a ship for a tour of the fleet. wherever appropriate, the pacta principle would be upheld, and to defeat it would require a frustrating event for both parties. treitel put it in the following terms: “this emphasis on the requirement that the purpose of both parties must be frustrated is found also in other english and american cases. it means that the supervening event must prevent one party from supplying, and the other from obtaining, what the former had contracted to provide and the latter to acquire under the contract”.158 thus, the court was 153 herne bay, supra note 144. 154 ibid. at 683. 155 treitel, supra note 46 at 324. 156 ibid. emphasis in the original. 157 herne bay, supra note 144 at 684. 158 treitel, supra note 46 at 324-325. emphasis in the original. 27 nordic journal of commercial law issue 2011#2 unwilling to allow the doctrine of frustration to be used by the defendant to escape from a bad commercial bargain. the doctrine of frustration of purpose has also been recognized in canadian law.159 however, even though the doctrine was considered to be innovative, it appears that the doctrine has had little practical effect on the courts in common law jurisdictions.160 some scholars have seen its development as arising from a unique set of events.161 it has also played a relatively insignificant role in the subsequent development of the law of impossibility, at least in england.162 this is likely due to the preference in the common law to place pacta sunt servanda ahead of the competing principle of rebus sic stantibus. 7.3 temporary impossibility as frustration can occur without the fault of either party, the courts have been able to fashion rules to excuse the parties from their contractual obligation as long as the impossibility continues. a problem arises, however, when the impossibility ceases and one party then insists on performance. in such cases, it must be determined whether the party should then perform, or whether the prolonged delay caused by the temporary impossibility should excuse performance entirely. in this respect, the term “temporary impossibility” must be distinguished from “partial impossibility”. the latter term is often used to designate a situation in which some part, but not all of the promised performance becomes legally impossible, while “temporary impossibility” refers to a delay in performance resulting from some operative facts of impossibility. the origin of the principle of temporary impossibility can be traced to roman law. the perpetuatio obligationis excused the delay in performance in those situations where the obligation had become temporarily impossible to perform.163 most importantly, it did not terminate the obligation to perform, but only suspended it.164 when the temporary impossibility ceased to operate, performance was expected, or could be demanded. the same rule applies today in the common law: a temporary impossibility may have other legal effects, but it does not discharge a 159 mccamus, supra note 108 at 577. 160 ibid. 161 see e.g. john d. wladis, “common law and uncommon events: the development of the doctrine of impossibility of performance in english contract law” (1987) 75 geo. l.j. 1575 at 1608-1622. 162 ibid. at 1608-1622. 163 w.a. ramsden, “temporary supervening impossibility of performance” (1977) 94 s. african l.j. 162 at 162. 164 dig. 46.3.98.8. 28 nordic journal of commercial law issue 2011#2 contract.165 in this respect, temporary impossibility is not firmly rooted in the principle of frustration. however, there is one exception. contracts will be discharged in cases of temporary impossibility only where it is deemed that time is of the essence.166 in such cases, the practical effect is to treat the contract as though it were wholly frustrated. this approach is similar to that found in german and swiss law, which is to treat a temporary impossibility as a permanent impossibility.167 problems of temporary impossibility seemed to arise most frequently in maritime cases. these situations typically involved either a charterer or the shipowner who sought a discharge from its obligation under the charter party agreement due to an unforeseen delay. for this reason, the term “frustration of the adventure” has often been used by the courts to refer to cases where delayed performance had rendered the charter of no value to one of the parties. an example of such a case is geipel v. smith where the defendant shipowner had contracted to ship coal from newcastle to hamburg, “restraint of princes” excepted.168 before performance was effected, war broke out and hamburg was blockaded. the court held that the blockade was likely to continue for some time, and the contract was not merely suspended, but dissolved. the court made the additional point that the contractual provision relating to the “restraint of princes” was a requirement to have performance made within a reasonable time. in a similar case, jackson,169 a ship was chartered from liverpool to newport (u.k.) to load rails for shipping to san francisco. it ran aground on its way to newport. in this case, it was the ship-owner who wished to enforce the contract against the charter party. the court decided that the contract was frustrated. in the court’s view, the delay in repairs meant that it would be unreasonable to require the charterers (the owners of the rails) to supply the cargo to the ship owner. the delay, although excusable, was held to so diminish the value of performance that the charterer was entitled to repudiate the agreement. the principle of temporary impossibility has extended to a series of cases involving prolonged delay. during world war i, for example, the principle became firmly established.170 in one wartime case, tamplin steamship co.,171 the house of lords went as far as to suggest that cases of prolonged delay were part of a line of jurisprudence established in taylor172 and krell.173 165 treitel, supra note 46 at 233. 166 ibid. at 233-235. 167 brunner, supra note 75 at 251. 168 (1872), l.r. 7 q.b. 404. 169 supra, note 140. 170 mccamus, supra note 108 at 578-579. 171 supra, note 137. 172 supra, note 98. 29 nordic journal of commercial law issue 2011#2 however, although there may be some justification for speaking of a general doctrine of frustration that could incorporate impossibility, frustration of purpose, and temporary impossibility, this merger of these separate distinctions has not occurred—at least not in the common law.174 as will be illustrated below, this contrasts with cisg article 79, which embraces the vagaries of frustration as found in the common law. 8 hardship and impracticability the early common law of england rejected any notion of hardship that did not amount to an impossibility. the principle of frustration was not applied to cases of rebus sic stantibus where unforeseen circumstances had rendered performance extremely onerous. treitel, for example, concluded that the “english cases do not provide a single clear illustration of discharge on such grounds [of hardship or “pure” impracticability] alone”.175 the house of lords has denied relief on the grounds of hardship or impracticability in a number of cases. as lord loreburn stated in one case: “the argument that a man can be excused from performance of his contract when it becomes ‘commercially’ impossible […] seems to me a dangerous contention which ought not to be admitted unless the parties have plainly contracted to that effect”.176 similar judicial hostility in england to hardship and impracticability appeared in a number of other cases involving contractual performance difficulties due to world war i. in one case, for example, the contract was not discharged even though it was “practically impossible for the vendor to deliver”.177 mccardie j. elaborated and expressed the view that it could not be “said that grave difficulty on the part of the vendor in procuring the contract articles will excuse him from the performance of his bargain”.178 this is representative of the common law’s preference towards pacta sunt servanda, and the subservient—or almost irrelevant—role played by rebus sic stantibus. this is in general contrast to the treatment of hardship in civil law jurisdictions, which have been much more receptive to cases of changed circumstances that result in situations of hardship and impracticability.179 173 supra, note 144. 174 mccamus, supra note 108 at 579. 175 treitel, supra note 46 at 283. 176 tenants (lancashire) ltd. v. c.s. wilson & co. ltd., [1917] a.c. 495 at 510. 177 blackburn bobbin co. ltd. v. t.w. allen & co., [1918] 2 k.b. 540 at 551, aff’d [1918] 2 k.b. 467. 178 ibid. at 545. 179 see infra, section d. b. imprevision, wegfall der geschaftsgrundlage, changed circumstances and other hardship principles. 30 nordic journal of commercial law issue 2011#2 not surprisingly, therefore, other english cases have demonstrated the hostile judicial attitude towards hardship and impracticability, even during times of war. this relatively rigid position may represent the fact that common law countries did not experience the same degree of wartime devastation as did the civil law countries of continental europe. thus, english courts have held that an unanticipated 88 percent increase in the cost of goods to be supplied,180 or a rise in the price of raw materials to manufacture paper,181 or in freight costs of the seller that made the transaction unprofitable, are not grounds to discharge a contract.182 similarly, in greenway brothers ltd. v. s.f. jones & co. the defendant, who had contracted to sell zinc ingots, was not excused even though, due to the outbreak of war, the defendant could obtain the metal alloy only at an “abnormal price”.183 the english common law hostility to the principle of hardship and impracticability also extended to events that arose during world war ii. the leading case concerned the contract for the supply of newsreels to cinemas during the war.184 after the end of the war, the cinema owners argued that the contract had been discharged by the end of the war. the court of appeal agreed that this “uncontemplated turn of events” had released the parties from the contract,185 but the house of lords reversed the decision.186 lord simon remarked that “parties to an executor contract are often faced, in the course of carrying it out, with a turn of events which they did not at all anticipate—a wholly abnormal rise or fall in prices, a sudden depreciation of currency, an unexpected obstacle to execution or the like. yet this does not of itself affect the bargain they have made”.187 later cases would follow this line of reasoning. for example, lord radcliffe would note that “it is not hardship or inconvenience or material loss itself which calls the principle of frustration into play”,188 and lord simonds would assert without any qualification that “an increase of expense is not a ground for frustration”.189 these judicial statements support the english common law view that to discharge a contract on the basis of hardship or impracticability would introduce too much uncertainty in contractual relationships. english law has, thus, 180 s. instone & co. ltd. v. speeding marshall & co. ltd. (1916), 33 t.l.r. 202. 181 e. hulton & co. ltd. v. chadwick taylor & co. ltd. (1916), 33 t.l.r. 202. 182 blythe & co. v. richards, turpin & co. ltd. (1916), 85 l.j.k.b. 1425. 183 greenway brothers ltd. v. s.f. jones & co. (1915) 32 t.l.r. 184. 184 british movietonenews ltd. v. london and district cinemas, [1952] a.c. 166 [h.l.] [british movietonenews]. 185 [1951] 1 k.b. 190 at 201. 186 supra, note 184. 187 ibid. at 185. 188 davis contractors, supra note 136at 729. 189 tsakiroglou & co. ltd. v. noble thorl gmbh, [1962] a.c. 93 at 115. 31 nordic journal of commercial law issue 2011#2 placed greater emphasis on certainty and pacta sunt servanda, even though the result has occasionally been harsh on one of the parties. as treitel has stated, after surveying english jurisprudence in this area of law: “[o]ne can conclude that no english decision supports a general rule of discharge by impracticability and the number of dicta of high authority appear to emphatically to reject such a rule”.190 with the notable exception of the united states, most common law jurisdictions have followed the english approach toward hardship and impracticability, and do not explicitly recognize the doctrine.191 even in the united states, where impracticability is recognized under the uniform commercial code,192 as well as under the restatement (second) of contracts at s. 261,193 the courts have applied it in a very restrictive manner.194 this strict approach has even led certain scholars to question whether a difference exists between american and english law of contractual discharge by “impracticability”.195 indeed, it has been observed that the us doctrine of impracticability is nothing more than a corollary of the english doctrine of frustration of purpose.196 such a view supports the proposition that while us law may explicitly 190 treitel, supra note 46 at 290-291. 191 see e.g. brunner, supra note 75 at 418: “a comparative law analysis shows that hardship is not universally, but widely recognized as a ground for exemption. this is especially true for civil law systems”. 192 under the heading “excuse by failure of presupposed conditions”, the uniform commercial code [ucc] s. 2-615 states in part: ‘except so far as a seller may have assumed a greater obligation and subject to the preceding section on substituted performance: (a) delay in delivery or non-delivery in whole or in part by a seller who complies with paragraphs (b) and (c) is not a breach of his duty under a contract for sale if performance as agreed has been made impracticable by the occurrence of a contingency the non-occurrence of which was a basic assumption on which the contract was made or by compliance in good faith with any applicable foreign or domestic governmental regulation or order whether or not it later proves to be invalid.’ although this provision refers explicitly to sellers, it has also been deemed to be applicable to buyers. this is through ucc s. 1-103 which preserves common law principles unless they are displaced by specific provisions of the ucc. because impracticability is a common law defense, ucc s. 1-103 permits a buyer to also assert the defense of impracticability even though this is not explicitly provided for under s. 2-615. 193 the restatement (second) of contracts at s. 261 establishes common law grounds for “discharge by supervening impracticability” as follows: “where, after a contract is made, a party's performance is made impracticable without his fault by the occurrence of an event the non-occurrence of which was a basic assumption on which the contract was made, his duty to render that performance is discharged, unless the language or the circumstances indicate the contrary”. 194 see e.g. brunner, supra note 75 at 408. according to brunner, “[i]n applying the impracticability test, american courts have adopted a restrictive attitude”. see also treitel, supra note 46 at 280: “in all these cases is therefore a strong indication of the restrictive attitude of the american courts towards impracticability as a ground of discharge”. 195 treitel, supra note 46 at 289, where he states: “the preceding discussion shows that it is hard to formulate the exact difference between english and american law on discharge by ‘impracticability’”. 196 see e.g. david r. rivkin, “lex mercatoria and force majeure,” in emmanuel gaillard (ed.), transnational rules in international commercial arbitration (paris: icc publ. no. 480, 4, 1993) 161 at 167 who puts it in the reverse: “frustration of purpose is the converse of impracticability”. see also treitel, supra note 46 at 419: 32 nordic journal of commercial law issue 2011#2 recognize impracticability, it still retains the relatively rigid common law approach to contractual discharge due to supervening events. section 2-615 of the ucc, entitled “excuse by failure of presupposed conditions”, explicitly adopts the doctrine of impracticability in circumstances where supervening events affect a seller’s performance.197 it can also be extended to buyers through s. 1-103.198 it provides that a seller’s failure to perform a contract, either in whole or in part, is not a breach of contract “if performance as agreed has been made impracticable by the occurrence of a contingency the non-occurrence of which was a basic assumption on which the contract was made”.199 the american principle of impracticability incorporates of the notion that the object of a contract could not be accomplished without commercially unacceptable costs and time input far beyond that contemplated in the contract. in this respect, it can be narrowly distinguished from frustration of purpose. while both principles fall short of cases of pure physical impossibility, frustration of purpose typically involves a party in which the performance received (or expected) has substantially decreased in value. with impracticability, the cost of performance for one party has increased so dramatically, that the original obligation has become economically unviable. the american doctrine of impracticability appears to have originated in the case of mineral park land co. v. howard,200 which relied in part on dictum in the english case of moss v. smith.201 mineral park involved a contract where the defendants agreed to take all of the gravel required for a nearby construction project from the plaintiff’s land. the plaintiff was to be paid 5¢ per cubic yard. only about half of the gravel was taken, which was the only part that was above water level. no greater quantity could have been taken by ordinary means, except at “a prohibitive cost” of ten to twelve times the typical cost of such an extraction.202 on this basis, the plaintiff’s claim was rejected. in his decision, sloss j. noted that “[a] thing is impossible in legal contemplation when it is not practicable; and a thing is impracticable when it can only be done at an excessive and unreasonable cost”.203 “english law acknowledges frustration of purpose as a ground of discharge, which may be considered as the mirrorimage of [the american doctrine of] impracticability”. 197 supra note 192. 198 ibid. 199 ibid. 200 172 cal. 289 (1916) [mineral park]. sloss’s j. quote came from beach on contracts at 459. 201 (1850), 137 e.r. 827, 9 c.b. 94. 202 ibid. 203 ibid. 33 nordic journal of commercial law issue 2011#2 it may appear paradoxical that english law, which first recognized the doctrine of frustration of purpose, as discussed in the coronation cases, above, has been reluctant to recognize its mirrorimage, the doctrine of impracticability. however, it must also be recalled that english jurisprudence has not expanded the doctrine of frustration of purpose since the coronation cases. similarly, american jurisprudence has applied the doctrine of impracticability in a number of cases, but such an application has been very restrictive.204 from this conceptual perspective, the difference between the two doctrines is not particularly striking. in addition, american law has made a distinction between those cases where performance of a contract has become merely more onerous for one of the parties, and where performance becomes excessively more onerous. it is only in the latter case where the doctrine of impracticability may apply. the official commentary on ucc s. 2-615 makes this point in terms of increased costs: “increased cost alone does not excuse performance”.205 although the term “impracticable” suggests that far less is required than “impossibility” to release an aggrieved party from its contractual obligations, the requisite threshold remains quite high in the us. the restatement (second) of contracts provides a number of examples of cases in which impracticability might apply, such as the loss or destruction of property necessary to perform the contract.206 however, the list is not intended to be exclusive. the required threshold whereby performance must become excessively more onerous to constitute impracticability is set considerably high. in one case, a us district court summarized american jurisprudence on this point: “[the court] is not aware of any cases where something less than a 100% cost increase has been held to make a seller’s performance ‘impracticable’”.207 as this statement suggests, in practice, us courts have interpreted rules regarding impracticability very strictly. new york courts, for example, have excused contractual obligations for impracticability “only in extreme circumstances”.208 financial difficulty or economic hardship “even to the extent of insolvency or bankruptcy” is generally not enough to render a contract impracticable.209 in other american jurisdictions, courts have similarly held that even long-term contracts will not be excused as impracticable if they become more 204 see supra note 194. 205 american law institute & national conference of commissioners on uniform state laws, official comment number 4 to u.c.c. s. 2-615. the full passage reads: “increased cost alone does not excuse performance unless the rise in cost is due to some unforeseen contingency which alters the essential nature of the performance. neither is a rise or a collapse in the market in itself a justification, for that is exactly the type of business risk which business contracts made at fixed prices are intended to cover”. 206 restatement (second) of contracts ss. 262-265 (1981). 207 publicker industries v. union carbide corp., 17 u.c.c. rep. serv. 989 at 992 (e.d. pa. 1975). 208 kel kim corp. v. central markets inc., 519 n.y.s.2d 384 at 385 (n.y. 1987). 209 406 east 61st garage inc. v. savoy fifth avenue corp., 23 n.y.2d 275 at 281 (n.y. 1968). 34 nordic journal of commercial law issue 2011#2 economically burdensome than anticipated.210 thus, it appears evident that us courts will rarely excuse performance because of mere financial hardship. james white and robert summers have also undertaken a comprehensive review of the ucc, and have similarly concluded that “american courts have generally rejected the sellers’ arguments under section 2-615”.211 they continue by adding that where sellers have sought to use the impracticability defense, “[t]he courts have…favored buyers”.212 thus, even though the doctrine of impracticability has been elevated in american law to black letter status, its importance appears to be significantly reduced, and it would seem that a change in this perspective should not be expected anytime soon. as white and summers have opined, “[b]y and large, american courts have been unreceptive to such claims [of impracticability] and we expect them to continue that hostility”.213 nicholas weiskopf has reached a similar conclusion on this topic. based on his survey of american jurisprudence on impracticability, “the inescapable conclusion is that the courts typically do not permit purchasers of goods and services to escape contractual liability because of supervening frustration of [the] bargaining objective [i.e., impracticability].”214 he further notes that american courts, while formally recognizing the doctrine, do little more than “pay lip service to its viability, and then virtually refuse to apply it”.215 based on this treatment, one must question whether american jurists take the doctrine of impracticability seriously, or view it as an interloper. courts there typically voice doctrinal acceptance to the doctrine, but then deny the defense on the grounds of foreseeability, contributory fault, or based on partial impracticability.216 notwithstanding the codification of impracticability in the ucc, the apparent american aversion to hardship and the doctrine of impracticability is consistent with the general common law attitude towards pacta sunt servanda and rebus sic stantibus. while civil law jurisdictions have maintained an affinity for rebus sic stantibus, the common law has emphasized the primacy of pacta sunt servanda. the reason for this difference in the approach in the civil law and common law towards hardship, impracticability, and force majeure (and its variants) can be traced to 210 valero transmission c. v. mitchell energy corp., 743 s.w.2d 658 at 663 (tex. app. 1988). 211 james j. white & robert s. summers, uniform commercial code (4th ed.) (st. paul, mn: west publishing co., 1995) at 129. 212 ibid. at 130. 213 ibid. 214 nicholas r. weiskopf, “frustration of contractual purpose—doctrine or myth?” (1996) 70 st. john’s l. rev. 239 at 242. 215 ibid. 216 ibid. at 261-262. 35 nordic journal of commercial law issue 2011#2 fundament differences in each legal system. the concept of force majeure was imported from the code of napoleon when the common law courts began dealing with commercial disputes that arose under merchant law. while the force majeure concept had its origins in the roman law, the common law was less-influenced by this ancient legal tradition. the civilians followed the roman rule impossibilium nulla obligation est—that no person can be obliged to perform the impossible. to the common law jurists, however, this did not mean that a contract, which became impossible to perform, was necessarily void. in this respect, the concept of force majeure was not embedded in the common law; rather, force majeure was viewed as an interloper, imported into the common law through its appearance in clauses in the contracts of commercial parties. rather than being a universally applicable concept as in civilian jurisprudence, a force majeure clause in the common law tradition became a purely contractual right. the foreign nature of these clauses, in part, may explain the difficulty that common law jurisdictions have had when dealing with concepts such as hardship, impracticability, frustration, and force majeure. fundamentally, the common law tradition is an adversarial system in which the courts’ function is to assign liability between the two adversarial parties on the basis of either tort or contract principles. in this tradition, pacta sunt servanda is paramount, and liability is imposed where a party to a contract fails to perform its contractual obligations. although it is often equated to the common law doctrine of contractual frustration, force majeure is different, and it has been applied much more broadly and flexibly than has its approximate common law counterparts of frustration or impracticability. a late nineteenthcentury english case illustrates this point. in jacobs v. credit lyonnaise the defendant shipper claimed force majeure after it failed to deliver a number of remaining shipments of esparto due to a war that had broken out in algeria.217 under french law, which prevailed in algeria at that time, the defendant argued that it would not have been liable due to“the insurrection in algeria and the military operations connected with it [which] had rendered the performance of the contract impossible; and that by the french civil code, which prevails throughout algeria, force majeure is an excuse for non-performance”.218 the court found that while french law may have given relief under force majeure, english law applied in this case, and there was no equivalent common law principle, including frustration, that could relieve the defendant of liability. while the intervening war had disrupted performance, it did not destroy the “subjectmatter” of the contract or the underlying rational for the bargain as was required for relief under the doctrine of frustration.219 as the court explained, “one of the incidents which the english law attaches to a contract is that [...] a person who expressly contracts absolutely to do a 217 (1884) 12 q.b.d. 589 (c.a.). 218 ibid. at 599. 219 ibid. at 600. 36 nordic journal of commercial law issue 2011#2 thing not naturally impossible is not excused for non-performance because of being prevented by vis major.”220 the differences between the civil law and common law become more clear when force majeure is contrasted with the common law doctrine of frustration. force majeure and the doctrine of frustration are similar in that they deal with unforeseen supervening events that are beyond the control of parties to an agreement. frustration requires that the entire subject matter or underlying rationale for the contract be entirely destroyed. it normally operates to relieve parties permanently from all of their contractual obligations, including those to perform and to pay, and essentially leaves the pieces of a contract to fall where they may. courts are not able to revise the terms of the contract to achieve a fair or equitable remedy. by contrast force majeure permits greater flexibility. the unforeseen events giving rise to relief can be broader, and the entire rationale or subject matter of the contract need not be destroyed in order for force majeure to operate. civilian courts typically have greater latitude to revise, or “re-write” contractual terms to account for the unforeseen event. force majeure may also be temporary, allowing the parties to suspend their contract temporarily, and then to reinstate it once the event passes or is remedied. this is in contrast to the doctrine of frustration, which is a blunt instrument that permanently ends all contractual obligations. the most significant difference between civil law’s force majeure and the concepts of hardship, impracticability, frustration, is that these latter principles are antithetical to common law principles and ideals. with the use of these defences for non-performance, parties avoid contractual obligations and fault or liability is ascribed to neither party to the contract, but rather to a cause deemed to be beyond the control of both parties. given the great divergence between common law values and the concepts of hardship, impracticability, frustration, and civil law’s force majeure, it is not surprising that common law courts have repeatedly shown great reticence in giving effect to these principles. 9 origins of the principle of excuse for non-performance in civil law 9.1 an exception to the rule of p a c t a s u n t s e r v a n d a the principle of an excuse for contractual non-performance developed along different lines in civil law jurisdictions. even though civilian jurists utilized many of the same philosophers who had enunciated the notion of pacta sunt servanda, they emphasized not the rule per se, but rather the exceptions to the rule. thomas aquinas, for example, had noted that individuals must always keep their word, even with enemies. however, he also stated that an individual’s 220 ibid. at 603. the term vis major is from latin, meaning “superior force”. 37 nordic journal of commercial law issue 2011#2 promise may be excused “if circumstances have changed with regard to persons and the business at hand”.221 niccolo machiavelli went much further, eschewing the pacta sunt servanda principle: “experience shows that princes who have achieved great things are those who have given their word lightly”.222 ever-changing circumstances were to be used to the advantage of the prince: “a prudent ruler cannot, and must not, honour his word if it places him at a disadvantage and when reasons for which he had given his promise no longer exist”.223 jean bodin (1530–1596), who opposed machiavelli’s views on power politics, was also able to formulate the exception to the rule that a prince must honour his word, for instance “in cases where what you have promised is by nature unfair or cannot be performed”.224 in the seventeenth century, the principle of pacta sunt servanda was also attacked by two prominent political philosophers, thomas hobbes (1588-1679) and benedict de spinoza (16321677). this attack was within the context of political arguments for the supremacy of state sovereignty, yet there was little difficulty in transforming the principle of rebus sic stantibus to contractual relations between individuals rather than applying it to relations between states. while hobbes acknowledged the importance of the sanctity of contracts (“[f]or performance is the natural end of obligation”), he also stressed the idea that the sovereign had almost unlimited power, and was “bound to himself only”.225 however, agreements need not be kept if they might cause a person harm or threaten the security of the state.226 spinoza similarly claimed that “no holder of state power can adhere to the sanctity of contracts to the detriment of his own country, without committing a crime”.227 it was also during spinoza’s time that rebus sic stantibus came to be regarded in certain european jurisdictions as an implicit condition in contracts, allowing parties freedom to adjust their agreements due to a change in circumstances.228 during the seventeenth century, the attack on the principle of pacta sunt servanda assisted in the growth and development of rebus sic stantibus.229 perhaps this was influenced by the philosophers of the era and the rise of the age of reason. seventeenth century europe 221 quoted in bederman, supra note 47 at 8 fn. 22. 222 niccolo machiavelli, the prince, trans. by george bull (london: the folio society, 2006) at 93. 223 ibid. at 94. 224 quoted in wehberg, supra note 48 at 778 225 thomas hobbes, leviathan (markham: penguin books, 1982) at 198, 313. 226 ibid. at 215. 227 quoted in wehberg, supra note 48 at 778. the passage is from spinoza’s tractatus theologico-politicus. 228 bederman, supra note 47 at 8 fn. 24. 229 reinhard zimmermann, the law of obligations: roman foundations of the civilian tradition (new york, oxford university press inc., 1996) at 581. 38 nordic journal of commercial law issue 2011#2 witnessed the culmination of the slow process of detachment of philosophy from theology, and reason was seen as the primary source for legitimacy and authority. in europe there began critical questioning of traditional institutions, customs, and morals, and a strong belief in rationality. this new perspective assisted in the growth of rebus sic stantibus as a rational counter-balance to the pacta principle. it appears that part of the attractiveness of rebus sic stantibus was due to efforts to address the devastation caused by numerous wars in europe. the rebus principle was also popular with the natural law theorists, particularly as it applied to public international law.230 it flourished on the continent for about 200 years. however, in the area of private law, rebus sic stantibus began to lose its credibility as a legitimate legal principle.231 by the nineteenth century most jurists were hostile to it, and the principle seemed to have disappeared. however, it is more accurate to term the disappearance as a transformation. while the term rebus sic stantibus may have fallen out of favour, the concept that it represented (i.e. changed circumstances) continued to develop. in this respect, the rebus principle only temporarily lost its attraction. as one legal commentator noted, the rebus principle, having been thrown out the door, found its way back in through the window.232 as already noted, the civil law system rejected the notion that a party could contract to do the impossible (impossibilium nulla obligation), even if this was promised in a contract. in addition, the focus of civil law remedies is on performance, not damages. as such, in civil law jurisdictions the obligor is released from its contractual performance obligations if the impossibility was not foreseen at the time of contracting, and if the impossibility arose after the contract was formed. alternatively, some civil law jurisdictions allow the courts to modify contracts in cases of unforeseen supervening events.233 to revise contracts is to interfere with party autonomy, and such an approach would be an anathema in common law systems. furthermore, with some exceptions, civil law jurisdictions are traditionally based on the fault principle.234 breach of contract presupposes fault on the part of the non-performing party. in common law, a contract is similar to a guarantee: if a party breaches any of its obligations under the contract, the aggrieved party is entitled to damages, regardless of the fault of the nonperforming party. from a conceptual perspective, the civil law and common law systems, thus, have opposing approaches to the principle of strict liability for breach of contract. 230 ibid. 231 ibid. 232 the remark is attributed to bernhard windscheid (1817-1892), a german jurist. see ibid. 233 see e.g. rosler, supra note 83 at 485. rosler notes that german courts now prefer “judicial adaptation” of the contract over discharging the contract. note also that the french principle of imprévision allows a contract to be modified in case of a change of circumstances. see schwenzer, supra note 55 at 710. 234 brunner, supra note 75 at 69. 39 nordic journal of commercial law issue 2011#2 in civil law, pacta sunt servanda is still, of course, an important principle. however, in comparative terms, continental legal systems have placed greater emphasis on the role of rebus sic stantibus, even though it is dependent on the pacta principle. for this reason, national laws in civilian law jurisdictions have developed an array of doctrines and principles to deal with a fundamental change in circumstances. all of these doctrines and principles differ to some extent from cisg article 79. in these national laws, the phrase rebus sic stantibus is rarely used, but other terminology has developed in its place. although the wording has been altered, the concept of changed circumstances has remained intact. this is evident in a comparative overview of excuses for non-performance in a number of continental legal systems. 9.2 force majeure there are numerous words and terms in national legal systems to describe supervening events that make contractual performance impossible or excessively more onerous. some of these terms are used interchangeably, but this is incorrect: such imprecision masks the subtle legal complexity behind these words. thus, even though the term “frustration” more accurately describes the common law recognition of an excuse for non-performance, courts in canada have occasionally imported the term force majeure into the nation’s legal vocabulary. dickson j. of the supreme court of canada, for example, noted in a leading case on the subject that “[a]n act of god clause or force majeure clause […] generally operates to discharge a contracting party when a supervening, sometimes supernatural, event, beyond control of either party, makes performance impossible. the common thread is that of the unexpected, something beyond reasonable human foresight and skill”.235 the term force majeure originated in one of the oldest codifications that still exists today: the french civil code of 1804.236 it is defined in articles 1147 and 1148 of the civil code.237 it 235 atlantic paper stock ltd. v. st. anne-nackawic pulp and paper company limited, [1976] 1 s.c.r. 580 at 583. 236 c.c.f. (1804-1807); reinhard zimmermann, “the civil law in european codes” in hector macqueen, antoni vaquer, & santiago espiau espiau, eds., regional private laws and codification in europe (new york: cambridge university press, 2003) at 19. zimmermann notes that the french civil code was based on the prussian code of 1794. the other oldest, current codification is the austrian general civil code of 1811, which was also based on the prussian code. 237 c. civ. article 1147: “the obligor will be found liable for the payment of damages, either by reason of the inexecution of the obligation, or by reason of delay in the execution, at all times when he does not prove that the inexecution does not result from an outside cause which cannot be imputed to him, and further that there was no bad faith on his part”. article 1148: “no damages arise when, as a result of force majeure or of a fortuitous event, the obligor was prevented from giving or doing that for which he had obligated himself, or did what was forbidden to him”. translation by rivkin, supra note 196 at 174. 40 nordic journal of commercial law issue 2011#2 generally describes circumstances outside one’s control.238 literally, force majeure (or its latin equivalent, vis major) means “superior force”, but the french term is often used in a generic manner in many jurisdictions, including those of the common law, to characterize a wide range supervening events. for example, even the international chamber of commerce promotes its own model “force majeure” clause which parties to international contracts may incorporate into their contracts.239 the unidroit principles similarly devotes an entire article to “force majeure”.240 the article also closely mirrors the language found in cisg article 79.241 in this respect, the term force majeure has been assimilated into the english language and is often used to express an extraordinary event or circumstance beyond the control of contracting parties. this may include such events a war, strike, riot, fire, storm or any “act of god”. however, strictly speaking, by way of contrast, legislation in common law jurisdictions rarely use the term force majeure. instead, terms such as “frustration”, “impracticability”, “impossibility”, or “hardship” are used in its place. in the private, commercial law of france, however, the principle of force majeure exhibits the approach developed out of the remnants of roman law, which focuses on the relative fault of the party in breach.242 it applies to two types of cases: i) legal impossibility, and ii) physical impossibility.243 legal impossibility can arise from a supervening change in the law or a governmental decree that make it illegal for a party to perform a contractual obligation. a physical impossibility is deemed to be an “act of god” or some other event (e.g. destruction of the goods) that makes performance of the contract materially impossible. 238 the shorter oxford english dictionary, 6th ed., defines “force majeure” as an “[i]rresistible force, overwhelming power”. 239 international chamber of commerce, icc force majeure clause 2003; icc hardship clause 2003 (paris: international chamber of commerce, 2003). 240 unidroit principles, supra note 36 at article 7.1.7 (force majeure). 241 ibid. article 7.1.7 states: ‘(1) non-performance by a party is excused if that party proves that the nonperformance was due to an impediment beyond its control and that it could not reasonably be expected to have taken the impediment into account at the time of the conclusion of the contract or to have avoided or overcome it or its consequences. (2) when the impediment is only temporary, the excuse shall have effect for such period as is reasonable having regard to the effect of the impediment on the performance of the contract. (3) the party who fails to perform must give notice to the other party of the impediment and its effect on its ability to perform. if the notice is not received by the other party within a reasonable time after the party who fails to perform knew or ought to have known of the impediment, it is liable for damages resulting from such nonreceipt. (4) nothing in this article prevents a party from exercising a right to terminate the contract or to withhold performance or request interest on money due.’ 242 rivkin, supra note 196 at 173. 243 rene david, “frustration of contract in french law” (1946) 28 j. comp. legis. & int’l l. 3d ser. 11 at 12. 41 nordic journal of commercial law issue 2011#2 as noted above, as a general principle, force majeure deals with cases involving legal or physical impossibility of performance, even though the term “impossibility” is not used in the code.244 as it is commonly understood, and as embodied in articles 1147 and 1148 of the civil code, force majeure is an event that is beyond a party’s control, making performance of a contract impossible. a party in default is not liable in damages only if the non-performance is a “result from an outside cause which cannot be imputed to him”.245 belgian, dutch, and luxembourgian law mirror the french approach.246 while articles 1147 and 1148 appear to be indistinguishable to the concept of strict liability as found in the common law, the civil code from its origins never adhered to the rigidity that was found in the english case of paradine. instead, french law, and other continental legal systems, utilized interpretive techniques to bring liability based on fault closer to the common law concept of strict liability. for example, french law focuses on the substance of a party’s performance obligation. in doing so, it makes a distinction between “result-based” obligations (obligations de resultat) and obligations of “best efforts” or conduct-oriented obligations (obligations de moyens).247 in the case of an obligations de moyens the plaintiff must prove that the defendant did not act as a prudent, average person when undertaking his/her obligations.248 with an obligations de resultat the plaintiff need only demonstrate that the result that the defendant undertook to provide had not been accomplished.249 swiss law takes a similar approach, and makes a distinction between non-performance and fault.250 as with the french civil code, this technique brings liability based on fault closer to the concept of strict liability. in switzerland, a party is at fault for non-performance if it can be proven that the obligor failed to use its diligence to fulfil its contractual obligations, regardless of whether this was intentional or done through negligence.251 however, in the case of a “best efforts” obligation, the distinction between non-performance and fault becomes irrelevant. recently, the swiss federal tribunal has focused on the requirement of non-performance, rather than on the requirement of fault.252 regarding the obligation to achieve a “specific result”, in theory, swiss law maintains the distinction between non-performance and fault. but 244 james gordley and arthur taylor von mehren, an introduction to the comparative study of private law (new york: cambridge university press, 2006) at 499. 245 c. civ. article 1147. 246 brunner, supra note 75 at 67. 247 ibid. 248 ibid. 249 ibid. 250 ibid. at 68. 251 ibid. 252 ibid. 42 nordic journal of commercial law issue 2011#2 in practical terms, if the plaintiff succeeds in proving the non-performance of a specific obligation, the defendant may only succeed if it can prove that it was not at fault due to a force majeure event. in this respect, it has been said that “fault is to a large degree merely the other side of the coin of non-performance”.253 in either case, as in french law, the non-performing party is excused if force majeure is found. so although the concept of force majeure appears different, and narrower than the common law concept of frustration, in actual cases, on similar facts, the same result may be reached. in traditional islamic law there is no legal doctrine that might be considered analogous to force majeure.254 in certain contracts, however, certain rules have been identified by muslim jurists that bear some resemblance to force majeure. these include the concepts of amer min allah (“act of god”) and afah samawiyyah (“calamity”), both of which render performance impossible.255 until the revision of the german civil code, the bürgerliches gesetzbuch (bgb), in 2002, that country followed the roman law rule by making a distinction between initial and subsequent liability. under the substantially amended bgb, it now makes no difference when the impossibility occurred. retained from the past, however, is the principle that liability for an impossible performance depended on whether a party was responsible for the fact that performance had became impossible.256 in such cases, that party was liable. according to s. 276, a party is “responsible” for “wilful default and negligence”.257 while the bgb incorporates the concept of force majeure and changed circumstances (i.e. rebus sic stantibus), these both fall under the german principle of wegfall der geschaftsgrundlage.258 it states: “[i]f circumstances upon which a contract was based have materially changed after conclusion of the contract and if the parties would not have concluded the contract or would have done so upon different terms if they had foreseen that change […]”.259 as noted, in cases of non-performance under wegfall der geschaftsgrundlage, the role of fault plays a key role in determining whether a claim for damages can be excluded due to a party’s non-performance.260 however, the amended bgb now also allows for instances where fault is not to be used as a “guiding principle”.261 thus, in addition 253 ibid. 254 adnan amkhan, “force majeure and impossibility of performance in arab contract law” (1991) 6 arab l.q. 297 at 298. 255 ibid. at 298-299. 256 bgb s. 276. 257 ibid. 258 bgb s. 313(1). 259 ibid. translation by brunner, supra note 75 at fn. 1969. 260 bgb s. 280(1). 261 brunner, supra note 75 at 39. 43 nordic journal of commercial law issue 2011#2 to an at-fault principle, the bgb incorporates the principle of liability without fault in certain circumstances. this stricter type of liability may apply where the obligor has assumed a guarantee, or assumed the acquisition risk to procure a certain item. these amendments to the bgb allow for greater flexibility for considering the scope of fault and liability in cases of impossibility and changed circumstances. however, with this flexibility comes, at least in theory, the possibility of greater uncertainty in the law. in france and many other continental legal systems, force majeure includes such events as a natural catastrophe, a strike, war, or a sovereign decree. more specifically, there are three characteristics of force majeure as recognized in the civil code. the first is the existence of an “outside cause” that cannot be imputed to the obligor. this must be an external event that occurred beyond the obligor’s sphere of control. secondly, force majeure event must have been “unforeseeable” at the time of the execution of the contract. in making this determination, all circumstances surrounding the event must be considered. in addition, while the test is a subjective one, it does include what a “prudent” (en bon père de famille, literally, a good father of a family) or “average man” should have foreseen.262 finally, the requirement of “irresistibility” constitutes the third characteristic of the force majeure principle. in other words, the event must have raised an insurmountable obstacle to the performance of the obligation. this is an event against which there is no defense, even if the party had foreseen the event. it leaves the obligor powerless. as already noted, civil law accepts that no one can be obliged to perform what is impossible. in this respect, the “irresistibility” characteristic of force majeure also incorporates the notion of rebus sic stantibus. this recognizes that the parties would not have contracted the same way if they had reasonably considered how events might otherwise develop. as under cisg article 79, in french law, where force majeure is found, the obligor is not liable for damages. in most cases of force majeure, french courts will discharge both parties from the obligation.263 but in contrast to the cisg, where an event of force majeure prevents performance of an obligation only partially, cancellation of the contract may be denied, but a corresponding diminution in the counter-performance of the obligee may instead be permitted.264 262 rivkin, supra note 196 at 175. 263 michael d. aubrey, “frustration reconsidered—some comparative aspects” (1963) 12 int’l & comp. l.q. 1165 at 1176. 264 rivkin, supra note 196 at 177. 44 nordic journal of commercial law issue 2011#2 9.3 imprevision, wegfall der geschaftsgrundlage, changed circumstances and other hardship principles imprevision, wegfall der geschaftsgrundlage, and rebus sic stantibus, inter alia, are all recognized hardship principles found in various civil law countries. each one of these principles recognizes an impediment to performance that consists of a fundamental change of circumstances that does not amount to a physical impossibility. in these situations, impossibility principles, such as force majeure, cannot apply since there is no contractual obligation that cannot be performed, but rather one where the promisor’s performance, though not impossible, has become excessively onerous. the basis for this approach is that in many business and legal circles a strict interpretation of the pacta sunt servanda rule was thought to be too severe, especially in contracts of a lengthy duration. in this respect, a hardship principle may be considered as a subset of the force majeure excuse. considering this specific group of hardship cases under force majeure, there exist more flexible legal rules and consequences than those found under force majeure and frustration. a variation of force majeure exists separately in the laws of france, and it fundamentally relies on the principle of rebus sic stantibus.265 in contracts with the french government, it is an implied term of such transactions that the continuation of the obligation is subject to the continued existence of fundamental facts or circumstances. this is the basis of the french principle of imprevision, which is a principle of changed circumstances (i.e. rebus sic stantibus). while french administrative courts will accept the defence of imprevision in contract cases involving private parties and the government, the civil courts have thus far refused to recognize this defence when applied to private contracts.266 as rene david stated many years ago, “[t]he doctrine of imprevision has never been admitted by the hierarchy of civil and commercial courts”, as they favour exclusively the concept of force majeure.267 however, this situation may be changing, as civil courts there have become increasingly more receptive to the concept in private law matters.268 until imprevision is fully accepted in all of france’s courts, the stricter defence of force majeure must be used in its place. conceptually, imprevision is closer to the common and civil law principle of hardship. it appears to have developed out of the civil code’s requirement of good faith, as well as the obligation it places on parties to reasonably comply with contractual obligations, while recognizing the doctrine of rebus sic stantibus.269 in addition, until 1914 the doctrine of force 265 ibid. at 174. 266 gordley and von mehren, supra note 244 at 524. 267 david, supra note 243 at 13. 268 brunner, supra note 75 at 404-405. 269 c. civ. articles 1134 and 1135. see also aubrey, supra note 263 at 1175-1177. 45 nordic journal of commercial law issue 2011#2 majeure was the only defence available to a party to discharge a contract in the event of new circumstances. the advent of world war i, and the outbreak of war again in 1939, forced the courts in france, and elsewhere on the continent, to expand the force majeure concept to discharge certain contracts.270 the new doctrine became known as the theorie de l’ imprevision. it encompassed cases where there was no impossibility of performance, but rather where performance had become much more onerous since the time of contracting. as part of this new doctrine, rebus sic stantibus was considered to be an implied or tacit condition stipulated by the parties to all contracts. in this respect, rebus sic stantibus was viewed as an intention of all contractual parties, regardless of whether or not this was expressed in the contract itself. in this way, imprevision could exist in harmony with the will theories of contracts, which became popular with jurists in the nineteenth century.271 as windscheid noted, the continuation of certain circumstances could simply evidence an “undeveloped condition” of the contract, the “undeveloped condition” being something that was not willed by the parties.272 in addition, the unforeseen economic hardship must be severe, such as the devaluation of the french currency after world war i, which resulted in a fundamentally different obligation for the plaintiff.273 the conseil d’etat has explained the term in the following manner: [a]n “unforeseen contingency” may be defined as a situation in which the balance of a contract is upset as a result of an event of a general character, which is either political or most often economic, which is, in any case, independent of the intention of the parties, and which was unforeseeable at the signing of the contract, and which, without making performance by the administration’s opposite contracting party impossible, makes the carrying out of his obligation intolerably onerous.274 imprevision is limited to contracts for future and/or continuous performance, and results in the discharge of the promisor’s contractual obligations. however, it can be distinguished from the english principle of frustration. with frustration a contract comes to an end because it becomes something beyond what the parties had contemplated; it is beyond the will of the 270 david, supra note 243 at 12. 271 gordley and von mehren, supra note 244 at 504. 272 ibid. 273 compagnie generale d’eclairage de bordeaux c. ville de bordeaux, conseil d’etat, march 30, 1916, (1916) iii d. 25; (1916) iii s. 17. 274 quote is from, and translated by, rivkin, supra note 196 at 178. 46 nordic journal of commercial law issue 2011#2 parties.275 with imprevision, the contract may also be discharged, but this interpretation is based on the will of the parties to the contract.276 for centuries, under the concept of rebus sic stantibus, many civil law jurisdictions accepted the principle of changed circumstances. it is not surprising, therefore, to find that many continental legal systems have statutes that recognize the concept of hardship. among them are germany, the netherlands, italy, greece, portugal, and the scandinavian countries.277 in italy, for example, the german principle of wegfall der geschaftsgrundlage was adopted in article 1467 of the italian civil code, which concerns cases of eccessiva onerosita sopravenuta.278 in other civil law jurisdictions, hardship is recognized in case law only. these countries include switzerland, austria, and spain.279 in addition, the modern civil codes in many arab countries have imported the concept of rebus sic stantibus from continental europe, and recognize cases of hardship through that principle.280 the hardship principle attempts to determine which party should bear the risk of changed circumstances, and to what extent. in civilian jurisdictions this issue is typically determined by weighing the importance of pacta sunt servanda against the principle of good faith in contractual performance. while the pacta principle demands performance (assuming that physical performance of the obligations is possible), this must be balanced against the counter-principle of good faith. a violation of good faith would likely occur if a party demanded performance of a contract according to its original terms even though this performance had become excessively burdensome for the obligor. such a demand might even be deemed an abuse of right.281 this assumes, of course, that the risk of changed circumstances was not assumed by the aggrieved party. it is also worth noting that, with the exception of the american ucc,282 the common 275 david, supra note 243 at 12-13. 276 ibid. 277 schwenzer, supra note 55 at 711. schwenzer provides the following examples at fn. 10: germany: bgb s. 313 (störung der geschäftsgrundlage); netherlands: dutch civil code (bw) art. 6:258; italy: cc, art. 1467 (eccessiva onerosità sopravvenuta); greece: greek civil code, art. 388; portugal: portuguese civil code, art. 437; austria: austrian bgb ss. 936, 1052, and 1170a. 278 c.cit. art. 1467. 279 brunner, supra note 75 at 403. however, schwenzer, supra note 55, notes that the austrian bgb recognizes hardship through analogy in ss. 936, 1052, and 1170a. 280 brunner, supra note 75 at 404. 281 ibid. at 394. 282 the key good faith provision of the ucc is s. 1-203, which states: “every contract or duty within the uniform commercial code imposes an obligation of good faith in its performance or enforcement.” the good faith obligation applies to all duties imposed by the ucc, as well as all contracts subject to the ucc. however, the good faith obligation does not appear to extend to the process of contract negotiation and formation. 47 nordic journal of commercial law issue 2011#2 law has been hostile to recognizing good faith. this may help to explain why civilian legal systems have generally been more receptive than the common law to the concept of rebus sic stantibus. by way of contrast, english law rejects not only good faith in law, but also any notion of relief for changed circumstances that do not amount to an impossibility. furthermore, the term “hardship” is more of a factual description than it is a recognized legal concept.283 as noted above, most common law jurisdictions follow the english approach. a notable exception is the united states, but even in that case, american courts have taken a rigid stance towards hardship and impracticability. while the ucc recognizes impracticability, us courts have tended to follow the rigid pacta sunt servanda rule in the common law, and have generally rejected the defence of changed circumstances. such an approach appears to be at odds with the promulgation of the ucc in 1953, and its adoption of the doctrine of impracticability in s. 2-615.284 the restatement (second) of the law of contracts reiterates this position,285 but courts there still appear to follow the traditional common law approach, favouring pacta sunt servanda and eschewing rebus sic stantibus. 10 cisg article 79 and hardship cisg article 79 provides a bridge between the extremes found in certain civil and common law jurisdictions. the term “hardship” and force majeure are not mentioned in the cisg. however, while article 79 does not explicitly recognize hardship, a compelling case can be made for the proposition that article 79 does, indeed, cover cases of hardship. the basis for a hardship defence exists even though article 79 relieves a party from paying damages only if the breach of contract was due to an impediment beyond its control. during the cisg negotiations in vienna, the idea that article 79 would cover cases of changed circumstances, i.e. hardship, thus recognizing the principle of rebus sic stantibus, was a highly contentious issue. a proposal made by the norwegian delegation sought to release a party from its obligation if, after the temporary impediment had passed, there had been a radical change of circumstances.286 the issue was 283 schwenzer, supra note 55 at 711. 284 see ucc s. 2-615, supra note 192. 285 american law institute, restatement of the law second, contracts, vol. 2 (st. paul, mn: american law institute publishers, 1981) at s. 261. under the heading “discharge by supervening impracticability” s. 261 states: “where, after a contract is made, a party’s performance is made impracticable without his fault by the occurrence of an event the non-occurrence of which was a basic assumption on which the contract was made, his duty to render that performance is discharged, unless the language or circumstances indicate the contrary”. 286 united nations, united nations conference on contracts for the international sales of goods, vienna, 10 march-11 april 1980, official records, un doc. a/conf.97/19 (new york: un, 1991) at 381-382. the norwegian delegation proposed that the draft of the convention should be revised to allow a party that fails to perform a 48 nordic journal of commercial law issue 2011#2 debated, and it was noted by both the swedish and french delegates that the norwegian proposal “was something very different from force majeure and much closer to the theorie de l’imprevision in french law or the doctrine of frustration in anglo-saxon law”.287 there was only limited support for the idea that hardship be explicitly recognized in article 79, thus, the norwegian proposal was rejected. however, the concept of hardship has been acknowledged as falling under article 79 by many courts, tribunals, and scholars.288 there can be no gap in the cisg regarding a party’s invocation of economic impossibility and the adaptation of the contract to changed circumstances and hardship. this outcome is due to the quest for uniformity of international sales law, i.e. the cisg, across national borders. to hold that hardship is not covered under article 79 would be to allow courts and tribunals to invoke national concepts, such as imprevision, wegfall der geschaftsgrundlage, frustration, rebus sic stantibus, etc., resulting diverging interpretations of the cisg. such a result would undermine the purposes of the cisg to create a uniform sales law that is able to transcend national borders. a recent statutory acknowledgement of hardship can be found in germany. the statute on the modernisation of the law of obligations in 2001 finally codified the right to have a contract adapted to a fundamental change in circumstances (i.e. rebus sic stantibus) in section 313 of the bgb.289 this section of the bgb is all-encompassing, and it covers not only cases of hardship, where an unforeseen change in circumstances has made contractual performance excessively more onerous for a party, as well as traditional force majeure-type cases of impossibility. in this respect bgb section 313 is extremely comprehensive in scope, and is, arguably, analogous to cisg article 79 in that it embraces a wide range of events that amount to a fundamental alteration of the equilibrium of a contract. although force majeure is dealt with under articles 1147 and 1148 of the french civil code, and imprevision is accepted only in administrative contracts with the state—which is effectively a rejection of imprevision in the private law of france—there is no other legal principle in that country that could be deemed a “hardship” provision. conceivably, under article 1137, non permanent exemption to the extent that, after the impediment is removed, the circumstances are so radically changed that it would be manifestly unreasonable to hold that party liable. 287 ibid. at 381. quote is from the french delegate, mr. plantard. 288 see cisg-ac opinion no. 7, exemption of liability for damages under article 79 of the cisg, rapporteur: alejandro m. garro, columbia university school of law, new york, n.y. at para. 3. adopted by the cisgadvisory council, 12 october 2007 [cisg-ac opinion no. 7]; georg gruber and hans stoll, “article 79” in peter schlechtriem and ingeborg schwenzer, eds., commentary on the un convention on the international sale of goods (cisg), 2d ed. (new york: oxford university press, 2005) at 810-811 [schlechtriem &schwenzer]; niklas lindstrom, “changed circumstances and hardship in the international sale of goods” (2006) 1 nordic j. com. l. 1 at 23-24 online: <http://www.njcl.utu.fi/1_2006/commentary1.pdf>; brunner, supra note 75 at 218. 289 schwenzer, supra note 55 at 711. 49 nordic journal of commercial law issue 2011#2 performance might be excused if there was a cause estrange, or an utter accident (cas fortuity) under article 1721. however, compared to other civil law jurisdictions, french law has not been favourable to the concept of hardship.290 where it might be recognized in france, a party would most likely use the defence of imprevision, which shares many of the same attributes as hardship. it is also important to note that while civil law emphasized rebus sic stantibus, the common law initially focused on the primacy of pacta sunt servanda. in conjunction with the rebus principle, civilian legal systems focused on the degree of fault of the non-performing party. breach of contract, thus, presupposed fault on the non-performing party. of course there were some exceptions, but civilian legal systems would then attempt to determine the degree of fault of the non-performing party. conceptually, this is at odds with the approach taken by the common law. with its closer affiliation with the pacta principle, the common law utilized a stricter and more rigid approach. it treated every contract as a guarantee, as in strict contractual liability. a party that breached its obligation under a contract entitled the aggrieved party to claim damages, regardless of fault on the non-performing party. typical of this perspective is the comment of lord edmund-davies: it is “axiomatic that, in relation to claims for damages for breach of contract, it is, in general, immaterial why the defendant failed to fulfil his obligations, and certainly no defence to plead that he had done his best”.291 from these two divergent approaches, each legal system developed unique methods to excuse contractual nonperformance in cases of supervening events. although there were some exceptions and concessions in each legal system, each began from a different vantage point. of utmost significance is how cisg article 79, as an autonomous principle of an excuse for nonperformance, has been able to bridge this common law-civil law divide. 11 cisg article 79 as an autonomous legal principle one of the unique aspects of cisg article 79 is its aspiration to bridge the differences between the civilian principles of hardship and force majeure with the common law’s limited recognition of impracticability, frustration, and impossibility. like many provisions within the cisg, article 79 represented a compromise between civil law and common law conceptions of excuses for non-performance due to an unforeseen supervening event. however, it is more than just a compromise provision; it is a self-contained, independent, concept that must be read and interpreted without reference to domestic legal principles. in this fashion, article 79 is deemed to be “autonomous”. 290 ibid. at 710. 291 raineri v. miles, [1981] 1 a.c. 1050 at 1086 (u.k.). 50 nordic journal of commercial law issue 2011#2 as noted above, civilian legal systems generally recognized the roman rule impossibilium nulla obligation. thus, parties were readily excused from the performance of their contractual obligations if such performance had subsequently become impossible. this principle was codified in the laws of most civilian jurisdictions in the form of force majeure-type provisions. indeed, the principle was later extended to include not only cases of physical impossibility, but also those of hardship—cases which fell far short of impossibility. in determining whether a party might be released from its contractual obligations, the extent of that party’s “fault” was also, taken into consideration. strict contractual liability was eschewed by the civilians. in this manner, the civilian jurisdictions emphasized rebus sic stantibus, and were more empathetic where circumstances had changed and performance had become more onerous for one of the parties. by contrast, the common law never adopted the impossibilium nulla obligation rule from roman law. a party could, therefore, be found contractually liable even though a supervening event had occurred without his or her fault, and had made performance physically impossible. in the common law, liability for breach of contract was often strict: a party would be held liable in damages even if, without fault, he or she contracted to do something that had subsequently become impossible to perform. an absence of fault was not enough to discharge a contractual obligation. contractual promises were seen as guarantees. such an approach towards commitments accounted for the primacy of pacta sunt servanda in the common law. this helps to explain the absence of force majeure-type legislation in the early common law. recall that issues of force majeure entered common law courts because the parties had borrowed the concept from civil law, and incorporated force majeure clauses into their contracts. otherwise, force majeure was viewed as an interloper in english law. the cisg can be regarded as one of the most successful international attempts in commercial law to harmonize divergent legal concepts and principles from various national laws and legal systems. the provisions within the cisg seek to eliminate the technical differences and peculiarities that are frequently encountered when comparing national laws and different legal systems. as ulrich magnus stated, “[t]he cisg provides a basic set of rules which has resulted from an intensive comparison of legal systems and politically supported compromises between these legal systems”.292 the cisg achieves this by avoiding references to abstract legal concepts or principles that are peculiar to domestic laws. instead, it uses an autonomous approach by using neutral language in describing specific circumstances, and then elaborating on the content of the rule without reference to national legal concepts. article 79 is included in section iv of part iii of the convention under the heading “exemptions”. the drafters of the cisg chose the broad term “exemptions”, rather than something more specific, in order to avoid any association with a national legal system. thus, article 79 does not refer to force 292 ulrich magnus, “general principles of un-sales law” (1997) 3 int’l trade & bus. l. ann. 33 at s. 6(b). 51 nordic journal of commercial law issue 2011#2 majeure, impossibility, frustration, hardship, impracticability or other related terms that have their origin in specific legal systems. rather, in plain, generic language it expresses a situation, as in, for example, article 79(1): “a party is not liable for a failure to perform any of his obligations if he proves that the failure was due to an impediment beyond his control and that he could not reasonably be expected to have taken the impediment into account at the time of the conclusion of the contract or to have avoided or overcome it or its consequences”.293 as andersen has noted, article 79 is an excellent example of “terminological neutrality”.294 the concept of “an impediment” beyond a party’s control that would excuse liability for failure to perform “would usually be deemed force majeure, wegfall, hardship, impossibility, or frustration in traditional legal terminology in numerous legal systems; but the drafters of the cisg sought to avoid such familiar terms, in the hope that article 79 would establish its own autonomous definition of impediments beyond a party’s control”.295 one salient feature of cisg article 79 is that the concept of an excuse for non-performance is unitary in scope.296 it is unitary in that article 79 encompasses a breach of any obligation under the contract. more importantly, it unifies the range of concepts that would be considered as legal excuses to non-performance. specifically, the phrase “failure to perform any of his obligations [...] due to an impediment beyond his control” is extremely broad in scope, and it covers a litany of related principles that are found in a variety of national laws and legal systems. the non-performance referred to under article 79 covers any failure to perform, for any cause whatsoever, including, for example, delay, the obligation to pay money, or the delivery of non-conforming or defective goods.297 the scope of article 79 thus includes not only typical force majeure-type events, or impossibility, but also related, narrower legal principles that are recognized in specific jurisdictions, such as frustration, hardship, imprevision, wegfall der geschaftsgrundlage, and impracticability, to name a few. in other words, conceptually, the impediments leading to a legal excuse for non-performance embrace a wide range of possibilities. the excuses available under article 79 may be applicable to all types of nonperformance. the range can be thought of as a spectrum of unforeseen supervening events, 293 cisg article 79(1). 294 camilla baasch andersen, uniform application of the international sales law. understanding uniformity, the global jurisconsultorium and examination and notification provisions (the netherlands: kluwer law international, 2007) at 94. 295 ibid. emphasis in the original. 296 brunner, supra note 75 at 57-61, 75-77. 297 sonja a. kruisinga, (non-)conformity in the 1980 un convention on contracts for the international sale of goods: a uniform concept? (antwerp: intersentia, 2004) at 130. see also brunner, supra note 75 at 111. cf. harry m. flechtner, “article 79 of the united nations convention on contracts for the international sale of goods (cisg) as rorschach test: the homeward trend and exemption for delivering non-conforming goods” (2007) 19 pace int’l l. rev. 29. 52 nordic journal of commercial law issue 2011#2 covering the most extreme cases at one end, such as physical impossibility because of the destruction of the subject-matter, to less-severe events, such as an unforeseen rise in prices, leading to hardship or something onerous to a party, at the opposite end. article 79 can, thus, be successfully invoked in any case where the non-performance is due to a partial, permanent, or temporary impediment that occurred after contract formation. cisg article 79 is also unitary in scope in that it reconciles the differing civil law and common law positions regarding fault. in many civil law jurisdictions, the principle of a breach of contract presupposes fault on the part of the non-performing party.298 this approach is due to the roman law influence, where an obligor was absolved of liability if the obstacle to performance occurred without his/her fault.299 the existence of various grades of culpa also accounts for the attempts in civil law to discern the subjective requirements for breach of contract, and to analyze, refine, and categorize the various degrees of fault.300 for example, friedrich mommsen, writing in the nineteenth century, considered the concept of impossibility of performance within the context of breach of contract.301 he applied and categorized impossibility into a wide-range of situations, such as initial and supervening, natural and legal, absolute and relative, objective and subjective, permanent and temporary, complete and partial, and apparent and “real” impossibility. the emphasis on rebus sic stantibus in civil law, with its allowance for changed circumstances, also reinforced this approach.302 this is conceptually at odds with the traditional common law principle of strict liability for breach of contract. in the english common law, a party’s obligation and liability to perform did not depend on fault. in accordance with pacta sunt servanda, all contractual promises were thought of as guarantees. exemptions for liability had to be incorporated into the contract, otherwise a party could be held liable even when a supervening event had made performance impossible. over time, the common law softened its rigid approach towards the pacta principle, and recognized the doctrine of frustration in the case of taylor in 1863.303 further developments in the common law occurred to mitigate the harsh consequences of the law’s recognition of absolute contracts and insistence on literal performance. nevertheless, these advancements failed to bridge fully the gap between the civil and common laws’ divergent approaches to excuses for non-performance. 298 brunner, supra note 75 at 65-68. 299 zimmermann, supra note 229 at 808. 300 ibid. 301 friedrich mommsen’s publication was entitled die unmoglichkeit der leistung in ihrem einfluss auf obligatorische verhaltnisse (1853). see zimmermann, ibid. at 809-810. 302 ibid. 303 supra note 98. 53 nordic journal of commercial law issue 2011#2 as noted above, in article 79’s attempt to bridge the civil-common law divide it provides a principle of non-performance that fuses together the civil and common laws’ distinctive approaches to this legal rule. it relies neither on the civil law’s concept of presumed fault, nor on the common law’s concept of strict liability.304 however, it does not abandon the concept of fault altogether. indeed, “fault” is still relevant, but it is not a question of law; it has been relegated to an interpretation of the facts. utilizing generic language, article 79 thus uses the objective test of an “impediment beyond the control” of a party. by doing so, it is implicit that such non-performance does not require fault on the part of the party in breach, nor does there need to be an absence of fault. in other words, an absence of fault is not a relevant consideration for an invocation of article 79, but the existence of fault leading to the impediment would exclude an application of article 79. with fault, the impediment would not be beyond the control of the non-performing party, or the impediment would have been reasonably foreseeable or avoidable. the legislative history of the cisg further supports the view that article 79 was not designed to rely on presumed fault as found in the civil law, nor on the common law’s principle of strict liability. instead, article 79 was designed as a compromise to bridge these two legal conceptions—and in doing so it has become an autonomous provision. in an early draft of this article from 1976, it provided that a party that failed to perform its obligations would not be liable in damages if the failure was due to an impediment that occurred without fault.305 in this early draft, therefore, fault was presumed, as in the civil law. the following year, in revising the grounds for exemption, this provision was changed.306 the requirement, that the party be without fault to be held not liable in damages, was dropped. the “fault” or “no-fault” requirement was replaced by a new, more objective test, as incorporated in article 79: an “impediment beyond the control” of the party.307 in this manner, cisg article 79 has connected the two conceptual approaches to fault as found in the civil and common law. the focus is not on “fault” or “no-fault”, but is shifted to something more neutral and objective: the conception of “impediment” and the equally official french empechement. while the difference between “fault” or “no-fault” and an exemption from non-performance for an “impediment beyond the control” of a party may appear to be slight, this unitary formulation of an important legal concept is of utmost significance. as andersen has commented, the attempt “to separate the language of the cisg from all other existing terminology demonstrates a good guideline for the uniformity of the cisg, as intended by the drafters: namely the quest for the development of autonomous terms–the 304 brunner, supra note 75 at 69. 305 the counterpart to cisg article 79 was article 50 in the 1976 geneva draft. see brunner, ibid. at 69. 306 the revised article was article 51 from the vienna draft, 1977. see brunner, ibid. at 69-70. 307 cisg article 79(1). see also brunner, ibid. 54 nordic journal of commercial law issue 2011#2 drafters aimed for a uniform language [...] to be understood universally the same, with no taint from domestic law”.308 even if the lofty goal of uniform and autonomous terminology is realized, it is necessary to look at whether there is uniformity in the application of the cisg among national courts and arbitral tribunals. this requires, for example, that article 79 be applied in similar ways across various jurisdictions. as hans stoll and georg gruber have stated, article 79 is the result of a difficult compromise between the advocates of an absolute guarantee [i.e. pacta sunt servanda] that the contract will be performed, in accordance with the anglo-american model, and the proponents of the principle of fault, characteristic for most of the continental european legal systems. the compromise must not be weakened by recourse to principles of liability under national law when interpreting article 79; the provision’s independent character must be observed.309 john o. honnold has similarly admonished courts, tribunals, and legal practitioners to “purge [their] minds of presuppositions derived from domestic traditions and, with innocent eyes, read the language of article 79 in the light of the practices and needs of international trade.”310 in other words, in the developing body of international cases, there should be no evidence of interpretive flexibility or divergence in its adaptation to the various national legal systems that have considered article 79. with the use of standardized contract clauses, self-governing contracts, trade term usages, recourse to commercial arbitration, and use of autonomous principles and rules, as in cisg article 79, international merchants have introduced their own self-governing regulatory regime into the global legal order. this operates as an addendum of national law. indeed, as this paper has argued, this is representative of the new law merchant or lex mercatoria, which is simply de-nationalized law, or non-state law.311 the past dissatisfaction with, and inadequacy of, national legal regimes and related doctrines and rules, has led to a renaissance of a new lex mercatoria. in the process, the modern effort to create a uniform transnational commercial law has been re-created. and article 79, the roots of which can be traced back to ancient times, is a living example of this new legal order. 308 andersen, supra note 294 at 38-39. 309 stoll and gruber, “article 79” in schlechtriem & schwenzer, supra note 288 at 807. 310 john o. honnold, uniform law for international sales under the 1980 united nations convention, 4th ed., harry flechtner, ed., (the netherlands: kluwer law international, 2009) at 615 [honnold & flechtner]. 311 see e.g. barton s. selden, “lex mercatoria in european and u.s. trade practice: time to take a closer look” (1995) 2 ann. surv. int’l & comp. l. 111. * mr. schwartz is in his final year of law school at pace university school of law. he received his ba in history from the university of california, los angeles and an mba from the california state university at fullerton. the recovery of lost profits under article 74 of the u.n. convention on the international sale of goods an analysis of court and arbitral decisions to determine possible causes of non-conformity and to identify solutions that would increase the consistency of awards by damon schwartz* nordic journal of commercial law issue 2006 #1 nordic journal of commercial law issue 2006 #1 1 see e. allan farnsworth, damages and specific relief, 27 american journal of comparative law 247, 247 (1979). 2 united nations convention on contracts for the international sale of goods (1980) [cisg] article 74: damages for breach of contract by one party consist of a sum equal to the loss, including loss of profit, suffered by the other party as a consequence of the breach. such damages may not exceed the loss which the party in breach foresaw or ought to have foreseen at the time of the conclusion of the contract, in the light of the facts and matters of which he then knew or ought to have known, as a possible consequence of the breach of contract. 3 see djakhongir saidov, methods of limiting damages under the vienna convention on contracts for the international sale of goods (2001), at 1. 4 this paper will not discuss mitigation issues stemming from article 77 cisg. the failure of an aggrieved party to mitigate possible lost profits would result in a reduction of a lost profit award; however this is secondary to the primary task of establishing whether lost profits actually occurred, and in what amount. the focus of this paper is on the difficulty in determining proof of lost profits and the discrepancies in lost profit awards, therefore the topic of mitigation will not be addressed. 5 see cisg article 74. 2 1. introduction the ability to obtain damages for losses suffered in the course of trade is a critical and necessary requirement for parties to be willing to engage in commerce. without legal recourse for losses as a consequence of other parties’ non-performance, the incentive to participate in trade is greatly diminished. international commerce is hampered to the extent that parties from different countries risk trading under foreign laws that might not offer comparable protection. the availability of relief for a breach of contract accords with economic efficiency in a free enterprise economy.1 the u.n. convention on the international sale of goods (cisg) was created in 1980 to codify and harmonize a legal framework aimed at encouraging and facilitating international trade. an important feature of the cisg is article 74, which provides a guide for the recovery of foreseeable losses, including lost profits, as a consequence of a party’s breach of contract.2 this right to obtain damages is a primary mechanism of the cisg remedial scheme.3 this paper will examine the recovery of lost profits under article 74 cisg and discuss the practical issues that tribunals and parties face when evaluating a lost profit claim. decisions concerning the recovery of lost profits under the cisg have been criticized as lacking uniformity due to problems in interpreting article 74 cisg, differences in domestic evidentiary standards, use or non-use of general principles of international law, arbitrator discretion, and difficulties in the actual calculation of lost profits.4 a discussion of these issues will attempt to shed light on the problems and determine if there is a lack of uniformity, and if so, what steps can be taken to increase the consistency of awards. 2. the purpose and limitations of article 74 cisg article 74 cisg states that an aggrieved party may recover foreseeable damages equal to the loss, including loss of profit, suffered as a consequence of the breach.5 the article is meant to put an nordic journal of commercial law issue 2006 #1 6 see john honnold, uniform law for international sales under the 1980 united nations convention (3d ed. 1999), at 444. 7 see e. allan farnsworth, damages and specific relief, 27 american journal of comparative law 247, 247 (1979). 8 see cisg article 74. 9 see john honnold, uniform law for international sales under the 1980 united nations convention (3d ed. 1999), at 446. 10 id. at 446. 11 id. at 447. 12 see schlechtriem/schwenzer/stoll/gruber, commentary on the un convention on the international sale of goods, 2d ed., oxford, art. 74, at 765. 13 see e. allan farnsworth, damages and specific relief, 27 american journal of comparative law 247, 247 (1979). 14 see peter schlechtriem & ingeborg schwenzer, commentary on the un convention on the international sale of goods, 2d ed., oxford, at 747. 15 id. at 767-68. 16 id. 17 id. 18 id. at 758. 3 injured party in as good a position as if the contract had actually been performed.6 in other words, a party should be entitled to receive the benefit of the bargain which had been contracted for.7 the second sentence of article 74 cisg contains an important limitation on the recovery of possible losses, in that the loss must be foreseeable or ought to have been foreseeable.8 this is a needed protection for the breaching party because losses can be extreme and unpredictable.9 the concept of foreseeability is well known in common law jurisdictions from the 1854 english decision of hadley v. baxendale.10 civil law countries such as france also recognize the theory of foreseeability and limit damages to those which were foreseen or which could have been foreseen at the time of the contract.11 the test of foreseeability is essentially an objective standard, where the question is whether a reasonable person in the position of the promisor and with knowledge of the circumstances surrounding the conclusion of the contract, ought to have foreseen the possible losses at the time of the conclusion of the contract.12 this important limit on the recovery of damages is to prevent compensating an injured party for losses that could not reasonably have been foreseen by the party in breach.13 article 74 cisg therefore has a dual purpose: to provide a mechanism for injured parties to obtain relief, and to only allow the recovery of foreseeable losses which gives merchants the ability to calculate and limit their contractual liability.14 the concept of foreseeability has its greatest impact on consequential losses, such as lost profits.15 a seller would be liable for a buyer’s lost profits on a resale of the goods only if the seller was aware or should have been aware of the resale.16 however, as one scholar points out, even in the absence of positive indications of a resale, the seller is always aware of this possibility when tradable goods are sold to a merchant.17 3. lost profits a loss of profit in the context of article 74 cisg would be any increase in assets that the breach of contract prevented.18 a loss suffered by a party is any costs and expenses incurred as a result of nordic journal of commercial law issue 2006 #1 19 see djakhongir saidov, standards of proving loss and determining the amount of damages, 22 journal of contract law 1, 19 (2006). 20 id. at 17. 21 id. 22 id. at 19. 23 id. at 39. 24 id. 25 see sieg eiselen, remarks on the manner in which the unidroit principles of international contracts may be used to interpret or supplement article 74 cisg, (october 2004), at ¶ s, available at http://www.cisg.law.pace.edu/ cisg/principles/uni74.html. 26 see peter schlechtriem & ingeborg schwenzer, commentary on the un convention on the international sale of goods, 2d ed., oxford, at 771. 27 id. at 772. 28 see sieg eiselen, remarks on the manner in which the unidroit principles of international contracts may be used to interpret or supplement article 74 cisg, (october 2004), at ¶ s, available at http://www.cisg.law.pace.edu/ cisg/principles/uni74.html. 29 id. citing hof van beroep antwerp, 18 may 1999 (belgium), available at http://cisgw3.law.pace.edu/cases/990518b1.html; rechtbank van koophandel hasselt, 8 oct. 1996 (belgium), available at http://cisgw3.law.pace.edu/cases/961008b1.html; handelsgericht aargau, 26 september 1997 (switzerland), available at http://cisgw3.law.pace.edu/cases/970926s1.html; 4 the breach.19 it is usually more difficult to prove a loss of profit than a loss suffered because of the typical speculation involved with lost profits in the hypothetical future or past.20 conversely, losses suffered can be established readily through paid invoices, receipts, or other types of bills. lost profits from the breach of a long term contract to supply goods can be particularly difficult to assess. the buyer might claim a loss on the resale of goods which the seller failed to deliver, but in the absence of orders for those goods it is difficult to state with precision that the alleged profits would have been earned.21 however, if the buyer could present orders for the goods that were not delivered, the loss of profit could be established readily.22 the situation of a manufacturer buyer that needs goods for production of finished products presents an additional problem.23 when a seller fails to supply goods and the manufacturer buyer is unable to complete the manufacturing process, the buyer will likely claim lost profits due to the inability to sell any finished goods. in this situation, what an aggrieved party will have to demonstrate is his or her ability to sell the goods at a profit.24 4. burden of proof it is generally accepted that the burden of proving the extent of damages lies on the aggrieved party.25 although the cisg does not expressly set forth the distribution of the burden of proof, the party who has suffered the loss must prove that the loss occurred, the amount of the loss, and that the breach of contract caused the loss.26 this becomes difficult in the absence of specific orders for goods or a precise calculation of expected profits. in order to discharge the burden of proof, an aggrieved party has to substantiate the amount of loss suffered in some manner.27 the situation where a party has failed to present proof of the exact extent of the losses presents a very difficult problem for tribunals, and there is divergence in the case law about the consequences.28 for example, german and american courts may dismiss the claim under these circumstances, while belgian and swiss courts may award an estimated amount according to their belief of what is right, or ex aequo et bono.29 the lack of uniformity in arbitral and court opinions http://www.cisg.law.pace.edu/ http://www.cisg.law.pace.edu/ http://cisgw3.law.pace.edu/cases/990518b1.html; http://cisgw3.law.pace.edu/cases/961008b1.html; http://cisgw3.law.pace.edu/cases/970926s1.html; nordic journal of commercial law issue 2006 #1 landgericht düsseldorf, 5 march 1996 (germany), available at http://cisgw3.law.pace.edu/cases/960305g1.html; landgericht hamburg, 17 june 1996 (germany), available at http://cisgw3.law.pace.edu/cases/960617g1.html. 30 see djakhongir saidov, standards of proving loss and determining the amount of damages, 22 journal of contract law 1, 6 (2006). 31 id. at 2. 32 id. at 7. 33 id. 34 see djakhongir saidov, methods of limiting damages under the vienna convention on contracts for the international sale of goods (2001), at 27. 35 see john gotanda, recovering lost profits in international disputes, 36 georgetown journal of international law 61, 66 (2004). 36 see djakhongir saidov, damages: the need for uniformity, journal of law and commerce (forthcoming), at 8. 37 see peter schlechtriem & ingeborg schwenzer, commentary on the un convention on the international sale of goods, 2d ed., oxford, at 759. 5 concerning the recovery of lost profits where precise evidence of losses is lacking has several causes. the following examination of the central issues involved in the divergence of the decisions will attempt to outline the problems and ascertain whether there is a possible solution. 5. standards of proof for the recovery of lost profits as a preliminary issue, the standard of proving loss refers to how much proof needs to be shown and what degree of specificity should come from the evidence presented in order to prove the alleged loss.30 unfortunately for tribunals, courts, and merchants, the issue of standards for proving loss and determining damages in the international sale of goods has not received sufficient attention in legal discourse.31 the lack of consensus and direction on what standards to apply may be due to the variability inherent in the determination of financial loss. one scholar points out that loss of profit involves guesswork in relation to future or hypothetical future events and depends on contingencies such as economic conditions, prices, and preferences of consumers.32 the uncertainty from utilizing multiple variables in a financial calculation makes it nearly impossible to substantiate an amount of loss with absolute precision.33 a uniform standard of proof to be applied by tribunals and courts in determining lost profits and damages could result in more consistent decisions. most legal systems have a requirement that damages claimed must be established with a level of certainty.34 however, the requirements for recovering lost profits and the limitations on their recovery vary from country to country.35 therefore, the relevant question to be resolved in light of the contrasting domestic standards is how the issue of proving lost profits and damages should be determined under the cisg, and if a uniform standard can be implemented.36 a. the cisg and standards of proof the cisg does not contain any express reference to certainty in article 74. in addition, there is no mention of what degree of probability to apply when appraising whether a profit would have been made.37 several tribunals have indeed emphasized the point that the cisg is silent as to the http://cisgw3.law.pace.edu/cases/960305g1.html; http://cisgw3.law.pace.edu/cases/960617g1.html. nordic journal of commercial law issue 2006 #1 38 see djakhongir saidov, standards of proving loss and determining the amount of damages, 22 journal of contract law 1, 7 (2006); citing commercial court zurich, 10 feb. 1999 (switzerland), available at http://cisgw3.law.pace.edu/cases/990210s1.html; district court saane, 20 feb. 1997 (switzerland), available at http://cisgw3.law.pace.edu/cases/970220s1.html. 39 djakhongir saidov, damages: the need for uniformity, journal of law and commerce (forthcoming), at 7. 40 see peter schlechtriem & ingeborg schwenzer, commentary on the un convention on the international sale of goods, 2d ed., oxford, at 759. 41 see djakhongir saidov, standards of proving loss and determining the amount of damages, 22 journal of contract law 1, 47-48 (2006); citing joseph lookofsky, consequential damages in comparative context: from breach of promise to monetary remedy in the american, scandinavian and international law of contracts and sales, jurist-og okonomforbundets forlag, copenhagen, 1989, at 283; eric schneider, consequential damages in the international sale of goods: analysis of two decisions, available at http://www.cisg.law.pace.edu/cisg/wais/db/articles/schnedr2.html; district court sissach, 5 november 1998 (switzerland), available at http://cisgw3.law.pace.edu/cases/981105s1.html; commercial court zurich, 10 feb. 1999 (switzerland), available at http://www.cisg.law.pace.edu/cisg/wais/db/cases2/990210s1.html; commercial court st. gallen, 3 december 2002 (switzerland), available at http://cisgw3.law.pace.edu/cases/021203s1.html. 42 see the uncitral digest of case law on the united nations convention on the international sale of goods, 8 june 2004, available at http://www.cisg.law.pace.edu/cisg/text/digest-art-74.html; citing bundesgericht, 15 sept. 2000 (switzerland), available at http://ci sgw3. law.pac e.edu/ ca ses/0 00 91 5s1 .ht ml; bezi rksger ic ht saane, 20 feb. 1997 (switzerland), available at http://cisgw3.law.pace.edu/cases/970220s1.html; helsingfors hovrätt helsinki, 26 oct. 2000 (finland), available at http://cisgw3.law.pace.edu/cases/001026f5.html; delchi carrier v. rotorex, federal district court (n.d.n.y. 1994), available at http://cisgw3.law.pace.edu/cases/940909u1.html. 43 djakhongir saidov, standards of proving loss and determining the amount of damages, 22 journal of contract law 1, 47-48 (2006); citing district court sissach, 5 november 1998 (switzerland), available at http://cisgw3.law.pace.edu/cases/981105s1.html; commercial court zurich, 10 feb. 1999 (switzerland), available at http://cisgw3.law.pace.edu/cases/990210s1.html; commercial court st. gallen, 3 december 2002 (switzerland), available at http://cisgw3.law.pace.edu/cases/021203s1.html; peter schlechtriem & ingeborg schwenzer, commentary on the un convention on the international sale of goods, 2d ed., oxford, at 772. 44 see john gotanda, recovering lost profits in international disputes, 36 georgetown journal of international law 61, 86 (2004). 6 standard of proving loss.38 these decisions, holding that the cisg does not provide guidance on the degree of certainty necessary for a judge to formulate a profit hypothesis illustrate an important point. the scholar djakhongir saidov states that these cases “ highlight the issue of standards of proving losses and determining the amount of damages which has been a source of non-uniformity in the application of the convention.” 39 thus, with the absence of a specific provision on determining lost profits under the cisg, one scholar states that a competent judge should be convinced that the profit would actually have been made had the contract been properly performed, before relief for this type of loss is granted.40 b. standards of proof from procedural law several tribunals and scholars suggest that because the cisg does not contain an express reference to any standard of proof for assessing lost profits, it is an issue beyond the scope of the cisg and the procedural law of the forum should apply.41 many cases have determined that the convention determines the grounds for recovery, but domestic procedural law applies to the assessment of evidence of loss and how a judge should reach his or her opinion.42 these decisions submit that the standard of proof for establishing lost profits is an evidentiary issue and one tribunal stated that the “ law of evidence is determined by the lex fori, as the law of evidence belongs to the procedural law ... therefore each court applies its own laws of evidence.” 43 the effect of this approach to the determination of lost profits has been to lose uniformity in decision-making through the variability in proof requirements from country to country.44 the compensation for lost profits fluctuates as courts are likely to apply the standards contained in http://cisgw3.law.pace.edu/cases/990210s1.html; http://cisgw3.law.pace.edu/cases/970220s1.html. http://www.cisg.law.pace.edu/cisg/wais/db/articles/schnedr2.html; http://cisgw3.law.pace.edu/cases/981105s1.html; http://www.cisg.law.pace.edu/cisg/wais/db/cases2/990210s1.html; http://cisgw3.law.pace.edu/cases/021203s1.html. http://www.cisg.law.pace.edu/cisg/text/digest-art-74.html; http://cisgw3.law.pace.edu/cases/000915s1.html; http://cisgw3.law.pace.edu/cases/970220s1.html; http://cisgw3.law.pace.edu/cases/001026f5.html; http://cisgw3.law.pace.edu/cases/940909u1.html. http://cisgw3.law.pace.edu/cases/981105s1.html; http://cisgw3.law.pace.edu/cases/990210s1.html; http://cisgw3.law.pace.edu/cases/021203s1.html; nordic journal of commercial law issue 2006 #1 45 see djakhongir saidov, standards of proving loss and determining the amount of damages, 22 journal of contract law 1, 66 (2006); joseph lookofsky, understanding the cisg in the usa (1995), at 79. 46 see djakhongir saidov, standards of proving loss and determining the amount of damages, 22 journal of contract law 1, 16-17 (2006). 47 see john gotanda, recovering lost profits in international disputes, 36 georgetown journal of international law 61, 76 (2004). 48 id. 49 see joseph lookofsky, understanding the cisg in the usa (1995), at 80. 50 see djakhongir saidov, standards of proving loss and determining the amount of damages, 22 journal of contract law 1, 54-55 (2006); citing appellate court celle, 2 sept. 1998 (germany), available at http://cisgw3.law.pace.edu/cases/980902g1.html; appellate court koln, 21 may 1996 (germany), available at http://cisgw3.law.pace.edu/cases/960521g1.html; district court munchen, 20 feb. 2002 (germany), available at http://cisgw3.law.pace.edu/cases/020220g1.html; icc case no. 9187, june 1999, available at http://www.cisg-online.ch/cisg/urteile/705.htm. 51 id. 52 see djakhongir saidov, damages: the need for uniformity, journal of law and commerce (forthcoming), at 7-8. 53 see djakhongir saidov, standards of proving loss and determining the amount of damages, 22 journal of contract law 1, 56 (2006). 54 id. at 65; citing district court of kuopio, 5 nov. 1996 (finland), available at http://cisgw3.law.pace.edu/cases/ 961105f5.html; cietac arbitration proceedings, 1995, available at http://www.unilex.info/case.cfm?pid=1&do= case&id=210&step=abstract; tribunal de commerce namur, 15 jan. 2002 (belgium), available at http://cisgw3. law.pace.edu/cases/020115b1.html; district court gottingen, 20 sept. 2002 (germany), available at http://cisgw3. law.pace.edu/cases/020920g1.html; appellate court hamburg, 5 oct. 1998 (germany), available at http://cisgw3. law.pace.edu/cases/981005g1.html. 55 see djakhongir saidov, standards of proving loss and determining the amount of damages, 22 journal of contract law 1, 65 (2006). 7 their national law on evidence.45 this approach is employed by some tribunals because there is no precise formula to provide how much and what type of evidence must be presented to prove a loss with reasonable certainty.46 one may hypothesize that common law jurisdictions or civil law jurisdictions may have similar evidentiary standards leading to consistent awards in their respective realms, but this is not necessarily the case. for example, the swiss code of obligations, article 42, allows for the recovery of lost profits, but contains a strict standard of proof making it fairly difficult for a claimant to obtain damages.47 conversely, belgian evidentiary standards only require that damages be certain in existence, not in amount.48 thus, depending on the national court, there may be a less than uniform application of the general damages rule when courts attempt to coordinate convention conceptions with those of local law.49 c. creating a standard of proof in the cisg some tribunals have resorted to a different approach than procedural law to determine what standard of proof is required to establish lost profits under article 74 cisg.50 these cases have referred to a level of proof to be determined by an exact, or precise, or specific ascertainment of damages.51 however, the cases do not explain how the judges or arbitrators arrived at these standards, nor do they explain the meaning of these standards.52 the cases have been criticized for the failure to demonstrate how the judgments were determined, because the cisg does not mention any of the standards used in the decisions.53 other cases have tried to add a standard of reasonableness or sufficient evidence to the cisg.54 again, at least one scholar has pointed out that the statements do not reference any legal standard which makes the decisions extremely difficult to analyze.55 http://cisgw3.law.pace.edu/cases/980902g1.html; http://cisgw3.law.pace.edu/cases/960521g1.html; http://cisgw3.law.pace.edu/cases/020220g1.html; http://www.cisg-online.ch/cisg/urteile/705.htm. http://cisgw3.law.pace.edu/cases/ http://www.unilex.info/case.cfm?pid=1&do= nordic journal of commercial law issue 2006 #1 56 see article 7(2) cisg: questions concerning matters governed by this convention which are not expressly settled in it are to be settled in conformity with the general principles on which it is based or, in the absence of such principles, in conformity with the law applicable by virtue of the rules of private international law. 57 see djakhongir saidov, damages: the need for uniformity, journal of law and commerce (forthcoming), at 9. 58 id. 59 see article 7(2) cisg: questions concerning matters governed by this convention which are not expressly settled in it are to be settled in conformity with the general principles on which it is based or, in the absence of such principles, in conformity with the law applicable by virtue of the rules of private international law. unidroit principles, if established as private international law, could be used to aid in the interpretation of cisg provisions. 60 id. 61 see sieg eiselen, unresolved damages issues of the cisg: a comparative analysis, 38 comparative and international law journal of south africa 32, 45 (2005/1). 62 see djakhongir saidov, standards of proving loss and determining the amount of damages, 22 journal of contract law 1, 62-63 (2006). 63 id. at 70-71. 64 see albert kritzer, reasonableness editorial remarks. available at http://www.cisg.law.pace.edu/cisg/text/ reason.html. 8 however, if there is a general principle of reasonableness in the cisg, in can be argued that through article 7(2) cisg, the principle of reasonableness can be utilized in the interpretation of article 74 cisg.56 if reasonableness is to be used in the interpretation of article 74 cisg, then a claimant should be required to prove loss with only a degree of precision or certainty which can be reasonably expected.57 basically, a claimant would have to prove losses with a reasonable degree of certainty.58 in the context of lost profit awards, the relevant question at this point would be whether arbitrators and judges from different legal regimes would have more consistent decisions using reasonableness as a uniform standard of proof. this would appear to be the motivation behind the use of reasonableness as a general principle of the cisg, and the analogous push to use the reasonableness standard found within the unidroit principles of private international law by virtue of article 7(2) cisg.59 d. the use of unidroit principles to interpret article 74 cisg the use of unidroit principles in the interpretation of article 74 cisg is arguably possible through article 7(2) cisg. article 7(2) cisg allows questions not addressed, or gaps in the cisg to be settled with the use of general principles from the cisg, or in the absence of such principles, private international law.60 article 7 encourages courts and tribunals to adopt solutions which take note of the international character of the convention and would lead to uniformity in practice when interpreting the convention and filling any gaps that exist.61 if article 74 cisg is silent on the issue of standards of proof to recover lost profits, the first step would be to try and identify a general principle to address the issue.62 if no general principle is found, then an applicable rule of private international law can be used to assist in interpretation of the question. 1. a general principle of the cisg may be applied one scholar submits that a general principle which may be relevant is that of reasonableness because of the pervasive use of the term in the cisg.63 the scholar albert kritzer has pointed out that the term reasonableness is mentioned in no less than thirty-seven provisions of the cisg, thus it would appear justified as a general principle of the convention.64 the application of the http://www.cisg.law.pace.edu/cisg/text/ nordic journal of commercial law issue 2006 #1 65 see djakhongir saidov, standards of proving loss and determining the amount of damages, 22 journal of contract law 1, 70-71 (2006). 66 id. citing unidroit principle 7.4.3(1): compensation is due only for harm, including future harm, that is established with a reasonable degree of certainty. 67 see cisg article 7(2). 68 see sieg eiselen, remarks on the manner in which the unidroit principles of international contracts may be used to interpret or supplement article 74 cisg, (october 2004), at ¶ k, available at http://www.cisg.law.pace.edu/ cisg/principles/uni74.html. 69 id. 70 id. at ¶ b. see unidroit principles 7.4.1 right to damages: any nonperformance gives the aggrieved party a right to damages either exclusively or in conjunction with any other remedies except where the nonperformance is excused under these principles; 7.4.2 full compensation: (1) the aggrieved party is entitled to full compensation for harm sustained as a result of the nonperformance. such harm includes both any loss which it suffered and any gain of which it was deprived, taking into account any gain to the aggrieved party resulting from its avoidance of cost or harm, (2) such harm may be nonpecuniary and includes, for instance, physical suffering or emotional distress; 7.4.3 certainty of harm: (1) compensation is due only for harm, including future harm, that is established with a reasonable degree of certainty, (2) compensation may be due for the loss of a chance in proportion to the probability of its occurrence, (3) where the amount of damages cannot be established with a sufficient degree of certainty, the assessment is at the discretion of the court. 71 see djakhongir saidov, methods of limiting damages under the vienna convention on contracts for the international sale of goods (2001), at 28. 72 see sieg eiselen, unresolved damages issues of the cisg: a comparative analysis, 38 comparative and international law journal of south africa 32, 34 (2005/1); citing bonell, new approach, at 12-13, citing kritzer, general observations on use of the unidroit principles to help interpret the cisg, at 34. 73 see djakhongir saidov, methods of limiting damages under the vienna convention on contracts for the international sale of goods (2001), at 28. 9 standard of reasonableness as a general principle will lead to the conclusion that losses need only be proved with a degree of precision that can reasonably be expected from the circumstances.65 under this interpretation, the scholar djakhongir saidov states that the standard becomes very similar to that fixed in the unidroit principles, where losses need to be proved with a “ reasonable degree of certainty.” 66 2. a principle of private international law can be used to supplement the cisg to use the unidroit principles to assist in the interpretation of article 74 cisg, there must be a question that is not expressly settled within the cisg.67 arguably, the question of what standard of proof should be used for the recovery of lost profits is not expressly addressed in article 74 cisg.68 the scholar sieg eiselen submits that a number of issues such as calculation of future damages and proof of damages have been left open or unresolved in the cisg.69 articles 7.4.1, 7.4.2, and 7.4.3, of the unidroit principles address the issues of damages and certainty of proof and can therefore be helpful in interpreting and applying article 74 cisg.70 3. the unidroit principles’ reasonable certainty as a standard of proof the use of the reasonableness standard for determining the certainty required to establish lost profits can be carried out on the basis of the unidroit principle 7.4.3(1).71 there is some controversy over the use of the unidroit principles, but there seems to be strong support for their use in a persuasive sense as rules which fulfill a modern international sales law.72 one of the stated purposes of the unidroit principles is to help interpret or supplement international law instruments such as the cisg.73 the cisg also contains provisions which allow the use of general http://www.cisg.law.pace.edu/ nordic journal of commercial law issue 2006 #1 74 id. 75 see comments of michael joachim bonell, at 1. available at http://cisgw3.law.pace.edu/cisg/text/matchup/ generalobservations.html. 76 see world trade organization 2004 data, available at http://www.wto.org/english/res_e/statis_e/its2005_e/section1_e/i05.xls; see also unidroit members, available at http://www.unidroit.org/english/members/main.htm; cisg members, available at http://www.uncitral.org/uncitral/en/uncitral_texts/sale_goods/1980cisg_status.html. 77 see unidroit principle 7.4.3(1): compensation is due only for harm, including future harm, that is established with a reasonable degree of certainty. 78 see sieg eiselen, unresolved damages issues of the cisg: a comparative analysis, 38 comparative and international law journal of south africa 32, 37-38 (2005/1). 79 see djakhongir saidov, standards of proving loss and determining the amount of damages, 22 journal of contract law 1, 69 (2006). 80 see djakhongir saidov, damages: the need for uniformity, journal of law and commerce (forthcoming), at 8. 10 principles or private international law, such as the unidroit principles, where issues are within the convention’s scope, but not expressly settled in it.74 one scholar also states that where the principles address issues also covered by the cisg and follow solutions found in that convention, the supranational committee of experts constituted to devise the unidroit principles can be regarded as a council of “ wise men [and women]” whose views can help us interpret the cisg.75 thus, there is no prohibition on the use of unidroit principles to assist in interpreting an issue within the cisg if the cisg is silent on that issue. other practical support for the use of unidroit principles in the interpretation of the cisg can be found in actual trade data. the top ten international importers and exporters of goods, constituting over 50% of the world’s trade, are all signatories to the cisg and all but 2 countries are members of unidroit.76 this would imply that use of the unidroit principles to aid in the explanation of cisg provisions would not be unreasonable, unpredictable, or even unexpected for the dominant international trading countries. use of the unidroit principles to help interpret article 74 cisg could aid tribunals and courts to arrive at more consistent decisions concerning proof of lost profits. unidroit principle 7.4.3 directly addresses the issue of certainty of harm.77 use of unidroit principle 7.4.3(1) to assist in the selection of a standard of proof for article 74 cisg would result in a requirement that lost profits be established or proven with a reasonable degree of certainty.78 use of this single standard for the level of certainty required to establish lost profits could lead to less arbitrary determinations than using variable standards based on domestic procedural law. thus, accepting a uniform standard to prove loss and the amount of damages is more likely to lead to a greater degree of consistency than if the matter was dealt with on the basis of applicable legal systems, each potentially containing a different standard.79 the critical issue with the use of unidroit principles is that the majority of tribunals and courts would have to utilize the principles voluntarily and eliminate the use of domestic standards of proof to achieve any tangible consistency in lost profit decisions. e. ex aequo et bono awards some tribunals and courts have based their awards on the concept of ex aequo et bono, or according to what is just and good.80 these decisions have contributed to the lack of uniformity in lost profit decisions. in these cases, although a party failed to prove the amount of the loss or expenses that http://cisgw3.law.pace.edu/cisg/text/matchup/ http://www.wto.org/english/res_e/statis_e/its2005_e/section1_e/i05.xls; http://www.unidroit.org/english/members/main.htm; http://www.uncitral.org/uncitral/en/uncitral_texts/sale_goods/1980cisg_status.html. nordic journal of commercial law issue 2006 #1 81 id. citing oberlandesgeright köln, 21 may 1996 (germany), available at http://cisgw3.law.pace.edu/cases/960521g1.html; icc case no. 9187, june 1999, available at http://www.cisg-online.ch/cisg/urteile/705.htm; landgericht göttingen, 20 sept. 2002 (germany), available at http://cisgw3.law.pace.edu/cases/020920g1.html; landgericht münchen, 20 feb. 2002 (germany), available at http://cisgw3.law.pace.edu/cases/020220g1.html. 82 john gotanda, recovering lost profits in international disputes, 36 georgetown journal of international law 61, 77 (2004). 83 see djakhongir saidov, standards of proving loss and determining the amount of damages, 22 journal of contract law 1, 73-74 (2006). 84 id. 85 id. at 75-76. 86 see john gotanda, recovering lost profits in international disputes, 36 georgetown journal of international law 61, 87 (2004). 11 had been incurred due to the breach of contract, the court believed a loss had occurred and awarded damages.81 the scholar john gotanda points out that some judges in civil law countries often base their award on “ intuition and justice” and that “ awards are not accompanied by discursive explanations, and theoretical basis thus is difficult to determine.” 82 the practice of allowing damages to be assessed at a court’s or tribunal’s discretion in the absence of the required degree of certainty reflects a concern for the claimant.83 one scholar refers to this process as a further continuation of the policy of disfavor of an all or nothing approach to the award of damages.84 however, while benefiting an injured party that does not have adequate evidence of the loss suffered, it also creates an extremely difficult situation for potentially defaulting parties to calculate the amount of liability they may be exposed to.85 the justification for this practice in aiding claimants without sufficient evidence of lost profits must be weighed against the lack of good faith in assessing awards against respondents that have essentially won their case on an evidentiary basis. the result of ex aequo et bono decisions is to create more discrepancies and non-uniformity in cases concerning the recovery of lost profits. while arbitral discretion is an important tool in the hands of tribunals, it does contribute to the lack of consistency in damage awards in some cases. f. summary of the issues with standards of proof and recovery of lost profits the issues involved with the standard of proof for establishing and recovering lost profits are complex. interpreting article 74 cisg consistently is unlikely to occur without substantive changes to the cisg provision or specific guidance on how article 74 should be interpreted. the dispute over whether the cisg is silent on the evidentiary burden, allowing reliance on domestic evidentiary rules or supplementation with the unidroit principles contributes to the lack of uniformity. the creation of unexplained standards within the cisg and ex aequo et bono awards are additional sources of inconsistency. however, one scholar submits that the lack of harmonization concerning standards of proof for lost profits is not an area of concern, but rather the calculation of lost profits that is in need of consistency and uniformity.86 http://cisgw3.law.pace.edu/cases/960521g1.html; http://www.cisg-online.ch/cisg/urteile/705.htm; http://cisgw3.law.pace.edu/cases/020920g1.html; http://cisgw3.law.pace.edu/cases/020220g1.html. nordic journal of commercial law issue 2006 #1 87 id. 88 id. 89 id. at 99. 90 id. 91 id. at 61. 92 id. 93 id. quoting himpurna cal. energy ltd. v. pt. (persero) perusahaan listruik negara, final award of 4 may 1999, 25 y.b. com. arb. 13, 102-103 (2000). 94 see john gotanda, recovering lost profits in international disputes, 36 georgetown journal of international law 61, 62 (2004); sieg eiselen, unresolved damages issues of the cisg: a comparative analysis, 38 comparative and international law journal of south africa 32, 40 (2005/1). 95 see john gotanda, recovering lost profits in international disputes, 36 georgetown journal of international law 61, 89 (2004). 96 id. 12 6. calculation of lost profits is the real issue in the nonuniformity of decisions in the opinion of the scholar john gotanda, tribunals have not had trouble determining whether a claimant is entitled to lost profits.87 the cause of the seemingly arbitrary awards is due to the complex process of calculating the lost profits.88 the discrepancies in national laws over the requirements and limitations of evidentiary standards are not problematic and the lack of national guidance on calculation of profits is the real issue.89 indeed, professor gotanda states that the fact that awards of lost profits by tribunals deciding transnational contract disputes seem to vary greatly is not in-and-of-itself a cause for concern.90 claims for lost profits raise arguably the most complicated issues for tribunals deciding international contract issues.91 this is due to the process of calculating lost profits; where tribunals must select a process from a number of calculation methods, examine financial data, and then apply projections where a small change in a variable can produce large swings in the amount of an award.92 this task may produce awards of lost profits that often seem inconsistent or arbitrary, but “ [s]uch a computation made in advance on the basis of purely theoretical data cannot hope to be absolutely accurate but only comparatively likely.” 93 therefore, the lack of uniformity in lost profit awards can be attributed to the fact that tribunals must proceed in the complex calculation of lost profits without any universal rules and with only the knowledge available at the time of the hearing.94 a. the lack of universal rules for the calculation of lost profits the most difficult cases for tribunals to determine lost profits involve the breach of a long term contract.95 this is because of the speculative projections of future earnings that may be greatly affected by changing and unpredictable economic conditions.96 interest rates, energy prices, and raw material costs all contribute to the complex process of forecasting the financial data necessary for the calculation of long term lost profits. for example, a buyer that enters into a long term contract with a seller for goods to be distributed on a national scale might incur lost profits if the seller fails to deliver the goods. the amount of lost profits will depend on current and future market share, current and future competition, future consumer purchasing habits, economic trends, future energy costs, and future transportation costs, among a multitude of other variables. nordic journal of commercial law issue 2006 #1 97 id. at 92. 98 id. 99 id. at 89. 100 id. at 90-91. 101 id. at 99. 102 id. quoting himpurna cal. energy ltd. v. pt. (persero) perusahaan listruik negara, reprinted in 25 y.b. com. arb. 13, 10203 (berm.-indon. 2000). 13 the obvious difficulty in calculating a precise amount of lost profits while taking these variables under consideration forms the essence of the problems facing tribunals and courts. in addition, the inclusion of mitigation responsibility for an aggrieved party under article 77 cisg may impact a tribunal’s decision. in icc final award in case no. 5946, lost profits were awarded for the duration of a forty month contract.97 conversely, icc final award in case no. 7006 only included the lost profits from one year of a long term contract under the determination that the claimant could have mitigated the losses after that year.98 an additional concern in the calculation of lost profits is how to calculate future cash flows to reflect the current loss. the generally accepted way for parties and tribunals to determine an award of future lost profits due to a breach of contract is the discounted cash flow (dcf) method.99 this method utilizes a discount rate to apply to the award of future profits to determine the amount in present day dollars. the problem with the dcf method is that it is difficult to apply in practice.100 not only is the determination of future cash flows dependent on estimations and future predictions, but selection of a discount rate is also a complex calculation dependent on any number of historical, current, and future financial variables. b. estimation and variability in financial claims is normal the use of dcf to calculate lost profits is a complicated process that contributes to the lack of uniformity in lost profit awards. however, businesses and financial institutions perform dcf calculations as part of normal business practice and operations. the variance in possible outcomes using the method is not a cause for concern and simply reflects the attempt to quantify an amount that is dependent on unpredictable variables.101 one tribunal summed up the process with the following: there is no reason to apologise for the fact that [the approach used to calculate lost profits, in this case the dcf method,] involves approximations; they are inherent and inevitable. nor can it be criticised as unrealistic or unbusinesslike; it is precisely how business executives must, and do, proceed when they evaluate a going concern. the fact that they use ranges and estimates does not imply abandonment of the discipline of economic analysis; nor, when adopted by the arbitrators, does this method imply abandonment of the discipline of assessing the evidence before them.102 thus, the most common method of calculating lost profits, the dcf method, contributes to the apparent discrepancies and arbitrariness of lost profit awards. however, the ability to forecast long nordic journal of commercial law issue 2006 #1 103 see joseph lookofsky, understanding the cisg in the usa (1995), at 80, n. 113. 104 id. at 80. 105 id. referencing restatement 2d of contracts §351(3): designed to prevent compensation for “ disproportionate (albeit foreseeable) loss.” 106 see john gotanda, recovering lost profits in international disputes, 36 georgetown journal of international law 61, 87 (2004). 107 id. at 89, 90-91. 108 id. at 109, 109-110. 14 term lost profits in the absence of perfect foresight requires some calculation techniques that will not be completely accurate. the use of dcf with its inherent weaknesses should be continued with the following suggestions for improvement in the next section of this paper. 7. possible solutions a. how to achieve a more consistent standard of proof for lost profits what standard of proof is required to establish lost profits is an undecided question. tribunals and courts have divergent opinions on what standards are within the cisg, whether recourse to procedural law of the lex fori is appropriate, or to utilize article 7(2) cisg and apply general principles within the cisg or from private international law such as unidroit. the inconsistency in awards of lost profits can be readily traced to these different approaches to the issue. one solution proposed by a scholar would be to develop a body of judge-made international rules, a lex mercatoria.103 he suggests that this method would support a uniform interpretation for lost profit standards of proof and recovery within the cisg regime.104 the lex mercatoria rule could supplement article 74 cisg in a manner similar to §351(3) of the restatement 2d of contracts.105 this concept is familiar in the common law as a form of stare decisis, where previous decisions by courts or tribunals are followed as precedent rather than reinventing the wheel with every new case. however, the concept of a lex mercatoria as providing a precedent for numerous domestic forums would likely face resistance in civil law jurisdictions, where stare decisis is not the norm. but given the confusion and diversity of approaches in determining what standard should be applied to proof of lost profits, the concept of a lex mercatoria for damages might warrant its application in some fashion. b. how to improve the calculation of lost profit awards the scholar john gotanda has submitted that the discrepancies in lost profit awards are not a cause for concern, but rather the lack of uniform rules for the calculation of lost profits.106 the general calculation method, dcf, has inherent flaws which contribute to divergent opinions on the amount of possible awards.107 however, he suggests that the dcf method is structurally sound and grounded in economic theory and practice: any steps to improve consistency in arbitral awards should concentrate on its application.108 nordic journal of commercial law issue 2006 #1 109 id. 109-110. 110 id. 111 id. 112 id. 113 id. at 109. 114 id. 115 id. 116 id. 117 id. 15 the first method to improve lost profit calculations would be to employ experts to assist in evaluating claims.109 the use of experts may help tribunals and parties better understand the complexities involved in calculating lost profits and lead to more consistent and reasoned decisions.110 the drawback from the use of experts would be the increased cost of arbitration and an increase in the time necessary to resolve disputes.111 these possible drawbacks can likely be overcome by the benefit of an expert’s skill when substantial sums are at risk.112 the use of experts should not face resistance from parties and tribunals other than in the additional costs it would entail. any party involved in a dispute with a sizeable claim of lost profits should seriously consider the use of experts to assist in the calculation process. a second method that would lead to more uniformity in decisions concerning the calculation of lost profits would be to employ final offer arbitration, utilized in baseball contract negotiations.113 final offer arbitration calls for the parties to propose an amount that the respective sides should be entitled to and the tribunal then chooses between the two totals.114 the advantage of this form of arbitration is that it forces the parties to be more reasonable in their positions and to be more realistic with their calculations.115 theoretically, this should lead to a narrowing of the gap between the amount of lost profits submitted by a claimant and the amount of lost profits a respondent believes it owes.116 final offer arbitration has great potential as a tool to increase the uniformity of lost profit awards. by increasing the risk to parties for submitting overly speculative claims, lost profit awards should become more consistent and reasonable. the final technique suggested by john gotanda to assist in calculating lost profits is to contractually stipulate how to calculate the losses.117 the inclusion of contractual terms for resolving various issues that inevitably arise during disputes is logical and reasonable. realistically, the insertion of terms becomes an issue of practicality, where parties engaged in commerce often do not stipulate many potential terms due to time constraints. however, merchants or companies that conclude large and substantial contracts should probably include some terms concerning lost profit calculations as a measure to limit financial exposure. 8. conclusion the lack of consistency in lost profit awards can be attributed to the divergent opinions on what standard of proof to use for establishing lost profits. while one scholar submits that tribunals do not have difficulty in determining a standard of proof to assess evidence, the various approaches to the issue demonstrate a lack of consensus. it is hard to imagine that utilizing evidentiary standards of the lex fori, unidroit principles, and arbitrator discretion all result in uniform nordic journal of commercial law issue 2006 #1 16 decisions. the use of a single standard, possibly the unidroit principle of reasonableness, would likely lead to more consistent results. the difficulties in the calculation of lost profits, described by john gotanda, also contribute to the arbitrariness of damage awards. the dcf method is a suitable process to determine calculations of long term profits. the suggestion of using final offer arbitration and experts to assist parties and tribunals in assessing and determining lost profit claims could lead to more uniform decisions and warrants further research. microsoft word islam.doc nordic journal of commercial law issue 2010#2 trips agreement and economic development: implications and challenges for least-developed countries like bangladesh by mohammad towhidul islam∗ ∗ the author is a phd candidate at the macquarie law school, sydney, australia and an assistant professor of law at the university of dhaka, dhaka, bangladesh. he is very thankful to ms. katja weckström, editor-in-chief of the nordic journal of commercial law and the anonymous reviewer for their comprehensive review of this article with insightful suggestions and comments. the author can be contacted at towhid.islam@mq.edu.au. nordic journal of commercial law issue 2010#2 1 1. introduction least-developed countries (ldcs) like bangladesh could benefit from increasing demand and appropriate intellectual property rigths (iprs) especially for patented agricultural and pharmaceutical goods. iprs protection could be used as a vehicle for economic development through trade.1 by appropriating rights, the country could use its comparative advantage of reverse-engineering, adding value through adaptation of existing technology goods (knowledge goods) accessed in formal and non-formal means. however, as a part of ensuring economic benefits to innovators, the world trade organization (wto) agreement on trade-related aspects of intellectual property (trips)2 obliges its members, irrespective of their level of development, to offer strict iprs protection in knowledge goods, including comprehensive control on technology diffusion. in theory, protection aims to foster beneficial technological development furthering innovation and increasing economic growth.3 however, quantitative research shows that iprs do not often contribute to economic growth leading to economic development in countries below a development threshold of about us$3,400 in gross domestic product (gdp), since countries at such a low level of development can neither 1) afford research and development (r&d), 2) or the technology, nor 3) do they have the ability to imitate, absorb, assimilate, replicate or do duplicative imitation of foreign inventions to meet consumption needs or fulfill economic goals.4 in addition, quantitative research implies that in countries which have little ability to imitate to meet survival needs, standardizing iprs protection not only restricts the previously free use of technology/knowledge goods, but also increases the cost of technological acquisition.5 in fact, 1 economic development commonly refers to economic performance in terms of human development and the human development supplements economic development by incorporating social welfare considerations and of sustainable development. see details, graham dutfield and uma suthersanen, global intellectual property law (2008) 272. 2 agreement on trade-related aspects of intellectual property rights, 15 april 1994, marrakesh agreement establishing the world trade organization, annex 1c, 33 i.l.m. 1197 [hereinafter trips agreement]. 3 gino gancia and fabrizio zilibotti, ‘technological change and the wealth of nations’ (2009) 1 annual review of economics 93. 4 see nagesh kumar, ‘intellectual property rights, technology and economic development: experiences of asian countries’ (study paper 1b, commission on intellectual property rights, united kingdom, 2002); mark a thompson and francis w rushing, ‘an empirical analysis of the impact of patent protection on economic growth: an extension’ (1999) 24 journal of economic development 1. they employ threshold regression techniques finding a threshold at an initial level of gdp of $3,400 (in 1980 dollars). for countries below this value there is no significant relationship between ipr protection and growth, but above, the relationship is positive and significant. 5 daniel gervais, ‘trips 3.0: policy calibration and innovation displacement’ in chantal thomas and joel trachtman (eds), developing countries in the wto legal system (2009) 391-392. nordic journal of commercial law issue 2010#2 2 historical analysis suggests that such free use of technology/knowledge goods once helped today’s developed countries to make economic progress.6 furthermore, in return for the inconvenient obligations, the trips does not provide for increased foreign direct investment (fdi) or trade in technology or knowledge goods that would aid ldcs and their economic welfare.7 however, to alleviate the restriction on use of technology, the trips allows for some flexibilities, including compulsory licenses or farmers’ privileges of saving, re-sowing or exchanging seeds based on ordre public8 and morality, as well as certain special and differential treatment in terms of an extended deadline for compliance and a promise of technology transfer.9 such exceptional treatment that legalizes informal technology and leads to follow-on innovations, holds some economic development prospects for ldcs, like bangladesh. however, such development is placed in disencouraging circumstances, under a constant fear of economic sanctions, loss of market access and imposition of the trips-plus obligations10. in addition, in apprehension of competition between developed and developing countries over low-cost manufacture and trade of pharma and agri goods, the trips severly curtails development by requiring ldcs to fulfill prerequisites for availing themselves of the compulsory licensing-mechanism tailored for access to patented pharmaceuticals and supplying domestic and export markets, or of utilizing farmers’ privileges in maintaining traditional farming practices.11 6 anil k lal and ronald w clement, ‘economic development in india: the role of individual enterprise (and entrepreneurial spirit)’ (2005) 12(2) asia-pacific development journal 81. 7 see robert l ostergard, ‘economic growth and intellectual property rights protection: a reassessment of the conventional wisdom’ in daniel j gervais (ed), intellectual property, trade and development (2007) 115-55; william m landes and richard a posner, the economic structure of intellectual property law (2003) 413-15. 8 the term ‘ordre public’ is derived from french law. it is very difficult to translate it into english, and therefore the original french term is used in article 27.2 of the trips agreement. it indicates concerns about matters threatening the social structures which bind a society together, i.e., matters that threaten the structure of civil society as such. 9 nagesh kumar, ‘intellectual property rights, technology and economic development: experiences of asian countries’ (2003) 38(3) economic and political weekly 209. 10 trips plus includes any new standards that restrict the ability of member countries to: 1) promote technological innovation and to facilitate the transfer and dissemination of technology; 2) take necessary measures to protect public health, nutrition and to promote the public interest in sectors of vital importance to their socio-economic and technological development; or, 3) take appropriate measures to prevent the abuse of intellectual property rights by right holders or the resort by right holders to practices which unreasonably restrain trade or adversely affect the international transfer of technology. as a result, the trips plus concept covers both those activities aimed at increasing the level of protection for right holders beyond that which is given in the trips. in addition, such measures reduce the scope or effectiveness of limitations on rights and exceptions under the trips. see for details, sisule f musungu and graham dutfield, multilateral agreements and a trips-plus world: the world intellectual property organization (wipo) (trips issues paper 3, quaker united nations office (quno), geneva and quaker international affairs programme (qiap), ottawa, 2003) <http://www.geneva.quno.info/pdf/wipo(a4)final0304.pdf> 8 july 2010. 11 m rafiqul islam, international trade law of the wto (2006) 380. nordic journal of commercial law issue 2010#2 3 much has been written on the potential costs and benefits of the trips protection for iprs, particularly in developing countries, in terms of economic development determinants such as innovation and technology transfer. they express either critical or cautious views about the impact of the trips on economic development, especially for ldcs.12 among them, a number of reports have either claimed that the trips and the current trends in international intellectual property rule-making, are harmful for development or suggests that some aspects of them may be. such reports are for example, the human development reports of 1999, 2000, 2001 published by the united nations development programme (undp)13, another undp publication ‘making global trade work for people,’14 as well as the world bank report ‘global economic prospects and the developing countries 2002’.15 useful and high quality documentation has also been produced in support of developing countries in forums of quaker united nations office, the south centre, the international centre for trade and sustainable development (ictsd) and united nations conference on trade and development (unctad). almost all of them invariably hold that the trips ‘onesize-fits-all’ approach to harmonizing international iprs makes little economic sense for developing and least developed countries.16 these studies concur that countries, which have capacity for innovation or reverse-engineering, utilize the trips rules and exception clauses as economy invigorating tools in order to manufacture and supply products at home and abroad. however, even these countries, as the documents suggest, need technology-transfer or other technology adaptation packages for their development. the suggested packages include forming 12 dutfield and suthersanen, above n 1, 275. 13 united nations development programme, ‘human development report 1999’ [hereinafter undp]. <http://hdr.undp.org/en/media/hdr_1999_en.pdf> 10 july 2010; undp, ‘human development report 2000’ <http://hdr.undp.org/en/media/hdr_2000_ch0.pdf> 10 july 2010; undp, ‘human development report 2001’ <http://hdr.undp.org/en/media/completenew1.pdf> 10 july 2010. 14 undp, ‘making global trade work for people’ <http://content.undp.org/go/cms-service/stream/asset/;jsessionid=ajpgrjsxo-nd?asset_id=1948257> 10 july 2010. 15 world bank, ‘global economic prospects and the developing countries’ <http://siteresources.worldbank.org/intgep2002/resources/gep2002complete.pdf> 10 july 2010. 16 sisule f musungu, rethinking innovation, development and intellectual property in the un, wipo and beyond (2005) (trips issues paper no. 5, quaker international affairs programme) <http://www.qiap.ca/pages/documents/trips53.pdf> 8 july 2010; graham dutfield and uma suthersanen, harmonisation or differentiation in intellectual property protection? the lessons of history (occasional paper 15, quaker united nations office, geneva, august 2004) <http://www.quno.org/geneva/pdf/economic/occassional/harmonisation-or-differentiation.pdf> 8 july 2010; unctad-ictsd, resource book on trips and development (2005) 61-91; sisule f musungu et al., utilizing trips flexibilities for public health protection through south-south regional frameworks (south centre, geneva 2004) <http://www.southcentre.org/publications/flexibilities/flexibilities.pdf> 8 july 2010. nordic journal of commercial law issue 2010#2 4 common fund to initiate r&d and supply inputs to countries or supporting open sources of knowledge used in a product.17 there is also specific analysis on the trips costs and benefits in pharmaceuticals and agriculture, for some newly industrialized countries (nics) and developing countries, which endorse striking a balanced compromise between iprs protection and development needs.18 the study conducted by the united kingdom government-sponsored commission on intellectual property rights is one of them. this study is perhaps the most thorough and widelypublicized study on the intellectual property-development nexus.19 its main argument is that due to different scientific and technological capacities and social and economic structures prevailing in developing countries, an optimal intellectual property system is bound to vary widely from country to country.20 consequently, while it appears that developing countries that have relatively advanced scientific and technological capacities, like india and china, may well benefit from high levels of iprs protection in some areas, many other countries, like bangladesh, senegal or niger, are likely not to do so. for bangladesh, it is not the trips itself with the high protection for iprs that would assist in achieving developmental objectives with innovation. such protection measure would rather relegate the gradually rising pharmaceutical firms and seeds industry to low value added segments and hinder its economic development.21 however, the protection measure conjoined with other factors such as market conditions, technology development policies, education etc. is likely to help such least developed economy gaining technology transfer by means of attracting fdi, licensing, joint ventures, material transfer agreements (mta) and others, and the exception clauses would hold some economy stimulations especially in agriculture and pharmaceuticals with reverse engineering.22 in order to overcome concerns and give effect to the economic prospects of the trips, this article offers policy recommendations to design a legal and infrastructural basis for this process in bangladesh. with this goal in view, the study advances a model that attempts to extend iprs protection, while meeting consumer needs and accommodating economic goals. based on the 17 dutfield and suthersanen, above n 1, 275-81; gervais, above n 5, 363-393. 18 for example, anitha ramanna, ‘intellectual property rights in south asia: opportunities and constraints for technology transfer’ in suresh chandra babu and asok gulati (eds), economic reforms and food security: the impact of trade and technology in south asia (2005) 188-9. 19 ibid. 20 commission on intellectual property rights, integrating intellectual property rights and development policy (2002), <http://www.iprcommission.org/papers/pdfs/final_report/ciprfullfinal.pdf> 20 march 2010 [hereinafter cipr]. 21 ibid. 22 keith maskus, ‘the role of intellectual property rights in encouraging foreign direct investment and technology transfer’ in c fink and k maskus (eds), intellectual property and development: lessons from recent economic research (2005) 70-1. nordic journal of commercial law issue 2010#2 5 reality of the trips, a standard economic theory of iprs, the benefit of hind-sight and previous empirical studies of iprs regime-changes in some nics and developing countries, this article recommends some legal and technological strategies for bangladesh that best utilize the trips rules, the trips transitional period and its clauses regarding agriculture and pharmaceuticals. the recommendations are drafted with the broader goals of fulfilling subsistence needs, increasing exports and thus, ultimately creating and enhancing economic development. at the same time, this study urges bangladesh and other ldcs to join the international coalition pressing for a rethink of the trips due to its implications and seeking alternatives, like the inclusion of specific and binding technology-transfer arrangements in the trips that takes into account the actual level of development of ldcs. 2. the relationship between intellectual property rights and economic development: historical analysis the relationship between iprs and economic development has been complicated since the beginning of international system for iprs protection in the 19th century. developed countries particularly britain and america viewed intellectual property rights as an instrument for promoting economic development through innovation of technology and its formal transfer.23 at the heart of the anglo-american iprs system is the belief that limited monopoly rights in the name of iprs are necessary to promote creativity and innovation, to transfer innovated technology and thus to make economic development.24 that belief is said to have based on the reward/justificatory theory and stamped with personality/privatisation of the property on achieving command over property/technology. the establishing of iprs command over technology came in prevention of the then rampant informal technology diffusion through industrial espionage by countries such as france, sweden, norway, denmark, the netherlands, and belgium.25 however, it is a fact that industrial espionage and inadequate protection of iprs of foreign citizens helped previously most of the now-developed countries in freely accessing foreign technologies and causing improvements to them.26 in addition, at that point of time, patent laws in most countries including britain, the us, the netherlands, austria, and france were 23 ha-joon chang, globalisation, economic development and the role of state (2003) 278. 24 ramanna, above n 18, 188-9. 25 for instance, in the 1950s, a former manchester textile finisher and jacobite office, john holker, was appointed as inspector general of foreign manufacturers in the french government. while also advising french producers on technological problems, his main activity under this euphemistic job title consisted of industrial espionage and suborning of british skilled workers. see j harris, industrial espionage and technology transfer: britain and france in the eighteen century (1998) 21. 26 kumar, above n 4. nordic journal of commercial law issue 2010#2 6 very lax on checking the originality of the invention and often explicitly allowed patenting of imported inventions by their nationals.27 for example, in the us, before the 1836 restoration of the patent law, patents were granted without any proof of originality. this not only led to the patenting of imported technologies but also encouraged racketeers to engage in rent-seeking by patenting devices already in use and by demanding money from their users under threat of suits for iprs infringement.28 with the introduction of such rent-seeking iprs laws in an increasing number of national jurisdictions and their trade presence in international arena, the pressures for an international iprs regime naturally started growing from the late-19th century. after several attempts, iprs get codified in an international regime comprising of the paris convention for the protection of industrial property (paris convention) and the berne convention for the protection of literary and artistic works (berne convention) paving the way for achieving economic development through innovation and guided technology transfer. however, with the ineffectiveness and flexibility of the iprs protection regime due to shorter period of protection and limited scope, a private good turns public once a good has been supplied and it allows an individual to get access to it free of charge without reducing the availability of the good to other individuals. such trend of public goods encouraging informal technology transfer assists individuals to easily copy the information. with taking on such option, even the most developed countries were routinely violating the iprs of other countries’ citizens well into the 20th century. for example, as late as in the late-19th century, britain was in a great concern with its iprs violation by germany who was at that time about to technologically overtake britain.29 the continuation of such trend of public goods encouraging informal technology transfer also helps some nics to develop.30 in fact, countries that possess reverse engineering capacity adopt the policy of freely using technology. for example, this free use-cum informal technology transfer brings in economic development to south korea, taiwan, singapore, and brazil in the pre-trips era.31 countries like china, india, argentina, malaysia and others also make good use of such policy and become competitors to industrialized countries. in addition to appropriation of technologies, the favourable market conditions also enable these nics or developing countries to attract fdi, and lead the economy to a progress. they believe a certain level of technology and capital requires before higher levels of iprs will assist in development since they find that piracy of iprs benefited many of the developed world earlier in promoting 27 w a dolfsma, ‘iprs, technological development, and economic development’ (research paper ers-2006-004org, erasmus research institute of management (erim), erasmus university, 2006). 28 ha-joon, above n 23, 279. 29 d landes, the unbound prometheus: technological change and industrial development in western europe from 1750 to the present (1969) 328. 30 ha-joon, above n 23, 281-2. 31 keith e maskus and jerome h reichman, ‘the globalization of private knowledge goods and the privatization of global public goods’ (2004) 7(2) journal of international economic law 279. nordic journal of commercial law issue 2010#2 7 economic development. for this, many developing nations did not recognize patents on medicines and agriculture. however, most of the ldcs fail to grossly avail of the iprs flexibility since they lack either the infrastructure necessary (e.g. presence of patents on medicines and agriculture) to engage in piracy or conditions that attract fdi, or capabilities/finance to afford technology and negotiation to press developed countries to transfer technology to them in consideration of development needs.32 as a way out to fulfil development needs in the existing context, developing countries that do not have r&d capacity to introduce innovation based economic development have long sought to use both national policies and international agreements to stimulate international technology transfer for making economic prosperity. they adopted national policies moving from the general, such as education and iprs protection, to the specific, such as tax incentives for purchase of certain types of capital equipment. to this effect, various agreements are also furnished between countries but agreements regarding actions that governments should pursue to encourage international technology transfer are largely of a best-endeavour nature. so, there arises the necessity to have a binding international agreement.33 with the view to effectuate technology transfer in a binding international agreement, the first official attempt to challenge the paris convention-led iprs regime for failing to meet the development needs of poor countries was made in 1961, when brazil submitted a draft resolution co-sponsored by bolivia to a committee of the united nations (un) general assembly. the draft put forward various concerns including the access to knowledge and experience in science and technology that is often limited by patents and similar arrangements designed to protect the right of ownership and exploitation of investors of new processes, techniques and products. brazil also requested the secretary general to prepare a report especially containing an indication of possibility of revising iprs legislation in accordance with principles of international law, with a view to permitting the rapid absorption of new products and techniques to accelerate the rate of economic development.34 the international bureaus for protection of intellectual property (birpi) and the international chamber of commerce (icc) were alarmed by the tone of such initiatives which actually seek to shift deliberations on patent standard-setting to the un general assembly. in response, they lobbied for a radical change of the tone. this move came to a success with the general assembly resolution 1713(xvi) entitled ‘the role of patents in the transfer of technology to 32 sanjaya lall, ‘indicators of the relative importance of iprs in developing countries’ (issue paper no. 3, unctad-ictsd project on intellectual property rights and sustainable development, june 2003). 33 bernard m hoekman, keith e maskus, and kamal saggi, ‘transfer of technology to developing countries: unilateral and multilateral policy options’ (2005) 33(10) world development 1587. 34 ibid. nordic journal of commercial law issue 2010#2 8 under-developed countries’.35 the resolution was much liked by both the icc and birpi since it shifted the terms of reference of the requested secretary general’s report in a less patent-hostile direction.36 however, the patent hostility towards developing countries remained. this led the un system to provide spaces for such dislike to be publicized. in 1964 when the first meeting of the unctad was held, it adopted a resolution recommending inter alia that: developed countries should encourage the holders of patented and unpatented technology to facilitate the transfer of licenses, know-how, technical documentation, and in general to developing countries, including the financing of the procurement of licenses and related technology on favourable terms.37 the resolution also calls for organizing additional facilities for information on and for the transfer of technical documentation and know–how within the un framework in consultation with appropriate international organizations.38 in the same year, the un economic and social council adopted a resolution. it concurred that access to knowledge and experience in the field of applied science and technology would facilitate the continued development of industrialization and international economic relations.39 in 1974, the un general assembly adopted two documents namely, the declaration on the establishment of a new international economic order and the programme of action on the establishment of a new international economic order.40 however, neither dealt explicitly with intellectual property. they both covered technology transfer in ways that implied dissatisfaction with the international intellectual property regime for failing to contribute in this regard. such ways appeared as a code of conduct for technology transfer and led to negotiations under the unctad on a draft international code of conduct on transfer of technology. however, no final agreement could be reached.41 35 united nations general assembly resolution a/res/1713(xvi) <http://daccess-ddsny.un.org/doc/resolution/gen/nr0/167/66/img/nr016766.pdf?openelement> 8 july 2010. 36 s p ladas, patents, trademarks, and related rights: national and international protection (1975) 171-4. 37 united nations secretary general, ‘the role of patents in the transfer of technology for developing countries’ 1964 [document e/3681]. 38 dutfield and suthersanen, above n 1, 272-80. 39 economic and social council resolution 1027 (xxxvii), 13 july – 15 august 1964 <http://daccess-ddsny.un.org/doc/undoc/gen/nr0/760/56/img/nr076056.pdf?openelement> 10 july 2010. 40 general assembly resolution a/res/s-6/3201 <http://www.un-documents.net/s6r3201.htm> 8 july 2010 and a/res/s-6/3202 <http://www.un-documents.net/s6r3202.htm> 8 july 2010. 41 dutfield and suthersanen, above n 1, 272-80. nordic journal of commercial law issue 2010#2 9 a similar lack of consensus arose in the early 1980s from efforts by a group of developing countries (group 77) at the world intellectual property organization (wipo) to revise the paris convention but it failed with opposition to such measures from many of the developed countries and also due to differences among the developing countries themselves.42 in order to break the deadlock, the trips agreement was adopted in 1995. it calls on countries to enforce comprehensive minimum standards of iprs protection on a nondiscriminatory basis. it also contains provisions relating to technology transfer, as discussed later in this article. in 2001, wto members established a working group on trade and technology transfer to examine the relationship between trade and technology transfer and explore ways to increase technology flows to developing countries in consideration of their development needs.43 however, the adoption of the trips agreement makes the relationship between iprs and economoc development evermore complicated. this is because the trips puts the policy cart before the empirical horse by equating the introduction of a trips-compatible level of iprs protection with an increase in trade and consequently economic development for all countries alike.44 this equation seems flawed especially when measured in terms of welfare increases.45 with the trips in place, the scope, depth, and enforcement of iprs is likely to differ between countries according to their economic and political institutions, and ability to engage in and disseminate the fruits of inventions.46 in addition, the trips underestimates the development needs of developing countries. this is because the development needs are based on iprsappropriation with the use of flexibilities. however, the trips framework merely serves profiteering interests of developed countries and restricts less developed countries from their existing economy invigorating measures of flexibilities. one is reminded by thomas jefferson, who describes the treaty’s sufficient flexibility in responding to the needs of a developing society as one of the most crucial elements for achieving growth.47 from the above discussion, it appears that in the pre-trips era there has generally been an association between weak rather than strong forms of patent protection allowing informal 42 ibid. 43 ibid. 44 wg park and d lippoldt, ‘international licensing and the strengthening of intellectual property rights in developing countries’, (oecd document td/tc/wp(2004)31/final, 21 december 2004). 45 c fink and ca primo braga, ‘how stronger protection of intellectual property rights affects international trade flows’ in c fink and keith maskus (eds), intellectual property and development: lessons from recent economic research (2005) 19-37. 46 la croix and konan, ‘have developing countries gained from the marriage between trade agreements and intellectual property rights?’ (economics working paper no. 06-5, university of hawaii – manoa, 2006). 47 zorina khan and kenneth l sokoloff, ‘historiacl perspectives on patent systems in economic development’ in neil weinstock netanel (ed), the development agendas: global intellectual property and developing countries (2009) 215-243. nordic journal of commercial law issue 2010#2 10 technology transfer and economic development enabling countries to become significant producers of innovations and new technology as seen in korea and india.48 as the iprs regimes strengthened, nics and some developing countries coped up with and became champion in creation and trade of cheaper technology but developing and least developed countries felt for fine-tuning technology transfer provisions in the iprs regimes. in line with the formative economic development history, bangladesh follows largely the pursuit of informal technology transfer in absence of local r&d and technology access through fdi. however, until the 1970s and 1980s most of the economy relied on the traditional agricultural sector due to lack of human resources and scientific and technological infrastructure, and resulted in low levels of industrial development. with liberal economic policies introduced worldwide in 1990s, such state of petite development prompts an ldc like bangladesh to have some dependence on foreign technology either through fdi or informal technology transfer i.e. copying and imitation of foreign technology as a good alternative tool for its economic development.49 policy reform was also initiated through structural adjustment programs and enhanced structural adjustment programs that were initiated in 1982, 1985-1986 and then again in 1991-1992, which resulted in a unilateral trade liberalization of bangladesh’s economy.50 3. the relationship between intellectual property rights and economic development: theoretical and empirical analysis 3.1 theoretical background there are many theoretical and empirical studies determining the impact of iprs on economic growth that leads to economic development.51 however, only a few studies have been done for non-oecd (organization for economic co-operation and development) countries, particularly ldcs, mainly because of problems relating to the collection of data. some studies are based on economic theory, while others are based on empirical research with country 48 kumar, above n 4. 49 carlos m correa, ‘pro-competitive measures under trips to promote technology diffusion in developing countries’ in peter drahos and ruth mayne (eds), global intellectual property rights: knowledge, access and development (2002) 41. 50 padmashree gehl sampath, ‘intellectual property and innovation in least developed countries: pharmaceuticals, agro-processing and textiles and rmg in bangladesh’ (background paper no. 9, the least developed countries report 2007, unctad, geneva, 2007); m a hossain and md karunarathne, ‘export response to the reduction of anti–export bias: empirics from bangladesh’ (discussion paper no. 303, school of economics, the university of queensland, brisbane, 2002); c a f dowlah, ‘bangladesh’ in m d ingco (ed), agriculture, trade and the wto in south asia (2003). 51 rod falvey, neil foster, and david greenaway, ‘intellectual property rights and economic growth’ (2006) 10(4) review of development economics 700; walter g park and juan carlos ginarte, ‘intellectual property rights and economic growth’ (1997) 15(3) contemporary economic policy 51; d m gould and w c gruben, ‘the role of intellectual property rights in economic growth’ (1996) 48(2) journal of development economics 323. nordic journal of commercial law issue 2010#2 11 specific analysis. the economic studies proceed on the assumption that every country in trade with strong iprs protection will benefit, and therefore, a positive relationship exists between strong iprs and economic growth leading to development.52 this assumption is based on the fact that iprs in general contribute to economic development by ensuring rewards to innovators for bringing new technologies and products to market.53 based on the same hypothesis it is claimed that the hope of economic rewards coming out of strong iprs persuades innovating countries to transfer technologies to developing and least developed countries.54 however, the economic benefit-argument, which developed countries use in trying to convince developing countries to adopt strong protection measures, seems based on unstable ground. first, adopting stronger iprs regimes in developing and least-developed countries promotes the economic growth of developed countries, possibly to the detriment of the economic development of developing and least-developed countries.55 second, the evidence suggests that unless ldcs enhance the skill-level or absorptive capacity of domestic firms in improving their productivity56 and contain iprs in competition policies or make them responsive to taxes, trade practices, tariffs, or contract laws, strengthening iprs to a certain extent offsets its growthenhancing benefits, since it requires domestic firms to shift from imitation to innovation and to facilitate other activities with growth-enhancing technology spillovers.57 however, empirical research shows that countries like senegal and niger, who have iprs laws similar to those of developed countries and tend to protect foreign iprs, still struggle in making economic progress and are not fulfilling consumption needs and economic goals. yet, they face the ’development dilemma’ by receiving political and economic threats for not protecting foreign iprs and promoting others’ economic growth.58 consequently, as the empirical evidence shows that for developing and least developed countries, iprs monopolise subsistence goods, impede technology transfer, and restrict the country’s comparative advantage in reverse-engineering, 52 keith e maskus, intellectual property rights in the global economy (2000) 150. 53 alireza naghavi, ‘strategic intellectual property rights policy and north-south technology transfer’ (2007) 143(1) review of world economics 55; robert sherwood, ‘some things cannot be legislated’ (2002) 10 cardozo journal of international and comparative law 37, 39-40; keith maskus, ‘intellectual property rights and economic development’ (2000) 32 case western reserve journal of international law 471. 54 gervais, above n 5, 391-392. 55 dov greenbaum, ‘determining optimal levels of intellectual property protection in developing nations: is less really more? is more really less?’ (2009) 97(11) current science 1604. 56 daniel gervais, ‘the trips agreement and the doha round: history and impact on economic development’ in p k yu (ed), intellectual property and information wealth: issues and practices in digital age (2007) 2372. 57 maskus and reichman, above n 31, 279; james boyle, ‘a manifesto on wipo and the future of intellectual property’ [2004] duke law and technology review 0009. 58 cipr, above n 20; anselm kamperman sanders, ‘intellectual property treaties and development’ in daniel gervais (ed), intellectual property, trade and development: strategies to optimize economic development in a trips plus era (2007)157-70; srividhya ragavan, ‘the jekyll and hyde story of international trade: the supreme court in phrma v walsh and the trips agreement’ (2004) 38 university of richmond law review 777, 789. nordic journal of commercial law issue 2010#2 12 with the consequence of putting off meeting consumption needs and increasing economic welfare.59 in contrast, countries like south korea, taiwan, and brazil have enhanced the absorptive capacity of their domestic firms improving their productivity by using a soft iprs regime in the pre-trips era, strengthened iprs post-trips to progress by accessing technology (transferred from developed countries), making inventions with minor adaptations of existing technologies, protecting these inventions from infringement, and hence encouraging domestic firms to increase investments and productivity. this method allowed them to finally change their status to nics.60 it thus appears that iprs protection help innovating western countries to make gradual economic progress, since iprs in the name of patents, trademarks and trade secrets afford firms greater certainty that they will face only limited threats of uncompensated appropriation. this certainty induces them to trade and license their technologies and products more readily, enhancing their diffusion into the economy. nevertheless, such security for investment through iprs protection brings in economic insecurity for developing and least developed countries in fulfilling their development needs based mostly on iprsappropriation. this is because for countries at a lower level of development that cannot afford r&d or technology, iprs protection is of no use in initiating innovation-based economic development. however, for them strengthening iprs would benefit technology transfer-based economic development when they attain certain level of technology-absorption capacity and make small investments in small and medium enterprises (smes). and for protecting such investments against unfair competition and misappropriation, iprs protection especially patent or trademark would be of a great necessity for them. lack of such iprs protection is likely to strangle their own technical change-based innovations, and thus hamper their creativity with patent or trademark infringement.61 in addition, inadequate iprs protection makes countries dependent on dynamically inefficient firms that rely on counterfeiting and imitation.62 such circumstances make developing and least developed countries with technology absorption capability (for example, bangladesh) feeling obligated to have iprs systems that favour information-diffusion 59 carlos m correa, intellectual property rights, the wto and developing countries: the trips agreement and policy options 18-19; mark ritchie, kristin dawkins, and mark vallianatos, ‘intellectual property rights and biodiversity: the industrialization of natural resources and traditional knowledge’ (1996) 11 st. john's journal of legal commentary 431; daryl lim, ‘innovation and access: legal strategies at the intellectual property rights and competition law interface’ in antoine masson and mary j shariff (eds), legal strategies: how corporations use law to improve performance (2010) 403-37. 60 carlos m correa, ‘can the trips foster technology transfer to developing countries?’ in keith maskus and jerome h reichman (eds), international public goods and transfer of technology under a globalised intellectual property regime (2005) 227-8. see also kumar, above n 4. 61 r evenson and l westphal, ‘technological change and technology strategy’ in j behrman and t n srinivasan (eds), handbook of development economics (1995) 2209-2300. 62 maskus, above n 53, 479-81. nordic journal of commercial law issue 2010#2 13 through low-cost acquisition of foreign products and technologies.63 so, it appears that there exists relationship between iprs and economic development and it is most likely dependent on the determinants of innovation and technology transfer.64 3.2. innovation as a determinant to economic development in intellectual property-economic development nexus, innovation is but one ingredient of a complex recipe.65 iprs rules allow local consumers and industry gain lawful access to innovations i.e. knowledge products and services for making further innovations.66 for example, through publication patent claims in innovations allow rival firms to use the information in them to imitate/develop further inventions.67 insofar as developing countries are concerned, innovation for them often proceeds through imitation of foreign technology and products, which requires some technical skills, then modification or improvements of the technology.68 intellectual property rights play a significant role in encouraging such innovation, product development, and technical change by stimulating acquisition and dissemination of new information.69 a recent paper by chen and puttitanun which made empirical research on a sample of 64 developing countries using panel data over the period 1975-2000 shows that domestic innovation in a country increases in its protection of iprs and its level of development.70 two similar studies by kanwar and world bank also find that innovations proceeding through imitation of foreign technology and 63 ulrike pokorski da cunha, study on the viability of high quality drugs manufacturing in bangladesh (2007) 26-8 (deutsche gesellschaft für technische zusammenarbeit (gtz) gmbh commissioned by federal ministry for economic cooperation and development, eschborn , germany 2007). 64 keith e maskus, ‘intellectual property challenges for developing countries: an economic perspective’ [2001] university of illinois law review 457. 65 the other drivers are trade, finance, migration and aid. see i goldin and k reinert, globalization for development: trade, finance, aid, migration and policy (2007) 21-46; samuel adams, 'globalization and income inequality: implications for intellectual property rights' (2008) 30 journal of policy modeling 725. 66 k maskus, ‘the economics of global intellectual property and economic development: a survey’ in peter k yu (ed), intellectual property and information wealth: issues and practices in digital age (2007) 158-86; daniel gervais, ‘the trips agreement and the doha round: history and impact on economic development’ in peter k yu (ed), intellectual property and information wealth: issues and practices in digital age (2007) 2372. 67 yi qian, ‘are national patent laws the blossoming rains? evidence from domestic innovation, technology transfers, and implementations in the period 1978-2002’ in neil weinstock netanel (ed), the development agendas: global intellectual property and developing countries (2009) 191-213. 68 adams, above n 65, 725. 69 world intellectual property organization, transfer of technology (2010) 4-9 (scp/14/4, standing committee on the law of patents, fourteenth session, geneva, 25-29 january 2010) <http://www.wipo.int/edocs/mdocs/scp/en/scp_14/scp_14_inf_2.pdf> 10 december 2010. 70 y chen and t puttitanun, ‘intellectual property rights and innovation in developing countries’ (2005) 78 journal of developing countries 474. nordic journal of commercial law issue 2010#2 14 products lead to an increase in agricultural or industrial production in less developed countries that could have positive effect on economic development.71 however, for most of the least developed countries as far as economic development through innovation is concerned, there is no clear domestic economic benefit in maintaining strong iprs protection for innovation since they lack r&d to promote innovation.72 nevertheless, in an ldc like bangladesh who can afford a little technology and possess some absorption capacity, iprs especially trademark protection is likely to encourage innovation through product development and opening of small and medium enterprises (smes) including ready-made garments (rmg), or benefits pharmaceutical generic manufacturers. in bangladesh, the rmg industry claims to have a strong interest in designing apparel of high quality and style targeting european and north-american markets. with the strong enforcement of trademark laws, this sector is likely to create further competition among entrepreneurs with quality product, creation of broader markets, earning foreign currency, and furthering the country’s economic development. trademark protection also carries prospects in the food products sector, where legitimate firms would flourish with the assurance that rivals will not be passing off consumer goods, such as soft drinks (coconut drink), processed foods (shrimps, chutneys, sauces) and spices under their trademarks. related prospects are also therein with innovative producers in the cosmetics, pharmaceuticals, leather, ceramics, and metal products sectors. thus, iprs especially trademark protection is likely to hold bright prospects for smes with local product development and establishment of new enterprises if they are not muffled by infringement with lower quality and loss of reputation. in addition, bangladesh possesses lively copyright industries including publishing, entertainment comprising of film, television, and music, and software. however, weak protection and enforcement, lower-quality copies are widely available and hampering the economy’s domestic cultural and technological development.73 with strong protection of copyright, there could be more innovative writers, film producers, musicians, and software industries whose creations could successfully be exported to neighbouring economies or in developed economies where expatriate people are living. 71 sunil kanwar, ‘intellectual property protection and technology transfer: evidence from us multinationals’ (economics working paper series 2007-05, department of economics, university of california at san diego, 2007); world bank, world development indicators (2005) <http://devdata.worldbank.org/wdi2005/cover.htm> 10 july 2010. 72 maskus, above n 53, 479-81. 73 international intellectual property alliance, ‘2007 special 301: bangladesh’ (12 february 2007) 202; <ww.iipa.com/rbc/2007/2007spec301bangladesh.pdf> at 19 november 2007. nordic journal of commercial law issue 2010#2 15 3.3. technology transfer as a determinant to economic development 3.3.1 theoretical background the relationship between iprs and economic development through the determinant of technology transfer is ambiguous in theory and depends on a country’s circumstances. in theory, iprs can play a positive role in knowledge diffusion, since the information available in patent claims is available to other potential inventors. in addition, strong iprs protection may encourage technology transfer in the process by which a firm in one country gains access to and employs technology developed in another country. for this, the iprs-consistent technology transfer from countries at the technological frontier is considered to be one of the main potential benefits of the iprs system and an essential economic development determinant along with market liberalization and deregulation, technology development policies and competition regimes, and a low level of corruption, particularly for developing countries that tend not to innovate significantly.74 this theoretical claim that strengthening iprs increases the transfer of technology by mncs to reforming countries is tested in a study by branstetter et al. who use affiliate level data on the united states’ (us) mncs and aggregate patent data. the results suggest that technology transfer is higher following ipr reforms, with an increase in technology transfer, as measured by intra-firm royalty payments from parent firms to affiliates located in iprs reforming countries.75 however, such theoretical and country specific prospects appear to be a misfit for ldcs since stronger iprs protection can also restrict the diffusion of technology, with patents preventing others from using proprietary knowledge and the increased market power of iprs holders potentially reducing the dissemination of knowledge due to lower output and higher prices in ldcs.76 now it stands that the iprs-consistent technology transfer brings in economic benefits either to transferors or transferees or both. with such traits in place, international technology transfer occurs sometimes between willing partners in formal transactions, but much comes through non-market transactions or spillovers i.e. informal channels. formal technology transfer takes place by trade in goods and services, with imports of goods having the potential to formally transfer knowledge through reverse engineering, but also through the cross-border learning of 74 rod falvey and neil foster, ‘the role of intellectual property rights in technology transfer and economic growth: theory and evidence’ (working paper, united nations industrial development organizations, vienna, 2006, 23-4) [hereinafter unido]. 75 lee branstetter, raymond fisman, and c fritz foley, ‘do stronger intellectual property rights increase international technology transfer? empirical evidence from u.s. firm-level panel data’ (2006) 121(1) quarterly journal of economics 321. 76 daniel chow, ‘the role of intellectual property in promoting international trade and foreign direct investment’ in peter k. yu (ed), intellectual property and information wealth: issues and practices in the digital age (2007) 187-200. ip promotes all four channels of trade – goods, services, technology transfer and fdi. china is a different case because of its, size, resources and influence. nordic journal of commercial law issue 2010#2 16 production methods, product design, organizational structure and market conditions.77 another formal channel is fdi, inward fdi in particular, with mncs expected to deploy advanced technology to their subsidiaries that may be diffused to host-country firms.78 licensing, which is a further means of technology diffusion involves the purchase of production and distribution rights for a product and the knowledge required to make effective use of these rights.79 the movement of skilled workers across borders can also act as a formal channel for international technology diffusion.80 the non-market channels include imitation, the movement of personnel from one firm to another taking with them specific knowledge of their original firm’s technologies, data in patent applications and the temporary migration of people such as scientists and students to universities and research institutes in advanced countries.81 with the aim to maximise economic benefits out of technology, iprs-consistent standards come into play for technology diffusion and encourage technology transfer in the way of international trade, fdi, licensing, and joint venture in almost all fields of technology for a country.82 3.3.2. international trade/imports with the security of investment in products, iprs protection leads significantly to higher trade or import flows of iprs-sensitive goods, services or inputs to a country.83 however, it is often found that mncs do not base their export decisions on iprs in the poorest countries since such countries have the weakest local threats of imitation and reverse engineering.84 usually, on taking imports or trade, local consumers and industries in countries with technology absorption capacity gain lawful access to those products and services. the access to foreign inputs and technology goods enables local industries to reverse engineer the imported products and learn from them, or enable the imported equipment to impart advanced techniques with aim to increase the productivity and may result in welfare gains for importing countries.85 however, the welfare gains vary by country, being greater in countries with stronger absorptive capacities 77 michael blakeney, ‘a critical analysis of the trips agreement’ in meir perez pugatch (ed), the intellectual property debate: perspectives from law, economics and political economy (2006) 17-32. 78 unido, above n 74, 23-4. 79 ibid. 80 ibid. 81 ibid. 82 joseph straus, ‘the impact of the new world order on economic development: the role of intellectual property rights system’ (2007) 15(1) european review 47-63; chow, above n 76, 187-200; maskus, above n 22, 70-71. 83 unido, above n 74, 29. 84 c fink and keith e maskus, ‘why we study intellectual property rights and what we have learned’ in carsten fink and keith e maskus (eds), intellectual property and development: lessons from recent economic research (2005) 1-15. 85 jonathan eaton and samuel kortum, ‘innovation, diffusion, and trade’ (nber working papers series no. 12385; cambridge: national bureau of economic research, 2006). nordic journal of commercial law issue 2010#2 17 (as measured by the level of local education attainment and research and development investments).86 in addition, increased trade flows may lead to new jobs in distributorships and their retail sector although these are likely to be low-skilled, low-paying positions. there also may be significant gains in terms of product quality and reliability, most notably in the area of high tech industries like pharmaceuticals although high tech firms may decide to serve foreign markets through fdi and licensing, so that exports in such industries may be little affected by variations in the degree of iprs protection.87 this may also however lead to price increases especially when goods whose status changes to pirate or counterfeit after the introduction of iprs protection are displaced by genuine goods sold at a higher price.88 furthermore, while stronger iprs protection may increase imports of high-tech goods, it also increases imports of low-tech consumer goods and may lead to the decline of indigenous industries relying on informal technology transfer especially imitation.89 3.3.3. foreign direct investment iprs protection is now-a-days considered as a pre-condition for fdi. economic analysis also shows that sufficient iprs protection is an essential component of increased inward fdi and trade flows in iprs-sensitive goods for countries cherishing to make economic development since the iprs-initiated fdi brings in investment securities for iprs-owning countries through effective rent payments.90 fdi transfers technology from the parent firm to the subsidiary or through labour mobility between subsidiaries and domestic enterprises or through vertical fdi where different plants produce products that can be used by the plant above it as an input to their product,91 and helps technological goods produced by subsidiaries to find uses locally or creates jobs boosting the local economy.92 in addition, such transfers help recipient countries develop their own capacity to export high-tech goods and learn-by-exporting.93 however, most of 86 ram c acharya and wolfgang keller, ‘technology transfer through imports’ (nber working papers 13086, national bureau of economic research, inc 2007). 87 unido, above n 74, 29. 88 ibid. 89 ibid. 90 gene grossman and edwin l.-c lai, ‘international protection of intellectual property’ (2004) 94(5) american economic review 1635; w g park and d lippoldt, ‘international licensing and the strengthening of intellectual property rights in developing countries during the 1990s’ (2005) 40 oecd economic studies 7. see also michele boldrin and david k.levine, against intellectual monopoly (2008) 42-64. they recognise the need for innovators to be rewarded and to have the right of sale with regard to their ideas. however, they challenge the right to regulate the use of innovations after their sale, they first sell their ideas. 91 ca primo braga and c fink, ‘the relationship between intellectual property and foreign direct investment’ (1998) 9 duke journal of comparative and international law 163, 172-3. 92 gervais, above n 5, 376. 93 b hoekman and b s javorcik (eds), global integration and technology transfer (2007) 118-20. nordic journal of commercial law issue 2010#2 18 the studies conducted so far show that such countries require a minimum economic development threshold, technology absorption capacity and large market conditions.94 despite the role of iprs in attracting fdi and ultimately following-on innovations, required with other components for economic development, some studies illustrate iprs as technology transfer obstacle since mncs are often likely to avoid transfer of their technology through fdi on the ground of having not strong enough iprs therein, in spite of these countries’ efforts in paying costs for technology.95 to test this assumption, smarzynska examines 24 transition economies and finds that weak iprs regimes deter fdi in high-tech sectors (i.e. drugs, cosmetics and health-care products, chemicals, machinery and equipment and electrical equipment) with some evidence suggesting that fdi is deterred in other industries too.96 in 14 countries surveyed, lee and mansfield find stronger evidence that the strength of iprs affects the volume and composition of the us mncs’ fdi decisions in host countries.97 however, it is also found in other studies that iprs play less of a role in high-tech industries due to the difficulty in imitating these industries’ products, while in low-tech industries other factors may be more important in determining fdi flows.98 having realized the role of fdi in economic development, government officials from a range of economies have pointed to strengthened iprs as a floorboard in their strategies to enhance fdi inflows and trade.99 for example, experts in some poor developing countries have seen the institution of trademark protection as a vehicle for reassuring investors in manufacturing industries that they can combat knock-offs. for wealthier countries, enhancement of iprs may be seen as a means to draw in high technology that can boost worker productivity and contribute to intensification of growth.100 this realization is reflected in the empirical research of qian who analyses a sample of 92 countries from 1978 to 2002. she finds technology transfer primarily proxied by fdi establishments and the subsidiaries established by mncs in the country of interest as the most successful iprs-driven economic development component.101 94 robert wade, governing the market (2nd ed, 2003) 268-9; thomas cottier, ‘from progressive liberalization to progressive regulation in wto law’ (2006) 9 journal of international economic law 779, 802; p o goldsmith, d k nauriyal and w peng, ‘seed biotechnology, intellectual property and agricultural competitiveness’ in jay p kesan (ed), agricultural biotechnology and intellectual property: seeds of change (2007) 19-37; maskus, above n 22, 70-1. 95 grossman and lai, above n 90, 1635; carsten vogel, ‘the impact and the implications of trips in a knowledge-based global economy: a developing country’s perspective’ (2006) 2(1) asia-pacific trade and investment review 47. 96 beata smarzynska javorcik, ‘the composition of foreign direct investment and protection of intellectual property rights: evidence from transition economies’ (2004) 48(1) european economic review 39. 97 jeong-yeon lee and edwin mansfield, ‘intellectual property protection and u.s. foreign direct investment’ (1996) 78(2) review of economics and statistics 181. 98 unido, above n 74, 32-3. 99 ibid. 100 ibid. 101 qian, above n 67, 191-213. nordic journal of commercial law issue 2010#2 19 however, in a recent analysis of the fdi component and its relation to iprs, professor yu shows on china that the growth of fdi does not seem to be correlated to increases in the level of intellectual property protection or political reforms. this suggests that in some cases at least, there are considerations of geopolitical realities that trump intellectual property concerns.102 3.3.4. licensing iprs protection increases licensing since mncs are mostly unwilling or hesitant to license their high-tech technologies to unaffiliated firms in countries with weak patent rights.103 a study demonstrates that iprs protection brings widespread licensing of new technologies in japan and helps it to improve its system of utility models, which contributed positively and significantly to its post war rise to productivity.104 however, studies also show that when mncs license their technologies to unaffiliated firms in countries with weak patent rights, they are very often found to charge excessive fees in security of their investments in r&d.105 such higher fees may lead to price increases of products making them inconsumable for the ldcs people. in addition, an increase in iprs strength in these countries, while reducing the risk of imitation slightly, would also increase the monopoly power of the licensor.106 there are other ways of technology transfer like joint ventures which combine many of the properties of fdi and licensing and hence will also involve technology transfer. in such a case iprs is an issue with other factors of market conditions.107 from the discussion above, it appears that iprs can directly stimulate local innovations as well as indirectly encourage the transfer of technologies that foster local innovations. for most developed countries, strengthening iprs raises growth at least partly, due to increased innovation and technology dissemination. however, for developing and least developed countries as the evidence suggests there needs initially some weak iprs system that helps these countries to shift from imitation to innovation. the development experience of india is an example where weak iprs protection helps it in building up local capabilities in 102 peter k yu, ‘intellectual property, economic development and the china puzzle’ in daniel gervais intellectual property, trade and development: strategies to optimize economic development in a trips plus era (2007) 173220. 103 edwin mansfield, ‘intellectual property protection, foreign direct investment and technology transfer’ (ifc discussion paper 19, the world bank, 1994). 104 k maskus and christine r mcdaniel, ‘impacts of the japanese patent system on productivity growth’ (1999) 11 japan and world economy 557. 105 guifang yang and keith e maskus, ‘intellectual property rights and licensing: an econometric investigation’ (2001) 137 weltwirtschaftliches archiv 58. 106 unido, above n 74, 34. 107 ibid, 40; dermot leahy and alireza naghavi, ‘intellectual property rights and entry into a foreign market: fdi versus joint ventures’ (2010) 18(4) review of international economics 633. nordic journal of commercial law issue 2010#2 20 pharmaceuticals.108 however, it is also evident in some cases that stronger iprs protection encourages foreign firms to transfer technology in ldcs since most ldcs will not have significant imitative or innovative capability in the near future.109 in the age of global trade, the costs and benefits arising out of the relation between intellectual property rights and economic development demand much attention for an ldc like bangladesh.110 previously, the economic development in bangladesh largely depends on traditional agriculture and trading and services of products chiefly reverse-engineered of low technologies informally acquired. and, for economic development through innovations, bangladesh does not have in fact sustainable r&d infrastructure in the most fields of technology or to a great extent it cannot afford the cost of formal technology transfer by way of licensing for follow-on innovations or reverse engineering.111 such stumpy economic progress disjointed with technology does not necessitate bangladesh to take up the challenge of merging intellectual property rights with economic development. however, being included in the outskirt of trade liberalization, bangladesh intends to achieve economic development entering others’ market with its products and opening its market especially for foreign direct investment by lowering tariffs, removing trade restrictions, granting privileges to fdi and enforcing iprs.112 however, such aspirations of achieving economic development put an ldc like bangladesh in the obligations of protecting others’ intellectual property rights, not for exclusively protecting its own economic interests.113 108 unido, ibid. 109 ibid. 110 yong-shik lee, ‘economic development and the world trade organization: proposal for the agreement on development facilitation and the council for trade and development in the wto’ in chantal thomas and joel trachtman (eds), developing countries in the wto legal system (2009) 291-319. 111 e.g. undp, human development report 2000 (2000) 84. it notes that ‘developing countries have little to gain from the stronger patent protection from the trips agreement because they have little research and development capacity. research and development for a new drug is estimated to cost around $150–200 million, but no developing country has a pharmaceutical sales volume of even $400 million. there is little evidence so far that patent protection has stimulated research and development in or for poor countries or that it offers the potential to do so.’ 112 adams, above n 65, 725. 113 gervais, above n 5, 371. nordic journal of commercial law issue 2010#2 21 4. trips agreement and economic development: implications and challenges 4.1 theoretical background being lagged behind developing countries in terms of competition in cheaper technology trade, industrialised countries claim that free-riding discourages industry to invest in goods, and leads to underproduction of innovative commodities. this logic has also been extended to suggest that industry would not invest in countries where iprs protection was weak. subsequently due to strong lobbying from developed country industries, the trips agreement appears with extensive iprs protection and lays down the ground rules for what must be protected by some kind of intellectual property right including plant varieties and pharmaceuticals.114 this standard-setting streamlines the use and licensing of technology and trademarks to independent firms, subsidiaries and joint ventures115 and is believed to secure the iprs owners’ rent-seeking interests.116 the trips also incorporates some disjointed technology use or transfer provisions in articles 7, 8, 24, and 66.2 on the face of huge resentment over streamlining of iprs. however, such standardarisation of technology transfer provisions holds monopolised approach and restricts developing and least developed countries’ use, reverse engineering or imitation and adaptation of patented technologies to develop new technology and thus leading to less competition and thus innovation.117 this dubious role of the trips itself in technology transfer questions the promotion of economic development objective as inserted in the trips preamble and in the body especially for a developing or least developed country. for its protective approach in relation to subsistence goods with the extent and duration of iprs protection, some commentators are of the opinion that the trips agreement keeps up fused relationships with economic development insofar as investments interests of developed countries are secured and developmental needs of developing and least developed countries are concerned.118 there are other commentators who describe the relation as frustrating for the economic developmental objectives as enunciated in the neo-liberalising wto due to the trips’ monopolised and competition fearing attitude as regards technology and its dissemination to least developed countries.119 commentators like jerome reichman finds the trips friendly with innovating 114 dutfield and suthersanen, above n 1, 272 -77. 115 trips agreement, articles 7, 8, 27.2 and 66.2. 116 derek eaton, 'intellectual property rights in plant breeding and biotechnology: a comparative institutional analysis' (paper prepared for the 11th annual conference of the international society for new institutional economics (isnie), reykjavik, iceland, 21-23 june, 2007). 117 trips agreement articles 7-8, 66.2. 118 maskus, above n 64, 457. 119 cameron hutchison, 'does trips facilitate or impede climate change technology transfer into developing countries?' (2006) 3(2) university of ottawa law & technology journal 517. nordic journal of commercial law issue 2010#2 22 countries’ economy uplifting but at the same time terms this trend as one-sided drive to reregulate the worldwide economy from an uneven position between developing and developed countries since the streamlining of technology use and its diffusion leads to less innovation and consequently hinders global economic development in the long run.120 from the discussion above, it appears that the trips role in driving economic development is assessed through the economic development variables of innovation and technology transfer. 4.2. strengthening iprs in the trips and innovation based economic development the main argument for strengthening iprs in the trips is to provide better conditions for appropriability of innovations. evidence shows that strengthening iprs improves prospects for innovative enterprises in developing nations to develop new products and enter markets.121 however, evidence also shows that the trips encourages domestic innovation in countries having significant domestic capacity for innovation and development but it has little impact on innovation in countries with a small innovative capacity.122 in addition, strengthening iprs particularly patent protection varies from industry to industry and is most effective only in chemical and pharmaceutical industries.123 in a study, mansfield shows that around 65 per cent of pharmaceutical and 30 per cent of chemical inventions would not have taken place but for patent protection. and such inventions could take place in developed countries that invested in r&d, and strengthening iprs protection could help these countries to promote their economic development.124 however, a number of studies conducted in developing countries empirically demonstrates that pharmaceutical and biotechnological patents or trade-secrets protection could affect much of the r&d activity which is of an adaptive nature and raise imitation or follow-on innovation costs for the use of new technologies, with the bulk of those costs being transferred to foreign patent owners as economic rents (profits), and place considerable pressures on imitative and innovative enterprises in developing economies causing significant drop in the number of inventions.125 for example, the number of global patents 120 jerome h reichman, ‘nurturing a transnational system of innovation’ (2007) 16(2) journal of transnational law and policy 143. 121 maskus, above n 52, 143-170. 122 gould and gruben, above n 51, 323. 123 ibid. 124 mansfield, above n 103. 125 r basant and b fikkert, `impact of r&d, foreign technology purchase and technology spillovers on indian industrial productivity: some estimates' (working paper no.11, institute for new technologies, united nations university masstricht, (1993). it suggests that a ‘weak patent regime may allow spillovers simultaneously to promote r&d and to have a positive direct effect on productivity’ and concluded that the adoption of a ‘stronger patent regime may not be optimal from either the shortor long-run perspectives’. see also a kumari, ‘productivity growth in indian engineering industries during pre-reform and post-reform period: an analysis at company level’ (institute of economic growth, delhi, (2000). nordic journal of commercial law issue 2010#2 23 originating in the 50 countries identified by the un as ldcs has dropped from an average of 66 per year in the early 1990s to just 10 per year between 2000 and 2004.126 incidentally, the us net surplus of royalties and fees increased from us$14 billion in 1991 to us$22 billion in 2001, while developing countries suffered a deficit of nearly us$7.5 billion in 1999 alone.127 so, for innovation based economic development in developing countries, softer regime rather than the trips appears to be helpful. the study by kumar and saqib supports this statement when it finds indian chemical industry enterprises to be among the more innovative ones in the indian industry. and they attribute this to the weak patent laws viz. absence of product patents in india which enabled indian enterprises to undertake alternative process development.128 in another study, haksar finds that the return to r&d in pharmaceutical industry particularly large and explains it to be possible since the development of alternative processes of known drugs takes place in absence of patents on pharmaceutical products. 129 so, it appears that the role of strengthening iprs as a determinant of innovative activity in developing countries is quite weak. in fact, stronger iprs may actually affect the innovative activity adversely by chocking the absorption of knowledge spillovers that are important determinants of innovative activity. mazzoleni and nelson conduct a survey of theoretical and empirical studies and conclude that ‘there is reason for concern that the present movement towards stronger patent protection may hinder rather than stimulate technological and economic progress.’130 4.3. strengthening iprs in the trips and technology transfer based economic development the trips being included in the wto’s free trade scheme of market liberalisation urges members to benefit out of trade in iprs goods. it asks members especially iprs-using developing countries to strengthen iprs with the aim to incentivising developed countries’ investments in iprs goods. in return, the agreement calls upon innovating developed countries to transfer their technology either through fdi, trade or licensing to developing country users for reaching production, raising product quality or adaptation to local circumstances leading to fulfilment of consumption needs and economic goals.131 such strengthening of iprs-led 126 unctad, trade and development report, 2007 (2007) 62. 127 adams, above n 65, 725. 128 nagesh kumar and mohammed saqib, ‘firm size, opportunities for adaptation and in-house r&d activity in developing countries: the case of indian manufacturing’ (1996) 25 (5) research policy 712. 129 haksar, vikram, ‘externalities, growth and technology transfer: application to the indian manufacturing sector, 1975-90’ (international monetary fund, washington dc, 1995) 130 roberto mazzoleni and richard r nelson, ‘the benefits and costs of strong patent protection: a contribution to the current debate’ (1998) 27(3) research policy 273. 131 alireza naghavi, above n 53, 55. nordic journal of commercial law issue 2010#2 24 technology transfer appears as economy enhancing not only for developing countries acting as a source of total factor productivity improvement and contributing to growth but also for innovative countries increasing the technology trade or licensing in goods, brand and brand names. to benefit mutually out of trade in iprs goods, the trips makes explicit the signatories’ intention to promote economic development as part of the general objectives of the agreement by strengthening iprs and facilitating technology transfer. for example, article 7 includes a corresponding reference: the protection and enforcement of intellectual property rights should contribute to the promotion of technological innovation and to the transfer and dissemination of technology, to the mutual advantage of producers and users of technological knowledge and in a manner conducive to social and economic welfare, and to a balance of rights and obligations. in addition, depicting patent rights, article 28.2 of the agreement provides for a mechanism for rights holders to transfer their property for use by others: ‘patent owners shall also have the right to assign, or transfer by succession, the patent and to conclude licensing contracts.’ the agreement also includes provisions preventing abuses that would limit technology transfer. for example, article 8.2 states the principle that: appropriate measures, provided that they are consistent with the provisions of this agreement, may be needed to prevent the abuse of intellectual property rights by right holders or the resort to practices which unreasonably restrain trade or adversely affect the international transfer of technology. article 40 sticks on control of anti-competitive practices in contractual licences, specifying the approach to dealing with this issue, beginning with the following point of understanding: members agree that some licensing practices or conditions pertaining to intellectual property rights which restrain competition may have adverse effects on trade and may impede the transfer and dissemination of technology. article 66.2 incentivises technology transfer from developed countries to ldcs: developed country members shall provide incentives to enterprises and institutions in their territories for the purpose of promoting and encouraging technology transfer to least-developed country members in order to enable them to create a sound and viable technological base. for the implementation of article 66.2, ministers issued a decision at the wto ministerial conference in doha in november 2001: reaffirming that the provisions of article 66.2 of the trips agreement are mandatory, it is agreed that the trips council shall put in place a mechanism for ensuring the nordic journal of commercial law issue 2010#2 25 monitoring and full implementation of the obligations in question. to this end, developed-country members shall submit prior to the end of 2002 detailed reports on the functioning in practice of the incentives provided to their enterprises for the transfer of technology in pursuance of their commitments under article 66.2. these submissions shall be subject to a review in the trips council and information shall be updated by members annually.132 furthermore, in its decision of 19 february 2003, the trips council puts in place the reporting mechanism asking developed countries to submit annual reports on their actions in relation to article 66.2.133 however, a review of such annual reports at the october 2006 meeting of the trips council finds continuing divergence between some developed and developing countries in the interpretation of article 66.2. the minutes from this meeting and other council documents highlight differences with respect to the definition of technology transfer, the ability to measure technology transfer and the role of both developed and developing countries under the agreement, among other issues.134 for example, whether technical assistance related to implementation of the trips agreement can be considered as contributing to satisfaction of article 66.2 gives rise to a debate.135 another significant step was taken at the 2007 g8 summit, at which the ‘heiligendamm process’ was agreed with the launching ‘a new form of co-operation’.136 it aims ‘to achieve tangible results within two years’.137 the summit included a dialogue between the g8 and the so-called ‘outreach 5’ (or ‘o5’) countries, namely brazil, china, india, mexico and south africa. according to the programme of the summit: the planned topics for the heiligendamm process are also to be ‘‘innovation’’ and ‘‘technology co-operations’’. the g8 countries are to share their know-how with the emerging economies especially when it comes to energy efficiency. at the same time, agreement is to be reached on more effective international property rights: protection against replicated machines, copied brand products and counterfeit medications.138 132 wto document wt/min(01)/17, para 11.2. 133 wto document ip/c/28. 134 wto document ip/c/m/52. 135 discussions on implementation of recommendations on technology transfer at the fourth session of the cdip held from november 16 to 20, 2009 (extracted from cdip/4/14 prov.). <http://www.wipo.int/edocs/mdocs/mdocs/en/cdip_4/cdip_4_14_discussions.pdf > 10 july 2010. 136 daniel gervais, ‘(re)implementing the agreement on trade-related aspects of intellectual property rights to foster innovation’ (2009) 12(5) journal of world intellectual property 348. 137 german federal government, ‘g8 summit 2007: the heiligendamm process’ (press release) <http://www.g8.de/nn_92160/content/en/artikel/__g8-summit/2007-06-08-heiligendamm-prozess__en.htmli/> 10 july 2010. 138 german federal government, ‘g8 summit 2007: breakthrough on climate protection’ (press release) <http://www.g-8.de/nn_92160/content/en/artikel/__g8-summit/2007-06-07-g8-klimaschutz__en.htmli> 10 july 2010. nordic journal of commercial law issue 2010#2 26 in addition to the general objective of promoting innovation and the transfer and dissemination of new technology referred to earlier (article 7), the trips also contains some specific requirements for developed country members to provide incentives for technology transfer to least developed countries. for example, the disclosure requirement of a patent application (that is, that applicants disclose the invention in a manner sufficiently clear and complete for the invention to be carried out by a person skilled in the art) is one of them. this provision helps for the transfer of and access to technology by providing information readily about from whom the technology can be obtained for the duration of the patent term or the information when the disclosed invention falls into the public domain and is freely available to all at the patent expiry or by enabling the experimental use of an invention in the name of ‘limited exceptions’ to the patent rights under article 30.139 the trips agreement also allows for cases where, if technology (whether patented or not) is in the control of a government, that government is free to transfer the technology on concessional terms if it so wishes. similarly, there is nothing in the trips, which would prevent a government or international financial institution from providing financial assistance to permit the voluntary transfer of privately-held proprietary technology on concessional terms.140 such initiatives to transfer technology within the strengthened iprs framework of the trips is likely to promote economic development for developed countries with ensured rents and facilitating technology transfer to help developing countries for follow-on innovations making economic progress to them through domestic consumption and exports. however, evidence also shows that technology transfer can have a significant impact on economic growth leading to economic development once a country has reached a certain level of development, as measured by initial gdp per capita.141 for this thompson and rushing employ threshold regression techniques finding a threshold at an initial level of gdp of us$3,400.142 for countries below this value, falvey and foster find no significant relationship between iprs-based technology transfer and growth, but above, the relationship is positive and significant.143 to resolve such dilemma, developing countries have made proposals at the wto and wipo citing issues in relation to their economic development in the trips context. forums like quake united nations office, the south centre, ictsd and unctad have in help with very useful and high quality documentation in support of developing countries. two important 139 carliene brenner, ‘intellectual property rights and technology transfer in developing country agriculture: rhetoric and reality’ (oecd development centre working papers no 133, oecd, development centre (1998) 25-6. 140 ibid. 141 grossman and lai, above n 90, 1635. 142 thompson and rushing, above n 4, 1. 143 unido, above n 74. nordic journal of commercial law issue 2010#2 27 proposals came to draft an access to knowledge (a2k) treaty144 and for wipo by establishing a development agenda145 to address the development-related interests of developing countries. such proposals covered technical cooperation, transfer of technology and other issues. with regard to wipo’s mandate, it is noted that as a un agency wipo should be guided by the un’s development goals including the mdgs. 146 however, it is true that for countries below the minimum development level, informal technology transfer is the only alternative means of achieving economic development in developing and least developed countries and even in some nics as well. with stopping this, the trips re-regulated technology transfer provision appears as a technology blockade to developing and least developed countries like bangladesh which have the comparative advantage in imitation and adaptation of foreign technologies.147 in effect, adding value to and improvements of the existing technological base is likely to be impeded in ldcs after the trips compliance.148 5. trips in agriculture and economic development: implications and challenges 5.1. theoretical background as part of iprs standard-setting, the trips speaks of the international iprs regime governing plant genetic resources (pgrs). it includes a sui generis provision for the protection of iprs associated with agriculture, commonly known as plant varieties protection (pvp). this provision appears to balance the interests of variety of actors involved in agricultural trade. for instance, pvp encourages investments in agricultural innovations especially plant breeding even by domestic companies although only in a limited group of major crops, namely, soybean, corn, wheat, and cotton.149 it also helps agriculture-prone ldcs like bangladesh building up agricultural economy through or transfer/trade of agricultural technology especially seeds.150 144 ‘access to knowledge (a2k) treaty’ <www.cptech.org/a2k/a2k_treaty_may9.pdf> 10 july 2010. 145 ‘development agenda’ <http://www.wipo.int/export/sites/www/ip-development/en/agenda/recommendations.pdf> 10 july 2010. 146 dutfield and suthersanen, above n 1, 275-81. 147 ramanna, above n 18, 188-9. 148 correa, above n 60, 227. 149 j m alston and r j venner, ‘the effects of the us plant variety protection act on wheat genetic improvement’ (2002) 31 research policy 527. 150 ha-joon, above n 23, 273-98; robert tripp, niels louwaars and derek eaton, 'plant variety protection in developing countries: a report from the field' (2007) 32 food policy 354, 356. nordic journal of commercial law issue 2010#2 28 as part of building up agricultural economy, this regime enriched with the new protection arrangements in the name of pvp is found to encourage seed trade to promote the seed industry, boost exports, protect seed quality, and contributes in general to promote economic development in agriculture-prone least developed countries like bangladesh with better yields in a small piece of agricultural land compared to the dense population.151 this regime is also found to help public research institutes with the better ability to protect their innovations especially new varieties or biotechnology, and ultimately to benefit from licensing and royalty revenues.152 however, such agricultural economy invigorating element of the trips is not free from shortcomings. for example, pvp which is similar to patents acts as a means of creating genetic use restriction technologies which do not help seeds reproducing.153 this causes an agriculture-prone ldc like bangladesh to have extra economic burdens on farmers. such role of pvp appears as contradictory to economic benefit approach of the wto’s trade liberalisation and lends support to general scepticism about the role of iprs in economic development.154 5.2. strengthening iprs in agriculture and innovation-based economic development in agricultural innovation based economic development and for achieving food security, r&d in pgrs and biotechnology is a sine qua non.155 to this end, the trips comes up in help for incentivising investments in biotechnology with a major contribution in the post-wto scenario. some empirical research substantiates this assertion when it shows that stronger iprs in agriculture help enhancing research and development efforts in pgrs and biotechnology, and greatly boosting up the potential utility areas especially economic interests of the world’s genetic resources.156 on such counts, iprs primarily in the forms of patents and pvp appear to provide the exclusivity needed to earn returns to invention and innovation. for instance, the us biotechnology industry with patents in place generates a yearly income of us$13 billion.157 151 mywish k maredia, james f oehmke and derek byerlee, ‘economic aspects of intellectual property rights in agricultural biotechnology’ in f h erbisch and k m maredia (eds), intellectual property rights in agricultural biotechnology (2004) 107 -24. 152 brenner, above n 139, 33-9. 153 c s srinivasan and colin thirtle, ‘potential economic impacts of terminator technologies: policy implications for developing countries’ (2003) 80(1) environment and development economics 187. 154 tripp, louwaars and eaton, above n 150, 354. 155 punjab singh, ‘technology options for achieving food security in south asia’ in suresh chandra babu, and asok gulati (eds), economic reforms and food security: the impact of trade and technology in south asia (2005) 163-173. 156 r kennedy, 'international conflicts over plant genetic resources: future developments' (2006) 20(1) tulane environmental law journal 1, 6-7. 157 international chamber of commerce, intellectual property: source of innovation, creativity, growth and progress (2005) <http://www.iccwbo.org/uploadedfiles/icc/policy/intellectual_property/statements/bascap_ip_pub.pdf> 10 december 2010. nordic journal of commercial law issue 2010#2 29 the research also shows that the potential utility of iprs helps encouraging the use of biotechnology to generate high yielding varieties leading to increase the incomes of small farmers and consumers.158 for example, utility patents in agriculture technology brought economic development in philippines with high yielding and exports.159 however, the absence of some form of market exclusivity of agricultural investments through iprs causes biotechnologies face an appropriation problem because of their inherent natural qualities that make imitation by others feasible at relatively low costs. innovative plant varieties, as embodied in seeds also readily reproduce in identical qualities simply by virtue of cultivating the plants.160 furthermore, new plant varieties face competing production and sales simply at the time they are brought in the market as an act that carries an inferred licence for replication and production without enumerated rights.161 however, since the trips recognises a trivial modification of existing pgrs as an invention, this results in an increasing number of patents, as well as the breadth of the claims which create a situation where companies conducting further research often find it difficult not to infringe the patent rights of other companies.162 lindner describes the variety and scope of claims made in the ‘basic processes and inventions’ as posing a danger of a patent gridlock for developing countries where it is virtually impossible to develop new transgenic plants without infringing one or other of these patents.163 for example, there appears a patent gridlock in the case of bt technology and gives rise to several hundred overlapping patent rights for it. for infringement of its patent rights for bt technology, recently syngenta filed two lawsuits against some of its competitors.164 in a bid to get rid of such danger of a patent gridlock and to create more freedom for research, a new trend of mergers and acquisitions has arisen in the global food, agrochemical and seed business, leading to significant concentration of the industry. however, as a part of global mergers and acquisitions, patents in the agricultural sector are now concentrated in the hands of just a few large mncs including monsanto, dupont, syngenta, dow, and bayer. such mergers and acquisitions create more monopoly causing price rise in agriculture technology. 158 brenner, above n 139, 27-28. 159 john h barton, ‘intellectual property, biotechnology, and international trade: two examples’ in thomas cottier and c petros (eds), intellectual property: trade, competition, and sustainable development (2003) 285-301. 160 tripp, louwaars and eaton, above n 150, 356. 161 keith e maskus, ‘intellectual property rights in agriculture and the interests of asian-pacific economies’ (2006) 29(6) world economy 715. 162 unctad, ‘the least developed countries report 2007: knowledge, technological learning and innovation for development’ (prepared by the unctad secretariat, geneva, 2007) 125-6. 163 bob linder, ‘prospects for public plant breeding in a small country’ in william h lesser (ed), transitions in agbiotech: economics of strategy and policy 561-600. 164 jagjit kaur plahe, ‘the implications of india's amended patent regime: stripping away food security and farmers' rights?’ (2009) 30(6) third world quarterly 1197. nordic journal of commercial law issue 2010#2 30 in addition, as part of iprs standard-setting in agriculture, the trips simplifies the agricultural innovation process by facilitating intense interaction and feedback among the different parts of the system: individual research institutes, universities and industry, the scientific community and farmers, the traditional agricultural research community and biotechnologists, the public and private sectors. industrialised countries, most notably in the us, have availed of such opportunities and made economic development through agriculture. however, in many developing countries, the linkages among the different parts of the system are weak. this is likely to inhibit, rather than facilitate, transfers of technology, innovation and economic development.165 5.3. strengthening iprs in agriculture and technology transfer-based economic development the trips technology provisions contribute to the growth of agriculture with new developments in trading arrangements by improving the ability of private breeders to control local seed markets, and preventing unauthorized trade in protected varieties, by increasing access to privately developed foreign seed varieties on making their developers more willing to market their products there, and by retaining farmers’ privileges, or the right of farmers to keep sufficient seeds from the harvest for replanting.166 however, for transition economies, such provisions become matters of concern in technology transfer for its role of ‘shutting out’ rather than ‘crowding in’.167 this is because member countries are required to have legal arrangements for the protection of newly developed varieties.168 with this caveat of the trips, it is clear that agricultural technologies that were available in developing countries in an unrestricted manner will no longer be freely available. in this respect, it is to be noted that with the free use of technologies farmers had rights to produce, save, and use the varieties, and brought in once the green revolution.169 so, it appears that for fulfilling welfare needs by achieving food security in developing countries, technology plays a major role, given the impressive record of technology in enhancing food grain production during the past half century. and now it has been argued that the challenge of food security cannot easily be met unless transfer of biotechnology is promoted.170 to this end, the trips inserts provisions on technology transfer as well. 165 brenner, above n 139, 29. 166 ibid. 167 linder, above n 163, 561-600. 168 maskus, above n 53, 471. 169 philippe cullet, ‘food security and intellectual property rights in developing countries’, (working paper 2003-3, international environmental law research center, geneva, 2003). 170 singh, above n 155, 163-173. nordic journal of commercial law issue 2010#2 31 however, agricultural technology is not likely to be available in an unrestricted manner as it was before due to the protectionist approach of the trips.171 this is because, with the creation of the trips in the wto, there arise problems in technology transfer since the technology owning mncs regulate technology transfer with their profiteering interests, not serving the interests of local farmers. in addition, mncs do not generally grant commercialisation licences to third parties and choose to retain the sole right to use the protected technology for commercial development. however, if the mncs do permit commercialisation licences, rights holders seek unreasonable or unacceptable terms. as a result, it is not only subsistence farmers who are at risk but licence holders also suffer in marketing. indeed, in countries with very little internal breeding capacity, the entry of mncs active in this field as noted by international plant genetic resources institute (ipgri) is unlikely to foster directly the development of domestic industrial capacity.172 it is thus unlikely that domestic breeding industries would substantially benefit from the introduction of monopoly rights rather this poses a threat for food security in developing and least developed countries.173 for example, with the trips into effect in india, trade in seeds get into the hands of mncs and as a result, the country can not utilise its substantial capabilities of making its own gmos freely accessing mncs-owned technology holding profiteering interests, not feeding the poor people.174 5.4. technology transfer mechanisms in agriculture little research has yet been done on transfer of technology related to agriculture specifically seeds, mechanisation, irrigation, and the application of chemical fertilizers and herbicides. the quantitative information regarding either the forms of genetic technology acquisition by developing countries or the different forms of technology transfer between oecd member and developing countries is also little. this is because the relative importance of one form of technology transfer compared to another would, clearly, vary from country to country, in accordance with the state of development of their agriculture sector and as a function of effective demand for technology. however, in accordance with some common practice, genetic technologies appears to be transferred through the purchase of an end product (as seeds or machinery), or as an input into the agricultural research process (for example, a patented genetic mapping technique, or a patented gene). the transfer may occur in many different forms, in a commercial or market context, in a non-market or ‘public good’ context, or by a combination of market and non-market mechanisms. and, in technology transfer transactions 171 dutfield and suthersanen, above n 1, 275-81. 172 phillipe cullet, ‘plant variety protection in africa: towards compliance with the trips agreement’ (2001) 45(1) journal of african law 97, 109-111. 173 singh, above n 155, 163-173. 174 pushpa m bhargava, ‘the social, moral, ethical, legal and political implications of today’s biological technologies: an indian point of view’ (2006) 1 biotechnology journal 34. nordic journal of commercial law issue 2010#2 32 between developed and developing countries, several different public and private partners may be involved. these may include national governments or government departments, ngos and non-profit private foundations like the international agricultural research council (iarcs).175 with respect to genetic technology as products, the most common form of transfer is probably the purchase or import of seeds, principally for cereal and forage crops, fruit and vegetables, and planting material for floriculture products. this would apply where countries have an important commercial farming sector, where a large share of planted area is sown to hybrids, where countries are major exporters of particular kinds of agricultural products or where countries have a dualistic system of production (large-scale commercial farming and low-income smallholders). while some small-scale farmers purchase seeds and are engaged in profitable production, among low-income, low-input farmers, the major form of technology transfer remains that of the informal exchange of seeds which are saved on farm.176 another form of agricultural technology transfer is joint ventures i.e. joint ventures between companies from developed and developing countries for the development of genetic technologies. however, little published data is available on joint ventures. the recent 50-50 joint venture between the plant genetic systems (since taken over by agrevo gmbh of germany) and the indian company proagro, set up to develop genetically modified oilseed rape and other products is one example. a number of joint ventures in seeds production and plant breeding are also being formed, particularly for the production and marketing of hybrid crops.177 for research purposes, the transfer or exchange of inbred or parental lines in respect to genetic materials especially seeds is also common in oecd member countries. this form of transfer takes place usually under a trade secret arrangement. however, such transfer to a developing country depends on whether hybrids are involved and/or whether the receiving country has already introduced pbrs.178 for research purposes, mtas are also used extensively to transfer genetic material. mtas are commonly used in the framework of collaborative research, particularly in publicly or donor funded research projects and programmes, where universities and/or public research institutions are partners. it is also the favoured form of technology transfer among and by the iarcs which, inter alia, are the designated custodians of the world’s plant genetic resources. 175 brenner, above n 139, 33-9. 176 ibid. 177 ibid. 178 ibid. nordic journal of commercial law issue 2010#2 33 iarcs agreements typically require that no iprs are sought, but do not include payment requirements.179 furthermore, public/private sector partnerships for bio-prospecting work as a mode of agricultural technology transfer. such initiatives are growing in countries rich in biodiversity which wish, at one and the same time, to maintain control and ownership over their genetic resources and to earn revenue to be reinvested in research on their identification, classification and preservation. for example, costa rica has negotiated a number of agreements for exploration of their genetic resources. in such agreements iprs are negotiated on a case-by-case basis and it is also ensured that any profits from inventions and materials protected by iprs or from products derived from those protected inventions and materials are shared by the various partners in such a way as to ensure further exploration and conservation in costa rica.180 for an ldc perspective, technology donation is another form of agricultural technology transfer. sometimes technology is donated to a developing country and usually to a public research organisation or government to be used under certain conditions. for example, a technology donation agreement is signed between the international service for the acquisition of agri-biotech applications (isaaa), monsanto and the centre of research and advanced studies (cinvestav) in mexico. it involves the transfer of monsanto patented gene technology for virus resistance in potatoes to a public mexican research institute. there is another example of donation where an agreement between ciba-geigy (now novartis) and the international rice research institute (irri) in the philippines, which is one of the iarcs is signed. it relates to the transfer of a synthetic bacillus thuringiensis (bt.) gene for insect resistance, patented by ciba-geigy, for use in transgenic rice research at irri. in both cases, the transfer was made as a royalty-free licence.181 6. trips in pharmaceuticals and economic development: implications and challenges 6.1. legal background as part of trips standard-setting of iprs in pharmaceuticals, the trips members are urged to introduce patents in pharmaceuticals. this standard-setting of iprs in pharmaceuticals brings in the security of huge investments made in pharmaceutical innovations especially drugs and active pharmaceutical ingredients (apis), and entitles countries with levies, taxes and royalties for the transfer of such innovated pharmaceutical products or technologies through selling, 179 ibid. 180 ibid. 181 ibid. nordic journal of commercial law issue 2010#2 34 licensing or exporting.182 however, for countries like bangladesh that do not have mentionable r&d in pharmaceuticals, such standard-setting is of no use but to secure developed countries’ economic interests.183 nevertheless, the standard-setting in pharmaceuticals qualifies exception clauses like differential treatment in transition period, compulsory licensing, and parallel importation keeping in mind the prevention of anticompetitive practices of innovators and responding to emergencies. for bangladesh, these exception clauses come in help for reverse-engineering pharmaceuticals, which qualifies one kind of innovations on accessing the transferred technologies and supplying them in the domestic and export market.184 such limited opportune in pharmaceutical innovation and technology transfer turns up with economic benefits to the country although there arises controversy recently as regards attempts by developed countries to block the exports of cheap hiv/aids drugs by some developing countries including china, india, thailand and brazil.185 6.2. trips strengthening of iprs in pharmaceuticals and innovation-based economic development strengthening of iprs in pharmaceuticals meaning the introduction of patents serves as an important incentive for pharmaceutical innovation since patents secure unambiguously the investments in innovation and turn into an economy stimulating tool by being recognised as key instruments for privately appropriating the economic benefits of innovation.186 and patents extract the economic benefits of pharmaceutical innovation by simplifying the innovation system with minor modification (for example, in terms of dosage) of existing products qualifying as inventions resulting in more products and revenues, and by squeezing free-riding or streamlining iprs flexibilities of compulsory licensing ensuring the maximum returns of innovating costs.187 in fact, streamlining of iprs secures investments in r&d of a drug formulation that costs about us$800 million.188 and with the help of reconfigured definition of invention, global brand name pharmaceutical corporations rebrand their products, get 182 roberto simonett, éric archambault, gregoire cote and dinar kale, 'the dynamics of pharmaceutical patenting in india: evidence from uspto data' (2007) 19(5) technology analysis & strategic management 625. 183 phillip mccalman, ‘who enjoys `trips' abroad? an empirical analysis of intellectual property rights in the uruguay round’ (2005) 38(2) canadian journal of economics 574. 184 gervais, above n 5, 363. 185 ‘fight over generic drug seizure takes centre stage at trips council meeting’ (2009) 13(9) bridges weekly trade news digest 1. 186 francesco laforgia, fabio montobbio, and luigi orsenigo, ‘iprs, technological and industrial development and growth: the case of the pharmaceutical industry’ (kites working paper no. 206, centre for research on innovation and internationalization, centre for knowledge, internationalization and technology studies, universita' bocconi, milano, italy, 2007) 187 gervais, above n 136, 348. 188 gunter festel, alexander schicker and roman boutellier ‘performance improvement in pharmaceutical r&d through new outsourcing models’ (2010) 7 (2) journal of business chemistry 89. nordic journal of commercial law issue 2010#2 35 patents on them (commonly known as patents for second use or evergreening) and seek to restrict the ability of generic manufacturers to produce and distribute essential medicines through patents or data exclusivity agreements. such strengthening of iprs causes significant impact on the innovative capabilities of pharmaceutical industries leading to economic development in developed countries but not in developing and least developed countries lagging behind the technological frontier and with low per capita income because broad patents on basic inventions might hinder further innovation, especially if licenses are given on exclusive terms or at very high prices which such countries cannot afford.189 for example, almost all the empirical studies on the indian case agree that patents in pharmaceuticals (1911 to 1970) did not help india move forward due to affordability of technology but a weaker intellectual protection system (from 1970 to 2005) encouraged the development of indigenous technological capabilities and catching-up.190 in addition to demoralising pure innovation based development, the trips extension of intellectual property to essential medicines and the reconfiguration of the ‘patentable invention’ definition revolve around the rights to issue compulsory licenses, and to manufacture and export generic versions of patented and brand name drugs which come out as qualified pharmaceutical innovations.191 however, because of the revolving, users based in poor countries, who rely on manufacture and export generic versions of patented and brand name drugs for meeting up health and developmental needs are put in a vicious shackle of mncs’ profiteering interests. to get out of the shackle, african countries in the grip of the hiv/aids pandemic, and countries like brazil, india, and other developing and least developed countries and their ngo advocates seek to clarify interpretations of the trips that permit compulsory licensing, parallel importing, generic manufacture and export. in response, there came the doha declaration supplemented by the waiver decision of 2005, which is due to be incorporated in the trips as an amended article 31bis upon ratification by two-thirds of the wto members allows countries producing generics of patented drugs under compulsory licensing and supplying them home or to countries affected with hiv/aids.192 in effect, such initiatives enable some ldcs trying to develop their own capability to produce pharmaceutical products. however, due to the market size in some countries and lack of 189 lall, above n 32. 190 shubham chaudhuri, pinelopi k. goldberg and panle gia, ‘estimating the effects of global patent protection in pharmaceuticals: a case study of quinolones in india’ (2006) 96(5) american economic review 1477. 191 see gervais, above n 136, 363. 192 wt/l/540, <www.wto.org> at 07 july 2008 (hereinafter the decision). on 6 december 2005, the wto members approved changes to the trips agreement as an amendment making permanent a waiver decision on patent and public health originally adopted in 2003. it will appear in the trips agreement as article 31bis if twothirds of the wto’s members ratify it within 31 december 2009 or such later date as may be decided by the ministerial conference. see for details, wt/l/711 21 december 2007, <www.wto.org> at 07 july 2008. <http://www.wtocenter.org.tw/smartkms/do/www/readdoc?document_id=89701> at 2 april 2008. nordic journal of commercial law issue 2010#2 36 technical persons and technology in some, it does not appear to be feasible to set up plants in many of these ldcs. such a picture is depicted in a recent survey conducted by the business monitor international (bmi). it reports that sixteen out of fifty ldcs,193 have no pharmaceutical manufacturing capabilities, and other thirty three countries have very limited or insufficient manufacturing capabilities. however, compared to all ldcs, only bangladesh has strong pharmaceutical manufacturing base, and with this infrastructure, it is broadly authorised to produce three types of pharmaceutical products. these are (a) products under compulsory license, (b) over-the-counter (otc) drugs commonly known as brand name generics, and (c) products under licensing agreement from an original manufacturer. except for the first type of drugs, there is no restriction to export the products to anywhere in the world. for the first category of drugs, pharmaceutical manufacturers of bangladesh can legally copy patented pharmaceutical products since it is exempted from patenting in pharmaceuticals till the end of 2015.194 and after the trips compliance, the doha declaration supplemented by the waiver decision hold economic benefits prospects. on using such opportunities, bangladesh tends to produce a number of generics of patented and off-patent drugs and supplies them competitively at home and abroad at cheaper prices.195 in that sense, bangladesh is fortunately in the privileged position today to capitalize the post-2005 opportunities till 31 december 2015 in selling generics of patented drugs in its domestic market and exporting them as well to other ldcs and non-members of the wto.196 analysts think if bangladesh can avail itself of the opportunity, it could export up to tk100 billion worth of drugs annually.’197 keeping this in mind, the bmi’s industry survey and forecasts series titled ‘bangladesh pharmaceuticals and healthcare report q 3 2008’ describes bangladesh as one of asia pacific’s most promising drug makers.198 for producing various types of drugs, there are about 250 local pharmaceutical companies registered in the country. out of this some 150 companies including 4 multinational 193 united nations, ‘list of least developed countries’ <http://www.un.org/special-rep/ohrlls/ldc/list.htm> 20 july 2009. 194 n g amrita, 'bangladesh braces to replace india in generics 14', in t smart (ed), revision to india patent law could affect future supply of affordable market (2005) 20. 195 ‘trade policy review 2006’ (wt/tpr/s/168, report by the secretariat, bangladesh 9 august 2006) <http://www.wto.org/english/tratop_e/tpr_e/s168-00_e.doc> 8 july 2009. 196 enamul haque, azreen karim, and wahid abdallah, ‘market access issues: eu-bangladesh trade regime a case study on market access: myths and realities’ (paper, international institute for sustainable development (iisd), 2005) <http://www.tradeknowledgenetwork.net/pdf/tkn_market_bangladesh.pdf> 5 july 2010. 197 see shahiduzzaman khan ‘pharma sector holds out new promise’ financial express (5 january 2006) <http://financialexpressbd.com/index3.asp?cnd=1/5/2006&section_id=1&newsid=11946&spcl=no> 5 july 2010. 198 business monitor international, ‘bangladesh pharmaceuticals and healthcare report q 3 2008’ <http://www.researchandmarkets.com/reports/655812> 8 july 2009. nordic journal of commercial law issue 2010#2 37 companies are actively engaged in producing quality medicines.199 on finding their operation less profitable due to the drug (control) ordinance 1982 which favours local pharmaceutical companies, most multinational pharmaceutical companies have actually either left or sold out their interests in bangladesh (i.e. organon). amongst 150 companies, only 20 companies like aci, beximco, square and some other leading local pharmaceutical industries are certified by iso 9000 for their unique quality systems with state-of-the-art manufacturing facilities and are enjoying a market share of more than 80 per cent while the multi-nationals are holding 20 per cent.200 with its very strong finished formulation-manufacturing base, bangladesh exploits all the advantages for its strategic location in the south asian pharmaceutical region and among the ldcs, and remains on top with 97 percent of total pharmaceutical production in ldcs and is growing up with 50 percent annually. currently the entire pharmaceutical manufacture in the country holds an annual turnover of about us$500 million, and is exported to over 70 countries.201 in a bid to boost its export further, the government declares ‘pharmaceuticals’ as the product of the year in 2008. such a move is the first in the country and pharmaceuticals has been singled out considering its tremendous prospect in the global market and diversification of export basket as well.202 for such initiatives and export outcomes, a world bank report prepared on bangladesh shows the export potential in pharmaceuticals more likely to be up for some years to come. however, its per capita expenditure on medicine which is only about us$4 per year compared to the per capita gdp of us$450 with the growth rate at over 6 percent a year poses health concerns since this is one of the lowest not only in the world but also in the subcontinent.203 nevertheless, to prove its efficiency as drug manufacturer, bangladesh began small-scale export of drugs and medicines back in the late 80s. only two local manufacturers, namely, beximco and square pharmaceuticals took initiatives on their own to export pharmaceutical products to some less-regulated overseas markets like neighbouring myanmar, nepal and sri lanka in the absence of any official support and incentives. in the early 90s, a few more companies joined the race and bangladesh could make inroads in some of the partially regulated markets, including russia, ukraine, georgia and singapore.204 in the year 2003-2004, bangladesh exported pharmaceutical products worth of tk556 million that has increased from tk367 199 da cunha, above n 63, 7-15. 200 md. shah amran, maruf ahmed, sm shaheen, sheikh niaz morshed, md. jahangir alam khandakar, md. masudur rahman, md. mosiur rahman & md. amjad hossain, 'a study on the packaging information of essential drug products used at union and thana health complex level in bangladesh' (2007) 20(4) pakistan journal of pharmaceutical science 327, 331. 201 <http://www.asiapharma.org/ape/south_asian_pharmaceutical_expo.php> 11 march 2009. 202 k m gopakumar, ‘trips implementation and public health safeguards’ in centad (ed), south asian yearbook of trade and development (2005) 234-235. 203 ibid. 204 ibid. nordic journal of commercial law issue 2010#2 38 million in the year 2002-2003.205 towards the european union, in the year 2003-2004, bangladesh exported pharmaceutical products worth of tk14 million to france and tk13 million worth of to germany.206 pharmaceutical export rose to us$17.64 million in the first five months of fy07-08 while it was us$11.86 million during the same period of fy06-07. to have more access in highly regulated markets like the eu and the us, bangladeshi pharmaceutical products have to pass through highly restrictive regulatory regime and require stern certifications.207 to this end, existing big pharmaceutical companies in bangladesh have commenced manufacturing in world class plants as mdi (metered dose inhaler) plant and are going for certification in the regulated markets. recently the beximco pharmaceuticals limited, one of the leading pharmaceutical companies in bangladesh, has invested us$50 million on a new plant conforming to the us fda (food and drug administration) standards. 208 the success in entering highly regulated markets is viewed as a major breakthrough for the bangladesh pharmaceutical industry. for such success, there are many factors to credit with. along with successful technology diffusion tools, the multidisciplinary professional education of the pharmacists ensured the quality of pharmaceutical products.209 in other developments as recent findings suggest the pharmaceutical industry in bangladesh is actively involved in the production of active pharmaceutical ingredients (apis). at present, 21 different companies manufacture locally 41 such products comprising only 20 percent and the rest are mostly imported from china and india.210 along side that, auxiliary or linkage industries (packaging, paper, plastic, bottles, caps, tubes, and ampoules, printing etc.) are also developed.211 however, as this has been well below the full potentials of the country for meeting domestic needs and exports, the government has approved the establishment of an api industrial park at an estimated cost of us$30bn on 300 acres of land in munshigonj. the world bank mission has agreed to provide necessary funds only after the completion of a study on social and environmental aspects of the project. another development partner, the united kingdom 205 annual export receipts, statistics department, bangladesh bank, 2003-04. 206 ibid. 207 masud ali, ‘implementing trips agreement: case study of bangladesh' in centre for trade and development (ed), south asian yearbook of trade and development: harnessing gains from trade: domestic challenges and beyond (2009) 205, 208. 208 haque, karim, and abdallah, above n 196. 209 m s amran, ‘trips, pharmaceuticals and bangladesh’ <http://www.bangladeshinfo.com/news/special16.php> 8 july 2010. 210 world bank, 'public and private sector approaches to improving pharmaceutical quality in bangladesh’ (paper no. 23, bangladesh development series, human development unit, south asia region, march 2008) 16. 211 m s amran, ‘pharmacy as education and profession’ (as cover story in the magazine of the daily bangladesh observer, 07 november 2003). nordic journal of commercial law issue 2010#2 39 department for international development (dfid) has agreed in principle to conduct the study. 212 in order to set up the proposed park, bangladesh small and cottage industries corporation (bscic) has been assigned. the project is expected to be completed by 2011. the corporation will develop the infrastructure with state-of-the-art facilities including a central effluent treatment plant (etp) and incinerator for solid and liquid wastes management. after completion of infrastructure development, a total of 40 industrial plots will be allocated to individual companies for setting up api plants. the park will be operated through a publicprivate partnership. at the api park, a total of 30 drug companies have already applied for plots. they have the money ready to establish plants. the companies will start producing apis within six months after the government hands over the plots to them. it is really impossible to be competitive in the international medicine market if a company doesn't produce its own raw materials. bangladeshi companies need to invest in a big way in api park if they want to have a big slice of the export pie. 213 the park is expected to turn the drug industry a major export earner and improve the country’s economy immensely. however, this depends on the quick set up of the park since bangladesh is now enjoying a special benefit to export drugs to all over the world under the trips waiver deal which allows ldcs to export patent-free drugs to anywhere in the world between 2006 and 2016. in addition, it is estimated that country can save at least 70 per cent of the import amount of tk15 billion as spent in 2009 by producing raw materials at the api park and api products worth us$750 million per annum could be exported over the next five years.214 6.3. trips strengthening of iprs in pharmaceuticals and technology transfer-based economic development since pharmaceutical r&d is very expensive and needs large markets to recoup the investments, pharmaceutical companies like to transfer technologies to different markets. to this end, pharmaceutical companies press for well-defined iprs in countries contributing to the development of markets for technologies and to the commercialization of inventions. the large markets in developing and least developed countries initially attract pharmaceutical mncs to capitalise their intentions but to secure huge investments they insist on iprs, in transfer of technology through fdi and possibly related r&d, licensing or joint venture agreements, 212 shahiduzzaman khan, ‘api park to give pharma industry a major boost’ 1 june 2008, the financial express <http://www.thefinancialexpress-bd.com/2008/06/01/35266.html> 8 july 2010. 213 ibid. 214 ‘bangladesh pharmaceuticals and healthcare report q3 2009’ (business monitor international june 2009). nordic journal of commercial law issue 2010#2 40 manufacture and market pharmaceuticals products, and make economic development. to such ends, iprs come in help. they provide a legal basis for negotiating contractual arrangements that transfer technological information among firms and across borders. they also facilitate market transactions and often act as the legal foundation around which strategic investment decisions, especially about technology transfer, are made.215 however, the survey researches of branstetter, fisman, foley, and saggi,216 lee and mansfield,217 and maskus218 made it clear that pharmaceutical mncs generally seek to avoid the transfer of strategically sensitive technology of pharmaceutical ones to unaffiliated parties, regardless of the perceived strength of the iprs regime. 6.4. technology transfer mechanisms in pharmaceuticals it is established that for strategic technology transfer decisions in pharmaceuticals, mncs often depend on ownership, location and internalization (oli) conditions. since they possess ownership, the further conditions of location and internalization must be met for them to transfer technologies overseas.219 location advantages are essential to make the business more profitable in the foreign country in terms of minimum transportation costs and tariffs, low input prices, access to distribution networks and local regulatory and enforcement environments. the mncs interpret the protection of iprs in the host country as a location advantage, as iprs are territorial in nature, and hence differ across national boundaries.220 in addition, internalization of production appears to be more profitable for firms rather than to sell or license their iprs to independent local firms in the foreign country.221 such advantages take the form of avoiding transaction costs with potential licensees, controlling inputs and protecting quality.222 different levels of protection in national iprs regimes may influence where an mnc decides to locate its business or to internalize or externalize its intellectual 215 keith e maskus and ruth l okediji, ‘economic and legal considerations for the international transfer of environmentally sound technologies’ (ictsd initiative on climate technology and trade, second expert meeting, bonn, 8 june 2009). 216 l branstetter, r fisman, f foley, and k saggi, 2007, ‘intellectual property rights, imitation, and foreign direct investment: theory and evidence’ (nber working paper 13033). 217 lee and mansfield, above n 97, 181. 218 maskus, above n 52, 70-1. 219 rajnish kumar rai, (2009) 11(5/6) journal of world intellectual property 404; j h dunning, ‘explaining changing patterns of international production: in defense of eclectic theory’ (1979) 41 oxford bulletin of economic statistics 269; j h dunning, ‘explaining the international direct investment position of countries: towards a dynamic or developmental approach’ (1981) 117 review of world economics 30. 220 rai, ibid. 221 ibid. 222 l branstetter, r fisman, f foley and kamal saggi, ‘does intellectual property rights reform spur industrial development’ (revised nber working paper 13033, december, 2009) nordic journal of commercial law issue 2010#2 41 assets.223 the oli framework and the arguments put forward, thus, suggest that iprs protection is one of many factors influencing firms’ decisions to transfer technologies to a particular country. however, the effects of strengthened iprs protection are often dependent on its interrelationship with the effects of other factors, such as the size of the domestic market, the structure of factor supply, productive infrastructure and the degree of stability of the macroeconomic environment.224 in view of the oli construction and significant iprs protection framework, bangladesh qualifies as a pharmaceutical technology transferee. this is because it is more attractive as a location to transfer pharmaceutical technologies through investment, licensing or outsourcing for its having bigger local market than most of the ldcs and in terms of geographical location. in addition, bangladesh has the potential to manufacture cheaper medicines out of accessed technologies and exports them all over the world. to qualify as a transferee, bangladesh does already have reliance on the trips transition period and the waiver decision, and starts exporting medicines to a country who is a developing country or least developing country member of the wto and has not yet enacted the patent protection law or to a country who is a member of the wto and provides patent protection but has granted compulsory licenses for the import of medicines, or to a country who is not the member of the wto.225 another big advantage for bangladesh is gaining the markets, where india and brazil used to sell until 2005, because these countries are now precluded from supplying medicines subject to patents, thereby strengthening the competitive positions of bangladeshi producers of medicines.226 in addition, almost in all such cases, medicines are reverse-engineered out of technologies transferred here informally availing of the trips transition period or of off-patent technologies. and, it is interesting to note that the existing patents and designs act, 1911 (patents and designs act) 227 framed during the british colonial rule does not recognise the trips transition opportunities of informal technology transfer for domestic consumption needs and exports.228 to utilize such markets after the trips compliance depends on formal modes of technology transfer. however, in bangladesh, a small amount of formal technology transfer in pharmaceuticals takes place through licensing, fdi and joint venture.229 to have more 223 c braga and c fink, ‘the relationship between intellectual property rights and foreign direct investment’ (1998) 9 duke journal of comparative and international law 163. 224 rai, above n 219, 404. 225 world bank, above n 210, 17. 226 ibid. 227 act ii of 1911, bangladesh code vol. vi. 228 see ferdaus ara begum, mesbah uddin, and sharifa khan, ‘assessing technical needs for implementing the trips agreement in bangladesh’ (presentation made at the ministry of industries, dhaka, 22 january 2009). 229 mustafizur rahman, 'globalisation, developed country policies, and market access: insights from bangladesh experience' in robert picciotto & rachel weaving (eds), impact of rich countries' policies on poor countries: towards a level playing field in development cooperation (2004) 67, 91. nordic journal of commercial law issue 2010#2 42 technology transfer, bangladesh has lately signed bilateral investment treaties with the eu and the us containing technology transfer provisions.230 such treaties require bangladesh to broaden definition of iprs. in addition, it has currently been under pressure to resume the pending talks with the us on reaching a deal named the trade and investment framework agreement (tifa).231 the proposed agreement contains a technology dealing asking bangladesh to insert trips-plus provisions on patentability in its legislations and limiting the trips transition period as pre-conditions for technology transfer.232 such agreements provide for the transfer of know-how in manufacturing to managerial practices. these explicit transfers are negotiated in addition to implicit transfers that occurr simply through the introduction of foreign personnel and techniques. this type of transfer has the effect of shifting the productive frontier of an economy and improving short-term economic performance. so, any resultant technological progress is expected to be crucial to the long-run growth process.233 however, such us and eu initiatives are likely to block the change or flexibility in the compulsory licenses clause through trips-plus agreements affecting the availability of essential drugs at reasonable price within the domestic market of bangladesh and other third world and developing countries.234 in addition to the oli formulation of technology transfer, technology transfer also takes place in an ldc like bangladesh through outsourcing or patent disclosure. to put such means through, many of the firms in india and china who are champion reverse engineers are recently interested to outsource their production in bangladesh as a potential manufacturer of generic versions of patented products which they cannot produce in their own country after 2005.235 furthermore, although the patents and designs act 1911 does not endorse outsourcing as a means of transfer of technology, it recognises disclosure of patent details.236 such disclosure helps for early generics approval serving in local and international markets. however, this does not happen to all patent applications stored in the mail box set up in 230 see european union-bangladesh cooperation agreement on partnership and development 1999, signed 22 may 2000, lex-faoc036142 <http://faolex.fao.org/docs/pdf/bi-36142.pdf> 2 april 2008; united states-bangladesh bilateral investment treaty 1986 signed 12 march 1986; entered into force 25 july 1989 treaty doc.99-23 congress; see also e mansfield, ‘intellectual property protection, foreign direct investment and technology transfer’ (discussion paper number 19, international finance corporation, world bank, washington, dc 1994). 231 ‘bangladesh to resume tifa negotiation talks with us, the new nation, 3 february 09. 232 mamun rashid, ‘transit, tifa and bangladesh’ the daily star, monday, july 20, 2009. 233 see linda y yueh, ‘global intellectual property rights and economic growth’ (2007) 5(3) northwestern journal of technology and intellectual property 436. 234 prosenjit chakraborty, syded ferhat anwar and mahjabeen ahmad, ‘strategies under the wto regime: the pharmaceutical sector in bangladesh’ (2003) 5(2) journal of bangladesh studies 42, 44-46. 235 srividhya ragavan and jamie mayer o'shields, ‘has india addressed its farmers’ woes? a story of plant protection issues’ (2007) 20 georgetown international environmental law review 97. 236 ibid. nordic journal of commercial law issue 2010#2 43 accordance with the executive order requiring the department of patents, designs and trademarks (dpdt) since it asks for data exclusivity.237 7. strategies to be framed 7.1. points of departure for both of its costs and benefits, the trips agreement is neither inherently good nor bad for economic development in an ldc like bangladesh, as current discussions seem to suggest. however, the opportunity for economic benefits which accrue through technology acquisition, follow-on innovations and their uses can not be achieved without adopting all out strategies. the strategic policy framework requires being such that supports trade liberalization, establishing incentives to attract fdi, and strengthening of iprs. such policy framework may be contained to reform their iprs regime to maximize economic gains, while limiting the potentially adverse effects of improved protection and to facilitate access of local entrepreneurs to the ipr system as has been done in india, thailand, and south korea. it is also to be noted that the developed and those developing countries that have achieved substantial growth rates have all fine-tuned their iprs system to match their development needs, rather than blindly implementing a comprehensive iprs policy.238 so, the trips agreement appears to hold economic development prospects for bangladesh if the existing iprs regime gets fine-tuned upon a policy that establishes a balance between intellectual property protection and welfare needs at the national and international levels. to have the balance, the trips needs to be neutralised in the local legislations by minimising imitation or follow-on innovation costs raised by pharmaceutical and biotechnological patents or trade-secrets protection or by expediting the pace of technological development by spreading the flow of r&d spillovers that are important inputs in research. since the trips agreement of the wto is a reality, which least developed countries like bangladesh have to exist with, ways and means related to the trips prior to 2016 and post 2016 require to be considered with the view to harnessing local consumption needs and economic welfare goals. this consideration involves national and international strategic trade partnership and legal preparations covering use of technology and technology trade in agriculture and pharmaceuticals. 237 dpdt/p&d law/2007/74/129 (government order issued in bangladesh by the department of patent, design and trademarks, 7 january 2008) [hereinafter dpdt order]; see also <http://www.wto.org/english/tratop_e/trips_e/implem_para6_e.htm> 2 april 2008. 238 dolfsma, above n 27. nordic journal of commercial law issue 2010#2 44 7.1. issues for national action to moderate the adverse effect 7.1.1. trips transitional period as part of forming national strategies covering use of technology and technology trade in agriculture and pharmaceuticals, two sets of preparations can be taken in ldcs like bangladesh, namely, strategy for the trips transitional period and strategy for after the trips compliance. there is historical precedent that modern developed countries often undertook policies that would be considered piracy by today’s standards. in practice, the rationale is a proven method for advancing technological and economic development, tested frequently and successfully by many of today’s developed countries during their history. developing countries that have weak iprs protection are doing nothing more than following historically proven methods for advancing development. so, it is rational for most of the least developed countries that have little incentive to adopt the trips to obtain iprs as inexpensively as possible by adopting policies that support formal and informal technology transfer and grow their iprs protection level in parallel with economic development and according to their own industrial and commercial strengths.239 among the policy responses that developing country governments can take at the national level in order to promote economic development include exploiting the policy spaces available in the trips fully for formal and informal technology transfer and exploit the technologies for followon innovations including petty patents and industrial design patents. although ldcs can continue informal technology transfer meaning piracy in the transition period, it is better to bring such informal technology transfer in legal coverage to avoid loosing market access in developed countries. and for this, there needs: incorporating the provisions of compulsory licensing in the ipr legislation, incorporating the research exception, early working exception or ‘bolar’ provision, allowing parallel imports or grey-market imports, incorporating breeders’ exceptions and farmers’ exceptions in sui generis plant variety protection. the experience of several east asian countries suggests that such steps help them in acquiring technology that leads to petty patents and industrial design patents, and ultimately prove to be effective means of encouraging domestic enterprises to undertake minor adaptive innovations and foster an innovation based rivalry among them. for this advantage to take into use in bangladesh, the existing patents and designs act 1911 needs to incorporate transitional provisions allowing the use of technology and technology trade with informal technology access and facilitating exports to countries having no infrastructure of reverse engineering and failing to support people with low cost life saving medicines or food. however, there arises a question of legality as regards reduction or 239 ostergard, above n 7, 115-55. nordic journal of commercial law issue 2010#2 45 withdrawal of the already protection. this is because where least-developed countries do provide some kinds of intellectual property protection even though they are not required to do so under the trips agreement, they are obliged not to reduce or withdraw the protection that they currently give.240 so, unless and until the trips council or the wto panel makes a decision on this, it is deemed to be a valid option to adopt informal technology access for a least developed country like bangladesh during the trips transition period and manufacture low cost drugs including the hiv/aids drugs, agricultural products and others for the uses at home or abroad. however, for producing and supplying low cost hiv/aids drugs, strong lobbying shall have to be made with the importing countries and also with the world health organization authorities who selects the potential suppliers to supply medicines for hiv/aids in the african countries. in addition, in order to facilitate exports of medicines, the pharmaceutical plants and the products must comply with the standards set by the importing countries. in many cases, it means that both the products and the plants are approved by the drug administration of the importing countries. furthermore, strategies to be made for encouraging countries like china, brazil, india and others to outsource in bangladesh for producing medicines or apis on taking its advantage of special and differential treatment in terms of the trips compliance. in this connection, it is to be noted that the limited outsourcing of low innovation coding or other functions (e.g. customer care call centres) tends to evolve to progressively more complex coding tasks and higher innovation activities, leading to significant innovations in the recipient (outsourced to) country. and this outsourced low innovation becomes a form of technology transfer and serves as a stepping stone to higher innovation functions, and eventually to world-class competitiveness for some countries.241 for example, through outsourcing by the us and the eu among others, china has become a power in technology although at the beginning it had not achieved a level of intellectual property protection and enforcement the us and the eu considered sufficient.242 for bangladesh, however, there might arise some issues raised from local pharmaceutical companies for competition with foreign companies. in that case outsourcing in pharmaceuticals can be restricted only to manufacturing of apis. 240 some analysts have questioned the legal validity of this “no roll-back” provision and regard it as being beyond the mandate of the wto council for trips, for example see s musungu, ‘a conceptual framework for priority identification and delivery of ip technical assistance for ldcs during the extended transition period under the trips agreement’ (quaker united nations office: geneva, 2007). 241 gervais, above n 5, 384. 242 ibid, 389. nordic journal of commercial law issue 2010#2 46 7.1.2. after trips compliance: the strategy for after the trips compliance requires taking advantage of flexibilities which allow some sort of informal technology transfer and preparing the country to attract formal technology transfer in the way of fdi, licensing or joint ventures. however, the costs for preparations impose a considerable financial burden on developing countries, particularly ldcs like bangladesh. for example, a world bank study notes that implementing the trips obligations would require the ldcs to invest in buildings, equipment, training and so forth that would cost each of them us$150 million for many of the ldcs this represents a full year’s development budget.243 the unctad provides some rough estimates of the administrative costs of complying with trips in various developing countries.244 for bangladesh, it anticipates one-time costs of administrative trips compliance (drafting legislation) amounting to us$250,000 and over us$1.1 million in annual costs for judicial work, equipment, and enforcement efforts.245 however, these estimates do not include training costs. such potential costs explain the reluctance of many developing economies to strengthen their regimes. as part of preparation by drafting iprs legislation for agricultural products, the country can legislate for a sui generis regime as indicated in article 27.3 of the trips for protecting local plant varieties in addition to the new varieties developed by local and mncs. this protection strategy is likely to attract mncs with fdi or joint venture in agricultural sector for its being an agriculture-prone country or convince mncs to license their agricultural technologies especially biotechnologies to the country. such technologies which already prove to be helpful in high yielding in india, thailand or the philippines may benefit hunger-stricken bangladeshis with food and economic means. this regime is also supposed to protect farmers’ traditional rights to re-sow and exchange seeds. such initiative can save local farmers from spending money each time they sow seeds and help them fulfilling subsistence needs. with a view to compliment the sui generis regime, the country can amend its seeds ordinance 1977246 to encourage seed trade to promote the seed industry, boost exports, and protect seed quality. such schemes are expected to provide adequate rewards to stimulate successful r&d of plant varieties without compromising local needs and would promote breeders exclusively as a means to promote agricultural trade since both over-protection and under-protection detrimentally affect trade, and discount food security issues.247 243 j m finger, ‘the wto’s special burden on less developed countries’ (2000) 19(3) cato journal 425. 244 unctad, the trips agreement and developing countries (1996) <http://www.unctad.org/en/docs/ite1_en.pdf > 10 july 2010. 245 ibid. 246 ordinance no. xxxiii of 1977. published in the bangladesh gazette, extraordinary, dated the 19th july 1977. 247 ragavan and o'shields, above n 235, 97. nordic journal of commercial law issue 2010#2 47 in addition, the patents and designs act 1911 which is inherited from the colonial times provides for protection of all inventions including pharmaceuticals. so, in some respect bangladesh is already in the trips arena but the protection has hardly managed only four mncs subsidiaries to have their operations in bangladesh. it is also true that because of the protection some pharmaceutical enterprises have tried to develop their own technology in producing generics of in-patent and off-patent drugs. however, this gain is nothing compared to india since the weak iprs regime started in 1970 could bring in the rapid evolution of indian pharmaceutical industry in building local capabilities and now it stands seven in the world ranking with a rising trend of residents in patent ownership in india, and in terms of the ability of india to raise her share in the us patents. not only that, it also accounts for 70 per cent of the bulk drugs production and 80 per cent of formulations produced in the country. so, it is not iprs but the technological capabilities of indian companies and institutions which have attracted leading mncs to open r&d joint ventures, hire contract research and establish r&d centres. ranbaxy, abbot laboratories, parke davis, and smith kline and beecham, among others are the examples of such indian technology adventures.248 so, in addition to strengthening iprs which is a reality now, bangladesh should give attention to building local capabilities by joint ventures, commissioning contract research and setting up r&d centres as india did. 7.2. issues for international action to moderate the adverse effect among the steps that developing country governments can unitedly take at the international level include building a consensus on the moratorium on further strengthening of iprs regime, granting flexibility to low income developing countries below a certain level of per capita income in implementing the provisions of trips, pressurizing the trips council to consider ways and means to operationalize the ‘best endeavour’ nature objective and principles in respect of transfer and dissemination of technology to developing countries, particularly the least developed countries249 with the incorporation of specific provisions for transfer of technology, and adopting differential pricing strategies for developed and developing countries. in addition, one of the ways of compensating the low income countries for the adverse effects of strengthened iprs regime is to provide increased technical assistance and international r&d funding to local enterprises to help them build local capabilities. developed countries’ donation of a substantial proportion of technology license fees collected from low income 248 for instance, eli lilly established a joint venture with ranbaxy in the mid-1990s for development of a cost effective process for synthesis of cefaclor, among other products, taking advantage of the latter’s process development capabilities. similarly, bayer contracted ranbaxy to develop single doses formulations of its proprietary ciprofloxacine. a number of leading mnes have also contracted indian public funded r&d institutions for synthesis of new molecules and process development. for more details, see kumar, above n 4. 249 carlos correa, ‘the trips agreement and transfer of technology’ in kevin p gallagher (ed), putting development first: the importance of policy space in the wto and ifis (2005) 126-145. nordic journal of commercial law issue 2010#2 48 countries to a fund created in the respective countries could also be possible to assist inventive activities of domestic enterprises. after all, developing countries should oppose any attempt of developed countries to introduce trips plus patent regime and ever-greening of patents.250 8. concluding remarks the analysis reviewed here claims that strengthening iprs in the trips web-netting agriculture and pharmaceuticals caries mixed economic prospects and concerns for an agriculture-prone and densely populated ldc like bangladesh. the trips standard-setting in relation to agriculture and pharmaceuticals does not help the country to fulfil subsistence needs or promote economic development through innovations. because, neither the agreement nor the existing bangladesh iprs legislations take into account the general subsistence needs and economic development of the great majority of poor people. however, exception clauses and special and differential treatment in terms of compliance deadline and technology transfer promises can help an ldc like bangladesh to reverse-engineer existing knowledge products and supply them to home and abroad with the broader view of meeting survival needs and making economic progress. to qualify for such treatments, bangladesh legislations need to streamline existing provisions that define patentable inventions, compulsory licensing and other differential treatment, and the trips needs to be more specific on technology transfer arrangements, which are currently in paper, not in practice. 250 kumar, above n 4. new rules for fast track arbitration in finland by patrik lindfors* nordic journal of commercial law issue 2004 #2 nordic journal of commercial law issue 2004 #2 2 in a new effort to boost the steadily growing popularity of arbitration as a dispute resolution mechanism in finland, the arbitration institute of the central chamber of commerce of finland has published rules for fast track arbitration in finland. the rules for expedited arbitration were adopted in april 2004 and they came into force on 1 june 2004. the approaches adopted in the new rules correspond largely to the more established fast track arbitration rules in europe. from a practitioner’s viewpoint the new institutional fast track rules are a welcomed development and are likely to further increase the attractiveness of arbitration as an alternative to litigation in finland. _______________________________ the fast track rules will be used only if expressly agreed upon by the parties and may be applied to both national and international commercial arbitrations. unlike some other international rules, the finnish fast track rules do not include any limits on the value or complexity of the cases or any automatic mechanism submitting small cases referred to the arbitration institute automatically to expedited arbitration. unless otherwise agreed upon by the parties, the arbitration institute of central chamber of commerce appoints the sole arbitrator of the case. the rules set out in detail the procedure of the arbitration. the parties are entitled to submit at most one written pleading besides the claim and the counterclaim, although the arbitrator has discretion to decide otherwise. all written pleadings must be brief and their time limit is fixed to fourteen days. an oral hearing will be held only if a party so requests and the arbitrator considers it necessary. the award does not have to state reasons unless a party so requests. the normal arbitration rules of the arbitration institute require that the award shall be rendered within one year after the arbitration institute has sent the file in the case to the arbitral tribunal. according to the statistics released for 2003, the median duration of the proceedings was roughly nine months. in the rules for fast track arbitration this time limit has been fixed to three months, which the arbitration institute may extend by another three months at the most. _______________________________ since the approaches adopted in the new finnish rules correspond largely to those of the other european fast track rules, the problems that are likely to arise are also similar. fast track arbitration is naturally not always suitable for cases involving complex issues or large amounts of conflicting evidence. when these types of cases are referred to fast track arbitration, the situation is difficult both to the arbitrator and to the parties. therefore, parties should consider carefully before including fast track arbitration clauses in complex commercial agreements since in practice it is usually difficult for the parties to agree upon procedural issues once a dispute between them has already actualised. although, it is a widely accepted principle in the finnish law that the parties are free to agree upon the procedural rules and waive any procedural rights, it remains to be seen whether fast nordic journal of commercial law issue 2004 #2 3 * partner, hannes snellman attorneys at law ltd track arbitration will give rise to arguments that the strict time limits or other restrictions to the parties’ possibility to present their cases are in conflict with the fundamental due process requirements. as the new rules have only been in force since 1 june 2004, it is somewhat premature to evaluate how widespread the use of the new rules will be. as of december 2004, no applications regarding expedited arbitration have been submitted to the arbitration institute. in sweden similar fast track rules have been adopted enthusiastically. according to the statistics of the arbitration institute of the stockholm chamber of commerce for 2003, the fast track rules were used in more than 30 % of the cases. therefore, it seems likely that fast track arbitration will in due time also gain popularity in finland. _______________________________ model arbitration clauses, information about the arbitration institute and the rules for expedited arbitration are available at the arbitration institute’s web site, www.arbitration.fi.1 (endnotes) microsoft word commentary2.doc how does the cookie crumble? legal costs under a uniform interpretation of the united nations convention on contracts for the international sale of goods by troy keily1 nordic journal of commercial law issue 2003 #1 1 troy keily is an australian lawyer. he holds a bachelor of arts & bachelor of laws (honours) degree from deakin university. this paper was completed as part of a masters degree in public & international trade law at the university of melbourne. nordic journal of commercial law, issue 2003 #1 2 1. introduction 1.1 how does the cookie crumble as it falls or following the event? a family owned mexican company, zapata hermanos sucesores, s.a. ("zapata"), sold approximately us$950,000 worth of cookie tins over a period of four years to the maurice lenell cooky company ("lenell"), an american company that produced baked goods. lenell failed to pay zapata for the cookie tins so zapata sought legal advice and instituted legal proceedings against lenell for breach of contract in the federal district court of illinios.2 the cookie tin sale contracts were governed by the united nations convention on contracts for the international sale of goods ("cisg"). zapata succeeded in its federal district court claim and, as part of the court's order, was awarded us$550,000 as foreseeable loss under article 74 of the cisg, being the amount of legal fees incurred by zapata in bringing proceedings against lenell. on appeal to the federal appellate court, however, the award of legal fees was overturned.3 the parties now find themselves contesting a leave application to appeal to the supreme court of the united states of america in a much anticipated debate over who should pay the lawyers.4 the decisions of the federal district court and federal appellate court, and now the application to appeal before the supreme court, are significant for two reasons. first, the decisions consider whether legal costs are payable by a losing party as damages for loss under article 74 of the cisg. for reasons that will be outlined below, this issue takes on even greater significance for parties litigating under the cisg in the united states. but the second and greater significance of these decisions is not what the courts decide but how they decide it. when interpreting the cisg, the means must justify the end. the cisg is a uniform contract law adopted by 62 countries that together account for over two-thirds of all world trade. the purpose of the cisg was to harmonise contract laws and provide greater certainty to merchants trading in goods across state borders and thereby encourage international trade. however, the harmonisation of the international sale of goods law in the cisg also demands a uniform application of its principles by tribunals around the world. recognising this need, article 7 of the cisg guides merchants, lawyers and tribunals on how to promote a uniform interpretation and application of the cisg. this paper will critically consider the treatment accorded to article 74 of the cisg by both the federal district court and the federal appellate court in light of the principles of interpretation set out in article 7. this paper concludes that the end decision of the federal district court was wrong, although the means adopted by the court did in part respect the mandate of article 7. the end decision of the federal appeal court, on the other hand, was correct. however, the path taken by the federal appeal court in reaching its decision did not accord with the requirements of article 7. the failure of the federal appeal court to pay due regard to article 7 represents a 2 zapata hermanos sucesores, s.a. v hearthside baking co., inc., d/b/a maurice lenell cooky company (2001) wl 1000927, also published at <http://cisgw3.law.pace.edu/cisg/wais/db/cases2/010828u1.html>. 3 zapata hermanos sucesores, s.a. v hearthside baking co., inc., d/b/a maurice lenell cooky company 313 f. 3d 385, also published at <http://cisgw3.law.pace.edu/cisg/wais/db/cases2/021119u1.html>. 4 no. 02-1318 in the supreme court of the united states of america. for a copy of zapata's petition for writ of certiorari, lenell's brief in opposition to petition for writ of certiorari, the motion for leave to file and brief amicus curiae and lenell's reply brief, see links at <http://www.cisg.law.pace.edu/cisg/text/e-text-74.html>. nordic journal of commercial law, issue 2003 #1 3 detrimental precedent to the future application of the cisg and ultimately undermines uniformity and the promotion of international trade. in this context, the application to appeal to the supreme court of the united states of america is a momentous opportunity for some of the world's most respected jurists to make potentially the most significant jurisprudential contribution in the short history of the cisg. in addition, the application to appeal to the supreme court has also given rise to interesting developments for the future interpretation and stewardship of the cisg. this paper will also consider these developments. part two of this paper briefly introduces the cisg and, specifically, articles 7 and 74. part three looks at the facts of the zapata case and various approaches in domestic legal systems to the payment of legal fees. the decisions of the federal district court and the federal appeal court are examined in parts four and five respectively and part six presents the authors view on whether an interpretation of loss under article 74 in accordance with article 7 includes legal fees. finally, part seven considers the significance of the appeal to the supreme court. 2. the cisg 2.1 cisg in a nutshell sixty two states are currently signatories to the cisg. this includes all major trading countries in the world with the notable exceptions of england and japan. accordingly, the importance of the cisg to the international trade in goods cannot be overstated. this significance is also recognised in the preamble of the cisg that records the commitment of contracting states to the view that: ... the adoption of uniform rules which govern contracts for the international sale of goods and take into account the different social, economic and legal systems would contribute to the removal of legal barriers in international trade and promote the development of international trade... this attestation to the goals of the cisg also pays tribute to the context in which the cisg was drafted. the delegates that contributed to the negotiation and drafting of the cisg represented an amalgam of different countries and legal systems including representatives from common law, civil law, socialist and third world countries. the delegates each sought to promote a harmonised law that most resembled their domestic legal system and accordingly the final text of the cisg represents an often hard won compromise between these different legal systems. the final result, however, was a contract law intended to operate independently from domestic laws as an autonomous instrument governing the formation of contracts for the international sale of goods, obligations of the seller and buyer and remedies for breach. critical to the autonomy of the cisg, and the successful harmonisation of international sale of goods law, is article 7. 2.2 article 7 of the cisg: interpretation template nordic journal of commercial law, issue 2003 #1 4 phanesh koneru states that article 7 is "arguably the single most important provision in ensuring the future success"5 of the cisg. likewise, john felemegas notes that the "area where the battle for international unification will be fought and won, or lost, is the interpretation of the cisg's provisions. only if the cisg is interpreted in a consistent manner in all legal systems that have adopted it, will the effort put into its drafting be worth anything."6 article 7 mandates how the cisg is to be interpreted. it is the template through which the cisg must be read. the text of article 7 reads as follows: (1) in the interpretation of this convention, regard is to be had to its international character and to the need to promote uniformity in its application and the observance of good faith in international trade. (2) questions concerning matters governed by this convention which are not expressly settled in it are to be settled in conformity with the general principles on which it is based or, in the absence of such principles, in conformity with the law applicable by virtue of the rules of private international law. the template prescribed in article 7 to interpret the cisg can be broken down into the following three steps. 2.3 step one: international character, uniformity and good faith first and foremost, the cisg directs those interpreting the cisg to have regard to its international character, the need to promote uniformity and the observance of good faith in international trade.7 this component imposes positive obligations to adhere to the plain meaning of the text of the cisg and to refer to foreign decisions, the legislative history of the cisg and academic commentary for guidance. this component also imposes negative obligations to avoid the 'homeward trend' and domestic techniques of interpretation. 2.3.1 the text the primary positive obligation is to look for the answer to all questions in the cisg. this places the pre-eminent importance on the text of the cisg. felemegas rightly argues that "fidelity to the words of the statute"8 is required which necessitates "adherence to the plain meaning of the text and comprehension of the full context of the convention's provisions."9 (a) foreign decisions the best measure of uniformity of interpretation of the cisg is to actually consider decisions of foreign tribunals. accordingly, the international character and need to maintain uniformity requires tribunals to consider decisions from outside their domestic jurisdiction. however, 5 phanesh koneru, ‘the international interpretation of the un convention on contracts for the international sale of goods: an approach based on general principles’ (1997) 6 minnesota journal of global trade 105. 6 john felemegas, ‘the united nations convention on contracts for the international sale of goods: article 7 and uniform interpretation’ <http://www.cisg.law.pace.edu/cisg/biblio/felemegas.html>. 7 for a discussion on the meaning and role of good faith see troy keily, ‘good faith & the vienna convention on contracts for the international sale of goods’ (1999) 3 the vindobona journal of international commercial law and arbitration 15. 8 felemegas, above n7. 9 ibid. nordic journal of commercial law, issue 2003 #1 5 there are significant practical problems with this requirement as will be demonstrated in part 6.1 below. 2.3.2 travaux preparatoires beyond the plain and contextual meaning of the text of the cisg and consideration of foreign decisions, the international character and the need to maintain uniformity requires the use of specific interpretative aids when determining the intended meaning of provisions in the cisg. the negotiation and drafting process of the cisg took many years and, as outlined above, required the involvement of delegates representing countries and legal systems from all corners of the globe. this rich legislative history or the travaux preparatoires should be referred to for guidance when interpreting the cisg. (a) academic commentary a further interpretive aid available when determining the application of the cisg is the use of expert academic commentary. the use of academic commentary does not generally sit well with the tradition of common law countries although civil law countries have always been accepted the important role of academic writing.10 in the context of the cisg however, recognition of its international character and the need to maintain uniformity can only be assisted by the use of academic commentary. 2.3.3 homeward trend the international character of the cisg requires recognition that it is not a piece of domestic legislation but rather a multinational treaty that has been incorporated into the domestic law of counties across the globe whose legal traditions vary considerably. accordingly, in addition to the positive obligations outlined above mandated by the international character and need to maintain uniformity, these characteristics of the cisg also impose the negative obligation to avoid the 'homeward trend' when interpreting the meaning of the cisg. the homeward trend is the propensity to interpret an international convention through a domestic lens and in accordance with domestic principles and concepts. it is the "temptation for judges and the parties settling disputes... to look at what is familiar especially as it appears to be so at first glance."11 when interpreting the cisg, the danger of the homeward trend is most pronounced with the reflex tendency to interpret legal concepts found within the cisg as if they were the same as concepts found in the domestic law or with the over reliance of domestic judicial decisions at the expense of decisions of foreign tribunals. 2.3.4 domestic interpretative techniques the danger of the homeward trend warns against the reliance on domestic concepts to understand principles in the cisg and the use of foreign decisions. it also requires the use of techniques of legislative interpretation that are different to techniques applied to domestic legislation. again, this reinforces the view when interpreting the cisg that it is not a normal piece of domestic legislation but an international treaty and that the cisg "should be seen as part of international law in the broad sense and should be entitled to an international, rather 10 ibid. 11 bruno zeller, 'the un convention on contracts for the international sale of goods (cisg) – a leap forward towards unified international sales laws' (2000) 12 pace international law review 79, 88. nordic journal of commercial law, issue 2003 #1 6 than national, interpretation."12 this warning is particularly pertinent to tribunals in the common law world given the common law tenancy to interpret domestic legislation narrowly. the cisg, however, should be given a broad interpretation as explained by professor bonell. "instead of sticking to its literal and grammatical meaning, courts are expected to take a much more liberal and flexible attitude to look, wherever appropriate, to the underlying purpose and policies of individual provisions as well as the convention as a whole."13 2.4 step two: general principles of the cisg steps two and three of the interpretation template prescribed by article 7 are the cisg's gap filling mechanisms. they come into play where the text of the cisg has left a gap in relation to the legal rights and obligations of a buyer or seller. such a mechanism is necessary because the cisg is not, and was never intended to be, an exhaustive body of rules providing solutions to all problems.14 the need to promote a uniform interpretation of the cisg is even more critical where the text of the cisg is silent because of the many divergent approaches that might be taken by tribunals around the world. accordingly, to maintain a uniform interpretation article 7(2) first directs those interpreting the cisg to settle matters that are governed by the cisg, but not expressly settled in it, in conformity with the general principles on which it is based. the cisg was designed as autonomous instrument as demonstrated by step two of the interpretation template that directs the reader to seek answers within the cisg by referring to its general principles. general principles upon which the cisg is based may be both expressly referred to in the cisg, such as the principles of good faith and party autonomy, or inferred from provisions in the cisg, such as the principles of reasonableness and mitigation.15 2.5 step three: rules of private international law the third step of the article 7 interpretation template is triggered only where the text of the cisg is silent on an issue and an answer is not otherwise provided by application of the general principles upon which the cisg is based. only after these two steps are exhausted is it permissible to proceed to step three which directs questions to be settled in conformity with the law applicable by virtue of the rules of private international law. accordingly, it is only at this stage that the cisg ceases to be autonomous and it is permissible to have recourse to the domestic law applicable under choice of law principles. 2.6 summary: the steps of the article 7 interpretation ladder the importance of maintaining a uniform interpretation of the cisg is enshrined in article 7. to give effect to this goal, article 7 offers an interpretation template or interpretation ladder.16 to summarise, the rungs of this interpretation ladder require that, first, provisions of the cisg 12 felemegas, above n7. 13 ibid. 14 ibid. 15 ibid. 16 frank diedrich, ‘maintaining uniformity in international uniform law via autonomous interpretation: software contracts and the cisg’ (1996) 8 pace international law review 303, also published at <http://www.cisg.law.pace.edu/cisg/biblio/diedrich.html>. nordic journal of commercial law, issue 2003 #1 7 be given a plain and contextual meaning with assistance from the cisg's own legislative history, academic commentary and, importantly, decisions of foreign tribunals. the international character and need to maintain uniformity of the cisg also warn against the homeward trend. that is, the interpretation of the cisg as a domestic statute or in reliance on domestic legal concepts or by recourse only to decisions of domestic tribunals. where the first rung of the interpretation ladder fails to provide an answer, reference should then be made to the general principles of the cisg. finally, it is only after these two steps are exhausted without determining the issue that recourse might be made outside the cisg to the domestic law applicable under choice of law principles. this paper will consider the extent to which the federal district court and the federal appellate court in zapata kept in step with the article 7 interpretation ladder in their respective interpretations of article 74 of the cisg. 2.7 article 74 of the cisg: foreseeable loss article 74 of the cisg provides the general rule for measuring damages in the case of breach.17 the text of article 74 reads as follows. damages for breach of contract by one party consist of a sum equal to the loss, including loss of profit, suffered by the other party as a consequence of the breach. such damages may not exceed the loss which the party in breach foresaw or ought to have foreseen at the time of the conclusion of the contract, in the light of the facts and matter of which he then knew or ought to have known, as a possible consequence of the breach of contract. accordingly, as a general rule, the cisg will award damages to an injured party that are foreseeable as a consequence of the breach. the reference to damages for 'loss of profit' in article 74 suggest that the purpose underlying an award of damages is to place the injured party in the same economic position the injured party would have been in had the contract been performed. this principle of full compensation is also supported by the legislative history of the cisg.18 unfortunately, the interpretation of article 74 by an american court has already provided an example of a court succumbing to the homeward trend and ignoring the template for interpreting the cisg set out in article 7. in delchi carrier s.p.a v roterex corp19 the court found that the "cisg requires that damages be limited by the familiar principle of foreseeability established in hadley v. baxendale." hadley v baxendale is a case familiar to common law lawyers as authority on the principle of foreseeability. however, by construing article 74 by reference to this common law case and legal concept, the court failed to comply 17 article 74 must be read together with other provisions of the cisg that regulate the award of damages. briefly, the relevant provisions are, article 45(1)(b) and article 61(1)(b) which establish the right to claim damages; article 75 and article 76 that define the method of calculating damages in certain circumstances; article 77 which sets out the rule of mitigation of damages; article 79 that establishes rules on exemption from liability for damages due to an impediment to performance and article 78 that provides that a claim by a party for interest is without prejudice to any claim for damages under article 74: see eric c schneider, 'cross-reference and editorial analysis: article 74' <http://www.cisg.law.pace.edu/cisg/text/cross/cross-74.html>. 18 jeffrey s sutton, 'measuring damages under the united nations convention on the international sale of goods' 50 ohio state law journal (1989) 737-752; also published at <http://www.cist.law.pace.edu/cisg/biblio/sutton.html>. 19 71 f.3d 1024 (u.s. ct. app 2d. cir. 1995). nordic journal of commercial law, issue 2003 #1 8 with article 7.20 in light of this and many other errors by american courts, the pending appeal to the supreme court represents an opportunity to correct the record. 3. the cookie dispute 3.1 the facts under article 1(1)(a) of the cisg, contracts for the international sale of goods are subject to the cisg where the place of business of the parties to the contract are in different states and those states are signatories to the cisg. zapata was a mexican company that manufactured tin products in mexico city. lenell was an american company that sold cookies. over a period of four years, zapata sold some 1,600,000 cookie tins to lenell valued at approximately us$950,000. the cookie tins are clearly goods and both mexico and america are signatories to the cisg. accordingly, the cisg applied to the contracts for the sale of the cookie tins. lenell accepted and used the cookie tins without complaint, but failed to pay for them. following this, zapata requested payment of its outstanding account before filling orders for more cookie tins. lenell responded by threatening not to pay unless all orders were filled. when zapata ceased future orders lenell made good its threat and refused payment requiring zapata to institute proceedings in the federal district court of illinios to recover payment. despite lenell's recalcitrant conduct throughout the proceedings, in which lenell continued to deny liability to pay for the cookie tins without any apparent defence, and its efforts to expand the scope and expense of the litigation through unnecessary discovery proceedings, zapata was ultimately successful in its claim and lenell was ordered to pay for the cookie tins. zapata's legal bill at this stage amounted to approximately us$550,000, over half of zapata's claim under the cookie contracts. accordingly, zapata's apparent success was diminished by lenell's obstinate attitude to payment that required zapata to incur significant legal fees to recover what it was due. the federal district court was then asked to consider whether zapata could recover from lenell the legal fees zapata had incurred as loss under article 74 of the cisg. the federal district court held in the affirmative, which decision was overturned by the federal appellate court and is presently pending an application to appeal to the supreme court. before proceeding to an analysis of these decisions however, it is necessary to give a context by briefly outlining the attitudes of different jurisdictions to the recovery of legal fees and expenses. 3.2 american rule – loss as it falls the united states is in the minority of countries to apply the 'american rule' in relation to legal fees and expenses. under this general rule, parties to litigation bear their own expenses. that is, the legal expense incurred by each party lies as it falls. this 'every man for himself' 20 susanne cook, ‘the un convention on contracts for the international sale of goods: a mandate to abandon legal ethnocentricity’ (1997) 16 journal of law and commerce 257, also published at <http://www.cisg.law.pace.edu/cisg/biblio/1cook.html>. nordic journal of commercial law, issue 2003 #1 9 approach encapsulated by the american rule is declared to be morally superior because of the uncertain nature of litigation meaning: "one should not be penalised for merely defending or prosecuting a lawsuit, and ... the poor might be unjustly discouraged from instituting actions to vindicate their rights if the penalty for losing included the fees of their opponents' counsel".21 accordingly, the american rule is inconsistent with the view that loss under article 74 of the cisg includes legal fees and expenses. 3.3 english rule – loss follows the event the approach adopted by the majority of the countries around the world has been dubbed the 'loser pays' or 'english rule'. under this rule the losing party to litigation is required to pay the legal fees of the winning party. that is, an award of legal costs follows the event of winning. this rule dates back to roman times and "reflects the rationale that victory is not complete in civil litigation if it leaves substantial expenses uncovered."22 unlike the american rule, the english rule is designed to make the prevailing party to litigation whole by placing the winning party in the same economic position it would have been in had the contract been performed. 4. federal district court 4.1 decision lenell argued before the federal district court that, given they were in an american court, the american rule should apply to the proceedings and accordingly lenell should not be required to pay the legal expenses of the winning party, zapata. this view was rejected. rather, the court found that the plain meaning of loss in article 74 included the legal fees incurred by zapata. 4.2 uniformity and the homeward trend in what appeared to be a resounding victory for a uniform interpretation of the cisg and recognition of the dangers of the homeward trend, the court criticised lenell's misleading contention "for the parochial application of the american rule."23 the federal district court recognised that a uniform interpretation of the cisg mandated universality rather than application of the purely home-town american rule. the court also referred with approval to the following passage from an earlier decision of an american court that considered the cisg: 21 w. kent davis, 'the international view of attorney fees in civil suits: why is the united states the 'odd man out' in how it pays its lawyers?' (1999) 16 arizona journal of international & comparative law 361, 401; see also john yukio gotanda, 'awarding costs and attorneys' fees in international commercial arbitration' (1999) 21 michigan journal of international law 1, 10. 22 davis, above n20. 23 zapata hermanos sucesores, s.a. v hearthside baking co., inc., d/b/a maurice lenell cooky company (2001) wl 1000927, also published at <http://cisgw3.law.pace.edu/cisg/wais/db/cases2/010828u1.html>. nordic journal of commercial law, issue 2003 #1 10 "one of the primary factors motivating the negotiation and adoption of the cisg was to provide the parties to international contracts for the sale of goods with some degree of certainty as to the principles of law that would govern potential disputes and remove the previous doubt regarding which party's legal system might otherwise apply... courts applying the cisg cannot, therefore, upset the parties' reliance on the convention by substitution familiar principles of domestic law when the convention requires a different result. we may only achieve the directives of good faith and uniformity in contracts under the cisg by interpreting and applying the plain language of [the cisg]".24 4.3 plain meaning having rejected the application of the american rule, the court resolved the issue of whether zapata was entitled to payment of its legal fees and expenses by lenell by focusing on the plain language and meaning of article 74. as explained by the court, "[w]hen the searchlight of analysis is thus properly focused on the language of the convention without any inappropriate overlay from the american rule, the question becomes a simple one."25 referring to the language of article 74, the court held that "the normal unstrained reading of article 74... calls for [zapata's] recover of its attorneys' fees as foreseen consequential damages."26 that is, lenell "foresaw or should have foreseen that if lenell failed to pay for the tins that it ordered, received and accepted, [zapata] would incur litigation costs including attorneys fees, to seek payment of the invoices for said tins."27 4.4 legislative history the court also found support for its decision that loss under article 74 included legal fees and expenses in the cisg's legislative history. the court noted that, in the context of discussion on appropriate interest rates payable on damages under the cisg, the drafters of the cisg intended to protect the "injured seller's make-whole expectations".28 the court then commented that zapata could only be made whole "by freeing its damages recovery from the burden of attorney's fees."29 in its discussion on the american rule, the federal district court recognised that the american rule was at odds with the approach adopted by the majority of commercial jurisdictions and that the american rule fails to place "the winners in contract disputes in the same economic position as if the breaching parties had performed their required obligations under the contracts".30 the legislative history of the cisg does support the view that the policy underlying article 74 of the cisg is to award damages such that the injured party is in the same economic position it would have been in had the contract been performed. 24 mcc-marble ceramic ctr., inc. v ceramica nuova d'agostino, s.f.a., 144 f.3d 1384,1391 (11th cir. 1998). 25 zapata hermanos sucesores, s.a. v hearthside baking co., inc., d/b/a maurice lenell cooky company (2001) wl 1000927, also published at <http://cisgw3.law.pace.edu/cisg/wais/db/cases2/010828u1.html>. 26 ibid. 27 ibid. the court referred to a stipulation entered into by the litigants prior to the trial. 28 ibid. 29 ibid. 30 ibid. nordic journal of commercial law, issue 2003 #1 11 4.5 foreign cases importantly, the court also referred to decisions of foreign tribunals that purportedly supported the proposition that article 74 loss included legal fees. unfortunately, the reference to these foreign decisions was fleeting and the court failed to analyse these decisions in any depth. as will be discussed in part 6.1 below, a closer analysis of these foreign decisions suggests the court's unquestioning reliance on these decisions was misguided. 4.6 comment the federal district court made one significant omission in its decision. despite keeping in step with the interpretation template set out in article 7, the court neglected to state that article 7 was the provision actually guiding the court in its interpretation. the court failed to refer to article 7. in any event, the court did pay due regard to the plain meaning of the text of article 74 and sought assistance from decisions of foreign tribunals and the legislative history of the cisg. also, the court was mindful of the need to promote a uniform interpretation of the cisg and to avoid the lure of the homeward trend by rejecting automatic application of the american rule. further, as the court found article 74 expressly settled the question in the affirmative that legal fees and expenses could be recovered as loss, the court did not proceed to consider the cisg's gap filling mechanisms. accordingly, the decision of the federal district court did respect the mandate of article 7. however, whether the decision was correct is altogether a different issue. 5. federal appellate court 5.1 decision judge posner, writing the unanimous judgment of the federal appeal court, overturned the decision of the federal district court and held that zapata could not recover its legal fees and expenses as loss under article 74 of the cisg for two reasons. first, posner j held that the award of legal fees and expenses was not a substantive issue governed by the cisg but a procedural issue to be determined by the law of the forum. and second, posner j held that, in any event, the cisg does not allow for the recovery of legal fees and expenses. this paper will now consider each of these arguments and concludes that, whilst the ultimate decision of the federal appellate court was correct and the cisg does not allow for the recovery of legal fees, the methodology and path employed by the court in reaching its end decision was flawed. 5.2 substance v procedure article 4 of the cisg stipulates that the cisg "governs only the formation of the contract of sale and the rights and obligations of the seller and buyer arising from such a contract." while posner j did not expressly refer to article 4, he noted that. nordic journal of commercial law, issue 2003 #1 12 "the convention is about contracts, not about procedure. the principles for determining when a losing party must reimburse the winner for the latter's expense of litigation are usually not a part of a substantive body of law, such as contract law, but a part of procedural law. for example, the 'american rule', that the winner must bear his own litigation expenses, and the 'english rule' (followed in most other countries as well), that he is entitled to reimbursement, are rules of general applicability." in effect, posner j held that the cisg governs substantive issues in relation to the formation of contract and the rights of parties, but not procedural issues. further, posner j held that principles governing the recovery of legal fees are generally procedural. accordingly, he found that this issue should be determined by the procedural law of the forum, being the state of illinios which applies the american rule. there are significant problems with this approach. first and foremost, the approach taken to determining whether a particular rule is substantive or procedural has significant potential to detrimentally impact on a uniform interpretation of the cisg. for example, on posner j's approach it is open for a court to merely declare an issue to be procedural and not substantive and therefore outside the scope of the cisg. for this reason, commentators note that extreme caution must be taken in labelling a rule as procedural or substantive and that the "label that the state law bears should be irrelevant."31 rather, the cisg should be given the widest possible interpretation guided by article 7 and the urgency of uniformity. however, the analysis of the procedural and substantive law issue offered by posner j was relatively dismissive and represents a detrimental precedent for the future interpretation and application of the cisg.32 the preferred approach is to consider whether the substance of the dispute, in this instance whether a party could recover legal costs, is a matter governed by the cisg interpreted in accordance with article 7, not merely to consider whether a matter is generally considered procedural or substantive under domestic law. only this approach ensures a uniform interpretation of the cisg. 5.3 article 74: international character, uniformity & good faith? the decision of the federal district court relied on the plain meaning of article 74 of the cisg to hold that loss included legal fees and expenses. the federal appeal court, after holding that this was a matter governed by the domestic procedural law of the forum and therefore outside the purview of the cisg, also considered whether legal fees could otherwise be recovered as loss under the cisg. it is not clear why the court also considered this issue after holding that the matter was not one governed by the cisg. indeed, the arguments were not even offered by the court as alternatives but merely presented together, adding to the confusion. this demonstrates a misunderstanding by the court of the operation of the cisg and provides a disappointing and potentially misleading template for future courts or tribunals seeking to interpret and apply the cisg. 31 john o honnold quoted in albert h kritzer 'editorial remarks: delchi carrier s.p.a. v. rotorex corp.' <http://www.cisg.law.pace.edu/cisg.wais/db/editorial/951206u1editorial.html>. 32 john felemegas, 'an interpretation of article 74 cisg by the u.s. circuit court of appeals' <http://cisgw3.law.pace.edu/cisg/biblio/felemegas4.html>. nordic journal of commercial law, issue 2003 #1 13 the federal appeal court rejected the decision of the federal district court and found that the loss under article 74 of the cisg did not include legal fees and expenses. in reaching this conclusion, the federal appeal court noted that there: "is no suggestion in the background of the convention or the cases under it that 'loss' was intended to include attorneys' fees, but no suggestion to the contrary either."33 it is true that the legislative history of the cisg does not expressly indicate one way or the other whether loss was intended to include attorneys' fees. however, the legislative history does detail the underlying policy of article 74, being to make the injured party whole, which is relevant when determining the legal fees issue. this aspect of the cisg's legislative history was completely ignored by the federal appeal court. also, the suggestion that there is no case law able to shed light on the issue is clearly incorrect and demonstrates a disturbing reluctance to look for or consider decisions of foreign tribunals. it is true to say that no american case law has considered the payment of legal fees under article 74, but as was recognised by the federal district court, there were several decisions of foreign tribunals that had considered the issue. the federal appeal court's reluctance to consider judgments from beyond the borders of the united states jeopardises a uniform interpretation of the cisg and is contrary to the principles set out in article 7. the court's reluctance to consider foreign judgments is made worse by the court's reference to other american court decisions in relation to domestic sales legislation to support the proposition that: "it seems apparent that 'loss' does not include attorneys' fees incurred in the litigation for a suit for breach of contract, though certain pre-litigation legal expenditures, for example expenditures designed to mitigate the plaintiff's damages, would probably be covered as 'incidental' damages."34 this passage from posner j's judgment was supported by reference to decisions of american courts. the reference to 'incidental damages' demonstrates how the homeward trend and reliance on domestic legal concepts and decisions to inform the meaning of the cisg undermines the uniformity of the cisg. article 74 speaks of consequential damages. there is no reference to incidental damages in article 74 or the cisg. rather, incidental damages are a concept found in the domestic american sales legislation and are in fact defined and distinguished from consequential damages.35 the decision of the court has thus opened the door for pre-litigation legal expenses to be recovered as incidental damages under the cisg which is a category of damages that the cisg does not recognise. 5.4 general principles of the cisg having satisfied itself that the plain meaning of article 74, assisted by the cisg's legislative history and 'lack' of case law, suggested that legal fees could not be recovered as loss, the court also referred to article 7(2) in stating that: 33 zapata hermanos sucesores, s.a. v hearthside baking co., inc., d/b/a maurice lenell cooky company 313 f. 3d 385, also published at <http://cisgw3.law.pace.edu/cisg/wais/db/cases2/021119u1.html>. 34 ibid. 35 felemegas, above n31. nordic journal of commercial law, issue 2003 #1 14 "there are no 'principles' that can be drawn out of the provisions of the convention for determining whether 'loss' includes attorneys' fees".36 there is an inherent contradiction in this statement that demonstrates a complete misunderstanding by the court of the operation of article 7(2). the court had previously stated that the issue of legal fees was not a substantive issue governed by the cisg but a procedural issue governed by the procedural law of the forum. it concluded that legal fees are not an issue governed by the cisg. however, article 7(2) would only need to be considered by the court if the payment of legal fees was a matter governed by the cisg because article 7(2) only operates to fill gaps by the application of general principles of the cisg in relation to "[q]uestions concerning matters governed by this convention." on the one hand, the court stated that the payment of legal fees is a procedural matter not governed by the cisg but then analyses this issue under article 7(2) which only applies to matters governed by the cisg.37 putting this somewhat confusing anomaly to one side, it is also concerning to note the dismissive examination by posner j of the general principles of the cisg. posner j merely offered the statement that there were no general principles concerning loss and legal fees. in so doing, the posner j ignored a general principle expressly referred to by the federal district court, being the principle of full compensation. as discussed above, this general principle can be derived both from the text of article 74 which provides for damages for loss, including loss of profit, and from the legislative history of the cisg which clearly states that the policy underlying the damages provisions in the cisg is to place the injured party in the same position he would have been in had the contract been performed. the general principle of full compensation could be used to assist an interpretation of loss in article 74 that includes legal fees and expenses so as to fully compensate the injured party.38 5.5 rules of private international law after a derisory examination and conclusion by the court that there were no general principles to be drawn from the cisg in relation to loss and legal fees, the court stated that: "by the terms of the convention itself the matter must be left to domestic law (i.e., the law picked out by 'the rules of private international law,' which means the rules governing the choice of law in international legal disputes)."39 the court failed to examine the choice of law rules or to expressly state the domestic law that would apply as a result. however, it is inferred from the judgement that this process lead to the application of the american rule and thus the court had reached the same conclusion by two different means. first the court held that the american rule applied because it was a procedural issue beyond the scope of the cisg. and second, the court found that as there were no general principles in relation to loss and legal fees and that therefore the issue was to be determined by the domestic law applicable under the choice of law principles being the american rule as the law of the state of illinios. 36 zapata hermanos sucesores, s.a. v hearthside baking co., inc., d/b/a maurice lenell cooky company 313 f. 3d 385, also published at <http://cisgw3.law.pace.edu/cisg/wais/db/cases2/021119u1.html>. 37 harry flechtner & joseph lookofsky 'viva zapata! america procedure and cisg substance in a u.s. circuit court of appeal' (2003) 7 the vindobona journal of international commercial law and arbitration 93, 100. 38 felemegas, above n30. 39 zapata hermanos sucesores, s.a. v hearthside baking co., inc., d/b/a maurice lenell cooky company 313 f. 3d 385, also published at <http://cisgw3.law.pace.edu/cisg/wais/db/cases2/021119u1.html>. nordic journal of commercial law, issue 2003 #1 15 commentators have noted the danger posed by courts who too quick take recourse to the rules of private international law in interpreting the cisg in accordance with article 7. courts may take this avenue as it offers an easy gap filling solution rather than examining and relying on general principles of the cisg. for example, gyula eorsi stated that "it is enough to state that no general principles can be found and therefore the only way out is to resort to private international law."40 this indeed may have occurred in this case. it appears that posner j's brief examination and dismissal of the contention that legal fees were included as loss under article 74 of the cisg was merely intended as an exercise to lead to the conclusion that the american rule should apply "by the terms of the convention itself"41 under the rules of private international law. this is not to suggest that the conclusion of the court of appeal in this regard was wrong. however, the uniform interpretation of the cisg and its ultimate success as a harmonised law demands that courts around the world respect article 7. the court of appeal failed to respect the mandate of article 7. 5.6 anomalies to further support the court's contention that loss in article 74 does not include legal fees, the court identified two anomalies that would result from this interpretation. first, the court noted that while a party who successfully brought a breach of contract claim may recover its legal fees as loss under article 74, the cisg does not provide for the successful defendant. there is no comparable provision in the cisg that would enable a party who successfully defended a breach of contract claim to recover the loss it suffered as a consequence of incurring legal fees. the cisg requires a breach of contract to trigger the right to damages. a defendant successfully defending a breach of contract claim would not be able to refer to a breach to trigger a damages claim. this successful defendant anomaly was an important point identified by the court of appeal. the impact of the successful defendant anomaly on the interpretation of article 74 of the cisg will be further considered in part 6.2 below. the second anomaly identified by the court of appeal considers whether a successful plaintiff could waive its rights under article 74 of the cisg to the payment of legal fees in favour of the domestic law where that domestic law is more generous, that is, where the plaintiff would be better off under the domestic law. this anomaly gives rise to a further issue which the court did not consider in detail, namely, how the quantum of legal fees under article 74 should be determined. this issue will also be considered below. 5.7 comment unlike the federal district court, the decision of the federal appeal court showed little regard for article 7. accordingly, the decision of the federal appeal court sets a dangerous precedent for future courts and tribunals and may undermine the uniform interpretation of the cisg. however, the finding of the federal appeal court, that legal fees are not included 40 gyula eorsi quoted in felemegas, above n31. 41zapata hermanos sucesores, s.a. v hearthside baking co., inc., d/b/a maurice lenell cooky company 313 f. 3d 385, also published at <http://cisgw3.law.pace.edu/cisg/wais/db/cases2/021119u1.html>. nordic journal of commercial law, issue 2003 #1 16 as loss under article 74, is arguably correct. this paper will now set out the method and reasons that justify this conclusion but will, unlike the federal appeal court, conform to the mandate of article 7. before proceeding it is worthy to note one further comment of the federal appeal court. after finding that a party could not recover legal fees under the cisg the court stated the following. "and how likely is it that the united states would have signed the convention had it thought that in doing so it was abandoning the hallowed american rule?"42 this comment reveals that the federal appeal court was predisposed to its own domestic law and susceptible to the homeward trend and unwilling to recognise and respect the cisg's international character and need for uniformity that is required by article 7. 6. does article 74 allow the recovery of legal fees? 6.1 step one: international character, uniformity and good faith 6.1.1 the text article 7(1) requires an interpretation of the cisg that respects its international character and the need to promote uniformity in its application. this requires fidelity to the words of the cisg. fidelity to the words of article 74 of the cisg provide the strongest argument in favour of the proposition that legal fees and expenses are recoverable as loss. this is because a party in breach of a contract must foresee that the injured party will seek to enforce the broken contract and accordingly seek legal assistance and incur legal fees and expenses in doing so. (a) foreign decisions the federal appeal court failed to refer to decisions of foreign tribunals to aid its interpretation of article 74. the federal district court did refer to foreign case law to support its finding that loss included legal fees under article 74. however, the federal district court did not provide any analysis of these decisions. harry flechtner has provided a comprehensive analysis of decisions of foreign tribunals that have considered this issue.43 however, flechtner's analysis also suggests the federal district court's reliance on these decisions may have been misplaced. flechtner identified only seven decisions where english translations or summaries were available. these decisions were from german courts, a german arbitral tribunal, a swiss court and a french arbitral tribunal. after considering these decisions, flechtner concludes that: 42 ibid. 43 harry m. flechtner, 'recovering attorneys' fees as damages under the u.n. sales convention: a case study on the new international commercial practice and the role of foreign case law in cisg jurisprudence, with a post-script on zapata hermanos sucesores, s.a. v. hearthside baking co.' <http://cisgw3.law.pace.edu/cisg/biblio/flechtner4.html>. nordic journal of commercial law, issue 2003 #1 17 "[i]n each case, it is clear that the tribunal awarded or claimed authority to award cisg damages to cover legal costs of the prevailing party, but it was not always clear exactly what those costs included."44 in some instances, legal fees were only awarded as loss under the cisg in respect of prelitigation expenses whereas legal expenses incurred during the litigation were awarded as loss under domestic procedural laws, not under the cisg. in another case, legal fees were awarded under the cisg but only as an alternative to the primary ground being an implied term between the parties agreeing to pay for the legal fees. in the decision of the swiss court however, legal fees were granted as "damages under article 74 of the cisg for all attorney costs of the prevailing party, including the fees incurred during the actual litigation."45 importantly, flechtner also notes that there are no cases that expressly reject a reading of article 74 that allows the recovery of legal fees as loss. accordingly, there is support in case law for the proposition that legal fees are recoverable as loss under article 74 of the cisg. however, it is by no means clear that the case law is unanimous in its reasoning. some cases distinguished between legal expenses incurred before and during litigation. also, some cases in part relied on domestic procedural laws or an agreement between the parties, in addition to the cisg, as the source of the obligation to pay for legal expenses. also, the commentary provided by fletchner demonstrates the inherent difficulties in sourcing and understanding foreign case law. for example, consideration of foreign case law assumes that accurate and reliable translations are freely available. flechtner's analysis however, uncovered discrepancies and contradictions between different translations of the same decisions and the original decision. flechtner also makes the following interesting observation: "it turns out that resolving the focused and easily-stated question of whether article 74 of the cisg should be interpreted to permit recover of damages for the attorney costs incurred by a successful litigation plunges one into a forest of challenges, such as determining the proper interpretative standards to apply to an international document like the convention, ascertaining the meaning of decisions by foreign courts construing the cisg, fixing the proper deference to be accorded such decisions, and a host of other difficulties... i emerged from the adventure with a new appreciation of the immense difficulties of practising in a genuinely international commercial law system, and even with some pessimism over whether the legal profession is truly ready for such practice."46 further, after taking into consideration such factors as the authority of the court in its own jurisdiction, the extent of consensus amongst the decisions and, importantly, the extent to which the foreign decision itself complied with article 7(1), flechtner concludes that: "the foreign cases that have granted an aggrieved party cisg damages to cover attorneys' fees are due little deference as precedent."47 (a) travaux preparatories 44 ibid. 45 ibid. 46 ibid. 47 ibid. nordic journal of commercial law, issue 2003 #1 18 the reference in article 7(1) to the cisg's international character also requires consideration of the cisg's legislative history. there is nothing in the legislative history to suggest that the issue of legal fees was expressly considered. indeed, the federal appeal court notes that: "to the vast majority of the signatories of the convention, being nations in which loser pays is the rule anyway, the question of whether 'loss' includes attorneys' fees would have held little interest; there is no reasons to suppose they thought about the question at all." however, as outlined above there is commentary on article 74 that is of assistance in determining the meaning of 'loss'. the legislative history clearly indicates that the concept of 'full compensation' underlies article 74. the principle of full compensation coupled with the plain meaning of article 74 suggests that loss under article 74 should include legal fees and expenses. it is only by recovering this loss that a party can be said to be fully compensated. 6.1.2. academic writing following the decisions of the federal district court and the federal appeal court, there has been considerable interest by academics around the world given to the question of recovering legal fees under the cisg. views, however, are divided with arguments presented both in favour48 and against49 the recovery of legal fees as loss under the cisg. 6.2 step two: general principles of the cisg while the plain language of article 74 and the principle of full compensation embodied in its language, and confirmed by the cisg legislative history, support the view that 'loss' under article 74 includes legal fees, this is not determinative of the issue. article 7(2) therefore requires consideration of general principles of the cisg. as explained above, article 7(2) requires that matters governed by the cisg but not expressly settled in it to be determined in conformity with the general principles on which the cisg is based. some authors have suggested that it is not appropriate to consider the gap filling mechanism under article 7(2) in relation to this issue because 'legal fees' are not a matter governed by the cisg.50 this author respectfully disagrees with this position. legal fees are not expressly referred to in the cisg. however, the recovery of loss is certainly a matter governed by the cisg and whether 'loss' includes legal fees is not expressly settled. accordingly, whether legal fees are included as loss is a matter to be settled in conformity with the general principles on which the cisg is based. this paper will now discuss the general principles of full compensation, equality, reasonableness and mitigation and consider how they settle the question of legal fees and loss under the cisg. 48 felemegas, above n31. 49 see flechtner, above n42; flechtner & lookofsky, above n35; joseph lookofsky, 'zapata hermanos v hearthside baking' (2002) the vindobona journal of international commercial law and arbitration 27. 50 flechtner & lookofsky, above n36. nordic journal of commercial law, issue 2003 #1 19 6.2.1 full compensation full compensation is a general principle of the cisg.51 as noted above, it is embodied in the language of article 74 and confirmed by the cisg's legislative history. interpreting loss in accordance with the general principle of full compensation suggests that loss should include legal fees. 6.2.2 equality the cisg treats the seller and the buyer under an international sale of goods contract equally.52 the rights of the buyer and the seller under the cisg are reciprocal. indeed, the cisg would not have enjoyed the acceptance it has around the world if it favoured either buyers or sellers, and therefore importing or exporting nations, over the other. accordingly, it is reasonable to suggest that the cisg recognises a general principle of equality or reciprocity between the buyer and seller. the general principle of equality impacts on the definition of loss under article 74. the federal appeal court identified the anomaly that would result from an interpretation of loss under article 74 that included legal fees. the court noted that this interpretation would allow a successful plaintiff to recover its legal costs as loss, but that the cisg did not contain a reciprocal provision enabling the same relief to flow to a successful defendant. accordingly, the general principle of equality suggests that loss under article 74 does not include legal fees because this interpretation would lead to unequal treatment of the parties. john felemegas concurs with this approach, noting that: "in the light of the structural and institutional equality enjoyed by seller and buyer under the cisg, it is reasonable to conclude that the drafters of the convention would not have intended such a divergence in the result between sellers and buyers -– plaintiffs and defendants."53 however, felemegas also suggests a solution that would allow a successful defendant to recover legal fees and thereby uphold the general principle of equality. the right to damages for loss under the cisg is triggered only by a breach. accordingly, felemegas proposes that: "it is arguable that there exists a duty of loyalty to the contract which would be breached by a party filing a suit for a breach of contract where a court later holds that party's suit to be lacking a proper foundation."54 this approach has little merit. as argued by harry flechtner: "an approach that requires such a result-oriented jurisprudential stretch (with collateral consequences that are hard to predict) in order to avoid egregious partiality, however, does not recommend itself."55 51 arthur b colligan jr, 'applying the general principles of the united nations convention on contracts for the international sale of goods to fill the article 78 interest rate gap in zapata hermanos, s.a. v hearthside baking co. inc.(2001)' (2002) 6 the vindobona journal of international commercial law and arbitration 40, 50. 52 felemegas, above n31; jarno vanto, 'attorneys' fees as damages in international commercial litigation' <http://cisgw3.law.pace.edu/cisg/biblio/vanto1.html>. 53 felemegas, above n31. 54 ibid. nordic journal of commercial law, issue 2003 #1 20 accordingly, the general principle of equality suggests that loss under article 74 of the cisg does not include legal fees. 6.2.3 reasonableness and mitigation the decision to allow the recovery of legal fees under the cisg would obviously have a significant impact in jurisdictions that follow the american rule. however, jurisdictions that follow the english rule would also be affected by the decision to include legal fees as loss under article 74. for example, domestic rules in english rule jurisdictions commonly regulate the recovery of legal fees with the use of schedules of permissible expenses or allow only the recovery of a percentage of the legal fees. these regulations or limitations on the recovery of legal fees would be lost in english rule jurisdictions if loss under article 74 included legal fees. rather, it would be necessary to look to the cisg to determine what, if any, limitations regulated the recovery of legal fees.56 article 74 and general principles of the cisg provide some assistance here. for example, article 74 would require any legal fees to be foreseeable. beyond this, the cisg recognises the general principles of reasonableness and mitigation. these principles could operate to limit the legal fees that can be recovered under article 74. however, in comparison to the tightly regulated systems that follow the english rule, the general principles of foreseeability, reasonableness and mitigation offer little concrete guidance. as explained by flechtner, the cisg "is not well designed for this purpose."57 uniformity of interpretation requires certainty. where buyers, sellers and courts are not certain about the laws or principles that regulate their affairs, uniformity of interpretation inevitably is the victim. while the general principles of reasonableness and mitigation would operate to regulate to some extent the legal fees that might be recovered under article 74, these general principles would not provide either the certainty of the american rule, under which no legal fees would be recoverable, or of the english rule, which has in place systems to regulate the quantum of fees that might be recovered. accordingly, the need for a certain and uniform interpretation of the cisg might best be served by holding that loss under article 74 does not include legal fees. 6.3 do general principles provide the answer? article 7(2) requires that matters governed by the cisg which are not expressly settled in it are to be settled in conformity with the general principles on which it is based. the discussion above demonstrates that there are various general principles of the cisg that can be used to determine whether loss under article 74 includes legal fees. these general principles, however, suggest contrasting conclusions. the general principle of full compensation requires the definition of loss to include legal fees. on the other hand, the general principle of equality suggests loss under article 74 was not intended to include legal fees. further, assuming loss does include legal fees the general principles of reasonableness and mitigation do provide some guidance about the quantum and limitations on the recovery of legal fees. however, these general principles are unlikely to provide the certainty a uniform interpretation of the cisg requires. 55 flechtner, above n42. 56 ibid. 57 ibid. nordic journal of commercial law, issue 2003 #1 21 in light of the contradictory guidance offered by the general principles of the cisg on the definition of loss under article 74, the interpretation of loss that should be adopted is the interpretation that best ensures uniformity. it is the opinion of this author that a uniform interpretation of the cisg would be best served by defining loss to exclude legal fees and expenses. the plain meaning of article 74 does permit a reading of loss under article 74 to include legal fees. this is further supported by the general principle of full compensation found within the cisg and confirmed by its legislative history. however, the legislative history of the cisg is otherwise silent on the actual question of whether legal fees are recoverable as loss under article 74. further, decisions of foreign tribunals on this issue offer little authoritative weight and the general principle of equality would be offended by a reading of article 74 that allowed only one party to recover legal fees as loss. an interpretation of loss that includes legal fees is likely to likely to lead to great uncertainty, unpredictable and inconsistent interpretations and, ultimately, distrust of the cisg. accordingly, certainty and uniformity would best be served by reading loss under article 74 to exclude legal fees. 6.4 step three: rules of private international law recourse to the rules of private international law under article 7(2) of the cisg is only required in the absence of general principles that settle the matter. this author has concluded that, while various general principles lead to conflicting answers, the general principle of equality together with the need for uniform interpretation of the cisg require a conclusion that loss under article 74 does not include legal fees and expenses. having reached a conclusion on the meaning of loss based on the cisg's international character, the need to maintain uniformity and general principles, it is not necessary to look further to the rules of private international law. 6.5 the cisg surrounded by a sea of procedure it should also be noted that, while as a matter of substantive law, according to the above analysis, the cisg does not allow the recovery of legal fees as loss under article 74 of the cisg: "the cisg does not attempt to provide all the law that fora will have to apply in litigation involving international sale of goods. the rules of procedure governing such litigation... remain subject to applicable domestic law. thus when applied to actual disputes the convention resembles an island of international rules surrounded by an ocean of still-applicable national law. this means the courts will often face difficult boundary questions as to exactly where the sovereignty of the cisg ends and domestic law takes over."58 accordingly, while the cisg does not give a party the substantive right to recover legal fees as loss, it is important to remember that the cisg operates within a domestic system of procedural law. so while a party to a contract for the international sale of goods may not recover legal fees as loss under the cisg, depending on whether the procedural law of the 58 harry m flechtner, 'the u.n. sales convention (cisg) and mcc-marble ceramic center, inc. v ceramica nuova d'agostino, s.p.a.: the eleventh circuit weighs in on interpretation, subjective intent, procedural limits to the convention's scope, and the parol evidence rule' (1999) 18 the journal of law and commerce 259, 286. nordic journal of commercial law, issue 2003 #1 22 forum follows the american rule or the english rule, the party may be entitled to recover legal fees and expenses as a procedural right. this ultimately was the conclusion of the federal appeal court although the short cut path taken by the court to reach this end did not respect the mandate of article 7 of the cisg. 7. united states supreme court 7.1 supreme court guidance the success of the cisg as a uniform law governing the international sale of goods depends on the correct observance by courts and tribunals around the world of the template of interpretation mandated by article 7. as demonstrated by the decision of the federal appeal court, the proper application of article 7 and the cisg has not been appreciated. in this climate, a direction by the supreme court of the united states of america on the proper application of article 7 of the cisg is a momentous opportunity. this author concurs with other commentators in calling for the supreme court to accept the application to appeal from the decision of the federal appeal court in order to provide judicial guidance for courts in the united states and around the world on the proper application of article 7.59 7.2 amicus curiae application the application to appeal to the supreme court has also given rise to an interesting development for the future interpretation and stewardship of the cisg. the application to appeal the decision of the federal appeal court has been joined by a supporting amicus curiae application from the international association of contract and commercial managers ("iaccm") and the institute of international commercial law of the pace university school of law ("pace university").60 iaccm is a professional association representing international corporations in over 80 countries and represents the interests of the traders that rely on the cisg in their business. the pace university under the guidance of professor albert kritzer has developed into a centre of expertise on the cisg and through its most impressive website shares knowledge on the cisg including academic commentary and case law from around the world. the joint petition of iaccm and pace university notes the following. "the zapata case offers the supreme court a unique opportunity to correct u.s. judicial errors and rule on a proceeding of national and international significance in a manner that puts the u.s. judiciary in the forefront of guidance to the bar and bench and the business community: • on the proper interpretation of uniform international sales law: autonomously, within its four corners; and 59 felemegas, above n31. 60 see the motion for leave to file brief amicus curiae and brief amicus curiae of the iaccm and pace university available at <http://cisgw3.law.pace.edu/cisg/biblio/zamicus.html>. nordic journal of commercial law, issue 2003 #1 23 • on attention to relevant case law: comity to foreign decisions much the same as u.s. courts give comity to interpretations of the ucc in sister states. drawing on the positive experience of the u.s. judiciary with uniform-law case law under the ucc, the u.s. supreme court is well postured to lead the global jurisconsultorium on the cisg."61 uniformity of the cisg is problematic because responsibility to achieve this end lies on courts and tribunals scattered around the world. there is no supranational judicial body able to give authoritative statements of the law. in light of this fact the move by iaccm and pace university to take an active interest in the stewardship of the cisg by urging the supreme court to lead the global jurisconsultorium on the cisg is to be welcomed. 8. conclusion 8.1 global jurisconsultorium applying the interpretation template set out in article 7 of the cisg, loss under article 74 of the cisg does not include legal fees and expenses. this interpretation is assisted by the cisg's legislative history, the general principle of equality and, decisively, the need for uniformity. the federal district court reached the opposite conclusion, although the judgment showed an understanding of the requirements of article 7. the federal appeal court on the other hand found that loss under article 7 does not include legal fees and expenses. unfortunately, the judgment of the federal appeal court demonstrated either a disregard or complete misunderstanding of article 7. the opportunity now exists for the supreme court of the united states to set the record straight and promote uniformity of the cisg. 61 ibid. 1. introduction 1.1 how does the cookie crumble as it falls or following the event? 2. the cisg 2.1 cisg in a nutshell 2.2 article 7 of the cisg: interpretation template 2.3 step one: international character, uniformity and good faith 2.3.1 the text 2.3.2 travaux preparatoires 2.3.3 homeward trend 2.3.4 domestic interpretative techniques 2.4 step two: general principles of the cisg 2.5 step three: rules of private international law 2.6 summary: the steps of the article 7 interpretation ladder 2.7 article 74 of the cisg: foreseeable loss 3. the cookie dispute 3.1 the facts 3.2 american rule – loss as it falls 3.3 english rule – loss follows the event 4. federal district court 4.1 decision 4.2 uniformity and the homeward trend 4.3 plain meaning 4.4 legislative history 4.5 foreign cases 4.6 comment 5. federal appellate court 5.1 decision 5.2 substance v procedure 5.3 article 74: international character, uniformity & good faith? 5.4 general principles of the cisg 5.5 rules of private international law 5.6 anomalies 5.7 comment 6. does article 74 allow the recovery of legal fees? 6.1 step one: international character, uniformity and good faith 6.1.1 the text 6.1.2. academic writing 6.2 step two: general principles of the cisg 6.2.1 full compensation 6.2.2 equality 6.2.3 reasonableness and mitigation 6.3 do general principles provide the answer? 6.4 step three: rules of private international law 6.5 the cisg surrounded by a sea of procedure 7. united states supreme court 7.1 supreme court guidance 7.2 amicus curiae application 8. conclusion 8.1 global jurisconsultorium comentary1.pmd nordic journal of commercial law, issue 2004 #1 1 interpretation of article 74 – zapata hermanos v hearthside baking – where next? bruno zeller* nordic journal of commercial law issue 2004 #1 nordic journal of commercial law, issue 2004 #1 2 1. introduction the facts are simple. the mexican seller supplied biscuit tins to the american firm for over four years. the american firm failed to pay for the tins and were subsequently sued in the federal district court of illinois.1 besides winning the action the court also awarded $550,000 as foreseeable loss under article 74 for incurring legal fees. on appeal to the federal appellate court2 the decision in relation to attorneys’ fees only was overturned. the whole matter was contested in a leave application to the supreme court of the united states of america. “a petition for a writ of certiorari, an amicus brief in support of the petition, a brief in opposition to the petition, a reply brief and a supplemental brief for the petitioner were filed with the u.s. supreme court.”3 in the end the supreme court invited the solicitor general to express the views of the united states in an amicus curiae brief. the solicitor general put the proposition forward that in his view the petition ought to be rejected. the dispute in essence is not so much concerning article 74 but rather how article 7 is to be interpreted and applied. the supreme court of the united states had the unique opportunity to make a significant contribution to the interpretation of the cisg as a whole. it is important therefore to be aware of the fact that it is not only article 74 which is on trial but also article 7 and therefore the interpretation and application of the cisg as a whole. the importance of the matter has been recognised by leading scholars and both sides of the dispute are well represented. it is argued that courts and many academics are looking for “the needle in the haystack” despite incantations that the words in the cisg with the help of article 7 must be given a plain meaning .it appears that in this debate the approach advocated by honnold has been forgotten. he advocated that to overcome the problem of literary “deconstruction” the cisg consciously “root[ed] out words with domestic legal connotations in favour of non-legal earthy words to refer to physical acts.”4 this paper attempts to have another look at he debate considering that the “heat of the battle” has subsided. it is argued that any solution at least in a theoretical way needs to look at the words as they appear at “first glance” without loosing sight of the purpose of the convention as a whole. in other words “attorneys” fees are placed back into the four corners of the convention and applied within that context. attention is given to the fact that, as the words in the cisg are not “technical” in nature, the method of interpretation cannot be “technical” in nature either. attention is specifically directed to the distinction between procedural and substantive law. the appeal court and some academic writers found this distinction to be of such importance as a tool as to exclude attorneys’ fees as a possible loss due to a breach of a contract. this paper will argue that such a distinction is founded on municipal law and is only sustainable if the mandate of article 7 is disregarded which would do violence to the very purpose of an international legal instrument.. 2. interpretation of the cisg simply put the function of a common legal theory on which the cisg relies is contained in article 7.5 whether a domestic or an international law is examined such an understanding is essential in order to elicit the ver y purpose of the law in question. only through such an understanding will consistent and predictable outcomes be achieved. the logical product of failure to achieve uniformity besides a possible loss of confidence is a search for the best solution resulting in “forum shopping.” the court of appeal unfortunately as one of their arguments contended that attorneys’ fees are not clearly included nor are they excluded.6 the court in effect appears to have looked for a clear instrucnordic journal of commercial law, issue 2004 #1 3 tion or term that attorneys’ fees are part of “loss” without paying sufficient attention to article 7 which holds the key to the understanding of the cisg. arguably the court did not take into consideration the important interpretational difference between clear and unclear terms which form the basis for an understanding specifically of article 7(2). it can be argued that: “… officially ‘clear and unambiguous terms’ as well as ‘unclear terms’ form the unique rules [of the cisg] based on compromise between various legal systems, a clear grasp of the mandate of article 7 is essential.”7 furthermore despite of all the available knowledge the interpretation of the cisg suffers in many instances from a homeward trend and the lack of logical application of an international instrument. what is familiar at first glance appears to distract courts too many times from the fact that domestic law and domestic statutory interpretation have no place in an international instrument. bonell commented correctly that: “in most common law countries domestic legislative instruments are traditionally interpreted narrowly so as to limit their interference with the law developed though jurisprudence.”8 however it can now be stated that many domestic courts have shown a willingness to abandon the ethnocentric approach and embrace a less narrow interpretation specifically for international instruments. in australia povey v civil aviation safety authority and ors9 is instructive. it deals with the warsaw convention and bongiorno j made three important observations. first he noted that it must be “constructed by reference to the principles of construction appropriate to an international convention.”10 secondly these principles of construction can be found in the vienna convention on the law of treaties and thirdly foreign jurisprudence of an appropriate court is highly persuasive if no jurisprudence is available in australia.11 arguably bongiorno j. supplied a template which can be applied to an application and interpretation of any international instrument. 3. the decision of the appeal court keeping the above template in mind it can be argued that the approach of the federal court is faulty on three counts. first they did not construct the matter “by reference to the principles of construction appropriate to an international convention” that is without recourse to domestic principles. secondly they did not fully appreciate and apply these principles of construction which would have been found in article 7 of the cisg. thirdly they did not consult foreign jurisprudence of an appropriate court. in essence the appeal court chose a narrow view which is expressed in the fact that they did not focus on “loss” as a general term. attention was given to attorneys” fees as something different to expenses. it is not the fact of attorneys” fees, which is important, but whether an expense whatever it may be is a consequence of the breach of the contract and is foreseeable as stipulated by article 74. in general the category of loss or items which are categorized as losses are dependent on the facts of a case and cannot be readily described. in addition the federal court argued that: “it seems apparent that ‘loss’ does not include attorneys” fees incurred in the litigation for a suit for breach of contract, though certain pre-litigation legal expenditures, for example expenditure designed to mitigate the plaintiff’s damages, would probably be covered as ‘incidental’ damages.”12 first it is not apparent that “loss does not include attorneys’ fees”13 otherwise this whole debate would nordic journal of commercial law, issue 2004 #1 4 never have eventuated. secondly, besides the fact that posner j supported his statement by reference to american decisions, his argument is confusing. it appears to suggest that there is a difference between being “just a little bit dead” and being “really dead.” how can it be apparent that one category of legal expenses is not included in “loss” whereas another legal expense is unless this difference is due to a municipal principle. perhaps he attempted to suggest that expenses which mitigate the plaintiff’s damages –or are reducing the defendant’s losses – are admissible irrespective of their label or source. it is not logical to suggest that those expenses, which help the breaching party to reduce their costs, are allowed but those costs, which are incurred by the innocent party, must withstand scrutiny beyond those where mitigation is the purpose. this is indeed an interesting point considering the facts of the case. lenell exhibited an extraordinary recalcitrant attitude and made a very good effort to increase legal fees admittedly for both parties. if one would argue mitigation then indeed lenell did not mitigate the losses for both parties. arguably therefore lenell is in breach of the good faith principle which however does not carry any penalty under the cisg. an example may illustrate this point further. a purchases machines from b. the machines after installation by a are not working. a engages an expert to ascertain whether the goods are faulty or whether it is the installation which stops the machines from working. as it turns out the machines are faulty and a will sue b for breach of contract. nobody would suggest that the cost of the technical expert does not form part of the full compensation claim pursuant to article 74.the costs of a only became necessar y because b breached the contract. if there had been no breach these expenses would not have eventuated. furthermore there is nowhere in the legislative history where expert advice is mentioned as falling under or adversely does not fall under claims covered by article 74. in zapata it is argued that attorneys” fees are not covered by the cisg. arguably the question can be asked what distinguishes technical advise from legal advise? both are a consequence or an incident of a breach of a contract otherwise such steps would not have to be taken. in essence if both parties perform their end of the bargain additional costs are not necessary. 4. problem of classification of expenses there is absolutely no logic in an argument that certain expenses are within the sphere of article 74 and others are not unless they are either specifically excluded or they are not covered by a general principle. whether the law in question is a procedural one or a substantive one in a municipal system is of no consequence as the question is whether the cisg covers “the field.” only if there is a gap and hence as a last resort pursuant to article 7(2) can domestic law be applied to fill the gap. article 74 speaks of two important variables. if any of the two variables cannot be met recovery of an expense as “loss” is problematic if not impossible. first the loss must be a consequence of the breach and secondly the loss must have been foreseen or ought to have been foreseen.14 article 74 also describes the upper limit of any claim namely “a sum equal to the loss including loss of profit.”15 in other words the principle of full compensation can be extracted from article 74 the argument therefore can be narrowed down to two possibilities. attorney’s fees are not envisaged to be a result of a breach of contract or are not foreseeable and hence pursuant to article 7(2) gap filling would lead to an application of domestic law. simply put both possibilities can be dispensed with quickly. arguably there is no debate that attorney’s fees are a foreseeable expense due to any breach of contract. the federal appeal court argued simply that there nordic journal of commercial law, issue 2004 #1 5 “is no suggestion in the background of the convention or the cases under it that ‘loss’ was intended to include attorney’s fees, but no suggestion to the contrary either.”16 if as the court suggests legal fees are not clearly in but also not clearly out then the only solution is to apply article 7 and find out whether a gap exist. the whole argument again reverts to the question of whether full compensation is a general principle of the cisg. arguably the weight of academic writing and decided cases would suggest that it is this only leaves one point to argue namely that attorneys’ fees are not within the sphere of full compensation pursuant to article 74. the question therefore is what is included into a “loss” or more appropriately what do we understand under the term “full compensation”. it has been suggested that the asset test is the appropriate test to determine whether a particular item falls under article 74. if one accepts the proposition that “the sum equal to the loss … suffered by the other party”17 can be determined or measured through the asset test full compensation can be measured. pecl in this instance is by analogy supplying a confirmation that the asset test is an appropriate tool to measure damages. article 9:502 states: “the general measure of damages is such sum as will put the aggrieved party as nearly as possible into the position in which it would have been if the contract had been duly performed.” to put a party into a position it would have been financially is simply asking the question has the balance sheet changes? if the asset base is diminished as a consequence of the breach then those items diminishing the asset base must be contemplated to fall under the principle of full compensation pursuant to article 74. the commentary to article 7.4.2 of the unidroit principles confirm the above observation as they specifically include the asset test into their explanations. the commentary states: “the notion of loss suffered must be understood in a wide sense. it may cover a reduction in the aggrieved party’s assets or an increase in its liabilities” it follows that the next question which must be asked is whether the asset test is a legitimate test anchored within the four corners of the cisg. it is argued that it is the only legitimate and practical test. this argument is given weight when honnold’s observation is to be taken into consideration namely that ” the cisg consciously “root[ed] out words with domestic legal connotations in favour of non-legal earthy words to refer to physical acts.”18 what can be more physical in ascertaining full compensation than an asset test? the logical conclusion therefore is that if the asset base is diminished as a consequence of the breach then those items diminishing the asset base must be contemplated to fall under the general principle of full compensation pursuant to article 74. however it is interesting to note that the federal court referred to article 7(2) and stated that: “there are no ‘principles’ that can be drawn out of the provisions of the convention for determining whether ‘loss’ includes attorneys” fees.”19 arguably the federal court did intend to state “general principles” and not merely principles or perhaps a definition of loss.. there is indeed no suggestion anywhere in the cisg that “loss” is a general principle. the general principle is “full compensation” which includes and consists of losses including loss of profits which are foreseeable the reason to point to article 7(2) is to determine whether general principles can be drawn out of the nordic journal of commercial law, issue 2004 #1 6 provisions of the convention. to do that an examination of the provisions themselves that is the four corners of the cisg will supply such an answer. . ”it is concerning to note the dismissive examination by posner j of the general principles of the cisg”20 specifically considering that he ignored the statements made by the federal district court on the matter. the appeal court merely stated that there are no general principles and hence the matter was closed as far as they were concerned. felemegas is correct to point out that: “… any issue that has not been expressly excluded by the cisg and which can be resolved by applying the general principles of the cisg should be solved accordingly.”21 to suggest that full compensation is not a general principle of the cisg would indeed be a novel approach not yet advocated by any serious academic. it is well embedded in article 74. furthermore it has been suggested that the federal appeal court ignored the travaux preparatoires completely.22 arguably such documents ought to be consulted only in extreme circumstances as the text of the convention is the starting point. travaux preparatoires can disclose perceived problems but it must be remembered that the views expressed are aspects frozen in time.23 the court supplied their own answer to the above when they noted that: “[to] the vast majority of the signatories of the convention being nations in which loser pays is the rule anyway, the question whether ‘loss’ includes attorneys” fees would have held little interest; there is no reason to suppose they thought about the question at all.”24 this statement is absolutely correct the delegates did not think about it at all otherwise a debate would have been recorded in the history. there are three points to be made. first the convention is not a law devised by some but a law borne out of consensus. furthermore if the u.s. delegation would have been vehemently opposed to such an inclusion no doubt it would have been recorded. secondly as the u.s. delegation has not made any representation to the contrary it is too late to complain as the united states have ratified the cisg. strange to see that the appeal court found it necessary to question 20 years too late: “… how likely is it that the united states would have signed the convention had it thought that in doing so it was abandoning the hallowed american rule?”25 the only answer one can give is by asking another question namely would the united states also not have signed the convention if they would have known that they abandoned the “hallowed american parol evidence rule?” the most important of the reasons is the third point. a lack of debate suggests strongly that attorneys” fees are included in the contemplated losses under article 74. by analogy history supplies us the answer. nobody tells another person, or writes in a letter information which is known to the recipient. such knowledge is assumed hence included into the knowledge base and not worthy of repeating. the same can be said in regards to attorneys” fees. the court of appeal themselves supplied to correct answer why full compensation includes legal fees because there was absolutely no reason to think about the question at all in the first place.26 nordic journal of commercial law, issue 2004 #1 7 5. procedural vs substantive law the question whether the awarding of attorneys’ fees is a procedural issue in essence needs to be analysed correctly. there are several positions to be taken. first and it is argued that this assumption was not contemplated by posner j, is that the cisg contains procedural rules. arguably there is no arguments that the cisg is about contract and not about procedure. such a statement was made by posner j. in zapata and it is a correct observation. the second argument is that attorneys’ fees are a procedural matter in domestic law and hence excluded form the sphere of the cisg. however it is of little value to ague this point as article 7 forbids the importation of municipal laws. this leads to he third and only argument, which deserves any merits. the essential argument is that attorneys’ fees are not included in the general principle of full compensation and therefore pursuant to article 7(2) a gap exists which must be settled “in conformity with the law applicable by virtue of the rules of private international law.”27 plainly speaking it not an argument to merely suggest that attorneys” fees fall under procedural law and therefore are outside the sphere of the cisg. it is the same false logic to suggest that fitness of purpose is a domestic law therefore the cisg does not apply. such a thought would not be entertained because it is plain that article 35 rules on that matter. in other words there is no gap whatsoever in the cisg which would make recourse to domestic law imperative pursuant to article 7(2). here is where the problem lies. the court instead of focusing on article 7 attempted to draw a distinction between procedural law and substantive law. indeed posner j noted “the convention is about contracts not procedure”28 he is correct to note that but he should have expanded that statement by pointing out that everything which is contained within the four corners of the cisg is about contracts. he then continued to note: “the principles for determining when a losing party must reimburse the winner for the latter’s expenses of litigation are usually not part a part of a substantive body of law, such as contract law, but a part of procedural law.”29 posner j in his homeward trend appeared to confuse domestic law with international law. it is not a question whether attorneys” fees are part of substantive law in a domestic setting but whether attorneys” fees are part of foreseeable expenses pursuant to article 74. in other words is the general principle of full compensation applicable. honnold correctly noted that “label that the state law bears should be irrelevant.”30 it is only if there is gap, which as a last resort must be filled by domestic law, will such an argument have any bearing on the matter. as it stands no attempt has been made to determine whether fees are part of general foreseeable expenses and hence fall under the gambit of the cisg. only with such an approach can a faithful application of the cisg and hence uniformity be guaranteed if one consults the travaux préparatoire the whole issue unfortunately will rest on assumptions. the only fact is that nowhere in the histor y of the convention is there a definitive pointer one way or another. flechtner and lookofsky argue that because of the silence on this issue the “recovering [of] attorney fees was simply assumed to be a procedural matter beyond the scope of the convention.”31 however in law nothing is ever simple and such an assumption is unfounded and not based on any sound reasoning. they further argue that “if it had been considered it could have been a ‘deal breaker’ and … the united states might well not have signed the convention.”32 these arguments are purely speculative and lack any basis. it is inconceivable considering that this point is so important that it could be a ‘deal breaker’ that no discussion whatsoever took place and it “was simply assumed to be a procedural matter.”33 furthermore whether the united states would have signed the convention or nordic journal of commercial law, issue 2004 #1 8 not does little in advancing the argument that attorneys” fees are not included in article 74. arguably as pointed out above the arguments relating to the drafting histor y of the cisg at least make some sense as they explain by analogy that if something is not mentioned then one strong reason is that it was not news worthy that is ever y body knew about it. such an argument is given weight by the fact that most delegates came from countries were the loser pays system operates. therefore the only statement which is defendable is simply to state that there is no explicit indication as to the intentions of the drafters of the cisg whether attorneys’ fees are to be included into the cisg or not. in sum the histor y of the cisg is at best of limited help in this determination. a further argument has been advanced in zapata namely that: “the time tested, carefully-crafted and elaborated domestic rules governing recovery of attorney fees in loserpays contracting states would be replaced by the vagaries of the art, 74 regime.”34 indeed it is true to say that recovery of legal fees is an elaborate rule. taking the broad international view two distinct environments can be discovered depending which municipal system one is looking at. not all systems include pre-trial expenses and in some domestic systems foreseeability does not need to be established whereas in others it does.35 the question simply is can these “different environments be neatly packed under the umbrella of article 74”36 or will they be replaced by ‘the vagaries of article 74? as pointed out above there are no vagaries in following the mandate of article 74 specifically the asset test. only in unified international laws is there a chance that “different environments can be nearly packed under one umbrella.”37 arguably the same question could be asked when attacking article 8, which trumps the “time-tested, carefully-crafted and elaborated domestic rule” of the parol evidence rule. nobody so far has advanced such an argument. the fact is that whenever an international instrument is enacted compromises must be made and many “time-tested, carefully-drafted” domestic substantive or procedural rules had to be abandoned. the problem remains that domestic labels can distort the application of article 7(1) which calls for a uniform application and importantly regard has to be had to the international character of the convention. admittedly for article 7 to apply the matter must be ruled by the convention. it has been argued above that attorney fees cannot be logically excluded from ‘loss’ which is based on the full compensation principle. there always will be tensions between domestic and international law and as a result depending on the jurisdiction varying judgements are the outcomes. it is crucial for international laws that: “abstract distinctions between substantive and procedural law become redundant if not harmful, especially when the parties turn to the courts for equal enforcement of their contractual rights pursuant to these uniform bodies of rules.”38 orlandi furthermore argues that the “outcome determinative test” must be one of the tools the courts ought to consider when a matter is not clearly settled and a possibility exists whether an issue is substantive or procedural. judges should: “look at the actual impact of the cisg provision on the outcome of the decision and apply the convention whenever this best guaranteed the policy goals of international uniformity.”39 there can be little debate that the best guarantee to achieve international uniformity would be to include attorneys’ fees under the umbrella of “loss” pursuant to article 74. nordic journal of commercial law, issue 2004 #1 9 another – and perhaps the real question, which needs to be addressed, is what is the relationship between substantive and procedural law? in essence “substantive law, in that it addresses all citizens, has a much wider audience. by contrast, procedural law … addresses all those involved in the administration of justice, for the most part lawyers.”40 furthermore it has also been suggested that procedure “governs the exercise of judicial power and therefore belongs to public law.”41 this leads back to the question what is the cisg attempting to achieve. no doubt the convention addresses all citizens and hence the question again needs to be asked whether all foreseeable losses are included in the mandate of article 74. considering that procedural law is lawyers’ law42 a strong argument must be advanced – and nobody has done so yet that only some losses due to a breach of a contract are not relevant to citizens as they are lawyers’ law whereas the remainder of losses is relevant to citizens that is it is substantive in nature. only if such a proposition is powerfully and convincingly argued is there a possibility to detach attorneys’ fees from the general principle of full compensation. it is simply not enough to merely state that before the introduction of the cisg attorney’s fees were procedural in nature therefore nothing has changed. the problem is that arguably attorneys” fees as an aspect of procedural law are so closely connected to the substantive issue of damages that a separation is not possible. this is specially so as the procedural law of attorneys’ fees is not uniform and hence a separation will be unhelpful and a “backward step” in the endeavour to create a uniform international law. it is compelling to note that: “… no proper international commercial intercourse is possible if the states engaged in international trade and other cooperation apply, under the principle of lex fori, totally divergent rules [like the american rule].43 if by analogy arbitral decisions are consulted where the line between procedure and substance is often by the very nature of arbitration in dispute. it can be noted that such a line is not always easy to draw.44 the closeness of the two issues give rise to an argument that even if attorneys’ fees could be ruled under domestic laws, in the interest of harmonisation such a distinction should be abandoned. much weight is given to this argument if one considers that in the whole zapata debate no compelling reason is given that attorneys’ fees are not part of a loss which a party will suffer if a contract is breached. the only reason given is that attorneys’ fees are procedural in nature and therefore do not form part of the cisg article 74. plainly speaking a ‘loss’ remains a ‘loss’ irrespective of how it is dressed up. it appears that the argument is caught up in an unnecessary procedural trap. 6. anomalies the federal court supported their rejection of attorneys” fees as falling under article 74 by pointing out that it would create an anomaly. the court noted that a successful defendant cannot recover attorneys” fees under the cisg because in order to fall under article 74 there has to be a breach of a contract and a successful defendant would not be in breach.45 on the contrary he would have just proven that he has fulfilled the obligations as stipulated in the contract. there are several answers the most important one being that the court not only discussed a hypothetical question but they used the outcome as a determinative factor in the decision of a real situation. the facts in zapata are clear the original plaintiff won the case, this decision was never tested and still stands. the court therefore never had to give a decision nor should they take into consideration nordic journal of commercial law, issue 2004 #1 10 what would happen in a hypothetical situation. even given that one could muse over such a question the conclusion simply is that the appeal court discovered a gap. the convention does not cover this situation either by a provision or through a general principle. therefore in this case article 7(2) is applicable and domestic law will provide the answer. it is doubtful that the promoters of the cisg ever stated that there are no oversights in the text of the convention. after all the cisg is a political instrument which had to gain consensus of various interest groups and legal systems. it was after all ratified by states ”warts and all”. it is a testimony to the drafters that very few anomalies are found in the cisg. 7. conclusion admittedly there are robust arguments to either reject or include attorneys” fees as part of article 74. the federal court found it necessar y to comment that attorneys’ fees are not included nor are they excluded and that the travaux preparatoires are silent on this issue. however it is interesting to speculate why an assembly of distinguished jurist did not comment on such an issue unless they thought it was so obvious that it did not merit any comments? arguably it is time to revisit early commentaries on the cisg and take note of the fact that the cisg consciously “rooted out words with domestic legal connotations in favour of non legal earthy words to refer to physical acts”46. an unconstraint reading of the cisg with the aid of article 7 and 8 can overcome the problem of “literary deconstruction” 47 in the end the question must be posed whether, in the light of increased globalisation and internationalisation of trade, an application of the cisg is more important or whether the homeward trend and the refuge behind municipal laws is superior. the path taken in the end depends whether the feet are firmly planted within the cisg or whether it is perceived that the grass is greener in the domestic paddock. however this paper attempted to demonstrate that there is more than sufficient ground to support a decision that legal fees should be subject to the full compensation principle pursuant to article 74. after all an international contract is not merely a domestic sale with incidental foreign elements.48 and most importantly of all the foreseeable losses due to a breach of a contract nothing is more certain and universal than attorneys’ fees. (footnotes) * lecturer in law, victoria university law school, melbourne australia 1.(2001) wl 1000927 [http://cisgw3.law.pace.edu/cisg/wais/db/cases2/010828u1.html] 2 see 2002 federal appellate court [7th circuit] [http://cisgw3.law.pace.edu/cases/021119u1.html] 3 see heading of petition for certiorari (reply brief) [http;// cisgw3.law.pace.edu/cisg/biblio/zreply.html] 4 honnold, j. “uniform laws for international trade: early “care and feeding” for uniform growth”, (1993) 1 international trade and business law journal., 1, at 2. 5 for a detailed discussion see zeller, b. “four corners – the methodology for interpretation and application of the un convention on contracts for the international sale of goods.” http://www.cisg.law.pace.edu/cisg/biblio/ 4corners.html 6 zapata above n 2. 7 zeller, b. above n 5, p 47. 8 biance & bonell (eds) “commentary on international sales law” (1987) at 72-73. 9 [2002] vsc 580 (20 december 2002) 10 ibid 17. 11 ibid 12 zapate above n 2. 13 ibid. 14 see article 74 15 see article 74 nordic journal of commercial law, issue 2004 #1 11 16 zapata above n2. 17 article 74. 18 honnold, j. “uniform laws for international trade: early “care and feeding” for uniform growth”, (1993) 1 international trade and business law journal., 1, at 2. it ought to be remembered that honnold was a member of the promoters of the cisg and his opinion must be given consideration. 19 zapata above n 2, at . 20 keily. t., “how does the cookie crumble? legal costs under a uniform interpretation of the united nations convention on contracts for the international sale of goods.” 1 nordic journal of commercial law 2003, at 14. 21 felemegas, j. an interpretation of article 74 cisg by the u.s. circuit court of appeals http:// www.cisg.law.pace.edu/cisg/biblio/felemegas4.html . 22 keily, t, above n 20.. 23 see zeller above n 5. chapter 2. 24 zapata above n 2. 25 ibid. 26 see fn 15 above. 27 article 7(2) 28 zpata above n 56, at 29 ibid 30 quoted by albert kritzer “editorial remarks” delchi carrier s.p.a. v rotorex corp [http://cisgw3.law.pace.edu/ cisg/wais/db/editorial/951206u.1.html] 31 flechtner, h. and lookofsky, j. “viva zapata! american procedure and cisg substance in a u.s. circuit court of appeal.” (2003) 7 vj 92, 97. 32 ibid. 33 ibid 34 ibid 35 vanto, j. “attorneys” fees as damages in international commercial litigation” 15 pace international law review (spring 2003) 203-222 36 ibid 37 ibid. 38 orlandi, c.g., “procedural law issues and law conventions” (2000) uniform law review vol v. 1, 23-41. 39 ibid. 40 kerameus, k., some reflections on procedural harmonisation: reasons and scope, uniform law review 20031/2, 443, 445. 41 ibid 448. 42 ibid. 43 ibid at 446. 44 see for instance international tank and pipe sak v kuwait aviation fuelling co ksc [1975] qb 224. 45 zapata above n 2. 46 honnold see fn 4. 47 honnold see above n 4. 48 audit b., “the vienna sales convention and the lex mercatoria” in carbonneau, t.e. (ed) “lex mercatoria and arbitration” (1998) at 174 special issue njcl 2018/1 1 the legal challenges of online intermediary platforms marie jull sørensen* & thomas neumann** (editors) * co-editor of nordic journal of commercial law. phd, master of laws. associate professor at the department of law, aalborg university, e-mail: mjs@law.aau.dk. ** editor of nordic journal of commercial law. phd, master of laws. associate professor at the department of law, aalborg university, e-mail: thn@law.aau.dk. foreword 2 foreword ................................................................................... 4 6 by marie jull sørensen eu regulatory models for platforms on the content and carrier layers: convergence and changing policy patterns................................................................................... 7 37 by andrej savin platforms as private governance systems – the example of airbnb ...................................................................................... 38 61 by vibe garf ulfbeck, ole hansen and clement salung petersen intermediary platforms – the contractual legal framework ............................................................................. 62 90 by marie jull sørensen digital collaborative platforms: a challenge for social partners in the nordic model ......................................... 91 115 by annamaria westregård platform work and the danish model – legal perspectives ...................................................................................... 116 145 by christian højer schjøler and natalie videbæk munkholm allocation of the right to tax income from digital intermediary platforms – challenges and possibilities for taxation in the jurisdiction of the user ..................... 146 171 by peter koerver schmidt and louise fjord kjærsgaard airbnb and the swedish tenancy legislation: an analysis of unexplored possibilities............................................ 172 200 by robert einefors njcl 2018/1 3 regulating equity crowdfunding service providers – an innovation-oriented approach to alternative financing ..................................................................................... 201 230 by elif härkönen peer-to-peer lending – a new digital intermediary, new legal challenges .............................................................. 231 260 by tanja jørgensen jurisdictional clauses in platform work contracts: a danish perspective ........................................................... 261 284 by asger lund-sørensen foreword 4 foreword new technology – new opportunities – new challenges – new regulation? this is the common line of thought in the 10 contributions in this special issue on online intermediary platforms. the 10 contributions each provide a critical view on how online intermediary platforms fit in the context of the authors’ areas of expertise. the contributions cover overarching regulatory models and frameworks along with specific problem areas such as consumer law, labour law and tax law as well as sector specific perspectives within accommodation and finance. last, but not least, the issue of jurisdiction is also presented. there is no common legal definition of online intermediary platforms, but the scope of the special issue is primarily online platforms where users register in order to enter into contract with each other. social platforms and search engines are thus excluded. despite this delimitation, the scope is still broad enough to cover a variety of platforms with different business structures. eleven contributions provide various valuable perspectives on these online intermediary platforms and together, the contributions form a comprehensive, though not exhaustive, analysis of legal challenges of the intermediary platforms. two common key challenges can be identified across the contributions. the first challenge is categorising the platform and platform users. the contributions reveal that the legal categories in existing legislation do not always fit the parties in the triangular structure of the intermediary platform. as a consequence, it becomes unclear how to apply existing regulation and the parties will not know their legal position. the other challenge identified concerns the striking of balance. on the basis of considerations expressed in existing legislation and expressed policies, the authors reflect on balance on various areas related to regulation of intermediary platforms. in regards to an overall level of choice of regulatory technique, the balance relates to self-regulation vs. state regulation and national vs. regional or international regulation. there is also the issue of balance between innovation and preserving status quo, and in addition, the balance between the many specific considerations, such as protection of the weaker party and social security vs. the possibility of running a business for the platform, freedom of contract etc. most of the specific legal challenges revealed in the contributions relate to a disturbance or a disruption of the existing notion of balance, and the provided suggestions for solutions or critical reflection on existing proposals for solutions thus aims at restoring this balance within the new business structure of platforms. the first two contributions focus on two different levels of regulatory techniques. andrej savin analyses the eu regulative approach to the area, arguing that there has been a shift in the target for regulation from services and networks to platforms. this shift is partly caused by a change in perception of enabling the flow of digital services to a need for constraining e.g. illegal content. savin calls for an integrated approach to njcl 2018/1 5 platforms of all layers of the platform including the wire, the content and the audio-video layer, based on an overarching platform policy. vibe garf ulfbeck, ole hansen and clement salung pedersen discuss the other end of the regulatory scale, as they discuss the consequences of selfregulation/private governance especially related to consumer protection and non-discrimination. the contribution is based on a case study of airbnb. the authors show that airbnb includes public values into their policy but argue that doing so is not as effective as statutory provisions for reasons such as difference in enforcement approach and the network effect of loyalty. in the third contribution, marie jull sørensen explores how four legal frames within danish consumer contract law may apply to the intermediary platforms. in analysing the four legal frames, the focus is on the role of the platform in regards to the contract between the two users (parties to the main contract). sørensen discusses how provisions from the liability regime of draft model rules on online intermediary platforms might help align the discrepancies between risk and control revealed in some of the four legal frameworks. the fourth and fifth contributions address the issue of protection of the platform worker. from a swedish standpoint, annamaria westregård considers when the nordic labour model applies on platform workers. westregård presents the swedish concept of dependent contractor as a relevant category for the platform worker. she discusses the need for connection between regulation of labour law, social security, collective agreements and tax law but warns against a too intrusive approach from legislators into the labour model. from a danish standpoint, christian højer schjøler and natalie videbæk munkholm provide a perspective on collective agreements, especially regarding their limitations in relation to competition law. schjøler and munkholm discuss who is covered by the danish labour model and present the first collective agreement for platform work which is being trialled for a one-year period. a novel aspect of the agreement is the fact that unlike other collective agreements the platform workers are free to choose whether they want to join the agreement or not. in the sixth contribution, peter koerver schmidt and louise fjord kjærsgaard argue that existing tax law is not suited for cross border platforms, as the law does not appropriately align the location in which profits are taxed (permanent establishment) and the location in which value is created (user-jurisdiction). schmidt and kjærsgaard focus on taxation of the platform in the user-jurisdiction and discuss if the value added by the user somehow can be taxed. the concepts of barter transactions and payment of royalties are also discussed in search for alternative ways to tax what might be seen as payments from the user to the platform. in the seventh contribution, robert einefors presents a commercial model for opening the swedish rental housing market to platforms such foreword 6 as airbnb. einefors argues that restrictive swedish housing regulation has prevented people from subletting partly because the tenants have to ask the landlord for permission to sublet. the suggested model gives the landlord an economic incentive to grant this permission by making it possible for landlords to charge an extra fee. in addition, the tenants can sublet to a higher price. the model requires that certain criteria are met in order to apply with existing law. the eight contribution by elif härkönen presents equity crowd funding as disruption of the traditional market for business financing and shows that there are different regulatory approaches in the nordic countries. härkönen argues that there is a need for harmonisation and that especially countries with smaller populations will benefit from an extended volume of potential lenders. in the ninth contribution, tanja jørgensen focusses on funding of private persons through peer-to-peer lending and argues that the peer-topeer service providers in these areas fill a gap partly caused by the financial crisis which resulted in restraints by the banks to lend out money. based on her analysis, jørgensen calls for a need for a single european regulatory framework on crowdfunding with specific focus on consumer protection. in the final contribution, asger lund-sørensen discusses the application of jurisdiction clauses. lund-sørensen argues that allowing to choose the jurisdiction creates predictability. however, in the case of platforms, he questions the autonomy of the user, as the terms are made on a take-it-or-leave-it basis. in regards to jurisdiction clauses, lundsørensen shows that the classification of the users is important as both consumers and employees are granted protection in international private law regulation. as shown, this special issue covers a large number of topics related to online intermediary platforms and i thank the contributors and nordic journal of commercial law for making this special issue possible. it is my hope that this publication will inspire and qualify the development of this important area of law and business. / marie jull sørensen cisg advisory council opinion no. 5 the buyer's right to avoid the contract in case of non-conforming goods or documents (by cisg advisory council) nordic journal of commercial law issue 2005 #2 nordic journal of commercial law issue 2005 #2 2 to be cited as: cisg-ac opinion no 5, the buyer's right to avoid the contract in case of non-conforming goods or documents, 7 may 2005, badenweiler (germany). rapporteur: professor dr. ingeborg schwenzer, ll.m., professor of private law, university of basel. jan ramberg, chair eric e. bergsten, michael joachim bonell, alejandro m. garro, roy m. goode, sergei n. lebedev, pilar perales viscasillas, peter schlechtriem, ingeborg schwenzer, hiroo sono, claude witz, members loukas a. mistelis, secretary the cisg-ac is a private initiative supported by the institute of international commercial law at pace university school of law and the centre for commercial law studies, queen mary, university of london. the international sales convention advisory council (cisg-ac) is in place to support understanding of the united nations convention on contracts for the international sale of goods (cisg) and the promotion and assistance in the uniform interpretation of the cisg. at its formative meeting in paris in june 2001, prof. peter schlechtriem of freiburg university, germany, was elected chair of the cisg-ac for a three-year term. dr. loukas a. mistelis of the centre for commercial studies, queen mary, was elected secretary. the cisg-ac has consisted of: prof. emeritus eric e. bergsten, pace university; prof. michael joachim bonell, university of rome la sapienza; prof. e. allan farnsworth, columbia university school of law; prof. alejandro m. garro, columbia university school of law; prof. sir roy m. goode, oxford; prof. sergei n. lebedev, maritime arbitration commission of the chamber of commerce and industry of the russian federation; prof. jan ramberg, professor of private law, university of stockholm, faculty of law; rector, graduate school of law, riga, latvia; prof. peter schlechtriem, freiburg university; prof. hiroo sono, faculty of law, hokkaido university; prof. claude witz, universität des saarlandes and strasbourg university. members of the council are elected by the council. at its meeting in rome in june 2003, the cisg-ac elected as additional members, prof. pilar perales viscasillas, universidad carlos iii de madrid, and prof. ingeborg schwenzer, university of basel. at its meeting in madrid in october 2004, professor jan ramberg was elected chair of the cisg-ac for a three-year term. for more information please contact <l.mistelis@qmul.ac.uk>. mailto:l.mistelis@qmul.ac.uk nordic journal of commercial law issue 2005 #2 3 opinion article 49 cisg (1) the buyer may declare the contract avoided: (a) if the failure by the seller to perform any of his obligations under the contract or this convention amounts to a fundamental breach of contract; or (b) [… ] 1. in determining whether there is a fundamental breach in case of non-conformity of the goods giving the buyer the right to avoid the contract according to art 49(1)(a) cisg, regard is to be given to the terms of the contract. 2. if the contract does not make clear what amounts to a fundamental breach, regard is to be given in particular to the purpose for which the goods are bought. 3. there is no fundamental breach where the non-conformity can be remedied either by the seller or the buyer without unreasonable inconvenience to the buyer or delay inconsistent with the weight accorded to the time of performance. 4. additional costs or inconvenience resulting from avoidance do not influence per se whether there is a fundamental breach. 5. the issue of avoidance in case of non-conforming accompanying documents such as insurance policies, certificates etc., must be decided by resorting to the criteria set forth in 1. to 4. 6. in the case of documentary sales, there is no fundamental breach if the seller can remedy the non-conformity of the documents consistently with the weight accorded to the time of performance. 7. in the commodity trade, in general, there is a fundamental breach if there is no timely delivery of conforming documents. 8. if the non-conformity does not amount to a fundamental breach, the buyer still has a right to withhold payment and to refuse to take delivery if reasonable under the circumstances. nordic journal of commercial law issue 2005 #2 1 the rapporteur gratefully acknowledges lic. iur. benjamin k. leisinger for his assistance in the preparation of this opinion. 2 cf. schlechtriem, subsequent performance and delivery deadlines -avoidance of cisg sales contracts due to nonconformity of the goods, at i. avoiding a contract on account of non-conformity with tendered goods, p. 1 et seq., online at <http://www.cisg-online.ch/cisg/schlechtriem-paceint'llrev.pdf>. 3 see iccpublication no. 560 ed. 4 see a8 of the respective clauses. 5 see b8 of the respective clauses. 6 this may be done, firstly, by express reference. furthermore, there is a tendency among courts and scholarly opinions t ha t suc h r u l es a m o u n t t o u s a g e s i n i n t e r n a t i o n a l t r a d e w i t h i n t h e m e an i ng of ar t 9 (2 ) ci sg . s e e witz/salger/lorenz/w. witz, international einheitliches kaufrecht, heidelberg 2000, art 9 para 14; italy, marc rich & co. a.g. v. iritecna s.p.a., corte d'appello di genova, 24 march 1995, cisg-online 315; argentina, elastar sacifia v. bettcher industries, inc., juzgado nacional de primera instancia en lo comercial, 20 may 1991, cisg-online 461; united states, st. paul ins. co. v. neuromed med. sys., us district court (s.d.n.y.), 26 march 2002, cisg-online 615; united states, bp international, ltd. and bp exploration & oil, inc., plaintiffs-appellants v. empressa estatal petroleos de ecuador, et al., defendants, empresa estatal petroleos de ecuador and saybolt, inc., defendants-appellees, us court of appeals (5th circuit), 11 june 2003, cisg-online 730. more differentiated: bridge, the international sale of goods, oxford 1999, at 2.48 and 2.49; schlechtriem/schwenzer/schmidt-kessel, commentary on the un convention on the international sale of goods (cisg), 2nd ed., oxford 2005, art 9 para 26. 4 comments1 1. introduction 1.1 rules on avoidance of contract in case of non-conforming goods have to take into account three different interests:2 the buyer is interested in a low threshold for avoidance, while the seller’s interest is in a high threshold for avoidance. economic reasons such as costs and risk of transportation or storage may also play a role. these conflicting interests have to be balanced. 1.2 there have been great differences of opinion among domestic legal systems concerning the question of under which circumstances the buyer may avoid the contract in case of nonconforming goods or documents. art 49(1)(a) cisg provides that avoidance is possible “ if the failure by the seller to perform any of his obligations under the contract or this convention amounts to a fundamental breach of contract.” according to art 25 cisg, a breach is fundamental ” if it results in such detriment to the [buyer] as substantially to deprive him of what he is entitled to expect under the contract, unless the [seller] did not foresee and a reasonable person of the same kind in the same circumstances would not have foreseen such a result.” 1.3 reference to case law shows that the interpretation of the notion of fundamental breach in cases of non-conforming goods by national courts and arbitration tribunals differs considerably even within one single legal system. 1.4 special problems arise with respect to non-conforming documents and the commodity trade in particular. special rules have been established by the international chamber of commerce. thus, the incoterms 20003 contain detailed rules governing the obligations of the seller to provide for documents,4 and the buyer to accept them,5 respectively. such rules are widely incorporated into international contracts.6 http://www.cisg-online.ch/cisg/schlechtriem-paceint'llrev.pdf nordic journal of commercial law issue 2005 #2 7 domestic legal systems use many different notions, such as termination, nullification, repudiation, cancellation, rescission or avoidance. this opinion always uses the expression ” avoidance” as this reflects the terminology of the cisg, see, e.g., in arts 49, 75, 76(1) cisg. 8 cf. germany: former § 462 bürgerliches gesetzbuch (bgb) (in force until 31 december 2001); france: art 1644 code civil; switzerland: art 205 code of obligations. but see austria: art 932 allgemeines bürgerliches gesetzbuch (abgb), only giving a right to avoid the contract in cases where repair is not feasible and a proper use is not possible. for details see rabel, recht des warenkaufs, volume 2, tübingen 1958, p. 232 et seq. 9 schuldrechtsmodernisierungsgesetz of 26 november 2001, in force since 1 january 2002, § 323 bgb. 10 see section 39 norwegian sale of goods act 1988 <http://www.jus.uio.no/lm/norway.sog.act.1988/doc#116>; section 39 finnish sale of goods act 1987 <http://www.finlex.fi/pdf/saadkaan/e9870355.pdf>; section 39 swedish sale of goods act 1990. for details see kjelland, das neue recht der nordischen länder im vergleich mit dem wiener kaufrecht (cisg) und dem deutschen kaufrecht, aachen 2000. 11 see art 6:265 burgerlijk wetboek. 12 see article 7.3.1 unidroit principles of international commercial contracts 2004. 13 see article 4.303 principles of european contract law. 14 under english law, avoidance depends upon the question whether there was a breach of condition or a mere breach of warranty. see for the distinction between "condition” and "warranty” : cehave n.v. v. bremer handelsgesellschaft m.b.h. (the hansa nord), 1 q.b. 44 (c. a.), 1976; see also s. 11, s. 14 and s. 15a of the sale of goods act 1994. according to § 2608(1) uniform commercial code (ucc), the buyer may revoke acceptance if acceptance of a lot or commercial unit whose non-conformity substantially impairs its value to the buyer if the buyer has accepted it. for an overview of the system of avoidance in common law systems in general see treitel, remedies for breach of contract, oxford 1988, sections 259, 260. 15 under english law, in s. 35(1) sale of goods act as amended by the sale and supply of goods act 1994, it is laid down that the buyer is deemed to have accepted the goods when he intimates to the seller that he has accepted them, or when the goods have been delivered to him and he does any act in relation to them which is inconsistent with the ownership of the seller. for details see benjamin’s sale of goods, 6th ed., london 2002, 12-044 et seq. in the ucc, acceptance is dealt with in § 2-606. acceptance occurs in three different ways: according to § 2-606(1)(a) ucc, the first possibility is that the buyer, after a reasonable possibility to inspect the goods, signifies to the seller that the goods are conforming or that he will take or retain them in spite of their non-conformity. pursuant to § 2-606(1)(b) ucc, acceptance also occurs, if the buyer fails to make effective rejection after the buyer had a reasonable opportunity to inspect the goods. finally, acceptance occurs if, according to § 2-606(1)(c) ucc, "the buyer does any act inconsistent with the seller’s ownership” . here, the buyer’s knowledge and behavior is decisive; for illustrations see white/summers, uniform commercial code, 5th ed., st. paul 2000, § 8-2. 16 see § 2-601(a) ucc, s. 35 sale of goods act 1994. 5 2. domestic legal systems 2.1 civil law systems were originally based upon the roman sales law rule that, in the case of defects in the quality of the goods, the buyer had the right either to demand reduction of the purchase price (actio quanti minoris) or to avoid7 the contract (actio redhibitoria).8 however, modern statutes, such as the german statute on modernization of the law of obligations 9, the scandinavian sales laws10 or the netherlands civil code11, are oriented towards the cisg and apply the notion of fundamental breach or similar key concepts for the avoidance of the contract. the same is true for other international uniform law instruments, such as the unidroit principles12 and the principles of european contract law13. 2.2 in contrast to this, common law sales law was based upon the idea that the buyer could only avoid (terminate) the contract if the non-conformity is sufficiently serious.14 this restriction, however, only applies to accepted goods15, thus making ” acceptance” or its revocation key notions. before there has been acceptance, the so-called ” perfect tender rule” 16 applies, giving the buyer the right to reject the goods if they do not conform to the contract in any respect. however, during the past decades the perfect tender rule itself has been subject to several restrictive modifications. thus, s. 15a sale of goods act, inserted by the sale and supply of goods act 1994, states that if the buyer does not deal as a consumer, the breach may not be treated as a breach of condition if the breach was so slight that it would be unreasonable for the buyer to reject the goods. similarly, http://www.jus.uio.no/lm/norway.sog.act.1988/doc#116 http://www.finlex.fi/pdf/saadkaan/e9870355.pdf nordic journal of commercial law issue 2005 #2 17 see § 1-203 ucc. see also treitel who points out, ” [t]his so-called perfect tender rule [particularly as recited in ucc 2601] at first sight gives rise to a very wide power to terminate regardless of the seriousness of the nonconformity. but the appearance is deceptive as the requirement of seriousness is re-introduced by a number of other provisions which must be read together with ucc 2-601." treitel, op. cit. (footnote _ref118263237\h \* mergeformat 16) section 269. for other relevant provisions of the ucc, see albert h. kritzer, guide to practical applications of the cisg, deventer/boston 1990, suppl. 4 (february 1993), p. 206. 18 such a cure can be the delivery of conforming replacement goods, repair or even price adjustments sufficient to compensate the buyer and reduction in the price. see for replacement goods: t.w. oil, inc. v. consolidated edison co., us court of appeals (n.y.), 15 december 1982, 1982 n.y. lexis 3846; del duca/guttman/squillante, problems and materials on sales under the uniform commercial code and the convention on international sale of goods, cincinnati 1993, p. 359; calamari & perillo, contracts, 3rd ed., st. paul 1988, § 11-20, p. 468. see for repair: wilson v. scampoli, us court of appeals (d.c.), 2 may 1967, 1967 d.c. app. lexis 156. for price adjustments and reduction: white/summers, op. cit. (footnote _ref80698755\h \* mergeformat 17), § 8-6, p. 338; oral-x corp. v. farnam cos., inc., us court of appeals (10th circuit), 26 april 1991, 1991 u.s. app. lexis 7377. 19 in the course of the recent revision of the ucc there have also been discussions in the study group as to whether to replace the perfect tender rule with the requirement that would permit rejection only if a non-conformity ” substantially i m p a i r s t h e v a lue of th e p e r f o r m a n c e t o t h e b u y e r ” , s e e t h e d r a f t o f § 2 5 0 1 u c c a s o f j u l y 1 9 9 6 <http://www.law.upenn.edu/bll/ulc/ucc2/ucc2sale.pdf>. however, ultimately a majority of the study group recommended that the perfect tender rule be maintained as the standard, see § 2-601 ucc draft 2002. for the whole discussion see: lawrence, symposium: the revision of article 2 of the uniform commercial code: appropriate standards for a buyer’s refusal to keep goods tendered by a seller, 35 wm and mary l. rev. 1635, 1637 et seq. (1994). 20 uniform law on the international sale of goods, online at <http://www.unidroit.org/english/conventions/c-ulis.htm>. 21 cf. o.r. p. 295 et seq., p. 300; schlechtriem/schwenzer/schlechtriem, op. cit. (footnote _ref87344905\h \* mergeformat 8), art 25 para 2. 22 during the drafting of the cisg, a number of attempts were made to reintroduce the ” time element” . see o.r., p. 354 et seq. 23 cf. schlechtriem, op. cit. (footnote _ref103565042\h4), p. 6. 6 some us courts have limited the perfect tender rule by applying the good faith principle17, especially in cases of a rightful and effective cure18 by the seller in accordance with § 2-508 ucc.19 3. drafting history 3.1 the basic concept of fundamental breach was already present in art 10 ulis20 and was not questioned during the preparatory work for the cisg. the function of this concept in the case of tender or delivery of non-conforming goods was to avoid causing these goods to be returned, which would result in considerable economic detriment. 3.2 although the concept of fundamental breach itself was unquestioned, the preconditions for the breach being fundamental and the necessity to declare the contract avoided remained in dispute until the vienna conference. ultimately, it was decided that the seriousness of the breach should be determined by reference to the interests of the promisee as actually laid down and circumscribed by the contract.21 concerning the avoidance of the contract, the cisg clearly deviates from ulis. under art 44(2) ulis, the buyer could fix an additional time to remedy any breach in cases, where the non-conformity of the goods or the delay in delivering conforming goods did not yet amount to a fundamental breach under art 43 ulis. the fruitless elapse of such a ” nachfrist” always enabled the buyer to avoid the contract, regardless of the fundamentality of the original defect in performance. art 49(1)(b) cisg, in contrast, limits the possibility for the buyer to fix an additional period of time to cases of non-delivery, thus excluding this possibility for nonconforming goods.22 still, also under cisg the weight the contract accords to the time of performance always has to be kept in mind when defining a fundamental breach.23 http://www.law.upenn.edu/bll/ulc/ucc2/ucc2sale.pdf http://www.unidroit.org/english/conventions/c-ulis.htm nordic journal of commercial law issue 2005 #2 24 art 86(1): ” if the buyer has received the goods and intends to exercise any right under the contract or this convention to reject them, [… ]” . art 86(2):” if goods dispatched to the buyer have been placed at his disposal at their destination and he exercises the right to reject them, [… ]” . 25 see o.r., p. 399. 26 this would amount to a ” condition” in english legal terminology. see also the notion of ” zusicherung” under former §§ 459(2), 463 bgb (in force until 31 december 2001) or the ” dicta et promissa” in roman sales law, see rabel, op. cit. (footnote _ref88972454\h10), p. 132 et seq. 27 see germany, olg stuttgart, 12 march 2001, cisg-online 841. 28 see cietac (china international economic and trade arbitration commission), 30 october 1991, cisg-online 842. 29 see switzerland, appellationsgericht basel-stadt, 22 august 2003, cisg-online 943. 7 3.3 the history of the cisg clearly documents that there is no equivalent to the original perfect tender rule in anglo-american law. although its wording could be misunderstood,24 art 86 cisg in itself does not give the buyer a general right to reject any non-conforming tender.25 rather, under the cisg such a right is limited to certain situations: art 52 cisg allows the buyer to refuse to take delivery only if the seller delivers the goods before the date fixed or if he delivers a quantity of goods greater than that provided for in the contract. in all other cases of nonconforming tender, the requirement for rejection is a fundamental breach. 4. interpretation a) general remarks 4.1 a fundamental breach of contract giving the buyer the right to avoid the contract or to ask for substitute goods presupposes that the defect has a serious importance to the buyer. in considering avoidance, one has to take into account whether the buyer can be required to retain the goods because he can be adequately compensated by damages or a price reduction. the substantiality of the detriment to the buyer may be ascertained by having regard to the terms of the contract, the purpose for which the goods are bought and finally, by the question of whether it is possible to remedy the defect. in any case, the question of time has to be given due consideration. aa) terms of the contract 4.2 first and foremost, it is up to the parties to stipulate what they consider to be of the essence of the contract.26 whether or not a contractual agreement is of the essence is a matter of interpretation under art 8 cisg. in doing so, several courts held a breach to be fundamental where the parties had explicitly agreed on certain central features of the goods, such as unsweetened apple juice concentrate27, the thickness of a roll of aluminium28 or soy protein products that have not been genetically modified.29 if the parties act accordingly, there is also no room for the seller to argue that he did not foresee the detriment to the buyer, if the goods do not conform to such express terms. bb) purpose for which goods are bought 4.3 if the contract itself does not make clear what amounts to a fundamental breach, one of the central questions is for what purpose the goods are bought. where the buyer wants to use the nordic journal of commercial law issue 2005 #2 30 see germany, lg münchen, 27 february 2002, cisg-online 654. 31 see united states, delchi carrier, s.p.a. v. rotorex corp., us court of appeals (2nd circuit), 6 december 1996, cisg-online 140. 32 see icc international court of arbitration, 7754 of 1995, cisg-online 843; germany, olg stuttgart, 12 march 2001, cisg-online 841. but see: germany, lg münchen, 27 february 2002, cisg-online 654, globes still could be used for advertising even though they were not able to rotate. 33 see germany, lg ellwangen, 21 august 1995, cisg-online 279; icc international court of arbitration, 8128 of 1995, cisg-online 526; switzerland, appellationsgericht basel-stadt, 22 august 2003, cisg-online 943; germany, bgh, 2 march 2005, cisg-online 999, in this case, however, avoidance was not declared, but the court granted a price reduction to zero. but see: germany, bgh, 8 march 1995, cisg-online 144, mussels still good for consumption because there was no health risk. 34 see germany, olg frankfurt a.m., 18 january 1994, cisg-online 123, the burden of proof that resale is not possible lies on the buyer; germany, olg stuttgart, 12 march 2001, cisg-online 841. 35 see germany, lg landshut, 5 april 1995, cisg-online 193, clothes; germany, hans. olg hamburg, 26 november 1999, cisg-online 515, jeans; germany, olg köln, 14 october 2002, cisg-online 709, designer clothes. see also: germany, olg oldenburg, 1 february 1995, cisg-online 253, limited circle of interested subbuyers would only buy the goods at a discount of 50%. 36 see germany, olg köln, 14 october 2002, cisg-online 709, buyers of designer clothes have higher standards. 37 see switzerland, handelsgericht des kantons aargau, 5 november 2002, cisg-online 715. 38 see germany, lg köln, 16 november 1995, cisg-online 265. 39 cf. schlechtriem/schwenzer/schlechtriem, op. cit. (footnote _ref87344905\h \* mergeformat 8), art 25 para 20. 40 all incoterms 2000 clauses in a4 call for delivery ” on the date or within the period agreed for delivery” . one german court, hans. olg hamburg, 28 february 1997, cisg-online 261, has argued that a c.i.f. contract has to be understood as a fixed term contract. but see: icc international court of arbitration, 7645 of 1995, cisg-online 844, the incoterms clauses c.f.r. do not, however, specify that abiding to the time limit is an obligation of especially essential importance. 8 goods himself, such as machinery for processing, globes for marketing purposes30 or compressors for use in air-conditioners31, in the usual case it cannot be decisive whether the goods could be resold even at a discount price. rather, the decisive factor is whether the goods are improper for the use intended by the buyer. however, regard is to be had to the question whether the buyer is able to make use of the goods or to process them differently without unreasonable expenditure.32 where the buyer himself is in the resale business, the issue of a potential resalability becomes relevant. there is also a fundamental breach here if the goods are not resalable at all, e.g., food not complying with national health regulations.33 if the defect of the goods does not hinder their resalability, still, it cannot be said that there is never a fundamental breach. the question then is whether resale can reasonably be expected from the individual buyer in his normal course of business.34 a wholesaler with broader access to markets in the business concerned has more opportunities to resell the goods than a retailer. a retailer cannot be expected to resell the goods at a discount price if, by doing so, he would be likely to damage his own reputation.35 in determining the likelihood of this, regard is to be had to the retailer’s specific target group of customers.36 in all these cases, due regard should be had to the possibilities of the seller himself to dispose of the goods, thus balancing the possibilities and interests of the buyer and seller. cc) possibility of repair or replacement 4.4 though the objective essential nature of the defect is always a necessary condition to establish a fundamental breach of contract, it will not always be sufficient. in cases where the nonconformity of the goods can be remedied by the seller – e.g., by repairing the goods37 or delivering substitute or missing goods38 – without causing unreasonable delay or inconvenience to the buyer, there is not yet a fundamental breach.39 here, due regard is to be given to the purposes for which the buyer needs the goods. if timely delivery of conforming goods is of the essence of the contract, repair or replacement usually will lead to unreasonable delay.40 in finding such unreasonableness nordic journal of commercial law issue 2005 #2 41 see obiter, germany, bgh, 3 april 1996, cisg-online 135, bghz 132, 290 et seq. 42 see germany, lg berlin, 15 september 1994, cisg-online 399. 43 see germany, lg oldenburg, 6 july 1994, cisg-online 274; united states, delchi carrier, s.p.a. v. rotorex corp., us court of appeals (2nd circuit), 6 december 1996, cisg-online 140. 44 for a thorough discussion of the dogmatic controversy considering the relationship between art 49(1)(a) cisg and art 48(1) cisg see: schlechtriem/schwenzer/schlechtriem, op. cit. (footnote _ref87344905\h \* mergeformat 8 ) , a r t 2 5 p a r a 2 0 ; f o u n t o u l a k i s , d a s v e r h ä l t n i s v o n n a c h e r f ü l l u n g s r e c h t d e s v e r k ä u f e r s u n d vertragsaufhebungsrecht des käufers im un-kaufrecht, internationales handelsrecht (ihr) 2003, p. 160 et seq. 45 see germany, lg heidelberg, 3 july 1992, cisg-online 38. 46 see cietac (china international economic and trade arbitration commission), 6 june 1991, cisg-online 845, transport costs of us $1,750 and storage costs for a period of three years approximately us $17,000. 9 the same criteria have to be applied as in case of late delivery; namely whether exceeding a time limit – either a date or the end of a period of time – amounts to a fundamental breach. furthermore, the buyer should not be expected to accept cure by the seller if the basis of trust for the contract has been destroyed, e.g., due to the seller’s deceitful behaviour.41 when the seller either refuses to remedy the defect42, simply fails to react, or if the defect cannot be remedied by a reasonable number of attempts within a reasonable time43, then a fundamental breach will also be deemed to have occurred.44 4.5 if in a given case the buyer is in a better position than the seller to have the goods repaired himself or by a third party, to buy missing parts45 or – in case of a defect in quantity – to buy the missing amount of goods, he is obliged to do so and may not declare the contract avoided for fundamental breach. dd) additional costs or inconvenience resulting from avoidance 4.6 it may be questionable as to whether the fact that the goods are still on the premises of the seller – e.g., in case of delivery exw, or if the buyer realizes the non-conformity before the shipping of the goods – or are stored in a warehouse affects the notion of fundamental breach because the goods do not have to be transported back to the seller in case of avoidance of the contract. the idea to prevent commercially unreasonable costs for the transport of the goods, might advocate lowering or raising the prerequisites for avoidance, respectively. however, even if the seller does not have to transport the goods back, he may face storage costs exceeding the costs for transportation.46 furthermore, in cases where the goods have already been shipped, they do not necessarily have to be transported back to the seller if the buyer avoids the contract; the seller may be able to redirect them to another buyer or sell them at the place where they are located. thus it would be necessary to decide on an approach, independent from the location of the goods, in order to assess the costs that the avoidance of the contract would cause to the seller. this, however, would lead to unpredictable results. b) non-conforming documents 4.7 in the first place, one has to distinguish between two different situations: first, there are various documents that usually accompany a contract of sale, e.g., insurance policies, certificates of origin, certificates of inspections, custom clearance certificates, etc. second, a contract of sale can require delivery by the handing over of documents of title, e.g., bills of lading. other nordic journal of commercial law issue 2005 #2 47 see germany, bgh, 3 april 1996, cisg-online 135, bghz 132, 290 et seq. 48 see for example: germany, bgh, 3 april 1996, cisg-online 135, bghz 132, 290 et seq. in this case, seller provided for a non-conforming certificate of origin and a non-conforming certificate of analysis. the court held that the seller could easily get a new certificate of origin from the local chamber of commerce and that the certificate made by buyer’s expert was a valid new certificate of analysis. 49 for references see supra (footnote _ref87344905\h8). 50 see the provision a8 of the respective clauses. 51 see secretariat commentary, o.r., p. 16, art 2 para 8. 10 documents such as dock warrants, warehouse receipts or their respective electronic equivalents can also be required. aa) accompanying documents 4.8 in the case of accompanying documents, the question as to whether the buyer may avoid the contract must be decided by resorting to the general mechanisms of the convention already established for determining a fundamental breach.47 4.9 if the documents are delivered but do not conform to the contract description, this is to be treated like a defect in quality. thus, initially, what is decisive is whether the defective documents limit the buyer in using the goods according to his plans, e.g., to resell them. if they do not, a fundamental breach can never be assumed. if they do limit him, the seriousness of the defect depends upon whether the buyer can still use the goods in a reasonable way even with nonconforming documents, or – if not – whether the non-conformity of the documents can be remedied in time either by the seller or by the buyer himself.48 4.10 the case of missing accompanying documents is to be treated like a defect in quantity and not as an equivalent to non-delivery of the goods. that means that also in this case, a fundamental breach of contract has to be established on the individual facts of the case, thus enabling the buyer to avoid the contract only in accordance with art 49(1)(a) cisg; art 49(1)(b) cisg is not applicable. bb) documentary sales 4.11 nowadays, a majority of international sales contracts incorporate the incoterms of the icc. a number of courts and scholars already hold that they have become a usage in international trade within the meaning of art 9(2) cisg, thereby complementing the rules of the convention.49 except for exw, all incoterms 2000 clauses contain the seller’s obligation to deliver or to assist the buyer to obtain certain documents of title.50 thus, in turn, all such contracts can be referred to as documentary sales contracts. 4.12 according to art 1(1) cisg, the convention applies to contracts of sale of goods. however, there cannot be any doubt that documentary sales of goods shall be covered by the convention as well, ” though in some legal systems such sales may be characterized as sales of commercial paper” 51. this even holds true for so called ” string transactions” , i.e., when documents nordic journal of commercial law issue 2005 #2 52 see the thorough discussion of this question by: schlechtriem, interpretation, gap-filling and further development of the un sales convention, at <http://www.cisg-online.ch/cisg/publications.html>, text accompanying footnotes 15-24. 53 see ibid, at ii.5.c)cc). 54 for a thorough discussion of this question, see above para. 4.4. 55 see schütze, das dokumentenakkreditiv im internationalen handelsverkehr, 5th ed., heidelberg 1999, p. 26; also see icc homepage: <http://www.iccwbo.org/home/documentary_credits/ documentary_credits.asp>. 56 cf. 1993 revision, iccpublication no. 500. 57 see for a list of countries that have acknowledged collectively and banks in other countries which also have acknowledged them: schütze, op. cit. (footnote _ref103590811\h57), appendix iv, p. 341 et seq. 58 see witz/salger/lorenz/w. witz, international einheitliches kaufrecht, heidelberg 2000, art 60 para 13, ibid, art 54 para 3. 59 see for agricultural products: fuhrmann/giucci, warenterminbörsen in deutschland, working paper 9603, at 2.a., online at: <http://www.uni-potsdam.de/u/makrooekonomie/docs/9603.htm>. for iron molybdenum: germany, hans. olg hamburg, 28 february 1997, cisg-online 261: price was 9,70 us $/kg and changed to 30 us $/kg. for commodity prices in general, see: matthies/timm, world commodity prices 1999-2000, association d’instituts européens de conjoncture economique working group on commodity prices, 1999, online at: <http://www.hwwa.de/publikationen/report/1999/report191.pdf>. 11 are sold and transferred several times until the final purchaser takes physical delivery of the goods.52 4.13 in documentary sales contracts, the tender of ” clean” documents is of the essence of the contract. thus, b8 of all incoterms 2000 clauses (except for exw) provides that the buyer must accept the transport document and/or other evidence of delivery in accordance with the seller’s obligation. this implies the buyer’s right to reject any tender of non-conforming documents irrespective of the goods’ actual conformity or non-conformity with the contract.53 4.14 however, the seller may remedy any lack of conformity in the documents. if, for example, the bill of lading is ” unclean” because it refers to damage to the goods or their packaging, the seller may tender a new bill of lading relating to other goods, which does not contain such a reservation. if the bill of lading indicates a late loading date, the seller may subsequently purchase goods ” afloat” which were loaded on time and tender to the buyer the bill of lading issued for those goods. however, again, this is only possible if it does not cause unreasonable inconvenience to the buyer or delay inconsistent with the weight accorded to the time of performance.54 4.15 in a majority of international sales contracts, the parties stipulate that the purchase price is to be paid by means of documentary credit including standby letter of credit.55 in this case, the ucp 50056 usually apply, either by express reference or, as is frequently held, as an international trade usage57 within the meaning of art 9(2) cisg.58 4.16 art 20 et seq. ucp 500 set out, in detail, under what circumstances the documents are to be accepted as clean, or may be rejected, respectively. however, this question concerns the relationship between the seller and the bank, which is not a subject of this opinion. suffice to say, that payment by means of documentary credit as such does not necessarily influence the possibility of the buyer to avoid the contract in case of non-conforming documents. c) commodity trade 4.17 in those parts of the commodity market, where string transactions prevail and/or prices are subject to considerable fluctuations59, special standards have to be applied in determining whether there is a fundamental breach. there, timely delivery by the handing over of clean documents – http://www.cisg-online.ch/cisg/publications.html http://www.iccwbo.org/home/documentary_credits/ http://www.uni-potsdam.de/u/makrooekonomie/docs/9603.htm http://www.hwwa.de/publikationen/report/1999/report191.pdf nordic journal of commercial law issue 2005 #2 60 cf. unidroit principles 2004, art 7.3.1, official comment 3.b.; bridge, the sale of goods, oxford 1997, p. 155; poole, textbook on contract law, 7th ed., oxford 2004, para 7.5.3.2; schlec htriem, op. cit. (footnote _ref80698633\h \* mergeformat 54), at i.1.; mullis, termination for breach of contract in c.i.f. contracts under the vienna convention and english law; is there a substantial difference?, in: lomnicka/morse (ed.), contemporary issues in commercial law (essays in honor of prof. a.g. guest), london 1997, p. 137-160, at: <http://www.cisg.law.pace.edu/cisg/biblio/mullis.html>. 61 see schlechtriem, op. cit. (footnote _ref80698633\h \* mergeformat 54), at i.1. 62 schlechtriem, op. cit. (footnote _ref80698633\h \* mergeformat 54), at ii.5.a). 63 see for a thorough discussion: schlechtriem, op. cit. (footnote _ref80698633\h \* mergeformat 54), at ii.5.; idem, internationales un-kaufrecht, 2nd ed., tübingen 2003, at: 42d, 205 et seq., 250; staudinger/magnus, wiener un-kaufrecht (cisg), berlin 2005, art 4 para 74a; w. witz, zurückbehaltungsrechte im internationalen kauf – eine praxisorientierte analyse zur durchsetzung des kaufpreisanspruchs im cisg, in: schwenzer/hager (eds.), festschrift für peter schlechtriem zum 70. geburtstag, tübingen 2003, p. 291, 293 et seq.; for case law see also germany, ag altona, 14 december 2000, cisg-online 692. the question was left open in germany, olg düsseldorf, 24 april 1997, cisg-online 385. section 42 of the scandinavian sale of goods acts (finland, norway and sweden) also sets forth an explicit right to withhold; for comments see ramberg, köplagen, stockholm 1995, pp.455-459. see also art 7.1.3 unidroit principles 2004. 12 that can be resold in the normal course of business – is always of the essence of the contract.60 if the parties do not stipulate this importance by respective clauses, this can be derived from the circumstances by an interpretation of the contract pursuant to art 8(2), (3) cisg.61 as a result, in practice, the seller’s possibility to remedy a defect in the documents normally does not exist in the commodity trade. thus, in this specific trade branch the solution under the cisg is quite similar to that under the perfect tender rule. however, the last buyer, who actually takes the goods, may not avoid the contract merely by relying on the non-conformity of the documents. d) buyer’s right to withhold performance 4.18 in non-documentary sales cases, if the non-conformity of the tendered goods does not amount to a fundamental breach, as a general rule, the buyer is obliged to accept the goods as a right to avoid the contract does not exist according to art 49(1)(a) cisg. however, in this situation, a right to withhold performance can be advocated independent of the regular legal remedies. the buyer can at least temporarily refuse payment and even suspend his obligation to take delivery until he has decided on his next courses of action.62 4.19 the cisg recognizes a right to withhold performance in several provisions. art 58 cisg embodies the principle of ” payment against delivery” as concurrent conditions. according to art 71 cisg, a party may also suspend its own performance if performance by the other party is insecure. further rights to withhold performance are contained in arts 81(2) second sentence cisg, 85 second sentence and 86(1) second sentence cisg. the prevailing literature derives a general principle of a right to withhold performance according to art 7(2) cisg from such provisions.63 4.20 as an initial consequence of that general right, the buyer may withhold the payment of the purchase price; however, this right must be limited to the extent of the non-conformity and the expected detriment. if the extent of the non-conformity cannot be easily ascertained, the buyer should be given the right to withhold the whole purchase price for a reasonable time that is necessary to inspect the goods and to estimate the extent of the expected detriment. http://www.cisg.law.pace.edu/cisg/biblio/mullis.html nordic journal of commercial law issue 2005 #2 64 see schlechtriem, op. cit. (footnote _ref80698633\h \* mergeformat 54), at ii.5.c)bb). 13 4.21 besides the possibility to withhold the purchase price, the general right to withhold performance allows the buyer to suspend his obligation to accept delivery within the meaning of arts 53, 60 cisg for a reasonable time.64 this, however, does not mean that the buyer is not obliged to physically take possession of the goods and preserve them according to art 86 cisg. the practical consequence of the buyer’s right to refuse to take delivery is only important where the risk of loss has not yet passed pursuant to arts 67 or 68 cisg. the risk then passes according to art 69(1) cisg when the buyer takes over the goods, which implies an acceptance – within the meaning of taking delivery – by the buyer. nordic journal of commercial law issue 2005 #2 1 annex to the cisg-ac opinion no 5, the buyer’s right to avoid the contract in case of non-conforming goods or documents, 7 may 2005, badenweiler (germany). rapporteur: professor dr. ingeborg schwenzer, ll.m., professor of private law, university of basel. the case overview was prepared for the cisg advisory council by benjamin k. leisinger, academic assistant at the university of basel, and contains all cases cited in or underlying opinion no 5. this means that some cases are related to the incoterms as an international trade usage or the relevance of time and are without direct connection to the avoidance of the contract because of non-conformity of the goods or documents. 14 annex1 country/ arbitration court date docket no. cisgonline no. details 1. arbitration icc court of arbitration 1995, january 1 7754 843 • facts: buyer ordered computer hardware from seller, which was to be provided by seller's supplier and assembled by buyer's customer. a modification to the hardware was made prior to delivery, which was unknown to buyer and buyer's customer. buyer's customer informed seller that it could not accept the modification and requested that the hardware be in accordance with the initial documentation. in the meantime, buyer informed seller that only half of the amount of hardware initially ordered would be needed due to difficulties experienced by buyer's customer. seller shipped an initial consignment of modified hardware to buyer, who accepted the equipment but refused to accept the rest. • decision: no fundamental breach. • reasons for the decision: the goods have to be totally improper for their utilization. in this case, the non-conformity only caused buyer severe problems. • case text: link to english text of arbitration award <http://cisgw3.law.pace.edu/cases/957754i1.html> 2. argentina juzgado nacional de primera instancia en lo comercial 1991, may 20 50272 461 • facts: buyer from argentina bought goods from us seller. the seller asked for interest accrued between the date of delivery of the goods and the date fixed in the contract for the deferred payment of the price. • decision: no discussion of fundamental breach. seller was granted interest. • reasons for decision: accrual of interest during the agreed period in case of deferred payment constitutes a usage widely known and regularly observed in international trade. this can be compared with the incoterms, which, being a trade usage, are also applicable through art. 9(2) cisg. • case text: english translation <http://cisgw3.law.pace.edu/cases/910520a1.html> http://cisgw3.law.pace.edu/cases/957754i1.html http://cisgw3.law.pace.edu/cases/910520a1.html nordic journal of commercial law issue 2005 #2 country/ arbitration court date docket no. cisgonline no. details 15 3. germany bundesgerichts hof 1996, april 3 viii zr 51/95 135 • facts: dutch company had entered into four separate sales agreements with the german buyer for the delivery of five tons of cobalt sulfate. they agreed that the goods should be of british origin and that the seller should su ppl y certificates of origin and quality. payment was by means of documentary credit and the parties agreed on delivery exw. • breach: certificate of origin was wrong. the goods were from south africa. the quality also fell short of the description in the contract because the seller delivered cobalt sulphate that is usually used for feeding animals. • decision: no fundamental breach. • reasons for the decision: the buyer could get the necessary documents himself without unreasonable expenditure. • case text: english translation + link to german text <http://cisgw3.law.pace.edu/cases/960403g1.html> 4. germany olg frankfurt am main 1991, september 17 5 u 164/90 28 • facts: italian producer sells shoes to german b u y er . th e par ti es had a g r e e d u p o n a n ancillary duty of preserving exclusivity. • breach: seller also sold shoes to other buyers. • decision: fundamental breach. • reasons for the decision: even the breach of an ancillary duty can amount to a fundamental breach. the trustworthiness of the seller was harmed. • case text: english translation + link to german text <http://cisgw3.law.pace.edu/cases/910917g1.html> 5. germany olg frankfurt am main 1994, january 18 5 u 15/93 123 • facts: german buyer purchases shoes from italian producer. • breach: shoes were non-conforming. wrong material, color, etc. • decision: no fundamental breach. • reasons for the decision: the buyer did not argue that he could not use the shoes in a reasonable way. • case text: english abstract + link to german text <http://cisgw3.law.pace.edu/cases/940420g1.html> 6. germany olg frankfurt am main 1994, april 20 13 u 51/93 125 • facts: german buyer bought 1.75 t of new zealand-mussels from swiss seller. buyer discovered the non-conformity in germany, i.e., after the transport. • breach: mussels were cadmium-contaminated. • decision: no fundamental breach. • reasons for the decision: mussels still could be used for consumption. • case text: english abstract + link to german text <http://cisgw3.law.pace.edu/cases/940420g1.html> 7. germany olg hamburg 1994, december 14 5 u 224/93 216 • facts and breach: see supra 3. • decision: no fundamental breach. • reasons for the decision: the fact that seller provided for the wrong certificates is not decisive as the buyer could easily acquire correct documents himself without unreasonable expenditure. it is not decisive whether the duty to provide for clean documents was a primary duty of the seller or not. http://cisgw3.law.pace.edu/cases/960403g1.html http://cisgw3.law.pace.edu/cases/910917g1.html http://cisgw3.law.pace.edu/cases/940420g1.html http://cisgw3.law.pace.edu/cases/940420g1.html nordic journal of commercial law issue 2005 #2 country/ arbitration court date docket no. cisgonline no. details 16 8. germany olg hamburg 1997, february 28 1 u 167/95 261 • facts: british buyer and german seller contracted for the supply of 18 tons of iron-molybdenum from c h i n a , c i f r o t t e r d a m . g o o d s h a d t o b e transported from china to rotterdam. • breach: delay in delivery. • decision: fundamental breach. • reasons for decision: it was essential to perform prior to that date. the parties agreed to incoterm cif, then time is always of the essence. • good example for fluctuations in price. • case text: english translation + link to german text <http://cisgw3.law.pace.edu/cases/970228g1.html> 9. germany olg hamburg 1999, november 26 1 u 31/99 515 • facts: german buyer purchasing pants from brazil seller. the non-conformities were discovered after transportation by plane. • breach: 80-90% of the goods were wrongfully labeled regarding their size and, partly, they were mouldy and stained. • decision: fundamental breach. • reasons for decision: the goods deviated altogether from the contractually agreed quality. • case text: english translation + link to german text <http://cisgw3.law.pace.edu/cases/991126g1.html> 10. germany olg hamm 1992, september 22 19 u 97/91 57 • facts: german buyer purchasing 200 t of bacon from italian enterprise. • breach: goods have not been packaged. • decision: having due consideration to the circumstances, the bac on d id n ot h ave to be packaged. thus, there was a duty to take delivery. • reasons for the decision: if a buyer wants to reject the goods (i.e., withhold performance of the duty to accept the goods, art. 53 cisg), it is decisive whether the seller acted in conformity with the contract. • case text: english abstract + link to german text <http://cisgw3.law.pace.edu/cases/920922g1.html> 11. germany olg koblenz 1997, january 31 2 u 31/96 256 • facts: dutch seller delivered acrylic blankets to a german buyer. • breach: some of the blankets were of inferior quality and buyer claimed that five reels of blankets were missing. • decision: no fundamental breach. • reasons for the decision: account has to be taken not only of the gravity of the defect, but also of the will in gn ess of the party in breach to provide substitute goods without causing unreasonable inconvenience to the other party. in this case, even a serious lack of quality was said not to constitute a fundamental breach as the seller had offered to furnish additional blankets. • case text: english abstract + link to german text <http://cisgw3.law.pace.edu/cases/970131g1.html> http://cisgw3.law.pace.edu/cases/970228g1.html http://cisgw3.law.pace.edu/cases/991126g1.html http://cisgw3.law.pace.edu/cases/920922g1.html http://cisgw3.law.pace.edu/cases/970131g1.html nordic journal of commercial law issue 2005 #2 country/ arbitration court date docket no. cisgonline no. details 17 12. germany olg köln 2002, october 14 16 u 77/01 709 • facts: german company bought designer clothes from italian seller. • breach: clothes were poorly cut. • decision: fundamental breach. • reasons for the decision: decisive whether or not it is possible for the buyer to otherwise manufacture or sell the goods in regular business dealings, possibly even with a price reduction, without unreasonable expense, despite the deviation of the goods from the contractually agreed quality or despite another defect. customers of expensive designer clothes have high standards and almost all clothes were rendered unmarketable by the defects. • case text: english translation + link to german text <http://cisgw3.law.pace.edu/cases/021014g1.html> 13. germany olg stuttgart 2001, march 12 5 u 216/99 841 • facts: german buyer purchasing 100 t of apple juice concentrate and str aw be rr ie s from austrian seller. goods had been transported from poland to germany. • breach: seller mixed apple juice concentrate with glucose syrup. buyer discovered the non-conformity of the goods after carrying out tests at its site in germany. • decision: no fundamental breach. • reasons for the decision: it is decisive whether, without unreasonable expenditure, the buyer was able to process the goods differently or sell them in the normal course of business, if only with a price discount, and if the buyer could reasonably be expected to take such measures. in this case, buyer used the goods for the production of apple fruit drinks, which may contain sugar additives. • case text: english translation + link to german text <http://cisgw3.law.pace.edu/cases/010312g1.html> 14. germany landgericht berlin 1994, september 15 52 s 247/94 399 • facts: german party buying shoes from italian seller. • breach: shoes were non-conforming. • decision: fundamental breach. • reasons for decision: when a party denies the breach and refuses to repair or to make a new delivery, there can be a fundamental breach. • case text: english translation + link to german text <http://cisgw3.law.pace.edu/cases/940915g1.html> 15. germany landgericht darmstadt 1992, december 22 14 o 165/92 177 • facts: see supra 6. • breach: mussels were cadmium-contaminated. • decision: no fundamental breach. • reasons for the decision: it was still possible to resell or eat the mussels. there was no danger to the health. • case text: link to german text <http://cisgw3.law.pace.edu/cases/921222g1.html> http://cisgw3.law.pace.edu/cases/021014g1.html http://cisgw3.law.pace.edu/cases/010312g1.html http://cisgw3.law.pace.edu/cases/940915g1.html http://cisgw3.law.pace.edu/cases/921222g1.html nordic journal of commercial law issue 2005 #2 country/ arbitration court date docket no. cisgonline no. details 18 16. germany landgericht ellwangen 1995, august 21 1 kfh o 32/95 279 • facts: german buyer purchasing 80 t of paprika from spanish seller. • breach: the paprika contained approximately 150% of the maximum concentration of ethyl oxide admissible under german food and drug law. • decision: fundamental breach. • reasons for the decision: the goods were not in accordance with german food and drug law and, therefore, were not suitable for resale in germany. • case text: english translation + link to german text <http://cisgw3.law.pace.edu/cases/950821g2.html> 17. germany landgericht hamburg 1993, november 5 404 o 175/92 215 • see supra 3. • case text: link to german text <http://cisgw3.law.pace.edu/cases/931105g1.html> 18. germany landgericht heidelberg 1992, july 3 o 42/92 38 • facts: german buyer purchasing computer components from us seller. • breach: seller delivered wrong amount. • decision: no fundamental breach. • reasons for the decision: subsequent delivery would have still been possible and reasonable. • case text: english abstract + link to german text <http://cisgw3.law.pace.edu/cases/920703g1.html> 19. germany landgericht landshut 1995, april 5 54 o 644/94 193 • facts: swiss buyer and german seller agreed on the delivery of sportswear in the value of 143,394.65 dm. • breach: sportswear shrunk about 10 to 15% after being washed. • decision: fundamental breach. • reasons for the decision: the clothes shrunk about two sizes. customers would have either returned the merchandise or would not have bought any more from the buyer. • case text: english translation + link to german text <http://cisgw3.law.pace.edu/cases/950405g1.html> 20. germany landgericht münchen 2002, february 27 5 hko 3936/00 654 • facts: german party bought globes from italian seller. • breach: globes were unable to spin because of insufficient performance of the motor. • decision: no fundamental breach. • reasons for decision: restitution of the goods is arduous, especially in international trade. the purpose of the goods is of the essence. in this case, the globes were to be used as a prestigious show object. the spinning of the globes is not the main function. • case text: english translation + link to german text <http://cisgw3.law.pace.edu/cases/020227g1.html> http://cisgw3.law.pace.edu/cases/950821g2.html http://cisgw3.law.pace.edu/cases/931105g1.html http://cisgw3.law.pace.edu/cases/920703g1.html http://cisgw3.law.pace.edu/cases/950405g1.html http://cisgw3.law.pace.edu/cases/020227g1.html nordic journal of commercial law issue 2005 #2 country/ arbitration court date docket no. cisgonline no. details 19 21. germany landgericht oldenburg 1994, july 6 12 o 3010/93 274 • facts: german purchaser buying furniture from austrian seller. • breach: there were deviations in the color and the joints were different in size. • decision: fundamental breach. • reasons for decision: an unsuccessful repair amounts to a fundamental breach. a reduction in price in the value of 50% constitutes a substantial loss. • case text: link to german text <http://cisgw3.law.pace.edu/cases/940706g2.html> 22. germany amtsgericht hamburg 2000, december 14 317 c 472/00 692 • facts: french buyer purchasing clothes from german seller. alleged non-conformities were discovered at buyer’s site in france. • breach: non-conformity not described. • d e c i s i o n : n o d i s c u s s i o n w i t h r e g a r d t o fundamentality of the breach. general principle of a right to withhold performance. • reasons for the decision: court impliedly stated that a rejection of the goods is possible if the buyer gave notice of non-conformity. • case text: link to german text <http://cisgw3.law.pace.edu/cases/001214g1.html> 23. germany amtsgericht ludwigsburg 1990, december 21 4 c 549/90 17 • facts: german buyer bought textiles from french seller. goods had to be transported. • breach: delay in delivery. • decision: no fundamental breach. • reasons for the decision: the value of the goods was not affected by a delay of two days. • case text: link to german text <http://cisgw3.law.pace.edu/cases/901221g1.html> 24. switzerland bundesgericht 2000, september 15 4c.105/ 2000 770 • facts: italian enterprise bought 40 t of cotton from swiss company – payable by means of letter of credit. goods had to be transported from egypt to italy. • breach: delay in the delivery of the goods. • decision: fundamental breach. • reasons for the decision: a delay in the delivery of goods constitutes a fundamental breach of contract if the parties decided that the delivery must be made at a specific date, and that date was determinative from the point of view of the interest of the buyer in the performance of the contract and the seller knew this, especially in cases concerning seasonal goods. the circumstances determine if the delivery must be without other delay. this is also true for the delivery at a certain date of goods for which the price in the market varies everyday. such circumstances exist when an agreement with a reseller is concerned and the price can go down suddenly and considerably. • case text: english translation + french text <http://cisgw3.law.pace.edu/cases/000915s2.html> http://cisgw3.law.pace.edu/cases/940706g2.html http://cisgw3.law.pace.edu/cases/001214g1.html http://cisgw3.law.pace.edu/cases/901221g1.html http://cisgw3.law.pace.edu/cases/000915s2.html nordic journal of commercial law issue 2005 #2 country/ arbitration court date docket no. cisgonline no. details 20 25. switzerland bundesgericht 1998, october 28 4c.179/ 1998 413 • facts: buyer from switzerland purchasing frozen meat from german seller. • breach: the value of the goods was reduced by 25.5% because of blood and moisture in the meat. • decision: no fundamental breach. • reasons for decision: an objective standard has to be applied. the relevant question to be asked is whether the goods can reasonably be used in another way or be resold, even with any reduction in price. in germany, a deviation of 10% of the value of the goods is considered to be fundamental. in the case at hand there was the opportunity to resell the goods in a reasonable way. • case text: english abstract + link to german text <http://cisgw3.law.pace.edu/cases/981028s1.html> 26. switzerland zivilgericht basel. stadt 2002, march 1 p 1997/48 2 729 • facts: swiss company buying soy protein products from belgian seller. goods had to be transported to switzerland. non-conformity was discovered in switzerland. • breach: 9/26 of the goods were genetically modified. • decision: fundamental breach. • reasons for the decision: the interest of the parties concerning a special agreement is decisive. for the parties and in the food industry in general, the question whether food is genetically modified or not is very important. • case text: english translation + link to german text <http://cisgw3.law.pace.edu/cases/020301s1.html> 27. switzerland handelsgericht des kantons aargau 2002, november 5 or.2001 .00029 715 • facts: german buyer purchasing inflatable tr iu mph al a rch from sw iss seller. non conformity was detected after installation in hockenheim. • breach: triumphal arch deflates. • decision: no fundamental breach. • reasons for the decision: repair or delivery of r e p l a c e m e n t g o o d s w a s p o s s i b l e w i t h o u t unreasonable delay. the triumphal arch was to be used over a longer period of time. • case text: english translation + link to german text <http://cisgw3.law.pace.edu/cases/021105s1.html> 28. switzerland kantonsgericht schaffhausen 2004, january 27 no. 11/1999 /99 960 • facts: swiss buyer bought fifty mo de l locomotives, each with a size of 75 cm and a weight of 10 kg, from german seller. • breach: locomotives had delicate gears and while the locomotives were in operation, there was unacceptable noise. • decision: fundamental breach • reasons for the decision: goods could not be used for resale. • case text: english translation + german text <http://cisgw3.law.pace.edu/cases/040127s1.html> http://cisgw3.law.pace.edu/cases/981028s1.html http://cisgw3.law.pace.edu/cases/020301s1.html http://cisgw3.law.pace.edu/cases/021105s1.html http://cisgw3.law.pace.edu/cases/040127s1.html nordic journal of commercial law issue 2005 #2 country/ arbitration court date docket no. cisgonline no. details 21 29. switzerland appellationsge richt basel. stadt 2003, august 22 33/2002 /sas/so 943 • facts and breach: see supra 26 • decision: fundamental breach • reasons for the decision: the question whether food is genetically modified or not was very important. • case text: english translation + link to german text <http://cisgw3.law.pace.edu/cases/030822s1.html> 30. usa u.s. court of appeals (5 th circuit) 2003, june 11 02-20166 730 • facts: buyer from ecuador purchasing 140,000 barrels of unleaded gasoline from us seller. g o o d s w e r e t o b e tr an sp o r t e d – c f r , incoterms – from texas to ecuador. nonconformity was discovered in ecuador after transportation. • breach: gum content of the gasoline was too high. • fundamentality of the breach was not discussed due to passing of the risk. • the cisg incorporates incoterms through article 9(2). • case text: <http://cisgw3.law.pace.edu/cases/030611u1.html> case name bp international, ltd. and bp exploration & oil, inc., plaintiffsappellants v. empressa estatal p e t r o l e o s d e e c u ad o r , e t a l . , defendants, empresa estatal petroleos de ecuador and saybolt, inc., defendants-appellees 31. usa u.s. court of appeals (2 nd circuit) 1995, december 6 95 -7182, 95-7186 140 • facts: italian enterprise bought from us seller 1 0 , 8 0 0 c o m p r e s s o r s f o r u s e i n a i r conditioners. the goods had to be shipped and payment was to be made by l/c. • breach: the compressors had reduced cooling capacity and consumed too much energy. • decision: fundamental breach. • reasons for the decision: cooling capacity und energy consumption are important aspects for air conditioners. • case text: <http://cisgw3.law.pace.edu/cases/951206u1.html> case name delchi carrier, s.p.a. v. rotorex corp. • 32. usa u.s. district court, (s.d. new york) 2002, march 26 00 civ. 934 (shs) 615 • facts: u s b u y e r p u r c ha s i n g m a g n e t ic resonance imaging system ("mri") from german seller. mri had to be transported – cif. • breach: mri was damaged when it arrived at its ultimate destination. • fundamentality of the breach was not discussed. • cif incoterm governed by virtue of article 9(2) cisg. risk passed. • case text: <http://cisgw3.law.pace.edu/cases/020326u1.html> case name st. paul guardian insurance company and travelers insurance company, as subrogees of shared imaging, inc. v. neuromed medical systems & support, gmbh, et al. • http://cisgw3.law.pace.edu/cases/030822s1.html http://cisgw3.law.pace.edu/cases/030611u1.html http://cisgw3.law.pace.edu/cases/951206u1.html http://cisgw3.law.pace.edu/cases/020326u1.html * faculty of law, university of haifa, israel. the author is extremely grateful for invaluable comments on a prior draft by prof. albert h. kritzer and dr. john felemegas, as well as gratefully acknowledges the hospitality of professor reinhard zimmermann, director of the max planck institute for comparative private and private international law in hamburg, under whose auspices this commentary was written, as well as that of its fellows and other staff. the seller's right to cure a failure to perform: an analytic comparison of the respective provisions of the cisg and the pecl by jonathan yovel* nordic journal of commercial law issue 2005 #1 nordic journal of commercial law issue 2005 #1 1 for a survey of national systems see ole lando & hugh beale eds., principles of european contract law: parts i and ii, kluwer law international (2000) 368-370; also treitel, remedies, §276. such is the general case in common law, expressed already in borrowman, phillips & co. v. free & hollis, (1878) 4 q.b.d. 500. see jacob s. ziegel, “the remedial provisions in the vienna sales convention: some common law perspectives” in galston & smit (ed.), international sales: the united nations convention on c o n t r a c t s f o r t h e i n t e r n a t i o n a l s a l e o f g o o d s , ( m a t t h e w b e n d e r , 1 9 8 4 ) p p . 9 1 t o 9 4 3 , a v a i l a b l e o n l i n e a t <http://cisgw3.law.pace.edu/cisg/biblio/ziegel6.html>. the english sales of goods act does not include a seller’s general right to cure, while the ucc §2-508 famously does. for elaboration on the position of english law see and goode, commercial law 298301; rex j. ahdar, “seller cure in the sale of goods”, 1990 lloyd’s mar. com. l. q. 364. other commentators are more skeptical concerning the availability of post-breach cure under english law; see anette gàrtner, “britain and the cisg: the case for ratification a comparative analysis with special reference to german law” in review of the convention on contracts for the i n t e r n a t i o n a l s a l e o f g o o d s ( c i s g ) , k l u w e r l a w i n t e r n a t i o n a l ( 2 0 0 0 2 0 0 1 ) 5 9 8 1 , a v a i l a b l e o n l i n e a t <http://cisgw3.law.pace.edu/cisg/biblio/gartner.html>; see also sale and supply of goods, law com. 85, scot. law com. 58 (1983) para 2.38 according to which “there is great uncertainty, at least in english law, as to the existence and extent of the seller's right to repair or replace defective goods”. 2 usca, title 15, appendix (supp. 1987). since entering into force in 1988, the cisg has been adopted by some 64 countries, representing roughly 2/3 of world international trade. subject to certain exemptions (see art. 2) and subject to the power of the parties to derogate from it (art. 6), the cisg covers all international sales transaction; in the us, it would substitute for ucc art. 2 as well as for non-code law in matters governed by its provisions. for general literature on the cisg see john honnold, uniform law for international sales (kluwer, 1999). a vast and usefully organized source of cisg-related materials is available on the pace university website at <http://cisgw3.law.pace.edu/cisg.html>. 3 concluded (in english) in 2003, the pecl is not a statute or convention nor—yet—a model law, but a scholarly document produced by an authoritative panel of european jurists under the auspices of the eu (a.k.a. the “lando commission” alluding to its chair). its purpose is to unify contract law in the several european states and provide interpretative directions. it has been compared to a restatement of law in its nature and “applies” to all contractual transactions, domestic and transnational. see ole lando and hugh beale (eds.), principles of european contract law: parts i and ii (kluwer law international (2000) (hereinafter “lando and beale”). 2 1. general a contractual party’s right to cure a non-performance under the condition that such cure does not create any – or at least any excessive – hardship for the aggrieved party, has emerged from common law traditions to become almost a staple of modern contract law, and of modern sales law in particular.1 this study reviews and analyses the respective provisions governing the seller’s right to cure under two important legal regimes, that of the un convention on contracts for the international sale of goods, 1980 (hereinafter cisg)2 and the newly drafted principles of european contract law, 2003 (hereinafter pecl).3 different justifications to the principle of cure may be cited, whether in terms of risk allocation, good faith obligations, or the relational approach to contract as a framework of relations between parties that shifts the analytic emphasis from overt rules (whether set contractually or by statute) to the actual framework of relations and interests involved. be the theoretical overview what it may, the principle of cure is perhaps the most important deviation from strict doctrines of liability for breach, and as such it maintains an important relation to the doctrine of contract avoidance (“termination” in the context of the pecl), as discussed below. curing a non-performance may be relevant in various contexts: payment, defective or missing documents, non-conforming or non-delivered goods, etc. in the pecl – which apply to any and all contractual transactions, not only sales or international sales – art. 8:104 recognizes a nonperforming party’s general right to cure, limited by parameters that will be discussed presently. in nordic journal of commercial law issue 2005 #1 4 see jonathan yovel, “comparison between provisions of the cisg (buyer’s right to avoid the contract: article 49) and the c o u n t e r p a r t p r o v i s i o n s o f t h e p e c l ( a r t i c l e s 9 : 3 0 1 , 9 : 3 0 3 a n d 8 : 1 0 6 ) ” , a v a i l a b l e o n l i n e a t <http://cisgw3.law.pace.edu/cisg/biblio/yovel49.html>. 5 commentators frequently use “right” and “power” interchangeably. hohfeld’s analytic language would be useful here (hohfeld supplied a saussurian-style analytic syntax whereby legal concepts are defined through their relation to other concepts): to claim that a holds a right – properly defined – correlates with b’s duty; a’s liberty correlates with b’s lack of right to object, and a’s power correlates with b being subject to that power in the sense that using the power would change the normative array of rights, duties, liberties, powers, subjections, immunities etc. between the parties. thus the “right to declare the contract avoided” is, properly speaking, a legal power (it changes the parties’ legal relations), as is the buyer’s power to set a nachfrist period; but as the seller’s “right to cure” does not in itself change the relational framework yet does require the buyer to accept the curative tender it is, properly speaking, a right. had it required no compliance from the buyer – had it been performed, say, by the seller and a third party – cure would be, properly speaking, a liberty. see welsley hohfeld, fundamental legal conceptions as applied in juridical reasoning (new haven: yale university press, 1964 [1919]). for an application of the hohfeldian matrix to the analysis of contractual relations see jonathan yovel, “what is contract law ‘about’? speech act theory and a critique of ‘skeletal promises’”, 94 northwestern u. law rev. (2000) 937-962. 3 the cisg – divided as it is into seller’s and buyer’s rights and obligations – the right to cure nonperformance depends upon the nature of the non-performance and the time of cure, and is divided into different typical situations, covered by several articles. some grant parties the right to cure defective performance prior to the time of the projected performance as contracted: in those cases, cure limits aggrieved parties’ power to declare contracts avoided in situations of anticipatory breach. thus, art. 34 relates to curing defective or non-conforming documents, and art. 37 deals with breach in respect to goods. other articles refer to the aggrieved party’s power to require curative performance, such as art. 46(2) and (3). these are relatively non-controversial issues, and one may argue that refusal to allow cure prior to the time set for performance is ad definitio a breach of good faith obligations. indeed, the true meaning of cure pertains to a defaulting party’s right to cure a defective performance or non-performance after the time of the projected performance has passed. thus this commentary deals with the seller’s right to cure under cisg art. 48 and pecl art 8:104, which extend the right to cure once the fact of breach has been established. although both the pecl and cisg recognize a right to cure under certain conditions, they differ both in general approach as well as in the specific rights granted. this may not be surprising, as the pecl applies to any and all contractual transactions, not only sales or international sales; however, the seller’s right to cure is closely related to the buyer’s right to avoid the contract, an issue on which the cisg and pecl share similar approaches.4 indeed, the relation between cure and avoidance must be a central topic for analysis once the nature of the right to cure has been clarified. 2. the jurisprudential nature of the right to cure one must distinguish between a breaching party’s general (or unqualified) right to cure and a qualified right. a general right means that within certain timeframe constraints and other objective constraints, the breaching party may exercise the right unilaterally, independent of anything the aggrieved party may do in respect to the breach. a qualified right means that the breaching party’s right to cure a non-performance depends upon the aggrieved party’s failure to use some power or exercise some right that renders cure unavailable.5 nordic journal of commercial law issue 2005 #1 6 see pecl art. 9:305. 7 see ziegel, supra note _ref99341181\h \* mergeformat 2 at 9-21. 8 see, e.g., unidroit principles art. 7.1.4(2); bgb [german civil code] §323(1); see also infra note _ref101280380\h \* mergeformat 36 and keyed text. 9 cure may, of course, be reached at in this way as well. such may be the case even when declarations of avoidance were deemed ineffective (e.g., because the alleged breach was not fundamental). in such cases, following a new agreement the question of the scope of seller’s obligation, although in essence being curative in nature and in relation to the prior contractual relations between the parties, is a matter of general contractual interpretation. courts would take into consideration the curative context, but allow that parties have since undertaken a new allocation of performances and risks. such was the case, e.g., in france 26 april 1 9 9 5 c o u r d 'a p p e l [ a p p el l a t e c o ur t ] g r en o b l e ( m a r q ue s ro q ue j o a c h im v . m a n in riv i) r e ) , a v a i l a b l e o n l i n e a t <http://cisgw3.law.pace.edu/cases/950426f2.html>. 4 the primary right that aggrieved parties may hold and whose exercise would frustrate any subsequent attempt to cure is the right to declare the contract avoided.6 once the contract is legally avoided there can be no cure.7 thus a contractual regime may subject the power to avoid the contract to the right to cure.8 in such cases, the breaching party is immune – at least temporarily, until the curative period is over and cure fails – from the aggrieved party’s power to declare the contract avoided. in all other cases, any post-avoidance communication or indeed curative performance by the breaching party would fail qua cure, amounting to an offer of a new or modified contract which may or may not excuse past breaches.9 the following discussion analyzes the relations between cure and avoidance of the contract in the pecl and cisg on these theoretical lines. both the cisg and pecl allow for post-breach cure and both restrict the right to circumstances discussed in detail below; however, while the cisg allows for cure subject to avoidance of the contract, the pecl makes no such overt, general qualification. as argued below, contextual considerations both rationalize this discrepancy and mitigate it. nordic journal of commercial law issue 2005 #1 10 see chengwei liu, “cure by non-conforming party: perspectives from the cisg, unidroit principles and pecl, available online at <http://cisgw3.law.pace.edu/cisg/biblio/chengwei1.html>. 11 ole lando & hugh beale eds., principles of european contract law: parts i and ii, kluwer law international (2000) 368-372. 5 3. cure for what? when analyzing cure mechanisms, two initial questions emerge: what failures of performance may be cured? under what restrictions? while the latter question is dealt with in detail below, the former requires special initial attention. under cisg art. 48(1) the seller is allowed to cure “any failure” to perform his obligations. as scholars comment,10 this is a general provision, which covers fundamental and non-fundamental breaches alike. likewise, pecl art. 8:104 covers all “tenders of performance” that do not “conform to the contract,” whether the non-conformance be fundamental or not, as long as the delay in performance itself does not constitute a fundamental non-performance. the breaching party’s right to cure, then, initially operates independently of the distinction between fundamental and non-fundamental breaches, on which its inverse right – the aggrieved party’s right to avoid the contract – hinges. however, unlike the cisg, pecl art. 8:104 restricts the right to cure to those cases in which the very delay in performance does not constitute a fundamental non-performance. in cases where “time is of the essence” as the comment to pecl 8:104 puts it,11 the only way to achieve cure is through the aggrieved party setting a nachfrist period; otherwise, the non-performing party has no right to cure. indeed, this point requires some clarification: pecl art. 8:104 sets apart a category of curative tenders that, while indeed remedying the initial non-performance at the time of the projected contractual performance – whether fundamental or not (e.g., a non-conformity of goods) – would, if allowed, constitute a fundamental non-performance at the time of cure. in transactions in which the time of performance is of the essence, the delay inherently associated with any curative performance may be such as to constitute a fundamental non-performance, even if the initial failure of performance was not fundamental and indeed cured. in such cases, the nonperforming party has no right to cure and, accordingly, the aggrieved party has no obligation to accept cure. in granting the right to cure, art. 8:104 is indifferent to the question of the fundamentality of the initial non-performance, but would not allow the curative tender itself to amount to a fundamental non-performance. otherwise, the right to cure under art. 8:104 exists in all (and only in all) cases where the delay itself – while ad definitio amounting to a nonperformance in relation to the contract – does not constitute a fundamental non-performance. in both the cisg and pecl, the crucial question of the relation between the seller’s right to cure and the buyer’s right to avoid the contract arises; ultimately, that question will determine in what cases the right to cure may actually take effect as a right rather than a newly-arrived agreement between the parties. this topic must be analyzed in detail, as follows. 4. the relation between cure and avoidance (termination) of the contract both the cisg and pecl must regulate the relations between the seller’s right to cure “any” failure to perform, and the buyer’s power to declare the contract avoided in certain cases (namely, fundamental and tantamount breaches). that is because cure and avoidance cannot both occur in the context of the same contract – it is an absurdity to have a contract both avoided and cured. nordic journal of commercial law issue 2005 #1 12 while avoidance and enforcement of the contract also negate each other in the same normative space – they maintain opposite obligations for the parties – it is only the aggrieved party that chooses between them. 13 see infra note _ref101280380\h \* mergeformat 36 and keyed text. 14 official records of the united nations conference on contracts for the international sale of goods, vienna 10 march 11 april 1980, a/conf. 97/19, at 40 et seq., available online at <http://cisgw3.law.pace.edu/cisg/text/link48.html>. 15 see yovel, supra note _ref99709231\h \* mergeformat 5. 6 cure and avoidance compete for positions of relative preeminence in the same normative space, while each is operated by a different party.12 granted, a successful curative performance by the seller – one that adheres to the relevant rules, etc. – cures her breach, ex post; this, however, does not entail that the seller’s ex-ante right to cure preempts the aggrieved buyer’s power to avoid the contract. accordingly, one can identify three theoretical models for relations between the right to cure and the power to avoid the contract: the preemptive model, according to which the right to cure preempts the power to declare the contract avoided, with the logical corollary that no avoidance can become effective unless proper opportunity for cure has been allowed;13 the unconditional model, according to which avoidance of the contract is allowed irrespective of the availability of cure, and once the contract has been avoided no cure – even when otherwise available – could take place; the independent or “race” model according to which whichever is invoked earlier in time, whether the right to cure or a declaration of avoidance, becomes effective, rendering the other unavailable; but no a-priori normative hierarchy is established. in the remainder of this section, the three models are invoked in the contexts of the convention and the european principles while remarking on the differences between their approaches as well as that of the unidroit principles. as we shall see, both pecl and cisg take the unconditional model (2) as their general framework while weaving in elements of the independent model (3) as well. 4.1 cure for non-fundamental breaches under cisg the relation between cure and avoidance of the contract in the cisg has been subject to considerable controversy within the drafting committee,14 and remains in academic controversy today. obviously, whether the right to cure is contingent upon the contract not having been avoided is a major relational characteristic of the contractual framework. however, both pecl and to an even greater degree the cisg apply a stringent approach to the buyer’s right to avoid the contract following breach by the seller.15 to wit, declaring the contract avoided is generally reserved – with one significant exception – to fundamental breaches. this means that the right to cure is unqualified in the sense defined above in both pecl and cisg for any non-fundamental breach. does the latter statement indeed hold? it might be argued that under both pecl and cisg avoidance of the contract may precede and thus frustrate seller’s attempt to cure even in the cases nordic journal of commercial law issue 2005 #1 16 for reasonableness being a general principle of the cisg (and in this somewhat mitigating the absence thereof of a general obligation to act in good faith) see albert h. kritzer, “overview comments on reasonableness”, available online at <http://cisgw3.law.pace.edu/cisg/text/reason.html>: “reasonableness is specifically mentioned in thirty-seven provisions of the cisg and clearly alluded to elsewhere in the uniform sales law. reasonableness is a general principle of the cisg.” see also comments by jelena vilus, available online at <http://cisgw3.law.pace.edu/cisg/text/reason.html#vilus>; rpr. in homenaje a jorge barrera graf, vol. 2, mexico: universidad nacional aut4noma de mexico (1989) 1440-1441. for the definition of reasonableness recited in the principles of european contract law and references to reasonableness in continental and common law domestic rules, doctrine and jurisprudence, go to <http://cisgw3.law.pace.edu/cisg/text/reason.html#def>. for further discussion regarding the correlation between the pecl’s definition of reasonableness and the meaning of this term to cisg legislators when they used the concept in drafting the convention’s provisions, see <http://cisgw3.law.pace.edu/cisg/text/reason.html#over>. 7 of some non-fundamental breaches. the issue here is, of course, that dealt with by cisg art. 49(1)(b), whose proper interpretation engaged several scholarly disputes, and by its counterpart pecl 8:106(3). those provisions allow for avoidance of the contract even for non-fundamental breaches, as long as three conditions are satisfied: that the breach in question is one of non-delivery (according to cisg) or delay in performance (according to pecl); that the non-performing party was allowed a reasonable time extension to perform – so-called nachfrist period; and that he has failed to do so. the non-fundamental breach is then “upgraded” and avoidance of the contract becomes available. on the face of it, this seems to belie the cure doctrine of cisg art. 48. in fact, however, the two doctrines sit very well together due to the curative nature of the nachfrist mechanism. in fact, whether the buyer allows a curative period on a nachfrist mechanism such as cisg art. 47 or pecl art. 8:106, or whether the seller invokes cure based on the provisions discussed here, are two sides of the same coin and probably of little practical importance. because the requirements of reasonableness direct both doctrines,16 the curative period in both cases is of the same nature. 4.2 cure for non-fundamental breaches under pecl the first clause of pecl art. 8:104 simply states the right to cure a non-conforming tender at any time prior to the designated time for performance; it is therefore the counterpart of cisg art. 37 rather than art. 49 and relatively non-controversial. the second clause of art. 8:104 grants a nonperforming party the right to cure after the designated time to perform has passed (of course, following the sphere of application of the pecl, in any contractual context and not limited to sellers). however, unlike the cisg, this right under pecl is limited to cases where the delay would not amount to a fundamental non-performance. the nature of this limitation is discussed below in the section devoted to cure; it does not affect the clear rule that, in all cases of nonfundamental non-performance, the non-performing party maintains a general right to cure. what is being cured under art. 8:104? the language here is somewhat peculiar: it is a “tender of performance” that “does not conform” to the contract. the term “tender performance” appears nordic journal of commercial law issue 2005 #1 17 see especially pecl arts. 6:108 (quality of performance), 7:103 (early performance), 9:201 (right to withhold performance) and 9:303 (notice of termination). 18 see supra note _ref99709183\h \* mergeformat 12. 19 see peter schlechtriem, “interpretation, gap-filling and further development of the un sales convention” available online at <http://cisgw3.law.pace.edu/cisg/biblio/schlechtriem6.html>. 20 such is the case with the construction of “non-delivery” in cisg art. 49(1)(b) that authorities agree is different from “partial delivery”; see yovel, supra note 3. in other contexts, some legal systems allow defenses against enforcement of negotiable instruments in cases of completer failure of consideration tendered but not in cases of partial failure, etc. 8 elsewhere in the principles though infrequently;17 in most cases, to “tender performance” seems to mean “to perform”, whether the performance conforms to the contract or not. to emphasize this, the examples given in the pecl comment on cure include both cases of sales and of services.18 art. 8:104 also indicates that cure occurs in cases where the other party refused “acceptance” of the performance, although parties under pecl generally have no right to reject non-conforming tender and the so-called “perfect tender” of the ucc § 2-601 is unknown to it.19 the defining words are, therefore, “tender conforming to the contract,” similar to that used in art. 9:401 (right to reduce price). what does “non-conformity” of tender to the contract (as opposed of non-conformity of goods) mean? specifically, is the language of “non-conforming tender” different in any material sense from the simpler “non-performance” more prevalent in the pecl? is the right to cure under art. 8:104 reserved to cases where some performance was tendered, as opposed to total failure to perform? there is nothing in the short pecl comment on cure to indicate such a construction. while legal regimes sometimes distinguish between complete failure to perform and partial failure,20 and while one can admit to the logic of allowing for cure in cases of debtors who at least tried and managed to complete a portion of their obligations, such a distinction is generally reserved to specific areas of law and is justified by specific contexts. it does not seem correct to make it a core precept of the general principle of cure. thus, for the time being and until tribunals and cases offer casuistic constructions of art. 8:104 the conclusion should be that there is no essential difference between “tender non-conforming to the contract” and “any failure to perform,” the more overt language of the cisg art. 48(1). 4.3 cure for fundamental breaches under cisg the cisg’s treatment of the relation between cure and avoidance of the contract changes drastically in respect to fundamental breaches . under cisg art. 48(1) the seller is allowed to cure “any failure” to perform his obligations. on the other hand, under art. 49(1) the buyer may avoid the contract where the seller's failure amounts to a fundamental breach, whether the seller offers to cure or not. the relation between the two competing rights is set up in art. 49(1) where the operative language makes the seller’s right to cure “subject to art. 49.” art. 49 regulates avoidance of the contract following either fundamental breach or “constructed fundamentality” following failure to perform nordic journal of commercial law issue 2005 #1 21 for a similar criticism see christopher kee, “commentary on the manner in which the unidroit principles may be used t o i n t e r p r e t o r s u p p l e m e n t a r t i c l e 4 8 o f t h e c i s g ” , j u l y 2 0 0 4 , a v a i l a b l e o n l i n e a t <http://cisgw3.law.pace.edu/cisg/principles/uni48.html>. 22 see john honnold, uniform law for international sales under the 1980 united nations convention, kluwer law international, 3d ed. (1999); pp. 320-21, available online at <http://cisgw3.law.pace.edu/cisg/biblio/ho48.html>. with respect, i dispute this jurisprudential point on the following grounds. cure is certainly more specific than breach in general, in the sense that the set of all the cases of cure is a sub-set of all the cases of breach (it is complemented by the set of non-cured breaches). had avoidance been available for any breach, the set of all available avoidances would then be identical with the set of all breaches and honnold’s argument would hold. however, under both cisg and pecl avoidance of the contract is generally limited to cases of fundamental breach (and even then not to all such cases, as reasonable time limitations render avoidance unavailable in some cases). there are cases where cure is available but avoidance is not, namely the set of non-fundamental breaches. hence both the set of all instances of cure and the set of all rightful avoidances are both independent subsets of the general set of breaches – they maintain a certain zone of convergence, namely, the set of fundamental breaches that where the contract has not been avoided – yet none is more or less specific than the other. indeed, to claim that the set of instances of cure is in some sense a subset of the set of available avoidances is simply assuming that which is to be determined. 9 throughout a nachfrist period. as the second case in fact allows for cure – initiated by the aggrieved buyer – the remainder of this section will discuss cure in cases of fundamental breaches. what does “subject to art. 49” mean? does it mean that under cisg the seller’s right to cure is qualified, in that in case of fundamental breach it can be cut off through the buyer’s exercise of his power to declare the contract avoided? or does it even indicate that cure is not designated for cases of fundamental breaches at all? if either of these is the proper construction of the relation between arts. 48 and 49, then the right to cure in cases of fundamental breach under cisg seems limited indeed; it would then also stand in contrast to the pecl’s much more liberal approach to cure. in the following, i shall argue that the proper construction of the relation between cure and avoidance of the contract under pecl in fact allows for cure even in cases of fundamental breach, although in those cases they are indeed subject to being cut off by the buyer’s exercise of the right to avoid the contract; hence a qualified right to cure in the terms specified above. it is worthwhile to note that under unidroit principles the breaching party’s right to cure is unequivocally stronger than the aggrieved party’s power to terminate the contract. unidroit principles art. 7.1.4(2) states that “the right to cure is not precluded by notice of termination”; the comment adds that “if the aggrieved party has rightfully terminated the contract … the effects of termination … are also suspended by an effective notice of cure. if the non-performance is cured, the notice of termination is inoperative.” this is not the place for a comprehensive critique of this approach; to this commentator, it seems unattractive in the extreme in the sense that rightful terminations of contracts may posthumously be rendered inoperative, thus introducing serious uncertainty into the calculations of the aggrieved part who has terminated the contract rightfully and wishes to move on; it also plays havoc with the conceptual integrity of termination of contract.21 nor does the pecl contain a similar provision, as discussed below. according to professor honnold, the seller’s right to cure under art. 48, being more specific than the general right to avoid the contract, prevails over the buyer’s right to avoid the contract.22 with nordic journal of commercial law issue 2005 #1 23 i use the term “clause” here according to the american usage of normative rather than textual structure, viz., to designate a complete and separate norm, even if within the formal structure of the text holding it, it does not occupy a separate position. 24 see uncitral digest of case law on the united nations convention on the international sale of goods (8 june 2004), a/cn.9/ser.c/digest/cisg/48; digest 2. available at: <http://www.uncitral.org/english/clout/digest_cisg_e.htm>. see also john o. honnold, uniform law for international sales under the 1980 united nations convention (kluwer 1980) 296 (hereafter cited as “honnold”); michael will, “article 48” in bianca-bonell commentary on the international sales law, giuffr): milan (1987) 347-358 available online at <http://cisgw3.law.pace.edu/cisg/biblio/will-bb48.html>; and mirghasem jafarzadeh, “buyer's right to withhold performance and termination of contract: a comparative study under english law, vienna convention on c o n t r a c t s f o r t h e i n t e r n a t i o n a l s a l e o f g o o d s 1 9 8 0 , i r a n i a n a n d s h i ' a h l a w ” ( 2 0 0 1 ) a v a i l a b l e o n l i n e a t <http://cisgw3.law.pace.edu/cisg/biblio/jafarzadeh1.html>. 25 some courts appear to have in fact established a different hierarchy. in one german case, the court held that the right to avoid the contract under art. 49(b)(2) was not available to a buyer who did not allow the seller the proper opportunity to cure; hence, the declaration of avoidance in that case was deemed unlawful. however, in that case the court also ruled that no fundamental breach was committed as the goods that were delivered – fabrics for the manufacture of goods – passed the relevant tests of conformity. as this was not a case of non-delivery, art. 49(b) could not apply and, if avoidance of the contract was unavailable, that must have been the cause, not the relations between avoidance of the contract and cure. furthermore, this case should be read in the context of cisg arts. 47 and 48(2), as the seller has communicated to the buyer his intention to cure; the unavailability of avoidance during the ensuing period follows art. 48(2), not necessarily an inverse relation between arts. 48 and 49 to the one argued for above. additionally, the court held that by sending samples of fabric instead on the curing goods themselves seller has performed lawfully, as there was no certainty that buyer would accept the substitute goods. to this commentator, it seems that the court deemed that the seller has performed reasonably and in good faith in attempting to cure the alleged breach. in itself, however, that cannot change the normative hierarchy between avoidance of the contract (which under cisg as under pecl is not a matter of fault but one of objective performance) and cure under cisg. indeed, the fact that the power to avoid is normally suspended following art. 48(2) is a logical corollary of that hierarchy; it would be redundant otherwise. germany, 24 september 1998 landgericht [district court] regensburg; case presentation including english translation available online at <http://cisgw3.law.pace.edu/cases/980924g1.html>. 26 ziegel, supra note _ref99341181\h \* mergeformat 2, at 9-21. such is also professor schlechtriem’s opinion, see peter schlechtriem, uniform sales law the un-convention on contracts for the international sale of goods (manz, vienna: 1986) pp. 76-77, available online at <http://cisgw3.law.pace.edu/cisg/biblio/schlechtriem.html>. professor schlechtriem adds that this construction was objected to at the committee by the german delegation that wished to strengthen the right to cure so that it does not become subject to cut off by avoidance of the contract, but that this approach was not ultimately accepted. for case law where the court had – among other determinations – accepted the buyer’s effective declaration of avoidance of the contract as putting an end to the availability of cure by the breaching seller see italy 24 november 1989 court of first instance parma (foliopack v. daniplast), presentation including english translation available online at <http://cisgw3.law.pace.edu/cases/891124i3.html>. 27 this conclusion is supported by case law. see italy 24 november 1989 court of first instance parma (foliopack v. daniplast), clout case no. 90, case presentation including english translation available at <http://cisgw3.law.pace.edu/cases/891124i3.html>; germany 17 september 1991 oberlandesgericht [appellate court] frankfurt, clout case no. 2, case presentation including english translation available at <http://cisgw3.law.pace.edu/cisg/cases/910917g1.html> ; 10 respect, such a construction might hold absent the operative words “subject to art. 49.” as the clause stands,23 following a long and tortured legislative history in the drafting committee,24 it clearly regulates the relationship between cure and avoidance by creating a hierarchy between them: cure is available only inasmuch as the power to avoid the contract under art. 49 has not been rightfully exercised.25 as professor ziegel puts it, “no right to cure survived avoidance of the contract by the buyer.“26 thus, under terms of cisg art. 48(1), the buyer’s right to avoid under art. 49 is an independent right unaffected by the seller’s intentions to cure. this conclusion is strengthened by art. 48(2) that deals with suspension of the buyer’s power to declare the contract avoided during a curative period requested by the seller: the aggrieved buyer’s communicative act (including failure to communicate) is necessary for such a suspension. had the seller’s right to cure been preemptive in relation to the buyer’s power to avoid the contract, no such communicative act on behalf of the buyer would be necessary: the buyer would then have been automatically enjoined from exercising the power to avoid the contract during the period specified in the seller’s notice (which would not then be a “request” at all) (for discussion see below). case law generally supports this conclusion,27 although cases exist in which courts remark, at least in nordic journal of commercial law issue 2005 #1 germany 1 february 1995 oberlandesgericht [appellate court] oldenburg , clout case no. 165, case presentation including english translation available at <http://cisgw3.law.pace.edu/cisg/cases/950201g1.html> ; germany 25 june 1997 bundesgerichtshof [supreme court], clout case no. 235, case presentation including english translation available at <http://cisgw3.law.pace.edu/cisg/cases/970625g2.html>; i c c a r b i t r a t i o n c a s e n o . 7 5 3 1 o f 1 9 9 4 , c l o u t c a s e n o . 3 0 4 , c a s e pr es en t a t i o n a v a i l a b l e a t <http://cisgw3.law.pace.edu/cisg/cases/947531i1.html>. see also official records of the united nations conference on contracts for the international sale of goods, vienna, 10 march–11 april 1980 (united nations publication, sales no. e.81.iv.3), p. 41. 28 as well as contra the proper construction of cisg art. 49 that requires no grace period for performance as a condition for declaring the contract avoided. 29 see supra note _ref99613505\h \* mergeformat 26; other courts casually argue that “[seller] offered to repair the defect: [buyer] should have accepted this proposal, instead of seeking avoidance of her contract with the [seller]”, even in cases of alleged fundamental breach; switzerland 27 april 1992 district court locarno campagna, case presentation including english translation available at <http://cisgw3.law.pace.edu/cases/920427s1.html>. such dicta, in consideration of the above argument, seem to reflect preferred rather than the applicable law. 30 see supra note _ref99709183\h \* mergeformat 12. 31 termination for non-fundamental delays in performance is also available, following a nachfrist period set by the buyer (see pecl art. 8:106(3)); however, in such cases it is pointless to ask cure is available as the essence of the nachfrist mechanism is the granting of a curative period, although set by the buyer rather than by the seller. 11 obiter dicta, and contra the analysis presented here,28 that buyer’s right to avoid the contract is in some manner contingent upon giving the seller a proper opportunity to cure the defect.29 4.4 cure and termination under pecl as noted above, unlike the cisg, pecl art. 8:104 restricts the right to cure to those cases in which the very delay in performance does not constitute a fundamental non-performance. this is not a matter of competition between the non-performing party’s right to cure and the aggrieved party’s power to terminate the contract (under pecl art. 9:301), that would obviously kick in in such cases. whether the aggrieved party intends to terminate or not, in cases where “time is of the essence” as the pecl comment on art. 8:104 puts it,30 the only way to achieve cure is through the aggrieved party setting a nachfrist period, i.e., suspending its power to terminate the contract for the duration of the curative period. while the cisg, in the opening words of art. 48(1), sets the relations between cure and avoidance of the contract, the pecl does not overtly make the right to cure subject to the buyer’s power to terminate the contract. in the terms discussed above, the right to cure in art. 8:104, although limited to the classes of cases discussed above, is general rather than qualified. this would seem to indicate a stronger right to cure in the pecl than in the cisg that would extend to the relation between cure and termination. however, as noted above, art. 8:104 limits the right to cure to cases where the delay in performance would not amount to a fundamental nonperformance. under pecl 9:301, only fundamental non-performances allow the buyer to terminate the contract.31 it thus follows that the seller has no right to cure in any case where due to the delay the buyer holds the power to terminate the contract, even if the buyer eventually does not exercise that power. under pecl art. 8:104, the question of whether the seller’s right to cure is or is not subject to the buyer’s power to terminate the contract simply cannot occur in cases where the power to terminate stems from the very delay associated with the curative tender. nordic journal of commercial law issue 2005 #1 32 this is of course not particular to the pecl: as the german bundesgerichtshof [federal court] spells it, “provisions of the law… like para. 323 bgb [provision of the civil code of germany that deals with termination], are only applicable if the notice of termination…was validly declared.” case viii zr 140/75, date 3 november 1976, english translation available online at <http://www.ucl.ac.uk/laws/global_law/german-cases/print_bundes.shtml?03nov1976> 12 what about cases of fundamental non-performance that may be cured without the delay amounting to fundamental non-performance? such cases potentially involve two competing norms: ostensibly, they allow for the non-performing party’s right to cure under art. 8:104, as well as for the aggrieved party’s power to terminate the contract under art. 9:301. what is the relation between these two norms? had there been no overt solution to this question we would have to move towards jurisprudential considerations such as offered by honnold, e.g., examining whether there is some established solution to a clash of the two norms (such as the application of the more specific over the more general one), or employ some general framework of risk allocation. in the context of the pecl, however, interior analysis shows that the power to terminate the contract is generally independent and effectively not contingent upon the right to cure, as follows. the general way in which termination of contract in the pecl is executed is through appropriate notices (see art. 9:301). it is typical of the pecl that it regulates substantive rights through a regulation of the corresponding notices.32 art. 9:303(3)(a), allows the aggrieved party to give a notice of termination either before or after a late tender – such as cure – has been made; the only restriction is that for a post-cure notice of termination to be effective it must be given in reasonable time. this is therefore not merely a procedural rule regarding the proper way to exchange notices but a regulation of the relations between termination and cure in the pecl. under pecl art. 9:305(1) that governs the effects of termination of contract, “termination of the contract releases both parties from their obligation to effect and to receive future performance.” cure is obviously a future performance (the language of art. 8:104 is “tender of performance” but the semantic difference is meaningless), and so termination of the contract under pecl releases the aggrieved party from any obligation to receive cure, exactly as its effect is to relinquish her right to enforce the contract through specific performance. pecl art. 9:303(3)(b) mitigates the harshness – for the non-performing party – created by the strict hierarchy in favor of termination over cure in art. 9:303(3)(a). it determines that in cases in which the aggrieved party “knows or has reason to know” of forthcoming cure in reasonable time, it must notify the curing party of its refusal to accept cure in order to maintain its power to terminate the contract. failure to notify the curing party accordingly will render termination of the contract unavailable and the road to cure open; however, a notice of refusal to accept cure would keep the power to terminate the contract alive. even then – unless the refusal to accept cure includes or is constructed to include a notice of termination of the contract – the right to cure under art. 8:104 would still hold. only a termination of the contract would relieve the aggrieved nordic journal of commercial law issue 2005 #1 33 reinhard zimmermann, “liability for non-conformity: the new system of remedies in german sales law and its historical context,” 10th john maurice kelly memorial lecture, dublin 2004, at pp. 38-9. 34 see bgb §§ 437 et seq. 35 bgb § 323(1). that is the general case; there are specific clauses such as § 635 (for contractor’s option to cure). bgb § 323(2) lists several categories of exemptions and scattered clauses add to those (e.g. § 440 and the obvious § 325(5)). 13 party from her obligation to accept cure. the conclusion then must be, that the right to curative performance depends on the contract not having been previously terminated. art. 9:303(3)(b) is a relational protection of the non-performing party’s reliance interests in the context of curative performance, but it obviously recognizes the aggrieved party’s power to terminate the contract, which can be rendered ineffective only under the specified circumstances indicated. note, that the onus-creating language in pecl art. 9:303(3)(b) relating to the aggrieved party “knows or has reason to know” is wider than under the corresponding cisg art. 48(2) and (3), according to which the information relating to the forthcoming cure must be communicated by the breaching party itself. the pecl recognizes that there are instances in which the aggrieved party should assume that cure is forthcoming, even absent direct communication from the breaching party to that effect. of course, the aggrieved party’s notification to the non-performing, cure-aspiring party under 9:303(3)(b) may be that it refuses cure and hereby terminates the contract; like under the cisg, the pecl does not offer non-performing parties a preemptive right to cure in cases of fundamental and tantamount non-performances (there are no other relevant cases in fact), unless the aggrieved party assents to accept cure or unreasonably fails to notify the curing party that it would not accept it. the analytic conclusion then must be that the power to terminate the contract under pecl – which exists only in cases of fundamental and tantamount breaches – is independent of any allowance for cure, except where the aggrieved party’s power becomes suspended under art. 9:303(3)(b). this differs from the approach of several national legal systems. as professor zimmermann explains it, in german sales law the right to “supplementary performance” is the aggrieved buyer’s “primary right.”33 although not spelled out as such,34 termination of the contract under german law generally becomes available to the aggrieved party following the breaching party’s failure to cure.35 that is not the approach of either the cisg or the pecl. under pecl, termination of the contract releases the aggrieved party from the obligation to accept cure and thus nullifies the non-performing party’s right to cure, which otherwise exists in relation to both fundamental and non-fundamental non-performances alike (with the exception of the fundamentality of the delay itself, as discussed above). the aggrieved party is allowed to terminate the contract even after a curative tender, as long as it does so in reasonable time. of nordic journal of commercial law issue 2005 #1 36 cure obviously becomes available also in cases of non-fundamental non-delivery if the buyer has set a nachfrist period. failure to cure throughout that period makes avoidance of the contract available to the buyer under cisg art. 49(1)(b). 37 honnold’s proposal to internalize the offer to cure into the construction of the fundamentality of the breach would have been a brilliant resolution to the relation between cure and avoidance; unfortunately it was not accepted. see ziegel, supra note _ref99341181\h \* mergeformat 2, at 9-21. see also michida, “cancellation of contract”, 27 am.j. comp. l. 286-288 (1979), available online at <http://cisgw3.law.pace.edu/cisg/biblio/michida.html> occasionally courts would determine that willingness to cure may reduce the severance of the breach from fundamental to not-fundamental; see germany 31 january 1997 o b e r l a n d e s g e r i c h t [ a p p e l l a t e c o u r t ] k o b l e n z , c l o u t c a s e n o . 2 8 2 , c a s e p r e s e n t a t i o n a v a i l a b l e o n l i n e a t <http://cisgw3.law.pace.edu/cisg/cases/970131g1.html>. this is an attractive relational notion, consistent with the pecl’s general obligations of good faith and fair dealing; however, i doubt whether it may hold under the cisg’s approach to avoidance of contract, see yovel, supra note _ref99709231\h \* mergeformat 5. 14 course, a successful cure may frustrate the availability of post-cure termination if the cure – as successful cure should – renders the non-performance at the time of cure non-fundamental. 4.5 no preemptive cure as unqualified right under cisg and pecl both the cisg and pecl allow for some measure of preemptive cure, i.e., cure that renders avoidance of the contract unavailable, whether temporarily or irrevocably. this does not mean, however, that preemptive cure is given the normative status of right that unilaterally tramps rights and powers held by the aggrieved party. under the cisg art. 48(2), if the aggrieved buyer allows the seller to cure during the time indicated in his request (whether by assenting or failing to reply), she is barred from avoiding the contract during that period. note, however, that the decision whether to suspend the power to avoid the contract or not remains with the aggrieved buyer: she may always answer in the negative to a seller’s request. as the seller’s right to cure operates whether the buyer consents to accept cure or not, the buyer’s refusal to accept cure in itself has no legal effect other than keeping her power to avoid the contract effective. however – as concluded above – nor is the buyer’s power to avoid the contract effected merely by the seller’s intention or efforts to cure. that power becomes available only in cases of fundamental and tantamount breaches, and we conclude that those are the cases in which art. 48(2) really matters. the question of preemptive cure becomes relevant in cases of fundamental breach, because otherwise the seller has no right to avoid the contract. yet the only way in which cure can be preemptive in those cases is when the buyer agrees in advance to withhold exercising her power to avoid the contract for an indicated duration; and under both pecl and cisg the buyer’s silence operates as such an assent to cure. 4.6 conclusion under the risk-allocating terms of cisg art. 48(1) (no unreasonable delay, no inconvenience to buyer, and assumption of costs by seller), the seller holds an unqualified right to cure in all cases of non-fundamental breach.36 however, the seller’s right to cure in cases of fundamental breach is qualified in that it may be cut off and become unavailable if the seller rightfully avoids the contract under art. 49(1), unless the buyer has assented to accept cure or failed to object to it, which would result in suspension of her power to avoid the contract under art. 48(2).37 nordic journal of commercial law issue 2005 #1 38 germany 9 june 1995 oberlandesgericht [appellate court] hamm, clout case no. 125, case presentation available including english translation available online at <http://cisgw3.law.pace.edu/cases/950609g1.html> (costs for replacing defective windows). 39 by analogy because in curing, the seller is not performing an obligation but excersicing a right. the purported gap in art. 8:104 – the allocation of costs and risks associated with cure – calls for completion by analogy from within the pecl before we proceed to external sources of construction. 40 icc arbitration case no. 7754 of january 1995, icc international court of arbitration bulletin 2000, 46, case presentation available at <http://cisgw3.law.pace.edu/cases/957754i1.html> (the conditions are satisfied when, e.g., defective motors can easily be adjusted in due time and at minimal costs). 41 see bgb § 121. german courts acknowledged a possible discrepancy between “reasonable time” and “without unreasonable delay,” even when the facts happened to satisfy both; see germany 17 september 1991 oberlandesgericht [appellate court] frankfurt, case presentation including english translation available at <http://cisgw3.law.pace.edu/cases/910917g1.html> (in this case a one-day delay in sending an avoidance telex after the breach was discovered at a trade fair was judged both reasonable and unverzüglich). in another case, an italian buyer of a used car was allowed to avoid the contract three months after she discovered the car was previously stolen and title cannot be transferred; the court accepted the time as pertinent to the various inspections required. had the seller attempted to cure, however, it might have been determined that the condition of “without reasonable delay” could not be met: germany 22 august 2002 landgericht [district court] freiburg, case presentation including english translation available at <http://cisgw3.law.pace.edu/cases/020822g1.html>. 42 e.g. arts. 1139, 1146. 15 under pecl art. 1:804, the right to cure is not qualified for either fundamental or nonfundamental non-performances, although it is limited in cases where time is of the essence, as discussed above. however, under art. 9:303(3)(a) the aggrieved party’s power to terminate the contract is unaffected by later cure as long as the notice of termination is given in reasonable time after cure was performed. this provides a strong incentive to non-performing parties to communicate their intention to cure so as to bring about the suspension of the aggrieved party’s power to terminate the contract under art. 9:303(3)(b), as otherwise their cure will not operate preemptively. 5. expenses of cure and associated risks cure may accrue costs and internalize risks that are not allocated between the parties in the contract. if any exist, the cisg art. 48(1) allocates them to the seller.38 as far as the buyer is concerned, the curative performance is to be as close as possible to the projected contractual performance. obviously, any associated costs which would effectively serve to remove or reduce the seller’s susceptibility to a lawsuit for breach of contract must be borne by the seller. the pecl is silent on this point, but as this rule seems germane to the logic of cure it must hold under it, as well. also, as cure is a substitute performance, pecl art. 7:112, according to which each party must bear “the costs of performance of its obligations”, will apply here, by analogy if not directly.39 6. “without unreasonable delay” there must be a limit to the period during which the aggrieved buyer must accept cure. cisg art. 48(1) limits cure only to cases where it can be achieved without unreasonable delay.40 this language, similar to the “unverzüglich” of the bgb [german civil code]41 or the “interpellation suffisante” prevalent in the french code civil,42 indicates a relatively shorter period than the nordic journal of commercial law issue 2005 #1 43 see icc arbitration case no. 9083 of august 1999, case presentation including english translation available online at <http://cisgw3.law.pace.edu/cases/999083i1.html>. 44 see supra note _ref99709794\h \* mergeformat 17. 45 see official records of the united nations conference on contracts for the international sale of goods, vienna 10 march 11 april 1980, a/conf. 97/19, at 40 et seq., available online at <http://cisgw3.law.pace.edu/cisg/text/link48.html>. 46 namely, seller may cure “if he can do so without such delay as will amount to a fundamental breach of contract”. art. 44 (later became art. 48) of the 1978 draft. see official records, supra note _ref99449495\h \* mergeformat 46. 47 see honnold, 298. 48 see official records of the united nations conference on contracts for the international sale of goods, vienna, 10 march–11 april 1980 (united nations publication, sales no. e.81.iv.3), 41, para. 14. 16 “reasonable time” under which a declaration of avoidance must be given according to cisg art. 49.43 it is therefore a further application of the general principle of reasonableness that, as professor kritzer has argued, is a general principle of the cisg.44 in cases where the seller has indicated to the buyer the length of the intended cure period – as must be the case when the breach is fundamental (under cisg art. 49(2)) and is prudent also when it is non-fundamental – that indication, subject to the requirement of reasonableness, will determine the period for cure. in no case other than when he has explicitly accepted is the buyer obligated to accept cure later than that.45 the pecl’s generally stringent approach to delay bears an interesting relation to the parallel requirement in cisg art 49(1). pecl art. 8:104 in fact uses language that appeared in early drafts of the cisg and was later scrapped for the “unverzüglich” principle.46 in the context of the pecl, the general obligation to act in good faith and fair dealing (art. 1:201) governs the substantial right to cure. it should be added, that in similar contexts the pecl treats delayed performance more severely than the cisg. for instance, while avoidance of contract for nonfundamental breaches is available under cisg in cases of non-delivery only (following a nachfrist period, see cisg art. 49(1)(b)), pecl allows avoidance following nachfrist in the wider category of cases of non-fundamental delays in performance (see pecl art. 8:106(3)). may there be cure in a time that is longer than “reasonable”? honnold47 emphasizes, that the seller’s request according to art. 48(2) should not necessarily be restricted to the conditions of cure of art. 48(1); seller may therefore request to perform cure under different conditions, to which the buyer may agree or not, but will be held to if she fails to respond to the said request. what if the seller’s request under art. 48(2) and (3) does not indicate a time frame for cure? according to some sources, such an indication is a sine qua non of the request and without it, it can have no effect.48 to this commentator, this seems too harsh; if the seller does not indicate a time for cure, the default time indicated in art. 48(1) – namely, “without reasonable delay” – would kick in and govern the undertaking to cure. art 48(2) allows the seller to attempt to divert from the minimal time requirement, but does not oblige him to do so. nordic journal of commercial law issue 2005 #1 49 in one french case, reliance damages were awarded the aggrieved buyer for expenses incurred in the process of cooperating with the performance of cure by the seller (applying extra transportation, etc.) in that case, however, the damages were assessed as 10% of the full sale price. to this commentator, this seems a dubious approach: determining damages must be an empirical, verifiable matter. damages added to cure – the “whether” covering expectation or reliance interests – should be determined according to evidence pertaining to actual losses suffered (including loss of expected gain), as opposed to a lump sum or a neat proportion of the total sale price. see france 26 april 1995 cour d'appel [appellate court] grenoble (marques roque joachim v. m a n i n r i v i ) r e ) , c a s e p r e s e n t a t i o n i n c l u d i n g e n g l i s h t r a n s l a t i o n a v a i l a b l e o n l i n e a t <http://cisgw3.law.pace.edu/cases/950426f2.html>. 50 it may be argued that the damages clause in cisg art. 48 is redundant because such cases as would fall under it would fall under the more general art. 45(2) according to which “the buyer is not deprived of any right he may have to claim damages by exercising his right to other remedies.” that would be a jurisprudential mistake, as under cisg (and pecl) cure is not a right of the aggrieved buyer but of the breaching seller. so although both clauses are consistent they do not cover the same cases. contra oberlandesgericht hamm, supra note _ref99620076\h \* mergeformat 39. 51 see austria 14 january 2002 oberster gerichtshof [supreme court], case presentation including english translation available online at <http://cisgw3.law.pace.edu/cases/020114a3.html>. the court also curiously refers to cure as a “right” of the aggrieved buyer although under cisg (and pecl) the seller does not generally have an obligation to cure; she has a right to cure, as analyzed above. had there been a buyer’s right to impose cure and a seller’s obligation to make one, and the seller would default on that, that would have to become an issue separate from her breach of the contractual obligation itself. obviously, nowhere in the cisg is a party obligated to perform more than the contract stipulates. of course, under certain conditions the buyer has a right to specific performance that needs be enforced in court (see cisg arts. 28, 46) but that is a different matter entirely, not to be mixed with that of cure. switzerland 5 november 2002 handelsgericht [commercial court] des kantons aargau, case presentation including english translation available at <http://cisgw3.law.pace.edu/cases/021105s1.html>. 17 7. retaining the right to damages the performance of cure does not obliterate the fact that a contract was breached. thus, although the performance of appropriate cure virtually substitutes for that of the original contractual obligation (hence making both avoidance of the contract and any order for specific performance inappropriate), it does not preclude an additional order for damages.49 under cisg art. 48(1) these are damages “as provided for in this convention” i.e., including those damages covered by art. 74.50 (a dictum by an austrian court suggests that while cisg generally provides for reliance as well as expectation damages for breach of contract, cure generally revokes the availability of the latter.51 however, one must note that while in cases of successful cure expectation damages will not be awarded on the merits (that, after all, is what cure is aimed to achieve), it does not follow that this is the proper construction of the damages clause in art. 48. even cure that is identical to the projected contractual performance in all save the time of performance may fail to compensate for loss of some of the projected (and foreseeable, etc.) added value to the buyer expected from the contract. there is no reason to indemnify the seller from liability in such cases. from this perspective, what cure affords breaching sellers (and to what it subjects aggrieved buyers) is, in fact, the possibility of mitigating any damages to which the seller would otherwise be liable through substitute performance. there is no guarantee that the substitute performance will cover the entire loss to the buyer generated by the breach. pecl art. 8:104 says nothing about damages; however, it does not preclude further damages in cases of cure and the same logic should apply here. thus the general pecl clauses that make damages available to aggrieved buyers would operate here. cure would not preclude damages, although it would contribute towards there mitigation, and a perfect performance of cure would mitigate those damages completely. nordic journal of commercial law issue 2005 #1 52 contra liu, supra note _ref99345016\h \* mergeformat 11 at 5. 53 in terms of speech acts, the matter of request is not determined literally but as a matter of contextually constructing a communicative performance: under art. 48(3) a “notice” by the seller that she intends to cure within a specified time is assumed to amount to such a request. this is an “indirect” speech act; see jerrold fodor, semantics (new york: crowell, 1977), at p. 57 et seq. 54 see jonathan yovel, “comparison between provisions of the cisg (buyer’s right to avoid the contract: article 49) and the c o u n t e r p a r t p r o v i s i o n s o f t h e p e c l ( a r t i c l e s 9 : 3 0 1 , 9 : 3 0 3 a n d 8 : 1 0 6 ) ” , a v a i l a b l e o n l i n e a t <http://cisgw3.law.pace.edu/cisg/biblio/yovel49.html>. 18 8. system of notices while avoidance is declared, cure is performed. however, declaring the intention to cure (or otherwise making it known to the aggrieved party, cf. pecl art. 9:303(3)(b)) may carry with it a legal effect in the sense of shifting a certain communicative onus to the aggrieved party who wishes to retain the power to avoid the contract. this is true for both pecl (as discussed cursorily above) and the cisg, as follows. while pecl art. 8:104 does not indicate any special mode for notices of cure exchanged by the parties – and is thus subject to the regular rules governing communication, set in art. 1:303, and indirectly those governing notices of termination in art 9:303 – the cisg designates an entire communicative system to govern the establishment of cure, art. 48(2), (3) and (4). this system governs, however, more than merely the ways in which notices in the context of cure are to be exchanged between the parties, as it regulates some of the substantive rights of the parties contingent on their communicative behavior. under both cisg and pecl (and unlike under the unidroit principles), cure may be exercised without notice to the aggrieved buyer.52 cisg art. 48(2), however, discusses the case in which the seller “requests” the buyer’s approval of the seller’s intended cure.53 (literally, the relevant language is “accept[ing] performance”, by the buyer, a slightly awkward wording within the context of the cisg which does not operate under the perfect tender rule and thus buyers have no right to reject performance other than by avoiding the contract).54 there are two separate operations involved here. in case of non-fundamental breach, the seller is not so much “requesting” anything as much as giving notice of cure it is not a request because the buyer has no right to refuse. the operation of the request is much more significant under conditions of fundamental breach. as under such conditions the buyer retains the right to avoid the contract, the seller in fact offers to cure the breach under condition that the buyer forebear from exercising her right to declare the contract avoided. the buyer may, of course, refuse the offer to cure and exercise her power to avoid the contract (or not avoid it, as the case might be, and resort instead to other remedies, such as damages). but if she agrees to “accept” cure, or simply fails to respond to the request within a reasonable time, she will become estopped from exercising her right to avoid the contract or reducing the price for the duration indicated in the request. note that this is an exception to the general rule of the cisg art. 18(1) according to which “silence or inactivity does not in itself amount to acceptance.” nordic journal of commercial law issue 2005 #1 55 seller must then allow “reasonable time” for the buyer to answer. see finland 12 november 1997 turku court of appeal, case presentation including english translation available at <http://cisgw3.law.pace.edu/cases/971112f5.html>. see also when a communication “reaches” an addressee, cisg art. 24. 19 the harshness of this rule is mitigated by art. 48(4) according to which a request according to art. 48(2) becomes effective upon receipt by the buyer (itself an exception to the general rule in art. 27 where it suffices to dispatch the notice).55 of course, whether a breach is fundamental or not may be controversial; the buyer herself may be unsure of the availability of avoidance, the seller unsure whether she holds a right to cure. art. 48(2) provides a strong incentive to the cautious seller to communicate with the buyer and sort this out. there is no prejudice to the seller for if the breach is non-fundamental than she retains to right to cure whatever the buyer’s response may be. yet it would prevent the situation of a seller engaging in costly cure while buyer intends to declare the contract avoided. the “race” between cure and avoidance is thus best resolved through application of cisg art. 49(2). * associate lawyer, hannes snellman attorneys at law ltd. changed circumstances and hardship in the international sale of goods by niklas lindström* nordic journal of commercial law issue 2006 #1 nordic journal of commercial law issue 2006 #1 2 i. introduction the purpose of a contract is to establish the contracting parties’ rights and responsibilities under the contract. both parties’ interest, at least at the time of entering into the contract, is to see that the contract is performed as agreed. it is essential that the parties to a contract are familiar with the contents of the contract and possible non-mandatory regulations that might complement the contract. a failure to perform a contract often results in liability for damages. whether a party is liable for a breach of contract is largely dependent on how strict the liability is under the contract, i.e. which prerequisites must be fulfilled in order for liability to arise. in the united nations convention on contracts for the international sale of goods (hereinafter the “ cisg” or the “ convention” ) a party is liable for all events in its control. in other words a party is liable unless the event causing the breach of contract is beyond its control. after the conclusion of a contract but before the contract is performed a party’s situation may change due to changed circumstances, especially when the contract is to be performed over a long period of time or in a more distant future. in accordance with what could be called the foundation of contract law, pacta sunt servanda, changed circumstances are of no relevance with regard to a party’s rights and responsibilities under the contract. a breach of contract results in liability. it cannot, however, be regarded as reasonable that a party would always be required to perform the contract regardless of what happens with the surrounding circumstances. such a legal state would be too harsh. hence, it is important that a contract in exceptional cases can be adapted to changed circumstances. however, also situations where all contracts would automatically be entered into with a precondition that circumstances do not change or where contracts due to even slight changes would be adapted or avoided would be fatal for international trade. this would admittedly result in a flexible legal state but at the same time the contract as a legal transaction would lose its importance. the doctrine of pacta sunt servanda needs, thus, exceptions that can be applied in special circumstances. most national legal orders contain such provisions. some provisions allow a deviation from what has been agreed on only in cases of impossibility, other provisions allow a deviation also when the performance of a contract has become much more onerous but not impossible. such provisions provide some flexibility to legal relations that can be regarded as appropriate and should not be in conflict with the general concept of justice. this article discusses a breaching party’s exemption from liability under the cisg due to changed circumstances. the article contemplates the relationship between the doctrine of hardship and an exemption from liability under the cisg. under the cisg a party is responsible for all events in its control and a party’s liability is independent of its negligence. however, a party shall not be liable for a failure to perform the contract if the failure was due to an impediment beyond its nordic journal of commercial law issue 2006 #1 1 flambouras 2001, p. 282. 3 control. it is important to discuss what can be regarded as an “ impediment beyond control” , as the article concentrates on a party’s possibility for an exemption in situations where a performance has become more expensive than expected and the equilibrium of the contract has been altered due to changed circumstances and a performance in the new situation would be something totally different than at the time of the conclusion of the contract. the latter can be referred to as a situation of hardship. ii. hardship there is no explicit rule in the cisg for situations of hardship. hence, the question whether situations of hardship are governed by the cisg (and how) shall be considered by means of the provision on exemptions in article 79. as the cisg does not include a provision on hardship, no definition on what is understood by the term hardship can be found in the cisg. the unidroit principles of international commercial contracts (the “ unidroit principles” ) article 6.2.2 defines hardship in the following way: “ there is hardship where the occurrence of events fundamentally alters the equilibrium of the contract either because the cost of a party’s performance has increased or because the value of the performance a party receives has diminished, and (a) the events occur or become known to the disadvantaged party after the conclusion of the contract; (b) the events could not reasonably have been taken into account by the disadvantaged party at the time of the conclusion of the contract; (c) the events are beyond the control of the disadvantaged party; and (d) the risk of the events was not assumed by the disadvantaged party.” hardship is in this paper understood in accordance with the definition of hardship in the unidroit principles. hence, there is hardship when an external event fundamentally alters the balance of the performances under the contract and an unreasonable burden is placed on one of the parties. the performance of the contract becomes excessively onerous due to changed circumstances for one of the parties who is thus faced with hardship. the burden is often economic.1 in case of hardship it is not impossible to perform the contract, only excessively more onerous than at the time of contracting. in accordance with the unidroit principles and the principles of european contract law (the “ pecl” ), a party faced with hardship is not automatically released from its obligations under the contract. a normal effect of hardship is that the disadvantaged party is entitled to renegotiations and adaption of the contract with a view to restoring its equilibrium. the last alternative is termination of the contract. nordic journal of commercial law issue 2006 #1 2 the states that ratified ulis and ulf are belgium, gambia, israel, italy, luxembourg, the netherlands, san marino, great britain and west-germany. 3 ramberg, herre 2004, p. 47. 4 bonell 2000, p. 90. 4 iii. changed circumstances and cisg article 79 1. background even before the cisg there has been a will to draft an international convention for the sale of goods. work that began in the 1920’s resulted in 1964 in two conventions, the convention relating to a uniform law on the international sale of goods (“ ulis” ) and the convention relating to a uniform law on the formation of contracts for the international sale of goods (“ ulf” ). these two conventions did not succeed and were ratified by only 9 states.2 shortly after the drafting of ulis and ulf a new working group was appointed in order to draft the text for a new convention. the wording of the new convention would be based on the already existing conventions, ulis and ulf. the result of the working group was a draft for a new convention that was ready in 1978. a diplomat conference, in which representatives from 62 states and 8 international organisations participated, was held in vienna in 1980. after 10 states had ratified the cisg, the convention came into force on 1 january 1988.3 thereby, the cisg is a result of more than 50 years’ work.4 2. remedies under the cisg – an overview when a contracting party fails to perform its obligations under the contract, the non-breaching party may resort to different remedies under the cisg. the main remedies are the right to require performance, the right to declare the contract avoided, reduction of price and compensation for damages. avoidance of a contract is possible only if the breach amounts to a fundamental breach of contract or when the party in breach does not perform within an additional period of time. when a reduction of price comes to question, the price may be reduced in the same proportion as the value that the goods actually delivered had at the time of the delivery bears to the value that conforming goods would have had at that time. damages have on the other hand a dual role as a remedy. damages can namely be claimed as a separate remedy or in combination with other remedies. in the following chapters a breaching party’s possibility to an exemption from damages is examined. it must be noted that the cisg as a point of departure only provides for an exemption from damages. the other remedies are still possible even if their effect might suffer from the fact that damages no longer can be claimed. 3. exemptions cisg article 79 and cisg article 80 provide for situations in which a party is exempt from the strict liability that is otherwise applicable under the convention. article 79 provides exemptions nordic journal of commercial law issue 2006 #1 5 tallon 1987, p. 596-600, honnold 1999, p. 495 and ramberg, herre 2004, p. 565. 6 ramberg, herre 2004, p. 565-566. 7 rimke 2000, p. 211. 8 ramberg, herre 2004, p. 568. 9 tallon 1987, p. 578. 5 from damages and article 80 expresses a general principle according to which “ a party may not rely on a failure of the other party to perform, to the extent that such failure was caused by the first party’s act or omission” . as article 80 is included in the section regarding exemptions and directly in connection with article 79 on exemption from damages, article 80 is regarded only as a complement to article 79 and not as an independent provision that could also be applied in other situations than regarding damages resulting from a breach of contract.5 article 80 will not be discussed in this article. during the drafting of article 79 it was regarded as vital to create an independent expression for the ground on which an exemption from damages could be claimed. the explanation was that a ground for exemption that would derive from a national law would be influenced by the meaning that the expression (e.g. wegfall der geschäftsgrundlage, force majeure, imprévision, frustration, impracticability) has in national law and by the legal praxis in the country in question.6 cisg article 79 is the counterpart of ulis article 74. ulis was regarded as making an exemption due to changed circumstances too easily possible7, wherefore the drafters of the cisg consciously rejected the regulation in ulis.8 however, in the interpretation of cisg article 79 guidance is often taken from ulis article 74. the argument is that the interpretation of cisg article 79 must be stricter than the interpretation of ulis article 74, as the drafters’ intent was to create a more rigid rule for exemptions under the cisg. 4. exemption from damages as stated above, a party’s exemption from damages due to a breach of contract is governed by cisg article 79. according to article 79(1): “ a party is not liable for a failure to perform any of his obligations if he proves that the failure was due to an impediment beyond his control and that he could not reasonably be expected to have taken the impediment into account at the time of the conclusion of the contract or to have avoided or overcome it or its consequences.” the article states four different conditions that all must be fulfilled in order to make an exemption possible: 1) an impediment, 2) beyond control, 3) that could not reasonably have been taken into account at the time of the conclusion of the contract and 4) the consequences of which could not have been avoided or overcome. these conditions are the traditional elements of force majeure and it seems that article 79 is primarily intended for that type of situations.9 however, article 79 contains several wordings that leave room for interpretation or require an evaluation of reasonableness and it is not always clear how the article should be applied to an actual case. nordic journal of commercial law issue 2006 #1 10 tallon 1987, p. 579. 11 ramberg, herre 2004, p. 566. 12 hudson 1991, p. 176. 13 lookofsky 1996, p. 102. 14 stoll, gruber 2005, p. 812, tallon 1987, p. 579 and ramberg, herre 2004, p. 568. 15 gomard, rechnagel 1990, p. 222. 16 government decree 1986:198, p. 37. 6 tallon has noted that the interpretation of article 79 becomes even harder as the french and english versions of the convention, which both are authentic, seem to be somewhat different. where the english version states “ impediment beyond his control” , the french version states “ un empêchement independent de sa volonté” , which tallon translates as “ independent of his will” . according to tallon, the more objective english version is preferred instead of the more subjective french version.10 it is possible that this difference in the wording of the cisg defers from the fact that the national english doctrine of frustration can be seen as more objective than the french doctrine of imprévision. however, the also authentic spanish version (“ un impedimento ajeno a su voluntad” ) seems to be in line with the french version. ramberg and herre note that the french and spanish versions of the convention seem to refer to what is subjectively possible to avoid. the scholars are, however, of the opinion that this has probably not been the intention and thereby give their support to the english wording.11 even if article 79 is one of the longer articles in the convention and has been the object of extensive preparations, the article is unsatisfactory in many ways. this does not, however, cause as many practical problems as one could imagine as most standard agreements and other agreements contain force majeure clauses and even hardship clauses that deal with questions that otherwise would fall under article 79.12 it must be kept in mind that the cisg is non-mandatory and article 6 allows the parties to exclude the application of the convention and to derogate from or vary the effect of any of its provisions. the burden to prove that all the prerequisites of article 79 are fulfilled lies with the party claiming relief.13 in the following the prerequisites of article 79 will be examined in more detail. 4.1. impediment the term “ impediment” that is used in the cisg has not been defined in the convention or elsewhere. in ulis the word “ circumstances” was used instead of “ impediment” . by replacing “ circumstances” with “ impediment” the drafters of the convention wanted to take distance from ulis as well as underline the objective nature of the impediment and a narrow interpretation of the term. it is important to keep this in mind in the interpretation of article 79.14 what constitutes then an impediment under article 79? it is clear that something which makes the performance objectively impossible can constitute an impediment.15 a party cannot be asked to perform what is impossible (impossibilium nulla obligatio est). hence, the fact that the sold item is destroyed constitutes an impediment in the sale of specific goods. also events such as war, civil war, acts of terrorism and export or import bans as well as natural catastrophes can constitute impediments within the meaning of article 79.16 it is impossible and also inexpedient to make an exhaustive list of events that can constitute an impediment. the evaluation must be done in casu. it is also important to note that no event can constitute an impediment only due to its nature, but nordic journal of commercial law issue 2006 #1 17 unidroit principles article 6.2.1. and the pecl article 6:111. 7 the event in question must also in fact prevent the contracted performance. for example, a war does not constitute an impediment if the agreed performance is still completely possible. events such as war, mutiny and government bans are typical situations of force majeure. the question whether also an event which does not make the performance of a contract impossible can constitute an impediment under article 79(1) is more interesting. the question is whether an event that only makes the performance significantly more difficult can constitute a relevant impediment? an important type of situation where the performance of a contract due to changed circumstances has become significantly more difficult or burdensome is when fulfilment in the new situation would become much more expensive than the agreed performance, i.e. when a significant rise in costs create what can be called an economic impediment for performance. all trade is associated with risks and the hardship provisions in both the unidroit principles and the pecl stress that even if performance becomes more onerous for a party, the party is still obligated to perform.17 this must be seen as a wanted legal status and marks the balance between the principles of pacta sunt servanda and rebus sic stantibus. the strong starting point under the unidroit principles and the pecl is that events causing price increases or other objectively avoidable impediments are irrelevant. the same can be assumed to apply under the cisg. unilex d. 02.05.1995 (belgium, rechtbank van koophandel, hasselt). a chilean seller concluded a contract with a belgian buyer for the delivery of frozen raspberries. the contract provided that the buyer should pay through letter of credit. failing the required opening of the letter of credit, the seller did not proceed to ship the goods. the buyer asked for a delay in the delivery and requested the company which had acted as mediator to negotiate with the seller for a lower price, alleging a significant drop in the world market price for the purchased goods. the seller refused to accept a reduced price, declared the contract avoided and commenced an action to recover damages. the court held that the significant drop in the market price of the purchased goods after the conclusion of the contract did not constitute a case of force majeure exempting the buyer for nonperformance under article 79 cisg. fluctuations of prices are foreseeable events in international trade and far from rendering the performance impossible they result in an economic loss well included in the normal risk of commercial activities. also note unilex d. 12.06.2001 below. but is the situation different if changed circumstances have caused such increases in price that are completely outside the preconditions of the agreement and a performance in the new situation would be something completely different than what the parties have agreed upon? the question whether economic difficulties (in the nordic countries also known as economic force majeure) in exceptional cases could constitute an impediment has been discussed. schlechtriem asserts that the general view during the preliminary uncitral discussions was that both physical and economic impossibility could exempt an obligor. he notes, however, that economic difficulties only under very narrow conditions can constitute an impediment and that increased procurement nordic journal of commercial law issue 2006 #1 18 schlechtriem 1986, p. 102. 19 government decree 1986:198, p. 37. 20 ramberg, herre 2004, p. 569. 21 stoll, gruber 2005, p. 815-817. 22 sandvik 2004, p. 102. 23 cisg article 79(2). 24 ramberg, herre 2004, p. 571. 25 tallon 1987, p. 580-581. 8 and production costs alone do not constitute exempting impediments.18 also honnold is of the opinion that impossibility cannot be the prerequisite of an impediment, which seems to indicate that also events that make performance excessively more difficult could constitute relevant impediments for performance. 4.2. beyond control to show that a relevant impediment has occurred is not enough for being granted an exemption under article 79. the party claiming an exemption must also prove that the impediment is beyond its control. article 79 is based on the thought that a party is responsible for all events that normally are within its control and on which the party normally can make an impact. this is the case even if the party in a particular case could not affect the occurrence of the impediment. hence, a party’s actual possibility to control events is irrelevant. what matters is what kind of events a party normally can control.19 an event constituting an impediment beyond control must be of a type that is uncontrollable.20 only events outside a party’s sphere of control can be regarded as relevant grounds for an exemption. no event within a party’s sphere of control, such as events relating to a party’s person or a party’s employees, can exempt a party from its contractual liability.21 the content of article 79 can be described as a strict responsibility with exception for impediments beyond control.22 also assistants used in order to fulfil a contract are within a party’s sphere of control and a so called double force majeure is required in order for an exemption to be possible.23 4.3. unforeseeability for an exemption to be possible under cisg article 79, the impediment beyond control must be unforeseeable. hence, a party is obligated to compensate for damages even if these are the result of an impediment beyond control, if the party reasonably could be expected to have taken the impediment into account at the time of the conclusion of the contract. the question of unforeseeability requires an evaluation of reasonability.24 article 79 refers to the words “ could not reasonably” to the standard of bonus pater familias or “ the reasonable person” . according to tallon, this is a person “ halfway between the inveterate pessimist who foresees all sorts of disasters and the resolute optimist who never anticipates the least misfortune” .25 reoccurring events such as flu epidemics and rain periods are foreseeable and cannot be referred to in order for a party to be exempt. nor can an import prohibition, which can constitute an impediment beyond control, qualify as a ground for an exemption if a reasonable nordic journal of commercial law issue 2006 #1 26 ramberg, herre 2004, p. 571. 27 tallon 1987, p. 580. 28 lookofsky 1996, p. 103. 29 stoll, gruber 2005, p. 817. 30 ramberg, herre 2004, p. 572. 31 tallon 1987, p. 581. 9 person in the same situation could have foreseen the prohibition at the time of the conclusion of the contract.26 if an event is foreseeable, the defaulting party is considered as having assumed the risk of its realization.27 according to lookofsky, the fulfilment of the unforeseeability element is the hardest one to prove, as virtually all potential impediments to performance are foreseeable to some extent. lookofsky also purports that even dramatic price increases are foreseeable, which suggests that an exemption rarely could be available in that type of situations. those who sell goods on a long-term basis are in the business of assuming that kind of risk.28 stoll and gruber point out, however, that since virtually all events are theoretically foreseeable it would be wrong to interpret article 79 purely empirically. instead, the scholars argue that the question of foreseeability is one about what a party reasonably could foresee. thereby the scholars give their support to the view that also this element of article 79 requires an evaluation of reasonability. the scholars argue that article 79 expresses an allocation of risk for the completion of the contract. according to this, the notion of unforeseeability ought to be understood in the following way: should a party under conditions prevailing at the time of the conclusion of the contract and taking into account the trade usage within a particular branch have foreseen that an impediment exists or that an impediment will occur?29 4.4. avoidance even if all elements discussed above are fulfilled, an exemption under article 79 still requires that the breaching party could not have avoided or overcome the impediment or its consequences. hence, a party is required to take active appropriate measures in order to avoid the impediment or the consequences of the impediment.30 tallon describes the meaning of the term “ avoid” by “ taking all the necessary steps to prevent the occurrence of the impediment” and the meaning of the term “ overcome” by taking all the necessary steps to preclude the consequences of the impediment” . also here reference is made to the reasonable person, i.e. how a person with the same knowledge and expertise would have acted in a similar situation. the evaluation of what is possible to overcome can create difficulties. it is one thing to determine what is objectively impossible to overcome and another thing to determine where the line should be drawn to economic impossibility. how extensive economic sacrifices is a party obligated to make? a ship carrying an object sinks to the bottom of the sea. the object can be retrieved in good condition but at a great cost. is a seller obliged to retrieve the object and fulfil the contract? the result can hardly be the same regardless of the object’s value. naturally, also here a case by case analysis is required.31 in november 1956 the suez canal was closed due to military actions between israel and egypt. export companies had entered into contracts with a cif clause before the closing of the canal but the delivery was to take place after the canal had been closed. on the day of delivery the only nordic journal of commercial law issue 2006 #1 32 darcy, murray, cleave 2000, p. 113. 33 stoll, gruber 2005, p. 817. 34 nystén-haarala 1998, p. 183-184, lookokfsky 1996, p. 103 and runesson 1996, p. 268. 35 runesson 1996, p. 268. 36 sandvik 2004, p. 89. a case often referred to concerning commercial impracticability is “ florida power and light co. v. westinghouse electric corp.). in this case westinghouse pleaded commercial impracticability as the price of uranium had increased by 600%. westinghouse refused to deliver, as the fulfilment of the contract would have resulted in losses of 2.5 billion dollars for westinghouse. the court held that “ westinghouse did not meet its burden of establishing that it is entitled to excuse” . 37 tallon 1987, p. 592. 38 enderlein, maskow 1992, p. 324. 39 zeller 2005, p. 182. 40 wilhelmsson, sevón, koskelo 1999, p. 64. 41 stoll, gruber 2005, p. 818. 10 possible route was the considerably longer route around the cape of good hope. delivery was possible but was much more difficult and expensive for the seller. british courts applied the doctrine of frustration and found that the impediment was not such to exempt the sellers.32 also under the cisg a seller is obliged to transport goods in a significantly more expensive way in order to overcome the impediment, even if this would result in a loss for the seller.33 most impediments can be overcome in one way or the other. the question is how extensive economic sacrifices a party is obliged to face in order to overcome an impediment. this limit, which a party is not obligated to exceed in order to fulfil a contract, is often referred to as the sacrifice limit or sacrifice threshold.34 it is impossible to decide on a general level where this limit of sacrifice lies. that is a question of reasonability and must naturally be decided on a case-by-case basis.35 however, the evaluation ought to be strict and only in exceptional cases allow for an exemption. the conclusion is that an exemption under the cisg should be possible if the occurrence is such that it would fall under the nordic concept of economic force majeure or the american concept of commercial impracticability.36 tallon is of the opinion that even if the cisg seems to provide for a more flexible view on changed circumstances than the traditional concept of force majeure, the cisg is nevertheless stricter than the concepts of frustration and commercial impracticability.37 an important aspect also in this evaluation is which measures one could reasonably expect a party to take in order to overcome an impediment. a party must take measures that are customary or which similar persons in a similar situation would take. an exemption is possible only when stricter measures would be required.38 in the evaluation of the sacrifice limit only efforts within reasonable economic limits can be taken into account. nearly all impediments can be avoided, but all means are not economically possible and a party cannot be obliged to perform miracles. the reasonable person test is of importance also in this evaluation.39 it can be noted that also the time of the occurrence of the impediment can be of significance for a party’s possibility to overcome the impediment. an impediment occurring close to the agreed delivery date can be harder to overcome than an impediment occurring earlier. the point of time can even be of importance in the assessment whether an impediment has occurred at all.40 at times a party can be obliged to deliver a commercially feasible substitute which fulfils an intended purpose as well as the product agreed upon in order to overcome the impediment.41 in case unilex d. 28.2.1997 (oberlandesgericht frankfurt) the court held that “ in case of replaceable goods, the seller could only be exempted from its liability when it is impossible to find on the market goods of similar quality, a circumstance that in the case at hand had not been nordic journal of commercial law issue 2006 #1 42 tallon 1987, p. 58 and 586. 43 zeller 2005, p. 170. 11 proved by the seller” . however, a buyer is not obliged to accept a substitute even if it was very similar to the agreed goods. this can result in a situation where a seller is liable even if the seller offers the buyer a substitute almost identical with the agreed goods but which the buyer rejects without reason. hence, also a seller’s obligation to offer a commercially feasible substitute can be criticised.42 iv. hardship and cisg article 79 1. alternatives in the cisg for a solution on situations of hardship the cisg takes a traditional perspective on the fulfilment of contractual obligations. naturally, the main principle is the traditional doctrine of “ pacta sunt servanda” , i.e. a contract shall be fulfilled as the parties have agreed. the only article in the cisg that regulates changed circumstances is article 79. hence, all situations of hardship must be evaluated on the basis of article 79 or be treated as a breach of contract. the cisg does not seem to have any provision that would allow a different solution than the ones mentioned above. no provisions are found for the type of situations that are between a clear breach of contract and impossibility. such provisions can be found in many national jurisdictions and international principles.43 in the absence of an explicit hardship provision it is of great importance to find an answer to the question whether article 79 governs hardship, as the other alternative seems to be full liability for the party suffering hardship. a third alternative could, however, be that there is a gap concerning hardship in the cisg, which then in accordance with cisg article 7(2) would be settled in conformity with the general principles on which the cisg is based or, in the absence of such principles, in conformity with the law applicable by virtue of the rules of private international law. such a solution could allow for an adaption of the contract due to changed circumstances. when looking for an answer to the question whether article 79 regulates hardship, the first step is to define what is understood by the question. it is possible that the cisg regulates hardship in a way that non-performance or a faulty performance due to hardship always shall be regarded as a breach of contract. this solution would mean that a contractual imbalance caused by changed circumstances could not be regarded as an insurmountable impediment. furthermore, article 79 could be interpreted to allow an exemption from liability for non-performance in case of hardship. in the latter case it would be of importance to decide what can be regarded as an impediment within the meaning of article 79 and what can be expected from a party to overcome the impediment. it is also essential to discuss what happens when the impediment ceases to exist. even if economic impediments can be relevant impediments under cisg article 79 and even if a party could not be expected to overcome too heavy economic burdens, it is unsettled what happens when the original impediment does not exist anymore but instead the circumstances, e.g. the situation on the market, has changed so dramatically during the time the impediment has existed that a performance in the new situation would be something totally different than what the parties have agreed upon. can the dramatic change on the market then be a relevant impediment under nordic journal of commercial law issue 2006 #1 44 tallon 1987, p. 584. 12 article 79 and exempt the party suffering hardship from liability or is a party obliged to perform in such situation in order to avoid liability? is it possible to complete article 79 with the general principles of the convention and in that way allow for an adaption of the contract in cases of changed circumstances? the alternative solutions when a party is struck by hardship and the cisg is the governing law seem to be the following: 1. hardship is a question governed by the cisg so that the cisg in the case of hardship does not allow for any kind of deviation from what has been contracted. a breach of contract due to hardship results in full liability for damages. 2. hardship is regulated by article 79 so that an exemption from liability in case of hardship is possible during the time the impediment exists. after the impediment has ceased to exist a party is obligated to fulfil the contract. (this is, however, not a question of actual hardship in the way hardship is defined in this article, but a question of an economic impediment for performance.) 3. hardship is regulated by article 79 so that an exemption from damages, and possibly even the obligation to perform, is possible even after the impediment has ceased to exist. 4. hardship is a question governed by the cisg, but not expressly settled in it, wherefore the question shall be settled in conformity with the general principles on which the cisg is based or, in the absence of such principles, in conformity with the law applicable by virtue of the rules of private international law. in the following the questions and alternatives presented above will be discussed. the questions will not be discussed separately, as the discussion concerning one question also concerns the others. the discussion will begin with a further examination of the interplay between the requirements of an impediment and a party’s obligation to overcome the impediment. the aim is to find a solution on the question whether relevant economic impediments exist and whether these can be regarded as unavoidable. next the discussion shifts to problems concerning impediments that exist during a long period of time and the possibility of taking changed circumstances into account under article 79. 2. does article 79 apply to hardship? 2.1. an impediment and the obligation to overcome it on the basis of what has been stated above it is clear that article 79 contains many words and concepts that can be interpreted in different ways. the question whether situations of hardship are governed by article 79 is one of the most difficult and most discussed questions concerning the article. courts have a significant role in the application and interpretation of the article. an answer to whether an actual case fills all the requirements set forth by article 79 always requires consideration on many points.44 it is material to establish what can be regarded as an impediment and what kinds of impediments a party must overcome. it has been stated above that a relevant impediment does not require a nordic journal of commercial law issue 2006 #1 45 lando 1987, p. 299. 46 gomard, rechnagel 1990, p. 223. 47 routamo, ramberg 1997, p. 219. 48 article 7: “ in the interpretation of this convention, regard is to be had to its international character and to the need to promote uniformity in its application and the observance of good faith in international trade.” 49 krüger 1999, point 5.1. 50 sandvik 2004, p. 86. 13 situation of absolute impossibility. hence, it is clear that also economic impediments can be relevant impediments under article 79. the question of the relevance of an impediment shall, however, be discussed in connection with what a party should overcome, as economic impediments are always possible to overcome. lando states that article 79 governs both situations of absolute impossibility and situations where performance has become so burdensome that it would not be reasonable to expect performance.45 lando’s view is supported by other scholars. gomard and rechnagel state that a party shall do all that is possible and reasonable in order to overcome an impediment.46 routamo and ramberg point out that absolute impossibility cannot be a requirement for exemption but that the question is what a party reasonably can overcome. as an example the scholars state that it cannot be regarded as reasonable to require a party to save a plane that lays 100 meters below sea level.47 such an impediment would be possible to overcome but the scholars regard such an operation as unreasonably expensive. in the evaluation of what constitutes an impediment that cannot be overcome, the main question is where the limit of sacrifice shall be drawn, i.e. what a party reasonably can be expected to undertake in order to overcome the impediment. the wording of article 79 does not suggest that a party would be obliged to take on extraordinary responsibilities in order to perform. on the contrary, if the word “ reasonably” in article 79 also regards the obligation to overcome the impediment, article 79 only obligates a party to make a reasonable effort to perform. according to article 748, stating how the cisg shall be interpreted, regard is to be had to the observance of good faith in international trade when the meaning of the word “ reasonable” is sought.49 the answer to the question on the sacrifice limit shall be sought in an objective risk analysis.50 2.2. long-term impediments above, the question whether economic difficulties can constitute a ground for exemption under article 79 has been discussed. the conclusion is that also economic difficulties can constitute an impediment and that the most challenging question on this part is where the limit of sacrifice shall be drawn. regarding hardship, however, it is more important to find an answer to the question whether the exemption can continue after the impediment has ceased to exist, i.e., is it possible for the effect of the impediment to continue to exist after the impediment has disappeared? can changed circumstances as such be a relevant impediment? this is of great importance regarding article 79(1), but also regarding the question of the right to specific performance. the question is controversial. the time that a party is exempt from liability is stated in article 79(3): nordic journal of commercial law issue 2006 #1 51 ramberg, herre 2004, p. 575. 52 secretariat commentary to article 79. it must be noted that the example is from the time before the word “ only” was deleted from the wording of article 79(3). 53 ramberg, herre 2004, p. 577. 54 honnold 1989, p. 602. 55 honnold 1989, p. 349-350. 14 “ the exemption provided by this article has effect for the period during which the impediment exists.” it is clear under article 79(3) that an impediment is of relevance during the time the impediment exists. hence, measures to perform must as a general rule commence as soon as the impediment has ceased to exist.51 a party is not liable for its breach of contract if it performs the contract immediately after the impediment has ceased, even if this would be two years too late. the meaning of article 79(3) can be described with the following example52: because of a fire which destroyed seller’s plant, seller was unable to deliver the goods under the contract at the time performance was due. he was exempted from damages under paragraph (1) until the plant was rebuilt. seller’s plant was rebuilt in two years. although a two-year delay in delivery constituted a fundamental breach which would have justified buyer in declaring the avoidance of the contract, he did not do so. when seller’s plant was rebuilt, seller was obligated to deliver the goods to buyer and, unless he decided to declare the contract avoided because of fundamental breach, buyer was obligated to take delivery and to pay the contract price. with regard to situations of hardship it is of great interest whether a party is always obligated to perform after the impediment has ceased to exist. during long-term impediments the preconditions for performance may have changed radically in comparison with performance on the agreed point of time.53 during the work on the convention two norwegian proposals were made for a new third paragraph. the norwegian delegates were of the opinion that it was not desirable that the exemption ended at the same time as the impediment ceased to exist, as circumstances might change during long-term impediments in such manner that it would be unreasonable to demand performance in the new circumstances.54 the first norwegian proposal to article 79(3) stated: “ where the impediment is temporary, the exemption provided by this article has effect for the period during which the impediment exists. nevertheless, the party who fails to perform is permanently exempted to the extent that, after the impediment is removed, the circumstances are so radically changed that it would be manifestly unreasonable to hold him liable.” the obligation to perform after a long-term impediment, during which circumstances have changed radically, ceases to exist was discussed in length during uncitral. it was unclear if and how the convention applied to situations of hardship. the delegate from great britain stated, giving his support to the norwegian proposal, that it was unclear whether the question of permanent exemption should be decided under national law or not. the swedish delegate, on the contrary, opposed the norwegian proposal, among others, on the ground that it was impossible to cover all possible aspects.55 the norwegian delegates also had a second alternative for a new third paragraph in case the first proposal would not be accepted. the delegates proposed that the word “ only” that was included nordic journal of commercial law issue 2006 #1 56 honnold 1989, p. 602-603. 57 honnold 1989, p. 350. the proposed provision on hardship has great similarities with the provision on hardship in the unidroit principles. 58 honnold 1999, p. 489-490. 59 honnold 1989a, p. 442-443. 15 in the original proposition would be omitted. the original proposition stated that “ the exemption provided by this article has effect only for the period during which the impediment exists” . the first norwegian proposal was supported by the delegates from many countries but was rejected after voting. some delegates were of the opinion that the proposal would introduce the french doctrine of “ imprévision” to the convention. the argentinean delegate was on the other hand of the opinion that the result of radically changed circumstances should not be an exemption from liability, but a fair adaptation of the contract. it is interesting that adaptation is the primary result of hardship under the unidroit principles and the pecl. the second norwegian proposal was accepted and the word “ only” was omitted from the text of article 79(3).56 during the uncitral phase and the diplomatic conference proposals were made to expand the regulation of exemptions to situations where changed circumstances have created hardship. during the uncitral phase an actual article to govern hardship was considered. the proposed article stated: “ if, as a result of special events which occurred after the conclusion of the contract and which could not have been foreseen by the parties, the performance of its stipulations results in excessive difficulties or threatens either party with considerable damage, any party so affected has the right to claim an adequate amendment of the contract or its termination.” as support for the proposition it was stated that the problem of unforeseeable changed circumstances is one of the most important problems for the contracting parties and that an article providing for the amendment or termination of the contract therefore should be included. a provision of this kind would also prevent a party from benefiting from “ gifts from above” on the other party’s expense.57 the proposed provision was not accepted. also this proposition was regarded as having too great an effect on the parties’ obligation to perform. the cisg does not contain any provision that would allow for an amendment of the contract or renegotiations in situations of hardship. scholars do not agree on the meaning of the deletion of the word “ only” . tallon does not seem to regard this as significant, whereas e.g. honnold gives more attention to this. honnold states that the purpose of the deletion of the word “ only” was designed to avoid any impression that paragraph 79(3) laid down a rigid rule requiring contract relations to resume on the original basis no matter how long the interruption or how great the changes in circumstances.58 honnold also states that the rejection of the first norwegian proposal does not mean that article 79 could not be applied when economic circumstances have changed greatly due to a radical change in circumstances. thus, a change in economic circumstances can, according to honnold, result in an exemption from liability also after the impediment has ceased to exist. the rejection of the norwegian proposals shows, according to honnold, that article 79 governs the question of economic hardship.59 schlechtriem’s view supports the one of honnold. schlechtriem states that “ it is imperative to treat radically changed circumstances as “ impediments” under article 79 in exceptional cases in nordic journal of commercial law issue 2006 #1 60 schlechtriem 1986, p. 192 note 422a. also sandvik 2004, p. 93 note 66, who is of the opinion that schlechtriem thus commits the same act as he himself has apprehensions for, i.e. lets national law influence the interpretation of the convention. sandvik regards schlechtriem’s interpretation as being close to the german doctrine of “ wegfall der geschäftsgrundlage” . 61 schlechtriem 1986, p. 102 note 423. 62 nicholas 1984, p. 17-18. 63 kritzer 1989, p. 509. 64 jenkins 1998, p. 2024. 65 flambouras 2001, p. 277. 66 sandvik 2004, p. 96. 16 order to avoid the danger that courts will find a gap in the convention and invoke domestic laws and their widely divergent solutions” .60 according to schlechtriem, changed circumstances as such can constitute relevant impediments. schlechtriem states that the deletion of the word “ only” makes clear that it is possible that a new impediment occurs in the form of changed circumstances after the original impediment has ceased to exist.61 schlechtriem argues his view that the convention governs hardship with the convention’s aim to promote uniformity in the contracting states. also nicholas emphasizes the deletion of the word “ only” . he argues that the deletion was made with the intent to allow for an exemption even after the impediment has ceased to exist. nicholas states that article 79(3), which has the wording “ the exemption provided by this article has effect for the period during which the impediment exists” , should be read as:62 “ the exemption has effect for the period during which the impediment exists and may have permanent effect if after the impediment has ceased to exist the circumstances have so radically changed that it would be manifestly unreasonable to hold the non-performing party liable.” nicholas admits that this interpretation might be regarded as the most meaningful deletion of one word ever. nicolas also argues that it is hard to imagine that a court would interpret the article in such manner without being familiar with the travaux préparatoires. in my opinion the suggested interpretation would be hard to reach even if one were familiar with the travaux préparatoires. according to the above views, a permanent exemption is possible when circumstances have changed in such a manner during the existence of the original impediment that the changed circumstances shall be regarded as a new impediment justifying a continued, permanent exemption. kritzer is, on the other hand, of the opinion that the cisg does not provide for an exemption based on radically changed circumstances.63 jenkins argues that article 79 expresses a traditional view of pacta sunt servanda and does not govern hardship but only situations where performance has become impossible due to changed circumstances.64 flambouras states that the majority’s view is that hardship is not covered under the cisg. according to him, the cisg does not adopt the doctrine of clausula rebus sic stantibus and that events such as a sudden increase in the price of raw materials or a dramatic devaluation of currency will not allow the seller to avoid liability for non-delivery of the goods or to require renegotiation of the contract terms.65 sandvik states that the question is solved so that the cisg does not allow for the consideration of changed circumstances after the impediment has ceased to exist unless the parties have otherwise agreed.66 an acceptance of the first norwegian proposal would without doubt have made the interpretation of article 79 more comprehensible. to interpret the second norwegian proposal as having the nordic journal of commercial law issue 2006 #1 17 same content as the first norwegian proposal seems like a dangerous attempt at forcing a certain meaning into the provision. it is in the author’s view hard to comprehend how such an interpretation would be possible. neither the first norwegian proposal nor an explicit article on hardship was accepted. furthermore, when the first norwegian proposal was rejected an explicit fear was expressed for introducing the théorie de l'imprévision or the doctrine of frustration into the convention. is it possible that the rejection of the proposed provisions means that the convention nevertheless contains the content of the proposed provisions and thereby provisions similar to the doctrines that the drafters expressly did not want to include? would an opposite interpretation not be more logical? since the proposed provisions were not accepted, the drafters did not want to include such provisions or their meaning into the convention. it is important to note that the first norwegian proposal was rejected largely due to a fear of introducing a doctrine of changed circumstances into the convention. no actual statements were made concerning the second norwegian proposal. hence, it is hard to see that the drafters of the convention would have intended that the contents of the first norwegian proposal would have been accepted in the words of the second proposal. on the other hand, the deletion of the word “ only” should be given some effect. otherwise a vote concerning a meaningless word with no effect on the interpretation of the provision has been taken at the diplomat conference. this alternative does not seem logical either. the bottom line is that the meaning of the second norwegian proposal simply cannot be established with the help of the travaux préparatoires and legal literature. it is unfortunate that there is no clarifying case law concerning the question. with regard to the fact that many of the legal scholars who seem to be of the opinion that the deletion of the word “ only” is meaningful participated in the drafting of the convention themselves, one would believe that the deletion actually is of great significance. these persons ought to have the best understanding of the meaning of different decisions. on the other hand, these scholars have not been able to argue their interpretation in an unambiguous way. it is fully possible that these scholars express their personal view on how the convention should be interpreted regardless of the objective meaning of the change in article 79(3). it must be noted that the persons who later have expressed their support for taking changed circumstances into account are mainly the same persons who voted in favour of the first norwegian proposal. 2.3. exemption from damages and the obligation to perform article 79(5) states that “ nothing in this article prevents either party from exercising any right other than to claim damages under this convention” . hence, it appears that article 79 only applies on a party’s liability in damages. the party exempt from damages still seems to be obligated to perform the contract if this is required by the other party. also the right to avoid the contract, the right to price reduction and the right to claim interest remain. what does this mean with regard to situations of hardship? typical solutions on situations of hardship are adaption or termination of the parties’ obligations. if the obligation to perform remains, a party that is exempt from liability nevertheless is obliged to perform the contract, even though the obligation to perform is somewhat thinned by the fact that liability in damages does not exist as a remedy anymore. this arrangement has been criticized. scholars are worried that the nordic journal of commercial law issue 2006 #1 67 among others tallon 1987, p. 589 and sandvik 2004, p. 38. 68 honnold 1999, p. 227. 69 honnold 1999, p. 494-495. 70 liu 2005 a, point 8.6. 71 sandvik 2004, p. 38-39 and 92. 72 unilex d. 11 december 1998 (italy, corte di apello di milano). 18 exemption from damages becomes only illusionary if the non-breaching party nevertheless is entitled to claim specific performance. furthermore, it has been pointed out that the right to claim a specific performance is illogical if the performance has become impossible.67 it is vital, however, to notice the importance of cisg article 28 in this context. according to article 28 “ if, in accordance with the provisions of this convention, one party is entitled to require performance of any obligation by the other party, a court is not bound to enter a judgement for specific performance unless the court would do so under its own law in respect of similar contracts of sale not governed by this convention” . for example, under finnish law the problem is thus solved, as the finnish sale of goods act contains in its section 23 a provision stating that the seller is not obliged to perform if a relevant impediment exists or if it were unreasonable to demand performance. further, the finnish act on contracts contains a provision allowing for adaption of contracts in this type of situations. however, the problem still remains at least partly. it is clear that cisg article 28 makes the otherwise rigid rule on specific performance softer.68 in practice article 28 means that a claim for specific performance often is without effect. however, the problem remains at least in theory. honnold argues that it would be inconsistent with the basic provision that a party is not liable when performance is barred by an impediment, to read article 79(5) as to say that a party who is entitled to an exemption from damages could nevertheless be required to perform. furthermore, honnold argues that in many cases an action to require performance would call for an impossibility and that there is no indication that the legislators intended such an absurd result.69 liu reasons that it would be contrary to good faith and the intention of the parties if a party could be demanded to perform even if it is exempt from damages.70 on the other hand, some scholars argue that the above presented interpretation is prevented by considering an exemption from specific performance as contrary to the convention’s principles of a party’s responsibility for everything in its control. this controversy with the convention’s principles would further prevent a national court from exempting a party from its obligation to perform.71 however, case law suggests the opposite. in unilex d. 11 december 1998 the court held that the principle of good faith laid down in cisg article 7(1) precludes the possibility of taking into account any impediments to perform. according to the court, the matter should be settled, under cisg article 7(2), in conformity with the law otherwise applicable to the contract by virtue of the rules of private international law.72 the court seems to have been of the opinion that the question of exemption from specific performance is a question governed by the cisg, but not expressly settled by it, and that there are no general principles in the cisg that could solve the question. a west-german proposal was made during the work on the convention according to which a party exempt from liability for damages also would be exempt from his obligation to perform. the proposal was, however, rejected. the reasons for the rejection were several. for instance, the drafters were worried that an acceptance of the proposal would also result in that other nordic journal of commercial law issue 2006 #1 73 schlechtriem 1986, p. 102-103. 74 kritzer 1989, p. 103. 75 schlechtriem 1986, p. 103. 19 obligations, such as the obligation to pay interest, would be abandoned.73 the general opinion during the work on the convention was that impossible performances would not be demanded in the future and in any case not be adjudicated by courts.74 an acceptance of the west-german proposal would without doubt have clarified the situation. an interpretation of article 79(5) as also allowing an exemption from the obligation to perform can be regarded as expedient. however, if such an interpretation was the drafters’ purpose, the wording of article 79(5) has failed miserably. if courts interpret the article in such a manner, a party’s legal safety can be endangered, as such an interpretation is hard to be reached on the basis of the wording of article 79(5). in a situation of hardship specific performance is not impossible. hence, the possibility to claim specific performance even when the party in breach is exempt from liability in damages is of greater importance in situations of hardship than in situations of impossibility. presuming that article 79(3) is interpreted as allowing for an exemption even after the impediment has ceased to exist but circumstances have changed radically during its existence, and presuming that article 79(5) is interpreted as preventing a claim for specific performance when a party is exempt from liability; a party suffering hardship could in exceptional cases be exempt from both damages and the obligation to perform. if the interpretation in the case referred to above is correct, the question of specific performance is one that shall be solved in accordance with national law. for example, under german law, a party could then be exempt from his obligation to perform.75 if, on the other hand, article 79(3) is interpreted as not allowing for a continued exemption after the impediment has ceased to exist, article 79(5) is of lesser importance and a party is naturally obliged to perform when the impediment ceases to exist. the problems concerning article 79(5) are thus in connection with long lasting and permanent impediments. 3. gap filling – is there a gap in the cisg concerning hardship? the question whether hardship is governed by article 79 is of great importance. if the cisg neither regulates hardship in article 79 nor as a breach of contract (in situations of nonperformance), the result is that there is a gap in the cisg concerning hardship and that other provision then can be applied. these situations are referred to as gap filling, i.e. a gap in the cisg is filled with the convention’s general principles or with national law. the provision on gap filling is found in cisg article 7(2): “ questions concerning matters governed by this convention which are not expressly settled in it are to be settled in conformity with the general principles on which it is based or, in the absence of such principles, in conformity with the law applicable by virtue of the rules of private international law.” as the situation concerning hardship is unclear, a theoretically easy solution could be found by solving the problem with the help of article 7(2). if one finds that hardship is governed by the cisg but not expressly settled in the convention, the problem shall be solved in accordance with the cisg’s general principles. some of these principles are spelled out in the convention, such as nordic journal of commercial law issue 2006 #1 76 e.g. articles 8, 25, 35 and 79. 77 e.g. articles 19, 25, 49 and 71. 78 bonell 1987, p. 80-82. 79 as an example for a contract provision concerning this, bonell (bonell 2000, p 97) has suggested “ this contract shall be governed by the cisg, and with respect to matters not covered in this convention, by the unidroit principles of international commercial contracts” . 80 bonell 2000, p. 97. 81 even though he has also stated that changed circumstances should in exceptional cases be treated as impediments under article 79 in order to prevent finding a gap in the convention. 82 this is a very interesting interpretation by schlechtriem as he has also been of the opinion that the cisg governs hardship, i.e. the opposite (as referred to above). 83 transcript of a workshop on the sales convention, p. 236. 20 the principle of good faith in the interpretation of the convention. however, most general principles have to be extracted from articles governing specific questions, e.g. the reference to a “ reasonable person” that can be found in several articles76 and the principle of favour contractus.77 the convention’s general principles shall be found in the convention itself or in internationally accepted general principles. resort to national principles is not possible.78 scholars often argue that international principles such as the pecl or the unidroit principles could be used to complement the cisg and to fill possible gaps in the cisg. how international principles could fill a gap in the cisg seems to remain somewhat unclear. according to article 7(2), questions concerning matters governed by the cisg which are not expressly settled in it are to be settled in conformity with the general principles on which the cisg is based or, in the absence of such principles, in conformity with the law applicable by virtue of the rules of private international law. where do international principles fit in this system? if the contracting parties have agreed that e.g. the unidroit principles shall fill possible gaps in the cisg, the principles would be applicable79, but this would require that the parties have so agreed. the principles are then part of the contract between the parties. bonell argues that help and guidance in finding the convention’s general principles could be sought in the unidroit principles. he points out that the only requirement for applying a provision in the unidroit principles is that the provision is an expression of a general principle in the cisg.80 is there a gap in the cisg concerning hardship? schlechtriem has expressed that he takes a liberal view on finding gaps in the convention.81 he states that a gap could be found in the cisg concerning hardship and that the gap could be filled with the convention’s general principles.82 he argues that the principle of good faith and fair dealing then presumes that both parties try to adapt the contract to unpredictable and unforeseen changed circumstances.83 this argumentation contains, however, several problems. firstly, schlechtriem assumes that the principle of good faith and fair dealing is one of the principles that the convention is based on, even though article 7(1), which expressly refers to good faith and fair dealing, only concerns the interpretation of the convention. secondly, even if this principle were one that the convention is based on, there is no indication that the principle would include an obligation for the parties to adapt the contract to changed circumstances. what this principle is regarded to contain is largely dependent on the interpreter and the interpreter’s legal background. further, schlechtriem argues that the provision in article 50 concerning price reduction could be read as including a general principle allowing for an adaption of the contract in situations of hardship, i.e. in situations of changed circumstances after the impediment has ceased to exist. the provision on price reduction can according to schlechtriem be read as an adaption of the contract nordic journal of commercial law issue 2006 #1 84 transcript of a workshop on the sales convention, p. 235-236. schlechtriem points out, however, that according to his view the question of hardship was during the work on the convention considered as one covered in the convention, wherefore the existence of a gap could be questioned. 85 sandvik 2004, p. 93. 86 slater 1998, p. 253-254. 87 slater 1998, p. 260. 21 after the balance between the contractual obligations has been disturbed. the non-conformity in the performance (article 50) also causes an imbalance between the contractual obligations. the price reduction amends this imbalance, i.e. the relationship between performance and counterperformance.84 also this argumentation can be criticized. sandvik points out that this reasoning allows for the adaption of contracts in accordance with the german doctrine of “ wegfall der geschäftsgrundlage” , according to which a contract shall be adapted if it were unreasonable to claim performance in accordance with the original contract.85 schlechtriem’s argumentation can thus be considered as influenced by national law, which he himself stresses that must be avoided. with reference to schlechtriem’s above presented theory regarding a general principle on adaption, the hardship provisions in the unidroit principles could be seen as an expression of the general principle of adaption in the cisg and, hence, as applicable presuming that the cisg contains a gap concerning hardship. this argumentation would build on schlechtriem’s theory of a general principle on adaption and bonell’s theory that provision in the unidroit principles can be applied if they express a general principle of the cisg, even if the parties have not agreed on the application of the principles. such theories are, however, far fetched and in my view not possible in practice. also slater argues that the cisg contains a gap concerning hardship. he states that “ although there is no consensus on the issue, many courts and scholars believe that the term “ impediment” as contained in article 79 does not extend so far as to encompass hardship” . he also argues that the legislative history of the convention supports this view. slater argues that a glance at the text of article 79 reveals that the term “ hardship” is not expressly included in its language. nor is hardship explicitly excluded from the cisg’s coverage. it is according to slater, therefore, plausible to contend that the convention has a marked gap concerning hardship and that this gap can easily be filled by the detailed hardship provisions of the unidroit principles.86 slater concludes, however, that the above presented arguments are not durable. he states that despite some wishful thinking on the part of commentators in civil law nations, the unidroit principles are not general principles on which the cisg is based. there is thus a discrepancy between the above presented view of bonell and that of slater. the question whether the cisg governs hardship remains unsettled. slater argues that the general principle favouring performance of contracts where feasible suggests that no hardship remedy is available for contracts governed by the cisg, as performance is feasible in these instances. if, however, a tribunal considering the issue fails to ascertain this general principle, it must, under article 7(2), look to the domestic law applicable via conflict of laws rules. this course presents a much greater likelihood of relief for a party facing hardship since many nations provide some remedy for this predicament.87 nordic journal of commercial law issue 2006 #1 88 tallon 1987, p. 591-592. 89 rimke 2000, p. 218. 90 in the unilex database 19 cases concerning article 79 are found, but only 3 concern hardship. 91 krüger 1999, chapter 4. 92 compare this with the doctrine of “ wegfall der geschäftsgrundlage” in germany that builds on the principle of good faith (“ treu und glauben” ). 22 since the situation is unsettled there is a risk that courts find a gap concerning hardship in the cisg and apply national law instead of the cisg.88 the temptation is even bigger as many national laws contain rules on the effect of hardship on the trade of goods. even if courts do not find a gap in the cisg, they have a natural tendency to interpret article 79 in the light of their national law. it has been stated that “ article 79 is a chameleon-like example of superficial harmony” and that it is possible to interpret the article so that it suits the interpreters’ background the best.89 one of the problems seems to be that there is no actual case law concerning the question that would set aside the national solutions.90 krüger emphasizes that article 79 must be read as an independent rule free from national contract laws. in particular w h e r e n a t i o n a l l a w s h a v e c r e a t e d d o c t r i n e s s u c h a s “ i m p r é v i s i o n ” , “ w e gf al l de r geschäftsgrundlage” and “ bristende forutsetninger” .91 in countries where different rules exist side by side for situations of impossibility and situations of changed circumstances, it might be natu ral to interpret article 79 as only concerning impossibility. in that case the question of changed circumstances would be solved in accordance with the general principle of “ good faith” .92 tallon regards such a solution as unacceptable. he points out that the principle of “ good faith” cannot be used to set aside explicit provisions of the convention. furthermore, uniformity would be endangered if this principle was the ground for a doctrine of changed circumstances. another risk is that it is held that the question of changed circumstances has not been expressly solved in the convention and that the solution cannot be found in the convention’s general principles, opening a door for the application of national laws. tallon is of the opinion that the convention has opted for a unitary conception of an exemption and has thus, even if this choice may be criticized, set aside the theory of changed circumstances and thus solved the question whether changed circumstances are governed under article 79. an italian court has ruled that the effect of hardship is not governed by the convention. in other words, economic impediments for performance cannot under the cisg be a ground for an exemption after the impediment has ceased to exist. the court also held that the cisg does not contain a gap with regard to hardship: unilex d. 14 january 1993 (italy, tribunale civile di monza). an italian seller and a swedish buyer concluded in february 1988 a contract for the sale of 1,000 metric tons of metal (ferrochrome). the seller did not deliver the goods. the seller claimed avoidance of the contract for hardship (‘eccessiva onerosità sopravvenuta’) since the price of the goods had increased between the time of the conclusion of the contract and the time fixed for delivering by approximately 30%. the court held that cisg did not apply. in the court’s opinion, even if cisg had applied, the seller could not have relied on hardship as a ground for avoidance, as cisg does not contemplate this as a remedy either in article 79 or elsewhere. a domestic court could not integrate into cisg provisions of domestic law granting avoidance for hardship, as hardship is not a matter which is expressly excluded from the scope of the convention by article 4 cisg. nordic journal of commercial law issue 2006 #1 93 sandvik 2004, p. 96. 23 in case unilex d. 14 may 1993 (germany, landgericht aachen) the court held that “ the application of cisg precluded the recourse to domestic law regarding mistake as to the quality of the goods and regarding ‘wegfall der geschäftsgrundlage’, being these matters exhaustively covered by cisg” . in unilex d. 12 june 2001 (france, cour d’appel de colmar) a swiss seller and a french buyer concluded a framework agreement whereby the former undertook to supply a certain quantity of goods to the latter. under the contract the goods had to be delivered over a period of eight years depending on the needs of the final customer to whom the goods had to be resold. faced with the final customer’s decision to reduce the repurchase price, the buyer refused to take delivery of most of the goods. the court held the buyer liable for breach of contract under cisg (article 61 cisg). in reaching this conclusion, the court rejected the buyer’s argument that its decision not to take delivery of goods was caused by an event beyond its control and unpredictable at the time of conclusion of the contract (article 79 cisg). not only was the reduction of the repurchase price by the final customer predictable at the time of conclusion of the contract, but it was up to the buyer, who was aware of entering into a long-term business relationship, to provide for mechanisms of renegotiation for the case of changes of circumstances (i.e. by including a hardship clause in the contract). it must, however, be noted that the tribunals have not made a clear distinction between the obligation to overcome the impediment and the possibility for a continued exemption due to changed circumstances after the impediment has ceased to exist. the cases referred to above could as well be regarded as concerning the questions of the intensity of the impediment and the limit of sacrifice.93 the solution regarding the question whether article 79 governs economic impediments and hardship could with the above arguments in short be the following: also economic impediments can in exceptional cases be regarded as relevant impediments. regarding the obligation to overcome the impediment and its consequences the evaluation shall be made in casu, but the evaluation is strict towards an exemption from liability. the question is how extensive economic sacrifices can be required of a party in order to overcome the impediment. after the impediment has ceased to exist a party is, with the risk of being liable in damages, obligated to perform unless the other party has not avoided the contract. an extended exemption is thus not possible in my view after the impediment has ceased to exist. v. conclusions there is a danger that a presentation on changed circumstances and hardship in the international sale of goods is only a list of different scholars’ vague thoughts on the topic and that the reader does not get a clear picture of the writer’s own interpretation. it is easy to state that the situation is unclear, but this is of no avail to anyone, especially not when a solution shall be found in a practical situation. it is apparent that the flexible terms of article 79 will always leave considerable room for judicial appraisal and different views can well be argued. personally the author is of the nordic journal of commercial law issue 2006 #1 24 opinion that hardship is governed by the convention and that a gap allowing for the application of national laws cannot be found. the convention cannot be complemented by e.g. the unidroit principles that otherwise are intended to complement the cisg, unless the parties have so agreed. an interpretation of article 79(3) as allowing for an exemption after the impediment has ceased to exist is in my view unacceptable. the fact that the first norwegian proposal that would have allowed this was rejected cannot mean that the content of this proposal was accepted in the words of the second proposal. especially as this has not been expressed in any way during the work on the convention and as the wording of the accepted article 79(3) in no way suggests such an interpretation. even though the legislative history can be of guidance in the interpretation of the article, the most important question is not which alternatives were discussed during the work on the convention, but the wording and meaning of the final version of the text. different arguments concerning the relationship between hardship and article 79 have been presented above. there are several arguments for the view that the cisg governs hardship and even includes a possibility to adapt the contract, as well as for the view that the cisg does not govern hardship at all and that the question should be solved with the help of national law. these two alternatives can be regarded as opposites. it is noteworthy that both views have gained wide support and that even one and the same scholar has supported both alternatives. that the same scholar expresses support for both views could mean that the scholar has changed position or that he regards both alternatives as possible, but it is more likely that the scholar’s arguments shall be regarded as alternative ways to interpret article 79 and that these interpretations shall be regarded as openers for a wider discussion. the large number of different arguments, all of which can be considered as more or less justifiable, makes it much more difficult to clarify the content of article 79. in many cases scholars’ arguments are so vague that they very well can be interpreted to fit different situations and to mean different things. it is evident that many scholars have an urge to either find a gap in the cisg concerning hardship or an urge to interpret article 79 so that the article governs hardship and makes a permanent exemption possible. such an urge is understandable and is most probably a result of the fact that one of these solutions would be hoped-for and appropriate. the author’s own interpretation, in other words the notion that the cisg governs hardship but does not allow for a permanent exemption, is not well-suited in practice as this interpretation results in an inflexible system that only allows an exemption in cases of impossibility. this is an inappropriate interpretation for tradesmen whose contract is governed by the cisg and also unsuitable for modern international trade. provisions that allow for an exemption only in cases of impossibility can neither be regarded as modern nor functional. such provisions do not reflect the principles of loyalty or favour contractus. the fact that the above presented interpretation is not desirable to all parts does not mean that it is wrong. the problem is that the convention has on this part been drafted in a manner that leaves room for enhancement. the interpretation of the article cannot be entirely dependent on which solution would be the best solution for international trade or a desirable solution on the problem of changed circumstances. such a target-oriented interpretation, in which the article is interpreted so that a pre-determined target is reached, is unacceptable. nordic journal of commercial law issue 2006 #1 25 it must be ascertained and accepted that the convention contains a weak spot concerning the relationship between hardship and article 79. this is, however, not a problem as long as it is realized. an express goal in the convention is according to article 7(1) its uniform application. the interpretation of article 79 could be done with an aim to interpret the article so that a uniform application of the convention is best reached. an interpretation that reaches this goal could appropriately be considered successful and purposeful. an interpretation of article 79 resulting in a gap in the cisg concerning hardship would not promote this goal. in that case the question of hardship would be settled in conformity with the general principles on which the convention is based or, in the absence of such principles, in conformity with the law applicable by virtue of the rules of private international law. both alternatives would result in a great range of solutions. if the question could be settled in accordance with the convention’s general principles, the guidance received from the general principles would in any case be vague and make several different solutions possible. also an application of national laws would result in inconsistency. undeniably the application of the convention would then be uniform, i.e. the convention contains a gap concerning hardship that shall be filled with national law, but the solutions on the question of hardship would be divergent and entirely dependent on which law happens to be applicable by virtue of the rules of private international law. neither would an interpretation of article 79 allowing for a permanent exemption from liability, and possibly also from specific performance, support a uniform application of the convention. in that case article 79 would constitute an extremely vague provision for changed circumstances, the interpretation of which would likely be influenced by rules on changed circumstances in the interpreters’ own national law. the presented interpretation can, however, be regarded as supporting the goal of a uniform application relatively well, wherefore the interpretation can be regarded as successful. that article 79 governs hardship but does not consider changed circumstances as an impediment, means that the question has been settled in a uniform manner. another question is, however, as stated above, that this solution is not hoped-for with regard to practical situations and the strive for flexibility in contractual relations. as more or less all questions concerning hardship and article 79 are unsettled and as the views differ greatly, the interpretation of article 79 in a practical case is far from certain. hence, it is recommendable that the contracting parties agree on the procedure if faced with hardship and do not leave questions of hardship to be settled under article 79. the contracting parties can in their sales contract agree on a suitable manner of proceedings in case of hardship, or by reference to the unidroit principles or the pecl transfer the question of hardship to one of these principles containing clear and functional provisions on the matter. one of the big problems concerning hardship and article 79 is that still, 18 years after the cisg came into force, there is no broad case law concerning the question. especially regarding article 79, which often is referred to as the most unsuccessful part of half a century’s work, clarifying case law would be of avail. nordic journal of commercial law issue 2006 #1 26 the fact that an explicit provision on hardship has been included into more recent regulations implies that there is a need for such a provision. there must be an explicit provision on hardship in order to find a desirable solution on the problem of changed circumstances, unless a general clause on adaption (as in nordic law) exists. regarding the cisg, one of the problems might have been the large number of drafting states and the problem to reach uniformity among the drafters. it is uncertain what to expect on the question of hardship and article 79 in the future. one can only hope for more case law that would clear the situation. it is also possible that the unidroit principles, containing an explicit hardship clause, will become more important in the future. both the unidroit principles and the pecl contain solutions on the problems of changed circumstances and hardship in the international sale of goods that can be regarded as adequate for the needs of modern contract law. nordic journal of commercial law issue 2006 #1 27 bibliography bonell, michael joachim, article 7-interpretation of the convention, p. 65-94, in commentary on the international sales law, the 1980 vienna sales convention, bianca m. & bonell m.j, giuffrè-milan, milan 1987 (bonell 1987) bonell, michael joachim, unidroit principles of international commercial contracts and the united nations convention on contracts for the international sale of goods – alternatives or complementary instruments?, business law international 2000, p. 89-98, (bonell 2000) d’arcy, leo, murray, carole & cleave, barbara, schmitthoff’s export trade: the law and practice of international trade, sweet and maxwell limited, london 2000 (d’arcy, murray, cleave 2000) enderlein, fritz & maskow, dietrich, international sales law, united nations convention on contracts for the international sale of goods, oceana publications 1992, (enderlein, maskow 1992) flambouras, dionysios p., the doctrines of impossibility of performance and clausula rebus sic stantibus in the 1980 vienna convention on contracts for the interntional sale of goods and the principles of european contract law: a comparative analysis, 13 pace international law review (fall 2001), p. 261-293 (flambouras 2001) gomard, bernhard & rechnagel, hardy, international köbelov, juristog ökonomforbundets forlag, gylling 1990 (gomard, rechnagel 1990) hellner, jan & ramberg, jan, speciell avtalsrätt i, köprätt, juristförlaget, stockholm 1989 (hellner, ramberg 1989) honnold, john, documentary history of the uniform law for international sales, kluwer law and taxation publishers, deventer/netherlands 1989 (honnold 1989) honnold, john, uniform law for international sales under the 1980 united nations convention, kluwer law and taxation publishers, deventer/netherlands 1989 (honnold 1989 a) honnold, john, uniform law for international sales under the 1980 united nations convention, 3rd edition, kluwer law and taxation publishers, the hague 1999 (honnold 1999) hudson, a.h., exemptions and impossibility under the vienna convention, in force majeure and frustration of contract, ed. ewan mccendrick, p. 175-194, lloyd's of london press ltd., london/england 1991 (hudson 1991) jenkins, sarah howard, exemption for nonperformance: ucc, cisg, unidroit principles a comparative assessment, 72 tulane law review (1998) 2015-2030 (jenkins 1998) journal of law & commerce, transcript of a workshop on the sales convention: leading cisg scholars discuss contract formation, validity, excuse for hardship, avoidance, nachfrist, contract interpretation, parol evidence, analogical application, and much more, journal of law & commerce 1999, p. 191-258 (transcript of a workshop on the sales convention 1999) kritzer, albert h., guide to practical applications of the united nations convention on contracts for the international sale of goods, kluwer law and taxation publishers, boston 1989 (kritzer 1989) krüger, kai, financial force majeure, rättsvetenskapliga studier till minnet av tore almén, justus förlag, stockholm 1999, p. 239-273 (krüger 1999) lando, ole, udenrigshandelens kontrakter, 3. upplagan, jurist og ökonomförbundets forlag, copenhagen 1987 (lando 1987) liu, chengwei, force majeure; perspectives from the cisg, unidroit principles, pecl and case law [2nd edition: case annotated update (april 2005)], internet 22 september 2005, (http://cisgw3.law.pace.edu/cisg/biblio/liu6.html#fmix) (liu 2005 a) http://cisgw3.law.pace.edu/cisg/biblio/liu6.html#fmix nordic journal of commercial law issue 2006 #1 28 lookofsky, joseph, fault and no-fault in danish, american and international sales law. the reception of the 1980 sales convention, scandinavian studies in law 1983, p 107-138 (lookofsky 1983) lookofsky, joseph, understanding the cisg in scandinavia, djæf publishing copenhagen, copenhagen 1996 (lookofsky 1996) nicholas, barry, impracticability and impossibility in the u.n. convention on contracts for the international sale of goods. in galston & smit: international sales 1984, chapter 5, p. 5-1 to 5-24. (nicholas 1984) nystén-haarala, soili, the long-term contract, contract law and contracting, kauppakaari oyj, helsinki 1998, (nystén-haarala 1998) ramberg, jan, köpavtal, exportrådet av förlags ab industrilitteratur, stockholm 1993 (ramberg 1993) ramberg, jan & herre, johnny, internationella köplagen (cisg), second edition, norstedts juridik ab, gothenburg 2004 (ramberg, herre 2004) rimke, joern, force majeure and hardship: application in international trade practice with specific regard to the cisg and the unidroit principles of international commercial contracts. pace review of the convention on contracts for the international sale of goods, kluwer 1999-2000, p. 197-243 (rimke 2000) routamo, eero & ramberg, jan, kauppalain kommentaari, kauppakaari oy, lakimiesliiton kustannus, helsinki 1997 (routamo, ramberg 1997) runesson, eric m., rekonstruktion av ofullständiga avtal särskilt om köplagens reglering av risken för ökade prestationskostnader, juristförlaget, stockholm 1996 (runesson 1996) sandvik, björn, säljarens kontrollansvar: skadeståndsansvarets grund och omfattning enligt köplagen och cisg, åbo akademis förlag, åbo 2004 (sandvik 2004) schlechtriem, peter, uniform sales law, the un-convention on contracts for the international sale of goods, manzsche verlagsund universitätsbuchhandlung, wien 1986 (schlechtriem 1986) secretariat commentary, guide to cisg article 79, internet 10 oktober 2003: http://www.cisg.law.pace.edu/cisg/text/secomm/secomm-79.html (secretariat commentary) slater, scott d., overcome by hardship: the inapplicability of the unidroit principles’ hardship provisions to cisg, florida journal of international law (summer 1998), p. 231-262 (slater 1998) stoll hans & gruber georg, section iv, exemptions, in commentary on the un convention on the international sale of goods (cisg). ed. peter schlechtriem and ingeborg schwenzer, p. 806-844, second english edition, oxford 2005 (stoll, gruber 2005) tallon, denis, section iv. exemptions, p. 572-596, in commentary on the international sales law, the 1980 vienna sales convention, bianca m. & bonell m.j, giuffrè-milan, milan 1987 (tallon 1987) unidroit, unidroit principles of international commercial contracts 2004, international institute for the unification of private law, rome 2004 (unidroit 2004) wilhelmsson, thomas, sevón, leif & koskelo, pauliine, huvudpunkter i köplagen, second edition, kauppakaari oyj, helsinki 1999 (wilhelmsson, sevón, koskelo 1999) zeller, bruno, damages under the convention on contracts for the international sale of goods, oceana publications 2005 (zeller 2005) http://www.cisg.law.pace.edu/cisg/text/secomm/secomm-79.html nordic journal of commercial law issue 2006 #1 29 government decree reg. prop. 198/1986 till riksdagen om godkännande av vissa bestämmelser i konventionen angående avtal om internationella köp av varor case law unilex d. 14.1.1993, tribunale civile di monza, nuova fucinati s.p.a v. fondmetal international a.b, italy. unilex d. 14.5.1993, landgericht aachen, nummer 43 o 136/92, germany. unilex d. 2.5.1995, rechtbank van koophandel, hasselt, nummer ar 1849/94, vital berry marketing nv v. dira-frost nv, belgium. unilex d. 28.2.1997, oberlandesgericht frankfurt, nummer 1 u 167/95, germany. unilex d. 11.12.1998, corte di apello di milano, bielloni castello s.p.a. v. ego s.a., italy. unilex d. 12.6.2001, cour d’appel de colmar, france. florida power & light co. v. westinghouse electric corp., 510 so.2d 899 (fla. 1987) liuchang.pmd nordic journal of commercial law, issue 2004 #1 1 comparison of cisg article 27 and counterpart notice provisions of the unidroit principles and pecl chengwei liu* nordic journal of commercial law issue 2004 #1 nordic journal of commercial law, issue 2004 #1 2 for the purpose of this discussion, the “notices” discussed below cover the whole range of notices, declarations and other communications.1 -form of notice -cisg approach -receipt principle as general rule -the dispatch principle for cases of default form of notice a. as for the form of the notice, the cisg is silent on whether the notice must be in writing or can be presented orally. although one may submit that art. 27 does not include a rule for oral declarations,2 it seems more appropriate to conclude from the convention’s “informality principle” as contemplated in art. 11,3 that generally there are no formal requirements for the notice under the convention and it can be oral or written. this “informality principle” regarding the notice is clearly adopted under each of the two sets of principles: in art. 1.9(1) of the unidroit principles of international commercial contracts. and pecl art. 1:303(1), respectively. in other words, it is the principle that notices or any other kinds of communication of intention (declarations, demands, requests, etc.) required by individual provisions of the two sets of principles are not subject to any particular requirement as to form, but may be given by any means appropriate in the circumstances.4 however, this informality principle does not apply if the contract, usages or practices provide otherwise.5 b. on the other hand, it would not be consistent with good faith and fair dealing for a party to rely on, for instance, a purely casual remark made to the other party. the comments to the pecl provide that: “for notices of major importance written form may be appropriate.”6 as an example, while notice by telephone may suffice, it can be harder to prove than written notice. particular care will have to be taken when choosing the means for communication of such an important decision as avoidance. all three texts require that the notice be given by means appropriate in/to the circumstances. which means are appropriate will depend on the actual circumstances of the case, in particular on the availability and the reliability of the various modes of communication, and the importance and/ or urgency of the message to be delivered. thus, if the postal service is unreliable, it might be more appropriate to use fax, telex or other forms of electronic communication for a communication which has to be made in writing, or the telephone if an oral communication is sufficient. in choosing the means of communication, the sender must as a rule take into account the situation which exists both in its own and in the addressee’s country.7 c. in short, notices may be made in any form — orally, in writing, by telex, by fax or by electronic mail, for example — provided that the form of notice used is appropriate to the circumstances.8 a communication is appropriate to the circumstances, if it is appropriate to the situation of the parties. however, a means of communication which is appropriate in one set of circumstances may not be appropriate in another set of circumstances.9 on the other hand, there may be more than one means of communication which is appropriate in the circumstances. in such a case, the sender may use the one which is the most convenient for him.10 cisg approach nordic journal of commercial law, issue 2004 #1 3 d. a number of scholars interpret the rule in art. 27 cisg as an acceptance of the dispatch theory. without reference to the veracity of such a proposition, it can never be concluded that art. 27 establishes the general dispatch principle for the whole cisg. this is firstly for the fact that art. 27 only applies to part iii of the cisg. unlike the declarations covered in part iii, part ii declarations are, for the most part, expressly regulated under the receipt theory.11 secondly, part iii of the convention contains exceptions to this rule in cases where it was considered that communication ought to be received to be effective (official records [o.r.], 27).12 as clarified by the secretariat commentary, the general rule in art. 27 that the risk of delay, error or loss in respect of a communication is to be borne by the addressee arises out of the consideration that it is desirable to have, as far as possible, one rule governing the hazards of transmission.13 one advantage of the rule is that at least a clear and unequivocal solution has been found for the question which was generally left open by the hague sales and formation conventions, ulf and ulis, the antecedents to the cisg.14 e. the theory of dispatch would be useful where a party fulfilled an obligation or required remedy for a loss; not, however, where it served to substantiate an obligation for the other party (o.r., 303). thus, under the convention, as with most part ii declarations on offer and acceptance, the legal effectiveness of part iii declarations regulated under articles 47(2), 48(4), 63(2), 65(1), 65(2), and 79(4) is tied to the moment of receipt. one way to treat these declarations is to rule that the declaring party is bound from the moment that his declaration is received, but also to allow him to withdraw or change his declaration up until this moment.15 however, on the other hand, it was believed that acceptance of a generalized receipt theory would have required that the convention contain supporting procedural rules to establish whether a notice had in fact been received by the addressee since legal systems which operate on the theory that notices are effective on dispatch often do not contain such supporting rules.16 as a result, it is not very clear whether a general dispatch or a general receipt has been established under the convention. receipt principle as a general rule f. by contrast with the cisg’s ambiguity with regard to the general principle, both the unidroit principles and the pecl adopt the receipt principle as a general rule. unidroit principles art. 1.9(2) stipulates that “[a] notice is effective when it reaches the person to whom it is given”. similarly, art. 1:303(2) pecl states pertinently that “any notice becomes effective when it reaches the addressee.” it is important in relation to the receipt principle to determine precisely when the communications in question “reach” the addressee. in this respect, both art. 1.9(3) of the unidroit principles and pecl art. 1:303(3) follow in substance the rule in cisg art. 24.17 in an attempt to define the concept, unidroit principles art. 1.9(3) draws a distinction between oral and other communications. the former “reach” the addressee if they are made personally to it or to another person authorized by it to receive them. the latter “reach” the addressee as soon as they are delivered either to the addressee personally or to its place of business or mailing address. the particular communication in question need not come into the hands of the addressee. it is sufficient that it be handed over to an employee of the addressee authorized to accept it, or that it be placed in the addressee’s mailbox, or received by the addressee’s fax, telex or computer.18 in other words, as confirmed by pecl art. 1:303(3), it is not necessary that the notice should actually have come to the addressee’s attention provided that it has been delivered to him in the normal way, e.g., a letter placed in his letter box or a message sent to his telex or fax machine.19 g. a plain understanding of the receipt principle is that a party cannot rely on a notice sent to the other party unless and until the notice reaches that party.20 a most practical importance of this receipt concept is the ability of the declaring party to withdraw or change his declaration at any time prior to the time of receipt. accordingly, pecl art. 1:303(5) expressly sets out that “a notice has no nordic journal of commercial law, issue 2004 #1 4 effect if a withdrawal of it reaches the addressee before or at the same time as the notice.” without a similar counterpart, such a rule seems to be implied by the general receipt principle established in unidroit principles art. 1.9(2). similarly, the risk of errors in the notice is normally placed upon the sender. however, the principle of good faith and fair dealing means that a party cannot complain that it has not received a notice, or has not received it in time, if it has deliberately evaded receiving it.21 on the other hand, as the result of practices or usages, the dispatch rule can apply. moreover, the parties are, of course, always free to expressly stipulate the application of the dispatch principle. this may be appropriate in particular with respect to the notice a party has to give in order to preserve its rights in cases of the other party’s actual or anticipated non-performance when it would not be fair to place the risk of loss, mistake or delay in the transmission of the message on the former. this is all the more true if the difficulties which may arise at international level in proving effective receipt of a notice are borne in mind.22 the dispatch principle for cases of default h. however, this rigid solution of unidroit principles art. 1.9 might lead to some unreasonable situations. particularly, many of the situations in which one party gives a notice to the other are situations in which the party to be notified is in default, or it appears that a default is likely. here, it seems appropriate to put the risk of loss, mistake or delay in the transmission of the message on the defaulting party rather than on the aggrieved party.23 it is to be mentioned that unidroit principles art. 1.9 is optional and does not eliminate the application of party autonomy. the parties are therefore at liberty to set other requirements, such as dispatch for communications to be effective.24 nonetheless, such a solution is not sufficient particularly in consideration of the complexity of international contracts. in this respect, cisg art. 27 demonstrates merit and is persuasive, for example, in the case of a notice of defects, since the seller is responsible for ensuring that the quality of goods conforms to the contract. such a persuasive solution as adopted in cisg art. 27 is also followed by pecl art. 1:303(4).25 as mentioned above, the pecl adopts the receipt principle as a general rule. at the same time, pecl art. 1:303 links this general rule to two qualifications for the operative effect of communications, one of which is set out in pecl art. 1:303(4).26 i. a notice subject to the general “receipt” principle takes effect when it is received. a notice subject to the dispatch principle may be effective even though it never arrives or is delayed, but it is not effective the moment it is dispatched. it would not be fair that even a non-performing party should be affected by a notice as from a time at which it could not have known about it. accordingly the notice takes effect only from the time at which it would normally have been received.27 in other words, in the event of loss of the communication, effectiveness occurs at the hypothetical moment of receipt under normal circumstances.28 finally, it is to be noted that the dispatch principle will not apply if the means of notice was not appropriate in the circumstances. for instance, for the dispatch principle to apply, the means chosen must be fast enough. if great speed is needed, a letter sent by airmail may not be appropriate and the sender may not rely on the fact that it was dispatched. it will be able to rely on it only if and when it arrives.29 _____________________________________________________________________ footnotes * ll.m. of renmin university of china; attorney-at-law on global law office; 37th floor, jing guang center, hu jia lou, chaoyang district; beijing 100020 china; <lexway@mail.com>. 1. the “notices” include under the convention part ii declarations and any notice, request or other communication given or made by a party in accordance with part iii (cisg art. 27); under the unidroit principles a declaration, demand, request or any other communication of intention (upicc art. 1.9(4)); under the pecl the communication of a promise, statement, offer, acceptance, demand, request or other declaration (pecl art. 1:303(6)). nordic journal of commercial law, issue 2004 #1 5 2. for instance, schlechtriem states in this respect: “unfortunately, article 27 does not include a rule for oral declarations. the wording — ‘transmission of the communication’ and ‘failure to arrive’ — makes it clear, however, that the article refers only to messages transmitted by means similar to correspondence. on the basis of article 7, it can be assumed that an oral declaration must be intelligible to those present or on the telephone; a statement that is not intelligible or not perceptible to the addressee has not been communicated by appropriate means.” peter schlechtriem, uniform sales law – the un-convention on contracts for the international sale of goods, manz: vienna (1987) fn. 14, p. 62. available online at <http://cisgw3.law.pace.edu/cisg/biblio/ schlechtriem-27.html>. 3. cisg art. 11 reads: “a contract of sale need not be concluded in or evidenced by writing and is not subject to any other requirement as to form. it may be proved by any means, including witnesses.” 4. see comment 1 on art. 1.9 unidroit principles. 5. furthermore, it is to be noted that eight states, including china, made declarations under cisg art. 96 rejecting provisions of cisg that allowed effective notification in form other than in writing — e.g., arts. 11, 12, 96. for online identification of declarations, see <http://www.uncitral.org/english/status-e.htm>. it is also to be noted that the “informality principle” has been clearly adopted by the new china contract law (e.g., art. 10).) nonetheless, even when contracting states make use of the reservation in art. 96, domestic requirements on form are only to be regarded as far as they relate to the formation of the contract, its modification or consensual termination. the precise formulation contained in arts. 12, 29 and 96 “its modification or termination by agreement” makes it clear that a one-sided declaration to terminate a contract does not fall within the scope of the reservation and the corresponding domestic regulations on form. schlechtriem, supra. fn. 5, p. 45. 6. see comment and notes to the pecl: art. 1:303. comment b. available online at <http://cisgw3.law.pace.edu/cisg/text/ peclcomp27.html>. 7. supra. fn. 4. 8. supra. fn. 6. 9. for example, even though a particular form of notice may normally be sent by airmail, in a given case the need for speed may make only electronic communication, telegram, telex, or telephone, a means appropriate “in the circumstances.” infra. fn. 10, comment 2. for guidance on electronic communications under cisg, see cisg-ac opinion no. 1. available online at <http://cisgw3.law.pace.edu/cisg/cisg-ac-op1.html>. 10. see secretariat commentary on art. 25 of the 1978 draft [counterpart of cisg art. 27], comment 3. available online at <http:// cisgw3.law.pace.edu/cisg/text/secomm/secomm-27.html>. 11. in part ii of the cisg, the legal effectiveness of an offer under article 15(1) and the legal effectiveness of an acceptance under article 18(2) are tied to the moment of receipt as defined in article 24. the same rule applies to the withdrawal of an offer (article 15(2)), the rejection of an offer (article 17), a declaration fixing a period of time for acceptance of an offer (article 20(1)), and the withdrawal of an acceptance (article 22). infra. fn. 15. article 16(1) is an exception; it turns on the common law “mailbox rule”: an offeror may not revoke an offer once the offeree has dispatched his acceptance. 12. such exceptions to art. 27 in part iii are contained in article 47, paragraph 2, and article 63, paragraph 2, in which receipt of a notice is actually already a condition for the activities of the other party caused by it; article 48, paragraph 2, article 65, paragraphs 1 and 2, and article 79, paragraph 4. see fritz enderlein, dietrich maskow, international sales law: united nations convention on contracts for the international sale of goods, oceana publication (1992), p. 119. available online at <http:// cisgw3.law.pace.edu/cisg/biblio/enderlein.html>. schlechtriem also states similarly but in more details as: “part iii of the cisg contains five articles which tie the legal effectiveness of a contract to the receipt of a buyer’s or seller’s notice. under article 47(2), a seller’s notice that he will not perform within the period fixed by the buyer becomes effective upon receipt of this notice. similarly under article 63(2), the legal effectiveness of a buyer’s notice that he will not perform within the period fixed by the seller also becomes effective upon such receipt. the same rule applies to (1) the seller’s request for clarification or notice that the buyer will perform within a specified timed; (2) the seller’s request that the buyer supply missing specifications and the seller’s notice to the buyer that he will supply such specifications if buyer fails to do so; and (3) the notice of an impediment and its effect upon a party’s ability to perform.” infra. fn. 15. 13. supra. fn. 10, comment 4. 14. schlechtriem, supra fn. 5, p. 61. 15. see peter schlechtriem in “effectiveness and binding nature of declarations (notices, requests or other communications) under nordic journal of commercial law, issue 2004 #1 6 part ii and part iii of the cisg”: cornell review of the convention on contracts for the international sale of goods (1995), pp. 95-114. available online at <http://cisgw3.law.pace.edu/cisg/biblio/schlecht.html>. 16. supra. fn. 13. 17. cisg art. 24 reads: “for the purpose of this part [part ii] of the convention, an offer, declaration of acceptance or any other indication of intention “reaches” the addressee when it is made orally to him or delivered by any other means to him personally, to his place of business or mailing address or, if he does not have a place of business or mailing address, to his habitual residence.” 18. see comment 4 on art. 1.9 unidroit principles. 19. supra. fn. 6, comment c. 20. ibid. 21. supra. fn. 19. 22. see comment 3 on art. 1.9 unidroit principles. 23. supra. fn. 6, comment d. 24. supra. fn. 22. 25. it is to be mentioned again, either cisg art. 27 or pecl art. 1:303(4) is optional; the parties are also at liberty to set other requirements, such as receipt for communications to be effective. even absent explicit agreement, usages or practices established between the parties can modify the principle stated in cisg art. 27 or pecl art. 1:303(4). 26.the dispatch principle thus applies to notices given under the following articles of the pecl: 7:109 property not accepted; 7:110 money not accepted; 8:105 assurance of performance; 8:106 notice fixing additional time for performance; 9:102(3) nonmonetary obligation (loss of right to specific performance); 9:301 right to terminate the contract; 9:303 notice of termination; 9:304 anticipatory non-performance. the dispatch rule does not apply to a notice which is to be given by the defaulting party, e.g., under article 8:108(3), or by a party which wishes to invoke hardship, see article 6:111, or to an assurance of performance under 8:105(2). (supra. fn. 23.) 27. supra. fn. 6, comment f. 28. in a cisg case in which schlechtriem participated as an expert witness on uniform sales law, the buyer declared avoidance of the contract, claiming that the machines he purchased produced an unacceptable amount of waste because of a malfunctioning electronic control system. the seller denied any non-conformity and rejected the buyer’s declaration of avoidance (and his demand for repayment of the purchase price). more than three years of litigation followed. taking into account the uncertainties of the lawsuit, the buyer mitigated his losses by repairing the machines himself. during the litigation, the court determined that the machines had not conformed to the contract when they were delivered, and that this non-conformity amounted to a fundamental breach. the court also realized that the seller was in serious financial straits and would not be able to refund the purchase price or pay the damages caused by the breach of contract. in order to avoid having to return the machines and account to the seller for the benefits the buyer had derived from them in the meantime, the buyer revoked his declaration of avoidances. the buyer instead declared a reduction of the purchase price under article 50, claiming restitution of only a part of the purchase price and additional damages. he was well aware that even this reduced demand would not be satisfied by the seller, but cut his overall losses by keeping the machines which were now functioning more or less properly. the seller objected to the revocation of the declaration of avoidance. he agreed with a termination of the contract and asked for the machines to be returned to him. this case illustrates some of the practical reasons supporting a rule that permits the revocation of a declaration governed by article 27 after the declaration has been dispatched. although not relevant to this buyer, the theor y that such declarations should at least remain ineffective prior to receipt makes sense. a declaration which avoids the contract or reduces the price should not occur before the other party has a chance to know the declaration and the change in the legal situation brought about thereby. such a declaration is characterized as a “unilaterally shaping declaration” (einseitige gestaltungserklärung). supra. fn. 15. 29. supra. fn. 6, comment e. microsoft word huttunen_anniina_korjattu.doc nordic journal of commercial law issue 2010#2 liberating intelligent machines with financial instruments by anniina huttunen*, jakke kulovesi**, william brace**, lorenz g lechner ***, kari silvennoinen**, vesa kantola** * * institute of international economic law (katti), p.o. box 4 (yliopistonkatu 3) fi – 00014 university of helsinki ** aalto university school of science and technology, school of economics *** central facility for electron microscopy ulm university this article is based on a group assignment in the research course “bitbang – rays to the future”. we would like to thank professor yrjö neuvo and all other organizers of the course. also, we show our gratitude to all guest lecturers, as well as, fellow students for insightful thoughts and discussions. professor juha karhu (previously pöyhönen) kindly commented on the draft of the paper. nordic journal of commercial law issue 2010#2 1 1. introduction in science fiction, isaac asimov's three laws of robotics, as presented in his novel i, robot, are the classical starting point for machine responsibility analysis.1 machine ethics research has widely followed asimov's example2. murphy and woods3 propose alternative laws inspired by asimov's original laws that emphasize a developer’s view on the ethics of robotics. in these works, machine responsibility is presented from the ethical point of view, but product liability issues are mostly absent, as is legal analysis. the present state of robot legal liability issues is to some extent described in existing literature.4 this paper addresses responsible robotics from a legal perspective. however, instead of focusing on ethical considerations elaborated in philosophy and artificial intelligence (ai)5 communities6, the legal liability risks related to inherently error-prone intelligent machines are considered and a solution combining legal and economical components is proposed. because of the technological difficulties in creating perfectly functioning machines and the cognitive element inherent in intelligent machines and machine interactions, we propose a new kind of legal approach, i.e. a financial instrument liberating the machine. in this framework, a machine can become an ultimate machine by emancipating itself from its 1 according to asimov law’s 1) a robot may not injure a human being or, through inaction, allow a human being to come to harm, 2) a robot must obey orders given to it by human beings, except where such orders would conflict with the first law, and finally 3) a robot must protect its own existence as long as such protection does not conflict with the first or second law. 2 w. wallach, "implementing moral decision making faculties in computers and robots", ai & society, vol. 22, no. 4, pp. 463-475, april, 2008. c. allen, w. wallach, i. smit, "why machine ethics?," ieee intelligent systems, vol. 21, no. 4, pp. 12-17, july/aug. 2006, doi:10.1109/mis.2006.83. j. gips, "towards the ethical robot", in android epistemology, mit press, cambridge, ma, 1995, pp. 243-252. 3 r. murphy, d. woods, "beyond asimov: the three laws of responsible robotics", intelligent systems, vol. 24, no. 4, pp. 14-20, july/aug. 2009. 4 p. m. asaro, "robots and responsibility from a legal perspective," in proc. of the ieee 2007 international conference on robotics and automation (icra’07), rome, april 2007. m.r. calo, “open robotics” maryland law review, vol. 70, no. 3, 2011. 5 artificial intelligence is “the science and engineering of making intelligent machines, especially intelligent computer programs….intelligence is the computational part of the ability to achieve goals in the world.” john mccarthy, basic questions, what is artificial intelligence? http://www-formal.stanford.edu/jmc/ whatisai/node1.html 6 n.e. sharkey, "the ethical frontiers of robotics", science, vol. 322, no. 5909, pp. 1800-1801, dec. 2008, doi: 10.1126/science.1164582. r.. arkin, "governing lethal behavior: embedding ethics in a hybrid deliberative/reactive robot architecture", acm/ieee international conference on human robot interaction, pp. 121-128, march 12-15, 2008. j. gips, "towards the ethical robot", in android epistemology, mit press, cambridge, ma, 1995, pp. 243-252 nordic journal of commercial law issue 2010#2 2 manufacturer/owner/operator. this can be achieved through the creation of a legal framework around this ultimate machine that in itself has economic value. we start this article by assessing the liability risks related to intelligent machines. currently, the manufacturer or operator is held liable depending on the circumstances. thereafter we will examine the management of the risks by technical and legal means, i.e. by means of liability stocks liberating the machine. the article relates to the european context. however, the solution can easily be adapted to other jurisdictions. 2. identifying and evaluating risk in intelligent machines in this paper, the intelligent machine can be a robot, an artificial agent or other machine that implements some functions requiring autonomous decision making. such a machine consists of the machine hardware, software, and an additional level of abstraction, the machine cognition. these three abstraction levels are used to look at the same entity from different perspectives. in reality, the physical machine hardware implements the software and similarly, the software implements the machine cognition. however, from a legal perspective, these levels have traditionally been understood to require separate considerations. hardware can malfunction, break, or simply not fulfill its specifications, potentially causing harm. similarly, software can have bugs, i.e. undesired features or non-compliance with specifications. these kinds of software problems can cause damage directly or through control over the hardware. in machine design, an ideal machine has both hardware and software that are error-free, disregarding the occasional need for maintenance and malfunction due to natural wear and tear. however, the third abstraction level, the cognition, lacks clear measures for perfect performance and thus causes problems from a legal perspective. with respect to human cognition, this imperfection is subsumed under the term "human error".7 in contrast, intelligent machines are not yet given this acknowledgment of imperfection, i.e., we do not speak of "machine error" in analogy to human error. traditionally, the element of cognition is the starting point for speculation about robot rights. since the early days of digitalization there has been an-ongoing debate over the idea of civil rights for robots.8 recently, a british government report anticipated a "monumental shift" in the area of robo-rights, once robots would become sufficiently intelligent.9 while it is true that 7 d. woods, l. johannesen, r. cook, n. sarter, behind human error: cognitive systems, computers and hindsight. ohio state university, dec. 1994. 8 r. freitas jr., “the legal rights of robots”, http://www.rfreitas.com/astro/legalrightsofrobots.htm, student lawyer 13, january 1985, pp. 54-56. 9 r. beschizza, british govt. report anticipates rights for artificial consciousness. december 21, 2006. http://www.wired.com/gadgetlab/2006/12/british_govt_re/ robots could demand legal rights, 21 december 2006, http://news.bbc.co.uk/2/hi/technology/6200005.stm nordic journal of commercial law issue 2010#2 3 courts have found robot judgment superior to human judgment in certain circumstances,10 it should be pointed out that the capability of developing artificial intelligence is not connected to legal rights or duties. in other words, the ability to act rationally is not the deciding factor for granting rights to human beings. even though robots can give humans orders that they are legally obliged to follow, like in the court cases mentioned earlier, they are still, like ordinary machines, considered the property of humans. however, the increasing use of sensory input in machines and the associated gain in autonomy and intelligent behavior is likely to lead to the need for robot liberation. what is intelligence then? here, the following definition is proposed: intelligence is an adaptation to complexity. complexity can vest in the environment, the task, the dynamics of the world, or anywhere relevant to the agent or machine. in the presence of complexity, perfection is rendered impossible by the combinatorial explosion of different possibilities that should be considered in order to make an optimal decision. intelligence is understood here as the art of managing complexity. elaborating on the definition adopted above, the more complexity an agent can handle and the better it succeeds, the more intelligent it is considered to be. in the absence of perfect knowledge and inference, intelligence is about making good guesses in relative uncertainty. this observation is the main cause of "cognitive errors", i.e., when the guess is wrong, an intelligent agent is operating under false model conditions. thus, an intelligent machine is inherently error-prone following directly from the definition of intelligence. aside from this, there is another important factor relating to intelligence: since it is an adaption it has to be evaluated in its context. outside the specific adaptation domain, intelligence is lost if new domains differ from the native one. humans, for example, have a broad scope of intelligence, whereas the deep blue chess computer has only a very limited context in which it behaves intelligently. manifestation of intelligence in a machine or an agent can be divided into three main classes. first, the agent can be autonomously intelligent. in this case, a machine agent implements intelligent functions independently, without need for human intervention. secondly, the machine can augment human intelligence, acting in tight interplay with a human. in this case intelligence is both borrowed from the human and created from human-robot interaction. thirdly, intelligence can be analogous to swarm intelligence,11 i.e., multiple robots can elicit complex and intelligent behavior when interacting together, even when any of the robots could be safely considered "stupid" in individual examination. humans express all three origins of intelligence. we can operate independently or in complex social constructs like states and companies. in addition, humans adopt tools to augment their physical and mental capabilities. in the second case examined above, liability can often be attributed to the human operator. but 10 in klein v. u.s. (13 av.cas. 18137 [d.md. 1975]). wells v. u.s. (16 av.cas. 17914 [w.d.wash. 1981] 11 e. bonabeau, m. dorigo, g. theraulaz, swarm intelligence: from natural to artificial systems, oxford university press, 1999. nordic journal of commercial law issue 2010#2 4 when the robot is acting independently or a group of robots is expressing complex behavior, attributing responsibility and liability becomes much more complex. naturally, the question occurs whether the relationship between a robot and owner is then similar to that of slave and dominus in ancient rome? the superficial similarities are plentiful: slaves were forced labor enabling the productivity and wealth of society and, as such, normally had no rights, but were considered property of their masters. at first glance, this seems to correspond exactly to the relationship between humans and robots. however, there are some fundamental differences between the legal status of robots and slaves. most importantly, with robots also the manufacturer has to be taken into account. while the robot is its owner’s property, the manufacturer is closely connected to the use of the robot — at least, if the robot cannot be considered to operate like clockwork and damage is caused neither to humans nor property. according to the product liability directive 85/374/eec12 "liability without fault on the part of the producer is the sole means of adequately solving the problem, peculiar to our age of increasing technicality, of a fair apportionment of the risks inherent in modern technological production." product liability applies to defective or dangerous products (i.e. tangible products, e.g. services are excluded). pursuant to the product liability directive product manufacturers, distributors, suppliers, retailers and marketers can be held liable for injuries caused by defective products. product liability is a category of so-called strict liability, i.e., the manufacturer can be held liable, even if, it did not act negligently, when manufacturing the defective product. moreover, in the context of robot-related services (operators) the tort liability considerations have to be taken into account. in accordance with the law of torts, anyone who intentionally or negligently causes damage to another is liable to compensate said damage. negligence in this context means carelessness that causes damage to another person or property. from a legal point of view, it is important to keep in mind the distinction between situations where machines cause damage, i.e. product liability or tort liability, and situations where machines do not work as they should work, but damage is not necessarily caused, i.e. contractual liability. in europe, the applicable directive in the first case is the product liability directive (and national tort law principles in the context of robot-related services and in situations where the damage is caused to third parties), whereas the consumer sales and guarantee directive13 and the unfair contract terms directive14 are of relevance in the context of contractual liability. liability is a prerequisite for the insurance framework. 12 council directive 85/374/eec of 25 july 1985 on the approximation of the laws, regulations and administrative provisions of the member states concerning liability for defective products, oj l 210 , 07.08.1985, p. 29. 13 directive 1999/44/ec of the european parliament and of the council of 25 may 1999 on certain aspects of the sale of consumer goods and associated guarantees, oj l 171, 7.7.1999, p. 12. 14 council directive 93/13/eec of 5 april 1993 on unfair terms in consumer contracts, oj l 95, 21.4.1993, p. 29. nordic journal of commercial law issue 2010#2 5 3. risk management the first step in creation of a legal framework around this ultimate machine is to make applying for the insurance mandatory. however, not all machines need to be insured. in the following chapter we classify machines into different risk-categories, analogously using the classification of different vehicles in traffic (e.g. there is no duty to insure bicycles) in the nordic traffic liability insurance system. the obligation to apply for insurance is based on the categories so created. at the same time, risk-profiling provides the necessary information for the market to estimate the price for the risk before actual statistical data becomes available. the second step is to allocate the risk to the market by means of liability stocks. the liability stocks can be compared to reinsurance practices. 3.1 step 1 – mandatory insurance for certain types of machines setting design practices / risk-profiling managing risk is only possible, if the risks and associated factors are identified. we consider two main risk factors: predictability and damage potential. predictability relates to how foreseeable the actions of a machine are. when the proposition of "intelligence equals to unpredictability" is accepted, the obvious conclusion is that from a predictability point of view simplicity or even "stupidity"is preferable over intelligence. a stupid machine that is well-designed and implemented is reliable and predictable according to clockwork logic. in contrast, even a welldesigned and well-implemented intelligent machine carries the potential for errors and is unpredictable by nature. it is therefore essential to identify the machine's task and performance requirements in order to choose the level of required intelligence properly. damage potential estimates the magnitude of material damage, and/or bodily injury the malfunction of a machine could cause. as a rule of thumb, the more physically powerful a machine is the more damage it can possibly cause. in addition, the environment in which a machine operates can dramatically increase its damage potential and needs to be taken into account. risk profiling is employed in order to assess the potential liabilities of autonomous machines.. risk-profiling can be understood as a continuum of risk-reducing and risk-increasing factors that add up to a risk evaluation profile with the two dimensions of predictability and potential damage. the following presents some central factors to be considered in intelligent machine design: human presence: whether or not a robot is operating in relative proximity of humans. are the humans in the robot environment trained to work with the robot or outsiders with no prior experience in dealing with the robot? what is the amount of human contact and interaction in normal operation? unnecessary human contact should be avoided to reduce the potential risk of causing harm to humans, when the robot behaves erroneously. robot physical capabilities: what kind of physical manipulation is the robot capable of. the reach, strength, and speed of the robot is included. in addition, it includes the robot’s physical nordic journal of commercial law issue 2010#2 6 form as such are there sharp edges or hard surfaces that can easily injure a human in unintended contact? the robot should ideally be designed so that damage caused in an accident or collision is minimized. robot connections and power over external entities: the extent to which the robot has external control. the power to control external forces is an important factor in increasing the potential for harm. an internet virus is a good example of a case where an intelligent agent has virtually unlimited potential for damage, should all things go wrong. thus, keeping the connections limited and adding some hard firewalls or areas of hard boundaries to robot influence is a good practice in limiting the potential for harm. robot mobility: what kind of obstacles can it overcome and what is its operational range. how fast can the robot move? robot mobility increases both its damage potential and its unpredictability. precautions should be taken to prevent the robot from escaping from its intended environment, i.e., to prevent a hospital robot from accidentally wandering around in the streets. in addition, it is essential for the robot to be able to identify its dislocation and react accordingly. restricting robot mobility can be of great help in managing the risk of a robot causing damage through its cognitive or physical errors. level of autonomy: how in/dependent is the robot the more autonomous the robot, the more difficult it generally becomes to predict its actions. robot learning and adaptation capabilities: how flexible and capable of learning is the robot. the more the robot can learn by itself and adapt to its surroundings and tasks, the more difficult it is to predict the robot’s actions. connections to human infrastructure: the extent to which robots are integrated in infrastructure. robots that operate as part of an infrastructure have the potential to create huge indirect harm. should a traffic control robot malfunction, the potential for cumulative harm would be significant. this type of damage is different in nature from that in most of the other cases mentioned so far instead of mainly causing additional damage, a infrastructurecritical robot or agent causes the loss of the benefit it creates and the benefit to which it has been bound. thus, binding intelligent machines to human infrastructure greatly increases the potential for harm. connections to the natural environment: the extent to which robots are integrated into nature. plant-eating robots have been suggested15 and robots can have connections to our environment in countless other ways. close interaction of the robot with the environment causes greater potential risks. 15 energetically autonomous tactical robot (eatr) project. [online]. available: http://www.robotictechnologyinc.com/ index.php/eatr [accessed: sept. 26, 2009] nordic journal of commercial law issue 2010#2 7 self-replication and self-maintenance: the extent to which a robot is self-sustained. the more a robot can take care of itself, the greater the risk for harm and unexpected consequences. a self-replicating robot that has access to all the resources it needs has a carries huge potential for damage. thus, capability to self-replicate should be considered costly with respect to both the potential damage and unpredictability factors. the above factors are added up to give an estimated worst-case scenario, and an estimated normal-operational scenario for the sphere of influence of the robot or agent. for example, an autonomous mine-shaft car is limited in its influence to the shaft itself and its immediate surroundings, depending on the nature of the mine and the mobility-restriction techniques used. in contrast, the sphere of influence of an autonomous vehicle operating in the public road network is in the worst case limited only by its maximum cruising range. in a more abstract case, a power-plant optimizing agent has influence over entire continents in the worst case, and only its local electricity distributing domain in the most probable case. next, the factors influencing potential for damage have to be added up in a similar way. in total, the robot's sphere of influence (reflecting uncertainty) is multiplied with its potential for damage, giving the final risk profile classification. the obligation to insure should be set based on the above-mentioned factors. moreover, the risk-profiling serves as a starting point for pricing. 3.2 step 2 – creating liability stocks traditional insurance business is based on quantifiable risks with large customer pools, so that annual variance is minimized and losses can be managed by adjusting the price of the insurance policy. one difference in comparison to the traditional insurance business is that smart machines are more prone to class-based malfunctions. unlike fires and cancer, which are random, risks relating to smart machines are easier to quantify on the basis of historical data and the amount of annual occurrences can be forecasted. however, such information may not be available for intelligent machines due to their fast innovation cycles. further, a fire at one type of a house does not mean similar houses will burn down in the near future. in this respect intelligent machines are more comparable to modern operating systems with which it can be anticipated that if one version is vulnerable, all other versions will be vulnerable as well. airplanes are a good example of class-based malfunctions and how they are managed today. an incident with certain model of an aircraft causes investigations and repair work on all aircrafts of the affected model. this is possible, because of the extensive certifications and paperwork kept on all aspects of an aircraft's lifecycle, e.g. repairs. one major challenge in creating a financial instrument for smart machines is transforming uncertainty into a quantifiable risk. as described in step 1, one way to achieve this is through risk profiling. having a quantifiable risk is important for proper pricing of financial instruments. nordic journal of commercial law issue 2010#2 8 an alternative way to cover one's exposure to risk is through the financial markets. it is likely that at first, liability stocks will be "exotic" financial instruments. it may be difficult to build a model to quantify the risks related to a class of machines due to the lack of historical information. statistical models are hard to build without any historical information.16 therefore the first machine insurances may be expensive from the buyer’s perspective, because of the perceived risk and non-liquidity of markets. the counter-parties are most likely to be large reinsurance companies, investment banks or hedge funds, which are capable of handling such risks (fig 1). figure 1: players in the ultimate insurance machine liability stocks model reinsurance companies are traditionally used by insurance companies to manage their risks better. certain risks (e.g. earthquakes, extended droughts) have a very low probability, but if the risk actualizes, the damage will be too high for any single insurance company to cover. similarly, in case of a new product, like machine insurances, a single insurance company may not have the expertise in such a specialized risk, and therefore might transfer the risk to a reinsurance company instead.17 such reinsuring may be most suitable for robots that are most vulnerable to class-based risks. however, as to earthquakes and nuclear power plants, if the worst scenario materializes, monetary compensation is not enough to cover the damage. this shows the limits for risk management what insurance can provide. robot-related liability stocks are comparable to reinsurances. as with traditional reinsurance models, the risks are transferred to the individual investors buying the stocks, and do not remain with the reinsurance companies. alternatively, the liability stocks could also be directed to manufacturers. moreover, in another model the government could also be a buyer of these stocks. government could play a crucial role to provide the necessary liquidity for liability markets to function properly, acting as a sort of a "counterpart-of-last-resort". it is worth mentioning that the insurance constellation could be compared to a limited liability corporation (approved in england in 1856). in the 18th century, the lord chancellor of great 16 compare with nordic traffic liability insurance systems. this will be elaborated later with references to e.g., e. routamo, liikennevahinko (1967). 17 p. li, m. shaw, k. stolarick, and k. wallnau, "the potential for synergy between certification and insurance", international workshop on reuse economics in conjunction with icsr, 2002. nordic journal of commercial law issue 2010#2 9 britain18 remarked about corporations that they "had no soul to damn and no body to kick" and were therefore hard to hold accountable for misdeeds. the same thing will probably apply to intelligent machines. while they have a "body to kick", kicking will not do much good, as they still lack a soul to damn. as noted previously, the insurance constellation could also be compared to the nordic traffic liability insurance systems. the liability stocks constellation could also be seen as an indemnity obligation. indemnity obligations have their origin in the anglo-american contracts tradition. it is a contractual obligation used to transfer liability between the contracting parties. thorpe and bailey19 define indemnity clauses as follows: "an indemnity is an undertaking by one party to meet a liability which would otherwise fall on the other." the condition of indemnity is expressed in general with words like "indemnify and to hold harmless". an indemnity obligation is a specific performance obligation, which is based on an agreement. it does not correspond to tort liability, but is approaching liability insurance, or first demand conditions in a warranty. this is the same type of payment obligation as damages paid to the customer based to the insurance. 3.3 case: liability for erroneous software liability for erroneous software is a negative example, where the current liability regime fails to provide proper guidance. again, it is important to highlight the distinction between machines, which do not work as they should work according to the contract and machines which cause personal injuries or damage to property. what effect would it have if the scope for the insurance framework would be extended to the liability risks relating to contractual defects? then at issue would not only be damages to property and persons, but the product itself would also covered. currently, the issue under debate in european consumer policy is not the product liability legislation, but the directives on contractual liability between a seller and a consumer. the debated issue is whether the scope of the consumer sales and guarantee directive should be extended ‘to include intangible goods, such as software and data’, as the loophole in the legislation is considered a ‘potential consumer protection lacuna’.20 currently, consumers are 18 j. coffee, jr., “’no soul to damn: no body to kick’: an unscandalized inquiry into the problem of corporate punishment,” michigan law review, vol. 79, no. 3 (jan. 1981), pp. 386-459. 19 c. thorpe & j. bailey, commercial contracts. kogan page limited: london 1999. 20 green paper on the review of the consumer acquis (com(2006) 744 final m. loos, "consumer sales law in the proposal for a consumer rights directive". european review of private law, forthcoming; centre for the study of european contract law working paper series no. 2009/07. available at ssrn: http://ssrn.com/abstract=1425036 a. huttunen, v. oksanen, j. laine, "digital consumer and user rights in eu policy", acm international conference proceeding series; vol. 342. proceedings of the 10th international conference on electronic commerce innsbruck, austria. session: semweb/egov table of contents. article no. 30 year of publication: 2008. nordic journal of commercial law issue 2010#2 10 left without proper protection when they buy software in contrast, embedded systems, such as robots, are included in the normal consumer protection legislation. naturally, the business sector, including digital service providers, is against the extension of liability.21 according to them e.g. “it very much depends on the way the consumer installs the software on his computer, and whether or not he/she was aware or not at the beginning of the compatibility of the service with his/her own material.” moreover, “there are many different parts that interact with each other but are not necessarily always compatible according to the quality of the product, the “age” of the computer, or the other software/ hardware installed. contributors indicated that if there is a malfunctioning of the digital product supplied, it would be extremely difficult to determine which one of the elements caused the damage.” those arguments were used in the context of a review of consumer acquis on consumer law issues related to consumer sales. the review of the consumer acquis does not cover product liability. it seems, however, that the arguments could be used as a motivation for the insurance machine also when it comes to product liability issues. lately, the debate has concerned software, music and games, which do not work as they ought to, even though they typically do not cause damage to anyone. however, due to the emergence of intelligent machines the product liability issues are likely to become topical. we most definitely do not want to end up with the same problems we have with software liability, when it comes to robots that are capable of doing much more than just deleting our pictures, music, and documents. 3.4 the new intelligent system development approach through intensive research activities, we are standing at the edge of a new renaissance in science and technology. this is substantiated by an understanding of the structure and behavior of matter from the nano-scale up to the complex system of the human brain. science began its separation from philosophy two centuries ago, but at present there is an ongoing unification of science based on unity in nature.22 for a complex machine to serve society in an efficient way, the unification with nature should be accompanied with a new risk-management tool. holistic investigation of this unification leading to the technological and risk-management convergence and thus a more sophisticated machine is inevitable. rapid advances in convergent technologies have the potential to enhance both machine performance and reduce the strain of the natural world on elements, but so far do not address liability issues. 21 preparatory work for the impact assessment on the review of the consumer acquis dg health and consumer protection analytical report on the green paper on the review of the consumer acquis submitted by the consumer policy evaluation consortium. (06/11/2007). available at: http://ec.europa.eu/consumers/rights/detailed_analysis_en.pdf 22 m. roco, w. bainbridge, converging technologies for improving human performance, springer, apr. 2003. nordic journal of commercial law issue 2010#2 11 innovative advances are blurring the interfaces between the previously separated fields of science and technology. development in system approach, through the use of systems engineering processes in conjunction with convergence technology allows for a thorough understanding of the natural world.23 human performance is included in design approaches to improve human behavior and to reduce accidents caused by humans. likewise, legal responsibility should be analyzed and included in design approaches. new product development (npd) is the term used to describe a recent complete process of bringing new products involving integration of business and engineering, to the market.24 there are two parallel paths involved in this approach: one involves generating the idea, product design and detail design and the other involves market research and marketing analysis. we propose a new approach, the new intelligent system development (nisd) to converge engineering design, business/market practices, legal and financial practices to bring an ultimate machine to the market. thus, instead of two parallel paths, as proposed in npd, there will be three parallel and integrated parts (fig. 2). figure 2: the nisd approach with interacting parts 23 pahl g. and beitz w. engineering design. a systematic approach 3rd edition. 2007,ken wallace, luciënne blessing, translators and editors. (springer, berlin-heidelberg). blanchard b., fabrycky w. (2006) systems engineering and analysis 4th edition. prentice hall incose se terms glossary version 0 october 1998 copyright (c) 1998 by incose. 24 husig, s; kohn, s; poskela, j (2005). "the role of process formalisation in the early phases of the innovation process". 12th int. prod. development conf. copenhagen. nordic journal of commercial law issue 2010#2 12 in existing design processes, business analysis and market analysis is parallel to the design process.25 in the nisd approach, the business/market analysis and the legal/financial practices will be integrated in the design process right from the conceptual design phase. engineering design is a challenging activity, because it deals with largely unstructured problems that are important to the needs of society. the first fundamental canon of the abet code of ethics states that “engineers shall hold paramount the safety, health, and welfare of the public in the performance of their profession.” even though a similar statement has been presented in engineering codes of ethics, since the early 1920s, society has increasingly participated in enforcing good engineering practices.26 the major social forces that have had an important impact on engineering practices are occupational health and safety, consumer rights, environmental protection, the freedom of information and public disclosure movements. these have led to several regulations, which have been adopted right from the conceptual design phase as constraints on the design. in our proposal, insurance contract practices should be added to the social forces. the subsequent regulation will influence engineering practice in the following ways: • greater influence of lawyers on engineering decisions • greater influence of the financial market in engineering design • more time spent in planning and predicting the influence of the financial market and future effects on engineering projects • increased emphasis on “defensive research and development”, which is designed to protect the ultimate insurance machine against possible litigation • increased efforts expended on research, development, and engineering to create a legal framework around the ultimate insurance machine which in itself do not directly enhance corporate profit, but can affect profit in the financial market the conceptual design includes a system design specification (sds), which serves as the basic control of and reference for the design and manufacturing of the system. thus, the insurance regulation is included as an element of sds. the intelligent system will go through a cycle from birth, into an initial growth stage, into a relatively stable period, and finally into a declining state that eventually ends in the retirement of the system (fig. 3). 25 husig, s; kohn, s; poskela, j (2005). "the role of process formalisation in the early phases of the innovation process". 12th int. prod. development conf. copenhagen. 26 dieter, g., and schmidt, l.c., 2008, engineering design” mcgraw-hill, new york, ny. nordic journal of commercial law issue 2010#2 13 figure 3: intelligent system life cycle looking more closely at the system life cycle, we identify that the cycle is made up of many individual processes (fig. 4). in this case the cycle has been divided into the pre-market and market phase. the former extends to the conceptual phase and includes the research & development and the marketing studies needed to bring the system to the market phase. the investment (negative profit) needed to create the intelligent system is shown along with the profit. a financial market studies is added to the life cycle process as shown in fig. 4. this will span across the two phases (pre-market and market) starting from a market study in the premarket phase and continuing in the market phase. this brief discussion serves to emphasize that the nisd approach, which leads to an ultimate insurance framework, is a complex, costly, and time-consuming process, but it will help to emancipate the machine and create a new kind of financial instrument. figure 4: expanded intelligent system life cycle with financial market study 4. conclusion the development and use of intelligent machines faces tremendous challenges in current legal systems. technological development is stifled by liability risks. currently, the manufacturer or operator is held liable depending on the circumstances. due to both the technological limitations for perfectly functioning machines and the unpredictable cognitive element, intelligent machines are not perfect and it is almost guaranteed that there will be failures causing harm. however, this nordic journal of commercial law issue 2010#2 14 is not an excuse not to aim for failure-free operation. instead, the inevitable failures should be managed so that present economical or legal issues do not hinder the potential human development and prosperity enabled through the adoption of new technologies. we propose a new kind of legal approach, i.e. the ultimate insurance framework, to solve the related legal and economical difficulties in order to support the technological pursuits. in the insurance framework, a machine can become an ultimate machine by emancipating itself from its manufacturer/owner/operator.. this can be achieved by creating a legal framework around this ultimate machine that in itself has economical value. the first step in creation of a legal framework around the machine is to make applying for the insurance mandatory. the obligation to apply for insurance is based on risk profiling created in this paper. similarly, this article makes an attempt to include legal responsibility in design approaches. if machines are considered legal persons, they can be considered items having rights and duties. interestingly, this insurance machine constellation does not make it necessary to decide, whether robots or software agents have to be treated as legal persons. currently, there is an ongoing debate in europe on the idea of extending the consumer sales and guarantee directive to software. this is a contract law issue. because of the advent of autonomous intelligent machines, it is likely that a discussion on product liability issues will follow. presently, robots as embedded systems are included in the normal product liability scheme. however, issues related to robots as services, and the liability division between the manufacturer and operator/owner, may become topical, as there is no specific legislation covering the area. moreover, even if the product liability and tort law scheme was considered as sufficiently extensive, a new approach on the allocation of liability is needed, both from the manufacturers' and consumers' point of view. contracts, risks and management = contractual risk management nordic journal of commercial law issue 2012#1 comparative commercial law: methodologies, black letter law and law-in-action by edward t. canuel nordic journal of commercial law issue 2012#1 1 1 introduction evaluating the strengths and weaknesses of international business transactions presents vexing challenges for the legal comparativist and practitioner. divergent legal regimes impact business decisions, as commercial transactions extending across different legal jurisdictions may produce different and perhaps unexpected results. exclusively relying on black-letter law does not sufficiently capture the entire comparative landscape. rather, evaluating how black letter law, or law-in-the-books, reacts with law in practice presents the optimal analytical vantage point.1 such approach necessitates that a credible, neutral and objective method evaluates the international business transaction — one which considers that economic, cultural and sociological viewpoints, perhaps competing, all exist. these analytical methods, while providing valuable reference points, do not independently present a complete picture.2 rather, a hybrid comparative theory, objective pluralism, incorporating all of these methodologies, is a more effective evaluator tool providing the optimum means for evaluating comparative commercial law issues.3 the totality of this review presents a balanced perspective offering unique issue insights. part one introduces the need for objective modes of comparative law analysis within the context of international business transactions, most notably contractual relationships. discussing the disparate common and civil law families evidences why objective methods are necessary to explore legal problems extending over systematic divergences. focusing on how good faith under comparative contract law is interpreted quite differently between (and within) these families demonstrates that legal concepts transplanted across legal families may have different meanings. part two explores how black letter law is applied in practice, through the lens of objective pluralism, yielding nuances while providing comparativists with an important toolkit to further “test” a legal problems. the economic comparative method is evaluated, with special focus given to efficiency and transaction-based economic methodologies. next, the sociological comparative method is analyzed, with emphasis on behavioral theory. relational contracting, which contains elements of economic-based methodologies, is subsequently reviewed. the 1 palmer, vernon valentine, from lerotholi to lando: some examples of comparative law methodology, 53 am. j. comp. l. 261, 266 (2005) (“the researcher must always delve beyond judicial decisions, doctrinal writings and the black letter law of code and statute and reach into the ill-defined region of “deeper structures” where law perhaps meets philosophy, sociology, and social culture”). see also goldfarb, phyllis, theoretics of practice: the integration of progressive thought and action: beyond cut flowers: developing a clinical perspective on critical legal theory. 43 hastings l.j. 717, 737 (1992) (law-in-action indicates chaotic interplay of a wide variety of detail and doctrine, variables and values, people and perspectives). 2 halperin, jean-louis, law in the books and law in action: the problem of legal change, 64 me. l. rev. 45, 47 (2011) (discussing the ongoing debate of “how to build a legal science without erecting a phantasmagoria of imagined law without connection to how law is actually used and actually works”). 3 note that this term was introduced in a philosophical context by albert p. brogan, objective pluralism in the theory of value 41 international journal of ethics 287-295 (1931). http://www.brocku.ca/meadproject/brogan/brogan_1931.html. http://www.brocku.ca/meadproject/brogan/brogan_1931.html nordic journal of commercial law issue 2012#1 2 paper then proposes the new methodology, objective pluralism, as the most efficient tool for analyzing the strengths and weaknesses of comparative business transactions. practical application of objective pluralism involves a carefully-constructed survey or empirical study. 2 the comparative law dilemma: the need for objective standards, divergent systems comparative law study, in its quest to examine the function and utility of legal concepts among various legal systems, demands objective, neutral comparative standards. these standards allow a useful review of legal systemic commonalities and differences, unhindered by certain cultural-specific or innate characteristics which prevent evaluating the utility of an existing legal framework.4 the comparative method consists of reviewing the similarities and differences between legal systems, while assessing the breath of differences which the comparative researcher must consider.5 one of the greatest challenges confronting comparative law projects remains the problem of equivalency: comparativists strive to prove how studied legal systems are similar or dissimilar.6 rarely do different legal systems share precise equivalents, although certain rules and institutions may, in a broad sense, be quite similar—which is a vexing problem for the comparative law scholar.7 objective analytical devices yield important perspectives, allowing comparativists to focus on the similarities, and differences, between and among legal systems—presenting discoveries as to the unique aspects of the compared systems and how they commonly react to a specific issue.8 the distinctive aspects of each system may be defined, while also creating an appreciation of legal system commonalities—which, together, create insights into a particular legal matter under review.9 comparativists must also present reasons for the differences and similarities between divergent legal systems, and provide analysis as to their significance for the studied cultures. accordingly, comparative scholars argue that the legal analyst must look to, and beyond, the law, including “the respective political, economic, and social systems and historical traditions of which they are a part.”10 effecting these goals is the real challenge, as scholars 4 substantial scholarship exists considering the various comparative law theoretical foundations. see, e.g., de cruz, peter, comparative law in a changing world (cavendish, 1999); glenn, h. patrick, legal traditions of the world (oxford press, 2007). 5 reitz, john c., how to do comparative law, 46 am. j. comp. l. 617, 620 (1998). 6 see id. at 622. 7 see id. 8 reitz, john c., how to do comparative law, 46 am. j. comp. l. 617, 624 (1998). 9 see id. 10 reitz, john c., how to do comparative law, 46 am. j. comp. l. 617, 627 (1998). nordic journal of commercial law issue 2012#1 3 evaluating comparative systems must collect and analyze data gathered from “cultural neutral” sources.11 2.1 structural and theoretical differentiations: civil and common law traditions for comparative purposes, objective pluralism takes into account the different legal systemic constructs and cultural norms/perceptions which reflect decision-making existing between (and among) the civil12 and common legal traditions. these traditions diverge in several areas, including the influence of precedent (stare decisis)13. under the civil law tradition, courts interpret and apply written laws, which include codes, 14 statutes and decrees.15 hearkening back to its roman tradition, civil law regimes often look to legal scholarship for assistance in determining the state of the law on a given subject, serving to organize principles and decisions into a legal framework.16 a civilian code17 serves as an elaboration of legal doctrines, rules and 11 for interesting discussions on cultural influences within comparative law, see jackson, john d., playing the culture card in resisting cross-jurisdictional transplants: a comment on legal processes and national culture, 5 cardozo j. int’l & comp. 51, 63 (1997). 12 while recognizing that not all member legal regimes of the common or civil law legal traditions are identical, the similarities greatly outweigh any divergences. accordingly, this paper will not generally focus on the differences between members of the same legal traditions, such as, for example, those existing between germany and france. pejovic, caslav, civil law and common law: two different paths leading to the same goal, 32 vuwlr 817, 818 n.3 (2001) at www.upf.pf/img/doc/16pejovic.doc citing to schlesinger, r.b. et al, comparative law 282 (1998) (“even though the civil codes of different countries are not homogenous, there are certain features of all civil codes which bind them together and “sets them apart from those who practice under different systems”). 13 “the doctrine of stare decisis requires all tribunals of inferior jurisdiction to follow the precedents of courts of superior jurisdiction, to accept the law as declared by superior courts, and not to attempt to overrule their decisions.” sellers, n.s. mortimer, the doctrine of precedent in the united states of america, 54 am. j. comp. l. 67, 86 (2006); see also auto equity sales v. superior court of santa clara county, 369 p.2d 937, 939-940 (1962). for a comprehensive review of stare decisis’ historical development in the united states, see sellers, n.s. mortimer, the doctrine of precedent in the united states of america, 54 am. j. comp. l. 67 (2006). 14 the civilian legal tradition is born through codification, with clear divisions between public and private law. stein, peter g., relationships among roman law, common law, and modern civil law: roman law, common law, and civil law, 66 tul. l. rev. 1591, 1595-1596 (1992). for example, the exclusive source of private law under the civilian legal system is the written law, with systematized modern codes behind the civilian law’s reasoning. id. at 1596. 15 freisen, jeffrey l., when common law courts interpret civil codes, 15 wis. int’l l. j. 1, 7 (1996). 16 freisen, jeffrey l., when common law courts interpret civil codes, 15 wis. int’l l. j. 1, 8 (1996). see also goutal, jean louis, characteristics of judicial style in france, britain, and the u.s.a., 24 am. j. comp. l. 43, 44 (1976); cappalli, richard b., open forum: at the point of decision: the common law’s advantage over the civil law, 12 temp. int’l & comp. l. j. 87, 94 (1998). 17 dainow defines “code” very broadly: “a code is not a list of special rules for particular situations; it is, rather, a body of general principles carefully arranged and closely integrated. a code achieves the highest level of generalization based upon a scientific structure of classification. a code purports to be comprehensive and to encompass the entire subject matter, not in the details but in the principles, and to provide answers for questions which may arise.” see dainow, joseph, the civil law and the common law: some points of comparison, 15 am. j. comp. l. 419, 424 (1967). see also apple, james g. and robert p. deyling, a primer on the civil-law system, at http://www.fjc.gov/public/pdf.nsf/lookup/civillaw.pdf/$file/civillaw.pdf. while recognizing that the http://www.upf.pf/img/doc/16pejovic.doc http://www.fjc.gov/public/pdf.nsf/lookup/civillaw.pdf/$file/civillaw.pdf nordic journal of commercial law issue 2012#1 4 institutions.18 alternatively, the common law family is composed of organic law, with judges reliant upon precedents and the persuasive effect of the works of other common law jurisdictions.19 simply stated, common law is case law, with judicial decisions modifying new rules or adapting existing rules.20 by studying case holdings that underlie the reasoning behind a particular decision, the reach of a precedent, considering a decision’s origins and justifications, may be discovered.21 the common law thus provides an organic continuum of law “creation,” as each precedent builds upon, and into, the body of existing case law, providing future rules, definitions, branches or exceptions.22 substantive law of civil (and common) law systems may differ among countries, certain “general features that distinguish the civil-law tradition from the common-law tradition” exist, according to apple and deyling. apple, james g. and robert p. deyling, a primer on the civil-law system at 1 in http://www.fjc.gov/public/ pdf.nsf/lookup/civillaw.pdf/$file/civillaw.pdf. these authors note that “[c]ivil codes…emphasize form, structure, and the enumeration of both abstract and concrete principles of law within a unified whole. the reasoning process from code provisions is deductive—one arrives at conclusions about specific situations from general principles. the function of the jurists within and for the civil-law system is to analyze the basic codes and legislation for the formulation of general theories and extract, enumerate, and expound on the principles of law contained in and to be derived from them.” id. at 19. 18 cappalli, richard b., open forum: at the point of decision: the common law’s advantage over the civil law, 12 temp. int’l & comp. l. j. 87, 93 (1998). 19 id. at 92. it has been asserted that the common law has an “obsession” with noting the reason behind rules. id. at 91. 20 freisen, jeffrey l., when common law courts interpret civil codes, 15 wis. int’l l. j. 1, 11 (1996). american legal scholarship has extensively covered the modern emergence of so-called “super precedence” (or “super stare decisis”). see sinclair, michael, precedent, superprecedent, 14 geo. mason l. rev. 363, 364 (2007) (“a superprecedent would be so effective in defining the requirements of the law that it prevents legal disputes from arising in the first place, or, if they do arise, induces them to be settled without litigation”); reese, jessica, the lone second amendment interpretation: has it reached the status of “superprecedent?” 32 s. ill. univ. law jour. 211, 220 (2007) citing to richmond med. ctr. for women v. gilmore, 219 f.3d 376 (4th cir. 2000) (in discussion of landmark abortion rights case roe v. wade, 410 u.s. 113 (1973), reviewing judge lettig stated that, due to repeated confirmation by courts, roe reached “super stare decisis” status). a commentator suggests that several traditional factors may determine whether a reviewing court shall strictly follow a “superprecedent,” as opposed to depart from existing law, including the type of case the court is deciding, whether the precedent’s rule of law has been substantially relied upon by society, whether the court opinion serving as precedent as issued unanimously (or for a divided court), the decision’s age and whether a decision could be “workable” or creating a clear standard to guide state governments and lower courts. reese, jessica, the lone second amendment interpretation: has it reached the status of “superprecedent?” 32 s. ill. univ. law jour. 211, 221 (2007). 21 cappalli, richard b., open forum: at the point of decision: the common law’s advantage over the civil law, 12 temp. int’l & comp. l. j. 87, 89-90 (1998). but see pejovic, caslav, civil law and common law: two different paths leading to the same goal, 32 vuwlr 817, 819 n.7 (2001) (asserting distinction as to how stare decisis doctrine is applied by u.s. and english courts. “in the united states, under this doctrine a lower court is required to follow the decision of a higher court in the same jurisdiction. in england, the previous rule under which courts were bound by their own prior decisions was reversed by the house of lords (practice statement) which declared that it considered itself no longer formally bound by its own precedents and announced its intention “to depart from a previous decision when it appears right to do so.” [1966] 1 wlr 1234”). 22 cappalli, richard b., open forum: at the point of decision: the common law’s advantage over the civil law, 12 temp. int’l & comp. l. j. 87, 93 (1998) citing to cappalli, richard b., the american common law method (1997) (see chapters 4, 10). stare decisis has been elevated as “the characteristic and all-pervading method of the common law,” the right hon. lord wright, precedents, 8 cambridge law jour. 118 (1943) cited in sinclair, http://www.fjc.gov/public/pdf.nsf/lookup/civillaw.pdf/$file/civillaw.pdf http://www.fjc.gov/public/pdf.nsf/lookup/civillaw.pdf/$file/civillaw.pdf nordic journal of commercial law issue 2012#1 5 common and civil law theoretical divergences may also be found in perceptions of formalistic versus standards-based legal approaches, respectively.23 formalism is understood as those legal rules which limit the interpreter’s focus to “a subset of materials that may or may not give rise to the same inferences as would the universe of materials as a whole.”24 alternatively, standardsbased or “substantive” interpretive approaches involve attempting “to come to a more allthings-considered understanding, based on all of the materials reasonably available.”25 courts opting to involve formalist strategies often ensure compliance with all relevant legal formalities, follow rule-bound law and restrain judicial discretion as cases are decided.26 freedom of contract theory is influential in the development of the common law’s more formalistic approach.27 such perspective focuses on leaving the contracting parties to their own agreement, recognizing that contracting parties are free to enter into mutually beneficial economic exchanges.28 under the common law interpretation, a court, absent demonstrable fraud, will not inquire into the bargain’s wisdom.29 compare this to a civil law regime’s theoretical michael, precedent, superprecedent, 14 geo. mason l. rev. 363, 364 (2007). see also payne v. tennessee, 501 u.s. 808, 827 (1991) (chief justice rehnquist held that stare decisis “promotes the evenhanded, predictable, and consistent development of legal principles, fosters reliance on judicial decisions, and contributes to the actual and perceived integrity of the judicial process”). 23 a scholar differentiates these legal interpretative perspectives by highlighting methods of evaluating formalism, as follows: “one sees the dichotomy expressed in terms of rules versus standards, rules versus discretion, textual versus contextual modes of interpretation, static versus dynamic interpretation, simplicity versus complexity, determinacy versus flexibility, objective versus subjective standards, and so on. each of these opposed pairs highlights different functional aspects of the formalism problem, but what they have in common is that the first member of each opposed pair connotes an interpretive approach that focuses on a more limited set of authoritative or evidentiary materials, and the second member connotes an approach that embraces or allows for the consideration of a more expansive set of materials.” see katz, avery w., the economics of form and substance in contract interpretation, 104 colum. l. rev. 496, 515 (2004). 24 id. at 498. 25 id. 26 sunstein, cass r., must formalism be defended empirically?, university of chicago law school john m. olin law & economics working paper no. 70 (2nd series) at 3 (1999), found at http://www.law.uchicago.edu/ publications/working/index.html. 27 henrietta mills, inc. v. commissioner, 52 f. 2d. 931, 934 (4th cir. 1931) (“the court will not write contracts for the parties to them nor construe them other than in accordance with the plain and literal meaning of the language used”). see also lu, shumei, gap filling and freedom of contract (master’s thesis, university of georgia) (2000) at http://digitalcommons.law.uga.edu/ (last reviewed june 20, 2008). 28 “the freedom of parties to structure their own agreement is universally acknowledged to be at the heart of the common law of contracts.” dimatteo, larry a., theory of efficient penalty: eliminating the law of liquidated damages, 38 am. bus. l. j. 633, 634 (2001). see also dimatteo, larry a., theory of efficient penalty: eliminating the law of liquidated damages, 38 am. bus. l. j. 633, 641 (2001). 29 note that a growing legal movement, new american formalism, adopts a middle road: clear, direct interpretive guidelines should be legislated, which courts may interpret and refine through, ultimately, a body of caselaw. charny, david, the new formalism in contract, 66 u. chi. l. rev. 842, 842-43 (1999); see also katz, avery w., the economics of form and substance in contract interpretation, 104 colum. l. rev. 496, 505 (2004) (courts must depart from traditional formalism in certain clear instances; the first restatement of contracts (first restatement) (1932) made, for example, exceptions for fraud or mistake); barnett, randy e., the richness of contract theory, 97 mich. l. rev. 1413, 1414-15 (1999) (book review). http://www.law.uchicago.edu/publications/working/index.html http://www.law.uchicago.edu/publications/working/index.html http://digitalcommons.law.uga.edu/ nordic journal of commercial law issue 2012#1 6 underpinnings. namely, under a standards-based approach, civil law judges are empowered to utilize a flexible interpretation method, with the ability to examine the intent of the parties rather than be limited to a contract term’s literal meaning.30 2.2 good faith doctrine and the role of judges: black-letter civil law the contractual doctrine of good faith illustrates how seemingly similar commercial legal concepts may be interpreted and enforced quite differently in jurisdictions spanning across legal families. legal systemic differences, such as the differing role of judges, also affect the application of legal doctrine. such divergences demonstrate the need for comparative analysis of legal concepts via black letter law, while suggesting that a complementary law-in-action evaluative approach is also necessary. while common law courts historically avoid judicial intervention into the contracting parties’ relationship,31 the civil law systems allow the judiciary a more expansive opportunity to interpret the parties’ bargain.32 such proactive judicial stance has been collectively identified as 30 garello, pierre, the breach of contract in french law: between safety of expectations and efficiency (http://ideas.repec.org/a/eee/irlaec/v22y2002i4p407-420.html), 22 international review of law and economics 407, 412 (2003); see also gordley, james, contract law in the aristotelian tradition, in the theory of contract law 266 (2001) (with respect to civil law, fairness and distributive justice are foundations of the binding force of contractual promises, rather than an individual will); moss, giuditta cordero, international contracts between common law and civil law: is non-state law to be preferred? the difficulty of interpreting legal standards such as good faith, 7 global jurist (advances) 19 (2007). 31 for a discussion of historical restraints by american judges to intervene, see weigand, tory, the duty of good faith and fair dealing in commercial contracts in massachusetts, 88 mass. l. rev. 174 (2004). 32 for a description of the german legal regime, where courts have the power to rewrite a contract, see dimatteo, larry a., an international contract law formula: the informality of international business transactions plus the internationalization of contract law equals unexpected contractual liability, 23 syracuse j. int’l l. & com. 67, 85-86 (1997) citing to von teichman, germany, federal republic, in 1 legal aspects of doing business in western europe 205, 218 (dennis campbell ed., 1983). see also powers, paul j., defining the undefinable: good faith and the united nations convention on contracts for the international sale of goods, 18 journal of law and commerce 333-353 (1999) found at http://www.cisg.law.pace.edu/cisg/biblio/powers.html#def (no page numbers online) (“civil law states tend to use a more expansive approach to the good faith obligation applying it to both contract formation and performance. common law states prefer a more narrow good faith duty applicable only to contract performance”). note that powers continues that “the civil law approach to good faith is more encompassing than its common law counterpart. a civil law contracting party owes a pre-contract duty of good faith to negotiate fairly and openly with the other party. this obligation extends to contract performance and requires parties to act reasonably, or more specifically, not to breach the relationship of trust with those with whom they negotiate and contract. good faith is an important public policy in countries adhering to the civil law approach. in these countries, good faith can be relied upon by both parties to a contract.” see also moss, giuditta cordero, commercial contracts between consumer protection and trade usages: some observations on the importance of state contract law, in schulze, r. (ed.), common frame of reference and existing ec contract law, 65, 68 (2008) (“[t]he civilian judge has a larger power to evaluate the fairness of the contract and intervene to reinstate the balance of interests between the parties; he or she is more concerned with creating justice in the specific case than with implementing the deal in the most predictable manner. in doing so, the civilian judge is guided by general clauses and principles of good faith and fair dealing”). http://ideas.repec.org/a/eee/irlaec/v22y2002i4p407-420.html http://www.cisg.law.pace.edu/cisg/biblio/powers.html#def http://folk.uio.no/giudittm/commercial%20contracts%20and%20acquis.pdf http://folk.uio.no/giudittm/commercial%20contracts%20and%20acquis.pdf nordic journal of commercial law issue 2012#1 7 the “good faith” interpretation,33 where courts are empowered to address perceived gaps in the contracting parties’ bargaining relationship. civil law judges are thus able to use a subjective interpretation method, examining the good-faith intent of the parties rather than contract terms’ literal meaning.34 this standards-based approach is particularly evident in the scandinavian legal context, as bo madsen describes its informal characteristics, evidenced by the recognition of contract formation on the basis of “social typical conduct,” judging contracts on the general requirement of “fairness,” interpreting contracts “pragmatically” (while taking into account the social and economic status of contracting parties) and, particularly in the consumer context, “employing in many connections “legal standards” which are often to be “filled out” in practice by quasi-legal bodies dominated by lay judges (e.g. the consumers complaints board).”35 thus, the civil law tradition accepts that individuals are bound by certain conduct, even if not included specifically within the contract.36 while this may be captured in a statutory framework, as discussed below, it is accepted that legislatures “cannot foresee all possible situations.”37 similarly, contract law under the french system is viewed as a “shared undertaking,” with courts concerned that the parties adhere to their agreement and the law. french courts attempt to compel contractual performance before resorting to finding for damages as substitution relief for a contractual breach’s “moral wrong doing.”38 the germanic system39 also has an ethical character, as the law is understood as a positive system of rules and a way to develop new rules and to tackle societal problems.40 under the 33 good faith is defined as “an intangible and abstract quality with no technical meaning or statutory definition, and it encompasses, among other things, an honest belief, the absence of malice and the absence of design to defraud or to seek an unconscionable advantage...” black’s law dictionary 693 (1990). mitchell, andrew d., good faith in wto dispute settlement, melbourne j. int’l law, 14 (2006) (no page numbers available online) (in civil law context, good faith is “a principle of fair and open dealing”). 34 garello, pierre, the breach of contract in french law: between safety of expectations and efficiency, 22 international review of law and economics 407, 412 (2003); see also moss, giuditta cordero, international contracts between common law and civil law: is non-state law to be preferred? the difficulty of interpreting legal standards such as good faith, 7 global jurist (advances) 19 (2007) (“as opposed to common law, concepts such as good faith or fair dealing and rules governing contracts in general or a certain type of contract in particular may be invoked in civil law to interpret the contract, to integrate it or even to correct it”). 35 bo madsen, palle, scandinavian contract law within the eec: a social dimension in contract law by harmonization or recognition, in perspective of critical contract law 107, 109 (thomas wilhemsson, ed., 1992). 36 de ly, filip, commercial law as a refuge from contract law: a comparative and uniform law perspective, 45 wayne l. rev. 1825, 1854 (2000). 37 id. (discussing the german legal tradition) 38 miller, lucinda, penalty clauses in england and france: a comparative study, 53 iclq 79, 97-98 (2004). for a comprehensive analysis of french law, see also wells, michael, french and american judicial opinions, 19 yale j. int’l l. 81, 99-100 (1994) (quoting dawson, john p., the oracles of the law 401 (1968) in farber, daniel a., book review: the hermeneutic tourist: statutory interpretation in comparative perspective, 81 cornell l. rev. 513, 527 (1996). 39 dimatteo, larry a., an international contract law formula: the informality of international business transactions plus the internationalization of contract law equals unexpected contractual liability, 23 syracuse j. int’ l. & com. 67, 70 (1997). http://ideas.repec.org/a/eee/irlaec/v22y2002i4p407-420.html nordic journal of commercial law issue 2012#1 8 german civil code (bürgerliches gesetzbuch, the “german civil code” or “bgb”) established in 1900 (and revised in 2002), contracting parties are given broad freedom to structure their contractual relationships.41 german jurists tend to look more to the purpose of the legal instruments used, rather than the literal judicial interpretation of the language.42 german law does not restrict itself to a provision’s literal wording, but rather pursues interpreting the provision in a manner that best addresses the provision’s purpose.43 context in determining the actual intent of a contractual provision is paramount, with the goal of ascertaining such intention the cornerstone of german contract interpretation. specifically, article 133 of the german civil code holds that “when a declaration of intent is interpreted, it is necessary to ascertain the true intention rather than adhering to the literal meaning of the declaration.”44 it has also been asserted that article 133 encourages contract interpretation “in light of the contractual economic purposes.”45 the civil law judge may interpret contractual relationships to supplement, correct, or revise contracts.46 initially, a civil law judge will review a contract in such a fashion that revision is unnecessary, although it may practically revise the contract, through judicial interpretation. civil law courts will then seek to reform the contract in light of new circumstances, revising the agreement in what is perceived as the parties’ interests and intentions; if that fails, the entire 40 de ly, filip, commercial law as a refuge from contract law: a comparative and uniform law perspective, 45 wayne l. rev. 1825, 1854 (2000). see also miller, lucinda, penalty clauses in england and france: a comparative study, 53 iclq 79, 100 (2004) (noting that the french civil code often contains certain “abstract concepts,” such as good faith and morality, outside those traditionally found within the common law, in addition to doctrines of collaboration and loyalty. collectively, these principles create a so-called moralization of law which encourages judicial redrafting of agreements and produces uncertainty). 41 moss giuditta cordero, international contracts between common law and civil law: is non-state law to be preferred? the difficulty of interpreting legal standards such as good faith, 7 global jurist (advances) 12 (2007). for the official english translation, see bundesministerium der justiz at http://www.gesetze-iminternet.de/englisch_bgb/index.html. for an interesting description of the historical development of german commercial law, see zimmermann, reinhard, the german civil code and the development of private law in germany, oxford university comparative law forum 1 (2006) at http://ouclf.iuscomp.org/articles/ zimmermann.shtml. 42 dimatteo, larry a., an international contract law formula: the informality of international business transactions plus the internationalization of contract law equals unexpected contractual liability, 23 syracuse j. int’l l. & com. 67, 7071 (1997). 43 see id. see also temkin, harvey l., when does the “fat lady” sing?: an analysis of "agreements in principle" in corporate acquisitions, 55 ford. l. rev. 125, 206 (1986) (citing to calamari, john d & joseph m. perillo, contracts 2-7, at 30-33 (1977)). 44 official english translation, bundesministerium der justiz at http://www.gesetze-im-internet.de/ englisch_bgb/englisch_bgb.html section 133; see also dimatteo, larry a., an international contract law formula: the informality of international business transactions plus the internationalization of contract law equals unexpected contractual liability, 23 syracuse j. int’l l. & com. 67, 71 (1997) citing to german civil code book i, 133. 45 dimatteo, larry a., an international contract law formula: the informality of international business transactions plus the internationalization of contract law equals unexpected contractual liability, 23 syracuse j. int’l l. & com. 67, 71 (1997) citing to naglar, nassar, sanctity of contracts revisited: a study in the theory and practice of long-term international commercial transactions 44 (1995). 46 de ly, filip, commercial law as a refuge from contract law: a comparative and uniform law perspective, 45 wayne l. rev. 1825, 1854 (2000) (german jurist perspective). http://ouclf.iuscomp.org/articles/zimmermann.shtml http://www.gesetze-im-internet.de/englisch_bgb/englisch_bgb.html#section%20133 http://www.gesetze-im-internet.de/englisch_bgb/englisch_bgb.html#section%20133 nordic journal of commercial law issue 2012#1 9 contract will be voided.47 norwegian jurists directly interpreting a commercial contractual relationship, or indirectly employing interpretative techniques to otherwise reach a perceived reasonable good-faith driven result,48 share qualities found under civil law systems. according to dimatteo, the german system believes that “the judiciary is very important as judges have to fill gaps that may exist, and have to develop the contracts and enforce them in accordance with both the parties’ intent and objective standards of reasonable and fair dealing.”49 as such, the full, entire contractual relationship can be used to determine contractual intent “in the face of an instrument that indicates otherwise.”50 civil law countries use rules which may not necessarily allow one to immediately reach conclusions from a rule’s application: such is the case with § 242 of the bgb (treu und glauben), through which judicial interventionism activates the rules operating as a delegation from the legislature to the judiciary “to fill gaps in the legislative system, to develop new rules, and to police contract law.”51 while § 242 allows adjusting contract law to meet new or specific circumstances, it has been proposed that the clause “may create unpredictability and uncertainties in contract law.”52 many of the civil legal regimes were substantially transformed in the early twentieth century, adopting good faith principles. the german civil code’s proactive judicial character took roots soon in its formative period, and has been painted, through its proactive nature, as safeguarding certain value-laden contractual rights. this is the perceived “good faith” approach, which often is at odds with the common law perception of freedom of contract.53 a clear example occurred 47 dimatteo, larry a., an international contract law formula: the informality of international business transactions plus the internationalization of contract law equals unexpected contractual liability, 23 syracuse j. int’l l. & com. 67, 8586 (1997) citing to von teichman, christoph, germany, federal republic, in 1 legal aspects of doing business in western europe 205, 218 (dennis campbell ed., 1983). 48 see dalbak, camilla, lojalitetsplikt som grunnlag for å begrense og utvide fleksibilitet i avetaleforhold (particularly section 2.2) (2007) at www.idunn.no. 49 dimatteo, larry a., an international contract law formula: the informality of international business transactions plus the internationalization of contract law equals unexpected contractual liability, 23 syracuse j. int’l l. & com. 67, 8586 (1997) citing to von teichman, christoph, germany, federal republic, in 1 legal aspects of doing business in western europe 205, 218 (dennis campbell ed., 1983). schäfer, hans-bernd, the relevance of law and economics for development of judge made rules: examples from german case law, 40 european economic review 989, 991 (1996) (large amount of german civil law based judge-made rules, filling legislative gaps). 50 dimatteo, larry a., an international contract law formula: the informality of international business transactions plus the internationalization of contract law equals unexpected contractual liability, 23 syracuse j. int’l l. & com. 67 (1997). 51 de ly, filip, commercial law as a refuge from contract law: a comparative and uniform law perspective, 45 wayne l. rev. 1825, 1854 (2000). see bundesministerium der justiz at http://www.gesetze-im-internet.de/ englisch_bgb/index.html. 52 id. 53 de ly, filip, commercial law as a refuge from contract law: a comparative and uniform law perspective, 45 wayne l. rev. 1825, 1849 (2000). the germanic principle of good faith performance may be traced to the roman age, http://www.idunn.no/ http://www.gesetze-im-internet.de/englisch_bgb/index.html http://www.gesetze-im-internet.de/englisch_bgb/index.html nordic journal of commercial law issue 2012#1 10 during the 1920s, as german courts interpreted contract cases based on the notions of good faith and fair dealing under bgb § 242, and proposed that new obligations could be judicially supplemented into contracts under the ergänzungsfunktion.54 moreover, courts can draw on good faith to “interfere with contract terms, and prohibit the exercise of contractual rights, if this conflicts with fair dealing (schrankefunktion).”55 further, german courts may “adapt contracts to new circumstances as a result of a significant change in the circumstances that originally led to the conclusion of the contract, under the korrekturfunktion.”56 the reviewing judge, under german civil code § 157, may thus fill in contractual gaps to ensure that the concept of good faith is adhered to.57 bgb § 242 goes even further, serving “as a barrier against enforcement of a contractual right, in case the exercise of that right brings to unfair results or disrupts the balance of interest between the parties.”58 finally, the german law on general business conditions or agb-gesetz (agbg) voids contract provisions which work to disadvantage a contract party in a manner “irreconcilable with good faith.”59 in each of these examples, the german jurist holds broad powers, which, as exercised, allow direct access into the contractual relationship. a french judge, similarly, may thrust elements of social and moral values into private bargaining, and reemerged during middle ages. dimatteo, larry a., an international contract law formula: the informality of international business transactions plus the internationalization of contract law equals unexpected contractual liability, 23 syracuse j. int’l l. & com. 67, 85 (1997) citing to anderson, jill p., lender liability for breach of the obligation of good faith performance, 36 emory l. j. 917, 919-920 (1987). 54 de ly, filip, commercial law as a refuge from contract law: a comparative and uniform law perspective, 45 wayne l. rev. 1825, 1849 (2000). see also weigand, tory, the duty of good faith and fair dealing in commercial contracts in massachusetts, 88 mass. l. rev. 175 n.5 (2004) (treu und glauben provides that the “debtor is bound to effect performance according to requirements of good faith giving consideration in common usage”) citing to powers, paul j., defining the undefinable: good faith and the united nations convention on contracts for international sale of goods, 18 j.l. & com. 333 (1999). 55 de ly, filip, commercial law as a refuge from contract law: a comparative and uniform law perspective, 45 wayne l. rev. 1825, 1849 (2000). 56 see id. 57 moss, giuditta cordero, international contracts between common law and civil law: is non-state law to be preferred? the difficulty of interpreting legal standards such as good faith, 7 global jurist (advances) 12 (2007); see also dimatteo, larry a., an international contract law formula: the informality of international business transactions plus the internationalization of contract law equals unexpected contractual liability, 23 syracuse j. int’l l. & com. 67, 85 (1997) citing to von teichman, christoph, germany, federal republic, in 1 legal aspects of doing business in western europe 205, 217 (dennis campbell ed., 1983) (modern german civil code also voids contractual terms considered contrary to good faith). 58 moss, giuditta cordero, international contracts between common law and civil law: is non-state law to be preferred? the difficulty of interpreting legal standards such as good faith, 7 global jurist (advances) 12 (2007). section 242 of the german civil code uses the good faith concept of geschaftsgrundlage, or “basis of the bargain” to excuse performance. dimatteo, larry a., an international contract law formula: the informality of international business transactions plus the internationalization of contract law equals unexpected contractual liability, 23 syracuse j. int’l l. & com. 67, 85-86 (1997) citing to von teichman, christoph, germany, federal republic, in 1 legal aspects of doing business in western europe 205, 218 (dennis campbell ed., 1983). 59 dimatteo, larry a., an international contract law formula: the informality of international business transactions plus the internationalization of contract law equals unexpected contractual liability, 23 syracuse j. int’l l. & com. 67, 85 (1997) citing to von teichman, germany, federal republic, in 1 legal aspects of doing business in western europe 205, 217 (dennis campbell ed., 1983). nordic journal of commercial law issue 2012#1 11 as it is allowed to consider the parties’ bad (or good) faith, enabling the judge to examine the contract through many prisms.60 2.3 exploring additional divergences outside and within legal families: norway and the civil law system comparative review may discern complexities within a single legal family.61 despite the overall consistencies with the civil law family, a comparativist must recognize key factors which distinguish the norwegian (and scandinavian) 62 legal tradition63 from other civil law traditions, including the lack of a systematic codification of the law of obligations, perceived elements and understandings of judicial pragmatism and a vibrant, pervasive goal, and sense, of social solidarity, which elevates equitable justice over individual autonomy.64 the nordic model’s “harmonization” of contract law, in particular, stemmed from the shared history, language and continuing nordic cultural unity, which is further based on “common ideological and political values.”65 the similarity in social ideals and the nordic nations’ mutual development in the region created legal uniformity, with closeness made stronger through determined cooperation in legal issues, as evidenced in the “general clause.”66 the nordic countries also share many traits in commercial laws, ranging from business registration rules to real estate acquisitions, 60 miller, lucinda, penalty clauses in england and france: a comparative study, 53 iclq 79, 100-101 (2004). 61 for discussions on divergent comparative contractual outcomes within a shared legal family, see canuel, edward t., comparing exculpatory clauses under anglo-american law: testing total legal convergence, pp. 81-103, in cordero moss, giuditta, et. al., boilerplate clauses, international commercial contracts and the applicable law (cambridge press, 2011) (analyzing how anglo-american courts interpret and apply exculpatory clauses, finding that the clauses have varying legal effects even within the same legal family). 62 norwegian law is grouped within the scandinavian legal systems, classified as a separate legal family, but accepted as largely having its roots, particularly within contract law, in the germanic legal tradition. moss giuditta cordero, international contracts between common law and civil law: is non-state law to be preferred? the difficulty of interpreting legal standards such as good faith, 7 global jurist (advances) 11 (2007). 63 for a basic overview of the various scandinavian legal systems, see michael bogdan, comparative law (1994); zweigert, konrad and hein kötz, introduction to comparative law (1987). see also pejovic, caslav, civil law and common law: two different paths leading to the same goal, 32 vuwlr 817, 818 n.3 (2001) at www.upf.pf/img/doc/16pejovic.doc (“the term “civil law” has two meanings: in its narrow meaning it designates the law related to the areas covered by the civil codes, while broader meaning of civil law relates to the legal systems based on codes as contrasted to the common law system”). 64 moss, giuditta cordero, international contracts between common law and civil law: is non-state law to be preferred? the difficulty of interpreting legal standards such as good faith, 7 global jurist (advances) 14 (2007). unlike other germanic-inspired countries, norway has not codified its obligations law. rather, norway has founded its contract interpretation on the act on formation of contracts of 1918. see, e.g., moss, giuditta cordero, international contracts between common law and civil law: is non-state law to be preferred? the difficulty of interpreting legal standards such as good faith, 7 global jurist (advances) 13 (2007) citing to hov, j., avtaleslutning og ugyldighet, kontratsrett i, 60, 167-168 (2002). 65 bo madsen, palle, scandinavian contract law within the eec: a social dimension in contract law by harmonization or recognition, in perspective of critical contract law 107, 109 (thomas wilhemsson, ed., 1992). 66 see id. http://www.upf.pf/img/doc/16pejovic.doc nordic journal of commercial law issue 2012#1 12 from patent protections to the sale of goods.67 alternatively, the common law family is composed of organic law, with judges reliant upon precedents and the persuasive effect of the works of other common law jurisdictions.68 the scandinavian reasonableness rule has been held as not a dramatic departure from german law, particularly given that the good faith obligations found under the german civil code’s § 242 “largely serve the same purpose of equitable justice.”69 a norwegian jurist, similar to a german judge, would “correct the literal interpretation of a contract to avoid an unfair result, and would integrate the terms of the contract in case of gaps: it would go even further than a german court, and would correct the wording of the contract to achieve a better balance of interest between the parties, even if the [applicable] contract regulation does not lead to unfair results.”70 similar contract interpretation is also found under norwegian contract law, with respect to both performance and negotiations, which include “a duty to take into consideration the other party’s reliance on contractual negotiations, and in a duty to inform the other party of matters that might have a material significance for that party’s evaluation of the prospective contract.”71 further evidencing such interpretation of necessary equitable requirements, cordero moss notes that “§ 33 of the act on formation of contracts provides that a contractual provision is not binding on a party, if enforcement thereof would be unfair because of circumstances that were known to the other party at the moment of conclusion of the contract.”72 focusing less on the individual freedom and more on justice and reasonableness than other civilian systems,73 the norwegian judge enjoys broad flexibility in the interpretive process.74 these underlying principles may be evidenced through contract formation requirements, a system which requires neither specific contractual form, nor invalidates oral agreements (which, under the norwegian system, are as binding as a written contract).75 the norwegian fact finder seeks the contracting parties’ objective intent, while strongly influenced in the context of 67 see gustafsson, leif, business laws in the nordic countries: legal and tax aspects (1998). 68 cappalli, richard b., open forum: at the point of decision: the common law’s advantage over the civil law, 12 temp. int’l & comp. l. j. 87, 92 (1998). it has been asserted that the common law has an “obsession” with noting the reason behind rules. id. at 91. 69 see moss, giuditta cordero, international contracts between common law and civil law: is non-state law to be preferred? the difficulty of interpreting legal standards such as good faith, 7 global jurist (advances) 15 (2007). 70 id. 71 id. 72 id. at 16. 73 note that judicial roles vary among civil law legal regimes. for general discussions as to the different approaches between the germanic and french legal systems, see, respectively, dimatteo, larry a., an international contract law formula: the informality of international business transactions plus the internationalization of contract law equals unexpected contractual liability, 23 syracuse j. int’ l. & com. 67, 70 (1997); miller, lucinda, penalty clauses in england and france: a comparative study, 53 iclq 79, 97-98 (2004). see also pearce, brian, the comity doctrine as a barrier to judicial discretion: a u.s.-e.u. comparison, 30 stan. j. int’l l. 525, 567-570 (1994). 74 moss, giuditta cordero, international contracts between common law and civil law: is non-state law to be preferred? the difficulty of interpreting legal standards such as good faith, 7 global jurist (advances) 14 (2007). 75 gustafsson, leif, business laws in the nordic countries: legal and tax aspects 392 (1998). nordic journal of commercial law issue 2012#1 13 contract law by the subject agreement’s purpose.76 contract interpretation by the norwegian judge will follow what is perceived to be the contract’s function.77 for example, given the absence in formal requirements, norwegian law also considers it decisive that the “company or person who has issued a statement, written or orally, did so with the intention to establish rights and obligations between the parties considered.”78 in short, norway’s civil law framework emphasizes a standards-based review rather than a formalistic approach.79 norwegian courts stress the flexibility of a judge, particularly in a quest to ensure compliance with good faith principles. gap-filling is a highly-accepted element of civil law legal regimes. civil law judges are empowered with far-ranging judicial tools, allowing them significant opportunities and ability to intervene as necessary when perceived contractual intent is violated.80 providing a norwegian judge procedural or interpretive flexibilities embraces legal realism goals, less concerned as to levels of judicial discretion and more focused upon avoiding static, rigid mechanisms which may promote mistakes or inequities.81 within the contract law context, section 36 of the act on formation of contracts of 191882 provides norwegian judges expansive interventionist powers, allowing them to either void or reformat a contractual clause deemed unreasonable.83 norwegian judges either directly or indirectly use section 36.84 76 moss, giuditta cordero, international contracts between common law and civil law: is non-state law to be preferred? the difficulty of interpreting legal standards such as good faith, 7 global jurist (advances) 14 (2007). 77 see id. 78 gustafsson, leif, business laws in the nordic countries: legal and tax aspects 392 (1998) (emphasis added). a discussion of how norwegian law contends with oral contract amendments (and general analysis as to when american contracts are allowed to be oral in form), is found in westly, jens christian, no oral amendments clauses, paper presented in norway at the anglo-american contract model project seminar on june 16-17, 2008 (on file with author). 79 civil law regimes often place great importance upon legislated codes which suggests a formalist approach. germany provides an interesting example, as it codified the principle of good faith under section 242 of the german civil code, which provides a reviewing judge the power to render standards-based decisions. see bundesministerium der justiz at http://www.gesetze-im-internet.de/ englisch_bgb/index.html. 80 see miller, lucinda, penalty clauses in england and france: a comparative study, 53 iclq 79,100-101 (2004); de ly, filip, commercial law as a refuge from contract law: a comparative and uniform law perspective, 45 wayne l. rev. 1825, 1854 (2000). 81 katz, avery w., the economics of form and substance in contract interpretation, 104 colum. l. rev. 496, 497 (2004) (“positive imperatives of lawmaking thus lead naturally to interpretive conventions that disfavor formalist decision-making”). 82 the 1918 act is composed of four separate chapters, with section 36 found in chapter three, dealing with contracts voided due to exploitation of another party’s weakness, fraud or duress. krüger, kai, norsk kjøpsrett 693 n.70 (1999); hagstrøm, viggo, obligasjonrett 275 (2003). prior to its amendments, the original section 36 did specifically address the concern that excess penalties could be misused. 83 swedish law specifically provides for an evaluation of the relative bargaining power of the parties in making the reasonableness determination. section 36(2) of the swedish commercial code provides that “particular consideration” shall be given to protecting the party “in a subordinate position in the contractual relationship.” dimatteo, larry a., theory of efficient penalty: eliminating the law of liquidated damages, 38 am. bus. l. j. 633, 654 (2001) citing to international chamber of commerce, guide to penalty and liquidated damages clauses 38 (1990). http://www.gesetze-im-internet.de/englisch_bgb/index.html nordic journal of commercial law issue 2012#1 14 2.4 good faith doctrine and the role of judges: black-letter common law anglo-american contract law varies significantly from the civil law interpretations of good faith, which also indicate the differing role held by judges. under the common law approach, good faith is found sporadically in certain areas, such as contract termination and good faith in negotiations.85 the common law system’s reluctance to integrate equitable principles between the contracting parties, such as good faith, evidences the importance stressed upon commerce and business, given that such principles may create uncertainty.86 additionally, a civil legal regime’s good faith excuse for non-performance may result in contractual rescission, which would be nearly impossible to pursue, if ever, under the common law context.87 the common law tradition focuses more on remedies, or remedial satisfaction, but somewhat less on the rights and duties that are at its core, as compared to civil law’s concentration on the obligor’s duty of performance and the underlying right of the obligee to receive performance.88 under the u.s. interpretation, duties of good faith and fair dealing89 are “elusive and ill-defined,” with courts opting to address claims under such legal doctrines on an “individualized, fact 84 see hagstrøm, viggo, obligasjonrett 275 (2003); woxholt, geir, avtalerett (2003); dalbak, camilla, lojalitetsplikt som grunnlag for å begrense og utvide fleksibilitet i avetaleforhold (particularly section 2.2) (2007) at www.idunn.no. 85 dimatteo, larry a., an international contract law formula: the informality of international business transactions plus the internationalization of contract law equals unexpected contractual liability, 23 syracuse j. int’l l. & com. 67, 86 (1997); see also hillman, robert a., an analysis of the cessation of contractual relations, 68 cornell l. rev. 617 (1983); weigand, tory, the duty of good faith and fair dealing in commercial contracts in massachusetts, 88 mass. l. rev. 174 (2004). 86 moss, giuditta cordero, international contracts between common law and civil law: is non-state law to be preferred? the difficulty of interpreting legal standards such as good faith, 7 global jurist (advances) 1 (2007). see also demott, deborah a., puzzles and parables: defining good faith in the mbo context, 25 wake forest l. rev. 15, 19 (1990) (“a key component of business judgment analysis [in the u.s.], good faith, has always been a concept arguably unequalled for its malleability and formlessness”). 87 dimatteo, larry a., an international contract law formula: the informality of international business transactions plus the internationalization of contract law equals unexpected contractual liability, 23 syracuse j. int’l l. & com. 67, 8586 (1997) citing to von teichman, christoph, germany, federal republic, in 1 legal aspects of doing business in western europe 205, 218 (dennis campbell ed., 1983); moss, giuditta cordero, international contracts between common law and civil law: is non-state law to be preferred? the difficulty of interpreting legal standards such as good faith, 7 global jurist (advances) 1 (2007). 88 miller, lucinda, penalty clauses in england and france: a comparative study, 53 iclq 79, 97 (2004). 89 good faith and fair dealing concepts are found in the restatement (second) of contracts and the u.c.c., which is a uniform act promulgated to harmonize the law of the sale of goods and other transactions in the u.s., and adopted, in whole or in part, by all u.s. states. for example, u.c.c. § 1-203 specifically refers to an obligation of good faith, and notes that every contract/duty within the u.c.c. imposes such good faith obligation. see also farnsworth, e. allen, good faith performance and commercial reasonableness under the uniform commercial code, 30 u. chi. l. rev. 666 (1983); restatement (second) of contracts, section 205 (“every contract imposes upon each party a duty of good faith and fair dealing in its performance and its enforcement.”). but see weigand, tory, the duty of good faith and fair dealing in commercial contracts in massachusetts, 88 mass. l. rev. 174, 177 (2004) citing to white, james j. & summers, robert s., uniform commercial code § 4 (1988) (u.c.c. is “not applicable to a majority of commercial transactions and leaves many issues such as contract formation to the “common law””). see also appellant brief for shelby resources, llc v. wells fargo bank, national association, 2006 wl 4082450 at 2 (2006) (arguing that “weight of authority is that all of the common law should be applied to u.c.c. claims when it http://www.idunn.no/ nordic journal of commercial law issue 2012#1 15 specific basis.”90 jurists have argued that such doctrines act as “an unwarranted invitation to the judiciary to impermissibly intrude into freedom.”91 in massachusetts, for example, good faith and fair dealing were limited in the early 20th century to isolated cases, including the prohibition of employees using garnered business information with their former employer’s competitor, and protecting the vendee’s goodwill against the possibility of a vendor creating a rival business.92 confined to such limited instances, u.s. courts generally hold that the words and terms used in the contracting parties’ agreement must be given primacy. this understanding embodies freedom of contracting principles. the rationale is that the contracting parties, except in limited instances where public policy would otherwise be contravened, should have contractual freedom to dictate their own agreements.93 unambiguous contracts are to be construed by courts within the agreements’ “plain terms” or “four corners,” where introducing any extrinsic evidence in contract disputes that contradict or supplement the agreement’s express terms were forbidden.94 recent u.s. decisions mainly reject alleged contractual breaches of the duty of good faith and fair dealing, and reemphasize the freedom of contract.95 many modern opinions contain a repetitive appears that duties in addition to u.c.c. duties exist on the part of a defendant); weinberg, lisa g., letter of credit litigation: bank liability for punitive damages, 54 fordham l. rev. 905, 911 n.31 (1986) (asserting that common law applies unless displaced by code, noting u.c.c. § 1-103 (1977) states that “[u]nless displaced by the particular provisions of this act, the principles of law and equity . . . shall supplement its provisions”). for a general discussion as to how sales of goods are distinguished from sales of services, see gimeno, christine, et. al., 79 c.j.s. secured transactions §2. 90 weigand, tory, the duty of good faith and fair dealing in commercial contracts in massachusetts, 88 mass. l. rev. 174 (2004). for a description of the english view toward good faith, see judge brimham lj in interfoto picture library ltd. v. stiletto visual programmes ltd. [1988] 2 w.l.r. 615 (“english law has, characteristically, committed itself to no such overriding principle [as the principle of good faith] but has developed piecemeal solutions in response to demonstrated problems of unfairness…”) cited in moss, giuditta cordero, international contracts between common law and civil law: is non-state law to be preferred? the difficulty of interpreting legal standards such as good faith, 7 global jurist (advances) 9 (2007). 91 weigand, tory, the duty of good faith and fair dealing in commercial contracts in massachusetts, 88 mass. l. rev. 174-175 (2004) citing to n. heel corp. v. comp. indus., 851 f.2d 456, 466 (1st cir. 1988). 92 see id. at 174, 176, citing to essex trust co. v. enwright, 214 mass. 507 (1913); foss v. roby, 195 mass. 292, 298 (1907). 93 see levenson v. feuer, 60 mass. app. ct. 428, 437-438 (2004) (conveyance instrument which would assist real estate contracting parties seeking to dodge statutes concerning government foreclosure process was voided); beacon hill civic ass’n v. ristorante toscano, inc., 422 mass. 318, 320 (1996), quoting farnsworth, e. allan, contracts, 5.1 at 345 (1990) (“the public interest [is] to accord individuals broad powers to order their affairs through legally enforceable agreements”). 94 weigand, tory, the duty of good faith and fair dealing in commercial contracts in massachusetts, 88 mass. l. rev. 174, 177 (2004); see also shoe & leather nat’l bank v. dix, 123 mass. 148, 150 (1877) (where contracts inoperative under their “true meaning,” the courts cannot “suppose a meaning which the parties have not expressed”); pdc-el paso meridien, llc v. alstrom power, 18 mass. l. reptr. 14 (2004) (no page numbers available online) (absent “special circumstances,” court held that “[i]t is not the role of the court to alter the parties’ agreement”). 95 weigand, tory, the duty of good faith and fair dealing in commercial contracts in massachusetts, 88 mass. l. rev. 174, 188 (2004). note that freedom of contract theory is influential in the development of common contract law. the theory focuses on leaving the contracting parties to their own agreement, recognizing that contracting parties nordic journal of commercial law issue 2012#1 16 holding that such duties will not be used to “rewrite the parties’ agreement.”96 courts refuse to “accomplish by judicial fiat what [a party] neglected to achieve contractually.”97 commercial parties will be held to their chosen language and the relationship embodied in the contract. courts will thus not “attempt to rewrite the parties’ contract to conform to the court’s sense of equity or preference for a different outcome, no matter how appealing.”98 for example, in the massachusetts case owen v. kessler, 56 mass. app. ct. 466 (2002), a real estate commitment outlined a specific timeframe as to when an executed purchase and sale agreement must be provided. when the buyer delivered the agreement late, less than half an hour later than the agreed time, the seller refused to sell the property.99 the appellate court rejected the buyer’s claim of a violation of the good faith and fair dealing duty, finding any such duty could not override an express contractual term.100 a u.s. court has also flatly rejected a good faith duty even when a preliminary agreement expressly stated or inferred such obligation, holding that “[a]n agreement to negotiate in good faith is amorphous and nebulous, since it implicates so many factors that are themselves indefinite and uncertain that the intent of the parties can only be fathomed by conjecture and surmise.”101 good faith interpretation ensuring a core civilian contracting value, a reasonable dispute outcome, is less exalted in the common law systems. the common law focuses often on contractual freedom, a contract’s literal meaning, the individual contracting parties’ autonomy and expected judicial recognition of the contracting parties’ relationship—even when a contract may yield “unfair” results.102 for example, english courts are reluctant to impose additional are free to enter into mutually beneficial economic exchanges. see dimatteo, larry a., theory of efficient penalty: eliminating the law of liquidated damages, 38 am. bus. l. j. 633, 641 (2001) (“the freedom of parties to structure their own agreement is universally acknowledged to be at the heart of the common law of contracts”). 96 see weigand, tory, the duty of good faith and fair dealing in commercial contracts in massachusetts, 88 mass. l. rev. 174 at 188 n. 182 (2004) citing to chokel v. genzyme corp., 2003 mass. super. lexis 417 (nov. 12, 2003) (van gestel, j.) (“new or independent duties separate from those already in contract cannot be added by a judge under the cloak of an implied covenant of good faith and fair dealing”); kroutik v. momentix, inc., 2003 mass. super. lexis 112 (apr. 2, 2003); owen v. kessler, 56 mass. app. ct. 466 (2002) (same). 97 northern heel corp. v. compo indus., inc., 851 f.2d 456, 466 (1st cir. 1988); mathewson corp. v. allied marine indus., inc., 827 f.2d 850, 855 (1st cir. 1987) (court held it is “[f]ar wiser for a court to honor the parties’ words than to imply other and further promises out of thin air”). 98 weigand, tory, the duty of good faith and fair dealing in commercial contracts in massachusetts, 88 mass. l. rev. 174, 188 n. 184 (2004) citing to epstein, becker & green, p.c. v. atlas venture, 2003 mass.super. lexis 84, 10 (2003); rogaris v. albert, 431 mass. 833, 835 (2000). 99 owen v. kessler, 56 mass. app. ct. 466, 467-469 (2002). 100 see id. at 471-472. see also bryant v. nickerson, 65 mass. app. ct. 1118 (2006) (no page numbers available online) (prospective real estate buyer failed to provide notice of inability to obtain financing at date designated in purchase agreement; seller awarded liquidated damages contemplated under the agreement). 101 candid prods., inc. v. int’l skating union, 530 f. supp. 1330, 1337 (s.d.n.y. 1982); see also metromedia broadcasting corp. v. mgm/ua entertainment co., inc., 611 f. supp. 415 (d.c. cal 1985). 102 de ly, filip, commercial law as a refuge from contract law: a comparative and uniform law perspective, 45 wayne l. rev. 1825, 1852 (2000); moss, giuditta cordero, international contracts between common law and civil law: is non-state law to be preferred? the difficulty of interpreting legal standards such as good faith, 7 global jurist (advances) 4 (2007). nordic journal of commercial law issue 2012#1 17 contract terms, and, in but few examples (such as the doctrine of frustration) will not revise contracts in the instance of changed circumstances which make it more difficult for a contracting party to perform.103 moreover, english contract law does not interpret contracts by examining party intent, but focuses on what the contracting parties have “expressed and written down.”104 “english judges do not openly interfere with contract terms in order to supplement, correct, or revise them. the basic attitude is much more pragmatic; contracts work most efficiently if the parties stick to what they have expressed, without judges interfering to speculate about their intentions and to depart from the terms of the commercial deal and negotiation power.”105 under the common law, as contracting parties will be held to their bargain, and courts will not interpret a contract outside the agreement’s expressed meaning.106 extrinsic contract circumstances, such as conduct during, before, or after contract execution, are generally not considered by the judge.107 thus, in order to ensure commercial predictability, the common law parol evidence rule disallows parties producing evidence which may vary, add or contradict a contract’s wording.108 but note that the parol evidence rule has a series of exceptions that admit evidence of the factual background existing at or before the date of the contract (but not after that date, as opposed to the civilian systems), at least in respect of facts that were known to both parties.109 the anglo-american legal tradition’s maintenance of an approach more formalistic than the civil law system is also demonstrated when comparing contract formation requirements. the norwegian tradition, for example, finds that oral agreements are valid and binding.110 compare this with the american approach, involving the statute of frauds. under the statute, certain 103 de ly, filip, commercial law as a refuge from contract law: a comparative and uniform law perspective, 45 wayne l. rev. 1825, 1852 (2000). a commentator proposes that u.k. courts are unlikely to inordinately intervene with commercial dealings, which “interruptions” will be damaging for business dealings and comprises predictability. miller, lucinda, penalty clauses in england and france: a comparative study, 53 iclq 79, 90 (2004). 104 de ly, filip, commercial law as a refuge from contract law: a comparative and uniform law perspective, 45 wayne l. rev. 1825, 1852 (2000). 105 dimatteo, larry a., an international contract law formula: the informality of international business transactions plus the internationalization of contract law equals unexpected contractual liability, 23 syracuse j. int’l l. & com. 67 (1997); see also moss, giuditta cordero, international contracts between common law and civil law: is non-state law to be preferred? the difficulty of interpreting legal standards such as good faith, 7 global jurist (advances) 4 (2007) (the common law judge’s central role enforcing what the parties agreed through their bargain, rather than creating justice). 106 weigand, tory, the duty of good faith and fair dealing in commercial contracts in massachusetts, 88 mass. l. rev. 174, 188 n. 184 (2004). 107 moss, giuditta cordero, international contracts between common law and civil law: is non-state law to be preferred? the difficulty of interpreting legal standards such as good faith, 7 global jurist (advances) 5 (2007). in repeated caselaw, american courts underscore that interpretation is bound to the “four corners” of the contract. 108 see id. at 5 n.7. 109 see id. at 6. for a description of various american parol evidence rule exceptions, including contractual negotiations, see glasser, mark k. and keith a. rowley, on parol: the construction and interpretation of written agreements and the role of extrinsic evidence in contract litigation, 49 baylor l. rev. 657, 705-711 (1997). 110 gustafsson, leif, business laws in the nordic countries: legal and tax aspects 392 (1998). nordic journal of commercial law issue 2012#1 18 contracts are deemed unenforceable unless the agreements are in writing and executed by the person bound under the contract’s terms. although formalized requirements vary from state to state, particular industry or trade-specific agreements are bound under the statute’s requirements. typical contracts requiring the statute include those: (i) involving real property interests, (ii) sureties, (iii) agreements for the sale/lease of goods at $500 or more, (iv) certain non-competition agreements, (v) separation agreements and (vi) made by or on behalf of a municipality.111 contractual intent is thus also a means of contrasting the common and civil law traditions. for example, the common law legal system holds that business communications with uncertain contractual intent are presumed unenforceable.112 under the traditional common law view, all enforceable commercial contracts maintained a proof of a clear intent to enter a legal relationship, and certainty as to all material contract terms.113 conversely, civilian countries do not demand contract relations as a prerequisite to contract enforceability, as in the common law.114 accordingly, as compared to the common law jurisdictions, civil law countries tend to find contractual parties legally bound “at an earlier stage of the negotiation process.”115 the common law approach in the u.s. thus places great weight (and responsibility) on the parties, as effected through their contractual arrangement.116 exercising judicial interpretation based upon good faith violations is exceedingly rare. unambiguous contracts are to be construed by courts within the agreements’ “plain terms” or “four corners,” where introducing any extrinsic evidence in contract disputes that contradict or supplement the agreement’s express terms were forbidden.117 alternatively, civil law courts attempt to avoid unjust 111 brinkley, martin h., the regulation of contractual change: a guide to no oral modification clauses for north carolina lawyers, 81 n.c. l. rev. 2239 (2003). 112 dimatteo, larry a., an international contract law formula: the informality of international business transactions plus the internationalization of contract law equals unexpected contractual liability, 23 syracuse j. int’l l. & com. 67, 69 (1997). 113 see id. 114 see id. at 67, 70. 115 dimatteo, larry a., an international contract law formula: the informality of international business transactions plus the internationalization of contract law equals unexpected contractual liability, 23 syracuse j. int’l l. & com. 67, 70 (1997) citing to klein, john & carla bachechi, precontractual liability and the duty of good faith negotiation in international transactions, 17 hous. j. int’l l. 1, 17 (1994). 116 publishers resource inc., v. walker-davis publications, inc., 762 f.2d 557 (7th cir. 1985), citing to stein v. malden mills, inc., 9 ill. app. 3rd 266, 270-271 (1972) (“obviously the terms of the contract control, and it is not our [the court’s] function to rewrite them according to our own notions of fairness”); dresser indus. v. pyrrhus ag, 936 f.2d 921, 933 (7th cir. 1991); scheduling corp. of america v. massello, 503 n.e.2d 806, 811 (1987). 117 weigand, tory, the duty of good faith and fair dealing in commercial contracts in massachusetts, 88 mass. l. rev. 174, 177 (2004); see also shoe & leather nat’l bank v. dix, 123 mass. 148, 150 (1877) (where contracts inoperative under their “true meaning,” the courts cannot “suppose a meaning which the parties have not expressed”); pdc-el paso meridien, llc v. alstrom power, 18 mass. l. reptr. 14 (2004) (no page numbers available online) (absent “special circumstances,” court held that “[i]t is not the role of the court to alter the parties’ agreement”). nordic journal of commercial law issue 2012#1 19 solutions stemming from a contract’s literal interpretation.118 such is the divergence between a civilian good faith approach and a common law interpretation of contractual relations. 3 exploring law-in-action: objective pluralism considerations reviewing the comparative commercial civil and common law precepts of good faith demonstrates that key legal concepts may be interpreted differently across legal families. exploring the black letter law of good faith reveals divergences. in order to ascertain how the law acts in practice, an additional dimension to a theoretical textbook framework is, however, needed. thus, a law-in-action approach is demanded. in addition to ascertaining the strengths and weaknesses of one’s own legal regime, reviewing an international business law legal standard presents practical implications. namely, business parties are presented with opportunities to evaluate legal equivalency—decision-makers are informed on the implications of pursuing multi-jurisdictional transactions. yet, the challenge remains to find evaluative, objective measures which complement a traditional black letter law review.119 such is objective pluralism, which analyzes a comparative legal problem from economic, social, behavioral and, as applicable, relational contracting law perspectives. the totality of such review produces balanced insights, using a multiplicity of factors—precluding the dangers of approaching a problem with the mislaid goal of a “one-size-fits-all” perspective.120 3.1 the economic method: transaction costs, efficiency economic analysis allows the evaluation of business law in divergent legal systems, necessitating the consideration of several interlinked factors, including transaction costs, risk allocation and economic utility. despite criticism, such analysis offers comparativists insights and modes of comparison otherwise unavailable when distinguishing law under purely sociological mechanisms. when analyzing legal concepts under different legal regimes, economics can ultimately create efficient models “which work as homogeneous grounds of comparison.”121 economic analysis increases outcome prediction success rates,122 while avoiding value 118 moss, giuditta cordero, international contracts between common law and civil law: is non-state law to be preferred? the difficulty of interpreting legal standards such as good faith, 7 global jurist (advances) 1 (2007). 119 karl n. llewellyn, the bramble bush 12 (2nd ed. 1951) (“[r]ules alone, mere forms of words, are worthless”) cited in halperin, jean-louis, law in the books and law in action: the problem of legal change, 64 me. l. rev. 45, 52 (2011). 120 palmer, vernon valentine, from lerotholi to lando: some examples of comparative law methodology, 53 am. j. comp. l. 261, 264 (2005) (“reaching the “law in action” is still a scientific ideal of mainstream comparative law, but one is never quite sure how high the cognitive bar has been set”). 121 see mattei, ugo, comparative law and economics 94-95 (1997). 122 ogus, anthony, what legal scholars can learn from law and economics, 79 chi.-kent l. rev. 393 (2004). see also friedman, milton, the methodology of positive economics, in essays in positive economics 3, 14-16 (1953) nordic journal of commercial law issue 2012#1 20 judgments generally associated with sociological studies which often seek to determine what composes fair law and policy.123 economics also predicts what economic consequences flow from the differences among legal systems.124 several issues emerge when employing an economic analysis of comparative law. it has been argued that three key elements characterize modern law and economic theory: (i) people “maximize,” in that they try to reduce costs and increase benefits, (ii) markets reconcile individual wants with the limited resources available and (iii) more efficient markets and laws have the potential to make people “better off.”125 looking deeper at legal economic theory,126 significant scholarship has been dedicated to studying how transactional parties contend with internal and external costs—all within the context of economic efficiency. utilizing the economic evaluative method mandates focus on two distinct areas: economic efficiency and transaction costs, which often intersect. 3.1.1 understanding efficiency “efficiency” is defined in economic terms as acting with a minimum of effort, waste and expense.127 in the contracting context, agreements are viewed as efficient means of wealth maximization.128 efficiency, when voiced in the context of international legal transactions from a contracting standpoint, involves the costs of instituting required legal mechanisms—all while (unimportant that economic reasoning is based on assumptions that do not reflect the “real world” so long as those assumptions produce “predictable” results). 123 posner, richard a. and anthony t. kronman, the economics of contract law 1-5 (1979). 124 ogus, anthony, what legal scholars can learn from law and economics, 79 chi.-kent l. rev. 393 (2004) (under rubric of french and english law, economics provides evaluation of differences between national legal principles governing identical factual situations) 125 baird, douglas g., the future of law and economics: looking forward, 64 u. chi. l. rev. 1129, 1164 (1997). 126 law and economics, at least with respect to the so-called “chicago school” of economics, has been defined as sharing certain familiar characteristics, including “reliance on the neo-classical assumption that individuals are rational maximizers; equating change in legal rules with change in relative prices; and adoption of kaldor-hicks efficiency (“potential pareto efficiency,” in more obscure terms) in the sense of wealth maximization as a standard of evaluation.” harris, ron, the uses of history in law and economics, 4 theoretical inquiries l. 659, 666-667 (2003). 127 malloy, robin paul, law and economics: a comparative approach to theory and practice 38 (1990). 128 dimatteo, larry a., theory of efficient penalty: eliminating the law of liquidated damages, 38 am. bus. l. j. 633, 642 (2001); brizzee, david, note, liquidated damages and the penalty rule: a reassessment, 1991 byu l. rev. 1613, 1615. nordic journal of commercial law issue 2012#1 21 weighing the necessary autonomy of contracting parties.129 this creates tensions, which economists urge should be considered in terms of overall transaction costs.130 note that reviewing comparative business law regimes under an efficiency prism must overcome hurdles. for example, how is efficiency effectively (if not singularly) measured, particularly within the contractual law context? economists measure efficiency differently, most notably through pareto superior and kaldor-hicks models. if an economic transaction is “pareto superior,” the contractual breaching party would be in a more favorable economic position following breach, while the non-breaching party would not be in a worse position.131 pareto efficiency thus occurs if no superior points are available, meaning that it is impossible to “make any individual better off without making someone else worse off.”132 the classic example is a voluntary market exchange where, in the absence of factors such as fraud or duress, both parties are bettered by the exchange. each party valued the other bargained object “more than which they were originally holding, or else they would not have made the exchange…[and it is thus] ascertainable as to how great transaction costs may prevent otherwise efficient exchanges”133 pareto analysis therefore “allows economists to identify improvements without assessing relative values of these improvements to parties.” 134 under the kaldor-hicks standard, an economic action is efficient if a new outcome allows the benefiting party to be “sufficiently better off,” receiving a utility increase, even if the contractual 129 a legal economist argues that drafting “efficient” contract terms may be prohibitively costly, particularly as negotiating clear language may be overly time-consuming to, or both parties will lack essential information necessary for drafting such clauses. charny, david, nonlegal sanctions in commercial relationships, 104 harv. l. rev. 373, 436 (1990). 130 “the difficulty of balancing various dimensions of efficiency in heterogeneous circumstances suggests two general institutional responses: choosing legal default rules that are second best, and permitting freedom of contract so that individual parties can use their local knowledge to improve on the general defaults that public lawmakers have set. for example, if we think that private bargaining is relatively costly due to bilateral monopoly or other transaction costs, we should choose default rules to implement the tradeoff that best suits majority preference; conversely, if we think that private bargaining is relatively cheap, we should select default rules that encourage such bargaining.” goetz, charles j. and robert e. scott, the limits of expanded choice: an analysis of the interactions between express and implied contract terms, 73 cal. l. rev. 261 (1985) cited in katz, avery w., remedies for breach of contract under the cisg, 25 int’l rev. of l. and econ. 382 (2005). 131 coleman, jules, markets, morals, and the law 97 (1988); dodge, william s., the case for punitive damages in contracts, 48 duke l. j. 629, 652 n.132 (1999) (pareto efficient transactions result in a net increase in wealth, without anyone in a worsened condition as a result of the transaction; the contract gainers compensate losers for any losses caused by the transaction); see also cooter, robert & thomas ulen, law and economics 41-42 (1997) (discussing pareto efficient transactions and the kaldor-hicks standard); malloy, robin paul, law and economics: a comparative approach to theory and practice 39 (1990) (pareto superiority refers to a status quo change where at least one person is made better off without making anyone else worse off). for an additional “textbook” analysis of pareto theory, see mclure, michael, pareto, economics and society (routledge, 2008). 132 malloy, robin paul, law and economics: a comparative approach to theory and practice 39. 133 see id. at 40. 134 cender, joshua, knocking opportunism: a reexamination of efficient breach of contract, 1995 ann. surv. am. l. 689, 697 (1996); see also posner, richard a., economic analysis of law 13 (1992). nordic journal of commercial law issue 2012#1 22 “losers” would be compensated:135 the efficiency of an action may be weighed if an alternative policy, condition, or program is “better.”136 the kaldor-hicks theory therefore focuses on whether society’s aggregate utility is maximized, and not whether resource allocation will make certain parties worse off.137 within a contractual context, efficiency may also look to the duration of an agreement and the relationship between the parties.138 in short, resource reallocation is efficient if those gaining from it obtain enough to compensate for those who lose from it, although no requirement exists that actual compensation occurs.139 the kaldor-hicks theory therefore focuses on whether society’s aggregate utility is maximized, and not whether resource allocation will make certain parties worse off.140 distinguishing between kaldor-hicks and pareto superior models of efficiency thus involves, in the former instance, a social utility dimension. a hypothetical case demonstrates the tensions between both efficiency theories under a legal setting.141 for example, a commercial landlord’s office building may be targeted by municipal authorities for use in its redevelopment plans. a developer asserts that a major project at the site will rejuvenate the city, and provide the municipality with twice the fair market value which the city offers the landlord. the landlord resists the offer, instead preferring to remain operational. it would not be a pareto superior state if the municipality opts to pay the fair market value, given the landlord’s objections to sell, and its decreased utility following the conveyance. the kaldor-hicks test would find an efficient transaction, assuming that the 135 sidhu, dawinder, the immorality and inefficiency of an efficient breach, 8 tenn. j. bus. l. 61, 65 (2006) citing to coleman, jules, markets, morals, and the law 98 (1988); linzer, peter, on the amorality of contract remedies-efficiency, equity, and the second restatement, 81 colum. l. rev. 111, 114. (1981) (“society’s welfare increases through a benefit to one individual, even as loss also passes to another party, to the extent that the benefited party may fully compensate the “losing party,” and “remain better,” than before. if the breaching party is not required to compensate the nonbreaching party, the breach is kaldor-hicks efficient”); dodge, william s., the case for punitive damages in contracts, 48 duke l. j. 629, 652 n.132 (1999) ( “a transaction is kaldor-hicks efficient if the gainers gain more than the losers lose”); posner, richard a., the ethical and political basis of the efficiency norm in common law adjudication, 8 hofstra l. rev. 487, 491 (1980); posner, richard a., the problems of jurisprudence 19 (1990) (wealth maximization standard only requires that “the winners’ gains exceed the losers’ losses”); posner, richard a., economic analysis of law 13-16 (1992) (kaldor-hicks involves wealth maximization state, where a more superior state exists when more wealth is generated); katz, steven b., the california tort of bad faith breach, the dissent in seaman’s v. standard oil, and the role of punitive damages in contract doctrine, 60 s. cal. l. rev. 509, 521-28 (1987). but see cender, joshua, knocking opportunism: a reexamination of efficient breach of contract, 1995 ann. surv. am. l. 689, 697 n.59 (1996) (kaldor-hicks theory is limited as it ignores wealth distribution; unlike pareto model, as long as one party’s gain is higher than another party’s loss, kaldor-hicks superior state realized). for an additional “textbook” analysis, see varian, hal r., intermediate microeconomics (w.w. norton & co., 6th ed. 2006) at 15-16. 136 schelling, thomas c., economic reasoning and the ethics of policy, 63 the public interest, 37, 50 (1981). 137 see id. 138 schelling, thomas c., economic reasoning and the ethics of policy, 63 the public interest, 37, 50 (1981). 139 malloy, robin paul, law and economics: a comparative approach to theory and practice 40 (1990). 140 see id. 141 the illustration is based on an example found in malloy, robin paul, law and economics: a comparative approach to theory and practice 41-42 (1990). nordic journal of commercial law issue 2012#1 23 municipality’s increase in value (considering that the pay-out of fair market value to the commercial landlord is sufficient, and that the community will reap reward from the developer in this beneficial redevelopment project) will result in a total social utility increase, even if the landlord is somehow worsened by the transaction.142 3.1.2 transaction costs transaction costs drain the efficiencies flowing from contractual provisions and are associated with all aspects of such clauses, from negotiation to implementation. while transaction costs have many definitions and interpretations, they are generally understood in the commercial contracting context as those costs incurred during the actual contractual negotiations, given that parties remain possibly uncertain as to whether other contracting partners shall honor their contractual commitments, or breach.143 acquisition of information is a necessary, central transaction cost.144 nevertheless, transaction costs may have alternate meanings in different legal systems, and cultures---the depth of what such topic covers may also be unwieldy in scope. the breaching contracting party’s reputational loss is another cost, as parties would hesitate to enter into contracts with “deliberate breachers,” or parties prone to breaching; if they do, onerous contractual terms to deter a breach would likely be required.145 transaction costs also include expenses associated from dealing with the breach, including dispute resolution costs, finding alternative suppliers, and entering into new agreements.146 the transaction costs may vary in international settings, where, for example, disputing costs and monitoring costs are higher, given the unfamiliarity with the forum involved and local legal requirements.147 with respect to drafting, note that commercially-incomplete contracts are quite expensive to create, given that drafting parties may seek to withhold information needed to complete the agreement. the parties may also purposefully leave the contract incomplete (missing significant contractual terms), hoping to agree on certain terms at a later date.148 contracts, particularly those encompassing international transactions, necessitate a multiplicity of jurisdiction-specific rules and further require specific drafting in order to not only provide parties their desired 142 malloy, recognizing this social dimension, thus holds that “a kaldor-hicks test permits moves where a pareto superior test does not.” malloy, robin paul, law and economics: a comparative approach to theory and practice 41-42 (1990). 143 sidhu, dawinder, the immorality and inefficiency of an efficient breach, 8 tenn. j. bus. l. 61, 89 (2006). 144 georgakopoulos, nicholas l., principles and methods of law and economics: basic tools for normative reasoning 246 (2005) (noting that buyers entering into transactions after precisely researching the exact benefits never into disadvantageous acquisitions. “if at time of contracting the buyer’s benefits are imprecise, then by entering into the contract the buyer takes some risk”). 145 sidhu, dawinder, the immorality and inefficiency of an efficient breach, 8 tenn. j. bus. l. 61, 89 (2006). 146 see id. 147 katz, avery w., remedies for breach of contract under the cisg, 25 int’l rev. of l. and econ. 383 (2005). 148 baker, scott and kimberly d. krawiec, incomplete contracts in a complete contract world, 33 fla. st. u. l. rev. 725, 726 (2006). nordic journal of commercial law issue 2012#1 24 confidence, but also to be sufficiently clear for judicial enforcement.149 common law parties, in particular, will likely strive for an exact document which provides mechanisms revealing, for example, how to comply with the terms of the bargain, setting out the procedures should breach occur, and whether, if not how, to sue. form commercial documents may also add transaction cost pressures, given that revisions to standard forms, due to unique situations, could escalate the contract drafting expenses.150 finally, parties seeking background knowledge of the local rules in international contracting may increase contract negotiating and drafting costs.151 3.1.3 criticism of economic analysis critics challenge the usefulness and merit of economics as a comparative analytical tool. first, economics offer “hazy” definitions of efficiency, which proponents confess have no clear definitional parameters.152 critics present that a pure economics analysis disregards the unending complexities of human behavior, and that neoclassical economic analysis narrowly (and incorrectly) presupposes that maximizing welfare, measured by wealth increase, dominates societal decisions.153 definitions, including pure economic loss, also vary among legal systems.154 some economists presuppose that a comparative legal approach must “refrain from 149 charny, david, nonlegal sanctions in commercial relationships, 104 harv. l. rev. 373, 403 (1990). see also hirsch, werner z., law and economics: an introductory analysis 148 (1988) (transaction costs include the costs of negotiating, preparing and signing a contract) 150 hirsch notes that, at least within a consumer sense, non-negotiated boilerplate contracts may reduce transaction costs, avoiding the need for drafting new contracts (assuming no negotiation is involved). hirsch, werner z., law and economics: an introductory analysis 154 (1988). 151 gilson, ronald j., value creation by business lawyers, 94 yale l. j. 239 (1984). 152 mattei, ugo, comparative law and economics 145 (1997); rogers, catherine a., gulliver's troubled travels, or the conundrum of comparative law, 67 geo. wash. l. rev. 149, 185 (1998). supporters rebut such presumption noting that economic legal theory, including a flexible definition of efficiency, is particularly relevant in comparative law insofar that comparison allows academics to discern which rule or institution possesses lower transaction costs and greater market acceptance. see, generally, mattei, ugo, comparative law and economics 145 (1997). 153 hillman, robert, the limits of behavioral decision theory in legal analysis: the case of liquidated damages, 85 cornell l. rev. 717 (2000). under the neoclassic view, a free market’s voluntary exchange occurs as parties value what is received more than what is lost. see id. as such exchange moves resources to “higher valued uses,” allocative efficiency is increased. farnsworth, e. allan, contracts 762 (1999). see also posner, eric a., a theory of contract law under conditions of radical judicial error, 94 nw. u. l. rev. 749 (2000) (neoclassical model refers to contracts understood as “discrete, one-shot exchanges”); posner, richard a., economic analysis of law 10-11 (1992) (efficiency occurs when resources used when their value is highest, and people thus benefit society as they pursue self-interest); hillman, robert, the limits of behavioral decision theory in legal analysis: the case of liquidated damages, 85 cornell l. rev. 717, 726 (2000); h.m.o. sys., inc. v. choicecare health servs., inc., 665 p.2d 635, 639 (colo. ct. app. 1983); rogers, catherine a., gulliver's troubled travels, or the conundrum of comparative law, 67 geo. wash. l. rev. 149, 185 (1998), citing to becker, gary s., the economic approach to human behavior 14 (1976). 154 see dari-mattiacci, giuseppe and hans-bernd schäfer, the core of pure economic loss, 27 int’l rev. of law and econ. 8, 12 (2007) citing to bussani, mauro, pure economic loss in europe at 4 (2003). pure economic loss is outlined in law and economics theory. nordic journal of commercial law issue 2012#1 25 attempting a conceptual definition” of pure economic-loss.155 economists also necessarily use several noteworthy, and often contested, assumptions in the law and economics framework, including: (i) individuals may access a reasonable information flow, (ii) individuals know their own wants and needs, which understanding may not be shared by a third party, (iii) people understand market signals, (iv) the market disregards fairness or justice issues—and thus individuals should not be offended by market functions, (v) market competition, involving multiple actors, is assumed, (vi) people and resources are freely transferable and (vii) an existing distribution of income and resources is accepted.156 criticism is raised when individuals are considered to act as rational utility maximizers, a key element of the law and economics movement.157 a legal theorist contends that individuals frequently deviate from “rational norms” in their decision-making process.158 comparative legal systems have different methods of evaluating the strength of business law precepts. while aspects of economic analysis of comparative law problems add crucial insights, such analysis alone also presents questions and concerns. 3.2 sociology as an objective method: behavioral theory sociological studies, while allowing empirical data to be collected in comparative legal reviews, face many criticisms from legal scholars, primarily those attacking the limited ability to involve neutral evaluative standards. one proposed example of a sociological methodology is behavioral theory. the relative inflexibility of that comparative method, however, renders its usefulness as questionable. behavioral theory, asserting that individuals act irrationally, serves as a challenge to the legal economists’ view of the “global rationality of man.”159 the theory’s goal is the attainment of a modeling which determines how individuals react to inconsistent legal rules and regimes, with the expectation that the results of such reactions lead to predicting individual responses, with 155 dari-mattiacci, giuseppe and hans-bernd schäfer, the core of pure economic loss, 27 int’l rev. of law and econ. 8, 12 (2007). dari-mattiacci, giuseppe and hans-bernd schäfer, the core of pure economic loss: working paper, amsterdam center for law and economics working paper no. 2005-003 (2005) (abstract), at http://www.law.gmu.edu/assets/files/publications/working_papers/05-22.pdf (no page numbers available online) (“the established law and economics wisdom considers pure economic loss as a transfer of wealth from the victim to a third party, whose earnings increase as a consequence of the accident. such transfers do not amount to a social loss and, hence, should not be compensated”). 156 malloy, robin paul, law and economics: a comparative approach to theory and practice 33 (1990). 157 prentice, robert a., chicago man, k-t man, and the future of behavioral law and economics, 56 vand. l. rev. 1663 (2003). 158 id. at 1667. the chicago school’s assumption of individual goals for wealth maximization has been suggested to allow “no room for cognitive limitations, emotion, or altruism, [describing] neither how man does act nor how man should act.” id. at 1672. 159 see simon, herbert a., a behavioral model of rational choice, 69 quarterly j. econ. 99 (1955). http://www.law.gmu.edu/assets/files/publications/working_papers/05-22.pdf nordic journal of commercial law issue 2012#1 26 certainty.160 within a comparative contractual analysis, behavioral legal theory introduced the concept that the non-breaching party’s loss of contractual rights at breach is an entitlement loss.161 as such, the non-breaching party ultimately values the loss greater than any gain, even if common law compensatory damages adequately compensated the monetary loss. 162 behavioral law theory attacks pure economic-guided legal review, challenging the central legal economist assumption that individuals behave rationally, at least as far as an individual’s pursuit of wealth maximization.163 behavioral theorist opponents debunk the reasoning that actors always behave irrationally.164 an economic theorist challenges such assumption, concluding that uniform, cross-cultural irrationality is not a given: “[d]ifferences in education, training, cognitive capacity, thinking dispositions, sex, and cultural background across individuals appear to be reliably associated with different levels of cognitive performance. furthermore, emotional differences, developmental differences, and different modes of mental processing appear to be associated with different levels of cognitive performance within individuals. therefore, depending on the characteristics of the individual and the system of thought activated in a particular decision making situation, the behavior of different groups of individuals and the behavior of the same individual may vary considerably, from perfect rationality to seeming irrationality.”165 many legal theorists doubt behavioral theorist propositions that individuals consistently act irrationally, and the assertion that “departures from rationality are sufficiently systematic to be useful in making legal policy.”166 proposing legal “trends” of irrationality is, by definition, inconsistent, and whether behavior theory offers a means to adjudge the competence or validity 160 rostain, tanina, educating homo economicus: cautionary notes on the new behavior and law and economics movement, 34 law & soc’y rev. 973, 983 (2000). 161 dimatteo, larry a., theory of efficient penalty: eliminating the law of liquidated damages, 38 am. bus. l. j. 633, 704 (2001) citing to sunstein, cass r., behavioral analysis of law, 64 u. chi. l. rev. 1175 (1997); see also pouncy, charles r.p., the rational rogue: neoclassical economic ideology in the regulation of the financial profession, 26 vt. l. rev. 263, 264 (2002) (“economic rationality as it is currently deployed is a grossly inadequate approximation of the factors motivating human conduct”). 162 dimatteo, larry a., theory of efficient penalty: eliminating the law of liquidated damages, 38 am. bus. l. j. 633, 704 (2001) citing to sunstein, cass r., behavioral analysis of law, 64 u. chi. l. rev. 1175 (1997). 163 prentice, robert a., chicago man, k-t man, and the future of behavioral law and economics, 56 vand. l. rev. 1663, 1722 (2003). 164 see mitchell, gregory, taking behavioralism too seriously? the unwarranted pessimism of the new behavioral analysis of law, 43 wm. & mary l. rev. 1907 (2002); mitchell, gregory, why law and economics’ perfect rationality should not be traded for behavioral law and economics’ equal incompetence, 91 geo. l. j. 67 (2002). 165 mitchell, gregory, why law and economics’ perfect rationality should not be traded for behavioral law and economics’ equal incompetence, 91 geo. l. j. 67, 87 (2002). 166 prentice, robert a., chicago man, k-t man, and the future of behavioral law and economics, 56 vand. l. rev. 1663, 1725 (2003). nordic journal of commercial law issue 2012#1 27 of legal frameworks is thus questionable.167 while legal economists fend off criticism, the enormity of opposition to the behavioral law theory cannot be discounted.168 for example, even if parties agree to a mutually objective meaning of fairness, it is debatable whether commercial actors in a long-term contractual arrangement are willing to continue amicable future relations after a party breaches, particularly due to opportunism. scholars melding strict behavioral law theory with economics169 studies face criticism that they oversimplify, if not over generalize, data concerning human understanding and rationalism in order to elevate them as important scholarly discoveries.170 another significant criticism of behavioral theory is the discouragement of empirical data, crucial to developing significant conclusions of the effectiveness of legal rules.171 mitchell concludes that: “intelligent predictions of the behavioral effects of alternative legal policies depend on reliable data regarding (i) the relative frequency of rational and nonrational behavior across persons and situations and (ii) the resistance of nonrational behavior to incentives and debiasing mechanisms that may be available through the legal and economic systems. currently, psychology, behavioral economics, and behavioral law and economics provide only limited answers to these empirical questions because they fail to examine legal decision-making in all its complexity and variety. for instance, recognition of the research on individual and situational differences in rationality discussed here would better inform the legal system on ways in which it could redress cognitive imperfections and irrationality.”172 167 mitchell, gregory, why law and economics’ perfect rationality should not be traded for behavioral law and economics’ equal incompetence, 91 geo. l. j. 67 (2002) (“[b]ehavioral law and economics treats all legal actors in all situations as if they were equally predisposed to commit errors of judgment and choice”). 168 rostain, tanina, educating homo economicus: cautionary notes on the new behavior and law and economics movement, 34 law & soc’y rev. 973, 984 (2000) (“[w]e are still a long way from arriving at a broad, predicatively powerful account of human behavior, and….we are not likely ever to achieve it. it is not clear, for one, how easy it is to turn laboratory results into observations about how human beings will behave in “the field”). but see mitchell, gregory, why law and economics’ perfect rationality should not be traded for behavioral law and economics’ equal incompetence, 91 geo. l. j. 67 (2002): “law and economics’ perfect rationality assumption is drawn from neoclassical microeconomic theory and is refutable as an empirical matter because empirical studies often find participants whose behavior systematically deviates from economic definitions of rationality. proponents of law and economics acknowledge this descriptive inaccuracy but retain the assumption for lack of a better alternative for prediction and policy analysis.” 169 see rostain, tanina, educating homo economicus: cautionary notes on the new behavior and law and economics movement, 34 law & soc’y rev. 973, 978 (2000) (“people reason poorly about risk, tend to jump too quickly to erroneous conclusions from incomplete information, and are otherwise poor statisticians”). 170 mitchell, gregory, why law and economics’ perfect rationality should not be traded for behavioral law and economics’ equal incompetence, 91 geo. l. j. 67, 72 (2002). 171 posner, richard a., rational choice, behavioral economics, and the law, 50 stan. l. rev. 1551, 1575 (1998) (arguing that “experts” can behave irrationally and that behavioral economics implies a “cure” for “cognitive quirks and weakness of will” that thwart rational behavior). 172 mitchell, gregory, why law and economics’ perfect rationality should not be traded for behavioral law and economics’ equal incompetence, 91 geo. l. j. 67, 75 (2002). nordic journal of commercial law issue 2012#1 28 relatedly, tracking deviations from rational thought and behavior through statistical review would presumably show trends of rational thought intermingled with irrational behavior—an endeavor which must account for great statistical volatility.173 practitioners and legal scholars often fail to recognize market implications and, in such situations, sociological research could offer a comparativist useful support. an economist, however, may note the positive, or negative, financial results following an effected contract, the product of a bargaining which may have never occurred unless both parties experienced some degrees of social comfort, or need, to include certain contractual clauses as “protective” mechanisms. the motivations for instituting such provisions could range broadly, whether it be assessing possible agreement breach costs or creating a needed understanding of the roles and expectations of the contracting parties. the positive social effects of the successful contract, such as increased corporate morale or heightened job satisfaction, also cannot be discounted. for these factors, using behavioral law theory as the sole methodological tool to review a comparative commercial law issue, ignoring economics, is not sufficient. 3.3 socio-economic hybrid tool: relational contracting another objective tool measuring law-in-action within comparative commercial contracting problems is relational contracting. discrete and long-term contracts are difficult to define, and the expectations and understanding of parties under single or multiple agreements may be unclear. contractual relationalism involves various contracts or relations which may “relate” in different senses, and degrees.174 under macneil’s “relational model,” contracts serve as aspects of relationships which, in themselves, are not governed by contractual intentions. rather, the relations are influenced by social and conduct normatives emerging from and inside that relationship.175 contracting parties accept their contracts within such relationship.176 accordingly, the parties “relationships” under relational contracts have: “the propensity to generate norms, define or inform parties’ expectations, provide sources of reassurance, facilitate co-operation, create interdependence (and so on) – – over and above, indeed potentially instead of, what can be gleaned from the express terms of the contract or contracts to which they are parties, and over and above what is 173 id. at 77 (“ultimately, the choice of behavioral assumptions to guide policy will depend to some extent on value preferences and unrealistic or untestable assumptions about human nature, because while empirical research can provide better answers than we currently have, it will not provide incontestable or simple answers about legal rationality for prescriptive use”). 174 see eisenberg, melvin a., why there is no law of relational contracts, 94 nw u lr 805, 813 (2005); kimel, dori, the choice of paradigm for theory of contract: reflections on the relational model, 27 oxford j. legal stud. 233, 235 (2007). 175 thompson, robert, b., value creation by lawyers within relational contracts and in noisy environments, 74 oregon law review 315, 317 (1995) (“relational contracting recognizes that parties often do not come together as strangers making discrete, self-contained contracts but rather interact in an expectation of an ongoing relationship in which the prospect of future exchanges will shape the parties interactions and the remedies they choose”). 176 eisenberg, melvin a., why there is no law of relational contracts, 94 n.w. univ. law rev. 805, 816 (2005). nordic journal of commercial law issue 2012#1 29 provided by the bare legal norms and legal mechanisms that underlie or support these contracts in the relevant jurisdiction.”177 the relational contract is distinguished from the discrete, single or “one shot” transaction approach, generally isolated from relationship factors amassed through the parties’ interaction.178 relational contract theory is thus viewed as emphasizing the interdependence of individuals in relationships.179 from an economic perspective, using a relational contract methodology raises a problematic situation: it is difficult to predict events in the future, and thus contracting parties are unable to allocate distant payments or obligations which maximize the contractual value.180 at a point during a long-term contract, for example, the agreement’s parties would then necessarily consider renegotiation. such is the circular reasoning: “if the parties expect to renegotiate, then they cannot bind themselves to a contract, in which case the party whom events throw in the vulnerable position will be at the mercy of the party whom events favor.”181 relational contract theorists propose the removal of some contractual provisions, and recognize implied provisions, such as broadening the range of excuses for non-performance.182 the relationship between the contracting parties thus assumes an integral position, with a legal theorist suggesting that the contract’s nature involves pre-conceived notions of the contracting parties overturning conventional wisdom.183 but allegations that contracts mirror all aspects of 177 kimel, dori, the choice of paradigm for theory of contract: reflections on the relational model, 27 oxford j. legal stud. 233, 235 (2007). see also gordon, r.w., macaulay, macneil, and the discovery of solidarity and power in contract law, wisc. law rev. 565, 569 (1985) (relational contract parties “treat their contracts more like marriages than like one night stands,” noting that relationship contracts involve those that change according to circumstances and signify a “commitment to cooperate”). 178 kimel, dori, the choice of paradigm for theory of contract: reflections on the relational model, 27 oxford j. legal stud. 233, 237 (2007). 179 macneil, ian r., contracts: adjustment of long-term economic relations under classical, neoclassical, and relational contract law, 72 nw. u. l. rev. 854 (1978); see also posner, eric a., a theory of contract law under conditions of radical judicial error, 94 nw. u. l. rev. 749, 751 (2000) (asserting that under relational theory courts implicitly, or explicitly, accept the parties relational contracting); kimel, dori, the choice of paradigm for theory of contract: reflections on the relational model, 27 oxford j. legal stud. 233, 243 (2007); macauley, stewart, relational contracts floating on a sea of custom? thoughts about the ideas of ian macneil and lisa bernstein, 94 nw. u. l. rev 775, 800 (2000). 180 posner, eric a., a theory of contract law under conditions of radical judicial error, 94 nw. u. l. rev. 749, 751 (2000). 181 see id. 182 see id. 183 dori kimel suggests that the contracting parties: “do not see the terms of the contract to which they are party as a conclusive list of fixed rights and obligations, but rather as merely a starting point for re-negotiation and adjustment when circumstances change or difficulties arise parties in practice not insisting upon their contractual rights and not taking too seriously the option of litigation, but rather exhibiting the ongoing willingness to make the necessary adjustments in order to continue to co-operate; parties not having very precise or fully articulated aims in entering contractual relations in the first place, but rather merely a vague desire to establish a relationship and “take it from there”; and so on. armed with this kind of data, the constructive part of the relational argument nordic journal of commercial law issue 2012#1 30 human interaction, and that concepts not encapsulated within the contractual rubric are thus invalid, may be challenged as too expansive. deeming that human and commercial relationships may be “contractualized” has spurred additional debate. namely, one questions the alternatives to contract: under what framework will certain relationships remain outside the ambit of a contract? moreover, in such relational context, the elements of the parties’ interactions that shall be included or excluded (purposefully or otherwise) under an agreement, must be examined.184 the balancing act between personal and professional relationships, moving beyond the essential contractual terms, has been proposed to be a “detached code,” consisting of “a certain stable baseline, comprising of clearly articulated, for the most part enforceable rights and obligations, which can be relied upon to provide at least a modicum of assurance or a safety-net of sorts in case of an unforeseen breakdown of the relationship, and which is relatively immune from being eroded as a result of, say, the on-going desire to co-operate rather than part ways, supererogation, displays of flexibility or gestures of goodwill--indeed all those positive things that can develop around the contractual core and that in the life of the relationship may well become more central and more important and more determinative of the parties’ conduct than any or all express terms.”185 utilizing a relational contract methodology, without any economic or traditional sociological considerations, does not create a fulsome analytical tool. relational contracting’s valuable lawin-action insights, however, play a string complementary role which should not be ignored. 4 conclusion: how to use objective pluralism, the comparative law bridge the exploration of common and civil law divides, both in form and substance, demonstrates that black-letter law analysis provides necessary and important insights when analyzing legal concepts implicit in international business transactions. good faith, as discussed, is a relevant example as to how a legal concept may be treated differently among (and within) legal systems. but black letter analysis should not be the only prism to evaluate legal problems transcending legal systems. rather, a law-in-action review provides valuable insights into what motivates here is that theory of contract must systematically reflect this reality; it must bear out such facts, and do away with the largely fictitious vision of contract that emerges from a study of its established, formal rules….” kimel, dori, the choice of paradigm for theory of contract: reflections on the relational model, 27 oxford j. legal stud. 233, 253 (2007). 184 eisenberg warns that this tendency to contractualize all relationships “obscures critical differences between economic and affective relationships, between explicit and tacit reciprocity, between relationships that should be enforceable by both law and social norms and relationships that should be enforceable only by social norms, and between relationships that are triggered by promise and relationships that are not.” eisenberg, melvin a., why there is no law of relational contracts, 94 n.w. univ. l. rev 805, 820 (2000). 185 kimel, dori, the choice of paradigm for theory of contract: reflections on the relational model, 27 oxford j. legal stud. 233, 248 (2007). nordic journal of commercial law issue 2012#1 31 business parties and how legal concepts are interpreted in the real world. these issues are particularly relevant to practitioners and business people charged with designing an international transaction and/or drafting relevant agreements. such areas are also of import to comparative law scholars, needing to discern the true meaning behind words and concepts, precluded from considering a legal issue only on its face. objective pluralism entails reviewing a comparative law problem from economic, sociological and, as applicable, relational contracting perspectives. presenting such multiple vantage points allows a comparativist or practitioner a full palate, with the ability to observe what factors influence law-in-action on a case-by-case basis. but how does one accomplish this task? engaging in an objective pluralistic approach necessarily involves constructing scientificallysound surveys or empirical studies to weigh the various social, economic and relational contract considerations. the legal scholar lisa bernstein’s extensive law and economics scholarship evidences that carefully-construed surveys and studies, testing black-letter law through a law-in-action viewpoint, yields important insights. bernstein has analyzed several trades and legal frameworks, all through the lens of formal and informal contract enforcement. for example, bernstein’s significant, in-depth review of the diamond industry discussed relational contracts under a trade context. 186 her commercially-focused study in that industry concluded that reputation was “an essential business asset whose value will often be reflected in the selection of transactional partners as well as in the transaction price, the transaction structure, and other terms.”187 reviewing law and economics scholarship dedicated to investigating the factors shaping the conduct of actors in specific industries reveals the commercial considerations ultimately influencing how contracts are drafted, negotiated and enforced. important factors such as reputation, otherwise not captured in conventional black-letter law review, provide insights into the strengths, and possible weakness, in studied legal regimes.188 for example, bernstein’s empirical review of private arbitration systems revealed the striking importance of achieving and maintaining excellent industry reputations, and the value of reputation-based non-legal sanctions.189 186 see, e.g., bernstein, lisa, opting out of the legal system: extralegal contractual relations in the diamond industry, 21 j legal stud 115 (1992); bernstein, lisa, the questionable empirical basis of article 2’s incorporation strategy: a preliminary study, 66 u. chi. l. rev. 710 (1999). 187 bernstein, lisa d., private commercial law in the cotton industry: creating cooperation through rules, norms, and institutions, 99 mich. l. rev. 1724, 1737 (2001). 188 see, e.g., bernstein, lisa, opting out of the legal system: extralegal contractual relations in the diamond industry, 21 j legal stud 115 (1992); bernstein, lisa, the questionable empirical basis of article 2’s incorporation strategy: a preliminary study, 66 u. chi. l. rev. 710 (1999). bernstein, lisa d., private commercial law in the cotton industry: creating cooperation through rules, norms, and institutions, 99 mich. l. rev. 1724, 1737 (2001). 189 id. at 1724. she interviewed a cotton merchant, who noted that “you want to do business where you know people and can depend on what they say about quality, since it is so subtle and so subjective. you are more likely to rely on quality when you know the guy.” id. at 1746. nordic journal of commercial law issue 2012#1 32 bernstein’s review of the u.s. cotton industry provides an excellent example of relational contracting influences. her study discussed how the cotton industry opted out of the public legal system, replacing it with a private commercial law mechanism.190 contracts in that industry were concluded under privately drafted sets of contract default rules, and made subject to arbitration in one of several merchant tribunals. based upon her review, which included extensive interviews with industry leaders, arbitration awards were both respected and promptly complied with, and that the industry’s private law system kept “transactions costs, error costs, legal system costs, and collection costs” low.191 these insights assist practitioners when considering private legal system alternatives to the public judicial system. additionally, before undertaking her empirical study, bernstein presupposed that the cotton industry arbitration system would be less formalistic and more pragmatic than a public judicial fora. her research revealed that this was not necessarily the case, as industry arbitrators employed formalistic procedures in an adjudicative approach, placing less emphasis on custom and usage, “even when their sense of fairness suggests that additional considerations are relevant or that a contrary result should be reached.”192 accordingly, these insights assist academics analyzing comparative legal structures—insights which would not have been discovered without an empirical study analyzing “law in action.” carefully-construed surveys and empirical studies193 may provide deep insights into possible sociological, economic, relationship and cultural aspects which factor into the construction and operation of a studied legal problem. 194 presenting inquiries, which allow ample opportunity for explanation, from a broad, yet relevant, societal sampling creates needed points of reference. all the discussed review methods independently do not provide a fulsome picture. as noted, behavior is inconsistent by definition. relationships influence behavior—but those 190 bernstein, lisa d., private commercial law in the cotton industry: creating cooperation through rules, norms, and institutions, 99 mich. l. rev. 1724 (2001). 191 id. at 1725-1726. 192 bernstein, lisa d., private commercial law in the cotton industry: creating cooperation through rules, norms, and institutions, 99 mich. l. rev. 1724, 1737 (2001). she noted that one interviewed arbitrator proposed that: “[w]e look to the contract and then to the trade rules; this is all we have to base it [our decision] on. other things like custom and the background [of the deal] are infinitely variable so we don't look to them.” id. 193 there is evident tension among many legal scholars who employ purely economic, or wholly sociological, legal review strategies. ayres, ian, never confuse efficiency with a liver complaint, 1997 wis. l. rev. 503, 506 & n.12 (“sociology is bad journalism,” statement attributed to an anonymous historian). see also posner, richard a., the sociology of the sociology of law: a view from economics, 2 eur. j.l. & econ. 265, 275 (1995) (criticizing “law and sociology” for having no “general theory of human behavior”). employing strictly social research has spurred criticism in other disciplines, including family law. see ramsey, sarah h., using social science research in family law analysis and formation: problems and prospect, 3 s. cal. interdisc. l. j. 630, 633 (1994) citing to deech, ruth, divorce law and empirical studies, 106 l. q. rev. 229 (1990) (“the influence of the social scientists has led to an apparent reduction in the intellectual challenge and content of the law”). 194 bernstein, lisa, private commercial law in the cotton industry: value creation through rules, norms, and institutions, 99 mich. l. rev. 1724 (2001) (evidencing the interconnection of economic, behavioral and relational contracting issues in one of the scholar’s interviews: “over time a buyer gets the idea that he wants to deal with me not just because of our business relationship, but also because of our personal relationship. so you tell me, when you want to do business who will you call, the guy you like or the guy you don’t like”). nordic journal of commercial law issue 2012#1 33 relationships also admittedly are influenced by economics. an economics-based approach must focus on two independent elements—efficiency and transaction costs—which may often intersect. economic reviews must also confront the assumption that humans behave rationally in a transaction’s decision-making. rationality in an economic sense also does not take into consideration human indecisiveness, or the value of sociology. objective pluralism, incorporating all such elements, reveals the problem. given the black-letter law divergences among the common and civil legal systems concerning “good faith,” a serious study into aspects of that doctrine should be undertaken, providing scholars and practitioners needed law-in-action perspectives to see how striking the actual divide is between both legal traditions within this contractual doctrine.195 the divergence in the common and civil law interpretations of good faith undermines the arguments of comparativists advocating the strengths of common and civil law systemic convergence, an increasingly popular196 and hotly contested topic in modern comparative law.197 with respect to comparative law, convergence refers to “the phenomenon of similar solutions reached by different legal systems from different points of departure.”198 the success of importing legal transplants from one regime to another indicates the possibility of convergence.199 scholars agree that within the civil law framework, the laws of individual states, particularly germany, have influenced european union law, leading to the eu-wide adoption of certain obligations.200 influence should not, however, be misidentified as supporting convergence. for example, pejovic, encouraged by systemic convergence, has stressed the increasing role of common and 195 note that good faith was indirectly analyzed in the context of an empirical study reviewing liquidated damages clauses under the norwegian and u.s. legal regimes. see canuel, edward t., analyzing norwegian and u.s. contractual damages clauses: a comparative approach, published with the university of oslo faculty of law (2009), issn 1890-2375. 196 nottage, luke, comment on civil law and common law: two different paths leading to the same goal, 32 vuwlr 843, 848 (arguing that convergence theorists form “the majority view”) (2001) 197 the statement of noted american comparativist john henry merryman indicates the tenor of this scholarly debate, as he stated that: “in some cases the desire for convergence of legal systems merely expresses a yearning for simplicity. it responds to popular discontent with complexity and seeks to impose order where there is untidy diversity. this approach to legal diversity would hardly merit recognition and discussion, since it is little more than an expression of frustration at the fact that the world is complicated, disorderly and uncertain, were it not so firmly rooted in human psychology. it is closely related to an exaggerated demand for certainty in the law.” nottage, luke, comment on civil law and common law: two different paths leading to the same goal, 32 vuwlr 843, 849 found at www.upf.pf/img/doc/17nottage.doc (2001) citing to merryman, john henry, on the convergence (and divergence) of the civil law and the common law in the loneliness of the comparative lawyer and other essays in foreign and comparative law 17, 27 (1999). 198 mattei, ugo and alberto monti, abstract: comparative law and economics 505,508 (1999) at http://encyclo.findlaw.com/0560book.pdf. 199 see id. 200 see cordero moss, giuditta, commercial contracts between consumer protection and trade usages: some observations on the importance of state contract law, in schulze, r. (ed.), common frame of reference and existing ec contract law, 65, 67 (2008), citing to schlectriem, p., the functions of general clauses in grundmann, stefan and denis mazeaud (eds.), general clauses and standards in european contract law: comparative law, ec law and contract law codification 41, 45, et. seq. (2006) (suggesting that bgb §242’s ancillary obligations were codified by community directives). http://www.upf.pf/img/doc/17nottage.doc http://encyclo.findlaw.com/0560book.pdf http://folk.uio.no/giudittm/commercial%20contracts%20and%20acquis.pdf http://folk.uio.no/giudittm/commercial%20contracts%20and%20acquis.pdf nordic journal of commercial law issue 2012#1 34 civil law harmonization through international treaties, conventions and laws containing elements of both civil and common law, such as the cisg.201 another scholar notes, however, that within europe the opposing views of good faith and fair dealing under the english common law and civil law regimes question the reality of such convergence.202 most specifically “[i]f a common-law inspired contract is governed by a law from a civil jurisdiction, many of its clauses will not be interpreted literally and the exercise of rights and remedies regulated in the contract will be mitigated, supplemented or corrected by the principle of good faith and fair dealing present, in varying degrees, in the legal family of civil law. if the same contract is governed by english law, most of its clauses will be interpreted and applied literally.”203 with respect to the import of transnational agreements or conventions buttressing claims of convergence, the scholar suggests that skeptics may find such agreements contain vague principles with inexact content, which question assertions that they demonstrate an actual legal convergence, in practice.204 the debate continues, and objective pluralism should be considered when reviewing a comparative commercial law issue. as aesop suggests, appearances are often deceiving. one must understand the disparities existing in good faith doctrine, examining comparative contractual clauses as written and analyzing how such clauses manifest themselves in practice. 201 pejovic, caslav, civil law and common law: two different paths leading to the same goal, 32 vuwlr 817, 838 (2001) at www.upf.pf/img/doc/16pejovic.doc. 202 see, generally, cordero moss, giuditta, commercial contracts between consumer protection and trade usages: some observations on the importance of state contract law, in schulze, r. (ed.), common frame of reference and existing ec contract law 65 (2008). 203 cordero moss, giuditta, commercial contracts between consumer protection and trade usages: some observations on the importance of state contract law, in schulze, r. (ed.), common frame of reference and existing ec contract law, 65, 77-78 (2008). supporting this point, the scholar also provides notes that merger clauses have specific contractual clauses which have different interpretations under english law and civil law. see id. at 79. 204 see id. for example, it is noted that the cisg is silent on the issue of good faith as a duty between contracting parties. see id. at 83. compare with pejovic, caslav, civil law and common law: two different paths leading to the same goal, 32 vuwlr 817, 839-840 (2001): “the differences which exist between civil law and common law should not be exaggerated. it is also important to note that differences on many issues exist both among civil law and among common law countries. the differences between civil law and common law systems are more in styles of argumentation and methodology than in the content of legal norms. by using different means, both civil law and common law are aimed at the same goal and similar results are often obtained by different reasoning. the fact that common law and civil law, despite the use of different means arrive at the same or similar solutions is not surprising, as the subject-matter of the legal regulation and the basic values in both legal systems are more or less the same.” http://www.upf.pf/img/doc/16pejovic.doc http://folk.uio.no/giudittm/commercial%20contracts%20and%20acquis.pdf http://folk.uio.no/giudittm/commercial%20contracts%20and%20acquis.pdf http://folk.uio.no/giudittm/commercial%20contracts%20and%20acquis.pdf http://folk.uio.no/giudittm/commercial%20contracts%20and%20acquis.pdf the u.n. convention on contracts for the international sale of goods, article 7(1) – the interpretation of the convention and the norwegian approach by marius sollund nordic journal of commercial law issue 2007#1 nordic journal of commercial law issue 2007 #1 1 1. introduction∗ # the need for a uniform international sales law has become increasingly more important as the commercial market has become very complex,1 and most countries are involved in international trade to some extent. in order to obtain certainty and predictability in international trade, and thereby make sure that international transactions run as smoothly as possible, it is imperative that the different legal systems around the world are being replaced by a uniform body of law to govern the relationship between the commercial actors.2 by establishing such an uniform body of law one minimises the degree of uncertainty related to which domestic law should be applicable in case of a dispute, and uncertainty in connection with the proper application of the relevant foreign legal system.3 this was one of the reasons why the uncitral initiated the establishment of the united nations convention on contracts for the international sale of goods. in addition the drafters intended to establish a ‘new international economic order’4 by promoting peaceful co-existence among states5 through ‘(… ) the development of international trade on the basis of equality and mutual benefit.’6 this development would be promoted by the establishment of common rules applicable to all contracts of international sale originating ∗ the subject matter of this paper is an analysis of the cisg article 7(1) and its consequences. i also examine the norwegian implementation of the convention, how the norwegian approach relates to the obligations set forth in article 7(1), and whether that approach is a loyal compliance with those obligations. i further address the problems caused by the norwegian transformation and how those problems might be solved. # this essay states the law as at 25 january 2007. 1 cook: the need for uniform interpretation p. 200. 2 honnold: a uniform law for international sales pp. 299, 300, 316; mendes: the u.n. sales convention & u.s.canada transactions p. 112; berman and kaufman: international commercial transactions p. 264; zeller: the four corners of the cisg p. 252; felemegas: uniform interpretation p. 123. 3 felemegas: uniform interpretation p. 74. 4 the cisg, preamble. 5 ryan: divergent interpretations p. 100. 6 the cisg, preamble. nordic journal of commercial law issue 2007 #1 2 in one of the contracting states.7 overcoming language problems and poor contract drafting was also emphasised by the drafters.8 the aim behind the convention was therefore not to create new provisions for international sales, but to establish a uniform instrument to be applicable independent of national laws:9 “ (… ) the adoption of uniform rules which govern contracts for the international sale of goods and take into account the different social, economic and legal systems would contribute to the removal of legal barriers in international trade and promote the development of international trade.” 10 most lawyers would probably prefer the transaction to be governed by their domestic law, but it is generally acknowledged that the cisg provides good solutions based on compromises between different legal systems around the world.11 there are still several countries that have not yet ratified the convention, and when it comes to implementation there are two methods available to them; transformation or incorporation.12 it might be very tempting to those countries to choose to transform the convention, since this will allow them to stick to what they are used to; they are comfortable with their domestic law, and they would prefer to implement the convention in a way which would not disturb or be contradictory to their traditional legal system. however, such a solution is not recommendable; the norwegian approach, which will be thoroughly analysed later in this essay,13 is an excellent example of why incorporation and not transformation would be the preferred way of implementing the convention. i believe it is imperative that the prospective ratifying countries look at the possible consequences in relation to the method of transformation, and the norwegian experiences, when they are going to decide how to implement the convention. otherwise, one might be running the risk of having even more countries with a rather ‘original’ approach to the convention, which again would impede the achievement of the goals set out in article 7(1). in this paper, i will first analyse article 7(1) in order to find the correct meaning of its three requirements in relation to the interpretation of the convention; (1) its international character, (2) the need to promote uniformity in its application, and (3) the observance of good faith in international trade. in light of this analysis i will look at the norwegian implementation of the convention, and especially the choice of transformation instead of incorporation, as this raises some important questions in relation to the requirements in article 7(1). lastly, i will address some of the material differences between the convention and the norwegian transformed version of the convention, and point out some of the problems this may cause in relation to article 7(1). 7 gomard and rechnagel: international købelov p. 20. 8 ryan: divergent interpretations p. 101. 9 flechtner: challenges to the uniformity principle p. 187. 10 the cisg, preamble. 11 cook: cisg: from the perspective of the practitioner p. 350. 12 see chapter 4.1. 13 see chapters 4 and 5. nordic journal of commercial law issue 2007 #1 3 i have chosen to address the specific issues relating to the norwegian implementation in separate chapters (4 and 5) instead of analysing those problems in chapters 2 and 3. the reason for this is that most of those problematic issues actually relate to more than one of the general points in article 7 at the same time, and my approach to these problems will therefore cause less repetition. the aspects of article 7(1) will thus be analysed in the norwegian context in chapters 4 and 5. 2. historical background there had been an international awareness of the need for a uniform set of rules for the international sale of goods long before the coming into force of the convention. lex mercatoria was for centuries a flexible regulation of international trade.14 it embodied the customs of the market and fairs, in addition to maritime customs.15 under this system it was not lawyers or judges who determined what the law should be, but rather the merchants themselves.16 therefore the law was capable of addressing the issues concerned in a very practical and dynamic manner. however, the acceptance into the english common law system deprived it of its flexibility and led to its decline. in the eighteenth century, england became a leading commercial power,17 and at the same time, in order to meet the merchants’ need for a more defined law developed officially and not only by commercial experience,18 the common law courts were given the authority to overrule decisions from the more specialised mercantile courts.19 one leading case is pillans v van mierop,20 where lord mansfield stated that the mercantile law should be decided by the courts rather than matters of custom. inconsistent practices and understandings of merchants should no longer be able to interfere once the court had declared a custom.21 given the major role played by england in international commerce, and the fact that the common law courts had the power to overrule decisions by the mercantile courts, lex mercatoria lost its position as a dynamic body of law governing international transactions. another important factor was the increased need for a more precise body of law to meet the requirements of an industrialised commercial world, as the vague and imprecise rules of lex mercatoria were incapable of addressing those needs. in 1929 the international institute for the unification of private law (unidroit) was established, and they took the initiative to produce a uniform law on the international sale of goods. 14 cook: the need for uniform interpretation p. 201. 15 mendes: the u.n. sales convention & u.s.-canada transactions p. 110. 16 mendes: the u.n. sales convention & u.s.-canada transactions p. 111. 17 berman and kaufman: international commercial transactions p. 226. 18 berman and kaufman: international commercial transactions p. 226. 19 mendes: the u.n. sales convention & u.s.-canada transactions p. 111. 20 pillans v van mierop [1765] 3 burr. 1663 (hl). 21 berman and kaufman: international commercial transactions p. 227. nordic journal of commercial law issue 2007 #1 4 the work was temporarily brought to an end during world war ii,22 but resumed in 195123 and in 1964 a diplomatic conference was held in hague where two conventions were adopted; the uniform law for the international sale of goods (ulis), and the uniform law on the formation of contracts for the international sale of goods (ulf). however, these two conventions did not achieve the necessary wide acceptance in order to become a uniform instrument for international trade.24 they were mainly adopted by european civil law nations, but the united states and most third world nations did not contribute to its success as a uniform sales law.25 in addition, they were very detailed and contained a number of inner contradictions, and thus did not meet the needs of the emerging new economic order. a new initiative was taken by the uncitral (united nations commission on international trade law) when they established a working group consisting of fourteen states with the task to come up with a draft, which would gain a wider acceptance. uncitral was founded specifically to address the issues and problems related to the lack of a uniform international trade law.26 the mandate of uncitral was ‘(… ) the unification and harmonization of international trade law in order to eliminate legal obstacles to international trade and to ensure an orderly development of economic activities on a fair and equal basis.’27 the drafters had obviously learned from the earlier mistakes made in relation to the establishment of an unified sales law, and therefore ensured to have world-wide representation at each stage of the convention’s development.28 the group sat together from 1970 to 1977 and on the basis of the two hague conventions, it prepared two drafts which were adapted into one draft by the uncitral commission29 in 1978, and was named the 1978 draft convention.30 this draft convention, with some modifications, was adopted unanimously by 62 countries at a conference in vienna 11 april 1980, and was named the united nations convention on contracts for the international sale of goods (cisg). commentators have stated31 that since the convention came into force in 1988 it has become a great success. the states that have ratified the convention32 are involved in more than twothirds of the world trade.33 all continents are represented, and some of the most influential trading nations, inter alia. australia, canada, china, the united states, france and germany, 22 kastely: unification and community p. 579. 23 ferrari: uniform interpretation p. 190. 24 honnold: uniform law p. 88. 25 cook: the need for uniform interpretation p. 202. 26 mendes: the u.n. sales convention & u.s.-canada transactions p. 115; farnsworth: the vienna convnetion: history and scope p. 18. 27 sono: uncitral and the vienna sales convention p. 8. 28 kastely: unification and community p. 581. 29 the commission consisted of 36 members from around the world. 30 hagstrøm: kjøpsrett p. 25. 31 lookofsky: internationale køb p. 11; hagstrøm: kjøpsrett p. 24. 32 as per 21 january 2007, 70 countries have adopted the convention. an updated list can be found at www.unilex.info 33 henscel: varens kontraktsmæssighed p. 12; lookofsky: cisg in scandinavia p. 1; felemegas: uniform interpretation p. 96. http://www.unilex.info nordic journal of commercial law issue 2007 #1 5 have ratified the convention. as stated by bonell: ‘(… ) the largest part of commercial transactions at world-wide level are in principle subject to the vienna convention.’34 two nations which, given their presence on important international markets, would have been natural parties to the convention are japan and the united kingdom.35 however, they have not at this time chosen to ratify the convention. the convention has not, however, managed to establish itself as the preferred body of law on all areas. some organisations, e.g. gafta,36 have chosen to stick to their own standard contracts. those contracts are very detailed in order to meet the specific needs of the members, and the convention, which is a rather simple instrument, is not suited to deal with those issues. as an example, gafta has more than 80 standard forms of contracts, which address issues specifically related to regional differences, the level of risk, the use of the grain or seeds, shipping requirements, quality, conditions etc. even though the convention is designed to deal with commodities, it is not a suitable instrument for such specialised trade. 3. article 7(1) 3.1. introduction all legal provisions need to be interpreted in order to find the correct meaning of the law. within national systems, the interpreters – the courts or arbitrators – will have the advantage of being able to rely on established principles and methods of interpretation.37 when interpreting an international instrument like the cisg, which is based on a compromise between several different legal traditions, the interpreters will face a much more challenging task when it comes to establishing the correct understanding of the law. article 7 deals with the interpretation of the convention. paragraph (1) aims at securing a uniform application in all the contracting states, whereas paragraph (2) provides a tool for gapfilling in situations where the convention does not provide any clear solutions. those two paragraphs together help to ensure a dynamic development of the convention.38 there is no doubt that article 7 is perhaps the single most important provision of the convention,39 since it sets out guidelines to the courts on how to achieve the very goal of the convention; a uniform set of rules applied in the same way in all contracting states. 34 bonell and liguori: a critical analysis of current international case law (part i) p. 148. 35 further analysis of the reasons as to why the u.k. has not yet ratified the convention may be found in moss: why the united kingdom has not ratified the cisg; forte: reason or unreason in the united kingdom; and linarelli: the economics of uniform laws and uniform lawmaking. 36 the grain and feed trade association. 37 felemegas: uniform interpretation p. 65. 38 schlechtriem: commentary on the un convention p. 94. 39 koneru: the international interpretation p. 106. nordic journal of commercial law issue 2007 #1 6 article 7(1), which is the main object of the analysis in this paper, sets out three requirements with regard to the interpretation of the convention; (1) regard is to be had to the international character of the convention, (2) the need to promote uniformity in its application, and (3) the observance of good faith in international trade. some commentators have argued that the first two criteria are so closely connected that they should in reality be treated as one. bonell advocates this view; ‘the two criteria are only apparently independent from each other. on examination the second criterion turns out to be nothing more than a logical consequence of the first.’40 however, schlechtriem treats them as two separate principles,41 and since i believe this will give the reader a more profound understanding of the interplay between the three conditions, that is the approach i will pursue in the following analysis. 3.2. the international character42 the international character of the convention is expressed in several ways. one is the fact that its jurisdiction is transaction-focused and not party-focused.43 it is the cross-border transaction that determines whether the convention applies or not; the nationality of the parties is irrelevant.44 another example is the types of sales which are covered by the convention, and which types are left out. transactions that are characteristic for the different national systems are excluded from the application of the convention.45 article 2 of the convention is a good example, which leaves it to the national jurisdictions to regulate consumer sales, auction sales, etc. first and foremost, the reference to the convention’s international character implies that the convention has to be interpreted autonomously, i.e., not in the light of domestic law, but in the context of the convention itself.46 as a general rule, the traditional methods used in different national systems should be avoided. as formulated by dimatteo: ‘(… ) the convention is meant to be interpreted based upon its uniqueness and not its similarities to any one of the legal systems from which it was created.’47 an interpretation based on the interpreter’s domestic legal system would be a violation48 of the condition that the convention should be interpreted in light of its international character. as formulated by zeller: ‘predictability of outcome and clear and simplified norms, the most important goals of any law, can only be achieved through uniformity of application at an international level as opposed to a national one.’49 40 bianca and bonell: international sales law p. 72. 41 schlechtriem: commentary on the un convention p. 95. 42 see chapters 4.4., 4.5, 5.1.1., 5.2.1., and 5.2.2. for detailed analyses of the impact of the norwegian implementation on the international character-requirement. 43 dimatteo: the interpretative turn in international sales law p. 308. 44 sono: uncitral and the vienna convention p. 12. 45 dimatteo: the interpretative turn in international sales law p. 309. 46 ferriari, flechtner, brand: the draft uncitral digest and beyond p. 140; bianca and bonell: international sales law p. 74; gebauer: uniform law p. 687. 47 dimatteo: the cisg and the presumption of enforceability p. 133. 48 felemegas: uniform interpretation p. 67. 49 zeller: the four corners of the cisg p. 252. nordic journal of commercial law issue 2007 #1 7 the convention’s international character also implicates that national definitions and interpretations cannot necessarily be applied to the convention.50 reliance on domestic law could seriously undermine the very purpose of the convention. there is, however, a limited room for domestic interpretation in relation to gap-filling in article 7(2), provided that such a gap cannot be filled autonomously. an autonomous interpretation not only promotes uniformity, but it also prevents forum shopping,51 which was one of the aims behind the creation of a uniform sales law; making it irrelevant which country’s law the choice-of-law rules would point at. the courts should also refrain from sticking to a narrow grammatical interpretation; they should instead focus on ‘(… ) the underlying purposes and policies of individual provisions as well as of the convention as a whole.’52 this is because the underlying principles may to some extent more fully represent the basic objectives of the convention than the wording of the provisions. those general principles are what the delegates formulating the convention agreed upon53 and focus on the principles will therefore be the most certain way of ensuring a correct international interpretation, and will avoid a domestic approach to the cases before the court. since the convention does not expressly state what those principles are, they must be found in the text itself, the legislative history, and other sources. when the interpreters are searching for those principles that are not expressly found in the text itself, they should have the convention’s overall goal in mind;54 to promote international trade by removing legal barriers that arise from different social, economic, and legal systems of the world.55 several courts have also referred to the need to take the convention’s international character into consideration, for example the u.s. case medical marketing international inc v internazionale medico scientifica, where the court stated that: ‘(… ) under cisg, the finder of fact has a duty to regard the “ international character” of the convention and to promote uniformity in its application. cisg article 7.’56 when interpreting the convention one must bear in mind that it is a result of a compromise between several independent states. its provisions form a uniform platform, which embodies the common principles agreed upon by those states. it is therefore imperative that one is utterly careful with liberal interpretations, which might conflict with the agreed common understanding of the convention. later in this paper i will address some particular issues of liberal interpretation in relation to the norwegian implementation. 50 schelchtriem: commentary on the un convention p. 96. 51 ferrari: uniform interpretation p. 199. 52 bianca and bonell: international sales law p. 73. 53 koneru: the international interpretation p. 115. 54 koneru: the international interpretation p. 116. 55 the preamble of the convention. 56 u.s. district court for the eastern district of lousiana, united states, 17 may 1999 (clout case no. 418). nordic journal of commercial law issue 2007 #1 8 a swiss case57 may be a good illustration as to how a domestic court should approach a problem in order to have regard to the convention’s international character. in this case, an italian seller delivered boxes of artificial blood vessels to a swiss buyer. some of those were resold to a swiss hospital. when the hospital discovered that the items were not in conformity with the contract, they were returned to the buyer. the swiss buyer then sent a notice of non-conformity to the italian seller three and a half months after delivery, and refused to pay the purchase price. the italian seller took action in order to recover the contract price. the interesting question in this case was whether a period of three and a half months was in accordance with article 39(1) of the convention, which states that a notice of non-conformity has to be given ‘(… ) within a reasonable time after [the buyer] has discovered [the lack of conformity] or ought to have discovered it.’ the court recognised that there existed conflicting views among the different contracting states to the convention with regard to the interpretation of ‘reasonable time.’ in germany, eight days was the limit, whereas according to the courts in the united states and the netherlands, several months would be acceptable. in order to have regard to the international character of the convention, the court came to the conclusion that a good balance between the different approaches would be reached if the time limit was set to one month. such an approach is in line with the idea of autonomous interpretation, and helps to preserve the convention’s independence from the different domestic legal systems. 3.3. the need to promote uniformity in its application58 as has already been emphasised in the introduction, the very aim of the establishment of the convention was to obtain a uniform set of rules for the international sale of goods. the uniformity requirement is closely connected to the principle of autonomous interpretation (see chapter 3.2.), since an autonomous interpretation will quite often promote uniform application.59 complete uniformity will, of course, not be possible in practice, and article 7(1) does not require strict uniformity to be the result; it only puts an obligation on the contracting parties to ‘promote’ uniformity.60 nevertheless, the very wording of the convention stresses the importance of uniformity; ‘(… ) the need to promote uniformity’ (emphasis added). actually, some non-uniformity is desirable in order for the convention to maintain the necessary flexibility to manoeuvre in the different legal, political and social contexts present in the different contracting states. a major task would therefore be to distinguish between that desired flexibility, and the unwanted non-conformity61 stemming for example from ambiguities between the different official language versions of the treaty. 57 obergericht kanton luzerne, 8 january 1997, n. 11 95 123/357 (unilex 1997). 58 see chapters 4.2., 4.5., 5.1.1., 5.1.2., and 5.2.1. for detailed analysis of the impact of the norwegian implementation on the uniformity-requirement. 59 gebauer: uniform law p. 686; felemegas: uniform interpretation p. 68. 60 flechtner: challenges to the uniformity principle p. 205. 61 flechtner: challenges to the uniformity principle p. 209. nordic journal of commercial law issue 2007 #1 9 even though strict uniformity is not what the convention is aiming at, a functional or relative approach would be preferable62 to the pre-cisg situation, where all states applied different rules to international sales contracts. hackney argues that even though perfect uniformity is not achievable, this ‘(… ) is not detrimental to the goal of the convention.’63 in order to achieve the desired level of uniformity, it will of course not be sufficient merely to agree on a number of provisions – it is essential that those provisions are also applied in a uniform manner in all the sontracting states.64 the house of lords in scruttons ltd. v midland silicones ltd formulated this very point quite precisely:65 ‘it would be deplorable if the nations should, after protracted negotiations, reach agreement (… ) and that their several courts should then disagree as to the meaning of what they appeared to agree upon.’ one problem is, of course, that there is no international supreme court, like the national ones, that can work as a correction and give directions as to whether the states are interpreting the convention in a uniform manner or not. without such an international organ, there will always be a risk of different interpretations in each state.66 the duty of interpretation is entirely placed upon the national courts themselves. it is therefore imperative that the contracting states are careful when they interpret the cisg. in theory, there is no reason why a supranational court could not be established; such a tribunal exists inter alia within the eu. however, there are some differences between the eu and the convention, which suggest that a similar court would face practical problems in the area of the convention. one obvious challenge, based on the fact that the convention is not limited to a smaller regional area like the eu, would be to get all the contracting states, with their different legal and social structures, to agree upon conferring power to a supranational body to decide disputes between them.67 instead of establishing an international tribunal, the cisg drafters chose to include in the convention a specific interpretation rule, leaving it to the national courts in the contracting states to interpret the convention. one of the major threats to international uniformity is that the national judges read the convention as if it were a domestic legal document.68 in order to avoid that, and to obtain uniformity, the contracting states have to take court decisions from other contracting states into account when they are going to make a decision in any particular case. as formulated by honnold: ‘(… ) courts in states that adopt the sales convention should have no doubt as to their responsibility to consider interpretations in other countries.’69 62 dimatteo: the interpretative turn in international sales law p. 310. 63 hackney: achieving uniformity? p. 476. 64 ferrari, flechtner, brand: the draft uncitral digest and beyond p. 138; ferrari: a new challenge for interpreters? p. 245. 65 scruttons ltd. v midland [1962] ac 471 (hl). 66 bonell: international uniform law in practice p. 867. 67 bianca and bonell: international sales law p. 89; gebauer: uniform law p. 684. 68 honnold: the sales convention in action p. 208. 69 honnold: the sales convention in action p. 211. nordic journal of commercial law issue 2007 #1 10 especially two problems may arise in such situations; (1) the decisions may not be readily available to the court, and (2) the decisions may be written in a language foreign to the judges who are going to make the decision. uncitral has taken an initiative to remedy those difficulties by establishing an information system named clout70 (case law on uncitral texts).71 the idea is that the contracting states may send in all cases relevant to the convention. the case will be available to the other states in its original language, in addition to abstracts translated into all the working languages of the convention. there are also a number of other initiatives taken by universities, which aim at making it easier for the contracting states to access the case law from other states, for example the pace institute of international commercial law in new york.72 foreign case law will not be binding in other countries, but such decisions may nevertheless have, if they are well-reasoned, a persuasive authority,73 which means that the case law will not be binding per se, but will rather provide the judge or arbitrator with a set of good arguments to apply on the case they are about to decide. making foreign case law binding would make it much easier to achieve a uniform application, but then the major concern would be to avoid the risk of being ‘(… ) locked into a foolish interpretation of the convention for the sake of uniformity.’74 another obvious problem with a situation of binding case law, is that one would have to establish a system under which it is decided which decisions from which courts should be considered to be on a higher level in a hierarchy than decisions from other courts. this would be almost an insurmountable task and is therefore a quite convincing argument in favour of a system where the foreign case law only have persuasive value. ferrari argues that foreign case law should only have persuasive value,75 which implies that one can look to foreign case law to find good arguments or counterarguments. this would also mean that the interpreter would not have to decide between which courts to look to; a decision from an arbitral tribunal may be just as relevant as a ruling from a state’s supreme court. even case law from non-contracting states may be taken into consideration if it can provide valuable arguments in the given case. even though one considers foreign case law only to have persuasive value, such case law should be granted considerable weight by the contracting states in order for them to comply with the uniformity condition.76 the obligation to take foreign case law into consideration will not be sufficient to ensure uniformity, because this will not eliminate differing interpretations in the different contracting states.77 if the observance of foreign case law were a guarantee to ensure uniformity, it would 70 www.uncitral.org 71 schlechtriem: commentary on the un convention p. 98. 72 www.cisg.law.pace.edu 73 schlechtriem: commentary on the un convention p. 99. 74 hackney: achieving uniformity? p. 479. 75 ferrari: a new challenge for interpreters? p. 260. 76 cook: the need for uniform interpretation p. 199. 77 ferrari: a new challenge for interpreters? p. 258. http://www.uncitral.org http://www.cisg.law.pace.edu nordic journal of commercial law issue 2007 #1 11 mean that the first case deciding a specific matter by any court would be shaping all subsequent cases dealing with that issue. dimatteo has emphasised that the national courts will have two functions when it comes to looking at foreign case law in order to interpret the convention: ‘first, they would look at decisions of foreign courts for guidance. second, they would actively unify international sales law by distinguishing seemingly inconsistent prior decisions and by harmonizing differences in foreign interpretations.’78 the question is then; does this work in practise? do the states take foreign case law into consideration? an italian case decided by tribunale di vigevano79 is a very good illustration that they do. when deciding those issues relevant to the convention (whether the buyer had lost his right to rely on lack of conformity due to inadequate notice), and even though it stated that foreign case law was not binding, the court referred to some forty foreign cases, inter alia, from austria, france, germany, the netherlands, switzerland, and the united states.80 in a more recent case, the tribunale di rimini81 referred to about thirty foreign cases when it was to decide a case where cisg was applicable.82 what can be learned from this is that the national courts do take foreign case law into consideration whenever that is necessary in order to maintain a uniform application of the convention in the contracting states, and apparently the initiatives from unicitral and other bodies have helped, at least to some extent, to overcome the obvious obstacles related to availability of the case law and the language problem. article 7(1) sets out the goals in relation to uniform application, but it does not, however, say anything about which methods should be used in order to reach those goals.83 the question is then whether not only the terminology should be interpreted autonomously, but also the methodology used for interpreting the convention should be derived from the convention itself. roth and happ argue that autonomy cannot be the solution when it comes to methodology, because the convention does not say anything about this matter.84 one therefore has to look elsewhere to find the answers to the methodological questions. one solution is to look at the principles of interpretation provided in international law. gebauer states that autonomous interpretation would not have any meaning except for the goal of uniform application, if uniform application is the supreme goal of law-unifying 78 dimatteo: cisg and the presumption of enforceability p. 136. 79 tribunale di vigevano, 12 july 2000, giurisprudenza italiana 2001, 280 et seq. (clout case no. 378). 80 ferrari: applying the cisg in a truly uniform manner p. 208. 81 tribunale di rimini, 26 november 2002, giurisprudenza italiana 2003, 896 et seq. 82 ferrari, flechtner, brand: the draft uncitral digest and beyond p. 147. 83 roth and happ: interpretation of the cisg according to principles of international law p. 1; ferrari: uniform application and interest rates p. 471. 84 roth and happ: interpretation of the cisg according to principles of international law p. 2. nordic journal of commercial law issue 2007 #1 12 conventions.85 according to some commentators86 the answer to this would be to replace the concept of autonomous interpretation by the principles of interpretation as set out in the vienna convention on the law of treaties.87 according to gebauer,88 however, uniformity of result is not the sole objective of interpreting uniform law – the solution must also be right. in addition to the two requirements in article 7(1) dealing with the convention’s international character and the need to promote uniformity, article 7(2) is in accordance with the concept that the convention should be supplemented by the common principles of treaty construction.89 thus, the principles laid down in the vienna convention on the law of treaties may be a relevant source when it comes to the determination of the correct applicable method of interpretation. there exist an enormous amount of academic writings on most issues relating to the convention, and such writings may undoubtedly be of great value when it comes to the promotion of uniformity. traditionally, there has been a variation between the legal systems as to the weight they put on scholarly writings in the interpretive process of establishing the content of the law.90 civil law countries have always looked to doctrine, whereas the common law countries have been more reluctant to do so. however, there has been movement in the common law countries in their view of doctrine as a factor of interpretation, and the fothergill case,91 a judgment by the english house of lords, is a good example of that. this dispute was governed by an article in the warsaw convention on carriage by air, and, when giving its judgment, the house of lords put a great emphasis on doctrine. honnold argues that the legislative history may play an important role when determining the content of the convention: ‘when important and difficult issues of interpretation are at stake, diligent counsel and courts will need to consult the convention’s legislative history. in some cases this can be decisive.’92 in civil law countries, the use of travaux préparatoires is quite common in the interpretation of statutes and conventions. not all countries are part of this tradition, and some commentators have therefore argued that one should be careful when using those sources in the interpretation of the convention.93 however, in the fothergill case the house of lords made reference to the legislative history in order to interpret a provision of the warsaw convention. this, i believe, is a step in the right direction, making it easier for common law judges to have recourse to the legislative history when interpreting international instruments. 85 gebauer: uniform law p. 691. 86 roth and happ: interpretation of the cisg according to principles of international law p. 8. 87 the vienna convention on the law of treaties, may 23, 1969, 1155 u.n.t.s., articles 31-33. 88 gebauer: uniform law p. 692. 89 cook: the need for uniform interpretation p. 211. 90 felemegas: uniform interpretation p. 80. 91 fothergill v monarch airlines ltd [1980] 2 all er 696 (hl). 92 honnold: uniform laws for international trade p. 5. 93 ferrari: uniform interpratation p. 207. nordic journal of commercial law issue 2007 #1 13 another problem in relation to the achievement of uniformity relates to the fact that articles 92 through 97 of the convention make it possible for states to make reservations with regard to the convention’s applicability when they become contracting parties to the convention. however, the drafters made an attempt to minimise the negative effects on uniformity, which might result from articles 92 through 97, by specifically authorising only certain types of reservations.94 in spite of this, there are still problems relating to reservations.95 one is the reservation made by the scandinavian countries in relation to part ii of the convention, which deals with contract formation. if you, for example, have a situation where one of the parties wishes to withdraw his notice of termination, you cannot look to part iii for guidance, since this part does not address this issue. the question is then where to look for guidance. according to article 7(2) gap filling is to be based on the general principles upon which the convention is founded. in relation to this question, it would be natural to look to part ii, but that will of course be impossible because of the reservations made by the scandinavian countries. 3.4. the observance of good faith in international trade one of the most debated and controversial issues in connection with the cisg is the role and definition of the principle of good faith.96 this debate is a very good example of the difficulty of reaching a common understanding when a uniform body of law is to be established. one question one has to ask is whether the reference to ‘good faith’ only relates to the interpretation of the convention, or if article 7(1) also refers to good faith in relation to the parties’ behaviour. the fact that the term ‘good faith’ is only present in the provision in the convention dealing with interpretation should be an argument against taking the parties’ behaviour into account. the very wording of article 7(1) suggests that good faith should only be related to the interpretation of the convention: ‘in the interpretation of this convention, regard is to be had to (… ) the observance of good faith in international trade.’ it is also important to bear in mind that there are not many countries which through their domestic legislation have imposed a duty of good faith on the parties’ behaviour, especially countries which belong to the common law tradition. among the civil law jurisdictions there are, however, countries which have imposed such a duty of behaviour. two examples of the latter are germany97 and france. being aware of this difference between the countries, one should be careful with interpreting the convention in a way which would impose a duty of good faith on the parties’ behaviour. it is very difficult to define the concept of good faith, and the expression itself is very vague. it may thus open up for different interpretations. this might actually conflict with the obligation 94 the convention, article 98. 95 flechtner: challenges to the uniformity principle p. 193. 96 felemegas: uniform interpretation p. 33. 97 bgb 242 nordic journal of commercial law issue 2007 #1 14 to ensure uniformity in the application of the convention.98 this in itself is an argument against an interpretation, which imposes a general obligation on the parties to act in good faith. also the legislative history indicates that the reference to good faith only has to do with the interpretation of the convention: the reference to ‘good faith’ in article 7(1) is the result of a compromise between those who would like to impose a duty on the parties to act with good faith, and those who did not want any reference to good faith in the convention at all.99 when the convention was being drafted there was a big discussion on whether one should include a reference to good faith in the convention or not. some delegates would not include such a reference, and they inter alia argued that it represented a moral exhortation, which should not be elevated to the status of a legal obligation.100 it was also argued against such an inclusion because they thought it was unnecessary since the principle was implicit in all national laws anyway. another argument put forward was that the convention does not specify any sanctions for failing to comply with the good faith principle, with the consequence that this would be left open to national law,101 which would jeopardise the achievement of uniformity of sanctions. other delegates, however, favoured the inclusion and argued that there would be little harm in having such a provision because the principle was ‘universally recognized.’102 they also claimed that it would not be necessary to spell out the consequences of a violation of the good faith obligation, since this could be developed in a flexible manner on a case-by-case basis. as a result of this intense debate, the delegates finally agreed on the compromise103 of including the reference to good faith in the provision dealing with the interpretation of the convention; article 7(1). a number of prominent commentators, ferrari,104 honnold,105 hagstrøm,106 and lookofsky,107 are opposed to the idea that good faith is a general principle of the convention – that good faith should be related to the parties’ behaviour. they argue that good faith only refers to the interpretation of the convention. 98 ferrari, flechtner and brand: the draft uncitral digest and beyond p. 152; ferrari: uniform interpretation p. 210. 99 bianca and bonell: international sales law p. 83. 100 honnold: documentary history p. 369. 101 felemegas: uniform interpretation p. 64. 102 koneru: the international interpretation p. 139. 103 felemegas: uniform interpretation p. 64. 104 ferrari, flechtner, brand: the draft uncitral digest and beyond p. 155. 105 honnold: uniform law p. 100. 106 hagstrøm: kjøpsrett p. 26. 107 lookofsky: internationale køb p. 22. nordic journal of commercial law issue 2007 #1 15 powers108 claims that schlechtriem is a representative for the other view: that article 7(1) also imposes a duty on the parties. he uses a statement from the 1998-edition of schlechtriem’s ‘commentary’ to back his argument: ‘[good faith mentioned in the cisg] should amount to a general principle, such as section 242 of the german bgb.’109 it is questionable if this is the correct interpretation of what schlechtriem really means. in the new edition of the commentary from 2005 the relevant section has been rephrased, and what schelchtriem now says is that: “ as its history shows, the origin of that term lies in the reference to good commercial practice and it was initially intended to govern not the interpretation of the convention’s rules by courts, but the parties’ conduct. but such opinions, which are influenced not least of all by the german understanding of the principle of treu und glauben and its bearing on legal texts as well as individual contracts, cannot being regarded as having prevailed. the maxim of ‘observance of good faith in international trade’, therefore, concerns the interpretation of the convention only and cannot be applied directly to individual contracts (… )” 110 from this extract it is hard to see that schlechtriem disagrees with the view that ‘good faith’ in article 7(1) relates only to the interpretation of the convention. even though the wording of article 7(1) and the legislative history clearly suggest that good faith only relates to the interpretation of the convention, some commentators have argued that the provision should not be read so narrowly. bonell seems to favour such a wider application of the good faith principle, so that it also includes the behaviour of the parties; even as a simple aid to the interpretation of the cisg’s specific provisions, the principle of good faith may have some impact on the behaviour of the parties. koneru seems to argue along the line that even though the drafters of the convention may have intended the inclusion of good faith only to relate to the interpretation of the convention, they may have indirectly imposed a duty on the parties to act in good faith. he states that: ‘(… ) good faith cannot exist in a vacuum and does not remain in practise as a rule unless the actors are required to participate.’111 the result may be that the principle of good faith actually has two roles within the convention; one which relates to the judiciary – those who are going to interpret the convention – , and one which relates to the parties and their duty to act with good faith: ‘while the convention does not explicitly impose an obligation of good faith on the parties, many of the convention’s general principles operate collectively to create such an obligation.’112 certain courts have also taken the view that the principle of good faith should be given a wider application. one example is the french case, s.a.r.l. bri production ‘bonaventure’ v socit pan 108 powers: defining the undefinable p. 345. 109 schlechtriem: commentary (1998) p. 61. 110 schlechtriem: commentary on the un convention p. 95. 111 koneru: the international interpretation p. 140. 112 koneru: the international interpretation p. 152. nordic journal of commercial law issue 2007 #1 16 african export,113 where the court ordered the payment of damages based on the fact that the liable party’s conduct was ‘(… ) contrary to the principle of good faith in international trade laid down in article 7 cisg.’ such diverging views do not promote the uniform application of the convention, and no matter which view one would consider to be the most correct with regard to the position of the doctrine of good faith under the convention, it would be easy to agree with powers when he states that: ‘the only thing that seems clear through all these competing arguments is that the uniformity sought by the cisg is definitely lacking with respect to the existence and extent of a good faith obligation.’114 he argues further that, even though imposing a general duty of good faith on the contracting parties might be considered as an amendment to the convention expressly rejected by the drafters, good faith is nevertheless an international principle,115 and should thus be made part of any international agreement on contracts.116 however, this is a highly controversial approach. when the drafters expressly rejected the imposition of such a duty on the parties, one cannot subsequently alter this position by analogies from other sources, such as the unidroit principles. even if one chooses to restrict the application of the principle of good faith in article 7(1) to the interpretation of the convention, this does not necessarily mean that there is no room for a more general principle of good faith in relation to other provisions in the convention. one example may be the doctrine of ‘gap-filling’ in article 7(2).117 however, as felemegas118 puts it: “ what is less, if at all, legitimate is the subsequent catapulting of the concept of good faith as a ‘general principle’ of the cisg under article 7(2), into the interpretative mechanism of the cisg under article 7(1), through the reference to ‘good faith in international trade’.” since article 7(1) expressly refers to ‘good faith in international trade’ (emphasis added), it is quite clear that the principle of good faith should not be analysed in light of standards ordinarily adopted within the various national legal systems.119 however, as also argued by bonell, national standards, both in relation to good faith and the specification of the principles upon which the convention is based, should be taken into consideration to the extent that they are commonly accepted at a comparative level.120 honnold argues along the same lines: “ the convention’s goal ‘to promote uniformity’ should bar the use of purely local definitions and concepts in construing the international text. but this objection does 113 cour d’appel grenoble, chambre commerciale, 22.02.1995, 93/3275, journal du droit international 632-639. available at http://131.152.131.200/cisg/urteile/151.htm. (clout case no. 154). 114 powers: defining the undefinable p. 348-349. 115 see for example the unidroit principles, article 1.7. 116 powers: defining the undefinable p. 353. 117 bianca and bonell: international sales law p. 85. 118 felemegas: uniform interpretation p. 45. 119 bianca and bonell: international sales law p. 86. 120 bianca and bonell: international sales law p. 86; felemegas: uniform interpretation p. 70. http://131.152.131.200/cisg/urteile/151.htm. nordic journal of commercial law issue 2007 #1 17 not apply to ‘good faith’ principles that reflect a consensus – a ‘common core’ of meaning – in domestic law.” 121 to take domestic definitions of good faith of one single country into consideration, without analysing how the principle is applied in other countries, would, however, contradict the idea of uniform application of the convention.122 i believe that the correct approach would be to limit the principle of good faith to the interpretation of the convention. the very aim of the convention – to create a uniform sales law – would be easier to achieve this way. considering the legislative history, this would also be the most loyal approach to this problem. 4. the norwegian approach 4.1. introduction the norwegian legal tradition is based on the dualistic principle when it comes to the implementation of international conventions, which means that a special act of ratification needs to be presented by the parliament before the convention comes into force. this is opposed to the monistic system under which international obligations will be automatically internally binding. there are basically three different ways of implementing a convention under the dualistic system; (1) transformation, i.e. the convention is re-written into an independent domestic act of parliament, (2) incorporation, i.e. the convention is directly given the status of an act, and (3) ‘passive transformation’, i.e. a statement saying that the national law is compatible with the international obligations.123 traditionally, the nordic countries have tried to create a uniform legal platform in different areas, inter alia when it comes to the sale of goods. the nordic countries have a pretty similar social structure and political traditions, and since much trading takes place between companies in the different nordic countries it is therefore quite convenient to have a common legal basis. with this in mind, they established a commission in 1980, the year of the adoption of the cisg, in order to sort out the possibilities of passing new sale of goods acts in all the nordic countries based on the new developments that the cisg would initiate. since the cisg is concerned with international sales, there was not really a need to change the norwegian sale of goods act of 1907.124 however, since the cisg was not considered to contradict the domestic sale of goods act in any major way, it was decided to conduct a revision of the act in order to obtain an even higher degree of uniformity. 121 honnold: uniform law p. 100. 122 zeller: good faith – the scarlet pimpernel of the cisg p. 227; powers: defining the undefinable p. 334. 123 nou 1972: 16 p. 7. 124 hagstrøm: kjøpsrett p. 35. nordic journal of commercial law issue 2007 #1 18 4.2. the norwegian implementation norway, as the only country in the world, chose to transform (‘re-write’) the convention into a single body of law, which governs both domestic and international sales, and thereby creating an ‘unofficial’125 version of the convention:126 the sale of goods act.127 lookofsky has commented on the norwegian approach to the implementation of the convention that ‘norway went a step further: it transformed the authentic cisg text into norwegian, and integrated the norwegian rules for domestic and international sales law into a single – and in several respects highly controversial – statutory instrument.’128 the consequence of the choice of transformation is that the convention has been translated, restructured, and interpreted in a norwegian act of parliament.129 all other countries,130 because of their incorporation of the convention, have two bodies of sales law; one which is applicable to domestic sales, and one which is applicable to international sales.131 the norwegian approach, however, has resulted in a situation where the interpreters and contracting parties have to handle one body of rules containing both the transformed provisions of the cisg and provisions exclusively applicable to domestic transactions. in the process of deciding which way to implement the convention, one of the major concerns was the small and medium size export and import companies, and their difficulty in handling such a complicated set of rules as the convention. the drafters claimed that since very few companies have a department specifically established to deal with issues related to international trade it would be much easier for those companies to handle a domestic sale of goods act, which includes the rules for international sale of goods.132 it was also argued that transformation traditionally was the most widely used way of implementing international conventions regulating areas of common interest which ordinary citizens would be dealing with.133 incorporation was, according to the drafters, reserved for technical and complicated sets of rules, which are not, to any particular degree, aimed at the ordinary citizens. some commentators have warned against looking at the convention as a part of domestic law even after it has been implemented: 125 lookofsky: cisg in scandinavia p. 5. 126 lookofsky: alive and well in scandinavia: cisg part ii p. 289. 127 the sale of goods act of 13 may 1988 (act no. 27). available in english at www.lovdata.no/info/ueng.html 128 lookofsky: cisg in scandinavia p. 2. 129 hagstrøm: kjøpsrett p. 37. 130 it is worth noting that israel has also taken a somewhat unique approach to the convention. the convention was incorporated into israeli law by the sales law (international sale of goods) 5760-1999, which came into effect on 5 february 2000. however, for international sales contracts concluded prior to that date, the previous laws, i.e. ulis and ulf, would continue to apply. the result would be that for a period of time there will be three conventions relating to international sales (cisg, ulis and ulf) working side by side, and the courts which are going to decide on cases involving israeli companies would have to pay particular attention to which set of rules is applicable in any given case, as problems may have to be addressed differently depending on which convention is applicable. see also www.bin.ac.il/law/cisg 131 lookofsky: cisg in scandinavia p. 5. 132 ot.prp. no. 80 (1986-1987) p. 18. 133 bergem and rognlien: kjøpsloven p. 402. http://www.lovdata.no/info/ueng.html http://www.bin.ac.il/law/cisg nordic journal of commercial law issue 2007 #1 19 “ even though the cisg is incorporated into municipal law, international sales law should not be regarded as a part of various national legal systems because this would inhibit its development as an autonomous branch of law and distort its interpretation and application.” 134 bearing this in mind, it is quite obvious that the norwegian approach of transforming the convention, instead of using the method of incorporation, will pose a threat to the goal of uniform application. keeping the domestic sale of goods act separate from the convention would make it much easier for the interpreters to avoid confusion and the use of national interpretative methods on the international transactions covered by the convention. unless the parties to a contract expressly agree otherwise,135 the norwegian sga will be applicable whenever the choice-of-law rules state that norwegian law should be the applicable law. krüger is very critical to the norwegian solution: “ (… ) [t]he method for adaptation of the cisg 1980 into norwegian law was a major mistake. one simply tried to do something which cannot be done properly. firstly, the reading of the act is a very complicated task (… ) secondly, the method has resulted in blatant discrepancies in the wording of statutory sales of goods law (… )” 136 4.3. is the transformation in itself a violation of the basic principles of the convention? since norway is the only contracting state that has implemented the convention by transformation, it is only natural to raise the question of whether this is an available solution at all. is this a loyal approach in the light of the basic goals of the convention, and article 26 of the vienna convention on the law of treaties,137 which states that ‘every treaty in force is binding upon the parties to it and must be performed by them in good faith’? (emphasis added). an examination of the legislative history of the implementation of the convention shows that the drafters touched this issue in their discussions.138 traditionally the conventions that norway has ratified have not prescribed any preferred method of implementation; it has usually been up to the legislator to choose which method to use. the drafters recognised, however, that in certain circumstances there is a need for a convention to be implemented provision by provision, without any technical adjustments. ulis and ulf are considered to be examples of that. however, the norwegian legislators did not consider the cisg to pose any restrictions with regard to the method of implementation.139 lookofsky supports this view,140 and so do bergem 134 felemegas: uniform interpretation p. 66. the word ‘incorporation’ in this extract must mean the more specific method of transformation, since incorporation would not very likely make the interpreters mix the methods together to the same extent as a transformation would. 135 bergem and rognlien: kjøpsloven p. 403. 136 krüger: norsk kjøpsrett, ch. 26.1. 137 the vienna convention on the law of treaties, may 23, 1969, 1155 u.n.t.s. 138 nou 1972: 16 p. 9. 139 ot.prp. no. 80 (1986-1987), appendix 5, p. 322. 140 lookofsky: internationale køb p. 18. nordic journal of commercial law issue 2007 #1 20 and rognlien.141 like the legislators, both lookofsky and bergem/rognlien seem to base their conclusions solely on the fact that the convention, unlike ulis,142 does not contain any provisions with regard to the method of implementation. they therefore consider the legislator to be free to use whichever method he may find most appropriate. but even though norway chose to transform the convention, this does not mean that they are free to interpret the convention in light of their domestic law;143 they cannot deviate from the obligation in article 7(1) to interpret the convention in light of its international character in order to promote uniform application just because they have chosen another method of implementation than the other contracting states. i believe, however, that by reaching this conclusion the legislator puts too much emphasis on ulis as a historic predecessor of the cisg. as already mentioned elsewhere in this paper, ulis was based on a much narrower mandate and did not achieve such a broad acceptance as the cisg has. also, because the idea behind the convention was to create a common frame of reference, it would have to be a much simpler instrument and not so detailed as ulis. the cisg was initiated as a result of ulis’ failure to become a unified sales law for the entire commercial world – a failure resulting to some extent from not taking the interests of the developing countries and the common law tradition sufficiently into account. ulis had no provision like the cisg article 7(1),144 and the inclusion of a specific reference to the promotion of uniformity, combined with the diverse background of the delegates in the drafting committee, suggest that the approach in relation to the cisg was much more ambitious. an antithetical interpretation would therefore overestimate ulis’ role. i would argue that even though the convention does not contain any specific provisions as to how the convention is to be implemented by the contracting states, there might be other factors to take into consideration when one is going to make a choice. in my opinion, article 7(1) imposes certain restrictions in this respect; if one chooses to transform the convention it has to be done in a way, which ensures the compliance with this provision. otherwise, there is a risk that the whole project of establishing an international uniform sales law would fail. in fact, the very idea behind the convention – the creation of a common ground of reference – would give directions to the national authorities on how the convention is to be implemented, regardless of the non-existence of a provision like the ulis article i, paras, (2) and (3). the argument that since the cisg, unlike ulis, does not contain a specific provision relating to the method of implementation, and consequently that it is entirely up to the states how to implement the cisg, cannot, therefore, carry any weight. the overall aim of the establishment of the convention was to create a common ground of reference, with the result that it would not make any difference, in the case of a dispute, which country’s set of rules was prescribed – all the parties would be familiar with the convention.145 however, this aim would not be satisfied when the prescribed set of rules is norwegian law; the 141 bergem and rognlien: kjøpsloven p. 447. 142 ulis article i, paras 2 and 3. 143 lookofsky: internationale køb p. 21. 144 honnold: uniform law p. 88, note 1. 145 hagstrøm: kjøpsrettskonvensjon p. 563. nordic journal of commercial law issue 2007 #1 21 contracting parties would have to deal with the norwegian sale of goods act.146 since this is a transformed version of the convention, it would be quite confusing for a person not familiar with the act. one example is article 79 regarding the exemption from the duty to pay damages. in the norwegian transformed text this provision has been divided into three different rules; §§ 27, 40, 57(1) and (2).147 such a restructuring of the common ground of reference would of course present problems for foreign contracting parties, judges and arbitrators. one problem is that: “ (… ) the ‘transformed’ portion of the sga text is itself clearly at odds with the authentic cisg text on a number of significant points, thus raising the possibility that norwegian courts will have to face complex ‘supremacy’ issues.148 (… ) i.e. whether to uphold norway’s obligations under the cisg treaty in the face of contrary (transformed) national legislation. the resolution of these issues in the concrete context concerned may depend on whether the norwegian legislator (a) made a mistake in transformation or (b) intended to depart from the authentic cisg text.” 149 prospective ratifying countries should therefore be extremely careful when they are going to decide on a method of implementation, as transformation might actually in itself be a violation of the basic principles set forth in article 7(1). 4.4. practical consequences of the norwegian implementation as will be more thoroughly analysed in chapter 5, the norwegian implementation has caused a number of discrepancies in relation to the authentic text of the cisg. as a result, the choice-oflaw rules will still be relevant. this is a clear evidence of the fact that the norwegian implementation is not in conformity with the convention’s goal of uniformity. as stated by winship: ’if all states adopted uniform rules, of course, there would be no need for choice-oflaw rules, except perhaps where states adopt divergent readings of the uniform rules.’150 a few practical examples can help to illustrate what kind of difficulties the courts, arbitrators, and parties to the contract may face as a result of the norwegian approach. if the seller is in norway and the buyer in france, article 1(1)(a) applies since both norway and france are contracting states to the convention. what would be the situation if the dispute is going to be heard in france, but the parties have not agreed on which country’s law should be applicable? in this situation, the correct approach would be to stick to the solution prescribed by the rules of private international law. those rules customarily dictate that in a case where the parties have not decided which country’s law should be applicable to the contract, the sale should be 146 see chapter 4.4. 147 hagstrøm: kjøpsrett p. 37. 148 lookofsky: cisg in scandinavia p. 6. 149 lookofsky: cisg in scandinavia p. 6, note 41. 150 winship: private international law and the u.n. sales convention p. 487. nordic journal of commercial law issue 2007 #1 22 governed by the law at the seller’s place of business.151 in this example, that would be norwegian law, i.e. the norwegian sga. the french court or arbitration tribunal would therefore have to get familiar with the norwegian implemented version of the cisg, its legislative history, etc. it goes without saying that this would lead to major practical problems in relation to translations, understanding the structure of the sga, and the way it is interpreted. a major problem for the french tribunal would be to have recourse to the norwegian travaux préparatoires. not only would they have to be translated, but the tribunal would also have to operate a totally foreign system of doctrine and sources of law in order to obtain a correct interpretation of the provisions in the norwegian sga. if the buyer and seller switch places – the buyer is in norway and the seller is in france – the solution would be different. if one falls back on the rules of private international law, it would be french law, i.e., the authentic text of the convention that would govern the contract. both a french and a norwegian court would have to apply the original convention. we can also have a situation where the seller is in norway, the buyer in new york, but the dispute is going to be heard in paris. if the parties have decided that the sale is to be governed by american law the french tribunal would have to apply the authentic convention. if, on the other hand, the parties have decided that norwegian law should be applicable the norwegian sga would be the relevant law, and the tribunal would then face all the problems described in the first example. finally, if the seller is in germany, the buyer in denmark, and the dispute is heard in norway, what law should then be applicable? since no norwegian company is a party to the dispute, the sga would have no relevance. in this situation it would not make any difference which party’s law the choice-of-law rules would point to; both germany and denmark have incorporated the convention and use the authentic text in all international transactions, and the norwegian tribunal would therefore have to apply the original text. as can be seen from these four examples, the private international law rules still play an important role whenever a norwegian seller is involved, even though one of the aims of the establishment of the convention was to eliminate the importance of those rules.152 these examples also illustrate the likely practical implications that might occur if prospective ratifying countries do not pay sufficient attention to the consequences of their chosen method of implementation. one can only imagine what would be the result if several other countries followed the norwegian path of paying more attention to domestic needs than the promotion of uniform application and adherence to the international character of the convention; the whole project of creating a common ground of reference would collapse. 151 convention sur la loi applicable aux ventes a caractère international d’objets mobiliers corporels, june 15, 1955, article 3. (this convention is ratified by france). 152 honnold: uniform law p. 34-35. nordic journal of commercial law issue 2007 #1 23 4.5. assessment of the chosen method of implementation with regard to the method of implementation, the ministry of justice153 acknowledged that international transactions play a vital part for norwegian industry and commerce, and thus the rules governing international sales will be of great importance to norwegian commercial parties. even though the major part of international sales is carried out by big companies, smaller companies, with relatively insignificant legal expertise, play an important role as well. the ministry held that it would be a great advantage for those companies to deal with a norwegian text since only a minority of the companies have established a corporate legal department dealing exclusively with international trade. they would benefit from having one single body of rules relating to both international and domestic sales. the ministry also claimed that transformation traditionally has been the preferred method of implementation of conventions containing rules that have a broad common interest, which ordinary citizens might be expected to deal with, while incorporation has mainly been reserved for technically, complicated rules that do not address ordinary citizens. it seems like the wish to maintain a high degree of accessibility to the users of the convention was a determinate factor in the choice between the methods of implementation. the legislator’s aim was to create one body of law which should contain all the rules relating to sales. the transformed sga should cover all the situations that norwegian traders would encounter; norwegian, nordic, and international. compared to the old sga such an approach would lead both to a regionalization and an internationalization of the law of sales. it is hard to see how the argument that small and medium size companies would have difficulties dealing with the original version of the convention could carry any weight. even though the convention is transformed into a norwegian act of parliament, norwegian traders would nevertheless have to deal with the original text of the convention, for example whenever the choice-of-law rules state that another country’s law should be applicable to the given contract of sale. also, in order to comply with the sga §88(1), the original text of the convention would have to be taken into consideration as a relevant factor in the process of interpretation. this provision states that: “ in international sales, the interpretation of the rules of this act shall take into account the need to promote uniform application of rules based on the un convention on contracts for the international sale of goods 1980, their international character and the observance of honesty and good faith in international trade.” 154 the argument that small and medium size companies would have problems dealing with an english convention in their relations with foreign traders is not very convincing. first of all, it is highly unlikely that norwegian companies, even if they do not have a separate department dealing with international trade, would have any greater problems dealing with an english text than the other parties coming from non-english speaking countries that have chosen to incorporate the convention, like germany, italy, sweden, etc. secondly, companies trading internationally would have to deal with a lot of documents in foreign languages anyway, 153 ot.prp. no. 80 p. 18. 154 the sga, §88(1). nordic journal of commercial law issue 2007 #1 24 especially english since this has become the most commonly used language in international business. another argument made by the ministry of justice was that the accessibility of the convention required a transformation into a norwegian text. the thought might have been that the norwegian sga would be more readily available to the norwegian parties than the convention itself, and that a transformation into one single body of law would indirectly make the convention more accessible. it might be so that the sga is more readily available than the convention, but i do not believe that a transformation of the convention into the domestic sga would make it more accessible to the parties. as analysed elsewhere in this paper, the method of transformation has resulted in a complete restructuring of the convention, leaving it almost unrecognisable compared to the original text. in my opinion, the present situation is not contributing to the accessibility of the convention. quite the contrary, the transformation has only promoted confusion and actually made it more difficult to access the true meaning of the convention. the development of modern systems of electronic communication has also deprived this argument of promoting accessibility of most of its validity. the last argument put forward by the legislators was that transformation was the most common way of implementing conventions like the cisg. it is true that transformation has been used earlier as a method of implementation of very detailed and complicated conventions, but in most cases those conventions have had the national level as their main area of application,155 and the provisions have then been translated one by one without restructuring the whole convention. this is, however, not the case with the cisg where international uniformity is the overall goal. even though those arguments analysed in the foregoing are relevant to some extent, it is quite clear that they may be contradictory to the principles laid down in article 7(1). the primary consideration must be to implement the convention according to the overarching goal of uniformity in article 7(1), which would make the arguments favouring transformation as the method of implementation put forward by the ministry of justice secondary considerations. the question is then whether the legislators have, to the required extent, taken the principles in article 7(1) into consideration when they chose the method of transformation instead of incorporation. in my opinion, they focused too much on the secondary considerations, and thus placed too little emphasis on achieving international uniformity. in chapter 3.3, i emphasised the importance of having regard to foreign case law in order to promote uniformity in the application of the convention. the norwegian approach makes it much harder to do so. when the interpreters in the different countries do not base their decisions on the same documents,156 this will undoubtedly make it difficult for norwegian 155 inter alia, conventions relating to the transportation sector, cheques, and bills of exchange. 156 norwegian interpreters would use the transformed version of the convention, whereas interpreters from other countries, which have incorporated the convention, would use the authentic version. nordic journal of commercial law issue 2007 #1 25 interpreters to make use of foreign case law in situations where the transformed version of the convention is not consistent with the authentic text, and vice versa; decisions from norwegian courts would not easily be taken into account by foreign interpreters when either the material provisions or structure of the sga is different from the convention. one example is sga §18 and article 35(1) of the convention regarding information on properties or use, which is analysed more thoroughly in chapter 5.1.1. in this area, it would be impossible to obtain a uniform application, since the rules are materially different. the problems connected to taking foreign case law into consideration, would be seriously increased if more countries choose to implement the convention the same way as norway has done. since the convention is an international instrument, based on a compromise between many states from different jurisdictions and with different legal traditions, it may be both vague and imprecise. therein, however, lies both its strength and weakness; the strength is that it preserves the need for flexibility in international trade, but within limitations such as article 7(1). the weakness is that it does not possess the precision that is necessary in a wellfunctioning domestic sales law. this should suggest that one keeps the domestic sga and international sales law separated. in other words; when the convention is vague, or even silent, on certain points this is for a reason. the drafters wanted to preserve a dynamic approach on those areas. it is therefore contradictory to the very essence of the convention when the norwegian solution gives a precise regulation in such areas. see for example the issue of interest rates discussed in chapter 5.2.2. the transformation of the convention resulted in a lot of structural changes;157 provisions were moved, split into several other provisions, and some provisions from the convention cannot even find its counterpart in the sga. two examples of the splitting up in several other provisions are article 67, which in the sga is split into three different provisions: §§7, 13 and 14, and article 79 which is split into §§27, 28, 40 and 57. it goes without saying that such structural changes will make it very difficult for someone who does not have intimate knowledge of the sga to apply it on an international sales contract. when the convention was transformed, the legislator, by an act of parliament, carried out interpretations, which, in my opinion, are inconsistent with the obligations set out in article 7(1). the dynamic element of the convention is lost when interpretations are hammered out by a domestic act. article 7(2), however, opens up the possibility of gap-filling when this is in conformity with ‘the general principles on which it is based’. interpretations, or gap-fillings, based on national law will thus be a violation of the obligation to promote a uniform body of law. a close examination of the changes that resulted from the transformation shows that they are to a large extent based on the scandinavian legal tradition, and in practice the national norwegian tradition. whether this results from a lack of understanding of the underlying 157 hagstrøm: kjøpsrett p. 39. nordic journal of commercial law issue 2007 #1 26 principles of the convention, or a deliberate violation of article 7, does not really matter. in any case, the norwegian legislator has pushed the limits of his freedom of gap-filling too far. as already mentioned elsewhere in this paper, one of the main goals behind the establishment of the convention was to make it virtually irrelevant which country’s law the choice-of-law rules would point at in case of a dispute. in most cases, the choice-of-law rules dictates that it is the law in the seller’s country that shall be applicable.158 when an international buyer is dealing with a norwegian export company, the buyer can demand to make the norwegian sga applicable to the sale of goods contract. even though the sga might seem like something foreign and strange to the buyer, it is not unlikely that he would prefer the sga to the original convention. a close examination of the sga shows that the liberal interpretations and violations of the conventions to a great extent are beneficial to the buyer.159 it is therefore not given that the buyer would insist on using the convention instead of the sga. given the fact that quite a few export companies are based in norway, one would imagine that the solution chosen by the norwegian legislator would be quite problematic for a huge part of the norwegian industry. a situation like this, where the buyer may be better off choosing one country’s law instead of another’s, promotes forum-shopping which was exactly one of the reasons why one wanted to establish an international uniform sales law. language problems will, of course, also be an issue in those situations where the buyer chooses to apply the sga to the contract. some commentators on the convention have expressed great criticism on the norwegian way of implementing the convention. krüger has claimed that ‘(… ) the method for adaptation of the cisg 1980 into norwegian law was a major mistake.’160 hagstrøm advocates that the legislator should aim at reversing what has been done in relation to the norwegian implementation.161 prospective ratifying countries should take these comments very seriously, as they would most likely be faced with the same problems if they choose to implement the convention by transformation. i believe that the present situation is very unfortunate. the transformation of the convention into the norwegian sga is clearly a violation of article 7(1), as it to some extent actually contradicts the very goals of the convention; uniformity of application, avoiding forumshopping, making the choice-of-law rules virtually redundant on this particular area, and as a result of all this making trading between contracting states more efficient.162 the problems resulting from the norwegian implementation could very easily be dealt with, by reversing the whole process and separate the convention from the sga and thereby have one body of law dealing with domestic sales, and one dealing with international sales. 158 convention sur la loi applicable aux ventes a caractère international d’objets mobiliers corporels, june 15, 1955, article 3. 159 hagstrøm: kjøpsrettskonvensjon p. 569; hagstrøm: implementation in norway p. 247. 160 krüger: norsk kjøpsrett, ch. 26.1. 161 hagstrøm: kjøpsrettskonvensjon p. 569. 162 specific examples will be discussed in chapter 5. nordic journal of commercial law issue 2007 #1 27 5. differences between the cisg and the norwegian sale of goods act, and the consequences in relation to article 7(1) in addition to all the structural differences between the sga and the convention, the transformation has also led to a number of material differences. in this chapter, i will identify some of those differences and analyse the consequences of the discrepancies in relation to article 7(1). these examples should be a clear warning to prospective ratifying countries of what practical problems might arise if they choose to transform the convention. this analysis is not, however, meant to be exhaustive. 5.1. provisions that do not exist in the cisg, but which are purported to follow from an interpretation of the convention 5.1.1. sga §18 and article 35(1) of the convention – information on properties and use the issue of conformity of the goods is a good example of an area where the norwegian legislator has constructed a provision with no equivalent in the convention – a discrepancy, which would be beneficial to the buyer. according to the sga §18(1), the rules of non-conformity apply when ‘(… ) the goods are not in accordance with information which the seller, in his marketing or otherwise, has furnished about the goods, their properties or use and which may presumably have influenced the sale.’ the seller is strictly liable for such divergence, i.e. it is not dependent on his negligence. it is sufficient that the information does not de facto coincide with the actual condition of the goods. the only limitation is that the buyer have to have relied on the information when he entered into the agreement: ‘(… ) which may presumably have influenced the sale (… )’ in sga §18(2) the seller’s liability is extended to other persons who have provided information to the buyer on behalf of the seller: ‘(… ) when the goods are not in accordance with information which any person other than the seller has furnished on the packaging of the goods, in advertising or other marketing on behalf of the seller or prior sales stages (… )’ and the only exception is if the seller ‘(… ) neither knew nor ought to have known that the information had been given (… )’ this rule is undoubtedly in accordance with the norwegian and scandinavian legal tradition,163 but it is highly questionable whether it is in conformity with the convention.164 the norwegian legislator has purportedly claimed that this rule follows from an interpretation of the 163 rt. (the norwegian supreme court reporter) 1924 p. 91; rt. 1930 p. 1462; rt. 1934 p. 740; rt. 1959 p. 581; 1992 p. 166. 164 lookofsky: cisg in scandinavia p. 82; hagstrøm: kjøpsrettskonvensjon p. 565. nordic journal of commercial law issue 2007 #1 28 convention.165 it seems like national traditions and considerations have prevailed at the expense of the needs connected with the international character of the convention. the only support one can find in the convention is article 35(1), which says that ‘the seller must deliver goods which are of the quantity, quality and description required by the contract.’ as one can clearly see, this provision does not, as a point of departure, say anything about the seller’s liability with regard to incorrect information. not even the rules in article 35(2) on more specific matters – which has its equivalent in §17(2) litra a and b of the sga – mention anything about such liability. the inclusion of this provision, which is materially quite different from the convention, would jeopardise the achievement of a uniform application of the convention. this is because it will be much harder for a seller to avoid liability under the sga than under the convention, which again will lead to different standards with regard to what kind of non-conformity the buyer must accept. these discrepancies will make it virtually impossible to take foreign case law on this area into account, because the rules are strict and unambiguous. 5.1.2. the sga §84 – claims against prior sales stages this provision says that ‘(… ) the buyer may as a consequence of non-conformity of the goods bring claims against a prior sales stage if a corresponding claim on account of the nonconformity can be brought against the seller.’ this rule makes it possible for the buyer to make a claim against, for example, the seller’s supplier. such a rule may have wide-ranging practical implications on the relationship between the seller, the buyer, and third parties. an opportunity to make a claim in contract against third parties contradicts the idea that a contract only regulates the relationship between the contracting parties,166 and this may be the reason why many european countries have not adopted such a rule, and probably why one cannot find a similar provision in the convention. even though the convention is silent on this matter it does not, however, necessarily mean that the topic is not governed by the convention. if so, it would then have to be solved by reference to article 7(2) through gap-filling, and claims against prior sales stages would then have to be considered to be in accordance with the general principles upon which the convention is based. however, to my knowledge there is no one who argues that claims against prior sales stages are within the scope of the convention. some might say that the norwegian inclusion of this rule is thus a matter, which only concerns the domestic law and not international transactions under the convention. this would have been an accurate view if the norwegian legislator had specifically exempted the application of 165 hagstrøm: kjøpsrett p. 69. lando: udenrigshandelsret p. 334 argues that a provision like the sga §18(1) may be deduced from article 35 of the convention, but that it is questionable whether the rule in the sga §18(2) is in conformity with the convention. see also henschel: varens kontraktsmæssighed p. 99. 166 dunlop pneumatic tyre company ltd. v selfridge and company ltd. [1915] ac 847 (hl), 853: ’my lords, in the law of england certain principles are fundamental. one is that only a person who is a party to a contract can sue on it.’ the same principle can be found in french law (code civil article 1165), and in german law: see von bar: law of torts p. 492 et seq. nordic journal of commercial law issue 2007 #1 29 §84 in cases of international sales. this has not, however, been done. the provisions in the sga are applicable to both national and international sales unless they are explicitly exempted. §5(1) states that: “ international sales are subject to this act with the special rules contained therein, especially chapter xv below.” the norwegian legislator has clearly, in its eagerness to promote the established domestic solution to this issue, with which it felt familiar, gone far beyond what might be argued to be a solution compatible with article 7(1). the norwegian inclusion of a rule regarding this matter is therefore contradicting the very aims of the convention; the establishment of a common body of law. the achievement of uniformity would become an illusion, and we would be back to the starting point where all the countries had different rules. 5.2. provisions based on an arguable interpretation of the cisg 5.2.1. sga §36 and article 48 of the convention – the seller’s right to rectify the norwegian legislator has also created provisions which do not have a counterpart in the convention, but which the legislator claims follow from an interpretation of the convention. this is a highly questionable approach.167 the result is that the interpretative development is being locked by a domestic interpretation, making it impossible to take international developments into consideration. one example is the seller’s right to rectify. the particular point i want to examine here is the fact that it is not certain that the convention opens up an opportunity for the seller to rectify when there has been a material breach of contract. the uncertainty is brought about by the reservation made in article 48; ‘subject to article 49, the seller may, even after the date for delivery, remedy at his own expense any failure to perform his obligation (… )’ logically one would assume that as long as the conditions for rectifying the failure are fulfilled, the opportunity to terminate the agreement would have to be suspended.168 this is the solution according to the norwegian sga §37; ‘if rectification or delivery of substitute goods is not accepted or is not performed within a reasonable time after the buyer complained of the lack of conformity, the buyer may (… ) cancel the contract under §§38 or 39 (… )’ however, this is not how article 48 is constructed. one has to take the rules regarding termination into account in order to get the complete picture of the seller’s right to rectify. the seller is only allowed to rectify if this takes place within the closing date for termination as set out in article 49(1). this follows from the reservation in article 48; ‘subject to article 49.’ the intention has not been to deprive the buyer of his right to terminate the agreement on the basis of a material breach if the seller offers to rectify. however, since the assessment of whether the buyer should be allowed to 167 hagstrøm: kjøpsrettskonvensjon p. 564. 168 hagstrøm: kjøpsrettskonvensjon p. 577. nordic journal of commercial law issue 2007 #1 30 terminate is based on all relevant factors, the fact that the seller has offered to rectify would have to be taken into consideration. prominent commentators argue that the seller cannot meet the buyer’s notice of termination with a counterclaim on rectification when his breach of contract constitutes a fundamental breach.169 the norwegian equivalents can be found in sga §§36 and 37. according to those provisions the seller may insist on rectifying as long as this will not inflict major disadvantages upon the buyer, and provided that this condition is fulfilled; in cases where there is a fundamental breach, the buyer’s right to terminate the contract will be eliminated. the norwegian rule might be said to be technically preferable to the convention. however, even though this rule may not directly contradict the convention, the inclusion of this rule – based on an interpretation of the convention – cannot be deemed to be a loyal implementation of the convention. it may seem like the norwegian legislator has been too focused on creating a rule that is easy to apply, and thereby interpreted the convention too liberally. a practical example would help to illustrate the differences between the sga and the convention: a norwegian exporting company sells something to an italian buyer. it turns out that the goods suffer from a defect, which constitutes a fundamental breach. the buyer claims to terminate the contract, but the seller makes a counterclaim to rectify instead since this would be much less expensive to him. pursuant to the convention, it might be argued that the buyer will be allowed to terminate, whereas the sga gives the seller the opportunity to insist on rectification, if this is done within reasonable time. case law from other countries contradicts the norwegian interpretation regarding this issue. one example is a decision from the icc court of arbitration in paris,170 which ruled that since the breach by the seller constituted a fundamental breach the buyer was entitled to avoid the contract according to article 49(1) of the convention. as a result, the seller was not entitled to remedy by supplying substitute goods under article 48(1). another example is a german case171 where the court stated in an obiter dictum172 that in a case of fundamental breach, the buyer’s right to avoidance prevails over the seller’s right to cure. in situations like the one described above it would be an advantage to the seller if the sga would be applicable, since this would give him the opportunity to insist on rectification. this is 169 schlechtriem: commentary on the un convention p. 567; honnold: documentary history p. 376; hagstrøm: kjøpsrettskonvensjon p. 577. 170 arbitral award, the icc court of arbitration, paris, no. 7531/1994 (unilex 1994). 171 oberlandesgericht koblenz (germany), 31 january 1997, n. 2 u 31/96 (unilex 1997). 172 based on the facts of the case the court held that the lack of conformity of goods did not constitute a fundamental breach. nordic journal of commercial law issue 2007 #1 31 therefore one of the few examples where the seller is given an advantage over the buyer when the sga applies. again we can see, that the norwegian approach reduces the level of predictability in contractual relations that the convention was aiming at establishing. when the norwegian sga and the convention produce different results in such a practical important area, it will undoubtedly jeopardise the opportunity to achieve a uniform application of the convention. 5.2.2. sga §71 and article 78 of the convention – interest rate the right to claim interest was one of the most debated issues in the drafting committee; partly because the muslim countries do not allow interest on payments, and partly because many of the eastern-european countries did not have a regular market on which the principle of interest is based.173 pursuant to article 78 of the convention the seller is entitled to interest if the buyer does not pay the contract price. however, the convention does not say anything regarding the interest rate or from which time it is to be calculated. when analysing the case-law it becomes clear that there are two approaches to this issue; some decisions have looked upon the lack or regulation of the rate as a matter which is governed by the convention but not expressly settled in it (lacuna praeter legem), and should therefore be solved with reference to article 7(2) as a matter of gap-filling. other decisions, however, argue that the interest rate is a matter which is not governed by the convention at all (lacuna intra legem) and should therefore be solved on the basis of other principles. an austrian arbitration case174 based its decision on the lacuna praeter legem principle. it was held that the interest rate had to be established in conformity with the general principles upon which the convention is based. the arbitrator, professor bonell, found that full compensation was one of the basic principles of the convention, and since the application of a state’s domestic law could lead to a result where no interest is awarded,175 this would violate this principle. therefore the rule regarding the interest rate would have to be found within the convention itself. given the fact that the damaged party would most likely borrow money from a local bank, it was held that the interest rate in the country of the damaged party would be the correct rate. another case from the same arbitral tribunal, given the same day, argues along the same lines,176 and also states that full compensation is one of the general principles upon which the convention is based: 173 hagstrøm: kjøpsrettskonvensjon p. 574; ramberg and herre: internationella köplagen p. 553. 174 internationales schiedsgericht der bundeskammer der gewerblichen wirtschaft – wien, june 15, 1994, sch4318 (clout case no. 94). 175 not all states acknowledge the principle of interests. 176 internationales schiedsgericht der bundeskammer der gewerblichen wirtschaft – wien, june 15, 1994, sch4366 (clout case no. 93). nordic journal of commercial law issue 2007 #1 32 “ this second view is preferred,177 not least because the immediate recourse to a particular domestic law may lead to results which are incompatible with the principle embodied in art. 78 of the cisg, at least in the cases where the law in question expressly prohibits the payment of interest. one of the general legal principles underlying the cisg is the requirements of ‘full compensation’ of the loss caused (… ) it follows that, in the event of failure to pay a monetary debt, the creditor, who as a business person must be expected to resort to bank credit as a result of the delay in payment, should therefore be entitled to interest at the rate commonly practiced in its country with respect to the currency of payment, i.e. the currency of the creditor’s country or any other foreign currency agreed upon by the parties.” both of the austrian cases actually referred to the solution in article 7.4.9 (2) of the unidroit principles,178 which is based on the full compensation approach. this view is backed by academic writings; sutton argues that ‘(… ) the interest market of the injured party’s principal place of business would normally be the most accurate reference point for determining the cost to the injured party (… )’, and continues with reference to the lacuna intra legem approach, that ‘(… ) such an approach ignores the stated goal of interpreting the convention in order “ to promote uniformity” .’179 one example of the lacuna intra legem approach is a german case180 where a french seller sold clothes to a german buyer. the choice-of-law rules pointed to german law as germany had the closest connection to the sale, and the german private international law then made french law applicable. the question regarding the interest rate was therefore decided in accordance with french law. an american case, delchi, deals with the issue of interest rate in the same way: “ delchi is entitled to prejudgment interest pursuant to unccisg article 78. because article 78 does not specify the rate of interest to be applied, the court in its discretion awards delchi prejudgment interest at the united states treasury bill rate as set forth in 28 u.s.c. §1961(a).” 181 the court gives no answer as to how article 78 leads to the application of american law when it comes to the interest rate. neither is it clear whether the court examined how this is solved in other countries. 177 lacuna praeter legem. 178 unidroit principles of international commercial contracts, 2004 edition. available at www.unilex.info 179 sutton: measuring damages p. 750. 180 oberlandesgericht (olg) frankfurt am main 5 u 261/90, june 13, 1991 (germany) (clout case no. 1). 181 delchi carrier spa v rotorex corp., wl 495787 (n.d.n.y. 1994) (clout case no. 85). http://www.unilex.info nordic journal of commercial law issue 2007 #1 33 there have also been other cases based on lacuna intra legem.182 there are good arguments in favour of the lacuna intra legem approach.183 as i have argued elsewhere in this paper, the fact that the convention is silent on certain topics is because the drafters agreed not to include a solution in the convention. one should pay respect to the compromise they reached at the vienna conference, and ensure that the parties applying the convention are not being surprised by unforeseen developments. as a consequence the problem of the interest rate should be solved on the basis of private international law. however, this approach would not conform with the obligation under article 7(1) to ensure uniformity in application. however, according to behr ‘this deficiency in the convention must be accepted. this is preferable to rewriting the convention without benefit of a new conference and a renewed convention.’184 there are, however, strong arguments favouring the lacuna praeter legem approach as well. one may argue, like koneru,185 that since it is only the mechanism of establishing the interest rate that is excluded from the convention, and not the very issue of interest payment itself, the question regarding the rate should be resolved by having regard to the general principles upon which the convention is based. the lacuna intra legem approach results from ‘(… ) a misunderstanding of the overall scheme of the convention, as well as the express provisions of article 7(2) and the general principles on which the convention is based.’186 according to koneru, the principle of full compensation will not be reached if one only looks to national laws in order to determine the applicable interest rate – one should focus on the interest rate, which fully compensates the aggrieved party. this argumentation is thus in line with the austrian arbitration ruling handed down by professor bonell, that it is the interest rate in the plaintiff’s country that should be applied.187 an interpretation in accordance with the lacuna praeter legem approach would undoubtedly lead to certainty for the parties involved; if the relevant interest rate is based on the prevailing rate in the non-breaching party’s country, which would be the result if one takes the principle of full compensation into account, it would be much easier for the parties to predict the outcome of a breach of contract. the norwegian approach to this problem is quite clear: ‘if the price or other outstanding amount is not paid in time, the debtor shall pay interest under the overdue payments interest act of 17 december 1976 no. 100.’188 this is in line with those scholars and court decisions, 182 for example: landgericht hamburg 5 o 543/88, september 26, 1990 (germany) (clout case no. 5); pretore della giurdizione di locarno-campagna, december 15, 1991 (switzerland) (clout case no. 55); hauptstadtgericht budapest 12 g. 41.471/1991/21, march 24, 1992 (hungary) (clout case no. 52). 183 behr: the sales convention in europe p. 296. 184 behr: the sales convention in europe p. 297. 185 koneru; the international interpretation p. 123. 186 koneru: the international interpretation p. 125. 187 this is, of course, unless the plaintiff is able to demonstrate that his business usually deposits its funds in countries with a higher interest rate. then this higher rate would have to be applied in order to compensate the plaintiff for his actual loss. see koneru p. 129, note 102. 188 the sga §71. nordic journal of commercial law issue 2007 #1 34 for example the delchi case, that favour the lacuna intra legem approach. however, this solution would clearly undermine the principle of full compensation, since it does not distinguish between the situations where the breaching party is norwegian or from some other country. another aspect in relation to the norwegian solution, which is contradictory to the principle of full compensation, is the level of the interest rate itself. pursuant to the opia §3(1), the rate is calculated with reference to the interest rate, which at any given time is fixed by the norwegian central bank, added 7%. it is obvious that this interest rate is not connected to the actual economic loss suffered by the claimant, but rather has a penal element to it. it is thus contradictory to one of the basic principle upon which the convention is based. the norwegian solution is not in line with the international character of the convention. the issue of interest rate is not clearly settled in the convention, and, as has been emphasised in this chapter, there exist divergent interpretations as to which approach should prevail. interpretations that promote certainty and predictability to international trade should be encouraged and followed.189 since no consensus has been reached on this matter, one should be reluctant to establish a clear interpretation like the norwegian legislator has done through the sga. there are good arguments in favour of both the lacuna intra legem and the lacuna praeter legem approach, and courts have used both on different occasions. when the norwegian solution clearly states that the lacuna intra legem principle should be applied, this does not pay sufficient respect to the compromise reached by the drafters and it will be a hindrance to a dynamic development of the convention. as a result of this, the norwegian approach is clearly not in conformity with the obligation to take the international character of the convention into consideration. it seems like the wish to apply the domestic well-known rule on international transactions as well as domestic trade has prevailed at the expense of the intention of the drafters. prospective ratifying countries, if they choose to transform the convention, might also be tempted to apply their domestic rules in relation to interest rates. this would, however, contradict the principles in article 7(1). 5.3. other issues 5.3.1. sga §87 and article 1(1) of the convention – application of the rules a provision in the sga, which is not directly contradictory to the convention, but which clearly illustrates the norwegian legislator’s liberal approach to the convention, is §87, which deals with the application of the sga. according to this provision, the rules regarding international sales should be applicable to ‘(… ) contracts of sale concluded between parties who have their places of business in different states (… )’ in other words; the sga would also be 189 koneru: the international interpretation p. 127. nordic journal of commercial law issue 2007 #1 35 applicable to contracts between parties from states that have not ratified the convention.190 the sga is therefore applicable to a wider range of contracts than the convention, which states in article 1(1) that: “ this convention applies to contracts of sale of goods between parties whose places of business are in different states: (a) when the states are contracting states; or (b) when the rules of private international law lead to the application of the law of a contracting state.” because of the formulation in §87, the sga does not require application of the ‘contracting states’-rule in article 1(1)(a) or the ‘private international law’-method set forth in article 1(1)(b).191 6. conclusion today 70 states have adopted the convention, which makes it applicable to a great number of transactions throughout the world. the creation of the convention was mainly motivated out of the idea that a uniform international sales law would enhance predictability and make trading between different states more efficient. the biggest challenge with such an international instrument is to achieve uniform application of the rules. as can be seen from the earlier discussions in this paper, there are several obstacles to this goal. ideally the state’s implementation of the convention should not be an impediment to the achievement of the basic goals of the convention. however, the norwegian approach – to transform the convention – has created a number of difficulties. one might even say that the method of implementation chosen by norway is an outright violation of the obligations under the convention. the norwegian solution should be a warning to the countries that have not yet ratified the convention. in order to pay sufficient attention to the obligations under article 7(1) of the convention they should be very careful if they choose the method of transformation instead of incorporation. otherwise, one might end up with a situation of great confusion and uncertainty, which could ultimately jeopardise the achievement of a common sales law applicable worldwide. 190 lookofsky: cisg in scandinavia p. 15. 191 lookofsky: cisg in scandinavia p. 15. nordic journal of commercial law issue 2007 #1 36 bibliography, cases and materials books and articles: behr: the sales convention in europe volker behr, ‘the sales convention in europe: from problems in drafting to problems in practice’ [1998] 17 journal of law and commerce 263 bergem and rognlien: kjøpsloven john egil bergem and stein rognlien, ‘kjøpsloven – kommentarutgave til kjøpsloven av 1988 og fnkonvensjonen 1980 om internasjonale løsørekjøp’, oslo, 2nd. ed., 1995 berman and kaufman: international commercial transactions harold j. berman and colin kaufman, ‘the law of international commercial transactions (lex mercatoria)’ [1978] 19 harvard international law journal 221 bonell: international uniform law in practice michael joachim bonell, ‘international uniform law in practice – or where the real trouble begins’ [1990] 38 american journal of comparative law 865 bonell and liguori: a critical analysis of current international case law (part i) michael joachim bonell and fabio liguori, ‘the u.n. convention on the international sale of goods: a critical analysis of current international case law (part i)’ [1996] 1 uniform law review 147 bianca and bonell: international sales law c.m. bianca and m.j. bonell (ed), ‘commentary on the international sales law – the 1980 vienna sales convention’, milan, 1987 cook: the need for uniform interpretation susanne cook, ‘the need for uniform interpretation of the 1980 united nations convention on contracts for the international sale of goods’ [1989] 50 university of pittsburgh law review 197 cook: cisg: from the perspective of the practitioner susanne cook, ‘cisg: from the perspective of the practitioner’ [1998] 17 journal of law & commerce 343 dimatteo: the cisg and the presumption of enforceability larry a. dimatteo, ‘the cisg and the presumption of enforceability: unintended contractual liability in international business dealings’ [1997] 22 yale journal of international law 111 dimatteo: the interpretative turn in international sales law larry a. dimatteo, lucien dhooge, stephanie greene, virginia maurer, and marisa pagnattaro, ‘the interpretative turn in international sales law: an analysis of fifteen years of cisg jurisprudence’ [2004] 24 northwestern journal of international law & business 299 farnsworth: the vienna convention: history and scope e. allan farnsworth, ‘the vienna convention: history and scope’ [1984] 18 international lawyer 17 felemegas: uniform interpretation john felemegas, ‘the united nations convention on contracts for the international sale of goods’ (february 2001) pace university essay, available at: www.cisg.law.pace.edu/cisg/biblio/felemegas.html ferrari: uniform application and interest rates franco ferrari, ‘uniform application and interest rates under the 1980 vienna sales convention’ [1994] 24 georgia journal of international and comparative law 467 ferrari: uniform interpretation franco ferrari, ‘uniform interpretation of the 1980 uniform sales law’ [1994] 24 georgia journal of international and comparative law 183 ferrari: a new challenge for interpreters? franco ferrari, ‘cisg case law: a new challenge for interpreters?’ [1998] 17 journal of law and commerce 245 ferrari: applying the cisg in a truly uniform http://www.cisg.law.pace.edu/cisg/biblio/felemegas.html nordic journal of commercial law issue 2007 #1 37 manner franco ferrari, ‘applying the cisg in a truly uniform manner: tribunale di vigevano (italy), 12 july 2000’ [2003] 6 uniform law review 203 ferrari, flechtner and brand: the draft uncitral digest and beyond franco ferrari, harry flechtner and ronald a. brand (ed.), ‘the draft uncitral digest and beyond: cases, analysis and unresolved issues in the u.n. sales convention’, london, 2004 flechtner: challenges to the uniformity principle harry m. flechtner, ‘the several texts of the cisg in a decentralized system: observations on translations, reservations and other challenges to the uniformity principle in article 7(1)’ [1998] 17 journal of law and commerce 187 forte: reason or unreason in the united kingdom angelo forte, ‘the united nations convention on contracts for the international sale of goods: reason or unreason in the united kingdom’ [1997] 26 university of baltimore law review 51 gebauer: uniform law martin gebauer, ‘uniform law, general principles and autonomous interpretation’ [2000] 5 uniform law review 683 gomard and rechnagel: international købelov bernhard gomard and hardy rechnagel, ‘international købelov – de forenede nationers konvention om internationale køb’, copenhagen, 1990. hackney: achieving uniformity? philip hackney, ‘is the united nations convention on the international sale of goods achieving uniformity?’ [2001] 61 lousiana law review 473 hagstrøm: kjøpsrettskonvensjon viggo hagstrøm, ‘kjøpsrettskonvensjon, norsk kjøpslov og internasjonal rettsenhet’ [1995] tidsskrift for rettsvitenskap 561 hagstrøm: kjøpsrett viggo hagstrøm, ‘kjøpsrett’, 1st. ed., oslo, 2005 hagstrøm: implementation in norway viggo hagstrøm, ‘cisg – implementation in norway, an approach not advisable’ [2006] 6 internationales handelsrecht 246 henschel: varens kontraktsmæssighed rené franz henschel, ‘varens kontraktsmæssighed i internationale køb’, århus, 2003 honnold: a uniform law for international sales john o. honnold, ‘a uniform law for international sales’ [1959] 107 university of pennsylvania law review 299 honnold: the sales convention in action john o. honnold, ‘the sales convention in action – uniform international words: uniform application?’ [1988] 8 journal of law and commerce 207 honnold: documentary history john honnold, ‘documentary history of the uniform law for international sales’, deventer, 1989 honnold: uniform laws for international trade john o. honnold, ‘uniform laws for international trade: early ” care and feeding” for uniform growth’ [1995] 1 international trade & business law journal 1 honnold: uniform law john o. honnold, ‘uniform law for international sales under the 1980 united nations convention’, 3rd. ed., the hague, 1999 kastely: unification and community amy h. kastely, ‘unification and community: a rhetorical analysis of the united nations sales convention’ [1988] 8 northwestern journal of international law & business 574 koneru: the international interpretation phanesh koneru, ‘the international interpretation of the un convention on contracts for the international sale of goods: an approach based on general principles’ [1997] 6 minnesota journal of global trade 105 nordic journal of commercial law issue 2007 #1 38 krüger: norsk kjøpsrett kai krüger, ‘norsk kjøpsrett’ [norwegian sales law] 4th. ed., bergen, 1999. reproduced in english at the pace law school web site: www.cisg.law.pace.edu/cisg/biblio/kruger.html lando: udenrigshandelsret ole lando, ‘udenrigshandelens kontrakter. udenrigshandelsret 1.’, 4th ed., copenhagen 1991 linarelli: the economics of uniform laws and uniform lawmaking john linarelli, ‘the economics of uniform law and uniform lawmaking’ [2003] 48 wayne law review 1387 lookofsky: internationale køb joseph lookofsky, ‘internationale køb – united nations convention on contracts for the international sale of goods’, copenhagen, 1989 lookofsky: alive and well in scandinavia: cisg part ii joseph lookofsky, ‘alive and well in scandinavia: cisg part ii’ [1999] 18 journal of law and commerce 289 lookofsky: cisg in scandinavia joseph lookofsky, ‘understanding the cisg in scandinavia’, copenhagen, 2nd. ed., 2002. mendes: the u.n. sales convention & u.s.canada transactions errol p. mendes, ‘the u.n. sales convention & u.s.-canada transactions; enticing the world’s largest trading bloc to do business under a global sales law’ [1988] 8 journal of law and commerce 109 moss: why the united kingdom has not ratified the cisg sally moss, ‘why the united kingdom has not ratified the cisg [2005/06] 25 journal of law and commerce 483 powers: defining the undefinable paul j. powers, ‘defining the undefinable: good faith and the united nations convention on the contracts for the international sale of goods’ [1999] 18 journal of law and commerce 333 ramberg and herre: internationella köplagen jan ramberg and johnny herre: internationella köplagen (cisg) – en kommentar’, 2nd ed., stockholm 2004 roth and happ: interpretation of the cisg according to principles of international law marianne roth and richard happ, ‘interpretation of the cisg according to principles of international law’ [1999] 4 international trade & business law ann. 1 ryan: divergent interpretations lisa m. ryan, ‘the convention on contracts for the international sale of goods: divergent interpretations’ [1996] 4 tulane journal of international and comparative law 99 schlechtriem: commentary (1998) peter schlechtriem, ‘commentary on the un convention on the international sale of goods (cisg)’, 2nd. ed. (in translation), oxford, 1998 schlechtriem: commentary on the un convention peter schlechtriem and ingeborg schwenzer, ‘commentary on the un convention on the international sale of goods (cisg)’, 2nd. (english) ed., oxford, 2005 sono: uncitral and the vienna sales convention kazuaki sono, ‘uncitral and the vienna sales convention’ [1984] 18 international lawyer 7 sutton: measuring damages jeffrey s. sutton, ‘measuring damages under the united nations convention on the international sale of goods’ [1989] 50 ohio state law journal 737 von bar: law of torts christian von bar, ‘the common european law of torts, volume one’, oxford, 1998 winship: private international law and the u.n. sales convention peter winship, ‘private international law and the u.n. sales convention’ [1988] 21 cornell international law journal 487 zeller: good faith – the scarlet pimpernel http://www.cisg.law.pace.edu/cisg/biblio/kruger.html nordic journal of commercial law issue 2007 #1 39 of the cisg bruno zeller, ‘good faith – the scarlet pimpernel of the cisg’ [2001] 6 international trade & business law ann. 227 zeller: the four corners of the cisg bruno zeller, ‘the black hole: where are the four corners of the cisg?’ [2002] 7 international trade & business law ann. 251 cases: english: dunlop pneumatic tyre company ltd. v selfridge and company ltd. [1915] ac 847 (hl) fothergill v monarch airlines ltd. [1980] all er 696 (hl) pillans v van mierop [1765] 3 burr. 1663 (hl) scruttons ltd. v midland [1992] ac 471 (hl) american: delchi carrier spa v rotorex corp., wl 495787 (n.d.n.y. 1994) (clout case no. 85) medical marketing international inc. v internazionale medico scientifica, u.s. district court for the eastern district of lousiana (united states), 17 may 1999 (clout case no. 418) norwegian: rt. (the norwegian supreme court reporter) 1924 p. 91 rt. 1930 p. 1462 rt. 1934 p. 740 rt. 1959 p. 581 rt. 1992 p. 166 other european cases: internationales schiedsgericht der bundeskammer der gewerblichen wirtschaft – wien, june 15, 1994, sch-4318 (austria) (clout case no. 94) internationales schiedsgericht der bundeskammer der gewerblichen wirtschaft – wien, june 15, 1994, sch-4366 (austria) (clout case no. 93) s.a.r.l. bri production ‘bonaventure’ v socit pan african export, cour d’appel grenoble, chambre commerciale, 22 february 1995, 93/3275, journal du droit international 632 (france) (clout case no. 154) oberlandesgericht (olg) frankfurt am main 5 u 261/90, 13 june 1991 (germany) (clout case no. 1) landgericht hamburg 5 o 543/88, 26 september 1990 (germany) (clout case no. 5) oberlandesgericht koblenz (germany), 31 january 1997, n. 2 u 31/96 (unilex 1997) hauptstadtgericht budapest 12 g. 41.471/1991/21, 24 march 1992 (hungary) (clout case no. 52) tribunale di vigevano, 12 july 2000, giurisprudenza italiana 2001, 280 ff. (italy) (clout case no. 378) tribunale di rimini, 26 november 2002, giurisprudenza italiana 2003, 896 ff. (italy) pretore della giurdizione di locarno-campagna, 15 december 1991 (switzerland) (clout case no. 55) obergericht kanton luzerne, 8 january 1997, n. 11 95 123/357 (switzerland) (unilex 1997) arbitral award, the icc court of arbitration, paris, no. 7531/1994 (unilex 1994) nordic journal of commercial law issue 2007 #1 40 travaux préparatoires: nou 1972: 16 – gjennomføring av lovkonvensjoner i norsk rett ot.prp. no. 80 (1986-1987) – a kjøpslov, b lov om samtykke til ratifikasjon av fn-konvensjonen om kontrakter for internasjonale løsørekjøp acts: the norwegian sale of goods act of 13 may 1988 (act no. 27). available in english at www.lovdata.no/info/ueng.html treaties: the united nations convention on contracts for the international sale of goods, april 11, 1980 the vienna convention on the law of treaties, may 23, 1969 convention sur la loi applicable aux ventes a caractère international d’objets mobiliers corporels, june 15, 1955. http://www.lovdata.no/info/ueng.html on legal uncertainty regarding timely notification of avoidance of the sales contract by ari korpinen nordic journal of commercial law issue 2005 #1 nordic journal of commercial law issue 2005 #1 2 abstract the paper deals with the topic of timely notification of avoidance. it is noted that legal uncertainty in contractual relations in international trade can be caused by a strict interpretation of the wording in article 49(2)(b)(i) cisg, which states that the buyer loses his right to avoid the sales contract, unless he avoids the contract within a reasonable period after he knew or ought to have known of the seller’s breach of contract. a strict interpretation of the said article does not allow for the acknowledgment of the buyer’s difficulties in assessing the fundamentality of the breach. in a situation where the defect in the delivered goods worsens gradually over time, the breach is yet not fundamental at the time he makes his notice of non-conformity pursuant to article 39(1) cisg. later he may learn that the breach has evolved into a fundamental breach and that he would have an interest to avoid the sales contract. a strict interpretation of the wording in article 49(2)(b)(i) cisg means that the time limit for notifying avoidance is triggered at the same time as the time limit for notifying non-conformity pursuant to article 39(1) cisg. consequently, the buyer may already have lost his ability to efficiently avoid the sales contract at the time he would have the right to invoke that remedy in his case. this paper presents a solution to that problem, based on the application of article 7(1) cisg. it is concluded that uniform application of the cisg as well as the need to observe good faith in international trade requires that the time limit for notifying avoidance is triggered at the time the buyer learned or ought to have learned about the fundamentality of the breach, which could be later than when the buyer learned of the breach as such. nordic journal of commercial law issue 2005 #1 3 1. introduction (1.) when a seller and a buyer conclude a sales contract, the seller has an interest to know whether the buyer intends to invoke the remedy of avoidance, or whether the seller can regard the transaction to be permanently finalized. on the other hand, the buyer has an interest to be able to rely on efficient contractual remedies in case the seller has delivered defective goods. article 49(1) of the united nations convention on contracts for the international sale of goods (cisg) provides the remedy of avoidance for the buyer in case the seller is guilty of a fundamental breach. article 49(2)(b)(i) cisg stipulates that the buyer loses the right to avoid the contract, unless he submits to the seller a notice of avoidance within a reasonable time after he knew or ought to have known of the breach. the time limit is designed to protect the seller’s interest of reliance on concluded contracts. (2.) practical problems arise when the buyer does not learn about the “fundamentality” of the breach at the same time as he learns about the defect that constitutes the breach. such a situation may arise when the defect in the delivered goods is of such nature that it worsens gradually over time. a strict interpretation of the wording in article 49(2)(b)(i) cisg provides that the time limit for notifying non-conformity and notifying avoidance are triggered at the same point in time, despite the fact that the buyer may have learned about the fundamentality of the breach later than about the defect in the goods. consequently, the buyer may already have lost his right to avoid the contract at the time he learns that he would have a right to invoke that remedy. this issue is of practical importance, since the buyer may in fact lose recourse to the economically most efficient remedy for breach due to a strict interpretation of the wording in the cisg. (3.) in this paper i will show that there are differing viewpoints on this issue in cisg legal literature and that this controversy is also reflected in case law. furthermore, i will present a solution to the problem which is based on applying article 7(1) cisg. my first conclusion is that (1) from the need to apply the cisg uniformly follows a requirement to acknowledge separate triggering dates for the time limits for notifying non-conformity and avoidance, respectively. my second conclusion is that (2) the argument of separate triggering dates is supported by the need to observe good faith in international trade. 1.1 purpose and scope of the paper (4.) the purpose of this paper is to provide an argument for why it is necessary to acknowledge separate triggering dates for the time limits for notifying non-conformity on one hand and notifying avoidance on the other hand. furthermore, the purpose is to show how this result can be achieved within the framework of the cisg. (5.) for the purposes of the discussion it is assumed that the seller has delivered goods that are in non-conformity to the sales contract (article 35 cisg) and that the non-conformity amounts to a fundamental breach of the sales contract (article 25 cisg). it is also assumed that the buyer has taken delivery of the goods and paid the purchase price (article 53 cisg) as well as that the buyer nordic journal of commercial law issue 2005 #1 1 see leser(schlechtriem), p.187 2 see case icc arbitration, 1 march 1999 4 has inspected the delivered goods (article 38(1) cisg). furthermore, it is assumed that the buyer has submitted a notice of non-conformity to the seller, pursuant to article 39(1) cisg. it is assumed that the buyer has not fixed an additional period for performance for the seller (article 47(1) cisg), which would have the effect of triggering the said time limit after such an additional period has expired (article 49(2)(b)(ii) cisg). it is further assumed that the seller has not made a request for providing remedy at his own expense for failure to perform his obligations pursuant to article 48(2) cisg, which would have the effect of triggering the said time limit after the buyer has declared that he will not accept performance (article 49(2)(b)(iii) cisg). 1.2 structure of the paper (6.) after having explained the topic problem in section (2.1), i will present two court cases that provide differing viewpoints as regards the topic problem (2.2). in section (3.1) i submit that the differing case law reflects contradicting views on the topic in cisg legal literature. after that i will present arguments for why separate triggering dates for the respective notifications can be justified under the requirement of uniform application of the cisg in article 7(1) cisg (3.2). in (3.3) i will explain why the same result can be achieved through recourse to the need to promote good faith in international trade, pursuant to article 7(1) cisg. 2. on legal uncertainty regarding timely notification of avoidance of the sales contract 2.1 the legal problem explained (7.) after having taken delivery of and inspected the goods in accordance with the sales contract, the buyer may find a defect in those goods and consequently make a claim that the said goods do not conform to the sales contract. the buyer then wants to invoke a remedy (e.g. price reduction under article 50 cisg or specific performance under article 46(1) cisg) against the seller. under article 39(1) cisg the buyer loses the right to rely on a lack of conformity of the goods if he does not give notice to the seller specifying the nature of the lack of conformity within a reasonable time after he has discovered it or ought to have discovered it. therefore, in order to be able to invoke a remedy such as a price reduction or specific performance against the seller, the buyer must send to the seller a notice of non-conformity pursuant to article 39(1) cisg. (8.) the notice of non-conformity under article 39(1) cisg does not allow the buyer to invoke the remedy of avoidance. avoidance means that the parties are released from their unperformed obligations and that both parties have to reimburse each other what has been paid or supplied under the contract before the declaration of avoidance.1 in order to be able to avoid the sales contract efficiently, the buyer must, pursuant to article 26 cisg, send to the seller a notice of avoidance. article 26 cisg stipulates that “a declaration of avoidance of the contract is effective only if made by notice to the other party”. in that notice the party entitled to avoidance must “clearly and unambiguously make it clear to the other party that the party entitled to avoidance does not intend to stand by the contract any longer”.2 article 49(2)(b)(i) cisg stipulates that “the buyer loses the right to declare the contract avoided unless he does so in respect of any breach nordic journal of commercial law issue 2005 #1 3 see case ch – handelsgericht zürich, 26.4.1995 4 see ibid. 5 other than late delivery within a reasonable time after he knew or ought to have known of the breach. both article 39 cisg and article 49(2)(b)(i) cisg stipulate that the buyer must make both the notice of non-conformity and notice of avoidance within a reasonable time after he knew or ought to have known of the breach. problems arise in a particular sales transaction when the buyer first makes the notice of non-conformity and only later makes the notice of avoidance. such a situation could arise for instance when the delivered goods have a defect that deteriorates over time. for example, the seller has delivered packaging machines with which it is not possible to package a certain type of goods, even though the buyer has clearly informed the seller of his specific purpose to package such goods and the buyer has not (and should not have) detected the defect during the inspection of the machines. in such a situation it can be that the buyer makes the notice of non-conformity when he learns that the goods are defective, but does not at the time avoid the contract because the defect has yet not developed into a fundamental breach. the goods continue to deteriorate after the submission of the notice of non-conformity so much so that the seller’s breach of contract eventually amounts to a “fundamental breach” pursuant to article 49(1) cisg, which entitles the buyer to avoid the contract. then the aforementioned packaging machines deteriorate over time since they are used to package unsuitable goods and the seller has not informed the buyer of the unsuitability of the machines to package those goods. the buyer did not submit the notice of avoidance at the time he initially learned of the defect, because he did not find the defect to amount to a fundamental breach. (9.) prima facie, a comparison of the language in article 39(1) cisg and article 49(2)(b)(i) cisg gives the impression that the time limit (“reasonable time”) is triggered at the same point in time, i.e. when the buyer knew or ought to have known of the breach. the buyer may then lose the right to avoid the contract under article 49(2)(b)(i) cisg, if he submits the notice of avoidance only after the notice of non-conformity. a strict interpretation of the said articles produces this result. however, such a result in interpretation can be considered to cause legal uncertainty and confusion in executing certain international trade transactions. 2.2 the problem in case law (10.) the problem with timely notification of avoidance has been dealt with in cisg case law. a swiss court has ruled in line with the aforementioned [para 8] strict interpretation of the stipulations in article 49(2)(b)(i) cisg and article 39(1) cisg. in the said ruling the court observed that “if the buyer wishes to declare the contract avoided, it must do so within the same time requested to give due notice of the lack of conformity under article 39(1) cisg”.3 the court specifically stipulated that the buyer must “in principle” declare avoidance at the same time as declaring non-conformity.4 (11.) the aforementioned stipulation of the handelsgericht zürich differs from later case law. an italian court has ruled in favour of an interpretation that the time limit for notifying nonconformity on one hand and the time limit for notifying avoidance on the other hand are triggered at different points in time. the court stipulated that “the starting point of the time limit for declaring avoidance is not the same moment as that of the time limit for giving notice of nonconformity”. the court further found that “whereas non-conformity has to be notified as soon nordic journal of commercial law issue 2005 #1 5 see case it – tribunale di busto arsizio, 13.12.2001 6 see ibid. 7 technically the facts in the aforementioned italian and swiss rulings differ from each other. in the italian case, the ecuadorian buyer submitted first the notice of non-conformity and only after the italian seller did not succeed in its attempts to cure the defect, did the buyer avoid the contract. in the swiss case, the german buyer gave the notice of non-conformity and notice of avoidance simultaneously (and in the court’s opinion, too late). despite the difference in the facts surrounding the case, a comparison of the findings in those rulings can me made in the assessment of the topic problem. the courts have in both cases made categorical statements as to when the time limit for notifying avoidance is triggered. it appears therefore that the different viewpoints regarding this issue clearly represent a genuine difference of opinions between the courts. 8 see leser(schlechtriem), p.190 9 see ibid. 6 as it is discovered or ought to have been discovered, avoidance has to be declared only after it appears that the non-conformity amounts to a fundamental breach which cannot otherwise be remedied”.5 the court argued that this finding is justified by the fact that the remedy of avoidance of contract represents a last resort as compared to all other remedies available to the buyer.6 (12.) a comparison of the aforementioned rulings reveals that case law is not uniform as regards the issue of when the notice of avoidance can be efficiently made.7 the swiss ruling emphasized strictly the wording of article 49(2)(b)(i) cisg, i.e. that the time limit for notifying avoidance begins when the buyer learned or ought to have learned about the breach as such. in the italian ruling, the court emphasized that in assessing the starting point for the said time limit, regard must be had to the question of when the buyer learned or ought to have learned of the fundamentality of the breach. the finding of the italian court thus provides new substance for solving cases where e.g. the delivered goods deteriorate over time due to a defect in those goods. 3. solutions for approaching the problem of timely notification of avoidance 3.1 fundamentality of the breach is a different issue than the breach itself (13.) the finding in the aforementioned italian court ruling is in line with opinions in legal literature concerning the cisg. leser has noted that “in determining the period within which a declaration [of avoidance] must be made, regard must be had to the difficulty of assessing, whether or not the breach of contract is already fundamental”.8 leser further notes that “once it is clear that a party has a right to avoid the contract, he should then be required to make the declaration within a reasonable period thereafter.9 this means that the time limit for efficient avoidance of the sales contract begins at the time when the buyer learned or ought to have learned that the defect in the goods amount to a fundamental breach of the sales contract. this time can be later than the time when the buyer learned or ought to have learned about the defect (i.e. the nonconformity) itself. in the case of slowly deteriorating goods [see para 8], this stipulation means that the buyer can efficiently avoid the contract when he learns that a major part of the delivered goods have become defective, even if the buyer already has made the notice of non-conformity under article 39(1) cisg. (14.) the finding in the swiss court ruling is in line with the argument presented by will. will maintains that under article 49(2)(b)(i) cisg “the time limit for avoidance begins to run as soon nordic journal of commercial law issue 2005 #1 10 see will(bianca/bonell), p. 365 11 see honnold, p. 327 7 as the buyer knows or ought to have known of the breach” and that “the time limits for both [notifying non-conformity and notifying avoidance] begin to run simultaneously […]”.10 it appears that there are conflicting views between will and leser on this issue and that the aforementioned swiss and italian rulings follow this line of division. in this paper i will provide justifications for why the finding in the italian ruling can be regarded as accurate. (15.) in my opinion, article 7(1) cisg can be used to justify the argument of separate triggering dates for the time limits for notifying non-conformity and avoidance. article 7(1) cisg stipulates that “in the interpretation of this convention, regard is to be had to its international character and to the need to promote uniformity in its application and the observance of good faith in international trade”. firstly, it can be maintained that “uniformity in application” of the cisg requires that separate triggering points for the time limits for notifying non-conformity and avoidance are accepted. secondly, it can be maintained that “observance of good faith in international trade” requires acceptance of separate time limits. 3.2 “uniformity in application” of the cisg motivates separate triggering dates for the time limits (16.) article 49(1) cisg stipulates as a prerequisite for the buyer’s right to avoid the sales contract that the seller’s breach of contract is “fundamental”.11 other remedies such as price reduction (article 50 cisg) or specific performance (article 46(1) cisg) can be invoked even when the breach of contract is not fundamental. it is therefore clear that the cisg makes a distinction between remedies as regards the prerequisites for invoking them. in order for the cisg to be uniformly applied pursuant to article 7(1) cisg, that distinction must be noted also in the interpretation of the language in article 49(2)(b)(i) cisg. consequently, when assessing the issue of when the “reasonable time” for avoiding the contract begins, regard is to be had to the fact that a “fundamental breach” of contract is required for a claim of avoidance to be successful. in a particular business transaction the buyer may not be able to assess whether the seller’s breach of contract is fundamental at the time the buyer detects the defect in goods. if the fact that the cisg requires a “fundamental breach” is not noted in the interpretation of the language in article 49(2)(b)(i) cisg, the cisg is in fact not uniformly applied as required by article 7(1) cisg. such a practice would mean that the requirement of a “fundamental breach” would only be noted when applying article 49(1) cisg, but not when applying article 49(2)(b)(i) cisg. 3.3 “good faith in international trade” motivates separate triggering dates for the time limits (17.) the parties of a sales contract, i.e. the buyer and the seller, have concluded the contract in order to execute a business transaction. the essential elements of the sales contract are the seller’s obligation of delivering goods that conform to the contract and the buyer’s obligation of paying the purchase price and taking delivery. the purpose of the sales contract is to facilitate a trade-off between the parties, i.e. the buyer pays money to the seller in order to receive a good that can be used in production of revenue-creating goods or directly in revenue-creating sales of the purchased good. in order for this theory to hold, the buyer must have remedies at his disposal when the seller breaches the contract (e.g. delivers defective goods). furthermore, the buyer must be able to nordic journal of commercial law issue 2005 #1 12 see leser(schlechtriem), p. 190 13 see ibid. 14 see honnold, p.101 15 see huber(v.caemmerer/schlechtriem), p. 493 16 see schlechtriem 1995, p.110 17 term used by leser, see leser(schlechtriem), p.187 8 withdraw entirely from the contract (i.e. to avoid) in a situation where invoking other remedies would not be as economically efficient a solution for the buyer. since the cisg has been created to facilitate international trade, the aforementioned realities must also be accepted in the interpretation of the cisg. consequently, in interpreting the language of article 49(2)(b)(i) cisg, regard is to be had to the availability of the remedy of avoidance for the buyer when the seller is guilty of a fundamental breach of contract. it follows, as leser has noted, that in assessing the triggering date for the time limit for an efficient notice of avoidance, “regard is to be had to the difficulty in assessing the fundamentality of the breach”.12 if the time limits for both notifying non-conformity and avoidance are set to begin at the same time, the buyer would not have at its disposal the remedy of avoidance in a situation where the defect in the delivered goods develops into a “fundamental breach” of contract after the buyer has submitted the notice of nonconformity. that result is contrary to good faith in international trade, since it means that the initial purpose of the sales contract – i.e. facilitating a trade-off between the buyer and the seller – is not realized merely due to a strict legal interpretation of the language in article 49(2)(b)(i) cisg. (18.) in legal literature it has been discussed that the party entitled to avoidance might speculate with his right to avoid the contract.13 for example honnold has argued that a “delay in […] avoiding a contract after a market change […] may well be inconsistent with the convention’s provisions governing these remedies when they are construed in light of the principle of good faith”.14 a buyer who is entitled to avoidance might for instance hold its decision to avoid the sales contract in anticipation of a change in the market price of the good. in order to prevent such speculation in bad faith, the time limit pursuant to article 49(2)(b)(i) cisg should as such be relatively short. (19.) in the author’s opinion the requirement of observing good faith in international trade must also be assessed from the seller’s point of view when setting the triggering date pursuant to article 49(2)(b)(i) cisg. allowing separate triggering dates for the time limits for notifying nonconformity and notifying avoidance has in practice the same effect as having simultaneous triggering points but allowing a longer time limit for notifying avoidance than for notifying nonconformity. in cisg legal literature it has been recognized that the seller has an interest “worthy of protection” to know as soon as possible after the contract is formed, whether the buyer will invoke the remedy of avoidance.15 the stipulation in article 49(2)(b)(i) cisg reflects the basic idea that insecurity as regards the fate of the sales contract should be avoided.16 the seller’s interest to be able to trust that an already concluded contract holds is larger, the bigger the contract value is. this follows from the fact that avoidance of the sales contract transforms the contract into a “contractual restitutionary relationship”17 between buyer and seller, with restitution being made of what has been supplied or paid under the contract. i.e. the seller must reimburse to the buyer the purchase price that the buyer has paid. at least when the reimbursement to the buyer involves a big sum of money, it will affect at least temporarily the seller’s cash-flow situation. it would be unreasonable for the seller to live in uncertainty about the fate of the sales contract for an excessively long time. therefore it can be argued that “observance of good faith in nordic journal of commercial law issue 2005 #1 9 international trade” pursuant to article 7(1) cisg also requires a rather strict assessment of when the buyer “ought to have known” about the fundamentality of the breach, when setting the triggering date pursuant to article 49(2)(b)(i) cisg. in the final analysis it is a question of balancing the right of the buyer to economically efficient remedies and the right of the seller to be able to trust concluded contracts. 4. conclusions (20.) the topic of this paper was the situation where the seller has delivered goods to the buyer that do not conform to the sales contract and where the defect in the goods is of such nature that it worsens gradually over time. since under a strict interpretation of article 49(2)(b)(i) cisg the time limit for notifying avoidance is triggered at the same time as the time limit for notifying nonconformity, the author noted that the buyer may in some cases have already lost the ability to efficiently avoid the contract when he in fact learns for the first time that he would have reason to avoid the contract. the author noted that this problem causes legal uncertainty in international trade transactions [para. 9]. (21.) in this paper the author presented from cisg case law two court rulings in which the courts have assumed different positions as to the issue of when the time limit for notifying avoidance is triggered, and also noted that these different rulings reflect the controversy regarding the issue in cisg legal literature [para. 14]. a strict interpretation of the wording in article 49(2)(b)(i) cisg calls for a solution under which the time limit for notifying avoidance is triggered at the time the buyer knew or ought to have known of the breach itself (i.e. regardless of whether he knew or ought to have known of the fundamentality of the breach). a more flexible interpretation would acknowledge the buyer’s difficulties in assessing whether the breach is fundamental. the author recommended that flexible interpretation for the case where the defect in the delivered goods is shown to worsen gradually over time. in the author’s opinion that result can be achieved within the framework of the cisg in two separate ways [para. 15], i.e. by acknowledging that (a) the need to apply the cisg uniformly and (b) the need to promote good faith in international trade call for the aforementioned flexible interpretation of the wording in article 49(2)(b)(i) cisg. on the other hand, the author also concluded that the need to promote good faith for the benefit of the seller requires that a strict interpretation is assumed as to the issue of when the buyer ought to have learned of the fundamentality of the breach [para. 19]. nordic journal of commercial law issue 2005 #1 10 list of authorities honnold, john o. uniform law for international sales under the 1980 united nations convention 3rd. ed., the hague 1999 cited as: honnold 1999 huber, ulrich “rechtshelfe des käufers wegen vertragsletzung durch den verkäufer”, in: v. caemmerer, ernst & schlechtriem, peter (ed.): kommentar zum einheitlichen un – kaufrecht, munich 1990 cited as: huber(v.caemmerer/schlechtriem) leser, hans g. “general provisions” in: schlechtriem, peter (ed.): commentary on the un convention on the international sale of goods (cisg), 2nd.ed. in translation, oxford 1998 cited as: leser (schlechtriem) schlechtriem, peter internationales un – kaufrecht, freiburg 1995 cited as: schlechtriem 1995 will, michael r. commentary on article 25 cisg in: massimo c. bianca & m. joachim bonell (ed.), "commentary on the international sales law", milan 1987 cited as: will (bianca & bonell) nordic journal of commercial law issue 2005 #1 11 index of cases icc court of arbitration icc international court of arbitration case no. 9978, 1 march 1999 http://www.cisg.law.pace.edu/cisg/wais/db/cases2/999978i1.html cited as: icc arbitration, 1 march 1999 italy tribunale di busto arsizio, 13 december 2001 http://www.cisg.law.pace.edu/cisg/wais/db/cases2/011213i3.html cited as: it – tribunale di busto arsizio, 13.12.2001 switzerland handelsgericht zürich, case n:o hg920670, 26 april 1995 http://www.cisg.law.pace.edu/cisg/wais/db/cases2/950426s1.html cited as: ch handelsgericht zürich, 26.4.1995 list of abbreviations ch switzerland cisg united nations convention on contracts for the international sale of goods it italy icc international chamber of commerce p. page para. paragraph un united nations * giulio giannini is a graduate student in law at bocconi university, milan. he has studied abroad in paris and at the university of richmond law school in virginia. the formation of the contract in the un convention on the international sale of goods: a comparative analysis by giulio giannini* nordic journal of commercial law issue 2006 #1 nordic journal of commercial law issue 2006 #1 1 zimmermann, the law of obligations, roman foundations of the civilian tradition, oxford, 1997, at 563 2 kötz, european contract law, oxford, 1997, at 18. 3 united states filanto s.p.a. v. chilewich international corp., 789 f.supp. 1229 (s.d.n.y.), 14 april 1992, available online at <http://cisgw3.law.pace.edu/cases/920414u1.html>. 4 schlechtriem, commentary on the un convention on the international sale of goods, oxford, 1998, at 144. 2 introduction: the consent of the parties a contract is formed when parties express their agreement in congruent declarations, a prior offer and a consequence acceptance. for a long time there was no practical need to force consent into the structure of offer and acceptance because parties always made their contracts face to face. in rome, for example, contractual obligations were originally made by stipulatio, for which the parties needed to be physically present together, and even when this formality was dropped, contracts generally continued to be made in the presence of the parties, possibly represented by a slave or a son-inpower or even a free man appointed for that purpose. as a consequence the roman jurists never came to think of two declarations named “ offer” and “ acceptance” as necessary for consent.1 the need for the agreement of the parties expressed in the offer and acceptance arose when a reliable postal service and contracting at a distance became possible; but even if no difficulties arise when the contract is concluded between parties who are in the same place or in immediate communication, when a contract is to be concluded inter absentes, and, after their declarations, it takes time for each of them to reach its addressee, several questions can arise. in many cases in which a contract has unquestionably been formed, it is impossible, unrealistic or arbitrary to regard the conduct of one party as an offer and that of the other as an acceptance2; the stipulatio in a sale of land or the case of a customer who pays cash for a packet of cigarettes are situations in which it is difficult to say that one party is making an offer to the other who is declaring his acceptance. another important situation is where an agreement is reached only after a long period of negotiation such as in a typical export sale where none of the letters exchanged may be defined as an offer or an acceptance. nevertheless there are other forms of reaching agreement (e.g., agreement reached in a point-bypoint negotiations or with a performance) where the ‘dissection’ of individual statements as ‘offer’ and ‘acceptance’ would constitute an arbitrary legal operation as in the criticized decision of a us federal court in filanto s.p.a. v. chilewich international corp.3 in which the memorandum was considered as an offer and the seller’s conduct as an acceptance in a possible but certainly not mandatory way.4 http://cisgw3.law.pace.edu/cases/920414u1.html nordic journal of commercial law issue 2006 #1 5 part two of the convention does not apply in states which have entered a reservation under article 92 cisg, e.g., the scandinavian states. 6 schlechtriem, supra note 4, at 110. 7 kötz, supra note 2, at 19. 8 id. 9 honnold, uniform law for international sales, kluwer, 1999, at 147. 3 this paper deals with this important requirement for the effective conclusion of a sale contract achieved by means of offer and acceptance. the starting point will be the part two of the un convention on the international sales of goods (cisg)5 but each aspect of the latter objective agreement will be discussed in a comparative analysis with the three most important legal systems, namely the anglo-saxon legal family where the offeror is the least bound, the german system in which he is most strongly bound and the romanistic one which adopts an intermediate position. 1. the offer the offer is the first step which leads to a contract because, if accepted, the latter is formed. the parties are then said to be ‘ad idem’. it follows that an effective offer arises only if it presents two inner peculiarities, as art. 14 un sales law states: if it ‘indicates the intention of the offeror to be bound in case of acceptance’ and if it is ‘sufficiently definite’. 1.1. intention to be bound the ‘intention to be bound’ is the offeror’s intention to be bound in the event of acceptance and it has nothing to do with the question of whether the offeror is bound by his offer or not. the ‘intention to be bound’, in fact, is a material feature of an offer which is not a matter for the autonomy of the parties6. it follows that when a contract arises through offer and acceptance, the offer must make it clear that, if accepted, the offeror intends to be bound otherwise there is in law no offer at all but just an invitation for the addressee to make an offer or to start bargaining (invitatio ad offerendum, invitation to treat, offre de pourparlers).7 the wording of the first sentence of article 14(1) cisg makes it clear that it is the proposal’s objective meaning which is significant and not the subjective one8. if doubts arise from the bare text of the parties’ statements, they should first of all call for communication, as a consequence of a general principle of good faith (article 7 cisg) which states that a party may not take advantage of ambiguity when an inquiry could readily remove the doubt.9 moreover if a party was unaware or could not have been aware that the subjective intention was different from the objective meaning, article 8 cisg requires that the statements should be interpreted in their full context, ‘according to the understanding that a reasonable person of the same kind would have had in the same circumstances’, including the ‘negotiations, any practices which the parties have established between themselves, usages and any subsequent conduct of the parties’. nordic journal of commercial law issue 2006 #1 10 id. 1 1 germany oberlandesgericht frankfurt, 30 august 2000, num. 9 u 13/00, translated text available online at <http://cisgw3.law.pace.edu/cases/000830g1.html>. 12 switzerland bezirksgericht st. gallen, c. v. w, 3 july 1997, num. 3pz 97/18, at www.unilex.info. 13 schlechtriem, supra note 4, at 112. 14 schlesinger, formation of contracts, a study of the common core of legal systems, oxford, 1968, 101. 15 schlechtriem, supra note 4, at 112 4 as a consequence, the parties’ understanding is a question of fact that is peculiar to each transaction and article 14 cisg contains general guides for interpreting the parties’ intent, playing just a subordinate and a supporting role.10 relating to this problem a court in germany11 held that ‘it depends on the objective content of the statement whether the buyer must have understood the invoice as an offer’ and if the seller answers, indicating all the ‘necessary determinations’ because he was told by the buyer to do so, there is no intention to be bound. in this case, circumstances show that the buyer could not understand the statement as an offer because the communication by which the buyer received the invoice said expressly that the seller acted because the buyer asked him to do so. moreover a court in switzerland12 held that, in the absence of any relevant circumstances or practices between the parties at the time the contract was concluded, the intention to be bound had to be interpreted according to the subsequent conduct of the parties after the conclusion of the contract. in particular, it held that the buyer's request to the seller to issue the invoice of the delivered textiles to the embroiderer was sufficient evidence of the buyer's intention to be bound at the time it made its proposal. to distinguish an offer from an invitatio offerendi the proposal should describe itself either as a binding offer or else as sans engagement, senza impegno, freibleibend, without obligation or other words of the same effect; in absence of any such indications, article 8 cisg pays attention on how the proposal would be understood by a reasonable person in the position of the addressee.13 article 14(2) cisg incorporates the generally accepted premise that a party may make an offer to as large a group as it wishes14 but ‘a proposal other than one addressed to one or more specific person is to be considered merely as an invitation to make an offer, unless the contrary is clearly indicated by the person making the proposal’. there is no intention to be bound where a proposal is made to enter into negotiations, nor is there such an intention in particular in the case of an invitatio ad offerendum: article 14 cisg presumes that in case of doubt proposals to an indefinite group of persons are invitations to treat. however, article 14 cisg permits a proposal made to an indefinite group of persons to take effect as an offer, if that is clearly indicated by the offeror, indicating the ‘intention of the offeror to be bound in case of acceptance’ and if it contains the minimum elements required by article 14(1), second sentence, except the case in which parties agreed to derogate from the latter requirement.15 http://cisgw3.law.pace.edu/cases/000830g1.html http://www.unilex.info. nordic journal of commercial law issue 2006 #1 16 bianca/bonell, commentary on the international sales law, milan, 1987, art. 14 note 2.2.2 17 schlechtriem, supra note 4, at 106 18 bianca/bonell, supra note 16, art. 14 2.2.2 1 9 f ran ce cour d'appel de paris, 10 september 2003, num. 2002/02304, translated text available onlin e a t <http://cisgw3.law.pace.edu/030910f1.html>. 20 bianca/bonell, supra note 16, art. 14 note 2.2.4.2. 21 united states geneva pharmaceuticals technology corp. v. barr laboratories, inc., et al., 201 f.supp. 236 (s.d.n.y.), 21 august 2002, available online at <http://cisgw3.law.pace.edu/cases/02082u1.html>. 22 austria oberster gerichtshof, 20 march 1997, num. 2 ob 58/97m; austria oberster gerichtshof, 10 november 1994, num. 2 ob 547/93, translated text available online at <http://cisgw3.law.pace.edu/cases/941110a3.html> ; switzerland bezirksgericht st. gallen, 3 july 1997, num. 3pz 97/18, at www.unilexinfo. 23 schlechtriem, supra note 4, at 106. 5 1.2. definiteness of the offer in order to constitute an offer, a proposal to conclude a contract must be sufficiently definite (essentialia contractus) that, if it is accepted, a contract is created with obligations which can be enforced into the courts.16 article 14(1) cisg, second sentence, states that the goods, their quantity and the price are the minimum elements; however they may still be insufficient17 if other elements such as the time and the place of delivery may also be ‘essentialia negotii’ in the particular case in which previous negotiations or practices of the parties show that an offer must specifically refer to such additional details.18 goods are definite when they are expressly specified and they may be indicated either specifically or generally; article 14(1) cisg, second sentence, moreover, allows the quantity and the price of them to be fixed ‘implicitly’. silence cannot in itself indicate the goods, their amount, or the price, if this does not refer to matters capable of being interpreted as an indication of a definite price, goods or amount, such as on the basis of the parties’ practices or framework contracts which have already established the requirements for a valid offer. the court of appeal in paris19 held that ‘in order for a contract to be concluded, the proposal must be sufficiently definite and that, even if acceptance may result from the behavior of the offeree, silence or inactivity does not in itself amount to acceptance’. the term ‘implicitly’ in the article 14 cisg indicates also that it is sufficient that the prevision on these elements makes them determinable also when these relevant factors will come into existence or be established only at a latter date20 such as in a future supply of commercial quantities as the u.s. district court of new york states in geneva pharmaceuticals technology corp. v. barr laboratories, inc., et al.21 holding that ‘not only were the goods involved clearly identified, but also the indication of a "commercial amount" was an appropriate criterion for determining the quantity and price, taking into account the industry usages automatically incorporated into the agreement’. as many european courts have held22, an offer is also capable of acceptance if a ‘reasonable person of the same kind’ and ‘in the same circumstances’ as the recipient would have understood the necessary minimum content to have been expressed in sufficiently definite terms according to article 8(2) cisg.23 the third element requested by the art. 14 cisg for the definiteness of an offer is the price: a proposal does not constitute an offer if it fails to fix a price, at least implicitly, or to make http://cisgw3.law.pace.edu/030910f1.html http://cisgw3.law.pace.edu/cases/02082u1.html http://cisgw3.law.pace.edu/cases/941110a3.html nordic journal of commercial law issue 2006 #1 24 austria oberster gerichtshof, 10 november 1994, num. 2 ob 547/93, supra note 22. 25 france cour de cassation, sté fauba france fidis gc electronique v. sté fujitsu mikroelectronik gmbh, 4 january 1995, translated text available online at <http://cisgw3.law.pace.edu/cases/950104f1.html>. 26 hungary metropolitan court of budapest, 24 march 1992, num. az 12.g.41.471/1991, at www.unilex.info. 27 amato, (1993) 13 the journal of law and commerce 1, at 16. 28 russia tribunal of int'l commercial arbitration at the russian federation chamber of commerce, 3 march 1995, num. 309/1993, at www.unilex.info. 29 honnold, supra note 7, at 155; corbisier, rev. int. dr. comp. 1988, 767, 828; joseph, (1984) 3 dick. j. int. law, 122. 30 schlechtriem, supra note 4, at 109. 31 bianca/bonell, supra note 16, art. 55, note 2.2.2. 6 provision, also in this case at least implicitly, for determining the price. the austrian supreme court24 held that a price is sufficiently definite if it’s agreed on a range, the single price depending on the quality of the single good and the french supreme court25 assumed a price to be determinable also if it could be revised according to market trends. a hungarian court, moreover, held that an offer is sufficiently definite if the quality, quantity and price of the goods are impliedly fixed by the practices established between the parties who have had a commercial relationship for a long time26. however, the latter case was completely distorted, in a criticized decision27, by the hungarian supreme court on 25 september 1992 which held that no effective contract had been concluded since the supplier’s offer had not given a complete price for the entire system but only for a part of it and there was no market for price for such system, so that the price could therefore not be determined under article 55 cisg either. nevertheless, the definiteness of a contract can also be satisfied if the price is determined neither explicitly nor implicitly and article 55 cisg does not apply if parties agree to determine the price of the goods in a future date28. during preparation of cisg there was a fierce dispute as to whether a contract should nevertheless come into existence if a price had not been fixed and as to which mechanism for fixing the price should be used to fill the gap. the convention recognizes that contracts can be made without following the two-step-formula of offer and acceptance in the article 18(3), which provides that a contract may be concluded “ by performing an act” and in the article 8(3) in which statements are to be interpreted to include trade usages and the parties’ practices and are to be construed in the light of “ any subsequent conduct of the parties” . as a consequence, does article 14 cisg deal not only with the peculiarities of an offer but also with the validity of a contract of sale which does not determine the price? the answer to this question is not obvious and the solution takes place in the conflict between article 14 and article 55 cisg, the latter dealing with the mechanism for fixing the price. some authors29 assume that article 55 basically takes priority, so that the requirement for a definite price in article 14 is largely redundant30 and others, in the same way, assume that a binding contract may come into effect irrespective of the requirements for a valid offer under article 14 cisg31; these authors, in fact, sustain that in the face of article 4 cisg, which states that “ except as otherwise expressly provided in this convention, it is not concerned with the validity of the contract or of its provisions” , it is difficult to say that article 14 deals with the validity of a contract of sale. article 55 cisg is consequently applicable, overcoming article 14 cisg, stating that when a contract “ has been validly concluded” , on the basis of the applicable national law, without any expressly or implicitly provision for determining the price, “ the parties are considered to have impliedly made reference to the price generally charged … for such goods sold under comparable circumstances” . some commentators assume that there is an obvious conflict, due to the http://cisgw3.law.pace.edu/cases/950104f1.html http://www.unilex.info. http://www.unilex.info. nordic journal of commercial law issue 2006 #1 32 schlechtriem, supra note 4, at 109. 33 ghestin, revue de droit des affaires internationales, 1988, at 6. 34 schmidt, négotiation et conclusion de contrats, paris, 1982, at 72. 35 italy corte di cassazione, 17 october 1992. 36 spain tribunal supremo, 10 october 1980. 37 spain tribunal supremo, 30 june 1972.. 7 circumstances in which the convention arose, which must be solved in various techniques according to specific cases32; so that article 55 cisg is important where the cisg is to be applied without part two and the applicable domestic law permits a contract to be concluded without a price being determined or when no price has been indicated because it is determined implicitly and rules of interpretation should be applied; in many other cases a contract may still be considered to have been concluded by agreement because the parties implicitly derogate from article 14(2) cisg, second sentence, or because the contract was validly concluded otherwise than the mechanism of offer and acceptance; only in the remaining rare cases in which an offer without a price is a vital component of the agreement and this can be determined neither ‘expressly nor implicitly’, it can be concluded that no contract was formed. finally, other authors claim that article 14(1) cisg, second sentence, takes absolutely priority33. 1.3. a comparative analysis most of the civil law systems follow the article 14 cisg conception; an offer must be definite, that is, it must specify the essentials of the proposed deal with sufficient precision that a valid contract will be formed if the addressee announces that he accepts it34. in the french law, a contract is defined in article 1101 of the code civil as “ an agreement by which one or more persons promise one or more others to give, to do or not to do something” . moreover, article 1108 sets out the four essential conditions for the validity of a contract: consent of the party who undertakes to perform the obligation, his or her capacity to contract, a predetermined objet or obligation and a lawful cause. article 1129 says that “ the obligation must have as its object a thing of a definite description. the amount thereof can be undetermined, provided it is ascertainable” . also italian law specifies the requisites of the contract in article 1325 codice civile, which are: agreement, object, causa and form, if the latter is required by the law in the single statements, adding in article 1346 that the object of the contract must be possible, lawful and certain or ascertainable. in italy, however, it is not necessary that all the details of a contract are decided, if the parties act as if bound by it, as stated by the corte di cassazione35. in spain article 1261 of the civil code says that a contract requires consent, definite subject matter, and a causa for obligation. moreover, article 1262 says that consent is shown by concurrence of offer and acceptance of the thing in issue and the causa, which together constitute the contract. an offer should be precise and complete and intended to be binding. a spanish supreme court decision36 held that “ once the offer of contract of proposal, with all necessary elements for the future contract, has been made, the contract comes into being with the assent of the other party” . article 1273 states that a clear and certain subject matter is another contractual requirement but an uncertain quantity or sum is still acceptable if it can be determined without the need for a new agreement; an agreement on a contract of sale of a piece of land, in which the precise piece is not from among various holdings, is held void for uncertainty if it is left to be decided at a later date, as in an earlier supreme court decision37. nordic journal of commercial law issue 2006 #1 38 kötz, supra note 2, at 18. 39hillas v. arcos, (1932) 147 l.t. 503 (h.l.). 40 united states lonergan v. scolnick, 129 cal.app.2d 179, cal. app. 4 dist., 23 november 1954. 41 ucc § 2-204, official comment 3. 42 gabriel, pratictioner’s guide to the convention on contracts for the international sale of goods and the uniform commercial code, new york, 1994, 44. 43 france cour de cassation, 6 march 1990. 44 france cour de cassation, 20 march 1972. 45 france t.c. seine, 28 may 1981. 8 nevertheless, in most of the civil law countries, a valid contract of sale may even exist if the price is neither stated nor inferable from the surrounding circumstances but this will be so only if it emerges from the negotiations as a whole that the parties have agreed that the contract is to be valid notwithstanding that the price is to remain open for the time being.38 a different solution is given under common law, where judges wish to give an effect to disputed agreements, rather than nullify them by strict or literal interpretation. in hillas v. arcos39, lord tomlin explained that “ the problem of a court of construction must always be so to balance matters that, without violation of essential principles, the dealings of men may so far as possible be treated as effective and the law may not incur the reproach of being the destroyer of bargains” . the same opinion can be found in the british coal case of the scottish court of session which held that “ if parties have apparently intended to bind themselves, the court should be slow to abort that intention on the basis that there is some inadequacy on a particular aspect” . in american common law this principle is always followed but in lonergan v. scolnick40, court held that there can be no contract unless the parties have met and mutually agreed upon some specific things. in the same way, the uniform commercial code differs from article 14 cisg in determining whether an offer is sufficiently definite to be valid. section 2-204(3) of the ucc does not specify which terms will affect the sufficiency of an offer so that ucc test is not “ certainty as to what the parties were to do nor as to the exact amount of damages due to plaintiff … if the parties intend to enter into a binding agreement, recognizes that agreement as valid in law, despite missing terms, if there is any reasonably certain basis for granting a remedy” 41. ucc §§ 2-201(1) and 2-204 require that a contract for sale specify the quantity of goods but the latter need not be identified and a fixed price is not essential to a valid sales contract under ucc § 2-305 and when a ucc contract is silent about price, the assumption is that the parties intended the sale to be at a reasonable price at the time and place of delivery42. like article 14 cisg, the principle of the intention to be bound as a peculiar part of the offer and the presumption of a proposal to an indefinite group of persons as an invitatio ad offerendum, is peculiar to both civil and common law countries. in france, the supreme court has held that an offer to contract is one which shows clearly the intention of the offeror to enter into a binding contract on the terms set out and which contains the essential elements of the contract43 differing from a letter of intent or offer to start negotiating, which may create only an obligation to negotiate in good faith otherwise it can give raise to a quasi-delictual liability44. just the proposal to an indefinite group of person as a non binding act could be subject to some exceptions, above all in france and denmark and switzerland: courts in france have held that displaying goods with their prices usually constitutes an offer for sale45 and where someone has advertised goods for sale in a newspaper, a contract is formed with the first person to fulfill the conditions of the nordic journal of commercial law issue 2006 #1 46 france cour de cassation, 13 june 1972. 47 england harvey v. facey, (1893), ac 552. 48 england scancarriers v. aotearoa, (1985) 135 n.l.j. 799. 49 england carlill v. carbolic smoke ball co., (1892), 2 qb 484. 50 united states izadi v. machado (gus) ford, inc., 550 so.2d 1135, fla. app. 3 dist., 1 august 1989. 51 gabriel, supra note 42, at 42. 52 ucc § 1-103(b). 53 united states ray v. william g. eurice & bros., inc., 201 md. 115, 93 a.2d 272, md., 5 december 1952. 9 offer46, unless he lacks particular attributes which it is reasonable for the advertiser to insist on, such as solvency or reliability. danish law recognizes the distinction between an offer and an invitation to treat, but nonetheless holds that a statement of price attached to goods generally constitutes a binding offer as in a supreme court judgment in 1985 (ufr 877). also article 7(3) of the swiss law of obligations provides that the ‘display of goods marked with the price is normally to be seen as an offer’. in germany and in italy, on the other hand, the common distinction is adopted and goods displayed and priced in a shop window represent only an ‘invitatio offerendi. in england an offer differs from an invitation to treat because the latter is a stage before the former, being only an expression of a general willingness to bargain and as such of no legal effect. most of the advertisement are in the ‘intention to treat’ category, above all when it concerns statements of price, whether or not attached to the goods in question, and even if given in response to a specific inquiry as court held in harvey v. facey47 and in scancarriers v. aotearoa48. a different solution is found in carlill v. carbolic smoke ball co.49 in which court held that the advertisement in newspapers that £100 would be paid to any reader who contracted influenza after inhaling ‘carbolic smoke ball’ was an offer, explaining the reason that these kinds of statements amount to an offer because they proposed or required particular responses from their readers. in the united states, the general rule is that an advertisement does not constitute an offer and it is merely an invitation for offer but in izadi v. machado (gus) ford, inc.,50 a florida court held that “ a binding offer may be implied from the very fact that deliberately misleading advertising intentionally leads the reader to the conclusion that one exists” . like article 14 cisg, the uniform commercial code indicates that an offer need not specify all the terms to set forth and that the primary determination of an offer’s sufficiency and validity will be the offeror’s intent51. ucc under § 2-204 (1) expressly provides that formation can be made in any manner to show agreement, including offer and acceptance and conduct by both parties which recognizes the existence of a contract. however, because of the ucc silence on the intention to be bound, the matter is a question of common law contract52. like in the cisg the objective theory is accepted today in common law contract: one is ordinarily bound or not bound by the reasonable interpretation of his words and actions. in ray v. william g. eurice & bros., inc.,53 a maryland court says that “ the law is clear, absent fraud, duress, or mutual mistake, that one having the capacity to understand a written document who reads and signs it, or without reading it or having it read to him, signs it, is bound by his signature in law ... it follows that the test of a true interpretation of an offer or acceptance is not what the party making it, thought it, meant or intended it to mean, but what a reasonable person in the position of the parties would have thought it meant” . nordic journal of commercial law issue 2006 #1 54 schlesinger, supra note 14, at 683. 55 schlechtriem, supra note 4, at 115. 56 second restatement of contracts §§ 23, 24, 28; united states craft v. elder & johnson co., (1941), 34 ohio app. 2d 605. 57 § 130 bgb; art. 167 greek civil code; art. 224 portuguese civil code; art. 1335 italian civil code, according to which an offer is effective only if addressee has knowledge of it and this such knowledge is presumed as soon s it reaches the right address. the presumption can be rebutted by proof that the addressee was not blame for not learning of the offer, a proof which could be truly defined as a probatio diabolica. 58 § 130 bgb; art. 230 portuguese civil code; but in art. 9(1) swiss law of obligation, an offer is considered to have been withdrawn if the addressee learns of the withdrawal before he learns of the offer itself, even though the withdrawal may have reached him after the offer. 59 enderlein/maskow/stohbach, international salesllaw, new york, 1992, art. 16, note 3. 10 2. effect of the offer article 15 cisg states that “ an offer becomes effective only when it reaches the offeree” . an offer reaches the offeree only if it has been sent with the consent of the offeror; consequently if an offer is drawn up and agreed by a competent body, but not dispatched, and comes into the possession of the addressee in an unauthorized manner, it has not ‘reached’ him and is therefore ineffective54. moreover an offer cannot be accepted before it has become effective, even if the offeree is already aware of it55. the fact that an offer becomes effective only when it reaches the offeree means that it can be withdrawn by the offeror before or at the same time as it reaches the offeree, even if the offer is irrevocable. withdrawal leads to the termination of the offer and a withdrawal cannot itself be withdrawn, consequently a new offer must be made instead. the reason supporting the effect of the offer in article 15 is that the enforcement of contracts is designed to protect expectations and none arose before the offeree is reached by an offer not withdrawn. the same principle of the effect of an offer just when it reaches the offeree is adopted both in common law56 and in civil law57 systems as the principle that an offer is ineffective if notice of its withdrawal reaches the offeree before the offer or at the same time58. 3. revocation of the offer article 16(1) cisg states the principle that an offer is revocable; however, this principle is restricted by providing the statement that not only the conclusion of the contract but even the dispatch of acceptance rules out the revocation of an offer. moreover, article 16(2) cisg adds (a) a reference to the situation in which the offeror states a fixed time for acceptance, that could be understood, at first sight, as indicating an intention to be bound by his offer for this period, and (b) states that the offeror is also bound if the offeree has acted in reliance on the offer being irrevocable and it was reasonable for him to do so. 3.1. revocability until acceptance like the withdrawal of an offer in article 15, article 16(1) cisg states that a revocation of an offer must be made by a declaratory act that reaches the addressee59. the offeree’s knowledge, possibly gained from a third party, that the offeror intends to revoke his offer does not bring about revocation. moreover, a revocation of a revocation is not generally possible and a new offer is nordic journal of commercial law issue 2006 #1 60 schlechtriem, supra note 4, at 119. 61 id. 62 id. 63 restatement second of contracts § 71 states that “ to constitute consideration, a performance or a return promise must be bargained for; a performance or return promise is bargained for if it is sought by the promisor in exchange for his promise and is given by the promise in exchange for that promise” . 64 honnold, supra note 7, at 163. 65 schlechtriem, supra note 4 , at 121; honnold, supra note 7, at 163. 11 necessary in the same way as in a revocation of an offer; nevertheless some authors60 think that an exception could be when the addressee has not yet acted on reliance on it and, in particular, has not yet acquired knowledge of the first revocation; the party making the revocation bears the burden of proof. article 16(1) cisg provides that revocation is precluded by the dispatch of an acceptance, that is before the contract is concluded after an effective acceptance under article 18(2) cisg. consequently, a revocation after dispatch of an acceptance is ineffective even though the contract is not concluded until the acceptance reaches the offeror; there is a state of suspense until the acceptance reaches him61. termination of the right to revoke upon the dispatch of an acceptance is not a mandatory rule, consequently the offeror can extend this time. the offeree bears the burden of proving that his acceptance was sent before the arrival of the revocation and on the other hand, the offeror must prove the time at which the revocation reached the offeree62. 3.2. offers indicated to be irrevocable the offeror can make his offer irrevocable if his offer indicates that fact. this result reflects the approach of various civil law system without the need, stated in common law, for ‘consideration’63 (e.g., an act of counter performance or a counter obligation) or the observance of particular forms (as in § 2-205 ucc) and without a time period being prescribed during which the offeror is bound by his offer (as in the same § 2-205 ucc). an intention to be bound can be expressed by unambiguous wording (‘firm offer’ or ‘will be opened’) or words understood in the particular trade to express an intention to be bound interpreted under rules stated in article 8 cisg. the significance of stating a fixed time was a matter of dispute at the vienna conference because of the different views common law and civil law countries have on the argument of fixing a period for acceptance. while the drafts and relevant proposals in vienna always intended that, irrespective of the offeror’s intention to be bound, the stating of a fixed time for acceptance should mean that the offer was irrevocable until that time, the opposite view ultimately prevailed and the setting of a fixed time was only one factor indicating the intention to be bound and the words should be understood as setting a time limit beyond which the acceptance would be too late. even after that formulation had been adopted, some delegations in vienna still took the view that fixing a time for acceptance by itself indicated irrevocability. it is not easy to assess the outcome of this dispute, which may well appear to be a tempest in a teapot64; both decisions, however, should be accommodated by concluding that the fixing of a period for acceptance should be a presumption of an intention to be bound for that period, but the presumption can be rebutted by showing that the offer in its full setting was only intended to indicate that the offer would lapse after that time rather than a promise not to revoke65. nordic journal of commercial law issue 2006 #1 66 honnold, supra note 7, at 164. 67 bianca /bonell, supra note 16, art. 16 note 2.2.2. 68 schlechtriem, supra note 4, at 122. 69 honnold, supra note 7, at 168. 70 england dickinson v. dodds, (1875-76) l.r. 2ch. d. 463. 71 england byrne v. van tien hoven, (1879-80) l.r. 5 c.p.d. 344. 72 kötz, supra note 2, at 22. 73 zweigert/kötz, an introduction to comparative law, oxford, 1992, at 383. 12 3.3. reliance on the offer and responsibility article 16(2) cisg expresses the principle that a person should not act in a contradictory manner otherwise it causes the offeror to be bound by the reliance which he has induced66. two conditions must be satisfied: there must be reliance, justified in the particular case (i.e., it must be ‘reasonable’) and there must be an act by the party relying on the offer. an act performed in reliance on the binding nature of the offer may be indicated by commencing production, acquiring materials or concluding contracts for those purposes67, or under certain circumstances by taking on employees, provided always that such conduct was the result of ‘reasonable’ reliance, in the offeree’s own particular situation; moreover act means not only a positive act, but also a failure to act. moreover, in geneva pharmaceuticals technology corp. v. barr laboratories, inc., et al. the us district court of new york held that article 16(2) cisg does not expressly require neither that the offeree’s reliance must have been foreseeable to the offeror nor detrimental. where revocation is precluded, the legal consequence is that the offeror is bound by his offer and the offeree therefore has an opportunity to accept and create a contract. the cisg leaves no room for remedies under domestic law, consequently claims for damages under domestic law arising in culpa in contrahendo or on the basis of the general law of tort or delict must be excluded68. however, some authors think that since the convention provides one remedy for wrongful revocation (namely the offeree can accept the offer in spite of revocation), when special circumstances make this remedy ineffective to the damages caused by a wrongful revocation, it would be reasonable for a tribunal to close the gap by domestic law under article 7(2) cisg69. 3.4. a comparative analysis in english law revocation is in principle permitted: an offer may be revoked at any time until it has been accepted even if the offeror undertook to keep it open for a given period of time; in dickinson v. dodds70 the court said that the effect of stating a limit of time is to ensure that the offer lapses at the end of it, not that it may be not be revoked earlier and in byrne v. van tien hoven71 that “ there is no doubt that an offer can be withdrawn before acceptance, and it is immaterial whether the offer is expressed to be open for acceptance for a given time or not” . the reason why the common law imposes no obligation on the offeror is to be found in the doctrine of consideration, whereby in the absence of a formal deed or of an ‘option’, a promisor is only bound if the other party has rendered or promised a counterperformance72. offers are normally made without any counterperformance by the addressee and they are hardly ever clothed in solemn form, so normally the offeror is not bound by the offer73. even english commentators find unsatisfactory that the offeror’s stated intention to keep the offer opened for a specific period does not bind him unless he has received ‘consideration’ because the revocation of the offer within the nordic journal of commercial law issue 2006 #1 74 england routledge v. grant, (1828), 4 bing 653. 75 united statesnormile v. miller, 313 n.c. 98, 103, 326 s.e.2d 11, n.c., 27 february 1985. 76 restatement second of contracts § 42. 77 restatement second of contracts § 37. 78 restatement second of contracts § 87. 79 france cour de cassation, 10 march 1968. 80 france court of appeal, colmar, 4 february 1936. 13 period allowed for acceptance may lead to inequitable results if the offeree has incurred expenditure in reliance on the promise, as in routledge v. grant74 . english law does consider the interest of the offeree, like cisg, on the contrary, also if a really ‘light’ disposition, in the ‘mail box’ rule, whereby acceptance by letter or telegram, so the time limit to revoke, takes effect when offeree dispatched the acceptance by post rather than when it reaches the offeror. the uniform commercial code in § 2-205 provides that an offeror may withdraw or revoke the offer at any time prior to the offeree’ s acceptance; a north carolina court states in normile v. miller75 that “ it’s a fundamental tenet of the common law that an offer is generally freely revocable and can be countermanded by the offeror at any time before it has been accepted by the offeree” and that “ generally, notice of the offeror’s revocation must be communicated to the offeree to effectively terminate the offeree’s power to accept the offer. it is enough that the offeree receives reliable information, even indirectly that the offeror had taken definite action inconsistent with an intention to make the contract” . the code, also consistent with general principles of common law contracts, restricts the revocability of offers76 by an option contract77 supported by consideration or by detrimental reliance78. the ucc, nevertheless, unlike the common law principle, in the same § 2-205 states that an offer is not revocable if a ‘firm’ or irrevocable offer was made. ucc defines a ‘firm offer’ as “ an offer by a merchant to buy or sell goods in a signed writing which by its terms gives assurance that it will be held open and that it is not revocable, for lack of consideration, during the time stated or if no time is stated for a reasonable time, but in no event may such period of irrevocability exceed the three months” . so, in ucc there is no definition of an offer and the common law definition applies but it states the concept of ‘firm offer’ as a dispensation to the general common law rule and specify a maximum length of period for the irrevocability which consist in a reasonable time of three months. in french law, an offer has rather more binding force and although courts state that notwithstanding an offer may be withdrawn at any time until it has been accepted by the offeree, revocation may be treated as illegitimate and as a faute leading to liability under art. 1382 code civil if it is abusive and frustrates the offeree’s justified expectations when the offeror revokes his offer before the expiry of any time he himself fixed for acceptance79 or, if no time was specified, he revokes it before a délai raisonnable inferable from the surrounding circumstances or trade usage. the court of appeal of colmar80 held that an offer is binding if it follows an express or silent agreement but indiscutible because it was formulated to be irrevocable for a certain period of time. italian law follows the same principle stating in article 1329 codice civile that an offer can be revoked at any time before acceptance but the offeree has a claim for damages for the loss caused to him by the withdrawal of the offer if, as art. 1328 codice civile states, “ with no knowledge of the withdrawal of the offer he in good faith started to perform the contract” . both in italian and in french law, the quantity of claimed damages depends not only on the harm suffered by the offeree in reliance on the offer remaining open but also to the harm because he is nordic journal of commercial law issue 2006 #1 81 § 130 and § 145 bgb; art. 3 and 5 swiss law of obligations; § 862 abgb; art. 185 greek civil code; art. 230 portuguese civil code. 82 germany bundesgerichtshof, 8 march 1984. 83 honnold, supra note 7, at 162. 84 bianca/bonell, supra note 16, art. 16, note 2.2.1. 85 schlechtriem, supra note 4, at 122. 86 schlechtriem, supra note 4, at 124. 14 not in the position he would have enjoyed if the contract had come into being; these losses are named by italian courts as lucro cessante, that is the party’s harm deriving indirectly from the failure of the contract and danno emergente, which is what the party suffered directly from the illegal revocation of the offer. the greatest effect to the offer is given in german, swiss and austrian law. as soon as the offer reaches the offeree the offer is bound and revocation is impossible and ineffectual until the expiry of any period fixed in the offer or, if no period is fixed, then a reasonable period81. this binding effect can be excluded if the offeror describes his offer as freibleibend or not binding; with that formula the offeror is allowed to revoke even after acceptance has reached him and the contract formed. moreover, the court hold that this ‘not binding offer’ is not in law an offer at all, but only an invitation to treat82. what if offeror and offeree are from countries with two different legal systems? article 16(2) cisg is a rule of interpretation and supplements article 8 cisg in that respect83. where the parties are from civil law countries, it will be possible to assume that the offeror intended his offer to have a binding effect (article 8(1) cisg) and that the offeree understood it as such. on the other hand, where the parties are from common law countries, article 8(2) cisg, in conjunction with article 16(2) cisg, will by themselves not always indicate that the offeror intended to be bound for that period unless other indications to that effect84. however, an offeror from a common law country making an offer to an offeree of a civil law country may find himself bound for the period he has indicated, even though he did not intend his offer to have such effect, because of the rule in article 16(2) cisg in conjunction with article 8(2), the latter requiring regard to the recipient’s understanding who, however, is not blindly advised to assume that fixing a period for acceptance in itself indicates that the offeror has bound himself for that period85. 4. rejection reaching the offeror article 17 cisg provides that an offer is terminated when the offeree’s rejection reaches the offeror even if the offer is irrevocable; the rejection has that effect even if it is rejected during a period fixed for acceptance which has not yet expired. the procedure for concluding a contract can then be initiated only by making a new offer. rejection can be declared expressly or implicitly but in any case it must reach the offeror. moreover, an offer to buy goods is not rejected by the sale of those goods by the offeree to a third party86. as inferred indirectly from article 22 cisg in conjunction with article 7(2) cisg, an offer may be rejected even after the dispatch of an acceptance if the rejection reaches the offeror before or at the same time as the acceptance. nordic journal of commercial law issue 2006 #1 87 id. 88 § 146 bgb; art. 187 greek civil code; § 5 swedish contract law. 89 restatement second of contract § 38. 90 schlechtriem, supra note 4, at 126. 91 bianca/bonell, supra note 16, art. 18 note 2.1. 92 id. 15 the cisg does not state whether death, loss of full legal capacity, institution of insolvency proceedings or similar proceedings affecting a party’s powers cause an existing offer to be terminated; the effects of such events, therefore, are governed by domestic law87. 4.1. comparative analysis civil law countries adopt the same approach, therefore if an offer is rejected by the offeree, it expires then, and this is true even if the time fixed for acceptance is still running88. also the common law approach leads to the same result found in the convention and “ an offeree’s power of acceptance is terminated by his rejection of the offer, unless the offeror has manifested a contrary intention” 89. similarly to the cisg, the ucc provides that once an offeree has rejected an offer, the offer terminates; cisg and ucc, however, differ in what constitutes a rejection; unlike the convention, the ucc § 2-207 does not treat an acceptance which modifies an original offer with additional or different terms as a rejected offer but, on the contrary, it allows an acceptance that states additional or different terms from the offer to be validly enforceable. 5. the acceptance article 18(1) cisg defines an acceptance as “ a statement made by or other conduct of the offeree indicating assent to the offer is an acceptance. silence or inactivity does not in itself amount to acceptance” . the statement of acceptance must express assent to the offer and to its terms and it does not have to adopt any specific wording; the acceptor, in fact, may restrict himself to a simple indication of assent or repeat the offer in whole or in part90. mere confirmation of receipt of the offer, an expression of thanks for the offer, or an indication of interest does not express an intention to accept it91. acceptance may in principle be indicated using any method of communication and the acceptor is not obliged to use the same means as the offeror; a written offer may be accepted orally, by telex or by any other mean of communication unless the offeror has prescribed a particular means of indicating acceptance92. article 18(1) cisg, first sentence, also permits acceptance by ‘other conduct’ and except in so far as article 18(3) applies, the declaration indicated by the conduct expressing acceptance must, in principle, reach the offeror because article 18(2) cisg, providing that the ‘indication of assent’ becomes effective only when it reaches the offeror, makes it clear for both forms of assent indicated in article 18(1) cisg. examples of such declaratory conduct are the dispatch of the goods, even partial deliveries (in germany courts held that the dispatch of the goods by the nordic journal of commercial law issue 2006 #1 93 germany oberlandesgericht frankfurt am main, 23 may 1995, num. 5 u 209/94, translated text available online at <http://cisgw3.law.pace.edu/cases/950523g1.html>. 94 germany oberlandesgericht stuttgart, 5. zivilsenat, 28 february 2000, num. 5 u 118/99, translated text available online at <http://cisgw3.law.pace.edu/cases/000228g1.html>. 95 switzerland handelsgericht des kantons zürich, 10 july 1996, num. hg 940513, translated text available online at <http://cisgw3.law.pace.edu/cases/960710s1.html> 96 id. note 2.2 97 united states magellan international corporation v. salzgitter handel gmbh,(1999), 76 f.supp. 2d 919, n. d. ill., 7 december 1999, available online at <http://cisgw3.law.pace.edu/cases/991207u1.html>. 98 germany oberlandesgericht saarbrücken, 13 january 1993, num. 1 u 69/92, at www.unilex.info 99 schlechtriem, supra note 4, at 130. 100 bianca/bonell, supra note 16, art. 18 note 2.3. 1 0 1 g e r m a n y o b e r l a n d e s g e r i c h t f r a n k f u r t a m m a i n , 5 j u l y 1 9 9 5 , t r a n s l a t e d t e x t a v a i l a b l e o n l i n e a t <http://cisgw3.law.pace.edu/cases/950705g1.html>. 102 france cour d'appel de grenoble, sté calzados magnanni v. sarl shoes general international s.g.i., 21 october 1999, num. 96j/00101, translated text available online at <http://cisgw3.law.pace.edu/cases/991021f1.html>. 103 argentina cámara nacional en lo comercial, sala e, inta s.a. v. mcs officina meccanica s.p.a, 14 october 1993, num. 45626, available online at <http://cisgw3.law.pace.edu/cases/931014a1.html>. 16 seller93 and buyer’s taking delivery of the goods94 constitute acceptance but in the latter situation, a swiss court held that “ the buyer’s taking delivery through a third party could not be considered as a conduct indicating assent to the modified acceptance in absence of a particular usage or practice established between the parties” 95), packaging the goods for dispatch to the buyer or in accordance with his offer, acceptance or processing of the goods, payment, preparation for performance by concluding a cover transaction or by commencing production96. moreover, also opening a letter of credit for the purchase price as the district court of illinois held in magellan international corporation v. salzgitter handel gmbh97 and a letter of confirmation sent by the seller after buyer’s taking delivery of the goods98 constitute an implied acceptance. article 18(1) cisg indicates also that silence or inactivity can in principle also express an intention to accept and there is no question of its reaching the addressee. however the wording of the provision ‘in itself’ clearly shows that there must be additional factors associated with the silence or inactivity to indicate assent99. the possibility that silence may indicate assent does not mean that an offeror can insert a term to that effect in the offer as a way of binding the offeree if he fails to reply to the offer100. these other circumstances, which should be associated with silence or inactivity, could above all be the existence of an agreed usage and a usage deemed to be agreed by virtue of article 9 (2) cisg. nevertheless, a court in germany held that the usage must be international and the german usage to conclude a contract through a letter of confirmation ('kaufmännisches bestätigungsschreiben') is not international, since it was recognized only at the receiver's place of business (germany), while in france, such a usage was not habitual” 101. other circumstances can be practices established between the parties by virtue of article 8 (3) cisg as the court of appeal of grenoble held in sté calzados magnanni v. sarl shoes general international s.g.i., in which acceptance of the seller was not required accordingly to the practices previously established between the parties.102 moreover, in filanto s.p.a. v. chilewich international corp, a u.s. federal district court held that in view of the extensive previous transactions between the parties the offeree ought to have objected the arbitration clause in the offer and his silence and certain other indications showed the seller’s intention to be bound by the terms of the offer. another circumstance, as an argentinean court held, could be the buyer’s countersigning of the invoice forms and the consequently sending to a finance institution103. http://cisgw3.law.pace.edu/cases/950523g1.html http://cisgw3.law.pace.edu/cases/000228g1.html http://cisgw3.law.pace.edu/cases/960710s1.html http://cisgw3.law.pace.edu/cases/991207u1.html http://www.unilex.info http://cisgw3.law.pace.edu/cases/950705g1.html http://cisgw3.law.pace.edu/cases/991021f1.html http://cisgw3.law.pace.edu/cases/931014a1.html nordic journal of commercial law issue 2006 #1 104 united states chateau des charmes wines ltd. v. sabaté usa inc., sabaté s.a., 328 f. 3d 528, 9th cir. (cal.), 5 may 2003, available online at <http://cisgw3.law.pace.edu/cases/030505u1.html>. 105 honnold, supra note 7, at 175. 106 schlechtriem, supra note 4, at 132. 107 bianca/bonell, supra note 16, art. 18, note 2.7. 108 id. 109 icc international court of arbitration – paris, 1994, num. 7844/1994, at www.unilex.info 110 schlechtriem, supra note 4, at 133 111 id. 112 schlechtriem, supra note 4, at 133. 113 id. in the author’s opinion, telephone is also an oral communication together with other electronic methods of communication equivalent to the telephone if they permit spoken declarations to be transmitted in a comprehensible form and a reply to be received by the same means. communication via telex or by e-mail cannot be treated as ‘oral’ even though they render direct dialogue possible. 114 id. 17 5.1. time limits for acceptance under article 18(2) cisg, first sentence, an indication of assent becomes effective when it reaches the offeror both in case of an oral declaration of acceptance, as a u.s. court held in chateau des charmes wines ltd. v. sabaté usa inc., sabaté s.a.104, and in case of an implicit indication of assent, therefore putting the risk of transmission on the offeree105. a declaration by implicit conduct does presuppose that such a declaration is capable of ‘reaching’ the offeror, otherwise (e.g., where the goods sent with the offer are consumed by the offeree) the contract can be only concluded under article 18(3) cisg106. acts of acceptance which make it possible for the assent thereby indicated to ‘reach’ the offeror (e.g., the dispatch of the goods) may be accompanied by communication and if the latter reaches the offeror before the assent indicated by dispatch of the goods, it probably causes the conclusion of the contract107. even a communication by a third party (e.g., by a bank involved in the payment process or a carrier), is said to result in the assent indicated by the initiation of the payment procedures or by the dispatch of the goods ‘reaching’ the offeror108. if the offeror has fixed a time, then the acceptance must reach him within the time fixed, in so far as no other significance is to be attributed to that time, as the icc court of arbitration in paris held in 1994109; if no time has been fixed, or none that can be established by interpretation110, then a ‘reasonable time’ applies as stated by article 18(2) cisg. a reasonable time is made up of three elements: the time taken by the offer to reach the offeree, the time required for the acceptance to reach the offeror, and a period for consideration111. first of all, the time required for offer and acceptance to reach their respective addressees depends on the means of communication employed by the offeror (article 18(2) cisg, second sentence); the consideration, on the other hand, is to be established taking into account the extent, subject-matter, and the nature of the transaction offered, such as the existence of fluctuating market prices, the stability or perishability of the goods, the need to obtain information, to negotiate with suppliers, sub-contractors or finance institutions and the purpose of the purchase112. in case of an oral offer, which is a declaration encompassing first of all words spoken inter praesentes113, if the latter indicates a period for its acceptance, the offer must be accepted within that period but if the offer does not fix such a period, then article 18(2) cisg, third sentence, states that it must be accepted immediately unless the circumstances, such as the negotiations of the parties or the necessity for the offeree to obtain information or consent, indicate otherwise114. http://cisgw3.law.pace.edu/cases/030505u1.html http://www.unilex.info nordic journal of commercial law issue 2006 #1 115 id. 116 honnold, supra note 7, at 178; on the contrary, see schlechtriem, supra note 4, at 136. 117 id. 118 § 130 bgb; art. 167, 192 greek civil code, § 2, 3 swedish contract law; art. 1335 italian civil code. 119 kötz, supra note 2, at 24. 120 france cour de cassation, 2 march 1962. 121 france cour de cassation, 2 may 1870. 122 france cour de cassation, 21 june 1983. 123 france cour de cassation, 21 may 1951. 18 article 18(3) cisg permits also an effective indication of assent to be made without the need for it to reach the offeror and to be effective ‘at the moment the act is performed’, indicating that act as, for example, one relating the dispatch of goods or the payment of the price. there is a dispute, however, whether an indication of assent which does not need to reach the offeror under article 18(3) cisg refers only to acts equivalent to acceptance or includes also written declarations; the latter view is objected on the basis that it would place the risk of the loss of the declaration of acceptance on the offeror, if the declaration had been dispatched on time but was late to reach him. moreover, the word ‘act’ used and the examples given in article 18(3) cisg (dispatch of goods or payment of the price) are intended to be the only permitted cases of acceptance without notice to the offeror115. according to some authors116, however, in some cases a contract is not formed under article 18(3) cisg. in particular, if the communication does not reach the offeror and the offeror states a time within which the act should be performed, if the act (e.g., the arrival of the goods to the offeror) reaches the offeror after the time stated in the contract, the contract is not concluded because the acceptance did not arrive on time; not the beginning of the act (e.g., the dispatch of the goods by the offeree) but the moment in which the act (arrival of the goods) reaches the offeror is important in such circumstances. as a consequence of article 6 cisg, parties are entitled to derogate from the rules on the contracting procedures and thus from the principle that a declaration must reach the addressee. an indication of assent which does not reach the offeror is possible and effective where the offeror has framed his offer in order to permit it. silence or inactivity is to indicate acceptance if the parties exceptionally agree that, then silence after the offer has reached the offeree creates a contract, except in so far as the offeree indicates otherwise. also practices between the parties, established through lengthy business relations, will often show not only that a particular conduct indicates acceptance but also that the need for the assent so expressed to reach the offeror is waived117. 5.2. a comparative analysis most civil legal systems118, like article 18(2) cisg, hold that an acceptance, like an offer, becomes effective when it reaches the offeror, that is, when it enters his zone of control and he is informed of it119. in france, acceptance must be of the offer as a whole, so that reservations or modifications of the terms of the offer constitute a counter-offer120. like the cisg, silence does not generally constitute acceptance121 and the latter may be implicit, as where the terms of the offer are fulfilled122, or there is a continuing business tradition between the parties and also trade usages may indicate acceptance despite the absence of any response to an offer123. a problem much discussed concerns nordic journal of commercial law issue 2006 #1 124 france com. 7 january 1981, bull. cass. 1981 iv no. 11. 125 ghestin, traité de droit civil, la formation du contract, paris, 1993, at 353. 126 spain tribunal supremo, 13 february 1978. 127 reastatement second of contracts § 63. 128 e.g., l-112-2 of the french code des assurances and § 362 of the german commercial code. 19 the place of formation of the contract rather than the time of it. in fact, some decisions of the cour de cassation turn the issue to the dispatch of acceptance (théorie de l’ expedition) while others base it onto its arrival (théorie de la reception). a decision of the court de cassation124 states, on the question of an acceptance dispatched in time but arriving late, that, unless otherwise specified by the offeror, it is enough that the acceptance is dispatched in time and that a contract is formed even though the contract is late in reaching the offeror or has been lost by the post not reaching him at all. writers recognize, however, that the solution does not refer to an abstract analysis but it depends on the contrasting concrete interests125. in the same way, italian law states that acceptance must reach the offeror within the time he has specified, or otherwise within a reasonable time. article 1329 codice civile rules that if the offeror promises to keep his offer open for a certain period of time, his offer is irrevocable once it comes to the other’s notice. moreover, in article 1333 codice civile, an offer in the form of an option, that is a promise binding the offeror but which the offeree may accept or refuse at his discretion, is likewise irrevocable for the period stated or determined as reasonable by the courts. in spain, acceptance must be clear and unequivocal, and directed to the offeror. it may be express or implied and acceptance can also be inferred from silence126 but must show the intention to complete the proposed contract; but, while in ordinary ‘civil’ contracts the latter is concluded when acceptance comes to the notice of the offeror, as stated in article 1262 of the spanish civil code, article 54 of the commercial code rules that a commercial contract by exchange of letters is complete when the acceptance has been posted. in common law, unlike civil law and the cisg, the ‘mail box’ rule is applied; ‘unless the offer provides otherwise, an acceptance made in a manner and by a medium invited by an offer is operative and completes the manifestation of mutual assent as soon as put out of the offeree’s possession, without regard to whether it ever reaches the offeror’127. although the ucc does not specify the ‘mail box’ rule, under ucc § 1-103 principles of common law contracts are applied if they are not supplanted or superseded by code language. parallel to article 18 cisg, ucc § 2-206 permits acceptance by actions where appropriate, providing that unless unambiguously indicated by the language or circumstances, acceptance is permitted ‘in any reasonable manner and by any medium reasonable under the circumstances’ and taking, consequently, like cisg, a flexible approach in the offeree’s mode of acceptance. ucc, moreover, recognizing under § 2-204 any manner of expression of agreement, oral, written or otherwise, as sufficient to establish it, states that acceptance of an offer may be inferred from the offeree’s conduct. ucc § 2-206, like the cisg, provides that a promise to ship or actual shipment constitutes acceptance; however, ucc, unlike the cisg, requires that an unambiguous act of acceptance must be communicated to the offeror within a reasonable time, recognizing, consequently, the beginning of a performance as effective acceptance but only if the offeree gives notice of acceptance within a reasonable time like in the convention and in civil law, also common law countries have the general principle that mere silence does not by itself amount to acceptance to an offer, even if the offeror was bold enough to state in his offer that it is to do so except in some circumstances prescribed by statute128. nordic journal of commercial law issue 2006 #1 129 schlechtriem, supra note 4, at 139. 130 id. 131 bianca/bonell, supra note 16, art. 19, note 2.8. 132 id. 133 schlechtriem, supra note 4, at 140; honnold, supra note 7, at 187. 134 schlechtriem, supra note 4, at 141. 20 6. qualified acceptance article 19(1) cisg states the traditional and widely accepted ‘mirror image’ rule; that is, a reply which purports to accept an offer but which contains modifications ‘is a rejection of the offer and constitutes a counter-offer’. an exception is given in article 19(2) which states that ‘additional or different terms which do not materially alter the terms of the offer constitutes an acceptance unless the offeror, without undue delay, objects orally to the discrepancy or dispatches a notice to that effect’. 6.1. material alterations material alterations are changes to terms of an offer which affect the significance of the offer under article 8 cisg129. if there are discrepancies in the wording (as can occur in international transactions owing to inaccurate translation, insufficient command of a foreign language or even typing or transmission errors) some authors130 think that if the parties agree in substance, then there are no different terms within the meaning of article 19 cisg. others131 assume, on the other hand, that mere differences in the words used or grammatical or typographical changes are different terms, even though not material under article 19 cisg. article 19(1) cisg also applies if the acceptance contains ‘additions’, that is, matters to which the offer does not refer and the same rule is applied when usage lead to an addition to the offer (e.g., arbitration clauses), so that any addition by the acceptor does not in fact amount to a different term132. it is not easy to distinguish between immaterial and material obligations but the list recited in article 19(3) cisg lays down a clear line between them for the majority of contractual clauses: additional or different terms relating, among other things, to the price, payment, quality and quantity of the goods (e.g., a reduction in quantity), place and time of delivery (e.g., a change in time of delivery), extent of one party’s liability to the other, settlement of disputes (e.g., a demand for arbitration clauses or jurisdiction clauses) are considered material alteration to the terms of the offer. nevertheless, that does not rule out the possibility that even changes to those matters in the declaration of acceptance may be considered immaterial on account of the particu lar circumstances of the case, the practices of the parties, preliminary negotiations or usage, or the irrebuttable presumption that the parties want to intend the material matters listed under article 19(3) cisg as immaterial133. changes made to the advantage of the offeror should not require acceptance by him and should all be capable of forming part of the contract134. in the opinion of an austrian court, in fact, “ a modification concerning the elements listed in art.19(3) cisg is to be considered material only if the circumstances of the case, the practices which the parties had established between nordic journal of commercial law issue 2006 #1 135 austria oberster gerichtshof, 20 march 1997, num. 2 ob 58/97m, at www.unilex.info. 1 3 6 germany landgericht baden-baden, 14 august 1991, num. 4 o 113 /9 0, tr an sla ted text a va il ab le online at <http://cisgw3.law.pace.edu/cases/910514g1.html>. 1 3 7 g e r m an y bundesgeri ch tsh of, 9 ja nua ry 20 02 , num. vi i i z r 3 0 4 / 0 0 , t r a n s l a t ed t e x t a va i l a b l e o n l i ne a t <http://cisgw3.law.pace.edu/cases/020109g1.html>. 1 3 8 germany oberlandesgericht koblenz, 4 october 2002, num. 8 u 1909/01, translated text available online at <http://cisgw3.law.pace.edu/cases/011004g1.html>. 139 hungary metropolitan court of budapest, in malev hungarian airlines v. united technologies international inc. pratt & whitney com mercia l eng in e b us in es s , 1 0 j a nu ar y 1 9 9 2 , n um . 3 . g .5 0 . 2 8 9 /1 9 9 1 / 3 2 , t ranslated text available at <http://cisgw3.law.pace.edu/cases/920110h1.html>. 140schlechtriem, supra note 4, at 143. 141 bianca/bonell, supra note 16, art. 19, note 3.2. 21 themselves, the negotiations or the usages do not indicate otherwise. in particular, a modification of the offer concerning the quantity of the goods which is exclusively favorable to the offeror would have to be considered non material. given that the offeror did not object, the contract should be validly concluded as it results from the modified acceptance” 135. a material alteration to the terms of the offer is considered to constitute a rejection of the offer and, as a consequence of article 17, the rejection terminates the offer and the ineffective acceptance takes effect as a counter-offer to which articles 14 to 17 cisg apply. 6.2. immaterial terms immaterial terms are changes which do not affect the agreement in substance. these terms can be established a contrario from article 19(3) cisg and an acceptance with such terms, unless the offeror objects, leads to the conclusion of the contract with the different or additional terms as part of it. it is possible to find same examples of immaterial modification in the decisions of the courts; a german court held that “ a term contained in the acceptance indicating that notice of defects must be given within 30 days after the date of invoice could not be considered a material modification of the terms of the offer in accordance with article 19(2) cisg” 136. moreover the partial conflict of the parties' standard terms could not lead to a failure of the entire contract, since the parties, in performing the contract, had shown that such a conflict was not to be considered a material modification of their agreement137. another court, also in germany, held that also a change in transportation costs is not a material alteration of the contract, so that even if the buyer’s order contains a “ frei baustelle” , that is free carrier named place, in response to a seller’s condition of the clause “ transport costs 9 dm per km” , the contract is concluded138. finally, it has also been held that the introduction of a mere request to treat the letter confidentially added by the buyer does not amount to a material modification of the offer and it is therefore to be considered as part of the agreement in accordance with article 19(2) cisg139. however, by objecting to the discrepancy, the offeror can prevent the conclusion of the contract a quo but the objection must be made without undue delay and the offeree must bear the risk of the loss or late arrival of the offeror’s objection and the risk of incurring obligations as a result of is reliance on the effective conclusion of a contract, because he created the anomaly which caused the risk140. the objection can be both oral and by other means but the words ‘with undue delay’ apply to both because it would be strange, if the condition would apply just to an oral objection, since the offeror could gain time by making a non-oral objection and so leave the contract in a suspended state141. http://www.unilex.info. http://cisgw3.law.pace.edu/cases/910514g1.html http://cisgw3.law.pace.edu/cases/020109g1.html http://cisgw3.law.pace.edu/cases/011004g1.html http://cisgw3.law.pace.edu/cases/920110h1.html nordic journal of commercial law issue 2006 #1 142 schlechtriem, supra note 4, at 145. 143 sclechtriem, supra note 4, at 145; kötz, supra note 2, at 32. 144 honnold, supra note 7, at 191. 145 schlechtriem, supra note 4, at 144. 146 honnold, supra note 7, at 192. 147 schlechtriem, supra note 4, at 144. 22 6.3. the battle of forms differences between a declaration of acceptance and an offer are nearly always the result of the incorporation of or attempts to incorporate standards terms of contract. there is usually a conflict simply as a result of a clause in each party’s terms which purports to make the incorporation of the party’s terms into the contract an essential part of his offer or acceptance and expressly to override the other party’s terms142. the cisg does not contain special rules on the ‘battle of forms’ but many solutions, based on article 19 cisg, are proposed. it is always clear in these cases from the parties’ conduct (e.g., the exchange of an offer and a purported acceptance, followed by shipment and acceptance of the goods) that the parties made a contract but what are the terms of the contract? in this situation an interpretation under the cisg which gives effect to the contract is very important because it prevents one party from using divergent standard terms as a mean of escaping from a transaction which has become disadvantageous for him. that possibility to escape under the ‘mirror image rule’ has always been the subject of criticism143. one approach seeks a way to choose between the terms of the two conflicting communications in the sense that one communication gives effect to the last form in the sequence on grounds that further performance indicates agreements to its term144. this is the so called ‘last shot rule’ which can be regarded as an expression of the assent to the counter-offer for the purpose of article 8(2) and article 18(1) and 18(3) cisg145. it could be especially troubling to place the risk of a modification on the one who received a reply that purported to be an acceptance when both parties proceed with performance in the face of its ambiguity; a solution could be found in article 8(2), which leads to the second approach: statements or conduct of one party ‘are to be interpreted according to the understanding that a reasonable person of the same kind as the other party would have had in the same circumstances’. consequently the general principle that doubt is to be resolved against the party who created the ambiguity, should be accepted. this approach also might discourage ambiguity by denying benefit to the party who created the ambiguity by sending an ambiguous acceptance146. both theories are strongly criticized as casuistic and unfair147. if it can be established, in fact, that the parties agree on the essentialia negotii of the contract, it can then be presumed that they have waived the application of their conflicting terms and, by virtue of the autonomy of the parties under article 6, have departed from the cisg procedure for the formation of a contract and from article 19 cisg. consequently the solution can be found in what it is called the “ knock out” rule. under this rule, the contract takes effect as one that nordic journal of commercial law issue 2006 #1 148 sclechtriem, supra note 4, at 145; honnold, supra note 7, at 192. in the same way art. 2.22 unidroit principles: ‘where both parties use standard terms and reach agreement except on those terms, a contract is concluded on the basis of the agreed terms and of any standard terms which are common in substance unless one party clearly indicates in advance, or later and without undue delay informs the other party that it does not intend to be bound by such a contract’. 1 4 9 g e r m a n y a m t s g e r i c h t k e h l , 6 o c t o b e r 1 9 9 5 , n u m . 3 c 9 2 5 / 9 3 , t r a n s l a t e d t e x t a v a i l a b l e o n l i n e a t <http://cisgw3.law.pace.edu/cases/951006g1.html>. 1 5 0 g e r ma n y bu nd es ge ri c h t sh o f , 9 j a nu a ry 2 0 0 2 , nu m . v i i i z r 3 0 4 /0 0, tra nsla ted tex t ava ila ble online at <http://cisgw3.law.pace.edu/cases/020109g1.html>. 151 § 150(2) bgb; art. 191 greek civil code; art. 1326 italian civil code;§ 6(1) swedish contract law; art. 233 portuguese civil code. 23 includes on the one hand the cisg rules at the place of the conflicting one and on the other hand any of the parties’ terms which they agree in their forms148. german courts follow the latter theory so that in a case149 between a german buyer and an italian seller who concluded a contract for a sale of fashion goods, in which their standard forms contained a different choice of the applicable law, the court held that the choice of law of the italian seller had not become part of the contract because the fact that the parties had started performance of the contract showed their intention to be bound by it and by the terms already agreed upon as well as by any standard terms which were common in substance, with the exclusion of the conflicting terms such as the choice of law clauses. consequently derogating from article 19 cisg, the contract was validly concluded, but neither was the choice of law clause in favor of german law contained in the buyer's standard terms deemed valid, as the buyer failed to give evidence that it had sent its general conditions of purchase in a language other than german, which was not the language of the contract. finally, court held that the law is to be determined in compliance with german private international law rules which referred to italian law. the latter “ knock out” rule was confirmed also by the german supreme court150, according to which conflicting standard terms simply do not become part of the contract; the evaluation of such a conflict must proceed, however, from a systematic interpretation of all the rules involved. in this case, in fact, a german seller and a dutch buyer entered into several contracts for the sale of powdered milk but there were two different clauses on seller’s liability for lack of conformity. in its decision, the supreme court of germany held, first of all, that assuming that the partial conflict of the parties' standard terms (battle of the forms) could not lead to a failure of the entire contract, since the parties, in performing the contract, had shown that such a conflict was not to be considered a material modification of their agreement (art. 19(1) and (3) cisg); then that the liability of the seller for lack of conformity was governed by the cisg. thus, both buyer’s and seller's standard terms were not applicable to the contract as far as non conformity was concerned. 6.4. a comparative analysis like the convention, civil law countries take the ‘mirror image rule’ in the sense that acceptance must express unqualified concurrence with the offer151. like the cisg, moreover, in these countries if the acceptance differs markedly from the offer and is therefore to be regarded as a counter-offer, a contract is formed only if this counter-offer is accepted in its turn. http://cisgw3.law.pace.edu/cases/951006g1.html http://cisgw3.law.pace.edu/cases/020109g1.html nordic journal of commercial law issue 2006 #1 152 italy corte di cassazione, 7 january 1993. 153 spain tribunal supremo, 14 march 1973. 154 france cour de cassation, 17 july 1967. 1 5 5 g erman y bund esger ic ht shof 2 6 septemb er 1973; oberlandesgericht cologne 19 march 1980; germany bundesgerichtshof 20 march 1985. 156 see united states princess cruises. inc v. general electric co. 157 united states princess cruises, inc. v. general electric co., 525 u.s. 982, u.s., 9 november 1998. 158 england butler v. ex-cell-o, (1979), 1. w.l.r. 401 ca. 24 concerning the ‘battle of forms’ in most of these countries the battle would be won by the party that fired the last shot, that is, the one who insisted on his own terms of business just before the other party started to perform. italian law, in article 1326 of the codice civile, on the battle of forms takes the strict view that if the parties do not expressly agree on exactly the same terms, there is no contract. thus, a purported acceptance which does not conform exactly with the offer is seen as a counter-offer, although it may involve only minor modification of the offer. mmoreover, the italian supreme court stated that the courts cannot make a contract for the parties out of whatever common ground may appear between them152. in the same way, the spanish supreme court held that a purported acceptance which in fact modifies the offer or makes it subject to a new condition is only a counter-offer153. french courts follow the principle that the judges infer the common intention of the parties on a case by case basis but if the forms cannot be reconciled, the relevant clause is deemed not agreed and the contract not formed as originally formed by the offeror154. a different solution in such a case, similar to the second approach we talk about, is given by art. 6:225(3) nbw (the new netherlands civil code) which provides that the conditions of the offeror take precedence unless expressly objected to in the acceptance, by what is called a ‘defense clause’. nevertheless, like the cisg, the best solution is given in germany whose courts have rejected the theory of the ‘last shot’ and hold that to the extent of any conflict between the parties’ general terms neither of them becomes part of the contract, the resulting gap being filled by dispositive law or by terms implied by law155. also the common law adopts the ‘mirror image rule’156, so a statement of acceptance is effective only if it is a mirror image of the offer and expresses unconditional assent to all of the terms and conditions imposed by the offeror as expressed by the second restatement § 59. consequently if an offeree responds to an offer by proposing terms other than those contained in the original offer, he makes a counter-offer. the last shot rule is a consequence of this principle so that if a party impliedly assented to that thereby accepted a counter-offer by conduct indicating lack of objection to it. in princess cruises, inc. v. general electric co157., the court held that ‘having concluded that general electric’s response should be viewed as a counter-offer under the mirror image rule, the court than goes on to hold that princess cruises accepted that counter-offer by conduct: by not objecting to its terms; by accepting the services performed by general electric; and by paying the price stated in general electric’s counter-offer’. also the english common law follows the mirror image rule, but the solution is not always so easy. in butler v. ex-cell-o158, lord denning explored this problem: “ in most cases where there is a battle of forms there is a contract as soon as the last of the forms is sent and received without objection being taken to it. the difficulty is to decide which form, or which part of which form, is nordic journal of commercial law issue 2006 #1 159 gabriel, supra note 42, at 61. 160 united states texas plastics, inc. v. roto lith, ltd. 356 u.s. 957, u.s. tex., 19 may 1958. 161 gabriel, contracts for the sale of goods: a comparison between domestic and international law, new york, 2004, at 82. 25 a term or condition of the contract.” in this case the sellers quoted a price to the buyers and on the back of the quotation were various provisions including a price variation clause and the statement that “ these terms shall prevail over any terms in the buyer’s order” . the buyers ordered the goods but in their terms there was no variation clause but a form requiring the seller to agree to their last terms. finally, the seller signed and returned the form, but sent with it a letter saying they were fulfilling the order in accordance with their original quotation. in this case the sellers fired the first shot and they made clear the contract was to be made on their terms alone; for this reason the trial judge thought the sellers should win because they had made the price variation clause the basis of all subsequent dealings. the court of appeal reversed his decision and apart from lord denning, who was concerned with the overall effect of the negotiations. his lordship thought the issue regarded just the decision of who made the offer and who accepted. in the case a quo, the sellers had offered but by returning the buyer’s form had seemed to accept the buyer’s counter-offer. the most important weakness of the ‘last in time’ principle is that it can obviously cause injustice because it would be too easy for one of the contracting parties to take advantage of the other by slipping in another clause at the very last stages in the negotiation and hoping it would not be noticed. under the original ucc § 2-207, unlike the mirror image rule and unlike the cisg, a varying response will not prevent contract formation where there is otherwise a demonstrated intent to deal159. ucc § 2-207(1) provides that an acceptance or confirmation that contains additional or different terms operates as a valid acceptance but three vital rules are to be respected. first, the offeror’s original terms may make it clear that any subsequent amendment is of no effect (thus reaching the opposite conclusion to that in butler case); second, if the new terms ‘materially alter’ (which unlike cisg, ucc does not define) those in the offer, that by itself ensures they are not binding; and third, the offeror’s express objection, within a reasonable time of receiving the new terms likewise nullifies them. ucc in § 2-207(2) operates to determine, where a valid acceptance exists, what the exact terms of the bargain are, providing the offeree a limited power to unilaterally alter the terms of an agreement or proposed bargain. in the latter case offeree’s responsive document constitutes the requisite ‘definite and seasonable expression of acceptance’ so that, if modifications are not material, the contract is concluded under his terms. the principle above incorporates the distinction between material terms which lead to the original contract condition, nullifying offeree’s different or additional terms, and the immaterial ones which, on the other hand, make the offeree’s terms prevail, following the so called ‘last shot rule’. these rules were changed by the court in the roto-lith160 case in which the original common law was applied so that the offeree’s modification of the terms of the contract, which, concerning warranties, should be considered as material, were seen as a counter-offer which the offeror accepted in his performance. a new solution to this problem is now given in the revision of the section 2-207 of the ucc in which it pays attention on the ambiguous conducts which cannot determine terms’ agreement. unlike the result under original § 2-207 the baseline for the terms will not be the offer. instead, terms that appear in the records of both parties will become part of the contract and the remaining gaps will be filled by terms supplied or incorporated under the code. in other words, only those terms which the parties actually agree upon will be part of the contract161. nordic journal of commercial law issue 2006 #1 162 gabriel, supra note 42, at 65. 163 see icc court of arbitration – paris, num. 7844/1994, at www.unilex.info. 164 schlesinger, supra note 14, at 1563. 165 schlechtriem, supra note 4, at 151. 166 bianca/bonell, supra note 16, art. 21, note 2.2. 26 7. interpretation of offeror’s time limit for acceptance article 20 cisg sets the offeror’s time limit for acceptance providing under article 20(1) that any time provision in an offer begins to run from the date internal to the offer (the date of the letter or postmark), not from the date of the offer’s effectiveness (when received by the offeree). article 20(2) specifies that holidays or other nonbusiness days will operate to extend the offer only if their occurrence precludes delivery of the acceptance to the offeror on the last day for acceptance. the extension exists only when delivery of the acceptance is to be made at the offeror’s place of business on an holiday or nonbusiness days. therefore the extension does not apply if delivery of the acceptance is to the offeror’s home162. the ucc does not address the issues raised in article 20. the common law of contracts provides that an offer that has fixed time of acceptance lapses upon the stated time if the offer has not been accepted in the stated time. however ucc, taking a more flexible approach to contract formation, recognizes that ‘an agreement sufficient to constitute a contract for sale may be found even though the moment of its making is undetermined’. 8. late acceptance article 21 cisg extends and elaborates the basic rule of article 18(2) cisg that an acceptance ‘is not effective if the indication of assent does not reach the offeror within the time he has fixed or, if no time is fixed, within a reasonable time’. it distinguishes between two reasons for lateness: late dispatch of acceptance (article 21(1) cisg) and discernible delay in transmission (article 21(2) cisg), in both cases allowing a contract to be formed by the late acceptance. article 21(1) cisg governs the case of late acceptance, which under article 18(2) cisg, second sentence, is invalid163, but if an offer has already lapsed owing to the expiry of a period for its acceptance, the parties’ substantive agreement should not found on the ‘logical impossibility’ of a valid acceptance of a lapsed offer164. the only point in issue is whether, if an offer has lapsed, an acceptance should be treated as a counter-offer or whether article 21(1) should be applied. a late acceptance can still give rise to a contract. nevertheless, a first precondition is that it reaches the offeror, a second is that the offeree must have intended his declaration to constitute an acceptance. otherwise, if he characterizes his answer as a counter-offer, then a contract arises only if the offeror accepts the counter-offer within a reasonable period165. if a contract is to be concluded despite a late acceptance, it is necessary for the offeror to inform the offeree without delay, that he is treating the acceptance as effective and his declaration, because it is a declaratory act, cures a late acceptance, even if his declaration is lost or arrives late166. the contract is not formed when the offeror gives notice of approval to the offeree, but retroactively at the time when the late declaration of acceptance reached the offeror; in the case of http://www.unilex.info. nordic journal of commercial law issue 2006 #1 167 schlecthriem, supra note 4, at 152. 168 bianca/bonell, supra note 16, art. 21, note 3.3. 169 honnold, supra note 7, at 196. 170 schlechtriem, supra note 4, at 153. 171 § 149 bgb; § 862a sent. 2 abgb; art. 5(3) swiss law of obligations; art. 190 greek civil code; art. 6:223(2) nbw. 172 schlechtriem, supra note 4, at 153. 27 conduct equivalent to acceptance (article 18(3) cisg), the contract is formed at the time when the conduct was performed. consequently, the fact that the arrival of a late acceptance has led to the conclusion of an effective contract also means that it is then no longer possible for the offeree to withdraw his declaration of acceptance167. some authors consider that this unduly favours the offeror, since he can, by making a declaration of approval, nullify a declaration of withdrawal received after a late acceptance168. other authors would allow withdrawal to be made up until dispatch of the offeror’s declaration of approval169. moreover, article 21(1) cisg is dispositive so as a result of the parties’ agreement or, exceptionally, relevant usages, silence may indicate approval of a late acceptance on the understanding that the late acceptor cannot validly include in his acceptance a term stipulating that the offeror’s silence will automatically be deemed to indicate approval. the offeree can also set conditions for the necessary approval or make it easier for the offeror to give his approval170. article 21(2) cisg is based on the principle that the offeree’s chances of concluding a contract should not be impaired by a failure in the transmission system; if transmission had been normal the acceptance would have been on time and a contract concluded. on the one hand, the offeree relies on the conclusion of a contract and that reliance is protected. on the other hand, the offeror, who, after the expiry of the period for acceptance, no longer has to consider the possibility of an acceptance, is protected by the right to object to the delayed acceptance and thereby prevent the conclusion of a contract. if the offeror wishes to prevent the conclusion of a contract, he must protest ‘without delay’ by dispatching a written notice or orally informing the acceptor. also article 21(2) cisg is dispositive and could be derogated by parties’ will. 8.1. a comparative analysis both in civil and in common law we can find a similar approach. nevertheless, a different solution is given in some cases by german law imposing a duty for the offeror to inform the offeree. where the acceptance must arrive within a reasonable period (because no exact period has been fixed by the offeror) and the offeree might not know exactly how long that period was, where the delay was slight, and where the offeree could not know that the offeror’s position was going to change when the period expired171. 9. withdrawal of acceptance article 22 states that an acceptance may be withdrawn only before or at the same time as it would have become effective because once an acceptance is effective, under article 18 cisg, the contract is concluded and the parties are bound. as in article 15 cisg this rule is both theoretically and practically correct172. nordic journal of commercial law issue 2006 #1 173 id. 174 schlechtriem, supra note 4, at 159. 175 restatement second of contracts, § 63(a). 176 gabriel, supra note 161, at 87. 28 it is theoretically correct because to have a binding agreement there must be assent by both parties at the same time. since the act of acceptance (dispatch) may be at a different time than the effectiveness of the acceptance (receipt), it is simply assumed that the offeree still has the intent to be bound by the acceptance during the pending period between the act and the effectiveness of the acceptance. otherwise article 22 cisg provides a basis for the offeree to express this change of intent and thereby the true will of the parties173. the result is also practically correct because until the time the offeror received the acceptance, he has no basis for believing on the existence of the agreement and for acting in reliance of it. 9.1. a comparative analysis civil law countries have a similar approach to the cisg. on the contrary, in common law an acceptance is effective upon dispatch under restatement second of contracts § 63 which states: ‘unless the offer provides otherwise, an acceptance is operative and completes the manifestation of mutual assent as soon as put out of the offeree’s possession’. consequently, in common law there is no basis to withdraw an acceptance once made. 10. time of conclusion of contract article 23 cisg provides that a contract is concluded when the acceptance becomes effective. this rule is self-evident174, since the time when the contract is concluded in the case of the traditional procedure is already fixed by article 18(2) cisg, first sentence or by article 18(3) cisg which states that a contract comes into existence when acceptance or an indication of assent reaches the offeror or, exceptionally, upon performance of conduct amounting to acceptance. 10.1. a comparative analysis civil law countries have a similar approach to the cisg. under the ucc, on the contrary, which presupposes the application of common law principles, the acceptance becomes effective, and thereby as a consequence the contract is formed, as soon as the acceptance is put out of the offeree’s possession, without regard of whether it ever reaches the offeror, unless the offer provides otherwise175. however the ucc expands the formalities of common law contract formation, and also provides under § 2-204(2) that ‘an agreement sufficient to constitute a contract for sale may be found even though the moment of its making is undetermined’. consequently, under the ucc, if the parties are operating under the assumption of a contract, the existence of the agreement will be recognized although the evidence is unclear as to when and if the parties had a mutual time of assent176. nordic journal of commercial law issue 2006 #1 177 schlesinger, supra note 14, at 1584. 178 schlechtriem, supra note 4, at 99. 179 id. 180 zweigert/kötz, supra note 73, at 390. 181 id., at 388. 182 id. 183 id. 184 see england adams v. lindsell, (1818) 1 b. & ald. 681, 106 eng. rep. 250. 185 zweigert/kötz, supra note 73, at 390. 29 conclusion articles 14 to 24 of the cisg lay down contract formation rules which, following the traditional ideas common to all legal systems177, use ‘offer’ and ‘acceptance’ as the elements through which agreement between parties is created178. nevertheless, there are other forms of reaching agreement, where the ‘dissection’ of individual statements into ‘offer’ and ‘acceptance’ would constitute an arbitrary legal operation (e.g., agreement reached in point-by-point negotiations or by exchange of correspondence)179. two factors are the most discussed among the different legal systems concerning the formation of the contract: the binding concept of an offer and the moment in which the contract is concluded. regarding the first factor, the cisg does not adopt a clear solution of making an offer generally binding. starting from the principle that offers may be withdrawn, some exceptions are made in article 16(2) cisg, practically coming very close indeed to the german solution of § 145 bgb180. thus an offer is irrevocable if it states a period for acceptance or that it is binding. furthermore, an offer has the same effect if it was reasonable for the offeree to rely on the offer as being irrevocable and he is acted in reliance of the latter. the comparative analysis has shown that the effect of an offer is different in the three legal systems. in the common law an offer has no binding force at all (due to the “ consideration doctrine’) and it is not even a ground for liability in damages. in the romanistic legal system the premature withdrawal of an offer leads to liability in damages. in german law every offer is irrevocable and a purported withdrawal has no legal effect unless the offeror has excluded the binding effect of his proposal. nevertheless, there is a clear trend in the united states legislation and, above all, in the uniform commercial code towards making offers binding181. important authors182 think that the german system is the best because its results are practical and equitable; the offeree can act with assurance in the knowledge that his acceptance will conclude the contract and also, putting the risk of any changes in supplies and prices on the offeror, the allocation of the risk will be placed in the right part it is the offeror who takes the initiative and it is he who invokes the offeree’s reliance and so it must be up to him to exclude or limit the binding nature of his offer, failing which is only fair to hold him bound183. regarding the second factor, article 16(1) cisg states that, if an offer may be revoked, the withdrawal must reach the offeree before he dispatched the acceptance. thus, the convention follows the english ‘mailbox theory’184, differentiating from the latter, however, in stating the moment in which the contract is concluded: posting the acceptance puts an end to the offer’s revocability but it does not conclude the contract185. the comparative analysis has shown that nordic journal of commercial law issue 2006 #1 186 id., at 389. 187 id. 30 english ‘pure mailbox theory’ leads to unsatisfactory results because it means that a contract is concluded even if the acceptance is lost or is withdrawn by a telegram which the offeror receives earlier than the letter. the romanistic system, on the other hand, requiring the addressee to have knowledge of the declaration, presents something which, turning into an internal event, a legal system should avoid because of difficulties of proof186. the german system, on the contrary, makes the question turn on the arrival, that is, the entry of the declaration into the addressee’s zone of influence. also in this case the german solution seems to be fair and equitable because it not only allocates the risk of transmission between sender and addressee in the right way but also makes the condition an ascertainable and provable event187. bibliography bianca/bonell, commentary on the international sales law, milan, giuffrè, 1981 enderlein/maskow/stohbach, international sales law, new york, oceana publications inc., 1992 gabriel, contracts for the sale of goods: a comparison of domestic and international law, new york, oceana publications inc., 2004 gabriel, practitioner’s guide to the convention on contracts for the international sale of goods and the uniform commercial code, new york, oceana publications inc., 1994 ghestin, traité de droit civil, la formation du contract, paris, l.g.d.j. 1993 honnold, uniform law for international sales, deventer, kluwer law and taxation, 1999 kötz, european contract law, oxford, clarendon press, 1997 whincup, contract law and practice, deventer, kluwer law international, 2001 schlectriem, commentary on the un convention on the international sale of goods, oxford, clarendon press, 1998 schlesinger, formation of contracts, a study of the common core of legal systems, oceana, dobbs ferry, 1968 schmidt, négotiation et conclusion de contrats, paris, dalloz, 1982 zimmermann, the law of obligations, roman foundations of the civilian tradition, oxford, clarendon press, 1997 zweigert and kötz, an introduction to comparative law, oxford, clarendon press, 1992 * the author is tremendously indebted to professor albert kritzer of pace university institute of international commercial law for his enormous support and illuminating advice on this article. ** fan yang, mciarb (london), member of the practice & standards committee arbitration sub-committee working group (prc representative), chartered institute of arbitrators, barrister (england & wales), phd researcher(london), llm(birmingham), llb(shanghai,prc), certificate in international & comparative law (cornell university (usa) & université paris 1 sorbonne), researcher, school of international arbitration, centre for commercial law studies, queen mary university of london, uk the application of the cisg in the current prc law and cietac arbitration practice* by fan yang** nordic journal of commercial law issue 2006 #2 nordic journal of commercial law issue 2006 #2 1 introduction it is generally acknowledged that the cisg has influenced the legislation of the people’s republic of china (prc), but what and where exactly are the influences? how and to what extent has the cisg influenced the prc legislations and/or legislators? a careful study of the interaction between the cisg and the legislation history and development of the prc law is needed. this chapter will address these issues before reviewing the application of the cisg in the current prc law and practice. it is submitted that it is impossible to examine the impacts of the cisg on the prc legislation without first studying the incorporation history of the cisg in the country. the first task of this chapter is therefore to explore not only the 1980 diplomatic conference records and texts, but also the historical, social, economic, political and cultural backgrounds for the incorporation of the cisg in the prc. the two reservations under article 95 and article 96 declared by the prc upon ratification of the cisg will be analysed in detail so as to appreciate the reasons for and the influences behind these declarations. more importantly, the second task of this chapter is then to review the current law and practice in the prc in applying the cisg. it is proposed to deal with this task in two parts, i.e. the application of the cisg in current prc law and the application of the cisg in current prc arbitration practice. in particular, about thirty cases and arbitral awards concerning the application of the cisg in hong kongmacao-taiwan-related sales will be reviewed and discussed. finally a conclusion will be drawn. 1.1. historical context on the one hand, before the prc delegation attended the 1980 diplomatic conference in vienna, there was no prc domestic legislation, at least not in the codified form, on the subject of contract law or civil law in general.1 this was because before the reform and opening up started in 1978, the prc was under a strict state-planned economy. the legislations governing private law areas, such as contract, commercial transactions, and civil activities were largely unfledged. however, surprisingly or not, by the time when the cisg was ratified in the prc on 11 december 1986, the prc had promulgated the prc economic contract law on 13 december 1981, the foreign-related economic contract law on 21 march 1985 and the prc general principles of civil law on april 12, 1986. these three pieces of prc domestic legislation were of great significance in the incorporation history of the cisg in the prc. on the other hand, the final text of the cisg was approved at the diplomatic conference convened by the united nations general assembly in vienna in 1980.2 but the work of the 1 though there had been some attempts to draft and codify the prc civil law. the evolution of the prc civil law will be discussed in the next chapter. 2 the convention conference was convened by general assembly resolution 33/93. g.a. res. 93, 33 u.n. gaor supp. (no. 45) at 217, u.n. doc. a/33/45 (1978), see final act of the united nations conference on contracts for the international sale of goods, apr. 10, 1980. u.n. doc. a/conf. 97/18, with annex, united nations convention on contracts for the international sale of goods, reprinted in 19 i.l.m. 668 (1980). nordic journal of commercial law issue 2006 #2 2 uncitral, established in 1966 as a permanent committee of the un, on the unification of international sales law was started as long ago as 1968.3 by 1976 a draft convention on sales law had been prepared and was later revised by uncitral in 1977 at its tenth session in geneva.4 in 1978, the rules on the formation of the contract were discussed by uncitral at its eleventh session and merged with the substantive provisions on the sale of goods to form the “ new york draft” .5 the new york draft was then the basis for the vienna conference in spring 1980. having participated in the 1980 vienna diplomatic conference, the prc signed the cisg in 1981. it then took prc five years to ratify the cisg in 1986. on 1 january 1988, the cisg finally came into force in the prc. emphasis is put on the time of the above events because, as will be discussed below, the period of 1976 to 1989 happens to have marked a distinct phase in the history of the prc. chairman mao, the founder of the prc died on 9 september, 1976. this was followed by a political power struggle, which was put to an end eventually by the rise of deng xiaoping, who travelled abroad and had a series of diplomatic meetings with western leaders. in 1979, deng travelled to the united states to meet president jimmy carter at the white house. carter finally recognized the prc, which had replaced the taiwan-based republic of china (roc) as the sole chinese government recognized by the un security council in 1971. before the recognition of the prc by the united states in 1979, the prc had mostly a very limited and passive role within the un. deng effectively opened a new page of prc diplomacy. after 1979, the chinese leadership moved toward more pragmatic policies in almost all fields. in the domestic arena, artists, writers and journalists were encouraged to adopt more critical approaches in cultural, political and social movements. overseas, prc diplomats sought participation and involvement in a broader international political arena. the 1980 vienna diplomatic conference certainly provided such a timely opportunity. mr. li chih-min, the prc delegate in the 5th meeting of the first committee of the 1980 vienna diplomatic conference, indeed expressed his delegation's gratification at its participation for the first time in a conference such as the united nations conference on contracts for the international sale of goods.6 1.2. the reform and opening up the period between 1976 to 1989 marks the first phase of the prc’s reform and opening-up to the outside world. led by deng, the pragmatists within the communist party of china (cpc) emphasized economic development. at the pivotal december 1978 third plenum of the 11th cpc congress, the leadership adopted economic reform policies known as the four 3 for a detailed account of the cisg’s genesis, see principally herber, riw 1974, 577; riw 1976, 125; riw 1977, 314; huber, rabelsz 43 (1979), 413; see also schlechtriem, commentary on the cisg, (2nd edition), oxford, 1998 at introduction. 4 for “ geneva draft” or “ geneva working group draft” see yb vii (1976), pp 89-96; for its subsequent treatment see yb viii (1977), pp25-56. 5 see schlechtriem, commentary on the cisg, (2nd edition), oxford, 1998 at page 2. 6 see legislative history 1980 vienna diplomatic conference summary records of meetings of the first committee, 5th meeting, thursday, 13 march 1980, at 3 p.m. chairman: mr. loewe (austria): http://www.cisg.law.pace.edu/cisg/firstcommittee/meeting5.html http://www.cisg.law.pace.edu/cisg/firstcommittee/meeting5.html nordic journal of commercial law issue 2006 #2 3 modernizations: the modernization of agriculture, industry, science and technology, and military force. the concept of "socialism with chinese characteristics" was at the same time successfully introduced to resolve the theoretical and political conflicts,7 at least in the eyes of the prc leaderships at that time, between planned and liberal economic systems, between socialism and capitalism, between marxism and nonmarxism. the notion of “ chinese characteristics” not only won support among the people, but also has since then been widely employed and deepened into the hearts of all walks of life in the understanding and appreciation of the prc’s mixed and transitional economic, political, social, cultural, legal systems. to develop prc into a modern industrialized country, one of the most important aspects of the reform and opening up movement is to attract foreign investment and promote international trade. thus, the prc participated in the drafting and the formulation of the cisg with great impetus and enthusiasm, in the concern of not only politics, but also, perhaps more importantly, the economy and social development of the prc. the major concern for the prc delegation in the 1980 diplomatic conference was therefore the removal of barriers so as to facilitate international trade on the basis of equality and mutual benefit. 1.3. the prc delegation in the 1980 diplomatic conference mr. li chih-min, on behalf of the prc delegation, stated the following in the 5th meeting of the first committee in the 1980 vienna diplomatic conference: [his] delegation found it desirable to convene, pursuant to general assembly resolution 33/93, an international conference on plenipotentiaries to consider the draft convention on contracts for the international sale of goods, and to formulate a convention acceptable to all, in accordance with the basic objectives and principles of equality and mutual benefit set forth in the declaration and programme of action on the establishment of a new international economic order adopted by the general assembly at its sixth special session. such a convention would be of great importance in the gradual removal and final elimination of the barriers to international trade, especially as they affected the developing countries, the elimination of certain inequitable and unjust situations in international trade and its promotion on the basis of equality and mutual benefit.8 7 john gittings in the changing face of china said: "planning and market forces are not the essential difference between socialism and capitalism. a planned economy is not the definition of socialism, because there is planning under capitalism; the market economy happens under socialism, too. planning and market forces are both ways of controlling economic activity." see john gittings, the changing face of china, oxford university press, oxford, 2005. 8 see legislative history 1980 vienna diplomatic conference summary records of meetings of the first committee, 5th meeting, thursday, 13 march 1980, at 3 p.m. chairman: mr. loewe (austria): http://www.cisg.law.pace.edu/cisg/firstcommittee/meeting5.html http://www.cisg.law.pace.edu/cisg/firstcommittee/meeting5.html nordic journal of commercial law issue 2006 #2 4 towards the end of his speech, he stated that his delegation “ pledged its full co-operation in the efforts of all the participants and hoped that agreement would be reached on the text of a convention which would attract the maximum number of ratifications by states” .9 1.3.1. the positive attitude and contribution the positive attitude reflected in the above statements had been carried along by the prc delegation throughout the 1980 diplomatic conference in vienna. the input by the prc delegation was sincere and genuine. for instance, prc delegation’s opinions were recorded in seventeen out of the thirty-eight meetings in the first committee proceedings,10 four out of the nine meetings in the second committee proceedings,11 and four out of the last six plenary conference proceedings.12 prc delegation was fair-minded and stressed the balance of interests between buyer and seller, for example, in the 16th and the 19th meetings when draft article 36 [became cisg article 38] and draft article 42 [became cisg article 46] were discussed.13 articles raised interests and concerns of the prc delegation in the first committee meeting proceedings include draft article 5 [became cisg article 6],14 draft article 6, 7 [became cisg article 7, 8],15 draft article 8 [became cisg article 9],16 draft article 3 [became cisg article 3],17 draft article 17 [became cisg article 19],18 draft article 23 [became cisg article 25],19 9 see legislative history 1980 vienna diplomatic conference summary records of meetings of the first committee, 5th meeting, thursday, 13 march 1980, at 3 p.m. chairman: mr. loewe (austria): http://www.cisg.law.pace.edu/cisg/firstcommittee/meeting5.html 10 see legislative history 1980 vienna diplomatic conference summary records of first committee proceeding: http://www.cisg.law.pace.edu/cisg/summaryfirst.html 11 see legislative history 1980 vienna diplomatic conference summary records of second committee proceeding: http://www.cisg.law.pace.edu/cisg/summarysecond.html 12 there were 12 plenary conference proceedings, but the first six were organizational meetings. see legislative history 1980 vienna diplomatic conference summary records of plenary conference proceeding: http://www.cisg.law.pace.edu/cisg/plenary.html 13 see legislative history 1980 vienna diplomatic conference summary records of meetings of the first committee, 16th meeting, thursday, 20 march 1980, at 3 p.m. chairman: mr. loewe (austria): http://www.cisg.law.pace.edu/cisg/firstcommittee/meeting16.html; legislative history 1980 vienna diplomatic conference summary records of meetings of the first committee, 19th meeting, monday, 24 march 1980, at 10 a.m. chairman: mr. loewe (austria), later: mr. mathanjuki (kenya): http://www.cisg.law.pace.edu/cisg/firstcommittee/meeting19.html 14 see legislative history 1980 vienna diplomatic conference summary records of meetings of the first committee, 4th meeting: http://www.cisg.law.pace.edu/cisg/firstcommittee/meeting4.html 15 see legislative history 1980 vienna diplomatic conference summary records of meetings of the first committee, 5th meeting: http://www.cisg.law.pace.edu/cisg/firstcommittee/meeting5.html and 6th meeting: http://www.cisg.law.pace.edu/cisg/firstcommittee/meeting6.html 16 see legislative history 1980 vienna diplomatic conference summary records of meetings of the first committee, 6th meeting: http://www.cisg.law.pace.edu/cisg/firstcommittee/meeting6.html and 7th meeting: http://www.cisg.law.pace.edu/cisg/firstcommittee/meeting7.html 17 see legislative history 1980 vienna diplomatic conference summary records of meetings of the first committee, 8th meeting: http://www.cisg.law.pace.edu/cisg/firstcommittee/meeting8.html 18 see legislative history 1980 vienna diplomatic conference summary records of meetings of the first committee, 10th meeting: http://www.cisg.law.pace.edu/cisg/firstcommittee/meeting10.html 19 see legislative history 1980 vienna diplomatic conference summary records of meetings of the first committee, 12th meeting: http://www.cisg.law.pace.edu/cisg/firstcommittee/meeting12.html and 18th meeting: http://www.cisg.law.pace.edu/cisg/firstcommittee/meeting18.html http://www.cisg.law.pace.edu/cisg/firstcommittee/meeting5.html http://www.cisg.law.pace.edu/cisg/summaryfirst.html http://www.cisg.law.pace.edu/cisg/summarysecond.html http://www.cisg.law.pace.edu/cisg/plenary.html http://www.cisg.law.pace.edu/cisg/firstcommittee/meeting16.html; http://www.cisg.law.pace.edu/cisg/firstcommittee/meeting19.html http://www.cisg.law.pace.edu/cisg/firstcommittee/meeting4.html http://www.cisg.law.pace.edu/cisg/firstcommittee/meeting5.html http://www.cisg.law.pace.edu/cisg/firstcommittee/meeting6.html http://www.cisg.law.pace.edu/cisg/firstcommittee/meeting6.html http://www.cisg.law.pace.edu/cisg/firstcommittee/meeting7.html http://www.cisg.law.pace.edu/cisg/firstcommittee/meeting8.html http://www.cisg.law.pace.edu/cisg/firstcommittee/meeting10.html http://www.cisg.law.pace.edu/cisg/firstcommittee/meeting12.html http://www.cisg.law.pace.edu/cisg/firstcommittee/meeting18.html nordic journal of commercial law issue 2006 #2 5 draft article 34 [became cisg article 36],20 draft article 36 [became cisg article 38],21 draft article 42 [became cisg article 46],22 draft article 37 [became cisg article 39],23 draft article 61[became cisg article 65],24 draft article 69 and interest [became cisg article 84, 78],25 draft article 75 [became cisg article 86],26 draft article 62(1) [became cisg article 71(1)],27 draft article 63(2) [became cisg article 72(2)]28. in the second committee meeting proceedings, the prc delegation’s attention was drawn to the new article c bis [not adopted (would have affected cisg article 6)], 29 article (x) [became cisg article 96],30 article e [became cisg article 100], 31 draft protocol to the convention on the limitation period in the international sale of goods32. in the plenary conference proceedings, the prc delegation addressed articles 39 and 40 [became cisg article 41, cisg article 42 and cisg article 43],33 article 80 [became cisg article 68]34. 20 see legislative history 1980 vienna diplomatic conference summary records of meetings of the first committee, 15th meeting: http://www.cisg.law.pace.edu/cisg/firstcommittee/meeting15.html 21 see legislative history 1980 vienna diplomatic conference summary records of meetings of the first committee, 16th meeting: http://www.cisg.law.pace.edu/cisg/firstcommittee/meeting16.html 22 see legislative history 1980 vienna diplomatic conference summary records of meetings of the first committee, 19th meeting: http://www.cisg.law.pace.edu/cisg/firstcommittee/meeting19.html 23 see legislative history 1980 vienna diplomatic conference summary records of meetings of the first committee, 21st meeting: http://www.cisg.law.pace.edu/cisg/firstcommittee/meeting21.html 24 see legislative history 1980 vienna diplomatic conference summary records of meetings of the first committee, 26th meeting: http://www.cisg.law.pace.edu/cisg/firstcommittee/meeting26.html 25 see legislative history 1980 vienna diplomatic conference summary records of meetings of the first committee, 29th meeting: http://www.cisg.law.pace.edu/cisg/firstcommittee/meeting29.html 26 see legislative history 1980 vienna diplomatic conference summary records of meetings of the first committee, 30th meeting: http://www.cisg.law.pace.edu/cisg/firstcommittee/meeting30.html 27 see legislative history 1980 vienna diplomatic conference summary records of meetings of the first committee, 38th meeting: http://www.cisg.law.pace.edu/cisg/firstcommittee/meeting38.html 28 see legislative history 1980 vienna diplomatic conference summary records of meetings of the first committee, 38th meeting: http://www.cisg.law.pace.edu/cisg/firstcommittee/meeting38.html 29 see (a/conf.97/c.2/l.3) and also see legislative history 1980 vienna diplomatic conference summary records of meetings of the second committee, 1st meeting: http://www.cisg.law.pace.edu/cisg/2dcommittee/articles/meeting1.html 30 see (a/conf.97/c.1/l.88, l.96), and see also legislative history 1980 vienna diplomatic conference summary records of meetings of the second committee, 3rd meeting: http://www.cisg.law.pace.edu/cisg/2dcommittee/articles/meeting3.html 31 see (a/conf.97/c.2/l.11), see also legislative history 1980 vienna diplomatic conference summary records of meetings of the second committee, 4th meeting: http://www.cisg.law.pace.edu/cisg/2dcommittee/articles/meeting4.html 32 see (a/conf.97/7; a/conf.97/c.2/l.14, l.18, l.18/add.1, l.18/add.2, l,21, l.26), see also legislative history 1980 vienna diplomatic conference summary records of meetings of the second committee, 8th meeting: http://www.cisg.law.pace.edu/cisg/2dcommittee/articles/meeting8.html 33 see legislative history 1980 vienna diplomatic conference summary records of the plenary meetings, 7th meeting: http://www.cisg.law.pace.edu/cisg/plenarycommittee/summary7.html 34 see (a/conf.97/l.15), see also legislative history 1980 vienna diplomatic conference summary records of the plenary meetings, 8th meeting: http://www.cisg.law.pace.edu/cisg/plenarycommittee/summary8.html http://www.cisg.law.pace.edu/cisg/firstcommittee/meeting15.html http://www.cisg.law.pace.edu/cisg/firstcommittee/meeting16.html http://www.cisg.law.pace.edu/cisg/firstcommittee/meeting19.html http://www.cisg.law.pace.edu/cisg/firstcommittee/meeting21.html http://www.cisg.law.pace.edu/cisg/firstcommittee/meeting26.html http://www.cisg.law.pace.edu/cisg/firstcommittee/meeting29.html http://www.cisg.law.pace.edu/cisg/firstcommittee/meeting30.html http://www.cisg.law.pace.edu/cisg/firstcommittee/meeting38.html http://www.cisg.law.pace.edu/cisg/firstcommittee/meeting38.html http://www.cisg.law.pace.edu/cisg/2dcommittee/articles/meeting1.html http://www.cisg.law.pace.edu/cisg/2dcommittee/articles/meeting3.html http://www.cisg.law.pace.edu/cisg/2dcommittee/articles/meeting4.html http://www.cisg.law.pace.edu/cisg/2dcommittee/articles/meeting8.html http://www.cisg.law.pace.edu/cisg/plenarycommittee/summary7.html http://www.cisg.law.pace.edu/cisg/plenarycommittee/summary8.html nordic journal of commercial law issue 2006 #2 6 1.3.2. influences favouring the prc’s ratification the extensive participation and positive contribution of the prc delegation were not only welcomed internationally, but also favoured internally. on the domestic level, the participation of the prc delegation and the input they made in the preparation of the cisg influenced and favoured the later ratification of the convention in the prc. it was felt that the cisg was prepared under the participation of prc among various other countries and regions representing to the largest extent a world-wide participation. it was felt that different opinions and voices were heard and different interests were represented and balanced in the convention. the acknowledgement of the world-wide participation in the preparation of the cisg and the belief that an equal and balanced outcome had been achieved through such a world-wide participation were of great significance for the prc particularly under the domestic economic and political background at that time, when the country shortly inaugurated the reform and opening up policy national wide. the reassurances that the prc sought in the cisg were flagged up in the opening speech by the prc delegate in the 1980 diplomatic conference quoted above. emphasis was put in the quote below: … to formulate a convention acceptable to all, in accordance with the basic objectives and principles of equality and mutual benefit35 set forth in the declaration and programme of action on the establishment of a new international economic order adopted by the general assembly at its sixth special session.36 at the end, in the 12th plenary meeting the prc delegation expressed satisfaction over the outcome of the conference: mr. li-chih-min (china) expressed his satisfaction that five weeks of intensive work had culminated in the success of the conference. the convention, which was a step towards the harmonization of international trade law, would permit legal obstacles to international trade to be removed, facilitate trade and promote the establishment of an economic order founded on equality and mutual interest. his government would examine the convention carefully and take positive action, to the extent possible. he congratulated the participants at the conference, the austrian government, all the officers of the conference and the secretariat. in particular, he thanked the representatives for the constructive approach they had adopted. the above “ closing speech” by the prc delegation indicated that a promising ratification of the cisg in the prc should follow. indeed, having been convinced of the above stated satisfactory outcome of the 1980 diplomatic conference, the prc signed the convention in 1981 and ratified it on 11 december 1986 together with the united states and italy. 35 equality and mutual benefit are the keywords that have always been and will continue to be the backbone of the prc diplomatic principles and guidelines. 36 see legislative history 1980 vienna diplomatic conference summary records of meetings of the first committee, 5th meeting, thursday, 13 march 1980, at 3 p.m. chairman: mr. loewe (austria): http://www.cisg.law.pace.edu/cisg/firstcommittee/meeting5.html http://www.cisg.law.pace.edu/cisg/firstcommittee/meeting5.html nordic journal of commercial law issue 2006 #2 7 1.4. application of the cisg under current prc law under current prc law, there are limitations on the application of the cisg in the prc, which has filed an article 95 declaration and a declaration on the general subject of article 96. 1.4.1. article 95 reservation "the people's republic of china does not consider itself to be bound by subparagraph (b) of paragraph 1 of article 1 . . . "37 pursuant to article 95, the prc made the above declaration. article 1(1)(b) extended the cisg’s sphere of application to sales where the parties do not have their places of business in different contracting states, but conflicts rules refer to the law of a contracting state. article 95 relieves the reservation state from the need to have regard to article 1(1)(b).38 the legislative history of the cisg revealed that article 95 was introduced by the czechoslovak representative in the 11th plenary meeting of the 1980 vienna diplomatic conference. it was designed to exclude the application of the cisg under article 1(1)(b). according to the czechoslovak representative, article 1(1)(b) raised difficulties in countries like his own or the german democratic republic where special legislation had been enacted to govern transactions pertaining to international trade. similar legislation was under preparation in poland and romania. for countries with such a system, article 1(1)(b) would mean the exclusion of whole areas of the special legislation enacted to govern international trade transactions. the net result was that countries like czechoslovakia would be unable to ratify the convention because of the effect which cisg article 1(1)(b) would have on the application of their special legislation on international trade.39 based on the above understanding, taking into account the immature economic background, the very early stage of the reform and opening up, and the somewhat lack of prc domestic legislation at that time, which will be discussed in the next chapter, it is understandable, or at the least perhaps not surprising that prc felt the need to make such a reservation envisaging separation legislation for international trade, so as to protect the immature domestic market and/or to buffer the impacts of the rapid reform and opening up. later prc did implement separate legislations, the prc economic contract law 1981 applying to domestic contract and the foreign-related40 economic contract law 1985 applying to non-domestic contract. in this regard, special legislation enacted to govern transactions pertaining to international trade, as an idea learned from the vienna conferences by the prc legislation, was perhaps an unexpected and certainly negative influence of the cisg on the chinese legislators in the sense that it is not in favor but rather against the cisg. the fact that the united states had made the article 95 reservation may also be a factor that influenced the prc to follow the suit and make such a reservation as well. 37 see http://www.cisg.law.pace.edu/cisg/countries/cntries-china.html 38 see czerwenka, riw 1986, 293, 294; see also schlechtriem, commentary on the cisg, (2nd edition), oxford, 1998 at page 27. 39 see legislative history 1980 vienna diplomatic conference summary records of the plenary meetings, 11th meeting: http://www.cisg.law.pace.edu/cisg/plenarycommittee/summary11.html 40 prc used the phrase foreign-related to encompass hong kong, macau, taiwan and foreign countries. http://www.cisg.law.pace.edu/cisg/countries/cntries-china.html http://www.cisg.law.pace.edu/cisg/plenarycommittee/summary11.html nordic journal of commercial law issue 2006 #2 8 with the implementation of the prc contract law 1999 (discussed in detail in the next chapter), the economic contract law 1981, the special law on technology contracts and the foreign-related economic contract law 1985 were all invalidated. thus the prc replaced its separate legislation for domestic and international contracts through one single body of rules the prc contract law 1999. the rapid development and the maturing economic background are the more important factors which contributed to the change of the prc legislation model. if the purpose of the article 95 reservation was to safeguard the separation legislation on international trade as prc legislators once seemed to expect, the combination of domestic and international contract legislation under the prc contract law 1999 perhaps has made the prc article 95 declaration dysfunctional. the interpretation and the effects of reservation under article 95 have proven to be controversial. de ly cites three variations in the interpretation of such reservations:41 "the first variation is the mere reservation against the extension of cisg to sales where one of the parties has its place of business in a non-contracting state but is faced with the application of cisg by virtue of a conflict rule of the court having jurisdiction leading to the application of the law of a contracting state. for instance, the us, the people's republic of china, singapore, the czech republic and slovakia have used this mere reservation variation. "a second variation is the german variation where german courts will not apply article 1(1)(b) cisg in sales where article 95 reservation states are involved. "a third one is the dutch variation. article 2 of the dutch implementing cisg act dated december 18, 1991 request foreign judges in article 95 reservation states not to apply the dutch civil code provisions on sales (book 7, title 1 of the civil code) but rather cisg, if dutch law were to be applicable by virtue of the local conflict rule. this suggestion is of course not binding on foreign courts but by enacting this dutch solution the legislator has indicated that under dutch law it prefers a solution which enhances uniformity rather than one that relies on local dutch law."42 concerning the prc, if, for example, a seller in the prc sells to a buyer in state x, a noncontracting state, article 95 means that the prc courts are not bound to apply the convention rules even if the relevant rules of private international law lead to the application of prc law (i.e. the law of a cisg contracting state). in this situation, if the relevant conflictof-laws rule points to the seller's law, a prc court would apply domestic prc law, i.e. the prc contract law and the prc general principles of civil law. the prc general principles of civil law could be relevant because of their co-relation with the prc contract law and the fact that these two legislations overlap and interact to some extent. where there is ambiguity or a gap in the application and interpretation of the prc contract law, the prc general principles of civil law will apply. in particular, chapter vi civil liability, section 2 civil liability for breach of contract, and chapter viii application of law in foreign-related civil relations, could be relevant for international sales contract. where there are overlaps and 41 see http://www.cisg.law.pace.edu/cisg/text/e-text-95.html 42 philip de ly, "sources of international sales law: an eclectic model", at uncitral -siac conference on 25 years united nations convention on contracts for the international sale of goods, singapore (22 september 2005) http://www.cisg.law.pace.edu/cisg/text/e-text-95.html nordic journal of commercial law issue 2006 #2 9 conflicts between these two legislations, the contract law, as a special legislation, shall prevail over the general principles of civil law, as a general legislation. another relevant concern of the article 95 reservation would be that courts in contracting states which have not made an article 95 declaration would sometimes need to consider the effect of that declaration when deciding cases involving a party who resides in an article 95 declaration state. upon ratifying the convention the government of germany declared that it would not apply article l(l)(b) in respect of any state that had made an article 95 declaration.43 this german 'declaration,' while not expressly authorized by cisg part iv; can be viewed as the second variation of the article 95 reservation, as stated above. therefore, german courts in a contracting state which has not made an article 95 declaration would not apply article 1(1)(b) in respect of any contracting state that has made an article 95 declaration (e.g. prc) when the conflict of law rules of the forum point to the law of the declaring state (e.g. the prc). here it is a different scenario from the one discussed in para 1.24, where the parties autonomously choose the prc law as governing law. again the starting point is the prc general principles of civil law, in particular, chapter viii application of law in foreign-related civil relations, article 142, which stipulates: if any international treaty concluded or acceded to by the people's republic of china contains provisions differing from those in the civil laws of the people's republic of china, the provisions of the international treaty shall apply, unless the provisions are ones on which the people's republic of china has announced reservations. international practice may be applied to matters for which neither the law of the people's republic of china nor any international treaty concluded or acceded to by the people's republic of china has any provisions. the first sentence of the above article 142 has made it clear that because of the cisg article 95 reservation, the prc is not obliged to apply article 1(1)(b) according to its own domestic prc law. the second sentence then suggests that “ international practice” may be applied to matters for which neither the law of the people's republic of china nor any international treaty concluded or acceded to by the people's republic of china has any provisions. it is submitted that the following three questions may arise from the second sentence of the article 142 of the prc general principles of civil law. firstly, whether the cisg, although a convention, can be applied as “ international practice” under the second sentence of article 142? there is no legislative definition of “ international practice” (“ guo ji guan li” in chinese pinyin) in prc law. the author is aware that the word “ practice” used in a legal context tends to connect to “ procedure” , particularly for english lawyers perhaps, for example, it may denote informal rules of procedure as distinct from those derived from rules of court.44 yet in the context of prc law, the translation “ international practice” refers to international customs and 43 see: schlechtriem. p., 'uniform sales law the experience with uniform sales laws in the federal republic of germany,' juridisk tidsskrift vid stockholms universitet (1992) pp. 6-7, see http://www.cisg.law.pace.edu/cisg/biblio/schlechtriem.html 44 see oxford dictionary of law, 5th edition, 2002, where it states “ a book on practice and procedure, such as the civil procedure rules.” http://www.cisg.law.pace.edu/cisg/biblio/schlechtriem.html nordic journal of commercial law issue 2006 #2 10 practices, not in the sense of international public law, but in the areas of private and/or commercial law, with a more general and loose meaning as you can find, for instance, in the “ ucp” : the uniform customs and practices for documentary credits. in this sense, the prc “ international practice” may have similar meanings to “ lex mercatoria” 45, as a body of "spontaneous" law -law created by standard commercial practices. it is important to point out that the prc legislations, from 1978 onward, since the reform and opening up, have been amazingly positive and respectful to “ international practice” , particularly in the areas of private law. besides article 142 of the prc general principles of civil law, the prc foreign-related economic contract law 1985 stipulates in article 5: “ international practice may be applied to matters for which the prc law has no provisions.” the prc maritime code article 268, the prc civilian aviation law article 184, and the prc negotiable instruments law article 96 all stipulated that “ international practice may be applied.” furthermore, the “ new” (from 1978 onward, since the reform and opening up) prc legislations have widely employed a comparative approach. the prc contract law 1999 is a good example showing the prc’s comparative technique in modern prc law drafting. ding ding points out that "many foreign contract laws and civil laws and international unification laws had been under thorough comparison and discussion. the cisg and the unidroit principles [of international commercial contracts] were the main references."46 having compared the advantages and disadvantages of various foreign laws and/or international legal instruments, the prc law drafter has the opportunity to consider the advantages in some to make up for the shortcomings in others. by doing this compareandselect exercise, the prc law drafters often find themselves in a better position to decide what suits the prc the best in the law that is being drafted. such a comparative and selective approach as reflected in the provisions of the prc laws then guides the prc courts to be openminded and international/foreign laws minded when applying and interpreting the law. with regard to the cisg, given its importance as the world’s most successful and pre-eminent international uniform sales law, the “ international” and “ practical” character of the cisg is beyond doubt. the positive and respectful attitude towards international customs and practice in general and the willingness to compare laws of foreign countries and different international instruments, including the cisg in particular, as shown in the prc contract law and civil law drafting, have convinced that the cisg is highly applicable as “ international practice” under the prc law in appropriate circumstances. then the next question is in what circumstances can the cisg be applied as “ international practice” under prc law? 45 for this topic, see bernard audit, “ the vienna sales convention and the lex mercatoria” , lex mercatoria and arbitration, thomas e. carbonneau ed., rev. ed. a chapter of the 1990 edition, (juris publishing 1998) pages 173194; also available in the pace database: http://www.cisg.law.pace.edu/cisg/biblio/audit.html 46 see "cisg and china an intercontinental exchange," edited by michael will, with contributions by bruno zeller and ding ding, geneva 1999. another good example of how the prc legislation has made good use of the comparative approach in law drafting can be found in the prc maritime code. although the prc has not yet acceded to any of the hague rules 1924, or the visby rules 1968, or the hamburg rules 1978, the prc maritime code in fact selected those suit the prc the best from three of the rules. http://www.cisg.law.pace.edu/cisg/biblio/audit.html nordic journal of commercial law issue 2006 #2 11 focus is on the second sentence of article 142 of the prc general principles of civil law: “ international practice may be applied to matters for which neither the law of the people's republic of china nor any international treaty concluded or acceded to by the people's republic of china has any provisions” . today the ambit, within which neither the law of the prc nor any international treaty concluded or acceded to by the prc has any provisions, has to be very narrow, given the fact that numerous legislations have been implemented in the prc in the last twenty to twenty-five years and the number of treaties entered by the prc has not been small. therefore, the scope, to which the cisg can be applied as international practice under the prc law, has seemingly been limited to perhaps an almost negligible extent in theory. surprisingly or not, in practice, however, numerous cases and arbitral awards have evidenced contrary to the above textual theory. as a matter of fact, the cisg has been widely applied by the prc courts and arbitral tribunals even in some cases in which the cisg would not seem to apply in theory. the application of the cisg in current prc arbitration practice will be dealt with in section v. below. furthermore, it is submitted that the cisg has long been rooted into the prc law, as early as at the drafting stage . the fingerprint it has placed on the drafting of the prc legislation has made the cisg highly relevant to the prc law from the very beginning. the compare-andselect approach employed in the prc law drafting has woven the essence, e.g. the principle of good faith, the balance of interests of buyer and seller, the principle of equality and equity, and the concept of reasonableness etc, into the prc subsequent legislations. believe it or not, ask any judge or practitioner in the prc, the general perception is that the current prc legislations have indeed learned a great deal from foreign laws and international uniform law instruments, such as the cisg. the prc legislators have endeavoured to make the prc legislations to reflect international practice as much as possible. thus it is believed that the prc contract law 1999 was drafted in line with the cisg, under which the prc’s treaty obligation has been taken seriously. a closer comparative study of the contents, the individual provisions of the prc general principles of civil law, the prc contract law 1999 and the cisg will be dealt with in the next chapter. yet here perhaps there is a third concern in article 142 of the prc general principles of civil law. the phrase “ may be applied” seems to suggest that a wide discretion has been left to the prc courts. again, paragraphs 1.39 to 1.42 are repeated. it is submitted that the prc courts’ discretion is most likely to be tipped in the favour of the application of the cisg. the application of the cisg by prc arbitrators could only be easier and more likely, for the even wider and freer discretion they have in deciding the applicable law in arbitration proceedings. thus, the prc article 95 reservation does not seem to have achieved its effects in limiting the application of the cisg in prc law as much as the prc legislators perhaps originally expected or those critics tended to or used to believe. given the fact that the cisg has been widely adopted by 68 states that account for over three-quarters of all world trade,47 the effect of the article 95 reservation has been minimal in any case. 47 as of 17 july 2006, the united nations reports that 68 states have adopted the cisg. see pace database: http://www.cisg.law.pace.edu/cisg/countries/cntries.html http://www.cisg.law.pace.edu/cisg/countries/cntries.html nordic journal of commercial law issue 2006 #2 12 1.4.2. article 96 reservation "the people's republic of china does not consider itself bound by . . . article 11 as well as the provision of the convention relating to the content of article 11."48 this is the other declaration made by prc under article 96,49 which allows a contracting state to declare that any provision of article 11, article 29, or part ii of the cisg, that allows a contract of sale or its modification or termination by agreement or any offer, acceptance, or other indication of intention to be made in any form other than in writing, does not apply where any party has his place of business in that reservation state. it may be declared only by a state which itself requires written form for contracts of sale under its domestic law.50 interestingly enough, at the time when the prc delegation attended the 1980 diplomatic conference in vienna, there was no prc domestic legislation, at least not in the codified form, on the subject of contract or civil law in general, although there had been some attempts to draft and codify the prc civil law.51 by 11 december 1986 when the prc ratified the cisg and declared the two reservations, three important prc domestic legislations had been adopted. from 1980 to 1986, within six years, the prc had finished the drafting and implementation of the prc economic contract law promulgated on 13 december 1981, the foreign-related economic contract law promulgated on 21 march 1985 and the prc general principles of civil law promulgated on april 12, 1986.52 to a large extent, these three pieces of prc domestic legislation were in fact adopted to prepare the prc for the ratification of the cisg. having attended the 1980 diplomatic conference and observed the debates on all the relevant subjects and issues, the prc delegation returned to the prc with a clear goal in mind: that is to ratify the cisg, to participate in international trade, to modernise the prc domestic laws and its legal system thus, the impact and influence of the cisg on the prc legislation in general and on the prc contract law in specific, which was almost from scratch at that time, are self-evident. the structure and contents of the foreign-related economic contract law 1985 had significant reference to the cisg.53 although the cisg had less influence on the prc economic contract law 1981, which was largely influenced by the soviet union law, it is submitted that without the insights, the experience gained from the 1980 diplomatic conference on the cisg and the aim to ratify the cisg, the prc would perhaps have no separation of legislation for domestic and international trade in the first place. what exactly had been prescribed regarding to the requirements as to form in these “ purposemade” pieces of legislation? 48 see http://www.cisg.law.pace.edu/cisg/countries/cntries-china.html 49 see xiaolin wang and camilla baasch andersen, the chinese declaration against oral contracts under the cisg, available at: <http://cisgw3.law.pace.edu/cisg/biblio/andersen4.html> 50 see schlechtriem, commentary on the cisg, (2nd edition), oxford, 1998 at page 699. 51 the evolution of the prc civil law will be discussed in the next chapter. 52 the prc technology contract law came into force on 1 november 1987. 53 see discussion in details in the next chapter. http://www.cisg.law.pace.edu/cisg/countries/cntries-china.html http://cisgw3.law.pace.edu/cisg/biblio/andersen4.html nordic journal of commercial law issue 2006 #2 13 article 3 of the prc economic contract law 1981 stipulated: “ economic contract, except when payment is made immediately, shall be in writing; document, telegram or telex on alteration of the contract by mutual agreement between parties form part of the contract.” 54 article 7 of the foreign-related economic contract law 1985 provided: a contract shall be formed as soon as the parties to it have reached a written agreement on the terms and have signed the contract. if an agreement is reached by means of letters, telegrams or telex and one party requests a signed letter of confirmation, the contract shall be formed only after the letter of confirmation is signed. article 31 of the prc general principles of civil law article 31 states: “ partners shall make a written agreement covering the funds each is to provide, the distribution of profits, the responsibility for debts, the entering into and withdrawal from partnership, the ending of partnership and other such matters.” having said that these prc domestic pieces of legislation were adopted to prepare the prc for the ratification of the cisg, the contents of the above provisions, however, reveal that they were made for the reservations of the cisg rather than in favor of the cisg. the prc could have made those provisions in line with article 11 of the cisg instead. it is submitted that apart from the cultural tradition that chinese merchants tend to feel more secure with written deeds, the attitudes and positions taken by the union of soviet socialist republics (ussr) were the main influence for the prc to make the article 96 reservation. the u.s. delegate, mr farnsworth, in the 8th meeting of the first committee in the 1980 vienna diplomatic conference pointed out that at the tenth session of uncitral at vienna, it had been decided that the written form would not be compulsory: “ … the intention was not to allow too many countries to make reservations, either partial or total. the aim was merely to remove the difficulties which might be encountered by the ussr or perhaps by other countries where the state was responsible for international trade.” 55 in the early 1980s, the reform and opening up was still at a very early stage. the prc legislators were not decisive at the beginning as to whether to follow the ussr pattern or the western, the u.s. pattern. the mainstream at that time inclined to the ussr. for example, the term “ economic contract” was translated and borrowed from the ussr. it was used in the prc economic contract law 1981 and later was largely retained in the foreign-related economic contract law 1985. the concept of “ foreign-related economic contract” itself evidenced the ussr’s influence on the prc legislation at that time. the impression and observation gained in the 1980 diplomatic conference, that the article 96 reservation was designed for the ussr, in which the state was responsible for international trade, convinced the prc to follow the ussr suit, because not until recently, after the prc 54 translated by the author. 《中华人民共和国经济合同法》（已失效） 第三条： 经济合同，除即时清结者外，应当采用书面形式，当事 人协商同意的有关修改合同的文书、电报和图表，也是合同的组成部分。 55 see legislative history 1980 vienna diplomatic conference summary records of meetings of the first committee, 8th meeting at para 43: http://www.cisg.law.pace.edu/cisg/firstcommittee/meeting8.html http://www.cisg.law.pace.edu/cisg/firstcommittee/meeting8.html nordic journal of commercial law issue 2006 #2 14 entered into the wto, was the right to international trade centrally controlled by the prc government. at the beginning of the reform and opening up, it was then not unreasonable to believe that the prc governmental organizations, the state-owned entities, would be dominant in representing the prc in international trade. again it was an unexpected experience learned by the prc in the diplomatic conference and a somewhat negative influence of the cisg on prc legislation. besides it is a general perception that the chinese culture embraces the idea that anything formal and anything important should be done in written forms, so as to avoid the difficulties in evidence and proof if later disputes arise. as beginners, learners in the international trade, the prc naturally inclined to treat the forms of contracts for international sale with greater attentions and preferred them to be done in formal and written forms. nonetheless the reform and opening up is a gradually and constantly evolving process in the prc. the prc contract law 1999 has changed the prc’s position on the requirements as to form of contracts. article 10 forms of contract prescribes: writing requirement a contract may be made in a writing, in an oral conversation, as well as in any other form. a contract shall be in writing if a relevant law or administrative regulation so requires. a contract shall be in writing if the parties have so agreed. article 11 definition of writing a writing means a memorandum of contract, letter or electronic message (including telegram, telex, facsimile, electronic data exchange and electronic mail), etc. which is capable of expressing its contents in a tangible form. the language of the above english translation of the prc contract law 1999 may perhaps have left some room for improvement, but these are the prc official translations as they stand.56 the point here is that the above provisions clearly embraced the freedom of requirements as to form of contracts. moreover, a step further than the stipulations of the cisg was taken to encompass not only the conventional forms, e.g. letter, telegram, telex, but also modern electronic data exchange and electronic communications. again the comparative and selective approach adopted in the prc law drafting was evident on the one hand; the intent to make the prc law compatible with the rapid economic development on the other. thus the prc contract law 1999, the current contract law in the prc, has adopted the original position under article 11 of the cisg. the evolution, from the prc economic contract law 1981 and the foreign-related economic contract law 1985, to the prc contract law 1999, reflects not only the internal need of the prc legislation to back up the fast economic and social development undergoing in the prc, but also the willingness of the prc legislators to harmonise the prc legislation with the international law and practice. the prc’s contributions in the harmonisation and unification of the international sales law have been evidently significant. 56 these are official prc translations published by: http://www.chinalaw.gov.cn http://www.chinalaw.gov.cn nordic journal of commercial law issue 2006 #2 15 yet the prc has not filed a withdrawal of the article 96 declaration. under article 97 (4) of the cisg, a declaration may be withdrawn. the wording of the article 97 (4) seems to suggest no obligation to file a withdrawal. but the cisg is silent as to the effects of the absence of a withdrawal when the declaration is no longer valid or does not make practical sense any more. article 96 reservation is only available for a contracting state whose domestic legislation requires the form of contracts. since the current prc domestic law does no longer require the form, article 96 reservation should have ceased to be available for the prc. would the change of domestic law invalidate the declaration under the article 96? what are the effects of the absence of a withdrawal under these circumstances? the cisg is silent and provides no answer. technically speaking, the absence of the prc’s withdrawal of its article 96 reservation caused a dilemma. if a contract concluded verbally between two parties, one of which has its place of business in prc, a reservation state and the other in the united states, a non reservation state, gave rise to litigation and the litigation in question came under the jurisdiction of the u.s., should and could the judge consider whether article 96 is still applicable to the prc? although the end result may be very different, if the judge simply considers in the absence of a withdrawal the prc reservation is still valid, and then goes ahead applying the conflict rules to decide the applicable law to the form. but the question in the first place should be whether the prc’s reservation is still valid? could the reservation cease to be valid automatically or as a default upon change of circumstances in domestic law? these questions do leave uncertainties in law and practice. it is hoped that the prc shall duly file a declaration to withdraw the article 96 reservation. 1.4.3. the cisg forms part of current prc law having established the impacts and influence of the cisg in the prc legislation and having examined the two reservations and their implications on the current prc law, it is now perhaps more important to review and study how exactly the cisg has been applied in the current prc law and practice. how does the cisg fit in the overall prc legislation structure? whether the cisg stands on its own, being separated or outside of the prc domestic law, or whether it becomes part of the prc law? first of all, although being named as a convention, the “ united nations convention on contracts for the international sale of goods (1980) [cisg]” is in fact a treaty. generally speaking, international treaties are called by several names: treaties, international agreements, protocols, covenants, conventions, exchanges of letters, exchanges of notes, etc. there may be different connotations and/or denotations regarding different terms used. however, under international law these are equally treaties and the rules applied to them shall be the same. according to the prc general principles of civil law, chapter viii application of law in foreign-related civil relations, article 142 stipulates: nordic journal of commercial law issue 2006 #2 16 if any international treaty concluded or acceded to by the people's republic of china contains provisions differing from those in the civil laws of the people's republic of china, the provisions of the international treaty shall apply, unless the provisions are ones on which the people's republic of china has announced reservations. international practice may be applied to matters for which neither the law of the people's republic of china nor any international treaty concluded or acceded to by the people's republic of china has any provisions.57 it is submitted that a correct reading of the above article reveals that the right position should be that the cisg is superior to the prc domestic legislation, i.e. the first hierarchy of the prc law, as a treaty concluded and acceded to by the prc. the prc domestic legislation then follows as the second hierarchy in the middle. the international practice58 contributes as the third hierarchy. although the cisg is above the prc domestic legislation, it is within the broader picture of the three-tier hierarchy of the source of the prc law. therefore, if the parties of international sales have chosen the law of the prc, a contracting state of the cisg, it is submitted that the cisg should apply as having been incorporated and become part of the prc law. if the court then finds that the cisg contains provisions differing from those in the prc domestic legislations, the provisions of the cisg shall prevail. 1.4.3.1. can the cisg apply to the prc domestic sales? a further interesting question following the above submission that the cisg shall be regarded as part of the prc law is whether the cisg can also apply to prc domestic sales. under current prc law, it is generally perceived that in prc domestic sales, parties do not have the right to choose applicable law. however, it is submitted that a careful examination of current prc law reveals that it is literally an arguably open question as to whether parties of prc domestic contract can legally choose the applicable law. although there is no direct provision under the current prc law “ positively” granting parties of domestic contracts59 the power and/or the freedom to choose applicable law, parties of domestic sales have not been prohibited from the freedom to choose the applicable law either. according to the universally acknowledged legal principle, this is also generally accepted by the prc legal academic and practice, that “ an act is permissible unless forbidden by law” . based on this legal principle and the fact that the current prc law does not after all forbid parties of contracts from choosing the applicable law, it is therefore argued that, in principle, parties of domestic sales in the prc should be free to choose applicable law. moreover, there are no stipulations under current prc law that require, for example that the prc contract law 1999 (current) shall apply to all domestic contracts. the purpose of the prc legislators and/or the current trend in the development of the prc law is indeed to merge the differences that used to exist in distinguishing domestic contracts from contracts involving foreign interests. the unification of the economic contract law 1981 applying to domestic contract and the foreign-related economic contract law 1985 applying to nondomestic contract, and the special law on technology contracts evidenced the purpose of the 57 this is official prc translations published by: http://www.chinalaw.gov.cn 58 see later a further discussion on the “ international practice” in paragraphs 1.38 and 1.39. 59 bear in mind that the concept of contract includes not only the contact of sales. http://www.chinalaw.gov.cn nordic journal of commercial law issue 2006 #2 17 prc legislations and the current trend of prc law of practice.60 thus it is argued that the power to choose the applicable law expressly available under the prc general principles of civil law (1986) to parties of foreign-related contracts should also be available to parties of domestic sales as well. otherwise parties of domestic sales have not been given an equal treatment under the current prc contract law. taking into account the fast economic development in the prc, the above policy reason for the prc legislators and the current development of the prc law and practice, it is an unjustifiable inequality for parties of domestic sales not to have the right to choose the applicable law. therefore it is submitted that parties of prc domestic sales should also be able to choose the applicable of law for their contracts. should this submission hold water, there is no reason why the cisg could not be chosen by the parties and applied to prc domestic sales as well.61 1.4.3.2. “ foreign-related” under current prc law and practice according to the prc general principles of civil law, chapter viii application of law in foreign-related civil relations, article 145 stipulates: “ the parties to a contract involving foreign interests may choose the law applicable to settlement of their contractual disputes, except as otherwise stipulated by law. if the parties to a contract involving foreign interests have not made a choice, the law of the country to which the contract is most closely connected shall be applied.” although the above english version translated by the brueau of legislative affairs of the state council of the prc, published by the china legal system publishing house uses the phrase “ involving foreign interests” , it is submitted that “ foreign-related” would be literally more precise to the original chinese text.62 according to the opinions of the supreme people's court on several questions on the implementation of the prc general principles of civil law, section 7 opinion no. 178 subparagraph 1 states: “ foreign-related civil relation includes when one party or bother parties of a civil relationship is foreign person or a person with no nationality or a foreign legal entity; or the subject matter of the civil relationship locates abroad; or the legal event creates, alters or terminates the rights and obligations of the civil relation happens abroad.” 60 see further discussion in para 1.30-1.31. 61 this issue of opting-in was expressly dealt with by the 1964 hague convention relating to a uniform law on the formation of contracts for the international sale of goods, which contained a provision, article 4 expressly providing the parties with the possibility of “ opting in” . the fact that the convention does not contain a provision comparable to the opting-in article does not necessarily mean that the parties are not allowed to “ opt in” . this view is supported by the fact that a proposal made by the former german democratic republic during the diplomatic conference. see official records of the united nations conference on contracts for the international sale of goods, vienna, 10 march-11 april 1980 (united nations publication, sales no. e.81.iv.3), 86, 252-253. 62 it is importantly noticed in the english version translated by the brueau of legislative affairs of the state council of the prc, published by the china legal system publishing house that in case of discrepancy, the original version in chinese shall prevail. nordic journal of commercial law issue 2006 #2 18 the above opinion has defined the scope and the concept of “ foreign-related” and/or “ involving foreign interests” in a very flexible and broad way. it clearly encompasses not only “ involving foreign interests” , but also foreign person, person with no nationality, foreign entity, and foreign subject matter and relevant events happened abroad. further, according to some prc judiciary interpretations, in specific, the official reply of the supreme people's court on several questions in dealing with economic dispute cases involving the hong kong-macau-taiwan regions (1987.10.19)63, and the current prc law and practice, court cases and arbitral awards have decided uncontroversially that cases related to hong kong, macao and taiwan regions have also been treated as foreign-related cases. it is also for this reason that the phrase of “ foreign-related” is arguably more accurate to reflect the current law and practice than that of “ involving foreign interests” . another good example of treating hong kong-macao-taiwan-related cases in accordance with rules applying to foreign-related can be found in the official notice of the supreme people's court on several questions in dealing with foreign-related arbitration and foreign arbitral awards (1995.08.28).64 1.5. application of the cisg in cietac arbitration practice with the prc’s entry into wto and the emergence of prc as a market economy and its fast development and boom in international trade, the china international economic and trade arbitration commission (cietac) has become one of the most active international commercial arbitration institutions in the world.65 1.5.1. cietac arbitration practice in general cietac’s history dates back to 1956, well before the cisg has been ratified. the china council for the promotion of international trade (ccpit) inaugurated the foreign trade arbitration commission (ftac).66 in 1979-1980 ftac became known as the foreign economic and trade arbitration commission (fetac) upon the inclusion of settlement of disputes among chinese and foreign joint venture partners.67 in 2000, cietac dealt with 543 arbitration cases, compared to 500 by the aaa (american arbitration association), 541 by the icc international court of arbitration, and 294 by the hong kong international arbitration centre.68 from january 2000 until 2005, cietac caseload was respectively: 543, 731, 684, 709, 850, 979. headquartered in beijing with two sub-commissions, south china subcommission in shenzhen and shanghai sub-commission, cietac has become the first world arbitration forum in terms of caseload.69 63 see最高人民法院关于审理涉港澳经济纠纷案件若干问题的解答 （１９８７年１０月１９日） 64 see关于人民法院处理与涉外仲裁及外国仲裁事项有关问题的通知(1995年8月28日法发(1995)18号) 65 see zhang l. “ the enforcement of cietac arbitration awards” , hong kong lawyer, february 2002, accessed via http://www.hk-lawyer.com/2002-2/feb02-china.htm 66 see hobbs, b., o’melveny & myers, cietac arbitration rules and procedures: recent developments and practical guidelines, april 1999, p2. 67 for the introduction of the cietac, see its official website, url at <http://www.cietac.org.cn/english/introduction/intro_1.htm#2>. 68 see http://www.hkiac.org/hkiac/hkiac_english/en_statistics.html 69 see wu, dong: 2005. cietac's practice on the cisg, presentation at uncitral-siac seminar on celebrating success: 25 years united nations convention on contracts for the international sale of goods, http://www.hk-lawyer.com/2002-2/feb02-china.htm http://www.cietac.org.cn/english/introduction/intro_1.htm#2 http://www.hkiac.org/hkiac/hkiac_english/en_statistics.html nordic journal of commercial law issue 2006 #2 19 given that the majority of chinese arbitral awards involving the cisg were mainly made by cietac, and considering that the issue of the application of the cisg is in a rather different light in arbitration than before a state court, a review and critical analysis of cietac awards on the methods employed in determining the application of the cisg in prc is required. 1.5.2. cisg has been applied to contract between two prc parties based on the above analysis of the definition and scope of the concept of “ foreign-related” , parties of foreign-related contract has the power to select applicable law, even if both parties are from the prc. this result further advances the above argument that parties of pure domestic contracts should not be prevented from the freedom of choosing applicable law, so as to avoid unjustifiable different treatment under the current prc contract law. indeed in the fishmeal case,70 the cisg was applied to a contract between two prc parties. the contract of sale in that case involved an international shipment of goods. therefore, the contract fell into the category of “ foreign-related” under current prc law, although it was signed by two prc companies which have the power to enter into foreign trade. in deciding the applicable law, the arbitration tribunal holds that according to the theory of closest connection, the law of the prc on economic contracts involving foreign interest should be applied. however, interestingly, the tribunal goes on to state that when the prc law does not stipulate, the cisg and international customs shall be applied. therefore, the tribunal first applies article 7 of the law of the prc on economic contract involving foreign interest to deal with the issue of contract formation; then applies article 68 of cisg when dealing with the issue of passage of risk; hence, the cisg has been applied as gap-filling of the prc domestic contract law in relation to foreign-related contract between two prc parties. 1.5.3. cisg has been applied to contracts between parties from hong kong and the prc, hong kong and hong kong, macao and prc, taiwan and prc when the prc ratified the cisg in 1986, the prc lacked the power to enter into international conventions for hong kong and macao. after the return of hong kong in 1997 and macao in 1999, pending the filing with the secretary-general of the united nations of a suitable cisg-related depositary notification by the people's republic of china, it is uncertain whether the cisg shall be in effect in hong kong and macao. some commentators suggested that the courts of china and hong kong are unlikely to regard the cisg as in effect in the hong kong special administrative region.71 but some others suggested otherwise.72 whether the cisg is applicable in taiwan is another mystery. nonetheless, in fact, a number of decisions by the prc courts have been reported where the cisg has been applied to sales contracts between parties from prc and hong kong dated singapore (22 september 2005) 43 p. at para 2 cietac and cietac awards; see also nordic journal of commercial law <http://www.njcl.utu.fi/2_2005/article2.htm> 70 see china 1 april 1997 cietac arbitration proceeding (fishmeal case) [translation available] [cite as: http://cisgw3.law.pace.edu/cases/970401c1.html] 71 see e.g. http://www.cisg.law.pace.edu/cisg/countries/cntries-china.html 72 see e.g. ulrich schroeter, "the status of hong kong and macao under the united nations convention on contracts for the international sale of goods": http://www.schroeter.li/pdf/schroeter_16_pace_intl_l_rev_2004_307.pdf http://www.njcl.utu.fi/2_2005/article2.htm http://cisgw3.law.pace.edu/cases/970401c1.html http://www.cisg.law.pace.edu/cisg/countries/cntries-china.html http://www.schroeter.li/pdf/schroeter_16_pace_intl_l_rev_2004_307.pdf nordic journal of commercial law issue 2006 #2 20 both prior to and after the return in 1997.73 there are also numerous cietac arbitral awards applying the cisg to contracts between parties from hong kong and the prc, hong kong and hong kong, macao and prc, taiwan and prc. 1.5.4. rationales for applying the cisg to contracts between parties from hong kong and the prc, hong kong and hong kong the following rationales have been used for applying the cisg to contracts between parties from hong kong and the prc, hong kong and hong kong: 1.5.4.1. prc law “ referring to” or “ in light of” the cisg as an international convention in a cement case between a prc seller and a hong kong buyer,74 having decided the applicable law is the law of prc referring to the international convention, the tribunal in its opinion only apply the relevant article of cisg (article 53) without actually referring to any relevant prc domestic law instead. 1.5.4.2. parties’ explicit agreement in a rolled wire rod coil case between two hong kong parties,75 the arbitration tribunal noted that the parties reached consensus regarding the applicable law during the oral hearing that the cisg shall apply. accordingly, the tribunal decided that cisg should be the applicable law in this case. in the rebar coil case,76 the two parties both from hong kong agreed in the contract attachment that the applicable law of the contract is the cisg; therefore, the tribunal held that the cisg should be applied to the dispute. also in the caffeine case between a hong kong buyer and a prc seller,77 the tribunal was of the opinion that the parties did not stipulate the applicable law in the contract. however, when the application for arbitration was filed, the parties agreed that the united nations convention on contracts for the international sale of goods (1980) (cisg) should be applied to this case. 73 china 31 december 1992 xiamen intermediate people's court (lian zhong v. xiamen trade) [cite as: http://cisgw3.law.pace.edu/cases/921231c1.html]; china 1993 people's court (international industrial company c of hong kong v. five mines machinery industrial chemicals and chinese medicine import-export company) [cite as: http://cisgw3.law.pace.edu/cases/930000c1.html]; china 7 march 1994 guandong higher people's court (zhanjiang textiles v. xian da fashion) [cite as: http://cisgw3.law.pace.edu/cases/940307c1.html]; china 5 september 1994 xiamen intermediate people's court (xiamen trade v. lian zhong) [cite as: http://cisgw3.law.pace.edu/cases/940905c1.html]; 74 china 26 march 1993 cietac arbitration proceeding (cement case) [translation available] [cite as: http://cisgw3.law.pace.edu/cases/930326c1.html] 75 see china 15 may 1995 cietac arbitration proceeding (copper cable case) [translation available][cite as: http://cisgw3.law.pace.edu/cases/950515c1.html] 76 china 20 november 1997 cietac arbitration proceeding (rebar coil case) [translation available] [cite as: http://cisgw3.law.pace.edu/cases/971120c1.html] 77 china 29 march 1996 cietac arbitration proceeding (caffeine case) [translation available] [cite as: http://cisgw3.law.pace.edu/cases/960329c1.html] http://cisgw3.law.pace.edu/cases/921231c1.html http://cisgw3.law.pace.edu/cases/930000c1.html http://cisgw3.law.pace.edu/cases/940307c1.html http://cisgw3.law.pace.edu/cases/940905c1.html http://cisgw3.law.pace.edu/cases/930326c1.html http://cisgw3.law.pace.edu/cases/950515c1.html http://cisgw3.law.pace.edu/cases/971120c1.html http://cisgw3.law.pace.edu/cases/960329c1.html nordic journal of commercial law issue 2006 #2 21 according to the facts, the court session and the parties' intention, the cisg was applied in this case. another interesting case is the three-ply board case between a prc buyer and a hong kong seller. article 21 of the export contract signed by the parties on 21 june 1993 stipulates that, "if the contracting place or the place of residence of the goods at the time of dispute is within the people's republic of china, or the respondent is chinese legal person, the laws of the people's republic of china should apply, otherwise, the cisg should apply". the arbitration tribunal holds that the choice of applicable laws by the parties should be respected and therefore the aforesaid laws should be applied to the settlement of the dispute. 1.5.4.3. parties’ implicit agreement in the antimony ingot case between a prc seller and a hong kong buyer,78 the arbitration tribunal noted that the parties did not stipulate the applicable law in the contract. however, in the seller's arbitration application and the buyer's defenses, the cisg was mentioned as a basis for each party's assertion. therefore, the arbitration tribunal deems that the parties have reached an agreement on the applicable law during the arbitration process; therefore, the cisg should be applied. in the oxetrecycline case,79 the prc seller stated in its contract form that the prc law and incoterms 1990 should be applied, but the hong kong buyer stated in its contract confirmation that the law of hong kong should be applied. the tribunal took the view that the two parties did not reach an agreement on the applicable law. however, during the arbitration, the prc seller applied the cisg to support its defense, and later the hong kong buyer replied the defense applying the cisg as well. the arbitration tribunal is of the view that two parties applied the cisg during the arbitration process; therefore it should be deemed that both parties have reached an agreement on applying the cisg, thus, the cisg is the applicable law. in the black melon seeds case80 between a hong kong buyer and a prc seller, there was no agreement on the applicable law in the relevant contract, however, both parties applied the cisg and the prc economic contract law to establish their cases in the arbitration. therefore, the tribunal held that it can be regarded that the parties have impliedly agreed on the applicable law, i.e., prc law and the cisg. 1.5.4.4. cisg applied as “ filling gaps” of the prc law in addition to the fishmeal case81 discussed above, where the cisg was applied as a gap-filler to the prc domestic contract law in relation to foreign-related contract between two prc parties, 78 see china 5 february 1996 cietac arbitration proceeding (antimony ingot case) [translation available] [cite as: http://cisgw3.law.pace.edu/cases/960205c2.html] 79 see china 15 november 1996 cietac arbitration proceeding (oxtetrecycline case) [translation available] [cite as: http://cisgw3.law.pace.edu/cases/961115c1.html] 80 china 4 april 1997 cietac arbitration proceeding (black melon seeds case) [translation available] [cite as: http://cisgw3.law.pace.edu/cases/970404c1.html] 81 see china 1 april 1997 cietac arbitration proceeding (fishmeal case) [translation available] [cite as: http://cisgw3.law.pace.edu/cases/970401c1.html] http://cisgw3.law.pace.edu/cases/960205c2.html http://cisgw3.law.pace.edu/cases/961115c1.html http://cisgw3.law.pace.edu/cases/970404c1.html http://cisgw3.law.pace.edu/cases/970401c1.html nordic journal of commercial law issue 2006 #2 22 in the silicon metal case82 between a hong kong buyer and a prc seller, the tribunal reached its conclusion that the prc law is applicable. the tribunal noted that both parties also agreed that the cisg shall apply when there is no certain regulation in prc law; hence, the cisg was applied as gap-filler for the prc law. in the kidney bean case,83 the parties did not stipulate the applicable law in the contract, but both referred to the prc law and the cisg to support their cases. the tribunal held that it should be deemed that parties agree that prc law should be the applicable law and the cisg should be applied as a gap-filling reference. again in the air conditioner equipment case84 between a hong kong seller and a prc buyer, the tribunal delivered the opinion that because the contract was formed in shenzhen, and the place of business of the buyer and the seat of arbitration were in the prc; pursuant to the proximate connection principle, the prc law was applicable. lacking an applicable stipulation in the prc law, the tribunal hed that the cisg is then applied. 1.5.4.5. cisg applied as international trade practice in the hot-rolled steel plate case,85 the contract did not contain a choice-of-law clause. the arbitration tribunal held that it has the power to decide the issue of applicable law and “ given that both the conclusion and the performance of the contract had the closest connections with the prc and the seat of arbitration was also the prc, according to the principle of closest connection, the prc law shall apply to the contract in this case.” furthermore, since both parties have employed the cisg to support their arguments, the arbitration tribunal decided that reference can also be made to the cisg as relevant international trade practice, “ so long as they are not in conflict with the prc law” .86 so far there seems to be no direct case in which the cisg was rejected on the ground that it is in conflict with the prc law. however there is a case, bread improving tablets case87 between a hong kong and a prc parties that may shed some light on the meaning and the effects of “ so long as they are not in conflict with the prc law” . there were two contracts in this case with identical contract number, date, goods, and quantity. the main difference was that the price of goods in the first contract was us $3,060 per ton totalling us $275,400, and in the second contract it was us $1,530 per ton for a total of us $187,000. after investigation by the tribunal, it was clear that the second contract was made to evade prc custom duties. therefore by virtue of article 9 of the law of the people's republic of china on economic 82 china 11 april 1997 cietac arbitration proceeding (silicon metal case) [translation available] [cite as: http://cisgw3.law.pace.edu/cases/970411c1.html] 83 china 27 june 1997 cietac arbitration proceeding (kidney beans case) [translation available] [cite as: http://cisgw3.law.pace.edu/cases/970627c1.html] 84 china 5 april 1999 cietac arbitration proceeding (air conditioner equipment case) [translation available] [cite as: http://cisgw3.law.pace.edu/cases/990405c1.html] 85 china 22 january 1998 cietac arbitration proceeding (hot-rolled steel plate case) [translation available] [cite as: http://cisgw3.law.pace.edu/cases/980122c1.html] 86 ibid 87 china 27 february 1993 cietac arbitration proceeding (bread improving tablets case) [translation available] [cite as: http://cisgw3.law.pace.edu/cases/930227c1.html ] http://cisgw3.law.pace.edu/cases/970411c1.html http://cisgw3.law.pace.edu/cases/970627c1.html http://cisgw3.law.pace.edu/cases/990405c1.html http://cisgw3.law.pace.edu/cases/980122c1.html http://cisgw3.law.pace.edu/cases/930227c1.html nordic journal of commercial law issue 2006 #2 23 contracts involving foreign interests,88 the second contract was void for violating prc law and social and public interest. as the parties did not choose the applicable law, the tribunal decided to apply the prc law only, on the basis that the contract was signed in harbin, china, and according to the principle of closest relation with the contract, the applicable law would be where the contract was signed, i.e. the prc law. obviously the tribunal did not expressly rely on the “ illegality/public interest” point to exclude the application of the cisg, but attention was drawn to the fact that this was a very rare case where the prc law was applied in a foreignrelated case without even referring to the cisg, albeit the hong kong seller (claimant) requested to apply the cisg. 1.5.4.6. cisg applied “ naturally” without reason? in cold-rolled steel plate case,89 the tribunal simply applied the cisg so naturally without even dealing with the issue of applicable law. in its award, it directly applied the cisg in dealing with the issue of mitigation and reduction of price. having quoted article 50 of the cisg in full, the tribunal decided that the hong kong seller was liable for the prc buyer for the amount of the difference between the value of the defect goods and that of the conforming goods at the time of delivery. again in the talcum block case between a prc buyer and a hong kong seller, the arbitral tribunal did not deal with the applicable law at all, but simply applied article 40 of the cisg and held that the seller is not entitled to rely on the provisions of article 38 and 39 regarding the time limit for the buyer's inspection of the goods and for giving notice to the seller of the nature of the lack of conformity if the lack of conformity relates to facts of which the seller knew or could not have been unaware. 1.5.4.7. cisg applied in parallel with the prc law in the refrigeration equipment case,90 the parties, a hong kong seller and a prc buyer, did not provide for the applicable law in the contract. during the court session, when the arbitration tribunal asked the parties for their opinions, the parties unanimously agreed that the applicable laws of this case are: (1) the laws of the people's republic of china (prc); and (2) although hong kong is not a party that subscribed to the united nations convention on contracts for the international sale of goods (cisg), the parties agreed to apply cisg as well; (3) since this case relates to letters of credit, the uniform customs and practice for documentary credits (ucp 500), the international chamber of commerce's no. 500 publication, is also applicable. these agreements were respected by the arbitration tribunal. accordingly, the cisg has been applied in parallel with the prc law. 88 article 9 of the law of the people's republic of china on economic contracts involving foreign interests stipulates that contract violating prc law and/or made against social and public interest is void, but parties can amend the contract by agreement to cure the contract and make it valid. 89 china 30 july 1998 cietac arbitration proceeding (cold rolled steel plates case) [translation available] [cite as: http://cisgw3.law.pace.edu/cases/980730c1.html] 90 china 28 january 1999 cietac arbitration proceeding (refrigeration equipment case) [translation available] [cite as: http://cisgw3.law.pace.edu/cases/990128c1.html] http://cisgw3.law.pace.edu/cases/980730c1.html http://cisgw3.law.pace.edu/cases/990128c1.html nordic journal of commercial law issue 2006 #2 24 in the gray cloths case,91 the hong kong buyer and the prc seller agreed in their contract that the prc law and the cisg shall apply to disputes. the arbitration tribunal thus applied both the cisg and the prc law in parallel. 1.5.5. cisg has been applied to contracts between parties from taiwan and prc so far there is only one taiwan case identified and published in the pace cisg database. the chemical cleaning product equipment case92 was between a taiwan seller and a prc buyer. parties did not provide in the contract for the applicable law, but during the hearing, parties explicitly agreed to apply the prc laws to resolve the disputes under the contract and that where there is no applicable regulation in prc laws, the cisg should be applied. therefore, the arbitral tribunal decided to apply the cisg as a gap-filling law. 1.5.6. cisg has been applied to contracts between parties from macao and prc in the wool case 93 the contract did not stipulate the applicable law. the arbitral tribunal held: “ china and portugal, of which macau is under the jurisdiction at present, are parties of the united nations convention on contracts for the international sale of goods (cisg), and the parties did not exclude the application of cisg, so when the contract does not stipulate or not stipulate clearly the applicable law, the cisg applies to this case” again, in the natural rubber case94 between a prc buyer and a macao seller, parties did not stipulate the applicable law in the contract. the arbitral tribunal held that china and portugal, which macau at that time belonged to, are parties to the cisg. since the parties to the contract did not exclude the cisg, the tribunal decides that cisg was applicable. the above reasoning was also repeated in the steel channels case95 between a macao seller and a prc buyer, who did not stipulate the applicable law in their contract. again the tribunal took it for granted that since portugal is a contracting state of the cisg, the contract should be governed by the cisg. the above three pre-1999 macao and prc cases were decided when macao was still under the jurisdiction of portugal before it was returned to china on 20 december 1999. it is interesting that the tribunals have made the same mistake in all the three cases in taking it for granted 91 china 2 april 1999 cietac arbitration proceeding (gray cloths case) [translation available] [cite as: http://cisgw3.law.pace.edu/cases/990402c1.html] 92 china 20 april 1999 cietac arbitration proceeding (chemical cleaning product equipment case) [translation available] [cite as: http://cisgw3.law.pace.edu/cases/990420c1.html ] 93 china 27 february 1996 cietac arbitration proceeding (wool case) [translation available] [cite as: http://cisgw3.law.pace.edu/cases/960227c1.html] 94 china 4 september 1996 cietac arbitration proceeding (natural rubber case) [translation available] [cite as: http://cisgw3.law.pace.edu/cases/960904c1.html] 95 china 18 november 1996 cietac arbitration proceeding (steel channels case) [translation available] [cite as: http://cisgw3.law.pace.edu/cases/961118c1.html] http://cisgw3.law.pace.edu/cases/990402c1.html http://cisgw3.law.pace.edu/cases/990420c1.html http://cisgw3.law.pace.edu/cases/960227c1.html http://cisgw3.law.pace.edu/cases/960904c1.html http://cisgw3.law.pace.edu/cases/961118c1.html nordic journal of commercial law issue 2006 #2 25 that portugal is a contracting state of the cisg.96 as we know in fact portugal has never been a contracting state of the cisg. however it is submitted that the tribunal may well correctly apply the cisg on any other valid grounds that have been applied in between hong kong and prc parties, e.g. applying the cisg as international trade practice. it would be interesting to see whether cietac employs a different approach in applying the cisg in macao-prc case after the return of macao to prc in 1999. so far the pace database has not yet published any such macao-prc case decided after the return in 1999. but it is submitted that the approaches in dealing with macao-prc cases would not and should not differ much from those that have been applied in hong kong-prc pre-1997. as a matter of fact, the current prc law and practice have always taken consistent and/or similar approaches in dealing with matters concerning the three special regions, i.e. hong kong, macao and taiwan. 1.5.7. justification of the application of the cisg in arbitration indeed unlike a state court, arbitration tribunal enjoys more freedom and liberty in deciding the applicable law and the application of an international private convention such as the cisg.97 an arbitrator should concern himself or herself much less in terms of conflict law rules or territoriality.98 rather, the arbitrator can either consider that parties explicitly or implicitly agreed on choosing the cisg, or find that no choice of law has made and then apply the cisg as he or she considers such a choice to be appropriate.99 given that arbitrators have much broader discretion in arbitration, even though the cietac awards are wrong in the reasoning on the ground that portugal100 is a contracting state of the cisg, their choice of the cisg as applicable law will not and should not be subject to review by state courts, for the review of arbitral awards on the merits is prohibited by the new york convention and the vast majority of national arbitration legislations. 96 see wu, dong 2005. cietac's practice on the cisg, presentation at uncitral-siac seminar on celebrating success: 25 years united nations convention on contracts for the international sale of goods, singapore (22 september 2005) 43 p. at para 1.4 application in error; see also nordic journal of commercial law <http://www.njcl.utu.fi/2_2005/article2.htm> 97 see alexis mourre, application of the vienna international sales convention in arbitration, icc international court of arbitration bulletin vol.17/no.1 2006 98 ibid 99 ibid 100 besides portugal, japan and republic of korea (before 2005) have also been mistakenly regarded as contracting states of the cisg in cietac arbitration. see hot-rolled coils case of 15 december 1997 china 15 december 1997 cietac arbitration proceeding (hot-rolled coils case) [translation available] [cite as: http://cisgw3.law.pace.edu/cases/971215c1.html] where republic of korea was mistakenly thought as contracting state of the cisg. see award of 7 november 1996 [cisg/1996/50] (stone products case). other examples as: award of 2 april 1997 [cisg/1997/03] (wakame case); award of 15 december 1997 [cisg/1997/34] (hot-rolled coils case) where japan was mistakenly believed to be a contracting state of the cisg. http://www.njcl.utu.fi/2_2005/article2.htm http://cisgw3.law.pace.edu/cases/971215c1.html nordic journal of commercial law issue 2006 #2 26 conclusion it is evident that the internal need for social, political and economic development of the prc pushed the country to reform and open up to the outside world. the reform and opening up led to international exchange of not only goods in trade but also values in culture, perhaps more importantly, concepts and ideas in social, political and legal structures. the shocks and crashes involved during the process of massive international exchanges could perhaps hardly be avoided, but could also emblaze beautiful sparkles. the cisg is one of the most glorious sparkles created by tremendous international interaction and exchange among the vast majority of nations and states which participated and contributed proactively. from having no relevant legislation in 1980 to the promulgation of three most important legislations in the areas of contract and civil law in 1986 before it rectified the cisg, the prc had leapt to the modern and advanced theory and legislation of contract law, from scratch. the comparative and selective approach widely and wisely adopted by the prc legislations accelerated the modernisation of prc law and contributed to the building and modernisation of the whole legal system and structure, which can then back up the further economic development. the 1980 diplomatic conference was a great experience for the prc legislators in every sense, and thanks to the cisg. the cisg’s impacts on the prc legislation are undeniable. the three pieces of legislation, the prc economic contract law 1981, the foreign-related economic contract law 1985 and the prc general principles of civil law 1986 were in the first place issued to accommodate the ratification of the cisg in the prc. the deliberate separation legislation for international, or the so-called “ foreign-related” contracts, and the specific prescription for mandatory written forms were evidence of this, albeit unexpectedly being on the opposite position as encouraged by the cisg. yet these opposite positions taken by the prc at that time upon ratification of the cisg by way of reservations did not and could not survive the test of practice. the subsequent prc contract law 1999 amalgamated domestic and foreign-related contracts and abandoned the formality requirements. this roundabout in the prc’s legislation history, on the one hand witnessed the evolution and development of the prc, on the other hand evidenced the victory of the cisg. history reveals the truth! it is felt that over the years the compromise character of the cisg as an outcome of political and diplomatic negotiations has been overstated and mistakenly overemphasized. all those well respected scholars, who had contributed outstandingly to unify the law on the international sale of goods since as early as the 1920s, from ernst rabel to vittorio scialoja, from peter schlechtriem to many others, they and their guts and courage to pursue a dream of the unification of international sales law in the first place, deserve more appraisal and emphasis. the ongoing efforts offered by the uncitral, the working groups, and all the delegations of participating states deserve more acknowledgements as well. the guts and courage, the openness, the wisdom and the intelligence crystallized in the cisg are remarkable. soon after the success of the cisg, the unification and harmonisation movement was spread over the areas of commercial law and private law. the cisg is a milestone in the history of international uniform law and its impacts have gone far beyond any individual nation, crossed the globe and passed through time and space. nordic journal of commercial law issue 2006 #2 27 yet we know that textual uniformity does not necessarily come hand in hand with legal uniformity. is the application of the cisg in china different from those in other countries? is it a serious threat or a genuine effort to the uniformity aimed at by the cisg? how compatible is chinese doctrine and practice with international standards and principles as elaborated by the cisg? in order to answer these main concerns, large amount of cases and arbitral awards are needed to support a meaningful empirical study on this important area of law. the bundle of about twenty cietac awards reviewed in this article is really merely a tip of the iceberg. there is an abundance of cietac awards and prc court decisions on the cisg. the study of cietac awards in this article does not mean to be exhaustivel, but simply intends to be a starting point for further research and reference. a more detailed and elaborated study of the interpretation of the cisg in the prc will be followed in the next part of this research. nonetheless, the above cietac cases have evidenced that the principle of party autonomy has been respected and observed correctly. the tribunals will apply the cisg when parties have explicitly or implicitly chosen the cisg. it seems common for the tribunals to apply the prc law while at the same time with reference to the cisg, or “ in light of” of the cisg. it seems somehow natural for the tribunals to apply the cisg as gap-filling of the prc law, with the presumption that the prc law has gaps in dealing with international sales contracts. it also seems common to apply the cisg in parallel with the prc law. the cisg has definitely been applied as international trade practice in some instances. it also seems plain that the current prc law and practice does not stress solely on the place of business, but takes into account some foreign-related elements in deciding whether to apply the cisg or not. the cisg has been applied between two prc parties, two hong kong parties, parties from the prc and hong kong, the prc and macao, the prc and taiwan. from the review of the cietac cases above, we have already been able to sense a strong flavour of the willingness of cietac arbitrators in applying the cisg whenever possible, even in some situations where the application of the cisg would seem to be not so right in theory. the recognition, acceptance and appreciation of the value of the cisg as not only an international convention but also a standard, a set of rules reflecting international practice, in cietac arbitration practice and in prc general legal practice at large are very encouraging indeed. there are problems, not surprisingly. the reasoning for the application of the cisg is not always comprehensive, more often too short or even without spelling out any reason or the rationale employed to support the tribunal’s decision. on the other hand, it is submitted that a more liberal and confident approach should be taken by the arbitration tribunals in applying the cisg, bearing in mind that arbitrators enjoy much broader discretion in deciding the issue of applicable law. when parties have made no choice of law, if arbitrators consider a choice of the cisg to be appropriate, they can do so more confidently by all means. as an application of the conflict of law rules or an analysis of territoriality, place of business is not at all a prerequisite in international commercial arbitration, where party autonomy and arbitrator’s discretion triumph. more importantly, it is felt that the cietac arbitral awards have made too little or no reference at all to cases and/or awards decided in other jurisdictions. it is understood that unlike common law jurisdictions, cases and precedents play no significant role in the current prc law and practice. but it is submitted that in the application and interpretation of the cisg, an international uniform law, cross-border consultation is highly desirable and needed. nordic journal of commercial law issue 2006 #2 28 in this regard, the idea of global jurisconsultorium, a term offered by vikki rogers and professor albert kritzer in their comprehensive trade law thesaurus on terminology of international sales to denote the need for cross-border consultation in deciding issues of uniform law plays a fundamental and crucial role in achieving the harmonisation and unification of international sales law ultimately. in an article by camilla baasch andersen, she examined the genesis of the cisg, the scholarly jurisconsultorium from which it sprang, and the need for practitioners (i.e. judges, arbitrators and legal counsel) to extend the jurisconsultorium in practice to ensure uniformity. one of the most widely acknowledged cisg database, the pace database on the cisg offered by the institute of international commercial law of the pace university school of law, has located about 200 chinese arbitration awards dealing with the cisg. the most recent award shared on the database was dated may 2005.101 about 170 of these awards have been translated and published on the internet. as indicated by professor albert kritzer of the pace institute of international commercial law, if the trend during the five years preceding january 2000 continued during the five subsequent years, one could document the prc as the world’s leader in the volume of cases on peaceful resolution of international commercial disputes in reliance upon the cisg. there is no doubt that since the cisg came into force in 1 january 1988, many cases as well as arbitral awards have been decided under the cisg during the period of about 20 years of its application in china. with china’s entrance into wto, a great deal of interest in the research and study of the application and interpretation of the cisg in china has arisen. it is believed that the quality of cietac awards will be tremendously enhanced by engaging in the exercise of global jurisconsultorium, which promotes sharing and exchanging ideas and approaches in the application and interpretation of an international uniform law instrument such as the cisg. the reasoning behind the cietac awards will be enriched which in return will reinforce the persuasiveness of the awards and the observance of the rule of law in the cietac arbitration practice. to conclude, the general willingness in the application and reference to the cisg in the prc is very encouraging indeed. but more on-going efforts to make the application of the cisg in the prc more consistent and predictable and the need for prc legal profession (including lawyers, judges and arbitrators) to extend the jurisconsultorium in practice to ensure uniformity are called for. it is also hoped that prc court cases and arbitral awards will be made available for both domestic and international scholars, practitioners and traders to exchange ideas and share expertise and benefit from the global jurisconsultorium for the sake of the harmonisation and unification of the international sales law. it is further proposed that a thorough study and review of the prc court cases and arbitral awards on the cisg would be very useful for cietac, for the prc and for the world trade community at large. finally, embracing the concept and method of global jurisconsultorium in the application and interpretation of the cisg in the prc will make chinese jurisprudence more valuable in contributing to the global modernisation and harmonisation of the international sales law so as to achieve the uniformity aim of the cisg and the ultimate goal of facilitation of international trade. 101 see china 10 may 2005 cietac arbitration proceeding (hat case) [cite as: http://cisgw3.law.pace.edu/cases/050510c1.html] accessed on 15 december 2005. http://cisgw3.law.pace.edu/cases/050510c1.html nordic journal of commercial law issue 2006 #2 2 nordic journal of commercial law issue 2006 #2 3 taken from world trade organization database data from march 2004 http://stat.wto.org/countryprofile/ wsdbcountrypfview.aspx?language=e&country=cn 4 http://stat.wto.org/countryprofile/wsdbcountrypfview.aspx?language=e&country=cn 5 the share in world total exports and imports of merchandise. breakdown by main commodity group: agricultural products refer to food and raw materials, fuels and mining products include ores and other minerals; fuels and non-ferrous metals. manufactures refer to iron and steel, chemicals, other semi-manufactures, machinery and transport equipment, textiles, clothing and other consumer goods. 6 supra 2 3 1. introduction the people’s republic of china (prc) has long been a source of much speculation for economists and trade pundits; with its staggering population of 1,296,500,0003 it has become a force to be reckoned with. it is with china’s accession to the world trade organization (wto) on december 11, 2001 that one can assess the impact and volume of trade that has taken place over the past 5 years. to put this in perspective, worldwide china is ranked third overall in merchandise import and exports in 2004.4 also, in 2004 in the area of merchandise trade5 which consists of agricultural products, fuels and mining products, and manufactured products, china commanded a 6.46% share in the world’s total exports and 5.88% share in the world’s total imports.6 http://stat.wto.org/countryprofile/ http://stat.wto.org/countryprofile/wsdbcountrypfview.aspx?language=e&country=cn microsoft word neuman accepted changes _2_.doc nordic journal of commercial law issue 2009#2 shared responsibility under article 80 cisg by thomas neumann1 1 the author wishes to express his thanks to albert kritzer, bruno zeller, joseph lookofsky, morten midtgaard fogt and rené henschel for their comments. thomas neumann is a phd candidate at the centre for international business law at the aarhus school of business, master of laws from aarhus university and founder of the cisg nordic database (cisgnordic.net). nordic journal of commercial law issue 2009#2 2 i. introduction a promisor’s failure to perform will render it liable and a range of remedies will be available to the aggrieved party pursuant to articles 45 and 61 of the un convention on contracts for the international sale of goods (cisg).2 if the failure to perform has been caused by the aggrieved party, article 80 provides: a party may not rely on a failure of the other party to perform, to the extent that such failure was caused by the first party's act or omission. the provision applies to the situation where a promisee interferes with the promisor’s performance in such a way that it fails. honnold gives the example that a buyer might persuade officials in the country of import not to issue an import licence to the seller, thereby causing the seller to fail to deliver to the buyer in the country of import.3 the provision allows the defaulting promisor to be exempt from liability and it seems only fair that a promisee should not be able to obtain a benefit from interfering with the promisor’s performance. in this way, the provision has ‘… the seductive charm of a self-evident statement.’ 4 the defaulting promisor is exempt from liability, if the sole cause of interference is the other party to the contract. the wording ‘to the extent’ indicates that article 80 also applies to the situation of the promisee’s partial interference with the promisor’s performance. however, the article does not provide much guidance for the complex situations where both parties seem to have caused one party’s failure to perform, but without it being possible to delimit the consequences of each party’s contribution, e.g. where the parties have agreed that a method of inspection of the goods will be determined before delivery, but neither party takes steps to do so, thus making it impossible to determine whether the goods are defective due to the seller’s faulty production or the buyer’s defective inspection method.5 an apportionment of responsibility based on a comparison of the acts and omissions of the parties is needed, thus making it a situation of shared responsibility where the aggrieved party will have parts of a claim dismissed due to its own interference. in this article, the term ‘shared responsibility’ is used to describe situations where responsibility for a party’s failure to perform can be ascribed both to the defaulting and the aggrieved party to the contract. as a result, the aggrieved party will lose its right to remedies in part and the defaulting party will be partly 2 united nations convention on contracts for the international sale of goods, (adopted 10 march to 11 april 1980, entered into force 1 january 1988) 1489 unts 3 (cisg). 3 honnold, john o, uniform law for international sales under the 1980 united nations convention (kluwer law international, hague, 3rd ed. 1999), article 80, § 436.2. 4 ibid, article 80, § 436. 5 see also infra section 3.2, and footnote 69. nordic journal of commercial law issue 2009#2 3 liable. the literature is sporadic in this field and with a growing amount of case law addressing these situations, the aim of this article is to investigate the characteristics of shared responsibility situations. compared to other provisions in the cisg, article 80 has lived a quiet life. it could be argued that this is because it does not have an independent scope of application, especially compared to articles 77 and 79. in this article it is demonstrated how, despite its vague wording, article 80 has an independent scope of application. the primary focus of this article is on the particular situation known as shared responsibility and the problems arising from the need for a causal link. the choice between an objective and a subjective approach is also investigated. it is shown that there is a growing amount of case law expressing a concept similar to the one found in article 80. the basis for the conclusions are, besides the text of the cisg itself, scholarly works, preparatory works, case law and other international rules concerning sales. for the sake of uniformity one must not either use domestic law or compare domestic law to identify concepts under the cisg.6 in order to promote uniformity and the international application of the cisg, international principles like the upicc and the pecl could and should be used as aids to interpretation.7 the international rules looked into are the acquis principles (acqp),8 the draft common frame of reference (dcfr),9 the principles of european contract law (pecl),10 central’s transnational law digest and bibliography (tldb)11 and the unidroit principles (upicc).12 these international rules are not tied to a particular domestic legal system and therefore they are valuable sources of inspiration when the international character of the cisg is being considered. the upicc has particular added legitimacy as it is a clear expression of general principles.13 furthermore, soft law like the upicc expresses truly internationally recognized rules, since the adoption of non-recognized rules would make contracting parties choose other rules to govern their contracts. the entire success of soft law depends on its ability to produce rules that are recognized by the contracting parties, as it would otherwise become obsolete or redundant. it is beyond the scope of this article to compare domestic rules. 6 felemegas, john in felemegas (ed), an international approach to the interpretation of the united nations convention on contracts for the international sale of goods (1980) as uniform sales law (cambridge university press, cambridge 2007), pp. 27-29 and enderlein, fritz and maskow, dietrich, international sales law (oceana publications 1992), article 7, para. 9.2. 7 felemegas, p. 33. 8 principles of existing ec private law, acquis principles, 2007, by the acquis group (acqp). 9 principles, definitions and model rules of european private law, draft common frame of reference, interim outline edition (dcfr). 10 the principles of european contract law, 1999, by the commission of european contract law (pecl). 11 transnational law digest and bibliography, list of principles, 2008, by center for transnational law (tldb). 12 unidroit principles of international commercial contracts, 2004, (upicc). 13 felemegas, p. 34. nordic journal of commercial law issue 2009#2 4 two areas are dealt with in this paper. first, the scope of article 80 is defined and delimited. second, the particular situation of shared responsibility is investigated. during the drafting of the cisg the german democratic republic suggested supplementing article 79 by including a new article 80.14 the latter is not a mere extension of article 79 but it has its own independent sphere scope of application.15 as is demonstrated in the section immediately below, article 80 differs from the closely related rules in article 77 (mitigation) and article 79 (force majeure) in five major respects: firstly, their position in the structure of the cisg and the point in time at which they apply; secondly, the focus of the articles; thirdly, the cause of the detriment or loss that occurs; fourthly, the remedies that they affect; and finally, the extent of the duty to overcome or avoid the detriment or loss that occurs. ii. an independent scope position and point in time looking at the structure of the cisg, one can see that articles 77, 79 and 80 are positioned differently. the positioning of these articles cannot be ignored since headings are considered a part of the convention and since the positioning of the article was given consideration during the drafting of the convention.16 article 77, on the one hand, and articles 79 and 80, on the other, are not only positioned differently in the convention, but their applicability to preand post-breach situations is different. article 77 is placed under the heading ‘damages’ and concerns the calculation thereof. it primarily applies to post-breach situations, but it may already apply when a breach is threatened.17 articles 79 and 80 are both placed under ‘exemptions’, which presupposes that these two articles apply only in post-breach situations. when a breach has been established and attributed to a party, articles 79 and 80 provide for the possibility of being exempt from liability. 14 ‘summary records of the first committee, 28th meeting’ united nations conference on contracts for the international sale of goods (vienna 10 march – 11 april 1980) (28 march 1980) un doc a/conf.97/19, para.s 50-64. 15 schwenzer and manner, ‘the pot calling the kettle black: the impact of the non-breaching party's (non-) behavior on its cisg-remedies’ in andersen, camilla b. and schroeter, ulrich g. (eds), sharing international commercial law across national boundries festschrift for albert h kritzer on the occasion of his eightieth birthday (wildy, simmonds & hill publishing, london 2008), p. 474. 16 honnold, article 80, § 436.1. 17 lookofsky, joseph, understanding the cisg (kluwer law international, the netherlands, 3rd worldwide edition, 2008), p. 136 and schwenzer and manner, p. 481. nordic journal of commercial law issue 2009#2 5 focus the three articles investigated have a different focus. article 77 concerns the avoidance of loss and regulates situations where the aggrieved party has not mitigated the loss caused by the breaching party,18 whereas article 80 regulates a promisee’s own interference with the promisor’s performance. the difference between the two situations is that the former addresses the duty to mitigate potential or actual loss, whereas the latter is a question of contributory negligence, a distinction known to the cisg.19 the distinction broadly corresponds to the rules in the upicc and the pecl.20 as an example, article 7.1.2 of the upicc restricts the exercise of remedies and article 7.4.7 thereof limits, on the basis of fairness, the right to damages to the extent that the aggrieved party has contributed to the harm.21 according to the official upicc commentary, these provisions must be distinguished from articles concerning mitigation of loss22, which are dealt with in article 7.4.8 of the upicc. in comparison, the focus of article 79 of the cisg is on the existence of an impediment that can be said to be outside the defaulting party’s sphere of control, unforeseeable and unavoidable. the exemption is very narrow and typically comprises catastrophes, war, government bans, boycotts, etc.23 cause of detriment or loss the three articles apply to different areas when it comes to causation. the situation where a party fails to perform because of an impediment beyond its control is within the scope of article 79.24 article 80 covers a failure caused by an act or omission by the other party, whereas article 79 covers impediments. the two articles appear to supplement each other and are in this way in harmony25 and apply concurrently26. article 77 is different again: it applies to situations where a 18 stoll and gruber in schlechtriem, peter and schwenzer, ingeborg (eds), commentary on the un convention on the international sale of goods, 2nd english (oxford university press, oxford 2005), article 80, para. 2.a. 19 ibid, article 77, para. 6. 20 schwenzer and manner, p. 472. 21 international institute for the unification of private law, unidroit principles 2004 (unidroit, rome 2004), p. 242, para. 1. 22 ibid, pp. 242-243, para.s 2 and 4. 23 stoll and gruber in schlechtriem and schwenzer, article 79, paras. 1 and 10 and enderlein and maskow, article 79, para.s 3.1 and 3.6. 24 tallon, dennis, ‘article 80’ in bianca and bonell (eds) commentary on the international sales law (giuffrè, milan 1987), article 80, para. 2.2. 25 ibid. 26 stoll and gruber in schlechtriem and schwenzer, article 80, para. 2. nordic journal of commercial law issue 2009#2 6 party has not mitigated loss that was solely caused by the defaulting party27 and not by any impediments or by the aggrieved party itself. affected remedies the remedies affected are different in respect of the three articles. interference with a promisor’s performance in a way that falls under article 80 can affect all remedies,28 as the interfering party ‘… may not rely on a failure …’ at all. in contrast, article 79 affects only the liability to pay damages, according to paragraph 5 thereof. the wording of article 77 states that it applies to claims to damages. it is uncertain whether a broad interpretation can be used to justify applying article 77 to all remedies. this was rejected during the drafting of the convention and contradicts case law29, the wording and the positioning of the article. however some scholars argue that it can be applied to all remedies as a part of the principle of good faith.30 article 80 is placed under the heading ‘exemptions’, thus dealing with exemption from responsibility in all respects, affecting all remedies available. duty to avoid or overcome detriment or loss according to the wording of article 79, a defaulting party must pass the foreseeability threshold if it is to be exempt from liability. only impediments and consequences that the promisor could not reasonably avoid or overcome can excuse liability. the wording of article 77 is slightly less strict: the aggrieved party claiming damages must take ‘… such measures as are reasonable …’ in order to mitigate loss occurring from the other party’s breach. by comparison, article 80 does not comprise a duty to avoid or overcome a detriment or loss,31 at least not from its wording. article 7(1) applies to the interpretation of all articles in the cisg, but besides the requirement of good faith following from that provision, there is no obvious obligation under article 80 to avoid or overcome one’s own failure to perform when it 27 stoll and gruber in schlechtriem and schwenzer, article 77, para. 6 and article 80, para. 2 and schäfer, friederike, ‘editorial remarks on whether and the extent to which the unidroit principles may be used to help interpret article 80 of the cisg’ (commentary, july 2004) <www.cisg.law.pace.edu/cisg/biblio/schafer.html> accessed 27 august 2008, section 5. 28 stoll and gruber in schlechtriem and schwenzer, article 80, para. 2; schwenzer and manner, p. 475 and p. 478 and enderlein and maskow, article 80, para. 3.1. 29 oberste gerichtshof [supreme court], austria, roofing material case, 9 march 2000, <http://cisgw3.law.pace.edu/cases/000309a3.html> and uncitral, digest of case law on the united nations convention on the international sale of goods (2008), article 77, para. 1. 30 enderlein and maskow, article 77, para. 4. 31 schwenzer and manner, p. 475. nordic journal of commercial law issue 2009#2 7 has been caused by the contractual partner.32 it has been argued that in the situation where the promisee’s interference is not the only possible logical cause of the failure of performance it has to be determined on a case-by-case basis whether the promisor could have been expected to overcome the promisee’s conduct.33 consequently, the threshold for being exempt from liability is lower in article 80 than in articles 79 and 77, with article 79 the strictest of the three. this is illustrated in the yellow phosphorus case34, where a seller made incomplete deliveries. the seller claimed to be exempt from liability as the incomplete deliveries were caused partly by natural disaster in the seller’s region and partly by the buyer’s issuance of a non-contractual letter of credit. regarding the first cause, the tribunal stated that the seller could have overcome the impediment by acquiring substitute goods. by choosing not to, the seller was fully liable. regarding the second cause, it was stated that a contractual letter of credit is a ‘... precondition for the seller to deliver the goods, but not the necessary condition for the seller to prepare the goods.’ however, since the buyer did cause inconvenience, the claims made against the seller were reduced. comparative chart illustration 1 art. 77, mitigation art. 79, force majeure art. 80, interference focus mitigation impediment interference cause of detriment or loss solely by the failing party an impediment outside sphere of control the aggrieved party or both parties affected remedies damages damages all point in time where applicable from threat of breach when breach is occurring when breach is occurring duty to avoid or overcome consequence within reasonableness, according to wording within reasonableness, according to wording within good faith, under article 7(1) 32 stoll and gruber in schlechtriem and schwenzer, article 80, para. 5; enderlein and maskow, article 80 para. 3.3 and schäfer, para. 3(a). 33 schäfer, para. 3(a). 34 china international economic & trade arbitration commission [cietac], china, yellow phosphorus case, 9 august 2002, <http://cisgw3.law.pace.edu/cases/020809c1.html>. nordic journal of commercial law issue 2009#2 8 though the three articles may present similarities, the comparative chart above shows that the combination of the five investigated features are different, thus making the articles applicable to different situations. the salient feature of article 80 is that interference by the aggrieved party can result not only in total loss, but also partial loss of that party’s remedies in cases of shared responsibility. this logic is to be found also in article 50, where it is stated that a buyer’s claim for a price reduction is lost if it denies performance. even though we do not find the words ‘… to the extent …’, as in article 80, article 50 has been used to lower a price reduction proportionately.35 by comparison, article 77 covers the duty to reduce damage occurring as a result of the other party’s failure and article 79 deals with impediments that it is not possible to ascribe to any one party. iii. causation by both promisor and promisee three case types in this section the focus is on cases where ‘… the failures of the two parties are so closely interwoven that their effects cannot be delimited and attributed to the breach of contract.’ 36 it would seem unfair to absolve one party of responsibility entirely or to give full compensation, despite a party’s own contribution to the failure of performance. an either/or solution would not be just as it would either compensate the aggrieved party’s own wrongdoing or it would hold the defaulting party liable for a failure from which it could normally be exempted; this has been described as‘the pot calling the kettle black …’.37 these cases are described as cases of shared responsibility.38 in general, the cases that can justify exempting a promisor from liability under article 80 can be grouped into three categories, as set out below. 35 the link confirmed in oberlandesgericht koblenz [provincial court of appeal], germany, acrylic blankets case, 31 january 1997, <http://cisgw3.law.pace.edu/cases/970131g1.html>, where the same interference by the buyer meant a loss of price reduction pursuant to article 50 and loss of damages pursuant to article 80. see also china international economic & trade arbitration commission [cietac], china, diaper machines case, 8 august 1998, <http://cisgw3.law.pace.edu/cases/960808c1.html>, where the price reduction pursuant to article 50 was lowered due to joint causation. 36 enderlein and maskow, article 80, para. 6.c. 37 schwenzer and manner, p. 470. the phrase is used to describe ‘… someone accusing another of faults similar to those committed by himself’ according to room, adrian and brewer, ebenezer cobham, brewer’s dictionary of phrase and fable, (cassell, london, 15th edition, 1995). 38 responsibility refers to the fact that either the promisor or the promisee will be responsible for the promisor’s failure to perform and thus having to bear the consequences thereof. the promisor is responsible for its failure to perform unless it can be exempted due to interference by the promisee. shared refers to the outcome of the apportionment called for. each party may bear the responsibility in part, thus leading to a partial dismissal of the aggrieved party’s claim. nordic journal of commercial law issue 2009#2 9 the first category covers cases where the promisor’s failure to perform is caused solely by the promisee, e.g. when a buyer sues the seller for damages because of non-delivery caused by the buyer’s persuasion of state officials to deny the seller a licence needed for it to deliver. 39 in cases of a promisee’s sole interference with the promisor’s performance, adjudicators have, by reference to article 80, exempted promisors from liability for: failure to pay the price40; failure to take delivery41; failure to designate port of shipment42; failure to deliver goods in conformity with the contract43; withholding of delivery44; unlawful avoidance of the contract45; and denial of the promisor’s cure of a lack of conformity.46 the second category comprises cases where there is joint causation by the parties and the consequences of each contribution can be delimited, e.g. when the promisor’s breach of contract in the form of late delivery is prolonged due to interference by the promisee. in such cases the promisee’s remedies apply to the former period but not to the latter.47 an example is a case of non-conformity in relation to 100 units of goods. if the first 50 units are faulty because of the promisor’s faulty packaging it would be responsible for this, whereas it will be exempt from liability under article 80 if the remaining units are faulty because of faulty instructions provided by the promisee. if each consequence can be delimited, this must be done. in these cases of joint causation ‘… the consequences of the different causes can be delimited from one another, [and] every cause has to be attributed its legal remedy.’48 these are not cases of shared 39 honnold, article 80, § 436.2. 40 oberlandesgericht münchen [provincial court of appeal], germany, leather goods case, 9 july 1997, <http://cisgw3.law.pace.edu/cases/970709g1.html>; belarusian chamber of commerce and industry international court of arbitration, belarus, att v. armco case, 5 october 1995, <http://cisgw3.law.pace.edu/cases/951005b5.html> and oberlandesgericht münchen [provincial court of appeal], germany, shoes case ii, 1 july 2002, <http://cisgw3.law.pace.edu/cases/020701g1.html>. 41 oberlandesgericht münchen [provincial court of appeal], germany, automobiles case, 8 february 1995, <http://cisgw3.law.pace.edu/cases/950208g1.html>. 42 oberster gerichtshof [supreme court], austria, propane case, 6 february 1996, <http://cisgw3.law.pace.edu/cases/960206a3.html>. 43 tribunal of international commercial arbitration, ukrainian chamber of commerce & trade, ukraine, equipment case, 21 june 2002, <http://cisgw3.law.pace.edu/cases/020621u5.html>. 44 landgericht kassel [district court], germany, wooden poles case, 21 september 1995, <http://cisgw3.law.pace.edu/cases/950921g1.html>. 45 oberlandesgericht düsseldorf [appellate court], germany, shoes case i, 24 april 1997, <http://cisgw3.law.pace.edu/cases/970424g1.html>. 46 germany, acrylic blankets case. 47 enderlein and maskow, article 80, para. 6.a.aa. 48 enderlein and maskow, article 80, para. 6.a. nordic journal of commercial law issue 2009#2 10 responsibility in the context of this article as it is possible to attribute a specific consequence to each cause. each party must bear the consequences of its respective interference.49 the third category is cases where there is joint causation by the parties, but it is not possible to delimit the consequences of each party’s contribution since the acts and/or omissions of both parties could potentially have caused the promisor’s failure to perform. these are cases of shared responsibility. as will be explained immediately below, there is good support for the proposition that the appropriate solution in cases of shared responsibility is a pro rata apportionment of the responsibility in accordance with each party’s contribution. however, fundamental uncertainties are exposed in the attempt to reach such a solution. these are due to unresolved questions as to the requirement of a causal link50 and confusion as to the appropriate approach in comparing the parties. having concluded supra section 0 that article 80 has an independent scope of application, this section deals in particular with the third category of shared responsibility and the issues arising therefrom. apportionment is appropriate compared with an all-or-nothing approach, the possibility of apportioning detriments and losses in accordance with the relative contribution of the parties ‘… represent[s] a conceptually refined solution’.51 it has support in preparatory works, literature, other international rules and case law. following a question from norway during the preparation of the cisg, it was clarified that the wording ‘… in so far as …’52 in article 80 allows the court to determine each party's share of the responsibility.53 a minority do not find in article 80 the legal basis for a pro rata apportionment of the consequences in cases of shared responsibility54; however, they do support the solution per se. 49 this is not saying that the attribution is without difficulty, but it is beyond the scope of this paper to investigate this matter further. see enderlein and maskow, para. 6.a.aa.-ab. for suggested solutions. 50 the words causal link is here used to describe the fact that in order for article 80 to apply there needs to be a connection between the promisee’s conduct and the promisor’s failure to perform. the nexus may vary in strength. 51 schwenzer and manner, p. 487. 52 this was the wording of the article being discussed. article 80, as worded in the cisg, reads ‘… to the extent that …’, which does not seem to change the applicability of the article to cases of shared responsibility. 53 ‘summary records of the first committee, 30th meeting’ united nations conference on contracts for the international sale of goods (vienna 10 march – 11 april 1980) (31 march 1980) un doc a/conf.97/19, para.s 1-18. nordic journal of commercial law issue 2009#2 11 under this view, article 80 is seen as an all-or-nothing solution. only cases where the failure to perform is caused solely by the other party can be subsumed under article 80.55 cases of shared responsibility are preferably solved by reference to article 77 or to the underlying principle of article 80. however, pro rata apportionment is nonetheless seen as the appropriate solution for shared responsibility, whatever the legal basis. however, the majority view is that article 80 applies to situations of shared responsibility56 and that an apportionment is appropriate in such cases. the concept of shared responsibility is not unknown within the cisg. a similarity can be seen in the arrangement of articles 39, 40 and 44. the starting point here is that a buyer will lose all available remedies if it does not give notice of a non-conformity within a reasonable period of time. however, the loss of remedies can be partial, depending on the circumstances. the concept of shared responsibility is also found in article 50, which has been used as the legal basis for a partial loss of price reduction.57 the pecl, upicc and acqp also suggest an apportionment in situations of partial interference by the promisee. the close similarity between the relevant provisions in these instruments and article 80 of the cisg on this issue not only indicates that a pro rata solution is the appropriate and widely agreed solution in international trade. it also acts as an interpretation aid for the cisg in a way that takes account of its international character, in accordance with the method set out in article 7 of the cisg. concerning the upicc, bonell indicates that the situation where the conduct of the promisee makes performance by the promisor impossible58 falls within the scope of article 7.1.2 thereof (interference by the other party). that article also comprises the situation where the conduct of the promisee acts as a partial impediment to the promisor’s performance59; it is very similar in this respect to article 80 of the cisg. such similarity can also be seen in article 7.4.7 (harm due in part to the aggrieved party), which gives the opportunity to assess the contribution of the harm and apportion correspondingly.60 54 huber, peter and mullis, alastair, the cisg, (sellier, european law publishers, 2007), pp. 267-268 and stoll and gruber in schlechtriem and schwenzer, article 80, para. 7, n. 24 where the authors in support of this view are listed as: piltz, schmid, koziol, soergel/lüderitz/dettmeier and, with some restrictions, achilles. 55 piltz, burghard, internationales kaufrecht [international law of sales] (c. h. beck münchen, 1993), § 4, para. 214. 56 schäfer, para. 4.a.; enderlein and maskow, article 80, para. 6.; tallon in bianca and bonell, article 80, para. 2.4-2.5 and stoll and gruber in schlechtriem and schwenzer, article 80, para. 7, n. 28 where the authors in support of this view are listed as: audit, bianca/bonell/tallon, enderlein/maskow/strohbach, herber/czerwenka, neumayer/ming, ziegler, staudinger/magnus, bamberger/roth/saenger and schlechtriem. 57 see for example cietac, diaper machines case, where the price reduction pursuant to article 50 was lowered due to joint causation. 58 upicc commentary, p. 194, para. 1. 59 ibid, p. 195, para. 1. 60 schäfer, para. 4.b. nordic journal of commercial law issue 2009#2 12 an apportionment in cases of shared responsibility is also the suggested solution under article 8:101(3) of the pecl.61 in the commentary62 to the pecl it is stated that when loss is caused by both the promisor and the promisee, the whole range of remedies should not be available. the wording ‘… to the extent …’ in articles 8:101(3) and 9:504 of the pecl is the same as in article 80 cisg and it too covers the situation of partial causation of the aggrieved party. the wording is also to be found in the acqp63, where the preliminary comments to article 8:102 state that an apportionment should be allowed.64 the wording ‘… to the extent …’ is not to be found in either the dcfr or the tldb. however, the former instrument does deny the aggrieved party access to remedies in situations where that party itself caused the promisor’s failure to perform.65 whether an either/or solution or apportionment is appropriate is not clarified. furthermore, it is uncertain whether either no. i.4 (no advantage in case of own unlawful acts) or no. x.1 (unjust enrichment) of the tdlb comprises shared responsibility and permits an apportionment. however, the solution of apportionment is not directly rejected in either of the two abovementioned sets of rules. with such great support in both scholarly works and other rules relating to international sales it is striking to see that adjudicators have yet to make a pro rata apportionment with express reference to article 80 of the cisg.66 it is just as striking to see that there are several cases where an apportionment has been carried out67: without any reference to the legal basis for doing so, and in some cases with multiple references to provisions other than article 80 of the cisg.68 the cases in which a pro rata apportionment has been carried out can be seen as confirmation that an apportionment is the appropriate solution and that the way to reach that result has been considered as being of secondary importance. the adjudicator may have been searching 61 a similar principle is seen in pecl article 9:504 (loss attributable to aggrieved party). 62 lando, ole and beale, hugh, principles of european contract law (kluwer law international, the hague, 2000), specific comments on 8:101(3), pp. 359-362. 63 the acqp is meant to contribute to the common frame of reference by showing common principles of existing ec contract law. see schulte-nölke, hans, ‘the commission's action plan on european contract law and the research of the acquis group’, (2003), 2 era forum 142, p. 144. 64 schulze, reiner (ed), common frame of reference and existing ec contract law (sellier, munich, 2008), p. 307, para. 4. 65 dcfr iii. – 3:101 (remedies available). 66 a good number of cases concerning sole interference by the promisee have been decided with express reference to article 80, see supra footnotes 40-46. 67 for details see infra 3.3.3. the majority of cases conducting apportionments are from china. this may be due to the fact that chinese contract law provides for the possibility of a pro rata apportionment. 68 see for example icc international court of arbitration, food products case, december 1997, <http://cisgw3.law.pace.edu/cases/978817i1.html> and tribunal of international commercial arbitration at the russian federation chamber of commerce and industry, russia, sensitive russian components case, 6 june 2003, <http://cisgw3.law.pace.edu/cases/030606r1.html>. described further infra section 3.3.3. nordic journal of commercial law issue 2009#2 13 for the legal basis to support what the adjudicator and the parties would consider a fair result. not referring to the legal basis for a result is harmful to the goal of uniform application laid down in article 7(1). having said that, the outcome of the cases seems to be correct and, especially in arbitration cases, the adjudicator may rightfully be more concerned with the outcome than a formalistic reference to a specific provision. to illustrate: in the sensitive russian components case69 between a russian seller and a south korean buyer, the arbitral tribunal reduced the damages by one-third by reference to the cisg, the upicc and the russian federation civil code. the goods in question were highly sensitive components that the parties agreed were defective, as proved by the buyer’s examination. however, the parties did not agree what caused the defect, thus making the case a dispute as to causation (liability) and not mitigation of the loss that resulted (amount of damages).70 it was suspected that the inspection had in itself damaged the goods. the arbitral tribunal found that, due to prior dealings, the buyer was entitled to inspect the goods in the way that it did, since the seller failed to instruct the buyer otherwise. the tribunal also found that both seller and buyer, being experts within the field, had contributed to the goods being defective by not setting procedures and methods for inspection. as the tribunal stated: ‘both parties failed to take steps necessary to duly perform their obligations under the contract.’ the tribunal considered articles 74 and 77 of the cisg and brought in article 7.4.7 of the upicc to determine that a party’s act or omission may demonstrate participation in the creation of damages. the tribunal then found it appropriate to apply a principle of shared responsibility: it placed responsibility for two-thirds of the damage on the seller and dismissed the remaining one-third. this was also to be found to be in line with article 404(1) of the russian federation civil code. it appears to be unnecessary to refer to the domestic civil code. furthermore, it is contrary to the method set out in article 7, according to which a solution is only to be found outside the cisg if no solution can be reached within the cisg itself,71 for example in article 80. besides this, the apportionment conducted in the case cited above is in itself in line with article 80 cisg and scholarly works, and it appears to be the widely accepted solution in international trade. the case illustrates that a pro rata apportionment was seen as the right solution and that pinpointing a legal basis is of secondary importance. the adjudicators did not find the legal basis in article 80, despite the fact that the situation is within the scope thereof. 69 russia, sensitive russian components. 70 see the distinction supra section 0. 71 schlectriem in schlechtriem and schwenzer, article 7, para. 35 and zeller, bruno, cisg and the unification of international trade law (routledge-cavendish, new york, 2007), pp. 100-101. nordic journal of commercial law issue 2009#2 14 the outcome of the case is correct, but the articles cited by the arbitral tribunal either have a different scope from article 80 or overlap with it, so that reference could have been made to article 80 instead, thus observing the method established by article 7. articles 74 and 77 of the cisg do not directly provide an opportunity for an apportionment in cases of shared responsibility as they cover the calculation of damages, as explained supra at section 0. article 404(1) of the russian federation civil code72 and article 7.4.7 of the upicc do on the other hand provide an opportunity for an apportionment where both parties have caused the failure to perform, but they are outside the text of the cisg. the four provisions referred to by the adjudicators apply to two different situations: the duty to mitigate loss occurring in post-breach circumstances and a prohibition on interfering with the promisor’s performance and at the same time deriving a benefit from it. a similar situation was seen in the bilateral commission case73 where a seller was found 75% liable by reference to articles 35, 36, 45 and 74 of the cisg and articles 475 and 476 of the russian federation civil code.74 similarly to the sensitive russian components case, in a case of shared responsibility an apportionment was found to be appropriate and, overlooking article 80, the legal basis was justified by means of multiple references. thus far it has been established that article 80 has an independent scope of application and that a pro rata apportionment is the appropriate and widely accepted solution in cases of shared responsibility. it has also been pointed out that there is a lack of guidance as to how to conduct such an apportionment and a clear tendency not to refer to article 80 as the legal basis. an apportionment in a case of shared responsibility invites a comparison of the parties. the lack of guidance relates to the factors that are relevant when conducting this comparison. these are dealt with immediately below. two issues in cases of shared responsibility it is widely agreed that an apportionment is appropriate in cases of shared responsibility,75 but the concept is not as refined as one might have hoped. this is due to the fact that article 80 is vague and an apportionment invites a comparative evaluation of the two parties in order to deduct a fraction according to which the responsibility, and consequently the remedies, can be 72 russian federation civil code article 404(1): ‘if the non-discharge or an improper discharge of the obligation has occurred through the fault of both parties, the court shall correspondingly reduce the scope of the debtor's responsibility. the court shall also have the right to reduce the scope of the debtor’s responsibility, if the creditor has intentionally or through carelessness contributed to the increase of the losses, caused by the non-discharge or by an improper discharge, or if he has not taken reasonable measures to reduce them.’ <http://www.russian-civil-code.com/parti/sectioniii/subsection1/chapter25.html>. 73 tribunal of international commercial arbitration at the russian federation chamber of commerce and industry, russia, bilateral commission, 29 december 2004, <http://cisgw3.law.pace.edu/cases/041229r1.html>. 74 articles 475 and 476 of the russian federation civil code cover the conformity of goods. 75 see supra section 3.2. nordic journal of commercial law issue 2009#2 15 apportioned.76 the problem with a comparative evaluation is twofold: firstly, it is uncertain how strong the requirement of a causal link between the promisee’s conduct and the promisor’s failure to perform is; and secondly, the approach and thus the relevant or mandatory factors when comparing the two parties are uncertain. these two issues are dealt with in turn below. causal link it should be pointed out that in this paper the term causal link refers to the fact that if a promisor is to be exempt from liability under article 80 there must be at least some connection between the promisee’s act or omission and the promisor’s failure to perform. however, the threshold that must be satisfied to be exempt is uncertain. put in an extreme way: one could either require that the interference must have been the direct and necessary cause of the failure, or an indirect and potential interference could be seen as enough to allow an exemption.77 the issue was not raised during the preparation of the cisg. one view is that the failure to perform must be the characteristic consequence of the other party’s conduct that can be expected in international trade,78 thus excluding situations with an unusual chain of cause and effect. a second view is that the conduct must have caused the failure to perform in a logical sense and that it must objectively be of such a nature that it prevents performance.79 under this view the cause cannot be attributed to a party’s conduct if it did not impair the ability to fulfil the contract.80 indirect causation is enough if the conduct created a risk within that party’s sphere of influence and that risk has been realized.81 a final view82 is that the requirement of a causal link changes focus depending on whether an objective or a subjective approach to the comparative evaluation is chosen. under an objective approach, the decisive criterion is the degree of probability that the conduct would result in the failure to perform, whereas the focus of the subjective method is the behaviour of the parties. since the latter would entail reverting to the notion of fault, the former is preferred. however, 76 though it may be difficult to apportion other remedies than damages it is not impossible, e.g. specific performance according to article 28 can still be available if the party claiming it indemnifies the seller its proportionate share in accordance with the causation fraction. see, for example, schwenzer and manner, pp. 479-480. 77 the question of causal link is equally relevant to all three case types described supra section 3.1. 78 enderlein and maskow, article 80, para. 5.1. 79 stoll and gruber in schlechtriem and schwenzer, article 80, para. 4. 80 ibid, article 80, para. 6. 81 ibid, article 80, para. 4. in support of the argument that indirect causation is enough to lose remedies under article 80 see also schäfer, article 3.a. 82 tallon in bianca and bonell, article 80, para. 2.5. nordic journal of commercial law issue 2009#2 16 the two approaches are related ‘…insofar as the more reprehensible the behavior of one party is, the more likely it is to have played an important causal role in the other party's failure to perform.’83 turning to case law,84 it can be seen that a promisee lost its right to remedies under article 80, even though the interference of the promisee did not make the promisor’s performance impossible, thus supporting a less strict requirement of the causal link. in the propane case85 between a german seller and an austrian buyer, the court found that the seller could not rely on the failure of the buyer to open a letter of credit. the seller did not name the place of loading, as it was agreed that it should and the buyer chose not to open the letter of credit. the cause of the buyer’s failure to perform was found to be the seller’s failure to name the place of loading, but opening the letter of credit would in fact still have been possible despite the seller’s failure. however, the court did not hold that the omission was necessary for the failure to perform and it stated that the buyer could not be obliged to open a blank letter of credit. a similar result was achieved in the soinco v. nkap case86, where the court stated that no reasonable business person would initiate payment when the seller had breached a primary obligation concerning delivery. in that particular case it was still possible to initiate payment despite the act of the seller. the two cases could either support a view that indirect causation is enough to become partialy exempt from liability for a failure to perform. however, they could also support an exemption from a requirement of direct causation insofar as demanding a blank letter of credit or initiation of payment would have put the buyer in a high-risk situation. no conclusion can safely be drawn from the insufficient amount of case law. there is no guidance to be found on the causal link issue in other international rules. this is due to the fact that those rules do not address the issue and they present the same uncertainty due to a close similarity to the cisg.87 relevant case law relating to other international rules has not been identified.88 83 ibid. 84 for an example of direct causation see: germany, automobiles case, where a buyer refused to take delivery. 85 austria, propane case. 86 zürich chamber of commerce, switzerland, soinco v. nkap case, 31 may 1996, <http://cisgw3.law.pace.edu/cases/960531s1.html>. 87 for example schäfer, para. 3.b. states that there is no interpretation aid to be found in upicc. 88 identified case law based on the upicc concerns direct causation. see: icc international court of arbitration, 9 october 2006, <http://www.unilex.info/case.cfm?pid=2&do=case&id=1177>; international arbitration court of the chamber of commerce and industry of the russian federation, russia, 2 september 1997, <http://www.unilex.info/case.cfm?pid=2&do=case&id=670>. a small indicator of allowing indirect causation was seen in icc international court of arbitration, march 2000, nordic journal of commercial law issue 2009#2 17 the issue of the causal link requirement remains mainly unresolved. there is support in favour of indirect causation being enough to bring article 80 into play. it seems correct to draw the limit for being exempt at cases that would put a party at high risk of not receiving something in return for its primary performance. the primary obligations of the two parties must be determined in each specific case using article 8 and, consequently, the issue of whether or not the causal link is strong enough to allow an exemption from liability is determined on a case-by-case basis. objective or subjective approach the second issue that arises in cases of shared responsibility is the pro rata apportionment based on each party’s contribution,89 which requires a comparison of the parties. the comparative evaluation reveals a set of unresolved issues that stretches beyond the scope of article 80 itself. basically, the question is how the adjudicator should approach a case where both parties seem to have caused the promisor’s failure to perform, i.e. shared responsibility. it has been suggested that two approaches to the comparison are possible: an objective and a subjective approach.90 an objective comparison involves assessing the probability that the conduct caused the failure to perform, whereas the subjective approach compares the gravity of the conduct of the parties, thus bringing it closer to the idea of fault.91 it has also been suggested that the objective approach is to be preferred as it is in line with the no-fault liability rule in the cisg, the spirit of the convention and the letter of the text. 92 however, the favoured objective approach is not followed strictly since: ‘… the more reprehensible the behaviour of one party is, the more likely it is to have played an important causal role in the other party’s failure to perform.’ 93 the reservation allows relevant tortious behaviour to be included in the evaluation as part of the good faith requirement, as long as the tort has a connection with the failure to perform.94 it seems contradictory to favour an objective approach based on the no-fault concept yet at the same time bring in highly subjective standards of good faith and tort. the reservation to the objective approach brings it closer to the slightly different alternative view under which cases of <http://www.unilex.info/case.cfm?pid=2&do=case&id=697>, where it was stated that it is contrary to the principle of good faith to ‘... indirectly [do] what the contract prevents from doing directly’. 89 see supra section 3.2. 90 tallon in bianca and bonell, article 80, para. 2.5. 91 ibid. 92 in support of the objective approach: tallon in bianca and bonell, article 80, para. 3.1., enderlein and maskow, article 80, para. 4. and ramberg & herre, internationella köplagen (cisg) [the international law of sales (cisg)] (nordstedts juridik ab, 2001), p. 554. 93 tallon in bianca and bonell, article 80, para. 2.5. 94 ibid, article 80, para. 2.3. also in favour of including tortuous behaviour in the evaluation is enderlein and maskow, article 80, para. 4. nordic journal of commercial law issue 2009#2 18 shared responsibility are resolved by reference to the respective degree of each party’s contribution to causation.95 under this alternative view, the distinction between an objective and a subjective approach is not followed. the relevant factors here are the probability that the conduct would lead to loss, the degree of negligence and the gravity of the breach,96 thus making the preferred approach a mix of an objective and a subjective approach. the preparatory works do not support a strictly objective approach. during the drafting norway asked to what extent article 80 presupposed that the other party was at fault. the answer given was that article 80 applies to situations of both fault and no fault. in line with the instruction in article 7(1) to have regard to the international character of the cisg, it is relevant to seek inspiration from other international sales laws.97 however, other relevant international rules favouring an apportionment98 do not indicate clearly whether an objective or subjective approach is to be preferred. case law case law seems to supports a less strict requirement as to the causal link and supports a subjective approach. cases that adopt a pro rata approach to shared responsibility with express reference to article 80 have yet to be clearly identified.99 the most clear reference is found in the russian goods case,100 where a seller was found to have showed ‘… a certain degree of negligence …’ that caused the buyer to delay its payment. in an obiter dictum the tribunal stated that had the seller claimed interest on money in arrears or damages caused by the late payment that claim would have been dismissed by virtue of article 80 of the cisg. the court found that the buyer was obliged to pay for the received goods as the seller had claimed. in several cases the principle in article 80 has been applied to situations of shared responsibility. the cases can be grouped in two categories: those overlooking the legal basis for 95 stoll and gruber in schlechtriem and schwenzer, article 80, para. 7. 96 ibid, article 80, para. 10. 97 it is beyond this paper to explain the method, advantages and disadvantages of filling in the gaps in the cisg by reference to other international instruments. 98 see supra section 3.2 where the rules calling for an apportionment are articles 7.1.2 and 7.4.5 of the upicc, 8:101(3) of the pecl and 8:102 of the acqp. 99 in china international economic & trade arbitration commission [cietac], china, hot-rolled coils case, 15 december 1997, <http://cisgw3.law.pace.edu/cases/971215c1.html>, the english abstract indicates that the decision is based on article 80, whereas this is not confirmed in the english translation of the case. the original chinese case text could not be retrieved. for case law where the failure to perform is caused solely by the aggrieved party, see supra footnotes 40-46. 100 tribunal of international commercial arbitration at the russian federation chamber of commerce and industry, russia, russian goods case, 10 june 1999, <http://cisgw3.law.pace.edu/cases990610r1.html>. nordic journal of commercial law issue 2009#2 19 the result in article 80 of the cisg, referring to several other international and domestic rules, and those that do not refer to any particular provision as the basis for the apportionment. in the first category we find the previously described sensitive russian components case101. the tribunal found that the principle of joint liability set out in article 404(1) of the russian federation civil code was appropriate, and it referred to article 7.4.7 of the upicc and articles 74 and 77 of the cisg as the basis for reducing the damages claimed by the buyer by one-third. a similar approach to the legal basis for apportionment is seen in the bilateral commission case,102 where the seller was found 75% liable by reference to principles of fairness and justice, articles 35, 36, 45 and 74 of the cisg, and articles 475 and 476 of the russian federation civil code.103 in the second category we find, among other cases, the food products case104. here the tribunal found that the seller was not entitled to invoke a clause in the contract allowing termination of the contract without notice. the reason for the termination was a substantial change in the management of the buyer’s company. however, the tribunal did not find this reason valid since the seller partially caused the dismissal of the general manager in the buyer’s company by having delivered goods in secrecy to the manager’s other company. no legal basis for the conclusion was given. a similar partial reduction of a claim without reference to a legal basis has been applied in shared responsibility cases where: delayed shipment was caused by the buyer’s many requests for modification of the goods and the seller’s non-request for postponed shipment date;105 deliveries were incomplete because of the buyer’s issuance of a non-contractual letter of credit and the seller’s failure to prepare the goods for delivery;106 production of goods were stopped at the buyer’s request and the seller did not object thereto, but without any party subsequently taking steps either to cancel or start production again;107 a payment was not made in full as the seller had given indications that could have led the buyer to believe that a set-off could be applied;108 goods could not be given a quality certificate and be shipped since neither the buyer 101 russia, sensitive russian components case. see also summary of the case supra section 3.2, p. 13. 102 russia, bilateral commission case. 103 articles 475 and 476 of the russian federation civil code cover the conformity of goods. 104 icc, food products case. 105 china international economic and trade arbitration commission [cietac], china, velvet clothes case, 13 september 2002, <http://cisgw3.law.pace.edu/cases/020913c1.html>. 106 cietac, yellow phosphorus case. 107 supreme court of people's republic of china, china, singapore da guang group v. jiangsu machines import & export ltd. case, 11 january 2001, <http://cisgw3.law.pace.edu/cases/010111c1.html>. 108 china international economic & trade arbitration commission [cietac], china, aureomycin case, 11 january 2000, <http://cisgw3.law.pace.edu/cases/000111c1.html>. nordic journal of commercial law issue 2009#2 20 nor the seller reacted to the fact that parts of the goods suffered from a non-conformity;109 a seller had to resell the goods at a lower price since the buyer did not revise a letter of credit and the buyer packed the goods in a non-contractual manner;110 a buyer had to deal with customs authorities detaining the goods and the seller did not cooperate in having the goods released;111 the rights and duties with regard to a failed trial run of a machine could not be resolved.112 the common factors in all cases113 of shared responsibility are that: firstly, an apportionment is carried out; secondly, the cisg is applicable, but the legal basis is not found in article 80 thereof; thirdly, the focus in the evaluative comparison of the parties is subjective; and fourthly, it is not possible to delimit the consequences of each party’s interference. the identified case law supports a subjective approach and a less strict causal link requirement. however, it suffers from not having identified the legal basis, which could have been done by reference to article 80 of the cisg. iv. conclusion, critique and questions from this investigation of international law, preparatory works, scholarly opinions and case law it can be concluded that article 80 does in fact have an independent scope of application in the cisg. the provision also addresses situations of shared responsibility and in such situations an apportionment of the responsibility is the solution called for. however, the possibility of being partially exempt from liability by reference to article 80 has to a large extent been overlooked in the case law, thus ignoring the potential for developing a uniform application of article 80 and the cisg. regarding the requirement of a causal link between the promisee’s conduct and the promisor’s failure to perform, it can be concluded from the case law that a lack of cooperation, disloyal conduct or conduct that could in itself potentially have caused the failure to perform is enough for the failing party to become partially exempt from liability. 109 china international economic & trade arbitration commission [cietac], china, raincoat case, 10 august 1999, <http://cisgw3.law.pace.edu/cases/990810c1.html>. 110 china international economic & trade arbitration commission [cietac], china, hot-dipped galvanized steel coils case, 16 december 1997, <http://cisgw3.law.pace.edu/cases/971216c1.html>. 111 china international economic & trade arbitration commission [cietac], china, steel channels case, 18 november 1996, <http://cisgw3.law.pace.edu/cases/961118c1.html>. note that the cietac wrongly presumes that portugal is a cisg state. compare the un treaty collection: <http://treaties.un.org/pages/viewdetails.aspx?src=treaty&id=228&chapter=10&lang=en>. 112 cietac, diaper machines case. 113 cietac, hot-rolled coils case; russia, russian goods case; russia, sensitive russian components case; russia, bilateral commission case; icc, food products case; cietac, velvet clothes case; cietac, yellow phosphorus case; china, singapore da guang group v. jiangsu machines import & export ltd. case; cietac, aureomycin case; cietac, raincoat case; cietac, hot-dipped galvanized steel coils case; cietac, steel channels case and cietac, diaper machine case. nordic journal of commercial law issue 2009#2 21 the investigation conducted in this paper raises a number of uncertainties that have yet to be clarified. firstly, in theory the cisg is based on a principle of no-fault liability.114 the core of no-fault liability is that liability for a breach is established regardless of culpability or fault. however, ‘good faith’ and ‘reprehensible behaviour’, have a core of blameworthiness, thus bringing the cisg in the direction of culpability and fault – and with good reason: there is a nexus between article 80 and the subjective principle of good faith.115 the precise content of the principles of good faith and reprehensible behaviour under the cisg is vague. the concept of good faith can on the one hand be seen as a narrow compendious term comprising nothing more than specific principles, or on the other hand as a broad concept from which rights and obligations can be derived.116 furthermore, subjectivity is not in itself unfamiliar to the cisg. it is the starting point in article 8, when the rights and duties of the parties have to be determined prior to a possible exemption of liability under article 80. in the case law, the comparative evaluation of the parties seems to be based on concepts of fault and negligence. a caveat must be pointed out, namely that the case law identified is from russia and china. it is possible that these two jurisdictions are affected by their national systems when solving international disputes: both chinese and russian domestic law allow apportionment.117 there is no sign of the adjudicators being aware of the distinction between an objective and subjective approach. further study is needed in this field. second, it cannot be clarified what standard is to be applied when assessing concepts of fault or negligence. this has the consequence that parties in international trade cannot be certain what rules or standards will apply to them. one might ask whether the parties can be allowed to prescribe this standard themselves. alternatively, the parties could opt out of article 80. however, this raises the question of whether article 80 and its underlying concept of good faith are mandatory or not. on the one hand, one should allow the parties to form the rules that apply between them in accordance with the autonomy of the parties recognized in article 6 of the cisg. on the other hand, a concept of good faith is, at least to some extent, included in the cisg. there can be 114 lookofsky, p. 109. 115 a nexus between article 80 and the principle of good faith is supported in scholarly writings and case law. see for example germany, automobiles case and bundesgerichtshof [federal supreme court], germany, surface protective film case, 25 november 1998, <http://cisgw3.law.pace.edu/cases/981125g1.html>, enderlein and maskow, article 80, para. 1.1 and stoll and gruber in schlechtriem and schwenzer, article 80, para. 1. 116 for an overview of the role of good faith in the cisg see: zeller in janssen, andré and meyer, olaf (eds), cisg methodology (sellier, munich, 2009), pp. 133-149. 117 article 404(1) of the russian civil code and article 120 of the contract law of the people’s republic of china, 1999. the chinese concept of bilateral breach has been criticised by ling, bing, contract law in china (sweet & maxwell, hong kong, 2002), pp. 397-399. nordic journal of commercial law issue 2009#2 22 little doubt that good faith applies to the interpretation of the cisg, as this appears directly from article 7(1). however, whether good faith applies as a general obligation between the contracting parties is disputed.118 a clarification regarding good faith and its mandatory character119 in the cisg is needed, as is a prioritisation of the principles of the autonomy of the parties, certainty and good faith. such clarification could reveal whether the parties can be allowed to exclude the application of article 80, which has been said to be based on good faith. though it might be convenient if good faith could be given specific content it may not be possible to do so. the cisg suffers from being a political document where the discussion of good faith was, as has been put forward, given an “…honourable burial…”120 in article 7. despite having been discussed, it clearly appears from the wording of article 7 that good faith was included in the convention. the evolution of the cisg will give the concept more specific content on an ex post basis. parties to international trade, adjudicators and law-makers would be better served by a clarification of the concept of shared responsibility: a concept that is currently in existence and is being applied without reference to the legal basis for doing so. clear references to the appropriate articles in the cisg will facilitate the development of concepts like the one expressed in article 80 and the cisg as a whole. based on the investigation in this paper, it can be concluded that despite the uncertainties, article 80 of the cisg does in fact have its independent scope and is applicable to situations of shared responsibility. if it is impossible to delimit the consequences of each party’s contribution, an apportionment is the appropriate solution. the relevant factors, the approach and the requirements of causal link need to be investigated further. it has been demonstrated that the case law, the cisg and other international sales laws all support a pro rata apportionment solution in cases of shared responsibility. the reason for this may simply be that we are observing an underlying global concept of which article 80 of the cisg is but one manifestation. future research may give the concept the clarity it deserves. 118 compare farnsworth, allan e, ‘duties of good faith and fair dealing under the unidroit principles, relevant international conventions, and national laws’ tulane journal of international and comparative law, volume 3, (1995), p. 56 and bonell, michael joachim, ‘article 7’ in bianca and bonell (eds) commentary on the international sales law (giuffrè, milan 1987), article 7, para. 2.4.1. 119 see for example zeller in janssen and meyer, p. 143. the requirement of good faith has expressly been made mandatory under the upicc: see article 1.7 (good faith and fair dealing). 120 keily, troy, ‘harmonisation and the united nations convention on contract for the international sale of goods’ nordic journal of commercial law, issue 1, (2003), p. 11, para. 3.4. * assistant professor, ph.d., department of private law, university of aarhus, denmark the duty to pay interest on advance payments under art. 84 (1) cisg by ana m. lópez-rodríguez* nordic journal of commercial law issue 2005 #2 nordic journal of commercial law issue 2005 #2 2 abstract one of the primary effects of contract avoidance is the restitution of performances already made. in this regard, art. 81.2 cisg authorizes either party to the contract who has performed in whole or in part to claim the return of whatever he has supplied or paid under the contract. furthermore, the parties must return all benefits of possession – profits and advantages of use. the buyer is only bound to return the benefits he actually derived from using the goods, or part of them (art. 84.2 cisg). likewise, if the seller is bound to refund the price, it must also pay interest on it, from the date on which the price was paid (art. 84.1 cisg). a closer look to the cisg reveals, however, that the convention does not settle – at least not expressly – the applicable interest rate under art. 84.1. this article attempts, accordingly, to determine the extent to which this issue is regulated in the cisg and how a possible gap is to be filled. special attention is paid to the practice of national courts on this matter. nordic journal of commercial law issue 2005 #2 1 civil law systems generally allow restitutionary claims by a defaulting party. see notes to pecl arts. 9:305-9:309, lando, o. and beale, h., principles of european contract law, parts i and ii, kluwer law international, 2000, p. 426 ss. common law is, however, more restrictive. except in a claim for the recovery of monies paid, (dies v. british& international mining& finance co., (1939) 1 k.b. 724, appvd. in stockloser v. johnson (1954) 1 q.b. 476, c.a.), a party in breach cannot bring a successful restitutionary claim unless he has substantially completed his performance or unless the other party is deemed to have accepted or agreed to the deficient performance: cutter v. powell (1795) 6 t.r. 320; britain v. rossiter (1879) 11 qbd 123; cheshire& fifoot, the law of contract, 9th ed., pp. 523-24. see ziegel, j., report to the uniform law conference o f c a n a d a o n c o n v e n t i o n o n c o n t r a c t s f o r t h e i n t e r n a t i o n a l s a l e o f g o o d s , a v a i l a b l e a t http://www.cisg.law.pace.edu/cisg/text/ziegel81.html. 2 http://www.cisg.law.pace.edu/cisg/text/secomm/secomm-81.html. 3 1. introduction (1.) the 1980 u.n. convention on the international sale of goods, hereinafter cisg, regulates in arts. 81-84 the effects of contract avoidance. the primary effect is that prescribed in art. 81.1 cisg: both parties are released from their obligations under the contract, subject to any damages which may be due. it is likely that either party may be left with property transferred by the other or with a payment made by the other. in that case, the parties can agree on a formula for adjusting the price to the deliveries already made. but, either party may also wish to rid itself of a performance received because it is of no value to it; recover money transferred to the other party if nothing has been received in return and/or recover property. for this reason, art. 81.2 cisg authorizes either party to the contract, who has performed in whole or in part, to claim the return of whatever he has supplied or paid under the contract. accordingly, under the cisg either party may claim restitution of performances already made, independently of whether the party demanding restitution is entitled to avoid the contract cif. art. 81.2 cisg. on this point, the cisg adopts a different approach than other legal systems, where only the aggrieved party can make demand for restitution.1 according to the secretariat commentary on art. 66 of the 1978 draft – draft counterpart of art. 81 cisg – the underlying idea is that the avoidance of the contract undermines the basis on which either party can retain that which he has received from the other party.2 therefore, the parties must return all benefits of possession – profits and advantages of use. the buyer is only bound to return the benefits he actually derived from using the goods, or part of them (art. 84.2 cisg). likewise, if the seller is bound to refund the price, it must also pay interest on it, from the date on which the price was paid (art. 84.1 cisg). a closer look to the cisg reveals, however, that the convention does not settle – at least not expressly – the applicable interest rate under art. 84.1. this article attempts, accordingly, to determine the extent to which this issue is regulated in the cisg and how a possible gap is to be filled. special attention is paid to the practice of national courts on this matter. 2. interest rates and gap-filling of the cisg as known, art. 7.2 cisg deals with gap-filling of the convention. pursuant to art. 7.2, “ questions concerning matters governed by this convention which are not expressly settled in it are to be settled in conformity with the general principles on which it is based or, in the absence of such principles, in conformity with the law applicable by virtue of the rules of private international law.” it follows from this provision that national law should be the last recourse for http://www.cisg.law.pace.edu/cisg/text/ziegel81.html. http://www.cisg.law.pace.edu/cisg/text/secomm/secomm-81.html. nordic journal of commercial law issue 2005 #2 3 see gebauer, m., “ uniform law, general principles and autonomous interpretation” , ulr 2000-4, pp. 683ff. 4 unidroit international institute for the unification of private law principles of international commercial contracts, rome, unidroit, 1994; unidroit principles of international commercial contracts 2004. 5 see e.g. garro, a., “ the gap-filling role of the unidroit principles in international sales law” , 69 tulane law review , p. 1 1 4 9 ff; bonell, m.j., “ unification of law by non-legislative means: the unidroit draft principles for international commercial contrats” , 40 am.j.comp.l, 1992, pp. 628ff; basedow, j., “ uniform law conventions and the unidroit principles of international commercial contracts” , ulr 2000-1, pp. 129ff; drobnig, u., “ the use of the unidroit principles by national and s upranational cour ts” , un idroit p r inciples for international commercial contracts: a new lex mercatoria?, icc publication n. 490/1, 1995, pp. 223-32. 6 garro, a., 69 tulane law review, pp. 1156-7; bonell, m.j., 40 am.j.comp.l, at p. 629; drobnig, u., icc publication n. 490/1, at p. 228; contrary, basedow, j., ulr 2000-1, at pp. 133-5. 7 internationales schiedsgericht der bundeskammer der gewerblichen wirtschaft, wien, schiedsspruche sch 4318 and sch 4366 of 15 june 1994: see them published in the original german version in riw, 1995, p. 590ff., with note by schlechtriem, p. (p. 592ff.); for an english translation see bonell, m.j. (ed.), unilex. international case law & bibliography on the un convention on contracts for the internati onal sa le of goods, transnational publishers, inc., ardsley, ny, december 1998 release, e.1994-13 and e.1994-14. for a succinct presentation in french, see s eidl-hohenveldern, i., in jdi, 1995, pp. 1055-1056. source: www.unilex.info. 4 the purpose of gap-filling in the convention. only when an autonomous rule cannot be derived from the cisg, resort is to be made to private international law. finally, for gaps in matters totally excluded from the scope of the convention, such as the matters contemplated in cisg arts. 4 and 5, national law applies. the application of art. 7.2 presupposes, accordingly, the existence of a veritable gap, an issue that is not expressly addressed by cisg, but which falls under a matter covered by the convention. the problem is that there are many issues arising from international sales that are not expressly settled by cisg, but very few matters not governed by the convention. indeed, cisg deals with restitutionary claims in arts. 81-84. yet, the absence of an express regulation of the applicable interest rate to price refunds may, perhaps, respond to the drafters’ will to exclude them from the scope of the convention. in consequence, one should be very careful in filling hypothetical gaps in the cisg by reading into it something that is not there. insofar as the application of art. 7.2 cisg is verified, it is necessary to ascertain the general principles on which the convention is based, applicable to the issue at hand. in this regard, the expression “ general principles” refers to the internal principles found within the convention itself, in its legislative history, in the underlying objectives of each provision and the whole text. these principles may also be found through the analogous application of other cisg provisions, which deal with a similar conflict of interest as the issue in question.3 the general principles of the convention are different from external principles, which may be taken from other legal texts such as the unidroit principles of international commercial contracts, hereinafter up.4 the scholarly debate has largely concentrated on the role of the up to fill the gaps in the cisg5 and this is not the place to consider this discussion. briefly explained, some scholars are of the opinion that as far as the up are inspired by the cisg, the decision maker should turn to the up before resorting to national law.6 such opinions have found support in practice, in particular, in establishing the rate of interest to which a party is entitled under art. 78 cisg. as far as this provision does not endorse how to determine such a rate, at least three arbitral awards7 have made recourse to up art. 7.4.9 (2), which indicates that the applicable interest rate shall be the average bank shorthttp://www.unilex.info. nordic journal of commercial law issue 2005 #2 8 gebauer, m., ulr 2000-4, at p. 702. 9 see e.g. h onnold, j. o., uniform law for international sales under the 1980 united nations convention, 3rd ed. (1999), kluwer law international, pp. 465-471; perales viscasillas, m. p., “ la determinación del tipo de interés en la compraventa internacional” , cuadernos juridicos (julio-agosto 1996) no. 43, 5-12, available at: http://www.cisg.law.pace.edu/cisg/biblio/78art.html. 5 term lending rate to prime borrowers prevailing for the currency of payment at the due place of payment or, in the absence of such a rate, the rate fixed by the law of the state in which the payment has to be made. contrary to this opinion, some argue that internal principles have priority over external principles8 and, only when it is proven that the solution provided by the up does not contradict a teleological and systematic interpretation of cisg, may the former be applied to fill a gap within the convention. in any case, pursuant to art. 7.2 cisg, as far as it is not possible to infer a principle in the convention applicable to the issue at hand, national law shall apply. turning back to restitutionary claims, it follows from these considerations that in order to ascertain the applicable interest rate to advance payments, it is essential to establish whether we are dealing with matters that fall outside the scope of the cisg, or whether the gap is praeter legem, that is to say, a matter governed but not expressly settled by the convention (art. 7.2 cisg). finally, for gaps praeter legem, it will be necessary to infer a principle from the convention applicable to the issue at hand or, in the absence of such, recourse will have to be made to national law. 3. the duty to pay interest as mentioned, the cisg incorporates the idea that the avoidance of the contract undermines the basis on which either party can retain that which he has received from the other party. as a result, the parties must return all benefits of possession – profits and advantages of use. the cisg deals with this duty to return all benefits of possession in art. 84. pursuant to art. 84.1 cisg, if the seller is bound to refund the price, he must also pay interest on it, from the date on which the price was paid. the provision does not settle – at least not expressly – what the applicable interest rate under art. 84.1 is. the duty to pay interest under art. 84.1 cisg is not the only provision in the convention on interest. indeed, art. 78 cisg deals generally with this subject and neither does this article establish the rate of interest and the method of calculating it. the different approaches on how to establish the rate of interest to which a party is entitled under art. 78 cisg are widely known.9 here, opinions range from a connection to domestic law to the application of a general principle under the convention, with or without a reference to instruments external to the convention, such as the up. http://www.cisg.law.pace.edu/cisg/biblio/78art.html. nordic journal of commercial law issue 2005 #2 10 schlechtriem, p., einheitliches un-kaufrecht, 3. auflage, 2000, at p. 94. 11 see e.g. case no. 12 o 153/92, landgericht krefeld, 24 november 1992, available at www.unilex.info; icc award no. 7660/jk, 23 august 1994, available at www.unilex.info; case no. 8 hko 24667/93, landgericht münchen, 8 february 1 9 9 5 , available at www.unilex.info ; case no . 5 4 o 6 4 4 /9 4 , la ndg e r ic h t la nds h ut, 5 april 199 5 , available at www.unilex.info ; case no . 2 0 u 76/94, oberlandesgericht celle, 24 may 1995, available at www.unilex.info; case no. t.171/95, bezirksgericht der saane, switzerland, 20 february 1997, available at www.unilex.info; arbitral award from the schiedsgericht hamburger freundschaftliche arbitrage, 2 9 dec emb er 1 9 9 8 , available at www.unilex.info; case no. 12.97.00193, tribunale di appello di lugano, seconda camera civile, 15 january 1998, available at www.unilex.info and, the icc arbitral award no. 9978/99, march 1999, available at www.unilex.info. 12 case no. 16 u 77/01, oberlandesgericht köln, 14 october 2002, available at www.unilex.info. 13 icc award no. 6653/1993, 26 march 1993, available at www.unilex.info. 6 logically, the discussion has been transferred to the context of art. 84.1 cisg. in this regard, the solutions provided in case law and by the doctrine do not always coincide. according to a first approach, the cisg does not deal with the issue on the rate of interest. subsequently, differences appear as to the method to calculate the interest payable. another approach maintains that the calculation of the rate of interest lies within the framework of the convention and that the gap shall be filled according to general principles. 3.1 the leading view: the application of national law the leading view is that the calculation of the rate of interests falls outside the scope of the convention and shall be established according to the applicable domestic law.10 this has been confirmed in a considerable number of cases.1 1 to provide a recent example, a decision of the oberlandesgericht köln from 200212 can be mentioned. the dispute concerned a contract for the sale of high quality seasonal women's clothes, concluded between an italian seller and a german buyer. following the non-conformity of the goods, the buyer avoided the contract and requested the refunding of the partial payment already made. after that, the seller commenced an action to recover full payment. as to the merits of the case, the court held that the buyer had validly avoided the contract in accordance with art. 49.1(a) cisg and was entitled to be refunded of the partial payment made in accordance with art. 81.2 cisg, plus interest at the rate determined according to the otherwise applicable law (art. 1284 of the italian civil code). 3.2 the rate currently used in international trade pursuant to another view, the calculation of the rate of interest also falls outside the scope of the convention, although the method to calculate the rate of interest differs from that of the leading view. hence, under this approach the rate shall be fixed by way of reference to the rate currently used in international trade. this was, at least, the approach of the arbitrators in the icc award no. 6653/1993.13 the dispute concerned a contract for the sale of steel bars concluded between a german seller and a syrian buyer. following the non-conformity of some of the goods received the buyer asked the seller to cease delivery, take back the goods and refund the price paid. in this regard, the arbitral tribunal found that some of the lots of steel bars delivered were of nonconforming weight, and entitled the buyer to partial avoidance of the contract and a refund of http://www.unilex.info; http://www.unilex.info; http://www.unilex.info; http://www.unilex.info; http://www.unilex.info; http://www.unilex.info; http://www.unilex.info; http://www.unilex.info http://www.unilex.info. http://www.unilex.info. http://www.unilex.info. nordic journal of commercial law issue 2005 #2 14 hornung, r., “ effects of avoidance” in schlechtriem, p. and schwenzer, i., commentary on th e un convention on the international sale of goods (cisg), second edition, 2005, oxford, p. 883ff. 15 ibid, p. 885. 16 secretar iat commentar y on ar t. 6 9 of th e 1 9 7 8 dr aft – draft counterpart of art. 84 cisg – available at http://www.cisg.law.pace.edu/cisg/text/secomm/secomm-84.html. 17 case no. hg 95 0347, handelsgericht zürich, 5 february 1997, available at www.unilex.info. 18 case no. s 96/605, court of appeal of eastern finland, 27 march 1997, available at www.unilex.info. 7 the price already paid for the non-conforming lots. in accordance with arts. 78 and 84 cisg the buyer was awarded interest on the price to be refunded, accruing from the date of payment for each non-conforming lot of steel bars. the court finally held that as cisg does not determine the rate of interest, the applicable rate was to be the one currently used in international trade with respect to eurodollars, the currency in which payment had to be made. the court subsequently applied the annual london international bank offered rate (libor). 3.3 the applicable rate at the seller’s place of business un d er a t h ird view, the calculation of the rate of interest falls within the scop e o f t h e convention. within the framework of art. 7.2 cisg, the calculation of the rate of interest shall be made according to the law of the seller’s place of busi n ess, based on the principle of equalization of benefits under arts. 81.2 and 84 cisg. 1 4 as the seller was able to use the sum received from the buyer and work with it, once the contract is avoided, he is no longer entitled to retain those benefits. indeed, it is the possible benefit of the seller which must be removed.15 this approach is supported by the secretariat commentary on art. 84 cisg, which proclaims that ‘[...] since the obligation to pay interest partakes of the seller's obligation to make restitution and not of the buyer’s right to claim damages, the rate of interest payable would be based on that current at the seller's place of business’.16 the decision from the commercial court of zürich from 5 february 199717 also seems to affirm this view. the case concerned a contract for the sale of italian sunflower oil concluded by a german buyer and two french sellers. following a nondelivery, the buyer declared the contract avoided. the buyer brought an action to recover the advance payment and damages. in the court’s opinion, the buyer had validly avoided the c o n t r a ct a nd, inter alia, was entitled to receive restitution of the advance payment a s a consequence of the avoidance of contract (art. 81.2 cisg). the court held, in this regard, that according to art. 84 cisg the buyer was entitled to interest on the advance payment, to be calculated from the date payment had been made. as to the applicable rate of interest, the court applied the interest rate of the sellers' place of business, ‘that being the place in which the sellers usually invest their money’. 3.4 joint application of interest rates? a finnish decision from 199718 may be reflecting a fourth view on the applicable rate under art. 84.1 cisg. the case concerned a contract for the delivery of butter concluded between a lithuanian buyer and a finnish seller. following a non-delivery, the buyer commenced action http://www.cisg.law.pace.edu/cisg/text/secomm/secomm-84.html. http://www.unilex.info. http://www.unilex.info. nordic journal of commercial law issue 2005 #2 19 hornung, r., commentary on the un convention, at p. 884. 20 on the legislative history of art. 84 see http://www.cisg.law.pace.edu/cisg/text/matchup/matchup-d-84.html. 8 against the seller demanding, inter alia, the return of the advance payment. the court held, among other things, that according to art. 84 cisg the seller had to refund the price and pay interest on it. furthermore, according to art. 74 cisg, the seller had to pay the buyer damages for lost profits. in this regard, the court found that the seller knew that the buyer had to take credit to finance the advance payment and therefore the damages also included compensation for interest loss. but, as it was not shown that the seller knew or should have known about the interest rates in lithuania, namely 7% per month and 0.5% per day interest in arrears, which essentially differs from interest reates in western europe, the court found that the seller should have estimated a loss of about 10% of the sale price. the seller, accordingly, had to compensate for this loss. finally, the court found that the seller had to pay interest according to art. 78 cisg, which was determined by the interest rate of the bank of finland added with 7%. it is difficult to establish whether the interest awarded in this decision was based on the loss suffered by the aggrieved buyer rather than on a restitutionary approach to prevent unjust enrichment by the seller under art. 84 cisg. normally, in situations such as in this case, where it is necessary for the buyer to take a loan at a higher rate of interest, the claim for interest in excess is deemed to fall within the scope of art. 74 cisg, as a general damages rule.19 this loss was apparently recovered by the buyer – although limited by the principle of foreseeability of the loss – when it was awarded 10% of the sale price in damages. being so, the interest awarded in the decision must have corresponded to the right to interest under art. 84.1 cisg. now, the court awarded the interest rate of the bank of finland – the sellers’ place of business – added with 7%. this added percentage was, in fact, the applicable interest rate in lithuania. although the finnish court did not clarify whether it considered the calculation of the interest rate to fall withtin the scope of the convention, the method used by the finnish court appears to be a joint application of the interest rates at the seller and the buyer’s place of business. 4. assessment as seen, the calculation of the interest rate under art. 84.1 cisg is an unsettled issue. from the different approaches found in theory and in caselaw the application of the interest rate of the seller’s place of business within the framework of art. 7.2 cisg seems to be in better accordance with the purpose behind art. 84.1. the practical details of restitutionary duties are regulated in arts. 81-84 and, apparently, there were no major discussions on the drafting of the duty to pay interest on advance payments, as in the case of the general duty to pay interest under art. 78 cisg.20 in consequence, the calculation of the rate of interest applicable to the refund of advance payments falls, prima facie, within the scope of the cisg and should be solved according to the general principles on which the convention is based. in this regard, article 84.1 cisg operates irrespective of which party http://www.cisg.law.pace.edu/cisg/text/matchup/matchup-d-84.html. nordic journal of commercial law issue 2005 #2 21 hornung, r., commentary on the un convention, at pp. 883 ff. 22 see e.g., perales viscasillas, m. p., cuadernos juridicos, under iii. 9 breached the contract.21 it is founded on the idea that contract avoidance destroys the basis on which the seller can retain the sums it has received from the buyer. following from this, the provision is not aimed at compensating the buyer’s loss, but at preventing unjust enrichment of the seller, who may have invested the sum prepayed by the buyer and obtained benefits from it. for this reason, the discussions on the applicable interest rate under art. 78 cisg should not be transferred to the context of restitution and viceversa.22 considering that art. 84 cisg, as a whole, reflects the principle of equalization of benefits, it seems logical to apply the interest rate of the place where the money is likely be invested – the seller’s place of business. microsoft word note2.doc remarks on the manner in which the principles of european contract law may be used to interpret or supplement article 75 of the cisg by bojidara borisova * nordic journal of commercial law issue 2003 #1 * bojidara borisova received her law degree from sofia university “st.kl.ohridsky”, bulgaria, in 2001. currently, she is a ph.d. candidate at the same university, working on her research project on international investment law, more particularly the right of protection of foreign investments in cases of expropriation. nordic journal of commercial law, issue 2003 #1 2 1. introduction article 75 of the convention is part of the set of rules and principles that provide the law of damages in the cisg.1 cisg article 75 regulates the operation of a substitute transaction, which is adopted in most legal systems as well as in basic multilateral instruments such as the cisg and the pecl.2 pursuant to cisg art. 75, as a result of a breach of contract the aggrieved party may carry out a substitute transaction in a reasonable manner and within a reasonable time after avoidance and may recover the difference between the contract price and the price of the substitute transaction. the same issue is regulated in substantively identical terms in pecl art. 9:506. however, the drafters of the pecl go further and in other provisions of the european principles define terms that may help the interpretation and application of pecl art. 9:506 and its counterpart cisg provision. cisg article 75 provides a method for measuring damages when a party avoids a contract, usually due to a fundamental breach by the other party. this provision represents a specific application of cisg art. 74, which states the general rule for the measurement of damages.3 both cisg art. 75 and pecl art. 9:506 stipulate the same basic premises that have to exist before the substitute transaction takes place. firstly, one of the contracting parties must breach the contract and in consequence the innocent party must undertake action for the termination of the contract. as far as it concerns this premise, a problem may arise in respect of the determination of the moment when the contract is declared avoided. secondly, there must be a substitute transaction effected by the aggrieved party. here the issues that have to be discussed are in respect of the substitute transaction's characteristics and aspects. thirdly, the substitute transaction must be performed in a reasonable manner and within a reasonable time after avoidance. specific attention must be drawn to the concept of “reasonableness”. 1 see also the text of cisg articles 74, 76, 77 and 78. 2 see vilus, provisions common to the obligations of the seller and the buyer, petar sarcevic & paul volken eds., international sale of goods: dubrovnik lectures, oceana (1986), also available online at <http://cisgw3.law.pace.edu/cisg/biblio/vilus.html>. 3 see sutton, measuring damages under the united nation convention on the international sale of goods, 50 ohio state law journal (1989), 737-752, also available online at <http://cisgw3.law.pace.edu/cisg/biblio/sutton.html>. see also the following case decisions [all decisions cited in this note and the subsequent notes are available in original language and english translation at the citations indicated]: austria 6 february 1996 supreme court, <http://cisgw3.law.pace.edu/cases/960206a3.html>; austria 9 march 2000 supreme court <http://cisgw3.law.pace.edu/cases/000309a3.html>; russia 22 october 1998 arbitration 196/1997 <http://cisgw3.law.pace.edu/cases/981022r1.html>; austria 28 april 2000 supreme court <http://cisgw3.law.pace.edu/cases000428a3.html>, where it is stated that cisg art. 75 is a specific provision about the calculation of damages in the case of avoidance of a contract following a breach. nordic journal of commercial law, issue 2003 #1 3 fourthly, the amount of the damages claimed by the aggrieved party must be assessed. the method for measuring damages stipulated in cisg art.75 is seemingly clear but still needs elucidation. finally, cisg art. 75 cisg, like pecl art. 9:506, provides for the possibility of recovery of further damages. 2. scope of application cisg article 75 and pecl art. 9:506 deal with the issues of substitute transaction and the amount of recoverable. the basic contractual obligation imposed on both the buyer and the seller is the obligation that each contracting party must perform all of its obligations required by the contract.4 logically, the remedy stipulated in cisg art. 75 is applicable to both contracting parties – the buyer and the seller depending on which party breaches the contractual agreement.5 3. when is the contract is deemed avoided in the interpretation of cisg art. 75, the issue of determining the time of avoidance is important because it substantiates the moment from which the “reasonable” time period starts to run. the other provisions which regulate the law of damages in the cisg and the pecl cannot contribute to the clarification of this issue because no clear determination of that issue can be found either explicitly or impliedly. however, article 72(1) of the 1978 draft convention, corresponding to art. 76 of the cisg, refers to the time of avoidance as the time when the injured party first could have declared avoidance.6 the purpose for the creation of such rule had been the desire to prevent the injured party from speculating at the other's expense. the drafters of the final text of the convention did not elect to include that in this text because of its controversial nature and uncertainty.7 in the interpretation of cisg art.75, it must be emphasized that the problem in determining the time of avoidance appears especially in the event of delayed or non-conforming performance. in this situation, the aggrieved buyer cannot undertake a substitute transaction until the moment of avoidance is defined. some scholars8 propose that the provision of cisg art. 49(2) be used for identifying the time of avoidance. but especially in the case of art. 49(2)(b)(i), the identification of the exact time of avoidance is difficult and a matter of subjective judgment, because the initial moment from which the reasonable time period starts to run precedes the moment when the buyer could avoid the contract since at that moment the 4 see cisg arts. 30 and 53, stating the principal obligations of the parties. 5 see sutton, op. cit. 6 the legislative history of cisg art. 76 and its match-up in the 1978 draft is available online at <http://cisgw3.law.pace.edu/cisg/text/matchup/matchup-d-76.html>. 7 see schlechtriem, extent and measure of damages (cisg arts. 74-76), in uniform sales law – the un-convention for the international sale of goods, vienna: manz (1986), also available online at <http://cisgw3.law.pace.edu/cisg/biblio/schlechtriem76.html>. 8 see schlechtriem, op. cit. nordic journal of commercial law, issue 2003 #1 4 buyer is still not aware of the breach. to draw a general conclusion, the substitute transaction can be made within a reasonable time limit, beginning to run not until the aggrieved party had in fact declared the contract avoided, which must be proved undeniably by the party’s conduct.9 4. substitute transaction although using slightly different wording, cisg art. 75 and its counterpart pecl provision are substantively similar. it might be said that cisg art. 75 uses a more descriptive method, while the corresponding pecl art 9:506 applies more general terminology that emphasizes the essence of the substitute transaction. according to the text of the convention, the remedy provided in cisg art. 75 applies to cases where the initial contract has been avoided and replacement goods have in fact been purchased or the seller has in fact resold the goods. the basic characteristic of the purchase and the resale is their substitute, replacement function. all the other elements of the transaction must be subordinated to this primary function and to the reasonableness criterion. to this effect, the substitute transaction may occur in a different location or have different terms compared to the original transaction, but should not be so different from it in value or nature as not to be a reasonable substitute.10 such lack of complete correspondence to the initial transaction may not influence the right to receive the remedy provided in cisg art. 75 if the substitute transaction corresponds to the other premises outlined in it, but may lead to the adjustment of the exact amount of the damages, so that any increase in costs or expenses saved could be taken into consideration.11 neither cisg art. 75 nor pecl art. 9:506 provide any other details or specifications concerning the substitute transaction beyond requiring that it should be made in a reasonable manner and within a reasonable time after avoidance.12 5. reasonableness although “reasonableness” is considered to be a general principle of the cisg and is mentioned in thirty-seven provisions of the convention,13 there can be found no legal 9 see the texts of the following decisions stating that the substitute transaction may be performed only after the contract have been properly avoided: germany 14 january 1994 appellate court düsseldorf <http://cisgw3.law.pace.edu/cases/940114g1.html>; icc arbitration case no. 8574 of september 1996 <http://cisgw3.law.pace.edu/cases/968574.html>; russia 24 january 2000 arbitration 54/1999 <http://cisgw3.law.pace.edu/cases/000124r1.html>; germany 6 april 2000 district court münchen <http://cisgw3.law.pace.edu/cases/000406g1.html>; germany 13 january 1999 appellate court bamberg. <http://cisgw3.law.pace.edu/cases/990113g1.html>. see also the text of austria 6 february 1996 supreme court decision, supra note 3, according to which “the intention of the buyer not to adhere to the contract anymore has to be obvious beyond any doubt”. 10 see sutton, op. cit. see also the legislative history of cisg art. 75 and its match-up in the 1978 draft convention, which is available online at <http://cisgw3.law.pace.edu/cisg/text/matchup/matchup-d-75.html>; the secretariat commentary on the 1978 draft provision of cisg art. 75 is available online at <http://cisgw3.law.pace.edu/cisg/text/secomm/secomm-75.html>. 11 see text of secretariat commentary on article 71 of the 1978 draft convention, available online at <http://cisgw3.law.pace.edu/cisg/text/secomm/secomm-75.html>. 12 see flechtner, remedies under the new international sales convention: the perspective from article 2 of the u.c.c., 8 journal of law and commerce (1988) 53-108, also available online at <http://cisgw3.law.pace.edu/cisg/biblio/flecht.html>. nordic journal of commercial law, issue 2003 #1 5 definition of the concept in the text of the convention. such a definition exists in the pecl, article 1:302, where it is said that “reasonableness” is to be judged by what persons acting in good faith and in the same situation as the parties would consider to be reasonable. all relevant factors should be taken into consideration when deciding what is reasonable.14 the concept of “reasonableness” outlined in art. 1:302 pecl can be applied to the definition of this issue as regards cisg art. 75. in relation to the interpretation and application of that article of the convention, it should firstly be determined what is a reasonable period for waiting before the conclusion of the substitute transaction, i.e., what is meant by the expression “within a reasonable time”. next, the nature and the purpose of the avoided contract and respectively the characteristics of the substitute transaction should be examined, i.e., what is meant by the expression “in a reasonable manner”. in general, both aspects of the required “reasonableness” – the reasonable time and the reasonable manner – must be examined within the concept of the “reasonable person”,15 because the manner and the time of acting is a manifestation of a personal and, consequently, subjective choice. to make the determination of the issue more impartial, it should be emphasized that the criterion of a “reasonable person” should be assessed in conformity with the conduct of a person “of the same kind”, engaged in the same kind of business or in the same trade, etc.16 examining the “reasonable manner”, it must be said that the reasonable person’s behavior should be to perform the substitute transaction at the most favorable conditions, i.e., the resale to be made at the highest price reasonably possible in the circumstances, or the cover purchase to be made at the lowest price reasonably possible.17 the same criteria should be applied for the determination of the fairness of the substitute transaction terms and conditions. as far as the “reasonable time” is concerned, the concept of the reasonable person must also be applied. in the first place, account should be taken of the nature and the purpose of the avoided contract and respectively of the substitute transaction; secondly, the circumstances of the particular case should be examined; and thirdly, the behavior of the reasonable person is reflected by the usages and the practices of the trade or profession in which he is engaged. 13 for a discussion of the concept of “reasonableness” in the cisg, see the editorial comments available online at <http://cisgw3.law.pace.edu/cisg/text/reason.html> and see also the following case decisions: germany 14 january 1994 appellate court düsseldorf, supra note 9; italy 11 december 1998 appellate court milan <http://cisgw3.law.pace.edu/cases/981211i3.html>; netherlands 15 october 2002 netherlands arbitration institute case no. 2319 <http://cisgw3.law.pace.edu/cases/021015n1.html>. 14 pecl art. 1:302 provides the following definition of “reasonableness”: “under these principles reasonableness is to be judged by what persons acting in good faith and in the same situation as the parties would consider to be reasonable. in particular, in assessing what is reasonable the nature and purpose of the contract, the circumstances of the case and the usages and practices of the trades or professions involved should be taken into account.” 15 see schlechtriem, op. cit. 16 see honnold, uniform law for international sales under the 1980 united nations convention, 3d ed., kluwer law international (1999). 17 see text of secretariat commentary on article 71 of the 1978 draft convention, op. cit. nordic journal of commercial law, issue 2003 #1 6 6. damages the damages recoverable under cisg art. 75 amount to the difference between the contract price and the price in a reasonable substitute transaction.18 pecl article 9:506 defines the remedy provided for a substitute transaction in a similar fashion. both counterpart articles use the so-called “concrete” method19 of establishing damages, which accomplishes the common law goal of having contract remedies lead to the “relief of the promisee” instead of the “compulsion of the promisor”.20 this method of establishing damages eliminates the burden of having to prove the market price of the goods and instead applies a more pragmatic criterion. under this basic formula for measuring damages, the aggrieved party often may not be able to recover all the damages that it suffered by the breach of the contract – such as additional expenses caused by: receipt of non-conforming goods; necessity to search for substitute goods; advertisement expenses for the resale of the goods under the original contract; loses caused by the later delivery of the substitute transaction goods compared to the original contract date, etc. considering the possibility that such additional expenses may occur, plus the desire to restore the aggrieved party into the position that it should have been if the original contract had not been breached, both cisg art. 75 and pecl art. 9:506 stipulate that the injured party may seek further damages under the basic rule for recovery of full compensation. the calculation of these additional damages is based on the principle of foreseeability.21 this regulation confirms the statement that cisg art. 75 represents a specific application of art. 74 cisg, although a detailed analysis of the latter provision is not a subject of this study. 18 national courts and arbitral tribunals apply very consistently the method for measuring damages provided in cisg art. 75, which leads to the conclusion that this part of cisg art. 75 generates no controversy. in confirmation of this statement, see the following case decisions: switzerland 20 february 1997 district court saane <http://cisgw3.law.pace.edu/cases/970220s1.html>; spain 28 january 2000 supreme court <http://cisgw3.law.pace.edu/cases/000128s4.html>; germany 6 april 2000 district court münchen, supra note 9; germany 30 july 2001 district court braunschweig <http://cisgw3.law.pace.edu/cases/01730g1.html>; austria 28 april 2000 supreme court, supra note 3. 19 see, sutton, op. cit.; see also saidov, methods of limiting damages under the vienna convention on contracts for the international sale of goods, 2001, available online at <http://cisgw3.law.pace.edu/cisg/biblio/saidov.html>. in a similar manner, the switzerland 15 september 2000 supreme court decision, <http://cisgw3.law.pace.edu/cases/000915s2.html>, describes as “concrete” the method of establishing damages used in cisg art. 75. 20 see farnsworth, damages and specific relief, 27 am.j.comp.l. 247 (1979), also available at <http://cisgw3.law.pace.edu/cisg/biblio/farns.html>. 21 in confirmation of the aggrieved party’s right to obtain full compensation including the additional costs, see germany 13 january 1999 appellate court bamberg decision, supra note 9. 1. introduction 2. scope of application 3. when is the contract is deemed avoided 4. substitute transaction 5. reasonableness 6. damages collective countermeasures and the wto dispute settlement: ‘solidarity measures revisited’ by yenkong ngangjoh h.* nordic journal of commercial law issue 2004 #2 nordic journal of commercial law issue 2004 #2 2 1. introduction in the ten years of the existence of the world trade organization (wto) dispute settlement system, eighty cases have led to the adoption of the panel reports and sixty-one to the adoption of the appellate body (ab) reports. among these cases, the enforcement mechanism of last resortcountermeasure has been resorted to eight times. the eight cases include, ec – bananas (us), ec – bananas (ecuador),1 ec – hormones (us, canada),2 brazil – aircraft,3 fsc,4 canada – aircraft ii,5 us – 1916 act,6 and the ”byrd amendment”.7 this number is almost four times more than those under the forty-seven year life-span of the wto’s predecessor-the general agreement on tariffs and trade (gatt) 1947. on the other hand, there are also cases where compliance with the dispute settlement reports has been contested.8 the relatively frequent recourse to countermeasures and the disagreement with the level of compliance presumably suggest that the present enforcement regime of the wto dispute settlement body (dsb) reports seems to be arduous.9 we therefore contend in this writing that the weakness of countermeasures is not because countermeasures by nature cannot induce compliance, but because the wto countermeasures are not coercive enough to induce compliance. the traditional international law counter-measures (which may be collective) were codified by the international law commission (ilc) on the responsibility of states for internationally wrongful act in 2001 and are presumably applicable to all fields of international law where there arises a question of state responsibility, except there is a derogation provided for by a particular regime. classical treaty law also considers a material breach of a multilateral treaty by one party as a sufficient ground for the suspension in part or in whole of the operation of the treaty by other parties to the treaty.10 neither the panel nor the appellate body (ab) has really considered addressing these issues in its rulings and recommendations since the establishment of the wto; though a number of academic writings and dispute settlement reports suggest that the wto regime should not be conceived as an isolated field of international law. the following section of this paper examines from a more general perspective the use of collective remedies under international law. the third section of the paper presents the debate on collective countermeasures developed in the ilc’s draft articles. this, we will call solidarity measures.11 by using past panels and ab jurisprudence, section four sets forth arguments in support of the view that acceding to the wto engages the state so doing to a multilateral engagement, which may be invoked by any wto member at any time in case of a breach. section five makes the case for solidarity measures in the wto dispute settlement, while section six deals with the conclusions. 2. collective remedies under international law remedies under international law have always been traditionally viewed as something more bilateral than collective.12 thus, according to this view, only states which have directly suffered injuries from an illegal act can claim damages.1 3 but recent events and practices in the international legal system have proven this traditional view not necessarily correct. as early as in 1915, eliahu root argued that states engaging in the illegal use of force or taking other actions which constitute threats to law and order in the international community should be subject to remedies from other states which are not directly injured by the defendant’s illegal act.14 nordic journal of commercial law issue 2004 #2 3 the incorporation of collective countermeasures into the international legal system is based on the assumption that international agreements from a broad perspective have a multilateral effect in the events of their violation. the remedies at the disposal of a directly injured state may also be inadequate for such state to make a recalcitrant state to respect its obligations under international law. seeking the participation of third states for the eventual application of collective remedies in such a situation may be seen as a desirable alternative. it could also be possible that a directly injured state may be capable of imposing sufficient sanctions on a recalcitrant state; but due to blatant and widespread violation of international law the application of a sufficient unilateral countermeasure is often not possible. for instance, during the war in the persian gulf between iraq and iran, the safety of neutral vessels was threatened. the united nations intervened and did not oppose other neutral states that deployed forces in the gulf to protect their flags and other flag vessels from illegal attacks from those engaged in battle.15 there is no world police to command or coerce obedience to international law rules. instead, the international community has to rely on the combination of other mechanisms such as countermeasures to win respect and compliance for these duties. the jurisprudence of the wto dispute settlement system (dss) suggests alternatively that collective countermeasures against the impairment or nullification of wto law are still alien in the practice of the system.16 for the reason stated above, countermeasures must be effective in the sense that in their collective form; the rights of smaller states to a particular agreement would be respected as much as the rights of powerful member states. countermeasures must also be effective in order to achieve its primary purpose of inducing compliance. in the first place, when we try to establish a case law argument for third states remedies in international law, we would often rely upon the land-mark wimbledon case in which the permanent court of international justice (pcij) allowed third party members of a multilateral treaty to intervene.17 the pcij in this case allowed poland to intervene, though it had no interest in the case. the basis for poland’s intervention rested on the fact that it was a party to the treaty of versailles which had been violated by germany. though the wimbledon case seems to have established only a good procedural support for third states intervention in third party adjudication under international law, it does provides some supportive arguments for collective action under international dispute resolutions. this is based on the theory that legal rights belong to all parties to a multilateral treaty. 3. international law codification and collective remedies recent codifications of international law reflect the desire of the international community to clearly bring to the fore the idea of collective countermeasures in case of a continuous violation of international law.18 the draft articles prepared by the international law commission (ilc)19are important in the evaluation of the application of collective countermeasures in the wto dispute settlement mechanism (dsm). the adoption in august 2001 by the ilc of its articles on responsibility of states for internationally wrongful acts clearly marked a defining moment in the more than half a century journey of the work of the ilc on the definition of the nature of the obligations of states and other actors in international law. the ilc has undergone a long journey nordic journal of commercial law issue 2004 #2 4 in accomplishing its duties on the codification of customary international law in the field of state responsibility. the issue of solidarity measures occupied an important part of the debates in the ilc’s work as it is demonstrated in article 54 of the draft. in the last years of the ilc work, the role of third states as regards the enforcement of the decisions of an international tribunal formed one of the three most important substantive problems to resolve. the other two main issues were the fate of states’ crimes and the delimitation of the notion of ‘injured state,’20 however, the ilc work in its draft stage has already attracted attention from international adjudicating body, as seen from the comments of j. charpentier and g. apollis in the rainbow warrior case.21 though, without detailed guidelines on invoking solidarity measures, perhaps the best support for collective countermeasures against a state for a continuous violation of a multilateral treaty is found in the ilc’s articles. even if not promptly adopted by the general assembly of the united nations as the case may be, the ilc’s articles now represents an authoritative restatement of customary international law,2 2which maybe useful in a sense for international dispute resolution. consequently from this viewpoint, the ilc’s articles seemingly appear as a relevant starting point for solidarity measures in the enforcement of member states obligations under the multilateral trading system. 3.1. the importance of the ilcs draft on approaching collective remedies prior to the adoption of the last draft of the commission’s report in 2001, some members made candid statements indicating that the outcome of the commission’s final reports would be a significant move towards the ‘construction of international public law.’23 such statements were far from being wrong. as pointed out above, the final articles of the commission’s work adopted in 2001 might seemingly not be open for signatures by members of the united nations. it might take the form of a resolution of the general assembly of the united nations. however, it appears that if there is no diplomatic conference to sanction the application of the articles, the ilc’s work will best serve the needs of the international community only if it is weighed, interpreted, and applied with much care.24 this is no surprise. the vienna convention on the law of treaties (vclt), which is widely applied now by international courts ”as customary international law and not by its reason of being treaty”, witnessed the same care.25 in a way, the proposal on collective countermeasures in the ilc’s articles may be seen as ‘the beginning of international public enforcement.’26 however, the question whether a non-injured state should be allowed to go with the directly injured state or entirely on her own, seemed to have presented some difficulties in the final stages of the work of the commission.27 the sensitive nature of the issue explained why some of the commission’s members were quite cautious about it. on the other hand, the importance of collective countermeasures in the commission’s work was further developed by the proposal of james crawford in 2000. in the proposal, crawford identified two scenarios where collective countermeasures could be imposed in order to enforce the rulings of an international tribunal. first, the injured state could request assistance from a third state, where it finds itself incapable of inducing the recalcitrant state to respect the rulings of the tribunal. secondly, third states may collectively impose countermeasures when they perceive that the responsibility breached is of a nordic journal of commercial law issue 2004 #2 5 general interest.28 hence, the rationale for the latter is based on what martti koskenniemi describes as ”solidarity measures.”29 and, as mentioned earlier, we will be using it interchangeably with collective countermeasures in this writing. though some governments preferred rather to shift the issue of collective countermeasures to the discretionary power and general mandate of the security council, crawford’s proposal received a wide degree of support from within and outside the ilc. the grudging wariness with which the commission viewed the importance of countermeasures permeated the entire project.30 however, the importance of the work of the commission has not only sparked a stream of intellectual writings by academics,31 but also attention from an international adjudicating body.32 the international court of justice (icj) and the ilc have so far had a protracted relationship. it is not only that the icj makes citations from the work of the ilc, but also the ilc members have always been elected members of the court.33 not withstanding the difficulties that surrounded the task of the commission members, the ilc draft is an important step toward the codification of customary international law. 3.2. the ilc’s articles and legal regimes without specification on particular remedy one open-ended question as regards different legal regimes is when such regimes do not provide for specific remedies. but a regime with specific rules on how to clinch differences stemming from such a regime may provide a definitive leeway for disputes resolution. the usefulness of such a regime also stems from the fact that it may provide better access to the will of the parties intended to be bound by such treaty as the case may be. but when the lex specialis nature of such a regime fails for instance, in the domain of remedies, the whole issue of specific remedies appropriate for the illegality at hand may fall back to what might be ascertained by the judge as the common intention or the will of the parties at the time of concluding the treaty in question. thus, either the ‘common intention’ of the parties or general international law would be the guiding force for the judiciary in such a case.34 this issue appeared to have been handled in a more general manner by the pcij in the chorzow factories case.35 though it may be difficult to say with certainty when a lex specialis has failed, if the limitation of lex specialis can only be cured by general or customary practice, the conclusion of the ilc’s work demonstrated a significant move towards the codification of the rule of customs in the international sphere.36 furthermore, a special regime may also be complemented not on the basis of a particular failure, but to fill lacunae. if such cases concern closing a gap without which certain objectives might not be achieved; for instance, inducing compliance by countermeasures in the case of wto jurisprudence, a resort to classical treaty law maybe unavoidable. thus, article 60.2 of the vclt which is presumably by its nature applicable to all domains of public international law (including the wto law), considers a material breach of a multilateral treaty, as a sufficient ground by other parties to the treaty to suspend in part or in whole or to terminate altogether the operation of such treaty against the defaulting party.37 in part four article 55 of the ilc’s draft articles, dealing with lex specialis, the draft applies only where there is no provision under a particular convention governing the wrongful act committed.38 there is a presumption that the draft will be very useful for an adjudicating body where there is a lacuna as regards a particular treaty provisions. to this extent, (assuming it represents an authoritative text or an authoritative restatement of customary international law) the ilc draft may be applicable if not directly, indirectly to the dispute settlement regime of the wto. nordic journal of commercial law issue 2004 #2 6 4. contextual issues in the perspective of the wto dispute settlement understanding (dsu), article 19.1 sentence two is to the effect that in addition to the recommendations of the panel or appellate body (ab), they may suggest ways of implementation of their decisions to the non-compliant member. to this extent, article 19.1 does not prejudge the limit of the panel in making such suggestions. in line with this reasoning, the dsu does not preclude the suggestion of a specific remedy. the wto agreement is an international treaty, and acts committed in breach of an international treaty amount to international wrongful acts. parties to an international treaty would not just sit and watch another contracting party walk away from their international obligations under such treaty. from this perspective, the ilc’s draft is consequently relevant for the evaluation of the necessity of solidarity measures under the wto agreements. many negotiators in geneva may be quite sceptical as regards this view. the scepticism stems from the fact that they consider the wto regime to be quite special in itself (lex specialis), as opposed to other branches of general international law. eventually, they are ‘insulated from general public international law.’39 much has been said about the special nature of the wto law.40 the question one would ask at this juncture is; how special wto law really is? it is worth noting that being a member of the wto creates international obligations, which members must respect in good faith. the principle of pacta sunt servanda which applies to all international law obligations including those of the wto requires states to respect their treaty obligations in good faith.41 this principle, at once a principle of law and a general principle of international law, controls the exercise of rights by wto members.42 joost pauwelyn rightly argues that, ”[s]tates in their treaty relations, can contract out of one, more or in theory, all rules of general international law (other than those of jus cogens), but they cannot contract out of the system of international law. as soon as states contract with one another, they do so automatically and necessarily within the system of international law.”43 by implication, the moment the accession process to the wto of a particular state is completed; such member will be subjected within the system of international law to conform its trade practices to the treaty text obligations of the wto and annexed agreements. however, the debate on whether to conceive international economic law such as gatt/wto in isolation from the general corpus of international law has long been contentious within the academic circles. in his report on the societé francaise pour le droit international, prosper weil argued that international economic law has the same place as the law of treaties and the law of neutrality in international law.44 the understanding of the meaning of ‘self contained’ regime in itself seems to be very uncertain. nonetheless, in its first report, the ab acknowledged that the wto agreement and its annexes are not to be read in clinical isolation from public international law.45 this judgment seems to have been confirmed and followed in subsequent dispute settlement rulings.46 nordic journal of commercial law issue 2004 #2 7 in this particular respect, the ilc’s articles have dealt with the issue of countermeasures taken by third states and where the responsibility is owed to the international community at large (erga omnes).47 collective countermeasures may also be invoked in a situation where the responsibility is owed to a group of states of which the state taking the countermeasure is a member and the obligation is established for the protection of the collective interests of that group of states. taking into account the fact that wto rules are rapidly expanding in the sense of the parties that they affect, there is a strong reason to consider wto obligations as multilateral and not merely bilateral.48 any breach of wto obligations affects not only members as governments, but also individual companies, consumers and other economic operators in the domestic and global market places. furthermore, pursuant to dsu article 3.8, a breach of a particular wto obligation affects not only a particular wto member, but all the members to the agreement in question. thus, a particular breach has a multilateral effect.49 the panel in the united states section 301-310 case stressed the importance of the ”creation of market conditions conducive to individual economic activity in national and global market places”.50 indeed, the panel recognised the importance of the individual consumers and undertakings in various member states when applying a measure within the wto disciplines. the arbitration has also pointed out that the dsu has very significant objectives, ”[t]he most relevant in our view are those which relate to the creation of market conditions conducive to individual economic activity in national and global markets and to the provision of a secure and predictable multilateral trading system.”51 the arbitration reiterated on the fact that the dsu is the wto cornerstone for providing predictability and security to the entire wto disciplines and through it that of the market place and its different operators.52 with this in mind, there is an incentive to believe that a nullification or impairment of benefits accruing to any member state to the wto treaty entails a breach of responsibility under a multilateral treaty.53 thus, such wrongdoers shall be compelled or induced to bring their measures into conformity with their responsibility under the wto law and also be liable for the provision of compensation.54 furthermore, on appeal in the ec – bananas iii case, the ab upheld the panel rulings that the increased interdependence of the global economy is a glaring indication that any wto member has an interest in any particular violation. thus, all wto ”members have a stake in enforcing the wto rules” now more than ever.55 to this extent, the ilc’s draft articles deal with collective countermeasures by permitting states not ‘directly injured’ by the illegal measures to invoke the responsibility of other states and take countermeasures where there is continuous violation of a treaty obligation.56 the issue of collective implementation of the rulings of the dispute settlement body (dsb) seem to have been taken note of, though has rarely been literally raised. according to the second sentence of dsu article 21.6, ”[t]he issue of implementation of recommendations or rulings may be raised at the dsb by any member at any time following their adoption.”57 nordic journal of commercial law issue 2004 #2 8 alternatively, since the purpose of countermeasures in the dsu (suspension of concessions as in wto parlance) is to induce compliance,58 the ilc’s draft seem to be more clear on this issue59 in the sense that the ilc’s articles provide a good basis for the arguments for collective countermeasures in the context of the dsu. 5. the case for solidarity measures in enforcing dsb rulings and recommendations the underlining rationale for a call for solidarity measures in the context of the dsb rulings and recommendations enforcement process would depend on whether a violation of a particular wto covered agreement would be seen as a breach of a member’s obligation under international law and also largely on the implications of a non-compliance with the wto law. in this context, having made these determinations in the foregoing sections, it is still not self-evident why alternative enforcement possibilities under customary rules of state responsibility cannot be resorted to if the remedy (suspension of concessions by the ‘directly injured’ state alone) under the dsu appears illusory to result in compliance.60 it is true, that the dsu in itself does not explicitly provide any real guidance or reference to the general rules of state responsibility in the context of the wto, let alone a possibility to resort to an alternative enforcement regime provided for by the customary rules of state responsibility in a situation where the dsu becomes insufficient to respond to continues violation of a relevant wto treaty commitment.61 it is also true that even if the panels or the ab on its own, make use of the customary rules of state responsibility, their recommendations cannot add to or diminish the rights and obligations of members under a covered agreement.62 but, it is clear that the concept of violation and or nullifications or impairment of benefits presupposes both the determination that a member has failed to carry out its conventional obligations and the establishment of the legal consequences stemming from such conduct.63 the fact that the dsu is silent about the invocation of other rules of international law such as those provided for under the law of state responsibility to counter breaches of the wto agreements presumably implies that the wto members have not contracted out of those rules.64 consequently, the dsu only sets forth a number of rules dealing with the consequences of a particular breach of the wto agreements. this means that these rules in themselves can still be less exhaustive and may require other international rules or customary rules to complement them.65 it is also clear from the ilc’s articles that to the extent that there is no special regime (lex specialis) taking care of a continuous violation of a treaty, the ilc’s articles will be valid in the enforcement of such a treaty.66 thus, by inference, assuming that the ilc work also represents the ‘common intention’ of the multilateral community; article 54 ‘solidarity measures’ of the ilc’s codified customary law would be relevant in the context of the wto treaty system.67 in the context of dsu article 3.2, there is already an understanding that the dsu was not meant to be an exhaustive set of rules. any relevant rules of international law can be used by the panel and or the ab when interpreting the provisions of the wto covered agreements, so long as the interested parties are also parties to those set of rules in question.68 with this in mind, presumably, the extent to which non-wto rules would be relevant in a particular dispute would still largely depend on the will of the parties and probably the reasoning of the panels or the ab. for instance, in the ec – computer equipment,69 the ab, in rejecting one of the decisions of the nordic journal of commercial law issue 2004 #2 9 panel, expressed regrets as to why the panel did not consider the harmonized system and its explanatory notes to which both the ec and the us were parties to, during the conclusion of the uruguay round trade negotiations.70 article 48 of the ilc’s articles establishes grounds on which other members, other than a directly injured state for a breach of a convention can invoke the responsibility of the wrongdoing state while article 54 states; the chapter does not prejudice the right of any state, entitled under article 48, paragraph 1 to invoke the responsibility of another state, to take lawful measures against that state to ensure cessation of the breach and reparation in the interests of the beneficiaries of the obligations breached.” conversely, dsu article 3.2 clearly states the objective of wto dispute settlement. it states; ”…[t]he members recognize that it serves to preserve the rights and obligations of members under the covered agreements, and to clarify the existing provisions of those agreements in accordance with customary rules of interpretation of public international law.” if by virtue of the provisions of dsu article 3.2, article 54 of the ilc’s work is used by the panels or ab, as a codified version of customary practice, it would be doing so only because it would serve to preserve the wto member’s rights and obligations under the relevant covered agreements.71 but, by virtue of article 3.2 and 19.2 of the dsu, it has been argued that the wto members did not intend to incorporate customary international law rules into the wto acquis, other than those dealing with treaty interpretations, as provided for under articles 31 and 32 of the vclt.72 with this in mind, other aspects of general international law can only be incorporated into the wto acquis when there is a renvoi to such rules under a particular covered agreement.73 but, this view may somehow be misleading, if we conceive inter-state relations as an evolving process. even if the wto law is considered self-contained from different angles, its operation may be conditioned ‘by its legal-systemic environment’.74 the fact that dsu article 3.2 seem to be referring only to the question of interpretation as under customary international law does not mean that article 3.2 of the dsu shut its door to all other aspects of customary international law when dealing with a particular dispute under the wto agreements.75 the panels and the ab have applied other general international law rules and even some concepts embedded in member states practices, when dealing with aspects unrelated to interpretation. for example, in us – wool shirts and blouses, the ab in order to determine the party to which the burden of proof rested, held that: ”…[v]arious international tribunals, including the international court of justice, have generally and consistently accepted and applied the rule that the party who asserts a fact, whether a claimant or the respondent, is responsible for providing proof thereof. also, it is a generallyaccepted canon of evidence in civil law, common law and, in fact, most jurisdictions that the burden of proof rests upon the party whether complaining or defending, who asserts the affirmative of a particular claim or defence.”76 furthermore, the panels and the ab have in a number of cases referred to other international law practices unrelated to treaty interpretation such as, locus standi,77 and manifest error in the formation of a treaty etc.78 nordic journal of commercial law issue 2004 #2 10 5.1. ilc article 55 lex specialis in the context of wto dispute settlement countermeasures from the foregoing section, it may be understood that the wto members did not intend to prioritise the use of countermeasures. the countermeasures are meant to be resorted to only when there is a continuous violation of agreed negotiated tariff commitments. a countermeasure is thus a fall-back in the event of non-compliance with a particular dispute settlement report.79 this also seems to be true under other international practices. for instance, the icj in the gabcikovonagimaros project stated that countermeasure must only be taken when the injured state has called upon the wrongdoing state to discontinue its wrongful act and to make reparation, to no avail. the purpose of the countermeasures must be to induce compliance with an international obligation.80 alternatively, with the current situation in the wto, this function can only be attained if there are sufficient trade relations between the directly affected member and the implementing member. but in certain cases, particularly those concerning a developing country against a developed country, such trade relations might be absent. by implication, unilateral countermeasures by such a developing country would not be sufficient to induce compliance. thus, unless such compliance is induced, the enforcement mechanism of the wto dispute settlement system cannot function properly.81 eventually, article 3.2 of the dsu and article 55 of the ilc’s draft article presumably, set forth grounds for the invocation of ilc article 54 solidarity measures. the dsu only set forth the purpose of countermeasure and does not say much about the situation where inducement cannot be achieved.82 thus, article 55 lex specialis of the ilc’s draft states; ”these articles do not apply where and to the extent that the conditions for the existence of an internationally wrongful act or the content or implementation of the international responsibility of a state are governed by special rules of international law.”83 from this point of view, we could assume that the ilc’s articles are meant to be applicable to all fields of international law provided that there arises the problem of state responsibility,84 especially where there is no alternative regime to effectively deal with such breaches. contextually, panels or the ab could only refrain from taking inspiration from the ilc’s draft article 54, to recommend other wto members to jointly enforce the dsb recommendations, if there is a justification that the dsu or other covered agreements have provisions dealing with illusory countermeasures. to this extent, there seems to be no such justification.85 it is however, true that the panel and the ab do not in any case represent judicial law-making institutions of the wto. only a ministerial conference, as provided for in article ix of the wto agreement can lawfully perform such a task.86 nonetheless, by arguing that the panel and the ab could resort to the use of collective countermeasure as provided for under article 54 of the ilc’s draft, to fill the lacunae in the dsu is not a plea to tend the panel and the ab to a judicial law-making body of the wto. the competence of the panel and the ab is to interpret and apply the law and not to add or diminish the rights and obligations of the wto members. obviously, extending the application of customary international law beyond treaty interpretation to deal with nordic journal of commercial law issue 2004 #2 11 enforcement in the dispute settlement system will not be an over-stretch of the normal judicial bounds of the panel and ab. it would be an issue of sources of law87 and whether the wto treaty system is part of the general corpus of international law.88 as has been mentioned earlier, a review of the wto jurisprudence already demonstrates that the panel and the ab would not be exceeding their mandates by using the ilc’s articles in adjudication. by referring to an earlier version of the ilc’s draft (article 49 of the 1997 version), the arbitration in the ec – bananas case held that ”…[c]umulative compensation or cumulative suspension of concessions by different wto members for the same amount of nullification or impairment would run counter to the general international law principle of proportionality of countermeasures”.89 most importantly, in the cotton yarn case, the ab again in justifying its position on the proportionality of countermeasures, referred to article 51 of the 2001 ilc’s articles.90 consequently, it is not self-evident as to why the 2001 ilc’s draft article 54 may not be resorted to by the wto dispute settlement organs. 6. tentative conclusions the enquiry in this writing demonstrates that the non-effective nature of countermeasures, as a last resort remedy in the wto dispute settlement seems to present a threat to the credibility of the wto. it is true that if compared with other third parties adjudicating bodies and most importantly the gatt, the wto dispute settlement up to this point seems to have worked quite well. but, it appears that the rules of international trade are generally silent as to what will happen, if violation of the wto obligations cannot be cured by a countermeasure taken by a relatively small wto member. in this respect, and considering the fact that the wto dispute settlement organ already started using the ilc’s draft articles (both the 1997 draft version and the 2001 version, adopted by the drafting committee on its second reading) to fill the lacunae in dsu article 22, it would be useful for the purpose of preserving the security and predictability of the wto to find a way of inducing compliance through a resort to ilc’s article 54 solidarity measures. there seems to be no provision in the dsu or any other covered agreements, preventing the panel or the ab in doing so. moreover, when the panels and the ab deal with other aspects not covered by the dsu, it seems they do not generally depart from the solutions provided for under general international law. only in some rare cases there appear to be derogations from the rules of general international law. as there is now a growing common understanding that the wto would routinely needs other public international law rules to complement or to better understand certain of its provisions, it will be increasingly difficult to justify why traditional international law remedy such as solidarity measures provided for under article 54 of the ilc’s draft articles and vclt article 60, might not be considered so as to induce compliance, if countermeasures taken by an ldc or developing country for instance, proves unworkable. although with very limited elaboration, the primary rules that might govern collective countermeasures as provided for under the ilc’s draft articles, and vclt article 60, seem to be sufficiently precise if framed in the wto dispute settlement context. but the danger of their abuse might also be great. a resort to a collective countermeasure by the wto may entail supportive institutional procedures, transparency and political will. though a legally clear and circumscribed solidarity measure will be an important step towards the enhancement of the confidence in the multilateral trading system, it would be wrong to take this important step nordic journal of commercial law issue 2004 #2 12 * visiting scholar at the world trade institute-bern at the time of writing this article and research fellow at the faculty of lawuniversity of helsinki. i am grateful for the useful comments on the draft of this paper provided by martti koskenniemi, matthias oesch, martin björklund and fernando pierola. the opinions expressed are strictly personal. all errors, of course, remain mine. the author can be contacted through hodu.ngangjoh@helsinki.fi 1 european communities – regime for the importation, sale and distribution of bananas, wt/ds27/arb/ecu, (may 18 2000). 2 european communities – measures concerning meat and meat products (hormones) (us and canada), wt/ds26/arb, wt/ds48/arb, (july 26 1999). 3 brazil – export financing programme for aircraft, wt/ds46/arb, (december 12 2000) 4 united states – tax treatment for ”foreign sales corporations”, wt/ds108/arb, (may 7 2003). 5 canada – export credits and loan guarantees for regional aircraft, wt/ds222/arb, (march 18, 2003). 6 united states – anti-dumping act of 1916, wt/ds136/arb, (february 24, 2004). 7 united states – continued dumping and subsidy offset act of 2000 (byrd amendment), wt/ds217/arb, wt/ds234/arb, (august 31, 2004). 8 twelve cases have led to the adoption of article 21.5 compliance panel reports and eight cases to the adoption of article 21.5 appellate body (ab) reports. source, legal affairs division, wto secretariat. 9 it is true that taking this number as a fraction of the eighty cases that have gone through the system, would show a very positive picture of the wto dispute settlement system. but, it is important to note that most of these cases that have resulted to countermeasures have concerned very sensitive disputes that could effectively test the enforcement regime of the system. 10 see the 1969 vienna convention on the law of treaties (vclt) article 60. united nations treaty series (unts), vol. 1155, at 331. 1 1 ‘solidarity measures’ is a borrowed phrase from the comments of martti koskenniemi on the 2001 international law commission’s articles. see martti koskenniemi, ” solidarity measures: state responsibility as a new international order?” british year book of international law (brit y.b. int. l.) 2001 340 (hereinafter, koskenniemi, 2001). 12 in its judgment on the merits in the case concerning military and paramilitary in and against nicaragua, the international court of justice (icj) considered whether the united states had the unilateral rights to use force in response to nicaragua’s action against other central american states. military and paramilitary in and against nicaragua, (nicaragua v. united states) 1986, icj reports 14 at para. 106-11. though the court ruled that third states could contribute in countermeasures, it finally rejected the claim by the united states to have a unilateral rights against nicaragua. see para. 146-49 of the icj reports. 13 see the case of south west africa (ethiopia v. south africa; liberia v. south africa) (1960-1966), where in the applications of south africa as regards the merits of the case, it argued that the court should rule that both ethiopia and liberia had no locus standi in the case. for a concise analysis of this case, see ian brownlie on ‘principle of international law’ 5th edition, 1998. hereinafter brownlie 1998, 469-476. also, willem riphagen writing about the fourth report of the international law commission draft on the responsibility of states for internationally wrongful acts supported the idea of collective countermeasures in the case of multilateral commitments such as international crimes committed by a state. riphagen, fourth report on the content, forms and degrees of international responsibility, in koskenniemi, 340, (2001). precipitously without extensive discussion since doing so might present more problems than it would resolve. a definitive solidarity measure would be important for the multilateral spirit that binds the wto members though. but, a proper recourse to solidarity measure might also entails a definition in the wto agreements of which categories of countries or which breaches would lead to a call for solidarity measures in which the ‘directly injured’ state should not be left alone, else, the system would soon become a forum for great power policy. however, the purpose of legal research is rather to lay a foundation for changes in approaches within the academics and practitioners circles. (endnotes) nordic journal of commercial law issue 2004 #2 13 14 see root elihu, the outlook for international law, american society of international law (asil) 2, 5-10, (dec 1915), in charney jonathan i., third states remedies in international law, hereinafter, charney, 10 mijil 57, 60-64, (1989). 15 at a news conference on october 22nd 1987, the then president of the united states-ronald reagan, stated that ‘we’re there to protect neutral nation shipping in international waters that under international law are supposed to be opened to all traffic.’ reagan’s news conference on domestic and foreign matters, new york times october 23rd 1987 at a8. collective countermeasures are thus a necessary part of any legal system, like the international legal system that lacks strong ‘vertical’ enforcement. see for instance, daniel badansky, john r. crook and david j. bederman, hereinafter known as bodansky, crook and bederman in ‘counterintuiting countermeasures,’ 96 amjil 817, 1 2002. 16 though a broad interpretation of article 19.1 of the dsu may give one the impression that a panel or appellate body has a mandate in some circumstances to permit collective countermeasures, since they have a mandate to make suggestions on implementation in addition to their recommendations. 17 s.s wimbledon, uk, france, italy, japan v. germany, pcij 1923 (ser. a) no. 1, 21. in this case, germany was held liable for the abrogation of one of the clauses of the treaty of versailles on the right of navigation in the kiel canal. france was awarded reparation, but the other parties who intervened did not claim any pecuniary interest in the dispute. see brownlie, 471, (1998), see also jan klabbers, clinching the concept of sovereignty: wimbledon redux, austrian review of international and european law (ariel), vol. 3, no. 3, 345-367, (1999). hereinafter, klabbers (1999). 18 see for instance, article 54 of the international law commission draft (ilc draft) on state responsibility which allow states other than the injured state take countermeasures for the benefit of the injured state or the other states for the obligation breached. 19 draft articles on responsibility of states for internationally wrongful acts, adopted by the ilc at its fifty-third session (2001). official records of the un general assembly, fifty-sixth session, supplement no. 10 (a/56/10), chp.iv.e.1) november 2001, also obtainable at http://www.un.org/law/ilc. 20 martti koskenniemi, brit y.b. int. l. (2001). 21 see j. charpentier, ’l’affaire du rainbow warrior’, annuaire français de droit international, 31 (1985) 210-220 and g. apollis, ‘le règlement de l’affaire du rainbow warrior’, review gènèrale de droit international public 91 (1987) 9-43, see also the comments of james crawford on the last version of the ilc articles, ”the ilc’s articles on responsibility of states for internationally wrongful acts: a retrospect” 96 american journal of international law (ajil) 874, (2002). 22 koskenniemi, 341, (2001). 23 see koskenniemi, 340 footnote 16, (2001). 24 coron, david d., the ilc articles on state responsibility: the paradoxical relationship between form and authority, 96 ajil, 857, 873 (2002). 25 see crawford 96 ajil, 889, (2002). 26 see koskenniemi, supra. footnote 12. 27 see james crawford, ”the ilc’s articles on responsibility of states for internationally wrongful acts: a retrospect,” 96 amjil, 2002, 874-875, (hereinafter j. crawford, 2002). 28 j. crawford, 884-885, (2002). 29 koskenniemi, 339, (2001). 30 see for instance, for a careful extrapolation of the importance of countermeasure as regards the commission’s work, bodansky, crook and bederman, 96 amjil 817, at 830-832, (2002). see also james crawford’s comments on the earlier version of the draft in ‘revising the draft articles on state responsibility,’ european journal of international law (ejil) vol. 10. no 2, 435-460, (1999), (hereinafter crawford 1999). 31 see in this case crawford, ibid, charney, 10 mijil 57 (1989), ian brownlie, (1998), petros c. mavroidis ‘remedies in the wto legal system: between a rock and a hard place’ ejil (2000). (hereinafter mavroidis 2000), joost pawelyn, ’the role of public international law in the wto: how far can we go?’ 95 amjil 535, (2001), (hereinafter pauwelyn 2001). 32 see most importantly the comment of j. charpentier and g. apollis in the rainbow warrior case as mentioned above. 33 see bodansky, crook and bederman, 818-819, (2002). 34 see for instance, the recent report by the study group on the fragmentation of international law: difficulties arising from the diversification and expansion of international law, fifty-sixth session of the international law commission, geneva, 3 may-4 june and 5 july-6 august 2004, a/cn.4/l.663/rev.1 paras. 8-18. 35 ”…it is a principle of public international law that the breach of an engagement involves an obligation to make reparation in an adequate form. reparation therefore is an indispensable complement of a failure to apply a convention and there is no necessity for it to be stated in the convention itself.” pcij, 1929, series a, no. 8, 4 at 21. see also article 1 of the ilc draft which states that ”every international wrongful act of a state entails the international responsibility of that state.” nordic journal of commercial law issue 2004 #2 14 36 see crawford’s retrospective comments on the report of the ilc, 96 ajil 874, (2002), see also koskenniemi, (2001). 37 vienna convention on the law of treaties, adopted on 22 may 1969 and opened for signature on 23 may 1969 by the united nations conference on the law of treaties. entry into force on 27 january 1980. see text, united nations treaty series (unts), vol. 1155, at 331. 38 article 55 states ”these articles do not apply where and to the extent that the conditions for the existence of an internationally wrongful act or the content or the implementation of the international responsibility of a state are governed by special rules of international law.” 39 see petros c. mavroidis in ”remedies in the wto legal system: between a rock and a hard place,” european journal of international law (ejil), vol. 11 no. 4, 763-813 (2000), (hereinafter mavroidis 2000). mavroidis also disagree with the view that the wto regime should be isolated from the general corpus of international public law. 40 see for instance pieter jan kuijper, ‘the law of gatt as a special field of international law,’ 1994, netherlands year book of international law (neth. y.b.int.l), 227, (1994),(hereinafter kuijper, 1994). the expression ‘self contained’ regime as used in some of the arguments as regards the nature of the wto law was employed by the icj to refers to the rules of the diplomatic law in the case of united states of america v iran, see judgment of the icj of 24 may 1980, icj reports 1980, at 40, para. 86. see a study on self contained regimes in simma bruno, ‘self contained regimes’, 6 neth. y.b.int.l, 111-136, (1985). 41 for the argument on the relationship between the principle of pacta sunt servanda and wto obligations, see ngangjoh h. yenkong, pacta sunt servanda and complaints in the wto dispute settlement, forth-coming manchester journal of international economic law (mjiel), (september 2004). 42 ab report, united states – import prohibition of certain shrimp products, wt/ds58/ab/r, para. 158, (12 october 1998). 43 joost pauwelyn, role of public international law in the wto law, 95 american journal of international law (ajil), 539 (2001). 44 see weil prosper, le droit international economique, mythe ou realité?, societé francaise pour le droit international, aspects du droit international economique, colloque d’orleans, paris, eds. pedone, 1-34, at 31, (may 1971). 45 united states – standard for reformulated and conventional gasoline, wt/ds2/ab/r, 17, (march 20 1996). 46 united states import prohibition of certain shrimp and shrimp products, wt/ds58/ab/r, (12 october 1998). in order to judge the legality of the panel interpretation in the light of gatt article xx, the ab used a number of international agreements including the rio declaration on environment and development (rio declaration on environment and development, 3-14 august 1992, un general assembly doc. a/conf.151/26 vol. i). para. 154. 47 articles 48.1(b) and 54 of the ilc articles, which indicates that third states can take countermeasures for the benefit of other states to the obligations breached. 48 see christian walter, ”constitutionalizing (inter)national governance-possibilities for and limits to the development of an international constitutional law,” german yearbook of international law (gybil), vol. 44, 172-73, (2001). (hereinafter walter 2001). 49 see the ab report in the ec – bananas iii case where in rejecting ec argument that the us could not have been affected by the ec bananas regime, the ab held that though the us did not export bananas to the ec, ”[t]he internal market of the united states could be affected by the ec banana regime, in particular, by the effect of the regime on world supplies and world prices of bananas”. see wt/ds27/ab/r, 61, para. 36, (9 september 1997). 50 united states sections 301-310 of the trade act of 1974, panel report, wto document wt/ds152/r, para. 7.73, (december 22, 1999). 51 see para. 7.71 of the panel report. also, in the ec – bananas case (wt/ds27/arb) the arbitrators held that, ”while it may be necessary to develop more sophisticated rules in this regard in the future, we believe that the line we have drawn is appropriate in this particular case, which involves the suspension of concessions. we imply no limitations on the extent of wto obligations for this or other cases by this decision”. para. 6.18. 52 see para. 7.75 ibid. 53 in the us – shrimp case, the ab concurred that ”an abusive exercise by a member of its own treaty rights thus results in a breach of a treaty rights of the other members and, as well, a violation of the treaty obligations of the member so acting”. wt/ds58/ab/r, 92, para. 158. 54 chorzow factories analytical definition of the concept of reparation. 55 para. 136. 56 articles 48 and 54 of the ilc draft articles. 57 see also dsu article 3.8. nordic journal of commercial law issue 2004 #2 15 58 ”compensation and the suspension of concessions or other obligations are temporary measures available in the event that recommendations and rulings are not implemented within a reasonable period of time.” article 22.1 dsu. 59 see for instance articles 48, 49.1 and 54 of the draft dealing with countermeasures. 60 since the purpose of countermeasures ‘should be to perform an instrumental function of ensuring compliance’ article 54 of the ilc ‘s articles, thus establishes a baseline for effecting such countermeasures by other states in a situation where unilateral countermeasure by the ‘directly injured’ state prove ineffective to induce compliance. see for instance james crawford’s comments on the third report on state responsibility, a/cn.4/507/add.3, 3, paras. 287 and 289 referring to the purpose of countermeasure established by the icj in the gabcikovo-nagimaros project, 56-57, para. 87. see also vclt article 60.2. 61 article 23.1 of the dsu states ”when members seek the redress of a violation of obligations or other nullifications or impairment of benefits under the covered agreements or an impediment to the attainment of the objective of the covered agreements, they shall have recourse to, and abide by, the rules and procedures of this understanding.” it is not very clear whether this provision indicates that wto members in their commitments clearly waived their rights to resort to alternative tribunals for instance the icj even if they find that the remedies provided by the dsu is insufficient. in the us – sections 301-310 for example, the panel pointed out that ”article 23.1…imposes on all members to have recourse to…the dsu dispute settlement system to the exclusion of any other system, in particular a system of unilateral enforcement of wto rights and obligations. this, what one could call ”exclusive dispute resolution clause”, is an important new element of members’ rights and obligations under the dsu.” wt/ds152/r, para. 43. 62 dsu article 3.2. 63 see for instance villalpando santiago m., attribution of conduct to the state: how the rules of state responsibility may be applied within the wto dispute settlement system, jiel 393-420, (2002). 64 it is important in this respect to note the clear reference to customary rules of interpretation provided for under article 3.2 of the dsu. 65 see pauwelyn, 573-575, (2001), see also villalpando, 398-399, (2002). 66 article 55 of the ilc’s article. 67 in pointing out the importance of the ‘common intention’ of members when interpreting a relevant wto covered agreement, the ab in the ec – computer equipment held that ”the purpose of treaty interpretation under article 31 of the vienna convention is to ascertain the common intentions of the parties. these common intentions cannot be ascertained on the basis of the subjective and unilaterally determined ”expectations” of one of the parties to a treaty.” wt/ds62/ab/r, wt/ds67/ab/r, wt/ds68/ab/r, para. 84. 68 the rules of interpretation as required by the vclt states ”…there shall be taken into account, together with the context…any relevant rules of international law applicable in the relations between the parties”. see vclt article 31.3 (c). 6 9 european communities – customs classification of certain computer equipment, wt/ds62/ab/r, wt/ds67/ab/r, wt/ds68/ab/r, (adopted, june 22, 1998). 70 ”we are puzzled by the fact that the panel, in its efforts to interpret the terms of schedule lxxx, did not consider the harmonized system and its explanatory notes. we note that during the uruguay round negotiations, both the european communities and the united states were parties to the harmonised system…neither the european communities nor the united states argued before the panel (footnote omitted) that the harmonized system and its explanatory notes were relevant in the interpretation of the terms of schedule lxxx. we believe, however, that a proper interpretation of schedule lxxx should have included an examination of the harmonized system and its explanatory notes. ab reports, ec – computer equipment, 33-34, para. 89. 71 dsu article 3.2. see also matsushita mitsuo, thomas j. shoenbaum & petros c. mavroidis, the world trade organization. law, practice and policy, oxford, 25, (2003). (hereinafter, matsushita). 72 see trachtman joel p. the domain of wto dispute resolution, harvard international law journal (hilj), vol. 40 no. 2, 333337, at 343 (spring 1999). see also palmeter david and petros c. mavroidis, the wto legal system: sources of law, 92 ajil, no. 3, 116, (1998). 73 see for instance article 2 of the agreement on trade related intellectual property rights (trips). 74 see report of the study group of fragmentation of international law: difficulties arising from the diversification and expansion of international law, (2004), a/cn.4/l.663/rev.1, para. 9, at 5. 75 for this view, see pauwelyn 95 ajil, 562-565, (2001), garcia-rubio, graduate institute of international studies (giis), geneva, 67-73, (2001). 76 see ab report, united states measure affecting imports of woven wool shirts and blouses from india wt/ds33/ab/r, 14. see also ab report in european communities – conditions for the granting of tariff preferences to developing countries, wt/ds246/ab/r, at 33, para. 87, (adopted 20 april, 2004). nordic journal of commercial law issue 2004 #2 16 77 see european communities – regime for the importation, sale and distribution of bananas (ec – bananas), wt/ds27/r, para. 133, (september 27 1997). it is also important to note in this context that the panel and the ab in the bananas case went as far as employing the lomé convention which was not part of general international law. 78 in dealing with the issue of error in treaty formation, under the concept of non-violation complaint, the panel in the korea – measures affecting government procurement, wt/ds163/r, (may 2000), resorted to customary international law practice (from permanent court of international justice-pcij to the icj), as codified in vclt article 48. see panel report, paras. 7.120-7.123. 79 jackson john h., the world trade organization, constitution and jurisprudence, london, 85, (1998). 80 icj reports, gabcikovo-nagimaros project (hungary/slovakia), general list no. 92, paras. 82-87 (25 september 1997). see also www.icj-cij.org/icjwww/idocket/ihs/ihsjudgement/ihs_ijudgment_970925_frame.htm last visited 22-06-04. 81 see ec – bananas arbitration, where in reiterating the object and purpose of countermeasure under dsu article 22, the arbitrators insisted that ”…[i]f a complaining party seeking the dsb's authorization to suspend certain concessions or certain other obligations were required to select the concessions or other obligations to be suspended in sectors or under agreements where such suspension would be either not available in practice or would not be powerful in effect, the objective of inducing compliance could not be accomplished and the enforcement mechanism of the wto dispute settlement system could not function properly”. wt/ds27/arb/ecu, at 19, para. 76 (24 march 2000). 82 dsu article 22.1. 83 part four, article 55, draft articles on responsibility of states for internationally wrongful acts, adopted by the ilc at its fiftythird session (2001), official records of the general assembly, fifty-sixth session, supplement no. 10 (a/56/10), chp.iv.e.1) (november 2001). 84 see villalpando, 399 (2002). 85 for example, the agreement on subsidies and countervailing measures (scm), in annex i (k), provides for a situation where a non-wto rule can be a justification for derogating from one’s obligations under the scm agreement. 86 the ministerial conference is the only decision making body with the competent to amend the provisions of the marrakesh agreement establishing the wto or the provisions of any of the multilateral trade agreements in annex 1 of the wto agreements. 87 see for instance garcia-rubio, (2001) and villalpando, (2002). 88 an elaborate analytical response to whether the wto is an isolated regime of law has been provided in the eminent writings of john h. jackson ( 2004 ”international law status of wto dispute settlement reports: obligation to comply or option to ”buy out”?”, ajil, vol. 98, 109-125, (2004)) and joost pauwelyn (the role of public international law in the wto: how far can we go? 95 ajil, 535-578, (2001)) 89 wt/ds27/arb, at 38, para. 6.16 (april 19 1999). 90 appellate body report, united states – transitional safeguard measure on combed cotton yarn from pakistan, wt/ds192/ab/r, 37, para. 120, footnote 90, (adopted, november 5, 2001). rene.pmd nordic journal of commercial law, issue 2004 #1 1 conformit y of goods in international sales governed by cisg article 35: caveat venditor, caveat emptor and contract law as background law and as a competing set of rules rené franz henschel nordic journal of commercial law issue 2004 #1 nordic journal of commercial law, issue 2004 #1 2 1. introduction in his pioneering work das recht des warenkaufs, ernst rabel undertook a comparative analysis of sales laws with a view to postulating common global rules on the sale of goods. following a review of the concept of ‘lack of conformity’ of goods2 to the contract in different western legal systems, rabel reached the following conclusion:3 “das »wesen« der gewährleistung ist nur historisch erklärbar. in einem rationellen system ein stück vertragsrecht, das ausdrüchliche fürsorge nur in einem bescheidenen mabe benötigt.” the background to rabel’s conclusion was that the legal systems which he had studied had differing views about the legal conditions for a buyer to claim that the goods lack conformity to the contract.4 thus, he found that some legal systems considered lack of conformity from a standpoint which has its roots in the roman law principle of tale quale, where it is assumed that the goods are ‘bought as seen’ (also referred to as the principle of caveat emptor5), according to which there is an assumption that the buyer bears the risk if it appears that the goods do not conform to the contract.6 other legal systems had developed more balanced rules, where the assumption was that the seller is responsible for defects in the goods, including those based on explicit or implicit guarantees about the quality of the goods (and the principle of caveat venditor which is derived from this), while yet other legal systems have operated without codified definitions of lack of conformity.77 cf. also andreas schwartze: europäische sachmängelgewährleistung beim warenkauf: optionale rechtsangleichung auf der grundlage eines funktionalen rechtsvergleich (tübingen, 2000), p. 26; reinhard zimmermann: the law of obligations (münchen, 1993), p. 307. here the assessment of lack of conformity was developed in the practice of the courts and in theor y on the basis of principles which were largely similar to those known from the other legal systems with codified rules for assessing lack of conformity. on this basis, rabel recommended that an attempt should be made to work out a common definition for lack of conformity of goods to the contract: “es bleibt nötig, den begriff des sachmangels zu definieren, aber nur deshalb, weil die mängelskataloge derzeit abweichen und zusammengefabt werden müssen.”8 among other things, it was on the basis of rabel’s work that the uniform sales laws, ulis9 and ulf10 were developed, and these later led to the adoption of the cisg in 1980.11 on the basis of rabel’s recommendations, it was decided to include a rule in the uniform sales laws and in the cisg on the conformity of the goods to the contract. the rule in article 35 of the cisg is as follows: article 35 (1) the seller must deliver goods which are of the quantity, quality and description required by the contract and which are contained or packaged in the manner required by the contract. (2) except where the parties have agreed otherwise, the goods do not conform with the contract unless they: (a) are fit for the purposes for which goods of the same description would ordinarily be used; (b) are fit for any particular purpose expressly or impliedly made known to the seller at the time of the conclusion of the contract, except where the circumstances show that the buyer did not rely, or that it was unreasonable for him to rely, on the seller’s skill and judgement; (c) possess the qualities of goods which the seller has held out to the buyer as a sample or model; nordic journal of commercial law, issue 2004 #1 3 (d) are contained or packaged in the manner usual for such goods or, where there is no such manner, in a manner adequate to preserve and protect the goods. (3) the seller is not liable under subparagraphs (a) to (d) of the preceding paragraph for any lack of conformity of the goods if at the time of the conclusion of the contract the buyer knew or could not have been unaware of such lack of conformity. in recent years, the cisg in general and the provisions on lack of conformity in article 35 in particular have prompted a number of changes to national sale of goods laws. more recently there have been changes to the eu law on the sale of goods, following the adoption of a directive on the sale of consumer goods which was also strongly influenced by the cisg rules on lack of conformity.12 the focus of this article on the provisions of article 35 on the conformity of goods to the terms of a sales contract also leads to a focus on the inspiration for changes made to sale of goods laws in a number of legal systems, including eu law. the purpose of this article is twofold: namely to analyse the battle between the principles of caveat venditor and caveat emptor and to analyse the relationship between article 35 and the contract law as background law and as a competing set of rules. the aim is to illustrate whether or not article 35 creates uniform rules on the conformity of goods in international sales. the article first discusses the basic principles of article 35. then, the relationship to supplementary and competing rules is discussed. the article then analyses how theory and practice generally have seen article 35 as an independent concept. following this, the battle between caveat venditor and caveat emptor is described through an analysis of art. 35(2)(a) and article 35(3). finally, the paper ends up concluding that the article 35 operates in an area of tension between differing doctrines and rules of the law of obligations, so there is sometimes conflict and thus uncertainty about the application of article 35. this is unquestionably a problem to achieving uniform application of the provision. 2. the basic principles of article 35 article 35 is founded on the basic principle that the seller has a duty to deliver the goods required by the contract. the premises of this argument are exoteric, evident and universal: the characteristics of the goods are presumed to lie within the sphere of influence of the seller,13 and the seller is presumed to know more about the characteristics of the goods than the buyer who has paid for the goods and is therefore entitled to receive his part of the bargain (quid pro quo). in this respect the starting position of the convention is caveat venditor, which has been the general tendency in the law on the sale of goods since the end of the 19th century.14 this is a natural solution in international sales law, where there are distances and where the buyer often enters into an agreement without having had previous sight of the goods. as distinct from the roman law of the market, where the prime rule was caveat emptor, trading at a distance means that the buyer must rely to a higher degree on the information in the contract and on the seller’s information about the goods. furthermore, the seller is usually the one who knows about the goods. the seller becomes the “eyes” of the buyer, so that the nature of the goods is overwhelmingly a matter within the sphere of influence of the seller. the seller must answer for the information he gives and what is agreed. the conclusion is that the seller – as a starting point – must effectively carry the risk of the goods conforming to the contract, and that the buyer can, with justification, expect to receive deliver y which conforms to the contract.15 the principle underlying article 35 is an ethical-juridical axiom,16 and constitutes an important element of the guarantee of trade.17 if the premises of the argument are changed, for example if the buyer supplies materials for the manufacture of the goods, if the buyer plays a role in selecting the goods or materials for them, or if the buyers knowledge and skills are superior to the sellers,18 then nordic journal of commercial law, issue 2004 #1 4 the validity of the argument is weakened, and the allocation of risk changes, since there are now elements which are outside the seller’s sphere of influence which can affect the assessment of lack of conformity to the contract.19 the conformity of the goods to the contract now falls within the buyer’s sphere of influence – caveat emptor. this alternation between caveat venditor and caveat emptor is the core of article 35 and – in general – in ever y assessment of the conformity of the goods. article 35 can therefore be considered as a rule in which the principles of caveat emptor and caveat venditor meet. it is only through a careful balancing of these principles that it is possible to decide whether or not a good complies with the contractual obligations or not. it is the proposition of this article that the principles of caveat emptor and caveat venditor, as expressed in article 35, should to a large extent be assessed on the basis of which party’s sphere of influence is more closely linked to the conformity of the goods to the contract, and on the basis of a number of suggested presumptions. for example, the starting point is that it is assumed that the seller should supply goods which are of the description laid down in the contract, cf. article 35(1), or are fit for the purposes for which goods of the same description would ordinarily be used, cf. article 35(2)(a). if the goods do not meet these standards, they do not comply with the contract. in other words, the starting point is the principle of caveat venditor. but what if there is a difference between the understanding of the terms in the contract, normal quality standards or fitness for purpose between the seller’s country and the buyer’s country? in this case, it is assumed that the seller should supply goods which meet the standards in the buyer’s country or in the seller’s country? unless the solution follows from an interpretation of the contract, this can only be decided if a choice is made between the principles of caveat emptor and caveat venditor. it is the proposition of the present writer that the party with whose sphere of influence the disputed factors are judged to be more closely linked ought to be liable for ensuring that the goods comply with such contractual requirements. 3. article 35 and its relationship to supplementary and competing rules. in this article the analysis of art. 35 are also based on the argument in rabel’s general conclusion that the assessment of lack of conformity is not an independent legal category, but is part of the law of contract. the law of contract is customarily divided into special parts, e.g. the sale of goods, and the general part containing the basic legal principles of obligations. however, these fundamental rules, or principles, are also expressed in the special parts so, for example, the danish law of sale of goods is regarded as a codification of many of the principles of the law of obligations. in other words, the law of sale of goods partakes both of the special part and the general part. the same can be assumed to apply to article 35. the provision lays down a number of rules which can be regarded as fundamental to international sales. however, the article should also be seen in the context of article 8 on interpretation and article 9 on usage. this means that it is relevant to study the content of the principles of each of these provisions. it is also clear that article 35, taken together with articles 8 and 9, cannot be assumed to be exhaustive with respect to the fundamental rules and principles which are relevant to assessing the compliance of goods to the contract. other provisions in the convention must also be referred to, cf. article 7.20 for example, there can be fundamental rules on bona fides, contract interpretation or on estoppel (under the rule of venire contra factum proprium, by which a party cannot contradict his own previous conduct). if the convention does not provide all the answers, then help can be sought elsewhere when making a thorough apportionment of liability under the law of obligations. in such circumstances it may be possible to apply both national rules and principles, but internationally recognised rules and principles, for example unidroit principles (by the international institute for the unification of prinordic journal of commercial law, issue 2004 #1 5 vate law) or pecl (principles of european contract law by the commission on european contract law, also known as the lando-commission) may be helpful in providing a truly international and uniform solution. there are also provisions which compete with article 35, in particular the rules on validity. since article 4 clearly states that the convention – unless otherwise expressly provided – is not concerned with the validity of a contract, national laws should apply. however, on certain occasions the rules on validity will overlap with the rules on lack of conformity, for example in cases of mistake. in other words, there can be situations in which there are conflicts between the convention and national law, unless the convention supersedes or absorbs the competing national rules. it is therefore not possible to analyse the concept of lack of conformity in article 35 without taking account of the fact that the provision should be seen in the context both of general and of special contract law and the law of obligations, under the convention and outside it, just as article 35 finds itself in competition with such rules, for example national rules on validity. since there is no general agreement on these questions, due to the differing points of view on the priority of the convention and its regulator y scope, it is the second proposition of this article that article 35 cannot be expected to lead to a fully harmonised law before either the general contract law which lies behind it is harmonised, or the provisions of the convention are amended. to conclude, in every case where article 35 comes into play, this brings into focus the question of contract law as background law to the convention and as a competing legal regime, since a party will be able to address the question of conformity of goods from a number of different angles:21 -the formation of the contract (that the conditions concerning a specific characteristic “x” of the goods is actually in, or is not in the contract),22 -the interpretation of the contract (that the conditions concerning the characteristics of the goods means “x” rather than “y”), and -the validity of the contract (the party was misled, as he thought the quality was “x” when in fact it was “y”). in this context it is likely that a party will rely on the rules of the convention to support their arguments but it is also possible that national rules will compete with the convention rules and a party will be able to rely on these in the alternative. to a great extent the rules on formation of contract, interpretation and validity are the same in different jurisdictions, but there are still major in differences, i.e. between the literal approaches to contract interpretation in common law and the more liberal approach to contract interpretation in civil law.23 if the convention can be said to govern a question exhaustively, or if article 35 applies as a lex specialis, then it cannot be assumed that there is scope for competing rules, though this is not recognised by everyone. in jurisdiction in which there is a principle of exhaustion of rights, the contract law rules on lack of conformity of goods will have priority over certain rules on validity, but this is not recognised in all jurisdictions.24 there does not seem to be a prospect for solving this conflict before the underlying contract law is harmonised or the convention rules are amended.25 this means that the parties still need to make a choice of law in order to avoid unpleasant surprises. it should also be noted that there can be elements in the agreement which could trigger the application of other competing national laws, for example culpa in contrahendo or rules on product liability. according to the opinion of the present writer, if the convention does not give an exhaustive functionally adequate solution, then national rules ought to apply. for example, article 79 has been referred to as a competing provision granting exemption from liability which could undermine the nordic journal of commercial law, issue 2004 #1 6 seller’s liability to pay compensation for defects in the goods. honnold argues that if article 79 were applicable, this would undermine the seller’s obligation to deliver goods which conform to the contract, cf. article 35, since the courts would have to enter into complicated considerations of the seller’s and the third party’s possibilities for taking into account any structural failure in the planning or production process, etc.26 in contrast to this, the prevailing view in continental european doctrine is that article 79 can be relied on in cases of defective deliver y of goods.27 there is thus nothing in the rules of the convention, whether taken individually or collectively, which supports the view that the seller will not be able to rely on article 79 in cases of defective delivery.28 in the practice of the courts, article 79 is applied in cases of lack of conformity of goods to the contract.29 however, some aspects of the practice of the courts can be criticised for the use made of the provision, as article 79 ought, in general, to be applied relatively infrequently in connection with the delivery of defective goods.30 4. article 35 in theory and practice 4.1. the conformity of goods according to the contract – article 35(1) in general, courts have regarded favourably attempts to interpret article 35(1) as an independent concept which covers variances of quantity and quality, and the supply of totally different goods than those agreed, as well as the way the goods are contained or packaged. thus, concepts and distinctions which are rooted in national laws and which are relevant to evaluating the conformity of goods to the contract are rejected. in assessing the conformity of goods to the contract in accordance with article 35, the theory rejects impractical distinctions between delays and short deliveries, and both theory and the practice of the courts reject the idea of giving independent significance to special distinctions in national law between ordinary information and assurances and guarantees, even though the existence of assurances or guarantees can be included in an assessment under article 35.31 although the overall conclusion is that the starting point is that article 35 governs cases of aliud pro alio, there is some difference between the decisions of the german federal supreme court and the austrian supreme court, as the german court left the door slightly ajar in particularly gross cases of aliud.32 here, domestic rules on mistake might be allowed to govern the case, and therefore the parties ought to take this into consideration in there contract. the relevance of the concept of insignificant defects has been rejected both in theory and in practice,33 since any variance at all from the agreed description of the goods is assumed to mean that the goods do not conform to the contract. the significance of the defect for the buyer is then decided according to the rights of the buyer in the event of lack of conformity of the goods, and this will typically involve compensation or a reduction in the price, although a minor defect will also amount to a fundamental breach in some cases. furthermore, it is not relevant to distinguish between the container or packaging of goods and the conformity of the goods to the contract, since the requirements for the containment and packaging of the goods can be an integral part of the conformity of the goods to the contract under article 35. finally, the review of practice and theory shows that the interpretation of what requirements can be made of the goods, cf. article 35(1), is decided on the basis of an interpretation of the agreement between the parties, so that articles 8 and 9 are actively considered.34 national rules which compete with article 35, cf. articles 8 and 9, give way to the convention where the convention rules give guidance as to how a particular problem of law should be solved, cf. the ruling of the american courts to disregard the parol evidence rule in favour of article 8(3) in cases of lack of conformity covered by article 35(1).35 nordic journal of commercial law, issue 2004 #1 7 4.1. article 35(2)(a) – fitness for ordinary purposes the rule in article 35(2)(a) on the fitness of the goods for their ordinary purposes is not an objective legal standard, but a rule about the presumed intention of the parties which should be interpreted on the basis of all the relevant circumstances of the case, cf. article 8 and article 9.36 the starting point for assessing the ordinary use of the goods is the objective norm in the relevant commercial sector.37 some writers think that, in such cases, the principle should be that the norms in the seller’s state should apply.38 others think that such cases should be assessed according to the norms in the buyer’s state.39 yet others think that such general guidelines cannot be given, and that it depends on the actual circumstances of each case as to whether the norms of the seller’s, buyer’s, or some entirely different state should apply.40 if it is assumed that norms for the ordinary purposes of goods are often not defined in international trade, it must right to refrain from laying down absolute rules about which norms should be used. nevertheless, there can be situations in which it is not possible, on the basis of the interpretation of the agreement between the parties, to determine which norms the parties can be assumed to have agreed upon for assessing the fitness of the goods for their ordinary purposes. in such cases, the decision will depend on which party ought to bear the risk, if the goods cannot be used for what that party considers to be their ordinary use. in other words, in such cases there will be a presumptive rule to decide whether the starting point is that the norm in the seller’s or the buyer’s state, or some other state, should be decisive, since there should in any case be full apportioning of all the risks of the obligations arising out of the transaction between the buyer and the seller. here, the prevailing view, both in theory and in practice, is that the seller cannot be assumed to know of the norms in the buyer’s state.41 this is in line with the principle that it is not assumed that it is within the seller’s sphere of influence to know about the norms in the buyer’s state. this can also be justified on economic grounds, since the buyer can obtain the relevant information more effectively and cheaply than the seller can.42 this principle was laid down by the german federal supreme court in its decision of 8th march 1995 (the mussels case), where a swiss seller and a german buyer had entered into an agreement for the sale of new zealand mussels, which should be delivered to germany for onward sale. it was found that the mussels had such cadmium levels that the local german public health authorities could not declare that the mussels were safe to eat, since they possibly exceeded the recommended, but not binding, legal thresholds for meat products (the so-called zebs standard). because of this, the authorities requested further samples of the goods, in addition to the routine samples which had been taken when the goods arrived in germany. even though the sale and consumption of the mussels had nor been prohibited, so the mussels were still considered to be edible, the buyer demanded that the contract should be declared void, as there were now no german retailers or consumers who would buy the mussels. the german federal supreme court stated that, as a starting point, the conformity of the goods to the contract should be assessed on the basis of the agreement between the parties, cf. article 35(1). nothing had been agreed about the need for the goods to comply with the german standards.43 even though the goods had been delivered to germany, and the seller knew that the goods should be sold there, this did not mean it was implicitly agreed that the goods should be capable of being retailed, nordic journal of commercial law, issue 2004 #1 8 still less that they should comply with special german rules.44 in the absence of agreement, the conformity of the goods to the contract must be judged according to article 35(2)(a) and article 35(2)(b). by way of introduction, the court stated that it was not necessary to decide whether the ordinary use of the goods required them to be of average quality or merely of merchantable quality, since it had not been shown that the mussels delivered had a higher cadmium level than the average for mussels in new zealand.45 the court then stated that, even on the basis that the goods should be merchantable, meaning that they should be capable of being sold on, there was not a lack of conformity to the contract, since the seller could not be expected to know of the public health regulations in the buyer’s or consumers’ state.46 in the view of the court, it was not necessary to decide how far the compliance of the goods to the requirements of public law was, in principle, governed either by article 35(2)(a) or by article 35(2)(b). it was thus not necessary to express a view on the debate between legal writers about whether the standard in the seller’s state will always be decisive, so the conformity of the goods to public law requirements is not a question of the goods’ fitness for ordinary purposes, cf. article 35(2)(a), but should, where relevant, be decided under the provisions of article 35(2)(b) on particular purposes. in any case, the goods need only satisfy the requirements in the buyer’s state, where corresponding rules apply in the seller’s state, if the buyer has made the seller aware of such rules, in which case the matter would probably be decided under article 35(2)(b), or if, due to special circumstances, the seller knew or ought to have known of the rules in the buyer’s state. however, the court found that none of these circumstances applied in this case:47 thus, it was not shown that corresponding public health provisions applied in the seller’s state, switzerland. nor was the agreement about where the goods should be delivered and the final destination of the goods a sufficient condition under article 35(2)(a) or article 35(2)(b), even if it could be considered an indication that the buyer wanted to retail the goods in germany, since the seller could not be expected to know the frequently opaque public regulations or administrative practice in the buyer’s state, any more than the buyer should be expected to have the seller’s professional knowledge on matters which concerned him. it was most natural for the buyer to know the regulations in his own state, so the buyer should have made the seller aware of these regulations. this applied not least to the case before the court, which concerned not so much the cadmium levels for mussels, but the fact that the local german public health authorities applied the regulations for meat analogously to fish,48 which was not a widespread practice even in germany, just as there was doubt about what sanctions the authorities were authorised to impose. whether the decision would have been different if, for example, the seller knew of the public health regulations in the buyer’s state, or if the buyer could have assumed that the seller either knew or ought to have known of these regulations, perhaps because the seller had a branch in the buyer’s state, the parties had had a long-term trading arrangement, the seller had regularly exported to the buyer’s state, or the seller had marketed his goods in the buyer’s state, was irrelevant in this case, as the buyer had not asserted any of these circumstances.49 finally, it was not at the seller’s risk that the goods were confiscated, since the confiscation was made under the german public law rules which, as argued above, were a matter for which the buyer bore the risk. nordic journal of commercial law, issue 2004 #1 9 as stated by the german federal supreme court, the starting position can be derogated from if information about the norms of the destination state are brought within the seller’s sphere of influence, for example if the seller knows about the rules, if the parties have previously traded together and the seller knows of the buyer’s expectations, or if the seller has marketed the goods in the seller’s country. this was the case in the decision of the grenoble court of appealof 13th september 1995, where, on the basis of the negotiations between the parties etc., the seller of parmesan cheese could not have been unaware that the goods should be capable of being sold in france, and therefore had to satisfy the french requirements as to product declarations and ‘best before’ date as well as in the decision from the us district court, e.d. of louisiana, 17th may 1999, and the principles in the mussels case now seems to have widespread acceptance, see also the austrian supreme court of 13th april 2000, making the judgement of the german federal supreme court ipso facto stare decisis.50 4.2. the limited caveat emptor principle in art. 35(3) the idea behind this provision is that the buyer’s expectations will not be disappointed if he is aware of some defect, so the buyer ought not to enjoy the protection of the relatively “buyer-friendly” rules of article 35(2).51 article 35(3) is also an expression of a certain relaxation of the burden of evidence for the seller, who need not prove the buyer’s actual awareness of some defect, which can often be very difficult to prove, but merely that the buyer could not have been unaware of the defect.52 the fact that the seller is not liable not only means that the buyer cannot hold the seller responsible for the payment of compensation, but that all the remedies of the buyer lapse, for example, the right to revoke the contract, the right to have the goods repaired, and the right to a proportionate reduction in the price.53 compared with ulis article 36, samples and models are now also covered by the seller’s exemption from liability under article 35(3).54 the main area where this provision applies is in connection with the sale of specific goods, for example, second-hand machines,55 but the provision can apply to all kinds of sales covered by the convention, including goods manufactured to the order of the buyer, cf. article 3(1), and sales where a subordinate part of the sales contract consists in supplying labour or other services, cf. article 3(2).56 as will be seen in the following review of this provision, it expresses a limited caveat emptor rule.57 according to its clear wording and its antecedents, article 35(3) only covers cases that are covered by articles 35(2)(a) to (d). if the seller delivers goods and the buyer knew or could not have been unaware that they were not fit for their usual purposes, or for the particular purpose of the buyer, or did not possess the qualities of a sample or model, or were not contained or packaged in a usual or adequate manner, then the seller is not liable. at the diplomatic conference in vienna, norway proposed that article 35(3) should also refer to article 35(1), but this was rejected by a majority of the delegates. this is also expressed in the secretariat commentary, though it only refers to cases where the requirements are expressly stated in the agreement.58 this means that an analogous or expanded interpretation of the provision so as to apply it to article 35(1) seems in principle to be ruled out,59 at least where the requirements for the goods are explicitly stated in the agreement between the parties. the background for this restriction in relation to article 35(1) is the view that a buyer out to be able to rely on what the parties have agreed. therefore, the starting point is that the buyer can assume that the seller will make good any defects if there is any discrepancy between the contract and the goods nordic journal of commercial law, issue 2004 #1 10 inspected, cf. in more detail below.60 the presumptive rule in article 35(3) must mean that it is the seller who must, in the first instance, show that the parties have agreed that the goods shall a different quality than that stated (in practice, explicitly) in the agreement; in other words, the fact that the buyer knew of or could not have been unaware of the defect, and that those parts of the agreement which conflict with this cannot be relied on by the buyer. if this were not the case, and if there were a reference to article 35(1) in article 35(3), the provision could support the view that the seller could argue that the buyer had, de facto, accepted that the goods should be delivered with the defects in question, merely by showing that the goods were defective when they were examined by the buyer, or that the buyer knew that the goods did not conform to the contract on the basis of other information.61 however, this argument is somewhat weakened by the argument that articles 35(2)(a) to (d) are largely an expression of rules of contractual interpretation which do not, in principle, need to be stated, but can be contained in article 35(1).62 in any event, the fact that there is not a reference to article 35(1) in article 35(3) gives some protection to the buyer. this means that the buyer is entitled to expect that the goods will conform to the agreement, in practice the written agreement, and that any variance from what should apply under the agreement and under article 35(1) will be made good by the seller prior to delivering the goods to the buyer.63 this applies regardless of whether the buyer knows of a defect, if it is agreed64 that the seller shall deliver the goods without the defects.65 the principle that article 35(3) does not apply in connection with article 35(1) can also be said to apply under the general rules of contractual interpretation. under the general rules of priority, the parties must be assumed to have expressed their wishes in their written agreement. if the seller has drafted the terms of the contract, then any lack of clarity will be construed against him. an example of this is the situation in which the buyer, either prior to entering into an agreement or in connection with the agreement, examines a construction vehicle which is quite obviously missing a wheel. immediately afterwards, the buyer sends his order, to which he adds that he expects the vehicle to be delivered in a state in which it is “ready to drive”. the seller accepts the order by sending the vehicle to the buyer, but without it being ready to drive. at no point have the parties discussed the missing wheel. the fact that the construction vehicle was missing a wheel effectively means that it was not fit for the purpose for which goods of that description are ordinarily used, since it could not be driven. however, article 35(2)(a) is not applicable, since the goods have been described as being expected to be “ready to drive,” cf. article 35(1). in such a situation the assumption under article 35(1), cf. article 35(3), is that the buyer is entitled to have a vehicle delivered which is ready to drive, and thus with all its wheels, since this is clearly expressed in the agreement. the fact that the buyer knew from his examination of the goods, or could not have been unaware, that at the time of the entering into the agreement, the vehicle was not in fact ready to drive, cannot justify exempting the seller from liability under article 35(3). the fact that the seller cannot rely on the provisions of article 35(3) does not mean that he cannot rely in the provisions of article 35(1). thus, under article 35(1), which is the primary rule in article 35, the seller has the possibility of showing that, despite the wording of the written agreement, the parties have otherwise agreed that the vehicle should be delivered as seen, or that the buyer could not nordic journal of commercial law, issue 2004 #1 11 have been unaware that the goods were not as described in the agreement.66 for example, this may be supported by witness statements or on the basis of the practice or usage between the parties, cf. articles 8 and 9. schlechtriem gives another example of this dichotomy, where a buyer has examined a machine which, on the basis of its construction and the kind of steel plates which can be used by the machine in production, can only produce steel wire up to a thickness of 1mm, but where the contract states that the machine can produce steel wire up to a thickness of 2mm. in schlechtriem’s view, it is an open question whether the buyer will be able to hold the seller liable. according to schlechtriem, this will depend on the facts of the case, cf. article 8(3).67 the evaluation of these cases could thus depend on whether the seller could make good the defect relatively easily, or whether this would require extensive and expensive changes to the goods before they could live up to the specifications of the buyer.68 in the example with the construction vehicle, this would typically be to the advantage of the buyer, but in the example with the wire drawing machine, this would be to the advantage of the seller. it would seem more reasonable to focus on the price of the goods, since this can indicate whether the buyer can expect the quality of the goods to be brought up to the level expressed in the agreement or not. in schlechtriem’s example, this could also follow from the minimum rule, since the seller cannot be presumed to have entered into a contract which results in extraordinary costs for him. reference can also be made to the principle of equivalence and thus to interpretation on the basis of reasonableness. this means that it does not seem possible to fix a precise limit to when the provision in article 35(3) applies, and the special circumstances under which a defect cannot form the basis of a claim, and when article 35(1) applies, so there is not, by definition, a defect since the buyer has merely received what has been agreed, cf. articles 8 and 9.69 in other words, the application of article 35(3) is conditional on it having been established that there is a defect, which will not be the case if, under article 35(1), it is found that the buyer has got what was agreed. this is a dichotomy which undermines the restriction of article 35(3) to apply only to cases covered by article 35(2).70 see the decision of the vaud cantonal appellate court of 28th october 1997.71 an oral agreement was entered into for the sale of a second-hand bulldozer between an italian seller and a swiss buyer. the buyer examined the bulldozer before the contract was entered into. it was agreed that the seller should carry out 3 minor repairs before delivering the machine to the buyer. after the bulldozer had been delivered, the buyer complained about other defects. to start with, the court stated that, according to article 35(1), a seller has a duty to deliver goods in accordance with the agreement between the parties. however, this was not the case if the buyer knew or could not have been unaware that the goods were defective, cf. article 35(3). a buyer who buys goods, despite their obvious defects, must be assumed to have accepted the goods as they are. this is also in accordance with the principle in article 36 and the observance of good faith in international trade.72 in this case, the seller had explicitly informed the buyer about the condition of the good, and the buyer had also tested the bulldozer. apart from the three repairs, there was no agreement that anything else should be done to the bulldozer, so the seller had delivered the goods as agreed, and in a condition which was known to the buyer, so the seller had no further liability, cf. article 35(1). see also the decision of the sion cantonal appellate court of 29th june 1998, which concerned the sale of sports clothing as part of a reciprocal distribution agreement between a swiss buyer and an italian seller.73 in its analysis of the conformity of the goods to the contract under article 35(1), the court emphasised that the buyer could not complain about defects of which he either knew or could not nordic journal of commercial law, issue 2004 #1 12 have been unaware, cf. article 35(3). a person who buys goods despite their obvious defects accepts the goods as they are. the court also said that this is in accordance with the principle in article 36 and the observance of good faith in international trade.74 thus, both decisions directly link the application of article 35(3) to article 35(1), and refer to the principle in article 36 and the observance of good faith in international trade, even though this is directly contrary to the wording of article 35(3) and the antecedents of the provision and the view of it in theory.75 however, it is not necessar y to apply article 35(3) if it has been agreed that the goods shall have the quality in question, since article 35(3) will not then be relevant. however, it can sometimes be very difficult to establish what has been agreed. neither of the cases referred to above involved clear written requirements for the goods. in this respect see the decision of the us district court, illinois, eastern division, of 28th october 1998. a swedish seller offered aircraft spare parts for sale on an international database using specification numbers. the buyer understood that each part had an individual number, while the seller intended the parts to be offered under several different specification numbers. the buyer placed an order for spare parts with the specification number 729640. in his order confirmation the seller had given the same number, but did not think this was decisive as he had previously sent the buyer a fax in which he stated that he could not be absolutely sure that the parts had the number given. he therefore sent the buyer a fax giving the numbers which were on the spare parts, and encouraged the buyer to check that the spare parts corresponded to the specification numbers. furthermore, the seller pointed out that the buyer was a specialist in the trade in spare parts of this kind, but the seller was not. it was therefore at the buyer’s risk that he had not investigated the spare parts in more detail prior to buying them. in refusing to give a preliminary ruling, the court said that in deciding whether the goods conformed to the contract or not, attention should be paid not only to the statement of the specification number in the order and order confirmation, but also to the intentions of the parties, cf. article 8(1). in this connection, all the relevant circumstances of the case should be taken into account, including the negotiations between the parties, cf. article 8(3). the court thus rejected the application of the parol evidence rule. this decision also illustrates the connection between article 35(1) and article 35(3). the seller had clearly listed the goods with the specification number in the contract. according to a restrictive theory, article 35(3) does not apply, but this presupposes that there is a defect. there will not be a defect if it has been agreed that the seller cannot guarantee that the spare parts have the given number, or that the buyer accepts the risk of this. this shows that this question is closely linked to whether the seller has given a guarantee or assurance of the description or quality of the goods. it also shows that the application of article 35(3) may not exclude the use of certain elements of contractual interpretation, cf. article 8(3), since otherwise article 35(3) would be a de facto parol evidence rule. unless it is clear from the agreement that the buyer can expect the goods to be free from defects upon delivery, a buyer who insists on enforcing the written contract, even though he knew that the goods were not free from defects, will not be entitled to a remedy, cf. the general principles of good faith, venire factum contra proprium76 and the observance of good faith in international trade.77 as stated, it is also possible that the buyer may not claim that the goods are defective if they are in accordance with the practice or usage of the parties, for example if the seller has usually sold goods to the buyer which have been defective without the buyer objecting, or if, purely on the basis of the price of the goods, the buyer should expect to receive defective goods.78 however, the most simple solution is to conclude that the condition of the goods, as known to the nordic journal of commercial law, issue 2004 #1 13 buyer, should be the basis for defining the agreement between the parties, cf. article 35(1).79 in this connection, see the decision of the tribunal of international commercial arbitration at the russian federation chamber of commerce, of 22nd january 1997.80 an agreement was entered into between a german seller and a russian buyer for the sale of 300 tons of butter. at least, that was what the buyer understood. in the pre-contractual negotiations the butter was described as “table butter 82% fat”, and in the seller’s invoices as “animal fat butter”. however, the seller was not able to procure belgian butter, so he wrote to the buyer saying that he would instead supply “absolutely equivalent english butter”. in the accompanying specification the goods were stated to be “pura sub butter, 80% fat content, 05-07 salt content”. the buyer accepted this offer. upon the arrival of the goods in russia, the obligatory certificate of quality had to be obtained. the buyer obtained a report from the certifying institute in russia. from this appeared that the goods were in fact margarine (“pura sub butter” corresponded to “domestic margarine of standard quality”), and that under the russian public health rules there the level of lead in the butter was higher than permitted, so the obligator y certificate of quality could not be issued. the buyer then rejected the goods on the grounds that they did not conform to the contract, and claimed compensation corresponding to the difference in price between margarine and butter. the seller rejected the buyer’s claim “pura sub butter” had been sold, and because the seller did not believe that the finding of the certifying institute should be decisive, since tests made in germany did not show too high a level of lead. the arbitration tribunal started by stating that, by accepting the offer of the seller, despite the different description of the goods, the buyer had accepted delivery of margarine, cf. article 35. since the buyer had not asked for a reduction of the price in this connection, the buyer could not subsequently claim such a reduction.81 the contract did not provide for how certificates of quality required by law should be obtained. according to the rules in the buyer’s country, the buyer could obtain a statement from an expert from the local certifying authority. since the tribunal did not have any reason to doubt the conclusion of the report, the seller’s claim for compensation for the costs of the buyer’s rejection of the goods was dismissed, since the buyer was unable to accept delivery for reasons which were beyond his control, cf. article 74. this decision is a good illustration of the close connection between a decision about whether the parties have agreed on the specification of the goods, and the question of whether, if agreement has not been made on the specific point, the buyer knew or could not have been unaware of the defect. in the unilex database the decision is listed under article 35(3), but strangely enough, not under article 35(1). an explanation for this can be that there is nevertheless some doubt about whether it was agreed that butter should have been delivered. the great majority of the written material points towards the conclusion that the goods should have been butter. the specification of the goods was decisive. normally this follows from the ordinary rules of interpretation, cf. the rule of priority, but in this case the specification of the goods effectively meant that the primary description of the goods in the contract (butter) was changed to something totally different (margarine). this somewhat undermines the application of the rule of priority. at the same time, the buyer appeared to pay the price for butter, which ought also to have been considered relevant to the interpretation, cf. the minimum rule. finally, the status of the parties can be relevant, and this is not referred to in the report of the case.82 if it can be shown that the buyer knew or could not have been unaware of some lack of conformity of the goods to the contract, the assumption is that the seller will be exempt from liability. however, there is an exception to this where the seller has deliberately and in bad faith kept quiet about a defect nordic journal of commercial law, issue 2004 #1 14 which was known to him, since even a buyer who is grossly negligent is more deserving of protection that a seller who acts in bad faith. in such cases, the seller cannot rely on the buyer’s acceptance of the goods as being in conformity with contract, cf. the principle of the observance of good faith in international trade, cf. article 7(1), as well as the principle in article 40 that the seller is not entitled to rely on the provisions of articles 38 and 39 if the lack of conformity relates to facts of which he knew or could not have been unaware, cf. article 7(2).83 this principle is clearly established in the decision of the cologne provincial court of appeal of 21st may 1996, on the sale of a car which it appeared had a higher mileage than shown in the contract between the seller and buyer and than shown on the car’s odometer. also, the car had initially been registered in 1990, and not, as stated in the contract, in 1992. after having established that the goods did not conform to the contract in accordance with article 35(1), the court held that the seller could not have been unaware that the car had been registered earlier than was shown in the contract, and that it must have been driven further than shown on the odometer. the seller’s claim that the buyer could not have been unaware that the car was registered in 1990, as the buyer’s wife had been informed of this, so that the buyer could not make a claim to this effect, cf. article 35(3), was rejected by the court, on the grounds that even a very negligent buyer deserves more protection than a fraudulent seller. the court stated that this was in accordance with the principle in article 40, in connection with article 7(1).84 in this case, an objection to the validity and revocation of the contract would not be relevant, since the car had been sold on, and the buyer had an interest in obtaining a remedy in the form of compensation, as he had already paid out compensation to the subsequent buyer of the car. the seller had to have acted in a culpable manner for compensation to be payable. however, if the buyer has positive knowledge of the defect, he cannot benefit from this protection, as the seller will have been able to rely on the seller’s acceptance of the goods. the principle was also laid down in the decision of the arbitration institute of the stockholm chamber of commerce, 5th june 1998, which stated that a seller cannot rely on the provisions of articles 38 and 39, cf. the principle in article 40 which applies as a general principle, cf. article 7(1), regardless of whether there was a lack of conformity of the goods to the contract according to article 35, or as the result of a contractual guarantee given by the seller. if the seller has given a guarantee or assurance to the buyer that the goods are without defects, the assumption is that the buyer will be able to base a claim on any defects, regardless of whether the buyer could not have been unaware of the defects.85 here, the caveat venditor seems to supersede the caveat emptor. 5. conclusive remarks as stated in the beginning of this article, the assessment of the lack of conformity of goods to the contract is not an independent legal category, but is part of the law of contract. article 35 is an attempt to express the contract law principles on the assessment of lack of conformity, and in its provisions the principle of caveat venditor confronts the principle of caveat emptor. as also stated, the principles of caveat venditor and caveat emptor, as expressed in article 35, should be considered mainly on the basis of which party’s sphere of influence is more closely linked to the conformity of the goods to the contract. this leads to proposals for a number of presumptive rules. the party, whose sphere of influence lies closest to disputed circumstances which are relevant to the conformity of the goods to the contract, ought to bear the risk if, in respect of these circumstances, nordic journal of commercial law, issue 2004 #1 15 the goods do not (allegedly) conform to the contract. the review of the practice of the courts and of legal theory also shows that the assessment of lack of conformity to the contract under article 35 requires a balance to be struck between the principles of caveat venditor and caveat emptor, as expressed in article 35 and in general contractual principles. where article 35 does not give any direct guidance, the courts fall back on consideration of the relevant sphere of influence, which can also be seen as an expression of reasonableness or of economic considerations. thus, the assumption is that the norm in the seller’s country shall form the basis for judging what is a customary purpose, or a particular purpose or the usual manner for containers and packaging. these principles find strong support in the decision of the german federal supreme court of 8th march 1995, which has been widely accepted both in practice and in theory. there are a number of exceptions to this rule which are also expressions of the concept of the sphere of influence, for example if the seller is aware of the norms which apply in the destination state of the goods, regularly makes exports there, or markets his goods to that countr y etc., just as the generally recognised principles of contractual interpretation apply. laying down such assumptions, and exceptions to them, affects the burden of proof, as the buyer must show that the seller knew or could not have been unaware of the norm in the destination state, i.e., that the relevant elements were within the seller’s sphere of influence. it is also pointed out that there are a number of rules which compete with article 35, especially rules on contractual validity. since the convention does not, in general, govern questions of validity of contracts, the assumption is that national law should apply to such cases. however, in some cases the rules on validity overlap with the rules on lack of conformity, for example where one or other of the parties has been misled. this means that there is potential conflict between the convention and national laws, unless the convention displaces the competing national rules. this means that it is not possible to analyse the concept of lack of conformity contained in article 35 without at the same time recognising that the provisions should be seen in the context of the rules of general contract law, both under the convention and outside it, and that article 35 is in competition with such rules, for example national rules on the validity of contracts. since there is not a unanimous view on these questions, due to differing views on the priority to be given to the convention and the scope of its regulatory powers, the second thesis of this article was that article 35 cannot be expected to lead to fully uniform law, cf. article 7, before the law of contract which lies behind it has been harmonised or before the rules of the convention have been amended. whether this will happen is a matter of legal policy. it has also been seen that a restrictive interpretation has been used, especially on the question of how far the principle of the exhaustion of rights should apply, or whether national rules on the validity of contracts can be asserted in competition with article 35. these are dichotomies which cannot only be solved by looking for a functionally adequate solution in the convention, since there is not even agreement within individual national legal systems about how to solve such problems. therefore, even though a dynamic interpretation is chosen, it must be recognised that there are questions to which answers cannot be found on the basis of lege lata (existing law), but which depend on statements of legal policy. overall it can be concluded that article 35 amounts to a codification of sale of goods principles which can also be seen as an expression of the general, internationally recognised principles of the nordic journal of commercial law, issue 2004 #1 16 law of obligations. these principles radiate like ripples through water in sale of goods laws, and from there through the general law of obligations. at the same time, the practice of the courts and the arguments of legal theorists show that the article 35 operates in an area of tension between differing doctrines and rules of the law of obligations, so there is sometimes conf lict and thus uncertainty about the application of article 35. this is unquestionably a problem to achieving uniform application of the provisions. this automatically puts a focus on the need for the harmonisation of contract law or a revision of the convention. this is illustrated by the fact that an informal body has now been set up which, as in the manner of the european court of justice, gives its opinion on the interpretation of the convention.86 it is suggested that the ideal approach would be to seek globally recognised principles on the basis of comparative analyses, as seen, for example, in the unidroit principles. however, whether the solution is to be found in binding rules, or whether an international lex mercatoria is sufficient is in the end a matter of legal policy, and not something on which a definitive answer is offered the present context. alternatively, the practice of the courts and the writings of legal theorists will work out the principles on which the convention, including article 35, will be developed. this article can be seen as an example of this. footnotes) 1 assistant professor, ph.d., master of law (llm), department of law, aarhus school of business. external associate professor, aarhus university. editor, www.cisg.dk, senior-editor, www.unilex.info. this article is an abstract of some few of the most important points in the authors ph.d.-thesis: the conformity of goods in international sales, published in a revised and updated version in june 2004 (thomson, copenhagen). 2 cf. ernst rabel: das recht des warenkaufs, vol. 2 (berlin, 1968), p. 101 et seq. this applies to actual lack of conformity (sachmängelhaftung), but the same conclusion applies to the sale of specific goods (gewährleistung für speciesachen), p. 111. for a general discussion of the differences between concepts of lack of conformity in various legal systems, see pp. 119-130, for guarantees see pp. 146-148, and for sales made on the basis of a sample or model see pp. 154-157. 3 cf. rabel: above , p. 132 and p. 282 et seq. 4 cf. rabel: above, pp. 101-104. 5 caveat emptor is not the original roman law term, but a concept developed in english law which nevertheless ref lects the roman law principle with the same content, cf. jakob nørager-nielsen and søren theilgaard: købeloven med kommentarer (københavn, 1993), p. 855, with reference to stig iuul.: caveat emptor-reglens oprindelse, festskrift til henry ussing, p. 220. 6 this was because the earlier roman law was strongly influenced by the direct exchange of goods in the open market, cf. bruno huweiler: die »vertragsmässigkeit der ware«. romanistische gedanken zu art. 35 und 45 ff. des wiener kaufrechts, in eugen bucher: wiener kaufrecht (bern, 1991), p. 249 et seq. 7 cf. also andreas schwartze: europäische sachmängelgewährleistung beim warenkauf: optionale rechtsangleichung auf der grundlage eines funktionalen rechtsvergleich (tübingen, 2000), p. 26; reinhard zimmermann: the law of obligations (münchen, 1993), p. 307. 8 cf. ernst rabel: above, p. 288. 9 uniform law for the international sale of goods. 10 uniform law on the formation of contracts for the international sale of goods. nordic journal of commercial law, issue 2004 #1 17 11 united nations convention on contracts for the international sale of goods. following a diplomatic conference the convention was adopted in vienna on 11th april 1980 (see un document a/conf.97/18). “cisg” can either be pronounced letter-by-letter, or as a word with a sibilant ‘c’. as for the abbreviation of cisg in relation to other abbreviations in theory and practice, see peter schlechtriem in peter schlechtriem: kommentar zum einheitlichen un kaufrecht (cisg) (münchen, 2000), p. v, note 1. 12 directive 1999/44/ec of 25 may 1999 on certain aspects of the sale of consumer goods and associated guarantees, oj 1999 l 171/12. 13 in the following, the term sphere of influence is distinct from the sphere of control in article 79(1) which emphasises the control of one party. however, there is a close connection between the reasoning in article 35 and in article 79, which has led to a discussion about the possibility of the seller avoiding liability for defects under article 79. 14 cf. ulrich krüger: modifizierte erfolgshaftung im un-kaufrecht (frankfurt a. m, 1997), p. 25 et seq. 15 compare this with jan heilmann: mängelgewährleistung in un-kaufrecht (berlin, 1994), p. 141. 16 the principles of the law of obligations are often supported by reference to a multiplicity of considerations, for example, regard for the maintenance of values, good faith, the satisfaction of reasonable expectations, predictability, fairness, operational efficiency, and not least economic effectiveness, cf. mads b. andersen and joseph lookofsky: lærebog i obligationsret (copenhagen, 2000), vol. 1, p. 34. 17 the principle thus has a legal-economic content. 18 see for example article 35(2)(b) and article 35(3), discussed below. 19 this does not take into account the change to the premisses which can result from the changed considerations. 20 article 7 states: (1) in the interpretation of this convention, regard is to be had to its international character and to the need to promote uniformity in its application and the observance of god faith in international trade. (2) questions concerning matters governed by this convention which are not expressly settled in it are to be settled in conformity with the general principles on which it is based or, in the absence of such principles, in conformity with the law applicable by virtue of the rues of private international law. 21 see also kai krüger: norsk kjøpsrett (bergen, 1999), p. 36 et seq. 22 this creates particular problems for the nordic countries, as they are not contracting states to part ii of the convention (the article 92 reservation), see rené franz henschel, above, chapter 3. 23 for an analysis of this, see rené franz henschel, above, chapter 3. see also jan h. dalhuisen: dalhuisen on international commercial, financial and trade law (oxford, 2000), chapter 2, especially p. 262-264. 24 see ulrich drobnig: substantive validity, american journal of comparative law, vol. 40 (1992), p. 635 et seq. for a view supporting exhaustion of rules of validity, see ferrari in peter schlechtriem: kommentar zum einheitlichen un kaufrecht (cisg), p. 97, pt. 4; john honnold: uniform law for international sales under the 1980 united nations convention (hague, 1999), p. 261 et seq.; jan ramberg in jan ramberg and johnny herre: internationella köplagen (cisg) (stockholm, 2000), p. 112; wilhelm-albrecht achilles: kommentar zum un-kaufrechtsübereinkommen (cisg) (neuwied, 2000), p. 19; karin flesch: mängelhaftung und beschaffenheitsirrtum (baden-baden, 1994), p. 140 et seq., especially at pp. 156-159; seemingly heilmann: above, p. 146, though here the view is that only the buyer’s mistake is covered, not the seller’s; bruno zeller: the united nations convention for the international sale of goods: a methodology for its interpretation and application (melbourne, 2001), p. 194 et seq.; but opposed to this, see bernhard gomard and hardy rechnagel: international købelov (københavn, 1990), p. 38, where it is argued that national law should apply, and correspondingly martin gstoehl: das verhältnis von gewährleistung nach un-kaufrecht und irrtumsanfechtung nach nationalem recht (zeitschrift für rechtsvergleichung, internationales privatrecht und europarecht, 1998/1, p. 1 et seq.). see also joseph lookofsky: understanding the cisg scandinavia (copenhagen, 2002), p. 31, concerning the competition between contractual and non-contractual compensation, where it is uncertain whether national rules must give way to convention rules. nordic journal of commercial law, issue 2004 #1 18 25 cf. michael bridge: international sale of goods: law and practice (oxford, 2000), p. 82 et seq. 26 cf. honnold: above, p. 479. see similarly denis tallon in c.m bianca and m. j. bonell: commentary on the international sales law (milan, 1987), pt. 2.6.1 and 2.6.2. 27 cf. krüger: above, p. 14, footnote 5; stoll in peter schlechtriem: above, p. 760 et seq., with further references to the literature in footnote 44. 28 cf. krüger: above, p. 68, after a review and refutation especially of honnold’s arguments. 29 see the german federal supreme court decision of 24th march 1999, analysed in rené franz henschel, above, chapter 2. 30 see rené franz henschel, above, chapter 2, with reference to more cases. 31 cf. bianca in bianca and bonell: above, p. 270: “in article 35 all cases of non-conformity of the goods are regarded as defective performances of the delivery obligation. thus, the convention has avoided the various distinctions still acknowledged in domestic laws between conditions and warranties, and specially the difficult distinction between delivery of goods of a different kind (aliud pro alio) and defects or lack of quality.” see correspondingly schwenzer in peter schlechtriem: above, p. 374, pt. 4; ramberg in ramberg and herre: above, pp. 226-229; achilles: above, p. 93; as well as the decision of the german supreme court of 3rd april 1996 (see unilex), where it is stated that: “the cisg is different from german domestic law, whose provisions and special principles are, as a matter of principle, inapplicable for the interpretation of the cisg (art. 7 cisg).” as for the distinction in french law between vice caché (latent defect) and vice apparent (patent defect), refer to the decision of the french supreme court of 17th december 1996 (see unilex). 32 see the german federal supreme court decision of 3rd april 1996, but compare the austrian federal supreme courts decisions of 29th june 1999 and 21st march 2000 (unilex) 33 see schwenzer in peter schlechtriem: above, p. 383, pt. 3; jan heilmann: above p. 202 et seq, and zurich cantonal commercial court34 of 21st september 1999 (unilex), but compare teija poikela: conformity of goods in the 1980 united nations convention on contracts for the international sale of goods, nordic journal of commercial law, issue 2001 # 1, p. 19, note 78. 35 see for instance oldenburg district court of 28th februar y 1996, swiss federal supreme court of 22nd december 2000 and for more examples: rené franz henschel: above, chapter 3. 36 in this respect see the decision of the us district court, illinois, eastern division, of 28th october 1998, referred to in section 4.2 below, overruling earlier american case law. 37 cf. peter schlechtriem: internationales un-kaufrecht (tübingen, 1996), p. 80 et seq. 38 cf. also article 9 of the convention. 39 cf. bianca in bianca and bonell: above, p. 274; fritz enderlein and dietrich maskow: international sales law (new york, 1988), p. 144; wolfgang kircher: die voraussetzungen der sachmängelhaftung beim warenkauf (tübingen, 1998), p. 52; burghard piltz: internationales un kaufrecht (münchen, 1993), p. 187. 40 see gomard and rechnagel: above, p. 115, note 15. 41 see peter schwenzer in schlechtriem: kommentar zum einheilichen un-kaufrecht (cisg), p. 378: “letzlich ist jedoch auch die frage der standards ein problem der auslegung des vertrages,” and at p. 379: “im übrigen verbietet sich jede generelle regel, und es ist auf die umstände des einzelfalles abzustellen” (emphasis in the original). see also honnold: above, p. 256: “some writers have felt that it was necessary to give a general answer to the following question: does subparagraph (2)(a) refer to the understanding of the contract description of the goods that prevails at the seller’s place of business or at the place where the buyer intends to use the goods? writers have disagreed over the choice between these two places. it should not be necessary to answer this question if one accepts the view, suggested above (§222), that the role of article 35(2) is to aid in construing the agreement of the parties.” 42 see bianca in bianca and bonell: above, p. 274; and in connection with this enderlein and maskow: above, p. 144 and achilles: above, p. 95. nordic journal of commercial law, issue 2004 #1 19 43 see anna veneziano: non conformity of goods in international sales: a survey of current case law on cisg (international business law journal), no. 1 (1997), p. 46. 44 compare this with the decision of the hertogenbosch district court of 2nd october 1998, which concerned an agreement for the sale of milk formula, where it was agreed between the parties that the milk formula should live up to the public health regulations in singapore with respect to the level of radioactive traces. 45 see the following citation from the judgment (translation source: the cisg database at pace law school law library): “in this respect, an agreement between the parties is primarily relevant (cisg art. 35(1)). the court of appeals did not even find an implied agreement as to the consideration of the zebs-standards. [buyer] did not argue against this finding, and it is not legally objectionable. the mere fact that the mussels should be delivered to the storage facility in g.g. does not necessarily constitute an agreement regarding the resalability of the goods, especially in germany, and it definitely does not constitute an agreement regarding the compliance with certain public law provisions on which the resaleability may depend.” 46 see paragraph ii.1.b) aa) of the judgment (translation source: the cisg database at pace law school law library): “in the examination of whether the goods were suitable for ordinary use, the court of appeals rightly left open the question — controversial in the legal literature — whether this requires generic goods of average quality or whether merely “marketable” goods are sufficient (see, e.g., schwenzer in von caemmerer/schlechtriem, supra, art. 35 6 15 (with further citations)). even if on appeal, goods of average quality were found to be required, [buyer] has still not argued that the delivered mussels contain a higher cadmium contamination than new zealand mussels of average quality. it is true that, according to the report from the examination laboratory of dr. b., submitted by [buyer] to the trial court, and the contents of which is thereby alleged, “there are also other imported new zealand mussels on the market … that do not show a comparable cadmium contamination.” it does not follow, however, that average new zealand mussels on the market contain a smaller amount of cadmium than the mussels delivered to [buyer].” 47 cf. paragraph ii.1.b) bb) of the judgment (translation source: the cisg database at pace law school law library): “according to the absolutely prevailing opinion in the legal literature, which this court follows, the compliance with specialized public law provisions of the buyer’s country or the country of use cannot be expected.” the lower court avoided making this assessment, partly by emphasising that the mussels were in any case edible, and partly by emphasising the fact that the guidelines of the german authorities were not binding. 48 cf. the judgment (translation source: the cisg database at pace law school law librar y): “some uncertainties, noticeable in the discussions in the legal literature and probably partly caused by the not very precise distinction between subsections (a) and (b) of cisg art. 35(2), do not require clarification in the evaluation of whether this question must be integrated into the examination of the ordinary use of the goods or the examination of the fitness for a particular purpose. there is, therefore, no need to finally decide whether, within the scope of cisg art. 35(2)(a), as most argue, the standards of the seller’s country always have to be taken into account (see, e.g., bianca, supra, 6 2.5.1; piltz, supra, 6 41; enderlein in enderlein/maskow/ strohbach, supra; aue, mängelgewährleistung im un-kaufrecht unter besonderer berücksichtigung stillschweigender zusicherungen (guaranty with respect to non-conformity with a contract pursuant to the u.n. law of sales under special consideration of implied promises), at 75 (doctoral thesis 1989); probably different schlechtriem, supra; hutter, supra, at 40), so that it is not important for the purposes of subsection (a) whether the use of the goods conflicts with public law provisions of the import country (see, e.g., herber/czerwenka, supra, 6 4). in any event, certain standards in the buyer’s country can only be taken into account if they exist in the seller’s country as well (see, e.g., stumpf in von caemmerer/schlechtriem, supra, 6 26; schwenzer, supra, 6 16; bianca, supra, 6 3.2) or if, and this should possibly be examined within the scope of cisg art. 35(2)(b), the buyer has pointed them out to the seller (see, e.g., schwenzer, supra, 66 16, 17; enderlein, supra) and, thereby, relied on and was allowed to rely on the seller’s expertise or, maybe, if the relevant provisions in the anticipated export country are known or should be known to the seller due to the particular circumstances of the case (see, e.g., piltz, supra, 6 35; bianca, supra). none of these possibilities can be assumed in this case.” 49 it had also been argued by the seller, that consumers would not normally be expected to eat the same quantities of mussels as of meat, so the threshold levels for meat are not necessarily suitable for assessing fish products. 50 cf. paragraph ii.1.b) bb) ccc) of the judgment (translation source: the cisg database at pace law school law library): “ this court need not decide whether the situation changes if the seller knows the public law provisions in the country of destination or if the purchaser can assume that the seller knows these provisions because, for instance, he has a branch in that country (see, e.g., neumayer/ming, supra), because he has already had a business connection with the buyer for some time (see, e.g., schwenzer, supra, 6 17), because he often exports into the buyer’s country (see, e.g., hutter, supra, at 47) or because he has promoted his products in that country (see, e.g., otto mdr 1992, 533, 534). [buyer] did not allege any such facts.” compare this with bonell in bianca & bonell: commentary, nordic journal of commercial law, issue 2004 #1 20 p. 283, which substantially lists all the arguments which were used by the german federal supreme court in the present case. the book was published in 1987. 51 all the cases can be found on unilex 52 cf. heilmann: above p. 205. 53 cf. schwenzer in peter schlechtriem: above, p. 384, pt. 34. 54 cf. gomard and rechnagel: above, p. 117, note 27. as far as is known, this question is not dealt with by other writers. 55 cf. bianca in bianca and bonell: above, p. 279, pt. 2.9.1. 56 cf. schwenzer: ibid. 57 the main comments in the following review of this provision also apply to the buyer’s awareness of defects relating to the element of the supply of labour and other service provision in such agreements. 58 compare with lookofsky: above, p. 91. 59 cf. the secretariat commentary to article 33, pt.14: “this rule does not go to those characteristics of the goods explicitly required by the contract and, therefore subject to the first sentence of paragraph (1). even if at the time of the conclusion of the contract the buyer knew that the seller would deliver goods which would not conform to the contract, the buyer has a right to contract for full performance from the seller. if the seller does not perform as agreed, the buyer may resort to any of his remedies which may be appropriate.” this is indeed a literal approach to contract interpretation. 60 see schwenzer in peter schlechtriem: above, , p. 385, pt. 38; achilles: above, p. 98, pt. 17; kircher: above, p. 55; poikela: above, , p. 52, although modified on p. 53. but for a opposite view see: enderlein and maskow: above, p. 147 et seq., pt. 19; and r. rognlien in j. bergem and r. rognlien: kjøpsloven 1988 og fn-konvensjonen 1980 om internasjonale løsørekøb (oslo, 1995), p. 504 et seq. 61 cf. schlechtriem: ibid. 62 the argument is most often illustrated by reference to examination of the goods, but it could be based on circumstances other than examination. 63 cf. ramberg in ramberg & herre: above, p. 237, pt. 8. 64 cf. ramberg: ibid. 65 if the buyer has expressed himself ambiguously or with lack of clarity, this will be interpreted against him. 66 cf. schwenzer in schlechtriem: above, p. 384, pt. 36; heilmann: above, pp. 207-208. 67 it is also possible that the seller may rely on national rules of invalidity, see below. 68 schlechtriem in n ina m.galston and hans smit: international sales: the united nations convention on contracts for the internaitonal sale of goods (new york, 1984), pp. 6-24, § 6.03. 69 cf. rognlien in bergem and rognlien: above p. 504. 70 see lookofsky: above, p. 91, note 102: “if, under domestic sales law conceptions, we say that the caveat emptor (“what you see is what you get”) principle applies in a given situation, that is really the same as saying the goods conform to the contract …” 71 compare with hyland in schlechtriem: einheitliches kaufrecht, above, p. 326. 72 the report of the judgment is reported in the unilex and pace university cisg websites. note that in the pace website the case is wrongly listed under the valais cantonal appeal court. nordic journal of commercial law, issue 2004 #1 21 73 cf. section 4.b) of the judgment. 74 the report of the judgment is reported in the unilex and pace university cisg websites. note that in the pace website the case is wrongly listed under the valais cantonal appeal court. 75 cf. section 7.b) of the judgment. 76 cf. bianca in bianca & bonell: above, p. 280: “the fact that the buyer knows or ought to know of the real condition of the goods is irrelevant when there is a specific contractual provision because it does not change the content of what the seller has promised to the buyer nor can it free him from his promise.” 77 cf. achilles: kommentar, pp. 98-99, pt. 17. 78 cf. rognlien in bergem & rognlien: kjøpsretten, p. 504 et seq.; karollus: un-kaufrecht, p. 119. 79 cf. bianca in bianca & bonell: commentary, p. 279, pt. 2.8.3. 80 see lookofsky: cisg scandinavia, p. 91, note 102. 81 see the unilex and pace university cisg websites. 82 “the arbitration tribunal found that the claimant, having received the specification for pura sub butter, could not have failed to notice the difference between the terms and some other descriptions of the substitute goods offered for delivery and those specified in the supplement number 2 but, however, agreed in his letter to the seller of 10 february 1995 with the goods and did not ask for a price reduction. on this ground the tribunal, under reference to art. 35 cisg and para 459 of the german civil code, dismissed the buyer’s plea for damages concerning the difference between the contract price and price for margarine, having taken into consideration the opinion of the independent laboratory experts who had qualified the goods stated in the supplement number 2 and pura sub butter as “domestic margarine of standard quality.” 83 the decision is also notable in relation to the problem of the conformity of goods to the public law rules in the buyer’s country. among other things, the buyer rejected the goods because the legally required certificate of quality could not be issued due to the level of lead in the product. it is not clear from the case report whether the level of lead exceeded the permitted level in the seller’s country, or the average market standard, or whether it made the goods unfit for consumption, but it does appear from the case report that the seller had himself presented an analysis report from which it appeared that there was not a high level of lead in the goods. however, it does not seem that the seller put forward such arguments, but instead sought to cast doubt on the quality report presented by the buyer. it is possible that the tribunal would have reached a different conclusion if the arguments discussed in relation to the mussels case had been put forward. 84 cf. schwenzer in schlechtriem: above, pp. 384-385, pt. 37; dagmar valcárel schnüll: die haftung des verkäufers für fehler und zugesicherte eigenschaften im europäischen rechtsvergleich (bonn, 1994), p. 164; kircher: above, p. 54 et seq., and ulrich ziegler: leistungsstörungsrecht nach dem un-kaufrecht (baden-baden, 1995), p. 103. 85 cf. section 2 of the judgment of the court: “it has to be inferred from the basic idea of art. 40 cisg, whereby a seller is not entitled to rely on the conduct of the buyer if the seller is to blame more, in connection with art. 7(1) cisg, that in case of a fraudulent conduct of the [seller], the [seller] has to accept responsibility even if the [buyer] could not be unaware of the non-conformity. therefore, the statements of the [seller] pertaining to the supposed possibilities of perception of the [buyer]’s wife which, as has to be pointed out supplementary, cannot be equated with the possibilities of perception of the [buyer] himself are not relevant. even a grossly negligent unknowing buyer appears to be more protection-worthy than a seller acting fraudulently (von caemmerer/ schlechtriem, kommentar zum einheitlichen un-kaufrecht, cisg, 2nd edn., art. 35, annotation 37 with further evidence). consequently, when there is fraudulent conduct of the seller, the inapplicability of art. 35(3) cisg follows from art. 40 in connection with art. 7(1) cisg.” 86 see joachim aue: mängelgewährleistung im un-kaufrecht unter besonderer berücksichtigung stillschweigender zusicherungen (frankfurt a. m., 1989), p. 85. 87 see the recently established “cisg-advisory council” in london, which give advisory opinions on the interpretation of the cisg convention. the list of members can be seen at http://www.ccls.edu/ eclu/iclaw/courses/ schmitthoff.html. nordic journal of commercial law issue 2009#1 an “unconventional truth”: conflict of laws issues arising under the cisg by antonin i. pribetic* * b.a. hons. (york), ll.b. (osgoode), ll.m. (osgoode), mciarb., litigation counsel, steinberg morton hope & israel llp, toronto, ontario, canada. email: apribetic@smhilaw.com. mailto:apribetic@smhilaw.com nordic journal of commercial law issue 2009#1 2 i. introduction the united nations convention on contracts for the international sale of goods, 1980 (cisg) 1 is the uniform international sales law of countries that account for two-thirds of all world trade. aftern ten years of preparatory work by uncitral, the cisg was adopted in april 1980 at the united nations diplomatic conference attended by sixty-two states. it later entered into force in january 1988. from a contractual perspective, the cisg is generally regarded as the most widely adopted international convention dealing with international business transactions. all canadian provinces have adopted and enacted the cisg, including ontario under the international sale of goods act. currently, 73 countries are parties to the cisg, with the notable exceptions of the united kingdom, brazil and india.2 the number of international court and arbitration decisions is increasing exponentially.3 yet, canadian jurisprudence is lagging far behind. some possible reasons are: 1. lack of familiarity with the cisg among contracting parties, primarily due to simplistic contracts, invoices and purchase orders which do not contain a choice of law clause, opting in or out of the cisg; 2. the “fear factor”: commercial lawyers drafting international contracts may be unfamiliar with the cisg’s benefits and prefer provincial sale of goods legislation or other domestic sales legislation. oftentimes, the choice of law and choice of forum clauses are the last to be considered or negotiated;4 1 united nations convention on contracts for the international sale of goods, april 11, 1980, s. treaty doc. no. 98-9 (1984), u.n. doc. no. a/conf.97/19, 1489 u.n.t.s. 3, incorporated by, international sale of goods act, r.s.o., ch. i-10 (1990) (can.), available online at: www.elaws.gov.on.ca/dblaws/statutes/english/90i10_e.htm. although sometimes also referred to as the vienna convention”, “cisg” is the generally accepted acronym and is used throughout this article. the cisg has been adopted in canada federally on may 1, 1992 by the international sale of goods contracts convention act , s.c. 1991, c. 13 and subsequently by all constituent provinces and territories, including the province of quebec: see an act respecting the united nations convention on contracts for the international sale of goods , r.s.q., c. c-67.01. see, cisg canada website, (hosted by osgoode hall law school, york university and edited by peter j. mazzacano), available online at http://www.cisg.ca; http://www.yorku.ca/osgoode/cisg. 2 see united nations commission on international trade law (uncitral) website, available at: http://www.uncitral.org/uncitral/en/uncitral_texts/sale_goods/1980cisg_status.html. 3 see pace database on the cisg and international commercial law, pace university school of law (pace law school institute of international commercial law), available at http://cisgw3.law.pace.edu, which currently contains links to 2,180 case presentations. 4 see, luke nottage, “who's afraid of the vienna sales convention (cisg)? a new zealander's view from australia and japan” sydney law school research paper no. 06/21; (2005) 36 victoria university of wellington l. rev. 815, available at ssrn: http://ssrn.com/abstract=880372. http://www.cisg.ca;/ http://www.yorku.ca/osgoode/cisg. http://www.uncitral.org/uncitral/en/uncitral_texts/sale_goods/1980cisg_status.html. http://ssrn.com/abstract nordic journal of commercial law issue 2009#1 3 3. canadian litigators have yet to embrace the cisg’s default applicability when drafting pleadings; and, 4. canadian judges are not yet as familiar with the cisg as their international counterparts, particularly european judges, who benefit from a wealth of cisg caselaw, the principles of european contract law (pecl),5 unidroit principles 6 and other international legal instruments. 7 5 although limited in application to the european union membership, the impact of the principles of european contract law (pecl) on the cisg should not be overlooked. according to the commission on european contract law: the principles have been drawn up by an independent body of experts from each member state of the european union under a project supported by the european commission and many other organisations. the principles are stated in the form of articles with a detailed commentary explaining the purpose and operation of each article. in the comments there are illustrations, ultra short cases which show how the rules are to operate in practice. each article also has comparative notes surveying the national laws and other international provisions on the topic. the principles of european contract law parts i and ii (hereinafter referred to as pecl i and ii.) cover the core rules of contract, formation, authority of agents, validity, interpretation, contents, performance, non-performance (breach) and remedies. the principles previously published in part i (1995) are included in a revised and re-ordered form. part iii covers plurality of parties, assignment of claims, substitution of new debt, transfer of contract, set-off, prescription, illegality, conditions and capitalisation of interest. 6 the preamble to the unidroit principles provides: preamble (purpose of the principles) these principles set forth general rules for international commercial contracts. they shall be applied when the parties have agreed that their contract be governed by them. they may be applied when the parties have agreed that their contract be governed by general principles of law, the lex mercatoria or the like. they may provide a solution to an issue raised when it proves impossible to establish the relevant rule of the applicable law. they may be used to interpret or supplement international uniform law instruments. they may serve as a model for national and international legislators. according to the preamble official comment: recourse to the principles as a substitute for the domestic law otherwise applicable is of course to be seen as a last resort; on the other hand it may be justified not only in the event of the absolute impossibility of establishing the relevant rule of the applicable law, but also whenever the research involved would entail disproportionate efforts and/or costs. the current practice of courts in such situations is that of applying the lex fori. recourse to the principles would have the advantage of avoiding the application of a law which will in most cases be more familiar to one of the parties. nordic journal of commercial law issue 2009#1 4 this article will discuss the applicability of the cisg from a canadian conflict of laws perspective---both in terms of jurisdiction and choice of law. a detailed review of the cisg or choice of law doctrine is beyond the scope of this article.8 the objectives are more modest. the analysis is framed by providing an outline of the key jurisdictional and choice of law principles developed within canadian jurisprudence. following a brief contextual overview of the cisg, articles 1(1) (a) and 1(1) (b) and article 6 of the cisg are highlighted, with specific reference to recent canadian and foreign judicial decisions and foreign arbitral awards involving canadian parties. the article concludes with a clarion call to justice stakeholders, particularly, canadian commercial lawyers and judges, to better understand and apply the cisg in the future. ii. jurisdiction and choice of law since the early 1990’s, canadian conflict of laws jurisprudence has developed along two parallel, albeit uneven, lines. the first line—jurisdiction—predominates the juridical landscape; producing three separate (arguably inter-related) judicial tests: unidroit principles of international commercial contracts, preamble, at http://www.unidroit.org/english/principles/contracts/principles2004/blackletter2004.pdf. see unilex on convention & unidroit principles, centre for comparative and foreign law studies, at http://www.unilex.info; the international institute for the unification of private law (unidroit), at http://www.unidroit.org; secretariat of the united nations commission on international trade law (uncitral), vienna international centre, at http://www.uncitral.org. 7 see, convention of 27 september 1968 on jurisdiction and the enforcement of judgments in civil and commercial matters (brussels convention) [available at: http://curia.europa.eu/common/recdoc/convention/en/c-textes/brux-idx.htm]; convention of 16 september 1988 on jurisdiction and the enforcement of judgments in civil and commercial matters (lugano convention) [available at: http://curia.europa.eu/ common/recdoc/convention/en/c-textes/_lug-textes.htm]; and the council regulation (ec) no 44/2001 of 22 december 2000 on jurisdiction and the recognition and enforcement of judgments in civil and commercial matters (brussels regulation) [available at: http://ec.europa.eu/justice_home/doc_centre/civil/acquis/doc_civil_acquis_en.htm]. see also, convention on the law applicable to contractual obligations opened for signature in rome on 19 june 1980 (80/934/eec)(rome convention) [available at: http://www.rome-convention.org/instruments/ i_conv_orig_en.htm] and regulation (ec) no 864/2007 of the european parliament and of the council of 11 july 2007 on the law applicable to non-contractual obligations (rome ii) [available at: http://eur-lex.europa.eu/lexuriserv/site/en/oj/2007/l_199/l_19920070731en00400049.pdf]. 8 see henry mather, “choice of law for international sales issues not resolved by the convention”, (2001) 20 j.l. & com. 155, 170. for a canadian conflict of laws perspective on choice-of-law in torts, see joost blom, choice-of-law methodology, in private international law in common law canada: cases, text, and materials 475-508 (2d ed. 2003); janet walker, “are we there yet?” towards a new rule for choice of law in tort, (2000) 38 osgoode hall l.j. 331; robin m. junger, a proposed choice of law methodology for tort in canada: comparative evaluation of british and american approaches 1994) 26 ottawa l. rev. 75. http://www.unidroit.org/english/principles/contracts/principles2004/blackletter2004.pdf. http://www.unilex.info;/ http://www.unidroit.org;/ http://www.uncitral.org./ http://curia.europa.eu/common/recdoc/convention/en/c-textes/brux-idx.htm http://curia.europa.eu/ http://ec.europa.eu/justice_home/doc_centre/civil/acquis/doc_civil_acquis_en.htm http://www.rome-convention.org/instruments/ http://eur-lex.europa.eu/lexuriserv/site/en/oj/2007/l_199/l_19920070731en00400049.pdf nordic journal of commercial law issue 2009#1 5 (i) the concept of jurisdiction simpliciter: whether a canadian court can assumeadjudicatory or judicial jurisdiction based upon a “real and substantial connection”9 between the subject-matter of the dispute and the non-resident (and non-attorning) defendant;10 (ii) even where jurisdiction simpliciter is established (whether by personal jurisdiction, consent-based jurisdiction or assumed jurisdiction), 11 a canadian court may still decline jurisdiction based upon the discretionary “forum non conveniens” test; 12 and (iii) the “strong cause” test which has also gained currency in cases involving forum selection clauses.13 the second jurisprudential line—choice of law—is often relegated to ancillary status; either as only one of a multitude of enumerated factors within a court’s discretionary analysis, or simply deferred to later determination by a trial judge.14 for example, the factors for a court to decline to assume jurisdiction on forum non conveniens grounds is set out by the ontario court of appeal in muscutt: 9 see, janet walker, “beyond a real and substantial connection: the muscutt quintet” in the annual review of civil litigation, 2002, the honourable mr. justice todd l. archibald & michael cochrane, eds. (toronto: thomson carswell, 2003). for an excellent critique of the “real and substantial connection” test, see tanya j., monestier, “a ‘real and substantial’ mess: the law of jurisdiction in canada” (2007), 33 queen’s l.j. 179 and jean-gabriel castel, “the uncertainty factor in canadian private international law”, (2007), 52 mcgill l.j. 555. 10 morguard investments ltd. v. de savoye [1990] 3 s.c.r. 1077, (1990) 76 d.l.r. (4th) 256, (1990) 122 n.r. 81, [1991] 2 w.w.r. 217, (1990) j.e. 91-123, (1990) 52 b.c.l.r. (2d) 160, (1990) 46 c.p.c. (2d) 1, (1990) 15 r.p.r. (2d) 1, (1990) 24 a.c.w.s. (3d) 478 (s.c.c.); beals v. saldanha [2003] 3 s.c.r. 416, (2003) 234 d.l.r. (4th) 1, (2003) 314 n.r. 209, (2003) j.e. 2004-127, (2003) 182 o.a.c. 201, (2003) 39 b.l.r. (3d) 1, (2003) 39 c.p.c. (5th) 1, (2003) 113 c.r.r. (2d) 189, (2003) 127 a.c.w.s. (3d) 648 (s.c.c.). 11 muscutt v. courcelles, (2002) 60 o.r. (3d) 20 at 35, 213 d.l.r. (4th) 577 (ont. c.a.) [hereinafter “muscutt”-cited to o.r.]; see also the companion cases: gajraj v. debernardo, [2002] 213 d.l.r. (4th) 651 (ont. c.a.); leufkens v. alba tours int’l inc., [2002] 213 d.l.r. (4th) 614 (ont. c.a.); lemmex v. sunflight holidays inc., [2002] 213 d.l.r. (4th) 627 (ont. c.a.); sinclair v. cracker barrel old country store inc., [2002] 213 d.l.r. (4th) 643 (ont. c.a.). 12 for a discussion of the forum non conveniens doctrine in canada from a contractual perspective, see antonin i. pribetic,“strangers in a strange land”: transnational litigation, foreign judgment recognition, and enforcement in ontario, (2004), 13 j. transnat’l l. & pol’y, vol. 2, 347-391. 13 z.i. pompey industrie v. ecu-line n.v., [2003] 1 s.c.r. 450, 2003 scc 27, 224 d.l.r. (4th) 577, at ¶ 19 (scc) per bastarache j. (mclachlin c.j. and gonthier, iacobucci, major, binnie and lebel jj. concurring) [hereinafter “z.i. pompey”]. see also, red seal tours inc. v. occidental hotels management b.v., 2007 onca 620 (canlii), 2007 onca 620 (ont. c.a.) at ¶ 13, per sharpe, j.a. (cronk and lang jj.a. concurring). 14 see, dean edgell, product liability law in canada at 279 (toronto: butterworths, 2000) wherein the author notes, “the issue of choice of law, unlike jurisdiction, is not one that need be decided early in a law suit.” (and cases cited therein). nordic journal of commercial law issue 2009#1 6 (1) the location of the majority of the parties; (2) where each party carries on business; (3) where the cause of action arose; (4) where the loss or damage occurred; (5) any juridical advantage for the plaintiff in this jurisdiction; (6) any juridical disadvantage for the defendant in this jurisdiction; (7) convenience or inconvenience to potential witnesses; (8) the cost of conducting the litigation in this jurisdiction; (9) applicable substantive law; and (10) difficulty in proving foreign law, if necessary. 15 16[emphasis added] the key difference between the forum non conveniens and “strong cause” tests is that “the presence of a forum selection clause ... is sufficiently important to warrant a different test, one where the starting point is that the parties should be held to their bargain."17 as labrosse, j.a. has observed “[w]here the parties have not included a forum selection clause in their contract, a forum will have jurisdiction where it has a real and substantial connection to the contract. 18 in any event, the issue is one of consent-based jurisdiction, not assumed jurisdiction under the “real and substantial connection” test for establishing jurisdiction simpliciter (i.e. assumed jurisdiction).19 justice la forest, in hunt v. t & n plc,20 emphasized the principles of order and 15 muscutt, supra note 11 at pp.34-5. 16 in schreiber v. mulroney, 2007 canlii 56529 (on s.c.), justice cullity appears to conclude that the eightfactor muscutt formulation is focused on tort claims, and that further factors are necessary in respect of contract claims (para. 37). the factors he suggests: i.e. the place where the contract was made, performed and breached and where any damage was sustained, are those factors referenced in the discretionary forum non conveniens test, which allows a court to stay an action, following the preliminary inquiry into jurisdiction simpliciter over the parties and the dispute. 17 id., at ¶ 21. 18 crown resources corp. s.a. v. national iranian drilling co., (2006) 273 d.l.r. (4th) 65 at para.65 (ont. c.a.), per labrosse, laskin and armstrong jj.a. also citing janet walker, castel & walker canadian conflict of laws, vol. 2 (markham: butterworth, 2005, at §11.5); varying (2005) 142 a.c.w.s. (3d) 421 (ont. s.c.j.) (ont. c.a.) application for leave to appeal dismissed without reasons on march 8, 2007 [2006] s.c.c.a. no. 412 (s.c.c.) 19 muscutt, supra note 11 at 586. 20 hunt v. t & n plc, [1993] 109 d.l.r.4th 16 (s.c.c.) [hereinafter “hunt”]; see also, united states of america v. ivey (1995), 26 o.r. (3d) 533, [1995] o.j. no. 3579 (gen. div.), aff’d (1996), 30 o.r. (3d) 370, [1996] o.j. no. 3360 (c.a.) nordic journal of commercial law issue 2009#1 7 fairness” which underscore the “real and substantial connection” test.21 in tolofson v. jensen,22 justice la forest further observed that: while, no doubt, as was observed in morguard, the underlying principles of private international law are order and fairness, order comes first. order is a precondition to justice. 23 on the international level, the increasing importance of exclusive jurisdiction clauses (also referred to as “forum selection” or “choice of forum” clauses) in the private international law arena has culminated in the recent signing of the hague choice of court convention24 25 in addition to order and fairness, the “real and substantial connection” test must also be considered in view of prevailing customary international law 26 principles of uniformity, harmonization of international rules, comity and reciprocity.27 21 id. at 42. 22 tolofson v. jensen [1994] 3 s.c.r. 1022 (s.c.c.) 23 id. at 1058 (emphasis added). 24 convention of 30 june 2005 on choice of court agreements, no. 37, concluded on june 30th, 2005 at the twentieth session of the hague conference on private international law [the “hague choice of court convention”]. to date, only mexico has acceded to the hague choice of court convention: (see the hcch website: http://www.hcch.net/index_en.php?act=conventions.status&cid=98). however, both the european union and the united states are poised to ratify the convention. see, proposal for a council decision on the signing by the european community of the convention on choice-of-court agreements of 2005 (com(2008) 538, commission of the european communities presented dated 5 september 2008 and international law prof blog “u.s. to sign hague conference choice of courts convention” http://lawprofessors.typepad.com/international_law/2008/11/us-to-sign-hagu.html. 25 with respect to parallel proceedings (lis alibi pendens), the forum non conveniens test still requires that choice of forum be determined on the basis of factors designed to ensure that the action is tried in the jurisdiction that has the closest connection with the action and the parties and not to secure a juridical advantage to one of the litigants at the expense of others in a jurisdiction that is otherwise inappropriate. the existence of a more appropriate forum must be clearly established to displace the forum selected by the plaintiff. see, spiladia maritime corp v cansulex ltd., [1987] a.c. 460 (h.l.); amchem products inc. v british columbia (workers compensation board) [1993] 1 s.c.r. 897 (s.c.c.); s.n.i. aerospatiale v. le kui jak [1987] 3 all e.r. 510 (h.l.). see also, janet walker "a tale of two fora: fresh challenges in defending multijurisdictional claims" (1996) 33 osgoode hall l j 549. 26 see r. v. hape, [2007] 2 s.c.r. 292 , (2007), 280 d.l.r. (4th) 385, (2007), 220 c.c.c. (3d) 161, (2007), 160 c.r.r. (2d) 1, (2007), 47 c.r. (6th) 96, (2007), 227 o.a.c. 191 (s.c.c.) vis-à-vis the majority’s approval of the doctrine of adoption qua reception of customary international law into canadian domestic law. in the united states, customary international law is traditionally defined as the “general and consistent practice of states followed by them from a sense of legal obligation.” see, restatement (third) of the foreign relations law of the united states § 102(2) (1987); see also statute of the international court of justice, jun. 26, 1945, art. 38, 59 stat. 1055, 1060, (available online at: http://www.icj-cij.org/icjwww/ibasicdocuments/ibasictext/ibasicstatute.htm) which reads: article 38 http://www.hcch.net/index_en.php?act=conventions.status&cid=98). http://lawprofessors.typepad.com/international_law/2008/11/us-to-sign-hagu.html. http://www.icj-cij.org/icjwww/ibasicdocuments/ibasictext/ibasicstatute.htm) nordic journal of commercial law issue 2009#1 8 applying the private international law principles to jurisdictional analysis may also reduce transactional costs and potentially foster settlement opportunities, especially if both litigants are obliged to retain foreign legal experts to prove foreign law.28 however, while the foregoing jurisdictional tests provide guidance on how a canadian court should assume or decline jurisdiction, they do not explain why or when the applicable law applies (or will apply) to the resolution of the dispute. the answers to these questions are not trifling. from a choice of law perspective, a canadian court’s determination of the applicable law (the “lex causae”) will often be dispositive, particularly since it is the substantive law and not procedural law, which determines issues of liability, causation and damages. 29 yet, it is surprising how often the cisg is ignored or misapplied by domestic courts. 30 1. the court, whose function is to decide in accordance with international law such disputes as are submitted to it, shall apply: a. international conventions, whether general or particular, establishing rules expressly recognized by the contesting states; b. international custom, as evidence of a general practice accepted as law; c. the general principles of law recognized by civilized nations; d. subject to the provisions of article 59, judicial decisions and the teachings of the most highly qualified publicists of the various nations, as subsidiary means for the determination of rules of law. 2. this provision shall not prejudice the power of the court to decide a case ex aequo et bono, if the parties agree thereto. [emphasis added] 27 see theodor schilling, “on the constitutionalization of general international law”, jean monnet working paper 06/05, the jean monnet program, professor j.h.h. weiler european union jean monnet chair, (available online at: http://www.nyulawglobal.org/workingpapers/documents/ glwp0505schilling.pdf) 28 in canada, judicial notice is not taken of foreign law, and evidence rules require experts to be qualified by the court to be permitted to prove the law of a foreign jurisdiction. see john sopinka & sidney n. lederman, the law of evidence in civil cases, 311-12 (1974). 29 see generally, j.g. castel and janet walker, canadian conflict of laws, 6th ed. (markham: lexisnexis butterworths, 2005) vol. 1, chap. 3 “characterization and the incidental question” and chapter 6 “substance and procedure”, §6.2, p. 6-2, where prof. walker notes that “[t]he distinction between substance and procedure, or right and remedy, is an important subject of characterization...the characterization of a particular rule, whether foreign or domestic, as substantive or procedural, cannot be done in the abstract because substance and procedure are not clear-cut or unalterable categories.” 30 a number of articles have been written, mostly by american and canadian scholars, commenting on the failure by domestic courts to either recognize or correctly apply the cisg: see, john e. murray, “the neglect of cisg: a workable solution” (1998) 17 j. l. & comm. 365-379 (available online at: http://cisgw3.law.pace.edu/cisg/biblio/murray1.html); jacob ziegel, the future of the international sales convention from a common law perspective: new zealand bus. l.q. 6 (2000) 336 (available online at: http://cisgw3.law.pace.edu/cisg/biblio/ziegel3.html); marlyse mcquillen, “the development of a federal cisg common law in u.s. courts: patterns of interpretation and citation” (2007) 61 u. miami l. rev. 509-537 (available online at: http://cisgw3.law.pace.edu/cisg/biblio/mcquillen.html); monica kilian, cisg and the problem with common law jurisdictions, (2001) 10 j. transnat'l l. & pol'y 217 (available online at: http://www.law.fsu.edu/journals/transnational/vol102/kilian.pdf); joseph lookofsky and harry flechtner, “nominating manfred forberich: the worst cisg decision in 25 years?” (2005) 9(1) vindobona j. of int’l comm. law and arb. 199-208 (available online at: http://cisgw3.law.pace.edu/cisg/biblio/lookofsky13.html); rajeev sharma, "the united nations convention on contracts for the international sale of goods: the canadian experience" (2005) 36 vuwlr 847-858; peter j. mazzacano, “brown & root services v. aerotech herman http://www.nyulawglobal.org/workingpapers/documents/ http://cisgw3.law.pace.edu/cisg/biblio/murray1.html); http://cisgw3.law.pace.edu/cisg/biblio/ziegel3.html); http://cisgw3.law.pace.edu/cisg/biblio/mcquillen.html); http://www.law.fsu.edu/journals/transnational/vol102/kilian.pdf); http://cisgw3.law.pace.edu/cisg/biblio/lookofsky13.html); nordic journal of commercial law issue 2009#1 9 iii. applicability of the cisg by default i. a brief overview of the cisg the cisg aims to promote uniformity of international sales law based upon the recognition that international sales and domestic sales contracts differ in significant ways. the cisg is essentially a codification of uniform rules which are intended to promote harmonization among different common law and civil law systems. in this sense, the cisg is considered superior to national or provincial sales laws, which do not necessarily reflect the emergent issues of globalization, cross-border transactions and international trade, generally. the cisg preamble reads in part: considering that the development of international trade on the basis of equality and mutual benefit is an important element in promoting friendly relations among states, being of the opinion that the adoption of the uniform laws which govern contracts for the international sale of goods and take into account the different social, economic and legal systems would contribute to the removal of legal barrier in international trade and promote the development of international trade,… the cisg governs two aspects of an international sales transaction: formation of an international sale of goods contract and the right and obligations of parties to these sales contracts. the scope of the cisg is limited in four important ways: 1) it governs only international sales; 2) it applies only to the commercial sale of goods; 3) it does not apply to specified types of contract issues (e.g. validity); and, 4) the parties are free to exclude the application of the cisg, or vary its effect or derogate from some of its provisions. nelson: the continuing plight of the u.n. sales convention in canada” in review of the convention on contracts for the international sale of goods (cisg) 2004-2005, pace international law review, ed., (munchen: sellier european law publishers, 2006), 169-178 (available online at: http://cisgw3.law.pace.edu/cisg/biblio/mazzacano.html ; antonin i. pribetic, “the (cisg) road less travelled”: grecon dimter inc. v. j.r. normand inc.,” (2006) 44 can. bus. l. j. 92-114 (pre-print available online at: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=861944); mathias reimann, “the cisg in the united states: why it has been neglected and why europeans should care” (2007) 71 rabels zeitschrift für ausländisches und internationales privatrecht 115-129 (available online at: http://cisgw3.law.pace.edu/cisg/biblio/reimann.html); christopher sheaffer, “the failure of the united nations convention on contracts for the international sale of goods and a proposal for a new uniform global code in international sales law” (2007) 15 cardozo j. of int’l and comp. l. 461-495 (available online at: http://cisgw3.law.pace.edu/cisg/biblio/sheaffer.html);. geneviève saumier, “international sale of goods law in canada: are we missing the boat?” (2007) 7 can. int’l lawyer 1-8, james m. klotz, peter j. mazzacano and antonin i. pribetic ”all quiet on the cisg front guiliani v. invar manufacturing the battle of the forms, and the elusive concept of terminus fixus” (2008) 46 can. bus. l. j. 430 (available online at ssrn: http://ssrn.com/abstract=1127850). http://cisgw3.law.pace.edu/cisg/biblio/mazzacano.html http://papers.ssrn.com/sol3/papers.cfm?abstract_id=861944); http://cisgw3.law.pace.edu/cisg/biblio/reimann.html); http://cisgw3.law.pace.edu/cisg/biblio/sheaffer.html);. http://ssrn.com/abstract nordic journal of commercial law issue 2009#1 10 the cisg forms part of the modern lex mercatoria, or law merchant (including custom, trade usages, etc.), 31which is continued under various provincial sale of goods legislation. in ontario, section 57 (1) of the sale of goods act defines its scope of applicability as follows: the rules of the common law, including the law merchant, except in so far as they are inconsistent with the express provisions of this act, and in particular the rules relating to the law of principal and agent and the effect of fraud, misrepresentation, duress or coercion, mistake or other invalidating cause, continue to apply to contracts for the sale of goods. canadian courts generally apply the lex loci contractus in lieu of an ex ante agreement on choiceof-law. 32 article 7 of the cisg reads: in the interpretation of this convention, regard is to be had to its international character and to the need to promote uniformity in its application and the observance of good faith in international trade. questions concerning matters governed by this convention which are not expressly settled in it are to be settled in conformity with the general principles on which it is based or, in the absence of such principles, in conformity with the law applicable by virtue of the rules of private international law.33 the three main principles underlying article 7(1) of the cisg are its “international character,” “uniformity” and “good faith.” gap filling is dealt with under article 7(2), which, although not expressly addressed, is based upon the premise that courts should first apply the cisg’s general principles and policies and, if a gap exists, then resort should be made to the principles of “private international law.”34 professor hillman has identified four main policies underlying the rules of the cisg: (1) freedom of contract; (2) co-operation and reasonableness; (3) successful completion of exchanges and (4) compensating injured parties for breach.35 since the 31 see, peter j. mazzacano, “the lex mercatoria as autonomous law” clea 2008 meetings paper clpe research paper no. 29/2008 (available at ssrn: http://ssrn.com/abstract=1137629). 32 j.g. castel and janet walker, canadian conflict of laws, 6th ed. (markham: lexisnexis butterworths, 2008) vol. 2 at 31-5 to 31-7. 33 cisg, article 7 (emphasis added). 34 id., art. 7(2). 35 robert a. hillman, cross-reference and editorial analysis of convention article 7, at http://cisgw3.law.pace.edu/cisg/text/hillman.html, 1-10 (emphasis added, citations omitted). peter j. mazzacano comments: http://ssrn.com/abstract http://cisgw3.law.pace.edu/cisg/text/hillman.html nordic journal of commercial law issue 2009#1 11 cisg is an international convention which has been adopted into the canadian federation generally, and within each of canada’s constituent provinces, it is self-evident that the foregoing principles and policies must inform any judicial analysis of contractual choice-of-law for claims governed by the cisg brought within the domestic forum. the validity of a choice of forum clause, the issue of whether a court has jurisdiction, and, generally, any other issue of procedural law are some of the issues considered outside of the scope of the cisg.36 thus, article 4 excludes issues such as fraud,37 lack of capacity, misrepresentation, duress, mistake38, unconscionability, and contracts contrary to public policy.39 article 1(1) limits the applicability of the cisg to “contracts for sale of goods”, a term undefined by the cisg, albeit better understood within the “hopefully, guidance will be given to lower courts to utilize the interpretive methodology embodied within the cisg. regard must be had to its international character and the need to promote uniformity in its application at the international level. this dictates that the cisg be interpreted by courts in an autonomous manner, and not through the lens of domestic law. however, as the brown & root case illustrates, this is where errors most often seem to arise. to echo the words of ziegel, unless legal practitioners develop a better understanding of this autonomous interpretive methodology—or unless the supreme court puts them straight—the future of the convention in canadian law will continue to languish.” peter j. mazzacano, “brown & root services v. aerotech herman nelson: the continuing plight of the u.n. sales convention in canada”, pace review of the convention on contracts for the international sale of goods (2004-2005), (münchen: sellier european law publishers, 2006) . 36 see uncitral digest of case law on the united nations convention on the international sales of goods .report of the united nations commission on international trade law on the work of its twenty first session, new york, 11-20 april 1988, united nations document a/43/17, ¶’s 98-109. clout reports are published as united nations documents a/cn.9/ser.c/abstracts/1to a/cn.9/ser.c/abstracts/42. the forty-two clout reports are also available online on uncitral’s website at http://www.uncitral.org/. in particular, see clout article 4 a/cn.9/ser.c/digest/cisg/4 at p. 5-6, fn.’s 33, 41 and 42 and cases cited therein. see also, “cisg applicability flowchart”, infra at p. 40. 37 see peter schlechtriem, “the borderland of tort and contract opening a new frontier?” (1988), 21 cornell int’l l.j. 467 473-74 (1988), stating that the cisg does not preempt claims for “misrepresentation, fraud, betrayal and intentional harm to economic interests”, available online at http://cisg.law.pace.edu/cisg/ biblio/schlechtriem.html#ps1 and sonox sia v. albury grain sales inc., [2005] q.j. no. 9998 (que. s.c.), affd [2005] q.j. no. 17960, 2005 qcca 1193 (que. c.a.), district of montreal (per otis, rayle and hilton jj.a.). 38 prof. kritzer notes: “there are also issues which may or may not be regarded as within the purview of the convention, "mistake" for example. when there is a mistake, some commentators believe that contract rights and remedies are in many cases governed solely by the convention, except in the case of fraud. others regard mistake as a validity doctrine that is reserved unto domestic law.” “checklist on the cisg” adapted excerpt from albert h. kritzer ed., guide to practical applications of the united nations convention on contracts for the international sale of goods (the hague, kluwer law international, 1994). available online at: http://www.cisg.law.pace.edu/cisg/biblio/kritzer2.html. see also, patrick c. leyens, “cisg and mistake: uniform law vs. domestic law-the interpretative challenge of mistake and the validity loophole” pace international law review (ed.), review of the convention on contracts for the international sale of goods (2003-2004) (münchen, sellier european law publishers, 2005) pp.3-51, also available online at http://www.cisg.law.pace.edu/cisg/biblio/leyens.html. 39 see jacob s. ziegel and claude samson, report to the uniform law conference of canada on convention on contracts for the international sale of goods, article 4 commentary, available online at http://www.cisg.law.pace.edu/cisg/text/ziegel4.html. http://www.uncitral.org/. http://cisg.law.pace.edu/cisg/ http://www.cisg.law.pace.edu/cisg/biblio/kritzer2.html. http://www.cisg.law.pace.edu/cisg/biblio/leyens.html. http://www.cisg.law.pace.edu/cisg/text/ziegel4.html. nordic journal of commercial law issue 2009#1 12 context of articles 2-5. article 1(1) generally defines the scope of the cisg in terms of territoriality and internationality (“between parties whose places of business are in different states”). the parties may also have chosen to expressly exclude the cisg by choosing one of the parties’ domestic law, or mandatory arbitration. the availability and effectiveness of partially or completely opting out under article 6 will accordingly be considered. there are, in fact, three key features which underscore the cisg’s autonomous interpretation. firstly, article 7 (interpretation of the cisg) calls for an approach to interpretation that is consistent with its character and purpose since the cisg has a very special function, i.e. to replace diverse domestic rules with uniform international law. this purpose includes the observance of good faith in international trade. secondly, under article 8 (interpretation of statements or other conducts of a party), which applies in several situations to determine whether or not the parties have made a contract, raise significant problems of legal effect and interpretation. finally, article 9 (usages and practices applicable to contract) is regarded as one the most important features of the cisg, as it gives legal effect to commercial usages and practice by providing for their application in contracts governed by the cisg. however, the cisg text is not accompanied by any official comments. the "secretariat commentaries" (the detailed analysis accesses the commentaries prepared by the secretariat of the united nations pursuant to un general assembly resolution 33/93) are the closest available counterpart to an official cisg commentary. as discussed in article 1(1)(b) infra, for international sales contracts, the applicable law is to be determined by the rules of private international law (conflict of laws), or on the basis of international treaties, or, alternatively, on the basis of a law chosen by the parties (choice of law). 40 professor mather further notes: if an issue is expressly excluded from the scope of the cisg, it is not "governed" by the cisg, article 7(2) does not apply, cisg general principles do not come into play, and the court must apply its choice-of-law rules leading to substantive rules that are external to the cisg regime. 41 40 in the swiss cisg case, regional tribunal (tribunal cantonal) of jura 3 november 2004 [ap 91/04], the appellate court panel held: in the case of a sale of an international nature, the applicable law can be determined on the basis of internal laws of international private law which resolve conflicts of laws, that is to say, on the basis of the swiss federal law on international private law of 18 december 1987 (ldip), or on the basis of international treaties or alternatively on the basis of a law chosen by the parties (choice of law). available online at: http://cisgw3.law.pace.edu/cases/041103s1.html (translation by julia hoffmann). see also, clout case no. 196 [handelsgericht des kantons zürich, switzerland, 26 april 1995] 41 mather, “choice of law for international sales issues not resolved by the convention” supra note 8 at 170. http://cisgw3.law.pace.edu/cases/041103s1.html nordic journal of commercial law issue 2009#1 13 a more detailed discussion of conflict of laws is beyond the scope of this article.42 however, it is important to keep in mind that the issues of jurisdiction simpliciter (whether the canadian court may assume jurisdiction) 43 and the doctrine of forum non conveniens (whether the canadian court should decline jurisdiction in favour of another more convenient forum) are often intertwined with the enforceability of forum selection and arbitration clauses, all of which may involve, directly or indirectly, the cisg as the governing law. the supreme court of canada’s own recognition of the primacy of ‘party autonomy’ and ‘freedom of contract’44 (cf. article 6, infra) and the fundamental principles of ‘comity’45 and ‘order and fairness’46 may also be found in the cisg’s principles of autonomous interpretation (cf. “international character,” “uniformity” and “good faith” discussed under article 7(1), supra). ii. the basic rules and principles of the cisg cisg article 1basic rules of applicability; internationality; territoriality (1) this convention applies to contracts of sale of goods between parties whose places of business are in different states: (a) when the states are contracting states; or (b) when the rules of private international law lead to the application of the law of a contracting state. (2) the fact that the parties have their places of business in different states is to be disregarded whenever this fact does not appear either from the contract or from any 42 see j.g. castel & janet walker, canadian conflict of laws , vol. 2, 31-5 – 31-7 (6th ed.) , markham: lexis nexis-butterworths, 2005); antonin i. pribetic, "bringing locus into focus": a choice-of-law methodology for cisg-based concurrent contract and product liability claims, pace review of the convention on contracts for the international sale of goods (2004-2005) 179-223 (münchen: sellier european law publishers, 2006); joost blom, choice-of-law methodology, in private international law in common law canada: cases, text, and materials 475-508 (2d ed. 2003). 43 beals v. saldanha [2003] 3 s.c.r. 416 at 453 (s.c.c.) per major, j. (mclachlin c.j., gonthier, bastarache, arbour and deschamps jj. concurring). 44 grecon dimter inc. v. j.r. normand inc. et al., 2005 scc 46, (2005) 255 d.l.r. (4th) 257 at 271, (2005) 336 n.r. 347, (2005) j.e. 2005-1369 (s.c.c.) [cited to d.l.r.][hereinafter “grecon dimter v. normand”]. 45 comity was defined by the supreme court of canada as "the deference and respect due by other states to the actions of a state legitimately taken within its territory”, needed to be contemporized “in light of a changing world order." morguard investments ltd. v. de savoye, [1990] 3 s.c.r. 1077 at 1095, 1097 (s.c.c.) 46 justice la forest, in hunt v. t & n plc, noted at p. 42 that the assessment of the "reasonableness" of a foreign court's assumption of jurisdiction was not a mechanical accounting of connections between a case and a territory, but a decision "guided by the requirements of order and fairness." nordic journal of commercial law issue 2009#1 14 dealings between, or from information disclosed by, the parties at any time before or at the conclusion of the contract. (3) neither the nationality of the parties nor the civil or commercial character of the parties or of the contract is to be taken into consideration in determining the application of this convention. while the cisg does not contain an objective definition of a “contract of sale”, the generally understood meaning may be inferred from articles 30 and article 53, which impose coextensive obligations between seller and buyer to conclude an international sales contract. 47 furthermore, article 30 imposes on the seller an obligation to deliver the goods and relevant documents and to transfer property in the goods.48 the official english text of the cisg refers to “goods” while the official french version refers to “marchandises”.49 the prevailing view, is for an expansive definition which includes all moveable, tangible objects relating to commercial sales contracts.50 types of contracts governed by the cisg 51 are the delivery of goods by 47 peter schlechtriem & ingeborg schwenzer, commentary on the un convention on the international sale of goods (cisg) pt.1 chap. isphere of application-article 1 at p. 26, §14 (2d ed) (new york: oxford university press, 2005) [hereinafter referred to as “schlechtriem/schwenzer” with attribution to the contributing author] see also uncitral digest of case law on the united nations convention on the international sales of goods. report of the united nations commission on international trade law on the work of its twenty first session, new york, 11-20 april 1988, united nations document a/43/17, [hereinafter “clout digest”]. the clout digest contains authoritative commentary and case law reports which are published as united nations documents: a/cn.9/ser.c/abstracts/1 to a/cn.9/ser.c/abstracts/42. the forty-two clout digest reports are also available online on uncitral’s website at: http://www.uncitral.org/ in particular, see clout digest article 1 a/cn.9/ser.c/digest/cisg/1 at p. 2, ¶3. 48 cisg, articles 30-34-seller’s obligations. 49 the new consumer protection act, 2002, s.o. 2002, c. 30, sched. a [“cpa 2002”] came into force in ontario on july 30, 2005. the cpa 2002 repeals, inter alia, the existing consumer protection act, the business practices act and motor vehicle repair act, consolidating them into one consumer protection statute. it also extends the definition of “goods” to “any type of property” (“marchandises”): "goods" means all chattels personal, other than things in action and money, and includes emblements, industrial growing crops, and things attached to or forming part of the land that are agreed to be severed before sale or under the contract of sale; ("objets")). in québec, see book five of the civil code of québec. 50 schlechtriem: schlechtriem/schwenzer, art. 1, at p. 28, §20; sonja a. kruisinga, (non-) conformity in the 1980 un convention on contracts for the international sale of goods: a uniform concept? at p. 8 (antwerp/oxford/newyork:intersentia, 2004 [hereinafter “kruisinga”]; john o. honnold, uniform law for international sales under the 1980 united nations convention, 3rd ed. the hague: kluwer law international, 1999, at p. 50, §56 [hereinafter “honnold-uniform law”]. 51 in particular, see clout digest article 1 a/cn.9/ser.c/digest/cisg/1 at p. 4, §§8-10 and cases cited therein. http://www.uncitral.org/ nordic journal of commercial law issue 2009#1 15 installment;52 sales involving a carriage of goods;53 delivery of goods sold directly from the supplier to the seller’s customer;54 and an agreement to modify or rescind a sales contract.55 article 53 obliges the buyer to pay the agreed upon price and to facilitate completion of the transaction based upon the terms of the contract.56 57 for example, in the lacquer handicraft case, a cietac arbitration decision,58 the canadian buyer and the chinese seller concluded a contract for the sale of lacquer handicraft on may 2, 1994. the price of the goods was us $27,986 cif (toronto) to be shipped prior to may 30, 1994 and paid via telegraphic transfer (t/t). the chinese seller shipped the goods but upon arrival in toronto, the canadian buyer claimed serious defects in the goods and refused to make payment. although the parties negotiated a reduction in the price to us $22,897.45, the canadian buyer still failed to make payment, resulting in the chinese seller applying to cietac for arbitration. the canadian buyer failed to respond to the arbitration notice sent by the cietac secretariat, which led to the unilateral appointment of an arbitrator pursuant to the cietac arbitration rules. the chinese seller’s attorney attended the arbitration hearing held in beijing on july 8, 1996, but the canadian buyer did not, resulting in a default hearing relying solely upon the attorney for the chinese seller’s oral and written submissions. on the issue of applicable law, the arbitration tribunal noted that: “…no applicable law was agreed on in the contract. since both china and ontario, canada, which toronto is subordinate to have cited the united nations convention on contracts for the international sale of goods (hereinafter referred to as the "cisg"), cisg shall be applied to the settlement of the dispute under the case.” 52 see cisg, article 73(1). for example, see schiedsgericht der hamburger freundlichen arbitrage, germany, 29 december 1998, internationales handelsrecht, 2001, 337; clout case no. 251 [handelsgericht des kantons zürich, switzerland, 30 november 1998]; cf. schlechtriem: schlechtriem/schwenzer, art. 1 at p.26, fn.25. 53 see cisg, article 67 generally and schlechtriem: schlechtriem/schwenzer, art.1, at p. 26, fn. 23. see also clout digest article 1a/cn.9/ser.c/digest/cisg/1 at p. 2, ¶4 and citations therein. 54 id., clout digest article 1 a/cn.9/ser.c/digest/cisg/1 . 55 but only where the cisg governs the contract. see cisg, article 29-contract modification. 56 cisg, articles 53-60 buyer’s obligations. 57 schlechtriem: schlechtriem/schwenzer, art. 1, at p. 26, §14 citing herber/czerwenka, internationales kaufrecht, kommentar zu dem übereinkommen der vereinten nationen vom 11. april 1980 über vertage über den internationalen warenkauf, münchen: beck (1991). 58 china 6 august 1996 china international economic & trade arbitration commission [cietac] arbitration proceeding (lacquer handicraft case) (translation by chen gang and edited by jiang chi) available online at: http://cisgw3.law.pace.edu/cases/960806c1.html [hereinafter “cietac-lacquer handicraft case”] http://cisgw3.law.pace.edu/cases/960806c1.html nordic journal of commercial law issue 2009#1 16 thus, the arbitration tribunal found that the chinese seller had fulfilled its delivery obligation under article 30, while the canadian buyer (in absentia) was found to have breached its obligation to pay for the goods under article 53, thereby entitling the chinese seller to damages pursuant to article 74 and interest on the amount owed at the rate of 9% (usd) or 12% (chinese yuan) under article 78. the arbitration tribunal also awarded the chinese seller its costs, including legal fees, enforcement fees of property preservation and arbitration fees throughout. 59 iii) article 1(1)(a) on contracting states article 1(1)(a) denotes that the parties must be from different states. for parties with places of business in different contracting states, where the contract is within the scope of the cisg, the contract is governed by the cisg by default, unless the parties indicate otherwise. 60 61article 1(2) may come into play in cases where one of the parties acts as an agent for an undisclosed foreign principal. essentially, article 1(2) restricts applicability of the cisg in circumstances where one of the parties was unaware of the “internationality” component of the commercial sales contract. thus, the cisg will not apply if the fact of the buyer’s or seller’s foreign place of business is not apparent either on the face of the contract, or from any prior dealings between the parties, or from any information disclosed by the parties prior to conclusion of the contract. in most commercial sales transactions, the parties’ place of business should be easily discernable from correspondence, invoices, purchase orders, etc. while “place of business” is not defined, reference should be made to article 10, sub-paragraph (a) which deals with the issue of multiple places of business.62 the importance of properly identifying the cisg’s applicability under article 1(1)(a) was highlighed in a french court decision involving a québécois company. in lombard and cofranca 59 id., cietac-lacquer handicraft case, part iv: opinion of the arbitration tribunal and part v: the award. 60 for example, see russia 13 may 1997 arbitration proceeding 3/1996, tribunal of international commercial arbitration at the russian federation chamber of commerce and industry, [icac] also available online at: http://cisgw3.law.pace.edu/cases/970513r1.html (translation by mykhaylo danylko; translation edited by djakhongir saidov) [hereinafter “icac case 3/1996”]. icac case 3/1996 involved a contract of sale between a russian buyer and canadian seller. the russian arbitration tribunal held that the cisg applied pursuant to article 1(1)(a): “since the contract was concluded between the parties whose commercial companies are located in states that are contracting states to the cisg, the cisg is to be applied to the relations between the parties by virtue of article 1(1)(a) cisg”. 61 see also, denmark 3 may 2006 hojesteret [supreme court] which involved a dispute between a danish seller and a canadian buyer of a machine designed to mass-produce concrete slats for pig sties, available at http://cisgw3.law.pace.edu/cases/060503d1.html. 62 see cisg, article 10 and articles 92(2) and 93(3) (to determine when a state is a “contracting state”). http://cisgw3.law.pace.edu/cases/970513r1.html http://cisgw3.law.pace.edu/cases/060503d1.html. nordic journal of commercial law issue 2009#1 17 v. boucherie debeaux, ets. barbaud et al., the co-defendant, cofranca import export inc., a quebec company (subsequently bankrupt), sold horsemeat to two other co-defendant french companies, boucherie debeaux, the distributor, and etablissements barbaud, the supplier, for importation and distribution of the horsemeat in france. the horsemeat was contaminated and an outbreak of trichinosis occurred. the victims of the trichinosis epidemic sued both the canadian exporter and french importers for damages. at second instance, the french appellate court found that the cisg applied to the sales contract between the french companies and the quebec seller under art. 1(1)(a), and ordered all three defendants to indemnify the victims, including the canadian supplier pursuant to article 35(1). on appeal, the cour de cassation [french supreme court] reversed and remanded, stating that while the french appellate court had properly found that the sales contract was governed by cisg, it had violated art. 16 of the french code of civil procedure, since it applied the cisg, sua sponte, without giving the parties an opportunity to make submissions on the issue of the cisg’s applicability under articles 1(1)(a) and 2(a).63 alternatively, if a party does not have a place of business, then the party’s “habitual residence” is relevant (article 10(b)). internationality (“the parties have places of business in different states”) is to be disregarded if the fact is not disclosed by the contract or any pre-contractual dealings (article 1(2).) thus, in the case of an agent acting for an undisclosed foreign principal, if the facts relating to the foreign place of business are not readily apparent “from the contract or from any dealings between, or from information disclosed by, the parties at any time before or at the conclusion of the contract”, then the cisg would not apply. take for example a nova scotia agent who buys scaffolding equipment on behalf of an ontario company from the manufacturer who principal place of business is in the state of washington, usa. if the agent does not disclose the identity of his or her ontario principal, then the contract for the sale of goods would not meet the “internationality” requirement, given that the terms of the third party agency agreement (i.e. the agency contract, dealings or background information) would not likely be known by the american seller/manufacturer. 64 the interplay between articles 1(2) and 10(b) arose in easom automation systems, inc. v. thyssenkrupp fabco, corp., 65 which involved a dispute between the plaintiff, easom automation 63 lombard and cofranca v. boucherie debeaux, ets. barbaud et al,. france 2 october 2001 cour de cassation [supreme court] case no. b 99-13.461, arret no. 1436 f-p available online at http://cisgw3.law.pace.edu/cases/011002f1.html [hereinafter “lombard and cofranca v. boucherie”] 64 the cisg applies only to buyers and sellers, not to third parties, cisg art. 4. see also usinor industeel v. leeco steel prods., inc., 209 f.supp.2d 880, 884 at 885 (n.d.ill.2002), stating that the text of the cisg and analysis by commentators suggests that the cisg does not apply to third parties. [hereinafter “usinor industeel v. leeco steel”] 65 easom automation systems, inc. v. thyssenkrupp fabco, corp. 2007 wl 2875256 (e.d.mich.) (u.s. district court, e.d. mich.), also available at: http://cisgw3.law.pace.edu/cases/070928u1.html. http://cisgw3.law.pace.edu/cases/011002f1.html http://cisgw3.law.pace.edu/cases/070928u1.html. nordic journal of commercial law issue 2009#1 18 systems, inc. (“easom”), a michigan corporation which designs, builds, integrates and installs automation equipment and systems for the auto industry andthe defendant, thyssenkrupp fabco, corp. (“thyssenkrupp”), a nova scotia corporation headquartered in ontario, which supplies medium and heavy metal stampings and systems to automotive customers. the parties entered into an agreement where easom was to design, fabricate and install a sport bar assembly system (sba)---a special machine used to fabricate roll bars for daimlerchrysler corporation's jk platform, the 2007 jeep wrangler---for thyssenkrupp. eason alleged that on july 19, 2005, thyssenkrupp orally instructed easom to commence work on the sba for which easom issued a quote to thyssenkrupp for a price of $5,400,000.00 and a delivery date of march 30, 2006. easom asserted that thyssenkrupp issued a written purchase order on august 30, 2005, which included the following choice of law/forum selection clause: "25. jurisdiction/governing law. the contract created by seller's acceptance of buyer's offer as set out in paragraph 3 hereof shall be deemed in all respects to be a contract made under, and shall for all purposes be governed by and construed in accordance, with, the laws of the province where the registered head office of buyer is located and the laws of canada applicable therein. any legal action or proceeding with respect to such contract may be brought in the courts of the province where the registered head office of buyer is located and the parties hereto attorn to the non-exclusive jurisdiction of the aforesaid courts." the court denied easom’s motion for immediate possession and held that: “under either the plaintiff's quote or defendant's purchase orders, the cisg applies as neither the quote nor the purchase orders expressly indicated that the cisg did not apply. further, stating that the law of canada applied to the agreement indicates that the cisg applied as well, as the convention is the law of canada. the cisg governs only the formation of the contract of sale, and the rights and obligations of the seller and the buyer arising from such a contract. as such, if the plaintiff's quote constitutes the contract in this case, as opposed to defendant's purchase orders, the michigan special tools lien act may apply to the parties' agreement. ... at this juncture, there remain issues of fact as to which document constitutes the contract in this case-the quotes prepared by plaintiff or the purchase orders prepared by defendant. until this issue is resolved, the court is unable to determine whether michigan law applies and whether the michigan's special tools lien act applies.” conversely, in novelis corp. v. anheuser-busch, although the plaintiff’s predecessor, alcan aluminum corporation, was a canadian corporation, the court concluded that the cisg did not apply, stating: " 4. the parties have agreed, and the court finds, that new york law applies... if alcan aluminum corporation's place of business was in canada in 2004, such that the contract at issue was between a canadian company (novelis's predecessor) and an american company (a-b), it would be governed by the united nations convention on contracts for the international sale of goods ("cisg"), not new york law. see bp oil nordic journal of commercial law issue 2009#1 19 int'l ltd. v. empresa estatal petroleos de ecuador, 332 f.3d 333, 336 (5th cir. 2003) ("where parties seek to apply a signatory's domestic law in lieu of the cisg, they must affirmatively opt-out of the cisg."). however, having examined the supplement the court ordered novelis to file, the court is satisfied that novelis's predecessor was a texas corporation whose principal place of business was in ohio as of the agreement's date of execution in 2004. because the two contracting parties both were companies whose places of business were in the united states, the cisg does not apply and the parties' choice of new york law will be given force.”66 the importance of identifying the cisg’s applicability before the court is highlighted in a two american cases involving canadian parties. in the first case, sky cast, inc. v. global direct distribution llc, 67 the plaintiff, sky cast, inc. ("sky cast"), a canadian corporation based in guelph, ontario brought an action against the defendants global direct distribution, llc ("global"), a limited liability company with its principal place of business in lexington, kentucky; david j. dixon ("dixon"), a managing member of global; and raymond a. sjogren ("sjogren"), a managing member of global, for breach of contract, alleging that global was indebted to it in the principal amount of $83,203.78 for concrete light poles that sky cast manufactured and delivered to global's customer in florida in 2006. sky cast also asserted claims against the defendants for unjust enrichment and fraud. sky cast sought judgment in the amount it was owed under its contract with global, prejudgment interest, post judgment interest, and its costs and attorney's fees. in response, global counterclaimed alleging that sky cast breached their contract by failing to deliver the concrete light poles on agreed terms and that global sustained damages by sky cast's failure to perform the contract in a timely manner. global also asserted claims for negligent misrepresentation and fraud and concealment. global sought unspecified compensatory damages, postjudgment interest, its costs and attorney's fees. the parties brought several motions before the court. with respect to the cisg, the court granted skycast’s motion for partial summary judgment on its breach of contract claim, stating: “since this contract concerns the sale of goods between parties in different countries (canada and the united states of america), since these two countries are signatories to the cisg, and since there is no indication that the parties opted out of the cisg, the court concludes that the cisg governs this contract and that it preempts the applicability of article 2 of the ucc to this transaction for the sale of goods that ordinarily would be controlled by article 2 of the ucc. however, even though the cisg, 66 novelis corp. v. anheuser-busch, 2008 u.s. dist. lexis 49201 (u.s. district court, n.d. ohio, e. d.), also available at: http://cisgw3.law.pace.edu/cases/080522u1.html. 67 sky cast, inc. v. global direct distribution llc 2008 wl 754734 (e.d.ky.) (u.s. district court, e.d.ky.) also available at: http://cisgw3.law.pace.edu/cases/080318u1.html. http://cisgw3.law.pace.edu/cases/080522u1.html. http://cisgw3.law.pace.edu/cases/080318u1.html. nordic journal of commercial law issue 2009#1 20 rather than article 2 of the ucc, controls this contract, the court also concludes that fact does not operate to defeat sky cast's motion for summary judgment on its breach of contract claim, and the court further concludes that based on the undisputed facts of this case, at least as to liability, sky cast is entitled to summary judgment on its breach of contract claim. this conclusion is based on the fact that sky cast supplied the goods that were purchased by global in the various purchase orders, that global accepted these goods and made no efforts to reject these goods, that these goods were used in the construction project, and that global failed to pay sky cast in full for the total amount of the invoices sky cast sent to global concerning these goods. therefore, liability on sky cast's breach of contract claim against global is no longer an issue. the only remaining aspect of sky cast's claim for breach of contract is the amount of damages to which sky cast is entitled.” [emphasis added] in the second case, norfolk southern railway company v. power source supply, 68 the plaintiff, norfolk southern railway company (“norfolk”) a virginiabased corporation operating a locomotive repair facility in altoona, pennsylvania, commenced an action the defendant, power source supply, inc. (“power source”), an alberta corporation which supplies used and rebuilt equipment to the railroad, oil, and gas industries, for breach of contract and in the alternative unjust enrichment and seeking recovery of the remainder of the agreed-upon price for the sale of locomotives. after norfolk moved for summary judgment, power source failed to respond. in granting summary judgment, judge kim r. gibson noted since the parties’ documents were silent as to choice of law and both were from contracting states (namely the u.s. and canada), the cisg applied under article 1(1)(a). in contrast, canadian decisions have overlooked the cisg’s applicability, with inconsistent results. in nrf distributors inc. v. starwood manufacturing inc.,69 the plaintiff, nrf, a mainebased distributor of wood and other flooring, paid to starwood, an ontario-based manufacturer of wood flooring, the sum of us $112,056 in advance for the delivery of hardwood flooring. starwood took the money but did not deliver the product. instead, it applied the money to debts that were owed to starwood by another company called korca (no longer in business), a wisconsin-based milling company that manufactured and sold wood products. starwood claimed that korca was nrf's agent and this justified the set-off. according to belobaba, j.: “3 the only question on this motion is whether starwood's claim that korca was nrf's agent and the set-off was therefore justified is a genuinely triable issue. is there a genuine 68 norfolk southern railway company v. power source supply 2008 u.s. dist. lexis 56942 (u.s. district court, w.d. penn.) also available at: http://cisgw3.law.pace.edu/cases/080725u1.html . [hereinafter “norfolk v. power supply”]. 69 nrf distributors inc. v. starwood manufacturing inc., 2009 carswellont 520, 2009 canlii 3786 (ont. s.c.j.) [hereinafter “nrf distributors”]. http://cisgw3.law.pace.edu/cases/080725u1.html nordic journal of commercial law issue 2009#1 21 dispute or a genuine issue of credibility that requires a trial? does starwood's agency claim have a real chance success? in my view, the answer to these questions is 'no.' 4 having taken a good, hard look at the evidence, i am satisfied that there is absolutely no merit to starwood's claim that korca was nrf's agent. korca's debts to starwood are its own. there is no basis for starwood's claim for set-off and no genuine issue for trial. nrf is entitled to summary judgment.” 70 however, in the nrf distributors case, starwood claimed that korca was nrf's agent and that nrf was responsible for korca's debts to starwood, an allegation which nrf denied, taking the position that its relationship with korca was always that of “buyer” and “seller”. there is no reference to choice of law or choice of forum in the invoices referenced throughout the reasons for decision. arguably, the cisg applied by default under article 1(1)(a) (both parties in the main action were from contracting states: i.e. usa and canada) and the cisg was not expressly excluded under article 6. if so, then there may have been an interesting question as to whether the issues of agency and set-off---both traditionally excluded under article 4(a) as external gaps---were governed by ontario law or maine law. although it appears as though the defendant, starwood, attorned or otherwise did not challenge the ontario court’s jurisdiction, there is no indication as to whether they pleaded foreign law on the excluded issues. the defence of set-off is excluded under the cisg, primarily due to the difficulty in developing gapfilling rules within the contours of the principles of autonomous interpretation established under article 7(2). in any event, the conflict rules of the forum apply to determine the scope or quantum of the set-off, and whether it is contractual, or equitable, in nature. 71 in another recent canadian case, unique labeling inc. (international private beverage) v. gerling canada insurance company, 72 the plaintiff attempted to enforce in ontario a $1.5 million jury award obtained against the defendants in oregon for damages arising from the negligent supply of bottled water. the plaintiff sought to recover in ontario, pursuant to s. 132(1) of the insurance act, against the defendants’ commercial liability insurers. section 132(1) reads: 132. (1) where a person incurs a liability for injury or damage to the person or property of another, and is insured against such liability, and fails to satisfy a judgment awarding damages against the person in respect of the person’s liability, and an execution against the person in respect thereof is returned unsatisfied, the person entitled to the damages 70 id. at ¶’s 3-4. 71 cf. the parties’ respective rights to withhold performance under article 58 and article 71, et seq. and stefan kröll, “selected problems concerning the cisg’s scope of application” (2005) 25 j. l. com. 39 at 42-43 (agency) and 50-53 (set-off).) 72 unique labeling inc. (international private beverage) v. gerling canada insurance company, 2008 canlii 53846 (ont. s.c.j.) [hereinafter “unique labeling”]. nordic journal of commercial law issue 2009#1 22 may recover by action against the insurer the amount of the judgment up to the face value of the policy, but subject to the same equities as the insurer would have if the judgment had been satisfied.73 [emphasis added] the defendant insurers denied liability on the basis that the oregon judgment did not impose liability for damage to “injury or damage to the person or property of another”, as required by s. 132(1), but rather the jury awarded damages for pure economic loss. the plaintiff argued that the requirement in s. 132(1) of “injury or damage to property” creates a much lower threshold than “physical injury to tangible property”, the latter term applying to the wording of the cgl policies. it further argued that the property damage at issue included both tangible and intangible property, such that it was indisputable that its property was damaged when the defendants supplied contaminated bottled water which later had to be destroyed. in a case of first instance, the parties were unable to cite any judicial precedents where a judgment creditor successfully relied upon the provisions of s. 132(1). 74 however, justice moore obliquely refers to the cisg in his reasons at para. 17, stating: “…similarly, each defendant was found by the jury to have breached express and implied warranties and the convention on contracts for the international sale of goods, thereby causing damage to unique.” [emphasis added] unsurprisingly, given that the parties’ counsel neither pleaded nor argued the cisg’s applicability, the court concluded that the oregon jury award related strictly to pure economic loss and not property damage: [188] what input, if any, unique may have had in drafting the form and content of the jury questions in oregon is not at all clear. i suspect that if unique’s counsel in oregon had been aware of the provisions of s. 132(1) and had anticipated unique’s interest in pursuing recovery under the section in this case, a concerted effort to reword questions to the jury may have followed. [189] the jury was not asked to clarify whether its award of damages was intended to include a component for destruction of labels and/or flavorings, for example. unique asserts that those components of the finished water products were owned by unique and became damaged property by virtue of the withdrawal and destruction processes initiated by kroger. [190] i agree with the defendants, however, that the triumbari defendants did not, by virtue of the jury findings and judgment in oregon, incur a liability for damage to the property of another within the meaning of s. 132(1). 73 insurance act, r.s.o. 1990, c. i.8, § 132(1) (as am.). 74 unique labeling, supra note 72, at ¶ 71. nordic journal of commercial law issue 2009#1 23 [191] i accept the opinion of mr. peterson, that for purposes of oregon law, the liability of the defendants is a liability to pay purely economic losses and a liability that does not arise from property damage. [192]in addition, i agree with the analysis and conclusion reached by goodearle j. in g.b. catering, . [g.b. catering services ltd. v. beckley 1994 canlii 7252 (on s.c.), (1994), 18 o.r (3d) 135 (ont. ct. gen. div.)] where the distinction is drawn between damages awarded for property damage and those for economic loss [193] the parties agree and i concur that a finding solely of economic loss cannot support access to judgment under s. 132(1)… the jury awarded unique damages for loss of profit and expenses. without more in the way of clarity in the jury questions, i find that the jury awarded damages solely for economic losses. [194] as to the requirement that the property damage contemplated by s. 132(1) be occasioned to property of another, i am persuaded that the section must be read to contain a temporal connection between the damage to the property in question and the time that the damage occurs.” 75 assuming arguendo that the cisg applied at first instance, the trial judge’s instructions to the jury would necessarily have implicated article 5 of the cisg.76 if so, article 74 of the cisg, which reflects the general principle of full compensation, should have entitled the plaintiffs to compensatory damages, including loss of profit. article 74 reads: article 74 cisg damages for breach of contract by one party consist of a sum equal to the loss, including loss of profit, suffered by the other party as a consequence of the breach. such damages may not exceed the loss which the party in breach foresaw or ought to have foreseen at the time of the conclusion of the contract, in the light of the facts and matters of which he then knew or ought to have known, as a possible consequence of the breach of contract.77 the solution for canadian courts to apply the cisg is relatively simple; both counsel and judges must become familiarized with the cisg in order to identify its applicability. canadian litigators must know when the cisg is included or excluded when drafting pleadings and to bring forth cisg caselaw, arbitral decisions and scholarly commentary to the court’s attention. equally important, canadian judges must also become well-versed in the cisg to avoid misapplying domestic sales law and caselaw when rendering a decision. 75 id., at ¶’s 188-194 [citations omitted]. 76 see, pribetic, "bringing locus into focus": a choice-of-law methodology for cisg-based concurrent contract and product liability claims, supra note 42. 77 see also cisg-ac opinion no. 6, calculation of damages under cisg article 74 (available online at: http://cisgw3.law.pace.edu/cisg/cisg-ac-op6.html#* ) http://cisgw3.law.pace.edu/cisg/cisg-ac-op6.html# nordic journal of commercial law issue 2009#1 24 iv) article 1(1)b)applying national law the reference in article 1(1)(b) to the rules of private international law (pil) directs the domestic court to apply its own conflicts of law analysis to determine cisg applicability. in this sense, article 1(1)(b) is not a choice of law rule per se, but rather an interpretative tool. 78 generally, if one of the parties is from a non-contracting state, then the cisg will not apply, unless the contract specifies that the cisg applies (a choice of law provision) or where the rules of private international law (conflicts of law) lead to the cisg’s application. if the proper law of contract (the “lex loci contractus”) is in a contracting state, then the cisg will apply by default, subject to a limited number of reservations available.79 for example, if a contract between an ontario company and an english company (a noncontracting state) specifies that the “laws of ontario shall apply”, then the cisg will apply, unless it is expressly excluded. 80 conversely, if the contract specifies that “english law shall apply” then the english sale of goods act, 1979 would apply. 81 this is, of course, subject to article 95, which allows a contracting state to make a declaration that it will not be bound by article 1(1)(b). 82 canada initially filed an article 95 declaration to the effect that the province 78 as prof. schlechtriem remarks: “states declaring a reservation under article 95 are, however, (unlike states declaring reservations under articles 92(2) and 93(3)) [footnote omitted] ‘contracting states’ in the meaning of article 1(1)(a). if the parties to the contract…have their places of business in the us, a contracting (reservation) state, and in germany, a contracting (non-reservation) state, a court in canada has to apply the cisg, if its conflict rules refer either to german or us law.” schlechtriem: schlechtriem/schwenzer, art.1, at p. 37, §44. some commentators argue that the forum (contracting) state is indirectly bound by article 95 and applicable declared reservations. cf. albert kritzer, guide to practical applications of the united nations convention on contracts for the international sale of goods, deventer: kluwer law and taxation (1989) at p.78 [hereinafter “kritzer-guide to practical applications”] and honnold-uniform law, supra note 50, at ¶ 47.5. 79 cisg, part iv-final provisions: articles 91-98-declarations and reservations. 80 for a discussion of the difficulties posed by the text of the various provincial legislations for opting out of the cisg, see discussion under article 6, infra. 81 sale of goods act 1979, c. 54, as amended by: sale of goods (amendment) act 1994, c.32; sale and supply of goods act 1994, c.35, sale of goods (amendment) act 1995,c.28, and the sale and supply of goods to consumers regulations 2002, 2002 no. 3045. 82 cisg, article 95 reads: "any state may declare at the time of the deposit of its instrument of ratification, acceptance, approval or accession that it will not be bound by subparagraph (1)(b) or article 1 of this convention." to date, article 95 declarations have been made by china (prc), czech republic, singapore, slovakia and the united states. nordic journal of commercial law issue 2009#1 25 of british columbia would not be bound by article 1(1)(b) of the cisg, however, this declaration was subsequently withdrawn.83 84 in impuls i.d. internacional, s.l., et al v. psion-teklogix inc.,85 the florida district court considered the applicability of the cisg in the context of an international contract of sale involving multiple parties from both contracting and non-contracting states. on june 21, 2000, the plaintiffs -a spanish computer products company (“impuls-spain”), its u.s. distributor (“impuls-us”) and an argentine distributor (“psiar”) – concluded an oral contract in london, england with representatives of psion enterprise computing, ltd., a division of psion llc (“psion”), for the purchase and distribution of psion’s computer merchandise throughout latin america. 86 from july to december 2000, psion followed the terms of the oral contract and shipped its computer merchandise to impuls-us. however, in september 2000, psion merged with teklogix inc. to form the ontario-based canadian corporation, psionteklogix, inc. (“psion-telogix”). 87 following the merger, the president of the newly formed psion-teklogix sent an email notifying the plaintiffs that the contract would be terminated in ninety days as it was in the process of reorganizing its distribution plans.88 the plaintiff buyers objected, stating that canadian defendant’s strategy would effectively destroy their original business plan. the canadian defendant then offered the plaintiffs the option of continuing as a reseller, which the plaintiffs rejected, opting instead to commence an action for breach of the original agreement. 89 the psion companies were not named as defendants in the action.90 83 the official un text of canada’s article 95 declaration withdrawal reads: 10. on 31 july 1992, the government of canada, by virtue of article 97 (4) of the convention, notified the secretary-general of its decision to withdraw the following declaration made upon accession by virtue of article 95, which read as follows: "the government of canada also declares, in accordance with article 95 of the convention, that, with respect to british columbia, it will not be bound by article 1.1 b) of the convention." excerpted from the official united nations treaty collection, multilateral treaties deposited with the secretary-general: available online at: http://untreaty.un.org/english/bible/englishinternetbible/parti/chapterx/treaty20.asp#declarations 84 for a discussion of the debate whether the cisg is to be applied where the forum’s conflict of rules lead to the law of a reservation state, see schlechtriem: schlechtriem/schwenzer, art. 1, at pp. 36-37, §§ 42-44. 85 impuls i.d. internacional, s.l., et al v. psion-teklogix inc.,234 f.supp. 2d 1267; 2002 u.s. dist. lexis 22977; 2002 wl 3168146; 16 florida law weekly fed. d 34 (s.d.fla.), available online at: http://cisgw3.law.pace.edu/cases/021122u1.html [hereinafter “impuls v. psion-teklogix”] 86 id. 87 id. 88 id. 89 id. http://untreaty.un.org/english/bible/englishinternetbible/parti/chapterx/treaty20.asp#declarations http://cisgw3.law.pace.edu/cases/021122u1.html nordic journal of commercial law issue 2009#1 26 the court held that the cisg was inapplicable on various grounds. first, it noted that some of the parties to the concluded contract were from a non-contracting state, namely, the united kingdom, which, to date, has yet to become a signatory to the cisg. thus, under art.1(1)(a) and art. 100(1), the internationality requirement was not met. secondly, pursuant to article 1(2), zloch, c.d.j. disregarded the fact that the defendant, psion-teklogix was from a contracting state (namely canada), since this fact did not appear either from the contract or from any dealings between, or from information disclosed by psion, the british seller, before or at the conclusion of the contract. third, the florida district court considered the history of negotiation or the practical interpretation of the cisg concluding that the 'universalist' approach adopted by the 1964 hague conventions had been expressly rejected during the vienna conference as reflected in the final text of art. 1(1)(a). fourth, the chief district court judge recognized that the united states had made a declaration under art. 95 that it would not be bound by art.1(1)(b), thereby proscribing application of the rules of private international law to determine whether the cisg governed the contract. finally, the court was unable to cite any precedent or authority for the applicability of the cisg to a merged or successor corporation, in circumstances where the original party to the contract was from a noncontracting state.91 in icc arbitration case no. 7197 of 1992, the arbitral tribunal held that where the parties failed to specify any applicable law, both austrian and bulgarian rules of private international law led to the application of austrian law. given that the cisg was incorporated into the austrian legal system, the tribunal applied the cisg to the dispute in accordance with article 1(1)(b) of the cisg. given that the applicable rules of private international law led to the application of the law of the seller’s place of business, the fact that bulgaria -where the buyer had its place of business --was not a party to the cisg was irrelevant at the time the contract was concluded.92 90 id. notwithstanding the merger into psion-teklogix, it appears that psion plc remains a going concern (see http://www.hoovers.com/free/co/factsheet.xhtml?coid=47010), such that the plaintiffs could have added either british company as a party defendant. quaere whether this would have affected the outcome with respect to the court’s subject matter jurisdiction, personal jurisdiction or forum non-conveniens analysis and conclusions? 91 cisg, article 4. the court’s reference to the history of negotiation and practical interpretation of the cisg is more commonly referred to as the “travaux preparatoires” or legislative history. see, http://www.uncitral.org/uncitral/en/uncitral_texts/sale_goods/1980cisg_travaux.html. 92 clout case no. 104 [icc arbitration case no. 7197 of 1992, court of arbitration of the icc international chamber of commerce] available online at http://cisgw3.law.pace.edu/cases/927197i1.html [hereinafter “icc arbitration case no. 7197 of 1992”] http://www.hoovers.com/free/co/factsheet.xhtml?coid=47010), http://www.uncitral.org/uncitral/en/uncitral_texts/sale_goods/1980cisg_travaux.html. http://cisgw3.law.pace.edu/cases/927197i1.html nordic journal of commercial law issue 2009#1 27 iv. opting-out i) article 6exclusion, variation or derogation article 6 the parties may exclude the application of this convention or, subject to article 12, derogate from or vary the effect of any of its provisions. article 6 enshrines two of the cisg’s key principles—party autonomy and contractual primacy. thus, the parties are free to exclude or “opt-out” of the cisg altogether. alternatively, subject to article 12,93 the parties may derogate from or vary the cisg’s provisions, or partially “optin” to the cisg. the ability of parties to exclude, vary or derogate from the cisg’s provisions reflects the realities of 21st century international trade and commerce or the modern lex mercatoria.94 in fact, the supreme court of canada has itself recently reaffirmed “the precedence to the principle of the autonomy of the parties”95 in the context of international sales transactions. whether or not the parties should exclude the cisg is largely a normative issue, albeit the preamble to the cisg firmly entrenches the cisg’s goals of uniformity and certainty, which are clearly superior to any parochial and inconsistent domestic sales laws.96 prof. honnold observes: when the places of business of the seller and buyer are in different contracting states, the applicability of the convention mandated by article 1(1)(a) is not undercut when rules of private international law point to a non-contracting state. the convention may be excluded by the parties, but only by an express agreement or an agreement that is clearly implied in fact.97 93 where one of the parties is from an article 96 reservation state and thus domestic rules as to form prevail over articles 11, 12, 20 and part ii of the cisg. 94 for an excellent discussion of the historical antecedents of the cisg evolving from the traditional and modern lex mercatoria (also known as the “law merchant”), see peter j. mazzacano, “canadian jurisprudence and the uniform application of the un convention on contracts for the international sale of goods,” pace international law review, vol. 18, no. 1 (spring 2006), chap. 2 “the background to the cisg” [also available online at: http://www.cisg.law.pace.edu/cisg/biblio/mazzacano1.html]. 95 grecon dimter v. normand, supra note 44. 96 the preamble to the cisg states in part that the “development of international trade on the basis of equality and mutual benefit is an important element in promoting friendly relations among states” and “ the adoption of uniform rules which govern contracts for the international sale of goods and take into account the different social, economic and legal systems would contribute to the removal of legal barriers in international trade and promote the development of international trade”. see also cisg, art. 7, supra note 33. 97 honnold-uniform law, supra note 50 at p. 80, and generally, §§75-77. http://www.cisg.law.pace.edu/cisg/biblio/mazzacano1.html nordic journal of commercial law issue 2009#1 28 however, while there is no doubt the parties may exclude the cisg, the effectiveness of partially or completely opting out under article 6 must be considered in light of article 4 validity issues, as well as the choice of law rules of the domestic forum which govern conflict of laws.98 99 ii) opting-out: explicit exclusion where the cisg otherwise applies under article 1(1)(a) or 1(1)(b) and is not excluded under articles 2-5, the parties may mutually exclude100 the cisg by (1) expressly stating that the cisg 98 prof. farnsworth adds: "article 6 purports to give the parties an unqualified power to vary the effect of the convention by agreement. on the other hand, article 4 makes it clear that, absent a contrary provision, the convention does not affect any rule of domestic law dealing with the "validity" of a contract provision. taken together, articles 6 and 4 create a tripartite hierarchy, with domestic law on validity at the top, the agreement of the parties in the middle, and the convention at the bottom. the domestic law on validity continues to control the agreement of the parties, and both control the convention. this subordination of the convention to both the domestic law on validity and the agreement of the parties was part of the price paid by the convention's sponsors for its acceptance by adopting nations." e. allan farnsworth, “review of standard forms or terms under the vienna convention” 21 cornell international law journal (1988) 439-447, also available online at: http://www.cisg.law.pace.edu/ cisg/biblio/farns1.html. 99 prof. schlechtriem further notes: “the autonomy of the parties operates on two levels, which often are not clearly distinguished. first, it may allow a choice of law at the level of conflict of law rules: even if, by virtue of article 1, the cisg is applicable to a contract in the forum of a contracting state, the parties may nevertheless choose the law of a non-contracting state and thereby derogate from the forum state’s law including the cisg. this is a conflict of laws matters governed not by article 6 but by the rules of private international law of the forum, which in a number of contracting states are enacted pursuant to international treaties such as the rome convention on the law applicable to contractual obligations of 1980 or the hague convention on the law applicable to international sale of goods…the second level of the parties’ autonomy is governed by article 6. it is the freedom of contract, i.e. autonomy to vary the content of a contract by deviating from or modifying the provision of the cisg applicable on account of articles 1 et seq. article 6 states that the cisg is not mandatory law of a contracting state. in other words, on the level of the substantive law of international sales enacted by the convention, parties are making use of freedom of contract and their autonomy to shape the contents and terms of their contracts governed by the cisg. their freedom of contract may be restricted and limited only on the basis of sentence 2(a) of article 4 by rules and provision of the domestic law applicable to the contract in addition, but subordinate, to the cisg that render certain contractual terms invalid.” schlechtriem: schlechtriem/schwenzer, art. 6, pp.83-4, §§ 3-4, et seq. 100 schlechtriem: schlectriem/schwenzer, art. 6, p. 85, §6. http://www.cisg.law.pace.edu/ nordic journal of commercial law issue 2009#1 29 does not apply and (2) choosing an alternate governing law. 101 compare the following two examples: example a102 15. (b) this agreement and its application and interpretation will be governed exclusively by the laws prevailing in the province of british columbia, canada which will be deemed to be the proper law hereof. the parties irrevocably attorn to the jurisdiction of the courts of british columbia, canada in the event of any proceedings regarding this agreement. the international sale of goods act r.s.b.c. 1996, c. 236 and the united nations convention on contracts for the international sale of goods set out in the schedule thereto shall not apply to the governance or any interpretation of this agreement. example b 103 26. applicable law and arbitration a) a purchase order shall be governed by the law of buyer's principal place of business without regard to conflict of laws provisions thereof, and litigation on contractual causes arising from a purchase order shall be brought only in that jurisdiction. for ford motor company, a delaware corporation and any u.s. subsidiary, joint venture or other operation located in the u.s., the principal place of business will be deemed to be michigan. the un convention for the international sale of goods is expressly excluded. in each of the above examples, the canadian courts held that the governing law clauses were effective in excluding the cisg’s application. however, such clauses must be drafted with the utmost care, since terms such as referring to the “law of the seller’s place of business” or “the laws of germany” may lead to ambiguity and unintentional application of the cisg by default under article 1(1)(b).104 in grecon dimter v. normand, the supreme court of canada considered the following choice of forum and choice of law clauses: 101 “a complete disapplication of the cisg can be achieved by a choice of law clause, either nominating the law of a non-contracting state (positive choice of law) or simply by excluding the law of the contracting state that would otherwise have applied (negative choice of law clause).”schlechtriem: schlectriem/schwenzer, art. 6, p. 85, §7. 102 see multiactive software inc. v. advanced service solutions inc.[2003] b.c.j. no. 945 , 2003 bcsc 643 (2003) 48 c.p.c. (5th) 125 (bcsc) [hereinafter “multiactive software”] 103 see ford aquitaine industries sas c. canmar pride (the) [2004] a.c.f. no 1743 , 2004 cf 1437 , (2004) 267 f.t.r. 115 ,(f.c.) aff’d [2005] f.c.j. no. 535 , 2005 fc 431 (f.c.) [hereinafter “the canmar pride”] 104 as prof. schlechtriem observes: nordic journal of commercial law issue 2009#1 30 choice of forum it is agreed, by and between the seller and buyer, that all disputes and matters whatsoever arising under, in connexion with, or instant to this contract (whether arising under contract, tort, other legal theories, or specific statutes) shall be litigated, if at all, in and before a court located in alfeld (leine), germany to the exclusion of the courts of any other state or country. choice of law this agreement is governed by and construed under the laws of germany to the exclusion of all other laws of any other state or country (without regard to the principles of conflicts of law). regrettably, the supreme court of canada’s decision failed to apply the cisg, which was applicable, inter alia, under article 1(1)(a) as the parties were all from contracting states. 105 106 “if the law of a contracting state is chosen without other qualifying terms specifying which rules are meant, as for instance the mere reference to "german law," it is long established -and such was already the case with respect to the hague convention on international sales [ulis] -that such a reference includes the application of cisg as part of the chosen law.[citations omitted] regard for the choice of law of a contracting state as a selection of the cisg, to the extent the scope of the cisg fits the transaction, is also the prevailing international practice.”[citations omitted]. peter schlechtriem, “uniform sales law in the decisions of the bundesgerichtshof” in 50 years of the bundesgerichtshof [federal supreme court of germany] a celebration anthology from the academic community, (english translation by todd j. fox): available at: http://cisgw3.law.pace.edu/ cisg/biblio/schlechtriem3.html [hereinafter“schlechtriem-bundesgerichtshof”]. 105 grecon dimter v. normand , supra note 44. in grecon dimter v. normand, the plaintiff, scierie thomas-louis tremblay inc. ("tremblay") operated a saw mill in the province of québec. the defendant, j.r. normand inc. ("normand"), also a québec company, serviced and sold industrial wood working machinery. the co-defendant, grecon dimter, inc. [“grecon”] is a german manufacturer that manufactured and sold specialized equipment used in processing plants and sawmills, but had no place of business or assets in québec. for an analysis of the grecon dimter v. normand decision from a cisg perspective, see antonin i. pribetic, “the (cisg) road less travelled: grecon dimter, inc. v. j.r. normand inc.” (2006) 44 can. bus. l. j. 92-114, pre-print available online at: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=869784. two other recent ontario cases which similarly failed to refer to the cisg are: hershey canada, inc. v. solae, llc, 2007 canlii 34847 (on s.c.) available on canlii at: http://www.canlii.org/en/on/onsc/doc/2007/2007canlii34847/2007canlii34847.html; (cf. solae, llc v. hershey canada, inc. 557 f. supp. 2d 452 (u.s. dist. ct-delaware) which involved parallel proceedings brought by solae, llc for a declaratory judgment and breach of contract action against hershey canada. hershey canada brought a motion to dismiss which was granted through the u.s. federal court’s application of the contract formation rules under the cisg). see also, guiliani v. invar manufacturing (sub nom. linamar holdings inc. v. igm u.s.a. inc.) 2007 wl 2758802, 2007 carswellont 5922 (ont. sup. ct. j.); aff’d 2008 onca 256 (ont. c.a.). see also, klotz, mazzacano and pribetic, “all quiet on the cisg front guiliani v. invar manufacturing the battle of the forms, and the elusive concept of terminus fixus”, supra note 30. 106 as prof. schlechtriem notes: “…since the cisg in the court of a contracting state is applicable ipso jure, i.e. as law it need not be invoked by the parties, at least in legal systems that adhere to the rule of jura novit curia, i.e. the court has to know the law. if the parties and a lower court have overlooked the cisg, the decision should be cancelled or reversed by the higher court, unless the parties clearly alter their contract in order to make the domestic law applicable. [citations omitted]. http://cisgw3.law.pace.edu/ http://papers.ssrn.com/sol3/papers.cfm?abstract_id=869784. http://www.canlii.org/en/on/onsc/doc/2007/2007canlii34847/2007canlii34847.html; nordic journal of commercial law issue 2009#1 31 by contrast, international arbitrators do not appear to have any difficulties in identifying and applying the cisg. for example, in icc arbitration case no. 11333 of 2002 (machine case), 107 a canadian company in 1991 entered into an equipment purchase agreement (the agreement) to purchase two machines from an italian manufacturer/seller. the agreement also provided that the italian seller would supply engineering, supervision and additional accessories. the italian seller further warranted the delivered equipment against defects in material and workmanship for a period of one year from the final date of commissioning, but in no event exceeding eighteen months from the date of delivery. the agreement also contained a one-year guarantee against defects for a starting from the date of order. the parties agreed that the contract would be governed by french law and that any disputes would be settled in accordance with the icc rules of arbitration. the machines were delivered in 1992. in 1998, the buyer and an insurer entered into a machinery insurance policy assigning to the insurer a right of subrogation to recover any sum paid to the buyer under the insurance policy. after compensating the canadian buyer for damage suffered due to the failure of one of the machines, the insurer filed a request for arbitral proceedings against the italian seller. the arbitral tribunal first held that pursuant to art. 100(2), since the contract was concluded before canada had ratified or acceded to the cisg, art. 1(1)(a) had no application. however, the arbitral tribunal held that cisg could be applied pursuant to art. 1(1)(b) if the rules of private international law led to the application of the law of a contracting state. given that arbitrators are not bound by domestic conflict of laws rules, but rather by the parties' choice of law made in conformity with the principle of party autonomy; such a principle was read in as a rule of private international law referred to in art. 1(1)(b) cisg (as well as according to art. 17(1) of the icc rules of arbitration and art. 1496 of the french code of civil procedure). accordingly, unless the parties, by choosing french law, intended to exclude the application of cisg, it was to be applied as it forms part of french law. iii) drafting anomalies in canadian cisg implementing legislation a number of canadian legal commentators have identified drafting inconsistencies in the cisg federal implementing legislation108, as well as in most of the provincial implementing statutes; schlechtriem: schlechtriem/schwenzer, art. 6, p. 92, §14. 107i cc arbitration case no. 11333 of 2002 (machine case) available at: http://cisgw3.law.pace.edu/cases/021333i1.html; see also, 31 yearbook commercial arbitration (2006) 117-126 and unilex database http://www.unilex.info/case.cfm?pid=1&do=case&id=1163&step=fulltext. 108 international sale of goods contracts convention act, s.c., ch. 13(1991) (can.), an act to implement the united nations convention on contracts for the international sale of goods [assented to 1st february, 1991], available at http://www.cisg.ca. section 5(2) reads: exclusion of convention http://cisgw3.law.pace.edu/cases/021333i1.html; http://www.unilex.info/case.cfm?pid=1&do=case&id=1163&step=fulltext. http://www.cisg.ca./ nordic journal of commercial law issue 2009#1 32 namely: alberta, new brunswick, newfoundland, nova scotia, ontario, prince edward island and saskatchewan. 109 there are two significant drafting anomalies in the provincial implementing statutes. for example, the ontario international sale of goods act reads in part: exclusion of convention 6. parties to a contract to which the convention would otherwise apply may exclude its application by expressly providing in the contract that the local domestic law of ontario or another jurisdiction applies to it or that the convention does not apply to it. r.s.o. 1990, c. i.10, s. 6. [emphasis added] firstly, the reference to the “local domestic law of ontario” is ambiguous; if the drafters meant the “local domestic sales law of ontario” then they should have stipulated the “ontario sale of goods act, as amended”. further, the phrase “or another jurisdiction applies to it” is bound to lead to confusion, particularly since it may refer to the domestic law of a non-unified state or a non-contracting state. if the contractual choice of law clause does not provide that “the parties agree that the cisg is expressly excluded and that the sale of goods act, ontario applies”, but rather “the parties agree that the law of ontario applies”, this may lead a foreign court to apply its conflict of laws analysis and conclude that the parties’ mutual intention was not to exclude the cisg under article 1(1)(b). secondly, express derogation or exclusion of the cisg under article 6 requires the parties’ mutual affirmative intent to exclude the cisg and the choice of an alternative domestic or foreign sales law. hence, the use of the disjunctive “or” rather than the conjunctive “and” is both confusing and problematic. 110 the point is simply this: if the cisg otherwise applies (i.e. internationality requirement met under art. 1(1) (a)), then the parties may nevertheless expressly derogate from the cisg under article 6 of the cisg. it is respectfully submitted that the “exclusion of convention” section (2) parties to a contract to which the convention would otherwise apply pursuant to subsection (1) may exclude its application in accordance with the terms of the convention and, in particular, by providing in the contract that other law applies in respect of the contract.[emphasis added] 109 alberta: see section 2(1) of the international conventions implementation act , s.a. 1990, c. i-6.8; new brunswick: see section 6 of the international sale of goods act , s.n.b. 1989, c. i-12.21; newfoundland: see section 7 of the international sale of goods act , r.s.n. 1990, c. i-16; nova scotia: see section 8 of the international sale of goods act , s.n.s. 1988, c. 13; ontario: see section 6 of the international sale of goods act , r.s.o. 1990, c. i.10; prince edward island: see section 6 of the international sale of goods act , s.p.e.i. 1988, c. 33; saskatchewan: see section 6 of the international sale of goods act , s.s. 1990-91, c. i-10.3 110 professor ziegel's assessment is: "all this is . . . bound to lead to much confusion...[the legislative wording] may prevail before an ontario court but it would cut little ice outside canada. this is because a foreign tribunal or arbitrator would probably hold that ontario cannot unilaterally change the meaning of article 6 of the convention." jacob ziegel, “canada prepares to adopt the international sales convention”, (1991) 18 c.b.l.j. 3 at 9-11.” see also, james m. klotz, international sales agreements. an annotated drafting and negotiating guide (2nd rev. ed.) (the hague: kluwer law international, 2008) chap. 1-preliminary matters pp. 20-21 and chios c. carmody, “the harmonization of international commercial contracting: canadian experience with the cisg” (october 12, 2007), available at ssrn: http://ssrn.com/abstract=1273258. http://ssrn.com/abstract nordic journal of commercial law issue 2009#1 33 should be entirely deleted altogether. alternatively, the section wording should be amended to read as follows: exclusion of convention 6. parties to a contract to which the convention would otherwise apply may exclude its application by expressly providing in the contract that the local domestic [sales] law of ontario or [the local domestic sales law of] another jurisdiction applies to it [and] that the convention does not apply to it. professor ferrari states: “in my opinion, the mere fact that the parties argue on the sole basis of a domestic law does not per se lead to the exclusion of the cisg, a view recently confirmed by several courts, unless the parties are aware of the cisg’s applicability or the intent to exclude the cisg can otherwise be inferred with certainty. if the parties are not aware of the cisg’s applicability and argue on the basis of a domestic law merely because they believe that this law is applicable, the judges will nevertheless have to apply the cisg on the grounds of the principle iura novit curia, provided that this principle is part of the lex fori. “[citations omitted]111 the problem, of course, is that the principle of iura novit curia is a civil law concept, and does not apply to common law procedural rules of pleading and proof. notwithstanding the aforementioned drafting anomalies, it is submitted that express exclusion or derogation is required to effectively opt-out of the cisg, where both parties are from contracting states. since the cisg is both uniform international sales law and has been implemented federally and provincially throughout canada; the cisg is canadian law (or provincial law as the case may be), not foreign law. party autonomy and contractual freedom presumes consensus ad idem on all material terms, including governing law. a foreign court or arbitral tribunal analyzing a choice of law clause such as “the laws of ontario shall apply” , would likely conclude that the parties’ intention to exclude the cisg was ineffective, unless the court under article 8 determined the parties’ objective intention to choose domestic, rather than, uniform sales law adopted by the parties’ respective jurisdictions. conversely, a choice of law clause such as: “the cisg is expressly excluded and the parties agree that the ontario sale of goods act shall apply” constitutes, in this author’s view, an effective opt-out. 111 franco ferrari, ”remarks on the uncitral digest's comments on article 6 cisg from the proceedings of the uncitral viac joint conference, 15-16 march 2005, vienna: celebrating success: 25 years united nation convention on contracts for the international sale of goods (cisg) (published in the journal of law and commerce, volume 25, issue 1, fall 2005) at pp. 30-31. nordic journal of commercial law issue 2009#1 34 if the section remains in effect, then it is likely to create a conflict of laws conundrum in a future cisg case; particularly, if the law of another jurisdiction chosen by the parties is within another contracting state which has not made an cisg article 95 reservation. in this author’s view, the american “explicit derogation” approach, which is reinforced by the preamble, travaux préparatoires (i.e. the legislative history of the 1980 vienna diplomatic conference) , and the interpretative methodologies of cisg article 7(1) and 7(2), is to be preferred. clearly, if the cisg is incorporated into canadian law by implementing provincial legislation, then it is neither “foreign law”; nor “customary international law”, but “canadian law”. a fortiori, it has international treaty status and represents a primary layer of commercial sales legislation which trumps the secondary layer of domestic sales law, unless the parties have expressly excluded it by mutual assent or consensus ad idem (subject to a court’s analysis of objective intent under cisg article 8). the uniform law conference of canada (ulcc) has recently tabled its annual report which lists the convention on the limitation period in the international sale of goods and protocol (uncitral) [the “limitation period convention”] as a “high priority” for federal and provincial implementation. 112 hopefully, legislative action to remedy the drafting anomalies in the provincial cisg implementing legislation is imminent, particularly in light of the pending accession to the limitation period convention which requires harmonization (if not uniformity) between both international legal instruments. in any event, the wording of article 3 of the limitation period convention is sufficient and reads: article 3 (1) this convention shall apply only if, at the time of the conclusion of the contract, the places of business of the parties to a contract of international sale of goods are in contracting states. 112 see, united nations convention on the limitation period in the international sale of goods 1980 (new york, 14 june 1974) (including amending protocol-vienna, 11 april 1980) art. 8 which imposes a four-year limitation period; available at: http://www.uncitral.org/pdf/english/texts/sales/limit/limit-conv.pdf see, uniform law conference of canada civil section “activities and priorities of the department of justice in international private lawreport of the department of justice canada 2008”, at 13-14. according to the doj: “e. conventions on the limitation period in the international sale of goods and protocol (uncitral) [1] these conventions, which entered into force august 1, 1988, grew out of the work of uncitral to unify international sales law. there are 26 states party to the limitation convention of 1974, and 19 states party to the amended limitation convention, including, in both cases, our north-american trade partners, the united states and mexico. [2] the conventions dovetail with the united nations convention on contracts for the international sale of goods (vienna, 1980), which is in force for all of canada. there is substantial similarity between the three conventions, in particular the articles setting out the sphere of application, declarations and reservations, the federal state clause, and the final clauses. [emphasis added].” http://www.uncitral.org/pdf/english/texts/sales/limit/limit-conv.pdf nordic journal of commercial law issue 2009#1 35 (2) unless this convention provides otherwise, it shall apply irrespective of the law which would otherwise be applicable by virtue of the rules of private international law. (3) this convention shall not apply when the parties have expressly excluded its application.[emphasis added] iv) opting-out-implicit exclusion some commentators are of the view that the cisg allows for implicit derogation.113 however, a number of cisg decisions have held to the contrary. in asante technologies v. pmc-sierra, the court held that where parties seek to apply a signatory's domestic law in lieu of the cisg, they must affirmatively opt-out of the cisg.114 in valero marketing & supply company v. greeni oy & greeni trading oy, where an agreement to include a provision that new york law governed failed to specifically exclude application of the cisg, the court held that the cisg remained applicable.115 in bp oil v. empresa the court held that "if the parties decide to exclude the [cisg], it should be expressly excluded by language which states that it does not apply."116 113 schlechtriembundesgerichtshof, supra note 104; schlechtriem: schlechtriem/schwenzer, art. 6 pp. 82-92; michael joachim bonell & fabio liguori [italy], excerpt from “the un convention on the international sale of goods: a critical analysis of current international case law 1997 (part 1)”, uniform law review (1997) 385-395, available online at: http://www.cisg.law.pace.edu/cisg/text/libo6.html.; peter winship [u.s.], excerpt from changing contract practices in the light of the united nations sales convention: a guide for practitioners, 29 international lawyer (1995) 525-554 available online at: http://www.cisg.law.pace.edu/cisg/text/winship6.html. 114 asante technologies v. pmc-sierra 164 f. supp. 2d 1142; 2001 u.s. dist. lexis 16000 and 2001 wl 1182401 (n.d. cal) which held that where parties seek to apply a signatory's domestic law in lieu of the cisg, they must affirmatively opt-out of the cisg: available at: http://www.cisg.law.pace.edu/ cisg/wais/db/cases2/010727u1.html. 115 valero marketing & supply company v. greeni oy & greeni trading oy, 373 f.supp.2d 475 at 482 (d.n.j.2005) available online at: http://cisgw3.law.pace.edu/cases/050615u1.html [hereinafter “valero marketing v. greeni oy”]; rev’d and remanded on other grounds: 2007 wl 2064219 (c.a.3 (n.j.) available on line at: http://cisgw3.law.pace.edu/cases/070719u2.html “we do not perceive a conflict between the cisg and new york law on the issue of whether the september 14 agreement is valid and binding.” (at fn. 7 per barry, fuentes and jordan, circuit judges). 116 bp oil international, ltd. v. empresa estatal petroleos de ecuador 332 f.3d 333 (5th cir. 2003) (court file no. m 02-20166) per jerry e. smith, circuit judge; barksdale, circuit judge, fitzwater, district judge, holding that "if the parties decide to exclude the [cisg], it should be expressly excluded by language which states that it does not apply": available at: http://www.ca5.uscourts.gov/opinions%5cpub%5c02/02-20166.cv0.wpd.pdf; also available at: http://cisgw3.law.pace.edu/cases/030611u1.html; 5th circuit petition for rehearing denied 7 july 2003, available at: http://www.ca5.uscourts.gov/opinions%5cpub%5c02/02-20166.cv1.wpd.pdf.; http://www.cisg.law.pace.edu/cisg/text/libo6.html.; http://www.cisg.law.pace.edu/cisg/text/winship6.html. http://www.cisg.law.pace.edu/ http://cisgw3.law.pace.edu/cases/050615u1.html http://cisgw3.law.pace.edu/cases/070719u2.html http://www.ca5.uscourts.gov/opinions%5cpub%5c02/02-20166.cv0.wpd.pdf; http://cisgw3.law.pace.edu/cases/030611u1.html; http://www.ca5.uscourts.gov/opinions%5cpub%5c02/02-20166.cv1.wpd.pdf.; nordic journal of commercial law issue 2009#1 36 in ajax tool works, inc. v. can-eng manufacturing ltd.., the court concluded that a contract stating the agreement shall be governed by the laws of canada did not exclude the cisg.117 in the icc arbitration case no. 11333 of 2002 (machine case) cited above, the arbitral tribunal rejected the insurer’s argument for implicit derogation based upon the parties’ choice of french law; particularly so since “the parties have not shown any element enabling this tribunal to ascertain a common intention to exclude the application of the cisg." the arbitral tribunal similarly declined the insurer’s argument that the contractual derogation concerning the warranty period implied a mutual intention to exclude the cisg’s application, stating: “[w]hen a contractual clause governing a particular matter is in contradiction with the cisg, the presumption is that the parties intended to derogate from the cisg on that particular question. it does not affect the applicability of the cisg in general.” 118 in american mint llc v. gosoftware, inc., the federal district court of pennsylvania held: “the alleged contract in this case contains a provision selecting georgia law as the law governing disputes under the contract. however, the contract fails to expressly exclude the cisg by language which affirmatively states it does not apply. bp oil, 332 f.3d at 337. thus, if the facts are proven as alleged, then the cisg would pre-empt domestic sales laws that otherwise would govern the contract. accordingly, the court rejects 117 ajax tool works, inc. v. can-eng manufacturing ltd., no. 01-5938, 2003 wl 223187, at *8 (n.d.ill. jan.30, 2003) available online at: http://cisgw3.law.pace.edu/cases/030129u1.html [hereinafter “ajax tool v. can-eng.”]. 118 the arbitral tribunal also concluded that although the canadian buyer qua insurer had failed to give notice of lack of conformity within the two-year limit time provided for in art. 39 cisg, pursuant to art. 40, the italian seller was not entitled to rely on arts. 38 and 39 if it knew or ought to have known the defects. the tribunal found that such an issue could only be settled if the applicable limitation period had elapsed and, since the issue of limitation periods is an external gap in the cisg, the matter had to be determined in conformity with the applicable domestic law (i.e. french law). in the arbitral tribunal’s view: [22] "however, the application of different limitation periods to the rights provided for by the cisg amounts to artificially re-creating distinctions existing under the applicable national law and from which the cisg was detached with a view to international uniformity. this objective of uniformity would be defeated if each national law were to supply the judge or arbitrators with numerous time limits. limitation periods provided for by the national laws have been adopted to apply specifically to particular actions of the national laws, and not to actions provided for a heterogeneous source of law such as the cisg. [page 125] [23] "the arbitral tribunal is of the view that it is thus fit to apply the general 10-year limitation period, provided for by art. 189 bis of the french code of commerce, independently of the specific cause of action. [24] "consequently, the arbitral tribunal finds that claimant's claim is not time-barred by the 10-year statute of limitation applicable to it as less than 10 years have elapsed between the conclusion of the agreement in 1991 and claimant's filing of its demande d'arbitrage with the icc in december 2000. [25] "this finding is without prejudice to the obligation on claimant (in art. 40 cisg) to demonstrate that [seller] knew or could not have been unaware of the alleged lack of conformity. this issue has not been 'bifurcated', and neither the parties' submissions nor this award did address it.” [citations omitted] http://cisgw3.law.pace.edu/cases/030129u1.html nordic journal of commercial law issue 2009#1 37 defendant's choice of law argument as a basis for finding that the court lacks jurisdiction over this dispute.” 119 prof. kritzer remarks: “subject to an overstatement ('if the parties decide to exclude the [cisg], it should be expressly excluded by language which states that it does not apply' [emphasis added]), this is consistent with the holding of courts of other jurisdictions. see uncitral digest of article 6 case law; and uncitral digest cases plus added cases. it is clear that, to be effective, the exclusion should clearly express the intent of the parties, with the standards for determining intent as set forth in cisg article 8. however, there is nothing in either the language of the cisg or its legislative history to require that such an exclusion must be express. the rule is as the chairman of the first committee of the vienna diplomatic conference at which the cisg was promulgated advised the delegates to this conference: ‘exclusions of the application of the convention could be either express or implied." he advised that this "was also the conclusion which had emerged from the preparatory work.’* * official records, 248, para. 4. the conclusion that emerged from the preparatory work, which is as the chairman [mr. loewe of austria] describes it, may be found at uncitral yearbook vii, a.cn.9.ser.a/1976, p. 29.” 120 in contrast, the court in mcdowell valley vineyards, inc. v. sabaté usa inc. et al. found that the majority of the representations about the product came from california, hence, under the cisg, the parties' places of business were held to be in the same state and the cisg was, therefore, determined to be inapplicable to the sale and consequently the court lacked jurisdiction over the case.121 119 american mint llc v. gosoftware, inc. 2006 wl 42090 (m.d.pa.); 2006 u.s. dist. lexis 1569 (u.s. district court, m.d. pa.) available online at: http://cisgw3.law.pace.edu/cases/060106u1.html [hereinafter “american mint”]. 120 albert h. kritzer, “editorial remarks”, american mint llc v. gosoftware, inc., available online at: http://cisgw3.law.pace.edu/cases/060106u1.html. 121 mcdowell valley vineyards, inc. v. sabaté usa inc. et al. 2005 wl 2893848 (n.d.cal.) federal district court [california] available online at: http://cisgw3.law.pace.edu/cases/051102u1.html. see also, chateau des charmes wines v. sabate, 2003 wl 2012551 (usca, 9th cir. cal.) (per curiam: betty b. fletcher, alex kozinski, stephen s. trott, circuit judges) also available online at: http://cisgw3.law.pace.edu/cases/030505u1.html and chateau des charmes wines ltd. v. sabate, usa, inc. [2005] o.j. no. 4604 court file no. 03-cv-261424cm 3 (ont. s.c.j.) .see also, cisg, article 8. http://cisgw3.law.pace.edu/cases/060106u1.html http://cisgw3.law.pace.edu/cases/060106u1.html. http://cisgw3.law.pace.edu/cases/051102u1.html. http://cisgw3.law.pace.edu/cases/030505u1.html nordic journal of commercial law issue 2009#1 38 however, canadian courts are not alone in misinterpreting the cisg’s applicability. in american biophysics v. dubois marine, 122 the rhode island based manufacturer, american biophysics corporation ("abc") and the manitoba distributor, dubois marine specialties ("dubois") entered into a "non-exclusive distributorship agreement" (the "distributorship agreement") whereby dubois was to purchase and resell "mosquito magnets" designed to attract and kill mosquitoes, manufactured by abc. pursuant to the distributorship agreement, dubois was to make payment within thirty days after receiving abc's invoice and it provided for interest on overdue amounts "at the greater of (a) eighteen percent (18%) per annum or (ii) the highest rate of interest allowed by the laws of the state of rhode island." subsection 11(h) of the distributorship agreement contained the following provision: "this agreement shall be construed and enforced in accordance with the laws of rhode island. the parties agree that the courts of the state of rhode island, and the federal courts located therein, shall have exclusive jurisdiction over all matters arising from this agreement." 123 abc sued for breach of contract or, alternatively, to recover on book account or for goods sold and delivered in the amount of $513,985.94, plus $96,512.75 in interest accrued through july 22, 2005, the date the claim was commenced. dubois moved to dismiss on the grounds of forum non conveniens and lack of personal jurisdiction, relying on, inter alia, “…an excerpt from the united nations convention on contracts for the international sale of goods, 1980 ("cisg"); and copies of manitoba statutes that deal with excluding the cisg from contracts to which it might otherwise apply.”124 125 the court held that a choice of law clause specifying “the laws of rhode island” was sufficient to exclude application of the cisg, stating: “in any event, it appears that the cisg is inapplicable. the cisg governs ‘contracts for the sale of goods where the parties have places of business in different nations, the nations are cisg signatories, and the contract does not contain a choice of law provision.’ amco ukrservice v. am. meter co., 312 f.supp.2d 681, 686 (e.d.pa.2004) (emphasis added); see 15 u.s.c.app. at art. 1(1)(a). more specifically, chapter i, article 6 of the cisg provides that: ‘the parties may exclude the application of this 122 american biophysics v. dubois marine specialties, a/k/a dubois motor sports, 2006 wl 225778 (u.s. dist. ct. d.r.i.) per torres, c.j. available online at: http://cisgw3.law.pace.edu/cases/060130u1.html [hereinafter “american biophysics v. dubois marine”]. 123 id. 124 id. 125 section 6 of the international sale of goods act, c.c.s.m., c. s11 (as am.) reads: excluding application of convention 6. the parties to a contract to which the convention would otherwise apply may exclude its application by expressly providing in the contract that the convention does not apply. [emphasis added] http://cisgw3.law.pace.edu/cases/060130u1.html nordic journal of commercial law issue 2009#1 39 convention or, subject to article 12, derogate from or vary the effect of any of its provisions.’"126 in denying dms’s motion to dismiss, the court held in part: “dubois argues that subsection 11(h) does not ‘expressly’ exclude the application of cisg as required under manitoba law. however, manitoba law does not apply. furthermore, even if manitoba law did apply and even if the cisg called for a different forum, the forum selection clause does ‘expressly’ vest jurisdiction in this court. see summit packaging sys., inc. v. kenyon & kenyon, 273 f.3d 9, 13 (1st cir.2001) (‘[w]hen parties agree that they 'will submit' their dispute to a specified forum, they do so to the exclusion of all other forums.’); see also lambert v. kysar, 983 f.2d 1110, 1116 (1st cir.1993) (forum selection clause will be enforced ‘ 'where venue is specified with mandatory language'.’) (quoting docksider, ltd. v. sea tech., ltd., 875 f.2d 762, 764 (9th cir.1989)).”127 the court’s analysis in american biophysics v. dubois marine raises a number of difficulties. first, it appears as though the court confused the issues of choice of forum and choice of law, insofar as the parties’ choice of forum is immaterial to the applicable law. both parties were from contracting states -the plaintiff manufacturer/seller was from rhode island, u.s.a. and the defendant buyer (reseller/distributor) was from manitoba, canada -thus, the international sales contract met the internationality requirement under article 1(1)(a) of the cisg. second, the fact that the parties entered into a distributorship agreement is not, in and of itself, determinative. abc manufactured and delivered the goods in question to dubois and rendered an invoice specifying goods which dubois allegedly refused or neglected to pay. thus, the dispute was not breach of the distributorship agreement per se, but rather a breach of a contract for goods sold and delivered under the distributorship agreement, the latter of which is clearly within the scope of the cisg. 128 third, the court misapprehended the ratio of the u.s. cisg decisions cited in support of the nature and effect of the parties’ choice of law in excluding the 126 american biophysics v. dubois marine, supra note 122. 127 id. 128 cf. helen kaminski pty. ltd. v. marketing australian products, inc., no. 97-8072a, 1997 wl 414137, at *2 (s.d.n.y. july 23, 1997) [hereinafter “helen kaminski”] where the court states: “the distributor agreement requires map to purchase a minimum quantity of total goods, but does not identify the goods to be sold by type, date or price. in contrast, the cisg requires an enforceable contract to have definite terms regarding quantity and price.” (cf. cisg, article 14). for a critique of the helen kaminski decision, see victoria m. genys, “blazing a trail in the "new frontier" of the cisg: helen kaminski v. marketing australian products, pty. ltd. inc.” 17 journal of law and commerce (1998) 415-426, available online (along with the helen kaminski decision) at: http://cisgw3.law.pace.edu/cisg/wais/db/cases2/970721u1.html. http://cisgw3.law.pace.edu/cisg/wais/db/cases2/970721u1.html. nordic journal of commercial law issue 2009#1 40 cisg’s applicability. most notably, amco ukrservice v. american meter company 129 was cited as authority for the view that any alternative choice of law provision implies exclusion of the cisg under article 6. however, the court in amco ukrservice did not exclude the cisg based upon the parties’ alternative choice of law under article 6. rather, citing both american and german cisg jurisprudence which held that distributorship agreements (in german, referred to as “framework agreements”) were excluded under article 4, the court concludes: “…although the cisg may have governed discrete contracts for the sale of goods that the parties had entered pursuant to the joint venture agreements, it does not apply to the agreements themselves.”130 finally, the line of authority followed by amco ukrservice traces back to decisions where choice of law was inapplicable: fercus, s.r.l. v. palazzo,131 was a new york federal district court decision relating to an oral agreement arising from an exclusive distributorship agreement, which originally cited the u.s. court of appeals (2nd circuit) decision in delchi carrier v. rotorex,132 where the contract was silent on choice of law. 133 129 amco ukrservice et al. v. american meter company 312 f. supp. 2d 661; 2004 u.s. dist. lexis 5301; 2004 wl 692233 (u.s. dist.ct. e.d.pa.) available online at: http://cisgw3.law.pace.edu/cases/040329u1.html [hereinafter “amco ukrservice”] 130 id. dalzell, j. notes: “in the few cases examining this issue, courts both here and in germany have concluded that the cisg does not apply to such contracts. in helen kaminski pty. ltd. v. marketing australian products, inc., 1997 wl 414137 (s.d.n.y. july 23, 1997), the court held that the cisg did not govern the parties' distributorship agreement, but it suggested in dictum that the cisg would apply to a term in the contract that addressed specified goods. id. at *3. three years later, judge dubois of this court followed helen kaminski and held that the cisg did not govern an exclusive distributorship agreement, an agreement granting the plaintiff a 25% interest in the defendant, or a sales commission agreement. viva vino import corp. v. farnese vini s.r.l., no. 996384, 2000 wl 1224903, at *1-2 (e.d.pa. aug. 29, 2000) (dubois, j.). two german appellate cases have similarly concluded that the cisg does not apply to distributorship agreements, which they termed "framework agreements," but does govern sales contracts that the parties enter pursuant to those agreements. see olg düsseldorf, unilex, no. 6 u 152/95 (july 11, 1996), abstract available at http://cisgw3.law.pace.edu/cases/960711g1.html; olg koblenz, unilex, no. 2 u 1230/91 (sept. 17, 1993), text available at http://cisgw3.law.pace.edu/ cases/930917g1.html.” 131 fercus, s.r.l. v. palazzo 2000 wl 1118925, at *3 (s.d.n.y. aug. 8, 2000) available online at: http://cisgw3.law.pace.edu/cisg/wais/db/cases2/000808u1.html. 132 delchi carrier s.p.a. v. rotorex corp 71 f 3d 1024 (1995) available online at: http://cisgw3.law.pace.edu/cisg/wais/db/cases2/951206u1.html. http://cisgw3.law.pace.edu/cases/040329u1.html http://cisgw3.law.pace.edu/cases/960711g1.html; http://cisgw3.law.pace.edu/ http://cisgw3.law.pace.edu/cisg/wais/db/cases2/000808u1.html. http://cisgw3.law.pace.edu/cisg/wais/db/cases2/951206u1.html. nordic journal of commercial law issue 2009#1 41 the importance of drafting clear and unambiguous choice of law clauses is highlighted in another international arbitral decision. in icc arbitration case no. 9117 of march 1998, 134 a russian seller and canadian buyer entered into a contract for delivery of goods. a portion of the goods was delivered before expiry of us import licenses; the remainder was delivered after the deadline. the canadian buyer refused to pay the full price alleging the russian seller’s failure to ship all the goods before expiry of the u.s. import licenses. the canadian buyer also alleged that the russian seller violated the canadian buyer’s exclusive u.s. import rights. the russian seller then commenced arbitration in accordance with the arbitration agreement in the contract, directing arbitration pursuant to the icc rules of arbitration and reconciliation. although the contract did not contain a choice of law clause, the arbitral tribunal held that the relevant usages135 and the cisg applied pursuant to both art. 13 (3) and (5) of the icc rules for reconciliation and arbitration, and the contractual provisions agreed upon by the parties. the law of the russian federation governed any other issues. in another russian cisg decision, this time involving a canadian seller and russian buyer,136 the icac arbitral tribunal reached a different result, primarily due to an interpretative ambiguity arising from two equally authoritative, but contradictory, arbitration clauses. in icac case 217/2001, a russian company [the “russian buyer”] commenced arbitration proceedings against a canadian company [the “canadian seller”] for breach of contract in connection with the canadian seller’s failure to deliver equipment and materials. pursuant to the terms of the contract dated october 1, 1998, the russian buyer made a 100% advance payment for the goods. under the terms of the contract, the goods were to be delivered by the canadian seller within 180 days following the advance payment. in the event of non-delivery, the canadian seller was obliged to refund the advance payment within the same time-frame. during the term of the contract, the canadian seller short-changed the russian buyer by delivering goods valued at less than 5% of the advance payment and failed to refund the advance payment. the canadian seller then demanded an additional payment of 133 cf. beltappo inc. v. rich xiberta, s.a. 2006 wl 314338 (w.d.wash.) (u.s. district court, western district, wash. feb. 7, 2006, per zilly, j.) where the court denied the defendant’s motion to dismiss for lack of personal jurisdiction or, in the alternative, for forum non conveniens, and for costs and attorneys' fees, on the basis of, inter alia, the defendant’s concession that "there will be no conflict with a sovereign state because of the choice-of-law provision and the fact that both spain and the united states are signatories to the cisg. this factor is neutral." also available online at: http://cisgw3.law.pace.edu/cases/060207u2.html. 134 icc arbitration case no. 9117 of march 1998, cc international court of arbitration bulletin [icab], vol. 10/no.2 (fall 1999) 96-101; vol. 11/no. 2 (fall 2000) 83-92; http://www.unilex.info/case.cfm?pid=1&do=case&id=399&step=fulltext (unilex) also available online at: http://cisgw3.law.pace.edu/cases/989117i1.html. [hereinafter “icc case no. 9117/1998”] 135 see also unidroit principles, art. 8, and contract modification or termination, under cisg art. 29(2). 136 russian federation arbitration proceeding 217/2001 of 6 september 2002,icac (translation by yelena kalika; translation edited by mykhaylo danylko) available online at: http://cisgw3.law.pace.edu/cases/020906r1.html [hereinafter “icac case 217/2001”] http://cisgw3.law.pace.edu/cases/060207u2.html. http://www.unilex.info/case.cfm?pid=1&do=case&id=399&step=fulltext http://cisgw3.law.pace.edu/cases/989117i1.html. http://cisgw3.law.pace.edu/cases/020906r1.html nordic journal of commercial law issue 2009#1 42 approximately 10% of the amount already paid, claiming additional expenses incurred. the canadian seller stopped the shipment of goods in transit, which were to be delivered fca calgary under incoterms-90, until the russian buyer made the requested additional payment. after the russian buyer commenced arbitration proceedings, the canadian seller brought a preliminary motion contesting the icac arbitral tribunal’s jurisdiction, relying on its own interpretation of the arbitration clause. the icac arbitral tribunal analyzed clause 4.5 of the contract (arbitration clause) and found that it was contradictory. the russian version stipulated that disputes be arbitrated at the “arbitration court at the russian federation chamber of commerce and industry.” the english version provided that disputes be submitted "to the arbitration court of russia". the icac arbitral tribunal rejected the canadian seller's position that the english version governed, and held it the canadian seller’s interpretation that disputes had to be brought within a russian state arbitration court was unreasonable. according to the icac arbitral tribunal: “it is well known that the english expression "arbitration court" is the equivalent to the russian expression "treteiskiy sud". such conclusion clearly follows both from the relevant international treaties, the rules of international arbitral tribunals and from other publications. for example, the convention on recognition and enforcement of foreign arbitral awards (new york, 1958), to which both russia and canada are contracting states, applies only to awards rendered by foreign arbitral tribunals ("arbitral awards"). it does not apply to decisions of foreign state courts (whose decisions are not arbitral). the same approach is followed by the uncitral arbitration rules (adopted by the un general assembly on 15 december 1976) and the uncitral model law on international commercial arbitration (1985). the laws of many states on international commercial arbitration are based on the said model law. such states include english speaking states. in particular, they include canada (both on the federal level and in all the provinces and territories), australia, four u.s. states (california, connecticut, oregon and texas) and scotland. the relevant law in russia (1993) is also based on the model law. the english name for the arbitral tribunal at the international chamber of commerce in paris is the "international court of arbitration of the icc". the terminology used by the international arbitral court in london is similar.” 137 the icac arbitral tribunal interpreted the arbitration clause based on article 431 of the russian federation civil code taking into consideration that, pursuant to the agreement of the parties, disputes were to be resolved in accordance with russian federation laws. thus, the 137 icac case 217/2001, “tribunal’s reasoning”, §3.1. nordic journal of commercial law issue 2009#1 43 icac arbitral tribunal’s conflicts of law analysis and application of trade usages (including unidroit principles) favoured the wording of the russian version of the contract, including the arbitration clause. since it was established that the contract was originally drafted in russian and then translated into english, given the discrepancies between the texts in different languages, when interpreting the contract, the russian text of the contract was to be preferred. this was particularly so, given that several words were clearly omitted in the english texts (referring to the arbitral tribunal in which the parties intended to arbitrate their disputes.). finally although the parties’ respective places of business were within contracting states, (i.e. the russian federation and canada), the parties’ agreement to apply russian law precluded the application of the cisg in resolving the dispute, including the interpretation of any conflicting contractual terms. in travelers property casualty company of america et al. v. saint-gobain technical fabrics canada limited 138 the u.s. federal district court in minnesota held that the cisg applied to litigation involving both american and canadian parties. in saint-gobain, the initial dispute arose after kroenke arena company, llc, a colorado-based company hired various contractors to design and construct the pepsi centre arena in denver, colorado. tec specialty products, inc. (“tec”), a minnesota corporation (now known as specialty construction brands, inc.) provided components used in the pepsi center exterior insulation and finish system ("eifs"). tec issued a purchase order dated september 28, 1998 to saintgobain technical fabrics canada limited, formerly known as bay mills (“saint-gobain”) an ontario sub-division of a french-based global manufacturer and distributor of construction reinforcing products, which included the reinforcing mesh used in the pepsi center’s exterior walls. the back of the tec purchase order contained tec's general terms and conditions of purchase. on october 21, 1998, saint-gobain shipped mesh in response to tec's purchase order. later that day, saint-gobain prepared and sent an invoice that included saint-gobain's general terms and conditions of sale. following construction, portions of the pepsi center's delaminated, necessitating repairs to the exterior walls.139 litigation ensued. the colorado court initially dismissed third party claims made against saint-gobain based on a forum selection clause in favour of minnesota. the colorado litigation eventually settled. the plaintiffs qua assignees and subrogees, then sued saint-gobain in the federal district court in minnesota for: contribution under either the colorado or minnesota statutes; common law or 138 travelers property casualty company of america et al. v. saint-gobain technical fabrics canada limited 2007 wl 313591 (d. minn.) (january 31, 2007) per anne d. montgomery u.s. district judge, also available online at: http://cisgw3.law.pace.edu/cases/070131u1.html [hereinafter “saint-gobain”] 139 “the pepsi center eifs is a multi-layered, multi-component exterior cladding consisting of, inter alia, a base coat applied to the face of the expanded polystyrene ("eps") insulation board, a glass fiber reinforcing mesh embedded into the base coat, and a textured decorative finish coat consisting of synthetic polymers, pigments, and filler materials. id. at 2. the base coat, mesh, and finish coat are collectively referred to as ‘lamina.’” saint-gobain, id., per montgomery, dist. ct. j. http://cisgw3.law.pace.edu/cases/070131u1.html nordic journal of commercial law issue 2009#1 44 contractual indemnification; breach of contract/warranty; negligence; breach of implied warranty of merchantability and/or fitness for a particular purpose (either common law and statutory). the parties then each brought interlocutory motions for various forms of relief, including summary judgment and pleadings-related motions. the minnesota court agreed with the plaintiffs’ assertion that the cisg applied and governed contract formation issues in the case.140 the plaintiffs had argued that under the cisg, the terms of the contract between tec and saint-gobain were the terms set forth in tec’s purchase order, including tec's indemnity and warranties clauses, because the cisg follows the last shot rule under articles 18 and 19 of the cisg. however, the minnesota court disagreed that the indemnity and warranties clauses contained in the tec purchase order were dispositive, noting: “this court finds that material factual issues exist regarding formation of the parties' contract which preclude partial summary judgment for plaintiffs. the parties seem to assume that only their writings could have formed a contract; the cisg, however, explicitly states that ‘[a] contract of sale need not be concluded in or evidenced by writing and is not subject to any other requirement as to form. it may be proved by any means, including witnesses.’ cisg art. 11. under the cisg, a proposal for concluding a contract is sufficiently definite to constitute an offer ‘if it indicates the goods and expressly or implicitly fixes or makes provision for determining the quantity and price.’ cisg art. 14(1). thus, oral discussions between the parties agreeing to the goods, quantity, and price may have formed a contract before any purchase orders and invoices were exchanged...the record contains no evidence of discussions tec and saintgobain personnel may have had before tec sent purchase orders, and the parties have not briefed whether an oral contract could have been formed. assuming arguendo that no oral discussions occurred, purchase orders and invoices were exchanged for each of tec's mesh orders. however, only tec's september 1998 purchase order is in the record. the lack of evidence in the record as to the timing of the exchange of the parties' forms prevents this court from finding as a matter of law that the terms of tec's purchase orders were part of a contract formed between tec and saint-gobain... given this holding, it is unnecessary at this time to address arguments regarding the interpretation of tec's indemnification and express warranties clauses. such arguments will be properly addressed only if the court determines that the clauses are part of the contract between tec and saint-gobain.” [citations omitted] 140 “the court adopts the majority position on applicability of the cisg. therefore, the cisg governs "the formation of the contract of sale and the rights and obligations of the seller [saint-gobain] and the buyer [tec] arising from such a contract." cisg art. 4(a).” saint-gobain, id., per montgomery, dist. ct. j. nordic journal of commercial law issue 2009#1 45 accordingly, the plaintiffs’ motion for partial summary judgment was denied. v) opting-out-partial exclusion the parties may also partially derogate from the cisg’s provisions, by either referring to domestic sales law of the contracting state or by modification of the cisg in the terms and conditions of the contract. thus, the parties may modify or supplement the contract formation provisions of part ii by incorporating domestic sales law or unidroit principles or the pecl (cisg, articles 14-24).141 the parties may also extend or abridge notice periods under cisg article 39(1).142 in romania 6 june 2003 high court of cassation and justice (terracotta stoves case)143 a dispute arose between the canadian plaintiff (respondent) buyer (sc m.r. sa canada) and the romanian defendant (appellant) seller (sc m.n. sa deva) relating to a contract for the delivery of 12 pieces of terracotta stoves (type l) and 15 pieces of terracotta stoves (type d). the canadian buyer paid for the goods which the romanian seller delivered; however, following a visual inspection by the canadian buyer’s experts, the terracotta stoves showed visible cracks. the canadian buyer then sued and obtained judgment for damages and recovery of the purchase price paid and incidental expenses based upon on the non-conformity under cisg article 36(1). on appeal, the romanian high court of cassation and justice reversed and dismissed the action. citing cisg art. 38(2), the romanian appeal court held that the canadian buyer had failed to “prove that the quality control was done when the products were picked up from the company in charge with the transport” and also failed to notify the romanian seller of the nonconformity in a timely fashion pursuant to cisg art. 39(1). the romanian appeal concluded that: “…regarding the fulfillment of the [romanian] seller’s obligations, the claim with regard to the contract resolution is without foundation, and there is no evidence (it cannot be proved) that the [romanian] seller was at fault.” 141 schlechtriem: schlechtriem/schwenzer, art. 6, p. 88, §12. see cisg, arts. 7 and 8. 142 see cisg, arts. 38-40. 143 romania 6 june 2003 high court of cassation and justice (terracotta stoves case) [inalta curte de casatie si justitie(high court of cassation and justice)] case no. 2957/2003; docket no. 945/2002; rev’g 1st instance hunedoara tribunal 23 january 2001; 2d instance court of appeal of alba iulia 16 november 2001 available at: http://cisgw3.law.pace.edu/cases/030606ro.html. the author wishes to thank mr. sorin aslau for his able english translation of the case. http://cisgw3.law.pace.edu/cases/030606ro.html. nordic journal of commercial law issue 2009#1 46 the parties may also limit or cap the amount of damages recoverable under cisg articles 74-76 via limitation of liability or disclaimer clauses, or change the passing of risk provisions (e.g. by selecting incoterms).144 however, the parties cannot derogate from or modify the provisions of cisg part iv-final provisions, which relate to public international law and treaty obligations of the contracting states and not to the parties themselves. 145 vi) opting-in given that the cisg is not truly mandatory law by virtue of party autonomy rights under article 6, the parties may also opt-in to the cisg in cases where the subject-matter of the international sales transaction is otherwise excluded under articles 2-5, inclusive. in situations where the parties are from non-contracting states and have mutually agreed to have the cisg apply, they may do so, subject to the applicable conflict of laws rules of the domestic forum and any domestic statutes or consumer protection legislation which retains subject-matter jurisdiction.146 144 schlechtriem: schlechtriem/schwenzer, art. 6, p. 88, §12. see also cisg, arts. 8, 14-24 and 29. 145 schlechtriem: schlechtriem/schwenzer, art. 6, p. 84, §3. 146 schlechtriem: schlechtriem/schwenzer, art. 6, p. 88, §11 and pp.89-90, §13. nordic journal of commercial law issue 2009#1 47 conclusion the cisg took root within canadian law over fifteen years ago. yet, the growth of canadian cisg jurisprudence remains sparse and uneven. canadian commercial practitioners and judges need to start understanding and applying the cisg for it to flourish. more importantly, all justice stakeholders in the canadian legal system have a vested interest in promoting a better understanding of the cisg for the following reasons: 1) to maintain canada’s reputation in the international law field; 147 2) to contribute to the global jurisconsultorium; 148 3) to avoid potential professional negligence (errors & omissions) claims as a consequence of the failure to plead or rely upon the cisg149 and 4) to avoid dubious legal precedents based upon the application of the wrong law, which represents a potential misuse of judicial resources and diminishes access to justice. 150 hope springs eternal. 147 whether or not canada’s “state reputation” has diminished in the context of multilateral or bilateral trade is another matter. see, colin b. picker, “reputational fallacies in international law: a comparative review of united states and canadian trade actions”, (2004), 30 brooklyn j. int’l l. 68. 148 “a global jurisconsultorium on uniform international sales law is the proper setting for the analysis of foreign jurisprudence.” vikki rogers and albert kritzer, in “a uniform international sales law terminology”, in schwenzer, i. / hager, g. eds., festschrift für peter schlechtriem zum 70. geburtstag, tübingen: j.b.c. mohr / paul siebeck (2003) 223-253, available online at: http://cisgw3.law.pace.edu/cisg/biblio/rogers2.html. see also, camilla baasch andersen, “the uniform international sales law and the global jurisconsultorium” 24 journal of law and commerce vol. 2 (2005), available online at http://www.cisg.law.pace.edu/cisg/biblio/andersen3.html where the author suggests that the concept of a global jurisconsultorium: “...denote[s] the need for cross-border consultation in deciding issues of uniform law. it is an excellent descriptive term for the phenomenon of meeting of minds across jurisdictions in the shaping of international law. however, the term jurisconsultorium also lends itself well to the formation of such law in a scholarly jurisconsultorium. in essence, this article will examine the genesis of the cisg and the scholarly jurisconsultorium from which it sprang, and the need for practitioners (i.e. judges, arbitrators and legal counsel) to extend the jurisconsultorium in practice to ensure uniformity.” 149 see william dodge "teaching the cisg in contracts" (2000) 50 j legal educ. 72 (“failing to determine the law that governs a contract (particularly when it is the law of the united states) is probably malpractice.” see also, ronald a. brand, professional responsibility in a transnational transactions practice, (1998) 17 j.l. & com. 301, 336-37 and reimann, “the cisg in the united states: why it has been neglected and why europeans should care”, supra note 30 at 121. 150 peter l. fitzgerald, “the international contracting practices survey project: an empirical study of the value and utility of the united nation's convention on the international sale of goods (cisg) and the unidroit principles of international commercial contracts to practitioners, jurists, and legal academics in the united states” j. l. & com. vol. 27, 2008 (forthcoming) at 14, available at ssrn: http://ssrn.com/abstract=1127382. http://cisgw3.law.pace.edu/cisg/biblio/rogers2.html. http://www.cisg.law.pace.edu/cisg/biblio/andersen3.html http://ssrn.com/abstract cisg flowchart applicability-internationality-territoriality exclusions (external gaps) internationality parties’ places of business in different states (art. 1(1)) contract of sale of goods (arts. 1(1), 8, 11, 13, 29 and part ii)) pil rules lead to application (art.1(1)(b) contracting states (art.1(1)(a)) nationality and civil or commercial character of parties or contract irrelevant (art. 1 (3)) opt out provision (art. 6, art. 12 and art. 96 declaration) definition of place of business (art.10) declaration by contracting state that it will not be bound by article 1(1) (b) (art. 95) -consumer transactions -sales by: auction; execution or by lawful authority; stocks, shares, etc.; ships, vessels, hovercraft, aircraft; electricity (art.2 (a)(f)) goods to be manufactured; services (art.3) exclusion of validity, usage and property issues (art.4) exclusion of liability for death and personal injury (art.5) internationality disregarded if fact not disclosed by contract or parties’ dealings (art.1 (2)) internal gaps concurrent tort and restitutionary claims; product liability(property damage claims); pre-and postjudgment interest rate; trade terms; validity of penal clauses; burden of proof; transfer and/or retention of title; agency relationships; forum selection clauses; limitation periods/prescription; currency of payment; assumption of debt; setoff; legal capacity of individuals; legal personality of corporations; assignment of receivables; validity and enforceability of settlements. (arts. 7(1), 7(2) and 9)) ©antonin i. pribetic, 2009. all rights reserved microsoft word note3.doc arbitration in finland – characteristic features currently under discussion by patrik lindfors1 nordic journal of commercial law issue 2003 #1 1 patrik lindfors is attorney at law and partner, heading dispute resolution at hannes snellman attorneys at law of helsinki, finland. nordic journal of commercial law, issue 2003 #1 2 1. introduction dispute resolution has traditionally been court of law oriented in finland. however, arbitration has recently become increasingly popular especially among legal persons, i.e. business entities, as an alternative to court of law procedure. consequently so-called business-to-business disputes are more often submitted to arbitration. arbitration is considered to hold certain advantages in comparison with dispute resolution in courts of law. arbitration provides for speedy resolutions in contrast to generally lengthy proceedings in courts of law. arbitral proceedings and arbitral awards are generally private, whereas proceedings and judgments in courts of law are public. furthermore, in arbitration the disputing parties may utilize the best experts as arbitrators on a case-by-case basis, which is not possible in courts of law. hence, in arbitration the probability of objectively correct resolutions is considered to be greater than in courts of law. arbitration is based on the principle of freedom of contract. there are two basic forms or types of arbitration: ad hoc and institutional. both of these forms are based on the parties’ agreement. in ad hoc arbitration the parties agree on the particular arbitration mechanism on a case by case basis. the arbitration will be ad hoc, unless the parties have explicitly opted for institutional arbitration. in the latter kind of arbitration the parties submit their disputes to arbitration conducted under the auspices of, or administered or directed by an existing institution. arbitration proceedings are however not considered institutional if the arbitration institute in question only is competent to appoint the arbitrators, without applying the rules of the institute to the actual arbitral proceedings. the arbitration institute of the central chamber of commerce of finland is the leading arbitration institute in finland. during the years 1998–2002 the number of requests for arbitration to the central chamber of commerce of finland has almost tripled. the number of ad hoc arbitration proceedings is not public. however, the development is presumably similar to that of institutional proceedings, i.e. the number of ad hoc arbitration proceedings is increasing. in the year 2002, 50 requests for arbitration were submitted to the arbitration institute of the central chamber of commerce of finland. furthermore the institute appointed 16 arbitral tribunals for redemption cases under the finnish companies act. the number of requests pending this year (2003) is approximately the same as in 2002. in 2002 the rules of the institute were applied to 66 per cent of the cases, excluding redemption cases. 23 per cent of the requests concerned international disputes, i.e. one or more of the parties to dispute were from abroad. the legal issue in the requests for arbitration to the central chamber of commerce indicates that certain types of disputes are most frequently solved by means of arbitration. in 2002, 16 per cent of the requests concerned sale of shares, 16 per cent co-operation agreements, 12 per cent breaches of competition clauses, 8 per cent sale of business operations and 8 per cent shareholders’ agreements. the basic rules of finnish arbitration are contained in the finnish arbitration act (hereafter the “act”). finnish arbitration proceedings have certain characteristics which deviate to some nordic journal of commercial law, issue 2003 #1 3 extent from the major international rules and regulations on arbitration. this should be taken into account when initiating arbitration in finland. it should be noted that the present article discusses questions relating to arbitral proceedings based on an arbitration agreement between the parties to the dispute. arbitrations of a statutory nature, e.g. redemption of shares of minority shareholders (“squeeze out”) in accordance with the finnish companies act, are not the subject of this article. 2. characteristics of finnish arbitration 2.1 arbitration agreements 2.1.1 general the principal provisions concerning arbitration agreements are contained in sections 2 and 6 of the act. no general distinction between a submission and an arbitration clause is recognised in finnish law. an arbitration agreement may concern an existing dispute as well as future disputes. in order to be considered arbitrable a prospective dispute should arise from a particular legal relationship defined in the agreement. a reference to “any dispute, controversy or claim arising out of or relating to this contract” fulfils the requirement in accordance with finnish law. in certain foreign judicial systems a more specific definition, i.e. “any dispute, controversy or claim arising out of or relating to this contract or the termination or validity thereof” may be required. a reference to any dispute arising between the parties, without any defined connection to a specified contractual relationship, may however be invalid also in accordance with finnish law. nevertheless, certain distinctions between a submission and arbitration clause exist in finnish law as far as consumer contracts and certain transport contracts are concerned. for example an arbitration clause in a consumer contract cannot be invoked against the weaker party, i.e. the consumer. however, an arbitration agreement, which has been concluded after the particular dispute has arisen, is valid and can usually be invoked against the consumer. in finland an arbitration clause is considered independent of the agreement containing the clause. hence the validity and existence of the clause must be determined separately from the agreement itself, irrespective if the clause is in the same document or not. the possible invalidity of an agreement does not in general cause the invalidity of an arbitration clause included in the agreement. 2.1.2 the form of arbitration agreements an arbitration agreement must be in writing. this formal requirement is not only a matter of proof, but rather a precondition for the validity of the arbitration agreement. an arbitration agreement is construed as written if it is contained in a document signed by the parties or in an exchange of letters, telegrams, telexes or other documents. the arbitration agreement is in writing also when it is contained in other electronic messages which provide a record of the agreement, or in an exchange of statements of claim and defence in which the nordic journal of commercial law, issue 2003 #1 4 existence of an agreement is alleged by one party and not denied by the other. the requirement of written form corresponds to the requirement in the uncitral model law. that requirement is fulfilled by a reference to general contract terms containing an arbitration clause. if general terms have been incorporated in the individual contract, an arbitration clause included in those terms will usually be valid. in accordance with the ordinary principles of interpretation of contracts general terms do not have to be attached to the individual contract in order to be valid. to some extent these requirements may differ from the corresponding requirement in the new york convention on the recognition and enforcement of foreign arbitral awards 1958 (hereafter the “new york convention”), which finland has ratified. legal literature indicates that in order for the requirement of written form to be fulfilled in accordance with the new york convention, the general terms must be attached to the individual contract and the individual contract must contain a reference to the arbitration clause in the general terms. 2.1.3 arbitration agreements vs. mandatory law, case examples arbitrability arbitration is based on the freedom of contract. parties to a dispute are in general entitled to settle their disagreements any way they find adequate. according to section 2 of the act matters which are amenable to out of court settlement are arbitrable. there are however certain material exceptions. a general definition of arbitrability in finnish jurisprudence is that arbitration applies only to non-mandatory disputes, i.e. to matters which can be settled without the intervention of public authorities. mandatory matters, i.e. matters of public law or public interest, cannot be submitted to final settlement by arbitration. for instance matters concerning the status or legal capacity of natural persons, divorce, adoption or custody of children cannot be submitted to arbitration. the question of arbitrability has recently been the subject of a judgement by the finnish supreme court (hereafter “kko”). in the case kko 2003:45 the plaintiffs were minority shareholders of a public limited liability company, hereafter “company”. they demanded that the company be placed in liquidation in accordance with chapter 13 section 3 of the finnish companies act. according to the company’s articles of association all disputes between the directors and shareholders were to be submitted to arbitration. the question was whether a demand to place the company in liquidation could be settled by arbitration or must be submitted to a court of law. the supreme court ruled that the claim was arbitrable. the supreme court established that even though the shareholders and the company cannot agree to place the company in liquidation, the general meeting of shareholders was competent to make that decision without the intervention of courts or of other authorities. for these reasons the supreme court ruled that the claim could be submitted to arbitration. the court action was rejected. nordic journal of commercial law, issue 2003 #1 5 adjusting or setting aside an arbitration agreement the other recent case in the supreme court (kko 2003:60) concerned the application of section 36 of the finnish contracts act. according to that provision a contract can be adjusted or set aside as unreasonable. the supreme court ruled that an arbitration agreement was a contract in the meaning of the contracts act and that it could be set aside as unreasonable. however the circumstances were somewhat particular. the party (a) claiming that the arbitration agreement was unreasonable was a private entrepreneur, equivalent to a consumer. a had no assets or income. the supreme court considered it impossible for him to provide the security for arbitration costs, which would have been imposed by the arbitral tribunal. neither was the other party (b) willing to provide the security on behalf of a. in addition a was granted costfree legal proceedings and legal counsel in another case between the parties in a court of law. such a facility was not available in arbitration proceedings. the supreme court considered it impossible for a to safeguard his interests and rights in an arbitration proceeding. for these particular reasons the supreme court set the arbitration agreement aside and the case was submitted to a court of law. notwithstanding the fact that the judgment might possibly result in similar procedural pleas in the future in disputes between business entities, it is evident that the supreme court restricted its ruling to concern only situations where the party claiming that an arbitration agreement is unreasonable must be considered to be a private entrepreneur, equivalent to a private person or consumer to succeed with the claim. this interpretation of the decision is in conformity with established finnish jurisprudence and case law (see the judgement kko 1996:27). it is also in conformity with the travaux préparatoires of the contracts act, which indicate that the application of section 36 of the act is in general limited to situations where one contracting party is a legal person or a business entity and the other party a consumer or private person. in a commercial contract between legal persons, in particular if the contract is international, an arbitration clause would hardly in practice be set aside as unreasonable by virtue of section 36 of the contracts act. 2.2 the arbitral tribunal 2.2.1 appointment of arbitrators general section 7 of the finnish arbitration act provides for a three member arbitral tribunal, unless the parties have agreed otherwise. the parties are free to establish the number of arbitrators they find appropriate. parties appoint persons whom they wish to act as arbitrators either jointly in the case of one single arbitrator, or separately in case each party appoints an arbitrator in an arbitral tribunal of more than one arbitrator. however, if the parties are not able to agree on the appointment of one single arbitrator, a court of law, i.e. the local district court, shall have the competence to decide on the appointment. nordic journal of commercial law, issue 2003 #1 6 personal qualifications for appointment parties are in general free to appoint anyone as arbitrator, whatever his or her nationality, education or age. nevertheless an arbitrator must be over 18 years of age. according to section 8 of the act, the arbitrator must have “full legal capacity”. independence and impartiality are generally considered the primary prerequisites of a prospective arbitrator. when a person is approached in view of his or her appointment as an arbitrator, he or she shall immediately disclose any circumstances likely to give rise to justifiable doubts as to his or her impartiality and independence, unless he or she refuses to accept the appointment. from the time of his or her appointment and throughout the arbitral proceedings an arbitrator shall without delay disclose any circumstances of which the parties have not previously been informed. the arbitrator must be independent of all parties, including the nominating party. the independence of an arbitrator may also be endangered in cases of indirect relationships between an arbitrator and a third person. for example an arbitrator’s connection to a party’s representative or even its counsel, or a party’s connection to an arbitrator’s law firm may constitute an indirect relationship, which can endanger the requirement of independence. in addition to being independent an arbitrator must also be impartial. an arbitrator may be financially and otherwise independent, but nevertheless partial. impartiality is rather a subjective qualification, contrary to independence, which should be based on objective criteria. thus it may not be easy to detect the partiality of an arbitrator who is independent by objective criteria, but who has subjective prejudices against one of the parties. it is also possible that the neutrality of an arbitrator is put in doubt. the neutrality of an arbitrator is frequently considered in connection with his or her nationality. a party may for instance be inclined to select one of its own nationals as arbitrator in order to obtain the understanding by a member of the arbitral tribunal of a behaviour which obstructs or delays the proceedings, although such an attitude is not acceptable. the independence and impartiality of an arbitrator has recently been under discussion in the international bar association. the committee on arbitration and adr (committee d) of the association has appointed a working group of 19 experts in international arbitration from 14 countries to study national laws, judicial decisions, arbitration rules and practical considerations and applications regarding impartiality, independence and disclosure in international arbitration. the purpose of the exercise was to promote and improve the decision making process in arbitral tribunals. the working group has prepared a draft “iba guidelines on impartiality, independence and disclosure in international commercial arbitration” (hereafter the “draft”). the draft (second draft 22 august 2003) contains certain provisions which to some extent are different from the provisions of the finnish arbitration act. the draft lists categories of situations which can occur in arbitral proceedings and which concern the independence and impartiality of arbitrators. based on the categorisation the working group has drafted three specific lists, i.e. the red list, the orange list and the green list, of reasons which may or may not cause unacceptable dependence or non-impartiality of arbitranordic journal of commercial law, issue 2003 #1 7 tors. in comparison with the finnish arbitration act a significant point is that the red list contains both “non-waivable” and “waivable” grounds of dependence and/or non-impartiality. the non-waivable red list sets out situations of incapacity deriving from the overriding principle that no person can be his or her own judge. according to the list such situations would occur for example when “there is an identity between a party and the arbitrator, or the arbitrator is a legal representative of an entity that is a party in the arbitration”. the finnish arbitration act does not, however, contain any provision according to which a party cannot waive his or her right to invoke a particular ground of disqualification of an arbitrator. the parties are in principle entitled to appoint even one of the parties as sole arbitrator. according to the draft such an appointment is not possible even in theory because a party cannot waive his or her right to invoke such grounds of disqualification. it is important to note that the iba guidelines are not a legal code and by themselves they lack any legal or contractual status. as the iba is a private body it has no legislative competence. thus the iba guidelines are not a source of law or of legal rules. it is uncertain, what effect if any the draft and the future final guidelines will have on national or international rules and regulations on arbitration. irrespective whether the provisions set out in the guidelines were to be to some extent implemented in the finnish arbitration act or not, it cannot be excluded that the provisions could at least be used to present arguments when an arbitrator’s impartiality or independence is under consideration. neither can it be excluded that the guidelines may have even more impact on international arbitration and court practice reflecting the overriding principle of fair trial. in the words of the working group: “these guidelines are not rules of law and do not override any applicable national law or arbitral rule by the parties. however, the working group hopes that these guidelines will find general acceptance within the international arbitration community (as was the case with the iba rules on the taking of evidence in international commercial arbitration) and that they thus will help practitioners, arbitrators, institutions and the courts in their decision-making process on these very important questions of impartiality, independence, disclosure and objections and challenges made in that connection.” so far the draft has not received all that far-reaching approval – on the contrary many of its provisions have faced criticism. partly because of the current discussion another revised draft is expected to be made by the working group. 2.3 arbitral proceedings the finnish arbitration act sets out party autonomy as the main principle in arbitration proceedings. section 23 of the act sets out that: “unless otherwise provided in this act, the proceedings shall be conducted in accordance with the agreement of the parties…” nordic journal of commercial law, issue 2003 #1 8 there are few provisions and principles in the act which are of a mandatory nature and which restrict party autonomy. the wording of the section 23 refers primarily to the principle of audiatur et altera pars which is set out in section 22 of the act: “the arbitrators must reserve the parties sufficient opportunity to plead their case” this means that each party must be given an opportunity to respond to the claims and evidence presented by the other party. a violation of the principle of audiatur et altera pars may lead to the setting aside and the non-enforceability of the arbitral award. similar provisions are contained in the new york convention. one of the recently discussed aspects of finnish arbitral proceedings is the production of documents. there are few provisions on the subject in statutory law and institutional rules in finland. the act and the arbitration rules of the arbitration institute of the central chamber of commerce of finland (hereafter the “rules”) do not contain such detailed provisions concerning the production of documents as for example article 3 of the iba rules on the taking of evidence in international commercial arbitration. the production of documents in finnish arbitral proceedings is governed by section 27 of the act, which provides that the arbitral tribunal shall promote an appropriate and expedient settlement of the matter. the tribunal may request a party or another person in possession of a document or other object relevant as evidence to produce it. as regards requests made by the parties, an admissible request must fulfil three preconditions. the document must be identifiable, relevant and in possession of the party to whom the request is directed. thus arbitral tribunals generally require identification of the issue to be proved, the type of the document and in some cases the date of preparing the document. in a recent three-member tribunal arbitral proceeding conducted under the act the tribunal decided that particularly extensive data, i.e. more than 100.000 pages of documents relating to a reinsurance arrangement, could not be considered as a written document and the request to produce such evidence was denied. the party requesting the production of a document must also present prima facie evidence that the document is in the possession of the party to whom the request is directed and that it can be assumed to have relevance as evidence. relevance means that the requested documents must prove facts which directly or indirectly constitute the legal basis of the claim or the reply. the arbitrators do not have the authority to impose a penalty on or give enforceable procedural orders to a person who fails to comply with the tribunal’s decision on procedure. this applies even if the tribunal’s procedural order is based on a specific institutional rule or regulation. despite the fact that inter alia section 30 a of the rules provides that an arbitral tribunal is entitled to give procedural orders, such as injunctions and orders to produce evidence, such orders are not enforceable. nor is the tribunal entitled to support such orders by imposing a penalty. section 29 of the act however provides that the party requesting the production of evidence may request court of law assistance. the request shall be made to the arbitral tribunal and if the nordic journal of commercial law, issue 2003 #1 9 tribunal finds it necessary the party can be authorized to request court assistance. with the consent of the tribunal the party is then able to have a court of law order on the production of evidence under penalty of a sanction. in accordance with section 27 of the rules an arbitral tribunal may refuse evidence which concerns irrelevant or already established facts. the tribunal may also refuse evidence if it can be produced by other means in a considerably less burdensome way or at considerably less expense. chapter 17 section 7 of the finnish code of judicial procedure contains a similar provision. also in arbitral proceedings conducted under the act tribunals have in practice rejected requests which are admissible as such, but which would be evidently irrelevant in a particular case, although there is no such provision in the act. 2.4 arbitral award a final arbitral award on the merits constitutes res judicata immediately when rendered. it is final and binding on the parties and must be recognised by courts of law, other authorities and arbitral tribunals as a final decision on the issues submitted to the arbitration. if one party later brings a court action against the other party in relation to the subject matter of the arbitration, the court will dismiss the action because the issues have been finally settled and are res judicata. the same applies if the case were brought for trial before another arbitral tribunal, unless otherwise agreed by the parties. the award is enforceable immediately when issued. the award will also qualify for recognition and enforcement under the relevant international conventions (i.e the new york convention). in addition the award marks the beginning of the time period within which a party must bring an action for setting aside the award, or to appeal against the arbitrators’ decision regarding their remuneration. that time period commences on the date the party in question received the award. the mandate of the arbitrators is terminated after the final award has been issued. certain exceptions relating to amending and supplementing the award exist in sections 38-39 of the act, but they cannot be further discussed in this context. with respect to form, there are two statutory requirements which the award must fulfil in order to be valid. the award must be in writing and it must be signed by all arbitrators (section 36 of the act; section 37 of the rules). failure to fulfil these requirements induces invalidity. the award is however valid if a majority of the arbitrators have signed it and stated in the award the reason why all the arbitrators have not signed it. there are no statutory requirements in finland that the arbitrators shall state the reasons for the award. hence the award cannot be successfully challenged only on the basis of lack of reasons. this is in contrast for example with the provisions of the uncitral model law. the act provides that certain defects and inaccuracies in the arbitral award result in its invalidity, irrespective of a party invoking them or not. if the award is for example in conflict with ordre public or if the award is incomplete and incoherent to the extent that its content is unclear, the award is null and void. nordic journal of commercial law, issue 2003 #1 10 certain errors have to be invoked by a party in order to set aside the award. section 41 of the act provides that an arbitral award may be set aside, inter alia, when the arbitrators have exceeded their powers, an arbitrator is not appointed in due process or is incompetent. furthermore an arbitral award may be set aside if the arbitrators have not granted the parties sufficient opportunity to plead their case. such a division where certain grounds induce nullity by law and other grounds require a party to invoke the nullity is not known in the leading international rules and regulations concerning arbitration proceedings and the difference should be noted when initiating finnish arbitration proceedings. it must also be noted that even though section 31 of the act explicitly sets out that “the arbitrators must base the arbitral award on law” the award is not challengeable, nor void by law, solely on the basis that the arbitrators are considered to have applied substantive law wrongly, i.e. objective incorrectness of an award does not constitute a basis for a successful contestation nor for nullity by law. 3. conclusion today there is a certain preference for arbitration in finland and it is considered to be an advantageous substitute for court of law proceedings. increasing numbers of business-to-business disputes are submitted to final settlement in arbitration. this trend is expected to continue and even to gain momentum in the future, especially if and when proceedings in more complex disputes in courts of law remain extremely lengthy, i.e. over five years in the worst case. the essential prerequisite for successful arbitration proceedings is that the appointed arbitrators are competent and proficient enough to perform their task properly and that they hand down a well reasoned and substantively correct arbitral award. with such arbitrators also the potential savings in time and costs are considerable in comparison with corresponding proceedings in a court of law. 1. introduction 2. characteristics of finnish arbitration 2.1 arbitration agreements 2.1.1 general 2.1.2 the form of arbitration agreements 2.1.3 arbitration agreements vs. mandatory law, case examples arbitrability adjusting or setting aside an arbitration agreement 2.2 the arbitral tribunal 2.2.1 appointment of arbitrators general personal qualifications for appointment 2.3 arbitral proceedings 2.4 arbitral award 3. conclusion microsoft word elina_raitanen_lopullinen.docx nordic journal of commercial law issue 2011#2 eu state aid regulation & incentives for forest biodiversity conservation study of the constraints by elina raitanen nordic journal of commercial law issue 2011#2 1 “in the long term, economic sustainability depends on ecological sustainability."1 1 introduction 1.1 economic incentives to preserve biodiversity ecosystems provide society with necessary and irreplaceable services. ecosystem services are the beneficial outcomes, for the natural environment or people, which result from ecosystem functions. these benefits arise from the regulating, supporting, provisioning and cultural services that biodiversity and ecosystems supply.2 together, these services provide critical life support functions, contributing to human health, well-being and economic growth.3 biodiversity4 is essential for these services to stay in balance. due to the increasing exploitation of natural resources and the resulting loss of species and ecosystem richness, nature conservation has become one of the most important sectors of environmental policy. legislation, financing, economic control, and different combinations of these are essential measures in environmental protection. in the past years the use of new instruments, especially the incentive-based mechanisms, has increased remarkably. binding regulatory measures are the longest-established environmental policy option in the world. they set the baseline for minimum norms of protection typically including development restrictions, control of damaging activities, creation of protected areas and protection of certain habitat types and species. however, these “command and control” tools have limitations. they can generate strong opposition among the affected groups, take time to draft and adopt and be 1 “america’s living oceans” pew oceans report, 2003. 2 provisioning services are the products obtained from ecosystems such as food, fuel, fresh water, and genetic resources; regulating services are the benefits obtained from the regulation of ecosystem processes such as air quality and climate regulation, and water purification. cultural services refer to the nonmaterial benefits people obtain from ecosystems through, for example, recreation and aesthetic experiences; while supporting services are those that are necessary for the production of all other ecosystem services. their impacts are often indirect or occur over a long time period. examples include nutrient and water cycling, and photosynthesis. the millenium ecosystem assessment 2005. ecosystems and human well-being: biodiversity synthesis. world resources istitute, washington, dc. 3 oecd 2010, p. 22. 4 according to the convention on biological diversity (article 2): "biological diversity" means the variability among living organisms from all sources including, inter alia, terrestrial, marine and other aquatic ecosystems and the ecological complexes of which they are part; this includes diversity within species, between species and of ecosystems. with respect to the concept of biodiversity as adopted by the rio de janeiro convention in 1992, the biodiversity concept has similarities with concepts of nature and environment already used in different legal contexts. the main problem is to get hold of the criteria of biodiversity that are crucial order to prioritize biodiversity against e.g. the needs of forestry (hollo 2007). that is because such forest management methods that would maximize timber revenue and biodiversity value at the same plot simultaneously do not exist, at least for boreal environment (horne 2006, p. 170). nordic journal of commercial law issue 2011#2 2 expensive and difficult to monitor, particularly if they go against general social norms about the use and conservation of nature. because of their constraining and de-motivating character, purely restrictive regulatory measures neither provide a basis for active conservation of land nor encourage public participation or encourage innovation. they can even inadvertently discourage people from practising good stewardship. for example, many private landowners shudder at the thought of having an endangered species occupy their land, because they fear the government will limit their ability to use the land. in extreme cases, landowners might consider removing the endangered species to avoid the associated complications.5 incentive measures, on the other hand, are designed to modify behaviour by encouraging private individuals, organisations and business to participate actively in conservation. even the convention on biological diversity (cbd) recognises their importance6.7 positive incentives to motivate stakeholders can be economic (direct payments, tax reliefs) or non-economic (recognition, awards for outstanding performance, reputation). disincentives internalize the costs of damage to biological resources to discourage activities that harm biodiversity.8 the economic incentive measures are required to internalise the full costs of biodiversity loss in the activities that lead to this loss, and to provide the necessary information, support and incentives to sustainably use or conserve biological diversity.9 forests are among europe’s most precious renewable resources. they are also of particular importance to european and global nature conservation by providing habitats for many rare plants, fungi, mosses and lichens.10 the role of forests varies from one member state to another and the forest policy falls within the sphere of competence of the member states. as finland is one of the most forested countries in the eu with 20 million hectares of forest11, this study analyses the incentives for forest biodiversity conservation particularly from the finnish perspective. 5 vickerman 1998. 6 the convention on biological diversity (cbd), article 11: “each contracting party shall, as far as possible and as appropriate, adopt economically and socially sound measures that act as incentives for the conservation and sustainable use of components of biological diversity”. 7 shine 2005, p. 6. 8 see eg. shine 2005, p. 6. 9 oecd 1999, p. 9. 10 glover—hollo 2008, p. 23. 11 finnish forest research institute 2009, p. 449. finnish statistical yearbook of forestry. nordic journal of commercial law issue 2011#2 3 1.2 biodiversity conservation as a responsibility of state eu and member states hold the primary responsibility for protecting biodiversity.12 according to the convention on biological diversity (cbd)13, ”states have, in accordance with the charter of the united nations and the principles of international law, the sovereign right to exploit their own resources pursuant to their own environmental policies, and the responsibility to ensure that activities within their jurisdiction or control, do not cause damage to the environment of other states or of areas beyond the limits of national jurisdiction”.14 state responsibility is elaborated on in other articles of the cbd15 and is usually flexibly expressed. this flexibility however, does not eliminate the fact that states are bound by the charter of the united nations and the principles of international law. pursuant to the preamble of the charter of the united nations, states promote social progress and better standards of life in larger freedom, and reaffirm faith in fundamental human rights. reaching these goals is not possible without proper environmental protection. taking into account the ascertainment in the preamble of the cbd according to which the conservation of biological diversity is a common concern of humankind, states have but sovereign rights over their own biological resources, also responsibility for conserving their biological diversity and for using their biological resources in a sustainable manner. more generally, this can be called the responsibility of a state to conserve biodiversity.16 all the obligations of the cbd are binding towards the european union as well.17 pursuant to council decision concerning the conclusion of the convention on biological diversity, the union, alongside its member states, has competence to take actions aiming at the protection of the environment.18 1.3 state aid challenges the millennium ecosystem assessment (ma) was carried out between 2001 and 2005 under the auspices of the united nations and governed by a multistakeholder board that included representatives of international institutions, governments, indigenous peoples, nongovernmental organizations (ngos), and business. it set out to assess the consequences of ecosystem change for human well-being and to establish the scientific basis for actions needed to enhance the conservation and sustainable use of ecosystems and their contributions to 12 kokko 2003, p. 49. 13 the convention on biological diversity, united nations 1992. (cbd) entered into force on 29 december 1993. 14 cbd, article 3. 15 cbd, eg. articles 4 and 15. 16 kokko 2003, p. 50. 17 article 1 of the 93/626/eec: council decision of 25 october 1993 concerning the conclusion of the convention on biological diversity oj l 309 , 13/12/1993 p. 0001 – 0020. 18 annex b of the 93/626/eec: council decision of 25 october 1993 concerning the conclusion of the convention on biological diversity nordic journal of commercial law issue 2011#2 4 human well-being. as a result of the ma, numerous remedies for biodiversity and ecosystem services were proposed.19 elimination of subsidies that promote excessive use of specific ecosystem services as well as correction of market failures in internalizing environmental externalities were considered promising intervention measures. the ma highlights that because many ecosystem services are not traded in markets, markets fail to provide appropriate signals that might otherwise contribute to the efficient allocation and sustainable use of the services. in countries with supportive institutions in place, market-based tools can be used to correct some market failures and internalize externalities, particularly with respect to provisioning ecosystem services.20 direct grants, subsidies and payments are the most common positive biodiversity policy incentives in the european context21. other favoured incentives include contracts with certain land-use sectors. as set out in the lisbon strategy, a full internalization of environmental costs should be the ultimate target in european environmental policy. there are, however, many challenges in internalizing the externalities22: internalizing negative externalities23 will affect the revenue of the polluter negatively and is thus likely to lead to a loss of economic competitiveness. as a result, conservation remains insufficient. an even more important challenge follows from the positive externalities24. if the property rights were complete and exclusive covering all the aspects of forestland, any conservation values provided in the forest would constitute positive externalities. the conservation of biodiversity has, however, typical public goods character, which means that once the good is provided to one individual, it is provided to all simultaneously and enjoyment of the good by one individual does not reduce the benefits available to others. hence, there is a temptation to free-ride on the provision of public goods by others. as a result, there is a lack of effective demand for public goods, implying that suppliers would be unlikely to cover their production costs. market forces thus fail to supply public goods, even though their supply would enhance community welfare. this often leads to underinvestment in public goods relative to what would be socially optimal.25 19the millenium ecosystem assessment 2005. ecosystems and human well-being: biodiversity synthesis. world resources istitute, washington, dc. 20 ecosystems and human well-being: biodiversity synthesis, p. 86. 21 shine 2005, p. 8. 22 externalities are said to exist when the activities of an individual, firm or other organisation have spillover effects on others and when these spillovers are not reflected in market price. 23 when the production or consumption damages environmental goods without that damage being reflected in the prices of goods or services, there will arise negative externalities. 24 for example farmers who live near a well maintained forest benefit from reduced erosion and flooding among from wells that do not run dry. even though the farmers enjoy positive externalities, the forest owners cannot charge for these benefits. 25 arentino et al. 2001, p. 12. nordic journal of commercial law issue 2011#2 5 these challenges consequently raise the question of whether the society should meet some costs of conservation on behalf of the general community. a well-designed incentive framework could thus ensure that public resources flow in ways that support conservation. yet, there is a problem with society paying undertakings for actions that improve the environment. unjust and selective advantages (e.g. direct grants and payments) to some undertakings decelerate the function of market forces, cause disorder in the common market, and may, more specifically, constitute state aid in the meaning of article 107(1) of the treaty on the functioning on the european union (tfeu)such aid is, on principle, prohibited under the competition rules of the european union. the rules on state aid concern measures with which the public sector grants aid or other benefits to undertakings. the form of the aid is not significant. the definition of state aid is based on the interpretation of article 107(1) tfeu, which establishes the general rule that state aid is forbidden, if 1) it is granted selectively to certain undertakings or for the production of certain goods, 2) it distorts competition or threatens to do so and 3) it affects trade between member states. however, some aids of a social character and aid to make good damage caused by natural disasters, are exempted from this prohibition. in addition, the commission has the power to grant exemptions in respect of aid promoting certain objectives that are of common interest tothe eu26. environmental protection is such an objective.27 under certain terms and conditions environmental state aid may thus be compatible with the common market. competition is vital for sustaining an efficient economyand consequently to make use of europe’s growth potential to the benefit of the european citizens. in this context, efficiency refers to the extent to which welfare is optimised in a particular market or the economy at large. market failure occurs , when regulation of the market does not produce an economically efficient outcome. market failures may originatein high externalities the public goods nature of a given commodity. when markets do not produce economic efficiency, member states or the union may want to intervene, for example, by using state aid.28 to be an efficient measure of a common interest (here: the conservation of biodiversity), state aid should correct the market failure and consolidate biodiversity values for society and for individuals. it is claimed, that european environmental policy is more a battle of environmental markets than a solution of environmental problems. 29 creating a market for biodiversity could well be one solution in harmonising the aims of competition and nature conservation, if new genuinely 26 see closer the article 107(3) tfeu. 27 state aid policy safeguards competition in the single market and it is closely linked to many objectives of common interest, like services of general economic interest, regional and social cohesion, employment, research and development, environmental protection and the protection and promotion of cultural diversity. state aid action plan 2005, point 15. 28 state aid action plan, p. 7. 29 naskali—hiedanpää—suvantola 2004, p. 24. nordic journal of commercial law issue 2011#2 6 market-based measures, such as habitat banking and offset schemes30, were utilised. however, as long as no market for biodiversity values exists, the market failure remains and has to somehow be corrected. yet, it is not just a matter of existing market failures, but also a matter of governmental responsibility over the absolute value of maintaining a sustainable environment. the conservation of biodiversity values provides typical public goods, the benefit of which cannot be exclusive to the private forest owner. the eu and member states hold the primary responsibility for protecting biodiversity. thus, the governments should share some costs of biodiversity conservation on behalf of all citizens.31 1.4 the structure of the study the goal of the study is to find out whether biodiversity conservation instruments and state aid rules are conflicting and, if so, in what ways. the research is completed through analysing the restrictions on the use of incentivizing biodiversity conservation instruments rising from eu`s state aid regulations (107 – 109 tfeu), more generally speaking, the aim is to examine the tension between the interest to support local undertakings in environmental conservation and the aim of liberalising the common market. the aim of this study is thus to outline the main factors based on the relevant regulation, guidelines and case-law that define compatibility of certain incentive instruments with the eu’s state aid regime. . next, eu environmental policy is briefly described. in chapter three, eu state aid policy is analysed. after defining the concept of state aid, the aim is to find out whether the biodiversity conservation instrument can be considered state aid within the meaning of the 107 tfeu. in chapter four, the conditions for evaluating whether instruments that can be considered state aid, can still be compatible with the common market, are discussed. then,commissiondecisions on a few of the more important biodiversity conservation instruments, are introduced and analysed, in order to exemplify regulatory challenges and development needs. finally, some conclusions about the regulation of positive incentives for biodiversity conservation are drawn with the aim of supporting future forestbiodiversity governance. 30 habitat banking is a market-like system where credits from actions beneficial for biodiversity can be purchased to offset the debit from environmental damage. credits can be produced in advance of, and without ex-ante links to, the debits they compensate for, and stored over time” (eftec, ieep et al. 2010). like any market-system, habitat banking and offsets require a relevant involvement of the national and regional levels of governance, to support the development and monitoring of the system. typically habitat banking involves three key actors, “buyers” who seek ways to compensate the damage they cause, “sellers” who create credits with actions beneficial for biodiversity, and “regulators” who oversee the process (policymix – wp2 review habitat banking and offsets). under a system of biodiversity offsets, land use change activities that have significant negative consequences for biodiversity are "taxed" through a requirement to compensate for all unavoidable biodiversity impacts. revenues are collected to finance these biodiversity credits provided by the habitat bank (blom – bergsma – korteland 2008). 31 arentino et al. 2001, p. 15. nordic journal of commercial law issue 2011#2 7 2 eu environmental policy 2.1 environment in the treaties since environmental protection is the premise for authorisation of the use of state aid here, it is essential to know the basis for and the content of it in the eu regime. in the following, the essential environmental provisions will be analyzed to untwine their effect and meaning in the interpretation of environmental protection in the eu. biodiversity protection is one central aspect of environmental protection. among regulation on natura 2000, the eu`s biodiversity policy is chiefly realised through certain programmes and communications. these will be introduced shortly in chapter 2.2. as a separate policy field, environmental policy will encounter challenges stemming from other policy fields. these challenges, and also the opportunities that environment creates, will be illustrated in chapter 2.3. under article 3 of the treaty on the european union (teu), the european union should take measures to promote “a high level of protection and improvement of the quality of the environment”. the eu environmental policy objectives, principles and policy aspects to be taken into account are all codified in the article 191 tfeu. article 191(1) defines the goals for the union`s environmental policy32 and article 191(3) shows aspects, which the union shall take account of, when preparing its policy on the environment. 33 environmental policy is the only field in the eu that has its principles defined in the treaty. these principles are mentioned in article 191(2) tfeu and they will ultimately define the way in which the environment-related regulations are interpreted in the union and member states. according to the high level of protection principle, european environmental policy shall aim at a high level of protection taking into account the diversity of condtions in the various regions of the union. the precautionary principle holds that potential pollution should be pre-emptively avoided. the prevention principle allows action to be taken to protect the environment at an early stage. prevention is, for instance, linked to the notion of deterrence and the idea that disincentives, such as penalties and civil liability, will cause actors to take greater care steering their behaviour to avoid the increased costs, thus preventing pollution from occurring.34 with that in mind, also positive incentives could be seen as effective measures in preventing irreversible biodiversity loss. 32 the environmental objectives to be pursued by the eu in the article 191(1) tfeu are: preserving, protecting and improving the quality of the environment; protecting human health; prudent and rational utilisation of natural resources; promoting measures at international level to deal with regional or worldwide environmental problems, and in particular combating climate change. 33 in preparing its policy on the environment, the union shall take account of: available scientific and technical data, environmental conditions in the various regions of the union, the potential benefits and costs of action or lack of action, the economic and social development of the union as a whole and the balanced development of its regions. 34 environmental law: a handbook for afghan judges. united nations environment programme 2009, p 13. nordic journal of commercial law issue 2011#2 8 the polluter pays principle (ppp) is of particular importance in connection with state aid35. the essence of the ppp is that the person who introduces a pollutant should also be responsible for the removal of any sub-sequent pollution. this principle can displace other general principles, such as the right to property. the principle that the polluter has to pay is thoroughly based upon economics and is not punitive in character (although it could evolve into a principle of criminal law), but is rather restitutionary. true to its economic nature it operates consistently with the laws of the market and reduces costs to society as a whole. the ppp forces the polluter to internalise the costs associated with his or her production or consumption. thus, it eliminates, at least in theory, the problem of free riders and over users. in theory, it leads to efficient cost allocation, because the costs of cleanup and benefits of pollution are closely related. 36 ppp can be implemented either by setting mandatory environmental standards or by introducing market-based instruments. this “internalisation” of the external costs effectively pushes undertakings to minimise their environmental costs. in practice, however, there are certain challenges in internalising externalities: internalising negative externalities will consequently raise the private costs borne by the polluters37 and thereby negatively affect their revenue. hence, there is a fear of losing economic competitiveness and jobs. this might further cause the industry to eventually move to less-regulated areas.38 another challenge concerns public goods i.e. goods which are beneficial for society, but which are not normally provided by the market given that it is difficult or impossible to exclude anyone from using the goods. biodiversity conservation typically produces these kinds of goods39. for these reasons, in addition to regulation, member states need positive economic incentives to facilitate the achievement of higher levels of environmental protection.40 the source principle is related to the polluter pays principle as it simply states that any form of pollution should be treated as closely as possible to its source. there are also certain general principles in the treaties that have relevance in environmental protection. these (general) principles are essential in defining the position of environmental 35 state aid may not be an appropriate instrument in the context of ppp for it would relieve the polluter from paying the cost of its pollution. see chapter 4.2.2. 36 engle 2009, p. 3. 37 eu competition law applies only to undertakings. “it comprises all kinds of activities undertaken on an independent basis for remuneration, and the aim pursued is immaterial”. case c-41/90 höfner and elser v. macrotron [1991] ecr i-1979, para 21. 38 moreover, since the generation of pollution is unevenly spread among industries and undertakings, the costs of any environmentally friendly regulation tend to be differentiated, not only between undertakings, but also between member states. member states may furthermore have a different appreciation of the need to introduce high environmental targets. community guidelines on state aid for environmental protection, para 21. 39 even though the ppp has been confirmed as an environmental principle, the expansion of it on the biodiversity conservation needs still further clarification. see closer p 64 of this study. 40 community guidelines on state aid for environmental protection, points 19-22. nordic journal of commercial law issue 2011#2 9 policy in relation to other union policies and between the union and member states: the integration principle is one of the most important principles of eu law of relevance for environmental protection. according to article 11 tfeu the requirement of environmental protection must be integrated into the definition and implementation of the union`s policies and activities, in particular with a view to promoting sustainable development. the wording confers a duty on eu institutions to elaborate all policies in the service of sustainability, as an overall treaty objective.41 the integration principle is primarily meant to ensure that protection of the environment is taken into consideration when other decisions are being taken, for example, in the field of competition policy42. the principle would seem to include both the environmental policy objectives43 and the environmental principles. article 5(3) teu refers to the principle of subsidiarity according to which, in areas that do not fall within its exclusive competence, the union shall act only if and so far as the objectives of the proposed action cannot be sufficiently achieved by the member states, either at central level or at regional and local level, but can rather, by reason of the scale of effects of the proposed action, be better achieved at union level. the institutions of the union shall apply the principle of subsidiarity as laid down in the protocol on the application of the principles of subsidiarity and proportionality. the protocol states that action is justified where the issue under consideration has transnational aspects, which cannot be satisfactorily regulated by member state action44. in general, action by the eu on transfrontier environmental matters (such as maintenance of biodiversity) would seem to pass the test of subsidiarity.45 in light of subsidiarity principle, it may thus be legitimate to pose the question whether biodiversity conservation, to suffice, demands more stringent regulation at the european union level. under the principle of proportionality (article 5(4) teu), the content and form of union action should not exceed what is necessary to achieve the objectives of the treaties. the european legislature must choose measures, which leave the greatest degree of freedom for national decisions. directives should be preferred above regulation. minimum standards should be used, whereby member states are free to lay down stricter national standards. non-binding instruments and voluntary codes of conduct should also be preferred, wherever possible46. contrary to the principle of subsidiarity, the principle of proportionality could be prima facie taken to imply justification of national environmental measures -such as state aid. yet, the 41 bär—kraemer 1998, p. 318. 42 jans—vedder 2008, p. 17. 43 preserving, protecting and improving the quality of the environment, protecting human health, prudent and rational utilisation of natural resources, and promoting measures at international level to deal with regional or world-wide environmental problems. article 191(1) tfeu. 44 protocol on the application of the principles of subsidiarity and proportionality. 45 jans—vedder 2008, p. 11 12. 46 oj c321/i counsil resolution on the drafting, implementation and enforcement of community environmental law. jans—vedder 2008, p. 14 15. nordic journal of commercial law issue 2011#2 10 concept of proportionality has proven to be particularly strong in relation to environmental measures, because it has allowed the court to question the appropriateness of the very level of environmental protection determined by the member states47.48 2.2 the eu`s biodiversity policy at the union level, biodiversity objectives are essentially integrated in the lisbon strategy and the sustainable development strategy49. the eu policy approach gives special attention to the protection of the natura 2000 network of protected areas. environmental action regarding areas outside natura 2000 is provided for by dedicated nature policy (action for threatened species and connectivity of the natura 2000) and by integration of biodiversity needs into agricultural, fisheries and other policies. the eu`s focus in the international arena has been on strengthening the convention on biological diversity (cbd)50 among other biodiversity-related agreements.51 the sixth environment action programme52 embraces a general environmental definition of policy, including strengthening the diversity of policy measures. it clearly 47 see eg. case 302/86 [1988] ecr 4607 danish bottles and c-203/96 [1998] ecr i-4075 dusseldorp. 48 notaro 2001 p. 339. 49 com(2001) 264 final. a sustainable europe for a better world: a european union strategy for sustainable development. this strategy provides an eu-wide policy framework to deliver sustainable development, i.e. to meet the needs of the present without compromising the ability of future generations to meet their own needs. it rests on four separate pillars: economic, social, environmental and global governance – which need to reinforce one another. pursuant to commission`s communication on 2009 review of the european union strategy for sustainable development (com(2009) 400 final.) “evidence shows that the destruction of biodiversity is continuing at a worrying rate. degradation of ecosystems not only reduces the quality of our lives and the lives of future generations, it also stands in the way of sustainable, long-term economic development”. for that reason the focus should be taken on the eu's long-term goals in crucial areas, notably by intensifying environmental efforts for the protection of biodiversity, water and other natural resources. 50 many articles of the cbd have a clear economical connection. article 6 recommends each contracting party to develop national strategies, plans or programmes for the conservation and sustainable use of biological diversity, and integrate the conservation and sustainable use of biological diversity into relevant sectoral or cross-sectoral plans, programmes and policies. article 7 requires to identify processes and categories of activities which have or are likely to have significant adverse impacts on the conservation and sustainable use of biological diversity. article 8 demands to regulate or manage biological resources important for the conservation of biological diversity and promote the protection of ecosystems, natural habitats and the maintenance of viable populations of species in natural surroundings. article 10 prompts to integrate consideration of the conservation and sustainable use of biological resources into national decision-making. the most important in the light of innovative social and economical incentives is the article 11, which invites each contracting party to adopt economically and socially sound measures that act as incentives for the conservation and sustainable use of components of biological diversity. 51 see com(2006) 216 final. halting the loss of biodiversity by 2010—and beyond: sustaining ecosystem services for human well-being. 52com(2001) 31 final. the sixth environment action programme of the european community entitled "environment 2010: our future, our choice". nordic journal of commercial law issue 2011#2 11 emphasizes new measures that rest on voluntarism, flexibility, self-regulation, price guidance and other arrangements. in may 2006, the european commission adopted a communication on "halting biodiversity loss by 2010 – and beyond: sustaining ecosystem services for human well-being". the communication underlined the importance of biodiversity protection as a pre-requisite for sustainable development, as well as setting out a detailed eu biodiversity action plan to achieve this. in march 2010, the eu council agreed on a post-2010 vision and an ambitious new 2020 target for biodiversity to replace the expiring 2010 target. the new target aims to "halt the loss of biodiversity and the degradation of ecosystem services in the eu by 2020, restore them in so far as feasible, while stepping up the eu contribution to averting global biodiversity loss". the council asked the commission to develop a full-fledged strategy focused on a limited set of measurable sub-targets for different ecosystems, drivers of biodiversity loss, and response measures. this survey is intended to canvas opinions about the various policy options available to fine-tune the new strategy.53 pursuant to the new ambitious “2050 vision”, eu biodiversity and the ecosystem services it provides are protected, valued and appropriately restored for biodiversity's intrinsic value and for their essential contribution to human well-being and economic prosperity, and so that catastrophic changes caused by the loss of biodiversity are avoided, by 2050.54 2.3 challenges and opportunities the eu has developed a comprehensive environmental policy over three decades. despite obvious efforts and eu`s relatively high capacities, the actual impact of the eu environmental policy is considered far from satisfactory55. the reason for this is not only the poor implementation of eu environmental policies in the member states but also the fact that progress in the environmental policy field is counteracted by developments in other policy fields56. policies that lead to geographical expansion of different economic sectors and incentives that encourage greenhouse emission may cause huge losses for the biodiversity. also the occidental agricultural aid is in large measure a perverse incentive from the aspect of biodiversity.57 for example in sweden, subsidisation of forest land drainage to increase timber production has led to the loss of over 30,000 hectares of wetlands annually58. the good farming 53 see further at: http://ec.europa.eu/environment/consultations/biodecline.htm. 54 com(2011) 244 final. 55 european environment agency, 1999. 56 “in the eu – and in most of its member states – sectoral polices such as agricultural policy, transport policy, energy policy, cohesion policy, fiscal policy and so on are formulated in disregard of their environmental impact.” lenschow 2005, p. 296. 57 naskali—hiedanpää—suvantola 2004, p. 72. nordic journal of commercial law issue 2011#2 12 practice, which forms the basis for the cross-compliance requirements,59 includes the requirement for “maintenance of the land in a good agricultural condition”. this clearly has the aim to slow down the abandonment of farmland, but it also prevents afforestation in regions where forest and farmlands are alternative land uses.60 during the meeting of the european council in lisbon (2000), the heads of state or government launched a "lisbon strategy" aimed at making the european union the most competitive economy in the world and achieving full employment by 2010. this strategy rests on three pillars, one of which is an environmental pillar. the environmental scope was added to the strategy at the göteborg european council meeting in june 2001. it draws attention to the fact that economic growth must be decoupled from the use of natural resources. the high level group chaired by wim kok has assessed the lisbon strategy. according to its analysis61 promoting eco-efficient innovations is clearly a win-win opportunity that should be fully exploited in view of reaching the lisbon goals. innovations that lead to less pollution, less resource-intensive products and more efficiently managed resources support both growth and employment while at the same time offering opportunities to decouple economic growth from resource use and pollution.62 on these grounds, european environmental policy seems to be more a battle of environmental markets than solution of environmental problems. yet, the markets may also be part of the solution.63 in the international discourse the core idea of sustainable development is that environmental protection, economic growth, and social development are mutually compatible, rather than conflicting objectives.64 as enshrined in state aid action plan, environmental protection can be a source of competitive advantage for europe, in addition to being essential as such by providing opportunities for innovation, new markets and increased competitiveness through resource efficiency and investment65. 58 bagri—blockhus—vorhies 1999, p. 21-22. 59 cross-compliance is a mechanism that links direct payments to compliance by farmers with basic standards concerning the environment, food safety, animal and plant health and animal welfare, as well as the requirement of maintaining land in good agricultural and environmental condition. 60 schmid, e., j. balkovic and r. skalsky: biophysical impact assessment of crop land management strategies in eu25 using epic. carbon sink enhancement in soils of europe: data modelling, verification. jrc scientific and technical reports. s. v., l. montanarella and p. panagos, european communities 2007, luxembourg. p. 160183. 61 facing the challenge: the lisbon strategy for growth and employment.report from the high level group chaired by wim kok 2004. p. 36-38. 62 report from the high level group chaired by wim kok, p. 36-37. 63 naskali—hiedanpää—suvantola 2004, p. 24. 64 lenschow 2005, p. 295-297. 65 state aid action plan—less and better targeted state aid: a roadmap for state aid reform 2005-2009. com(2005) 107 final. nordic journal of commercial law issue 2011#2 13 the eu policies are under constant change. the latest notable one occured in december 2009 when the lisbon treaty entered into force. although sustainable development and environmental protection have been included in previous treaties, the treaty of lisbon now sets out clear definitions, reinforcing the eu`s action in these fields. this could imply that environmental aspects have stronger effect in future state aid decisions as well. 3 when does the measure constitute state aid? 3.1 introduction when a member state decides to increase the level of environmental protection, this will result in increased costs and thus a deterioration of the position of the national industry. therefore no member state will have an incentive to make the first move with the internalisation of environmental costs. state aid, for example in the form of direct grants and payments, may then be the most appropriate measure in helping the national industry towards higher protection. however, a measure constituting a grant of state aid within the meaning of article 107(1) triggers a duty of notification to the commission66 according to article 108(3). the commission decides whether the proposed aid is compatible with the common market. until the commission has taken a final favourable decision, the member state may not put its proposed measure into effect. for all the necessary aid measures to be duly notified, it is important to know the exact boundaries of state aid. this however is not self-evident, since the definition of state aid presents many difficulties. in the following, the concept of state aid in the meaning of article 107(1) will be outlined as comprehensively as possible within the framework of this study. in chapter 3.2, the policy behind state aid regulation will be shortly introduced. the actual concept of state aid will be defined in chapter 3.3. finally, chapter 3.4 presents a process of deductive reasoning to determine whether or not the above-mentioned key incentiveinstruments constitute state aid within the meaning of article 107(1). 66 the european commission is the executive branch of the european union. the body is responsible for proposing legislation, implementing decisions, upholding the union's treaties and the general day-to-day running of the union. the european commission has established a system of rules under which state aid is monitored and assessed in the european union. the european commission possesses strong investigative and decision-making powers. at the heart of these powers lies the notification procedure which the member states have to follow. it is only after the approval by the commission that an aid measure can be implemented. moreover, the commission has the power to recover incompatible state aid. through these means, three directorate-generals are carrying out effective state aid control. the commission aims at ensuring that all european companies operate on a levelplaying field, where competitive companies succeed. it ascertains that government interventions do not interfere with the smooth functioning of the internal market or harm the competitiveness of eu companies. the commission invites interested parties to submit comments through the official journal of the european union when it has doubts about the compatibility of a proposed aid measure and opens a formal investigation procedure. nordic journal of commercial law issue 2011#2 14 3.2 eu`s state aid policy the single market constitutes the very heart of the eu, where it is seemingly all about regulationbringing down barriers to trade and simplifying existing rules to enable the free movement of people, goods, services and capital. these freedoms are enshrined in the teu and form the basis for the single market. 67 whereas the eu and member states have shared competence in the principal area of the environment, the union has exclusive competence in regulating competition in a manner necessary for securing the functioning of the internal market68. the idea behind eu competition policy is that a market-based economy is considered to provide the best guarantee for improving living conditions in the eu to the benefit of citizens, which is one of the primary objectives of the eu treaty. it is essential to have functioning markets to provide consumers with the products at low prices. competition also creates a business environment in which efficient and innovative companies are rewarded.69 however, the treaty allows exceptions to the ban on state aid where the proposed aid schemes may have a beneficial impact in overall eu terms. the control of state aids is a unique feature of competition policy in the eu. the benefits of state aid control are clear. in many circumstances, subsidies can reduce economic welfare by weakening the incentives for firms to improve their efficiency and by enabling the less efficient to survive or even expand at the expense of the more efficient. the resulting distortions of trade can lead to friction between national governments and to retaliatory measures, which may be a source of further inefficiency. furthermore, unless some supranational discipline is imposed, competition between governments to attract investment can lead to costly subsidy races. the eu’s system of control, based on an agreed set of fundamental principles firmly anchored in the treaties therefore makes an important contribution towards ensuring that the benefits of economic integration can be realised.70 state aid may becompatible with the treaties provided it fulfils clearly defined objectives of common interest, like services of general economic interest, regional and social cohesion, employment, research and development, environmental protection or the protection and promotion of cultural diversity.71 since state aid measures can correct market failure and thereby improve the functioning of markets and enhance european competitiveness, they may be effective tools for achieving these objectives. in addition to being justified as such, environmental protection may also be considered a source of competitive advantage for europe. 67 see eg. historical overview of the eu single market at european commissions web page > internal market > general policy framework > historical overview. available at: http://ec.europa.eu/internal_market/top_layer/ index_2_en.htm. last visited in 25.10.2010. 68 article 3 tfeu. 69 com(2005) 107 final. 70 buelens—garnier—johnson—meiklejohn 2007, p. 2. 71 state aid action plan, com(2005) 107 final. nordic journal of commercial law issue 2011#2 15 the treaty debars the application of state aid rules in the following sectors: agriculture (article 42 tfeu), transport (article 93 tfeu), disequilibrium in the balance of payments (article 143 tfeu), world trade (articles 206 and 207 tfeu) and protection of the security (article 346 tfeu). yet, in recent years, there has been a clear trend to invoke the eu `s rules on state aid in certain sectors in which the role of the state has traditionally been dominant.72 in the agriculture sector for example, the single common market organization regulation, which applies to most agricultural products, provides for the application of the state aid rules of articles 107, 108 and 10973 tfeu. likewise the rural development regulation expressly provides that articles 107 – 109 tfeu are applicable to aid granted by member states to support rural development74.75 hence, practically all the regulations establishing the common organizations of the market provide for the application of the state aid rules of articles 107, 108 and 109 of the treaty to the products concerned76. also services of general economic interest (sgei)77 are subject to the internal market and competition rules of the teu. as an interesting curiosity, the environment is also an area where these services might be established78. the teu affords the commission the task to monitor proposed and existing state aid measures by member states. this way the commission can ensure that member states do not distort intra-community competition and trade contrary to the common interest.79 72 plender 2004, p. 5. 73 see (ec) no 1234/2007 of 22 october 2007 establishing a common organisation of agricultural markets and on specific provisions for certain agricultural products (single cmo regulation), article 18. 74 (ec) no 1698/2005 council regulation on support for rural development by the european agricultural fund for rural development (eafrd), article 88. 75 heidenhain 2010, p. 288-289. 76 community guidelines for state aid in the agriculture and forestry sector, point 10. 77 sgeis are activities economic in nature, such as postal services, telecommunications, transport services and also the supply of electricity and gas. they have a clear europe-wide dimension and are therefore regulated by a specific union legislative framework 78 communication of the commission of 12.5.2004 com(2004)374 final, section 3.4. 79 com(2005)107 final, p. 3-4. nordic journal of commercial law issue 2011#2 16 3.3 the definition of state aid article 107 tfeu regulates generally the prohibition of state aid and possible exceptions. the first part (107(1)) says: save as otherwise provided in the treaties, any aid granted by a member state or through state resources in any form whatsoever which distorts or threatens to distort competition by favoring certain undertakings or the production of certain goods shall, insofar as it affects trade between member states, be incompatible with the common market. the most important legal consequence of a measure being a grant of aid within the meaning of article 107(1) tfeu is that it has to be notified to the commission according to article 108(1). state aid may however receive approval without notification on the basis that it fits within an already notified and approved general aid scheme or so called "block exemption" regulation80. the state aid rules also treat previously “existing aid”81 differently from aid granted after a member state signs up. the difference is that existing aid is presumed lawful unless the commission challenges it, whereas “new aid” is illegal until the european commission approves it. consequently the aid is illegal, if it is granted without the commission being informed or without its approval. neither may a member state put the proposed measure into effect before the commission has taken a final favourable decision. this so-called “stand still clause” has direct effect82.83 before considering the question under what circumstances the commission may consider state aid compatible with the common market, it has to be decided whether the measure in question is to be regarded as state aid according to the tfeu. first of all, it is necessary to understand the precise boundaries of state aid. it seems clear from the case law of the court that the term “aid” must be interpreted broadly84. however, there is no exhaustive definition for state aid in eu law. that is why the definition must eventually be made on a case-by-case-basis. according to settled case-law, four cumulative conditions must exist for a state measure to be classified as state aid85. the aid must; 1) be granted by a member state or through state resources, 2) favour certain undertakings or the production of certain goods, 3) distort or threaten to distort competition and 4) affect trade between member states. 80 (ec) no 800/2008 (6.8.2008). 81 aid existing before member state joined the union. 82 case 47/69 steinike & weinlig [1977] ecr 595. 83 jans—vedder 2008, p. 288 289. 84 jans—vedder 2008, p. 289. 85 case c-280/00, altmark trans gmbh [2003] ecr i-07747. nordic journal of commercial law issue 2011#2 17 3.3.1 aid granted through state resources economic advantage granted by public authority is a fundamental feature of state aid86. from case law87 it seems clear that the concept of “state” embraces regional and local authorities as well as other public bodies set up by government88. in finland the concept includes for example municipalities. thus, any financial advantage which directly or indirectly comes from the resources of state is regarded as a grant through state resources. even if a benefit entails no actual transfer of resources, it may still be regarded as “granted through state resources”, even in form of revenue foregone as a result of exemptions from taxation and other compulsory levies89. according to case law, if no burden on state resources is caused, state aid rules will not apply. at least some kind of indirect connection to public economy is required, and the advantages that result from administrative regulation of economic life should not alone constitute state aid90. for example, in openbaar ministerie v van tiggele, the court held that "article 92 (now 107) of the treaty must be interpreted to mean that a fixing of minimum retail prices for a product at the exclusive expense of consumers by a public authority does not constitute an aid granted by a state within a meaning of that article"91. similarily, in preussenelektra92 the court of justice concluded that "the obligation imposed on private electricity supply undertakings to purchase electricity produced from renewable energy sources at fixed minimum prices does not involve any direct or indirect transfer of state resources to undertakings which produce that type of electricity. therefore, the allocation of the financial burden arising from that obligation 86 siikavirta 2007, p 99. 87 case c-5/89 bug-alutechnik [1990] ecr i-3437; case 177/78 pigs and bacon commission v mccarren [1979] ecr 2161. 88 ahlborn—berg 2004 p. 55. 89 bellamy—child 2001, european community law of competition, fifth edition, 19-015. 90 siikavirta 2007, p 107. originally from nicolaides—kekelekis—buyskes: state aid policy in the european community. a guide to practitioners. kluwer law international. 2005. on pages 11 13 there is a refer to case c379/98 preussenelektra ag v schhleswag [2001] ecr i-2099, para 58:”in that connection, the case-law of the court of justice shows that only advantages granted directly or indirectly through state resources are to be considered aid within the meaning of article 92(1). the distinction made in that provision between 'aid granted by a member state' and aid granted 'through state resources' does not signify that all advantages granted by a state, whether financed through state resources or not, constitute aid but is intended merely to bring within that definition both advantages which are granted directly by the state and those granted by a public or private body designated or established by the state—“ 91 case 83/77, para 24. 92 case c-379/98, para 59-60. nordic journal of commercial law issue 2011#2 18 for those private electricity supply undertakings as between them and other private undertakings cannot constitute a direct or indirect transfer of state resources either"93. still, article 107 might be taken to imply that aid is granted through state resources, even if it is not granted from the actual resources of state, but is instead granted by another body. according to plender94, crucial in considering whether the aid should be regarded as "granted through state resources", is whether the body granting the aid is subject to control by the state. aid pursuant to article 107(1) may, for example, be financed by taxes or payments collected from users. these payments may then be dispatched into a fund wherefrom payments are deferred to certain enterprises.95 such financing has been regarded as granted from state resources, when 1) it is based on legislation, 2) payments are compulsory, 3) the administration and execution of the payment are based on law and 4) the fund is founded by the state.96 3.3.2 favouring certain undertakings for article 107(1) to apply there must be an advantage that must benefit certain undertakings. any digression from conventional application of a general scheme can be considered aid. sectoral, geographical or company-based selectivity, are all basically discriminatory. besides direct grants, the provision of infrastructure by public authorities, serving specifically the interest of a certain undertaking or type of product may constitute state aid97. also more generally, channelling of public funds to private undertakings can be interpreted as state aid on relatively many, and sometimes rather slight signals of discrimination. the european courts have defined the concept of aid as "a direct or indirect economic advantage on the beneficiary, which it would not have obtained in the ordinary course of business"98, in other words "gratuitous benefit".99 such benefit might typically be the 93 preussenelektra claimed that the mechanism established by german law amounted to state aid. the basis of their claim was on two arguments: first, that financing through state resources should not be constituting element of state aid and the measure being a result of action by a member state regardless of whether the aid was privately or publicly funded should suffice. second, they alternatively argued that the german legislation had the effect of converting private resources into public resources. they likened the system established by the german legislation to a parafiscal charge: where private funds are under the direct control of the state, they should be caught by the state aid rules. 94 plender 2004, p. 19-20. 95 siikavirta 2007, p. 108. 96 see joined cases c-78/90, c-79/90, c-80/90, c-81/90, c-82/90 and c-83/90. compagnie commerciale de l'ouest and others v receveur principal des douanes de la pallice port. references for a preliminary ruling: cour d'appel de poitiers france. parafiscal charges on petroleum products. [1992], ecr i-01847. 97 plender 2004, p. 13. 98 case 61/79 amministrazione delle finanze dello stato v denkavit italiana srl [1980] ecr 1205. 99 ahlborn—berg 2004, p 60. nordic journal of commercial law issue 2011#2 19 contribution via sale, lease or purchase of land by public bodies to or from private parties at non-market prices, but it might even occur in the national administration of eu structural funds.100 selective labour experiment101 and discounts on employer contributions102 may also be regarded as aid. the so-called “market investor test” is applicable in cases where the state intervenes by means comparable to private investors. according to the test, state aid is allocation of resources in situations where a private investor seeking profit, and not because social, political or philanthropic aims, after examining the situation, would not give such aid. 103 the grant of loans at reduced rates as well as the provisions of loans at market rates, where it is apparent that a private investor would not act as the public authority does, amount to aid.104 according to ahlborn and berg, the expansive interpretation of selectivity has turned state aid control into a broad rule against unjustified discrimination through state measures. for instance, in its widest interpretation the application of selectivity leaves barely any scope for general public measures. neither is there clear guidance as to the criteria which determine whether any discrimination is justified. the policy of the commission seems random and distinction between cases is sometimes hard to justify.105 for instance, there seem to exsist a "contradiction" between commission v italy106 and commission decision belgique107. in commission v italy, a reduction in contributions to the health insurance scheme for female employees, was held to be selective for it favored certain italian industries employing large numbers of female employees. whereas, in the belgique case, a reduction of employer`s social security contributions for firms that introduced shorter working hours, was regarded as general measure, as it applied to all firms in belgium. it is probable that the measure is regarded as aid, if the public authority exercises discretion in granting it. in french republic v commission the litigation arose from the financial participation of the fonds national de l`emploi (fne) in the implementation of a social plan by the company kimberly clark sopalin108. the court concluded that the fne enjoys a degree of latitude, which allows it to adjust its financial assistance having regard to a number of 100 state aid and public procurement: a practical guide. available at: http://www.cobbetts.com/ourservices/ eccompetition/stateaidandpublicprocurementapracticalguide. 101 plender 2004, p. 15. 102 hancher—ottervanger—slot 1999, p. 32. 103 for example, in deciding whether services are supplied by an entity subject to the control of the state to recipients who are alleged to have paid less than they are worth or whether an undertaking which has provided services to the state is alleged to have received a reward exceeding their value. see joined cases c-278/92, c-279/92 and c-280/92 kingdom of spain v commission of the european communities, [1994] ecr i-4103. 104 plender 2004, p. 8 10. 105 ahlborn—berg 2004, p. 53. 106 case c-203/82, commission v italy [1983] ecr i-2525. 107 commission decision n232/2991 belgique, 3.7.2001. 108 case c-241/94 french republic v commission of the european communities [1996] ecr i-04551. nordic journal of commercial law issue 2011#2 20 considerations, in particular, the choice of beneficiaries, the amount of the financial assistance and the conditions under which it is provided. thus, the court held that by virtue of its aim and general scheme, the system under which the fne contributed to measures accompanying social plans was liable to place certain undertakings in a more favorable position than others.109 the criterium of discretionary power on the part of public authorities is not however an absolute demand. in adria-wien pipeline gmbh110, which concerned an austrian legislative measure providing tax exemptions from energy taxes on natural gas and electricity, the court regarded measures selective and as constituting state aid within the meaning of the article 107(1) of the ec treaty. the court reached its conclusion, although the measure was established in the context of an overall package of measures to consolidate the budget, and exemptions were based on objective automatic criteria without the administrative authorities having any discretionary power in selecting the beneficiaries, and the measure gave benefits for a very large number of undertakings. one of the main reasons for this conclusion was that the tax exemption was applied only to undertakings whose activity was mainly in the manufacturing sector. the court held that the ecological considerations underlying the national legislation did not justify treating the consumption of natural gas or electricity by undertakings supplying services differently than the consumption of such energy by undertakings manufacturing goods, because the damage to the environment was the same. the court stated that undertakings in the services sector may, just like undertakings in the manufacturing sector, be major consumers of energy and incur a high level of energy taxes. therefore, they were in a disadvantaged position. the application of state aid rules on taxation is complicated, since schemes of taxation are usually generally expressed, but may still unequally affect taxpayers, based on their circumstances. the main criterion in applying state aid to a tax measure is that the measure provides an exception to the application of the tax system in favor of certain undertakings in the member state. the common system applicable should thus first be determined. it must then be examined whether the exception to the system or differentiations within that system are justified by the nature or general scheme of the tax system. if this is not the case, then state aid is present. 111 the fact that some firms or some sectors benefit more than others from some of these tax measures does not necessarily mean that they are caught by the competition rules 109 case c-241/94 french republic v commission of the european communities [1996] ecr i-04551, para 23 24. 110 case c-143/99 gmbh and wietersdorfer & peggauer zementwerke gmbh v finanzlandesdirek adria-wien pipeline tion für kärnten [2001] ecr i-08365. 111 commission notice on the application of the state aid rules to measures relating to direct business taxation. oj 1998 c384/3, para 16. nordic journal of commercial law issue 2011#2 21 governing state aid112. tax measures of a purely technical nature as well as measures pursuing general economic policy objectives through a reduction of the tax burden related to certain production costs, do not constitute state aid.113 most environmental support measures constitute an advantage for the undertaking, but in some cases the commission has found that there is no advantage. for example, in waste disposal system for car wrecks114, the commission found that there was no economic advantage for the companies in question, and therefore no state aid. the aim of the waste management system was to ensure that the companies that produce and sell cars also take the responsibility for a high degree of recycling of car wrecks, which corresponds to the polluter pays principle. the dutch government had declared that all car producers and importers had to pay charge for each car registered in the netherlands. the collected resources were paid to car dismantling companies. as the charge for car producers and importers and premiums to the dismantling companies were corresponding to the cost of recycling, the commission found that there was no advantage and state aid for car producers, nor for car dismantling companies. a state measure that must be regarded as compensation for the services provided by the recipient undertakings in order to discharge public service obligations (a benefit for public services) is generally regarded as compensation instead of aid, when it grants no notable economic advantage to the undertaking115. in adbhu 116the court followed the compensation approach. it involved the granting of indemnities that did not exceed the actual yearly costs to waste oil disposal undertakings as compensation for the obligations imposed on them to collect and dispose of waste oil. as the indemnities were held as appropriate compensation for waste disposal services, they did not constitute state aid. in altmark trans, the court specified its interpretation and stated: "--for such compensation to escape classification as state aid in a particular case, a number of conditions must be satisfied-first, the recipient undertaking must actually have public service obligations to discharge, and the obligations must be clearly defined.- second, the parameters on the basis of which the compensation is calculated must be established in advance in an objective and transparent manner-third, the compensation cannot exceed what is necessary to cover all or part of the costs incurred in the discharge of public service obligations, taking into account the relevant receipts and a reasonable profit-fourth, where the undertaking which is to discharge public service obligations, in a specific case, is not chosen 112 measures designed to reduce the taxation of labour for all firms have a relatively greater effect on labour intensive industries than on capital intensive industries, without necessarily constituting state aid. similarly, tax incentives for environmental, r&d or training investment favour only the firms which undertake such investment, but again do not necessarily constitute state aid. oj 1998 c384/3, para 14. 113 quigley 2004, p. 208. 114 c-11/2001 (ex n 629/00). invitation to submit comments pursuant to article 88(2) of the ec treaty concerning the waste disposal system for car wrecks in the netherlands. 115 case c-280/00 altmark trans gmbh [2003] ecr i-07747, para 87. 116 case 240/83 procureur de la république v adbhu [1985] ecr 531. nordic journal of commercial law issue 2011#2 22 pursuant to a public procurement procedure which would allow for the selection of the tenderer capable of providing those services at the least cost to the community, the level of compensation needed must be determined on the basis of an analysis of the costs which a typical undertaking, well run and adequately provided would have incurred in discharging those obligations".117 3.3.3 distortion or threat to competition & adverse effect on trade between member states generally avoiding discrimination and selectivity is recommended in state support measures, so that they can be considered general measures and not state aid measures. the baseline is that all state aid has an adverse effect on trade and competition118. it is crucial to separate injurious aid from the beneficial. even though no explicit regulation for this exists, it is quite clear according to article 107(2) and (3) that aid may be used as a remedy in achieving acceptable goals.119 the eu courts have stated in several cases that article 107(1) defines aid in relation to its effects instead of drawing distinction according to the causes or aims120.121 the development of “distortion of competition” as an independent analytical concept is the starting point of an effects-based state aid analysis. it is to say, that an improvement of the beneficiary`s relative market position (the effect) is a necessary condition for the "distortion of competition" interpretation. however, not every measure which affects the relative position of competitors should be viewed as distortion of competition. the ultimate aim of competition policy is the protection of competition, not competitors. this means that state aid control should be primarily concerned with the harm to those competitors that are at least as efficient. therefore, competition is distorted when state aid allows inefficient undertakings to survive artificially in a 117 case c-280/00 altmark trans gmbh [2003] ecr i-07747, para 88 93. the general provisions are now listed in the community framework for state aid in the form of public service compensation (2005/c 297/04), para 6. 118 see for example the traditional case 730/79 philip morris holland bv v commission of the european communities. [1980] ecr i-02671. according to advocate general, mr capotorti “--it is permissible—to start from the presumption that any public aid granted to an undertaking distorts competition—or threatens to do so where the aid is only proposed and not yet granted--“. 119 siikavirta 2007, p. 112. 120 yet, the aim is naturally taken into account by the commission when it determines whether an aid is compatible with the common market. 121 for example: case 173/73, commission v italy, [1974] ecr 709: “the social character of such state measures is not sufficient to exclude them outright from classification as aid for the purposes of article 92 of the treaty. article 92(1) of the treaty does not distinguish between measures of state intervention by reference to their causes or their aims but defines them in relation to their effects”; case c-126/01 ministère de l'économie, des finances et de l'industrie v gemo sa. [2003] ecr i-13769. opinion of mr advocate general jacobs delivered on 30 april 2002: “article 87(1) ec (now 107(1)) does not distinguish between measures of state intervention by reference to their causes or aims but defines them in relation to their effects. the causes or aims of a measure are not to be taken into account for its classification as aid but only for the assessment of its compatibility under article 87(2) and (3) ec (107(2) and (3))”. nordic journal of commercial law issue 2011#2 23 competitive market to the detriment of more efficient competitors.122 in practice, the criteria of distortion of competition and effect on trade between member states are met when an undertaking trades cross-border or when the branch extends from one member state to another123.124 small amounts of aid are not regarded competition-distorting or as affecting trade between member states.125 the above discussion of the conditions for evaluating the legality of state aid can be depicted as follows: 122 ahlborn—berg 2004, p. 49 50. 123 see commissions decision no 543/2001 – ireland capital allowances for hospitals (c (2002)608fin) where the ireland government proposed to introduce a system of capital allowances for investors in hospitals which meet specified service criteria and which undertake to reserve a minimum number of beds for national health patients. the commission held that the direct beneficiaries of this measure can only be private individuals with their economic interest based in ireland. therefore it cannot be considered as effecting trade between member states. it was also pointed out that the hospitals which receive an advantage from this measure operate on a market where the provision of facilities is liberalised and consequently there could be a potential effect on cross-border trade. however, in this specific case there are a number of factors which should be taken into account and which moderate this view. thus, although the three other cumulative conditions of state aid fulfilled, commission concluded that "the features of this specific case indicate that there is no effect on cross-border trade. consequently, even though there is an advantage to hospitals, the measure can be considered as not constituting state aid under article 87(1) [107(1)]". 124 siikavirta 2007, p. 113. 125 more about the de minimis aid on page 38. nordic journal of commercial law issue 2011#2 24 identifying state aid economic advantage: this can be in the form of sale of land at less than open market value, capital injection, loan guarantees, tax reliefs, privileged infrastructure access or simply direct grants. yes granted by public authority: does the aid involve a transfer of state resources (including central or local government, other public sector bodies, or private bodies acting under public direction and funding). yes selectivity: is the aid only available to a limited number of enterprises? (cf. general measures). yes effect on trade and competition: does the undertaking trade cross-border or does the branch extends from one member state to another? yes is the aid less than eur 200 000 (eur 100 000 in the road and transport sector & eur 7 500 in the agriculture sector) over a three fiscal year period ("de minimis" rule)? no is the aid covered by a block exemption regulation: the commission exempts some categories of state aid from the obligation of notification provided that the terms of the block exemption are respected. no has the aid already been approved by the commission as part of an existing aid scheme? no the aid needs to be individually notified and approved by the commission. 3.4 conclusions: does the measure constitute state aid? it should be fair to assume that all the following incentive instruments, if not purely marketbased, non-economic or solely granted to undertakings functioning in the markets where there is no cross-border transaction, distort or threaten to distort competition and affect trade between member states. consequently, the main focus here is on the conditions of selectivity and whether the aid must be granted by state or through state resources. nordic journal of commercial law issue 2011#2 25 having said this, it seems clear that tax reliefs126 as well as subsidies127 based on public financing constitute a grant through state resources. in addition, if the measures are selective, they most probably constitute state aid. schemes executed in the form of administrative contracts, for instance, within the forest biodiversity programme for southern finland (metso)128 seem to be somewhere in the grey zone between state aid and compensation for public services. when a public authority and landowner make an agreement on reimbursement for certain commitments it supports the interpretation that the measure is normal public procurement of services. yet, the measure in question allows the national authority to seek politically found targets that alternatively could be realized through binding national regulation, which is a genuine ground for state aid. it is anyhow quite challenging to evaluate the measure in the light of the general provisions of public service, set out in altmark trans gmbh 129, for no corresponding private service-markets yet exist.130 however, it should be born in mind that the metso program is executed only in non-industrial private forests and the policy is based on economic incentives and voluntarism on the part of forest owners. biodiversity conservation through binding regulation is thus not in practice an alternative to it. in a recent commission 126 tax reliefs for biodiversity conservation would be arrangements and provisions in general tax schemes, with the explicit aim of providing positive financial incentives steering the taxpayers’ behaviour in a more biodiversityfriendly direction. this definition excludes the use of tax revenues to finance or subsidize biodiversity conservation. it also excludes specific environmental taxes (for example, pollution charges and taxes on the conversion of nature into urban areas). examples of tax-reliefs include reduced rates or exemptions for forest and nature areas, tax relief on income from forest exploitation and deduction of expenses for nature management and losses on nature protection. tax reliefs can also be made on income from investments in nature and naturefriendly enterprises or in the form of reduced rates or exemptions for forest and nature areas, exemptions if the forest is managed sustainably or reduced tax-rates for eco-labelled (certified) products (policymix task 2.2. literature review on tax reliefs for biodiversity conservation). 127 environmental subsidies are used to stimulate changes in consumer behavior and create new markets for environmental goods. in this study the focus is especially in national payments for environmental services (pes) schemes. although the line between traditional subsidies and pes is blurred, the main difference is that, at least in theory, pes are more conditional on performance and can be suspended if the landowner defaults. environmental subsidies consist of financial assistance (often from governmental bodies) to businesses, citizens, or institutions to encourage a desired activity by reducing costs for beneficial activities, or by increasing the revenues of such entity for the purpose of achieving an objective. there are technical assistance grants or targeted grants for capacity building and knowledge sharing. pes schemes redistribute national wealth by making direct payments or compensations to those who produce the conservation benefit. (the payments considered in this study are made to landowners the use of market incentives to preserve biodiversity 2006, p 14). an example of a national pes scheme is a pilot nature values trading scheme in finland where voluntary conservation of sites was contracted against a fee that consisted of a payment for ecological values and a compensation for lost income. most pes schemes aiming at biodiversity conservation focus their attention on forest protection. when assigning an economic value to biodiversity, it must be recognized that biodiversity has both intrinsic and instrumental values. the latter includes revenues and potential revenues from ecotourism, bioprospecting and services that already have a market value. intrinsic value on the other hand is based on existence value in time and space. valuation of both the services is limited by the poor knowledge and understanding of their biophysical parameters and the nonexistence of markets for those services (chacón-cascante – porras – robalino 2010). 128 mmmp 144/2000. 129 case c-280/00, altmark trans gmbh [2003] ecr i-07747, para 88-93. 130 siikavirta 2007, p. 90. nordic journal of commercial law issue 2011#2 26 decision on state aid, environmental conservation tasks have now, for the very first time, been defined as services of general economic interest (sgei) by a member state131. according to the commission, the criteria that differed the sgei from a classical environmental aid measure, is that in the latter case the activities can only be carried out by undertakings on a voluntary basis, whereas sgei falls within the remit of the state acting as public authority. additionally, subsidies for conservation tasks132 implemented in the form of administrative contracts within the metso program have already been regarded as state aid by the european commission133. there is no legal difference whether the aid is granted by state or by county, federal authority, municipality or any other organ using public authority. as such, transfer of assets between public authorities is not generally regarded as aid. ecological fiscal transfer134 is state aid, if it ends up giving advantage to certain undertakings. in conclusion, if a municipality addresses the assets that it has received as central government transfers forward to certain undertakings, the measure is state aid and the municipality is the “aid-official”. if however, the assets received as central government transfers are not forwarded to undertakings (e.g. the measure does not provide tax reliefs or any other subsidies) but are rather just used to level the loss of municipals tax incomes135 caused by land use restrictions, the measure is presumably not regarded as state aid (in practice this might enable maintaining a lower municipal tax level in the future).136 tradable permits137, and possibly also habitat banking138, may constitute state aid if the trading instruments set by the officials are seemingly artificial, discriminatory or create economic 131 c(2009) 5080 final. this case will be dealt more carefully later in this study. 132 maintaining and restoring ecological, protective and recreational functions of forest, biodiversity and healthy forest ecosystems. 133 the european commission has regarded certain subsidies granted on grounds of law on finance for sustainable forestry (laki kestävän metsätalouden rahoituksesta 1094/1996) as state aid. see commissions decision n 130a/2007, para 27-29. 134 investments and maintenance of socio-economic public sector functions of urban agglomerations (such as schools, hospitals, and theatres) have long been a justification for targeted fiscal transfer schemes. targeted fiscal transfers are a suitable instrument for internalizing positive externalities. in the case of ecological fiscal transfers, this means greening the public expenditure. protected areas, for example, involve land-use restrictions that may force municipalities to forego development opportunities that would generate communal income. if transfers are made to compensate for these protected areas, their acceptance could be increased both at the municipal decisionmaking level, and by citizens in the area. brazil and portugal have implemented ecological fiscal transfers, compensating municipalities for land-use restrictions imposed by protected areas (ring 2008, p. 143-150). 135 see 1704/2009, chapter 7. 136 the interpretation is partly based on communication with kristian siikavirta, october 2010. 137 tradable permits are a way to provide market incentives to trade rights to pollute, use natural resources or develop areas that have previously been forest or pristine environments. they are designed to achieve fixed reduction targets in a cost efficient way (much reiterated but in a way also an unproven claim). in the cap-and-trade approach, allowances for future emissions or development of land are sold or granted free (grandfathering) to existing polluters or developers (the use of market incentives to preserve biodiversity 2006, p. 14). 138 see footnote on page 7. nordic journal of commercial law issue 2011#2 27 advantages. for example, the commission considers emission trading instruments (and possible habitat banking instruments) such as quotas, allowances, certificates and credits to be intangible assets for recipients if they are tradable in the market. when the state on its own initiative allocates such assets free of charge, the allocation can constitute state aid139. as such, certificates140 do not generally constitute state aid if the measure is not taken from the state budget.141 in its decision on the green oil certificate system in sweden (n789/2002), the commission held that an advantage given to the producers of green oil by granting them free oil certificates, which they can sell to the suppliers on the (future) green certificate market, does not constitute state aid.142 because the grant of free green certificates does not cause revenue forgone to the state, it does not constitute state aid. neither does the obligation by the state for licensed electricity suppliers to purchase a certain amount of green certificates (comparable to the obligation to purchase electricity produced from renewable energy sources at fixed minimum prices143), constitute state aid. however, if the certificate scheme, for example, includes sanctions for omission to buy the necessary amount of certificates, and suppliers who have not bought a sufficient amount have to pay a fine to a fund wherefrom the payments are 139 see national allocation plans for emissions trading: http://www.europa.eu.int/comm/environment/climat/ emission_plans.htm. last visited on 22.10.2010. 140 certificates are proofs of qualification. in the biodiversity context they imply that activities are carried out in an environmentally friendly way, for instance forest certification can advance biodiversity conservation in commercial forests through setting certain standards for sustainability of forest management and use. it can set even very strict standards for ecological sustainability and conservation of certain characteristics, e.g. retention trees, and setting aside certain habitat patches. certification is not a forest protection instrument, as it does not aim at protecting new areas nor can it influence the management of strictly protected forests, since forestry is forbidden in these by law. consequently forests in protected areas are not certified. forest certification can however ensure that conservation values in strictly protected forests are not endangered by forest work in adjacent commercial forests. increasing consumer demand for certification creates a powerful incentive for retailers and manufacturers to seek out suppliers that follow sustainability standards. this in turn prompts forest managers to adopt certified practices aimed at maintaining natural forest characteristics, and to move away from destructive practices (natural resources defence counsil). 141 in order to decide that the notified measure on green certificates constitutes state aid, the commission has to determine whether state resources are at stake. see eg. commissions decision n 504/2000, p 11. 142 "de svenska myndigheternas avsikt är att ge producenter av grön elektricitet extrainkomster genom försäljning av elcertifikat på marknaden. systemet utgör därför en förmån för dem. orsaken till att förmånen ges till dessa producenter är att det av miljöskäl är önskvärt att höja den gröna elektricitetens konkurrenskraft på den avreglerade elmarknaden. en åtgärd utgör emellertid inte statligt stöd om det inte är fråga om statliga medel. kommissionen har redan slagit fast att utdelning av gratis elcertifikat till producenter inte innebär någon förlust av statliga medel, eftersom certifikaten endast är ett bevis på att grön el har producerats. inte heller i föreliggande fall tas medlen från statsbudgeten, utan dessa betalas av alla elförbrukare – myndigheter, företag och enskilda – som omfattas av skyldigheten att köpa elcertifikat. elleverantörerna hanterar endast inköpsskyldigheten för slutkonsumenterna och får en hanteringsavgift för dessa tjänster". statligt stöd n 789/2002 – sverige elcertifikatsystemet (c(2003)382fin). 143 see case preussenelektra above. nordic journal of commercial law issue 2011#2 28 forwarded to producers, in order to secure a "guarantee price", such a fund-based procedure may constitute state aid.144 especially habitat banking and certificate schemes may coexist with some kind of fund-based financing, which for that reason is target for closer scrutiny. also, depending on the amount of state`s control, fund-based financing may be regarded as given through state resources. however, interpretations vary. as enshrined in van tiggele, the court also confirmed in sloman neptun145 that “advantages granted from resources other than those of the state do not fall within the scope of the provisions in question”. in some cases the commission has regarded fund-based measures as aid, yet compatible with the common market in the light of environmental protection. in a dutch case the commission authorised two measures called mep (milieukwaliteit van de elektriciteitsproductie — environmental quality of electricity production), aimed at stimulating renewable energy146 and combined heat and power (chp) production147. the purpose of this subsidy scheme was to increase supply. the scheme was financed through a compulsory contribution by electricity consumers in the form of an increased connection fee that was fed into a fund. the fund would favour dutch producers of renewable electricity and of chp electricity who feed their electricity into the high-voltage grid. the commission noted that the fund was set up by the state, was managed by a state company and would support only dutch producers of renewable electricity and of chp electricity. the commission therefore concluded that the scheme constituted state aid within the meaning of article 107(1) of the treaty and thus assessed the measures in the light of the community guidelines on state aid for environmental protection.148 environmental taxes, fees and charges149 are naturally left outside the definition of state aid for no grant from state`s resources occurs. the conclusion is that tax reliefs, subsidies, fiscal transfers, fund-based financing, tradable permits and liability compensation schemes may include state aid in the meaning of the article 107(1) tfeu. once a measure is considered to include state aid it must then be decided whether it still could be and on what conditions compatible with the common market in the light of environmental protection. 144 see commissions decisions n 789/2002 and n 504/2000. 145 joined cases c-72/91 and c-73/91 firma sloman neptun schiffahrts ag v seebetriebsrat bodo ziesemer der sloman neptun schiffahrts ag. [1993] ecr i-00887, para 19. 146n 707/2002. 147n 708/2002. 148 european commission, xxxiiird report on competition policy 2003, p. 102. 149 environmental taxes are compulsory, unrequited payments to general government levied on tax-bases deemed to be of particular environmental relevance. taxes are unrequited because benefits provided by government to society are not normally in proportion to their payments. environmental fees and charges are requited compulsory payments to the government, levied in proportion to services provided (the use of market incentives to preserve biodiversity 2006, p. 14). nordic journal of commercial law issue 2011#2 29 in conclusion, we can assess whether typical environmental measures would constitute state aid, based on the chart below. does the instrument constitute state aid? taxes, fees and charges (disincentives) are naturally left outside the definition of state aid for no state resources are at stake. subsidies subsidies for conservation tasks, also the ones implemented in the form of administrative contracts, have been regarded as state aid by the european commission. tax reliefs are regarded as state aid if they provide in favor of certain undertakings in the member state an exception to the application of the tax system: first the common system applicable should be determined, and then examined whether the exception to the system or differentiations within that system are justified by the nature or general scheme of the tax system. if not, state aid might be present. fund-based financing may be regarded as "given through state resources" depending on the amount of state`s control. in order to assess the involvement of state resources three cumulative criteria have to be fulfilled: the fund must be established by the state, the fund must be fed by contributions imposed by the state, and the fund must be used to favour specific enterprises. tradable permits may constitute state aid if the trading instruments set by the officials are seemingly artificial, discriminatory or create economic advantages. habitat baking and offsets may constitute state aid if the trading instruments set by the officials are seemingly artificial, discriminatory or create economic advantages. where payments for credits are dispatched into a fund, from where they are deferred to the creators of beneficial biodiversity outcomes, there is a possibility that this fund-based finance will be regarded as “granted trough state resources”. certificates as such, do not generally constitute state aid if the measure is not taken from states budget, which is usually not the case. if eg., the certificate scheme includes sanctions for omission to buy necessary amount of certificates and suppliers who do not have sufficient amount have to pay a fine to a fund from where those payments are granted forward to the producers to provide them a "guarantee price", such fund-based measure may constitute state aid. fiscal transfers as such, transfer of assets between public authorities is not generally regarded as aid. such transfer is state aid if it ends up giving advantage for certain undertakings: if a municipality addresses the assets that it has received as central government transfers forward to certain undertakings, the measure is state aid and the municipality is the “aidofficial”. if however, the assets received as central government transfers are not delivered forward to undertakings but are rather just used to level the loss of municipals tax incomes, caused by land use restrictions, the measure is presumably not regarded as state aid. nordic journal of commercial law issue 2011#2 30 4 when is the measure which constitutes state aid compatible with common market? 4.1 preface – the antithesis of environmental policy and competition policy according to article 4 tfeu, the eu shares competence with the member states in the principal area of environment. article 193 tfeu provides for the so-called environmental guarantee of the member states. pursuant to that, the member states are allowed to introduce more stringent national policies as long as the measures are compatible with the treaties and have been notified to the commission. according to articles 34-35 tfeu quantitative restrictions on imports and exports and all measures having equivalent effect are prohibited between member states. article 107 tfeu provides the principal prohibition on the use of state aid. the formation of the internal market through realization of the single european act (1986) had a crucial influence, since the completion of the internal market and the approaching economic and monetary union required an increasingly effective control of state aid, and such aid could be used to resurrect barriers to trade that had already been dismantled in the integration process.150 on the other hand, the environmental exceptions in the treaty have been invoked to justify these policy measures. pursuant to article 36 tfeu “the provisions of articles 34 and 35 shall not preclude prohibitions or restrictions on imports, exports or goods in transit justified on grounds of public morality, public policy or public security; the protection of health and life of humans, animals or plants; the protection of national treasures possessing artistic, historic or archaeological value; or the protection of industrial and commercial property”. in the case-law of the european court of justice, environmental protection has become accepted as a legitimate objective capable of hindering the free movement of goods. the danish bottles case”151 was the first case where the court recognized that the protection of the environment is a mandatory requirement, which may limit the application of article 28 (now 34).152 in bluhme153 the danish kriminalret decided to refer to the court the question as to whether danish legislation complied with community law. in order to protect an indigenous population of bees in specific areas, a danish legislative decree provided that only nectar-gathering bees of the 150 fifth survey on state aid in the european union in the manufacturing and certain other sectors. report from the commission. com (97) 170 final, 16 april 1997. 151 case 302/86. judgment of the court of 20 september 1988. commission of the european communities v kingdom of denmark. free movement of goods containers for beer and soft drinks. ecr 1988, p. 4607. 152 in order to protect the environment, denmark introduced and applied an order which meant that all containers for beer and soft drinks must be returnable, and that the containers must be approved by a national agency. according to the court, the mandatory collection system for containers of beer and soft drinks applied in denmark was justified by a mandatory requirement related to the protection of the environment. case 302/86, point 7. 153 case c-67/97 criminal proceedings against ditlev bluhme [1998] ecr i-08033. nordic journal of commercial law issue 2011#2 31 subspecies apis mellifera mellifera (læsø brown bee) may be kept on the island of læsø and certain neighbouring islands. mr bluhme argued that the danish legislation hinders the free movement of goods. the court held that a national legislative measure prohibiting the keeping on an island such as læsø of any species of bee other than the subspecies apis mellifera mellifera (læsø brown bee) must be regarded as justified, under article 36 of the treaty, on the ground of the protection of the health and life of animals.154 regardless of the principal prohibition of state aid, the treaty includes many exemptions in articles 107(2) and 107(3). accordingly, certain beneficial aids that foster the function of the common market should be permitted. hereby the demarcation must be made between artificial aids granted with protectionist aims on the one hand and genuinely justifiable aids, on the other155. for instance, aid may be justified by it giving private firms an incentive to invest more in environmental protection or through relieving some firms from a relatively high financial burden in order to enforce a stricter environmental policy overall. the growth of the importance of environmental protection, as well as the position of environmental arguments as a ground for restriction of trade liberalisation, has followed the general development of eu environmental policy. especially this has happened after the treaty of amsterdam.156 additionally, the charter of fundamental rights in the european union (article 37) pronounces that “a high level of environmental protection and the improvement of the quality of the environment must be integrated into the policies of the eu and ensured in accordance with the principle of sustainable development”. since according to article 6 teu the eu recognises the rights, freedoms and principles set out in the charter has the same legal value as the treaties, the environmental protection can be seen more as a fundamental right than as a restriction principle for trade liberalisation157. it so seems that trade liberalisation no longer takes precedence over the environmental protection in the interpretation of eu law, but they are given more or less equal importance. the question is thus about consolidating these two goals in accordance with the relevant regulation, which will be presented in the following. 154 case c-67/97, para 38. 155 for example, the commission is aware that almost all new investments in technological developments have an indirect positive effect on the environment and there is a temptation to present normal productive investments as being determined by environmental factors in order to attract state aid (see eg. commissions decision c34/2000). facenna 2004, p. 253. 156 paunio 2007, p. 63. 157 about environmental protection as a fundamental right, see eg. paunio 2007, p. 117-120. nordic journal of commercial law issue 2011#2 32 4.2 the justification grounds for state aid 4.2.1 preface though state aid is basically prohibited under article 107(1), paragraphs 2 and 3 define the exemptions under which aid measures can be authorised. member states cannot themselves assess the eligibility of aid, but a prior notification procedure is applied. over the past decades, a lot of secondary legislation and guidelines have emerged in order to give practical guidance as to the application of these exemptions. the rules must evolve to keep pace with economic and technological change, with the emergence of new political priorities, such as the increased emphasis placed on the protection of the environment during the last decade.158 articles 107(2) and (3) enable aid that fosters the growth of the economy, competition and the functioning of the common market, if such effects can be formulated. regulation also allows aid as an instrument for society politics. the idea is that beneficial aids should be permitted.159 the european commission and ultimately the court of justice decide whether the aid is compatible with the common market according to the treaties. the commission has wide discretion, the exercise of which involves economic and social assessments which must be made in eu context. the court may primarily only interfere with clear errors concerning the discretion.160 4.2.2 aid compatible as such according to article 107(2) the following shall be compatible with the internal market: (a) aid having a social character, granted to individual consumers, provided that such aid is granted without discrimination related to the origin of the products concerned; (b) aid to make good the damage caused by natural disasters or exceptional occurrences; (c) aid granted to the economy of certain areas of the federal republic of germany affected by the division of germany, in so far as such aid is required in order to compensate for the economic disadvantages caused by that division. five years after the entry into force of the treaty of lisbon, the council, acting on a proposal from the commission, may adopt a decision repealing this point article 107(2) does not seem to have much relevance from an environmental point of view, but at least point (b) may well be relevant for the regulation of the environment. exemplary is the case of the floods caused by the river maas in the south-east of the netherlands, which gave rise 158 buelens—garnier—johnson—meiklejohn 2007, p. 2. 159 siikavirta 2007, p. 114. 160 siikavirta 2007, p. 115. nordic journal of commercial law issue 2011#2 33 to aid approved under the natural disaster or exceptional occurrence provision.161 also state aid– finland draft decree of the council of ministers on compensation to fishermen for losses caused by seals (n: o n 102/01), was justified on the ground of the article 107(2)(b). the purpose of the draft decree was to grant aid to fishermen for the catch losses caused in 2000 and 2001 by seals and it embraced partial compensation for proven catch losses, less an amount to be borne by the fisherman162. 4.2.3 aid that may be considered compatible article 107(3) stipulates that the following may be considered compatible with the internal market: (a) aid to promote the economic development of areas where the standard of living is abnormally low or where there is serious underemployment, and of the regions referred to in article 349, in view of their structural, economic and social situation; (b) aid to promote the execution of an important project of common european interest or to remedy a serious disturbance in the economy of a member state; (c) aid to facilitate the development of certain economic activities or of certain economic areas, where such aid does not adversely affect trading conditions to an extent contrary to the common interest; (d) aid to promote culture and heritage conservation where such aid does not affect trading conditions and competition in the union to an extent that is contrary to the common interest; (e) such other categories of aid as may be specified by decision of the council on a proposal from the commission. it must be examined to what extend the normal grounds for exemption can be used to make aid compatible. in the light of the integration principle such exemptions should be interpreted 161 xxivth competition report, point 354. 162 pursuant to point 2.9.3. (aid to make good damage caused by natural disaster or exceptional occurrences) of the guidelines for the examination of state aid to fisheries and aquaculture (oj c n:o 19, 20.1.2001, p 7): "according to article [107(2)(b) of tfeu], aid to make good damage caused by natural or exceptional occurrences is deemed to be compatible with the common market". pursuant to council directive 92/43/eec ringed seal and gray seal are protected species. the aid was thus justified on the exception grounds (article 16) of that directive. accordingly, "provided that there is no satisfactory alternative and the derogation is not detrimental to the maintenance of the populations of the species concerned at a favourable conservation status in their natural range, member states may derogate from the provisions-to prevent serious damage, in particular to crops, livestock, forests, fisheries and water and other types of property--". from that aspect, and foremost taking into account the exceptional increase of the seal population, the hunting prohibition of the seals and the size of the damage caused, there was a reason to assume that the aid was meant to compensate the damage caused by natural disaster. nordic journal of commercial law issue 2011#2 34 in an environmentally friendly way163 for the requirements of environmental protection need to be integrated into the definition and implementation of competition policy, particularly in order to promote sustainable development. two grounds for exemptions are essentially relevant for environmental state aid: article 107(3)(b)164 and topmost article 107(3)(c).165 it is for member states to show that the aid benefits the environment. even though protection of the environment may seem one of the more legitimate objectives of state aid, there is an immediate potential contradiction with a fundamental principle of environmental policy, i.e. the polluter pays principle (ppp).166 accordingly, the ppp is the main rule for achieving a higher level of environmental protection. state aid is in fact the second-best option and may not be an appropriate instrument in the context of ppp for it would relieve the polluter from paying the cost of its pollution167. whilst the polluter pays principle means that polluters should not be relieved of the obligation to pay for their own waste, the commission has allowed environmental aid in several cases.168 according to european council recommendation exceptions to the ppp may be justified in limited cases where the immediate application of very stringent standards or the imposition of substantial charges is likely to lead to serious economic disturbances and where, in the context of other policies investment affecting environmental protection benefit from aid intended to solve certain industrial, agricultural or regional structural problems.169 a large number of the environmental measures approved serve the support of renewable energy production, using different aid instruments for 163 jans—vedder 2008, p. 295. 164 the court held, in the case 62/87 exécutif régional wallon and sa glaverbel v commission of the european communities. [1988] ecr 1573, para 20 22, that “a project may not be described as being of common european interest for the purpose of that article [107(3)(b)] unless it forms part of transnational european programme supported jointly by a number of governments of the member states, or arises from concerted action by a number of member states to combat a common threat such as environmental pollution”. 165 it should be noted that, in assessing aid by member states in fields other than that of the environment, the environmental effects of aid should be taken into account. equally, aid for projects which entail disproportionate effects for the environment should be avoided. see jans—vedder 2008, p. 295. 166 jacobs 2004, p. x. 167 the decision of the commission (oj 1993 l 273/51) shows that state aid cannot be given if it conflicts with the polluter pays principle. the commission concluded that the proposed aid to cartiere del garda does not meet the “polluter pays principle” contained in the treaty. the commission doubted whether the aid was necessary to achieve the desired objective. “the derogations may be applied only if the commission finds that, if the aid were not granted, market forces alone would not be sufficient to induce the recipients to act in such a way as to achieve one of the objectives pursued”. 168 sec (2007) 860, para 28. report on competition policy 2006. 169 council recommendation 75/436 of 3 march 1975, regarding cost allocation and action by public authorities on environmental matters. (oj l 194, 25.7.1975, p. 1 4). nordic journal of commercial law issue 2011#2 35 that purpose, mostly investment aid and operating aid in the form of tax reductions or feed-in tariffs170. the ppp is based on the assumption that market failure171 may be avoided if individuals are required to incur the full costs of their actions, including any negative externalities their actions may impose on the community through environmental damage and biodiversity loss.172 under ppp, impacters are required to contribute to the costs of activities that improve biodiversity or prevent biodiversity damage in proportion to their impacts on biodiversity. environmental aid to assist undertakings just to comply with valid eu standards cannot thus be authorised, for such aid would not lead to a higher level of environmental protection173. neither is state aid granted to farmers for simply respecting or not meeting an obligation to keep all agricultural land in good agricultural and environmental condition.174 however, there are limits on the application of the ppp and some environmental costs are not fully reflected in the prices, because adequate standards do not exist. this regulatory failure should not prevent member states from reducing negative externalities to the greatest extent possible and from imposing requirements for environmental protection that go beyond eu requirements. by lowering the burden on undertakings, state aid may be an appropriate instrument in helping member states to adopt national environmental regulation that goes beyond eu standards. when environmental protection is unsatisfactory, state aid may also provide positive incentives for undertakings to carry out non-mandatory activities.175 4.3 exemption from the obligation of notification in addition to aid approved without notification on the basis that it fits within an already notified general aid scheme, the commission may exempt some categories of state aid from the obligation of notification. these general block exemptions (gber)176 simplify the eu regulations. in order to be exempted from the obligation to notify, the categories of aid concerned must 170 see for example: nn162/a/2003 and n317/a/2006, austria, support of electricity production from renewable sources under the green electricity act (feed-in tariffs) (oj c 221, 14.9.2006, p 9), nn162/b/2003 and nn317/b/2006, austria, support of chp production under the green electricity act (support tariff) (oj c 221, 14.9.2006, p 9). 171 when individuals do not bear the full cost of their decisions, resources are misallocated and market failure occurs. 172 arentino et al. 2001, p 15. 173 community guidelines on state aid for environmental protection (oj 2008 c 82/1). 174 (ec) no 1782/2003. 175 community guidelines on state aid for environmental protection, oj c 82, 1.4.2008, p. 4 7. 176 commission regulation (ec) no 800/2008 (6.8.2008) declaring certain categories of aid compatible with the common market in application of articles 87 and 88 of the treaty (general block exemption regulation). (oj l 214). nordic journal of commercial law issue 2011#2 36 conform to all the conditions (specifically they must have an incentive effect and conform to transparency criteria) and the relevant provisions (intensity of the aid, eligible costs, maximum amount of aid) listed in detail in this particular regulation (ec) no 800/2008. the gber authorizes the following aid types: aid in favor of small and medium-sized undertakings (smes), aid for research and innovation, regional development aid, training aid, employment aid, aid in the form of risk capital, environmental aid177, and aid promoting entrepreneurship.178 another exemption from obligation of notification is the so-called de minimis rule.179 the de minimis rule was introduced in order to exempt small aid amounts180. it sets a ceiling below which aid is deemed not to fall within the scope of article 107(1) and is therefore exempt from the notification requirement. according to the de minimis rule, an aid of no more than eur 200 000 (eur 100 000 in the road and transport sector) granted over a period of three fiscal years is not regarded as state aid within the meaning of article 107(1)181. in order to avoid circumvention of maximum aid intensities provided in different community instruments, de minimis aid should not be cumulated with state aid in respect of the same eligible costs if such accumulation would result in an aid intensity exceeding that fixed in the specific circumstances of each case by a block exemption regulation or decision adopted by the commission. this regulation should apply only to transparent aid, for which it is possible to calculate precisely the gross grant equivalent ex ante without a need to undertake risk assessment. such precise calculation can, for instance, be realised as regards grants, interest rate subsidies and capped tax exemptions.182 in view of the special rules, which apply in the agriculture sector and of the risks that even low levels of aid could fulfill the criteria of article 107(1) of the treaty in that sector, the primary 177 accordingly, in some cases, investment aid enabling undertakings to go beyond community standards for environmental protection or increase the level of environmental protection in the absence of community standards; aid for acquisition of new transport vehicles which go beyond community standards or which increase the level of environmental protection in the absence of community standards; aid for early adaptation to future community standards for smes; investment aid for energy saving measures; investment aid or high-efficiency cogeneration; investment aid for the promotion of energy from renewable energy sources; aid for environmental studies; and aid in the form of reductions in environmental taxes do not need to be notified. however, any such aid needs to be notified if it exceeds the individual notification thresholds of eur 7.5 million per undertaking per investment project. similarly, if the conditions of the gber are not fulfilled, aid also needs to be notified and will be assessed on the basis of the guidelines. 178 see closer about the eligible cost etc in (ec) no 800/2008. 179 (ec) no 1998/2006 (15.12.2006) on the application of articles 87 and 88 of the treaty to de minimis aid. (oj l 379). 180 the idea of state aid regulation is that injurious aids must be banned. small aids are not regarded to have an adverse effect on the competition and trade. 181 when an overall aid amount provided under an aid measure exceeds this ceiling, that aid amount cannot benefit from this regulation even for a fraction not exceeding that ceiling. 182 (ec) no 1998/2006 (15.12.2006), points 11-13. nordic journal of commercial law issue 2011#2 37 production of agricultural products are excluded from the general de minimis regulation.183 pursuant to regulation (ec) no 1535/2007184 the maximum non-aid amount in the agriculture sector is eur 7500 per beneficiary over a period of three fiscal years and the ceiling of annual output is 0,75%. the forestry sector has its "own" guidelines185 according to which the forest sector can benefit from aid granted under the de minimis regulation applicable to industrial activities. however, pursuant to aforementioned regulation (ec) no 1535/2007 undertakings active in the primary production of trees and other plants would seem to be excluded from the general de minimis regulation186 and environmental conservation tasks executed under primary production of forests would seem to be left under the scope of (ec) no 1535/2007 and the maximum nonaid ceiling of eur 7500. yet, the court187 has held that “the aid to the forestry holdings is aimed at a sector, forestry sector, which is not included in the list of agricultural products in annex ii188 to the treaty and therefore does not relate to an agricultural product within the meaning of article 38189 of the treaty”.190 thus, the crucial question seems to be whether environmental conservation tasks in forests are forestry or not. for the commission has held that the land use of a farmer is too interconnected to create a separation into different functions, such as environmental services and forestry191, it seems that environmental conservation in forests is to be held forestry, and the general de minimis rule applies. 183 also aid for fisheries and aquaculture, export-related activities, the coal sector, the acquisition of road freight transport vehicles or firms in difficulty, or to aid tied to the use of domestic over imported goods are excluded from regulation (ec) no 1998/2006. 184 (ec) no 1535/2007 on the application of articles 87 and 88 of the ec treaty to de minimis aid in the sector of agricultural production. 185 chapter vii of the community guidelines for state aid in the agriculture and forestry sector 2007 to 2013 (oj c 319, 27.12.2006). 186 according to article 2 of (ec) no 1535/2007. "undertakings in the sector of agricultural production" means undertakings active in the primary production of agricultural products and "agricultural products" means the products listed in annex i to the treaty, which includes live trees and other plants (in chapter 6). 187 joined cases c-346/03 and c-529/03 [2006] state aid decision 97/612/ec preferential loans in favour of agricultural undertakings article 92(2)(b) and (3)(a) and (c) of the ec treaty (now, after amendment, article 87(2)(b) and (3)(a) and (c) ec) admissibility legal basis legitimate expectations. ecr i-1928. 188 now annex i, which includes eg. live trees and other plants. 189 article 38, according to which the union shall define and implement a common agriculture and fisheries policy. the internal market shall extend to agriculture, fisheries and trade in agricultural products. ‘agricultural products’ means the products of the soil, of stockfarming and of fisheries and products of first-stage processing directly related to these products. references to the common agricultural policy or to agriculture, and the use of the term ‘agricultural’, shall be understood as also referring to fisheries, having regard to the specific characteristics of this sector. 190 joined cases c-346/03 and c-529/03, para 43. 191 see closer chapter 5.2. of this study: case of netherlands. nordic journal of commercial law issue 2011#2 38 4.4 guidelines according to state aid action plan the compatibility of state aid is fundamentally about balancing the negative effects of aid on competition with its positive effects in terms of advancing a common interest192. in balancing the positive impact of the aid measure against the potentially negative side effects, the commission has to consider whether the aid measure is aimed at a well-defined objective of common interest (here: the protection of biodiversity) and whether the proposed aid address the market failure or other objective. this includes deliberating whether the state aid is an appropriate policy instrument, whether it has an incentive effect in changing the behaviour of undertakings, and whether the aid measure is proportional -or could the change in behaviour be obtained with less aid. finally, the commission has to estimate whether the distortions of competition and effect on trade is so limited that the overall balance is positive.193 the duration of aid schemes should be subject to reasonable time limits. however, member states have a possibility to re-notify a measure after the time limit has passed. member states may also support notifications of aid measures by rigorous evaluations of similar past aid measures demonstrating the incentive effect of the aid.194 while the principles put forward in the action plan apply to all sectors, the commission has issued several regulations, guidelines and notifications which more specifically define the grounds for acceptabitility of the exceptions laid down in article 107(3) tfeu. besides the already mentioned general block exceptions and de minimis regulation, the most important rules in the view of biodiversity conservation are the community guidelines on state aid for environmental protection (hereinafter environmental aid guidelines)195 and community guidelines for state aid in the agriculture and forestry sector (hereinafter agriculture and forestry aid guidelines)196.197 since conservation tasks may sometimes be seen as public services, also the community framework198 considering public service compensation may apply. the environmental aid guidelines function on the basis of article 107(3)(c) and the exemption provided for in article 107(3)(b). in these guidelines the commission has identified a series of measures in respect of which it considers a priori that state aid will address a market failure 192 if state aid on the basis of balancing test leads to increased environmental protection activities without adversely affecting trading conditions contrary to the common interest, it is compatible with the common market within the meaning of article 107(3)(c). 193 state aid action plan—less and better targeted state aid: a roadmap for state aid reform 2005-2009. com(2005) 107 final, point 10-12. 194 community guidelines on state aid for environmental protection, point 71. 195 community guidelines on state aid for environmental protection (oj 2008 c 82/1). 196 community guidelines for state aid in the agriculture and forestry sector 2007 to 2013 (oj c 319, 27.12.2006). 197 see also guidelines for the examination of state aid to fisheries and aquaculture oj c 84/06 2008. 198 community framework for state aid in the form of public service compensation (oj c 297 29.11.2005). nordic journal of commercial law issue 2011#2 39 hampering environmental protection or improve on the level of environmental protection. measures that are targeted at environmental protection, but are not covered by environmental aid guidelines or a general block exemption regulation, as well as certain remarkable aid amounts, will be subject to a detailed assessment according to chapter five of the environmental aid guidelines. these measures will be declared compatible if the balancing test results in an overall positive evaluation.199 as a result of this detailed assessment, the commission may approve the aid, declare it incompatible with the common market or take a compatibility decision subject to conditions.200 the environmental aid guidelines apply to state aid for environmental protection in all sectors governed by the eu treaty. they also apply, unless otherwise disposed, to those sectors which are subject to specific eu rules on state aid. hence, the environmental aid guidelines, also apply to the agriculture sector201 and to the forestry sector. in the forestry sector though, the use should be limited to authorizing additional state support for forestry, promoting the ecological, protective and recreational functions of forests.202 the agriculture and forestry aid guidelines apply to all state aid granted in connection with activities related to the production, processing and marketing of agricultural products203. the guidelines describe the main types of aid, which the commission can accept and the conditions attaching to the granting of the aid. chapter vii of the agriculture and forestry aid guidelines contains rules for aids for the forestry sector, including aids for the afforestation of agricultural land. pursuant to that chapter it is an established commission practice to authorize state aid for conservation, improvement, development and maintenance of forests on account of the ecological, protective and recreational functions of forest. traditionally the commission has accepted state aid up to 100 % of eligible costs for measures promoting the maintenance of the forest environment.204 199 additional scrutiny is necessary, because of higher risks of distortion of competition and trade. the additional scrutiny will generally consist in further and more detailed factual analysis of the measure in accordance with chapter 5. community guidelines on state aid for environmental protection, para 40. 200 guidelines are given for two types of assessments: a standard assessment for measures involving aid under a certain threshold or aid granted to installations with a production capacity below a certain threshold (chapter 3) and a detailed assessment for measures involving aid above that threshold or aid granted to installations with a production capacity above that threshold as well as for aid granted to new plants producing renewable energy where the aid amount is based on a calculation of the external costs avoided (chapter 5), para 13. 201 community guidelines for state aid in the agriculture and forestry sector 2007 to 2013, points 49, 61-63. 202 community guidelines for state aid in the agriculture and forestry sector 2007 to 2013, point 174a. 203 see the annex i of the treaty. 204 community guidelines for state aid in the agriculture and forestry sector 2007 to 2013, point 173. nordic journal of commercial law issue 2011#2 40 5 commission’s decisions 5.1 introduction the commission is bound by the guidelines and notices that it issues in the area of supervision of state aid where they do not depart from the rules in the treaty and are accepted by the member states. 205 yet the commission has a wide discretion, the exercise of which involves economic and social assessments. as mentioned before, article 107(1) defines aid in relation to its effects. consequently, the used measure is not pivotal and the state aid rules seem to be quite neutral regarding the form in which the aid is awarded. however, different instruments are conventionally used for different kind of nature and biodiversity conservation activities. next, examples on a few of the more important biodiversity conservation measures will be presented. by reviewing commission practice, the aim is to form an overall perception on what kind of state aid challenges these conservation measures may need to deal with. 5.2 conservation areas 5.2.1 purchase of land nature conservation areas are the most conventional way to preserve biodiversity values. in addition to expropriation, states may procure land for conservation purposes on a voluntary basis. if a landowner wishes to establish a private conservation area in his forest, he will be paid for the economic loss based on the intrinsic value of the timber in the area. when a landowner sells the land to the state, the price will be set based on the intrinsic value of the timber and the sub grade. the pricing methods are the same as those used in the forestry land and in the sales of properties. the costs of timber production are taken into account in pricing. luxuriant sub grades, such as groves, are valued higher than unproductive sub grades.206 the sales of land between private and public authority may include an element of state aid in favor of the private party. with regard to the problem of state aid through sales of land and buildings by public authorities, the commission has drawn up general guidance to member states in order to make its general approach transparent and to reduce the number of cases it has to examine.207 even though the guidance concerns only the sales of land and buildings by public authorities, the principle of forbidden state aid is equally applied on over-pricing of the 205 case c-351/98 kingdom of spain v commission of the european communities [2002] ecr i-8031, para 76. 206 metso uutiskirje 1/2011. available at: http://www.metsonpolku.fi/metso/uutiskirje/2011/1/fi/ rahajuttu.php. last visited in 30.3.2011. 207 commission communication on state aid elements in sales of land and buildings by public authorities (oj) c 209, 10.7.1997, p. 3-5. the guidance describes a simple procedure that allows member states to handle sales of land and buildings in a way that automatically precludes the existence of state aid and specifies clearly cases of sales of land and buildings that should be notified to the commission to allow for assessment of whether or not a certain transaction contains aid and, if so, whether or not the aid is compatible with the common market. nordic journal of commercial law issue 2011#2 41 purchase of land by public authorities208. according to commission`s decision n 657/1999 “the acquisition and development of land and buildings are addressed in part by the ec public procurement directives209, which, if satisfied, generally eliminate state aid from the transactions.”210 according to the public procurement regulation the awarded contract should be either the most financially advantageous tender or the lowest price. if the contract is awarded on the basis of the most financially advantageous tender, tenders are compared against the predescribed criteria. to escape the classification as state aid the purchase of the land has to be in conformity with the market economy investor principle (meip). accordingly, when a public authority invests on terms and in conditions which would be acceptable to a private investor operating under normal market economy conditions, the investment is not a state aid. the meip is a construction, a test of what the treaty means by “favour” in article 107(1).211 pursuant to that, the purchase of the properties has to be done under market conditions.212 also, when the state arranges an open auction where it invites landowners to make offers of biodiversically rich land areas and then selects the overall economically most advantageous offer, the purchase seems to be done under market conditions. in this case the state is able to take into account the biodiversity richness as one selection criteria in weighing the option that best suits its needs, since any market investor in principle has the same right. fixing up an open auction would seem to be quite strong proof that the public authority is seeking to avoid the possibility of state aid. hence, in so far as land is bought at the highest price, which a private investor acting under normal competitive conditions is ready to pay in the same situation, the purchase complies with the market economy investor principle and therefore does not constitute state aid.213 if the public authority however pays "extra" on top of the market value, the purchase most likely constitutes state aid. according to the detailed assessment of environmental aid guidelines, in order to be compatible with the common market, the state aid has to: induce undertakings to pursue environmental protection which they would not otherwise have pursued, be targeted at a market failure by having a substantial impact on environmental protection, be an appropriate 208 see state aid c 37/2004 finland – alleged aid to componenta. 209 see closer at: http://ec.europa.eu/internal_market/publicprocurement/legislation_en.htm. 210 state aid no n 657/1999 – united kingdom business infrastructure development, p. 4. 211 the market economy investor principle has been a cornerstone of state aid control ever since the commission published its communication on government capital injections (bulletin ec 9-1984). ben slocock, directorategeneral competition: the market economy investor principle. competition policy newsletter. number 2—june 2002, p. 23-26. 212 see eg. state aid c 12/2009 (ex n 19/2009) – potential aid measures in favour of järvi-suomen portti osuuskunta, paras 28-29. 213 the interpretation is partly based on communcation with julius parikka, november 2010. nordic journal of commercial law issue 2011#2 42 instrument to obtain the objective of environmental protection, result in the recipient changing its behaviour to increase the level of environmental protection, be necessary, be kept to the minimum amount and go through a proportional selection process. in addition, the commission will assess the likelihood that the beneficiary will be able to increase or maintain sales as a result of the aid.214 even if the state aid improves environmental protection, it is yet quite challenging for any "overvaluation" to pass the balance test in the assessment of the commission, since its established practice is to only compensate for the revenue losses and additional costs.215 it would thus seem illogical to accept “trade of nature values”. it might also be hard to provide evidence of necessity of the aid, since at least in principle, the possibility for expropriation exists, too. nevertheless, the state aid rules do introduce uncertainty, with it only being possible to obtain certainty through state aid notification to the commission216. the aid may also be granted as tax relief (as an exception to the tax system). for example, in finland, according to the income tax act,217 profit gained from assignment of one`s real estate is not taxable income when taxpayer assigns it to the state, or commercial enterprise of the state, to be used as a natural conservation area consistent to the definition in natural conservation act (luonnonsuojelulaki 1096/1996).218 the main criterion in applying state aid to a tax measure is that the measure provides an advantage in favor of certain undertakings in the member state. if so, it must then be examined whether the exception to the system or differentiations within the system, is justified by the nature or general scheme of the tax system. if this is not the case, then the tax relief might be considered state aid. 219 the application of state aid rules to taxation presents particular difficulties, as distinguishing between them and general measures of economic policy may be rather obscure220. according to advocate general darmon, “the only fundamental precondition for the application of article [107(1)] is that the measure should constitute a derogation by virtue of its actual nature, from the scheme of the general system in which it is set”221. this particular tax exception could well involve aid as it constitutes a derogation from the ordinary rules relating to income taxes, in favor of 214 community guidelines on state aid for environmental protection, points 165-185. 215 see eg. "payments for environmental services" below (in chapter 5.2.). 216 if the compensation for natural values was included in the agri-environmental state aid payments it could also be more justifiable to accept similar aid measures for land procurement. 217 tuloverolaki 30.12.1992/1535, 48.4 §. 218 according to the same point, profit gained from land exchange, when the assingned land is used as a natural conservation area, is neither taxable income of the taxpayer. 219 commission notice on the application of the state aid rules to measures relating to direct business taxation. oj 1998 c384/3, para 16. 220 quicley, c: the notion on state aid in the eec, 13 elrev (1988) 243 at 245. 221 opinion of advocate general darmon, [1993] ecr i-887, para 50. nordic journal of commercial law issue 2011#2 43 landowners whose activity on this land is mainly in the primary production of forest.222 yet, there is no discretion on the part of the tax authority. this would speak in favor of a general measure, as it applies to all taxpayers who assign their real-estate to the state, or commercial enterprise of the state, to be used as a natural conservation area. assuming the advantage is given through exemption from income taxation, it constitutes state aid if it distorts competition and affects trade between member states. as practically all aid distorts competition it is up to the criterion of affecting trade between the member states whether the measure in question is state aid within the meaning of article 107(1). as stated above, this criterion is met when an undertaking trades cross-border or when the sector extends from one member state to another, which is usually the case with forestry sector. it is most probable that the aforementioned tax relief is to be held as a general scheme, and even if it was state aid within the meaning of article 107(1), it could still be viewed as so-called “existing aid”, which the state aid rules treat differently from aid granted after a member state signs up. also, the original basis for the tax relief, the income tax act (tuloverolaki), was in force already before finland joined the european union in 1995. the difference is that existing aid is presumed lawful unless the commission challenges it.223 5.2.1 services of general economic interest (sgei) making the demarcation between compensation of public service and market investment is sometimes difficult. the interpretative guidance ability of the market investor principle is so imperfect that it does not seem to apply to cases where no private market actor exists, for in such cases there is no natural parallel to evaluate the market terms of the measure against.224 it is also worth noting that nature conservation is never based purely on commercial consideration, but there is also a constitutional dimension in all environmental issues. in situations where a public undertaking takes care of the services of general economic interest ”normal market terms” are inevitably hypothetical. the state aid programme nn 8/2009 – germany nature conservation areas consisted of the gratituitous transfer of federally-owned natural heritage sites and the funding of large-scale nature conservation projects. pursuant to the description of the scheme, valuable natural 222 comparably to the case adria-wien pipeline gmbh, where the court of justice found that the measure is selective for the tax exemption was applied only for undertakings whose activity is mainly in the manufacturing sector. see closer in chapter 3.2.2. 223 the following might also be considered analogically applicable to the sales of forestry land: pursuant to point 175(g) of the guidelines for state aid in agriculture and forestry sector, “the commission will declare state aid up to 100 % compatible with article 107(3)(c) of the treaty for the costs of purchase of forestry land used or to be used as nature protection areas”. 224 raitio 2008, p 861. nordic journal of commercial law issue 2011#2 44 heritage sites existed on federally-owned land in germany. however, due to budgetary constraints the german authorities found it increasingly difficult to finance the long-term upkeep and development of these areas wherefore they needed to be transferred to ensure their proper upkeep. experience gathered had shown that, where such areas were sold to private individuals, their naturalistic value was significantly degraded over the years. besides, nature conservation organizations did not have the financial means to purchase the federally-owned land and to pay for follow-on costs. germany therefore decided not to sell the areas concerned, but to transfer responsibility for the conservation of these areas of outstanding naturalistic value to the länder and the deutsche bundesstiftung umwelt (dbu, german environment foundation). the länder were entitled to further transfer these areas gratuitously to nature conservation organizations. while ownership of the land was transferred to the recipients free of charge, all other costs related to the transfer (for example surveying costs and taxes) as well as maintenance costs and inherited pollution risks were borne by the recipients of the areas. the federal programme for the establishment and protection of valuable natural areas and landscapes of national importance, aimed to finance projects on conservation of landscapes and natural heritage sites. the main aim of the measures was the maintenance of biodiversity.225 in its assessment the commission held that the nature conservation entities were undertakings226 and that the measures constituted state aid227. the commission considered that a necessary precondition for qualifying a measure as a service of general economic interest (sgei) is that it genuinely serves the interest of citizens. the conservation tasks entrusted by germany to the nature conservation entities pursued objectives, which were in the interest of society as a whole, namely the preservation of intact habitats of outstanding naturalistic value for future generations. these tasks, which can be construed as services rendered to all citizens, clearly fall within the remit of the state acting as public authority, which however may find it appropriate to entrust them to other entities, for example for budgetary reasons. "in that sense, the scheme differs from a classical environmental aid measure: in the latter case the activities which are beneficial for the environment cannot be carried out by the state, but can only be carried out by undertakings on a voluntary basis". therefore, the commission accepted that the conservation tasks at issue constituted services of general interest. the commission assessed 225 nn 8/2009, points 8-17. 226 “according to settled case-law, any activity consisting in supplying goods or services on a given market is an economic activity. the commission considers that, in the case at hand, activities like sales of wood, leases of land and tourism must be classified as economic in nature. the german nature conservation entities concerned by the notified measures should therefore be considered as undertakings within the meaning of article 107(1) of the ec treaty insofar as they exercise these activities”, point 41. 227 nn 8/2009, points 43-52. nordic journal of commercial law issue 2011#2 45 the compatibility of the aid on the basis of the post-altmark package228 and concluded that the measure was compatible with the common market. the separation between the tasks of the scheme and a classical environmental aid measure seems rather artificial, since the ownership of the land was transferred to the recipients. however, as will become evident, the agrarian function of a farmer's land cannot be disconnected from its recreational or natural functions. hence, the agri-environmental aid measures have to be assessed under the agriculture and forestry aid guidelines (not on the basis of the post-altmark package). 5.3 payments for environmental services 5.3.1 the case of finland as strictly protected areas have been fiercely resisted by landowners, and as they do not provide for spatial continuity, nor alone capable of ensuring conservation of biodiversity, it is necessary to combine biodiversity protection with other resource use, such as forestry.229 the southern finland forest biodiversity programme (metso), launched in 2002, introduced two new economic conservation instruments: nature values trading and bidding competition. they were based on voluntarism in offering sites and negotiations on payments for conservation. the metso nature values trading produced mainly ten year contracts where compensation was paid for loss in forest income, and to some degree, based on the biodiversity values of the sites.230 the bidding competition was used to attract landowners whose lands hosted certain biodiversity values. they led through negotiations, mostly to permanent conservation or land purchase. the compensation or payment for these conservation contracts were tied either only to the potential forest revenue, or to that potential and to the conservation value (i.e. decayed wood, large aspen trees and such environmentally valuable elements have “a price tag”).231 these measures were in line with article 107(3)(c) tfeu under the previous guidelines on state aid for agriculture sector, pursuant to which "the commission takes a favorable view of aid schemes which are intended to provide technical support in the agricultural sector. such soft aids improve the efficiency and professionalism of agriculture in the community, and thus 228 public service compensation which cannot be qualified as non-aid on the basis of the altmark criteria may, however, be found compatible if it complies with the conditions laid down in the community framework for state aid in the form of public service compensation. community framework for state aid in the form of public service compensation (oj c 297 29.11.2005). 229 wolf – primmer 2006, p 845. 230 paloniemi—varho 2009. 231 horne 2006, p. 171. nordic journal of commercial law issue 2011#2 46 contribute to its long-term viability while producing only very limited effects on competition. aid may therefore be granted at a rate of up to 100 % of costs to cover activities such as- activities for the dissemination of knowledge relating to new techniques, such as reasonable small scale pilot projects or demonstration projects".232 since new guidelines on state aid for agriculture and forestry became effective in 2007, this also caused changes on the aid measures within metso program233. the following commission decision assesses the compatibility of biodiversity conservation measures in a current state aid practice. state aid no n 130a/2007 – finland aid for forestry involved maintaining and restoring ecological, protective and recreational functions of forests, biodiversity and healthy forest ecosystems. the finnish authorities affirmed that grants are discretionary and granted only for schemes that are significant for biodiversity preservation, aid can never exceed 100% of the actual costs of the conservation and the authorities monitor that aid amounts too high will not be paid. the aid will only be granted for tasks that commence after commission approval.234 the commission considered that the aid had an incentive effect and examined it against the background of chapter vii of the community guidelines for state aid in the agriculture and forestry sector 2007 to 2013235. the aid scheme included plenty of measures, many of which were not related to biodiversity conservation, but other forest functions. environmental aidaccording to § 16 of law on financing sustainable forestry 236, which is the legal national basis of the aid scheme, may be granted for commitments to improve biodiversity in forests. these commitments last for 10 years and beneficiaries have to go beyond the mandatory regulation. such aid was regarded as being in accordance with point 176 of the guidelines. pursuant to that point, actions are compatible with article 107(3)(c) of the treaty if the aid meets conditions laid down in article 47 of regulation (ec) no 1698/2005. accordingly, 232 community guidelines for state aid in the agriculture sector (oj c 28 1.2.2000), point 14.1. pursuant to the new guidelines community guidelines for state aid in the agriculture and forestry sector 2007 to 2013 (oj c 319, 27.12.2006) “aid granted for private landowners for pilot and demonstration projects connected to sustainable use of forests will now be authorised if the aid fulfils the conditions set out in point 107 of the guidelines. accordingly, the commission will examine such activities on a case by case basis and the member state shall provide a clear description of the project including an explanation of the novel character of the project and of the public interest in granting support for it (for example because it has not been tested before) and demonstrate that the number of participating companies and the duration of the pilot scheme shall be limited to what is necessary for proper testing, the combined amount of aid for such projects granted to a company shall not exceed eur 100 000 over three fiscal years, the results of the pilot scheme shall be made publicly available and that any other condition the commission may deem necessary to avoid the scheme having a distorting effect on the market or amounting to operating aid”. 233 a new metso programme 2009-2016 institutionalizes voluntary site allocation and a possibility to make fixed term conservation contracts. 234 n 130a/2007, paras 9-12. 235 n 130a/2007, paras 29-31. 236 law and decree on finance for sustainable forestry (laki ja asetus kestävän metsätalouden rahoituksesta). nordic journal of commercial law issue 2011#2 47 "payments shall be granted to beneficiaries who make forest-environmental commitments on a voluntary basis. these payments shall cover only those commitments going beyond the relevant mandatory requirements and shall be undertaken for a period between five and seven years. where necessary and justified, a longer period shall be determined in for particular types of commitments. the payments shall cover additional costs and income foregone resulting from the commitment made. support shall be fixed between 40 and 200 euros per hectare"237.238 conservation value -based payments are no longer granted. instead, the commission will only authorise state aid for additional costs and income foregone. whereas in the pilot phase the compensation or payment for conservation contract was tied either only to the potential of forest revenue, or to that potential and to the conservation value, the compensation is now based only on the market value of the timber in the area to be protected239. aid exceeding the amounts fixed in the annex to regulation (ec) no 1698/2005 can in principle only be declared compatible with article 107(3)(c) of the treaty, if granted for demonstrated additional costs and/or income foregone, in exceptional cases taking into account specific circumstances to be duly justified, in favour of commitments which lead to a demonstrable and significant positive effect on the environment.240 the finnish authorities grant payments per contracted hectare of forest to beneficiaries who make forest-environmental commitments that go beyond the relevant mandatory requirements on a voluntary basis. however, the duration of these commitments is 10 years and the payment exceeds the maximum amount of 200 euros in some cases. since finland`s forests are located in a subarctic area where the nature renews slowly, the populations of flora and fauna need enough time to recover. the commission therefore assessed that only longer-lasting measures have a positive effect on biodiversity and approved the exceptional contract period of ten years. the payments may cover additional costs and income foregone resulting from the commitments made. on ground of a calculation made by the finnish authorities, some areas in southern finland have such high income value that the aid amount exceeds 200 euros per year. the commission considered that the limit of 200 euros is exceeded only in some areas which are proved to be exceptionally valuable in biodiversity and the compensation is based on actual income forgone. it is also required that such commitments would not be made on normal payment level. hence, in such special situations caused by exceptional circumstances aid amounts exceeding 200 euros per hectare may exceptionally be accepted.241 pursuant to point 175(d) of the guidelines state aid for restoration and maintenance of natural pathways, landscape elements and features and the natural habitat for animals, including 237 (ec) no 1698/2005, article 47 & annex. 238 n 130a/2007, paras 48-49. 239 n 130a/2007, para 20 240 community guidelines for state aid in the agriculture and forestry sector 2007 to 2013, point 177. 241 n 130a/2007, paras 50-52. nordic journal of commercial law issue 2011#2 48 planning costs, is compatible with article 107(3)(c) tfeu. aid can be accepted up to 100% of eligible costs. thus, aid meant for biodiversity preservation in committed areas is compatible up to 100% of eligible costs and may be granted by the finnish authorities.242 5.3.2 the case of netherlands the netherlands case-study uncovers both resources and barriers for establishing new agrienvironmental schemes. accordingly, two local nongovernmental nature and landscape organizations and a local agricultural nature association took the initiative to involve farmers in the management of the countryside to sustain the mixed landscape of cultural and natural grounds. financial means were considered necessary to pay for their activities. instead of working with a fixed set of measures, as in the traditional agri-environmental schemes, the initiative was intended to draw up “custom-made contracts” based on market-based prices. the introduction of the concept of green services (gs) reframed the maintenance of landscape and nature, from a bad external circumstance into a desirable social demand. instead of compensating these activities as additional labor costs, they should be rewarded with a marketrelated price. 243 the initiative was included in a pilot project by the ministry of agriculture, nature and food (manf), which supported and facilitated bottom-up initiatives that sustained the quality of the rural landscape. however, the european commission stated that market-based payments to farmers granted by governments would be considered market distortion and therefore would not be allowed. instead, payments could be based only on the loss of revenues and additional labor costs. these requirements could not be changed because of international agreements244. 245 hence, to make certain that the pilot projects would meet the eu state aid requirements for farmers, the manf required that the gs projects would be notified to and approved by the commission. farmers could be paid only on the basis of a loss of revenues and additional labor costs and those contracts could be drawn up for a maximum period of six years. as contracts can be drawn up only for activities that "go beyond what is legally obliged" and the definition of what is legally obliged changes as rules are updated, contract periods could not exceed this period.246 242 n 130a/2007, paras 50-54. 243 zwaan—goverde 2010, p. 771-772. 244 wto trade agreements. 245 zwaan—goverde 2010, p. 772-773. 246 zwaan—goverde 2010, p, 774. nordic journal of commercial law issue 2011#2 49 these requirements were not readily accepted by all local or regional actors involved in the pilot programme, because they wanted to work on the basis of market-based prices and to increase the duration of the contracts up to ten years. therefore, the actors contracted a private consultancy office which advised that they should qualify the gss as "services of general interest" (sgei) that would meet the so-called "altmark" criteria. the consultancy office suggested that the agrarian function of a farmer's land would be disconnected from its recreational or natural functions. by separating these functions it would become possible to bypass the eu state aid requirements for farmers as farmers would not carry out any agrarian activities on this recreational or natural land, and would formally only be a landowner of the recreational or natural land. by using this construction, gss could be qualified as services of general interest, to which the state aid requirement for farmers would not apply. in addition, the suggestion was made to establish a "landscape fund" that would be entrusted in the care of independent actors who could draw up the contracts with farmers for these gss. the landscape fund would be "filled" with both public and private money from local businesses or profits from building projects. governmental contributions were considered to be important especially at the start of the fund to cover overhead costs.247 the european commission however, stressed that payments had to be based on a "loss of revenues and additional labor costs'' and argued that the land use of a farmer is too interconnected to create a separation into different functions. it would be impossible, for example, for the commission to check whether a farmer leaves a piece of land fallow for bird breeding, or whether this allows him to access his arable land more easily.248 in its decision on state aid programme nn 8/2009 – germany nature conservation areas the commission also stated, that if member states define services of general economic interest for sectors of the economy which have been the object of harmonisation measures at eu level, then these services must be reviewed with special care in order to avoid inconsistencies. since the forest sector is harmonised and state aid for forestry is subject to the “community guidelines for state aid in the agriculture and forestry sector 2007 to 2013”, the commission first examines whether the agriculture and forestry guidelines are applicable to the case at hand. the agriculture and forestry aid guidelines apply to all state aid granted in connection with activities related to the production, processing and marketing of agricultural products249 and under them state aid is permitted to support the ecological, protective and recreational functions of forests.250 that being the case, the agri-environmental aid measures in question were assessed under the agriculture and forestry guidelines. 247 zwaan—goverde 2010, p, 774. 248 zwaan—goverde 2010, p. 776. 249 see the annex i of the treaty. 250 nn 8/2009 – germany nature conservation areas, point 59. nordic journal of commercial law issue 2011#2 50 if the landowner gave up all the forestry in his land (i.e. gave up the production, processing and marketing of agricultural products) and thus became only a landowner of recreational or natural land, was it logical that he could then, by fostering naturalistic values for future generations, start producing services of general economic interest (sgei)? also, if certain areas in landowners land were already protected by law, would the silvicultural tasks in these areas serve objectives that are in the interests of society as a whole? for example, the tasks in favour of habitat types, which are of great value for future generations, increase the public goods251 which fall within the remit of the state acting as public authority. when member states enjoy a wide margin of discretion when deciding whether and in what way to finance the provision of services of general economic interest252 they should really take maximumadvantage of that. at least the possibility to produce sgei also in private natural (forestry-free) lands should be thoroughly investigated. 5.3.3 summary as the agriculture and forestry aid guidelines apply to all state aid granted in connection with activities related to the production, processing and marketing of agricultural products,253 the payments granted to beneficiaries who make forest-environmental commitments on a voluntary basis may cover only additional costs and income foregone resulting from the commitment made.254 forests produce a multitude of environmental services alongside consumable goods like timber and berries. some of these goods and especially the services are public goods. the conservation of native species or biodiversity has typical public goods character, the benefit of 251 public goods are goods which are beneficial for society but which are not normally provided by the market given that it is difficult or impossible to exclude anyone from using the goods (and hence making them pay for the goods). 252 state aid action plan, p. 9-10. 253 community guidelines for state aid in the agriculture and forestry sector 2007 to 2013, point 175. 254 pursuant to point 176 of the guidelines. actions are compatible with article 107(3)(c) of the treaty if the aid meets the conditions laid down in article 47 of regulation (ec) no 1698/2005. and be fixed between certain minimum and maximum amounts. in addition, they shall be undertaken for a period between five and seven years “the commission considered that the limit of 200 euros exceeds only in some areas which are proved to be exceptionally valuable in biodiversity and the compensation is based on actual income forgone. it is also required that such commitments would not be made on normal payment level. hence, in such special situations caused by exceptional circumstances aid amounts exceeding 200 euros per hectare may exceptionally be accepted.” nordic journal of commercial law issue 2011#2 51 which cannot be exclusively experienced by the private forest owner. 255 when there is no market for biodiversity conservation, or market value for biodiversity, those who experience and value forest nature and biodiversity benefit from positive externalities but the forest owners cannot charge for these benefits. as the state aid compensation is based on additional costs and income foregone, and as biodiversity values bring no revenue to the landowner, the aid is based only on the market value of the timber in the area to be protected. this seems to be problematic, since in many cases, the sites that are most valuable for biodiversity conservation are not necessarily the most productive forestry areas (lots of tree species not used commercially, lots of decayed wood, long hauling distance, etc.).256 it follows that the landowners who possess the most valuable sites for biodiversity conservation may not find it compelling to make forest-environmental commitments when they would only get paid for the revenue losses based on the market value of the timber in the area. actually, sites with poorer diversity are offered protection because payments for such sites may well be higher than payments for ecologically more valuable, yet not so productive sites. this is not effective environmental protection, and does not provide any incentive for the landowners to identify and offer ecologically valuable sites for conservation. on a temporary contract, the landowner actually risks the economic value of the forest shrinking during the contract period, if the trees are very old and decaying257. positively the commission has recognized that exceptional, longer conversation contracts may be approved when only longer-lasting measures have a positive effect on biodiversity, and that the limit of 200 euros may exceptionally be exceeded in biodiversically valuable areas possessing so high income value that the commitments on biodiversity conservation would not be made on normal payment level. yet this does not eliminate the problem that compensation for additional costs and income foregone is based only on the market value of the timber in the protected area, since no market value for biodiversity values exists. 5.4 proposed amendments and introduction of new measures the commission will continue to develop criteria to fulfil its assessment of aid compatibility, in particular through analyses of specific sectors. it is for member states to provide the necessary 255 according to coasean logic the compensation obligation depends on the property rights. the definition of the ownership of different forest goods and services varies between countries, as it is specific to national jurisdiction. depending on the definition of the ownership, environmental public goods can be viewed as either positive or negative externalities. if the property rights were complete and exclusive covering all the aspects of forestland, any conservation values provided in the forest would be positive externalities and the owner should be compensated for all the lost private values when the resource is used to produce public services. innes—polasky—tschirhart (1998): takings, compensation and endangered species protection on private lands. journal of economic perspectives 12(3): 35–52. 256 horne 2006, p. 171. 257 communication with eeva primmer, february 2011. nordic journal of commercial law issue 2011#2 52 evidence in this respect, prior to any implementation of the envisaged measure.258 therefore, , the member states should provide evidence that because the agrarian function of a farmer's land cannot be disconnected from its recreational or natural functions, the nature values of the sites should also be included in the state aid compensation, in order to be efficient and also in order to attract those biodiversically rich forests that are not necessarily the most productive forestry areas. since also possible new incentives, such as habitat banking and offsets259 require a relevant involvement of the national and regional levels of governance, state aid may be involved. comparable to what was shown in preussenelektra260, the obligation to purchase a specific amount of credits did not include any transfer of state resources. hence, the obligation as such did not constitute state aid within the meaning of article 107(1) tfeu. where however, these payments are dispatched into a fund(bank), from where payments are deferred to the creators of beneficial biodiversity outcomes, there is a possibility that this fund-based finance will be regarded as “granted trough state resources”261. the court jurisprudence has established three cumulative criteria in order to assess the involvement of state resources where money is transferred by a fund262: 1) the fund must be established by the state, 2) the fund must be fed by contributions imposed by the state, and 3) the fund must be used to favour specific enterprises. thus, if the commission concludes that state`s resources are involved and also all other criteria of state aid in the meaning of article 107(1) are fulfilled, the measure constitutes state aid. hence, it would be better to organise the fund/bank in a way that escapes the criteria of the involvement of state resources. the following assessment is hypothetical based in relevant part on no n 416/2001 uk emission trading scheme, and discusses possible incentives for introducing a habitat banking and offset scheme. this scheme was introduced before the european union greenhouse gas emission trading system (eu ets) commenced operation. since the decision at hand is given before implementation of the eu ets, it is interesting to see how a new measure that promotes the execution an important project of common interest, has been assessed by the commissionprior to its launch. the uk ideawas to introduce a voluntary trading scheme to reduce greenhouse gas emissions. the scheme granted an incentive for a period of five years, 258 state aid action plan, p. 6-8. 259 see definition on chapter 2.3. and assessment on chapter 3.3. of this study. 260 case c-379/98 "an obligation imposed on private electricity supply undertakings to purchase electricity produced from renewable energy sources at fixed minimum prices does not involve any direct or indirect transfer of state resources". 261 for example within biobanking, new south wales astralia (threatened species conservation amendment act 2006), developers buy credits from landowners generating them. part of these incomes will be deposited in the biobanking trust fund and paid to the owner of the biobank site in annual payments for carrying out the agreed management activities in perpetuity. fromond – similä – suvantola, 2009, p. 23. 262 c-173/73 italy vs commission and c-78/79 steinike vs germany. nordic journal of commercial law issue 2011#2 53 spread across all entities entering the scheme in return for participating and taking on absolute emission reductions. companies bid for the incentive in an auction.263 comparably, a member state could introduce a habitat bank and offset scheme to reduce the biodiversity loss through obliging developers to purchase credits from a habitat bank. since implementing the scheme would increase the costs borne by the undertakings, the member state could grant an incentive for a restricted period of time for all undertakings adapting to national standards. the uk government considered the emission trading scheme to constitute state aid insofar as the incentive was concerned. the uk government held that the aid was compatible under article 107(3)(b) as it promoted the execution of an important project of common european interest, and even if article 107(3)(b) would not have applied, the scheme was compatible under article 107(3)(c) as it complied with the environmental aid guidelines. according to article 107(3)(b), state aid may be considered compatible with the common market if it promotes the execution of an important project of common european interest. point 73 [now point 147] of the environmental aid guidelines says that “aid to promote the execution of important projects of common european interest which are an environmental priority and will often have beneficial effects beyond the frontiers of the member state(s) concerned can be authorised under the exemption provided for in article 107(3)(b). however, the aid must be necessary for the project to proceed, and the project must be specific, well defined and qualitatively important and must make an exemplary and clearly identifiable contribution to the common european interest.” the commission acknowledged that tackling climate change was a priority of environmental policy of the eu. the scheme was regarded an important element in achieving the targets that the member states undertook to fulfil, and it is evident that emission trading would deliver most effects if it was done on an eu-wide basis. in the absence of a binding eu emission trading scheme, the uk government made specific choices on the main elements of its scheme in order to best adapt the scheme to national needs. even though these choices were not necessarily the choices that will be made for a trading scheme at european level264 the commission appreciated the uk initiative to already go ahead with an emission trading scheme while there were no rules at european level. the uk scheme thus contributed valuable learning experience to the establishing of other emission trading schemes in other member states. therefore the commission assessed the uk emission trading scheme under article 107(3)(c). it considered that the scheme was compatible with chapter f, “policies, measures and 263 n 416/2001, p. 3. 264 the commission in its proposal for a directive on an eu emission trading scheme developed potential criteria, which aim to reflect the wider european interest. nordic journal of commercial law issue 2011#2 54 instruments for reducing greenhouse gases”, of the community guidelines on state aid for environmental protection.265 similar assessment could be used within a possible habitat banking and offset scheme. since biodiversity protection is regarded as a pre-requisite for sustainable development266 and the new target aims to "halt the loss of biodiversity and the degradation of ecosystem services in the eu by 2020267", it seems evident that biodiversity preservation is a crucial element in eu`s environmental policy, and the habitat banking scheme would be an important element in achieving that target. the scheme might be considered compatible under article 107(3)(b), or most likely, under 107(3)(c) and article 18 of the general block exemption regulation268 as an “investment aid enabling undertakings to go beyond community standards for environmental protection or increase the level of environmental protection in the absence of community standards”. such aid could be compatible with the common market within the meaning of article 107(3) of the treaty and exempt from the notification requirement of article 108(3) of the treaty, provided that certain conditions are met.269 within the habitat banking and offset scheme, the condition of enabling the beneficiary to increase the level of environmental protection resulting from its activities in the absence of 265 the kyoto protocol, signed by the member states and by the community, provides that the parties undertake to limit or reduce greenhouse gas emissions during the period 2008-2012. for the community as a whole, the target is to reduce greenhouse gas emissions by 8 % of their 1990 level. in the absence of any community provisions it is for each member state to formulate the policies, measures and instruments it wishes to adopt in order to comply with the targets set under the kyoto protocol. (the previous guidlines, oj c 37 of 3.2.2000). in the current guidelines (oj c 82 of 1.4.2008) the basis for commission`s assessment concerning aid involved in tradable permit schemes is set out in point 55. 266 see the communication on "halting biodiversity loss by 2010 – and beyond: sustaining ecosystem services for human well-being". 267 --restore them (ecosystem services) in so far as feasible, while stepping up the eu contribution to averting global biodiversity loss. 268 commission regulation (ec) no 800/2008 (6.8.2008) declaring certain categories of aid compatible with the common market in application of articles 87 and 88 of the treaty (general block exemption regulation). (oj l 214). 269 the eligible costs shall be the extra investment costs necessary to achieve a level of environmental protection higher than the level required by the community standards concerned, without taking account of operating benefits and operating costs. the eligible investment shall take the form of investment in tangible assets and/or in intangible assets. in the case of investments aiming at obtaining a level of environmental protection higher than community standards, the counterfactual shall be chosen as follows: (a) where the undertaking is adapting to national standards adopted in the absence of community standards, the eligible costs shall consist of the additional investment costs necessary to achieve the level of environmental protection required by the national standards; (b) where the undertaking adapts to or goes beyond national standards which are more stringent than the relevant community standards or goes beyond community standards, the eligible costs shall consist of the additional investment costs necessary to achieve a level of environmental protection higher than the level required by the community standards. the cost of investments needed to reach the level of protection required by the community standards shall not be eligible; (c) where no standards exist, the eligible costs shall consist of the investment costs necessary to achieve a higher level of environmental protection than that which the undertaking or undertakings in question would achieve in the absence of any environmental aid. nordic journal of commercial law issue 2011#2 55 community standards270 would seem to be fulfilled. on the contrary, a subsidy granted by a public authority for measures taken in order to compensate for damage to a natura 2000 site could not be accepted in the light of environmental protection271. viable use of state aid within measures to preserve biodiversity in the forests purchase of land by the state • to escape the classification as state aid the purchase of the land has to be in conformity with the market economy investor principle (the purchase of the properties has to be done under market conditions, such as an evaluation of the properties by an independent expert). the purchase based on an open auction (where state invites landowners to make offers of land and then selects the overall economically most advantageous offer) would seem to be done under market conditions. • the purchase most likely constitutes state aid if public authority pays "extra" ie. more than the highest price which a private investor acting under normal competitive conditions was ready to pay in the same situation this "over-valuation" (based on nature value-trading) would probably not pass the balance test in detailed assessment (hard to provide evidence of necessity of the aid since there is also possibility for expropriation). since commission`s practice is to only compensate for the revenue losses and additional costs it would seem illogical to accept trade of nature values here either. hence, it would be important to include compensation for nature values in state aid payments. services of general economic interest (sgei) • public service compensation which cannot be qualified as non-aid on the basis of the altmark criteria may be found compatible if it complies with the conditions laid down in the community framework for state aid in the form of public service compensation. • the objectives have to be in the interest of society as a whole. • whereas in a classical environmental aid measure the activities which are beneficial for the environment cannot be carried out by the state, but can only be carried out by undertakings on a voluntary basis, the tasks, which can be construed as sgei clearly fall within the remit of the state acting as public authority (which however may find it appropriate to entrust them to other entities). • tasks that foster biodiversity values increase the public goods even if they were carried out in a private recreational or natural land – for that reason, the possibility for sgei should be similar. voluntary protection in private forests within forestry • in order to contribute to the maintenance and improvement of forests and to promote their ecological, protective and recreational function the commission will declare state aid up to 100 % compatible with article 107(3)(c) of the treaty • payments may be given to beneficiaries who make forest-environmental commitments on a voluntary basis. • payments can cover only those commitments going beyond the relevant mandatory requirements. 270 article 18(2)(b) of (ec) no 800/2008 (6.8.2008). 271 according to article 38 of (ec) no 1698/2005 support provided for natura 2000 payments shall be granted annually and per hectare of uaa to farmers in order to compensate for costs incurred and income foregone resulting from disadvantages in the areas concerned related to the implementation of directives 79/409/eec, 92/43/eec and 2000/60/ec –not in order to compensate for damage to a natura 2000 site. however, in the case of an undertaking acting as a contractor for a public authority to build an infrastructure, the subsidy would not be considered as a state aid as long as it is granted in exchange of works carried out. (compensation for public services will be assessed according to "altmark" criteria). nordic journal of commercial law issue 2011#2 56 • commitments shall be undertaken for a period between five and seven years. where necessary and justified, a longer period shall be determined in for particular types of commitments. • payments may cover additional costs and income foregone resulting from the commitment made. • support shall be fixed between 40 and 200 euros per hectare albeit these amounts may be increased in exceptional cases taking account of specific circumstances to be justified in the rural development programmes. • for the aid to be efficient, also the compensation for nature values should be included in the agrienvironmental state aid payments. market based measures (eg. habitat banking and offsets) • a possible incentive for introducing habitat banking and offset scheme? (on the basis of 107(3)(b) as "aid to promote the execution of important projects of common european interest which are an environmental priority and will often have beneficial effects beyond the frontiers of the member state(s) concerned" or on the basis of 107(3)(c) as "investment aid for undertakings which go beyond community standards or which increase the level of environmental protection in the absence of community standards"). 6 contemplation and improvement suggestions 6.1 should states compensate for the nature values? as a general rule under the ppp governments should not subsidise individuals to conserve biodiversity, which means that the government’s cost share is generally zero, unless the government is also an impacter and therefore required to pay.272 it is however claimed, that even though the ppp has been confirmed as an environmental principle, the expansion of it onto biodiversity conservation needs still further clarification.273 inversely the ppp signifies that no compensation is paid for disallowance of a licence to actions that are harmful to the environment.274 still, under the nature conservation act in finland, compensation is paid for disallowance of a licence to deviate from a habitat-type conservation.275 this kind of principle is called the “society pays” or the “beneficiary pays” principle. because different parties bear the costs and benefits of biodiversity conservation, some activities that are desirable from a national perspective may not occur for they do not generate net benefits to those implementing them and are not privately profitable. as a result, insufficient conservation may occur from a social perspective. this raises the question of whether it may be in the interests of society for the wider community to meet some costs related to on ground activities to ensure they proceed. this would involve the government meeting some costs of conservation on behalf of the general community.276 in contrast to the ppp, which obliges resource users to pay for conservation, the 272 arentino et al. 2001, p. 15-16. 273 kokko 2003, p. 109. 274 naskali—hiedanpää—suvantola 2004, p. 118. 275 kuusiniemi 2001. 276 arentino et al. 2001, p. 5. nordic journal of commercial law issue 2011#2 57 “beneficiary pays” principle can only be used to encourage voluntary conservation. this is because compulsory conservation is equivalent to an obligation under existing property rights.277 it seems that the commission has already approved the “beneficiary pays” principle for it allows states to grant payments to beneficiaries who make forest-environmental commitments on a voluntary basis. the government is consequently meeting some costs of conservation on behalf of the general community. with that in mind, there should not be a big difference in whether the nature values were included in these costs too. mcneely argues that since nowadays the perception of one`s own advantage is determined by economic actors, the conduct that affects preservation of biodiversity can best be modified by offering such approach to conservation that alters that perception.278 within forestry, this could be realised by including compensation for natural values in agri-environmental state aid payments. if nature values were included in the agri-environmental payments, the landowners who possess the biodiversically most valuable sites would be more willing to commit themselves to conservation. this would also be effective, not only from an environmental point of a view, but also economically. as set out in the lisbon strategy, environmental protection is essential in itself, and can also be a source of competitive advantage for europe. according to the commission, the effective use of state aid stipulates that state aid measures are used to correct market failures.279 the legal meaning of the requirement of efficiency is however not yet completely solved for the requirement itself is still relatively new.280 in addition to the principle that state aids are legitimate responses to market failure, economic analysis of eu state aid policy stipulates that the state aids should not lead to undue market distortions. in other words, the realization of state aid should not be incompatible either with competition in the market or with competition for the market. accordingly, intervention is warranted only if its expected benefit, in terms of improving market outcomes, outweighs the expected cost of intervention. as a consequence, state aid should only be used as a remedy for market failures if it is the best feasible remedy. while this is uncontroversial as a matter of general principle, its application in concrete cases may not be straightforward.281 277 arentino et al. 2001, p. 15-16. 278 mcneely, jeffrey a. 1988. economics and biological diversity: developing and using economic incentives to conserve biological resources. iucn, gland, switzerland. 279 state aid action plan—less and better targeted state aid: a roadmap for state aid reform 2005-2009. com(2005) 107 final, para 23. the principal economic justifications for state aid can be subsumed under the general heading of market failures. since state aid measures can correct market failures and thereby improve the functioning of markets and enchance european competitiveness, they may sometimes be effective tools for achieving these objectives. 280 siikavirta—parikka 2010, p. 16. 281 clemenz—dewatripont—motta—neven—seabright—zemplinerova 2006, p. 1. nordic journal of commercial law issue 2011#2 58 the state aid action plan requires that state aid only be used when it is an appropriate instrument for meeting a well-defined objective, when it creates the right incentives, is proportionate and when it distorts competition to the least possible extent. for that reason, appreciating the compatibility of state aid is fundamentally about balancing the positive impact of the aid measure (reaching an objective of common interest) against its potentially negative side effects (distortions of trade and competition). the efficiency requirement shows much similarity to the proportionality principle, which, according to the practice of the court of justice, would seem to embrace these elements the first criterion of proportionality, the measure`s appropriateness, is also referred to as “suitability”, “usefulness” or “effectiveness” criterion. the second criterion is often “necessity” and “least trade-restrictiveness”. the third and most controversial element of determining proportionality includes cost-benefit analysis.282 the growth of the importance of environmental values has affected the way the court has assessed whether the acts of the member states are accordant with the proportionality principle.283 in the danish bottles case284 the court assessed the allowance of the national measure (order that all containers for beer and soft drinks must be returnable) in relation to the restrictions it caused on the internal market. at the time the court was only ready to accept measures that were proportionate in relation to the restrictions on the internal market. in later cases, the court has emphasized environmental aspects more. for example, in bluhme285 the court assessed the proportionality of the national measure mostly on the basis of environmental protection. it stated that the establishment of a protection area constituted an appropriate measure in relation to the aim pursued by the convention on biological diversity286.287 the traditional, wide interpretation of the proportionality of a measure is based on the idea that environmental measures are permitted only when their importance is higher than the free movement of goods.288 according to cruz and castillo de la torre289 the court has, in its environmental cases, to some degree already given up the traditional wide interpretation of the proportionality principle. in other words, the court has moved from balancing the positive effects of a measure against its negative effects on the internal market, to the assessment of the 282 wiers 2002, p. 72-73. 283 sorto 2002, p. 251. 284 case 302/86, p. 4607. 285 case c-67/97. 286 case c-67/97, para 37. 287 hanhijärvi 2003a, p. 76. 288 krämer 2000, p. 78. 289 cruz, julio baquero—castillo de la torre, fernando: a note on preussenelektra. european law review 26/20001, p. 499. nordic journal of commercial law issue 2011#2 59 necessity of the measure.290 this is reasonable, since, although proportionality is a fundamental eu principle, environmental protection cannot be held categorically inferior to it.291 on the contrary, according to the article 11 tfeu the environmental protection requirement must be integrated into the definition and implementation of the eu `s policies and activities, in particular with a view to promoting sustainable development. this allows placing a duty on eu institutions to reconsider all policies for sustainability, as an overall treaty objective.292 pursuant to article 193 tfeu, the member states are allowed to introduce more stringent national policies as long as the measures are compatible with the treaties. state aid may be declared compatible with the treaty provided it fulfils clearly defined objectives of common interest. since state aid can correct market failures, it may be an effective tool for achieving these objectives. to be an effective tool, state aid should be appropriate, incentivizing, proportionate and distort the competition to the least possible extent. in compliance with environmental protection within the treaties and pursuant to recent practice of the court of justice, the efficiency test as an assessment of suitability and necessity is better suited with environmental standards than cost-benefit analysis293. that is because the benefits of biodiversity conservation typically occur in the uncertain future and may thus be challenging to show. yet, the integration of environmental considerations must be strengthened by the need to seriously address the existing pressures on biodiversity, now and in the future, for failure to act now means greater, and possibly irreversible, damage or higher remedial costs in the long term294. hence, the member states should provide evidence that because the market fails to reflect the value of biodiversity it is in the interest of the eu as a whole to correct the following market failure by including compensation for natural values in agri-environmental state aid payments. for the protection to be effective and well-suited to its purpose, the compensation for nature values would constitute an appropriate measure in relation to the aim of protecting biodiversity, which is the responsibility of eu and the member states, pursuant to the convention on biological diversity.295 principally, it would also be possible to avoid all the challenges described above, by regulating environmental aid to be paid as the de minimis aid. then it would not be state aid within the meaning of the treaty and would thus be left outside of the restrictions therein. since the general de minimis rule applies to the forestry sector, an aid of eur 200 000 over a period of 290 hanhijärvi 2003a, p. 77. 291 hanhijärvi 2003a, p. 78. 292 bär—kraemer 1998, p. 318. 293 see e.g. hanhijärvi 2003a, p. 79. 294 see facing the challenge: the lisbon strategy for growth and employment. report from the high level group chaired by wim kok 2004. why is the environment a source of competitive advantage for europe?, p. 36. 295 see case c-67/97, para 37. nordic journal of commercial law issue 2011#2 60 three fiscal years could be freely granted to all undertakings that commit themselves to the conservation. however, the de minimis option is problematic in the light of constitutional equality rule296 and thus also politically difficult to accept. the de minimis regulation is hassle free for those landowners who do not practice other activities for which the de minimis aid could be granted. however, farmers (who practice agriculture) also often practice forestry. among these farmers, there are those who have got paid agricultural or general de minimis aid. farm counselling and flood compensation are examples of agricultural de minimis aid; start up aid, investment aid and development aid examples of general de minimis aid. the de minimis regulation may also become problematic within large jointly owned forests. for jointly owned forests, the aid for forestry is paid to the management associations which, according to relevant law297, manage the jointly owned forests. for that reason, pursuant to financing legislation, the management associations are the aid recipients instead of discrete joint owners. on part of the largest jointly owned forests, the de minimis ceiling would thus be reached and the environmental aid could not be paid completely.298 it should also be born in mind, that as long as there is an effective aid scheme, the de minimis aid should not be cumulated with state aid in respect of the same eligible costs, if such accumulation would result in an aid intensity exceeding that fixed in the decision adopted by the commission. 6.2 sgei as a possibility in environmental conservation also the improvement needs in protected areas bring new challenges for nature conservation. for example, in finland many habitat types which suffer from eutrophication (e.g. esker forests) need silvicultural measures such as clearing of excessive vegetation, but the landowner cannot be obliged to commit these tasks. therefore, to make biodiversity preservation more efficient also in protected private forestry-free lands, the possibility to use the concept of services of general economic interest (sgei) in imposing an obligation on the landowner to produce “green services” could be thoroughly investigated. services of general economic interest (sgei) as laid down in article 14 and article 106 of tfeu, are defined in eu competition law as economic activities that public authorities identify as being of particular importance to citizens and that would not be supplied (or would be supplied under different conditions) if there were no public intervention. the rules that should 296 11.6.1999/731, 6 §. 297 law on jointly owned forests (yhteismetsälaki) 14.2.2003/109. 298 based on communcation with kirsi taipale, mmm, february 2011. nordic journal of commercial law issue 2011#2 61 constrain the way in which national, regional and local governments deal with their sgei constitute a special case of “state aid policy”.299 in economic terms, the concept of sgei as defined above is closely related to that of “universal service obligations” (uso), that is, obligations imposed on one or more firms of a given industry to supply given products or services to all citizens. sgei are by definition services which are provided at a loss by firms, otherwise there would be no need to impose the sgei. therefore firms often need be compensated for the provision of such services. since the private benefit is lower than the social benefit, there may be scope for subsidising into the network citizens who would not otherwise have subscribed the service.300 since social and political priorities vary greatly across member states, it is impossible to determine at a supra-national level which sectors should have which sgei. the eu should typically not constrain the desire of national, regional or local governments to define what are to count as instances of sgei. this allows each member state to have a wide margin of discretion in setting sgei. the role of the european commission should be only to check that there exist no manifest errors and no abuses in exercising such discretion. to this end, each member state is rightly required to clearly and explicitly indicate services that are classified as sgei.301 in line with the eu’s policy on sustainable development, due consideration has to be taken of the role of sgei for the protection of the environment and of the specific characteristics of services of general interest directly related to the environmental field.302 in the preamble of the convention on biological diversity, the contracting parties reaffirm that states have but sovereign rights over their own biological resources also responsibilities for conserving their biological diversity and for using their biological resources in a sustainable manner. the parties also determine to conserve and sustainably use biological diversity for the benefit of present and future generations. as mentioned above, states are additionally bound by the charter of the united nations and the principles of international law. reaching the obligations therein303, it is a requisite to care for the environment properly.304 additionally, the basic right related to the environment is included in plenty of national constitutions. according to the finnish constitution 20 § 2 “public authorities must endeavour to guarantee for 299 clemenz—dewatripont—motta—neven—seabright—zemplinerova 2006, p. 1. 300 clemenz—dewatripont—motta—neven—seabright—zemplinerova 2006, p. 2. 301 clemenz—dewatripont—motta—neven—seabright—zemplinerova 2006, p. 3. 302 communication of the commission of 12.5.2004 com(2004)374 final, section 3.4. 303 pursuant to the preamble of the charter of the un, states promote social progress and better standards of life in larger freedom and reaffirm faith in fundamental human rights. 304 also the european union strategy for sustainable development (com(2001) 264 final) provides an eu-wide policy framework to meet the needs of the present without compromising the ability of future generations to meet their own needs. nordic journal of commercial law issue 2011#2 62 everyone the right to a healthy environment and for everyone the possibility to influence decisions that concern their living environment”.305 the formulation “public authorities must endeavour to guarantee” differs from other safeguarding obligations, which obligate the public authority to improve the right referred to regulation in question. the obligation is thus proportioned, but the choice of the formulation is not considered to make any difference in regards to its binding nature. the question is about the safeguarding obligation directed at the public authority. it is within the core of a right to a healthy environment that the habitat is viable in a way that it does not cause people any direct or indirect health risk. in the 20 § 2 of finnish constitution, the obligation to ensure the right to a healthy environment is understood in a wider sense: including also the environmental satisfaction. even though the statement remains somewhat open, it can be seen to refer also to aesthetic and landscape values.306 the english jurist and philosopher jeremy bentham, who is best known for his advocacy of utilitarianism, thought that according to the nature of things, the law cannot grant a benefit to any, without, at the same time, imposing a burden on someone else. in other words, a right cannot be created in favour of anyone, without imposing a corresponding obligation on another. so that the basic right related to the environment would not be just a declaration but a real right, the public authority has to have a responsibility in ensuring it. in the commission's view a measure can only be classified as a service of general interest if it actually serves the interests of citizens. the nature conservation tasks that can constitute a service of general economic interest differ from classic environmental protection measures in that under the classic measures only the undertakings can voluntarily implement actions for the benefit of the environment, and not the state itself.307 silvicultural measures in forestry-free private lands i.e. “green services” could be considered to bring public benefit/be of general interest and consequently fall within the remit of the state. hence, a public service obligation might be imposed on them. the difference to activities related to the agriculture and forestry guidelines is that the latter are connected to the production, processing and marketing of agricultural products whereas the “green services” are connected to responsibility of a state to conserve biodiversity and obligation to guarantee for everyone the right to a healthy environment. instead of producing these services themselves, the public authorities impose the public service obligation to be fulfilled by a public or private company -in this case, the landowner. where the services are of general economic interest, the member states are required to apply community law, such as competition rules (including those on state aid) and rules on public 305 perustuslaki (finnish constitution) 20 § 2. 306 kumpula, anne: perustuslain 20 § ja sen merkitys kaivoslainsäädännön valmistelussa. available at: http://ktm.elinar.fi/ktm_jur/ktmjur.nsf/all/41fafd5bbec7cd57c22571c4003b68c0/$file/anne%20kump ula_kaivoslausunto.pdf. last visited in 28.3.2011, p. 9-10. 307 state aid no. nn 8/2009 – germany, point 58. nordic journal of commercial law issue 2011#2 63 procurement. although economic efficiency considerations might exist on principle, in practice justifications for sgei are in the vast majority of cases related to non-efficiency objectives. the altmark judgement`s key provisions have been incorporated into the community framework for state aid in the form of public service compensation308. it establishes that compensation for a sgei should not be considered as state aid within the meaning of the treaty if the following conditions are satisfied: 1) the universal service obligation is clearly defined, 2) the parameters for the compensation are objective, transparent, and are established in advance, 3) the compensation do not exceed costs plus a reasonable profit, 4) the compensation is determined either through public procurement (that is, a public tender has taken place and it is the winning firm which is chosen to provide the sgei) or, if no public tender has taken place, the firm is compensated on the basis of the costs of a typical well-run company. the community framework also lays down the conditions under which sgei which constitute state aids (because the conditions above are not fulfilled) may still be compatible with the treaty. importantly, the framework indicates that as long as the first three above mentioned conditions are fulfilled and the firm is not overcompensated, the sgei will be compatible. this implies that firms which are inefficient but not overcompensated would not be sanctioned.309 7 final words the upcoming challenges of eu`s environmental policy deal with the expansion of the eu. this is considered to indicate that differentiation, as well as the subsidiarity principle, are going to be emphasized. increase of different regional and local experiments is also predictable.310 as a guideline for the future, it is foreseeable that eu will encourage member states in adopting singular environmental taxes and solutions that are consistent with the ecological tax reform. the reversal of environmentally injurious aid and tax systems will also be actively carried out.311 biodiversity cannot be protected solely by regulations, but the conservation necessitates actions and measures in many sectors of society. more attention should be paid to biodiversity in development of existing aid schemes. within forestry, this could be realised by including compensation for nature values in agri-environmental state aid payments. to make biodiversity preservation more efficient also in protected private forestry-free lands, the possibility to take advantage of producing “green services” as services of general economic interest (sgei) should 308 oj 29/11/05, see http://europa.eu.int/eurlex/lex/lexuriserv/site/en/oj/2005/c_297/c_29720051129 en00040007.pdf. 309 clemenz—dewatripont—motta—neven—seabright—zemplinerova 2006. 310 naskali—hiedanpää—suvantola 2004, p. 24. 311 naskali—hiedanpää—suvantola 2004, p. 25. nordic journal of commercial law issue 2011#2 64 be untwined, especially since the environment has already been accepted by the commission as an area where these services might be established312. some new aid measures have already been approved at the eu level. under the rules on state aid the european commission has authorised, for instance, a revised version of a dutch tax incentive measure, "regeling groenprojecten" (green funds scheme), to stimulate investments in projects that have a positive effect on nature and the environment in the netherlands.313 the “regeling groenprojecten” offers a fiscal incentive to invest in green projects, including projects in the areas of nature, forestry and organic agriculture. in order to be eligible, projects need a “green certificate”, issued by the ministry of environment. presently, all major banks have dedicated “green funds”, investing in eligible green projects. money invested or saved in such “green funds” is exempt from income tax, which allows the bank to pay a lower dividend on such investments and thus to charge a lower interest rate on the money lent to the project initiator, or to accept a lower level of profitability. this has resulted in significantly higher numbers of certain species found on organic farmland than on conventional farmland.314 among existing aid schemes, new, genuinely market-based measures like habitat banking and offset schemes could be more utilized. there are various options available to try to ensure longterm management of the offsets, including regulatory instruments, contracts, conservation easements, and funding -and combinations thereof. an interesting example of a mix of these instruments can be found in the bio banking trust fund established in new south wales. owners of the lands in bank receive an annual payment out of this fund if they adequately carry out the management actions that have been set in an agreement concluded between the minister of the environment and the owner. if not, they do not receive the payment or have to repay the money paid.315 habitat banking is not part of the eu policy for tackling biodiversity loss, but it can make a significant contribution to several eu policies. this instrument can complement the use of public funds from the common agricultural policy enhancing the provision of public goods by agriculture, and it can potentially be incorporated into several directives, including the habitats directive, the environmental impact assessment and the environmental liability directive.316 incentives for introducing habitat banking and offset scheme on the basis of 107(3)(b) as an 312 see state aid no. nn 8/2009. 313 the commission found the various parts of the scheme to be in line respectively with its guidelines on state aid to agriculture, to fisheries, to the environment and with treaty rules on state aid for the development of certain economic activities (article 107(3)(c)). 314 see state aid n 249/2008 netherlands – green funds. 315 department of environment and climate change nsw, november 2007: pilot report of the may 2007 draft biobanking assessment methodology. available at: http://www.environment.nsw.gov.au/resources/biobanking/ biobankingpilot07535.pdf. last visited in 31.3.2011. 316 eftec, ieep et al. 2010. nordic journal of commercial law issue 2011#2 65 “aid to promote the execution of important projects of common european interest which are an environmental priority and will often have beneficial effects beyond the frontiers of the member state(s)” or on the basis of 107(3)(c) as an “investment aid for undertakings which go beyond community standards or which increase the level of environmental protection in the absence of community standards” -could possibly be used to facilitate the implementation of these measures. in accordance with its treaties, the eu has established an internal market which works for sustainable development based on balanced economic growth and a high level of protection and improvement of the quality of the environment. so that the market economy is able to improve the living conditions to the benefit of eu citizens in a sustainable manner, the legal frames must be built to guarantee that biodiversically rich environment, which not only is a prerequisite for healthy and wealthy living, but also enables innovation and new markets, is protected. that is why it is vital to integrate environmental protection requirements into the definition and implementation of all eu’s policies and activities. environmental protection is no longer inferior to trade liberalisation requirements under eu law, but both interests are given more or less equal importance. additionally, environmental protection, economic growth, and social development should be viewed as mutually compatible, rather than conflicting objectives. forestry has traditionally defined the use of natural resources in forests in a major way. lately however, it has been realised that biodiversically rich forests are irreversible for many ecosystem services to stay in balance as well. this balance has a remarkable effect on the economy. hence, it is not only accordant with european environmental principles, especially the high level of protection-, the precautionary and the prevention principle, but also with the objective of achieving an efficient economy, that biodiversity conservation is taken solemnly. if a market operates on the basis of outdated values, it works neither sustainably nor efficiently. the sustainable values to strive for can be shown effectively with the help of economic incentives. the commission should, in cooperation with member states, keep under constant review all systems of aid existing in those states317 and it should also continue to develop criteria to fulfil its assessment of aid compatibility, in particular through analyses of specific sectors318. each member state has the best knowledge of their own legislative, political and economical functions. hence, it is for member states to provide the necessary evidence in respect of developing the criteria of aid compatibility. so that the conservation would also be a real alternative to forestry the compensation for conservation would have to be competitive. by aiding actions that conserve biodiversity, also by giving compensation in money for nature values, states can not only carry their share for the 317 article 108(1) tfeu. 318 state aid action plan, p. 6-8. nordic journal of commercial law issue 2011#2 66 public goods, also act as forerunners for the future markets for ecosystem services. it should yet beborn in mind that these “markets” only work in addition to, not as a substitute for regulation. since the minimum level of protection should remain based on regulation the fears of nature values turning into merchandise seem somewhat overstated. by defending their desired measures, the member states can help to educe the eu and its policies towards the most appropriate, sustainable and effective ways of action. "in the end, we will conserve only what we love, we will love only what we understand and we will understand only what we are taught319." we must now learn the multiple values of nature and that the threats to biodiversity are also threats to economic goals, human health and eventually, human life. consequently, we will understand that investing in nature values today makes it possible to benefit from them also tomorrow. 319 baba dioum, senegalese conservationist. nordic journal of commercial law issue 2011#2 67 references literature ahlborn, christian – berg, claudia (2004): can state aid control learn from antitrust? the need for a greater role for competition analysis under the state aid rules. in book biondi, andrea – eeckhout, piet – flynn, james (edit.): the law of state aid in the european union. oxford university press, gbr, p 41-65. arentino, barbara—holland, paula—matysek, anna—peterson, deborah (2001): cost sharing for biodiversity conservation: a conceptual framework, productivity commission staff research paper, ausinfo, canberra. available at: http://www.pc.gov.au/__data/assets/pdf_file/0005/8294/csbc.pdf. bagri, andrea—blockhus, jill—vorhies, frank (1999): perverse subsidies and biodiversity loss – a draft scoping paper for iucn-the world conservation union and the van lennep programme iucn economics service unit., p 21-22. available at: http://env.chass.utoronto.ca/env200y/essay04/ peverse_subsidies.pdf. last visited in 15.3.2011. bellamy – child (2001): european community law of competition, fifth edition, 19-015. blom – bergsma – korteland (2008): economic instruments for biodiversity setting up a biodiversity trading system in europe. available at: http://www.landecon.cam.ac.uk/research/eeprg/cleed/pdf/ blom_et_al.pdf. bräuer – müssner – marsden – oosterhuis – rayment – miller – dodoková (2006): the use of market incentives to preserve biodiversity. final report. a project under the framework contract for economic analysis env.g.1/fra/2004/0081. available at: http://ec.europa.eu/environment/enveco/ biodiversity/pdf/mbi/pdf. buelens, christian—garnier, gaëlle—johnson, matthew—meiklejohn, roderick (2007): the economic analysis of state aid: some open question. european economy: economic papers. no 286, september 2007. available at: http://ec.europa.eu/economy_finance/publications/publication9549_en.pdf. bär, stefani – krämer, andreas (1998): european environmental policy after amsterdam, journal of environmental law 2/1998, p 316-330. chacón-cascante, adriana – porras, ina – robalino, juan (2010): review of policy instruments and their role in a policy mix payment for environmental services (pes). clemenz, gerhard—dewatripont, mathias—motta, massimo—neven, damien—seabright, paul—zemplinerova, alena (2006) : services of general economic interest opinion prepared by the state aid group of eagcp. available at: http://ec.europa.eu/competition/state_aid/legislation/sgei.pdf. eftec, ieep et al. 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(edit.): the law of state aid in the european union. oxford university press, gbr, p 207-217. raitio, juha (2008): valtiontuen käsite sisämarkkinoilla, markkinasijoittaja –periaate ja sgei-palvelut. defensor legis 2008/5, p 854-865. ring, irene (2008): compensating municipalities for protected areas – fiscal transfers for biodiversity conservation in saxony, germany. gaia 17/51 (2008): p 143-151. sadeleer, nicolas de (2002): environmental principles – from political slogans to legal rules. oxford university press. nordic journal of commercial law issue 2011#2 69 shine, clare (2005): using tax incentives to conserve and enhance biodiversity in europe. council of europe publishing. siikavirta, kristian (2007): valtiontuki oikeuden ja politiikan yhtymäkohdassa – esimerkkinä ympäristönsuojelu. helsingin yliopisto, helsinki. siikavirta, kristian—parikka, julius (2010): eu:n valtiontukisäännöt. edita publishing oy. sorto, anna (2002): ympäristönsuojelu ja ey:n perustamissopimuksen 28 artikla. in book: yritys eurooppalaisessa oikeusyhteisössä (edit. mylly, tuomas and helander, petri), helsinki. zwaan, pieter – goverde, henri (2010): making sense of eu state aid requirements: the case of green services. environment and planning c: government and policy 2010, volume 28, p 768-782. vickerman, sara: national stewardship initiatives conservation strategies for u.s. land owners 1998. defenders of wildlife. available at: http://www.defenders.org/resources/publications/programs_and_ policy/biodiversity_partners/national_stewardship_incentives_conservation_strategies_for_u.s._landow ners.pdf. wiers, jochem (2002): trade and environment in the ec and the wto. europa law publishing. wolf, steven – primmer, eeva (2006): between incentives and action – a pilot study of biodiversity conservation competencies for multifunctional forest management in finland. society & natural resources: an international journal 9/2006, volume 19, p 845-861. official documents council recommendation 75/436 of 3 march 1975, regarding cost allocation and action by public authorities on environmental matters. oj l 194, 25.7.1975. european commission, xxivth report on competition policy 1994. european commission (1997): fifth survey on state aid in the european union in the manufacturing and certain other sectors. com (97) 170 final. commission communication on state aid elements in sales of land and buildings by public authorities (oj) c 209, 10.7.1997. counsil resolution on the drafting, implementation and enforcement of community environmental law, oj c321/i 1997. european commission (1998): sixth survey on state aid in the european union in the manufacturing and certain other sectors. com (98) 417 final. commission notice on the application of the state aid rules to measures relating to direct business taxation. oj 1998 c384/3. the sixth environment action programme of the european community entitled "environment 2010: our future, our choice". com(2001) 31 final. a 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final. other (online) sources facing the challenge: the lisbon strategy for growth and employment.report from the high level group chaired by wim kok 2004. available at: http://ec.europa.eu/research/evaluations/pdf/archive/ fp6-evidencebase/evaluation_studies_and_reports/evaluation_studies_and_reports_2004/the_lisbon_ strategy_for_growth_and_employment__report_from_the_high_level_group.pdf. forest certification in finland – what is it? finnish forest foundation 2005. available at http://www.pefc.fi/media/asiakirjat/esitteet/kt_englanti.pdf. natural resources defence counsil. available at http://www.nrdc.org/land/forests/qcert.asp. state aid and public procurement: a practical guide. available at: http://www.cobbetts.com/ ourservices/eccompetition/stateaidandpublicprocurementapracticalguide. the millenium ecosystem assessment (2005). ecosystems and human well-being: biodiversity synthesis. world resources istitute, washington, dc. legal practice european court of justice c-47/69 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[1988] ecr 1988. c-5/89 bug-alutechnik [1990] ecr i-3437; case 177/78 pigs and bacon commission v mccarren [1979] ecr 2161. joined cases c-72/91 and c-73/91 firma sloman neptun schiffahrts ag v seebetriebsrat bodo ziesemer der sloman neptun schiffahrts ag [1993] ecr i-00887. c-241/94 french republic v commission of the european communities [1996] ecr i-04551. case c-67/97 criminal proceedings against ditlev bluhme [1998] ecr i-08033. c-351/98 kingdom of spain v commission of the european communities [2002] ecr i8031. case c-379/98 preussenelektra ag v schhleswag [2001] ecr i-2099. c-143/99 gmbh and wietersdorfer & peggauer zementwerke gmbh v finanzlandesdirek adria-wien pipeline tion für kärnten [2001] ecr i-08365. c-280/00 altmark trans gmbh [2003] ecr i-07747. the european commission`s decisions the commission decision of 22 july 1993 concerning aid the italian government intends to grant to cartiere del garda (oj 1993 l 273/51). n 657/1999 – united kingdom business infrastructure development. n 504/2000 renewables obligation and capital grants for renewables technologies. n 102/2001 – finland draft decree of the council of ministers on compensation to fishermen for losses caused by seals. n 232/2001 – belgique réduction de cotisations patronales de sécurité sociale en cas d'application d'une durée de travail hebdomadaire de 38 heures et en cas de réduction du temps de travai.l n 543/2001 – ireland capital allowances for hospitals. n 416/2001 uk emission trading scheme. c-11/2001 (ex n 629/00) invitation to submit comments pursuant to article 88(2) of the ec treaty concerning the waste disposal system for car wrecks in the netherlands. n 789/2002 – sverige elcertifikatsystemet. n 707/2002 mep stimulating renewable energy. n 708/2002 mep stimulating chp. c 37/2004 finland – alleged aid to componenta. n 130a/2007 – finland aid for forestry. c 12/2009 (ex n 19/2009) – potential aid measures in favour of järvi-suomen portti osuuskunta. nn 8/2009 – germany nature conservation areas. nordic journal of commercial law issue 2011#2 72 list of abbreviations bpp beneficiary pays principle cbd the convention on biological diversity ec the european community eu the europen union eu ets the european union greenhouse gas emission trading system gber general block exemption regulation gs green services ma the millennium ecosystem assessment meip the market economy investor principle metso the southern finland forest biodiversity programme pes payments for environmental services ppp polluter pays principle sgei services of general economic interest sme small and medium-sized undertakings teu the treaty on the european union tfeu the treaty on the functioning of the european union microsoft word article4.doc arbitration clause – is it transferred to the assignee? by dr. andrea vincze1 nordic journal of commercial law issue 2003 #1 1 dr. vincze received her ph.d. from university of miskolc, hungary nordic journal of commercial law, issue 2003 #1 2 1. introduction the question whether an arbitration clause is transferred to the assignee in cases of assignment of receivables, has remained a major problem even after the text of the uncitral convention on the assignment of receivables in international trade (hereinafter: receivables convention) was finalized in 2001. aims of the treaty are “to promote the movement of goods and services across national borders by facilitating increased access to lower-cost credit”…to ”remove legal obstacles to certain international financing practices, (…) to “enhance security and predictability with respect to the law applicable to key issues”, and to “harmonize domestic assignment laws by providing a regime governing priority between competing claims for states to opt-into”.2 the convention needs five accessions for entry into force, however, only luxembourg has signed it so far3 (status of 30 august 2003). hence, in this case, two major issues are concerned: arbitration and international assignment of receivables. the first one, arbitration, has an important role amongst means of dispute resolution. this results from its numerous advantages, e.g. more effective consideration of professional points of view, cheaper and speedier procedure compared to that of the state courts4, neutrality and guaranteed enforceability with the assistance of the new york convention on the recognition and enforcement of foreign arbitral awards (hereinafter: the new york convention)5. moreover, in the era of modern developed economy enormous amounts of money are involved in business transactions, which implies several supplementary issues and legal institutions including payment, banking activities etc. the receivables convention was also necessary because of the fact that the assignment of receivables has recently become even more widespread than it used to be. in search for quick and effective means of dispute resolution, assignment cases are more frequently dealt with by arbitrators. this is where the question of the article rises – whether an arbitration clause can be transferred from an assignor to an assignee when the receivables included in a certain contract are assigned to the latter. 2. the main question – is the transfer automatic? the principle of automatic transfer has developed in the roman law, namely in the ius commune. it has also been acknowledged in both continental and common law systems. in practice, however, the tendency is that the validity of arbitration clauses must be examined not only according to conflict of laws rules and substantive legal provisions but also with regard to specific rules of arbitration. the expression ‘automatic’ concerns so-called ‘further rights’ other than those which are undisputedly the subject of transfer (e.g. money or other receivables). therefore, automatic transfer applies to accessory rights deriving from the original (basic) contract and they are transferred to the assignee if the receivables were validly assigned to a third party. the general tendency in practice has recently become automatic transfer of all, including accessory, rights and this is underlined by international and national arbitration practice6. 2 http://www.uncitral.org/english/texts/payments/paymentsindex.htm 3 luxembourg ratified the convention on 12 june 2002. 4 born p.7 5 roth-wulff-cooper p. 3-4.; berger p. 726 6 code civil (france): 1692. §; the netherlands: b.w., boek 6., 142. §.,; belgium: b.w. 1692. §; switzerland: co 170.§ (1). nordic journal of commercial law, issue 2003 #1 3 with regard to theoretical issues, firstly, the question whether an arbitration clause is a contractual collateral or a real accessory right, must be taken into account. according to a decision by the german federal constitutional court7, arbitration clauses and contractual collaterals work analogously (as provided by art. 401 bgb), and the arbitration clause is a means of enforcing payment, therefore, it took the opinion that the arbitration clause is automatically transferred. this point of view was shared by art. 1394 abgb which implies that „the assignee’s rights concerning the assigned receivables are the same as those of the assignor’s”. furthermore, art. 170 (1) of the swiss obligation law (schweizerisches obligationsrecht) states that „the assignment of receivables includes the advantages concerning the receivables and the right deriving from it”. art. 1692 of the code civil further emphasizes this view by saying that „the assignment includes the transfer of all accessory rights related to the receivables”. however, according to other opinions (e.g. the receivables convention), that arbitration clauses are not contractual collaterals because they do not operate like ‘real’ contractual guarantees e.g. warrant or hypothec. according to these opinions, automatic transfer concerns accessory rights and not arbitration clauses because the latter are not in close connection with the receivables themselves i.e. the existence of the receivables is not dependant on the validity of the original contract8. even if this opinion was right, the nature of arbitration clauses implies that transfer is possible for the following reasons. on the one hand, an arbitration clause is always laid down with regard to the fact that legal disputes may occur. therefore, the clause itself would not be interpretable if there was not any possibility of and reference to an incidental legal dispute. on the other hand, if the arbitration clause was not transferred in cases of assignment, the whole clause would be meaningless since its application could be evaded simply by assigning it to a third party. this opinion was emphasized in the hosiery mfg. corp. v. goldston case where the court of appeals in new york expressed that none of the parties can deprive the other of the advantages of arbitration9. other american courts have also stated that the transfer is automatic because if it was not, assignment of rights deriving from the original contract would be modified unilaterally since in that case, means of dispute resolution different from what was laid down in the original contract would have to be used10. what other factors strengthen the principle of automatic transfer? some courts have stated that the principle of reasonableness supports the idea11. therefore, an arbitration clause operates as a procedural means of enforcing rights deriving from a contract. on the other hand, automatic transfer serves for the protection of the debtor. it ensures for the debtor to be able to enjoy the benefits of arbitration and not to be obliged to go to a state court. debtor protection is appropriate if the possibility of neutral arbitration originally provided for in the contract is 7 bundesgerichtshof: iii zivilrecht 2/96, 2 october 1997; bundesgerichtshof: iii zivilrecht 18/77, 28 may 1979, neue juristische wochenschrift; bundesgerichtshof: iii zivilrecht 103/73, 18 december 1975. 8 lionnet p. 65, cf. girsberger-hausmaninger p. 121, 131, 137, 139. 9 hosiery manufacturing corp. v. goldston 238 n.y. 22. (newyork court of appeal 1924), 28; gmac commercial credit llc v. springs industries, inc. 44 uniform commercial code reporting service, second series (callaghan) (hereinafter: rep.serv.) 903 (united states district court, southern district of new york (hereinafter: s.d.n.y.)2001.) 10 gmac commercial credit llc v. springs industries, inc. 44 uniform commercial code reporting service, second series (callaghan) 903 (s.d.n.y. 2001.): „an assignment cannot alter a contract’s bargained-for remedial measures, for then the assignment would change the very nature of the rights assigned”; cone constructors inc. v. drummond community bank 754 so. 2d 779 (1st district court of appeal of florida,. 2000); banque de paris et des pays-bas v. amoco oil company 573 federal supplement (hereinafter: f. supp.) 1464 (s.d.n.y 1983), 1469; robert lamb hart planners and architects v. evergreen ltd. 787 f. supp. 753 (united states district court, southern district of ohio 1992). 11 icc no. 3281, 1981.; icc no. 1704, 1977.; icc no. 2626, 1977.. nordic journal of commercial law, issue 2003 #1 4 harmed because in those cases the debtor is not obliged to take part in less advantageous proceedings12. another factor that emphasizes automatic transfer is the requirement of legal certainty. in practice, state courts reject the assignee’s claim if the debtor refers to an arbitration agreement laid down in the original contract13. state courts explained automatic transfer with the fact that otherwise, by assigning the receivables, the other party would ensure for himself proceedings before a state court. the latter reasoning provides for the possibility of the transfer which is not only possible but also automatic. besides, validity of the arbitration clause is not affected by the assignment either. the assignee has the chance to examine the clause even before the assignment took place. therefore, a party cannot say that he is not affected by the arbitration clause once he accepted the legal relationship ‘as it is’. including an arbitration clause into a contract means that solely arbitration is open for an incidental dispute resolution, all other ways, e.g. state court jurisdiction, are excluded. hence, the assignee will be obliged to refer a dispute to arbitration by all means, even if there was no direct connection (agreement) between himself and the original contracting party. full transfer of the arbitration clause is supported by practical cases as well. the french court de cassation has recently laid down that „an international arbitration clause, the validity of which depends only on the parties’ intentions, is transferred to the assignee along with the rights related to the receivables and in the same form and way as they were valid between the assignor and the original contracting party”14. the paris court of appeals referred to financial interests when emphasizing automatic transfer of the arbitration clause in the c.c.c. filmkunst case15. the court expressed that the party to which the exploitation rights of a film were assigned, is bound to the arbitration clause. it stated that assignment implies that the assignor assigns the beneficiary means of arbitral dispute resolution with regard to the fact that the clause is related to financial aspects of the contract. this reasoning is imperative because both the assignee and the original contracting party have financial interests in turning to arbitration. the district court of new york went on to build up a procedural principle by stating that „an assignee is (…) is bound by the remedial provisions bargained for between the original parties to the contract”16. 12 according to girsberger & hausmaninger, there is no neutrality if the seat of the assignee is the same as that of the arbitral tribunal, or if the assignee is a native of that country the law of which was chosen as applicable law by the original parties, especially if this results in a close connection with the previously nominated arbitrator. (p. 146-147) 13 cour de cassation, 19 october 1999, revue de l’arbitrage (rev. arb.) 2000, 86; paris (1re ch urg.), 20 april 1988, rev. arb., 1988, 570; gmac commercial credit llc v. spring industries, inc. (u.s. district court, s.d.n.y., 24 april 2001, 00 civ. 2893 (nrb); dimercurio v. sphere drake insurance plc. (u.s. court of appeals, first circuit, 31 january 2000, 202 f.3d 71); heirs of augusto l. salas, jr v. laperal reality corp., (supreme court of the phillippines, 13 december 1999, g.r. no. 135362); cone constructors, inc v. drummond community bank (court of appeal of florida, first district, 10 june 1999, 754 so.2d 779); thomson-csf, s.a. v. american arbitration association (u.s. district court, s.d.n.y., 31 october 1983, 573 f.supp 1464); lumbermens mutual casualty company v. the borden company (u.s. district court, s.d.n.y. 7 april 1967, 268 f.supp. 303); instituto cubano v. the mv driller (u.s. district court, s.d.n.y., 11 february 1957, 148 f. supp. 739). 14 banque worms v. bellot, cass. 1e ch. c., 05.01.1999, no. s. 96-20.202, rev. arb. 2000, 85 (86) 15 c.c.c. v. filmkunst, ca paris, 28.01.1988, 1988 rev. arb. 567. 16 banque de paris et des pays-bas v. amoco oil company, 31.10.1983, s.d.n.y. 573 f.supp. 1464 (1469). nordic journal of commercial law, issue 2003 #1 5 3. is automatic transfer exclusive? in spite of all those arguments supporting automatic transfer of the arbitration clause from the assignor to the assignee, still there are some practical examples of the fact that the clause is not always assigned. three main points will be discussed here: first, ‘deliberate’ actions excluding transfer of the arbitration clause (‘express clause’, informing the debtor of exclusion) and then ‘implied’ theoretical factors making automatic transfer impossible (intuitu personae and separability). 3.1. ‘deliberate’ actions excluding automatic transfer two main cases of these ‘deliberate’ actions must be named here. the first one is called using an ‘express clause’ in order to exclude automatic transfer of the arbitration clause if the parties want it to be effective only between themselves and exclude third parties (e.g. assignees) from it. the parties are obliged to set out beyond doubt that the clause is of personal nature and it cannot be transferred at all. the express exclusion must be in writing and in detail. mentioning the names of the parties throughout the whole contract is not enough for such an exclusion because, according to related practice, it can only be interpreted and evaluated as a form of naming the parties but it does not fulfil the requirements of a separate and detailed exclusion in writing (express clause). therefore, a contract using the names of the parties is valid not only between the original contracting parties but it results that it is not valid only between themselves but the arbitration clause may apply to third parties, i.e. assignees, too. even if one of the parties had the opinion that the clause is not applicable to an assignee, these kinds of secret reservations can be taken into account only if they are shared by the other party as well17. yet, an american court overruled this point of view by stating that an arbitration agreement reflecting the parties’ intentions must be interpreted literally and not extensively18. turning to the question in which cases it is useful and necessary to exclude third parties from the arbitration agreement, two main possibilities have to be mentioned. firstly, there are cases when the possibility of the assignment has already occurred at the time of concluding the contract and the arbitration clause. alternatively, the parties may, at the time of the conclusion of the contract and the arbitration clause, be aware of a possible subsequent assignment. in such cases, the debtor might have to face an unknown and unfavourable assignee. it is also possible that several arbitration proceedings at the same time would be brought against the debtor. the latter situation might occur if separate receivables were to be assigned separately and different arbitration proceedings were initiated concerning each of those receivables19. with regard to all these dangers and uncertainties concerning the assignability of the arbitration clause, parties to a contract had better precisely clarify in writing whether the clause was meant to be applicable only between themselves or it can be assigned to a third party. such an appropriate clarification is for example the following: „this agreement to arbitrate is binding only upon the signatories hereto and not to their successors or assigns”20. in order to avoid 17 zweigert-kötz p. 402; unidroit principles 4.1.; cisg art. 8.; principles of european contract law 2:102. 18 mccarthy v. azure, 22 f.3d 351. 19see: dr. vincze andrea: a választottbírósági klauzula jogi sorsa a szerződésben foglalt követelés engedményezése esetén nemzetközi kitekintés , in: cég és jog, 2003/1-2, p. 42-45. 20 born: international arbitration and forum selection agreements, p. 81. nordic journal of commercial law, issue 2003 #1 6 misinterpretations or failures in applying the arbitration clause, the original contracting parties should provide for the exclusion or admittance of third parties – otherwise they should not be surprised if problems occurred regarding the interpretation of the arbitration clause. after having examined the first means of excluding automatic transfer, the second one will be analysed. this implies that transfer is not automatic either if the assignee informs the debtor that he does not consider the clause valid to himself. according to a decision of an american court21, the assignee can ask for the debtor’s permission that the receivables be transferred to him (the assignee) without the arbitration clause. this opinion was further developed by another court which stated that the assignee may be released from the requirement if it can show that it has given „proper notice of the limited nature of its involvement, or by obtaining a separate and legally sufficient agreement with the account debtor that the debtor will pay without asserting offsets or counterclaims”22. consequently, automatic transfer is overruled if the assignee commits pre-determined, deliberate actions in order to avoid it. this implies explicit exclusion of transferring the arbitration clause to third parties or informing the debtor of neglecting the arbitration clause either by making a literal agreement on it or by expressing that the debtor will not initiate proceedings against the assignee if he does not intend to be bound to the arbitration clause. next, ‘implied’ factors denying automatic transfer will be dealt with. 3.2. ‘implied’ factors making automatic transfer impossible there are some factors which, by themselves, make automatic transfer of an arbitration clause impossible. they are referred to as ‘implied’ because their main and original purpose is not the avoidance of automatic transfer but they serve other specific aims concerning the performance of the contract (intuitu personae) or they are based on an important theoretical feature of the relationship between the main contract and the arbitration clause (separability). the first ‘implied’ factor is the institution of ‘intuitu personae’. according to the definition, the arbitration clause is not transferred to the assignee if the original contract was concluded with regard to the fact that the other contracting party was chosen for a specific reason (intuitu personae) and therefore, possible assignees and other entities acting on behalf of the assignor would not be able to perform as good as the original contracting partner. the mentioned specific reason can be any special ability, confidential or long-term business relationship between the parties. besides these special features, the contractual partner must trust the other party’s good faith and he must accept that particular means of dispute resolution. therefore, automatic transfer is possible only if one can prove that the legal relationship is exempt from the above mentioned features. consequently, the implied factor in this case is that the parties concluded the original contract with regard to a special ability or relationship, which was originally aimed at achieving the best performance possible. however, the ‘background’ effect of this confidential relationship means that the arbitration clause refers to the original contractual partner and therefore, the arbitration clause must not be transferred to any subsequent third party. 21 gmac commercial credit llc v. springs industries, inc. 44 u.c.c. rep. serv. 2d (callaghan) 903 (s.d.n.y. 2001) 22 banque de paris et des pays-bas v. amoco oil company 573, f. supp. 1464 (s.d.n.y. 1983), 1466. nordic journal of commercial law, issue 2003 #1 7 under what circumstances can a party refer to the fact that the contract was not concluded intuitu personae and therefore, the arbitration clause is automatically transferred to the assignee? one of these cases is when the performance of the contract does not require any special skills of the other party or any special confidential relationship between the parties23. in other words, it is the negative wording of what was mentioned before, namely the criteria of the ‘specific reason’. back to the latter reasoning, if the personality of the other contracting party was not a determining factor in signing the original arbitration agreement, it can be assumed that the other party to the contract implicitly agreed to transfer the clause by assigning it to a third party24. however, this is still not enough. it must also be taken into account that in most cases the basis of arbitration clauses is not primarily the confidential relationship with the other party but the validation of the advantages of arbitration. in the shayler v. woolf25 case automatic transfer was found by the court of appeals of england by stating that an arbitration clause is not of personal nature. a contrary reasoning was born in the cottage club estates v. woodsides estates co.26 case where the same court ruled that the arbitration is of personal nature but it must be examined in each and every case – i.e. there are no general rules of determining whether the clause is of personal nature and such rules are not necessary either. the other ‘implied’ factor concerning the exclusion of automatic transfer is a widespread point of view distinguishing between substantive legal and procedural aspects of a contract. according to the principle of separability, if the contract containing the clause is invalid or void, the arbitration clause is still valid, i.e. it is separable from the main contract27. consequently, it is also possible that the main contract and the arbitration clause are governed by different laws. the doctrine of separability can be interpreted in two main ways concerning the assignment of receivables. on one hand we can contend that autonomy of the arbitration clause results that it cannot be transferred to the assignee, and on the other hand we can assume that the aim of the doctrine is to ensure arbitration even if the clause itself is void or invalid. looking at the first alternative, what evidence underlines the submission that the autonomy of the arbitration clause means intransferability? according to practical cases28, the arbitration clause is an autonomous procedural agreement which is separate from all other aspects of the contract. consequently, as the assigned receivables are included in the main contract, the clause separate from the latter is not assigned to the assignee. this kind of autonomy also suggests that different laws might be applicable to the main contract and the autonomous arbitration clause because the latter is, thus, not affected by changes regarding the main contract29. 23 application of reconstruction finance corp. v. harrions & crosfield, ltd. (106 f.supp. 358 (s. d.n.y 1952) 360); kelso p. 89. 24 fouchard-gaillard-goldman p. 431. 25 shayler v. woolf (1946) ch. 320 (323) 26 (1928) 2 kb 463, 466. 27 fouchard-gaillard-goldman: no. 410; girsberger-hausmaninger p. 121.; raeschke-kessler-berger no. 379-től; redfernhunter no. 5-30. 28 sojuznefteexport v. joc oil ltd., yca 1998, 745.; imp group v. aeroimp, moscow district court, yearbook commercial arbitration 1998, 745. 29 fouchard – gaillard – goldman p. 470. nordic journal of commercial law, issue 2003 #1 8 another consequence of the autonomy of the arbitration clause implies that the arbitration agreement forms a fully separate contract and therefore arbitration is not only a right but also an obligation for the original parties – yet, exclusively for the original parties, which means that the arbitration clause cannot be transferred to an assignee30. however, several scholars say that this latter statement can be overruled31, i.e. the arbitration clause can be transferred to the assignee but only if all parties involved in the legal relationship have agreed to it. a similar argumentation can be found in art. 15 (1) of the receivables convention but that one implies that the arbitration clause can be transferred to the assignee without any special act as well. according to the provision, “except as otherwise provided in this convention, an assignment does not, without the consent of the debtor, affect the rights and obligations of the debtor, including the payment terms contained in the original contract.” interpreting this rule, as transferring the arbitration clause does not affect or alter any such rights and obligations, the legal situation of the debtor remains the same and consequently, automatic transfer is possible. this is what leads us to the second way of interpreting the doctrine of separability. therefore, it can also be contended that the aim of the doctrine is to ensure arbitration even if the clause is void or invalid. this means that autonomy is to be interpreted in a way that the assignee is bound to arbitration, even if there are legal disputes concerning the main contract, e.g. the assignment itself. therefore, separability is aimed at ensuring and encouraging arbitration in any case32. summarizing the application of separability, we can contend that exact interpretations can be different. therefore, once again, we have to emphasize that the most secure way is to lay down clearly in the original contract (or in the arbitration agreement) whether the arbitration clause can be transferred or not. doing so, many subsequent problems of interpretation can be avoided. 4. the interpretation of the ‘writing-requirement’ in cases of assignment it is a requirement of concluding an arbitration agreement that it must be in writing33. however, if an arbitration clause is transferred (assigned) to a third party who originally had nothing to do with the basic contract and the other contracting party, the question rises whether the latter requirement applies here. alternatively, is it sufficient in cases of assignment that there is a written arbitration agreement only between the original parties (and it is analogously transferred to the assignee) or is the arbitration clause valid between the assignee and the original contracting party only if they concluded another, separate arbitration clause? in examining this question, firstly, the principle of the priority of the contract must be taken into account. this has two main aspects – first, that only those parties can refer to an 30 at & t technologies, inc. v. communications workers of america et al., 475 u.s., 643., 649., 106 s.ct., 1415, 1419; lachmar v. trunkline lng company, 753 fed. rep. 2nd series, p. 8., 10; laborers intern. union v. foster wheeler corp., 868 f.2d 573, p. 576. 31 schricker p. 103-105., schopp p. 259., girsberger-hausmaninger p. 121.; schwab-walter: kap. 7., no. 32.; farnsworth 11.10 §, p. 742. 32 weinacht p. 9-10.; trade finance inc. v.bulgarian foreign trade bank ltd. (stockholm chamber of commerce, 5 may 1997); hosiery manufacturing corp. v. goldston (238 n.y. 22, new york court of appeal 1924) 33 art. 7 (2) of the uncitral model law on international commercial arbitration; art. ii 2. new york convention. nordic journal of commercial law, issue 2003 #1 9 arbitration clause who originally agreed to turn a possible legal dispute to arbitration34. secondly, arbitration as a contractual question means that the party which did not expressly agree to the clause, cannot be obliged to take part in arbitration35. this is supported by the view that it is the arbitration clause “which gives rise to the consensual and predominantly bilateral nature of the arbitration to the exclusion of third parties”36. according to van den berg and reithmann & martiny37, the requirement of writing relates to both drafting the clause and transferring it to a third party. therefore, referring to an oral or an implicit agreement is not enough for transferring the arbitration clause. representatives of the contrary point of view state that the ‘writing-requirement’ does not apply to parties entering into a legal relationship subsequently. according to girsberger & hausmaninger38, the requirement of writing set out in art. 7 (2) of the uncitral model law on international commercial arbitration refers only to the original contracting parties. it aims at protecting the contracting parties and making them aware of the consequences of their agreement. furthermore, lack of the ‘writing-requirement’ could only be objected to by the assignee because he is the only one who did not take part in concluding the original contract. consequently, both necessity and ignorability of the ‘writing-requirement’ are present and at the same time disputed in theory and in practice. final resolution of the question might depend on tendencies in practice. 5. summary with regard to the fact that international trade and commerce is developing at a rapid pace, several new problems might emerge. however, development cannot be hindered either by too extensive interpretation or by too casuistic regulation. assignment of receivables is truly a complex legal institution. although the main rule seems to be automatic transfer, each and every case is to be determined separately. the mentioned exceptions to the main rule emphasize that special legal characteristics, security of trade and commerce and legal security have a very special role in practice. we can also contend that judicial discretion and ‘equity’ have a lot to do in such cases but it does not mean that, without exact legal provisions, the legal fate of the arbitration clause would be degraded by certain interests. as relevant cases have proven, imperative rules of law are always in the first place in governing the problem of assignment, and some kind of general tendency is being developed. however, the text of the receivables convention has already been finalized but it has not entered into force yet. more effective solutions and a unified interpretation of the transfer of the arbitration clause will only be instituted if the convention will be more generally 34 fouchard-gaillard-goldman p. 280. 35 labors international union of north america v. foster wheeler corp., 868 f.2d 573, 576; reyes compania naviera s.a. v. manumante s.a., 649 f.supp. 789, 791; nicholas a. califano, m.d. v. shearson lehman bros., 690 f.supp. 1354, 1355. 36 russel, p. 5, 1-003. 37 van den berg p. 206; reithmann-martiny-hausmann, no. 2341. 38 38 girsberger-hausmaninger p. 138, rubino-sammartano p. 229, loquin p. 1030, uncitral model law on international commercial arbitration 16. §. nordic journal of commercial law, issue 2003 #1 10 widespread. until that time, theoretical and practical tendencies can be followed by courts and unified methods and interpretations must be urged in order to lay down the foundations of a generally accepted doctrine of ‘automatic transfer’ and the exceptions to it. nordic journal of commercial law, issue 2003 #1 11 bibliography berger, klaus-peter: international economic arbitration. deventer, boston, 1993. (cited as: berger) born, gary: international arbitration and forum selection agreements – planning, drafting and enforcing. the hague, 1999. (cited as: born: int. arb. and forum selection agreements) born, gary b.: international commercial arbitration in the united states, commentary and materials. deventer, boston 1994. (cited as: born) farnsworth, e. allan: contracts. 3rd ed., 1999. (cited as: farnsworth) fouchard, philippe – gaillard, emmanuel – goldman, berthold: fouchard, gaillard, goldman on international commercial arbitration. szerk.: gaillard, e.savage, j., the hague, boston, london 1999. (cited as: fouchard-gaillard-goldman) girsberger, d. – c. hausmaninger: assignment of rights and agreement to arbitrate. 1992 8 (2), arbitration international 121-165. (cited as: girsberger-hausmaninger) kelso, r.c.: international law of commerce. 2. kiadás, new york, dennis & co., inc., 1961. (cited as: kelso) lionnet, klaus: handbuch der internationalen und nationalen schiedsgerichtsbarkeit. stuttgart, münchen, hannover, berlin, weimar, dresden, 1996. (cited as: lionnet) loquin, eric: note on filmkunst decision. 116 journal de droit international (1989) 1025. (cited as: loquin) mustill, michael j. – boyd, stewart c.: the law and practice of commercial arbitration in england. london, 1982. raeschke-kessler, hilmar – berger, klaus-peter: recht und praxis des schiedsverfahrens. 3rd ed., cologne 1999. (cited as: raeschke-kessler-berger) redfern, a. – m. hunter: law and practice of international commercial arbitration. 2nd ed., london, sweet & maxwell, 1991. (cited as: redfern-hunter) reithmann, christoph – martiny, dieter: internationales vertragsrecht. 5th ed., cologne, 1996. (cited as: reithmann-martiny) nordic journal of commercial law, issue 2003 #1 12 roth, bette j. – wulff, randall w. – cooper, charles a.: the alternative dispute resolution practice guide. new york, 1998. (cited as: roth-wulff-cooper) rubino-sammartano, m.: international arbitration law. deventer: kluwer law and taxation publisher, 1990. (cited as: rubino-sammartano) russel on arbitration (ed.: sutton, david st. john; kendall, john; gill, judith): russel on arbitration 21st ed., london, 1997. (cited as: russel) schlechtriem, peter: schuldrecht – besonderer teil. 5th ed., tübingen, 1998. schopp, heinrich: die abtretung in schiedsgerichtsverfahren. kts 1979, p. 255. (cited as: schopp) schricker, gerhard: zur geltung von schiedsvertragen bei anspruchsabtretung. in: festschrift für karlheinz quack zum 65. geburtstag. berlin, new york, 1991., 99.o. (cited as: schricker) schwab, karl heinz – walter, gerhard: schiedsgerichtsbarkeit, 6th ed., münchen, 2000. (cited as: schwab-walter) van den berg, a.j. (ed.) : international dispute resolution: towards an international arbitration culture. the hague, kluwer law international, 1998. (cited as: van den berg) weinacht, f.: party succession in agreements to arbitrate, sweden backs down on practical considerations. (1999) 14/9 mealey’s international arbitration report 1. (cited as: weinacht) yearbook commercial arbitration 1992 zweigert, konrad – kötz, hein: einführung in die rechtsvergleichung aug dem gebiete des privatrechts. 3rd ed., tübingen, 1996. (cited as: zweigert-kötz) nordic journal of commercial law, issue 2003 #1 13 list of legal authorities abgb [allgemeines bürgerliches gesetzbuch] – austrian civil code bgb [bürgerliches gesetzbuch] – german civil code code civil – the french civil code schweizerisches obligationsrecht swiss obligations law uncitral convention on the assignment of receivables in international trade new york convention on the recognition and enforcement of foreign arbitral awards 1. introduction 2. the main question – is the transfer automatic? 3. is automatic transfer exclusive? 3.1. ‘deliberate’ actions excluding automatic transfer 3.2. ‘implied’ factors making automatic transfer impossible 4. the interpretation of the ‘writing-requirement’ in cases of assignment 5. summary bibliography list of legal authorities microsoft word mezei_peter.doc nordic journal of commercial law issue 2010#1 digital technologies – digital culture1 by péter mezei 1 péter mezei, j.d., phd., is an associate professor at the institute of comparative law, faculty of law, university of szeged, hungary and member of the hungarian copyright expert board. the author wants to thank llewellyn gibbons, jacqueline lipton, lynn mclain, tuomas mylly, peter yu, and katja weckström for their useful notes on the material. special contribution should be given to samantha cheesman for the improvement of the text of the article. nordic journal of commercial law issue 2010#1 1 i. introduction in light of the existing copyright system and the latest developments of the law of the european union (with a special focus on the authors’ home country, hungary) and the united states, the article tries to answer whether and how the phenomena of web 2.0 and p2p (“peer-to-peer” filesharing), the digitization for cultural preservation, and several other special technologies affect the culture of our age. this article argues that the several different usages influence the culture in three main ways: it can improve, preserve or deteriorate the culture. naturally, it is hard to determine, if a use is either right or wrong. for example, p2p filesharing services are generally used for illegal purposes, despite the fact that the technology has several positive effects. vice versa: one example of web 2.0, youtube, collects millions of home videos created by “average users”. however, episodes of copyrighted tv shows or sports events are also accessible on the youtube servers. similarly, the google books project impressively aims to preserve and provide access to millions of books in digital form. however, the original plan to execute the project raised legitimate copyright and competition law concerns, and so it sheds another light on google. to sum up: only time will tell, whether a technological innovation or use will result in the improvement of culture or contribute to the deterioration of it. due to the technological revolution almost all areas of life have undergone a major transformation in the past few decades. digital technologies earned a vital role in this reform, since they made time, space and energy saving activities possible through replacing analogue technologies.2 digital technology heavily affected intellectual creative activity as well. the spread of digital technologies have had at least two important consequences: first, intellectual creations may be copied and changed without limitation and without changing the quality.3 second, due to the evolution of digital networks the distribution of, access to, and the forming of an opinion on accessible works has changed too: it has become easier, faster and more effective – both in time and in place. the traditional forms of human communication have been generally changed as well. nowadays, people cannot imagine their life without digital technologies. social networking sites, chat rooms, blogs, podcasts, e-newspapers, or streaming of tv or radio programs are great examples. 2 laurence lessig: free culture – how big media uses technology and the law to lock down culture and control creativity, the penguin press, new york, 2004: 9. 3 the hungarian copyright expert board [szerzői jogi szakértői testület] emphasized this opinion in one of its statements. see (in hungarian language): szjszt 20/2001: 1-11. (www.mszh.hu/testuletek/szjszt/ szjszt_szakvelemenyek/2001/2001pdf/ szjszt_szakv_2001_020.pdf). nordic journal of commercial law issue 2010#1 2 the evolution of an entirely new digital culture is apparent. intellectual creative activity has become something of a norm in our everyday lives. it would appear that besides the traditional copyright paradigm a new copyright conception emerges, where the user-generated content earns great importance.4 due to the mass creation of works of literature, musical and audiovisual works, and photographs the respect of copyright law and intellectual creativity has partially disappeared. the young digital generations – by lack of a better example – may feel that easier, faster and cheaper accessible materials do not have any monetary value. the article starts with an introduction that introduces three separate effects of digital technologies upon the improvement, preservation, and deterioration of digital culture. part two discusses the phenomena of web 2.0, i.e. the way internet users communicate via the world wide web and contribute to culture at the same time. this part makes it clear that the present copyright rules are capable of solving the legal controversies raised by web 2.0. part three reflects upon the controversial question of file sharing. the article concludes that though file sharing may have several positive effects, it is clear that it the application is generally used for illegal activities, and therefore has a remarkable negative effect upon the entertainment industry and culture. part four introduces the topic of digitization of already existing works, and emphasizes that there are several major differences between the existing copyright regimes of the european union, the united kingdom, hungary and the united states. the author proposes consideration on whether it is necessary to broaden current statutory rules on digitization by libraries, in order to allow for the much broader preservation and making available of the valuable cultural heritage of our world. based upon this logical line of events the article will continue to introduce the main effects of digital technologies upon the culture: the improvement, the deterioration and the preservation of culture. ii. the improvement of digital culture – the phenomena of web 2.05 2.1. what does web 2.0 mean? since web 2.0 is not a definition of copyright law, but a technological term, it is impossible to provide an exact, scientific definition. generally, web 2.0 covers internet services and 4 concerning the „democratization” of music see (in german language): emil salagean: sampling im deutschen, schweizerischen und us-amerikanischen urheberrecht, ufita-schriftenreihe, band 248, nomos, baden-baden, 2008: 59-60. 5 it is worth mentioning that the improvement of our culture by digital technologies is conceivable through several means. for example the market of ebooks is still unable to approach the market of traditional paper books. it offers, however, a real alternative for the access to works of literature, and thus it opens a new dimension in the improvement of digital culture. below i will cover only the phenomena of web 2.0. nordic journal of commercial law issue 2010#1 3 applications, where interactivity of the users: the constant and mutual sharing of content is at the heart of the model. in web 1.0 the internet surfaces had only one-way traffic, that is, the content was provided only by the owner of the website. in the case of web 2.0, users fill the internet portals with information.6 web 2.0 takes many different forms. first, traditional social networking sites, like facebook, linkedin or the hungarian iwiw,7 belong to this category. these sites offer the possibility to create a network (establish contacts) of friends and relatives, as well as provide the infrastructure for members to share information (photographs, videos and profile data) about themselves to the public. online auction sites, like ebay, or the hungarian vatera,8 are another form of web 2.0. second, the “online auction house” is only a digital location for trade that the registered sellers enter to sell their goods, and the buyers leave with the purchased items. third, websites that are specialized in allowing the sharing of photographs and videos (like flickr and hungarian indafotó for photographs, and youtube and hungarian indavideó for audiovisual content9) are important nowadays. it is undisputed that there has never been as much photography, filming, directing or editing in the world as there is today.10 these photographs and videos can be easily distributed to a broad audience. fourth, an ever-increasing number of blogs are accessible on the internet, which illustrates the interactivity of users. there are several types of blogs: ranging from blogs that contain personal experiences of the users, to blogs that cover specific issues,11 straight through to websites that cover thousands of different blogs (like a catalogue).12 on her blog the blogger can easily distribute her own intellectual creations, and she may attach copyrighted works related to a specific entry. all these entries contribute to the present culture. the cooperation of several 6 paul anderson: what is web 2.0? ideas, technologies and implications for education, jisc technology & standard watch, february 2007: 7-13. (www.jisc.ac.uk/media/documents/techwatch/tsw0701b.pdf). 7 available at: www.facebook.com; www.linkedin.com; www.iwiw.hu. 8 available at: www.ebay.com; www.vatera.hu. 9 available at: www.flickr.com; http://indafoto.hu; www.youtube.com; http://indavideo.hu. 10 according to interesting data more audiovisual creations were uploaded to youtube since it began operating compared to how many audiovisual were created in total in the previous (around) century (since the motion picture exists). see: robert j. kasunic: copyright’s uneasy transition into the web 2.0 environment, landslide, march/april 2009: 11. naturally the truth of this data may be questionable. in all honesty there is the minor question of whether or not youtube has overstepped the boundary in terms of audiovisual uploading. 11 see for example laurence lessig’s copyright blog (which is actually rest for good): http://lessig.org/blog. 12 see for example (in hungarian language): http://blog.hu. nordic journal of commercial law issue 2010#1 4 web 2.0 services is illustrated by social networking sites. another example is twitter13 that mixes the advantages of blogs and the sharing of audiovisual content.14 finally, the best possible example of the web 2.0 phenomenon are the wiki portals15 that aim to synthesize and provide easy access to selected knowledge that is written and edited by the users of the sites. these websites are accurately called online encyclopedias.16 these encyclopedias are mirrors of the constantly changing and broadening knowledge of our society. due to easy access and user-friendly structure these portals are not only collectors, but also distributors of knowledge.17 interactivity is not a self-sustained activity: the underlying purpose is the synthesizing and digital distribution of the knowledge of society. for example youtube and wikipedia show that the online society of our age shifts the entertainment, the acquisition of knowledge, the developing of social contacts, the execution of business transactions from the analogue, physical world to the digital environment. the participants of this world have an ever-increasing role in the formation of this environment.18 2.2. implications of web 2.0 kevin kelly describes our present internet-based society as a new socialist system.19 according to kelly those, who write or edit the articles of the wikipedia, upload pictures to flickr or videos to youtube, or who share content via p2p applications, are the pathfinders of the new digital socialism. kelly argues that the ultimate goal of the digital socialism is – similarly to the evolution of socialism itself– to reach collectivism; starting from simple sharing growing into cooperation of 13 available at: http://twitter.com. 14 thus for example several nba basketball players share their everyday life in words and videos in order to “dialogue” with their fans. 15 interestingly the word „wiki” means in hawaiian language: „fast”. 16 this is easily proved by the name of the most well-known wiki portal. the word wikipedia mixes wiki with encyclopedia. 17 it is worth to mention though that the reliability of these online encyclopedias is not equivalent to the (for example) encyclopedia britannica. for example a us american court concluded once that the wikipedia may not be accepted as an authentic source of information in legal processes. see: lamilem badasa v. michael b. mukasey, 540 f.3d 909 (2008). 18 a final example is the google earth project, where google offers satellite pictures of the earth for free and allows users to connect their own pictures to a specific geographical area or building. this kind of cooperation of a company and any member of the society is a praiseworthy form of improvement of our culture. 19 kevin kelly: the new socialism: global collectivist society is coming online, wired magazin, 17.06.2009 (www.wired.com/culture/culturereviews/magazine/17-06/nep_newsocialism?currentpage=all). nordic journal of commercial law issue 2010#1 5 users and finally reaching well-organized collaboration of the masses. kelly understands sharing, like the distribution of personal photos or videos over the internet, as the mildest form of socialism. the users edit/tag (based on keywords, categories, labels) the shared information through which they achieve a much wider and more successful cooperation of (the) people.20 if this cooperation coupled with a high degree of organization – like in the case of open source software linux – then a communist-style production (a collaboration of masses) is realized. this serves as a counterpart to the present dominant capitalist style of production. finally, however, some kind of hierarchy has to be involved in all cases of collaboration that aims to ease decision-making on important issues.21 kelly concludes “at the heart of online collectives is actually a sign that stateless socialism can work on a grand scale.” without analyzing kelly’s theory from a political aspect we can conclude that it counters several problems from a copyright perspective. naturally, he recognizes that the social networking sites and other internet services dominantly influence human communication. however, kelly fails to mention that this is also valid for television and mobile phones. kelly correctly identifies the advantages of the web 2.0. it is feasible that our society will become an online society. it still does not mean what kelly writes, “this new brand of socialism [would] operate in the realm of culture and economics, rather than government”; that “digital socialism is socialism without the state”. kelly further argues that “operating without state funding or control (…) this mostly free marketplace achieves social good at an efficiency that would stagger any government or traditional corporation.” these statements seem inaccurate, not only from a copyright aspect, but from the perspective of the whole legal system. all web 2.0 applications are subordinated to e.g. strict data protection, competition, civil and criminal law provisions. state control in this context is, however not necessarily evil, instead it is overwhelmingly justified. the use of state enforcement measures is generally not adequate, but its overall usefulness is not doubted. it is likely that there will always be more pirated software than the right holders and the police can catch. people will download more musical compositions illegally than they buy original cds, but without state control and restrictions we would be talking about digital anarchy, not socialism. this argument is bolstered by the fact that kelly mentioned p2p file sharing only in passing, despite the fact that file sharing is responsible for several copyright disputes.22 20 kelly uses the example of the microsoft’s photosynth software that allows to create three dimensional pictures from the several users’ photographs. check out the software at: http://photosynth.net. 21 for example millions of people contribute to the broadening of wikipedia’s content; there are, however, only some thousands of people, who are allowed to edit the written articles. 22 it seems so that kelly even forget about the fact that whilst the soviet revolution had to reckon “only” with a state symbol (the czar and his family), the present digital pathfinders had to fight with whole states and their legal systems, and – which is sometimes harder than the previous – with powerful, politically backed multinational organizations and companies, like the riaa, mpaa, hollywood companies, or the microsoft. nordic journal of commercial law issue 2010#1 6 herein lies the paradox. all web 2.0 portals were founded for the purpose of enabling the free flow of information; at the same time they also enjoy protection under national law at the time of intellectual creation.23 these companies are therefore simultaneously promoters of digital socialism and magnates of digital capitalism. naturally, they will make decisions based on economics, when deciding on which side to take on any one topic of legal debate. the positive effects of web 2.0 upon culture are undeniable. the publication of our achievements on twitter, on youtube or the sharing of knowledge on wikipedia contributes to the distribution and improvement of our culture. on the other hand, the unauthorized and mass use of the protected expression of others should not be encouraged. if the previous are the digital pathfinders, the latter are digital anarchists. 2.3. web 2.0 and copyright infringement web 2.0 services affect copyright law greatly, causing millions of infringements. the dominant copyright regime – at least on a normative level – can handle the new and different types of uses satisfactorily. the question of enforcement is an entirely different story. effective enforcement of claims is unlikely due to the massive nature of use. it is similarly true that the use of these services supposedly may weaken public faith in effective legal protection. this issue is, however, beyond the scope of this article. this article seeks to discover whether and how the use of web 2.0 applications can be integrated into the framework of the present copyright system. here, the starting point is distinguishing content respecting their legitimacy. the source of user-generated content is important when considering legitimacy. as long as the user independently creates an original work of expression based on its own ideas, the question of infringement should not be raised. if the user builds on preexisting materials, his act will not result in a breach of copyright, as long as he adopts only the idea of the previous work. furthermore, in the copyright system of the united states uses that do not exceed the threshold of the de minimis test will not be deemed as infringing.24 the german/austrian concept of “free adaptation” (in german: “freie benutzung”) is somehow similar to the de minimis test, according to which new, original creations that were simply inspired/stimulated (in german: “anregung”) by the source work are also protected under the copyright law. should any part of the original work be copied into the new work the user may excuse his taking, if it is impossible to recognize 23 a great example for that is the google’s reasoning in the viacom v. youtube case, where it was argued that the creation of the youtube’s source code required more time than one thousand people’s whole year work time, or the „video id” software was completed in more than 50.000 working hours. see: viacom international inc., et al., v. youtube inc., et al., 253 f.r.d. 256 (2008): 259-260. 24 as the us federal court of appeals for the second circuit declared it: “the law does not concern itself with trifles”. see: ringgold v. black entertainment television inc., 126 f.3d 70 (1997): 74. – see further: robert m. szymanski: audio pastiche: digital sampling, intermediate copying, fair use, 3 ucla entertainment law review, 1996: 300-301. nordic journal of commercial law issue 2010#1 7 the affected segment due to its transformation. if the user does not transform the segment taken, he may even excuse his activity, if he combines that segment with many other motifs, and it finally has a subordinated role in the new creation.25 in sum, it seems evident all over the world that if the taking is quantitatively high, then the unauthorized use should be deemed an infringement. in continental copyright regimes – due to the strong protection of moral rights – uses that hurt the authors’ right of integrity may result in an infringement, no matter how large the taking. such protection of moral rights is unknown in the united states. secondly, if the user-generated content earns copyright protection, and it is used by someone else without prior authorization, it can result in an infringement of its creator’s copyright. unlike the uploading of an original photograph to flickr or a home video to youtube, the publication of personal data on a social networking site is exempted. the creator of the usergenerated content – like other authors – has the exclusive right to decide, whether she wants to protect her expression at all. it is more common to assign works to the public domain nowadays. the most well-known examples are the creative commons movement,26 and the gnu general public license system.27 thirdly, the making available to the public of illegal content automatically raises the question, whether and how other actors on the internet can be held liable for the support they provide to infringers. the united states was the first country that created safe-harbor protection for content, hosting, mere conduit and search engine service providers.28 just a few years later the 25 salagean supra note 6, at 104-106. – art. 24 para. 2 of the german copyright act (hereinafter durhg) contains, however, an important restriction (nothing similar exists in austria). according to the rule of “melody protection” (in german: “melodienschutz”), if the melody of the source work recognizably forms the basis of the secondary work, no protection is granted to the new creation. 26 concerning the analysis of the cc movement see in the united states especially: laurence lessig: free culture how big media uses technology and the law to lock down culture and control creativity, the penguin press, new york, 2004 – adrianne k. goss: codifying a commons: copyright, copyleft, and the creative commons project, chicago-kent law review, 2007: 963-996. – lynn m. forsyth deborah j. kemp: creative commons: for the common good?, university of la verne law review, 2009: 346-369. in germany and austria (in german language): erik moeller: freiheit mit fallstricken: creative-commons-nc-lizenzen und ohre folge. in: bernd lutterbeck matthias bärwolff robert a. gehring (hrsg.): open source jahrbuch 2006, lehmanns media, berlin, 2006: 271-282. – markus eidenberger andreas ortner: kreativität in fesseln: wie urheberrecht kreativität behindert und doch mit seinen eigenen waffen geschlagen werden kann. in: leonhard dobusch, christian forsterleitner (hrsg.): freie netze. freies wissen. echomedia, wien, 2007. in hungary (in hungarian language): gábor faludi: a creative commons felhasználási engedély (cc-licenc) egyes jogi sajátosságai [some legal features of the creative commons license]. in: fehér könyv a szellemi tulajdon védelméről 2006, magyar szabadalmi hivatal, 2006: 136-145. 27 concerning the gnu gpl licenses see: lawrence rosen: osl 3.0: a better license for open source software, computer law review international, 6/2007: 166-171. – john p. beardwood andrew c. alleyne: open source hybrids and the final gplv3, computer law review international, 1/2008: 14-20. – sapna kumar olaf koglin: gpl version 3’s drm and patent clauses under german and u.s. law, computer law review international, 2/2008: 33-38. – thomas thalhofer: commercial usability of open source software licenses, computer law review international, 5/2008: 129-136. 28 art. 512., digital millennium copyright act (1998) (hereinafter dmca). nordic journal of commercial law issue 2010#1 8 european union had regulated the same issue in a directive29 that the member states of the european union had to implement in their national laws.30 the dmca also introduced the socalled “notice-and-take-down procedure”. under this procedure the right holders can demand the removal or disabling of the infringing materials and in case of non-compliance the service provider can face liability.31 the e-commerce directive of the european union does not contain exact rules on the “notice-and-take-down procedure”, which means that members states may create their own provisions on that.32 finally, both in the united states33 and the european union34 right holders have a broad scope of measures available to forbid or prevent infringing activities, or for example to identify people, who use the service to commit direct copyright infringements. as a final remark it has to be noted that issues occurring under these regulations place a massive burden on the courts of these countries.35 right holders also enjoy protection outside copyright law. for example, web 2.0 services providers face litigation for trademark infringements by their users that sell counterfeit goods on their sites.36 several anomalies also arise under competition law, or due to the unauthorized use of personal data or trade secrets, or material related to child pornography and/or pedophile crimes. however, the present article will not discuss these issues in depth. in sum, the legal 29 art. 12-14. of the directive 2000/31/ec of the european parliament and of the council of 8 june 2000 on certain legal aspects of information society services, in particular electronic commerce, in the internal market (hereinafter e-commerce directive). a major difference between the us and the european union regulation is that the e-commerce directive does not provide a safe harbor provisions that includes search engines. 30 see for example the electronic commerce statute of hungary (art. 7-13., act cviii of 2001), austria [art. 13-19., bgbl i nr. 152/2001. s. 1977. (01.01.2002)], or germany [art. 7-10., telemediengesetz vom 26. februar 2007 (bgbl i s. 179), geändert durch artikel 2 des gesetzes vom 25. dezember 2008 (bgbl i s. 3083)]. 31 dmca, art. 512(c)(3). 32 e-commerce directive, art. 14(3): „this article (…) does it affect the possibility for member states of establishing procedures governing the removal or disabling of access to information.” it is interesting that for example the german legislator missed to regulate the procedure on statutory level. this means that each service providers should have their own regulations on the issue. the hungarian legislator created a thorough and easily applicable system of “notice-and-take-down procedure”. see: act cviii of 2001, art. 13. 33 dmca, art. 512(h) and (j). 34 the whole topic is covered by the directive 2004/48/ec of the european parliament and of the council of 29 april 2004 on the enforcement of intellectual property rights. 35 concerning the above mentioned viacom v. youtube case, and the german, french, italian, spanish and british court practice on the liability of service providers see: ben allgrove paolo balboni alexander haines norman heckh lorenza mosna nicholas quoy: liability of web 2.0 service providers – a comparative look, computer law review international, 3/2008: 65-71. 36 thus for example ebay was convicted several times in connection to the infringements of louis vuitton, christian dior, kenzo or givenchy companies’ trademark. see: computer law review international, 1/2009: 20-23. in an actual us decision the district court for the southern district of new york refused to impose liability on ebay, holding that “the law does not impose liability for contributory trademark infringement on ebay for its refusal to take such preemptive steps in light of ebay's ‘reasonable anticipation’ or generalized knowledge that counterfeit goods might be sold on its website.” seed: tiffany (nj) inc., et. al., v. ebay, inc., 576 f.supp.2d 463 (2008), 470. nordic journal of commercial law issue 2010#1 9 problems arising under the web 2.0 phenomena fit easily into the dominant copyright paradigm. an ever stronger demand to broaden the present system in a more user-friendly way is clearly present. the prevalence of (for example) creative commons or the gnu licenses, however, proves that there are no well-developed alternatives that may be able to substitute the present copyright system. the fight against illegal uses that have a destructive effect upon society and culture faces several hurdles, due to the unlimited nature of the internet and difficulties connected to international enforcement. on the other hand, the constant growth and broadening of online content by the users all around the world, clearly contributes to the improvement our culture. iii. the deterioration of digital culture – the phenomena of p2p file sharing since the birth of napster in 1999 file sharing rapidly became significant in society. a large proportion of the world’s population uses p2p file sharing applications,37 and an enormous proportion of internet data-transfer is related to these services.38 several court decisions conclude that the sharing of illegally upand downloaded content was very high on p2p sites.39 the use of file sharing services naturally has significant economic consequences worldwide.40 in 37 some data show that napster had been used around the millennia near 40 million users. see: frederike hänel: napster und gnutella – probleme bei der übertragung von mp3-dataien nach deutschem urheberrecht [napster and gnutella – problems of sharing of mp3 data under the german copyright law], jur-pc web-dok. 245/2000, abs. 27. (available in german language at: www.jurpc.de/rechtspr/20000245.htm) another expressive data shows that there were some periods, when the number of napster users had grew by 200% per month, 100 new users had registered each second, and 10.000 files had been shared every second. see: llewellyn j. gibbons: napster: the case for the need for a missing direct infringer, 9 villanova sports & entertainment law journal, 2002: 61. later, in the well known grokster case the us supreme court stated that around 100 million users installed on their private pcs morpheus and grokster. see: metro-goldwyn-mayer studios, inc., et al., v. grokster, ltd., et al., 545 u.s. 913 (2005): 923. 38 according to the research of the german ipoque research center 70% of the night and 30% of the daytime data transfer had been related to the p2p in germany in 2006, whilst filesharing had been amounted to 70% in the average of day and nighttime data one year later. see: ipoque p2p survey 2006: 2. (www.ipoque.com/userfiles/file/p2p_survey_2006.pdf) and ipoque internet study 2007: 2. (www.ipoque.com/userfiles/file/internet_study_2007.pdf). 39 napster court found that 87% of the contents were illegally shared. see: a&m technology, inc., et al., v. napster, inc., et al., 239 f.3d 1004 (2001), p. 1013. the grokster decision contained a 90% figure. see: mgm v. grokster supra note 36, at 922. finally a belgian district court similarly concluded that 90% of the files shared via p2p applications were infringing. see: sabam v. s.a. tiscali (scarlet), district of brussels, no. 04/8975/a, decision of june 2007, aelj translation series, 2008: 1285. 40 due to the uncertainties of the calculations conducted by the movie and music industry, i will omit referring to these researches and studies. on the same issue see: malla pollack: rebalancing section 512 to protect fair users from herds of mice – trampling elephants, or a little due process is not such a dangerous thing, santa clara computer & high technology law journal, march 2006: p. 549-550. nordic journal of commercial law issue 2010#1 10 the present article, the main question is whether the p2p file sharing services have only negative effects upon our existing culture, or do they contribute to the culture in some way?41 in europe, art. 3 (2) of the infosoc directive introduced a new type of public distribution right: the right of making available to the public.42 the respective authors and neighboring right holders are allowed to authorize or prohibit the making available to the public, by wire or wireless means, in such a way that members of the public may access them from a place and at a time individually chosen by them. this does not require that the respective work or performance may be reproduced, thus only the purpose of “providing the chance to reproduce” is enough to infringe this right. analogous with the situation of hyperlinks the simple creation of a torrent file (as the most popular form of file sharing nowadays) does not constitute infringement, as long as no reproduction or making available to the public takes place. therefore, the defense of the defendants in the pirate bay case, according to which the upload of a torrent file to a tracker does not constitute infringement either, as long as no seeding43 takes place, seems proper.44 however, no infringement takes place, if the users simply use the respective copyrighted works within the limits of a free use exception or limitation. in connection to the file sharing the only real option is copying for private purposes, but even this exemption is inapplicable, since the exception covers only reproduction (downloading) and not distribution or making available to the public (uploading).45 in addition, the private copying exception does not cover software in the european union. the previous argument is equally important for every country, whether the national copyright statutes contain any provision on the legality of the copied work. for example, under the german copyright law the reproduction shall be considered legal, only if the source work is 41 it is worth mentioning that the peer-to-peer services are erroneously identified as similar to the filesharing applications. the p2p software arrange data transfer between two parties (peers), which does not necessarily contain sharing or changing files. it is therefore more appropriate to talk about one or many-sided data transfer. the best example to demonstrate this is skype, the internet-based telephone system (“voice over internet protocol”, that is, voip), where the two parties “share” voices with each other, and not copyrighted contents. this is similarly true for the chatting programs (like yahoo! or windows msn that allows the real time conversation of the participants. these p2p services generally do not contravene the legal system, and therefore they do not deteriorate our culture. this is theoretically guaranteed in the united states by the “staple article of commerce” doctrine, under which “the sale of other articles of commerce does not constitute contributory infringement if the product is widely used for legitimate, unobjectionable purposes”. see: sony corporation of america et al. v. universal city studios, inc. et al. 464 u.s. 417 (1983), 442. 42 in german language: „zurverfügungsstellen” or „zugänglichmachung”; in hungarian language: “a nyilvánosság számára hozzáférhetővé tétel”. the previous international sources of this right can be found in art. 8 of wipo copyright treaty, and art. 10 and 14 of the wipo performances and phonograms treaty. 43 that is, providing a source for the “torrent information package”. 44 see: www.edri.org/edri-gram/number7.4/pirate-bay-trial-sweden. 45 some national regulations of this rule are the followings: hungarian copyright act (hereinafter: hca) art. 40; durhg, art. 53 para. (6); austrian copyright act (hereinafter: öurhg) art. 42 para. (5). nordic journal of commercial law issue 2010#1 11 legitimate, that is, reproduced or made available to the public in a lawful way (for example by the right holder).46 although, the hungarian copyright law does not contain similar regulations, the hungarian copyright expert board has concluded that the requirement of legality can be deduced from broader legal principles, specifically applied to the three-step-test.47 this interpretation is supported by such general principle as “nemo plus iuris”.48 it should also be kept in mind that file sharing – when viewed from the copyright perspective – should not be reduced to its components nor be viewed in a static way, but only be assessed in its entirety including its dynamics. one of the basic features of the most recent file sharing services is that users share the downloaded content with others. therefore those, who do not find anything objectionable in downloading a song from the internet, generally forget that they simultaneously become uploaders, and therefore infringers as well.49 file sharing is treated differently in the united states. as the us court of appeals for the ninth circuit declared in the napster case, any downloading injures the authors’ right of reproduction, and the uploading of any content to the napster’s central indexing servers infringes the authors’ right of public display.50 subsequent court practice has followed napster on the question of liability for down loaders. consequently, most users sued by right holders have settled out of court.51 those, who have decided to try their case in court, have generally lost.52 since the copyright act of the united states (usca)53 does not grant any right of “making available to the public” to authors, the person, who allows the free downloading of content from a shared folder on his personal computer, does not commit a legal offence.54 since 46 durhg art. 53 para. (1). 47 szjszt 17/2006. in: iparjogvédelmi és szerzői jogi szemle, 2006/4., 228-248. (only in hungarian language.) the three-step-test is codified by the berne convention, art. 9. para. (2); the trips agreement art. 13.; the wipo copyright treaty, art. 10.; the wipo performances and phonograms treaty, art. 16. para. 2.; and the infosoc directive art. 5. para. (5). 48 in latin: „nemo plus iuris ad alium transferre potest quam ipse habet.” this means in english: „no one can transfer to another a larger right than he himself has.” see: http://www.inrebus.com/legalmaxims_n.php 49 it is sad that one of the most relevant german court decisions declared the fact of infringement (together with criminal liability) without any deep analysis of the operation of p2p filesharing services. see (in german language): ag cottbus 6.5.2004 [95 ds 1653 js 15556/04 (57/04)]. in: jur-pc web-dok. 236/2004 (www.jurpc.de/rechtspr/20040236.pdf). 50 a&m v. napster supra note 38., at 1014. 51 see: http://arstechnica.com/news.ars/post/20081219-no-more-lawsuits-isps-to-work-with-riaa-cut-off-p2p-users.html. 52 see for example: bmg music, et al., v. cecilia gonzalez, 430 f.3d 888 (2005). 53 copyright law of the united states of america (17 u.s.c. 1976) (hereinafter: usca). 54 atlantic recording corporation, et al., v. pamela and jeffrey howell, 554 f.supp.2d 976 (2008): 983-984. nordic journal of commercial law issue 2010#1 12 infringement of the distribution right requires the transfer of copyrighted content,55 this system seems to be the opposite of the european system. since the usca does not contain a right to make available, the reasoning of the napster court seems logical. nevertheless, the decision seems to forget the dynamics of file sharing. that is, uploading requires the making available of some content – you can download something from the internet only if it is accessible.56 if a plaintiff proves infringement the defendant can raise a fair use defense.57 the fair use defense was, however, found inapplicable by both the napster and grokster courts. first, the napster court found convincing that “the more music that sampling users download, the less likely they are to eventually purchase the recordings on audio cd”.58 secondly, the fact that the downloaded works were shared with others, excluded any legitimate purposes. in light of these arguments the four statutory fair use factors cannot support the defendant’s position.59 these factors are “1. the purpose and character of the use, including whether such use is of a commercial nature or is for nonprofit educational purposes; 2. the nature of the copyrighted work; 3. the amount and substantiality of the portion used in relation to the copyrighted work as a whole; and 4. the effect of the use upon the potential market for or value of the copyrighted work”. as the napster court made it clear the “repeated and exploitative copying of copyrighted works, even if the copies are not offered for sale, may constitute a commercial use”60, and the downloading by users does not transform the original content in any way.61 the first factor thus favored the right holder. since users generally acquire the whole of the copyrighted (creative) contents with the help of p2p services the second and third factor also supports the plaintiff’s 55 usca art. 106 para. (3) says that “to distribute copies or phonorecords of the copyrighted work to the public by sale or other transfer of ownership, or by rental, lease, or lending.” 56 concerning the criticized reasoning of the arizona district court see atlantic v. howell supra note 45., at 986-987. 57 usca art. 107. 58 a&m v. napster supra note 38., at 1018. – a similar reasoning was given by the us federal court of appeals for the seventh circuit. see: bmg v. gonzalez supra note 50., at 890. 59 gibbons supra note 36., at 68-71. – william s. coats heather d. rafter vickie l. feeman john g. given: blows against the empire: napster, aimster, grokster and the war against p2p file sharing, practising law institute, 2003: 478-481. 60 coats et. al. supra note 58., at 478-481. 61 a&m v. napster supra note 38., at 1015. nordic journal of commercial law issue 2010#1 13 position.62 finally, the use of file sharing applications clearly has a negative, detrimental effect upon the potential market or value of the original work or author’s market.63 this does not mean that every use by p2p services is unfair. for example the activity of “a law professor demonstrating napster for a cyber law class; an investigating attorney; a judge or law clerk downloading certain files for a better understanding of the issues in the case; members of the media demonstrating napster as part of a news story; or individuals privately distributing mp3 files from napster to friends or acquaintances” would fit into the frames of the fair use test.64 in light of the previous facts, mass file sharing generally has a negative effect upon the entertainment industry and – with the radical transformation of public opinion on the aims and justification of copyright protection – upon culture. it seems necessary to mention, however, that p2p file sharing has several positive features as well. for example, the file sharing programs can be beneficial to new and less famous bands, amateur moviemakers, and even wellknown authors may benefit from their use.65 p2p systems make it easier to distribute public domain works as well. although the napster court argued differently, it is possible that users, after downloading songs, may decide to buy the entire original album.66 some commentators also recognize the possibility the legalization of p2p systems in a future free culture.67 p2p systems are therefore also capable of improving culture, though this is not their general “profile”. 62 a&m v. napster supra note 38., at 1016. – bmg v. gonzalez supra note 50., at 890. 63 a&m v. napster supra note 38., at 1016-1017. – „downloads from peer-to-peer networks such as kazaa compete with licensed broadcasts and hence undermine the income available to authors.” see: bmg v. gonzalez supra note 50., at 891. 64 gibbons supra note 36., at 78. 65 christopher geiger: right to copy v. three-step test the future of the private copy exception in the digital environment, computer law review international, 2005: 10. 66 such a prominent success was the arctic monkeys’ debut album in 2006, perhaps due to the fact that a selection of their music was available on p2p systems before the album was released. see monkeys let music do the talking, bbc news, 24th february, 2006 (http://news.bbc.co.uk/1/hi/entertainment/4644214.stm). this “advertisement” offered a sampling of their musical style and when the band launched their album, “whatever people say i am, that’s what i’m not,” it became the best musical debut in england. ibid. 67 lessig supra note 4., at 179-180. nordic journal of commercial law issue 2010#1 14 iv. the preservation of culture – the digitization of cultural heritage 4.1 digitization in practice in addition to the newly-created content, humanity possesses an immeasurable amount of knowledge displayed in intellectual works.68 the purpose of our copyright system is to preserve these creations, and to assure following generations the chance to become acquainted with them. several different methods have been applied towards reaching this goal worldwide. one initiative is the hungarian digital literature academy (dla).69 the project was initiated by 39 outstanding poets and writers in 1998, and its goal is the worldwide distribution and popularization of hungarian literature. within the framework of the dla all the (now 71) former and newly selected contemporary and posthumous members contractually license and non-exclusively make available digitally their life-work to the dla, in exchange for a monthly sum that equals the hungarian minimal salary quadrupled.70 although this initiative covers only a small segment of prominent hungarian artists (thus ensuring its high quality) it constitutes a remarkable way of digital preservation and distribution of intellectual creations. libraries, public archives and records can serve as another medium of digitization, because their general purpose is the distribution and/or making available of collected and managed copyrighted works to members of society. the legal framework of this activity (like rules on public lending, interlibrary loans, photocopying by libraries, or copying for archiving purposes) is well-developed. in the last few years, however, a real demand has emerged to use digital technologies more intensively and in order to present material in a more user-friendly way. today, one main goal is to share the knowledge collected and managed by libraries, that is, to make our cultural values available online and in an interactive form. the national and international regulations are nevertheless far from synchronized, and the digital archiving of our intellectual heritage fuels a recurring debate. the strongest promoters of the initiative are universities and research centers that argue that worldwide access to the contents of digital libraries would make their work much easier. one of the latest contributions concerning the digitization by libraries is the gowers review. the report criticizes the defects of the british copyright law71 that materially restricts the digitization by libraries. a comparison of the copyright laws of the european union (including hungary as an example for the implementation) and the united states can help the reader analyse the legal provisions on this subject in another country. it will be asked, whether national (and supranational) copyright laws restrict (1) the types of works that may be archived; (2) the 68 to highlight just a few of the most typical: an incredible number of books, newspapers, photographs, works of fine arts, sound recordings, audiovisual works, broadcasted contents belong to our intellectual heritage. 69 see (only in hungarian language): www.pim.hu/object.d8f182da-fdfa-45ba-914f-2688ce822346.ivy. 70 that is, around 1500$/month (depending on the exchange rate). 71 copyright, designs, and patents act of 1988, hereinafter referred to as: cdpa. nordic journal of commercial law issue 2010#1 15 number of copies allowed; (3) the possibility of format-shifting72 the original work; (4) the distribution or making available of the copy to the public. 4.2. digitization in the european union the copyright or infosoc directive73 lays down the legal framework in the eu that enumerates on the one hand the exclusive rights of authors, and on the other hand the exceptions and limitations thereto.74 the specific provisions that relate to this topic are the following. first, according to art. 5. para. 2. point c) “member states may provide for exceptions or limitations to the reproduction right (…) in respect of specific acts of reproduction made by publicly accessible libraries, educational establishments or museums, or by archives, which are not for direct or indirect economic or commercial advantage”. second, under art. 5. para. 3. point n) “use by communication or making available, for the purpose of research or private study, to individual members of the public by dedicated terminals on the premises of [publicly accessible libraries, educational establishments, museums, or archives] of works and other subject-matter not subject to purchase or licensing terms which are contained in their collections”. third, as the directive makes it clear in its preamble these exceptions “should be limited to certain special cases” and such exceptions “should not cover uses made in the context of on-line delivery of protected works or other subject-matter”.75 finally, art. 5. para. 5. draws our attention to the fact that the limitations of and exceptions to the exclusive rights may be accepted only in the light of the three-step-test:76 72 this means the reproduction of the work on a modern data carrier. 73 directive 2001/29/ec of the european parliament and of the council of 22 may 2001 on the harmonisation of certain aspects of copyright and related rights in the information society. 74 concerning a detailed analysis of the directive see: study on the implementation and effect in member states’ laws of directive 2001/29/ec on the harmonisation of certain aspects of copyright and related rights in the information society, final report, 2007 (www.ivir.nl/files/implementation_ 2001_29_ec/index_eng.html). 75 information directive, recital (40). the same recital stresses nevertheless that “this directive should be without prejudice to the member states' option to derogate from the exclusive public lending right in accordance with article 5 of directive 92/100/eec.” 76 green paper – copyright in the knowledge economy, brussels, 16.7.2008, com (2008) 466 final, 7-8. (http://eur-lex.europa.eu/lexuriserv/lexuriserv.do?uri=com:2008:0466:fin:en:pdf). (hereinafter: green paper.) nordic journal of commercial law issue 2010#1 16 „the exceptions and limitations provided for in paragraphs 1, 2, 3 and 4 shall only be applied in certain special cases which do not conflict with a normal exploitation of the work or other subject-matter and do not unreasonably prejudice the legitimate interests of the rightholder.” due to the fact that the infosoc directive fails to answer the first three questions raised above, it was left to national legislators to resolve the missing questions. the hungarian implementation of the directive can serve as a concrete example. the leading provisions can be found in art. 35. para. 4. and art. 38. para. 5. of the hca. the first contains a general description of the limitation of the exclusive right of reproduction, in favor of libraries. accordingly, non-profit public libraries and archives77 may reproduce copyrighted works for the purposes of, 1) academic or scientific research; 2) public library services; 3) displaying the copies on computer terminals installed and operated in these institutions for members of the public for scientific research or for learning. libraries are also allowed to 4) make a copy of a small part of a published work, or of articles in newspapers/periodicals for internal purposes.78 the hungarian legislator may pass specific legislation concerning archiving79 and has done so once, when passing the so-called nava act.80 the hca does not restrict the types of works that may be archived, and thus makes it possible to preserve all possible types of works.81 since the purpose of the archiving is neither restricted by the statute, quality correction82 and modification (or shifting) of format83 is also acceptable. this argument is strongly supported by art. 2 of the nava act, which contains the word “restoration”. this refers to the mending of the substance of the archived work or the restitution of its original conditions. the question of the quantity of copying by reason of the purpose of the use is equally important. specific balancing is required; however, it makes it leaves room for the possibility to create more than three copies (as is allowed in the united states).84 77 the hca similarly guarantees this right to public educational institutions, museums, and public collections of picture and sound recordings. 78 hca art. 35 para. (4) point (a)-(c). 79 hca art. 35 para. (4) point (d). 80 act cxxxvii of 2004 on the national audiovisual archives. 81 it is worth mentioning that sound recordings, audiovisual works or broadcasted contents are not covered by the cdpa. the united kingdom patent office emphasized that sound recordings, films and broadcasts were originally not covered by the cdpa due to the available technologies and the requirements of libraries at the time of drafting the statutory exception. see: taking forward the gowers review of intellectual property – proposed changes to copyright exceptions, uk intellectual property office, 2007: 28. (www.ipo.gov.uk/consult-copyrightexceptions.pdf). 82 for example in case of an old tape. 83 for example if the original data carrier, like an old celluloid tape, is not in circulation. 84 the united kingdom copyright rules are even more restrictive in this field. the cdpa only allows creating one copy per work. see: cdpa art. 42 (1)(a)-(b). nordic journal of commercial law issue 2010#1 17 here we also have to be aware of the requirements of the three-step-test, and therefore the acceptable number of copies has to be interpreted narrowly. the hca is very liberal concerning the distribution or the making available of the copy to the public. for example, article 35.4(b) contains the term “public library services”, and thus it supposedly allows putting these works at the users’ disposal. however, the second segment of the same article narrows the right to circulate copies. accordingly, the display of the copies is allowed only on computer terminals installed and operated in these institutions. the members of the public are only allowed to use these terminals for scientific research or for learning purposes. this simply means that no other method of publication is allowed. 4.3. digitization in the united states the united states copyright act (usca) section 108 differentiates between three main types of uses.85 provisions concerning the purpose of the use, the allowed number of copies, the nature of the source work, the “fate” of the copy, and the conditions of the use are significantly different from each other and vary depending on the case. the first option grants the right for all libraries and archives that are open to the public, to create and distribute one copy of any kind of work, if the use is made without any purpose of direct or indirect commercial advantage, and the reproduced or distributed copy contains a notice of copyright.86 the second option allows a right to reproduce and distribute any unpublished work in three copies, solely for purposes of preservation or for deposit for research use in another library or archive, supposing that the original work is in the collection of the institute, and only if the work reproduced in a digital format is not distributed or made available to the public outside the premises of the library or archive.87 finally, three copies of a published work may be created – but never distributed – for the purpose of “replacing a copy that is damaged, deteriorated, lost, or stolen, or if the existing format in which the work is stored has become obsolete”.88 the latter condition allows libraries and archives to format-shift their collections.89 the 85 thus where the statute mentions only distribution, there the making available to the public is not allowed. the previous exclusive right does not cover the latter use, as held by several court decisions. an arizona district court found that the art. 106 para. 3 of the usca demands the actual transfer of the source work to hurt the exclusive right of distribution. the usca states that “to distribute copies or phonorecords of the copyrighted work to the public by sale or other transfer of ownership, or by rental, lease, or lending.” as the court reasoned “infringement of [the distribution right] requires an actual dissemination of either copies or phonorecords.” see: atlantic v. howell supra note 52., at 981., 985. see another decision that was based on the previous holding: capitol records inc., et al., v. jammie thomas, 579 f.supp.2d 1210 (2008). 86 usca art. 108 (a)(1)-(3). 87 usca art. 108 (b)(1)-(2). 88 usca art. 108 (c). 89 according to the last sentence of usca art. 108 (c) “a format shall be considered obsolete if the machine or device necessary to render perceptible a work stored in that format is no longer manufactured or is no longer reasonably available in the commercial marketplace.” nordic journal of commercial law issue 2010#1 18 preconditions for format-shifting are that the library or archives may create the reproductions after a reasonable search for finding an unused replacement of the deteriorated original work at a fair price, and the work reproduced in a digital format is not distributed or made available to the public outside the premises of the library or archive.90 4.4. comparative discussion on rules and technological development do the current copyright rules concerning the preservation of cultural goods require any modification due to the rapid development of digital technologies? at present the countries mentioned above have a rational system regarding archiving. the number of allowed copies is closely tied to the purpose of the use everywhere. the usca regulates three different cases, and uses fixed numbers in each of them. the hungarian statute seems more flexible, however requires more attention paid by the copier. it is also important that the copyright acts do not restrict the types of works that may be reproduced. since every creation has cultural value, the preservation of each work is supported equally strongly. digital technologies make fast, easy, and cost-effective storage of data possible. this advantage should not be constrained by the prohibition of format-shifting. devotion to old formats may hinder the preservation and even the enjoyment of the works in the future. therefore, it seems that the present regulations fulfill all the requirements for the effective archiving of cultural heritage. the original question is therefore modified in the following way: is it necessary to allow for the digitization of works in order to provide much broader availability of these works? the us and hungarian statutes regulate the right to make the copied works available to the public via terminals of the respective institution in accordance with the basic threshold of the three-step-test. though these rules seem to be useful, they also restrict easy and (inter)active access to the cultural goods of the digital world. i argue that the much broader distribution of our present cultural assets is a highly supported cause in an economically, legally and culturally globalizing world – without which the digitization of intellectual works would become a purposeless effort. this argument is supported by the general goals of the i2010: digital libraries initiative in the european union and the subsequent introduction of the european union’s online multimedia library.91 the europeana92 originally had made around 2 million pieces of books, maps, charts, paintings, archive documents, digital copies of films etc. available in a userfriendly way and free of charge. all this content was provided by national libraries, archives and other collections, for example the louvre, the british library, and the hungarian national 90 usca art. 108 (c)(1)-(2). 91 i2010: digital libraries – communication from the commission to the european parliament, the council, the european economic and social committee and the committee of the regions, brussels, 30.9.2005 com(2005) 465 final. (http://eur-lex.europa.eu/lexuriserv/lexuriserv.do?uri=com:2005:0465:fin:en:pdf). 92 see: www.europeana.eu/portal. nordic journal of commercial law issue 2010#1 19 széchenyi library. even though most of these works are in the public domain, the general idea of and the initiative itself is an extraordinary one. the hungarian nava act93 was introduced in accordance with the provisions of the european convention for the protection of audiovisual heritage,94 and complies with all the requirements of the infosoc-directive. this archive records all the broadcasts of analogue and digital television channels. it is considered equally important to preserve this expression of our cultural and historical heritage, as other copyrighted materials. some clarifying conclusions can be drawn at this stage. first, it is not the author’s intention to advocate that the digital reproduction and distribution of copyrighted materials should be accepted as free use. such an exception would disrupt the present balance of rules, existing business models, as well as arguably contravene with the international minimum requirement concerning copyright limitations and exceptions, mainly the three-step-test. secondly, the contents that are collected by the libraries and archives greatly differ. a large part of our cultural works is part of the public domain and can be distributed without restrictions. another large part constitute orphan works, whose owners cannot be identified or located,95 and it is therefore impossible to obtain consent to use the copyrighted work from them.96 however, these creations have such an important value that their exploitation must be socially justified. the number of works that are no longer exploited commercially is also enormous. the collections of libraries also contain such copyrighted materials that are exploited by their owners actively. the reproduction and distribution/making available to the public of the works in the first three categories would constitute an essential means towards the improvement and the effective preservation of the culture. only the last category of works raises copyright concerns and could lead to heavy debate. thirdly, it can be argued that digitization can take place respecting copyrighted works. the european commission has stated in a recommendation that “europe's cultural material should be digitized, made available and preserved in full respect of copyright and related rights”.97 the commission refers to the provisions of the infosoc-directive. another working document from the european union, the medina draft report supported subjecting digitization by libraries to the three-step-test. the rapporteur also stated that “the phenomenon of works being put online 93 see: www.nava.hu. 94 the convention was commissioned by the council of europe. the text of the convention is available at http://conventions.coe.int/treaty/en/treaties/word/183.doc. 95 green paper supra note 75., at 10. 96 according to the estimation of the british library one of each four printed books, and more than half of the randomly selected sound recordings were orphan. see: gowers supra note 81, at 63, 69-71. 97 commission recommendation of 24 august 2006 on the digitisation and online accessibility of cultural material and digital preservation (2006/585/ec), recital 10. nordic journal of commercial law issue 2010#1 20 by digital libraries can be very damaging to copyright holders”.98 both of these reports start from the premise that the current copyright regimes are untouchable. this is, however, unconvincing, if we look at the social importance of the issue. the rethinking and rebalancing of the present national and international copyright framework is inevitable. the medina draft report seems to be based on a misunderstanding of the three-step-test. the test aims to restrict only the royalty-free uses; however, the national legislators may introduce some statutory limitations, where the members of the society are allowed to use the copyrighted works, if they pay the necessary royalty.99 this is why it is extremely important that the commissioner for information society and media viviane reding, publicly called for the digitization of the cultural heritage for preservation purposes, raising the necessity of eu legislation to the level of directives.100 below follows a short summary on how national rules allow the digitization and distribution of works with different “status”. since no one has any economic rights to the works in the public domain, the question of archiving and making available these works to the public is theoretically really simple. because these works are old and possibly kept on an obsolete datacarrier, format-shifting should not be restricted. the situation is different in the case of out-ofprint works and orphan works. they are generally protected by copyright law, although the exercise of the rights can be questioned. first, it is conceivable that the work is already unmarketable, or the publisher is liquidated, and therefore no one can publish the original work again. in these situations digitization seems to be the only real alternative. this way of reproduction is easy, fast, and cost-effective, and the distribution is also simple. digitization seems to be the best option for all of the interests involved (author, consumer and distributor). out-of print works may also become “orphaned”. the biggest problem with these (protected) works is that the consent of the right holder is required for their use. however, the time, energy and money required for discovering the owner is excessive, and hampers the utilization of the creative content. for example, many documentaries and sound recordings are hidden in the depth of archives that inform us about significant historical events without crediting the creator of the works. their utilization is impossible without the authorization of the right holder; however, not relinquishing them for use deprives society of the creation of new useful works. distributors of digitized old films face similar difficulties. the original use contracts were signed 98 draft report on the commission report on the application of directive 2001/29/ec on the harmonisation of certain aspects of copyright and related rights in the information society, committee on legal affairs, rapporteur: manuel medina ortega, 14.10.2008 [2008/2121(ini)], 10. (http://www.europarl.europa.eu/sides/ getdoc.do?pubref=-//ep//nonsgml+comparl+pe-413.997+01+doc+pdf+v0//en&language=en). 99 p. bernt hugenholtz ruth l. okediji: conceiving an international instrument on limitations and exceptions to copyright, final report, 2008: 24. (www.ivir.nl/publicaties/hugenholtz/finalreport2008.pdf). 100 „let us be very clear: if we do not reform our european copyright rules on orphan works and libraries swiftly, digitization and the development of attractive content offers will not take place in europe, but on the other side of the atlantic.” see: viviane reding: digital europe – europe’s fast track to economic recovery, the ludwig erhard lecture 2009, lisbon council, brussels, 9 july 2009: 9. nordic journal of commercial law issue 2010#1 21 by the right holders; however, these contracts did not contain the right to create digital copies of the works. that is, the digital versions of the films may be distributed only, if the original author or her descendants permit the use. acquiring permission causes serious problems in practice. the problem was high-lighted, when the united states’ congress terminated the renewal mechanism imbedded in the old copyright act by the “copyright renewal act” (cra) in 1992, and the term of protection was extended by the “sonny bono copyright term extension act” (ctea) with 20 years in 1998. before the enactment of the cra and ctea, if the right holder did not initiate (“opt-in”) the extension of the copyright term at the end of the original term, then the work became part of the public domain, thus allowing any kind of use. due to the modifications, practically every copyrighted expression earned a post mortem auctoris of 70 years, even if the original author (or her descendant) was not interested in the commercial exploitation of her work. this system is usually referred to as the “opt-out” regime. therefore the question suddenly emerged, what is the fate of those works, which are protected by copyright, but no identifiable right holders can be connected to the work?101 the us register of copyrights has discussed this topic in detail.102 it argued that the use of orphan works should be deemed an infringement, except if the user can prove that she made a reasonable effort to find the right holder. if the right holder later “appears” the parties can sign a contract with respect to the future uses. the european commission also supports the creation of mechanisms to facilitate the use of orphan works, and promotes the making of lists of known orphan works and works in the public domain and making them available.103 the interim report of the digital library initiative high level expert group in 2006,104 and the final report in 2008105 similarly urged 101 the constitutionality of these statutes was also discussed by the usa federal courts. in the famous kahle case it was held that „the outer boundary of ’limited times’ is determined by weighing the impetus provided to authors by longer terms against the benefit provided to the public by shorter terms. that weighing is left to congress, subject to rationality review. (…) congress passed the ctea in light of demographic, economic, and technological changes, and rationally credited projections that longer terms would encourage copyright holders to invest in the restoration and public distribution of their works.” see: brewster kahle, et. al. v. alberto r. gonzalez, 487 f.3d 697 (2007): 701. 102 report on orphan works – a report of the register of copyrights, january 2006 (www.copyright.gov/orphan/orphanreport-full.pdf). later the congress of the united states passed an act on orphan works (and thus modifying art. 514 of the usca. the statutory provisions are generally equivalent with the content of the report of the register of copyrights. the act is available on the following site: http://www.kasunic.com/legislation.htm. 103 2006/585/ec recommendation, point 6. a) és c). 104 european digital library initiative high level expert group – copyright subgroup, interim report (16.10.2006). available at: http://ec.europa.eu/information_society/activities/digital_libraries/doc/hleg/reports/ copyright/interim_report_16_10_06.pdf. nordic journal of commercial law issue 2010#1 22 action concerning orphan works. the hungarian legislator introduced some pioneering articles of hca concerning the orphan works in 2008.106 according to these, the hungarian patent office (hpo) shall grant a license to the person, who is unable to locate the author of a respective orphan work under reasonable circumstances. the license is granted for a maximum of five years, it is limited to the territory of hungary, it is non-exclusive, cannot be transferred, and it carries no right to grant additional use rights or rights for adaptation of the works in question. the license fees are determined by the hpo.107 in case of non-commercial uses the license fee is paid directly to the author as soon as she becomes known. if the use serves commercial purposes the fee shall be deposited with the hpo.108 in this latter case, as soon as the author becomes known, the fee has to be paid to her, and the original license is revoked (to force the conclusion of a new agreement directly between the parties);109 otherwise the sum will be handed over to the respective collective rights management association (or the national cultural fund).110 logically the most pointed debates arise regarding the archiving of protected works that are still available on the market and the right holders intend to commercially exploit them. for example the songs of the beatles, the episodes of the tv-show married with children, or the books of john steinbeck are still really famous. the archiving of these works by public libraries necessarily requires the clarification of their connection to the exclusive economical rights of public performance and/or public display, making available to the public and public distribution. the issue is therefore, whether it is possible to restrict the scope of the economic rights (even if that causes some economical harm to the right holders) in order to support the archiving purposes of the libraries? 105 i2010: digital libraries high level expert group – copyright subgroup, final report on digital preservation, orphan works, and out-of-print works (04/06/2008). available at: http://ec.europa.eu/ information_society/activities/digital_libraries/doc/hleg/reports/copyright/copyright_subgroup_final_report_265 08-clean171.pdf. 106 act cxii of 2008 (hereinafter: reform hca), art. 8 introduced the new hca art. 57/a-c. the above statement is naturally true concerning the european continent. canada has for example since the 1980’s national rules on the use of orphan works. 107 hca art. 57/a par. 1. 108 hca art. 57/a par. 2. 109 hca art. 57/a par. 3 and 5. 110 hca art. 57/a par. 5. it is worth to mention that hca art. 57/a par. (7) clearly excludes the application of the above rules regarding works, whose licensing falls within the scope of collective rights management. the hca reform amended the rules on public lending at the same time (by the introduction of the new art 23/a and the modification of the earlier art. 23 and 39), according to which the authors and the performers of musical compositions and motion picture works may license the use of their works only through an obligatory collective rights management. this practically means that the licensing of orphan musical compositions and motion picture works that are accessible only from the collection of a library or archives remain outside of the statutory provisions, and therefore possibly more difficult than the new hpo process. nordic journal of commercial law issue 2010#1 23 it seems easy to answer this question by a simple “no”. in the case of public domain works the fear of the “vanishing of the work” (due to lack of protection and the cessation of the intent of exploitation); and in case of orphan and out-of-print works the social demand on the easing of access to them strongly supports the involvement of the libraries/archives in the distribution of works (and not only in the preservation of them). there is no similar reason for works that are still commercially exploited. the right holders are able to utilize their works with the help of a broad range of business models. thus, a sound recording may be accessed via the publisher’s online database. this is the same with the marketing of books.111 an important such initiative is the hungarian website, where a fairytale plays and cartoons of the hungarian national television are streamed.112 this seems to be only the first step in our digital world. it is therefore worth discussing the google books library project. the project aims at the digitization and worldwide making available of public domain, orphan and out-of-print works, thus allowing the search, reproduction or buying of these books for everybody around the world. this new dimension of access to millions of literary works seems to be extraordinarily important.113 the project however, contains many uncertainties from the perspective of right holders. the adversity surrounding the google book settlement that was signed by google, the authors guild, and the association of american publishers, confirms this point. the parties concluded the original settlement in october 2008,114 and the trial court judge was scheduled to decide upon the matter on october 7th, 2009. the us justice department, however, submitted its objections in september 2009 stating that it would be harmful to approve the settlement.115 the parties also announced that they planned to revise their original agreement, and they submitted the amended settlement in november 2009, which was preliminarily approved by the trial court judge.116 the main problem of these settlements is that they generally concentrate on the exclusive copyrights provided by the usca. this means that even foreign right holders are “covered” by the agreement, i.e. they also have a share in the revenues derived from the sale of their works, but only with regard to the use of their works within the united states.117 under continental copyright regimes google’s activity constitutes a clear infringement of the authors’ and other 111 thus for example paolo coelho made available some of his books via different torrent sites. see: http://torrentfreak.com/best-selling-author-turns-piracy-into-profit-080512. 112 downloading is not allowed via the site. see (hungarian language only): http://mese.tv. 113 siva vaidhyanathan: the googlisation of everything and the future of copyright, u.c. davis law review, march 2007: p. 1207-1231. 114 jonathan band: the google settlement: international implications, computer law review international, 3/2009: 72-75. 115 statement of interest of the united states of america regarding proposed class settlement, 18.09.2009, www.justice.gov/atr/cases/f250100/250180.pdf. (hereinafter referred to as: us statement.) 116 the amended settlement is available at: http://books.google.com/booksrightsholders. 117 except if they effectively “opt-out” the application of the settlement until 7th december, 2009 nordic journal of commercial law issue 2010#1 24 right holders’ interests. thus, even if the google books site displays only samples of the books118 google servers contain the whole copy of the works, and this results in infringement, if the reproductions took place without prior authorization. nevertheless, even the display rights can be infringed by allowing the preview of the books, supposing that this part also contains enough originality to earn copyright protection. this is why in european countries, like france,119 trials have started. even the european union has publicly opposed the settlements raising both copyright and competition law concerns. as a result google books library project is still not available (in its complete form) on the european continent. the united states justice department had also emphasized its fears concerning the possible harms of the original settlement on antitrust law, that is, that it would create a monopoly for google.120 the amended settlement therefore contains a clear reference to the non-exclusivity of the authorization (given by the authors guild and the association of american publishers).121 anyway, this is the future. the enviable online world library developed by google should be a model to be followed by the libraries, archives etc. that maintain european cultural values. the european union should take active steps towards developing a working system on the european union. it needs on the one hand the adoption of new provisions that serve as a basis for the effective preservation of culture and knowledge. on the other hand, it is vital to guarantee the possibility for other institutions/companies to start their archiving projects. this means that if google abuses its current de facto monopoly over the distribution of digital copies of public domain, orphan and out-of-print works, the company should face antitrust procedures. naturally a long list of questions should be answered in connection to this topic. thus, should only the non-profit sector be allowed to participate in this european initiative, or even the profit-oriented companies? what kind of fee should be paid after the use of the works, maybe a 118 according to the amended settlement: „google may display (in addition to the table of contents, title page, copyright page and other pages that appear prior to the table of contents, and the index) up to twenty percent (20%) of the pages of a book to a user but no more than five (5) adjacent pages at a time (…), before or after which no fewer than two (2) pages are blocked; provided that, for fiction, google will block the final five percent (5%) of the book’s pages (or a minimum of the final fifteen pages in the book).” see: amended settlement supra note 120., at 63. [article iv., point 4.3(b)(i)(1)]. the original agreement contained similar conditions. see: band supra note 117., at 73. 119 earlier a german procedure was initiated; however, it was later withdrawn. see: danny sullivan: google book search wins victory in german challenge (http://blog.searchenginewatch.com/060628-152950). concerning the initiation of the french trial see: john oates: french publisher sues google, the register, 7th june, 2006 (www.theregister.co.uk/2006/06/07/france_sues_google). at the end of 2009 the respective french court finally found the google books project as an infringement. as a commentator noted: “the paris civil court said google violated the french copyrights of two groups representing publishers, editors and authors and awarded 300,000 euros ($430,000) to publisher editions du seuil sas, which filed the lawsuit.” see: heather smith: google’s french book scanning project halted by court (http://www.bloomberg.com/apps/news?pid=20601087&sid=apz3ug9cplo8). 120 us statement supra note 118., at 16-26. 121 amended settlement supra note 120., at 26. (article ii., point 2.4.) nordic journal of commercial law issue 2010#1 25 statutory license or the introduction of a new compulsory license would be possible? what kind of economic rights may be included in this use? should it cover only online reading (like streaming of audioand audiovisual contents) or would even downloading be acceptable? should digital right management be used in this context? in sum, copyright law is what the legislators declare it to be. it is therefore encouraging that vivian reding suggested that the copyright law of the european union is ready for reform.122 v. conclusion the interpenetration of technology and copyright law is undeniable. this is simply proved by the fact that copyright law was developed after the evolution of printing. this interpenetration is heavily accelerated by the improvement and spreading of digital technologies, especially the internet. everyday access to the internet led to the development of web 2.0 that partially caused the appearance of a new model of creation, and a new dimension of the improvement of the digital culture. this occurred only partially, because not all web 2.0 services contribute to the creation of copyrighted works (like in the case of ebay), and other applications, like file sharing, also help share infringing content. the present article discussed the digital preservation of our cultural heritage. making information broadly available to society in our globalized world should be strongly supported. the realization of this project is, however, a different question. should private actors be allowed, for example google (or other similar companies) to supervise the digitization, or should this task be given to our libraries? the latter would fit much easier into our existing copyright regimes, but in practice there is nothing like the google books library project, not even the europeana. commissioner reding made it clear that digital preservation is one of the main interests of future generations, and therefore the modification of the present copyright regime will be indispensable. nevertheless, we are used to these major shifts. copyright law has endeavored to follow and react to the challenges of technology. we are fortunate to be able to say that we will bear witness to such a development soon. 122 reding supra note 103., at 9. lakiteksti.uusi7.pmd nordic journal of commercial law, issue 2004 #1 1 nordic journal of commercial law issue 2004 #1 preservation of the goods: comparison of articles 85-88 cisg and counterpart provisions of the principles of european contract law francesco g. mazzotta1 nordic journal of commercial law, issue 2004 #1 2 1.preservation of the goods under the cisg. -seller’s duty to preserve the goods (art. 85) -buyer’s duty to preserve the goods (art. 86) -provisions common to both parties: deposit in warehouse (art. 87) and sale of goods (art.88) 2.preservation of the goods under pecl (arts. 7:110 – 7:112) -situations where pecl article 7:110 may be helpful in construing the meaning of the coun terpart provisions of the cisg 3. conclusion 1. preservation of the goods under the cisg as a general rule, section vi of chapter v of the cisg requires that the party left in possession of, or otherwise in control of the disposition of the goods has the duty to protect and preserve the goods. this duty, which applies to any party to the transaction, “is an expression of the general obligation to cooperate, as it can be deduced from this provision [cisg article 85] or that provision of the cisg as one of the convention’s underlying principles.” 2 -seller’s duty to preserve the goods (article 85)3 the scope of the provision comprises two situations: first, where the buyer is in delay in taking the goods4 and, second, where the buyer fails to pay the price when payment is to be made concurrently with delivery.5 in these cases, the seller is obligated to take measures to preserve the goods. the standard to be applied is that the seller is required to take any reasonable step under the circumstances to preserve the goods, which will often be decided based on usage.6 failure to fulfill this duty may give rise to stringent consequences especially in those cases where the risk of loss has already passed to the buyer although the seller still has control over the disposition of the goods.7 in fact, a seller’s failure to preserve the goods releases the buyer from liability arising from loss even though the risk has already passed to the buyer,8 “regardless of whether or not the property in the goods has passed”9 to the buyer. this is the “substance” of the obligation to preserve the goods.10 if, however, the risk of loss has not passed to the buyer, even though found liable for preservation costs, the seller is not entitled to damages to the good for prolonged storage.11 moreover, it must be noted that “reasonable circumstances and reasonable expenses are common law notions which provide standards according to which a judge or arbitrator can evaluate the necessar y steps and expenses.”12 the cisg does not state the length of the obligation to preserve the goods. however, “[i]t follows from article 88(1) that the seller is quite entitled to limit the period of preservation and that upon certain conditions [article 88], he may at any time proceed to sell the goods, provided that he has previously informed the buyer of that intention.”13 the seller may also be freed from the obligation to preserve the goods when he avoids the contract under article 64.14 in addition, it must be noted that the seller’s obligation to preserve the goods does not end if the seller brings an action to require the buyer to pay the price.15 the seller is responsible for the costs arising from reasonable measures to be taken to preserve the nordic journal of commercial law, issue 2004 #1 3 goods;16 however, the seller can sell the goods and retain from the proceeds an amount equal to the reasonable expenses incurred in preserving the goods and seller also has the right to retain the goods until those expenses are paid.17 however, according to many authors,18 “the buyer will have to be allowed a right to satisfy the right of retention by providing reasonable security.”19 the article 85-88 provisions on the preservation of the goods may be easily overcome by means of interim relief procedural tools, which are governed by domestic law.20 courts often regard damages arising from preserving the goods pursuant to article 85 as damages recoverable under cisg article 74.21 -buyer’s duty to preserve the goods (article 86)22 the buyer, similar to the seller, is bound to preserve the goods when (i) after receiving them, (ii) he intends to exercise the right to reject them. if both requirements are met, the buyer must take such reasonable23 measures as the case may be. the buyer is, however, entitled to retain the goods until the seller reimburses the buyer for the reasonable expenses incurred in preserving the goods.24 failure to take reasonable measures regarding the goods may result in denial of a claim for warehouse expenses (article 86(1)).25 the rejection may be exercised from the time the right to reject26 arises until it expires.27 while the period to decide whether to reject the goods is running, the buyer still has a duty to preserve the goods,28 which continues until the duty has been discharged pursuant to articles 87 and 88.29 if the goods have been dispatched to the buyer and placed at his disposal without having physical possession of them, the buyer, in order to be able to reject the goods, must take them into custody on behalf of the seller as long as it can be done without the payment of the price and without unreasonable inconveniences or unreasonable expenses (article 86(2)). of course, this rule does not apply if the seller or a person authorized by the seller to take charge of the goods is present at the place of destination of the goods. articles 85 and 86 establish the duty to preserve the goods. as already mentioned, a party may discharge his duty by (i) depositing the goods in a warehouse and/or (ii) selling the goods. -deposit in warehouse (article 87) the deposit of the goods in a warehouse30 (of a third person, if necessary) will be at the expense of the other party. however, unless otherwise provided, the party who deposits the goods is primarily liable to the warehouse although he may seek reimbursement from the other party to the sale contract.31 to be recoverable, depositing expenses must be reasonable.32 it should be noted that unreasonable expenses only affect the depositing party’s right to obtain full reimbursement. the right of reimbursement exists only in regards to those expenses that are proportionate.33 moreover, “[t]he incurring of unreasonable expense does not lead to the risk of storage in a warehouse being transferred to the other party.”34 two issues may give rise to some uncertainty as they are not regulated by the cisg: (i) the relationship between the parties to the storage contract and the parties to the sale of goods contract, which, as it has been suggested, should be “governed by the domestic law applicable in each particular case”35 and (ii) the legal consequences to the sale contract of the deposit of the goods in a warehouse: whether the deposit in a third person’s warehouse is to be qualified as a substitute for the original obligation. it should not be deemed to constitute an exemption from the original obligation36 unless nordic journal of commercial law, issue 2004 #1 4 the property involved is money. -sale of the goods (article 88) article 88(1) allows the party who is bound to preserve the goods to sell them if the other party fails to take action in a reasonable time (also known as self-help sale). it is an option (not an obligation).37 there are only two requirements the selling party must comply with to exercise such an option: (i) unreasonable delay by the other party in taking the property,38 and (ii) reasonable notice to the other party of the intention to sell the goods.39 this notice does not need to be in a specific form: it needs only to be appropriate under the circumstances. article 88(2) requires the party who is bound to preserve the goods to sell them when the “goods are perishable or their preservation would involve unreasonable expenses” (also known as emergency sale). in this case, selling the goods is a duty. failure to sell the goods in an emergency situation may give rise to a right to the other party to seek damages.40 two issues arise in connection with article 88(1) and 88(2) not dealt with by the cisg: (i) legal consequences of failure to give notice and, (ii) whether the other party may object. as to the first, however, it has been suggested that “a party who performs a self-help sale, without giving notice of his intention to do so, breaches an ancillary contractual obligation and will be under an obligation to compensate the other party for any resultant damage.”41 on the other hand, in an emergency sale situation, a claim for lack of notice may be difficult to bring it successfully. as to the second issue, some authors believe that the sale can be made regardless of any objection made by the other party,42 although the other party may bring an action for breach of an obligation to proceed based on reasonableness standard. -article 88(3) whether it has been a self-help or emergency sale, the party may retain from the proceeds of the sale the reasonable expenses incurred in preserving and selling the goods and require the other party to pay the balance. there is no reference in the cisg regarding (i) how any objections in connection with the reasonable expenses standard may be raised, (ii) whether the party who sold the goods may retain damages from the proceeds, as some authors have suggested and (iii) how the balance should be returned to the other party. however, based on the general principles behind the rules on the preservation of goods, as well as the other principles on which the cisg is based, it may be possible to assume that: (i) claims regarding the proper application of the reasonableness standard may be brought as damages for breach of a secondar y obligation; (ii) as the provision clearly states that the party may retain the costs to preserve the goods and the costs to sell the same, there should not be any doubt that the balance must be accounted for by the other party.43 this does not mean, however, that the party may not bring an action for damages setting-off his claim from the proceeds;44 and (iii) the balance should be paid at the other’s party place of business. if the party still refuses to take the money back, it may be useful to resort to a solution similar to pecl article 7:111 (depositing the money to the order of the other party in accordance with the law where the payment is due). 2. preservation of the goods under pecl (articles 7:1107:112)45 pecl article 7:110 considers mainly three cases: (i) buyer refuses to take deliver of goods; (ii) the buyer rejects the goods and seller refuses to take them back; and (iii) the contract has been terminated and the goods must be returned to the other party who refuses to take them back. article 7:110 may be helpful, as the issue is not dealt with by the cisg. nordic journal of commercial law, issue 2004 #1 5 the substance of pecl article 7:11046 is, therefore, ver y similar to cisg articles 85-88. thus, what it has been said about the cisg also applies under the pecl with the following distinctions. first, the main difference between the two sets of rules concerns the structure: pecl article 7:110 comprises both the seller’s and buyer’s duty to preserve the goods in only one provision, whereas the cisg considers both parties’ duties separately. the other difference concerns the wording: pecl outlines more simply than the cisg regarding how the party left in possession of the goods may discharge its duty. -situations where pecl article 7:110 may be helpful in construing the meaning of the counterpart provisions of the cisg (1) preservation of money. pecl specifically deals with the case where the property to be protected and preserved is money (article 7:111), a case not specifically dealt with by the cisg and, therefore, it may be of help when applying the cisg in such instances. specifically, the provision applies where the debtor attempts to perform a primary (e.g. payment of the goods) or secondary (e.g., repayment of money received or payment of damages under chapter 9 section 5) duty to pay.47 pursuant to article 7:111, the debtor discharges its duty to pay by “depositing the money to the order to the first party [creditor] in accordance with the law of the place where payment is due,”48 after giving the creditor a reasonable notice. by dong so, the debtor may also prevent claims by the creditor concerning interest on the sum to be held on behalf of the creditor. (2) avoidance and preservation of goods. reading articles 81 and 86 cisg, with the guidance of pecl, one should draw the conclusion that, where the contract has been avoided, the buyer must arrange the restitution of them to the seller as the former cannot keep those goods nor can he destroy or let them being destroyed. while the party is in possession of goods to be taken by the other party, the very same party must also arrange a way to preserve them pursuant to articles 87-88.49 as to the seller, if (i) the seller still has possession of, or control of, the goods, and (ii) the contract has been avoided, the seller cannot claim expenses for preserving the goods from the buyer. the pecl, contrary to cisg, does clearly deal with the case just mentioned, which makes article 7:110 useful when dealing with restitution and preservation of the goods when the contract has been avoided. 3. conclusions pecl’s language is ver y similar to cisg. however, one feature makes pecl articles 7:110 and 7:111 very useful when dealing with preservation of money, and preservation of goods as result of the avoidance of the contract, as these situations are not directly dealt with by the cisg. as a general rule, for all of the other general legal issues herein mentioned not directly solved by the cisg, it may be appropriate to first resort to the general principles of the cisg, unless the matter is clearly outside the scope of the cisg (e.g., storage agreement). the otherwise applicable domestic law, however, should control all of the more technical and detailed questions of substantive and, of course, procedural law. (footnotes) 1 the author is an associate of the institute of international commercial law of the pace university school of law (new york). nordic journal of commercial law, issue 2004 #1 6 2 see fritz enderlein & dietrich maskow, international sales law, united nations convention on contracts for the international sale of goods – convention on the limitation period in the international sale of goods, oceana publications 351 (1992). available at <http://cisgw3.law.pace.edu/cisg/biblio/ enderlein.html>. 3 for literature specifically relevant to the provisions of article 85, see <http://cisgw3.law.pace.edu/cisg/text/mono85.html>. see also harry flechtner, in the draft uncitral digest and beyond: cases, analysis and unresolved issues in the u.n. sales convention, 861 (franco ferrari, harry flechtner, ronald a. brand eds. 2004) [hereinafter uncitral digest]. 4 see hans e. eberstein, annotations 1-18 on article 85, in commentary on the un convention on the international sale of goods (cisg) 663, 667 (peter schlechtriem, ed. 1998) [hereinafter annotations 85]; herbert bernstein & joseph lookofky, understanding the cisg in europe 103 (2003) [hereinafter cisg in europe]; flechtner, uncitral digest, supra note 3. but see icc arbitration case no. 7197 of 1992 available at <http://cisgw3.law.pace.edu/ cases/927197i1.html> [the preservation costs were awarded as result of failure of opening a letter of credit]. 5 this language is also explained in a colloquy at the 1980 vienna diplomatic conference available at <http://cisgw3.law.pace.edu/ cisg/text/link85.html>. official records of united nations conference on contracts for the international sale of goods, vienna, march 10 – april 11, 1980, a/conf. 97/19 (hereinafter official records). see also jorge barrera graf, in commentary on the international sales law 614, 613-619 (massimo c. bianca and m. joachim bonell eds., 1987); eberstein, annotations 85, supra note 4, at 667; bernstein & lookofky, cisg in europe, supra note 4 at 103; flechtner, uncitral digest, supra note 4. see also hamburg arbitration proceeding, germany, december 29, 1998, available at <http:/ /cisgw3.law.pace.edu/cases/981229g1.html>. 6 eberstein, annotations 85, supra note 4, at 664 and 668. 7 see peter schlechtriem, uniform sales law – the un convention on contracts for the international sale of goods, manz: vienna 108 (1986). available at <http://cisgw3.law.pace.edu/cisg/biblio/ schlechtriem.html>. 8 see the secretariat commentary on article 74 of the 1978 draft [draft counterpart of cisg article 85] reprinted in official records, supra note 5, at 62, available at <cisgw3.law.pace.edu/cisg/text/seccomm-85.html>; see schlechtriem, supra note 7; john o. honnold, uniform law for international sales under the 1980 united nations convention, 3d ed., 519 (1999); harry m. flechtner, remedies under the new international sales convention: the perspective from article 2 of the u.c.c., 8 jl&c 53, 104 (1988) [available at <http://cisgw3.law.pace.edu/cisg/biblio/flecht.html>] [hereinafter “remedies”]; and jelena vilus, provisions common to the obligations of the seller and the buyer, in international sales of goods: dubrovnik lectures, oceana publications 259, 237-264 (petar sarcevic & paul volken eds., 1986) [available at <http:// cisgw3.law.pace.edu/cisg/biblio/vilus.html>]. 9 eberstein, annotations 85, supra note 4, at 665. 10 see enderlein & maskow, supra note 2, at 352. 11 icc arbitration case, no. 7197 of 1992, available at <http://cisgw3.law.pace.edu/cases/927197i1.html>. 12 see vilus, supra note 8; see also enderlein & maskow, supra note 2, at 352, “[w]hat is to be considered as steps that are reasonable in the circumstances will have to be determined using the measure which the cisg applies to flesh out such vague descriptions. it amounts to taking such steps that they would be taken by a reasonable person in the same circumstances;” carlo scognamiglio, nuove leggi civili commentate 326, 325-342 (massimo c. bianca ed., 1989). for the definition of reasonableness under the cisg and pecl and references to reasonableness in continental and common law domestic rules, doctrine and case law, visit <http://cisgw3.law.pace.edu/cisg/text/reason.html#overv>. as to case law, see oberlandesgericht braunschweig, germany, october 28, 1999, available at <http://cisgw3.law.pace.edu/cases/991028g1.html>; tribunal of international commercial arbitration at the russian federation chamber of commerce and industry, april 25, 1995, case 142/1994, available at <http://cisgw3.law.pace.edu/cases/950425r2.html>. 13 eberstein, annotations 85, supra note 4, at 668. 14 eberstein, annotations 85, supra note 4, at 669. if a contract has been avoided, the seller may not claim reimbursement of expenses incurred in preserving the goods: hamburg arbitration proceeding, germany, december 29, 1998, available at <http:/ /cisgw3.law.pace.edu/cases/981229g1.html>. nordic journal of commercial law, issue 2004 #1 7 15 honnold, supra note 8, at 520. 16 eberstein, annotations 85, supra note 4, at 669. 17 see oberlandesgericht braunschweig, germany, october 28, 1999, available at <http://cisgw3.law.pace.edu/cases/ 991028g1.html>; tribunal cantonal vaud, switzerland, 17 may 1994, available at <http://cisgw3.law.pace.edu/cases/ 940517s1.html>. 18 eberstein, annotations 85, supra note 4, at 669; enderlein & maskow, supra note 2, at 353. 19 eberstein, annotations 85, supra note 4, at 669. 20 see tribunal cantonal vaud, switzerland, may 17, 1994, available at <http://cisgw3.law.pace.edu/cases/940517s1.html> where the court states: “[t]he vienna convention … rules only on substantive issues. therefore it does not exclude that a different solution may be given in the frame of provisional measures.” 21 see, e.g., oberlandesgericht braunschweig, germany, october 28, 1999, available at <http://cisgw3.law.pace.edu/cases/ 991028g1.html>, where the court also stated “[w]hen applying the cisg, the duty to pay damages is based on article 74, in part also on article 85”; delchi v. rotorex, federal appellate court 2nd circuit, usa, december 6, 1995, available at <http:// cisgw3.law.pace.edu/cases/951206u1.html> federal district court, new york, usa, september 9, 1994, available at <http:// cisgw3.law.pace.edu/cases/940909u1.html>; icc arbitration case, no. 7531 of 1994, available at <http://cisgw3.law.pace.edu/ cases/947531i1.html>; icc arbitration case no. 7197 of 1992 available at <http://cisgw3.law.pace.edu/cases/927197i1.html>. 22 for selected texts specifically relevant to the provisions of article 86, visit <http://cisgw3.law.pace.edu/cisg/text/mono86.html>. see also bernstein & lookofsky, cisg in europe, supra note 4; flechtner, uncitral digest, supra note 3, at 864. 23 see supra note 12. 24 see cour de cassation, france, january 4, 1995, case 92-16.993, available at <http://cisgw3.law.pace.edu/cases/950104f1.html>; icc arbitration case no. 7531 of 1994 available at <http://cisgw3.law.pace.edu/cases/947531i1.html>. 25 china international economic and trade arbitration commission [cietac] shenzhen commission, (june 6, 1991, arbitration proceeding 164/1996, available at <http://cisgw3.law.pace.edu/cases/910606c1.html>): the court stated that warehouse expenses, which almost amounted the price of the contract, were unreasonable. the court also noted that the extend deposit caused the goods to decompose. 26 see, e.g., articles 46(1), 46(2), 49(1)(a), 49(1)(b) and maybe a right to reject exist under articles 52 and 71. see hans e. eberstein, annotations 1-26 on article 86, in commentary on the un convention on the international sale of goods (cisg) 671 (peter schlechtriem, ed., 1998) [hereinafter annotations 86]. 27 it can be exercised even at a later time after receiving the goods e.g., non-conforming goods must be rejected within a reasonable time after the buyer discovers or should have discovered the defects. 28 see honnold, supra note 8, at 524; see also eberstein, annotations 86, supra note 26, at 671; fritz enderlein, dietrich maskow and heinz strohbach, internationales kaufrecht, article 86, note 3.2 (1991). 29 it has been suggested that the buyer has no duty to take the goods in possession when he rejected them at earlier stage (see secretariat commentary on article 75 of the 1978 draft [draft counterpart of cisg article 86] reprinted in official records, supra note 5, at 62, available at <cisgw3.law.pace.edu/cisg/text/seccomm-86.html>; rolf herber and beate czerwenka, internationales kaufrecht, article 86, paragraph 6 (1991). however, the provisions do not support such view as once the goods are the buyer’s disposal whether he rejects them or only intends to reject them, he is still bound to preserve the goods pursuant to articles 87 and 88. see also eberstein, annotations 86, supra note 26, at 675; enderlein/maskow/strohbach, supra note 28, at art. 8, note 7. 30 the term “warehouse” means “any place appropriate for the storage of goods of the type in question.” secretariat commentary on article 76 of the 1978 draft [draft counterpart of cisg article 87], reprinted in official records, supra note 5, available at <cisgw3.law.pace.edu/cisg/text/seccomm-87.html>. nordic journal of commercial law, issue 2004 #1 8 31 honnold, supra note 8, at 525. as to case law, see icc arbitration case no. 7531 of 1994, available at <http:// cisgw3.law.pace.edu/cases/947531i1.html>; cf. tribunal cantonal vaud, switzerland, may 17, 1994, available at <http:// cisgw3.law.pace.edu/cases/940517s1.html> [in the context of interim relief]. 32 tribunal of international commercial arbitration at the russian federation chamber of commerce and industry, april 25, 1995, case 142/1994, available at <http://cisgw3.law.pace.edu/cases/950425r2.html>. 33 id. 34 see hans e. eberstein, annotations 1-12 on article 87, in commentary on the un convention on the international sale of goods (cisg) 677 (peter schlechtriem, ed., 1998) [hereinafter annotations 87] [footnote omitted]. 35 id. at 678. see also enderlein & maskow, supra note 2, at 357. 36 see herber/czerwenka, supra note 29, at art. 87, paragraph 5; eberstein, annotations 87, supra note 34, at 678. but see enderlein/ maskow/strohbach, see supra note 28, at art. 87, note 1.2. 37 see honnold, supra note 8, at 526. 38 see tribunal of international commercial arbitration at the russian federation chamber of commerce and industry, april 25, 1995, case 142/1994, available at http://www.cisgw3.law.pace.edu/cases/950425r2.html>; icc arbitration case no. 7531 of 1994, available at <http://cisgw3.law.pace.edu/cases/947531i1.html>. 39 oberlandesgericht braunschweig, germany, october 28, 1999, available at <http://www.cisg.law.pace.edu/cases2/ 991028g1.html>. 40 see hans e. eberstein, annotations 1-32 on article 88, in commentary on the un convention on the international sale of goods (cisg) 683 (peter schlechtriem, ed., 1998) [hereinafter annotations 88]. 41 id. at 682 [footnote omitted]; scognamiglio, supra note 12, at 340. 42 id. 43 see ebersten, annotations 88, supra note 40, at 684; flechtner, remedies, supra note 8, at 80; but see scognamiglio, supra note 12, at 341; (as to ulis) h.j. mertens and e. rehbinder, internationales kaufrecht, articles 94 and 95, note 8 (1975). 4 4 see secretariat commentary on article 77 of the 1978 [draft counterpart of cisg article 88], reprinted in official records, supra note 5, at 63, available at <cisgw3.law.pace.edu/cisg/text/seccomm-88.html>. see also flechtner, remedies, supra note 8, at 81; ebersten, annotations 88, supra note 40, at 684 citing also herber/czerwenka, supra note 29, art. 88, paragraph 8; enderlein/ maskow/strohbach, supra note 28, art. 88, note 9. 45 for the full text of the principles of european contract law, visit <http://cisgw3.law.pace.edu/cisg/text/textef.html>. 46 for the text of pecl article 7:110, visit <http://cisgw3.law.pace.edu/cisg/text/textef.html a7110>. 47 see comment and notes on article 7:111 in principles of european contract law: parts i and ii 352-357 (ole lando & hugh beale eds., 2000) available at <http://cisgw3.law.pace.edu/cisg/text/peclcomp85.html >. 48 see oberster gerichtsof, austria, june 29, 1999, available at <http://cisgw3.law.pace.edu/cases/990629a3.html>, where the court dealing with the issues of determining the place of restitution as result of the avoidance of the sale contract (cisg article 81), found that “[t]he cisg does not contain any provisions pertaining to the place of performance for restitution. nevertheless, the gaps arising from the absence of relevant agreements within the framework of art 7(2) cisg can be bridged without recourse to national provisions (leser, op. cit., art. 81 annotation 17; weber, op. cit., art. 81 annotation 21). the place of performance for the obligations concerning restitution should mirror the place of performance for the primary contractual obligations (posch, in schwimann, 2d ed., cisg art. 81, annotation 9).” i expect, however, that other courts may refer this issue to the law otherwise applicable to the contract. 49 icc arbitration case no. 7531 of 1994, available at <http://cisgw3.law.pace.edu/cases/947531i1.html>. 1 graduated from pontifícia universidade católica do rio grande do sul, in the city of porto alegre, rs, brazil (2002). ll.m. in corporate law (2005) at new york university, new york, ny. candidate for a specialist degree in international law from universidade federal do rio grande do sul, porto alegre, rs, brazil. currently working at veirano advogados in the city of porto alegre, rs, brazil with civil litigation and contracts. gap-filling in the cisg: may the unidroit principles supplement the gaps in the convention? by lucia carvalhal sica1 nordic journal of commercial law issue 2006 #1 nordic journal of commercial law issue 2006 #1 1 final act of the united nations conference on contracts for the international sale of goods, april 10, 1980, u.n. doc. a/conf.97/18 (1980), reprinted in s.treaty doc. 98-9, (1983) and available at <http://www.unilex.info>. 2 franco ferrari, gap-filling and interpretation of the cisg: overview of international case law, 7 vj 63, 79 (2003). 3 see, for example, article 4(2) of the convention on international factoring and article 6(2) of the convention on international financial leasing. 4 in this paper, reference will be made to the current version of the unidroit principles of 2004, available at <http://www.unidroit.org/english/principles/contracts/principles2004/blackletter2004.pdf> (last visited april 17, 2005). 2 i. introduction it seems evident that an international body of law such as the united nations convention on contracts for the international sales of goods (hereinafter “ cisg” or “ convention” )1 cannot be exhaustive2. as it is difficult to cover all necessary matters, there must be provisions to fill gaps when one faces issues which are not dealt with by an instrument of law such as the convention. thus, it is essential that all treaties have a provision regarding gap-filling to guide in cases where there is an omission or lack of specific rules. the cisg, as other similar conventions3, refers to general principles regarding gap-filling in its article 7(2). as shall be further discussed in this paper, recourse to general principles will be made whenever there is a gap, and, as ultima ratio one will reach to domestic law rules to fill gaps. on the other hand, if there are no gaps, there shall not be recourse to general principles, but solely to the specific provisions and rules set forth in the convention. under the cisg, due to the party autonomy principle, parties can stipulate in the contract which rules and/or principles will be taken into consideration to fill in any gaps. in fact, in practice, it is common that the parties do not specify how to fill gaps, notwithstanding their ability to do so under the party autonomy principle. this paper will, therefore, disregard parties’ provisions regarding gap-filling and consider possibilities as if there were no agreement in this respect. in cases that the parties of a contract under the cisg do not provide for filling of gaps, there is a discussion whether external principles, such as the unidroit principles of international commercial contracts4 (“ unidroit principles” ) are able to fill those. the unidroit principles were first enacted in 1994 and stated in their preamble the idea of supplementing other international uniform law instruments. hence, the main issue that will be analyzed in this paper is the possibility of filling cisg gaps with the unidroit principles. http://www.unilex.info http://www.unidroit.org/english/principles/contracts/principles2004/blackletter2004.pdf nordic journal of commercial law issue 2006 #1 5 also called external gaps. 6 also called internal gaps. 7 franco ferrari, general principles and international uniform commercial law conventions: a study of the 1980 vienna sales convention and the 1988 unidroit conventions on international factoring and leasing, 10 pace int’l l. rev. 157, 162 (summer, 1998). 8 see franco ferrari, specific topics of the cisg in the light of judicial application and scholarly writing, 15 j.l. & com. 1, 120 (fall, 1995). 9 for a detailed discussion of the convention’s scope of application, see franco ferrari, scope of application: articles 4-5, in draft uncitral digest and beyond: cases, analysis and unresolved issues in the u.n. sales convention 96 (franco ferrari et al. eds., munich, sellier 2004). 10 henry mather, choice of law for international sales issues not resolved by the cisg, 20 j. l. & com. 155, 159 (spring, 2001). 11 article 2 of the cisg excludes from its application the sales: “ (a) of goods bought for personal, family or household use, unless the seller, at any time before or at the conclusion of the contract, neither knew nor ought to have known that the goods were bought for any such use; (b) by auction; (c) on execution or otherwise by authority of law; (d) of stocks, shares, investment securities, negotiable instruments or money; (e) of ships, vessels, hovercraft or aircraft; (f) of electricity.” 12 according to this provision, the cisg does not apply to contracts in which “ the preponderant part of the obligations of the party who furnishes the goods consists in the supply of labor or other services.” 13 issues of validity and the effect on property being sold are also expressly excluded by the cisg. 14 “ the convention does not apply to the liability of the seller for death or personal injury caused by the goods to any person.” 3 ii. from the cisg to the unidroit principles 1. gap-filling under the cisg 1.1. intra legem and praeter legem gaps it is important to understand the notion of intra legem5 and praeter legem6 gaps before discussing gap-filling. the general principles of the cisg are only considered for the purpose of filling praeter legem gaps7. the difference of the concepts is highly relevant and this paper will address solely praeter legem gaps, because intra legem gaps are, under article 7(2) of the cisg, filled in by domestic law applicable by virtue of the conflict of laws rules of the forum state; the focus here is only on gap-filling within the context of the convention. on the other hand, with respect to praeter legem gaps, according to the same article 7(2) of the cisg, one will primarily resort to the general principles on which the convention is based or, only in the absence of such principles, by having recourse to the law applicable by virtue of the rules of private international law8. intra legem gaps refer to those issues not dealt with by the convention, such as matters that are excluded from the scope of application9 of the cisg. if an issue is expressly excluded from the scope of the cisg, it is not governed by the convention, article 7(2) does not apply, cisg general principles do not come into play, and the court must apply the conflict of laws rules10. whereas articles 211 and 3(2)12 expressly exclude some contracts from the convention’s sphere of application, articles 413 and 514 expressly exclude some matters of the cisg’s scope of application. nordic journal of commercial law issue 2006 #1 15 to a contrary opinion, see alejandro m. garro, the gap-filling role of the unidroit principles in international sales law: some comments on the interplay between the principles and the cisg, 69 tul. l. rev. 1149, 1159 (1994-1995) (stating that in issues concerning validity, even though the unidroit principles are not a binding instrument, in the absence of any other indication by the parties, the judge or arbitrator may resort to them, sticking to international standards instead of falling back on the domestic grounds). 16 franco ferrari, supra note 8, at 120-122 (citing authority to both positions). 17 id, at 120; franco ferrari, uniform application and interest rates under the 1980 vienna sales convention, 24 ga. j. int’l & comp. l. 467, 472 (winter, 1995). 18 phanesh koneru, the international interpretation of the un convention on contracts for the international sale of goods: an approach based on general principles, 6 minn. j. global trade 105, 129 (winter, 1997) (the author also mentions the principle of unjust enrichment. however, it is argued that the broader and primary goal of the convention is to compensate the aggrieved party fully. according to the same scholar, once this goal is accomplished, if there is still unjust enrichment on the part of the breacher, such unjust enrichment should be disgorged depending on the facts.). see also karin l. kizer, minding the gap: determining interest rates under the un convention for the international sale of goods, 65 u. chi. l. rev. 1279, 1295-1296 (fall, 1998) (making reference to the principle of full compensation and, as an alternative, to the principle of unjust enrichment). 19 robert a. hillman, construction of the uniform commercial code: ucc section 1-103 and “ code” methodology, 18 b.c. ind. & comm. l. rev. 655, 657 (1977) (when using this approach, one should look only to the code itself, but no further). 20 grant gilmore, legal realism: its cause and cure, 70 yale l. j. 1037, 1043 (1961). also cited, among others, by james w. bowers, incomplete law, 62 la. l. rev. 1229, 1232 (summer, 2002); gunther a. weiss, the enchantment of codification in the common-law world, 25 yale j. int’l l. 435, 526 (summer, 2000). 4 these contracts and issues will be dealt with by the appropriate body of law; in most cases domestic law, applicable pursuant to the rules of private international law15. on the other hand, there are topics that are intended to be governed by the cisg, but, for some reason, its provisions contain gaps. these are the so called praeter legem gaps, which will be the object of concern in this paper. once such a gap has been identified, one must know how to overcome it in accordance with the convention. in other words, when a dispute arises regarding a praeter legem gap and the parties did not state in the agreement how to fill gaps, one must look at the convention’s provisions regarding gap-filling, which will lead to the use of the general principles and only as a last resort to the conflict of laws rules. at this point, it may be convenient to give an example of an issue governed by the cisg, but not completely regulated by it. one of them is the way of assessing the interest rate that a party has the right to receive in accordance with articles 78 and 84 of the cisg. the absence of a formula to calculate the rate of interest has been interpreted in divergent ways; some understand it as a prater legem gap and others, as an intra legem gap16. these different interpretations necessarily lead to diverging solutions, since under the cisg, the aforementioned kinds of gaps have to be dealt with differently17. if considered an internal gap, interpretation will first fall back on the general principles and, lastly, to private international law rules, whereas external gaps will be directly resolved by recourse to the latter. supposing this issue is a praeter legem gap, one would have to verify which general principles of the convention apply. in this specific case, it has been acknowledged18 that the principle of full compensation should be taken into consideration. 1.2. gap-filling methods there are basically three gap-filling methods. the so-called “ true code approach” is the one that limits the interpreter to the text of the convention itself, considering that the legal document is comprehensive enough19. when explaining this method, grant gilmore20 states that a code “ is a legislative enactment which entirely pre-empts the field and which is assumed to carry within the nordic journal of commercial law issue 2006 #1 21 regarding “ meta-code” concepts, see generally, steve h. nickles, problems of sources of law relationships under the uniform commercial code, part i: the methodological problem and the civil law approach, 31 ark. l. rev. 1 (1977-1978). 22 robert a. hillman, applying the united nations convention on contracts for the international sale of goods: the elusive goal of uniformity, available at <http://www.cisg.law.pace.edu/cisg/biblio/hillman 1.html> (last visited march 6, 2005) (citing bianca and bonell). 23 id. at n. 24. 24 franco ferrari, uniform interpretation of the 1980 uniform sales law, 24 ga. j. int’l & comp. l. 183, 218 (1994-1995) (citing other commentators). 25 robert a. hillman, supra note 22. 26 id. 27 alejandro m. garro, supra note 15, at 1159. 28 phanesh koneru, supra note 18, at 106. 29 gyula eörsi, general provisions, in international sales: the united nations convention on contracts for the international sale of goods 2-1, 2-9 (matthew bender ed. 1984), available at <http://cisg.law.pace.edu/cisg/biblio/eorsi1.html> (last visited feb. 26, 2005) (citing h. dölle). 30 annex 834 un treaty ser 109 (1964), reprinted in 13 am. j. comp. l. 453. 31 see also jacob s. ziegel, report to the uniform law conference of canada on convention on contracts for the international sale of goods, available at <http://www.cisg.law.pace.edu/cisg/text/ziegel7.html> (last visited feb 26, 2005) (stating that article 7(2) is not an innovation as it has a counterpart in article 17 of ulis). 5 answers to all possible questions: thus when a court comes to a gap or an unforeseen situation, its duty is to find, by extrapolation and analogy, a solution consistent with the policy of the codifying law (… )” . the “ meta-code approach” 21, in contrast, relies on the use of external legal principles. finally, the last approach is a combination of the first two methods. it has been said that the drafters of the convention compromised after some debate regarding the above mentioned methods22. legislators from civil law traditions believed in the “ true-code approach” , alleging that “ the courts could fill gaps by applying both the convention’s general principles and, either directly or by analogy, the more specific principles embedded in particular provisions” 23. although the meta-code approach “ seems to be favored in common law” , other commentators demonstrate that the united states uniform commercial code (ucc) is based on the civil law approach24. in the end, the drafters of the cisg opted for a compromise including both methodologies25, choosing the method that combines both the true-code and the meta-code approaches. in the convention’s system, however, when principles are available, they trump domestic rules.26 domestic rules will only be applied as a last resort, when there are no general principles underlying the convention27. 1.3. article 7(2) from a theoretical point of view, article 7 of the cisg has been considered one of the most important provisions of the convention28. article 7(2) tries to solve the issue of gaps in the convention, stating that “ questions concerning matters governed by this convention which are not expressly settled in it are to be settled in conformity with the general principles on which it is based or, in the absence of such principles, in conformity with the law applicable by virtue of the rules of private international law” . gyula eörsi29 points out that, notwithstanding the absence of the word “ gap” in this article, it serves to fill gaps and corresponds to article 17 of ulis (uniform law on the international sale of goods30, adopted at a hague conference in 1964)31, one of cisg antecedents. in spite of the fact that both articles refer to gaps, it must be said that ulis http://www.cisg.law.pace.edu/cisg/biblio/hillman http://cisg.law.pace.edu/cisg/biblio/eorsi1.html http://www.cisg.law.pace.edu/cisg/text/ziegel7.html nordic journal of commercial law issue 2006 #1 32 franco ferrari, supra note 7, at 164-165 and franco ferrari, general principles and international uniform commercial law conventions: a study of the 1980 vienna sales convention and the 1988 unidroit conventions, 3 uniform l. rev. 451, 456 (1997). 33 gyula eörsi, supra note 29, at 2-3 and 2-4. 34 joseph lookofsky, in dubio pro conventione? some thoughts about opt-outs, computer programs and preemption under the 1980 vienna sales convention (cisg), 13 duke j. comp. & int’l l. 263, 282 (summer, 2003). 35 bruno zeller, four-corners – the methodology for interpretation and application of the un convention on contracts for the international sale of goods, available at <http://cisg.law.pace.edu/cisg/biblio/4corners.html> (last visited feb. 26, 2005). 36 in this respect, see phanesh koneru, supra note 18, at 115. 3 7 gert brandner, admissibility of analogy in gap-filling under the cisg, available at <http://www.cisg.law.pa ce. ed u/ cisg/biblio/brandner.html> (last visited april 9, 2005) (also concluding that article 7(2) prefers autonomous gap-filling in the form of recourse to general principles to making resort to the law applicable by virtue of the rules of private international law and stating that autonomous gap-filling preserves the advantages of uniform law.) 38 maría del pilar perales viscasillas, el contrato de compraventa internacional de mercancias (convención de viena de 1980), 10 (2001), available at <http://www.cisg.law.pace.edu/cisg/biblio/perales1-07.html> (last visited feb. 26, 2005). 39 phanesh koneru, supra note 18, at 116. (making reference to the convention’s preamble). 6 relied on the “ true code” approach, while the drafters of the cisg, as mentioned above, rejected this approach32 in favor a combination of the “ true-code” and “ meta-code” techniques. one must keep in mind that article 7(2) is applicable whenever a gap is deemed to exist. for that reason, the general principles will come into place solely when there is a gap in the text of the convention. in other words, if there are specific provisions regarding any issue, they should be applied, without resort to the general principles. furthermore, gyula eörsi33 reads article 7(2) of the convention as containing two devices pointing to different solutions: i) conformity with the general principles on which the convention is based, which serves to exclude the homeward trend, and ii) rules of private international law, that seeks a solution outside the convention. regarding the second part of the article or the second device therein established, there does not seem to be much controversy, different from the first part34, which, as shall be further discussed, has been interpreted in more than one way. as mentioned above, it has been understood that recourse to domestic laws should be a last resort, solely when there are no principles underlying the convention. the controversies arise regarding the first half of the provision, particularly to determine what are the principles on which the convention is based. in summary, article 7(2) prescribes the policy to fill gaps and, in doing so describes the boundary between the cisg and domestic law35. the use of rules of private international law, thus, should be the second option. that is to say, article 7(2) of cisg requires courts to rely on the general principles of the convention before applying domestic law as a last resort36. this rule is appropriate to the rationale underlying the convention: achieve uniformity in international sales transactions. in addition, it has been affirmed that this article’s main virtue is to avoid any premature recourse to domestic laws, creating an auto-sufficient37 system which obviously has no aspiration of governing all issues that may be involved in a sales contract38. at the same time, the general principle provision can have the narrow effect of guarding against the use of local (and divergent) legal concepts of domestic laws in construing the specific provisions and the broader effect of authorizing tribunals to create new rules not directly based on the textual provisions, but relying on principles, which are broad concepts39. http://cisg.law.pace.edu/cisg/biblio/4corners.html http://www.cisg.law.pace.edu/ http://www.cisg.law.pace.edu/cisg/biblio/perales1-07.html nordic journal of commercial law issue 2006 #1 40 see, for example, alejandro m. garro, supra note 15, at 1156; phanesh koneru, supra note 18, at 116; robert a. hillman, supra note 23. 41 see, among others, franco ferrari, supra note 7, at 168-177; ulrich magnus, general principles of un-sales law, available at <http://www.cisg.law.pace.edu/cisg/biblio/magnus.html> (last visited march 6, 2005); henry mather, supra note 10, at 157-158. 42 see, among others, rheinland versicherungen v. atlarex s.r.l, tribunale [district court] di vigevano, italy, 12 july 2000, case number 405, translation to english available at <http://cisgw3.law.pace.edu/cases/000712i3.html (last visited mar. 20, 2005)>; al palazzo s.r.l. v . b e r n a r d a u d s . a . , t r i b u n a l e [ d i s t r i c t c o u r t ] d i r i m i n i , i t a l y , 2 6 n o v e m b e r 2 0 0 2 , 3 0 9 5 , a v a i l a b l e a t <http://cisgw3.law.pace.edu/cases/021126i3.html> (last visited apr. 9, 2005); scatolificio la perla s.n.c. di aldrigo stefano e giuliano v. martin frischdienst gmbh, tribunale [district court] di padova, italy, 31 march 2004, case number 40466, translation to english available at <http://cisg3.law.pac.edu/cisg/wais/db/cases2/04033li3.html> (last visited jan. 13, 2005) (all mentioning the identification of the general principle regarding the allocation of the burden of proof); bv ba g-2 v. as c.b., rechtbank van koophandel [district court] veurne, belgium, 25 april 2001, available at <http://www.cisg.law.pace.edu/cisg/wais/db/cases2/010425b1.html> (last visited a p r i l 1 2 , 2 0 0 5 ) ; l a n d g e r i c h t [ d i s t r i c t c o u r t ] s t e n d a l , g e r m a n y , 1 2 o c t o b e r 2 0 0 0 , a v a i l a b l e a t <http://www.cisg.law.pace.edu/cisg/wais/db/cases2/001012g1.html> (last visited april 12, 2005) (both stating that the principle of party autonomy underlies the convention); conservas la costeña s.a. de c.v. v. lanín san luis s.a. & agroindustrial santa adela s.a., compromex comisión para la protección del comercio exterior de méxico [mexican commission for the protection of foreign trade], mexico, 29 april 1996, available at < http://cisgw3.law.pace.edu/cases/960429m1.html> (last visited may 2, 2005) (mentioning the principle of iformality); so. m. agri s.a.s di ardina alessandro & c. v. erzeugerorganisation marchfeldgemüse g m b h & c o . k g , t r i b u n a l e [ d i s t r i c t c o u r t ] d i p a d o v a , i t a l y , 2 5 f e b r u a r y 2 0 0 4 , 4 0 5 5 2 , a v a i l a b l e a t <http://cisgw3.law.pace.edu/cisg/wais/db/cases2/040225i3.html> (last visited jan. 13, 2005) (mentioning various principles). 43 franco ferrari, supra note 24, at 222-226. 44 for a complete discussion and description of evolution of theories distinguishing rules and principles, see humberto ávila, a distinção entre princípios e regras e a redefinição do dever de proporcionalidade, revista diálogo jurídico v. 1, n. 4 (july 2001) available at <http://www.direitopublico.com.br/pdf_4/dialogo-juridico-04-julho-2001-humberto-avila.pdf> (last visited april 16, 2005). 45 klaus peter berger, the lex mercatoria doctrine and the unidroit principles of international commercial contracts, 28 law & pol’y int’l bus. 943, 946 (summer, 1997). 7 as a result, first of all, it is important to understand what was meant by the drafters of the cisg when they referred to “ the general principles on which it is based” . commentators40 point out that the cisg fails to indicate which provisions contain the “ general principles” on which it is based. although the convention does not expressly state the principles, legal writers41 and court decisions42 have inferred them from the text. indeed, despite the fact that some of the principles are expressly stated in the convention, most principles must be derived or extracted from its specific provisions43. 2. key distinctions for the comparison between cisg and unidroit principles 2.1. distinction between principles and rules when discussing gap-filling with recourse to principles, it is crucial to avoid confusion between the notions of rules and principles44. once the two concepts are distinguished, it is possible to clarify that some general rules stated both in the cisg and in the unidroit principles are of no relevance to the gap-filling structure of article 7(2) of the convention, and to establish what are the principles to fill gaps. the unidroit principles have a structure similar to the american restatement of contracts; they contain both basic rules and legal principles formulated as black letter law45. therefore, one must note that, albeit the name of the instrument refers to the word “ principles” , many of its provisions are simply rules. moreover, it is critical to understand this distinction in order to correctly determine the principles that underlie the cisg. http://www.cisg.law.pace.edu/cisg/biblio/magnus.html http://cisgw3.law.pace.edu/cases/000712i3.html http://cisgw3.law.pace.edu/cases/021126i3.html http://cisg3.law.pac.edu/cisg/wais/db/cases2/04033li3.html http://www.cisg.law.pace.edu/cisg/wais/db/cases2/010425b1.html http://www.cisg.law.pace.edu/cisg/wais/db/cases2/001012g1.html http://cisgw3.law.pace.edu/cases/960429m1.html http://cisgw3.law.pace.edu/cisg/wais/db/cases2/040225i3.html http://www.direitopublico.com.br/pdf_4/dialogo-juridico-04-julho-2001-humberto-avila.pdf nordic journal of commercial law issue 2006 #1 46 ronald dworkin, the model of rules, 35 u. chi. l. rev. 14, 23 (1967-1968). 47 id, at 25. 48 luís afonso heck, o modelo das regras e o modelo dos princípios na colisão de direitos fundamentais, 781 revista dos tribunais 71, 75 (november 2000). 49 john felemegas, the united nations convention on contracts for the international sale of goods: article 7 and uniform interpretation, available at <http://cisg.law.pace.edu/cisg/biblio/felemegas.html> (last visited feb. 26, 2005). 50 id. (citing several authors). 8 ronald dworkin has established some guidelines to differentiate rules and principles. he calls “ a principle a standard that is to be observed, not because it will advance or secure an economic, political, or social situation deemed desirable, but because it is a requirement of justice or fairness or some other dimension of morality” 46. furthermore, stating that the difference is logic, he clarifies that both of them “ point to particular decisions about legal obligation in particular circumstances, but they differ in the character of the direction they give” ; indeed, “ [r]ules are applicable in an all-or-nothing fashion” : “ [i]f the facts a rule stipulates are given, then either the rule is valid, in which case the answer it supplies must be accepted, or it is not, in which case it contributes nothing to the decision.” 47 while principles can be in some way conflicting, but with different values attached to them, the rules cannot be contradicting and applied to a same situation. luís afonso heck48, in stating that the rules are definitive (absolute) commands, explains that a conflict between rules could be solved in two different manners: (i) by creating an exception in one of the rules that will eliminate the conflict, or (ii) by declaring one of the rules invalid. “ a general principle stands at a higher level of abstraction than a rule, or might be said to underpin more than one such rule” 49. in this sense, john felemegas has mentioned some rules in the cisg that, although referred to as principles, should not be treated as such50. he refers to: (a) the principle that widely known and largely observed usages must be taken into account; (b) the principle that, if a party fails to pay the price or any other sum that is in arrears, the other party is entitled to interest on it; (c) the principle that, unless otherwise expressly provided (in part iii of the cisg), any notice or other kind of communication made or given after the conclusion of the contract becomes effective on dispatch (article 27); and (d) the principle that the agreement between parties is not subject to any formal requirement. regarding the last issue, it seems that, contrary to the commentator’s view, a principle of informality can be derived from the convention’s provisions. 2.2. unidroit principles and cisg: differences in sphere of application, nature and time before establishing similarities and conflicts between the unidroit principles and the cisg principles, it is necessary to compare the instruments themselves. 2.2.1. difference in sphere of application both the convention and the unidroit principles deal with international contracts. the internationality of contracts under the cisg is defined in accordance to a subjective criterion, depending on the parties having their places of business (or habitual residences) in different http://cisg.law.pace.edu/cisg/biblio/felemegas.html nordic journal of commercial law issue 2006 #1 51 franco ferrari, the cisg’s sphere of application: articles 1-3 and 10, in draft uncitral digest and beyond: cases, analysis and unresolved issues in the u.n. sales convention 21, 24 (franco ferrari et al. eds., munich, sellier 2004) (citing court decisions that state this criterion). see article 1.1(a) and 10(b) of the cisg. 52 franco ferrari, defining the sphere of application of the 1994 “ unidroit principles of international commercial contracts” , 69 tul. l. rev. 1225, 1236 (1994-1995) (citing georges r. delaume for a discussion in general on how to determine what is an international contract). 53 id., at 1236 (stating that “ if the unidroit principles had binding character, it would be necessary to define the concept of international contract in order both to define their sphere of application and to promote uniformity in their application” ). 54 “ this convention applies to contracts of sale of goods between parties whose places of business are in different states: when the states are contracting states; or when the rules of private international law lead to the application of the law of a contracting state.” 55 “ contracts for the supply of goods to be manufactured or produced are to be considered sales unless the party who orders the goods undertakes to supply a substantial part of the materials necessary for such manufacture or production” . 56 id., at 1237. 57 id., at 1237. 58 franco ferrari, supra note 51, at 84 (stating that a contract does not need to be concluded for either commercial or industrial purposes in order to be governed by the cisg). 59 harry m. flechtner, the cisg impact on international unification efforts: the unidroit principles of international commercial contracts and the principles of european contract law, in the 1980 uniform sales law: old issues revisited in the light of recent experiences 169, 194 (franco ferrari ed., milan, giuffrè editore, 2003). 9 contracting states51. the unidroit principles, in contrast, do not prescribe their own rules to fulfill the internationality requirement52. franco ferrari argues that this lack of definition does not matter, due to the fact that the unidroit principles application is conditioned to the parties’ adopting it, since it does not have a binding character53. in addition, among contracts deemed international, the first substantial difference between the cisg and the unidroit principles refers to their substantive sphere of application. as the convention’s name already states, its applicability is limited solely to the sale of goods (under article 154) and similar contracts (under article 3(1)55). on the other hand, the unidroit principles include not only sales of goods, but any kind of international commercial contracts. here, also, the unidroit principles do not furnish any guidance in determining what constitutes a commercial contract56. regarding this omission, franco ferrari also argues that “ as long as the unidroit principles are not binding, their direct applicability by virtue of party autonomy prevents an exact definition from becoming relevant” 57. furthermore, regarding consumer contracts, the cisg sets forth in article 2(a) that it “ does not apply to sales of goods bought for personal, family or household use, unless the seller, at any time before or at the conclusion of the contract, neither knew or ought to have known that the goods were bought for any such use” . since the cisg only excludes consumer contracts, “ the cisg is also applicable where the goods were bought for professional use” 58. 2.2.2. difference in nature additionally, there is a great difference in the nature of these two sets of rules. while the unidroit principles do not constitute law, the convention is applicable law for contracts and issues within the scope of the cisg where the parties have not opted out59. the unidroit principles have been considered, as it was suggested in their introduction, an international nordic journal of commercial law issue 2006 #1 60 scott d. slater, overcome by hardship: the inapplicability of the unidroit principles’ hardship provisions to cisg, 12 fla. j. int’l l. 231, 239 (summer, 1998). 61 the draft was submitted to a diplomatic conference held in vienna in 1980; after necessary ratifications pursuant to article 99, the cisg entered into force in january 1, 1998. 62 michael joachim bonell, the unidroit principles of international commercial contracts: why? what? how?, 69 tul. l. rev. 1121, 1129 (1994-1995). 63 scott d. slater, supra note 60, at 245. 10 restatement of general principles of contract law. due to the fact that this text does not carry the legal force of an international treaty, its application is not mandatory in any nation60. the cisg, in contrast, is binding law if all its applicability requirements are met. 2.2.3. difference in time also, it is pertinent to mention the point in time in which the documents were drafted and enacted. the cisg went into effect on january 1, 198861, while the first version of the unidroit principles was promulgated only in 1994. as the unidroit principles were elaborated after the cisg, it is obvious that the latter did not make reference to the former regarding gap-filing or any other issue. among other codifications and compilations, the cisg was one of the sources of inspiration to the unidroit principles, due to the fact that the former was recently enacted at the time the latter was drafted62. despite the aforementioned diverging points, this paper intends to compare the principles and analyze the possibility of applying the unidroit principles to fill cisg gaps. scott slater63 has claimed that these would be reasons for a court to “ justifiably refuse to apply the principles as a gap-filling aid” . these differences, however, do not by themselves preclude the use of the unidroit principles to fill cisg gaps. whether or not this is possible requires a comparative analysis of the principles underlying both instruments, which shall be endeavored in the next part of the paper. nordic journal of commercial law issue 2006 #1 64 see, supra note 41. 65 see, supra note 42. 66 article 1.7(1). 67 article 4.8(2)(c). 68 michael joachim bonell, the unidroit principles in practice – caselaw and bibliography on the principles of commercial contracts 58 and 61 (transnational publishers, inc. 2002). 69 articles 2.1.4(2)(b), 2.1.15, 2.1.16, 2.1.18, 2.1.20, 3.5, 3.8, 3.10, 4.1(2), 4.6, 4.8, 5.1.2, 5.1.3, 6.1.3, 6.1.5, 6.1.16(2), 6.1.1(1), 6.2.3(3)(4), 7.1.2, 7.1.6, 7.17, 7.2.2(b)(c), 7.4.8 and 7.4.13. 70 paul j. powers, defining the undefinable: good faith and the united nations convention on the contracts for the international sale of goods, 18 j. l. & com. 333, 335-342 (spring, 1999). 71 id., at 343. 11 iii. unidroit principles and gap-filling in the cisg as many commentators64 and court decisions65 have identified the principles underlying the cisg, we shall mention some of them. this paper will, first, analyze the principles the convention shares in common with the unidroit principles and, second, the principles that might contradict with each other. 1. common principles 1.1. principle of good faith the unidroit principles explicitly provide that “ each party must act in accordance with good faith and fair dealing in international trade” 66. in addition, in supplying an omitted term, it is set forth that, among other factors, good faith and fair dealing should be considered in determining the appropriate term67. furthermore, bonell68 lists a number of provisions which constitute a direct or indirect application of the principle of good faith and fair dealing69. paul j. powers70 demonstrates that there is a contrast in the concept of good faith in civil law and common law. according to his explanation, “ civil law states tend to use a more expansive approach to the good faith obligation, applying it to both contract formation and performance” , while “ common law states prefer a [narrower] good faith duty applicable to contract performance” . furthermore, the different approaches around the globe led to debate regarding the drafting of the good faith provision in the convention. in the end, a working group was formed and it proposed a compromise article which protected the cisg’s international character while promoting uniformity and good faith71. nordic journal of commercial law issue 2006 #1 72 john felemegas, the united nations convention on contracts for the international sale of goods: article 7 and uniform interpretation, available at <http://cisg.law.pace.edu/cisg/biblio/felemegas.html> (last visited feb. 26, 2005) and franco ferrari, supra note 24, at 223 (both citing audit, enderlein & maskow and rolf herber & beate czerwenka). 73 see, among others, bruno zeller, the un convention on contracts for the international sale of goods (cisg) – a leap forward towards unified international sales laws, 12 pace int’l l. rev. 79, 92 et seq. (spring, 2000); ulrich magnus, remarks on good faith, 1, available at <http://www.cisg.law.pace.edu/cisg/principles/uni7.html#um> (last visited feb. 26, 2005); paul j. powers, supra note 70, at 342-353. 74 john felemegas, comparative editorial remarks on the concept of good faith in the cisg and the pecl, 13 pace int’l l. rev. 399, 400-401 (fall, 2001). 75 michael joachim bonell, the unidroit principles of international commercial contracts and cisg – alternatives or complementary instruments?, 1 uniform l. rev. 26, 30-31 (1996). 76 john o. honnold, uniform law for international sales under the 1980 united nations convention 146-147 (2d ed. 1991). 77 bruno zeller, supra note 73, at 93. 78 secretariat commentary [on article 7 of the 1978 draft], united nations conference on contracts for the international sale of goods, official records: documents of the conference and summary records of the plenary meetings and of the m e e t i n g s o f t h e m a i n c o m m i t t e e s ( v i e n n a , 1 0 m a r c h – 1 1 a p r i l 1 9 8 0 ) 1 7 1 8 , ( 1 9 8 1 ) , a v a i l a b l e a t <http://www.cisg.law.pace.edu/cisg/text/secomm/secomm-07.html> (last visited apr. 17, 2005) (citing various provisions of the convention). 79 ulrich magnus, supra note 73, at 5. see also ulrich magnus, remarks on good faith: the united nations convention on contracts do the international sale of goods and the international institute for the unification of private law, principles of international commercial contracts, 10 pace int’l l. rev. 89 (summer 1998). 12 indeed, the good faith principle has been recognized as one of the principles expressly set forth by the convention72. however, there has been doctrinal discussion regarding the reach of the good faith principle in the cisg73. the cisg does not contain an express provision that the parties should deal with each other in accordance with the principle of good faith74. therefore, the issue raised is whether the principle of good faith is only applicable to the interpretation of the convention or to the dealings of the parties and their rights and obligations. bonell75, one of the drafters of the unidroit principles, states that both instruments depart from each other regarding this principle, due to the fact that “ the principles impose upon the parties a duty to act in good faith throughout the life of the contract, including the negotiation process, while the cisg, in contrast, expressly refers to good faith only in the context and for the purpose of the interpretation of the convention as such” . professor honnold76, for instance, in the same line of thought of professor bonell’s interpretation, argues that good faith in the cisg acts only as a principle for the interpretation of the convention itself. nonetheless, it seems correct to declare that if we have to apply article 7 within the context of the cisg, good faith would have to be considered a general principle on which the convention is based77. in fact, the secretariat commentary to the cisg states that “ there are numerous applications of this principle in the particular provisions of the convention” 78, supporting this argument. in this same sense, ulrich magnus79 concludes his editorial remarks on article 7 stating that the differences in wording of both texts do not matter in essence. in fact, to reach this conclusion, the commentator makes an excellent analysis of the contents of the good faith principle, comparing http://cisg.law.pace.edu/cisg/biblio/felemegas.html http://www.cisg.law.pace.edu/cisg/principles/uni7.html#um http://www.cisg.law.pace.edu/cisg/text/secomm/secomm-07.html nordic journal of commercial law issue 2006 #1 80 id. (stating that in both texts “ it is clear that no specific national good faith concept can be applied but only one which fits for international trade relations” ) 81 id. (stating that even though the object of good faith is less clear in the cisg, the “ convention also intends to secure that (sales) contracts between parties from different countries are governed by the good faith principle” ) (footnote omitted). 82 id. (stating that “ both the cisg and the principles provide for a number of rules specifying what good faith is designed to mean in certain situations” and citing examples) 83 bruno zeller, supra note 35. 8 4 f o r i n s t a n c e : f i l a n t o , s . p . a . v . c h i l e w i c h i n t e r n . c o r p . , 7 8 9 f . s u p p . 1 2 2 9 , ( s . d . n . y . 1 9 9 2 ) , a v a i l a b l e a t <http://cisgw3.law.pace.edu/cases/920414u1.html> (last visited apr. 12, 2005); dulces luisi, s.a. de c.v. v. seoul international co. ltd. y seoulia confectionery co., compromex comisión para la protección del comercio exterior de méxico [mexican c o m m i s s i o n f o r t h e p r o t e c t i o n o f f o r e i g n t r a d e ] , m e x i c o , 3 0 n o v e m b e r 1 9 9 8 , a v a i l a b l e a t <http://cisgw3.law.pace.edu/cases/981130m1.html> (last visited april 3, 2005); budapest arbitration proceeding vb 94124 (1995) available at <http://cisg3.law.pace.edu/cases/951117h1.html> (last visited april 3, 2005); sarl bri production "bonaventure" v . s o c i ét é p a n a fr i c a n e x po r t , c o ur d ’a p p e l [ a p p e a l c o u r t ] g r e n o b l e , f ra n c e, 2 2 f eb r ua r y 1 9 9 5 , a v a i l a b l e a t <http://cisgw3.law.pace.edu/cases/950222f1.html> (last visited april 3, 2005). for an analysis of these cases, see bruno zeller, supra note 35. 85 peter schlechtriem, commentary on the un convention on the international sale of goods (cisg) 61 (geoffrey thomas trans., clarendon press 2nd ed 1998). 86 bruno zeller, supra note 35 (citing articles 29(2), 38, 39, 40 and 49(2)); judith martins costa, os princípios informadores do contrato de compra e venda internacional na convenção de viena de 1980, available at <http://www.uff.br/cisgbrasil/costa.html> (last visited april 16, 2005) (citing articles 27, 32(1), (2) and (3), 35(1),(2) and (3), 36(1) and (2), 38(1), 46(1), 54, 62, 68, 77 and 79). 87 article 27. 88 article 32(2). 89 article 38(1). 90 article 68. 91 article 77. 92 article 79(4). 13 the unidroit principles and the cisg in the following different aspects: (i) the international good faith80; (ii) the object of good faith81; and (iii) the specific good faith rules82. in favor of magnus’ position, bruno zeller83 states that good faith applies to the parties’ rights and obligations besides being applicable to the interpretation of the convention. in addition, case law84 has also demonstrated courts’ acknowledgment of good faith as a general principle. peter schlechtriem85 also argues that the good faith mentioned in the cisg should amount to a general principle. moreover, some scholarly writings86 have cited many of the convention’s provisions from which the good faith principle can be inferred. in fact, there are various provisions in the cisg from which one can infer the principle of good faith. for instance, notice is to be made by means appropriate in the circumstances87, seller must arrange appropriate means of transportation for carriage of the goods88, buyer must examine the goods as practicable in the circumstances89, seller’s duty to disclose the risk of loss of the goods90, duty to mitigate losses91, duty to give notice of any impediment to perform the agreement92. in sum, according to a majority of the commentators, it could be affirmed that the principle of good faith underlies both instruments. it is true that as it is expressly mentioned solely as a means to interpretation in the cisg, it might not have as much strength as this principle usually is conferred in other instruments, such as the unidroit principles. however, as demonstrated above, it is clear that the good faith principle underlies many provisions of the cisg, and hence it should be used as a principle to fill gaps. http://cisgw3.law.pace.edu/cases/920414u1.html http://cisgw3.law.pace.edu/cases/981130m1.html http://cisg3.law.pace.edu/cases/951117h1.html http://cisgw3.law.pace.edu/cases/950222f1.html http://www.uff.br/cisgbrasil/costa.html nordic journal of commercial law issue 2006 #1 93 michael joachim bonell, supra note 62, at 1137. 94 articles 2.1, 2.11, 2.12, 2.14, 2.22, 3.2, 3.3, 6.2.1 to 6.2.3, 7.3.1 to 7.3.6 and 7.1.4. 95 marco torsello, remedies for breach of contract under the 1980 convention on contracts for the international sale of goods (cisg), in quo vadis cisg? celebrating the 25th anniversary of the united nations convention on contracts for the international sale of goods 43, 55 (franco ferrari ed, munich, sellier 2005) (stating that “ the convention does this by enhancing spontaneous cure of defective performance by the party in breach, but it also does this by favoring judicial claims leading to the same result over claims for the avoidance of the contract, which seem to be relegated to the role of extrema ratio remedies” ); franco ferrari, supra note 24, at 225; ulrich magnus, supra note 41; gert brandner, supra note 37. 96 alejandro m. garro, supra note 15, at 1185. 97 id. at 1185. 98 franco ferrari, supra note 24, at 225 (referring to article 77 and citing audit and frignani for similar affirmations); franco ferrari, supra note 7, at 175. 99 see, for example, so. m. agri s.a.s di ardina alessandro & c. v. erzeugerorganisation marchfeldgemüse gmbh & co. kg, tribunale [district court] di padova, italy, 25 february 2004, 40552, available at <http://cisgw3.law.pace.edu/cisg/ wais/db/cases2/040225i3.html> (last visited jan. 13, 2005); fcf s.a. v. adriafil commerciale s.r.l., bundesgericht [supreme court], switzerland, 15 september 2000, available at http://cisgw3.law.pace.edu/cases/000915s2.html (last visited may 2, 2005). 100 franco ferrari, supra note 24, at 225; franco ferrari, supra note 7, at 174; ulrich magnus, supra note 41; judith martins costa, supra note 86. 101 articles 8 (1),(2) and (3), 35(1), 38(3), 39(1), 43(1), 46(3), 48(1) and (2), 49(2)(a), 60(a), 65(1), 79(1). 14 1.2. favor contractus favor contractus is another basic idea underlying the unidroit principles, in accordance with bonell93, who points out some of the provisions inspired by this principle94. similarly, the cisg “ aims at preserving the parties’ commitments and at favoring the performance of their agreement, thus relying on a general principle of favor contractus” 95. thus, it is accurate to suggest that both instruments “ share the same policy of preserving the enforceability of the contract if at all feasible” 96. “ this common goal is reflected by offering the breaching party the possibility to cure, requiring the nonbreaching party to provide an additional period for performance, and, most importantly, by allowing the termination of the contract only when the breach or nonperformance qualifies as ‘fundamental’” 97. 1.3. mitigation principle the principle of mitigation can be extracted from the convention’s provisions, according to which “ parties must take reasonable measures to limit damages resulting from the breach of the contract” 98. there have also been court decisions regarding this issue99. this principle is also present in the unidroit principles, according to its article 7.4.8, which requires the parties to mitigate the harm resulting to them from the breach of contract. the mitigation principle, hence, seems to coincide in both instruments. 1.4. principle of reasonableness the principle of reasonableness can be inferred from the convention’s provisions100. judith martins costa enumerates various rules of the convention which derive from this principle101. in the same sense, the unidroit principles also set forth some rules that embed this principle, http://cisgw3.law.pace.edu/cisg/ http://cisgw3.law.pace.edu/cases/000915s2.html nordic journal of commercial law issue 2006 #1 102 article 1.8(2). 103 article 2.4(2)(b). 104 article 2.7. 105 article 4.8(2)(d). 106 franco ferrari, supra note 7, at 172; franco ferrari, supra note 24, at 223; franco ferrari, cisg rules on exclusion and derogation: article 6, in draft uncitral digest and beyond: cases, analysis and unresolved issues in the u.n. sales convention 114, 116 (franco ferrari et al. eds., munich, sellier 2004); ulrich magnus, supra 41 (stating that “ all agree that the parties’ agreements prevail over the provisions of the cisg” and citing other authors). this principle has also been mentioned by some court decisions, among others: bv ba g-2 v. as c.b., rechtbank van koophandel [district court] veurne, belgium, 25 april 2001, available at <http://www.cisg.law.pace.edu/cisg/wais/db/cases2/010425b1.html> (last visited april 12, 2005); landgericht [ d i s t r i c t c o u r t ] s t e n d a l , g e r m a n y , 1 2 o c t o b e r 2 0 0 0 , a v a i l a b l e a t <http://www.cisg.law.pace.edu/cisg/wais/db/cases2/001012g1.html> (last visited april 12, 2005); so. m. agri s.a.s di ardina alessandro & c. v. erzeugerorganisation marchfeldgemüse gmbh & co. kg, tribunale [district court] di padova, italy, 25 february 2004, 40552, available at <http://cisgw3.law.pace.edu/cisg/wais/db/cases2/040225i3.html> (last visited jan. 13, 2005). 107 article 6. 108 article 9(1). 109 ulrich magnus, supra note 41. 110 e. allan farnsworth, an international restatement: the unidroit principles of international commercial contracts, 26 u. balt. l. rev. 1, 4 (summer, 1997); michael joachim bonell, supra note 62, at 1134; ole lando, comparative law and lawmaking, 75 tul. l. rev. 1015, 1028 (march, 2001). 111 article 1.1 of the unidroit principles. 112 article 1.5 of the unidroit principles. 113 indeed, the entire set of rules of the unidroit principles are not mandatory; the parties are of course free to choose not to apply them. 15 such as reasonable usages102, reasonableness in revocation of offers103, reasonable time of acceptance104, and reasonableness in supplying omitted terms105. the principle of reasonableness seems to be common in both the unidroit principles and the convention, without any differences or limitations. 2. different principles 2.1. principle of party autonomy the principle of party autonomy is one of the principles underlying the cisg106. this principle seems to be implicit in some of the convention’s provisions, such as the article that allows parties to exclude application of the convention itself or derogate some of its provisions107 and the article that allows parties to bind themselves to any usages or practices they have established in their transactions108. it is necessary to mention that while the parties have autonomy to regulate their relationship, there are some limitations that should be observed109, such as a reservation as to form requirements (article 12). one of the most fundamental general principles stated by the unidroit principles is freedom of contract110, according to which parties are free to enter into a contract and to determine its content111 and may exclude the application of the principles or vary their effect112. similar to the cisg, the unidroit principles also have some mandatory provisions which it expressly provides that cannot be derogated, if the parties adopt the principles in their agreement113. for instance, good faith and fair dealing, as set forth in article 1.7, cannot be excluded by the parties. http://www.cisg.law.pace.edu/cisg/wais/db/cases2/010425b1.html http://www.cisg.law.pace.edu/cisg/wais/db/cases2/001012g1.html http://cisgw3.law.pace.edu/cisg/wais/db/cases2/040225i3.html nordic journal of commercial law issue 2006 #1 114 ulrich g. schroeter, freedom of contract: comparison between provisions of the cisg (article 6) and counterpart provisions of the principles of european contract law, available at <http://www.cisg.law.pace.edu/cisg/biblio/schroeter2.html> (last visited april 14, 2005) (considering article 6 of the cisg as a provision from which the principle of freedom of contract is derived); alejandro m. garro, supra note 15, at 1165 and harry m. flechtner, supra note 59, at 176. 115 bojidara borisova, remarks on the manner in which the unidroit principles may be used to interpret or supplement article 6 of the cisg, 9 vj 153, 153 (2005). 116 see michael joachim bonell, supra note 68, at 49. 117 michael joachim bonell, supra note 68, at 245. 118 ulrich magnus, supra note 41. 16 some commentators114 have treated the above mentioned provisions of each instrument as equivalent. however, notwithstanding that both the above mentioned principles rely on the same rationale, they are not essentially the same. in fact, the principle of party autonomy is greater than the freedom of contract; party autonomy “ accommodates the fulfillment of the principle of freedom of contract” 115. 2.2. pacta sunt servanda article 1.3 of the unidroit principles “ lays down another basic principle of contract law, that of pacta sunt servanda” 116. according to article 6.2.1 of the unidroit principles, even if performance becomes more onerous for one of the parties, that party is nevertheless bound to perform its obligations. here, referring to article 1.3, professor bonell117 clarifies that “ the purpose of this article is to make it clear that as a consequence of the general principle of the binding character of the contract performance must be rendered” . ulrich magnus118 states that even though the basic rule that contracts are binding is not expressly mentioned in the cisg, it is implied in numerous provisions, such as article 30 and 53, which determine the duty to deliver and the duty to effect payment. furthermore, he points out that articles 71-73 and 79 show that the binding effect of the contract cannot be avoided in cases such as a simple change of circumstances or frustration of contract, but only if the requirements listed in these provisions are met, and he concludes that without the binding nature of the contract these provisions would not make sense. however, it is true that all those provisions (articles 30, 53, 71-73 and 79) can be derogated from by the parties under article 6 of the convention and, thus, are not binding. nevertheless, it is still possible to say that the principle of pacta sunt servanda underlies the convention. the fact that the parties can vary the effect of the provisions only confirms the argument: if the will of the parties prevail over the provisions of the cisg, logically, the will of the parties should be enforced to the maximum extent. it would not make any sense for the convention to give the parties full autonomy and then remove the binding effect of their agreement. at a first analysis, as the principle of pacta sunt servanda is derived from provisions of both instruments, no differences regarding this principle in both instruments seem evident. however, it must be noted that the unidroit principles have provisions regarding hardship (articles 6.2.1 to 6.2.3), which is an institute that limits the effects of the pacta sunt servanda principle. http://www.cisg.law.pace.edu/cisg/biblio/schroeter2.html nordic journal of commercial law issue 2006 #1 119 ole lando, salient features of the principles of european contract law: a comparison with the ucc, 13 pace int’l l. rev. 339, 367 (fall, 2001). 120 scott d. slater, supra note 60, at 254-255 (citing other authors). 121 for a contrary opinion, see, for instance, jennifer m. bund, force majeure clauses: drafting advice for the cisg practitioner, 17 j.l. & com. 381, 392 (spring, 1998). 122 alejandro m. garro, supra note 15, at 1184 (stating that force majeure comes into play when performance becomes impossible (at least temporarily), whereas a situation of hardship arises when the performance has become much more burdensome, but not impossible” . furthermore, he adds that, “ more importantly, hardship is mainly directed at the adaptation of the contract, whereas force majeure is directed at settling the problems resulting from nonperformance” ) (footnote omitted). 123 id., at 1184 (the commentator, however, argues that “ in many circumstances in which a party cannot invoke force majeure, fair and adequate redress may be found under the hardship provisions of the unidroit principles” ) 124 nuova fucinati s.p.a. v. fondmetall international a.b., tribunale civile [district court] di monza, italy, 14 january 1993, 4267/88, case report available at <http://cisg3.law.pace.edu/cases/930114i3.html> (last visited january 23, 2005). 125 marco torsello, supra note 95, at 81; franco ferrari, supra note 32, at 463, eric c. schneider, measuring damages under the cisg, 9 pace int’l l. rev. 223, 231 (summer 1997). 126 john felemegas, an interpretation of article 74 cisg by the u.s. circuit court of appeals, 15 pace int’l l. rev. 91, 97 (spring, 2003). 17 the cisg, on the contrary, does not have any specific provision about hardship119. regarding the inexistence of an express provision of hardship on the cisg and the discussion whether article 79 would extend so far as to encompass hardship, scott d. slater120 states that “ there is authority for the propos iti on t hat t he c on ce pt o f har dship is not within article 79’s definition of impediment” 121. also, alejandro garro establishes differences122 between hardship and force majeure and states that, “ if this conceptual and functional distinction is accepted, one must conclude that the cisg’s provisions on exemption of liability for nonperformance contemplate different factual situations and remedies than those envisioned by the hardship provisions incorporated into the unidroit principles” 123. particularly with regards to hardship and article 79 of the convention, in a case decided in italy124, the court held that the seller could not rely on hardship as a ground for avoidance, since cisg did not contemplate such a remedy in article 79 or elsewhere. accordingly, in spite of the fact of both instruments being under the pacta sunt servanda principle, as the cisg does not contemplate any provisions that limit the referred principle, such as hardship, it is not to be deemed equal. in other words, the same principle is actually treated differently in both instruments, with different levels of strength, due to the limitations imposed on this principle in the unidroit principles. 2.3. principle of full compensation it has been pointed out that the principle of full compensation underlies the cisg and is spelled out by article 74125. in the unidroit principles, this principle is expressly referred to in article 7.4.2. in fact, convention provides for damages for loss, including loss of profit, suffered as a consequence of a breach of contract (under article 74), but does not define in more detail which are the losses for which compensation can be obtained. therefore, in order to identify the losses for which compensation may be demanded, regard must be had to the principle of full compensation in the context of the particular contract concerned126. http://cisg3.law.pace.edu/cases/930114i3.html nordic journal of commercial law issue 2006 #1 127 for an analysis of methods that limit damages, see djakhongir saidov, methods of limiting damages under the vienna convention on contracts for the international sale of goods, 14 pace int’l l. rev. 307 (fall, 2000). 128 karin l. kizer, supra note 18, at 1295-1296. 129 “ (… ) such damages may not exceed the loss which the party in breach foresaw or ought to have foreseen at the time of conclusion of the contract, in the light of the facts and matters of which he then knew or ought to have known, as possible consequence of the breach of contract.” 130 franco ferrari, comparative ruminations on the foreseeability of damages in contract law, 53 la. l. rev. 1257, 1261 (1992-1993); franco ferrari, supra note 24, at 226 (also citing frignani and maskow). see also so. m. agri s.a.s di ardina alessandro & c. v. erzeugerorganisation marchfeldgemüse gmbh & co. kg, tribunale [district court] di padova, italy, 25 february 2004, 40552, available at <http://cisgw3.law.pace.edu/cisg/wais/db/cases2/040225i3.html> (last visited jan. 13, 2005). 131 maría del pilar perales viscasillas, the formation of contracts & the principles of european contract law, 13 pace int’l l. rev. 371, 374 (fall, 2001); franco ferrari, supra note 24, at 224; alejandro m. garro, supra note 15, at 1165 (both ferrari and garro adding article 29(1) of the cisg). 132 ulrich magnus, supra note 41. 133 for instance, so. m. agri s.a.s di ardina alessandro & c. v. erzeugerorganisation marchfeldgemüse gmbh & co. kg, t r i b u n a l e [ d i s t r i c t c o u r t ] d i p a d o v a , i t a l y , 2 5 f e b r u a r y 2 0 0 4 , 4 0 5 5 2 , a v a i l a b l e a t <http://cisgw3.law.pace.edu/cisg/wais/db/cases2/040225i3.html> (last visited jan. 13, 2005); conservas la costeña s.a. de c.v. v. lanín san luis s.a. & agroindustrial santa adela s.a., compromex [mexican commission for the protection of foreign trade], mexico, 29 april 1996, available at < http://cisgw3.law.pace.edu/cases/960429m1.html> (last visited may 2, 2005); fcf s.a. v. adriafil commerciale s.r.l., bundesgericht [supr eme cour t], switzerland, 15 september 2000, available at http://cisgw3.law.pace.edu/cases/000915s2.html (last visited may 2, 2005); sa ed v. s.p.a. lp, cour d’appel [appellate court] liège, belgium, 28 april 2003, available at < http://cisgw3.law.pace.edu/cases/030428b1.html> (last visited may 2, 2005). 134 regarding interpretation of the term writing, see, ulrich g. schroeter, interpretation of writing: comparison between provisions of c i s g ( a r t i c l e 1 3 ) a n d c o u n t e r p a r t p r o v i s i o n s o f t h e p r i n c i p l e s o f e u r o p e a n c o n t r a c t l a w , a v a i l a b l e a t <http://www.cisg.law.pace.edu/cisg/biblio/schroeter3.html> (last visited march 28, 2005). 18 this principle, however, has to be interpreted with some limitations127. for instance, a party may not receive payment for damages and be unjustly enriched128. regarding this aspect, the unidroit principles and the convention seem to be interpreted in the same way. comment number 3 to article 7.4.2 of the unidroit principles states that damages must not enrich the aggrieved party. despite the similarities, pursuant to the second part of article 74129, in the cisg this principle is to be also limited by foreseeability of the damages130. this limitation could not be verified under the unidroit principles’ provisions. in this sense, it must be noted that the principle of full compensation is not to be treated equally in contracts under the convention and under the unidroit principles. 2.4. principle of informality freedom of form is a general principle embodied in the cisg article 11 and unidroit principles article 1.2131. although there is a possibility of making a reservation to article 11 (and 29) under articles 12 and 96, ulrich magnus132 argues that lack of formality is a general principle from which one can infer that declarations of all kinds are not subject to any form requirement under the cisg. court decisions, as well, have considered the principle of informality under the cisg133. the cisg does not define form nor writing134 — the only form occasionally required — but it does contain a provision that constitutes an interpretative rule in article 13 that aids in defining http://cisgw3.law.pace.edu/cisg/wais/db/cases2/040225i3.html http://cisgw3.law.pace.edu/cisg/wais/db/cases2/040225i3.html http://cisgw3.law.pace.edu/cases/960429m1.html http://cisgw3.law.pace.edu/cases/000915s2.html http://cisgw3.law.pace.edu/cases/030428b1.html http://www.cisg.law.pace.edu/cisg/biblio/schroeter3.html nordic journal of commercial law issue 2006 #1 135 franco ferrari, writing requirements: articles 11-13, in draft uncitral digest and beyond: cases, analysis and unresolved issues in the u.n. sales convention 206, 209 (franco ferrari et al. eds., munich, sellier 2004). 136 franco ferrari, supra note 24, at 224 (referring to herber for a similar affirmation) and ulrich magnus, supra note 41 (listing prevalence of usage among the general principles of the convention); clayton p. gillette, the law merchant in modern age: institutional design and international usages under the cisg, 5 chi. j. int’l l., 157, 168 (summer, 2004); steven walt, for specific performance under the united nations sales convention, 211, 229, available at < http://www.cisg.law.pace.edu/cisg/biblio/walt.html> (last visited may 1, 2005). 137 article 9(1). 138 so. m. agri s.a.s di ardina alessandro & c. v. erzeugerorganisation marchfeldgemüse gmbh & co. kg, tribunale [district court] di padova, italy, 25 february 2004, 40552, available at <http://cisgw3.law.pace.edu/cisg/wais/db/cases2/040225i3.html> (last visited jan. 13, 2005); geneva pharmaceuticas tech. corp. v. barr labs. inc., u.s. district court for the southern district o f n e w y o r k , u n i t e d s t a t e s o f a m e r i c a , 1 0 m a y 2 0 0 2 , a v a i l a b l e a t < h t t p : / / w w w . c i s g . l a w . p a c e . e d u / c i s g / wais/db/cases2/020510u1.html#vi> (last visited may1, 2005); oberster gerichtshof, austria, 21 march 2000, available at <http://www.cisg.at/10_34499g.htm>, clout case n. 240, austria, 1998. 139 michael joachim bonell, supra note 62, at 1135. 140 michael joachim bonell, supra note 75, 31. 141 “ this convention governs only the formation of the contract of sale and the rights and obligations of the seller and the buyer arising from such a contract. in particular, except as otherwise expressly provided in this convention, it is not concerned with: the validity of the contract or of any of its provisions or of any usage; the effect which the contract may have on the property in the goods sold.” 142 see franco ferrari, trade usages and practices established between the parties: article 9, in draft uncitral digest and beyond: cases, analysis and unresolved issues in the u.n. sales convention 191, 202 (franco ferrari et al. eds., munich, sellier 2004). see also oberster gerichtshof, austria, 21 march 2000, available at <http://www.cisg.at/10_34499g.htm>, clout case 19 writing135. article 13 establishes that, “ for the purposes of the convention, writing includes telegram and telex” . at the same time, the unidroit principles provide a definition of writing in article 1.11, according to which it means “ any mode of communication that preserves a record of the information contained therein and is capable of being reproduced in tangible form” . it is clear that both instruments have different understandings regarding how the word writing should be interpreted: whereas article 13 provides a few examples which may be of limited application, article 1.11 contains a definition that can be extended to various different technologies. 2.5. openness to usages it has already been noted that the cisg expressly enunciates a principle whereby widely known and largely observed usages must be taken into account136. in addition to the possibility of choosing to incorporate usages in a contract137, according to the cisg, the parties who at least “ knew or ought to have known” the relevant usages would be bound by them, pursuant to article 9(2). also, some court decisions have mentioned this issue138. openness to usages is also an essential element of the unidroit principles139. however, michael bonell140 points out that, in accordance with article 1.8(2) of the unidroit principles, usages do not bind the parties whenever their application would be unreasonable. therefore, there is significant difference between the convention and the unidroit principles: under the cisg, there is no express requirement of reasonableness of the usages to which the contract is open. it is true that the principle of reasonableness is also a cisg principle, it does not seem that article 9(2) contains a gap that would require that gap-filling action of this principle. in other words, article 9(2) does not open the possibility of questioning usages on any grounds within the framework of the cisg; rather, if a usage is invalid or abusive, such matter is to be solved under domestic law applicable by virtue of the conflict of laws rules, as article 4(a)141 expressly provides142. http://www.cisg.law.pace.edu/cisg/biblio/walt.html http://cisgw3.law.pace.edu/cisg/wais/db/cases2/040225i3.html http://www.cisg.law.pace.edu/cisg/ http://www.cisg.at/10_34499g.htm http://www.cisg.at/10_34499g.htm nordic journal of commercial law issue 2006 #1 n. 240, austria, 1998. 143 ulrich magnus, supra note 41. 144 regarding the dispatch principle set forth in article 27, see also franco ferrari, supra note 24, at 224 (also citing audit) and franco ferrari interpretation of the convention and gap-filling: article 7, in draft uncitral digest and beyond: cases, analysis and unresolved issues in the u.n. sales convention 138, 166 (franco ferrari et al. eds., munich, sellier 2004) (stating that “ the dispatch principle set forth in article 27 appears to be the cisg’s general principle concerning communications made after the parties have concluded their contract” ). 145 michael joachim bonell, supra note 140, at 31. 146 richard hyland, on setting forth the law of contract: a foreword, 40 am. j. comp. l. 541, 548 (1992). 147 regarding policing of unfairness in the unidroit principles, see michael joachim bonell, policing the international commercial contract against unfairness under the unidroit principles, 3 tul. j. int’l & comp. l. 73 (1995). 148 michael joachim bonell, supra note 62, at 1139 (stating that “ the unidroit principles move toward a more realistic evaluation of international commercial bargains and provide a variety of means for policing the contract or its individual terms against both procedural and substantive unfairness” ). 20 in fact, according to the concepts above mentioned, the issue of openness to usages is not exactly a principle; instead, each of the instruments bring among its provisions, rules regarding how usages should be dealt with. in this sense, one could conclude that if the rules of the unidroit principles and the cisg are in one aspect contradictory, namely the exception in respect to unreasonable usages under the unidroit principles, they could not coexist in one same situation or contract. therefore, considering the difference pointed out, in this case, unidroit principles should not be used to fill gaps of the cisg. 2.6. theory of dispatch ulrich magnus143 lists theory of dispatch as one of the general principles of the cisg. article 27144 of the cisg sets forth that “ unless otherwise expressly provided in this part of the convention, if any notice, request or other communication is given or made by a party in accordance with this part and by means appropriate in the circumstances, a delay or error in the transmission of the communication or its failure to arrive does not deprive that party of the right to rely on the communication” . conversely, the unidroit principles, pursuant to article 1.10(2), “ adopt the ‘receipt’ principle for every kind of notice, including the notice a party must give in order to preserve its rights in case of the other party’s non-performance” 145. in sum, the convention places the risk of failed communication on the party in breach while the unidroit principles place the risk on the risk on the party who is to send the notice146. once again it seems that both cisg article 27 and unidroit principles article 1.10(2) are rules, not principles. therefore, the different provisions should not be used to complement each other due to their impossibility to coexist. 2.7. principle of fairness in addition to conflicting principles, there are some principles that are present in the unidroit principles and not mentioned in the cisg, such as the general principle of fairness147. in fact, this is a matter of substantial validity, dealt by the unidroit principles148. according to one of the nordic journal of commercial law issue 2006 #1 149 e. allan farnsworth, supra note 110, at 4. 150 article 3.10 151 article 2.1.20 152 michael joachim bonell, supra note 62, at 1140 (citing, respectively, articles 3.8, 3.9 and 4.6). 153 michael g. bridge, uniformity and diversity in the law of international sale, 15 pace int’l l. rev. 55, 82 (spring, 2003). 154 alejandro m. garro, supra note 15, at 1156. 155 franco ferrari, supra note 52, at 1233. 21 members of the working group that drafted the unidroit principles, professor farnsworth149, this principle can be inferred from two provisions of the principles, one regarding gross disparity150 and the other referring to surprising terms151. in addition to these provisions, bonell includes the rules on fraud and threat, as well as the contra proferentem rule, which aims to protect the adhering party in cases of use of standard terms152. 3. applicability of the unidroit principles to fill cisg gaps michael g. bridge153 asserts that a reference to the principles can be a useful guide in the search for the immanent general principles in the cisg, so long as the principles do not conflict with the provisions of the convention. moreover, he states that the principles might also be invoked to assist in the international interpretation of the cisg under article 7(1). regarding the first issue, professor garro154 has the same point of view, assuming that the parties have not chosen any other supplementing source of law, and the application of the unidroit principles is not otherwise in conflict with the mandatory rules of law, the intention of the parties and the applicable trade usages. he sustains that, “ as long as the unidroit principles provide a solution to issues that may conceivably fall under the scope of application of the cisg, they should be used to supplement all questions regarding formation, interpretation, content, performance and termination of contracts for the international sale of goods” . first of all, one cannot speak in such general terms. as the cisg has its own provision on how to fill gaps, it must be applied. this provision (article 7(2)) determines the applicability of the principles on which the convention is based, and, as a last resort, of domestic law. therefore, to fill a gap, one must look into the convention to determine the principles that underlie it. considering that it is mandatory to seek the principles on which the convention is based, external principles, such as the ones that underlie the unidroit principles, will never be applicable when they are conflicting or different to any extent. on the other hand, when they amount to the same principle, the issue is solved under article 7(2). nonetheless, in this case, when one of the provisions is more specific, containing more details, it might be necessary to interpret the rule that lacks specificity. if that is so regarding one of the principles found in the cisg, those applying the law would have to interpret the principle in accordance with article 7(1) providing that regard is to be had to the international character and to the need to promote uniformity. hence, to interpret the principle, one would seek the answer among court decisions, scholarly writings and other instruments such as the unidroit principles. as franco ferrari points out155, the “ unidroit principles may serve as instruments for the interpretation and gap-filling of international uniform law, thus providing guidelines for an nordic journal of commercial law issue 2006 #1 156 alejandro m. garro, supra note 15, at 1152. 157 sunil r. harjani, the convention on contracts for the international sale of goods in united states courts, 23 hous. j. int’l l. 49, 56 (fall, 2000). 158 franco ferrari, supra note 24, at 216 (citing gyula eörsi). 159 michael joachim bonell, supra note 75, at 36. 22 ‘autonomous’ interpretation – an interpretation based upon the uniform law’s international character” . it is a fact that “ the gap-filling role of the unidroit principles is aimed at supplying those “ international uniform law instruments” with a set of rules that the interpreter or decision-maker is unable to find, expressly or impliedly, in those instruments” 156. sunil r. harjani157, when speaking about interpretation in the cisg, says that the line between interpretation and gap-filling is not easy to draw. in fact, that is true and both are closely linked. referring to article 7(2), franco ferrari also states that its aim “ is not very different from that which the interpretation rules are pursuing, i.e. uniformity in the convention’s application” 158. however, one cannot state that the unidroit principles are able to directly supplement the cisg gaps due to the fact that, as analyzed above, there are some conflicting principles. the principles used to fill gaps pursuant to article 7(2) cannot be external and conflicting principles; instead, they should be principles underlying the text of the provisions, extracted or derived from its rules. on the other hand, considering the aim to achieve uniformity of conventions such as the cisg, one can resort to instruments such as the unidroit principles as a means of interpretation and to make an analogy at the time of decision making. also, the unidroit principles feature comments, elaborated by the drafters, that may be useful to the interpreter. finally, michael bonell also correctly considers the undroit principles as a source to fill gaps found in the cisg. he claims that “ the only condition which needs to be satisfied is to show that the relevant provisions of the unidroit principles are the expression of a general principle underlying the cisg” 159. nordic journal of commercial law issue 2006 #1 23 iv. conclusion the cisg sets forth in its article 7(2) the guidelines for gap-filling.. whenever an issue is not dealt with in the convention, this provision is not applicable. conversely, when dealing with internal gaps, it must be applied. indeed, it is only when there is such a gap that recourse should be made first to the convention’s general principles, and as a last resort, to the provisions of domestic law by means of the conflict of laws rules. the question posed was whether the unidroit principles may supplement the gaps in the convention. the conclusion here is that it is not possible. first, the analysys established that there are differences between the instruments of the convention and the unidroit principles, such as in the sphere of application, in nature and in time. these differences, however, do not lead directly to the conclusion of this paper. in other words, it is not because of these differences that the unidroit principles are not supposed to supplement the convention’s principles. in addition, the analysis demonstrates that each instrument has its own principles. both the convention and the unidroit principles contain principles on which theyare based, all that have been inferred and derived from their own provisions. some of the principles embedded in the convention are common to general principles set in the unidroit principles. others, on the contrary, are different principles, having some contradicting aspects. in this sense, the external conflicting principles of the unidroit principles should not be applied to a contract under the cisg, due to the fact that they are not “ principles in which the convention is based” . the common principles, in contrast, are already applicable to contracts under the cisg, because they are “ principles in which the convention is based” . nevertheless, it is true that the common principles may not be described in the exact same words in each instrument. there might be cases in which a provision of one of the instruments is less specific and requires interpretation. solely in this case, the unidroit principles may serve, as any other secondary authority, as a means to interpretation. in sum, the unidroit principles may be able to supplement the cisg solely in terms of interpretation, allowing an “ autonomous” interpretation of the cisg within its own principles. 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international sale of goods in united states courts, 23 hous. j. int’l l. 49 (fall, 2000). nordic journal of commercial law issue 2006 #1 26 heck, luís afonso, o modelo das regras e o modelo dos princípios na colisão de direitos fundamentais, 781 revista dos tribunais 71, 75 (november 2000). hillman, robert a., applying the united nations convention on contracts for the international sale of goods: the elusive goal of uniformity, available at <http://www.cisg.law.pace.edu/ cisg/biblio/hillman 1.html> (last visited march 6, 2005). hillman, robert a, construction of the uniform commercial code: ucc section 1-103 and “ code” methodology, 18 b.c. ind. & comm. l. rev. 655 (1977). honnold, john o., uniform law for international sales under the 1980 united nations convention 146-147 (2d ed. 1991). hyland, richard, on setting forth the law of contract: a foreword, 40 am. j. comp. l. 541 (1992). kizer, karin l., minding the gap: determining interest rates under the un convention for the international sale of goods, 65 u. chi. l. rev. 1279 (fall, 1998). koneru, phanesh, the international interpretation of the un convention on contracts for the international sale of goods: an approach based on general principles, 6 minn. j. global trade 105 (winter, 1997). lando, ole, comparative law and lawmaking, 75 tul. l. rev. 1015 (march, 2001). lando, ole, salient features of the principles of european contract law: a comparison with the ucc, 13 pace int’l l. rev. 339 (fall, 2001). lookofsky, joseph, in dubio pro conventione? some thoughts about opt-outs, computer programs and preemption under the 1980 vienna sales convention (cisg), 13 duke j. comp. & int’l l. 263 (summer, 2003). magnus, ulrich, general principles of un-sales law, available at <http://www.cisg.law.pace.edu/ cisg/biblio/magnus.html> (last visited march 6, 2005). magnus, ulrich, remarks on good faith, available at <http://www.cisg.law.pace.edu/cisg/ principles/uni7.html#um> (last visited feb. 26, 2005). magnus, ulrich, remarks on good faith: the united nations convention on contracts do the international sale of goods and the international institute for the unification of private law, principles of international commercial contracts, 10 pace int’l l. rev. 89 (summer 1998). mather, henry, choice of law for international sales issues not resolved by the cisg, 20 j. l. & com. 155 (spring, 2001). nickles, steve h., problems of sources of law relationships under the uniform commercial code, part i: the methodological problem and the civil law approach, 31 ark. l. rev. 1 (1977-1978). powers, paul j., defining the undefinable: good faith and the united nations convention on the contracts for the international sale of goods, 18 j. l. & com. 333 (spring, 1999). saidov, djakhongir, methods of limiting damages under the vienna convention on contracts for the international sale of goods, 14 pace int’l l. rev. 307 (fall, 2000). schlechtriem, peter, commentary on the un convention on the international sale of goods (cisg) 61 (geoffrey thomas trans., clarendon press 2nd ed 1998). schneider, eric c., measuring damages under the cisg, 9 pace int’l l. rev. 223 (summer 1997). schroeter, ulrich g., freedom of contract: comparison between provisions of the cisg (article 6) and counterpart provi sions of the p rinci ples o f eu ro pe an c on tract law , availabl e at <http://www.cisg.law.pace.edu/cisg/biblio/schroeter2.html> (last visited april 14, 2005). http://www.cisg.law.pace.edu/ http://www.cisg.law.pace.edu/ http://www.cisg.law.pace.edu/cisg/ http://www.cisg.law.pace.edu/cisg/biblio/schroeter2.html nordic journal of commercial law issue 2006 #1 27 schroeter, ulrich g., interpretation of writing: comparison between provisions of cisg (article 13) and counterpart provisions of the principles of european contract law, available at <http://www.cisg.law.pace.edu/cisg/biblio/schroeter3.html> (last visited march 28, 2005). slater, scott d., overcome by hardship: the inapplicability of the unidroit principles’ hardship provisions to cisg, 12 fla. j. int’l l. 231 (summer, 1998). torsello, marco, remedies for breach of contract under the 1980 convention on contracts for the international sale of goods (cisg), in quo vadis cisg? celebrating th 25th anniversary of the united nations convention on contracts for the international sale of goods 43 (franco ferrari ed, munich, sellier 2005). walt, steven, for specific performance under the united nations sales convention, 211, 229, available at < http://www.cisg.law.pace.edu/cisg/biblio/walt.html> (last visited may 1, 2005). weiss, gunther a., the enchantment of codification in the common-law world, 25 yale j. int’l l. 435 (summer, 2000). viscasillas, maría del pilar perales, el contrato de compraventa internacional de mercancias (convención de viena de 1980), (2001), available at <http://www.cisg.law.pace.edu/ cisg/biblio/perales1-07.html> (last visited feb. 26, 2005). viscasillas, maría del pilar perales, the formation of contracts & the principles of european contract law, 13 pace int’l l. rev. 371 (fall, 2001). zeller, bruno, four-corners – the methodology for interpretation and application of the un c o n v e n t i o n o n c o n t r a c t s f o r t h e i n t e r n a t i o n a l s a l e o f g o o d s , a v a i l a b l e a t <http://cisg.law.pace.edu/cisg/biblio/4corners.html> (last visited feb. 26, 2005). zeller, bruno, the un convention on contracts for the international sale of goods (cisg) – a leap forward towards unified international sales laws, 12 pace int’l l. rev. 79 (spring, 2000). ziegel, jacob s., report to the uniform law conference of canada on convention on contracts for the international sale of goods, available at <http://www.cisg.law.pace.edu/cisg/text/ziegel7.html> (last visited feb 26, 2005). 2. court decisions al palazzo s.r.l. v. bernardaud s.a., tribunale [district court] di rimini, italy, 26 november 2002, 3095, available at <http://cisgw3.law.pace.edu/cases/021126i3.html> (last visited apr. 9, 2005). b u d a p e s t a r b i t r a t i o n p r o c e e d i n g v b 9 4 1 2 4 ( 1 9 9 5 ) a v a i l a b l e a t <http://cisg3.law.pace.edu/cases/951117h1.html> (last visited april 3, 2005). bv ba g-2 v. as c.b., rechtbank van koophandel [district court] veurne, 25 april 2001, available at <http://www.cisg.law.pace.edu/cisg/wais/db/cases2/010425b1.html> (last visited april 12, 2005). conservas la costeña s.a. de c.v. v. lanín san luis s.a. & agroindustrial santa adela s.a., compromex comisión para la protección del comercio exterior de méxico [mexican commission f o r t h e p r o t e c ti on o f f o r e i g n t r a d e ] , m e x i c o , 2 9 a p r i l 1 9 9 6 , a v a i l a b l e a t < http://cisgw3.law.pace.edu/cases/960429m1.html> (last visited may 2, 2005). dulces luisi, s.a. de c.v. v. seoul international co. ltd. y seoulia confectionery co., compromex comisión para la protección del comercio exterior de méxico [mexican commission for the p r o t e c t i o n o f f o r e i g n t r a d e ] , m e x i c o , 3 0 n o v e m b e r 1 9 9 8 , a v a i l a b l e a t <http://cisgw3.law.pace.edu/cases/981130m1.html> (last visited april 3, 2005). http://www.cisg.law.pace.edu/cisg/biblio/schroeter3.html http://www.cisg.law.pace.edu/cisg/biblio/walt.html http://www.cisg.law.pace.edu/ http://cisg.law.pace.edu/cisg/biblio/4corners.html http://www.cisg.law.pace.edu/cisg/text/ziegel7.html http://cisgw3.law.pace.edu/cases/021126i3.html http://cisg3.law.pace.edu/cases/951117h1.html http://www.cisg.law.pace.edu/cisg/wais/db/cases2/010425b1.html http://cisgw3.law.pace.edu/cases/960429m1.html http://cisgw3.law.pace.edu/cases/981130m1.html nordic journal of commercial law issue 2006 #1 28 fcf s.a. v. adriafil commerciale s.r.l., bundesgericht [supreme court], switzerland, 15 september 2000, available at http://cisgw3.law.pace.edu/cases/000915s2.html (last visited may 2, 2005). filanto, s.p.a. v. chilewich intern. corp., 789 f.supp. 1229, (s.d.n.y. 1992), available at <http://cisgw3.law.pace.edu/cases/920414u1.html> (last visited apr. 12, 2005). geneva pharmaceuticas tech. corp. v. barr labs. inc., u.s. district court for the southern d i s t r i c t o f n e w y o r k , u n i t e d s t a t e s o f a m e r i c a , 1 0 m a y 2 0 0 2 , a v a i l a b l e a t <http://www.cisg.law.pace.edu/cisg/wais/db/cases2/020510u1.html#vi> (last visited may1, 2005). l a n d g e r i c h t [ d i s t r i c t c o u r t ] s t e n d a l , g e r m a n y , 1 2 o c t o b e r 2 0 0 0 , a v a i l a b l e a t <http://www.cisg.law.pace.edu/cisg/wais/db/cases2/001012g1.html> (last visited april 12, 2005). oberster gerichtshof, austria, 21 march 2000, available at <http://www.cisg.at/10_34499g.htm>, clout case n. 240, austria, 1998. rheinland versicherungen v. atlarex s.r.l, tribunale [district court] di vigevano, italy, 12 july 2000, case number 405, translation to english available at <http://cisgw3.law.pace.edu/ cases/000712i3.html> (last visited mar. 20, 2005). sa ed v. s.p.a. lp, cour d’appel [appellate court] liège, belgium, 28 april 2003, available at < http://cisgw3.law.pace.edu/cases/030428b1.html> (last visited may 2, 2005). sarl bri production "bonaventure" v. société pan african export, cour d’appel [appeal court] grenoble, f r an ce , 2 2 f e b r u a r y 1 9 9 5 , a v a i l a b l e a t < ht tp :/ /cisg w3.law.pace.edu/ cases/950222f1.html> (last visited april 3, 2005). scatolificio la perla s.n.c. di aldrigo stefano e giuliano v. martin frischdienst gmbh, tribunale [district court] di padova, italy, 31 march 2004, case number 40466, translation to english available at <http://cisg3.law.pac.edu/cisg/wais/db/cases2/04033li3.html> (last visited jan. 13, 2005) . so. m. agri s.a.s di ardina alessandro & c. v. erzeugerorganisation marchfeldgemüse gmbh & co. kg, tribunale [district court] di padova, italy, 25 february 2004, 40552, available at <http://cisgw3.law.pace.edu/cisg/wais/db/cases2/040225i3.html> (last visited jan. 13, 2005). 3. documents secretariat commentary [on article 7 of the 1978 draft], united nations conference on contracts for the international sale of goods, official records: documents of the conference and summary records of the plenary meetings and of the meetings of the main c o m m i t t e e s ( v i e n n a , 1 0 m a r c h – 1 1 a p r i l 1 9 8 0 ) 17-18, (1981), availabl e a t <http://www.cisg.law.pace.edu/cisg/text/secomm/secomm-07.html> (last visited apr. 17, 2005). http://cisgw3.law.pace.edu/cases/000915s2.html http://cisgw3.law.pace.edu/cases/920414u1.html http://www.cisg.law.pace.edu/cisg/wais/db/cases2/020510u1.html#vi http://www.cisg.law.pace.edu/cisg/wais/db/cases2/001012g1.html http://www.cisg.at/10_34499g.htm http://cisgw3.law.pace.edu/ http://cisgw3.law.pace.edu/cases/030428b1.html http://cisgw3.law.pace.edu/ http://cisg3.law.pac.edu/cisg/wais/db/cases2/04033li3.html http://cisgw3.law.pace.edu/cisg/wais/db/cases2/040225i3.html http://www.cisg.law.pace.edu/cisg/text/secomm/secomm-07.html microsoft word article3.doc harmonisation and the united nations convention on contracts for the international sale of goods by troy keily1 nordic journal of commercial law issue 2003 #1 1 troy keily is an australian lawyer. he holds a bachelor of arts & bachelor of laws (honours) degree from deakin university. this paper was completed as part of a masters degree in public & international trade law at the university of melbourne. nordic journal of commercial law, issue 2003 #1 2 1. introduction after many years of negotiation, the united nations convention on contracts for the international sale of goods (“cisg”) came into force in 1988. today, 62 states have adopted the cisg. together these countries account for over two-thirds of all world trade.2 on this basis alone, the cisg is an outstanding success in the legal harmonisation of the law governing the international sale of goods. however, the cisg has its critics and much comment has been made on the failure of the cisg to achieve its goal of promoting international trade through a body of uniform rules. the primary motivation driving the push for a harmonised law on the international sale of goods is economic: a harmonised law makes it easier and more efficient for the business person to sell and buy goods across state borders. however, the engine driving the push for harmonisation is political and cultural; and the task of creating the harmonised law belongs to the diplomat.3 a study of the cisg demonstrates that the political and cultural demands on the diplomat also act as shackles that restrain the achievement of a harmonised law. this paper will consider the cisg and discuss the constraints on treaty making as a mechanism for legal harmonisation. part one discusses the constraints faced when creating a uniform text. part two discusses the problems with the text of the cisg that result from the negotiation process. finally, part three discusses the constraints faced in maintaining the uniformity of the cisg. 2. the diplomats 2.1 the cisg and the promotion of international trade the preamble of the cisg reads like a petition. in adopting the cisg, states are attesting their commitment to the purpose of the cisg as set out in the preamble. the preamble states: ‘the states parties to this convention, bearing in mind the broad objectives in the resolution adopted by the sixth special session of the general assembly of the united nations on the establishment of a new international economic order, considering that the development of international trade on the basis of equality and mutual benefit is an important element in promoting friendly relations among states, being of the opinion that the adoption of uniform rules which govern contracts for the international sale of goods and take into account the different social, economic 2 <http://www.cisg.law.pace.edu/cisg/cisgintro.html> the pace university website dedicated to the cisg includes a map of the globe that details the countries of the world that have adopted the cisg. the wide acceptance of the cisg is immediately evident. sixty-one countries have adopted the cisg as of 1 may 2002. 3 arthur rosett, ‘unification, harmonization, restatement, codification, and reform in international commercial law’, (1992) 40 the american journal of comparative law 683, 684. nordic journal of commercial law, issue 2003 #1 3 and legal systems would contribute to the removal of legal barriers in international trade and promote the development of international trade, have decreed as follows:’4 what follows is a treaty comprising 101 articles that deal with the scope of the cisg,5 rules governing the formation of contracts for the international sale of goods,6 the rights and obligations of the buyer and seller arising from the contract7 and details of when the cisg comes into force and the reservations and declarations permitted.8 2.2 the long and winding road the cisg in its final form however has a long history that is a testament to the constraints on treaty making as mechanism for legal harmonisation. a brief examination of the history of the cisg demonstrates two important points: first, treaty making is a both a labor and time intensive process and, second, the process is unlikely to succeed unless it is inclusive of states. the twentieth century trend towards the unification of laws in multinational treaties that govern transnational commerce has its origin in the middle ages and the development of the lex mercatoria.9 however, the modern day cisg has its origins in international attempts to create a uniform law for the international sale of goods which commenced in the 1930s. the governing council of the international institute for the unification of private law (unidroit) developed the first draft of a uniform law on the sale of goods in 1935. after the interruption of the world war ii and several further drafts, two conventions were approved in 1964 at a conference at the hague. these conventions were the uniform law on the international sale of goods (“ulis”) and the uniform law on the formation of contracts for the international sale of goods (“ulf”).10 only 28 states participated in the 1964 hague conference that approved the ulis and ulf and only nine countries gave force to these treaties. the failure of these treaties to win wider acceptance is in part attributed to the dominant influence of the civil law traditions of western europe11 and to the neglect of both socialist and third world countries. the socialist and third world countries refused to enact the ulis and ulf because they considered that these conventions were modelled on the demands of the industrialised states.12 accordingly, the 4 preamble to the cisg. 5 see part i, articles 1 13 of the cisg. 6 see part ii, articles 14 – 24 of the cisg. 7 see part iii, articles 25 – 88 of the cisg. 8 see part iv, articles 89 – 101 of the cisg. for a brief overview of the structure and scope of the cisg, see john felemegas, ‘the united nations convention on contracts for the international sale of goods: article 7 and uniform interpretation’ <http://www.cisg.law.pace.edu/cisg/biblio/felemegas.html>. 9 franco ferrari, ‘uniform interpretation of the 1980 uniform sales law’ (1994) 24 the georgia journal of international and comparative law 183, 184. also published at <http://cisgw3.law.pace.edu/cisg/biblio/franco.html>. a comparison of the cisg and the lex mercatoria from the perspective of harmonising international law is also interesting as they represent different approaches to harmonisation. the cisg being harmonisation by multi-national treaty developed by nation states and administered by the courts (and arbitrators) whereas the lex mercatoria was based on mercantile customs, was administered by merchants and had an informal procedure. 10 ibid, 189. 11 philip hackney, ‘is the united nations convention on the international sale of goods achieving uniformity?’ (2001) 61 louisiana law review 473. 12 ferrari, above n 8, 190. nordic journal of commercial law, issue 2003 #1 4 lesson learned from the failure of the hague conventions to gain wide acceptance was that the successful harmonisation of laws governing the international sale of goods requires broad based participation in the drafting process. in 1966, following the failure of the hague conventions the united nations established the united nations commission on international trade law (uncitral) and gave it the task of promoting the harmonisation of international trade law. after 10 years of negotiation and drafting, uncitral produced the 1978 uncitral draft convention. in 1980, 62 countries participated in a diplomatic conference in vienna, reviewed the 1978 draft convention and, after some amendments, unanimously approved the cisg.13 after two failed treaties and the better part of half a century, the cisg finally came into force in 1988 and today 61 countries have adopted it.14 the factor that distinguished the cisg in its success from the two hague conventions was the widespread participation by representatives of states from all parts of the globe in its drafting.15 2.3 clash and compromise as an exercise in harmonisation, the cisg demonstrates the predicament that faced its authors in creating an international uniform law and the mechanisms used to overcome these hurdles. gyula eörsi, a delegate representing hungary at the cisg drafting conventions and a leading author on the cisg, explains the predicament in an satirical play script titled ‘unifying the law (a play in one act, with a song)’, which commences as follows.16 ‘chairman/bang!/the discussion is open on art. 1. the distinguished delegate from knowhowland has asked for the floor. the delegate from knowhowland: thank you mr. chairman. my delegation proposes that art. 1 should read as follows: “the dog shall bark.” thank you mr. chairman. the delegate from oraculum: with greatest respect mr. chairman, this proposition runs against all experience. my delegation proposes the following wording: “the cat shall mewl.” thank you. the delegate from knowhowland: my delegation is terribly sorry to disagree with my friend from oraculum, mr. chairman, but i have to remind you that my proposal stating that “the dog shall bark” is backed by a 700 year old, uninterrupted line of court decisions in my country. thank you mr. chairman. 13 felemegas, above n 7. 14 a common problem with the harmonisation of law by treaty making is the long period of time it takes to encourage states to ratify the treaty. albert kritzer explains that ‘[r]atification of conventions on international commercial law normally proceeds at a glacial pace. however, cisg ratification quadrupled in the few short years since it came into effect’: see albert kritzer, ‘the convention on contracts for the international sale of goods: scope, interpretation and resources’ (1995) cornell review of the convention on contracts for the international sale of goods 147. also published at <http://cisg.law.pace.edu/cisg/biblio/kritzer.html>. 15 felemegas, above n 7. ‘at the 1965 hague conference, which finalized ulis and ulf, 28 countries took part: 22 european or other developed western countries, 3 socialist, and 3 developed countries. at the 1980 vienna conference which adopted the cisg, 62 states took part: 22 european and other developed western states, 11 socialist, 11 south-american, 7 african and 11 asian countries; in other words, roughly speaking, 22 western, 11 socialist and 29 “third world” countries.’: gyula eörsi, ‘a propos for the 1980 vienna convention on contracts for the international sale of goods’ (1983) 31 the american journal of comparative law 333, 335. 16 gyula eörsi, ‘unifying the law (a play in one act, with a song)’ (1977) 25 the american journal of comparative law 658. nordic journal of commercial law, issue 2003 #1 5 the delegate from oraculum: without underestimating, mr. chairman, the erudition, frugality and creative force of the courts and the importance of judge-made law, may i call your attention to the fact that the proposal tabled by the delegation of the republic of oraculum stating “the cat shall mewl” is warranted not only by our civil code but also by our greatest brains in legal thinking from the early 18th century up to the present days and is sociologically correct. thank you mr. chairman.’ the call for the harmonisation of laws on the international sale of goods assumes that there are differences in the domestic legal techniques of states. amongst the states represented at the diplomatic convention that authored the cisg, the differences in legal technique were most evident in conflicts between common law and civil law systems. there were also considerable differences between the socialist and western legal systems and between developed and developing countries.17 the following examples illustrate these differences in legal concepts. • in common law systems, contracts require consideration to be enforceable. however, consideration is not a concept recognised by civil law countries.18 • common law and civil law systems have different rules that state when an acceptance to an offer is effective.19 under the civil law receipt theory, if a party posts his or her acceptance to an offer but the acceptance is lost or delayed in transmission, the risk of the loss or delay falls on the person accepting the offer. that is, acceptance does not become effective until it is received by the offeror. under the common law, however, acceptance is effective on its dispatch.20 • civil law systems are sympathetic to the issue of specific performance, whereas common law courts place strict restrictions on the circumstances in which it will be allowed.21 • socialist systems generally require a contract to be in writing whereas western systems do not.22 • western legal systems allow a contract to come into being if the price or the way of fixing the price are absent from the contract. however, socialist legal systems do not allow a contract to come into being in this situation.23 the business person who is familiar with the law that governs international trade and international contracts has a clear commercial advantage over the business person who is not familiar with the law. accordingly, each state representative at the conferences that debated and developed the cisg had an economic interest in promoting a harmonised law that most 17 eörsi, above n 14, 346-352 (for a discussion on the conflict between developed and developing countries see eörsi, above n 14, 349-352); sara zwart, ‘the new international law of sales: a marriage between socialist, third world, common, and civil law principles’ (1988) 13 north carolina journal of international law and commercial regulation 109-128, also published at <http://cisgw3.law.pace.edu/cisg/biblio/zwart.html>. 18 the cisg adopts the civil law approach and makes no mention of the doctrine of consideration. 19 the cisg generally adopts the civil law approach although not exclusively. the cisg compromise is discussed further in part two. 20 eorsi, above n 14, 311. 21 the cisg compromise is discussed further in part two. 22 the cisg compromise is discussed further in part two. 23 eorsi, above n 14, 341-342. nordic journal of commercial law, issue 2003 #1 6 reflected their domestic legal system. underlying this selfish motivation is the natural tendency “to assume that what is familiar is probably better than what is new and strange”.24 the examples listed above demonstrate the fundamental differences in legal technique between the different states. the existence of these differences, coupled with the interest of each state to promote its own legal techniques and their ‘know-how’ advantages, meant reaching a consensus was extremely difficult. the drafting of the cisg involved reaching compromises on important legal concepts rather than the ‘best’ legal concepts. arthur rosett describes the process of reaching consensus as follows. ‘the delegates of sixty-two participating nations did not reach consensus by a magical process. the majority, representing nations that follow the civil-law tradition, did not suddenly realize the virtues of the common-law approach to contract and commercial transactions. nor did the representatives of states with planned socialist economies suddenly recognise the virtues of free enterprise and the private allocation of risks by contract. and the many representatives of poorer and underdeveloped nations did not come to a new appreciation of the plight of the wealthy creditors of the world. after thirty years of hard technical negotiation by experts, worldwide agreement was by diplomatic compromise.’25 returning for a moment to the perplexing question of barking dogs or mewling cats, eörsi also offers a compromise in the spirit of harmonisation. ‘the delegate from balcony: …but with your permission sir, i have a tentative proposal which i put forward in the spirit of compromise. we could say “an animal shall make a noise.” this would cover both proposals and would also satisfy our business circles. thank you mr. chairman. the delegate from transcendentia: this proposal, mr chairman, has a certain appeal to my delegation. may i remark, however, that not all kinds of animals are capable of making a noise. i have particularly fish in mind, sir. the delegate from balcony: well sir, this depends on how the words “shall make a noise” are construed.’26 2.4 methodology of compromise professor john honnold served as chief of the united nations international trade law branch and secretary of uncitral during the drafting of the cisg. professor honnold argues that the methods employed by the authors of the cisg to overcome the conceptual barriers of their own legal background to reach a common and acceptable solution made reaching a consensus decision easier.27 24 eorsi, above n 14, 311. 25 arthur rosett, ‘critical reflections on the united nations convention on contracts for the international sale of goods’ (1984) 45 ohio state law journal 265-305 <http://www.cisg.law.pace.edu/cisg/biblio/rossett.html>. 26 eorsi, above n 15, 659. 27 amy kastely, ‘the right to require performance in international sales: towards an international interpretation of the vienna convention’ (1988) 63 washington law review 607, also published at <http://www.cisg.law.pace.edu/cisg/biblio/kastely1.html>. nordic journal of commercial law, issue 2003 #1 7 rather than commencing with proposed legislative drafts, professor honnold explains that the delegates used the common-law case method whereby delegates focused on hypothetical situations and sought consensus on the desired outcome. the delegates focused on results and not legislative words. professor honnold argues that this method was more conducive to compromise and overcame some of the constraints on treaty making as a mechanism for legal harmonisation. ‘what came next was, for me, even more significant: the relative ease with which delegates, from different backgrounds, reached agreement on results. some will say this shows that there is a universal natural law – others, that there are basic principles of commercial and legal efficiency, just as survival in the sea (beyond the reef) … molded the dolphin and the shark into almost identical lines although they entered the sea from wildly different backgrounds. to return to dry land: after agreement was reached on what results should flow from a series of factual cases, it was not too difficult to agree on words to express the result.’28 article 67 of the cisg is an example of this ‘results-orientated’ process. article 67 provides: ‘(1) … the risk passes to the buyer when the goods are handed over to the first carrier for transmission to the buyer in accordance with the contract of sale. … (2) nevertheless, the risk does not pass to the buyer until the goods are clearly identified to the contract, whether by markings on the goods, by shipping documents, by notices given to the buyer or otherwise.’ the purpose of article 67 is to describe when risk passes to the buyer. in doing so the drafters have used words to describe a specific event typical of international transactions, being the handing over of goods from the seller to a carrier for transmission to the buyer. having agreed on the desired outcome, words to describe that result were not difficult to find. article 67 is also important because of the language that it does not use. the issue in article 67 is the point in time when risk passes. in common law systems, this issue would normally be coupled with concepts such as ‘delivery’, ‘property’ and ‘title’ to explain the law. these words and concepts have deliberately been excluded from article 67 because they are words and concepts sourced from one legal system and have specific legal nuances associated with them.29 however, the drafters could not avoid using language sourced from one legal system completely. some language and concepts found in the cisg are familiar to domestic legal concepts of some states. part two below will discuss the issues that arise from this practice and the consequences for the harmonisation process. 28 professor honnold quoted in kastely, above n 26, 608. eörsi also speaks of the tradition that developed in uncitral of a ‘readiness for compromise’, in eorsi, above n 15, 323. 29 felemegas, above n 7. nordic journal of commercial law, issue 2003 #1 8 3. cisg & the uneasy compromise 3.1 a compromise on harmony as demonstrated with the compromise proposed by the delegate from balcony in eörsi’s play, the politically expedient compromise is not without its own problems. the same is certainly true with the cisg and the concessions made to appease the competing demands of the state representatives. that is to say, the formation and adoption of a multinational treaty such as the cisg is a political process and by necessity this process requires compromise. these compromises however often create additional complications, as argued by arthur rosett. ‘the difficulty with many of these apparent compromises is that they simply do not resolve the problem they purport to address. they do not reflect two parties having yielded part of their positions to each other for the sake of agreement, but rather two sides agreeing to give the appearance by verbal formula which does not provide meaningful guidance in concrete situations.’30 part ii of this paper will discuss some examples of the ‘uneasy compromises’ found within the text of the cisg that are symptomatic of the multinational treaty negotiation process. these compromises take on further significance in the context of the purpose of the cisg, being the promotion of international trade through the creation of uniform law. this purpose is emphasised in article 731 of the cisg, which dictates that regard must be had to the need to promote uniformity in the application of the cisg.32 uniform application is fundamental for the successful harmonisation of laws by international treaty. accordingly, to the extent that compromises within the text of the cisg derogate from its uniform application, they also detract from the success of the cisg as an exercise in harmonisation. 3.2 scope of the cisg the first question asked by both business and legal practitioners when considering the cisg is when does it apply? accordingly, a clear definition of the jurisdictional scope of the cisg is crucial to both its understanding and success. however, the ambiguity of the jurisdictional scope of the cisg has received much criticism.33 30 rosett, above n 24, 282. 31 article 7 is discussed in greater detail in part iii of this paper. 32 susanne cook suggests that the cisg ‘uses urgent language when it refers to uniformity. there is a “need” for uniformity which is thereby elevated to a critical, obligatory consideration – one that every court dealing with the provisions of the convention has to entertain and which, in the convention’s spirit, cannot be discounted.’: susanne cook, ‘the need for uniform interpretation of the 1980 united nations convention on contracts for the international sale of goods’ (1988) 50 the university of pittsburgh law review 197, 212, also published at <http://cisgw3.law.pace.edu/cisg/biblio/1cook.html>. 33 see rosett, above n 24.; arthur rosett, ‘unification, harmonization, restatement, codification, and reform in international commercial law’, (1992) 40 the american journal of comparative law 683; trevor cox, ‘chaos versus uniformity: the divergent views of software in the international community’, (2000) 4 the vindobona journal of international commercial law and arbitration 3, also published at <http://www.cisg.law.pace.edu/cisg/biblio/cox.html>; frank diedrich, ‘maintaining uniformity in international uniform law via autonomous interpretation: software contracts and the cisg’ (1996) 8 pace international law review 303, also published at <http://www.cisg.law.pace.edu/cisg/biblio/diedrich.html>; camilla baach andersen, ‘uniformity in the cisg in the first decade of its application’ <http://www.ccls.edu/eclu/events/schmitthoff/symposium_draft_1-3.html>; hannu honka, ‘harmonization of contract law through international trade: a nordic perspective’(1996) 11 the tulane european and civil law forum 111; james bailey, ‘facing the truth: seeing the convention on contracts for the international sale of goods as an obstacle to a uniform law of international sales’ (1999) 32 cornell international law journal 273. nordic journal of commercial law, issue 2003 #1 9 as early as the 1960s uncitral recognised the failure of the ulis to adequately define its jurisdiction and the imperative that this issue be rectified in the cisg. many options were considered, however the solution in article 1 of the cisg is said to be even ‘inferior to the imperfect solution of ulis’.34 article 1(1) of the cisg states that: ‘this convention applies to contracts of sale of goods between parties whose places of business are in different states: (a) when the states are contracting states; or (b) when the rules of private international law lead to the application of the law of a contracting state.’ the first observation to be made of article 1 is the omission of the word ‘international’. significantly, this word is only found in the title of the cisg but is otherwise absent from the text of the treaty. rather than determining the application of the cisg by the movement of goods across state borders, the authors of the cisg chose to apply the criterion of ‘place of business’. the drafters of the cisg were unable to agree on an adequate definition of an ‘international transaction’.35 arthur rosett argues this was due to the fact that international trade is increasingly integrated and does not in practice exist as a distinct category of trade. the fear preventing the drafters from adopting the concept of international transaction to define the scope of the cisg was the concern that the jurisdictional net of the cisg would be spread wider than intended.36 a compromise was reached and the scope of the cisg was defined instead by reference to the parties’ ‘place of business’. but this concept also has problems that may give rise to uncertainty and dissonance. for example, article 10 outlines how a party’s place of business is to be determined. james bailey argues that, as a result of the rules in article 10, ‘the cisg can apply to transactions which are ostensibly domestic sales.’37 a further problem with the scope of the cisg is the definition of ‘goods’. the cisg does not define goods. the uniform application of the cisg is therefore subject to courts and tribunals around the world applying a consistent definition of goods.38 this challenge is best illustrated with the example of software.39 legal systems around the world treat software differently.40 34 rosett, above n 24, 274. 35 ibid, 274-277. rosett demonstrates the difficult of defining an international transaction with the following example. ‘clearly, if parties enter into a contract that calls upon the seller to ship and deliver goods to the buyer’s nation before payment is due, the contract is international. however, such transaction are not very common. more frequently, the parties will make a c.i.f. contract that contemplates the packing, shipment, and insurance of goods from one country to another. this is an international contract, even though the definition of a c.i.f. contract provides that title passes and risk of loss shifts from the seller to the buyer before the goods leave the seller’s country.’ 36 ibid. 37 bailey, above n 32, 301. bailey offers the following example, ‘if a paris-based branch office of a new york corporation buys a product from a party located in indiana for delivery to a montana address, that transaction may well be governed by the cisg because the parties to the transaction are located in separate cisg nations. deciding whether the cisg applies in that situation will hinge on a court’s application of article 10. conversely, a court could decide that the cisg does not apply if the paris office ordered delivery to its new york headquarters. in that instance the court could conclude that new york is the location of the buyer because the new york office has the closest relationship “to the contract and its performance.”’ 38 ibid, 303. 39 see cox, above n 32, 3; diedrich, above n 32, 303. nordic journal of commercial law, issue 2003 #1 10 some, such as the united kingdom,41 treat software not as a good but as a supply of a service. others, such as germany, treat software as a good. if countries categorise software differently, there is a danger that an international contract for the sale of software will be treated by some courts as governed by the cisg and others as outside the scope of the cisg. accepting the statement that a ‘clear, unambiguous, and simple definition of the convention’s jurisdictional scope is critical to the success of the whole enterprise’,42 the ambiguities discussed above do not bode well for a uniform application of the cisg. 3.3 specific performance as discussed above, civil law legal systems emphasise the non-breaching party’s right to compel performance of the breaching party’s obligations under contract. common law systems however prefer to award damages to the non-breaching party as opposed to compelling performance by the breaching party.43 the drafters of the cisg were unable to find a compromise solution to this specific performance conflict that promotes uniformtiy. instead, the compromise that found itself in the text of the cisg is described as an overt recognition of the failure to overcome obstacles to the unification of law.44 articles 46 and 62 are concessions to the civil law preference for specific performance. article 46(1) states that: ‘the buyer may require performance by the seller of his obligations unless the buyer has resorted to a remedy which is inconsistent with this requirement.’ conversely, this time setting out the seller’s rights, article 62 states that: ‘the seller may require to pay the price, take delivery or perform his other obligations, unless the seller has resorted to a remedy which is inconsistent with this requirement.’ article 28 however, described as the ‘enclave built into the realm of unified law’,45 states that: ‘if, in accordance with the provisions of this convention, one party is entitled to require performance of any obligation of the other party, a court is not bound to enter a judgement for specific performance unless the court would do so under its own law in respect of similar contracts of sale not governed by this convention.’ articles 42 and 62 state that specific performance is available under the cisg as a remedy. article 28 contradicts this position and declares that states that do not recognise specific performance do not have to award it. the compromise on specific performance impairs the unification of law because ‘bluntly speaking, everybody may apply his own law.’46 40 the issue would appear to also depend on the form of the software with courts making the distinction between software on a disk and software that is delivered electronically. 41 note, the united kingdom is not a signatory to the cisg. whilst the countries that are signatories to the cisg account for over two thirds of world trade the absence of the united kingdom and other important trading nations is a continuing challenge to the harmonisation of international sale of goods law. 42 rosett, above n 24, 273. 43 kastely, above n 26, 609–611. 44 eorsi, above n 14, 346. 45 ibid. 46 ibid, 354. nordic journal of commercial law, issue 2003 #1 11 3.4 good faith one of the most fiercely contested issues during the drafting of the cisg concerned the role of good faith.47 article 7(1) of the cisg states: ‘in the interpretation of this convention, regard is to be had to its international character and to the need to promote uniformity in its application and the observance of good faith in international trade.’ this incarnation of good faith in article 7 has been described variously as a ‘hard won compromise’,48 a ‘statesman like compromise’,49 a ‘strange compromise’50 and an ‘inconvenient compromise’.51 ‘statesman like’ and ‘hard won’ because the divide between common law and civil law delegates on the issue was so great, and ‘strange’ and ‘inconvenient’ because of the uncertainty of the final result. while the approach to good faith in common law countries is not homogenous, there was a consensus amongst common law countries in their opposition to any reference to good faith being included in the cisg. civil law countries, on the other hand, argued for the inclusion in the cisg of a principle of good faith directed at governing the conduct of contractual parties. failing this, it was suggested by the civil law countries that good faith should apply to the interpretation of the contract. with neither faction willing to surrender its position absolutely, a compromise was reached and good faith was ‘shifted to the provisions on interpretation of the convention, thus… giving it an honorable burial.’52 if the wealth of commentary on the meaning and effect of good faith in article 7 is any guide, the uncertainty surrounding this statesman like compromise is set to continue. 3.5 revocation the process of forming a legally binding agreement differs greatly amongst legal systems. one source of difference concerns the stage in a transaction in which the parties are free to withdraw. at one extreme is the view that parties are free to terminate negotiations up to the point when the contract is concluded. at the opposite end of the spectrum is the view that after entering negotiations it would be an act of bad faith to revoke an offer until the other side has had a chance to respond.53 article 16 of the cisg seeks to settle this issue by detailing when an offer can be revoked. article 16 states: 47 the author also discusses this issue in troy keily, ‘good faith & the vienna convention on contracts for the international sale of goods’ (1999) 3 the vindobona journal of international commercial law and arbitration 15-40, also available at <http://cisgw3.law.pace.edu/cisg/biblio/keily.html>. 48 n povrzenic, ‘interpretation and gap-filling under the united nations convention on contracts for the international sale of goods’ <http://www.cisg.law.pace.edu/cisg/biblio/povrzenic.html>. 49 e. a. farnsworth, ‘the eason-weinmann colloquium on international and comparative law: duties of good faith and fair dealing under the unidroit principles, relevant international conventions, and national laws’ 3 tulane journal of international and comparative law 47, 55. 50 eorsi, above n 14, 349. 51 a kritzer, international contract manual: guides to practical applications, kluwer, 70. 52 gyula eörsi in kritzer, above n 50. 53 rosett, above n 24. nordic journal of commercial law, issue 2003 #1 12 ‘(1) until a contract is concluded an offer may be revoked if the revocation reaches the offeree before he has dispatched an acceptance. (2) however, an offer cannot be revoked: (a) if it indicates, whether by stating a fixed time for acceptance or otherwise, that it is irrevocable; or (b) if it was reasonable for the offeree to rely on the offer as being irrevocable and the offeree has acted in reliance on the offer.’ the choice of language used in article 16 is interesting because it shows a compromise to appease both the civil law and common law positions by stating the same rule but in language sourced and familiar to each system. as eörsi explains, article 16(2)(a) uses language familiar to civil lawyers and article 16(2)(b) uses language familiar to common law lawyers, ‘[b]ut they both say the same thing’.54 thus the compromise is ‘illusory’.55 3.6 reservations it is technically incorrect to speak of a single cisg text,56 as the cisg allows states to make specified reservations to its text. this mechanism was included to make the cisg more attractive to a wider range of states. the consequence, however, is that states can tinker with the text and create their own version of the cisg a concept that does not sit will with the objective of uniformity. article 98 allows states wishing to become parties to the cisg to make reservations authorised by the cisg. the cisg authorises the following reservations: 57 • article 92 authorises the exclusion of part ii (concerning formation of the contract) and part iii (concerning obligations of the buyer and seller and remedies for breach). for example, the scandinavian states have declared that they will not be bound by part ii of the cisg. • article 93 permits a state in which two or more territorial units apply different systems of law to declare that the cisg does not extend to all of its territorial units. australia, for example, has declared that the cisg does not apply to the territories of christmas island, the cocos (keeling) islands and the ashmore and cartier islands. • article 94 allows a state that has an existing agreement regarding matters governed by the cisg to declare that the cisg does not apply to parties that have their place of business in that state. the scandinavian states have again exercised their right under article 94 to exclude inter-scandinavian trade from the cisg as a treaty already exists between these countries. 54 eorsi, above n 14, 355-356. 55 ibid. 56 also note, there are six official language texts of the cisg, being arabic, chinese, english, french, russian and spanish. this poses a further challenge to uniformity because of the difficulty task of translating in each language texts that corresponds with each other. this task is made more difficult because words used in one language will often be connected with implications that are not easily transcribed with a translation. for a discussion on this issue see felemegas, above n 7. 57 see <http://www.cisg.law.pace.edu/cisg/countries/cntries.html>. nordic journal of commercial law, issue 2003 #1 13 • article 95 states that article 1(1)(b), dealing with conflict rules when determining the jurisdiction of the cisg, may be excluded. china, singapore and the united states of america have each declared that they would not be bound by article 1(1)(b). • article 96 allows a state whose law requires contracts to be in or evidenced by writing to exclude any provision of article 11, article 29 or part ii (which provides that a contract need not be in writing under the cisg). countries including argentina, chile, russia and china have made declarations under article 96. the following example demonstrates the challenge to uniformity that arises from the inclusion in the cisg of the ability of states to make reservations. imagine a contract for the sale of goods between two parties whose places of business are respectively australia and china. does the cisg apply? both states are signatories to the cisg but what if the australian party has its place of business on christmas island? further, what is the consequence of the contract not being in writing? the cisg provides that a written contract is not required, but the chinese reservation under article 96 throws this issue into uncertain waters. the australia/china hypothetical explains how the cisg reservation procedure complicates the harmonisation process. without the reservations, parties to a transaction between australia and china need be aware of only one law, the cisg. however, as a result of the reservations, parties need be aware of three layers of law,58 being the standard cisg provisions, the reservations that australia and china have made to the cisg, and the law of china regarding the sufficiency of writing in contract formation. business supports the harmonisation of laws because harmony brings certainty. the australian business person is happy to sell goods to china because the uncertainty of submitting to a different legal system is ameliorated by the acceptance of the cisg by both countries. however, the reservations of both australia and china detract from this certainty and are detrimental to uniformity. 3.7 comment the successful harmonisation of law by international treaty requires compromise. as demonstrated by the examples in part two, these compromises at times do not best serve the purpose of uniformity. however, while these examples are a compromise on uniformity, they allow the drafting process to continue to completion, as explained in the following statement. ‘even compromises that are seemingly against unification in fact favor it by making it possible for the conference to continue its work to completion, figuratively saving the bulk of the cargo by throwing only a small part of it overboard.’59 58 bailey, above n 32, 312-313. 59 eorsi, above n 14, 346. nordic journal of commercial law, issue 2003 #1 14 4 maintaining uniformity 4.1 the battle front60 having agreed on a final text for the international sale of goods, the next challenge for harmonisation, and the ultimate success or failure of the cisg, is the uniform application of the cisg. part three of this paper will discuss the constraints countenanced in maintaining the uniformity of the text and the mechanism employed by the cisg to overcome these hurdles. before proceeding. it is necessary to comment on the concepts of ‘harmonisation’ and ‘unification’ as they relate to the cisg. 4.2 harmonisation and unification harmonisation and unification are related concepts. they differ in the degree to which each tolerates variation. to harmonise is to bring together and make similar; to unify, however, is to make the same. unification does not tolerate variation. unification of the law therefore requires the law of states to be made the same. harmonisation of law is also understood as a process. therefore, unification of law is an exercise in harmonisation where ‘unification’ is the standard or benchmark. article 7 of the cisg outlines the need to promote uniformity in the application of the cisg. importantly, the cisg does not speak of the need to promote harmony in its application. this distinction is important because, as the purpose of the cisg is the unification of international sale of goods law, there can be no variation in the way it is interpreted and applied by courts around the world. the cisg does not permit room for error. this point is also important because, by expressing the cisg’s purpose as the promotion of uniformity, the bar for determining its success or failure has been set higher. the absence of variation in the unification of law is subject to one caveat suggested by professor sundberg. the professor suggests that a margin of imperfection is permissible in the unification of law, but only to the extent that the variance does not encourage forum shopping.61 this proposition is best explained using the issue discussed above regarding software and the definition of ‘goods’ under the cisg. if a court in france determines that software is not a good, an international contract for the sale of software will not be governed by the cisg. however, if a court in canada decides that software is a good, the cisg will apply to the contract. adopting professor sundberg’s view, camilla andersen argues that: ‘… any legal counsel representing a party who has breached an agreement in some way would be well advised to encourage his client to hurriedly forum-shop to a venue where software is not considered goods, to avoid the provisions of the pro-contractual cisg for breach.’62 60 john felemegas argues that ‘[t]he area where the battle for international unification will be fought and won, or lost, is the interpretation of the cisg’s provisions. only if the cisg is interpreted in a consistent manner in all legal systems that have adopted it, will the effort put into its drafting be worth anything.’: see felemegas, above n 7. 61 professor sundberg quoted in baach, above n 32. 62 ibid. nordic journal of commercial law, issue 2003 #1 15 therefore, the variation between the way states define software would be an unacceptable variation because the different approaches would encourage forum shopping to avoid the application of the cisg. 4.3 article 7 article 7 of the cisg is ‘arguably the single most important provision in ensuring the future success’63 of the cisg. article 7 details the objectives of the cisg and how to give effect to these objectives. the battle for unification depends on the effectiveness of article 7.64 article 7 defines the protocol to be followed when interpreting the cisg. it directs those interpreting the cisg to take the following steps. first, regard must be had to the cisg’s ‘international character and the need to promote uniformity in its application and the observance of good faith in international trade’. second, questions not expressly settled by the cisg are to be determined ‘in conformity with the general principles on which it is based’. third, in the absence of those general principles, questions are to be settled ‘in conformity with the law applicable by virtue of the rules of private international law.’ steps two and three establish the mechanism to fill gaps in the cisg. this paper will focus on step one. 4.4 international character & uniformity lawyers must not read the cisg as they would a piece of legislation in their home state. to have regard to the international character of the cisg requires all lawyers to put aside the interpretative baggage with which they are familiar. the cisg calls for a new interpretative method that stems from the requirement in article 7 of the cisg to have regard to its international character and the need to promote uniformity. to have regard to the international character of the cisg involves recognition that it is a multinational treaty that has been incorporated into the domestic law of different legal systems. practically speaking, the requirement to have regard to the international character of the cisg is a call for vigilance against two traps the use of domestic techniques of legislative interpretation and reliance on the ‘homeward trend’ when interpreting the meaning of the cisg. each of these traps for harmonisation will be discussed below. 4.5 international interpretation when interpreting the cisg. it is important to avoid the techniques of legislative interpretation that would otherwise apply to domestic legislation. the cisg is not a normal piece of domestic legislation but is an international treaty. the cisg ‘should be seen as part of international law in the broad sense and should be entitled to an international, rather than national, interpretation.’65 therefore, as opposed to the common law tendency to interpret 63 phanesh koneru, ‘the international interpretation of the un convention on contracts for the international sale of goods: an approach based on general principles’ (1997) 6 minnesota journal of global trade 105, also available at http://cisgw3.law.pace.edu/cisg/biblio/koneru.html>. 64 the full text of article 7 states: ‘(1) in the interpretation of this convention, regard is to be had to its international character and to the need to promote uniformity in its application and the observance of good faith in international trade. (2) questions concerning matters governed by this convention which are not expressly settled in it are to be settled in conformity with the general principles on which it is based or, in the absence of such principles, in conformity with the law applicable by virtue of the rules of private international law.’ 65 felemegas, above n 7. nordic journal of commercial law, issue 2003 #1 16 domestic legislation narrowly, for example, the cisg should be given a broad interpretation. professor bonell explains the appropriate interpretative technique as follows. ‘instead of sticking to its literal and grammatical meaning, courts are expected to take a much more liberal and flexible attitude and to look, wherever appropriate, to the underlying purposes and policies of individual provisions as well as of the convention as a whole.’66 this international interpretation approach involves a rejection of the view that, in domestic proceedings, treaties ‘transform themselves into domestic law and therefore their interpretation and integration must take place according to the interpretative techniques … of the domestic systems in which they are transplanted and will be applied’. this view cannot be reconciled with the requirement in article 7 to pay regard to the international character of the cisg and the need to promote uniformity. 4.6 homeward trend when searching for the meaning of terms used in the cisg, the international character of the cisg demands that care be taken to avoid the ‘homeward trend’ of interpreting terms in the cisg in accordance with domestic understandings. the cisg directs that answers be found within the four corners of the cisg. the homeward trend is the ethnocentric propensity to interpret an international convention such as the cisg in accordance with domestic principles and concepts. that is, the ‘temptation for judges and the parties settling disputes … to look at what is familiar especially as it appears to be so at first glance.’67 parts of the cisg are familiar to concepts used in legal systems around the world. however, it is an error to refer to these domestic concepts when interpreting the cisg. to promote uniformity and give effect to the cisg’s international character, the cisg must be interpreted as an autonomous legal instrument. this approach was exemplified in the recent decision of the united states district court in zapata hermanos sucesores v. hearthside baking co.68 this case involved a contract for the sale of goods under the cisg. the court held that the award of damages to the seller for a breach of contract included counsel’s fees as foreseeable consequential damages under article 74 of the cisg. 69 importantly, in reaching its decision, the court rejected the buyer’s argument that in an american court the ‘american rule’, that requires litigants in federal court actions to bear 66 ibid. 67 bruno zeller, ‘the un convention on contracts for the international sale of goods (cisg) – a leap forward towards unified international sales laws’ (2000) 12 pace international law review 79, 88, also published at <http://cisgw3.law.pace.edu/cisg/biblio/zeller3.html>. 68 u.s. district court, 28 august 2001, available at <cisgw3.law.pace.edu/case/010828.html> also see john felemegas, ‘the award of counsel’s fees under article 74 cisg, in zapata hermanos sucesores v. hearthside baking co. (2001) 6 the vindobona journal of international commercial law and arbitration 30-38, also available at <http://cisgw3.law.pace.edu/biblio/felemegas1.html>. after this paper was completed, the decision of the district court was reversed by the federal appellate court, see <http://cisgw3.law.pace.edu/cases/02119u1.html>. further, at the date of publication of this paper the decision of the federal appellate court was the subject of an application for leave to appeal to the supreme court of the united states of america, for further information see links at <http://cisg.law.pace.edu/cisg/text/e-text74.html>. 69 article 74 provides that ‘[d]amages for breach of contract by one party consist of a sum equal to the loss, including loss of profit, suffered by the other party as a consequence of the breach. such damages may not exceed the loss which the party in breach foresaw or ought to have foreseen at the time of the conclusion of the contract, in the light of the facts and matters of which he then knew or ought to have known, as a possible consequence of the breach of contract.’ nordic journal of commercial law, issue 2003 #1 17 their own legal expenses, applies. the court recognised the importance of the international character of the cisg and the need to promote uniformity70 and in so doing rejected the application of the american rule. the court did not succumb to the homeward trend to explain the meaning of article 74. the court in zapata noted that the principle of foreseeability is the limitation on damages under article 74. this principle was also recognised by a different united states court in delchi carrier s.p.a. v. roterex corp.71 however, in this case the court succumbed to the homeward trend to reach its conclusion. the court found that the ‘cisg requires that damages be limited by the familiar principle of foreseeability established in hadley v. baxendale’.72 hadley v. baxendale is a case familiar to all students of the common law system as authority on the principle of foreseeability. by construing foreseeability in article 74 of the cisg by reference to a, common law case and domestic concept the court failed to satisfy the mandate of article 7. by using a domestic concept to interpret the cisg the court did not pay regard to the international character of the cisg but succumbed to the homeward trend. one further important point to note is that the homeward trend would not pose a threat to the uniform application of the cisg if there was a supranational body to hear cases on the international sale of good. however, states were not willing to surrender their sovereignty to a cisg court. instead the task of determining disputes under the cisg has been given to the courts of all states. accordingly, all courts determining disputes under the cisg must be mindful of the important obligations imposed on them under article 7 of the cisg. 4.7 other resources courts have grappled with issues of uniformity and the international character of treaties other than the cisg. the house of lords discussed these problems in scruttons ltd v midland silicones ltd.73 scruttons case concerned whether of the word ‘carrier’ in the hague rules included a stevedore. in reaching a decision viscount simonds said: ‘it is not surprising that the questions in issue in this case should have arisen in other jurisdictions where the common law is administered and where the hague rules have been embodied in the municipal law. it is (to put it no higher) very desirable that the same conclusions should be reached in whatever jurisdiction the question arises. it would be deplorable if the nations should after protracted negotiations reach agreement as in the matter of the hague rules and that their several courts should then disagree as to the meaning of what they appeared to agree on’.74 the decision of viscount simonds is critical for its recognition of the importance of maintaining a uniform application of treaties. it is also interesting for the comment his honour makes on the use of foreign decisions when interpreting an international treaty. this issue is also relevant to the interpretation of the cisg. 70 the court stated that a ‘treaty, occupying international scope as it does and (as in this case) defining the relationships between nationals of different signatory countries, calls for uniformity of construction.’ u.s. district court, 28 august 2001. 71 71 f.3d 1024 (u.s. ct. app 2d. cir. 1995), <http://cisgw3.law.pace.edu/cases/951206u1.html>. see also zeller, above n 56, 88-90. 72 71 f.3d 1024 (u.s. ct. app 2d. cir. 1995). 73 1 all e.r. 74 1 all e.r. p.9 per viscount simonds. nordic journal of commercial law, issue 2003 #1 18 to give effect to the international character of the cisg and ensure uniformity in its application, it is not sufficient to simply rely on the text of the cisg. rather, ‘uniformity can only be attained if the interpreter in interpreting the provisions has regard to the practice of the other contracting states.’75 uniformity requires consideration of foreign case law. this requirement gives rise to two practical problems access to foreign cases and translation to a known language.76 commendable steps have however been undertaken to remedy these difficulties. for example, uncitral in 1988 developed a procedure with the cooperation of contracting states to gather and distribute information about court decisions. this information is now translated into the six official cisg languages and released as part of the uncitral secretariat clout system of standardised reporting through the united nations.77 as additional ‘antidotes’78 to the danger of divergent interpretations, the legislative history or travaus préparatoires of the cisg and academic writing should be used in interpreting the cisg. the use of legislative history is an interesting example because it again demonstrates the importance of a technique of interpretation that is international rather than domestic in focus. this is because common law countries have traditionally been reluctant to refer to legislative history as an aid to interpretation. civil law countries on the other hand commonly use this technique.79 conclusion the process of drafting a uniform sales law ran over many decades, involved intense debate, required numerous drafts, two failed treaties and, in the end, concessions from all parties before a treaty could be agreed upon. however, the harmonisation process was not complete with an agreement on the final text. the real challenge for harmonisation and the ultimate success or failure of the cisg is dependent on its uniform application. article 7 of the cisg recognises the innate problems with maintaining a uniform law. a treaty is not a domestic creature but is a product of the international diplomatic stage. treaties therefore should not be treated like domestic legislation and respect must be paid to their unique ‘international character’. if in the application of the cisg its international character is not respected and a uniform approach is not realised, the hard work and uneasy compromises of the diplomats in creating the cisg are futile and the promotion and development of international trade is placed in doubt. 75 ferrari, above n 8, 204. 76 felemegas, above n 7. 77 ibid. other resources include the unilex database maintained by the centre for comparative and foreign law studies in rome and the pace university website, which this author can highly recommend. 78 professor honold quoted in ferrari, above n 8, 206. 79 ferrari, above n 8, 207-208. nordic journal of commercial law, issue 2003 #1 19 bibliography andersen, camilla baach, ‘uniformity in the cisg in the first decade of its application’ <http://www.ccls.edu/eclu/events/schmitthoff/symposium_draft_1-3.html>. boodman, martin., ‘the myth of harmonization of laws’ (1991) 39 the american journal of comparative law 699. bailey, james, ‘facing the truth: seeing the convention on contracts for the international sale of goods as an obstacle to a uniform law of international sales’ (1999) 32 cornell international law journal 273. carrigan, frank, ‘globalisation and legal transnationalism’ (1999) 10 australian journal of corporate law 122. cook, susanne, ‘the need for uniform interpretation of the 1980 united nations convention on contracts for the international sale of goods’ (1988) 50 the university of pittsburgh law review 197. cook, susanne, ‘the un convention on contracts for the international sale of goods: a mandate to abandon legal ethnocentricity’ (1997) 16 journal of law and commerce 257, also published at <http://www.cisg.law.pace.edu/cisg/biblio/1cook.html>. cox, trevor, ‘chaos versus uniformity: the divergent views of software in the international community’, (2000) 4 the vindobona journal of international commercial law and arbitration 3, also published at <http://www.cisg.law.pace.edu/cisg/biblio/cox.html>. curran, vivian grosswald, ‘the interpretive challenge to uniformity’ (1995) 15 journal of law and commerce 175, also published at <http://www.cisg.law.pace.edu/cisg/biblio/curran1.html>. darkey, joanne m., ‘a u.s. court’s interpretation of damage provisions under the u.n. convention on contracts for the international sale of goods: a preliminary step towards an international jurisprudence of cisg or a missed opportunity?’ (1995) 15 journal of law and commerce 139 also published at <http://www.cisg.law.pace.edu/cisg/biblio/darkey2.html>. diedrich, frank, ‘maintaining uniformity in international uniform law via autonomous interpretation: software contracts and the cisg’ (1996) 8 pace international law review 303, also published at <http://www.cisg.law.pace.edu/cisg/biblio/diedrich.html>. fox, eleanor m., ‘harmonization of law and procedures in a globalized world: why, what, and how?’ (1992) 60 antitrust law journal 393. eörsi, gyula, ‘a propos for the 1980 vienna convention on contracts for the international sale of goods’ (1983) 31 the american journal of comparative law 333. eörsi, gyula, ‘problems of unifying law on the formation of contracts for the international sale of goods’ (1979) 27 the american journal of comparative law 311, also published at <http://www.cisg.law.pace.edu/cisg/biblio/eorsi.html>. eörsi, gyula, ‘unifying the law (a play in one act, with a song)’ (1977) 25 the american journal of comparative law 658. farnsworth, e. a., ‘the eason-weinmann colloquium on international and comparative law: duties of good faith and fair dealing under the unidroit principles, relevant international conventions, and national laws’ 3 tulane journal of international and comparative law 47. nordic journal of commercial law, issue 2003 #1 20 felemegas, john, ‘the award of counsel’s fees under article 74 cisg, in zapata hermanos successors v. hearthside baking co. (2001) 6 the vindobona journal of international commercial law and arbitration 30, also published at <http://cisgw3.law.pace.edu/cisg/biblio/felemegas1.html>. felemegas, john, ‘the united nations convention on contracts for the international sale of goods: article 7 and uniform interpretation’ <http://www.cisg.law.pace.edu/cisg/biblio/felemegas.html>. ferrari, franco, ‘interpretive decision applying cisg: commentary: uniform law of international sales: issues of applicability and private international law’ (1995) 15 the journal of law and commerce 159. ferrari, franco, ‘recent developments: cisg: specific topics of the cisg in light of judicial application and scholarly writing’ (1995) 15 the journal of law and commerce 1, also published at <http://www.cisg.law.pace.edu/cisg/biblio/2ferrari.html>. ferrari, franco, ‘ten years of the united nations sales convention: cisg case law: a new challenge for interpreters?’ (1998) 17 the journal of law and commerce 245, also available at <http://www.cisg.law.pace.edu/cisg/biblio/ferrari3.html>. ferrari, franco, ‘uniform interpretation of the 1980 uniform sales law’ (1994) 24 the georgia journal of international and comparative law 183, also published at <http://www.cisg.law.pace.edu/cisg/ferrari2.html>. frisch, david, ‘commercial common law, the united nations convention on the international sale of goods, and the inertia of habit’ (1999) 74 tulane law review 495. hackney, philip, ‘is the united nations convention on the international sale of goods achieving uniformity?’ (2001) 61 louisiana law review 473. hillman, robert a., ‘applying the united nations convention on contracts for the international sale of goods: the elusive goal of uniformtiy’ (1995) cornell review of the convention on contracts for the international sale of goods 21, also published at <http://www.cisg.law.pace.edu/cisg/biblio/hillman.html>. honka, hannu, ‘harmonization of contract law through international trade: a nordic perspective’(1996) 11 the tulane european and civil law forum 111. kastely, amy, ‘the right to require performance in international sales: towards an international interpretation of the vienna convention’ (1988) 63 washington law review 607. also published at <http://www.cisg.law.pace.edu/cisg/biblio/kastely1.html>. keily, troy, ‘good faith & the vienna convention on contracts for the international sale of goods’ (1999) 3 the vindobona journal of international commercial law and arbitration 15, also published at <http://www.cisg.law.pace.edu/cisg/biblio/keily.html>. koneru, phanesh, ‘the international interpretation of the un convention on contracts for the international sale of goods: an approach based on general principles’ (1997) 6 minnesota journal of global trade 105, also published at <http://www.cisg.law.pace.edu/cisg/biblio/koneru.html>. kritzer, a., international contract manual: guides to practical applications, kluwer, 70. kritzer, albert, ‘the convention on contracts for the international sale of goods: scope, interpretation and resources’ (1995) cornell review of the convention on contracts for the nordic journal of commercial law, issue 2003 #1 21 international sale of goods 147, also published at <http://cisg.law.pace.edu/cisg/biblio/kritzer.html>. mistelis, loukas a., ‘regulatory aspects: globalization, harmonization, legal transplants, and law reform – some fundamental observations’ (2000) 34 international lawyer 1055, also published at <http://www.cisg.law.pace.edu/cisg/biblio/mistelis.html>. murphy, maureen t., ‘united nations convention on contracts for the international sale of goods: creating uniformity in international sales law’ (1989) 12 fordham international law journal 727, also published at <http://www.cisg.law.pace.edu/cisg/biblio/murphy.html>. nottage, luke, ‘a realist’s view from new zealand – and a way forward?’ <http://www.law.kyushu-u.ac.jp/-luke/nzlj95.html>. povrzenic, n., ‘interpretation and gap-filling under the united nations convention on contracts for the international sale of goods’ <http://www.cisg.law.pace.edu/cisg/biblio/ povrzenic.html>. rosett, arthur, ‘critical reflections on the united nations convention on contracts for the international sale of goods’ (1984) 45 ohio state law journal 265, also published at <http://www.cisg.law.pace.edu/cisg/biblio/rossett.html>. rosett, arthur, ‘unidroit principles and harmonization of international commercial law: focus on chapter seven’ ,http://www.unidroit.org/english/publications/review/articles/19973.html>. rosett, arthur, ‘unification, harmonization, restatement, codification, and reform in international commercial law’, (1992) 40 the american journal of comparative law 683. ryan, lisa m., ‘the convention on contracts for the international sale of goods: divergent interpretations’ (1995) 4 tulane journal of international and comparative law 99. sim, disa, ‘the scope and application of good faith in the vienna convention on contracts for the international sale of goods’ <http://www.cisg.law.pace.edu/cisg/biblio/sim1.html>. tetley, willian, ‘mixed jurisdictions: common law vs civil law (codified and uncodified)’ <http://www.cisg.law.pace.edu/cisg/biblio/tetley.html>. twibell, t.s., ‘implementation of the united nations convention on contracts for the international sale of goods (cisg) under shari’a (islamic law): will article 78 of the cisg be enforced when the forum is an islamic state?’ (1997) 9 international legal perspectives 25, also published at <http://www.cisg.law.pace.edu/cisg/biblio/twibell.html>. zeller, bruno, ‘good faith – the scarlet pimpernel of the cisg’ <http://www.cisg.law.pace.edu/cisg/biblio/zeller2.html>. zeller, bruno, ‘the un convention on contracts for the international sale of goods (cisg) – a leap forward towards unified international sales laws’ (2000) 12 pace international law review 79, also published at <http://www.cisg.law.pace.edu/cisg/zeller3.html>. zwart, sara, ‘the new international law of sales: a marriage between socialist, third world, common, and civil law principles’ (1988) 13 north carolina journal of international law and commercial regulation 109, also published at <http://www.cisg.law.pace.edu/cisg/zwart.html>. 1. introduction 2. the diplomats 2.1 the cisg and the promotion of international trade 2.2 the long and winding road 2.3 clash and compromise 2.4 methodology of compromise 3. cisg & the uneasy compromise 3.1 a compromise on harmony 3.2 scope of the cisg 3.3 specific performance 3.4 good faith 3.5 revocation 3.6 reservations 3.7 comment 4 maintaining uniformity 4.1 the battle front 4.2 harmonisation and unification 4.3 article 7 4.4 international character & uniformity 4.5 international interpretation 4.6 homeward trend 4.7 other resources conclusion bibliography microsoft word article2.doc means of interference into arbitration by state courts: comparative analysis of the uncitral model law, german and hungarian law by dr. andrea vincze1 nordic journal of commercial law issue 2003 #1 1 dr. vincze is researcher in private international law at the university of miskolc, hungary. nordic journal of commercial law, issue 2003 #1 2 1. introduction nowadays, international commercial arbitration is widely considered as an effective alternative of state court jurisdiction, it has become an essential feature of today’s globalized economy. the more popular and widespread international commercial arbitration gets, the more urgently the question rises: what kind of relationship is there between arbitration and the activity of state courts? has arbitration been acknowledged as a totally separate institution with is own methods and devices or is it subsidiary to state courts in the meaning of the word that the latter might have some effect on it? before answering these questions, let us examine the theoretical basis and necessity of arbitration. the first factor is that the legal culture of a certain country affects the possibility of institutionalizing arbitration. furthermore, it is also one of the logical consequences of party autonomy and freedom of contracting, i.e. if a party obliges himself through private law contracts, he also has the right to enforce performance of the contract by arbitration and not being obliged to turn to state courts. this is required by the idea of constitutional state, too, which implies that in the 21st century, exclusivity of state court jurisdiction is not appropriate because special needs of special sectors must be taken into account as well. the interests of the parties are best fulfilled if there are several ways of dispute resolution besides just state courts. the necessity of arbitration lies in the following factors. first, inflexible and not easily modifiable procedural rules of state court jurisdiction do not harmonize with the interests of the parties who would prefer freer, quicker and more effective procedure and a decision serving their interests at the most. another factor deriving from strict procedural rules of state court jurisdiction is that the procedure is public which might be disadvantageous and awkward for the parties who would prefer not to ‘publicize’ their confidential business-related affairs. similarly disadvantageous may be the course of judicial control of court decisions. on one hand it might be preferable because it allows of avoiding incorrect decisions but on the other hand, it can unreasonably prolong the procedure and raises its costs. this is not very useful in a dynamically changing economy. turning to a broader aspect, in international legal disputes, a party may be afraid of foreign procedural rules, i.e. those of the state court making the decision2. institutionalization of arbitration has several consequences. firstly, obligations of the constitutional state will not be shared between state jurisdiction and arbitration: safeguarding legality of dispute resolution and excluding arbitrariness will be a common and mutual obligation of the two institutions. therefore, state jurisdiction and arbitration are becoming equal and co-operative entities. state jurisdiction stands by arbitration without interfering into it unnecessarily. requesting the help of state courts is not compulsory but a possibility. arbitration is a separate legal institution with its own advantages which are the following: the procedure is quicker, therefore, it does not interfere into the normal course of business for a longer time which might reduce the costs as well. the procedure is not public, thus, the concerned companies etc. do not have to fear for being forced ‘to wash their dirty linen in public’. 2 prof. dr. günther hirsch: schiedsgerichte – ein offenbarungseid für die staatlichen gerichte?, schiedsvz zeitschrift für schiedsverfahren 2/2003, p. 49-50. nordic journal of commercial law, issue 2003 #1 3 arbitrators have special skills and knowledge possession of which could not be expected from state court judges dealing with so many different cases and issues. thus the parties may feel the procedure more convenient and favourable, being aware of the fact that the judges making the decision are experts of the field concerned. coming to the closing point of a procedure, another advantage of arbitration is that the decision is utter and it can be enforced immediately (with special exceptions of course) by related international conventions. the issue of the relationship between arbitration and state court jurisdiction arises at this point of the analysis. regarding the status of the two institutions within the system of dispute resolution, state jurisdiction is situated at one end of an imaginary line of process, while arbitration, as an alternative of state jurisdiction, can be placed somewhere in the middle between state jurisdiction and ‘self-help’ which is situated at the other end of the imaginary line. the ideal relationship between arbitration and state jurisdiction would be a complementary one where both institutions would add something to the other one according to the interests and requests of the parties. state courts have two main functions concerning arbitration: firstly, they ‘roll over’ the arbitration process if it is stuck (e.g. they nominate an arbitrator if one of the parties failed to do it, or play an important role in determining the scope of arbitral jurisdiction); secondly, they have control over arbitration to some extent (e.g. when setting aside an award by the arbitral tribunal). this article will examine the relationship between state court jurisdiction and arbitration according to the uncitral model law (hereinafter: mal), german and hungarian law. before the thorough analysis, these sources of law will be introduced briefly. the mal, accepted on 21 june 19853 and adopted by 42 countries so far4, creates the foundations for the unification of the rules of arbitration by consolidating advantageous characteristics of regulations and international experience so far and by comprehending requirements in order to make arbitration more effective. therefore, the mal is eligible for implementation into domestic laws and for winding up ‘double regulation’ by national and international provisions. the mal is being revised continuously by uncitral working group ii. (international arbitration and conciliation) which plays an important part in specification, actualization and unification of international commercial arbitration regulations. both examined countries have adopted the mal with slight individual differences which will be introduced in this study. the german regulation can be found in book 10 (zehntes buch) of the zpo (german code of civil procedure) from art. 1025 to 1048. hungary, on the contrary, has a separate source of law on arbitration, i.e. ‘act of the parliament no. 71 of 1994 on arbitration’ (‘1994. évi lxxi. törvény a választottbíráskodásról’). 3 by uncitral decision no. 40/72 and confirmed by the un general assembly. 4 australia, azerbaijan, bahrain, belarus, bermuda, bulgaria, canada, croatia, cyprus, egypt, germany, greece, guatemala, hong kong special administrative region of china, hungary, india, iran (islamic republic of), ireland, jordan, kenya, lithuania, macau special administrative region of china, madagascar, malta, mexico, new zealand, nigeria, oman, paraguay, peru, republic of korea, russian federation, singapore, sri lanka, tunisia, ukraine, within the united kingdom of great britain and northern ireland: scotland; within the united states of america: california, connecticut, illinois, oregon and texas; zambia, and zimbabwe (status of 26 september 2003, source: http://www.uncitral.org/en-index.htm) nordic journal of commercial law, issue 2003 #1 4 2. means of state court intervention into arbitration – in general the mal recognizes state court intervention into arbitration in nine main cases, which are: 1. the substantive claim is brought before a state court (art. 8.) 2. awardable interim measures by a state court (art. 9.) 3. appointment of arbitrators (art. 11.) 4. challenge procedure (art. 13.) 5. termination of the arbitrator’s mandate (art. 14.) 6. jurisdiction of the arbitral tribunal (art. 16.) 7. court assistance in taking evidence (art. 27.) 8. setting aside an arbitral award (art. 34.) 9. recognition and enforcement of an arbitral award (art. 35-36.) these cases can be divided into two groups. the first one includes cases in connection with appointment, challenge and termination of the mandate of an arbitrator (art. 11, 13, 14.), jurisdiction of the arbitral tribunal (art. 16.) and setting aside an arbitral award (art. 34.). the latter cases are referred to in art. 6 mal as functions which shall be borne by the court or other authority (e.g. chamber of commerce etc.) designated by each state. this designation does not mean that only one court or other authority would have the right to deal with these cases, instead, assigning certain types of courts or authorities would be preferable. therefore, the wording of the mal should not be interpreted too narrowly. thus, designating a whole court or one of its chambers is not necessary either, assigning the task to the chairman of a court or a tribunal would suffice as well, since there are only administrative questions to decide on. the mal allows for the designation of other outsider authorities e.g. international arbitration commission, institution or other institute dealing with international affairs. however, the two examined national laws stick to the ‘traditional’ solution: the zpo5 gives this power to the oberlandesgericht (provincial court of appeal) distinguishing several cases, and the hungarian arbitration act6 designated the county court which makes the decision in non-litigation process7. the remaining functions, i.e. court assistance in taking evidence (art. 27.) recognition of the arbitration agreement, including its compatibility with court-ordered interim measures of protection (articles 8 and 9), and recognition and enforcement of arbitral awards (articles 35 and 36). after all, what does state court intervention mean? the explanatory note to the mal8 explains that the current tendency is to urge limitation of state court intervention. art. 5 mal provides that “/i/n matters governed by this law, no court shall intervene except where so provided in this law”. this rule, however, does not answer the question what exact role state courts have 5 zpo art. 1062. 6 art. 51. an exception is the ordering of interim measures which is the obligation of the municipal court on the territory of which taking evidence can be carried out the most effectively. (art. 37) 7 except for the proceedings on setting aside an arbitral award. there is no remedy against the decision. (art. 53) 8 www.uncitral.org/english/texts/arbitration/ml-arb.htm nordic journal of commercial law, issue 2003 #1 5 but it “guarantees the reader and user that he will find all instances of possible court intervention in this law, except for matters not regulated by it (e.g., consolidation of arbitral proceedings, contractual relationship between arbitrators and parties or arbitral institutions, or fixing of costs and fees, including deposits)”9. in the following chapters, the means of intervention provided for in the mal, the zpo and the hungarian arbitration act will be presented and compared, and practical cases will be analysed. 3. arbitration and substantive claim before court (art. 8 mal) according to art. 8 mal, a court before which an action is brought in a matter which is the subject of an arbitration agreement shall, if a party so requests not later than when submitting his first statement on the substance of the dispute, refer the parties to arbitration unless it finds that the agreement is null and void, inoperative or incapable of being performed. by such an action, arbitral proceedings may nevertheless be commenced or continued, and an award may be made, while the issue is pending before the court. art. ii (3) of the new york convention on the recognition and enforcement of foreign arbitral awards (hereinafter: the new york convention) sets out nearly the same criteria but art. 8 mal refers to each and every court of a state and it is not restricted to arbitration agreements where the place of arbitration is in the same country where the court is. art.8 mal is imperative, therefore, a certain legal dispute must be referred to arbitration unless the exceptions apply. thus, the possibility of referring a case to arbitration is a negative consequence of the arbitration agreement because the disputes are always resolved by arbitration regardless of whether or not the arbitration clause contains the exclusion of state courts. now, let us examine the national laws. the zpo10 contains exactly the same provision apart from two differences. while the mal designates ‘submitting his first statement on the substance of the dispute’ as deadline, the german law provides for ‘the first oral hearing’. the other difference concerns the role of state courts by saying that prior to the constitution of the arbitral tribunal, an application may be made to the court to determine whether or not arbitration is admissible11. the hungarian arbitration act is a bit different because here, the court before which an action was brought in a case which is the subject of the arbitration agreement, must dismiss the claim without issuing a warrant or terminates the proceedings on the request of any party except when the court finds that the arbitration agreement is null and void, inoperative or incapable of being performed12. in the latter case, a party must request termination before the submission of the counterclaim, and legal effects of the claim remain in force until 30 days13. the difference compared to the mal is that, in the latter cases, it refers the dispute to arbitration. yet, the hungarian act is not against arbitration either, whatsoever it repeats the wording of the mal by stating that arbitral proceedings may nevertheless be commenced or continued, and an award may be made, while the issue is pending before the court14. 9 mal explanatory note, b. 1. b) 16. 10 zpo art. 1032. 11 zpo art. 1032 (2) 12 art. 8 (1) 13 art. 8 (1), (2) 14 art. 8 (3) nordic journal of commercial law, issue 2003 #1 6 practical cases show that interpretation of art. 8 mal is not always unanimous. several courts have stood for narrow interpretation and exceptionality15, while in the nanisivik i. case16 the court explained that referring the case to arbitration is compulsory if the requirements of art. 8 mal have been fulfilled, and so is the termination of the state court proceedings even if some issues are not subject to arbitration. this latter rule was refined in traff et al. v. evancic et al17. where the court ruled that the state court proceedings must be terminated if any aspect of the dispute must be resolved by arbitration. the contrary point of view, presence of ‘residual jurisdiction’ of the state courts was stressed in another case18 which contends that the court may refuse to refer the dispute to arbitration if it finds that one of the parties named in the proceedings is not a party to the arbitration agreement, the dispute is not subject to the arbitration agreement, or if the application came too late. an important feature of a substantive claim before court is the significance of deadline. deadline according to the mal is ‘submitting his first statement on the substance of the dispute’, i.e. ‘entry of appearance’. the consequence of missing the deadline is that the state court proceedings cannot be stayed and the dispute cannot be referred to arbitration. the working group drafting the mal originally intended to include in the provision that “the failure of the party should have a wider effect precluding that party from relying on the arbitration agreement also in other contexts and proceedings”19. in the end, these lines were not incorporated into the text because they could not find a sufficiently general wording which applies to all aspects of the question. nevertheless, we can contend in general that the aim of the provision on pursuing arbitral proceedings is to preclude dilatory tactics by the parties. relevant practical cases prove that keeping the deadline is a key issue. the question is how to interpret the ‘entry of appearance’. the easiest issue is if the defendant participates in the litigation process from its commencement. the british columbia supreme court20 qualified this as the defendant’s approval of state court proceedings and did not refer the case to arbitration. the ontario court of justice stressed that the requests of staying the state court proceedings is late if it is submitted along with the counterclaim. the right procedure is, the court stated, to apply for the stay after receiving the statement of claim but before submitting a statement of defence21. similar decisions were made when the court stated that there was no dispute to be referred to arbitration if the defendant had admitted the claim as to liability and quantum22. however, admission of liability can be a difficult question on its own. for example, in the zhan jiang e & t dev area service head co. v. an hau company limited case23, the court explained that admission of liability in a letter and offering compensation does not constitute unequivocal admission of liability. nevertheless, a decision contrary to the few above was made in a. bianchi s.r.l. v. bilumen lighting ltd. where the court explained that “the delay in invoking 15 navionics v. flota maritima mexicana s.a. et al http://www.interarb.com/clout/clout015.htm 16 nanisivik mines ltd. and zinc corporation of america v. canarctic shipping co. ltd. http://www.interarb.com/clout/clout070.htm 17 http://www.interarb.com/clout/clout180.htm 18 gulf canada resources ltd. v. arochem international ltd. http://www.interarb.com/clout/clout031.htm 19 a/cn.9/246, 22. 20 queensland sugar corp. v. „hanjin jedda” (the) http://www.interarb.com/clout/clout181.htm 21 abn amro bank canada v. krupp mak maschinenbau gmbh mealey’s international arbitration report, may 1995, p. 11. 22 joong and shipping co. limited v. choi chong-sick (alias choi chong-sik) and chu ghin ho trading as chang ho company http://www.interarb.com/clout/clout063.htm 23 http://www.interarb.com/clout/clout061.htm nordic journal of commercial law, issue 2003 #1 7 the arbitration clause and the step undertaken in the judicial proceedings did not amount the renunciation of the arbitral procedure (…) and mandatory nature of the provision and the absence of judicial discretion required that the parties be referred to arbitration”24. besides keeping to the time-limits, subject-matter issues play also an important role in admitting a case to be referred to arbitration. the high court of hong kong favoured the validation of the parties’ rights at the highest level possible, and laid down that if the parties express their intention to arbitrate, the dispute can be referred to arbitration even if an unspecified third country, a non-existent organization or non-existent rules were contained in the arbitration agreement25. the situation gets a bit more complicated if the parties do intend to arbitrate but somehow their agreement contains an arbitration and a state court clause at the same time. in such a case the court ruled that arbitration is not excluded even if there is a provision of referring legal disputes to a state court, whatsoever, this question must be decided upon by the arbitral tribunal since the arbitral tribunal decides on its own jurisdiction (kompetenzkompetenz)26. another court decision concerns the scope of referring a case to arbitration. accordingly, if one defendant requests stay of the state proceedings and reference to arbitration, a concessive court decision does not extend to other co-defendants27. a further important subject-matter aspect may be the personality of the arbitrator. no doubt that the state court did not refer the dispute to arbitration when it found out that doing so would lead to the awkward situation that one of the contracting parties would have been an arbitrator, because in doing so, spirit of arbitration and the principle of impartiality would have been harmed28. 4. interim measures by a state court (art. 9 mal) the possibility of ordering interim measures amounts to an important exception from the general principle that state court cannot interfere into arbitration proceedings. it is also supported by the fact that, all in all, it is not contrary to the parties’ intentions and does not stay arbitral proceedings, whatsoever, ordering interim measures fosters the efficiency of arbitration and the expected results. art. 9 mal, art. 1033 zpo and art. 37. (1), (2) of the hungarian arbitration act provide for the criteria of ordering interim measures by a state court. “it is not incompatible with an arbitration agreement for a party to request, before or during arbitral proceedings, from a court an interim measure of protection and for a court to grant such measure.” (mal). the wording ‘not incompatible’ should mean that requesting interim measures is not incompatible with the arbitration agreement, it is neither prohibited, nor to be regarded as a waiver of defence. the provision applies to any country to the court of which the request is made, it may not be treated as an objection against or disregard of a valid arbitration agreement. this argumentation was 24 http://www.interarb.com/clout/clout186.htm 25 lucky-goldstar international (h.k.) limited v. ng moo kee engineering http://www.interarb.com/clout/clout057.htm 26 mind star toys inc. v. samsung co. ltd http://www.interarb.com/clout/clout032.htm; rio algom limited v. sammi steel co. http://www.interarb.com/clout/clout018.htm 27 stancroft trust limited, berry and klausner v. can-asia capital company, limited, mandarin capital corporation and asiamerica capital limited http://www.interarb.com/clout/clout017.htm 28 charbonneau v. les industries a.c. davie inc et al http://www.interarb.com/clout/clout066.htm nordic journal of commercial law, issue 2003 #1 8 followed in a court decision29 when stressing that “interim court orders designed to protect the applicant from the risk of being unable to enforce a final arbitral award were not incompatible with arbitration”, furthermore, staying the proceeding would not set aside the interim measure because the original claim does not merge into the arbitration award. what do national laws provide for the issue of interim measures? zpo30 uses the expression ‘preliminary interim measures of protection’ which should be related to the subject of arbitration. the hungarian law31 deals with measures of protection separately which can be ordered if the party requesting it proves existence, quantum and expiry of the claim with an official document or a private document representing conclusive evidence. the certification by the domestic arbitral tribunal proving that arbitration process has been commenced must be submitted along with the request. practical cases point to the core of ordering interim measures. the most important questions are: what can be regarded as an interim measure and under what circumstances can a court order them? answering the first question, two examples must be cited. in one case the court decided that a mareva injunction falls under the scope of art. 9 mal since the protection afforded by it is capable of reducing in the risk of the amount of the claim32. yet, in vibroflotation a.g. v. express builders co. ltd.33 the court found that issuing a subpoena duces tecum does not fall under the scope of art. 9 mal but art. 27 mal applies to it. a very general answer was given to the question on the circumstances of ordering an interim measure in delphi petroleum inc. v. derin shipping and training ltd.34 where the court explained that a court jurisdiction to order interim measures according to art. 9 mal but it should avoid taking measures conductive to dilatory tactics of the parties. as practical cases have shown as well, art. 9 mal is closely related to art. 27 mal, problems of interpretation and delimitation might occur. the latter provision will be examined later with regard to these problems. 5. appointment of arbitrators (art. 11 mal) the main rule in appointing arbitrators is the most entire freedom possible in determining the procedure of appointing their arbitrators35. this is only restricted by means which can be used if the parties did not make such an agreement or if any of them acted contrary to it. according to the examined legal sources, two main spheres must be introduced: the situation if the parties did not agree on the appointment of the arbitrators at all, and if there is such an agreement but it is not fulfilled accordingly. looking at the first issue, the mal, the zpo and 29 trade fortune inc. v. amalgamated mill supplies ltd. http://www.interarb.com/clout/clout071.htm 30 zpo art. 1033. 31 art. 37. (1), (2) 32 katran shipping co. ltd. v. kenven transportation ltd. http://www.interarb.com/clout/clout039.htm 33 http://www.interarb.com/clout/clout077.htm 34 http://www.interarb.com/clout/clout068.htm 35 art. 11 (2) mal, zpo art. 1035 (1), hungarian arbitration act art. 14. (1). nordic journal of commercial law, issue 2003 #1 9 the hungarian arbitration act are unanimous in the question that failing such an agreement, in an arbitration with three arbitrators, each party shall appoint one arbitrator, and the two arbitrators thus appointed shall appoint the third arbitrator. if a party fails to appoint the arbitrator within thirty days of receipt of a request to do so from the other party, or if the two arbitrators fail to agree on the third arbitrator within thirty days of their appointment, the appointment shall be made, upon request of a party, by the court or other authority specified in accordance with article 636, and the same applies in cases with a sole arbitrator.37 the second issue is also the same in all three legal sources. this affects the situation when the agreement on the procedure of appointing the arbitrators is not fulfilled accordingly. the concordant provisions contain that in such a case a party fails to act as required under such procedure, or the parties, or two arbitrators, are unable to reach an agreement expected of them under such procedure, or a third party, including an institution, fails to perform any function entrusted to it under such procedure, any party may request the court or other authority specified in accordance with article 6 to take the necessary measure, unless the agreement on the appointment procedure provides other means for securing the appointment38. these provisions are aimed at ensuring continuity of the procedure and avoiding dilatory tactics of the parties39. therefore, the right to ask for state court assistance cannot be waived either. after having clarified the procedure of appointing arbitrators, the question rises what factors the court should consider by the appointment. all three legal sources are unified in the opinion that regard must be taken to any qualifications required of the arbitrator by the agreement of the parties and to such considerations as are likely to secure the appointment of an independent and impartial arbitrator and, in the case of a sole or third arbitrator, shall take into account as well the advisability of appointing an arbitrator of a nationality other than those of the parties40. this provision was emphasized and refined by the high court of hong kong when explaining that when appointing an arbitrator on behalf of the party in default, the court is obliged to ensure that no sense of grievance is felt, however unreasonable that attitude might appear to others41. the two examined national laws govern the question more or less the same but there are slight differences. the mal provides that a court decision on appointing an arbitrator shall be subject to no appeal42 and the mal commentary also lays down that the decision is final43. this rule is not followed by either national laws44. 36 in germany the oberlandesgericht (zpo art. 1062), in hungary the county court (art. 53); cf. supra 6. 37 art. 11 (3) mal, zpo art. 1035 (3), hungarian arbitration act art. 14. (2)-(4). 38 art. 11 (4) mal, zpo art. 1035 (4), hungarian arbitration act art. 15. 39 a relevant case is safond shipping sdn. bhd. v. east asia sawmill corp. (http://www.interarb.com/clout/clout060.htm) where the court found that it is contrary to the spirit of arbitration, constitutes a breach of the obligation to arbitrate and unacceptable defiance to the court proceedings if the party in default, will not, on the order of the court, appoint his arbitrator. 40 art. 11. (5) mal, zpo art. 1035. (5), hungarian arbitration act art. 16. 41 fung sang trading limited v. kai sun sea products and food company limited in: yearbook commercial arbitration xvii, deventer, netherlands, kluwer, 1992, p. 289-303. 42 art. 11 (5) mal 43 analytical commentary on draft text of model law on international commercial arbitration: report of the secretary-general (a/cn.9/264) 44 zpo art. 1035, hungarian arbitration act art. 11-17. nordic journal of commercial law, issue 2003 #1 10 6. challenge procedure (art. 13 mal) similarly to the appointment of arbitrators, parties are free to agree on the challenge procedure as well45. next, the structure of the provision follows that of the appointment of arbitrators by saying that failing such agreement, a party who intends to challenge an arbitrator shall, within fifteen days (zpo: two weeks) after becoming aware of the constitution of the arbitral tribunal or after becoming aware of any ground for challenge, send a written statement of the reasons for the challenge to the arbitral tribunal. unless the challenged arbitrator withdraws from his office or the other party agrees to the challenge, the arbitral tribunal shall decide on the challenge.46 the next provision is shared by all three regulations concerning the fact that if a challenge under any procedure agreed upon by the parties or under the request of challenge is not successful, the challenging party may request, within thirty days (in the wording of the zpo: ‘one month’ but the parties can agree on a different time-limit as well) after having received notice of the decision rejecting the challenge, the court or other authority to decide on the challenge; while such a request is pending, the arbitral tribunal, including the challenged arbitrator, may continue the arbitral proceedings and make an award47. the right to turn to state courts in deciding upon the challenge cannot be waived – not even is cases where the forum provided for in art. 6 mal is an ‘other authority’. also, it is a “compromise solution with regard to the controversy of whether any resort to a court should be allowed only after the final award is made or whether a decision during the arbitral proceedings is preferable. thus, advantageous features of both apply because it prevents dilatory tactics, removes the challenged arbitrator in time and saves time and costs as well. the important requirement of quick procedure in arbitration is not violated either, since the court can interfere during the course of the arbitral proceedings, there is a strict deadline for the party to make the request, and the court makes a final decision. therefore, principles of arbitration are not harmed even if in the end the court finds that the challenge was unfounded. 7. termination of the arbitrator’s mandate (art. 14 mal) the three legal sources48 are unanimous in providing for the termination of the arbitrator’s mandate except for the order of the rules which is different in the hungarian arbitration act. all of them lay down that if an arbitrator becomes de iure or de facto unable to perform his functions or for other reasons fails to act without undue delay, his mandate terminates if he withdraws from his office or if the parties agree on the termination. otherwise, if a controversy remains concerning any of these grounds, any party may request the court or other authority to decide on the termination of the mandate. this decision shall be subject to no appeal according to the mal, but the zpo and the hungarian arbitration act do not contain such a provision. furthermore, if an arbitrator withdraws from his office or a party agrees to the termination of the mandate of an arbitrator, this does not imply acceptance of the validity of any ground for challenge. the three sources of law use different expressions in determining the reason for the 45 art. 13 (1) mal, zpo art. 1037 (1), hungarian arbitration act art. 19 (1). 46 art. 13 (2) mal, zpo art. 1037 (2), hungarian arbitration act art. 19 (2). 47 art. 13 (3) mal, zpo art. 1037 (3), hungarian arbitration act art. 20. the mal does but the two national laws do not contain that such a decision by the court is subject to no appeal. 48 art. 14 mal, zpo art. 1038, hungarian arbitration act art. 21-22. nordic journal of commercial law, issue 2003 #1 11 termination of the mandate. the mal and the zpo include “an arbitrator becomes de iure or de facto unable to perform his functions or for other reasons fails to act without undue delay an arbitrator becomes de iure or de facto unable to perform his functions or for other reasons fails to act without undue delay”, while the hungarian law mentions “an arbitrator does not meet the requirements of challenge because a change that occurred after the arbitrator accepted the nomination, or the arbitrator became de facto unable to perform his duty”. the explanatory note states that the most flexible word of broadest meaning is ‘failure’, and determines which factors should be taken into account in determining whether the arbitrator committed such a failure. these are e.g. what the arbitrator was obliged to under the arbitration agreement; if the arbitrator did not act at all, did he cause undue delay in the exact circumstances and did it constitute a ‘failure’; how can the failure be evaluated in the light of efficiency of the arbitrator’s work and his abilities?49 in practice, the most common cases of court (‘other authority’) intervention are in connection with acting in undue delay, significantly less cases concern the issue of becoming unable to perform the functions. in addition, art. 15 mal50 provides some more reasons for terminating an arbitrator’s mandate and in those cases a substitute arbitrator is appointed. these reasons are withdrawal from the office for any other reason or revocation of the arbitrator’s mandate by agreement of the parties or ’any other case’. 8. jurisdiction of the arbitral tribunal (art. 16 mal) before analysing the relevant provisions of the mal, the zpo51 and the hungarian arbitration act52 regard has to be paid to a terminological issue. while the mal speaks about ‘jurisdiction’, the zpo uses the word ‘zuständigkeit’ and the hungarian act ‘hatáskör’. the latter two are not unambiguous equivalent to ‘jurisdiction’, they rather extend to ‘scope authority’ which comes into question only a positive decision was made concerning jurisdiction which means in those legal systems that that particular country has the right to deal with the case. however, the word ‘jurisdiction’ will be used with regard to the latter statement but assuming that they have the same meaning concerning these provisions. according to the mal, the arbitral tribunal may rule on its own jurisdiction53, including any objections with respect to the existence or validity of the arbitration agreement (kompetenzkompetenz). for that purpose, an arbitration clause which forms part of a contract shall be treated as an agreement independent of the other terms of the contract. a decision by the arbitral tribunal that the contract is null and void shall not entail ipso iure the invalidity of the 49 explanatory note by the uncitral secretariat on the model law on international commercial arbitration, www.uncitral.org/english/texts/arbitration/ml-arb.htm. 50 the same as zpo art. 1039 and hungarian arbitration act art. 23. 51 zpo art. 1040. 52 hungarian arbitration act art. 24-25. 53 this means that it is the arbitral tribunal that shall decide on its own jurisdiction first and foremost. the court referred to this finding in fung sang trading limited v. kai sun sea products and food company limited (cf. supra 40) where the plaintiff turned to the court to appoint an arbitrator. the court decided that in doing so, it may not deal with the question whether there was a valid arbitration agreement between the parties, because its first duty is to decide upon its own jurisdiction. consequently, it held that the decision of the arbitral tribunal was neither final nor exclusive but subject to immediate review under art. 16 (3) mal. the same opinion was shared by the supreme court of bermuda in skandia international insurance company and mercantile & general reinsurance company and various others where it found that a challenge to the existence, validity and scope of the arbitration agreement was a matter to be first determined by the arbitral tribunal under art. 16 (3) mal.(http://www.interarb.com/clout/clout127.htm) nordic journal of commercial law, issue 2003 #1 12 arbitration clause (separability)54. a plea that the arbitral tribunal does not have jurisdiction shall be raised not later than the submission of the statement of defence. a party is not precluded from raising such a plea by the fact that he has appointed, or participated in the appointment of, an arbitrator. a plea that the arbitral tribunal is exceeding the scope of its authority shall be raised as soon as the matter alleged to be beyond the scope of its authority is raised during the arbitral proceedings. the arbitral tribunal may, in either case, admit a later plea if it considers the delay justified55. the arbitral tribunal may rule on a plea the arbitral tribunal does not have jurisdiction either as a preliminary question or in an award on the merits. if the arbitral tribunal rules as a preliminary question that it has jurisdiction, any party may request, within thirty days after having received notice of that ruling, the court specified in article 6 to decide the matter, which decision shall be subject to no appeal; while such a request is pending, the arbitral tribunal may continue the arbitral proceedings and make an award56. the zpo and the hungarian arbitration act literally follow these rules except that they do not provide for the fact that the decision shall be subject to no appeal, however, art. 53 of the hungarian act includes a general provision that “the court – except for the procedure of setting aside an arbitral award – conducts non-litigation process without the cooperation of lay assessors. the decision shall be subject to no appeal”. another difference to the wording of the mal is that the zpo uses a time limit of ‘one month’ instead of ‘thirty days’. according to art. 16 mal, decision of the arbitral tribunal concerning its own jurisdiction is subject to court control57. if jurisdiction of the arbitral tribunal was decided upon in the award on the merits, the objecting party may initiate court control by requesting setting aside of the award. the situation is the same if the jurisdiction of the arbitral tribunal was decided upon as a preliminary question because dilatory tactics of the parties shall be prevented. three protection mechanisms were included into the proceedings: short time-limit of thirty days, exclusion of appeal and that arbitral proceedings can be continued in between. the disadvantage of the solution is, however, that lengthy proceedings and taking evidence may lead to considerable waste of time and money. advantages and disadvantages are hard to weigh at a general level, therefore, in exact cases, discretion should be given to the courts in order to be able to decide with regard to the given circumstances whether instant court control is needed or a procedural ruling which can be contested only in an action for setting aside the award on the merits.58 art. 16 mal does not deal with the case if the arbitral tribunal finds that it has no jurisdiction to hear the case. a previous draft of the mal contained a relevant provision that ”a ruling by the arbitral tribunal that it has no jurisdiction may be contested by any party within 30 days before the court specified in art.6.”. the aim of the provision was not to force the arbitrators to continue the proceedings but to obtain a decision on the existence of a valid arbitration agreement. the drafters had the opinion that such an arbitral ruling is final and binding concerning these arbitration proceedings but did not answer the question whether the substantive claim is to be decided by the state court or the arbitral tribunal. therefore, as such a 54 art. 16 (1) mal 55 art. 16 (2) mal 56 art. 16 (3) mal 57 in international civil aviation organization (icao) v. tripal systems pty. ltd. the court held that once the arbitral tribunal had declared itself competent, the superior court would be competent to review this decision in accordance with art. 16 (3) mal, if a party requested so. (http://www.interarb.com/clout/clout182.htm) 58 analytical commentary on draft text of model law on international commercial arbitration: report of the secretary-general (a/cn.9/264): article 16, para 13. nordic journal of commercial law, issue 2003 #1 13 provision was not incorporated in the mal, it is up to the national source of law on arbitration or civil procedure to determine whether court control can be requested against the decision of the arbitral tribunal denying its own jurisdiction59. 9. court assistance in taking evidence (art. 27 mal) significance of the mal providing for court assistance in taking evidence lies in two main aspects. first, before the introduction of the mal, some national laws did not contain any regulation on the issue, i.e. nowadays, it has become a general requirement for the countries to implement such rules. secondly, the mal creates the frame for a detailed national regulation which is, of course, elaborated by the countries themselves with regard to national habits and characteristics of civil procedure. again, the mal and the zpo contain nearly the same wording, while the hungarian arbitration act has a little bit different text and structure. according to the mal and the zpo60, the arbitral tribunal or a party with the approval of the arbitral tribunal may request from a competent court of the state assistance in taking evidence. the first important factor is that the requesting party must also ask for the approval of the arbitral tribunal which prevents dilatory tactics. the second one is that the ‘court’ in this place is not the same as what is provided for in art. 6 mal (specified in zpo art. 37 and hungarian arbitration act art. 53 – cf. para 5-6.). instead, the court on the territory of which the taking of evidence is the most expedient. the court may execute the request within its competence and according to its rules on taking evidence. a canadian court decision dealt with the interpretation of this very question and held that a court may assist in taking evidence but “it should avoid taking measures conductive to dilatory tactics of the parties”. since according to the federal rules of procedure, the witness whose testimony is sought may have information on an issue in the action. this requirement was not met because the issue concerned was already decided upon by the arbitrator and the court “was not satisfied that the evidence before it demonstrated that the witness had any information”61. now, there is one difference between the provisions of the mal and the zpo. the latter adds to the above rules that court assistance cannot only be requested in taking evidence but also in other judicial acts, and that the arbitrators are entitled to participate in any judicial taking of evidence and to ask questions. this is how the hungarian arbitration act comprehends the issue: “if taking evidence caused significant hardship or disproportionate rise of costs, the municipal court, by request of the arbitral tribunal, provides legal aid in taking evidence and applying coercive instruments necessary for the latter”62. this is a slightly different wording compared to that of the mal and zpo but a more important one is that the hungarian law provides for measures of protection in the same article while the latter two have different articles for interim measures of protection and court assistance in taking evidence63. 59 analytical commentary on draft text of model law on international commercial arbitration: report of the secretary-general (a/cn.9/264): article 16, para 15. 60 art. 27 mal, zpo art. 1050. 61 delphi petroleum inc. v. derin shipping and training ltd. http://www.interarb.com/clout/clout068.htm 62 art. 37 (3) 63 cf. chapter 3. nordic journal of commercial law, issue 2003 #1 14 by examining art. 9 mal, the importance of the relationship between art. 9 and 27 mal has already been mentioned. a court decision explained the core of the question64. in the instant case, the court ruled that a subpoena duces tecum does not qualify as an interim measure in the meaning of art. 9 mal, instead, it is governed by art. 27 mal. the court held that the subpoena was issued in accordance with art. 27 mal and with the approval of the arbitral tribunal. nevertheless, such a subpoena can only be applied for in relation to an evidentiary hearing which, in that case, was held months, years before the application. therefore, the court clarified that for court assistance in taking evidence, proper integration into the taking evidence by the arbitral tribunal is needed. 10. setting aside an arbitral award (art. 34 mal) the reason why this provision was incorporated into the mal is that previously several national laws had no separate regulation on judicial review of arbitral awards. in many cases the same rules applied to them as to normal state court decisions. this was not appropriate because the difference of state jurisdiction and arbitration requires different reasons of recourse and one of the most essential advantages of arbitration, quick procedure could not be present. mal initiated a separate and individual regulation for arbitral awards where setting aside an arbitral award become the only possibility of recourse. the working group did not specify what kind of awards can be subject to recourse, and , in lack of time, it did not give a definition of ‘award’.65 again, this provision is nearly the same in all three legal sources66 except that the hungarian act also provides that the arbitral award shall not be subject to an appeal, solely setting aside the award can be requested. according to the mal, an arbitral award may be set aside by the court specified in article 6 in two main cases: if it is requested by a party or if the court finds any of the reasons to do so. the first group includes the following reasons for setting aside: a party to the arbitration agreement was under some incapacity in drafting the arbitration agreement; or the said agreement is not valid under the law to which the parties have subjected it or, failing any indication thereon, under the law of this state; or the party making the application was not given proper notice of the appointment of an arbitrator or of the arbitral proceedings or was otherwise unable to present his case; or the award deals with a dispute not contemplated by or not falling within the terms of the submission to arbitration, or contains decisions on matters beyond the scope of the submission to arbitration, provided that, if the decisions on matters submitted to arbitration can be separated from those not so submitted, only that part of the award which contains decisions on matters not submitted to arbitration may be set aside67; or the composition of the arbitral tribunal or the arbitral procedure was not in accordance with the agreement of the parties, unless such agreement was in conflict with a provision of this law from which the parties cannot derogate, or, failing such agreement, was not in accordance with this law68. 64 vibroflotation a.g. v. express builders co. ltd. http://www.interarb.com/clout/clout077.htm; cf. chapter 3. 65 report of the working group on international contract practices on the work of its sixth session a/cn.9/246, 129., paras. 192-194. 66 art. 34 (1) mal, zpo art. 1059 (1), hungarian arbitration act art. 54. 67 this latter requirement is not fulfilled if the requesting party refers to its breach by stating that the parties did not agree on the form of the award and objects to incoherent and incomprehensible reasons given by the arbitrators. navigation sonamar inc. v. algoma steamships limited and others http://www.interarb.com/clout/clout010.htm 68 art. 34 (2) a) mal, zpo art. 1059 (2), hungarian arbitration act art. 55 (1) nordic journal of commercial law, issue 2003 #1 15 the second group contains the circumstances under which a court by itself may set aside an arbitral award, which are: the court finds that the subject-matter of the dispute is not capable of settlement by arbitration under the law of this state; or the award is in conflict with the public policy of this state69. definition of public policy is not always easy. in international practice a court held that an award is contrary to public policy if it undermines the integrity of international commercial arbitration e.g. fraud, corruption, bribery or serious procedural irregularities70. in hungarian practice, the high court of hungary expressed that public policy does not mean only the most important constitutional values but also political aims and conceptions71. this list of reasons for setting aside an award is exhaustive and cannot be interpreted extensively72. looking further at the reasons for refusing enforcement and recognition of an award, nearly the same list can be found, i.e. the mal and the zpo mentions exactly the same reasons, while the hungarian law refers only to the last two73. the significance of this lies in the fact that the party can choose between requesting the court to set aside or to refuse recognition and enforcement of the award. this results the “salutary effect of avoiding ‘split’ or ‘relative’ validity of international awards, i.e. awards which are void in the country of origin but valid and enforceable abroad”74. a good practical example for this can be found in art. 1059 (3) zpo which provides that no application for setting aside the award may be made once the award has been declared enforceable by a german court. looking at the time factor concerning requesting the setting aside of an arbitral award, different solutions can be found: within three months according to the mal and the zpo75 and within sixty days (term of preclusion) according to the hungarian arbitration act76. these time limits can be extended by not more than one month according to the zpo77 if the request was made for correction and interpretation of an award or making an additional award. art. 34 (3) mal refers to correction, interpretation and additional award but it differs from the regulation by the zpo, because the mal provides only that the time limit is calculated from the date on which that request had been disposed of by the arbitral tribunal. 69 art. 34 (2) b) mal and zpo art. 1059 (2) 2. are unanimous that these circumstances can only be found by the court, while the art. 55 (2) of the hungarian arbitration act does not mention this. yet, logically, the two are the same because the court examines the case only if the parties requested it to do so and set aside the award only if it (the court) finds that the dispute is not subject to arbitration or the award is contrary to public policy. furthermore, the mal and the hungarian arbitration act, by the last reason for setting aside, mentions that the award is contrary to public policy, while the zpo provides that recognition and enforcement of the award should be contrary to public policy. 70 zimbabwe electricity supply commission v. genius joel maposa – the court held that since the arbitrator did not commit any moral turpitude, the award cannot be set aside by referring to an alleged conflict with public policy. harare high court judgment no. hh23198. 71 judgement by the high court of hungary no. gf.vi.30.848/1997/8. 72 see: d. frampton & co. ltd. v. sylvio thibeault and navigation harvey & fréres inc. http://www.interarb.com/clout/clout012.htm 73 art. 36 (1) mal, new york convention on the recognition and enforcement of foreign arbitral awards art. v., zpo art. 1060, hungarian arbitration act art. 59. 74 74 explanatory note by the uncitral secretariat on the model law on international commercial arbitration, commentary to art. 34, para 13., www.uncitral.org/english/texts/arbitration/ml-arb.htm 75 art. 34 (3) mal, zpo art. 1059 (3). 76 art. 55 (1), (3) 77 zpo art. 1059 (3) nordic journal of commercial law, issue 2003 #1 16 now let us turn to the question of what special effects the request of setting aside the award may have. the mal and the zpo78 provide for suspension of the setting aside proceedings incorporated into the latter79. suspension is important because it enables the arbitral tribunal to reconsider a special aspect of the case without being obliged to make a completely new decision. the mal contains that the court, when asked to set aside an award, may, where appropriate and so requested by a party, suspend the setting aside proceedings for a period of time determined by it in order to give the arbitral tribunal an opportunity to resume the arbitral proceedings or to take such other action as in the arbitral tribunal's opinion will eliminate the grounds for setting aside. the zpo simply states that the court, when asked to set aside an award, may, where appropriate, set aside the award and remit the case to the arbitral tribunal. in practice, the court sets a time-limit for the arbitral tribunal to reconsider the issue until which recognition and enforcement of the award are suspended, too and if the arbitral tribunal fails to take the appropriate measures, the setting aside procedure is continued. concerning the scope of remission to the arbitral tribunal, a very characteristic decision was made in d. frampton & co. ltd. v. sylvio thibeault and navigation harvey & fréres inc. where the court held that „the court cannot draw authority from art. 34 (4) mal to refer the matter back to the arbitral tribunal and request that it reconsider a question which was not originally considered by the arbitrators”80. the two examined national laws contain special provisions in addition to those harmonizing with the mal. the zpo, for example, lays down that setting aside the arbitral award shall, in the absence of any indication to the contrary, result in the arbitration agreement becoming operative again in respect of the subject-matter of the dispute81. the hungarian arbitration act further explains that complementary rules on the procedure of the state court are those of the hungarian code of civil procedure, except that the decision of the court should be subject to no appeal but the party may request recourse against a legally binding court decision82. 11. recognition and enforcement of an arbitral award (art. 35-36 mal) recognition and enforcement are not unanimously provided for in the mal, the zpo and the hungarian arbitration act. therefore, the three sources of law will be analysed separately. turning to the mal, the question is why such a provision was incorporated into the mal if the new york convention deals with the whole issue separately. the reason is that besides already existing bilateral and multilateral treaties, a supplementary network of recognition and enforcement was needed in order to provide equal treatment for domestic and international awards and to unify domestic legal provisions. art. 35 contains general rules while art. 36 provides for the grounds for refusing recognition and enforcement. an arbitral award, irrespective of the country in which it was made, shall be recognized as binding and, upon application in writing to the competent court, shall be enforced subject to 78 art. 34 (4) mal, zpo art. 1059 (4). 79 in common law systems, suspension is a separate procedure. 80 http://www.interarb.com/clout/clout012.htm 81 zpo art. 1059 (5) 82 hungarian arbitration act art. 57. nordic journal of commercial law, issue 2003 #1 17 the latter provisions and those concerning grounds for refusing recognition and enforcement (i.e. art. 36)83. during the course of the recognition/enforcement process, the court cannot reconsider the case84. the binding force mentioned in the provision appears between the parties from the date of the court decision. in a more general aspects, to achieve the expected results, reciprocity is not needed between the country where the award was made and the country at the court of which recognition or enforcement is sought. it is very important that the provision distinguishes between recognition and enforcement. it is logical that recognition is not only the condition of enforcement but also an individual institution. art. 35 (2) mal determines the criteria of submitting a request on recognition or enforcement to the court. accordingly, the party relying on an award or applying for its enforcement shall supply the duly authenticated original award or a duly certified copy thereof, and the original arbitration agreement or a duly certified copy thereof. if the award or agreement is not made in an official language of this state, the party shall supply a duly certified translation thereof into such language. this provision, which is the same as art. iv of the new york convention, sets maximum standards, therefore it would not be contrary to the harmonization to be achieved by the model law if a state retained even less onerous conditions85. this also means that no more and no stricter rules can be applied by a state, as has been found in murmansk trawl fleet v. bimman realty inc. where the court found that, in order to be enforceable, it was not necessary that a foreign award be confirmed under the law of the place where the arbitral award was issued. this conclusion was also supported by the fact that public policy favours the avoidance of delays once the parties have chosen a way of dispute resolution which is aimed at more efficient (and quick) dispute resolution86. art. 36 (1) mal provides that recognition or enforcement of an arbitral award, irrespective of the country in which it was made, may be refused only on any of the grounds listed. these grounds are the same as those in art. v of the new york convention and the grounds for setting aside an award (art. 34 mal), yet, compared with the latter there is one more ground for refusal which can be invoked by the party, i.e. the award has not yet become binding on the parties or has been set aside or suspended by a court of the country in which, or under the law of which, that award was made. apart from this, all grounds are the same in setting aside and refusal of recognition or enforcement in the mal, thus, the drafters wanted to give the possibility to the parties to choose between the two, irrespective of the country in which the award was made and is intended to be recognized or enforced. in order to avoid parallel procedures, art. 36 (2) provides that if an application for setting aside or suspension of an award has been made to a court referred to in the paragraph containing the extra ground for refusal87, the court where recognition or enforcement is sought may, if it considers it proper, adjourn its decision and may also, on the application of the party claiming recognition or enforcement of the award, order the other party to provide appropriate security. detailed procedural rules are not provided for in the mal because they depend on those of the certain country dealing with the issue. 83 art. 35 (1) mal 84 in robert e. schreter v. gasmac inc., the court followed this opinion and held that the case cannot be re-opened unless serious procedural irregularities or conflict with public policy is found. http://www.interarb.com/clout/clout030.htm 85 note to art. 35 (2) mal 86 http://www.interarb.com/clout/clout117.htm 87 art. 36 (1) a) v. nordic journal of commercial law, issue 2003 #1 18 rules of the mal are not exactly followed by the zpo and the hungarian arbitration act. the zpo deals with recognition and enforcement of domestic and foreign awards separately. art. 1060 (1) zpo provides that enforcement of a domestic award takes place if it has been declared enforceable. concerning grounds for refusal, art. 1060 (2) provides that an application for a declaration of enforceability shall be refused and the award set aside if one of the grounds for setting aside88. grounds for setting aside shall not be taken into account, if at the time when the application for a declaration of enforceability is served, an application for setting aside based on such grounds has been finally rejected; also in cases where a party may request setting aside or refusal, if the time-limits of application89 have expired without the party opposing the application having made an application for setting aside the award. from these provisions it is evident that the german regulation emphasizes the connection between the alternatives of setting aside and recognition/enforcement of an arbitral award. therefore, the procedure is simpler and dilatory tactics are also avoided because e.g. recognition/enforcement cannot be refused if a prior application for setting aside the award was refused on the same grounds. rules of recognition and enforcement of foreign arbitral awards can be found in art. 1061 zpo which shall be subject to the provisions of the new york convention and other treaties on the recognition and enforcement of arbitral awards shall remain unaffected90. if the declaration of enforceability is to be refused, the court shall rule that the arbitral award is not to be recognized in germany91. if the award is set aside abroad after having been declared enforceable, application for setting aside the declaration of enforceability may be made92. the hungarian arbitration act emphasizes that effect of an arbitral award is the same as that of a legally binding court judgement and it is to be enforced according to the act on court enforcement93. enforcement can be refused only in two cases: if the court finds that the dispute is not subject to arbitration according to hungarian law, or if the award is contrary to the hungarian public policy94. these possibilities are consonant to the second group of grounds for setting aside or refusal in the mal. although not all questions are explicitly settled by the act, the hungarian code of civil procedure is not a background source of law in all cases, only if the parties agreed to its application or if the arbitral tribunal having the right to decide upon its procedure admits to it. the ‘real’ supplementary source of law to the hungarian arbitration act is the new york convention95 according to which grounds for refusal of recognition/enforcement are the same as those of setting aside an award. the hungarian act uses provisions similar to the german regulation. hence, recognition and enforcement are to be refused if the award was set aside by the court; if no setting aside proceedings were initiated but the court finds that the subject-matter f the dispute is not capable of arbitration or the award is contrary to public policy. official commentary to the act 88 zpo art. 1059 (2) 89 zpo art. 1059 (3) 90 zpo art. 1061 (1) 91 zpo art. 1061 (2) 92 zpo art. 1061 (3) 93 act of parliament no. 53 of 1994, as provided by the hungarian arbitration act art. 58. 94 hungarian arbitration act art. 59. 95 enacted by 1962. évi 25. tvr. hungary made a reservation to the convention the application of which it allows only in connection with recognition and enforcement of awards made in any other contracting state and deriving from legal relationships which are qualified as commercial according to hungarian law. nordic journal of commercial law, issue 2003 #1 19 explains that ”this is necessary because by those two grounds legal interest if the state is that the award be not enforceable, therefore, refusal of enforcement does not depend only on whether the party requested refusal of enforcement. it is also possible that the arbitral award was made before the court decision on the lack of jurisdiction of the arbitral tribunal and enforcement of the arbitral award. the court is not obliged to enforce this award, not even when the other party did not request setting aside, because a court decision affirming its own jurisdiction binds all parties (this is suggested by public policy)96. art. 60 of the hungarian arbitration act harmonizes with art. 35 (2) mal in providing that “the party referring to or requesting enforcement of an arbitral award shall supply the duly authenticated original award or a duly certified copy thereof (thus, the award shall not be put into court deposit); and if the award is in a language other than hungarian, a duly certified translation is to be supplied. summarizing the analysed provisions we can contend that these national provisions are those which were mentioned before, i.e. which fill in the framework of the mal with specific domestic rules harmonizing with the civil procedure regulation of that certain country. summary it is a saluted fact that the uncitral model law on international commercial arbitration has been adopted by numerous countries of the world. in order to ensure further unification and effectuation of arbitral proceedings, even more countries should follow its exemplary provisions. implementation of the mal into national laws and its completion with domestic legal features enable developed countries to own an up-to-date arbitration regulation. taking over this example might help developing countries to create their own rules and integrate their legal regulation into a globalizing system of arbitration. german and hungarian law have fulfilled the latter requirement, as proven in this comparative analysis. unification of the rules of arbitration is being realized at a high level but, of course, with regard to unique legal characteristics of each country, full unification cannot be effectuated. in globalizing economy, advantageous features of arbitration may be strengthened by unification because if the different arbitration rules of different countries have the same core, participants of an international arbitration procedure shall not have to face unknown legal provisions and cross-border boundaries of arbitration can easily be eliminated. the model law provides for protective procedural measures, therefore, international commercial arbitration cannot be hindered by the countries who wish to protect their own interests by sticking to their own rules of procedure. hopefully, more and more countries will decide to adopt the model regulation in order to ensure a more global system of international commercial arbitration. 96 commentary to the hungarian arbitration act, commentary to art. 58-60. nordic journal of commercial law, issue 2003 #1 20 bibliography analytical commentary on draft text of model law on international commercial arbitration: report of the secretary-general (a/cn.9/264) hirsch, günther prof. dr.: schiedsgerichte – ein offenbarungseid für die staatlichen gerichte?, in: schiedsvz zeitschrift für schiedsverfahren 2/2003 huber, peter prof. dr.: das verhältnis von schiedsgericht und staatlichen gerichten bei der entscheidung über die zuständigkeit, in: schiedsvz zeitschrift für schiedsverfahren 2/2003 mádl ferenc – vékás lajos: nemzetközi magánjog és nemzetközi gazdasági kapcsolatok joga, nemzeti tankönyvkiadó, budapest 1997. mealey’s international arbitration report, may1995. report of the working group on international contract practices on the work of its sixth session (1983) uncitral yearbook, vol. xv : 1984 report of the working group on international contract practices on the work of its sixth session a/cn.9/246 várady tibor – john j. barceló – arthur taylor von mehren: international commercial arbitration: a transnational perspective, west publishing co. 1999. yearbook commercial arbitration xvii., deventer, netherlands, kluwer, 1992 www.dis-arb.de www.mkik.hu www.uncitral.org www.interarb.com/clout nordic journal of commercial law, issue 2003 #1 21 list of legal authorities uncitral model law on international commercial arbitration act of parliament no. 71 of 1994 (hungary) on arbitration and official commentary [1994. évi lxxi. törvény a választottbíráskodásról és a törvény indoklása] german code of civil procedure [zivilprozessordnung, referred to as: zpo] (http://bundesrecht.juris.de/bundesrecht/zpo/htmltree.html) new york convention on the recognition and enforcement of foreign arbitral awards 1. introduction 2. means of state court intervention into arbitration – in general 3. arbitration and substantive claim before court (art. 8 mal) 4. interim measures by a state court (art. 9 mal) 5. appointment of arbitrators (art. 11 mal) 6. challenge procedure (art. 13 mal) 7. termination of the arbitrator’s mandate (art. 14 mal) 8. jurisdiction of the arbitral tribunal (art. 16 mal) 9. court assistance in taking evidence (art. 27 mal) 10. setting aside an arbitral award (art. 34 mal) 11. recognition and enforcement of an arbitral award (art. 35-36 mal) summary bibliography list of legal authorities nordic journal of commercial law issue 2009#1 a theory of the law and policy of intellectual property building a new framework by yoshiyuki tamura* translated** to english by nari lee * the 21st century coe program “the law and policy of intellectual property: building a new global framework” is a research project that lasted for 5 years until march 2008. this article is an attempt to sum up the project achievements and research findings so far. as the project leader, the author gratefully acknowledges all the cooperation and supports that the project received in various forms during the last five years. ** this article has been first published in japanese as yoshiyuki tamura, chitekizaisan hōseisakugaku no kokoromi, 20 chitekizaisan hōseisakugaku kenkyu [hereinafter ‘intell. prop. l. & pol’y j.’] 1 (2008). in the course of translation into english, the author and the translator removed some footnotes that cite japanese sources. please see the original japanese version with full japanese citations, at http://www.juris.hokudai.ac.jp/coe/pressinfo/journal/vol_20/20_1.pdf. nordic journal of commercial law issue 2009#1 2 1. justification for intellectual property rights 1.1 natural rights theory versus incentive theory two conflicting theories explain and justify the foundation of intellectual property.1 at one extreme, natural rights theory justifies the foundation of intellectual property rights to be based on the natural right that originates from the act of creation, as one owns one’s own creation. at the other end of spectrum is the theory that allowing free-riding by the second runner who imitates would give the second runner an excessive advantage and provides a disincentive to the creator who invested in the intellectual creation as the first runner. incentive theory explains that intellectual property is founded to prevent this free riding. 1.2 two strands of natural rights theory 1.2.1 lockean labour based theory of property one strand of natural rights theory is based on lockean labour theory of property, which claims that a person is entitled to own the fruits of his labour. however, the lockean theory premises on the existence of the nature which the god has given to humans in common. the usage of the resources that becomes separated from the nature before it gets spoiled is justified. the spoilage justifies the claims of property on this fruits of one’s labour does not require consents from the others of the community.2 this aspect differs in intellectual property. as intellectual property is intangible and cannot be reduced to possession unlike the tangibles, intellectual property can be used without excluding the others. further the spoilage does not exist in the intangibles. thus, intellectual property starts from a different premise. in addition, lockean labour based property theory starts from the point that one holds a property right over ones own body(person), and as a corollary, one owns a property rights over ones labour and the fruits of the labour belongs to the same person. however, a flip side of the 1 see wendy j. gordon, intellectual property, in the oxford handbook of legal studies 617, 623-624 (peter cane & mark tushnet eds., 2003). see also robert p. merges et al, intellectual property in the new technological age 2-24 (4th ed., 2006). for a more detailed philosophical analysis, see peter drahos, a philosophy of intellectual property (1996); li yang (translated to japanese by jin xun), chitekizaisanken no kan’nen ni tsuite: h teishugi oyobi sono tekiy [the concept of ipr: the numerus clausus and its application], 12 intell. prop. l. & pol’y j. 35, 44-65 (2006). 2 john locke, two treatises of government, 286, 288-289 (peter laslett ed., 1988) (1698), drahos, supra note 1, at 43. nordic journal of commercial law issue 2009#1 3 principle of owning one’s own person is that one cannot claim a right over other persons.3 if that is the case, intellectual property right becomes unacceptable, as intellectual property right is a right that directly restricts other persons freedom of action and to justify this right based on the labour based property theory becomes internally contradictory. therefore, it is difficult to justify the foundation of intellectual property with labour based property theory.4 1.2.2 hegelian thesis of “mental property” (geistiges eigentum) another strand of natural rights based theory is the personality thesis that intellectual property protection is based on the personal rights of the creator.5 this is based on the hegelian thesis (g. w. f. hegel) who argues that authors own the expression of their will of freedom and the authors need to retain title over this even after the assignment of the tangibles (i.e. book) that embody the will. he further supplements this argument with the consideration of the users’ liberty by arguing that this mental property will lead to the progress of science and arts, and that the act of borrowing the substance of creation is permissible as long as it is not a verbatim copying of the creation.6 in general, hegel acknowledges a property right to be based on the expression of the free will. this is because of the fact that persons possessing free will in mental world still need to live in the external physical worlds, they need to make decisions in the external worlds. a property right can be understood as the first concretization of this free will, to claim that the external world as one’s own.7 from this, a property right needs to be recognised as a reflection of free 3 locke, supra note 2, at 287-288; drahos, supra note 1, at 43-44. 4 susumu morimura, locke shoy ron no saisei [revitalizing lockean theory of property] 121, 241-261 (1997). for an application of the lockean proviso to limit the scope of copyright, see gordon, supra note 1 at 11-12, and see also wendy j. gordon, a property right in self-expression: equality and individualism in the natural law of intellectual property, 102 yale. l. j. 1533, 1538-39, 1556-72 (1993). see also yoshiyuki tamura, efficiency, diversity and freedom challenges to the copyright institution facing the internet age, in 9 teollisoikeudellisia kirjoituksia 43 (katariina sorvari ed., 2008). 5 on the development of mental property theory, see for example, heinrich hubmann, das recht des schöpferischen geistes 70-71 (1954). in general, mental property theory is distinguished from personality right and is contrasted to it. see drahos, supra note 1, at 80, for the discussion on the right of the authors, contrasting the theories of kant and hegel. however, if one takes the view that the use of ownership is not a legislative technique but related to the origin of the protection, hegel’s theory may be contrasted to the labour based property theory that is based on the act of creation, as hegel starts from the free will of a person. 6 g. w. f. hegel, philosophie des rechts nach der vorlesungsnachschrift k. g. v. griesheims 1824/25 209-211, 230-238, 240 (karl-heinz ilting ed., 1974). 7 id. at 238; drahos, supra note 1, at 76-77. nordic journal of commercial law issue 2009#1 4 will, as a property becomes essential for the person who is the subject of this will to live in the social context. as a corollary, to deny a property right means also denial of free will.8 however, free will in the external world cannot be carried through in the external word in such form as it exists in the mental world. this is because in the external world, others property rights that are an embodiment of others free will exist. it is inevitable to restrict one’s property right, as long as it is related to the others’ property right. this coordination becomes one task of a social policy.9 it is generally believed that this consideration has a significant impact on intellectual property rights. this consideration would support the view that the excise of the property right should be confined to physical restrictions so that a person with a free will can live in a physical society and that the right need not to restrict others freedom beyond that is necessary to provide this property right. in other words, as intellectual property rights clashes with the exercise of others' property rights which are the embodiment of others’ free will, it becomes difficult to justify the intellectual property as an absolute right, because it is an expression of free will. it is thus logically inevitable that hegel justified copyright not just on the expression of free will, but also based on the incentives of promoting science and arts.10 1.3 traits of intellectual property rights and welfare while it is true that the intellectual property right is a right on the intangibles, it is needless to say that the subject matters of the intellectual property right, the “intellectual property” is different from the tangible objects. thus it is correct to call it a right on the information, in this context. however, the meaning of “information” may be questioned. the information that is the subject matter of intellectual property right actually is a pattern of human action. as the intellectual property right restricts the patterns of human actions, it restricts the freedom of 8 hegel, supra note 6, at 182, 184-185; drahos, supra note 1, at 77. 9 hegel, supra note 6, at 590-591. 10 in addition, japanese patent law allows exercise of rights against the independent inventor and this makes it difficult to view the right as a natural right. even if there is an original prior inventor, the applicant who files for patent would be prioritized. see japanese patent law art. 39.1, first to file rule. unless the prior inventor has prepared for production (japanese patent law art. 79.1), the original inventor cannot even use his/her own invention, as it would infringe the right of the patent holder. see yoshiyuki tamura, tokkyoken no k shi to dokusenkinshih [exercise of patent right and anti-monopoly law], in shij , jiy , chitekizaisan [market, freedom and intellectual property] 141, 143-144 (2003). thus to explain patent right as a natural right, it has to be where the exercise against the independent creator or inventor has to be denied, in the manner similar to a copyright. see for example, robert nozick, anarchy, state and utopia 182 (1974). however there is a room to justify this by using lockean proviso and a positivistic verification of this possibility has to be explored. see gordon, supra note 1, at 624. nordic journal of commercial law issue 2009#1 5 human actions. when the thing-likeness of the object of this right is emphasized, the right may be simply viewed to exist for a thing, rather than information, and the fact that the right cuts out a pattern of human action may be disregarded. intellectual property right is merely a privilege that artificially restraints patterns of human actions that human being otherwise would freely engage in, physically.11 as seen with the lockean and hegelian theses, if the intellectual property right is a right to restraint others freedom, the proposition of creation alone cannot justify the right that broadly restricts others` freedom. thus, the justification for intellectual property right needs to be refocused on the fact that the right protects not only the interests of the individual right holder, but also the system of rights benefits the interests of the many. in other words, it is possible to bring the perspectives of welfare or efficiency, that the public suffers from the loss from the decreased intellectual creation, unless free riding is prevented to a certain degree.12 13 in this case, the proposition of creation becomes a passive justification for restricting others’ freedom, based on intellectual property right system that actively implements the objectives of welfare and efficiency.14 11 see gordon, supra note 1, at 617, 619, 621-622. gordon argues that the label of property is used in intellectual property to describe the relationship between a person and a person, not confined to a person and a thing, as is the case of the ownership right in the tangibles. thus she stresses that intellectual property rights should be called a right over a similar patterns of human action. in addition to this, see drahos, supra note 1, at 17-21, 32-33. drahos starts from the philosophical question over the existence of the intangible thing and argues that intellectual property right is not a property right but a privilege to restrict the act of uses of others. 12 susumu morimura, zaisanken no riron [theory of property right] 168-171 (1995). 13 for constitutional law based position of this argument, see yoshiyuki tamura, ky chitsujo to minp gaku [competitive order and civil law], in k no shik keishiki [perspectives of competition law] 35, 50-52 (1999). narifumi kadomatsu, keizaiteki jiy ken [right to economic freedom], in 2 kenp [constitutional law] 213, 234-235 (takayuki andoh ed., 2001). a detailed explanation that uses the protection of fundamental right, duty to support may be criticized from the constitutional law scholarship that is premised on the traditional indirect application theory of constitutional law. 14 yoshiyuki tamura, chitekizaisan h [intellectual property law] 20 (4th ed., 2006). under the current japanese patent law, the discovery of useful medicinal plant in an unknown regions will still be denied of patent protection categorically, as long as it remains a mere discovery (patent law 2.1.1). this is regardless of the assessment whether there is a need to provide incentives for these types of exploration. this may be explained using the natural rights theory in a passive manner. the origin of the art. 2.1.1 of the japanese patent law that distinguishes the discovery of the law of nature and patentable invention is based on the perspective of josef kohler who actually uses the natural rights theory. see josef kohler, lehrbuch des patentrechts 13-17 (1908). see also yoshiyuki tamura, tokkyohatsumei no teigi [definition of patent invention], in shij , jiy , chitekizaisan [market, freedom and intellectual property], supra note 10, at 125, 128-129. nordic journal of commercial law issue 2009#1 6 1.4 difficulties in assessing efficiency and legitimization by democratic process at this juncture, it has to be stressed that the justification based on efficiency and the possibility of improving welfare, in and of itself does not automatically leads to the optimal allocation of resources. information asymmetry in the market creates transaction costs, and actual market operates in a competitive condition that is far from perfect competition and to bring the market to a perfect competition is highly difficult. furthermore, that an institution would optimally allocate resources may be illusory. in this context, it is more pragmatic to justify a specific intellectual property institutional arrangement would lead to an efficient result or a probable improvement of welfare, regardless whether such arrangement is optimal or wealthmaximizing.15 however, actively justifying the institution of intellectual property with efficiency perspectives raises the following question – that the assessment of efficiency is nearly impossible. gains or loss in social efficacy in the adoption of a particular institutional arrangement of intellectual property is difficult to measure. this is because not only the definition of efficiency is debated, but also comparison of each individual utility is difficult. moreover, as intellectual property right involves the trade off between the short term static efficiency against the improvement of long term dynamic efficiency, the assessment of its efficacy has the axis of time as well.16 these difficulties in the assessment of efficiency make it less convincing to use a consequential method to justify a specific institutional arrangement of intellectual property by looking at the degree of efficiency gains from its adoption. thus the positive justification of intellectual property needs to be based on not merely the degree of efficiency, but from the fact that the legitimacy of the process of adopting each arrangement. for example, a typical example would be the democratic decision making process used by the legislature and the justification for the intellectual property right in this case is partially dependent on the political responsibilities of the legislature. 1.5 pitfalls of legitimization by democratic decision and the legitimacy of process democratic decision making alone does not legitimize every decisions. this is not just because the nature of intellectual property right which necessarily restricts other’s freedom forces the 15 among the scholars, the incentive theory sometime understood as a theoretical ground to maximise wealth. see naoki koizumi, chosakuken seido no kihonriron [normative theory of copyright institution], in america chosakuken seido [us copyright system] 13, 25 (1996). it should be noted that even though the incentive theory is used in such manners by some, this is not always the logical conclusions from all of the incentive theories. 16 see for details, nari lee, toward a pluralistic theory on an efficacious patent institution, 6 j. marshall rev. intell. prop. l. 224 (2007), also available as berkeley center for law and technology, law and technology scholarship, paper 35, at http://repositories.cdlib.org/bclt/lts/35. http://repositories.cdlib.org/bclt/lts/35. nordic journal of commercial law issue 2009#1 7 trade offs between the freedom and efficiency. even from the point of efficiency alone, democratic decision making process has an inherent limitation. this due to the limitation of political process in the sense that the process is more easily influenced by the aggregated minority interests that may easily be organised than the interests that are disaggregated thus difficult to organise. despite this limitation of the political process, for example in the case of the ownership right of a tangible has a focal point where a use is connected to a specific tangible object, and the right is catered around this focal point. this does not mean that the ownership right over the tangibles does not regulate the person to person relationship, and that it simply regulates the person to an object relationship. even when it regulates a person to person relationship, the focal point stops an ownership rights to expand indefinitely. however, in the case of intellectual property where the patterns of human actions are regulated without any physical contact with a specific tangible object, a physical restriction against the expansion of a right does not exist. this is because there is no such focal point. moreover, as this may regulate human action nearly without any geographical limit, the right may also be expanded beyond territorial borders.17 with growth of economies, the value of the privileges reaches beyond the borders. in response to this, a rational choice of a company (especially mnes) would be to strongly protect their own intellectual property rights both domestically and internationally. as a result, intellectual property right may become stronger than it is demanded by the societal conditions. in deed, intellectual property rights show the tendency to be internationally expanded and to be strengthened, as exemplified by international treaties such as trips agreements, as well as bilateral agreements, as used unilaterally by the united states.18 even within a national border, the legislative process is biased due to the fact that the process reflects the interests of the easily organizable few large companies, than the interests of the smes and individuals that are difficult to organize. the democratic decision made in this manner may be biased in terms of welfare aspect.19 in addition, as argued in the above, the legitimization by the process cannot be sought from the legislative process alone, as freedom 17 see drahos, supra note 1. for a detailed discussion on the first connection thesis of drahos, see also nari lee, patent eligible subject matter reconfiguration and the emergence of proprietarian norms the patent eligibility of business methods, 45 idea 321, at 351-354 (2005). 18 for the discussions on the role of mnes on the international trend of of strengthening of intellectual property right through trips agreement and bilateral treaties, see peter drahos & john braithwaite, information feudalism: who owns knowledge economy? (2004); peter drahos, intellectual property industries and the globalization of intellectual property: pro-monopoly and anti-development?, 3 intell. prop. l. & pol’y j. 65 (2004); peter k. yu, the international enclosure movement, 82 ind. l. j. 827 (2007). see also peter k yu, five disharmonizing trends in the international intellectual property regime, in 4 intellectual property and information wealth 73, 96-97 (peter k. yu, ed., 2007). 19 dan l. burk & mark a. lemley, policy levers in patent law, 89 va. l. rev., 1575, 1637-1638 (2003); drahos, supra note 1, at 135-140. see also jessica litman, digital copyright 35-69, 144-145, 192-194 (2000) (on the us copyright law and institution). nordic journal of commercial law issue 2009#1 8 need to be ensured as well as the welfare. it follows from these perspectives that the theories on intellectual property institution need to consider four key elements and the division of their functions and roles market (or market oriented decision making) surrounding the uses of intellectual property, the legislative, the administrative and the judiciary.20 21 2. division of competence and functions among market, legislative, administrative, judiciary as a decision making process 2.1 utilization of market a market based decision provides stimulus for improved goods and services through the process of competition. in addition to this, as market operates via price mechanism that is based on supply-demand information of the goods and services, trading of goods and services in the market would lead to a more efficient allocation of resources, although it may not be optimal.22 market excels in inducing a certain type of innovation, and discovering and distributing of private and individual information. this function cannot easily be replaced by authoritative decision making23 by the legislative, administrative and the judiciary.24 moreover, the idea of liberty that essentially accompanies the market principle makes market oriented decision making more acceptable over the authoritative decision making.25 when the market oriented decision making is functioning, the decision making is not done by a specific individual and thus an individual person is not controlled by another individual. in this sense, market oriented decision making may promote more freedom and liberty than an authoritative 20 yoshiyuki tamura, tokkyoseido wo meguru h to seisaku [law and policy over patent system] 1339 jurist 124 (2007). 21 drahos, supra note 1, at 173-193, 199-223. see also li, supra note 1, at 59-64. 22 f. a. hayek, the use of knowledge in society, 35 am. econ. rev. 519 (1945); keiko ishihara, k seisaku no genri to genjitsu [competition policy principles and reality] 22-24 (1997); paul milgrom & john roberts, economic organization and management 27-28 (1992). 23 for the distinction between market based and authoritative decision, see yoshio hirai, h seisakugaku [theory on law and policy] 62-68 (2d ed., 1995). 24 id. at 121-125, 130; hayek, supra note 22; ishihara, supra note 22, at 6-7. 25 hirai, supra note 23, at 123; ishihara, supra note 22, at 3-5; hitohiko hirano, 1994-nendo nihon tetsugakkai gakujutsutaikai t itsu theme ni tsuite [on the theme of japan legal philosophy conference of 1994], 1994 h tetsugaku nenp [annals legal phil.] 1, 4 (1995). nordic journal of commercial law issue 2009#1 9 decision making.26 as a corollary, when questions concerning efficiency are raised, it may be sufficient to relegate it to market, as long as the market is functioning. 2.2 when should law intervene? (authoritative decision) 2.2.1 eligibility of technological determination law needs to intervene when the market does not function. however, it is important to note that it is nearly impossible to build an institution that is optimal from the point of efficiency through authoritative decision making. as a definitional problem, for example, when the comparison of individual utility is difficult, a gauge to assess efficiency cannot be assured. even if the gauge can be obtained, assessing efficiency gains or loss from a specific decision is not far from easy.27 as market has the advantages that are described in the above, this is the very reason why a functioning market needs to be utilized. even when an authoritative intervention is considered, it is necessary to approach it functionally and ask if there is really a market failure, if the authoritative intervention could improve the situation, and which institution then would be most competent in making that decision. in this manner, it is possible to adopt efficiency based perspective to the construction of the institution. some administrative organization may be more competent than the legislature and the judiciary on observing market trends and may be better equipped to issue a speedy response that meets the market condition. for example, in intellectual property, patent and trade office is a typical example of such organisation. 2.2.2 question of political responsibility the difficulty in measuring efficiency makes it also difficult to legitimize the norm (rule) that is established through authoritative decision making, simply by the efficiency of the outcome alone. as a result, the legitimization of rule (norm) needs to be sought not just from the achievement of efficiency, but also from the process that has been employed to get there. in cases where there is uncertainty over the efficiency, the legitimization of the process becomes more desirable. in addition, these types of political responsibility need to be borne by the legislative, and not by the judiciary. 26 when a good such as intellectual property where an authority need to interfere to produce it via the market, the freedom and liberty enjoyed as a result of this interference cannot be based on the market based decision. rather, this is a restriction based on the authoritative decision making. 27 see for an example of patent system and law, lee, supra note 16. nordic journal of commercial law issue 2009#1 10 2.2.3 distortion in the authoritative decision making process however, complexity still persists. smes and consumers interests are likely to the ip users’ interests. as argued in the above, despite their aggregate sum of interests may be large, the interests that are difficult to be coordinated and organized may not be prioritized than the right holders interests, often represented and easily organized by a large companies, even when their aggregate interests is smaller. in this context, the judiciary may have a better competence to ensure their interests than other authorities.28 3. conceptualising a theory of intellectual property law and policy 3.1 introduction a process oriented perspective of intellectual property right provides important insights on the institution of law. i have earlier proposed the following three steps to be part of the interpretative and legislative theory in the construction of intellectual property institution.29 first is the perspective of market oriented intellectual property law. by focusing on the sharing of function between the market and law, the junction where the market stops and law need to intervene must be sought. secondly, when the law based decision is necessary, the next step should be to determine which organization would be best suit to exercise competence and actually make the decision. (institutional perspective) for example, a decision need to be done on whether the court based decision is sufficient, or whether an administrative organization such as the patent offices needs to intervene. at this point, the selection on the concrete forms and substance of regulation need to be evaluated. for example, would a remuneration right (including compensatory damages) be sufficient or an injunctive relief is required; should the protection be such that a system of registration is adopted so that assignment of rights can be facilitated. in earlier work i called this a functional perspective on intellectual property law. 28 yoshiyuki tamura, gijyutsukanky no henka ni tai shita chosakuken no seigen no kanousei ni tsuite [on the possibility to limit the scope of copyright in response to the technological changes], 1255 jurist 124 (2003). 29 yoshiyuki tamura, chitekizaisan h s ron [introduction to intellectual property law], in shij , jiy , chitekizaisan [market, freedom and intellectual property], supra note 10, at 73; tamura, supra note 14, at 7-21. nordic journal of commercial law issue 2009#1 11 thirdly, the impact of the proposed rule as an outcome the above exercise on the individual freedom of thought and action need to be scrutinised. from this perspective of intellectual property law as system of law governing individual freedom, it needs to be examined whether the proposed rule would excessively control and restrict the individual freedom. this paper argues that a process oriented perspective needs to be added to these three steps in the construction of intellectual property law institution. the view to think about intellectual property law from three different aspects of market oriented, functional, and freedom governing institution of law aims to actualise an efficacious institution through division of the competences (market, legislative, administrative, and judiciary) and to ascertain individual freedom. it includes the process oriented perspective30. these two view points i.e. process and division of competence may be said to form the fabric of the theory of intellectual property to propose a system of intellectual property. in the following, i would like to clarify how the process oriented perspective that is proposed in the above is applied to actual makings of intellectual property law. 3.2 division of functions in market and law the institution of intellectual property functions through the market that creates by enabling the trading on entitlements. the entitlements that these transactions are based stem from the artificial restriction certain patterns of human actions which otherwise physically could be done freely. in this sense, intellectual property law utilises the market based decision making. at the same time, because of these market-based exchanges would not occur without the legal grants of rights, it should be viewed as a legal intervention, as it does not completely delegate the decision making to the market. 3.2.1 determining the necessity of protection the protection of an intellectual property right is not necessary if the market functions without the intervention of the intellectual property system. this position is justified from the incentive theory, and not from the natural rights theory as it has been argued in the above.31 when a specific subject matter is not regulated explicitly in the intellectual property law, one may argue that there is a need to provide legal protection, and that further this legal deficiency calls for a 30 on the foundation of the intellectual property, see yoshiyuki tamura, chosakuken h gaisetsu [copyright law] 7-8 (2d ed., 2001). 31 tamura, supra note 14, at 8-14. see also nobuhiro nakayama, multimedia to chosakuken [multimedia and copyright law] 4-5 (1996). nordic journal of commercial law issue 2009#1 12 legislation (legislative reform). these types of arguments cannot be grounded on the incentive theories, but on the natural rights theory. for example, when relevant incentives are present, such as market lead time and the reputations, appropriate level of innovative production may be developed without the legal intervention of intellectual property. in this case, an artificially constructed right loses the ground to restrict physically “free” human actions. this in turn, means that a creation of intellectual right over this particular subject matter becomes groundless as well. 3.2.2 distinguishing market oriented approach from market driven approach even when a market oriented intellectual property law is adopted, it is important to distinguish this from other market based approaches such as a market driven approach. a market driven approach views market as a universal solution, in the sense that law creates market based on the exclusive rights on intellectual property, and that market takes care of the rest.32 the market driven approach is based on the optimistic view on the occurrence of efficient transaction, which underestimates the costs from the exclusive rights.33 needless to say, the coasean world where the rational parties have perfect information, and where there is no transaction costs (and further no wealth effect), thus making the coase theorem real, actually does not exist.34 32 see frank h. easterbrook cyberspace and the law of the horse, 1996 u. chi. legal. f. 207 (1996), applying coase theorem to intellectual property law. compare, hideaki serizawa, procd v. zeidenberg no bunseki [analysis on procd v. zeidenberg], 61 hougaku 189, 231-243 (1997). a concrete application of these types of thinking is the prospect theory that argues the that patent law coordinate the uses surrounding the invention, by preventing the duplicative investment and rent seeking, by early grant of right. see edmund w. kitch, the nature and function of the patent system, 20 j. law & econ. 265 (1977). see also i. trotter hardy, the proper regime for cyberspace, 55 u. pitt. l. rev. 993 (1994) (utilising this argument to put forward a strict liability rule for copyright infringement by a third party). see also the opinion of judge easterbrook in procd, inc. v. zeidenberg, 86 f.3d 1447 (7th cir. 1996); american geophysical union v. texaco inc., 60 f.3d 913, 930-932 (2d cir. 1994). against these applications, see yoshiyuki tamura, ch sh ka suru biotechnology to tokkyoseido no arikata (2) [patent protection of biotechnology in the information age (pt. 2)], 11 intell. prop. l. & pol’y j. 65, 68, 73-78 (2006). see also tamura, supra note 4; maiko murai, chosakuken shij no seisei to fair use (1)(2) [copyright market and fair use (pts. 1 & 2)], 6 intell. prop. l. & pol’y j. 155 (2005), 7 intell. prop. l. & pol’y j. 139 (2005). 33 robert p. merges & richard r. nelson, on the complex economics of patent scope, 90 colum. l. rev. 839, 877 (1990); mark a. lemley, the economics of improvement in intellectual property law, 75 tex. l. rev. 989, 1048-51 (1997); mark a. lemley, ex ante versus ex post justification for intellectual property, 71 u. chi. l. rev. 129, 148 (2004); burk & lemley, supra note 19, at 1648-1649. 34 ronald h. coase, the firm, the market and the law 114 (1988): see also lemley, economics, supra note 33, at 1048. nordic journal of commercial law issue 2009#1 13 it is likely that the cost from the exclusive rights becomes greater, the earlier the rights are allocated.35 in addition, the information (if it is not encoded) can be accessed and used by any body and as such, it has characteristics of public goods. when an exclusive right is granted on its use, it may create costs over the uses that would have remained unrestricted, without intellectual property. 3.2.3 means to identify the original right holder when incentive theory is used as a foundation for intellectual property rights, it may deny the axiom that the creator is always entitled to a right.36 of course, to incentivize creative activities, it may be necessary to return the benefits [of creations] to the creators themselves. however, if the rights are, for example, given to the persons who the creators trade with, then the benefit may be shared with the creators through this transaction. further still, if there is a need to give incentive to those other than the creators, then an arrangement to allow the benefits to flow to these others may be sufficient. for example, it may recommendable to grant the rights to the organisations that distribute the benefits.37 moreover, to stimulate the use of the intellectual property, external users, it may be preferable to provide environment where the permission for use of intellectual property is easily obtainable by the external users. if these above considerations are prioritized, this would lead to a view that in the case of the creation which typically requires many producers, a uniform control by an organization and not the individual creator may be preferred. the number of the users needs to be considered in the determination to what degree should the utilisation of the intellectual property need to be prioritized. in this 35 see for the similar argument against the scope of protection of the exclusive right, merges & nelson, supra note 33, at 877. an extremely large cost leads to the tragedy of the commons. see m. a. heller & r. s. eisenberg, can patents deter innovation? the anticommons in biomedical research, 280 science 698 (1998). see also nari lee, patented standards and the tragedy of anti-commons, 7 teollisoikeudellisia kirjoituksia 1 (ari saarnilehto ed., 2006), also available at http://ssrn.com/abstract=881702; kenji yamamoto, gendai fuh k i h gaku ni okeru ‘kousei’ tai ‘kenri’ [welfare and right in contemporary tort law], 133 minsh h zasshi 875, 903-904, 912-921 (2006). 36 under the current law, there are several variation. as the case of copyright on works made for hire (japanese copyright law art. 15.1), there is no established principle that the right belongs to the creator. see tamura, supra note 29, at 388-390. moreover, the case of employee invention, the japanese patent law provides for a system where the employer could claim the right as their own. see for the policy discussion on this, yoshiyuki tamura & noriyuki yanagawa, shokumu hatsumei no taika ni kansuru kisorironteki na kenkyu [on the theoretical foundation for evaluating the remuneration for an employee invention], 128 minsh h zasshi 447, 448-451 (2003). also yoshiyuki tamura, shokumu hatsumei no arikata [on employee invention], in shokumu hatsumei [employee inventions] 2, 9-13 (yoshiyuki tamura & keizo yamamoto eds., 2005). see also yoshiyuki tamura, s sakusha no hogo to chitekizaisan no katsuy no s koku [reconciling protection of creator with utilization by third party in intellectual property law], 29 nihon k gy shoyukenh gakkai nenp [ann. indus. prop. l.] 95, 97-98 (2006). 37 see yoshiyuki tamura, aoiro hakk diode jiken k soshin wakaikankoku ni tsuite [blue led case and reasonable remuneration for employee’s invention], 8 intell. prop. l. & pol’y j. 1, 5-6 (2005). http://ssrn.com/abstract nordic journal of commercial law issue 2009#1 14 manner, the allocation of the intellectual property right needs to be based on diverse policy considerations.38 39 3.3 division of competences among the legal decision making bodies protection of intellectual property right is called for, when the legal intervention is called for in terms of the division of functions of the market and the law. when an intellectual property right is selected over the market, the next questions would include which authority (among legislative, administrative, and the judiciary) would make the decisions on the types of rights, the scope of rights, and the available remedies through which a right of exclusion could be enforced, for example whether a remunerative right is sufficient or a separate regulation is required. 3.3.1 division of competence based on organizational/technical proficiency the choice of the decision making body among the legislative, the administrative and the judiciary, should be based on the consideration on the each organisation’s competence for expert decision making and stability of decision. this perspective of technical proficiency may be applied widely through various legislative and interpretative theories of intellectual property, in the ranges of the regulation of verbatim industrial copying,40 definition of patent eligible invention,41 doctrine of equivalents,42 defence of invalidity in patent infringement,43 file 38 for details, see tamura, reconciliation, supra note 36. see for the warning against the romantic authorship that does not take a strictly incentive based theory, james boyle, shamans, software, and spleens: law and the construction of the information society 42, 56-59, 121-143, 155, 168-173, 177179, 183-184 (1996). 39 furthermore, an interpretation that aims to allow fragmented allocation of the right may not be wise. for example, if a new type of right that is acknowledge by law after the assignment of the original copyright, it is possible to reserve the new right on the original right holder (assignor). when one considers the impact on the third party of the transaction, after the right has been originally allocated, this fragmented allocation of rights may not be desirable policy direction. for an opposing view to this position, see tadashi fujino, chosakurinsetsuken j tokeiyaku no teiketsugo ni h teisareta shibunken no kizoku [who owns the right of public transmission newly legislated after the assignment of neighbouring rights?], 19 intell. prop. l. & pol’y j. 313 (2008). 40 yoshiyuki tamura, fusei k h [unfair competition law] 282-287 (2d ed., 2003). 41 tamura, supra note 14. on biotechnology, see also yoshiyuki tamura, ch sh ka suru biotechnology to tokkyoseido no arikata (1-3) [patent protection of biotechnology in the information age (pts. 1-3)], 10 intell. prop. l. & pol’y j. 49, 11 intell. prop. l. & pol’y j. 65, 12 intell. prop. l. & pol’y j. 91 (2006). on business method patents, see lee, supra note 17. 42 tamura, supra note 29, at 104-106. nordic journal of commercial law issue 2009#1 15 wrapper estoppel,44 scope of enquiry for cancellation of trial decision,45 binding power,46 scope of the double jeopardy principle,47 protection of applied arts,48 interface of exercise of intellectual property right and anti-monopoly law49 and the like. 3.3.2 window on legitimacy and correction of the bias a new proposal for the decision of the legislative and the judiciary two more distinctive perspectives need to be added to this perspective of technical proficiency. on one hand, as intellectual property institution temporarily restricts freedom, its active justification need to be founded on the efficiency gains from the adopting of the intellectual property. however as argued in the above, it is difficult to verify the efficiency gain and thus instead, it becomes necessary to justify the institution by legitimization of the democratic process through which the institution is adopted. however as noted in the above, the process of the policy making is structured in such manner that it reflects easily the interests that may be easily organised (ex. large companies) and that the interests of the individuals or smes whose interests are relatively difficult to organise. this structural bias needs to be corrected. 43 yoshiyuki tamura, tokkyoshingai sosh ni okeru k chigijutsu no k ben to t zenmuk no k ben [defence of prior art and invalidity in patent infringement litigation], in kin teki chitekizaisan h no riron [functional theory of intellectual property] 58 (1996). for a detailed discussion, see makiko takabe, tokkyoh 104-j -no-3 wo kangaeru [consideration on patent law article 104-3], 11 intell. prop. l. & pol’y j. 123 (2006). 44 yoshiyuki tamura, handankikan bunka no ch seigenri to shiteno h taikinhangen no h ri [reconsidering filewrapper estoppel], 1 intell. prop. l. & pol’y j. 11 (2004). see also hiroshi yoshida, saikin no saibanrei ni miru kinhangen no kenky : shinpan [a study of estoppel in recent case: new edition], 1 intell. prop. l. & pol’y j. 41 (2004); yasuyuki echi, shinsakeika kinhangen no rirontekikonkyo to handan wakugumi (1)-(5) [the doctorine of “prosecution history estoppel” (pts. 1-5)], 155-6 h gakurons 1 (2004), 156-1 gakurons 37 (2004), 156-2 h gakurons 112 (2004), 157-1 h gakurons 20 (2005), 157 h gakurons 28 (2005). 45 yoshiyuki tamura, tokkyomuk shinpan to shinketsutorikeshisosh no kankei ni tsuite [relashionship between trial for invalidation of a patent and suit against trial decision], in kin teki chitekizaisan h no riron [functional theory of intellectual property], supra note 43, at 138, 138-162. 46 kazuo masui & yoshiyuki tamura, tokkyo hanrei guide [patent case law guide] 281-287 (3rd ed., 2005). see also hiroaki murakami, torikeshi sosh ni okeru shinri no han’i to hanketsu no k sokuryoku [scope of examination and binding force of judgment in administrative litigation], 10 intell. prop. l. & pol’y j. 145 (2006). 47 masui & tamura, supra note 46, at 289-294; ayumu iijima, tokkyomuk shinpan ni okeru ichijifusairi [double jeopardy in patent invalidation proceedings], 16 intell. prop. l. & pol’y j. 247 (2007). 48 tamura, supra note 29, at 31-36. see also liu hsiao-chien, jitsuy hin ni fusareru design no bijutuchosakubutu gait sei (1)(2) [copyrightability of functional designs (pts. 1-2)], 6 intell. prop. l. & pol’y j. 189 (2005), 7 intell. prop. l. & pol’y j. 177 (2005). 49 tamura, supra note 10. see also tadashi shiraishi, gijutsu to ky s no houtekik z [legal structure of technology and competition] (1994); tadashi shiraishi, chitekizaisanken no license kyozetsu to dokkinh [refusal to license an intellectual property and antimonopoly law], in 21-seiki ni okeru chitekizaisan no tenb [prospect of intellectual property in the 21st century] 229 (institute of intellectual property ed., 2000); toshifumi hienuki, chitekizaisanken to dokusenkinshih [intellectual property rights and antimonopoly law], in shij , chitekizaisan, ky s h [market, intellectual property, competition law] 1 (2007) nordic journal of commercial law issue 2009#1 16 these two perspectives can be applied to the division of the competence of the legislative and the judiciary, in the context of intellectual property law. first, when the judiciary faces an interpretation of law to create an intellectual property right or to strengthen it, the judiciary need to respect the political responsibility borne by the legislative branch concerning the efficiency determination. this means that the judiciary need to adopt a means of interpretation according to the objective of the law, derived from the structure of the law. one reason behind this is because the court is a suitable institution to deal with political responsibility. in addition to this, a comprehensive decision or a decision that requires a specific expertise, the court may have a limited competence. this is the problem of technical proficiency. moreover, if the right holders’ interests are easily reflected in the policy making process, due to the structural bias, a correction of this bias via the route of legislation is required. thus the determination on this aspect may have to take a cautiously path. an example of this in japan is the question surrounding the copyright infringement liability, especially on the third party liability. recently the courts in japan has applied a direct infringement liability to those who provide means and services to induce large scale private copying or non-commercial use of copyrighted material, through a type of vicarious liability doctrine known as the “karaoke doctrine”.50 as a result, the courts allowed claims for injunction against these third parties.51 originally, the doctrine was applied to an area where there is a personal control over the act of physical uses and users. however when this doctrine is applied to the provision of means [of physical uses], an ironical conclusion may occur. this is because when the actual uses that are tied to the finding of the infringement liability might be allowed non infringing uses that are under the exceptional provisions in the copyright law. when the court is allowed to interpret the law in this manner, this amounts to the judicial creation of infringement. this would require a separate debate on the questions such as whether to regulate such type of conduct at all (ex. a conduct of providing a system that induces 50 karaoke doctrine is based on the japanese supreme court decision of 15 mar. 1988, 42 minsh 199 <club catseye>. see tamura, supra note 30, at 149-153. this case dealt with the liability of the karaoke bar proprietor over the singing conduct of customers. the decision is understood to have established two requirements for karaoke bar proprietor’s third party liability, that is, (i) the bar proprietor manages (management) the conduct of the customers and (ii) derives the benefits from this (benefit). these two conditions are generally understood to form the basis of the third party liability for copyright infringement in japan. see for the applicability and critique on the decision, tatsuhiro ueno, iwayuru ‘karaoke h ri’ no saikent [reexamining so-called karaoke doctrine], in chitekizaisanh to ky s h no gendaitekitenkai [recent development of the academic disputes on the intellectual property laws and the competition law] 781 (2006). 51 see tokyo d. ct. decision of 9 apr. 2002, 1780 hanrei jih 25 <file rogue neighbouring right provisional order>; tokyo d. ct decision of 29 jan. 2003, 1810 hanrei jih 29 <same, interim decision>; tokyo d. ct decision of 11 apr. 2002, 1780 hanrei jih 25 <file rogue copyright provisional order>; tokyo d. ct decision of 29 jan. 2003, heisei 14 (wa) 4249 <same, interim decision>. see for the detailed case commentary, yoshiyuki tamura, kensaku site wo meguru chosakukenh j no shomondai (3) [copyright issues on search engines (pt. 3)], 18 intell. prop. l. & pol’y j. 31 (2007). nordic journal of commercial law issue 2009#1 17 a non commercial uses and private copying in large scale); if regulated, should it entitle a right holder a pecuniary remuneration right similar to the rights provided by the private audio-visual recording levy system, or should it include also injunctive relief. these questions are best considered to be within the mandate of the legislature.52 needless to say, this does not mean that the judiciary should not interpret the law in such ways to create or strengthen an intellectual property right. however, what this paper argues is that such interpretation should also consider the structure of the law and objectives of the institution that can be deduced from it. for example, a claim based patent system creates a principle that the alleged infringing technology in the patent infringement litigation will fall outside the scope of the patent protection, if the claim does not literally read on the alleged infringing technology. (japanese patent law art. 70.1) however, if claiming system aims to ensure the predictability among the interested parties, the court may affirm the infringement even when the claim does not read on the allegedly infringing devise, if a specific element in a patent claim can be easily substituted. (doctrine of equivalents).53 this interpretation is one implementation of legislative objective and naturally, is within the purview of the judicial mandates. in addition, under the current laws, there should be cases where an affirmative intervention from judiciary may be allowed. this would be case when it is obvious that where it is against the efficiency and there is no obvious risk to inadvertently provide overlapping regulation, as there may be no problem of conflicting technical proficiency. an example of this is the application of the general tort principle under the japanese civil code art 709 to a type of conduct that is not explicitly regulated in the intellectual property law. as long as this is an interpretation that creates an intellectual property right, it has to be cautiously considered, in principle. however, an exception does exist. this is because the decision that the law should regulate a type of free riding conducts could have been made 52 for this reason, a joint tort liability may be utilised for those who provide a physical means, tied to the infringement of the physical users. see sup. ct decision of 2 mar. 2001, 55 minsh 185 <night pub g7 appellate decision>. see also for case commentary, yoshiyuki tamura, karaoke s chi lease gy sha no ky d fuh k isekinin no seihi [the liability of karaoke device lease business proprietor], 694 nbl 14 (2000). in this case, i argued elsewhere that the scope of the injunctive relief to be equivalent to that of the scope of indirection infringement in patent law. see tamura, supra note 51; yoshiyuki tamura, takin gata kansetsushingai seido ni yoru honshitsutekibubun no hogo no tekihi [is it proper to protect essential part of the invention under the doctrine of contributory infringement?], 15 intell. prop. l. & pol’y j. 167 (2007). see also katsumi yoshida, chosakuken no ‘kansetsushingai’ to sashitomeseikyu [‘indirect infringement’ of copyright and injunction], in shinsedai chitekizaisanh seisakugaku no s sei [establishing law and policy of intellectual property] 253 (yoshiyuki tamura ed., 2008). 53 together with other requirements, see sup. ct. decision of 24 feb. 1988, 52 minsh 113 <ball-splined shaft bearing decision>. see tamura, supra note 14, at 224-237. nordic journal of commercial law issue 2009#1 18 through a democratic decision making process, as long as the regulation is not an excessive intervention. this may be the case of intellectual property laws, where there is an obvious efficiency based value judgement behind the entire system of laws.54 for example, before the enactment of art. 2.1.3 of the law on prevention of unfair competition in japan, the courts used tort to regulate a verbatim commercial copying (of external design, features and shapes of commercial products). (tokyo h. ct. decision of 17 dec. 1991, 23 chisaish 808 <mokumekesh shi>)55 similarly, the court used tort principle to protect a comprehensive data base which fell outside the scope of copyright protection for lack of originality (creativity). (tokyo d. ct. decision of 25 may 2001, 1774 hanrei jih 132 <super front man>) mainly these are the cases where there is obvious need to decide without having to wait for the legislation. when it is believed that a separate legislation is required to provide the conditions for protection, the court need to avoid sole judicial creation of intellectual property right. some of the recent japanese court cases show a tendency to apply the general tort based liability on the free riding conducts, while holding that the act is outside the copyright protection, without considering specific factors why copyright law shall not cover these conducts. (for example, ip h. ct. decision on ts kin daigaku law course case.56) these decisions are questionable in light of the perspectives of the above. this is because if there is a problem in the law, it needs to be corrected through legislative process and the interests of those who would benefit from the creation of intellectual property right would be reflected in this process. in principle, the decision whether such protection of their interests is necessary or not should be mandated to the democratic decision making process.57 secondly, a limiting interpretation of an intellectual property right need to be considered as a judicial breathing room to reflect the users’ interests, and sometimes, irrespective of the 54 yoshiyuki tamura, chitekizaisanken to fuh k i [intellectual property rights and torts], in shinsedai chitekizaisanh seisakugaku no s sei [establishing law and policy of intellectual property], supra note 52, at 3. see also atsumi kubota, fuh k ih gaku kara mita publicity [a note on the role of tort law in the protection of the rights during the publicity building process: a tort law perspective], 133 minsh h zasshi 721, 741 (2006); nobuhiro nakayama, chosakukenho [copyright law] 209 (2007). in this case, to acknowledge the tort liability, it is believed that the interests in suit is socially acknowledged as an interest that merits legal protection. see kubota, supra, at 741-743. however, this paper argues that at least in japan, there is a general value judgment embodied in the intellectual property that allows law to regulate the free riding to the extent that there are insufficient incentives for research and development. this is a competitive prosperity theory, pointed out by hasegawa, supra note 21, at 18-24. the reason why the judiciary has to take a reserved approach is not because there is no social acknowledge for the need but because the technological decision making is so complex that it makes it difficult to take the political responsibility. thus the premise that kubota requires may not be necessary. 55 yoshiyuki tamura, tanin no sh hin no deddo copy to fuh i no seihi [verbatim and slavish imitation and tort], 14 tokkyokenky [patent studies] 32 (1992). 56 takakuni yamane, case note, ip h. ct. decision of 15 mar. 2006, heisei 17 (ne) 10095 et. al., 18 intell. prop. l. & pol’y j. 221 (2007). 57 tamura, supra note 54. nordic journal of commercial law issue 2009#1 19 legislative objectives. this is because of the bias in the policy making process. when one considers the structural difficulties to reflect the interests of the intellectual property users in the legislation, the correction of this bias should not be relied on the legislation, and in this context, the court need to ensure the freedom of the users. this is particularly so in the case where the interpretation is not based on the efficiency gains, but on the ground of freedom. this requires neither technical proficiency nor political responsibility and thus calls for an active intervention of the judiciary. for example, a general exception of fair use does not exist in the japanese copyright law.58 in this context, the japanese courts have freely adopted various means to limit copyrights. 59even in cases where such existing doctrine or limiting provisions cannot be applied, it is believed that the courts should be allowed to generally limit a copyright to ensure the freedom of the users.60 61 3.3.3 adjusting a traditional model of rechtstaat /rule of law principle adoption of a new perspective on the division of competence by the administrative and the judiciary in the context of the japanese patent law, the majority of commentator view that the there is no discretion in the patent office as the patent grant is based on an “entitlement” perspective (i.e. 58 yoshiyuki tamura, kensaku-site wo meguru chosakukenh j no shomondai (1) [copyright issues on search engines (pt. 1)], 16 intell. prop. l. & pol’y j. 73, 96-99 (2007). 59 there are several examples. see for example, tokyo h. ct. decision of 18 feb. 2001, 1701 hanrei jih 157 <setsu-getsu-ka>. the court ruled that the copyright of the calligraphy artwork included in the advertising catalogue for lighting equipment is not infringed as the size of the reproduced calligraphy in the catalogue, 3-9 mm per letter, was such that the creative expression in the calligraphy is not reproduced. in another decision, tokyo d. ct. decision of 25 jul. 2000, 1758 hanrei jih 137 <hataraku jid sha>, the court ruled on the act of including the photograph of the municipal bus in a book. the bus in question had a painting art work on the body of the bus and the infringement of the painting artwork was alleged. the court utilised the japanese copyright law art. 46 that provides copyright exception to the use of the work that is constantly displayed in the open and accessible outdoors, and denied the copyright infringement of the painting work. for the commentaries, see maiko murai, access-kan na chosakubutsu ni taisuru k sh no riy no jiy [freedom of use in the publicly accessible copyrighted work], 10 intell. prop. l. & pol’y j. 247 (2006). see also toshiaki iimura, chosakuken shingaisosh no jitsumu [the practice of copyright infringement litigation], in chosakuken seido gaisetsu oyobi ongaku chosakuken [copyright system and music copyright right] 207, 211-212 (meiji univ. law sch. ed., 2006). 60 tamura, supra note 28. 61 to deal with the bias in the policy making process, the correction is expected not only by the judiciary but also through the governance of the policy making process on the intellectual property so that the interests of the minorities users and the developing countries is reflected in this process. this governance approach is exemplified by cooperation among the developing countries patent offices. see peter drahos, trust me: patent offices in developing countries, (austl. nat’l u. cgkd working paper, nov. 2007), available at http://cgkd.anu.edu.au/menus/workingpapers.php. another governance based approach is ngo based movement such as creative commons. see creative commons digital jidai no chitekizaisanken [creative commons – intellectual property rights in digital age] (creative commons japan ed., 2005). http://cgkd.anu.edu.au/menus/workingpapers.php. nordic journal of commercial law issue 2009#1 20 the applicant is entitled to a right, as long as the application meets the patentability requirement) of a patent right and patentability.62 if this “entitlement” view is held as an antithese of the view that a patent right is a sovereign privilege based on the discretion of a king, this is a correct description of the current japanese patent law as it does not allow arbitrary operation. however, as argued in the above on the intellectual property rights in general, and as clearly exemplified by the changes with product patents, in particular,63 patent right is clearly not a natural right, but an instrumentalist right based on an industrial policy, for a purpose of encouraging technological creations and the utilization. in addition, it is indubitable that the patent office as an expert organization is better equipped to decide which types of technology should be granted with patent rights, than the courts. it is needless to say that under the sovereignty of the people, the discretion of the patent office need to be bound by the law. however, it would be erroneous to think that there is no discretion whatsoever for the patent office, (i.e. the concept of non-discretionary administrative acts in the administrative law) in relation to the courts, in case where there is a difference between the interpretation of the text of law. this is most visible in the new subject matter area where there is lack of (at least temporary) international consensus, such as computer program and biotechnology. for example, the examination guideline of the japanese patent office on computer program related inventions has been through many revisions, and the court does not scrutinize every revision.64 in this context, the most recent revised examination guideline on computer software related invention was adopted on dec. 28th 2000 (h12), but it was inapplicable to the application filed before the jan.10th 2001 (h13). confusion may occur, when the courts examine individual cases. an arbitrary or nontransparent change in the operation would be against the egalitarianism and deprive an opportunity of administrative governance by the people. however, examination guidelines are revised through coherent and transparent process. one may argue that the courts need to respect the discretion of the patent office through this type of operational changes.65 62 see 1 nobuhiro nakayama, k gy shoy ken h [industrial property law] 60-61 (2d appended ed., 2000), where the entitlement perspective is used in contrast to the discretionary grant of patent as a favouritism sovereign. but it is not clear whether this entitlement perspective denies any discretion of the patent office. 63 in japan, patent law allowed only the process invention claims even when the invention was for the new chemical substances, out of the concern for domestic industry. this has changed when japanese chemical technology reached an internationally advanced level and the patent law revision of the 1975 introduced a product patent over chemical substances. 64 on the historical changes in japanese patent examination guidelines, see kazuhiko takeda, tokkyo no chishiki [knowledge on patent] 31-41 (8th ed., 2006). 65 see tamura, supra note 14, at 131-132. nordic journal of commercial law issue 2009#1 21 traditional “rechtstaat” model relies on the “laws” that gives a binding authority to a legislative decision at a specific time, and at the same time subjects it to a full judicial review, and thereby provide a one-track governance model to administration. however, it is questionable whether this one track model can be applied uniformly to the administration of industrial and technological policies. this is because industrial policy regulates economic matters that constantly change that create relevant knowledge at every turn. similarly, technological policy regulates subject matters which are understood, differently at different times, such as computer programs and biotechnology. in these cases, it is necessary to propose an interactive model to divide the competence and function of the legislative, the administrative, the judiciary or other institutions. an interactive mode would follow the axis of time that feed the changes in the subject matter back to the substance of regulation66 and at the same time would utilise the knowledge that the administration has gained over time, to influence the judiciary, and not just simply prioritise the judiciary between the law (judiciary) and the administration. 3.4 governance of the process by consequentialist approach so far, i have argued that ultimately, a political responsibility has to be relied on, as a complete analysis and verification of efficiency is difficult, and that in case where there is a structural bias in the policy making process, the emphasis on the political responsibility would lead to a fine tuning by the judiciary. however, a just intellectual property institution cannot be constructed by the means suggested in the above. to a degree that is possible, it is desirable to clarify the types of institution would improve or would not improve the efficiency, so that a framework can be set to discourage inefficient policy decisions. in addition to this, the scope of freedom that must be ensured by the legislation or the judiciary has to be clearly presented. as concrete examples of this consequentialist exercise, we examine two theories a policy lever theory in the context of patent institution and policy and third wave theory in the context of copyright law. 3.4.1 theory of patent policy levers67 a patent institution has three functions. first it promotes inventions and its disclosure and secondly, by early grant of patent rights, it prevents duplicative investments on the inventive 66 see for an risk administration model with the example of environmental policy, ry ji yamamoto, riskgy sei no tetsuzukitekik z [a procedural structure of risk management], in kanky to seimei [environment and life] 3, 9-15 (hideaki shiroyama & ry ji yamamoto eds., 2005). 67 burk & lemley, supra note 19. nordic journal of commercial law issue 2009#1 22 activities, and thirdly this early grant promotes commercialisation of the products that are related to the particular patent. all of these functions are related to efficiency. however, the patent problem ultimately relates to the question of the rights and obligations of the two interested parties, as it is operated as judicial norms. thus this creates a standard that judging a case according to a certain set of rule would lead to efficiency, in total, even in case where an individual case specific efficiency is doubted. several theories generally approach this framework differently.68 for example, a prospect theory supports earlier patent grants to prevent rent seeking on the same invention and to provide additional incentivisation of investment for related invention.69 a competitive innovation theory proposes innovation occurs by high competition, and not by the stagnation from monopolistic position.70 a cumulative innovation theory explains that there is a need to provide incentives for both basic patents and improvement patents and thus patent rights need to be granted to both, but as a default rule, it allows a mutual check and balance. as a result, patent promotes the transaction, as the parties need to enter into contracts with each other.71 anti-commons theory points out that innovation may be prevented by multiple, fragmented, and heterogeneous patents over one subject matter such as dna fragment.72 similarly, when the scope of a patent protection is too broad, and complex, the patent thickets theory argues that it would lead to a problem.73 68 following the categories in burk & lemley, supra note 19. for detail, see tamura, supra note 32. see also on the co-relation among the prospect theory, competitive innovation theory and cumulative innovation theory, noboru kawahama, gijutsu kakushin to dokusenkinshih [innovation and antimonopoly law], 20 nihon keizaih gakkai nenp [ann. of japan ass’n econ. l.] 50, 51-57 (1999). 69 kitch, supra note 32. see for criticism, lee, supra note 35, at 18-20. 70 kenneth j. arrow, economic welfare and the allocation of resources for innovation, in the rate and direction of inventive activity 609 (richard r. nelson ed., 1962). this paper put emphasis on the comparison with other theories and thus used arrow as understood by burk & lemley, supra note 19. for a more correct understanding of arrow in japan, see the introduction by kawahama, supra note 68, at 51-53. 71 merges & nelson, supra note 33. 72 see heller & eisenburg, supra note 35. see also the texts accompanying the note 35. 73 carl shapiro, navigating the patent thicket: cross licenses, patent pools and standard setting, in 1 innovation policy and the economy 119 (adam jaffee, josh lerner & scott stern eds., 2001). patent thickets can be distinguished from the anticommons theory, as pointed out by burk & lemley, supra note 19, at 1613. the patent thicket is used to describe the situation the use is prevented because not only there are multiple right holders but also the scope of protection is too broad and overlapping. anticommons problem may be alleviated if the number of the rights is reduced, but patent thickets cannot be removed by reducing the number of the patents alone, but also by narrowing the scope of the patent protection. nordic journal of commercial law issue 2009#1 23 at a glance these five theories seem to be conflicting with each other. however, a policy levers thesis of burk and lemley propose that each of these theories applies to different industries and thus patent policies need a change of gear depending on the field of its application.74 according to burk and lemley, the prospect theory is applied to the pharmaceutical industry. in this industry, acquisition of patent could lead to a high profit and thus the probability of rent seeking is also very high. in addition, the commercialization of the products after the patent grant involves large investment costs, such as clinical tests. furthermore in case of medicines, one patent is likely to cover one product and the early grant of patents may have less negative impacts. thus prospect theory that proposes early grant of patent seems to be convincing. the second theory of competitive innovation is applicable to business method patents. before the decision of state street bank & trust co. v. signature financial group, inc., 149 f.3d 1368 (fed. cir. 1998),75 a business method patent was believed to be ineligible for patent protection in the usa. in other words, business methods have developed without the patents and maybe the need to grant patent protection also is also believed to be minimal. burk and lemley apply the third cumulative theory to software industry. at least in japan, this may apply to electronics industry. despite the fact that many patents are granted in the electronics industry, majority of the japanese electronics companies are homogenous and often do not rashly enforce their patents, in fear of retaliation. as a result, negotiations for license agreements are promoted and often they enter into comprehensive cross licensing agreement.76 the anticommons theory and the patent thickets theory are proposed in the context of biotechnology and semi-conductor industry and in practice, they apply these fields. the contribution of the burk and lemley’s thesis is in noting that as each field is supported by different theories, and thus an ideal patent institution for each industry is different. different industry conditions make it unnecessary to paint a uniform picture of an ideal patent institution. while the five theories are not conflicting but comprehensively networked, a desirable policy goal would be to treat each field differently, for example, by utilizing tools such as non-obviousness standard and scope of protection.77 further, burk and lemley examines the 74 see burk & lemley, supra note 19, at 1615-1630. 75 ry ta hirashima, beikokutokkyoh ni okeru hogotaish no hen’y – iwayuru “business method exception” wo meguru d k ni tsuite [the changes in the patent subject matter in the american patent law – changes surrounding so called business method exception], 41 chizaiken forum 23 (2000). 76 yoshiyuki tamura, h katsuteki cross license to shokumuhatsumei no hosh kingaku no santei [comprehensive cross licensing and calculating compensation for employee invention], 2 intell. prop. l. & pol’y j. 1 (2004). 77 see takeda, supra note 62, at 134-136, arguing the terminological difference between the inventive step and non-obviousness requirement of japanese patent law art. 29.2. nordic journal of commercial law issue 2009#1 24 proper policy making body whether it is the legislative or the judiciary, suitable for each field and thus instead of stressing the need to construct a comprehensive rules, they argue a case for an individual case specific examination. moreover, they highlight the role of the judiciary as it is more resilient against the lobbying. this insight is highly useful as it connects the policy making process and the framework of legal institution. the legislation has the problem of bias in the policy making process.78 on the other hand the judiciary as recommended by burk and lemley is indifferent to lobbying, to a certain degree. however, considering the limitation of the judiciary in collecting necessary information to form policies and the relative weakness in terms of democratic legitimacy, at least in japan, policy making by a third alternative organisation of the administration, the patent office, can be considered. indeed, the patent office has various patent examiners who are specialised in their field, and as a practice, they apply patent law to each technological field and in particular, some of these technologically specific standards of review are informed to the public in the form of examination guideline.79 as argued in the above 3.3.3, this emphasis on the role of patent office necessarily adjusts the traditional rechtstaat model (rule of law) based on the full review of the judiciary on the examination guidelines. 3.4.2 the third wave theory of copyright80 in terms of copyright, occasional arguments that regard the right against copying as the permanent golden rule are still observed. however, as a copyright is a right that is created in response to the technological and societal changes and it needs to be changed according to the changes in time as well.81 the origin of the contemporary copyright laws dates back to the english law around the early 18th century. historically, this is the time when the publishing industry bloomed together with the distribution of type-printing technology. this increased competitions on the books that contain the same materials, and as a result, it became difficult to recoup the cost of investment on this technology. it is generally believed that from this, the need to prevent the decrease in 78 in fact, trips art 27.1 is a product of lobbying that requires members not to discriminate on the technological field. see on the negotiating history unctad, resource book on trips and development, 368-374 (2005). 79 for example, jpo’s guidelines on inventions related to computer programs, biotechnology, and mmedicines. see, jpo, examination guidelines for patent and utility model in japan, part 7. 80 tamura, supra note 4. 81 nakayama, supra note 52, at 241, 272. nordic journal of commercial law issue 2009#1 25 the publication combined with the need to protect an author’s interest has lead to the birth of modern copyright institution.82 the copyright law that has emerged together with the distribution of printing technology still focus on the right to prevent copying and added restrictions on the act of public uses.83 this structure of right focusing on the right to prevent copying may have less impact on the personal freedom at the time when the copying technology was not distributed to the personal level and thus when the right regulated only the public arena (as opposed private domain)84 however, in the late 20th century, audiovisual recording and reproduction technology have reached the private domain and as a result the copyright right framework seems to excessively restrict freedom of individuals, and its efficacy has been questioned. the significance of the copyright institution of these technologies allows us to call the distribution of the printing technology as the first wave, and the distribution of copyright technology to a private domain as the second wave. in responses to these technologies, copyright law started to introduce complementary measures such as rental rights and remuneration right as against private audio-visual recording, while still maintaining copyprevention centric view of right. if one takes this copy prevention as a golden rule, at an extreme, all copying becomes wrong. however, when copying (reproduction) is easily done and the quality of a copy is not different from the original, this expands potentials to enrich human life. the institution of law should not keep the enjoyment of the technological progress in shackles, simply because the law is the way it is. a more liberal idea, not confined to the copyprevention centric view, needs to be employed when considering a long-term legislative theory.85 however, the age of the internet brought new challenges that are qualitatively different from those of the second (which is not yet resolved); on the premises of copyright law, and this is the 82 see hideaki shirata, copyright no shitekitenkai [historical development of copyright] (1998). 83 tamura, supra note 30, at 108-111. 84 see also jessica litman, revising copyright law for the information age, 75 or. l. rev. 19, 36-37, 48 (1996), arguing copyright law did not regulate non-commercial user and non-institutional user. see also jessica litman, supra note 19, at 18-19, 177-178. 85 for example, arguing a case for copyright registry as a condition for protection against digital use, see yoshiyuki tamura, digital-ka jidai no chitekizaisanh seido [intellectual property law in digital age], in kin teki chitekizaisan h no riron [functional theory of intellectual property], supra note 43, at 183. see also jessica litman, supra note 19, at 180-182, arguing that the copyright infringement should be found only in the large scale commercial uses that deprive the right holder of the economic opportunity and that the standard should be found in the common-law or court based concretization of the standard to delineate the commercial use from other uses (see also suggests introduction of social norms by the jury trials). litman also argues that it is difficult to to demand the general public who does not participate in the policy-making process of copyright law to follow the law that is only understandable by the copyright law experts. nordic journal of commercial law issue 2009#1 26 third wave of changes. in other words, as the distribution of communication technology enables information communication networks, in addition to the copying technology, anybody can make information publicly available. this unifies the public arena with the private domain and it becomes difficult to distinguish them. in this context, not just the copy prevention centric view, but also the use in the “public” sphere also has to be used as a device to prevent the excessive intervention in the private person’s freedom. additionally, further defence systems are being constructed such as copy protection technology and technological management against public transmission, and click-on contracting. these additional means should be viewed as an intermediate step to facilitate the recoupment of the right holder’s interests and need to be accompanied by the distribution of circumventing technology and the levy system. otherwise, several types of technological protection would make a copyright system a means to simply protect the vested interests of the old technology media that have distributed the copyrighted work. this may deprive the society, to more precisely, private members of the society, of the benefits from the widespread diffusion of copy and communication technology.86 in this sense, what is called for the copyright law is a paradigm shift from the copy-prevention centric view toward a combined perspective of copyprevention and regulation of the general use in the public sphere. originally, as is the case in other types of intellectual property right, the justification of a copyright is based on two conflicting theories and the paradigm shift proposed in this paper may be criticised as being only based on the incentive based theory. however, even if one adopts a natural right based theory, it is fundamentally questionable that the proposition of “creation” (i.e. that a person creates something) can be used as a ground to change back the society toward the direction before the development of new technologies. 86 see lawrence lessig, code version 2.0, 169-199 (2006), for a warning that the technological access and copy control in the cyberspace unsettles the traditional balance of protection and the public, and calling for a creation e.g. by law of a certain incompleteness in cyberspace. see also, dan l. burk & julie e. cohen, fair use infrastructure for rights management systems, 15 harv. j. l. & tech. 41 (2001), suggesting a concrete proposal for a framework that systematic and technical provision of fair-use, accompanying the technological protection. see, for the formation and validity of click-on type contracts, sono hiroo, j h keiyaku ni okeru jiy to k jo [copyright takeover: the expansion of contract under ucita], 1999 americah 181, 192 (2000). see also hiroo sono, keiyaku to gijutu ni yoru chosakuken no kakuch ni kansuru nihonh no j ky [dealing with contractual and technological expansion of copyright under japanese law], 3 intell. prop. l. & pol’y j. 185 (2004), arguing that the mass market contract and the individual negotiation cannot be the same. see also, a balancing these two views, tamura, supra note 14, at 427-428, 433-434. nordic journal of commercial law issue 2009#1 27 4. concluding remarks a theory of intellectual property law and policy that this paper proposed so far can be summarised as following five arguments: a. as long as intellectual property right is a freedom inhibiting regulation, it is difficult to justify its foundation based on the labour-base property theory or theory of personhood. the foundation then should be based on the efficiency gain from the provision of efficiency. b. on the other hand, efficiency is difficult to assess and the trade offs between efficiency and the freedom become questioned. as the verification of the efficiency gains is difficult, the justification ultimately depends on the legitimization of the process based on political responsibility through democratic decision making. c. however, the policy-making process is structurally biased. it easily reflects the organized and aggregated interests of large companies, but neglects the interests of the disaggregated private individuals. this leads to excessive strengthening of the intellectual property rights. d. in this context, it is necessary to ensure the legitimacy of the process by utilizing the role of the judiciary that fine tunes the law to ensure individual freedom, while seeking a governing mechanism to correct the bias in the policy making process as much as possible.87 e. if possible it is desirable to clarify the types of institution would improve or would not improve the efficiency. in addition, by adopting a consequentialist theory, the scope of fundamental freedom that must be ensured by the legislation or the judiciary may become clarified. this should reduce a grey area and narrows the room for discretion in the decision making process. finally, i would like to add the area where the theory proposed in the above may be applied. the theory outlined in the above is based on the premise that it is socially desirable to view the active justification for intellectual property law regulation to be based on the promotion of creative production and its distribution.88 thus, as stated several times in the above, it s believed that there is a democratic consensus that the japanese domestic law incorporate these premises supporting each intellectual property laws. intellectual property right inhibits others’ freedom to use without physical and geographical limits, and the mnes activities tend to expand the rights internationally. in this 87 see supra text accompanying note 61. 88 ko hasegawa, ky tekihan’ei to chitekizaisanh genri [‘competitive flourishing’ and the principles of intellectual property law], 3 intell. prop. l. & pol’y j. 17, 17-25 (2004). nordic journal of commercial law issue 2009#1 28 sense, a theory suitable for one domestic law should not be applied to all intellectual property laws in general. in addition, incentive theory is premised on the vision of a society that reached a threshold of a certain level of economic development that could prosper through competition. thus this may be inapplicable to a society with different degree of maturity in economic development.89 however, the process oriented theory may be even more suitable to be applied to the international community where the conflict of interests is visibly stronger. thus a clarification of a consequentialist governance theory may be called for, while seeking legitimacy in policy making process, and acknowledging the bias in the international intellectual property policy making process. typical examples of non universal applicability of incentive theory are the international debates surrounding the traditional knowledge and the genetic resources. as widely known, there is a strong tension between the developed country and the less developed and developing countries that are endowed with traditional knowledge and genetic resources.90 traditional knowledge can be approached from a cultural pluralistic perspective.91 the friction stems from the tension between the ip system based on the culture of developed country that is dynamic, industrial, and individualistic against the gradual, ecological and communitarian protection of traditional knowledge.92 furthermore, the question of protecting traditional knowledge and genetic resources is related to ecosystem and thus cannot be discussed without discussing the policy and value choices between prioritising the industrial development or biodiversity and environmental protection.93 when one considers the differences in the culture and value system, consequentialism cannot be applied at all. ultimately, a process oriented solutions such as international treaty 89 id. at 24, 30. 90 vandana shiva, protect or plunder? understanding intellectual property rights (2001), see for a theoretical review, yoshiyuki tamura, dent tekichishiki to idenshigen no hogo no konkyo to chitekizaisanh seido: sairon [revisiting the normative foundations of protection of traditional knowledge and genetic resources], 19 intell. prop. l. & pol’y j. 157 (2008); yoshiyuki tamura, dent tekichishiki to idenshigen no hogo no konkyo to chitekizaisanh seido [normative foundation of protection of traditional knowledge and genetic resources], 13 intell. prop. l. & pol’y j. 53 (2006). 91 see will kymlicka, contemporary political philosophy: an introduction ch. 8 (2nd ed., 2002). 92 ko hasegawa, senj min no chitekizaisanhogo ni okeru tetsugakutekibunmyaku [the philosophical context of the intellectual property protections for indigenous people], 13 intell. prop. l. & pol’y j. 27 (2006). see also boyle, supra note 37, at 128-130. they suggest that there is need to share or return profits to the indigenous people to preserve biodiversity and the nature. in particular, the bellagio declaration similarly critics the vision of creatorship in the current intellectual property and calls for a special neighboring rights to protect the traditional knowledge. see boyle, supra, at 192-200. 93 shiva, supra note 90. nordic journal of commercial law issue 2009#1 29 negotiation has to be adopted, and ensuring the legitimacy of the process becomes crucial.94 in this case, even if it is not possible to adopt a natural right based conclusion that the traditional knowledge and genetic resources should be protected as such, it is equally erroneous to argue that their protection is outside the scope of intellectual property, simply because they do not fit to the current shape of intellectual property law system of developed countries.95 94 see also yuka aoyagi, dent tekichishiki ni kansuru h seibi eno senj min oyobi chiikiky tai no sanka ni tsuite [participation of indigenous and local communities to the development of legal systems on traditional knowledge, genetic resources and folklore], 8 intell. prop. l. & pol’y j. 95 (2005). 95 tamura, sairon [revisiting], supra note 90. microsoft word tohka_sanna_valmis.doc nordic journal of commercial law issue 2010#2 application and the interpretation of the cisg in finnish case law 1997–2005 by sanna tohka nordic journal of commercial law issue 2010#2 1 1. introduction the united nations convention for the international sale of goods (hereinafter the cisg or the convention) was unanimously approved by a diplomatic conference of sixty-two states in vienna, austria on 11 april 1980. as of 15 august 2010, the united nations commission on international trade law (uncitral) reports that 76 states have adopted the cisg, including the nordic countries, russia, usa and china.1 the purpose of the cisg is to promote uniformity in the sphere of international commerce. private international law and the conflict of law rules do not always provide the predictability and certainty needed in the international trade concerned. finland ratified the cisg on 20 march 19872 and the cisg came into force on 1 january 19893. the purpose of this article is to introduce the main findings and conclusions of the english language licentiate thesis ‘the application and the interpretation of the cisg in the finnish case law 1997-2005’. the core of the thesis covers nine cases tried in public courts in finland between the years 1997 and 2005: 1. turku court of appeal, s 95/1023 (18 february 1997); 2. district court of kuopio, 95/3214 (5 november 1996)4; 3. turku court of appeal, s 97/324 (12 november 1997); 4. helsinki court of appeal, s 96/1129 (29 january 1998); 5. helsinki court of appeal, s 96/1215 (30 june 1998); 6. helsinki court of appeal, s 00/82 (26 october 2000); 7. turku court of appeal, s 00/855 (12 april 2002); 8. helsinki court of appeal, s 01/269 (31 may 2004); 9. turku court of appeal, s 04/1600 (24 may 2005). 1 as of 15 august, 2010, the contracting states are: albania, argentina, armenia, australia, austria, belarus, belgium, bosnia and herzegovina, bulgaria, burundi, canada, chile, china, colombia, croatia, cuba, cyprus, czech republic, denmark, dominican republic, ecuador, egypt, el salvador, estonia, finland, france, gabon, georgia, germany, guinea, honduras, hungary, iceland, iraq, israel, italy, japan, kyrgyzstan, latvia, lebanon, lesotho, liberia, lithuania, luxembourg, mauritania, mexico, moldova, mongolia, montenegro, netherlands, new zealand, norway, paraguay, peru, poland, republic of korea, romania, russian federation, saint vincent and the grenadines, serbia, singapore, slovakia, slovenia, spain, sweden, switzerland, syrian arab republic, the former yugoslav republic of macedonia, turkey, uganda, ukraine, united states of america, uruguay, uzbekistan, zambia. united nations commission on international trade law (uncitral), http://www.uncitral.org/uncitral/en/index.html – uncitral texts and status – international sale of goods (cisg) – 1980-united nations convention on contracts for the international sale of goods (cisg) – status). 2 act concerning the acceptance of some of the provisions of the convention on contracts for the international sale of goods 20.3.1987, 795/1988. 3 degree 16.9.1988/796. 4 itä suomen ho (the court of appeal of eastern finland), s 96/605 (27 march 1997) tried the case only in the relation to the joint liability of the seller and the seller’s ceo. the cisg issues were not appealed nordic journal of commercial law issue 2010#2 2 all these decisions have become final after the proceedings in the court of appeal. the analyses of the cases were restricted to the issues relating to the cisg. the decision by the supreme court on 14 october 2005 (kko:2005:114, s 2004/50) that returned the matter to the district court to be retried on the merits relating to the cisg has been left to lighter scrutiny. from both the academic and practical point of view, the main issues of the case relate to matters of jurisdiction. the cisg database maintained by the institute of international commercial law at the pace university was essential in writing the thesis.5 the cisg is an international convention and it is essential that internationality is promoted in its application. the analyses of the cases rendered in the finnish legal system increases the understanding of the cisg by scholars, business practitioners, lawyers and judges alike and promotes uniform application in the future. furthermore, for a truly international instrument of law, it is important that the case law from even a small legal community is incorporated and discussed in the sphere of the larger community. from a practical point of view, it is not sufficient to know the black letter law to be well prepared for unanticipated incidents in advance. one must understand the meaning of the black letter law. 2. applicable law 2.1. applicable law to the issue at hand the cisg has now been in force in finland more than 20 years. yet the decisions by the court of appeal are rare pleasure for those operating in the field on international sales law, professionally or academically. unfortunately this means that also the courts decide issues relating to the cisg only rarely. especially, since rulings relating to the cisg by public courts are not that common in finland, a thorough discussion of the issue of applicable law is necessary. further, not all issues that are dealt with in international sales are covered by the cisg; which raises the importance of the determination of the applicable law relating to those issues that are covered. in addition, the finnish declaration exempting part ii of the convention becomes significant when determining applicable law. in general, the basic rules on applicability have been applied correctly. article 1(1)(a) provides that the cisg applies directly, if the parties to contract of sale of goods have their places of business in different contracting states, independent of whether a different solution is provided for by the rules of private international law. even if the rules of private international law of the forum would lead to non-contracting state, the cisg applies, if the parties are from 5 http://www.cisg.law.pace.edu/. the thesis is availeble from the said database: http://www.cisg.law.pace.edu/ cisg/biblio/kuoppala2.html nordic journal of commercial law issue 2010#2 3 contracting states. only if the cisg is not applicable by virtue of article 1(1)(a), the rules of private international law are considered. by virtue of article 1(1)(b) the cisg is applicable when the rules of private international law lead to the application of the law of the contracting state. even when the other party’s place of business was in a non-contracting state (i.e. the united kingdom), the court correctly applied the cisg by virtue of conflict of law rules and article 1(1)(b) (district court of kuopio, 95/3214 (5 november 1996)). from the nine decisions under scrutiny, only once did the district court make a classical error and applied the finnish sale of goods act rather than the cisg (district court of helsinki, judgment 17450 (18 july 1995)). the error was corrected by the court of appeal (helsinki court of appeal, s96/1129, (29 january 1998)). however, a more detailed and thorough analysis of the basic rules on applicability would have been in order in many cases. helsinki court of appeal, s 96/1215 (30 june 1998) illustrates well the prevailing approach in the finnish courts. the case involved a sale of skincare products delivered from a swiss seller to a finnish buyer. the seller stated that due to the fact that the place of business of the seller who accepted the order was in switzerland, swiss law was applicable to the contract – making a indirect reference to the finnish conflict of law rules6. there was no agreement between the parties on the applicable law. the buyer stated, as did the seller, that the cisg was applicable to the case. the court made no reference to the applicable law as there was no dispute on the issue. however, the correct approach would have been to apply the cisg by virtue of article 1(1)(a). both countries, finland and switzerland, were contracting states at the time of the conclusion of the contract, thus the cisg applied as such by virtue of article 1(1)(a). 2.2. applicable law in relation to secondary issues of the case 2.2.1. need for discussion? the basic rules on applicability are mastered moderately, but the reasoning of the finnish courts on applicable law relating to the issues not covered by the cisg, contain weaknesess. it seems that the secondary issues are not seen as important as the main dispute naturally involves 6 in finland, the act on law applicable to sale of goods of international character (26.6.1964/387, as amended by the act 27.5.1988/468), provides that in the absence of a choice of law under section 3, the sale shall be governed by the law of the state where the seller had his place of habitual residence when he received the order. if the order was received by a business owned by the seller, the sale shall be governed by the law of the state where the business is situated (section 4, subsection 1). only if the buyer places the order in the state where the buyer has his habitual residence or where he owns a business and the seller or his agent receives the order in said state, the sale shall be governed by the law of the buyer’s state (section 4, subsection 2). nordic journal of commercial law issue 2010#2 4 the actual sale of goods, such as delay in delivery or non-conformity of the goods. the determination of the applicable law is however important in relation to all issues of the case. 2.2.2. rate of interest according to the cisg in some cases the court did refer to the conflict of law rules in relation to some aspects of the case, while ignoring the issue in other respects; e.g. in turku court of appeal, s 95/1023 (18 february 1997) the court analysed the applicable law in relation to the partial payment to be credited, but not in relation to the rate of interest. the discussion in relation to the law applicable to the rate of interest would add to the interesting dialogue relating to the sphere of application of the cisg. some of the provisions of the cisg are vague and lack precise definition. the most evident example is article 78 of the cisg: “if a party fails to pay the price or any other sum that is in arrears, the other party is entitled to interest on it, without prejudice to any claim for damages recoverable under article 74.” thus, article 78 provides that the cisg awards interest on sums in arrears but does not state the amount or percentage of the interest to be applied, nor does it provide a specific formula for calculating the interest. as cisg article 78 does not provide the definite rate of interest, if the parties have not agreed on rate of interest to be applied, one must look at the convention to find an answer to the question. the applicable rate of interest was, however, one of the issues not successfully agreed upon when drafting the convention.7 the solutions offered by scholars to solve the issue on the rate of interest vary from a restitutionary approach to applying the applicable national law by virtue of the rules of private international law. professor honnold suggests that the solution on the rate of interest should be derived by analogy to the cisg rules on compensation for breach of contract (cisg article 74, 75 and 76), in accordance with cisg article 7(2). according to article 7(2), questions concerning matters governed by the convention, but not expressly settled in it, are to be settled in conformity with the general principles on which the convention is based on. only if such general principles can not be identified, can one turn to the applicable national law. cisg article 74 provides that “damages … consist of a sum equal to the loss … suffered … as a consequence of the breach”. if the aggrieved party has made a reasonable substitute transaction that can be identified, cisg article 75 provides that “the party claiming damages may recover the difference between the 7 on the legislative history briefly, see bacher in schlechtriem, peter; schwenzer, ingeborg (2005): commentary on the un convention on the international sale of goods (cisg). second (english) edition. edited by peter schlechtriem, ingeborg schwenzer. great britain. oxford university press. [cited as author in schlechtriem & schwenzer 2005, p. .]. p. 795. honnold, john o. (1999): uniform law for international sales under the 1980 united nations convention/by john o. honnold. – 3rd ed. the hague, the netherlands. kluwer law international. p. 465-466. mazzotta gives a more detail but yet a brief history of article 78 in mazzotta, francesco g.(2004): cisg article 78: endless disagreement among commentators, much less among the courts. available from the www: <url: http://cisgw3.law.pace.edu/cisg/biblio/mazzotta78.html> nordic journal of commercial law issue 2010#2 5 contract price and the price in the substitute transaction”. if a substitute transaction can not be identified or such transaction has not been made, under cisg article 76, the aggrieved party can base the damages on the current price: “the party claiming damages may … recover the difference between the price fixed by the contract and the current price”. if the other party fails to pay the price or any other sum that is in arrears, the aggrieved party can replace those funds by borrowing. if the “substitute transaction” can be identified, the loss suffered by the aggrieved party could be measured as the cost of this substitute transaction. if a substitute loan cannot be pinpointed, the aggrieved party’s loss could be measured by the “current price” of credit. the rate of interest is based on the aggrieved party’s cost of borrowing. 8 professor bacher 9 is more sceptical in reaching an international, uniform rule in relation to the rate of interest by reference to general principles. the main concern opposing the adoption of the uniform rule is that the diplomatic conference was not able to reach a solution on the issue. the different solutions proposed by legal writers and courts should also be looked at with caution. bacher further points out that even if the uniform approach is accepted instead of the approach to applying domestic laws, in both cases there is no agreement on the rate of interest. bacher suggests that the solution is to connect the rate of interest with the currency in which the sum is to be paid and further, to the prime rate of the currency involved.10 there is extensive case law on the issue of the rate of interest. professor mazzotta has surveyed an extensive amount of cases relating to the rate of interest.11 he concludes that the majority of authors and courts have clearly stated that the rate of interest is to be governed by the law of the relevant country as determined by the rules of conflict of laws of the forum state. mazzotta is of the opinion that the interest rate is within the sphere of application of the cisg as the cisg does establish a general entitlement to interest, although the actual figure is not to be determined through the convention or its general principles, but by resorting to the applicable domestic law. mazzotta stresses that even if the general principles may give some guidance in determining the actual interest rate, they are not helpful in terms of assuring either certainty or uniformity. during the life of the cisg neither commentators nor courts have been able to settle the issue. mazzotta recognises that resorting to domestic rules of private international law is not the best solution, but it is still better than resorting to any other method that is expressly outside the scheme of the convention. he stresses however that the domestic rules of private international law should be subject to the ‘good faith’ and ‘international character’ requirements set forth by article 7(1) of the convention. according to article 7(1) in the interpretation of this convention, regard is to be had to its international character and to the need to promote uniformity in its application and the observance of good faith in international 8 honnold 1999, supra note 8, p. 467-471. 9 bacher in schlechtriem & schwenzer 2005, supra note 8, p. 800-803. 10 bacher in schlechtriem & schwenzer 2005, supra note 8, p. 800-803. 11 mazzotta 2004, supra note 8. nordic journal of commercial law issue 2010#2 6 trade. excessive unforeseeable interest resulting in unjust enrichment of one party over the other, may not be awarded.12 mazzotta also notes that interest as described under article 78 is different from interest under article 84(1), where the right to interest is also mentioned. according to article 84(1), if the seller is bound to refund the price, he must also pay interest on it, from the date on which the price was paid. under article 84(1) interest is intended to compensate the creditor (buyer) for the fruits (interest) of not having benefited the money owed by the debtor (seller) due to the avoidance of the contract. in other words, interest under article 84(1) is based on the principle that money produces fruits, but is owed only when, as a result of the avoidance of the contract, the price must be refunded to the buyer. moreover, interest under article 84(1), as opposed to article 78, must be paid from the date on which the price was paid and there is no reference to any "arrears" requirement.13 the parties can naturally agree on the rate of interest even prior to the conflict. the primacy of the parties’ contract is the dominant theme of the convention. according to article 6 the parties may exclude the application of this convention or, subject to article 12, derogate from or vary the effect of any of its provisions.14 2.3. applicable law in relation to the formation of the contract 2.3.1. exemption of part ii of the convention in addition to the problems relating to the applicable law as such and in relation to secondary issues, the meaning and purpose of the declaration not to be bound by part ii of the cisg remains obscure, since not even the courts applying the cisg, consider the issue important. finland has ratified the cisg subject to a declaration under cisg article 92 not to be bound by part ii of the convention: formation of the contract. as far as part ii of the convention, finland is not a contracting state as provided in cisg article 1(1)(a). if the conflict of law rules as provided for in cisg article 1(1)(b) point to the law of a country that has not made a similar declaration part ii of the convention, nevertheless applies. part ii of the convention naturally also applies, if the parties to a contract have agreed that the cisg is to be applied. 12 mazzotta 2004, supra note 8. 13 mazzotta 2004, supra note 8. 14 article 12 provides that the parties freedom of contract is limited by a reservation provided for in article 96. article 12 states that any provision of article 11, article 29 or part ii of this convention that allows a contract of sale or its modification or termination by agreement or any offer, acceptance or other indication of intention to be made in any form other than in writing does not apply where any party has his place of business in a contracting state which has made a declaration under article 96 of this convention. under article 96 a contracting state whose legislation requires contracts of sale to be concluded in or evidenced by writing may at any time make a declaration in accordance with article 12 that any provision of article 11, article 29, or part ii of this convention, that allows a contract of sale or its modification or termination by agreement or any offer, acceptance, or other indication of intention to be made in any form other than in writing, does not apply where any party has his place of business in that state. nordic journal of commercial law issue 2010#2 7 in the above mentioned case helsinki court of appeal, s 96/1215 (30 june 1998)15, since switzerland had not made any reservation to the cisg and the conflict of law rules pointed to swiss law, also part ii of the convention applied to the case. as noted above, the district court did not discuss the issue of the applicable law. the applicable law to the formation of the contract was nevertheless in any case the swiss law, i.e. the cisg. 2.3.2. formation of the contract versus its interpretation in helsinki court of appeal, s 01/269 (31 may 2004), the court had a chance to evaluate the relationship between the rules on interpretation and rules on the formation of the contract. unfortunately, neither the district court nor the court of appeal took this challenge. the case involved a sale of phenol from the finnish seller to a swiss buyer. the questions in dispute included among other things what had been agreed upon regarding the quality of the phenol. there was no dispute on the applicable law. as the parties had their places of business in different contracting states, the cisg was the applicable law (article 1(1)(a)). in relation to the formation of the contract the finnish contracts act was the applicable law even though no reference to the conflict of law rules was made. after this solution on applicable law, when determining the contents of the contract the court based its decision on the evidence presented and the testimonies of witnesses heard. no reference was made to the cisg rules on interpretation of the statements and conduct of the parties as provided for in article 8. despite of the reservation under article 92, article 8 is binding on the nordic countries as well. finland has not made a reservation in relation to article 8, not that it could have.16 article 8 applies equally to the interpretation of the unilateral acts of each party, i.e., communications in respect of the proposed contract, the offer, the acceptance, notices, as well as of the contract itself, when the contract is embodied in a single document.17 thus, the rules 15 chapter 2.2. applicable law as a matter of course, above. 16 ämmälä in saarnilehto, ari; hemmo, mika; kartio, leena (2001): varallisuusoikeus. juva. wsoy. lakitieto. [cited as author in saarnilehto et a. 2001, p. ]. p. 896; routamo, eero; ramberg jan (1997): kauppalain kommentaari. helsinki. lakimiesliiton kustannus. p. 30-31. 17 text of secretariat commentary on article 7 of the 1978 draft (draft counterpart of cisg article 8). commentary on the draft convention on contracts for the international sale of goods, prepared by the secretariat. document a/conf.95/7, o.r.14-66. available from the www: for article-by-article commentaries, go to annotated text of the cisg; click on the article of interest: <url: http://cisgw3.law.pace.edu/cisg/text/cisg-toc.html>; [cited as text of the secretariat commentary on article x of the 1987 draft (draft counterpart of cisg article y)]. lookofsky, joseph (2000): the 1980 united nations convention on contracts for the international sale of goods in: j. herbots ed. / r. blanplain general ed., international encyclopaedia of laws contracts, suppl. 29, kluwer law international (december 2000) 1-192. kluwer law international. the hague. p.55. farnsworth in bianca, c. massimo; bonell, michael joachim (1987): commentary on the international sales law: the 1980 vienna sales convention/edited by c.m. bianca, m.j. bonell. milan giuffrè. p. 95-96, 97-98. nordic journal of commercial law issue 2010#2 8 on interpretation of the offer and acceptance are also extended to the subsequent statements after the formation of the contract.18 in effect article 8 excludes recourse to domestic rules of interpretation.19 according to article 8(1), for the purposes of this convention statements made by and other conduct of a party are to be interpreted according to his intent where the other party knew or could not have been unaware what that intent was. interpretation according to the actual intent of the party requires that the party to whom the statement or the other conduct is addressed, has knowledge of the intent of the other party, or could not have been unaware of such intent.20 as the standard under article 8(1) is subjective and raises problems as to proof, the objective approach under article 8(2) is said to be the principal standard of interpretation in the sphere of the convention.21 article 8(2) provides that if the approch provided for in article 8(1) is not applicable, statements made by and other conduct of a party are to be interpreted according to the understanding that a reasonable person of the same kind as the other party would have had in the same circumstances. under the objective approach, the statements and the conduct of a party is interpreted according to a hypothetical reasonable person of the same kind as the other party.22 in determining the intent of the party or the understanding a reasonable person would have had, article 8(3) provides that due consideration is to be given to all relevant circumstances of the case including the negotiations, any practices that the parties have established between themselves, usages and any subsequent conduct of the parties. article 9(1) further provides that the parties are bound by any agreed usage or by any practices, which they have established between themselves. article 9(1) in effect affirms the rule provided for in article 8.23 according to article 9(2) a widely known and regularly observed usage in international trade can be applicable even impliedly. what is the relationship between the domestic rules of interpretation and the rules of interpretation provided in the cisg? in the international sphere of the cisg there ought to be no recourse to the domestic rules of interpretation that would endanger the uniformity of the application of the cisg. the court specifically stated that the rules on formation of the contract as provided for in the cisg were not applicable in this particular case, but did not specifically state whether it applied the domestic rules of interpretation or the rules provided for in the cisg when determining the parties’ intent and understanding of the offer and 18 honnold 1999, supra note 8, :p. 115-116, specifically footnote number 1. 19 schmidt-kessel in schlechtriem & schwenzer 2005, supra note 8, p. 112. 20 schmidt-kessel in schlechtriem & schwenzer 2005, supra note 8, p. 118. 21 honnold 1999, supra note 8, p. 118; schmidt-kessel in schlechtriem & schwenzer 2005, supra note 8, p. 119. 22 see further schmidt-kessel in schlechtriem & schwenzer 2005, supra note 8, p. 120. 23 schmidt-kessel in schlechtriem & schwenzer 2005, supra note 8, p. 141-142. nordic journal of commercial law issue 2010#2 9 acceptance. there are no written rules on interpretation in finnish law, but the rules on interpretation are drawn from legal practice and from legal doctrine. the legal principles on interpretation applicable in finland do not differ from the rules of interpretation provided for in cisg article 8.24 nevertheless, the court ought to have given some consideration to the applicable rules in respect of interpretation. when determining the contents of the contract due consideration was given to the statements and conduct of the parties during the negotiations and the previous contracts between the parties. the emphasis seemed to have been on the buyer’s understanding what had been agreed upon. the buyer ought not to have understood to assume the risk of change of colour in the phenol nor ought the buyer have had such information that would have alerted him to the risk. further, the seller had in any case become aware of the buyer’s intention to buy colourless phenol. if the court’s reasoning is compared to the wording of cisg article 8, it is seems that the court considered the evidence to be sufficient and applied the interpretation according to the intent of the party (article 8(1)). the buyer had in his reply to the district court noted that the contract between the parties was not an oral contract. it was customary that the buyer always sent a written confirmation of the contract. the parties had concluded several written contracts before the sale in question. the buyer further stated that if cisg article 9 was applicable when evaluating the contract between the parties, it must be concluded that the parties had followed a practise, which they had established between themselves. second paragraph of article 9 according to which a widely known and regularly observed usage in international trade can be applicable even implicitly applies only if the first paragraph cannot be applied. there is no such usage that is widely known and regularly observed by according to which the contracts should be oral. as noted above the court made no reference to article 8. neither was article 9 discussed in the reasoning, i.e. what effect the practices established between the parties had on the formation of the contract. the silence or inactivity of the party cannot itself constitute an acceptance of an offer neither under cisg article 18(1) nor under finnish contracts act section 825. however the circumstances may be such that the other party is alerted, which raises the duty to inquire.26 the buyer stressed that it was an established practice between the parties that the contract was confirmed by a written confirmation, thus the contract could not have been based only on the oral negotiations held between the parties. like article 8, which is applicable to the contents of 24 ämmälä in saarnilehto et al. 2001, supra note 16, p. 896, 898. 25 cisg article 18 (1) provides: “a statement made by or other conduct of the offeree indicating assent to an offer is an acceptance. silence or inactivity does not in itself amount to acceptance.” section 8 of finnish contracts act provides: “if the offeror has stated that an express acceptance is not required or if the circumstances indicate that he/she does not expect one, the offeree shall, nevertheless, upon request, let the offeror know whether he/she accepts the offer; otherwise the offer shall be deemed to have expired.” 26 in relation to the cisg see further schmidt-kessel in schlechtriem & schwenzer 2005, supra note 8, p. 127-128. nordic journal of commercial law issue 2010#2 10 the contract as well as to the conduct or statement of the parties, article 9 is not limited to the content of the contract, but also applies to the contract formation. practices from earlier contracts can also apply to contract formation.27 there may also be an applicable usage according to which a contract can be based on an implied acceptance.28 the buyers had sent a confirmation of the contract to the seller to which the seller had not objected to. the court stated that had the seller opposed to the confirmation he should had given a notice of the alleged inconsistencies. this was supported by the finnish contracts act29 and by the prevailing usage in trade concerned. as no reference to cisg articles were made in this respect in the reasoning of the court it is not clear whether the court even paid attention the buyer’s reference to article 9. the effect of the confirmation of the contract should have been analysed in more detail. the silence as a response to confirmation may range from setting the contract terms to treating the writing as a mere means of proof or aid of interpretation, especially if the binding usage is drawn on the bases of article 9(2).30 in the case in question the confirmation had a contract forming effect. further more, the definition of a binding usage differs in the finnish sale of goods act and the cisg. according to section 3 of the finnish sale of goods act, the act is subject to the terms of the contract between the parties, to any practice which has been established between them and to any other usage which is to be considered binding on the parties. thus, the applicable usage becomes binding whether of not the parties acting in a certain field of commerce were familiar with the usage.31 under cisg article 9 the mere existence of a usage does not make it applicable to the contract. the actual knowledge of usage is neither required under the cisg, but the usage must be widely known to and regularly observed by, parties to contacts of the type involved in the particular trade concerned.32 27 schmidt-kessel in schlechtriem & schwenzer 2005, supra note 8, p. 142. 28 hemmo, mika (2003): sopimusoikeus i. talemtum media oy. jyväskylä. gummerus kirjapaino oy, p. 565. 29 finnish contracts act section 6, paragraph 2. section 6 provides: “a reply that purports to be an acceptance but which, due to an addition, restriction or condition, does not correspond to the offer, shall be deemed a rejection constituting a new offer. however, the provision in paragraph (1) shall not apply if the offeree has considered the reply to correspond to the offer and the offeror must have understood the same. if the offeror in that case does not wish to accept the reply, he/she shall, without undue delay, notify the offeree thereof; otherwise a contract shall be deemed concluded on the terms contained in the reply.” 30 schmidt-kessel in schlechtriem & schwenzer 2005, supra note 8, p. 151. 31 routamo-ramberg 1997, supra note 16, p. 36. ämmälä in saarnilehto et al. 2001,supra note 16, p. 846. 32 professors routamo and professor ramberg criticize the requirement that the usage ought to widely known to and regularly observed by in international trade. these requirements influence the determination whether the parties ought to have known about the usage, but if the parties in fact knew about the existence of the usage and were familiar with it, the usage should nevertheless be applicable even if not widely observed by. see further routamo-ramberg 1997, supra note 16, p. 37. nordic journal of commercial law issue 2010#2 11 there has been understandable criticism towards the adoption of the reservation under article 92.33 since then the ministry of justice has commenced a project to cancel the declaration not to be bound by part ii of the convention (om 2/42/2009) in co-operation with norway, sweden and denmark, also bound by the same reservation. all major specialinterest groups have given their opinion on the memorandum relating to the issue. further steps shall be determined later. the aim of the project is to clarify the legal state and to reaffirm the contract parties’ possibilities to anticipate what are the legal provions to be applied in the formation of the contract of international sale of goods. 2.4. summary on applicable law the applicable law is the starting point in any dispute if the contract itself does not provide answers. international collaboration is part of the current legal realm. in order to be acquainted with and adapt to this new framework it is important to start from the basics and then more forward to the substance of the case. the sphere of application of the cisg must be clear in order to promote the uniformity in its application. too haste recourse to the domestic rules reflects the courts’ unfamiliarity with the cisg. the cisg needs to be read and applied in the international vacuum, free from any preconceptions based on the national sales law. 3. uniformity in the application of the cisg 3.1. the independent nature of the cisg the literal meaning of the cisg provision relating to the very core and basic questions of substance of international trade, such as conformity of the goods or examination of the goods, had been understood by the courts with the reservation of whether the courts had sincerely taken into account the international nature of cisg. however, as the problems arose, no special attention was given. the convention provides its own rules on interpretation of the convention.34 according article 7 (1) in the intrepretation of the convention, regard is to be had to its international character and to the need to promote uniformity in its application. the preparatory works of the convention are of course essential. international scholarly writings and case law are also now readily available and play an ever important role. article 7(1) also stresses the need to promote the observance of good faith in international trade. the most important thing in the 33 lookofsky, joseph (1996): understanding the cisg in scandinavia. a compact guide to the 1980 united nations convention on contracts for the international sale of goods by joseph lookofsky. copenhagen. djøf publishing copenhagen. p. 128. 34 see also discussion in chapter 2.3.2. rate of interest according to the cisg, above. nordic journal of commercial law issue 2010#2 12 interpretation of the convention is to avoid reading and applying the convention in the light of domestic legal traditions and giving meaning to the convention through meanings of domestic legal terms. article 7(2) provides that the unsolved questions concerning matters governed by the convention are to be settled in the first hand in conformity with general principles on which the convention is based. in the absence of such general principles the answers must be sought from the applicable law by virtue of the rules of private international law. it is important to value the restrains article 7 sets for the gap-filling. the reference to the applicable domestic law should not be used too hastily. if the convention lacks specific provisions on the issue it governs, the question should be solved by analogical application of the general principles when possible. the uniformity of the convention’s application is endangered if tribunals invoke domestic law too easily.35 the possible application of the general principles may be tested against applicable trade usages and against contract practices and modern rules of law specially designed for international transactions.36 recourse to the finnish rules on procedure should not be used too hastily. uniform application of an international instrument – whether relating to questions of substance or questions of proof is essential in order to protect the confidence and reliance upon it. when applying the cisg the national courts should avoid recourse to the local concepts used in the legal system of the country of the forum. each article and each concept embodied in the cisg must be construed in uniformity within the international legal community, irrespective of the legal traditions and framework of the country where the court is situated.37 uniformity is however hard to acquire as the courts do not pay attention to comprehensive case law now readily available.38 whether the general carefullness of finnish courts in referring to existing case law in their reasoning influences the decisions now under scrutiny is pure guess 35 honnold 1999, supra note 8, p. 109-110. 36 honnold 1999, supra note 8, p. 110. 37 text of the secretariat commentary on article 6 of the 1978 draft (draft counterpart of cisg article 7(1)), supra note 17. 38 concurring baasch andersen, camilla (1998): reasonable time in article 39(1) of the cisg – is article 39(1) truly a uniform provision? pace essay (1998) pace ed., review of the convention on contracts for the international sale of goods (cisg) 1998, kluwer law international (1999), p. 63-176 [cited as baasch andersen 1998, section no, paragraph no] available from the www (revised edition of her text; processed for entry in the database): <url: http://cisgw3.law.pace.edu/cisg/biblio/andersen.html>. p. 161-162. nordic journal of commercial law issue 2010#2 13 work. however, the conclusions of international case law need not be taken as binding, but can be seen as a guide when interpreting the cisg.39 in addition to the international case law there are international scholarly writings readily available in written form and through the internet. scholars are not omniscient, but their detailed and comparative analyses could be used as an aid in determining the uniform application of the cisg.40 out of the nine decisions under detailed scrutiny in this theses, only once did the court refer to international scholarly work (district court of helsinki, judgment 28966, 97/20514 affirmed in relation to the reasoning by the helsinki court of appeal, s 00/82 (26 october 2000)), however not by author and not specifically to the writing relating to the cisg. 3.2. uniformity in relation to the burden of proof in relation to the burden of proof the courts seemed to have overlooked the plain meaning of the cisg. even though the burden of proof is not specifically settled in the cisg, it is a matter governed by the cisg. this is supported by a scholarly writings and by international case law.41 39 franco ferrari (2000-2001): applying the cisg in a truly uniform manner, p. 203-215 in uniform law review / revue de droit uniforme (2000-1) available from the www: <url: http://cisgw3.law.pace.edu/cisg/biblio/ferrari4.html>[cited as ferrari 2000-2001, tribunale di vigevano, p.], p.209; enderlein, fritz; maskow, dietrich (1992): international sales law: united nations convention on contracts for the international sale of goods: convention on the limitation period in the international sale of goods: commentary / by fritz enderlein, dietrich maskow. oceana publications, new york, london, rome. p. 55; baasch andersen 2005, supra note 38, p. 167. 40 baasch andersen 2005, supra note 38, p. 172. 41 ferrari 2000-2001, supra note 39, p. 1-8. saidov, djakhongir (2001): methods of limiting damages under the vienna convention on contracts for the international sale of goods. available from the www: <url: http://cisgw3.law.pace.edu/cisg/biblio/saidov.html> [cited as saidov 2001, section no, paragraph no]. section ii, paragraph 7. see also knapp in bianca & bonell 1987, supra note 17, p. 541. in tribunale di vigevano, 405 (12 july 2000) the italian court examined the question of the burden of proving the lack of conformity of the goods. the court rejected the opinion that the burden of proof is a question excluded from cisg and governed by the applicable domestic law (art. 4, first sentence, cisg). on the contrary, it held that the burden of proof is a matter governed but not expressly settled by cisg, and which therefore has to be settled in conformity with the general principles underlying cisg (art. 7(2) cisg). in the court's view, it is a general principle underlying the cisg that the plaintiff should bring evidence in favour of its cause of action. such principle may be derived inter alia from art. 79(1) cisg which expressly states that the non performing party must prove the circumstances exempting it from liability for its failure to perform, thereby implicitly confirming that it is up to the other party to prove the fact of the failure to perform as such. therefore, it is up to the buyer to prove the existence of a lack of conformity and the damage ensuing from it. see further editorial remarks by charles sant’elia in http://cisgw3.law.pace.edu/cases/000712i3.html, and ferrari, franco (2001): tribunale di vigevano: specific aspects of the cisg uniformly dealt with, p. 225-239 in 20 journal of law and commerce (spring 2001). available also from the www: nordic journal of commercial law issue 2010#2 14 any party who wants to derive beneficial legal consequences from a legal provision has to prove the existence of the factual prerequisites of that provision, e.g. the party wishing to avoid the contract must prove that there indeed has been a fundamental breach of the contract.42 on the other hand, any party claiming an exception has to prove the existence of the factual prerequisites of that exception, e.g. the party in breach does not escape liability merely by proving that he did not in fact foresee the result. he must also prove that he had no reason to foresee it.43 those facts that are exclusively in a party's sphere of responsibility and which therefore are, at least theoretically, better known to that party, have to be proven by that party since it is that party who exercises the control over that sphere.44 in relation to damages, the burden of proof lies on the party who is claiming damages. according to artilce 74 damages for breach of contract by one party consist of a sum equal to the loss, including loss of profit, suffered by the other party as a consequence of the breach. such damages may not exceed the loss which the party in breach foresaw or ought to have foreseen at the time of the conclusion of the contract, in light of the facts and matters of which he then knew or ought to have known, as a possible consequence of the breach of contract. the damaged buyer has the burden of proving the objective prerequisites of his claim for damages, i.e. the damage, the causal link between the breach of contract and the damage, as well as the foreseeability of the loss.45 it has also been argued that in order to discharge the burden of proof the party in breach has to substantiate the amount of loss he suffered. however, in helsinki court of appeal, s 00/82 (26 october 2000), helsinki court of appeal, s 01/269 (31 may 2004) and turku court of appeal, s 04/1600 (24 may 2005) the courts took the approach that the burden of proof as to the amount of damages was a question of a procedural nature. <url: http://cisgw3.law.pace.edu/cisg/biblio/ferrari6.html>.professor ferrari praises the decision. the court took account the foreign case law in a way no court had done before in order to promote uniformity. ferrari 2001, p. 231-232. in handelsgericht zürich, hg 920670 (26 april 1995) a swiss court held that the buyer had lost its right to declare the contract avoided under article 49 cisg since the buyer had failed to notify the seller about the lack of conformity of the goods in a timely fashion (articles 39 and 49(2)(b)(i) cisg). the court also mentioned that the seller's failure to perform its obligation was probably not a fundamental breach as the damage concerned was easily repairable. however, since the buyer had lost its right under article 49(2)(b)(i) cisg, the court did not address this question fully. as regards damages, the court found that the buyer had lost its rights for failure to claim damages for the leak of the delivered containers within a reasonable time. compensation for damages caused by the transport of the container was denied by the court because the buyer failed to prove them sufficiently (article 74 cisg). 42 ferrari 2000-2001, supra note 39 p. 2. this rule is also specifically embodied in article 79 according to which the party relying on the impediment must prove its existence and further, that he could not reasonably be expected to have taken the impediment into account at the time of the conclusion of the contract or to have avoided or overcome it or its consequences. 43 ferrari 2000-2001, supra note 39, p. 2; text of the secretariat commentary on article 23 of the 1978 draft (draft counterpart of cisg article 25), supra note 17, honnold 1999, supra note 8, p. 209. 44 ferrari 2000-2001, supra note 39 p. 2-3. 45 ferrari 2000-2001, supra note 39, p. 2-3. saidov 2001, supra note 41, section ii, paragraph 7. see also knapp in bianca & bonell 1987, supra note 17, p. 541; stoll-gruber in schlechtriem & schwenzer 2005, supra note 8, p.771-772. nordic journal of commercial law issue 2010#2 15 for example, in turku court of appeal, s 04/1600 (24 may 2005) as to the proof in relation to the amount of damages suffered by the buyer was hard to acquire, the court estimated reasonable damages as provided for the finnish procedural law.46 in the reasoning the court of appeal stated that the starting point in relation to the damages is that the injured party is placed in the same position he would have been had the contract been fulfilled properly. thus, the amount of damages may exceed the contract value of the sales contract. the court of appeal also acknowledged that the seller had been aware of the fact that the buyer had acted as an intermediate, i.e. the buyer had sold the products delivered by the seller further to his own customers. in these circumstances the seller ought to have understood, already at the time of the conclusion of the contract that if the goods delivered to the buyer did not confirm with the contract the buyer might not be able to fulfil his contractual duties towards his own customers and this might cause damages to the buyer. all the damages claimed by the buyer were of such nature that could be compensated under cisg article 74. in relation to article 77 and the mitigation of the damages, the court of appeal confirmed the decision of the district court: the buyer had not acted contrary to the requirements set out in article 77. the court of appeal however stated that as the proof in relation to the amount of damages suffered by the buyer was hard to acquire, the court had a right to estimate reasonable damages as provided for in finnish code of judicial procedure chapter 17, section 6: the finnish code of judicial procedure, chapter 17, section 6 (571/1948) provides: “if the issue relates to the quantum of damages and no evidence is available or if evidence can only be presented with difficulty, the court shall have the power to assess the quantum, within reason.” purely domestic rules which allow the abstract calculation of damages or presume that a loss has occurred should not be considered, when applying the cisg.47 3.3. uniformity in relation to the rules on conciliation there is no specific provision in the cisg on conciliation. if the parties have made no indication to the conciliation can the court supplement the contract or have recourse to the rules of domestic law on conciliation by way of the rules of international law? article 7 provides that in the interpretation of this convention regard is to be had among other things to the observance of goods faith in international trade. in addition article 7(2) provides that the questions concerning matters governed by this convention that are not expressly settled in it, are to be settled in conformity with the general principles on which it is based on. the notion of good faith was however specifically left to concern only the interpretation of the 46 the case involved a sale of powdered paprika from the spanish seller to a finnish buyer. the questions in dispute included whether the delivered paprika confirmed with the contract and was there a lack of conformity in the goods, had the buyer given notice of the non-conformity in time and was the seller liable for damages caused to the buyer because of the defect. 47 stoll-gruber in schlechtriem & schwenzer 2005, supra note 8, p. 772. nordic journal of commercial law issue 2010#2 16 convention and it cannot be applied directly to individual contracts.48 further, even if a standard of good faith in international trade could be established in relation to conciliation, this does not mean that it would override clear decisions embodied in provisions of the cisg.49 article 74 embodies the principle of full compensation.50 no domestic rules on conciliation are allowed to be applied.51 reference should also be made to article 8 of the cisg. according to article 8 on interpretation, the determination of contract content is based on the actual, common intent of the parties.52 if only one party’s intent is determinable, the other must be aware what he intent was. if no such intent is determinable, the objective approach is adopted and the contract is interpreted according to the understanding that a reasonable person of the same kind as the other party would have had in the same circumstances.53 article 8 also has a function in supplementing contacts.54 also in this respect it has been held that the convention does not permit to strike out unfair contract terms based on good faith and article 8. nor can the reduction of contractual penalty on grounds of equitableness be supported by article 855 the solution of full compensation adopted in the cisg is in itself limited by the foreseeability required by article 74 and further by the mitigation requirements set out in article 77.56 the party in breach is only liable for damages he foresaw or ought to have foreseen at the time of the conclusion of the contract, in the light of the facts and matters of which he then knew or ought to have known, as a possible consequence of the breach of contract. the basic approach is that the foreseeablity of the damages is judged objectively by way of referring to a reasonable person in the same circumstances. however, if at the time of the conclusion of the contract the 48 schlechtriem in schlechtriem & schwenzer 2005, supra note 8, p. 94-95. 49 schlechtriem in schlechtriem & schwenzer 2005, supra note 8, p. 100. 50 cisg-ac opinion no 6, calculation of damages under cisg article 74, spring 2006. rapporteur: professor john y. gotanda, villanova university school of law, villanova, pennsylvania, usa. 51 stoll-gruber in schlechtriem & schwenzer 2005, supra note 8, p. 746; lookofsky 2000, supra note 17, p. 154. 52 see also discussion in chapter 2.4.2 formation of the contract versus interpretation, above 53 schmidt-kessel in schlechtriem & schwenzer 2005, supra note 8, p. 120-121. 54 schmidt-kessel in schlechtriem & schwenzer 2005, supra note 8, p. 117. 55 schmidt-kessel in schlechtriem & schwenzer 2005, supra note 8, p 124. 56 according to article 77 a party who relies on a breach of contract must take such measures as are reasonable in the circumstances to mitigate the loss, including loss of profit, resulting from the breach. if he fails to take such measures, the party in breach may claim a reduction in the damages in the amount by which the loss should have been mitigated. and even further, the damages are limited by the exemption available to the party in breach as provided for in article 79. article 79(1) provides that a party is not liable for a failure to perform any of his obligations if he proves that the failure was due to an impediment beyond his control and that he could not reasonably be expected to have taken the impediment into account at the time of the conclusion of the contract or to have avoided or overcome it or its consequences. nordic journal of commercial law issue 2010#2 17 party that eventually is liable for the breach of contract has some special knowledge of the unusual risk, the liability may be extended.57 professor lookofsky has raised a controversial question whether the foreseeability limitation in article 74 would function as a sufficient surrogate for other domestic law standards designed to prevent compensation for “disproportionate” loss.58 like lookofsky has stressed that the courts ought to be cautious in taking into consideration the conceptions of the domestic law.59 article 7 itself requires that in interpretation of the convention regard is be had to its international character and to the need to promote uniformity in its application. further, it can be argued that the duty to mitigate and the reference to a reasonableness lead to the conclusion that conciliation of excessive damages is an issue governed by the cisg but not expressly settled in it and thus must be settled with the general principles on which it is based on. according to the finnish sale of goods act section 70 paragraph (1) the injured party must take reasonable measures to mitigate his loss. if he fails to do so, he must bear the corresponding part of the loss himself. paragraph (2) provides for adjustment of damages: the amount of damages payable to the injured party may be adjusted if the amount is unreasonable taking into account the possibilities of the breaching party to foresee and prevent the loss as well as other circumstances. in conciliating the damages all the relevant circumstances of the individual case must be taken into consideration, including the nature of the sale, the reason for the breach of contract, the extent of the damages and who the parties to the contract were. conciliation is clear departure from the principle of full compensation of damages and it should be applied exceptionally.60. most importantly the cisg does not include a similar provision on conciliation.61 in turku court of appeal, s 00/855 (12 april 2002), the court stated specifically that in relation to evaluating the reasonableness of the contract or the interest rate, the cisg was not applicable. the reasoning for the statement was that the cisg did not have an article enhancing reasonableness of the contract and no other relevant articles relating to the interest 57 stoll-gruber in schlechtriem & schwenzer 2005, supra note 8, p. 765. 58 lookofsky 2000, supra note 17, p. 154. 59 lookofsky 2000, supra note 17, p.49-50, 154. 60 ämmälä in saarnilehto et al. 2001, supra note 16, p. 878-879. 61 ämmälä in saarnilehto et al. 2001, supra note 16, p. 879; routamo-ramberg 1997, supra note 16, p. 534-536. nordic journal of commercial law issue 2010#2 18 other than article 78. 62 the case involved a sale of components to be attached to forestry equipments between a german buyer and a finnish seller. in relation to the buyer’s claim that the warranty terms had been severe and surprising, the court applied the finnish contarcts act. the freedom of contract is fairly strong in the commercial setting, but a reference has to be made to the notion of fairness and reasonableness provided for in section 36 of the finnish contracts act. the finnish contracts act (13.6.1929/228) section 36 subsection 1 states: “if a contract term is unfair or its application would lead to an unfair result, the term may be adjusted or set aside. in determining what is unfair, regard shall be had to the entire contents of the contract, the positions of the parties, the circumstances prevailing at and after the conclusion of the contract, and to other factors..”.in a case where a contractual term is unreasonable, conciliatory measures aim at rectifying the imbalance of the duties of the contractual parties. taking relevant factors into account, as a conclusion the court held that the warranty terms had not been unreasonable, even though they had strongly limited the seller's liability for non-conformities and thus, there was no need for conciliating the contractual terms. also in turku court of appeal, s 04/1600 (24 may 2005), the court of appeal held that in relation to the conciliation of the damages the cisg did not include any provisions according to which the damages could be conciliated or amended for reasons of equity.63 the district court had on the other hand applied the domestic law in conciliation without a blink of an eye even though the cisg was applicable. 3.4. a new approach a change is under way. in supreme court 2005:114, s 2004/50 (14 october 2005)64 the court took a detailed and well reasoned approach in relation to the main issue: whether the court 62 similarly in gerechtshof’s (hof) arnhem, 94/305 (22 august 1995) the court held that the cisg was not applicable in relation to conciliation. the case involved a sale of live lambs. the buyer alleged that the penalty required by the penalty clause contained in the contract should be diminished in accordance with articles 7, 8(3), and 77 of the cisg. the penalty was inequitable, for it was not proportional to the loss incurred. the court of appeals held that neither article 8(3) concerning the interpretation of the declarations of the parties, nor article 77 relative to the obligation to mitigate losses resulting from the infraction of the contract, nor any other clause of the convention can serve as a foundation for the reduction of the penalty amount. this question must therefore be settled according to the applicable law of the contract, in this case german law for which the reduction is not possible in commercial matters (§ 348, c. com. german). 63 discussed above in relation to the burden of proof, chapter 3.2 uniformity in ralation to the burden of proof. 64 the case had firstly been tried by the district court of heinola as early as in january 2003. the case had then been dismissed on the grounds of jurisdiction. the court of appeal of kouvola confirmed the decision in november 2003. the plaintiff petitioned for and was granted leave to appeal by the supreme court. the supreme court returned the matter to the district court to be retried on the matters relating to the cisg. decision by the distrcit court of heinola given in april 2006 was again appealed for. the decision the court of appeal of kouvola in march 2007 had become final. nordic journal of commercial law issue 2010#2 19 had jurisdiction at all. the supreme court concentrated on the issue whether the court had jurisdiction on the basis of the brussels convention on jurisdiction and the enforcement of judgments in civil and commercial matters 1968 (from herein the brussels convention).65 the case involved a sale of a log house kit in connection with a contract of agency. a finnish company had sold a log house kit to a german buyer to be used as his and his family’s home, but also as a model house in connection with the agency. in relation to the jurisdiction the supreme court had first to resolve the issue whether the buyer was a consumer. the sale of a log house kit had been concluded on the same day than the contract for agency. the negotiations for both contracts had been held simultaneously and the contracts had been singed concurrently. by referring to a similar judgement of the european court of justice (among the others mentioned c-269/95, benincasa, judgment 3 july 1997 and c-464/01, gruber, judgement 20 january 2005) the supreme court concluded contrary to the district court and the court of appeal that the sale of log house kit was closely connected with the buyer’s business operations and that the connection between the sale and the business operations could not be held insignificant taking into account the agreement as a whole. the buyer could not be considered a consumer within the meaning of the brussels convention. the next question related to the place of performance. according to article 5 paragraph 1 subparagraph 1 of the brussels convention, in matters relating to a contract, the action must be brought in the courts for the place of performance of the obligation in question. in relation to this matter the district court had applied the 1980 rome convention. the reference in the agency agreement to the finnish law did not suffice; as the parties have not made an explicit choice on applicable law, according to article 4 of the 1980 rome convention, the contract is governed by the law of the country with which it is most closely connected. more specifically article 4(2) of the 1980 rome convention provides that it shall be presumed that the contract is most closely connected with the country where the party who is to effect the performance which is characteristic of the contract has, at the time of conclusion of the contract, his habitual residence, or, in the case of a body corporate or unincorporate, its central administration. the official report on the 1980 rome convention provides some examples in identifying the characteristic performance of a contract. usually in the modern contract the other party’s obligation takes the form of money and the other party’s obligation the form of delivery of goods, the provision of a service, transport, security etc., depending on the type of the contract. it is the performance for which the payment is due which usually constitutes the characteristic 65 the brussels convention has since been replaced by the council regulation (ec) no 44/2001 of 22 december 2000 on jurisdiction and the recognition and enforcement of judgments in civil and commercial matters (brussels i regulation). nordic journal of commercial law issue 2010#2 20 performance of the contract66. thus, the applicable law was the finnish law, according to which a debt of money must be paid at the debtor’s place, and the claim in question could be tried in finland. however, as note above, the district court dismissed the case on the grounds that it considered the buyer to be a consumer, thus the contents of the finnish law was not discussed further. the court of appeal had confirmed the district’s court’s decision on the status of the buyer. the supreme court noted that according to article 21 of the 1980 rome convention, the application of the said convention does not prejudice the application of international conventions to which a contracting state is, or becomes, a party. both finland and germany were contracting parties to the cisg and thus the cisg was the applicable law. the supreme court took into account the cisg article 2(a) that states that the convention does not apply to sales of goods bought for personal, family or household use, unless the seller, at any time before or at the conclusion of the contract, neither knew nor ought to have known that the goods were bought for any such use. the supreme court held that taking into account to the legislative history of the convention, article 2(a) must be interpreted to mean that the cisg is also applicable in relations to the sales of goods where the goods are bought only partly for business purposes and partly for personal use. when drafting the article it was considered whether the principal purpose of use ought to be given any significance in determining the scope of the convention but this proposal was dismissed. the meaning of article 2(a) must be interpreted restrictively so that it applies only to sales of goods for exclusively personal use. progressively the supreme court specifically referred to professor schlechtriem’s commentary on the un convention on the international sale of goods (cisg), 1998, p. 32 and other commentary by jan ramberg and johnny herre, internationella köplagen (cisg) 2004, p. 93. even though the immediate and principal purpose of the log house was to function as a home for the buyer and his family the sale had a connection to the agency business to be commenced at a later stage. in relation to the scope of application, the intended purpose of goods was decisive not the actual use (the agency had not been commenced at all due to the disagreements between the parties). thus, the place of performance was to be determined by the rules of the cisg. according to article 57(1)(a) if the buyer is not bound to pay the price at any other particular place, he must pay it to the seller at the seller's place of business. similarly, the purchase price referred to in the claim must be paid for at the seller’s place of business, in finland. the court has jurisdiction to examine the claim and therefore the matter was returned to the district court. the adopted approach ought to be promoted and recommended. the fact that the case involved an eu-connection may have influenced the more liberal use of the international 66 giuliano, mario – lagarde, paul (1980): report on the convention on the law applicable to contractual obligations by mario giuliano, professor, university of milan, and paul lagarde, professor, university of paris i. official journal of the european union c 282, 31/10/1980 p. 0001-0050. p. 20-21. nordic journal of commercial law issue 2010#2 21 sources of law. unfortunately, the lower courts did not fully follow the lead. however, the core of the case in relation to the contract itself and the issues covered by the cisg lied in evidentiary issues where cisg in the essence surely sets the legal boundaries and consequences for the certain acts but does not of course determine as such what has actually happened between the parties67. nevertheless, the criticism presented earlier applies also here: in order to fully appreciate and honour the international nature of the convention those who apply it and interpret it ought to emphasize also international sources of law – academic literature as well as case law – more thoroughly and openly. 4. conclusion from the academic point of view the cisg is captivating and raises endless questions. from a practical point of view the problems i have raised do not squarely relate to every day business life. however, in going through every case step by step and comparing to international scholarly writings and case law the resulting analysis benefits not only the court clerks, judges and justices struggling with cases dealing with the cisg, but also the business partners, in-house lawyers and others dealing with international trade on an every day basis. the cisg is a truly uniform law readily available to all business partners, regardless of background and prejudice. it therefore should be utilized more readily. 67 the questions in dispute relating to the actual contract and the cisg involved among the others the dispute on the contents of the contract, the dispute on the conformity of the goods, whether the reclamation was given within a reasonable time and whether reasonable measures where taken to mitigate the losses. microsoft word commentary1.doc remarks on the manner in which the unidroit principles may be used to interpret or supplement article 76 of the cisg by bruno zeller* nordic journal of commercial law issue 2003 #1 * dr. bruno zeller is lecturer of law, victoria university of technology, melbourne. nordic journal of commercial law, issue 2003 #1 1. introduction it is true to say that both the unidroit principles and the convention are instruments which can be used to assist in the interpretation of contracts if they address the same issues. indeed the principles in the preamble state that they may be used to interpret or supplement international uniform law instruments.1 the icc court of arbitration in paris took advantage of this possibility in a case where no express choice of law clause was included in the contract. they referred to both article 76 cisg and article 7.4.6 of the unidroit principles as being relevant to assist in their deliberations.2 arguably the tribunal was guided by the official comments on the unidroit principles which included a direct reference to cisg article 76: “the purpose of this article, which corresponds in substance to art. 76 cisg, is to facilitate proof of harm where no replacement transaction has been made …”3 however, it must also be remembered that the cisg is part of municipal law, that is, courts are obliged to use it when applicable. at best, the unidroit principles can be used by courts to assist where the provisions of the cisg are not clear. furthermore, such assistance can only be considered if cisg articles 7 or 8 have not produced a solution. it can be argued that if there is a gap in the cisg then the unidroit principles should be consulted if possible to fill the gap before recourse to domestic law is taken.4 a set of rules and principles is placed in a fairly simple-looking formula.5 the drafters of the convention purposefully used earthy words devoid of municipal meaning and it must also be understood that articles within the cisg cannot be read in isolation. cisg articles 7 and 8 clearly demand that all interpretation and application of any principle contained in the convention must be undertaken within the four corners of the cisg.6 all principles and therefore all articles are an interlocking construct regulating the interactions of international contracting parties with the aim to maintain business relations as long as possible and afford compensation to parties without unduly disadvantaging the breaching party. 2. avoidance cisg article 76 is no exception. the first criterion is that this article only applies if the contract has been avoided pursuant to cisg article 25 and hence cisg articles 49 or 64. this is confirmed by the district court of münchen, where the court indicated that compensation 1 see kritzer, a. “general observations on use of the unidroit principles to help interpret the cisg”, available at <http://www.cisg.law.pace.edu/cisg/text/matchup/general-observations.html> 2 icc court of arbitration, case no. 8502, november 1996, available at <http://cisgw3.law.pace.edu/cases/968502i1.html>. 3 see the official comments on article 7.4.6 of the unidroit principles, comment 1, available online at <http://cisgw3.law.pace.edu/cisg/principles/uni76.html#official >. 4 for further elaboration see kritzer, a., supra note 1. 5 see eiselen. s, “remarks on the manner in which the unidroit principles of international commercial contracts may be used to interpret or supplement article 74 of the cisg”, para. a.; available online at <http://cisgw3.law.pace.edu/cisg/principles/uni74.html#editorial> 6 see zeller, b., four corners – the methodology for interpretation and application of the un convention on contracts for the international sale of goods, available online at <http://cisgw3.law.pace.edu/cisg/biblio/4corners.html>. nordic journal of commercial law, issue 2003 #1 of damages for non-performance cannot be claimed if the contract has not been avoided.7 the court added that otherwise the rules pertaining to the avoidance of contract would be superfluous.8 the unidroit principles do not use the word “avoidance” but “termination” when referring to such a situation. arguably the different terminology of “avoidance” or “termination” is of little significance. in either case the parties do not intend to fulfil their contractual obligations. it can also be further argued that cisg article 76 as well as the counterpart unidroit principle is merely an addition to cisg article 74, namely, fully compensating9 the innocent party for a loss suffered due to a breach of contract. it attempts to clarify situations where despite the avoidance of the contract the party seeks to demand damages if they purchased goods from another source. 3. calculation of damages cisg article 76 and the counterpart unidroit principle in essence establish a formula whereby the injured party can calculate damages where the contract has been avoided and no substitute transaction has been entered into.10 it is established that cisg article 76 and hence unidroit article 7.4.6 are only to be used if a concrete calculation of damages pursuant to cisg article 75 is not possible.11 the formula allows calculating damages “abstractly”, that is, without having made a clearly definable cover transaction. the purpose of both instruments is to prescribe a method by which the market price can be calculated. the icc court of arbitration reached its conclusion by analyzing both instruments. as they yielded the same result, it can be argued that there is no significant difference between cisg article 76 and unidroit article 7.4.6. nevertheless, differences between the two provisions are observable. the cisg distinguishes between situations where there was no substitute purchase or resale and situations where goods have been taken over. the principles, on the other hand, merely point to the fact that no replacement transaction has taken place. it is true to say that the situation where goods have been taken over only applies to the buyer.12 there are really only two situations which could reasonably be contemplated, namely, the buyer avoided the contract after taking over the goods, or in relation to subsection (2) of cisg article 76, by fixing an earlier time to prevent the buyer from speculating.13 the principles arguably may be lacking in taking these situations into consideration and the cisg would need to be used to clarify and help interpreting the principles. 7 germany, landgericht [district court] münchen 12 hko 4174/99; case presentation including english translation available online at <http://cisg3.law.pace.edu/cases/000406g1.html>. 8 ibid. 9 for a treatment of article 74 and the concept of full compensation see also sieg eiselen on < http://cisgw3.law.pace.edu/cisg/text/anno-art-74.html >. 10 the secretarial commentary is the closest counterpart to an official commentary on the cisg; see <http://cisgw3.law.pace.edu/cisg/text/secomm/secomm-76.html>. 11 germany, oberlandesgericht [appellate court] hamm, 19. zivilsenat, 22 september 1992, 19 u 97/91, <http://cisgw3.law.pace.edu/cases/920922g1.html>. 12 enderlein, f., and maskow, d., international sales law, oceana 1992, at 307, also available online at ,http://cisgw3.law.pace.edu/cisg/biblio/enderlein.html>. 13 enderlein, op. cit, at 307. nordic journal of commercial law, issue 2003 #1 4. current price cisg article 76(2) and unidroit principle 7.4.6 (2) attempt to clarify the current price by tying it to the prevailing place where delivery of the goods should have been made. in general, unidroit article 7.4.6 uses simpler language and condenses parts of cisg article 76 into a more readable form. it can be argued therefore that it would be advantageous if the principle were read before the counterpart provision of the cisg is applied. it would allow the court or arbitral tribunal to get a “feeling” of what the cisg attempts to achieve. cisg article 76 and unidroit article 7.4.6 attempt to give solutions to two problems, namely, the determining of the date when the contract has been declared avoided and, secondly, the place where the current price has to be determined. the problem of timing has been addressed and clarified at the 10th plenary meeting of the diplomatic conference at which the cisg was promulgated.14 the meeting minutes clearly state that the time is not the time when the party who “declared the contract avoided had for the first time the right to do so.”15 instead the crucial time is the “time of avoidance”. this phrase was taken over by the cisg as well as the unidroit principles. both instruments use the same phraseology and therefore the clarification has been provided and the time is definitely not when a “nachfrist” was granted pursuant to cisg articles 49 or 64. 5. timing of calculation of damages cisg article 76 also adds to the timing the “taking over of goods”. unidroit article 7.4.6 does not do so, as mentioned above. arguably the promoters of the principles took note of schlechtriem who argues that the “taking over of goods” as a trigger point is difficult to justify. schlechtriem notes: “in the event of a delayed or non-conforming performance, the buyer who can neither undertake nor prove a definite cover transaction under article 75 uses the reasonable16 time period permitted by article 49(2) at his own risk. in the case of article 49(2)(b)(i), the reference point actually precedes the moment when the buyer could avoid the contract because the buyer, at the that time, still did not know of the breach.”17 in this situation, as pointed out above, the unidroit principles are of little help to overcome this problem. it appears though that schlechtriem foresaw a problem which technically can cause problems but jurisprudence on this point has not revealed any disputes. 14 legislative history, 1980 vienna diplomatic conference, summary records of meetings of the plenary meetings, para. 38 et seq. (a/conf.97/c.l.245). 15 ibid, para. 40. 16 reasonableness is a general principle of he cisg and is directly mentioned in 37 provisions of the convention. for further comments on the definition and operation of this concept see a.h. kritzer, “reasonableness: overview comments”, available at <http://cisgw3.law.pace.edu/cisg/text/reason>. 17 schlechtriem, p. “uniform sales law – the un-convention on contracts for the international sale of goods (1986), at 98, also available online at <http://cisgw3.law.pace.edu/cisg/biblio/schlechtriem.html> nordic journal of commercial law, issue 2003 #1 6. conclusion the question of how to determine the “current price” does not appear to pose any problems. that is the case as cisg article 76 and unidroit principles article 7.4.6 are essentially identical and the icc court also in its determination did not distinguish between the two counterpart provisions. the court’s decision simply confirmed that the market price is to be determined pursuant to the place of delivery of goods.18 arguably, if the promoters of the principles had seen or anticipated problems in the application of cisg article 76 they would have worded unidroit article 7.4.5 differently to overcome the perceived problem. this has been done on other occasions such as unidroit article 7.3.1, which can be used for a better understanding of cisg article 25. the time of avoidance or the time the contract is terminated is not always an uncontroversial point of reference. the problem still remains that a party can delay avoidance in order to gain an advantage, however the problem is that the party may be held to have violated the duty to mitigate as well as being in breach of cisg article 7, namely disregarding the principle of good faith. 19 18 icc court of arbitration, case no. 8502, see supra note 2. 19 the concept of good faith has generated a lively debate. felemegas in his editorial on cisg art. 7, available online at <http://cisgw3.law.pace.edu/cisg/text/peclcomp7.html#er> states that it is “circumscribed to the interpretation of the law and should not be allowed to impose additional duties of a positive nature to the parties.” the present writer is of the opinion that good faith in addition also imposes a duty on the behavior or the parties (see “four corners – the methodology for the interpretation and application of the un convention on contracts for the international sale of goods, supra note 6) see also the remarks by ulrich magnus, available online at <http://cisgw3.law.pace.edu/cisg/principles/uni7.html#um>. 1. introduction 2. avoidance 3. calculation of damages 4. current price 5. timing of calculation of damages 6. conclusion 0 preface revised 1 preface current legal issues in crowdfunding thomas neumann* * phd, master of laws. associate professor of commercial law and chair of the clear project: ‘crowdfunding, law, education, and research’ at aalborg university, denmark. the author discloses an economic interest below a total of €10,000 placed through the following crowdfunding service providers: brickshare/the many, flexfunding, kameo, lendino and mintos. https://orcid.org/0000-0002-0477-7429. current legal issues in crowdfunding 2 njcl 2022/2 3 preface current legal issues in crowdfunding by thomas neumann ............................................................................... 1 6 status artis: research in the law and practice of crowdfunding by stefano cattelan & thomas neumann .................................. 7 53 the new eu crowdfunding regulation explanations & perspectives by søren brinkmann & mads ebert rasmussen ........................ 54 72 civil liability for the key investment information sheet in denmark by stefan westh wiencken & rasmus schou pedersen ........ 73 89 the challenges awaiting the european crowdfunding services providers regulation: ready for launch? by eugenia macchiavello .............................................................. 90 115 the fundraiser's transfer of personal data from the european union to the united states in context of crowdfunding activities by nicolai kjærgaard sørensen & ulla steen .................... 116 136 tied agents under a liability umbrella within the ecspr regime by till otto, patrick wambold & karsten wenzlaff ......... 137 143 current legal issues in crowdfunding 4 introduction and credit receiving contributions from a large number of people is by no means a new method of financing an activity. popular examples go back to pullitzer’s campaign to finance the statue of liberty’s pedestal in 1885 and alexander pope’s translation of homer’s illiad in 1713. with the emergence of the internet and its widespread integration in households it has become possible for fundraisers to reach many more investors. one of the first to harness the power of crowdfunding over the internet was the british rock band marillion who, in 1996, raised usd 60,000 to finance their tour of the united states using crowdfunding in 1996. since then, a lot has happened in terms of the number of crowdfunding products, platforms and the amount of money raised. the number of investors engaged in crowdfunding increases, and so too does the number of legislative initiatives and amount of research attention devoted to it. on 13 april 2021 we established the clear research group at aalborg university. the group has as its declared mission to undertake the study of legal phenomena in crowdfunding and to communicate relevant, research-based knowledge to actors in the field investors, entrepreneurs, representatives from crowdfunding platforms, and public authorities. collaboration is in the clear group’s dna. hence, we asked a number of crowdfunding scholars and practitioners from around the world to provide us with their views on current legal issues pertaining to crowdfunding. we have held talks with numerous crowdfunding enthusiasts and practitioners and in the end, twelve authors decided to join us in our efforts to increase focus on legal research in crowdfunding through the publication of this special issue of nordic journal of commercial law. knowing that the legal aspects of crowdfunding are many, and that crowdfunding and law as a research area is in its infancy, we thought it important to give each author free hands in choosing their topic and perspective in their article. hence, you will find articles addressing a wide range of issues in crowdfunding in this special issue. i thank all authors for their thought-provoking contributions. i would also like to mention phd fellow cecilie højvang christensen, research assistant stefano cattelan, student assistant signe lyngholm lindbjerg, and student assistant anna risgaard lindbjerg, and to thank them for their contribution in establishing the clear research group at aalborg university and their assistance in preparing this special issue of the nordic journal of commercial law. thomas neumann chair of the clear research group on crowdfunding www.theclearproject.dk njcl 2022/2 5 presentation of contributions the first contribution to the issue has been written by dr cattelan and dr neumann. from the assumption that research on legal issues pertaining to crowdfunding is underdeveloped, the authors set out to collect, systematize and synthesize the current legal scholarship in the field. after collecting and examining almost 300 publications concerning legal issues in crowdfunding, the authors conclude that legal research in this area of life is indeed still in its infancy. the authors argue that the time is ripe for more legal scholars to show an interest in the field as the amount of money being raised through crowdfunding keeps increasing. at the same time, increased scholarship may add to the clarity needed for this market to grow even further. the authors find that the existing legal scholarship is often concerned with questions of how to regulate a highly internationalized market, how to encourage development to the benefit of innovation and, at the same time, to protect often inexperienced, or so-called ‘unsophisticated' investors’. most of the scholarly attention is directed toward debt-based and equity crowdfunding, with significantly less focus on donation and reward crowdfunding. further themes in the literature are the predictability of law, the conduct of the crowdfunding businesses, protection of investors / disclosure, and access to risk capital. while many key concepts of crowdfunding have been introduced in the literature, the legal scholarship seems not to take full comparative advantage of the fact that many concerns are common across jurisdictions, such as encouraging sme development through access to risk capital or ensuring the protection of the unsophisticated investor. to stimulate further development of research into the legal aspects of crowdfunding, a categorised bibliography is attached. the second contribution to the special issue is authored by two legal practitioners brinkmann, esq. and rasmussen, esq. from their standpoint in legal practice they provide the reader with an introduction to the content of the new eu crowdfunding regulation ecspr. in doing so, they bring several salient features to the reader’s attention, including uncertainties of a practical nature. throughout the text the authors relate the new rules of the ecspr to the existing legal regime in denmark, in which it becomes obvious that the danish legislature has taken a reluctant approach to regulating crowdfunding activities. the third piece is also written by two legal practitioners – wiencken, esq. and pedersen, esq. they address the liability regime applicable to the information contained in the mandatory key investment information sheet (kiis). while the kiis is mandatory according to ecspr, the liability regime for wrongful information contained in the kiis is left to domestic legal regulation. the two practitioners study the domestic setting of denmark. while no danish legislation has been enacted regulating civil liability for the kiis, wiencken and pedersen find that the project owner is the current legal issues in crowdfunding 6 party primarily responsible for the accuracy of the kiis and as such will be the party held primarily responsible in any civil claims resulting from errors or omissions in the information sheet. the crowdfunding service providers’ civil liability is most likely limited to such errors, misleading information and omissions in the information sheet that result from inadequate procedures adopted by the crowdfunding service provider or their failure to comply with such procedures. in the fourth paper dr macchiavello evaluates whether the newly adopted ecspr is able to withstand current international challenges that the author predicts will be significant adversaries to the regulation’s success. taking into account the scope, architecture, and specific rules of the ecspr, dr macchiavello considers a number of aspects; the residual fragmentation/uncertainty that brexit, climate change together with recent sustainable finance framework and other eu actions, and the pandemic crisis. she concludes that while the ecspr appears to be an advancement in facilitating crowdfunding services, there are several challenges to its implementation?. one such challenge is that small crowdfunding service providers will experience being more tightly regulated under the ecspr. in terms of the four challenges considered by the author, she finds the ecspr to present a potential high level of resilience. however, she also points out aspects tainted by uncertainty and insufficient harmonisation. dr macchiavello points out that further adjustments may be desirable. in the fifth contribution to the present special issue, sørensen, esq. and dr steen demonstrate how transfer of personal data to the us may take place in situations of reward crowdfunding. the authors highlight the fundraiser’s obligations as data controller in such transfers and underline that no simplesolution exists in achieving an adequate level of personal data protection. current contractual solutions are difficult to comply with. considering that the fundraiser is also obliged to make a transfer impact assessment, the fundraiser faces significant risks using us reward platforms. the authors reason that the legal barriers to data transfer to the us is due to us security legislation authorizing disproportionate access for us intelligence services to citizens' personal data, compared to eu law. sørensen, esq. and dr steen stress that a possible solution may be on the horizon, in the form of the new tadp (trans-atlantic data privacy framework) currently being negotiated between eu and us. the sixth and final contribution is by otto, esq. wambold, esq. and wenzlaff. the authors discuss how existing mifid regime licenses can be used in parallel to a license under the ecspr in germany, where the implementation law of mifid may indicate otherwise. the authors conclude that mifid, ecspr and the intention of the german legislator is to allow concurrent authorizations under the separate regimes. microsoft word note1.doc the arbitration institute of the stockholm chamber of commerce by ulf franke1 nordic journal of commercial law issue 2003 #1 1 ulf franke is secretary general of the arbitration institute of the stockholm chamber of commerce. he is also secretary general of the international council for commercial arbitration (icca) and president of the international federation of commercial arbitration institutions (ifcai). nordic journal of commercial law, issue 2003 #1 2 1. introduction 1.1 establishment, development and structure the arbitration institute of the stockholm chamber of commerce (scc institute) was established already in 1917 and has since then been active in both domestic and international arbitration. while at the outset the scc institute mainly administered domestic arbitrations, the international activities have increased significantly over the past twenty-five years. out of the about 160 cases in 2004, roughly half the number is international. although the international cases involve parties from virtually all parts of the world, east-west arbitration plays a predominant role. on the eastern side there are parties from the russian federation and other republics of the former soviet union, as well as from china, and on the western side us and western european corporations. the scc institute is an entity within the stockholm chamber of commerce. it is, however, functionally independent and decisions of the board of the institute are final and not subject to review by the chamber. the present chairman of the board is dr. leif thorsson, justice of the supreme court. the day-to-day activities of scc are handled by its secretariat headed by a secretary general. the present secretary general is mr ulf franke who has held this position since 1980. apart from the secretary general there is an assistant secretary general and three other lawyers, as well as four assistants. the lawyers and assistants are organised in three divisions, each handling one third of the cases. 1.2 activities apart from resolving disputes, which, of course, is the main activity and will be dealt with more fully below, scc publishes twice a year a newsletter and a book, stockholm arbitration report. the latter includes articles on topical issues in international arbitration. emphasis is placed on publishing extracts from arbitral awards and court decisions, with in-depth commentaries by scholars and practitioners. 1.3 rules and model arbitration clause the present scc rules came into force in 1999 and are available in chinese, english, french, german, russian, spanish and swedish. the scc institute also has adopted rules for expedited arbitrations, which are mainly aimed at minor disputes, insurance arbitration rules, which are specifically designed for insurance disputes, as well as procedures and services offered by the scc institute when applying the uncitral arbitration rules. in 1999 scc set up a mediation institute. the model arbitration clause recommended by the scc institute reads as follows. “any dispute, controversy or claim arising out of or in connection with this contract, or the breach, termination or invalidity thereof, shall be settled by arbitration in accordance with the rules of the arbitration institute of the stockholm chamber of commerce.” nordic journal of commercial law, issue 2003 #1 3 2. facts and figures 99 97 100 110 122 135 135 130 120 160 0 20 40 60 80 100 120 140 160 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 (est) number of cases nationality of the parties 2002 other (21) sweden (85) germany (3) great britain (7) usa/canada (7) the netherlands (6) other scandinavian countries (12) switzerland (4) singapore (4) italy (4) china (15) russia (9) ukraine (3) nordic journal of commercial law, issue 2003 #1 4 subject of dispute 2002 share purchases (18) other (28) sale and purchase of business (6) co-operation (8) sales of goods (36) construction (7) employment (4) joint ventures (5) licences (8) 3. how proceedings are commenced 3.1 request for arbitration the scc rules provide in article 5 for a simplified initial procedure consisting of a brief request for arbitration rather than a full demand coupled with documentary evidence. apart from the names and addresses of the parties, the request should contain a summary of the dispute and a preliminary statement of the relief claimed. the arbitrator appointed by the claimant should also be named at the time of the request. a claimant is, of course, free to file a more extensive document at the outset, equivalent to the statement of claim provided for in article 21, which the claimant is expected to file when the case has been referred to the arbitrators. usually, however, requests for arbitration are very brief and do not include more than the basic requirements mentioned above. after having received the request for arbitration the scc institute will, as a preliminary matter, determine whether there is a prima facie agreement to arbitrate. however, only if it is clear that the institute lacks competence over the dispute the request will be dismissed. for example, a request may be dismissed if the arbitration clause refers to some other arbitration institution than the scc institute, or clearly provide for ad hoc arbitration. 3.2 the respondent's reply if the scc institute determines that it has competence over the dispute, the request for arbitration will be communicated to the respondent, who will be asked to submit a reply within the time fixed by the institute. nordic journal of commercial law, issue 2003 #1 5 the reply is meant to mirror the request for arbitration and is envisaged to be correspondingly brief. it should comment on the request for arbitration and name the arbitrator appointed by the respondent. if the respondent wants to make a counterclaim or plead a set-off, a statement to that effect shall also be made in the reply. if the respondent wishes to object to the jurisdiction of the scc institute, this is the time when such objection shall be filed. a reason for such objection may be an ambiguously drafted arbitration clause, but it also happens that a party holds that the arbitration clause is invalid for other reasons, or that he is not a party to the contract containing the arbitration clause. sometimes objections are filed in an obvious attempt to delay or disrupt the arbitration. such attempts are seldom successful but underline the importance of clear-cut arbitration clauses. there are also arbitrations where the respondent tries to avoid the arbitration by not submitting any reply at all or otherwise communicate with the scc institute. this will, however, not stop the arbitration from proceeding. 3.3 decisions of the scc institute in practice, it is often necessary for the scc institute to engage in further correspondence with the parties to clarify points in the initial stages of proceedings. when the exchange of written submission has been concluded the scc institute will make another prima facie determination of its jurisdiction if the respondent has filed an objection. 2 if it is not clear that jurisdiction is lacking, the institute will proceed to appoint the third arbitrator who will be the chairman of the arbitral tribunal. the scc institute will also determine the place of arbitration unless the parties have done so, and fix the advance on costs. as soon as the chairman of the arbitral tribunal has been appointed and the advance been provided, the scc institute will refer the case to the arbitral tribunal. referral of a case to the arbitral tribunal normally marks the end of involvement on the part of the scc institute in proceedings and the beginning of the six-month-period within which the arbitrators must render their award. there are instances also in such later stage, however, when decisions by the scc institute may be called for. one such instance may be if a party challenge an arbitrator. another is if there is a need for an extension of the time for rendering the award. as will be described below the scc institute also decides on the fees and costs of the arbitrators at the end of the arbitration. 2 a report on prima facie decisions on jurisdiction taken by scc is included in the stockholm arbitration report 2000:2. nordic journal of commercial law, issue 2003 #1 6 4. composition of the arbitral tribunal 4.1 appointment of arbitrators the scc rules provide for an arbitral tribunal of three arbitrators, unless the parties have agreed otherwise. however, if the parties have not specified the number of arbitrators the scc institute may decide on a sole arbitrator, if the circumstances so warrant, for example a fairly low amount in dispute or a clearly uncomplicated dispute. the main advantages of referring a dispute to a sole arbitrator rather than a three-membertribunal are speed and economy. a sole arbitrator needs only to make up his own mind and will not have to spend time in consultation with colleagues. also meetings and hearings can be more easily arranged. the interest of economy is served, since the parties will only have to bear the fees and expenses of one arbitrator rather than three. still there seems to be a preference in international arbitration for three arbitrators. the reasons are obvious. several arbitrators can be expected to make a more thorough analysis than a sole arbitrator. it is also a matter of confidence. with three arbitrators each party will have the opportunity to nominate one arbitrator. this is particularly important in international arbitration where there may be differences of language, tradition and culture between the parties and, indeed, among the members of the arbitral tribunal. an arbitrator nominated by a party will be able to ensure that the party's case is properly understood by the arbitral tribunal. this is the reason why there is a preference for three arbitrators. if the dispute is to be decided by a three arbitrators each party appoints one arbitrator and the scc institute the third arbitrator, unless the parties have agreed otherwise. although the third arbitrator thus is most often appointed by the scc institute, the parties may have an influence on the choice in so far as a common wish by the parties on the individual to be appointed will be respected by the institute. the parties may also agree on any other way to appoint the chairman of the arbitral tribunal, for example by the party-appointed arbitrators. if a party fails to appoint an arbitrator within the time specified by the scc institute, then the institute will make the appointment. 4.2 qualifications and disclosure there are no restrictions, as to nationality or otherwise, regarding the identity of the arbitrators. nor are there any lists from which the arbitrators must be picked. the parties are thus free to appoint anyone as arbitrators and very often they appoint nationals of their own respective countries. it is important to note, however, that all arbitrators, including those appointed by the parties, are required to be independent. they are not regarded nor should they act as agents of the parties. the scc rules contain a disclosure rule requiring every prospective arbitrator to disclose to nordic journal of commercial law, issue 2003 #1 7 those who approach him in connection with a possible appointment “any circumstances likely to give rise to justifiable doubts as to his impartiality or independence”. these circumstances include, to give some examples, a family or business tie with a party or the fact that he has served as a party's lawyer or advisor, or, more commonly, that a colleague of his has served in such capacity. this disclosure requirement is continuous in so far as an arbitrator must immediately disclose any disqualifying circumstances that he becomes aware of in the course of the arbitral proceedings. in such case he shall inform both the parties and his co-arbitrators. 4.3 challenge of arbitrators an arbitrator may be challenged before the scc institute if there exist justifiable doubts as to his impartiality or independence. a challenge shall be made within 15 days of the date on which the allegedly disqualifying circumstances became known to the party. failure to notify a challenge within the prescribed time is deemed to constitute a waiver of the right to make such challenge. the challenge shall be notified to the scc institute, which will provide the arbitrators and each party an opportunity to comment on the challenge. decisions on challenges are made by the scc institute, which may discharge an arbitrator on the ground of disqualification. the most common ground, as indicated earlier, is that the arbitrator, or another lawyer at the arbitrator’s law firm, has had previous contacts with one of the parties, for example assisted such in a legal matter. such circumstances have in some cases resulted in an arbitrator being discharged. other reasons for filing a challenge have been, for example, that the arbitrator has been arbitrator in another case where one of the parties was involved, a person associated with the arbitrator mazy have expected a benefit as a result of the outcome of the dispute, or he arbitrator have worked with a colleague of counsel for one of the parties. 3 if an arbitrator is discharged the scc institute shall appoint new arbitrator. this is the case whether or not the discharged arbitrator was appointed by the scc institute or a party. however, if the arbitrator was originally appointed by a party, such party shall be consulted by the scc institute before the appointment. 5. presentation of the case before the arbitrators 5.1 basic issues: place, language and representation the parties may agree on any place of arbitration within or outside sweden. although most arbitrations under the scc rules are conducted in sweden, the scc institute may also administer cases where the place of arbitration is situated in another country. hence, the scc institute has handled cases which have taken place in, for example, england, denmark and hong kong. 3 a report on decisions by the scc institute on challenges to arbitrators are included in the stockholm arbitration report 2000:1. nordic journal of commercial law, issue 2003 #1 8 even if the place of arbitration is in sweden, hearings and other meetings may be held abroad. if, for example, there are several witnesses to be heard in a certain country it may be cost-effective to hold a hearing in such country. the parties may also agree on any language or languages for the proceedings. if the parties cannot agree in this respect, the question will be decided by the arbitrators. if needed, interpretation will be arranged. the parties may be represented or assisted by any person of any nationality. no specific legal or other qualifications are required. parties are often represented by counsel from their own respective countries, which seldom cause any problem as the procedure is very international. if a party desires to obtain the assistance of a swedish lawyer, there is normally no difficulty in finding one who is experienced in international matters and fluent in the language or languages concerned. 5.2 statements of claim and defence the parties and arbitrators have a considerable freedom to adopt the procedure they consider best suited to the circumstances of the case so long as each party is given a sufficient opportunity to present his case. the scc rules contain in article 20 a general rule providing that the arbitrators shall conduct the case in an impartial, practical and expeditious manner. the arbitrators will begin by requesting the claimant to submit a statement of claim setting out the specific relief sought, the material facts and circumstances relied on, and a preliminary statement of evidence. when this has been received, the respondent will be invited to submit a defence stating whether and to what extent the respondent accepts or denies the relief sought by the claimant, the material facts and circumstances on which the respondent relies, any counterclaim or set-off claim and the grounds on which it is based, and, finally, a preliminary statement of evidence. the statements of claim and defence are the basic documents in the arbitration. the arbitrators may, however, and usually will, decide on the submission of additional written statements. a party may amend his claim and defence in the course of the proceedings under two conditions, namely that his case, as amended, is still comprised by the arbitration agreement and that the arbitral tribunal does not consider the amendment inappropriate having regard to the point of time at which the request is made and the prejudice that may be caused to the other party. 5.3 applicable law the parties are free to agree on the law to be applied to the substance of the case and it is wise to do so. the scc institute recommends a governing law clause, which reads as follows. “this contract shall be governed by the substantive law of …” nordic journal of commercial law, issue 2003 #1 9 it is, of course, not always possible for the parties to agree on the law to be applied, and in such event it will be decided by the arbitrators. the scc rules contain a provision on the applicable law, which reads as follows: “article 24 applicable law (1) the arbitral tribunal shall decide the merits of the dispute on the basis of the law or rules of law agreed by the parties. in the absence of such an agreement, the arbitral tribunal shall apply the law or rules of law, which it considers to be most appropriate. (2) any designation made by the parties of the law of a given state shall be construed as directly referring to the substantive law of that state and not to its conflict of laws rules. (3) the arbitral tribunal shall decide the dispute ex aequo et bono or as amiable compositeur only if the parties have expressly authorized it to do so.” if the applicable law has been agreed upon already by the time the arbitration starts, that will, no doubt, save time. prior agreement also enables the parties to avoid any uncertainty as to the outcome of arbitrators' decisions thereon, and they will accordingly be in a better position to prepare their case.4 5.4 failure of party to appear it occurs in international arbitration that a party chooses not to participate in the proceedings, neither in writing nor orally. probably such party believes that he, by not taking part in the proceedings, will not be affected of the result thereof, i.e. the arbitral award. this is of course not correct. it is common practice in international arbitration, however, that failure of a party to appear at a hearing or otherwise to comply with an order of the arbitral tribunal will not stop the proceedings. this principle is laid down also in the scc rules. a good piece of advice is that it is always better to appear and file a defence than not. 5.4 waiver of procedural irregularities the scc rules also contain a waiver-rule to the effect that a party shall be deemed to have waived his right to invoke any deviation from the arbitration agreement or other rules applicable to the proceedings if he fails to object within a reasonable time to such irregularity. 6. evidence unless otherwise agreed, both written and oral evidence may be submitted and there are in principle no restrictions upon the admissibility of evidence in arbitrations under the scc rules. however, the arbitrators may not subpoena witnesses to attend or administer oaths. this may, however, be arranged with the assistance by the courts. 4 an article on applicable law issues, which includes an analysis of various awards rendered by arbitral tribunals adjudicating under the scc rules, is included in the stockholm arbitration report 2003:1. nordic journal of commercial law, issue 2003 #1 10 as noted in 5.2 above the statements of claim and defence should be accompanied by preliminary statements of evidence. frequently the statements of claim and defence will be accompanied by the documentary evidence on which the party wishes to rely. if they are not, the arbitrators will determine a period of time within which such evidence should be submitted. the oral evidence will be normally be presented at the final hearing. the arbitrators may appoint an expert unless both parties agree to the contrary. although it is not laid down in the scc rules it is the practice to draw up terms of reference for an expert with the agreement of the parties and to allow parties to cross-examine the expert engaged by the arbitral tribunal. parties also often invoke expert evidence. 7. hearings the scc rules also deal with oral hearings and state, inter alia, that an oral hearing shall be arranged if requested by either party, or if the arbitral tribunal considers it appropriate. the oral part of the proceedings could take the form of one or several preparatory (preliminary) meetings and a main hearing, sometimes also called final hearing. the preparatory hearing is normally held for the purpose of clarifying the parties' positions on the various issues. the preparatory hearing may in some cases also offer an opportunity for the tribunal to find out whether there may be a possibility of reconciling the parties and have them settle the dispute, wholly or in part, by an amicable settlement. if the parties are from different parts of the world the preparatory part of the proceedings are, for cost-reasons, frequently conducted in writing. when the case has been sufficiently prepared either orally or in writing the arbitral tribunal will normally convene the parties to the main hearing. the principal object of that hearing is to enable the parties to present their case in its entirety, to introduce and lay before the tribunal all the evidence they have invoked, whether in the form of documents or testimonies, and finally to plead their case, in facts and in law. 8. the award quite many cases, generally more than twenty five per cent of the total number, are settled amicably in the course of the proceedings, or otherwise terminated in the course of the arbitration. in all other cases the arbitrators will give an award. the award shall be made not later than six months after the case has been referred to the arbitrators. the scc institute may, however, extend such period. the award must be in writing and signed by at least a majority of the arbitrators. it must also be nordic journal of commercial law, issue 2003 #1 11 accompanied by reasons. apart from the final award the arbitrators may also, at the request of a party, render separate awards. a separate issue or part of a matter in dispute may be decided in such an award. where a party has partially admitted a claim, a separate award, based on such admission may also be rendered. most awards are decided unanimously. the award may, however, be decided by a majority, or in the case of an equality of votes, by the chairman alone. a decision could therefore always be obtained. all arbitrators are expected to sign the award even if one arbitrator does not agree with the decision reached by the majority. an arbitrator is, however, entitled to attach a dissenting opinion to the award. in practice such arbitrator usually fully states the reasons for his dissent. arbitral awards rendered in sweden are final and without appeal as regards the merits of the case. accordingly, awards may be challenged only for procedural defects and in such cases only if basic minimum standards of a fair procedure have not been met. 9. cost of arbitration the arbitrators’ fees, which are the main cost of arbitration, are decided by the scc institute according to the amount in dispute. at the outset of the arbitration both parties will be asked to pay a deposit, or advance on costs as it is called in the scc rules, to cover the estimated costs of arbitration, including the arbitrators' fees and expenses and the administrative fee of the scc institute. a table of costs for determining the amount of the advance is included in the scc rules. the amount is normally calculated between maximum and minimum and is in most cases equivalent to the final cost of arbitration. the arbitration costs, and their apportionment between the parties, shall be fixed in the award or other order by which the arbitral proceedings are terminated. 10. conclusion this article has focused on the scc institute. equally important as institutional rules and practice are the law and practice of the country where the arbitration takes place or will take place. as most scc arbitrations are conducted in sweden, swedish arbitration law and practice should be taken into account. to give an account also on the swedish arbitration law and practice would, however, fall outside the scope of this article. very briefly, however, it should be mentioned that a new swedish arbitration act came into force on 1 april 1999. the act applies equally to domestic and international arbitration. although the new swedish arbitration act is not identical with the uncitral model law on international commercial arbitration the utmost attention was given to each provision of the model law when drafting the act and there are in substance few differences between the act and the model law. 1. introduction 1.1 establishment, development and structure 1.2 activities 1.3 rules and model arbitration clause 2. facts and figures 3. how proceedings are commenced 3.1 request for arbitration 3.2 the respondent's reply 3.3 decisions of the scc institute 4. composition of the arbitral tribunal 4.1 appointment of arbitrators 4.2 qualifications and disclosure 4.3 challenge of arbitrators 5. presentation of the case before the arbitrators 5.1 basic issues: place, language and representation 5.2 statements of claim and defence 5.3 applicable law 5.4 failure of party to appear 5.4 waiver of procedural irregularities 6. evidence 7. hearings 8. the award 9. cost of arbitration 10. conclusion lakiteksti9.pmd nordic journal of commercial law, issue 2004 #1 1 a new corporate governance recommendation for finnish listedcompanies mikko heinonen nordic journal of commercial law issue 2004 #1 nordic journal of commercial law, issue 2004 #1 2 the new corporate governance recommendation for listed companies (“recommendation”) was announced on 2 december 2003. it was drafted by a corporate governance working group appointed by hex plc, the central chamber of commerce of finland, and the confederation of finnish industry and employers. although the recommendation will take effect on 1 july 2004, companies may implement it immediately. the recommendation is intended for the companies listed on the helsinki exchanges, provided that it is not in conflict with the regulations of the company’s domicile. it is designed to complement the statutory corporate governance procedures of finnish listed companies. these procedures are currently based primarily on mandator y provisions in several finnish laws. the aim of the recommendation is to harmonise the practices of listed companies, improve the transparency of their operations, harmonise the information given to shareholders and improve the quality of disclosure. the regulation includes 57 recommendations that address, among other things, questions on the organisation of general meetings, the election and composition of the board of directors and the performance and organisation of its duties, internal control, risk management and internal audits, and the presentation of information concerning corporate governance. first and foremost, the recommendation encourages companies to adopt an open disclosure practice and transparency in their internal operations. companies are to report the financial benefits based on the service contracts of the managing director and of the full-time chairman of the board and disclose the average attendance of directors at the board meetings. according to the recommendation, companies are to have a website on the internet where they will present information on issues of corporate governance. in the future, particular attention must also be paid to the independence of the directors in relation to the company and to its significant shareholders. according to the recommendation, a majority of the members of the board of directors need to be independent of the company. the independence of a board member shall be evaluated in accordance with the detailed provisions of the recommendation. the recommendation has been drafted in accordance with the “comply or explain” principle. companies listed on the helsinki exchanges should in general comply with the recommendation and are bound to explain any deviation from this practice. they must also give information on overall compliance with the recommendation in both their annual report and on their website. although the recommendation will take effect on 1 july 2004, the decisions that need to be made in the general meeting and any necessary changes to the articles of association may be made at the next annual general meeting after the above date (in most cases spring 2005). before such a meeting companies do not have to explain practices that may deviate from the recommendation. the recommendation is available in english on the following websites: www.hex.com www.tt.fi www.keskuskauppakamari.fi the 2004 united states-australia free trade agreement by christopher arup* nordic journal of commercial law issue 2004 #2 nordic journal of commercial law issue 2004 #2 2 this note is primarily a short report from australia on a new bilateral fta between australia and the united states (ausfta). while it conveys the experience of a very small country, at the other end of the earth, i want to use this example for what it says about the increasingly complex and fluid nature of law making in trans-national commercial law fields like foreign investment and intellectual property. australia has been a strong supporter of the multilateral trade agreements at the wto.1 ausfta is not australia’ first bilateral fta, but it is significant because the partner this time is the strongest of the developed countries. in many ways, the constituents of australia’s commercial law already reflect the washington policy consensus. nonetheless, this agreement with the united states lays down detailed requirements for changes to australian domestic law. the requirements are not simply a direct translation of united states law. they represent another building block in an edifice of global economic law. 1. patterns of international law making the paper begins with some remarks about nature of law making which this fta may represent. in seeking an understanding of contemporary law making, the insights of socio-legal studies have much to offer. socio-legal studies recommend that we do not start by looking for formal hierarchies of legal authority and settled rules for conduct. the boundaries between legal fields are blurring and there are many more encounters between differing legalities. fuzzier concepts, such as global governance and legal pluralism, will assist most with understanding. on this understanding, the nation-state is not to be regarded as the sole source of legal authority. law across the world is not simply inter-national law.2 even where the law is made by nation-states, it comes in many different directions and styles. one characterisation that conveys this dynamism is regulatory competition and cooperation.3 not only should we expect to find multiple sources of law, we must try to map the interactions between them. a major theoretician, bonaventura de sousa santos, has called this ‘inter-legality’.4 the regulatory criss-cross the dimensions of law making are both horizontal and vertical. they form a regulatory criss-cross. the interest lies in legal principles and processes that mediate the interaction between them. thus, horizontally, trans-national and inter-national laws do not simply compete for supremacy, they defer to each other within certain spaces and they draw on each other’s resources. concepts with currency in international law such as multilateralisation, mutual recognition, incorporation, harmonisation and the community of courts capture important aspects of these relationships.5 likewise, vertically, global law does not only direct and constrain national law. we expect such law to limit the nation state’s choices of regulation. often, it leaves gaps for national legislation (and other sources of law) to operate or sets minimums on which countries may advance individually (or bilaterally).6 it sometimes directs, while expressly allowing countries to make exceptions or attach qualifications. nordic journal of commercial law issue 2004 #2 3 interaction does not only occur when new treaties are being aligned against existing treaties and domestic law. it is seen as an ongoing process. interaction is built into the implementation of a treaty, when it provides for instance for standard setting systems, alternative paths to compliance, and the settlement of disputes.7 compliance might be shown, for example, by adherence to the standards of another international convention or to customary international law. the standard of review for national law may allow a ‘margin of appreciation’ to the national legislators or even accept their assurance of compliance.8 national governments may be asked to do no more than make all reasonable efforts to obtain conformity from other levels of government, such as regional authorities and domestic courts. governments agree to working groups to develop common standards. the treaties leave room to make authoritative interpretations or to grant waivers of troublesome provisions. this approach employs a relaxed sense of what law is, as well as where law is found. the styles of law making may be both hard and soft. while there is a natural interest in any move to legalisation, this looser fit finds a resonance in much contemporary international relations and international law scholarship too.9 nonetheless, as lawyers, we remain interested in how clashes are resolved and rulings made in the individual situation.10 neither is this inquiry out of keeping with the inquiries of the other disciplines. they may still stress the part that power plays (persuasive, coercive, hegemonic etc) in determining relationships between sources of law. for instance, we would expect that some nation states will seek a way to have their models adopted as the international norms. some models are exported directly, while others are insinuated into the bloodstreams of trans-national institutions. in this vein, scholars are identifying a new jurisprudence, possibly a new constitutionalism, that would entrench trans-national rights of commerce and property over national public regulation. some wish to see this come to fruition, others are more inclined to warn of the dangers.11 this scholarship seems particularly relevant to understanding the bilateral fta. it casts light on its substantive provisions, its aspiration for global traders and investors to enjoy commercial freedoms and property protections. it alerts us too to its careful specification of the relationships with other sources of law, even at the point when disputes will have to be determined.12 bits, bips and ftas australia’s partner, the united states, is a major force in bilateral treaty formation. the european union is active too, especially where it fails to see the new issues, like an investment agreement, added to negotiations at the wto.13 consistent with our general approach, we can see that bilateral bargaining does not work alone. it may form part of a broader strategy.14 so, for example, in order to maximise the gains, the united states is prepared to move between forums. most recently, it has moved away from the multilateral organisations, such as the wto, to the level of the regional compact and bilateral agreement. behind this strategy lies the wealth of its own domestic economy and the threat of unilateral measures. for investment, the bilateral approach is stepping up. the number of agreements is increasing rapidly. ambitions have increased beyond the early trade and investment treaties, which provided for fair treatment and physical protection to those foreigners who had become involved in other countries. the newer bits and the ftas have become, for the time being at least, the major nordic journal of commercial law issue 2004 #2 4 vehicle for both investment liberalisation (national treatment, rights of establishment, and prohibitions on performance requirements) and investment protection (not just against nationalisation but ‘indirect expropriation’ too). the newer bits and now the ftas are also an advance on the multilateral agreements. the wto uruguay round could only achieve a narrow set of disciplines for trade-related investment measures. apart from non-discrimination, the agreement on trade-related investment measures (trims) focuses on certain performance requirements for those manufacturing goods on-shore. since 1995, the wto membership has not been prepared to negotiate a full-scale investment code. the mai, while inviting developing countries to become associates, proved too stringent a regime for even the industrialised countries inside the oecd to accept at the time. the agreement was shelved. famously, the wto’s director-general had to reassure members that he had not claimed they were writing ‘a constitution for a world economy’.15 there is a link to intellectual property protection. for the developing countries, where intellectual property protection has been limited, the bit is made conditional on agreement to a bip.16 in protracted negotiations, the partners are softened up with threats of unilateral action, the withdrawal of aid and preferences, and wto complaints. while the wto produced a quite comprehensive multilateral trips agreement, the bilateral demands are ‘trips-plus’. they seek further protections and they may ask the partners to forgo allowances given them under the consensus decision making of the multilateral agreement.17 they urge parties to sign up to other international treaties that are strengthening intellectual property rights. to these inducements, the new ftas can add the attraction of improved market access for industrial goods and agricultural produce. they blend trips-plus intellectual property rights, investment rights and the freer flow of capital-intensive high technology services into a package. after establishing basic protections, these agreements institute working groups, joint committees and dispute panels to continue the law making, at levels of specification normally the preserve of local legislative, administrative and judicial authorities. the effect is cumulative. each gain in intellectual property standards is expressed as a minimum and the parties are free to extend protection. interacting with the trips agreement, the minimums are adopted on an mfn basis, so they are spread to other countries as well.18 thus, one country partner serves, temporarily, as the pace setter for intellectual property overall. a ‘script’ is written for subsequent bilateral agreements and possible consolidation in a new round of multilateral treaty making. the script is revised in the light of the experience of the previous agreements. this pressure is felt back at the wto too, though resistance here is a reason for the current forum shift. if it were to gain purchase, the new constitutionalism would establish rights for investments and property across a range of societies. constitutional rights should put protections beyond the reach of local re-regulation and popular revision.19 the partners agree to modify their domestic constitutional and legislative arrangements and to concede that international law rules and tribunals will determine the scope of the rights subject only to any reservations its negotiators may enter for non-conforming measures at the time the agreement is struck. this commitment nordic journal of commercial law issue 2004 #2 5 locks in future governments and the local electorate, limiting their scope to fashion regulation responsive to changing circumstances. yet, while this account has much to tell us, it is rather one-sided. the studies show that localities, each in their own way, resist, translate and coopt the demands being made from outside through globalisation.20 at this stage, certainly, there is some doubt whether constitutionalism is a helpful way to characterise either the wto agreements or the bilateral treaties.21 a comparison could be made with developments within the european union22 or with what some countries are doing individually, such as south africa,23 or those countries in eastern europe. even in these instances, the picture is far from clear. ausfta what does ausfta say about the accuracy of this portrayal? the paper now offers an account of the making of the agreement and an analysis of the particulars of two chapters. the origins of ausfta the australian government initiated the discussions with the united states. australia has a developed economy, but it is very small and incomplete on a world scale. australia depends on trade. traditionally, it has traded in agricultural and mineral commodities. it makes some headway now exporting expert services and cultural products. however, it remains a net importer of manufactured goods and intellectual property. it relies heavily on inward investment, though again, recently, australian investors have been venturing abroad, for instance into the united states. australia has floated its currency and abolished controls on movement of capital. announcing the negotiations, the government said the fta would give australian producers preferential access to the wealthy united states markets. yet it undertook negotiations with very little economic analysis of the costs and benefits. it soon received criticism from within its own circle of international trade specialists. they argued that the economic gains from an agreement with the united states would be slight. indeed, the agreement ran the danger of diverting trade from markets more important to australia such as those in east asia. furthermore, the strategy would undermine australia’s stake in successful multilateral negotiations and rule based regulation at the wto, where a small country can share in benefits it could not possibly extract on the basis of bilateral bargaining. in particular, concern was expressed that concessions to the us position on agricultural quotas and subsidies would compromise australia’s stand as a member of the cairns group. the australian government conducted consultations with selected industry stake-holders and it received submissions from public interest groups. as well, news of some mooted provisions appeared in the press. this was not a popular debate, however. the best source of media information was a specialist business paper, the australian financial review. the labor or social democrat opposition party, the australian labor party, remained quiet during the negotiations. quite possibly, it was fearful that the government would play ‘wedge politics’ nordic journal of commercial law issue 2004 #2 6 and brand it as anti-american. sceptics from within the party relied heavily on public interest groups to research the costs and make a case for opposition to the fta or for safeguards to be included. these groups included a civil liberties association and catholic justice commission, a social democrat think-tank, a coalition of pharmacology and legal academics, a philanthropic foundation, a public interest advocacy centre, and a fair trade and investment network.24 commentators have suggested that the government’s initiative was as much about geo-politics as trade and investment. as a member of the ‘coalition of the willing’, the australian government wished to firm its national security alliance with the us and to keep the us engaged in australia’s region. at the signing of the agreement, the minister for trade declared: ‘the blood of young australians and americans has been shed in most continents of the world in defence of our shared ideals of freedom and democracy’.25 it is fair to say that the two governments are close temperamentally. the present australian government is right-wing, strong on security of borders, socially conservative and neo-liberal economically. it is notable that the australian prime minister, john howard, had earlier rebuffed an overture from the clinton administration to negotiate a free trade agreement.26 for the united states part, australia must rate as a minor market. elimination of the remaining vestiges of investment and trade controls, in sensitive sectors such as media, would see relatively small gains compared to other countries with which the united states trades. consistent though with a broader strategy, the agreement may serve as a standard setter for agreements with other western countries, and most formidably with the european union. so far the united states has concentrated on the developing countries.27 the ausfta negotiations the negotiations for the fta were conducted in confidence. a team reporting to the minister for trade and the department of foreign affairs and trade represented australia’s interests. over the course of a year, the team engaged in six rounds of negotiations with a team from the office of the united states trade representative. from reports, negotiations seemed always to be on a precipice. in truth, a few of the provisions may have been settled at the last moment. but many follow the script of earlier united states agreements, for example with singapore and chile.28 certainly, in fields like investment and intellectual property, the united states was clearly the demandeur. parliament and the australian public had to wait until release of the draft text to see what had actually been undertaken. by way of contrast, we should recall that the oecd was moved to put drafts of the mai on the worldwide web. so too, in the negotiations over the free trade agreement of the americas (ftaa), the drafts have been exposed.29 release of the ausfta text was delayed even after the agreement had been concluded. its release was preceded by australian government publicity that greatly glossed the impact of the agreement; sceptics went to the ustr website for a point of comparison. according to australian law, treaties do not require ratification by the parliament. subject of course to their own requirements for coming into force, they create international obligations when nordic journal of commercial law issue 2004 #2 7 the executive government signs. but they are not ‘self-executing’, even if they come in the form of legal rules and they prescribe legal rights for private parties.30 some provisions of ausfta were already reflected in local australian law and some changes could be made by administrative fiat. but other changes required amendment to legislation in order to have local effect. legislation meant the support of the major opposition party, the australian labor party, was needed in the upper house of the parliament, the senate. here, the government has not held the balance of power. the senate also contains independents and minority parties, but too many of them had decided to vote against implementation of the fta. following the uruguay round, a committee of both houses of parliament, the joint standing committee on treaties (jscot), was established to give some more popular examination to treaties negotiated by the executive. this committee now commenced a review of the fta. with the support of independents, the labor opposition established a second committee to review the fta, a senate select committee. both committees took submissions and held hearings over several months following the conclusion of the agreement. in may, before they had reported, the minister for trade went to washington to sign the fta. jcsot reported favourably on the fta in june.31 yet still the labour opposition had not declared its position. despite pressure from the government, labor said it would reserve its judgement until it had the report of the senate committee. when the committee reported on 2 august 2004,32 the opposition gave its endorsement to the fta. by this time, the government had introduced its implementing legislation into the parliament. the implementation bill seemed deliberately styled to minimise the legal changes necessary, raising queries, as we shall see, whether australian law would be in compliance with the fta.33 labor then moved two amendments. the first, which the government accepted immediately, was to enshrine in legislation the local media content quotas that the government had reserved as non-conforming measures under the fta. the second was a provision designed to discourage patent holders bringing infringement proceedings to delay the release of generic drugs (see below). the government resisted this amendment, finally conceding in order to ensure the bill was passed. soon after, the date for a national election was set. in the election campaign, little was heard of the fta. on october 9, the government was returned to office with an increased majority, including the numbers it needed to overcome obstructions in the senate to its legislative wishes. given concerns about the patents legislation (see below), the united states ambassador reiterated the administration’s reservations about certifying the conformity of australia’s legislation with the provisions of the fta. certification is due in november this year, if the fta is to come into force on 1 january 2005. 2. investment australia has a liberal policy of accepting foreign investment. nonetheless, it chooses to screen proposals for acquisition or establishment, both in sensitive sectors (such as the media) and across the board if they are of sufficient economic proportions. the australian government also retains nordic journal of commercial law issue 2004 #2 8 the discretion to attach conditions to approvals on the recommendation of an advisory board.34 in exceptional circumstances, when it is not confident that such conditions will safeguard the national interest, it will block a proposal. australia is a member of the wto and therefore bound by trims. however, trims addresses measures relating to trade in goods only; other major sectors are not included. the gats comprehends investment measures, so long as they relate to commercial presence in another territory as a mode for the supply of a service. but gats only applies to the extent that a member chooses to make a commitment to national treatment or market access, either across all sectors or in a specific services sector. the gats employs a negative listing approach. the investment chapter of ausfta is then a major change to the complexion of investment regulation for australia. it contains a full set of contemporary investment freedoms, rights and protections. they include rights to non-discrimination both at the pre and post establishment stages, minimum standards of treatment including fair and equitable treatment and full protection and security, the limitation of performance requirements, and protection against expropriation direct and indirect. the ausfta provisions are built on a body of investment repertoires in nafta and other ftas, the growing number of bits, and the united states own model for bits. rulings by intergovernment panels and arbitrations by investor-state tribunals have produced interpretations of the early provisions. in subsequent deliberations and negotiations, the parties have reformulated basic provisions, issued notes of interpretation and annexed statements for ‘greater certainty’. these clarifications and revisions have addressed some of the substantive requirements directly. they have also specified more selectively the law which is to govern, should a dispute need to be determined. kantor observes: ‘where the original 1994 u.s model bit covered investor-state arbitration in forty-three lines, the new draft model u.s bit now devotes more than thirteen pages to the topic.’35 investment rights and protections the ausfta investment chapter applies to measures adopted or maintained by a party relating to investors of the other party and to covered investments. the definition of investment is broad. it is to mean every asset that an investor owns or controls, directly or indirectly, that has the characteristics of an investment, including such characteristics as the commitment of capital or other resources, the expectation of gain or profit, or the assumption of risk. the forms that an investment may take include enterprises, shares, futures, certain types of contracts, intellectual property rights, licences, authorisations, permits and similar rights conferred pursuant to the applicable domestic law, and other tangible or intangible, movable or immovable property, and related property rights. this elaboration aims to settle doubts that were raised in certain of the investor arbitrations regarding expropriation of investments.36 ausfta requires national treatment and most-favoured nation treatment both for investors of the other party and for covered investments.37 for covered investments, ausfta requires treatment in accordance with the customary international law minimum standard of treatment of aliens, including fair and equitable treatment nordic journal of commercial law issue 2004 #2 9 and full protection and security. article 11.5 cautions that these two concepts do not require treatment in addition to or beyond that which is required by that standard, and do not create additional substantive rights. it specifies that the obligation to provide fair and equitable treatment includes the obligation not to deny justice in criminal, civil, or administrative adjudicatory proceedings in accordance with the principles of due process embodied in the principal legal systems of the world. full protection and security requires each party to provide the level of police protection required under customary international law. this statement is an embellishment on a note of interpretation issued by the nafta free trade commission.38 some commentators regard the note as a clarification; others have argued that, by inserting the word ‘customary’ before the concept ‘international law’, it cuts back on investment protection.39 article 1105 of nafta says each party shall accord to investments of investors of another party treatment in accordance with international law, including fair and equitable treatment and full protection and security. the ausfta investment chapter is not confined to such general standards. it addresses the particular of domestic regulation. it prevents the parties from imposing or enforcing certain performance requirements, or enforcing certain commitments or undertakings. the main targets are requirements that foreign establishments source content locally or export product from the host country. ausfta also proscribes technology transfer requirements. such performance requirements may not be applied as a condition of the investor obtaining an advantage from the host government. the offer of advantages may be linked with certain other requirements. here, ausfta allows requirements that the investor establish a presence in the host country, train or employ workers locally, or carry on research and development. these provisions restrict the host government’s options to ensure that benefits flow back to the locality from foreign investment. the particulars hark back to the gatt and to the indicative list in the wto trims agreement. but they are much more prescriptive. the model is nafta and the recent us bilateral agreements; a similar approach was attempted in the draft mai. protection against expropriation the current generation of ftas contains a broader challenge to domestic regulation. they place a ban on the expropriation of investments. such protection begins conventionally with a ban on direct expropriation or nationalisation. however, in keeping with nafta and other more recent bits and ftas, ausfta goes on to say that neither party may expropriate a covered investment indirectly through measures equivalent to expropriation. in a standard clause, ausfta allows the parties only the one limited exception to this ban on expropriation. the expropriation, whether direct or indirect, must be: (a) for a public purpose (b) in a non-discriminatory manner (c) on payment of prompt, adequate and effective compensation, and (d) in accordance with due process of law. here, ausfta is clearly ahead of the multilateral agreements and, for australia, it extends protection beyond the national constitutional guarantees regarding compulsory acquisition of property. such special protection may make the host country’s general regulatory policy an issue of expropriation, triable at the investor’s initiative by international commercial arbitration. nordic journal of commercial law issue 2004 #2 10 when such protection was mooted, local opposition pointed to the investor suits challenging health and environmental policies under chapter 11 of the nafta. the record suggests that many of the nafta claims are about other protections of the investment chapter. nevertheless, investors have won rulings against indirect expropriation. with such an encouragement, investors may be tempted to run cases speculatively, placing respondent governments under pressure to settle claims rather than contest their legalities.40 a more subtle effect is the ‘chill factor’ – the prospect of suit may make governments reluctant to introduce new regulations.41 ausfta includes an annex, annex 11-b: expropriation, which carries a set of clarifying statements. these statements are a mixture of consolidations for investors and reassurances to governments. the ausfta annex has been transplanted from earlier united states ftas, such as the agreement with chile; this ausfta version can now be found in the recently concluded ftaa.42 annex 11-b begins by saying the parties conform their shared understanding that expropriation article is intended to reflect customary international law concerning the obligation of states with respect to expropriation.43 it then declares that an action by a party cannot constitute an expropriation unless it interferes with a tangible or intangible property right or property interest in an investment. it identifies indirect expropriation to be where an action by a party has an effect equivalent to direct expropriation without formal transfer of title or outright seizure. annex 11-b then provides that whether actions of a government constitute an indirect expropriation requires a case-by-case, fact-based inquiry. the inquiry will consider three factors, among others. the first factor is the economic impact of the government action, although the fact that an action has an adverse effect on the economic value of an investment, standing alone, does not alone establish that an indirect expropriation has occurred. the two other factors are the extent of interference with distinct, reasonable investment-backed expectations and the character of the government action. these factors are reminiscent of the distinctively united states constitutional doctrine of ‘regulatory takings’, a doctrine which is quite foreign to australian law.44 the annex finishes with a statement that ‘except in rare circumstances, non-discriminatory regulatory actions that are designed and applied to protect legitimate public welfare objectives such as public health and safety and the environment do not constitute indirect expropriation’. dispute settlement nafta gave investors the right to bring suit directly against a host government. they did not have to seek the sponsorship of their home government or another government party.45 they can take those disputes to ad hoc appointed supra-national tribunals. those tribunals may be appointed under the aegis of the international centre for the settlement of investment disputes (icsid), the icsid additional facility or the united nations commission on international trade law (uncitral). in a notable departure, ausfta did not give private investors access to supra-national tribunals. the australian government guide to the fta advises that this omission: ‘reflects the fact both countries have robust, developed legal systems for resolving disputes between foreign investors and nordic journal of commercial law issue 2004 #2 11 government’.46 the omission means that, instead, the investors will need to bring actions in the domestic australian courts, casting the onus on australian judges. or they will rely on the us government to represent their case in the government to government dispute settlement proceedings under chapter 21 of ausfta. here, consistent with other ftas, ausfta provides a panel procedure for the settlement of disputes between the parties. where the standards of protection require interpretation, the constitution of these panels (especially the chair), and the jurisprudence they develop, could be influential in determining the impact of the fta. under nafta, this government to government dispute settlement has been used sparingly.47 when investors may not bring suit directly, the practice may be different. ausfta also keeps a small opening for director investor-state arbitration. article 11.16(1) requires consultations, if there is a change in circumstances affecting the settlement of investment disputes, and, in the light of these changes, the government parties should consider allowing an investor to submit to arbitration with the other party. what will be the reference point for interpretation? nafta article 102 indicates that the parties shall interpret and apply the provisions of the agreement in the light of its objectives and in accordance with applicable rules of international law. for investor-state arbitrations, article 1131 says a tribunal shall decide the issues in dispute in accordance with the agreement and applicable rules of international law. while it is clear that the primary focus is to be on the words of the agreement itself, this formulation appears to range wider, allowing consideration of other treaties that are in force, customary international law and the general principles of international law.48 in contrast, the dispute settlement chapter of ausfta states that the panels shall consider the provisions of the agreement in accordance with applicable rules of interpretation as reflected in articles 31 and 32 of the vienna convention on the law of treaties. this statement appears to narrow the frame of reference for the interpretation of ausfta and for the determination of the parties’ compliance. some say the operation of article 31(3)(c) of the vienna convention lets in consideration of other treaties. also relevant is whether it will allow consideration of the jurisprudence surrounding those treaties, including the case law of the investor-state tribunals under nafta.49 3. intellectual property protection for intellectual property is now one of the strongest sub-sets of public international law. the multilateral wto agreement, trips, did more than insist on non-discrimination when a country sets its own levels of protection for intellectual property. it required all members to observe substantive levels of protection across key categories of intellectual property. the trips agreement was also notable for its prescription of the procedures and remedies that each member was to make available (administratively and judicially) for the effective enforcement of rights. while trips was a major convergence in protection across the world, it held back from legislating in some areas, such as the on-line media and traditional knowledge and folklore. it allowed countries discretion to pick their own level of protection in others. so did the 1996 world nordic journal of commercial law issue 2004 #2 12 intellectual property organisation (wipo) copyright and performances and phonograms treaties, wct and wppt, while they extended copyright and related rights for the authors of works, the producers of phonograms and performers, into the digital environment. in its bilateral initiatives, the us has been pressing the developing countries, particularly those in latin america, to forego their allowances under trips. these forbearances include the phase-in periods for implementation, the right to except plants and animals from patentability, the right to adopt a sui generis system of protection for plant varieties other than the 1991 version of the international convention for the protection of plant varieties (upov), and a full set of grounds for compulsory licensing. the strategy has been backed by complaints to the wto.50 the us is, nonetheless, being selective, for it opposes certain extensions of rights itself at home and in the international forums.51 with historically high levels of protection, australia is much closer to the us position. nevertheless, the ustr wanted australia to tighten protection for us products such as patented pharmaceuticals, entertainment with copyright content, and brand names that are well-known marks. the ustr wrote of establishing standards that build on the foundations established in trips and other agreements such as the wipo treaties; seeking to enhance the level of protection beyond trips in new areas of technology, such as internet service provider liability; in other areas, such as patent protection and protection of undisclosed test data; seeking to have australia apply levels of protection and practices more in line with us law and practices; and seeking to strengthen domestic enforcement procedures, including criminal penalties, to deal with piracy and counterfeiting.52 relationship to the multilateral agreements the ip chapter begins by making reference to the major ip multilateral agreements. in article 17, each party affirms that it has ratified or acceded to an itemised list of such agreements. the list starts with recent versions of paris (1967) and berne (1971), also mentioning the patent cooperation treaty (1970), budapest (1980), the madrid protocol (1989), the satellite convention, upov (1991), trips (1994) and the trademark treaty (1994). australia is directed to ratify the wct and wppt.53 both parties undertake to make their best efforts to comply with the provisions of two other treaties, the hague designs agreement (1999) and the patent law treaty (2000). despite this general affirmation, we shall see that, in certain categories of protection, ausfta restates key provisions of these treaties. we might suppose their direct expression in the text creates a base on which to build the additional protections that the fta requires. curiously, though, these statements tend to reword the multilateral provisions. even the most emphatic multilateral agreement is likely to contain its share of generalities and vacuities. such agreements leave gaps, indeed make allowances for departures at the national level from the protections they advance. it is apparent the united states government has wanted to give specification and provide elaboration to crucial intellectual property protections. united states dissatisfaction with the direction of decision making within the multilateral forums, including the dispute settlement rulings, may help explain these restatements. nordic journal of commercial law issue 2004 #2 13 from a legal perspective, the question remains whether the fta provisions conform to the existing agreements which bind the us and australia, or whether they cut across their provisions. generally we should expect them to conform, but we cannot assume for instance that something styled as an elaboration is necessarily consistent. the possibility of a legal clash is eased somewhat by the allowance that the multilateral agreement makes for more extensive protection on a unilateral or bilateral basis. notably, article 1.1 of trips provides that members are legally free, on an individual basis, to institute more extensive protection than is required by the agreement, provided such protection does not contravene the provisions of the agreement. this allowance says the agreement is not a code; mostly it does not set maximum levels of protection.54 then, in a further interaction, the trips mfn obligation insists that the nationals of all wto members have the benefit of these extensions.55 so the extra protections given the nationals of the bilateral partner, the united states, must be extended to the nationals of other members too, but without the assurance of reciprocal protection. for australia, this means significant exporters from such countries as the members of the european union. a related reason for restating certain of the multilateral ip provisions is to give the parties access to the inter-governmental dispute settlement proceedings under the fta. ausfta overlaps considerably with trips. while the trips agreement has a compelling procedure for non-compliance, a complaint attracts attention from the diverse wto membership. the fta procedures may be more inviting.56 the wto dispute settlement understanding presses members to use the wto itself for redress.57 however, in article 21.4, ausfta purports to give the complaining party a choice between its own dispute settlement processes and the wto. if the complainant chooses the fta process, will the application of vienna convention articles 31 and 32 let in consideration of the wto trips jurisprudence or that of the other multilateral conventions? ausfta is also an advance on trips. we should note in particular that, in the case of intellectual property rights, the ausfta dispute settlement chapter allows for ‘non-violation complaints’. ausfta article 21.2 says the proceedings apply where a benefit a party could reasonably have expected to accrue is being nullified or impaired as a result of a measure that is not inconsistent with the agreement. while non-violation complaints are a recognised part of gatt and wto dispute settlement, these complaints cannot currently be brought under the trips agreement. moreover, ausfta takes up provisions from the treaties that are administered by wipo. wipo does not have a compelling dispute settlement system. patent rights and limitations while ausfta builds on the multilateral agreements, it contains notable extensions in several categories of intellectual property. for example, the term of protection for copyright in australia is brought into line with the european union and united states extension of the term to seventy nordic journal of commercial law issue 2004 #2 14 years. ausfta greatly elaborates the responsibilities of internet service providers for preventing infringements and it attacks further the circumvention of technological protection measures. the paper’s example is the ausfta’s calculated specifications for patents. ausfta begins by presenting a version of the lead trips article, article 27.1. under ausfta article 17.9, each party is to make patents available for any invention, whether a product or process, in all fields of technology. thus, ausfta retains the concept of invention, but without defining it. the liberality of patent grants will remain essentially a matter for national law and practice.58 at the same time, article 17.9 carries a statement that the parties confirm that patents shall be available for any new uses or methods of using a known product. like trips, the grant of patents is subject to the demands of the common technical criteria: that the invention is new, involves an inventive step and is capable of industrial application. regarding the third of these technical criteria, article 17.9.13 says each party shall provide that a claimed invention is useful if it has a specific, substantial, and credible utility. this requirement links australian practice into the us pto policy and the trilateral commission. this interaction also shows how patenting practices can also be internationalised through memoranda of understanding and coordination at the level of the national intellectual property offices.59 ausfta seeks to confine the parties’ exclusions from patentability to two categories. the first in familiar terms is a trips allowance. parties may exclude from patentability inventions the commercial exploitation of which is necessary to protect ordre public or morality including to protect human, animal, or plant life or health or to avoid serious prejudice to the environment. the fta’s other allowable exception is made for diagnostic, therapeutic and surgical methods for the treatment of humans and animals. such an exception seems unimportant to australian law, since the recent interpretations the local courts have placed on the 1990 act.60 again it remains faithful to trips. yet the trips exception for plants and animals is not here. neither party applies this exception anyway, but the us has been consistent in seeking to eliminate it from national law. it persuades its partners to agree not to make use of the trips allowance. its position at the wto is for removal of the allowance.61 those interpreting trips have faced some difficulty reconciling the articles laying out the patent holder’s rights with those making allowances for exceptions to infringement.62 ausfta does not repeat the trips article 27 requirement that the parties make patents available and patent rights enjoyable without discrimination as to place of invention, the field of technology, or whether products are imported or locally produced. neither does ausfta enumerate the patent holder’s rights. trips article 28 says a patent shall confer the exclusive rights to prevent third parties from making, using, offering for sale, selling, or importing for these purposes. regarding parallel importation, the united states has argued that trips article 6 is subject to articles 27 and 28.63 article 6 says for the purpose of dispute settlement, subject to articles 3 and 4, nothing in the agreement shall be used to address the issue of exhaustion of intellectual property rights. trips article 6 appears to leave the level at which rights are exhausted to national policy. nordic journal of commercial law issue 2004 #2 15 for patents, ausfta seeks to cut through this argument. article 17.9.4 states that each party shall provide that the exclusive right of the patent holder to prevent importation of a patented product, or a product that results from a patented process, without the consent of the patent owner, shall not be limited by the sale or distribution of that product outside its territory, at least where the patentee has placed restrictions on import by contract or other means. ausfta article 17.9.3 is a take from trips article 30. the parties may provide limited exceptions to infringement, provided the exceptions do not unreasonably conflict with a normal exploitation of the patent and do not unreasonably prejudice the legitimate interests of the patent owner, taking into account the legitimate interests of third parties.64 while its statement of these powers is narrower than the paris convention a century before, trips does provide for member governments to license compulsorily. in its bilateral agreements, the us has been seeking to cut away at the grounds conceded in trips article 31. ausfta article 17.9.7 now allows the two grounds.65 the first ground is to remedy a practice deemed, after judicial or administrative process, to be anticompetitive under the competition policy of the party.66 the other is the case of public noncommercial use or of national emergency or other circumstances of extreme urgency. this ground has become vital to the debate over pharmaceuticals, a topic of particular interest to the bilateral parties also. patents and pharmaceuticals the wto members have experienced difficulties reconciling patent protection with access to essential medicines. in contention has been the freedom with which a developing country may licence the production of cheaper generic versions during the life of the patent. invoking art ix.2 of the wto agreement, the members have adopted a liberal interpretation of trips. the doha declaration on the trips agreement and public health seeks to shield free use of key trips allowances from challenge.67 among its provisions, it states that each member has the right to grant compulsory licences and the freedom to determine the grounds on which such licences are granted; each member has the right to determine what constitutes a national emergency or other circumstances of extreme urgency, it being understood that public health crises, including those relating to hiv/aids, tuberculosis, malaria and other epidemics, can be so; and each member is free to establish without challenge its own regime for the exhaustion of rights. after the declaration, issues remained to be resolved within the trips council. recently, the wto settled on a system to permit production from another country, when the country in need of the drugs does not have local manufacturing capacity.68 trips article 31(f) says that compulsory licensing should be predominantly for the supply of the domestic market of the member authorizing such use. no part of the declaration or its follow-up is incorporated in ausfta. in fact, ausfta contains limitations that appear designed to ensure that, as a developed country, australia does not participate in this trade. nordic journal of commercial law issue 2004 #2 16 yet the australian government runs a public program, the pharmaceutical benefits scheme (pbs), where drugs are listed and their cost to the consumer are subsidised by the taxpayer according to a reference price. the pbs is evidence that some australians can also find the market price of patented drugs difficult. there has been some disquiet about the fta’s provisions for review of pbs listing and pricing decisions.69 here the focus is on the intellectual property implications. one united states objective is for partners to offer extensions to the patent term for pharmaceuticals. ausfta article 17.9 says that extensions should be made available, if the applicant has encountered unreasonable delays in the issuance of the patent, or if there was an unreasonable curtailment of the normal term due to the time it took to obtain marketing approval for the patented version. as a result of pressure that the united states has applied in the past, the australian government has already amended the local patents act to enable extensions to be granted. at the same time, the united states wants partners to cut back on their allowances for the secondary generic producers to ‘springboard’ off the intellectual property of the original brand name producer. the background to this request is a wto dispute settlement decision.70 the ec challenged two canadian provisions assisting generics to get onto the market quickly. the wto panel considered one exception to patent infringement to be inconsistent with trips, one that permitted generics to be manufactured and stockpiled ready for release as soon as the term expired. but the other exception was upheld, which was to test and trial the drugs for the purpose of obtaining regulatory approval. ausfta makes it clear that australia must control the use made of the subject matter of a subsisting patent. if, under the limited exceptions allowed to exclusive rights, a party permits the use of the subject matter to support an application for marketing approval for the generic version, then it must insist that the version is not be made, used, sold or exported for any other purpose. this provision limits australia’s freedom, not only to produce generics under compulsory licence for the domestic market, but also to export to other countries under the trips allowances. this year, the canadian parliament amended its patents legislation to enable this to be done.71 it seems the united states is also fighting a rear guard action against the cost of drugs in its home market. reportedly, united states ‘seniors’ cross the border into canada to buy drugs cheaper under canada’s own public pharmaceutical benefits scheme.72 article 17.9.4, the general right to control imports, has application here too. it will for instance enable a patentee to prevent a pharmaceutical product, which is released into another market at a discounted price, from being re-routed into australia. ausfta contains provisions to preserve the exclusivity of chemical, safety or efficacy data, which is submitted as a condition of obtaining marketing approval for a new pharmaceutical product. in addition, the fta contains a us paragraph 4 style requirement. according to article 17.10.5, if a party permits competitors to rely on such safety or efficacy information for marketing approval, the party shall provide measures in its marketing approval process to prevent such persons from marketing a product or a product for an approved use – where that product or use is claimed in a patent. if the party permits a secondary producer to request approval during the term of such a patent, it shall provide that the patent owner be notified. nordic journal of commercial law issue 2004 #2 17 for pharmaceutical patents and data, the government’s implementing legislation has been minimal. the major change has been the response to article 17.10.5. amendments to the local therapeutic goods administration act introduce a certification procedure. the applicant must certify either: (1) that the applicant, acting in good faith, believes on reasonable grounds that it is not marketing the therapeutic goods in a manner or in circumstances that would infringe a valid claim of a patent that has been granted in relation to the therapeutic goods, or (2) that a patent has been granted and the applicant proposes to market the therapeutic goods before the end of the term of the patent, and they have given the patentee notice of the application. following the senate select committee report, the alp countered with an amendment to this legislation, arguing the need to discourage the pursuit of ‘dodgy’ patent claims. in its submission to the committee, the australian generic medicines industry association had expressed concern at the breadth of the fta provision. citing the canadian experience of ‘evergreening’, it suggested that article 17.10.5 would assist the pharmaceutical companies to make patent claims for the purpose of delaying the marketing of generics. the practice of evergreening involves claiming new uses, reformulations or methods of administration for drugs reaching the end of their patent term.73 the alp amendment has sought to intervene in this process by challenging the bona fides of infringement proceedings against the generic producers. under the amendment, the plaintiff must certify that the proceedings are to be commenced in good faith, have reasonable prospects of success and will be conducted without reasonable delay. the plaintiff must have reasonable grounds (in addition to the ‘fact of the grant of the patent’) for believing that final relief will be granted and that each of the claims in respect of which infringement is alleged is valid. a court may apply a penalty if the certificate is false. a further provision provides for orders if the plaintiff obtains an interlocutory injunction in such circumstances. there has been some question here whether the government’s certification procedure goes far enough in providing a measure for ‘preventing’ the marketing of products ‘claimed’ in a patent. on the other hand, the united states administration has flagged its concern that the labor amendment undermines the fta protection for patents.74 a further suggestion is that the amendment runs contrary to the trips requirement that patents be granted without discrimination. it remains to be seen whether the united states will insist that the australian government use its new majority in the senate (from next july, 2005) to repeal the amendment. 4. conclusion what is the general significance of the making of such a fta? it would be easy to say that ausfta is just another element in the fluid contemporary mix of trade regulation, global governance and legal pluralism. but such ftas are making a distinctive contribution to investment and intellectual property law. australia is already very much a dutiful member of the multilateral agreements that operate in these fields. by comparison, the fta is a more strategic engagement. immediately, it conveys detailed additional prescriptions for australian domestic law. it carries careful specifications regarding the extent to which other international law will affect its requirements. planning ahead, it is a key step in the construction of a global model. directly, and indirectly, the legal rights of private investors and producers receive another boost. nordic journal of commercial law issue 2004 #2 18 * christopher arup is a professor in the law school at victoria university. he is ba, llb (hons) (melbourne) and llm (monash) and a barrister and solicitor of the supreme court of victoria. professor arup taught at la trobe university where he was also head of the school of law and legal studies. he has held visiting appointments at the universities of chicago, durham, sussex and warwick. he has worked as a policy advisor to international organisations, community groups and government in australia. professor arup is the author and editor of a number of publications on international law, intellectual property and trade in services, including two monographs with cambridge university press, innovation, policy and law, and the new world trade organization agreements: globalizing law through services and intellectual property. he has also written on these topics for australian intellectual property journal, law and policy, journal of world trade, journal of world intellectual property, and european intellectual property review. he is co-editor of an international monograph series with cambridge university press, studies in law and society. he also researches civil justice, labour law, compensation decision making, dispute resolution, legal services and the legal profession. he was a founding editorial committee member for the alternative law journal and a contributor to the first fitzroy legal service legal resources and law handbooks. he headed the research and publications group for the first national pro bono law conference and co-edited with kathy laster the collection of papers, for the public good: pro bono and the legal profession in australia (federation press, sydney, 2001). 1 for background on australian trade policy, see a. capling, australia and the world trading systems; from havana to seattle (cambridge university press, melbourne, 2001). 2 eg. g. teubner, global law without a state (dartmouth, aldershot, 1997). 3 d. esty and d. geradin (eds), regulatory competition and economic integration: comparative perspectives (oxford university press, oxford, 2001); y. dezalay and b. garth, dealing in virtue: international commercial arbitration and the construction of a transnational order (university of chicago press, 1996). 4 b. de sousa santos, towards a new legal common sense: law, globalization and emancipation (butterworths, london, 2002). 5 eg. j. braithwaite and p. drahos, global business regulation (cambridge university press, 2000); a. slaughter, ‘a global community of courts’ (2003) 44 harvard international law journal 191. 6 j. trachtman, ‘the domain of wto dispute resolution’ (1999) 40 harvard international law journal 40. 7 eg. c. arup, ‘trips: across the global field of intellectual property’ (2004) 26 european intellectual property review 7. 8 eg. r. howse, ‘adjudicative legitimacy and treaty interpretation in international trade law’ in j. weiler (ed), the eu, the wto, and the nafta: towards a common law of international trade? (oxford university press, new york, 2001). 9 see m. finnemore and s. toope, ‘alternatives to “legalization”: richer views of law and politics’ (2001) 55 international organization 743, criticising, for a preoccupation with formal liberal law, the editors of the special issue of international organization on legalisation. the critique appears to have provoked the bridging piece, a. slaughter, a. tulmello and s. wood, ‘international law and international relations theory: a new generation of interdisciplinary scholarship’ (1998) 92 american journal of international law 367, where the authors recommend several law and society perspectives. 10 giving rise to the exacting scholarship in journals such as this, see for example m. pere, ‘non-implementation of wto dispute settlement decisions and liability actions’ (2004)#1 nordic journal of commercial law. generally, see j. pauwelyn, conflict of norms in public international law: how wto law relates to other rules of international law (cambridge university press, 2003). 1 1 see for example the exchanges between petersmann and howse and alston in volume 13 of the european journal of international law. 12 c. brouwer, c. brouwer, ii and j. sharpe, ‘the coming crisis in the global adjudication system’ (2003) 19 arbitration journal 415. 1 3 s. choo, ‘a bridge too far: the fall of the fifth wto ministerial conference in cancun and the future of trade constitution’ (2004) 7 journal of international economic law 219. 14 this account draws on the analysis of p. drahos, see ‘bits and bips: bilateralism in intellectual property’ (2001) 6 world intellectual property journal 791. 15 ‘wto denies claim by special interests linking ruggiero to mai’, wto press release press/91, 17 february 1998. 16 s. picciotto, ‘linkages in international investment regulation: the antinomies of the draft multilateral agreement on investment’ (1998) 19 university pennsylvania journal of international economic law 731. 17 s. sell, private power, public law: the globalization of intellectual property rights (cambridge university press, new york, 2003). 18 subject to correction, possibly for bits too, see discussion of the maffezini case in r. singh, ‘the impact of the central american free trade agreement on investment treaty arbitrations; a mouse that roars?’ (2004) 21 journal of international arbitration 329. 19 d. schneiderman, ‘investment rules and the new constitutionalism’ (2000) 25 law and social inquiry 757; j. kelsey, ‘global economic policy making: a new constitutionalism?’ (1999) 9 otago law review 535. 20 eg. j. jenson and b. de sousa santos (eds), globalizing institutions: case studies in regulation and innovation (ashgate, aldershot, 2000). 21 for a recent consideration, see c. joerges, ij. sand and g. teubner (eds), transnational governance and constitutionalism (hart publishing, oxford, 2004). 22 g. de burca and j. scott (eds), the eu and the wto: legal and constitutional issues (hart publishing, oxford, 2001). (endnotes) nordic journal of commercial law issue 2004 #2 19 23 h. klug, constituting democracy: law, globalism and south africa’s political reconstruction (cambridge university press, 2001). 24 submissions were also put to a parliamentary committee during the negotiations, see parliament of australia, senate foreign affairs, defence and trade committee, voting on trade: the general agreement on trade in services and an australia-us free trade agreement, 26 november 2003, at www.aph.gov.au/senate/fadt_ctte/gats/report. 25 the age newspaper, melbourne, 20 may 2004. 26 in 1997, a framework agreement with the european union failed at the last hurdle, when the australian government refused to agree to the european union’s human rights clause. 27 the most recent being the fta with five central american countries. 28 text of the agreements are available at the ustr website, www.ustr.gov/new/fta. 2 9 jose antonio rivas-campo and rafel tiago juk benke, ‘ftaa negotiations: a short overview’ (2003) 6 journal of international economic law 661. 30 p. alston and m. chiam (eds), treaty making and australia: globalisation versus sovereignty? (federation press, sydney, 1995). specifically, m. chiam, now that’s freedom: australia and free trade agreements, law and policy paper 25 (federation press, sydney, with centre for international and public law, australian national university, 2004). 31 report, australia-united states free trade agreement, tabled 23 june 2004, at www.aph.gov.au/house/committee/jcsot/ usafta/report. 32 summary of inquiry, at www.aph.gov.au/senate/committtee/freetrade_ctte/report/summary/index. 3 3 us free trade agreement implementation act 2004, available at department of foreign affairs and trade website, www.dfat.gov.au/trade/negotiations/us. 34 commonwealth of australia. department of treasury, foreign investment review board, a guide to australian investment (australian government publishing service, canberra). 35 see m. kantor, ‘the new draft model u.s. bit: noteworthy developments’ (2004) 21 journal of international arbitration 383, at 385. 36 for useful analysis of these cases, see r. bishop and w. russell, ‘survey of arbitration awards under chapter 11 of the north american free trade agreement’ (2002) 19 journal of international arbitration 505. 37 in its schedules to the agreement, australia reserves some non-conforming measures. 38 for the note, see r. bishop and w. russell, ‘survey of arbitration awards under chapter 11 of the north american free trade agreement’ (2002) 19 journal of international arbitration 505, at 552. 39 see c. brouwer, c. brouwer, ii and j. sharpe, ‘the coming crisis in the global adjudication system’ (2003) 19 arbitration journal 415, at 432. 40 for a comprehensive list of suits, see m. staff and c. lewis, ‘arbitration under nafta chapter 11: past, present, and future’ (2003) 25 houston journal of international law 301. 41 liberty victoria and the catholic commission for justice, the big chill? concerns about the investor/state provisions in the proposed australia-us free trade agreement, briefing paper, 1 november 2003, at www.melbourne.catholic.org.au.ccjdp, citing a canadian study. 42 r. singh, ‘the impact of the central american free trade agreement on investment treaty arbitrations: the mouse that roars?’ (2004) 21 journal of international arbitration 331. 43 there is even a statement of what customary international law is. annex 11a declares that the parties confirm their shared understanding that customary international law results from a general and consistent practice of states that they follow from a sense of legal obligation. 44 j. starner, ‘taking a constitutional look: nafta chapter 11 as an extension of member states’ constitutional protection of property’ (2002) 33 law and policy in international business 405. these factors were taken up in the investor-state arbitration, metalclad corp v united mexican states, icsid case no arb(af)97/1, 30 august 2000, 5 icsid reports 209. 45 compare the experience under the wto agreements, see g. shaffer, defending interests: public-private partnerships in wto litigation (brookings institution press, washington, 2003). 46 the guide is at www.dfat.gov.au/trade/negotiations/us_fta/guide/17/html. 47 see, for instance the saga of one dispute: c. arnett, ‘comment: the mexican trucking dispute’ (2003) 25 houston journal of international law 561. 48 t. weiler, ‘nafta article 1105 and the principles of international economic law’ (2003) 42 columbia journal of transnational law 35. 49 compare also the wto experience: see c. arup, ‘the state of play of dispute settlement “law” at the world trade organization” (2003) 37 journal of world trade 897. the dsu says the provisions of the wto agreements may be clarified in accordance with the customary rules of interpretation of public international law (article 3:2). 50 s. sell, private power, public law: the globalization of intellectual property rights (cambridge university press, new york, 2003). 51 at the wto, the outstanding issues include the availability of non-violation complaints, stronger protection for geographical indications, patents and sui generis protection for plants and animals, and technology transfer; at wipo, remuneration for the use of performances in audio-visual media, a broadcaster’s right, sui generis protection for data bases, and appropriate recognition for folklore. 52 robert zoellick’s letter to congress, at www.ustr.gov/releases/2002/11/2002-11-3-australia-byrd. 53 in 2000, the government implemented many parts of the wct and wppt. but some parts, notably stronger protection for performers, were delayed. the us fta implementation act now completes them. nordic journal of commercial law issue 2004 #2 20 54 d. gervais, the trips agreement: drafting history and analysis (second edition, 2003), p. 86. 55 trips article 3. so long as they come with the designation of the protection of intellectual property. in the cuban rum dispute, the wto appellate body interpreted art 1.2 to mean all categories traversed by pt ii, not just those the subject of express protection there, see united states-s.211 of the omnibus appropriations act, wt/ds176/ab/r, january 2, 2002. for instance, trips incorporates many provisions of the paris convention. 56 note g. marceau, ‘the dispute settlement rules of the north american free trade agreement: a thematic comparison with the dispute settlement rules of the world trade organization’, in e. petersmann, international trade law and the gatt/wto dispute settlement system (kluwer law international, the hague, 1997). 57 article 23, understanding on rules and procedures governing the settlement of disputes. in the dispute, united statesss.301310 of the trade act of 1974, ws/dt152/r, december 22, 1999, the us undertook to exhaust its wto remedies before resorting to unilateral action. 58 picciotto observes: there is ‘no basis for complaints about over-broad protection that is due to lax interpretation of patentability requirements’, see ‘defending the public interest in trips and wto’, in p. drahos and r. mayne (eds), global intellectual property rights: knowledge, access and development (sweet and maxwell, london, 2002) p 235. concern is expressed australia will follow the us practice of granting software patents liberally, see australian financial review, 16 july 2004. 59 see l. davies, ‘technical cooperation and the international coordination of patentability of biotechnological inventions’ (2002) 29 journal of law and society 137. 60 bristol-myers squibb v fh faulding (2000) 97 fcr 524; rescare ltd v anaesthetic supplies pty ltd (1992) 25 ipr 119. though it does mean that australia retains an important policy discretion. 61 the allowance came under review in 2000. other members have linked change to recognition and reward for traditional knowledges; see b. sherman, ‘regulating access and use of genetic resources: intellectual property and biodiscovery’ (2003) 25 european intellectual property review 301. 62 generally, see nuno pires de carvalho, the trips regime of patent rights (kluwer law international, the hague, 2002). 63 see f. abbott, ‘the trips-legality of measures taken to address public health crises: responding to ustr state-industry positions that undermine the wto’, in d. kennedy and j. southwick (eds), the political economy of international trade law (cambridge university press, 2002), p. 320. 64 see panel report, canada-patent protection for pharmaceutical products, wt/ds/114/r, march 17, 2000. 65 it may also cut back on australia’s own provisions for compulsory licensing. see patents act 1968, section 135, the ‘reasonable requirements of the public’. 66 see also the exchange of letters on aspects of intellectual property applied to australia. 67 wt/min(01)/dec/2, 20 november 2001. 68 document ip/c/w/405; see wto press release/350, august 20, 2003. further d. matthews, ‘wto decision on implementation of paragraph 6 of the doha declaration on the trips agreement and public health: a solution to the access to essential medicines problem?’ (2004) 7 journal of international economic law 73. 69 see p. drahos, b. lokuge, t. faunce. m. goddard and d. henry, ‘pharmaceuticals, intellectual property and free trade: the case of the us-australia free trade agreement’ (2004) 22 prometheus 243. 70 panel report, canada-patent protection for pharmaceutical products, wt/ds/114/r, march 17, 2000. 71 ‘fight against aids’, the guardian weekly, 9-15 july 2004. 72 b. kuhlik, ‘the assault on pharmaceutical intellectual property’ (2004) 71 university of chicago law review 93. 73 canadian generic pharmaceutical association, the patented medicines (notice of compliance) regulations, a submission to the house of commons standing committee on industry, science and technology, go to senate select committee website (submission number 77) at www.aph.gov.au/senate/committee/freetrade_ctte; see also united states federal trade commission, generic drug entry prior to patent expiration, a ftc study, july 2002, at www.ftc.gov/reports. 74 the age newspaper, 14-15 august and 21-22 august 2004. disclosure of third-party funding in commercial arbitration + thn corrections disclosure of third-party funding in commercial arbitration caroline overgaard* and johan tufte-kristensen** * assistant attorney at gorrissen federspiel and ll.m. from king’s college london and the university of copenhagen. ** assistant professor at the university of copenhagen, denmark. orcid 0000-00020076-3791. 1. introduction ...................................................................................... 3 2. the hype and hysteria about third-party funding ............. 4 2.1. defining the concept ........................................................... 4 2.2. recent development ............................................................. 5 2.3. risks and benefits ................................................................... 6 3. existing duties of disclosure ....................................................... 8 4. is a duty of disclosure feasible? .................................................. 9 4.1. advantages ............................................................................. 10 4.2. disadvantages ....................................................................... 12 4.3. necessity .................................................................................. 14 4.4. a duty of disclosure is feasible ...................................... 14 5. how to adopt it ................................................................................ 14 6. how to construct it ....................................................................... 15 7. conclusion ......................................................................................... 17 njcl 2020/2 3 abstract third-party funding used to be an unknown phenomenon to the majority of arbitration scholars and practitioners but, over the past decade, the phenomenon has entered the arbitration scene and become subject to significant attention. today, arbitral proceedings may involve sophisticated funding arrangements. such arrangements may promote access to arbitration and entail other advantages, but when they remain unknown to the arbitrators and the funded party’s opponents, they may give rise to a series of practical issues concerning, inter alia, costs and conflicts of interest. when a party has raised funding from a third-party funder, the arbitrators and opponents need to know about it. a series of practitioners and academics have contributed to the general field of thirdparty funding in arbitration. they have examined the prevalence of the phenomenon and identified the issues associated with it. however, only a few have provided practical and operational solutions to these issues. the article explains how to solve the issues by way of disclosure. it examines the consequences of compelling a funded party to disclose its funding arrangements, and it examines how to adopt and construct a duty of disclosure in the most feasible manner. the article thereby contributes to the development of legal and institutional tools to tackle the issues associated with third-party funding in arbitration. 1. introduction third-party funding has been subject to attention in the arbitration community over the past few years.1 the phenomenon has become increasingly prevalent and has consequently given rise to unprecedented practical and procedural issues in arbitration.2 does the existence of an unknown funder disqualify an arbitrator? should the funding arrangement influence the allocation of costs and decisions on security for costs? what is the accepted extent of the funder’s influence on the funded party? questions as these arise on an increasingly frequent basis in practice, and they have resulted in numerous articles and blog posts as well as two handbooks and one published dissertation.3 the aim of this article is not 1 see e.g. jonas von goeler, third-party funding in international arbitration and its impact on procedure (wolters kluwer 2016); lisa bench nieuwveld and victoria shannon sahani, third-party funding in international arbitration (2nd edn, kluwer law international 2012). in 2013, the icca and queen mary, university of london established the icca-queen mary task force on third-party funding whose work culminated in the icca-queen mary task force report on third-party funding published in april 2018. 2 goeler (n 1); nieuwveld and sahani (n 1). 3 goeler (n 1); nieuwveld and sahani (n 1); nikolaus pitkowitz (ed), handbook on thirdparty funding in international arbitration (jurisnet 2018). see also burcu osmanoglu, ‘third-party funding in international commercial arbitration and arbitrator conflict of interest’ [2015] journal of international arbitration 325 ff.; 4 disclosure of third-party funding to answer the relevant questions altogether, but to answer a specific practical question related to all of them: is it time to make parties disclose their sources of funding? a thorough discussion of this question will help arbitration institutes and other arbitral regulators develop their rules and guidelines on third-party funding in the best possible way. first, the article briefly examines the concept of third-party funding (section 2). then, it identifies the existing legal and institutional framework of the disclosure of third-party funding (section 3). the article discusses the feasibility of duties to disclose third-party funding (section 4) and the possible ways to adopt (section 5) and construct (section 6) such duties. finally, the article concludes that it is, in fact, time to make parties disclose their sources of funding, but only in particular ways (section 7). 2. the hype and hysteria about third-party funding despite its spot in the limelight, third-party funding is an ambiguous concept. to understand the underlying phenomenon and the increasing attention it gathers, the concept of third-party funding needs to be defined (section 2.1); its recent developments need to be addressed (section 2.2), and the compelling risks and benefits associated with third-party funding need to be identified (section 2.3). 2.1. defining the concept resolving a legal dispute involves many costs. in arbitral proceedings, the parties are required to remunerate the arbitrators and pay for their meeting facilities, catering services, and transportation. in addition, they might need to remunerate an administering institution and a number of experts. typically, the parties will also need to spend significant sums on legal representatives. for the individual party, these costs may cause severe harm. generally, the costs associated with international arbitral proceedings are considered high. this particularly applies to the losing parties, because arbitral tribunals tend to allocate costs based on the austrian yearbook on international arbitration 2017 (manz’sche verlagsund universitätsbuchhandlung 2017) 12; james rogers and matthew townsend, ‘cietac hong kong consults on draft guidelines on third party funding’ (kluwer arbitration blog, 13 august 2016) <http://arbitrationblog.kluwerarbitration.com/2016/08/13/cietac-hong-kongconsults-on-draft-guidelines-on-third-partyfunding/?doing_wp_cron=1594549605.1177089214324951171875> accessed on 12 july 2020; aren goldsmith and lorenzo melchionda, ‘the icc’s guidance note on disclosure and third-party funding: a step in the right direction’ (kluwer arbitration blog, 14 march 2016) <http://arbitrationblog.kluwerarbitration.com/2016/03/14/theiccs-guidance-note-on-disclosure-and-third-party-funding-a-step-in-the-rightdirection/?doing_wp_cron=1594549532.4014689922332763671875> accessed on 12 july 2020. njcl 2020/2 5 principle of “costs follow the event” more and more often.4 facilitating third-party funding enables a party to recover a major part of its costs. put simply, a third-party funding arrangement means that someone who is not a party to a legal dispute provides funding to someone who is a party to the dispute. a third-party may provide several different types of litigation funding and arbitration funding to a party. a large amount of recent literature concerns funding agreements, under which a funder is obliged to fund a party’s arbitration costs, and the funded party is not obliged to repay the funded amount but is obliged to pay a fixed or variable amount in case of a favourable result.5 such funding agreements constitute a narrow definition of third-party funding. other types of funding include contingency fees, under which the party’s counsel shall only receive its fees if the party wins the case, and conditional fees, under which the counsel’s fees are reduced if the party loses the case. they also include traditional loans, under which a lender funds the party’s costs against the payment of an interest rate and insurance agreements, under which insurers are obliged to cover possible costs related to pursuing or defending a claim against the payment of premium. finally, the funding may consist of the transfer of the disputed claim to a third party. all of these types of funding arrangements fall under a broader definition of third-party funding. when it comes to the need for disclosure, one might not need to distinguish between the narrow and broad definitions of third-party funding. however, the narrow definition concerns a specific, increasingly prevalent type of funding. this type of funding is usually comprehensive and hidden in a specific case. due to these characteristics, arbitrators and parties need to be able to identify the specific type of third-party funding covered by the narrow definition above. 2.2. recent development different types of third-party funding have long been accepted and widely used in the united kingdom, the united states, and australia.6 in international arbitration, the use of third-party funding as covered by the narrow definition is fairly new.7 4 decisions on costs in international arbitration – icc arbitration and adr commission report, icc dispute resolution bulletin 2015 4 ff. 5 bernardo m. cremades, ‘third party litigation funding: investing in arbitration’ [2011] tdm 1, 2; edouard bertrand, ‘the brave new world of arbitration: third-party funding’ [2011] asa bulletin 607, 609; cento veljanovski, ‘third-party litigation funding in europe’ [2012] jlep 405; osmanoglu (n 3). 6 michele destefano, ‘nonlawyers influencing lawyers: too many cooks in the kitchen or stone soup?’ [2012] fordham law review 2791, 2819 ff.; nieuwveld and sahani (n 1) 75 and 101. 7 maya steinitz, ‘whose claim is this anyway? third-party litigation funding’ [2011] minnesota law review 1268, 1278; osmanoglu (n 3) 328; christopher bogart, ‘overview 6 disclosure of third-party funding despite its novelty, the use of third-party funding in international arbitration appears to be growing rapidly. the increased focus on the phenomenon indicates its growing use, but even more so do testimonies from practitioners within the field. james delaney, who currently manages the global funding broker thejudge, has stated that the market for funding of arbitration cases “has probably grown by well over 500 per cent since 2012, in terms of both the number of completed deals and the volume of active funders looking for viable opportunities”.8 other practitioners have stated that they have experienced a similar development.9 the cause of this development may be the latest financial crisis, which encouraged investors to seek new and more predictable markets.10 the cause may also be the increasing costs associated with arbitration proceedings.11 furthermore, there may be limited opportunities to raise other types of funding in international arbitration, while third-party funding in the narrow sense is not yet subject to heavy regulation in national law and institutional rules.12 2.3. risks and benefits a series of different risks have caused concern about the use of thirdparty funding in international arbitration. first, the funding arrangement may lead to a commercialization of the arbitration process, ultimately of arbitration finance’ in cremades and dimolitsa (eds), dossier x: third-party funding in international arbitration (dossiers icc institute of world business law 2013) 55. 8 james delaney, ‘mistakes to avoid when approaching third-party funders’ (global arbitation review, 15 april 2014) <https://globalarbitrationreview.com/article/1033321/mistakes-to-avoid-whenapproaching-third-party-funders> accessed on 12 july 2020. 9 kantor, mark, ’third-party funding in international arbitration: an essay about new developments’ [2009] icsid rev. 65; alexander brabant and others, ‘third party funding in international arbitration: practical consequences and tactical considerations’ [2016] int alr 113. 10 steinitz (n 9) 1283 ff.; valentina frignati, ‘ethical implications of third-party funding in international arbitration’ [2016] arbitration international 505; khushboo hashu shahdadpuri, ‘third-party funding in international arbitration: regulating the treacherous trajectory’ [2016] asian international arbitration journal 77. 11 the icca-queen mary task force report on third-party funding (2018) 18; susanna khouri, kate hurford and clive bowman, ‘third party funding in international commercial and treaty arbitration a panacea or a plague? a discussion of the risks and benefits of third party funding’ [2011] tdm 1. 12 goeler (n 1) 81; steinitz (n 9) 1278; victoria shannon, ‘harmonizing third-party litigation funding regulation’ [2015] cardozo l. rev. 861, 870; aren goldsmith and lorenzo melchionda, ‘third party funding in international arbitration: everything you ever wanted to know (but were afraid to ask)’ [2012] int'l bus. l.j. 53, 54. njcl 2020/2 7 making the process subject to financial speculation rather than a pursuit of justice.13 second, the funding arrangement may encourage arbitral “litigiousness”, thereby increasing the number of frivolous claims and unnecessary costly arbitral proceedings that the parties could have avoided by virtue of settlements.14 third, the funding arrangement may increase the costs associated with each case, because the funder and the funded party may be motivated to maximize claims and increase the extent of procedural measures in order to put pressure on the funded party’s opponent.15 fourth, the existence of a third-party funder may give rise to conflicts of interest. due to the funder’s inevitable interest in the outcome of the case, certain relations between a funder and an arbitrator may give rise to justifiable doubts about the arbitrator’s impartiality and independence. the funding arrangement may also reduce the funded party’s control of the process for the benefit of the funder’s control of the process. having invested substantial amounts of money in the case, the funder’s desire to control the process may be significant and obvious. finally, due to the funder’s desire to control the process, as explained above, the arrangement may give rise to conflicts and disagreement within the triangular relationship between the party, its counsel, and the funder, whose individual demands and expectations may be mutually incompatible. despite these risks, third-party funding is a beneficial tool in many respects. it improves opportunities for parties to pursue their claims and thereby promotes access to justice. this advantage does not only apply to impecunious parties. even though a party could afford to pursue its claims itself, the funding arrangements can allow the party to transfer some or all of its financial risks associated with the proceedings to the funder.16 13 stephen jagusch, third party funding of international arbitrations, in newman og hill (eds), the leading arbitrators’ guide to international arbitration (2014) 217; edouard bertrand, ‘the brave new world of arbitration: third-party funding’ [2011] asa bulletin 607, 609; goeler (n 1) 88. 14 khouri, hurford and bowman (n 13) 2; cassandra burke robertson, ‘the impact of third-party financing on transnational litigation’ [2011] case w. res. j. int'l l.159, 171; john beisner, jessica miller og gary rubin, selling lawsuits, buying trouble: thirdparty litigation funding in the united states (2009) 5 f. 15 aren goldsmith and lorenzo melchionda, ‘everything you ever wanted to know (but were afraid to ask) – part two’ [2012] int'l bus. l.j. 221, 223; stoyanov, marie and owczarek, olga, ‘third-party funding in international arbitration: is it time for some soft rules?’ [2015] bcdr international arbitration review 171, 191; goeler (n 1) 87. 16 victoria shannon, ‘judging third-party funding’ [2016] ucla law rev 388, 392; khouri, hurford and bowman (n 13) 4; shahdadpuri (n 12) 82; derric yeoh, ‘third party funding in international arbitration: a slippery slope or leveling the playing field?’ [2016] journal of international arbitration 115, 116. 8 disclosure of third-party funding the funding arrangements can also equalize the balance of forces between strong and weak parties. by providing financial strength to a weak party who holds a meritorious claim, the third-party funder can facilitate access to justice for a party who would not otherwise be able to pursue its claim, at least not with the same force. finally, the funding arrangements may lead to an early assessment and determination of the case and its possible outcomes. typically, the third-party funder conducts thorough due diligence before deciding to invest in the case. the result of such due diligence may indicate what submissions and arguments to focus on and what settlement amount to accept. accordingly, third-party funding is generally a useful and necessary tool. however, it entails a number of risks. arbitrators and arbitral institutions need to be aware of these risks, and they need to address them through the necessary steps. a strong third-party funder may influence the process in a way that satisfies none of the parties’ interests. if the funder is unknown to the funded party’s opponent or the tribunal until a late stage of the proceedings, the existence of the funder may disqualify the arbitrator at this late stage. therefore, the question is: how should these risks be addressed? one obvious way to address them is to oblige parties to disclose the existence of third-party funders. by making the funded party’s opponents and arbitrators aware of the funding arrangements, the funded party can eliminate a significant part of the problems described above. 3. existing duties of disclosure only a few arbitration laws and institutional rules currently oblige the parties to disclose the existence of third-party funders, and this is due to recent amendments in these laws and rules. under a revised version of the hong kong arbitration ordinance, a party shall disclose the existence and identity of a third-party funder.17 the hong kong international arbitration centre recently laid down a similar duty in its rules.18 under article 24 (a) of the 2017 investment arbitration rules of the singapore international arbitration centre, the tribunal may order the parties to disclose the existence of a party’s third-party funding arrangement and the identity of the third-party funder. if appropriate, the tribunal may also order the parties to disclose details of the third-party funder’s interest in the outcome of the proceedings and possible commitment to undertake adverse costs liability. under section 49 a (1) 17 this follows from section 98t. see also the sanction that follows from section 98 v. in 2018, the secretary of justice in hong kong published the hong kong code of practice for third party funding in arbitration, which contains similar disclosure rules. this code came into effect on 1 february 2019. 18 this follows from article 44 of the hkiac administered arbitration rules that were adopted to take effect from 1 november 2018. njcl 2020/2 9 of singapore’s legal profession act, a legal practitioner must disclose the existence and identity of a third-party funder in international arbitration cases.19 furthermore, a series of soft law instruments require the parties to disclose the existence and identity of third-party funders. according to the iba guidelines, a party shall disclose “any relationship, direct or indirect, between the arbitrator and the party … or between the arbitrator and any person or entity with a direct economic interest in, or a duty to indemnify a party for, the award to be rendered in the arbitration”.20 similar requirements are laid down in the cietac guidelines for third party funding in arbitration, siac’s practice note on arbitrator conduct in cases involving external funding and scc policy on disclosure of third parties with an interest in the outcome of the dispute.21 the danish institute of arbitration requests parties to disclose facts and circumstances that may give rise to justifiable doubts about an arbitrator’s impartiality and independence, including their sources of funding. the institute does not oblige parties to disclose the relations, as it does with arbitrators. accordingly, the institute does not impose any sanctions on a party’s failure to accommodate the request. however, if the failure gives rise to additional costs, the tribunal may impose these costs on the party who failed to disclose. the rules of the newly established institution, nordic offshore and maritime arbitration association (noma), does not contain provisions regarding third-party funding. however, the door does not seem closed on this issue. it has been pointed out that there is room to adapt to users’ wishes and also, that the tribunal may bear the topic in mind when conducting the arbitration “in such manner as it considers appropriate”, cf. article 15 of the noma rules.22 4. is a duty of disclosure feasible? as explained in section 3 above, certain but few legal frameworks are obliging parties to disclose the existence and identity of third-party 19 this follows from singapores civil law (third-party funding) regulations 2017 section 3. 20 iba guidelines, p. 15. 21 see the cietac guidelines for third party funding in arbitration article 3, the siac practice note on arbitrator conduct in cases involving external funding articles 5 and 7 and the scc’s policy on disclosure of third parties with an interest in the outcome of the dispute. 22 jacob skude rasmsusen and jens v. mathiasen, ’nordic offshore and maritime arbitration association (noma): could the nordic maritime model attract a wider audience?’ (kluwer arbitration blog, 26 march 2018) <http://arbitrationblog.kluwerarbitration.com/2018/03/26/nordic-offshore-andmaritime-arbitrationassociation/?doing_wp_cron=1594548296.6015739440917968750000> accessed on 12 july 2020. 10 disclosure of third-party funding funders in international arbitration. notably, the revised hong kong arbitration ordinance and singapore’s legal profession act lay down such obligations. is this approach a step ahead? or is it a step too far? the present section will identify the advantages (section 4.1), disadvantages (section 4.2), and necessity (section 4.3) of the approach. based on these elements, the section concludes that duties of disclosure are beneficial and necessary if designed in a proper way (section 4.4). 4.1. advantages if the funded party openly shared its information about its funding arrangements with the other parties, the arbitrators and any arbitral institution involved in the specific case, it would tackle a number of the risks identified in section 2.3 above. first, the information would reduce the risk of long and costly challenge procedures. in most modern jurisdictions, arbitrators are subject to strict requirements about impartiality and independence.23 circumstances that give rise to justifiable doubts about the arbitrator’s impartiality and independence can make a party challenge the arbitrator. the tribunal, institution, or national court may then disqualify the arbitrator. if the circumstances arise after the rendering of the award, the party may challenge the award before the national courts. ideally, the parties identify any possible conflict of interest, including conflicts caused by funding arrangements, before the appointment of the arbitrator and the initiation of the arbitral proceedings. as long as the circumstances are unknown, the potentially challenging party cannot identify the conflict. if the party identifies the conflict and raises the challenge at a late stage of the proceedings, the resources spent on the proceedings so far may be wasted. second, disclosing the existence of a funding arrangement will make it easier for the tribunal to determine the need for security for costs.24 such security may be necessary to ensure the proper remuneration of the arbitral tribunal. the existence of a third-party funder may indicate that the funded party is impecunious or may soon become so. in that case, security for costs may be necessary for the arbitrators to receive their fees. 23 see e.g. lcia arbitration rules article 5(3); uncitral model law article 12(2); icc arbitration rules article 11(1); scc arbitration rules article 18(1); siac arbitration rules article 13(1); hkiac administered arbitration rules article 11(1). 24 see regarding this argument the following: frignati (n 12) 518 ff.; kelsie massini, risk versus reward: the increasing use of third funders in international arbitration and the awarding security for costs (2015) 7 y.b. arb. & mediation 323, 331 ff.; william kirtley and koralie wietrzykowski, 'should an arbitral tribunal order security for costs when an impecunious claimant is relying upon third-party funding?' (2013) 30 journal of international arbitration 17 ff.; the icca-queen mary task force report on third-party funding (2018) chapter 6. the icca-queen marty task force concluded that the existence of funding is not generally relevant to determinations on security for costs, but examines exceptions that may exist. njcl 2020/2 11 third, the disclosure may help the tribunal to allocate the costs between the parties.25 this may be the case regardless of the outcome. the funding arrangement will reduce the funded party’s own procedural costs to the extent that the third-party funder covers these costs. if the third-party funder covers the funded party’s entire procedural costs, the procedure does not incur that party any costs. under the rules of several different arbitral institutions, the tribunal shall only order a party to pay another party’s costs if the procedure has incurred that other party costs.26 the funding arrangement may be an important factor for the tribunal to take into account in this respect. on the other hand, if the funded party loses the case, it might be necessary to make the funder cover the winning party’s costs, to the extent that this is possible. as explained above, the funded party may be impecunious. the funded party’s payment of security would cover the arbitrators’ fees but not necessarily the winning opponent’s costs. the funded party may not be able to cover the winning party’s costs. if the third-party funder has agreed to cover the funded party’s procedural costs, it may be argued that the agreement obliges the third-party funder to cover the winning opponent’s costs in such a case. fourth, the disclosure may help the funded party to accommodate any agreed obligation to keep the proceedings confidential. such an obligation may conflict with the funder’s need for information about the case. a strict non-disclosure agreement would prohibit the party from disclosing confidential information about the case to the funder. however, such information may be necessary for a funder to determine whether the case is a good investment and to follow the progress of the arbitral proceedings. if all of the parties and the tribunal know about the funder’s involvement in the case, they can mutually permit the transmission of information from the funded party to the funder. the disclosure may entail a fifth advantage concerning the funder’s control over the proceedings. as explained in section 2.3, such control may be a consequence of the funding arrangement. one may argue that the tribunal should be able to limit the funder’s control by issuing appropriate measures.27 without information about the funding arrangement, the tribunal cannot issue such measures. however, the tribunal may not be able to deal with the funder’s control in any event. the control may be implicit and take place behind 25 see the icca-queen mary task force report on third-party funding (2018) chapter 6, where the icca-queen mary task force provides guidance regarding the impact of third-party funding on allocation of costs. 26 icc arbitration rules article 38(1); lcia arbitration rules article 28(3); scc arbitration rules article 50; uncitral arbitration rules article 40(2)(e); cietac arbitration rules article 52(2). see e.g. this argument discussed by goeler (n 1) 378 ff. 27 see elizabeth chan, ‘proposed guidelines for the disclosure of third-party funding arrangements in international arbitration’ [2015] am. rev. int'l arb. 181, 299; marc goldstein, ‘should the real parties in interest have to stand up?’ [2011] tdm 1, 15. 12 disclosure of third-party funding the scenes. furthermore, there is hardly any compelling reason why the tribunal should in fact limit the funder’s control at all. as stated by goeler, the funder’s control is “none of the arbitral tribunal’s business”.28 the funder’s control is a private matter between the funder and the funded party, and the funder is not a party to the arbitration. the funded party is responsible for the funder’s control, and the control primarily affects the funded party. therefore, the funded party, and not the tribunal, is the one to deal with this possible issue. 4.2. disadvantages to make the funded party disclose its funding arrangement would not only entail advantages. any duty entails disadvantages, and a duty for the party to disclose its funding arrangement is no exception. first, it may be difficult to delimit the duty. there is no clear and simple way to categorize the specific funding arrangements that need to be disclosed. however, such categorization may not be necessary to make at all. if a party is required to disclose any kind of funding, from insurance to loans, the scope of the duty will be straightforward. as explained in section 5 below, there is no compelling need to limit a duty of disclosure to certain types of funding, although certain types of funding agreements may be more important to identify than others. second, one may argue that funding arrangements are private affairs that the parties should be allowed to keep secret. parties need a certain degree of freedom in terms of procedural strategy, and the funders need discretion regarding their investments. imposing a duty of disclosure would indirectly compromise the parties’ need for freedom and directly compromise the funders’ need for discretion. however, these needs are not compelling when compared to the need for information about the funding arrangements. third, disclosure about possible funders may negatively interfere with the conduct of the parties and arbitrators. the funded party may act excessively risky, and the non-funded party may seek to delay the process in order to increase the funder’s expenses.29 the tribunal may base its decision on a conscious or unconscious impression that the funded party has a stronger case because of the funder’s decision to fund the party.30 the tribunal may also make decisions on fees, costs, or other procedural issues based on its knowledge about the funding arrangement. 28 goeler (n 1) 143. 29 maxi scherer, aren goldsmith and camille fléchet, ‘third party funding in international arbitration in europe: part 1’ (2012) int'l bus. l.j. 207, 218; osmanoglu (n 3) 341. 30 scherer, goldsmith and fléchet i (n 32) 218; goeler (n 1) 271; laurent lévy and regis bonnan, ‘third-party funding disclosure, joinder and impact on arbitral proceedings’ in cremades and dimolitsa (eds), dossier x: third party funding in international arbitration (dossiers icc institute of world business law 2013) 79. njcl 2020/2 13 duties of disclosure are not the only possible way to address these scenarios. other measures, such as guidelines on the conduct of the parties and arbitrators, could address the scenarios too. however, a duty of disclosure would probably be more effective. fourthly, a duty of disclosure may delay the arbitration procedure. complying with such a duty may take time, especially if the disclosure results in separate submissions or challenges. the duty would probably be worth the delay in most instances. when the information gives rise to submissions or challenges and thereby delays the procedure more significantly, the duty would arguably be particularly useful and necessary. in these instances, the arrangements give rise to concern for one reason or the other. without the duty of disclosure, the arrangements could remain unknown through most or all of the proceedings. furthermore, it would hardly take much time to comply with the duty. as explained in section 6 below, all it should take for a party to comply with the duty is to disclose the existence and identity of its funder in an email or a letter to its opponents, the arbitrators, and possibly an administering institution. accordingly, this fourth alleged disadvantage is not a compelling reason to refrain from implementing a duty of disclosure. finally, the duty might compromise the funded party’s duty of confidentiality towards the funder. a funding arrangement typically entails a non-disclosure agreement between the funded party and the funder. a requirement that the funded party discloses the funding arrangement puts the funded party in a dilemma. either the party complies with its nondisclosure agreement and fails to provide the information, or the party provides the information and breaches its non-disclosure agreement with the funder. arbitrators face a similar dilemma. if an arbitrator cannot comply with its duty of disclosure under the applicable conflicts-of-interest rules without breaching a non-disclosure agreement, the arbitrator must either deny the appointment or breach the non-disclosure agreement. similarly, a duty of disclosure for the funded party would force that party to (i) provide the information, (ii) sacrifice the funding arrangement, or (iii) breach the duty of disclosure and accept the legal consequences. arguably, the funder should not need the party to keep the funding arrangement secret from other parties or arbitrators involved in the case, as long as they are all subject to non-disclosure agreements in relation to the arbitration. accordingly, a duty of disclosure would probably be compatible with most funding arrangements as long as the arbitration is confidential. however, the arbitration is not necessarily confidential. under danish law, the arbitration is not confidential unless the parties agree to make it confidential. the model law, upon which the danish arbitration act is drafted, contains no duty of confidentiality. to make the duty of disclosure as feasible and harmless as possible, the parties need to ensure that the arbitration is confidential. they can do so by reference to a set of 14 disclosure of third-party funding institutional rules or to national arbitration law under which the arbitration is confidential. 4.3. necessity it has been argued that the tribunal’s power to order document production renders a duty of disclosure needless.31 the tribunal can demand the submission of information on the funding arrangement through discovery or other types of document production. however, for the tribunal to demand the submission of certain information, the tribunal needs to know about the existence of the information. if the tribunal has no knowledge of the funding arrangement, it cannot demand the submission of information about the arrangement. therefore, the duty could be a prerequisite for the tribunal’s decision to demand document production. accordingly, the duty is necessary, despite the tribunal’s opportunity to order document production. goeler argues that arbitrators and non-funded parties are likely to know about the funding arrangement even if the funded party has not explicitly made them aware.32 the argument does not seem convincing. third-party funders may invest in any type of case and any type of party. the funding arrangement does not necessarily appear significant from any available facts or circumstances in the specific case, so the arbitrators and non-funded parties do not necessarily know about it. 4.4. a duty of disclosure is feasible balancing the arguments in the subsections above leads to the conclusion that a duty of disclosure is feasible and necessary. the duty would prevent many practical problems to which the parties’ possible funding arrangements may give rise, and it would not necessarily create any major problems. the duty would, therefore, be valuable to arbitration practitioners. however, the duty would only avoid creating other problems if it would take the obstacles mentioned in subsection 4.2 into account. particularly, the concerns about confidentiality, efficiency, and party autonomy should be observed in this respect. the party’s duty to disclose information about a funder should entail a duty for the recipients of the information to keep the information confidential, and as clarified in section 6 below, the duty should be swift and easy to accommodate. 5. how to adopt it the results of the analyses in the previous sections leave us with two major questions. how could a duty of disclosure be adopted, and how should it be constructed? the present section deals with the first question, and section 6 below deals with the second question. 31 goeler (n 1) 133 ff. 32 goeler (n 1) 155. njcl 2020/2 15 when it comes to the adoption of the duty, three different opportunities could be considered. first, national legislators may implement the duty by law. second, national or international organizations may implement the duty into soft law instruments. third, arbitral institutions may implement the duty as part of their institutional rules. one opportunity does not exclude the other, but they will be dealt with individually in the following. the first opportunity is ideal, but it would be overly optimistic to believe that national legislators would change their arbitration laws and adopt the duty. singapore’s and hong kong’s legislators have done so, but, in other countries, governments are hardly as progressive and dynamic when it comes to arbitration as in singapore and hong kong. the second opportunity is realistic, but laying down the duty in soft law instruments would hardly have any direct effect on the parties’ willingness to disclose their funding arrangements. the iba guidelines already provide a duty for the parties to disclose relationships between their funders and the arbitrators, but the guidelines do not impose any sanctions on the party’s failure to meet the duty. the guidelines may have influenced the few legislators and institutions that are now implementing the duty into law or institutional rules, but soft law instruments as the iba guidelines do not seem to be influencing the conduct of the parties in any direct way when it comes to the disclosure of funding arrangements. the third opportunity seems realistic and effective. as private entities, the institutions are able to draft their rules as they wish. compared with national legislators, the institutions have significant leeway and flexibility when it comes to rule-making and amendments. as mentioned in section 3 above, two institutions have already implemented amendments that require the parties to disclose the existence and identity of their funders, and the danish institute of arbitration is now encouraging parties to disclose their sources of funding. accordingly, the ball is in the institutions’ court. the institutions are realistically able to make parties disclose their funding arrangements, and they may do so in an effective, quick, and uncomplicated way. institutions should not be concerned about implementing such duties. as mentioned in section 4 above, the duties would not do any harm if constructed properly. parties can accommodate the duty without much effort, and third-party funders have no reasonable and legitimate interest in remaining unknown to arbitrators, non-funded parties, and administering arbitral institutions. 6. how to construct it the only remaining question concerns the construction of the duty. what should it look like? a number of issues are relevant to consider in this respect. these issues include delimitations, the extent of information, recipients, the duty’s beginning and end, and the sanctions of breaching the duty. 16 disclosure of third-party funding as mentioned in subsection 4.2 above, there is no compelling reason to delimit the duty to certain types of funding. no matter whether the funding arrangement is an insurance agreement, a loan, an agreement to pay contingency fees, or any other type of arrangement, the need for disclosure is the same. only funding arrangements related to the specific case should be disclosed. the parties need not disclose their insurance agreements and loans altogether, but only the ones that cover or depend on the specific case. accordingly, the duty should encompass any funder who provides coverage for any kind of costs associated with the case or who might otherwise have a financial interest in the outcome of the case or an influence on that outcome. information about the funder’s mere existence and identity may sufficiently enable the non-funded party, the arbitrators and any administering institution to accommodate the needs described in section 4.1 above. in that case, it would be unnecessarily onerous for the party to disclose all available information about the funder and the funding agreement. accordingly, the duty should require the party to disclose the existence and identity of the funder and, in principle, nothing else. if the information about the funder’s existence and identity does not provide the necessary basis for decisions on challenges, security for costs or the allocation of costs, the duty might authorize the tribunal to demand further information as long as this is necessary and relevant. it may for instance be necessary for the tribunal to know the identities of the funder’s affiliates or the duration of the funding agreement. the information about the funder’s existence and identity is primarily relevant to the other parties and the arbitrators, but it may also be relevant to an administering arbitral institution. the institution may be involved in challenge decisions or decisions about the security for costs. accordingly, the recipients of the disclosure should be all parties involved in the case as well as the arbitrators and any administering institution. as soon as a party has initiated arbitration and the funding agreement is concluded, the need for information about the funding arrangement has arisen. there is no need for disclosure of the funding arrangement before the initiation of arbitration. accordingly, the duty of disclosure should run from the time when (i) a party has initiated arbitration, and (ii) the funded party has entered into a funding agreement. if the information about the funding arrangement remains unknown for too long, the problems identified in subsections 2.3 and 4.1 may appear at the time when the other parties and the arbitrators become aware of the arrangements. the consequences of breaching the duty may give rise to discussion. what sanctions would be effective, and should there be any sanctions at all? the right answers are straightforward. arbitrators are subject to duties of disclosure too and, for arbitrators, the sanctions are provided by private law. an arbitrator may lose its fees or become liable for damages if the njcl 2020/2 17 arbitrator breaches the duty of disclosure. similar sanctions should apply to the parties. if a party fails to disclose the existence and identity of its funder, the failure should affect the tribunal’s allocation of costs, and if the general requirements under national tort law are met, the failure should make the party liable for damages. 7. conclusion the increasing use of third-party funding is beneficial, but nonfunded parties and arbitrators need to be made aware of any funding agreement in the case. without information about the funding arrangement, the arrangement may give rise to long and costly challenge procedures. furthermore, the information about the arrangement would make it easier for the tribunal to allocate the costs and determine the need for security for costs. the information might also make it easier to keep the proceedings confidential. a duty for the parties to disclose the existence and identity of its funders would motivate parties to provide information about their funders. the duty would entail a number of disadvantages, but certain measures could mitigate these disadvantages. first, the party’s duty to disclose information about its funder should entail a duty for the recipients of the information to keep the information confidential. second, the duty should be swift and easy to accommodate. it would be optimistic to believe that national lawmakers are ready to implement the duty into national arbitration laws. soft law instruments would hardly be effective. the most effective and realistic solution is that arbitral institutions implement the duty into their institutional rules. they can do so in an effective, quick, and uncomplicated way. the institutes may construct the duty in numerous different ways. the best way would arguably be without limiting the duty to certain types of funding and without requiring disclosure of anything but the mere existence and identity of the funder. the funded party should provide the information to the other parties involved in the case as well as the arbitrators and any administering institution. the party should do so when the arbitral proceedings are initiated and when the funded party has entered into the funding agreement with the funder. if the funded party fails to comply with the duty of disclosure, the failure should affect the allocation of costs and, if the conditions under national tort law are met, make the party liable for any damages caused. 6 otto riethmueller wenzlaff 1 tied agents within the ecspr regime till otto*, patrick wambold** & karsten wenzlaff*** * lawyer, annerton law firm, germany. ** lawyer, gsk stockmann law firm. *** secretary-general, german crowdfunding association, germany, research affilitate at the european centre for alternative finance at the university of utrecht and the cambridge center for alternative finance at the university of cambridge. njcl 2022/2 138 1. does an ecspr license exclude being a tied agent under mifid – the case in germany .................................................... 139 2. compatibility of the licence as a crowdfunding service provider with the activity as a tied agent ....................... 140 2.1. obligation of interpretation in conformity with the directive ......................................................................... 140 2.2. scope of the ecspr regarding crowdfunding service providers differs from investment brokerage subject to mifid ii ...................................... 142 2.3. combination of service provision permitted under ecspr and mifid ................................................................. 142 3. conclusion ........................................................................................ 143 njcl 2022/2 139 abstract the european crowdfunding service provider regime allows the intermediation of securities, loans and other admitted instruments for crowdfunding purposes up to five million euro. crowdfunding offers above five million euro continue to be subject to national crowdfunding regimes, which may be regulated under mifid. the authors discuss how existing mifid licenses can be used in parallel to a license under ecspr, with a focus on tied agents who operate under a so-called liability umbrella (investment firm or credit institution) holding a mifid license. in germany, the law implementing mifid states that tied agents can operate “solely [in the name,] for the account and under the liability of” an investment firm or credit institution acting as liability umbrella. this raises the question, whether a tied agent can hold a license under ecspr itself at the same time. however, the authors argue that both mifid and ecspr as well as the intent of the german legislator provide for the fact that one can hold an ecspr authorization and at the same time be appointed as tied agent of a mifid investment firm or credit institution. 1. does an ecspr license exclude being a tied agent under mifid – the case in germany since 10 november 2021, the european crowdfunding service provider regulation (ecspr)1 has been directly applicable in the member states of the european union. since the ecspr came into force, it lays down requirements for, among other things, the provision of crowdfunding services (i.e. investment brokerage, or the reception and transmission of client orders) between an entrepreneur as project owner and investors, provided that the brokering takes place via a crowdfunding platform. according to art. 1(2) lit. c) ecspr, the ecspr’s scope is limited to crowdfunding offers with an equivalent value of up to five million euro. some market participants see a need for financing with a higher total issue volume. this raises the question whether companies can act as crowdfunding service providers with a licence under art. 12(1) ecspr and broker instruments between project owners and investors up to five million euro and, for issue volumes above five million euro, can provide the placement or brokerage as a tied agent of a so-called liability umbrella subject to authorisation under the national mifid implementation of the respective member state. crowdfunding service providers in germany, offering the intermediation of securities, mostly operate within the tied agent regime under a so-called liability umbrella, which holds a license to intermediate 1 regulation (eu) 2020/1503 of the european parliament and of the council of 7 october 2020 on european crowdfunding service providers for business and amending regulation (eu) 2017/1129 and directive (eu) 2019/1937. tied agents within the ecspr regime 140 securities within the mifid framework. only one german crowdfunding platform has its own mifid license, as scholars generally agree that the implementation of the mifid regime has been gold-plated by the german legislator. the national competent authority (nca) for the ecspr, and thus responsible for the compliance and supervision of crowdfunding service providers under the ecspr, is the bundesanstalt fuer finanzdienstleistungsaufsicht (bafin). asked whether it is possible to apply for the ecspr license and then outsource one’s license to tied agents, bafin indicated that this would not be allowed. esma, the european securities market authority, confirmed this view. therefore, tied agents have to apply for and obtain an ecspr license themselves, if they want to provide services under ecspr. however, under the german implementation of the mifid regime, tied agents are required to “solely act for the account and under the liability” of one investment firm. this has led to the question whether tied agents can also apply for and receive their own ecspr license. if that would be the case, a crowdfunding service provider could operate under the ecspr regime for emissions below five million euro, and could operate within the mifid regime and the german exemption from the prospectus regulation (regulation (eu) 2017/1129) for issues between five and eight million euro. if a tied agent would not be able to apply for an ecsp license without losing its status as tied agent, it would have to apply for the ecsp license with a separate legal entity. the two legal entities would have to share a common investor base. such a practice would entail high costs of legal compliance. the authors argue in this article that both mifid and the ecspr foresee that a tied agent of a mifid investment firm can also obtain its own ecsp license. the exclusive ties to a so-called liability umbrella does not foreclose intermediating securities outside of mifid and within the ecspr. the argument is highly relevant also outside of germany, as it discusses the relationship between the two regimes and entities planning to operate in both regimes. 2. compatibility of the licence as a crowdfunding service provider with the activity as a tied agent 2.1. obligation of interpretation in conformity with the directive the provisionsof the second markets in financial instruments directive2 (mifid ii) as well as the legistlative materials of the european 2 directive 2014/65/eu of the european parliament and of the council of 15 may 2014 on markets in financial instruments and amending directives 2002/92/ec and 2011/61/eu. njcl 2022/2 141 and german legislator on the tied agent speak in favour of a general combinability of both activities. recital 100 mifid ii reads: “this directive should be without prejudice to the right of tied agents to undertake activities covered by other directives and related activities in respect of financial services or products not covered by this directive [...]. " in line with this, art. 29 (4) mifid ii states: "member states shall require investment firms […] [to] take adequade measures in order to avoid any negative impact that the activities of the tied agent not covered by the scope of this directive could have on the activities carried out by the tied agent on behalf of the investment firm.” (emphasis added by the authors.) the european legislator thereby clarifies that the activity as a tied agent does not have to be provided exclusively. rather, the legislator assumes that the tied agent can and may provide other activities outside the scope of mifid ii. this is precisely the case here, as mifid ii does not regulate crowdfunding services which are subject to ecspr (see section 2.2 below for more details). furthermore, there is no evidence in the german legislative history that would speak in favour of an intended prohibition of simultaneous activity as a tied agent and as an ecspr institution. with the mifid implementation act3, the german legislator, in implementation of mifid i, has revised the field exemption for tied agents and introduced the exclusivity requirement provided therein. the legislator stated that due to "the degree of integration within the organisation of the company [(the liability umbrella provider)], a tied agent can only be someone [...] who works solely for one company".4 against this background, the purpose of the provision and the chosen wording is, according to the grounds of the law, merely to exclude "multiple representation" of different investment firms by a single tied agent.5 this also corresponds to views in published literature.6 said multiple representation was still possible before the revision of the field exception, provided that the participating investment firms assumed joint and several liability for the activities of the tied agent.7 with the new version of the field exception for tied agents, the german legislator did not intend to go beyond the scope required by mifid ii and 3 frug, bt-drs. 16/4028. 4 bt-drs. 16/4028, p. 93. translation by the authors. 5 bt-drs. 16/4028, p. 93; cf. also recital 36 of the first financial markets directive (mi fid i) and now recital 99 of mifid ii). 6 cf. reschke in: beck/samm/kokemoor, kreditwesengesetz mit crr, § 2 rn. 605, albert in: reischauer/kleinhans, kreditwesengesetz, 7th el 2022, § 2 marginal no. 154. 7 bt-drs. 13/7142, p. 72. tied agents within the ecspr regime 142 did not want to extend the exclusivity requirement to the permissible, see above activities of tied agents outside the scope of mifid ii. as will be explained in more detail below, the activity as a crowdfunding service provider subject to ecspr is not covered by mifid ii and is therefore also permissible alongside the activity as tied agent, taking into account the legislative intent of the national legislator. thus, the required interpretation of the provisions on tied agents in conformity with the directive, paired with the freedom to choose an occupation and the freedom to provide services, already speaks against an (implicit) prohibition of simultaneous activity as a tied agent and as a crowdfunding service provider subject to ecspr. 2.2. scope of the ecspr regarding crowdfunding service providers differs from investment brokerage subject to mifid ii the european legislator assumes a competitive relation and the possibility of a requirement of dual authorisation only for "the same activity". this is not the case if, on the one hand, services are provided under the ecspr and on the other hand, the placement or brokerage of issues in excess of five million euro falls outside the scope of ecspr. the brokerage of crowdfunding offers by crowdfunding service providers is substantially different from the pure investment brokerage or placement of financial instruments according to mifid ii. this is exemplified by recital 3 of directive (eu) 2020/1504 amending mifid ii, which was adopted as a supplement to the ecspr, as well as article 1 thereof. from the recital can be concluded that exclusivity is not required for different activities: "to provide legal certainty as to the persons and activities falling within the scope of regulation (eu) 2020/1503 and of directive 2014/65/eu of the european parliament and of the council, respectively, and in order to avoid a situation where the same activity is subject to multiple authorisations within the union, legal persons authorised as crowdfunding service providers under regulation (eu) 2020/1503 should be excluded from the scope of directive 2014/65/eu." art. 1 of the directive stipulates the corresponding exemption from the scope of mifid ii by adding a new letter p) to art. 2(1) mifid ii. 2.3. combination of service provision permitted under ecspr and mifid that the provision of crowdfunding services as crowdfunding service provider under the ecspr in combination with other investment services regulated under mifid ii is permissible, can already be deducted from the statutory provision of art. 12(14) ecspr. according to this provision, the requirements to obtain an ecspr authorisation for njcl 2022/2 143 investment firms that have already been granted a mifid licence are eased. this logically assumes the admissability of a corresponding combination of services. moreover, the admissibility of this combination is also recognised by the european securities and markets authority (esma), which is primarily responsible for interpretation of the ecspr: esma has updated its questions and answers on the ecspr as of 23.9.2022.8 in question 3.8, esma comments on the question of whether crowdfunding services under ecspr and investment services and activities provided in accordance with mifid ii can be provided by means of the same website. esma answers the question by stating that a combination of both services via the same website is possible, “provided that the distinction between crowdfunding services and mifid ii investment services and activities is very clear to the client at any moment, including with regards to the regulatory framework applicable to such services or activities”.9 esma thus assumes that both, the provision of crowdfunding services under ecspr and the provision of investment services under mifid ii, can be provided simultaneously. as the provisions with regard to the tied agent are based on a provision of mifid ii10, esma's considerations can be applied here as well. 3. conclusion an explicit prohibition of the combination of the provision of crowdfunding services up to five million euro as a crowdfunding service provider under the ecspr and the activity as tied agent of an investment firm for issues above five million euro can neither be derived from the ecspr nor mifid ii itself nor the german national mifid ii implementation. the provision of crowdfunding services under the ecspr represents a qualitatively different activity than the brokerage or placement pursuant to mifid ii and therefore the activities are not in competition with each other. this is exemplified by the accompanying directive to the ecspr, which excludes crowdfunding service providers and the provision of crowdfunding services according to ecspr from the scope of mifid ii. this conclusion is also supported by the relevant provisions of mifid ii and the ecspr as well as opinions of esma, which all assume simultaneous activity under the mifid regime and the ecspr is permissible. 8 esma, questions and answers on the european crowdfunding service providers for business regulation, available at: https://www.esma.europa.eu/sites/default/files/library/esma35-421088_qas_crowdfunding_ecspr.pdf; as of 17.10.2022. 9 ibid. 10 cf. art. 29 mifid ii. microsoft word article3.doc harmonisation and the united nations convention on contracts for the international sale of goods by troy keily1 nordic journal of commercial law issue 2003 #1 1 troy keily is an australian lawyer. he holds a bachelor of arts & bachelor of laws (honours) degree from deakin university. this paper was completed as part of a masters degree in public & international trade law at the university of melbourne. nordic journal of commercial law, issue 2003 #1 2 1. introduction after many years of negotiation, the united nations convention on contracts for the international sale of goods (“cisg”) came into force in 1988. today, 62 states have adopted the cisg. together these countries account for over two-thirds of all world trade.2 on this basis alone, the cisg is an outstanding success in the legal harmonisation of the law governing the international sale of goods. however, the cisg has its critics and much comment has been made on the failure of the cisg to achieve its goal of promoting international trade through a body of uniform rules. the primary motivation driving the push for a harmonised law on the international sale of goods is economic: a harmonised law makes it easier and more efficient for the business person to sell and buy goods across state borders. however, the engine driving the push for harmonisation is political and cultural; and the task of creating the harmonised law belongs to the diplomat.3 a study of the cisg demonstrates that the political and cultural demands on the diplomat also act as shackles that restrain the achievement of a harmonised law. this paper will consider the cisg and discuss the constraints on treaty making as a mechanism for legal harmonisation. part one discusses the constraints faced when creating a uniform text. part two discusses the problems with the text of the cisg that result from the negotiation process. finally, part three discusses the constraints faced in maintaining the uniformity of the cisg. 2. the diplomats 2.1 the cisg and the promotion of international trade the preamble of the cisg reads like a petition. in adopting the cisg, states are attesting their commitment to the purpose of the cisg as set out in the preamble. the preamble states: ‘the states parties to this convention, bearing in mind the broad objectives in the resolution adopted by the sixth special session of the general assembly of the united nations on the establishment of a new international economic order, considering that the development of international trade on the basis of equality and mutual benefit is an important element in promoting friendly relations among states, being of the opinion that the adoption of uniform rules which govern contracts for the international sale of goods and take into account the different social, economic 2 <http://www.cisg.law.pace.edu/cisg/cisgintro.html> the pace university website dedicated to the cisg includes a map of the globe that details the countries of the world that have adopted the cisg. the wide acceptance of the cisg is immediately evident. sixty-one countries have adopted the cisg as of 1 may 2002. 3 arthur rosett, ‘unification, harmonization, restatement, codification, and reform in international commercial law’, (1992) 40 the american journal of comparative law 683, 684. nordic journal of commercial law, issue 2003 #1 3 and legal systems would contribute to the removal of legal barriers in international trade and promote the development of international trade, have decreed as follows:’4 what follows is a treaty comprising 101 articles that deal with the scope of the cisg,5 rules governing the formation of contracts for the international sale of goods,6 the rights and obligations of the buyer and seller arising from the contract7 and details of when the cisg comes into force and the reservations and declarations permitted.8 2.2 the long and winding road the cisg in its final form however has a long history that is a testament to the constraints on treaty making as mechanism for legal harmonisation. a brief examination of the history of the cisg demonstrates two important points: first, treaty making is a both a labor and time intensive process and, second, the process is unlikely to succeed unless it is inclusive of states. the twentieth century trend towards the unification of laws in multinational treaties that govern transnational commerce has its origin in the middle ages and the development of the lex mercatoria.9 however, the modern day cisg has its origins in international attempts to create a uniform law for the international sale of goods which commenced in the 1930s. the governing council of the international institute for the unification of private law (unidroit) developed the first draft of a uniform law on the sale of goods in 1935. after the interruption of the world war ii and several further drafts, two conventions were approved in 1964 at a conference at the hague. these conventions were the uniform law on the international sale of goods (“ulis”) and the uniform law on the formation of contracts for the international sale of goods (“ulf”).10 only 28 states participated in the 1964 hague conference that approved the ulis and ulf and only nine countries gave force to these treaties. the failure of these treaties to win wider acceptance is in part attributed to the dominant influence of the civil law traditions of western europe11 and to the neglect of both socialist and third world countries. the socialist and third world countries refused to enact the ulis and ulf because they considered that these conventions were modelled on the demands of the industrialised states.12 accordingly, the 4 preamble to the cisg. 5 see part i, articles 1 13 of the cisg. 6 see part ii, articles 14 – 24 of the cisg. 7 see part iii, articles 25 – 88 of the cisg. 8 see part iv, articles 89 – 101 of the cisg. for a brief overview of the structure and scope of the cisg, see john felemegas, ‘the united nations convention on contracts for the international sale of goods: article 7 and uniform interpretation’ <http://www.cisg.law.pace.edu/cisg/biblio/felemegas.html>. 9 franco ferrari, ‘uniform interpretation of the 1980 uniform sales law’ (1994) 24 the georgia journal of international and comparative law 183, 184. also published at <http://cisgw3.law.pace.edu/cisg/biblio/franco.html>. a comparison of the cisg and the lex mercatoria from the perspective of harmonising international law is also interesting as they represent different approaches to harmonisation. the cisg being harmonisation by multi-national treaty developed by nation states and administered by the courts (and arbitrators) whereas the lex mercatoria was based on mercantile customs, was administered by merchants and had an informal procedure. 10 ibid, 189. 11 philip hackney, ‘is the united nations convention on the international sale of goods achieving uniformity?’ (2001) 61 louisiana law review 473. 12 ferrari, above n 8, 190. nordic journal of commercial law, issue 2003 #1 4 lesson learned from the failure of the hague conventions to gain wide acceptance was that the successful harmonisation of laws governing the international sale of goods requires broad based participation in the drafting process. in 1966, following the failure of the hague conventions the united nations established the united nations commission on international trade law (uncitral) and gave it the task of promoting the harmonisation of international trade law. after 10 years of negotiation and drafting, uncitral produced the 1978 uncitral draft convention. in 1980, 62 countries participated in a diplomatic conference in vienna, reviewed the 1978 draft convention and, after some amendments, unanimously approved the cisg.13 after two failed treaties and the better part of half a century, the cisg finally came into force in 1988 and today 61 countries have adopted it.14 the factor that distinguished the cisg in its success from the two hague conventions was the widespread participation by representatives of states from all parts of the globe in its drafting.15 2.3 clash and compromise as an exercise in harmonisation, the cisg demonstrates the predicament that faced its authors in creating an international uniform law and the mechanisms used to overcome these hurdles. gyula eörsi, a delegate representing hungary at the cisg drafting conventions and a leading author on the cisg, explains the predicament in an satirical play script titled ‘unifying the law (a play in one act, with a song)’, which commences as follows.16 ‘chairman/bang!/the discussion is open on art. 1. the distinguished delegate from knowhowland has asked for the floor. the delegate from knowhowland: thank you mr. chairman. my delegation proposes that art. 1 should read as follows: “the dog shall bark.” thank you mr. chairman. the delegate from oraculum: with greatest respect mr. chairman, this proposition runs against all experience. my delegation proposes the following wording: “the cat shall mewl.” thank you. the delegate from knowhowland: my delegation is terribly sorry to disagree with my friend from oraculum, mr. chairman, but i have to remind you that my proposal stating that “the dog shall bark” is backed by a 700 year old, uninterrupted line of court decisions in my country. thank you mr. chairman. 13 felemegas, above n 7. 14 a common problem with the harmonisation of law by treaty making is the long period of time it takes to encourage states to ratify the treaty. albert kritzer explains that ‘[r]atification of conventions on international commercial law normally proceeds at a glacial pace. however, cisg ratification quadrupled in the few short years since it came into effect’: see albert kritzer, ‘the convention on contracts for the international sale of goods: scope, interpretation and resources’ (1995) cornell review of the convention on contracts for the international sale of goods 147. also published at <http://cisg.law.pace.edu/cisg/biblio/kritzer.html>. 15 felemegas, above n 7. ‘at the 1965 hague conference, which finalized ulis and ulf, 28 countries took part: 22 european or other developed western countries, 3 socialist, and 3 developed countries. at the 1980 vienna conference which adopted the cisg, 62 states took part: 22 european and other developed western states, 11 socialist, 11 south-american, 7 african and 11 asian countries; in other words, roughly speaking, 22 western, 11 socialist and 29 “third world” countries.’: gyula eörsi, ‘a propos for the 1980 vienna convention on contracts for the international sale of goods’ (1983) 31 the american journal of comparative law 333, 335. 16 gyula eörsi, ‘unifying the law (a play in one act, with a song)’ (1977) 25 the american journal of comparative law 658. nordic journal of commercial law, issue 2003 #1 5 the delegate from oraculum: without underestimating, mr. chairman, the erudition, frugality and creative force of the courts and the importance of judge-made law, may i call your attention to the fact that the proposal tabled by the delegation of the republic of oraculum stating “the cat shall mewl” is warranted not only by our civil code but also by our greatest brains in legal thinking from the early 18th century up to the present days and is sociologically correct. thank you mr. chairman.’ the call for the harmonisation of laws on the international sale of goods assumes that there are differences in the domestic legal techniques of states. amongst the states represented at the diplomatic convention that authored the cisg, the differences in legal technique were most evident in conflicts between common law and civil law systems. there were also considerable differences between the socialist and western legal systems and between developed and developing countries.17 the following examples illustrate these differences in legal concepts. • in common law systems, contracts require consideration to be enforceable. however, consideration is not a concept recognised by civil law countries.18 • common law and civil law systems have different rules that state when an acceptance to an offer is effective.19 under the civil law receipt theory, if a party posts his or her acceptance to an offer but the acceptance is lost or delayed in transmission, the risk of the loss or delay falls on the person accepting the offer. that is, acceptance does not become effective until it is received by the offeror. under the common law, however, acceptance is effective on its dispatch.20 • civil law systems are sympathetic to the issue of specific performance, whereas common law courts place strict restrictions on the circumstances in which it will be allowed.21 • socialist systems generally require a contract to be in writing whereas western systems do not.22 • western legal systems allow a contract to come into being if the price or the way of fixing the price are absent from the contract. however, socialist legal systems do not allow a contract to come into being in this situation.23 the business person who is familiar with the law that governs international trade and international contracts has a clear commercial advantage over the business person who is not familiar with the law. accordingly, each state representative at the conferences that debated and developed the cisg had an economic interest in promoting a harmonised law that most 17 eörsi, above n 14, 346-352 (for a discussion on the conflict between developed and developing countries see eörsi, above n 14, 349-352); sara zwart, ‘the new international law of sales: a marriage between socialist, third world, common, and civil law principles’ (1988) 13 north carolina journal of international law and commercial regulation 109-128, also published at <http://cisgw3.law.pace.edu/cisg/biblio/zwart.html>. 18 the cisg adopts the civil law approach and makes no mention of the doctrine of consideration. 19 the cisg generally adopts the civil law approach although not exclusively. the cisg compromise is discussed further in part two. 20 eorsi, above n 14, 311. 21 the cisg compromise is discussed further in part two. 22 the cisg compromise is discussed further in part two. 23 eorsi, above n 14, 341-342. nordic journal of commercial law, issue 2003 #1 6 reflected their domestic legal system. underlying this selfish motivation is the natural tendency “to assume that what is familiar is probably better than what is new and strange”.24 the examples listed above demonstrate the fundamental differences in legal technique between the different states. the existence of these differences, coupled with the interest of each state to promote its own legal techniques and their ‘know-how’ advantages, meant reaching a consensus was extremely difficult. the drafting of the cisg involved reaching compromises on important legal concepts rather than the ‘best’ legal concepts. arthur rosett describes the process of reaching consensus as follows. ‘the delegates of sixty-two participating nations did not reach consensus by a magical process. the majority, representing nations that follow the civil-law tradition, did not suddenly realize the virtues of the common-law approach to contract and commercial transactions. nor did the representatives of states with planned socialist economies suddenly recognise the virtues of free enterprise and the private allocation of risks by contract. and the many representatives of poorer and underdeveloped nations did not come to a new appreciation of the plight of the wealthy creditors of the world. after thirty years of hard technical negotiation by experts, worldwide agreement was by diplomatic compromise.’25 returning for a moment to the perplexing question of barking dogs or mewling cats, eörsi also offers a compromise in the spirit of harmonisation. ‘the delegate from balcony: …but with your permission sir, i have a tentative proposal which i put forward in the spirit of compromise. we could say “an animal shall make a noise.” this would cover both proposals and would also satisfy our business circles. thank you mr. chairman. the delegate from transcendentia: this proposal, mr chairman, has a certain appeal to my delegation. may i remark, however, that not all kinds of animals are capable of making a noise. i have particularly fish in mind, sir. the delegate from balcony: well sir, this depends on how the words “shall make a noise” are construed.’26 2.4 methodology of compromise professor john honnold served as chief of the united nations international trade law branch and secretary of uncitral during the drafting of the cisg. professor honnold argues that the methods employed by the authors of the cisg to overcome the conceptual barriers of their own legal background to reach a common and acceptable solution made reaching a consensus decision easier.27 24 eorsi, above n 14, 311. 25 arthur rosett, ‘critical reflections on the united nations convention on contracts for the international sale of goods’ (1984) 45 ohio state law journal 265-305 <http://www.cisg.law.pace.edu/cisg/biblio/rossett.html>. 26 eorsi, above n 15, 659. 27 amy kastely, ‘the right to require performance in international sales: towards an international interpretation of the vienna convention’ (1988) 63 washington law review 607, also published at <http://www.cisg.law.pace.edu/cisg/biblio/kastely1.html>. nordic journal of commercial law, issue 2003 #1 7 rather than commencing with proposed legislative drafts, professor honnold explains that the delegates used the common-law case method whereby delegates focused on hypothetical situations and sought consensus on the desired outcome. the delegates focused on results and not legislative words. professor honnold argues that this method was more conducive to compromise and overcame some of the constraints on treaty making as a mechanism for legal harmonisation. ‘what came next was, for me, even more significant: the relative ease with which delegates, from different backgrounds, reached agreement on results. some will say this shows that there is a universal natural law – others, that there are basic principles of commercial and legal efficiency, just as survival in the sea (beyond the reef) … molded the dolphin and the shark into almost identical lines although they entered the sea from wildly different backgrounds. to return to dry land: after agreement was reached on what results should flow from a series of factual cases, it was not too difficult to agree on words to express the result.’28 article 67 of the cisg is an example of this ‘results-orientated’ process. article 67 provides: ‘(1) … the risk passes to the buyer when the goods are handed over to the first carrier for transmission to the buyer in accordance with the contract of sale. … (2) nevertheless, the risk does not pass to the buyer until the goods are clearly identified to the contract, whether by markings on the goods, by shipping documents, by notices given to the buyer or otherwise.’ the purpose of article 67 is to describe when risk passes to the buyer. in doing so the drafters have used words to describe a specific event typical of international transactions, being the handing over of goods from the seller to a carrier for transmission to the buyer. having agreed on the desired outcome, words to describe that result were not difficult to find. article 67 is also important because of the language that it does not use. the issue in article 67 is the point in time when risk passes. in common law systems, this issue would normally be coupled with concepts such as ‘delivery’, ‘property’ and ‘title’ to explain the law. these words and concepts have deliberately been excluded from article 67 because they are words and concepts sourced from one legal system and have specific legal nuances associated with them.29 however, the drafters could not avoid using language sourced from one legal system completely. some language and concepts found in the cisg are familiar to domestic legal concepts of some states. part two below will discuss the issues that arise from this practice and the consequences for the harmonisation process. 28 professor honnold quoted in kastely, above n 26, 608. eörsi also speaks of the tradition that developed in uncitral of a ‘readiness for compromise’, in eorsi, above n 15, 323. 29 felemegas, above n 7. nordic journal of commercial law, issue 2003 #1 8 3. cisg & the uneasy compromise 3.1 a compromise on harmony as demonstrated with the compromise proposed by the delegate from balcony in eörsi’s play, the politically expedient compromise is not without its own problems. the same is certainly true with the cisg and the concessions made to appease the competing demands of the state representatives. that is to say, the formation and adoption of a multinational treaty such as the cisg is a political process and by necessity this process requires compromise. these compromises however often create additional complications, as argued by arthur rosett. ‘the difficulty with many of these apparent compromises is that they simply do not resolve the problem they purport to address. they do not reflect two parties having yielded part of their positions to each other for the sake of agreement, but rather two sides agreeing to give the appearance by verbal formula which does not provide meaningful guidance in concrete situations.’30 part ii of this paper will discuss some examples of the ‘uneasy compromises’ found within the text of the cisg that are symptomatic of the multinational treaty negotiation process. these compromises take on further significance in the context of the purpose of the cisg, being the promotion of international trade through the creation of uniform law. this purpose is emphasised in article 731 of the cisg, which dictates that regard must be had to the need to promote uniformity in the application of the cisg.32 uniform application is fundamental for the successful harmonisation of laws by international treaty. accordingly, to the extent that compromises within the text of the cisg derogate from its uniform application, they also detract from the success of the cisg as an exercise in harmonisation. 3.2 scope of the cisg the first question asked by both business and legal practitioners when considering the cisg is when does it apply? accordingly, a clear definition of the jurisdictional scope of the cisg is crucial to both its understanding and success. however, the ambiguity of the jurisdictional scope of the cisg has received much criticism.33 30 rosett, above n 24, 282. 31 article 7 is discussed in greater detail in part iii of this paper. 32 susanne cook suggests that the cisg ‘uses urgent language when it refers to uniformity. there is a “need” for uniformity which is thereby elevated to a critical, obligatory consideration – one that every court dealing with the provisions of the convention has to entertain and which, in the convention’s spirit, cannot be discounted.’: susanne cook, ‘the need for uniform interpretation of the 1980 united nations convention on contracts for the international sale of goods’ (1988) 50 the university of pittsburgh law review 197, 212, also published at <http://cisgw3.law.pace.edu/cisg/biblio/1cook.html>. 33 see rosett, above n 24.; arthur rosett, ‘unification, harmonization, restatement, codification, and reform in international commercial law’, (1992) 40 the american journal of comparative law 683; trevor cox, ‘chaos versus uniformity: the divergent views of software in the international community’, (2000) 4 the vindobona journal of international commercial law and arbitration 3, also published at <http://www.cisg.law.pace.edu/cisg/biblio/cox.html>; frank diedrich, ‘maintaining uniformity in international uniform law via autonomous interpretation: software contracts and the cisg’ (1996) 8 pace international law review 303, also published at <http://www.cisg.law.pace.edu/cisg/biblio/diedrich.html>; camilla baach andersen, ‘uniformity in the cisg in the first decade of its application’ <http://www.ccls.edu/eclu/events/schmitthoff/symposium_draft_1-3.html>; hannu honka, ‘harmonization of contract law through international trade: a nordic perspective’(1996) 11 the tulane european and civil law forum 111; james bailey, ‘facing the truth: seeing the convention on contracts for the international sale of goods as an obstacle to a uniform law of international sales’ (1999) 32 cornell international law journal 273. nordic journal of commercial law, issue 2003 #1 9 as early as the 1960s uncitral recognised the failure of the ulis to adequately define its jurisdiction and the imperative that this issue be rectified in the cisg. many options were considered, however the solution in article 1 of the cisg is said to be even ‘inferior to the imperfect solution of ulis’.34 article 1(1) of the cisg states that: ‘this convention applies to contracts of sale of goods between parties whose places of business are in different states: (a) when the states are contracting states; or (b) when the rules of private international law lead to the application of the law of a contracting state.’ the first observation to be made of article 1 is the omission of the word ‘international’. significantly, this word is only found in the title of the cisg but is otherwise absent from the text of the treaty. rather than determining the application of the cisg by the movement of goods across state borders, the authors of the cisg chose to apply the criterion of ‘place of business’. the drafters of the cisg were unable to agree on an adequate definition of an ‘international transaction’.35 arthur rosett argues this was due to the fact that international trade is increasingly integrated and does not in practice exist as a distinct category of trade. the fear preventing the drafters from adopting the concept of international transaction to define the scope of the cisg was the concern that the jurisdictional net of the cisg would be spread wider than intended.36 a compromise was reached and the scope of the cisg was defined instead by reference to the parties’ ‘place of business’. but this concept also has problems that may give rise to uncertainty and dissonance. for example, article 10 outlines how a party’s place of business is to be determined. james bailey argues that, as a result of the rules in article 10, ‘the cisg can apply to transactions which are ostensibly domestic sales.’37 a further problem with the scope of the cisg is the definition of ‘goods’. the cisg does not define goods. the uniform application of the cisg is therefore subject to courts and tribunals around the world applying a consistent definition of goods.38 this challenge is best illustrated with the example of software.39 legal systems around the world treat software differently.40 34 rosett, above n 24, 274. 35 ibid, 274-277. rosett demonstrates the difficult of defining an international transaction with the following example. ‘clearly, if parties enter into a contract that calls upon the seller to ship and deliver goods to the buyer’s nation before payment is due, the contract is international. however, such transaction are not very common. more frequently, the parties will make a c.i.f. contract that contemplates the packing, shipment, and insurance of goods from one country to another. this is an international contract, even though the definition of a c.i.f. contract provides that title passes and risk of loss shifts from the seller to the buyer before the goods leave the seller’s country.’ 36 ibid. 37 bailey, above n 32, 301. bailey offers the following example, ‘if a paris-based branch office of a new york corporation buys a product from a party located in indiana for delivery to a montana address, that transaction may well be governed by the cisg because the parties to the transaction are located in separate cisg nations. deciding whether the cisg applies in that situation will hinge on a court’s application of article 10. conversely, a court could decide that the cisg does not apply if the paris office ordered delivery to its new york headquarters. in that instance the court could conclude that new york is the location of the buyer because the new york office has the closest relationship “to the contract and its performance.”’ 38 ibid, 303. 39 see cox, above n 32, 3; diedrich, above n 32, 303. nordic journal of commercial law, issue 2003 #1 10 some, such as the united kingdom,41 treat software not as a good but as a supply of a service. others, such as germany, treat software as a good. if countries categorise software differently, there is a danger that an international contract for the sale of software will be treated by some courts as governed by the cisg and others as outside the scope of the cisg. accepting the statement that a ‘clear, unambiguous, and simple definition of the convention’s jurisdictional scope is critical to the success of the whole enterprise’,42 the ambiguities discussed above do not bode well for a uniform application of the cisg. 3.3 specific performance as discussed above, civil law legal systems emphasise the non-breaching party’s right to compel performance of the breaching party’s obligations under contract. common law systems however prefer to award damages to the non-breaching party as opposed to compelling performance by the breaching party.43 the drafters of the cisg were unable to find a compromise solution to this specific performance conflict that promotes uniformtiy. instead, the compromise that found itself in the text of the cisg is described as an overt recognition of the failure to overcome obstacles to the unification of law.44 articles 46 and 62 are concessions to the civil law preference for specific performance. article 46(1) states that: ‘the buyer may require performance by the seller of his obligations unless the buyer has resorted to a remedy which is inconsistent with this requirement.’ conversely, this time setting out the seller’s rights, article 62 states that: ‘the seller may require to pay the price, take delivery or perform his other obligations, unless the seller has resorted to a remedy which is inconsistent with this requirement.’ article 28 however, described as the ‘enclave built into the realm of unified law’,45 states that: ‘if, in accordance with the provisions of this convention, one party is entitled to require performance of any obligation of the other party, a court is not bound to enter a judgement for specific performance unless the court would do so under its own law in respect of similar contracts of sale not governed by this convention.’ articles 42 and 62 state that specific performance is available under the cisg as a remedy. article 28 contradicts this position and declares that states that do not recognise specific performance do not have to award it. the compromise on specific performance impairs the unification of law because ‘bluntly speaking, everybody may apply his own law.’46 40 the issue would appear to also depend on the form of the software with courts making the distinction between software on a disk and software that is delivered electronically. 41 note, the united kingdom is not a signatory to the cisg. whilst the countries that are signatories to the cisg account for over two thirds of world trade the absence of the united kingdom and other important trading nations is a continuing challenge to the harmonisation of international sale of goods law. 42 rosett, above n 24, 273. 43 kastely, above n 26, 609–611. 44 eorsi, above n 14, 346. 45 ibid. 46 ibid, 354. nordic journal of commercial law, issue 2003 #1 11 3.4 good faith one of the most fiercely contested issues during the drafting of the cisg concerned the role of good faith.47 article 7(1) of the cisg states: ‘in the interpretation of this convention, regard is to be had to its international character and to the need to promote uniformity in its application and the observance of good faith in international trade.’ this incarnation of good faith in article 7 has been described variously as a ‘hard won compromise’,48 a ‘statesman like compromise’,49 a ‘strange compromise’50 and an ‘inconvenient compromise’.51 ‘statesman like’ and ‘hard won’ because the divide between common law and civil law delegates on the issue was so great, and ‘strange’ and ‘inconvenient’ because of the uncertainty of the final result. while the approach to good faith in common law countries is not homogenous, there was a consensus amongst common law countries in their opposition to any reference to good faith being included in the cisg. civil law countries, on the other hand, argued for the inclusion in the cisg of a principle of good faith directed at governing the conduct of contractual parties. failing this, it was suggested by the civil law countries that good faith should apply to the interpretation of the contract. with neither faction willing to surrender its position absolutely, a compromise was reached and good faith was ‘shifted to the provisions on interpretation of the convention, thus… giving it an honorable burial.’52 if the wealth of commentary on the meaning and effect of good faith in article 7 is any guide, the uncertainty surrounding this statesman like compromise is set to continue. 3.5 revocation the process of forming a legally binding agreement differs greatly amongst legal systems. one source of difference concerns the stage in a transaction in which the parties are free to withdraw. at one extreme is the view that parties are free to terminate negotiations up to the point when the contract is concluded. at the opposite end of the spectrum is the view that after entering negotiations it would be an act of bad faith to revoke an offer until the other side has had a chance to respond.53 article 16 of the cisg seeks to settle this issue by detailing when an offer can be revoked. article 16 states: 47 the author also discusses this issue in troy keily, ‘good faith & the vienna convention on contracts for the international sale of goods’ (1999) 3 the vindobona journal of international commercial law and arbitration 15-40, also available at <http://cisgw3.law.pace.edu/cisg/biblio/keily.html>. 48 n povrzenic, ‘interpretation and gap-filling under the united nations convention on contracts for the international sale of goods’ <http://www.cisg.law.pace.edu/cisg/biblio/povrzenic.html>. 49 e. a. farnsworth, ‘the eason-weinmann colloquium on international and comparative law: duties of good faith and fair dealing under the unidroit principles, relevant international conventions, and national laws’ 3 tulane journal of international and comparative law 47, 55. 50 eorsi, above n 14, 349. 51 a kritzer, international contract manual: guides to practical applications, kluwer, 70. 52 gyula eörsi in kritzer, above n 50. 53 rosett, above n 24. nordic journal of commercial law, issue 2003 #1 12 ‘(1) until a contract is concluded an offer may be revoked if the revocation reaches the offeree before he has dispatched an acceptance. (2) however, an offer cannot be revoked: (a) if it indicates, whether by stating a fixed time for acceptance or otherwise, that it is irrevocable; or (b) if it was reasonable for the offeree to rely on the offer as being irrevocable and the offeree has acted in reliance on the offer.’ the choice of language used in article 16 is interesting because it shows a compromise to appease both the civil law and common law positions by stating the same rule but in language sourced and familiar to each system. as eörsi explains, article 16(2)(a) uses language familiar to civil lawyers and article 16(2)(b) uses language familiar to common law lawyers, ‘[b]ut they both say the same thing’.54 thus the compromise is ‘illusory’.55 3.6 reservations it is technically incorrect to speak of a single cisg text,56 as the cisg allows states to make specified reservations to its text. this mechanism was included to make the cisg more attractive to a wider range of states. the consequence, however, is that states can tinker with the text and create their own version of the cisg a concept that does not sit will with the objective of uniformity. article 98 allows states wishing to become parties to the cisg to make reservations authorised by the cisg. the cisg authorises the following reservations: 57 • article 92 authorises the exclusion of part ii (concerning formation of the contract) and part iii (concerning obligations of the buyer and seller and remedies for breach). for example, the scandinavian states have declared that they will not be bound by part ii of the cisg. • article 93 permits a state in which two or more territorial units apply different systems of law to declare that the cisg does not extend to all of its territorial units. australia, for example, has declared that the cisg does not apply to the territories of christmas island, the cocos (keeling) islands and the ashmore and cartier islands. • article 94 allows a state that has an existing agreement regarding matters governed by the cisg to declare that the cisg does not apply to parties that have their place of business in that state. the scandinavian states have again exercised their right under article 94 to exclude inter-scandinavian trade from the cisg as a treaty already exists between these countries. 54 eorsi, above n 14, 355-356. 55 ibid. 56 also note, there are six official language texts of the cisg, being arabic, chinese, english, french, russian and spanish. this poses a further challenge to uniformity because of the difficulty task of translating in each language texts that corresponds with each other. this task is made more difficult because words used in one language will often be connected with implications that are not easily transcribed with a translation. for a discussion on this issue see felemegas, above n 7. 57 see <http://www.cisg.law.pace.edu/cisg/countries/cntries.html>. nordic journal of commercial law, issue 2003 #1 13 • article 95 states that article 1(1)(b), dealing with conflict rules when determining the jurisdiction of the cisg, may be excluded. china, singapore and the united states of america have each declared that they would not be bound by article 1(1)(b). • article 96 allows a state whose law requires contracts to be in or evidenced by writing to exclude any provision of article 11, article 29 or part ii (which provides that a contract need not be in writing under the cisg). countries including argentina, chile, russia and china have made declarations under article 96. the following example demonstrates the challenge to uniformity that arises from the inclusion in the cisg of the ability of states to make reservations. imagine a contract for the sale of goods between two parties whose places of business are respectively australia and china. does the cisg apply? both states are signatories to the cisg but what if the australian party has its place of business on christmas island? further, what is the consequence of the contract not being in writing? the cisg provides that a written contract is not required, but the chinese reservation under article 96 throws this issue into uncertain waters. the australia/china hypothetical explains how the cisg reservation procedure complicates the harmonisation process. without the reservations, parties to a transaction between australia and china need be aware of only one law, the cisg. however, as a result of the reservations, parties need be aware of three layers of law,58 being the standard cisg provisions, the reservations that australia and china have made to the cisg, and the law of china regarding the sufficiency of writing in contract formation. business supports the harmonisation of laws because harmony brings certainty. the australian business person is happy to sell goods to china because the uncertainty of submitting to a different legal system is ameliorated by the acceptance of the cisg by both countries. however, the reservations of both australia and china detract from this certainty and are detrimental to uniformity. 3.7 comment the successful harmonisation of law by international treaty requires compromise. as demonstrated by the examples in part two, these compromises at times do not best serve the purpose of uniformity. however, while these examples are a compromise on uniformity, they allow the drafting process to continue to completion, as explained in the following statement. ‘even compromises that are seemingly against unification in fact favor it by making it possible for the conference to continue its work to completion, figuratively saving the bulk of the cargo by throwing only a small part of it overboard.’59 58 bailey, above n 32, 312-313. 59 eorsi, above n 14, 346. nordic journal of commercial law, issue 2003 #1 14 4 maintaining uniformity 4.1 the battle front60 having agreed on a final text for the international sale of goods, the next challenge for harmonisation, and the ultimate success or failure of the cisg, is the uniform application of the cisg. part three of this paper will discuss the constraints countenanced in maintaining the uniformity of the text and the mechanism employed by the cisg to overcome these hurdles. before proceeding. it is necessary to comment on the concepts of ‘harmonisation’ and ‘unification’ as they relate to the cisg. 4.2 harmonisation and unification harmonisation and unification are related concepts. they differ in the degree to which each tolerates variation. to harmonise is to bring together and make similar; to unify, however, is to make the same. unification does not tolerate variation. unification of the law therefore requires the law of states to be made the same. harmonisation of law is also understood as a process. therefore, unification of law is an exercise in harmonisation where ‘unification’ is the standard or benchmark. article 7 of the cisg outlines the need to promote uniformity in the application of the cisg. importantly, the cisg does not speak of the need to promote harmony in its application. this distinction is important because, as the purpose of the cisg is the unification of international sale of goods law, there can be no variation in the way it is interpreted and applied by courts around the world. the cisg does not permit room for error. this point is also important because, by expressing the cisg’s purpose as the promotion of uniformity, the bar for determining its success or failure has been set higher. the absence of variation in the unification of law is subject to one caveat suggested by professor sundberg. the professor suggests that a margin of imperfection is permissible in the unification of law, but only to the extent that the variance does not encourage forum shopping.61 this proposition is best explained using the issue discussed above regarding software and the definition of ‘goods’ under the cisg. if a court in france determines that software is not a good, an international contract for the sale of software will not be governed by the cisg. however, if a court in canada decides that software is a good, the cisg will apply to the contract. adopting professor sundberg’s view, camilla andersen argues that: ‘… any legal counsel representing a party who has breached an agreement in some way would be well advised to encourage his client to hurriedly forum-shop to a venue where software is not considered goods, to avoid the provisions of the pro-contractual cisg for breach.’62 60 john felemegas argues that ‘[t]he area where the battle for international unification will be fought and won, or lost, is the interpretation of the cisg’s provisions. only if the cisg is interpreted in a consistent manner in all legal systems that have adopted it, will the effort put into its drafting be worth anything.’: see felemegas, above n 7. 61 professor sundberg quoted in baach, above n 32. 62 ibid. nordic journal of commercial law, issue 2003 #1 15 therefore, the variation between the way states define software would be an unacceptable variation because the different approaches would encourage forum shopping to avoid the application of the cisg. 4.3 article 7 article 7 of the cisg is ‘arguably the single most important provision in ensuring the future success’63 of the cisg. article 7 details the objectives of the cisg and how to give effect to these objectives. the battle for unification depends on the effectiveness of article 7.64 article 7 defines the protocol to be followed when interpreting the cisg. it directs those interpreting the cisg to take the following steps. first, regard must be had to the cisg’s ‘international character and the need to promote uniformity in its application and the observance of good faith in international trade’. second, questions not expressly settled by the cisg are to be determined ‘in conformity with the general principles on which it is based’. third, in the absence of those general principles, questions are to be settled ‘in conformity with the law applicable by virtue of the rules of private international law.’ steps two and three establish the mechanism to fill gaps in the cisg. this paper will focus on step one. 4.4 international character & uniformity lawyers must not read the cisg as they would a piece of legislation in their home state. to have regard to the international character of the cisg requires all lawyers to put aside the interpretative baggage with which they are familiar. the cisg calls for a new interpretative method that stems from the requirement in article 7 of the cisg to have regard to its international character and the need to promote uniformity. to have regard to the international character of the cisg involves recognition that it is a multinational treaty that has been incorporated into the domestic law of different legal systems. practically speaking, the requirement to have regard to the international character of the cisg is a call for vigilance against two traps the use of domestic techniques of legislative interpretation and reliance on the ‘homeward trend’ when interpreting the meaning of the cisg. each of these traps for harmonisation will be discussed below. 4.5 international interpretation when interpreting the cisg. it is important to avoid the techniques of legislative interpretation that would otherwise apply to domestic legislation. the cisg is not a normal piece of domestic legislation but is an international treaty. the cisg ‘should be seen as part of international law in the broad sense and should be entitled to an international, rather than national, interpretation.’65 therefore, as opposed to the common law tendency to interpret 63 phanesh koneru, ‘the international interpretation of the un convention on contracts for the international sale of goods: an approach based on general principles’ (1997) 6 minnesota journal of global trade 105, also available at http://cisgw3.law.pace.edu/cisg/biblio/koneru.html>. 64 the full text of article 7 states: ‘(1) in the interpretation of this convention, regard is to be had to its international character and to the need to promote uniformity in its application and the observance of good faith in international trade. (2) questions concerning matters governed by this convention which are not expressly settled in it are to be settled in conformity with the general principles on which it is based or, in the absence of such principles, in conformity with the law applicable by virtue of the rules of private international law.’ 65 felemegas, above n 7. nordic journal of commercial law, issue 2003 #1 16 domestic legislation narrowly, for example, the cisg should be given a broad interpretation. professor bonell explains the appropriate interpretative technique as follows. ‘instead of sticking to its literal and grammatical meaning, courts are expected to take a much more liberal and flexible attitude and to look, wherever appropriate, to the underlying purposes and policies of individual provisions as well as of the convention as a whole.’66 this international interpretation approach involves a rejection of the view that, in domestic proceedings, treaties ‘transform themselves into domestic law and therefore their interpretation and integration must take place according to the interpretative techniques … of the domestic systems in which they are transplanted and will be applied’. this view cannot be reconciled with the requirement in article 7 to pay regard to the international character of the cisg and the need to promote uniformity. 4.6 homeward trend when searching for the meaning of terms used in the cisg, the international character of the cisg demands that care be taken to avoid the ‘homeward trend’ of interpreting terms in the cisg in accordance with domestic understandings. the cisg directs that answers be found within the four corners of the cisg. the homeward trend is the ethnocentric propensity to interpret an international convention such as the cisg in accordance with domestic principles and concepts. that is, the ‘temptation for judges and the parties settling disputes … to look at what is familiar especially as it appears to be so at first glance.’67 parts of the cisg are familiar to concepts used in legal systems around the world. however, it is an error to refer to these domestic concepts when interpreting the cisg. to promote uniformity and give effect to the cisg’s international character, the cisg must be interpreted as an autonomous legal instrument. this approach was exemplified in the recent decision of the united states district court in zapata hermanos sucesores v. hearthside baking co.68 this case involved a contract for the sale of goods under the cisg. the court held that the award of damages to the seller for a breach of contract included counsel’s fees as foreseeable consequential damages under article 74 of the cisg. 69 importantly, in reaching its decision, the court rejected the buyer’s argument that in an american court the ‘american rule’, that requires litigants in federal court actions to bear 66 ibid. 67 bruno zeller, ‘the un convention on contracts for the international sale of goods (cisg) – a leap forward towards unified international sales laws’ (2000) 12 pace international law review 79, 88, also published at <http://cisgw3.law.pace.edu/cisg/biblio/zeller3.html>. 68 u.s. district court, 28 august 2001, available at <cisgw3.law.pace.edu/case/010828.html> also see john felemegas, ‘the award of counsel’s fees under article 74 cisg, in zapata hermanos sucesores v. hearthside baking co. (2001) 6 the vindobona journal of international commercial law and arbitration 30-38, also available at <http://cisgw3.law.pace.edu/biblio/felemegas1.html>. after this paper was completed, the decision of the district court was reversed by the federal appellate court, see <http://cisgw3.law.pace.edu/cases/02119u1.html>. further, at the date of publication of this paper the decision of the federal appellate court was the subject of an application for leave to appeal to the supreme court of the united states of america, for further information see links at <http://cisg.law.pace.edu/cisg/text/e-text74.html>. 69 article 74 provides that ‘[d]amages for breach of contract by one party consist of a sum equal to the loss, including loss of profit, suffered by the other party as a consequence of the breach. such damages may not exceed the loss which the party in breach foresaw or ought to have foreseen at the time of the conclusion of the contract, in the light of the facts and matters of which he then knew or ought to have known, as a possible consequence of the breach of contract.’ nordic journal of commercial law, issue 2003 #1 17 their own legal expenses, applies. the court recognised the importance of the international character of the cisg and the need to promote uniformity70 and in so doing rejected the application of the american rule. the court did not succumb to the homeward trend to explain the meaning of article 74. the court in zapata noted that the principle of foreseeability is the limitation on damages under article 74. this principle was also recognised by a different united states court in delchi carrier s.p.a. v. roterex corp.71 however, in this case the court succumbed to the homeward trend to reach its conclusion. the court found that the ‘cisg requires that damages be limited by the familiar principle of foreseeability established in hadley v. baxendale’.72 hadley v. baxendale is a case familiar to all students of the common law system as authority on the principle of foreseeability. by construing foreseeability in article 74 of the cisg by reference to a, common law case and domestic concept the court failed to satisfy the mandate of article 7. by using a domestic concept to interpret the cisg the court did not pay regard to the international character of the cisg but succumbed to the homeward trend. one further important point to note is that the homeward trend would not pose a threat to the uniform application of the cisg if there was a supranational body to hear cases on the international sale of good. however, states were not willing to surrender their sovereignty to a cisg court. instead the task of determining disputes under the cisg has been given to the courts of all states. accordingly, all courts determining disputes under the cisg must be mindful of the important obligations imposed on them under article 7 of the cisg. 4.7 other resources courts have grappled with issues of uniformity and the international character of treaties other than the cisg. the house of lords discussed these problems in scruttons ltd v midland silicones ltd.73 scruttons case concerned whether of the word ‘carrier’ in the hague rules included a stevedore. in reaching a decision viscount simonds said: ‘it is not surprising that the questions in issue in this case should have arisen in other jurisdictions where the common law is administered and where the hague rules have been embodied in the municipal law. it is (to put it no higher) very desirable that the same conclusions should be reached in whatever jurisdiction the question arises. it would be deplorable if the nations should after protracted negotiations reach agreement as in the matter of the hague rules and that their several courts should then disagree as to the meaning of what they appeared to agree on’.74 the decision of viscount simonds is critical for its recognition of the importance of maintaining a uniform application of treaties. it is also interesting for the comment his honour makes on the use of foreign decisions when interpreting an international treaty. this issue is also relevant to the interpretation of the cisg. 70 the court stated that a ‘treaty, occupying international scope as it does and (as in this case) defining the relationships between nationals of different signatory countries, calls for uniformity of construction.’ u.s. district court, 28 august 2001. 71 71 f.3d 1024 (u.s. ct. app 2d. cir. 1995), <http://cisgw3.law.pace.edu/cases/951206u1.html>. see also zeller, above n 56, 88-90. 72 71 f.3d 1024 (u.s. ct. app 2d. cir. 1995). 73 1 all e.r. 74 1 all e.r. p.9 per viscount simonds. nordic journal of commercial law, issue 2003 #1 18 to give effect to the international character of the cisg and ensure uniformity in its application, it is not sufficient to simply rely on the text of the cisg. rather, ‘uniformity can only be attained if the interpreter in interpreting the provisions has regard to the practice of the other contracting states.’75 uniformity requires consideration of foreign case law. this requirement gives rise to two practical problems access to foreign cases and translation to a known language.76 commendable steps have however been undertaken to remedy these difficulties. for example, uncitral in 1988 developed a procedure with the cooperation of contracting states to gather and distribute information about court decisions. this information is now translated into the six official cisg languages and released as part of the uncitral secretariat clout system of standardised reporting through the united nations.77 as additional ‘antidotes’78 to the danger of divergent interpretations, the legislative history or travaus préparatoires of the cisg and academic writing should be used in interpreting the cisg. the use of legislative history is an interesting example because it again demonstrates the importance of a technique of interpretation that is international rather than domestic in focus. this is because common law countries have traditionally been reluctant to refer to legislative history as an aid to interpretation. civil law countries on the other hand commonly use this technique.79 conclusion the process of drafting a uniform sales law ran over many decades, involved intense debate, required numerous drafts, two failed treaties and, in the end, concessions from all parties before a treaty could be agreed upon. however, the harmonisation process was not complete with an agreement on the final text. the real challenge for harmonisation and the ultimate success or failure of the cisg is dependent on its uniform application. article 7 of the cisg recognises the innate problems with maintaining a uniform law. a treaty is not a domestic creature but is a product of the international diplomatic stage. treaties therefore should not be treated like domestic legislation and respect must be paid to their unique ‘international character’. if in the application of the cisg its international character is not respected and a uniform approach is not realised, the hard work and uneasy compromises of the diplomats in creating the cisg are futile and the promotion and development of international trade is placed in doubt. 75 ferrari, above n 8, 204. 76 felemegas, above n 7. 77 ibid. other resources include the unilex database maintained by the centre for comparative and foreign law studies in rome and the pace university website, which this author can highly recommend. 78 professor honold quoted in ferrari, above n 8, 206. 79 ferrari, above n 8, 207-208. nordic journal of commercial law, issue 2003 #1 19 bibliography andersen, camilla baach, ‘uniformity in the cisg in the first decade of its application’ <http://www.ccls.edu/eclu/events/schmitthoff/symposium_draft_1-3.html>. boodman, martin., ‘the myth of harmonization of laws’ (1991) 39 the american journal of comparative law 699. bailey, james, ‘facing the truth: seeing the convention on contracts for the 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goods: scope, interpretation and resources’ (1995) cornell review of the convention on contracts for the nordic journal of commercial law, issue 2003 #1 21 international sale of goods 147, also published at <http://cisg.law.pace.edu/cisg/biblio/kritzer.html>. mistelis, loukas a., ‘regulatory aspects: globalization, harmonization, legal transplants, and law reform – some fundamental observations’ (2000) 34 international lawyer 1055, also published at <http://www.cisg.law.pace.edu/cisg/biblio/mistelis.html>. murphy, maureen t., ‘united nations convention on contracts for the international sale of goods: creating uniformity in international sales law’ (1989) 12 fordham international law journal 727, also published at <http://www.cisg.law.pace.edu/cisg/biblio/murphy.html>. nottage, luke, ‘a realist’s view from new zealand – and a way forward?’ <http://www.law.kyushu-u.ac.jp/-luke/nzlj95.html>. povrzenic, n., ‘interpretation and gap-filling under the united nations convention on contracts for the international sale of goods’ <http://www.cisg.law.pace.edu/cisg/biblio/ povrzenic.html>. rosett, arthur, ‘critical reflections on the united nations convention on contracts for the international sale of goods’ (1984) 45 ohio state law journal 265, also published at <http://www.cisg.law.pace.edu/cisg/biblio/rossett.html>. rosett, arthur, ‘unidroit principles and harmonization of international commercial law: focus on chapter seven’ ,http://www.unidroit.org/english/publications/review/articles/19973.html>. rosett, arthur, ‘unification, harmonization, restatement, codification, and reform in international commercial law’, (1992) 40 the american journal of comparative law 683. ryan, lisa m., ‘the convention on contracts for the international sale of goods: divergent interpretations’ (1995) 4 tulane journal of international and comparative law 99. sim, disa, ‘the scope and application of good faith in the vienna convention on contracts for the international sale of goods’ <http://www.cisg.law.pace.edu/cisg/biblio/sim1.html>. tetley, willian, ‘mixed jurisdictions: common law vs civil law (codified and uncodified)’ <http://www.cisg.law.pace.edu/cisg/biblio/tetley.html>. twibell, t.s., ‘implementation of the united nations convention on contracts for the international sale of goods (cisg) under shari’a (islamic law): will article 78 of the cisg be enforced when the forum is an islamic state?’ (1997) 9 international legal perspectives 25, also published at <http://www.cisg.law.pace.edu/cisg/biblio/twibell.html>. zeller, bruno, ‘good faith – the scarlet pimpernel of the cisg’ <http://www.cisg.law.pace.edu/cisg/biblio/zeller2.html>. zeller, bruno, ‘the un convention on contracts for the international sale of goods (cisg) – a leap forward towards unified international sales laws’ (2000) 12 pace international law review 79, also published at <http://www.cisg.law.pace.edu/cisg/zeller3.html>. zwart, sara, ‘the new international law of sales: a marriage between socialist, third world, common, and civil law principles’ (1988) 13 north carolina journal of international law and commercial regulation 109, also published at <http://www.cisg.law.pace.edu/cisg/zwart.html>. 1. introduction 2. the diplomats 2.1 the cisg and the promotion of international trade 2.2 the long and winding road 2.3 clash and compromise 2.4 methodology of compromise 3. cisg & the uneasy compromise 3.1 a compromise on harmony 3.2 scope of the cisg 3.3 specific performance 3.4 good faith 3.5 revocation 3.6 reservations 3.7 comment 4 maintaining uniformity 4.1 the battle front 4.2 harmonisation and unification 4.3 article 7 4.4 international character & uniformity 4.5 international interpretation 4.6 homeward trend 4.7 other resources conclusion bibliography * petri keskitalo received his ll.m. degree from the university of lapland, rovaniemi, finland in 1993 and was trained on the bench at the district court of åland, mariehamn in 1994. he worked as senior secretary at the helsinki and vaasa courts of appeals before joining the faculty of law at the university of tromsoe, norway, where he took his doctor juris degree in 2000. keskitalo holds now the position of professor of law (under a qualification period). contracts + risks + management = contractual risk management? by petri keskitalo* nordic journal of commercial law issue 2006 #2 nordic journal of commercial law issue 2006 #2 1 proactive contracting and risk management have become an important part of the new vocabulary of commercial contract law books and courses for contracting professionals, for example in finland, during the past few years. more and more often one even stumbles over the term “ contractual risk management” in such material but very seldom does one find a definition of that term. i claim that the lack of definition(s) of this term in most of the current literature dealing with this subject is due to varying conceptualizations of the underlying interplay between contracts, risks and management. therefore, the goal of this paper is to discuss the different conceptualizations of that interplay. i will also present my prediction over the future development within the field of contractual risk management and my model for the governance of such future. however, before we set on our journey i would like to help the readers of this paper to place the discussion in this paper in the context of the different types of knowledge concerning the interplay between contracts, risks and management. this can be done through a visualization of the underlying multilayered structure of knowledge on this matter with the help of an illustration of the different layers of knowledge. such knowledge can namely be visualized as a pyramid, where the different layers support and guide one another. due to the practical nature of their work, many of the readers are most likely familiar with the pragmatic layers of knowledge of the interplay between contracts, risks and management. such pragmatic layers of knowledge focus on the practical knowledge, practices, tools and skills of contracting professionals. accordingly, such pragmatic layers focus on the questions of how and with what to manage the everyday interplay between contracts, risks and management. more experienced contracting professional have in addition developed knowledge on the limits and potential of this interplay and therefore understand how far the practices and tools for the management of this interplay can be driven. nevertheless, such pragmatic knowledge can be better understood, enhanced and developed with the help of a more theoretical and fundamental layer of knowledge that focus on the question of what the interplay between contracts, risks and management is really about and what alternative ways (models) we have for the governance of that interplay. an even more theoretical layer of knowledge explains the reasons why the interplay between contracts, risks and management is so important in the world of today; explains why this interplay is conceptualized in so many different ways by those who work within the field of contracts, risks and management; and last layers of knowledge of the interplay between contracts, risks and management: theory (know-why) operational models (know-what) tools (know-with-what) practice (know-how) potential (know-how-far) ? nordic journal of commercial law issue 2006 #2 2 but not the least, enables us to look for new ways of conceptualizing the interplay between contracts, risks and management. although knowledge of all these different layers will enhance our understanding of the true nature of the interplay between contracts, risks and management, people working with the pragmatic perspectives to such interplay do not need to master all layers of knowledge, e.g. the theoretical foundations of their work. they should however be familiar with the why and whatquestions in order to better understand the with-what and how-questions, and in order to fully realize the potential in the interplay. similarly, those who work with the theoretical layers of knowledge need to be familiar with the with-what and how-questions in order to be able to develop adequate theoretical explanations and models of this contracting phenomena. on the other hand, the theoretical knowledge might provide a shortcut to creative solutions for the governance of the interplay between contracts, risks and management since a theoretical approach to the issue intends to identify the underlying mechanisms of the interplay, below the casuistic surface of practices within the field of the of contracts, risks and management. as the illustration of the pyramid of knowledge on the interplay between contracts, risks and management suggests, this paper will mainly focus on the two elementary layers of knowledge, the theoretical knowledge based on the why and what questions. the more pragmatic layers of knowledge are the subject of majority of the existing contracting literature. the mutual understanding between these theoretical and pragmatic approaches is the basis for the understanding of the underlying potential in the interplay between contracts, risks and management. such a potential can namely be fully realized with the help of an adequately multilayered knowledge of the interplay. in this paper, i will show one possible direction for the development of such a mutual understanding, which hopefully will help the readers to develop their own understanding of the interplay between contracts, risks and management. nevertheless, there is yet another layer of knowledge that i have placed at the very top of the pyramid. this layer is quite essential for a successful application of the knowledge on the interplay between contracts, risks and management but it has less to do with pure knowledge or skills. without this layer, the knowledge on the interplay will lack the cutting edge that is needed in the successful implementation of such knowledge in the governance of the contracts, risks and management of an organization. however, i will let the content of this layer puzzle the mind of the reader and will not reveal it until the very end of this paper. 1 contracts and risks? the fact that contracts and risks are intertwined is hard to escape. the inescapable truth of decision making in today’s world is that it is all about risks and risk management. this perspective of the human decisionmaking has been a subject of a substantial amount of literature within the social sciences but has only to a small degree been reflected in the legal literature.1 this cultural difference is mainly due to differences in language, law and lawyers have not been familiar with the risk terminology and have often communicated the same type of reasoning through the concepts of prevention: prevention of accidents, conflicts, litigation 1 see keskitalo, petri, from assumptions to risk management, kauppakaari, helsinki 2000, chapter ii, for a discussion on the evolution of a risk oriented conception of the phenomena of changing circumstances within conract law. nordic journal of commercial law issue 2006 #2 3 etc. the essential point therefore is to realize that risk management as a particular type of reasoning is hardly totally new to law although lawyers are less familiar with the terminology and methodology that lies behind the risk management discipline. nevertheless, the relationship between contracts and risks can be approached from quite different directions. depending on the chosen approach to contracts and risks, the relationship between them will be viewed quite differently. if one chooses to approach contracts and the contracting activity of businesses and other organizations from the perspective of legal risks, contracts will most likely be viewed as sources of risks since contracts in such an approach are easily understood as primarily legal instruments. this perception of contracts as sources of risks is shared by the more analytic perspective of liability risks since contracts create contractual relationships loaded with rights and liabilities. on the other hand, if one chooses to approach contracts from the concept of contract risks, the focus shifts towards the details of contracts in order to deal with the risks that these contracts are embedded with. finally, if one approaches contracts from the perspective of business risks and sees the contracting activity as yet another branch of the organizations activities, contracts are no longer conceptualized merely as sources of risks but also as tools for the management of not only contract, liability of legal risks but also business risks. contracts can be tools for risk management and that applies to all types of contracts: businessto-business contract (b2b), business-to-government contracts (b2g), business-to-consumer contracts (b2c), consumer-to-consumer contracts (c2c), as well as government to government contract (g2g). however, this risk management aspect of contracting is most appealing to the first two groups of contracts due to the importance of contractual regulation of the relationships between the parties in these two types of contracts. it is almost needless to say that not all contracts are tools for risk management; only good contracts fulfil that role while bad contracts are in fact risks as such. the interplay between contracts and risks has in other words to do with the art and discipline of good contracting. but what is good contracting and what are good contracts? in order to answer these questions one should take a detour and discuss the role of contracts in different forms of business management. 2 contracts and management? what is then the relationship between contracts and management? what is management? due to the novelty of the concept of management in a contract law setting we need to clear out its various definitions, as well as the definitions of other related concepts such as control, compliance, administration and governance and their relationship to contracts. 2.1 contracts and control we start with the relationship between contracts and control. the concept of control has been on the foreground of contract legal vocabulary of nordic lawyers ever since the introduction of the new type of liability through the enactment of the “ new” sale of goods acts in finland, norway and sweden during the 1980’s and early 1990’s while keeping the liability rule of the art. 79 of the un covention on the international sale of goods (cisg) as their model. this new type of liability has later on been described as the so called “ control liability” in nordic legal literature. it is precisely the choice of the term “ control liability” that shows the problems that lawyers have in conceptualizing management. the so called “ control liability” has namely nordic journal of commercial law issue 2006 #2 4 only little to do with actual control, which normally is linked to the possibility of using power to sort things out. in fact, this new type of liability is more appropriately conceptualized as a particular type of risk management liability as i have argued in my book from assumptions to risk management.2 considering the fact that the wording of those provisions specifically points out liability even for certain types of impediments beyond control,3 it is in fact quite peculiar that the term “ control liability” was chosen to describe this new rule of liability and even more peculiar that the term has later on become the accepted vocabulary of lawyers throughout the northern nordic countries. the concept of control offers a very narrow approach to the conceptualization of the role of contracts in the management of organizations. 2.2 contracts and compliance another modern concept is that of compliance. compliance refers to the alignment of the organizations activities according to the legal regulation of such activities. compliance has become an increasingly important part of the management of organizations particularly in those countries where the legal order gives positive incentives for such proactive alignment. for example, according to the organizational sentencing guidelines of the u.s. sentencing commission, introduced in 1991 and last amended in november 2004, dramatically less severe fines for breaches against their legal duties are imposed against those u.s. organizations that have effective4 compliance programs.5 the definition of the concept of compliance resembles thereby the concept of due diligence, both concepts underlining the importance of diligent conduct of the persons responsible for organization’s activities. although the design and management of the compliance program of an organization has strong resemblance with the concept of management, the concept of compliance as such has little resemblance with the concept of management. but the concept of compliance does not only refer to compliance with legislation, it can also refer to compliance with contractual obligations i.e. contract compliance. contract compliance offers a slightly broader approach than the concept of control to the conceptualization of the interplay between contracts, risks and management but is far too narrow in order to realize the potential role of contracts in the management of organizations. 2 keskitalo, petri, from assumptions to risk management, kauppakaari, helsinki 2000, pp. 233-269. 3 this applies to impediments which themselves or their consequences – although being beyond control of the party in breach or his/hers subcontractors – could have been foreseen and/or to impediments which themselves or their consequences could have been avoided or overcome by the party in breach of by his/hers subontractors. 4 the effectiveness of the organizations compliance programs is determined by the seven points minimum criteria defined by the §8b2.1. of the organizational sentencing guidelines, that is available at http://www.ussc.gov/2004guid/8b2_1.htm. 5 these guidelines and information about the effect of efficient compliance programs are available at http://www.ussc.gov/orgguide.htm. for an introduction to the role and history of the sentencing committee and its guidelines as well as the practice concerning the impact of effective compliance programs see murphy, diane e., the federal sentencing guidelines for organizations: a decade of promoting compliance and ethics, iowa law review 2002, p. 697-719, available at http://www.ussc.gov/corp/murphy1.pdf. the last amendment of november 1, 2004 was due to the sarbanes-oxley act section 805 (a)(2)(5) as explained in the 2004 federal sentencing guideline manual, appendix c – 2004 supplement, available at http://www.ussc.gov/2004guid/appc-2004supp.pdf. http://www.ussc.gov/2004guid/8b2_1.htm. http://www.ussc.gov/orgguide.htm. http://www.ussc.gov/corp/murphy1.pdf. http://www.ussc.gov/2004guid/appc-2004supp.pdf. nordic journal of commercial law issue 2006 #2 5 2.3 contracts and administration another concept that is likely to receive attention in future contract law literature is that of administration. the reason for this is the increasing importance of effective administration/management of the portfolio of contracts that organizations have. contract administration is a very popular concept within the public sector contracting in united states. somewhat surprisingly this concept seems not to have had an established definition in the past. however, the majority of recent contracting literature seems to define contract administration as the processes dealing with the implementation of contracts after they have been created.6 although this conception of the role of contracts is broader than the compliance oriented approach, it is still a rather narrow conception of the potential and role of contracts in management of organizations. 2.4 contracts and management now we have finally come to the very central concept of management. this concept is naturally quite central due to the fundamental concept of business management. although this concept is often used as a synonym to business administration, it seems that the latter concept is seen less fashionable and is increasingly being used to address the work of lower level business executives, while the concept of business management is being used to address the work of top level business executives. regardless, the concept of business management has led to the rise of several more narrow concepts describing different areas of business management such as supplier relationship management (srm) and customer relationship management (crm). the concept of risk management is another such concept. although there is no consensus on a standard definition of the concept of risk management, which will be discussed in detail under chapter 3, there is a certain consensus that risk management refers to the processes that are directed towards the management of potential opportunities and the connected potential for adverse effects. the concept of project management is yet another related concept that refers to the processes to manage a particular project to meet its requirements. project management discipline is thereby a broader concept and can include for example risk management aspects of the project. within the world of contracting, the concept of management has gained a lot of attention through the concept of contract management which is closely related to the concept of contract administration and they have often been used synonymously. however, in the majority of recent contracting literature the concept of contract management refers to the processes of contract lifecycle management, rather than the management of implementation of contracts, which is the focus of contract administration. contract management offers an important perspective to the conceptualization of the role of contracts in the management of organizations, although it has challenges in fully realizing the potential role of contracts due to its focus on single contracts or transactions, rather than the entire contracting activity of the organization. the introduction of the broader enterprise contract management perspective, which will be discussed under chapter 4.3., will eventually help to develop the contract management perspective in a way that that will enable it to overcome this disadvantage. 6 similarly haapio, helena, tarjousja sopimussuunnittelu teollisuuden toimitusprojektien tukena, in haapio, helena, et.al., yritysten sopimusja vastuuketjut, tietosanoma, helsinki 2005, pp. 330-331. nordic journal of commercial law issue 2006 #2 6 2.5 contracts and governance the next but by far the least important perspective in the conceptualization of the relationship between contracts and management is the concept of governance. particularly the rapid rise of corporate governance to the forefront of the business vocabulary has brought this concept to the awareness of lawyers. corporate governance has gained a central role in the regulation of businesses throughout the world in the aftermath of a series of relatively recent business scandals in several countries.7 however, corporate governance as a discipline has existed already since the early 1990’s but was not given due attention to before the most recent corporate scandals. accordingly, corporate governance has recently been given a central role in the regulation of business even in most of the nordic countries. for example in finland the companies that are listed in the helsinki stock exchange are expected to comply with the helsinki stock exchange recommendation for corporate governance.8 the underlying definition of governance in this context lies quite close to the concepts of administration and management although the focus is shifted towards the overhanging governance of the corporation in order to assure the shareholders and the public of the compliance with certain standards of management in such corporations. we will discuss this perspective to governance under chapter 3.2. however there is another perspective to the concept of governance that can be illustrated through the concept of mechanisms of governance of business. unlike the previous concepts, this concept is first and foremost an academic concept that has been developed under the school of economics that is known as transactions costs economics.9 the role of contracts in business governance can be illustrated through a multilayered approach to the structure of commercial transactions, which is developed on the basis of the integration of the oliver e. williamson’s theory of mechanisms of governance and my own theory of contractual risk management as defined in my book from assumptions to risk management. in this multilayered approach the contract documents and the contract terms are just the surface of the transactions. under that surface lies the contract type, which stands for the chosen contractual risk management mechanism, which is chosen to operationalize the governance mechanisms that the business is relying on, which in its turn is chosen to fit the nature of the business. it is the governance mechanisms that form the key to the understanding of business governance and need to be discussed in detail. the following figure illustrates the basic features behind these alternative forms of governance mechanisms: 7 consider the recent scandals of enron, worldcom and tyco in u.s and parmalat in italy. 8 this comply or explain-recommendation for the publicly listed companies in finland is available in in english at http://www.hex.com/files/4yqxktefr/liite/cg_group_recommendation_engl__final1.pdf. 9 excellent introduction to this school of economics is found in ménard, claude & shirley, mary m. (eds.), handbook of new institutional economics, springer, dortrecht 2004. nature of business governance mechanism contract type contract terms anatomy of a business transactions: http://www.hex.com/files/4yqxktefr/liite/cg_group_recommendation_engl__final1.pdf. nordic journal of commercial law issue 2006 #2 7 in the early literature on such mechanisms of governance, it was claimed that there were two alternative mechanisms: market governance and hierarchy governance. the market governance was based on the use of transactions through contracting, while the hierarchy governance was based on the use of the organizational power within the firm. in other words, the firms either contracted with other firms or took care of the transactions within the firm, a matter which has later been crystallised as the question of make or buy.10 that dichotomy has been altered by the changes in the way that businesses operate, a development which that lead to the appearance and increasing popularity of a third type of governance mechanism: the hybrid governance that attempts to rely on the best features of the two original alternatives through the use of contractually created hierarchies. whereas these hybrids were originally seen as temporary governance mechanisms on the way of development from markets to hierarchies or vice versa, they are today seen as a very important alternative governance mechanism.11 it is particularly worth noting that the alternatives offer different means to the solution of the central economic problem for organizations: adaptation to market changes. whereas the hierarchy governance relies on the use of power within the organization of the firm itself, the market governance relies on the capability of the market to adapt to the new situation. the hybrid governance relies on the cooperative adaptation by both of the contract parties according to the contractual hierarchies that the firms have chosen for the particular transaction, which is the reason why i prefer to call this governance mechanism symbiosis governance since the firms are supposed to find a form of adaptation that is beneficial for both of the parties. those in charge of the firm’s contracting activity must know the differences between the alternative mechanisms of governance and must be able to use them in a meaningful way through the use of compatible contract instruments, standard 10 see rubin, paul h., managing business transactions, new york 1992. 11 whereas these hybrids were originally seen as temporary governance mechanisms on the way of development from markets to hierarchies or vice versa, they are today seen as a very important alternative governance mechanism. an excellent discussion of the role and key issues concerning such hybrids is found in ménard, claude, a new institutional approach to organization, in ménard, claude & shirley, mary m. (eds.), handbook of new institutional economics, springer, dortrecht 2004, pp. 281-318. contractual hierarchies firm a symbiosis governance organization contracts hierarchy governance market governance governance mechanisms: power market adaptation cooperative adaptation power governance subsidiary joint venture firm a sales office franchise market governance direct export sales sales agent symbiosis governance license agreement retailer g o v e r n a n c e m e c h a n i s m s transnational business : nordic journal of commercial law issue 2006 #2 8 contract terms and other contracting standards and tailored contract clauses. i will shortly discuss the link between governance mechanisms and contracts with the help of examples from the governance of transnational business transactions. market governance is based on sales contracts between two independent firms either through direct sales between the seller and the buyer, or through a reseller. market governance relies, as suggested by its name, on functional markets and does not necessarily aim towards a long-term business relationship between the firms. thereby it does not presuppose the creation of a particularly strong trust between the contract parties. use of the market governance-mechanism presupposes, however, that the contract parties are able to create a credible commitment with the help of their contract in order to enable the parties to make the necessary transaction specific investments. aided by market governance, the seller can enter foreign markets fast but does not have much ability to manage the development of its own market share, except through marketing either by herself or through imposing such obligations to the reseller with the help of the resale contract. the greatest advantage of the market governance from the seller’s point of view is the limited need for investments abroad. symbiosis governance is based on the already existing or through the contractual relationship evolving symbiotic business relationship.12 common contractual instruments for the symbiosis governance are agent, licensing, and franchise-contracts, and similar complicated contractual instruments, which rely on the reliance and trust that has been created or is evolving between the contract parties.13 with the help of the symbiosis governance the seller is able to manage the development of its foreign market shares better than with market governance since by binding the contracting party to a symbiotic contractual relationship the seller is able to use the interest and ability of his contracting party to develop the market through the know-how and investments of his contracting party. thereby the seller will be able to minimize the need for his own investment to develop the foreign market. on the other hand, the seller is submitting himself to the dependability of the true capabilities and interests of his contracting party to achieve such goals. this dependability may turn out to be problematic, when the transaction that was believed to be symbiotic turns out to have only limited value to the business of his contract party. the central problem for the seller in symbiotic contracting is the eventual opportunistic behaviour of the contract party, particularly the so called free-rider problem, where the contract party is trying to exploit the investments of the other parties in the business arrangement, while minimizing his own investments. the central practical problem for the seller is therefore the control of the quality of the contract party’s activity, for example the binding of royalties to clear sales targets in contracts with commercial agents. in licensing and franchising contracts this problem of the control of the quality concerns first and foremost the quality of the products or services that the contract party provides, in comparison with the general quality standards of the organization. problems with quality of the operations of the contract party will affect even the reputation of the seller business and in global market environments they may affect the sellers business even in markets that are not the responsibility 12 the term symbiosis governance is based on the term ” symbiotic arrangements” that schantze, erich, beyond contract and corporation: the law and economics of symbiotic arrangements, in riis, thomas & nielsen ruth (eds.), law and economics. methodology and application, djøf publishing, copenhagen 1998, pp. 113-130, uses to describe complex contractual mechanisms, which do not under the market and hierarchy governance mechanisms. 13 cf. nystén-haarala, soili, kaukoviisas ennakoiva oikeusajattelu ja jälkiviisas tuomioistuinjuridiikka; pohjonen, soile, sopimustoiminta, ajattelutavat ja muuttuva maailma; and taskinen, tommi, sopimisen arvontuotanto verkostoituvalle tuotekehityshankkeelle (2002) who all discuss such cooperation. all these articles which were published in pohjonen (ed.), ennakoiva sopiminen, wsoy lakitieto, helsinki 2002. nordic journal of commercial law issue 2006 #2 9 of the contract party. in franchise-contracts this problem is remedied through a highly detailed regulation of the business operations throughout the organization.14 another problem for the seller in symbiosis governance is the risk of the contract party’s opportunistic behaviour through the copying of the business concept. one instrument for the management of this risk is the joint venture contract, which relies on the use of both symbiosis and power governance. through a joint venture contracts one tries to commit both contract parties to the operation of the joint venture company in a way that makes it less attractive to start out a competitive business operation with the joint venture. hierarchy governance relies on the use of power within the organization. accordingly, it relies on instruments like joint venture contracts, the creation of fully owned subsidiaries or sales offices, either through acquisitions or start ups. even most of these instruments are relying on specific contractual mechanisms and solutions. the choice between these governance mechanisms, compatible contractual instruments and their fine-tuning are elementary challenges to businesses both in terms of outsourcing as well as in terms of expansion of the business. contracts are in other words elementary instruments in the operationalization of the strategic decisions of the firm in terms of desired business governance mechanisms. the concept of mechanisms of business governance offers an exiting potential for the development of our conceptualization of the interplay between contracts, risks and management since it links contracts to the core strategic decisions of businesses. thereby the concept of business governance opens new development opportunities for conceptualization of the role of contracts both in relation to risks as well as management. i will describe one such new conceptualization at the end of this paper. 2.6 contracts and integrated governance, risk and compliance management (grc) the most recent and most ambitious concept of management is the concept of integrated governance and risk and compliance management (grc). the appearance of this concept is not surprising considering the close relationship between the disciplines of corporate governance, risk management and compliance management, which necessitates some form of coordination between them in order to facilitate effective cooperation between them. not surprisingly, the eight annual global price waterhouse coopers corporate executive officer survey of 2005, focused on the conception of the integrated grc in business companies, shows that the most effective way to coordinate these three disciplines is an integration of them into one integrated and embedded framework.15 although the grc-concept is rather new, there are few competing models for the conceptualization of such an integrated approach. consider for example the pricewaterhousecoopers the governance, risk & compliance operating model™ and the committee of sponsoring organizations of the treadway commission’s, coso erm 14 see nystén-haarala, soili, ibid. 15 see pricewaterhousecoopers, 8th annual global ceo survey bold ambitions careful choices, available at http://www.pwc.com/extweb/insights.nsf/docid/48c44da89cb0cc4185256f7f0061c641, pp. 33-38. http://www.pwc.com/extweb/insights.nsf/docid/48c44da89cb0cc4185256f7f0061c641, nordic journal of commercial law issue 2006 #2 10 integrated framework,16 which will be shortly discussed under chapter 3.2. while the pricewaterhousecoopers’ the governance, risk & compliance operating model™ emphasis the role of ethics in such an integrated grc by addressing the importance of an “ integrity-driven performance strategy” , the coso erm integrated framework puts less emphasis on such issues. due to the complexity of such an integrated cooperation between governance, risk and compliance management, both of these models present a rather complex model for conceptualization of the grc. this applies particularly to the pricewaterhousecoopers the governance, risk & compliance operating model™ , which offers a highly complex model that sets rather high demands for the skills and motivation of the persons operating the model in organizations.17 although, the conception of the role of contracts within grc-discipline seems unclear for the time being, the grc-concept offers a great potential for the development of the role of contracts in management of organizations. one conceptualization of the role of contracts in such an integrated framework of contracts, governance and risk and compliance management will be presented under the chapter 5. 3 risk management (rm) as we already have touched upon the concept of risk management, it is time to explore it a bit further. risk management is an area of business management that has received increasing attention in the literature on business management over the past decade.18 the practical importance of risk management to businesses is even greater and it forms an essential part of the business operations of today.19 the viability of a discipline is displayed in its ability to develop itself further; this has been easy for the risk management-discipline. one such important development is the introduction of the first international standard on the terminology of the risk management discipline by the international organization for 16 the coso erm – integrated framework is presented in the executive summary of the framework, which available at http://www.coso.org/publications.htm, where the model itself can also be ordered. 17 a presentation of this model is found in pricewaterhousecoopers, integrity-driven performance: a new strategy for success through integrated governance, risk and compliance management: a white paper, 2004, available at http://www.pwc.com/extweb/service.nsf/docid/c8753369ed2d193e85256e1b001c03d6. 18 hamilton, gustaf risk management 2000, lund 1996, pp. 9-11 and berg, karl-erik, yrityksen riskinhallinta, jyväskylä 1994, pp. 18-20, identify the roots of risk management in the self-insurance related discussion in united states in the mid 1930’s, and hamilton suggests that the concept of risk management was first introduced in the mid 1950’s. the idea of risk management was imported into the nordic countries in the mid 1970’s, and the first textbook was published by hamilton in 1977 with the title risk management – vad är det? as an example of the increasing attention, consider the ever increasing number of textbooks on risk management. 19 there are numerous signals of the increasing appreciation of the importance of risk management. for instance, one should notice the increasing number of consultant services available for risk management. in finland, a remarkable project to promote risk management in small and medium-sized businesses has been organized and financed through the cooperation of the ministry of social affairs and health, the ministry of trade and industry, the european agency for safety and health at work, and several other organizations, businesses and universities. the project has developed a package of devices for the purposes of risk management. it consists of both information and know-how. information about the project is available on internet at http://www.pkrh.com/en/index.html, where the products of the project are available for free, both in english, finnish, german and swedish. the results of the originally finnish project have been adopted to the uk and german environments by the institution of occupational safety and health (iosh) respectively by institut für arbeitswissenschaft der technischen universität darmstadt (iad, tu darmstadt). http://www.coso.org/publications.htm, http://www.pwc.com/extweb/service.nsf/docid/c8753369ed2d193e85256e1b001c03d6. http://www.pknordic journal of commercial law issue 2006 #2 11 standardization (iso) and the international electrotechnical commission (iec).20 according to the iso/iec guide 73:2002 risk management – vocabulary, the term risk management refers to: “ and control an organization with regard to risk” , whereas the term risk refers to: “ combination of the probability of an event and its consequences” . this standardization eventually will help the risk management discipline to agree on the central terminology within this field. however, due to its focus on the risk management terminology, the actual content of risk management activies has not been addressed by this iso/iec standard and we need to look for answers elsewhere. due to the continuous development of the risk management discipline, we need to identify three perspectives to the phenomena in order to better understand it: the past, the future, and the present state of risk management. 3.1 rm past traditionally risk management has been described as a management activity consisting of five phases:21 target-setting for risk management, risk identification, risk evaluation, selecting methods for and estimating the costs of risk management, and developing a risk management system. the goal of risk management according to this traditional approach is to ensure that the chosen solutions will fulfil the tasks that are assigned to them strategically in a way that economizes on costs and minimizes risks.22 accordingly, risk management facilitates only a part of business management. the most important practical consequences of this limited scope of risk 20 see the iso/iec, guide 73:2002 risk management – vocabulary, international organization for standardization & international electrotechnical commission, geneve 2002. 21 see luotonen, eero, risk management and insurances, helsinki 1993, pp. 20-27. cf. samson, danny a., corporate risk philosophy for improved risk management, journal of business research 1987, p. 109, who divides the risk management process into five phases: risk identification, risk measurement and analysis, risk control and finance, evaluation, and accounting the costs of risks. this division adopts a broader approach to risk management that is more compatible with a business management approach, and it is also used by suominen, arto, riskienhallinan mahdollisuudet ja kehitysalueet, in kuusela, hannu & ollikainen, reijo, riskit ja riskienhallinta, tampere university press, vammala 1999, p. 135. even the division used by smith, robert j., allocation of risk – the case for manageability, international construction law review 1996, pp. 566-568, cf. robert j. smith, risk identification and allocation: saving money by improving contracts and contracting practices, international construction law review 1995, pp. 65-68, adopts an even broader business management perspective and operates in nine phases: (a) establish objectives, (b) commitment – schedule, budget, philosophy, staffing; (c) scoping/objectives conference; (d) risk identification, (e) risk allocation, (f) integration, (g) implementation/ orientation, and (h) evaluation. 22 cf. luotonen, eero, risk management and insurances, helsinki 1993, p. 18, who defines risk management as “ . . . a comprehensive view of the risk factors threatening the business operations and at the same time a systematic course of action, which aims at minimising the likelihood of risks materialising and the economic losses caused by the risk.” nordic journal of commercial law issue 2006 #2 12 management is that the specific objectives of risk management are based on the business strategies with which the organization operates.23 3.2 future rm: enterprise risk management? the traditional perspective to rm has been under a continuous transformation due to relatively strong winds of change. whereas the traditional rm has been promoted primarily by the insurance and financial sectors, and developed further by the project management discipline, the recent winds of change come from quite different directions. an important source of thrust to the change has been the rise of the corporate governance-discipline and its focus on the monitoring of the business management of the organization. another source for the winds of change has been the administrative implementation of corporate governance through compliance programs. this has been a particularly important factor in the u.s. where a lot of the recent legal discussion on corporate governance has been focused on the compliance with the reporting requirements of the sarbanes-oxley act (sox).24 the last but by far the least source of energy for the development of the rm discipline has been the rising interest towards strategic thinking in organizations.25 strategic thinking is increasingly being viewed as the most critical factor for the long-term success of organizations and has therefore managed to influence a wide range of business methods, including risk management. all these new ways of thinking have slowly but surely helped to transform the traditional insurance oriented risk management discipline towards a more holistic and versatile approach to risk management that is often addressed as enterprise risk management (erm). what is erm? despite the availability of several international risk management standards – like the australian/new zealand standard of as/nzs 4360,26 and the federation of european risk 23 for an introduction to the various aspects of business strategies from the perspective of procurement. see virolainen, veli-matti, motives, circumstances, and success factors in partnership sourcing, lappeenranta university of technology, lappeenranta 1998, pp. 16-31, who has surveyed the partnership transacting practices and strategies of the finnish telecommunication company nokia. 24 this force of change might not be enduring due to the increasingly critical theoretical and empirical studies on the effects of the sox. for an eloquent summary of such studies see ribstein, larry, sarbanes-oxley act after three years, illinois law and economics working paper series, working paper no. le05-016, draft june 20, 2005, available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=746884. 25 for an excellent practical presentation of the relevance of strategic thinking in organizations see freedman, mike & tregoe, benjamin b., the art and discipline of strategic leadership, mcgraw-hill, new york 2003. 26 the as/nzs 4360 standard was last reviewed in 2004 in order to to put greater emphasis the importance of embedding rm practices in the organization’s culture and process, as well as on the management of potential gains as well as losses. the standard can be ordered at http://www.riskinbusiness.com/. us soxa 2002 rm development trends: fin hex cg 2004corporate governance compliance coso erm 2004 traditional rh strategic thinking enterprise risk management fin mof framework 2005 http://papers.ssrn.com/sol3/papers.cfm?abstract_id=746884. http://www.riskinbusiness.com/. nordic journal of commercial law issue 2006 #2 13 management associations (ferma): a risk management standard27 until quite recently there was no established standard definitions of the erm. after the introduction of such definition by the committee of sponsoring organizations of the treadway commission (coso)28 in 2004, the development of erm-standards is likely to accelerate. in the meantime, the coso erm – integrated framework29 seems to be gaining growing popularity, as is shown in the findings of the second pricewaterhousecoopers’ benchmarking survey of erm in finland in 2006.30 the coso framework is even being adopted within the public sector, at least in finland, where the ministry of finance has used it as the platform for their framework for the internal revision and risk management of government agencies, institutions and funds.31 according to the coso erm – integrated framework: ” enterprise risk management is a process, effected by an entity’s board of directors, management and other personnel, applied in strategy setting and across the enterprise, designed to identify potential events that may affect the entity, and manage risk to be within its risk appetite, to provide reasonable assurance regarding the achievement of entity objectives.” one of the fundamental consequences of such an enterprise-wide focus is shift of the focus from negative risks to “ events” that specifically underlines also the opportunity side of the risks. what divides the erm-approach from the traditional rm-approach is the emphasis on the importance of four different objectives of risk management: the strategic, the operative, the reporting and the compliance. naturally the strategic objective has been acknowledged by the more traditional rm standards,32 but not to the extent that the erm27 this standard is available at http://www.ferma-asso.org/4-14.html. this standard has been translated to 14 languages. 28 coso is a voluntary private sector organization dedicated to improving the quality of financial reporting through business ethics, effective internal controls, and corporate governance. coso is sponsored by the american accounting association (aaa), the american institute of certified public accountants (aicpa), financial executives international (fei), the institute of internal auditors (iia), and the institute of management accountants (ima). for more information see http://coso.org. 29 the coso erm integrated framework and other related information is available at http://www.coso.org/publications.htm. 30 see pricewaterhousecoopers finland, enterprise risk management (erm) benchmarking survey 2006, available at http://www.pwcglobal.com/fi/fin/about/svcs/neuvonta/erm_study_2006.pdf. 31 information concerning this framework is available through the internet both in finnish http://www.vm.fi/vm/fi/03_tiedotteet_ja_puheet/01_tiedotteet/20051229suosit/name.jsp and in swedish http://www.vm.fi/vm/sv/03_pressmeddelanden_och_tal/01_pressmeddelanden/20051229intern/name.jsp. unfortunately, the framework itself is (at least for the time being) available only in finnish http://www.vm.fi/vm/fi/03_tiedotteet_ja_puheet/01_tiedotteet/20051229suosit/98830.pdf. 32 the text of the as/nzs 4360 standard, should be read together with handbook to the as/nzs 4360 standard.risk management guidelines. companion to as/nzs 4360:2004, standards australia international & standards new zealand, sydney – wellington 2004, where importance of the strategic perspective is pointed out more clearly. coso erm integrated framework © coso http://www.ferma-asso.org/4-14.html. http://coso.org. http://www.coso.org/publications.htm. http://www.pwcglobal.com/fi/fin/about/svcs/neuvonta/erm_study_2006.pdf. http://www.vm.fi/vm/fi/03_tiedotteet_ja_puheet/01_tiedotteet/20051229suosit/name.jsp http://www.vm.fi/vm/sv/03_pressmeddelanden_och_tal/01_pressmeddelanden/20051229intern/name.jsp. http://www.vm.fi/vm/fi/03_tiedotteet_ja_puheet/01_tiedotteet/20051229suosit/98830.pdf. nordic journal of commercial law issue 2006 #2 14 approach emphasizes them by underlining that an effective erm process must be applied within the context of strategy setting.33 so what is in the framework? the coso erm integrated framework offers a quite ambitious conception of the role and perspectives of the rm in the governance of businesses as is clearly feasible through the coso illustration of its framework that is featured in the figure. accordingly, the coso framework relies on a three-way analysis based on the three dimensions of the erm: the objectives (on top of the cube), organization (on side of the cube), and processes (on front of cube), the four categories of the objectives dimension (on top of the cube) have already been mentioned: strategic, operative, reporting, and compliance. when it comes to the organizational dimension (on the side of the cube), coso identifies four organizational levels: subsidiary, business unit, division and entity. accordingly, the framework offers a highly detailed focus on the different areas of the risk management in an organization. finally, when it comes to the erm processes dimension (on the front of cube), the coso erm integrated framework identifies eight interrelated components in erm processes: internal environment, event identification, risk assessment, risk response, control activities, information and communication, and monitoring. unfortunately, a detailed discussion on these dimensions and parts of the coso erm framework falls outside the scope of this paper. such a discussion is found in the coso enterprise risk management integrated framework – executive summary (2004).34 although some recent surveys are pointing to the direction of a development towards a wider acceptance of the erm as part of the best business practices, as will be discussed shortly, it remains to be seen if there will be a similarly wide acceptance for standardization of the erm e.g. through the coso erm intergrated framework. therefore, we should take a closer look at the current status of the risk management discipline. 3.3 present rm while the risk management discipline has departed its insurance focused past, the rm practice has not reached the future as described by e.g. the coso erm intergrated framework. what then is the present state of rm? what functions does rm have in organizations at the present? due to the diversity of organizational cultures, it is naturally impossible to describe the present state in detail. however, some idea of what is going on in organizations is available through the identification of eventual regulation of rm activities in organizations, through benchmarking studies, as well as through a look at the various rm services and products that are available at the rm market. i will focus on the first two alternatives. 3.3.1 regulation of rm activities the most extensive legally binding regulation of rm activities of private companies is found in the u.s. sarbanes-oxley act that imposes on companies a wide range of duties to report and inform its shareholders and the public of the status of the corporate governance within the 33 see coso’s answer to question 1 under the chapter b of the faqs for coso’s enterprise risk management – integrated framework at http://www.coso.org/publications/erm/erm_faq.htm. 34 the publication is available at http://www.coso.org/publications/erm/coso_erm_executivesummary.pdf. http://www.coso.org/publications/erm/erm_faq.htm. http://www.coso.org/publications/erm/coso_erm_executivesummary.pdf. nordic journal of commercial law issue 2006 #2 15 company. in comparison, there are only few european countries that have legally binding regulation of activities related to risk management, whereas legally non-binding regulations are found in the majority of european countries for the time being.35 nevertheless, the new eu directive on statutory audits of annual accounts and consolidated account (2006/43/ec)36 does indirectly imply that public-interest companies shall have risk management systems since according to article 41(2)(b) of the directive, audits committees of such companies shall: “ monitor the effectiveness of the company's internal control, internal audit where applicable, and risk management systems” interestingly, no equivalent eu regulation exists for the time being on the public-interest companies’ obligation to inform the public about such risk management systems. however, in its proposal for the amendement of directives concerning the annual accounts of certain types of companies and consolidated accounts (com 2004/0725), the eu commision37 proposes that listed eu companies shall include a corporate governance statement in their annual reports. eu commision proposes that such a statement shall, among other things, describe the company’s inernal control and risk management systems.38 it is worth noticing that neither of these eu documents make any references to the existing standards within the field of risk management. for the time being, in most of the european countries, the rm activities have been left to the markets to regulate to the extent that they find it appropriate and most of the european markets have adopted regulations that function on the principle of “ comply or explain” . in some european countries, particularly in the nordic countries, rm is addressed as part of the corporate governance “ codes” . for example in denmark, the chapter vii of the revised danish recommendation for corporate governance39 recommends that: “ vii. risk management effective risk management is a prerequisite allowing the supervisory board to perform its tasks in the best possible way. therefore, it is essential that the supervisory board arrange for appropriate 35 for an introduction to and overview of the present state of regulation of internal control and risk management in european countries, see the fédération des experts comptables européens (the european federation of accountants), risk management and internal control in the eu. discussion paper. marc 2005, available on-line at http://www.fee.be/publications/default.asp?library_ref=4&content_ref=351. 36 directive 2006/43/ec of the european parliament and of the council of 17 may 2006 on statutory audits of annual accounts and consolidated accounts, amending council directives 78/660/eec and 83/349/eec and repealing council directive 84/253/eec, available on-line at http://eurlex.europa.eu/notice.do?val=427746:cs&lang=en&list=429516:cs,427746:cs,&pos=2&page=1&nbl=2&pgs=10& hwords=2006/43/ec~. 37 proposal for a directive of the european parliament and of the council amending council directives 78/660/eec and 83/349/eec concerning the annual accounts of certain types of companies and consolidated accounts (com/2004/0725 final cod 2004/0250), available on-line at http://eurlex.europa.eu/lexuriserv/site/en/com/2004/com2004_0725en01.pdf. 38 in its opinion of the european economic and social committee on the proposal for a directive of the european parliament and of the council amending council directives 78/660/eec and 83/349/eec concerning the annual accounts of certain types of companies and consolidated accounts (com(2004) 725 final), available on-line at http://eurlex.europa.eu/lexuriserv/site/en/oj/2005/c_294/c_29420051125en00040006.pdf, the european economic and social committee finds the wording of the commisions proposal too wide and suggests the following wording for the article 46/a): “ a description of the main features of the company's internal control and risk management system in relation to the financial reporting process” . 39 the revised danish recommendation for corporate governance is available on-line in english at http://www.corporategovernance.dk/index.php?obj=&code=1. http://www.fee.be/publications/default.asp?library_ref=4&content_ref=351. http://www.corporategovernance.dk/index.php?obj=&code=1. nordic journal of commercial law issue 2006 #2 16 risk management systems to be established and generally ensure that such systems meet the requirements of the company at any time the purpose of risk management is to: • develop and maintain an understanding of the organisation of the company’s strategic and operational goals, including an identification of the critical success factors for achieving such goals. • analyse the possibilities and challenges related to the implementation of the above goals as well as the risk of these goals not being met. • analyse the most important activities launched by the company to identify the risks in this connection. • determine the venture spirit of the company. 1. identification of risks the committee recommends that the supervisory board and the executive board, when formulating the company’s strategy and overall goals, identify the greatest business risks involved in achieving such strategy and goals. 2. plan for risk management the committee recommends that the executive board prepare a plan for the company’s risk management on the basis of the risks identified and submit this plan to the supervisory board for approval, and that the executive board regularly report to the supervisory board to allow the latter to systematically follow the trends in significant risk areas. comment: such reporting may include procedures and action plans to eliminate, reduce, divide or accept these risks” . in comparison, according to the chapter 9.3 of the finnish corporate governance recommendations for listed companies40 concerning the organization of risk management: “ recommendation 50: the company shall describe the criteria according to which the risk management is organised. risk management is part of the control system of the company. the purpose of risk management is to ensure that the risks related to the business operations of the company are identified and monitored. effective risk management requires definition of the risk management guidelines. for the evaluation of the operation of the company it is important to provide shareholders with sufficient information on risk management. it is also recommended that the significant risks that have come to the knowledge of the board are described.” somewhat surprisingly, the stockholm stock exchange corporate governance code barely touches the matter of risk management by stating under the chapter 3.8.3 that “ the audit committee is 40 the finnish corporate governance code is available in english at http://www.hex.com/files/4yqxktefr/liite/cg_group_recommendation_engl__final1.pdf. http://www.hex.com/files/4yqxktefr/liite/cg_group_recommendation_engl__final1.pdf. nordic journal of commercial law issue 2006 #2 17 to… meet regularly with the company’s auditors to keep informed of the aims and scope of the audit work and to discuss… views on the company’s risks.” 41 similarly, the norwegian code of practice for corporate governance only indirectly addresses risk management activities as the only reference to such activities is found in relation to board committees under the commentary to the recommendation 9 on the work of the board of directors. remarkably, even here the norwegian code does not use the term risk management as it barely suggests that the duties of an audit committee typically include “ … monitoring the company’s internal control arrangements and its risk evaluation systems, as well as monitoring the internal audit function where this exists” .42 as can be seen, these quite varied corporate governance codes do not provide detailed regulation of the risk management activities of organizations and make no reference to existing standards of risk management. 3.3.2 rm benchmarking studies according to the findings of the recent european benchmarking study by the federation of european risk management associations (ferma), risk management: an assesment of european in 2004,43 only 19 % of the respondent companies identified the measure of ratio between risks and opportunity as the main objective of the company’s top risk management whereas 52 % focused on the avoidance of the negative side of risks. there are also strong signals of national rm cultures even within the europe as french companies were more focused on insurable and operational risks and majority of french companies had not separated risk and insurance management, compared with british and german companies. however, the knowledge of risk management standards and frameworks was surprisingly low as only 41 % of all companies were familiar with the ferma rm standard or other similar standards. the findings of four recent benchmarking studies of the status of enterprise risk management in denmark,44 finland45 and world-wide46 by pricewaterhousecoopers, show a more optimistic picture of the current status of the erm. accordingly, 38 % of ceos world-wide considered that their companies already had effective erm in place and 46 % of ceo’s believed that an erm would be in place within one to three years. in comparison, in a study of the years 2005 and 2006 in finland, 66 % of companies (up 11 % from the 2004 survey) considered that they had erm processes and/or functions in place and another 30 % were considering adoption in 41 the swedish stock exchange corporate governance code is available in english at http://www.omxgroup.com/stockholmsborsen/en/index.aspx?lank=114. 42 the norwegian code of practice for corporate governance, 8 december 2005, p. 33. the code is available online through http://www.nues.no/english/. 43 the ferma survey that was conducted in may to july 2004 is available at http://www.fermaasso.org/calendar%20of%20events/seminar%202004/survey/rm%20survey2004%20ferma%20ey%20axa %20-%205oct2004.pdf. 44 this study that was conducted in april and may 2005 among the 100 largest danish companies is available at http://www.pwc.com/extweb/pwcpublications.nsf/docid/603dc44afe80cac5802570190046e683. 45 there are two benchmarking studies conducted in finland: enterprise risk management benchmarking survey 2004, available in english at http://www.pwcglobal.com/fi/fin/issues/publ/pwc_erm.pdf. the study results are based on the answers of 23 of the 60 largest companies in finland, excluding financial institutions and insurance companies. a follow-up study conducted in 2005-2006 shows a further favorable development of erm in finland. see, enterprise risk management (erm) benchmarking survey 2006, available at http://www.pwcglobal.com/fi/fin/about/svcs/neuvonta/erm_study_2006.pdf. 46 7th annual global ceo survey. managing risk: an assessment of ceo preparedness, conducted in 2004 is available at http://www.pwc.com/extweb/insights.nsf/docid/d4700640c39f9d6780256e1a00417f29. http://www.omxgroup.com/stockholmsborsen/en/index.aspx?lank=114. http://www.nues.no/english/. http://www.fermahttp://www.pwc.com/extweb/pwcpublications.nsf/docid/603dc44afe80cac5802570190046e683. http://www.pwcglobal.com/fi/fin/issues/publ/pwc_erm.pdf. http://www.pwcglobal.com/fi/fin/about/svcs/neuvonta/erm_study_2006.pdf. http://www.pwc.com/extweb/insights.nsf/docid/d4700640c39f9d6780256e1a00417f29. nordic journal of commercial law issue 2006 #2 18 one to three years. the finnish 2005-2006 study further shows that over 80 % of the finnish companies considered erm to have become part of good business practices (up 15 % from the 2004 survey)), which is further underlined by the fact that over 55 % of the finnish companies in the 2004 study cited the company’s reputation as a benefit of the erm process. the most important finding of the finnish studies is, however, the significant impact that the adoption of erm has on the rm maturity47 of the firm, particularly in the areas of event identification, monitoring and internal rm environment.48 the national aspects of rm culture are feasible even in the nordic setting since whereas over 85 % of the finnish companies implied the corporate governance pressures to be an important motivation for the adoption of erm according to the finnish 2005-2006 study, only 33 % of danish companies agreed with them in the danish 2005 study. this difference can nevertheless partly be explained by the fact that the finnish studies focused on public listed companies whereas in the danish study such companies formed only a smaller part of the companies that were studied. the danish study also shows the increasing importance of the strategic aspects of rm to organizations: 71 % of the danish companies implied that assurance of whether the risk taking of the organization is in accordance with the organizations strategy was a function of the organization’s rm activities, and 44 % of the danish companies implied the increase of the likelihood that the organization meets its strategic goal as a function of rm. based on these benchmarking studies it can reasonably be claimed that erm is rapidly becoming an important part of good business practices. 4 contracts and rm? despite the rapidly increasing appreciation of the perspectives of risk management in business management, literature dealing with the contract legal perspective of risk management is still rather limited.49 the perspective of risk management is, however, nothing new to transaction lawyers, who will find it to be another label for their working method. the extent, consciousness, and depth of the contractual risk management-approach might nevertheless offer 47 rm maturity was measured according to a erm methodology developed by the pricewaterhousecoopers based on the self-assessments of the companies. 48 the study also points out how the risk monitoring and the internal environment were the least developed areas of rm in finnish companies. 49 the original breakthrough for risk management within legal reasoning took place in construction contracts, where the idea of risk management has been frequently discussed since mid-1980’s. see abrahamson, max w., risk management, international construction law review 1984, pp. 241-264 as well as several other articles in the subsequent volumes of the international construction law review. in the past ten years the risk management approach to legal question has been gaining popularity even in the nordic countries, particularly in finland, where a number of books dealing with different aspects of legal risk management have been published during the past five years. consider e.g. keskitalo petri, from assumptions to risk management, kauppakaari, helsinki 2000; pohjonen soile (ed.), ennakoiva sopiminen, wsoy lakitieto, helsinki 2002; wahlgren peter, juridisk riskanalys, jure, stockholm 2003; setälä ilkka, et.al., yrityksen ja yhteisön vastuuriskit, tietosanoma oy, helsinki 2004; iversen jon, legal risk management, forlaget thomson a/s, københavn 2004, which despite of its title is written in danish; haapio helena, et.al., yritysten sopimusja vastuuketjut, tietosanoma, helsinki 2005; haapio helena, et.al., yritysten sopimusja vastuuketjut, tietosanoma, helsinki 2005; hemmo mika, sopimusoikeus iii, talentum, jyväskylä 2005; and trzaskowski jan, legal risk management in electronic commerce, ex tuto publishing, copenhagen 2005, available on-line at http://www.legalriskmanagement.net/. the latest addition to such literature is the volume 49 of the scandinavian studies in law, dedicated to the subject of proactive approach. a broader legal perspective to risk management is found in baldwin, robert (ed.), law and uncertainty: risks and legal processes, 1997 and steele, jenny, risks and legal theory, hart, oxford 2004. http://www.legalriskmanagement.net/. nordic journal of commercial law issue 2006 #2 19 some insights even for the most experienced transaction lawyers, who in erich schanze’s terms have “ . . . large contract files . . . [and] anecdotal knowledge on the emergence and survival of numerous individual transactions, and they have developed a sense of whether a specific micro or macro structure of institutional design may be transferred into a different commercial context.” 50 what then is the relationship between contracts and risk management? what kind of a role can contracts and contracting play in the organization’s risk management? due to the different functions of risk management, even the answers to these two questions will vary from an organization to another, as well as from one person to another. accordingly, even if we were to agree that good contracts are an essential asset to the organization, we would most likely have different expectations and different views of what good contracts are and what functions the contracting has for the organization. contracting can therefore have different functions within the different interest groups in an organization. from the business administration perspective contracting might be associated with contract administration, whereas business governance perspective would see contracting as a tool for strategic management. a legal management perspective might lead us to associate contracting as a tool for compliance and a risk management perspective might see contracting as a tool for risk treatment. in addition, contracts and contracting can have quite different roles as part of the different risk management strategies of organizations. this is illustrated in the following table, which presents a caricatural picture of an eventual line of evolution in the role of contracts and lawyers as part of the risk management activities of an organization, which follows the line of evolution of the organizations risk management strategy as described by suominen,51 supplied with the last strategy category: the erm. 50 schanze, erich, legalism, economism, and professional attitudes towards institutional design, journal of institutional and theoretical economics 1993, p. 130, describing the method of “ better” consultants. 51 see suominen, arto, riskienhallinnan mahdollisuudet ja kehityshaasteet, in kuusela, hannu & ollikainen, reijo, riskit ja riskienhallinta, tampere university press, vammala 1999, pp. 137-142. nordic journal of commercial law issue 2006 #2 20 r es po ns ib ili ty fo r co nt ra ct in g la w ye r? la w ye r? la w ye r/ in -h ou se la w ye r in -h ou se la w ye r c hi ef c on tr ac ti n g o ff ic er la w ye rs r ol e “p la gu e” f ili ng c le rk ? e xp er t c ou ns el or t ea m p la ye r fo cu s of co nt ra ct in g d oc um en ta tio n d oc um en ta tio n o pe ra tio na l co nt ra ct p la nn in g pl an ni ng an d ad m in is tr at io n (a n d st ra te gi c m an ag em en t of co n tr ac ti n g? ) s tr at eg ic , op er at io na l, re po rt in g an d co m pl ia nc e m an ag em en t of co nt ra ct in g r ol e of co nt ra ct in g le ga l le ga l t oo l fo r bu si ne ss m an ag em en t? t oo l fo r bu si ne ss m an ag em en t! t oo l fo r bu si ne ss go ve rn an ce ! r ol e of co nt ra ct s c on tr ac t = r is k! c on tr ac t r is ks ? c on tr ac t r is ks ! c on tr ac ts & r m ? c on tr ac tu al e r m ! r m -r ol e of co nt ra ct s u ns tru ct ur ed u ns tru ct ur ed a d ho c a d ho c/ sy st em at ic s ys te m at ic an d in te gr at ed r m -s tr at eg y lu ck in su ra nc e fo cu se d r is k aw ar e v er sa til e e r m nordic journal of commercial law issue 2006 #2 21 all these different functions need to be addressed and integrated in a conceptualization of the interplay between contracts and risk management. how this is actually done depends on the chosen conceptualization of the role of contract in this interplay and the focus point in the management of contracting. in the following, i will discuss a few alternative approaches for the conceptualization of the relationship between contracts and risk management, namely: proactive contracting, contract administration, contract management, enterprise contract management and eventual alternatives beyond such conceptualizations. 4.1. proactive contracting proactive contracting represents a conceptualization of the relationship between contracts and risk management in a way that focuses first and foremost on the creation of contracts. accordingly, a major portion of the early literature on proactive contracting focuses on the creation of good contracts, which are synonymous to proactive contracts. proactive contracts are then understood as tools for managing the goals of the transactions as well as the expectations embedded to them. such proactive contracting presupposes that any false assumptions and unrealistic expectations can be prevented by the use of the proactive approach, which presupposes that the contract parties know why and when to contract, what about and what they contract for, as well as what they have not specifically contracted for but which is regulated by the default legal norms that will apply to the contract unless the contract contains contracts terms that alter these norms, to the extent that that is allowed by the legal norms that apply to the contract. such a primary focus within the early proactive contracting literature on the creation of contracts is a less than optimal conceptualization of the relationship between contracts and risk management since it has an unclear approach to the strategic perspective of risk management. furthermore, it does not pay due attention to the elementary nature of effective risk management as a disciplined process that starts already before the creation of the contracts and continues thereafter. 4.2 contract administration and rm contract administration is a discipline that is particularly popular in public sector contracting and refers to the administration of contracts after that they have been signed.52 this focus on the implementation of contracts is another way to conceptualize the relationship between contracts and risk management. contract administration-discipline is strongly influenced by the project management-discipline but has a more narrow focus due to the focus on implementation of contracts, whereas project management-discipline focuses on the entire lifecycle of a project. accordingly, contract administration concentrates on the implementation of (single) transactions, which is less than optimal considering the recent development of risk management discipline towards a more holistic governance and strategy oriented enterprise risk management. nevertheless, contract administration-discipline reminds us of the importance of the implementation of contracts after that they have been created, which is a very important lesson for contracting. 52 compare though boyce, successful contact administration, hawsmere, london 1992, who uses the term contract administration in a broader sense that covers even the contract creation. such use of the terminology seems however unusual in recent contracting literature. nordic journal of commercial law issue 2006 #2 22 4.3 contract management and rm contract management is sometimes used as a synonym to contract administration but such language is insensitive to the fact that the contract management-discipline has shifted its focus from the contract implementation to contract lifecycle management. accordingly, contract management refers to the processes of managing the entire lifecycle of contracts. contract management as a discipline has existed in the u.s. since the 1950’s and the oldest association of contract managers, the national contract manager association (ncma) was established as early as 1959.53 ncma has published two journals: contract management magazine54 since 1977 and the journal of contract management55 since 2002. although the contract manager profession is not new, it did not receive appropriate attention outside the u.s. before the 1990’s. the increasing status of this profession is reflected in the establishment of the first international association of contract managers, the international association for contract and commercial management (iaccm) in 1993.56 both of these associations offer a wide-range of on-site and on-line education and certification services for contract professionals. the status of contract management-discipline and the profession of contract managers is likely to increase extensively particularly in the u.s. due to the new corporate control pressures in the aftermath of the sarbanes-oxley act of 2002. although the contract management discipline is focused on the management of contracts through their entire lifecycle, there are other challenges in its relationship to risk management. contract management discipline seems to share the traditional focus on contract risks rather than business risks. it also seems that contract management is focused on the management of single contracts, or to be more precise on single transactions. from the perspective of the current trends in risk management such a focus is not optimal since effective management of business demands focus on the governance of the entire enterprise. 4.4 enterprise contract management and rm as suggested earlier, the contract management discipline is under development towards something that is often called enterprise contract management (ecm) that focuses on the organization’s entire contracting activity. this trend is first and foremost visible through and driven by the introduction of enterprise contract management it-systems. such a development is not surprising considering the practical problems that many organizations face in managing their contract portfolios and these problems are not about to diminish as many companies are outsourcing increasingly larger areas of their traditional business activities.57 according to a benchmarking study among over 100 of the forbes global 2000 companies in 53 information of the ncma is available at http://www.ncmahq.org/. 54 information concerning this journal is available at http://www.ncmahq.org/publications/cm/. 55 information concerning this journal is available at http://www.ncmahq.org/publications/jcm.asp. 56 information of the iaccm is available at http://www.iaccm.com. 57 according to the u.s. national association of purchasing managers, an average fortune 1000 company has between 20.000 and 40.000 contracts, see krappé & kallayil, contract management is more out of control than you think, journal of contract management 2003, p. 4, available on-line at http://www.iaccm.com/forum/articles/jcmapr03article.pdf. http://www.ncmahq.org/. http://www.ncmahq.org/publications/cm/. http://www.ncmahq.org/publications/jcm.asp. http://www.iaccm.com. http://www.iaccm.com/forum/articles/jcmapr03article.pdf. nordic journal of commercial law issue 2006 #2 23 2003,58 the state of contract management in some of the world’s largest companies is at an alarming level.59 according to the findings of this study: 81 % of companies had problems finding contracts, 20 % of companies said 10 % or more of their contracts may not be located at all, 33 % of companies stored contracts in more than 10 locations, 34 % of companies had no risk evaluation process before signing contracts, 52 % of companies did not know the expiration date of all their contracts, while 43 % of companies had more than 20 % of their contracts renewed automatically, thereby missing the opportunity to review the contract terms. ecm it-systems offer highly efficient platforms for a truly professional management of such practical problems, particularly in organizations that have hundreds and even thousands of contracts with their suppliers and customers. analysts claim that ecm it-systems fill a gap between the existing management it-systems like enterprise resource planning (erp), customer relationship management (crm) and supplier relationship management (srm) that includes supply chain, procurement and sourcing management, despite the effort of the vendors of such systems to cover even the contract management issues.60 the reason for the effectiveness of ecm it-systems is claimed to be their focus on the enterprise-wide approach, and the fact that an ecm it-system can (and should) communicate with the erp, crm and srm it-systems. independent industry analysts generally believe that ecm it-systems can dramatically improve organization’s economic performance. accenture believes that an organization can reduce procurement expenses with 3-5 %, reduce manual work efforts related to contract negotiation and management by 50-75 %, and increase net revenue through the avoidance of tens or hundreds of millions of dollars in increased contract liabilities.61 aberdeen group estimates e.g. 25-30 % reductions in administration costs and 55 % improvement in compliance management.62 if these estimations of the economic benefits of ecm it-systems are even close to reality, all organizations should seriously look into the possibilities and needs to implement such ecm it-systems. there are quite a few vendors of ecm it-systems both in north america and in europe but there are also guides to the choice of an ecm vendor.63 the market for ecm it-products is expanding at a very high speed and aberdeengroup estimates that the market for licences alone will top 351 million u.s. dollars in 2005 and continue to grow with 58 the forbes global 2000 list quotes every year the world’s 2000 largest companies. information concerning year 2005 global 2000 list is available at http://www.forbes.com/2005/03/30/05f2000land.html. 59 see krappé & kallayil, contract management is more out of control than you think, journal of contract management 2003, pp. 3-8, available at http://www.iaccm.com/forum/articles/jcmapr03article.pdf. 60 see accenture, managing contracts to increase revenue and profits, white paper, 2002, p. 15-16, available at http://www.accenture.com/global/research_and_insights/by_industry/health_and_life_sciences/pharmaceuti cals_and_medical_products/managingprofits.htm. 61 accenture, managing contracts to increase revenue and profits, white paper, 2002, p. 20, available at http://www.accenture.com/global/research_and_insights/by_industry/health_and_life_sciences/pharmaceuti cals_and_medical_products/managingprofits.htm. 62 aberdeengroup, the contract management solution selection report, june 2005, available through http://www.aberdeen.com/summary/report/benchmark/ra_cmsolselect_tm.asp. the estimates of this report are based on benchmarking studies of more than 300 companies. 63 see e.g. the aforementioned report by the aberdeengroup and the iaccm list of recommended vendors at http://www.iaccm.com/forum/vendors.php. http://www.forbes.com/2005/03/30/05f2000land.html. http://www.iaccm.com/forum/articles/jcmapr03article.pdf. http://www.accenture.com/global/research_and_insights/by_industry/health_and_life_sciences/pharmaceuti http://www.accenture.com/global/research_and_insights/by_industry/health_and_life_sciences/pharmaceuti http://www.aberdeen.com/summary/report/benchmark/ra_cmsolselect_tm.asp. http://www.iaccm.com/forum/vendors.php. nordic journal of commercial law issue 2006 #2 24 20 % yearly rate through 2008,64 which tells us something about the current demand for such systems. although such ecm it-systems can greatly enhance the contract management of an organization, they are only systems facilitating the actual enterprise contract management. accordingly, the persons responsible for the contracting activities of organizations still need to be trained in order to have the knowledge and skills needed to manage contracts and risks. further, the ease of use of the ecm it-systems should not distract the organizations attention from the fact that they still need to develop the necessary contract management know-how, particularly the strategic contract management know-how in order to enable the organization to fully exploit the opportunities in ecm it-systems. one aspect of such know-how is the need to differentiate between the levels of contract management expertise that are needed at different levels of contracting. at the same time the ecm it-systems also offer an opportunity to develop the role of corporate counsels, although that development comes at the price of an update of the it-skills of corporate counsels.65 accordingly, the most advanced it-systems will enable retrieval of records on previous contract negotiations and data on how those contracts have performed, what types of contracts have worked and what have not, to quickly collect specific transactional data in order to determine whether contractual obligations have been complied, and to pull out reports for auditing activities. such data retrieval necessarily demands certain skills but first and foremost it demands a clear understanding of the kind of a data that the system can provide and how that data can be used for analysis of the contract portfolio of the organization. despite the enterprise-wide focus there seems to be little focus on the strategy side of contracting. accordingly, the enterprise functions of ecm it-systems seem to focus on the different analytic functions of the systems, whereas one would expect a stronger focus of the strategic management of such it-systems. such shortcomings can, however, be remedied through active management and analysis of the information provided by such systems. naturally, the enterprise contract management need not rely on any it-system which will have decreasing added value in small companies that have clear visibility of their contracts. the functions that such it-systems have to offer should though be of interest particularly to companies that operate manual enterprise contract management systems. 4.5 beyond enterprise contract management? as we have seen, there are many different ways to conceptualize the relationship between contracts and risk management. and still, these alternatives have only to a small degree put emphasis on risk management. if enterprise risk management is going to achieve the position that the new erm-standards are describing, such a lack of focus on risk management will represent a challenge for the development of contracting towards such an enterprise-wide risk management approach. a stronger emphasis on risk management and particularly on enterprise 64 see aberdeengroup, the contract management solution selection report, june 2005, available through http://www.aberdeen.com/summary/report/benchmark/ra_cmsolselect_tm.asp. 65 for a more detailed discussion see i-many inc., contract management solutions and its impact on the role of corporate counsel. white paper, available at http://www.iaccm.com/forum/articles/contractmanagement_law.pdf. http://www.aberdeen.com/summary/report/benchmark/ra_cmsolselect_tm.asp. http://www.iaccm.com/forum/articles/contractmanagement_law.pdf. nordic journal of commercial law issue 2006 #2 25 risk management could namely bring on fundamental changes: shift of focus from the contract risk towards contractual management of all kinds of risks and separation of at least the strategic and operative aspects to the enterprise-wide use of contracts in risk management. an attempt to integrate such risk management perspectives with the enterprise contract management approach is the central theme for the next chapter. 5 contractual enterprise risk management (c-erm) my approach to conceptualization of the interplay between contracts, risks and management is based on the integration of legal, economic and risk management perspectives to this matter. whereas my original theory of contractual risk management (c-rm), presented in my doctoral thesis in 2000, was focused on the theoretical foundations for the creation of risk managing proactive contracts,66 the operative models of strategic and operative c-rm, which i developed in a paper published in 2002,67 were the first steps in adjusting my original theory to the strategical needs of the enterprise-wide governance of contracts and to the operative needs of the management of contracts. these adjustments have now led to the formulation of a theory of contractual enterprise risk management (c-erm) that addresses the management of all types of risks to an organization with help of governance and management of the contracting activities of the entire organization. in this adjusted theory, the enterprise contract management and enterprise risk management approaches have become fully integrated to my original contractual risk management approach. in the remaining pages of this paper i will only shortly present the framework for c-erm, focusing on its concepts and structures. hopefully i will be able to publish a more detailed presentation of c-erm by the end of 2007 in a book format. in the meantime, more information about c-erm and other related information on the interdisciplinary interplay between contracts, risks and management will be made available through the monitor of contractual risk management (mcorim) at www.mcorim.com, which is a web-portal that will be launched during the end of 2006. 5.1 goals of c-erm the goals of the c-erm are established under general erm. this external point of departure for the c-erm is the reason why the concept ‘contractual enterprise risk management’ was chosen as the name for the contract legal perspective to risk management, instead of the concept ‘contractual enterprise management’. however, c-erm can offer some insights for the general erm particularly in the phases of risk analysis and risk evaluation. 66 see keskitalo, petri, from assumption to risk management, kauppakaari, helsinki 2000. summary of this book is available at my homepage at: http://www.jus.uit.no/ansatte/keskitalo/summary_of_%20project.htm. 67 see keskitalo, petri, sopimuksellisen riskienhallinnan teoria ja toimintamallit, in pohjonen, soile (ed.), ennakoiva sopiminen, wsoy lakitieto, helsinki 2002, pp. 241-273. http://www.mcorim.com, http://www.jus.uit.no/ansatte/keskitalo/summary_of_%20project.htm. nordic journal of commercial law issue 2006 #2 26 5.2 structure of c-erm c-erm adopts the philosophy of erm but focuses on the enterprise’s contracting activities as tools for risk management. similarly to the coso erm integrated framework’s approach to risk management, c-erm separates between the strategic, operations, reporting, and compliance fields of the contracting activities of an organization. however, under the field of c-erm operations it also applies the crm processes and separation between the phases of creation, administration and monitoring of contracts. although the c-erm separation of four fields of contracting is similar to the division between four “ categories of objectives” within the coso erm integrated framework, my definition of the contractual-erm does not share the structure of coso erm integrated framework. accordingly, instead of the visualization of eight “ components” of the coso erm integrated framework, contractual-erm is based on a more analytical approach that identifies three levels of management that are built upon and linked to one another: internal environment, operative activities, and surveillance & development this three-level structure is shared by all of the four fields of c-erm. the level of internal environment forms the fundament of each of the four fields of c-erm. these internal environments consist of five areas: culture, policy, infrastructure, know-how, and finally, communication & information, an area that functions as the link between the three levels of management. the central role of this area is underlined in the illustration through the visualization of it as a pole in the centre of this level. all these five areas deal with several issues within their subject areas e.g. infrastructure addresses the matters of organization, resources and tools of management. strategic operations compliance reportingc-erm nordic journal of commercial law issue 2006 #2 27 the level of operative activities is built upon the level of internal environment of management. the operative activities are divided into four areas: objective setting, event identification, event evaluation, and event treatment. these represent the traditional core of risk management activities and form therefore the midlevel in the structure of all of the four fields of c-erm. the level of surveillance & development is built upon the lower levels of management and focuses on the surveillance and development of all of the three levels of management. even this level of management is divided into areas: control, monitoring and development. how do all these three levels hang together? as suggested earlier, it is the management of communication and information concerning the contracting activities of organization that does the job. this central role of the management of communication and information can be visualized with the help of an illustration of the three levels of management as parts of a traditional children’s toy: a stack pile, where the different pieces are kept in their place by a pole in the center of the fundament. however, the role of the communication and information is even more central when one considers the cooperation between the four fields of cerm: the strategic, operational, reporting and compliance perspectives to c-erm. communication and information between these fields is namely an elementary condition for the effectiveness of contractual enterprise risk management. therefore the internal communication and information concerning the organizations contracting activities links not only the different levels of management within each of these fields of c-erm but in addition it also internal environment infrastructurep oli cy culture kn ow-h ow communication & information © petri keskitalo 2006 c-erm strategic operations compliance reporting © petri keskitalo 2006 survaillence developme nt & control development monitoring iden tifi ca tion objectives evaluation treatm ent operative activities nordic journal of commercial law issue 2006 #2 28 links the four fields of management to one another. such effective management of communication and information concerning the organization’s contracting activities presupposes that someone within the organization has responsibility for the coordination of these fields of c-erm. due to the complex structure of contracting in many organizations, the relocation of all contracting activity to a separate contracting unit or division is not desirable. a more fruitful solution is most likely found through focus on the organization of the coordinating tasks. depending on the size of the organization this could a person, a group of persons or a council with top executive representatives from all of the divisions of the organization that are engaged in contracting activities.68 whereas the organizational form of this coordinative task is less important, the assignment of the coordinative responsibility in itself is crucially important and should be the starting point for a development of contractual enterprise risk management in organizations. from thereon the organizations can focus on the four fields of management, one at a time, developing the fields and levels of management and management areas therein according to the needs of the organization. such a development should be able to fully integrate and transform the existing contract administration, contract management and enterprise contract management disciplines, and even the governance, risk and compliance management (grc) activities within the organization into the c-erm system. the road of such implementation of c-erm is long and challenging but the reward of having a developed a disciplined and organized contracting activity that is updated to meet the challenges of the enterprise risk management should be rewarding. 6 beyond knowledge and skills at the end of our journey it is time to return to the illustration of the different layers of knowledge on the interplay between contracts, risks, and management as a pyramid with its structural implications. as suggested in the beginning of this paper, i have discussed the two elementary layers of such a pyramid of knowledge and only shortly touched upon the midlayers of knowledge of and skills for the interplay contracts, risk and management, leaving these more pragmatic layers to be studied with help of the increasingly broader literature on contracting. 68 creation of such a contract management governance council is one of the ten practical recommendations of the aberdeen group in their benchmarking report, written by minahan, tim a., best practices in contract management. strategies for optimizing business relationships, aberdeen group september 2004. internal environment iden tifi c ation objectives evaluation treatm ent surveillence developme nt & monito ring control development com & info culture kn ow-h ow infrastructurep oli cy operative activities © petri keskitalo 2006 nordic journal of commercial law issue 2006 #2 29 now it is time to return to my promise to reveal the very top of the pyramid that actually is not about knowledge or skills. what the top of the pyramid stands for is the art of creative thinking. the ability for creative application of the different layers of knowledge according to the needs and resources of the organization is the actual key to a successful implementation of the contractual risk management. at the same time, such creative thinking is difficult to learn through reading and is most effectively learned by doing; through attempts and mistakes. fortunately, the number of obvious mistakes can be narrowed down through the study of unsuccessful contractual risk management that can be found all around us and which is particularly visible in case law concerning contracting; contracts that end up in courts can namely be assumed to have failed, at least for one of the contract parties. another source for stories, stories with happier endings in contractual risk management, is benchmarking studies that are becoming increasingly popular. the dilemma in such studies is that due to their case study nature, the lessons to be learned might not be the right lessons for other organizations. a more comprehensive source of knowledge can be found in the empirical studies conducted under the academic discipline of law, economics & organization also known as the transaction cost economics that offers a great potential for the development of all the levels of knowledge concerning the interplay between contracts, risks and management. and still, at the end of day, the key to truly successful contractual risk management – the cutting edge lies in the creative minds of those in charge of the organizations contracting activity. theory (know-why) models of operation (know-what) tools (know-with-what) practice (know-how) potential (know-how-far) layers of knowledge concerning the interplay between contracts, risks and management: creative thinking! nordic journal of commercial law issue 2006 #2 30 literature: abrahamson, max w., risk management, international construction law review 1984, pp. 241-264. aberdeengroup, the contract management solution selection report, june 2005, available through http://www.aberdeen.com/summary/report/benchmark/ra_cmsolselect_tm.asp. accenture, managing contracts to increase revenue and profits, white paper, 2002, available at http://www.accenture.com/global/research_and_insights/by_industry/health_and_life_sciences/phar maceuticals_and_medical_products/managingprofits.htm. baldwin, robert (ed.), law and uncertainty: risks and legal processes, kluwer law international, london 1997. berg, karl-erik, yrityksen riskinhallinta, jyväskylä 1994. boyce, successful contact administration, hawsmere, london 1992. committee of sponsoring 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a., corporate risk philosophy for improved risk management, journal of business research 1987, pp. 107-122. schantze, erich, beyond contract and corporation: the law and economics of symbiotic arrangements, in riis, thomas & nielsen ruth (eds.), law and economics. methodology and application, djøf publishing, copenhagen 1998, pp. 113-130. schanze, erich, legalism, economism, and professional attitudes towards institutional design, journal of institutional and theoretical economics 1993, pp. 122-140. http://www.iaccm.com/forum/articles/contractmanagement_law.pdf. mailto:petri.keskitalo@jus.uit.no http://www.iaccm.com/forum/articles/jcmapr03article.pdf. http://www.aberdeen.com/summary/report/benchmark/ra_cmsolselect_tm.asp. http://www.aberdeen.com/summary/report/other/bpincm_092904a.asp?spid=30410023. http://www.ussc.gov/corp/murphy1.pdf. http://www.nues.no/english/. http://www.pwc.com/extweb/pwcpublications.nsf/docid/603dc44afe80cac5802570190046e683. http://www.pwcglobal.com/fi/fin/issues/publ/pwc_erm.pdf. http://www.pwcglobal.com/fi/fin/about/svcs/neuvonta/erm_study_2006.pdf. http://www.pwc.com/extweb/service.nsf/docid/c8753369ed2d193e85256e1b001c03d6. http://www.pwc.com/extweb/insights.nsf/docid/d4700640c39f9d6780256e1a00417f29. http://www.pwc.com/extweb/insights.nsf/docid/48c44da89cb0cc4185256f7f0061c641 http://papers.ssrn.com/sol3/papers.cfm?abstract_id=746884. nordic journal of commercial law issue 2006 #2 32 setälä, ilkka, et.al., yrityksen ja yhteisön vastuuriskit, tietosanoma oy, helsinki 2004. the sme risk management toolkit available at http://www.pk-rh.com/en/index.html. the english version of the toolkit has been developed and amended for the uk by the institution of occupational safety and health (iosh), from the original finnish concept by vtt. smith, robert j., allocation of risk – the case for manageability, international construction law review 1996, pp. 549-569. smith, robert j., risk identification and 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http://www.legalriskmanagement.net/. http://www.ussc.gov/2004guid/appc-2004supp.pdf. http://www.ussc.gov/2004guid/8b2_1.htm. 2 brinkmann rasmussen 1 the new eu crowdfunding regulation explanations & perspectives søren brinkmann* & mads ebert rasmussen** * attorney-at-law and partner at loeven law firm, denmark. ** junior associate at loeven law firm, denmark. njcl 2022/2 55 1. introduction ..................................................................................... 56 2. crowdfunding as alternative means of financing ......... 56 3. the need for harmonized eu regulation ........................... 57 4. the new legislative framework ............................................... 57 5. authorization requirements ..................................................... 57 6. payment services .............................................................................. 58 7. scope, activity and terminology ............................................. 58 8. instruments of the crowdfunding process .......................... 60 8.1. loans .......................................................................................... 60 8.2. transferable securities ..................................................... 60 8.3. admitted instruments for crowdfunding purposes .. ............................................................................................ 61 9. duties of the crowdfunding service provider .................. 63 10. distinction of investor sophistication ................................. 64 10.1. entry knowledge test ....................................................... 65 10.2. simulation test of ability to bear loss ...................... 65 11. due diligence on project owners ........................................... 67 12. handling of complaints ............................................................... 67 13. conflicts of interest ...................................................................... 68 14. prudential requirements ............................................................. 69 15. non-obliged entity (anti-money laundering) ................. 70 16. key investment information sheet ......................................... 70 17. conclusion .......................................................................................... 71 the new eu crowdfunding regulation 56 1. introduction this article is for scholars and lawyers with the purpose of providing the reader with a legal introduction to the new eu legislation on crowdfunding (regulation eu (2020/1503) on european crowdfunding service providers for business (hereinafter the “ecspr”)). the article focuses on key legal topics and aspects of the ecspr, and seeks to provide perspectives, where applicable, of how the provisions of the ecspr can be assessed from existing legislation of the eu member states, mainly in a danish law perspective. the authors are finance lawyers and will on the article include examples from practical legal application based in their experience. 2. crowdfunding as alternative means of financing crowdfunding is an alternative way to finance start-ups and small and medium sized enterprises (“smes”). this means of financing is becoming more and more widespread the recent years and has become an important source of non-bank financing. during the financial crisis, entrepreneurs started to receive capital through crowdfunding, which at that time was an alternative and new way of financing. since then, financing via crowdfunding has emerged and prospered, becoming an established and increasingly applied form of intermediation for the funding of business activities often without the publication of a prospectus. a “crowdfunding service provider“ (a “csp” or in plural “csps”), is within the meaning of the most recent eu legislation, a business which operates a digital platform matching the public, i.e., prospective investors or lenders with businesses that seek funding for their business or projects, according to art. 2(1) of the ecspr. the provision of crowdfunding services aims to facilitate the funding of a project by raising capital from a large number of people who each contribute relatively small investment amounts through a publicly accessible internet-based information system, i.e., being the crowdfunding platform. the ever-evolving traditional banking system has with time become heavily regulated resulting in banks being reluctant and (over)cautious to allocate financing to smes, thus, smes in general lacking access to financing, which has proved to be an issue for the investment climate of start-ups and smes1 . therefore, crowdfunding has become popular for smes as this way of financing provides easier access to financing than via the traditional banking system, thus filling out the gaps in the market for the lack of financing opportunities for smes. 1 dentons, ‘the new ecsp-proposal reaches the home straight on harmonized crowdfunding rules’ (july 30, 2020) https://www.dentons.com/en/insights/articles/2020/july/30/the-new-ecsp-proposalreaches-the-home-straight-on-harmonized-crowdfunding-rules, accessed 7 july 2022. njcl 2022/2 57 3. the need for harmonized eu regulation in the various eu member states, there is extensive and numerous financial regulation, and many eu member states have introduced regulatory regimes for crowdfunding but no harmonized rules on crowdfunding was introduced. these non-harmonized (national) rules in eu member states have resulted in significant divergence as regards the conditions of operating of crowdfunding platforms, the scope of permitted activities and the licensing requirements2. the present legal state on the area has caused confusion and challenges not benefitting the stakeholders and interested parties of the crowdfunding area. this fragmentation of rules and supervisory expectations as well as an absence of passporting rights made it very difficult for csps to operate cross-border. this fragmentation is now set to partly end with the legislators acknowledging and recognizing the problem, thus introducing harmonized rules for crowdfunding platforms, however noting, that there still are issues and questions on the area left for national decision in each of the eu member states. 4. the new legislative framework on 20 october 2020, the european commission published the ecspr as its legislation to regulate and harmonize crowdfunding for businesses within the eu. the aim of the new legislative framework is to ensure a harmonized eu crowdfunding regime and to assure legal certainty of the rules regulating crowdfunding activities across the eu member states, and thereby creating one of the world’s largest harmonized regulated environments for crowdfunding3. the ecspr is now in force and is directly applicable in all eu member states. 5. authorization requirements one of the requirements of the ecspr is that a csp needs to be authorized, according to art. 12, in order to provide their services legally. csps must therefore file an application with the competent authority of the given eu member state. csps successfully obtaining such a license (a “csp-license”) will be registered in a registry database of all csps under esma. the application which the csp must file in order to obtain a csplicense must include, among other requirements, a description of the type(s) of crowdfunding services the prospective to-be-licensed csp intends to provide, descriptions of the csps’ systems and resources, procedures for the control and safeguarding of data processing systems, description of operational risks, prudential safeguards in place and 2 ibid. 3 ibid. the new eu crowdfunding regulation 58 business continuity plan and any description of any outsourcing arrangements. upon the csp becoming authorized as a csp under the ecspr, the csp may avail of the european passporting regime as regards to offering their crowdfunding services throughout the eu. a licensed csp will therefore have the right to provide crowdfunding services cross border within the eu as known from the traditional passporting regime from the eu financial regulation. 6. payment services obtaining a csp-license does not per default provide the csp with authorization to handle payments similar to that of a separate payment institution or electronic money institution authorization. if a csp wish to conduct the handling of payments on their own, the csp will need to obtain separate authorization as payment institution or electronic money institution according to the danish financial business act, section 361(1)(9-10). the csp may involve a third-party provider authorized to handle such payments as an outsourcing arrangement provided it being disclosed for the users of the crowdfunding platform. 7. scope, activity and terminology on 20 october 2020, the european commission published the ecspr as its legislation to regulate and harmonize crowdfunding for businesses within the eu. the ecspr applies to certain csps in the eu. a csp can be described as the legal entity (i.e., a legal person) running a business offering an online interned-based platform accessible for the public (i.e., the “crowd”), which provides the facilitation of matching the crowd with businesses seeking funding for their projects, thus dubbing the activity the term “crowdfunding”, according to art. 2(1) (d-f) of the ecspr. the business seeking funding for a given project through the online platform of a csp is often referred to i.a. as the “project owner”, “borrower” and/or “offeror”, which may only be a business, i.e., a legal entity and not a consumer (natural person). an individual of the crowd deciding to fund a given project is often referred to as a “crowdinvestor” which may be a natural or legal person, according to preamble (2) of the ecspr. the ecspr applies to csps offering crowdfunding services reminiscent of financial services, i.e., investment-based and lending-based crowdfunding services, since those types of crowdfunding services can be structured as comparable funding alternatives to traditional financial services. hence, the ecspr does not apply to csps offering donationbased, reward-based and/or peer-to-peer-lending-based crowdfunding services, nor does it apply to consumer-loans. csps and crowdfunding services referred to hereinafter are only the ones in scope of the ecspr, njcl 2022/2 59 thus being the investment-based and lending-based csp and crowdfunding services (as follows). newly established csps, not priorly having provided crowfunding services, are required to obtain a csp-license in accordance with the ecspr at the latest of 10 november 2021, existing platforms will have an additional year to comply, i.e. being subject to a deadline of obtaining a csp-license at the latest of 10 november 2022 according to preambles (76) and (77) of the ecspr. the csp-license shall be obtained from the competent authority of the eu member state in which the legal entity of the csp is established. csps failing to obtain a csp-license cannot legally issue any new crowdfunding offers after said date. private persons and consumers (i.e., natural persons) cannot be subject to obtainment of a csp-license, why only legal entities can obtain a csp-license. hence, crowdfunding services targeted project owners that are consumers remains subject to the eu consumer credit directive as well as the national implementation thereof according to art. 1(2)(a). the crowdfunding services of the csps in scope of the ecspr are the facilitation of firstly to provide the opportunity for the project owner to “publish” a given project on the platform, the publishing thus making the project visible and accessible for the crowdinvestors. thereafter, the crowdfunding services of the csp can be described as providing the facilitation of the crowdinvestor’s allocation of funds to the project owner in return of either receiving (transferable) securities or an interest rate in return. if the crowdinvestor’s allocation of funds to the project owner happens in consideration of the receival of an interest rate in return, the activity is often referred to as being “crowdlending” and the crowdinvestor can in this case more specifically be called a “crowdlender”. in case the consideration for the allocation of funds are securities in return, the activity genuinely is “crowdinvesting”. however, speaking in general, the terms crowdinvestor and crowdinvesting covers both activities universally. such crowdfunding offers of lending and investment opportunities holds a threshold being capped at maximum eur five (5) million per project owner calculated on an annual basis according to art. 1 (2)(c). the cap means that each project owner can only seek and receive funds up to the maximum cap, whereof the project owner being considered as being the legal entity which the crowdfunding offer is conveyed through and thus subject to receival of the funds. offers seeking more than eur five (5) million are excluded from the ecspr’s scope. such offers would remain under the scope of existing regulations such as mifid ii and the eu prospectus regulation in addition to further local regulation in accordance with the given eu member states’ legislation subject to such offer. the new eu crowdfunding regulation 60 8. instruments of the crowdfunding process the applicable instruments of which the crowdinvestor can receive in return for funding of the project owner’s project thus effecting the crowdfunding transaction are as follows. 8.1. loans loans are allowed as instrument of a crowdfunding transaction and csps may therefore facilitate the granting of loans between crowdlenders and project owners according to art. 2(1)(a)(i). the crowdlender then receives repayment of the loan including interest rates from the legal entity of the project owner in return for making funds available. it is a requirement that the project owner assumes an unconditional obligation to repay the loan amount including accrued interest to the crowdlenders, in accordance with an instalment payment schedule according to art. 2(1)(b). this means that the csp and project owner must ensure that the crowdinvestors are fully informed on when and how much is going to be paid out accordingly. according to preamble (11) of the ecspr, the facilitation of granting of loans that falls within the scope of the ecspr shall be distinguished from the activity of a credit institution, which grants credits for its own account and takes deposits or other repayable funds from the public. this means that eu member states must ensure that any local legislation does not require csps and project owners to have authorisations alike credit institutions etc. for the facilitation and granting of loans. hereto, it may be seen that some eu member states will need to amend their local legislation to ensure that it does not contradict with the ecspr. 8.2. transferable securities securities are allowed as instrument of a crowdfunding transaction and csps may therefore facilitate the transfer of securities between crowdinvestors and project owners according to art. (2)(a)(ii). the crowdinvestor then receives securities (i.e., shares) in the legal entity of the project owner (or in a “special purpose vehicle” designated for the project ) in return for making funds available. it is a requirement for such securities to be transferable. restrictions on the transferability may apply to certain securities, according to local legislation of a given eu member states and/or the articles of association etc. the ecspr in art. 2(1)(m) explicitly refers to article 4(1)(44) of directive 2014/65/eu (“mifid ii”) for the exact definition of “transferable securities”, according to which such transferable securities are the classes of securities which are negotiable on the capital market, with the exception of instruments of payment, such as: njcl 2022/2 61 (a) shares in companies and other securities equivalent to shares in companies, partnerships or other entities, and depositary receipts in respect of shares; (b) bonds or other forms of securitised debt, including depositary receipts in respect of such securities; (c) any other securities giving the right to acquire or sell any such transferable securities or giving rise to a cash settlement determined by reference to transferable securities, currencies, interest rates or yields, commodities or other indices or measures. the transferable securities referred to in the ecspr most commonly being the shares of a public limited company according to the reference to mifid ii’s definition regarding securities which are negotiable on the capital market (as described above), the given public limited company being that of the project owner. however, the classification as transferable securities is subject to variations according to the national law of each eu member state. 8.3. admitted instruments for crowdfunding purposes the ecspr also provides for certain instruments being applicable for crowdfunding transactions other than loans (8.1) and transferable securities (8.2). such instruments are defined in the ecspr as ‘admitted instruments for crowdfunding purposes’ and differs from the transferable securities mentioned above under item ii, the difference lying in the restrictions on such instruments, for example in regard to its transferability, in comparison to securities of a common public limited company which, in principle, always should be transferable (as defined in mifid ii). the ecspr defines the admitted instruments for crowdfunding purposes in art. 2(1)(n) as meaning, in respect of each eu member state, shares of a private limited liability company that are not subject to restrictions that would effectively prevent them from being transferred, including restrictions to the way in which those shares are offered or advertised to the public. the ecspr describes the process hereof in the same article (art. 2(1)(a)(ii)) as the transferable securities mentioned under item ii, whereof the crowdinvestor in the case of these admitted instruments for crowdfunding purposes most commonly will receive securities (i.e., shares) in the legal entity (being a private limited company) of the project owner (or in a “special purpose vehicle”, being a private limited company, designated for the project) in return for making funds available. the definition in the ecspr shall as mentioned be applied in respect of each eu member state’s legislation, which is a result of the difference between eu member states’ local legislation on legal entity forms, of which the rules on transferability of shares differs between the different versions of the private limited company. the new eu crowdfunding regulation 62 the ecspr does in this regard set forth that project owners may seek and obtain funding from crowdinvestors by transferring securities in a private limited company in return, albeit such crowdfunding offers in general are reminiscent of public offerings, which however, as mentioned above, shall be applied in respect of each eu member state’s legislation. a mentionable example is the danish companies act’s legislation regarding the restriction imposed on an aps’ (danish version of a private limited company), whereof it under danish law is illegal to make a public offering for the subscription of shares in an aps according to section 1(3) of the danish companies act). presumably, denmark and italy is (to the best of our knowledge) the only eu member state having such restrictions on the advertising or offering of securities in a private limited company to the public. however, we may see other eu member states have similar issues, for example in regard to the transferability of shares in a private limited company in countries having a notarisation system in place (for example the german notary system).4 the german notary system and the mentioned restriction in the danish companies act can arguably be criticized due to its inefficiencies and non-pragmatism, hence, the ecspr fairly also can be critiqued for explicitly mentioning the need to see the definition in respect of each eu member state instead of letting the ecspr take precedence as lex superior ensuring further harmonization. the ecspr may nonetheless provide inspiration and food for thought for legislators in regard to whether such restrictions should be lifted or amended. for example, the politically government-established forum the danish business regulation forum (the “dbrf”) has, alongside dansk erhverv, provided recommendation to the danish parliament with specific reference to the discrepancy between the danish companies act and the ecspr to either delete in full the rule of section 1(3) or, as alternative to deletion in full, specify that the rule does not apply in the case of an aps advertising and offering for subscription of shares, provided such advertising and offering is conducted as means of crowdfunding through a crowdfunding platform5. the proposal to amend section 1(3) of the danish companies act was further endorsed and advanced by the interest organisations of landdistrikternes fællesråd (joint council of rural areas), dansk iværksætter forening (danish 4 dentpns, notary services in germany (no date) <https://www.dentons.com/en/find-yourdentons-team/practices/notary-services-germany/regional-practices/notary-services-ingermany> accessed july 7 2022. 5erhvervslivets euog regelforum, ’anpartsselskaber skal kunne lave crowdfunding med udbud af kapitalandele (no date). https://regelforum.dk/anbefalinger/anpartsselskaber-skal-kunne-lave-crowdfundingmed-udbud-af-kapitalandele, accessed july 7 2022. njcl 2022/2 63 entrepreneurs) and di (danish industry) as means of providing businesses in rural areas of denmark easier access to crowdfunding6. the danish government has answered the recommendation from the dbrf affirmative hence confirming that they will work to have the amendment of the legislation passed through by adoption of the danish parliament. initially, the first forecast was that the amendment should be passed in early january 2022 (effective as of january 2023), as part of a bill containing measures providing less strict and fever requirements towards start-ups and smes7. however, due to various reasons the processing, assessment and negotiations regarding the bill are currently postponed8. in the case of italy, the legislators have been innovative and acted on the conflicting provisions of the ecspr and italian national law. the result hereof was italy making it an exception for private limited companies seeking funding through csps hence allowing private limited companies to offer shares to the public as long as this is conducted by means of crowdfunding through a csp9. 9. duties of the crowdfunding service provider csps are subject to investor protectionary requirements imposed by the ecspr reminiscent of fiduciary duties and rules that follows from financial legislation imposed on credit institutions. according to the ecspr, the csps ‘shall act honestly, fairly and professionally in accordance with the best interests of their clients’ according to art. 3(2) which is the general clause of the ecspr. further, alike the aforementioned, the ecspr sets forth in preamble (18) that in order for maintaining a high standard of investor protection, to reduce the risks associated with crowdfunding and to ensure fair treatment of all ”clients” (i.e., the crowdinvestors or crowdlenders), csps should have in place a policy designed to ensure that projects on their platforms are selected in a ”professional, fair and transparent way”, and that the crowdfunding services of the csp also are provided in the same 6 landsdistrekternes fællesråd, ’lokal vækst med lokal kapital’ (no date) https://www.landdistrikterne.dk/wpcontent/uploads/sites/5/2021/11/15103_lf_publikation_finalpdf.pdf, accessed july 7 2022. 7 erhvervslivets euog regelforum, ’anpartsselskaber skal kunne lave crowdfunding med udbud af kapitalandele (no date) https://regelforum.dk/anbefalinger/anpartsselskaber-skal-kunne-lave-crowdfundingmed-udbud-af-kapitalandele, accessed july 7 2022 (see the tab “regeringens svar”). 8 christoffer lund-hansen, ’kollerup forventer at indkalde til forsinkede iværksætterforhandlinger før sommer’ (march 1 2022). ttps://www.altinget.dk/erhverv/artikel/kollerup-forventer-forsinkedeivaerksaetterforhandlinger-begynder-foer-sommer, accessed july 7 2022. 9 greenberg traurig, ‘view from italy: crowdfunding in italy’ (december 8 2014) (see “legal framework”) https://www.lexology.com/library/detail.aspx?g=ffa7d1bc-213b46e4-a601-0f55db1b9901, accessed july 7 2022. the new eu crowdfunding regulation 64 professional, fair and transparent way, thus referring to the same principles which the policy are based on. the management body of the csp must establish and implement the adequate policies and procedures needed to ensure effective and prudent management, including the segregation of duties, business continuity and the prevention of conflicts of interest, in a manner that promotes the integrity of the market and the interests of its clients according to art. 4(1). further, the responsible persons of the management body must be of good repute and have sufficient knowledge, skills and experience in the context of running the business of a csp, the wording and context of the provision being very similar to the eu rules of the ”fit and proper” regime imposed on the financial sector10 . additionally, to the mentioned general investor protective provisions, the ecspr also sets forth a number of specific duties and obligations to act which the csps must adhere to in order to stay compliant with the ecspr. csps failing to stay compliant may lose their csp-license as per the discretionary decision of the competent authority in the eu member state of the csp according to art. 17(1)(e-f). 10. distinction of investor sophistication for investor protective purposes, the ecspr distinguishes between sophisticated and non-sophisticated investors according to preamble (42), hence allowing the ecspr to introduce different levels of investor protection. a sophisticated investor follows the definition in mifid ii according to art. 2(1)(j) meaning any natural or legal person who is a professional client by virtue section i (points 1-4) of annex ii to mifid ii or any natural or legal person who has the approval of the csp to be treated as a sophisticated investor in accordance with the criteria and the procedure laid down in annex ii of the ecspr. on the contrary, a nonsophisticated investor means an investor who is not a sophisticated investor according to art. 2(1)(k). before a csp allows a prospective non-sophisticated investor full access to invest in crowdfunding projects on their crowdfunding platform, csps must assess whether and which crowdfunding services offered are appropriate for the given prospective non-sophisticated investor. in order to conduct such assessment csps must ensure that prospective nonsophisticated investors on their crowdfunding platform becomes subject to an entry knowledge test as referred to in the description of the header in art. 21. further, csps must also ensure that prospective nonsophisticated investors becomes subject to a simulation test of their ability to bear loss, calculated as 10% of their net worth. 10 the european central bank, ‘guide to fit and proper assessments’ (december 2021) https://www.bankingsupervision.europa.eu/ecb/pub/pdf/ssm.fit_and_proper_guide_ update202112~d66f230eca.en.pdf, accessed july 7 2022. njcl 2022/2 65 10.1. entry knowledge test the entry knowledge shall be based on information about the prospective non-sophisticated investor’s experience, investment objectives, financial situation and basic understanding of risks involved in investing in general and in investing in the types of investments offered on the crowdfunding platform on the csps according to art. 21(2). the information which csps must request, in accordance with according to art. 21(2)(a-b), to conduct the entry knowledge test are information about: a) the prospective non-sophisticated investor’s past investments in transferable securities or past acquisitions of admitted instruments for crowdfunding purposes or loans, including in early or expansion stage businesses; b) the prospective non-sophisticated investor’s understanding of the risks involved in granting loans, investing in transferable securities or acquiring admitted instruments for crowdfunding purposes through a crowdfunding platform, and professional experience in relation to crowdfunding investments. 10.2. simulation test of ability to bear loss csps must also require prospective non-sophisticated investors to simulate their ability to bear loss, calculated as 10 % of their net worth. the simulation test shall be based on the following information according to art. 21(5)(a-c): a) regular income and total income, and whether the income is earned on a permanent or temporary basis; b) assets, including financial investments and any cash deposits, but excluding personal and investment property and pension funds; c) financial commitments, including regular, existing or future commitments. if a prospective non-sophisticated investor do not provide the information required to conduct the entry knowledge test, or if the csp considers, on basis of the assessment made as per the outcome of the entry knowledge test, that the given prospective non-sophisticated investor has insufficient knowledge, skills or experience, the csp must inform the prospective investor as deemed a non-sophisticated investor, that the services offered on their crowdfunding platforms may be inappropriate for said investor and issue a risk warning hereto. but the csp shall not prohibit such non-sophisticated investor from access to the platform nor the available investments. the risk warning shall clearly state the risk of losing the entirety of the money invested. hereto it is a requirement, that such prospective nonsophisticated investors must expressly acknowledge that they have received and understood the warning issued by the csp according to art. the new eu crowdfunding regulation 66 21(4). subject to such acknowledgement, the non-sophistcated investor will be granted access to the platform. further, according to art. 21(7), each time before a prospective nonsophisticated investor or non-sophisticated investor accepts an individual crowdfunding offer thereby investing an amount that exceeds the higher of either eur 1,000 or 5 % of the given investor’s net worth, such result being based on the outcome of the simulation test of the ability to bear loss, csps must ensure that such investor: a) receives a risk warning; b) provides explicit consent to the crowdfunding service provider; and c) proves to the crowdfunding service provider that the investor understands the investment and its risks. such protective measures imposed towards the investors on the crowdfunding platforms can be seen as somewhat restrictive in the sense of being ”limiting” towards investors. however, the outmost consequence of the measures is the issuance of a risk warning with the investor having to acknowledge receival of the risk warning. therefore, as also according to art. 21(6), the rules do not prevent prospective non-sophisticated investors and non-sophisticated investors from investing in crowdfunding projects despite the outcomes of the entry knowledge test and/or simulation test of ability to bear loss. complementing the described distinction process, the ecspr holds provisions regarding a pre-contractual reflection period of four (4) calendar days for non-sophisticated investors from the moment of the offer to invest or ”the expression of interest” to invest in a crowdfunding offer according to art. 22(3). during the pre-contractual reflection period, the prospective nonsophisticated investor may, at any time, revoke his or her offer to invest or expression of interest in the crowdfunding offer without giving a reason and without incurring a penalty according to art. 22(2). seen from a danish perspective of law, the question can be raised of whether such investment in a crowdfunding offer conducted through an online platform is subject to sections 18(2)(15) according to section 18(3) of the danish consumer protection act. as per the danish consumer protection act, consumers making online purchases subject to said provisions, holds the right to cancel purchases in a period of fourteen (14) days from receival of order. in case of such transaction investing in a crowdfunding offer being subject to said provisions, the pre-contractual reflection period of the ecspr loses relevance, if the cancellation right was applicable anyways. reflecting further on the pre-contractual reflection period, it can be noted, that the danish consumer protection act is the result of the implementation of eu directive 2011/83/eu on consumer rights (the “eu consumer rights directive”), hence suggesting that the ecspr’s provisions on the pre-contractual reflection period may also lose some njcl 2022/2 67 relevance in other eu member states, depending on the interpretation of the eu consumer rights directive in the respective eu member states. the pre-contractual reflection period can also be seen in the context of danish corporate law. according to section 9 of the danish companies act, the majority of all shareholder resolutions are subject to an obligation of registration and must hereto be filed and duly registered with the danish business authority within two (2) weeks from passing the resolution (which may also conflicts with the danish consumer protection act albeit solely being a danish issue). in the case of crowdfunding offers, such registration-obliged shareholder resolution would presumably in most cases be investors’ subscription (i.e. issuance) of new shares in the legal entity of the project owner. according to section 31 of the danish companies act, investors cannot subscribe to new shares subject to reservations, i.e., a cancellation right. the pre-contractual reflection period may in this regard be seen as an subscription of shares subject to reservations. the above highlights the fact, that ecspr clearly is conflicting with the danish companies act by its provisions on the pre-contractual reflection period. further, the danish consumer protection act can be seen as ”conflicting” by means of potentially taking away some relevance of the ecspr’s provisions on the pre-contractual reflection period. 11. due diligence on project owners due diligence requirements follow of the ecspr’s art. 5, whereof csps are required to conduct a minimum level of due diligence on the project owner and related persons (i.e., the borrower or issuer of securities and related persons to that legal entity) prior to publishing the project sought funding for on the platform of the csp. the minimum level of due diligence which csps must perform (but not limited to) are to ensure that the project owner has no criminal record in respect of infringements of national legislation in fields of commercial law, insolvency law, financial services law, anti-money laundering law, fraud law or professional liability obligations and control that the project owner is not established in a non-cooperative jurisdiction, as recognised by the relevant union policy, or in a high-risk third country according to the definition hereof in art. 9(2) of directive (eu) 2015/849 (anti-money laundering directive “amld”). 12. handling of complaints the ecspr further obligates csps have in place effective and transparent procedures for the prompt, fair and consistent handling of complaints received from crowdinvestors and crowdlenders and shall publish and make those descriptions of those procedures available on the platform according to art. 7(1). the new eu crowdfunding regulation 68 further, the csps must make available standard templates for such complaints, and it must be free of charge for crowdinvestors and crowdlenders to complain against the csp. all complaints shall be investigated by the csp in a timely and fair manner, and the csp must hereafter communicate the outcome within a reasonable period of time to the complainant. 13. conflicts of interest preventive and mitigative measures remedying the csp’s possible conflicts of interest are legislated in art. 8. measures legislated in the ecspr are firstly, that csps are prohibited from having any “participation” in any crowdfunding offer on their crowdfunding platform, of which participation likely means that the csp -licensed legal entity cannot invest in offers in the same way as if the csp were a crowdinvestor on the crowdfunding platform. managers, employees and shareholders are allowed to invest in projects offered through their crowdfunding platform, however, it must be clearly disclosed which natural and legal person(s) that are admitted as crowdinvestors on the crowdfunding platform. further, the investing of such persons in project offered through the crowdfunding platform must be carried out on the same terms and conditions as those offered to other crowdinvestors. further, the csp cannot accept as project owners, in relation to the crowdfunding services offered on their crowdfunding platform, their managers, employees, or shareholders of the csp holding 20 % or more of the share capital (or voting rights). additionally, any natural or legal person linked to those managers, employees or shareholders by control (i.e., close links), as defined in point (35)(b) of article 4(1) of mifid ii, also cannot be accepted as project owners. the reference to mifid ii’s definition of close links considerably widening the extent of the prohibition and thereby protecting investors from conflicting interests. preamble (19) of the ecspr sets forth that csps should not accept any remuneration, discount or non-monetary benefit etc. for routing prospective crowdinvestors’ attention, and ultimately their investments, to a particular offer offered on their crowdfunding platform. however, csps are allowed to propose projects to individual crowdinvestors based on one or more specific risk indicative parameters and factors without this being seen as “investment advice” as defined in mifid ii. such parameters and factors could be the type or sector of business activity or level of credit rating, which the individual crowdinvestor explicitly has indicated in advance to the csp, in practice most likely indicated in connection when signing up on the crowdfunding platform. these measures are taken by the regulators in order to ensure that prospective crowdinvestors are offered investment opportunities on a neutral basis in accordance with the self-determined risk appetite of the crowdinvestor. njcl 2022/2 69 the use of filtering tools shall be seen in the context of offering investment opportunities on a neutral basis. in this regard, the ecspr protects csps since it explicitly states that such filtering tools or (investment) proposals based on parameters set by the crowdinvestor in advance, will not be seen as “investment advice” as defined in mifid ii. in accordance with the provisions of csps offering crowdinvestors investment opportunities on a neutral basis and in accordance with the crowdinvestors’ self-determined risk appetite, csps are allowed to have in place filtering tools on their crowdfunding platform. such filtering tools must be based on criteria relating purely on objective information. objective information in the context of a crowdfunding platform could, for example, be criteria as the economic sector, the instrument used (loans, securities etc.), key financial figures, interest rate (i.e., risk vs. reward) and risk category. however, with risk category as filtering tool, it is provided that the crowdinvestor is informed sufficiently regarding the calculation method of such risk category (i.e., full disclosure of calculation method). similarly, with key financial figures as filtering tool, it is provided that such key financial figures are calculated without any scope for discretion according to preamble (21). 14. prudential requirements according to the ecspr, crowdinvestors are exposed to potential risks related to the csps, particularly “operational risks” and in order to protect clients against such risks, csps are subject to prudential requirements, according to preamble (24). prudential requirements subject to csps concerns capital requirements thus mitigating the operational risks of the csp. the csps shall hereto, at all times, have in place prudential safeguards equal to an amount of at least the higher of either eur 25,000, or one quarter of the fixed overheads of the preceding year, reviewed annually. the fixed overheads must include the cost of servicing loans for three months if the csp also facilitates the granting of loans. the mentioned capital requirement must be in place in either the form of “own funds”, meaning capital existing as common equity tier 1 as referred to in the capital requirement regulation 201311 , or by an insurance policy (or a comparable guarantee) covering the territories of the eu where crowdfunding offers are actively marketed on the crowdfunding platform. the capital requirement may be fulfilled by a combination of common equity tier 1 funds and an insurance policy (or a comparable 11 common equity tier 1 according to regulation (eu) no 575/2013 (the “capital requirement regulation 2013” or “crr”), art. 26-30, after the deductions in full, pursuant to crr art. 36, without the application of threshold exemptions pursuant to crr art. 46 and 48. the new eu crowdfunding regulation 70 guarantee), according to art. 11(1-2). the specific required terms and characteristics of such insurance policy are governed by art. 11(6-7). in regard to the fixed overheads, specific methods for the calculation hereof are governed by art. 11(8-9). 15. non-obliged entity (anti-money laundering) it follows from the ecspr’s preamble (32), that csps can be exposed to money laundering and terrorist financing risks, which was underlined in a report of 26 june 2017 from the commission to the european parliament and the council. hence, the question was raised of whether the ecspr should set forth csps as entities obligated to comply with the national law of the given eu member state which implemented the amld. in response, the commission will in a report be assessing the necessity and proportionality of subjecting csps to the amld by adding csps to the obliged entities under the purposes of the amld. the commissions’ report assessing the question will come out by the latest of 10 november 2023. under current applicable law, csps are not obliged entities under the amld, however, we may see gold plating from local legislators thus amending their national law, which implemented the amld, to include csps to the list of obliged entities. in denmark csps will (very likely) be subject to the danish aml act. 16. key investment information sheet csps shall provide prospective crowdinvestors with a so-called key investment information sheet (“kiis”) which shall be made available in at least one of the official languages accepted by the given eu member states’ fca. the information of the kiis must be in accordance with the provisions set forth annex i of the ecspr. apart from information on the project owner(s) and the crowdfunding offer, annex 1 further provides, that the kiis must, among others, contain descriptions and information on the crowdfunding process, conditions for the capital raising or funds borrowing (as applicable), information related to the offer of transferable securities and admitted instruments for crowdfunding purposes (as applicable), information on spvs (as applicable), specific disclosures in regard to loans (as applicable), investor rights, risk factors and fees. art. 23 of the ecspr further provides that the kiis must contain specific disclosures stating that the crowdfunding offer at hand has not been verified or approved by competent authorities (i.e., esma or an fca) and that the crowdinvestor may suffer loss of the entire capital invested. further, the disclosure notes for the investor, shall also state that the invested capital is not covered by the deposit guarantee scheme or investor compensation scheme. the disclosures are expressly and explicitly formulated in art. 23(6)(b-c), and the kiis must contain these njcl 2022/2 71 disclosures in unmodified form appearing directly underneath the title on the kiis document. the kiis must be ”fair, clear and not misleading” and shall not contain any footnotes, other than those with references, including quotations where appropriate, to the applicable law. the kiis shall be presented on a stand-alone, durable medium that is clearly distinguishable from marketing communications and consist of a maximum of six sides of a4sized paper format according to art. 23(7). project owners are requested to notify the csp in case of any changes in information regarding the crowdfunding offer, in order for the csp to keep the provided kiis updated at all times. csps must immediately inform investors who have made an offer to invest or expressed an interest in the crowdfunding offer about any material change to the kiis according to art. 23(8). if a csp identifies an omission, mistake or inaccuracy in the kiis that could have a material impact on the expected return of the investment, the csp must signal such an omission, mistake or inaccuracy promptly to the project owner, who shall promptly complete or correct that information according to art. 23(12). the eu member states shall ensure that their laws, regulations and administrative provisions on civil liability apply to natural and legal persons apply to at least the project owner and its management body, who shall be responsible for the correctness of information regarding the kiis. those responsible for the kiis and its information shall be clearly identified in the kiis by, in the case of natural persons, their names and functions or, in the case of legal persons, their names and registered offices. further, the responsible person(s) must declare that, to the best of their knowledge, the information contained in the kiis are factual and that they have made no omissions in the provided information likely to affect its appearance towards prospective crowdinvestors according to art. 23(9-10). 17. conclusion although the implementation deadline of the ecspr in denmark is closing up, the danish fsa has still not made an application form available for existing and new crowdfunding providers to be licensed in denmark. consequently, applications must for now be made according to the application annex issued by esma, leaving the applicants with some uncertainty. the danish fsa has stated that the national application form will not be issued until the commision has adopted and thus issued a delegated regulation on the regulatory technical standards regarding application process and scheme12. 12 finanstilsynet (the danish fsa), ’finanstilsynet skal godkende udbydere af crowdfundingtjenester’ (june 23 2022) https://www.finanstilsynet.dk/nyheder-ogpresse/pressemeddelelser/2021/crowdfunding_101121, accessed july 7 2022. the new eu crowdfunding regulation 72 as the danish fsa, moreover, require not less than three (3) months case processing time, the latest application date is 10 august 2022 if the applicant shall have obtained the license not later than the implementation deadline 10 november 2022, assuming that the application is mint and raises no comments from the danish fsa. though the new legal crowdfunding regime to a far extent is clear in a legal perspective, there are still uncertainty on some aspects, and as no danish guidelines exist, this applies to the application process and practicalities as well. rene.pmd nordic journal of commercial law, issue 2004 #1 1 conformit y of goods in international sales governed by cisg article 35: caveat venditor, caveat emptor and contract law as background law and as a competing set of rules rené franz henschel nordic journal of commercial law issue 2004 #1 nordic journal of commercial law, issue 2004 #1 2 1. introduction in his pioneering work das recht des warenkaufs, ernst rabel undertook a comparative analysis of sales laws with a view to postulating common global rules on the sale of goods. following a review of the concept of ‘lack of conformity’ of goods2 to the contract in different western legal systems, rabel reached the following conclusion:3 “das »wesen« der gewährleistung ist nur historisch erklärbar. in einem rationellen system ein stück vertragsrecht, das ausdrüchliche fürsorge nur in einem bescheidenen mabe benötigt.” the background to rabel’s conclusion was that the legal systems which he had studied had differing views about the legal conditions for a buyer to claim that the goods lack conformity to the contract.4 thus, he found that some legal systems considered lack of conformity from a standpoint which has its roots in the roman law principle of tale quale, where it is assumed that the goods are ‘bought as seen’ (also referred to as the principle of caveat emptor5), according to which there is an assumption that the buyer bears the risk if it appears that the goods do not conform to the contract.6 other legal systems had developed more balanced rules, where the assumption was that the seller is responsible for defects in the goods, including those based on explicit or implicit guarantees about the quality of the goods (and the principle of caveat venditor which is derived from this), while yet other legal systems have operated without codified definitions of lack of conformity.77 cf. also andreas schwartze: europäische sachmängelgewährleistung beim warenkauf: optionale rechtsangleichung auf der grundlage eines funktionalen rechtsvergleich (tübingen, 2000), p. 26; reinhard zimmermann: the law of obligations (münchen, 1993), p. 307. here the assessment of lack of conformity was developed in the practice of the courts and in theor y on the basis of principles which were largely similar to those known from the other legal systems with codified rules for assessing lack of conformity. on this basis, rabel recommended that an attempt should be made to work out a common definition for lack of conformity of goods to the contract: “es bleibt nötig, den begriff des sachmangels zu definieren, aber nur deshalb, weil die mängelskataloge derzeit abweichen und zusammengefabt werden müssen.”8 among other things, it was on the basis of rabel’s work that the uniform sales laws, ulis9 and ulf10 were developed, and these later led to the adoption of the cisg in 1980.11 on the basis of rabel’s recommendations, it was decided to include a rule in the uniform sales laws and in the cisg on the conformity of the goods to the contract. the rule in article 35 of the cisg is as follows: article 35 (1) the seller must deliver goods which are of the quantity, quality and description required by the contract and which are contained or packaged in the manner required by the contract. (2) except where the parties have agreed otherwise, the goods do not conform with the contract unless they: (a) are fit for the purposes for which goods of the same description would ordinarily be used; (b) are fit for any particular purpose expressly or impliedly made known to the seller at the time of the conclusion of the contract, except where the circumstances show that the buyer did not rely, or that it was unreasonable for him to rely, on the seller’s skill and judgement; (c) possess the qualities of goods which the seller has held out to the buyer as a sample or model; nordic journal of commercial law, issue 2004 #1 3 (d) are contained or packaged in the manner usual for such goods or, where there is no such manner, in a manner adequate to preserve and protect the goods. (3) the seller is not liable under subparagraphs (a) to (d) of the preceding paragraph for any lack of conformity of the goods if at the time of the conclusion of the contract the buyer knew or could not have been unaware of such lack of conformity. in recent years, the cisg in general and the provisions on lack of conformity in article 35 in particular have prompted a number of changes to national sale of goods laws. more recently there have been changes to the eu law on the sale of goods, following the adoption of a directive on the sale of consumer goods which was also strongly influenced by the cisg rules on lack of conformity.12 the focus of this article on the provisions of article 35 on the conformity of goods to the terms of a sales contract also leads to a focus on the inspiration for changes made to sale of goods laws in a number of legal systems, including eu law. the purpose of this article is twofold: namely to analyse the battle between the principles of caveat venditor and caveat emptor and to analyse the relationship between article 35 and the contract law as background law and as a competing set of rules. the aim is to illustrate whether or not article 35 creates uniform rules on the conformity of goods in international sales. the article first discusses the basic principles of article 35. then, the relationship to supplementary and competing rules is discussed. the article then analyses how theory and practice generally have seen article 35 as an independent concept. following this, the battle between caveat venditor and caveat emptor is described through an analysis of art. 35(2)(a) and article 35(3). finally, the paper ends up concluding that the article 35 operates in an area of tension between differing doctrines and rules of the law of obligations, so there is sometimes conflict and thus uncertainty about the application of article 35. this is unquestionably a problem to achieving uniform application of the provision. 2. the basic principles of article 35 article 35 is founded on the basic principle that the seller has a duty to deliver the goods required by the contract. the premises of this argument are exoteric, evident and universal: the characteristics of the goods are presumed to lie within the sphere of influence of the seller,13 and the seller is presumed to know more about the characteristics of the goods than the buyer who has paid for the goods and is therefore entitled to receive his part of the bargain (quid pro quo). in this respect the starting position of the convention is caveat venditor, which has been the general tendency in the law on the sale of goods since the end of the 19th century.14 this is a natural solution in international sales law, where there are distances and where the buyer often enters into an agreement without having had previous sight of the goods. as distinct from the roman law of the market, where the prime rule was caveat emptor, trading at a distance means that the buyer must rely to a higher degree on the information in the contract and on the seller’s information about the goods. furthermore, the seller is usually the one who knows about the goods. the seller becomes the “eyes” of the buyer, so that the nature of the goods is overwhelmingly a matter within the sphere of influence of the seller. the seller must answer for the information he gives and what is agreed. the conclusion is that the seller – as a starting point – must effectively carry the risk of the goods conforming to the contract, and that the buyer can, with justification, expect to receive deliver y which conforms to the contract.15 the principle underlying article 35 is an ethical-juridical axiom,16 and constitutes an important element of the guarantee of trade.17 if the premises of the argument are changed, for example if the buyer supplies materials for the manufacture of the goods, if the buyer plays a role in selecting the goods or materials for them, or if the buyers knowledge and skills are superior to the sellers,18 then nordic journal of commercial law, issue 2004 #1 4 the validity of the argument is weakened, and the allocation of risk changes, since there are now elements which are outside the seller’s sphere of influence which can affect the assessment of lack of conformity to the contract.19 the conformity of the goods to the contract now falls within the buyer’s sphere of influence – caveat emptor. this alternation between caveat venditor and caveat emptor is the core of article 35 and – in general – in ever y assessment of the conformity of the goods. article 35 can therefore be considered as a rule in which the principles of caveat emptor and caveat venditor meet. it is only through a careful balancing of these principles that it is possible to decide whether or not a good complies with the contractual obligations or not. it is the proposition of this article that the principles of caveat emptor and caveat venditor, as expressed in article 35, should to a large extent be assessed on the basis of which party’s sphere of influence is more closely linked to the conformity of the goods to the contract, and on the basis of a number of suggested presumptions. for example, the starting point is that it is assumed that the seller should supply goods which are of the description laid down in the contract, cf. article 35(1), or are fit for the purposes for which goods of the same description would ordinarily be used, cf. article 35(2)(a). if the goods do not meet these standards, they do not comply with the contract. in other words, the starting point is the principle of caveat venditor. but what if there is a difference between the understanding of the terms in the contract, normal quality standards or fitness for purpose between the seller’s country and the buyer’s country? in this case, it is assumed that the seller should supply goods which meet the standards in the buyer’s country or in the seller’s country? unless the solution follows from an interpretation of the contract, this can only be decided if a choice is made between the principles of caveat emptor and caveat venditor. it is the proposition of the present writer that the party with whose sphere of influence the disputed factors are judged to be more closely linked ought to be liable for ensuring that the goods comply with such contractual requirements. 3. article 35 and its relationship to supplementary and competing rules. in this article the analysis of art. 35 are also based on the argument in rabel’s general conclusion that the assessment of lack of conformity is not an independent legal category, but is part of the law of contract. the law of contract is customarily divided into special parts, e.g. the sale of goods, and the general part containing the basic legal principles of obligations. however, these fundamental rules, or principles, are also expressed in the special parts so, for example, the danish law of sale of goods is regarded as a codification of many of the principles of the law of obligations. in other words, the law of sale of goods partakes both of the special part and the general part. the same can be assumed to apply to article 35. the provision lays down a number of rules which can be regarded as fundamental to international sales. however, the article should also be seen in the context of article 8 on interpretation and article 9 on usage. this means that it is relevant to study the content of the principles of each of these provisions. it is also clear that article 35, taken together with articles 8 and 9, cannot be assumed to be exhaustive with respect to the fundamental rules and principles which are relevant to assessing the compliance of goods to the contract. other provisions in the convention must also be referred to, cf. article 7.20 for example, there can be fundamental rules on bona fides, contract interpretation or on estoppel (under the rule of venire contra factum proprium, by which a party cannot contradict his own previous conduct). if the convention does not provide all the answers, then help can be sought elsewhere when making a thorough apportionment of liability under the law of obligations. in such circumstances it may be possible to apply both national rules and principles, but internationally recognised rules and principles, for example unidroit principles (by the international institute for the unification of prinordic journal of commercial law, issue 2004 #1 5 vate law) or pecl (principles of european contract law by the commission on european contract law, also known as the lando-commission) may be helpful in providing a truly international and uniform solution. there are also provisions which compete with article 35, in particular the rules on validity. since article 4 clearly states that the convention – unless otherwise expressly provided – is not concerned with the validity of a contract, national laws should apply. however, on certain occasions the rules on validity will overlap with the rules on lack of conformity, for example in cases of mistake. in other words, there can be situations in which there are conflicts between the convention and national law, unless the convention supersedes or absorbs the competing national rules. it is therefore not possible to analyse the concept of lack of conformity in article 35 without taking account of the fact that the provision should be seen in the context both of general and of special contract law and the law of obligations, under the convention and outside it, just as article 35 finds itself in competition with such rules, for example national rules on validity. since there is no general agreement on these questions, due to the differing points of view on the priority of the convention and its regulator y scope, it is the second proposition of this article that article 35 cannot be expected to lead to a fully harmonised law before either the general contract law which lies behind it is harmonised, or the provisions of the convention are amended. to conclude, in every case where article 35 comes into play, this brings into focus the question of contract law as background law to the convention and as a competing legal regime, since a party will be able to address the question of conformity of goods from a number of different angles:21 -the formation of the contract (that the conditions concerning a specific characteristic “x” of the goods is actually in, or is not in the contract),22 -the interpretation of the contract (that the conditions concerning the characteristics of the goods means “x” rather than “y”), and -the validity of the contract (the party was misled, as he thought the quality was “x” when in fact it was “y”). in this context it is likely that a party will rely on the rules of the convention to support their arguments but it is also possible that national rules will compete with the convention rules and a party will be able to rely on these in the alternative. to a great extent the rules on formation of contract, interpretation and validity are the same in different jurisdictions, but there are still major in differences, i.e. between the literal approaches to contract interpretation in common law and the more liberal approach to contract interpretation in civil law.23 if the convention can be said to govern a question exhaustively, or if article 35 applies as a lex specialis, then it cannot be assumed that there is scope for competing rules, though this is not recognised by everyone. in jurisdiction in which there is a principle of exhaustion of rights, the contract law rules on lack of conformity of goods will have priority over certain rules on validity, but this is not recognised in all jurisdictions.24 there does not seem to be a prospect for solving this conflict before the underlying contract law is harmonised or the convention rules are amended.25 this means that the parties still need to make a choice of law in order to avoid unpleasant surprises. it should also be noted that there can be elements in the agreement which could trigger the application of other competing national laws, for example culpa in contrahendo or rules on product liability. according to the opinion of the present writer, if the convention does not give an exhaustive functionally adequate solution, then national rules ought to apply. for example, article 79 has been referred to as a competing provision granting exemption from liability which could undermine the nordic journal of commercial law, issue 2004 #1 6 seller’s liability to pay compensation for defects in the goods. honnold argues that if article 79 were applicable, this would undermine the seller’s obligation to deliver goods which conform to the contract, cf. article 35, since the courts would have to enter into complicated considerations of the seller’s and the third party’s possibilities for taking into account any structural failure in the planning or production process, etc.26 in contrast to this, the prevailing view in continental european doctrine is that article 79 can be relied on in cases of defective deliver y of goods.27 there is thus nothing in the rules of the convention, whether taken individually or collectively, which supports the view that the seller will not be able to rely on article 79 in cases of defective delivery.28 in the practice of the courts, article 79 is applied in cases of lack of conformity of goods to the contract.29 however, some aspects of the practice of the courts can be criticised for the use made of the provision, as article 79 ought, in general, to be applied relatively infrequently in connection with the delivery of defective goods.30 4. article 35 in theory and practice 4.1. the conformity of goods according to the contract – article 35(1) in general, courts have regarded favourably attempts to interpret article 35(1) as an independent concept which covers variances of quantity and quality, and the supply of totally different goods than those agreed, as well as the way the goods are contained or packaged. thus, concepts and distinctions which are rooted in national laws and which are relevant to evaluating the conformity of goods to the contract are rejected. in assessing the conformity of goods to the contract in accordance with article 35, the theory rejects impractical distinctions between delays and short deliveries, and both theory and the practice of the courts reject the idea of giving independent significance to special distinctions in national law between ordinary information and assurances and guarantees, even though the existence of assurances or guarantees can be included in an assessment under article 35.31 although the overall conclusion is that the starting point is that article 35 governs cases of aliud pro alio, there is some difference between the decisions of the german federal supreme court and the austrian supreme court, as the german court left the door slightly ajar in particularly gross cases of aliud.32 here, domestic rules on mistake might be allowed to govern the case, and therefore the parties ought to take this into consideration in there contract. the relevance of the concept of insignificant defects has been rejected both in theory and in practice,33 since any variance at all from the agreed description of the goods is assumed to mean that the goods do not conform to the contract. the significance of the defect for the buyer is then decided according to the rights of the buyer in the event of lack of conformity of the goods, and this will typically involve compensation or a reduction in the price, although a minor defect will also amount to a fundamental breach in some cases. furthermore, it is not relevant to distinguish between the container or packaging of goods and the conformity of the goods to the contract, since the requirements for the containment and packaging of the goods can be an integral part of the conformity of the goods to the contract under article 35. finally, the review of practice and theory shows that the interpretation of what requirements can be made of the goods, cf. article 35(1), is decided on the basis of an interpretation of the agreement between the parties, so that articles 8 and 9 are actively considered.34 national rules which compete with article 35, cf. articles 8 and 9, give way to the convention where the convention rules give guidance as to how a particular problem of law should be solved, cf. the ruling of the american courts to disregard the parol evidence rule in favour of article 8(3) in cases of lack of conformity covered by article 35(1).35 nordic journal of commercial law, issue 2004 #1 7 4.1. article 35(2)(a) – fitness for ordinary purposes the rule in article 35(2)(a) on the fitness of the goods for their ordinary purposes is not an objective legal standard, but a rule about the presumed intention of the parties which should be interpreted on the basis of all the relevant circumstances of the case, cf. article 8 and article 9.36 the starting point for assessing the ordinary use of the goods is the objective norm in the relevant commercial sector.37 some writers think that, in such cases, the principle should be that the norms in the seller’s state should apply.38 others think that such cases should be assessed according to the norms in the buyer’s state.39 yet others think that such general guidelines cannot be given, and that it depends on the actual circumstances of each case as to whether the norms of the seller’s, buyer’s, or some entirely different state should apply.40 if it is assumed that norms for the ordinary purposes of goods are often not defined in international trade, it must right to refrain from laying down absolute rules about which norms should be used. nevertheless, there can be situations in which it is not possible, on the basis of the interpretation of the agreement between the parties, to determine which norms the parties can be assumed to have agreed upon for assessing the fitness of the goods for their ordinary purposes. in such cases, the decision will depend on which party ought to bear the risk, if the goods cannot be used for what that party considers to be their ordinary use. in other words, in such cases there will be a presumptive rule to decide whether the starting point is that the norm in the seller’s or the buyer’s state, or some other state, should be decisive, since there should in any case be full apportioning of all the risks of the obligations arising out of the transaction between the buyer and the seller. here, the prevailing view, both in theory and in practice, is that the seller cannot be assumed to know of the norms in the buyer’s state.41 this is in line with the principle that it is not assumed that it is within the seller’s sphere of influence to know about the norms in the buyer’s state. this can also be justified on economic grounds, since the buyer can obtain the relevant information more effectively and cheaply than the seller can.42 this principle was laid down by the german federal supreme court in its decision of 8th march 1995 (the mussels case), where a swiss seller and a german buyer had entered into an agreement for the sale of new zealand mussels, which should be delivered to germany for onward sale. it was found that the mussels had such cadmium levels that the local german public health authorities could not declare that the mussels were safe to eat, since they possibly exceeded the recommended, but not binding, legal thresholds for meat products (the so-called zebs standard). because of this, the authorities requested further samples of the goods, in addition to the routine samples which had been taken when the goods arrived in germany. even though the sale and consumption of the mussels had nor been prohibited, so the mussels were still considered to be edible, the buyer demanded that the contract should be declared void, as there were now no german retailers or consumers who would buy the mussels. the german federal supreme court stated that, as a starting point, the conformity of the goods to the contract should be assessed on the basis of the agreement between the parties, cf. article 35(1). nothing had been agreed about the need for the goods to comply with the german standards.43 even though the goods had been delivered to germany, and the seller knew that the goods should be sold there, this did not mean it was implicitly agreed that the goods should be capable of being retailed, nordic journal of commercial law, issue 2004 #1 8 still less that they should comply with special german rules.44 in the absence of agreement, the conformity of the goods to the contract must be judged according to article 35(2)(a) and article 35(2)(b). by way of introduction, the court stated that it was not necessary to decide whether the ordinary use of the goods required them to be of average quality or merely of merchantable quality, since it had not been shown that the mussels delivered had a higher cadmium level than the average for mussels in new zealand.45 the court then stated that, even on the basis that the goods should be merchantable, meaning that they should be capable of being sold on, there was not a lack of conformity to the contract, since the seller could not be expected to know of the public health regulations in the buyer’s or consumers’ state.46 in the view of the court, it was not necessary to decide how far the compliance of the goods to the requirements of public law was, in principle, governed either by article 35(2)(a) or by article 35(2)(b). it was thus not necessary to express a view on the debate between legal writers about whether the standard in the seller’s state will always be decisive, so the conformity of the goods to public law requirements is not a question of the goods’ fitness for ordinary purposes, cf. article 35(2)(a), but should, where relevant, be decided under the provisions of article 35(2)(b) on particular purposes. in any case, the goods need only satisfy the requirements in the buyer’s state, where corresponding rules apply in the seller’s state, if the buyer has made the seller aware of such rules, in which case the matter would probably be decided under article 35(2)(b), or if, due to special circumstances, the seller knew or ought to have known of the rules in the buyer’s state. however, the court found that none of these circumstances applied in this case:47 thus, it was not shown that corresponding public health provisions applied in the seller’s state, switzerland. nor was the agreement about where the goods should be delivered and the final destination of the goods a sufficient condition under article 35(2)(a) or article 35(2)(b), even if it could be considered an indication that the buyer wanted to retail the goods in germany, since the seller could not be expected to know the frequently opaque public regulations or administrative practice in the buyer’s state, any more than the buyer should be expected to have the seller’s professional knowledge on matters which concerned him. it was most natural for the buyer to know the regulations in his own state, so the buyer should have made the seller aware of these regulations. this applied not least to the case before the court, which concerned not so much the cadmium levels for mussels, but the fact that the local german public health authorities applied the regulations for meat analogously to fish,48 which was not a widespread practice even in germany, just as there was doubt about what sanctions the authorities were authorised to impose. whether the decision would have been different if, for example, the seller knew of the public health regulations in the buyer’s state, or if the buyer could have assumed that the seller either knew or ought to have known of these regulations, perhaps because the seller had a branch in the buyer’s state, the parties had had a long-term trading arrangement, the seller had regularly exported to the buyer’s state, or the seller had marketed his goods in the buyer’s state, was irrelevant in this case, as the buyer had not asserted any of these circumstances.49 finally, it was not at the seller’s risk that the goods were confiscated, since the confiscation was made under the german public law rules which, as argued above, were a matter for which the buyer bore the risk. nordic journal of commercial law, issue 2004 #1 9 as stated by the german federal supreme court, the starting position can be derogated from if information about the norms of the destination state are brought within the seller’s sphere of influence, for example if the seller knows about the rules, if the parties have previously traded together and the seller knows of the buyer’s expectations, or if the seller has marketed the goods in the seller’s country. this was the case in the decision of the grenoble court of appealof 13th september 1995, where, on the basis of the negotiations between the parties etc., the seller of parmesan cheese could not have been unaware that the goods should be capable of being sold in france, and therefore had to satisfy the french requirements as to product declarations and ‘best before’ date as well as in the decision from the us district court, e.d. of louisiana, 17th may 1999, and the principles in the mussels case now seems to have widespread acceptance, see also the austrian supreme court of 13th april 2000, making the judgement of the german federal supreme court ipso facto stare decisis.50 4.2. the limited caveat emptor principle in art. 35(3) the idea behind this provision is that the buyer’s expectations will not be disappointed if he is aware of some defect, so the buyer ought not to enjoy the protection of the relatively “buyer-friendly” rules of article 35(2).51 article 35(3) is also an expression of a certain relaxation of the burden of evidence for the seller, who need not prove the buyer’s actual awareness of some defect, which can often be very difficult to prove, but merely that the buyer could not have been unaware of the defect.52 the fact that the seller is not liable not only means that the buyer cannot hold the seller responsible for the payment of compensation, but that all the remedies of the buyer lapse, for example, the right to revoke the contract, the right to have the goods repaired, and the right to a proportionate reduction in the price.53 compared with ulis article 36, samples and models are now also covered by the seller’s exemption from liability under article 35(3).54 the main area where this provision applies is in connection with the sale of specific goods, for example, second-hand machines,55 but the provision can apply to all kinds of sales covered by the convention, including goods manufactured to the order of the buyer, cf. article 3(1), and sales where a subordinate part of the sales contract consists in supplying labour or other services, cf. article 3(2).56 as will be seen in the following review of this provision, it expresses a limited caveat emptor rule.57 according to its clear wording and its antecedents, article 35(3) only covers cases that are covered by articles 35(2)(a) to (d). if the seller delivers goods and the buyer knew or could not have been unaware that they were not fit for their usual purposes, or for the particular purpose of the buyer, or did not possess the qualities of a sample or model, or were not contained or packaged in a usual or adequate manner, then the seller is not liable. at the diplomatic conference in vienna, norway proposed that article 35(3) should also refer to article 35(1), but this was rejected by a majority of the delegates. this is also expressed in the secretariat commentary, though it only refers to cases where the requirements are expressly stated in the agreement.58 this means that an analogous or expanded interpretation of the provision so as to apply it to article 35(1) seems in principle to be ruled out,59 at least where the requirements for the goods are explicitly stated in the agreement between the parties. the background for this restriction in relation to article 35(1) is the view that a buyer out to be able to rely on what the parties have agreed. therefore, the starting point is that the buyer can assume that the seller will make good any defects if there is any discrepancy between the contract and the goods nordic journal of commercial law, issue 2004 #1 10 inspected, cf. in more detail below.60 the presumptive rule in article 35(3) must mean that it is the seller who must, in the first instance, show that the parties have agreed that the goods shall a different quality than that stated (in practice, explicitly) in the agreement; in other words, the fact that the buyer knew of or could not have been unaware of the defect, and that those parts of the agreement which conflict with this cannot be relied on by the buyer. if this were not the case, and if there were a reference to article 35(1) in article 35(3), the provision could support the view that the seller could argue that the buyer had, de facto, accepted that the goods should be delivered with the defects in question, merely by showing that the goods were defective when they were examined by the buyer, or that the buyer knew that the goods did not conform to the contract on the basis of other information.61 however, this argument is somewhat weakened by the argument that articles 35(2)(a) to (d) are largely an expression of rules of contractual interpretation which do not, in principle, need to be stated, but can be contained in article 35(1).62 in any event, the fact that there is not a reference to article 35(1) in article 35(3) gives some protection to the buyer. this means that the buyer is entitled to expect that the goods will conform to the agreement, in practice the written agreement, and that any variance from what should apply under the agreement and under article 35(1) will be made good by the seller prior to delivering the goods to the buyer.63 this applies regardless of whether the buyer knows of a defect, if it is agreed64 that the seller shall deliver the goods without the defects.65 the principle that article 35(3) does not apply in connection with article 35(1) can also be said to apply under the general rules of contractual interpretation. under the general rules of priority, the parties must be assumed to have expressed their wishes in their written agreement. if the seller has drafted the terms of the contract, then any lack of clarity will be construed against him. an example of this is the situation in which the buyer, either prior to entering into an agreement or in connection with the agreement, examines a construction vehicle which is quite obviously missing a wheel. immediately afterwards, the buyer sends his order, to which he adds that he expects the vehicle to be delivered in a state in which it is “ready to drive”. the seller accepts the order by sending the vehicle to the buyer, but without it being ready to drive. at no point have the parties discussed the missing wheel. the fact that the construction vehicle was missing a wheel effectively means that it was not fit for the purpose for which goods of that description are ordinarily used, since it could not be driven. however, article 35(2)(a) is not applicable, since the goods have been described as being expected to be “ready to drive,” cf. article 35(1). in such a situation the assumption under article 35(1), cf. article 35(3), is that the buyer is entitled to have a vehicle delivered which is ready to drive, and thus with all its wheels, since this is clearly expressed in the agreement. the fact that the buyer knew from his examination of the goods, or could not have been unaware, that at the time of the entering into the agreement, the vehicle was not in fact ready to drive, cannot justify exempting the seller from liability under article 35(3). the fact that the seller cannot rely on the provisions of article 35(3) does not mean that he cannot rely in the provisions of article 35(1). thus, under article 35(1), which is the primary rule in article 35, the seller has the possibility of showing that, despite the wording of the written agreement, the parties have otherwise agreed that the vehicle should be delivered as seen, or that the buyer could not nordic journal of commercial law, issue 2004 #1 11 have been unaware that the goods were not as described in the agreement.66 for example, this may be supported by witness statements or on the basis of the practice or usage between the parties, cf. articles 8 and 9. schlechtriem gives another example of this dichotomy, where a buyer has examined a machine which, on the basis of its construction and the kind of steel plates which can be used by the machine in production, can only produce steel wire up to a thickness of 1mm, but where the contract states that the machine can produce steel wire up to a thickness of 2mm. in schlechtriem’s view, it is an open question whether the buyer will be able to hold the seller liable. according to schlechtriem, this will depend on the facts of the case, cf. article 8(3).67 the evaluation of these cases could thus depend on whether the seller could make good the defect relatively easily, or whether this would require extensive and expensive changes to the goods before they could live up to the specifications of the buyer.68 in the example with the construction vehicle, this would typically be to the advantage of the buyer, but in the example with the wire drawing machine, this would be to the advantage of the seller. it would seem more reasonable to focus on the price of the goods, since this can indicate whether the buyer can expect the quality of the goods to be brought up to the level expressed in the agreement or not. in schlechtriem’s example, this could also follow from the minimum rule, since the seller cannot be presumed to have entered into a contract which results in extraordinary costs for him. reference can also be made to the principle of equivalence and thus to interpretation on the basis of reasonableness. this means that it does not seem possible to fix a precise limit to when the provision in article 35(3) applies, and the special circumstances under which a defect cannot form the basis of a claim, and when article 35(1) applies, so there is not, by definition, a defect since the buyer has merely received what has been agreed, cf. articles 8 and 9.69 in other words, the application of article 35(3) is conditional on it having been established that there is a defect, which will not be the case if, under article 35(1), it is found that the buyer has got what was agreed. this is a dichotomy which undermines the restriction of article 35(3) to apply only to cases covered by article 35(2).70 see the decision of the vaud cantonal appellate court of 28th october 1997.71 an oral agreement was entered into for the sale of a second-hand bulldozer between an italian seller and a swiss buyer. the buyer examined the bulldozer before the contract was entered into. it was agreed that the seller should carry out 3 minor repairs before delivering the machine to the buyer. after the bulldozer had been delivered, the buyer complained about other defects. to start with, the court stated that, according to article 35(1), a seller has a duty to deliver goods in accordance with the agreement between the parties. however, this was not the case if the buyer knew or could not have been unaware that the goods were defective, cf. article 35(3). a buyer who buys goods, despite their obvious defects, must be assumed to have accepted the goods as they are. this is also in accordance with the principle in article 36 and the observance of good faith in international trade.72 in this case, the seller had explicitly informed the buyer about the condition of the good, and the buyer had also tested the bulldozer. apart from the three repairs, there was no agreement that anything else should be done to the bulldozer, so the seller had delivered the goods as agreed, and in a condition which was known to the buyer, so the seller had no further liability, cf. article 35(1). see also the decision of the sion cantonal appellate court of 29th june 1998, which concerned the sale of sports clothing as part of a reciprocal distribution agreement between a swiss buyer and an italian seller.73 in its analysis of the conformity of the goods to the contract under article 35(1), the court emphasised that the buyer could not complain about defects of which he either knew or could not nordic journal of commercial law, issue 2004 #1 12 have been unaware, cf. article 35(3). a person who buys goods despite their obvious defects accepts the goods as they are. the court also said that this is in accordance with the principle in article 36 and the observance of good faith in international trade.74 thus, both decisions directly link the application of article 35(3) to article 35(1), and refer to the principle in article 36 and the observance of good faith in international trade, even though this is directly contrary to the wording of article 35(3) and the antecedents of the provision and the view of it in theory.75 however, it is not necessar y to apply article 35(3) if it has been agreed that the goods shall have the quality in question, since article 35(3) will not then be relevant. however, it can sometimes be very difficult to establish what has been agreed. neither of the cases referred to above involved clear written requirements for the goods. in this respect see the decision of the us district court, illinois, eastern division, of 28th october 1998. a swedish seller offered aircraft spare parts for sale on an international database using specification numbers. the buyer understood that each part had an individual number, while the seller intended the parts to be offered under several different specification numbers. the buyer placed an order for spare parts with the specification number 729640. in his order confirmation the seller had given the same number, but did not think this was decisive as he had previously sent the buyer a fax in which he stated that he could not be absolutely sure that the parts had the number given. he therefore sent the buyer a fax giving the numbers which were on the spare parts, and encouraged the buyer to check that the spare parts corresponded to the specification numbers. furthermore, the seller pointed out that the buyer was a specialist in the trade in spare parts of this kind, but the seller was not. it was therefore at the buyer’s risk that he had not investigated the spare parts in more detail prior to buying them. in refusing to give a preliminary ruling, the court said that in deciding whether the goods conformed to the contract or not, attention should be paid not only to the statement of the specification number in the order and order confirmation, but also to the intentions of the parties, cf. article 8(1). in this connection, all the relevant circumstances of the case should be taken into account, including the negotiations between the parties, cf. article 8(3). the court thus rejected the application of the parol evidence rule. this decision also illustrates the connection between article 35(1) and article 35(3). the seller had clearly listed the goods with the specification number in the contract. according to a restrictive theory, article 35(3) does not apply, but this presupposes that there is a defect. there will not be a defect if it has been agreed that the seller cannot guarantee that the spare parts have the given number, or that the buyer accepts the risk of this. this shows that this question is closely linked to whether the seller has given a guarantee or assurance of the description or quality of the goods. it also shows that the application of article 35(3) may not exclude the use of certain elements of contractual interpretation, cf. article 8(3), since otherwise article 35(3) would be a de facto parol evidence rule. unless it is clear from the agreement that the buyer can expect the goods to be free from defects upon delivery, a buyer who insists on enforcing the written contract, even though he knew that the goods were not free from defects, will not be entitled to a remedy, cf. the general principles of good faith, venire factum contra proprium76 and the observance of good faith in international trade.77 as stated, it is also possible that the buyer may not claim that the goods are defective if they are in accordance with the practice or usage of the parties, for example if the seller has usually sold goods to the buyer which have been defective without the buyer objecting, or if, purely on the basis of the price of the goods, the buyer should expect to receive defective goods.78 however, the most simple solution is to conclude that the condition of the goods, as known to the nordic journal of commercial law, issue 2004 #1 13 buyer, should be the basis for defining the agreement between the parties, cf. article 35(1).79 in this connection, see the decision of the tribunal of international commercial arbitration at the russian federation chamber of commerce, of 22nd january 1997.80 an agreement was entered into between a german seller and a russian buyer for the sale of 300 tons of butter. at least, that was what the buyer understood. in the pre-contractual negotiations the butter was described as “table butter 82% fat”, and in the seller’s invoices as “animal fat butter”. however, the seller was not able to procure belgian butter, so he wrote to the buyer saying that he would instead supply “absolutely equivalent english butter”. in the accompanying specification the goods were stated to be “pura sub butter, 80% fat content, 05-07 salt content”. the buyer accepted this offer. upon the arrival of the goods in russia, the obligatory certificate of quality had to be obtained. the buyer obtained a report from the certifying institute in russia. from this appeared that the goods were in fact margarine (“pura sub butter” corresponded to “domestic margarine of standard quality”), and that under the russian public health rules there the level of lead in the butter was higher than permitted, so the obligator y certificate of quality could not be issued. the buyer then rejected the goods on the grounds that they did not conform to the contract, and claimed compensation corresponding to the difference in price between margarine and butter. the seller rejected the buyer’s claim “pura sub butter” had been sold, and because the seller did not believe that the finding of the certifying institute should be decisive, since tests made in germany did not show too high a level of lead. the arbitration tribunal started by stating that, by accepting the offer of the seller, despite the different description of the goods, the buyer had accepted delivery of margarine, cf. article 35. since the buyer had not asked for a reduction of the price in this connection, the buyer could not subsequently claim such a reduction.81 the contract did not provide for how certificates of quality required by law should be obtained. according to the rules in the buyer’s country, the buyer could obtain a statement from an expert from the local certifying authority. since the tribunal did not have any reason to doubt the conclusion of the report, the seller’s claim for compensation for the costs of the buyer’s rejection of the goods was dismissed, since the buyer was unable to accept delivery for reasons which were beyond his control, cf. article 74. this decision is a good illustration of the close connection between a decision about whether the parties have agreed on the specification of the goods, and the question of whether, if agreement has not been made on the specific point, the buyer knew or could not have been unaware of the defect. in the unilex database the decision is listed under article 35(3), but strangely enough, not under article 35(1). an explanation for this can be that there is nevertheless some doubt about whether it was agreed that butter should have been delivered. the great majority of the written material points towards the conclusion that the goods should have been butter. the specification of the goods was decisive. normally this follows from the ordinary rules of interpretation, cf. the rule of priority, but in this case the specification of the goods effectively meant that the primary description of the goods in the contract (butter) was changed to something totally different (margarine). this somewhat undermines the application of the rule of priority. at the same time, the buyer appeared to pay the price for butter, which ought also to have been considered relevant to the interpretation, cf. the minimum rule. finally, the status of the parties can be relevant, and this is not referred to in the report of the case.82 if it can be shown that the buyer knew or could not have been unaware of some lack of conformity of the goods to the contract, the assumption is that the seller will be exempt from liability. however, there is an exception to this where the seller has deliberately and in bad faith kept quiet about a defect nordic journal of commercial law, issue 2004 #1 14 which was known to him, since even a buyer who is grossly negligent is more deserving of protection that a seller who acts in bad faith. in such cases, the seller cannot rely on the buyer’s acceptance of the goods as being in conformity with contract, cf. the principle of the observance of good faith in international trade, cf. article 7(1), as well as the principle in article 40 that the seller is not entitled to rely on the provisions of articles 38 and 39 if the lack of conformity relates to facts of which he knew or could not have been unaware, cf. article 7(2).83 this principle is clearly established in the decision of the cologne provincial court of appeal of 21st may 1996, on the sale of a car which it appeared had a higher mileage than shown in the contract between the seller and buyer and than shown on the car’s odometer. also, the car had initially been registered in 1990, and not, as stated in the contract, in 1992. after having established that the goods did not conform to the contract in accordance with article 35(1), the court held that the seller could not have been unaware that the car had been registered earlier than was shown in the contract, and that it must have been driven further than shown on the odometer. the seller’s claim that the buyer could not have been unaware that the car was registered in 1990, as the buyer’s wife had been informed of this, so that the buyer could not make a claim to this effect, cf. article 35(3), was rejected by the court, on the grounds that even a very negligent buyer deserves more protection than a fraudulent seller. the court stated that this was in accordance with the principle in article 40, in connection with article 7(1).84 in this case, an objection to the validity and revocation of the contract would not be relevant, since the car had been sold on, and the buyer had an interest in obtaining a remedy in the form of compensation, as he had already paid out compensation to the subsequent buyer of the car. the seller had to have acted in a culpable manner for compensation to be payable. however, if the buyer has positive knowledge of the defect, he cannot benefit from this protection, as the seller will have been able to rely on the seller’s acceptance of the goods. the principle was also laid down in the decision of the arbitration institute of the stockholm chamber of commerce, 5th june 1998, which stated that a seller cannot rely on the provisions of articles 38 and 39, cf. the principle in article 40 which applies as a general principle, cf. article 7(1), regardless of whether there was a lack of conformity of the goods to the contract according to article 35, or as the result of a contractual guarantee given by the seller. if the seller has given a guarantee or assurance to the buyer that the goods are without defects, the assumption is that the buyer will be able to base a claim on any defects, regardless of whether the buyer could not have been unaware of the defects.85 here, the caveat venditor seems to supersede the caveat emptor. 5. conclusive remarks as stated in the beginning of this article, the assessment of the lack of conformity of goods to the contract is not an independent legal category, but is part of the law of contract. article 35 is an attempt to express the contract law principles on the assessment of lack of conformity, and in its provisions the principle of caveat venditor confronts the principle of caveat emptor. as also stated, the principles of caveat venditor and caveat emptor, as expressed in article 35, should be considered mainly on the basis of which party’s sphere of influence is more closely linked to the conformity of the goods to the contract. this leads to proposals for a number of presumptive rules. the party, whose sphere of influence lies closest to disputed circumstances which are relevant to the conformity of the goods to the contract, ought to bear the risk if, in respect of these circumstances, nordic journal of commercial law, issue 2004 #1 15 the goods do not (allegedly) conform to the contract. the review of the practice of the courts and of legal theory also shows that the assessment of lack of conformity to the contract under article 35 requires a balance to be struck between the principles of caveat venditor and caveat emptor, as expressed in article 35 and in general contractual principles. where article 35 does not give any direct guidance, the courts fall back on consideration of the relevant sphere of influence, which can also be seen as an expression of reasonableness or of economic considerations. thus, the assumption is that the norm in the seller’s country shall form the basis for judging what is a customary purpose, or a particular purpose or the usual manner for containers and packaging. these principles find strong support in the decision of the german federal supreme court of 8th march 1995, which has been widely accepted both in practice and in theory. there are a number of exceptions to this rule which are also expressions of the concept of the sphere of influence, for example if the seller is aware of the norms which apply in the destination state of the goods, regularly makes exports there, or markets his goods to that countr y etc., just as the generally recognised principles of contractual interpretation apply. laying down such assumptions, and exceptions to them, affects the burden of proof, as the buyer must show that the seller knew or could not have been unaware of the norm in the destination state, i.e., that the relevant elements were within the seller’s sphere of influence. it is also pointed out that there are a number of rules which compete with article 35, especially rules on contractual validity. since the convention does not, in general, govern questions of validity of contracts, the assumption is that national law should apply to such cases. however, in some cases the rules on validity overlap with the rules on lack of conformity, for example where one or other of the parties has been misled. this means that there is potential conflict between the convention and national laws, unless the convention displaces the competing national rules. this means that it is not possible to analyse the concept of lack of conformity contained in article 35 without at the same time recognising that the provisions should be seen in the context of the rules of general contract law, both under the convention and outside it, and that article 35 is in competition with such rules, for example national rules on the validity of contracts. since there is not a unanimous view on these questions, due to differing views on the priority to be given to the convention and the scope of its regulatory powers, the second thesis of this article was that article 35 cannot be expected to lead to fully uniform law, cf. article 7, before the law of contract which lies behind it has been harmonised or before the rules of the convention have been amended. whether this will happen is a matter of legal policy. it has also been seen that a restrictive interpretation has been used, especially on the question of how far the principle of the exhaustion of rights should apply, or whether national rules on the validity of contracts can be asserted in competition with article 35. these are dichotomies which cannot only be solved by looking for a functionally adequate solution in the convention, since there is not even agreement within individual national legal systems about how to solve such problems. therefore, even though a dynamic interpretation is chosen, it must be recognised that there are questions to which answers cannot be found on the basis of lege lata (existing law), but which depend on statements of legal policy. overall it can be concluded that article 35 amounts to a codification of sale of goods principles which can also be seen as an expression of the general, internationally recognised principles of the nordic journal of commercial law, issue 2004 #1 16 law of obligations. these principles radiate like ripples through water in sale of goods laws, and from there through the general law of obligations. at the same time, the practice of the courts and the arguments of legal theorists show that the article 35 operates in an area of tension between differing doctrines and rules of the law of obligations, so there is sometimes conf lict and thus uncertainty about the application of article 35. this is unquestionably a problem to achieving uniform application of the provisions. this automatically puts a focus on the need for the harmonisation of contract law or a revision of the convention. this is illustrated by the fact that an informal body has now been set up which, as in the manner of the european court of justice, gives its opinion on the interpretation of the convention.86 it is suggested that the ideal approach would be to seek globally recognised principles on the basis of comparative analyses, as seen, for example, in the unidroit principles. however, whether the solution is to be found in binding rules, or whether an international lex mercatoria is sufficient is in the end a matter of legal policy, and not something on which a definitive answer is offered the present context. alternatively, the practice of the courts and the writings of legal theorists will work out the principles on which the convention, including article 35, will be developed. this article can be seen as an example of this. footnotes) 1 assistant professor, ph.d., master of law (llm), department of law, aarhus school of business. external associate professor, aarhus university. editor, www.cisg.dk, senior-editor, www.unilex.info. this article is an abstract of some few of the most important points in the authors ph.d.-thesis: the conformity of goods in international sales, published in a revised and updated version in june 2004 (thomson, copenhagen). 2 cf. ernst rabel: das recht des warenkaufs, vol. 2 (berlin, 1968), p. 101 et seq. this applies to actual lack of conformity (sachmängelhaftung), but the same conclusion applies to the sale of specific goods (gewährleistung für speciesachen), p. 111. for a general discussion of the differences between concepts of lack of conformity in various legal systems, see pp. 119-130, for guarantees see pp. 146-148, and for sales made on the basis of a sample or model see pp. 154-157. 3 cf. rabel: above , p. 132 and p. 282 et seq. 4 cf. rabel: above, pp. 101-104. 5 caveat emptor is not the original roman law term, but a concept developed in english law which nevertheless ref lects the roman law principle with the same content, cf. jakob nørager-nielsen and søren theilgaard: købeloven med kommentarer (københavn, 1993), p. 855, with reference to stig iuul.: caveat emptor-reglens oprindelse, festskrift til henry ussing, p. 220. 6 this was because the earlier roman law was strongly influenced by the direct exchange of goods in the open market, cf. bruno huweiler: die »vertragsmässigkeit der ware«. romanistische gedanken zu art. 35 und 45 ff. des wiener kaufrechts, in eugen bucher: wiener kaufrecht (bern, 1991), p. 249 et seq. 7 cf. also andreas schwartze: europäische sachmängelgewährleistung beim warenkauf: optionale rechtsangleichung auf der grundlage eines funktionalen rechtsvergleich (tübingen, 2000), p. 26; reinhard zimmermann: the law of obligations (münchen, 1993), p. 307. 8 cf. ernst rabel: above, p. 288. 9 uniform law for the international sale of goods. 10 uniform law on the formation of contracts for the international sale of goods. nordic journal of commercial law, issue 2004 #1 17 11 united nations convention on contracts for the international sale of goods. following a diplomatic conference the convention was adopted in vienna on 11th april 1980 (see un document a/conf.97/18). “cisg” can either be pronounced letter-by-letter, or as a word with a sibilant ‘c’. as for the abbreviation of cisg in relation to other abbreviations in theory and practice, see peter schlechtriem in peter schlechtriem: kommentar zum einheitlichen un kaufrecht (cisg) (münchen, 2000), p. v, note 1. 12 directive 1999/44/ec of 25 may 1999 on certain aspects of the sale of consumer goods and associated guarantees, oj 1999 l 171/12. 13 in the following, the term sphere of influence is distinct from the sphere of control in article 79(1) which emphasises the control of one party. however, there is a close connection between the reasoning in article 35 and in article 79, which has led to a discussion about the possibility of the seller avoiding liability for defects under article 79. 14 cf. ulrich krüger: modifizierte erfolgshaftung im un-kaufrecht (frankfurt a. m, 1997), p. 25 et seq. 15 compare this with jan heilmann: mängelgewährleistung in un-kaufrecht (berlin, 1994), p. 141. 16 the principles of the law of obligations are often supported by reference to a multiplicity of considerations, for example, regard for the maintenance of values, good faith, the satisfaction of reasonable expectations, predictability, fairness, operational efficiency, and not least economic effectiveness, cf. mads b. andersen and joseph lookofsky: lærebog i obligationsret (copenhagen, 2000), vol. 1, p. 34. 17 the principle thus has a legal-economic content. 18 see for example article 35(2)(b) and article 35(3), discussed below. 19 this does not take into account the change to the premisses which can result from the changed considerations. 20 article 7 states: (1) in the interpretation of this convention, regard is to be had to its international character and to the need to promote uniformity in its application and the observance of god faith in international trade. (2) questions concerning matters governed by this convention which are not expressly settled in it are to be settled in conformity with the general principles on which it is based or, in the absence of such principles, in conformity with the law applicable by virtue of the rues of private international law. 21 see also kai krüger: norsk kjøpsrett (bergen, 1999), p. 36 et seq. 22 this creates particular problems for the nordic countries, as they are not contracting states to part ii of the convention (the article 92 reservation), see rené franz henschel, above, chapter 3. 23 for an analysis of this, see rené franz henschel, above, chapter 3. see also jan h. dalhuisen: dalhuisen on international commercial, financial and trade law (oxford, 2000), chapter 2, especially p. 262-264. 24 see ulrich drobnig: substantive validity, american journal of comparative law, vol. 40 (1992), p. 635 et seq. for a view supporting exhaustion of rules of validity, see ferrari in peter schlechtriem: kommentar zum einheitlichen un kaufrecht (cisg), p. 97, pt. 4; john honnold: uniform law for international sales under the 1980 united nations convention (hague, 1999), p. 261 et seq.; jan ramberg in jan ramberg and johnny herre: internationella köplagen (cisg) (stockholm, 2000), p. 112; wilhelm-albrecht achilles: kommentar zum un-kaufrechtsübereinkommen (cisg) (neuwied, 2000), p. 19; karin flesch: mängelhaftung und beschaffenheitsirrtum (baden-baden, 1994), p. 140 et seq., especially at pp. 156-159; seemingly heilmann: above, p. 146, though here the view is that only the buyer’s mistake is covered, not the seller’s; bruno zeller: the united nations convention for the international sale of goods: a methodology for its interpretation and application (melbourne, 2001), p. 194 et seq.; but opposed to this, see bernhard gomard and hardy rechnagel: international købelov (københavn, 1990), p. 38, where it is argued that national law should apply, and correspondingly martin gstoehl: das verhältnis von gewährleistung nach un-kaufrecht und irrtumsanfechtung nach nationalem recht (zeitschrift für rechtsvergleichung, internationales privatrecht und europarecht, 1998/1, p. 1 et seq.). see also joseph lookofsky: understanding the cisg scandinavia (copenhagen, 2002), p. 31, concerning the competition between contractual and non-contractual compensation, where it is uncertain whether national rules must give way to convention rules. nordic journal of commercial law, issue 2004 #1 18 25 cf. michael bridge: international sale of goods: law and practice (oxford, 2000), p. 82 et seq. 26 cf. honnold: above, p. 479. see similarly denis tallon in c.m bianca and m. j. bonell: commentary on the international sales law (milan, 1987), pt. 2.6.1 and 2.6.2. 27 cf. krüger: above, p. 14, footnote 5; stoll in peter schlechtriem: above, p. 760 et seq., with further references to the literature in footnote 44. 28 cf. krüger: above, p. 68, after a review and refutation especially of honnold’s arguments. 29 see the german federal supreme court decision of 24th march 1999, analysed in rené franz henschel, above, chapter 2. 30 see rené franz henschel, above, chapter 2, with reference to more cases. 31 cf. bianca in bianca and bonell: above, p. 270: “in article 35 all cases of non-conformity of the goods are regarded as defective performances of the delivery obligation. thus, the convention has avoided the various distinctions still acknowledged in domestic laws between conditions and warranties, and specially the difficult distinction between delivery of goods of a different kind (aliud pro alio) and defects or lack of quality.” see correspondingly schwenzer in peter schlechtriem: above, p. 374, pt. 4; ramberg in ramberg and herre: above, pp. 226-229; achilles: above, p. 93; as well as the decision of the german supreme court of 3rd april 1996 (see unilex), where it is stated that: “the cisg is different from german domestic law, whose provisions and special principles are, as a matter of principle, inapplicable for the interpretation of the cisg (art. 7 cisg).” as for the distinction in french law between vice caché (latent defect) and vice apparent (patent defect), refer to the decision of the french supreme court of 17th december 1996 (see unilex). 32 see the german federal supreme court decision of 3rd april 1996, but compare the austrian federal supreme courts decisions of 29th june 1999 and 21st march 2000 (unilex) 33 see schwenzer in peter schlechtriem: above, p. 383, pt. 3; jan heilmann: above p. 202 et seq, and zurich cantonal commercial court34 of 21st september 1999 (unilex), but compare teija poikela: conformity of goods in the 1980 united nations convention on contracts for the international sale of goods, nordic journal of commercial law, issue 2001 # 1, p. 19, note 78. 35 see for instance oldenburg district court of 28th februar y 1996, swiss federal supreme court of 22nd december 2000 and for more examples: rené franz henschel: above, chapter 3. 36 in this respect see the decision of the us district court, illinois, eastern division, of 28th october 1998, referred to in section 4.2 below, overruling earlier american case law. 37 cf. peter schlechtriem: internationales un-kaufrecht (tübingen, 1996), p. 80 et seq. 38 cf. also article 9 of the convention. 39 cf. bianca in bianca and bonell: above, p. 274; fritz enderlein and dietrich maskow: international sales law (new york, 1988), p. 144; wolfgang kircher: die voraussetzungen der sachmängelhaftung beim warenkauf (tübingen, 1998), p. 52; burghard piltz: internationales un kaufrecht (münchen, 1993), p. 187. 40 see gomard and rechnagel: above, p. 115, note 15. 41 see peter schwenzer in schlechtriem: kommentar zum einheilichen un-kaufrecht (cisg), p. 378: “letzlich ist jedoch auch die frage der standards ein problem der auslegung des vertrages,” and at p. 379: “im übrigen verbietet sich jede generelle regel, und es ist auf die umstände des einzelfalles abzustellen” (emphasis in the original). see also honnold: above, p. 256: “some writers have felt that it was necessary to give a general answer to the following question: does subparagraph (2)(a) refer to the understanding of the contract description of the goods that prevails at the seller’s place of business or at the place where the buyer intends to use the goods? writers have disagreed over the choice between these two places. it should not be necessary to answer this question if one accepts the view, suggested above (§222), that the role of article 35(2) is to aid in construing the agreement of the parties.” 42 see bianca in bianca and bonell: above, p. 274; and in connection with this enderlein and maskow: above, p. 144 and achilles: above, p. 95. nordic journal of commercial law, issue 2004 #1 19 43 see anna veneziano: non conformity of goods in international sales: a survey of current case law on cisg (international business law journal), no. 1 (1997), p. 46. 44 compare this with the decision of the hertogenbosch district court of 2nd october 1998, which concerned an agreement for the sale of milk formula, where it was agreed between the parties that the milk formula should live up to the public health regulations in singapore with respect to the level of radioactive traces. 45 see the following citation from the judgment (translation source: the cisg database at pace law school law library): “in this respect, an agreement between the parties is primarily relevant (cisg art. 35(1)). the court of appeals did not even find an implied agreement as to the consideration of the zebs-standards. [buyer] did not argue against this finding, and it is not legally objectionable. the mere fact that the mussels should be delivered to the storage facility in g.g. does not necessarily constitute an agreement regarding the resalability of the goods, especially in germany, and it definitely does not constitute an agreement regarding the compliance with certain public law provisions on which the resaleability may depend.” 46 see paragraph ii.1.b) aa) of the judgment (translation source: the cisg database at pace law school law library): “in the examination of whether the goods were suitable for ordinary use, the court of appeals rightly left open the question — controversial in the legal literature — whether this requires generic goods of average quality or whether merely “marketable” goods are sufficient (see, e.g., schwenzer in von caemmerer/schlechtriem, supra, art. 35 6 15 (with further citations)). even if on appeal, goods of average quality were found to be required, [buyer] has still not argued that the delivered mussels contain a higher cadmium contamination than new zealand mussels of average quality. it is true that, according to the report from the examination laboratory of dr. b., submitted by [buyer] to the trial court, and the contents of which is thereby alleged, “there are also other imported new zealand mussels on the market … that do not show a comparable cadmium contamination.” it does not follow, however, that average new zealand mussels on the market contain a smaller amount of cadmium than the mussels delivered to [buyer].” 47 cf. paragraph ii.1.b) bb) of the judgment (translation source: the cisg database at pace law school law library): “according to the absolutely prevailing opinion in the legal literature, which this court follows, the compliance with specialized public law provisions of the buyer’s country or the country of use cannot be expected.” the lower court avoided making this assessment, partly by emphasising that the mussels were in any case edible, and partly by emphasising the fact that the guidelines of the german authorities were not binding. 48 cf. the judgment (translation source: the cisg database at pace law school law librar y): “some uncertainties, noticeable in the discussions in the legal literature and probably partly caused by the not very precise distinction between subsections (a) and (b) of cisg art. 35(2), do not require clarification in the evaluation of whether this question must be integrated into the examination of the ordinary use of the goods or the examination of the fitness for a particular purpose. there is, therefore, no need to finally decide whether, within the scope of cisg art. 35(2)(a), as most argue, the standards of the seller’s country always have to be taken into account (see, e.g., bianca, supra, 6 2.5.1; piltz, supra, 6 41; enderlein in enderlein/maskow/ strohbach, supra; aue, mängelgewährleistung im un-kaufrecht unter besonderer berücksichtigung stillschweigender zusicherungen (guaranty with respect to non-conformity with a contract pursuant to the u.n. law of sales under special consideration of implied promises), at 75 (doctoral thesis 1989); probably different schlechtriem, supra; hutter, supra, at 40), so that it is not important for the purposes of subsection (a) whether the use of the goods conflicts with public law provisions of the import country (see, e.g., herber/czerwenka, supra, 6 4). in any event, certain standards in the buyer’s country can only be taken into account if they exist in the seller’s country as well (see, e.g., stumpf in von caemmerer/schlechtriem, supra, 6 26; schwenzer, supra, 6 16; bianca, supra, 6 3.2) or if, and this should possibly be examined within the scope of cisg art. 35(2)(b), the buyer has pointed them out to the seller (see, e.g., schwenzer, supra, 66 16, 17; enderlein, supra) and, thereby, relied on and was allowed to rely on the seller’s expertise or, maybe, if the relevant provisions in the anticipated export country are known or should be known to the seller due to the particular circumstances of the case (see, e.g., piltz, supra, 6 35; bianca, supra). none of these possibilities can be assumed in this case.” 49 it had also been argued by the seller, that consumers would not normally be expected to eat the same quantities of mussels as of meat, so the threshold levels for meat are not necessarily suitable for assessing fish products. 50 cf. paragraph ii.1.b) bb) ccc) of the judgment (translation source: the cisg database at pace law school law library): “ this court need not decide whether the situation changes if the seller knows the public law provisions in the country of destination or if the purchaser can assume that the seller knows these provisions because, for instance, he has a branch in that country (see, e.g., neumayer/ming, supra), because he has already had a business connection with the buyer for some time (see, e.g., schwenzer, supra, 6 17), because he often exports into the buyer’s country (see, e.g., hutter, supra, at 47) or because he has promoted his products in that country (see, e.g., otto mdr 1992, 533, 534). [buyer] did not allege any such facts.” compare this with bonell in bianca & bonell: commentary, nordic journal of commercial law, issue 2004 #1 20 p. 283, which substantially lists all the arguments which were used by the german federal supreme court in the present case. the book was published in 1987. 51 all the cases can be found on unilex 52 cf. heilmann: above p. 205. 53 cf. schwenzer in peter schlechtriem: above, p. 384, pt. 34. 54 cf. gomard and rechnagel: above, p. 117, note 27. as far as is known, this question is not dealt with by other writers. 55 cf. bianca in bianca and bonell: above, p. 279, pt. 2.9.1. 56 cf. schwenzer: ibid. 57 the main comments in the following review of this provision also apply to the buyer’s awareness of defects relating to the element of the supply of labour and other service provision in such agreements. 58 compare with lookofsky: above, p. 91. 59 cf. the secretariat commentary to article 33, pt.14: “this rule does not go to those characteristics of the goods explicitly required by the contract and, therefore subject to the first sentence of paragraph (1). even if at the time of the conclusion of the contract the buyer knew that the seller would deliver goods which would not conform to the contract, the buyer has a right to contract for full performance from the seller. if the seller does not perform as agreed, the buyer may resort to any of his remedies which may be appropriate.” this is indeed a literal approach to contract interpretation. 60 see schwenzer in peter schlechtriem: above, , p. 385, pt. 38; achilles: above, p. 98, pt. 17; kircher: above, p. 55; poikela: above, , p. 52, although modified on p. 53. but for a opposite view see: enderlein and maskow: above, p. 147 et seq., pt. 19; and r. rognlien in j. bergem and r. rognlien: kjøpsloven 1988 og fn-konvensjonen 1980 om internasjonale løsørekøb (oslo, 1995), p. 504 et seq. 61 cf. schlechtriem: ibid. 62 the argument is most often illustrated by reference to examination of the goods, but it could be based on circumstances other than examination. 63 cf. ramberg in ramberg & herre: above, p. 237, pt. 8. 64 cf. ramberg: ibid. 65 if the buyer has expressed himself ambiguously or with lack of clarity, this will be interpreted against him. 66 cf. schwenzer in schlechtriem: above, p. 384, pt. 36; heilmann: above, pp. 207-208. 67 it is also possible that the seller may rely on national rules of invalidity, see below. 68 schlechtriem in n ina m.galston and hans smit: international sales: the united nations convention on contracts for the internaitonal sale of goods (new york, 1984), pp. 6-24, § 6.03. 69 cf. rognlien in bergem and rognlien: above p. 504. 70 see lookofsky: above, p. 91, note 102: “if, under domestic sales law conceptions, we say that the caveat emptor (“what you see is what you get”) principle applies in a given situation, that is really the same as saying the goods conform to the contract …” 71 compare with hyland in schlechtriem: einheitliches kaufrecht, above, p. 326. 72 the report of the judgment is reported in the unilex and pace university cisg websites. note that in the pace website the case is wrongly listed under the valais cantonal appeal court. nordic journal of commercial law, issue 2004 #1 21 73 cf. section 4.b) of the judgment. 74 the report of the judgment is reported in the unilex and pace university cisg websites. note that in the pace website the case is wrongly listed under the valais cantonal appeal court. 75 cf. section 7.b) of the judgment. 76 cf. bianca in bianca & bonell: above, p. 280: “the fact that the buyer knows or ought to know of the real condition of the goods is irrelevant when there is a specific contractual provision because it does not change the content of what the seller has promised to the buyer nor can it free him from his promise.” 77 cf. achilles: kommentar, pp. 98-99, pt. 17. 78 cf. rognlien in bergem & rognlien: kjøpsretten, p. 504 et seq.; karollus: un-kaufrecht, p. 119. 79 cf. bianca in bianca & bonell: commentary, p. 279, pt. 2.8.3. 80 see lookofsky: cisg scandinavia, p. 91, note 102. 81 see the unilex and pace university cisg websites. 82 “the arbitration tribunal found that the claimant, having received the specification for pura sub butter, could not have failed to notice the difference between the terms and some other descriptions of the substitute goods offered for delivery and those specified in the supplement number 2 but, however, agreed in his letter to the seller of 10 february 1995 with the goods and did not ask for a price reduction. on this ground the tribunal, under reference to art. 35 cisg and para 459 of the german civil code, dismissed the buyer’s plea for damages concerning the difference between the contract price and price for margarine, having taken into consideration the opinion of the independent laboratory experts who had qualified the goods stated in the supplement number 2 and pura sub butter as “domestic margarine of standard quality.” 83 the decision is also notable in relation to the problem of the conformity of goods to the public law rules in the buyer’s country. among other things, the buyer rejected the goods because the legally required certificate of quality could not be issued due to the level of lead in the product. it is not clear from the case report whether the level of lead exceeded the permitted level in the seller’s country, or the average market standard, or whether it made the goods unfit for consumption, but it does appear from the case report that the seller had himself presented an analysis report from which it appeared that there was not a high level of lead in the goods. however, it does not seem that the seller put forward such arguments, but instead sought to cast doubt on the quality report presented by the buyer. it is possible that the tribunal would have reached a different conclusion if the arguments discussed in relation to the mussels case had been put forward. 84 cf. schwenzer in schlechtriem: above, pp. 384-385, pt. 37; dagmar valcárel schnüll: die haftung des verkäufers für fehler und zugesicherte eigenschaften im europäischen rechtsvergleich (bonn, 1994), p. 164; kircher: above, p. 54 et seq., and ulrich ziegler: leistungsstörungsrecht nach dem un-kaufrecht (baden-baden, 1995), p. 103. 85 cf. section 2 of the judgment of the court: “it has to be inferred from the basic idea of art. 40 cisg, whereby a seller is not entitled to rely on the conduct of the buyer if the seller is to blame more, in connection with art. 7(1) cisg, that in case of a fraudulent conduct of the [seller], the [seller] has to accept responsibility even if the [buyer] could not be unaware of the non-conformity. therefore, the statements of the [seller] pertaining to the supposed possibilities of perception of the [buyer]’s wife which, as has to be pointed out supplementary, cannot be equated with the possibilities of perception of the [buyer] himself are not relevant. even a grossly negligent unknowing buyer appears to be more protection-worthy than a seller acting fraudulently (von caemmerer/ schlechtriem, kommentar zum einheitlichen un-kaufrecht, cisg, 2nd edn., art. 35, annotation 37 with further evidence). consequently, when there is fraudulent conduct of the seller, the inapplicability of art. 35(3) cisg follows from art. 40 in connection with art. 7(1) cisg.” 86 see joachim aue: mängelgewährleistung im un-kaufrecht unter besonderer berücksichtigung stillschweigender zusicherungen (frankfurt a. m., 1989), p. 85. 87 see the recently established “cisg-advisory council” in london, which give advisory opinions on the interpretation of the cisg convention. the list of members can be seen at http://www.ccls.edu/ eclu/iclaw/courses/ schmitthoff.html. electronic commerce and the un convention on contracts for the international sale of goods (cisg) by fernando gava verzoni nordic journal of commercial law issue 2006 #2 nordic journal of commercial law issue 2006 #2 1 see 19 i.l.m. 668 (1980) and 52 f.r. 6262-02 (united states internal notice of ratification, on march 2, 1987). 2 see andrea l. charters, fitting the ‘situation’: the cisg and the regulated market, 4 wash. u. global stud. l. rev. 1, 2 (2005). for an updated list of contracting states, see <http://www.uncitral.org/english/status/status-e.htm#united nations convention on contracts for the international sale of goods (vienna, 1980)> (last visited apr. 19, 2005). 3 the expression “ e-commerce” will be used in the paper in broad terms, meaning every trade transaction where the parties use electronic means of communication (not necessarily just to conclude the contract), but also for post conclusion interactions. 4 there is, however, a proposal for a draft convention on electronic communications (see infra note 48), sponsored by the uncitral, which is intended to have an impact on several international conventions, including the cisg. however, unless all the contracting states to the cisg adopt the new draft convention, the risk is that it will undermine the purpose of the cisg in achieving uniformity; on this problem, see note 54 infra. 2 i. introduction the text of the united nations convention on contracts for the international sale of goods (hereinafter “ cisg” )1 is a quarter of a century old. the drafting process ended in 1980 and the convention entered into force in 1988. since then, the cisg became potentially applicable to international trade transactions within a group of states that account for over two-thirds of world trade.2 while the number of contracting states increased, the reality of international trade changed significantly with the development information technology tools, particularly after the beginning of the 1990’s. parties began to conclude international contracts by using those tools, giving birth to the expression “ electronic commerce” (or simply “ e-commerce” ); even in cases where the contract was concluded by more traditional means, international commerce players began to interact with each other electronically in order to deal with post conclusion matters, such as the performance of the contract3. these changes in the behavior of the actors of international trade were certainly not foreseen by the drafters of the cisg; indeed, there are no specific provisions in the convention dealing with the issues that arise in e-commerce. since the cisg is a multilateral treaty with many contracting states, a proposal of concluding a protocol to the cisg would certainly take a long time, if a compromise is indeed possible4. if changing the cisg is not an alternative in a short term, the question is whether the cisg itself could provide a workable framework for e-commerce transactions. that is the topic explored in this paper. the cisg has a provision dealing specifically with gap-filling: article 7(2). under this provision, gaps (or, to use the cisg definition, “ matters governed by [the] convention which are not expressly settled in it” ) are to be filled in “ in conformity with the general principles on which it is based” ; only in the absence of such principles the matters will have to be solved by recourse to the domestic law applicable by virtue of the conflict of law rules. therefore, if some of the issues related to e-commerce are not expressly settled by the convention, the cisg itself might nevertheless provide the tools to develop a rule to solve these questions. http://www.uncitral.org/english/status/status-e.htm#united nordic journal of commercial law issue 2006 #2 5 on that issue, see ricardo l. lorenzetti, comercio electrónico 7 (buenos aires, abeledo-perrot, 2001). 6 due to that, non-instantaneous communication technologies are deemed to be inter absentes (see definition in the next paragraph of the text above). 3 i.1. the problem of dealing with technologies: methodological issues law and technology develop in different paces. technology changes very fast, whereas the process of developing new legal rules is significantly slower. if that is so, a statutory rule that undertakes to describe in detail technical solutions — which can in a short period of time be replaced by more advanced ones — will soon be obsolete along with the technologies, possibly even before being applied.5 thus, a “ technologically neutral” approach, i.e., not driven by specific technologies, should be favored in the process of developing legal rules. a similar methodology should be used in order to address the issues arising from e-commerce within the framework of the cisg. therefore, instead of seeking individual solutions for the issues relating to the use of each of the several technologies available, it is more appropriate to group the technologies in accordance with two criteria: (a) their function or role in e-commerce and (b) the characteristics of these technologies that create some problems under the cisg. once technologies are properly categorized, the analysis yields a more principled outcome, rather than casuistic and fragmental conclusions. a principled outcome is more resistant to technological developments because: (a) new technologies will probably fit in those categories and, absent a compelling reason based on a specificity of that technology, the solution will be same for the other ones in the group; (b) if the characteristics of a particular technology changes, there might be another category for that new technology and, consequently, a ready-made solution for the common issues. of course, the analysis will sometimes require recourse to “ technological specific” examples for didactic purposes, since an extremely abstract study would probably be unintelligible. moreover, if a technology has a relevant specificity that is not categorized, then the analysis might become more casuistic in order to make a solution to an individual problem possible. having said that, this paper will be based on a division of the available technologies in two great groups, according to the role they play in each individual transaction. the first one includes (1) technologies that simply extend the human ability to communicate, i.e., those that are used only to permit two persons to overcome the distance between them and interact with each other. the second one covers (2) technologies that play an active role in the formation of the sales contract, i.e., those that turn human intervention in the conclusion of an individual agreement unnecessary, since an information system issues by itself a message with an intention of binding the party who programmed that system to do so. each of those great groups has subcategories, designed according to the characteristics that are relevant for cisg purposes. i.1.1. technologies that merely extend human ability to communicate the first group subdivides in two: (1.1) the instantaneous communication technologies and (1.2) the non-instantaneous communication ones. the non-instantaneous are those in which there is a delay between the instant a message is sent and the moment it becomes available to the recipient6. in that aspect, those technologies are similar to regular mail; an example of those technologies is electronic mail (“ e-mail” ), which, once sent over the internet, might take some time to become nordic journal of commercial law issue 2006 #2 7 there are different technologies to broadcast human voice over the internet, all them grouped under the name voice over internet protocol (“ voip” ). in this category can be included all teleconference technologies, even those that do not use the internet to broadcast audio and video. 4 available to the recipient. in contrast, a data message sent via instantaneous communication technologies becomes available to the recipient at the moment it is dispatched. this subcategory has two other sub-subcategories. the first one includes (1.1.1) the instantaneous inter praesentes communication technologies, i.e., the ones in which by their nature there is simultaneous reception and cognizance of the message by the recipient, such as internet telephony7 and text chats; those means can be compared with a “ regular” telephone conversation. the second sub-subcategory includes (1.1.2) the instantaneous inter absentes communication technologies, the ones in which reception of the message and cognizance of its content happen in different moments; for instance, a fax message, which is transmitted in real-time a telephone line, but might be read later on by the recipient; telex falls also under this sub-subcategory, an older and currently less usual technology expressly mentioned in article 13 of the cisg. (1) technologies that merely extend human ability to communicate (1.1) instantaneous (1.2) non-instantaneous always inter absentes (1.1.1) inter absentes (1.1.2) inter praesentes examples examples examples .fax message .internet telephony .text chats .e-mail messages “ similar” to “ similar” to “ similar” to .telex .telephone conversation .regular mail .telegram i.1.2. technologies that play an active role in the formation of the contract the second group of technologies is also divided in two subcategories. the first one includes (2.1) the technologies based on a human/machine interaction, i.e., where one of the parties (a human being) interacts with an information system. in this case, a person — say, the buyer — will by herself issue a data message indicating her intention of being bound by an agreement and an information system, “ on behalf” of the seller, will issue another message indicating the intention of the latter of being bound. the second subcategory encompasses (2.2) the technologies based on a machine/machine interaction, i.e., where in both sides of the transaction there are information systems issuing data messages containing each party’s intention of being bound by an agreement. nordic journal of commercial law issue 2006 #2 8 article 2.2 of the european model edi agreement, approved by the commission recommendation 94/820, annex i, 1994 o.j. (l 338) 98, defines edi as “ the electronic transfer, from computer to computer, of commercial and administrative data using an agreed standard to structure an edi message” . see also christopher nicoll, e.d.i evidence and the vienna convention, j. bus. l. 21, 23 (1995) (defining edi as “ [t]he electronic transfer of formatted data messages between computer applications running on separate computers, using agreed standards to describe the format of data contained in the messages” ). 5 each of those subcategories has its own subdivisions. in respect to the first one, i.e., (2.1) human/machine interaction, it includes: (2.1.1) a group of technologies based on instantaneous communication, in the same meaning as above, i.e., the message conveyed becomes available to the recipient at the time it is dispatched. there are further subdivisions: (2.1.1.1) inter praesentes, where the interaction human/machine happens in real-time. for instance, sales transactions concluded through an interactive web site in the internet where the conclusion of the contract happens immediately (without, for instance, later confirmation); the order is immediately processed and accepted. (2.1.1.2) inter absentes, where the interaction is not in real-time. for instance, a sales transaction through a non-interactive web site where the prospective buyer places an order, which immediately becomes available to the seller (e.g. it is instantly recorded in a database maintained by the seller), but the information system delays processing the order (the prospective buyer does not receive a response at the moment in which she submits her request). (2.1.2) a group of technologies based on non-instantaneous communication. for instance, web forms for placing orders with automated processing: a prospective buyer fills in a form in a web site with all the information required by the seller; the data typed by the prospective buyer is sent in an e-mail message (non-instantaneous), which is automatically processed by an information system without human intervention. because of this delay, these communications is always inter absentes. in respect to the second subcategory, i.e., (2.2) technologies used for the formation of a contract without any human intervention on both sides (machine/machine interaction), the classification is identical to the prior one, including: (2.2.1) a group of technologies based on instantaneous communication, subdivided in: (2.2.1.1) inter praesentes, where the interaction machine/machine happens in real-time (i.e., the data message becomes available instantaneously and is processed by the recipient system at that moment). an example is an electronic data interchange (“ edi” )8 arrangement with a real-time connection between the information systems. (2.2.1.2) inter absentes, where the interaction is not in real-time, such as in an edi arrangement were a data message is immediately received, but nordic journal of commercial law issue 2006 #2 9 in an edi arrangement based on a “ store and retrieve” scheme, the data messages are posted in a mailbox under the control of the recipient; the recipient edi system processes the messages when it retrieves them from the information system where the mailbox is located. the process of retrieving the messages can be automated or triggered by human action. 6 processing is delayed. processing might be delayed, for instance, in an edi arrangement based on a “ store and retrieve” scheme9. (2.2.2) a group of technologies based on non-instantaneous communication. an example of this is an edi arrangement supported by non-instantaneous means of communication (i.e., the reception of the message is delayed and does not happen at the same time it is sent). since the communication is not instantaneous, it is always inter absentes. (2) technologies that play an active role in the formation of the contract (2.1) human/machine interaction (2.2) machine/machine interaction (2.1.1) instantaneous (2.1.2) non-instantaneous always inter absentes (2.2.1) instantaneous (2.2.2) non-instantaneous always inter absentes (2.1.1.1) inter absentes (2.1.1.2) inter praesentes (2.2.1.1) inter absentes (2.2.1.2) inter praesentes examples examples examples examples examples examples .noninteractive automated web site .interactive automated web site .orders placed via webforms, where the messages are automatically processed by the recipient system .edi with instantaneous receipt, but delayed processing .edi with real-time connection and processing .edi with delayed receipt (time of dispatch � time of receipt) i.2. structure of the analysis this paper is structured in two parts. the purpose of the first part is to determine whether the rules of the cisg in respect to the internationality of sales contract and its personal sphere of application (part ii.1), as well as the rules on the convention’s substantive sphere of application (part ii.2), can be used to determine whether a particular e-commerce transaction is governed by the cisg. in the second part, the substantive provisions of the cisg will be examined in order to verify whether they would cover electronic pre-contractual (part iii.2) and contractual (part iii.3) communications between the parties; that analysis will require that the general rules on form requirements of the cisg be examined in the search for principles suitable to fill-in eventual gaps in the text of the convention (part iii.1). nordic journal of commercial law issue 2006 #2 10 the exception is the concept “ contract of sale” , which is a pure legal definition which does not rely on elements attached to the physical reality, but nevertheless raises issues in some instances of electronic commerce, as it will be explained bellow (see infra part ii.2.2). 11 article 6, which gives the parties autonomy to exclude the application of the convention or to derogate some of its provisions (with the exception stated in article 12) could also be considered as defining the sphere of application of the convention; however, that provision is not relevant for the purposes of this paper. articles 4 and 5, by excluding some issues from the coverage of the cisg, deal with the scope of application of the cisg, i.e. the extent to which it is applicable; on that topic, see franco ferrari, scope of application: articles 4-5, in draft uncitral digest and beyond: cases, analysis and unresolved issues in the u.n. sales convention 96, 96 (franco ferrari et al. eds., munich, sellier 2004). 12 cisg article 1(1). if the forum is not a contracting state to the cisg, it might still be applicable by virtue of conflict of laws rules of the forum if those rules point to the law of a contracting state, assuming that the cisg can be seen as part of the municipal law of that contracting state. conflict of laws rules might also offer difficulties in the domain of e-commerce (see infra notes 17 and 18 and accompanying text). 13 article 1(2) provides that “ [t]he fact that the parties have their places of business in different states is to be disregarded whenever this fact does not appear either from the contract or from any dealings between, or from information disclosed by, the parties at any time before or at the conclusion of the contract” . this provision will be discussed in part ii.1.3. 14 see infra part ii.1.2.1. 7 ii. applicability of the cisg to e-commerce contracts the provisions of the cisg regarding its sphere of application raise relevant issues within the context of contract of sales concluded by electronic means. aiming to set the limits to the application of the convention, the drafters relied on legal concepts that are usually10 seen as related to physical reality; those legal concepts, once applied to electronic contracts matters, may cause certain difficulties. those difficulties will be examined in this part ii. the sphere of application of the cisg, i.e., its applicability to certain contracts, is governed by articles 1, 2, 3 and 1011. to determine its applicability, the convention relies on elements related to (a) the parties (and their connection to a contracting state of the cisg) and (b) to the transaction itself, as explained below. the first set of elements shapes the cisg’s personal sphere of application, which will be examined in part ii.1; the second set of elements delimitates the cisg’s substantive sphere of application, which will be examined in part ii.2. ii.1. internationality, personal sphere of application and e-commerce ii.1.1. overview and potential issues assuming that the forum state (where a cisg-related case is brought) is a contracting state to the convention, the first requirement to be met in order for the treaty to be applicable is the internationality of the contract, as the convention provides that it “ applies to contracts [… ] between parties whose places of business are in different states” 1 2. the definition of internationality is related exclusively to the parties: the sole requirement is that their places of business be in different jurisdictions. internationality must nevertheless be apparent at the time of the conclusion of the contract, as required by article 1(2)13, and, therefore, the transaction will not be international if one of the parties relied on the domestic setting of their dealings (and had no reason not to rely on it). the convention does not expressly define “ place of business” 14: the only provision that provides guidance to determine the parties’ places of business is article 10, but it is only applicable to the situations where one of parties has multiple places of business; it provides that the relevant place of business is the one “ which has the closest relationship to the contract nordic journal of commercial law issue 2006 #2 15 cisg article 10(a). article 10(b) deals with the situations where one of the parties does not have a place of business, providing that, in such cases, “ reference is to be made to his habitual residence” . 16 indeed, the cisg, as uniform law trumps the conflict of laws rules of the forum and therefore, once its applicability requirements are met, it will govern the issue directly. see peter winship, private international law and the u.n. sales convention, 21 cornell int’l l.j. 487, 520 (1988) (stating that “ the purpose of subparagraph (1)(a) is to eliminate the need to go through a conflicts analysis to determine whether the convention applies” ). if fact, there is case-law holding that the cisg, as uniform law, preempts the conflict of laws rules of the forum; see rheinland versicherungen v. atlarex s.r.l, tribunale [district court] di vigevano, italy, 12 july 2000, case number 405, translation to english available at <http://cisgw3.law.pace.edu/cases/000712i3.html> (last visited mar. 20, 2005) (holding that “ [u]niform substantive law is more specific per definitionem than the rules of private international law because the former settles ‘directly’ the question of applicable substantive law” ); tessile 21 s.r.l. v. ixela s.a, tribunale [district court] di pavia, italy, 29 december 1999, available at <http://cisgw3.law.pace.edu/cases/991229i3.html> (last visited apr. 6, 2005) (stating that “ one must prefer the relevant norms of uniform law created by international conventions which, by reason of their [specificity], prevail over conflict rules” ). 17 see, e.g., the restatement (second) on conflict of laws § 188(2) (1971), the general provision on the applicable law to contracts in the absence of a choice of law agreement, which lists elements to determine the place which has the “ most significant relationship” with a contract. some of those elements naturally pose some difficulties in e-commerce, such as “ place of contracting” (§ 188(2)(a)), “ place of negotiation of the contract” (§ 188(2)(b)) and “ place of business of the parties (§ 188(2)(e)); others offer some problems when the seller also performs its obligation by electronic means (e.g. an acquisition and simultaneous download of a software over the internet), such as the connecting factors “ place of performance” (§ 188(2)(c)) and “ location of the subject matter of the contract” (§ 188(2)(d)). for a comment on the insufficiency of the restatements first (lex loci delicti) and second (“ most significant relationship” ) approaches for torts in the cyberspace, as well of the restatement second and the rome convention approaches for electronic contracts, see matthew burnstein, note, conflicts on the net: choice of law in transnational cyberspace, 29 vand. j. transnat’l l. 75, 92-96 (1996). 8 and its performance, having regard to the circumstances known to or contemplated by the parties at any time before or at the conclusion of the contract” 15. however, internationality is not sufficient to determine the applicability of the convention: either the requirement set forth in article 1(1)(a) or the one in article 1(1)(b) must be fulfilled. under article 1(1)(a), the cisg is directly applicable if the parties have their places of business in contracting states to the convention, without regard to the conflict of laws rules of the forum16; in other words, the convention must be in force in the jurisdictions where the parties have their places of business. so far, there are two notions that might pose some problems in the e-commerce environment, place of business and parties, which will be discussed in parts ii.1.2 and ii.1.4 bellow; also, the requirement of apparent internationality also might create some difficulties, as it will be discussed in part ii.1.3. indeed, while the possibilities opened by the development of new communication technologies allow the parties to deal with anyone in the world, the lack of personal contact and the automation of the process of contracting can be troubling. for instance, one might wonder: (a) where is the place of business of a manufacturer who sells their products through a fully automated and interactive web site on the internet? (b) if a system accepts orders without human interaction should it be considered a party under the cisg? (c) how to find apparent internationality under article 1(2) if, due to the frequent lack of personal contact, the parties to an e-commerce transaction do not know whether they are dealing with someone in the neighborhood or in another country? the cisg might also be indirectly applicable by virtue of article 1(1)(b), i.e., if the conflict of laws rules of the forum “ lead to the application of the law of a contracting state” . that provision however does not raise e-commerce related issues, at least not within the framework of the convention. of course, depending on the connecting factors used by the conflict of laws rules of the forum, an electronic contract might represent several difficulties17, but those connecting http://cisgw3.law.pace.edu/cases/000712i3.html http://cisgw3.law.pace.edu/cases/991229i3.html nordic journal of commercial law issue 2006 #2 18 see note by the secretariat (legal aspects of electronic commerce – possible future work in the field of electronic contracting: an analysis of the united nations convention on contracts for the international sale of goods), uncitral working group on electronic commerce, 38th sess. at 6 (¶ 19), u.n. doc. a/cn.9/wg.iv/wp.91 (2001), available at <http://www.uncitral.org/english/workinggroups/wg_ec/index.htm> (last visited mar. 20, 2005) [hereinafter “ uncitral e-commerce wkg: secretariat note on e-contracting and cisg” ] (stating that the use of electronic means in the conclusion of international sales contracts in the context of article 1(1)(a) of the cisg only becomes relevant “ where the rules of private international law of the forum refer, as a connecting factor, to the place of conclusion of the contract” ); see also franco ferrari, brief remarks on electronic contracting and the united nations convention on contracts for the international sale of goods (cisg), 6 vindobona j. 289, 293 (2002). 19 see franco ferrari, the cisg’s sphere of application: articles 1-3 and 10, in draft uncitral digest and beyond: cases, analysis and unresolved issues in the u.n. sales convention 21, 27 (franco ferrari et al. eds., munich, sellier 2004). 20 see erik jayme, article 1, in bianca-bonell commentary on the international sales law 27, 30 (cesare massimo bianca ed., milan, giuffrè, 1987), available at <http://cisgw3.law.pace.edu/cisg/biblio/jayme-bb1.html> (last visited mar. 26, 2005). 21 see id. at 30. the stability requirement was expressly mentioned in oberlandesgericht [provincial court of appeal] stuttgart, g e r m a n y , 2 8 f e b r u a r y 2 0 0 0 , c a s e n u m b e r 5 u 1 1 8 / 9 9 , e n g l i s h t r a n s l a t i o n a v a i l a b l e a t <http://cisgw3.law.pace.edu/cases/000228g1.html> (last visited mar. 26, 2005). 22 see franco ferrari, the relationship between international uniform contract law conventions, 22 j.l. & com. 57, 69 (2003). 23 the requirement of autonomy underlies several decisions holding that the place where liaison offices or distributors conduct their activities is not the place of business of the seller; if those offices do not have autonomy to conclude the sales agreement independently from the seller, they are not places of business of the seller and do not serve as basis for internationality. on that matter, see asante technologies, inc. v. pmc-sierra, inc., 164 f.supp.2d 1142, 1147-49 (n.d.cal. 2001), available at <http://cisgw3.law.pace.edu/cases/010727u1.html> (last visited mar. 26, 2005) (holding that the seller had its place of business in canada, since the goods were manufactured in canada, the corporate headquarters of the seller were in canada, and the alleged breaches of representation were made from canada; rejecting contention that the seller’s u.s. based distributor was an agent of the seller and stating that the buyer’s dealings with the distributor did not establish seller’s place of business in the u.s.); icc court of arbitration, paris (france), case number 7531, 6 the icc international court of arbitration bulletin 67, n.2 (1995), case abstract available at <http://cisgw3.law.pace.edu/cases/947531i1.html> (last visited mar. 26, 2005) (holding that the fact that the buyer had conducted part of the negotiations through its liaison office situated in the seller’s country was of no relevance for the purposes of internationality under the cisg). 9 factors are defined and qualified in accordance with the standards of domestic law18 and, hence, are not covered by the cisg. ii.1.2. place of business and cyberspace the starting point to determine the place of business of the parties in cyberspace would be the definition of place of business for regular transactions under the cisg. however, the convention does not define it expressly, although it has been held that an autonomous definition of place of business can be derived from the cisg without recourse to domestic law (and, hence, without undermining the cisg’s unification purpose). ii.1.2.1. guidelines in the cisg: stability, autonomous character and substantial connection the place of business of each party is determined on a case-by-case basis; nevertheless, it has been said that there are some guidelines in the cisg19. those guidelines can be found in the purpose of article 120, as well as in its context in the convention, particularly in light of what article 10(a) provides. it is accepted that the mere place of contracting and the place where the negotiations have taken place are not relevant for that definition; indeed, reference is made to a permanent and stable business organization and not to the place where only preparations for the conclusion of the single contract have been made21. aside from stability, the autonomous character of the place of business is also required22, i.e., the place of business is where there is autonomous power to conclude the transaction with the other party23. in fact, a german court stated that “ [a] place of http://www.uncitral.org/english/workinggroups/wg_ec/index.htm http://cisgw3.law.pace.edu/cisg/biblio/jayme-bb1.html http://cisgw3.law.pace.edu/cases/000228g1.html http://cisgw3.law.pace.edu/cases/010727u1.html http://cisgw3.law.pace.edu/cases/947531i1.html nordic journal of commercial law issue 2006 #2 24 see oberlandesgericht stuttgart, supra note 21. 25 see supra note 15 and accompanying text. see also franco ferrari, supra note 19, at 30 (stating that, “ where the parties know that the contract is to be performed at a place of business different from the one involved in the conclusion of the contract, the text of article 10(a) suggest that the relevant place of business is the one where performance takes place” ). 26 article 10(a) is particularly relevant in this context because the cases in e-commerce where the determination of the place of business might be controversial are those where the use of electronic of means communication creates the impression that the party has more than one place of business; therefore, even if one finds that the elements of the definition of place of business are met for all the possible places of business, article 10(a) will be applicable to determine the relevant place of business. this matter will be explored in part ii.1.2.2. 2 7 e r i k j a y m e , s u p r a n o t e 2 0 , a t 3 1 . s e e a l s o a m t s g e r i c h t d u i s b u r g , g e r m a n y , 1 3 a p r i l 2 0 0 0 , a v a i l a b l e a t <http://cisgw3.law.pace.edu/cases/000413g1.html> (last visited apr. 9, 2005) (stating that “ [p]lace of business in the meaning of art. 1 and 10 cisg is the actual place of business” ). 28 telegram and telex are technological means of communication expressly acknowledged by the cisg and, for its purposes, are deemed to be in writing (article 13). this provision will be examined properly in part iii.1.2. 29 on the distinction between contracts inter absentes and inter praesentes, see generally ricardo l. lorenzetti, supra note 5, at 193 (stating that a contract is inter absentes when there is a relevant delay between the offer and the acceptance; this delay creates some risks that must be allocated between the parties). 10 business exists if a party uses it openly to participate in trade [… ], which means that the place of business must not be merely temporary and must display a certain degree of independence” and, based on that premise, held that a spanish representative of a german seller “ did not possess an independent authority to act in the form of power to decide upon and close a deal” , since “ negotiations concerning the formation of a contract, prices, delivery periods and remedies had to be held with the [seller]” 24. in the domain of electronic commerce, the rule set forth in article 10(a) is particularly relevant. as it was mentioned elsewhere25, article 10(a) deals with the situation where a party has multiple places of business, providing that, for cisg purposes, the place of business is the one “ which has the closest relationship to the contract and its performance” 26. pursuant to this provision, the circumstances relevant to determine whether a place of business meets that definition are the ones “ known to or contemplated by the parties at any time before or at the conclusion of the contract” . the reference to the relationship with the contract and (particularly) to its performance in article 10(a) reveals that determination of the relevant place of business is not formalistic neither abstract but, as pointed in scholarly writing, based on a “ more substantial and real connection” ; what matters is not the head office, but “ the place from which the transaction is to be performed” 27. ii.1.2.2. determining place of business in e-commerce as far as the group of technologies whose purpose is to extend human ability to communicate (e.g. e-mail, text chat, internet telephony) is concerned, the concept of place of business does not pose any additional difficulties compared to traditional transactions inter absentes using instantaneous or non-instantaneous communication tools (e.g. contract of sales concluded by letter, telegram, telex28), or inter praesentes (e.g. phone)29. those technologies serve only to connect two persons located in different places and allow them to negotiate their agreement. technologies for interpersonal communication do not create new relationships (or connections) of the parties with different jurisdictions. for instance, in a case of a contract of sale concluded in a voice call over the internet, the seller and the buyer are reaching each other by means of a global information network, but both of them, at least in principle, remain on their respective places of business. indeed, this situation (and others of instantaneous or non-instantaneous communications) is http://cisgw3.law.pace.edu/cases/000413g1.html nordic journal of commercial law issue 2006 #2 30 see infra part ii.1.3. 31 for a comment on that view, see ricardo l. lorenzetti, supra note 5, at 198-99. 32 indeed, in sharp contrast to the position here adopted, it has been already stated that the cisg would accept a “ virtual” place of business. see j.a. graham, la convención de viena sobre la compraventa internacional de mercaderías y el comercio electrónico, 39 r e d i r e v i s t a e l e c t r ó n i c a d e d e r e c h o i n f o r m á t i c o a t ¶ 2 ( v l e x , 2 0 0 1 ) a v a i l a b l e a t <http://premium.vlex.com/doctrina/redi_revista_electronica_derecho_informatico/convencion_viena_compraventa_in ternacional_mercaderias_comercio_electronico/2100-115520,01.html> (stating that, if a virtual domicile has been acknowledged by national courts for privacy purposes, it should de extended to the cisg, particularly due to the fact that it can be updated throughout time). 33 in fact, some commentators suggest that the technological developments should be followed by the development of a new field in the law, often called “ cyberspace law” . see i. trottter hardy, the proper legal regime for cyberspace, 55 u. pitt. l. rev. 993, 1053-1054 (1994) (concluding that some of the legal problems in cyberspace are that the same that arise in real world, but others are new enough to require solutions tailored to the cyberspace). 11 similar to the one where the parties conclude a contract of sale by phone: no one will inquire about a possible “ virtual” place of business or consider whether the fact that the voice was transmitted over the network of one or more telephone companies is somehow relevant. however, due to the fact that the parties are not physically present before each other, the use of those technologies poses some problems in respect to the requirement of apparent internationality (or non-reliance on the domestic setting of the transaction)30. in contrast, when the parties use technologies in a more extensive manner, some difficulties arise in determining where their places of business are. ii.1.2.2.1. exploring alternatives: possible “ places” of business the situation is different when information systems play an active role in the formation of the contract, since the use of those tools can potentially lead to the conclusion that the parties have other relationships with different states or even with no state at all. those difficulties arise due to the fact that the sales contract is formed without human intervention for that specific transaction — at least in respect to one of the parties — , creating sometimes the impression that the transaction transcends the physical reality and, therefore, that it does not have any territorial connection. as a consequence, some will say that, for instance, a transaction does not have a relationship with one particular jurisdiction, but was celebrated in a “ virtual place” 31. based on that, one could say that the parties’ places of business are also “ virtual” 32, not connected to the territory of any state (for instance, the seller’s place of business would be his web site). the consequence of that view is that the technological environment is a new (non-territorial) space for which special rules should be developed33; due to that circumstance, it can be used only for de lege ferenda purposes and it would certainly be incompatible with the text of the cisg, as it is claimed later on in this paper (part ii.1.2.2.2). an alternative to adopting a concept of a “ virtual” place of business would be to seek to determine the “ real” place of business of the parties. however, that is not a simple question, due to the existence of at least three different possibilities: (a) place where the hardware is located, (b) place from where the information system is accessed and (c) no specific rule. alternative (a) consists in setting a rule pursuant to which the party who uses information technology tools in the formation of contracts has her place of business where the hardware that http://premium.vlex.com/doctrina/redi_revista_electronica_derecho_informatico/convencion_viena_compraventa_in nordic journal of commercial law issue 2006 #2 34 usually, an e-commerce web server holds a database with information about the products (e.g. availability, price and other relevant information), and runs the applications necessary to make to make the web site operational. 35 general in personam jurisdiction, as opposed to specific jurisdiction, is based on the contacts of the defendant with the forum state and allows the court to hear any claim against that defendant (not only claims related to the contacts with the forum); in general terms, if the defendant “ does business” in the forum state, there is general jurisdiction. in helicopteros nacionales de colombia, s.a v. hall, 466 u.s. 408, 414 (1984), the u.s. supreme court extended the due process test affirmed in international shoe co. v. washington, 326 u.s. 310 (1945) for specific jurisdiction to a case of general jurisdiction, holding that “ [d]ue process requirements are satisfied when in personam jurisdiction is asserted over a nonresident corporate defendant that has certain minimum contacts with [the forum] such that the maintenance of the suit does not offend traditional notions of fair play and substantial justice” (citations and internal quotation marks omitted); according to the court, “ continuous and systematic general business contacts” are required, helicopteros, 466 u.s. at 416. some circuit courts found general “ doing business” jurisdiction based on contacts with the forum state stemming from an interactive web store (see infra note 36). 36 in gator.com corp. v. l.l. bean, inc., 341 f.3d. 1072 (9th cir. 2003) vacated rehearing granted en banc, 366 f.3d 789 (9th cir. 2004), the u.s. court of appeals for the 9th circuit found that california courts had general “ doing business” jurisdiction over l.l. bean, a seller of clothing and outdoor equipments which was not physically present in california, based on the fact that it did business in california through its “ interactive” web site. stating that general jurisdiction exists “ when there are ‘substantial’ or ‘continuous and systematic’ contacts with the forum state, even if the cause of action is unrelated to those contacts” , the court found general jurisdiction, among other reasons, because l.l. bean’s web site “ is clearly and deliberately structured to operate as a sophisticated virtual store in california” . id. at 1076-78. the court held that actual presence in the state is not required. id. at 1079. noting that “ l.l. bean’s web side is highly interactive and very extensive” and that “ l.l. bean ‘clearly does business over the internet’” , the court finally concluded that “ l.l. bean’s contacts with california were sufficient to confer general jurisdiction” . id. at 1080. although this decision seems to be highly questionable (see infra note 37), the same conclusion was reached by at least another court: see gorman v. ameritrade holding corp., 293 f.3d 506, 512-13 (d.c. cir. 2002). if those courts find that a defendant “ does business” in their states through her web site, it is not impossible nor improbable that they use this kind of reasoning to hold that a seller who sells her products over the web has her place of business where her site is accessed, i.e. where the buyer is located. 37 indeed, the conclusion reached by the court in gator.com seems to be unsound, specially considering the risks it creates. in that aspect, see robert j. condlin, “ defendant veto” or “ totality of the circumstances” ? it’s time for the supreme court to straighten out the personal jurisdiction standard once again, 54 cath. u. l. rev. 53, 135 n.514 (2004) (noting that the ameritrade rule “ would permit a plaintiff to bring any kind of claim against a party in a state in which that party has an accessible interactive website, even if the claim has no connection with the state or the website” and, “ [s]ince websites are usually accessible everywhere, this means that a defendant with an interactive website could be sued on anything, everywhere” ). 38 in fact, the only situation where internationality could be found would be when the buyer accessed the seller’s “ virtual” store in a state different from the one where the buyer has her place of business. 12 supports her system is physically located. for instance, if a seller uses a fully automated and interactive web site to sell its products, her place of business would be the situs where the machine (often called “ web server” 34) that “ hosts” the web site is located. this approach, however, has its drawbacks and might create even more difficulties, as it will be explored in part ii.1.2.2.3. alternative (b) takes into account the potential of those technologies in permitting a party to reach virtually anybody in the world. still considering the example of the seller who maintains a web site to sell its products, it is possible to say that this technology allows her to offer her products to anyone and anywhere, just like if it had set up a real store in all the places where its web site is accessible. indeed, those e-commerce solutions are often called “ virtual” stores, since they allow the buyer to buy goods and browse the seller’s offers like if she were physically inside a seller’s store without leaving the place where she is. in this line of reasoning, such a “ virtual” store would be located, for legal purposes, in the place from where it is accessed by the buyer; in other words, the seller’s place of business would be wherever the buyer is. this position has not been adopted within the context of the cisg, but in another field of u.s. domestic law (general judicial jurisdiction35) a similar construction has already been accepted36 — despite of the critiques made against it37. in fact, such a conclusion would lead to the exclusion of the great majority of those transactions from the sphere of application of the cisg: if the country of the seller’s place of business were the same as the buyer’s there would not be internationality under article 1(1)38. nordic journal of commercial law issue 2006 #2 39 in this example, whether the apparent seller is in fact a seller for cisg purposes (and not an agent of the party to whom he directs to deliver the goods to the buyer) is an issue governed by domestic law, not by the cisg. therefore, the law applicable under the conflict of laws rules of the forum will determine who are the parties to the contract of sale. see franco ferrari, supra note 19, at 25-26. see also, inter alia, rheinland versicherungen (tribunale di vigevano), supra note 16, at ¶ 23, amtsgericht [petty district c o u r t ] a l s f e l d , g e r m a n y , 1 2 m a y 1 9 9 5 , c a s e n u m b e r 3 1 c 5 3 4 / 9 4 , c a s e a b s t r a c t a v a i l a b l e a t <http://cisgw3.law.pace.edu/cases/950512g1.html> (last visited apr. 27, 2005); oberster gerichtshof [supreme court], austria, 20 march 1997, case number 2 ob 58/97m, case abstract available at <http://cisgw3.law.pace.edu/cases/970320a3.html> (last visited apr. 27, 2005). 40 see supra notes 20, 21, 22, 23, 24 and accompanying text. 13 finally, alternative (c) basically disregards the fact that the transaction was concluded by electronic means and seeks to determine the place of business of the parties like in any other contract of sale. among the four possibilities (i.e., the “ virtual” places of business rule, plus the three alternatives to determine the “ real” place of business) here described, the last one seems to be in line with the cisg, as it is claimed in parts ii.1.2.2.2 and ii.1.2.2.3 that follow. ii.1.2.2.2. rejecting a “ virtual” place of business acknowledging the existence of a “ virtual” place of business is clearly incompatible with the cisg, unnecessary to achieve its purposes and in fact would exclude e-commerce from its sphere of application. the reason is because the cisg rule on direct applicability, i.e. article 1(1)(a), relies extensively on territoriality: the convention is applicable only if the places of business of the parties are located in different contracting states. as a qconsequence, article 1(1)(a) only works if the places of business of the parties are attached to a jurisdiction and, therefore, a “ virtual” place of business, not linked to any territory, could never be the basis for direct applicability. acknowledging the possibility of a “ virtual” place of business, at least within the current framework of the cisg, would lead to the conclusion that the convention is not directly applicable to electronic contracts of sale. furthermore, the definition of goods “ as tangible movables” in the cisg (see infra part ii.2.2) suggests that, somewhere, even for a seller who operates based exclusively on the internet, there must be a physical place from where the goods are dispatched and/or at least from where she coordinates her activities. even in the extreme example of a seller who sells goods on her own name but only acts by directing third parties to deliver the goods to the buyer39, there will certainly be someplace from where the seller will run her business. however, it should be noted that the technology permits even an individual to run such a business without the need of hiring staff or investing on premises to explore her activities and, thus, there might be no actual place of business; in this case, article 10(b) will provide a solution: “ if a party does not have a place of business, reference is to be made to his habitual residence” . ii.1.2.2.3. finding the “ real” place of business to determine the “ real” place of business, one has to bear in mind the requirements of stability and autonomy developed by cisg case-law40 and the underlying idea of a “ substantial and real http://cisgw3.law.pace.edu/cases/950512g1.html http://cisgw3.law.pace.edu/cases/970320a3.html nordic journal of commercial law issue 2006 #2 41 see supra note 27 and accompanying text. 42 for a list of the several different manners a company may put an information system on-line, including the two mentioned above, see donald e. biederman et al, interactive on-line entertainment, 647 pli/pat 263, 395-398 (2001). 43 accord alessandra zanobetti, contract law in electronic commerce, 2000 int’l bus. l.j. 533, 546, n.5 (2000) (stating that “ the location where the server lies, and thus where the data are recorded, should not by itself have a legal effect with respect to the determination of [place of business]” ). 44 see supra note 34. 14 connection” behind article 10(a)41. based on that, it is possible to conclude that the place where the computer system (server) is located is not by itself a place of business nor, even if it could be seen in a particular case as a place of business of one of the parties, the relevant one under article 10(a). this place might be stable, but it does not necessarily have the required autonomous character. indeed, quite often those computer systems are physically installed in a location different from the parties’ places of business; there are several companies specializing in offering their own computer systems to host the applications necessary to run e-commerce solutions (“ web site hosting” ) or even to provide the infrastructure for computer systems owned by other companies (“ co-location” )42. since it is possible that the information system will be located in a place different from the one where a party carries on its activities, it must meet by itself the requirement of autonomy. however, it does not. firstly, an information system certainly does not have autonomy to decide whether to close a deal or not; rather, it will issue offers or acceptances only if programmed to do so in the given circumstances. secondly, the parties do not have to be physically close to the equipment: programming and transferring information to the server can be made remotely, without the need for continuous physical presence of the parties (i.e., no need for an autonomous structure around the equipment); indeed, the place from where the information system is programmed might have the required autonomous character. therefore, the place where the parties’ servers are located is not relevant by itself43. in fact, accepting such a definition could lead to additional problems, since it is not unusual for companies, particularly to transnational corporations, to have servers in different places and all of them might have a role in closing the transaction: for instance, one server might host the seller’s web site and another a database containing relevant information about her products and conditions for concluding a contract of sale44. alternative (b) — the place where the party’s interactive automated system is accessible — is also incompatible with the concept of place of business in the cisg, since it does not meet the requirement of stability. it is merely transitory: it will last just for the time that the other party is accessing that system; after the parties conclude the contract such place will no longer exist (if it indeed existed in the first place). there are at least two possible counter-arguments to this claim. the first is based on an analogy with a “ real-world store” ; for instance, if a buyer purchases goods in a seller’s store (i.e., her place of business) and, the next day, the seller closes the store, this circumstance would not exclude stability; the same would be true with the place of business where the information system is accessed, which would “ close” after the transaction is concluded. the second argument is that the buyer could “ re-open” it again by re-accessing the seller’s information system. those contentions, however, assume that one of the parties should be able to affect the stability of the other party’s nordic journal of commercial law issue 2006 #2 45 franco ferrari, supra note 19, at 28. see also john o. honnold, uniform law for international sales under the 1980 u n i t e d n a t i o n s c o n v e n t i o n § 4 3 , 3 2 3 4 ( k l u w e r l a w , t h e h a g u e , 3 d e d . 1 9 9 9 ) , a v a i l a b l e a t <http://cisgw3.law.pace.edu/cisg/biblio/honnold.html> (last visited apr. 16, 2005); allison e. butler, interpretation of ‘place of business’: comparison between provisions of the cisg (article 10) and the counterpart provisions of the pecl, 6 vindobona j. 275, 276, n.7 (2002). 46 for the criterion of article 10(a), see supra note 25 and accompanying text. 47 see council directive 2000/31, recital 19, 2000 o.j. (l 178) 1. in the 19th recital, the directive provides that “ [t]he place at which an “ information society service provider” is established should be determined in conformity with the case-law of the court of justice” , i.e., where there is “ actual pursuit of an economic activity through a fixed establishment for an indefinite period” . the directive further specifies what is not to be considered as place of establishment: “ the place of establishment of a company providing services via an internet website is not the place at which the technology supporting its website is located or the place at which its website is accessible” . for a comment on the 19th recital of the directive, see saul litvinoff, the european union and electronic commerce, 62 la. l. rev. 1211, 1222-23 (2002). the european court of justice defined “ establishment” in cases dealing with the right of establishment set forth in article 43 (ex 52) et seq of the european community treaty. see the queen v. secretary of state for transport, ex parte factortame ltd and others [“ factortame ii” ], case c-221/89, [1991] e.c.r. 3905, ¶ 20; commission of the european communities v. united kingdom of great britain and northern ireland, case c-246/89, [1991] e.c.r. 4585, ¶ 21. 48 see annex to the report of the working group on electronic commerce on the work of its forty-fourth session (vienna, 11-22 october 2004), u n c i t r a l , 4 4 t h s e s s . a t 4 8 , u . n . d o c . a / c n . 9 / 5 7 1 ( 2 0 0 4 ) , a l s o a v a i l a b l e a t <http://www.uncitral.org/english/workinggroups/wg_ec/index.htm> (last visited mar. 31, 2005) [hereinafter “ uncitral draft convention on electronic communications” ]. article 6(4) so far provides: “ a location is not a place of business merely because that is: (a) where equipment and technology supporting an information system used by a party in connection with the formation of a contract are located; or (b) where the information system may be accessed by other parties” . 15 place of business; the conduct of one of the parties should be relevant to determine only its own place of business, not the other party’s place of business. adopting such a conclusion would lead, for instance, to the awkward situation where a seller could have different places of business for an identical transaction made with different buyers. in respect to the first argument, the analogy is flawed: a “ real-world” store that closes in the next day is stable prior to the conclusion of the sales contract, in contrast to the “ place of business where the information system is accessible” , which is “ opened” for one transaction and “ closed” at the same time that the transaction is made. it is accepted among scholars that “ places of temporary sojourn cannot be considered ‘places of business’” , and, thus, “ one cannot consider conference centers housing exhibitions or hotels or rented offices at exhibitions as being places of business under the cisg” 45. although in those temporary exhibitions a contract of sale might be concluded, the locations where they are held are not accepted as places of business under article 1 of the convention. the situation is analogous to e-commerce, which is also a means to bring prospective sellers and buyers together and overcome the difficulties of dealing by distance. finally, even if the place from where the computer system is accessed were deemed to be a place of business, it would certainly not be the one with the closest relationship to the contract and its performance46, for one simple reason: the place where the buyer (“ a” ) is accessing the seller’s (“ b” ) information system would determine b’s place of business as being where a is located, even though b will certainly perform the contract from some place else, not “ inside” a’s place of business. these two approaches were also rejected by the european union, which adopted in the ecommerce context the traditional definition of “ establishment” set forth by the european court of justice case-law, which requires “ actual pursuit of an economic activity through a fixed establishment for an indefinite period” 47; they were also rejected by the uncitral working group on electronic commerce, in the negotiations of the draft uncitral convention on the use of electronic communications in international contracts48. in respect to the cisg, it has already been suggested that it is desirable to have only one place of business regardless of the http://cisgw3.law.pace.edu/cisg/biblio/honnold.html http://www.uncitral.org/english/workinggroups/wg_ec/index.htm nordic journal of commercial law issue 2006 #2 49 see uncitral e-commerce wkg: secretariat note on e-contracting and cisg, supra note 18, at 5 (¶ 12) (stating that, if an approach based on a definition of place of business is adopted, “ [s]uch a definition should of course not displace the generally-understood meaning of the notion of ‘place of business’ under the convention, as developed in legal literature in the absence of a definition of ‘place of business’ and that “ every effort should be made to avoid creating a situation where any given party would be considered as having its place of business in one country when contracting electronically and in another country when contracting by more traditional means” ). see also franco ferrari, supra note 18, at 291. 50 the idea that underlies the criterion set forth in article 10(a) is of a “ substantial or real connection” (see supra note 27 and accompanying text). therefore, it is doubtful that the places where information regarding an electronic contract is recorded or where the application supporting the party’s information system is running could be considered by themselves relevant, even if one does not agree with the argument that those places do meet the requirement of autonomy. furthermore, the place from where an information system is accessible might have a relation to the conclusion of the contract, but is certainly not connected to its performance; hence, even if one was to reject the claim that it cannot be a place of business due to the lack of stability and argue that it is indeed a place of business it will not be the relevant one under article 10(a). 51 in respect to item (c) above, see uncitral e-commerce wkg: secretariat note on e-contracting and cisg, supra note 18, at 4 (¶ 9) (stating that “ [w]here the parties to a contract concluded electronically clearly indicate where their relevant place of business is located, that place of business is to be taken into consideration in determining the internationality of the sales transaction” ). see also franco ferrari, supra note 18, at 290 and article 6(1) of the uncitral draft convention on electronic communications, supra note 48 at 47. in case one of the parties misrepresents the location of its place of business, it is not clear whether such issue would be governed by domestic law (i.e. if it would fall into the exclusion of validity issues under article 4(a) of the cisg) or resolved by the cisg itself; the uncitral draft convention on electronic communications solves the issue directly, when it provides in article 6(1): “ for the purposes of this convention, a party’s place of business is presumed to be the location indicated by that party, unless another party demonstrates that the party making the indication does not have a place of business at that location” . 52 see andreas f. lowenfeld, international economic law 7 (oxford university press 2003) (2002) (noting, in an analysis of the shortcomings of david ricardo’s theory of comparative advantage, that “ the rise of multinational enterprises has led to vast amounts of trade among affiliated firms in different countries, and to international investment as an alternative and supplement to trade, to a degree wholly unforeseen by the economists who developed and explored theories of international trade” ). 16 means used to the conclusion of the contract, electronic or the more traditional ones 49, an inconvenience that the two approaches analyzed above certainly create. in fact, it seems that none of these solutions would be compatible with the cisg; what is left is the traditional approach. the definition of place of business in e-commerce, like in any other transaction, should be made on a case-by-case basis. the abovementioned requirements of autonomous character and stability must be met; if more than one place meet those requirements, relevant one will be determined in accordance with the idea of substantial and real connection that underlies article 10(a). therefore, it is possible to state that the place of business of a party will be where she pursues her economic activity on a permanent basis and where there is autonomy to conclude the sales contract. one should nevertheless bear in mind that, (a) in e-commerce, autonomy might be construed as the ability to determine in advance the conditions under which it will issue offers and/or acceptances by programming a server or other information system, even remotely. also, if there is more than one possible place of business: (b) the relevant place of business is, under the principle that underlies article 10(a), the one where there is activity that is more closely connected to the conclusion of contract and its performance, considering the elements known by the parties at the time of conclusion of the contract50; (c) if the parties indicate where their places business is located, such indication should be accepted51. those elements will provide some guidance in the definition of place of business of the parties in each case, but it should be conceded that they might not lead to one clear answer in every case. however, this problem is not exclusive to contracts concluded by electronic means. there are multiple ways in which the parties can structure their activities. numerous companies, in order to benefit from specialization in trade and from the comparative advantages that different countries have, perform their activities in different jurisdictions52; for instance, it is not unusual for nordic journal of commercial law issue 2006 #2 53 see infra, part ii.2.2. 54 see uncitral draft convention on electronic communications, supra note 48 at 47. two important observations should be made: (a) although the draft convention crystallizes the requirement of stability (or “ nontransitory” establishment), it does not mention the requirement of autonomous character which was developed by legal scholarship and case-law on the cisg; (b) under article 19(1), the draft convention is intended to be applicable to the “ use of electronic means in connection with the formation or performance of a contract or agreement” to which the cisg (and other conventions) is applicable; the provision seems to limit the applicability of the draft convention to issues of formation and performance and, thus, it is possible to construe it as not being applicable to issues of applicability of the cisg; anyway, it seems that such impact over the cisg would be possible only if the draft convention is ratified by all contracting states to the cisg. 55 see uncitral e-commerce wkg: secretariat note on e-contracting and cisg, supra note 18, at 4 (¶ 8); franco ferrari, supra note 18, at 289; renaud sorieul, the united nations convention on contracts for the international sale of goods (cisg) as a set of uniform rules for electronic commerce, 4 bus. l. int’l 380, 381 (2000). 56 see john d. gregory, the proposed uncitral convention on electronic contracts, 59 bus. law. 313, 319 (2003) (reporting the argument of those who supported the idea of making the proposed convention applicable to both domestic and international transactions and noting that this difficulty is more significant when the parties are dealing with “ goods that a are deliverable online” ). 17 companies to coordinate their activities, design their products, manufacture, store and market them in completely different places. however, such movement is not directly related to the development of information technology tools (although they certainly turn those complex decentralization projects more feasible) and hence those issues arise regardless of the use of electronic means for the conclusion of the contract. the use of electronic means, however, brings additional problems in respect to the issue of awareness of the places of business (“ apparent internationality” ), as it will be examined subsequently in part ii.1.3. it should be acknowledged that the definition of place of business might become more problematic in respect to those contracts that are concluded and performed by the seller through electronic means (e.g. acquisition and download of software over the internet); however, since those kind of contracts are not covered by the cisg53, that is not a real issue. in fact, it does not seem that in a short term the elements of the concept of place of business will be modified, since the draft convention on the use of electronic communications in international contracts54 defines it under article 4(h) as “ any place where a party maintains a nontransitory establishment to pursue an economic activity other than the temporary provision of goods or services out of a specific location” . although inserted in a draft convention dealing specifically with the difficulties arising from electronic communications, this provision does not seem to take into account any particularity of electronic commerce in its definition of place of business. ii.1.3. the requirement of apparent internationality in article 1(2) in the domain of e-commerce, the distinction between domestic and international transactions tends to be blurred55, due to the fact that is difficult to know where parties are when they are dealing on-line56. under cisg article 1(2), the internationality of the transaction is to be disregarded if the fact that the parties have their places of business in different states “ does not appear either from the contract or from any dealings between, or from information disclosed by, the parties at any time before or at the conclusion of the contract” . the parties must have had the opportunity to be aware that the transaction is indeed international; if one of them had a basis to nordic journal of commercial law issue 2006 #2 57 see franco ferrari, supra note 19, at 31. 58 see secretariat commentary [on article 1 of the 1978 draft], united nations conference on contracts for the international sale of goods, official records: documents of the conference and summary records of the plenary meetings and of the m e e t i n g s o f t h e m a i n c o m m i t t e e s ( v i e n n a , 1 0 m a r c h – 1 1 a p r i l 1 9 8 0 ) 1 4 , 1 5 ( 1 9 8 1 ) , a v a i l a b l e a t <http://cisgw3.law.pace.edu/cisg/text/secomm/secomm-01.html> (last visited apr. 2, 2005) and in documentary history of the uniform law for international sales 405 (john o. honnold ed. 1989). 59 see discussion in part ii.2.2. if the cisg covered contracts performed by electronic means, then the parties would probably be able to completely disregard each other’s place of business. 60 that is the situation described in article 31(a) of the cisg. in the circumstances referred to in articles 31(b) and 31(c), it would be reasonable for the seller to rely on the domestic setting of the transaction. 61 domain name is an instrument used to make easier to find a resource in the internet; instead of typing the ip address (a number such as “ 192.168.100.100” ) of the server where the desired resource is located, a user can simply use the domain name (such as “ www.nyu.edu” ), which is more friendly. 62 see uncitral e-commerce wkg: secretariat note on e-contracting and cisg, supra note 18, at 4 (¶ 10) (stating that “ [w]here a party uses an address linked to a domain name connected to a specific country (such as addresses ending with ‘.at’ for austria, ‘.nz’ for new zealand, etc.), it can be argued that the place of business should be located in that country” ). see also franco ferrari, supra note 18, at 290. 63 that is the solution so far adopted in the uncitral draft convention on electronic communications, supra note 48 at 48. article 6(5) provides that “ [t]he sole fact that a party makes use of a domain name or electronic mail address connected to a specific country does not create a presumption that its place of business is located in that country” . according to uncitral working group on electronic commerce, nothing in the draft paragraph (5) of article 6 “ prevented a court or arbitrator from taking into 18 rely on the domestic setting57 of their dealings, the convention is not applicable. the underlying principle is to prevent that one of the parties be surprised by the applicability of the convention, as it is evidenced by the example given during the united nations conference that led to the final text of the cisg; according to the secretariat commentary, the convention would not be applicable under article 1(2) “ where the parties appeared to have their places of business in the same state but one of the parties was acting as the agent for an undisclosed foreign principal” 58. although some technologies allow the parties to negotiate from completely different parts of the world as easily as if they were in the same country, it should be noted that in many instances the parties will probably be compelled to consider at a certain point of their dealings the distance between them. that is so due to the fact that the cisg only covers contracts of sale of tangible goods, which will generally require transport from one location to another59. for instance, the buyer, even if not being advised by legal counsel and not concerned about the law applicable to the contract, will certainly consider the freight costs and possibly customs duties, since the goods will be imported from one country to another; conversely, if the seller has to arrange for the carriage of the goods, she will certainly have to know to where the goods should be transported60. in other situations where the internationality of the contract was not part of the negotiation of the parties, other elements might be considered to determine whether the requirements of article 1(2) were met. in electronic commerce, it has been suggested that, when the parties communicate with each other using an internet domain name61 (either by e-mail or through an web site) that is attached to a particular jurisdiction — such as the names with the suffixes “ .de” , “ .it” and “ .ar” , which stand for germany, italy and argentina, respectively — this element might be taken into account to determine the parties’ places of business62. however, such domain names do not create a presumption that the parties have their places of business in the jurisdictions mentioned in the name; rather, it can only be one of the factors considered to assist in determining whether the parties had conditions to be aware of the internationality of the contract, but it cannot be used by itself as a criterion of internationality63. the reason is that one of the parties might be using one http://cisgw3.law.pace.edu/cisg/text/secomm/secomm-01.html nordic journal of commercial law issue 2006 #2 account the assignment of a domain name as a possible element, among others, to determine a party’s location, where appropriate” , report of the working group on electronic commerce on the work of its forty-fourth session (vienna, 11-22 october 2004), u n c i t r a l , 4 4 t h s e s s . a t 4 7 ( ¶ 1 1 3 ) , u . n . d o c . a / c n . 9 / 5 7 1 ( 2 0 0 4 ) , a l s o a v a i l a b l e a t <http://www.uncitral.org/english/workinggroups/wg_ec/index.htm> (last visited mar. 31, 2005). 64 for a discussion of this problem, see uncitral e-commerce wkg: secretariat note on e-contracting and cisg, supra note 18, at 4-5 (¶ 11); franco ferrari, supra note 18, at 290-91 (both discussing the possibility of considering that the party who deals with someone using a top-level domain name could not say that she was not aware of the internationality of the transaction). see also report, uncitral working group on electronic commerce, 34th sess. at 19-20 (¶ 98-9), u.n. doc. a/cn.9/484 (2001), available at <http://www.uncitral.org/english/sessions/unc/unc-34/acn-484e.pdf> (last visited apr. 3, 2005) [hereinafter “ uncitral ecommerce wkg: 38th session report” ]. one inconvenience of this approach, however, is the fact that most u.s. companies use top-level domain names, even though some of them do not deal internationally. also, it is conceded that this approach only serves to the purpose of determination of apparent internationality; thus, another solution would be necessary for purposes of applicability under article 1(1)(a), which requires that the parties have their places of business in a particular jurisdiction. 65 the cisg is not intended to deal with the law of agency; for references of that issue, see supra note 39. 66 see renaud sorieul, supra note 55, at 383 (concluding that the party on “ whose behalf a computer is programmed, for example to issue purchase orders, is ultimately responsible for any message generated by the machine” ). 67 see articles 2(c) and 2(d) of the uncitral model law on electronic commerce and ¶ 35 of the guide to enactment, g.a. r e s . 5 1 / 1 6 2 , u . n . g a o r , 5 1 s t s e s s . , u . n . d o c . a / r e s / 5 1 / 1 6 2 ( 1 9 9 6 ) , e n g l i s h v e r s i o n a v a i l a b l e a t <http://www.uncitral.org/english/texts/electcom/ml-ecomm.htm> (last visited apr. 3, 2005) [hereinafter “ uncitral mlec” ]. 19 of those domain names without being necessarily in the territory referred to in the suffix. suppose, for instance, that an italian buyer negotiates by e-mail a contract of sale with an italian subsidiary of a german company; the contract is concluded and fully performed by the italian subsidiary, without any involvement of the parent company, except that the seller used the e-mail system of its parent company and, consequently, the german domain name (“ .de” ). it would be clearly unreasonable to assume that such transaction is international, just because of the domain names of the parties. also, since article 1(2) requires possibility of being aware, it is possible that one the parties might not have conditions to notice the suffixes of the domain names — for instance, if, while browsing a web site with a domestic domain name, she is forwarded to another one with a foreign domain name without having the possibility of noticing that (e.g., the new web site is loaded on a window which does not display the address of the page being viewed). there is still the possibility that one of the parties does not know to what the suffix of the domain name stands for. finally, a domain name based rule would not work for top-level domain names (such as “ .com” and “ .net” ), which do not have geographical suffixes.64 ii.1.4. the definition of parties and the issue of “ electronic agents” when technologies are used to replace human interaction in the formation of contracts, one might wonder who (or what) is party to the contract: the person that programmed (or entity on whose behalf a person programmed) the computer to issue an offer or acceptance on that particular circumstance, or the “ electronic agent” who issued the declarations that ultimately formed the contract? although the answer of who should be a party to that contract seems to be obvious, this issue is not settled by the cisg and, thus, is left to domestic law65. nevertheless, when the issue of electronic agents was discussed by the uncitral working group of electronic commerce, it has been generally admitted that “ a computer should not become the subject of any right or obligation” 6 6. indeed, the uncitral model law on electronic commerce defines “ originator” and “ addressee” of data messages as persons, and the guide to enactment indicates that “ the model law should not be misinterpreted as allowing for a computer to be made the subject of rights and obligations” 6 7. although any other view would be unreasonable, that matter is left to domestic law. http://www.uncitral.org/english/workinggroups/wg_ec/index.htm http://www.uncitral.org/english/sessions/unc/unc-34/acn-484e.pdf http://www.uncitral.org/english/texts/electcom/ml-ecomm.htm nordic journal of commercial law issue 2006 #2 68 for a comprehensive analysis of the cisg’s substantive sphere of application, see franco ferrari, supra note 19, at 58-95. 69 cisg article 1(1) provides, in the relevant part: “ [t]his convention applies to contracts of sale of goods [… ]” . 70 cisg article 3 presents the threshold requirements for the exclusion of contracts for the supply of goods to be manufactured or produced (article 3(1)) and contracts which involve the supply of both goods and services (article 3(2)). on that issue, see franco ferrari, supra note 19, at 65-74. 71 several commentators and courts sought to define goods autonomously; for references, see infra notes 72, 74 and 75. 72 see frank diedrich, the cisg and computer software revisited, 6 vindobona j. supplement 55, 59 (2002), available at <http://www.maa.net/vindobonajournal/vj_documents/vj_6_2_e_supplement_diedrich.pdf> (last visited apr. 6, 2005). 20 ii.2. substantive sphere of application and e-commerce ii.2.1. overview and potential issues articles 1(1), 2 and 3 set the limits of the convention’s ratione materiæ sphere of application. in order to be governed by the cisg, the contract between the parties must be a contract of sale of goods68, as article 1(1) provides69. therefore, the applicability of the uniform sales law requires a definition of contract of sale and goods, concepts that might pose some difficulties in some instances of electronic commerce, as it will be further explored in part ii.2.2. furthermore, article 2 of the convention excludes its applicability to some contracts, based on the (consumer) purpose of the sale (subparagraph (a)), method of selling (subparagraph (b)), the existence of public (national) interest in the sale (subparagraph (c)) or the nature of the goods sold (subparagraphs (d), (e) and (f)). within the scope of this paper, the exclusion of contracts of sale for consumer purposes is relevant. article 2(a) requires that the seller knew (or ought to have known) of the consumer use of the goods sold in order to exclude the application of the convention. such knowledge requirement for non-applicability, which already creates some problems in regular real-world transactions, poses additional difficulties when the contract is made with the use of electronic means, an issue which will be dealt with in part ii.2.3. article 3, although relevant for the definition of the cisg’s sphere of application, does not create any additional difficulties within the e-commerce environment70. ii.2.2. “ goods” , “ contract of sale” and performance over the internet there is some discussion on whether transactions involving software and other creations recorded in tangible media (or transmitted by electronic means) are covered by the cisg. such controversy arises due to the intangible nature of those creations (although they are often recorded in tangible media) and to the kind of agreement generally used in those transactions. the difficulty resides on the notions of goods and contract of sale, which are not expressly defined in the cisg. ii.2.2.1. basic concepts: “ goods” and “ contract of sale” the cisg does not define in express terms the expressions “ goods” and “ contract of sale” . nevertheless, it is generally said that an autonomous definition can be derived from the cisg without recourse to domestic law71. goods are usually defined as “ tangible movables” ; although the text of article 30 suggests that goods ought to be movable72, the tangibility requirement is based on the drafting history of the convention. the argument is that the notion of “ goods” http://www.maa.net/vindobonajournal/vj_documents/vj_6_2_e_supplement_diedrich.pdf nordic journal of commercial law issue 2006 #2 73 see convention relating to a uniform law on the international sale of goods, jul. 1, 1964, 834 u.n.t.s. 107, available at <http://www.unidroit.org/english/conventions/c-ulis.htm> (last visited apr. 6, 2005) [hereinafter “ ulis” ] and convention relating to a uniform law on the formation of contracts for the international sale of goods, jul. 1, 1964, 834 u.n.t.s. 169, available at <http://www.unidroit.org/english/conventions/c-ulf.htm> (last visited apr. 6, 2005) [hereinafter “ ulf” ]. 74 for this construction, see franco ferrari, specific topics of the cisg in the light of judicial application and scholarly writing, 15 j.l. & com. 1, 64-65 (1995). also using an historical approach to reach the same conclusion, see peter winship, changing contract practices in the light of the united nations sales convention: a guide for practitioners, 29 int’l law. 525, 533 (1995), available at <http://cisgw3.law.pace.edu/cisg/text/winship1.html> (last visited apr. 3, 2005). but see frank diedrich, supra note 72, at 64 (stating that “ [n]o reason can be derived from the cisg to limit its sphere of application to tangible things” ); joseph lookofsky, the 1980 united nations convention on contracts for the international sale of goods, in international encyclopaedia of laws: contracts [supplement 29] ¶ 58 (roger blanpain ed., kluwer law international, 2000) (stating that “ there is good reason to understand the cisg notion as broadly as possible, so as to cover all moveable — and not just ‘corporeal’ — things” ). 75 see al palazzo s.r.l. v. bernardaud s.a., tribunale [district court] di rimini, 26 november 2002, 8 vindobona j. 165, 171 (2004), available at <http://cisgw3.law.pace.edu/cases/021126i3.html> (last visited apr. 9, 2005) (stating that the cisg requires that “ the object of the sale, at the moment of delivery [… ] be moveable and tangible” ); kantonsgericht [district court] des kantons zug, switzerland, 21 october 1999, case number a3 1997 61, available at <http://cisgw3.law.pace.edu/cases/991021s1.html> (last visited apr. 9, 2005) (stating that the cisg is “ applicable only to movable property and to legal transactions where goods are exchanged for money” ); oberster gerichtshof [supreme court], austria, 10 november 1994, case number 2 ob 547/93, 6 vindobona j. 147, 150 (2002), also available at <http://cisgw3.law.pace.edu/cases/941110a3.html> (last visited apr. 17, 2005); (stating that “ ‘[g]oods’ means moveable property” ); oberlandesgericht [provincial court of appeal] köln, germany, 26 august 1994, case number 19 u 282/93, available at <http://cisgw3.law.pace.edu/cases/940826g1.html> (last visited apr. 9, 2005) (finding that a contract to perform a market study was not covered by the cisg and holding that “ [o]nly movable things that are typically the object of a commercial sale can be considered a ‘ware’ [good, in german]” ). 76 see soc. romay ag v. soc. behr france, s.a.r.l., tribunal de grande instance de colmar, france, 18 december 1997, available at <http://www.unilex.info/case.cfm?pid=1&do=case&id=981&step=fulltext> (finding the cisg inapplicable and stating that “ [l]a convention ne contient aucune définition expresse du contrat de vente internationale” , but that “ [l]es éléments de définition peuvent être tirés de certains articles de la convention, consacrés aux obligations des parties” ), vacated by cour d’appel de colmar, france, 12 june 2001, available at <http://cisgw3.law.pace.edu/cases/010612f1.html> (last visited apr. 9, 2005) (stating the same, but finding the cisg a p p l i c a b l e ) , a f f i r m e d b y c o u r d e c a s s a t i o n , f r a n c e , 3 0 j u n e 2 0 0 4 , c a s e n u m b e r y 0 1 1 5 . 9 6 4 a v a i l a b l e a t <http://www.unilex.info/case.cfm?pid=1&do=case&id=981&step=fulltext> (last visited apr. 9, 2005); al palazzo supra note 75, at 171 (stating that a definition of contract of sale “ can be derived from articles 30 and 53 of the cisg” ); tribunal [appellate c o u r t ] c a n t o n a l v a u d , s w i t z e r l a n d , 1 1 m a r c h 1 9 9 6 , c a s e n u m b e r 0 1 9 3 1 0 6 1 , a v a i l a b l e a t <http://cisgw3.law.pace.edu/cases/960311s2.html> (last visited apr. 9, 2005) (stating that “ [t]he vienna convention gives no definition of the sales contract which must be understood in its classic sense, namely, that one party undertakes an obligation to deliver goods and transfer the property in the goods to the other party for a certain price” ). 21 under the cisg corresponds to the one under the 1964 hague conventions73; such conclusion is based on the fact that the english version of the three texts (ulis, ulf and cisg) uses the expression “ goods” , while the french version of the cisg (which is also official) uses the expression “ merchandises” in contrast to the expression “ objets mobiliers corporels” used in the ulis and ulf; this difference in terms is deemed to be merely a terminological simplification from the hague conventions to the cisg and was not intended to be an evolution; therefore, it is possible to say that the notion of “ tangible movables” present in the hague conventions (from the frech text “ objets mobiliers corporels” ) was transposed to the cisg74. some courts have already interpreted article 1 of the cisg to conclude that only “ tangible moveable” goods are covered by the cisg75. on the other hand, the definition of contract of sale is derived from the text of the cisg, more specifically, from provisions of the cisg describing the obligations of the parties (articles 30 and 53)76. under article 30, “ [t]he seller must deliver the goods, hand over any documents relating to them and transfer the property in the goods” ; conversely, under article 53, “ [t]he buyer must pay the price for the goods and take delivery of them” . having said that, the conclusion is that a sales contract “ obliges one party (seller) to deliver goods and transfer the right of property, and the other party (buyer) to pay the purchase price and accept delivery” ; the underlying idea is “ an http://www.unidroit.org/english/conventions/c-ulis.htm http://www.unidroit.org/english/conventions/c-ulf.htm http://cisgw3.law.pace.edu/cisg/text/winship1.html http://cisgw3.law.pace.edu/cases/021126i3.html http://cisgw3.law.pace.edu/cases/991021s1.html http://cisgw3.law.pace.edu/cases/941110a3.html http://cisgw3.law.pace.edu/cases/940826g1.html http://www.unilex.info/case.cfm?pid=1&do=case&id=981&step=fulltext http://cisgw3.law.pace.edu/cases/010612f1.html http://www.unilex.info/case.cfm?pid=1&do=case&id=981&step=fulltext http://cisgw3.law.pace.edu/cases/960311s2.html nordic journal of commercial law issue 2006 #2 77 oberster gerichtshof, supra note 75, at 150. 78 this part will deal only with the situation where the characteristic performance is made through electronic means. any reference in this paper to “ contracts performed over the internet” or “ contracts performed electronically” is to be read as references to contracts whose characteristic performance is made through electronic means; payment of the price, in most contracts and in any contract of sale, is not deemed to be characteristic performance. 79 see trevor cox, chaos versus uniformity: the divergent views of software in the international community, 4 vindobona j. 3, 3 (2000) (stating that “ [s]oftware can be delivered via the internet (electronic software), mass-produced and delivered on a disk, or custom designed for a particular party” ). 80 it has already been said that on-line broadcasts would clearly fall into the category of services, and, thus, not be covered by the cisg; see uncitral e-commerce wkg: 38th session report, supra note 64, at 23 (¶ 117). 81 see frank diedrich, supra note 72, at 65 (stating that “ the cisg is certainly applicable to system software and standard software” ). for references to court decisions holding the cisg applicable to contracts of sale of standard software and system software, see infra note 83. 22 exchange [of] ‘goods for money’” 77. for the purposes of this paper, the critical issue in the definition of sales contract is the obligation of the seller of transferring the property in the goods. ii.2.2.2. unsuitability of the definitions to contracts performed over the internet aside from permitting the conclusion of a contract by electronic means, the technological developments now also allow the parties to perform their contractual obligations electronically. both the buyer and the seller can perform their obligations over the internet: the “ buyer” can pay the price electronically, whereas the “ seller” can, depending on the object of the contract of sale, provide it to the “ buyer” by electronic means. if the characteristic performance of the contract is made electronically, the applicability of the cisg becomes doubtful78. the most notorious example is the situation where a developer offers her software in a web site, a user purchases a license to use it, pays for it on-line (e.g. by credit card) and downloads it directly to her computer79. the software is not recorded on tangible media and shipped to the user, but transferred from one computer to another, where it is ultimately recorded, to be used and eventually for backup purposes. there are other sorts of digital content that are also suitable for being licensed and transferred electronically, such as music, images, video and texts (the so called “ e-books” ); from the perspective of the technology, the scheme used is very similar to the one adopted to license downloadable software, although sometimes the user is not allowed to retain a copy (i.e., the content is simply broadcasted over the internet).80 there is significant discussion among commentators in respect to the applicability of the cisg to software contracts. there is a consensus that the cisg can be applicable to standard software — i.e., software that is sold en masse “ as it is” to the public — and system software — i.e., software that is included in another good (such as a computer or an automobile) to make it operational81. in respect to custom-made software, i.e. the software that is designed or modified specifically for one client, it is consensus that the cisg will not apply if “ the preponderant part of the obligations of the party who furnishes the goods consists in the supply of labour or other services” (article 3(2)); therefore, if the economic value of the obligation of customizing (labor) the software exceeds 50% nordic journal of commercial law issue 2006 #2 82 it is generally accepted that the term “ preponderant” in article 3(2) should be read as “ more than half” and that the basis to determine “ preponderance” is the economic value of the obligations. in that respect, see peter schlechtriem, uniform sales law: the un-convention on contracts for the international sale of goods 31-32 (vienna, manz, 1986), available at <http://www.cisg.law.pace.edu/cisg/biblio/schlechtriem.html> (last visited apr. 17, 2005); franco ferrari, supra note 19, at 71-73. but see cisg-ac opinion number 4, contracts for the sale of goods to be manufactured or produced and mixed contracts (article 3 cisg), ¶ 3.3 and 3.4, 24 october 2004 (rapporteur: professor pilar perales viscasillas, universidad carlos iii de madrid), available at <http://cisgw3.law.pace.edu/cisg/cisg-ac-op4.html> (last visited apr. 9, 2005) (accepting the economic value approach, but stating that preponderance should be determined based on “ overall assessment” , not on fixed percentages). 8 3 see landgericht [district court] münchen, germany, 8 february 1995, case number 8 hko 24667/93, available at <http://cisgw3.law.pace.edu/cases/950208g4.html> (last visited apr. 9, 2005) (standard software); handelsgericht [commercial c o u r t ] z ü r i c h , s w i t z e r l a n d , 1 7 f e b r u a r y 2 0 0 0 , c a s e n u m b e r h g 9 8 0 4 7 2 , a v a i l a b l e a t <http://cisgw3.law.pace.edu/cases/000217s1.html> (last visited apr. 9, 2005) (holding the cisg applicable to a contract of supply of standard software, hardware, installation and training; disregarding, for purpose of applicability, the part of the contract which involved the supply of services, although incorrectly based on article 3(1)); oberlandesgericht [provincial court of appeal] koblenz, germany, 17 september 1993, case number 2 u 1230/91, available at <http://cisgw3.law.pace.edu/cases/930917g1.html> (last visited apr. 9, 2005) (system software embedded in a computer chip). 84 trevor cox, supra note 79, at 9 (concluding that there are valid arguments for applying the cisg to software downloaded over the internet); frank diedrich, maintaining uniformity in international uniform law via autonomous interpretation: software contracts and the cisg, 8 pace int’l l. rev. 303, 336 (1996), available at <http://cisgw3.law.pace.edu/cisg/biblio/diedrich.html> (last visited apr. 9, 2005) (concluding that “ the substantive sphere of application of the cisg extends to all international sales contracts despite [… ] whether the software is transmitted electronically or by means of a tangible data carrier” ). 85 see uncitral e-commerce wkg: secretariat note on e-contracting and cisg, supra note 18, at 7 (¶ 22); franco ferrari, supra note 18, at 294. 86 see john d. gregory, supra note 56, at 322. 87 see jeff c. dodd, time and assent in the formation of information contracts: the mischief of applying article 2 to information contracts, 36 hous. l. rev. 195, 211 (1999). 88 there is at least one decision holding the cisg applicable to the sale of books: handelsgericht [commercial court] zürich, switzerland, 10 february 1999, case number hg 970238.1, available at <http://cisgw3.law.pace.edu/cases/990210s1.html> (last visited apr. 10, 2005). 23 of the total value of the contract, the cisg will not be applicable82. based on that, courts have already held that the cisg is applicable to standard software and system software.83 however, there is still controversy among commentators in respect to the applicability of the cisg to software that is not incorporated in tangible media, such as the one downloaded over the internet. in general, those who believe that the expression “ goods” must have a broad definition believe that the cisg covers intangibles and, as corollary, downloaded software84; however, if the requirement of tangibility is maintained, the cisg is not applicable to downloaded software85, or to any other digital content transmitted electronically. aside from the issue of tangibility, the claim to exclude contracts performed over the internet is stronger when one considers that, when there is no tangible media, only the limited right to use the software (or other digital content) is transferred. therefore, one of the elements of the definition of the contract of sale — transfer of title in the goods — is absent: the developer maintains his intellectual property (“ ip” ) rights over the software and grants a limited ip right to the user. in this situation, the transaction looks “ less like a sale and more like a license” 86; usually the licenser, through standard-form contracts, seeks not only to limit her liabilities, but govern the use of the software by the licensee87, limiting what the latter can do with the computer program. when the transaction involves a copyrightable creation incorporated in tangible media (such as books88, optical discs, magnetic discs), there is at least a transfer of the property in the media used http://www.cisg.law.pace.edu/cisg/biblio/schlechtriem.html http://cisgw3.law.pace.edu/cisg/cisg-ac-op4.html http://cisgw3.law.pace.edu/cases/950208g4.html http://cisgw3.law.pace.edu/cases/000217s1.html http://cisgw3.law.pace.edu/cases/930917g1.html http://cisgw3.law.pace.edu/cisg/biblio/diedrich.html http://cisgw3.law.pace.edu/cases/990210s1.html nordic journal of commercial law issue 2006 #2 89 but see joseph lookosfsky, in dubio pro conventione? some thoughts about opt-outs, computer programs and preemption under the 1980 vienna sales convention (cisg), 13 duke j. comp. & int’l l. 263, 277-278, n.76 (summer 2003) (arguing that “ the fact that [the buyer] can only (legally) use the goods purchased in ways which respect [the seller]’s intellectual property rights in the software does not somehow turn a sale into a license, and if [the seller] supplies a term which attempts to escape the reality of the situation, that term ought not bind [the buyer]” ). 90 see eduardo jiménez de aréchaga, international law in the past third of a century, 159 rec. des cours 1, 42-48 (1978-i). 91 for an updated listed of contracting states, see: (a) ulis, <http://www.unidroit.org/english/implement/i-64ulis.pdf> (last visited apr. 10, 2005); (b) ulf, <http://www.unidroit.org/english/implement/i-64ulf.pdf> (last visited apr. 10, 2005); and (c) cisg, supra note 2. 92 joseph lookofsky, supra note 74, at ¶ 58. 24 as a data carrier, something that does not happen when digital content is transferred over the internet89. therefore, based on the current interpretation of article 1(1) of the cisg, the convention would not be applicable to contracts where the characteristic performance is done electronically. however, this conclusion is based exclusively on a mere interpretation of the provisions in the cisg and, thus, it poses a new issue: whether this interpretation that restricts the applicability of the convention should nevertheless be maintained despite the technological developments; i.e., whether the interpretation should also be updated or not to meet the current reality needs. ii.2.2.3. a critical analysis of the notion of “ goods” as tangibles: can it be “ updated” ? from the perspective of the law of the treaties, the construction of the concept of “ goods” as covering only tangibles does not seem fully persuasive. under the vienna convention, the “ extrinsic materials” mentioned in article 32 — i.e. “ those which have not been the object of the specific agreement of the parties, such as the preparatory work of the treaty and the circumstances of its conclusion” — are qualified as “ supplementary means of interpretation” in relation to “ intrinsic materials” — i.e., “ texts and related instruments which have been agreed to by the parties” 90. as described above in part ii.2.2.1, the construction of the term “ goods” is based on a historical analysis (i.e., on “ extrinsic materials” ) whose starting point is the hague conventions, which were adopted by a few states (basically european), in radical contrast to the cisg, which has almost universal acceptance91. a claim to extend a definition included in an earlier treaty with limited adhesion to a later treaty with wider acceptance is weaker than in the situation where all the states who participated in the formation of the second treaty also negotiated the first one; further, the claim to use elements outside the bargain reached by the contracting states is also weaker when the second treaty remains open to signature and is indeed adopted by other states. indeed, in the context of the cisg, relying exclusively on an historical interpretation would be tantamount to accept that the negotiations of the hague conventions could bind the original signatories of the cisg without their consent, as well as later signatories who did not even participate in the negotiation of the cisg itself. those circumstances make a claim for interpretation based on purpose (teleological) and context (systematic) stronger. since the issue is the applicability of a convention, automatically favoring an interpretation to expand the “ cisg as broadly as possible” 92 does not seem correct. an interpretation based on purpose suggests that, at least when it comes to determine the sphere of application of the convention, the matter should be solved on the basis of the suitability of the http://www.unidroit.org/english/implement/i-64ulis.pdf http://www.unidroit.org/english/implement/i-64ulf.pdf nordic journal of commercial law issue 2006 #2 93 but see id. at ¶ 58 (stating that “ even when computer programs are sold/downloaded over the internet [… ], the cisg default rules seem well-suited to regulate the parties’ obligations and remedies for breach” ). 94 several provisions make reference to “ delivery” , “ carriage” and “ marking the goods” , which are expressions that only make sense if the goods are tangible. however, if the cisg were to apply to contracts performed over the internet, one solution would be to disregard these provisions, or find electronic equivalents for the concepts used by them. therefore, the based on the convention’s reliance on terms that assume tangibility of the goods, by itself, is not sufficient to exclude the applicability of the cisg to these transactions. the stronger argument is based on the context of the convention. 95 article 30 provides that the seller has the obligation to “ transfer the property in the goods” ; the issue would be to determine to what extent “ property” should be understood. in software contracts, the user will at most “ own” the right to use it and the media were it is recorded in case there is tangible media. a possible counterargument would be that the cisg is not intended to govern “ the effect which the contract may have on the property in the goods sold” (article 4(b)) and therefore, even in the absence of contractual provisions, no one would claim that a software contract entitles the user to resell it freely. however, the issue here is different: the problem is not to determine the property rights of the buyer, but rather over what the user has a right (regardless if this right is property or anything else). 96 the expression “ contextual interpretation” is used here in the meaning of article 31(1) of the vienna convention on the law of the treaties (1969), meaning interpretation of the text of the cisg “ as whole” , i.e., based on the idea that it is intended to form an autonomous system, a claim that finds support in article 7 of the cisg. article 31 of the 1969 vienna convention provides that “ [a] treaty shall be interpreted in good faith in accordance with the ordinary meaning given to the terms of the treaty in their context and in the light of its object and purpose” (emphasis added). 97 see secretariat commentary [on article 2 of the 1978 draft], united nations conference on contracts for the international sale of goods, official records: documents of the conference and summary records of the plenary meetings and of the m e e t i n g s o f t h e m a i n c o m m i t t e e s ( v i e n n a , 1 0 m a r c h – 1 1 a p r i l 1 9 8 0 ) 1 6 , ( 1 9 8 1 ) , a v a i l a b l e a t <http://cisgw3.law.pace.edu/cisg/text/secomm/secomm-02.html> (last visited apr. 10, 2005). according to the secretariat commentary, the rationale to exclude consumer sales (article 2(a)) was “ that in a number of countries such transactions are subject to various types of national laws that are designed to protect consumers” , id. at ¶ 3. in respect to sales by auction (article 2(b)), those “ are often subject to special rules under the applicable national law and it was considered desirable that they remain subject to those rules even though the successful bidder was from a different state” , id. at ¶ 5. finally, “ [s]ubparagraph (c) of [article 2] excludes sales on judicial or administrative execution or otherwise by authority of law, because such sales are normally governed by special rules in the state under whose authority the execution sale is made” , id. at ¶ 6. 25 cisg to govern contracts performed by electronic means; the basic idea is: had the drafters discussed the matter, would they extend the applicability of the cisg to those contracts? although the provisions regarding the formation of contracts (articles 14-24, to be explored in part iii.2) might provide a good framework to those contracts, that is not clear in respect to the ones concerning obligations of the parties (articles 25-88)93, which often assume that goods are tangible94. however, a more comprehensive analysis would be necessary to examine whether these provisions are indeed suitable to the transactions at hand. regardless of that, in order to be a efficient set of default rules for transactions involving intangibles, the cisg would require rules defining the extent of the duty of the buyer to transfer property; otherwise, in the absence of contract, one could find that a transaction involving software would, for instance, give the licensee the right to copy or resale it freely under article 30 of the cisg95. assuming that, it is clear that the drafters would have decided to exclude those contracts from the application of the cisg; this conclusion is based on a contextual interpretation of the convention96. ip rights are basically national rights; certainly the cisg would not achieve its goal of having universal acceptance if it would affect a matter so intimately connected to national law; in fact, that is the rationale behind most of the exclusions in article 2 of the convention, notably (a), (b) and (c)97. indeed, an attempt to govern the matter of ip rights of the buyer — for instance, the drafters could have considered the rights of someone who buys books and objects of art, all of them goods covered by the cisg that raise ip issues — could have jeopardized the possibility of reaching a compromise. therefore, when there is no tangible property being sold, but rather the transfer of http://cisgw3.law.pace.edu/cisg/text/secomm/secomm-02.html nordic journal of commercial law issue 2006 #2 98 article 42(1) provides that the seller must deliver the goods free from any right or claim by a third party based on ip that the seller knew or could not have been unaware at the time of the conclusion of the contract; however, this obligation exists only when the ip claim is based on “ the law of the state where the goods will be resold or otherwise used, if it was contemplated by the parties at the time of the conclusion of the contract that the goods would be resold or otherwise used in that state” (subparagraph (a)) or “ under the law of the state where the buyer has his place of business” (subparagraph (b)). also, from what was said above, it is clear that the cisg is not intended to govern ip matters and, therefore, under article 7(2), they are to be settled by domestic law. 99 in that respect, see uncitral e-commerce wkg: 38th session report, supra note 64, at 23 (¶ 120) (noting that “ in electronic selling, the contact between seller and buyer might be so minimal that it would be impossible for the seller to know whether the prospective buyer was a consumer” ); john d. gregory, supra note 56, at 321 (stating that “ the ‘ought to have known’ test of the cisg is not [a] realistic online” ). 100 for those conclusions, see franco ferrari, supra note 19, at 87. 101 indeed, the convention on the use of electronic communications in international contracts so far simply excludes its applicability to consumer transactions, without giving the seller the benefit of relying on the applicability of the convention if he did not know of the consumer purpose; see supra note 48, article 2(1)(a). 102 franco ferrari, supra note 19, at 87. 26 a right defined and governed by domestic law, it seems that the correct conclusion is to exclude the application of the convention. in respect to ip rights related to tangible goods, the matter is governed, under the principle adopted by article 42(1), by domestic law98. ii.2.3. exclusion of consumer sales under article 2(a) under article 3(a), the sale of goods “ bought for personal, family or household use” is excluded from the sphere of application of the convention if the seller, “ at any time before or at the conclusion of the contract” , “ knew” or “ ought to have known” that the goods were bought for such purpose. the critical language is the expression “ ought to have known” : in a transaction celebrated by traditional means it might be difficult to know whether each buyer will use the goods professionally or not. when the parties are dealing electronically, the difficulty might be greater: how to acquire such knowledge if the contact between the parties is minimal99? it is true that one could say that the seller “ ought to have known” the consumer purpose of the sale when the goods sold are only suitable for non-commercial use; also, when the buyer purchases several units of the same item, it would be reasonable to presume that the sale was not for consumer purposes100. however, if those aspects (nature of the goods or number of units) do not lead to any conclusion, it will be difficult to determine whether the seller “ ought to have known” of the consumer purpose of the sale101. it has been suggested that the party who is arguing the applicability of the cisg would have the burden of proving that the seller did not know nor ought to have known of the consumer purpose of the sale102. nordic journal of commercial law issue 2006 #2 103 article 6 provides that “ [t]he parties may exclude the application of this convention or, subject to article 12, derogate from or vary the effect of any of its provisions” . there are some exceptions to party autonomy to derogate the cisg provisions, although extremely limited in number: article 12 (as article 6 expressly provides) and the provisions dealing with public international law matters (articles 89-101). in that respect, see rheinland versicherungen (tribunale di vigevano), supra note 16, at ¶ 11 (stating that “ all provisions of the united nations convention [… ] except for article 12 and articles 89-101, can be derogated from by the agreement of the parties” ). see also avery wiener katz, the relative costs of incorporating trade usage into domestic versus international sales contracts: comments on clayton gillette, institutional design and international usages under the cisg, 5 chi. j. int’l l. 181, 186, n.8 (2004) (stating the same). 104 indeed, it is possible to say that the cisg, by providing a good set of default rules, can reduce transaction costs. however, that is not necessarily true: it has already been said that “ inefficient defaults only raise transaction costs unnecessarily” , since the parties will be compelled to contract out of them; see alan schwartz & robert e. scott, contract theory and the limits of contract law, 113 yale l.j. 541, 608 (2003). it should be remember that, since the cisg is extremely liberal in respect to the possibility of derogation of its provisions, the costs of contracting out, either in case of exclusion or derogation, does not seem to be significant if the parties are already drafting a written agreement. 27 iii. electronic communications under the cisg the use of technological means raises not only issues related to the applicability of the cisg, which were explored in part ii, but also in respect to its material provisions. indeed, the parties may negotiate an agreement electronically: one of them might make, withdraw or revoke an offer by means of an electronic message, and the other party might make or revoke an acceptance using the same means. in those cases, the issue is whether the cisg allows the parties to use electronic communications in the process of formation of the sale contract, a matter that will be examined in part iii.2. after the contract is formed, the parties might still use electronic communications to interact with each other. then, the issue is whether the effects — attributed by the cisg to certain communications made after the conclusion of the sales contract — will also be given to electronic communications; this is the topic covered in part iii.3. the analysis of these issues requires a prior review of the general rules of the cisg in respect to communications between the parties in light of the technological developments. iii.1. general rules articles 11 and 13 of the cisg were inserted in the “ general provisions” chapter of the first part of the convention, suggesting that they are intended to play a role on the interpretation of the provisions related to formation of the contract, obligations of the parties and other matters contained in the second and third parts of the cisg. indeed, they are the basis of the principle of informality, which governs the interactions between the parties, either before or after a contract is concluded. article 13 states it expressly by presenting an explanation of a term (“ writing” ) that appears in other parts of the cisg; article 11, although phrased in a manner that limits its applicability to formation of the contract, has an important role in other matters, as it will be demonstrated in part iii.1.1 that follows. iii.1.1. absence of form requirements under article 11 the cisg is a set of default rules: under article 6, the parties can exclude the application of the convention or “ derogate from or vary the effect of its provisions” , subject to a few exceptions103. the idea is to provide a “ safe harbor” to the parties who are not willing or cannot afford to negotiate a detailed contract, giving them some degree of certainty and predictability104. that is in nordic journal of commercial law issue 2006 #2 105 see larry a. dimatteo et al., the interpretative turn in international sales law: an analysis of fifteen years of cisg jurisprudence, 24 nw. j. int’l l. & bus. 299, 322 (2004) (stating that “ [t]he cisg embodies a modern approach to contract formation, recognizing that contracts are often concluded quickly and without a formal writing” ). 106 see jerzi rajski, article 11, in bianca-bonell commentary on the international sales law 121, 121 (cesare massimo bianca ed., milan, giuffrè, 1987), available at <http://cisgw3.law.pace.edu/cisg/biblio/rajski-bb11.html> (last visited apr. 12, 2005). 107 see id at 122 (stating that article 11 adopts the theory of consensualism, well-known in european continental legal systems). 108 see inter alia so. m. agri s.a.s di ardina alessandro & c. v. erzeugerorganisation marchfeldgemüse gmbh & co. kg, t r i b u n a l e [ d i s t r i c t c o u r t ] d i p a d o v a , i t a l y , 2 5 f e b r u a r y 2 0 0 4 , c a s e n u m b e r 4 0 5 5 2 , a v a i l a b l e a t <http://cisgw3.law.pace.edu/cases/040225i3.html> (last visited apr. 12, 2005); oberlandesgericht [provincial court of appeal] köln, germany, 22 february 1994, case number 22 u 202/93, available at <http://cisgw3.law.pace.edu/cases/940222g1.html> (last visited apr. 12, 2005). see also geneva pharmaceuticals technology corp. v. barr laboratories, inc., 201 f.supp.2d 236, 281 (s.d.n.y. 2002), available at <http://cisgw3.law.pace.edu/cases/020510u1.html> (last visited apr. 14, 2005) (stating that, under article 11, “ [a] contract may be proven by a document, oral representations, conduct, or some combination of the three” ). 109 see franco ferrari, writing requirements: articles 11-13, in draft uncitral digest and beyond: cases, analysis and unresolved issues in the u.n. sales convention 206, 212 (franco ferrari et al. eds., munich, sellier 2004) (stating that article 11 precludes domestic law rules that exclude the possibility of witness evidence in cases where the value is higher then a threshold amount, such as ucc § 2-201). see also filanto, s.p.a. v. chilewich intern. corp., 789 f.supp. 1229, 1238, n.7 (s.d.n.y. 1992), available at <http://cisgw3.law.pace.edu/cases/920414u1.html> (last visited apr. 12, 2005) (stating that “ the convention essentially rejects both the statute of frauds and the parol evidence rule” ). 110 ucc § 2-202 adopts a parol evidence rule when it provides that a written document, on which the parties give their final expression of their agreement, “ may not be contradicted by evidence of any prior agreement or of a contemporaneous oral agreement” . in that respect, see mcc-marble ceramic center, inc., v. ceramica nuova d’agostino, s.p.a., 144 f.3d 1384, 1392 (11th cir. 1998), available at <http://cisgw3.law.pace.edu/cases/980629u1.html> (last visited apr. 13, 2005) (holding that “ [t]he cisg precludes the application of the parol evidence rule” ). see also filanto, supra note 109, at 1238, n.7; claudia v. olivieri f o o t w e a r l t d . , n o . 9 6 c i v . 8 0 5 2 ( h b ) ( t h k ) , 1 9 9 8 w l 1 6 4 8 2 4 , a t * 4 6 ( s . d . n . y . 1 9 9 8 ) , a v a i l a b l e a t <http://cisgw3.law.pace.edu/cases/980406u1.html> (last visited apr. 27, 2005). but see beijing metals & minerals import-export c o rp or a t io n v . a me ri c a n b us in es s c en t er i nc. et al., 9 9 3 f . 2 d 1 1 7 8 , 1 1 8 3 , n. 9 (5 t h ci r . 1 9 9 3 ) , a v a i l a b l e a t <http://cisgw3.law.pace.edu/cases/930615u1.html> (last visited apr. 27, 2005) (holding that “ we need not resolve this choice of law issue, because our discussion is limited to application of the parol evidence rule (which applies regardless), duress, and 28 fact the reality of international trade: a substantial part of the transactions are concluded without an effective discussion of the matters covered by the substantive provisions of the cisg or even without the concern of producing legal documents105; if the parties are concerned in having a written document, they will often use standard contract terms. if the cisg assumes that reality of simplicity, informality and little concern in preparing a detailed contract for each individual transaction, it would not make sense to adopt a restrictive and formalistic set of rules on formation of contracts. article 11 establishes a “ general principle of informality” 106 when it provides that a contract of sale (a) “ need not be concluded in or evidenced by writing” , (b) “ is not subject to any other requirement as to form” and (c) “ may be proved by any means, including witnesses” . the consequence of what the first part of article 11 provides — items ‘a’ and ‘b’ above — is that the simple consensus between the parties will be sufficient to form a contract, without any form requirement107. based on that, courts have already held that contracts can be formed by oral representations108. in that respect, article 11 preempts domestic law rules on formal validity, although validity is a matter excluded from the cisg scope of application by virtue of article 4(a). the second part of the provision — item ‘c’ — gives a procedural dimension to informality when it provides that the contract can be evidenced by any means, thus overriding any national law provision that conditions the enforceability of a contract to the existence of evidence in writing (such as a statute of frauds109) or that prohibits oral evidence that is prior or contemporaneous to the agreement between the parties (such as a parol evidence rule110). http://cisgw3.law.pace.edu/cisg/biblio/rajski-bb11.html http://cisgw3.law.pace.edu/cases/040225i3.html http://cisgw3.law.pace.edu/cases/940222g1.html http://cisgw3.law.pace.edu/cases/020510u1.html http://cisgw3.law.pace.edu/cases/920414u1.html http://cisgw3.law.pace.edu/cases/980629u1.html http://cisgw3.law.pace.edu/cases/980406u1.html http://cisgw3.law.pace.edu/cases/930615u1.html nordic journal of commercial law issue 2006 #2 fraudulent inducement” ). 111 see secretariat commentary [on article 10 of the 1978 draft, counterpart of the current article 11], united nations conference on contracts for the international sale of goods, official records: documents of the conference and summary records of the plenary meetings and of the meetings of the main committees (vienna, 10 march – 11 april 1980) 20, ¶ 2 (1981), available at <http://cisgw3.law.pace.edu/cisg/text/secomm/secomm-11.html> (last visited apr. 12, 2005). 112 there seems to be consensus on that topic. see cisg-ac opinion number 1, electronic communications under cisg, ¶ 11.1, 15 a u g u s t 2 0 0 3 ( r a p p o r t e u r : p r o f e s s o r c h r i s t i n a r a m b e r g , g o t h e n b u r g , s w e d e n ) , a v a i l a b l e a t <http://cisgw3.law.pace.edu/cisg/cisg-ac-op1.html> (last visited apr. 13, 2005) [hereinafter “ cisc-ac 1” ; uncitral ecommerce wkg: secretariat note on e-contracting and cisg, supra note 18, at 10 (¶ 31); franco ferrari, supra note 18, at 297 (all stating that article 11 permits electronic contracting). see also michael e. boersma, international business transactions, the internet, and the convention on the international sale of goods: preventing unintentional pitfalls, 7 j. int’l l. & prac. 107, 122 (1998) (stating that “ a contract evidenced solely by e-mail is sufficient to meet the requirements of article 11” ). 113 see franco ferrari, supra note 109, at 207 (stating that the informality principle “ should in fact apply generally to all matters governed by the cisg” ). 29 the legislative history of article 11 demonstrates that this provision was based on a concern of the then recent technological developments in the field of telecommunications: it was expressly mentioned that “ [t]he inclusion of article [11] in the convention was based on the fact that many contracts for the international sale of goods are concluded by modern means of communication which do not always involve a written contract” 111. of course, the “ modern” methods mentioned in the legislative history are not modern anymore; now, the concern is with new technologies developed after the convention was adopted. nevertheless, it is clear that, because the convention does not set any form requirement for the conclusion of the contract, it can be formed also by electronic means112. the underlying idea is that any form of communication can be used to form a contract as long as the parties can understand each other (i.e., the data message must be readable by the recipient). article 11, however, may not be applicable in case of an article 96 reservation, an issue that will be discussed in part iii.1.2.2. although article 11 is phrased in terms that seem to limit its applicability to issues of formation, the principle of informality which underlies that provision is e xtended to the entire convention113. that is a natural consequence when one considers that the cisg was adopted based on the assumption that a significant number of international trade transactions are made without a significant concern with formality matters. in fact, the informality principle appears in other parts of the convention, such as in article 29(1), which permits the modification or termination of a contract “ by the mere agreement of the parties” (see part iii.3.2). if the cisg accepts informality in the most crucial moments of the “ life” of a contract, its formation and its termination, it would not make sense to require formalities in the communications between the parties during the period where the parties are (or at least should be) performing their obligations under the contract. iii.1.2. definition of “ writing” under article 13 article 13 provides that “ [f]or the purposes of this convention ‘writing’ includes telegram and telex” . assuming that the cisg is based on the informality principle, it seems odd that the convention has a provision specifying what should be understood as “ writing” . however, the provision makes sense: aside from articles 11, 12, 13 and 96, articles 21(2) and 29(2) contain the http://cisgw3.law.pace.edu/cisg/text/secomm/secomm-11.html http://cisgw3.law.pace.edu/cisg/cisg-ac-op1.html nordic journal of commercial law issue 2006 #2 114 another issue is whether article 13 is relevant for the definition of writing requirements in other conventions. on that matter, see larry a. dimatteo et al., supra note 105, at 324 (stating that the cisg might be applicable to determine whether the writing requirements of the new york convention on the recognition and enforcement of foreign arbitral awards of 1958 — in respect to agreements to arbitrate — and of the brussels convention on jurisdiction and enforcement of judgments in civil and commercial matters — in respect to choice of forum agreements — are met). see also filanto, supra note 109, at 1237 (interpreting “ the ‘agreement in writing’ requirement of the arbitration convention in light of, and with reference to, the substantive international law of contracts embodied in the sale of goods convention” ); tribunal of international commercial arbitration at the russian federation chamber of commerce and industry, russian federation, 28 april 1995, case number 400/1993, at ¶ 3.4, available at <http://cisgw3.law.pace.edu/cases/950428r1.html> (last visited apr. 28, 2005) (holding that the arbitration agreement, formed by exchange of telexes, was valid, with reference to the new york convention and article 13 of the cisg). 115 for instance, the u.s. supreme court initially held, in a literal interpretation of the fourth amendment, that the protection of “ persons, houses, papers, and effects” against “ unreasonable searches and seizures” did not extend to telephone conversations. olmstead v. united states, 277 u.s. 438 (1928). it is interesting to notice the dissent by justice brandeis: he states that “ [c]lauses guaranteeing to the individual protection against specific abuses of power must have a [… ] capacity of adaptation to a changing world” . id. at 472. based on that, he makes an analogy between a “ private phone message” with a “ sealed letter” and does not find any difference between them. id. at 475. it is clear in his opinion that he tries to determine a general principle behind the fourth amendment (“ the right to be let alone” , id. at 478) and based on that adapt the constitutional provision to the new times. olmstead was later overruled by charles katz v. united states, 389 u.s. 347 (1967). 116 see gyula eörsi, general provisions, in the united nations convention on contracts for the international sale of goods 2-1, 2-34 (galston & smit ed., matthew bender, 1984), available at <http://cisgw3.law.pace.edu/cisg/biblio/eorsi1.html> (last visited apr. 13, 2005) (stating that article 13 “ needs no comment” ). 117 see john o. honnold, supra note 45, at § 130, 141; ulrich schroeter, interpretation of ‘writing’: comparison between provisions of t h e c i s g ( a r t i c l e 1 3 ) a n d c o u n t e r p a r t p r o v i s i o n s o f t h e p e c l , 6 v i n d o b o n a j . 2 6 7 , 2 7 0 ( 2 0 0 2 ) , a va il a b l e a t <http://cisgw3.law.pace.edu/cisg/biblio/schroeter3.html> (last visited apr. 16, 2005). 30 term “ writing” . furthermore, the parties might, under article 6, derogate article 11 and impose a writing requirement for the termination of the contract; if the parties do not define writing, article 13 will come into play. also, one could argue that article 13 might be relevant when there is an article 96 reservation, a controversial issue due to the ambiguous language of the cisg (see part iii.1.2.2)114. another relevant issue relating to article 13 is whether the definition of writing encompasses more modern means of communication aside from telegram and telex, which will be examined next (part iii.1.2.1). iii.1.2.1. article 13: gap-filling interpretation the interpretation issue arising from article 13 is not unusual: every jurisdiction faces similar problems when their courts seek to apply the existing statutory or constitutional law to new social phenomena; for instance, in the past, the development of new telecommunications technologies created some doubts regarding whether their use is protected against undue invasions.115 usually legal texts are drafted with a certain degree of generality in order to cover multiple situations, but it is impossible to foresee all possible future social changes. drafters have no alternative but to rely on information regarding the past and develop rules that are suitable to current needs. indeed, immediately after the vienna diplomatic conference that resulted in the final text of the cisg, article 13 seemed to be very straightforward, and some even said that there is nothing to discuss about it,116 a statement that is not true anymore. the wording of article 13 is a clear indication that its purpose is not to set the outer limits of the term “ writing” 117. rather, the expression “ includes” suggests that article 13 presents an exemplificative list of alternative means of communication, aside from the traditional ones, such as a letter or any other tangible document. the problem is that, today, there are several other means of communication which are not mentioned in article 13. based on that, it is submitted http://cisgw3.law.pace.edu/cases/950428r1.html http://cisgw3.law.pace.edu/cisg/biblio/eorsi1.html http://cisgw3.law.pace.edu/cisg/biblio/schroeter3.html nordic journal of commercial law issue 2006 #2 118 see siegfried eiselen, e-commerce and the cisg: formation, formalities and validity, 6 vindobona j. 305, 309 (2002) (stating that the gap “ clearly falls within the scope of the convention because it deals with other forms of communication and there is no indication that the convention intended to exclude any specific kind of communication” , but “ on the contrary, it seems to aim at being all inclusive” ). 119 see siegfried eiselen, electronic commerce and the un convention on contracts for the international sale of goods (cisg) 1980, 6 edi l. rev. 21, 36 (1999), also available at <http://cisgw3.law.pace.edu/cisg/biblio/eiselen1.html> (last visited apr. 16, 2005); ulrich schroeter, supra note 117, at 270. on cisg gap-filling in general, see franco ferrari, interpretation of the convention and gap-filling: article 7, in draft uncitral digest and beyond: cases, analysis and unresolved issues in the u.n. sales convention 138, 157-71 (franco ferrari et al. eds., munich, sellier 2004). 31 that article 13 contains a gap, i.e., it fails to address a situation which is clearly covered by the convention118, and therefore it requires gap-filling in accordance with article 7(2)119. in fact, there are two reasons to conclude that article 13 contains a gap: (a) first, as it was mentioned above (part iii.1.2), the definition of writing is relevant for the purposes of the convention; (b) the purpose of article 13 seems to be to define “ writing” , but instead of providing an explicit criterion, it relies on examples. however, it is possible to derive some guidelines from the examples; by interpreting the provision in light of the principle of informality (part iii.1.1), as directed by article 7(2), one can determine whether the new technologies are encompassed by article 13. the starting point is the characteristic of something that was certainly deemed to be a “ writing” when the cisg was drafted. for instance, a letter signed by one of the parties is certainly “ writing” . in general terms, its attributes are: a) means for future reference, i.e., the information is fixed in the document and can be subsequently used for reference. b) identification of the sender, i.e., the sender of the message is perfectly identifiable in the document and there is a device (signature) to authenticate her identity (although not infallible). c) inalterability of the content, i.e., in case there is an attempt to modify the content of the letter, in general it can be noticed. the convention could have required that any other “ writing” meet all of those three requirements, but the examples referred to in article 13 (telex and telegram) and the idea of informality that underlies the cisg indicate a different conclusion. there is no doubt that both technologies (telex and telegram) have the attribute (a) mentioned above: the recipient always receives a hardcopy of the message and he can use it for future reference. however, a telegram does not have a mechanism to authenticate the identity of the sender and, therefore, does not meet requirement (b). moreover, since a telex message is printed in the recipient’s device, the recipient is able to use that same device to easily retype the message (with whatever modifications she wants) and destroy the original; hence, this means of communication does not have attribute ‘c’. as corollary, the only criterion to determine whether something is “ writing” under the cisg is whether it has attribute (a), i.e., whether the data contained is recorded in a manner that allows future reference. this criterion is consistent with the informality principle that underlies the convention: if the cisg defined writing as requiring security measures to ensure identification http://cisgw3.law.pace.edu/cisg/biblio/eiselen1.html nordic journal of commercial law issue 2006 #2 120 the uncitral mlec (supra note 67, at article 6) provides that “ [w]here the law requires information to be in writing, that requirement is met by a data message if the information contained therein is accessible so as to be usable for subsequent reference” . 121 article 9(2) of the draft convention (supra note 48, at 48) provides that “ [w]here the law requires that a communication or a contract should be in writing, or provides consequences for the absence of a writing, that requirement is met by an electronic communication if the information contained therein is accessible so as to be usable for subsequent reference” . 122 see un convention on the assignment of receivables in international trade (2001), g.a. res, 56/81, u.n. gaor, 56th sess., u.n. doc. a/res/56/81 (2002), available at <http://www.uncitral.org/english/texts/payments/ctc-assignment-conventione.pdf> (last visited apr. 27, 2005) (defining “ writing” in article 5(c) as means any form of information that is accessible so as to be usable for subsequent reference” ). but see the unidroit convention on international factoring (1988), available at <http://www.unidroit.org/english/conventions/1988factoring/1988factoring-e.htm> (last visited apr. 27, 2005) (providing in article 1(4)(a) (b) that a “ notice in writing need not be signed but must identify the person by whom or in whose name it is given” and that the expression “ ‘notice in writing’ includes but is not limited to, telegrams, telex and any other telecommunication capable of being reproduced in tangible form” ). 1 2 3 s e e u n i d r o i t p r i n c i p l e s o f i n t e r n a t i o n a l co m m e r c i a l co n t r a c t s 2004 (rome 2004), a v a i l a b l e a t <http://www.unidroit.org/english/principles/contracts/principles2004/blackletter2004.pdf> (last visited apr. 16, 2005). article 1.11 defines writing as “ any mode of communication that preserves a record of the information contained therein and is capable of being reproduced in tangible form” . but see siegfried eiselen, remarks on the manner in which the unidroit principles of international commercial contracts may be used to interpret or supplement article 29 of the cisg, 14 pace int’l l. rev. 379, 382-383 (2002) (stating that, to fill the gap in article 13 of the cisg “ [i]t is suggested that the meaning of ‘written’ should be extended to include these forms of communications in accordance with the definition contained in article 1.10 of the [1994] unidroit principles” ). the 1994 version of the unidroit principles had the same definition of writing, but it was included in article 1.10. it should be mentioned that, even if the cisg did not have a workable definition of writing, it is dubious whether the gap could be filled by resort to the unidroit principles, as article 7(2) provides that, in case of absence of cisg principles to solve the matter, it should be settled in accordance with the law applicable by virtue of the conflict of laws rules. 32 of the sender (attribute ‘b’) and inalterability of the content (attribute ‘c’), it would in fact represent an obstacle to international commerce, in great part based on the notion of informality. furthermore, this definition of “ writing” is the same as the one contained in the mlec120, in the uncitral draft convention on electronic communications121 and another united nations convention122, although it is not necessary (nor allowed) to resort to those documents to interpret article 13 as containing the definition adopted by them. similarly, if the convention by its own means provides a workable definition of “ writing” , resort to the unidroit principles is forbidden by article 7(2), since the notion of “ writing” under those principles is more restrictive (or more formal): the information recorded in the writing must also be “ capable of being reproduced in tangible form” .123 nothing in the cisg suggests that writing must be reproducible in tangible form: as long as content can be used for future reference (even in a computer screen, for instance), it is sufficient. to oppose this view, a possible argument would be that the line of reasoning here presented has a wrong assumption: that a “ writing” has a fourth attribute, tangibility; to reinforce that argument, one might say that, at the time the cisg was drafted, all “ writings” — letters, telegram and telex — were tangible, which is not necessarily true in respect to some electronic communications (except when the recipient decides to print them). however, tangibility by itself does not have any function independently from the three attributes mentioned above. for instance, the tangibility of a letter serves only to permit future reference (attribute ‘a’) and prevent modification (attribute ‘b’), and nothing else; the tangibility of telex message serves only for future reference and does not prevent modification. therefore, tangibility cannot be considered an autonomous attribute of “ writing” . http://www.uncitral.org/english/texts/payments/ctc-assignment-conventionhttp://www.unidroit.org/english/conventions/1988factoring/1988factoring-e.htm http://www.unidroit.org/english/principles/contracts/principles2004/blackletter2004.pdf nordic journal of commercial law issue 2006 #2 124 see joseph lookofsky, supra note 74, at ¶ 98, available at <http://cisgw3.law.pace.edu/cisg/biblio/loo13.html> (last visited apr. 14, 2005) (stating that “ article 13 does not define the term to exclude such increasingly popular means of communication as telefax transmissions or electronic data exchange” ); franco ferrari, supra note 109, at 209 (arguing that telefax and communications transmitted electronically should be considered “ writings” ); john o. honnold, supra note 45, at § 130, 141 (mentioning edi and fax); siegfried eiselen, supra note 119, at 36 (mentioning fax, e-mail and edi messages); mario j.a. oyarzábal, international electronic contracts: a note on argentine choice of law rules, 35 u. miami inter-am. l. rev. 499, 504 (2002) (mentioning fax, e-mail and edi messages). 125 see john o. honnold, supra note 45, at § 130, 141-42. 126 for an extensive description of the different electronic signatures technologies, particularly digital signatures relying on publickey cryptography, see guide to enactment (¶ 29-62) of the uncitral model law on electronic signatures, g.a. res. 56/80, u . n . g a o r , 5 6 t h s e s s . , u . n . d o c . a / r e s / 5 6 / 8 0 ( 2 0 0 1 ) , e n g l i s h v e r s i o n a v a i l a b l e a t <http://www.uncitral.org/english/texts/electcom/ml-elecsig-e.pdf> (last visited apr. 16, 2005). 127 the reason is simple: if the law of the reserving state were to be automatically applicable, the situation where both parties are from countries which made an article 96 reservation would be without a solution. 128 see hispafruit bv v. amuyen s.a., arrondissementsrechtbank [district court] rotterdam, netherlands, 12 july 2001, case number ha za 99-529, ¶ 4.5, available at <http://cisgw3.law.pace.edu/cases/010712n1.html> (last visited apr. 12, 2005) (holding that, in case of an article 96 reservation, the “ question whether the contract has been validly concluded [… ] should be answered by the 33 given this broad definition of “ writing” , it seems to encompass any of the more modern means of communication.124 therefore, the data messages created by the use of most of the technologies mentioned in part i, either the ones that just extend the human ability to communicate (e.g. email, fax or a text chat), or the ones that play an active role in the formation of the contract (e.g. edi and e-commerce solutions for sales in a dynamic web site), can be considered “ writings” under the cisg, as long as a record is kept for future reference, even if it is in intangible media. however, if no record is kept, such as the case of internet telephony, then there is no “ writing” under article 13 of the cisg. under article 13 a “ writing” does not need have to have a signature125. however, today there are some security devices that can emulate, with a higher degree of safety, the function of a signature in a paper document, such as the so-called “ electronic signatures” ; for instance, a scheme of digital signature based on a public-key infrastructure (“ pki” ) gives the recipient of a data message certainty that it was really sent by the sender and that its content was not modified126. under the cisg, the use of those technologies is not required to give data messages the status of “ writings” , but the parties may, under article 6, agree to use electronic signatures in the communications between them and therefore alter the definition of writing. iii.1.2.2. possible impact of article 13 on an article 96 reservation under article 96 of the cisg, a contracting state whose legislation requires that contracts of sale be concluded or evidenced in writing may declare that the provisions that allow the formation, modification or termination of contract of sale in any form other than writing will not be applicable if one of the parties has her place of business in that contracting state. therefore, articles 11 and 29 might not be applicable in case of an article 96 reservation. however, the fact that one of the parties has her place of business in a reserving state does not turn the form requirements of the law of that state automatically applicable127. the majority view is that the form requirements of the reserving state will be applicable if the conflict of laws rules of the forum determine that the law of the reserving state is applicable; if the law of a non-reserving contracting state is applicable, then the cisg rules eliminating form requirements will be applicable128. http://cisgw3.law.pace.edu/cisg/biblio/loo13.html http://www.uncitral.org/english/texts/electcom/ml-elecsig-e.pdf http://cisgw3.law.pace.edu/cases/010712n1.html nordic journal of commercial law issue 2006 #2 law which is applicable according to the rules of private international law” and not directly by the rules of the contracting state which made an article 96 reservation). also adopting the same view: franco ferrari, supra note 109, at 213-14; peter schlechtriem, supra note 82, at 45; gyula eörsi, supra note 116, at 2-33. 129 peter schlechtriem, supra note 82, at 46 (acknowledging, however, that “ because of the awkward wording of article 13, this interpretation is open to criticism” ). see also jerzi rajski, article 13, in bianca-bonell commentary on the international sales law 128, 130, (cesare massimo bianca ed., milan, giuffrè, 1987), available at <http://cisgw3.law.pace.edu/cisg/biblio/rajskibb13.html> (last visited apr. 13, 2005) (concluding that article 13 may be applied also to “ writing requirements provided for by the provisions of domestic law exceptionally applied according to relevant conflict-of-law rules” in case of an article 96 reservations, but stating that it “ cannot eliminate some special requirements as to the form imposed by applicable domestic law such as authentication by a consulate or certification by a public authority, document under seal, etc.” ); larry a. dimatteo et al., supra note 105, at 324 (citing peter schlechtriem). 130 see john o. honnold, supra note 45, at § 130, 142 (stating that “ [w]hether electronic communications satisfy domestic formal requirements preserved by a declaration (reservation) under article 96 [… ] depends on the domestic law preserved by the reservation” ). see also tribunal of international commercial arbitration at the russian federation chamber of commerce and industry, russian federation, 10 june 1999, case number 55/1998, available at <http://cisgw3.law.pace.edu/cases990610r1.html> (last visited apr. 14, 2005). in this case, the arbitral tribunal rejected the buyer’s claim that the modifications of the contract made by the exchange of fax messages were invalid. since the seller was from a contracting state who made an article 96 reservation (russian federation), the arbitral tribunal applied, by virtue of the conflict of laws rules, russian law in respect to the form requirements. however, it did not rely on the definition of writing of article 13, but rather on article 434(2) of the civil code of the russian federation, which provides that “ the contract may be concluded in writing either by composing one single instrument signed by the parties, or by exchanging documents by mail, telegraph, teletype, electronic or other means of communication, which allow credible verification that the document is sent by the party to the contract” . 131 during the 1980 vienna diplomatic conference, the representative of the former ussr, which made an article 96 reservation, did not oppose to the german proposal that ultimately led to article 13, stating that “ a new domestic law adopted by [the former ussr] in 1977, whereby written agreements had become mandatory for foreign trade transactions, included telegrams or telex under the definition of ‘written’” ; therefore, it seems reasonable to assume that, at that time, the contracting states were aware of the impact of article 13 over domestic law of a state which made an article 96, including for formation of contracts (article 11), not only modification or termination (article 29(2)). see summary records of meetings of the first committee (1980 vienna diplomatic conference), 7th meeting (march 14, 1980), at ¶ 73, available at <http://cisgw3.law.pace.edu/cisg/firstcommittee/meeting7.html> (last visited apr. 17, 2005). 34 in case the law of a reserving state is applicable, the issue is whether the definition of “ writing” contained in article 13 (see part iii.1.2.1 supra) will have any impact on the writing requirement of the law of the reserving state. in other words, supposing the reserving state law provides that a contract might not be concluded or evidenced by the exchange of e-mails between the seller and the buyer, the issue is whether article 13 would trump the definition of writing of the reserving state’s domestic law. it has been already pointed out that article 13 of the cisg was included based on a proposal by the federal republic of germany, which was not intended to be only a “ definition of the term ‘writing’ as used in articles 21(2) and 29(2)” , but rather it was “ meant to achieve a uniform objective standard for form requirements, so that parties need not comply with domestic form requirements which perhaps impose higher standards and about which it may be difficult to obtain information” 129. this understanding, however, is universally accepted130. the main objection to the interpretation that extends the definition of “ writing” to the domestic law of a reserving state is the wording of article 13, which provides that “ writing” includes telegram and telex “ [f]or the purposes of this convention” . on the other hand, there is a strong argument to rely on the legislative history on this issue: if indeed article 13 was part of bargain to accept the possibility of reservation provided by article 96, it seems logical that the application of the domestic law by virtue of the reservation can be limited by article 13131. the fact that article 13 was inserted immediately after article 12, which deals with the effect of an article 96 reservation, is also suggestive. moreover, this construction advances the purpose of the cisg in achieving uniformity and predictability. based on those http://cisgw3.law.pace.edu/cisg/biblio/rajskihttp://cisgw3.law.pace.edu/cases990610r1.html http://cisgw3.law.pace.edu/cisg/firstcommittee/meeting7.html nordic journal of commercial law issue 2006 #2 132 however, the argument that interpreting article 13 differently would make it almost meaningless (see peter schlechtriem, supra note 82, at 46, n.144) is not persuasive: not only article 13 defines “ writing” for the purposes of articles 21(2) and 29(2), but it is also applicable in case the parties refer to “ writing” in their agreement (see franco ferrari, supra note 109, at 210). 133 if this interpretation is favored, article 13 is able to provide a good framework even in cases where the form requirements of the law of a reserving state are applicable. 134 see tribunal of international commercial arbitration at the russian federation chamber of commerce and industry, supra note 130. 135 siegfried eiselen, supra note 119, at 23. on that topic, see also uncitral e-commerce wkg: secretariat note on e-contracting and cisg, supra note 18, at 12-13 (¶ 42-44); franco ferrari, supra note 18, at 300-01. 136 siegfried eiselen, supra note 119, at 23-24. see also john o. honnold, supra note 45, at § 132.1, 145 (stating that “ the convention accommodates both the simple exchange of two communications and also the development of a contract when it is impossible to isolate an ‘offer’ and ‘acceptance’” ). 35 arguments132, it is possible to conclude that article 13 can have an impact when the domestic law a reserving state is applicable133. nevertheless, there is at least one arbitral award134 that examined this issue and applied the definition of “ writing” contained in the domestic law of the reserving state (which was also applicable by virtue of the conflict of laws rules). however, since the definition of the reserving state domestic law did not contradict the definition in article 13, it is dubious whether this precedent is indeed of value. iii.2. formation of the contract: pre-contractual communications once it was established in part iii.1.1 that a contract can be formed by electronic means under article 11 of the cisg, certain issues — that arise in connection of the use of more modern communications methods for the conclusion of a contract — should be examined. initially, it should be noted that the provisions of the cisg relating to formation (articles 14-24) rely on a rigid offer-acceptance structure, which causes some difficulties in “ complicated negotiations where there is a great deal of communication between the parties” and when they use “ methods of communication such as edi which requires a more flexible approach than the strict offer-acceptance dichotomy” 135. nevertheless, it seems that the cisg provisions provide “ enough flexibility to evade the constraints of forcing communications into either the offer or acceptance mould” 136; one example of a rule that provides flexibility is article 18(1), which provides that “ [a] statement made by or other conduct of the offeree indicating assent to an offer is an acceptance” . having said that, the issues relating to electronic formation of contracts under the cisg may be explored: first, is there an offer when a seller uses some technologies to market her products (part iii.2.1)? second, when does an electronic communication relating to the formation of contract produce effects, i.e., what is the exact moment in which a data message “ reaches” the addressee under article 24 (part iii.2.2)? third, how to fit the more modern methods of communications in article 20(1), which sets the moment when the period of time fixed by the offeror to accept an offer begins to run (part iii.2.3)? nordic journal of commercial law issue 2006 #2 137 see oberster gerichtshof, supra note 75, at 149-150. 138 uncitral e-commerce wkg: secretariat note on e-contracting and cisg, supra note 18, at 13 (¶ 47). see also franco ferrari, supra note 18, at 301; maria del pilar perales de viscasillas, el contrato de compraventa internacional de mercancías (convención de viena de 1980) § 153 (madrid, 2001), available at <http://www.cisg.law.pace.edu/cisg/biblio/perales1.html> (last visited apr. 17, 2005). 139 uncitral e-commerce wkg: secretariat note on e-contracting and cisg, supra note 18, at 13 (¶ 47). see also franco ferrari, supra note 18, at 301; jochen zaremba, international electronic transaction contracts between u.s. and eu companies and customers, 18 conn. j. int’l l. 479, 503 (2003) (stating that “ [t]he demonstration of the willingness on a web page to sell a certain product is usually not an offer but an invitation to make an offer” and, therefore, “ [i]n these cases the click on the purchase icon constitutes an offer” ). 140 uncitral e-commerce wkg: secretariat note on e-contracting and cisg, supra note 18, at 13 (¶ 48). see also franco ferrari, supra note 18, at 301-02. 36 iii.2.1.offer in e-commerce the use of information technology tools to massively market products is not unusual. for instance, a seller can set up a “ virtual” store to sell its products to internet users (technology that plays an active role in the formation of the contract). another possibility is to use mail merge tools to send several customized e-mails to different potential buyers (technology that extends human ability to communicate). the issue is whether a proposal made through the use of any of these technologies is an offer for cisg purposes. iii.2.1.1. the cisg definition of offer: article 14 under article 14(1), a proposal for concluding a contract is an offer if: (a) it is “ addressed to one or more specific persons” , (b) it is “ sufficiently definite” (i.e., “ if it indicates the goods and expressly or implicitly fixes or makes provision for determining the quantity and the price” ) and (c) if it “ indicates the intention of the offeror to be bound in case of acceptance” 137. in respect to requirement ‘a’, article 14(2) further clarifies that “ [a] proposal other than one addressed to one or more specific persons is to be considered merely as an invitation to make offers, unless the contrary is clearly indicated by the person making the proposal” . it is generally accepted that “ advertisements in newspapers, radio and television, catalogues, brochures, price lists, etc., are considered invitations to submit offers” , i.e., invitationes ad offerendum under article 14(2)138. the possibility of extending such understanding to web sites through which a prospective buyer can buy goods has already been acknowledged139; under this line of reasoning, the act of marketing products on a web site would not be construed as an offer. moreover, it has already been said that, since “ price circulars sent to an indefinite group of people are considered not to constitute offers, even where the addressees are individually named” , “ [t]he same general rule can apply as far as electronic messages are concerned” 140. iii.2.1.2. possibilities arising from electronically generated proposals the guidelines set forth in part iii.2.1.1 for proposals made through web sites and massive electronic messages are correct under the cisg: those proposals can be construed as not being “ addressed to one or more specific persons” under article 14(1). however, those guidelines may http://www.cisg.law.pace.edu/cisg/biblio/perales1.html nordic journal of commercial law issue 2006 #2 141 see definition “ 2.1.1.2” in part i.1.2 supra. 142 or it will show product z as being unavailable. in this case, it is reasonable to assume that, if the prospective buyer is still able to place an order, that such order will be an offer under the cisg (not the exhibition of product z as unavailable), unless the terms and conditions of use of the web site provide otherwise (i.e., the seller might be willing to assume the risk of the modification of the price). 143 compare with the uncitral draft convention on electronic communications, supra note 48, at article 11 (providing that “ [a] proposal to conclude a contract made through one or more electronic communications which is not addressed to one or more specific parties, but is generally accessible to parties making use of information systems, including proposals that make use of interactive applications for the placement of orders through such information systems, is to be considered as an invitation to make offers, unless it clearly indicates the intention of the party making the proposal to be bound in case of acceptance” ). the draft convention seems to disregard the possibility of concluding that a proposal made through a dynamic web site is an offer; the only exception is when the proponent clearly indicates her intention of being bound in case of acceptance. 1 4 4 the reason why the rules on withdrawal are useless is because the offer in this situation reaches the offeree almost instantaneously, not leaving time for the withdrawal to reach “ the offeree before or at the same time as the offer” (article 15(2)). 37 not be applicable in every situation: in some instances, the peculiarities of the transaction might undermine their general applicability. for instance, suppose a seller uses a technology that plays an active role in the formation of the contract, such as a dynamic web site for the sale of products (human-machine interaction, with instantaneous inter praesentes communication141). when a prospective buyer (“ buyer 1” ) enters in one of those dynamic web sites, in general a page is automatically generated with the information contained in a database maintained by the seller. in that database there will be multiple entries for each product; for instance, it will indicate that 300 units of product x are available at $ 5.00, 1 unit of product y is available at $ 10.00 and that product z is unavailable. therefore, the page viewed by buyer 1 will show products x and y at the prices above mentioned, but it will not show product z, because it is unavailable142. if buyer 1 places an order for product y, when buyer 2 visits the web site, even a fraction of a second after buyer 1 has placed her order, the page generated will only show product x, and no longer product y (which is now out of stock). this example clearly demonstrates that the message conveyed on a dynamic page is sufficiently specific: it is built for each visit that is made to the web site on the basis of the information stored in a database that is updated in real-time. in case the e-commerce solution used by the seller has that kind of technology, the buyer will have a strong case to argue that the proposal on the site was indeed an offer tailored to her143. the example mentioned above assumes human/machine interaction and, therefore, may cause a problem: the page is dynamically built based on the information available at the time the buyer enters the seller’s web site, but the buyer may naturally take some time after the page is generated to decide whether to buy or not the goods there offered. in this circumstance, terms and conditions of use of the web site might provide that those offers expire after a short period of time, given the fact that a product offered might become unavailable while the prospective buyer decides whether to accept or not the offer. the rules of the cisg on withdrawal (article 15(1)) are useless in this case144, but the rules on revocation (article 16) might play a significant role: the page generated might be programmed to be updated after some time; hence, if the page is updated and at that time the product becomes unavailable, the prospective buyer will receive a message on her computer screen stating that the product is no longer available (i.e., that the offer is revoked, if it was revocable in the first place). that is not, however, an issue when the contract is formed during a machine/machine interaction based on instantaneous inter praesentes communication technologies, such as the case of an edi arrangement with real-time connection and processing, since there is no delay for the offeree’s system to issue an acceptance. nordic journal of commercial law issue 2006 #2 145 siegfried eiselen, supra note 119, at 24. 146 id. at 24. 38 two important observations should be made: (a) under article 14, the party making the proposal to conclude a contract might explicitly state that she does not intend to be bound in case the other party adheres to the proposal (such as in the terms and conditions of use of the web site); (b) proposals made on static (non-dynamic) web site, similarly to an advertisement in a newspaper, are presumed to be invitations to make offers. indeed, it seems that the general principle (mentioned in part iii.2.1) for proposals made through a web site is focused on static (non-dynamic) web sites, where the analogy with an advertisement is perfectly appropriate. in respect to the massive use of technologies that extend human capability to communicate, such as the case of an “ e-mail merge” , there are some peculiarities too. it is clear that if a seller sends emails with her entire price list to all her clients, each data message will be construed as an invitation to make offers. however, there are more sophisticated applications for that technology. for instance, a seller might have an extensive database with a list of all its clients and all their recent purchases. with that information, if the seller decides to use it, computer software might create individualized e-mail messages for each customer. for instance, clients who purchased equipment x will receive a message with a proposal to buy a new accessory to that equipment (ax), clients that bought equipment y will receive proposals for accessory ay and clients that have x and y will receive proposals to buy both ax and ay; based on the number of units of x and y purchased in past transactions, the message might offer the exact corresponding number of units of accessories; the proposal might have discounts based on the number of past transactions or on the number units offered; older clients might receive an additional discount. in other words, the possibilities of customization might turn each message different from the others and the recipient of that message will have a strong argument to claim that the proposal met the specificity requirement of article 14(1), unless the sender expressly indicates her intention of not being bound in case the recipient agrees to buy the products. iii.2.2. reception theory: defining “ reaching” in the e-commerce environment when the parties communicate with each other through messages, they will be dealing with each other by distance (i.e., not face-to-face) and there might be a delay in time from the moment the message is made and the time is ultimately understood by the recipient. due to that, usually contract law defines the moment in which a communication becomes effective, i.e., when it produces its effects. there are four options: (a) information theory, under which a communication becomes effective “ once the recipient takes notice of the content of the communication” ; (b) reception theory, under which a communication becomes effective “ once the recipient has actually physically received the communication or it has at least been made available to it, even though it has not yet taken notice of the content” ; (c) postal or dispatch theory, under which a communication is effective “ once it has been posted or sent by the sender” ; (d) formulation theory, under which a communication “ becomes effective the moment that the responder begins to formulate its communication” 145. “ each of these approaches determines which of the parties carries the risk of a communication being lost, destroyed or damaged in the transition process” .146 roughly speaking, the cisg uses two of those options: the reception theory in respect to pre-contractual nordic journal of commercial law issue 2006 #2 147 for the distinction between contracts inter praesentes and inter absentes, see note 5 supra and accompanying text. 148 see tuzzi trend tex fashion gmbh v. w.j.m. keijer-somers, arrondissementsrechtbank [district court] amsterdam, netherlands, 5 october 1994, case number h93.2900, case abstract and comment available at <http://cisgw3.law.pace.edu/cases/941005n1.html> (last visited apr. 17, 2005) (interpreting article 24 as considering that a message has been received if it reaches the addressee’s invalid mailing address, but only in case the sender was not notified of the change of address). for a critical analysis of this decision, see maria del pilar perales viscasillas, comments on the draft digest relating to articles 14-24 and 66-70, in draft uncitral digest and beyond: cases, analysis and unresolved issues in the u.n. sales convention 259, 283-84 (franco ferrari et al. eds., munich, sellier 2004) (stating that, although the application of article 24 was mistaken in this case, the interpretation of this provision was nonetheless correct). 39 communications (part iii.2.2.1) and the dispatch theory in respect to contractual communications (part iii.3.1); however, this separation is not strict: the cisg sometimes use the information and the dispatch theories for issues of formation and the reception theory for contractual communications. iii.2.2.1. definition of “ reaching” : interpreting article 24 in analytical terms article 24 of the cisg provides that, for the purposes of the rules on formation of contract (articles 14-23), an offer, acceptance or any indication of intention “ reaches” the addressee when: (a) “ it is made orally to him” or (b) “ delivered by any other means to him” (b.1) in person, (b.2) “ to his place of business or mailing address” or, (b.3) “ if he does not have a place of business or mailing address, to his habitual residence” . the difference between ‘a’ and ‘b’ is whether the contract is concluded inter praesentes and inter absentes147: a) in case of communication inter praesentes (situation ‘a’), there is no delay between the moment in which the “ indication of intention” is issued and the moment it is noticed by the seller (e.g. negotiation face-to-face or by phone) and since there is no difference between the moment of receipt and the moment of cognizance, the information theory is accepted; b) in case of communication inter absentes (situation ‘b’), there is such a delay (e.g. offers or acceptances sen t by regular ma il) and the ci sg places the risk of the communication on the sender by adopting the reception theory. therefore, there are two definitions of “ reaches” in article 24, depending on how the parties are communicating with each other. in case there is a delay between the instant when a message is issued and the moment when the seller takes notice of it (‘b’), it is sufficient that the message be delivered to the addressee’s “ place of business or mailing address” (‘b.3’). therefore, it is not required that the recipient takes notice of the message: what matters is the moment when the message arrives at the recipient’s place of business or mailing address. if the mailing address is no longer valid (e.g. the recipient changed her address without notifying the sender) it is irrelevant: once the message arrives at the no longer valid address it has “ reached” the recipient under article 24148. among the provisions dealing with formation of the contract (articles 14-23), there are seven rules using the expression “ reaches” to determine the moment of effectiveness of (1) an offer, (2) a withdrawal of an offer, (3) a revocation of an offer, (4) a rejection of an offer, (5) an acceptance, (6) an instantaneous communication fixing period for acceptance and (7) withdrawal of an http://cisgw3.law.pace.edu/cases/941005n1.html nordic journal of commercial law issue 2006 #2 149 see articles 15(1), 15(2), 16(1), 17, 18(2), 20(1) and 22, respectively. for the same enumeration, see e. allan farnsworth, article 24, in bianca-bonell commentary on the international sales law 201, 201 (cesare massimo bianca ed., milan, giuffrè, 1987), available at <http://cisgw3.law.pace.edu/cisg/biblio/farnsworth-bb24.html> (last visited apr. 17, 2005). article 21(2) also uses the expression “ reached” but only to create an exception to the rule on effectiveness of acceptance in article 18(2). 150 once those two principles are acknowledged, the cisg offers an excellent framework to electronic commerce. however, if updating the text becomes a possibility, it would be better to make the provision more clear for electronic commerce, in light of other developments achieved by the international community. in that respect, see michael joachim bonell, do we need a global commercial code?, 106 dick. l. rev. 87, 92, n.24 (2001) (stating that the eventual “ revised articles 24 and 27 of the cisg, dealing with time and place of receipt and the transmission risk of declarations made by traditional means of communication, would require revision in light of article 15 of the uncitral electronic commerce law, dealing with time and place of dispatch and receipt of data messages” ). 151 once there is a delay in the process of transferring the message, there is a risk that must be allocated. in such case, the notion that comes into play under article 24 is the one of “ delivery” . 40 acceptance149. the penultimate situation, dealt with in article 20(1), will be examined separately in part iii.2.3 due to its peculiarities. iii.2.2.2. using the principle underlying article 24 to define “ reaching” in e-commerce there is clearly a gap in the cisg with regard to the definition of “ reaching” for more modern technologies. however, gap-filling interpretation pursuant to article 7(2) is relatively easy once the two major principles underlying article 24 were identified150. in order to transpose the definition of “ reaching” to electronic commerce, the only thing that is required is to determine the technological equivalents of “ cognizance” for the first principle (see item ‘a’ in part iii.2.2.1) and “ delivery” for the second (see item ‘b’ in part iii.2.2.1). iii.2.2.2.1. technological equivalent of “ cognizance” a technological equivalent of “ cognizance” is required for the situations where information systems play an active role in the formation of contract, but only when the communication is made in real-time (instantaneous inter praesentes)151, regardless of whether the interaction is between machine/machine or between human/machine. that is the case when: (a) a person sends a message that is immediately received and processed by an information system, such as when a person makes an offer or an acceptance through an web site; (b) an information system sends a message that is immediately received and processed by another information system, such as in an edi arrangement with real-time communication between the systems. a technological equivalent for “ cognizance” may be required in such circumstances because there will not be a human being reading the messages; rather, the computer system will receive and process the message. due to that, equivalent of “ cognizance” is “ recording” , i.e., when the message is stored by the information system and becomes available for processing. whether the message is processed in a later moment is irrelevant; this situation is analogous to the one where a person receives an acceptance by phone and waits some time to take the initial steps towards performance of the contract: the contract would be formed at the moment that person heard the acceptance on the phone. http://cisgw3.law.pace.edu/cisg/biblio/farnsworth-bb24.html nordic journal of commercial law issue 2006 #2 152 see note 9 supra. 153 see siegfried eiselen, supra note 119, at 29 (stating that “ [t]he principle underlying article 24 and aiding its interpretation, is the principle that any communications must either be received by the recipient personally (in the case of direct forms of communication) or must be effectively placed at its disposal at a place where it usually receives such communications or where it should expect to find communications in the normal course of business” ). 154 in that aspect, see uncitral mlec, supra note 67, at articles 15(2)(a)(i) (providing that “ if the addressee has designated an information system for the purpose of receiving data messages, receipt occurs: (i) at the time when the data message enters the designated information system” ) and 15(2)(b) (providing that “ if the addressee has not designated an information system, receipt occurs when the data message enters an information system of the addressee” ). see also uncitral draft convention on electronic communications, supra note 48 at article 15(2) (providing that “ [t]he time of receipt of an electronic communication is the time when it becomes capable of being retrieved by the addressee at an electronic address designated by the addressee” and that “ [a]n electronic communication is presumed to be capable of being retrieved by the addressee when it reaches the addressee’s electronic address” ). 41 in respect to technologies for instantaneous communications inter praesentes between two persons (e.g. text chats, internet telephony), there is no need for a technological equivalent of “ cognizance” . for instance, if internet telephony is used, there is no difference from a regular phone call and thus the data message will “ reach” the recipient as soon as it is orally made to her. as far as realtime text chats are concerned, each text message will “ reach” the recipient when it is read by her. iii.2.2.2.2. technological equivalent of “ delivery” a technological equivalent of “ delivery” is required for technologies that extend human ability to communicate, in the cases of non-instantaneous communications (e.g. e-mail) and instantaneous communications inter absentes (e.g. fax). also, a technological equivalent of “ delivery” is required when information systems play an active role in the formation of the contract, but the communication technology is non-instantaneous, or it is instantaneous but inter absentes; one example is an edi arrangement based on a “ store and retrieve” mode152). as it was mentioned above, what matters for the purposes of article 24 in case of communications inter absentes is whether the message is available at the recipient’s place of business or mailing address; the moment in which the recipient reads the message is irrelevant. in other words, a message “ reaches” the recipient when it is her disposal1 5 3. therefore, to determine the technological equivalent of “ delivery” one has to find the moment when the recipient is able to retrieve a data message. in general terms, it is possible to say that the recipient is able to do so when the message enters the information system under the control of the recipient154, even if that system is maintained by a third party (e.g., an internet access provider that gives its users mailboxes for email messages). if the recipient has multiple information systems under his control and the message passes through all of them, the first to receive the message is the relevant one, even though the recipient might retrieve the message only from the last information system in the chain; the reason is that the message is under the sphere of control of (and therefore available to) the recipient when it enters her first information system. based on that, it is possible to say casuistically that: (a) a fax message reaches the recipient when it is fully transmitted to her fax device; (b) an e-mail message reaches the recipient when it enters the mailbox assigned to that electronic address, even if that mailbox is maintained by a third party; (c) in case of edi in “ store and retrieve” mode, the data message reaches the addressee in the moment it enters the mailbox that can be accessed by the recipient’s edi system. nordic journal of commercial law issue 2006 #2 155 see inter alia landgericht [district court] heilbronn, germany, 15 september 1997, case number 3 kfh o 653/93, available at <http://cisgw3.law.pace.edu/cases/970915g1.html> (last visited apr. 18, 2005) (holding, based on article 8, that, because the general terms and conditions prepared by the seller were not in the language of the negotiation, they were not enforceable against the buyer). 156 see e. allan farnsworth, article 20, in bianca-bonell commentary on the international sales law 185, 186 (cesare massimo bianca ed., milan, giuffrè, 1987), available at <http://cisgw3.law.pace.edu/cisg/biblio/farnsworth-bb20.html> (last visited apr. 18, 2005). nevertheless, it has been already argued that article 20(1) causes an internal inconsistency within the cisg: “ [i]f the offer [under article 15(1)] is not effective until it reaches the offeree, why should the time stated in the offer begin to run upon dispatch or the time on the letter or envelope?” ; see john e. murray jr., an essay on the formation of contracts and related matters under the united nations convention on contracts for the international sale of goods, 8 j.l. & com. 11, 20-21 (1988). 42 of course, if a data message is not comprehensible by the recipient (e.g., it is scrambled) or is not capable of being processed by the offeror’s information system, the content of the message will not be effective. in this area, it is possible to make an analogy with the decisions regarding standard contract terms submitted in a language different from the one used during the negotiations155. iii.2.3. time to issue an acceptance: article 20(1) in case the offeror sets in the offer a certain period of time for the recipient to accept it, one has to determine the moment in which that period begins to run. for that purpose, the cisg has rules different from the ones contained in article 24. article 20(1) includes two different rules for that situation: a) “ a period of time for acceptance fixed by the offeror in a telegram or a letter begins to run from the moment the telegram is handed in for dispatch or from the date shown on the letter or, if no such date is shown, from the date shown on the envelope” . b) “ a period of time for acceptance fixed by the offeror by telephone, telex or other means of instantaneous communication, begins to run from the moment that the offer reaches the offeree” . the criterion for differentiation is no longer whether the communication is inter praesentes or inter absentes, but rather whether it is instantaneous or not; the cisg even uses the expression “ means of instantaneous communication” . if the communication is non-instantaneous (the examples presented by the cisg are telegram and letter), the period of time for acceptance runs from the dispatch of the message, whereas if the communication is instantaneous (the examples presented by the cisg are telephone and telex) the period of time for acceptance runs from the reception of the message. the rationale behind article 20(1) is merely evidentiary: it favors the dispatch because it is generally easier to prove the time of dispatch with reasonable certainty156. when the dispatch and receipt are simultaneous (as is in the case of instantaneous communications), article 20(1) adopts the receipt theory. in fact, it should be noted that the cisg could have simply provided that time for acceptance begins to run from the time of dispatch, without expressly making the differentiation between instantaneous and non-instantaneous communications: if the communication is instantaneous, the moment in which the message is dispatched and the http://cisgw3.law.pace.edu/cases/970915g1.html http://cisgw3.law.pace.edu/cisg/biblio/farnsworth-bb20.html nordic journal of commercial law issue 2006 #2 157 in its last sentence, article 18(2) provides that “ [a]n oral offer must be accepted immediately unless the circumstances indicate otherwise 158 in that respect, see cisc-ac 1 supra note 112 at ¶ 18.4. 159 see id. at ¶ 20.3 (stating that “ [e]-mail is not instantaneous communication and, with respect to dating, it is not wholly equivalent to letters sent in envelopes” and, therefore, “ [a] period of time for acceptance fixed by the offeror in e-mail communication begins to run from the time of dispatch of the e-mail communication” . but see siegfried eiselen, supra note 119, at 30 (stating that e-mail is a form of instantaneous communication). 160 on the definition of the moment in which a message can be deemed to be “ dispatched” , see part iii.3.1 infra. 161 see e. allan farnsworth, supra note 156, at 187. 162 john o. honnold, supra note 45, at § 171, 193. 163 cisg article 39. there are several other examples: articles 26 (declaration of avoidance), 32(1) (notice of consignment specifying the goods in case they are not marked — see also article 67(2)), 32(3) (buyer’s request for information in order to enable her to effect insurance), 43 (notice of a third-party claim), 46(2) (request for replacement of the goods), 46(3) (request for repair of the goods), 47(2) (notice by the seller that she will not perform within the period set by the buyer), 48(2) (3) (4) (request by the seller to remedy the failure to perform her obligations), 63(2) (notice by the buyer that she will not perform within the period set by the seller), 65(1) (request by the seller to the buyer to specify the form, measurement and other features of the goods), 65(2) 43 moment the message is received are obviously the same. hence, an identical result could have been achieved with fewer words. it should be noted that the second part (‘b’) of article 20(1) does not contain a gap: the clause “ or other means of instantaneous communication” permits that new technologies classified as of instantaneous communication to fit in that rule and, accordingly, be subject to the receipt theory. that is the case of fax, text chats, internet telephony and edi with real-time connection. in respect to instantaneous communications inter praesentes (all the above except fax and edi with real-time connection but delayed processing), if the offer does not contain a period of time for acceptance, the final rule contained in article 18(2)157 applies: the offeree must accept the offer immediately158. by exclusion, it is possible to include the more m odern means of non-instantaneous communication — such as e-mail159 and edi without real-time connection — in the first part (‘a’) of article 20(1); therefore, the beginning of the period of acceptance of an offer communicated by these methods is subject to the dispatch rule160. however, since the purpose of article 20(1) is merely evidentiary, one might be able to argue that, when new non-instantaneous technologies are used, the initial date of the period of acceptance will be the dispatch if it can be demonstrated more easily than the receipt of the message. in any event, the party making the offer may under article 6 derogate the effect of article 20(1) by stipulating in it the initial date from which the period for acceptance begins to run161; for instance, an e-mail with “ [a] statement such as ‘you may accept this offer within ten days after this offer reaches you’ would override the interpretive rule of article 20(1)” 162. iii.3. contractual communications once the contract is formed, the parties may continue to interact with each other by electronic means. many of the substantive provisions dealing with obligations of the parties and other matters (articles 25-88) require that one party communicates a given fact to the other one; for instance, to rely on the lack of conformity of the goods, the buyer must give the seller notice of the non-conformity163. since the principle of informality is also extended to these provisions of the nordic journal of commercial law issue 2006 #2 (communication of the specification of the goods made by the seller), 71(3) (notice of suspension of performance), 72(2) (notice of intention of declaring the contract avoided), 79(4) (notice of an impediment to the performance of the contract) and 88(1) (2) (notice of intention to sell the goods by the party bound to preserve them). 164 see oberlandesgericht [provincial court of appeal] naumburg, germany, 27 april 1999, case number 9 u 146/98, available at <http://cisgw3.law.pace.edu/cases/990427g1.html> (last visited apr. 19, 2005) (stating that “ [t]he sender may rely on the original content of his communication as long as he sent the notice by means appropriate in the circumstances, even if it reaches the addressee too late, altered or not at all” ; the court found, based on the testimony of a witness, that an effective notice declaring a contract avoided was sent). 165 see siegfried eiselen, supra note 119, at 32. 166 see peter schlechtriem, supra note 82, at 62. 167 see john o. honnold, supra note 45, at § 189, 217. 44 cisg (see part iii.1.1 supra), it is clear that all those interactions can be made through electronic means. the issue, as it was in part iii.2.2 in respect to matters of formation of the sales contract, is to determine which party bears the risk in case the communication fails, a topic to be explored in part iii.3.1. also, there is another kind of contractual communication not related to the performance of the obligations by the parties, but rather the eventual modification or termination of the agreement; this issue will be examined in part iii.3.2. iii.3.1. errors in communication: dispatch theory in article 27 article 27 states the general rule on allocation of risks of delays or errors in contractual communications. it provides that: “ [u]nless otherwise expressly provided in this part of the convention, if any notice, request or other communication is given or made by a party in accordance with this part and by means appropriate in the circumstances, a delay or error in the transmission of the communication or its failure to arrive does not deprive that party of the right to rely on the communication” 164. by providing that a party might still rely on the communication even if there is delay or error in the transmission (or if it fails), article 27 adopts the dispatch theory as a general rule165. the idea that underlies article 27 is that the party who should bear the risk of transmitting the message is the “ one who, as a result of his deviation from normal performance, caused the statement to be sent” 166. for instance, if the reception theory were adopted, an error in transmitting the buyer’s notice that the goods are non-conforming (article 39) would deprive the innocent party (buyer) of the right of relying on the non-conformity167. however, there are a few exceptions to this rule, as it can be inferred from the wording of article 27. iii.3.1.1. exceptions to the dispatch rule the first clause in article 27 states: “ [u]unless otherwise provided” . indeed, in the third part of the cisg there are several provisions that condition the effectiveness of a notice, request or communication to the receipt by the addressee. those provisions are articles 47(2) (notice by the seller that she will not perform within the period set by the buyer), 48(4) (request by the seller to remedy the failure to perform her obligations), 63(2) (notice by the buyer that she will not perform within the period set by the seller), 65(1) (request by the seller to the buyer to specify the form, measurement and other features of the goods), 65(2) (communication of the specification of the goods made by the seller) and 79(4) (notice of an impediment to the performance of the contract). the issue here is how to define receipt, since the applicability of the definition of “ reaches” http://cisgw3.law.pace.edu/cases/990427g1.html nordic journal of commercial law issue 2006 #2 168 see e. allan farnsworth, supra note 149, at 203-204 (stating that “ the analogy between the time when a communication ‘reaches’ an addressee under part ii and the time when there is ‘receipt’ of a communication under part iii is striking” , which justify extension of the principle of article 24 to part iii” ). see also john o. honnold, supra note 45, at § 179, 202. 1 6 9 see landgericht [district court] stendal, germany, 12 october 2000, case number 22 s 234/94, available at <http://cisgw3.law.pace.edu/cases/001012g1.html> (last visited apr. 19, 2005) (stating that “ [a]s soon as [one party] has made the decision to suspend her performance, she is bound to inform the other party without delay, which regularly requires an appropriate sending of the notice as stipulated by art. 27 cisg” ). 170 in that respect, see henry deeb gabriel, general provisions, obligations of the seller, and remedies for breach of contract by the seller, in draft uncitral digest and beyond: cases, analysis and unresolved issues in the u.n. sales convention 336, 34243 (franco ferrari et al. eds., munich, sellier 2004). 171 but see id. at 342 (stating that the solution of problem of determining “ whether there has been in fact a ‘dispatch’ [… ] is not within the domain of the cisg, but instead must be resolved by the slow emergence of international uniform standards for electronic commerce on such questions as what constitutes ‘receipt’” ). 172 in that aspect, see uncitral mlec, supra note 67, at article 15(1) (providing that “ [u]nless otherwise agreed between the originator and the addressee, the dispatch of a data message occurs when it enters an information system outside the control of the originator or of the person who sent the data message on behalf of the originator” ). see also uncitral draft convention on electronic communications, supra note 48 at article 10(1) (providing that “ [t]he time of dispatch of an electronic communication is the time when it leaves an information system under the control of the originator or of the party who sent it on behalf of the originator or, if the electronic communication has not left an information system under the control of the originator or of the party who sent it on behalf of the originator, the time when the electronic communication is received” ). specifically in respect to fax messages, see ericson p. kimbel, nachfrist notice and avoidance under the cisg, 18 j.l. & com. 301, 314 (1999) (concluding that a buyer could rely on immediate effectiveness of a nachfrist notice — which is governed by article 47 — “ when the fax machine has confirmed transmission” ). 45 contained in article 24 is limited by the text of this provision to issues of formation; however, it is contended that the article 24 definition is also applicable to these exceptions168. the other exception lies on the “ appropriateness of the means” test. under article 27, in case of delay, error or failure, the party sending the notice, request or communication may only rely on it if she has used the “ means appropriate in the circumstances” 169. the availability of electronic means of comm unication is a potential source of complications in determ ining the appropriateness of the means selected170; however, in the absence of agreement or practices between the parties, it is very difficult to set a priori some guidelines to determine what will be appropriate in a real case. for instance, it is not clear that the mere availability of a faster means of communication would render inappropriate the choice of a slower one. iii.3.1.2. dispatch of electronic communications the cisg does not define dispatch, not even for more traditional means of communications, such as letters, telegrams and telexes. but since article 27 uses the expression “ transmission” , it is possible to infer that a message can be deemed to be sent when it leaves the sphere of control of the seller171. this definition has the advantage of being symmetrical to the definition of “ reaches” for non-instantaneous and instantaneous inter absentes communications (see part iii.2.2.2.2 supra): if a message is received when it enters the sphere of control of the recipient, it is logical to assume that it is sent when it leaves the sphere of control of the sender. therefore, a letter is dispatched when it is given to the postal service. similarly, if the sender uses an information system to send it, an electronic message is deemed to be dispatched when it leaves that information system and enters a network over which she has no control172. of course, in order to be effective, the message should be able to reach the addressee; for instance, if the sender types the wrong e-mail address of the recipient, the former will not be able to rely on that message. http://cisgw3.law.pace.edu/cases/001012g1.html nordic journal of commercial law issue 2006 #2 173 the dispatch theory allocates the risk of the failure in transmission. there are situations when a data message will be properly transmitted, but still will not be readable, a risk that is not allocated to the recipient under the dispatch theory. thus, if the sender chooses a means of communication that issues messages that the recipient is not able to read (because, say, the latter does not have a required computer application), the risk is still on the sender by virtue of the exception of article 27; the reason is that the choice of a means that results in a message unreadable to the recipient is not “ appropriate” (see supra part iii.3.1.1). however, a good faith recipient will always advise the sender that the message could not be read (if, of course, the recipient can identify the sender). 174 see nv a.r. v. nv i., hof van beroep [appellate court] gent, belgium, 15 may 2002, case number 2001/ar/0180, available at <http://cisgw3.law.pace.edu/cases/020515b1.html> (last visited apr. 19, 2005) at ¶ 6.6 (stating that “ any agreement, regardless of the form in which it came about, can in principal be changed or ended by the mere agreement of the parties, which may be proved by any means, including the behavior of the parties themselves” ). 46 however, unlike the receipt theory, if the message is not comprehensible or unable of being processed by another information system due to a failure in the transmission process, the sender will nevertheless be able to rely on it173. iii.3.2. modification or termination of the contract article 29(1) provides that “ [a] contract may be modified or terminated by the mere agreement of the parties” . therefore, the same informality that governs the formation of the contract under article 11 will rule its eventual modification or termination: the parties may modify or terminate the contract by any means, even orally174. similarly to what has been claimed in part iii.1.1, the absence of form requirements permits the parties to modify and terminate a sales contract via electronic communications. if the parties provide in their agreement that the contract may only be modified in writing (article 29(2)), the contract may be modified by electronic means, unless the parties define “ writing” differently from the concept examined in part iii.1.2.1. in case the domestic law of contracting state that made an article 96 reservation is applicable, there will be an issue whether the definition “ writing” in article 13 would play any role in determining what kind of “ writings” would meet the domestic writing requirement; as it was claimed in part iii.1.2.2, article 13 may supersede the definition of “ writing” contained in the domestic law of the reserving state. http://cisgw3.law.pace.edu/cases/020515b1.html nordic journal of commercial law issue 2006 #2 47 iv. conclusion based on the analysis made in part ii, the use of electronic means by itself does not turn the cisg inapplicable, with one exception. even if those means are used, it is still possible to determine the parties’ places of business using the guidelines already settled by case-law and scholarly writing, which is essential to determine the internationality of the contract as well as whether it falls into the personal sphere of application of the convention (part ii.1.2). there might be some difficulties in respect to the requirement of apparent internationality (part ii.1.3), which often also exists for transactions concluded by more traditional means. one problem is the definition of parties to the sales transaction (part ii.1.4), a matter not governed by the cisg and thus left to domestic law applicable under the conflict of laws rules of the forum; however, since it is extremely improbable that any jurisdiction will grant the status of “ parties” to electronic agents, this problem is not in fact relevant. a more relevant issue deals with the cisg’s substantive sphere of application. due to the definition of “ goods” and “ contract of sale” , the convention is not applicable to contracts whose characteristic performance is made by electronic means, such as the supply of software or other digital content over the internet (part ii.2.2). that is one situation where the use of the technology by itself turns the convention inapplicable: for instance, the cisg can be applicable when standard software is distributed in tangible media, but not when it is provided over the internet. however, it is not clear whether the cisg is indeed suitable to those transactions or whether new specific rules should be developed; furthermore, since in this kind of transactions the parties usually agree on detailed conditions for their relationship (under the form of a “ license agreement” ), a set of default rules such as the cisg might be of questionable use. as a result of the potential lack of personal contact in the e-commerce environment, the exclusion of consumer sales from the sphere of application of the cisg is also a potential problem, since it will be difficult for the seller to know whether the buyer is a consumer (part ii.2.3) or not. the risk, however, is not a limitation on the applicability of the cisg, but rather an expansion of its sphere of application to consumer sales, since there is a higher probability (in comparison to traditional transactions) that the seller did not know nor ought to have known of the consumer purpose of the buyer. the analysis in part iii demonstrated that the substantive provisions of the cisg can also be applicable to electronic communications. based on the principle of informality, a contract might be formed (part iii.1.1), modified or terminated (part iii.3.2) by electronic means. furthermore, a definition of “ writing” can be derived from article 13, which clearly encompasses the more modern means of communication mentioned in this paper (part iii.1.2). this definition might override a conflicting one contained in the domestic law applicable due to an article 96 reservation, giving the parties certainty that, even if one of them is from a reserving state and that state’s law would be applicable by virtue of conflict of laws rules, they can rely on the definition of writing implicit in the cisg. moreover, the provisions of the cisg dealing with formation of contracts can also be applied to e-commerce. the definition of offer contained in article 14 addresses relevant issues arising from electronically generated proposals (part iii.2.1). article 24, which defines the moment in which a pre-contractual communication produces its effects, can also be applied to electronic nordic journal of commercial law issue 2006 #2 48 communications, once the technologies are properly categorized and technological equivalents for the concepts of “ cognizance” and “ receipt” are derived from the text of the convention (part iii.2.2). the same happens with article 20(1), which defines the moment in which time limit to issue an acceptance begins to run (part iii.2.3). finally, article 27, which deals with the risk of errors in the transmission of a contractual communications, can also be applicable to e-commerce environment once a technological equivalent of “ dispatch” is developed. therefore, it is possible to say that (a) the cisg can be applicable to e-commerce transactions and (b) the cisg provisions dealing with formation of the contract and contractual communications are perfectly suitable for the e-commerce environment. consequently, it is clear that the cisg provides a workable framework for international e-commerce transactions involving sale of goods; the difficulties that may arise are not sufficient to set aside the conclusion that the convention is able to deal with emerging issues in e-commerce. nordic journal of commercial law issue 2006 #2 49 v. references v.1. scholarly writing aréchaga, eduardo jiménez de. 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<http://cisgw3.law.pace.edu/cases/970320a3.html> (last visited apr. 27, 2005) rheinland versicherungen v. atlarex s.r.l, tribunale [district court] di vigevano, italy, 12 july 2000, case number 405, translation to english available at <http://cisgw3.law.pace.edu/ cases/000712i3.html> (last visited mar. 20, 2005). so. m. agri s.a.s di ardina alessandro & c. v. erzeugerorganisation marchfeldgemüse gmbh & co. kg, tribunale [ d i s t r i c t c o u r t ] d i p a d o v a , i t a l y , 2 5 f e b r u a r y 2 0 0 4 , c a s e n u m b e r 4 0 5 5 2 , a v a i l a b l e a t <http://cisgw3.law.pace.edu/cases/040225i3.html> (last visited apr. 12, 2005). soc. romay ag v. soc. behr france, s.a.r.l., tribunal de grande instance de colmar, france, 18 december 1997, available at <http://www.unilex.info/case.cfm?pid=1&do=case&id=981&step=fulltext> (last visited apr. 9, 2005). tessile 21 s.r.l. v. ixela s.a, tribunale [district court] di pavia, italy, 29 december 1999, available at <http://cisgw3.law.pace.edu/cases/991229i3.html> (last visited apr. 6, 2005). tribunal [appellate court] cantonal vaud, switzerland, 11 march 1996, case number 01 93 1061, available at <http://cisgw3.law.pace.edu/cases/960311s2.html> (last visited apr. 9, 2005). tribunal of international commercial arbitration at the russian federation chamber of commerce and industry, r u s s i a n f e d e r a t i o n , 2 8 a p r i l 1 9 9 5 , c a s e n u m b e r 4 0 0 / 1 9 9 3 , a t ¶ 3 . 4 , a v a i l a b l e a t <http://cisgw3.law.pace.edu/cases/950428r1.html> (last visited apr. 28, 2005). tribunal of international commercial arbitration at the russian federation chamber of commerce and industry, r u s s i a n f e d e r a t i o n , 1 0 j u n e 1 9 9 9 , c a s e n u m b e r 5 5 / 1 9 9 8 , a v a i l a b l e a t <http://cisgw3.law.pace.edu/cases990610r1.html> (last visited apr. 14, 2005). tuzzi trend tex fashion gmbh v. w.j.m. keijer-somers, arrondissementsrechtbank [district court] amsterdam, n e th e r l an d s , 5 o c to b e r 1 9 9 4 , c as e nu m b e r h 9 3 .2 9 0 0 , c a se ab str act an d co mme nt availab le at <http://cisgw3.law.pace.edu/cases/941005n1.html> (last visited apr. 17, 2005). v.2.2. other cases charles katz v. united states, 389 u.s. 347 (1967). commission of the european communities v. united kingdom of great britain and northern ireland, case c246/89, [1991] e.c.r. 4585. gator.com corp. v. l.l. bean, inc., 341 f.3d. 1072 (9th cir. 2003) vacated rehearing granted en banc, 366 f.3d 789 (9th cir. 2004) gorman v. ameritrade holding corp., 293 f.3d 506, (d.c. cir. 2002). helicopteros nacionales de colombia, s.a v. hall, 466 u.s. 408 (1984). international shoe co. v. washington, 326 u.s. 310 (1945). olmstead v. united states, 277 u.s. 438 (1928). the queen v. secretary of state for transport, ex parte factortame ltd and others [“ factortame ii” ], case c-221/89, [1991] e.c.r. 3905. http://cisgw3.law.pace.edu/cases/940222g1.html http://cisgw3.law.pace.edu/cases/940826g1.html http://cisgw3.law.pace.edu/cases/990427g1.html http://cisgw3.law.pace.edu/cases/000228g1.html http://cisgw3.law.pace.edu/cases/941110a3.html http://cisgw3.law.pace.edu/cases/970320a3.html http://cisgw3.law.pace.edu/ http://cisgw3.law.pace.edu/cases/040225i3.html http://www.unilex.info/case.cfm?pid=1&do=case&id=981&step=fulltext http://cisgw3.law.pace.edu/cases/991229i3.html http://cisgw3.law.pace.edu/cases/960311s2.html http://cisgw3.law.pace.edu/cases/950428r1.html http://cisgw3.law.pace.edu/cases990610r1.html http://cisgw3.law.pace.edu/cases/941005n1.html nordic journal of commercial law issue 2006 #2 53 v.3. other materials cisg-ac opinion number 1, electronic communications under cisg, 15 august 2003 (rapporteur: professor christina ramberg, gothenburg, sweden), available at <http://cisgw3.law.pace.edu/cisg/cisg-ac-op1.html> (last visited apr. 13, 2005). cisg-ac opinion number 4, contracts for the sale of goods to be manufactured or produced and mixed contracts (article 3 cisg), 24 october 2004 (rapporteur: professor pilar perales viscasillas, universidad carlos iii de madrid), available at <http://cisgw3.law.pace.edu/cisg/cisg-ac-op4.html> (last visited apr. 9, 2005). european commission recommendation 94/820, 1994 o.j. 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(l 178) 1. note by the secretariat (legal aspects of electronic commerce – possible future work in the field of electronic contracting: an analysis of the united nations convention on contracts for the international sale of goods), uncitral working group on electronic commerce, 38 th sess., u.n. doc. a/cn.9/wg.iv/wp.91 (2001), available at <http://www.uncitral.org/english/workinggroups/wg_ec/index.htm> (last visited mar. 20, 2005). report of the uncitral working group on electronic commerce, 34 th sess., u.n. doc. a/cn.9/484 (2001), available at <http://www.uncitral.org/english/sessions/unc/unc-34/acn-484e.pdf> (last visited apr. 3, 2005). report of the working group on electronic commerce on the work of its forty-fourth session (vienna, 11-22 o c t o b e r 2 0 0 4 ) , u n c i t r a l , 4 4 t h s e s s . , u . n . d o c . a / c n . 9 / 5 7 1 ( 2 0 0 4 ) , a l s o a v a i l a b l e a t <http://www.uncitral.org/english/workinggroups/wg_ec/index.htm> (last visited mar. 31, 2005). 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http://www.uncitral.org/english/sessions/unc/unc-34/acn-484e.pdf http://www.uncitral.org/english/workinggroups/wg_ec/index.htm http://cisgw3.law.pace.edu/cisg/firstcommittee/meeting7.html http://www.uncitral.org/english/texts/payments/ctchttp://www.uncitral.org/english/texts/electcom/mlhttp://www.uncitral.org/english/texts/electcom/ml-elecsighttp://www.unidroit.org/english/conventions/1988factoring/1988factoring-e.htm http://www.unidroit.org/english/principles/contracts/principles2004/blackletter2004.pdf microsoft word saxlin_elina.doc nordic journal of commercial law issue 2010#1 establishing coherence: the right to access to medicines, pharmaceutical patents and the wto medicines decision by elina saxlin-hautamäki nordic journal of commercial law issue 2010#1 1 i. introduction “it is a well-known paradox of globalization that while it has led to increasing uniformization of social life around the world, it has also led to its increasing fragmentation that is, to the emergence of specialized and relatively autonomous spheres of social action and structure. the fragmentation of the international social world has attained legal significance as it has been accompanied by the emergence of specialized and (relatively) autonomous rules or rule-complexes, legal institutions and spheres of legal practice.”1 the era of globalization has had a fundamental impact on international relations and international law. from 1970 through 1997, the number of international treaties more than tripled2. this has lead to a situation where states are increasingly bound to treaties that may appear to include conflicting norms, i.e. a situation where adherence to one provision may lead to the violation of another. how to govern this fragmentation of international law is a challenge. the relationship between the right to access to medicines and protection of pharmaceutical patents is a current example of this ambitious task.3 the agreement on trade-related aspects of intellectual property rights (“the trips agreement”) created a global patent system that can be enforced, when necessary, through the world trade organization (“wto”) and its dispute settlement mechanism. article 27 of the agreement stipulates that patents must be available also for pharmaceutical products and processes on a non-discriminatory basis.4 simultaneously, however, most wto members have other kinds of obligations that are arguably of more fundamental character – namely, human rights obligations. the right to health covered e.g. by article 12 of the international covenant on economic, social and cultural rights (“the icescr”) concluded in 1966 obligates 1 koskenniemi 2006, paras. 7–8. 2 alvarez 2002, p. 216. 3 for an in-depth research on the relationship between global patent protection and the right to access to medicines in international law, see hestermeyer 2007. 4 article 27(1) of the trips agreement: “subject to the provisions of paragraphs 2 and 3, patents shall be available for any inventions, whether products or processes, in all fields of technology, provided that they are new, involve an inventive step and are capable of industrial application. […] patents shall be available and patent rights enjoyable without discrimination as to the place of invention, the field of technology and whether products are imported or locally produced.” nordic journal of commercial law issue 2010#1 2 contracting states to ensure access to affordable medicines.5 the icescr has 160 parties; over 80 percent of the members of the wto are simultaneously bound by both agreements.6 the conflict between the trips agreement and the right to access to medicines has inspired a wealth of literature: while access to affordable medicines forms an integral part of the right to health, pharmaceutical patents tend to increase the prices of pharmaceuticals and may, thus, hinder access to medicines in developing countries. the current health crisis related to hiv/aids and other epidemics in developing countries has highlighted the gap between the haves of industrialized countries and the have-nots of developing countries: approximately 90 percent of deaths due to infectious diseases occur in developing countries that represent 10 percent of the global pharmaceuticals market7. human rights advocates have been calling for the supremacy of the right to access to medicines in relation to pharmaceutical patents. however, the fact is that the trips obligations are more precisely formulated and backed up by an efficient dispute settlement mechanism, whereas the icescr and other agreements on human rights are drafted in broader terms and lack efficient enforcement systems.8 similarly, the right to access to medicines as a norm of customary international law seems to have no practical significance in trade negotiations.9 yet, at a time 5 article 12 of the icescr:”1. the states parties to the present covenant recognize the right of everyone to the enjoyment of the highest attainable standard of physical and mental health. 2. the steps to be taken by the states parties to the present covenant to achieve the full realization of this right shall include those necessary for: (a) the provision for the reduction of the stillbirth-rate and of infant mortality and for the healthy development of the child; (b) the improvement of all aspects of environmental and industrial hygiene; (c) the prevention, treatment and control of epidemic, endemic, occupational and other diseases; (d) the creation of conditions which would assure to all medical service and medical attention in the event of sickness.” access to medicines is not mentioned in the icescr as an independent right. it is yet a critical component of the right to health both as a means of prevention, treatment and control of epidemic and endemic diseases and as a part of medical attention in the event of any kind of sickness. see yamin 2004, p. 112. 6 hestermeyer 2007, p. 102; a list of parties and signatories is available at http://treaties.un.org/pages/ viewdetails.aspx?src=treaty&mtdsg_no=iv-3&chapter=4&lang=en (last visited 26.3.2010). states have binding health-related obligations also through myriad other global and regional human rights instruments. see e.g. article 12 of the convention on the elimination of all forms of discrimination against women, article 24 of the convention on the rights of the child, article 5 of the international convention on the elimination of all forms of racial discrimination, article 16 of the african charter on human’s and people’s rights (“banjul charter”), article 11 of the european social charter, article xi of the american declaration on the rights and duties of man and article 10 of the subsequent additional protocol to the american convention on matters of economic, social and cultural rights (“protocol of san salvador”). in addition, access to medicines can be invoked in favour of various other human rights, such as the right to life (article 6 of the international covenant on civil and political rights, “iccpr”), rights to an adequate standard of living to social security, to education and to work, the right to benefits of scientific progress (articles 6, 9, 13 and 15 of the icescr). bearing in mind the indivisibility and interdependence of human rights, there is yet no need to further explain the significance of the right to health in relation to other human rights. 7 world health assembly (resolution wha56.27): intellectual property rights, innovation and public health (2003), preamble, para. 3. 8 cullet 2006, p. 195. 9 for an analysis of the right to access to medicines as a customary norm, see hestermeyer 2007 p. 122 ff. nordic journal of commercial law issue 2010#1 3 when approximately 17,6 million people in lowand middle-income countries die each year from communicable diseases and maternal and neonatal conditions10 – the occurrence of which is far lower in developed countries – individuals in need of medicines should not be exposed to any additional burdens. thus, the issue is how to strike a balance between global intellectual property protection and universal access to medicines – a task that literally turns into a life-anddeath question with respect to pharmaceutical patents in developing countries. the negative impact of pharmaceutical patents on access to medicines in developing countries was one of the central issues during the wto doha round. the well-known cases of southafrica11 and brazil12 generated a strong reaction from non-governmental organizations and international human rights organs that have been calling for exceptions to pharmaceutical patents on a public health basis as part of the reforms that should take place in the wto context.13 as the sub-commission on the promotion and protection of human rights put it, “[…] since the implementation of the trips agreement does not adequately reflect the fundamental nature and indivisibility of all human rights, including [...] the right to health, there are apparent conflicts between the intellectual property rights regime embodied in the trips agreement, on the one hand, and international human rights law, on the other”14. faced with immense public pressure and obscurities related to the implementation of the agreement, wto members managed to adopt the declaration on the trips agreement and public health at the 4th ministerial conference held in doha in november 2001 (“the doha declaration”). in the declaration, wto members agree that the trips agreement does and should not prevent wto members from taking measures to protect public health15. the need to extend the deadline for least-developed country members to apply provisions on pharmaceutical patents was recognized and the transitional periods have since been extended to 10 dutfield 2008, p. 107. 11 for an overview of the case of south-africa, see nagan 2002. 12 for an overview of the case of brazil, see lazzarini 2003. 13 see e.g. subcommission on the promotion and protection of human rights (resolution 2000/7): intellectual property rights and human rights; commission on human rights (resolution 2001/33): access to medication in the context of pandemics such as hiv/aids; world health assembly (resolution 28 may 2003): intellectual property rights, innovation and public health; oxfam: oxfam briefing paper 4 (2001): priced out of reach – how wto policies will reduce access to medicines in the developing world. 14 subcommission on the promotion and protection of human rights (resolution 2000/7): intellectual property rights and human rights, para. 2. 15 doha declaration, para. 4. nordic journal of commercial law issue 2010#1 4 january 201616. most importantly, the trips council was called upon to find a solution to the problem that many wto members lack the capacity to effectively utilize the exceptions to patent rights authorized by the trips agreement17. the adoption of the doha declaration thus launched a set of negotiations with the purpose of ensuring the ability of developing countries to use patented medicines in consistency with the trips agreement. in september 2003, after long negotiations and intensive politics, the general council of the wto adopted the decision on implementation of paragraph 6 of the doha declaration on the trips agreement and public health (“medicines decision”). the decision waives (i.e. temporarily suspends) certain obligations set out in article 31 of the trips agreement. the provision concerns the use of patents without permission of the patent holder, a practice most often referred to as compulsory licensing. a wto waiver means that a wto member will not initiate a complaint against another wto member, if the latter acts in accordance with the terms of the adopted waiver18. in december 2005, the general council of the wto adopted a decision to amend the trips agreement to make the medicines decision a permanent part of it19. this is done by inserting article 31bis, which corresponds with the content of the medicines decision, to the trips agreement. the protocol amending the agreement was initially open for acceptance until the 1st of december 2007; the deadline was subsequently extended to the 31st of december 200920. meanwhile, the medicines decision applies to all wto members. the three texts, the trips agreement, the doha declaration and the medicines decision, now provide the main legal framework regulating the use of compulsory licenses as a public health safeguard protecting developing countries against the possible negative effects of pharmaceutical patents on access to medicines. the conflict sketched out above, between pharmaceutical patents supported by the trips agreement and access to medicines as part of the human right to health, is an excellent example of fragmentation of international law – a situation where states are bound by obligations under different specialized systems that each establish their own principles and 16 ibid., paras. 6 and 7; council for trips: decision on the extension of the transition period under article 66.1 of the trips agreement for least-developed country members for certain obligations with respect to pharmaceutical products (1 july 2002) and wto general council: decision on least-developed country members — obligations under article 70.9 of the trips agreement with respect to pharmaceutical products (12 july 2002). it should be noted, however, that some least-developed countries have nevertheless chosen to enforce patent systems despite the transitional periods they have been granted (oh 2006, p. 30). 17 doha declaration, para. 6. 18 see also article 56 of the vienna convention of the law of treaties. 19 wto general council: amendment of the trips agreement (8 december 2005). 20 wto general council: amendment of the trips agreement – extension of the period for the acceptance by members of the protocol amending the trips agreement (21 december 2007). in order to replace the waiver, the amendment has to be formally accepted by two thirds of wto members in accordance with paragraph 3 of article x of the marrakesh agreement. nordic journal of commercial law issue 2010#1 5 institutions. assessment of the phenomenon varies. authors calling for coherence of international law have stated that the so-called sub-regimes or sub-systems of modern international law, such as wto law and human rights law, must not be considered separate and self-contained regimes, as this kind of assumption would nullify the significance of general international law. accordingly, even though a state can in theory contract out of all rules of international law, it cannot do that with respect to the system of international law, the maintenance of which requires a prohibition against the creation of sub-systems completely delinked from the rules of international law agreed upon elsewhere21. others have given up on searching for unity and are calling for “weak compatibility between the fragments” of international law22. institutional fragmentation is considered a natural expression of political plurality in a world where it is doubted that any legal unity existed in the first place. having rejected the idea of any “abstract consistency”, the proponents of this view believe that each special regime will continue speaking its own professional language and “seeks to translate that into a global esperanto”, while no overall solutions are available as to which system of law should be preferred in a particular situation23. the point of departure of this article is that no international regime can choose to exist in a legal vacuum – instead, all norms of international law can interact with each other. similarly, international intellectual property regulation is applied in a context where the right to health is a well-established human right, codified in several human rights instruments. the feasibility of exclusive rights introduced by the trips agreement must, however, also be ensured as an important part of economic relations between wto members. the issue, therefore, is how to maintain coherence between the sets of norms examined. in the following, i will first examine the obligations imposed by the right to access to medicines and its relationship to and position in the trips regime, in order to elucidate why these norms should be efficiently reconciled. i will continue by examining the content of the medicines decision – the amendment that was supposed to harmonize the trips agreement with the right to access to medicines – in order to provide a practical answer to the question of how to ensure that pharmaceutical patents do not hinder access to medicines in developing countries. 21 pauwelyn 2003, p. 9–10, 37–38. 22 fischer-lescano and teubner 2004, p. 1046. the authors present (p. 1024–1034) that with respect to pharmaceutical patents and the amendments made within the wto, the organization managed to create an internal limitation on its own logic through the reformulation of a principle of health protection – an act that the authors describe as the internal achievement of the regime that allowed it to maintain its autonomy over conflicting regimes and laws. 23 koskenniemi & leino 2002, p. 557, 578. nordic journal of commercial law issue 2010#1 6 ii. an illusion of incoherence? 2.1. the right to access to medicines and the trips agreement the obligations imposed by the right to access to medicines as part of the human right to health, and their position with respect to trips obligations, can be approached by the wellknown tripartite analysis of human rights: the obligations to respect, protect and fulfill. the obligation to respect is the negative dimension of the right to access to medicines, which requires states to refrain from interfering directly or indirectly with the enjoyment of the right.24 this obligation is closely connected to the prohibition of retrogressive measures.25 states must refrain from adopting legislation or policies that interfere with the enjoyment of any of the components of the right to health. they must thus take into account legal obligations regarding also the right to access to medicines, when entering into bilateral or multilateral agreements with other states, international organizations and other entities, such as multinational corporations.26 the introduction of pharmaceutical patents that have a price-increasing effect can constitute a violation of the obligation to respect the right to health if the regulation in question hinders access to medicines by increasing prices. it should be noted, however, that in accordance with the doha declaration, the trips agreement “shall be read in the light of the object and purpose of the agreement as expressed, in particular, in its objectives and principles”.27 pursuant to article 7 of the trips agreement, the object of the agreement is to promote technological innovation “in a manner conducive to social and economic welfare, and to balance of rights and obligations”. the provision is based on a proposal submitted by developing countries during the negotiations of the trips agreement and it represents a compromise between the global intellectual property protection, on the one hand, and the need to secure access technology in the south, on the other. it can well be used to legitimize exceptions to exclusive rights in order to strike a balance between the private and the public 24 dowell-jones 2004, p. 29; escr committee, general comment 14, para. 33. 25 escr committee, general comment 14, para. 32 (stating that if such measures are taken, “the state party has the burden of proving that they have been introduced after the most careful consideration of all alternatives and that they are duly justified by reference to the totality of the rights provided for in the covenant in the context of the full use of the state party's maximum available resources”). 26 escr committee, general comment 14, para. 50. the un commission on human rights also called states to “refrain from taking measures which would deny or limit equal access for all persons to preventive, curative or palliative pharmaceuticals or medical technologies used to treat pandemics such as hiv/aids or the most common opportunistic infections that accompany them” in its resolution 2002/32 access to medication in the context of pandemics such as hiv/aids (para. 3[a]). 27 doha declaration, para. 5(a). similarly, in the united states – standards for reformulated and conventional gasoline, the appellate body stated (ch. 13) that if applying article 31(1) of the vclt (which refers to the object and purpose of a treaty) provides the answer, it does not need to apply other rules of international law. nordic journal of commercial law issue 2010#1 7 interest.28 article 8 of the trips agreement (“principles”), in turn, explicitly grants all wto members a right to adopt policies that promote public health as long as they are consistent with the agreement.29 in addition to the significance of the provision in the interpretation of the trips agreement, it also means that a wto member challenging a measure adopted by another member in pursuance of public policy objectives should have the initial burden of proof regarding inconsistency with the trips agreement. the claimant should also be conscious of the fact that if there ever were doubts that the requirement of consistency with the agreement could override public health measures, these doubts would have been removed by the doha declaration.30 articles 7 and 8 of the trips agreement are of profound significance in the interpretation and implementation of the rights and obligations under the agreement.31 even though they do not give wto members an unlimited amount of room for exceptions to pharmaceutical patents, they nevertheless imply that trips norms have not been meant to over-run the pre-existing human rights obligations of wto members.32 the trips agreement should therefore be interpreted in a manner that does not constitute a retrogressive measure in relation to access to medicines. simultaneously, one must bear in mind that pharmaceutical patents can also enhance the realization of certain important aspects of the right to health: namely, availability and quality of medicines33. pharmaceutical patents contribute to the research and development of new medicines by making this profitable through an arrangement in which the inventor discloses and publicizes his invention to the society in exchange for the exclusive right granted by the state to exploit the invention for a fixed period of time. patents are thus needed for sustainable availability of effective medicines. similarly, the right to health requires health facilities, goods and services to be scientifically and medically appropriate and of good quality. this requires, inter alia, scientifically approved and unexpired medicines.34 to this end, new medicines must undergo 28 correa 2007, p. 91–92, 103. 29 article 8(1) of the trips agreement: “members may, in formulating or amending their laws and regulations, adopt measures necessary to protect public health and nutrition, and to promote the public interest in sectors of vital importance to their socio-economic and technological development, provided that such measures are consistent with the provisions of this agreement.” 30 correa 2007, p. 108. 31 ibid., p. 92. 32 frankel has stated that the significance of the articles should not be exaggerated. she refers to the canada – patent protection of pharmaceutical products, where the respondent invoked article 8 in favor of its policies by claiming that said article supported liberal interpretation of permissible exceptions to patent rights. the panel, however, stated that the interpretation of the relevant articles must be a case-by-case factual analysis that does not equal to renegotiation of the basic balance of the agreement (frankel 2006, p. 20–21). 33 see escr committee, general comment 14, para. 12. 34 ibid., para. 12(d). nordic journal of commercial law issue 2010#1 8 extensive clinical trials and other tests that demonstrate their efficacy and safety before the medicines are granted marketing authorizations. many developing countries do not require this kind of data but approve a drug on the basis that it has been approved by a reliable authority in an industrialized country.35 these clinical trials represent the lion’s share of the research and development costs of new medicines: it has been estimated that the total average cost of developing a medicine is approximately usd 802 million, of which approximately usd 467 million represent clinical trial expenditures.36 these expenditures are partly covered by the revenues pharmaceutical companies receive by selling their patented medicinal products. to summarize, instead of considering pharmaceutical patents as a mere hindrance to access to medicines, it should be remembered that a patent system is also conducive to the right to health. the obligation to protect implies the “horizontal effectiveness” of the right to access to medicines, often known as the drittwirkung of a right. this means that states must take all necessary measures to safeguard persons in their jurisdiction from infringements of the right by third parties – if a state is not in a position to realize the right itself, it must regulate private acts in order to ensure that individuals are not arbitrarily deprived of the enjoyment of their rights by other individuals.37 the obligation to protect includes, inter alia, the duties of states to adopt legislation or to take other measures ensuring equal access to health care services provided by third parties and to ensure that privatization of the health sector does not constitute a threat to the availability and accessibility of medicines. such omissions, as the failure to regulate the activities of individuals, groups and corporations so as to prevent them from violating the right to health, constitute a violation of the obligation to protect.38 article 8 of the trips agreement allows wto members to take necessary measures in order to protect public health. the provision can be considered a policy statement that explains the rationale for measures taken under articles 30 and 31 of the trips agreement that authorize exceptions to exclusive rights.39 article 30 allows exceptions to exclusive rights as long as they are kept limited, they do not unreasonably conflict with the normal exploitation of the patent and they do not unreasonably prejudice the legitimate interests of the patent owner.40 in relation to pharmaceutical patents and access to medicines, exceptions of paramount nature 35 dutfield 2008, p. 117. 36 dimasi, hansen & grabowski 2003, p. 165–167. 37 craven 1995, p. 111–112. 38 escr committee, general comment 14, paras. 35 and 51. see also human rights guidelines for pharmaceutical companies in relation to access to medicines drafted by the un special rapporteur on the right to the highest attainable standard of health. even though the guidelines are of non-binding character, they can be used as a guideline in order to specify the content of the obligation to protect. 39 gervais 2003, p. 121. 40 gervais 2003, p. 243–244; see also wto panel report canada – patent protection of pharmaceutical products, 17 march 2000. nordic journal of commercial law issue 2010#1 9 allowed by the provision are 1) the use of an invention before the expiration of the patent in order to commercialize a generic version of the product immediately after the expiration of the patent (the so-called bolar exception) and 2) parallel imports.41 article 31 of the trips agreement, in turn, allows for “other use without authorization of the right holder”. compulsory licenses referred to in this article can be granted in accordance with the conditions set forth in the provision e.g. in cases of national emergency.42 regardless of the fact that certain grounds are specifically referred to in the article, wto members can also determine other grounds for making exceptions to patent rights. similarly, compulsory licenses can be conferred to import or to produce a patented product locally.43 the conditions regarding the practice and their deficiencies that were addressed by the medicines decision are examined more closely below. however, taking into consideration the above mentioned provisions, it can be concluded that the trips agreement does not entail any legal impediments to states protecting the right to access to medicines. on the contrary, implementing any of the named practices is a question of political will. wto members can thus meet their obligation to protect access to medicines despite their obligation to grant patent protection to pharmaceutical products. the obligation to fulfill requires states to, inter alia, “give sufficient recognition to the right to health in national political and legal systems, preferably by way of legislative implementation” and to ensure provision of health care for all.44 states should actively implement policies and programs that enable individuals to enjoy access to underlying determinants of health where this has not been forthcoming through implementation of the previous two duties. the obligation to fulfill thus seems to remain a “catch-all” category the obligations of which require 41 based on current comparative law and other proposals made on the subject, correa has defined the following additional exceptions: acts done privately and on a non-commercial scale and for non-commercial purpose; using the invention for research and experimentation and for teaching purposes; preparation of medicines for individual cases according to a prescription, and use of the invention by a third party who started – or undertook bona fide preparatory acts – before the application for the patent or its publication (correa 2007, p. 303). 42 additional grounds specifically mentioned in article 31 are a refusal by the patentee to voluntarily license its patent, the use of compulsory licenses to remedy anti-competitive practices or for public non-commercial use, such as educational intentions, or for dependent patents (article 31[b], [c], [l]). 43 correa 1998, p. 210, 214. sean flynn has proposed developing countries to employ ”access gap theory” for exploring when a patent holder is abusing its dominant position in the relevant market in a manner that justifies the issuance of compulsory licenses. under this theory, a presumption on the existence of the preconditions for the issuance of compulsory licenses is present when there is a lack of access in society to a patented medicine needed to address an important public health problem and this deficiency is at least partly due to its significantly higher pricing when compared to a situation in a competitive market with reasonable royalties paid to the patent holder. where these factors are present, the burden should be on the patentee to prove that it has promoted the lowest price possible consistent with receiving due reward for use of its invention e.g. by opening a licensing program that issues licenses at reasonable royalties to any potential competitor. this kind of policy converts the patent right from an exclusive property right (right to exclude) to a right to be paid in the specific situation where competition is needed to increase access to medicines (flynn 2003, p. 538–539). 44 escr committee, general comment 14, para. 39. nordic journal of commercial law issue 2010#1 10 the mainstreaming of the right nationally on e.g. economic level.45 with respect to the right to access to medicines, the obligation to fulfill requires states to take positive measures in order to foster research into health-related areas.46 this can be considered as, inter alia, requiring states to subsidize research and development of new medicines. statistics indicate the unfortunate fact that medicines are currently developed only for diseases prevalent in developed countries, where their sales are most profitable. less than 1 percent of the nearly 1400 medicines that were registered between 1975 and 1999 were for the treatment of tropical diseases that mainly occur in the southern hemisphere47. it is often pointed out that developing countries seem to benefit from research and development today mainly when the rich also suffer from the same diseases48. as noted by sell, “market mechanisms to deliver innovation into the public domain fail spectacularly in the oligopolistic markets of the contemporary life sciences industries”49. however, the failure is not one of patents as such. in an economic sense, it is perfectly rational – whether or not admirable – to prioritize research in ways that generate most revenues. thus, other ways than giving up on patent protection must be found that make up for the market failure, i.e. ways that make research and development of medicines needed for the treatment of “neglected tropical diseases”50 economically feasible. government subsidies are one alternative that can surely be considered as being consistent with the obligation to fulfill. finally, human rights obligations of third states must also be considered. all members of the united nations have pledged themselves to take both joint and separate action in cooperation with the organization for the solutions of international economic, social, health, and related 45 dowell-jones 2004, p. 31–33. 46 escr committee, general comment 14, para. 37. 47 who: 10 facts on neglected tropical diseases (17 april 2007). in order to give a concrete example, it should be mentioned that while 95 percent of active tb cases occur in developing countries, no new medicines has been developed since 1967 (dutfield 2008, p. 112–113). 48 commission on intellectual property rights, innovation and public health 2006, p. 77. 49 sell 2007, p. 43. 50 neglected tropical diseases (“ntds”) refer to diseases that affect circa 1 billion people (i.e. one out of six) in developing countries. preventing, eliminating and eradicating these diseases is largely neglected due to the fact that they persist exclusively in the poorest populations of the world (who: 10 facts on neglected tropical diseases [17 april 2007]). nordic journal of commercial law issue 2010#1 11 problems.51 the limburg principles on the implementation of the icescr note that “international co-operation and assistance pursuant to the charter of the united nations and the covenant shall have in view as a matter of priority the realization of all human rights and fundamental freedoms, economic, social and cultural as well as civil and political”.52 the principle of international cooperation has been incorporated also to the icescr. pursuant to article 2(1) of the icescr, each contracting state “undertakes to take steps, individually and through international assistance and co-operation, especially economic and technical, to the maximum of its available resources” in order to progressively realize all the rights included in the covenant. the significance of the phrase has two diverging interpretations. on the one hand, it has been said to give rise to quite specific international obligations on the part of industrialized countries and to provide the foundations for the existence of a right to development. on the other hand, no legally binding obligation to provide aid to foreign countries has been read to the phrase.53 yet, the un committee on economic, social and cultural rights (“escr committee”) formulates specific obligations for third states in relation to the right to health.54 accordingly, contracting states must, inter alia, respect the enjoyment of the right to health in other countries and prevent third parties from violating the right to health in these countries, if they are able to influence them by way of legal or political means. they should also facilitate access to essential health goods in third countries when possible and provide needed aid. with respect to the conclusion of other international agreements, contracting states should ensure that these instruments do not adversely impact upon the right to health and ensure that their actions as members of international organizations take due account of the right to health.55 these obligations can easily be applied also to the trips agreement. when examining the implementation of the medicines decision, it will become clear that access to patented medicines in the south can only be ensured if also industrialized countries implement the medicines decision appropriately. if the aim is to ensure that pharmaceutical patents do not hinder access to medicines, the above presented obligations of states to respect, protect and fulfill the right to access to medicines of their own citizens must be considered to constitute 51see articles 55 and 56 of the charter of the united nations. see also article 3 of the declaration on the right to development: “1. states have the primary responsibility for the creation of national and international conditions favorable to the realization of the right to development; 2. the realization of the right to development requires full respect for the principles of international law concerning friendly relations and co-operation among states in accordance with the charter of the united nations; 3. states have the duty to co-operate with each other in ensuring development and eliminating obstacles to development. states should realize their rights and fulfill their duties in such a manner as to promote a new international economic order based on sovereign equality, interdependence, mutual interest and co-operation among all states, as well as to encourage the observance and realization of human rights. “ 52 the limburg principles, principle no. 29. 53 alston & quinn 1987, p. 187. 54 escr committee, general comment 14, para. 39. 55 escr committee, general comment 14, para. 39. nordic journal of commercial law issue 2010#1 12 only one side of the coin, while efficient assistance from industrialized countries forms the other. assuming this kind of joint responsibility is in line with the fact that decisions that may have a reverse impact on the lives of millions are also made jointly in an international setting, e.g. in inter-state trade negotiations. 2.2. the myth of a self-contained regime as pointed out above, the relationship between the obligations arising from the right to access to medicines and the trips norms may not be as complex as it is often claimed to be – permissive norms corresponding to the obligations wto members have based on the access norm can, to some extent, be found in the trips agreement. since the right to access to medicines is binding on all wto members as a well-established human rights norm, and since all states are expected to meet their obligations in good faith, it may prima facie seem difficult to find a strong legal justification for claims concerning the existence of conflict between these sets of norms. however, nothing in the trips agreement directly commands wto members to interpret trips norms in consistency with the access norm. if the trips regime, as part of the wto, would constitute a “self-contained” regime, its norms could be interpreted solely from the perspective of trade and thus human rights could be ignored. in order to construe a legal justification for why trips norms, that grant exclusive rights to medicinal compounds and products, should be interpreted harmoniously with the access to medicines norm, one has to examine the relationship between wto law and public international law, the latter referring to the aggregate of norms regulating relationships between states. a wealth of discussion exists over the applicability of public international law within the world trading system. the current opinion is spread across three main views, endorsing full, partial or no applicability of international law to trade disputes. those who see the wto as a closed legal system hold that as the jurisdiction and substantive mandate of wto panels and the appellate body are strictly limited to claims under wto governed agreements, only internal regulation of the organization should apply to the dispute resolution. proponents of partial applicability of international law are willing to give wto law a privileged status in relation to rules of public international law. they claim that the covered agreements should prevail against any attempt to introduce new rights or duties on behalf of other international rules. these privileged or autonomous positions nevertheless find little basis in the texts of the actual agreements and are not supported by the recent case law either.56 in fact, the appellate body itself has stated that the wto agreement “is not to be read in clinical isolation from public international law”.57 it is undisputable that the mandate of wto panels is to interpret wto law and to determine 56 lindroos & mehling 2006, p. 862–866. 57 wto appellate body report, the united states – standards for reformulated and conventional gasoline, at 18. nordic journal of commercial law issue 2010#1 13 whether a provision of the “covered agreements” has been violated.58 furthermore, in their decisions the panels “cannot add to or diminish the rights and obligations provided in the covered agreements” either.59 hence, the panels lack competence to reach a legal conclusion on violation or compliance with other treaties or customs, such as human rights norms. they cannot enforce or give effect to human rights provisions in a way that would add to or diminish wto rights and obligations either.60 however, this limited domain of the wto does not mean that the wto agreement exists in a “hermetically sealed system, closed off from general international law and human rights law”.61 a distinction should be made between its jurisdiction and the applicable law: the limited jurisdiction of the panels does not limit the scope of law they may apply.62 the binding nature of the rules of general international law in the wto is explicitly confirmed in article 3.2. of the dispute settlement understanding (“dsu”). accordingly, the wto covered agreements must be clarified “in accordance with customary rules of interpretation of public international law”. wto panels and the appellate body have in their decisions explicitly recognized the role of articles 31 and 32 of the vienna convention on the law of treaties (“vclt”) with respect to article 3.2. of the dsu. the provisions are generally accepted as embodying customary international law.63 therefore, even though not all wto members are parties to the vclt, to the extent that these provisions reflect customary international law, they are binding on all members.64 in the following, the content of article 31 of the vclt is illuminated so as to explain why the right to access to medicines should be considered in the interpretation of the trips provisions. it should be noted that each wto member has the right to make exceptions to pharmaceutical patents in consistency with articles 30 and 31 of the trips agreement as well as the medicines decision despite their general obligation to protect intellectual property rights. thus, making exceptions to intellectual property protection in order to ensure access to medicines would not as such “add to or 58 according to article 1.1 of the dsu, the dsu only applies to disputes brought pursuant to the consultation and dispute settlement provisions of the “covered agreements”. article 23(1) of the dsu also refers only to ”covered agreements”: “when members seek the redress of a violation of obligations or other nullification or impairment of benefits under the covered agreements or an impediment to the attainment of any objective of the covered agreements, they shall have recourse to, and abide by, the rules and procedures of this understanding.” 59 the dsu, articles 3(2) and 19(2). 60 marceau 2002, p. 762–763; pauwelyn 2001, p. 554. petersmann has suggested de lege ferenda the enforcement of human rights through wto dispute settlement system in order to exploit its strong enforcement mechanism. his suggestion, however, has faced strong opposition. see petersmann 2002 and alston 2002. 61 marceau 2002, p. 779. 62 pauwelyn 2001, p. 554–566; koskenniemi 2006, paras. 44–45. 63 wto appellate body report, the united states – standards for reformulated and conventional gasoline at 16; lindroos & mehling 2006, p. 867. 64 mitchell 2007, p. 807–808. nordic journal of commercial law issue 2010#1 14 diminish the rights and obligations provided in the covered agreements” – something that the panels would be prohibited from doing by virtue of articles 3(2) and 19(2) of the dsu. in accordance with article 31(1) of the vclt, a treaty shall be interpreted in good faith and in the light of its object and purpose. pursuant to article 7 of the trips agreement, the object of the agreement is to promote technological innovation “in a manner conducive to social and economic welfare, and to balance of rights and obligations”. article 8 of the trips agreement, in turn, explicitly grants all states a right to adopt policies that promote public health as long as they are consistent with the agreement. good faith interpretation of the agreement in the light of these articles would surely lead to a decision that adequately considers the right to access to medicines. pursuant to article 31(3)(b) of the vclt, any subsequent practice between the parties to an agreement regarding its interpretation must also be considered when interpreting the treaty.65 thus, the doha declaration holds relevance in the interpretation of the trips agreement. it is a common, unanimous statement of all wto members regarding the interpretation of the trips agreement and, as such, must be considered as a subsequent practice. in paragraphs 1 and 2 of the declaration, wto members stress the need for the trips agreement to be part of an international action addressing public health problems affecting many developing countries. in paragraph 4, they agree that the trips agreement does not and should not prevent wto members from taking measures to protect public health – instead, the agreement can and should be interpreted and implemented in a manner supportive of members’ right to protect public health and to promote access to medicines for all. moreover, wto members reaffirm in paragraph 5 that in applying the customary rules of interpretation of public international law, each provision of the trips agreement shall be read in the light of the object and purpose of the agreement as expressed in articles 7 and 8. in many respects, the doha declaration repeats the contents of the trips agreement and restates matters that should have been considered in the interpretation of the treaty by virtue of the dsu already prior to the adoption of the declaration. the declaration has, in fact, been called “a politically convenient overstatement that turns blind eye to the principles of treaty interpretation”66. nevertheless, as the juggling act between the rights of patent holders and the public interest is far from simple, the doha declaration brings an end to any possible speculation on the significance of public health needs in the application of the trips agreement. it should be considered an authoritative interpretation of the agreement, granting wto members an indisputable right to make exceptions to patent rights in order to realize an 65 article 31(3) of the vclt:”there shall be taken into account, together with the context: (a) any subsequent agreement between the parties regarding the interpretation of the treaty or the application of its provisions; (b) any subsequent practice in the application of the treaty which establishes the agreement of the parties regarding its interpretation; (c) any relevant rules of international law applicable in the relations between the parties.” 66 frankel 2006, p. 390. nordic journal of commercial law issue 2010#1 15 individual’s right to access to medicines. as such, it manifests the common will of the wto and its members to ensure coherence between the right to access to medicines and the trips agreement. in accordance with article 31(3)(c) of the vclt, any relevant rules of international law applicable between the parties must also be taken into account when interpreting a treaty. the words cover all sources of international law, including custom, general principles and, where applicable, other treaties.67 the overall aim of the article is to promote coherence in international law: all treaties should be interpreted in good faith so as to avoid conflicts, taking into consideration all relevant rules between the parties.68 accordingly, also wto panels must consider all rules of international law that hold relevance in a given case. general international law has been frequently considered by the dsb and the appellate body and its applicability to dispute settlement in the wto is generally accepted69. it was affirmed e.g. in korea – measures affecting government procurement. the panel took note to the content of article 3.2. of the dsu and went on to state that “the relationship of the wto agreements to customary international law is broader than this. customary international law applies generally to the economic relations between wto members. such international law applies to the extent that the wto treaty agreements do not ‘contract out’ from them. to put in another way, to the extent there is no conflict or inconsistency, or an expression in a covered wto agreement that implies differently, we are of the view that the customary rules of international law apply to the wto treaties and the process of treaty formation under the wto”70. in the absence of any “contracting-out”, the right to access to medicines as a customary norm should therefore also be considered when interpreting trips provisions relating to pharmaceutical patents. in addition to customary law, the wto dispute settlement bodies have referred to rules derived from other treaties in numerous cases.71 in article 31(3)(c) of the vclt, reference is made to “any relevant rules of international law applicable in the relations between the parties” (emphasis here). the question of which treaties can be used to interpret wto obligations arises. a 67 koskenniemi 2006, para. 426(b). . 68 marceau 2002, p. 785–786; marceau 2001, p. 1089. koskenniemi refers to the principle of systemic integration, according to which article 31(3)(c) of the vclt requires the “integration into the process of legal reasoning – including reasoning by courts and tribunals – of a sense of coherence and meaningfulness.” see koskenniemi 2006, paras. 410–423. 69 for a closer examination on the application of rules of general international law in the practice of the appellate body, see pauwelyn 2003, p. 268–274. 70 wto panel report, korea – measures affecting government procurement, para.7.96 (19 june 2000). the decision was not appealed. in addition, lindroos and mehling also point out in their study that the wto dispute settlement organs have repeatedly relied on decisions of other international tribunals, including the icj, the european court of human rights and the inter-american court of human rights as well as on the work of the international law commission (lindroos & mehling 2006, p. 871–873). 71 lindroos & mehling 2006, p. 865. nordic journal of commercial law issue 2010#1 16 narrow interpretation would require identical membership between the non-wto treaty and the wto-treaty. this, however, has several shortcomings. it would, inter alia, strongly limit the use of other international treaties by virtue of article 31(3)(c) of the vclt since identical memberships are rare in today’s world. as wto membership grows, fewer international agreements will match its membership. hence, a requirement of identical membership would lead to a paradoxical result that the wto would on some level become more and more isolated from the system of international law as the amount of its members increases. in addition, the appellate body seems to have adopted an approach that does not require identical membership: in the united states – shrimp, it examined provisions of the convention on international trade in endangered species and several other environmental agreements that did not have identical membership with the wto in order to define the term “exhaustible natural resources”. the requirement of identical membership therefore seems to be unnecessary. an alternative approach would be to allow the use of treaties with potentially universal membership or to allow the use of norms that are not strictly binding on most states but nevertheless reflect the common intention of wto members by being agreed to or tolerated. on the whole, it seems that the treaty provision in question must be of relevance for the international community. the membership, however, is no guarantee of its authentic relevance.72 considering the nearly universal membership of the icescr (see above) and the wide coverage of other human rights agreements and the relevance of the norms contained by these agreements for everyone, there is little doubt of the ability of wto panels to consider the right to access to medicines as formulated in the icescr when interpreting the scope of the patent protection granted for pharmaceuticals in the trips agreement. finally, the pacta sunt servanda principle requires that “every treaty in force is binding upon the parties to it and must be performed by them in good faith”, as stated in article 26 of the vclt. states cannot contract out from this principle by establishing a new regime.73 even though human rights law cannot be given direct effect within the wto, the adjudicating bodies of the organization must presume that wto members comply with their human rights obligations just as they are expected to do with all their international obligations at all times. the wto law must thus be applied in good faith and in harmony with human rights law.74 any other kind of conclusion would essentially transform the organization into a “safe haven” for all wto members seeking to backtrack on obligations entered into elsewhere. to conclude, wto norms should be interpreted in consistency with general international law – a matter that is clearly manifested in the dsu. the panels have also adopted a clear approach to dispute settlement, signaling that the organization can hardly be considered a self-contained 72 marceau 2002, p. 780–782. 73 koskenniemi 2006, para. 176 (noting that it would only be possible if the regime was meant to create no obligations at all). see also pauwelyn 2003, p. 37 where he presents that states cannot contract out of the system of international law due to the principle of pacta sunt servanda that could be considered a part of the jus cogens. 74 marceau 2002, p. 786. nordic journal of commercial law issue 2010#1 17 regime, isolated from international law75. further, the doha declaration should be considered a manifestation of the common will of wto members to maintain coherence between the right to access to medicines and exclusive rights covering pharmaceutical products. despite the incompetence of the panels to enforce the right to access to medicines or to allow it to supersede and set aside a wto provision, the access norm must be considered in the interpretation of the trips norms. all in all, it has become clear above that wto law does not operate in isolation from other rules of international law. as lindroos and mehling note, “the chimera of ‘self-contained regime’ remains a phantom with no legal basis in international law, a notion which, despite its persistent appearance in jurisprudential debate, is best confined to the lively world of myth and debate”76. 2.3. facilitating coherence: definition of conflict of norms interpreting trips norms harmoniously with the pre-existing human rights norms is also in line with the principle of presumption against conflict, a widely accepted principle of treaty interpretation that allows for avoidance of conflicts. accordingly, every new norm of international law, alike with norms of national legislation, is created within the context of preexisting regulation. there is a presumption that this new norm builds upon and further develops existing law77. in other words, the strong presumption against normative conflict in international law appears as “the thumb-rule that when creating new obligations, states are assumed not to derogate from their obligations”78. consequently, any deviation from existing law must be made in explicit language. when faced with two possible interpretations, the one that allows for harmonization of the two norms – and hence avoids conflict – ought to be preferred79. wto members have not contracted out of the access norm: the trips agreement is silent on the issue. therefore, based on matters presented above, the trips agreement can well be interpreted in consistency with human rights norms. it would consequently be tempting to conclude that no normative conflict exists between the right to access to medicines and pharmaceutical patents. nonetheless, one must first define what constitutes a “normative conflict” in order to see if reconciliation of the norms through interpretation is possible – namely, the presumption against conflict simply requires that an effort is made to interpret a new norm (here, a trips-norm) in harmony with the existing law (here, the access norm) and that this kind of interpretation is feasible. if reconciliation between the two norms is not 75 lindroos & mehlig 2006, p. 875. 76 ibid., p. 877. 77 pauwelyn 2003, p. 240. 78 koskenniemi 2006, paras. 37–38. 79 pauwelyn 2003, p. 240–241. nordic journal of commercial law issue 2010#1 18 feasible, that is where the presumption ends.80 therefore, if it turns out that the trips agreement is in a normative conflict with the right to access to medicines, the norms can no longer be interpreted harmoniously as this would mean that the conflict would be solved in favour of the earlier rule (i.e. the access norm). one would, instead, need to resort to rules of conflict resolution. most norms of international law can be divided into obligations and rights. they can be further divided into four categories: norms obligating states to do something (commands), norms obligating states not to do something (prohibitions), norms granting states a right not to do something (exemptions) and, finally, norms granting states a right to do something (permissions).81 these categories apply both to human rights norms, on the one hand, and the trips norms, on the other. for states, the right to access to medicines constitutes both a command (obligation to respect, protect, fulfill and cooperate) and a prohibition (prohibition of retrogressive measures). the trips agreements similarly contains norms obligating (obligation to grant pharmaceutical patents) and prohibiting (prohibition of discrimination) states. however, these trips commands and prohibitions are accompanied by flexibilities that are either permissions (e.g. articles 30 and 31 examined above) or exemptions (e.g. rights of least-developed country members not to enforce patents during the transitional periods, right to exclude certain subjects of patentability). conflict of norms in the strict sense can be defined as a situation in which “party to the two treaties cannot simultaneously comply with its obligations under both treaties”. 82 this narrow definition of conflict has been followed also in the wto jurisprudence. in indonesia – autos, the panel stated that “in international law for a conflict to exist between two treaties [....] [their] provisions must conflict, in the sense that the provisions must impose mutually exclusive obligations [...]. technically speaking, there is conflict when two (or more) treaty instruments contain obligations which cannot be complied with simultaneously”83. the appellate body has subsequently defined conflict as a situation “where adherence to the one provision will lead to a violation of the other”84. in accordance with the narrow definition of conflict, we have above arrived at a situation where no normative conflict exists between the right to access to medicines and pharmaceutical patents. although the trips agreement obligates wto members to provide exclusive rights for pharmaceutical inventions, it also exempts them from 80 ibid., p. 242–244; koskenniemi 2006, para. 42. koskenniemi notes that there are no normative conflicts whose intrinsic nature makes them unsuitable for harmonization – anything can be harmonized as long as the will to harmonization is present between the parties. however, if this will is not present, harmonization of the competing norms is no longer possible. 81 pauwelyn 2003, p. 159. 82 jenks 1953, p. 426. 83 wto panel report, indonesia certain measures affecting the automobile industry, para. 14.28, footnote 649. 84 wto appellate body report, guatemala anti-dumbing investigation regarding portland cement from mexico (1998), para. 65. nordic journal of commercial law issue 2010#1 19 certain obligations related to their enforcement and permits them to take necessary measures in order to protect public health. the right to access to medicines, in turn, prohibits states from taking retrogressive measures and commands them to exploit the flexibilities of the trips agreement when necessary for the protection of the right. wto members can thus comply with both agreements simultaneously by exploiting trips flexibilities and no conflict of norms arises. nonetheless, in order to comply with its human rights obligations, they no longer have a mere permission to execute exceptions to patents. instead, it has an obligation to do so if the trips agreement is to comply with the access norm. what used to be a may has now turned into a must85. exemptions and permissions have thus lost an integral part of their essence since wto members are now obligated to exploit these norms. this constitutes a “contradictory conflict” since both norms cannot be fully applied at the same time – a situation which is recognized as a conflict of norms in prevailing legal theory86. a wider definition of normative conflict has recently been supported by several scholars. it seems to lead to a requirement of complete harmony between international norms that can be considered cumulative, i.e. falling outside conflict. a mere possibility of inconsistency between divergent norms breaks this harmony. according to pauwelyn, norms of international law conflict if they cannot be “applied together and without contradiction at all times”87. he defines conflict of norms as a relationship between two norms where “one norm constitutes, has led to or may lead to a breach of the other”88. hestermeyer, albeit admitting that wto law is not in systemic conflict (i.e. conflict between principles or goals rather than mere norms) with the human rights regime, has also assumed a broad definition of normative conflict. he concludes that the trips agreement conflicts with the right to access to medicines since a permission to exploit trips flexibilities has now turned into an obligation to do so89. even though genuine conflicts cannot be “interpreted away”, conflict resolution and interpretation should not be completely distinguished from each other as rules always appear to be compatible or conflicting as a result of interpretation90. therefore, before it is possible to establish whether trips norms are in normative conflict with the right to access to medicines, the norms should be placed in their context. the main objective of any treaty interpretation is to identify the intention of the parties. taking in to consideration articles 7 and 8 of the trips agreement, it is evident that efforts have been made for maintaining balance. further, it 85 hestermeyer 2007, p. 176. 86 vranes 2006, p. 409. vranes (p. 415) suggests the following definition of conflict: “there is a conflict between two norms, one of which may be permissive, if in obeying or applying one norm, the other one is necessarily or possibly violated.“ 87 pauwelyn 2003, p. 161. 88 pauwelyn 2003, p. 175 ff. 89 hestermeyer 2007, p. 174–181. 90 koskenniemi 2006, para. 412. nordic journal of commercial law issue 2010#1 20 has been established above that the right to access to medicines must be considered in the interpretation of the trips agreement by virtue of the dsu, where reference is made to the vclt. the doha declaration also reaffirms that the agreement should not hinder access to medicines. if norms granting exclusive rights would nonetheless be considered to conflict with the right to access to medicines on theoretical grounds and since the regimes in question have divergent objectives, these efforts for maintaining coherence through interpretation would be nullified. a closer examination of the overall aim of the vclt to promote coherence in international law and the presumption against conflict reveals the inherent striving for coherence in international law that can be attained through harmonious interpretation of divergent norms. states are presumed to perform all their international obligations in good faith pursuant to the pacta sunt servanda principle. it can consequently be presumed that states have also negotiated all their treaties in good faith, taking into account their existing obligations. in the absence of any evidence to the contrary, all states’ obligations must be considered cumulative and should be read together91. it can be assumed that permissive norms have throughout time been included in treaties as well as domestic laws in order to allow for accumulation of norms and consistency between existing obligations and the new regulation. similarly, norms permitting exceptions and norms exempting wto members from certain obligations of the trips agreement are aimed at maintaining unity between the pre-existing human rights obligations of states and the new intellectual property regulation. if, however, wide definition of conflict of norms is assumed, relationships between various sets of norms that were previously considered consistent with each other would most likely turn out conflicting. interpreting these divergent norms so as to render them compatible would become even more difficult and these “subsystems” could no longer coexist without the means of conflict resolution. this kind of conclusion would be contrary to the striving for coherence in international law and be especially detrimental in times of fragmentation of the international community and international relations. to conclude, there is little reason to support a wide definition of conflict of norms in the present context. instead, one must allow interplay between the norms examined. as formulated by marceau, “if one believes that international commitments should be understood in the light of some coherent international legal order, one favors narrow definitions of conflicts, interpretations and applications of opposing norms that promote their harmonization”92. coherence between the trips agreement and the right to access to medicines can be maintained as long as conflict is defined in accordance with the traditional view: as a situation where a state cannot simultaneously meet its obligations derived from two distinct norms. since the permissive norms of the trips agreement ensure that wto members can still 91 marceau 2001, p. 1084, 1089. 92 marceau 2001, p. 1082–1083. nordic journal of commercial law issue 2010#1 21 comply with obligatory norms enshrining access to medicines, no conflict exists between the norms examined. the often alleged incoherence between them has thus proven to be an illusion. since no normative conflict exists between the right to access to medicines and the trips agreement, the norms can and should be interpreted harmoniously in order to avoid conflict, in accordance with the presumption against conflict. wto members have an obligation to ensure access to medicines, as outlined above, and the trips obligations must be interpreted accordingly. this requirement leads one to assume a human rights approach to the implementation of intellectual property regulation, meaning that human rights are employed as a guiding principle to the implementation and enforcement of exclusive rights93. it should be emphasized that a human rights approach to the implementation of these rights does not, however, mean that interpretation would be used to solve a conflict in favor of the relevant human right, i.e. it should not lead to de facto disregarding of exclusive rights. instead, it must preserve the viability of both sets of norms under examination. a model for this kind of implementation of the medicines decision – a permissive trips norm of key importance – is provided in the following. iii. establishing coherence: a human rights approach to the implementation of the medicines decision 3.1. in search of a golden mean the medicines decision – a result of the negotiations that followed the adoption of the doha declaration – forms an integral part of compulsory licensing as a means to ensure that the trips agreement does not hinder access to medicines. the aim of the decision is to ensure that the trips agreement does not hinder the right of wto members to adopt necessary measures for the protection of public health, as stated in paragraph 4 of the doha declaration. in the following, i will explore the practical implications of the right to access to medicines in the harmonious interpretation of the decision. as eide put it, “what counts, in the end, is whether human rights are realized in practice – whether the standards and institutions serve to bring about the changes which are required in order to make it possible for all to enjoy all human rights” 94. nothing in the trips agreement obligates wto members to implement the medicines decision in a manner that best considers the right to access to medicines – the access norm, however, does. nevertheless, as mentioned above, a human rights approach to the 93 see haracoglou 2008, p. 90–93 on the right to health as an interpretative principle in patent law and report of the high commissioner of the commission on human rights: the impact of the agreement on trade-related aspects of intellectual property rights on human rights (2001). 94 eide 2001, p. 553. nordic journal of commercial law issue 2010#1 22 implementation of the medicines decision should not undermine the integrity of the international patent system. the golden mean should, instead, be found in an implementation that ensures access to medicines in developing countries but simultaneously ensures that exclusive rights are adequately protected. representatives and proponents of the research based pharmaceutical industry often criticize exceptions to patent rights for strongly debilitating the position of right holders. exceptions to patent rights in the auspices of the medicines decision have similarly been claimed to be detrimental to research and development of new medicines needed in developing countries.95 these statements emerge from the raison d’être of patents which is to encourage innovations by rewarding the inventor with an exclusive right to exploit the invention for a predetermined period of time. if exceptions are repeatedly made to pharmaceutical patents covering medicines needed in developing countries, why would anyone contribute to their development as they will not receive any compensation for this work? this juxtaposition is inherent in the trips context. similarly, it was visible throughout the negotiations regarding the medicines decision.96 however, as pointed out above, today’s patent protection is not contributing to research and development of medicines needed in developing countries anyway – these countries are likely to benefit only when developed countries with purchasing power suffer from the same diseases.97 further, research based companies are not relying on the rents they receive from developing countries in their research budgets. some estimates suggest that only usd 1–1,5 billion per year of pharmaceutical budgets of companies based in the oecd may be dependent on developing country rents, while expenditures for research and development of these companies in 1995 were in the range of usd 25 billion and are substantially higher today.98 a study prepared for the british commission on intellectual property rights suggests that if developing countries gave no patent protection to pharmaceuticals at all, it would generate an aggregate loss of about one and a half billion dollars out of a total of usd 35 billion spent to research and development annually by the u.s. phrma companies. circa 90 percent of the revenues these companies received in 2001 came from sales in the united states, canada, western europe and japan, while 0,3 percent came from sales in africa.99 furthermore, research based companies spend on average only 15 percent of their revenues on research and development, while a much larger portion goes to administration and advertising (in developed countries).100 95 hoen 2006, p. 216. 96 see abbott [1] 2005 for a detailed presentation of the negotiations. 97 commission on intellectual property rights, innovation and public health 2006, p. 77; see footnote 47 above and the accompanying text. 98 abbott [1] 2005, p. 325 (note 58). 99 abbott [2] 2005, p. 420. 100 abbott [1] 2005, p. 325. nordic journal of commercial law issue 2010#1 23 all things considered, markets of developing countries currently hold minor significance for research based companies. exceptions to patents in the auspices of the medicines decision are thus unlikely to cause neither significant loss to right holders nor decrease research and development of medicines needed in developing countries. if re-diversion of medicines manufactured under compulsory licenses to the markets of developed countries is prevented, status quo of the research based industry in the pharmaceutical markets is preserved. a strict distinction must thus be made between patent protection in developed countries, on the one hand, and developing countries, on the other. 3.2. compulsory licensing under article 31 of the trips agreement article 31 of the trips agreement (“other use without authorization of the right holder”) regulates the use of compulsory licenses. the provision comprehends use by a government or a third party authorized by the government. as mentioned above, the trips agreement does not set any specific grounds based on which compulsory licenses can be granted as long as the conditions set forth in article 31 are followed. the medicines decision waives obligations set forth in paragraphs (f) and (h) of the provision which means that wto members are still obligated to follow most of the conditions set forth in the provision.101 they are, inter alia, obligated to provide for judicial or another independent review by a higher authority on the legal validity of any decision related to unauthorized use of patents102. this means that right holders can still challenge the compliance of wto members with the requirements embodied in article 31. pursuant to article 31 of the trips agreement, each license has to be considered on its individual merits.103 efforts shall be made in order to obtain authorization from the right holder on reasonable terms and conditions, apart from cases of national emergency or other circumstances of extreme urgency. in case of a national emergency, the right holder must, 101 in situations where government claims that it has lost “an expected benefit” as a result of actions of another government, it can initiate proceedings within the dsb regardless if a specific article has been breached. the purpose of this is to ensure that governments hold on to the commitments they make during multilateral trade negotiations (see trips agreement article 64.2). these non-violation complaints are not applicable to disputes related to intellectual property rights. thus, in order to initiate proceeding within the dsb, a wto member must address a specific provision of the agreement that the respondent has allegedly breached. currently non-violation complaints have been excluded by a moratorium while wto members are searching for a permanent solution that would be acceptable to all parties. see e.g. implementation-related issues and concerns, decision of 14 november 2001, para 11.1.; doha work programme, ministerial declaration of 18 december 2005, paragraph 45. most countries are in favour of excluding matters related to intellectual property from the possibility of non-violation complaints altogether; others, e.g. the united states and switzerland, claim that they are necessary in order to prevent wto members from getting around their trips commitments (sun 2004 p.142–143). 102 trips agreement, article 31(i). 103 trips agreement, article 31(a). nordic journal of commercial law issue 2010#1 24 regardless, be notified as soon as possible after the unauthorized use.104 the use of the patent shall be non-exclusive and non-assignable.105 the scope and duration of the license must be limited to meet the purposes for which it was granted: it must be terminated when the circumstances that lead to its issuance cease to exist. legitimate interests of licensees must nonetheless be protected: wto members shall guarantee that they also have access to justice on the basis of the relevant decision.106 patent holders are entitled to adequate remuneration pursuant to paragraph (h) of article 31. in accordance with the medicines decision, this remuneration will be paid in the exporting wto member (see below). any decision relating to the amount of remuneration must also be subject to judicial or other independent review in that member.107 the most crucial condition set forth in article 31 of the trips agreement is the requirement that compulsory licenses shall be granted “predominantly for the supply of domestic markets”.108 the provision limits the opportunities of developing countries with no local manufacturing capacity to utilize the mechanism. wto members are eligible for importing pharmaceuticals under compulsory licenses. this, however, is not possible from another member that has granted the medicine a patent, unless the exporting country has manufactured the product under a compulsory license for its national demands to a larger extent.109 only few countries, e.g. india, brazil and south-africa, possess manufacturing capacity of generic medicines that could suffice to export. in order to be eligible as exporters, they would first have to issue a compulsory license “predominantly for the supply of domestic markets” pursuant to article 31(f). then, they would be allowed to export a part of the amount manufactured under the license to other countries in need. the limitations entailed by the provision are obvious. another way to import generic medicines would be to import them from a non-wto country 104 trips agreement, article 31(b). in accordance with paragraph 5(c) of the doha declaration, each wto member has the right to determine which circumstances qualify as a national emergency. prior request is neither required for public non-commercial use nor in situations where licenses are granted to remedy anti-competitive practices (trips agreement, article 31[b], [k]). 105 trips agreement, article 31(d), (e). 106 trips agreement, article 31(c), (g). 107 trips agreement, article 31(j). pursuant to article 31(k), the obligation to pay adequate remuneration does not apply to cases where the license has been issued to remedy anti-competitive measures. durojaye has even suggested the use of article 31(k) and rules concerning anti-competitive measures as an alternative for the medicines decision. this would waive some of the essential conditions set forth on article 31. however, it would also require interpreting pharmaceutical patents and a refusal to license as anti-competitive measures which exposes said suggestion to criticism. see durojaye 2008, p. 30 ff. 108 trips agreement, article 31(f). according to paragraph (k) of article 31, said condition does not concern situations whereby licenses have been issued to remedy for anti-competitive practices either. 109 it is noteworthy, however, that some developed countries allow exceptions to patents without the limitation imposed by article 31(f); e.g. patent acts of australia and new zealand allow exports under an agreement with a foreign country to supply products required for the defence of that country (correa 2002, p. 27). nordic journal of commercial law issue 2010#1 25 that has not enforced patents for the product in question or where the term has expired110. in any case, finding a non-wto country that possesses sufficient manufacturing capacity for exporting medicines remains a mere theoretical possibility. the end of transitional period initially granted for developing countries highlighted the problem embodied in paragraph (f) of article 31. india, for example, has been the most influential supplier of generic medicines for many developing countries. its pharmaceutical industry is producing generic aids medicines for a half of the 700,000 hiv patients taking antiretroviral medicines in developing countries, at five percent of the price that pharmaceutical firms based in europe or the united states charge for the same product111. india has managed to develop an extensive industry that produces generic medicines by not enforcing patents on pharmaceutical products and only allowing patents on manufacturing processes. this kind of policy encourages the search for cheaper and cheaper processes for the manufacture of pharmaceutical compounds112. other wto members have previously been able to import medicines from india; in case the product in question would have been patented in their territory, they could have issued a compulsory license in accordance with article 31. medicinal products developed after january 2005 are, however, subject to patenting also in developing countries, including india113. due to the requirement that the generic medicines were intended “predominantly for the supply of domestic markets”, the end of the transitional period meant that it became difficult to obtain affordable versions of newly developed medicines.114 by failing to pay due attention to the needs of developing countries, article 31 fails to redeem the promise of leaving all wto members enough room to adopt necessary measures in order to protect public health despite newly introduced intellectual property regulation. these deficiencies are addressed by the medicines decision. several scholars have criticized the decision for not being faithful to the spirit of doha; civil society groups and activists have 110 correa 2004, p. 20. 111 yalamanchili 2007, p. 211. 112 finland is also among the countries that did not enforce product patents on pharmaceuticals before the entry into force of the trips agreement. said policy has resulted in a myriad of ongoing litigations between generic manufacturers and the holders of the original, so-called analogous process patents where the crux of the dispute is the scope of protection of these patents. 113 see articles 65.4; 70.8; 70.9 of the trips agreement. the end of transitional periods also meant that countries such as india started processing patent applications collected in its “mailbox” since january 1995. these medicines will be granted protection for the remainder of the 20-year term of filing date of the mailbox application. hitherto, however, the processing has been slow and india has allowed the generic producers to continue supplying medicines already in production in january 2005 under certain conditions, e.g. upon payment of a reasonable royalty (abbott & reichman 2007, p. 945). 114 furthermore, paragraph (f) is discriminatory against wto members with smaller markets. in countries such as india, the uk or the united states, it is economically profitable to produce medicines under a compulsory license due to the large amount of potential consumers in the national markets. for members with small sized domestic target groups, it is rather difficult to establish economically viable production if the product has to be “predominantly” sold in the domestic market of the licensee (correa 2002, p.19). nordic journal of commercial law issue 2010#1 26 described the medicines decision as a “gift bound in red tape”115. the question is: does the medicines decision and its implementation comply with the objective set forth in the doha declaration, i.e. does it secure the ability of countries with no manufacturing capacity to make effective use of compulsory licensing under the trips agreement for the protection of public health and access to medicines? 3.3. exporting under compulsory licenses: unnecessary red tape? one of the controversies raised during the negotiations that followed the adoption of the doha declaration related to the question of which trips provision the future decision should base on. different alternatives, such as temporary solutions in which permission to manufacture medicines would be granted in individual cases, were presented. an alternative strongly advocated by ngos and human rights organs was a system in which relevant exceptions would be legitimized under article 30 of the trips agreement that allows for limited exceptions to patent rights.116 however, the final system builds on article 31 of the trips agreement and is, as described below, a rather complex system. in order to initiate the procedure defined in the medicines decision, the importing country must make a notification to the trips council in which names and expected quantities of the products needed are specified. in case the importing wto member is not a least-developed country117, it has to confirm in the notification that it has insufficient manufacturing capacities. this is a matter of self-assessment and the results cannot be challenged by any of the members118. the importing country also has to confirm that it has granted or intends to grant a compulsory license to the pharmaceutical product patented in its territory in accordance with 115 durojaye 2008, p. 53–54. 116 the representative of the who, for example, reminded the trips council in its meeting in september 2002 that the basic public health principle being followed in the solution to be found was that the people of a country that did not have the manufacturing capacity to produce a needed product should be no less protected by compulsory licenses and other provisions and safeguards in the trips agreement, nor face greater procedural hurdles in comparison to the people of a country capable of producing the product. accordingly, the solution most consistent with this principle would have been the provision of a limited exception under article 30 (council for trips, minutes of meeting held in september 2002, para. 5). see also e.g. msf: why article 30 will work. why article 31 will not (24 june 2002) and msf, oxfam, cptech, health gap, third world network, & essential action, joint letter to members of trips council (28 january 2002). 117 least-developed countries are defined by the un committee for development policy based on their gross national income per capita, human asset index and economic vulnerability index. for further information, see http://www.un.org/esa/policy/devplan/profile/criteria.html (last visited 18.1.2008). 118 correa 2004, p. 17, 29. once it is established that such capacity has become sufficient to meet its needs, the system created by the medicines decision no longer applies. this is also assessed by the member itself (see annex of the decision). in the chairperson’s statement accompanying the medicines decision, members are urged to provide information in the notification on how the establishment has been rendered. all notifications are brought to the attention of the trips council (see general council chairperson’s statement, 13 november 2003, para. 5). nordic journal of commercial law issue 2010#1 27 article 31 of the trips agreement. the medicines decision waives its obligation to pay remuneration – the compensation is paid in the exporting wto member119. all other conditions set forth in article 31 remain valid. due to the extension of the transitional periods120, least-developed country members may regardless be excluded from obligations related to compulsory licensing. this follows from a possible decision by a government to refrain from offering legal protection to pharmaceutical patents.121 national legislation and article 31 of the trips agreement, apart from paragraph (f), determine the course of proceedings also in the exporting country. this means that the interested supplier first has to ask for a voluntary license in accordance with article 31(b). it can be argued that the exporting wto member is entitled to consider the situation in the importing country as an emergency or to recognize its public non-commercial use; then, it is possible to accelerate the process by ignoring this step122. the duration of the license is determined by the government of the exporting country. pursuant to article 31(g), legitimate interests of the licensees must be adequately considered. thus, the duration of the license should allow enough time to recoup production costs. according to paragraph 3 of the medicines decision, adequate remuneration pursuant to article 31(h) of the trips agreement shall also be paid in the exporting wto member, taking into account the economic value of the unauthorized use to the importing state. the generic company will thus compensate the use of the patent to the right holder. the competent national authority is responsible for determining the appropriate amount of compensation. the exporting state is only allowed to grant a license for the manufacture of the amount needed by the eligible importing country123. thus, the importing member must establish its exact needs when making the final agreement with the license holder. prevention of re-exportation is of crucial significance for the protection of patent rights. parallel imports of generic medicines manufactured under the system are thus not allowed. all wto members must take reasonable measures in order to prevent re-exportation of these medicines.124 the requirement of identifying the products produced under the system set out in the medicines decision also enhances the prevention of re-exportation: suppliers must distinguish such products through special packaging, shaping or colouring of the original product. such a distinction is to be feasible and have no significant impact on price. it applies to both formulated pharmaceuticals and active ingredients produced and supplied under the system. finished products using such active ingredients are also covered by this obligation: in 119 the medicines decision, para. 3. 120 see footnote 16 above. 121 the medicines decision, para. 2(a). 122 correa 2004, p. 19, 21. 123 the medicines decision, para. 2 (b)(i). 124 the medicines decision, paras. 4 and 5. nordic journal of commercial law issue 2010#1 28 case developing countries manufacture generic medicines locally, they have to make these products identifiable.125 the final step of the procedure is that the licensee shall post technical information, i.e. the quantities of products supplied to each destination and the distinguishing features of these products, to a website before the shipment begins.126 similarly, the exporting wto member must notify the trips council of the grant of the license, including the conditions attached to it.127 pursuant to article 31(i) of the trips agreement, the legal validity of any decision relating to the authorization shall be subject to judicial review or other independent review by a higher authority in the involved wto member. this means that a patent holder has an opportunity to hamper the actions taken under the medicines decision in both countries involved – an opportunity that is well catered for under an article 31 based solution. the medicines decision has been called a complex system satiated with several administrative conditions to fulfil that hinder the effective implementation of the decision128. the legislation implementing the decision in canada, for example, has been criticized for permitting dilatory litigation as it grants the patent holder the right to petition for various reasons other than grounds related to the possible misuse of the system129. correa has noted that a patent owner may exploit the complex system and exercise its rights under relevant national laws so as to block all use of the patent – a situation which effectively transforms the application of the medicines decision into a conflict between the country demanding access and the patent owner unwilling to supply130. the question arises: are these administrative hurdles turning the medicines decision into an excessively complex system that protects the rights of patent holders at the expense of access to medicines in developing countries? 125the medicines decision, para. 2(b)(ii). in the general council chairperson’s statement accompanying the decision, “best practices” guidelines have been established (attachment to the statement). there, examples are given of policies companies have used in order to prevent diversion of products donated. correa has suggested that the obligation to distinguish is not absolute: if it would not be feasible or would have significant impact on price, it could not be required under the medicines decision (correa 2004, p. 23). however, distinguishing products is a part of a normal manufacturing procedure and as such it cannot be assumed to constitute an unreasonable burden for the generic manufacturer. 126 the medicines decision, para. 2(b)(iii). 127 the medicines decision, para. 2(c). 128 abbott & reichman 2007, p. 934; see also e.g. msf 2006: neither expeditious, nor solution: the wto august 30th decision is unworkable. 129 lazo 2007, p. 266. a license issued in canada may be terminated if e.g. the generic company fails to maintain or update the relevant webpage, fails to notify the relevant parties during the exporting process or fails to pay the remuneration in time (the jean chrétien pledge to africa, section 21.14). 129 correa 2007, p. 339. 130 ibid, p. 339. nordic journal of commercial law issue 2010#1 29 the obligation of all states to protect the right to access to medicines and the duty of third states should be considered here. accordingly, also wto members must ensure that third parties do not curtail the right to access to medicines. this obligation also extends to the implementation process of the medicines decision. as stated in the maastricht guidelines on violations of economic, social and cultural rights, contracting states themselves “are responsible for violations of economic, social and cultural rights that result from their failure to exercise due diligence in controlling the behaviour of such non-state actors”131. the legislation implementing the decision must thus ensure efficiency of the system. if it turned out that patent holders tried to abuse the system and prevent exportation of medicines manufactured under it, any laws enabling such behaviour should be amended in consistency with the human rights obligations of the states involved. one important practical matter is whether patent holders are provided with an opportunity to obtain an injunction against the execution of the license decision for the duration of the possible appellate procedure. if this is possible, right holders may have the means to hinder the procedure to an unreasonable extent. thus, when implementing the medicines decision, wto members should – in consistency with their obligation to protect and duty to cooperate – avoid any provisions that may lead to an unnecessary interference with the utilization of the decision. correa has also referred to the difficulties faced in the philippines. 120 applications for compulsory licenses were filed under the former philippine patent law, out of which 51 compulsory licenses were granted. the appellate procedure, however, hindered the execution of the licenses. the beneficiary companies were not able to market their product during this appellate procedure. the delay also caused the dismissal of 23 applications while 14 applications were dismissed due to a compromise agreement between the parties. 8 applications were dismissed because the patent expired while the procedure was still pending. up until 2003, only one compulsory license applied for during the old patent legislation had been executed – the application had been lodged in 1991 and the execution took place in december 2001.132 the fact that the medicines decision was achieved by amending article 31 of the trips agreement ensures that the rights of patent holders are adequately protected. it does not necessarily imply inefficiency of the decision – as long as wto members meet their obligation to protect access to medicines and draft their laws accordingly. it may also be that basing any exportation on article 31 better justifies the action in the eyes of patent holders and thus increases their willingness to cooperate under the system. finally, the medicines decision is without prejudice to other flexibilities wto members have under the trips agreement133. this means that e.g. exceptions allowed under article 30 still remain available. 131 maastrict guidelines, para. 18. 132 correa 2004, p. 7. 133 the medicines decision, para. 9. nordic journal of commercial law issue 2010#1 30 in the following, main issues of the medicines decision are tackled by using the implementing regulations of canada134 (“jean chrétien pledge to africa”), the ec135 (“ec regulation”) and switzerland136 (“gesetzesänderung”) as concrete examples of the policies wto members have adopted at national level.137 these members have implemented the decision and they also have the capacity to export medicines under the system established. in addition, some of the solutions proposed in the u.s. amendment (“life saving medicines export act”) will be used as examples even though the bill never became a law138. what are alternatives that should be chosen if wto members are to meet their obligations to respect, protect and fulfil the right to access to medicines? 3.4. eligible importing countries 3.4.1. treatment of wto members the first essential issue is which countries are eligible to use the system established by the medicines decision. paragraph 6 of the doha declaration was intended to solve the problems of wto members “with insufficient or no manufacturing capacities in the pharmaceutical sector”. defining eligible importer countries proved divisive. developing countries supported the definition given in the declaration, whereby determination of eligibility would be made case-specifically. the ec and the united states, in turn, were interested in limiting the amount of prospective importing countries. using national income as a determinant or creating a predetermined list of eligible importing countries based on the level of local production capacity were options suggested during the negotiations.139 under the medicines decision, only least-developed country members are automatically eligible for importing generic medicines. other wto members can notify the trips council if they intend to use the system. this is a precondition for being eligible to import generic medicines that have been manufactured under the system. the notification may be unqualified or it can 134 chapter 23 of the canadian patent act (bill c-9): an act to amed the patent act and the food and drugs act (the jean chrétien pledge to africa), assented to 14th of may 2004. 135 regulation (ec) no 816/2006 of the european parliament and the council of 17 may 2006 on compulsory licensing of patents relating to manufacture of pharmaceutical products for export to countries with public health problems. 136bundesgesetz vom 25. juni 1954 über die erfindungspatente (patent gesetz, patg), article 40(d), 40(e). 137 among other countries that have implemented the medicines decision are india, south-korea, norway and china. see consumer project on technology: http://www.cptech.org/ip/wto/p6/index.html (last visited 10.4.2010). 138 see the united states: the proposed life saving medicines export act (http://www.govtrack.us/ congress/bill.xpd?bill=s109-3175 [last visited 10.4.2010]). 139 abbott [1] 2005, p. 326–327. nordic journal of commercial law issue 2010#1 31 be limited to certain exceptional circumstances, such as national emergencies140. further, pursuant to article 2(a)(ii) of the medicines decision, other than least-developed country members must make a determination that they have insufficient or no manufacturing capacity in the pharmaceutical sector for the products in question once they have decided to import medicines under the system. the criteria for this determination are set out in the annex to the decision. the matter is in the discretion of the officials of the importing wto member141. manufacturing capacity covers both technical aspects (i.e. availability of technology, trained personnel, equipment, access to raw material etc.) and economic feasibility of production. the notification is declaratory, i.e. it does not have to be approved by a wto organ. the chairman’s statement accompanying the medicines decision encourages wto members to include in the notification the information on the methodology they have used for assessing their manufacturing capacity – this, however, has no legal impact on the actual content of the decision142. the implementing legislations of canada, the ec and switzerland, for example, all give the importing wto member the power to determine whether it qualifies for importing the medicine in question while least-developed country members are automatically considered eligible143. thus, no prior limitations have been set for the eligibility of a wto member to utilize the medicines decision. 3.4.2. treatment of non-wto-countries treatment of non-wto countries lacking sufficient manufacturing capacity is an issue not covered by the medicines decision. it can be argued that exporting medicines to a non-wto country constitutes a limited exception to patent rights and as such is allowed under article 30 of the trips agreement. however, the medicines decision is silent on the issue. requiring 140 the medicines decision, para. 1(b). 141 annex of the medicines decision, para. 2: ”for other eligible importing members insufficient or no manufacturing capacities for the product(s) in question may be established in either of the following ways: (i) the member in question has established that it has no manufacturing capacity in the pharmaceutical sector; or (ii) where the member has some manufacturing capacity in this sector, it has examined this capacity and found that, excluding any capacity owned or controlled by the patent owner, it is currently insufficient for the purposes of meeting its needs. when it is established that such capacity has become sufficient to meet the member’s needs, the system shall no longer apply.” 142 correa 2004, p. 17–18. it should be noted that several wto members notified the trips council that they will not use the system as importing countries and some made a statement that in case they would use it, it would only be in cases of national emergency or extreme urgency. practically, all oecd countries are not using the system as importing states, including all members of the ec (the medicines decision, para. 1 [b]). abbott has explained this as a factor that made the ec to concede to an approach that set no prior limitations for possible exporter countries. the ec was primarily concerned on the possible price erosion and low-priced imports in developed countries – along with the control mechanism and the statement that developed countries would not employ the system as importers, the rights of patent holders seem to be adequately taken into account (abbott [1] 2005, p. 329). 143 jean chrétien pledge to africa, section 21.04(3)(d)(iii); ec regulation, article 4; gesetzesänderung, article 40(d)(1). nordic journal of commercial law issue 2010#1 32 membership in the wto as a precondition for benefiting from the established system would, in any case, be unreasonable from a human rights perspective. in order to take steps towards the realization of universal access to patented medicines, all prospective exporting wto members should tackle this question when implementing the decision. membership in the wto has not been set as an absolute precondition for utilizing the medicines decision in the implementing legislations under examination144. certain restrictive conditions have nonetheless been set e.g. in the ec. the ec regulation defines all least-developed countries as eligible importers regardless of their membership in the wto.145 it yet sets a strict criterion for the eligibility of other non-wto countries: pursuant to article 4 (c), “any country that is not a member of the wto, but listed in the oecd development assistance committee’s list of low-income countries with a gross national product per capita of less than usd 745, and has made a notification to the commission of its intention to use the system as an importer, including whether it will use the system in whole or in a limited way”, is eligible to import medicines manufactured under the system. thus, the scope of eligible non-wto countries is strongly limited in europe where the initial wish to set a predetermined criteria for eligible countries based on national income seems to be held on to in relation to non-wto countries. this can be criticized for its possible negative effects on access to medicines in certain countries. for example, turkmenistan is eligible for official development assistance as it is listed by the oecd as a low middle income country with a per capita gross national income between usd 936 and usd 3 705.146 however, the country is not a member of the wto.147 it is thus not eligible to receive any medicines manufactured under compulsory licenses from the territory of the ec. surely, turkmenistan does not possess manufacturing capacity of generic medicines sufficient to secure access to medicines for its people. if the government of turkmenistan wanted to provide its population access to patented medication that otherwise is unaffordable, it would have to turn to other potential exporters as the members of the ec have excluded themselves from this kind of action. this situation is untenable from the perspective of the 144 in switzerland, eligible country is a country “das über keine oder ungenügende eigene herstellungskapazitäten auf pharmazeutischem gebiet verfügt und diese produkte zur bekämpfung von problemen der öffentlichen gesundheit benötigt, insbesondere im zusammenhang mit hiv/aids, tuberkulose, malaria und anderen epidemien”. only countries that have notified the trips council that they will not use the system or that they will only use it in extreme circumstances are excluded from eligibility (gesetzesänderung, articles 40[d][1] and 40[d][2]). 145 ec regulation, article 4(a). 146see oecd list of countries eligible for official development assistance, available at http://www.oecd.org/dataoecd/62/48/41655745.pdf (last visited 16.2.2010). 147 list of wto members available at http://www.wto.org/english/thewto_e/whatis_e/tif_e/org6_e.htm (last visited 16.2.2010). nordic journal of commercial law issue 2010#1 33 goals all ec members have accepted by being members of the united nations and parties to various human rights conventions.148 when implementing the medicines decision, wto members should not set restrictive conditions for potential importing countries based on their membership in the wto. all countries should have the right to utilize the medicines decision for the protection of access to medicines. needless to say, this entails obligations also: they should have a duty of preventing re-exportation of the medicines in accordance with the decision (see section 3.6.6. below). such duties can, however, easily be established through license agreements – thus, patent rights would be respected just as they are if the importer is a wto member. finally, article 30 of the trips agreement remains applicable and there are no clear reasons why a wto member could not export medicines to a non-wto country under the article149. 3.4.3. position of non-governmental organizations ngos and international organizations are responsible for the supply and distribution of pharmaceutical products in many developing countries that are short of working local governance. the medicines decision is silent on whether these organizations are entitled to request importation of patented medicines under the decision. however, in the implementing legislations of canada and the ec, other than governmental entities are also specifically mentioned. pursuant to the ec regulation, evidence of a specific request from the importer must be attached to the license application. a request made by a non-governmental organization or a un body or other international health organization acting with the formal authorization of the importing country qualifies for this purpose150. similarly, products manufactured in canada can be sold to a non-governmental entity authorized by the government of the importing country151. in the proposed u.s. amendment, non-governmental 148 in canada, for example, eligible countries are listed in different schedules based on their economic status and wto membership. schedule 4 includes non-wto countries that are eligible for official development assistance. the scope of eligible countries is hence rather wide considering that the oecd list of countries eligible for official development assistance includes upper middle income countries that had per capita gross national income of up to usd 11 455 dollars in 2007. 149 abbott & reichman 2007, p. 958. the authors refer to the resolution adopted by the european parliament on the trips agreement and access to medicines. in paragraph 10 of the resolution, the parliament “calls on the council to adopt a joint policy statement with parliament to the effect that wto members remain free to use all exceptions from the trips agreement under their domestic patent laws to authorise production and export to address public health needs in importing members (emphasis added) and asks the council to ensure that the commission refrains from taking action to interfere with these proceedings. 150 ec regulation, article 6(3)(f)(ii) and (iii). 151 jean chrétien pledge to africa, section 21.04(2)(f). the requirement of permission from the government of the importing country has been criticized in canada (elliot 2007, p. 53). nordic journal of commercial law issue 2010#1 34 agencies were referred to for supportive purposes which would have seemingly left them in a less independent position152. ngos should be encouraged to promote the use of the system established by the medicines decision in countries where they are largely responsible for the provision of medicines. they may often have more accurate information on how the system can best be utilized in these countries. they may also have more knowledge on the needs of the local population. some scholars have gone as far as claiming that generic companies should be permitted to enter into an importation agreement directly with ngos, provided that the ngo in question supplies medicines to the eligible importing country153. despite the advantages of this suggestion, it would be questionable to allow ngos to act independently of the government as only states have the ability to take measures needed for the prevention of re-exportation (e.g. custom clearance). therefore, in order for a country to be able to utilize the medicines decision, its government has to be willing to cooperate. this, in turn, is an obligation of every state for the realization of access to medicines. including non-governmental agencies in the legislation implementing the medicines decision for supporting purposes is nevertheless essential and represents an up-to-date view on the measures that are required for ensuring universal access to medicines – a mission that can only be completed through efficient cooperation between all stakeholders involved. 3.5. scope and coverage of products and diseases in paragraph 1 of the doha declaration, wto members “recognize the gravity of the public health problems afflicting many developing and least-developed countries, especially those resulting from hiv/aids, tuberculosis, malaria and other epidemics”. paragraph 4 refers to public health and access to medicines without any further qualifications while in paragraph 6, reference is made to “wto members with insufficient or no manufacturing capacities in the pharmaceutical sector”. even though no limitations are set in the declaration, some wto members presented that the future decision should be limited only to medicines used for the treatment of diseases specifically named in the declaration. for home countries of major research based pharmaceutical companies, this would have been a way to minimize the amount of revenues eroded.154 the united states insisted on limiting the applicability of the medicines decision to the diseases named in paragraph 1 of the doha declaration.155 similarly, the representative of australia claimed that the declaration clearly articulated the scope and coverage of the future decision. accordingly, the future decision should only cover medicines 152 life-saving medicines export act section 298(b)(1), section 298(c)(2)(f). 153 lazo 2007, p. 264. 154 for the different suggestions presented in the negotiations, see abbott [1] 2005, p. 327–334. 155 see e.g. council for trips, minutes of meeting held in november and december 2002, para. 34 (where the inability of the u.s. delegation to agree to the consensus reached on the scope of diseases is expressed). nordic journal of commercial law issue 2010#1 35 for the treatment of hiv/aids, tuberculosis, malaria and other epidemics. additional products like active ingredients or diagnostic kits should only be included in the agreed criteria if they were related to the diseases specifically mentioned156. limiting the scope of diseases seems incomprehensible – after all, diseases individuals in developing countries suffer from are not limited to those that can be classified as epidemics. non-communicable conditions such as cardiovascular disease, cancer, diabetes and respiratory and musculoskeletal diseases are major causes of death also in developing countries157. similarly, medicines on the who list on essential medicines are increasingly for the treatment of chronic diseases such as cancer and diabetes158. newer, more effective medicines for these conditions are and will be patented also in the future. in the light of the human right to health, it is impossible to justify why compulsory licenses should only apply to infectious diseases of epidemic nature. as pointed out by abbott and reichman, “there is no public health justification for denying access to treatment for certain diseases because trade officials have decided that some diseases should be on (or off) an official list”159. “pharmaceutical products” as defined in paragraph 1 of the medicines decision mean “any patented product, or product manufactured through a patented process, of the pharmaceutical sector needed to address the public health problems as recognized in paragraph 1 of the doha declaration”, including “active ingredients necessary for its manufacture and diagnostic kits needed for its use”. the word “especially” used in paragraph 1 of the doha declaration implies that diseases specifically named in the declaration are mere illustrations. no exhaustive list is presented in the declaration. thus, the medicines decision cannot be interpreted as limiting the scope of diseases either. it neither limits the use of the system to certain types of products nor makes its applicability dependent on their characterization as e.g. essential medicines. the decision may also be applied to a patent covering a pharmaceutical formulation or a process for its manufacture. vaccines are not specifically named in the decision but by using e contrario deduction, one can conclude that had the drafters wanted to exclude them, they would have explicitly done so – after all, vaccines are produced by the pharmaceutical industry and they are used to solve public health problems.160 all in all, no limiting conditions have been set in the medicines decision regarding the scope of products or diseases. 156 council for trips, minutes of meeting held in september 2002, para. 30. see also statement supporting this view by the representative of japan. the ec and the united states favored a term of “constructive ambiguity” in order to find a desirable solution to the problem by interpretation. ibid., paras. 15 and 44. 157 see world health report 2002, annex table 3. accordingly, 45,9 % of the total amount of deaths was due to noncommunicable conditions in 2001. 158 who: 10 facts on essential medicines (22 october 2007). 159 abbott & reichman 2007, p. 937. see also abbott [1] 2005 on the relevant negotiations. 160 correa 2004, p. 10–11. nordic journal of commercial law issue 2010#1 36 in consistency with the medicines decision, neither the ec nor switzerland has nationally limited the scope of pharmaceutical products or diseases the decision can be used for.161 canada, in turn, has limited the applicability of the decision to patented products that were on the who list of essential medicines and were patented in canada at the time of the adoption of the national amendment. the decision also applies to antiretroviral medicines that were then approved for sale in canada.162 these products are listed in the annex (schedule 1) to the national amendment.163 the governor in council may amend the list by removing or adding a medicine, a dosage form, strength or a route of administration of a medicine “that may be used to address public health problems afflicting many developing countries and least-developed countries, especially those resulting from hiv/aids, tuberculosis, malaria and other epidemics” on the recommendation of the minister of health who is assisted by an advisory committee.164 the canadian policy narrows down the applicability of the medicines decision and is problematic for at least two reasons. firstly, taking this kind of retrogressive measures in relation to the medicines decision violates the obligation also touching upon canada to ensure that its acts do not adversely impact on access to medicines in third states. as pointed out by richard elliot, “by introducing a limited list of products in its implementing legislation, canada, which had repeatedly indicated it would wait for a multilateral solution to be agreed at the wto, has unilaterally undermined that consensus”165. secondly, a lot of discretionary powers are given to national officials. it is clear that a great deal of lobbying takes place around leading politicians wherefore politicizing an essential issue such as the one at hand is at least questionable. to conclude, wto members should not introduce any limitations as to the scope and coverage of products and diseases in the implementing legislation – instead, the medicines decision should, as a starting point, apply to all pharmaceutical products needed to address public health problems. 161 in the ec, “pharmaceutical product” is defined as “any product of the pharmaceutical sector, including […] active ingredients and diagnostic kits ex vivo.” (ec regulation, article 2). in switzerland, reference is made to “pharmazeutisher producte […] zur bekämpfung von problemen der öffentlichen gesundheit benötigt, insbesondere im zusammenhang mit hiv/aids, tuberkulose, malaria und anderen epidemien” (gesetztsänderung, article 40d1). 162 elliot 2007, p. 47. 163 jean chrétien pledge to africa, section 21.02. 164 ibid., section 21.03 (a)(i). since the passage of the legislation, the list in schedule 1 has been amended twice in response to requests from generic manufacturers and ngos: in september 2005 to add a fixed-dose combination aids drug containing the antiretroviral drugs zidovudine (azt), lamivudine (3tc) and nevirapine (nvp) (a fixeddose combination of which was subsequently manufactured by generic producer apotex), and again in september 2006 to add the anti-influenza antiviral oseltamivir (marketed by the patentee under the brand-name tamiflu). in each case, what had been repeatedly represented as being a simple process, turned out to be slow and complex. in fact, it took months before the government acted in consequence of repeated urging by ngos and would-be manufacturers (elliot 2007, p. 49). 165 elliot 2007, p. 48. nordic journal of commercial law issue 2010#1 37 3.6. procedural issues 3.6.1. prior negotiations in accordance with article 31(b) of the trips agreement, the interested supplier first has to ask for a voluntary license. in canada, the ec and switzerland, prior negotiations are expected to take place at least 30 days prior to the filing of the application166. pursuant to the proposed u.s. amendment, request for a voluntary license was to be performed at least 60 days before the submission of the application167. interpreting this to constitute “a reasonable period of time” within the meaning of article 31(b) of the trips agreement seems unreasonable for its part: it practically means that a person is denied access to medicines while it is obvious that the additional 30 days will do little for the achievement of a voluntary license agreement between the patent holder and the generic producer. thus, the definition of “reasonable” should not exceed 30 days. as previously mentioned, the exporting wto member can be entitled to consider the situation in the importing country as an emergency or to recognize its public non-commercial use; then, it is possible to accelerate the process by passing the prior negotiations168. after all, the exportation takes place for the control of a health crisis in the recipient country, not in the exporting member. however, from the national amendments examined only the ec regulation specifically allows for this kind of interpretation169. further, evidence of efforts that have been made in order to obtain a voluntary license is to be attached to the application pursuant to all national implementing legislations under examination170. in the absence of a specific mention on the possibility not to perform a prior request, the patent holder may challenge the issuance of a compulsory license for violating the requirement set forth in article 31(b) if no prior negotiations have occurred within a set period of time. it is thus desirable to provide for an explicit opportunity in the national legislation to pass the prior negotiations in case of outbreaks of epidemics that require immediate action. 166 ec regulation, article 9 (1), jean chrétien pledge to africa, section 21.04(3)(c), gesetzesänderung, article 40e. 167 life-saving medicines export act, section 298(2)(f). 168 correa 2004, p. 19, 21. 169 ec regulation article 9 (2): “the requirement in paragraph 1 shall not apply in situations of national emergency or other circumstances of extreme urgency or in cases of public non-commercial use under article 31(b) of the trips agreement.” 170 during the process that lead to the adoption of the jean chrétien pledge to africa in canada, suggestions were made according to which the patent holder would have obtained a right to block the issuance of a compulsory license if it agreed to match the terms of the agreement between the importing country and the generic producer (elliot 2007, p. 43). this kind of provision would have been unreasonable for generic producers and unnecessary when considering that patent holders have the chance to voluntarily license their patent when the required prior request is performed. nordic journal of commercial law issue 2010#1 38 3.6.2. notification from the importing country pursuant to paragraph 2 of the medicines decision, the importing country has to make a notification to the trips council in which names and expected quantities of the products needed are specified. it also has to confirm that, if the pharmaceutical is patented in its territory, it has granted or intends to grant a compulsory license in accordance with article 31 of the trips agreement and the provisions of the decision. determining which patents are required in both countries and their legal status is difficult and time-consuming. a compulsory license covering all patents related to a specific product to be acquired, whether identified or not, is an advantageous solution to this problem. this is possible if the license is applied for in cases of national emergencies when no prior request from the patent holder is required pursuant to article 31(b). this kind of comprehensive coverage would include e.g. processes and possible indications of the medicine.171 where prior negotiations with the patent holder are required, i.e. when the compulsory license is granted in other situations than those exempted from said obligation, there is regardless a need to recognize all patents related to the pharmaceutical product in question. in addition, right holders must in any case be notified as soon as reasonably possible after the unauthorized use, regardless of whether prior request has been performed172. the relevant patents must thus be recognized eventually. this is when assistance from developed countries is needed in order to secure effective implementation of the medicines decision. in the proposed u.s. amendment, for example, establishment of a separate office in connection with the national patent and trademark office was suggested that would have e.g. assisted in the identification of covered patents173. this model should be followed either in all exporting countries separately or on international level as a common enterprise. in article 67 of the trips agreement, developed countries commit themselves to cooperate and assist developing and least-developed country members technically and financially in order to facilitate the implementation of the agreement. in order to offer technical assistance and capacity building for the implementation of wto rules, the organization announced integrated framework for trade-related technical assistance to least-developed countries in 1996 which brings together six international agencies, including unctad and undp. the rationale for this framework is to, inter alia, offer support for wto-related aspects of a country’s development strategy as well as to assist with the costs of the implementation of wto obligations. the technical assistance programs carried out to serve this purpose have often been criticized for being inadequate and inefficient. however, since the doha round was launched in 2001, donors have provided more funding for the programmes and the wto secretariat has 171 correa 2004, p. 39. 172 trips agreement, article 31(b). 173 life-saving medicines export act section 298(c)(1)(b)(i). nordic journal of commercial law issue 2010#1 39 also improved in delivering its part.174 providing something similar to solve possible technical problems in countries that are willing to utilize the medicines decision might face, is an idea worth looking into. this kind of action would increase the effectiveness of the medicines decision: it would, first of all, familiarize the system in general and lower the political threshold for its use. it would also accelerate the procedure and thus enable more rapid reactions to emergency situations. importing countries, in turn, must ensure that the procedure for obtaining a compulsory license in their jurisdiction remains sufficiently simple. in case the receiving country has not enforced a patent on the product in question, the country only has to contact a generic producer and negotiate an agreement that meets its needs. the situation is more complex, if the country has enforced a patent on the needed product. in many countries, decisions concerning compulsory licensing require the involvement of various government departments and agencies. this prolongs and complicates the procedure in the importing country. in order to facilitate coherence and coordination, wto members should explore other available alternatives. establishing a separate multi-agency committee that is responsible for decision-making, for example, can provide the necessary means for simplifying the procedure175. all in all, activeness also on behalf of the importing country is important. while much depends on the political will of its government to employ the system, importing countries will nevertheless also need technical assistance in using the medicines decision. 3.6.3. determination of the amount of medicines needed it is difficult to estimate the amount of medicines that eventually need to be exported: the developments of health crises are hard to foresee. when making the notification to the trips council, the importing wto member must only specify the expected quantity of pharmaceuticals needed.176 reference to “expected” quantities means that it does not need to establish its exact needs before the conclusion of the actual license agreement: nothing in the decision prevents a wto member from modifying the notified quantity over time if its needs change or are specified.177 the decision does not establish any form or template for the notification regarding the expected quantities either. thus, the importing wto member is left with certain room for discretion. it could, for example, define the quantities needed by reference to a quantity of pharmaceutical product x sufficient to treat x number of patients 174 shaffer 2005, p. 660–661. 175 oh 2006, p. 28. 176 the medicines decision, article 2(a)(i). 177 abbott & reichman 2007, p. 933. nordic journal of commercial law issue 2010#1 40 over a period of x amount of time.178 the exporting wto member is not bound by the amount indicated in the notification according to the medicines decision either. yet, only the amount necessary to meet the needs of the importing party may be manufactured under the license pursuant to article 2(b)(i) of the decision. the “amount necessary to meet the needs” of the importing country may nevertheless be established on the basis of several criteria depending on the degree to which the needs of the importing country can be determined ex ante – thus, it does not necessarily imply recourse to the notification.179 the national implementing legislations of canada and the ec nonetheless only allow manufacture of the amount specified in the notification to the wto or, if the importing country is not a wto member, to other relevant entity.180 this makes it even more important to prefer flexible formulations already at the notification stage – otherwise, the amount imported may turn out insufficient. furthermore, an application for a compulsory license lodged in canada must set out the maximum quantity of the pharmaceutical to be manufactured and sold for export under the authorization181. canada does not provide for a chance to modify the license in order to export additional quantities to meet the needs of the importing country either. this can lead to the requirement of renewing the entire administrative procedure in order to obtain a new compulsory license for any possible increases in the products needed, regardless of their magnitude. needless to say, this is inconsistent with a human rights approach to the implementation of the medicines decision. the ec, instead, provides for an opportunity to revise the conditions of the license if necessary in accordance with a simplified and accelerated procedure. in case the amount exported turns out to be insufficient, the importing country must notify the competent authority of the matter. the licensee must then file a new application that contains relevant information regarding the amount of pharmaceuticals manufactured and the importing country. if prior negotiations would normally be required, this obligation is waived if the amount requested does not exceed 25 percent of the amount granted under the original license182. in accordance with the proposed live saving medicines act, the generic manufacturer would have notified the competent official on insufficiency of the estimated quantity. then, the amount could have 178 abbott & puymbroeck 2005, p. 24. the authors suggest the following text for the notification: “based on its present evaluation of its public health needs, [member] expects to import [quantity(ies)] of [pharmaceutical product name( s)]. however, because it is not possible to predict with certainty the extent of its public health needs [member] reserves the right to modify the foregoing estimate as necessary or appropriate.” 179 correa 2004, p. 21. 180 jean chrétien pledge to africa, section 21.05(2)(b); ec regulation, article 8(2). in the united states, it was suggested that an estimate of the quantities of the products to be exported as well as a stipulation that the amount manufactured and exported does not exceed the amount necessary to meet the needs of the country would be required by virtue of section 298(c)(2)(b) of the proposed amendment. 181 jean chrétien pledge to africa, section 21.04(2)(c). 182 ec regulation, article 16 (4). nordic journal of commercial law issue 2010#1 41 been adjusted to the quantity proposed by the licensee unless there would have been compelling evidence that the proposed quantity was excessive183. the ec has thus comparatively preferred a more limited approach. although the european approach does not allow for great flexibility, it is reasonable from the perspective of all parties involved. the importing country and the applicant should be able to assess the necessary amount at least to some extent in advance – otherwise, the situation becomes legally insecure for patent holders. during prior negotiations, they need to have as accurate information as possible on the exception that will be made to their rights in case they refuse to deal. in addition, the model proposed in the united states is unclear with respect to the burden of proof. what constitutes “compelling evidence”? who has the burden of proof? it would be unreasonable to expect the patent holder to provide this evidence, taking into consideration that the product may be exported to a country the existence of which they are hardly aware of. it is, in any case, important to allow revision of the license if needed. otherwise, states and generic manufacturers have to be overly cautious when making the notification or filing the national application which would delay the process. 3.6.4. adequate remuneration according to paragraph 3 of the medicines decision, adequate remuneration pursuant to article 31(h) of the trips agreement shall be paid in the exporting wto member, taking account of the economic value of the unauthorized use to the importing state. this means that the competent authorities in the exporting member determine the amount of compensation paid by the licensee to the patent holder. since the purpose of a pharmaceutical patent is to generate income for its holder who can exploit the exclusive right in its products or license the patent to another party, it is understandable that the issue of remuneration is of relevance when making exceptions to patents. in order for an exception to these rights to be as limited as possible, the patentee must receive adequate compensation. at the same time, however, attention should be paid to the effect these royalties have on the price of the exported product. the price must remain reasonable. the undp estimates royalties of four percent or less of the generic sales price, depending on the circumstances and the economic value of the medicine to the importing country, to be an appropriate policy of remuneration.184 due to the price effect of this kind of royalty rate, developing countries may find it unreasonable. for example, thailand, that issued compulsory licenses to certain medicines during years 2006 and 2007, had initially, without any success, offered a royalty of 0,5 percent to the patent holders in order to obtain voluntary licenses.185 183 life-saving medicines export act, section 298(d)(5). 184 undp: human development report 2001, p. 108. 185 abbott & reichman 2007, p. 953. nordic journal of commercial law issue 2010#1 42 the policy of four percent introduced by the undp seems to be followed in several countries. for medicines exported from the area of the ec, the remuneration shall, in case of a national emergency or other circumstance of extreme urgency and in cases of public noncommercial use, be a maximum of four percent of the total price paid by the importing country or another entity. in other cases, compensation shall be determined taking account of the economic value of the authorized use to the importing country or countries, as well as the humanitarian or non-commercial circumstances relating to the issuance of the license.186 in switzerland, the remuneration must take account of the economic value the license has to the importing country, as well as the level of development and health in that country, and the humanitarian urgency with respect to the need of medicines. the federal council determines the appropriate royalty rate.187 in canada, the governor of council determines the royalty rate. when doing so, the humanitarian and non-commercial reasons underlying the issuance of the license are considered.188 separate guidelines have been established for the determination of the royalty rate. the rate is dependent on the human development index (“hdi”) of the importing country assessed by the undp. there is a sliding scale of 0,02 percent up to four percent: most developing countries would be required to pay less than three percent royalties, whilst the rate would be less than one percent for most countries in africa.189 the federal court may on the application of the patent holder order payment of a rate greater than this, if it is dissatisfied with the original royalty rate. when doing so, it must take into account the reasons underlying the issuance of the license and the economic value of the use of the invention to the recipient country.190 it should be noted that article 31(j) of the trips agreement as such demands that any decision relating to the remuneration is subject to judicial review or other independent review by a competent authority in that wto member. therefore, the provision mentioned does not add anything to the rights of patent holders. the most detailed formulas for the determination of the appropriate royalty rate are found in the proposed u.s. life saving medicines act. the competent authorities would determine the royalty rate considering factors such as 1) the need of the licensee to make a reasonable return that is sufficient to sustain continued operations, and 2) the need for low-cost pharmaceutical products of the people in the importing country. the maximum royalty rate would be four percent of the commercial value of the supply agreement. alternative royalty rate formulas that 186 ec regulation, article 9. 187 gesetzesänderung, article 40e(5). 188 jean chrétien pledge to africa, section 21.08(1); 21.08(2). in the original draft of the bill, the government had proposed a flat 2 percent royalty rate for the patent holder. however, the industry association for pharmaceutical patent owners objected to this proposition (elliot 2007, p. 45). 189 oh 2006, p. 32. 190 jean chrétien pledge to africa, section 21.08(4) 21.08(7). nordic journal of commercial law issue 2010#1 43 utilize the hdi ranking of the recipient country are then presented from which the competent official would choose the most appropriate one. exportation to least-developed countries would, in accordance with the formulas established, lead to royalties below 0, 5 percent.191 it is important to fix the royalty rates as clearly as possible in order to accelerate the issuance of the license. including these formulas in the implementing legislation increases transparency; this is why the proposed u.s model seems most adequate. due to the economic interests underlying the entire issue, unambiguous rules are necessary. the global patent system has been a joint venture of developed countries and, as presented above, there are reasons to hold on to this venture. since these exclusive rights are of economic nature, respecting the rights of the inventors of pharmaceuticals exported under the medicines decision is possible by ensuring that they receive adequate remuneration. the recipient country may, nonetheless, claim that it cannot afford this kind of compensation. would it then not be in the interests of all parties that the government of the exporting wto member would subsidize this action in the form of development assistance (without decreasing the amount of other public development aid)? in case the exporting wto member would also be a developing country, international organizations offering development assistance could come to the rescue. a fund could also be created for this purpose in connection with the wto secretariat. wto members could decide on a fixed amount of royalties, say four percent, which would be paid to the patent holder. after all, providing medicines would be an efficient means of development assistance and it would thus promote the search for solutions of international economic, social, health and related problems in the spirit of articles 55 and 56 of the un charter. similarly, it would be consistent with article 2(1) of the icescr, according to which contracting states must “take steps, individually and through international assistance and cooperation, especially economic and technical,” for the realization of the rights recognized in the covenant192. at the same time, the money spent could be considered the price that must be paid in order to maintain the international patent system created by the trips agreement. 191 life-saving medicines export act, section 298 (e). the proposed act includes detailed formulas for the calculation of the royalty rate. for example, if the name of the importing country would have been on the hdi maintained by the undp, the royalty rate would have been determined as follows: (total number of countries listed on the hdi + 1 – the numerical rank on the hdi of the country to which the pharmaceutical product is to be exported) / (total number of countries listed on the hdi) × 0,04. in case the importation would have taken place in e.g. tanzania, which is a country of low human development, the royalty rate in accordance with this formula would be (178 – 159) / 178 × 0,04 = 0,0043. in comparison, exportation to kazakhstan, a country of medium human development, would have generated the patent holder royalties with the rate of 0,0237. if there would have been only one patentee, the total monetary value of the license agreement would have been multiplied by this royalty rate obtained; in case of several patentees entitled to compensation, the amount would have been divided by the number of patentees. hdi rankings are available at http://hdr.undp.org/en/statistics (last visited 11.4.2010). 192 see also escr committee, general comment 3, paras. 13 and 14. in the latter, the committee emphasizes that “in accordance with articles 55 and 56 of the charter of the united nations, with well-established principles of international law, and with the provisions of the covenant itself, international cooperation for development and thus for the realization of economic, social and cultural rights is an obligation of all states. it is particularly incumbent upon those states that are in a position to assist other in this regard.” nordic journal of commercial law issue 2010#1 44 3.6.5. making exportation economically efficient in order for the system established by the medicines decision to work, it has to be economically efficient. generic producers in both developed and developing countries have argued that, in addition to those of procedural character, economic barriers prevent their participation in the arrangements under the medicines decision. after all, they share with the research-based industry the common motivation of serving the interests of their shareholders193. as pointed out by lazo, no matter how altruistic a generic company may be, or how severe a pandemic – like aids – may become, failure to incorporate greater financial incentives will render the implementing legislation in question useless in the fight to improve the life or death problem of access to medicines in developing countries.194 this means that there has to be a sustainable operational framework for anyone willing to apply for a license and decent economic incentives for the manufacture of the generic product. the requirement of economic efficiency hence seems to lead to two requirements: firstly, the license has to remain valid for a period of time sufficient to recoup the production costs. secondly, the amount of medicines ordered and manufactured under the license has to be large enough. these conditions are interdependent: a license valid for the lifetime of the patent fails to encourage generic production if the amount manufactured remains limited. it is important that enough time is granted for the production and marketing of the generic product and for the recovery of the costs of this process. in many cases, this may require a license for the lifetime of the patent. otherwise, producing generic medicines is economically insecure and incentives for such action remain low.195 pursuant to article 31(c) of the trips agreement, the scope and duration of a compulsory license must be limited to the purpose for which it was granted. the medicines decision does not amend this requirement. in the ec and switzerland, no prior limitations as to the duration of the license have been set, but it has been restated that the duration shall be limited.196 canada, instead, has assumed a different kind of approach: an authorization granted under the jean chrétien pledge to africa is valid for a period of two years beginning on the day on which the authorization was granted.197 in the proposed life saving medicines act, the term of a compulsory license issued under the 193 commission on intellectual property rights, innovation and public health 2006, p. 120. 194 lazo 2007, p. 241. 195 correa 1998, p. 214. 196 ec regulation article 10(3), gesetzesänderung article 40e(2). 197 jean chrétien pledge to africa, section 21.09. nordic journal of commercial law issue 2010#1 45 medicines decision expires on the date that is the earliest of seven years after the date of issuance of the license.198 the generic producer incurs the costs of producing the exported medicine. these include e.g. the costs of reverse-engineering the pharmaceutical in question, presumably without any assistance from the patent holder. in addition, the generic producer must pay the royalties set in the exporting wto member.199 setting limitations for the duration of the license that are not required under the medicines decision forms an additional disincentive for generic producers to consider using the system: financial costs and risks associated with obtaining the required regulatory approvals and scaling up production appear greater than the short-term revenues that could be made under the contract. the alternative of applying for a new license includes additional costs and opportunities for the patent holder to intervene in the procedure, thus decreasing its value as a true alternative.200 therefore, setting unreasonable limitations for the duration of the license should be avoided. in addition to the duration of the license, the amount of medicines manufactured under a compulsory license must be as large as possible for the action to be profitable. contrary to original medicines, generic medicines should be produced with high volume and low margin returns. in order to ensure high volume of medicines manufactured, the importing countries should pool their purchasing power in order to bargain down the prices of pharmaceuticals. the wording in paragraph (2)(b)(i) of the medicines decision “only the amount necessary to meet the needs of the eligible importing member(s)” implies that it is possible to incorporate the needs of several eligible importing countries under one license. in the ec regulation, reference is also made to “importing country or countries”201. this seems to enable exporting to several countries under one license. the proposed life saving medicines act, in turn, would have taken a step forward by specifically addressing the issue of combined license applications. the national authority could have established procedures to permit a combined license application from more than one eligible country or issued a multi-country license if appropriate202. there is plenty of potential in allowing combined license applications. many developing countries suffer the same public health problems and lack the necessary manufacturing 198 life-saving medicines export act, section 298(d)(3)(a). pursuant to paragraph (c), termination of the license would have naturally been possible prior to this date on a petition from the original patent holder if the circumstances that lead to the issuance of the license cease to exist and it appears probable that such circumstances will not reoccur. 199 see lazo 2007, p. 271–274 (suggesting that one possible way of reducing the costs would be to motivate the patent holder to cooperate by rewarding such action by higher royalty rates). 200 canadian hiv/aids legal network 2006, p. 4. 201 ec regulation, articles 6(3)(d) and 10(2). 202 life saving medicines act, section 298(c)(3). nordic journal of commercial law issue 2010#1 46 capacity. at the same time, they may not have sufficient information on the possibility of importing generic medicines. cooperation could improve the ability of these countries to obtain medicines under medicines decision. in consequence of pooling their purchasing power, states could additionally obtain medicines at lower prices. however, the medicines decision requires each importing wto member to make a notification to the trips council which means that each importing member would yet have to notify its intentions to the council. allowing exportation to several countries under the same license is nevertheless a practical way of improving the economic efficiency and accelerating the procedure of obtaining a license. after all, the importing countries have the same legal right to import medicines and the same legal duties imposed by the medicines decision. since there are no legal obstacles for allowing combined licenses, it would be important to explicitly provide for this opportunity in the implementing legislations in order to avoid obscurity. in order to better cater to the needs of developing countries, an exception related to the ban of re-exportation was included in paragraph 6 of the medicines decision. where a developing or a least-developed country member is a party to a regional trade agreement at least half of which consists of countries presently on the un list of least-developed countries, re-exportation is allowed. the obligation to obtain an additional export license is waived to the extent necessary to enable exportation of a pharmaceutical produced or imported under the medicines decision to another developing or least-developed country that is a party to this regional trade agreement and shares the health problem in question203. this exception does not allow the generic producer to supply medicines for other states than those that are eligible to import medicines in accordance with the decision; it only allows re-exportation by the original importer. the new importing country also has to issue a compulsory license pursuant to article 31 of the trips agreement in case the imported product is covered by a patent in its territory. in addition to these restraints, it is worth remembering that most least-developed countries are situated in africa. the exception in question is thus relevant only in relation to some regional trade agreements in africa.204 in their article, abbott and reichman sketch the establishment of a regional pharmaceutical supply centre (“rpsc”) inside a loose trade association which would have at least six leastdeveloped country members. the rpsc could organize the procurement of pharmaceuticals needed to fulfil the demand of as many as twelve countries. it would act on behalf of its buyer governments that would now be in a better position to obtain low prices after having pooled their purchasing power. the rpsc would first make efforts to obtain voluntary licenses from patent holders who might be more willing to cooperate with a larger amount of buyers. if it 203 the medicines decision, para. 6(i). 204 the ec insisted that the solution should be limited to what is effectively sub-saharan africa. it rejected proposals that would have made it unnecessary for importing countries to separately issue compulsory licenses. in addition, developing countries considered the provision for assistance in the creation of regional patents as a part of an eu strategy to support its pharmaceutical industry (abbott & reichman 2007, p. 942). nordic journal of commercial law issue 2010#1 47 would fail to negotiate a voluntary license, it could purchase the product abroad under the system established by the medicines decision. the system established by the decision could also be used for importing active ingredients to be used for the manufacture of pharmaceutical products in the importing countries. through cooperation, developing countries could hence increase local production facilities.205 the proposal of abbott and reichman is one example of innovative thinking that expands the use of the medicines decision without requiring any legislative reforms. all it calls for is cooperation between states that employ the decision. similar suggestions should be presented in the wto context and, more importantly, they should be put into action. it is somewhat ironic that in a world where millions of people lack access to medicines, one obstacle for efficient use of the medicines decision could be the small size of relevant markets. 3.6.6. diversion of medicines in order for the medicines decision to serve its purpose, medicines manufactured under compulsory licenses must be diverted to individuals who lack access. this issue of appropriate diversion of medicines has two dimensions: internal and external. from the perspective of an effective patent regime and patent holders, the most central issue with respect to the medicines decision is the external aspect of diversion: re-exportation of medicines manufactured under the decision must be prevented. this is also important for the beneficiaries of the system, i.e. individuals lacking access to affordable medicines. otherwise, someone else is taking advantage of their suffering and the humanitarian concerns underlying the system are left unresolved. it is understandable that preventing re-exportation was one of the main issues during the negotiations – after all, it is the only way to ensure that patent protection is not eroded in the developed countries.206 preventing re-diversion of medicines requires cooperation. it is undisputable that if the products manufactured in the auspices of the medicines decision are re-diverted to the markets of developed countries, the rights of patent holders are infringed in an illegitimate manner. 205 abbott & reichman 2007, p. 974–977. during the negotiations preceding the adoption of the medicines decision, the representative of switzerland suggested an additional instrument of voluntary public tender procedure. in a voluntary public tender procedure the wto member with insufficient manufacturing capacity could be assisted in the examination of the offers by another organization with the necessary expertise and the know-how to choose the best offer (for example, the wto or the who). a voluntary public tender would ensure wide participation of potential suppliers in the process and as such is a proposition worth looking into (council for trips, minutes of meeting held in june 2002, para. 106). 206 see e.g. council for trips, minutes of meeting held in september 2002. the representative of switzerland, for example, stated that safeguards against diversion were most important to his delegation (council for trips, minutes of meeting held in september 2002, para. 82). it should be noted that the trips agreement as such obligates members to prevent the importation of any infringing goods into their territory (trips agreement, articles 28 and 44.1). nordic journal of commercial law issue 2010#1 48 according to paragraph 4 of the medicines decision, importing wto members must take reasonable measures in order to prevent re-exportation. in addition, all importing wto members must ensure the availability of effective legal means to prevent importation that is inconsistent with the decision. concrete actions range from efficient custom clearance to injunctions and liability for compensation. if a wto member considers that such measures are insufficient, the matter can be reviewed in the trips council207. it should yet be noted that developed countries are expected to assist the importing wto members in the prevention of re-diversion by providing them with technical and financial assistance208. further, developed countries pledge to cooperate and assist developing countries technically and financially in order to facilitate the implementation of the trips agreement in article 67 of the agreement. these are commitments that must be taken seriously, if the wish is to create efficient patent protection globally. a closer examination of the global patent system reveals that its gains are anything but distributed equally: ten developed countries account for 84 percent of global resources spent on research and development annually, and receive 91 percent of global cross-border royalties and technology license fees.209 in total, industrial countries account for the vast majority – 97 percent – of patents worldwide. for example, only 31 of the 26 088 applications for patents filed in 1997 under the auspices of the african intellectual property organization were from residents of africa while only seven of 25 731 applications registered that year by the african regional industrial property organization were filed by residents.210 considering this unequal distribution of the advantages of a global patent system, it would only be reasonable to hold the governments who benefit the most liable for the expenses caused by measures that secure the rights of patent holders. why should developing countries, that have no resources to secure their citizens access to very basic commodities, allocate their resources to the maintenance of a patent system that is more or less a joint venture of developed countries – an enterprise that they did not want in the first place and that at present hardly benefits them at all? although the medicines decision only addresses the external dimension of diversion of medicines, a few words can be said regarding its internal aspect. after all, the arrival of medicines manufactured under the system to the importing country as such can be considered a mere first step, while just distribution within that country forms the second step. the importing states are responsible for providing appropriate channels of distribution that ensure effective diversion of medicines within their territory. here, the physical accessibility of medicines is of significance: medicines must be within safe reach for all sections of the population211. similarly, 207 the medicines decision, para. 5. 208 the medicines decision, para. 4. 209 correa 2007, p. 91. 210 world bank: world development report 2000/2001, p. 184–185. 211 escr committee, general comment 14, para. 12 (b). nordic journal of commercial law issue 2010#1 49 any price decreases attained with the help of the medicines decision must be directly visible in the sales price of these medicines. this means that the government should not include any additional taxes in their prices. instead, it must ensure affordability of the imported medicines for all212. all this requires working governance. since ngos can participate in the distribution of the medicines manufactured under the decision, this is a choice a country ought to look into if its own capability turns out to be insufficient. invoking defences based on the level of development in this connection is unacceptable as ensuring internal diversion of medicines is less a matter of resources than a matter of political will. iv. from normative to political coherence as established above, the medicines decision leaves wto members sufficient room to strike a balance between the public interest and the private rights under examination. efficiency of the decision depends on the approaches assumed on the national level – how the obligations arising from the right to access to medicines are put into practice when implementing the decision. wto members must choose the alternatives that best ensure that pharmaceutical patents do not hinder access to medicines in developing countries; some examples have been given above. as hestermeyer commented the implementation of the medicines decision, “the adoption of such legislation is not just laudable, but a way to comply with the obligation to cooperate”213. as another matter, all wto members should accept the protocol amending the trips agreement in order to make the medicines decision a permanent part of the agreement. so far, a very limited amount of countries have done this, among these, only few developing countries214. although wto members have been given an opportunity to meet their obligations to respect, protect and fulfil the right to access to medicines despite protection of pharmaceutical patents, they have, for the time being, been unwilling to do so by utilizing the medicines decision. so far, only ruanda has notified the trips council of its intention to import medicines from a canadian generic manufacturer215. the reasons underlying this passivity are most often claimed to be of political nature: governments of developing countries are unwilling to publish their 212 ibid. 213 hestermeyer 2007, p. 169. 214 these are (in chronological order) the united states, switzerland, el salvador, rep.of korea, norway, india, philippines, israel, japan, australia, singapore, hong kong (china), china, the ec, mauritius, egypt, mexico, jordan, brazil, morocco, albania, macau (china), canada, bahrain, colombia, zambia, nicaragua and pakistan (wto: members accepting amendment of the trips agreement, last visited 11.3.2010). 215 council for trips: notification under paragraph 2(a) of the decision of 30 august 2003 on the implementation of the paragraph 6 of the doha declaration – rwanda (19 july 2007); notification under paragraph 2 (c) of the decision of 30 august 2003 on the implementation of paragraph 6 of the doha declaration – canada (8 october 2007). see also intellectual property quarter update 2005. nordic journal of commercial law issue 2010#1 50 intentions to exploit the flexibilities in the trips agreement as they are worried about its possible negative impact on foreign investment in their country and any additional political pressure it may cause216. these fears have been nourished by the policies of some developed countries. for example, when thailand issued three compulsory licenses from november 2006 through february 2007 to manage the costs of providing universal access to antiretroviral medicines (that amount to up to ten percent of the national budget), it found itself faced with immense political pressure. the united states placed the country on its “priority watch list”217, stating that regardless the fact that the licenses issued were in consistency with the trips agreement, the lack of transparency and due process exhibited in thailand represented a serious concern. the trade commissioner of the european commission claimed that the actions taken could lead to the isolation of thailand from “the global biotechnology investment community” and that a systematic policy of applying compulsory licenses whenever medicines exceed certain prices, was inconsistent with the agreement218. the hostilities targeted at the government of thailand are neither legally supported by the trips agreement nor the subsequent regulation, which, on the contrary, specifically elucidates that “the trips agreement does not and should not prevent members from taking measures to protect public health”219. what is even more important, these hostile actions violate the obligation of third states to cooperate by virtue of articles 55 and 56 of the un charter and article 2(1) of the icescr. the thai government was wise to declare its intention to bring a claim to the wto dispute settlement body, if trade sanctions were wrongfully imposed – there is little doubt that it would win a possible dispute on trips-compliance of its licensing for government use220. finally, it should be noted that compulsory licenses represent a last resort to access to patented medicines. voluntary licensing should be encouraged since patent holders may be willing to cooperate. for example, when the canadian generic producer apotex inc. requested voluntary licenses from the pharmaceutical companies that hold patents covering the pharmaceuticals that are exported to ruanda, all right holders expressed interest in the exploitation of their patents under a humanitarian initiative. they agreed to a royalty rate of zero percent, while their main concern was to ensure that the medicines would not be re-diverted from the original recipient country. boehringer ingelheim pharmaceuticals inc., one of the four pharmaceutical companies involved, went even further by offering a voluntary license that would have, inter alia, been valid for the entire patent life of the product, as opposed to the two year term provided by canadian law. furthermore, it permitted apotex inc. to extend the license to other developing countries in addition to ruanda by way of a simple letter of intent to the patent 216 oh 2006, p. 31. 217 ”priority warch list” is one category a country can fall to by virtue of section 301 of the us code that allows unilateral measures if a country is denying adequate protection of intellectual property rights. 218 abbott & reichman 2007, p. 947; 949–951. 219 doha declaration, para. 4. 220 abbott and reichman 2007, p. 956. nordic journal of commercial law issue 2010#1 51 holder.221 as noted by oh, prior negotiations with pharmaceutical companies constitute an integral part of the government’s strategy to cope with its public health crisis also in malaysia. these companies have become more cooperative, since authorized government use took place in the country between 2003 and 2005.222 it is thus not merely imaginary to claim that one day voluntary cooperation between the actors involved will result in affordable patented medicines in countries lacking manufacturing capacity. in the meanwhile, the medicines decision can be employed as a band-aid solution which allows for coherence between the right to access to medicines and pharmaceutical patents. either way, what is required at the moment are politics that are consistent with the normative regulation underlying the access dilemma. unfortunately, it seems that the recent developments in international intellectual property regulation point in the opposite direction. among these are bilateral and regional free trade agreements: by february 2010, 462 regional trade agreements had been notified to the gatt/wto.223 also issues of intellectual property protection are increasingly settled outside the wto: several bilateral and regional agreements contain provisions that may hinder the use of the flexibilities in the trips agreement described above.224 this hinders access to medicines. it thus seems that matters related to access to pharmaceutical patents in developing countries, should be negotiated in multilateral settings, where weaker states can be backed up by the wider international community. intellectual property protection is unsuited to be regarded as a matter falling exclusively within the scope of an economic “sub-system” of international law. it has become evident in the trips era that exclusive rights have an impact on fundamental human rights and therefore they are a matter of the human rights “sub-system” also. as such, intellectual property rights, at least to the extent they concern pharmaceutical products, should be negotiated in multilateral settings where human rights advocates are also able to express their concerns. then, coherence in international law is more likely to remain. v. conclusions in my article, i have explored whether coherence can be maintained in international law between the right to access to medicines and pharmaceutical patents introduced by the trips agreement. the trips agreement contains certain flexibilities that enable wto members to meet their obligations arising from the right to access to medicines. further, the trips 221 intellectual property quarter update 2005, p. 6. 222 oh 2006, p. 28. 223 wto: regional trade agreements (http://www.wto.org/english/tratop_e/region_e/region_e.htm [last visited 6.4.2010]). 224 for a critical view on the regional and bilateral free trade agreements, see e.g. drahos 2007 and sell 2007. for a review of the intellectual property provisions used in ftas concluded by the united states, see e.g. vivas-eugui 2003 (concerning the free trade area of the americas). nordic journal of commercial law issue 2010#1 52 agreement should be interpreted in consistency with human rights law pursuant to the customary rules of interpretation guiding the construction of the agreement. since wto members can exploit the permissive norms of the trips agreement in order to follow the obligatory norm of the right to access to medicines, no conflict of norms exists between the two and they should be interpreted harmoniously in accordance with the presumption against conflict. the medicines decision constitutes a permissive norm that plays a central role in this kind of reconciliation. by assuming a human rights approach to its implementation, wto members can simultaneously ensure that access to medicines is not hindered by pharmaceutical patents in developing countries and maintain an efficient patent system that is also in the best interest of the world community. as presented above, ensuring access to medicines necessitates the use of compulsory licenses. this inevitably erodes patent protection. however, a clear distinction must be made between developed and developing countries. policies relating to exclusive rights in the former must be distinguished from policies assumed in the latter. despite the formal creation of global intellectual property system, it has become evident that it will take time before global exclusive rights can be enforced in practice. for this to happen, people living in developing countries must afford to provide this kind protection. unfortunately, it seems unlikely that this will occur within the foreseeable future. for the time being, different standards of protection must be followed in developing and developed countries. using compulsory licenses in practice means that the scope of public domain is expanded at the expense of exclusive rights. it hence seems that the scope of public domain should remain wide in the southern hemisphere whereas it is increasingly limited in the north. however, there seems to be no alternative available for this double standard, since the models developed and upheld in industrialized countries fail to meet the reality in the developing world. as mentioned in the beginning of this article, the relationship between the right to access to medicines and exclusive rights enshrined by the trips agreement is an excellent example of the consequences of fragmentation in international relations. however, any legal fragmentation caused by this phenomenon can be ruled by means of the existing international norms. in my study, i have provided an example of how two divergent systems of international law can interact with each other in a manner that preserves coherence in international law. the medicines decision must be considered an affirmation of this kind of cross-fertilization between different sets of rules. the phenomenon in question is not a mere coincidence but a natural consequence of the emergence of divergent international institutions and structures within international law that by its nature favours coherence and presumes norms to be cumulative. allowing for interplay between norms of divergent “sub-systems” of international law provides a counterforce to the general phenomenon of fragmentation. as cassese has stated, “it shows that at least at the normative level the international community is becoming more integrated and – what is even more important – that such values as human rights and the nordic journal of commercial law issue 2010#1 53 need to promote development are increasingly permeating various sectors of international law that previously seemed impervious to them”225. further, it ensures the surveillance of diverging regimes simultaneously which is most often in favour of the entire international community. as a final remark, it should be emphasized that patents are not the main issue in relation to the right to access to medicines. the overwhelming poverty of individuals, absence of state health care financing, lack of medical personnel and distribution infrastructure are also issues of high importance226. furthermore, the current health crisis in the south is influenced by certain matters of even more fundamental character such as ecological and social conditions, including the lack of education and gender issues 227. all these issues are related to poverty that, needless to say, is the most fundamental problem underlying the access dilemma but one that cannot be resolved as easily as the relevant patent policies can be altered. the access dilemma can only be solved one piece at a time. ensuring that pharmaceutical patents do not hinder access to medicines must thus be considered as one of the pieces in the puzzle of global public health. yet, other pieces must be collected and put in their places as well. it must be borne in mind that the current public health crisis prevailing in the developing world is a sum of hundreds of individuals facing a human tragedy each day. as put by the commission of macroeconomics and health, “fighting disease will be the truest test of our common capacity to forge a true global community. there is no excuse in today’s world for millions of people to suffer and die each year for lack of usd 34 per person needed to cover essential health services. a just and far-sighted world will not let this tragedy continue”228. 225 cassese 2005, p. 45. 226 commission on intellectual property rights, innovation and public health 2006, p. 202. 227 commission on macroeconomics and health 2001, p. 74–76. 228 ibid., p. 110. 1 table of references literature abbott, frederick m. 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21 december 1965 (entered into force 4 january 1969). accessible at http://www.unhchr.ch/html/menu3/b/d_icerd.htm (last visited 24.10.2008). marrakesh agreement establishing world trade organization. 15 april 1994. accessible at http://www.wto.org/english/docs_e/legal_e/04-wto_e.htm (last visited 24.10.2008). vienna convention on the law of treaties (23 may 1969, entered into force 27 january 1980). united nations, treaty series, vol. 1155, p. 331. accessible at http://untreaty.un.org/ilc/texts/instruments/english/conventions/1_1_1969.pdf (last visited 25.10.2008). cisg advisory council1 opinion no. 18 set-off under the cisg 1 michael bridge, chair yesim atamer, eric bergsten, joachim bonell, harry flechtner, lauro gama, alejandro garro, roy goode, john gotanda, han shiyuan, johnny herre, pilar perales viscasillas, ulrich schroeter, ingeborg schwenzer, hiroo sono, claude witz, members sieg eiselen, secretary. 1. opinion .................................................................................................. 4 2. comments .............................................................................................. 4 2.1. introduction ............................................................................ 4 2.2. specific comments ................................................................... 9 2.2.1. 1. monetary claims governed by the cisg, whether they arise out of the same contract or not, may be set off by either party in conformity with the general principles underlying the cisg. ................................................. 9 2.2.2. 2. set-off has the same effect as the performance of a monetary obligation by payment. ......................................................................... 12 2.2.3. 3. set-off is exercised by a declaration made by notice. the notice must reach the other party but does not take effect before both claims are due. .......................................................................... 13 2.2.4. 4. exercising the right to set off does not require the claims to be liquidated or to be in the same currency. .................................................... 18 2.2.5. 5. the application of the cisg to a set-off does not affect matters of res judicata or counterclaims. ............................................................ 22 3. annex – table of cases .................................................................. 26 4. footnotes .......................................................................................... 29 3 introduction of the cisg-ac the cisg-ac started as a private initiative supported by the institute of international commercial law at pace university school of law and the centre for commercial law studies, queen mary, university of london. the international sales convention advisory council (cisgac) is in place to support understanding of the united nations convention on contracts for the international sale of goods (cisg) and the promotion and assistance in the uniform interpretation of the cisg. at its formative meeting in paris in june 2001, prof. peter schlechtriem of freiburg university, germany, was elected chair of the cisg-ac for a three-year term. dr. loukas a. mistelis of the centre for commercial law studies, queen mary, university of london, was elected secretary. the founding members of the cisg-ac were prof. emeritus eric e. bergsten, pace university school of law; prof. michael joachim bonell, university of rome la sapienza; prof. e. allan farnsworth, columbia university school of law; prof. alejandro m. garro, columbia university school of law; prof. sir roy m. goode, oxford, prof. sergei n. lebedev, maritime arbitration commission of the chamber of commerce and industry of the russian federation; prof. jan ramberg, university of stockholm, faculty of law; prof. peter schlechtriem, freiburg university; prof. hiroo sono, faculty of law, hokkaido university; prof. claude witz, universität des saarlandes and strasbourg university. members of the council are elected by the council. at subsequent meetings, the cisgac elected as additional members prof. pilar perales viscasillas, universidad carlos iii, madrid; professor ingeborg schwenzer, university of basel; prof. john y gotanda, villanova university; prof. michael g. bridge, london school of economics; prof. han shiyuan, tsinghua university, prof. yesim atamer, istanbul bilgi university, turkey, and prof. ulrich schroeter, university of mannheim. prof. jan ramberg served for a three-year term as the second chair of the cisgac. at its 11th meeting in wuhan, people’s republic of china, prof. eric e. bergsten of pace university school of law was elected chair of the cisgac and prof. sieg eiselen of the department of private law of the university of south africa was elected secretary. at its 14th meeting in belgrade, serbia, prof. ingeborg schwenzer of the university of basel was elected chair of the cisgac. 4 1. opinion 1. monetary claims governed by the cisg, whether they arise out of the same contract or not, may be set off by either party in conformity with the general principles underlying the cisg. 2. set-off has the same effect as the performance of a monetary obligation by payment. 3. set-off is exercised by a declaration made by notice. the notice must reach the other party but does not take effect before both claims are due. 4. exercising the right to set off does not require the claims to be liquidated or to be in the same currency. 5. the applicability of the cisg to set-off does not affect matters of res judicata or counterclaims. 2. comments 2.1. introduction 0.1 a set-off of monetary claims is usually referred to as the mechanism by which the amount which a party owes to the other party is reduced by the amount that the second party owes to the first, to the effect that that first party only has to pay the balance. the cisg does not use the term ‘set-off’, whereas it is often used in case law and legal writing relating to the convention. the notion ‘set-off’ is also found in numerous international legal uniform instruments, such as the 1974 limitation convention, the uncitral model law on secured transactions, the un convention on the assignment of receivables and the principles of international commercial contracts (hereafter the picc). 0.2 the cisg does not explicitly address the question of set-off. this might explain, at least in part, why the majority of case law and authors hold that a set-off arising out of a contract governed by the convention is subject to the law applicable by virtue of the rules of private international law, in accordance with article 7(2) in fine. only a few cases or authors explain this view. those who do generally consider that the cisg does not only not provide for any express rules on set-off, but that such rules cannot be derived from the existing provisions either. more recently, however, the highest instance courts in some contracting states, including the german supreme court, the austrian supreme court and, implicitly, the swiss federal tribunal, have held that a set-off of claims governed by the cisg falls within the scope of the convention if both claims arise out of the same contract. the applicability of the cisg to a set-off in such a constellation has also been admitted by numerous other courts and authors. 0.3 the case law applying the cisg to a set-off usually does so implicitly. typically, a judgment will order the defendant to pay only the 5 difference between the claimant’s and his own claim; as this is done without searching for a specific law that would govern set-off, it must be inferred that the court impliedly admits the application of the convention. 0.4 it is the goal of this opinion and its comments to elaborate the question of set-off under the cisg, to work out the details of the provisions and general principles of the convention, and to provide for a unified approach to set-off within the four corners of the cisg. the advisory council is of the opinion that such a unified solution from within the convention is consistent with the nature, the scope of application, and the goals of the cisg. furthermore, a unified approach derived from the convention avoids the complexity and unpredictability that are linked to the application of domestic law to a set-off. in fact, the domestic laws of set-off may differ considerably from one another. 0.5 thus, the ‘latin’ model, found in french law and the many legal systems influenced by the french code civil, provides that set-off takes place ipso iure (automatically) as of the time two parties hold mutual claims against each other. there is an automatic discharge of those mutual obligations to the extent of their respective amounts, even without the parties’ knowledge. the claims need not arise out of the same contract or be otherwise connected, but because latin set-off operates automatically, both claims must be due, ascertained, and enforceable. as set-off takes place as soon as the claims coexist, neither party is in default from that time on; the duty to pay interest on a sum ceases to exist at that moment, and any contractual penalties do not become due. all the described elements show that latin set-off is an automatism provided by substantive law. the court or arbitral tribunal only finds (‘constater’) that the claims have been set off. 0.6 set-off under the german model is a matter of substantive law too. unlike french law however, which imposes set-off on both parties, the german model gives the parties just the right to declare set-off. if there is no set-off declaration, the claims continue to exist independently from each other until they are extinguished by fulfilment of the respective obligations. german set-off thus considers set-off as a defence (figuratively speaking; it is not a judicial defence of procedural law); the party wishing to set off intends the extinction of the claims, whereas the other party arguably does not. this explains why, under german law, the claim with which set-off is declared must be enforceable, that is, admissible for legal action: the addressee of the set-off declaration must accept the extinction of its claim only if and insofar as the other party could claim fulfilment of its own claim. in contrast, the claim against which set-off is declared need be neither due nor enforceable. the claims need not arise out of the same contract or otherwise be connected with each other, and, unlike french law, they need not be liquidated either. interestingly, and for historical reasons, set-off has retroactive effect: once set-off has been declared, the two claims are considered as having been 6 extinguished as of the time they were eligible for set-off, as is the case under french set-off. 0.7 the common law provides for several categories of set-off. to take english law as an example, the traditional way of set-off is an instrument of procedural law (independent set-off, statutory set-off). it is only available in a pending action, and only if both claims are liquidated. set-off is brought about as of the date of judgment. until that date, the claims continue to exist. interest accrues and penalty clauses apply. besides independent set-off, english courts have developed another type of set-off which is said to be an instrument of substantive law (equitable set-off, transaction set-off). its effect, however, differs from the law of set-off of civil law jurisdictions. the debtor who, himself, has a claim against the creditor may deduct the sum owed to him and pay just the balance, very much like in german and french law. alternatively, the debtor may ask for an injunction which will preclude the creditor from claiming his debt in full before judgment. but the two claims remain in existence until they are extinguished by judgment. equitable set-off does thus not qualify as a purely substantive defence since it is the judgment which brings about the set-off. once set-off has been pronounced by the court, the debtor who has already deducted the amount owed to him from the creditor’s claim is not considered as having been in default until the pronouncement of set-off by the court. there is thus a partial retroactive effect to equitable set-off. equitable set-off only operates where both claims arise out of the same transaction. it is not required that they arise from the same contract, but the claim which is set off against the creditor’s claim must be inseparably connected with the transaction that gave rise to the first claim. furthermore, the party invoking set-off must show some equitable ground for being protected from its adversary’s demand; the court may deny set-off, despite the fact that both claims are closely connected, if the case does not give rise to an equity. the lack of ascertainment of the debtor’s claim may prevent equitable set-off. the court has considerable leeway. finally, another category of english set-off is abatement, which has a very narrow scope. it is limited to contracts for the sale of goods or for work and labour and allows the buyer or customer to deduct from the seller’s or contractor’s claim a reasonable amount corresponding to the diminution in value of the goods or services provided. it is very much comparable to the right of price reduction in article 50 cisg. a similar mechanism is provided in the american uniform commercial code (ucc) in section 2-717 (‘the buyer on notifying the seller of his intention to do so may deduct all or any part of the damages resulting from any breach of the contract from any part of the price still due under the same contract.’). in a contractual context, us law may allow for the equitable defence of ‘recoupment’, defined as the setting up of a demand arising from the same transaction as the plaintiff's claim, to abate or reduce that claim. ucc, § 2-717 and recoupment are 7 considered as different to actual set-off, the latter being similar to english independent set-off. 0.8 differences among the various domestic laws do not only concern the mechanism of set-off as such, but also conflict of laws rules applicable to set-off. this concerns not so much the choice-of-law rules in europe, where the rome i regulation provides for the same choice-oflaw regime for all member states except for denmark. but differences remain on a global level and especially in international arbitration, where manifold theories and approaches exist. 0.9 the short and, certainly, to some extent schematic overview shows that the questions of whether there is a possibility for set-off, how set-off is brought about and what its effects are, are answered differently depending on the applicable domestic law. the differences are considerable. they lead to a certain complexity and, as the case may be, unpredictability of the case. these difficulties are exacerbated by the wide variety of existing conflict of laws rules; they add to the said unpredictability – an unpredictability that the parties who have chosen the cisg as a unified law certainly wished to avoid. these elements taken together invite knowledgeable parties to forum shop and lead to unforeseen situations for less informed parties. 0.10 in contracts governed by the convention, the difficulties described arise when set-off is regarded as an issue not governed by the convention, to be determined by the applicable rules of private international law at the place of the court and to be resolved under national law (article 7 para. 2 in fine). the difficulties do not arise if the question of whether the buyer and the seller under a cisg contract may set off their mutual claims can be answered by the convention itself (article 7 para. 2 in initio). the advisory council is of the opinion that the set-off of claims governed by the cisg is a matter governed by the convention for which the general principles on which the cisg is based provide clear and adequate rules for the characteristic aspects of such a set-off between seller and buyer. it has therefore adopted the rules that are presented and explained in detail below. standards 1.1. many products today have some corresponding standard(s) concerning their composition, features, such as health and safety, or the process to be followed in making them. a standard can be understood as a benchmark or a level of quality or attainment, with reference to which something is evaluated or the compliance with which is desirable or expected.1 the international organisation for standardization (iso) defines a standard as ‘a document that provides requirements, specifications, guidelines or characteristics that can be used consistently to ensure that materials, products, processes and services are fit for their purpose’.2 it is helpful to distinguish ‘public’ from ‘private’ standards. the former are adopted by state organisations, often being contained in public law regulations, or by inter-governmental organisations, such the united nations, international labour organisation or codex alimentarius 8 commission.3 public standards can be mandatory or voluntary. other standards are ‘private’ in the sense that they are produced by non-state bodies, initiatives, associations and organisations. these can be: companies, adopting their own standards or codes of conduct, (such as tesco nature’s choice)4; national industry bodies, such as the british retail consortium (brc) and its brc global standards;5 international consortia of companies and their global standards, such as globalg.a.p. (‘good agricultural practice’),6 the global food safety initiative (gfsi)7 or the equator principles (ep) association;8 international organisations that adopt standards across various industries and sectors, such as the iso that adopts standards in a wide range of areas, including technology, food safety, agriculture, healthcare, environment;9 civil society, represented by non-profit non-governmental organisations (ngos), such as the fairtrade foundation10 that promulgate what might called ‘ethical’ standards, concerning human rights, child labour and other labour standards, environmental protection, sustainability and corruption. being adopted by non-state actors, private standards are voluntary. however, they can become mandatory or quasi-mandatory.11 the former is the case where a private standard is incorporated into a national regulatory framework.12 the example of the latter is where standards are applied by the majority of businesses in a particular sector and/or where compliance with such standards is required by large companies (usually, buyers) dominating the relevant sector or supply chain.13 1.2. the existence of such standards raises the question of their relationship with the convention on contracts for the international sale of goods (cisg) that governs the rights and obligations of the parties arising from a ‘contract’ of the sale of goods. being a contract law instrument that seeks to assign duties, risks, liabilities and remedies between the two contracting parties, the cisg is not concerned with giving effect to any such standards. however, buyers often claim that sellers breach a contract and/or the convention if the goods do not meet a particular public or private standard. an important question therefore is: to what extent should such standards be taken into account in defining the seller’s obligations as to the conformity of goods under article 35 cisg? this opinion addresses this question, providing guidance as to the degree to which standards should be taken into account in interpreting a contract, governed by the cisg, and article 35 cisg. 1.3. it is increasingly recognised that the conformity of goods comprises the relationship of the goods with their surrounding environment, of which standards are an important part.14 thus, the conformity of goods should in principle be determined not only by their quantity, quality, description, or packaging, but also by compliance with standards affecting the use of the goods. according to article 35(1) cisg, the ‘conformity’ of goods comprises their quantity, quality, description, containment or packaging. standards, whether public or private, are often concerned with these aspects of conformity, as well as with many others, 9 such as technical, ethical, environmental and health and safety considerations and/or the process of designing, manufacturing or producing the goods. it must also be stressed that when interpreting the contract under article 35(1), regard must be had to all relevant circumstances, as is made clear by article 8(3) cisg.15 given that standards deal with various aspects and features of the goods, the standards can be such a ‘relevant circumstance’ or factor that must be taken into account when interpreting the contract. 1.4. some key terms as to the conformity of goods, implied under article 35(2), focus on the use of the goods. article 35(2)(b) is concerned with the seller’s obligations where a particular purpose, for which the goods are intended to be used, has been made known to the seller. article 35(2)(a), in turn, provides a fall-back rule, according to which goods are to be ‘fit for the purposes for which goods of the same description would ordinarily be used’.16 standards can affect the use of the goods, whether it is the use flowing from the particular purpose under article 35(2)(b) or the ordinary use under article 35(2)(a), including their containment or packaging (article 35(2)(d)). thus, if a standard is contained in public law regulations, the use of the goods may be affected if they do not comply with this standard. even if a standard is not mandatory, companies in a given market, sector or supply chain may have to comply with such a standard in order to enter, remain in the market or carry on business effectively if such compliance is expected by within that market or sector17 and/or required by a company dominating a supply chain (usually, the buyer).18 2.2. specific comments 2.2.1. 1. monetary claims governed by the cisg, whether they arise out of the same contract or not, may be set off by either party in conformity with the general principles underlying the cisg. 1.1 monetary claims. the rule formulates the principle that the convention governs the set-off of monetary claims, for example, where the seller claims the purchase price whereas the buyer claims damages,19 or where the buyer claims restitution of the price and the seller counters with a claim for damages,20 or where the seller demands the equalization of benefits further to the avoidance of the contract and the buyer relies on damages,21 or certain other constellations.22 non-monetary claims are not considered. in fact, even though the picc, the pecl or domestic laws standing in a civil law tradition provide for a right to set off claims relating to goods of the same kind (‘similar goods’, ‘fungible goods’), the situation where the buyer and the seller hold reciprocal claims relating to goods of the same kind will hardly arise under the cisg, as the convention governs sales contracts, that is, contracts referring to the exchange of goods against money. the situations in which a set-off of claims relating to the ‘same 10 kind of goods’ are of practical importance, such as a set-off of obligations for company shares or other negotiable papers, or goods in futures trading23, have been excluded from the scope of application of the cisg (article 2(d)). to the extent the cisg applies to barter agreements24, it is very unlikely that the barter agreement involves goods of the same kind. 1.2 set-off as a matter governed by the cisg. the set-off of monetary claims both governed by the cisg is to be settled in conformity with the general principles underlying the convention. even though the cisg does not state explicit general rules for set-off, it acknowledges the principle of set-off as such. for instance, where the party bound to preserve the goods sells those goods, article 88(3) states that that party is entitled to retain from the proceeds of sale its reasonable expenses of preserving and selling the goods. provisions of the cisg other than article 88(3), without expressly providing for a right of set-off, state the rule that performance must be made concurrently (articles 58(1), 81(2)). the principle of concurrent performance and the right of set-off are based on a similar idea. in both cases, the main rationale is to prevent a party from recovering all that is owed to it while the other party is left with the risk of having to assert its claim before a court or arbitral tribunal.25 1.3 articles 58(1), 81(2), 88(3) reflect the idea of a fair balance of interests in the course of exchanging performances. as far as article 88(3) is concerned, the cisg focuses on an efficient and expedited way for settling reciprocal money debts between the parties. ultimately, the provisions deal with the way in which mutual payment obligations are performed; the question is a ‘matter governed by this convention’ (article 7(2)). 1.4 set-off is the accentuated version of concurrent performance. to take the situation dealt with in article 88(3), if the buyer sold the goods on account of the seller for, say, $10,000 and had preservation and selling costs of $800, the buyer, in strict application of the principle of concurrent performance, would give $10,000 to the seller and would receive, a couple of seconds later, $800 from him. this to and fro shifting of sums of money can be cut short in that the buyer pays only the difference between the resale price and his costs, that is, $9,200. instead of proceeding to a real concurrent exchange of a sum of money against another sum of money, the exchange is merely ‘virtual’; it ‘happens’ when calculating the difference between the sums that the parties owe each other.26 article 88(3) explicitly provides for this manner to ‘accelerate’ concurrent performance. the convention does not limit this way to proceed to the situation of article 88(3). on the contrary, it is inherent in the ideas underlying the principle of concurrent performance, namely a fair distribution of risks as well as efficiency, that a party may limit itself to paying the difference between its own and the other party’s claim instead of having to engage in an effective exchange of sums. this mere paying of the difference is the characteristic of a set-off as it is understood under the cisg (see above, para. 0.1). the advisory council has already had the 11 occasion to state that ‘a general denial of set-off as a subject dealt with by the convention is too widely stated’27, and has admitted that ‘concurrency in making restitution … is most effectively promoted by permitting setoff’28. in this opinion, the advisory council confirms its position whilst broadening the scope by holding that the set-off of monetary claims arising from the cisg is a question governed by the convention, even if the only place where it is settled expressly is article 88(3).29 1.5 application of general principles of the cisg. matters governed by the cisg but not expressly settled in it are subject to the general principles on which the convention is based, unless no such general principles exist (article 7 para. 2). black letter rule no. 1 states the rule that a set-off of monetary claims arising under the cisg are governed by the convention’s general principles. the rationale behind this rule is twofold: (a) the setting off of monetary claims is a mode of payment; (b) from the rules of the cisg regarding payment, general principles can be derived that indicate the way a set-off can take place, as well as its effects. the content of each of those general principles, their legal basis, and their application to set-off are exposed in detail in the comment on rules no. 2 to 4. for some specific questions, no general principle can be derived from the convention; those questions are therefore governed by the otherwise applicable law (article 7 para. 2 in fine). however, this shall not hinder the application of the cisg to the other aspects of the set-off (below, paras 4.8 et seq.). 1.6 claims governed by the cisg. the cases (quite numerous by now) where the convention has been held to apply to a set-off all concerned claims that were both governed by the cisg (see above, para. 0.2). as far as can be seen, it has never happened so far that the convention was applied in a situation where one of the claims in a set-off had its legal basis in a law other than the cisg. this is in line with the view of this opinion. in fact, as is generally known, the convention is limited in its scope: it governs the buyer’s and the seller’s claims arising out of the sales contract, but does not deal with other, not sales-specific claims, such as claims in tort or unjust enrichment, or claims relying on the invalidity of the contract (article 4). those claims are governed by the law designated by the applicable choice-of-law rules (article 7 para. 2). it is thus that other law, and not the cisg, that states whether such a claim has arisen, whether it must be asserted or whether courts and arbitral tribunals must consider it ex lege, whether it is subject to time limits, etc. 1.7 the fact that those claims are outside the scope of the cisg thus excludes the applicability of the convention to a set-off that would include such a ‘cisg-external’ claim. this is based on the following considerations. a set-off is a way to perform monetary obligations which is not explicitly settled in the convention (cf. above, para. 1.4, and below, para. 2). the cisg deals with performance and, more specifically, with payment only as far as the parties’ duties arising out of the sales contract stricto sensu are concerned. from those rules on performance and payment, 12 general principles can be derived. those general principles are applicable to ‘matters governed by the convention’ (article 7 para. 2). as for the matters not governed by the cisg, article 7 para. 2 cannot dictate that they be governed by general principles of the cisg, as this is a question that has to be answered by the law governing that cisg-external matter. in other words, set-off is a matter of the cisg only to the extent it concerns claims arising out of the cisg, and it is only with regard to such a set-off that the cisg can stipulate the application of its general principles. thus, the cisg’s general principles can only be applied to setoff to the extent that the set-off is between ‘cisg-internal’ claims. 1.8 claims arising out of the same contract or out of different contracts. rule no. 1 states the rule that, as long as both claims are governed by the cisg, the fact that the claims do not arise out of the same contract does not prevent the application of the convention to the set-off. the reason for this will be explained in relation with rule no. 5 (below, paras 5.1 et seq.). 1.9 parties’ agreement taking precedence. rule no. 1 does not explicitly state that the parties may derogate from or vary the rules on setoff derived from the general rules of the convention. these possibilities are a matter of course, derived from article 6 of the cisg. in practice, the parties do often provide for contractual arrangements. they may, for instance, agree that, in a specific case, their mutual claims do not have to be settled in kind, but that only the party that owes the greater amount will pay it to the other party (also called ‘set-off by agreement’). especially in long-standing business relationships, the parties may also provide for socalled ‘netting’ clauses, in which the parties agree on a mechanism of continuous discharge of liabilities.30 contrariwise, the parties may also exclude the possibility of setting off claims which they hold against each other. this too is not unusual31 and usually serves the purpose of preserving a party’s cash flow. common ways of excluding the right to set-off are payment clauses such as ‘net cash’, ‘cash on delivery’, ‘cash against documents’ or ‘documents against payment’.32 where no such agreement exists, the cisg provides the legal basis for one party’s right to set off its claim against the other party’s claim, and without that other party’s consent, under the requirements and to the effect derived from the convention’s general principles. 2.2.2. 2. set-off has the same effect as the performance of a monetary obligation by payment. according to the understanding underlying set-off under the cisg, set-off produces a balance, which is the difference between both monetary claims (above, para. 0.1). the residual amount remains due. this effect is explicitly provided for in article 88(3) cisg, which states that the party entitled to resell the goods on account of the other party may retain out of the proceeds of the sale the amount corresponding to the reasonable expenses of reselling the goods and must account for the balance. the 13 same effect has been accorded in all the other situations where a set-off has been admitted under the cisg: the party relying on the set-off is exempted from actually paying the claim addressed to it and owes only the difference between the two amounts.33 in other words, the party relying on set-off does not really pay, but nevertheless fulfils the claim the other party has against it, by setting off its own claim against the other party’s claim. the payment consists, so to speak, in the fact that the party setting off waives/renounces its right to receive actual payment for its own claim. of course, the effect of actual payment and the effect of set-off are not exactly identical, because the party faced with the set-off may not accept the existence of the other party’s claim and will have to, as the case may be, assert this fact in court or before an arbitral tribunal. but this risk on behalf of the first party is inherent in a set-off and, to the extent a set-off is considered as a matter governed by the convention (above, para. 1.2), accepted as such under the cisg. it is rather the mechanism of set-off as it operates under the cisg that matters, and which produces the effect that actual payment of the debt would have: the party relying on set-off ‘pays’ the other party by retaining the sum owed to it and remains liable only for the difference.34 2.2.3. 3. set-off is exercised by a declaration made by notice. the notice must reach the other party but does not take effect before both claims are due. 3.1 set-off is declared by making notice. in case law dealing with set off under the convention, there is usually only a general indication that the defendant is relying on a right of set-off, without further specifications of the manner or the modalities in which set-off is evoked.35 sometimes, a set-off is asserted no earlier than during the judicial proceedings.36 however, there are also some cases in which it is clear that a set-off has been ‘claimed’ or ‘effectuated’ before judicial proceedings were commenced.37 3.2 rule no. 3 poses the principle that a set-off governed by the cisg must be declared by making notice to the other party. this is based on the following considerations: set-off is meant to reduce the amount owed to the creditor by the amount which the creditor owes to the debtor (above, para. 1.4). either party can rely on set-off, provided that they both hold a monetary claim against each other. set-off avoids the need for each party to perform its obligation by making actual payment (above, paras 1.2 et seq.). nonetheless, where the parties have not agreed on a netting mechanism where mutual debts are automatically balanced on a regular basis at an agreed date (above, para. 1.9), set-off usually is of interest to one of the parties only, whereas the other party rejects the set-off, often by denying the very fact that the first party holds a claim against it, and by insisting on actual payment. because of this constellation, set-off is to be considered as a means of defence that is put forward by the party who argues that there is no need to make actual payment, since it (that party) 14 has a claim against the other party, too. in other words, the party who refers to set-off invokes the right not to make actual payment. 3.3 under the convention, rights which are granted to one of the parties have legal effect only if they are declared to the other party. this can be derived from a number of provisions, such as articles 14 et seq (offer and acceptance), article 26 (declaration of avoidance), article 39 (notice of lack of conformity), articles 47 and 63 (fixing an additional period of time), article 48(2)-(4) (notice of exercising the right to cure), article 50 (price reduction), article 65 (specification concerning features of the goods), article 71 (notice of suspension), article 72 (notice of avoidance for anticipatory breach), article 73 (notice of avoidance of an instalment contract), and articles 85-88 (notices relating to the duty to preserve the goods). article 88(3), which deals with set-off with respect to the party who is entitled to sell the goods which it was bound to preserve, states that that party ‘has the right to retain out of the proceeds of sale an amount equal to the reasonable expenses of preserving the goods and selling them’ and that it ‘must account to the other party for the balance’. by using these words, article 88(3) implicitly requires the party intending to set off to express this intention to other party.38 3.4 those provisions show that the convention has subscribed to the principle of declaration, meaning that rights on which a party wishes to rely under the convention must be communicated to the other party by way of declaration. in fact, as has been pointed out many times, the cisg has rejected both the concept that a party’s rights must be asserted by way of a judicial claim as well as the concept that rights are effectuated ipso facto.39 the principle of declaration applies without exception to all rights under the convention. it can thus easily be identified as a ‘general principle on which it is based’ (article 7 para. 2) and may be used as a basis for set-off under the convention.40 rule 3, 1st sentence, therefore states that a party who wants to rely on a set-off under the cisg must declare it to the other party. 3.5 absence of form requirements. the convention is based on the principle of freedom from form. this is shown in article 11, according to which a contract of sale need not be concluded in or evidenced by writing and is not subject to any other requirement as to form,41 and very generally in most, if not all other provisions of the cisg, which do not reserve a particular form for exercising a right, or for any other kind of communication. accordingly, it has often been said that a ‘general principle’ within the meaning of article 7 para. 2 can be derived, stating that all declarations and communications provided for in the convention are free from requirements as to form.42 this general principle can be used for set-off under the cisg. certainly, as set-off is not explicitly settled in the convention, ‘declaring set-off’ is not a declaration expressly provided for in the convention. however, there is unanimity on the point that the principle of freedom from form requirements does not only apply to declarations explicitly settled in the convention, but also to declarations 15 referring to matters governed by but not expressly settled in the cisg (article 7 para. 2).43 this is the case as regards set-off (above, para. 1.2). the principle of freedom from form requirements is therefore applicable to it. of course, the parties can agree otherwise in the contract and, for instance, subject the declaration of set-off to a writing requirement.44 3.6 the declaration must reach the other party but does not take effect before both claims are due. another question is the point in time at which the declaration of set-off becomes effective. the question comprises two aspects. the first point to be answered is the moment in time from which on the declaration is considered as having been made (below (a)). the second point concerns the question of when set-off takes effect, that is, the moment at which both claims are set off against each other (below (b)). 3.7 to answer those questions, the advisory council is guided by the following two considerations: on the one hand, the set-off must be declared (above, para. 3.2), and on the other hand, the set-off has the same effect as a payment (above, para. 2). 3.8 (a) the declaration must reach the other party. as regards the question of when the declaration is considered as having been made, the cisg operates the distinction between communications that only become effective once they have been received by the other party (such as in article 47 para. 2, 1st sentence, article 63 para. 2, article 65, or article 79 para. 4), and other communications. those other communications are governed by article 27 cisg. although the wording of this provision deals only with the risk of delay and distortion, it is usually treated as also providing for the rule that a declaration becomes effective upon dispatch.45 3.9 the rationale underlying article 27 is that the addressee of the communication is the party in breach, and that it is therefore for that party to assume the risk of loss or delay in the transmission of the communication.46 where neither party is in breach, or where the consequences triggered by the declaration are significant, the principle of receipt rather than the principle of dispatch applies. this must also hold true in relation to the declaration of set-off. where the parties have mutual claims, none of the parties is ‘more in breach’ than the other; rather, both parties owe each other performance of their respective duty. of course, it may be that one of the claims arises out of a breach of contract, e.g., where the buyer sets off a claim for damages against the seller’s claim for the purchase price. it might also be that both claims arise out of a breach of contract; this is the case where, e.g., the buyer claims an amount corresponding to the reduction of the purchase price to which it is entitled according to article 50, and the seller holds a claim for interest because of late payment of the purchase price (article 78). however, this is not decisive for the purposes of determining the appropriate rule regarding the point in time the set-off declaration is made. in fact, the rule in article 27 aims at putting the risk of loss or delay on the addressee in the course 16 of the execution of the sales contract, e.g., where the buyer notifies a nonconformity (article 39), or where buyer or seller fix an additional period of time for performance (article 47 para. 1, article 63 para. 1), claims performance (article 46 para. 1, article 62), or where a party terminates the contract (article 26). in other words, article 27 applies to situations in which the addressee is supposed to know that something in the execution of its obligations is ‘improper’ and calls for correct fulfilment. this is not the case with a set-off declaration, the only goal of which it is to inform the addressee of the fact that there will be a set-off instead of actual payment. the principle of article 27 is thus not suited to be applied to a declaration of set-off, and it is the receipt rule rather than the dispatch rule that must apply to the declaration of set-off. this means that the declaration of set-off must reach the other party; if it is not received, the declaration must be considered as not having been made. 3.10 this finding is corroborated by one further aspect. in fact, as set-off is understood as one way to perform a monetary obligation, that is, as an alternative to payment (above, para. 2), the rules of the cisg on the time of payment must be taken into account. in this regard, the convention stands for the view that payment occurs once the creditor of the monetary claim has received it.47 merely having initiated the payment process does not yet constitute payment. the rules on payment in the convention thus follow the ‘receipt theory’, so to speak, and not the theory of dispatch. applying this idea to set-off, it becomes evident that the notification with which set-off is declared must be received by the other party in order to be effective. 3.11 (b) set-off does not take effect before both claims are due. the moment in time at which set-off is declared must be distinguished from the moment a set-off becomes effective, that is, the time the claims are actually set off. set-off, despite its assimilation to payment, rests on a declaration. declarations can be made early (or retroactively) under the cisg; that is, what is stated in the declaration need not necessarily become effective immediately upon its having been declared. a party may, for example, declare the contract avoided in two weeks’ time, or may declare the contract avoided as of last week. the declaration of avoidance as such becomes effective upon dispatch, but the moment the declaration’s content takes effect is prior or later than that point in time. the same holds true for set-off, which may be declared before the claims are actually set off. 3.12 as set-off has the same effect as payment (above, para. 2), it seems appropriate to determine the moment set-off takes effect according to the rules governing the claim for payment of the purchase price or other sums. according to article 61 cisg, the right to claim the purchase price, or damages, requires that the buyer has failed to perform its contractual obligation. as long as performance is not due, the buyer who does not pay the price (or otherwise does not perform) is not in breach of contract. similarly, according to article 81(2), a claim to pay back the purchase price 17 cannot be raised as long as this duty to make restitution has not become due. the convention thus establishes the rule that a monetary claim must be due in order to be claimable.48 applied to set-off, as a set-off enables the party who relies on it to recover the claim that it has against the other party, the claim of the party declaring set-off must be due.49 as long as it is not due, a set-off, even if it has been declared, cannot have any effect. in fact, just as a party cannot claim payment before the due date, so the party who sets off instead of asking for actual payment must await the due date for recovering its claim by way of set-off. 3.13 another question is whether the claim against which set-off is declared must be due, too. in this regard, the opinion bases its considerations on article 58, which deals with the time of payment. in application of this provision, it has almost unanimously been held that the buyer is not entitled to pay earlier than at the date determined in the contract. in case of early payment, the seller can refuse its acceptance.50 the seller who accepts early payment may reserve its right to compensation of possible exchange rate losses.51 the seller’s right to refuse acceptance of early payment, although not explicitly stated in article 58, corresponds to the deliberations and the finding of the drafting committee. as schlechtriem states, ‘[w]hile a motion to clarify this point [i.e., the seller’s right to return the payment made before the due date] was rejected, it was nevertheless generally assumed that the seller could decline premature or partial payments. it was believed that only the question of whether the seller must return the money at once needed negotiation.’52 3.14 this rule, derived by interpretation of article 58, can be generalised for all sorts of monetary claims under the cisg and, in a next step, analogously applied to a set-off. in fact, as the debtor who relies on set-off is making a short-cut payment to the creditor (above, para. 2)., it should not be entitled to do so before the creditor’s claim has become due. just as it is held to not be possible to impose acceptance of an early payment on the seller, set-off cannot take effect before the creditor’s claim is mature. of course, as with actual payment, the creditor is free to accept set-off even if its monetary claim is not yet due. 3.15 one further point that needs clarification in this respect is the moment a claim becomes due. this point in time is determined either by the contract or the cisg.53 absent a parties’ agreement, the due date for a monetary claim is fixed, or can at least been derived, from the various provisions dealing with the different monetary claims. for instance, a claim for payment of the purchase price is governed by article 58, which provides that, absent an agreement between the parties to the contrary, the price must be paid when the seller places the goods or documents controlling their disposition at the buyer’s disposal. a claim for damages becomes due at the moment the loss occurs.54 interest on the purchase price that must be paid back after avoidance of the contract becomes due on the date the purchase price was originally paid,55 etc. applied to a setoff under the convention, the question of when each of the claims 18 becomes due will depend on their nature. for example, a set-off of the seller’s claim for payment of the purchase price and the buyer’s claim for damages can take place at the earliest once the seller’s claim has become due (which can be the moment the seller places the goods at the buyer’s disposal or some other date before or after that point in time, depending on the parties’ agreement) and the buyer’s loss has occurred (which gives right to its damages claim, which is immediately due). 3.16 set-off has no retroactive effect. as set-off is seen as an alternative form of payment, its effect must be similar to the effect payment has. in case of actual payment, the party owing a monetary claim has performed its obligation at the moment the other party can dispose of the sum which is owed to it. as long as the first party has not paid, its obligation to pay persists. likewise, if a party is in arrears with payment, it is bound to pay interest on the sum which is due until the moment it makes the payment (article 78).56 if liquidated damages have been agreed on in case of late payment, the party who does not pay on time must pay the amount provided for in the liquidated damages clause. in other words, payment deploys its effect only for the future and is not dated back to some earlier point in time (ex-nunc-effect as opposed to ex-tunc-effect). 3.17 the same must hold true for set-off. a set-off replaces actual payment of a monetary obligation. as long as it has not taken place, the debtor has not performed its obligation to pay. thus, if the debtor sets off the claim that it has against the creditor after the creditor’s claim has become due, the debtor has been in arrears with payment during the period in which payment had to be effectuated but was not. the debtor must pay interest for that time and, as the case may be, liquidated damages or penalties. in other words, set-off must have an ex-nunc-effect, too, as does actual payment. there is no reason to treat the party who sets off better than the party that makes actual payment. 3.18 the solutions found in certain civil law legislative instruments, according to which a set-off, once it has been evoked, dates back to the time the claims were eligible for set-off (above, paras 0.5 and 0.6), finds no support under the cisg. there are historical reasons for the retroactive effect of set-off under those legislative instruments that have no legitimate basis under the convention. rather, set-off under the cisg must be derived from the convention itself, in particular from its rules on payment, according to which the debtor has not fulfilled its obligation until the sum is paid. 2.2.4. 4. exercising the right to set off does not require the claims to be liquidated or to be in the same currency. 4.1 set-off need not be expressed in the same currency. quite often, the claims to be set off will be expressed in different currencies, for example, where a claim for payment of the purchase price is set off against a claim for damages. whereas the parties will usually have agreed on the currency in which the purchase price must be paid, the currency of the 19 damages claim will normally be the one in which that party suffered the loss,57 which usually is its place of business.58 as the case may be, the loss might also occur in another currency, for example, where the loss consists in expenditure incurred in debt collection.59 4.2 unlike, e.g., the picc 2016, the cisg does not specifically address questions of currency or, more specifically, the question of whether a monetary claim expressed in a certain currency may be fulfilled in another currency. however, most authors and tribunals agree that currency is a question governed by the convention.60 4.3 for the question of whether a set-off may take place where the claims are not in the same currency, article 88(3) and article 84 are of guidance. the first provision states a party’s right to retain out of the proceeds of sale ‘an amount equal to the reasonable expenses of preserving the goods and of selling them’. the provision also applies where the buyer reselling the goods on the seller’s account had already paid the purchase price. in this case, the seller must pay back the purchase price in the currency that was fixed for the payment of the purchase price,61 whereas the buyer must account ‘for the proceeds of the sale’ (article 88(3)). those will be in the currency agreed on for the resale with the third party and may thus differ from the currency in which the seller has to make restitution of the purchase price. similarly, article 84 provides that the seller who is bound to refund the price must pay interest on it, whilst the buyer must account to the seller for all benefits derived from the goods. it is generally admitted that the claims can be set off.62 at the same time, not infrequently, the two claims will not be expressed in the same currency. in fact, interest on the price to be paid back is held to be payable in the currency of payment,63 whereas the benefits for which the buyer must account will often have arisen in another currency, probably in the currency of the buyer’s country. 4.4 thus, both article 84 and article 88(3) provide for a set-off of claims of different currencies. the rule can be generalised to the effect that a set-off should be possible even if the claims are expressed in different currencies. this principle finds its limits where the claim that is used to declare set-off is expressed in a non-convertible currency, as this would make it impossible to determine the amount of that claim and thus also the amount that has been set off. the addressee of the set-off declaration who suffers currency losses will have a claim for damages under article 74.64 4.5 the rule will not apply where the parties have excluded the right to set off claims of different currency. as the case may be, it may matter to a party to receive payment in a foreign currency which is stronger or more reliable than its own currency, or that party might wish to receive payment only in one particular currency, e.g., the currency of its place of business. the contract may provide for individual or standard foreign currency clauses to make it clear that payment in a currency other than the 20 agreed one is excluded. a set-off of claims expressed in different currencies is not possible in that case. 4.6 the claims need not be liquidated. set-off under the convention will often involve a claim for damages, mostly on behalf of the party who declares the set-off. not infrequently, the amount of the loss which is claimed will not yet be determined (‘liquidated’). rule no. 4 adopts the view that set-off is not precluded in such a case. this is based on considerations developed in the light of the rules of the convention on interest (article 78). under the cisg, interest starts to accrue from the moment a ‘sum is in arrears’. as far as damages are concerned, they become due as soon as the loss occurs (above, para. 3.15). therefore, the party in breach of contract is in arrears from the day the loss occurred and has to pay interest on the claim for damages from that date on, regardless of whether the exact amount of the loss has been established or not.65 the term ‘sum’ used in article 78 thus includes unliquidated monetary claims. in other words, the debtor of a damages claim, the exact amount of which is yet to be determined, is under an obligation to pay a sum which is likely to cover the creditor’s loss in order to avoid having to pay interest accruing on that sum.66 4.7 for the sake of consistency in the interpretation of the convention’s notions, a ‘sum’ (‘monetary claim’) in relation to a set-off must involve unliquidated sums, too. it would be inconsistent for a debtor of a damages claim to be bound to pay a sum approximately covering the loss incurred (in order to avoid too high a sum of interest accruing on it), but not to be allowed to fulfil that same payment obligation by setting off its claim that it has against the creditor. likewise, set-off must be possible where the claim which is used to declare set off is not yet ascertained as to its amount. whether it is the claim that is put to set-off which is unliquidated or whether the claim of the other party is not yet ascertained as to its amount, in both cases the risk lies on the party setting off its claim to do so in an amount that is likely to correspond to the unliquidated claim. for example, if the debtor of an unliquidated damages claim estimates that the loss will amount to 50,000 € and sets off its payment claim in that same amount against the first party, and if it later turns out that the loss is 60,000 €, that same debtor has been in arrears with payment in the amount of 10,000 € since the occurrence of the loss. similarly, if the debtor of a payment claim of 50,000 € sets off with a claim for damages that it expects to amount to 50,000 € as well, whereas its loss is later fixed at 40’000 €, it will have been late on payment of the purchase price since the moment the other party’s claim for payment was due. 4.8 questions for which no rules can be derived from the cisg. having shown that rules can be derived from the general principles on which the cisg is based that can be applied to a set-off of cisg-internal claims, there are a number of questions regarding set-off where this is not possible. for instance, the question may be raised whether a set-off is possible where one of the parties has become insolvent, or where one of 21 the claims is time-barred, or where a claim which initially existed between the parties has been assigned to a third party. these situations involve matters that are, generally speaking, outside the scope of the convention.67 this does not constitute an obstacle to the application of the cisg to a set-off. 4.9 just as, in a sales contract governed by the cisg, matters of insolvency, prescription, or assignment are resolved in application of the respective domestic laws, or international rules of law, a set-off that would raise similar questions will have to comply with the applicable respective rules, notwithstanding the fact that the aspects that do not concern ‘cisgexternal’ matters will remain governed by the convention. 4.10 more precisely, for the question of set-off in insolvency, the decisive factor must be the extent to which the applicable domestic law regulates the operation and the effect of set-off in a mandatory manner. in fact, insolvency set-off may differ significantly from one legal system to the other, e.g., as concerns the automatic effect of set-off as soon as a party enters insolvency proceedings (as is the case in english law) or, in other jurisdictions, the date up to which a set-off is possible, whether insolvency set-off is mandatory or can be excluded by agreement, the date at which the account is taken, the requirements as to the nature of the claims that are set off, etc.68 if the insolvency proceedings do not modify the way set-off operates but merely provides for a cut-off date after which no set-off is possible, it is the cisg that governs the question of whether the requirements for a set-off are met; domestic law in that case only states whether the party relying on set-off may still do so after commencement of the insolvency proceedings.69 in contrast, where, according to the applicable insolvency law, the entering of a party into insolvency proceedings actually creates a (new) set-off situation, this insolvency setoff is, in its entirety, subject to domestic law. 4.11 if the question arises whether the claim with which set-off is declared is time-barred, and whether it may still be set off against the other party’s claim, the fact that the cisg does not provide for rules on prescription does not hinder its application to the other aspects of the setoff; just as in any other cisg-contract, the question of prescription, including its effects, must be resolved in conformity with the law, or rules of law, applicable by virtue of the rules of private international law (article 7 para. 2 in fine); the other points (e.g., the question of how set-off is brought about, questions of currency, ex-nunc effect of a set-off, etc.) remain governed by the cisg. the same holds true where the question arises of whether and under what conditions a party to a cisg-contract may set off its claim against the other party’s claim where that other party has assigned its claim to a third party, or where one of the parties has acquired a claim against the other party from a third party by way of assignment: in the absence of any provision on the matter in the cisg, the specific question of whether a set-off of claims that have been assigned 22 is governed by the otherwise applicable rules of law, such as the picc,70 or the applicable domestic law (article 7 para. 2 in fine). 4.12 finally, many domestic laws, and rules of law such as the picc, prohibit set-off by law in certain constellations. often, set-off is barred with regard to claims that cannot be transferred by law, such as salaries and pensions of civil service employees, or with regard to claims based on intentional civil wrongs. in other words, set-off is prohibited essentially where vital claims are concerned, or claims aimed at the compensation of gross injustice. the cisg does not address these questions and does not establish general prohibition rules, as this is outside its scope (article 4). thus, no rule can be derived from the cisg as to whether set-off is prohibited in certain situations. however, exactly because the set-off restrictions provided for in domestic laws concern claims that do not fall within the scope of the cisg, the absence of rules in this respect that would be derivable from the convention is irrelevant. in fact, the cisg has the authority to consider itself applicable only with respect to matters that fall within its scope, and it thus applies to a set-off only to the extent that the claims that are set off are governed by it. this concerns claims for payment of the purchase price or monetary contractual claims for breach of contract (above, para. 1.6). the set-off of such claims does not raise the question of its admissibility. the fact that the cisg does not provide for rules on prohibition of set-off is thus not be an obstacle to the application of the convention to a cisg-internal set-off. 2.2.5. 5. the application of the cisg to a set-off does not affect matters of res judicata or counterclaims. 5.1 the rule must be read together with rule no. 1, which states that monetary claims governed by the cisg may be set off in conformity with the general principles of the convention, regardless of whether they arise out of the same contract or not. the latter rule has been adopted because the application of the cisg to a set-off does not affect matters of res judicata (below, paras 5.7 and 5.8) or the possibility of a counterclaim (below, para. 5.9), and affects the question of judicial competence only to the extent the set-off under the cisg operates as a defence to the claim and not as an independent set-off of procedural nature (below, paras 5.4 et seq). 5.2 judicial competence. as a world-wide undisputed rule, the question of whether a court or arbitral tribunal is competent to hear a claim is a matter of civil procedural law or arbitration law as the case may be. a set-off may raise rather difficult questions where the claims to be set off would not be subject to the same jurisdiction, were they raised individually. in contract law matters, this situation arises if the claims arise out of different contracts which do not have the same jurisdiction. the scenarios may vary: it may be that the claim against which set-off is declared arises out of a contract that is subject to a jurisdiction clause, whereas the contract out of which the second claim arises is not, and vice 23 versa. it is possible that different forum selection clauses exist for both contracts, conferring, as the case may be, exclusive jurisdiction to the respective prorogated court. other constellations include claims arising out of contracts that are subject to different and diverging arbitration clauses, or claims originating from contracts of which the first one is subject to arbitration and the second one subject to state court jurisdiction, or vice versa. 5.3 if a party brings a claim before the court or arbitral tribunal competent to hear that claim and the defendant raises a right of set-off (which may either consist in the assertion that a set-off has taken place, or that the court or arbitral tribunal seized pronounce the set-off in the proceedings), the question arises whether the court or arbitral tribunal may hear the set-off defence.71 this will depend on the applicable laws or rules of the forum or place of arbitration, on the one hand, and the specific constellation in which the question arises, on the other hand.72 broadly speaking, the following approaches are either provided by law or applied by courts and arbitral tribunals: the court seized by the first party is competent to hear the set-off defence despite the absence of jurisdiction over the claim of the party relying on set-off; or the court stays the proceedings on the first claim, or execution, pending resolution of the second claim in the other jurisdiction; or the court declines to hear the setoff defence.73 where the first claim is subject to an arbitration clause whereas the second claim is not, or is subject to another arbitration clause, approaches also differ. to the extent the arbitration agreement cannot be interpreted conclusively, the question whether set-off will be entertained by the arbitral tribunal will depend on the approach taken in the applicable laws or rules or adopted by the arbitral tribunal. the approaches vary and are altogether similar to those developed under state court jurisdiction, even though the general trend moves towards an ‘attraction of competence’, that is, the permissibility of set-off despite lacking jurisdiction over the claim relied upon for the purposes of set-off.74 finally, the first claim may be subject to state court jurisdiction whereas the second claim is subject to an arbitration clause. again, different courts have come to different solutions as regards the question of whether the court that has been seized should entertain the set-off defence.75 5.4 allowing or not allowing the set-off defence to be heard, staying the proceedings, or proceeding yet in another manner: that question is, in principle, not linked to the one on the applicability of the cisg to a setoff. applying the convention to cisg-internal claims does not modify the existing rules on judicial competence, which remains a question of civil procedure law or arbitration law as the case may be. a court may thus, in application of its procedural lex fori, refuse to hear a set-off defence if the claim of the party that relies on set-off is subject to an arbitration clause.76 from a comparative perspective, this is quite obvious for civil law legal systems, which consider set-off as a matter of substantive law and where there is a priori no overlap between the question of which law is applied to 24 the set-off and the question of whether a court or arbitral tribunal may entertain the set-off defence. for legal systems where set-off is, in the first place, an instrument of procedural law, the divide between applicable law and competence to hear the set-off might be less obvious, but those systems also have well known situations in which a set-off operates as a substantive defence to the claim. this is particularly the case in situations with which this opinion is concerned, that is, in sales contracts arising out of the same contract or transaction.77 the position taken here is thus less foreign to sales laws of common law jurisdiction than it could seem at first glance, even though one should not overemphasise similarities with domestic concepts, as the approach under the cisg is autonomously derived from within the convention and is independent from solutions found under national laws. 5.5 rule 1 in conjunction with rule 5 thus states that the set-off of claims arising out of a contract governed by the cisg takes place according to the rules derived by the cisg. the rule does not raise questions of competence, as both the first and the second claim originate from the same contract, and the forum or arbitral tribunal competent to hear the dispute is the one chosen in the contract or determined in application of the relevant procedural rules.78 the court or arbitral tribunal competent to hear the first claim is also competent to adjudicate the question of a set-off (always provided that the set-off concerns cisginternal claims). this is not precluded by the fact that, in the absence of a specific party agreement, several places of jurisdiction may be possible for the contractual dispute. 5.6 rule 1 further states that a set-off of claims arising out of different contracts both governed by the cisg operates according to the rules derived from the cisg and has the effect provided by it. the application of the cisg is thus not limited to a set-off arising out of the same contract. in fact, there is no valid reason to consider that, where the set-off concerns claims from the same contract, the cisg provides for general principles governing the set-off, but does not so provide where similar claims, though arising from different transactions, are set off. 5.7 this approach does not modify the existing procedural rules on judicial competence as such. however, as with the requirements for setoff of cisg-internal clauses, its operation and its effect are governed by the convention. further, as a set-off under the convention need not be asserted before a court or arbitral tribunal and does not depend on a judgment or award, a set-off of cisg-internal claims constitutes a defence to the main claim provided for by the convention, that is, by substantive law. a court whose domestic law provides for procedural set-off can therefore not simply apply the criteria applicable to a set-off under its own law but must take account of the fact that the set-off it is asked to adjudicate is a matter of unified sales law. for example, a court which, in applying its own procedural law, would deal with a set-off only where a claim is liquidated cannot bar the defendant’s unliquidated set-off defence 25 where the set-off is governed by the cisg. this is because the convention allows for a set-off of unliquidated claims (above, paras 3.16 and 3.17). 5.8 res judicata. where the parties’ dispute is brought before a court or arbitral tribunal, the latter will admit or deny that the claims have been set off. the question may arise whether each of the claims may independently be raised in a new trial or whether the fact that there has been a judicial decision in the matter precludes adjudication by another court. the problem, known as res judicata (preclusion), is subject to the applicable procedural law. generally speaking, in civil law countries, res judicata applies only to the operative part of the judgment (dispositif du jugement; fallo de la sentencia; prononcé; urteilstenor). for example, where the defendant in a law suit argues that the plaintiff’s claim must be rejected in the amount the defendant has a claim that it has set off and the court follows this argument by approving the plaintiff’s claim only to the extent it exceeds the defendant’s set-off claim, the operative part of the judgment will be ‘order to pay x and dismissal of the remainder of the plaintiff’s claim’. the reason why part of the plaintiff’s claim is dismissed – the fact that the defendant could rely on set-off – is just the motive and does not belong to the operative part of the judgment. however, by now, most domestic procedural rules contain a rule which extends res judicata to set-off,79 or which entitles the plaintiff to demand an interim decision on the existence or non-existence of a right of set-off.80 res judicata in common law is considerably stricter than in civil law. broadly speaking, a final judgment on the merits has to be reached for it to be conclusive between the parties as to all matters that were litigated or that could have been litigated in that action, which includes claims there were brought as a set-off in the proceedings, or could have been brought but were not.81 the principle of res judicata has also been upheld in arbitration law.82 5.9 the procedural rules on res judicata remain unaffected by the application of the cisg to set-off. the question of the law applicable to set-off and the matter of res judicata are separate questions. the cisg governs the question of whether the claims have been set off. whether another court, or an arbitral tribunal, may come back to the question of whether there has been a set-off is a matter of procedural law. 5.10 counterclaim. finally, the application of the cisg to a set-off has no impact on the question of whether the claim in dispute can be brought as a counterclaim instead of being set off against the plaintiff’s claim. even though the terminology is not everywhere the same, and that under the us american federal rules of civil procedure, e.g., the term ‘counterclaim’ includes (procedurally operating) set-off,83 there are important differences between a set-off under the cisg and a counterclaim as it is habitually defined. from a comparative perspective, the most important difference is that a counterclaim requires a pending action, that is, it operates only before a court or arbitral tribunal. a counterclaim has the advantage that it enables the defendant to enforce its claim against the plaintiff even if the proceedings have been initiated by 26 the plaintiff, and it may exceed the amount claimed by the plaintiff. depending on the applicable procedural law, a counterclaim may also allow third parties to be involved in the litigation. however, a counterclaim requires a pending action, can be subject to time limits and formalities, has an effect on the court fees and the bearing of the costs of procedure, and usually requires that the counterclaim can be conducted in the same type of proceedings as the action.84 all those aspects, in particular availability, requirements and effects of a counterclaim, are subject to the procedural lex fori or lex arbitri. a counterclaim is thus an instrument that differs from any type of domestic set-off, also from procedurally operating set-off, and that differs considerably from a set-off under the cisg. for a party confronted with a claim arising from a sales contract, set-off and counterclaim presen85t different possibilities to react, depending on the circumstances of the case. obviously, where a party decides to raise a counterclaim rather than to rely on a set-off, in the merits, its claim will be governed by the cisg, but the applicability of the convention is limited to it, and the admissibility and operation of the counterclaim is subject to the applicable procedural law. 3. annex – table of cases austria oberster gerichtshof (austria), 22 october 2001, cisg-online 614, internationales handelsrecht 2002, 27. internationales schiedsgericht der wirtschaftskammer österreich, sch-4921, 11 march 2006, http://www.unilex.info. oberlandesgericht wien, 23 january 2017, internationales handelsrecht 2018, 241. oberster gerichtshof (austria), 10 may 2017, internationales handelsrecht 2018, 241 vienna arbitration proceeding (austria) s 2/97 (barley case), 10 december 1997, cisg-online 351 germany amtsgericht duisburg (germany), 13 april 2000, cisg-online 659 bundesgerichtshof (germany), 24 september 2014, cisgonline 2545, internationales handelsrecht 2015, 9. bundesgerichtshof (germany), 5 november 1998, neue juristische wochenschrift (1999) 635 bundesgerichtshof (germany), 9 january 2002, cisg-online 651 landgericht bamberg (germany), 23 october 2006, cisgonline 1400, internationales handelsrecht 2007, 113 27 landgericht duisburg (germany), , 17 april 1996, cisg-online 186 landgericht hagen (germany), 15 october 1997, cisg-online 311 landgericht mönchengladbach (germany), 15 july 2003, cisgonline 813 landgericht münchen (germany), 6 may 1997, cisg-online 341 landgericht stuttgart (germany), 29 october 2009, cisg-online 2017 oberlandesgericht celle (germany), 29 january 2015, cisg-online 2618, internationales handelsrecht 2015, 247 oberlandesgericht düsseldorf (germany), 21 april 2004, cisgonline 915 oberlandesgericht düsseldorf (germany), 22 july 2004, cisgonline 916 oberlandesgericht düsseldorf (germany), 28 may 2004, cisgonline 850 oberlandesgericht hamburg (germany), 25 january 2008, cisgonline 1681. oberlandesgericht hamburg (germany), 26 november 1999, cisgonline 515 oberlandesgericht hamburg (germany), 5 october 1998, cisgonline 473 oberlandesgericht karlsruhe (germany), 20 july 2004, cisg-online 858, internationales handelsrecht 246 (251) oberlandesgericht köln (germany), 14 august 2006, note ii.2.d), cisg-online 1405 oberlandesgericht köln (germany), 19 may 2008, cisg-online 1700 oberlandesgericht münchen (germany), 11 march 1998, cisgonline 310 oberlandesgericht münchen, (germany) 19 october 2006, cisgonline 1394 oberlandesgericht münchen (germany), 9 july 1997, cisg-online 282 oberlandesgericht stuttgart (germany), 20 december 2004, cisgonline 997 and 21 august 1995, cisg-online 150 oberlandesgericht hamburg (germany), 28 february 1997, cisgonline 261 switzerland appellationsgericht basel-stadt (switzerland), 26 september 2008, cisg-online 1732 28 bundesgericht (switzerland), 20 december 2006, cisg-online 1426, internationales handelsrecht 2007, 127. cour de justice de genève (switzerland), 9 october 1998, cisg-online 424 handelsgericht st. gallen (switzerland), 14 june 2012, cisgonline 2468, internationales handelsrecht 2014, 15 (21) handelsgericht st. gallen, (switzerland) 3 december 2002, cisg-online 727 handelsgericht zurich (switzerland), 22 december 2005, cisg-online 1995 handelskammer zürich (switzerland), 31 may 1996, cisgonline 1291. kantonsgericht freiburg (switzerland), 23 january 1998, cisg-online 423 kantonsgericht zug (switzerland), 14 december 2009, cisgonline 2026 united states of america bull v. united states, 295 u.s. 247, 262 (1935). maxxsonics usa, inc. v. fengshun peyjing electro acoustic co. ltd., n.d. ill., 21 march 2012, cisg-online 2372 china cietac china international economic & trade arbitration commission (china), 13 june 1989, cisg-online 865 greece decision 43945/2007 of the single-member court of first instance of thessaloniki (greece), 2008 (pace). spain district court badalona (spain), 22 may 2006, cisg-online 1391 russia federal arbitration court for the moscow region (russia), 26 may 2003, cisg-online 836 netherlands gerechthof arnhem (netherlands), 15 april 1997, cisgonline 1330 rechtbank arnhem (netherlands), 25 february 1993, cisgonline 98 rechtbank middelburg (netherlands), 25 january 1995, unilex, case no. 153; cisg-online 374 rechtbank roermond (netherlands), 6 may 1993, unilex, case no. 94 29 united kingdom in re izaguirre, 166 b.r. 484, 490-93 (bankr. n.d. ga. 1994) national westminster bank plc v skelton [1993] 1 wlr 72, 76. reiter v. cooper, 113 s. ct. 1213, 1218 n.2 (1993) the angelic grace [1980] 1 lloyd’s rep. 288 sweden swedish supreme court of 3 april 1998, stockholm arbitration report 1999/2, 77 et seq. russia tribunal of international commercial arbitration at the russian federation chamber of commerce and industry (russia), 9 march 2004, cisg-online 1184 tribunal of international commercial arbitration at the russian federation chamber of commerce and industry (russia), 17 june 2004, cisg-online 1240 ukraine tribunal of international commercial arbitration at the ukraine chamber of commerce and trade (ukraine), 10 october 2003, cisgonline 923 tribunal of international commercial arbitration at the ukraine chamber of commerce and trade (ukraine), 15 april 2004, cisg-online 1270 italy tribunale di padova (italy), 25 february 2004, cisg-online 819 4. footnotes 1 see <http://www.oxforddictionaries.com/definition/english/standard>. 2 see <http://www.iso.org/iso/home/standards.htm>. 3 ‘the codex alimentarius was established by fao and the world health organization in 1963 to develop harmonised international food standards, which protect consumer health and promote fair practices in food trade’ (<http://www.codexalimentarius.org/>). 4 <http://www.tesco.com/csr/g/g4.html>. 5 <http://www.brcglobalstandards.com/>. for examples of british standards in respect of heating appliances and carbon dioxide for industrial use, see medivance instruments ltd v gaslane pipework services ltd, vulcana gas appliances ltd [2002] ewca civ 500 and messer uk ltd and anr v britvic soft drinks ltd [2002] ewca civ 548, respectively. 6 <http://www.globalgap.org/uk_en/who-we-are/about-us/>. 7 <http://www.mygfsi.com/about-us/about-gfsi/what-is-gfsi.html>. 8<http://equator-principles.com/index.php/about-ep/governance-and-management>. 9 <http://www.iso.org/iso/home/about.htm>. 10 <http://www.fairtrade.org.uk/en/what-is-fairtrade/who-we-are>. 30 11 see d saidov, ‘standards and conformity of goods in sales law’ [2017] lmclq 65, 68-71. 12 see, eg, g smith, ‘interaction of public and private standards in food chain’ (2009) oecd food, agriculture and fisheries working papers no. 15, oecd publishing, 3233. 13 see, eg, ibid, 24. 14 see, eg, h collins, ‘conformity of goods, the network society, and the ethical consumer’ (2014) 5 european rev private l 619; i schwenzer, ‘conformity of the goods – physical features on wane?’ in i schwenzer and l spagnolo (eds), state of play: the 3rd annual maa schlechtriem cisg conference (the hague: eleven international publishing, 2012) 103-106; k maley, ‘the limits to the conformity of goods in the united nations convention on contracts for the international sale of goods (cisg)’ (2009) 12 int’l trade business l rev 82. 15 art 8(3) cisg: ‘in determining the intent of a party or the understanding a reasonable person would have had, due consideration is to be given to all relevant circumstances of the case including the negotiations, any practices which the parties have established between themselves, usages and any subsequent conduct of the parties.’ 16 art 35(2)(a). 17 take, for example, electronic industry citizenship coalition (eicc), that comprises more than 100 companies, probably including all major companies (see <http://www.eiccoalition.org/about/members/>). not only do the eicc members subscribe and are held accountable to a common code of conduct, but many of them have also adopted their own codes of conduct. in addition to the eicc members, thousands of suppliers of those companies are required to implement the eicc code (see: <http://www.eiccoalition.org/about/members/>; g nimbalker, c cremen, y kyngdon and h wrinkle, ‘the truth behind the barcode: electronic industry trend’, at: <http://www.baptistworldaid.org.au/assets/behindthebarcode/electronicsindustry-trendsreport-australia.pdf>, 15, (for the results of a survey of 39 eicc members, according to which 82% out of those companies have a code of conduct that covers core ilo principles)). 18 see, eg, smith (n 12). for the structure of supply chains, see f cafaggi, ‘sales in global supply chains: a new architecture of the international sales law’ in d saidov (ed), research handbook on international and comparative sale of goods law (edward elgar 2019; forthcoming). 19 see, e.g., oberlandesgericht düsseldorf, 28 may 2004, cisg-online 850; oberlandesgericht karlsruhe, 20 july 2004, cisg-online 858; oberlandesgericht münchen, 9 july 1997, cisg-online 282; landgericht stuttgart, 29 october 2009, cisgonline 2017; amtsgericht duisburg, 13 april 2000, cisg-online 659. 20 see, e.g., oberlandesgericht köln, 19 may 2008, cisg-online 1700; oberlandesgericht düsseldorf, 21 april 2004, cisg-online 915; handelsgericht st. gallen, 3 december 2002, cisg-online 727; oberlandesgericht münchen, 19 october 2006, cisg-online 1394. 21 see, e.g., district court badalona (spain), 22 may 2006, cisg-online 1391. 22 see bundesgerichtshof (germany), 24 september 2014, cisg-online 2545, where the buyer set off its costs of repair against the seller’s claim for the remaining purchase price; oberlandesgericht hamburg, 26 november 1999, cisg-online 515, where the buyer countered the seller’s claim for payment of the proceeds of sale under article 88(3) with a claim for damages. 31 23 see, e.g., bundesgerichtshof (germany), 5 november 1998, neue juristische wochenschrift (1999) 635; cour de justice de genève (switzerland), 9 october 1998, cisg-online 424; handelskammer zürich (switzerland), 31 may 1996, cisg-online 1291. 24 see, e.g., cietac china international economic & trade arbitration commission (china), 13 june 1989, cisg-online 865; federal arbitration court for the moscow region (russia), 26 may 2003, cisg-online 836; tribunal of international commercial arbitration at the ukraine chamber of commerce and trade (ukraine), 10 october 2003, cisg-online 923; tribunal of international commercial arbitration at the ukraine chamber of commerce and trade (ukraine), 15 april 2004, cisg-online 1270; tribunal of international commercial arbitration at the russian federation chamber of commerce and industry (russia), 9 march 2004, cisg-online 1184; tribunal of international commercial arbitration at the russian federation chamber of commerce and industry (russia), 17 june 2004, cisg-online 1240; see also schwenzer & kee, barter contracts and the cisg, internationales handelsrecht (2009) 219 et seq.; mohs in schlechtriem, schwenzer & schroeter (eds), ad art. 53 para. 28. 25 see zimmermann, comparative foundations of a european law of set-off and prescription, cambridge 2002, p. 29, with further references; pichonnaz/gullifer, set-off in arbitration and commercial transactions, oxford 2014, para. 2.61 et seq.; see also cisg advisory council opinion no. 9, consequences of avoidance of the contract, para. 3.11: ‘the concurrence of the parties’ obligations means that each party has a type of security in not having to give credit to the other.’ 26 see, e.g., fountoulakis, set-off defences in international commercial arbitration, a comparative analysis, oxford 2011, 7; wood, english and international set-off, london 1989, para. 1-4. 27 cisg advisory council opinion no. 9, consequences of avoidance of the contract, para. 3.23. 28 ibid. 29 see also bundesgerichtshof (germany), 24 september 2014, cisg-online 2545, note 56, internationales handelsrecht 2015, 9; magnus in staudinger, ad art. 4 para. 47. 30 netting arrangements serve the purpose of controlling certain types of risk (see, e.g., firth, derivates: law and practice, london 2013) and are, among other types of transactions, often used in futures contracts, which may fall under the cisg. 31 see oberlandesgericht hamburg, 5 october 1998, cisg-online 473, where the parties were held to have excluded the possibility of set-off by integrating the clause ‘net 40 days’ in their contract. the court held that the net-payment clause prohibited the buyer from deducting any alleged damages from the purchase price. see also oberlandesgericht münchen, 11 march 1998, cisg-online 310 (set-off excluded by § 10(2) of the standard conditions of the german textile and clothing industry); vienna arbitration proceeding s 2/97 (barley case), 10 december 1997, cisg-online 351 (set-off excluded in seller’s general terms and conditions). 32 see the cases cited in footnote 31; in legal writing, see mohs in schlechtriem, schwenzer & schroeter (eds), ad art. 61 para. 19; magnus in staudinger, ad art. 53 para. 13; huber in münchener kommentar, ad art. 53 para. 15, with further references. 33 e.g., bundesgerichtshof (germany), 24 september 2014, cisg-online 2545, internationales handelsrecht 2015, 9; oberlandesgericht wien, 23 january 2017, internationales handelsrecht 2018, 241; kantonsgericht zug, 14 december 2009, cisg-online 2026; oberlandesgericht münchen, 19 october 2006, note 3, cisg-online 1394; oberlandesgericht köln, 14 august 2006, note ii.2.d), cisg-online 1405. 34 it is to be noted that the idea to compare set-off with a short-cut payment is not unanimously shared in domestic laws. the differences in perception are due to the 32 qualification of set-off as either procedural or substantive, cf. pichonnaz/gullifer, set-off in arbitration and commercial transactions, oxford 2014, para. 2.61; fountoulakis, set-off defences in international commercial arbitration, oxford 2011, 8-9. 35 see, e.g., oberlandesgericht münchen, 9 july 1997, cisg-online 282. 36 see oberlandesgericht köln, 19 may 2008, cisg-online 1700. 37 district court badalona (spain), 22 may 2006, cisg-online 1391 (the seller paid back a part of the purchase price after having ‘discounted’ a certain amount as bank transfer costs); oberlandesgericht düsseldorf, 21 april 2004, cisg-online 915, in which the seller was held to have impliedly declared set-off by refusing to make full restitution of the purchase price because it allegedly held a damages claim against the buyer; landgericht stuttgart, 29 october 2009, cisg-online 2017. 38 magnus in leible (ed), 209 (221) et seq.; fountoulakis in schlechtriem, schwenzer & schroeter, ad art. 81 para. 21. 39 see uncitral yb iii (1972) 41-54, uncitral yb iii (1972) 85-86, paras 28-47; hellner, ipso facto avoidance, in ehmann (ed), privatautonomie, eigentum und verantwortung, festgabe für hermann weitnauer zum 70. geburtstag, berlin 1980, 85 et seq. 40 bundesgerichtshof (germany), 24 september 2014, cisg-online 2545, note 58, internationales handelsrecht 2015, 9; magnus in staudinger, ad art. 4 para. 47; fountoulakis in schlechtriem & schwenzer, ad art. 81 para. 21. 41 an exception to this is article 96, which allows states whose legislation requires contracts of sale to be concluded in or evidenced by writing to issue a reservation in accordance with article 12, to the effect that the principle of freedom from form requirements enshrined in the convention does not apply where any party has its place of business in that state. 42 see, e.g., schmidt-kessel in schlechtriem & schwenzer, ad art. 11 para. 10; perales viscasillas in kröll/mistelis/perales viscasillas, ad art. 11 para. 14; magnus in staudinger, ad art. 11 para. 7. 43 schmidt-kessel in schlechtriem & schwenzer, ad art. 11 para. 11; perales viscasillas in kröll/mistelis/perales viscasillas, ad art. 11 para. 6. 44 see also oberlandesgericht düsseldorf, 21 april 2004, cisg-online 915 (impliedly declared set-off considered being valid in terms of form). 45 schlechtriem and schroeter, internationales un-kaufrecht, 6th ed., tübingen 2016, para. 315; schroeter in schlechtriem, schwenzer & schroeter, ad art. 27 para. 28, with references; magnus in staudinger, ad art. 27 para. 24; benicke in münchener kommentar hgb, ad art. 27 para. 13 et seq. 46 schroeter in schlechtriem, schwenzer & schroeter, ad art. 27 para. 2. 47 piltz, münchener anwaltshandbuch, internationales wirtschaftsrecht, munich 2017, § 7 para. 202; piltz, internationales kaufrecht, 2nd ed., munich 2008, para. 4-124; mohs in schlechtriem & schwenzer, ad art. 53 para. 12; fountoulakis in beckogk, ad art. 53 para. 25. 48 see article 59, which provides that the buyer must pay the purchase price on the date fixed or determinable from the contract and the convention, in other words, at the time it is due. from this provision, a general principle is derived according to which the payment of sums other than the purchase price follow the same rule, that is, they must be paid on the date they become due. honnold and flechtner, uniform law for international sales, para. 340; schwenzer and hachem in schlechtriem & schwenzer, ad art. 7 para. 35; ferrari in schlechtriem, schwenzer & schroeter, ad art. 7 para. 55; mankowski in ferrari et al., ad art. 59 para. 11; mohs in schlechtriem, schwenzer & schroeter, ad art. 59 para. 33 6; fountoulakis in beckogk, ad art. 59 para. 8, 13; oberlandesgericht hamburg, 25 january 2008, cisg-online 1681. 49 in case law, the fact that the claim that is used for set-off must be due seems to have been underlying all cases in which the right to set-off was considered. the requirement of maturity of that claim is usually not explicitly examined. it rather appears as a commonly accepted general rule that this claim must fulfil the requirements which must be met in order to make a (separate) claim for payment (oberlandesgericht münchen, 19 october 2006, cisg-online 1394; oberlandesgericht köln, 14 august 2006, cisgonline 1405; oberlandesgericht düsseldorf, 21 april 2004, cisg-online 915; oberlandesgericht münchen, 9 july 1997, cisg-online 282; oberlandesgericht hamburg, 26 november 1999, cisg-online 515; oberlandesgericht hamburg, 5 october 1998, cisg-online 473; landgericht mönchengladbach, 15 july 2003, cisgonline 813 ; amtsgericht duisburg, 13 april 2000, cisg-online 659). 50 schlechtriem and schroeter, internationales un-kaufrecht, 6th ed., tübingen 2016, para. 530; magnus in staudinger, ad art. 58 para. 31; piltz, internationales kaufrecht, 2nd ed., munich 2008, para. 4-146; butler and harindranath in kröll/mistelis/perales viscasillas, ad art. 58 para. 33; mankowski in ferrari/kieninger/mankowski/otte/saenger/schulze/staudinger (eds.), internationales vertragsrecht, 2nd ed., munich 2018, ad art. 59 para. 10; huber in münchener kommentar bgb, ad art. 58 para. 28; fountoulakis in beckogk, ad art. 58 para. 44; contra mohs in schlechtriem & schwenzer, ad art. 58 para. 20. 51 maskow in bianca & bonnell, ad art. 58 note 2.4; magnus in staudinger, ad art. 58 para. 31; butler/harindranath in kröll/mistelis/perales viscasillas, ad art. 58 para. 33, with further references. 52 schlechtriem, uniform sales law – the un-convention on contracts for the international sale of goods, vienna 1986, p. 82 footnote 329, with references to a/conf. 97/c.1/l.206=o.r., p. 123 and a/conf. 97/c./sr.25 at 9 o.r., p. 370. 53 opinion no 14, interest under article 78 cisg, rule 3, sentence 2. 54 bacher in schlechtriem, schwenzer & schroeter, ad art. 78 para. 9; fountoulakis in beckogk, ad art. 59 para. 14, and 14.1. 55 fountoulakis in beckogk, ad art. 59 para. 14. 56 bacher in schlechtriem, schwenzer & schroeter, ad art. 78 para. 25a. 57 olg hamburg, 28 february 1997, cisg-online 261; schwenzer in schlechtriem & schwenzer, ad art. 74 para. 63, with further references. 58 magnus in staudinger, ad art. 74 para. 56; magnus, währungsfragen im einheitlichen kaufrecht. zugleich ein beitrag zu seiner lückenfüllung und auslegung, rabelsz 53 (1989) 116, 134-135. 59 magnus in staudinger, ad art. 74 para. 56; magnus, rabelsz 53 (1989) 116, 134-135; mankowski in münchener kommentar hgb, ad art 74. para. 14. 60 cf. magnus, rabelsz 53 (1989) 116, 127 et seq.; magnus in staudinger, ad art. 53 para. 20, with references; brunner, murmann and stucki in brunner (ed.), un-kaufrecht – cisg -, 2nd ed., bern: stämpfli, 2014, ad art. 4 para. 54; fountoulakis in beckogk, ad art. 53 para. 11 et seq.; martiny in reithmann & martiny, para. 6.64; contra schlechtriem and witz, convention de vienne sur les contrats de vente internationale de marchandises, paris 2008, para. 279. 61 cisg advisory council opinion no. 9, consequences of avoidance of the contract, rule no. 2.4. 62 cisg advisory council opinion no. 9, consequences of avoidance of the contract, para. 3.23. 34 63 cisg advisory council opinion no. 9, consequences of avoidance of the contract, para. 3.26. 64 see, for payment of the purchase price in another currency, fountoulakis in beckogk, ad art. 53 para. 14; for other situations see, e.g., cisg advisory council opinion no. 9, consequences of avoidance of the contract, para. 3.8. 65 opinion no 14, interest under article 78 cisg, rule 3 letter b and rule 4, comment 3.10. 66 opinion no. 14, interest under article 78 cisg, rule 3 letter b and rule 4, comment 3.10. 67 for many, see ferrari, in schlechtriem, schwenzer & schroeter, ad art. 4 para. 33, 3538; schwenzer and hachem, in schlechtriem & schwenzer, ad art. 4 para. 47, 50. this does not exclude that there remain interactions between domestic insolvency laws and the cisg, as is emphasised by those authors. 68 see pichonnaz/gullifer, set-off in arbitration and commercial transactions, oxford 2014, chapters 12 and 13. 69 this is generally the case in civil law jurisdictions see pichonnaz/gullifer, set-off in arbitration and commercial transactions, oxford 2014, para. 13.09 et seq. 70 for a case relying on the picc and the principles of european contract law in relation to the question of whether a party had fulfilled its obligation of payment by setting it off against claims it had against the creditor where the creditor had assigned its claim to a third party, see internationales schiedsgericht der wirtschaftskammer österreich, sch4921, 11 march 2006, http://www.unilex.info. 71 the term ‘defence’ is used in a non-technical manner. 72 pichonnaz/gullifer, set-off in arbitration and commercial transactions, oxford 2014, para. 3.03 et seq. 73 pichonnaz/gullifer, set-off in arbitration and commercial transactions, oxford 2014, para. 3.20 et seq., with further references. 74 mourre, the set-off paradox in international arbitration, arb. int. 2008, 387 et seq.; schöll, set-off defences in international arbitration. critera for best practice – a comparative perspective, asa special series no. 26 (2006), 97 et seq.; kee, set-off in international arbitration – what can the asian region learn?, 1 asian int. arb. j. (2005), 141 et seq.; gabriel and meier, set-off defenses in arbitration – conclusions from a swiss civil law perspective, 5(2) indian journal of arbitration (2017), 55 et seq. 75 ibid. 76 cf., e.g., kantonsgericht zug, 14 december 2009, cisg-online 2026, para. 14. 77 cf. § 2-717 ucc, on the one hand, and equitable set-off, on the other hand (above, para. 0.7). whereas the first is limited to the same contract, equitable set-off requires that the claims arise out of the same transaction, which is appreciated by the court and may, as the case may be, give rise to set-off even if the claims stem from separate contracts, see the angelic grace [1980] 1 lloyd’s rep. 288; national westminster bank plc v skelton [1993] 1 wlr 72, 76. 78 theoretically, the parties could provide otherwise in a forum selection or arbitration clause, but considering the difficulties arising from such an agreement, this seems very unlikely. 79 e.g., swedish code of judicial procedure, chapter 17, section 11 para. 2; german zpo, § 322 para. 2; ley de enjuiciamiento civil (spain), article 408.3. 80 austrian zpo, § 236. 81 see federal rules of civil procedure, rule 13(a)(1), according to which the defendant is obliged to state as a counterclaim (including set-off) any claim that he has against the 35 opposing party if the claim arises out of the transaction (or occurrence) that is the subject matter of the plaintiff’s claim. 82 see judgment of the swedish supreme court of 3 april 1998, stockholm arbitration report 1999/2, 77 et seq. and also reported in söderlund, lis pendens, res judicata and the issue of parallel judicial proceedings, 22(4) journal of international arbitration 2005, 301, 317-318: against the majority vote of the arbitrators and based on the domestic law of civil procedure, the supreme court found that legal finality in respect of an arbitral award extended to any claim that has been invoked for set-off purposes, even if the set-off claim exceeds the main claim. see also poudret/besson, comparative law of international arbitration, 2nd ed., london 2007, 279-280; günes, res judicata in international arbitration: to what extent does an arbitral award prevent the re-litigation of issues?, 12(6) transnational dispute management 2015, 1, 20. 83 cf. federal rules of civil procedure, rule 13(c). 84 for further differences between set-off and counterclaim and their respective advantages and disadvantages see pichonnaz/gullifer, set-off in arbitration and commercial transactions, oxford 2014, para. 5.13 et seq. looking for the basis of precontractual liablity in the cisg published how far does the dynamic doctrine go? looking for the basis of precontractual liability in the cisg anne rossen,* marie hummelshøj pedersen,** & thomas neumann*** * master of laws, assistant attorney at kammeradvokaten/poul schmidt, e-mail: annerossen@hotmail.com. ** master of laws, legal officer at the danish ministry of justice, department of civil affairs, e-mail: mariehummelshoej@hotmail.com. *** phd, master of laws, associate professor department of law, aalborg university, e-mail: thn@law.aau.dk. orcid.org/0000-0002-0477-7429. 1. introduction ...................................................................................... 3 2. scope of application ........................................................................ 6 3. the notion of good faith as imposing duties on the parties in the precontractual stage ...................................................... 13 3.1. good faith through interpretation according to article 7(1) ............................................................................... 14 3.2. good faith as a general principle according to article 7(2) ............................................................................... 17 3.3. determining the content of the potential duty to observe good faith .............................................................. 21 3.3.1 relevance of soft law instruments ................... 22 3.3.2 good faith in light of soft law ........................... 28 4. conclusion ......................................................................................... 29 njcl 2020/1 3 1. introduction imagine the businessman who enters into contract negotiations with the purpose of gaining otherwise confidential knowledge about a competitor’s trade practices. is he liable to pay the other party’s negotiation costs when the negotiations are broken off? the question is answered differently in domestic legal systems and it is understandable that one might attempt to classify the situation as either a contractual one or one of tort.1 the problem of such a binary view is often that “[…] the parties are no longer strangers to each other as presumed by tort law, nor are they parties to a contract which contract law requires to trigger all the rights and duties […]”,2 hence a third alternative way is used in some legal systems.3 the inherent conundrums of precontractual liability are familiar in most domestic legal systems, but they also turn overly complex if the parties are located in each their jurisdiction. this article analyses whether the united nations convention on contracts for the international sale of goods (cisg) governs any precontractual questions. precontractual liability under the cisg has been discussed sparsely in the literature and since the convention neither expressly deals with nor excludes precontractual liablity it leaves a gap of knowledge. a further examination of the convention’s applicability to precontractual liability, what the legal foundation of such precontractual duties may be, and what such duties may consist of is desired. some authors have relied upon art. 16(2) cisg as a basis for also imposing precontractual liability under the cisg.4 for instance, accepting a wrongfully revoked offer and hereafter claiming damages could arguably be impractical under certain circumstances. imagine the following scenario: the offeror has offered to buy machinery at a certain price and promised to hold the offer open for two months, giving the offeree time to start the process of designing the machinery to determine whether it would be possible to sell it at the offered price. if the offeror then revokes the offer before the expiry of the two months, the offeree would already have had expenses, but would not yet be ready to accept the offer since 1 hans henrik edlund, ‘culpa in contrahendo: tortious liability, breach of contract or an autonomous legal instrument?’. european business law review 30, no. 5 (2019), 815-822.; ingeborg schwenzer, pascal hachem and christoffer kee, global sales and contract law (1. edn, oxford university press 2012) 275. 2 schwenzer/hachem/kee, global sales (n 1) 275. 3 this is the approach in germany, according to schwenzer/hachem/kee, global sales (n 1) 283. 4 silvia gil-wallin, ‘liability under pre-contractual agreements and their application under colombian law and the cisg’ nordic journal of commercial law (2007/1) 1920; diane madeline goderre ‘international negotiations gone sour: precontractual liability under the united nations sales convention’ 66 u. cincinnati law review 1997 258-281, 281;john o. honnold, uniform law for international sales under the 1980 united nations convention (3rd edn. kluwer law international 1999) 167-168. 4 precontractual liability in the cisg the designing and examination process is not yet completed.5 an acceptance of the offer would require further expenses for the offeree in order to finish the designing and examination process to a level where the offeree would be able to accept the offer at the offered price. these expenses may or may not be compensated after having pursued a damage claim through a lawsuit.6 the offeree would then be in the unfortunate situation of having to choose between stopping the process with a loss or continue the process with increased expenses risking not being able to be reimbursed for these expenses through a lawsuit. it may be argued that the cisg in a situation like this provides no effective remedy, leaving a gap in the cisg. this gap may be filled by settling the matter in accordance with art. 7(2) cisg by giving the offeree the remedy of claiming damages directly for wrongful revocation of the offer.7 this would arguably be in line with the protection provided for in art. 71 and 72 cisg, regarding anticipatory breach, although these provisions would not be directly applicable unless a contract has been concluded.8 in this scenario the cisg encompasses precontractual liability since it provides for damages although no contract has been concluded. however, precontractual liability often denotes more than this single example and comprises any prior negotiations not necessarily involving offer and acceptance.9 the precontractual liability that may be based upon art. 16(2) cisg and its analogical application may still be limited. hence, the question arises whether there is support elsewhere in the cisg for establishing precontractual liablility or whether the matter is excluded altogether leaving aside the one example described above. it may be argued that the precontractual liability that may be derived from art. 16(2) reaches further than mere liability for wrongful revocation of an offer. it may also be argued that this protection might extend to negotiations and the withdrawal from them due to the similarities between these situations. if a party relies upon the negotiations and suffers a loss when the other party withdraws, it may be unjustified for the other party to withdraw. the party withdrawing may then be held liable for the unjustified withdrawal from the negotiations.10 imagine for example the situation where a party never intended to enter into a contract, but makes the proposition to contract only to gain access to confidential information, to distract or to make the other party make futile efforts. in that situation, a contract would never be concluded, and the aggrieved party may be left with a loss and in addition he may have granted the buyer access to 5 this example is constructed by honnold in honnold, uniform law (n 4) 167. 6 honnold, uniform law (n 4) 167. 7 honnold, uniform law (n 4) 168. 8 honnold, uniform law (n 4) 168, note 22. 9 albert h. kritzer (ed.), pre-contract formation, available at: pace law school institute of international commercial law https://www.cisg.law.pace.edu/cisg/biblio/kritzer1.html (accessed 11 may 2020). 10 gil-wallin, liability (n 4) 19-20. njcl 2020/1 5 confidential information. would an adjudicator be able to award the aggrieved party damages on the basis of precontractual liability in such situation? taking into account that the purpose of the cisg is to remove legal barriers in international trade and to promote uniformity and certainty in international trade,11 it could be argued that it is in accordance with this purpose to let the scope of the cisg reach as far as possible and thereby encompass more aspects of precontractual liability. since precontractual liability is dealt with very differently in the domestic laws of the different contracting states12 it would presumably promote uniformity and remove legal barriers if the cisg applied to the issue. in relation to domestic law, it has been noted that “[t]he existence and scope of pre-contractual duties depend on what stance a legal system takes towards the general principle of good faith.”13 this is similar to that of the cisg where good faith is relevant in two aspects. first, art. 7(1) in which good faith is mentioned as a tool of interpretation. how art. 7(1) is to be understood may affect the role of good faith and whether an analogical interpretation of art. 16(2) cisg is allowed, thus forming a foundation for precontractual duties under the cisg. second, if the precontractual liability is considered within the scope of the convention in accordance with art. 4 cisg, but without it being settled, art. 7(2) permits the use of underlying principles. one of such principles could potentially be a principle of good faith and fair dealing. however, whether or not precontractual liability is even within the scope of the cisg is often overlooked in the debate,14 but is nonetheless crucial. consequently, the analysis of the present paper is two-fold. first, it is analysed whether precontractual liability falls within the scope of the cisg. second, presupposing that the answer to the first question is affirmative, it is analysed whether the notion of good faith in the cisg provides enough footing for the cisg to deal with more precontractual issues than the art. 16-example explained previously. this paper predominantly focuses on establishing the legal foundation for precontractual liability under the cisg and does not seek to determine the effects of breaching precontractual duties in detail as this exceeds the limits of the paper. furthermore, art. 81(2) cisg and art. 84 cisg could possibly provide a basis for some form of precontractual liability under the cisg, 11 see cisg preamble and the uncitral website ‘united nations convention on contracts for the international sale of goods (vienna, 1980) (cisg)’ at https://uncitral.un.org/en/texts/salegoods/conventions/sale_of_goods/cisg (accessed 11 may 2020). 12 lisa spagnolo, ‘opening pandora’s box: good faith and precontractual liability in the cisg, opening pandora's box: good faith and precontractual liability in the cisg.’ 21 temple international and comparative law journal 2007 261–310, 282-283. 13 schwenzer/hachem/kee, global sales, p. 278. 14 spagnolo, pandora’s box (n 12) 293. 6 precontractual liability in the cisg that does not necessarily require acts in bad faith or contrary to good faith. however, none of these provisions have been subject of independent study as good faith is presumed to be the most plausible road to include precontractual liablity under the convention. 2. scope of application before discussing any possible duty to act in good faith under the cisg it is paramount to determine whether the convention may be extended to the precontractual phase, and thereby whether precontractual liability falls within the scope of the cisg. as mentioned previously this is an issue sometimes overlooked in scholarship.15 since precontractual liability is not expressly excluded by virtue of art. 2-5 cisg16 it is relevant to consider whether the issue is encompassed by the wording ‘formation of the contract’ or ‘rights and obligations’ arising from such a contract in accordance with art. 4 cisg. when formation of the contract is governed by the cisg the question might be asked: “is not precontract formation a part of formation of the contract?”17 it may be argued, that precontractual liability is outside the scope of the cisg, since there is no contract between the parties. the provisions that contain remedies in cisg part iii all appear to presuppose that a contract is concluded. damages provided for in art. 74 cisg, for instance, provides only for “damages for breach of contract”. it may, therefore, be argued that cisg part iii and the remedies contained therein do not apply unless a contract is concluded and that everything that happens prior to the conclusion is not really to be considered within the scope of the cisg18 leaving remedies on the basis of precontractual liability outside the scope of the convention. in contrast, however, cisg part ii does apply to the determination of whether a proposal is sufficiently definite to constitute an offer19 and whether such offer has been accepted,20 and thereby whether a contract is in fact concluded.21 the cisg therefore also applies in some situations, although a contract may never have been concluded. consequently, the precontractual phase could be governed by the cisg and a breach of precontractual duties could lead to damages following an analogical application of the conventions rules in part iii and through application of underlying principles. according to the wording of art. 4 cisg the convention “governs only” the formation of the contract and the rights and obligations of the 15 spagnolo, pandora’s box (n 12) 293. 16 camilla baasch andersen, francesco g. mazzotta, and bruno zeller, a practitioner’s guide to the cisg (1st edn. juris 2010) 78. 17 kritzer, pre-contract formation (n 9). 18 spagnolo, pandora’s box (n 12) 303 here referring to schlechtriem in workshop 230. 19 cisg art. 14. 20 cisg art. 18-19. 21 cisg art. 23. njcl 2020/1 7 parties arising from such. however, one could argue that the wording should be read as “governs without doubt”,22 since the cisg also contains provisions not directly related to formation of contracts or rights and obligations of the parties.23 as demonstrated above, some parts of the cisg applies also to situations where no contract is formed. though the present authors are sceptical, one could argue that a more liberal interpretation of the wording of art. 4 seems appropriate and that it therefore cannot be concluded that precontractual liability is excluded from the scope of the convention merely from the wording of art. 4 and the wording ‘formation of contract’. the close connection between negotiations and contract formation may make the issue of precontractual liability internal rather than external to the cisg.24 how close that connection is will however depend on the progress of the negotiations and it will be quite difficult to determine exactly when this connection is sufficiently close to make the issue internal to the cisg. when consulting the legislative history it is seen that the issue of precontractual liability was in fact considered. at the 8th session of the working group, a suggestion to include a provision that would give a party the right to claim compensation if the other party had violated a duty of care customary in the preparation of a contract was introduced:“in case a party violates the duties of care customary in the preparation and formation of a contract of sale, the other party may claim compensation for the costs borne by it.”25 delegates in favour found that it recognised duties on the parties prior to the conclusion of the contract and provided sanctions in case of violation. the majority of the delegates, however, were in opposition to this proposal and expressed the concern that the provision was too uncertain and might negatively affect the number of countries choosing to ratify the convention.26 the suggestion was rejected at the 9th session of the working group.27 at the 1980 diplomatic conference the german democratic republic suggested to include a quite similar provision: “where in the course of the preliminary negotiations or the formation of a contract a 22 ingeborg schwenzer (ed.) schlechtriem & schwenzer, commentary on the un convention on the international sale of goods (cisg) (4th edn. oxford university press 2016) 74. 23 schlechtriem/schwenzer, commentary (n 22) 74. here reference is made to art. 7, 8, 9, 11, 29 cisg. 24 spagnolo, pandora’s box (n 12) 298. 25 uncitral yb ix (1978), a/cn.9/ser.a/1978, 66, para. 70 reprinted in john o. honnold, documentary history of the uniform law for international sales. the studies, deliberations and decisions that led to the 1980 united nations convention with introductions and explanations (kluwer law and taxation publishers 1989) 298 26 uncitral yb ix (1978), a/cn.9/ser.a/1978, 67, paras. 84-85 reprinted in honnold, documentary history (n 25) 299. 27 uncitral yb ix (1978), a/cn.9/ser.a/1978, 67, para. 86 reprinted in honnold, documentary history (n 25) 299. 8 precontractual liability in the cisg party fails in his duty to take reasonable care, the other party is entitled to claim compensation for his expenses”.28 some delegates supported the proposal,29 but a majority did not.30 the delegates supporting the proposal considered the existing text to not sufficiently take into account the cases where no contract was concluded, but where one party might abuse its position and cause damage to the other party.31 those in opposition considered it too far-reaching, and that it was yet another attempt to include the concept of good faith despite the lengthy discussions regarding this concept.32 this proposal was also rejected.33 had any of the above mentioned provisions been included in the cisg, it would have contained an express reference to precontractual duties on the parties to act in good faith.34 as was the case with the general discussion on whether and how to include a good faith reference in the cisg, the delegates strongly disagreed on the question of precontractual liability in the cisg. the question of the application of the cisg to the precontractual phase, therefore, remains an open discussion. notwithstanding the drafting history, the salient question is whether courts have subsequently considered precontractual liability to be a matter within the convention’s scope. in a german court decision,35 the court had the opportunity to address the issue of precontractual liability in a contract governed by the cisg. the court decided that no contract had been concluded according to the cisg, and then decided whether the buyer had a claim under the domestic doctrine of ‘culpa in contrahendo’. the court did not explicitly establish that precontractual liability was outside the scope of the cisg, but this would appear to be implied since the court decided on this matter by recourse to domestic law with no further references to the cisg. the decision could indicate that the court found the issue clearly outside the scope of the cisg, but could as well be an expression of a homeward trend. when the court decided on the issue of contract formation the court decided the dispute upon the bgb36 and stated: “this is consistent with the provisions of the cisg, which apply in the present case”.37 the court continued to make references to the bgb and 28 spagnolo, pandora’s box (n 12) 272. 29 united nations conference on contracts for the international sale of goods, vienna, 10 march-ii april 1980, official records / un doc. a/conf. 97/19, 294-295, paras. 80, 84. 30 a/conf. 97/19 (n 29) 294-295, paras. 81, 82, 83, 85. 31 a/conf. 97/19 (n 29) 294-295, paras. 80, 84. 32 a/conf. 97/19 (n 29) 294-295, paras. 81, 85. 33 a/conf. 97/19 (n 29) 295, paras. 86, 87. 34 spagnolo, pandora’s box (n 12) 273. 354 march 1994 appellate court frankfurt, germany case no. 10 u 80/93. 36 german domestic contract law, bürgerliches gesetzbuch (bgb). 37 (n 35). original german quote reads: “dies stimmt mit der regelung des einheitlichen unkaufrechts (cisg) überein, das vorliegend anwendung findet” available at http://www.unilex.info/cisg/case/205 (accessed 11 may 2020). njcl 2020/1 9 subsequently to the cisg thus openly admitting to a homeward trend. consequently, the persuasive weight of the court decision is less. in a u.s. court decision,38 the court considered a contract to be governed by the cisg, but applied domestic law to determine whether one of the parties had claims arising from the precontractual phase. the court expressly debated the scope of cisg preemption, but found the cisg not to preempt claims based on promissory estoppel, except for those addressed by art. 16(2)(b) cisg. the court also found claims based on negligence and negligent misrepresentation outside the scope of the cisg. in a greek court decision,39 the court also considered the scope of the cisg and noted: “the issue of pre-contractual (established during the negotiations) liability, according to the opinion that this court adopts, is not regulated by the cisg, except for the cases in which the cisg regulates specifically an issue for the period before the conclusion of the contract (e.g., cisg article 16(2)).” as there does not seem to be case law where courts have applied the cisg to impose precontractual liability, it may be concluded that courts seem to find issues of precontractual liability, except for situations encompassed by art. 16(2), outside the scope of the cisg. however, one should carefully consider whether the few court decisions available are subject to some degree of homeward trend. this seems in line with the general assumption that domestic courts prefer a narrow interpretation of the cisg.40 the majority opinion among scholars is that precontractual liability falls outside the scope of the cisg,41 and some scholars even outright reject that precontractual liability is within the scope of the cisg without further discussion.42 a minority, on the other hand, is of the opposite opinion.43 one author has stated that the intention of the drafters of the cisg was to impose a duty of good faith on the parties that extends to the beginning of the negotiations,44 however when looking at the drafting history, this is hardly the case. based on the preparatory works the cisg 38 geneva pharmaceuticals technology corp. v. barr laboratories, inc. et al. / apothecon, inc. v. barr laboratories, inc. et al. 10 may 2002 u.s. district court for the southern district of new york [federal court of 1st instance], united states. 39 bullet-proof vest case 2009 multi-member court of first instance of athens, greece, decision 4505/2009. english editorial analysis available at: http://cisgw3.law.pace.edu/cases/094505gr.html (accessed 11 may 2020). 40 joseph lookofsky, ‘not running wild with the cisg’ 29 journal of law and commerce 2011, 143. 41 for authors observing this divergence see gil-wallin, liability (n 4) 14; kritzer, precontract formation (n 9); spagnolo, pandora’s box (n 12) 293. 42 andersen et al., practitioner's guide (n 16) 52; christoph brunner and benjamin gottlieb, commentary on the un sales law (cisg) (1st edn. wolters kluwer 2019) 119-120. 43 for authors observing this divergence see gil-wallin, liability (n 4) 14; kritzer, precontract formation (n 9); spagnolo, pandora’s box (n 12) 293. 44 gil-wallin, liability (n 4) 20. 10 precontractual liability in the cisg was arguably not meant to encompass issues of precontractual liability, leaving this to be resolved by domestic law.45 the role of good faith was extensively discussed during the drafting as well as whether to include an express reference to precontractual liability. the delegates could not agree on such inclusion and deliberately left it out. the drafting of the cisg was however long and difficult. an amendment would equally be. it may, therefore, be argued that the legislative history should not carry much weight since the cisg is a living instrument that must evolve over time46 to avoid that the convention becomes “a prisoner of the past”.47 as the borders of the convention are not always crystal clear many provisions are open-ended. the question of whether precontractual liability is within the convention should be answered by applying the autonomous interpretation method mandated in art. 7(1) and subsequently combined with art. 7(2), that allows for gap-filling and development of the convention.48 the cisg reflects the society and available knowledge at the time of the drafting and not every possible development could have been taken into account, such as new electronic means of communication.49 the cisg must be able to adapt to meet these new circumstances, so as not to become ‘petrified’.50 however, some issues were in fact foreseen by the drafters. they were discussed and deliberately rejected. precontractual liability is an example of such an issue.51 in these cases, it may be argued that it would be wrong to let the cisg expand in scope and to reintroduce such issues into the cisg.52 expanding the scope of the cisg to encompass precontractual liability may, therefore, be “overstepping the spirit of the international consensus”.53 it was most likely the differences between common law and civil law approaches that were the reason why the drafters of the cisg could not agree to include a reference to precontractual liability.54 in regard to good faith in bargaining, there was not and there is currently no international common core of the concept.55 it may be an oversimplicifcation to divide the approaches into civil law 45 peter schlechtriem, uniform sales law the un-convention on contracts for the international sale of goods (manz 1986) 57. 46 bruno zeller, ‘the observance of good faith in international trade’ in andré janssen and olaf meyer, cisg methodology (sellier. european law publishers, 2009) 138. 47 spagnolo, pandora’s box (n 12) 288. 48 spagnolo, pandora’s box (n 12) 288. 49 andersen et al. practitioner's guide (n 16) 78-79; schlechtriem/schwenzer, commentary (n 22) 133; spagnolo, pandora’s box (n 12) 287. 50 spagnolo, pandora’s box (n 12) 288. 51 spagnolo, pandora’s box (n 12) 287. 52 andersen et al. practitioner's guide (n 16) 78. 53 spagnolo, pandora’s box (n 12) 287. 54 gil-wallin, liability (n 4) 13; goderre, negotiations (n 4) 266. 55 schwenzer/hachem/kee, global sales (n 1) 280-281; spagnolo, pandora’s box (n 12) 282-283. njcl 2020/1 11 and common law, as there are differences among the approaches to precontractual liablity among common law countries as well as among civil law countries. however, there are general differences between common law and civil law systems which makes this classification beneficial. while civil law systems generally have acknowledged a duty to act in good faith during negotiations as a basis for imposing precontractual liability,56 common law systems have not acknowledged such a general duty during the negotiations. common law countries have however moved towards acknowledging some precontractual duties.57 this development was still at its early stages at the time the cisg was drafted.58 had the cisg been drafted today, then one may wonder if the delegates would have agreed to expressly include at least some precontractual duties. if one accepts that the cisg should be applied in a way that lets the convention evolve and adapt to new circumstances, it could be argued that the scope of the cisg should be expanded to encompass at least some precontractual duties, at least to the extent that these may now be an expression of an international common core. when taking into account that the purpose of the cisg is to remove legal barriers in international trade and to promote uniformity and certainty in international trade,59 it is arguably in line with the purpose of the cisg to let the scope encompass some precontractual liability. expanding the scope of the cisg to encompass precontractual liability would promote uniformity and predictability since the issue would be governed by a uniform law familiar to the parties rather than diverging domestic laws.60 if applying domestic law the result would likely be different in the various jurisdictions due to the different approaches in common law and civil law systems.61 the expansion of the scope of the cisg could in addition decrease transaction costs as the parties would not have to familiarise themselves with domestic laws on precontractual liability,62 which would be in accordance with the purpose of the cisg.63 theoretically, extending the scope of the cisg would improve 56 goderre, negotiations (n 4) 267. 57 goderre, negotiations (n 4) 270; farnsworth, precontractual liability (n 176) 222; spagnolo, pandora’s box (n 12) 268. 58 spagnolo, pandora’s box (n 12) 268. 59 see cisg preamble and the uncitral website ‘united nations convention on contracts for the international sale of goods (vienna, 1980) (cisg)’ at https://uncitral.un.org/en/texts/salegoods/conventions/sale_of_goods/cisg (accessed 11 may 2020). 60 spagnolo, pandora’s box (n 12) 281; gil-wallin, liability (n 4) 18-19. 61 gil-wallin, liability (n 4) 18. 62 spagnolo, pandora’s box (n 12) 282. 63 united nations commission on international trade law, united nations convention on contracts for the international sale of goods (vienna, 1980) (cisg), https://uncitral.un.org/en/texts/salegoods/conventions/sale_of_goods/cisg (accessed 11 may 2020). 12 precontractual liability in the cisg predictability and certainty, at least to the extent that the cisg preempts domestic law, so that the domestic law does not apply either exclusively or concurrently with the cisg.64 the fact that precontractual liability may be based on good faith and that the content of good faith has not yet been clearly defined in relation to the convention may, however, bring uncertainty to the cisg and its application. adjudicators may apply good faith differently and parties may therefore not be able to predict their legal status, and thus uniformity is not in fact promoted.65 if the cisg seems to be an unpredictable instrument to contracting parties, these parties may be more inclined to opt out of the cisg or less inclined to opt in.66 it may also affect the amount of non-contracting states that will choose to become parties to the convention in the future, as was also one of the concerns expressed when a proposal for an express inclusion of precontractual liability in the cisg was suggested during the drafting of the cisg.67 there is, however, no signs of states being reluctant to become parties to the convention. on the contrary, an ever increasing amount of states either ratify the convention of remove reservations made upon ratification. those arguing in favour of an extensive interpretation, letting the cisg develop and expand in scope to obtain greater formal uniformity, rather than dwelling in the legislative history, must do so accepting greater uncertainty and thereby the risk of decreased substantive uniformity.68 on the other hand, opponents of such approach, in preferring predictability and certainty, will trade greater formal uniformity in favour of substantive uniformity and respect for the original compromise.69 art. 7(1) cisg requires the interpreter to have regard for the need to promote uniformity “in its application”. this could indicate that the purpose of the cisg is to promote substantive uniformity within the sphere of the cisg, rather than in general to promote uniformity in all aspects of international trade. the cisg is a convention concerning international ‘sale of goods’. it is thereby concerned with sales law, not tort law. precontractual liability is a liability resembling tort law while still being closely connected to contract law. precontractual liability is a type of liability that in some legal 64 spagnolo, pandora’s box (n 12) 282-283. however, alone the issue of determining whether and when the cisg preempts domestic law could cause uncertainty, despite that theoretically expanded uniformity is achieved, see spagnolo, pandora’s box (n 12) 283. the question of preemption is beyond the framework of this article. 65 spagnolo, pandora’s box (n 12) 281, 283. 66 spagnolo, pandora’s box (n 12) 309-310. 67 uncitral yb ix (1978), a/cn.9/ser.a/1978, 67, para. 85 reprinted in honnold, documentary history (n 25) 299. 68 formal uniformity is regarded as a theoretical quantitative uniformity used to describe “the field of coverage of uniform law on paper”, whereas substantive uniformity is regarded as an actual uniformity used to describe “the quality of uniformity achieved within that field”, see spagnolo, pandora’s box (n 12) 281. 69 spagnolo, pandora’s box (n 12) 289. njcl 2020/1 13 systems is characterized as a contractual liability, while in others it is considered tortious or a third unique type.70 such differences in the domestic classifications should not be decisive of whether precontractual liability falls within the scope of the convention, but perhaps it is contributing to the confusion as to whether it does. it becomes apparent that answering whether precontractual liability is considered within the scope of the cisg is not simple. whether it will be considered within the scope will mainly depend on whether the legislative history is considered decisive, or whether instead the cisg is interpreted extensively and allowed to evolve to encompass such liability. however, even with an extensive interpretation, there must be limits as to how far the cisg scope may be allowed to expand. part of the answer may lie in an analysis of whether the convention can provide any footing for precontractual liability to exist. such footing would most likely be found in the concept of good faith. 3. the notion of good faith as imposing duties on the parties in the precontractual stage good faith in the convention is a somewhat controversial topic. good faith is mentioned merely once in the convention text, in article 7. boiled down, it can be said that there are three approaches to good faith in the convention. first, according to a literal understanding of art. 7(1) the interpreter will find that the observance of good faith is only applicable to the interpretation of the convention text. consequently, the provision does not impose a direct duty on the parties.71 the interpreter may in this regard furthermore reject the perception that good faith is a general principle underlying the cisg.72 second, the interpreter finds that good faith is an underlying principle to be used for gap-filling in accordance with art. 7(2). 73 third, art. 7(1) is not to be understood literally, meaning that it imposes a duty directly on the parties.74 which interpretation one prefers determines whether art. 7 and good faith may be considered a basis for precontractual liability under the cisg. in essence, this is a question whether one adheres to a dynamic doctrine and how far one is willing to take it. for the purpose of determining whether precontractual liability has enough of a footing in the cisg it is necessary to explore the closely linked concept of good faith further. 70 michael joachim bonell, ‘the law governing international commercial contracts and the actual role of the unidroit principles’ (oxford university press on behalf of unidroit) 23 uniform law review 2018, 15–41, 192, with note 55; schlechtriem/schwenzer, commentary (n 22) 258; schwenzer/hachem/kee, global sales (n 1) 283-284. 71 spagnolo, pandora’s box (n 12) 274. 72 goderre, negotiations (n 4) 275-276. 73 goderre, negotiations (n 4) 276-278; spagnolo, pandora’s box (n 12) 274-275. 74 goderre, negotiations (n 4) 278-280; spagnolo, pandora’s box (n 12) 275-277. 14 precontractual liability in the cisg 3.1. good faith through interpretation according to article 7(1) the black letter wording of art. 7(1) cisg suggests that the good faith requirement only applies to adjudicators when they interpret the convention text, but not to the relationship between the parties. however, the wording of art. 7(1) is ambiguous as to how this interpretation is to be conducted. how should the adjudicator exactly interpret the provisions with regard to the need to promote the observance of good faith? therefore, the question of whether art. 7(1) additionally imposes a duty on the parties has been discussed.75 as the wording of art. 7(1) provides little guidance, one may consult the drafting history. in 1969 uncitral established the working group that prepared a draft of the provisions that later became the cisg.76 at the 8th session of the working group, a direct duty on the parties to act in good faith in the course of the formation of the contract was suggested.77 at the 9th session of the working group and at the 11th session of the commission this concept was discussed and some argued for deleting any reference to good faith, since it was vague and lacked sanctions and therefore would increase uncertainty, while others found it implicit and therefore unnecessary. others again found good faith to be a well recognised principle and feared that leaving out a reference to good faith would send the wrong signals.78 the commission established a second working group with the purpose of drafting a compromise of these different opinions.79 a draft was proposed that essentially equals what later became art. 7(1) cisg. with that good faith was instead included as an interpretive concept, rather than a duty on the parties, as an attempt to find an acceptable compromise.80 this suggestion was the one presented at the 1980 diplomatic conference.81 at this conference, the delegates discussed the suggested article and two proposals for amendments.82 an italian proposal to require the parties to observe the principles of good faith in the formation and performance of the 75 spagnolo, pandora’s box (n 12) 274-279. 76 honnold, documentary history (n 25) 3. 77 uncitral yb ix (1978), a/cn.9/ser.a/1978, 66, para. 70 reprinted in honnold, documentary history (n 25) 298. 78 uncitral yb ix (1978), a/cn.9/ser.a/1978, 66-67, paras. 7377, 35, paras. 4448 reprinted in honnold, documentary history (n 25) 298-299, 369. 79 uncitral yb ix (1978), a/cn.9/ser.a/1978, 36, para 55 reprinted in honnold, documentary history (n 25) 370. 80 uncitral yb ix (1978), a/cn.9/ser.a/1978, 36, paras. 56-60 reprinted in honnold, documentary history (n 25) 370. 81 a/conf. 97/19 (n 29) 5, art. 6. 82 a/conf. 97/19 (n 29) 257-259, paras. 40-57. njcl 2020/1 15 contract83 and a norwegian proposal to move the notion of good faith to what eventually became art. 8(3) cisg84 were both rejected. some delegates supported these proposals85 while other delegates, although some moderately supportive, would prefer the existing text of the article.86 some delegates found that although it would be desirable for parties to behave in good faith, they were unable to support the italian suggestion since it was of uncertain meaning, dangerous in practice, and since it provided no sanctions in the event of failure to comply.87 some delegates considered the proposals unnecessary as good faith was already understood to be an underlying principle implicit in any legal transaction88. the existing text had already been discussed at length by the uncitral working group prior to the 1980 diplomatic conference, and the existing text represented a compromise.89 due to the various opinions expressed by the delegates, no agreement could be reached on any of the proposals for amendments, and retention of the existing text was agreed upon.90 consequently, the drafting history is of little assistance in clarifying the concept of good faith in the cisg. while the delegates could not agree on an explicit inclusion of a duty on the parties to observe good faith, the delegates did not unanimously agree that this duty should not be imposed on the parties either. even though the text of art. 7(1) cisg appears to be a compromise, it rather masks the continuing disagreement among the drafters, and “this pandora’s box gave the mere illusion of a compromise”.91 the discussion of whether this duty lies inherent within the cisg is therefore still open, although the existing text of art. 7(1) does not explicitly impose a duty directly on the parties. in regard to the understanding of the notion of good faith, the legislative history is, as becomes apparent from the above, inconclusive. it has been argued that the preparatory works in general often are inconclusive and seldom provide the answer to complex issues.92 furthermore, it has been argued that the preparatory works are “frozen in time” while the cisg is a “living instrument”,93 to be understood in light of 83 a/conf. 97/19 (n 29) 87, italy (a/conf.97/c.1il.59). interestingly this proposal was very similar to the one already suggested at the 8th session of the working group and rejected in the 11th session of the commission. 84 a/conf. 97/19 (n 29) 87, norway (a/conf.97ic.1il.28). 85 a/conf. 97/19 (n 29) 258, paras. 43-44. 86 a/conf. 97/19 (n 29) 258, paras. 45, 46, 48, 49, 52. 87 a/conf. 97/19 (n 29) 258, paras. 47, 50. 88 a/conf. 97/19 (n 29) 258-259, paras. 51, 53. 89 a/conf. 97/19 (n 29) 257-259, paras. 40, 45, 49, 50. 90 a/conf. 97/19 (n 29) 259, paras. 54-57. 91 spagnolo, pandora’s box (n 12) 273-174. 92 joseph lookofsky, understanding the cisg (5th edn. djøf publishing copenhagen 2017) 31. 93 zeller, good faith (n 46) 138. 16 precontractual liability in the cisg current scholarly works and case law. therefore, what the drafters discussed may generally carry little weight when assessing the understanding and extent of good faith,94 and other relevant sources must be consulted. scholars have expressed varying views on the notion of good faith.95 although a duty on the parties to observe good faith is not expressly evident in art. 7(1) cisg, it is advocated among some scholars that the good faith requirement in art. 7(1), in addition to imposing a duty on adjudicators, also imposes a duty directly on the parties.96 scholars advocating this view argue that the parties’ conduct and contract must be interpreted in accordance with the observance of good faith, either because the interpretation of the cisg and the contract is inseparable, or because art. 7(1) is additionally directed at the parties as well as the adjudicator.97 some scholars may not reach as far as to outright conclude that good faith may be imposed as a direct positive duty, but acknowledge that good faith reaches further than merely being an interpretive tool, and in addition, governs rights and obligations of the parties.98 in opposition other scholars have advanced a more narrow view of the wording of the provision’s text; “[i]n the interpretation of this convention” which in connection with the drafting history of art. 7 cisg entails that the requirement to observe good faith cannot be applied to the parties’ conduct, but merely to the interpretation of the cisg.99 regardless of the fact that it does not appear directly from the black letter wording of the cisg, the obligation to interpret the provisions with regard to the observance of good faith will ultimately influence the relationship between the parties. the obligation to interpret with regard to good faith must ultimately affect the obligations of the parties,100 as “good faith cannot exist in a vacuum and must be anchored to parties’ behaviour if used to interpret provisions”.101 thereby, although a literal reading of art. 7(1) cisg indicates that the good faith requirement only applies to the interpretation of the cisg, the concept of good faith may necessarily be 94 zeller, good faith (n 46) 138. 95 spagnolo, pandora’s box (n 12) 274-279. 96 schlechtriem/schwenzer, commentary (n 22) 121 (not itself following this position). for a description of this view see bonell, art. 7, p. 84; spagnolo, pandora’s box (n 12) 275277. 97 spagnolo, pandora’s box (n 12) 276. 98 zeller, good faith (n 46) 148. 99 camilla baasch andersen, ‘good faith? good grief!’ 17 international trade and business law review 2014 310-321, 317-318; andersen et al., practitioner's guide (n 16) 76; farnsworth, duties (n 124) 55-56; schlechtriem/schwenzer, commentary (n 22) 126127; spagnolo, pandora’s box (n 12) 274. 100 schlechtriem/schwenzer, commentary (n 22) 127; spagnolo, pandora’s box (n 12) 278279. 101 andersen, good grief (n 99) 318. njcl 2020/1 17 linked to the parties’ behaviour.102 the extent of the notion of good faith is debatable, but many seem to support that good faith, in one way or another, to a greater or lesser extent, may reach beyond strict applicability only to the interpretation of the cisg.103 and will at least indirectly be linked to the parties’ behaviour and their obligations. when looking at court practice it appears that domestic courts most often impose a standard of behaviour on the contracting parties when good faith is utilized, rather than merely referring to good faith as an interpretive tool.104 this supports the view that good faith, at least to some extent, reaches beyond the mere interpretation of the cisg text. this could partly answer how exactly the adjudicator should interpret the provisions with regard to the need to promote the observance of good faith. the provisions must necessarily at least be interpreted in relation to the parties’ behaviour, rights and obligations, but may additionally impose a direct duty on the parties, either due to the good faith reference in art. 7(1) or possibly as an underlying principle of the cisg according to art. 7(2). considering the debated and debatable concept of good faith in relation to art. 7(1) cisg, the footing that one may find in art. 7(1) to let a precontractual liablity develop seems to be an unstable one. if a proper leg-up is to be found, it could perhaps be in an underlying principle of a more flexible nature. it may be argued that if good faith is considered a general principle on which the cisg is based in the sense of art. 7(2) cisg then the significance of whether art. 7(1) imposes a duty directly on the parties or only imposes a duty on adjudicators might be lessened and has been referred to as an “arguably ‘academic’ distinction”.105 whether good faith is an underlying principle on which the cisg is based is therefore also highly relevant in assessing whether art. 7 and good faith may provide a basis for precontractual liability under the cisg. 3.2. good faith as a general principle according to article 7(2) art. 7(2) cisg demands that gaps in the convention be settled using the principles on which the cisg is based before resorting to any domestic law alternative. the question is now whether good faith is such a general principle, and whether it provides firmer ground for imposing a duty on the parties to observe good faith than good faith as an 102 andersen, good grief (n 99) 317-318; andersen et al., practitioner's guide (n 16) 76-77; lookofsky, cisg (n 92) 36-37; schlechtriem/schwenzer, commentary (n 22) 126-127; zeller, good faith (n 46) 140. 103 spagnolo, pandora’s box (n 12) 278-279. 104 thomas neumann, ‘the roots and fruits of good faith in domestic court practice’ 31 pace international law review 59, 2018, 81. this survey merely examines domestic court practices and not arbitration practice and did not examine domestic courts of every contracting state to the cisg. see in this regard (n 104) 73-75. 105 lookofsky, cisg (n 92) 37. 18 precontractual liability in the cisg interpretative tool according to art. 7(1) cisg. the wording of art. 7(2) itself provides no guidance on how to determine the general principles, or whether good faith may be such. it may be a starting point to consult the legislative history to see whether it was discussed which principles may be considered underlying principles of the cisg, or at least how such principles should be derived. the uncitral working group that prepared what eventually became art. 7(1), did not draft art. 7(2). what became art. 7(2) was not suggested until the 1980 diplomatic conference. bulgaria,106 czechoslovakia,107 and italy108 made proposals for a subsection (2), suggesting how to settle matters governed by, but not expressly settled in the cisg. the three proposals were all rejected and the german democratic republic suggested what essentially became art. 7(2),109 and this proposal was adopted.110 during the discussions, the delegates favoured this proposal, although some were concerned that a reference to general principles was dangerous,111 that such would be difficult to discern,112 and that it might lead to excessive freedom in interpreting what those principles are.113 there were no discussions among the delegates on how to derive such general principles,114 and the legislative history does therefore not provide any guidance in this regard. the delegates who rejected an express requirement for the parties to observe good faith or an express reference to good faith in what later became art. 8(3) cisg expressed that the convention already referred to general principles115 and that good faith was already to be understood as such principle.116 this may, therefore, support good faith as a general principle on which the cisg is based. while good faith is merely mentioned once in the cisg,117 which could lead to the impression that good faith does not constitute an underlying principle, the secretariat itself referred to the observance of good faith as a ‘principle’ in the secretariat commentary118 and notes that 106 a/conf. 97/19 (n 29) 87, bulgaria (a/conf.97/c.1il.16). 107 a/conf. 97/19 (n 29) 87, czechoslovakia (a/conf.97/c.1il.15). 108 a/conf. 97/19 (n 29) 87, italy (a/conf.97/c.1il.59). 109 a/conf. 97/19 (n 29) 87, 256, paras. 25-26. 110 a/conf. 97/19 (n 29) 87, 257, para. 35. 111 a/conf. 97/19 (n 29) 255, para. 12. 112 a/conf. 97/19 (n 29) 256, para. 17. 113 a/conf. 97/19 (n 29) 257, para. 28. 114 a/conf. 97/19 (n 29) 254-257, paras. 1-37. 115 a/conf. 97/19 (n 29) 258, para. 51. 116 a/conf. 97/19 (n 29) 258-259, para. 53. 117 art. 7(1) cisg. 118 there is no official commentary to the cisg, but the secretariat commentary to the 1978 draft included in the official records, can provide guidance as to the understanding of the 1980 convention text. it is, however, not a conclusive authority, since the 1978 draft that was presented at the 1980 vienna conference was modified and therefore not njcl 2020/1 19 numerous of the provisions in the cisg are manifestations of the requirement to observe good faith.119 after listing several examples of provisions the secretariat states that: “the principle of good faith is, however, broader than these examples and applies to all aspects of the interpretation and application of the provisions of this convention.”120 this supports the view, that good faith is a principle on which the cisg is based.121 it must, however, be noted, that when the provision that later became art. 7(1) was drafted, and the compromise on the good faith reference was first reached, the subsection that later became art. 7(2) had not yet been suggested. subsection (2) was first introduced at the 1980 diplomatic conference.122 therefore, the draft that the secretariat commented on in the secretariat commentary did not yet contain what later became art. 7(2). the secretariat did therefore not have this later provision in mind, and the applicability of general principles as a gap-filling mechanism when commenting on the draft. the temporal disorder in which art. 7(1) and 7(2) were drafted has been referred to as contributing to “good faith’s phoenix-like quality”,123 which may have caused the uncertainty of the role of good faith. some scholars reject good faith as a general principle124, by arguing that art. 7 cisg only permits good faith to be consulted when interpreting the provisions of the cisg, but that “it is not a general principle in itself; certainly not one with the power and flexibility to determine outcomes of cases”.125 in support of this, it is argued that the drafting history of the cisg is clear to the extent that the drafters rejected good faith as a general principle,126 and that it would be “a perversion of the compromise to let a general principle of good faith in by the back door”.127 as mentioned above, the preparatory works does not explicitly list which principles are to be considered underlying principles, and it was not explicitly discussed whether good faith was such. it might not be correct to state that it is clear, that a general principle of good faith was outright rejected. the rejection the final version of the cisg. see secretariat commentary and lookofsky, cisg (n 92) 31. 119 neumann, roots and fruits (n 104) 63; commentary on the draft convention on contracts for the international sale of goods prepared by the secretariat ("secretariat commentary") / un doc. a/conf. 97/5, 14-66, contained in official records / un doc. a/conf. 97/19, 18. 120 secretariat commentary (n 119) 18. 121 neumann, roots and fruits (n 104) 63. 122 a/conf. 97/19 (n 29) 87, 254-257, paras. 1-37. 123 spagnolo, pandora’s box (n 12) 273. 124 andersen, good grief (n 99) 318; allan farnsworth, ‘duties of good faith and fair dealing under the unidroit principles, relevant international conventions and national laws’ tulane journal og international and comparative law 1995, 56. 125 andersen, good grief (n 99) 318. 126 andersen, good grief (n 99) 318. 127 farnsworth, duties (n 124) 56. 20 precontractual liability in the cisg of an express reference to good faith beyond the mere interpretation of the cisg does not necessarily make it clear, that good faith was not already inherent in the cisg itself, as also indicated by some of the delegates at the 1980 diplomatic conference.128 furthermore, it has been argued that the search for general principles is not bound to the specific intent of the drafters, since this is not expressly required by art. 7 itself. art. 7(2) must rather be interpreted according to the broader purposes of the cisg as expressed in 7(1).129 it has also been argued, that the cisg is capable of adapting and that its underlying principles should be interpreted as being able to evolve with change.130 again, the matter can be boiled down to which degree one adheres to a dynamic doctrine. some scholars are not directly opposed to good faith as a general principle, but regard it as too vague and abstract to have any independent legal impact. instead, more specific principles, such as a duty to communicate, which are more specific and therefore more suited to fill gaps, can be derived from the principle of good faith.131 many scholars, however, refer directly to good faith as a generally acknowledged underlying principle of the cisg.132 sometimes defined negatively to exclude behaviour in bad faith, and sometimes considered having a positive role requiring behaviour in good faith.133 the principle of good faith is sometimes derived from art. 7(1),134 but more often the principle is derived from numerous provisions of the cisg, that may be considered an expression of such.135 the latter may find more support in the secretariat commentary that refers to numerous provisions as manifestations of good faith.136 good faith as an underlying principle also finds support in the uncitral case law digest, which refers to several court cases, in which courts have referred to ‘the principle of good faith’.137 a study of the utilisation of good faith additionally shows that when courts refer to good faith and when imposing a standard of 128 a/conf. 97/19 (n 29) 258-259, paras. 51, 53. 129 shani salama, ‘pragmatic responses to interpretive impediments: article 7 of the cisg, an inter-american application’ 38 university of miami inter-american law review 225, 2006, 242. 130 salama, pragmatic responses (n 129) 242. 131 spagnolo, pandora’s box (n 12) 276. 132 spagnolo, pandora’s box (n 12) 274-275; lookofsky, cisg (n 92) 37; andersen et al., practitioner's guide (n 16) 89; schlechtriem/schwenzer, commentary (n 22) 135. 133 spagnolo, pandora’s box (n 12) 275. 134 andré janssen and sörren claas kiene, ‘the cisg and its general principles’ in andré janssen and olaf meyer cisg methodology (sellier. european law publishers 2009) 270-273. 135 schlechtriem/schwenzer, commentary (n 22) 135; spagnolo, pandora’s box (n 12) 274275. 136 secretariat commentary (n 119) 18. 137 digest of case law on the united nations convention on contracts for the international sale of goods, uncitral, united nations, 2016 edition 43. njcl 2020/1 21 behaviour on the parties, the courts most often do so with reference to good faith being an underlying principle of the cisg.138 among the diverging opinions on good faith as a general principle, this position, therefore, seems to be the most reasoned. when relying on good faith in the application of the cisg it must first be clarified whether one relies on an interpretation in accordance with art. 7(1) or gap-filling in accordance with art. 7(2). arguably only a strict distinction provides for a correct application of the cisg.139 art. 7 contains three possible understandings of the extent of the notion of good faith. first, that art. 7(1) is merely an interpretative tool, although indirectly affecting the obligations of the parties. secondly, that art. 7(1) imposes a direct duty on the parties to observe good faith. thirdly, that art. 7(2) provides for good faith being a general principle used for gapfilling. if the adjudicator follows the first understanding, the interpretation with regard to good faith is naturally limited to the present provisions in the cisg. if the parties do not have a positive duty to act in good faith, beyond what appears from the present provisions, art. 7(1) may not solely provide a basis for precontractual liability, but may only do so in combination with an interpretation of other provisions in the cisg, such as art. 16(2) cisg. if on the other hand the adjudicator follows the second understanding, and thereby finds there to be a positive duty on the parties, the content of such duty is not expressly settled in the cisg and must therefore constitute a gap to be filled by virtue of art. 7(2). if the adjudicator follows the third understanding, and thereby finds that good faith is a general principle underlying the cisg, the content of such principle must equally be settled. with this line of argument, it might be reasoned that regardless of which of the two latter understandings the adjudicator applies, the result of the given case might not differ. the two latter understandings both leave the door open to a broader perception of precontractual liability under the cisg than mere liability for wrongful revocation of an offer. this naturally provides that one accepts that precontractual liability may fall within the scope of the cisg in the first place as described further above. 3.3. determining the content of the potential duty to observe good faith as the cisg aims to reach uniformity in practice it would be unproblematic to apply any rule that is already uniform across all domestic systems. however, there does not appear to be a common core of the 138 neumann, roots and fruits (n 104) 77, 81. this survey merely examines domestic court practices and not arbitration practice and did not examine domestic courts of every contracting state to the cisg. see in this regard pp. 73-75, 78. a general principle of good faith has also been acknowledged in arbitral practice, see in this regard goderre, negotiations (n 4) 278. 139 janssen/kiene, general principles (n 134) 273. 22 precontractual liability in the cisg concept ‘good faith’ across domestic systems140 that one can rely on. if one were to find that there is a gap in the cisg in this regard, and that no underlying principles are capable of filling it, domestic law would instead settle it with diverging results. when gap-filling the adjudicator must not overlook the obligation in art. 7(1) to interpret the cisg having regard to its international character and the need to promote uniformity.141 the adjudicator must therefore thoroughly search for underlying principles to fill the gap, or rather fill out the content of the concept of good faith, rather than resorting to the possibly diverging domestic laws.142 only such approach will properly have regard for the international character of the cisg and promote uniformity.143 the role of upicc, pecl and tlp in relation to underlying principles of the cisg is highly debated144 and the question essentially is to which degree these soft law instruments may assist in establishing the content of the duty to act in good faith. 3.3.1 relevance of soft law instruments first, a word of caution. upicc, pecl and tlp have a wider scope and may also apply to issues not covered by the cisg. if an expression of an underlying principle is to be found thoroughly described in soft law rules, one may be inclined to apply such as part of the cisg without further consideration. it must, however, be remembered, that just because a provision might be an expression of an underlying principle of the cisg, it may only be used to fill a gap, if there is, in fact, a gap to fill. utilising an underlying principle to determine whether an issue is within the scope of the cisg would entail the risk of expanding the scope of the cisg beyond its borders.145 upicc, pecl or tlp may not be used as gap-filler, if an issue is outside the scope of the cisg as there simply is no gap to fill. on one hand, the instruments themselves do not prohibit their use as gap-fillers of the cisg. the preamble of upicc states that the principles “may be used to interpret or supplement international uniform law instruments”. in the official comments to the preamble it is described that adjudicators increasingly apply upicc to interpret and supplement such 140 neumann, roots and fruits (n 104) 68-69. 141 pilar perales viscasillas, ‘the role of the unidroit principles and the pecl in the interpretation and gap-filling of cisg’ in andré janssen and olaf meyer cisg methodology (sellier. european law publishers, 2009) 293. 142 john felemegas, an international approach to the interpretation of the united nations convention on contracts for the international sale of goods (1980) as uniform sales law (1st edn. cambridge university press 2007) 37-38. 143 felemegas, international approach (n 142) 35, 38. 144 regarding upicc and pecl see viscasillas, upicc and pecl (n 141) 288; regarding upicc, see bonell, upicc (n 70) 32-33; michael joachim bonell, an international restatement of contract law: the unidroit principles of international commercial contracts (3rd edn. transnational publishers 2005) 232-233. 145 spagnolo, pandora’s box (n 12) 305-306. njcl 2020/1 23 instruments with reference to autonomous and internationally uniform principles, an approach expressed in art. 7 cisg.146 such instruments must include the cisg.147 pecl equally in art. 1:101(4), although less clearly, indicate that they may be used as a tool of interpretation or gapfiller, by stating that they may “provide a solution to the issue raised where the system or rules of law applicable do not do so”.148 tlp have no such general provision proclaiming its use, but it has been argued that tlp may equally be used “to allow for an autonomous interpretation of and for the filling of internal gaps in international conventions and other uniform law instruments”.149 on the other hand, some scholars disagree on the role of upicc in the interpretation and gap-filling of the cisg, but it seems that not much attention is generally being paid to pecl.150 also in case law it seems that much more attention is given to upicc than pecl.151 interestingly, even less attention is given to tlp.152 some scholars argue that no external principles, such as the above mentioned, rather than principles derived from the cisg itself, should be used to interpret or gap-fill. it is argued that they are not to be considered principles on which the cisg is based because they were drafted later than the cisg. the cisg cannot be based on a set of rules not existing at the time of its drafting.153 other scholars do find that instruments such as upicc are to be considered underlying principles, since they are considered expressions of general principles of international commercial contracts.154 it is argued that due to similarities in the origin and substance of these instruments and the cisg, and due to a common purpose of unifying international commercial law, the temporal mismatch in regard to the different points in time they were drafted, should not hinder their use. the reference to principles on which the cisg “is based” should be subject to a broader interpretation.155 it is argued that the search for general principles of the 146 upicc, pp. 4-5, preamble, comment 5. 147 viscasillas, upicc and pecl (n 141) 289. 148 viscasillas, upicc and pecl (n 141) 289. 149 viscasillas, upicc and pecl (n 141) 301, note 43; klaus peter berger, ‘lex mercatoria online: the central transnational law database at www.tldb.de’ 18 arbitration international 1, march 1st, 2002, 83–94, 91. 150 viscasillas, upicc and pecl (n 141) 296. 151 bonell, restatement (n 144) 354-356. 152 see for instance viscasillas, upicc and pecl merely mentioning tlp in a footnote, see (n 141) 301, note 43. 153 andersen et al., practitioner's guide (n 16) 89-90; bonell, restatement (n 144) 232; bonell, upicc (n 70) 32-33; peter huber and alastair mullis, the cisg a new textbook for students and practitioners (sellier. european law publishers 2007) 35-36; viscasillas, upicc and pecl (n 141) 296. 154 bonell, restatement (n 144) 233; bonell (n 70) 33; gil-wallin, liability (n 4) 15; viscasillas, upicc and pecl (n 141) 296-297. 155 felemegas, international approach (n 142) 33; salama, pragmatic responses (n 129) 243. 24 precontractual liability in the cisg cisg should not be limited to those which can be derived from the cisg itself, due to the need to have regard for its international character in accordance with art. 7(1) cisg.156 as a position in between these two polar opposites, some scholars have more cautiously argued that instruments such as upicc are not always, but nonetheless sometimes, applicable in interpreting or gap-filling the cisg, or that they may be applied to determine the meaning of an underlying principle,157 such as good faith.158 these instruments might be useful and could be applied to support the cisg, but not to add additional features to it.159 upicc, or other such instruments, may be used to interpret or gap-fill the cisg to the extent that the matter is governed by, but not settled in it, and that the relevant provision is to be considered an expression of a principle underlying both upicc and the cisg.160 despite the diverging scholarly opinions regarding the applicability of soft law instruments to interpret or gap-fill, adjudicators do not seem to pay much attention to theoretical distinctions as to when the instruments are applicable, but often uses upicc without justifying on which grounds they are applicable.161 it may not be possible to conclude that upicc, pecl or tlp are always or never applicable when interpreting the cisg in accordance with art. 7(1) or when gap-filling in accordance with art. 7(2). a case-by-case assessment must, therefore, determine their applicability. upicc, pecl and tlp all have general provisions requiring parties to act in accordance with good faith in upicc art. 1.7, pecl art. 1:201 and tlp no. i.1.1. although no exact definition of this duty is provided, they all furthermore provide examples of what it means to act in ‘bad faith’ or ‘contrary to good faith’ in upicc art. 2.1.15, pecl art. 2:301 and tlp no. iv.8.1. since the prevailing view is that soft law instruments may be used to interpret or gap-fill the cisg to the extent that the relevant provision is to be considered an expression of a principle underlying both the soft law 156 gil-wallin, liability (n 4) 15-16; salama, pragmatic responses (n 129) 242. 157 felemegas, international approach (n 142) 33-34; bonell, restatement (n 144) 233; bonell, upicc (n 70) 33; herbert kronke, ‘the un sales convention, the unidroit contract principles and the way beyond’ 25 journal of law and commerce 2005-06 451-465, 457-458. 158 huber/mullis, cisg (n 153) 36; peter schlechtriem and ingeborg schwenzer, commentary on the un convention on the international sale of goods (cisg) (2nd edn. oxford university press 2005) 109-110; viscasillas, upicc and pecl (n 141) 297-298, with note 34. 159 andersen et al., practitioner's guide (n 16) 90; schlechtriem/schwenzer, commentary (n 22) 137-138. 160 bonell, restatement (n 144) 233, 317-237; bonell, upicc (n 70) 33; felemegas, international approach (n 142) 33-34, 37; kronke, upicc (n 157) 458. 161 bonell, upicc (n 70) 33-34. njcl 2020/1 25 instrument and the cisg,162 it must be assessed whether upicc art. 2.1.15, pecl art. 2:301 and tlp no. iv.8.1 are expressions of principles also underlying the cisg. it may be argued that this is the case with reference to these provisions being expressions of a general duty to act in good faith also expressed in upicc, pecl, and tlp and that such a duty may be considered a general principle on which the cisg is also based.163 it has been described, that there are provisions in such soft law instruments that are to be considered “fleshing out bones already present in the skeletal structure of the uniform law”, and that there are provisions that have “bones and accompanying flesh” that may not be fixed to the uniform law in question164. in the first instance, the soft law instruments relevant may be used to interpret and gap-fill the cisg. they may often provide comments and illustrations, that may contribute to the understanding of the cisg, and thereby fleshing out its bones. with regard to the second instance, it is more doubtful whether they may be used to interpret and gap-fill.165 it must, therefore, be assessed whether one is merely filling out details missing in the cisg, or trying to force something into it that has no basis in the cisg itself. it could be argued, that upicc art. 2.1.15, pecl art. 2:301 and tlp no. iv.8.1 are fleshing out the bones of the cisg, in the sense that good faith is an underlying principle, being one of the bones in the cisg. the soft law instruments and the accompanying comments and examples could then be used to flesh out that bone. on the other hand, it is questionable whether the duty to act in good faith may be extended to the precontractual phase, especially considered the legislative history. in that sense, it could be considered an attempt to force new bones and accompanying flesh into the already fully boned skeleton that is the cisg. during the drafting of the cisg, precontractual liability was thoroughly discussed, but the drafters decided not to include an express provision. therefore, it is persuasive to consider the inclusion of such liability as an attempt to force new bones into the cisg. whether this should be allowed depends on whether one advocates letting the cisg evolve and expand in scope to let it adapt to new developments and thereby letting the cisg skeleton grow. upicc has been referred to as a private codification or ‘restatement’ of international contract law,166 however, upicc do not only represent tradition but also innovation. to the extent that upicc do not follow a common core of principles already generally accepted, but rather express 162 regarding upicc see bonell, restatement (n 144) 233, 317-237; bonell, upicc (n 70) 33; kronke, upicc (n 157) 458. regarding upicc and pecl see felemegas, international approach (n 142) 33-34, 37. 163 regarding upicc 2.1.15 see bonell, restatement (n 144) 322. 164 felemegas, international approach (n 142) 32. the metaphor is ascribed to albert h. kritzer. 165 felemegas, international approach (n 142) 32-33. 166 eckart j. brödermann, unidroit principles of international commercial contracts, an article-by-article commentary (1st edn. kluwer law international bv 2018), 3. 26 precontractual liability in the cisg the solution the drafters found to be the best, they instead become a ‘prestatement’.167 the adjudicator must pay attention to which provisions are mere ‘restatements’ and which are ‘prestatements’. a ‘prestatement’ may not necessarily be applicable when gap-filling the cisg. the above quoted provisions regarding precontractual liability may be considered such ‘prestatements’,168 since no similar provisions are to be found in the cisg, and have been referred to as the “most spectacular deviation from the cisg template”.169 although the provisions deviate from the cisg template, a common core could have developed, so that while the provisions may have been prestatements to begin with, they could over time become restatements. there are some provisions in the above described soft law rules, which are familiar to civil law systems, but not recognised in common law systems, as well as the other way around.170 the precontractual liability described in upicc, pecl and tlp resembles the civil law approach rather than the common law approach.171 even if the cisg may evolve, it should only do so as far as to resemble an international common core.172 it may be too much of a stretch to let such a broad concept of precontractual liability, as described in upicc, pecl, and tlp, be encompassed, when this does not reflect either what was agreed at the drafting stage or an international common core. in civil law systems, good faith as a basis for imposing precontractual liability is generally acknowledged, either by statutory law or general principles of law.173 the approach adopted by most civil law systems is the doctrine of ‘culpa in contrahendo’174 which has been generally defined as a duty to “deal in good faith with each other during the negotiation stage, or else face liability, customarily to the extent of the wronged party’s reliance.”175 such a general duty to act in good faith during negotiations has not been recognised as a 167 bonell, upicc (n 70) 22; kronke, upicc (n 157) 458-459. 168 regarding upicc art. 2.1.15 see bonell, upicc (n 70) 22 and kronke, upicc (n 157) 456, and 458-459, with note 21. 169 regarding upicc art. 1.7 and 2.1.15(2) see kronke, upicc (n 157) 456. 170 regarding upicc see bonell, upicc (n 70) 22. 171 regarding upicc see bonell, upicc (n 70) 22; goderre, negotiations (n 4) 274; regarding upicc and pecl see spagnolo, pandora’s box (n 12) 304. 172 kritzer, pre-contract-formation (n 9). 173 goderre, negotiations (n 4) 267; rodrigo novoa, ‘culpa in contrahendo: a comparative law study: chilean law and the united nations convention on contracts for the international sales of goods (cisg)’ arizona journal of international & comparative law, vol. 22, no. 3, 2005, pp. 583-612, 592. 174 novoa, culpa in contrahendo (n 173), 584-585. 175 friedrich kessler and edith fine, ‘culpa in contrahendo, bargaining in good faith and freedom of contract: a comparative study’ 77 harvard law review, 1963/64 401449, 401. njcl 2020/1 27 basis for imposing liability in common law systems.176 common law countries have, however, moved towards acknowledging some types of precontractual duties to act in good faith, for instance in the u.s. courts have recognised three types of precontractual duties. first, misrepresentation, which involves misinformation as to the intent to come to an agreement. secondly, promissory estoppel, which involves a promise which the other party has detrimentally relied upon, and thirdly, unjust enrichment, which involves restitution of benefits gained during the negotiations.177 common for both civil law and common law systems is, however, that no liability is imposed for merely breaking off negotiations.178 it is not the purpose of this article to investigate the differences in the civil law and common law approaches, nor to point out the specific situations in which a party would be held liable under either of these approaches. it is furthermore not the purpose of this article to examine to what extent there is an international common core regarding precontractual liability and the specific prerequisites required to impose liability under such common core. it will therefore merely be pointed out that such differences in the domestic approaches and the extent of an international common core must affect the extent to which precontractual liability may be imposed under the cisg. it may be argued that the cisg may only develop to let precontractual liability be imposed under the convention to the extent that it reflects what is commonly acknowledged internationally. since an amendment of the cisg would be lengthy and difficult it would be preferable to let the cisg develop to stay in line with a common core in international trade, instead of risking having a uniform law instrument that may become outdated. it would be preferable if adjudicators were able to determine the extent of an international common core regarding precontractual liability, and to only impose liability to such extent, but that would certainly be a difficult task. it has been argued that although there is different terminology in domestic laws concerning precontractual liability the result of the case may in many situations be the same,179 and therefore it may be reasonable to apply upicc art. 2.1.15, pecl art. 2:301 and tlp no. iv.8.1 as a possible expression of such common core. to have regard to the need to promote uniformity in the application of the cisg, it would seem preferable if adjudicators looked to acknowledged international instruments easily 176 allan farnsworth, ‘precontractual liability and preliminary agreements: fair dealing and failed negotiations’ 87 columbia law review no. 2, mar., 1987 217-294, 222; goderre, negotiations (n 4) 270; spagnolo, pandora’s box (n 12) 268. 177 farnsworth, precontractual liability (n 176) 222; goderre, negotiations (n 4) 270; novoa, culpa in contrahendo (n 173) 288, note 21; regarding unjust enrichment and estoppel see spagnolo, pandora’s box (n 12) 268. 178 schwenzer/hachem/kee, global sales (n 1) 280. 179 schwenzer/hachem/kee, global sales (n 1) 278; goderre, negotiations (n 4) 266; kessler/fine, culpa in contrahendo (n 175) 401. 28 precontractual liability in the cisg accessible rather than to find inspiration in the adjudicators own domestic law. to promote uniformity in the application of the cisg, adjudicators must unanimously apply the same sources and in this regard upicc, pecl and tlp provide a helpful tool. 3.3.2 good faith in light of soft law if the provisions in upicc, pecl, and tlp are applied to fill out the content of the duty to act in good faith during the negotiations, the content of these provisions must be discerned. common is that they all make it clear, that the parties are free to negotiate and will not generally be held liable for the mere failure to reach an agreement. this is in line with a general principle of freedom of contract.180 this freedom is however not unlimited, since it must not conflict with good faith.181 what can at least be considered common in regard to upicc art. 2.1.15, pecl art. 2:301 and tlp no. iv.8.1 is that the situations encompassed require behaviour in bad faith, behaviour contrary to good faith or some kind of negligence. this is in line with the fact that it has internationally been recognised that merely breaking off negotiations does not impose liability. these considerations would therefore also apply if precontractual liability were to be imposed under the cisg on the basis of art. 7 and the notion of good faith. common is furthermore, that a party who negotiates or breaks off negotiations in bad faith, or contrary to good faith, is liable for the losses caused to the other party. upicc, pecl and tlp all prescribe the same express example of what in particular will be considered bad faith or behavior contrary to good faith; to enter into or continue negotiations with no intention to reach an agreement. upicc 2016 comments provide further examples and illustrations of such acts. for instance entering into negotiations with the sole purpose of preventing the other party from contracting with a competitor, but not itself wishing to contract.182 the comments to upicc furthermore describe that it will be bad faith to deliberately or by negligence mislead the other party, either by actually misrepresenting facts or by not disclosing facts which should have been disclosed.183 this would, for instance, be if a party continues negotiations while knowing of circumstances that would prevent the conclusion or fulfillment of the contract but not disclosing such information.184 tlp is worded a bit differently than upicc and pecl explicitly mentioning that the other party must be left with the justified assumption that a contract would be concluded, and exemplifies that it is bad faith if a party insists on so clearly 180 upicc art. 1.1, pecl art. 1:102 and tlp no. iv.1.1. 181 upicc art. 1.7 and 2.1.15, comment 2, pecl article 1:201 and tlp no. i.1.1 and iv.8.1, comment 1 at https://www.trans-lex.org/939000 (accessed 12 may 2020). 182 upicc 2.1.15, comment 2, illustration 1. 183 upicc 2.1.15, comment 2. 184 upicc 2.1.15, comment 2, illustration 2 and 3. njcl 2020/1 29 unreasonable terms so that a contract could not be expected to be concluded, in case that party gains an advantage from such behavior.185 these are merely examples of what negotiating in bad faith or contrary to good faith is. there may be situations that would equally qualify as such behaviour although not encompassed by the provided examples, and these less clear situations are difficult to discern. it is exactly one of the issues of good faith and precontractual liability, that even if the precontractual phase is considered within the scope of the cisg, the determination of the precise content of the duty to act in good faith during the negotiations is difficult. even if soft law instruments can be consulted as means to determine the content of the duty to act in good faith, it is still not clear exactly what behaviour would result in liability. there does not seem to be any case law where precontractual liability has been imposed under the cisg, with or without the use of soft law instruments,186 why it would be impossible exhaustively and in detail to describe the content of such potential liability. it could be helpful to examine case law concerning precontractual liability under upicc, pecl, and tlp in constructing a clarification of the content of the duty to act in good faith during the negotiations, but this is beyond the framework of this article. 4. conclusion in the introduction it was asked; would it not be in accordance with the purpose of the cisg, which is to remove legal barriers in international trade and promote uniformity and certainty, to let the scope of the cisg reach as far as possible and thereby encompass a precontractual liability broader than mere liability for wrongful revocation of an offer? however, when answering this question it becomes clear that it must be taken into consideration that the concept of uniformity has two aspects and that promoting formal uniformity might entail the risk of decreasing substantive uniformity. the question of whether precontractual liability may be imposed under the cisg, besides liability for wrongful revocation of an offer, is not to be answered by a simple yes or no. the question must be answered having regard to the international character of the cisg, the need to promote uniformity in its application and the observance of good faith in international trade in accordance with art. 7(1) cisg. a basis for precontractual liability under the cisg may follow from an interpretation of the notion of good faith as expressed in art 7(1) or by considering good faith to be an underlying principle of the cisg in accordance with art. 7(2). the main obstacle when determining whether 185 tlp no. iv.8.1, comment 2 and 3 at https://www.trans-lex.org/939000 (accessed 12 may 2020). 186 the following cisg case law databases has been researched: http://www.cisgonline.ch/; https://www.uncitral.org/clout/; http://www.cisg.law.pace.edu/; http://www.unilex.info/ (accessed 12 may 2020). 30 precontractual liability in the cisg precontractual liability may be imposed under the cisg is whether it is within its scope and thereby whether a duty to act in good faith may be extended to the precontractual phase. this is doubtful. one of the main issues in this regard is that the phase prior to offer and acceptance is not clearly governed by the cisg. another issue is that the drafters considered including an express provision providing for precontractual liability, but rejected such. this indicates a deliberate exclusion from the scope of the cisg. to overcome the issue, one must allow the cisg to evolve and expand in scope to keep up with the international development in trade and sales law. whether precontractual liability will be considered within the scope of the cisg will therefore mainly depend on whether the legislative history is considered decisive, or whether instead the cisg is interpreted extensively and allowed to evolve to encompass such liability. there must be limits to the extent to which the cisg should be allowed to evolve in areas originally expressly excluded and given the lengthy discussions and disagreement on good faith and precontractual liability, the cisg should not be allowed to evolve to encompass precontractual liability. the road to precontractual liability goes through the uncertainties as to scope, as to the role of good faith as an interpretative tool, and as to the existence of, and contents of, a principle of good faith. letting the cisg encompass precontractual liability beyond the one situation covered by art. 16 could endanger the uniformity instead of enhancing it. considering that including precontractual liability per se under the scope of the cisg stands on debated and debatable views on scope, interpretation, and principles, the present authors conclude that there is not enough sturdy footing for such a view. if one despite this should find that precontractual liability is within the scope of the cisg it is suggested that precontractual liability may only be imposed to the extent that an international common core is discernible. as an international common core might be difficult to discern, adjudicators must consider the same sources to promote uniformity in the application of the cisg. in this regard upicc, pecl or tlp provide helpful tools to fill out the missing details in the cisg, but only to the extent that such does not expand the scope of the cisg. but even with the help from soft law instruments, the content of precontractual liability is difficult to define. however, what can surely be concluded is that the mere withdrawal from negotiations will not impose liability. there must be an act in bad faith, contrary to good faith or some kind of negligence involved. further details of such liability are difficult to determine, and since no case law exists to fill in the blanks, a definitive answer does not exist. whether the cisg can encompass precontractual liability is one among many interesting discussions when it comes to the cisg. while the present authors remain critical towards considering precontractual liability within the scope of the cisg, the answer is far from simple and njcl 2020/1 31 may change over time as the dynamic doctrine is a more fruitful approach than a restrive one. this paper mainly focused on art 16(2) cisg and art. 7 cisg in relation to precontractual liability under the cisg because these provisions may provide a basis for precontractual liability under the convention. however, other provisions in the cisg may also to some extent be relevant to this discussion of precontractual liability. art. 8 cisg must be utilised to interpret the statements and conduct of a party. statements and conduct of a party must be interpreted according to his intent or the understanding of a reasonable person according to art. 8(1) and 8(2). statements and conduct of a party during the negotiations may lead the other party to rely on such and to assume a serious intent to reach an agreement, and consequently suffer a loss due to such reliance when the other party withdraws from the negotiations.187 art. 8 is therefore a necessary part of the equation in determining whether a party may be held liable under the cisg in conjunction with art. 7.188 all things considered, it is concluded that the cisg does in fact deal with one specific situation of what could be classified as precontractual liablity according to art. 16. however, the convention is generally not able to deal with all situations of precontractual liablity as the legal grounds for allowing it to is too erratic. for situations not covered by art. 16, one must therefore rely on the otherwise applicable domestic law. 187 gil-wallin, liability (n 4) 16-18. 188 gil-wallin, liability (n 4) 16-17; goderre, negotiations (n 4) 280; john klein and carla bachechi, ‘precontractual liability and the duty of good faith negotiation in international transactions’ 17 houston journal of international law, no. 1, 1994, 22. passing of risk in international sale contracts: a comparative examination of the rules on risk under the united nations convention on contracts for the international sale of goods (vienna 1980) and incoterms 2000 by zoi valioti* nordic journal of commercial law issue 2004 #2 nordic journal of commercial law issue 2004 #2 2 abstract the allocation of risk is an issue which preoccupies equally both the seller and the buyer in an international sale contract, since it can affect the course and outcome of their transaction to a great extent. the rules on passing of risk answer the question of whether the buyer is obliged to pay the price for the goods even if they have been “accidentally” lost or damaged or whether the seller is entitled to claim their price. because of its harsh and sometimes unfair consequences, the passing of risk forms a subject, which the parties specifically refer to in their contract in an attempt to avoid confusion and possible litigation. owing to its importance, it could not be left out from the scope of one of the most successful attempts at unification of international sales law, which is the 1980 united nations convention on contracts for the international sale of goods (cisg). analogous rules are included in the international chamber of commerce’s standard trade terms, incoterms, which are widely used by commercial men and companies around the world. the present study will commence, in the first chapter, with some remarks on the history and scope of the vienna convention and some thoughts on trade terms and incoterms. it will also examine the notion of risk and the theories on its transfer, which have been formulated in different legal systems. next, the second chapter will focus on the rules on risk allocation under the vienna convention and incoterms 2000. the third chapter will concentrate on a thorough comparison between the two voices and an analysis of some intrinsic issues related to the transfer of risk, while making proposals for their most efficient settlement. finally, the present study will conclude with an overall evaluation of the rules pertaining to risk allocation and a wish that soon satisfactory solutions will be found for the problems that trouble this area of law. nordic journal of commercial law issue 2004 #2 3 1. acknowledgements i would like to thank dr indira carr, who supervised the present study, for her guidance and valuable advice. this paper is dedicated to my parents, anastasios and anna, who always stand by me, for their encouragement and understanding. 2. introduction the concept of risk and which will be the party who bears it, is an issue of extreme importance, which preoccupies both parties in a contract of sale. the reason of its importance is its peculiar nature, which might lead to certain harsh and unfair effects and result in the buyer being obliged to pay the price for the goods, even if they have been lost or damaged by a cause irrelevant to the party’s act or omission. therefore, because of its nature and especially because of its consequences, normally the parties will make specific arrangements in their contract regulating the passing of risk, or make express or implied agreements on the application of standard trade terms. in the rarest case of no previous arrangement, then national laws or international conventions regulating the matter will apply. the main preoccupations of the parties are the time of passing of risk from the seller to the buyer and whether there would be any case where the consequences of the transfer of risk could be smoothed out, for example whether the party could claim any remedies for its loss despite the passing of risk.1 nearly every national legal system includes rules on the passing of risksimilar rules appeared and formed a part of the roman law of contract. therefore, such an important chapter of sales law could not be left out of the scope of one of the most successful attempts to harmonise the law pertaining to international sale of goods, that is the united nations convention on contracts for the international sale of goods,2 adopted in vienna in 1980. furthermore, rules on the passing of risk have also been the subject of regulation in various international standard trade terms, which do not form a legal system but are rather popular among traders and businessmen due to their simplicity and lucidness. perhaps the most popular are incoterms (international commercial terms), which include rules on the distribution of the parties’ duties, the division of costs and the allocation of risk. the present study will examine the issue of the passing of risk in international sale contracts for the sale of movable goods, by making a comparative analysis of the rules pertaining to risk allocation under the vienna convention and incoterms 2000. the first chapter will make an introductory reference to the history and scope of the vienna convention and will continue with some remarks on trade terms and incoterms, followed by a final section on the notion of risk and the theories on its transfer. the second chapter will present the rules on the transfer of risk under the united nations convention on contracts for the international sale of goods, highlight the policy followed by the convention in core legal issues and the possible existing inconsistencies in its provisions, along with a critical commentary on the correctness and practicality of its rules. the second chapter will furthermore concentrate on the rules on passing of risk as these are formulated under incoterms 2000, considering their strong and salient nordic journal of commercial law issue 2004 #2 4 points and clarifying the reasons of their popularity in international commercial transactions. subsequently, the third chapter will focus on the inter-relationship of the convention and incoterms 2000, stressing their similarities and differences and examining whether and when the one prevails over the other. moreover, the same chapter will include a careful examination of some problematic areas and propose solutions for some of the “difficult” issues that arise in situations that involve the passing of risk in international sale contracts. finally, the conclusion will encompass a total evaluation of the convention’s rules and those of incoterms 2000, regarding their practicality and effectiveness, and express a wish that there will soon be efforts for the settlement of the intrinsic problems that trouble this area of law. 3chapter i: the vienna convention in a nutshellgeneral remarks on trade terms and incotermsrisk: a polymorph notion 3.1. the vienna convention in a nutshell it is true that during the last decades there have been various attempts mostly by international organisations to harmonise and unify the law of international trade.3 it is the development and evolution of international commerce that calls for the configuration and application of a generally acceptable set of rules governing international trade.4 moreover, international sales have developed significantly in the last century especially due to the amelioration of modes of transport and communication systems and to the augmentation of needs and demands of the markets worldwide. therefore, it was expected that similar attempts would be made in order to harmonise the law of international sales.5 the united nations convention on contracts for the international sale of goods can be considered as a respectful attempt to that effect. the convention was adopted in a diplomatic conference in 1980 in vienna, with the participation of 62 states and 8 international organisations. the cisg, which has entered into force on 1 january 19886 has certainly been a worldwide success; it has been ratified up to now by 62 countries and there is no doubt that it will soon be almost unanimously accepted. the convention was based on two previous conventions that were formed at the hague in 1964 and resulted in the adoption of the uniform laws on international sales; the uniform law on international sale of goods (ulis) and the uniform law on the formation of contracts for the international sale of goods (ulf).7 the uniform laws nevertheless, had not been very successful, since they were adopted by only 9 states, their biggest drawback being that they were seen as the result of cooperation among west european countries, leaving out countries from latin america and the third world, and therefore, were considered as failing to take into account the needs of the developing countries.8 some years later, the united nations commission on international trade law (uncitral)9 launched on the ambitious attempt to elaborate a text for the unification of international sales law, something that was already tried before by the hague uniform laws but without success. this time though, the commission provided a wide group of participant countries with every degree of development and from every part of the world.10 uncitral completed its task by adopting on 11 april 1980 the convention on contracts for the international sale of goods. even though the cisg has started from the hague uniform laws, it has evolved in various ways and has been considered as an independent text. and it is true that ‘the new convention, while retaining clear signs of its ancestry in ulis and ulfis, has nordic journal of commercial law issue 2004 #2 5 eliminated many of the more controversial concepts of the earlier uniform laws. overall, the convention has been an improvement on its ancestors’.11 the convention is a coherent text that encompasses 101 articles, which are not detailed but are quite precise and comprehensible.12 the convention provides that the contract of sale is not subject to any special requirements concerning its form; according to articles 11 and 13 it can be concluded either in writing (including telegram and telex) or orally (“by word of mouth”). additionally, according to articles 12 and 96, any state whose law requires contracts of sale to be concluded in writing has the right to make a declaration under article 96 excluding the application of article 11, where any party has its place of business in that state. the convention is organised into four parts. part i deals with the scope of application and general provisions, part ii contains the rules on the formation of the contract of sale, part iii regulates the basic issues that arise in a sales contract, like the obligations of the seller and the buyer, their remedies, the passing of risk and rules that are common to the seller and buyer, and finally part iv contains the final provisions. part i clarifies that the cisg applies only to international sale of goods,13 authorizes that it governs only the formation of the contract and the rights and obligations of the parties,14 declares that the convention constitutes ius dispositivum,15 since the parties can derogate from its provisions, and contains rules for the interpretation of the convention and for the interpretation of the contracts that it governs.16 part ii17 on contract formation ‘adopts the traditional pattern of contact formation (offeracceptance)’18 and it does not contain any specific or clear rules regarding the controversial issue of the “battle of the forms”.19 part iii20 is the most important one, since it regulates the most significant issues pertaining to the contract of sale. it contains rules on the parties’ obligations, which are followed by rules on their remedies in case of the parties’ failure to fulfil their responsibilities under the contract and the convention. after these provisions the rules on the passing of risk21 and then the rules common to both seller and buyer will follow. finally part iv22 deals with issues regarding the convention’s entry into force and regarding any declarations or reservations that the states are allowed to make along with their ratification or accession to the convention. 3.2. general remarks on trade terms and incoterms as it was already mentioned, due to the intrinsic importance of the rules on risk, the parties in almost every case will either have made an express agreement on the passing of risk that will govern their contract, or they will have made it clear that they agree on the application of specific trade terms commonly used in international commercial transactions. such terms among others are incoterms,23 of which the 2000 version is currently in use. it is interesting to note that the vienna convention does not contain any specific provisions on trade terms and does not give any definitions of them.24 the reason behind that could be, firstly that the vienna convention is a rather minimalist text, which provides its rules not in a detailed way, but in a compact manner; therefore, it could not contain definitions or special provisions regarding trade terms, especially since there are so many of them.25 secondly, a possible thought of the delegates could be that trade terms used in every day commerce are constantly changing and evolving in order to keep up with the developments and needs in the field of international sales. thus, if the convention included any provisions on trade terms, they would soon be outdated, nordic journal of commercial law issue 2004 #2 6 since a convention could not be revised in order to cover every development in trade customs.26 thirdly, it was thought that the international chamber of commerce and its committees around the world would more efficiently regulate an issue like that.27 nevertheless, the convention does make a reference to trade terms in article 9, which gives to the usages and practices established between the parties or to those widely known in international trade, precedence over the rules of the convention. since the cisg forms ius dispositivum the parties can agree to derogate from its rules;28 that is further supported by article 9, which in paragraph one provides that the usages and/or practices that the parties have agreed on are binding. in paragraph two it continues that unless the parties have agreed otherwise, they are bound by usages which are widely known and used in international trade and which they knew or ought to have known. it seems therefore, that the convention recognises the acceptance and wide use of trade terms and acknowledges their importance by considering them as superior to the convention’s provisions. this choice seems wise, since given the fact that some trade terms are used nearly exclusively in some particular types of trade, the convention’s insistence on the primacy of its provisions would have rendered them inapplicable.29 it is necessary to look at what trade terms are and how they are used. it can be said that the international trade terms are designed to ‘define the obligations of the seller and the buyer as regards the point of delivery, procurement of transport documents, contract of insurance, and other documents necessary for the export and import of the cargo’.30 the most popular trade terms (fob and cif) have a long history.31 their purpose was to allocate the responsibilities between the parties usually in carriage of goods contracts. but as it is inevitable in such situations where the various practices and usages were spread around and established by “word of mouth”, differences and variations in interpretation were an “every day” phenomenon. trade terms, especially the most common ones cif and fob, were interpreted differently in different countries,32 creating misunderstandings, which in turn led to conflicts and problems in the performance of the contract and eventually in time and money consuming litigation.33 but the most serious problem was that this situation was endangering the amelioration and normal development of international commerce. it is obvious that the need for the harmonisation of trade terms commonly used in international trade was urgent, since the creation of a common point of reference that would enhance the common interpretation, would minimize the conflicts and disputes between the parties and serve the unification of law in this field.34 considering these circumstances, the international chamber of commerce (icc) a private organisation, which is based in paris, decided to work on the attempt towards the harmonisation of international trade terms and in 1936 it published incoterms, which stands for “international commercial terms”; since then, the icc35 has published various versions of incoterms in its attempt to meet the needs and follow the developments in the ever evolving area of business.36 the starting point of work of the icc is traceable long before 1936; it started working during the 1920s and since then, it has published several versions of incoterms.37 an important revision was incoterms 1990; the most interesting change, which they introduced, was the acceptance of electronic documents and electronic data interchange (edi). the principle of functional equivalence of paper and electronic documents was embraced by incoterms, which welcomed the continuous increase of computer use in international commercial transactions and thus, met nordic journal of commercial law issue 2004 #2 7 the need for speed, ease and preciseness.38 moreover, ‘[t]he 1990 incoterms [took] into consideration the changed techniques, particularly with respect to the use of container shipment, multi-modal transport and roll-on and roll-off traffic with vehicles and railway wagons’.39 the latest revision is incoterms 2000,40 which since 1 january 2000 has replaced the rules of incoterms 1990. it is submitted that the 2000 version is more consistent and clear than the previous one and it contains some different rules in relation to the 1990 version.41 the most important question that arises while studying incoterms is the one regarding their legal nature and whether they form legal rules or interpretative criteria. the issue of incoterms’ legal framework is one of extreme importance, which affects the nature and extent of their application and use.42 there are two different approaches answering the previous question. according to the first view, they constitute an autonomous binding system of legal rules and predominant usages, which should be applied even if the parties did not expressly refer to them in their contract.43 therefore, if incoterms are to be considered as usages widely known and prevailing in international trade, then in conjunction with article 9(2) cisg, that would mean that the courts would be free to decide that, although the parties had not made an express reference to them, nevertheless, they had implicitly embodied them in their contract of sale.44 the second approach supports that incoterms constitute interpretative criteria for the interpretation of international commercial terms and therefore they cannot be considered as a source of law.45 based on that view, incoterms take effect only if the parties have expressly adopted them in the contract,46 otherwise the courts will use them as criteria for the interpretation of the parties’ will. this view is reinforced by the fact that the working group of incoterms 2000 in the introduction of the current version expressly states that the rules are embodied in the contract of sale with the express provision of the parties to the contract.47 furthermore, the approach that the icc rules form only interpretative criteria is supported by the argument that they constitute an incomplete set of rules,48 which results in the fact of recourse being necessary to the applicable law of the contract.49 after all, incoterms do not form the only set of rules that represent the internationally accepted commercial practice in international commercial sales.50 in summary, incoterms and more specifically incoterms 2000 provide a uniform set of rules for the interpretation of international trade terms most commonly used in international commercial contracts, trying to dissolve the ambiguities created by the different interpretations in different countries. 3.3. risk: a polymorph notion before examining the specific rules on risk under the convention and incoterms 2000, a reference to the basic rules on risk seems to be necessary. the notion of “risk” has various meanings. apart from the risk covered in the vienna convention and incoterms 2000, which is the “price risk”,51 the notion of risk may encompass the “insurance risk”, “commercial risk” and “political risk” as well.52 i) the meaning of risk the meaning of “risk” in a sales contract can cover various situations like physical loss, deterioration or damage of the goods sold.53 the common characteristic in all these cases is that nordic journal of commercial law issue 2004 #2 8 the loss or damage should be accidental, thus not caused by an act or omission of one of the parties.54 hence, under the word “risk” can be included situations like theft, seawater or overheating affecting the quality of the goods, confusion of the goods (especially liquids) with other goods, spoilage, evaporation, improper stowage or careless handling of the goods by the carrier.55 one important question is whether in the meaning of risk is included damage or loss of the goods due to acts of state, for example by reason of confiscation, import or export customs’ formalities or embargos. the view, which seems to prevail, is that these acts are left outside from the notion of risk. confiscation does not aim at the goods themselves but it creates a measurepenalty against the person who owns them.56 after all, an act of state is a legal measure which ‘has nothing to do with risk and,…it is practically impossible to obtain insurance protection against it’.57 on the contrary, it is more convincing to consider within the rules on risk situations where the goods are damaged or lost during a period of war by acts of the enemy (ie confiscation, bombardism, capture). the reason for the adoption of that approach is that the buyer is able to ensure the goods against war risks.58 ii) time and consequence of passing of risk it is true that the goods might suffer loss or damage in various points in time from the formation of the contract of sale till the actual handing over to the buyer, since these two actions might either coincide and take place at the same time, or a long period of time might elapse between them.59 during that time there is always the possibilitywhich commercial men know wellthat the goods might suffer loss or damage due to a sudden and unexpected accidental event, for which neither the seller nor the buyer share any responsibility for. as a result, the goods may be lost or damaged, for example while they are packaged at the seller’s warehouse, or on the way to the port where they would be exported (when there is a contract involving carriage of goods by sea), or during the sea journey or from the port of import to the buyer’s premises. the question that is of importance in all these situations is a question of time: when did the risk pass? the answer is decisive since by answering this question it is determined which of the parties; the seller or the buyer will bear the risk and its consequences.60 the rules on the passing of risk, therefore, are dealing with the issue of whether the buyer will still have to pay for the price of the lost or damaged goods even if he never received them or he received them in a poor state, and whether the seller will still be entitled to receive the price for the goods; that is called the “price risk”. some legal systems contain legal rules that regulate, apart from the “price risk”, the “risk of non performance” as well. the rules regulating the latter will indicate whether the seller will have to redeliver the goods, and subsequently whether the buyer will be entitled to ask for another delivery of the goods, even if they have been accidentally lost or damaged.61 iii) theories on the passing of risk it is true that the passing of risk has always been a problematic area, which has formed a subject of regulation in almost every legal system since roman law. depending on the legal structures, social circumstances and background, three main theories have developed and been adopted regarding the time of passing of risk:62 1) the first theory links the time of the passing of risk with the time of conclusion of the contract of sale.63 this theory is not very practical, since most of the times, especially in international sales, at the moment when the contract is concluded the goods are still in the hands of the seller and thus, under his control. a situation where the seller has the control nordic journal of commercial law issue 2004 #2 9 of the goods and the buyer has to bear the risk is hardly desirable, since the buyer will always claim that the seller did not exercise due diligence, creating serious disputes and litigation. 2) the other theory connects the passing of risk to the passing of ownership.64 this theory is quite impractical as well, since the ownership is not at all connected or related to the notion of risk. moreover, this theory does not correspond to the latest practices of sale of goods with retention of ownership, given that in these cases the seller maintains the ownership while the buyer possesses the goods. that means that the seller will have to bear the risk of goods that are under the control of the buyer. this result is undesirable as well, since it will certainly lead to litigation. 3) the third theory that has developed connects the passing of risk with the time of delivery of the goods.65 that means that the party, which has physical control over the goods will be the one bearing the risk. this theory seems the most fair and reasonable since the party that possesses the goods is in a better position to guard them, take the necessary precautions for their safety, or the appropriate actions to save them after the damaging event had occurred, collect the remaining goods that escaped the damage or loss, assess the damage and turn to the insurer for indemnification where and when the goods are insured.66 however, in the majority of cases in international sale contracts, ie cases which involve carriage of goods, the seller is supposed to hand the goods over not directly to the buyer, but to a carrier, who in turn will deliver them to the buyer. in these cases an odd situation is created, since neither the seller nor the buyer have physical control over the goods; in contrast the carrier is the one who has their physical possession. normally, the buyer then bears the risk from the time that the goods are delivered to the carrier. that seems to be unfair for the buyer, given that the goods are as far away from his control as from that of the seller, and the buyer is not in a position to watch over their carriage. let us confine to cases that involve carriage of goods by sea. usually in these cases, the seller arranges for the goods to be delivered by a sea carrier under a contract of affreightment. the carrier, then, issues a document, the bill of lading, which functions as:67 a) a receipt for the goods shipped, regarding their description, condition and quantity, b) an evidence of the contract of carriage, and c) a document of title.68 the latter function means that the bill of lading can be considered as equivalent to possession of the goods covered by it and that the holder can take delivery of the goods at the port of destination or sell the goods while in transit by endorsing the bill.69 hence, even though the buyer does not literally have the physical possession of the goods, by holding the bill of lading he has the goods under his disposal. it is worth mentioning that very often the bill of lading is used for the payment of the price when a letter of credit (l/c) is involved.70 the latter is a very popular mode of payment in international trade. accordingly, under a l/c transaction, where the buyer and seller have previously agreed on a sale contract, the buyer will instruct a bank (issuing bank) to open a documentary credit in favour of the seller. the issuing bank will ask a bank in the seller’s country to advise the seller of the opening of the credit (advising bank) and may ask for that bank’s confirmation (in that case it becomes the confirming bank). subsequently, the seller will be able to collect his payment from the issuing and/or confirming bank, provided that he presents, before the expiration date, all the correct documents referred to in the credit, proving that he shipped the goods.71 one of these documents is usually the bill of lading, along with the sales invoice and a policy of insurance covering the transit goods. it seems, therefore, that the third theory is not always effective, since the buyer, in cases involving carriage, will probably bear the risk even without having physical control over the goods. however, in these cases, the bill of lading has proven to be a useful mechanism, which soothes the buyer’s unfavourable position of having to bear the risk for goods that are not literally under his physical possession, by being able to dispose them at anytime. nordic journal of commercial law issue 2004 #2 10 iv) the convention’s choice as it will be seen below,72 the convention adopts the third theory73 connecting the passing of risk to delivery and possession of the goods;74 so, under the convention the risk passes to the buyer at the moment when the buyer or the carrier takes physical control over the goods.75 yet, there is one case where the convention adopts the theory of passing of risk at the moment of the conclusion of the contract and that is the case of sale of goods during transit.76 the next chapter will examine the rules on risk allocation under the cisg and incoterms 2000, starting with the convention’s provisions on the passing of risk, in articles 66-70. in fact, it will be seen below that ‘[t]he un sales convention made a fresh start on the passing of risk problem with an original approach differing remarkably from conventional wisdom, yet trying to be close to practical needs’.77 4. chapter ii: the passing of risk under the vienna convention and incoterms 2000 4.1. the passing of risk under the cisg i) the convention’s rules on the passing of risk: articles 66-70 cisg the convention’s provisions on the passing of risk will apply only when the parties had not made any previous express or implied arrangement on the issue, since the cisg forms positive law, which means that the parties can exclude the application of its provisions completely or vary the effect of specific articles.78the vienna convention regulates the passing of risk from the seller to the buyer in chapter iv of part iii, in articles 66-70 cisg. those articles deal with the allocation of “price risk” and give answers to the following questions; is the buyer in a case of accidental loss or damage of the goods still obliged to pay for their price notwithstanding their loss or damage? and does the seller still have the right to claim payment of the price? the cisg, unlike some national legal systems, does not deal with the passing of risk of non performance (whether the seller is obliged to make another delivery to the buyer in case of accidental loss or damage to the goods) in the chapter on risk, but contains some provisions on the matter in chapter ii of part iii, which deals with the seller’s obligations.79 the passing of risk of non-performance or the passing of risk of having to redeliver is regulated in articles 31-36 cisg; according to these articles risk passes to the buyer at the moment when the seller has fulfilled his obligations to deliver or has done anything that is necessary to fulfil his obligation to deliver. only at this point the seller will ‘be discharged from the obligation to re-deliver…, since from that moment on, the buyer bears the risk’.80 article 36(1) provides that the seller is liable for any lack in conformity of the goods, existing at the moment the risk passes to the buyer, irrespective of the fact that the inconformity might only be apparent after that time. the second paragraph of article 36 provides that the seller is also liable when the lack of conformity is a result of a breach of any of his contractual obligations including any special guarantees. if the goods are completely destroyed, in cases of sale of generic goods it will be easier for the seller to fulfil his obligation to deliver, since he can provide others from the same kind.81 if the goods have been lost or completely destroyed and it is impossible for the seller to redeliver, then the buyer has the nordic journal of commercial law issue 2004 #2 11 right to avoid the contract and is moreover entitled to restitution of the amount that he might have already paid.82 moreover, in case of accidental loss or damage articles 79 and 80 will answer the question of whether the seller will have to pay damages.83 ii) consequence of the passing of riskarticle 66 cisg the cisg does not define the meaning of “risk” in any of its articles. the convention begins rather backwards and devotes the first article of the chapter on risk to the consequences of its transfer and then examines the rules on risk in each individual case. therefore, the consequence of passing of risk according to the first sentence of article 66, is that the buyer will still be obliged to pay the price of the goods, which have been accidentally lost or damaged, as if he had received goods conforming to the contract of sale.84 the factors leading to that choice are various: the buyer will be the one who will receive the goods at the end of the day and he will be in a better position to check them and handle their possible loss or damage.85 the meaning of risk in chapter iv encompasses any loss or damage to the goods due to any incident for which neither of the parties is responsible. such loss or damage could be theft, deterioration, reduction of their quality, damage due to improper storage or packaging and more.86 the buyer will have to accept the damaged goods and pay the price, without having at his disposition the rights and remedies of part iii.87 since the loss was accidental, the buyer cannot accuse the seller for non-performance and deny fulfilling his obligations. this might seem a strict rule for the buyer, but in business there is always a possibility of unexpected incidents, especially in international sales, which is a quite risky field by its very nature and it is more reasonable for the buyer to be the party who suffers the loss. therefore, article 66 cisg clearly states that the buyer is obliged to pay for the price of the goods after the risk has passed to him. it should be noted though, that the time of passing of risk differs according to each case and is regulated by articles 67-69 cisg. accordingly, it is interesting to see how article 66 has been interpreted in case law; in a case in the german courts, a french seller (plaintiff) and a german buyer (defendant)who had a long-term business relationshiphad agreed on the sale of frozen chicken. the plaintiff delivered the chicken under the condition “free deliveryduty paiduntaxed” and handed the goods to a carrier. after the buyer’s denial that delivery had taken place, the seller issued a receipt with the buyer’s stamp, which was unsigned in order to prove delivery, but the buyer insisted on his denial to pay the price. the seller sued him for failing to pay, but whereas the court of first instance accepted the claim, the appellate court rejected it. it held that the unsigned receipt was not good enough to establish delivery and thus, the seller did not have the right to claim the price (according to articles 53 and 58 cisg). what is of interest is the second reason for dismissing the claim; the court held that the risk had not passed from the seller to the buyer when the goods were handed over to the carrier and therefore the buyer was under no obligation to pay the price of the goods (according to articles 66 and 67(1) cisg). the court decided that the term “free delivery” meant that the risk would pass when the seller delivered the goods at the buyer’s place of business and thus, that the seller was bearing the risk during transport. the court’s decision was reinforced firstly by the fact that the seller had previously obtained a transport insurance for the transportation of the goods and secondly by the fact that the seller had in other occasions carried goods for the buyer by his own means of transport. therefore, the intention of the parties was that the risk would pass at the buyer’s place of business. the seller failed to prove that delivery to the buyer had been completed and consequently the risk never passed to the buyerhence, according to article 66 cisg he had no obligation to pay the price.88 nordic journal of commercial law issue 2004 #2 12 nevertheless, the last phrase of article 66 introduces an exception to the previous rule of the first sentence of article 66. thus, if the loss or damage is caused by an act or omission of the seller, then the seller will be the party that will bear the risk and the buyer will not be obliged to pay the price. the buyer can refuse the delivery of damaged goods and can have recourse to the remedies of part iii of the convention;89 therefore, the buyer can avoid the contract in whole or in part (articles 49(1), 51), ask for substitute goods (article 46(2)) or for repair of the goods (article 46(3)) or a reduction in price (article 50) and/or damages (articles 74-77).90 but what is the exact meaning of the phrase “act or omission of the seller”? there are two different views answering that question. the first is that by the phrase “act or omission” is meant a breach of the seller’s obligations under the contract of sale or the convention.91 the second approach supports that the “act or omission” of the seller does not necessarily have to be of such nature in order to constitute a contractual breach, but it could be any event for which the seller is responsible, and resulted in the loss or damage. in cases like these he would be liable under either the law of contract or under the law of tort.92 schlechtriem and honnold support the second view; according to the former, article 66 should be interpreted in a way to encompass cases where the seller’s behaviour might not be unlawful under the law of contact (breach of obligations) but might be unlawful under the law of tort.93 the risk then remains with the seller. furthermore, according to honnold ‘this decision not to restrict the scope of article 66…seems wise since the seller, by a wrongful seizure of the goods or abuse of legal process, might cause damage to the goods under circumstances that might not constitute a breach of contract’.94 ‘ on the other hand, acts or omissions that are clearly lawful do not prevent the application of the provisions on risk’.95 a similar case was decided under the cietac.96 in 1992 there was an agreement between a chinese seller and a californian buyer for the sale of 10,000 kg of jasmine aldehyde (jasminal), cif new york. the buyer warned the seller of the sensitivity of the cargo to high temperatures and he asked him to make sure that it would be stored in a cool place. furthermore, he asked him to transport the jasminal on a direct line. the seller confirmed that the temperature at the port was appropriate, but when the cargo reached new york, after passing by the port of hong kong, a large part of it had melted and leaked because of excessive heat during the voyage. the cargo was shipped to the final user, who rejected it. it was then that the buyer informed the seller of the damage and he had the goods examined on that day. after a settlement agreement, the seller was obliged to pay us $ 60,000 as damages, of which us $20,000 would be paid in cash and the rest would be compensated in further transactions between them. the seller did not pay the cash and the further transactions could not be concluded. the buyer claimed payment of us $60,000 plus interest and damages, upon an arbitration commission. the arbitrators decided that the seller was responsible for the damage according to article 66 cisg. even though, according to the cif clause, the risk passes when the goods pass the ship’s rail, in the present case there had been a separate special contractual agreement regarding the temperature during transport. the seller had not complied with his obligations under the special contractual agreement, since he had not given sufficient and correct directions to the carrier and instead of arranging for a direct route, he had, on the contrary, sent the cargo via hong kong, which resulted in its deterioration. therefore, as provided in article 66 cisg, the damage was caused by “an act or omission of the seller” and as a result the risk had not passed to the buyer.97 nordic journal of commercial law issue 2004 #2 13 iii) passing of risk in cases involving carriage of goodsarticle 67 cisg the passing of risk in sales involving carriage of goods is regulated in the convention in a separate article, namely article 67,98 and since sales involving carriage of the goods is the most common situation in international sale contracts, article 67 forms the basic provision for the passing of risk under the convention.99 paragraph one of article 67 establishes two rules: a) if the seller and buyer did not agree for the goods to be handed over at a particular place, then the risk passes to the buyer when the goods are handed over to the first carrier in accordance with the contract of sale. b) if the parties agreed on the handing over of the goods to the carrier in a particular place, the risk passes when the goods are handed over to the carrier at that particular place. firstly, it should be examined what a sale of goods that involves carriage means. the answer should be something more than the obvious fact that the goods will be loaded on a truck, train, ship or airplane in order to be transported to the buyer. it should additionally mean that the seller would be the one who will have the discretion or the obligation to arrange for the carriage of the goods and will take the necessary actions for their transmission to the buyer.100 secondly, the phrase “in accordance with the contract of sale” might be ambiguous in the sense that it could be interpreted to mean that the passing of risk is effectuated when there is compliance with the contract of sale. the true meaning though, is that the handing over of the goods should be in accordance with the contract.101 a question that arises regarding the realization of transport is connected with the notion of the first carrier.102 is it sufficient for the seller to effectuate the transport himself with his own means of transport and with his own personnel103 or does it have to be carried out by an independent carrier? according to bianca and bonell104 there should be carriage by a third party and thus, the cases involving carriage of the goods by the parties themselves should not be included in the scope of article 67.105 instead, a third party should be responsible for the carriageie an independent carrier, since the wording of article 67(1) “when the goods are handed over to the first carrier…if the seller is bound to hand the goods over to a carrier”, expressly states that the seller is supposed to hand over the goods to a carrier, hence to a third party, because it is not possible to give the goods for carriage to himself. schlechtriem is of the same opinion,106 supporting the view that in order for the risk to pass to the buyer, the carriage should be made by an independent carrier and not by the seller’s personnel. the policy behind this view is simple: if the seller did not bear the risk during the transport, which he effectuated on his own, then in case of accidental loss or damage of the goods, the buyer would always accuse the seller of not exercising due care, increasing the possibility of dispute and litigation between the parties.107 another controversial issue is whether the notion of freight forwarder108 is included in the meaning of the “first carrier”. according to schlechtriem109 freight forwarder should be considered as a first carrier and risk should pass to the buyer from the moment when the goods are handed over to him, since he forms an independent entity, which takes control over the goods.110 nevertheless, flambouras makes a distinction using the “criterion of liability”; if the freight forwarder simply commissions the operation of transportation and excludes his liability, he should not be considered as first carrier within the meaning of the first sentence of article 67(1).111 but if, on the contrary, he takes part on the carriage of the goods accepting liability,112 then it is submitted that he should be considered as a first carrier. the same should apply for a multi-modal transport operator (mto) since often the notions of mto and freight-forwarder overlap.113 the author’s view is that since a nordic journal of commercial law issue 2004 #2 14 freight forwarder is an independent entity, which takes control over the goods, it should be considered as a first carrier. the first rule of paragraph one is usually applied in cases of multi-modal transport, ie in cases where the goods are carried with more than one modes of transportation.114 in most of the cases, the goods are loaded on a train or truck and carried to a near port wherefrom they are shipped to another port in the buyer’s country. in a situation like this the risk will pass from the time that the goods are handed over to the first carrier, ie when loaded onto the train or truck.115 this rule is very practical and efficient, since the splitting of transit risk is avoided and the buyer bears the risk during the whole transport in land and water. generally the splitting of transit risk is undesirable, as it presents serious problems of proof. hence, it is not easy to prove when the damage occurredif it happened before or after the point of passing of risk to the buyerespecially when it was caused by a non obvious event (overheating, seawater damaging the cargo), which is normally revealed at the end of the journey. the first sentence of article 67(1) eliminates that possibility by charging the buyer with the burden of bearing the transit risk. on one hand, that is fair, since the goods are not under the seller’s control anymore and he should not bear the risk of goods that are no longer in his hands. but on the other hand, the goods are not under the physical control of the buyer eitherthey are under the control of the carrier. is that rule therefore far too harsh for the buyer? the answer is that the party bearing the risk should be the buyer, since the loss or damage is usually revealed at the end of the journey when the goods are in his hands. he is, thus, in an advantageous position since it is he who will have the discretion to examine them, find their possible defects, save the goods that are not completely destroyed and turn to the insurer for indemnification.116 furthermore, the rule in the first sentence of article 67(1) is very efficient in cases of container transport.117 the rule in the second sentence of article 67(1) does not present any special difficulties.118 it applies in situations where the parties have agreed on the handing over of the goods in a specific place.119 in these situations the risk will not pass when the goods are handed over to the first carrier, but when they are handed over to the carrier in the agreed place, and if the place is generally described, the seller will have the right to specify it.120 it is interesting to see how the courts have interpreted this provision. actually, a spanish court ruled on a case of a contract involving the sale of steel profiles between an italian seller and a spanish buyer. the contract was in accordance with incoterms 1990. when the goods arrived at their destination they were found to be defective. but when they were loaded onto the ship at the port in italy, the captain confirmed their condition by signing the transport document bearing the remark “clean on board”, which means in a perfect condition. the court decidedafter taking into account the type of contractthat the risk had passed onto the buyer (according to articles 31 and 67 cisg) from the moment that the goods were loaded onto the ship at the port of origin. that was the moment when the risk passed from the seller to the buyer, irrespective of whether the buyer had insured the goods or not.121 the third sentence of article 67(1) stresses that even if the seller has retained any documents, with which he is able to control the disposition of the goods, this does not prevent the risk from passing. this phrase is an indicative declaration that the convention does not connect the passing of risk with ownership. ‘the purpose of the third sentence of article 67(1) is to ensure that the rules as to risk in the first two sentences are not subverted by the common practice of sellers of retaining the shipping documents as a form of security for the payment of the price… it nordic journal of commercial law issue 2004 #2 15 guards against misunderstanding which might arise, particularly in the minds of those accustomed to legal systems in which risk and property are linked’.122 the second paragraph of article 67 clearly requires that the goods should be “clearly identified to the contract” for the risk to pass to the buyer. through this prerequisite there is an attempt to protect the unsuspecting buyer from the seller’s false claims in a partial loss or damage, that the lost or damaged goods were those that the buyer bought.123 this provision especially refers to bulk goods and collective consignments, like wheat or oil and generally to liquid cargos. it is necessary, therefore, that the goods are identified and this happens, according to the article’s wording, when the seller puts markings on the goods, when the goods are expressly indicated in the shipping documents, when the seller gives notice to the buyer, or in any other way, since the enumeration in article 67(2) is not exhaustive. regarding the identification with a notice, its dispatch is sufficient, and it is not necessary that it reaches the buyer (art.27 cisg);124 the risk passes when the notice is dispatched and not retroactively from the time of shipment.125 it is submitted that the convention’s rule on passing of risk ex nunc in cases where the identification takes place after the goods have been dispatched is rather problematic; accepting the splitting of transit risk might lead to hardly desirable situations, since it may raise disputes and problems of proof126 regarding the exact time that the damage or loss occurred.127 it is submitted that the retroactive passing of risk is preferable, since it reduces relevant problems of proof considerably and minimizes the chances of litigation. the cases of fungible128 bulk goods and of collective consignments present a special issue because in these cases it is very difficult to ascertain the exact time of passing of risk; different opinions have been supported,129 but there is still no definite answer. cases of collective consignments (where this is permitted by the contract or a trade usage) include cases where there is one cargo of goods of the same kind ( ie oil, wheat, natural gas), which is meant to cover several contracts of sale, by distributing parts of the cargo to several buyers. for example, let us suppose that there is a ship loaded with 5,000 tones of wheat without further identification, that were meant to satisfy several sale contracts for various buyers, and of which 3,000 tones suffered severe damage due to overheating before the division of the cargo. in situations like these one view suggests that ‘the identification of the goods to the contract needs to relate only to the collective consignment. the buyers bear the risk collectively. a partial loss is borne by them pro rata; if the entire consignment is lost, each loses his entire share’.130 and the second view argues that the identification takes place only when the goods are divided among the various buyers with the taking over of the goods. thus, if the goods suffer loss or damage before their division, the buyers will not have to pay the price.131 it is the author’s opinion that if it is clear, for example that half of the wheat of quality b, which is kept in ship x and stored in part y of the ship, is sold to buyer s and the other half to buyer t and the approximate total quantity has been calculated, then there is no reason why the risk should not pass to the buyers, even though the goods are not divided.132 of course this should be considered separately in each case and it should be clear from the circumstances that the parties had made an implied agreement that the risk would pass to the buyers. it is true, though that the problem of passing of risk in cases of identifiable bulk goods is an obscure one and one, which is not clearly settled by the convention. it is truly unfortunate that the convention does not have any specific rules pertaining to collective consignments or bulk goods, since these are common cargos in international sales. for that reason, the parties are strongly advised to provide expressly in their contract for the exact time of passing of risk when the sale involves fungible goods in identified bulks. nordic journal of commercial law issue 2004 #2 16 iv) goods sold in transitarticle 68 cisg the convention has a separate article on the passing of risk of goods that are sold during transit. a sale during transit does not mean that the goods swim, fly or float, but that they are sold while usually kept in a ship or train or truck.133 this is frequently the case where the seller has bought in advance large cargos of oil, wheat, natural gas, and metals and generally goods that are carried in bulk and starts the journey towards a destination without having previously sold the goods and without knowing the recipients. the contracts of sale will then be concluded while the goods are in transit134 and in most cases the goods will be sold several times until their final destination. the cisg deals with this situation in article 68, which provides that the risk passes to the buyer from the moment that the contract is concluded (the rulefirst sentence of art.68) and only in special circumstances does the risk pass retroactively from the moment of handing over of the goods to the carrier who issued the documents embodying the contract of carriage (the exceptionsecond sentence of art.68). article 68 caused a lot of controversy and extensive discussion at the vienna conference.135 this article constitutes a compromise between two opposite opinions136 and as it happens in every compromise, some problems and inconsistencies are inevitable. the most striking drawback of the first sentence of article 68 is the fact that it allows the splitting of transit risk. in most of the cases of damage or loss it would be difficult to ascertain if the damaging event took place before or after the conclusion of the contract (unless the event is obvious, for example collision or explosion). this is quite problematic in container transport where the containers are sealed after loading and are not opened until after they reach their final destination.137 the rules on the burden of proof will decide which party bears the risk, but it seems that disputes will be unavoidable.138 the approach established by the second sentence of article 68139 as the exception, seems preferable as it diminishes the case of splitting the transit risk. the risk passes retroactively from the time the goods were handed over to the carrier who issued the documents embodying the contract of carriage. these documents should evidence the existence of the contract of carriage, since in a contrary situation the rule is inapplicable.140 nevertheless, notwithstanding its advantage of not splitting the transit risk, the provision requires as a “vague” precondition the existence of “indicative circumstances”. this ‘delphic provision’,141 has a rather imprecise wording; the question that arises is “which are those circumstances”? generally, the term “circumstances” should be interpreted as meaning the implied intentions of the parties,142 but moreover, according to a very widely accepted view it should include the transfer of insurance143 from the seller to the buyer, for example by an endorsement. ‘the endorsement would make buyer the only person who would claim under the policy and would clearly evidence an intent to transfer to buyer the total risk of the voyage’.144 and since the transfer of insurance is very common in international sales, the exception of the second sentence of article 68 becomes practically the rule. the third sentence of article 68 ‘introduces a proviso’;145 it provides that when the seller knew or was supposed to know at the moment when the contract was concluded, that the goods had suffered damage or loss and did not inform the buyer, then he bears the risk of the loss or damage. in that case the seller is punished for his bad faith; the question that arises though, is whether this sentence refers to both previous sentences or not. it is submitted that it refers only to the second nordic journal of commercial law issue 2004 #2 17 sentence, since the risk does not pass from the moment of conclusion of the contract if the loss or damage had already been effected, let alone if the seller knew about it.146 furthermore, the third sentence of article 68 involves further problems of interpretation; it states that the seller bears the risk of “the loss or the damage”,147 but without providing any further clarification. is it the one which had occurred before the conclusion of the contract and the seller knew or ought to have known about, or is it also the one which had occurred before the conclusion of the contract but of which the seller had no knowledge, or maybe is it also the one which occurred after the conclusion of the contract? this issue is not completely clear and more than one view is supported.148 according to schlechtriem149 the meaning of this phrase encompasses only the damage that the seller knew or ought to have known by the time of the conclusion of the contract,150 basing his approach on the different wording of the draft convention, which was not finally approved and to the linkage between the second and third sentences of article 68. nevertheless, this approach has once again the disadvantage of splitting the transit risk between the parties, something that is not at all desirable due to the problems of proof that it creates. on the contrary, hager151 and honnold152 support a different view and argue that the seller should bear the risk for the loss or damage before and after the conclusion of the contract, no matter whether the seller knew about it or not, as long as it was caused by the same damaging event as the original damage.153 another unclear point of article 68 is whether it is necessary for the passing of risk in sales of transit goods, for the goods to be identified to the contract. the article does not state anything about the identification of the goods like articles 67(2) and 69(3) do, but it is submitted that the requirement of identification should be applied by analogy to these cases as well.154 schlechtriem argues that article 68 is indeed applicable to sales of undivided bulk goods (collective consignments) and he draws a distinction between two situations:155 a) if the seller is entitled (by the contract or trade usage) to deliver a collective consignment, then the buyers bear the risk from the time stated in article 68 and share the risk pro rata.156 b) if, on the contrary, the seller is not entitled to deliver a collective consignment, then article 67(2) is applied by analogy and the risk passes when the goods are identified. v) the residual casesarticle 69 cisg the convention, after dealing with cases involving carriage of goods by a carrier and sale of goods in transit, deals in article 69 with the residual cases, ie those which are not covered by the previous articles. therefore, article 69 deals with cases which involve a) taking over of the goods at the seller’s premises (art.69 (1)), b) taking over of the goods at another person’s premises or at a public warehouse or c) handing over of the goods by the seller to the buyer or to a carrier named by the buyer157 (not to an independent carrier, since the latter is governed by art.67). the last two cases are covered by art.69 (2). article 69(1) covers cases where the buyer is supposed to pick up the goods from the seller’s premises. the risk passes to the buyer from the moment he takes over the goods, which are already put at his disposal. the goods are at his disposal when the seller has made all the necessary actions in order to enable the buyer to take them over, for example packagingidentification.158 the policy behind this provision is, that the party who has the goods under his physical control, in this case the seller, will be in a better position to look after them.159 nordic journal of commercial law issue 2004 #2 18 nevertheless, the seller cannot bear the risk forever. thus, if the goods are at the buyer’s disposal and he delays taking delivery for a long time, so as to commit a breach of contract by not taking them over, then the risk passes to him at the moment when the goods are placed at his disposal.160 but when does the failure to take over the goods in due time constitute a breach of contract? according to schlechtriem,161 1) if the parties have agreed on a specific date for taking over the goods, a failure to take them over constitutes a breach of contract when this time has passed, or if they did not agree on a specific date, when a reasonable period has passed after the buyer has received notice that the goods are ready for taking over. the notice is necessary only in the latter case.162 2) failure to take over the goods constitutes the buyer’s denial to pay the price of the goods as well. in cases like these, risk passes even though the goods are still under the custody and control of the seller.163 the buyer is being punished for his neglectful behaviour for not taking over the goods or for not paying their price.164 if the place of delivery is other than the seller’s place of business then article 69(2) comes into effect. this provision applies where the seller delivers the goods i) to the buyer’s place of business or ii) to a particular place to the buyer or to a carrier named by him. in reality, most of the cases involve situations where the goods are stored in a public warehouse. in the previous cases the risk passes when three conditions are met:165 1) delivery must be due, 2) the goods must be placed at the buyer’s disposal. unlike article 69(1) the buyer does not have to actually take over the goods in order for the risk to pass. the unilateral act of placing the goods at his disposal suffices. the seller should do all that is necessary to enable the buyer to take delivery. if the goods are in a warehouse, as it will be seen below, the seller should give instructions to the warehouse keeper or should give the buyer an effective delivery order. and 3) the buyer should be aware that the goods are at his disposal. if the parties did not agree on the time of disposal, the seller should send a notice to the buyer, which becomes effective from the moment of receipt166 (in contrast with art.27 cisg, which states that notification becomes effective from the time of dispatch).167 a relevant case is the one decided by a german court pertaining to the contract between two austrian sellers and a german buyer for the sale of furniture manufactured and stored in a warehouse in hungary. the sellers had sent to the buyer the storage invoices, and the buyer would be entitled to partial deliveries. the goods would be loaded either on wagons or on the buyer’s trucks for transmission to the buyer. the sellers issued several invoices and assigned their rights to a third party, plaintiff, who sent to the buyer his notice of the assignment, which was accepted by the buyer in writing. nevertheless, the buyer, after not having received the furniture listed in the storage invoices, refused to pay the price for the goods. the warehouse in hungary went bankrupt and the furniture disappeared. the plaintiff sued the buyer seeking the purchase price. the court of first instance dismissed the claim and the appellate court upheld its decision. the court decided that according to article 66 cisg the buyer did not have to pay the price, since the plaintiff did not prove that the furniture was lost after the passing of risk. the passing of risk had to be determined according to article 69(2) cisg, since the parties had agreed that the buyer was bound to take over the goods at a place other than the seller’s place of business. however, due delivery and the buyer’s awareness that the goods were placed at his disposal, the conditions for the passing of risk under article 69(2) cisg, were not fulfilled. the court decided that the sellers had not put the goods at the buyer’s disposal pursuant to article 31(b) cisg, because they had not fulfilled the preparatory acts required by the contract of sale.168 nordic journal of commercial law issue 2004 #2 19 more specifically, in case of goods stored in a public warehouse risk passes when the buyer is aware of the fact that the goods are at his disposal and furthermore, when he ‘can require the warehouse keeper to deliver [the goods] up to him. that is the case when the warehouse keeper has acknowledged the buyer’s right to possession of the goods or the seller provides the buyer with a document in which the warehouse keeper promises to deliver up the goods’.169 the seller should give the buyer a delivery note with a fixed time for the collection of the goods,170 since in a contrary case, a delivery note, which contains simply an instruction is not sufficient to effect the passing of risk to the buyer.171 the third paragraph of article 69 requires, as a prerequisite for the risk to pass to the buyer, the clear identification of the goods to the contract. a similar rule was encountered earlier in article 67(2) and therefore the same remarks apply to both provisions. thus, the seller is expected to send a notice to the buyer to inform him that the goods have been identified and are at his disposal; he will have then fulfilled his obligation to enable the buyer to take over the goods.172 again, particular problems arise in cases of fungible goods sold in identified bulks (ie wheat, oil, liquids in general). how is the requirement of “identification” satisfied in these situations? the wording of paragraph three suggests that identification is achieved and the risk passes when the part of the goods sold to the buyer is actually removed or when there is for example (if the goods are stored in a warehouse) an acknowledgement on the part of the warehouse keeper that he holds the specific quantity on the buyer’s behalf.173 it is submitted, though, that the strict interpretation of the requirement of identification is not desirable and it should be sufficient that the seller acts in a way that enables the buyer to take over the goods.174 vi) risk and remediesarticle 70 cisg article 70 regulates the relation between the passing of risk and the buyer’s remedies when the seller has committed a fundamental breach of contract. according to this article the remedies of the buyer remain intact and the rules of articles 67, 68 and 69 on the passing of risk do not prevent him from exercising his rights under the convention. the necessary prerequisite is the commitment of a fundamental breach of contract175 by the seller. any other breach will not be enough. of course it is obvious that the loss or damage of the goods should not be caused by reason of the seller’s fundamental breach, but it should be accidental, because in the former case we would not be talking about passing of risk, but about a breach of contract due to an act or omission of the seller. thus, ‘the fact that the seller has committed a fundamental breach of contract as meant in article 25 cisg does not prevent the risk from passing to the buyer under the provisions of articles 6769 cisg’.176 the meaning of article 70 would be better understood by means of an example.177 let us suppose that the seller x in new york agrees with the buyer y in melbourne on the sale of 2,000 television sets. the risk would pass when the goods were handed over to the first carrier. on arrival, the buyer, upon receiving the goods, found out that 1,200 were defective due to the lack of a microchip and 750 were destroyed due to seawater. only 50 of them were in good condition. in the above example there is a situation of fundamental breach; the seller, by sending 1,200 defective tv-sets, committed a fundamental breach of contract. the 750 sets were accidentally destroyed, since their loss was not caused by an act or omission of either of the parties. according to article 70 “if the seller has committed a fundamental breach of contract, articles 67, 68 and 69 nordic journal of commercial law issue 2004 #2 20 do not impair the remedies available to the buyer on account of the breach”. that means that the buyer will have at his disposal all the convention’s remedies offered to him in case of fundamental breach, despite the passing of risk and its consequences to him. therefore, ‘the buyer’s remedies on account of the seller’s fundamental breach of contract take priority over the risk rules’.178 thus, in the previous example, the buyer will have at his discretion the following remedies: 1) the buyer can declare the contract avoided according to article 49(1)(a)in that case the risk would be shifted back onto the seller179 and the buyer would not have to pay the price of the goods. in the above example, the buyer will have the right to avoid the contract and not pay the price of all 2,000 television sets. on the other hand, it is submitted that according to article 51(1)180 he can avoid the contract partially (the 1,200 television sets that were defective), keep the 50 that were conforming and bear the risk for the 750, which were accidentally destroyed.181 2) the buyer can ask for delivery of substitute goods, according to article 46(2). he can always claim this remedy even though the defective goods might have been destroyed. the risk in that case shifts back on to the seller just like in the case of avoidance.182 nevertheless, the buyer will be entitled to the substitution of the 1,200 television sets, whereas he will have to bear the risk for the other 750, which were accidentally lost. for that reason this remedy is not preferable over the previous one, since the avoidance of the contract releases the buyer from having to pay for all the goods.183 of course, the buyer in both the above cases should keep in mind that he is expected to make restitution of the goods in the condition they were, when he received them. that is required by article 82(1), which in that way restricts the application of articles 70, 49(1)(a) and 46(2). however, notwithstanding the restriction, its effect is mitigated by the exception that follows in the next paragraph, in article 82(2)(a),184 which provides that paragraph one does not apply if the impossibility of restitution is not due to an act or omission of the buyer.185 in other words, the buyer can avoid the contract or require substitute goods, while ‘the risk remains with the seller, since the buyer is permitted to exercise those rights irrespective of the loss of or damage to the goods except where that loss or damage is due to the buyer’s act or omission. (article 82(2)(a))’.186 3) another remedy that the buyer can claim despite the passing of risk to him is the repair of the goods (article 46(3))that obviously applies only in cases where the goods were only damaged and not completely lost, since in the latter case the remedy of repair would be automatically inapplicable.187 in the example, the buyer could request the repair of the 1,200 televisions, keep the 50 and bear the risk for the 750. if, however, the goods are destroyed before their repair188 the buyer may resort to other remedies with respect to the seller’s breach of contract because repair is no longer workable. this solution follows from article 47(2), which applies where the buyer has fixed “an additional period of time for performance by the seller of his obligations” and maybe expanded by analogy to cases in which such period has not been fixed.189 4) another remedy at the buyer’s discretion is his right to ask for a reduction in the price of the defective goods. of course, if the defective goods have been destroyed due to the nordic journal of commercial law issue 2004 #2 21 accidental event, then this remedy will have no meaning. in the above mentioned example the buyer can ask for a reduction in price regarding the 1,200 television sets, bear the risk for the 750 and keep the other 50. the buyer will rarely prefer this remedy, just like the previous one,190 since the first two are more advantageous and even more satisfactory.191 5) finally, the buyer has the right to ask for damages according to articles 7477 cisg, but again this right is restricted since it will only cover the damage or loss ‘which occurred before the materialization of the risk’.192 for that reason the remedy of damages is hardly satisfactory and therefore, the buyer will rarely prefer it. in the opposite case where the breach is not fundamental, the risk passes normally to the buyer and he has at his discretion only the remedies of repair, reduction in price and damages for the goods that were defective before the passing of risk and moreover, he has to bear the risk of any damage or loss of the goods due to the accidental event. he will not have the discretion to declare the contract avoided or ask for substitute goods, since these remedies are available only in cases of fundamental breach of contract. in the above example, a small number of defective television sets would constitute a non-fundamental breach of contract. thus, if the number was not significant, for example 15 television sets were defective, 40 were destroyed due to sea water and 1,945 were conforming to the contract, then the buyer would keep the conforming, bear the risk for the 40 and ask for repair, reduction in price or damages for the defective 15. in summary, it is obvious that the rules in articles 66-70 of the vienna convention generally connect the passing of risk with delivery (the passing of physical control over the goods). the same approach is followed by incoterms, the icc’s rules on the interpretation of international commercial terms, which as will be seen in the second part of this chapter, also connect the transfer of risk to delivery of the goods.193 4.1. the passing of risk under incoterms 2000 as it has already been mentioned above, one of the aspects that incoterms deal with is the allocation of risk between the parties.194 these international standard trade terms answer the question of who has to bear the risk in case of accidental loss or damage to the goods. here the question of time is once again of importance. when did the damage or loss occur? that question is closely connected to the following, namely which type of incoterms 2000 did the parties adopt to govern their sale contract? i) types of incoterms 2000 incoterms 2000 include a range of 13 different types of terms, which regulate different situations pertaining to the movement of goods.195 the 13 types are formulated in a way as to satisfy the needs of the specific contract of sale, regarding the modes of transport involved and the nature of the goods, giving the parties the chance to choose the one that best suits their own agreement. 196 nordic journal of commercial law issue 2004 #2 22 ii) risk allocation under incoterms 2000 a) meaning of risk just like the cisg, incoterms cover only the “price risk”, ie whether the buyer will be obliged to pay the price or the seller will be entitled to claim the price, in case of accidental loss or damage to the goods. therefore, incoterms do not regulate the risk of non-performance or of breach of contract for other reasons.197 the meaning of risk under incoterms 2000198 is the same as in the vienna convention and covers any physical loss or damage to the goods that is “accidental” and for which neither of the parties is responsible, ie caused by “acts of god” or acts or omissions of third parties. some examples are theft, deterioration due to overheating and bad storage. b) time of transfer the transfer of risk is regulated in sections a5 and b5, which provide that the risk in every incoterms term is passed to the buyer at the moment of delivery. the meaning of the moment of delivery is defined in sections a4 and b4 and it regulates the time of handing over of the goods by the seller and the taking over by the buyer.199 the time of delivery is different in the various types of incoterms and that means that the time of passing of risk varies as well. iii) passing of risk under the 13 terms exw: this term represents the minimum obligation for the seller since his only task is to place the goods at the disposal of the buyer either at the seller’s premises or at another place (ie factory, warehouse).200 risk passes at that time, upon delivery, ie. when the seller places the goods at the buyer’s disposal at the named place and on the agreed date.201 fca: under this term202 the seller has to deliver the goods at a named place, on the agreed date, to a carrier or another person nominated by the buyer. therefore, delivery is completed and risk passes when: i) the goods have been loaded on the means of transport at the seller’s premises, when the agreed place for delivery is the seller’s premises; in that case the seller is responsible for the loading.203 ii) in the rest of the instances, risk passes when the goods have been placed at the disposal of the carrier or the person nominated by the buyer or chosen by the seller. in these cases the seller is not responsible for unloading. fob: under the fob term204, the risk passes with delivery of the goods, which takes place when the goods pass the ship’s rail, on the agreed date or time period, at the port of shipment. the fob of the incoterms was actually based on, and formed according to the classic fob term, which first appeared at the beginning of the 19th century and is considered as ‘the outgrowth of the custom and usages of merchants instead of the product of legislation’.205 in the classic fob term, risk passes on shipment, which means when the goods are placed on board the vessel. at that time, the title of the property usually passes as well. nevertheless, since risk is in no way related to the title of the property, it will still pass on shipment, even if the title of the property passes later, for example when the goods are unascertained.206 nonetheless, the general statement that risk under a fob contract passes on shipment is rather vague and blurred, since it does not visibly specify the exact time of shipment. the law does not clearly stipulate as to the point of the loading process at which the risk passes from seller to buyer and the issue ‘has not been the subject of much judicial clarification’.207 one relevant leading case is pyrene co ltd v scindia navigation co ltd,208 which involved a fob contract for the sale of machinery. in the case, the cargo fell nordic journal of commercial law issue 2004 #2 23 from the ship’s tackle and was damaged during the process of loading, but before having crossed the ship’s rail. the issue was whether the carrier’s liability was limited by art. iv (5) of the hague rules. the shipper argued that the hague rules did not apply since the bill of lading had not been issued. devlin j decided that this did not mean that the rules were not applicable. on the contrary, the rules did apply even before the goods had passed the ship’s rail, despite the wording of art.i(e), which provided that for their application the goods should be “loaded” on the ship. in fact in art.2 “loading” meant the whole process of putting the goods on board the vessel.209 for that reason the defendants’ liability had commenced before the goods had passed the ship’s rail. the same reasoning could apply to the issue of the passing of risk. according to devlin j ‘[t]he ship’s rail has lost much of its nineteenth century significance. only the most enthusiastic lawyer could watch with satisfaction the spectacle of liabilities shifting uneasily as the cargo sways at the end of a derrick across a notional perpendicular projecting from the ship’s rail’.210 therefore, it is suggested that the ship’s rail is a quite imprecise criterion. in an attempt to clear the issue, two answers have been given to the critical question of when the goods had crossed the ship’s rail. the first one supports that the goods pass the ship’s rail when they actually cross the rail of the vessel. hence, if they get damaged in the loading process, the risk will be on the seller if for example they fall on the wharf or in the water, whereas it will be on the buyer if they fall on deck.211 the second approach suggests that the risk passes at the end of the loading process, when all the goods have already been loaded on board.212 moreover, it is possible, that the parties in a fob sale may add the words “stowed” and/or “trimmed”. the former means that the seller is obliged to perform the loading at his own expense and the latter that the seller will have to pay for the storage and safe placement of the goods inside the ship. it is not certain if the words “stowed (and/or) trimmed” mean that the passing of risk takes place at a later point.213 ‘it is likely that in these cases, risk does not pass when the goods pass the ship’s rail. however, no precise rules can be formulated, since it is dependant on a number of factorsfor example, custom at port, terms of the contract, and whether the seller in fact has a say in how the goods are trimmed or stowed’.214 for that reason the parties are strongly advised to make specific arrangements on that issue in order to avoid any possible disputes. fas: under the fas term215 risk passes at the moment when the seller places the goods alongside the vessel, at the named port of shipment, on the agreed date and in the manner customary at the port.216 cfr: delivery is completed and thus, risk passes at the moment when the goods pass the ship’s rail at the port of shipment. the buyer bears the risk of loss or damage from the moment that the goods are placed on board the vessel on the agreed date or timely period.217 cif: according to a4 and a5 the seller fulfils his obligation to deliver when the goods pass the ship’s rail at the named port of shipment on the agreed date or time period;218 it is after that moment that the risk passes onto the buyer.219 a reference should be made again here to the classic cif term,220 on which cif incoterms is based. under the classic cif contract,221 risk passes on shipment,222 ie when the goods pass the ship’s rail.223 ‘this is because the parties contemplate the risk of loss or damage in transit and cover it by the contracts of carriage and insurance which the seller is required to take out and transfer to the buyer’.224 as it was successfully illustrated by kennedy lj in biddell bross v e.clemens horst co,225 ‘[t]wo further legal results arise out of shipment. [one is that] the goods are at the risk of the purchaser, against nordic journal of commercial law issue 2004 #2 24 which he has protected himself by the stipulation in his cif contract that the vendor shall, at his own cost, provide him with a proper policy of marine insurance intended to protect the buyer’s interest, and available for his use if the goods should be lost in transit’.226 cpt: the risk is transferred to the buyer from the moment of delivery of the goods to the carrier (with whom the seller is responsible to contract), for their carriage at the named place of destination on the agreed date or in the agreed period.227 in case of a multi-modal transport agreement, risk passes when the goods are delivered to the first carrier.228 cip: under this term the risk is transferred to the buyer at the time of delivery of the goods to the carrier nominated by him. after that point the buyer will be responsible for any accidental loss or damage to the goods.229 just like in cpt, in cip in case of successive carriers, risk passes when the goods are delivered to the first carrier. daf: risk is transferred when the goods are placed at the buyer’s disposal, loaded on the means of transportation,230 at the agreed place of delivery at the frontier,231 but not before the customs border of the country of import, on the agreed date or in the agreed period.232 des: the buyer bears the risk of loss or damage to the goods from the moment that the seller places them at his disposal on board the vessel, at the named point in the named port of destination, on the agreed date or in the agreed time period, in a way that enables their unloading from the vessel by the appropriate unloading equipment.233 the seller does not have to discharge the goods.234 deq: the risk passes when the goods are placed at the buyer’s disposal, on the agreed date, on the quay at the named port of destination.235 the seller has the obligation to discharge the goods from the vessel onto the quay (wharf).236 ddu: the buyer bears the risk from the moment when the seller places the goods at the buyer’s (or another person’s named by the buyer) disposal, on the agreed date, on the arriving means of transport not unloaded, at the named place of destination.237 additionally, if the buyer fails to obtain the necessary documents for the import of the goods and to complete all the customs formalities necessary for their import, then he will bear the additional risks of loss of or damage incurred thereby. ddp:238 the risk is passed to the buyer when the seller puts the goods at the buyer’s (or another person’s named by the buyer) disposal, on the agreed date or within the agreed period for delivery, at the named place of destination, on the arriving means of transport not unloaded. the seller is responsible and bears the risk of carrying out the customs formalities for import in the country of destination.239 iv) premature transfer of risk from the above, it is obvious that risk under the 13 incoterms passes with delivery. however, that rule is not absolute. there is an exception, according to which the risk might be prematurely transferred to the buyer even before the seller has delivered the goods. the premature transfer of nordic journal of commercial law issue 2004 #2 25 risk and its prerequisites is dealt with in section b5. according to this section, risk is passed onto the buyer at a previous moment in time, ie from the agreed date or the expiry date of the agreed period for delivery, if: 1) the buyer fails to do what is expected in order to enable the seller to perform his delivery obligation, or 2) the buyer fails to take delivery of the goods. the buyer should give sufficient notice to the seller of all the relevant information regarding delivery, according to section b7.240 moreover, according to b5, for the risk to pass to the buyer even before delivery has taken place, it is necessary that the goods have been appropriated to the contract of sale or clearly set aside or identified by any other way as the contract goods. appropriation of the goods can occur by marking the goods or by naming the addressee(s).241 nevertheless, sometimes things might be more complicated, in cases of bulk goods, where marking the goods or naming the recipients is not possible. in these cases ‘the risk will not pass until effective appropriation has been made, for example, until the issuance of separate bills of lading or delivery orders for parts of the bulk consignment’.242 in the present chapter, the rules on passing of risk under the vienna convention and incoterms 2000 were thoroughly examined. next, in the following chapter, an analysis will be made of their similarities and differences and will be examined the relation between them in international sales contracts. furthermore, the next chapter will deal with some intrinsic problems, which preoccupy this area of law and proposals for their resolution will be suggested. 5. chapter iii: comparing the vienna convention and incoterms 2000some problematic issues and proposals 5.1. comparative evaluation i) general remarks the vienna convention and incoterms are both international instruments formed with the aim of unifying the law pertaining to international sales and providing a common denominator for the harmonisation of several aspects of international sale contracts. both are quite pragmatic and practical in a way so as to help the seller and buyer to cope with several issues that arise in international sale contracts. but what is the relation between the two? which one will apply in an international contract of sale? is there any case of parallel application and co existence? and does the cisg contain any rules on trade terms or incoterms? if the parties expressly agreed on the incorporation of incoterms in their contract, then their rules will govern the contract of sale and they will supersede the convention’s rules on the passing of risk, excluding therefore, the application of articles 66-70 cisg. that is because the nordic journal of commercial law issue 2004 #2 26 convention constitutes ius dispositivum, allowing the parties to derogate from or to completely exclude the application of its provisions.243 if the parties did not expressly agree on the incorporation of incoterms, then it remains unclear whether their rules could still be applied in the contract of sale. can the incoterms be applied through the articles of the convention even if the parties did not refer to them? the cisg does not openly and expressly refer either to the classic trade terms or the incoterms; it does not contain any articles that include specific rules on them. nevertheless, on one hand it has been supported that incoterms can be applied, if they are thought to constitute “usages” under the meaning of article 9(2)cisg;244 “usages” on which the parties have impliedly agreed and which the parties knew or ought to have known, and are widely known and used in the particular trade. indeed, if we accept the above mentioned approach, that would mean that incoterms would take precedence over the rules of the convention. that view has already been reflected in case law, where in a recent us case decided on 26 march 2002, the district court of new york held that incoterms constitute “usages” under the meaning of article 9(2)cisg. the parties were st paul guardian insurance co., et al. v neuromed medical systems & support, et al.245 in that case a german seller and an american buyer agreed on the sale of a magnetic resonance imaging (mri) machine, under a ‘cif new york seaport’ contract. the seller delivered the mri on board the ship undamaged and in good condition. nevertheless, when the ship reached usa, it was found that the mri had sustained great damage and needed repair. according to the cif term, risk was transferred when the goods had passed the ship’s rail at the port of shipment. the american buyerplaintiff sued the seller-defendant in a us court in order to recover for the damage. he argued that since the title to the goods would pass only when the final payment had been made, the risk of damage or loss would remain with the seller up to the moment when the goods were delivered at the port of new york. the seller argued that according to cif incoterms, risk had passed at the port of shipment. the buyer supported that since the parties had not expressly referred to incoterms in their contract, the cif incoterms would be inapplicable. the contract stated that the applicable law would be the german law. the court decided that the cisg governed the contract. the court rejected the plaintiff’s claims that the cif incoterms did not apply because the parties had not explicitly made a reference to them. it held that article 9(2)cisg was applicable and that incoterms formed “usages” widely known and used in international trade by which the parties were bound, and that the cif term was to be interpreted according to incoterms.246 in the end, the court dismissed the case. on the other hand, the contrary opinion has also been supported, which suggests that incoterms cannot be included in article 9(2), since they are not widely used in all types of trade (for example they are not that common in the sale of dry cargo247) and furthermore, they may have a different interpretation in different states (for example in the usa).248 moreover, another way through which incoterms can be applied even though they are not expressly mentioned in the contract, is article 8(3)cisg. according to that article, the parties’ intentions and statements can be interpreted in accordance with the practices and usages they have established between themselves. in consequence, incoterms could be regarded as “usages” established between the parties, if they have used them in previous transactions between themselves and as a result, they will be applied to their sales contract, even though they were not expressly referred to.249 nordic journal of commercial law issue 2004 #2 27 ii) similarities between the two voices the rules on passing of risk under the convention and incoterms have several similarities and common points. the first one is their common understanding of the notion of “risk”. under both, “risk” has the meaning of any “accidental” loss or damage to the goods, caused by neither an act nor an omission of any of the parties. furthermore, both refer only to the so called “price risk”, leaving out of their ambit the “risk of non performance”. also, they connect the passing of risk to delivery, i.e. the transfer of physical control over the goods from the seller to the buyer (with the exception of art.68 cisg, where the risk passes from the time of conclusion of the contract). finally, both instruments contain specific provisions, which require the previous identification of the goods to the contract in order for the risk to pass to the buyer. iii) comparison of the convention’s articles on the passing of risk with incoterms 2000 a) article 67 cisg article 67(1) first sentence by comparing the convention’s rules with incoterms 2000, it is easy to notice that article 67(1) first sentence could be applied to the fca term, which was formed in order to cover situations where multi-modal transport is involved, therefore making this term applicable in cases of successive carriers. the most appropriate rule in the convention is article 67(1) first sentence, according to which risk passes with delivery of the goods to the first carrier for transmission to the buyer. the meaning of “carrier” is the same under incoterms and the convention.250 the same rule, that of the first sentence of article 67(1),251 applies to cfr contracts as well. under the later, risk passes when the goods cross the ship’s rail at the port of shipment. the above rule of the convention is the closest for this type of incoterms, since under the cfr the seller is the one responsible to contract for the carriage and pay for the loading and unloading of the goods. therefore, the seller is obliged to deliver not to a particular place, but to the custody of a carrier, who in that case is the sea carrier selected by the seller; the seller has to deliver the goods on board his vessel at the agreed port of shipment. the case is the same under a cif contract, where the seller is obliged to deliver the goods on board the vessel selected by him and to contract for the carriage of the goods. risk passes from the moment that the goods cross the ship’s rail. under the cif clause the port of shipment does not constitute part of the sales contract.252 therefore, the seller is not supposed to hand the goods over at a “particular place” thus, making the convention’s article 67(1) first sentence the most compatible provision. under the latter, risk passes upon delivery to the first carrier for transmission to the buyer, who under the cif term is the sea carrier; the goods will be delivered on board his vessel at the agreed port of shipment. furthermore, under the cpt and cip terms, which can be used in all modes of transport including multi-modal transport, risk is transferred by handing the goods over to the carrier for transmission to the buyer or to the first carrier in case of successive carriers. it is suggested that art.67 (1) first sentence should be equated to both terms, since under the convention “the risk passes to the buyer when the goods are handed over to the first carrier for transmission to the buyer”. nordic journal of commercial law issue 2004 #2 28 article 67(1) second sentence article 67(1) second sentence provides that where the parties have agreed on delivery of the goods to a certain place, risk passes when the seller hands the goods over to the carrier at that place. it seems that this rule could be applied to fas contracts, where risk passes when the seller places the goods alongside the ship on the harbor. the buyer is the one who should take over the goods and load them on board the vessel; the procedure of loading is at the buyer’s risk. if the goods suffer any damage while they are being loaded, the seller is absolved from any liability. the responsibility of placing the goods alongside the vessel resembles the act of handing over the goods at a “particular place”. it is generally accepted that risk passes at the end of the handing over process.253 nevertheless, the convention’s rule differs from that of the fas term in that, whereas under the latter the risk passes when the goods have just been placed alongside the vessel, without being necessary that the buyer takes delivery, under the convention’s provision, the risk passes when the goods are delivered to the carrier at the particular place, and not when they are merely placed at his disposal. it seems, therefore, that the convention presumes that delivery is only valid if the goods are taken over by the other party, thus making delivery a bilateral act, which is not always the case in international trade.254 the same convention’s rule seems to apply to fob contracts as well. under the latter the seller should deliver the goods on board the vessel and risk passes when the goods cross the ship’s rail. the ship’s rail was seen in the old days as the border line between the seller’s and buyer’s territory as well as between the shipper’s and carrier’s or the customs agent’s and captain’s.255 nonetheless, the ship’s rail is a rather controversial criterion, which may be susceptible to different interpretations.256 article 67(1) second sentence would apply once more in that case, since delivery on board the vessel, at the agreed port under the fob term, equates to delivery at a “particular place”. b) article 68 cisg as it has already been examined,257 article 68 cisg deals with a particularly difficult issue, ie the passing of risk in case of goods sold in transit. usually this type of sale involves bulk goods like oil or wheat, where the seller embarks on a journey often without knowing the recipients of the cargo and arranges for its sale while it is being transported. whereas article 68 provides that the risk, in sales involving goods in transit, passes from the time of conclusion of the contract of sale, or in special circumstances (ie where there is an insurance cover) from the time of handing over the goods to the carrier who issued the contract of carriage, incoterms 2000 do not specifically provide any provision dealing with this issue. it is, therefore, suggested that in cases of sale of goods during transit, the cif and cfr terms usually apply by adding the word “afloat” after them.258 in that case, the risk will pass to the buyer from the moment when the goods pass the ship’s rail at the port of shipment. that option has the disadvantage of the buyer having to bear any loss or damage to the goods even before the contract is concluded.259 in order to avoid the disadvantages, ‘it is recommended that parties involved in similar contracts [should] agree in advance to the point in which risk is to be passed. relying on article 6 of the convention this may be done. in other words, parties should agree that risk passes either at the beginning of the contract or at the end of transit.’260 nordic journal of commercial law issue 2004 #2 29 c) article 69cisg article 69(1) the incoterms 2000 term that presents significant similarities to article 69(1), is exw. both provisions deal with cases that do not involve carriage of goods by a carrier. the convention’s provision regulates instances where the buyer is bound to take over the goods at the seller’s premises or where he is not bound to take them over at any particular place. risk passes when he takes over the goods, or from the moment when the goods are placed at his disposal and he commits a contractual breach by failing to take delivery. similarly, under exw incoterms 2000 risk passes from the moment when the goods have been placed at the disposal of the buyer at the seller’s premises. the two provisions differ though, in that whereas under the exw term the seller simply has to place the goods at the disposal of the buyer in order for the risk to pass, under the convention this is not sufficient. under the latter, risk passes from a later point, ie when the buyer takes over the goods, and only when he commits a breach by not taking delivery does the risk pass from the moment when they are placed at his disposal. let us now assume that a buyer in london and a seller in athens agree on the sale of 500 washing machines under an exw incoterms 2000 term.261 the goods would be available at the seller’s premises in athens from 1 march 2003 and for two weeks. on 1 march the seller informs the buyer that the goods are ready for taking over. on 12 march burglars break into the premises and the washing machines are stolen. under the exw term the buyer would have to bear the loss of the goods since the risk had passed to him from 1 march when the goods had been placed at his disposal. on the contrary, under the convention’s rule, the party bearing the risk would be the seller since the buyer had not committed a breach of contract by not taking delivery of the goods by the 12 march. if the goods were stolen on 25 march and the buyer had still not taken delivery, he would have to bear the loss since he would have then committed a breach of contract. article 69(2) all d-terms can most successfully be compared with article 69(2) cisg, which provides that “risk passes when delivery is due and the buyer is aware of the fact that the goods are placed at his disposal at that place”. indeed, under daf risk passes when the goods have been placed at the buyer’s disposal at the frontier at the country of export, whereas under the deq term, when they have been placed on the wharf or quay at the agreed port. under the des term risk passes when the goods have been tendered while on board the vessel (the buyer bears the risk during the unloading procedure). and finally, the provision of article 69(2) is also appropriate for the ddu and ddp terms, where risk once more passes when the goods have been placed at the disposal of the buyer. d) articles 66 and 70 cisg finally it should be stressed that incoterms 2000 deal only with “accidental” loss or damage to the goods; therefore, they do not regulate situations that involve loss or damage due to acts or omissions of the seller. in that case article 66 cisg applies.262 furthermore, incoterms 2000 do not contain any similar provisions to that of article 70 cisg either, thus, leaving it up to the convention to regulate cases of simultaneous “accidental” loss or damage and fundamental breach on the part of the seller. nordic journal of commercial law issue 2004 #2 30 5.2. some problematic issues and proposals i) the “ship’s rail” criterion as it has already been mentioned above, under the incoterms 2000 cif and fob terms, the point of delivery and hence, passing of risk is the moment when the goods pass the ship’s rail.263 this criterion, nonetheless, is rather unsatisfactory since it can lead to a great deal of confusion and unfair results. incoterms’ 2000 approach was based on the classic trade terms cif and fob, which, since their appearance and establishment over 150 years ago, had adopted as a critical point for the passing of risk the time of shipment and the placing of the goods on board the vessel respectively. so, the answer to the question, why incoterms 2000 did not change the point of passing of risk under the cif and fob sales,264 is simple. any alteration would have created lots of misunderstandings and confusion in the commercial world, since the traders for over a century had connected these trade terms with the “ship’s rail” criterion.265 nevertheless, this does not alter the fact that the “ship’s rail” criterion has actually a lot of disadvantages. the apparent difficulty is the specification of the exact time of passing of risk. what if the goods suffer loss or damage during the loading process? who will bear the risk then?266 on one hand, it has been suggested that in these situations risk passes literally when the goods pass the ship’s rail and therefore, the risk is on the seller if they fall on the wharf or in the sea, but it is on the buyer if they fall on deck, since they will have already passed the ship’s rail. this approach, though, is simplistic, is hardly practical and involves further problems of proof.267 on the other hand, the view has been supported that risk should pass at the end of the handing over process, when the loading operation has finished and the goods are not under the seller’s possession anymore.268 nevertheless, it is dubious if this approach is satisfactory, since if the parties wanted the risk to pass at the end of the loading procedure, they would have expressly added that to their contract by using the terms “stowed and/or trimmed”.269 the author is of the opinion that the “ship’s rail” criterion is insufficient to address the current issues in modern sales transactions and therefore it should not be preferred. a better option would be to relocate the moment of passing of risk at an earlier point, ie at the moment of handing over the goods to the carrier, before the start of the loading operation and thus, to put the risk during loading on the buyer.270 in that way the time and money consuming litigation would be avoided, as well as the problems of proof and examination of the exact time and place of the loss or damage.271 moreover, it is suggested that the proposed solution is in accordance with the convention’s rule on article 67(1) first sentence, according to which the risk is transferred when the goods are handed over to the first carrier for transmission to the buyer. the adoption of the convention’s rule avoids the vagueness and the uncertainty of the “rail criterion” and offers clear and straightforward answers. furthermore, the view that the latter criterion should be discarded is reinforced by the fact that in some ports, the “ship’s rail” criterion is not applied, where the custom practices have established a different point of passing of risk. for example in the port of antwerp and zeebrugge, the passing of risk under a fob contract ‘coincides with the transport agreement namely under the ship’s tackle’.272 nordic journal of commercial law issue 2004 #2 31 ii) appropriation and the transfer of risk an issue that is neither sufficiently nor satisfactorily settled by the convention is the passing of risk in cases of sales of bulk cargos. the convention in that case lacks clarity and the choice not to include a specific provision on bulk sales, which is a very common practice in international sale contracts, is one of its serious weaknesses. both articles 67 and 69 cisg contain specific provisions in paragraphs (2) and (3) respectively,273 which expressly require for the goods to be clearly identified to the contract of sale either by markings, by sending appropriation notices or by any other way. if the goods are not identified to the contract, then the risk cannot pass. article 68, dealing with goods sold in transit, does not have a similar provision, but it is accepted that the prerequisite of identification applies to that article as well.274 regarding the sending of a notice of appropriation, risk passes from the time of its dispatch, meaning that it does not have a retrospective power. that provision though, has certain disadvantages, since it results in splitting the transit risk and leads to further problems of proof, given that it will be difficult to ascertain the exact point of the loss or damage and if it occurred before or after the dispatch of the notice.275 the fact that the critical point for appropriation is that of dispatch (and not that of receipt) serves the quicker transfer of risk in favour of the seller. nevertheless, his position will be worse in case the goods are lost or damaged, as then he will have the burden of proving that the damaging event occurred after the identification.276 in case of sale of bulk goods while in transit, it should be stressed that in case of loss or damage, each buyer bears the risk pro rata, if the parties have made an express agreement on that or if it is a common practice in that type of trade, whereas in a contrary case the risk is transferred when it has been certified that the goods are those referred to the sales contract.277 furthermore, the convention in article 68 adopts the “knowledge criterion”; if the seller knew or ought to have known about the loss or damage and did not inform the buyer, and then the seller will be the one who bears the risk. what will happen though, when bulk goods have been shipped, sold and lost before appropriation? in that case the “knowledge criterion” offers satisfactory solutions, since the seller in all likelihood will be aware of the loss. on the contrary, if the goods were shipped, sold and then damaged before appropriation, the “knowledge criterion” will not be enough, since it is not always easy for the seller to discover the damage or deterioration of the goods while in transit.278 therefore, it is suggested that the convention’s provisions, besides being rather severe, fail to take into consideration certain very common situations in international contracts. it is the author’s opinion that the retrospective passing of risk should be preferred in any case and the risk should be transferred not from the time of appropriation, but from the moment of handing the goods over to the carrier for transmission to the buyer, since in that way the splitting of transit risk will be avoided and so will the additional problems of proof. moreover, the parties to a contract for the sale of bulk goods should specifically agree on the exact point of passing of risk in order to protect themselves from misunderstandings. the parties could additionally include out-turn clauses in their contract, the advantage of their incorporation being that the buyer will just have to pay for the price of what he finally receives at the end of the journey.279containerisation and issues on risk nordic journal of commercial law issue 2004 #2 32 the passing of risk when the transport of the goods is made in containers presents certain difficulties, and for that reason it requires separate examination. ever since the appearance of the first containers in the 1950s and the establishment of containerisation, the transport of goods in containers has been very popular. especially during the last decades the evolution and wide use of containerisation has been impressive.280 nowadays, container transport is preferred especially in long distance sales due to the speed, ease and security that it offers.281 the ‘containers are basically large boxes, 8 x 8 feet in crosssection, and either 10, 20 or 40 feet long’.282 they allow the safe storage of goods, since when loaded they are subsequently sealed and opened only at the place of destination, thus reducing the risks of theft or pilferage. moreover, they offer great automation of loading and transhipment, saving considerable time and money during transport.283 shipments in containers are either full container load (fcl) or less than a full container load (lcl).284 in the former case the container is loaded at the seller’s premises with goods that fill the whole container, whereas in the latter case, the seller delivers the goods to a container terminal, where the goods are stowed in the container along with additional cargo, since they are not sufficient to fill a whole container.285 usually, where containers are used, the transport of goods is multi-modal.286 the advantages of the latter are various,287 since the entire transit will be covered by one transport document ‘issued at the beginning by someone in a position to see what goes into the container and record the quantity and condition of the goods at that time’.288 consequently, it can be said that ‘the advantages…of containerisation are clear: cheaper insurance and packaging derived from the protection afforded by the container, faster transit, and lower freight rates’.289 conversely, despite the widely recognised advantages of container transport, there are certain problems related to containerisation and the passing of risk. it was mentioned above that the containers are usually loaded and sealed immediately, at the premises of the seller or at the container terminals before the beginning of the carriage and that they are not opened until they reach their final destination. hence, when the goods suffer damage or loss during transport it is difficult, and most of the times impossible to ascertain the exact time when the loss or damage took place, unless it was due to an obvious external event.290 consequently, it will be very hard to allocate the risk between the parties.291 it is evident that rules that split the transit risk between the parties cannot be efficient, since it will not be possible to detect the exact moment when the damaging event occurred.292 it is suggested that the parties should expressly include specific provisions in their contract, allowing for the risk to pass at the moment when the container is sealed. in so doing they will avoid intrinsic problems of proof.293 it is true that the cisg fails to deal specifically with containerised cargo and does not include separate provisions on risk in cases of transport in containers, even though this mode of transport is extremely popular in international sales.294 nevertheless, the convention’s provisions do contain satisfactory rules, which may be successfully applied in container transport. accordingly, in transport in containers the rule of the first sentence of article 67(1) can be an efficient proposal regarding the passing of risk issues.295 according to the provision, the risk will be transferred when the goods are handed over to the carrier for transmission to the buyer. in that way the splitting of transit risk will be avoided and the buyer will bear the risk of loss or damage during the whole carriage. nordic journal of commercial law issue 2004 #2 33 incoterms 2000, the drafters being aware of the importance of container transport in international sales, have incorporated terms, which are indeed appropriate for containerised and multi-modal transport. these terms include fca, cpt and cip, under which the risk passes when the goods are handed over to the carrier for transmission to the buyer.296 these terms are efficient for transport in containers, since as it was already mentioned, once the containers are sealed there is no possibility of opening them or checking the status of the goods, thus making it impossible to certify the exact point in time that the loss or damage occurred. by using the above incoterms 2000 terms any possible problems of proof are certainly abolished and the splitting of transit risk is undoubtedly avoided. 6. conclusion after examining the rules on risk allocation under the vienna convention and incoterms 2000 it is now easy to make an overall assessment of the efficiency and adequacy of their provisions. they both are international instruments created for the purpose of promoting international unification in the field of commerce and they have been quite successful in fulfilling their purpose. nevertheless, it is true that, when it comes to the issue of passing of risk, they do not manage to give completely clear and straightforward answers to certain important and usually encountered questions. the vienna convention’s rules on risk allocation, even though quite practical, lack clarity and comprehensiveness at some points, i.e. the convention does not define important notions like those of “delivery”, “first carrier”, or “indicative circumstances”, leaving it open for different and often divergent interpretations. this might lead to confusion and misunderstandings, thus putting the goal of harmonisation in danger. furthermore, some of its provisions are rather ambiguous and vague, like for example the rule on risk allocation on sales of goods in transit and its complicated technique for the attribution of retroactive effect. moreover, it seems that the convention fails to take into account modern developments and practices in international trade, since it does not include separate rules on containerisation despite the immense growth of use of containers. additionally, it does not contain any rules on the passing of risk in cases of sale of bulk goods, which is also a common practice in commercial sales. another weak point of the cisg is its lack of reference to international trade terms commonly used in sales contracts, even though it does acknowledge and respect their importance and considerable weight in international sales law. overall, it can be said that generally the risk allocation under the convention consists a reasonable compromise of the seller’s and buyer’s interests, in a problem where any solution seems harsh for any of the parties, which will have to bear the risk of loss or damage without having committed any contractual breach.297 despite its weaknesses though, it should not be forgotten that the cisg is a document, which resulted from the cooperation of countries with a different legal culture, economic status, social background and political history and it is more than anticipated and excused for containing compromises and unsettled issues. what is of significance is that the vienna convention is a document of vast magnitude and it undeniably provides an environment that promotes and strengthens international trade.298 of course, most of the times in issues concerning risk allocation the cisg will not apply, since the parties will have either made a specific agreement or will have incorporated international trade nordic journal of commercial law issue 2004 #2 34 terms in their contract, like for example incoterms. the latter are preferred by a range of companies and enterprises all over the world, due to the practicality, simplicity and clarity that they offer. it should not be forgotten though, that incoterms do not deal with all the issues that might arise in a sales contract and they generally only deal with passing of risk and payment of the price aspects. however, incoterms have succeeded in promoting harmonisation and providing safety and certainty in international sales law. they have taken into account the latest practices in trade by including terms, which can be applied in multi-modal and container transport, like fas, cpt and cip and at the same time they respect long established practices, like the “ship’s rail” criterion under the cif and fob terms, even though, as it was shown earlier,299 this is a hardly effective or satisfactory approach. in conclusion, it can be said that the two voices can harmoniously co exist and offer their own perspective towards the much debated issue of risk allocation in international sales. the wish expressed by the author is, for the parties in an international sales contract to pay additional attention to the passing of risk issues, since they can be of extreme importance to the outcome of their transaction, and for the legislator to act prudently and effectively in order to settle satisfactorily the intrinsic problems of risk allocation and to sort out its related vague and intricate aspects. bibliography books h.bernstein and j.lookofsky, understanding the cisg in europe (the hague; london; boston: kluwer law international, 1997). c.m.bianca and m.j.bonell (eds), commentary on the international sales law. the 1980 vienna sales convention (milan: giuffrè, 1987). m.bridge, the international sale of goods. law and practice (oxford: oxford university press, 1999). i.carr, principles of international trade law (london: cavendish publishing limited, 2nd edition, 1999). i.carr and r.kidner, statutes and conventions on international trade law (london: cavendish publishing limited, 3rd edition, 1999, reprinted 2000). j.c.t.chuah, law of international trade (london: sweet and maxwell, 1998). m.clarke, ‘containers: proof that damage to goods occurred during carriage’ in c.m.schmitthoff and r.m.goode (eds), international carriage of goods: some legal problems and possible solutions, the international commercial law series, volume 1 ([london]: centre for commercial law studies, 1988). l.d’arcy, c.murray and b.cleave, schmitthoff’s export trade. the law and practice of international trade (london: sweet and maxwell, 10th edition, 2000). m.d.day, the law of international trade (london: butterworths, 1981, reprinted 1987). e.p.ellinger, documentary letters of credita comparative study (singapore: university of singapore press, 1970). nordic journal of commercial law issue 2004 #2 35 f.enderlein and d.maskow, international sales law (oceana publications, 1992). c.gelens, ‘incoterms and contracts of carriage on liner terms’ in c.debattista (ed), incoterms in practice (paris: icc publishing s.a., 1995, reprinted 1996). r.goode, commercial law (london: penguin books, 2nd edition, 1995). w.hedley, bills of exchange and bankers’ documentary credits (london: lloyd’s of london press ltd, 2nd edition, 1994). j.o.honnold, uniform law for international sales under the 1980 united nations convention (the hague: kluwer law international, 3rd edition, 1999). h.van houtte, the law of international trade (london: sweet and maxwell, 2nd edition, 2002). g.jiménez, icc guide to exportimport basics, the legal, financial and transport aspects of international trade (paris: icc publishing s.a., 1997). k.m.johnson and h.c.garnett, the economics of containerisation (london: george allen & unwin ltd, 1971). t.portwood revised and updated by a.odeke, commercial law textbook, volume iiinternational trade (london: hlt publications, 3rd edition, 1992). j.ramberg, icc guide to incoterms 2000 (paris: icc publishing s.a., 1999). a.raty, ‘variants on incoterms’, in c.debattista (ed), incoterms in practice (paris: icc publishing s.a., 1995, reprinted 1996). d.m.sassoon, c.i.f. and f.o.b. contracts (london: sweet and maxwell, 4th edition, 1995). p.schlechtriem, commentary on the un convention on the international sale of goods (cisg) (oxford: clarendon press, 2nd edition, 1998). p.sellman, llb law of international trade casebook (london: hlt publications, 5th edition, 1994). p.sellman and j.evans, law of international trade. 150 leading cases (london: old bailey press, 2002). lord templeman and d.holloway, commercial law (london: old bailey press, 1997, reprinted 1999 and 2001). p.todd, bills of lading and banker’s documentary credits (london: lloyd’s of london press ltd, 1990). j.f.wilson, carriage of goods by sea (harlow: long man, 4th edition, 2001). b.wunnicke, d.b.wunnicke and p.s.turner, standby and commercial letters of credit (new york; chichester: wiley law publications, 2nd edition, 1996). articles s.bainbridge, ‘trade usages in international sales of goods: an analysis of the 1964 and 1980 sales conventions’ (1984) 24(3) virginia journal of international law 619. c.g.c.h baker and p.david, ‘the politically unsafe port’ (1986) lloyd’s maritime & commercial law quarterly 112. j.d.feltham, ‘the united nations convention on contracts for the international sale of goods’ (1981) journal of business law 346. j.d.feltham, ‘c.i.f. and f.o.b. contracts and the vienna convention on contracts for the international sale of goods’ (1991) journal of business law 413. d.flambouras, ‘international sales of goods. practical issues concerning the passing of risk under the vienna convention (1980)’ (marchapril 1998) synigoros 26 (in greek). nordic journal of commercial law issue 2004 #2 36 d.flambouras, ‘the icc rules on international commercial sale (incoterms 2000)’ 3/2000 (6th year) law of enterprises and companies 260 (in greek). d.e.goodfriend, ‘after the damage is done: risk of loss under the united nations convention on contracts for the international sales of goods’ (1983) 22 columbia journal of transnational law 575. b.nicholas, ‘the vienna convention on international sales law’ (1989) 105 law quarterly review 201. k.pantelidou, ‘issues from the allocation of risk under the vienna convention for the international sale of goods’ (2002) private law chronicle 97 (in greek). j.h.porter, ‘multimodal transport, containerization and risk of loss’ (1984) 25(1) virginia journal of international law 171. j.ramberg, ‘the implications of new transport technologies’ (1980) 15 european transport law 119. b.reynolds, ‘stowing, trimming, and their effects on delivery risk and property in sales “f.o.b.s.”, “f.o.b.t.” and “f.o.b.s.t.”’ (1994) lloyd’s maritime & commercial law quarterly 119. p.m.roth, ‘the passing of risk’ (1979) 27 american journal of comparative law 291. d.m.sassoon, ‘the origin of f.o.b. and c.i.f. terms and the factors influencing their choice’ (1967) journal of business law 32. k.sono, ‘uncitral and the vienna sales convention’ (1984) 18 international lawyer 7. d.n.tzouganatos, ‘the passing of risk under the articles 66-70 of the united nations convention on international sale of goods’ (1995) commercial law review 509 (in greek). h.de vries, ‘the passing of risk in international sales under the vienna sales convention 1980 as compared with traditional trade terms’ (1982) 17 european transport law 495. websites s.bollée, “the theory of risks in the 1980 vienna sale of goods convention”, available at http://cisgw3.law.pace.edu/ and http://www.cisgw3.law.pace.edu/cisg/biblio/bollee.html, 247-290, last accessed on 28/05/03. d.flambouras, “transfer of risk in the contract of sale involving carriage of goods: a comparative study in english, greek law and the united nations convention on contracts for the international sale of goods”, available at http://cisgw3.law.pace.edu/ and http://cisgw3.law.pace.edu/cisg/biblio/flambouras.html last accessed on 28/05/03. b.von hoffmann, “international sale of goods: dubrovnic lectures”, petar sarcevic and paul volken eds, oceana 1986, ch.8, 265-303, available at http://cisgw3.law.pace.edu/ and http://www.cisg.law.pace.edu/cisg/biblio/vonhoffmann.html last accessed on 28/05/03. m.t.murphy, “united nations convention on contracts for the international sale of goods: creating uniformity in international sales law”, 727-750, available at http://cisgw3.law.pace.edu/ and http://cisgw3.law.pace.edu/cisg/biblio/murphy.html last accessed on 28/04/03. n.g.oberman, “transfer of risk from seller to buyer in international commercial contracts: a comparative analysis of risk allocation under the cisg, ucc and incoterms”, available at http://cisgw3.law.pace.edu/ and http://www.cisgw3.law.pace.edu/cisg/thesis/oberman.html last accessed on 30/05/03. nordic journal of commercial law issue 2004 #2 37 ma del pilar perales viscasillas, “cross reference editorial analysis of cisg article 19, cisg w3 database pace university school of law”, december 1996, available at http://cisgw3.law.pace.edu/ and at http://www.cisg.law.pace.edu/cisg/text/cross19.html last accessed on 25/05/03. a.romein, “the passing of risk a comparison between the passing of risk under the cisg and german law”, available at http://cisgw3.law.pace.edu/ and http://cisgw3.law.pace.edu/cisg/biblio/romein.html, last accessed on 30/05/03. cisg pace university database, case: germany 23 june 1998 appellate court hamm, available at http://cisgw3.law.pace.edu/cisg/wais/db/cases2/980623gl.html last accessed on 17/06/03. clout database, case abstract no 247, spain 31 october 1997, appellate court cordoba, available at http://www.uncitral.org/english/clout/abstract/abst-24.pdf last accessed on 02/06/03. clout database, case abstract no 253, switzerland 15 january 1998, republica e cantone del ticino. la seconda camera civile del tribunale d’ appello, available at http://www.uncitral.org/english/clout/abstract/abst-25.pdf last accessed on 05/06/03. clout database, case abstract no 317, germany 20 november 1992, appellate court karlsruhe, available at http://www.uncitral.org/english/clout/abstract/abst-30.pdf last accessed on 01/06/03. unilex database, 1995cietac (china international economic and trade arbitration commission) available at http://www.unilex.info/dynasite.cfm?dssid=2376&dsmid=13356&x=1 last accessed on 16/06/03. unilex database, case st paul guardian insurance co., et al v neuromed medical systems & support, et al, available at http://www.unilex.info/article.cfm?pid=1&pos=67&iid=486&cid=44#iid486 last accessed on 23/07/03. united nations convention on contracts for the international sale of goods, vienna 1980 (official text), available at http://www.uncitral.org/ last accessed on 18/08/03. case law bonington & morris v dale & co ltd (1902) 7 com cas112 browne v hare (1858) 3 h&n 484 frebold and sturznickel (trading as panda o.h.g.) v circle products ltd (1970) 1 lloyd’s rep 499 healey v howlett (1917) 1 kb 337 joyce v swann (1864) 17 cv (ns) 84 pyrene co ltd v scindia navigation co.ltd (1954) 2 qb 402 stock v inglis (1884) 12 qbd 564 the parchim (1918) ac 157 nordic journal of commercial law issue 2004 #2 38 1 as it will be seen in chapter ii this is regulated in article 70 cisg. see chapter ii. a. vi). 2 from now on “the convention” or “cisg”. the text of the vienna convention is available at http://www.uncitral.org/ and in i.carr and r.kidner, statutes and conventions on international trade law (london: cavendish publishing limited, 3rd edition, 1999, reprinted 2000) 580. 3 some examples are: the un convention on carriage of goods by sea (the hamburg rules, 1978), the un convention on international bills of exchange and international promissory notes (new york, 1988), the un convention on the assignment of receivables in international trade (new york, 2001), the uncitral model law on international commercial arbitration (1985), the uncitral model law on international credit transfers (1992), the uncitral model law on electronic commerce (1996), the uncitral model law on electronic signatures (2001) and more. 4 the need for these ambitious attempts was urgent in that constantly evolving field of business, law and finance, since trade is an area of extreme importance globally and certainly one of the economic indicators of the status of development in countries across the world. 5 some of the early attempts include “the hague uniform laws on international sales (1964)” and one of the latest consists of “the unidroit principles of international commercial contracts (1994)”. 6 according to article 99(1) cisg, the convention would enter into force “on the first day of the month following the expiration of twelve months after the date of deposit of the tenth instrument of ratification, acceptance, approval or accession, including an instrument which contains a declaration made under article 92”. 7 the ulis and ulf texts can be found in i.carr and r.kidner, op cit, 130 and 155 respectively. 8 see b.nicholas, ‘the vienna convention on international sales law’ (1989) 105 law quarterly review 201, 203, m.bridge, the international sale of goods. law and practice (oxford: oxford university press, 1999) para 2.06 and h.van houtte, the law of international trade (london: sweet and maxwell, 2nd edition, 2002) para 4.06. primary sources united nations convention on contracts for the international sale of goods, vienna 1980, available at http://www.uncitral.org/ and in i.carr and r.kidner, statutes and conventions on international trade law (london: cavendish publishing limited, 3rd edition, 1999, reprinted 2000) 580. the uniform law on the international sale of goods (ulis), the hague, 1964 in i.carr and r.kidner, statutes and conventions on international trade law (london: cavendish publishing limited, 3rd edition, 1999, reprinted 2000) 130. the uniform law on the formation of contracts for the international sales of goods (ulf), the hague, 1964 in i.carr and r.kidner, statutes and conventions on international trade law (london: cavendish publishing limited, 3rd edition, 1999, reprinted 2000) 155. incoterms 2000: icc official rules for the interpretation of trade terms, entry into force 1st january 2000, international chamber of commerce (paris: icc publishing, 1999). sale of goods act 1979 in i.carr and r.kidner, statutes and conventions on international trade law (london: cavendish publishing limited, 3rd edition, 1999, reprinted 2000) 177. uniform customs and practice for documentary credits (ucp), icc brochure 500/1993 revision, international chamber of commerce. commission on banking technique and practice (paris: icc 1994). north american free trade agreement (nafta), 32 ilm 289 (1993). (endnotes) nordic journal of commercial law issue 2004 #2 39 9 the united nations commission on international trade law (uncitral), based in vienna, was established in 1966 and has as its goal to promote the harmonisation and unification of various aspects of international trade law, like for example the sale of goods, carriage of goods by sea, arbitration, banking and finance. and indeed, it has been successful in almost every attempt, since most of the international conventions and model laws that it has prepared were welcomed by the international community and adopted in many countries across the world. uncitral consists of a number of states, both developing and developed, thus allowing states with every degree of development to be part of the legislative process. therefore, it manages to accommodate both civil and common law rules and principles, taking into account the interests of countries of every degree of development and legal background. 10 see b.nicholas, op cit, 203. 11 j.d.feltham, ‘the united nations convention on contracts for the international sale of goods’ (1981) journal of business law 346, 347. 12 nevertheless, the convention does have flaws as well; as it happens with every similar attempt at harmonisation at an international level where various practices and laws from different social, economic and legal background are coming together, some inconsistencies and problems of interpretation seem to be inevitable. 13 article 1(1) cisg states: “this convention applies to contracts of sale of goods between parties whose places of business are in different states: when the states are contracting states; or when the rules of private international law lead to the application of the law of a contracting state”. 14 article 4 cisg provides: “this convention governs only the formation of the contract of sale and the rights and obligations of the seller and the buyer arising from such a contract. in particular, except or otherwise expressly provided in this convention, it is not concerned with: the validity of the contract or of any of its provisions or of any usage; the effect which the contract may have on the property in the goods sold”. 15 article 6 cisg states: “the parties may exclude the application of this convention or, subject to article 12, derogate from or vary the effect of any of its provisions”. 16 articles 7-13 cisg. 17 articles 14-24 cisg. 18 j.o.honnold, uniform law for international sales under the 1980 united nations convention (the hague: kluwer law international, 3rd edition, 1999) para 132.1. 19 nowadays, it is usual for the “offer” and “acceptance” to be sent in forms that incorporate on their back the standard trade terms of seller and buyer. usually these general conditions will not coincide and it will be difficult to define if a contract has been concluded and under which terms. this situation is referred to as “the battle of the forms” (see l.d’arcy, c.murray and b.cleave, schmitthoff’s export trade: the law and practice of international trade (london: sweet and maxwell, 10th edition, 2000) 64). the only provision that could be applied in similar situations is art.19 cisg. according to ma del pilar perales viscasillas there are two different trends of opinions regarding the battle of the forms and the convention. on one hand some commentators argue that the battle of the forms falls outside the scope of the convention and the solution should be found in the applicable domestic law, in accordance with article 4(a). on the other hand, some scholars agree that the problem is within the scope of the cisg, but they disagree on the provisions that should be applied. some hold that the solution lies in art.7 and that the general principles of the cisg should be applied in order to arrange problems that are not expressly settled by the convention. thus, by applying the principle of good faith, a solution can be found similar to the us “knock-out rule”. some others hold that the solution can be found under specific provisions of the convention. this is likely to lead to the application of the “last shot rule”: the last general conditions sent, prevail. on various occasions the courts have tried to solve problems like these by applying the “last shot rule”. see ma del pilar perales viscasillas, “cross reference editorial analysis of cisg article 19, cisg w3 database pace university school of law” december 1996, available at http://www.cisg.law.pace.edu/cisg/text/cross19.html , last accessed on 25/05/03. 20 articles 25-88 cisg. 21 the cisg regulates the passing of risk in chapter iv of part iii; articles 66-70. (in ulis this chapter was the final one, but in the cisg it became the fourth, just after the rules on the parties’ obligations, since it is closely connected to them). the cisg does not regulate in the chapter on risk the risk of non-performance, because these rules are connected with the area of breach of contract and the obligations of the parties. see a.romein, “the passing of risk a comparison between the passing of risk under the gisg and german law”, available at http://cisgw3.law.pace.edu/cisg/biblio/romein.html, last accessed on 30/05/03. 22 articles 89-101 cisg. 23 incoterms deal with the rights and obligations of the seller and the buyer with respect to the carriage of goods and also with issues of export and import clearance. furthermore, they regulate the allocation of costs and risks between the parties. this paper will examine the latter issue pertaining to the division of risk. the issues that incoterms do not cover are: 1) transfer of property rights, 2) relief from liability in case of unexpected events, 3) consequences of breaches of contract (apart from those related to the passing of risk and costs). see j.ramberg, icc guide to incoterms 2000 (paris: icc publishing s.a., 1999) 11. 24 see j.ramberg, icc guide to incoterms 2000 (paris: icc publishing s.a., 1999) 10. 25 it would not be possible to encompass every single trade term that is used in international commercial transactions all over the worldthat is something that is almost impossible and certainly an issue that the convention does not share an interest in. 26 see p.m.roth, ‘the passing of risk’ (1979) 27 american journal of comparative law 291, 309. 27 see j.ramberg, icc guide to incoterms 2000 ( paris: icc publishing s.a., 1999) 10. nordic journal of commercial law issue 2004 #2 40 28 article 6 cisg. 29 in conjunction with article 6 cisg. 30 i.carr, principles of international trade law (london: cavendish publishing limited, 2nd edition, 1999) 1. 31 fob (free on board) and cif (cost insurance freight) were established gradually during the 19th century and started as usages in a small scale, which, along with the development of commerce, began to develop in a much wider scale. as some early cases indicate, the fob term preceded the cif, but the latter soon became more popular especially in the second half of the 19th century. nevertheless, it faced a severe period of decline during the first and second world wars and later, while the fob term recovered impressively. there is not a lot known ‘of the factors which have throughout the years influenced the choice of preference for one term rather than the other’ (d.m.sassoon, ‘the origin of f.o.b. and c.i.f. terms and the factors influencing their choice’ (1967) journal of business law 32, 32), but most probably their evolution, success and magnitude are mostly a result of the economic, social and technological status prevailing in the various time periods. see d.m.sassoon, ‘the origin of f.o.b. and c.i.f. terms and the factors influencing their choice’ (1967) journal of business law 32, 35-37, and see also d.m.sassoon, c.i.f. and f.o.b. contracts (london: sweet and maxwell, 4th edition, 1995) 347 et seq. 32 some times there could be differences in interpretation even in different ports of the same country. 33 see d.flambouras, ‘the icc rules on international commercial sale (incoterms 2000)’ 3/2000 (6th year) law of enterprises and companies 260, 260in greek. 34 see n.g.oberman, “transfer of risk from seller to buyer in international commercial contracts: a comparative analysis of risk allocation under the cisg, ucc and incoterms”, available at http://www.cisgw3.law.pace.edu/cisg/thesis/oberman.html, last accessed on 30/05/03. 35 the icc has also published another very successful set of rules, the “uniform customs and practices for documentary credits” (ucp), dealing with bankers’ documentary credits. the version that currently applies is ucp 500/ 1993 revision. 36 and it seems that it has been rather successful in its attempt since incoterms are used very often in trade and are being chosen by parties all over the world to govern their contracts. 37 for the following see n.g.oberman, op cit. in 1920 the icc decided to create a working group that would examine and research the various issues connected to the parties’ rights and obligations in an international contract of sale. its first attempt took place in 1928 when it published some initial rules on commercial terms. but it was in 1936 that the icc published what was proved in the future to be the first version of incoterms, having as its goal the harmonisation of international trade terms. the next revision occurred in 1953 in a congress held in vienna and was more detailed compared to the previous one. the next modification was in 1967 and another one took place in 1976 (the latter version adopted the term fob airport). the following revision was only a few years later, in 1980 due to the vast and speedy developments in the field of international business transactions. the 1980 version was very important and modern compared to the previous ones, since it took into account all the then current changes in international trade (like the new modes of transport), and succeeded in unifying the use of international trade terms to a further extent. 38 see n.g.oberman, “transfer of risk from seller to buyer in international commercial contracts: a comparative analysis of risk allocation under the cisg, ucc and incoterms”, available at http://www.cisgw3.law.pace.edu/cisg/thesis/oberman.html, last accessed on 30/05/03. 39 ibid. 40 the parties who agree on the adoption of incoterms in their contract are strongly advised to refer to the year of publication (since there are various versions), in order to avoid misunderstandings and further disputes. see j.ramberg, icc guide to incoterms 2000 (paris: icc publishing s.a., 1999) 10. 41 see j.ramberg, icc guide to incoterms 2000 (paris: icc publishing s.a., 1999) 11. the most important differences are: 1) under incoterms 2000, in the fas term the export clearance is an obligation of the seller, whereas in the 1990 version it was placed on the buyer, 2) incoterms 2000 provide that in deq term the import clearance is an obligation of the buyer, while incoterms 1990 provided that this obligation was placed on the seller, 3) incoterms 2000 regulate that under fca the seller has the obligation to load the goods on the buyer’s collecting vehicle and the buyer has the obligation to receive the seller’s arriving vehicle unloaded . 42 for a further analysis see d.flambouras, ‘the icc rules on international commercial sale (incoterms 2000)’ 3/2000 (6th year) law of enterprises and companies 260, 261in greek. 43 ibid. 44 ibid. see also m.bridge, the international sale of goods. law and practice (oxford: oxford university press, 1999) para 2.48. bridge supports this view, but not totally; it is a fact that art.9(2) cisg demands usage, which the parties “knew or ought to have known and which in international trade is widely known to, and regularly observed by parties to contracts of the type involved in the particular trade concerned”. nevertheless, according to bridge, even though it is true that incoterms are widely known and used in international commerce, this is not the case for every kind of trade. he states that they are usually adopted in the oil trade, but not very commonly used in contracts of dry cargo. therefore, bridge supports that incoterms might be encompassed in the meaning of article 9(2) in the former situation (oil trade)even if they were not expressly mentioned in the contractbut they should not be applied in the latter situation (dry cargo)if there has not been an express agreement. 45 see d.flambouras, ‘the icc rules on international commercial sale (incoterms 2000)’ 3/2000 (6th year) law of enterprises and companies 260, 261in greek. nordic journal of commercial law issue 2004 #2 41 46 see h.van houtte, the law of international trade (london: sweet and maxwell, 2nd edition, 2002) para 4.58, m.bridge, the international sale of goods. law and practice (oxford: oxford university press, 1999) para 1.17, i.carr, principles of international trade law (london: cavendish publishing limited, 2nd edition, 1999) 1. 47 international chamber of commerce, incoterms 2000: icc official rules for the interpretation of trade terms (paris: icc publishing, 1999) 7 para 4. 48 they regulate only certain issues, like the parties’ obligations or the passing of risk, without dealing with other basic issues, like the formation of the contract or the transfer of property of the goods. 49 see d.flambouras, ‘the icc rules on international commercial sale (incoterms 2000)’ 3/2000 (6th year) law of enterprises and companies 260, 261in greek. 50 ibid, 261-262. a similar set of rules is encompassed in the cisg. moreover, in some legal systems, ie usa, uk, the courts do not apply incoterms often. thus, they cannot be considered either as the only widely known and used rules in international sales or as an autonomous legal system. 51 this will be further examined in the next chapter (chapter ii). 52 regarding the first, it should be pointed out that in international sales the rule is that the goods are insured during their transit from the seller’s to the buyer’s country (see i.carr, principles of international trade law (london: cavendish publishing limited, 2nd edition, 1999) 223). the “insurance risk” therefore (see d.m.day, the law of international trade (london butterworths, 1981, reprinted 1987) on the chapter on insurance in the international trade transaction, 104 et seq), is the risk covered by the insurance company or the insurer, who in case of realization of the risk, is obliged to indemnify the insured for his loss or damage and put him in the same position in which he would have been if the damaging event and consequently the damage or loss had never occurred. the meaning of risk and which types of it are covered under the contract is an issue on which the parties agree on, and might either include ‘all risks’ or specific ones, like for example fire or explosion, collision, volcanic eruption or earthquake, jettison and more. of course the insurer will always encompass exclusions to the insurance contract, in order to exclude his obligation to indemnify the insured (for example when the loss or damage is a result of the insured’s misconduct or due to an inherent vice of the subject matter). ‘the question of what type of insurance needs to be obtained to cover the cargofor example, marine insurance, air cargo insurancedepends on the mode of transport agreed by the parties in the contract of sale’ (i.carr, op cit, 223). it is true though, that ‘[t]he insurance of goods carried by land and air has not achieved the extent or the standardisation which has developed in marine insurance’ (d.m.day, op cit, 104). “commercial risk” could be described as failure of one of the parties to perform its obligations under the contract due to insolvency or repudiation of the contract (see d.flambouras, “transfer of risk in the contract of sale involving carriage of goods: a comparative study in english, greek law and the united nations convention on contracts for the international sale of goods”, available at http://cisgw3.law.pace.edu/cisg/biblio/flambouras.html, last accessed on 28/05/03). as regards “political risk” it can be supported that its meaning might include ‘outright warfare, blockade, civil unrest, politicallyinspired “retaliation” against vessels of a specific flag, terrorism, and trade union boycotts’ (c.g.c.h.baker and p.david, ‘the politically unsafe port’ (1986) lmclq 112, 113), without this list being exhaustive. the latter risks have as a common characteristic the existence of some kind of political incitement, which forms an obstacle to the performance of regular transactions. 53 see p.m.roth, ‘the passing of risk’ (1979) 27 american journal of comparative law 291, 291. 54 see f.enderlein and d.maskow, international sales law (oceana publications, 1992) 261. also according to bernstein and lookofsky, the accidental loss or damage covers both “acts of god” and the acts of mortal third parties, but not the acts or omissions of the seller or buyer. see h.bernstein and j.lookofsky, understanding the cisg in europe (the hague; london; boston: kluwer law international, 1997) para 5.1. 55 see d.flambouras, “transfer of risk in the contract of sale involving carriage of goods: a comparative study in english, greek law and the united nations convention on contracts for the international sale of goods”, available at http://cisgw3.law.pace.edu/cisg/biblio/flambouras.html, last accessed on 28/05/03 and d.e.goodfriend, ‘after the damage is done: risk of loss under the united nations convention on contracts for the international sale of goods’ (1983) 22 columbia journal of transnational law 575, 582. 56 see g.hager in p.schlechtriem(ed), commentary on the un convention on the international sale of goods (cisg) (oxford: clarendon press, 2nd edition, 1998) art 66, para 4. 57 g.hager in p.schlechtriem(ed), commentary on the un convention on the international sale of goods (cisg) (oxford: clarendon press, 2nd edition , 1998) art 66, para 4. 58 see g.hager in p.schlechtriem(ed), commentary on the un convention on the international sale of goods (cisg) (oxford: clarendon press, 2nd edition, 1998) art 66, para 4 and d.flambouras, “transfer of risk in the contract of sale involving carriage of goods: a comparative study in english, greek law and the united nations convention on contracts for the international sale of goods”, available at http://cisgw3.law.pace.edu/cisg/biblio/flambouras.html, last accessed on 28/05/03. therefore, traders who have commercial relations with countries, which are under war operations or are very likely to become involved in a war, are strongly advised to insure the goods against war risks. 59 see b.von hoffmann, international sale of goods: dubrovnic lectures ( p.sarcevic and p.volken eds, oceana, 1986) 267, available at http://www.cisg.law.pace.edu/cisg/biblio/vonhoffmann.html. 60 see p.m.roth, op cit, 291. 61 see a.romein, op cit. as it will be seen in the following chapters, the vienna convention and incoterms regulate only the “price risk”. indeed, the convention in the chapter on risk (part iii, chapter iv) regulates only the “price risk”. nevertheless, it contains rules on the “risk of non performance” in chapter ii of part iii in articles 31-36, dealing with the seller’s obligations. nordic journal of commercial law issue 2004 #2 42 62 see a.romein, “the passing of risk a comparison between the passing of risk under the gisg and german law”, available at http://cisgw3.law.pace.edu/cisg/biblio/romein.html, last accessed on 30/05/03, and b.von hoffmann, op cit, 268-269. 63 the theory of connecting the passing of risk to the conclusion of the contract is followed in switzerland (art.185 of the swiss or), spain (art. 1452 of the spanish cc) and the netherlands (art.1496 of the dutch bw). 6 4 the second theory is adopted in england (sga 1893 s 20(1), s 18 rule 1 and sga 1979 s 20, sec.18 rule 1), france (art.1624/1138(2) french cc) and italy (art.1465 italian cc). 65 germany ( s 446 german cc), greece (art.522 greek cc), sweden (art. 17 of the swedish act 1905) and united states of america ( para 2-509(3) ucc) follow the third theory and link the passing of risk with the handing/taking over of the goods. 6 6 s ee s . b o l l ée, “ t h e t h eo r y o f r i s k s i n t h e 1 9 8 0 vi en n a s a l e o f g o o d s c o n v en t i o n ” 2 4 7 , 2 4 8 a v a i l a b l e a t http://cisgw3.law.pace.edu/cisg/biblio/bollee.html, last accessed on 28/05/03. 67 67see j.f.wilson, carriage of goods by sea (harlow: long man, 4th edition, 2001) 122 et seq. 68 ‘a bill will only operate as a document of title, however, if it is drafted as an “order” bill, ie a bill under which the carrier agrees to deliver the goods at their destination to a named consignee or to his “order or assigns’”. see j.f.wilson, carriage of goods by sea (harlow: long man, 4th edition, 2001) 137. 69 see j.f.wilson, carriage of goods by sea (harlow: long man, 4th edition, 2001) 138. 70 there is an extensive bibliography on the letter of credit transaction, such as: e.p.ellinger, documentary letters of credita comparative study (singapore: university of singapore press, 1970), w.hedley, bills of exchange and bankers’ documentary credits (london: lloyd’s of london press ltd, 2nd edition, 1994), p.todd, bills of lading and banker’s documentary credits (london: lloyd’s of london press ltd, 1990), b.wunnicke, d.b.wunnicke and p.s.turner, standby and commercial letters of credit (new york; chichester: wiley law publications, 2nd edition, 1996). 71 see d.m.day, op cit, 138 et seq. 72 in the following chapter (chapter ii. a. iii) and v)). 73 articles 67 and 69 cisg. 74 it is obvious that in articles 67 and 69, the convention rejects the two theories on the passing of risk developed in some legal systems, which connect the passing of risk to the conclusion of the contract or to the passing of ownership. furthermore, the convention differs not only with the national legal systems, but also with the approach adopted in ulis as well, which in article 97(1) connects the transfer of risk with the notion of “délivrance”. according to art.97(1) ulis, risk passes only when there has been a delivery of conforming goods to the contract. that means that when the delivered goods do not conform to the contract, the risk does not pass to the buyer but is still on the seller. 75 see b.von hoffmann, op cit, 270. the convention generally embraces the view that the party which should bear the risk of accidental loss or damage to the goods should be the buyer, since the loss or damage is usually revealed at the end of the day when the goods are in the buyer’s hands. 76 see chapter ii. a. iv). 77 b.von hoffmann, op cit, 266. 78 in accordance with article 6 cisg. 79 see a.romein, op cit. 80 a.romein, op cit. 81 see s.bollée, op cit, 273. 82 see s.bollée, op cit, 273. 83 see a.romein. 84 the consequence is rather cruel for the buyer, but the injustice is mitigated, since the buyer can recover the loss by turning against the insurance company, provided that the goods were insured. 85 see b.nicholas in c.m.bianca and m.j.bonell (eds), commentary on the international sales law. the 1980 vienna sales convention (milan: giuffrè, 1987) art.66, para 3.3, and j.o.honnold, uniform law for international sales under the 1980 united nations convention (the hague: kluwer law international, 3rd edition, 1999) para 361, and s.bollée, “the theory of risks in the 1980 vienna sale of goods convention”, available at http://cisgw3.law.pace.edu/cisg/biblio/bollee.html, 245, 248, last accessed on 18/05/03. nevertheless, the fact that it is easier for the buyer to discover any possible loss or damage to the goods after their arrival, does not constitute an efficient explanation for the passing of risk. it is true that during carriage, the goods are not under the control of either the seller or the buyer and the buyer is not in a position to control their transport. in fact, in cases involving carriage, the seller is not obliged to deliver to the buyer’s place of business; for that reason it is logical to accept that the seller’s obligation to deliver ends when he hands the goods over to the carrier. therefore, he is not responsible for their accidental loss or damage after the fulfilment of that obligation; this latter argument seems more convincing. see further k.pantelidou, ‘issues from the allocation of risk under the vienna convention for the international sale of goods’, (2002) private law chronicle 97, 98in greek. 86 for the meaning of risk see chapter i. c. i). 87 see b.nicholas in c.m.bianca and m.j.bonell (eds), op cit, art.66, para 2.1. 88 see clout database, case abstract no 317, germany 20 november 1992, appellate court karlsruhe, available at http://www.uncitral.org/english/clout/abstract/abst-30.pdf last accessed on 01/06/03. 89 see b.nicholas in c.m.bianca and m.j.bonell (eds), commentary on the international sales law. the 1980 vienna sales convention (milan: giuffrè, 1987) art 66, para 2.2. 90 the buyer can claim these remedies only if the act or omission of the seller constitutes a fundamental breach of contract. if it is a non fundamental breach, he can claim only repair of the goods, reduction in price and/or damages. nordic journal of commercial law issue 2004 #2 43 91 see f.enderlein and d.maskow, op cit, 262. 92 see b.nicholas in c.m.bianca and m.j.bonell (eds), op cit, art.66, para 2.2. 93 see g.hager in p.schlechtriem(ed), op cit, art.66, para 6 and j.o.honnold, op cit, para 362. 94 j.o.honnold, op cit, para 362. 95 s.bollée, op cit, 275. according to a.romein (op cit) two opinions are supported; a) the first one is that in case of lawful conduct of the seller, the risk is passed back to him, whereas b) the second one, on the contrary, supports that the risk is not passed back to him. romein suggests that the second view is preferable, since the seller’s lawful conduct does not release the buyer from paying the price. 96 cietac is the acronym for china international economic and trade arbitration commission. 97 see unilex database, 1995cietac (china international economic and trade arbitration commission), available at http://www.unilex.info/dynasite.cfm?dssid=2376&dsmid=13356&x=1, last accessed on 16/06/03. 98 it should be noted that article 67 cisg differs from ulis article 97(1), which connected the passing of risk to “delivery” (“délivrance”). the latter article’s problem was that the same term was used in order to define several notions: a) the sellers’ obligations, ii) the point of passing of risk, iii) the time and place of payment and iv) the moment of identification of unascertained goods to the contract, rendering the provision far too complicated and impractical, and thus, making it the object of severe criticism. see b.nicholas in c.m.bianca and m.j.bonell (eds), op cit, art.67, para 1.1, g.hager in p.schlechtriem(ed), op cit, art. 67, para 1 and b.von hoffmann, op cit, 276. 99 see d.e.goodfriend, op cit, 589. 100 see f.enderlein and d.maskow, op cit, 264. 1 0 1 see b.nicholas in c.m.bianca and m.j.bonell (eds), op cit, art.67, para 1.4. according to hager (see g.hager in p.schlechtriem(ed), op cit, art.67 para 5a), ‘the reference to the contract of sale means only that the contract must provide for carriage of the goods. it does not make the passing of risk dependent on the observance of all the provisions of the contract’. the article uses the term “hand over”, which appears in other articles of the convention as well (31(a), 34, 58(2), 68, 71(2)) and with it, is expressed the taking over of control of the goods by the carrier. it would be best to accept that the risk passes to the buyer at the end of the process of handing over the goods. and as enderlein and maskow suggest (see f.enderlein and d.maskow, op cit, 266), the incoterms rules on this matter should be followed directly or by analogy; thus, it should be accepted that the handing over has ended when the goods have been placed on the carrier’s vehicle, or when they were ready for loading or when the goods were under the carrier’s surveillance. 102 according to von hoffmann (see b.von hoffmann, op cit, 287), the notion of “first carrier” does not include the notion of “local transportation” and thus, handing the goods over to local means of transportation cannot have the effect of passing of the risk to the buyer. enderlein and maskow (see f.enderlein and d.maskow, op cit, 265) disagree with the previous opinion and support the view that local carriers should not be treated differently in comparison with international carriers and thus, the handing over of the goods to them should cause the risk to pass to the buyer. goodfriend shares the same view with enderlein and maskow. see d.e.goodfriend, ‘after the damage is done: risk of loss under the united nations convention on contracts for the international sale of goods’ (1983) 22 columbia journal of transnational law 575, 595. 103 von hoffmann (see b.von hoffmann, op cit, 288) submits that the prevailing view is that the seller’s personnel is not considered as first carrier, but he believes that when the carriage is effected by the seller’s staff the risk should not stay with him, since he is providing lots of advantages to the buyer by doing the transportation quicker and cheaper than the existing carriers. therefore, he argues that the seller should, in the event of damage or loss, have the chance to prove that the damage or loss did not occur due to an act or omission of his personnel, but due to an accidental event and consequently, he should be relieved from the burden of bearing the risk. 104 see b.nicholas in c.m.bianca and m.j.bonell (eds), op cit, art.67, para 2.2. 105 105see f.enderlein and d.maskow, op cit, 265, who share the same opinion, and also d.e.goodfriend, ‘after the damage is done: risk of loss under the united nations convention on contracts for the international sale of goods’ (1983) 22 columbia journal of transnational law 575, 593. 106 see g.hager in p.schlechtriem(ed), op cit, art.67, para 5. honnold shares the same view as well (see j.o.honnold, op cit, para 369.1). 107 see b.nicholas in c.m.bianca and m.j.bonell (eds), op cit, art.67, para 2.2, and g.hager in p.schlechtriem(ed), op cit, art 67, para 5. flambouras (see d.flambouras, “transfer of risk in the contract of sale involving carriage of goods: a comparative study in english, greek law and the united nations convention on contracts for the international sale of goods”, available at http://cisgw3.law.pace.edu/cisg/biblio/flambouras.html, last accessed on 28/05/03) makes an interesting distinction; he agrees that the carrier should be an independent entity and not the seller himself but he suggests that before concluding whether the carrier is an independent entity or not, the “control criterion” should be applied, especially in cases where the seller might own a company, which effectuates transport operations and forms a part of his firm. therefore, in similar cases it should be examined whether the seller exercises sufficient control over his subsidiary freight company. if the subsidiary is only formally independent and in reality the seller exercises strict control over it, then the risk should be on the seller. if on the other hand he is not closely connected to the subsidiary company, then the buyer should bear the risk during transport, since the goods are not substantially under the seller’s control. 108 ‘a freight forwarder (spediteur, commissionaire de transport) is an operator, which acts as an agent of the seller and undertakes to arrange for the carriage of goods by entering into a series of individual carriage contracts with separate carriers by rail, road or sea and by restricting himself to this function. he does not carry out the actual carriage and normally excludes any personal liability nordic journal of commercial law issue 2004 #2 44 for damage or loss during carriage and transhipment from one mode to the other’. d.flambouras, “transfer of risk in the contract of sale involving carriage of goods: a comparative study in english, greek law and the united nations convention on contracts for the international sale of goods”, available at http://cisgw3.law.pace.edu/cisg/biblio/flambouras.html, last accessed on 28/05/03. 109 see g.hager in p.schlechtriem(ed), op cit, art.67, para 5. 110 a.romein as well, op cit supports the same opinion. 111 see d.flambouras, “transfer of risk in the contract of sale involving carriage of goods: a comparative study in english, greek law and the united nations convention on contracts for the international sale of goods”, available at http://cisgw3.law.pace.edu/cisg/biblio/flambouras.html, last accessed on 28/05/03. likewise, enderlein and maskow (see f.enderlein and d.maskow, op cit, 265) are of the opinion that forwarding agents are not considered as carriers only when they have not taken over obligations by self-execution of the contract of carriage. 112 some indications that he accepts carrier’s liability are for example if he is presented as a carrier, if he quotes his own freight, if he issues a forwarders bill of lading or a cmr bill in his own name. 113 see d.flambouras, “transfer of risk in the contract of sale involving carriage of goods: a comparative study in english, greek law and the united nations convention on contracts for the international sale of goods”, available at http://cisgw3.law.pace.edu/cisg/biblio/flambouras.html, last accessed on 28/05/03. 114 see j.o.honnold, op cit, para 369.2 and d.flambouras, “transfer of risk in the contract of sale involving carriage of goods: a comparative study in english, greek law and the united nations convention on contracts for the international sale of goods”, available at http://cisgw3.law.pace.edu/cisg/biblio/flambouras.html, last accessed on 28/05/03. 115 for example a seller in boston and a buyer in madrid agree on the sale of 5,000 videos which ought to be delivered to the port of barcelona; the videos are loaded on trucks for carriage from boston to the port of new york and from there they are shipped to spain. the risk will pass to the buyer from the time that the goods have been handed over to the first carrier, ie the truck carrier. 116 nevertheless, a more satisfactory argument would be that in cases involving carriage, the seller has no obligation to deliver to the place of business of the buyer and therefore, the seller’s obligation for delivery ends when he hands over the goods to the carrier and he does not share any responsibility for their accidental loss or damage after he had fulfilled that obligation. for that reason, the party who should bear the transit risk should be the buyer. see k.pantelidou, ‘issues from the allocation of risk under the vienna convention for the international sale of goods, (2002) private law chronicle 97, 98in greek. 117 see b.nicholas in c.m.bianca and m.j.bonell (eds), op cit, art.67, para 3.1. this issue will be further examined in the next chapter (chapter iii. b. iii)). 118 this rule forms an expression of the principle of freedom of contract. in this rule there are usually included cases where the parties agree on the adoption of international trade terms, which deal with the loading of the goods in a specific place. see d.flambouras, ‘international sales of goods. practical issues concerning the passing of risk under the vienna convention (1980)’ (marchapril 1998) synigoros 26, 27in greek. 119 see g.hager in p.schlechtriem(ed), op cit, art 67, para 6. 120 see g.hager in p.schlechtriem(ed), op cit, art 67, para 6. lets suppose that a seller in athens agrees to sell 1,000 refrigerators to the buyer in paris. they agree on the handing over of the goods at the port of piraeus where they should be shipped to the port of marseille. the goods would be transferred to piraeus from athens by truck. since there is an agreement for the goods to be handed over to the carrier in piraeus, the risk will pass to the buyer at that place, applying the second sentence of art.67(1). if on the contrary there was no such agreement, then the first sentence of art.67(1) would apply and the risk would pass when the goods were handed over to the first carrier, ie the truck carrier in athens for transport to the port of piraeus. 1 2 1 see clout database, case abstract no 247, spain 31 october 1997 appellate court cordoba, available at http://www.uncitral.org/english/clout/abstract/abst-24.pdf, last accessed on 02/06/03. 122 b.nicholas in c.m.bianca and m.j.bonell (eds), op cit, art.67, para 2.6. 123 see b.nicholas in c.m.bianca and m.j.bonell (eds), op cit, para 2.7and s.bollée, op cit, 256 and j.o.honnold, op cit, para 371. 124 see g.hager in p.schlechtriem(ed), op cit, art.67, para 10. 125 see g.hager in p.schlechtriem(ed), op cit, art.67, para 9. 126 it is true that a lot of problems of proof can arise, as is demonstrated by a case in the swiss courts. in that case, a swiss seller and an italian buyer agreed on the sale of 300 tons of cocoa beans, which were supposed to contain fat of at least 45% and acidity up to 7%. the cargo was shipped from ghana and payment was made against documents, which included a certificate of conformity, according to the sales contract. when the cargo arrived in italy, it was revealed that the beans were not of the agreed values. when the case reached the swiss courts it was not possible to ascertain if the goods were defective before or after the handing over to the carrier. regarding the issue of the burden of proof and which of the parties had to bear it, the court decided that it should be determined by the law applicable on the merits, which in that case was the vienna convention. the court after highlighting that the convention does not contain any special rules on the burden of proof as to the conformity of the goods, noted that the opinions pertaining to this issue are divided; others support that the convention should be interpreted as attributing the burden of proof to the buyer and others support that the burden of proof was an issue that should be decided by the domestic law. the court left the issue open since under both the law of the forum and the cisg the buyer was the party bearing the burden of proof. see clout database, case abstract no 253, 15 january 1998, switzerland: republica e cantone del ticino. la seconda camera civile del tribunale d’appello, available at http://www.uncitral.org/english/clout/abstract/abst-25.pdf, last accessed on 05/06/03. nordic journal of commercial law issue 2004 #2 45 127 the cisg does not have any rules on the allocation of the burden of proofnevertheless this is an issue that falls within its scope. therefore, ‘the gap should be filled in conformity with article 7(2) applying the general principle that a person who relies on a rule in his favour must prove that the preconditions for the application of that rule are satisfied’. g.hager in p.schlechtriem(ed), op cit, art 67, para 11. 128 the meaning of “fungible goods” is provided in article 415 (definitions) of the north american free trade agreement (nafta) in chapter four (rules of origin), according to which ‘fungible goods or fungible materials means goods or materials that are interchangeable for commercial purposes and whose properties are essentially identical’. nafta (1992) 32 ilm 289 (1993). 129 see p.schlechtriem, op cit, art.67, para 10a, s.bollée, op cit, 256 and f.enderlein and d.maskow, op cit, 269. 130 g.hager in p.schlechtriem(ed), op cit, art.67, para 10a. see also s.bollée, op cit, 256. 131 see f.enderlein and d.maskow, op cit, 269. 132 see j.o.honnold, op cit, para 371. 133 see k.pantelidou, ‘issues from the allocation of risk under the vienna convention for the international sale of goods’ (2002) private law chronicle 97, 97in greek. goods afloat are a quite special category that needs a separate regulation, since they are several times exposed to unusual circumstances, like perils of the sea, risks of war, piratery and more. see h. de vries, ‘the passing of risk in international sales under the vienna sales convention 1980 as compared with traditional trade terms’ (1982) 17 european transport law 495, 507. 134 by sending to the buyers the relevant documents, for example the bill of lading (when there is carriage of goods by sea), the invoice, the insurance contract, the certification of quality etc. 135 a reference to some points of the provision’s history (see j.o.honnold, op cit, para 372.1) is necessary in order to understand the reason for the conflict it had created. this article was based on ulis article 99, which provided that the risk passed retroactively from the time that the goods were handed over to the carrier (like the provision of the second sentence of art.68). the same was the wording of art.80 of the draft convention as well, but both the first committee and the plenary sessions, notably the delegates of the developing countries, opposed to its text (see s.bollée, op cit, 261). the latter supported the view that it would be unfair to shift the risk to the buyer before the buyer even contracts to buy the goods. they claimed that this was irrational since the buyer was held responsible for the loss or damage of the goods, which might not have even been his at the moment when the damaging event occurred (see b.nicholas in c.m.bianca and m.j.bonell (eds), op cit, art.68, para 1.1), rendering the provision unfavourable for the buyer, who would usually be represented by the developing countries (see b.nicholas, op cit, 239). of course on the other hand, there were arguments that supported this provision, which can be summarized as follows: firstly, this mode of risk allocation was common in international sales. secondly, it formed a clear issue of insurance technique (see b.nicholas, op cit, 239) and thirdly and most importantly, this rule did not favour the splitting of transit risk, which was extremely important, especially in a situation where the goods were in transit and it would be extremely difficult to ascertain the exact moment of damage or loss (see b.nicholas in c.m.bianca and m.j.bonell (eds), op cit, art 68, para 1.1). the final text of art.68 was approved by a majority and the once rule in the draft convention became the exception in the final convention’s text. 136 see previous footnote. 137 see chapter iii. b. iii). 138 see g.hager in p.schlechtriem(ed), op cit, art.68, para 3. 139 it is the same under ulis article 99, and draft convention article 80. 140 see s.bollée, op cit, 263. 141 see j.d.feltham, ‘the united nations convention on contracts for the international sale of goods’ (1981) jbl 346, 357. 142 see b.nicholas in c.m.bianca and m.j.bonell (eds), op cit, art.68, para 2.2, and s.bollée, op cit, 262. 143 see b.nicholas in c.m.bianca and m.j.bonell (eds), op cit, art 68, para 2.2, g.hager in p.schlechtriem(ed), op cit, art.68, para 4, j.o.honnold, op cit, para 372.2, f.enderlein and d.maskow, op cit, 271, b.von hoffmann, op cit, 295, h.de vries, op cit, 508. 144 j.o.honnold, op cit, para 372.2. 145 b.nicholas in c.m.bianca and m.j.bonell (eds), op cit, art.68, para 2.3. 146 see b.nicholas in c.m.bianca and m.j.bonell (eds), op cit, art.68, para 2.4, j.o.honnold, op cit, para 372.2, s.bollée, op cit, 264, f.enderlein and d.maskow, op cit, 271. 147 emphasis added. 148 it should be noted that the wording in the vienna and new york drafts was: “…such loss or damage”, whereas the french wording was different as well: “la perte ou la deterioration” (emphasis added). 149 see g.hager in p.schlechtriem(ed), op cit, art.68, para 5. 150 enderlein and maskow share the same opinion (see e.enderlein and d.maskow, op cit, 272). 151 see b.nicholas in c.m.bianca and m.j.bonell (eds), op cit, art.68, para 2.3. 152 see j.o.honnold, op cit, para 372.2 and also see a.romein, op cit. 153 additionally, according to honnold (see j.o.honnold, op cit, para 372.2 and s.bollée, op cit, 264) the non disclosure of the damage to the buyer constitutes or closely approximates fraud; by not revealing the damage, the seller commits a serious breach of contract and for that reason the buyer has at his discretion the convention’s remedies for fundamental breach of contract, including among others his right to avoid the contract (articles 25 and 49(1)(a)). but what is the situation when the parties conclude a contract for the sale of goods that do not exist anymore, and that being so without the parties’ knowledge? (some national legal systems provide for the voidness of such a contract. see for example the german law). the question is related to the issue of validity of the contract, which according to art.4 is outside the convention’s scope, but from the wording of art.68 it seems that such a contract would be valid (see b.nicholas in c.m.bianca and m.j.bonell (eds), op cit, art.68, para 3.1). nordic journal of commercial law issue 2004 #2 46 154 see s.bollée, op cit, 265. 155 see g.hager in p.schlechtriem(ed), op cit, art.68, para 6. 156 goodfriend also supports this view. see d.e.goodfriend, op cit, 587. 157 see b.nicholas in c.m.bianca and m.j.bonell (eds), op cit, art.69, para 3.3. 158 see s.bollée, op cit, 267. 159 see b.nicholas in c.m.bianca and m.j.bonell (eds), op cit, art.69, para 2.2. 160 see b.nicholas in c.m.bianca and m.j.bonell (eds), op cit, art.69, para 2.2. for example the seller x and buyer y agree on the taking over of the goods at the seller’s warehouse on 16 may. the seller packages the goods and places them at his warehouse on 13 may, where the goods are accidentally destroyed by fire on 15 may. who will bear the risk in that case? the risk would be on the seller, since the buyer, regardless of the fact that the goods were at his disposal, was not in breach of his contractual obligation to take delivery, since the agreed day of taking delivery was on 16 may. if the fire had occurred on 21 may and the buyer had not taken delivery yet, then he would be in breach of his obligation to take delivery of the goods and he would bear the risk of loss. ‘therefore, the risk remains with the seller during the time period the buyer is permitted but not contractually bound to take over the goods’ (b.von hoffmann, op cit, 295). 161 see g.hager in p.schlechtriem(ed), op cit, art.69, para 4. 162 see s.bollée, op cit, 267. f.enderlein and d.maskow are of the opinion that for the passing of risk, the notice containing the information that the goods are ready for taking over, should reach the addressee (in contrast with the rule of article 27 cisg, according to which the dispatch of the notice is sufficient), just as it is provided in art.69(2) by analogy. (see f.enderlein and d.maskow, op cit, 275). 163 this is a situation very likely to create disputes between the parties, since in case of loss or damage of the goods while they are under the seller’s custody, the buyer will always accuse the seller of not exercising due diligence for protecting the goods efficiently. 164 it seems that the “breach of contract” referred to in paragraph one, should be interpreted broadly in order to encompass not only situations where the buyer fails to take delivery, but other situations, which also constitute breaches of contract and cause the failure of taking delivery. for example when the buyer does not give instructions for the dispatch of the goods or refuses to pay for the price. however, the contrary opinion has also been supported, which suggests that these situations are not encompassed in the meaning of “breach of contract” under paragraph one and thus, do not affect the passing of risk. (see b.nicholas in c.m.bianca and m.j.bonell (eds), op cit, art.69, para 3.4). nevertheless, it is the author’s opinion that the rule should be interpreted broadly and encompasses the above-mentioned situations, since it would be unfair to leave the risk with the seller in cases where the fact of not taking delivery is the buyer’s fault. 165 see g.hager in p.schlechtriem(ed), op cit, art.69, paragraphs 6-7. 166 for the risk to pass “positive knowledge” is required from the part of the buyer. see f.enderlein and d.maskow, op cit, 277 and a.romein, op cit. 167 at this point some differences between the two first paragraphs of art.69 are noticeable; according to the first paragraph the risk passes when the buyer commits a breach of contract by not taking delivery of the goods, whereas that is not necessary under the second paragraph. furthermore, under paragraph one, when the parties have agreed on a specific date, the buyer does not have to be notified that the goods are at his disposal. on the contrary, under paragraph two, the buyer should actually be aware that the goods are ready to be taken over by receiving a notification. the policy behind this is that in these cases the goods are under the control of neither of the parties and therefore none is in a better position to look after themthe risk, in that case, should pass to the buyer as soon as he is in a position to take delivery of the goods. concluding, we notice that the risk under paragraph two passes to the buyer at an earlier point in time than under paragraph one (see b.nicholas in c.m.bianca and m.j.bonell (eds), op cit, art.69, para 2.3 and also g.hager p.schlechtriem(ed), op cit, art.69, para 6 and also j.o.honnold, op cit, para 377 and also s.bollée, op cit, 268). 1 6 8 s e e c i s g p a c e u n i v er s i t y d a t a b a s e, c a s e: g er m a n y 2 3 j un e 1 9 9 8 , a ppel l a t e c o ur t ha m m , a v a i l a b l e a t http://cisgw3.law.pace.edu/cisg/wais/db/cases2/980623g1.html, last accessed on 17/06/03. 169 g.hager in p.schlechtriem(ed), op cit, art.69, para 7. furthermore see a.romein, op cit. 170 see p.m.roth, op cit, 307. 171 see g.hager in p.schlechtriem(ed), op cit, art.69, para 7. 172 see b.nicholas in c.m.bianca and m.j.bonell (eds), op cit, art.69, para 3.1 and g.hager in p.schlechtriem(ed), op cit, art.69, para 8. 173 see b.nicholas in c.m.bianca and m.j.bonell (eds), op cit, art.69, para 3.1. it would be interesting to note what ulis article 98(3) provided on the matter: “where unascertained goods are of such a kind that the seller cannot set aside a part of them until the buyer takes delivery, it shall be sufficient for the seller to do all acts necessary to enable the buyer to take delivery”. 174 see b.nicholas in c.m.bianca and m.j.bonell (eds), op cit, art.69, para 3.1, and s.bollée, op cit, 270. 175 the convention gives the definition of “fundamental breach” in article 25 cisg, according to which: “a breach of contract committed by one of the parties is fundamental if it results in such detriment to the other party as substantially to deprive him of what he is entitled to expect under the contract, unless the party in breach did not foresee and a reasonable person of the same kind in the same circumstances would not have foreseen such a result.” 176 a.romein, op cit. 177 see b.nicholas in c.m.bianca and m.j.bonell (eds), art.70, para 2.2 et seq. 178 g.hager in p.schlechtriem(ed), op cit, art.69, para 2. 179 see d.e.goodfriend, op cit, 601. nordic journal of commercial law issue 2004 #2 47 180 the partial avoidance is established in article 51(1) cisg, according to which articles 4650 apply to the missing or not conforming part, in situations where the seller delivers only a part of the goods or if only a part of the goods is conforming to the contract. 181 see s.bollée, op cit, 284. 182 see j.o.honnold, op cit, para 382.1. 183 those that were lost or damaged because of the fundamental breach of contract, those that were accidentally lost or damaged and those that conformed to the contract. 184 article 82(2)(a) states: “the preceding paragraph does not apply: if the impossibility of making restitution of the goods or of making restitution of the goods substantially in the condition in which the buyer received them is not due to his act or omission”. 185 see g.hager in p.schlechtriem(ed), op cit, art.69, para 2 and s.bollée, op cit, 283. 186 g.hager in p.schlechtriem(ed), op cit, art.69, para 4. 187 see g.hager in p.schlechtriem(ed), op cit, art.69, para 2. 188 see g.hager in p.schlechtriem (ed), op cit, art.69, para 7. 189 s.bollée, op cit, 287. 190 regarding the third and fourth remedy it should be noted that ‘in case the goods are damaged by accident before the price reduction or remedy by repair has been exercised, the buyer can only reduce the price to the extent of the original breach of contract and also only for the part asking for remedy by repair, but not for damages which occurred afterwards. the buyer bears the risk for this when he chooses not to declare the contract avoided’. a.romein, op cit. 191 see g.hager in p.schlechtriem(ed), op cit, art.69, para 5a, and s.bollée, op cit, 286. 192 g.hager in p.schlectriem(ed), op cit, art.69, para 2. 193 nevertheless, in some cases there might be a situation of premature passing of risk to the buyer, ie before delivery takes place. these cases will be examined below in chapter ii. b. iv). 194 furthermore they deal with the parties’ obligations, the division of costs and the documentation required in global trade, indicating which party is responsible for which document. 195 it should be stressed that incoterms deal exclusively with the contract of sale and not with the other contracts needed in an international sales transaction, like the contract of insurance, carriage and finance. see international chamber of commerce, incoterms 2000: icc official rules for the interpretation of trade terms (paris: icc publishing s.a., 1999) 5, para 1. 196 exw is the acronym of ex works, fca (free carrier), fas (free alongside ship), fob (free on board), cfr (cost and freight), cif (cost insurance and freight), cpt (carriage paid to), cip (carriage and insurance paid to), daf (delivered at frontier), des (delivered ex ship), deq (delivered ex quay), ddu (delivered duty unpaid), ddp (delivered duty paid). incoterms 2000 can be listed in four categories depending on the common obligations of the seller. the first group (eterm) includes only one term exw, where the seller just places the goods at the disposal of the buyer at the seller’s premises without any further obligation. the second group (fterms) encompasses the fca, fas and fob terms, where the seller does not have to pay the costs for the main carriage, but only those for the transport of the goods until the delivery point when they are handed over to the international carrier in the country of export. the third group (c-terms) includes four terms: cfr, cif, cpt and cip, the common characteristic of which is that the seller has the obligation to pay the costs for the main international carriage, without bearing the risk for the loss or damage of the goods during the main carriage. finally, the fourth group (dterms) includes five terms; daf, des, deq, ddu and ddp, where the seller is obliged to place the goods at the buyer’s disposal on the contractually agreed place of destination. furthermore, incoterms 2000 can be categorised in two groups depending on the transportation mode used for the transfer of the sold goods. the first category encompasses the terms which allow the transport of the sold goods with any mode of transport separately or in combination with others (multi-modal transport); exw, fca, cpt, cip, daf, ddu, ddp. the second category includes the terms that allow the transport of the goods only by sea or inland waterway transport and these are: fas, fob, cif, cfr, des and deq. 197 see j.ramberg, icc guide to incoterms 2000 (paris: icc publishing s.a., 1999) 60. incoterms deal only with the price risk, but it should be noted that the passing of risk of non-performance is linked with delivery of the goods as well. thus, if the goods are accidentally lost or damaged before delivery takes place, the seller will have to provide substitute goods, ie he will be obliged to redeliver. 198 incoterms 2000 are written in a very minimalist but straightforward manner, in the form of an extended diagram; they are formed in two series, series a and series b, each of which encompasses ten articles. sections a1a10 regulate the seller’s obligations, the rules on the allocation of costs and risks and details on documentation, whereas sections b1b10 regulate the same issues on the part of the buyer. 199 nevertheless, as it will be seen further below, there are occasions of premature passing of risk in certain cases before delivery takes place. see chapter ii. b. iv). 200 if the parties wish that the seller would be responsible for loading the goods, they should expressly make a reference to that in their contract. 201 if, at the usual time of delivery of such goods there is no agreed date. the seller should give the buyer sufficient notice informing him on the exact time and place of delivery. 202 this trade term is usually used in cases where multi-modal transport is involved, ie where the goods are carried by more than one modes of transport (for example truck and train and/or plane and/or ship). nordic journal of commercial law issue 2004 #2 48 203 on that point the fca term differs from the exw term, since in the latter delivery is effected and risk passes when the goods have been placed at the carrier’s or buyer’s disposal, without having been loaded on the means of transport. the practical significance of that difference is obvious especially in cases where the loading process is quite long and thus more risky. 204 this term is used only for sea or inland waterway transport. it should not be used in cases of loading on train (for), truck (fot), plane (fob airport) or in container transport. in these cases fca should be preferred. see d.flambouras, ‘the icc rules on international commercial sale (incoterms 2000)’ 3/2000 (6th year) law of enterprises and companies 260, 264in greek. 205 d.m.sassoon, c.i.f. and f.o.b. contracts (london: sweet and maxwell, 4th edition, 1995) 350. 206 see stock v inglis (1884) 12 qbd 564. in that case the agreement was about a fob contract for the sale of sugar. a common usage to sugar trade was that the cargo was not supposed to be appropriated at the time of shipment, but only after the seller had obtained the bill of lading. consequently, the vessel was lost before appropriation and the defendant, an underwriter with whom the plaintiff had an insurance contract, refused to honour the contract, claiming that since the property did not pass, he did not have an insurable interest in the goods. brett mr proclaimed that in a fob contract, risk passed on shipment and the buyer was obliged to pay the price in any case (no matter if he received the goods or not) and despite the fact that the property in the goods had not passed before the cargo was lost. see also other relevant case law: joyce v swann (1864) 17 cv (ns) 84, the parchim [1918] ac 157, browne v hare (1858) 3 h&n 484, frebold and sturznickel (trading as panda o.h.g.) v circle products ltd (1970) 1 lloyd’s rep 499. 207 b.reynolds, ‘stowing, trimming and their effects on delivery risk and property in sales “f.o.b.s.”, “f.o.b.t.” and “f.o.b.s.t.”’ (1994) lmclq 119, 125. 208 pyrene co ltd v scindia navigation co ltd (1954) 2 qb 402. 209 see p.sellman, llb law of international trade casebook (london: hlt publications, 5th edition, 1994) 39, and see p.sellman and j.evans, law of international trade. 150 leading cases (london: old bailey press, 2002) 17, and also see m.bridge, op cit, para 10.43. 210 pyrene co ltd v scindia navigation co ltd (1954) 2 qb 402, 419. 211 see d.m.sassoon, c.i.f. and f.o.b. contracts (london: sweet and maxwell, 4th edition, 1995) 463. 212 see a.romein, op cit. 213 see b.reynolds, ‘stowing, trimming and their effects on delivery risk and property in sales “f.o.b.s.”, “f.o.b.t.” and “f.o.b.s.t.”’ (1994) lmclq 119, 125 and also j.ramberg, icc guide to incoterms 2000 (paris: icc publishing s.a., 1999) 32. 214 i.carr, op cit, 41. nevertheless, romein suggests that the risk still passes at the point when the goods pass the ship’s rail like in a classic fob contract, even though the parties have agreed on a fob stowed and/or trimmed type of contract (see a.romein, op cit). furthermore, a.raty is also of the opinion that these variants do not affect the point of passing of risk. see a.raty, ‘variants on incoterms’ in c.debattista (ed), incoterms in practice (paris: icc publishing s.a., 1995, reprinted 1996) 155. 215 the fas term has been changed in incoterms 2000 regarding the export clearance, which in the 2000 version burdens the seller. in the previous versions it was the responsibility of the buyer. this term should be used only for sea or inland waterway transport. 216 generally, in the fas term apply the same rules as for the fob termthat term is also only used for sea or inland waterway transport. they only differ on the time of passing of risk, since in fob sales delivery takes place and the risk is transferred at a later point, ie when the goods pass the ship’s rail. 217 once again this term should be used only for sea or inland waterway transport. 218 exactly like under the cfr term. 219 cif can be used only in sea and waterway transport and it means that the seller has to pay the costs, insurance and freight for the transport of the goods at the named port of destination. furthermore, the seller has to provide to the buyer at his own expense the minimum cover of marine insurance against the buyer’s risk of loss or damage during the sea carriage of the goods. 220 it should be mentioned that pertaining to the passing of risk under a cif contract, the rules of sale of goods act 1979, s 20 do not apply. according to s 20 “risk passes with property” (see case healey v howlett (1917)1 kb 337), “unless otherwise agreed” (see case bonington & morris v dale &co ltd (1902) 7 com cas 112). in truth, in cif risk and property are treated differently. 221 generally under a cif contract risk and property do not pass at the same time. property usually passes later, when the shipping documents are tendered to the buyer. see j.c.t.chuah, law of international trade (london: sweet and maxwell, 1998) 139, i.carr, op cit, 23, lord templeman and d.holloway, commercial law (london: old bailey press, 1997, reprinted 1999 and 2001) 164, d.m.sassoon, c.i.f. and f.o.b. contracts (london: sweet and maxwell, 4th edition, 1995) 224, l.d’arcy, c.murray and b.cleave, schmitthoff’s export trade. the law and practice of international trade (london: sweet and maxwell, 10th edition, 2000) 38. 222 see cases johnson v taylor bros [1920] ac 144, law and bonar ltd v british american tobacco ltd (1916) 2 kb 605, tregelles v sewel (1862) 7 h&n 574. 223 see j.c.t.chuah, op cit, 139, i.carr, op cit, 23, d.m.day, op cit, 77, p.sellman, law of international trade (london: hlt publications, 2nd edition, 1995) 48, m.bridge, op cit, para 10.50, d.m.sassoon, c.i.f. and f.o.b. contracts (london: sweet and maxwell, 4th edition, 1995) 224, l.d’arcy, c.murray and b.cleave, schmitthoff’s export trade. the law and practice of international trade (london: sweet and maxwell, 10th edition, 2000) 38. 224 t.portwood, revised and updated by a.odeke, commercial law textbook, volume iiinternational trade (london: hlt publications, 3rd edition, 1992) 63. 225 biddell bross v e.clemens horst co (1911) 1 kb 934, 937. 226 see d.m.day, op cit, 77. nordic journal of commercial law issue 2004 #2 49 227 cpt can be used in all modes of transport and also in multi-modal transport. 228 in incoterms 2000 ‘“carrier” means any person who in a contract of carriage, undertakes to perform or to procure the performance of transport by rail, road, air, sea, inland waterway or by a combination of such modes’. see international chamber of commerce, incoterms 2000: icc official rules for the interpretation of trade terms (paris: icc publishing s.a., 1999) 33. 229 nevertheless, the seller will be responsible for paying the cost of carriage to the named destination and furthermore for the insurance premium covering the carriage of the goods. 230 the parties can expressly agree that the seller will be responsible for the unloading of the goods at his own risk and expense. 231 if the parties have agreed generally that the agreed place of delivery is the frontier of a country, the seller will have the opportunity to select the specific point at the frontier that will serve him better. see j.ramberg, icc guide to incoterms 2000 (paris: icc publishing s.a., 1999) 139. 232 the seller, at the buyer’s request could arrange for the carriage of the goods to their final destination named by the buyer, in the country of import, at the latter’s cost and risk. 233 this term should only be used when there is delivery of the goods by sea or inland waterway or multi-modal transport on a vessel in the port of destination. 234 if the parties wish the seller to bear the costs and risks of discharging, then they should prefer the deq term. 235 this term should only be used when the goods are to be delivered by sea or inland waterway or multi-modal transport on discharging from a vessel onto the quay (wharf) at the port of destination. 236 it should be noted that under incoterms 2000 the deq term requires the buyer to be the one who is responsible for the clearance of the goods for import, whereas the previous versions put this burden on the seller. 237 this term can be used in every mode of transport. 238 the ddp term can be used in every mode of transport and it represents the maximum of the seller’s obligations, in contrast with the exw term, which represents the minimum obligation for the seller. 239 if the parties want to exclude some of the costs paid upon import by the seller, they should expressly indicate their will in the contract of sale. additionally, if the buyer fails to render to the sellerafter his request, risk and expenseassistance in order to obtain import licences or other official documents for the import of the goods, he should bear the additional risks incurred thereby. 240 the buyer should specify for example the time and place for taking delivery under the exw term, name the carrier and specify the time and place of handing the goods over to him under the fca term, give sufficient notice to the seller of the vessel’s name, loading point and required delivery time under the fob and fas terms. furthermore, under c-terms and d-terms the buyer is obliged to give the seller the necessary information pertaining to the time of dispatching the goods and/or their destination, whenever he is entitled to determine them. 241 see j.ramberg, icc guide to incoterms 2000 (paris: icc publishing s.a., 1999) 61. 242 j.ramberg, icc guide to incoterms 2000 (paris: icc publishing s.a., 1999) 61. 243 see article 6 cisg. 244 see m.bridge, op cit, para 2.48. to avoid repetition see chapter i. b. and also footnote 44 of the present study. 2 4 5 s e e c a s e s t p a u l g u a r d i a n i n s u r a n c e c o . , e t a l . v n e u r o m e d m e d i c a l s y s t e m s & s u p p o r t , e t a l , a v a i l a b l e a t http://www.unilex.info/article.cfm?pid=1&pos=67&iid=486&cid=44#iid486, last accessed on 23/07/03. 246 the plaintiff further argued that the retention of title to the goods modified the cif term regarding the passing of risk. the court, however, decided that this clause, according to articles 67(1)(third sentence) and 4 (b)cisg, does not affect the transfer of risk to the buyer (the cisg does not connect the transfer of risk to the transfer of ownership). 247 by the term “dry cargo” is usually meant grain, iron ore, coal, natural gas, sand or raw materials. the view that incoterms are not commonly used in sales of dry cargo is supported by some commentators (see d.flambouras, “transfer of risk in the contract of sale involving carriage of goods: a comparative study in english, greek law and the united nations convention on contracts for the international sale of goods”, available at http://cisgw3.law.pace.edu/cisg/biblio/flambouras.html, last accessed on 28/05/03, and m.bridge, the international sale of goods. law and practice (oxford university press, 1999), para 2.48), but in reality there are no statistics that confirm this opinion. on the contrary, it seems that in most of the relevant case law involving sales of dry cargo, incoterms had been chosen by the parties to govern their sales contract. to avoid repetition see the analysis made above in chapter i. b. and also see footnote 44. 248 see d.flambouras, “transfer of risk in the contract of sale involving carriage of goods: a comparative study in english, greek law and the united nations convention on contracts for the international sale of goods”, available at http://cisgw3.law.pace.edu/cisg/biblio/flambouras.html, last accessed on 28/05/03. 249 see j.d.feltham, ‘c.i.f. and f.o.b. contracts and the vienna convention on contracts for the international sale of goods’ (1991) journal of business law 413, 416. 2 5 0 let us assume that the seller s in madrid and the buyer b in rome agree on the sale of 2,000 tons of apricots fca incoterms 2000. the goods should be shipped from the port of barcelona on 19 march 2003 and be carried from madrid to barcelona by truck. the goods are loaded on the truck but on their way to barcelona they are damaged due to a road accident. who will bear the risk of damage under the incoterms and the convention? the goods were damaged after the handing over to the first carrier, ie in the present situation the truck carrier; consequently, under both incoterms and the convention, the buyer b will have to bear the risk of damage. 251 according to the first sentence of article 67(1) cisg, risk passes when the goods are delivered to the first carrier for transmission to the buyer. nordic journal of commercial law issue 2004 #2 50 252 see h .de vries, op cit, 521. 253 see n.g.oberman, op cit. 254 see h .de vries, op cit, 519. 255 see h .de vries, op cit, 520. 256 this will be examined below in chapter iii. b. i). 257 see chapter ii. a. iv). 258 see n.g.oberman, op cit. 259 by way of an example, let us suppose that the seller x ships 5,000 tons of grain and sells them while in transit to buyer y, who in his turn sells them to buyer z and z again sells them, while in transit, to buyer w. when w takes over the goods he realises that the goods have deteriorated due to water sea page. who will bear the risk of deterioration? the seller x or any of the subsequent buyers y, z or w? under the convention’s rule in art.68, risk passed from the time of conclusion of the contract of sale. that means that the buyer w would have to bear the risk of loss if the goods deteriorated after the conclusion of his contract. nevertheless, in that case the parties would have to deal with some difficult problems of proof, since it would be very hard to determine the exact time of deterioration. if, however, there had been an insurance coverage, the risk would pass from the moment when the goods were handed over to the carrier who issued the contract of carriage. if the seller x or any of the subsequent buyerssellers knew about the deterioration, then the loss would be at his risk according to the convention’s article 68 third sentence. on the contrary, if incoterms 2000 cif or cfr “afloat” applied, risk would pass from the moment that the goods had passed the ship’s rail at the port of shipment. 260 n.g.oberman, op cit. 261 see n.g.oberman, op cit. 262 see a.romein, op cit. 263 see chapter ii. b. iii). 264 in order to establish another point of passing of risk that would be more efficient and practical. 265 see j.ramberg, icc guide to incoterms 2000 ( paris: icc publishing s.a., 1999) 14. 266 see relevant case pyrene co ltd v scindia navigation co ltd (1954) 2 qb 402, examined above in chapter ii. b. iii). 267 it will be difficult to examine every time the exact time and place where the goods had landed. 268 see a.romein, op cit. 269 see d.flambouras, “transfer of risk in the contract of sale involving carriage of goods: a comparative study in english, greek law and the united nations convention on contracts for the international sale of goods”, available at http://cisgw3.law.pace.edu/cisg/biblio/flambouras.html, last accessed on 28/05/03. 270 ibid. 271 examination of whether the goods were damaged before or after they passed the ship’s rail and whether they fell on the wharf, sea or deck. 272 c.gelens, ‘incoterms and contracts of carriage in liner terms’ in c.debattista (ed), incoterms in practice (paris: icc publishing s.a., 1995, reprinted 1996) 140. 273 see chapter ii. a. iii) and v). 274 see chapter ii. a. iv). 275 see d.flambouras, “transfer of risk in the contract of sale involving carriage of goods: a comparative study in english, greek law and the united nations convention on contracts for the international sale of goods”, available at http://cisgw3.law.pace.edu/cisg/biblio/flambouras.html, last accessed on 28/05/03. 276 the seller will have to prove that the goods were destroyed or lost after they were identified to the contract of sale, since in that case the general principle of article 7(2) cisg applies, according to which a person who relies on a rule in his favour must prove that the preconditions for the application of that rule are satisfied. see d.n.tzouganatos, ‘the passing of risk under the articles 66-70 of the united nations convention on international sale of goods’ (1995) commercial law review 509, 523in greek. 277 see d.n.tzouganatos, ‘the passing of risk under the articles 66-70 of the united nations convention on international sale of goods’ (1995) commercial law review 509, 524in greek and also see d.e. goodfriend, op cit, 588. 278 see d.flambouras, “transfer of risk in the contract of sale involving carriage of goods: a comparative study in english, greek law and the united nations convention on contracts for the international sale of goods”, available at http://cisgw3.law.pace.edu/cisg/biblio/flambouras.html, last accessed on 28/05/03. 279 see n.g.oberman, op cit. 280 see d.e.goodfriend, op cit, 579. 281 see d.m.day, op cit, 94 and j.c.t.chuah, op cit, 29. 282 g.jiménez, icc guide to exportimport basics, the legal, financial and transport aspects of international trade (paris: icc publishing s.a., 1997) 181. 283 see g.jiménez, icc guide to exportimport basics, the legal, financial and transport aspects of international trade (paris: icc publishing s.a., 1997) 181. 284 see j.ramberg, icc guide to incoterms 2000 ( paris: icc publishing s.a., 1999) 15. 285 see g.jiménez, icc guide to exportimport basics, the legal, financial and transport aspects of international trade (paris: icc publishing s.a., 1997) 182. 286 see d.e.goodfriend, op cit, 579 and d.m.day, op cit, 94. nordic journal of commercial law issue 2004 #2 51 287 the advantages of multi-modal transport are various and can be summarised in that there is only ‘one carrier, one document and one responsibility covered by a total price from point of origin to point of destination’. j.ramberg, ‘the implications of new transport technologies’ (1980) 15 european transport law 119, 129 and see also d.m.day, op cit, 94. 288 m.clarke, ‘containers: proof that damage to goods occurred during carriage’ in c.m.schmitthoff and r.m.goode (eds), international carriage of goods: some legal problems and possible solutions, the international commercial law series, volume 1, ([london]: centre for commercial law studies, 1988) 88. 289 k.m.johnson and h.c.garnett, the economics of containerisation (london: george allen & unwin ltd, 1971) 89. 290 see a.romein, op cit. 291 see d.e.goodfriend, op cit, 579. 292 see d.m.day, op cit, 95. 293 see d.flambouras, ‘international sales of goods. practical issues concerning the passing of risk under the vienna convention (1980)’ (marchapril 1998) synigoros 26, 28in greek. 294 see d.e.goodfriend, op cit, 594. 295 see d.flambouras, “transfer of risk in the contract of sale involving carriage of goods: a comparative study in english, greek law and the united nations convention on contracts for the international sale of goods”, available at http://cisgw3.law.pace.edu/cisg/biblio/flambouras.html, last accessed on 28/05/03. 296 see a.romein, op cit, g.jiménez, op cit, 181 and s.bollée, op cit, 254. 297 see k.pantelidou, ‘issues from the allocation of risk under the vienna convention for the international sale of goods’ (2002) private law chronicle 97, 102. 298 see m.t.murphy, “united nations convention on contracts for the international sale of goods: creating uniformity in international sales law” 727, 750, available at http://cisgw3.law.pace.edu/cisg/biblio/murphy.html, last accessed on 28/04/03. 299 see chapter iii. b. i). 1 frustration of purpose, brexit, the covid-19 pandemic and commercial contracts mitja kovac* and paul aubrecht * professor of civil and commercial law at the university of ljubljana school of economics and business, slovenia, e-mail: mitja.kovac@ef.uni-lj.si  junior researcher at the erasmus university rotterdam school of law, rotterdam institute of law and economics, the netherlands, e-mail: paul.aubrecht@emle.eu njcl 2022/1 1. introduction ...................................................................................... 3 2. economically informed conceptual framework ............... 6 2.1. preliminaries ............................................................................ 7 2.2. modest increase in performance costs ...................... 10 2.3. excessively onerous performance ............................... 10 2.4. performance useless ........................................................... 12 2.5. simultaneous dramatic increase in performance costs and value .................................................................... 13 3. canary wharf case ........................................................................ 14 3.1. the doctrine of frustration of purpose under english common law .......................................................... 16 3.2. the doctrine of frustration and contractual construction ......................................................................... 18 3.3. comment on the canary wharf case .......................... 18 3.3.1. explicit risk allocation, superior risk bearer, and supervening illegality .................................. 23 3.3.2. onerous performance costs, excuse and divestiture ................................................................... 24 4. the implications of risk preferences on foreseeability, frustration, and the covid-19 pandemic ............................ 25 4.1. risk preferences and uncertainty ............................... 26 4.2. the covid-19 pandemic and frustration of purpose 28 5. conclusions ....................................................................................... 31 njcl 2022/1 3 abstract lawyers and commercial contracting have been stressed by extraordinary uncertainty over the past four years. brexit and the covid19 pandemic’s uncertain outcomes and the debate on the appropriate application of the frustration doctrine represent one of the most challenging issues for contract law scholars and practitioners. this paper contributes to the extensive scholarly debate on whether brexit and covid-19 constitute frustration of purpose events in contracts by exploiting the findings of the economic literature on the consequences of supervening events. it offers a conceptual framework for an improved legal intervention in case of supervening events in which a court must decide whether a certain event classifies as frustration of purpose and whether to discharge the promisor’s obligations. 1. introduction brexit and the covid-19 pandemic have been generally portrayed as unexpected, unforeseeable events that represent ongoing uncertainty. one of the multitudes of uncertainties currently facing contracting parties potentially affected by a hard brexit2 and the covid-19 pandemic is the effect on their existing commercial contracts, specifically whether the new circumstances provide an event that frustrates the contract. some welcome clarity has now been provided by the english high court's judgment in canary wharf (bp4) t1 ltd v european medicines agency.3 in delivering its judgment, the high court provided notable guidance on the application of the relevant principles to determine whether brexit (and also covid-19 pandemic) is likely, in a particular case, to constitute a frustrating event in contracts governed by english law. namely, the high court found that ‘the involuntary departure of the ema from its headquarters in the premises, due to the circumstances beyond its control, was something which on the face of it the lease expressly provided for’ and the contracts alienation ‘provisions draw no distinction between the reasons why the ema might abandon its headquarters’ but rather ‘simply deal with the fact’ of the ema leaving the premises at for seemingly any reason, including brexit.4 this article investigates whether, from the economic perspective, such a decision is the correct one or whether the 2 hard brexit' was a phrase used during the brexit process to capture the anticipated economic, social and political impact of a sharp break in relations between the uk and the eu as a result of the uk leaving the bloc. a 'hard' brexit came to mean a future relationship with the uk outside the eu's single market and customs union and trading with the eu based on a free trade agreement. 3 [2019] ewhc 335 (ch) (canary wharf). 4 in canary wharf ⦋2019⦌ ewhc 335 (ch) at ⦋241⦌. frustration of purpose 4 economic principles would lead to a different decision. undoubtedly, future cases will be litigated concerning the nature of brexit and the covid-19 pandemic regarding its interpretation as frustration of purpose. the current debate on the appropriate application of the frustration doctrine represents one of the most challenging issues for current contract law scholars and practitioners. shooter, speed, and baxter, for example, argue that, if brexit is to have an underlying effect on contracts and on the commercial bargain made by the parties (e.g., where import tariffs are increased), express provisions will need to address these impacts.5 on the other hand, araujo examines the negotiation, conclusion, and implementation of trade agreements concluded by the uk post-brexit and proposes a significant reform of existing inter-governmental cooperation mechanisms to ensure that the devolved administrations are given a meaningful voice in the shaping of future trade agreements.6 ribas suggests that brexit may have significant implications for interpretative, applicable law, and termination aspects of contracts.7 moreover, woods argues that if the wording of the particular clauses allows for termination in the event of a significant regulatory or legislative change, for example, then such a clause could also apply in the brexit case.8 additionally, pertoldi, blake, and kay suggest that the restriction, suspension, or withdrawal of any licences connected to brexit might also be covered by a general force majeure clause.9 conversely, pertoldi et al. note that 'a change in economic or market circumstances which makes the contract 5 s shooter, j speed, and k baxter, does brexit constitute a force majeure event in supply chain contracts?, bird & bird, london, 2019. 6 b a melo araujo, ‘uk post-brexit trade agreements and devolution’ (2019) 39 ls 4. 7 a r escobar, ‘and here remain with your uncertainty: the consequences of brexit for business law’ (2017) working paper ie law school aj8-239. see also j w cartwright, contract law. an introduction to the english law of contract for the civil lawyer, 3rd ed., hart, london, 2016, p 270; and m sonnentag, die konsequenzen des brexits fur das internationale privatund zivilverfahrensrecht, mohr siebeck, munich, 2017. 8 jane woods, ‘impact of brexit on contract law’ (2016) 79 student law review 15. see also jeremy heymann, ‘impact of brexit on european company law: a french private international lawyer perspective’ (2018) european papers. 9 anna pertoldi, neil blake and alex kay, ‘english law contracts post-brexit: what changes should commercial parties expect?’ (2016) contract disputes practical guides issue 7, herbert smith freehills. in addition, high court has in the tandrin aviation holdings v aero toy store [2010] ewhc 40 (comm) ruled that an 'unanticipated, unforeseeable and cataclysmic downward spiral of the world's financial market' is not sufficient to trigger a force majeure clause. such a clause under english law would be triggered merely if one party's performance of the obligations under the contract became either impossible or extraordinarily difficult. njcl 2022/1 5 less profitable or performance more onerous is not generally regarded as sufficient to trigger a force majeure clause.’10 finally, macmillan discusses the issues of post-brexit settlements and thoroughly investigates different types of possible effects upon the practice and substance of english contract law.11 first, this paper contributes to the extensive scholarly debate on whether brexit and covid-19 should constitute a frustration of purpose event in contracts by exploring the findings of the economic literature on the consequences of supervening events. second, it offers suggestions about how courts in the uk (and around the world, including common law jurisdictions such as singapore, canada, and australia) could approach contractual claims that attempt to rely on a covid-19 related frustration, given the nature of lockdowns, government edicts, and closed borders. third, this paper adds an economically inspired conceptual framework; and fourth, it critically evaluates the impact of the canary wharf judgment.12 however, it should be emphasized that this paper does not discuss the impact of brexit on the boilerplate clauses in commercial contracts and omits the discussion on the intertwined problem of restitution. in addition, the sole nature of the 'covid-19’ pandemic and its relation to standard force majeure and hardship doctrine, which exert a significant impact on the development of contract law, call for a rigorous interdisciplinary analytical treatment capable of offering a set of normative suggestions for informed policymakers, judiciaries, and practitioners. in this article, the analysis is as positive as it is normative. the analytical approach employs a classic law and economics methodology,13 which follows the classical comparative law and economics approach.14 this classical comparative law and economics approach serves as a bridge between facts and normative conclusions, between economic theory and 10 pertoldi et al., above, n 6, at 6. see also nick thody and victoria gwynedd-jones, ‘how might brexit impact your commercial contracts and what, if anything, can you do about it?’ (2017) osborne clark, london. 11 catherine macmillan, ’the impact of brexit on english contract law’ (2016) 27 king’s law journal 420. for a broad impact assessment of brexit, see m dougan, the uk after brexit: legal and policy challenges, intersentia, cambridge 2017. 12 ⦋2019⦌ ewhc 335 (ch). 13 for a synthesis of law and economics scholarship, see g de geest, contract law and economics – encyclopaedia of law and economics, volume 6, 2nd ed., edward elgar, cheltenham, 2011. also see r a posner, economic analysis of law, 8th ed., wolters kluwer law publishers, new york, 2011. 14 r bergh van den, the roundabouts of european law and economics, eleven international publishing, den hague, 2018, p 21-28. frustration of purpose 6 policy proposals for an improved legal system.15 it seeks to complement other legal disciplines by uncovering the underlying economic logic and the social effects of the assessed legal institutions.16 in looking for transparency in the law, the employed approach connects to what ‘the best traditional legal scholarship aims to do: clarifying the underlying order of law as it is; offering tools for fashioning law to cope with novel situations.’17 however, several caveats should be stated. namely, the paper aims not to impose a final word on the matter but to undertake an exploratory analysis of the relationship between the development of contract law and its economic effects. moreover, there are further factors and issues that might drive the observed results (and that call for further investigation), for example, issues of (i) political biases of courts, (ii) political neutrality of economic approaches, (iii) behavioral pandemic state of emergency effects, (iv) underlying sociological and psychological phenomena, and (v) fairness qualities. this paper is structured as follows. the first part outlines the optimal foreseeability threshold and provides an economically inspired conceptual framework for categorizing frustrating events. moreover, this part also investigates the issue of whether brexit and the covid-19 pandemic should constitute supervening events and whether they should be regarded as events that frustrate the purpose of the contract. the second part examines recent case law. the third part discusses the implications of risk preferences on foreseeability, renegotiation, frustration, and the covid-19 pandemic. finally, some brief conclusions are presented. 2. economically informed conceptual framework this section considers an economically informed conceptual framework as an alternative, supportive analytical tool for instances of supervening events where a court must decide whether a specific event should be classified as a frustrating one and whether to discharge the promisor’s obligations. 15 bergh van den, above, n 14, p 27. 16 this methodology complements traditional legal disciplines by bringing to light a logic that decision-makers follow without necessarily expressing it in their reasons for judgment, yet which constraints their results. it also seeks to make this logic transparent to outside observers; a ogus, costs and cautionary tales: economic insights for the law, hart publishing, cambridge, 2006, p 11-16. see also g calabresi, the future of law & economics, yale university press, new haven, 2016; and r a posner, divergent paths: the academy and the judiciary, harvard university press, cambridge, 2016. 17 e mackaay, law and economics for civil law systems, edward elgar, cheltenham, 2013, p 6. njcl 2022/1 7 2.1. preliminaries most of the economic literature on contractual excuse discusses notions of 'impossibility,' 'commercial impracticability,' and 'frustration of purpose' side by side. in their seminal article on impossibility and related doctrines in contract law, posner and rosenfield18 suggest that the question of whether to excuse the promisor from his obligation is one of choosing which party should bear the risk of increased costs of performance. they suggest that, in the absence of any express contractual provision to such effect, risk should be assigned to the superior risk bearer. if the promisor is the superior risk bearer, then non-performance should be treated as a breach of contract; if the reverse is true, discharge should be allowed.19 others focus their analysis on the allocation of risks and resources, and argue that what matters is the design of efficient remedies for a breach of a contract.20 they conclude that a remedy of expectation damages achieves or approximates pareto efficiency and is superior to the zero damages rule.21 18 r a posner and andrew m rosenfield, ‘impossibility and related doctrines in contract law: an economic analysis’ (1977) 6 j leg stud 83. see also m p gergen, ‘a defense of judicial reconstructions of contracts’ (1995) 71 ind lj 45; p l joskow, ‘commercial impossibility, the uranium market and the westinghouse case’ (1977) 6 j leg stud 119; and v p goldberg, rethinking contract law and contract design, edward elgar, cheltenham, 2015, pp. 137-180. 19see c l bruce, ‘an economic analysis of the impossibility doctrine’ (1982) 11 j leg stud 311; h b schäfer and v goldberg, framing contract law: an economic perspective, harvard university press, cambridge, 2006, p 327-376; m j trebilcock, the limits of freedom of contract, harvard university press, cambridge, 1993, p 130; c ott, lehrbuch des ökonomischen analyse des zivilrechts, springer, new york, 2012, p 250-58; t m roberts, ‘commercial impossibility and frustration of purpose: a critical analysis’ (2003) 16 canadian journal of law and jurisprudence 1, p 129-145; m a eisenberg, ‘impossibility, impracticability and frustration’ (2009) 1 journal of legal analysis 1, p 207-261; j camero, ‘mission impracticable: the impossibility of commercial impracticability’ (2015) 13 the university of new hampshire law review 1, p. 1-34; and to some extent joskow, above, n 17. 20 steven shavell, ‘damage measures for breach of contract’ (1980) 11bell j econ 466; m a polinsky, ‘risk sharing through breach of contract remedies’ (1983) 12 j leg stud 427; steven shavell, ‘the design of contracts and remedies for breach’ (1984) 99 q j econ 121; and m j white, ‘contract breach and contract discharge due to impossibility: a unified theory’ (1988) 17 j leg stud 353. 21 see a o sykes, ‘the doctrine of commercial impracticability in a second-best world’ (1990) 19 j leg stud 43; g g triantis, ‘contractual allocation of unknown risks: a critique of the doctrine of commercial impracticability’ (1992) 42 univ toronto l j 450; andrew kull, ‘mistake, frustration, and the windfall principle of contract remedies’ (1991) 43 hastings lj 1; c fried, contract as a promise: a theory of contractual obligation, harvard university press, cambridge, 1981, p 59-73; and j m perloff, ‘the effects of frustration of purpose 8 however, in addition to previous literature, we argue that, to invoke the frustration doctrine, the following preconditions should be fulfilled: first, if the contract is an aleatory one (aleatory contracts), where the risk is part of the contract itself, implying an implicit agreement on risk allocation, then enforcement of such contracts is suggested, regardless of how unforeseeable or onerous they become.22 second, if the risk was assigned expressly by the parties' agreement or by well-established rules of law on one of the parties, then wealthmaximization requires enforcement of such an agreement.23 if the substance of the contract became illegal, then efficiency requires a discharge of such contract. third, if the contract was not an aleatory one and if the risk has not been assigned expressly by the parties’ agreement or by well-established rules of law, then the question of whether such an event should be regarded as an unforeseeable or foreseeable one should be addressed. obviously, in order to invoke the frustration doctrine, the event should be ex ante unforeseeable and ex post verifiable. we define an unforeseeable event in a novel way: as an ex post verifiable event where the ex ante processing/description cost exceeds the ex ante expected benefits of having provided for such a contingency (i.e., a sort of a processing trade-off).24 namely, this processing trade-off only implies some contingencies in which expected benefits, due to low materialization probability, do not justify drafting expenditures, thus making it is ex ante cost efficient to ignore them. the novelty of our argument is in identifying both the increasing marginal costs of providing and processing for remote contingencies and the discounting effect of low probability on benefits, setting the threshold for ex post identification of which risks should be foreseeable and which not. it may be argued that parties, due to imperfect information, would not be aware of the possibility of some remote risks since, for example, they may not be aware of the possible devolution or breaches of forward contracts due to unanticipated price changes’ (1981) 10 j leg stud 221. 22 if the contract was purely aleatory – i.e., with the risk of ruinous losses as part of the contract itself -, the contracting parties in effect were betting on the future materialization of risks, and no excuse of performance should be granted. 23 in such a circumstance, there is no occasion to inquire which party is the superior risk bearer since it is one that has expressly accepted the risk and should thus bear it. see posner and rosenfield, above, n 17. 24 hence, the application of the optimal rule requires that the risk in concern be an unforeseeable one, where ex ante processing/description costs exceed the expected benefits of having processed such a contingency. njcl 2022/1 9 dissolution of the eu in the next ten years.25 it may also be argued that, although parties are remotely aware of the chance of such a contingency, the ex ante discounted benefits compared to costs of processing for them simply do not justify express contractual provision (prohibitive description costs). parties facing ex ante this processing trade-off simply decide rationally not to provide for those contingencies. however, from an ex post perspective, after risk materializes and performance becomes excessively onerous, this may seem a very irrational decision. this provides additional insight as to why some events should indeed be regarded as ex ante unforeseeable. in other words, due to the increasingly uncertain occurrence of most obscure events, parties have decreasing experiences encountering with and providing for those events. thus, the costs of processing (information, describing, calculating) increase for each additional unit (contractual term). approaching infinite uncertainty of an event always raises the costs of an additional unit (term) more than the previous ones. hence, there must be a point where negotiating, processing, calculating, and drafting contract terms for all possible contingencies makes no more sense. fourth, if all previous preconditions are satisfied, then the further requirement is that neither party is clearly the superior risk bearer (superior risk bearer capacity). if the risk was preventable or insurable, then wealthmaximization requires shifting this burden to the party which is in a better position to prevent the risk from materializing (at a lower cost than the other party) or if they are in a better position to insure against the risk (the superior/cheaper insurer).26 fifth, the exogeneity of an event (exogenous contingency) should be considered a necessary precondition for operating the provided optimal rule. if the contingency in question was due to one party’s fault and was thus not an exogenous one, then no frustration excuse should be granted.27 this requirement ensures precaution and that mitigation decisions are not distorted; besides, it also provides the contracting parties with an incentive to curtail their reliance investments and hence deters opportunism and moral hazard. the fulfilment of these conditions for invoking the frustration excuse deters moral hazard and opportunism, induces optimal reliance, 25 although this might seem highly unlikely, all events can be regarded as foreseen in one way or another. 26 as a result of lower risk-appraisal and transaction costs, through selfor market insurance; see posner and rosenfield (n 17). 27 gerhard wagner, ‘in defence of the impossibility defence’ (1995) 27 loy u chi lj 55. frustration of purpose 10 provides incentives for the optimal mitigation of damages, achieves optimal risk allocation, and decreases transaction cost. 2.2. modest increase in performance costs consider a contract in which the promisor agrees to supply the promisee with one unit of a specialized good or service. the net value of the contract to the promisee is the difference between the value and the price, whereas the net benefit to the promisor is the difference between the price and the costs of performance. this assumes that the value of performance exceeds the contractual price, and the price exceeds performance costs. thus, it can also be assumed that the promisor and promisee negotiate a pareto-efficient contract.28 such a contract would require the promisor to perform if and only if the costs of performance were no greater than the value of performance. having said all that, now assume an unforeseen event causes a rise in costs of performance for such a magnitude that they exceed the contract price, whereas the value of performance remains unchanged and is still above the new costs of performance. from the economic point of view, such a contract is still efficient and should be upheld. the promisor should either perform or breach the contract and pay expectation damages.29 parties must consider when a breach becomes efficient, or in other words, performance becomes inefficient given their estimation of expectation damages. hence, in cases of frustrating events resulting in a slight increase in performance costs, courts should not grant any relief and should enforce such contracts. 2.3. excessively onerous performance we continue our discussion of the situation in which a frustrating event results in excessively onerous costs of performance. to illustrate the situation, assume the net value of performance after the materialization of a frustrating event remains fixed, but this same event now increases the cost of performance so significantly that it exceeds the net value of performance. in such circumstances, economically speaking, the contract should not be performed, since the performance costs are well above the net value of performance. the contract should be discharged, or the 28 see a ogus, costs and cautionary tales: economic insights for the law, hart publishing, london, 2006, p 27; and j leitzel, concepts in law and economics: a guide for the curious, oxford university press, oxford, 2015, p 4-7. 29 the expectation damages remedy provides an incentive to perform if and only if doing so is economically efficient. see shavell, above, n 19, and p g mahoney, ‘contract remedies: general’ in b bouckaert and g de geest, eds., encyclopaedia of law and economics, 2nd ed., edward elgar, cheltenham, 2011. njcl 2022/1 11 promisor should, according to efficient breach theory, breach the contract and pay expectation damages to the promisee.30 however, we argue that the discharge of the promisor's obligation is a superior remedy in cases of frustrating events that increase the value of performance due to its risksharing function by letting each party bear the risk of not attaining its initial expected profit. moreover, if the remedy of specific performance is not given, then the promisor could, according to ‘efficient breach theory,’31 breach the contract and pay expectation damages. in this case, such a party will sustain losses amounting to the difference between the value and the performance cost with respect to their initial expectancy. this will also limit their risk exposure. however, if due to the same frustrating event which increased the cost of performance, the value of performance also increases, but still does not exceed the increased costs of performance, then the situation becomes much more complicated. as an illustration, consider events such as slight increases, which do not merely affect an individual promisor but causes an extraordinary change in market price, and where the promisee's benefit expressed in monetary terms also normally increases. in these circumstances, the limit of the promisor's risk in the case of expectation damages has increased too. the promisor now bears the entire risk of the increased cost of performance32 and the promisee gains his benefit33 with certainty. in such an instance, as trimarchi indicates, the promisor acts not just as an insurer of the promisee's initial expectancy but also as an insurer of the promisee’s windfall benefits.34 the principles of insurance would simply not warrant imposing a monetary transfer on the promisor in order to grant a promisee 30 on the efficient breach theory see leitzel, above, n 27, at 33; ogus, above, n 27, at 205; mackaay, above, n 16, at 403; h b schaefer and c ott, the economic analysis of civil law, edward elgar, cheltenham, 2004, p 329; and s shavell, foundations of economic analysis of law, harvard university press, cambridge, 2004, p 304. 31on efficient breach see j h barton, ‘the economic basis of damages for breach of contract’ (1972) 1 j leg stud 277; p a diamond and eric maskin, ‘an equilibrium analysis of search and breach of contract’ (1980) 10 bell j econ 282; p a diamond and eric maskin, ‘an equilibrium analysis of search and breach of contract ii. a nonsteady state example’ (1981) 25 j econ theory 165; and shavell, above, n 19. 32 sykes indicates that the expectation damages measure fails to implement another potentially important feature of that contract, namely risk-sharing between parties; sykes, above, n 20. 33 equal to the difference between increased value of performance and the price. 34 pietro trimarchi, ‘commercial impracticability in contract law: an economic analysis’ (1992) 11 int rev law econ 1, p 68. frustration of purpose 12 a windfall gain.35 hence, in such circumstances, a discharge of a contract features as a superior remedy.36 the potential windfall of having a contract's value change over time is a factor that parties can consider when ex ante assessing the risks of contracting. however, it may not be worth much time to consider a potential windfall, as the information costs of assessing such a scenario may be excessive and arguably speculative. the parties to a contract may anticipate the possibility of the contract leading to a windfall for one of the parties or at least anticipate changed circumstances in market values which the parties may value. in some cases, contracts are entered into specifically to spread risk for one or both of the parties to the contract or are entered into in speculation about the future value of performance. this may also complicate option contracts, which are also a mechanism used in private contracting to spread risk.37 courts should be particularly cautious when applying the doctrine of frustration to these types of contracts that specifically anticipate a certain amount of uncertainty and specifically allocate risk among the parties regarding this uncertainty. 2.4. performance useless suppose that after the conclusion of the contract, an unforeseen contingency materializes, causing a sharp drop of the promisee's value of performance to zero, whereas price and cost of performance remain unchanged. in this case, performance for the promisor is perfectly possible, since there were no increases in the cost of performance, whereas, for the promisee, it becomes useless. however, the mere fact that performance became less valuable for the promisee should not provide for any excuse of performance. the contract should be upheld, and the 35 trimarchi, above, n 33, at 69. 36 moreover, behavioural studies show that the efficient breach theory might not be supported in experimental findings (i.e., identified mismatch between efficient breach hypothesis and people's perception of contracts). see, e.g., daphna lewinsohn-zamir, ‘can't buy me love: monetary versus in-kind remedies’ (2013) 2013 univ ill law rev 151; lisa bernstein, ‘private commercial law in the cotton industry: creating cooperation through rules, norms and institutions’ (2001) 99 mich l rev 1724; and stewart macaulay, ‘non-contractual relations in business: a preliminary study’ (1963) 28 am sociol rev 55. 37 suppliers may contract to take into account market variations or how a firm with unknown future input needs may contract for an option to purchase the input in the future at a set price which may inevitably be at a different price than the daily price, like how airlines purchase fuel, i.e., fuel hedging. these contracts are specifically designed for one, if not both parties, to spread risks. njcl 2022/1 13 promisee should either perform or should breach the contract.38 excuse of performance in such instances may create serious moral hazard problems; provide incentives for opportunistic behaviour; sub-optimal contract entry; sub-optimal precaution and damage mitigation; increased transaction costs, and assignment of risk upon the party who is not the superior risk bearer. the only possible exemption could be the case where the promisee would also act as an insurer of the promisor's windfall gains. for example, it may happen that, after the promisee's breach, the promisor negotiates the contract with another party, using the same object as in the previous contract. the promisor would thus gain a share of the total benefit from the transaction, which is unlikely to differ much from what he would have gained under the initial contract, thus earning profit twice over. the promisor would earn profit through damages as well as through a substitute contract with another promisee. then the promisee's ‘insurance’ of initial expectancy would give the promisor an 'unjustified' gain. it is, then, only in these rare cases that the discharge of such an inefficient contract may be allowed. 2.5. simultaneous dramatic increase in performance costs and value finally, assume that, due to a supervening event, both cost and value of performance have increased dramatically, but the value for such a magnitude exceeds even the new costs of performance, whereas price remains unchanged. although a supervening event caused the dramatic rise in the cost of performance, the value of performance for the promisee has risen by an even more considerable proportion, so that contract performance is still justified. however, who shall then bear the risk of the exceptionally increased cost of performance? should the promisor bear all the ruinous losses, acting as an insurer of the promisee’s unexpected, exceptional windfall benefits? should the promisor resort to breach, or is a discharge or adjustment of a contract by a third party a better remedy?39 38 contrary to the previously discussed issue of excessively onerous performance, the promisee is now the one who bears the risk of unforeseen contingencies and who acts as the de facto insurer of the promisor. however, the main difference is that he only insures the promisor's initial expectancy and not, as before, also his windfall gains. the promisee now bears the unpreventable risk for which he was offset by the ex ante discount in price and where the principle of insurance would then apply. 39 if the contingency was due to the promisor's fault, or if the risk was assigned to them by well-established legal rules or express provisions, or the promisor was clearly the superior risk-bearer, then no excuse should be allowed. frustration of purpose 14 since the new value exceeds even the new costs of performance, the promisor is caught between the performance of the contract and the ‘expectation damage’ remedy. in other words, either the promisor must perform the contract and, due to a sharp increase in performance cost, sustain ruinous losses or pay even more significant expectation damages.40 the promisor is now bearing the entire risk of the increased cost of performance, and the promisee gains contractual benefit with certainty. the promisor thus acts not just as the de facto insurer of the promisee's initial expectancy but also as an insurer of his windfall gains. furthermore, since he has no way of avoiding those ruinous losses, they may even go bankrupt in the most extreme case. the financial shock harms the promisor’s planning and organization, which implies that the destruction of value is not offset by any corresponding additional gain to the promisee. in such instances, rational, risk-averse parties will prefer risk-sharing. also, the notion that the promisor would be compensated for his insurance of the promisee’s gains by an ex ante increase in price (insurance premium) cannot sustain critical assessment.41 in such circumstances, the discharge of a contract, which implies risk sharing, is an optimal solution. however, one may argue that, if we discharge such a contract, the valuable result of the transaction would also be lost. nevertheless, this may be achieved by a voluntary ex post renegotiation of such a contract.42 an ex post renegotiation may enable both parties to gain from performance, thus solving a problem of lost social benefits from trade when efficient breach leads to suboptimal social outcomes. 3. canary wharf case a recent legal dispute involving the eu and a private uk firm might shed some light on what the future interpretation of a contract without a specific brexit clause may look like. the case involves the lease of a 40 since the new value exceeds the new performance costs, they would even exceed the dramatically increased cost of performance. the amount is the difference between the new value of performance and the contractual price. 41 in addition, sykes and goldberg stated that the promisee may lack incentives to mitigate damages and may also over-invest in performance reliance; sykes, above, n 20, at 63. see also v p goldberg, ‘impossibility and related excuses’ (1988) 144 j inst theor econ 100; and v p goldberg, rethinking contract law and contract design, edward elgar, cheltenham, 2015, p 138. 42 trimarchi even proposes a rule, entitling the party seeking relief to discharge and the other party to prevent it by offering an adjustment to the contract price, and then transaction costs would be lower than those of free re-negotiation, and presumably much lower than the loss which would result from performing the initial contract: trimarchi, above, n 33, at 75. njcl 2022/1 15 property by the european medicines agency (hereinafter ema) from canary wharf ltd. the high court’s judgment in canary wharf43 identifies the most likely interpretation of the unforeseeable character of the brexit. namely, contracting parties who did not directly contract over an unforeseeable event may still have indicated how the parties would perform if something had frustrated the contract. for instance, parties could determine what would happen if other events were to occur, such as the assignment of a lease in the event the lessee no longer needed or wanted to continue using the leased property. this approach of contractual interpretation is what mr. justice marcus smith points to in his ruling in favour of canary wharf ltd., finding that the lease was not frustrated because of brexit. according to mr. justice marcus smith, ‘the involuntary departure of the ema from its headquarters in the premises, due to circumstances beyond its (or, indeed, the european union’s) control was something which – on the face of it – the lease agreement, in its clause 4.21.1(c), expressly provided for.’44 the ema leaving the premises under any circumstances is expressly provided within the contract, and the high court relies on these provisions to make their ruling. while the high court considers several issues identified by the ema and canary wharf, it is helpful to focus on the core arguments surrounding the question of whether the doctrine of frustration applies to the dispute. the ema argued before the court that the 25-year lease it had with canary wharf ltd. to rent office space was frustrated under five separate arguments. first, the loss of legal protections under protocol 7 of the tfeu45 to the ema. second, the inability of the ema to legally use the property as a matter of eu law. third, the inability of the ema or the eu to make economic use of the property due to the restrictive transfer provisions of the contract. fourth, the ‘future performance of the ema’s obligations’ are both unlawful and ultra vires, meaning the ema would not 43 canary wharf ⦋2019⦌ ewhc 335 (ch). 44 mr. justice marcus smith reached this conclusion by looking at the provisions which the ema and canary wharf included in the contract in the event that the ema would no longer occupy the premises. the lease contract between the ema and canary wharf ‘contained detailed provisions regarding alienation’, including provisions that permitted ema to share, assign or sub-let the rented premises; in canary wharf ⦋2019⦌ ewhc 335 (ch) at ⦋92(4), (c)⦌. 45 consolidated versions of the treaty on european union and the treaty on the functioning of the european union – consolidated version of the treaty on the functioning of the european union – protocols – annexes – declarations annexed to the final act of the intergovernmental conference which adopted the treaty of lisbon, signed on 13 december 2007, official journal c 326, 26/10/2012 p. 0001 – 0390. frustration of purpose 16 have any legal authority to continue performing. fifth, the payments of double rent by the ema for both the property in london and the current headquarters in amsterdam would ‘impair the ema’s capacity, effectiveness and independence’.46 the primary counterargument of canary wharf ltd. against the arguments of the ema was that, even if a ‘frustrating event’ were established, from either brexit or the relocation of the ema to amsterdam, it ‘could not (whatever the consequences) amount to an event capable of frustrating the lease’.47 the high court has partly followed the canary wharf’s arguments and found that the lease has not been frustrated by reason of supervening illegality. moreover, it concluded that the withdrawal of the united kingdom from the european union was on, the relevant date, 5 august 2011, theoretically foreseeable but not relevantly foreseeable when the agreements were entered into.48however, high court also found that “over this long period of time, there might be some development that would require the ema involuntarily to have to leave the premises due to circumstances beyond its control.”49 hence, if the contractual provisions of the lease agreement would be drafted in a different way, then withdrawal of the united kingdom from the eu might be regarded as an event capable of frustrating the agreements. 3.1. the doctrine of frustration of purpose under english common law in making his judgment, mr. justice marcus smith pointed to the most relevant precedent in english common law pertaining to the doctrine of frustration of purpose and generally argued that the arguments of the ema were unpersuasive. he points to three formulations for the test in applying the doctrine of frustration. the first formulation is that of lord radcliffe in the davis contractors 46 in canary wharf ⦋2019⦌ ewhc 335 (ch) at ⦋7⦌. 47 in canary wharf ⦋2019⦌ ewhc 335 (ch) at ⦋8⦌. 48 this highlights the importance of timing concerning the doctrine of frustration; in canary wharf ⦋2019⦌ ewhc 335 (ch) at ⦋216⦌. 49 “what is more, the parties appear to have catered for this possibility in the lease agreement: the lease contemplated the ema would be committed to the premises subject only to the alienations provisions of the lease agreement; in canary wharf ⦋2019⦌ ewhc 335 (ch) at ⦋226⦌. in other words, “whilst the united kingdom’s withdrawal from the european union was not contemplated by the parties as a potential cause of the ema’s relocation, the question of wholesale relocation of the ema away from the premises and the property (whether within or outside the united kingdom) was contemplated and was provided for in the lease;” in canary wharf ⦋2019⦌ ewhc 335 (ch) at ⦋239⦌. njcl 2022/1 17 ltd v fareham udc case50, which held that the doctrine of frustration can be applied when, 1) ‘the law recognises that without default or either party’, 2) ‘the contractual obligation has become incapable of being performed’ 3) due to circumstances where performance would result in something ‘radically different from that which was’ contracted over.51 the second formulation considered is the one of lord simon from the national carriers ltd v panalpina (northern) ltd.52 under lord simon’s test, the doctrine of frustration applies when: 1) there are supervening events, 2) ‘without default of either party’, 3) the contract fails to make sufficient provisions for, 4) and which ‘significantly changes the nature (not merely the expense or onerousness) of the outstanding contractual rights’, 5) which the parties would reasonably not have contemplated at the time of entering the contract, and 6) it would be unjust to enforce the contract literally under the current circumstances.53 finally, the third formulation considers the maxims of the doctrine of frustration which must be addressed according to bingham lj in the j lauritzen as v wijsmuller bv (the super servant two).54 under the bingham lj criteria; 1) the doctrine of frustration is designed to ‘mitigate the rigor of the common law’s insistence on literal performance’ of contracts in order to ‘give effect to the demands of justice’, to find an equitable outcome, to achieve what is ‘reasonable and fair’, in order to expedite the administration of justice and avoid injustice which would result of literal enforcement under changed circumstances; 2) ‘must not be lightly invoked and must be kept within narrow limits’ due to the contract being fully discharged under the doctrine; 3) has the effect of ending the contract; 4) must not be due to the action of the party seeking to invoke the doctrine, and; 5) the ‘frustrating event must take place without blame or fault’ of either party involved.55 considering the previous juridical basis for the doctrine of frustration, the high court in canary wharf found that the ‘performance rendered radically different by fundamental change in circumstances’ approach as the ‘best’ of the theories to use.56 50 [1956]1 ac 696 at 729. 51 canary wharf ⦋2019⦌ ewhc 335 (ch) at ⦋22⦌. 52 [1981] 1 ac 675 at 700. 53 [1981] 1 ac 675 at 688 (lord hailsham lc), at 717 (lord roskill). 54 [1990] 1 lloyd’s rep. 1. 55[1990] 1 lloyd’s rep. 1.; investors compensation scheme ltd v west bromwich building society [1998] 1 wlr 896 at 912-13 (lord hoffmann); prenn v simmonds [1971] 1 wlr. 1381 (hl); and reardon smith line ltd v yngvar hansen-tangen [1976] 1 wlr 989 (hl). 56 under this approach, ‘whether a contract is frustrated depends upon a consideration of the nature of the bargain of the parties when considered in the light of the supervening frustration of purpose 18 3.2. the doctrine of frustration and contractual construction the high court in canary wharf suggests that in the vast majority of cases, the 'construction of the contract will resolve the issue between the parties, including whether a subsequent ‘unforeseen’ event has allocated a risk to one party (by requiring that party to perform in more onerous circumstances) or to the other party (by an interpretation bringing the contract to an end because of those onerous circumstances).’57 furthermore, the judgement considers the ‘multi-factorial approach’ delineated in edwinton commercial corp v tsavliris russ (worldwide salvage & towage) ltd (the sea angel) by rix lj,58. this multifactorial approach takes into account several factors, including ‘the terms of the contract itself, its matrix or context, the parties’ knowledge expectations, assumptions, and contemplations, in particular as to risk, as at the time of the contracts, at any rate so far as these can be ascribed mutually and objectively, and then the nature of the supervening event, and the parties’ reasonable and objectively ascertainable calculations as to the possibilities of future performance in the new circumstances’.59 the multifactorial approach identifies that both the knowledge and contemplation of risk between the parties and the contemplation of possible future must be considered when applying the doctrine of frustration. these two factors have an inherent economic attribute which law and economics methodologies are uniquely qualified to incorporate to the doctrine of frustration, and are addressed in our conceptual framework. 3.3. comment on the canary wharf case comparison with the criteria for the frustration excuse found in the english common law reveals a surprisingly substantive alignment. namely, event said to frustrate that bargain’ and ‘[o]nly if the intervening event renders the performance of the bargain ‘radically different’, when compared to the considerations in play at the conclusion of the contracts, will the contract be frustrated;’ in canary wharf ⦋2019⦌ ewhc 335 (ch) at ⦋27⦌. on the role of precedents in the construction of contractual terms see, e.g., j w carter, john eldridge and elizabeth peden, ‘the role of precedent in the construction and implication of terms in contracts’ (2021) 37 jcl 1. 57in the view of mr. justice marcus smith ‘when one seeks to describe what a party promised, one does not recite the individual terms and conditions, but has regard to something much more elemental, that cannot necessarily be captured in the precise terms used by the parties in their contract, but which requires reference to what i will term the parties’ ‘common purpose’; in canary wharf ⦋2019⦌ ewhc 335 (ch) at ⦋29⦌. 58 [2007] 2 lloyd’s rep 517; [2007] ewca civ 547 (edwinton). 59 in canary wharf ⦋2019⦌ ewhc 335 (ch) at ⦋39⦌, quoting edwinton [2007] 2 lloyd’s rep 517; [2007] ewca civ 547. njcl 2022/1 19 english law in the first stage of a 'frustration inquiry’ investigates whether the frustrating event is covered by a term of the contract,60 was not selfinduced (endogenous), and was not covered by well-established rules of the law.61 namely, the traditional general rule is that an event cannot normally amount to frustration if the contract terms cover it.62 moreover, an event cannot be treated as frustrating a contract if it was foreseen or foreseeable at the moment of the formation of the contract, and therefore within the contemplating scope of the parties.63 thus, a party cannot treat as a frustrating event a risk which could have been foreseen and against which provision could have been made.64 however, it should be emphasized that, as mckendrick points out, english jurisprudence has an apparent difficulty with this formula, namely identifying what is and what is not foreseeable at the moment of entry into the contract.65 bell argues that the doctrine of frustration applies when it would not be reasonable to have expected the parties to have made specific provision for a risk or treated it as an ordinary risk they expected to have materialized.66 however, mckendrick argues that the question of how foreseeable an event has to be before it prevents reliance being placed upon the doctrine of frustration is one of degree.67 on the other hand, beatson argues that 60 a burrows, a casebook on contract, 5th ed., hart publishing, cambridge, 2016, p 731; p a mcdermott, contract law, butterworths, london, 2001, p 1021. see also e mckendrick, force majeure and frustration of contract, 2nd ed., routledge, london, 2014, p 7; and j h baker, ‘frustration and unjust enrichment’ (1979) 38 clj 266. 61 a burrows, a restatement of the english law of contract, oxford university press, oxford, 2016, p 164; e mckendrick, contract law: text, cases and materials, 7th ed., oxford university press, oxford, 2016, p 849; j bell, ‘the effect of changes in circumstances on long-term contracts’ in d harris and d tallon, eds., contract law today, anglo-french comparisons, clarendon press, oxford, 1989, p 208. see also m h whincup, contract law and practice, 3rd ed., kluwer law international, new york, 1996; s a smith, atiyah’s introduction to the law of contract, clarendon press, oxford, 2005, p 182; r upex and g bennett, davies on contract, 9th ed., sweet & maxwell, london, 2004, p 256; j w carter, carter’s breach of contract, 2nd ed, lexisnexis, sidney, 2018; j w carter, contract law in australia, 7th ed, lexisnexis, sidney, 2018; and j beatson, anson’s law of contract, 29th ed., oxford university press, oxford, 2006, p 530. 62 mcdermott, above, n 59, at 1021. 63 bell, above, n 60, at 208. see generally c g hall, ‘frustration and the question of foresight’ (1984) 4 ls 300. 64 g h treitel, frustration and force majeure, sweet & maxwell, london, 1994, p 466. 65 mckendrick, above, n 59, at 862. 66 bell, above, n 60, at 208. 67 mckendrick illustrates this with an example of an earthquake which is foreseeable since we are all aware they may take place. but in some parts of the world, they are more foreseeable than in others: mckendrick, above, n 59, at 862. frustration of purpose 20 this is just a question of contract construction.68 in mcguill v aer lingus & united airlines inc.,69 mcwilliam j., for example, spoke in terms of an unexpected event and held that if a party anticipated or should have anticipated the possibility of an event, he should not be permitted to rely on the happening of the event as causing frustration.70 in the ocean tramp tankers corp v v/o sovfrach,71 lord denning mr suggests that the requirement that the event should not have been foreseen essentially means that the parties should not have made a provision for it in the contract. he states: it has frequently been said that the doctrine of frustration only applies when the new situation is ‘unforeseen’ or ‘unexpected’ or ‘uncontemplated,’ as if that were the essential feature. but it is not. it is not so much that it is ‘unexpected,’ but rather that the parties should have made no provision for it in their contract.’72 insightfully, comparison with our conceptual framework, despite invoked criticism,73 reveals that lord denning's criteria correspond with an economically inspired foreseeability threshold. one should also note that it is correctly made in the first steps of the inquiry. it is also well established that a party may not rely on an event as frustrating the contract if it is due to his own conduct or to the conduct of those for whom he is responsible (self-induced).74 in order to raise a plea of frustration, it is essential that the event is outside the control of either party, with no fault of any kind; even negligence would suffice.75 however, one may wonder whether the fulfilment of these preconditions should automatically trigger the employment of the frustration doctrine. we argue that after this first stage of inquiry, one has to turn the analytical attention towards the problem of increased or decreased performance cost. this issue of the increased-decreased costs of performance forms the second part of our novel conceptual framework,76 to which we devote our attention in the following subsections. 68 whether the contract was intended to continue to be binding in that event or whether, in the absence of any express provision, the issue has been left open and thus allowed to be determined by the law of frustration: beatson, above, n 60, at 548. 69 (1983) iehc 71; quoted in mcdermott, above, n 60, at 1020. 70 mcdermott, above, n 60, at 1020. 71 (1964) 1 all er 161. 72 (1964) 1 all er 161 at 166. 73 treitel, above, n 63, at 468. 74 treitel, above, n 63, at 682 et seq. see also mckendrick, above, n 59, at 866; beatson, above, n 59, at 550; smith, above, n 59, at 186; and whincup, above, n 59, at 266. 75 mcdermott, above, n 60, at 1024. see also bell, above, n 59, at 209. 76 it should also form the second stage of frustration’s investigation, njcl 2022/1 21 the issue of whether brexit should be regarded as an unforeseeable event depends upon the facts of each case and should be assessed on a case-by-case basis. the proposed foreseeability threshold should serve as an additional tool and a substantive guideline for an optimal judicial application and interpretation of individually assessed cases. moreover, the ex ante parties’ contracting efforts (balancing marginal benefits and costs) would depend on how courts interpret missing and vague terms. as hermalin, katz and craswell point out, the question of how the courts enforce incomplete contracts is essential to an analysis of the effort that parties should make to provide for contingencies in question.77 thus, the proposed conceptual framework, which provides courts with economically inspired criteria of whether an event should be ex post regarded as foreseeable or unforeseeable, is designed to incentivize the parties' efficient ex ante contracting efforts. notably, the proposed conceptual framework offers valuable insights into how courts should interpret some contingencies and what remedies should apply to achieve ex post efficient allocation of risks and resources.78 hence, processing trade-offs only implies there are some contingencies, in which expected benefits, due to low materialization probability, do not justify drafting expenditure, are ex ante efficient for the parties to ignore. for example, this also provides an additional insight as to why a brexit before 2010 might indeed be regarded as an ex ante unforeseeable event.79 summarizing our conceptual framework, we can see that the high court emphasizes that foreseeability is merely one of the factors to be considered. their ruling is also in line with the proposed conceptual framework. the first stage of their inquiry determined that the withdrawal of the united kingdom from the eu was not relevantly foreseeable when the agreements were entered into and that it was only later than 2011 that 77 b e hermalin, a w katz and r craswell, ‘the law and economics of contracts,’ in m a polinsky and s shavell, eds, the handbook of law and economics, north-holland, amsterdam, 2008, p 95. 78 on the direct and indirect effects of the correct interpretation, and on the evaluation of contract interpretation, see shavell, above, n 19, at 301. 79 at this point, one should also discuss the problems of verifiability and informational asymmetry of contracting, which may lead to distortions in the written contract. as to the latter, spier points out that those asymmetries may well lead to contractual incompleteness; kathryn e spier, ‘incomplete contracts and signalling’ (1992) 23 rand j econ 432. however, this does not in any way hinder our definition of unforeseeable events; the parties still make an ex ante perfectly rational, efficient decision when deciding not to provide for those contingencies. it merely stresses the imperfect information problem and the fact that contracts are necessarily imperfect. frustration of purpose 22 the withdrawal of the uk from the eu could have been foreseeable.80 as to the issue of foreseeability, mr. justice marcus smith insightfully comments: ‘there will, no doubt, be many cases where something can be foreseen as a theoretical possibility, but where neither party can be criticised for failing to take it into account’.81 rather, as he comments in footnotes, ‘relevantly foreseeable’ means ‘sufficiently foreseeable that a court could draw the sort of inference’ and ‘that it should have informed the manner in which the parties framed their agreement’.82 this categorization of foreseeability is perhaps intentionally open to interpretation,83 though its ratio is aligned with the proposed conceptual framework. however, the employed approach on questions of foreseeability leaves room for future judicial review of questions concerning the nature of brexit in terms of foreseeability when applied to contracts that were entered into prior to the brexit vote. nevertheless, the failure of parties’ post-referendum to renegotiate their contracts entered before the brexit vote in order to consider the outcome of the brexit vote may also be a relevant factor to consider. after all, the judgment identifies how ‘the failure of the parties to a contract, post-referendum, to consider the inclusion of a ‘brexit clause’, might be considered relevant to the allocation of risk’.84 suppose the court can infer the intentions of parties as to the allocation of risk from a failure to include a ‘brexit clause’ in contracts entered into post-referendum. in that case, a court may perhaps be equally capable of inferring the parties' intentions as to the allocation of risk in pre-brexit contracts where the parties do not renegotiate post-referendum to account for risk emanating from brexit. in many instances, if not most, the parties to contracts are capable of further contracting over ‘brexit’ post-referendum. this fact may also be relevant as to the doctrine of frustration concerning the parties’ actions which contribute to the intervening event in question, especially in light 80 ‘…no inference from the parties failure to’ address the possibility in the contract can be drawn; in canary wharf ⦋2019⦌ ewhc 335 (ch) at ⦋216⦌. 81 in canary wharf ⦋2019⦌ ewhc 335 (ch) at ⦋211⦌. 82 in canary wharf ⦋2019⦌ ewhc 335 (ch) at ⦋211⦌. 83 after all, mr. justice marcus smith characterizes foreseeability as ‘something of a slippery concept, that needs careful handling;’ canary wharf (2019) ewhc 335 (ch) at ⦋213⦌. mr. justice marcus smith cautions courts from ‘framing questions of foreseeability too closely to the exact, specific, nature of the supervening event that ultimately occurred’ as ‘what the ‘frustrating event is…will in most cases, be capable of being framed in a number of ways;’ in canary wharf ⦋2019⦌ ewhc 335 (ch) at ⦋212⦌. 84 in canary wharf ⦋2019⦌ ewhc 335 (ch) at ⦋215⦌. njcl 2022/1 23 of this ruling, which identifies the problem of framing within the doctrine of frustration. could the counter party’s unwillingness to renegotiate when approached for renegotiation by the counterparty be framed as the supervening event, as according to mr. justice marcus smith, ‘[i]t might equally be said that the change in circumstances is the ema’s involuntary need to leave the premises due to the circumstances beyond its control’? indeed, one party cannot be said to have control over the other party if the contracts were entered into at arm's length and absent some other type of power, economic or otherwise, one party has over the other. 3.3.1. explicit risk allocation, superior risk bearer, and supervening illegality the four corners of the contract contain the information which the high court identifies as getting to the heart of the question over frustration. namely, in line with our conceptual framework, the judgment in the next stage of inquiry addresses the issue of supervening illegality and correctly concludes that there is no supervening illegality. furthermore, the judgment also addresses the question of explicit risk allocation and superior risk bearer capacity. according to the high court, ‘the involuntary departure of the ema from its headquarters in the premises, due to the circumstances beyond its control was something whichon the face of itthe lease expressly provided for’ and the contracts alienation ‘provisions draw no distinction between the reasons why the ema might abandon its headquarters’ but rather ‘simply deal with the fact’ of the ema leaving the premises at for seemingly any reason, including brexit.85 the judgment further finds there was ‘no common purpose beyond the purpose to be derived from a construction of the lease’ as ‘[t]here was no common view or expectation between the parties that the risk of the consequences of the ema abandoning its headquarters should be differently visited according to the reason for the ema’s departure’.86 the high court’s determination addresses how the contract directly addressed with specificity the allocation of risk related to the ema no longer occupying the premises and the future relationship between the ema and canary wharf ltd. in the event of the ema no longer occupying the leased property.87 moreover, the contract did not contain a 85 in canary wharf ⦋2019⦌ ewhc 335 (ch) at ⦋241⦌. 86 in canary wharf ⦋2019⦌ ewhc 335 (ch) at ⦋244⦌. 87 the court's decision is in line with the conceptual framework in that, although the brexit was out of the contemplating scope of both parties (and hence unforeseeable), the risk of involuntary departure of ema from its headquarters, due to circumstances frustration of purpose 24 specific break clause, which analytically allocates the risk of a change upon ema as a superior risk bearer.88 in addition, canary wharf did obtain insurance against non-payment of rent in the event that ema would be entitled to cease to pay the rent, and such an insurance policy suggests, as correctly stated by his justice, the risk of uncertain future events leading to the ema no longer occupying the premises had been allocated by parties in the agreement. saying all that, it is evident that the first part of the court’s judgment addresses all the necessary first steps suggested by our conceptual framework. 3.3.2. onerous performance costs, excuse and divestiture insightfully, the high court also embarks on the second stage of the proposed inquiry and investigates the issue of whether the materialization of brexit increased the costs of performance to such a level that performance would become excessively onerous. the decision correctly observes that ema would incur additional costs, but this increase was not a dramatic one, rendering performance excessively onerous or impossible. instead, as the facts of the case suggest, the performance became merely more onerous. the reasoning is in line with our conceptual framework that no excuse should be granted.89 moreover, ema could completely divest itself of the premises through assignment or sub-letting of the whole of the premises.90 this implies the onerous cost of performance could be decreased unilaterally by the ema’s divestiture, and the lack of such a divestiture leading to increased cost has been endogenously, at least in part, caused by ema’s inaction.91 beyond its control was expressly provided for and allocated upon ema; in canary wharf ⦋2019⦌ ewhc 335 (ch) at ⦋241⦌. 88 the absence of a break clause suggests the risk of a change over a 25-year lease duration has been allocated upon ema, and the parties allocated such risk by contemplating that ema would be committed to the premises subject only to the alienation provision of their contract. 89 recall that in cases of frustrating events resulting in a slight increase in performance costs, courts should not grant any relief and enforce such contracts. moreover, courts should not discharge such contracts even if the contingency satisfied all previously discussed conditions of exogeneity, superior risk bearer capacity, unforeseeability, nonassignment of risks, and non-aleatory character of contract (above, text at n 14 ff). 90 such option was expressly provided by the lease agreement between canary wharf ltd. and ema; in canary wharf ⦋2019⦌ ewhc 335 (ch) at ⦋239⦌. 91 as established by mr. justice marcus smith, the parties agreed precisely what would happen in such a case: the ema would assign the lease or sub-let the whole. if it could neither assign nor sublet the whole according to the terms of the lease, it would retain the premises and would be obliged to pay the rent; in canary wharf ⦋2019⦌ ewhc 335 (ch) at ⦋239⦌. such express provision should be analytically regarded as an explicit risk njcl 2022/1 25 the ruling of the high court is proper to the maxims which the common law requires from questions concerning the doctrine of frustration. it is kept within very narrow limits, but it also aligns with the proposed conceptual framework. there is no doubt that many subsequent cases concerning brexit and the doctrine of frustration will be substantially different in terms of the four corners of the parties' contracts and will pose a substantially different ‘matrix of fact’ for the court to consider. moreover, economically informed discussion suggests that it might be very likely that the english courts will continue to find ways to resolve similar disputes over who bears the risk via interpretation of the contract (as high court ultimately did) rather than via the doctrine of frustration. namely, underlying mechanisms of economic efficiency,92 ex ante incompleteness of frustration doctrine, and ex post superior availability of information advances an interpretation of the contract to common law judges as a more attractive, pragmatic, and economically more effective tool to resolve such disputes.93 finally, it has to be emphasized that most of the disputes where brexit might be invoked as a frustrating event might primarily be about increased costs (i.e., tariffs, non-tariff barriers) and thus analytically much more straightforward than the canary wharf case, where the status of the ema indeed raised several political and constitutional-type considerations that would not ordinarily arise in standard commercial contracts. 4. the implications of risk preferences on foreseeability, frustration, and the covid-19 pandemic presumably, prior to the june 2016 brexit vote, some contracting parties with profoundly analytical foresight envisioned that brexit could occur in the future, and they contracted over the prospect of brexit.94 allocation upon ema of instances where the premises cease to be the ema's headquarters. such an explicit risk allocation implies that a contract should not be discharged, and such an event should not be regarded as a frustrating event. 92 on the common law efficiency hypothesis, see isaac ehrlich and r a posner, ‘an economic analysis of legal rulemaking’ (1974) 3 j leg stud 257; and p h rubin, ‘why is the common law efficient?’ (1977) 6 j leg stud 51. 93 see, e.g., r a posner, ‘what do judges and justices maximize?’ (1994) 3 scer 1; and g l priest, ‘the common law process and the selection of efficient rules’ (1977) 6 j leg stud 65. 94 when considering the foreseeability of the brexit by the ema and canary wharf when they entered into a lease contract, mr. justice marcus smith comments that ‘as at the relevant date, 5 august 2011, i conclude that the withdrawal of the united kingdom from the european union was foreseeable as a theoretical possibility, but that i can draw no inference from the parties’ failure to cater for this specific possibility in the lease. frustration of purpose 26 many, if not most, parties were not so visionary and did not include a brexit clause in their contracts prior to the brexit vote.95 the high court comments that ‘the failure of the parties to a contract, post-referendum, to consider the inclusion of a ‘brexit clause’, might be considered relevant to the allocation of risk.’96 this highlights a significant difference between force majeure, mcs clauses, and brexit clauses, as a more specific and foreseeable event needs to be addressed explicitly in the contract. thus, in the instance that a specific contract lacks a brexit clause, and the parties would like to be discharged from their obligation, courts should be reluctant to grant it and should regard such an event (in the absence of specific provision) as a foreseeable one for parties to contracts entered into post brexit referendum.97 moreover, if one compares the covid-19 pandemic with brexit, then covid-19 pandemic was initially an unforeseen event, but soon after first cases appeared, it became a foreseeable one. both brexit and the covid-19 pandemic are identical in nature – i.e., unforeseen at a particular stage but foreseeable at a later stage. 4.1. risk preferences and uncertainty the behavioural law and economic literature98 offers examples of these days, and for the last two or so years, parties to contracts have no doubt been considering with some care what their contracts should say as regards the united kingdom’s withdrawal from the european union.’ however, mr. justice marcus smith ultimately determined ‘the withdrawal of the united kingdom from the european union was not relevantly foreseeable when the agreements were entered into;’ canary wharf (2019) 2 wluk 275; ⦋2019⦌ ewhc 335 (ch) at ⦋215⦌. 95 less visionary parties may have still considered unforeseen circumstances in their contracts, which, if worded sufficiently, could include the unique circumstance of the brexit, using mcs or force majeure clauses, or other contractual terms which allocate for risk among the parties. for contracts entered into after the vote, brexit was sufficiently foreseeable, and contracting parties could no longer rely on vague and broadly worded mcs or force majeure clauses to include it. 96 in canary wharf ⦋2019⦌ ewhc 335 (ch) at ⦋216⦌. 97 a survey of daily business contracting also reveals that law firms tend to advise their clients that some standard provisions should also be included in a commercial contract which could help if a brexit-related risk materializes and affects the contract adversely. these standard provisions include a force majeure clause, material adverse change clause, compliance with the law clause, hardship clause, change control clause, and a unilateral termination clause. thus, lawyers drafting contracts for firms conducting business across borders in different jurisdictions have found new ways to address these risks in their contracts using the so-called ‘quitaly’ or ‘brexit’ clauses. 98 for an excellent synthesis on the behavioural scholarship, see, for example, c r sunstein, behavioural law and economics, cambridge university press, cambridge, 2000. see also h a simon, models of thought, yale university press, new haven, 1979; h a njcl 2022/1 27 how risk-averse individuals are willing to take a certain loss in the face of potentially ruinous loss.99 while firms are not individuals, many of the parties who have renegotiated their existing contracts to include some form of brexit clause have done so in order to mitigate what they perceive as an unknown and potentially significant risk. the uncertainty likely means that, no matter what happens in the future of the brexit, some contracts will be brought before courts for interpretation either due to a failure to renegotiate (which high court alluded to)100 or because of renegotiation. because of the risk preference of one of the parties, some contracts which will be frustrated by brexit have not been renegotiated, and some contracts which will not be frustrated by brexit have been renegotiated. if the default rules are inadequate, then the recent efforts in private law to renegotiate existing contracts not only reflect those contracts with a duty to renegotiate but also reflect the risk preference of contracting parties who, having no duty to renegotiate, are unsatisfied with how current default rules assuages their worries about the court's inadequacy. because of the different approaches toward the duty to renegotiate in contract laws across the globe, one might expect to see divergent judicial rulings concerning factually similar disputes.101 a divergence of approaches across states may lead to a suboptimal reallocation of risks when there is an opportunity to renegotiate.102 moreover, in relation to the simon, models of bounded rationality, mit press, cambridge, 1982; daniel kahneman and amos tversky, ‘prospect theory: an analysis of decisions under risk’ (1979) 47 econometrica 263; richard thaler, ‘toward a positive theory of consumer choice’ (1980) 1 j econ behav organ 39. 99 according to guthrie ‘prospect theory predicts that people generally make risk-averse decisions when choosing between options that appear to be gains and risk-seeking decisions when choosing between options that appear to be losses’, since ‘people are often willing to take risks to avoid losses but are unwilling to take risks to accumulate gains;’ chris guthrie, ‘prospect theory, risk preference, and the law’ (2002) 97 nw u l rev 3, p 1115-1164, at 1116. 100 in canary wharf ⦋2019⦌ ewhc 335 (ch) at ⦋216⦌. 101 see, e.g., a o sykes, ‘economic ‘necessity’ in international law’ (2017) 109 am j int l 296. 102 for example, the new article 1195 of the french code civil lacks any operational definition of ‘unforeseeable circumstances’, and the current definition depends on what the law tells parties that is unforeseeable (tautology). parties may reasonably expect that the law is applied, and therefore the law has to better define ‘unforeseeable circumstances.’ moreover, there is no explanation of whether these circumstances must be outside of the parties' control. the exogeneity of an event should be, as we argue, besides the unforeseeability, verifiability, and superior risk bearer (prevention, insurance) capacity, considered as a necessary condition of any provision on change circumstances. furthermore, there is no requirement that an adaptation or discharge of a contract is not frustration of purpose 28 application of art 79(1) of the cisg103 where the cisg governs a contract, brexit might or might not be (i.e., factual analysis) regarded as an impediment beyond parties' control. the precise operation of art 79(1) of the cisg is uncertain, due to its shortcomings and vague criteria. 104 4.2. the covid-19 pandemic and frustration of purpose although the impact of the canary wharf case might be limited in its application to future disputes involving brexit, its impact upon covid19 related cases might be substantial. from the face of it, the judgment resolves the dispute without having to rule on what the impact of brexit is on the doctrine of frustration of purpose for subsequent cases by finding a solution to the dispute within the four corners of the agreement under the existing terms and existing rules of contractual interpretation. the past and present uncertainty over the efficiency or application of default rules may result in an overinvestment in renegotiating existing contracts which will not materially benefit from renegotiation to reflect the risks of brexit or covid-19, and an underinvestment in renegotiation when contracting parties fail to appreciate the inadequacy of current default rules given the specific risk inherent in their existing contracts. if it is uncertain how courts will apply existing default rules, then contracting possible if the contractual relationship was an aleatory one, if the risk in question was assigned expressly by the parties' agreement or by well-established rules of law, if the event was foreseeable, endogenous, preventable, or insurable. there is also no guidance as to when performance should be considered as ‘excessively onerous.’ another drawback of the french law in relation to english and german approaches is the absence of any clear hierarchy between adaptation and discharge. if the adaptation would be regarded (as in the german jurisprudence) as the first remedy and the discharge as merely a secondary option, then it should be criticized as a source of potential inefficiencies. last but not least, the ‘renegotiation’ requirement in article 1195 might induce opportunism, hold up problems, and moral hazard. thus, it is not so difficult to contemplate a scenario where there are excessive levels of renegotiation under a french rule, especially when there is uncertainty over if the change circumstances caused by brexit will result in an excessively onerous performance and contracting parties are riskaverse. 103 article 79 (1) cisg provides: a party is not liable for a failure to perform any of his obligations if he proves that the failure was due to an impediment beyond his control and that he could not reasonably be expected to have taken the impediment into account at the time of the conclusion of the contract or to have avoided or overcome it or its consequences; united nations convention on contracts for the international sale of goods, united nations commission on international trade law, united nations, new york, 2010. 104 namely, article 79(1) cisg lacks an operational definition of an ‘impediment beyond control,’ and lacks any guidance as to when performance should be considered as excessively onerous or commercially impracticable; above, n 103. njcl 2022/1 29 parties may want to consider this uncertainty in their contracts. the canary wharf ruling only mitigated some of the uncertainty which contracting parties must deal with. the remaining uncertainty must still be addressed. while the high court identifies how a failure to renegotiate a contract to reflect the risk of brexit may indicate the party’s intention to allocate brexit risks, the impact of canary wharf ruling on the risk attitudes of contracting parties concerning covid-19 may be reflected in the party's willingness to enter into an efficient renegotiation of existing contracts or willingness to refrain from entering into inefficient renegotiations. however, if renegotiation is only possible when bilaterally agreed upon, the failure of parties to renegotiate might only reflect the risk preference of one of the parties, and additional factors may need to be considered by judges in their effort to efficiently allocate risk into the contract. these efforts must also takes into account the possibility of moral hazard on the part of parties seeking to induce a breach through refusal to renegotiate.105 moreover, the proposed economically inspired conceptual framework and its stages of inquiry offer valuable insights into how courts should interpret the covid-19 pandemic and how courts in the uk106 could approach contractual claims that attempt to rely on frustration, as well as what remedies they should apply in order to achieve efficient allocation of risks and resources ex post. as emphasized, processing tradeoff implies that, given the nature of lockdowns, closed borders, and governments edicts, covid-19 might be regarded as a contingency in which expected benefits, due to low materialization probability, do not justify drafting expenditure, are ex ante efficient for the parties to ignore.107 this also provides an additional insight as to why covid-19 before february 2020, when the bergamo outbreak happened, might indeed be regarded as an ex ante unforeseeable event.108 moreover, after addressing the issue of foreseeability (and other preliminary inquiries), courts should 105 in this regard, it is crucial to identify the possibility that a party who is unwilling to renegotiate, even when faced with the knowledge of the risk of brexit, is doing so in order to behave strategically or opportunistically in order to take advantage of the changed circumstances, and may unilaterally frustrate the possibility for efficient renegotiations which reflect the risk of brexit. 106 including courts around the world and in common law jurisdictions such as singapore, the us, canada, and australia. 107 recall that if the substance of the contract became due to governmental lockdowns, edicts, closed borders illegal (i.e., legally impossible to perform), then efficiency requires a discharge of such contract. 108 after that outbreak in italy and super-fast transmission across europe, the covid-19 pandemic could no longer be regarded as an unforeseeable event. frustration of purpose 30 then embark on the second stage of the proposed inquiry and investigate the issue of whether the materialization of covid-19 increased the costs of performance to such a level that performance would become excessively onerous. hence, the issue of whether covid-19 should be regarded as a frustrating event depends upon the facts (time sequence and increased costs) of each case and should be assessed on a case-by-case basis. as shown, english courts will likely continue to find ways to resolve covid-19 related disputes over who bears the risk via interpretation of contract rather than via vague doctrine of frustration. although uk and us cases as not interchangeable, one may note that in a recent opinion, massachusetts superior court judge kenneth salinger, for example, ruled that a retail tenant (operating a café/coffee establishment) was excused from paying rent while indoor dining was paused under a state-wide executive order to halt the spread of covid19.109 moreover, in salam air saoc v latam airlines group plc110 the court is in line with the proposed economic framework, finding that due to the explicit allocation of risk, the obligation to pay rent was “absolute and unconditional irrespective of any contingency whatsoever.”111 to our knowledge, these were some of the first cases since the commencement of the covid-19 crisis where a court in line with the proposed conceptual framework actually excused the payment of rent (i.e., excessively onerous costs of performance) due to the doctrine of frustration of purpose.112 however, it has to be emphasized that, in instances where the covid-19 pandemic induced merely a modest increase in the costs of performance, courts have, in line with discussed economic principles, held that the frustration of purpose doctrine was not applicable.113 109 ‘under the doctrine of frustration of purpose, caffé nero’s obligation to pay rent was discharged while it was barred from letting customers drink or eat inside the leased premises, at least from march 24 to june 22, 2020;’ umnv 205–207 newbury llc v caffe nero americas inc. ⦋2020⦌ 2084cv01493-bls2 (mass. superior ct.). see also simon property group l.p. v pacific sunwear stores llc (2020) wl 5984297 (ind. super.)(trial order)). 110 salam air saoc v latam airlines group plc [2020] ewhc 2414 (comm). 111 see also wilmington trust sp services (dublin) ltd v spicejet ltd [2021] ewhc 1117 (comm); bank of new york v cine-uk ltd [2021] ewhc 1013 (qb); commerz real investmentgesellschaft mbh v tfs stores ltd. [2021] ewhc 863 (ch) and tkc london limited v allianz insurance plc [2020] ewhc 2710 (comm). 112 of course, as of speaking, it is unclear whether the court’s ruling will be appealed and whether or not other courts will follow judge salinger’s lead. 113 the reduction of foot traffic to the louboutin store, due to an unforeseen economic force, does not permit a court to “simply rip up a contract signed between two sophisticated parties;” 35 east 75th street corporation v christian louboutin llc (2020) wl 7315470 (n.y. sup.). likewise, the court also held that the impossibility defense is not njcl 2022/1 31 5. conclusions business lawyers and commercial contracting have been stressed by political and medical uncertainty over the past several years. brexit and the covid-19 pandemic pose several challenges for those who advise commercial practices. the withdrawal of the uk from the eu, as well as the covid-19 pandemic, creates several questions, some involving novel legal dilemmas, which legal scholarship, practitioners, and lawmakers must consider. this paper contributes to this extensive scholarly debate on whether the brexit and the covid-19 pandemic constitutes a frustration of purpose event in contracts by exploiting the findings of the economic literature on the consequences of supervening events. as argued, the problem of unforeseen contingencies should be seen as an ex post efficiency-enhancing, welfare-maximizing, and risk-sharing problem. while discussing this risk-sharing mechanism, an additional set of criteria for applying the optimal excuse rule has been offered. thus, as argued, wealth-maximization requires granting to the third party (judge), under severe preconditions, the power to discharge or enforce a contract in case of excessively onerous performance. focusing, instead of on ex ante, on ex post allocation of risks and resources is the preferable option. once remote risks materialize and render performance excessively onerous, the court is in the second-best position to discharge the performance of the contract to relieve the contracting parties from ruinous, unexpected losses that they never accepted or provided for in the contract. furthermore, according to the provided model, all the incentives would be preserved undistorted, opportunistic behaviour would be deterred, transaction costs would be saved, and welfare maximization would be achieved. in addition, legal certainty, contracting, cooperation, and relation-specific investments would be enhanced. gambling on future, supervening, unforeseen, disastrous losses is (leaving purely aleatory contracts aside) beyond a realistic scenario for the behaviour of rational, self-interested, risk-averse, and wealth maximizing parties. the assessed judgments correspond to the proposed economic framework. it is also evident that the first part of the high court’s judgment in the canary wharf case addresses all the necessary first steps suggested by proposed conceptual framework. moreover, addressed decisions can be seen as judgments representing an efficiency-minded approach, which leads to the enforcement of contracts that have applicable as the store is still intact and it is still permitted to sell its products. see also cab bedford llc v. equinox bedford ave inc. (2020) wl 7629593 (n.y. sup.); and 1140 broadway llc v bold food llc (2020) n.y. slip. op. 340178(u) (n.y. sup. ct.). frustration of purpose 32 contemplated the risks and remedies for a breach due to the brexit or any other contemplated, even if imprecisely, event (i.e., covid-19). the analysed cases also show that we are witnessing a skilful judicial approach to the problem, which, if followed in other european jurisdictions, may tend to decrease the risk of uncertain application of default rules across europe. moreover, recent cases show that the common law judiciary might be perfectly capable of dealing with brexit’s and covid-19 risks and that we are not dealing with an emergence of a new legal paradigm but rather an encyclopaedical, practitioner’s way to decrease the risk of uncertain application of default rules. 4 macchiavello the challenges awaiting the european crowdfunding services providers regulation: ready for launch? eugenia macchiavello* * assistant professor in economic law, university of genoa department of law; jean monnet centre of excellence on sustainable finance (eusfil) njcl 2022/2 91 1. introduction: the resilience of the ecspr: the analysis of the new regulation’s potential in facing with current opposing forces ............................................................. 92 2. the first opponent: residual fragmentation and uncertainty ....................................................................................... 94 2.1. explicit or implicit exclusions from the ecspr’s scope ........................................................................................... 94 2.1.1. consumer crowd-loans ........................................... 94 2.1.2. subordinated loans and profit-practicing loans, interest-free loans and invoice trading ........................................................................... 96 2.1.3. crowdfunding services not included and offers above €5 million .......................................... 97 2.1.4. crowdfunding services for public interest projects ........................................................................... 99 2.1.5. token offered through crowdfunding platforms ....................................................................... 99 2.2. areas left un-harmonised or of national discretion/competence ................................................... 100 2.2.1. criteria to identify transferable securities and ‘admitted instruments for crowdfunding purposes’ ....................................................................... 100 2.2.2. national competence and unclear aspects: marketing communications, civil liability; company law and additional national requirements for csps ........................................... 102 2.2.3. other national discretions/operations ..... 105 3. the second opponent: brexit ................................................... 105 4. the third opponent: climate change, the recent sustainable finance framework and other eu actions ................................................................................................................ 107 5. the fourth opponent: the pandemic crisis ........................ 111 6. conclusions ...................................................................................... 112 ecspr ready for launch? 92 abstract the regulation on european crowdfunding services providers for business (ecspr), adopted in october 2020, has started applying on 10 march 2022, in a period in history regarded as particularly complex for the entire world and for europe because of the post-pandemic effects. before that, the uk has decided to leave the european dream and the difficult negotiations have left the financial sector with uncertainty about the legal treatment of most financial services, including crowdfunding operations, across such new borders. at the same time, the eu is moving forward in its integration process, adopting several actions within the capital markets union (cmu) action plan: one of the main goals of the cmu is indeed the adaptation of existing financial regulation to smes’ needs. some legislative initiatives proposed, such as the markets in crypto-assets regulation (micar), can be regarded as potentially favouring crowdfunding platforms’ competitors, since they all provide services and in particular financing to smes. moreover, climate change effects are becoming more and more severe, also in europe, forcing international, european and national regulators to implement reforms and sustainable considerations in financial regulation. considering this background, it is important to assess whether the ecspr will be able to show the resilience needed to face all these challenges, with its text presenting already adequate responses or tools to adapt. the present paper will analyse the most relevant parts of the ecspr trying to assess whether such newly adopted regime has the potential, considering its architecture, scope and specific rules, to successfully deal with and overcome the highlighted challenges. 1. introduction: the resilience of the ecspr: the analysis of the new regulation’s potential in facing with current opposing forces a regulation on european crowdfunding service providers for businesses was first proposed by the commission in march 2018. the final text was adopted and published, with significant changes made during trilateral negotiations, as eu regulation no. 1503/2020 (hereinafter, ecspr) in october 2020. the ecspr has introduced a legal framework for providers of crowdfunding services which recalls mifid but simplified. it entails general conduct rules (to act honestly, fairly and professionally in accordance with the best interests of their clients), disclosure obligations (for both platforms and project owners), in addition to organizational, risk management and prudential requirements, especially in case of more complex business models, as well as special protections for un-sophisticated investors (entry-knowledge test, simulation of losses, 4-days reflection period and warnings for larger investments: art. 21-22). njcl 2022/2 93 the ecspr entered into force on 10 november 2020 and started applying exactly one year after.1 however, platforms authorized under national regimes at the time of the entry into force may continue to operate under such regimes until they get the new eu license also through national simplified procedures, anyway no later than 10 november 2022. in fact, after the expiration of the transitional period, all providers offering the services and products covered by the ecspr must be authorized and operate in compliance with the eu regulation. considering that the ecspr presents various innovative features compared to several national regimes, member states and their crowdfunding service providers (csps) will have to adapt their legal frameworks and business models in a short time. such difficulties are evident also from the recent esma report on the commission’s power to extend, for an additional year, such transitional period as regards platforms operating only at national level (art. 48 ecspr). in fact, only few member states have adopted simplified procedures and national competent authorities’ (ncas) report have received very few applications so far, likely experiencing troubles in adapting their business models and anyway waiting for the final version of regulatory technical standards (rts) and implementing technical standards (its).2 moreover, not all member states have issued national acts to adapt their legal framework to the ecspr. 1 for a detailed and comprehensive assessment of the ecspr, please let me refer to: e macchiavello (ed), regulation on european crowdfunding service providers for business: a commentary (edward elgar, forthcoming 2022); e macchiavello, ‘the european crowdfunding service providers regulation and the future of marketplace lending and investing in europe: the ‘crowdfunding nature’ dilemma’, (2021) 32(3) european business law review 431. see also e macchiavello and a sciarrone alibrandi, ‘marketplace lending as a new form of capital raising in the internal market: true disintermediation or re-intermediation?’, in e avgouleas and h marjosola (eds), digital finance in europe: law, regulation, and governance (de gruyter 2021) 37; p ortolani and m louisse (eds), the eu crowdfunding regulation (oup 2022); sn hooghiemstra, ‘the european crowdfunding regulation – towards harmonization of (equityand lending-based) crowdfunding in europe?’, 22 august 2020, <https://ssrn.com/abstract=3679142>; k wenzlaff and others, ‘crowdfunding in europe: between fragmentation and harmonization’, in r shneor, l zhao and b flåten, advances in crowdfunding (palgrave macmillan 2020). for commentaries on earlier drafts of the regulation: e macchiavello, ‘what to expect when you are expecting’ a european crowdfunding regulation: the current ‘bermuda triangle’ and future scenarios for marketplace lending and investing in europe’, 20 august 2019, european banking institute working paper series no 55, <https://ssrn.com/abstract=3493688>. with special regard to mifid ii services, m hobza and a vondráčková, ‘the new financial crowdfunding regulation and its implications for investment services under mifid ii’, 6 november 2020, charles university in prague faculty of law research paper no. 2020/iii/2, <https://ssrn.com/abstract=3725997>. 2 esma, ‘esma’s technical advice to the commission on the possibility to extend the transitional period pursuant to article 48(3) of regulation (eu) 2020/1503 final report’ (19 may 2022) esma35-42-1445. ecspr ready for launch? 94 during the drafting of the ecspr, several important events have occurred, such as brexit, the pandemic crisis and the further advancement of different huge bulks of eu financial regulation e.g. the capital markets union, sustainable finance, digital finance, etc. the present paper critically analyses whether the ecspr text appears to be ready for application and whether it is resilient to current and future threats and challenges. 2. the first opponent: residual fragmentation and uncertainty the ecspr’s main objective is to harmonise the regulation of crowdfunding in europe and facilitate cross-border operations, overcoming the pre-existing regulatory fragmentation. the level of harmonisation is indeed high as the ecspr does not only set minimum requirements to obtain the authorisation from the national competent authority (nca) and the consequent eu passport, but contains extremely detailed rules about csps’ organisation and provision of services, authorisation procedures and forms, ncas’ supervisory powers and cooperation among authorities. nonetheless, the ecspr also leaves room for residual fragmentation in the european crowdfunding market, under two different angles discussed below. first, exclusions from the ecspr’s scope, and second, areas left un-harmonised or of national discretions/options. 2.1. explicit or implicit exclusions from the ecspr’s scope the ecspr applies to crowdfunding services defined as ‘the matching of business funding interests of investors and project owners through the use of a crowdfunding platform’ and consisting of: a) the ‘facilitation of granting of loans’ (lending-based crowdfunding), with exclusive reference to business loans; b) the joint provision of placing without firm commitment and reception and transmission of orders (investment-based crowdfunding), not hereby defined but identified through reference to section a of annex i mifid ii, respectively, points 7 and 1 (although crowdfunding services are exempted from the same directive) and when pertaining to transferable securities or the new category of ‘admitted instruments’ (see below §2.2.1; article 2(1)a ecspr). however, the combination of this identification of scope with the definition of some of these terms and express exclusions leaves some services, products and offers outside the scope of ecspr. 2.1.1. consumer crowd-loans the ecspr expressly excludes its application to crowdfunding services ‘provided to project owners that are consumers’ as defined by art 3(a) of the consumer credit directive (ccd) no 2008/48/ec (article 1(2)(a)). despite a decrease in volumes also related to the pandemic, consumer crowd-lending segment remains the prevalent one of the njcl 2022/2 95 european crowdfunding market, not only compared to investment-based crowdfunding, which has always remained limited, but also to business crowd-lending.3 the exclusion of consumer crowd-lending can be partially justified by the ecspr being placed within the cmu which focuses on businesses’ funding. however, another justification for such exclusion relates to the assumption that consumer crowd-loans are more delicate and, in principle, already covered by the ccd4 or to be covered by the same once its review will be passed, which expressly includes peer-to-peer loans5. in any case, the proposed directive does not include a comprehensive and harmonised license and regime for providers of crowdfunding services for project owners who are consumers. combining all these aspects, it is evident that the regulation of consumer crowdlending segment, except for certain limited contractual rules, will remain 3 consumer crowd-loans represented in 2017 the 41% of the market (versus business loans 14%), 34% in 2019 (while business lending 12%) and 29% in 2020 (business lending 18,5%): see t ziegler and others, ‘shifting paradigms the 4th european alternative finance benchmarking report’, (2019), 31, <www.jbs.cam.ac.uk/fileadmin/user_upload/research/centres/alternativefinance/downloads/2019-04-4th-european-alternative-finance-benchmarking-industryreport-shifting-paradigms.pdf> (last access for all electronic sources: 24 may 2022); t ziegler and others, ‘the global alternative finance market benchmarking report’ (2020), 74, <www.jbs.cam.ac.uk/fileadmin/user_upload/research/centres/alternativefinance/downloads/2020-04-22-ccaf-global-alternative-finance-market-benchmarkingreport.pdf>. 4 see also recital 8 ecspr; commission, ‘inception impact assessment. legislative proposal for an eu framework on crowd and peer to peer finance’, (30 october 2017), 32-33, <https://ec.europa.eu/info/law/better-regulation/initiatives/ares-20175288649_en>. nonetheless, the ccd has been interpreted in many countries (eg belgium, italy and poland) as not applicable to crowd-loans for applying to consumer loans between a consumer and a ‘professional’ lender as defined by art 3(1)(b) ccd (even when facilitated by professional intermediaries) while crowd-lenders are generally non-professional lenders (cf article 2(1) ccd). some countries (the uk, the netherlands, finland, spain and lithuania), anyway, have decided to expressly extend ccd or certain provisions of the same to crowd-loans. instead, the commission considers that in case the platform performs an intermediary activity as described in art 3(f) ccd, the directive applies even in absence of a consumer loans as defined above (commission, ‘impact assessment’ 112-13; see also denmark, estonia). the european court of justice had not the opportunity, eventually, to provide its interpretation (case trustbuddy ab v lauri pihjalaniemi, c-311/15, 23 june 2015) because of the concerned platform went into bankruptcy. see e macchiavello ‘financial-return crowdfunding and regulatory approaches in the shadow banking, fintech and collaborative finance era’, (2017) 14(4) european company and financial law review 662, 696; macchiavello 'the european crowdfunding’ (n 1) 565; macchiavello and sciarrone alibrandi (n 1) 44. on the topic, see also m ebers and bm quarch, ‘eu consumer law and the boundaries of the crowdfunding regulation’, in ortolani and louisse (n 1) 88. 5 see commission, ‘proposal for a directive […] on consumer credits’ com(2021) 347 final. ecspr ready for launch? 96 fragmented along national borders and differently regulated than business crowdfunding. 2.1.2. subordinated loans and profit-practicing loans, interest-free loans and invoice trading the loan facilitated by csps and covered by the ecspr is defined by art 2(1)(b) as ‘an agreement whereby an investor makes available to a project owner an agreed amount of money for an agreed period of time and whereby the project owner assumes an unconditional obligation to repay that amount to the investor, together with the accrued interest, in accordance with the instalment payment schedule’ (emphasis added). the definition excludes not only interest-free loans and invoice trading,6 but also products where the repayment is conditional on the previous satisfaction of other creditors (subordinated loans) and products where the recognition of any return depends on the existence and the amount of profits generated by crowd-borrowers (profit-participation loans or, in german, partiarisches darlehen).7 such products have flourished in countries characterised by strict bank monopoly with the aim of overcoming regulatory restrictions e.g. germany8 and are common in other countries such as portugal.9 the ecspr should allow platforms to offer crowdfunding services in principle simply complying with its provisions and therefore overcoming per se previous national restriction. in particular, article 1(3) and recital 9 prevent member states from applying national requirements for banks to crowdfunding service providers, project owners or investors, unless these are already authorised as credit institutions, and from requiring a credit institution authorisation or an exemption from the same for project owners or investors in connection with the provision of crowdfunding services. therefore, some crowdfunding platforms, not constrained 6 entailing the anticipation by an investor to an entrepreneur of a sum of money corresponding to a credit claim of the same entrepreneur towards a third party and the assignment to an investor of the relative credit claim (invoice trading) cannot fit such definition and are consequently excluded. see e macchiavello, ‘the commission’s interim report and prospective adaptations of the ecspr’, in macchiavello, regulation (n 1), ch 31; u piattelli and s caruso, ‘invoice trading and regulation: the case of italy’, ibidem, ch 44. 7 instead, products assigning, together with the participation to the firms’ profit, the unconditional right to an interest might be included within the ecspr’s perimeter. 8 about the german legal framework for crowdfunding, see k wenzlaff, ‘the crowdfunding regulation within germany on the path to self-isolation?’, in macchiavello, regulation (n 1), ch 43; th tröger, ‘regulation of crowdfunding in germany’, (2018) safe working paper no 199/2018, 7, <https://ssrn.com/abstract=3122987>. 9 d pereira duarte and j da costa lopes, ‘the portuguese crowdfunding regime and the impact of the european regulation on crowdfunding service providers’ in macchiavello, regulation (n 1), ch 46. njcl 2022/2 97 anymore by national regulatory limitations, might decide to change their business models and move to the ecspr regime. otherwise, a part of the crowdfunding market, and potentially the crowd-lending market of an entire country, will remain outside the ecspr perimeter and potentially subject to different existing or new national crowdfunding regimes. for instance, portugal will keep its national law to cover subordinated loans and profit-participation loans among other things. 2.1.3. crowdfunding services not included and offers above €5 million crowdfunding services are not further defined or specifically described by art 2(1)(a). nonetheless, other parts of the ecspr provide some useful indication. recital 22 clarifies that the ‘regulation aims to facilitate direct investment and to avoid creating regulatory arbitrage opportunities for financial intermediaries regulated under other legal acts of the union, in particular union legal acts governing asset managers’. as a consequence, the investor must always ‘review and expressly take an investment decision in relation to each individual crowdfunding offer’ (article 3(4)). nonetheless, recital 21 specifies that the use of filtering systems to display projects, based on objective criteria of investor’s preference, such as economic sector, interest rate, and risk category, can be considered as part of the above-mentioned crowdfunding services, not amounting to investment advice when pertaining to transferable securities in the absence of personal recommendation nor investment portfolio management. for the same reasons, the use of special purpose vehicles (spv) to provide crowdfunding services is limited to cases involving only one illiquid or indivisible asset and where the decision to take partial exposure to the same only belongs to investors (see recital 22 and article 3(6)).10 however, the ecspr allows also more complex services, even with a component of asset management, which the commission seems to consider ancillary services,11 subject to additional requirements. this is the case of scoring/pricing of loans and debt-instruments and individual portfolio management of loans. in particular, the latter consists in the ‘allocation by the crowdfunding service provider of a pre-determined amount of funds of an investor […] to one or multiple crowdfunding projects […] in accordance with an individual mandate given by the investor on a discretionary investor-by-investor basis’, where such mandate is based on the investor’s preferences about interest rate, maturity, risk category or even target return (articles 2(1)c) and 6(1)). the allocation of funds based on investor’s preferences through automatic 10 about the limits to the use of spv, see also esma, ‘questions and answers on the european crowdfunding services providers for business regulation’, (20 may 2022) esma35-42-1088. 11 ibidem, sec 3.2. ecspr ready for launch? 98 systems (‘auto-bid’) is considered individual portfolio management of loans too. finally, platforms can also set up systems allowing clients to publish indications of their buy/sell interests regarding products previously subscribed through the platform (‘bulletin boards’) which cannot anyway consist in multilateral matching system bringing together buying and selling interests, i.e. trading venues, not even when only pertaining to loans, and therefore requiring the parties to conclude the transaction outside the platform and the platform to comply with certain requirements.12 other types of crowdfunding services, such as the ones provided as investment advice or investment portfolio management or through collective investment vehicles, cannot be provided by csps under the ecspr. however, these seem in principle not prohibited, but platforms offering them must thus far follow the respective national and/or eu regime, e.g. mifid ii or aifmd. in order to distinguish crowdfunding from banking and reduce conflict of interests, ecsps cannot have any financial participation in the offers, not even when aligning platforms’ and clients’ interests13, excluding therefore business models entailing platforms’ co-financing and direct lending. finally, the ecspr requires that crowdfunding offers of loans and transferable securities/admitted instruments alike and even combined do not exceed €5 million in total consideration within 12 months,14 taking into account any offer from the same project owner exempted from the prospectus regulation even under grounds other than the crowdfunding exemption and not for the same product.15 until 10 november 2023, member states with lower threshold of total consideration for the general exemption under the prospectus regulation, can require crowdfunding offers available in their territories to respect such lower threshold.16 in conclusion, while national crowdfunding regimes covering the same crowdfunding services, products and offers as the ecsps are expected to be repealed, the eu regulation does not specify whether national regimes can be truly residual and therefore cover any case not covered by the ecspr. the issue is raised, for instance, in regard to csps natural persons since the ecspr requires csps to be legal persons, offers of transferable securities and admitted instruments between €5 million and 12 e.g. to specify that bulletin boards are not regulated trading venues, that the exchanges are under the exclusive responsibility of investors and, where a price is suggested, that this is not binding (while substantiating the suggested reference price). 13 recitals 11 and 26; article 8(1) ecspr. 14 cf limits set for certain offerings of tokens in the ‘proposal for a regulation […] on markets in crypto-assets, and amending directive (eu) 2019/1937’ (micar) com/2020/593 final. 15 article 1(1)(c) ecspr. 16 article 49 ecspr. njcl 2022/2 99 €8 million, offers of business loans above €5 million that are not covered by any eu law, and business models entailing a csps’ financial participation to the loans’ intermediated. the nature of maximum harmonization of the ecspr17 might be used as argument in support of a negative answer. however, for this situation finland has introduced a national regime for offers of crowd-loans between €5 million and €8 million.18 2.1.4. crowdfunding services for public interest projects the above-mentioned definitions of crowdfunding services allow the exclusion from the ecspr’s scope of forms of crowdfunding not recognising a financial return to investors, such as donation and rewardbased crowdfunding. nonetheless, it is unclear whether crowdfunding services covered by the ecspr can be provided in relation to not-forprofit or public interest projects despite recognising a financial return to investors. article 2(1)(l) defines ‘crowdfunding project’ as ‘the business activity or activities for which a project owner seeks funding through the crowdfunding offer’ (emphasis added). this has induced france to maintain a special national regime for public interest projects involving public authorities and interest-free loans.19 nonetheless, the commission has clarified in its q&a on the ecspr pertaining to the concept of ‘business activity’ that also public entities and not-for-profit entities can be project owners under the ecspr ‘as long as they raise funds for an activity that generates some economic benefit’ even just for the ‘ultimate beneficiaries (whether monetary or nonmonetary)’, not only for its owners or members.20 2.1.5. token offered through crowdfunding platforms some commentators have interpreted the ecspr as excluding all sorts of tokens from its scope.21 recital 15 specifies that the ecspr does not cover ‘initial coin offerings’ (icos), considered too different from crowdfunding services to be regulated under the same rules.22 however, 17 see also macchiavello, 'the european crowdfunding’ (n 1) 598; macchiavello and sciarrone alibrandi (n 1) 63-64; a hakvoort, ‘secondary trading of crowdfunding investments’, in p ortolani and m louisse, the eu crowdfunding regulation (oup 2022) 273 (in favour of leaving to national laws offers between €5 million and €8 million). 18 see e härkönen, t neumann and c højvang christensen, the regulation of crowdfunding in the nordic countries, in macchiavello, regulation (n 1), ch 48. 19 jm moulin, crowdfunding in france after the adoption of the european regulation on crowdfunding service providers, ibidem, ch 42. 20 esma (n 10) 12, para 3.1. 21 see r battaglini and d davico, ‘is the crowdfunding regulation future-proof? forms of blockchain-based crowdfunding falling outside of the scope of the regulation’, in ortolani and louisse (n 1) ch 6. 22 the draft report of the committee on economic and monetary affairs of the european parliament, instead, included in the ecspr’s scope icos of tokens (under ecspr ready for launch? 100 the expression ‘icos’ often refers only to the offers of ‘utility tokens’ or tokens other than security tokens. moreover, the announced revisions of mifid ii and the prospectus regulation will change the reference to transferable securities in these texts, including also the ones ‘issued by means of distributed ledger technology’.23 therefore, such recital cannot exclude the offering of security tokens per se, i.e. tokens classified as financial instrument/transferable securities, from the scope of the ecspr when offered through crowdfunding platforms.24 2.2. areas left un-harmonised or of national discretion/competence 2.2.1. criteria to identify transferable securities and ‘admitted instruments for crowdfunding purposes’ member states have adopted different interpretations of the mifid ii term ‘transferable securities’ and identification criteria of the same. this has led to divergent classification of certain instruments, such as shares of private limited liability companies and silent partnerships, widespread in a crowdfunding context.25 since the classification as transferable security represents a condition for the application of other legal frameworks, e.g. mifid ii and prospectus regulation, this has also contributed to more stringent conditions to be defined through delegated acts) but the final draft reverted the choice, also recognizing the lack of adequate reflections and impact assessment on this aspect (european parliament-econ, ‘report on the proposal for a regulation of the european parliament and of the council on european crowdfunding service providers (ecsp) for business’, 9 november 2018, <www.europarl.europa.eu/doceo/document/a-8-2018-0364_en.html>). 23 see art 6(1) of the ‘proposal for a directive amending directives 2006/43/ec, 2009/65/ec, 2009/138/eu, 2011/61/eu, eu/2013/36, 2014/65/eu, (eu) 2015/2366 and eu/2016/2341’, com(2020) 596 final. in italy, consob is even considering incentivising the use of crowdfunding platforms for conducting icos of tokens (if not qualified as financial instruments or as other investment products already covered by eu law but this proposal might be limited by mica adoption (consob, le offerte iniziali (n error! bookmark not defined.). the bank of lithuania has simply specified that existing financial regulation, including the crowdfunding law, applies to offerings of tokens that can be qualified as financial instruments (bank of lithuania, ‘guidelines on securities token offerings’, october 2019, <www.lb.lt/uploads/documents/docs/23488_be8ce9606ecb203bf8a9a4bde09ac399.pd f>). 24 see m gargantini, ‘secondary markets for crowdfunding: bulletin boards’, in macchiavello, regulation (n 1) ch 21; f annunziata and t de arruda, ‘crowdfunding and dlts: the imperative need for more clarity’, ibidem, ch 36 (also discussing the interaction of the ecspr with the micar proposal and the ‘proposal for a regulation on a pilot regime for market infrastructures based on distributed ledger technology’ (dlt pilot) com/2020/594 final). 25 macchiavello, ‘the european crowdfunding’ (n 1); macchiavello, ‘financial-return’ (n 4). njcl 2022/2 101 subjecting crowdfunding to different regimes and a variety of levels of strictness among member states. therefore, the ecspr includes the new category of ‘admitted instruments for crowdfunding purposes’26 defined as shares of limited liability companies not considered transferable securities under national law, but not subject to restrictions on transferability according to article 2(1)(n). nonetheless, we can expect a residual high level of regulatory fragmentation in this regard. in fact, the national competent authority granting the csps’ authorisation maintains the power to assess whether the shares of a private limited company can be considered admitted instruments and in particular which are the obstacles to transferability preventing such classification.27 for instance, in sweden, denmark and germany, shares of private limited companies are not considered transferable securities and will likely not be listed among the admitted instruments for crowdfunding purposes, while in italy and romania, the same shares are not considered transferable securities, but have been indicated by the national competent authority to esma as admitted instruments for crowdfunding purposes.28 furthermore, platforms will have to take into account different national rules since the transfer of admitted instruments remains governed by national rules.29 importantly, admitted instruments are only equity-based ones while countries’ classifications as transferable securities might still diverge when it comes to debt-based instruments. one can here refer to mini-bonds and debt instruments issued by private limited companies which are differently categorised and subject to different limits in italy and portugal. moreover, standardised loans available on a bulletin board are considered transferable security in the netherlands but not in other countries.30 26 article 2(1)(a) ecspr. 27 article 2(2) ecspr. the council’s version entailed a more rigid (and therefore, inadequate) system, consisting in an annex (iii) to the regulation listing the shares of private limited liability companies to be considered admitted instruments and covered by the ecsps regulation (as decided by member states) and an information to be published by esma on its website in case of member states’ decision to add or remove an instrument from the list. 28 see esma, ‘european crowdfunding service providers for business regulation (2020/1503) miscellaneous reporting to esma’ (10 november 2021) esma35-421305, 3, <www.esma.europa.eu/file/121782/download?token=rkwn71ud>. 29 recital 14. 30 about different positions on the possibility to interpret the transferability of loans on a bulletin board as an evidence of their negotiability and therefore nature of transferable security: gargantini (n 24) and a hakvoort, ‘where the ecspr pinches the dutch shoe. some brain teasers from a dutch law perspective’, in macchiavello ‘regulation’ (n 1), ch 45; a hakvoort, ‘secondary trading of crowdfunding investments’, in ortolani and louisse (n 1) 281; macchiavello and sciarrone alibrandi (n 1) 54; macchiavello (n 4) 689. ecspr ready for launch? 102 2.2.2. national competence and unclear aspects: marketing communications, civil liability; company law and additional national requirements for csps as mentioned, the ecspr aims at achieving a high level of harmonisation in the regulation of crowdfunding. nonetheless, this cannot contradict traditional national competences, leaving the room for persistent regulatory fragmentation on relevant aspects. for instance, the ecspr recognises the competence of national rules as regards civil liability of the parties involved. in particular, csps have direct and indirect disclosure duties. before entering into the contract, they must provide fair, clear and not misleading information about themselves, the costs and risks involved, the functioning and project selection criteria to clients and potential clients, and warn them about the lack of a deposit guarantee or securities compensation coverage with additional requirements in case of facilitation of loans and complex services.31 in addition, in relation to single offers csps must also provide clients with a synthetic key investor information sheet (kiis) prepared by the project owner under his/her own responsibility32, except in case of portfolio management of loans which requires the csp to prepare the kiis)33 based on the model set by esma. following the prospectus regulation’s model, the ecspr requires member states to ensure the responsibility of, at least, the project owner and its main bodies for the information provided in the kiis, disregarding csps’ liability for the same. nonetheless, the same regulation requires csps to have in place systems to verify the clarity, completeness and ‘correctness’ of the kiis34 and requires the project owner to correct omissions, mistakes and inaccuracies when identified by the former.35 moreover, their insurance policy must cover also damages for misrepresentations/misstatements made (although this might be referred to information provided to clients on their own) and acts/omissions in breach of their legal obligations.36 finally, article 5 requires csps to perform due diligence checks on project owners only limited to criminal records for certain violations and establishment in non-cooperative jurisdictions under an anti-money laundering and counter-terrorism financing perspective. it is worth underlying that the regulation does not clarify the above mentioned term ‘correctness’ despite its relevance. while it is reported that during trilateral negotiations ‘correctness’ seemed to refer to the nonmisleading character of the information, covering at most also the absence 31 articles 19-20 ecspr. 32 art 23(1)-(2) and (9)-(10) ecspr. 33 art 24 ecspr. 34 art 23(11) ecspr. 35 art 23(12) ecspr. 36 art 11(7) ecspr. njcl 2022/2 103 of evident mistakes in filling the form, esma, in updating its q&a on the ecspr in may 2022, has asserted that ‘the csp maintains the responsibility to have adequate procedures in place to identify cases where inaccurate or misleading information may be provided by the project owner and to take appropriate action’, therefore shifting on csps a relevant burden, equivalent to the one recognize in some countries on ipo’s underwriters.37 member states tended to limit the responsibility for the information provided to crowdfunding investors to the project owner (norway, sweden, italy) in their legal frameworks before the entry into force of the ecspr, but differences exist. in spain, investment-based crowdfunding platforms could be held responsible for the concealment of data or lack of identity verification 38 and in finland a platforms’ liability might be recognised for the breach of their duties, which include the duty to oversee the services.39 therefore, also in consideration of the traditional differences among member states in the area of civil law and liability from omitted, false or misleading information, we can expect a variety of solutions in this regard both in terms of issuers and csps’ civil liability. finally, since one of the ecspr’s objectives was to remove previous regulatory obstacles to crowdfunding activities created at national level, it is reasonable to interpret the same as prohibiting member states to impose additional requirements on csps40, unless expressly allowed by the ecspr itself. this is the case, for instance of national offering limits during a transitional period or marketing communications rules. nonetheless, national competence in certain areas, such as corporate law, might support the argument in favour of the maintenance of certain national requirements. as an example, italy has not adapted its legal framework to the ecspr yet (as of 24 may 2022) and it has not been clarified whether corporate requirements for project owners such as ‘tag-along’ and other minority shareholders’ rights will be maintained, although we might propend for a negative answer. 37 macchiavello ‘the european’ (n 1) 588. 38 see m cuena casas and s álvarez royo-villanova, a comparative analysis of the spanish crowdfunding regulation and the ecsr, in macchiavello, regulation (n 1), ch 47. 39 see härkönen, neumann and højvang christensen (n 18). 40 see for instance art 1(3): as regards the application of banking law to peer-to-peer lending: ‘unless a crowdfunding service provider, a project owner or an investor is authorised as a credit institution in accordance with article 8 of directive 2013/36/eu, member states shall not apply national requirements implementing article 9(1) of that directive and shall ensure that national law does not require an authorisation as credit institution or any other individual authorisation, exemption or dispensation in connection with the provision of crowdfunding services in the following situations: a) for project owners that in respect of loans facilitated by the crowdfunding service provider accept funds from investors; or (b) for investors that grant loans to project owners facilitated by the crowdfunding service provider’. ecspr ready for launch? 104 a national competence is recognised also in the area of marketing communications (art 28(2)) and therefore also csps’ contractual duties towards clients. this will also re-invigorate the discussion about the application of certain legal acts within the area of the eu consumer acquis to crowdfunding and underline the relevant differences among member states in this regard. for instance, directive no 2002/65 on distant financial services is considered applicable to csps alongside the ecspr in denmark and sweden, while norway has excluded its applicability when ecspr’s rules already apply.41 from another angle, different interpretations of the same unclear provision can lead to divergent solutions. for instance, regulated providers, such as banks, investment firms, payment services and e-money providers, under the ecspr, seem allowed to conduct crowdfunding services after obtaining also the ecsp license through a simplified procedure according to recitals 35 and 55, and art 12(14)). nonetheless, as an example, sweden has regarded crowdfunding services offered by mifid ii investment firms as ancillary to investment services and consequently decided to allow the same to provide crowdfunding services simply after the nca’s approval of their request for an extension of authorisation.42 at the same time, the same ecsps will be allowed to offer additional services, complying with the relevant laws, including other regulated services such as payment, custodian or banking services and other investment services but, having to obtain, in this case, separate authorizations.43 anyway, relevant aspects in terms of conditions, limits and applicable rules and requirements as regards the provision of crowdfunding services by other regulated operators or by ecspr holding other authorisations remain uncertain. for instance, the ecspr clarifies that incumbents are exempt from the prudential safeguards set for crowdfunding services providers when already subject to capital adequacy requirements for operational risk but leaves implicit that they must comply with the ecspr’s conduct rules when providing crowdfunding services and with their own regime for the other services offered. however, the ecspr, unfortunately, does not provide details in this regard. since they can in principle conduct a varied range of activities different national interpretations and overlap in terms of rules and supervision might arise in case of joint provision of crowdfunding services under different business models where only some are covered by the ecspr, and some are not or even prohibited to ordinary csps.44 41 see härkönen, neumann and højvang christensen (n 18). 42 ibid. 43 see article 10 ecspr. 44 think, for instance, to a bank managing a crowdfunding platform and participating to crowd-loans or to an investment firm offering also crowdfunding investment advice. on this topic, see macchiavello ‘the european crowdfunding’ (n 1) 576-77; hooghiemstra njcl 2022/2 105 2.2.3. other national discretions/operations the kiis must be written in a language accepted by the nca but, in case of offering in different member states, the kiis must be prepared in a language accepted by the nca of each of these countries. the identification of the languages accepted might create different levels of investor protection, regulatory differences and arbitrage. according to the data communicated by member states to esma by march 2022, english will be among the language accepted only in spain, croatia, hungary, luxembourg and malta.45 finally, member states are free to introduce the requirement of the ex ante notification (not approval) of the kiis.46 other areas of residual differentiated regulatory treatment and arbitrage can result from the discretion left to member states in setting the intensity of supervision in line with the proportionality principle and administrative sanctions according to art 15(2) and 39 ff.47 moreover, although the procedure for applying for authorisation has been highly harmonised, ncas can freely set supervisory fees: the application of different supervisory fees, especially if proportionally high when compared to mifid ii firms’, can create fragmentation and regulatory arbitrage. 3. the second opponent: brexit the second element potentially challenging the ecspr and its objectives is brexit. considering in fact the prominent role of the uk in the eu financial sector in general and in the crowdfunding market in particular, brexit is expected to significantly affect the crowdfunding sector, and the scope and effective application of the ecspr, also creating regulatory competition between the two systems in attracting platforms and investors. while a draft of the ecspr circulating during trilateral negotiations presented by the econ committee of the eu parliament48 had proposed a separate regime for third countries providers with equivalent legal frameworks, the final version makes the ecspr regime accessible only by legal persons established in the eu (art. 3(1)), without mentioning the treatment of non-eu country providers. (n 1); e macchiavello, ‘the scope of the ecspr: the difficult compromise between harmonization, client protection and level-playing field’, in macchiavello regulation (n 1) ch 3 (with cross-references to other relevant chapters). 45 esma (n 28) 4-5. 46 art 24(14) ecspr. 47 see f chiarelli, l droghini and r d’ambrosio, ‘supervision and reporting obligations of crowdfunding service providers’, in macchiavello regulation (n 1) ch 14; k serdaris, ‘withdrawal rights in crowdfunding transactions: the precontractual reflection period’, ibidem, ch 19. 48 see european parliament-econ (n 22). ecspr ready for launch? 106 therefore, british crowdfunding providers, as third countries’ providers, cannot apply for a ecspr authorisation, unless establishing a separate stable organisation in one member state. despite the existence of a quite strict and well-functioning crowdfunding regime in the uk, the absence of an equivalence clause in the ecspr blocks any short-cut. in any case, the result of an equivalence decision might be difficult and therefore discretionary andsubject to political forces. the british 2019 reform has undoubtedly served as inspiration for the ecspr for the risk management measures for loan intermediation, partially the pricing criteria and portfolio management as well as business continuity arrangements. nonetheless, the solutions as regards investor protection do not always correspond. for instance, the uk regime presents investment limits and marketing restrictions absent in the ecspr, while the latter, in contrast to the former, entails due diligence obligations, reflection period and a sort of appropriateness/suitability test for un-sophisticated investors in addition to a maximum size threshold for offerings of loans. finally, considering the current lack of responses for the financial services in the uk-eu deal, non-eu operators will have to follow the general, unsatisfactory, complex and fragmentary principles about crossborder financial services which is further complicated by the abovementioned difference in crowdfunding services qualification and regulation among countries. for instance, if british crowdfunding platforms had to use an investment firm license to operate without creating a separate eu-based subsidiary, they might have access to the european crowdfunding market under mifid ii/mifir. however, such legal framework allows third country’s investment firms to operate only after a discretional and revocable with a 30-day notice decision of the commission supported by esma about the equivalence of the regimes. the decision is in principle based on the analysis of the requirements, their objectives and results, the supervision; under condition of reciprocity and new criteria set in the recent ifr for systemically-relevant firms,. moreover, such equivalence regime exists only as regards trading venues and investment services offered to professional investors and eligible counterparties and, by the way, equivalence decisions of such sorts have never been issued by the commission so far. also the equivalence clause in the aifmd pertains to services only towards non-retail investors, while uctis scope is limited to the eea territory. anyway, prospectuses of third-countries’ issuers could be offered in the eu when satisfying art. 29 prospectus regulation. in any case, this reasoning cannot be applied to lending-based crowdfunding: also considering that not even the psd 2 for payments services or the crd iv for deposits and lending services have an equivalence clause, such platforms will have to look for solutions in each njcl 2022/2 107 different national regime in terms of third country providers’ national regimes or bilateral agreements. 49 4. the third opponent: climate change, the recent sustainable finance framework and other eu actions in march 2018, the european commission adopted the ‘financing sustainable growth’ action plan,50 aiming at reorienting private capital to more sustainable investments, managing financial risks stemming from climate change, environmental degradation, and social issues as well as fostering transparency and long-termism in financial and economic activity.51 the european green deal of december 201952 has confirmed the important role played by sustainable finance in accompanying the eu in the ecological and sustainability transition.53 the eu has proposed and 49 about brexit and financial services: commission, ‘eu equivalence decisions in financial services policy: an assessment’, swd(2017) 102 final, 27 february 2017; commission, ‘equivalence in the area of financial services’, (communication) com/2019/349 final, 29 july 2019; j deslandes, ‘third country equivalence in eu banking and financial regulation’ august 2019, <www.europarl.europa.eu/regdata/etudes/idan/2018/614495/ipol_ida(2018)6 14495_en.pdf>; k alexander, ‘the uk's third-country status following brexit: postbrexit models, third-country equivalence and switzerland’, in k alexander and others, brexit and financial services. law and policy (hart 2018); s bergbauer and others, ‘implications of brexit for the eu financial landscape in ecb, financial integration and structure in the euro area’, (march 2020), <www.ecb.europa.eu/pub/fie/article/html/ecb.fieart202003_01~690a86d168.en.html #toc1>; m lehmann and da zetzsche, ‘how does it feel to be a third country? the consequences of brexit for financial market law’, (15 april 2018), <https://ssrn.com/abstract=3155355>; eo wymeersch, ‘uk post brexit access to the eu and its effect on dispute resolution’, (16 april 2018), ebi working paper series 2018, <https://ssrn.com/abstract=3169066>. 50 commission, ‘action plan: financing sustainable growth’, (communication) com/2018/097 final, 8 march 2018. 51 see also high level expert group on sustainable finance, ‘final report’, 31 january 2018, <https://ec.europa.eu/info/sites/default/files/180131-sustainable-finance-finalreport_en.pdf>. several international bodies have long been underlying the fundamental link between finance and sustainable development goals, such as the oecd, g20, un (creating in 1992 a partnership between the united nations environment programme and the global financial sector). 52 commission, ‘the european green deal’, (communication) com(2019) 640 final, 11 december 2019. 53 about eu sustainable finance, among others: d busch, ‘sustainable finance disclosure in the eu financial sector’, 13 july 2020, european banking institute working paper series 2020 no 70, <https://ssrn.com/abstract=3650407>; d busch, g ferrarini and a van den hurk, ‘the european commission's sustainable finance action plan’, 9 october 2018, <https://ssrn.com/abstract=3263690>; v colaert, ‘integrating sustainable finance into the mifid ii and idd investor protection ecspr ready for launch? 108 adopted several legal acts in this regard and a very fast pace. some of them are expected to have a revolutionary impact on the financial sector, aiming at integrating sustainability and therefore environmental, social and governance considerations, into investment firms’ and investment fund managers’ investment processes, including disclosure and organizational duties. for instance, the regulation no. 852/2020, so called ‘eu taxonomy regulation’ provides criteria to determine the environmental sustainability of economic activities54 and aims to set the basis not only for standards and labels for sustainable financial products, but also for the disclosure duties of the sustainable finance disclosure regulation (no. 2019/2088, sdfr),55 in order to reduce ‘greenwashing’56. in fact, the latter requires financial advisors and managers of various types of investment funds to disclose, at entity and product level depending on the case, whether (if not, why) and how they integrate sustainability risks in their organization and investment process as well as whether and how they consider the impact of their investments on the sustainability factors, with additional requirements in case of financial instruments marketed for their sustainability characteristics especially in case of environmental objectives, in relation to the eu taxonomy. revisions of the delegated regulations and directives of, among others, mifid ii, idd, aifmd, ucits57 have frameworks’, in danny busch, guido ferrarini, seraina grünewald (eds), sustainable finance in europe. corporate governance, financial stability and financial markets (springer 2021) ch 13; c gortsos, ‘the taxonomy regulation: more important than just as an element of the capital markets union’, 16 december 2020, european banking institute working paper series 2020 no 80, <https://ssrn.com/abstract=3750039>; m siri and s zhu, ‘will the eu commission successfully integrate sustainability risks and factors in the investor protection regime? a research agenda’, 11(22) sustainability 6292. 54 regulation (eu) 2020/852 of the european parliament and of the council of 18 june 2020 on the establishment of a framework to facilitate sustainable investment, and amending regulation (eu) 2019/2088 [2020] oj l 198/13. 55 regulation (eu) 2019/2088 of the european parliament and of the council of 27 november 2019 on of the sustainability-related disclosures in the financial services sector [2019] oj l317/1. art 26(2)(b) taxonomy regulation empowers the commission to propose the extension to sustainability factors other than environmental ones (eg social) in its review report. meanwhile the expert group has issued its final report on the social taxonomy: platform on sustainable finance, ‘final report on social taxonomy platform on sustainable finance’ (february 2022), <https://ec.europa.eu/info/sites/default/files/business_economy_euro/banking_and _finance/documents/280222-sustainable-finance-platform-finance-report-socialtaxonomy.pdf>. 56 ‘greenwashing’ is ‘the practice of gaining an unfair competitive advantage by marketing a financial product as environmentally friendly, when in fact basic environmental standards have not been met’ (art. 11 taxonomy). 57 mifid delegated regulation no 2017/565/eu and delegated directive no 2017/593/eu; aifmd delegated regulation no 231/2013/eu; ucits implementing directive no 2010/43/eu (as amended in april 2021). njcl 2022/2 109 integrated esg risks and esg preferences in existing organizational e.g. product governance, conflict of interest, due diligence, conduct, such as suitability test and report, and duties of financial intermediaries. considering the severe carbon footprint of technology, fintech and sustainability have not been associated since the beginning but the interest for the interaction of the two areas is growing58 and, currently, both digitalization and sustainability are identified as key factors for achieving more affordable, sustainable and healthier societies, within the recent eu industrial, smes, data and recovery strategies.59 in europe, there are several crowdfunding platforms facilitating investments in the form of loans or equity and debt instruments in sustainable economic activities.60 in a crowdfunding context, where the complex technical nature of renewable energy projects and of esg assessments is coupled with the platform-type of intermediation which entails in principle a lower level of due diligence -, the risk of greenwashing and lack of investors’ adequate information might appear higher. nonetheless, introducing sustainability requirements in the crowdfunding context equivalent to the above-mentioned ones of the traditional finance universe might imply excessive costs for all the parties involved, although other emerging technology-based solutions might help with that.61 the ecspr has so far omitted sustainability requirements, but there are even grounds for facilitations for ‘green crowdfunding’ platforms. in fact, certain ecspr requirements might not work so well in a esg context, in particular as regards renewable energy. for instance, the €5 million cap on the offers might frustrate the expectations of certain companies in the renewable energy segment where high initial investments are required. moreover, the restrictions on bulletin boards might significantly limit the level of liquidity of the market, disincentivizing investments, while the ban on platform’s co-investing might further reduce due diligence on the side of the latter. especially in this particular area, co-investing with business angels and funds can help reduce asymmetric information, but, at the same time, might leave retail investors with ‘lemons’ if certain conditions are not met, e.g. disclosure and equal terms. the ecspr does not contain particular provisions in this regard, leaving the corresponding risks unaddressed. furthermore, the restrictions in the ecspr to the use of spvs clash with the public-private 58 e macchiavello and m siri, ‘sustainable finance and fintech: can technology contribute to achieving environmental goals? a preliminary assessment of ‘green fintech’ and ‘sustainable digital finance’ (2022) 19(1) european company and financial law review 128. 59 see for instance commission, ‘a new industrial strategy for europe’, (communication) com/2020/102 final; commission, ‘an sme strategy for a sustainable and digital europe’ (communication) com/2020/103 final. 60 examples of these platforms are: lendosphere and lumo in france; oneplanetcrowd in the netherlands; ecomill in italy. 61 macchiavello and siri (n 58). ecspr ready for launch? 110 partnerships structure typically used in the ‘green’ sector.62 finally, existing experiences involving tokens related to renewable energy or sustainable behaviours exchanged on a p2p platform might suffer from the difficult interaction between the ecspr and the uncertain regime for hybrid or security tokens (mifid ii, prospectus, etc. with possible future adaptations) and utility tokens (micar). instead, we might also want to assess whether the ecspr should include requirements similar to the ones introduced for traditional providers aimed at integrating sustainability into their activity in the future. this would probably ensure a level playing field and respect the eu sustainability objectives but the additional compliance costs involved might discourage to proceed in this direction in order not to overburden the sector and avoid related negative effects in terms of smes access to finance. finally, other relevant legislative acts within the cmu and fintech action plan (renamed digital finance strategy) have progressed since the commission’s proposal. nonetheless, the ecspr does not always ensure coordination or consistency with these. while i have already discussed the lack of clarity about the relationship with micar, the ecspr does not clarify how it should be interpreted its interaction with some recent proposals, e.g. digital services act – dsa,63 or adopted act, e.g. digital content directive no 2019/770, conceived with the platform economy in mind and also dealing with platforms’ liability for the ‘illegal content’ published online. these do not mention either the ecspr but expressly exclude financial services from their scope and therefore seem not applicable to crowdfunding. doubts might exist on the applicability to crowdfunding of the regulation no 2019/1150 on fairness and transparency for business users of online intermediation services.64 this regulation aims at protecting business users instead of consumers – in respect to platforms and apply to online intermediation services, which are so broadly defined to cover in principle 62 ibidem; e macchiavello, ‘the crowdfunding regulation in the context of the capital markets union’, in ortolani and louisse (n 1) 25, 42. 63 proposal for a regulation […] on a single market for digital services (digital services act) and amending directive 2000/31/ec, com/2020/825 final. 64 regulation (ue) 2019/1150 of the european parliament and of the council of 20 june 2019 on promoting fairness and transparency for business users of online intermediation services oj [2019] l 186/57. njcl 2022/2 111 crowdfunding services.65 however, again, the ecspr might represent a lex specialis prevailing over the generalis.66 moreover, as already mentioned, since marketing communication rules remain mainly national, the ecspr does not clarify the applicability of certain consumer protection laws, such as the directive no 2002/65 on distant financial services and directive no 2005/29 on unfair businessto-consumer commercial practices and directive no 93/13 on unfair terms in consumer contracts, currently to be reviewed. 5. the fourth opponent: the pandemic crisis covid-19 pandemic has afflicted the lives of the worldwide population and depressed our economies, also rising the risk of defaults, increasing risk aversion and the offer of funds while aggravating firms’ and consumers’ need of financing (business and consumer lending). nonetheless, the european crowdfunding market has demonstrated some resilience during the pandemic crisis. the donation-based crowdfunding segment during 2020 recorded an incredible spur thanks to online charity directed to countries and hospitals most affected by the pandemic. the investment-based crowdfunding segment, after an initial slow down, has reprised its growth curve, while the lending-based crowdfunding market has registered a contraction (negative growth) in terms of volumes and number of transactions but an increase in the number of borrowers, in particular new ones.67 platforms has generally showed preparedness in adopting measures to respond to the economic downturn, such as waiver of late repayment fees, repayment easement, review of onboarding criteria, operational support in the preparation of contingency plans and provision 65 art 2(1) of directive 2019/1150 identifies ‘online intermediation services’ with the services meet all of the following requirements: (a) constituting ‘information society services’ under directive no 2015/1535; (b) facilitating business users to offer goods or services to consumers through direct transactions between the two; (c) provided to business users on the basis of contractual relationships with the provider of the same services. 66 on these topics, see also c estevan de quesada, ‘crowdfunding platforms, competition law and platform’, in macchiavello regulation (n 1) ch 37. 67 see t ziegler and others, ‘the global covid-19 fintech. market rapid assessment study’, (december 2020), 45ff, 87-88, <www.jbs.cam.ac.uk/wpcontent/uploads/2020/12/2020-ccaf-global-covid-fintech-market-rapid-assessmentstudy.pdf>. for preliminary data (april 2020) on the impact of the pandemic on marketplace lending and investing (capital inflow new investments – and deal flow number of new projects registered on platforms, payment delays, cash flow problems): european crowdfunding network (ecn), ‘early impact of covid19 on the european crowdfunding sector’, (april 2020), <https://eurocrowd.org/early-impact-of-covid19on-the-european-crowdfunding-sector-2/>; see also f battaglia, f busato, m manganiello, ‘equity crowdfunding: brave market or safe haven for the crowd during the covid-19 crisis?’, (1 july 2020), <https://ssrn.com/abstract=3666021>. ecspr ready for launch? 112 of information on government subsidies, but could not count on government support.68 therefore, the potential of crowdfunding in terms of fast, convenient, resilient and distant funding instrument has raised the question about the same deserving increased government support, both economic and regulatory. the recently approved ecspr, introducing a eu-wide regime for financial-return crowdfunding platforms, might push governments to consider this sector closer to the traditional one and therefore assimilated not only in terms of regulation but also of governmental measures.69 6. conclusions the ecspr represents a great advancement in the european crowdfunding world and should facilitate csps’ activities thanks to its passport, increased level of regulatory harmonisation and legal certainty. nonetheless, for several providers (especially small and previously lightly regulated ones) will represent a big change and challenge: as already mentioned, ncas are reporting difficulties of national providers to adjust in such a short time their business models to the new rules, therefore benefiting from the possibility to obtain an extension of the transitional period (see above §1). especially lending-based crowdfunding platforms might perceive their activities as more strictly regulated than in the past (but sometimes even if compared to similar activities such as alternative credit funds or investment portfolio management)70: for instance, in case of mere facilitation of loans, platform must demonstrate ‘appropriate systems and controls to assess the risks related to the loans intermediated on the crowdfunding platform’ (art 4(2), first period). moreover, when offering, instead, scoring/pricing services (loans and bonds), they must have in place policies and procedures ensuring a reasonable assessment of credit risk based on sufficient data (at least the ones indicated in article 4(4)b) and reasonable prices, using factors and criteria in accordance with technical standards set by eba and esma (art 4(4) and 19(7)). additional requirements, about the timing of the credit risk assessment, apply in case of loans (instead of debt-based financial instruments). finally, when platforms offer individual portfolio management of loans, they need to have in place robust internal processes and methodologies for risk management and financial modelling (article 4(2), second period) and for 68 ziegler and others (n 67) 17, 29-31, 45, 88-89; ecn (n 67) 5-6. 69 instead about us government measures supporting crowdfunding during the pandemic: a vanderlaan, ‘sec provides temporary relief from certain regulation crowdfunding requirements in response to covid-19’, 2020, <www.orrick.com/en/insights/2020/05/sec-provides-temporary-relief-fromcertain-regulation-crowdfunding-requirements-in-covid-19-response>. 70 see macchiavello and sciarrone alibrandi (n 1) 77. njcl 2022/2 113 complying with the requirements set in article 6(1)-(2), including respecting investors’ preferences and using appropriate data. they also need to assess the credit risk of individual crowdfunding projects selected for the investor’s portfolio, of the portfolio itself and of the project owners’ prospects of meeting their obligations. when offering and operating contingent funds, ecsps must have policies, procedures and organizational arrangements that will be specified through rts drafted by the eba in cooperation with esma (art 6(7)). another new requirement for several providers might consist in the prudential safeguards for operational risk, omitted in several jurisdictions: they will have to ensure, through cet1 or through professional insurance or a combination of these two, the higher between €25,000 and ¼ of overheads of the previous year.71 nonetheless, our main objective with this paper has been to test the ecspr’s resilience to several ‘external’ forces and challenges. to this end, previous paragraphs have identified several areas of potential residual fragmentation and critical aspects. however, the ecspr had already contemplated the need to adjust its text after the first years of application: in particular, article 45 requires the commission, ‘[b]efore 10 november 2023’ and ‘after consulting esma and eba’ to ‘present a report to the european parliament and the council on the application’ of the ecspr, ‘accompanied where appropriate by a legislative proposal’. the same provision presents a quite long list of areas potentially interested by this future revision and related to some of the challenges mentioned above. for instance, on a general level, the commission will assess the overall impact of the ecspr on the sector (also in terms of number of csps, in particular small ones, and cross-border operations) with the objective of adjusting over time the requirements in the light of the level playing field with other operators and respective regimes, financial inclusion implications as well as market evolutions (art 45(2), letters (a)(b), (f)-(g), (h)-(j), (t)-(w)). in terms of still insufficiently harmonised areas, the combination of articles 2(3) and 45 might reduce the existing fragmentation. article 2(3) requires in fact ncas to inform esma, on an annual basis, about the types of private limited liability companies and their shares that are offered falling within the ecspr’s scope.72 esma has to compare such 71 this requirement recalls class 3 firms’ capital requirements under investment firms regulation (ifr 2019/2033) and directive (ifd 2019/2034) but is potentially lower (since ifd/ifr requirement is based on the minimum capital requirement set depending on the service provided, where the lowest is €75,000). 72 as of 31 march 2022, only 7 countries have communicated to esma to consider certain shares of private limited companies as admitted instruments for crowdfunding purposes, while the others have either chosen not to envisage such types of instruments ecspr ready for launch? 114 information received from the ncas with the one obtained on its own collecting, for the first two year of ecspr’s application, the kiis of project owners offering admitted instruments, with particular regard to the national restrictions on such instruments and on their transferability, and transmit such comparison to the commission for the report under art 45 (article 2(4)).73 all this might eventually and hopefully lead to more common criteria and harmonised categorisation (although this is not made explicit). also in the area of administrative sanctions, art 45(2)(y) requires the commission to assess the effectiveness of the ecspr enforcement and against the risk of fragmentation, through the analysis of the ‘number and amount of administrative fines and criminal penalties imposed’ by member states in particular deciding whether further harmonization is needed as regards ‘administrative penalties provided for infringements’ of the ecspr (para 2, letter (o) and (y)).74 similarly, the report has to assess the effects of marketing communication rules, on the ‘freedom to provide services, competition and investor protection’ (para 2(n)), with the possibility to propose, as outcome of the assessment, further harmonization in this area. article 45 also takes into account the current lack of a third country regime: para 2, at letter q) entrusts the commission with evaluating in its report the appropriateness of allowing entities established in third countries to be authorised as crowdfunding service providers under the regulation. finally, according to article 45(2)(s), the commission might consider proposing the introduction in the ecsps regulation of specific measures to promote sustainable and innovative crowdfunding projects also through the use of union funds. this expression sounds ambiguous and might be interpreted as either suggesting the introduction of facilitations for csps in the area of sustainable finance or, on the contrary, to introduce requirements similar to the sustainable finance action plan ones to improve sustainability in finance. postponing the decision on how to ponder all interests involved (proportionality, smes access to finance, green transition, etc) for some years seems appropriate in consideration of the difficult balance and the novelty of the sustainable finance framework (therefore untested): the final outcome of such assessment and balance might depend on both the future evolution and stabilization of the eu sustainable finance legal framework and the assessment about the (5) or not provided such information (the remaining). see esma (n error! bookmark not defined.) 2-3. 73 in its report, the commission will have to assess ‘the use of admitted instruments for crowdfunding purposes in the cross-border provision of crowdfunding services’ (art 45(2)(c)). 74 see k serdaris, ex post enforcement of the eu crowdfunding regime: administrative sanctions and measures, in macchiavello, regulation (n 1), chp. 29. njcl 2022/2 115 compliance costs and overall impact of the already existing ecspr provisions on the sector. in conclusion, the ecspr present a potential high level of resilience to the highlighted challenges but some areas of uncertainty and insufficient harmonisation remain: in these cases, further adjustments at level one or, where allowed and anyway ensuring a careful and shared assessment of impact, at level 2 or at interpretative level are needed. microsoft word mazzacano_peterj.doc nordic journal of commercial law issue 2008#1 harmonizing values, not laws: the cisg and the benefits of a neo-realist perspective by peter j. mazzacano* * peter j. mazzacano is a visiting professor and the director of the legal process program at osgoode hall law school, york university, in toronto, canada. with prof. j. walker, peter co-coaches the osgoode vis moot team. he is the founder and editor of cisg canada (http://www.cisg.ca), hosted at osgoode hall law school, and jr. editor, unilex at the international institute for the unification of private law (unidroit), rome, italy (http://www.unilex.info). nordic journal of commercial law issue 2008#1 1 “custom, not law, has been the fulcrum of commerce since the origins of exchange”. leon trakman1 i. introduction 1. legal realism in the international context legal realism has been deemed as one of the most important jurisprudential movements in western society during the twentieth century.2 this group, which was by no means coherent, flourished particularly in the 1920s and 1930s at yale and columbia law schools, originated with such scholars as, oliver wendell holmes, john chipman, and karl llewellyn.3 although it has been thought that realism is “dead”, having been put to rest by h.l.a. hart’s derisive critique,4 there has been renewed interest in the subject in recent years.5 while it is difficult to speak of a single, comprehensive theory belonging to this group, certain unifying themes can be discerned from the writings of the realists’, particularly those that concern rule-skepticism and the indeterminacy of law.6 at the risk of simplifying the legal realist perspective, the 1 leon trakman, the law merchant: the evolution of commercial law (littleton, colo.: f.b. rothman, 1983) at 7. 2 brian leiter, “american legal realism” university of texas law, public law research paper no. 42 at 1 available at ssrn: http://ssrn.com/abstract=339562. 3 michael s. green, “legal realism as a theory of law” (2004-05) 46 wm. & mary l. rev. 1915 at 1917. 4 h.l.a. hart, the concept of law, 2nd ed. (oxford: clarendon press, 1994) at chapter seven. 5 see e.g. green, supra note 3 at 1918, where he states, “only recently has the study of legal realism become halfway respectable in philosophical circles. a prominent example of the renewed interest in the realists is brian leiter’s defense of their theory of adjudication against hart’s critique”. see also leiter, supra note 2 at 1-2, who states that “one of the important tasks for realists today is a philosophical reconstruction and defense of [their] views”. 6 see e.g. ibid. at 1919 where green states: “it is dangerous to speak of a theory held by the realists as a group, even when the group is limited to those most commonly agreed to be realists—karl llewellyn, jerome frank, walter wheeler cook, felix cohen, hessel yntema, herman oliphant, max radin, leon green, and joseph hutcheson. it is still more dangerous when the theory is in the philosophy of law, given that the realists—cohen excepted—did not have significant training in philosophy. nevertheless, realism remains a subject of more than historical interest precisely because unifying themes can be found in the realists’ writings”. see also brian bix, jurisprudence: theory and context, 3rd ed. (london: sweet & maxwell, 2003) at 177, who states, “[a]mong those writers who described themselves (or who were described by others) as “realists”, there was little by way of agreed views, values, subjectmatter, or methodology. it has become commonplace to note that it approaches distortion even to refer to ‘the legal realists’, as though it were a coherent movement (one commentator writing recently went so far as to refer to legal realism as a ‘feel’ or ‘mood’)”. thus, reference to realist “theory” in this paper refers more generally to common themes shared by members of this group. nordic journal of commercial law issue 2008#1 2 conventional view holds that legal realism is a theory7 that law is based, not on formal rules or principles, but instead on judicial decisions that originate from social interests and public policy. in other words, beneath a veneer of scientific and deductive reasoning of “mechanical jurisprudence”8 are legal rules and concepts—that is, legal doctrine—that are often indeterminate, and these are rarely as neutral as they appear. in the words of hart, the realists’ theory of law holds the view that “talk of rules is a myth, cloaking the truth that law consists simply of the decisions of courts and the prediction of them”.9 this realist theory of law is usually analyzed solely within the context of domestic case law and jurisprudence. but how does the realist theory of law apply in a global setting, that is, within the context of international law? particularly, would the realists have us believe that efforts to create uniform national laws through international treaties or conventions are subject to the same degree of uncertainty as domestic rule-making? in other words, can international conventions be as indeterminate as domestic legislation? considering that the objective of uniform law conventions is to standardize judicial rule-making across jurisdictions appears to directly challenge the realist notion that such laws are too indeterminate to be a significant influence on, or predictor of, a judges’ decision, how do we explain the development of functional uniformity10 in legal doctrine related to an international convention? 1.1 legal realism, the cisg, and the problem of formalism the open-textured nature of the united nations convention on contracts for the international sale of goods11 (“cisg” or “convention”), combined with its attempt to strike a balance among different legal systems, and a variety of competing national interests, provides a compelling opportunity to examine the legal realist12 theory of law within the context of the attempt to create a uniform sales law. within this setting, legal realism would suggest that beneath the black letter text of the cisg are legal rules, concepts, and reasoning that are indeterminate.13 7 the legal realists did not have a uniform or coherent “theory” per se, but rather had in common certain “themes”. see green and bix, ibid. 8 the term “mechanical jurisprudence” was coined by roscoe pound in “the path of the law” (1908) 8 colum. l. rev. 605 at 614. 9 hart, supra note 4 at 136. 10 “functional uniformity” must be differentiated from “absolute” or “strict uniformity.” it is closer to the concept of “harmonization” in that the goal is to lessen the legal impediments to international trade. 11 united nations convention on contracts for the international sale of goods, april 11, 1980, 1489 u.n.t.s. 3, 19 i.l.m. 671. 12 the definition of legal realism as used in this paper is broader than this traditional view, and incorporates the notion that as a corollary to indeterminacy and rule-skepticism, the realists’ are striving for nearperfection with laws, in particular, uniform laws such as the cisg. 13 see section 1, below. nordic journal of commercial law issue 2008#1 3 more specifically, the realist perspective would suggest that the convention is too ambiguous, or is inherently flawed, and is of little practical use as a uniform law in the international realm.14 this is primarily due to the flaws of legal formalism15 embedded in the cisg. formalism holds that law is a set of rules and principles independent of other political or social institutions. that is, the law, and judicial decisions, can be deduced from general concepts or rules with no reference to real-world conditions or consequences. law can be approached as a science, where logically consistent principles and doctrines can be discovered in case law. however, extrapolating from the realist approach to the convention suggests that the cisg will ultimately fail to achieve uniformity in international sales law. in this view, uniform judicial rule-making across jurisdictions is too unpredictable to be of practical use. 1.2 the cisg and the neo-realist solution like frustrated idealists,16 the legal realists have been searching for the perfect uniform law. this quest is misguided. while it might be possible to conclude that the unification of international commercial law is technically impossible, it is equally unrealistic to expect perfect uniformity and predictability in the application of case law involving the cisg—or for that matter, any other statute. what uniform laws in general, and the cisg in particular, provide for is international acceptance of similar norms, and a common medium for communication—a lingua franca.17 this is a form of international commercial law that is more helpful and predictable than the present set of competing national systems and interests. thus, what is required is a “neo-realist” approach to the cisg. this identifies the values and norms underlying the technical rules of international sale of goods law. from this perspective, the cisg would be an attempt to harmonize not just rules, but more importantly, the values about the conduct of international sales transactions. this paper will argue that the rule-scepticism embodied in the realist perspective has missed the point: strict uniformity and predictability in applying the cisg across national boundaries will never be achieved. but perfection was never the goal of the cisg. rather, the cisg seeks the objective of functional or relative uniformity in both the interpretation and application of the cisg across a common set of commercial norms. in other words, the cisg is an attempt to harmonize not so much the law of international sales transactions, but more precisely, the norms and values regarding the conduct of international trade in goods. in this 14 ibid. 15 critics labeled legal formalism a “mechanical jurisprudence”. legal formalism was espoused by a group of academics, including christopher columbus langdell and lon fuller. 16 the term “frustrated idealist” is borrowed from edward j. bloustein, “logic and realism: the realist as a frustrated idealist” (1964-65) 50 cornell l. q. 24. 17 the term lingua franca appears to have been coined by john honnold, in “the sales convention in action— uniform international words: uniform application?” (1988) 8 j.l. & com. 207. nordic journal of commercial law issue 2008#1 4 way, the cisg is the embodiment and expression of international mercantile customs, or a new lex mercatoria.18 for this reason, neo-realism requires an abandonment of the quest for strict uniformity in international sales law. in its place should be a new conception with a focus on the harmonization of values and norms in place of the unfruitful search for a predictable, homogeneous legal text for the international sale of goods. the first part of this paper will introduce a realist critique of the cisg. it will survey their attack on the cisg as an incomplete, unpredictable, and systematically imperfect set of rules. the second part of the paper will illustrate how the realists are misguided by failing to consider the importance of the commercial customs of trade usages, including the development of the lex mercatoria, as norms underlying the technical rules of the cisg. in the third section, it will be shown how the cisg incorporates a set of norms for international merchants. it is this system of organized ideological values which provides for a new, neo-realist perspective on the cisg. finally, part four will provide an alternative theoretical framework to the realist approach to the cisg. it will argue that a neo-realist perspective on the convention is required. like the lex mercatoria and the incorporation of mercantile customs, this alternate approach must focus on the harmonization of norms and values in international commercial transactions, at the expense of a rigid set of rules that strive for predictability and perfection. ii. the legal realist critique of the cisg 1. the problematic quest for uniformity 1.1 outward uniformity v. uniform application a broad issue that is often raised in academic commentary on the cisg is whether the convention’s goal of uniformity is achievable. surrounding this issue there has developed a lively scholarly debate on the relative success, or failure, of the cisg to promote uniformity in international sales law. this debate has frequently been spearheaded by legal realists. generally, this criticism appeared to be particularly strong in the early years of the convention. for example, long before the cisg became effective, r.j.c. munday notes, in words that appear to foretell the debate on the quest for uniformity, that “even when outward uniformity [is] achieved […] uniform application of the agreed rules [is] by no means guaranteed, as in practice different countries almost inevitably […] put different interpretations upon the same 18 on the new lex mercatoria see bernardo m. cremades & steven l. plehn, “the new lex mercatoria and the harmonization of the laws of international commercial transactions” (1983-1984) b.u. int’l l.j. 317; a. claire cutler, private power and global authority (cambridge: cambridge university press, 2003); louise hertwig hayes, “a modern lex mercatoria: political rhetoric or substantive progress?” (1976-1977) 3 brook. j. int’l l. 210; imtaz m. sattar, “the unidroit principles of international commercial contracts and the vienna sales convention: competing or completing ‘lex mercatoria’?” (1999) 4 int’l trade & bus. l. ann. 13. nordic journal of commercial law issue 2008#1 5 enacted words”.19 munday is unconvinced of the ability of the cisg to make a significant impact on uniform international sales law. in this respect, he shares the rule-skepticism of the realists. as munday foreshadows, much of the realist critique of the cisg surrounds the wording within the convention itself. words are often ambiguous, and this can sometimes lead to indeterminate results. however, as duncan kennedy notes, some indeterminacy is inherent in any system of rules.20 some commentators on the cisg are not legal realists per se, but rather take a “realistic” approach to the convention. in this view, because law is a human creation, it is subject to human foibles, frailties, and imperfections. arthur rosett takes this approach. he initially views the cisg as a product, not only as a “monumental achievement” for uniform law, but also as a document that makes a positive political statement, benefiting humankind by “giving concrete form to hopes for one peaceful family of nations living under a compatible legal order”.21 rosett suggests that the cisg may be a beacon of hope for the unification effort.22 he tells us that it is the product of more than 50 years of international negotiation, “which has produced a document unanimously approved by delegations representing sixty-two national legal systems”.23 since its adoption, the cisg has also received “the approval of groups of lawyers all over the world. little opposition has arisen to its ratification by the united states, and from all indications the reaction in other nations also has been very positive”.24 rosett’s optimistic words quickly dissipate. despite the lofty goals of the cisg, “the impressive talent of the drafters, the long period of gestation, and the universal acclaim with which the convention has been met”, rosett maintains that the fundamental strategy of attempting to create an exclusive and comprehensive statement of international sales law is poorly conceived. like the realist approach to doctrine, his argument is entirely pragmatic: one must uncover the political content behind the text of the convention. as international sales law harmonization and international sales law codification are not identical, the goal of harmonizing the legal treatment of international sales transactions is not advanced by the adoption of the cisg.25 19 r.j.c. munday, “the uniform interpretation of international conventions”, (1978) 27 int’l & comp. l.q. 450 at 450. 20 duncan kennedy, “form and substance in private law adjudication”, (1976) 89 harv. l. rev. 1685 at 1701. kennedy further notes that the typical historical pattern of legal development involves the growth of indeterminacy in what begins as a determinate body of rules. however, evidence of the convergence of cisg jurisprudence would contradict kennedy’s assertion. 21 arthur rosett, “critical reflections on the united nations convention on contracts for the international sale of goods” (1984) 45 ohio st. l.j. 265 at 265-266. 22 ibid. at 267. 23 ibid. at 265. 24 ibid. at 266. 25 ibid. at 267. nordic journal of commercial law issue 2008#1 6 in the fifty year period of negotiations leading to the cisg, rosett believes that the nature of the problem had changed. in the early years of negotiations, it seemed a worthy idea to promote trade through a unifying codification of national sales laws. during the intervening period economic integration proceeded rapidly and supported a number of important harmonization efforts. these reduced the substantive anomalies that concerned the early proponents of the cisg. the need for a unified doctrinal statement of contract principles, thus, became less important than it appeared at the outset. as rosett notes, “[t]his diminished urgency is reflected in the slightly outdated character of some of the issues that most concerned the drafters”.26 for example, the cisg does not deal with many contemporary issues of commercial law that are considered important in the u.s. and abroad. for instance, it does not directly address the issues of product liability that are related to other doctrinal rules announced by the convention.27 rosett’s list of imperfections with the cisg continues. typifying the realist perspective, rosett focuses on the indeterminate legal rules and concepts embodied within the text of the cisg. in conclusion, he believes the convention provides “no unifying guidance on the host of issues”, and predicts that some of the ambiguous provisions within the cisg will continue to divide scholars, including those academics who participated in the drafting process.28 1.2 uniform words or a lingua franca? as john honnold notes, however, uniform words in themselves will not guarantee uniform results.29 he additionally concedes that the legal realists are “dead right” with their perspective on the quest for uniform laws that are designed to cross national borders.30 as legal practitioners are required to use unreliable and imperfect tools—words—they will never be able to craft the perfect law, treaty, or convention. he notes that even a simple phrase, such as “home sweet home”, presents the french translator with a challenge.31 at the international level these difficulties with words are raised to a higher level. for example, common law legal concepts, such as “consideration”, “trust”, and “tort”, are almost impossible to translate in civil law jurisdictions. honnold is not a critic of the cisg, but he provides a valuable survey of the difficulties and criticisms that are encountered in quests for the international unification of law. honnold remarks that, like confirmed bachelors or spinsters who have built their lives in search of the perfect spouse, the legal realists have been searching for the perfect uniform 26 ibid. at 302. 27 ibid. at 303. 28 ibid. 29 honnold, supra note 17 at 207. 30 ibid. 31 ibid. nordic journal of commercial law issue 2008#1 7 law.32 this is an impossible quest. he states that he could simply conclude “[a]s our sad-faced [r]ealists predicted, international unification is impossible”.33 instead, he ends on an optimistic note: “we cannot expect perfect uniformity in applying the [c]onvention—or for that matter, any other statute”.34 what uniform laws in general, and the cisg in particular, provide for is international acceptance of the same rules—an expression of international mercantile customs and shared values—and a common medium for communication—a lingua franca. 1.3 the problem with open-textured wording words that are unique to specific jurisdictions are charged with legal meaning. to address this problem the cisg requires the displacement of domestic legal concepts. this explains why the cisg uses generic or neutral words that describe certain events, results, or practices that are typical in an international transaction, and not technically charged legal terms specific to a legal system. this is perhaps why honnold dubbed the convention the new lingua franca.35 however, amy kastely, in the realist tradition, is critical of the attempt at a new lingua franca, and argues that because of the open-textured wording within the cisg, there is a very real possibility that it will fail. of course, the legal realists were never concerned with the relative success or failure of a convention or piece of legislation. llewellyn even claimed that the realists did not have a normative program.36 the realist would focus on the open-textured nature of the law to demonstrate how a judge, for example, would be able to justify any result he/she desired in any particular case. in other words, the open-textured nature of the cisg is particularly helpful in allowing a competent adjudicator to make a decision in favour of either side in any given lawsuit.37 utilizing rhetorical analysis on the text of the cisg, kastely uncovers many of the contextual problems and weaknesses within the convention. such an approach is typical of realist attacks 32 ibid. 33 ibid. emphasis in the original. 34 ibid. at 212. 35 ibid. 36 allen r. kamp, “between-the-wars social thought: karl llewellyn, legal realism, and the uniform commercial code in context” (1995-96) 59 alb. l. rev. 325 at 327. kamp is skeptical of llewellyn’s statement, particularly in light of the fact that many realists accepted positions under franklin d. roosevelt’s administration. 37 duncan kennedy provides an example of how an apparently determinate legal rule can be, in fact, “opentextured” in that it allows a judge to square of a number of factors: “legal directives that looked general and formally realizable were in fact indeterminate. take, for example, the ‘rule’ that a contract will be rescinded for mutual mistake going to the ‘substance’ or ‘essence’ of the transaction, but not for mistakes as to a ‘mere quality or accident’, even though the quality or accident in question was the whole reason for the transaction. we have come to see legal directives of this kind as invitations to sub rosa balancing of the equities. such covert standards may generate more uncertainty than would a frank avowal that the judge is allocating a loss by reference to an open textured notion of good faith and fair dealing”. kennedy, supra note 20 at 1700. nordic journal of commercial law issue 2008#1 8 on formalism. she states: “[t]o unify the law among nations means to subject people around the world to a single set of rules and principles and to have them understand and conform to these rules and principles as they would to the laws of their own communities”.38 the problem, as kasteley understands it, is that while “human communities are natural, organic, or inevitable […] [t]he community created and promoted by the convention […] is thoroughly consensual and artificial”.39 this artificial community is precarious, and “vulnerable to the whim of human choice and self-interest”.40 the bonds keeping it together are no stronger than the paper on which the convention is printed. kasteley, thus, predicts the failure of the cisg, even though such a concern is not typical of the legal realists. she concludes by stating the possibility that it will “only be ratified by a few states or in only a limited part of the world”.41 even if the cisg is widely accepted, “it is possible that the system of unified law will be short-lived, with states denouncing the convention after a trial period, or by domestic courts interpreting the convention in mechanical or isolated ways”.42 realists have often critiqued the “mechanical” jurisprudence and “closed” normative system of formalism, but formalism, like the realist approach, is of little assistance when assessing the relative success of the cisg as a uniform international law. however, while her prediction has not proved true, kastely is correct to the extent that the cisg, like most—if not all—laws, is not a perfect legal text. 1.4 problems of interpretation interpretational problems will always arise with uniform laws. realist critics of the cisg have often focused on this problem, without fully acknowledging that national laws also face problems of interpretation. fortunately, the interpretational challenge was recognized during the drafting of the convention. as gyula eörsi notes, for example, unlike many other conventions, the cisg contains two articles (arts. 7(1) and 8) specifically devoted to ensuring that the convention is interpreted in a uniform manner.43 article 7 in particular specifically urges tribunals and courts not to make recourse to domestic law unless specifically directed to do so by the cisg itself. acknowledging that because language frequently tends to be vague, ambiguous, or provides multiple meanings, eörsi predicts the problems the cisg might encounter: “it could be argued 38 amy h. kastely, “unification and community: a rhetorical analysis of the united nations sales convention” (1988) 8 nw. j. int’l l. & bus. 574. 39 ibid. at 588. 40 ibid. at 589. 41 ibid. at 621. 42 ibid. 43 gyula eörsi, “general provisions”, in international sales: the united nations convention on contracts for the international sale of goods, galston & smit eds., 1984, 2-1 available at http://cisgw3.law.pace.edu/cisg/ biblio/eorsi1.html. nordic journal of commercial law issue 2008#1 9 that the [interpretive] provisions of article 7(1) [of the cisg] are but pious wishes: the paragraph is necessarily vague and therefore open to surprising results”.44 eörsi was likely ahead of her time in predicting that the interpretive articles within the cisg would play an important role in its ultimate success, particularly with regard to the unification of international sales law. she states: “the elements of regard to the international character of the convention and uniformity in its application were well chosen. the first, as we have seen, was devised to check the homeward trend, and the second is an admonition to follow precedents on the international plane”.45 iii. the lex mercatoria and the evolution of commercial norms, trade usages, and customs 1. the legal realist and folkways karl llewellyn and his contemporaries, collectively referred to as legal realists, were a decentralized group of reformist academics who were generally influenced by the social sciences, particularly anthropology and economics.46 the connection between the realist’s and anthropology is particularly interesting. many of the realists sought to apply it to the study of law.47 more specifically, the realists wanted to study the law objectively, in the same manner that an anthropologist might study the activities of a tribe. this approach is based on the assumption that modern society functions in similar ways as traditional societies. while this simplification is questionable, the realists have astutely contemplated the parallel characteristics between the practices of tribes and the trade practices of commercial merchants. llewellyn, for example, felt that even the modern merchant followed a cohesive body of traditions and trade practices in the same manner that tribes would follow certain folkways.48 in this respect, the realists have correctly identified the importance of mercantile customs in contemporary commerce. however, their fixation on the indeterminate nature of the law has blinded the realists from seeing the relative success that certain uniform laws, such as the cisg, have enjoyed. to understand the importance of the norms and values in international commerce—as opposed to a rigid legal code— the evolution of the function and customs of trade usages and practices, within the context of the cisg, must be considered. this development illustrates the 44 ibid. at 2-5. 45 ibid. at 2-5. 46 kamp, supra note 36 at 327. 47 ibid. at 354. 48 ibid. at 355. nordic journal of commercial law issue 2008#1 10 importance of a contextual interpretative approach in commercial relationships, which are frequently employed by international merchants. that llewellyn and his contemporaries showed interest in the “folkways” of commercial merchants is particularly interesting, considering that later realists would reject an interpretative and contextual approach to the trade customs and rules embodied in the modern lex mercatoria,49 the cisg. the focus on trade usages and practices demonstrates how these values have superseded the strict legal provisions of a uniform law convention. the history of these commercial norms can be traced back to the ancient lex mercatoria and beyond.50 1.1 the medieval lex mercatoria the term lex mercatoria, which is literally translated into the english language as “law merchant”, or “mercantile law”, has been described as “a uniform system of law to regulate international commercial transactions, avoiding the vagaries of differing national systems”.51 at the core of the lex mercatoria are commercial customs, which materialize in the form of trade usages and practices. as julian lew notes, “[t]his system of law [the lex mercatoria] comprises the rules which have been developed to regulate and facilitate international trade relations and the customs and practices which have attained universal (or at least very extensive) recognition in international trade”.52 thus, the quest for predictability and uniformity in the rules of international trade is not a modern phenomenon. indeed, it is argued that the roots of the cisg can be traced back more than 800 years to the beginning of the eleventh century when medieval europe experienced a commercial resurgence that required a need for a special law to govern its commercial activities.53 the earliest known version, entitled lex mercatoria, has been dated circa 1280.54 this legal code is inextricably tied to the marketplace, as the first sentence in the treatise notes: “mercantile law is thought to come from the market, and thus we first need to know where 49 on the new or modern lex mercatoria, see note 18, supra. 50 the lex mercatoria is also known as the law merchant. in fact, the latin and english terms are often used interchangeably. 51 alan redfern & martin hunter, law & practice of international commercial arbitration, 2nd ed., (london: sweet & maxwell, 1991) at 117. 52 julian d.m. lew, applicable law in international commercial arbitration (dobbs ferry, n.y.: oceana publications, 1978) at 436. 53 see errol p. mendes, “the u.n. sales convention & u.s.-canada transactions; enticing the world’s largest trading bloc to do business under a global sales law” (1988) 8 j.l. & com. 109 available at http://cisgw3.law.pace.edu/cisg/biblio/mendes.html. 54 mary elizabeth basile et al., eds. & trans., lex mercatoria and legal pluralism: a late thirteenth century treatise and its afterlife (cambridge: the ames foundation, 1998) at 107. this treatise, written in latin, formed part of a collection of material compiled by william de colford, the recorder of bristol in the 1340s. it is sometimes also referred to as the little red book of bristol. nordic journal of commercial law issue 2008#1 11 markets are held from which such laws derive”.55 however, it is not made explicit in the english medieval record until the fifteenth century that the lex mercatoria is considered to be positive law in the international community. a 1473 case involving the seizure of goods from a foreign merchant records the notion that the lex mercatoria is transnational in its application.56 the chancellor of the star chamber asserted that foreign merchants must not be judged according to english law, but rather according to “the law of nature which by some is called the law merchant, which is law universal throughout the world”.57 gerard malynes, writing in 1622, traces the existence of uniform merchant customs back to ancient greek and biblical times, “[s]o that it plainely appeareth, that the law merchant, may well be as ancient as any humane law, and more ancient than any written law”.58 its precursor may have also been the sea law of rhodes59 from ancient greece, and the roman ius gentium, which was the body of law that governed trade between foreigners and roman citizens.60 however, during malynes’ time, the lex mercatoria had gained such a foothold in the commercial routes of europe and the mediterranean that he could declare, “[f]or albeit that the government of the said kingdoms and common-weales doth differ one from another: 1 in the making of lawes and ordinances for their owne government […] yet the law-merchant hath always beene found semper eadem, that is, constant and permanent without abrogation, according to her most auncient customes, concurring with the law of nations in all countries”.61 indeed, one of malynes’ themes throughout his work is that ancient customs grew into a unique body of transnational law, and this law deals most effectively with merchants’ disputes. 1.2 the development of merchant customs with the middle ages came the rise of independent city-states, flourishing seaports, town markets, and boroughs which led to the flow of goods across new national borders.62 the merchants not only brought goods across borders, they also transported their unique customs 55 ibid. at ch. 1, p. 1. 56 ibid. at 128. 57 ibid. at 128-129. the case is anon. v. sheriff of london (the carrier’s case), yb eas. 13 edw. 4, fol. 9, pl. 5, in exchequer chamber cases, 2:32. 58 gerard malynes, the merchant’s almanac of 1622 or lex mercatoria, the ancient law-merchant (metheglin press ed., 1996) (1622). malynes provides numerous references to ancient commercial laws and customs as being uniform among all trading states, from the time of solon in ancient greece to the publication of his lex mercatoria. he also refers to the trade endeavors of jacob, joseph, and moses, as well as minos, lycurgus, phalcas, and others. 59 cutler, supra note 18 at 113. 60 ana mercedes lopez rodriguez, lex mercatoria, rettid (2002) 46 available at http://www.rettid.dk/artikler/20020046.pdf#search='lex%20mercatoria. 61 malynes, supra note 58 at 5 (grammar, spelling, and italics in the original). 62 mendes, supra note 53. nordic journal of commercial law issue 2008#1 12 and practices into foreign markets. the impetus to create or crystallize rules for merchants came from a “desire to overcome the fragmentary and obsolete rules of feudal and roman law”, which were unsuited to the needs of international commerce.63 thus, trading centers began to “reduce local practices into regulatory codes” and the laws of particular towns eventually “grew into dominant codes of custom” with an international flavor.64 stimulated by the maritime trade of burgeoning seaport towns throughout europe, the lex mercatoria soon acquired its “cosmopolitan character and reflected [a retreat] from local law to a universal system of law” that transcended sovereigns and national boundaries.65 the end result was a new legal order, free from burdensome local laws and local legislators.66 in other words, the lex mercatoria became not only an autonomous body of commercial law, but also the embodiment of commercial practices as reflected in merchant customs. a unique feature of the lex mercatoria was that it incorporated the customs of commerce, trade fairs, markets, and maritime customs relating to trade into a single law.67 it also had additional features, some of which were not unlike the principles adopted by its modern incarnation, the cisg: it was a transnational law; cross-border disputes could be administered by the market tribunals of various trade centers, rather than by professional judges and state courts; justice was quick and informal; and the law stressed equity and fairness, hence, decisions were made on the basis of ex aequo et bono.68 these features speak in favour of the importance of norms and values regarding merchant conduct in trade, and override the importance of adherence to a rigid code of law to govern international sales transactions. this point appears to be lost on the legal realists. 1.3 the nationalization of the lex mercatoria the lex mercatoria governed international commerce for an extremely long period, until the early seventeenth century. at this point the autonomous mercantile courts began to decline in relative importance and the lex mercatoria began to merge with common law.69 the reason for this wane is attributed to the rising influence of nationalism and the quest for state sovereignty.70 the pace accelerated under the influence of sir edward coke, who initiated a comprehensive common law 63 rodriguez, supra note 60. 64 gesa baron, do the unidroit principles of international commercial contracts form a new lex mercatoria? at http://www.cisg.law.pace.edu/cisg/biblio/baron.html. 65 ibid. 66 ibid. 67 louise hertwig hayes, “a modern lex mercatoria: political rhetoric or substantive progress?” (1976-1977) 3 brook. j. int’l l. 210 at 212-214. 68 baron, supra note 64. 69 ibid. 70 see e.g. rodriguez, supra note 60 at 46-47. nordic journal of commercial law issue 2008#1 13 for england and the british empire.71 “during this period, the common law courts were given the power to override any decision[s] in the mercantile courts”.72 thus, in the case of a dispute, merchants would initiate an action with the common law courts and bypass the mercantile courts altogether. eventually, the mercantile courts became superfluous and fell into disuse. those that remained were eventually abolished by national laws.73 “the customs and usages of the merchants, while still relevant, were deemed not binding in the common law courts”.74 instead, “they were treated as ordinary questions of fact, which had to be proved [in each] case to the satisfaction of twelve [civilian] jurors”.75 with the blending of the lex mercatoria with the peculiarities of national law, the former began to lose much of its uniform and cosmopolitan character. it likely would have faded into oblivion had it not been recognized in the mid-eighteenth century by lord mansfield, the chief justice of the king’s bench. in the famous case of pillans v. mierop,76 mansfield held that the rules of the lex mercatoria were questions of law to be decided by the courts, not issues of fact to be proved by the disputing parties.77 with this ruling, the lex mercatoria became “an integral part of the common law”.78 the nationalization of mercantile law, including international sales law, occurred in the nineteenth century. during this period, states began to codify commercial common law rules into national legislation. they decided to take full control over international trade and developed new laws to regulate all aspects of economic relations between commercial parties.79 furthermore, disputes between domestic and foreign parties were to be resolved in state courts by referring to private international law.80 the emergence of these national laws, and the exclusive state court jurisdiction over commercial disputes, marked the demise of the ancient lex mercatoria. by the end of this era, it had dissolved into an array of domestic legal regimes. with nationalization and codification, a universal, developing, cosmopolitan, commercial law ceased to exist.81 71 mendes, supra note 53. 72 ibid. 73 see ibid. 74 ibid. 75 ibid. 76 pillans v. mierop, 3 burr. 1663, 97 e.r. 1035 (1765). 77 baron, supra note 64. 78 ibid. 79 imtyaz m. sattar, “the unidroit principles of international commercial contracts and the vienna sales convention: competing or completing ‘lex mercatoria’?”, (1999) 4 int’l trade & bus. l. ann. 13 at 14. 80 friedrich k. juenger, “the lex mercatoria and private international law”, (2000) 60 la. l. rev. 1133 at 1136. 81 baron, supra note 64. nordic journal of commercial law issue 2008#1 14 1.4 disenchantment with national commercial laws but by the 1900s, there were already signs that the international trade community felt unduly restricted by the array of national legal systems governing their cross-border transactions. as w. mitchell remarks, “whenever the private law is splintered into many jurisdictional fragments, the need for uniformity shows up most strongly in the field of commercial law”.82 the complexity of the rules of private international law, and the obsolete character of domestic laws, failed to satisfy the business community’s need for simplicity and predictability in cross-border trade. in particular, conflict of law rules often produced results that appeared arbitrary and impractical. it also became recognized that national laws were primarily enacted to govern domestic transactions and often failed to address the unique requirements of international transactions.83 the end result was the impairment of global trade. as lord justice kennedy wrote in 1909: the certainty of enormous gain to civilised [sic] mankind from the unification of law needs no exposition. conceive the security and the peace of mind of the shipowner [sic], the banker, or the merchant who knows that in regard to his transactions in a foreign country the law of contract, of moveable property, and of civil wrongs is practically identical with that of his own country.84 states soon became aware of the negative impact on international commerce by a world divided into so many legal systems. non-governmental institutions, such as the international chamber of commerce (“icc”) and its international court of arbitration were established to address some of the flaws inherent in the national regulation of global commerce.85 in 1926, the international institute for the unification of private law (“unidroit”), an independent intergovernmental organization, was also founded as an auxiliary organ of the league of nations. its objective was to find methods for modernizing and harmonizing private international law between states or groups of states.86 following the demise of the league, unidroit was re-established in 1940 and continues to work towards preparation of modern, harmonized uniform rules of private law.87 82 mendes, supra note 53, citing w. mitchell, essay on the early history of the law merchant (1st ed. 1969) at 90. 83 see e.g. rodriguez, supra note 60 at 51. 84 lord justice kennedy, “the unification of law”, (1909) 10 j. soc’y of comp. legis. 21, 214-15 reprinted in kastely, supra note 38. 85 international chamber of commerce, merchants of peace, the icc story available at http://www.iccwbo.org/id6167/index.html. 86 international institute for the unification of private law (unidroit), about unidroit, http://www.unidroit.org/english/presentation/main.htm. 87 see ibid. nordic journal of commercial law issue 2008#1 15 1.5 the rise of the new lex mercatoria the establishment of the icc and unidroit reflected the renewed interest in—and rediscovery of—the historical, cosmopolitan character of commercial law and the desire on the part of the business community to free itself from the restrictions of national law.88 states began to address this dissatisfaction by introducing international conventions and model laws in the effort to harmonize private international law across borders.89 considering the various economic, social, political, and legal systems of numerous participating states, the process was— and continues to be—difficult and time-consuming. however, considerable progress has been made, especially in the fields of arbitration, factoring, leasing, letters of credit, sale of goods, and contracts. in the 1960s, academics also began to question the effectiveness of national law in international transactions, and they also noted the revitalization of the lex mercatoria.90 as ana rodriguez notes, “[j]ust as the medieval merchants overcame feudal law, present time traders were adopting alternative solutions to avoid the application of national law to their transactions”.91 with the use of standardized contract clauses, self-governing contracts, trade term usages, and recourse to international commercial arbitration, merchants began to introduce their own regulatory regime, which operated autonomously, as an addendum of national law.92 indeed, some academics have suggested that the new law merchant is simply denationalized law.93 this development has since become known as the new lex mercatoria.94 it is within the context of this dissatisfaction with national legal regimes, and the renaissance of the lex mercatoria, that the cisg came into being.95 88 mendes, supra note 53. 89 see ibid. 90 rodriguez, supra note 60 at 47. 91 ibid. 92 see ibid. 93 see e.g. barton s. selden, “lex mercatoria in european and u.s. trade practice: time to take a closer look” (1995) 2 ann. surv. int’l & comp. l. 111. barton provides an interesting contemporary example of denationalized (or internationalized) law. he notes a remarkable clause in the agreement to construct the english channel tunnel between eurotunnel (the owner and operator) and transmanche link (the group of english and french construction companies). the clause provides that the agreement shall “be governed by and interpreted in accordance with the principles common to both english law and french law, and in the absence of such common principles by such general principles of international trade law as have been applied by national and international tribunals”. selden, ibid. at 116. 94 on the new lex mercatoria see note 18, supra. 95 john felemegas, “the united nations convention on contracts for the international sale of goods: article 7 and uniform interpretation”, (2001-2002) pace rev. of cisg 115, 130-140. see also bernardo m. cremades & steven l. plehn, “the new lex mercatoria and the harmonization of the laws of international commercial transactions” (1983-1984) b.u. int’l l.j. 317 at 319-323. nordic journal of commercial law issue 2008#1 16 berthold goldman in the 1960s, and lord mustill in the 1980s, spearheaded the modern revitalization of the lex mercatoria.96 this movement ultimately led to the creation of the cisg and related uniform conventions, such as the uncitral model law on international commercial arbitration,97 and the unidroit principles of international commercial contracts,98 to name a few. lord mustill analyzed the principles of the lex mercatoria and defined this body of law and custom as follows: in the first place, the lex mercatoria is ‘anational.’ this concept has two facets. first, the rules governing an international commercial contract are not, at least in the absence of an express choice of law, directly derived from any one national body of substantive law. second, the rules of the lex mercatoria have a normative value which is independent of any one legal system. the lex mercatoria constitutes an autonomous legal order.99 the lex mercatoria is, thus, a set of principles and norms from which merchants, courts, and arbitral panels can seek guidance to settle disputes. a difficult issue, however, is to determine which principles constitute the lex mercatoria. this imperfection allows the realist to charge that the lex mercatoria—and by implication, its modern incarnation, the cisg—is a vague set of rules, or perhaps a “non-subject”.100 even lord mustill had to consider the usefulness of the lex mercatoria and ask “whether it can and does exist as a viable system”.101 96 andrew tweeddale & keren tweeddale, arbitration of commercial disputes (oxford: oxford university press, 2005) at 194. the sources referred to in tweeddale & tweeddale include: bertold goldman, “la compagnie de suez, societe international” (4 october 1956) le monde at 3; frontieres du droit et lex mercatoria (1964) archives de philosophie du droit at 177; la lex mercatoria dans les contrats et l’arbitrage internationaux: realite et perspectives (clunet, 1979) at 475. lord mustill, “the new lex mercatoria: the first twenty-five years” (1987) in liber amicorum for lord wilberforce. 97 uncitral model law on international commercial arbitration, united national commission on international trade law (“uncitral”), (united nations document a/40/17, annex i, 21 june 1985). 98 international institute for the unification of private law, unidroit principles of international commercial contracts 2004, (rome: international institute for the unification of private law (“unidroit”) 83rd session, 2004). note that the preamble states: these principles set forth general rules for international commercial contracts. they shall be applied when the parties have agreed that their contract be governed by them. they may be applied when the parties have agreed that their contract be governed by general principles of law, the lex mercatoria or the like. 99 lord mustill, quoted in tweeddale & tweeddale, supra note 96 at 194. 100 ibid. at 194-195. 101 ibid. at 195. nordic journal of commercial law issue 2008#1 17 2. the indeterminacy of customs-based law 2.1 the legal realist critique of the new and medieval lex mercatoria a main point that the realist charge is that the lex mercatoria is not a “law”, or it is, at most, “soft law”, that is, it is a guide that sets a standard of conduct, but it is not legally binding. this criticism has similarly been made of the cisg.102 however, courts and arbitral panels have used soft law rules as evidence of international customary law in order to oust national laws.103 realists’ may argue that the lex mercatoria lacks both a methodological base, and a legal system supporting it, and is dependent on national legal systems to work efficiently. moreover, it does not have any state authority from which it can derive its binding force. as such, it is typically argued, it cannot govern a contract, because a contract concluded between private parties must be based on the municipal law of some state. law is made exclusively by nation-states. hence, a contract intended to be subject to the lex mercatoria would be a stateless contract, one floating in a legal vacuum. a state-free contract, thus, presents a logical impossibility, and is an intellectual solecism. furthermore, trade practices, usages, and customs of international trade only acquire the character of law to the extent that they are incorporated into national legal systems, either expressly or impliedly. perhaps most importantly, implicit in the realist perspective is the notion that the lex mercatoria, as an autonomous body of law, is incomplete, vague, and somewhat incoherent. in other words, it is indeterminate. they attempt to uncover what constitutes this alleged body of law, or try to locate where it can be found. the general principles, rules which are reflected in the law of all trading nations and which are said to constitute the core of the lex mercatoria, are to be distilled by means of a comparative analysis of representative national laws. however, uncovering rules and principles that are common to most nations is a daunting task. considering the diversity of national legal systems and the vast number of states, there are only very few principles that are truly common to a representative number of legal systems. while this is not a concern of the realists, it is important to note that “common principles” are often too general and too broad to solve any but the simplest problem, let alone a complex commercial dispute. the often cited principles of, for example, good faith or pacta sunt servanda, are as such abstract principles. they gain meaning only through the supplementary rules, court decisions, and the enforcement mechanisms in the various national legal systems. however, the realist sees these interpretive devices as leading to doctrinal inconsistency. as clare dalton notes, “doctrinal inconsistency necessarily undermines the force of any conventional legal 102 for an example of the use of cisg as “soft law”, see larry a. dimatteo, “resolving international contract disputes” (1998) 53 disp. resol. j. 75, at 79. dimatteo states: “the cisg, along with the unidroit principles, provide arbitrators a suitable framework for deciding international contract disputes by the application of the general principles that underlie [these] documents”. see also e.g. rosett, supra note 21 and kastley, supra note 38. 103 larry a. dimatteo, “contract talk: reviewing the historical and practical significance of the principles of european contract law” (2002) 43 harv. int’l l.j. 569 at 571. nordic journal of commercial law issue 2008#1 18 argument, and […] opposing arguments can be made with equal force […] [l]egal argumentation disguises its own inherent indeterminacy […] [l]egal doctrine is unable to provide determinate answers to particular disputes”.104 dalton’s focus on doctrinal inconsistency, and by extension, the indeterminacy of law, is misplaced. while she was addressing issues in contracts, and not the lex mercatoria or the cisg, dalton fails to appreciate that an international commercial code can provide for the acceptance of similar norms, and a common medium for communication—a lingua franca. 2.2 undermining the legal realist critique the lex mercatoria evolved independently of local political authorities or institutions. it comprised a deterritorialized legal order, “that did not derive its normative claims from treaties amongst sovereign states”.105 as a private commercial order, it existed outside the local political economy. this gave rise to a dualistic system of governance in commerce: laws and regulations for local commerce and the lex mercatoria for transnational commerce. it was essentially a selfregulatory merchant community in the creation of laws, and in dispute resolution.106 this community also created property rights and entitlements that were entirely inconsistent with traditional medieval concepts of property.107 the conception of equity in merchant courts also differed considerably form the canonical view of equity.108 although there existed normative and institutional pluralism in medieval society, including canon law, feudal law, manorial law, urban law, and local merchant law, local authorities were unable to enforce the lex mercatoria, and deferred to merchant courts.109 the lex mercatoria, as an autonomous body of law, evolved contrary to the jurisprudence of positivism. positivism is based on the theory that all law is derived from the will of sovereign states, and that international law is derived from the combined wills of many sovereign states. hence, legislation is seen as the heart of law, and, contrarily, the realist would tend to downplay the importance of the role of commercial customs, norms and values as guiding behaviour. as ole lando states, “the binding force of the lex mercatoria does not depend on the fact that it is made and promulgated by state authorities but that it is recognized as an autonomous norm system by the business community and by state authorities”.110 as such, the lex mercatoria, as a code of legal-commercial norms is different to the traditional concept of 104 clare dalton, “an essay in the deconstruction of contract doctrine” (1985) 94 yale l. j. 997 at 1007. 105 boaventura de sousa santos, quoted in cutler, supra note 18 at 109. 106 cutler, supra note 18 at 110. 107 ibid. at 111. 108 ibid. at 116-117. 109 ibid. at 109. 110 ole lando, “the lex mercatoria and international commercial arbitration” (1985) 34 i.c.l.q. 747 at 754. nordic journal of commercial law issue 2008#1 19 “law” as the law to be found in legal texts, codes, and case law. it is, moreover, an evolving, “living law” which is the product of the adaptability and inventiveness of commercial merchants and which, therefore, concentrates on those legal norms that can be enforced in practice. the principles of the lex mercatoria are embodied not only in the cisg, but elsewhere as well. indeed, in recent years the lex mercatoria has developed into a substantial code. for example, lists of the constituent elements of the lex mercatoria have been compiled.111 while by no means definitive, the lists include: public international law; uniform laws; the general principles of law; the rules of international organizations; customs, practices, and usages; and the reporting of arbitral awards.112 furthermore, the transnational law database lists over eighty principles which constitute the lex mercatoria.113 this database is regularly updated with new principles and case awards. in commercial practice, the lex mercatoria has been applied by parties to assist in the resolution of disputes, including the iran-united states claims tribunal.114 most modern arbitration legislation will also permit parties to choose an applicable law, even if this law is not a national law per se, but rather the lex mercatoria.115 thus, the realist criticism that the lex mercatoria, and its related conventions, such as the cisg, are too indeterminate to provide a comprehensive set of rules that can guide merchant behavior, and help to resolve disputes, is undermined. iv. the embedded norms of the cisg and the neo-realist approach 1. the incorporation of norms 1.1 the “general provisions” of the cisg one of the most interesting features of the cisg is how it incorporates a set of norms for international merchants. it does this through the incorporation of certain principles, which evolved from the lex mercatoria. in particular, the cisg organizes ideological values by giving legal sanction and effect to commercial usages, practices, and customs. in this way, the cisg can be viewed as more of an attempt to harmonize international commercial values, than as a model of unified black letter law. for example, it provides for the inclusion of “general 111 lando, ibid. at 749-751. lando lists the following elements that comprise the law merchant: 1) public international law; 2) uniform laws; 3) general principles of law; 5) rules of international organizations; 6) customs and usages; 7) standard form contracts; and, 8) the reporting of arbitral awards. 112 see e.g. ibid. and tweeddale & tweeddale, supra note 96 at 195. 113 center for transnational law (central), university of cologne, germany, transnational law database at http://www.tldb.net. 114 tweeddale & tweeddale, supra note 96 at 196. 115 ibid. nordic journal of commercial law issue 2008#1 20 provisions”,116 which are a means for avoiding repetitions in the text of the law. they govern a broad field, and as a body of rules they are heterogeneous—or indeterminate, in the language of the realists. they serve many purposes, and govern the interpretation of the cisg. general provisions also deal with closing gaps in the law, and provide rules for the interpretation of the statements and conduct of the parties to a contract, that is, the commercial understandings between parties. however, it is the indeterminate nature of these “gaps” in the form of general provisions that provide the realists with the fuel to critique the cisg as a body of law. the realist would reject the legal rule involved in filling gaps in the cisg through the use of the convention’s general provisions, as this simply provides an example of the law’s inability to provide reasons for obedience. 1.2 rules of interpretation the failure of the realist to consider the importance of an open-textured, interpretative approach to the cisg is where they go wrong. article 7 establishes the main interpretive rules, or the normative framework, for the convention. in this regard, article 7 states that “[i]n the interpretation of this convention, regard is to be had to its international character and to the need to promote uniformity in its application and the observance of good faith in international trade”.117 this requires courts to avoid recourse to domestic legal concepts, unless they have no other option. to this end, article 7(1) emphasizes the importance of having due regard for the convention’s international character, as well as for the need to promote uniformity across all signatory states. strict uniformity, while not a direct concern of the realist, is not possible. from a slightly different perspective, article 7 also contributes significantly to the harmonization of values. reliance on domestic law would likely lead to different, contradictory, and confusing rules, ultimately defeating the purpose of the cisg. as a result, the functional uniformity at the heart of the cisg requires that legal practitioners, tribunals, and courts look to standards of international practice (i.e. international commercial customs) in an interpretation or a determination of provisions of the convention. as c.k. allen notes, “[t]he operation of statute is not automatic, and can never be so. like all legal rules, it has to take effect through the interpretation of the courts”.118 this is where the realists direct their attack. instead of considering that the embedded norms within the cisg might guide doctrine (and thus, behavior), the realist would instead note that any body of legal doctrine allows a judge to justify any result desired in any particular case. indeterminacy involves revealing that a seemingly determinate legal rule is in fact “open textured” in that it allows a judge to perform a makeshift balancing of a number of factors. legal doctrine is 116 see eorsi, supra note 43. 117 cisg, supra note 11 at art. 7(1). 118 c.k. allen, law in the making, 6th ed., (1958) at 466 quoted in eorsi, supra note 43 at 2-13. nordic journal of commercial law issue 2008#1 21 deemed indeterminate because any legal rule can be opposed by a counterrule. because the rule and the counterrule support opposing results, the authoritative legal materials, taken as a whole, fail to provide determinate outcomes in any given case. duncan kennedy provides an example in contract law: in [certain] situations, a “rule” that appears to dispose cleanly of a fact situation is nullified by a counterrule whose scope of application seems to be almost identical. agreements that gratuitously increase the obligations of one contractual partner are unenforceable for want of consideration. but, such agreements may be binding if the judge can find an implied rescission of the old contract and the formation of a new one incorporating the unilaterally onerous terms. the realists taught us to see this arrangement as a smokescreen hiding the skillful judge's decision as to duress in the process of renegotiation, and as a source of confusion and bad law when skill was lacking.119 in the common and civil law systems there are various methods of statutory interpretation which provides for unpredictable legal outcomes. this helps to explain why the realists are skeptical of legal rules as determinants of legal decisions. however, the realist preoccupation with rules has blinded them of common norms embedded within doctrine. these norms help in the establishment of a certain degree of consistency in judicial rulemaking. for example, the swiss code of obligations provides that interpretation should be based on the common intent of the parties without regard to vague expressions and terms.120 such an approach speaks to an embedded norm. however, in the example involving the swiss code, the realists would typically focus their criticism on the rule, and not the norm, that is, the focus would be on the vague expressions and terms instead of on the degree of consistency in the application of the common intent of the parties. similarly, the german bgb contains a provision on the interpretation of a declaration of intent in general, and another specifically on the interpretation of contracts; the first requires that the true intent, and not the literal meaning of the wording, should be taken into consideration, and the second provides that a contract must be construed in conformity with treu und glauben.121 again, the attention is on the norms embedded in rules. finally, the hungarian civil code provides that a contractual declaration shall be construed in the way the other party must have meant, in accordance with the generally accepted meaning of the wording employed, having regard to the presumed intent of the party making the statement, and to the circumstances of the case.122 there is also the debate between broad or restrictive interpretation. the realist might argue that either approach still focuses on a closed system of rules, and that any judicial decision 119 kennedy, supra note 20 at 1700. 120 eorsi, supra note 43 at 2-13. 121 ibid. 122 ibid. nordic journal of commercial law issue 2008#1 22 following thereafter is a (flawed) form of deduction. generally, common law traditions are rooted in the style in which statutes are drafted to favour narrow interpretation, and the civil law systems, with their systematic codes, favour broad interpretation.123 in any event, as c. k. allen notes, the “greatest inconsistency is between ‘broad’ and ‘narrow’ interpretation”.124 this may be true but there is also much truth in the arguments of lazlo réczei who believes that the policy of the cisg is to extend its sphere of application to approach universality. this suggests the acceptance and embracement of a common set of values across national borders. certainly it follows from article 7 that the cisg must be interpreted extensively in order to encompass doubtful issues under the convention, and offset the homeward trend, which only leads to divergent, and non-uniform interpretations of the convention. however, perfection in the interpretation of the cisg was never its goal. flawlessness or judicial predictability in any legal instrument will never be achieved. the cisg incorporates a practical approach that is simultaneously interpretative and normative. article 8(3) of the cisg states, for example, that “[i]n determining the intent of a party or the understanding a reasonable person would have had, due consideration is to be given to all relevant circumstances of the case including the negotiations, any practices which the parties have established between themselves, usages and any subsequent conduct of the parties”.125 this provision uses trade usages as a factor for interpreting the will of the parties as it lends an interpretative value to the usages. in fact, modern interpretation, particularly in the field of contracts, is inclined to rely on such devices as the commercial practices established between the parties, the preliminary negotiations, trade usages, prior and subsequent conduct, as noted in article 8(3). the policy rationale for this approach is to assure legal security and commercial predictability in both domestic and international trade, but by default this approach recognizes the existence of an inherent set of common values. 1.3 trade usages, the hierarchy of norms and the cisg other important provisions in the cisg concerning trade usages are those embodied in article 9. it states that “[t]he parties are bound by any usage to which they have agreed and by any practices they have established between themselves” and that “[t]he parties are considered, unless otherwise agreed, to have impliedly made applicable to their contract or its formation a usage […] which in international trade is widely known to, and regularly observed by, parties to contracts of the type involved in the particular trade concerned”.126 in this way, article 9 grants normative value to trade usages. 123 according to eorsi, ibid. 124 c.k. allen, at 509 quoted in eorsi, ibid. at 2-14. 125 cisg, supra note 11 at art. 8(3). 126 ibid. at art. 9(1) and 9(2) respectively. nordic journal of commercial law issue 2008#1 23 article 9 also reconciles two competing theories regarding trade usages. the first is the subjective theory, according to which usages can only be applicable if parties have agreed to them. the usages are seen as part of the contract and usages unknown to either party can never, according to this theory, be applicable. in contrast is the objective theory, based on the notion that usages are applicable if they represent a legal norm and have a normative power. the application of usages in an agreement is independent of the intention of the parties. it “comes from the binding force of the usage itself” and implies that “[e]ven usages unknown to both parties can be applicable to an agreement in this theory”.127 both theories, and their reconciliation, are reflected in article 9 of the cisg. the reconciliation of the subjective and objective theories can be determined in the hierarchy of norms.128 this is crucial, as it suggests that the norms embedded in the cisg are paramount, especially relative to any strict reading of the text. the convention does not expressly state that in case of a conflict between usages and the provisions of the convention the former will prevail. this does not mean that under the cisg the usages may apply only to the extent that they do not conflict with any of the convention’s provisions. according to the prevailing view within uncitral,129 and during the negotiations and drafting of the cisg at the vienna conference,130 such an express statement was simply considered to be unnecessary as the precedence of the usages applicable under article 9(1) and (2) automatically follows from article 6, which embodies the principle of the parties’ autonomy.131 case law supports the recognition of the norms embodied in the cisg through the concept of trade usages. thus, the usages of trade should prevail over the textual provisions of the convention, independently of whether they bind the parties pursuant to article 9(1) or article 9(2). for example, according to the austrian oberster gerichtshof, “[t]hus adopted, agreed usages, established practices and widely known and regularly observed usages prevail over other deviant cisg provisions”.132 in an earlier decision, regarding the employment of trades, the court stated that “austrian usages, if applicable, would prevail over the provisions of the 127 patrick x. bout, “trade usages: article 9 of the convention on contracts for the international sale of goods” (1988) available at http://www.cisg.law.pace.edu/cisg/biblio/bout.html. also quoted in chalarambos pamboukis, “the concept and function of usages in the united nations convention on the international sale of goods” (2006) 25 j.l. & com. 107 at 109. 128 pamboukis, ibid. at 109. 129 ibid. 130 ibid. 131 ibid. cisg article 6 states: “the parties may exclude the application of this convention or, subject to article 12, derogate from or vary the effect of any of its provisions”. 132 clout case no. 425 [oberster gerichtshof, austria, 21 mar. 2000] available at http://cisgw3.law.pace.edu/ cases/000321a3.html. nordic journal of commercial law issue 2008#1 24 cisg”.133 another example can be found in a ruling by a german court, which “observed that the provisions contained in the articles 38 and 39 [of the cisg] can be derogated [...] through a usage, [even though] in the case at hand, [the court] excluded such a possibility”.134 moreover, according to the national commercial court of first instance in argentina, “‘international trade usages’ are assigned by [the] cisg itself a hierarchical position higher than the very same cisg provisions”.135 the hierarchical rank of the applicable rules of law to a contract that falls within the scope of the cisg has been analyzed by chalarambos pamboukis.136 his analysis is also supported by patrick x. bout.137 pamboukis states these rules can be placed in the following order of importance: a) the mandatory provisions of the applicable national law. b) the trade usages that the parties have impliedly made applicable to their contract (article 9(2)). c) the trade usages to which the parties have explicitly or implicitly agreed or the practices they have established between themselves (article 9(1)). d) the provisions of the convention. e) the general principles underlying the convention (article 7(1)). f) the law applicable by virtue of the rules of private international law of the forum state (article 7(2)).138 this hierarchy demonstrates the influence of trade usages, which are an integral part of the norms embedded in the cisg, on the drafters of the convention. trade usages are not only capable of both filling in the gaps in a contract and interpreting it’s terms, they also constitute 133 clout case no. 240 [oberster gerichtshof, austria, 15 oct. 1998] available at http://cisgw3.law.pace.edu/ cases/981015a3.html. 134 clout case no. 292 [oberlandesgericht saarbrücken, germany, 13 jan. 1993] available at http://www.unilex.info/case.cfm?pid=1&do=case&id=180&step=abstract. 135 juzgado nacional de primera instancia en lo comercial, argentina, 6 oct. 1994 (bermatex v. valentin rius) available at < http://cisgw3.law.pace.edu/cases/941006a1.html>. 136 pamboukis, supra note 127 at 110. 137 bout, supra note 127 at i states: “usages applicable to a case take precedence over contradictory articles in the cisg. this precedence is mainly based on the autonomy of the parties in article 6 cisg. usages that, based on article 9 cisg, are applicable to an agreement, are also part of that agreement. by virtue of article 6 cisg, parties are free to opt out of the cisg or to fit it to their individual needs. a contradictory usage can in that sense be seen as an adaptation of the cisg, agreed between the parties. an otherwise applicable usage can, however, be excluded from an agreement, due to its conflict with a national validity rule”. 138 pamboukis, supra note 127 at 110. nordic journal of commercial law issue 2008#1 25 the core of the lex mercatoria.139 both trade usages and the will of the parties prevail over national law with the exception of the mandatory provisions. in other words, the cisg’s value system is of overriding importance. consequently, international trade practice led to the creation of a convention that sets as its primary goal to regulate practice by assigning normative value to trade usages. in the process, strict interpretations and the narrow confines of doctrine are relegated to a subordinate role. the convention provides the foundation for the legal effect of usages, by giving them a status superior to the convention rules itself. usages will, thus, prevail over other articles of the cisg either by virtue of the will of the parties (article 9(1)) or objectively (article 9(2)). on the contrary, and in light of the complex character of international transactions, the convention did not intend to provide, or even to incite, a codification of trade usages and it does not contain a definition of usages or practices. this deliberate omission provides much fodder for the realists. finally, the cisg incorporates a variety of contextual legal standards that depends on ex post substantive interpretation of their open-textured content. these include not only the general principles of article 7(1) and the trade usage provisions of article 9, but also provisions that prescribe a reasonableness test for all interpretative questions;140 that allow contractual liability to be imposed without any formal writing requirement;141 that direct tribunals to interpret the entire convention in light of unspecified standards of good faith in international trade;142 and, that direct tribunals to consider all relevant evidence in interpreting the parties’ intentions and expectations, including even communications that would be barred as parol evidence under common law systems.143 in short, these provisions constitute part of the mercantile value system. and it is this system of values which provides for a new, neo-realist perspective on the cisg. 139 ibid. at 105. 140 cisg, supra note 11 at article 8(2). 141 ibid. at article 8(3). 142 ibid. at article 7(1). 143 ibid. at article 11. nordic journal of commercial law issue 2008#1 26 v. the contributions of the legal realists, the cisg, and the harmonization of values 1. the benefits of the legal realist perspective 1.1 challenging orthodoxy the need for a neo-realist perspective on the cisg does not discard all of the teachings of the realists movement. the realist school has had a positive impact on jurisprudence, legal theory, and legal institutions. in the words of joseph william singer, “[l]egal realism has fundamentally altered our conceptions of legal reasoning and the relationship between law and society”.144 this is the message that the critical legal studies movement inherited, as singer suggests: “all major current schools of thought are, in significant ways, products of legal realism. to some extent, we are all realists now”.145 morton j. horwitz adds to this praise, and notes that “the most important legacy of realism” is its “challenge to the orthodox claim that legal thought was separate and autonomous from moral and political discourse”.146 the realist attack on deductive legal reasoning constituted the realists’ most “original and lasting contributions to legal thought”.147 but if we are all realists now, why is their message still controversial? perhaps in their vigour, the realists’, to use the words of edward bloustein, simply “overshot their mark”, that is, they destroyed one dogma, but then substituted another in its place.148 2. neo-realism: focusing on the harmonization of commercial norms realism is concerned with the logical deductions behind the façade of the law. thus, neorealism should be viewed more as a variation of the realist approach in that it attempts to identify the values and norms that underlie the technical rules of laws, such as the lex mercatoria and the cisg. from this perspective, a neo-realistic approach to the cisg is more of an attempt to harmonize not so much the law of the convention across national borders, but rather calls for a new focus on the harmonization of commercial values and norms in place of the unfruitful search for a perfectly predictable, transnational, uniform law. such an approach would also acknowledge the importance of international commercial norms, that is, the new lex mercatoria. its recent re-emergence may be due to certain similarities of today’s commercial environment to that of medieval europe. both periods can be characterized by a geographically 144 joseph william singer, “legal realism now” (1988) 78 cal. l. rev. 465. 145 ibid. at 467. 146 morton j. horwitz, the transformation of american law, 1870-1960: the crisis of legal orthodoxy (new york: oxford university press, 1992) at 193. 147 ibid. at 199. 148 bloustein, supra note 16 at 24. nordic journal of commercial law issue 2008#1 27 mobile commercial class operating across national borders, where local laws rarely agreed. yet, despite wide differences among national legal systems, there exists a high degree of uniformity in norms and contract practices for the international sale of goods. 2.1 transplanting law or commercial norms? the notion that laws can be successfully transplanted (i.e. harmonized or unified), that is, promulgated and interpreted in various national jurisdictions, has been a matter for debate for centuries. this debate continues today regarding the relative success or failure to implement uniform laws across nations.149 one of the earliest examinations of this question was undertaken by montesquieu in his 1748 publication of the spirit of the laws.150 montesquieu, for example, discussed the transferability of the law at great length, and identified such indigenous characteristics as climate, terrain, population and religion as keys to determining governmental structures, and to understanding the diverse practices of nations in matters of public and private law.151 on the specific question of the transferability of law, montesquieu states, “[a]s the civil laws depend on the political institutions, because they are made for the same society, whenever there is a design of adopting the civil law of another nation, it would be proper to examine beforehand whether they have both the same institutions and the same political law”.152 to montesquieu, differences in the political and social makeup between nations impede the successful transplantation of laws. montesquieu’s observations regarding the transferability of law have been debated more recently. unfortunately, this debate has failed to consider the role of the lex mercatoria as a set of norms, and as a commercial law that transcends national boundaries. in any event, this debate provides the necessary theoretical context for the application of a neo-realist approach to the attempt to create uniform law, such as the cisg. it is significant that much of this debate focuses on the law, rather than the norms that lie beneath the law, as is evident in the lex mercatoria and cisg. otto kahn-freund, for example, relies on montesquieu to support his own proposition that law is so inextricably linked to its environment that it can rarely change its habitat.153 where the “habitant” of the law is transnational is not considered. his central thesis is that while it may be more than two hundred years since montesquieu’s work, the 149 see e.g. james e. bailey, “facing the truth: seeing the convention on contracts for the international sale of goods as an obstacle to a uniform law of international sales” (1999) 32 cornell int’l l.j. 273; philip hackney, “is the united nations convention on the international sale of goods achieving uniformity?” 61 la. l. rev. (2001) 473; paul b. stephan, “the futility of unification and harmonization in international commercial law” (1999) 39 va. j. int’l l. 743; steven walt, “novelty and the risks of uniform sales law” (1999) 39 va. j. int’l l. 671. 150 baron de montesquieu, the spirit of the laws, trans. by thomas nugent (new york: hafner publishing co., 1959). 151 ibid. at vol. ii, 42-43. 152 ibid. at vol. ii, 163. 153 otto kahn-freund, “on uses and misuses of comparative law” (1973) 37 mod. l. rev. 1. nordic journal of commercial law issue 2008#1 28 geographic, economic, and social differences between nations may have narrowed, but the political differences have greatly expanded.154 kahn-freund statement may be less persuasive today, as it was written during the cold war. the geo-political structure of the world has since changed with the collapse of the soviet union and the fall of communism, and the arrival of the asian economic tigers. the important point, however, is that religious, social, political, and economic differences between nations can provide barriers to the transferability of law. the implication for the cisg is that uniform law stands little chance of successful transplantation from one nation to another, even though it is not a “national” law per se. however, the growth of globalization in the last few decades, which has tended to blunt national differences, favours unification efforts, and the development of the new lex mercatoria. in response to kahn-freund, alan watson does not dispute that law is deeply embedded in its political context. but where law is autonomous, that is, free from the confines of national political institutions, is not addressed. he argues that both montesquieu and kahn-freund, like true realists’, underestimate the degree of successful transplantation of legal ideas that has taken place not only historically, but also in the modern era.155 watson states that successful borrowing can be accomplished from very different legal systems, even without systematic knowledge of the law or the political structure of the donor state or legal system.156 he concludes by stating that “[w]hat the law reformer should be after in looking at foreign systems was an idea which could be transformed into part of the law of his country”.157 this close link between ideas and norms has not been lost on the drafter’s of the cisg. watson continues this line of thinking in a later article, and points to the lengthy history of legal transplantation from roman times to the present.158 in doing so, he challenges kahn-freund’s link between law and social structures: to a large extent law possesses a life and vitality of its own; that is, no extremely close, natural or inevitable relationship exists between law, legal structures, institutions and rules on the one hand and the needs and desires and political economy of the ruling elite or of the members of the particular society on the other hand. if there was such a close relationship, legal rules, institutions and structures would transplant only with great difficulty, and their power of survival would be severely limited. changes in societal structure would always entail changes in the law.159 154 ibid. at 8. 155 alan watson, “legal transplants and law reform” (1976) 92 law q. rev. 79. 156 ibid. 157 ibid. emphasis added. 158 watson, “comparative law and legal change” (1978) 37 cambridge l.j. 313. 159 ibid. at 314-315. nordic journal of commercial law issue 2008#1 29 bernard grossfeld has analyzed the transferability of law based on the same factors and national endowments noted by montesquieu.160 he argues that “[t]he culture and law of a country are as dependent on its geography as is its very terrain”.161 accordingly, grossfeld rejects the notion that ideas are universal, or are capable of easy transplantation and reception across national boundaries. such a view fails to explain the success, longevity, and re-emergence of the lex mercatoria. grossfeld’s position also contrasts with the words of lord mansfield, who expressed the view more than 250 years ago that “mercantile law […] is the same all over the world. for from the same premises, the sound conclusions of reason and justice must universally be the same”.162 other scholars have focused on the transformative power of legal transplants.163 they echo the teachings of montesquieu, kahn-freund, and grossfeld by suggesting the lack of success with the transferability of law.164 similarly, according to anthony d’amato, modern legal theory, borrowing heavily from literary criticism, puts forward the proposition that law cannot be easily transferred.165 this suggests that legal texts are not authoritative statements of either the author’s intent or the objective, plain meaning. there is little in any text that can effectively convey the author’s intent or any stable meaning to the reader. instead, the focus shifts to the reader’s construction of the text based on the reader’s life experience, social setting, and value system. black letter law and doctrine would rarely, if ever, transfer to another setting with its exact message intact. the implications for the cisg are clear: the transfer or harmonization of international commercial law does not necessarily offer any realistic prospect for the desired outcomes, assuming that strict uniformity of the cisg is its primary goal. as the realists’ tend to focus on strict uniformity, instead of the relative uniformity of commercial norms, the law that is transferred upon each nation’s ratification of the cisg is not likely to be identical in every signatory state. 2.2 convergence or divergence? not surprisingly, according to a recent study, the divergent interpretations of the cisg remain a problem with most signatory states.166 some of the problem is due to the ambiguous and open-textured language incorporated in the cisg. oftentimes, a high level of abstraction and 160 bernard grossfeld, “geography and law” (1984) 82 mich. l. rev. 1510. 161 ibid. at 1511. 162 pelly v. royal exch. assurance co., 97 e.r. 342, 346 (1757). 163 see e.g. anthony allott, “the unification of laws in africa” (1968) 16 am. j. comp. l. 51 and john h. beckstrom, “transplantation of legal systems: an early report on reception of western laws in ethiopia” (1973) 21 am. j. comp. l. 557. 164 ibid. 165 anthony d’amato, “aspects of deconstruction: the failure of the word ‘bird’” (1990) 84 nw. u. l. rev. 536. 166 larry a. dimatteo et al., “the interpretive turn in international sales law: an analysis of fifteen years of cisg jurisprudence” (2004) 34 nw. j. int’l l. & bus. j. 299 at 447. nordic journal of commercial law issue 2008#1 30 the use of neutral language were necessary in order to accommodate the diverse political considerations during the drafting of the convention.167 while this created a law that is formally and linguistically uniform in numerous jurisdictions, subsequent litigation creates many opportunities for divergent interpretations of the convention’s provisions.168 perhaps for this reason, dimatteo et al., in their fifteen year review of cisg jurisprudence, found that “[a]t one extreme, some courts have largely ignored the cisg’s mandate that interpretations are to be formulated with an eye toward the international character of the transaction and the need for uniformity of application”.169 at the other extreme are courts that have made a concerted effort to apply the above mandates of the cisg and to attempt to seek out the common values within the cisg, which provides for functional uniformity.170 one example of many is the u.s. court of appeals for the eleventh circuit in mcc-marble ceramic center v. ceramica nuova d’agostino where the court cites foreign jurisprudence on the cisg, and refers to academic commentary.171 the court then notes: [t]he cisg was to provide parties to international contracts for the sale of goods with some degree of certainty as to the principles of law that would govern potential disputes [….] courts applying the cisg cannot, therefore, upset the parties’ reliance on the convention by substituting familiar principles of domestic law.172 not surprisingly, as dimatteo notes, the vast majority of cisg cases fall somewhere in the middle, between the two extremes of recognition and insensitivity to the interpretive requirements of the convention.173 dimatteo concludes on a positive note by acknowledging that there are signs that courts are making a greater effort in applying the cisg’s interpretive methodology in a more uniform manner.174 at the very least, this development illustrates the fundamental difficulties that nations face when trying to implement uniform international law. indeed, as leonardo graffi states, “diverging interpretations by national courts is a problem of all international uniform laws”.175 167 clayton p. gillette & robert e. scott, “the political economy of international sales law”, n.y.u. l. & eco. research paper series, working paper no. 05-02, 2005 available at http://ssrn.com/abstract=709242. 168 ibid. gillette and scott proceed to predict the demise of the cisg because of its failure to supply a truly uniform interpretive language to resolve all contractual problems. 169 dimatteo et al., supra note 166 at 440. 170 on “functional uniformity” see note 10, supra. 171 mcc-marble ceramic center v. ceramica nuova d’agostino, 144 f.3d 1384 (11th cir. 1998). 172 ibid. at 1391. 173 dimatteo et al., supra note 166 at 440. 174 ibid. 175 leonardo graffi, “case law on the concept of ‘fundamental breach’ in the vienna sales convention”, (2003) 3 int’l bus. l.j. 338 at 338. nordic journal of commercial law issue 2008#1 31 vi. conclusion however, considering the divergent interpretations of the cisg, there appears to be little chance of successfully transplanting or harmonizing the cisg in the signatory states, which number over sixty—at least not if the goal is to achieve strict uniformity and doctrinal perfection. thus, what is needed is a neo-realist approach to the transplantation or harmonization of international commercial law. this recognizes both the unique social construction and embedded norms present in the cisg. as values converge, statements of the norms to be honoured may be more useful than the enunciation of a rigid rule or doctrine. neo-realism in this context would look behind the formal text of the rules within the cisg. in the past, this focus has been on the unrealistic, technical sphere of law. divergence in law will never be eliminated, but it can be narrowed. the neo-realist would, instead, examine harmonization of the cisg within the context of the valueand norm-sensitive aspects of lawmaking, which is particularly important when attempting to harmonize law across national borders. successful transference or harmonization ultimately hinges on values, norms and behaviour, not legal rules and texts. references conventions, treaties, and model laws uncitral model 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1 i. introduction∗ # the purpose of this article is to address the importance of pre -contractual liability in the regulation of contemporary commercial relations in an international context. in first instance, i will address the regulation of pre-contractual agreements under colombian domestic law. second, i will be briefly comparing the application and regulation of precontractual liability in colombian domestic law with its application in american law. finally, i will address its application under the cisg and i will include a brief comparison of this convention with colombian domestic law in respect to this matter. in addition, i will provide practical examples to illustrate the application of pre-contractual liability under colombian domestic law and the united nations convention on contracts for the international sale of goods (cisg). ii. the effects of pre contractual agreements in colombia and their liability under the domestic law a. brief historical prospective of pre-contractual liability the law, the doctrine and the jurisprudence in civil law jurisdictions have been regulating issues related to contractual and extra-contractual liability for centuries. however, only in the last century have they turned their attention to pre-contractual liability. in the early years, there was a dilemma in respect to the recognition of pre-contractual liability because it was understood that this pre-contractual stage did not generate responsibility for the parties because there was not a contract and they had freedom to decide whether they wanted to proceed with the negotiations or simply back out from them. therefore, any cost spent by the parties in pre-contractual negotiations should been assumed by them if the contract failed to materialize. ∗ the subject matter of this paper is an analysis of the cisg article 7(1) and its consequences. i also examine the norwegian implementation of the convention, how the norwegian approach relates to the obligations set forth in article 7(1), and whether that approach is a loyal compliance with those obligations. i further address the problems caused by the norwegian transformation and how those problems might be solved. # this essay states the law as at 25 january 2007. nordic journal of commercial law issue 2007 #1 2 conversely, it had been held by some scholars that pre-contractual agreements caused liability. in their opinion, the parties acquire obligations and rights during the pre-contractual stage. for instance, where two parties have been engaged in extended negotiations for the purchase of a complex business, they ought to owe to each other the obligation to act in good faith. therefore, after one party has invested a large amount of money studying and researching the business due to its complexity and in reliance on the other party’s intention to reach a future agreement, the party ought to be compensated for the economical loss caused by the unjustified withdraw from the negotiations by the other party. the innocent party should be able to demand the relief for the damage caused by such conduct. the innocent party should be allowed to recover the pecuniary loss for the cost of his investment and the loss of opportunities. these situations were the ones that inspired rudolph von jhering to write his monographic on “ culpa in contrahendo.” 1 his goal was to eliminate the injustice that was generated by the impossibility to impose responsibility on the party that without justification and reason withdrew from pre-contractual negotiations causing damages to the other contracting party. it is imperative to indicate that the doctrine of culpa in contrahendo is intimately related to the concept of good faith and presupposes fault or negligence by the guilty party. precisely, the foundation of the jhering theory is based on the principle of the good faith that has to be observed between the contracting parties since the beginning of the negotiations. the doctrine of pre-contractual liability considers the damages that occur as a consequence of the conduct of one of the parties that produced the nullity of the contract or generated the conditions for the cancellation of the negotiations. as mentioned above, the doctrine also considers the damages generated by the intentional and unjustified rupture of the negations by one of the parties. one example of such conduct is when the seller, knowing that he is not the owner of the goods, sells them to the buyer. in such a situation, the contract will be void because it will be impossible for the performance of the contract since the goods belong to a third party who is not part of the transaction and will claim his ownership of the goods. similarly, under the doctrine of pre-contractual liability, a party will be held liable for damages when initiating the previous negotiations with respect to the purchase of a corporation with the intention to gather confidential information of the business and abruptly interrupt the negotiations after the accomplishment of this purpose. before the formulation of the doctrine of culpa in contrahendo, the law appeared to have ignored pre-contractual stages, more specifically what happened before the formation of the contract, even though, the parties had been involved in extended, complex and expensive negotiations that required them to act in good faith and with due diligence. 1 rudolph von jhering, “ culpa in contrahendo: oder schadensersatz bei michtigen oder nicht zur perfektion gelangten verträgen, jherings jahrbücher !v (1861) 1-113. nordic journal of commercial law issue 2007 #1 3 this historical perspective leads one to think that pre-contractual liability is supported not only in jhering’s theory but also in the principles of good faith, fair dealing and unjust enrichment. it is paramount that once parties enter into contractual negotiations, they owe to each other a relationship of trust and confidence regardless of the negotiation’s success or failure. b. pre-contractual agreements and their liability under colombian law pre-contractual agreements are intimately connected with what are called “ pre contractual relations.” pre-contractual relations arise between the parties who are interested in entering into a contract. these relations arise from the first contacts between the parties until the adoption of a preparatory contract. such preparatory contracts are termed under the colombian legislation “ la option o la promesa de contratar” which means the option or the promise to enter into a contract. this stage is known as the “ pre-contractual period.” 2 in our complex economic world, we can find that there are contracts that can be concluded instantaneously according to the nature of their object or their small economic value such as the trading of regular and domestic consumer products which are displayed on supermarket shelves with their prices marked indicating that offers to the public have been made and therefore, it is possible to immediately acquire them for the payment of the price by the consumer. however, there are other kinds of contracts that for their nature and high economic value require a long period of negotiation as well as technical and budget studies by the contracting parties; therefore, the formation of such contracts is progressive. such contracts, for instance, can be for the construction of complex structures like airports, railroads or the purchase of banks or large corporations.3 moreover, it is in this type of contract where pre-contractual agreements take place. they constitute an important stage where the parties have the opportunity to discuss, learn and discover the advantages and disadvantages of the business. it is in this stage where the parties gather the confidential information of the business such as technical studies, production, marketability of the products, and industrial standards. in this stage, the party interested in the purchase of the business or company may invest a large amount of money as well as time in order to get the information required to make an informed decision in respect to the possible offer and later the conclusion of the contract. these pre-negotiations are called in different civil legislations “ tratos preliminaries” , “ conversaciones previas” or “ tratativas” . colombian legislation regulates the liability of pre-contractual agreements under article 863 of the commercial code, which provides that the parties shall act in good faith and without fault during pre-contractual negotiations, and that in case of the violation of this provision, the party at fault will be liable for damages caused to the innocent party. moreover, article 872 of the colombia commercial code provides that the celebration and execution of the contract shall be in good faith. as indicated above, this concept has been extended to the pre-contractual stage. therefore, the parties have the duty to act in good faith 2 gabriel escovar sanin, negocios civiles y comerciales tomo ii, dike 379 (1994). 3 id. at 380. nordic journal of commercial law issue 2007 #1 4 and without fault, which means that it is not sufficient that they are convinced that they are acting according to the principles of good faith but that they are acting without negligence. additionally, article 830 of the colombia commercial code indicates that a person who abuses his rights and harms another would be liable for the damages caused to the innocent party. this is called “ abuso del derecho” and it is one of the principles that inspired precontractual liability. finally, article 831 is related to the principle of unjust enrichment. accordingly, the importance of the pre-contractual stage is not only related to the protection of the parties against negligence, unfair practices and unjust enrichment, but it is fundamental to the interpretation of the contract. therefore, the initial acts, agreements, and negotiations between the parties tending toward the celebration and culmination of the contract will indicate their intention to enter into a future contract. for that reason the colombia civil code in article 1618 indicates that, once the intention of the contracting parties is known, such intention prevails over the literal interpretation of provisions of the contract. in colombia, pre-contractual liability does not require the element of “ culpa” (fault), it only requires the arbitrary rupture of the negotiations; even if such rupture by the contractual party is without fault it will generate liability. the fundamental point is that it goes against commercial equity and good faith. therefore, the law should not permit one to unfairly withdraw from pre-contractual negotiations without legal consequences in situations in which a party has invested a large amount of money and work searching the business. the importance here it is to protect the parties’ patrimonial interest because the frustration of pre-contractual negotiations can caused the same or superior damages as those cause by the breach of the executed contract. colombian’s supreme court has studied the implication of liability for pre-contractual agreements and has encountered some difficulties in the interpretation of the limits of liability and how best to frame the appropriate level of responsibility. the court’s major concern is not to contravene the ambit of freedom of contract. in addition, the colombia supreme court had held that the compensation for damages caused by one contractual party to the other at the pre-contractual stage is divided into two different categories as follows: “ daño emergente” and “ lucro cesante.” “ daño emergente” had been defined as the harm suffered by the injured party for the loss of expenses and financial inversions made during the pre-contractual stage. colombia’s legislation considered that these expenses constitute a negative contractual interest for the abrupt and unjustified rupture of pre-contractual negotiations. in consequence, this interest is limited to the amount of the loss of expenses. this negative interest does not include the expectation interest that the party could have if the contract would have been executed. moreover, “ daño emergente” includes the monetary correction. the interest that emerges from the breach of a valid executed contract is known as “ interés de cumplimiento” or “ interés positivo” (positive interests) because its goal is to put the contracting party in the same financial situation that he would have been if the contract had been nordic journal of commercial law issue 2007 #1 5 performed. the positive interest is the equivalent to the american expectation interest for the breach of a contract. however, the negative interest, which is also know as an “ interés de confianza” (trust interest), is oriented to compensate the injured party for the loss of expenses that he incurred during pre-contractual negotiation as a consequence of his reliance on the other contracting party interest to continue with the negotiations to finally execute a contract. the negative interest is similar to the american reliance interest for the breach of contract but at a pre-contractual stage. according to pedro lafont pianetta, who is a colombian supreme court justice, the negative interest compensates for the loss of expenses, material and moral damage that result from the frustration of pre-contractual agreements. the goal is to bring the injured party to the same financial situation that he was in before he started with pre-contractual negotiations.4 moreover, gabriel escovar sanin indicated that the negative interest has two aspects: 1. the necessity to repair the harm caused by the reliance on the other contractual party, for the trust in her promise 2. the necessity to support and encourage trust and good faith in commercial negotiations.5 the understanding of these two aspects is fundamental for the integral interpretation and understanding of the primary goal of pre-contractual liability and its compensation system. moreover, the “ lucro cesante” is defined as a lost of the opportunities that the injured party suffered on reliance of pre-contractual negotiations. in colombia this is call “ perdida del chance” (loss of a chance). this situation is presented when an innocent party refused to enter into the negotiations of another contract offered by a third party in reliance of the on-going negotiations with the guilty party. in such case the party at fault has to pay for the loss of opportunities suffered by the injured party. colombia supreme court justice alejandro bonivento has indicated that the compensation for the breach of pre-contractual negotiations is composed of the “ daño emergente” and “ lucro cesante” , therefore both interests have to be calculated in order to determine the final compensation.6 however, there was a polemic in relation to the amount of damages that should be paid as a consequence of the “ lucro cesante” . the supreme court has held that this interest should be measured by the loss of profit that the injured party suffered for the loss of opportunities. for instance, the losses of profits caused when the party refuse to accept another contract proposed by a third party at the same time that he was involved in the negotiations of the frustrated contract.7 4 corte suprema de justicia, sentnecia de junio 27 de 1990, m.p: dr. pedro lafont pianetta. 5 sanin, supra note 1, at 394 6 corte suprema de justicia, sentencia de noviembre 23 de 1989, m.p: dr. jose alejandro bonivento fernandez 7 corte suprema de justicia, sentencia de noviembre 23 de 1989, m.p: dr. jose alejandro bonivento fernandez nordic journal of commercial law issue 2007 #1 6 finally, pre-contractual liability in colombia seems to be similar to the reliance interest, and the american doctrine of promissory estoppel in contracts. the concepts of “ daño emergente” and “ lucro cesante” have the same inspiration as the principle of the reliance interest: to place the injured party in the same situation as he was before the contract was made. however, the main difference is that such liability is generated in colombia from the first negotiations and agreements between the parties in pre-contractual stages where there is a tacit agreement between the parties to act in accordance with good faith, fair business, diligence and loyalty. also, in colombia there are three stages in the formation of a contract as follows: the first is pre-contractual agreements or negotiations, the second, is the contractual stage and the last is the post-contractual stage. each of these stages generates liability to the parties in case of breach. c. hypothetical examples to illustrate how pre-contractual liability is applied in colombia the following are some examples of the situations where pre-contractual liability occurs as defined in colombia. a. a company accepted an engineer as a capital partner in the company. the engineer in reliance on the word of the company’s president and ceo proceeded to sell some of his properties at a lower price than the commercial price because he wanted to collect the amount of money that he had to pay to become a partner. also, at the same time, he quit his job in another company. however, a few hours before the execution of the document that recognized him as a partner, the company notified him that they changed the qualifications of admission of the possible partner, and under these new requirements it was impossible for him to become a partner of the company8. in this case, the company, even without the existence of a contract, should be responsible for the damages caused to the innocent party because in reliance on their word he left his job and proceeded to sell his properties to respond for the payment that the company required him to make as a capital partner. here, one party unfairly raised in the other party a hope that a contract will be made. b. juan was an old and outstanding client of a bank. he asked for a loan of $500,000.00 dollars (this sum was lower than of the prior sums loaned to him by the bank.) he needed this money for the purchase of some equipment for his company. in compliance with the prior practices with the bank, and the bank holding his mortgages, and the bank’s manager’s oral confirmation of acceptance of the loan, he proceeded to negotiate for the industrial equipment with the seller and signed a promise of purchase. after the negotiation, he went to the bank to pick up the money for the payment of the equipment. however, he was informed that the credit committee declined his petition for the loan due to a restriction on loans. juan’s financial situation and payments to the institution had been outstanding and did not change from the prior times when he asked the bank for loans. as a consequence, of the negative 8 sanin, supra note 1, at 423. nordic journal of commercial law issue 2007 #1 7 actions of the bank juan had to pay the amount of a penal clause and suffer enormous detriments in the development and progress of his company.9 in this example, the bank’s manager made a promise to juan and broke that promise. therefore, the bank under the law on pre-contractual agreements, is responsible for the damages caused for their negative action on the loan. the bank’s manager knew that, in accordance with prior practices and dealings with juan, he would commence the negotiations for the equipment and the bank manager’s word of acceptance would give juan a green light to even sign a promise of purchase. juan acted in reliance on prior practices and the manager’s word. in this case, as in the first example, there was a hope that a future contract would be made. d. brief comparison between pre-contractual liability as applied in colombia and under american law the first example that i gave to illustrate the application of pre-contractual agreements under the colombian legislation is similar in a way to the case of feinberg v. pfeiffer co. where the plaintiff worked for a long time for the defendant and in consideration of his years of services and in gratitude for his hard work, the company made a resolution to recognized an extra payment for the plaintiff upon his retirement (two hundred dollars for life). the plaintiff, in reliance on this promise, retired. the company made the promised payments for some time until they decided to stop the payments arguing that a promise to make a gift is not binding without consideration and in their case the payment was only a promise and not a standing contract. the court held that in the instant case the plaintiff acted on reliance upon the promise contained in the resolution, and this therefore created an enforceable contract under the doctrine of promissory estoppel. (see § 90 of the restatement second of contracts.) here the plaintiff, in reliance on the promise, retired. the defendant should have reasonably expected that the plaintiff would act in reliance on their promise; in other words, the defendant induced the plaintiff to retire. consequently, the court ordered the payments for life.10 it is imperative to mention the similarities between the concepts of reliance interest and promissory estoppel in american law and the effects of concept of pre-contractual liability in colombia. first, under the concepts of reliance interest and the promissory estoppel, the contractual liability arises when one of the parties makes a promise to the other contractual party as a part of the contract. these two concepts presuppose the existence of a valid contract and, as a consequence of it, one party changes his position during the contractual stage in reliance upon the other party promises to perform the contract. whereas in colombia precontractual liability is imposed as a consequence of the reliance of one party on the other party’s promise or inducement to believe that it would be a probable conclusion of a future contract, this liability is generated as a consequence of the rupture of pre-contractual negotiations and the detriment suffered by one party due to the other side’s inducement to believe in the possibility of a future contract. therefore, this kind of liability does not suppose the breach of a valid contract, merely the breach or rupture of the negotiations. 9 sanin, supra note 1, at 424 . 10 feinberg v. pfeiffer co. 322 s.w. 2d 163 (mo. ct. app.1959) nordic journal of commercial law issue 2007 #1 8 in general. the american legal system does not provide for the concept of culpa in contrahendo or pre-contractual liability. however, puerto rico has contemplated the doctrine of the culpa in contrahendo in its legislation as a consequence of its civil law system. in contrast, the common law states do not recognize the fundamentals of the doctrine of culpa in contrahendo and precontractual liability. as i have mentioned before, colombian’s legislation statutorily regulates the figures of culpa in contrahendo and, specifically, the liability of pre-contractual agreements. colombia’s legislation provides remedies for reliance where there has been an arbitrary rupture of pre-contractual negotiations. in consequence, the guilty party will be obligated to pay for the damages cause to the innocent party, who in reliance of the other’s word and behavior invests time and money in the initial pre-negotiations stage in order to know the details and gather the information required to make an informed decision before the celebration of the contract. with respect to the doctrine of the promissory estoppel, günter kühne has stated that philosophically it was developed as a consequence of the insufficiency of reliance produce by the bargain and the exchange concept consideration: “ in the united states the promissory estoppel took over the tract to make up for the reliance deficit produced by the bargain and the exchange philosophy of the consideration principle. it became an instrument to enforce gratuitous promises where one, relying on the promise, changed his position and incurred financial losses.” 11 the concept of the doctrine of promissory estoppel is similar to the conception of precontractual liability in colombia in the fact that the main inspiration is to avoid unjust enrichment, to promote fair business practices, and to imposed responsibility on the party who either intentionally or unintentionally made a promise to another and had reason to know that the other party will act in a certain way in reliance on his promise. the difference is that promissory estoppel operates on a contractual stage, in other words, where a valid contract has been made, and to lock in the offer in a bid case once the contractor has notified the subcontractor that he won the contract. however, pre-contractual agreements do not require the formation of a valid contract, only the pre-negotiations of it whether or not they come to fruition. pre-contractual agreements do not require the complete meeting of the minds as is required to obtained relief under the concept of promissory estoppel and the reliance interest in american law. pre-contractual agreements only required that the party seeking recovery had reason to conclude from the other party’s conduct that a future contract will be made. here, what is punished is the careless inducement in reliance and the late rupture of negotiations and frustration of 11 kühne, günter, promissory estoppel and culpa in contrahendo, 10 tel aviv university studies in law, tel aviv 282 (1990). nordic journal of commercial law issue 2007 #1 9 reliance investment. consequently, the main point is to recover for the reliance invested during the dealing and the recovery for the economic loss.12 günter kuhne indicates that in the case of culpa in contrahendo and pre-contractual liability, it is possible to conclude that liability of the party is recognized based on two elements: a. “ violation of a pre-contractual duty, which is the duty in regard to the contractual process before a break-off. (the duty is not to rupture negotiations for other than valid reasons, so the break-of itself caused liability.) b. the inducement of reliance action to the detriment of the other party. one party changes his position in reliance of the other one promise and behavior.” 13 in respect to the liability imposed through these two elements, it is clear that the parties owed to each other the obligation to act in good faith since the beginning of the negotiations. it is also reasonable to expect the reliance of the other party in the negotiations in changing his position to investigate and gather the prudence information in respect to the business. consequently, the party might hire attorneys, accountants, engineers and any kind of consultants that he might require to understand and to inform him with respect to the business in negotiation. therefore, the blameworthy party will be liable for the arbitrary rupture of the negotiations due to the investment made by the other party on reliance on the possible contract, based on the behavior and promises of the other party. in conclusion, it is possible to understand that the liability imposed through these two elements was the natural consequence of its breach. moreover, another difference between the colombian’ legislation and the american law in respect to pre-contractual agreements is that the element of good faith is not require in america in pre-contractual stages. in other words, it is not extended to the negotiations. there is not a specific duty to bargain in good faith but there is a duty to be performed in good faith obligation, which is imposed during the contractual stage. consequently, the uniform commercial code requires merchants to perform in good faith and fair dealing. for instance, in the case of a merchant, the good faith element imposes on him the obligation to observe reasonable commercial standards of fair dealing in the trade and to perform with respect of such standards.14 while in colombia, the commercial code imposes an obligation on the contractual parties to observe good faith during the pre-contractual stage, therefore, the blameworthy party would be liable for his breach of such duty. the fundamental point of such provision is that during the pre-contractual stage the parties engaged in the negotiations build between them relationships based on trust similar to the ones that arise in the contractual stage, so they will have to comply with a high standard of care. in conclusion, pre-contractual liability in colombia has a high importance in the contractual relations between the parties and therefore the commercial and civil code regulates it extensively. its goal is to promote good faith and fair dealing during all the contractual stages and as well as to prevent the unjust enrichment of one of the parties to the detriment of the 12 id. at 282 13 kühne, supra note10, at 288 14 kessler, friedrich/fine, edith, culpa in contrahendo, bargaining in good faith and freedom of contract: a comparative study, harvard law review, 1964. pg 408. nordic journal of commercial law issue 2007 #1 10 other party. the goal of the concept of pre-contractual liability is to restore the damages suffered by one party in reliance on the blameworthy party. during the negotiation of pre-contractual agreements, some obligations and rights are generated to the parties. the main obligation is to act in good faith, meaning that the parties have to initiate the negotiations with the intention to reach an agreement, and to withdraw as soon as possible, before the other party, in reliance of the negotiations, invests in the research of the business. also, good faith requires the obligation of reserve which means that information with respect to the business and financial situation of one of the parties ought not to be disclosed if it is confidential. finally, it requires the obligation of custody and conservation of all the material that has been given to the parties in the course of the negotiations. the withdrawal itself does not cause the liability. there has to be some kind of unfair act such as not intending to reach an agreement and omitting to communicate the determination to he other party, not disclosing trustworthy information, or continuing the negotiations after realizing that the contract will never be concluded. iii. a brief view of pre-contractual liability under the cisg we cannot find any provision in the cisg that specifically regulates pre-contractual liability. in this respect, the cisg is silent. however, the application of this concept can nevertheless be inferred from the cisg’s general principles, from its provisions and from its interpretation as a whole. the first approach is to look at article 7(1), which addresses the international character of the convention and its promotion of the principle of good faith in international trade. one then turns to article 7(2) which indicates that, for matters governed by the convention, but not expressly settled in it, the correct approach is to interpret the matter according to the general principles of the convention, where such principles are present. article 8 of the cisg is also highly relevant. a. applicability of pre-contractual agreements under the cisg according to article 7 and article 8 in my view, in order to have a full understanding of the application of pre-contractual liability under the cisg, one must review the legislative history of article 7 which refers to the good faith principal. i will emphasize in its importance. according to the legislative records of the vienna diplomatic conference at which the cisg was promulgated, there was a lack of consensus as to the meaning of the principle of good faith provided in article 7. the following are some of the views that were discussed in respect to the inclusion of good faith in international trade: “ colloquy at diplomatic conference on proposal to provide a more specific reference to good faith (“ article [7] [is] not the appropriate place for a reference to a principal of major importance in international trade relations. a separate article [is] required.” proposal rejected” comments by delegates, some regarding a good faith requirement as present without such a separate article; some not wanting such an article because it would document the existence of a good faith requirement applicable to a contracting parties. or 257-259,paras. 40-56 [or=official records of the nordic journal of commercial law issue 2007 #1 11 united nations conference on contracts for the international sale of goods, vienna 10 march11 april 1980, a/conf. 97/19]” 15 the draft of article 6 that was presented in 1978 was approved as article 7(1) of the official text of the cisg. the major modifications proposed were presented by italy and norway as follows: “ [italy (a/conf.97/c.1/l.59): delete the words “ and the observance of the good faith in international trade” (cf. in this respect the proposed new article 6 [became cisg article 7] ter) and add new sentence: “ questions concerning matters governed by this convention which are not expressly settle therein shall be settle in conformity with the general principles on which this convention is based or, in the absence of such principles, by taking account of the national law of each of the parties.” ] [add a new article 6 [became article 7] ter to read as follows: “ in the formation [interpretation] and performance of a contract of sale the parties shall observe the principles of the good faith and international co-operation.” ] {norway (a/conf.97/c.1/l.28): delete the words: “ and the observance of the good faith in international trade” article [6] [became article 7]” 16 during the discussions, mr. bonell, who was a member of the italian delegation indicated that an inclusion of a provision regulating the observance of good faith principle was required in the cisg. therefore, he supported and proposed the adoption of a separate provision for the regulation of a major principle of good faith. in addition, he stated that his delegation proposed to add a reference to “ international cooperation” with the intention to clarify that only those aspects of good faith that were internationally acceptable would apply to the interpretation of the principles under the cisg.17 mr. rognlien, of norway, stated that the reference to the principle of good faith should be transferred from article 6 to article 7. he also indicated that the observance of good faith was related to the contract between the parties not to the interpretation of the provisions of the convention. therefore, he considered that the reference to good faith should be transferred from article 6 to article 7 (which become article 8 (3) of the cisg). he disagreed with the inclusion of the reference to the international cooperation proposed by italy.18 miss o’flynn who represented united kingdom stated that there was no need to add a new article for the provision of the good faith as it was proposed by italy. she indicated that the 15 article 7 colloquy, interpretation of the convention. points of view expressed at vienna diplomatic conference, colloquy on issue related to a good faith: proposal to add to cisg a version of concept of culpa in contrahendo (pre-contractual liability): proposal rejected [official records 294-295, paras. 77-87] (1980) 16 id. at 294-295 17 id. 18 id.. nordic journal of commercial law issue 2007 #1 12 meaning of the article involved an uncertain interpretation, the principles of the good faith were not defined, and there was no provision for the application of sanctions that would be applied as a consequence of the failure of one party to act in good faith. in conclusion, she did not support the italian proposal.19 finally, mr. allan farnsworth, representing the united states, noted that he had a preference for the existing text because the italian proposal with respect to the application and interpretation of the good faith in an international context was uncertain and dangerous.20 the issue related to the prohibition of the parties from departing from their obligation to act in good faith was debated during the discussion related to the principal of good faith. a canadian proposal read as follows: “ change article 5 [became cisg article 6] to read as follows: (canada (a/conf.97/c.1/l.10): “ (1) the parties may exclude the application of this convention or, subject to article 11 [became cisg article 12], derogate from or vary the effect of any of its provisions. however, except were the parties have wholly excluded this convention, the obligation of good faith, diligence and reasonable care prescribe by this convention may not be excluded by agreement, but the parties may by agreement determinate the standards by which the performance of such obligations are to be measure if such standards are not manifestly unreasonable.]” 21 with respect to this issue, mr. farnsworth indicated that he did not support the canadian proposal because it will impose a general obligation of good faith. the majority of the committee was against the canadian proposal therefore it was not approved. finally, the committees discussed a proposal specifically related to pre-contractual liability. the delegates from the german democratic republic proposed that a new article on this subject be added to part ii of the convention. (a/conf.97/c.1/l.95). the following are some of the comments with respect to this proposal:22 “ 78. mr. plunkett (ireland) asked whether the proposal envisaged that compensation would be payable even if no contract had been conclude, or if a contract had been conclude, whether it should be payable for something other than a breach of contract. “ 79. mr. maskow (german democratic republic) replied that it was the essence of his proposal that compensation for expenses could be claim even if there were no contract. “ 80. mr. bonell (italy) strongly supported the proposal. his delegation had already submitted a proposal along similar lines. the existing text of the convention did not take sufficiently into account cases where no contract was concluded but the parties had engaged in detailed negotiations at the pre-contractual stage. such cases needed regulation because of the risk that one of the parties might abuse its position and act in such a way as to damage the interest of the other party. he thought the drafting of the proposal could be improved, notably by the deletion of the phrase “ in the course of the preliminary negotiations” , and also by the inclusion of a phrase to 19 id. 20 id. 21 official records pp 257-259 22 id. at 294-295. nordic journal of commercial law issue 2007 #1 13 cover the situation in which the party had not necessarily had expenses, but had suffered damages. he suggested that an ad hoc working group be set up to produce an agreed text. “ 81. mr. schlechtriem (federal republic of germany) sympathized with the object of the proposal but considered it much too far-reaching. such a general clause might change some of the solutions of the draft, e.g., the provisions dealing with the obligations of the parties or with the revocability of the offer. it would touch on the problem of form requirements and would also affect matters outside the scope of the convention such as the avoidance of the contract for errors, or the authority of agents. “ 82. mr. bennett (australia) said that he had great difficulty with the proposal. it referred to a failure in duty to take reasonable care, a notion that was not found anywhere else in the convention. it was not clear what was the standard of reasonable care that was envisaged. the problem was an important one and not merely one of drafting.” as it is reflected in the reading of the opinions, the proposal for pre-contractual liability was highly objected to by members if the committee and was not agreed on. however, in my opinion, the failure of the approval of the committee to adopt this provision on the regulation of pre-contractual liability under the csig was the result of a lack of understanding of the concept by the common law delegations. as i indicated in the first chapter of this article, pre-contractual liability has not been recognized as a part of the contractual law at common law jurisdictions. i think that their major fear is to contravene the principal of freedom of contract. conversely, the position of the common law jurisdictions, in their effort to protect freedom of contract, is lacking in protection for the contractual parties during pre-contractual negotiations. it is my view that this is a dangerous approach because during pre-contractual negotiations the damages that can result by the unjustified withdraw of the negotiations can be major or equal to the damages caused by the breach of the contract. therefore, in order to avoid unjust enrichment and honor the principles of good faith and fair dealing from the beginning of the negotiations of a probable contract, the concept of precontractual liability should be regarded as a part of contract law. in addition to its discussion at the vienna diplomatic conference, the concept of precontractual liability had been discussed earlier in 1977 at the 9th session where the uncitral working group presented its finished draft of the “ formation of the contract.” the draft included the requirement that fair dealing and good faith had to be observed by the parties during the course of the formation of the contract. the german democratic republic suggested that a third paragraph be added to the proposal of hungary (as indicated above such proposal was raised and objected in the vienna conference). in addition, the german democratic republic maintained that the observance of fair dealing and good faith was required from the parties during the course of formation of the contract and, if during the preparation and formation of the contract one of the parties violated their duties of customer care the other party had the right to claim compensation for the economic loss.23 23 uncitral yearbook ix, (1978), a/cn.9/ser.a/1978 pp 66-67; honnold documentary history pp 298-299. nordic journal of commercial law issue 2007 #1 14 furthermore, for some of the drafters the concept of good faith and fair dealing was considered a moral obligation. therefore, it was highly important that they elevated these principals to the stage of a legal obligation. however, they were concerned that the application of such principles to particular transactions might not lead to the development of a uniformed and coherent case law in international trade because each national court might be influenced by its own legal traditions and beliefs. to conclude, it was the majority opinion that the proposals for precontractual liability under the cisg were properly rejected. the view that prevails is that precontractual liability is not part of the scope of the convention. however, there is a minority opinion to the effect that, even though the cisg does not include an express provision dealing with pre-contractual liability, it will be possible for the tribunals to impose its application by the interpretation of the general provision of observance of good faith in international trade and the interpretation of the principals of the convention as a whole. respect to this point, bonell has noted:24 “ the fact that cisg does not have a provision expressly dealing with the pre-contractual liability of the parties for theirs conduct during the negotiations does not necessarily mean that the issue fall outside the scope of the convention. in fact, pre-contractual liability could simply be -to use the language of article 7 — one of those questions concerning matters governed by [the] convention which are not expressly settled in it… . issues which are outside the scope of the convention continue to be governed by domestic law while, in the case of simple lacuna, the solution has to be found primarily within the convention itself, i.e., in conformity with the general principles on which it is based, and only in the absence of such principles, may resort be had to the law applicable by virtue of the relevant conflict of law rules (cf. article 7(2))… .” i agree with professor bonell. it is clear that pre-contractual liability should not be considered outside the scope of the cisg. its application can be possible through the interpretation of the convention as a whole and in conformity with the application of its general principles. from the analysis of the principles of good faith, and fair dealing in conjunction with the interpretation of the conduct and intention of the parties, it is possible to establish the existence of a pre-contractual liability under the cisg. additionally, the application of the principles of good faith and fair dealing has also been recognized by the unidroit principles. article 1.7 regulates the general application of the principal of good faith and fair dealing in international trade. furthermore, the article indicates that the parties cannot “ exclude or limit such obligation.” 25 moreover, article 2.1.15 which rules on negotiations in bad faith provides:26 a party is free to negotiate and is not liable for failure to reach an agreement. however, a party who negotiates or breaks off negotiations in bad faith is liable for the losses caused to the other party. 24 bonnell “ formation of contracts and pre-contractual liability under the vienna convention on international sale of goods” formation of contracts and pre-contractual liability (icc publishing pub. no. 440/9: 1990) pp 167-171. 25 steven j. burton and melvin a. eisenberg, contract law: selected sources materials, unidroit pinciples,thomson west p381 (2006) 26 id. at 384. nordic journal of commercial law issue 2007 #1 15 it is bad faith, in particular, for a party to enter into or continue negotiations when intending not to reach an agreement with the other party.” according to rodrigo novoa, it is possible for the courts to find that the adoption of precontractual duty to bargain in good faith under the unidroit could be extended to the cisg because the main purpose of the unidroit principles is to provide guidelines for the interpretation and application of the uniform law instruments on international commercial contracts such as the cisg. therefore, it is probable that the adoption of the pre-contractual duty to bargain in good faith by the undroit principles might persuade a court that this duty is also present under the cisg.27 moreover, shani salama considered that article 7(2) of the cisg provides an interpretation tool of the convention. therefore, when the courts are filling the gaps encountered in the interpretation of a matter that is not settled in the convention like the pre-contractual liability they should look at article 7(2) and interpret such matters within the general principles that inspired the convention. according to salama the interpretation under article 7(2) required the use of hierarchy methods of interpretation. she indicates that the first approach by a court when it is filling the gaps under the cisg is to look at the provisions and the general principles that inspired the convention even if the matter is not expressively settled. second, if the matter is excluded of the scope of the convention, for instance, the liability of the seller for death and personal injury (art 5 cisg), such matter should be resolved according to the rules applicable under the private international law and not the cisg. in consequence, article 7(2) would be inapplicable.28 furthermore, she emphasized that the scholars have not been clear in respect to the interpretation of the definition of “ general principles that inspired the cisg. she noted: “ the definition of “ general principles upon which the convention is based” falls short of receiving any clear interpretation in the scholarly works. reference is made to these principles in article 7(2) without further explanation. jeffrey hartwing writes that the “ general principles are to be derived from the convention’s own provisions” . moreover, professor honnold writes that a “ particular general principal must be moored to premises that underlie specific provisions of the convention.” 29 in addition, salama indicates that the interpretation of the general principles of the convention should be broader then just limiting their construction only to the general principles that derive from the convention. moreover, such construction should not even be limited to the intent of the drafters. the interpretation of the general principles should be broader according to the international character of the convention article 7(1). in consequence, salama considered that the courts should look carefully and extensively to the general principles of the convention because it is a living body capable of changes and adaptation to the new commercial transactions in international commerce. thus the interpretation of the general principles of the convention should follow the changes and 27 rodrigo novoa, culpa in contrahendo: a comparative law study: chilean law and the united nations convention on contracts for the international sale of goods (cisg),22 ariz. j. int’l & comp. l. 583. p 611 (2005) 28 shani salama, pragmatic responses to interpretive impediments: article 7 of the cisg, an inter-american application, 28 university of miami inter-american law review p 7-8 (fall 2006) 29 id at 8 nordic journal of commercial law issue 2007 #1 16 transactions in international trade. this point of view is consistent with the regulation provided in article 7(2) because one of its goals is to resolve not expressly regulated matters like those that will arise in the future. to conclude, she also supports the view of professor guilmard that “ promotes that the use of principles of the undroit and pecl as a source of general principles in art 7(2).” 30 i really like salama’s approach regarding the interpretation of art 7(2). as i stated before, the precontractual liability is within the scope of the cisg .therefore, following salama’s theory, if a court has to decide a case on pre-contractual liability the first step for the court is to look at the general principles that inspired the cisg because it constitutes and unsettled matter. thus the interpretation and regulation of the pre-contractual liability will be possible through its principles. consequently, there is no need to refer and resolve the case according to the private international law. furthermore, as salama stated, the interpretation of the general principles of the cisg should be broader according to its international character and not only limited to those derived from the convention. consequently, it is possible to conclude that the principles of the undroit and pecl constitute a source of the general principles referred in art 7 (2) and therefore the adoption of pre-contractual duty to bargain in good faith under the unidroit could be extended to the cisg. finally, it is imperative to indicate that interpretation of the conduct and intention of the parties is fundamental in the analysis of the application of the pre-contractual liability under the cisg. article 8 provides:31 “ (1) for the purposes of the application of this convention statements made by and other conduct of a party are to be interpreted according to his intent where the other party knew or could not have been unaware what that intent was. (2) if the preceding paragraph is not applicable, statements made by and other conduct of a party are to be interpreted according to the understanding that a reasonable person of the same kind as the other party would have had in the same circumstances. (3) in determining the intent of a party or the understanding a reasonable person would have had, due consideration is to be given to all relevant circumstances of the case including the negotiations, any practices which the parties have established between themselves, usages and any subsequent conduct of the parties.” from the reading of article 8 of the cisg, it is clear that this provision is not related to the interpretation of the convention but to the interpretation of the parties’ statements, intentions, conducts, usages and practices in light of an international contract of sale of goods. there are two tests that apply in the interpretation of the party’s statements and conduct. the first is the subjective test which indicates that the statements and conducts of the parties are to be understood according with its intent (article 8(1)) “ where the other party knew or could not have been unaware what that intent was.” the second is the objective test, which refers to the understanding of the statement and conduct by a reasonable person under the same 30 id. 31 burton and eisenberg, supra note 24, at 350. nordic journal of commercial law issue 2007 #1 17 circumstances (article 8 (2)). the objective test will be applicable when the other party neither knew or nor could have been aware of the intent. in reference to this article, i would like to emphasize the importance of the interpretation of the conduct, statements and intentions of the parties when they are dealing with precontractual negotiations because they will lead one of the parties to rely on and conclude the serious intentions of the other contractual party to a contract. therefore, the party in reliance on the other party’s statements and behaviors will study, research and invest time and money learning the benefits and disadvantages of the future contract. consequently, if one of the parties abruptly withdraws from the negotiations without justification, it should be liable for the damages caused to the other contractual party. b. hypothetical case to illustrate the application of pre-contractual liability under the cisg. the following is a hypothetical example that will help to illustrate the application of precontractual liability under the cisg: wine co. is a vineyard company located in italy. the company is selling its entire production for 2006. the wine is stored in a warehouse located in a distant place. on january 2, 2006, wine co. sent information to all its clients stating that it was offering its entire production in the vineyard for 2006 but that the price could not be lower than us $6 per bottle, and its entire production was approximately three million bottles. in addition, wine company advised that clients interested in buying the production would have to respond by communication sent to piero monestier, ceo of the company no later then january 30, 2006 and that a final contract should be signed by march 30, 2006, after the inspection and testing of the product by interested buyers. the inspection was programmed for february 16, 2006. three south american firms expressed interest: concha co. from colombia; toro from chile and tinto from argentina. these three clients traveled to italy for the inspection. the inspection was held for four days and the clients brought specialists to determine the quality of the wine. the contract was to be awarded to the best proposal twenty days after of the inspection. however, wine co. informed its clients ten days after the inspection its refusal to continue with the negotiations. wine co. did not give any specific reason to its clients. the company only indicated that due to a policy of the company the negotiation was canceled. wine co. knew since january 30, that the negotiation would be canceled due to their contractual obligation with an italian client. however, the company did not stop the negotiations and continued with them until the inspection and then, only a few days before the award of the contract, withdrew its proposal. all the countries involved in the negotiations had their relevant places of business in countries that subscribed to the cisg. the damages caused to the clients included the loss of out-of-pocket expenses and the loss of opportunities because they refrained from negotiating with other providers due to the ongoing negotiations with wine co. to establish a case under the concept of pre-contractual liability, four elements are required:32 32 novoa, supra note 27, at 583 nordic journal of commercial law issue 2007 #1 18 1. “ preliminary negotiations; 2. breach of the duty to bargain in good faith; 3. causation in fact; and 4. compensable damages.” the hypothetical case meets these requirements. there were preliminary negotiations, (the requirement of prior inspection of the product and the posterior communication of the offer after 20 days of the inspection), wine co. without justification and in bad faith withdrew the negotiations and, as a consequence of the rupture of the negotiations, its clients suffered damages in reliance on its statement and conduct. wine co. promoted the preliminary negotiations and did not withdraw the negotiations, as soon as it found out that such a contract would not be concluded. the company continued with the inspection and let the clients invest money in their travel expenses, salary of experts and caused them to miss other opportunities. in situations as illustrated in this hypothetical case the application of pre-contractual liability under the cisg should be possible. first, the cisg promotes the general principals of good faith and fair dealing. therefore, it is possible to conclude that the parties, since the beginning of the negotiation, have the obligation to bargain in good faith and the breach of such obligation will render legal consequences for the damages caused by the breach. also, it is reasonable to conclude that a party, in reliance on the other party’s promises, statements or conduct, will proceed with the due diligence that was required to obtain the conclusion of the contract. for instance, in the hypothetical example any reasonable person in the same situation would have understood that wine co. had a serious intention to conclude the negotiations and award the contract to the best offer (article 8). the parties would never incur such investment in money and work if they did not have an understanding that the proposal sent by wine company was serious. therefore, the intention of the parties was clear. the wine company showed an intention to conclude a contract. it would be unfair to conclude that the parties should pay for the cost of the inspection and travel because wine company required them to execute the inspection as a condition precedent before the awarding of the contract under circumstances in which. wine company knew its intention to withdraw the negotiations but failed to communicate this determination in time. wine company did not act according the general principles of good faith and fair dealing that inspire the cisg. conversely, i would like to think of the outcome of this case under the analysis of the majority view that held that pre-contractual liability is outside of the scope of the cisg. in their analysis they will probably indicate that the domestic law would apply instead of the cisg because the convention is silent to this respect. in my opinion, regarding pre-contractual liability as outside the scope of the cisg will lead to uncertainty and ambiguous interpretations and outcomes because the gap will be fulfilled according to the provisions of the domestic laws. therefore, if a pre-contractual liability case is decided in common law jurisdictions, it is likely that the parties will not be allowed to recover damages for the unjustified withdraw of pre-contractual negotiations. conversely, if the same case is resolved by a judge in the civil law jurisdiction, the innocent party will likely be allowed to recover the damages caused in reliance on the other party’s intention to conclude a future contract. in consequence, the innocent party will be compensated for the cost of expenses and the lost of opportunities suffered during pre-contractual negotiations. nordic journal of commercial law issue 2007 #1 19 i believe that the application of domestic law in cases of pre-contractual liability in international contracts would infringe the major principals and goals of the cisg because it will be a lack of unity in the interpretation and outcomes in this matter. therefore, this conclusion would not honor the uniformity and unity that the convention pursues. c. comparison between the application of pre-contractual liability under the cisg and colombian domestic law colombian legislation regulated pre-contractual liability under the civil and commercial code. in contrast, the cisg is silent respect to this matter. the majority of the scholars opine that pre-contractual liability is not within the scope of the cisg. however, i believe that precontractual liability is regulated under the cisg and is not outside its scope. as i indicated before, it is possible to infer its application through the interpretation of its general principles and provisions as a whole. in consequence, the application of pre-contractual liability is possible under the interpretation of the regulations provided in articles 7 and 8 of the cisg. article 7 regulates the international character of the convention and provides for the promotion of good faith in international trade. in addition, this article indicates that where a matter is governed by the convention but not expressly settled in it, the correct approach is to resolve the matter according to its general principles, where such principles are present. similarly, article 863 of the colombian commercial code sets forth the obligation of the contracting parties to act in good faith and without fault during pre-contractual negotiations and provides that the failure to comply with this obligation will cause the liability of the party at fault. in addition, article 872 of the commercial code indicates that the celebration and execution of the contracts shall be in good faith. moreover, the cisg in article 8 states that the intention, statements and conduct of the contractual parties should prevail in the interpretation of the contract. in this aspect, the cisg is also similar to the colombian legislation because article 1618 of the colombian civil code states that, once the intention of the contractual party is known, that intention prevails against the literal interpretation of the provisions of the contract. finally, both legislations will award damages in reliance to the innocent party. in both cases, the innocent party will be compensated for his out-of-pocket expenses and lost opportunities. it is also important to mention that, under article 16(2)(b), the cisg regulates promissory estoppel. according to this article, an offer can be withdrawn at any time before its acceptance except when is reasonable to believe that the offeree in reliance on the offer acted in a certain way. for instance, the party commenced investment in production, hired some employees and invested in infrastructure, and as a consequence, will suffer damages if the offer is revoked. thus, he should be allowed to recover damages in reliance. in my view, this protection can be extended to pre-contractual agreements because we are facing similar situations. in prenordic journal of commercial law issue 2007 #1 20 contractual negotiations, we have a party who acted in reliance on the negotiations and as a consequence researched the business, invested money and time learning the opportunities and benefits of the future contract. therefore, in case of an unjustified withdraw of the negotiations the blameworthy party should be held responsible for the damages caused in reliance. iv. conclusion it is true that there is no provision in the cisg that specifically regulates pre-contractual liability. in this respect, the cisg is silent. however, its application can be inferred from its general principles and provisions and from the interpretation of the convention as a whole. as stated before, the first step is to look to article 7(1), which indicates the international character of the convention and its promotion of the principal of good faith in international trade. in addition, article 7(2) indicates that where a matter is governed by the convention but not expressly settled in it the correct approach is to resolve the matter in accordance with the general principles of the convention where such principles are present. in my opinion, the intention of the drafters of the cisg was to bind the contracting parties to the compliance of good faith since the beginning of the negotiations of the contract of sale. furthermore, one must analyze the intention of the contracting parties according to article 8. the questions that may arise are: was there an intention to conclude a contract? where there promises, statements or conduct that would lead the other contracting party to infer the conclusion of a contract and therefore proceed with the researching the business? if these questions are answered in the affirmative, then it is possible to infer the application of precontractual liability due to the reliance of one party in the other’s statements and conduct. moreover, i think that the unidroit provision on bargaining in good faith could be extended to the cisg because the interpretation of the general principles of the convention should be broader and not only limited to the general principles derived from the convention. thus, it could be sustained that the principles of the undroit and pecl can be used as a source of the general principles provided in article 7(2) cisg as it have been sustained by salama’s theory. nordic journal of commercial law issue 2007 #1 1 i. introduction∗ # the purpose of this article is to address the importance of pre -contractual liability in the regulation of contemporary commercial relations in an international context. in first instance, i will address the regulation of pre-contractual agreements under colombian domestic law. second, i will be briefly comparing the application and regulation of precontractual liability in colombian domestic law with its application in american law. finally, i will address its application under the cisg and i will include a brief comparison of this convention with colombian domestic law in respect to this matter. in addition, i will provide practical examples to illustrate the application of pre-contractual liability under colombian domestic law and the united nations convention on contracts for the international sale of goods (cisg). ii. the effects of pre contractual agreements in colombia and their liability under the domestic law a. brief historical prospective of pre-contractual liability the law, the doctrine and the jurisprudence in civil law jurisdictions have been regulating issues related to contractual and extra-contractual liability for centuries. however, only in the last century have they turned their attention to pre-contractual liability. in the early years, there was a dilemma in respect to the recognition of pre-contractual liability because it was understood that this pre-contractual stage did not generate responsibility for the parties because there was not a contract and they had freedom to decide whether they wanted to proceed with the negotiations or simply back out from them. therefore, any cost spent by the parties in pre-contractual negotiations should been assumed by them if the contract failed to materialize. ∗ the subject matter of this paper is an analysis of the cisg article 7(1) and its consequences. i also examine the norwegian implementation of the convention, how the norwegian approach relates to the obligations set forth in article 7(1), and whether that approach is a loyal compliance with those obligations. i further address the problems caused by the norwegian transformation and how those problems might be solved. # this essay states the law as at 25 january 2007. nordic journal of commercial law issue 2007 #1 2 conversely, it had been held by some scholars that pre-contractual agreements caused liability. in their opinion, the parties acquire obligations and rights during the pre-contractual stage. for instance, where two parties have been engaged in extended negotiations for the purchase of a complex business, they ought to owe to each other the obligation to act in good faith. therefore, after one party has invested a large amount of money studying and researching the business due to its complexity and in reliance on the other party’s intention to reach a future agreement, the party ought to be compensated for the economical loss caused by the unjustified withdraw from the negotiations by the other party. the innocent party should be able to demand the relief for the damage caused by such conduct. the innocent party should be allowed to recover the pecuniary loss for the cost of his investment and the loss of opportunities. these situations were the ones that inspired rudolph von jhering to write his monographic on “ culpa in contrahendo.” 1 his goal was to eliminate the injustice that was generated by the impossibility to impose responsibility on the party that without justification and reason withdrew from pre-contractual negotiations causing damages to the other contracting party. it is imperative to indicate that the doctrine of culpa in contrahendo is intimately related to the concept of good faith and presupposes fault or negligence by the guilty party. precisely, the foundation of the jhering theory is based on the principle of the good faith that has to be observed between the contracting parties since the beginning of the negotiations. the doctrine of pre-contractual liability considers the damages that occur as a consequence of the conduct of one of the parties that produced the nullity of the contract or generated the conditions for the cancellation of the negotiations. as mentioned above, the doctrine also considers the damages generated by the intentional and unjustified rupture of the negations by one of the parties. one example of such conduct is when the seller, knowing that he is not the owner of the goods, sells them to the buyer. in such a situation, the contract will be void because it will be impossible for the performance of the contract since the goods belong to a third party who is not part of the transaction and will claim his ownership of the goods. similarly, under the doctrine of pre-contractual liability, a party will be held liable for damages when initiating the previous negotiations with respect to the purchase of a corporation with the intention to gather confidential information of the business and abruptly interrupt the negotiations after the accomplishment of this purpose. before the formulation of the doctrine of culpa in contrahendo, the law appeared to have ignored pre-contractual stages, more specifically what happened before the formation of the contract, even though, the parties had been involved in extended, complex and expensive negotiations that required them to act in good faith and with due diligence. 1 rudolph von jhering, “ culpa in contrahendo: oder schadensersatz bei michtigen oder nicht zur perfektion gelangten verträgen, jherings jahrbücher !v (1861) 1-113. nordic journal of commercial law issue 2007 #1 3 this historical perspective leads one to think that pre-contractual liability is supported not only in jhering’s theory but also in the principles of good faith, fair dealing and unjust enrichment. it is paramount that once parties enter into contractual negotiations, they owe to each other a relationship of trust and confidence regardless of the negotiation’s success or failure. b. pre-contractual agreements and their liability under colombian law pre-contractual agreements are intimately connected with what are called “ pre contractual relations.” pre-contractual relations arise between the parties who are interested in entering into a contract. these relations arise from the first contacts between the parties until the adoption of a preparatory contract. such preparatory contracts are termed under the colombian legislation “ la option o la promesa de contratar” which means the option or the promise to enter into a contract. this stage is known as the “ pre-contractual period.” 2 in our complex economic world, we can find that there are contracts that can be concluded instantaneously according to the nature of their object or their small economic value such as the trading of regular and domestic consumer products which are displayed on supermarket shelves with their prices marked indicating that offers to the public have been made and therefore, it is possible to immediately acquire them for the payment of the price by the consumer. however, there are other kinds of contracts that for their nature and high economic value require a long period of negotiation as well as technical and budget studies by the contracting parties; therefore, the formation of such contracts is progressive. such contracts, for instance, can be for the construction of complex structures like airports, railroads or the purchase of banks or large corporations.3 moreover, it is in this type of contract where pre-contractual agreements take place. they constitute an important stage where the parties have the opportunity to discuss, learn and discover the advantages and disadvantages of the business. it is in this stage where the parties gather the confidential information of the business such as technical studies, production, marketability of the products, and industrial standards. in this stage, the party interested in the purchase of the business or company may invest a large amount of money as well as time in order to get the information required to make an informed decision in respect to the possible offer and later the conclusion of the contract. these pre-negotiations are called in different civil legislations “ tratos preliminaries” , “ conversaciones previas” or “ tratativas” . colombian legislation regulates the liability of pre-contractual agreements under article 863 of the commercial code, which provides that the parties shall act in good faith and without fault during pre-contractual negotiations, and that in case of the violation of this provision, the party at fault will be liable for damages caused to the innocent party. moreover, article 872 of the colombia commercial code provides that the celebration and execution of the contract shall be in good faith. as indicated above, this concept has been extended to the pre-contractual stage. therefore, the parties have the duty to act in good faith 2 gabriel escovar sanin, negocios civiles y comerciales tomo ii, dike 379 (1994). 3 id. at 380. nordic journal of commercial law issue 2007 #1 4 and without fault, which means that it is not sufficient that they are convinced that they are acting according to the principles of good faith but that they are acting without negligence. additionally, article 830 of the colombia commercial code indicates that a person who abuses his rights and harms another would be liable for the damages caused to the innocent party. this is called “ abuso del derecho” and it is one of the principles that inspired precontractual liability. finally, article 831 is related to the principle of unjust enrichment. accordingly, the importance of the pre-contractual stage is not only related to the protection of the parties against negligence, unfair practices and unjust enrichment, but it is fundamental to the interpretation of the contract. therefore, the initial acts, agreements, and negotiations between the parties tending toward the celebration and culmination of the contract will indicate their intention to enter into a future contract. for that reason the colombia civil code in article 1618 indicates that, once the intention of the contracting parties is known, such intention prevails over the literal interpretation of provisions of the contract. in colombia, pre-contractual liability does not require the element of “ culpa” (fault), it only requires the arbitrary rupture of the negotiations; even if such rupture by the contractual party is without fault it will generate liability. the fundamental point is that it goes against commercial equity and good faith. therefore, the law should not permit one to unfairly withdraw from pre-contractual negotiations without legal consequences in situations in which a party has invested a large amount of money and work searching the business. the importance here it is to protect the parties’ patrimonial interest because the frustration of pre-contractual negotiations can caused the same or superior damages as those cause by the breach of the executed contract. colombian’s supreme court has studied the implication of liability for pre-contractual agreements and has encountered some difficulties in the interpretation of the limits of liability and how best to frame the appropriate level of responsibility. the court’s major concern is not to contravene the ambit of freedom of contract. in addition, the colombia supreme court had held that the compensation for damages caused by one contractual party to the other at the pre-contractual stage is divided into two different categories as follows: “ daño emergente” and “ lucro cesante.” “ daño emergente” had been defined as the harm suffered by the injured party for the loss of expenses and financial inversions made during the pre-contractual stage. colombia’s legislation considered that these expenses constitute a negative contractual interest for the abrupt and unjustified rupture of pre-contractual negotiations. in consequence, this interest is limited to the amount of the loss of expenses. this negative interest does not include the expectation interest that the party could have if the contract would have been executed. moreover, “ daño emergente” includes the monetary correction. the interest that emerges from the breach of a valid executed contract is known as “ interés de cumplimiento” or “ interés positivo” (positive interests) because its goal is to put the contracting party in the same financial situation that he would have been if the contract had been nordic journal of commercial law issue 2007 #1 5 performed. the positive interest is the equivalent to the american expectation interest for the breach of a contract. however, the negative interest, which is also know as an “ interés de confianza” (trust interest), is oriented to compensate the injured party for the loss of expenses that he incurred during pre-contractual negotiation as a consequence of his reliance on the other contracting party interest to continue with the negotiations to finally execute a contract. the negative interest is similar to the american reliance interest for the breach of contract but at a pre-contractual stage. according to pedro lafont pianetta, who is a colombian supreme court justice, the negative interest compensates for the loss of expenses, material and moral damage that result from the frustration of pre-contractual agreements. the goal is to bring the injured party to the same financial situation that he was in before he started with pre-contractual negotiations.4 moreover, gabriel escovar sanin indicated that the negative interest has two aspects: 1. the necessity to repair the harm caused by the reliance on the other contractual party, for the trust in her promise 2. the necessity to support and encourage trust and good faith in commercial negotiations.5 the understanding of these two aspects is fundamental for the integral interpretation and understanding of the primary goal of pre-contractual liability and its compensation system. moreover, the “ lucro cesante” is defined as a lost of the opportunities that the injured party suffered on reliance of pre-contractual negotiations. in colombia this is call “ perdida del chance” (loss of a chance). this situation is presented when an innocent party refused to enter into the negotiations of another contract offered by a third party in reliance of the on-going negotiations with the guilty party. in such case the party at fault has to pay for the loss of opportunities suffered by the injured party. colombia supreme court justice alejandro bonivento has indicated that the compensation for the breach of pre-contractual negotiations is composed of the “ daño emergente” and “ lucro cesante” , therefore both interests have to be calculated in order to determine the final compensation.6 however, there was a polemic in relation to the amount of damages that should be paid as a consequence of the “ lucro cesante” . the supreme court has held that this interest should be measured by the loss of profit that the injured party suffered for the loss of opportunities. for instance, the losses of profits caused when the party refuse to accept another contract proposed by a third party at the same time that he was involved in the negotiations of the frustrated contract.7 4 corte suprema de justicia, sentnecia de junio 27 de 1990, m.p: dr. pedro lafont pianetta. 5 sanin, supra note 1, at 394 6 corte suprema de justicia, sentencia de noviembre 23 de 1989, m.p: dr. jose alejandro bonivento fernandez 7 corte suprema de justicia, sentencia de noviembre 23 de 1989, m.p: dr. jose alejandro bonivento fernandez nordic journal of commercial law issue 2007 #1 6 finally, pre-contractual liability in colombia seems to be similar to the reliance interest, and the american doctrine of promissory estoppel in contracts. the concepts of “ daño emergente” and “ lucro cesante” have the same inspiration as the principle of the reliance interest: to place the injured party in the same situation as he was before the contract was made. however, the main difference is that such liability is generated in colombia from the first negotiations and agreements between the parties in pre-contractual stages where there is a tacit agreement between the parties to act in accordance with good faith, fair business, diligence and loyalty. also, in colombia there are three stages in the formation of a contract as follows: the first is pre-contractual agreements or negotiations, the second, is the contractual stage and the last is the post-contractual stage. each of these stages generates liability to the parties in case of breach. c. hypothetical examples to illustrate how pre-contractual liability is applied in colombia the following are some examples of the situations where pre-contractual liability occurs as defined in colombia. a. a company accepted an engineer as a capital partner in the company. the engineer in reliance on the word of the company’s president and ceo proceeded to sell some of his properties at a lower price than the commercial price because he wanted to collect the amount of money that he had to pay to become a partner. also, at the same time, he quit his job in another company. however, a few hours before the execution of the document that recognized him as a partner, the company notified him that they changed the qualifications of admission of the possible partner, and under these new requirements it was impossible for him to become a partner of the company8. in this case, the company, even without the existence of a contract, should be responsible for the damages caused to the innocent party because in reliance on their word he left his job and proceeded to sell his properties to respond for the payment that the company required him to make as a capital partner. here, one party unfairly raised in the other party a hope that a contract will be made. b. juan was an old and outstanding client of a bank. he asked for a loan of $500,000.00 dollars (this sum was lower than of the prior sums loaned to him by the bank.) he needed this money for the purchase of some equipment for his company. in compliance with the prior practices with the bank, and the bank holding his mortgages, and the bank’s manager’s oral confirmation of acceptance of the loan, he proceeded to negotiate for the industrial equipment with the seller and signed a promise of purchase. after the negotiation, he went to the bank to pick up the money for the payment of the equipment. however, he was informed that the credit committee declined his petition for the loan due to a restriction on loans. juan’s financial situation and payments to the institution had been outstanding and did not change from the prior times when he asked the bank for loans. as a consequence, of the negative 8 sanin, supra note 1, at 423. nordic journal of commercial law issue 2007 #1 7 actions of the bank juan had to pay the amount of a penal clause and suffer enormous detriments in the development and progress of his company.9 in this example, the bank’s manager made a promise to juan and broke that promise. therefore, the bank under the law on pre-contractual agreements, is responsible for the damages caused for their negative action on the loan. the bank’s manager knew that, in accordance with prior practices and dealings with juan, he would commence the negotiations for the equipment and the bank manager’s word of acceptance would give juan a green light to even sign a promise of purchase. juan acted in reliance on prior practices and the manager’s word. in this case, as in the first example, there was a hope that a future contract would be made. d. brief comparison between pre-contractual liability as applied in colombia and under american law the first example that i gave to illustrate the application of pre-contractual agreements under the colombian legislation is similar in a way to the case of feinberg v. pfeiffer co. where the plaintiff worked for a long time for the defendant and in consideration of his years of services and in gratitude for his hard work, the company made a resolution to recognized an extra payment for the plaintiff upon his retirement (two hundred dollars for life). the plaintiff, in reliance on this promise, retired. the company made the promised payments for some time until they decided to stop the payments arguing that a promise to make a gift is not binding without consideration and in their case the payment was only a promise and not a standing contract. the court held that in the instant case the plaintiff acted on reliance upon the promise contained in the resolution, and this therefore created an enforceable contract under the doctrine of promissory estoppel. (see § 90 of the restatement second of contracts.) here the plaintiff, in reliance on the promise, retired. the defendant should have reasonably expected that the plaintiff would act in reliance on their promise; in other words, the defendant induced the plaintiff to retire. consequently, the court ordered the payments for life.10 it is imperative to mention the similarities between the concepts of reliance interest and promissory estoppel in american law and the effects of concept of pre-contractual liability in colombia. first, under the concepts of reliance interest and the promissory estoppel, the contractual liability arises when one of the parties makes a promise to the other contractual party as a part of the contract. these two concepts presuppose the existence of a valid contract and, as a consequence of it, one party changes his position during the contractual stage in reliance upon the other party promises to perform the contract. whereas in colombia precontractual liability is imposed as a consequence of the reliance of one party on the other party’s promise or inducement to believe that it would be a probable conclusion of a future contract, this liability is generated as a consequence of the rupture of pre-contractual negotiations and the detriment suffered by one party due to the other side’s inducement to believe in the possibility of a future contract. therefore, this kind of liability does not suppose the breach of a valid contract, merely the breach or rupture of the negotiations. 9 sanin, supra note 1, at 424 . 10 feinberg v. pfeiffer co. 322 s.w. 2d 163 (mo. ct. app.1959) nordic journal of commercial law issue 2007 #1 8 in general. the american legal system does not provide for the concept of culpa in contrahendo or pre-contractual liability. however, puerto rico has contemplated the doctrine of the culpa in contrahendo in its legislation as a consequence of its civil law system. in contrast, the common law states do not recognize the fundamentals of the doctrine of culpa in contrahendo and precontractual liability. as i have mentioned before, colombian’s legislation statutorily regulates the figures of culpa in contrahendo and, specifically, the liability of pre-contractual agreements. colombia’s legislation provides remedies for reliance where there has been an arbitrary rupture of pre-contractual negotiations. in consequence, the guilty party will be obligated to pay for the damages cause to the innocent party, who in reliance of the other’s word and behavior invests time and money in the initial pre-negotiations stage in order to know the details and gather the information required to make an informed decision before the celebration of the contract. with respect to the doctrine of the promissory estoppel, günter kühne has stated that philosophically it was developed as a consequence of the insufficiency of reliance produce by the bargain and the exchange concept consideration: “ in the united states the promissory estoppel took over the tract to make up for the reliance deficit produced by the bargain and the exchange philosophy of the consideration principle. it became an instrument to enforce gratuitous promises where one, relying on the promise, changed his position and incurred financial losses.” 11 the concept of the doctrine of promissory estoppel is similar to the conception of precontractual liability in colombia in the fact that the main inspiration is to avoid unjust enrichment, to promote fair business practices, and to imposed responsibility on the party who either intentionally or unintentionally made a promise to another and had reason to know that the other party will act in a certain way in reliance on his promise. the difference is that promissory estoppel operates on a contractual stage, in other words, where a valid contract has been made, and to lock in the offer in a bid case once the contractor has notified the subcontractor that he won the contract. however, pre-contractual agreements do not require the formation of a valid contract, only the pre-negotiations of it whether or not they come to fruition. pre-contractual agreements do not require the complete meeting of the minds as is required to obtained relief under the concept of promissory estoppel and the reliance interest in american law. pre-contractual agreements only required that the party seeking recovery had reason to conclude from the other party’s conduct that a future contract will be made. here, what is punished is the careless inducement in reliance and the late rupture of negotiations and frustration of 11 kühne, günter, promissory estoppel and culpa in contrahendo, 10 tel aviv university studies in law, tel aviv 282 (1990). nordic journal of commercial law issue 2007 #1 9 reliance investment. consequently, the main point is to recover for the reliance invested during the dealing and the recovery for the economic loss.12 günter kuhne indicates that in the case of culpa in contrahendo and pre-contractual liability, it is possible to conclude that liability of the party is recognized based on two elements: a. “ violation of a pre-contractual duty, which is the duty in regard to the contractual process before a break-off. (the duty is not to rupture negotiations for other than valid reasons, so the break-of itself caused liability.) b. the inducement of reliance action to the detriment of the other party. one party changes his position in reliance of the other one promise and behavior.” 13 in respect to the liability imposed through these two elements, it is clear that the parties owed to each other the obligation to act in good faith since the beginning of the negotiations. it is also reasonable to expect the reliance of the other party in the negotiations in changing his position to investigate and gather the prudence information in respect to the business. consequently, the party might hire attorneys, accountants, engineers and any kind of consultants that he might require to understand and to inform him with respect to the business in negotiation. therefore, the blameworthy party will be liable for the arbitrary rupture of the negotiations due to the investment made by the other party on reliance on the possible contract, based on the behavior and promises of the other party. in conclusion, it is possible to understand that the liability imposed through these two elements was the natural consequence of its breach. moreover, another difference between the colombian’ legislation and the american law in respect to pre-contractual agreements is that the element of good faith is not require in america in pre-contractual stages. in other words, it is not extended to the negotiations. there is not a specific duty to bargain in good faith but there is a duty to be performed in good faith obligation, which is imposed during the contractual stage. consequently, the uniform commercial code requires merchants to perform in good faith and fair dealing. for instance, in the case of a merchant, the good faith element imposes on him the obligation to observe reasonable commercial standards of fair dealing in the trade and to perform with respect of such standards.14 while in colombia, the commercial code imposes an obligation on the contractual parties to observe good faith during the pre-contractual stage, therefore, the blameworthy party would be liable for his breach of such duty. the fundamental point of such provision is that during the pre-contractual stage the parties engaged in the negotiations build between them relationships based on trust similar to the ones that arise in the contractual stage, so they will have to comply with a high standard of care. in conclusion, pre-contractual liability in colombia has a high importance in the contractual relations between the parties and therefore the commercial and civil code regulates it extensively. its goal is to promote good faith and fair dealing during all the contractual stages and as well as to prevent the unjust enrichment of one of the parties to the detriment of the 12 id. at 282 13 kühne, supra note10, at 288 14 kessler, friedrich/fine, edith, culpa in contrahendo, bargaining in good faith and freedom of contract: a comparative study, harvard law review, 1964. pg 408. nordic journal of commercial law issue 2007 #1 10 other party. the goal of the concept of pre-contractual liability is to restore the damages suffered by one party in reliance on the blameworthy party. during the negotiation of pre-contractual agreements, some obligations and rights are generated to the parties. the main obligation is to act in good faith, meaning that the parties have to initiate the negotiations with the intention to reach an agreement, and to withdraw as soon as possible, before the other party, in reliance of the negotiations, invests in the research of the business. also, good faith requires the obligation of reserve which means that information with respect to the business and financial situation of one of the parties ought not to be disclosed if it is confidential. finally, it requires the obligation of custody and conservation of all the material that has been given to the parties in the course of the negotiations. the withdrawal itself does not cause the liability. there has to be some kind of unfair act such as not intending to reach an agreement and omitting to communicate the determination to he other party, not disclosing trustworthy information, or continuing the negotiations after realizing that the contract will never be concluded. iii. a brief view of pre-contractual liability under the cisg we cannot find any provision in the cisg that specifically regulates pre-contractual liability. in this respect, the cisg is silent. however, the application of this concept can nevertheless be inferred from the cisg’s general principles, from its provisions and from its interpretation as a whole. the first approach is to look at article 7(1), which addresses the international character of the convention and its promotion of the principle of good faith in international trade. one then turns to article 7(2) which indicates that, for matters governed by the convention, but not expressly settled in it, the correct approach is to interpret the matter according to the general principles of the convention, where such principles are present. article 8 of the cisg is also highly relevant. a. applicability of pre-contractual agreements under the cisg according to article 7 and article 8 in my view, in order to have a full understanding of the application of pre-contractual liability under the cisg, one must review the legislative history of article 7 which refers to the good faith principal. i will emphasize in its importance. according to the legislative records of the vienna diplomatic conference at which the cisg was promulgated, there was a lack of consensus as to the meaning of the principle of good faith provided in article 7. the following are some of the views that were discussed in respect to the inclusion of good faith in international trade: “ colloquy at diplomatic conference on proposal to provide a more specific reference to good faith (“ article [7] [is] not the appropriate place for a reference to a principal of major importance in international trade relations. a separate article [is] required.” proposal rejected” comments by delegates, some regarding a good faith requirement as present without such a separate article; some not wanting such an article because it would document the existence of a good faith requirement applicable to a contracting parties. or 257-259,paras. 40-56 [or=official records of the nordic journal of commercial law issue 2007 #1 11 united nations conference on contracts for the international sale of goods, vienna 10 march11 april 1980, a/conf. 97/19]” 15 the draft of article 6 that was presented in 1978 was approved as article 7(1) of the official text of the cisg. the major modifications proposed were presented by italy and norway as follows: “ [italy (a/conf.97/c.1/l.59): delete the words “ and the observance of the good faith in international trade” (cf. in this respect the proposed new article 6 [became cisg article 7] ter) and add new sentence: “ questions concerning matters governed by this convention which are not expressly settle therein shall be settle in conformity with the general principles on which this convention is based or, in the absence of such principles, by taking account of the national law of each of the parties.” ] [add a new article 6 [became article 7] ter to read as follows: “ in the formation [interpretation] and performance of a contract of sale the parties shall observe the principles of the good faith and international co-operation.” ] {norway (a/conf.97/c.1/l.28): delete the words: “ and the observance of the good faith in international trade” article [6] [became article 7]” 16 during the discussions, mr. bonell, who was a member of the italian delegation indicated that an inclusion of a provision regulating the observance of good faith principle was required in the cisg. therefore, he supported and proposed the adoption of a separate provision for the regulation of a major principle of good faith. in addition, he stated that his delegation proposed to add a reference to “ international cooperation” with the intention to clarify that only those aspects of good faith that were internationally acceptable would apply to the interpretation of the principles under the cisg.17 mr. rognlien, of norway, stated that the reference to the principle of good faith should be transferred from article 6 to article 7. he also indicated that the observance of good faith was related to the contract between the parties not to the interpretation of the provisions of the convention. therefore, he considered that the reference to good faith should be transferred from article 6 to article 7 (which become article 8 (3) of the cisg). he disagreed with the inclusion of the reference to the international cooperation proposed by italy.18 miss o’flynn who represented united kingdom stated that there was no need to add a new article for the provision of the good faith as it was proposed by italy. she indicated that the 15 article 7 colloquy, interpretation of the convention. points of view expressed at vienna diplomatic conference, colloquy on issue related to a good faith: proposal to add to cisg a version of concept of culpa in contrahendo (pre-contractual liability): proposal rejected [official records 294-295, paras. 77-87] (1980) 16 id. at 294-295 17 id. 18 id.. nordic journal of commercial law issue 2007 #1 12 meaning of the article involved an uncertain interpretation, the principles of the good faith were not defined, and there was no provision for the application of sanctions that would be applied as a consequence of the failure of one party to act in good faith. in conclusion, she did not support the italian proposal.19 finally, mr. allan farnsworth, representing the united states, noted that he had a preference for the existing text because the italian proposal with respect to the application and interpretation of the good faith in an international context was uncertain and dangerous.20 the issue related to the prohibition of the parties from departing from their obligation to act in good faith was debated during the discussion related to the principal of good faith. a canadian proposal read as follows: “ change article 5 [became cisg article 6] to read as follows: (canada (a/conf.97/c.1/l.10): “ (1) the parties may exclude the application of this convention or, subject to article 11 [became cisg article 12], derogate from or vary the effect of any of its provisions. however, except were the parties have wholly excluded this convention, the obligation of good faith, diligence and reasonable care prescribe by this convention may not be excluded by agreement, but the parties may by agreement determinate the standards by which the performance of such obligations are to be measure if such standards are not manifestly unreasonable.]” 21 with respect to this issue, mr. farnsworth indicated that he did not support the canadian proposal because it will impose a general obligation of good faith. the majority of the committee was against the canadian proposal therefore it was not approved. finally, the committees discussed a proposal specifically related to pre-contractual liability. the delegates from the german democratic republic proposed that a new article on this subject be added to part ii of the convention. (a/conf.97/c.1/l.95). the following are some of the comments with respect to this proposal:22 “ 78. mr. plunkett (ireland) asked whether the proposal envisaged that compensation would be payable even if no contract had been conclude, or if a contract had been conclude, whether it should be payable for something other than a breach of contract. “ 79. mr. maskow (german democratic republic) replied that it was the essence of his proposal that compensation for expenses could be claim even if there were no contract. “ 80. mr. bonell (italy) strongly supported the proposal. his delegation had already submitted a proposal along similar lines. the existing text of the convention did not take sufficiently into account cases where no contract was concluded but the parties had engaged in detailed negotiations at the pre-contractual stage. such cases needed regulation because of the risk that one of the parties might abuse its position and act in such a way as to damage the interest of the other party. he thought the drafting of the proposal could be improved, notably by the deletion of the phrase “ in the course of the preliminary negotiations” , and also by the inclusion of a phrase to 19 id. 20 id. 21 official records pp 257-259 22 id. at 294-295. nordic journal of commercial law issue 2007 #1 13 cover the situation in which the party had not necessarily had expenses, but had suffered damages. he suggested that an ad hoc working group be set up to produce an agreed text. “ 81. mr. schlechtriem (federal republic of germany) sympathized with the object of the proposal but considered it much too far-reaching. such a general clause might change some of the solutions of the draft, e.g., the provisions dealing with the obligations of the parties or with the revocability of the offer. it would touch on the problem of form requirements and would also affect matters outside the scope of the convention such as the avoidance of the contract for errors, or the authority of agents. “ 82. mr. bennett (australia) said that he had great difficulty with the proposal. it referred to a failure in duty to take reasonable care, a notion that was not found anywhere else in the convention. it was not clear what was the standard of reasonable care that was envisaged. the problem was an important one and not merely one of drafting.” as it is reflected in the reading of the opinions, the proposal for pre-contractual liability was highly objected to by members if the committee and was not agreed on. however, in my opinion, the failure of the approval of the committee to adopt this provision on the regulation of pre-contractual liability under the csig was the result of a lack of understanding of the concept by the common law delegations. as i indicated in the first chapter of this article, pre-contractual liability has not been recognized as a part of the contractual law at common law jurisdictions. i think that their major fear is to contravene the principal of freedom of contract. conversely, the position of the common law jurisdictions, in their effort to protect freedom of contract, is lacking in protection for the contractual parties during pre-contractual negotiations. it is my view that this is a dangerous approach because during pre-contractual negotiations the damages that can result by the unjustified withdraw of the negotiations can be major or equal to the damages caused by the breach of the contract. therefore, in order to avoid unjust enrichment and honor the principles of good faith and fair dealing from the beginning of the negotiations of a probable contract, the concept of precontractual liability should be regarded as a part of contract law. in addition to its discussion at the vienna diplomatic conference, the concept of precontractual liability had been discussed earlier in 1977 at the 9th session where the uncitral working group presented its finished draft of the “ formation of the contract.” the draft included the requirement that fair dealing and good faith had to be observed by the parties during the course of the formation of the contract. the german democratic republic suggested that a third paragraph be added to the proposal of hungary (as indicated above such proposal was raised and objected in the vienna conference). in addition, the german democratic republic maintained that the observance of fair dealing and good faith was required from the parties during the course of formation of the contract and, if during the preparation and formation of the contract one of the parties violated their duties of customer care the other party had the right to claim compensation for the economic loss.23 23 uncitral yearbook ix, (1978), a/cn.9/ser.a/1978 pp 66-67; honnold documentary history pp 298-299. nordic journal of commercial law issue 2007 #1 14 furthermore, for some of the drafters the concept of good faith and fair dealing was considered a moral obligation. therefore, it was highly important that they elevated these principals to the stage of a legal obligation. however, they were concerned that the application of such principles to particular transactions might not lead to the development of a uniformed and coherent case law in international trade because each national court might be influenced by its own legal traditions and beliefs. to conclude, it was the majority opinion that the proposals for precontractual liability under the cisg were properly rejected. the view that prevails is that precontractual liability is not part of the scope of the convention. however, there is a minority opinion to the effect that, even though the cisg does not include an express provision dealing with pre-contractual liability, it will be possible for the tribunals to impose its application by the interpretation of the general provision of observance of good faith in international trade and the interpretation of the principals of the convention as a whole. respect to this point, bonell has noted:24 “ the fact that cisg does not have a provision expressly dealing with the pre-contractual liability of the parties for theirs conduct during the negotiations does not necessarily mean that the issue fall outside the scope of the convention. in fact, pre-contractual liability could simply be -to use the language of article 7 — one of those questions concerning matters governed by [the] convention which are not expressly settled in it… . issues which are outside the scope of the convention continue to be governed by domestic law while, in the case of simple lacuna, the solution has to be found primarily within the convention itself, i.e., in conformity with the general principles on which it is based, and only in the absence of such principles, may resort be had to the law applicable by virtue of the relevant conflict of law rules (cf. article 7(2))… .” i agree with professor bonell. it is clear that pre-contractual liability should not be considered outside the scope of the cisg. its application can be possible through the interpretation of the convention as a whole and in conformity with the application of its general principles. from the analysis of the principles of good faith, and fair dealing in conjunction with the interpretation of the conduct and intention of the parties, it is possible to establish the existence of a pre-contractual liability under the cisg. additionally, the application of the principles of good faith and fair dealing has also been recognized by the unidroit principles. article 1.7 regulates the general application of the principal of good faith and fair dealing in international trade. furthermore, the article indicates that the parties cannot “ exclude or limit such obligation.” 25 moreover, article 2.1.15 which rules on negotiations in bad faith provides:26 a party is free to negotiate and is not liable for failure to reach an agreement. however, a party who negotiates or breaks off negotiations in bad faith is liable for the losses caused to the other party. 24 bonnell “ formation of contracts and pre-contractual liability under the vienna convention on international sale of goods” formation of contracts and pre-contractual liability (icc publishing pub. no. 440/9: 1990) pp 167-171. 25 steven j. burton and melvin a. eisenberg, contract law: selected sources materials, unidroit pinciples,thomson west p381 (2006) 26 id. at 384. nordic journal of commercial law issue 2007 #1 15 it is bad faith, in particular, for a party to enter into or continue negotiations when intending not to reach an agreement with the other party.” according to rodrigo novoa, it is possible for the courts to find that the adoption of precontractual duty to bargain in good faith under the unidroit could be extended to the cisg because the main purpose of the unidroit principles is to provide guidelines for the interpretation and application of the uniform law instruments on international commercial contracts such as the cisg. therefore, it is probable that the adoption of the pre-contractual duty to bargain in good faith by the undroit principles might persuade a court that this duty is also present under the cisg.27 moreover, shani salama considered that article 7(2) of the cisg provides an interpretation tool of the convention. therefore, when the courts are filling the gaps encountered in the interpretation of a matter that is not settled in the convention like the pre-contractual liability they should look at article 7(2) and interpret such matters within the general principles that inspired the convention. according to salama the interpretation under article 7(2) required the use of hierarchy methods of interpretation. she indicates that the first approach by a court when it is filling the gaps under the cisg is to look at the provisions and the general principles that inspired the convention even if the matter is not expressively settled. second, if the matter is excluded of the scope of the convention, for instance, the liability of the seller for death and personal injury (art 5 cisg), such matter should be resolved according to the rules applicable under the private international law and not the cisg. in consequence, article 7(2) would be inapplicable.28 furthermore, she emphasized that the scholars have not been clear in respect to the interpretation of the definition of “ general principles that inspired the cisg. she noted: “ the definition of “ general principles upon which the convention is based” falls short of receiving any clear interpretation in the scholarly works. reference is made to these principles in article 7(2) without further explanation. jeffrey hartwing writes that the “ general principles are to be derived from the convention’s own provisions” . moreover, professor honnold writes that a “ particular general principal must be moored to premises that underlie specific provisions of the convention.” 29 in addition, salama indicates that the interpretation of the general principles of the convention should be broader then just limiting their construction only to the general principles that derive from the convention. moreover, such construction should not even be limited to the intent of the drafters. the interpretation of the general principles should be broader according to the international character of the convention article 7(1). in consequence, salama considered that the courts should look carefully and extensively to the general principles of the convention because it is a living body capable of changes and adaptation to the new commercial transactions in international commerce. thus the interpretation of the general principles of the convention should follow the changes and 27 rodrigo novoa, culpa in contrahendo: a comparative law study: chilean law and the united nations convention on contracts for the international sale of goods (cisg),22 ariz. j. int’l & comp. l. 583. p 611 (2005) 28 shani salama, pragmatic responses to interpretive impediments: article 7 of the cisg, an inter-american application, 28 university of miami inter-american law review p 7-8 (fall 2006) 29 id at 8 nordic journal of commercial law issue 2007 #1 16 transactions in international trade. this point of view is consistent with the regulation provided in article 7(2) because one of its goals is to resolve not expressly regulated matters like those that will arise in the future. to conclude, she also supports the view of professor guilmard that “ promotes that the use of principles of the undroit and pecl as a source of general principles in art 7(2).” 30 i really like salama’s approach regarding the interpretation of art 7(2). as i stated before, the precontractual liability is within the scope of the cisg .therefore, following salama’s theory, if a court has to decide a case on pre-contractual liability the first step for the court is to look at the general principles that inspired the cisg because it constitutes and unsettled matter. thus the interpretation and regulation of the pre-contractual liability will be possible through its principles. consequently, there is no need to refer and resolve the case according to the private international law. furthermore, as salama stated, the interpretation of the general principles of the cisg should be broader according to its international character and not only limited to those derived from the convention. consequently, it is possible to conclude that the principles of the undroit and pecl constitute a source of the general principles referred in art 7 (2) and therefore the adoption of pre-contractual duty to bargain in good faith under the unidroit could be extended to the cisg. finally, it is imperative to indicate that interpretation of the conduct and intention of the parties is fundamental in the analysis of the application of the pre-contractual liability under the cisg. article 8 provides:31 “ (1) for the purposes of the application of this convention statements made by and other conduct of a party are to be interpreted according to his intent where the other party knew or could not have been unaware what that intent was. (2) if the preceding paragraph is not applicable, statements made by and other conduct of a party are to be interpreted according to the understanding that a reasonable person of the same kind as the other party would have had in the same circumstances. (3) in determining the intent of a party or the understanding a reasonable person would have had, due consideration is to be given to all relevant circumstances of the case including the negotiations, any practices which the parties have established between themselves, usages and any subsequent conduct of the parties.” from the reading of article 8 of the cisg, it is clear that this provision is not related to the interpretation of the convention but to the interpretation of the parties’ statements, intentions, conducts, usages and practices in light of an international contract of sale of goods. there are two tests that apply in the interpretation of the party’s statements and conduct. the first is the subjective test which indicates that the statements and conducts of the parties are to be understood according with its intent (article 8(1)) “ where the other party knew or could not have been unaware what that intent was.” the second is the objective test, which refers to the understanding of the statement and conduct by a reasonable person under the same 30 id. 31 burton and eisenberg, supra note 24, at 350. nordic journal of commercial law issue 2007 #1 17 circumstances (article 8 (2)). the objective test will be applicable when the other party neither knew or nor could have been aware of the intent. in reference to this article, i would like to emphasize the importance of the interpretation of the conduct, statements and intentions of the parties when they are dealing with precontractual negotiations because they will lead one of the parties to rely on and conclude the serious intentions of the other contractual party to a contract. therefore, the party in reliance on the other party’s statements and behaviors will study, research and invest time and money learning the benefits and disadvantages of the future contract. consequently, if one of the parties abruptly withdraws from the negotiations without justification, it should be liable for the damages caused to the other contractual party. b. hypothetical case to illustrate the application of pre-contractual liability under the cisg. the following is a hypothetical example that will help to illustrate the application of precontractual liability under the cisg: wine co. is a vineyard company located in italy. the company is selling its entire production for 2006. the wine is stored in a warehouse located in a distant place. on january 2, 2006, wine co. sent information to all its clients stating that it was offering its entire production in the vineyard for 2006 but that the price could not be lower than us $6 per bottle, and its entire production was approximately three million bottles. in addition, wine company advised that clients interested in buying the production would have to respond by communication sent to piero monestier, ceo of the company no later then january 30, 2006 and that a final contract should be signed by march 30, 2006, after the inspection and testing of the product by interested buyers. the inspection was programmed for february 16, 2006. three south american firms expressed interest: concha co. from colombia; toro from chile and tinto from argentina. these three clients traveled to italy for the inspection. the inspection was held for four days and the clients brought specialists to determine the quality of the wine. the contract was to be awarded to the best proposal twenty days after of the inspection. however, wine co. informed its clients ten days after the inspection its refusal to continue with the negotiations. wine co. did not give any specific reason to its clients. the company only indicated that due to a policy of the company the negotiation was canceled. wine co. knew since january 30, that the negotiation would be canceled due to their contractual obligation with an italian client. however, the company did not stop the negotiations and continued with them until the inspection and then, only a few days before the award of the contract, withdrew its proposal. all the countries involved in the negotiations had their relevant places of business in countries that subscribed to the cisg. the damages caused to the clients included the loss of out-of-pocket expenses and the loss of opportunities because they refrained from negotiating with other providers due to the ongoing negotiations with wine co. to establish a case under the concept of pre-contractual liability, four elements are required:32 32 novoa, supra note 27, at 583 nordic journal of commercial law issue 2007 #1 18 1. “ preliminary negotiations; 2. breach of the duty to bargain in good faith; 3. causation in fact; and 4. compensable damages.” the hypothetical case meets these requirements. there were preliminary negotiations, (the requirement of prior inspection of the product and the posterior communication of the offer after 20 days of the inspection), wine co. without justification and in bad faith withdrew the negotiations and, as a consequence of the rupture of the negotiations, its clients suffered damages in reliance on its statement and conduct. wine co. promoted the preliminary negotiations and did not withdraw the negotiations, as soon as it found out that such a contract would not be concluded. the company continued with the inspection and let the clients invest money in their travel expenses, salary of experts and caused them to miss other opportunities. in situations as illustrated in this hypothetical case the application of pre-contractual liability under the cisg should be possible. first, the cisg promotes the general principals of good faith and fair dealing. therefore, it is possible to conclude that the parties, since the beginning of the negotiation, have the obligation to bargain in good faith and the breach of such obligation will render legal consequences for the damages caused by the breach. also, it is reasonable to conclude that a party, in reliance on the other party’s promises, statements or conduct, will proceed with the due diligence that was required to obtain the conclusion of the contract. for instance, in the hypothetical example any reasonable person in the same situation would have understood that wine co. had a serious intention to conclude the negotiations and award the contract to the best offer (article 8). the parties would never incur such investment in money and work if they did not have an understanding that the proposal sent by wine company was serious. therefore, the intention of the parties was clear. the wine company showed an intention to conclude a contract. it would be unfair to conclude that the parties should pay for the cost of the inspection and travel because wine company required them to execute the inspection as a condition precedent before the awarding of the contract under circumstances in which. wine company knew its intention to withdraw the negotiations but failed to communicate this determination in time. wine company did not act according the general principles of good faith and fair dealing that inspire the cisg. conversely, i would like to think of the outcome of this case under the analysis of the majority view that held that pre-contractual liability is outside of the scope of the cisg. in their analysis they will probably indicate that the domestic law would apply instead of the cisg because the convention is silent to this respect. in my opinion, regarding pre-contractual liability as outside the scope of the cisg will lead to uncertainty and ambiguous interpretations and outcomes because the gap will be fulfilled according to the provisions of the domestic laws. therefore, if a pre-contractual liability case is decided in common law jurisdictions, it is likely that the parties will not be allowed to recover damages for the unjustified withdraw of pre-contractual negotiations. conversely, if the same case is resolved by a judge in the civil law jurisdiction, the innocent party will likely be allowed to recover the damages caused in reliance on the other party’s intention to conclude a future contract. in consequence, the innocent party will be compensated for the cost of expenses and the lost of opportunities suffered during pre-contractual negotiations. nordic journal of commercial law issue 2007 #1 19 i believe that the application of domestic law in cases of pre-contractual liability in international contracts would infringe the major principals and goals of the cisg because it will be a lack of unity in the interpretation and outcomes in this matter. therefore, this conclusion would not honor the uniformity and unity that the convention pursues. c. comparison between the application of pre-contractual liability under the cisg and colombian domestic law colombian legislation regulated pre-contractual liability under the civil and commercial code. in contrast, the cisg is silent respect to this matter. the majority of the scholars opine that pre-contractual liability is not within the scope of the cisg. however, i believe that precontractual liability is regulated under the cisg and is not outside its scope. as i indicated before, it is possible to infer its application through the interpretation of its general principles and provisions as a whole. in consequence, the application of pre-contractual liability is possible under the interpretation of the regulations provided in articles 7 and 8 of the cisg. article 7 regulates the international character of the convention and provides for the promotion of good faith in international trade. in addition, this article indicates that where a matter is governed by the convention but not expressly settled in it, the correct approach is to resolve the matter according to its general principles, where such principles are present. similarly, article 863 of the colombian commercial code sets forth the obligation of the contracting parties to act in good faith and without fault during pre-contractual negotiations and provides that the failure to comply with this obligation will cause the liability of the party at fault. in addition, article 872 of the commercial code indicates that the celebration and execution of the contracts shall be in good faith. moreover, the cisg in article 8 states that the intention, statements and conduct of the contractual parties should prevail in the interpretation of the contract. in this aspect, the cisg is also similar to the colombian legislation because article 1618 of the colombian civil code states that, once the intention of the contractual party is known, that intention prevails against the literal interpretation of the provisions of the contract. finally, both legislations will award damages in reliance to the innocent party. in both cases, the innocent party will be compensated for his out-of-pocket expenses and lost opportunities. it is also important to mention that, under article 16(2)(b), the cisg regulates promissory estoppel. according to this article, an offer can be withdrawn at any time before its acceptance except when is reasonable to believe that the offeree in reliance on the offer acted in a certain way. for instance, the party commenced investment in production, hired some employees and invested in infrastructure, and as a consequence, will suffer damages if the offer is revoked. thus, he should be allowed to recover damages in reliance. in my view, this protection can be extended to pre-contractual agreements because we are facing similar situations. in prenordic journal of commercial law issue 2007 #1 20 contractual negotiations, we have a party who acted in reliance on the negotiations and as a consequence researched the business, invested money and time learning the opportunities and benefits of the future contract. therefore, in case of an unjustified withdraw of the negotiations the blameworthy party should be held responsible for the damages caused in reliance. iv. conclusion it is true that there is no provision in the cisg that specifically regulates pre-contractual liability. in this respect, the cisg is silent. however, its application can be inferred from its general principles and provisions and from the interpretation of the convention as a whole. as stated before, the first step is to look to article 7(1), which indicates the international character of the convention and its promotion of the principal of good faith in international trade. in addition, article 7(2) indicates that where a matter is governed by the convention but not expressly settled in it the correct approach is to resolve the matter in accordance with the general principles of the convention where such principles are present. in my opinion, the intention of the drafters of the cisg was to bind the contracting parties to the compliance of good faith since the beginning of the negotiations of the contract of sale. furthermore, one must analyze the intention of the contracting parties according to article 8. the questions that may arise are: was there an intention to conclude a contract? where there promises, statements or conduct that would lead the other contracting party to infer the conclusion of a contract and therefore proceed with the researching the business? if these questions are answered in the affirmative, then it is possible to infer the application of precontractual liability due to the reliance of one party in the other’s statements and conduct. moreover, i think that the unidroit provision on bargaining in good faith could be extended to the cisg because the interpretation of the general principles of the convention should be broader and not only limited to the general principles derived from the convention. thus, it could be sustained that the principles of the undroit and pecl can be used as a source of the general principles provided in article 7(2) cisg as it have been sustained by salama’s theory. technological populism and its archetypes: blockchain and cryptocurrencies asress adimi gikay & cătălin gabriel stănescu  lecturer in artificial intelligence, disruptive innovation and law at brunel university, united kingdom, phd researcher, sant’anna school of advanced studies, department of law, politics and development, pisa, italy, asress.gikay@brunel.ac.uk. assistant professor and marie curie fellow at centre for market and economic law, faculty of law, university of copenhagen, denmark, catalingabriel.stanescu@jur.ku.dk. abstract ......................................................................................................... 66 1. introduction .................................................................................... 66 2. populism and blockchain an overview ............................... 70 2.1.1. what is political populism? ................................... 70 2.2. what is blockchain? ............................................................ 75 2.3. blockchain and populism—conceptual and rhetorical associations ................................................... 77 3. the populist promises of blockchain technology .......... 80 3.1. disruption challenging the establishment .......... 80 3.2. empowering the disenfranchised against the elites 83 3.2.1. the illusion of decentralization ..................... 84 3.2.1.1 decentralization is not real ..................................... 84 3.2.1.2 decentralization is not feasible .............................. 86 3.2.1.3 decentralization is not desirable ............................ 87 3.2.2. trust in computation — getting unmerited trust ............................................................................... 90 3.2.3. anonymity— anarchy with a drop of privacy ........................................................................................... 95 3.3. summing up: the false promises of technological populism .................................................................................... 96 4. explaining the rise of technological populism ............... 97 4.1. the role of media and intellectual sycophants .. 98 4.1.1. the media ...................................................................... 98 4.1.2. the intelligentsia .................................................... 99 4.1.2.1. hype by all means? ................................................ 99 4.1.2.2. a 21st century dilemma: to regulate or not to regulate? ............................................................................................ 102 4.1.3. regulatory oversight .......................................... 104 5. conclusion: a call for technological populism consciousness ................................................................................. 108 njcl 2019/2 66 abstract blockchain technology claims to disrupt the existing financial system, the way of doing business, and to empower ordinary citizens against an elitist economy through decentralization of the decision-making process. in the political arena, the disruptive ideology branded as ‘populism’ challenges the neo-liberal establishment. by appealing to peoples’ fears, frustrations, and dissatisfaction with the political elites, exploiting distrust in the so-called establishment, populism claims to deliver more power to the people. in this article, we draw a parallel between core foundations of political populism and those of blockchain and propose a theory of technological populism. technological populism as reflected by blockchain platforms exploits the rhetoric of empowering the disenfranchised through decentralized decision-making process, enabling anonymity of transactions, dehumanizing trust (promoting trust in computation rather than trust in humans and institutions) as well as breaking the monopoly in the financial system and money supply. the rhetoric of empowering the disenfranchised against financial elites is not only propaganda but also a method of accumulating wealth for technocratic elites. ultimately, the blockchain and cryptocurrency world has perfected what political populists have pioneered — unrealistic promises, turning the citizen against “the elites” only so long as they are not the elites in charge. key words: technological populism, populism, distributed digital ledger (dlt), bitcoin, democracy, blockchain, cryptocurrencies, anarchy, political promises 1. introduction when bitcoin was launched in 2009, there was great enthusiasm for its potential. today, cryptocurrencies and blockchain transcended the sphere of peer-to-peer online payment and have become a multi-billion dollar industry.1 bitcoin could replace fiat money,2 could bank the 1 as of april 25, 2019, the total market capitalization for cryptocurrencies is over $ 170 billion. cryptolization, retrieved from <https://cryptolization.com/> accessed 25 april 2019. 2 frank holmes, ‘bitcoin could replace cash in 10 years’ business insider (1 may 2018), retrieved from <https://www.businessinsider.com/bitcoin-might-replace-cash-10years-2018-5?ir=t> accessed 23 february 2019. 67 technological populism and its archetypes unbanked,3 while blockchain could revolutionize finance, could help in fighting against poverty,4 could be used to safeguard the environment and combat climate change.5 these are just some of the claims made by entrepreneurs, industry experts, advocates, intellectuals, and the media in regard to cryptocurrencies and blockchain. with cryptocurrencies failing to deliver on their promises of replacing fiat currencies and tripartite payments systems,6 the enthusiasts shifted their focus from the currency/payment aspect to blockchain as a malleable distributed ledger technology (dlt) with various applications across industries.7 the past ten years have also revealed many direct or indirect challenges facing the technology, ranging from fraudulent practices in crowd financing of various projects linked to the technology to its use for criminal activities. a report published in 2018 shows that 80% of the 3 paul vigna and michael j. casey, ‘bitcoin for the unbanked: cryptocurrencies that go where big banks won’t, foreign affairs’ (foreign affairs, 25 october 2017), retrieved from <https://www.foreignaffairs.com/sponsored/bitcoin-unbanked> accessed 6 july 2018; steve forbes, ‘how bitcoin will end world poverty’ forbes (02 april 2015, retrieved from <https://www.forbes.com/sites/steveforbes/2015/04/02/howbitcoin-will-end-world-poverty/#62cee38f2a5a> accessed 6 july 2018 & george basiladze, ‘how cryptocurrencies can help bank the unbanked’ (fin. magnets, 16 august 2015), retrieved from <https://www.financemagnates.com/cryptocurrency/bloggers/how-cryptocurrenciescan-help-bank-the-unbanked/> accessed 6 july 2018. 4 gillian tett, ‘bitcoin, blockchain and the fight against poverty’ the financial times (22 december 2017), retrieved from <https://www.ft.com/content/60f838ea-e514-11e78b99-0191e45377ec> accessed 29 june 2018. 5 anteneh tesfaye ‘blockchain is here and it’s changing the world’ data driven investor (oct 15, 2018), retrieved from <https://medium.com/datadriveninvestor/blockchain-is-here-and-its-changing-theworld-c54dd401695e?sk=546aacee45e899cb78ed0217c9eeab45> 23 february 2019. 6 yuwa hedrick-wong ‘cryptocurrencies have failed, and blockchain still has yet to be proven useful’ forbes (nov. 11 2018), retrieved from <https://www.forbes.com/sites/yuwahedrickwong/2018/11/11/cryptocurrencieshave-failed-and-blockchain-still-has-yet-to-find-its-use/#7a214b02406c> accessed 25 april 2019. 7 i. kiviat trevor, ‘beyond bitcoin: issues in regulating blockchain transactions’ 65 duke law journal 569, p. 570. ‘…—the true innovation behind the bitcoin protocol. simply, blockchain technology solves an elusive networking problem by enabling “trustless” transactions: value exchanges over computer networks that can be verified, monitored, and enforced without central institutions (for example, banks). this has broad implications for how we transact over electronic networks.’ njcl 2019/2 68 initial coin offerings (icos) (a method of crowdfunding for blockchainbased projects)8 were fraudulent.9 blockchain’s ability to revolutionize finance, data sharing and even combating poverty or preserving the environment has been discussed often by employing optimistic rhetoric. however, potential is not a substitute for facts. similarly, the claim of empowering ordinary citizens against elitist economy and institutions through decentralization across sectors lies at the heart of the campaign for blockchain. nevertheless, the technology’s promise of easy solutions to multifaceted societal challenges is nothing more than demagoguery and a business opportunity. the technology that should have significantly disrupted the old economic and financial establishment has made many people rich (or richer), but failed to deliver on its original promises. in the political sphere, there is a similar phenomenon. the neoliberal establishment is being challenged by a disruptive political movement or ideology labeled as “populism”. appealing to peoples’ fears, frustrations, and dissatisfaction with the political elites, populism claims to deliver more power to the people and to reconnect political representatives with their constituencies. however, the leaders of the populist camp either promise the impossible or fail to deliver on them. in this article, we postulate that there is a close association between blockchain technology and populism at a conceptual level and investigate the common traits between blockchain and cryptocurrencies, on the one hand, and political populism, on the other. in order to do so, we propose a new concept “technological populism,” — to refer to the phenomenon by which technological innovations that promise and promote disruptive effects as societal benefits and claim to solve pressing socio-economic problems by 8 initial coin offering (ico) is a scheme whereby an entity promoting a new cryptocurrency or crypto-asset raises money from the public where investors are usually issued a token that entitles them to different kinds of rights such as the right to profit sharing and voting in the entity issuing the token. see a. sehra, p. smoth & p. gomes, ‘economics of initial coin offerings’ (allen & overy, 01 august 2017) 2 <http://www.allenovery.com/sitecollectiondocuments/ico-article-nivaura20170822-0951%20%20-%20final%20draft.pdf > accessed 6 july 2018 & a. majumda, ‘a regulatory outlook on initial coin offerings’ (oxford business law blog, 03 august 2017), retrieved from <https://www.law.ox.ac.uk/business-lawblog/blog/2017/08/regulatory-outlook-initial-coin-offerings> accessed 6 july 2018. 9 shobhit seth, ‘$9 million lost each day in cryptocurrency scams’ (investopedia, 2 april 2 2018), retrieved from <https://www.investopedia.com/news/80-icos-arescams-report%20/> accessed 17 october 2018. 69 technological populism and its archetypes empowering the ‘disenfranchised’ and replacing the ‘elites’ are ‘hyped’10 for the economic and commercial benefits of a select few. blockchain’s promise of a simple solution to complex problems, just like what “populists” promise in politics, is used to create a temporary alliance with ordinary citizens in order to convince them to invest money in a system run by invisible entities distributed across a network of nodes. institutions that oversee the market and are generally adamant about populism, embraced this ‘populist’ innovation. intellectuals and businessmen, who are otherwise critical about simple solutions to complex societal problems, paradoxically ignore or minimize the risks to consumers, for the rule of law and even for the environment. by the time the true nature of the technology was revealed, some of the advocates of the technology have made fortunes.11 we name this category of blockchain advocates and profiteers ‘technological populists.’ by taking an interdisciplinary and cross-jurisdictional approach, we methodically extract the core elements of political populism and populist rhetoric and juxtapose them with ideals of cryptocurrencies and blockchain to argue that both employ demagoguery to grab power and control. we do not discuss the legitimate and limited use cases of blockchain12 as that goes beyond the scope and purpose of our analysis. we focus instead on the problematic aspects of blockchain to shed a light on how society should see new technologies that over-promise without reasonable demonstration of their value to society. the notion of technological populism is therefore used pejoratively to describe digital 10 the verb ‘hype’ is defined by cambridge english dictionary as “a situation in which something is advertised and discussed in newspapers, on television, etc. a lot in order to attract everyone’s interest”, while as a noun, it means “information that makes something seem very important or exciting (many times more than it is). for a full list of meanings: <https://dictionary.cambridge.org/dictionary/english/hype> accessed 28 april 2019. 11 satoshi nakamoto, who to this date remains anonymous and who wrote the white paper for bitcoin, has earned an estimated $19 billion from cryptocurrencies making him/her the number profiteer of the technology. cherry reynard, ‘who are the richest cryptocurrency investors?’ the telegraph (25 may 2018), retrieved from <https://www.telegraph.co.uk/technology/digital-money/richest-crypto-investors/> accessed 25 april 2019. 12 blockchain could be used for tracking goods in a supply chain. it can also be used to manage data in a decentralized manner. nevertheless, even these use cases are not proven to be efficient and effective as researchers are still exploring the potential of the technology. see yoav vilner ‘5 blockchain product use cases to follow this year’ forbes (june 27, 2018), retrieved from <https://www.forbes.com/sites/yoavvilner/2018/06/27/5-blockchain-product-usecases-to-follow-this-year/#500bce621b60> accessed 28 april 2019. njcl 2019/2 70 innovations that do not solve genuine social problems, but rather serve the interest of specific stakeholders. the article is divided into three sections. section one briefly explains political populism and extrapolates its core principles that can be used to explain blockchain demagoguery. it also introduces the definition of blockchain and cryptocurrencies to provide background information to the reader. section two explains the core features of blockchain and cryptocurrencies that embody populist principles and undertones. section three provides an explanation for the rise of technological populism. the paper concludes with a call for technological populism consciousness. 2. populism and blockchain an overview populism and blockchain (or any other digital technology) seem to have remote connections. a closer inspection reveals otherwise. in this section, we provide a necessary overview of the two concepts. 2.1.1. what is political populism? populism is undoubtedly one of the most widely used terms by political commentators, both at national and international level. the term is associated with both conservative and right-wing politicians, such as donald trump (usa), nigel farage (the uk), matteo salvini (italy) or viktor orban (hungary) and left-wing movements such as syriza (greece), podemos (spain) or leaders hugo chavez (venezuela), jeremy corbyn (the uk) or even the us senator elizabeth warren. given that one cannot define or attribute populism to a certain side of the political spectrum,13 it becomes important to determine its characteristics, rather than confine it within the political manifestations associated with it. populism is “a complex phenomenon deeply connected with democracy [...] a modality of social expression of ‘popular sovereignty’, which acquires different forms, but has specific traits that are determined by the social conditions of the context where it manifests itself.”14 nowadays, the process of globalization, the increased interconnectivity, the creation of new social spaces and forms for politics and social consensus have given birth to new forms of populism,15 such as media populism, web-populism, or tele-populism.16 to these, we add technological populism. 13 j.w. müller, what is populism? (penguin books limited 2017), p viii. 14 m. anselmi and l.f. morrisey, populism: an introduction (routledge 2017), p 2. 15 c. mudde and c.r. kaltwasser, populism: a very short introduction (oxford university press 2017), p 6. 16 anselmi and morrisey, p 3. 71 technological populism and its archetypes before delving into the intricacies of technological populism, one should first determine the building-blocks of political populism.17 and, in order to understand how political populism came to be the buzz-word it is nowadays, 18 one must look at the social and institutional crisis that precedes it. populism is mainly the reaction to an established (and potentially declining) elite,19 an attempt to mobilize excluded sectors of society for one main purpose: disrupting the status quo20 and replacing the elite with a new one (the populists).21 from this perspective, three major building blocks can be distinguished. the first building block is an interclass homogenous group of people22 that perceives itself as the absolute holder of ‘popular sovereignty’ expressing an anti-establishment23 attitude and portraying itself as an alternative to the pre-existing elite (anti-pluralist24). this group may or may not have a leader voicing the group’s message. the second is the challenged elite, be it another group of people, another party, an institution, or even a class. the third, and maybe most important, a discursive, argumentative, manichean style of communication where the group is referring to itself as ‘us’ and to those challenged as ‘them’25. this 17 cristobal rovira kaltwasser, how to define populism? reflections on a contested concept and its (mis)use in the social sciences, in g. fitzi, j. mackert and b.s. turner, populism and the crisis of democracy: volume 1: concepts and theory (taylor & francis 2018), pp 64-65. 18 mudde and kaltwasser, p 1. 19 anselmi and morrisey, p 4. 20 mudde and kaltwasser, pp. 3, 18. 21 müller, p 29. muller notices here one of the inherent paradoxes of populism. populists do not have a problem with representation as long as they are the representatives and they are fine with elites leading people, as long as they are those elites. same observation is made by cristobal rovira kaltwasser, how to define populism? reflections on a contested concept and its (mis)use in the social sciences, in fitzi, mackert and turner, p 74. 22 for more considerations regarding the concept of ‘the people’ mudde and kaltwasser9-11. also: müller, pp 22-23. 23 for more considerations regarding the concept of ’the elite’ mudde and kaltwasser, pp 11-16. 24 müller, p 101 25 according to another view, the three core elements of populism are ’the people’, ’the elite’ and ’the general will’, the latter being defined as the capacity of people to join together into a community and legislate to enforce their common interests. the concept of general will, however, is centered around the populist leader capable of identifying, triggering and channeling the general will, mudde and kaltwasser, p 16. thus, while named different, we perceive these core elements as being fundamentally the same as those employed in the main text. a detailed discussion on various theories proposed is provided by cristobal rovira kaltwasser, how to define populism? reflections on a njcl 2019/2 72 discourse is aimed at creating political polarization,26 which can then be further used for political support. all the above will feed in a constant social attitude against the elite or any form of intermediation27 (generally, but necessarily, institutional).28 the idea of defining populism by using common traits is not new.29 since it would be beyond the paper’s purpose to propose a new political theory of populism, we will refer to previous research instead. among the long list of potential traits that have been advanced some capture our attention: populism is more moralistic than programmatic,30 it is always anti-establishment and against the ruling elite, it is subjected to corruption and burgeoisification processes, it often demonizes financiers, it can be urban, or it opposes social and economic inequalities produced by institutions, but it accepts those related to tradition and lifestyle (its ‘own’ meritocracy). as the concrete examples in subsection 1.3 reveal, all these traits are easily identifiable in the blockchain manifestos and, thus, can be said to define technological populism as well. we started this section by noting that populism has manifested itself on both ends of the political spectrum31. this constant oscillation between left and right is confusing in regard to the nature of populist ideology, which led certain scholars to argue that populism is not a self-standing ideology, but a discursive form that can complement and accommodate various political views32. laclau, for instance, argued that populism is a discursive logic centred on the rhetorical appeals to “the people” against common enemies, regularly identified with unresponsive institutions,33 financial institutions, or concentrated groups of economic and political power (referred to as ‘elite’, ‘oligarchy’ or ‘establishment’).34 his point, however, contested concept and its (mis)use in the social sciences, in fitzi, mackert and turner, pp 64-66. 26 anselmi and morrisey, p 8, mudde and kaltwasser, p 6, müller, p 3. 27 anselmi and morrisey, p 29. 28 for instance, in political populism the idea is that ‘the people’ should take the most important decisions instead of delegating them to the parliament, while in the aftermath of the financial crisis and the wake of bitcoin, the idea is to disrupt financial institutions. 29 anselmi and morrisey, pp 21-22. 30 müller, pp 3, 19. on the meaning of morality in populism, cristobal rovira kaltwasser, how to define populism? reflections on a contested concept and its (mis)use in the social sciences, in fitzi, mackert and turner, p. 66. 31 p. gerbaudo, the mask and the flag: populism, citizenism, and global protest (oxford university press 2017), p. 73. 32 ibid 73. 33 e. laclau, on populist reason (verso books 2018), p. unavailable (online source). 34 gerbaudo, p. 77, mudde and kaltwasser, p. 5. 73 technological populism and its archetypes was that populism could serve as a positive force in organizing excluded sections of society to pursue political and socioeconomic integration,35 a view which, as we will show, is very common in the discourse surrounding blockchain technology and technological populism. recent theories place even more emphasis on the communicative nature of populism. according to these views, populism is a “rhetorical macro-device that asserts itself” and “operates in an attempt to overturn the people’s subalternity to the dominant social class”. these views still revolve the dichotomy between ‘the people’ and the ‘elite’, nevertheless, in this narrative, the people’s attitude and (re)action is the result of a specific communicative strategy,36 which can easily transform into manipulation. in our opinion, extrapolating these views and applying them to the so-called ‘blockchain revolution’, would explain the ‘hype’ around the ‘buzz word’. as shown in subsection 1.3, blockchain manifestos are not technological or programmatic documents, but mainly communication strategies meant to attract supporters and create a polarization that keeps the ‘hype’ real. nothing seems to be more effective to this end, than resorting to populist rhetoric. this is not to say that populism is merely an issue of style or form, without its own substantive content, or that it constitutes a completely negative phenomenon. on the contrary. revolving around ‘the people’ – whoever they may be – the principle of popular sovereignty is central to populist discourse37 in both politics and technology, as both claim to return power to its original owners by removing it from the hands of illegitimate profiteers, be it an elite or an intermediary institution. it is a reaction to social issues and has a corrective potential for any type of politics that is disconnected from ‘the people’.38 this allows certain politicians to proudly claim they are populist, as long as populism infers working for the people and reveals a particular issue of distinguishing between ‘good’ and ‘bad’ populism.39 for instance, satoshi nakamoto’s bitcoin manifesto starts with what could be labelled and interpreted as ‘populist’ statement, given that later it was used as basis for most blockchain manifestos: “a purely peer-to-peer 35 cristobal rovira kaltwasser, how to define populism? reflections on a contested concept and its (mis)use in the social sciences, in fitzi, mackert and turner, p. 63. 36 anselmi and morrisey, p. 43. 37 gerbaudo, p. 74. 38 cas mudde and cristobal rovira kaltwasser (eds) cited by müller, p 8. 39 ibid 9-11. such division is more easily identifiable on the two shores of the atlantic. while populism is perceived as somewhat progressive and egalitarian in the americas, in europe it entails solely demagoguery and irresponsible politics. njcl 2019/2 74 version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution.”40 the statement’s content, although disruptive in effect, does not target directly the financial industry. yet, other blockchain manifestos do. two problems arise, which constitute the main paradoxes of populism. on the one hand, such social support in favour of either political or technological populism based on communication strategies lacks substance. although populists portray themselves as antiestablishment and anti-elite, that ends when they become the establishment or the elite.41 on the other hand, its message can be easily (mis)appropriated and marketed as being for the people, while, in reality, it creates more wealth for the very ‘elite’ it allegedly tries to fight. the best example is the election of trump. although himself a poster image of capitalism, and thus a member of the ‘elite’, he managed to present himself as an anti-systemic candidate and made it to the oval office. nevertheless, his election simply meant replacing the political elite with the economic one, thus perfectly illustrating how the capitalist class can control the political narrative and maintain its direct rule and domination over politics42 by merely employing the recipe of disruptive discourse of populism.43 as indicated, we believe the traits of populism can be extrapolated from the purely political sphere and applied to technology as well. the postulate that discursive elements and paradoxes associated with populism are easily identifiable in the discourse of technological disruption as well will be proved by resorting to examples of technological speech regarding blockchain technology. but before delving into the rhetorical similarities of political and technological populism, we must first explain what blockchain is. 40 satoshi nakamoto, bitcoin: a peer-to-peer electronic cash system, p. 1, retrieved from <https://bitcoin.org/bitcoin.pdf>, accessed 5 april 2019. 41 see supra fn 9. 42 panayota gounari, authoritarianism, discourse and social media: trump as the ‘american agitator’ in j. morelock, critical theory and authoritarian populism (university of westminster press 2018), pp. 208, 221. also müller, pp 29-30 and cristobal rovira kaltwasser, how to define populism? reflections on a contested concept and its (mis)use in the social sciences, in fitzi, mackert and turner, p 67. 43 morelock, p 209. 75 technological populism and its archetypes 2.2. what is blockchain? blockchain is a distributed digital ledger (database),44 which records transactions on a chain of blocks, in the order in which the transactions occurred.45 the technology emerged from the first cryptocurrency— bitcoin. cryptocurrency is “a system of currency that uses cryptography to allow secure transfer and exchange of digital tokens in a distributed and decentralized manner.”46 thus, while cryptocurrencies are digital currencies or assets47, blockchain is a distributed database where those assets are generated, stored, and transacted on. once a transaction is initiated on a blockchain, it must be approved by the majority of nodes (computers) in the network through a 'consensus mechanism'. regarding the work model adopted by bitcoin, consensus is established by the node being able to solve an automatically generated mathematical puzzle.48 solving the puzzle entitles the miner (‘transaction validator’) to reward crypto-asset(s). regarding the stake model, generally, the node with higher stake (‘ownership’) has a higher chance to validate transactions and claim the reward.49 44 robby houben & alexander snyers, ‘cryptocurrencies and blockchain: legal context and implications for financial crime, money laundering and tax evasion’ (2018) pe 619.024, 15, retrieved from <http://www.europarl.europa.eu/cmsdata/150761/tax3%20study%20on%20crypto currencies%20and%20blockchain.pdf>accessed 20 october 2018. 45 chuen david lee kuo, handbook of digital currency : bitcoin, innovation, financial instruments, and big data (9780128023518 9780128021170, 2015), p. 49. see also pierluigi cuccuru, ‘beyond bitcoin: an early overview on smart contracts’ 25 international journal of law and information technology 179, pp. 1, 4. 46 eli dourado and jerry brito, ‘cryptocurrency: from the new palgrave dictionary of economics’ (2014, online edition) 1, retrieved from <https://coincenter.org/wpcontent/uploads/2015/05/cryptocurrency-article.pdf> accessed 28 october 2018. there are over 2000 cryptocurrencies (or digital tokens created by cryptography) in the market today. cryptocurrency market capitalization, retrieved from <https://coinmarketcap.com/all/views/all/> accessed 22 september 2017. 47 also called ‘crypto-assets’. crypto-asset is a term that refers to all cryptographic assets including cryptocurrencies and cryptographic tokens that are ill-suited to bear the name cryptocurrency as they are neither designed to be currencies, nor function as one in practice. kevin kim, ‘what is cryptocurrency & why the term doesn’t apply to most coins & tokens today’ (the blockchain review, 02 july 2018), retrieved from <https://blockchainreview.io/what-is-cryptocurrency-coin-token-bitcoin-ethereum/> accessed 19 november 2018. 48 the process is known as mining. robby houben & alexander snyers (n 22). 49 ibid. also mike orcutt, ‘bitcoin uses a massive amount of energy — but there's a plan to fix that’ business insider (19 nov. 2017), retrieved from <https://www.businessinsider.com/bitcoin-uses-massive-amounts-of-energy-plan-tofix-it-2017-11?ir=t> accessed 19 november 2018. njcl 2019/2 76 based on access, blockchain can be classified into two, i.e., permissionless and permission blockchain. a permissionless blockchain lacks oversight, planning, and control by a central authority.50 in ‘permissionless' blockchain, transaction validators can join the network without a need for approval by a central authority,51 whereas in ‘permission’ blockchain, joining the network requires approval by the entity running the network.52 originally, bitcoin, being based on permissionless blockchain, was meant to be ‘peer-to-peer decentralized electronic cash’ with no intermediary involved in facilitating transactions.53 cryptocurrency exchange platforms, as intermediaries, emerged to accommodate the needs of users who were not able to transact directly on the blockchain or wished to trade on organized platforms. exchange platforms buy and sell cryptocurrencies and, in most cases, provide custodial digital wallet services.54 some platforms exchange cryptocurrencies only for other cryptocurrencies, while others convert cryptocurrencies also to fiat currencies and vice-versa.55 during earlier times, while blockchain-based assets were created mainly to facilitate payment, even claiming to be alternative currencies, improvements to the technology gave rise to different types of blockchainbased assets, mainly classified as ‘pure currency tokens’, ‘utility tokens’, ‘investment tokens’, and ‘hybrid tokens’, each serving different purposes and triggering the application of different legal rules. each of the blockchain-based assets is created with a certain degree of rebellion against the existing system that it aspires to replace. section 2 explains in detail how this aspect of blockchain technology and its failure to achieve its self-proclaimed goals make the technology akin to political populism. 50 john blocke, ‘decentralization fetishism is hindering bitcoin’s progress', (medium 6 july 2017), retrieved from <https://medium.com/@johnblocke/decentralizationfetishism-is-hindering-bitcoins-progress-11cfa5c7964d>accessed 09 september 2017. 51 robby houben & alexander snyers, supra fn. 44. 52 ibid. 53 satoshi nakamoto, ‘bitcoin: a peer-to-peer electronic cash system’ (2008), retrieved from <https://bitcoin.org/bitcoin.pdf> accessed 23 february 2019. 54 robby houben & alexander snyers, supra fn. 44. 55 ibid. 77 technological populism and its archetypes 2.3. blockchain and populism—conceptual and rhetorical associations having defined political populism and blockchain, we will now return to the conceptual and rhetorical associations between them, in order to determine the existence of technological populism. in subsection 1.1, we have established that the concept of populism is determined by the existence of three building blocks: ‘the people’, ‘the elite’, and ‘a disruptive discourse’ by which ‘the people’ challenge and try to replace ‘the elite’. we also showed that the disruptive discourse employs manichean, antipluralist rhetoric. this subsection proves that all the above characterize the ‘blockchain revolution’ discourse, by highlighting them in the blockchain manifestos advanced by technological pundits. according to nakamoto’s bitcoin manifesto, the main purpose of bitcoin was to provide “a solution to the double-spending problem” and that of “a trusted third party”, meaning a solution by which the intermediary would be removed from the transaction.56 while not a direct attack on banks and financial institutions, one cannot ignore the conspicuous disruptive effects bitcoin was intended to have on the banking system, especially in the light of the blockchain manifestos that followed. once removed from handling transactions, banks would lose a significant amount of revenues, while states would lose the capacity to supervise financial transactions if parties were to choose to remain anonymous. a stronger populist message can be identified in the blockchain manifesto of naval ravikant.57 the manifesto is conceived in 37 points, following a logical sequence. the starting point is that “blockchain will replace networks with markets”58, thus creating the premises of polarization: ‘blockchain’ versus ‘networks.’ it goes on to argue that “networks must be organized according to rules: and require “rulers to enforce these rules”.59 as networks “create a winner-take-all dynamic”60, the “rulers of these networks become the most powerful people in society”.61 in other words, networks generate the same type of phenomena witnessed in society and politics, leading to the creation of oligarchs and 56 id. at 1. 57 naval ravinkant, blockchain manifesto, retrieved from: https://medium.com/koinok/blockchain-manifesto-by-naval-ravikant-insightful-read4cc793606a0c, accessed 5 april 2019. 58 id at point 1. 59 id at point 7. 60 id at point 8. 61 id at point 9. njcl 2019/2 78 unaccountable elites. who are they? the answer depends on the type of network: “kings and priests”,62 “corporations”,63 “elites (doctors, academics, bankers)”,64 “dictators”,65 “mobs”,66 “markets (credit, stock, commodities, money markets)”.67 the blockchain manifesto argues that its own rise will replace all these inefficient, abusive, dangerous, powerful and unmeritorious networks with a new one “that allows meritorious participants in an open network to govern without a ruler and without money.”68 put simply, the rhetoric advertises replacing the network elite, with the blockchain one. the blockchain manifesto resorts to populistic discourse to advance its own agenda and advertise a profound technological revolution: “blockchains’ open and merit-based markets can replace networks previously run by kings, corporations, aristocracies, and mobs”.69 in this sentence, one can identify all traits of the populist rhetoric: blockchain generated open and merit markets (‘the people’), and kings, corporations, aristocracies and mobs (‘the established elite’). the manifesto concludes with a typical disruptive message associated with the populist movement: “blockchains give us new ways to govern networks. for banking. for voting. for search. for social media. for phone and energy grids. networks governed without kings, priests, elites, corporations, and mobs. networks governed by anyone with merit to the network.”70 these restate laclau’s point of view71 according to which populism could serve as a positive force in organizing excluded sections of society to pursue political and socioeconomic integration. only that in the cited manifesto, populism was replaced with blockchains. this message is reiterated in the ten principles advanced by the “blockchain for good” movement.72 the populist antagonism with the oligarchy, referred to as “the privileged” or “the select few” is omnipresent. to take some examples: 1) “for far too long, power has been 62 id at point 10. 63 id at point 11. 64 id at point 12. 65 id at point 14. 66 id at point 13. 67 id at point 17. 68 id at point 20. 69 id at point 30 70 id at points 33-34. 71 supra fn. 35. 72 retrieved from < https://www.blockchainforgood.com/manifesto-1> accessed 5 april 2019. 79 technological populism and its archetypes mediated by the select few […] it is time to take back control”;73 2) “old value is controlled […] by the privileged, the select few” […] blockchain passes value through to the people, […] the incentive is upon us all, not for the select few”;74 3) “old prosperity is wealth […] enjoyed by the select few and out of reach to the masses, new prosperity is open to everyone”75; or “new power is power to the people”.76 whilst these principles refer to the potential of software, taken out of context it would be hard to distinguish between the arguments of political and technological populism. it is also apparent that blockchain manifestos are not as much technological or programmatic documents, but empty promises and communication strategies meant to attract supporters and create polarization. populist rhetoric is employed to keep up the ‘hype’. the populist discourse is found in all manifestos of blockchain aficionados, but citing them all would go beyond the purposes of our paper. what we would still wish to address in regard to connections between blockchain and populism, is the potential for (mis)appropriation by the members of the challenged elite, just like trump managed to do in the us elections. this potential did not go unnoticed by populists themselves. steve bannon, the man who many credit for the success of trump’s 2016 presidential campaign and now seems to be coordinating european populist movements, asserted that ‘bitcoin and other cryptocurrencies can disrupt banking the way trump disrupted american politics.’77 he wanted to create a blockchain-based token for the worldwide populist movement, known as ‘the deplorables,’ driving its name from the famous ‘basket of deplorables’ category in which hillary clinton put half of trump supporters.78 its aim was to take control of money and finance as a tool to control political constituency. so far, our narrative demonstrated that the very foundation of the blockchain is framed and communicated using populist discourse and 73 principle 3: blockchain is distributed power. 74 principle 4: blockchain is new value. 75 principle 8: blockchain is prosperity – but not as we know it. 76 principle 10: blockchain is new power. 77 jeremy w. peters and nathaniel popper ‘stephen bannon buys into bitcoin’ new york times (june 14, 2018), retrieved from < https://www.nytimes.com/2018/06/14/technology/steve-bannon-bitcoin.html> accessed 7 april 2019. 78 anthony cuthbertson ‘steve bannon is betting on bitcoin and may release his own ‘deplorables” cryptocurrency’ independent (june 15, 2018), retrieved from < https://www.independent.co.uk/life-style/gadgets-and-tech/news/steve-bannonbitcoin-deplorables-coin-cryptocurrency-a8400051.html> accessed 7 april 2019. njcl 2019/2 80 strategy. the following section elaborates on the populist concepts as reflected by blockchain technology. 3. the populist promises of blockchain technology we have briefly explained political populism and highlighted its close conceptual association with blockchain. in this section, we focus on two facets of blockchain technology manifestos that capture the populist rhetoric in the political sphere, namely disruption and the people vs. the elite rhetoric. 3.1. disruption challenging the establishment one of the founding aims of the bitcoin, the first cryptocurrency, was to disrupt the existing financial system, including the creation and control of money. nakamoto’s manifesto employed a neutral language and perhaps conveyed an economic efficiency rationale in advocating for ‘purely peer-to-peer (p2p) version of electronic cash that allows online payments to be sent directly from one party to another without going through a financial institution.’79 while cutting out middlemen in conducting transactions cuts costs and increases speed, the p2p cash system has an implication that goes beyond efficiency. it has effect not only on simple payments but on the creation and control of money supply. it takes away the exclusive power of creating money from central banks and states. according to charles david george “[…] bitcoin looks like it was designed as a weapon intended to damage central banking and money issuing banks, with a libertarian political agenda in mind—to damage states’ ability to collect tax and monitor their citizens’ financial transactions."80 the disruptive effect of bitcoin removes not only intermediaries in economic transactions but also aims to reject legitimate government 79 satoshi nakamoto, bitcoin: a peer-to-peer electronic cash system (november 1, 2008). the original paper is retrieved from <https://bitcoin.org/bitcoin.pdf> accessed 23 february 2019. 80 charles davide george ‘charlie stross,” why i want bitcoin to die in a fire’ (december 18, 2014), retrieved from <http://www.antipope.org/charlie/blogstatic/2013/12/why-i-want-bitcoin-to-die-in-a.html> accessed 7 april 2019. 81 technological populism and its archetypes regulation.81 bitcoin is a tool for criminal enterprises such as laundering money, tax evasion, or other shady transactions.82 the blockchain technology is the most important innovation emerging from bitcoin, supposedly having unlimited application across sectors. the promise of recapturing power from financial elites and handing it back to the disenfranchised individual provides a universal legitimacy for blockchain, just as it legitimizes support for populist leaders. it aspires to disrupt the existing system of finance, data governance, corporate governance and other important aspects of modern economy. nevertheless, the disruptive goal of blockchain has failed in many regards, as illustrated by the following two examples. the first example pertains to blockchain and finance, where the technology was set to fundamentally disrupt banking and reduce the profitability of banks.83from the very outset, it was clear that a p2p system of payment with no central clearing system would not function. that is because payment processing84—approval and clearing—is expected to be conducted by individuals in the network, incentivized by rewards they obtain for their computational skill and resource, with no central office in charge of rectifying delays or irregularities in payment.85 the bank of international settlement (bis) pointed out this unsuitability of cryptocurrencies in its 2018 annual report. bis stated that “cryptocurrencies cannot scale with transaction demand, are prone to congestion and greatly fluctuate in value. overall, the decentralised technology of cryptocurrencies, however sophisticated, is a poor 81 andreas m. antonopoulos, mastering bitcoin, programming the open blockchain (1491954388, second edition edn, o'reilly 2017), p. 3. 82 sean foley, jonathan r karlsen and tālis j putniņš, ‘sex, drugs, and bitcoin: how much illegal activity is financed through cryptocurrencies?’ 32 the review of financial studies 1798, p. 1798. 83 antonopoulos stated ‘as with the many industries disintermediated by the internet, banks will survive. but they will be fundamentally changed and their power and profitability will be significantly reduced. they can’t adapt and they can’t stop this disruption.’ daniel araya, ‘the promise of bitcoin: an interview with andreas m. antonopoulos’ futurism (february 29, 2016), retrieved from <https://futurism.com/promise-bitcoin-interview-andreas-m-antonopoulos> accessed 25 april 2019. 84 joan antonio donet, cristina perez-sola, and jordi herrera-joancomart, the bitcoin p2p network (march 7, 2014). 85 asress gikay, regulating decentralized cryptocurrencies under payment services law: lessons from european union law, case western reserve journal of law, technology & the internet,vol. 9, 2018, vol 9 (2018), pp. 25-26. njcl 2019/2 82 substitute for the solid institutional backing of money.”86 bis’s position is a severe blow to those who advanced the narrative that bitcoin would disrupt the financial system. second, blockchain has not delivered a concrete result in its other industry applications. in 2018, a group of researchers studied forty-three highly praised blockchain use cases and concluded that they found no evidence of an actual result.87 one area in which blockchain is supposed to thrive is replacing traditional contract negotiation through a smart contract— “programmable computer protocols that are able to selfenforce the terms therein encoded upon certain triggering conditions.”88 yet, blockchain-based smart contracts have been proven to be impracticable. on the one hand, creating a computer program that self-executes complex contractual relationships involving various legal terms, conditions, and limitations and other human elements, such as good faith and trust, is decidedly impossible.89 on the other hand, many of the blockchain based smart contracts utilized for corporate governance showed deviations in the publicly stated promises and the actual terms coded in the smart contract.90 based on the study of the top fifty initial coin offerings in 2017, sklaroff et al found a significant discrepancy between publicly available white papers or other contract types and the actual smart contracts, where founders maintained undisclosed codes and sometimes unilaterally modified entity governance structure.91 these 86 bis, annual economic report (june 2018), 91, retrieved from <https://www.bis.org/publ/arpdf/ar2018e.pdf > accessed 8 april 2019. 87 aaron hankin, ‘blockchain companies go silent when their tech promises fall short, research group finds’ market watch (dec 4, 2018), retrieved from <https://www.marketwatch.com/story/blockchain-companies-go-silent-when-theirtech-promises-fall-short-research-group-finds-2018-12-04> accessed april 25, 2019. 88 cuccuru, p 1. 89 sklaroff argues that smart contracts, in attempting to replace flexibility in human negotiation increases transactions costs. he states ‘’ these tradeoffs suggest that technology cannot replace what is fundamentally a human activity. smart contracting certainly proposes exciting new changes to the way transactions might take place and presents a meaningful step forward from the days of edi. but a full-scale smart contracting revolution would introduce costs far more extreme and intractable than the ones it seeks to solve. proponents who argue for a complete replacement of semantic contracts underestimate the power of fluid human behavior and judgment in the contracting process. the flexibility of semantic contracts is a feature, not a bug. jeremy sklaroff, ‘smart contracts and the cost of inflexibility’ (philadelphia) 166 university of pennsylvania law review 263, p. 303. 90 shaanan cohney and others, ‘coin-operated capitalism’ <https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3215345> , pp. 20-27. 91 ibid 86. 83 technological populism and its archetypes stories suggest that the smart contracts, although inflexible and computer programmable, far from distributing decision making power and empowering the individual, give leeway to technocrats to maintain asymmetrical power relationship visa-a-vis the crowd. the technology’s inability to deliver on promises of disruption in finance, corporate governance, and contract execution did not stop the advocates from pushing the hype. thus, the promises of blockchain technology can easily be compared with trump’s promise to build a wall and make mexico pay for it. although patently unrealistic, such promise was taken seriously by his base. the rhetoric of the wall is still being pushed by the us president, with a changed narrative, suggesting that mexico will pay in a form of tariff, rather than directly. 3.2. empowering the disenfranchised against the elites as shown, populism creates a divide between ‘the people’ and ‘the elites’ accused of having hijacked power from the people and running the system to their own benefit.92 after his presidential election, trump declared that: “the forgotten men and women of our country will be forgotten no longer.”93 the message could not be clearer. the political elites no longer represent everyday citizens. rather, they collude with corporations and financial institutions fighting for their common interest. blockchain technology was built on similar rhetoric and now struggles to distance itself from its own history by changing the narrative as the technology evolves. in the proceeding sub-sections, we examine how the three features of cryptocurrencies and potentially other blockchain-based currencies or assets claim to empower the disenfranchised. these features are decentralization, trust in computation, and anonymity. ultimately, none of these empowers the people. on the contrary, they are used to accumulate wealth for a small group of people through hyperbolic marketing, manipulation and deception tactics. 92 william galston, ‘the populist challenge to liberal democracy’ (baltimore) 29 journal of democracy 5, p. 11. ‘these observers argue that elites, by taking important issues such as economic, monetary, and regulatory policies off the public agenda and assigning them to institutions insulated from public scrutiny and influence, have invited precisely the popular revolt that now threatens to overwhelm them.’ 93 david jackson, and doug stanglin, ‘‘trump is now president: 'the forgotten ... will be forgotten no longer'’, usa today (jan 20, 2017), retrieved from <https://eu.usatoday.com/story/news/politics/2017/01/20/donald-trumpinauguration-day-president-white-house/96782700/> accessed 9 april, 2019. njcl 2019/2 84 3.2.1. the illusion of decentralization as shown, one of the philosophies of cryptocurrencies (permissionless blockchain) is the lack of central authority that controls them, meaning an authority that issues them and controls the technological infrastructure in which they function. permissionless blockchain is available to anyone who is willing and able to engage in a transaction verification process.94 the imagined virtue of decentralization is cutting out middlemen in transaction processing, primarily payment systems; but the principle is equally applicable to blockchain based systems including data transfer, corporate governance, and other transactions. antonopoulos stated “bitcoin’s decentralized security model puts a lot of power in the hands of the users. with that power comes responsibility for maintaining the secrecy of the keys.”95 although antonopoulos is referring to the security of bitcoin network, he does imply that the decentralization of bitcoin puts the user in charge as opposed to traditional banking or payment system where a central authority is in charge. echoing this sentiment, bitcoin’s early investor and entrepreneur charlie shrem wrote “for me, this is the most important aspect of bitcoin and cryptocurrency: its role in propagating power to the greatest number of people possible. what satoshi did when he democratized money was hand every individual alive – and generations to come – vast personal liberty.”96 whether the above is true or not is not for this paper to determine. what is clear is that nakamoto sold something for an estimated value of $19 billion.97 and what he sold was neither personal liberty nor money. but let us return to the fundamental questions. is decentralization real, feasible, and desirable? 3.2.1.1 decentralization is not real early critique quickly pointed out that, although decentralized in principle, a closer look at the governance structure shows that bitcoin is not truly decentralized. de filippi and loveluck argue: 94 antonopoulos, p. 177. 95 ibid 232. 96 charlie shrem, ‘bitcoin’s white paper gave us liberty – let’s not give it back’ (coindesk, october 20, 2018), retrieved from <https://www.coindesk.com/bitcoinswhite-paper-gave-us-liberty-lets-not-give-it-back> accessed 9 april 2019. 97 satoshi nakamoto’s estimated earnings from cryptocurrencies as of 2018 is $19 billion making him/her the number one profiteer of the technology. cherry reynard, ‘who are the richest cryptocurrency investors?’ the telegraph (25 may 2018), retrieved from <https://www.telegraph.co.uk/technology/digital-money/richest-crypto-investors/> accessed 25 april 2019. 85 technological populism and its archetypes ‘[…] hence, just like many other open source projects, there is a discrepancy between those who can provide input to the project (the community at large) and those who have the ultimate call as to where the project is going. indeed, while anyone is entitled to submit changes to the software (such as bug fixes, incremental improvements, etc.), only a small number of individuals (the core developers) have the power to decide which changes shall be incorporated into the main branch of the software.’98 in the governance structure of bitcoin, decentralization shrinks at the top level with implication not only on the democratic decision-making process but also on the technical functioning of the system. one example illustrates the problem. in the design of the bitcoin blockchain, every block had a capacity of 1 megabyte.99 the block size limit was placed allegedly to ensure that the blockchain remains decentralized, since high block size means that there would be delays in transaction propagation as large miners could benefit at the expense of small miners, hence creating centralization.100 some of the core developers of bitcoin wanted to increase the block size on the ground that it has been arbitrarily fixed and it is causing a delay in transaction confirmation.101 it was claimed that transactions remained unexecuted between 60 seconds to 14 hours as a direct consequence of the limit in block size.102 we note here that lately transaction delays are in terms of days and weeks. due to disagreement among the core developers on whether to increase the block size, mike hearn, one of the core developers resigned as a full-time bitcoin developer in january 2016.103 due to the sustained disagreement among the developers and miners, as of august 1, 2017, a split or what is referred to in a technical term as “a hard fork” has occurred, leading to two different chains in the 98 filippi primavera de and loveluck benjamin, ‘the invisible politics of bitcoin: governance crisis of a decentralised infrastructure’ 5 internet policy review, p.13. 99 blockchain, average block size (2017), retrieved from <https://blockchain.info/charts/avg-block-size> accessed 24 july 2017. see also ibid 7. 100 retrieved from <https://www.reddit.com/r/bitcoin/comments/5p9iv8/arguments_against_increasin g_the_block_size/> accessed 24 july 2017. 101 mike hearn, the resolution of the bitcoin experiment (2016), retrieved from <https://medium.com/@jgarzik/bitcoin-is-being-hot-wired-for-settlementa5beb1df223a>, accessed 24 july 2017. 102 retrieved from <https://forums.prohashing.com/viewtopic.php?f=11&t=679>, accessed 4 april 2017. 103 retrieved from <http://www.newsbtc.com/2016/01/15/mike-hearn-resigns-andleaves-bitcoin-permanently/>, accessed 4 april 2017. njcl 2019/2 86 blockchain.104 with the hard fork, two separate systems have been created. in one chain, due to a software upgrade, the block size increased from 1 megabyte to 2. in the other, the block size to 8 megabytes.105 the latter option led to the creation of a new cryptocurrency – bitcoin cash (bcc).106 both bitcoin and bitcoin cash co-exist ever since then, each having its backers and different market values.107 the story highlights how millions of citizens who believed in the promise of decentralization are forced to accept a decision made by a technical elite who claimed that it will take power back from the state, central banks, and traditional financial institutions and give to the people. weather in part or in full, decentralization is not real. 3.2.1.2 decentralization is not feasible further, in 2018, a group of companies that engage in bitcoin mining combined their hashing power and colluded to compel a software upgrade which resulted in the creation of new cryptocurrency based on bitcoin blockchain against the rule that decision has to be made by the majority of the network’s members.108 they were the majority. only that they rigged the system to create the majority and diluted the power of the individual. the scandal led to a lawsuit in the district court of southern district of florida, where the plaintiff claimed, among others, compensation for various damages caused by a global meltdown of the value of bitcoin.109 104 bitcoin cash: 5 fast facts you need to know, retrieved from <http://heavy.com/news/2017/08/how-does-bitcoin-cash-work/>, accessed 2 august 2017. 105 ibid. 106 ibid. 107 ibid. “on the 1st of august 2017, several hours after the fork had been completed, coin market cap reported that bitcoin cash (bch) which is the newly created by using the 8 megabytes block is priced around $379.40, a fraction of the original bitcoin’s value, which is priced at $2720.” 108 united american corp. vs bitmain, inc., us district court of southern district of florida, complaint, para 70-80, retrieved from <https://www.scribd.com/document/395100102/2018-12-06-1complaint#from_embed?campaign=skimbitltd&ad_group=100652x1574425xa95dc b5495e61f31dc1885674d6d1cdf&keyword=660149026&source=hp_affiliate&medium =affiliate> accessed 9 april 2019. 109 united american corp. vs bitmain, inc., us district court of southern district of florida, complaint, retrieved from <https://www.scribd.com/document/395100102/2018-12-06-1complaint#from_embed?campaign=skimbitltd&ad_group=100652x1574425xa95dc b5495e61f31dc1885674d6d1cdf&keyword=660149026&source=hp_affiliate&medium =affiliate> accessed 9 april 2019. 87 technological populism and its archetypes the problem known as the ‘51 % attack’ occurs when a decision has to be made based on consensus, but an entity or a group of entities controlling 51% of the hashing/computing power override the decision, prevent it or even reverse transactions that were already confirmed.110 the case demonstrates that the bitcoin protocol is not decentralized and is susceptible to be controlled by a single entity. whatever core changes take place within the bitcoin protocol depends on whether the core developers—a select few— agree on it.111 the core developers are not a group of people elected democratically. they were chosen based on their expertise, their involvement in the project and their shared ideology with the founder.112 in other words, they are the elite of both the technically and financially empowered elites. the small miners down the ladder are insignificant as far as significant changes are concerned. thus, it is impossible to make a claim that a system that is built by the elite, for the elite empowers citizens around the world. 3.2.1.3 decentralization is not desirable antonopoulos argues that bitcoin’s complete decentralization ensures robustness, prevents criminals from breaching the system, and makes the network government intervention-proof.113 even if this assertion was true, the question from both consumers’ and regulators’ perspective becomes whether total decentralization is desirable and to what end. we will use the european union’s payment services law as an example. although there are slight variations in national laws, the regulation of payment services has the same fundamentals in many countries. 110 antonopoulos, p. 211. ‘one attack scenario against the consensus mechanism is called the “51% attack.” in this scenario a group of miners, controlling a majority (51%) of the total network’s hashing power, collude to attack bitcoin. with the ability to mine the majority of the blocks, the attacking miners can cause deliberate “forks” in the blockchain and double-spend transactions or execute denial-of-service attacks against specific transactions or addresses. a fork/double-spend attack is one where the attacker causes previously confirmed blocks to be invalidated by forking below them and re-converging on an alternate chain. with sufficient power, an attacker can invalidate six or more blocks in a row, causing transactions that were considered immutable (six confirmations) to be invalidated.’ 111 today, the top-level administrators of bitcoin called, maintainers are three in number. see bitcore, retrieved from <https://bitcoincore.org/en/team/ > accessed 09 april 2019. 112 primavera de and benjamin. 113 antonopoulos, p. 3. njcl 2019/2 88 first, the legal regime governing payment services in the eu—the payment services directive (psd ii) 114— does not accommodate permissionless blockchain-based payment system. under the psd ii, to get an authorization to engage in payment service provision, a payment service institution must have prudent management, robust governance arrangement, clear organizational structure, and well-defined, transparent, and consistent lines of responsibility.115 cryptocurrencies based on permissionless blockchain inherently reject a centrally managed organization because the transfer of funds can be performed directly between the sender and the receiver, with no central processing authority.116 in this system, individuals with no legal obligation to clear transactions engage in transaction validation. hence,117 those who are unable to complete a transaction due to the inaction of transaction validators have no central office to seek remedy from. in payment services provided by traditional currencies, the payment service provider is liable for any charges and interest resulting from the non-execution, defective, or late execution of the payment transaction.118 for transactions ‘on the blockchain’, no similar rule could be designed because there is no central office in charge of executing payments. since the transaction validator could be anyone in the world, there is no way for a legislature or supervisory authority to design workable redress and penalty systems.119 although cryptocurrency exchange platforms have created centralization, they are effective only in executing 'off-chain' transactions, meaning the transactions conducted without updating the public ledger on which the cryptocurrency is based.120 to benefit from central payment processing, users must go through exchange platforms to conduct their 114 directive 2015/2366 of the european parliament and of the council of 25 november 2015 on payment services in the internal market, amending directives 2002/65/ec, 2009/110/ec and 2013/36/eu and regulation (eu) no 1093/2010, and repealing directive 2007/64/ec, ojeu l 337/35 (psd ii). 115 id at art. 11(4). 116 id at art. 11(4). 117 joan antoni donet donet, cristina perez-sola, and jordi herrera-joancomart, the bitcoin p2p network in rainer böhme and others, financial cryptography and data security, fc 2014 workshops, bitcoin and wahc 2014, christ church, barbados, march 7, 2014, revised selected papers (3662447746, springer 2014), p. 87. 118 psd ii (n 87) art. 89(3). 119 for rules on complaint and penalty mechanisms under psd ii, see ibid arts 90 and 103 respectively. 120 hughes sarah jane and t. middlebrook stephen, ‘advancing a framework for regulating cryptocurrency payments intermediaries’ 32 yale journal on regulation 495, p. 559 89 technological populism and its archetypes transactions.121 in any event, final settlement of any cryptocurrency transaction must be registered on the relevant blockchain,122 which means that exchange platforms themselves ultimately encounter the potential delay or irregularity in settling their payment on the blockchain. it is for this reason that the bis finally gave its verdict that ”[c]ryptocurrencies cannot scale with transaction demand […] overall, the decentralised technology of cryptocurrencies, however sophisticated, is a poor substitute for the solid institutional backing of money.”123 notwithstanding all the above, one could ask about decentralization in other aspects of the economy. ten years after blockchain started being implemented, there is no evidence that its decentralisation has other concretely proven industrial applications. the idea of distributed storage of data or asset management with no central authority is simply a talking point. nouriel puts it as follows: ‘as for blockchain itself, there is no institution under the sun – bank, corporation, non-governmental organisation or government agency – that would put its balance sheet or register of transactions, trades and interactions with clients and suppliers on public decentralised peer-to-peer permissionless ledgers. there is no good reason why such proprietary and highly valuable information should be recorded publicly. moreover, in cases where distributed-ledger technologies – so-called enterprise dlt – are actually being used, they have nothing to do with blockchain. they are private, centralised and recorded on just a few controlled ledgers. they require permission for access, which is granted to qualified individuals. and, perhaps most important, they are based on trusted authorities that have established their credibility over time. all of which is to say, these are “blockchains” in name only.’ if blockchain technology would have had a ground-breaking industrial application, we would have heard about it and many would have written about it. that is not the case. as we have shown, blockchain-based currencies cannot be purely decentralized. there would be a central point of control for the system to create responsibility, accountability, and efficiency. decentralizing everything from payments to storing data, tracking goods and services, and empowering everyone by excluding intermediaries 121 edward v. murphy et al, ‘bitcoin: questions, answers, and analysis of legal issues’ (2015) us congressional research report 7-5700, 5. 122 david lee kuo, p. 49. 123 bis, annual economic report (june 2018), 91, retrieved from <https://www.bis.org/publ/arpdf/ar2018e.pdf > accessed 8 april 2019. njcl 2019/2 90 is an appealing promise. however, our research reveals it to be largely a utopia, with no or little basis in reality. 3.2.2. trust in computation — getting unmerited trust political science establishes a close relationship between populism and lack of trust in mainstream political parties and government institutions.124 lack of trust was exacerbated during and after the financial crisis, when citizens lost faith not only in financial institutions but also in the political actors who chose to bail out these institutions, to the detriment and at the expense of the citizens. restoring public trust in financial institutions became the beacon of all legislative acts that followed. for instance, in the preamble of the mortgage directive,125 the european parliament, and the council of the eu stated that the financial crisis has led to ”a lack of confidence among all parties, in particular consumers”.126 restoring and strengthening their confidence was, thus, a concern for all european institutions.127 while states were engaging in implementing measures aimed at restoring trust in the market and financial institutions, technology geeks were crafting a strategy to capitalize on the crisis. the emergence of bitcoin during the period of diminishing confidence in the existing financial institutions in the aftermath of the 2008 global financial crisis128 is not a coincidence. the crisis has certainly helped marketing the technology. varoufakis alluded to this stating: ‘the crash of 2008 has infused our societies with enormous skepticism on the role of the authorities, both government and central banks. it is quite natural that many dream of a currency that politicians, bankers, and central bankers cannot manipulate; a currency of the people by the people for the people. bitcoin has emerged as the great white hope of something of the sort.’129 124 catherine fieschi and paul heywood, ‘trust, cynicism and populist anti‐politics’ [taylor and francis ltd] 9 journal of political ideologies 289, pp. 289-309. 125 directive 2014/17/eu on credit agreements for consumers relating to residential immovable property, retrieved from: <https://eur-lex.europa.eu/legalcontent/en/txt/pdf/?uri=celex:32014l0017&from=en>, access on 22 april 2019. 126 recital 3, mortgage directive. 127 restoring, strengthening, or ensuring confidence is mentioned several times in the preamble to the mortgage directive: recital 3, recital 31, and recital 35. 128 m. uslaner eric, ‘trust and the economic crisis of 2008’ 13 corporate reputation review 110, pp. 210-223. 129 yanis varoufakis, bitcoin and the dangerous fantasy of ‘apolitical’ money, yanis varoufakis blog (apr. 22, 2013), retrieved from 91 technological populism and its archetypes thus, one of the alleged attributes of cryptocurrencies is that they do not require trust in any central authority, private or public. in traditional banking customers should trust third-party intermediaries, including banks and other third-party payment service providers,130 while in cryptocurrency systems, trust in third-party intermediaries is unnecessary.131 this is one of the sales pitches for cryptocurrencies and other blockchain-based transactions emulating the philosophy behind bitcoin. scholars acknowledge that “bitcoin was born out of a distrust for authority and driven by a desire for governance by community consensus rather than central authority.”132 the question becomes, what is the underlying trust-related problem that computation aims to solve? and, furthermore, is trust in a third-party truly limited by blockchain? antonopoulos states: “here’s the most important effect of this new trust model of trustby-computation: no one actor is trusted, and no one needs to be trusted. there is no central authority or trusted third party in a distributed consensus network. that fact opens up a completely new network model, as the network no longer needs to be closed, access-controlled, or encrypted. trust does not depend on excluding bad actors, as they cannot ‘fake’ trust. they cannot pretend to be the trusted party, as there is none.”133 the fundamental problem seems to be the inability of trusted financial institutions to protect customers from bad actors that get involved in double spending funds or outright theft through breaching <https://www.yanisvaroufakis.eu/2013/04/22/bitcoin-and-the-dangerous-fantasy-ofapolitical-money/> accessed 9 april 2019. 130 nakamoto states “commerce on the internet has come to rely almost exclusively on financial institutions serving as trusted third parties to process electronic payments. while the system works well enough for most transactions, it still suffers from the inherent weaknesses of the trust-based model.” 131 brian kelly, the bitcoin big bang : how alternative currencies are about to change the world (9781118963647 9781118963654 9781118963661, 2015), p. 69. 132 usha rodrigues, ‘law and the blockchain’ (iowa city) 104 iowa law review 679, 715. kiviat describes it as ‘in short, the blockchain is a “trustless” technology. “trustless” means—for the first time in history—exchanges for value over a computer network can be verified, monitored, and enforced without the presence of a trusted third party or central institution.’(citations omitted). trevor, p. 574. 133andrea antonopoulos, bitcoin security model: trust by computation a shift from trusting people to trusting math (2014), retrieved from <http://radar.oreilly.com/2014/02/bitcoin-security-model-trust-bycomputation.html>, accessed 24 july 2017. njcl 2019/2 92 cybersecurity or fraudulent behaviors.134 the distributed digital ledger makes it closer to impossible to engage in these kinds of behaviors. is that true? the answer to this question should be given based on the overall infrastructure in which cryptocurrencies function and various tools that bad actors might exploit. the claim that trust is not needed at the heart of bitcoin or other cryptocurrencies makes more sense to the technical experts than to average people. evidence shows that even experts have lost their trust in the system, which is why they take each other to courts of law over a matter that should have been solved by computation.135 there are areas where trust is required within the bitcoin ecosystem. one of them is the transaction verification, the very system where trust in a third-party is deemed irrelevant. given that the cost for verification of transactions is covered by transaction fees and different users can offer different rates, certain transactions could remain unconfirmed in the blockchain. that is because miners could choose to dedicate their computational power to higher fee transactions.136 users who offer lower transaction fees are, thus, uncertain that their transactions get confirmed in time. this requires trust in the integrity of the miners, who, in this case, act as third-parties, not to discriminate against low paying transactions. furthermore, the argument that blockchain removes trusted thirdparties assumes that the blockchain is the only infrastructure necessary for the functioning of cryptocurrencies. in practice, cryptocurrencies cannot function without other supporting infrastructures, such as exchange platforms and digital wallets. non-expert users of cryptocurrencies purchase cryptocurrencies from exchange platforms using traditional currencies and this renders the exchange platforms a necessary part of the cryptocurrency ecosystem. only technical experts can earn 134 ibid. see also nakamoto who states that ‘commerce on the internet has come to rely almost exclusively on financial institutions serving as trusted third parties to process electronic payments. while the system works well enough for most transactions, it still suffers from the inherent weaknesses of the trust-based model. completely nonreversible transactions are not really possible, since financial institutions cannot avoid mediating disputes.’ 135 united american corp. vs bitmain, inc., us district court of southern district of florida, complaint, para 70-80, retrieved from <https://www.scribd.com/document/395100102/2018-12-06-1complaint#from_embed?campaign=skimbitltd&ad_group=100652x1574425xa95dc b5495e61f31dc1885674d6d1cdf&keyword=660149026&source=hp_affiliate&medium =affiliate> accessed 9 april 2019. 136 olusegun ogundeji, ‘bitcoin transactions confirmation delays’ cointelegraph, oct, 27, 2016 <https://cointelegraph.com/news/bitcoin-transactions-confirmation-delays> accessed 10 april 2019. 93 technological populism and its archetypes cryptocurrencies by mining.137 the non-expert users may need to store their cryptocurrencies in third-party administered digital wallets who should keep funds safely. cryptocurrency exchange platforms and digital wallet providers are similar to traditional financial institutions. they are third-party intermediaries that operate on the same principle of trust. they are susceptible to the same challenges traditional financial institutions, including theft and cyber security breaches.138 in 2018, bitgrail, an exchange platform, was declared bankrupt before an italian court due to a security breach that cost its customers $70 million.139 generally, loss of funds due to a security breach affecting an exchange platform is covered by the exchange platform, but bitgrail blamed the hacking on a defect in its software developed by a third-party developer, attributing the fault and liability to the software developer140 and dragging the consumer through lengthy litigation. similarly, the florida litigation on the manipulation of decision making by dominant entities within the bitcoin network141 illustrates that users have no reason to trust the system, even when it is in its purest form with no adulteration by external ecosystems. in ‘trust, but verify: why the blockchain needs the law’, werbach documents multiple trust-related problems in blockchain.142 he underlines that the smart contract itself suffers from errors, for instance, costing a canadian exchange platform quadrigacx, over $ 14 million.143 137 the process of creating bitcoin and other cryptocurrencies is known as mining solving automatically generated mathematical puzzles towards processing transactions of users simultaneously. in more technical terms, “…mining is the competitive process of collecting transactions and adding them to the blockchain in the form of blocks.” c. barski and c. wilmer, bitcoin for the befuddled (no starch press, incorporated 2014), pp. 4, 26. 138 see generally mt. gox collapse of 214 resulting in loss of 850000.000 btc due to hacking, bitcoin talk (nov. 16, 2014), retrieved from https://bitcointalk.org/index.php?topic=57633; see wolfie zhao, $30 million: ether reported stolen due to parity wallet breach, coindesk (july 19, 2017), https://www.coindesk.com/30-million-ether-reported-stolen-parity-wallet-breach/. 139 c. edward kelso, ‘bitgrail bitcoin assets taken by italian government, victims still fuming’, bitcoin.com (16 june 2018), retrieved from <https://news.bitcoin.com/bitgrail-bitcoin-assets-taken-by-italian-government-victimsstill-fuming/ > accessed 3 july 2018. 140 see bitgrail lasts news, retrieved from <https://bitgrail.com/news> accessed 3 july 2018. 141 united american corp. vs bitmain, inc., (supra n 109). 142 kevin werbach, ‘trust, but verify: why the blockchain needs the law’ (berkeley) 33 berkeley technology law journal 487, pp. 490-552. 143 ibid. njcl 2019/2 94 the cause of the loss was permanent inaccessibility of ethereum blockchain-based tokens due to error in the smart contract.144 in 2016 distributed autonomous organization (dao), a crowdfunded artificially intelligent entity based on blockchain was able to receive millions of dollars in crowdfunding.145 dao was supposed to operate based on smart contract and enable corporate governance with no directors and board members. because the blockchain and smart contract did not distinguish between legitimate fund transfer and theft, in 2017, $70 million worth ether was stolen by a hacker.146 these incidents debunk the myth that distributed digital ledgers filter back actors with no need for a trusted central authority as a custodian. according to 2018 report, ‘each day $2.7 million is stolen from exchanges.’147 this evidence shows that not only unsophisticated consumers are prone to theft and cyber-attack. even well-financed institutions dealing with blockchain are incapable of protecting themselves and the public. the defect is not only in the external infrastructures and support systems but also in the most cherished byproducts of bitcoin: blockchain and smart contracts. none can be trusted. none can replace trust-based institutions, where legal rules sanction breach of such trust. the postulate of trusting in computation is no different than a populist slogan that manufactures distrust in the establishment or points out the reasons for which the establishment should not be trusted, while not offering a shred of evidence as to why the alternative is different. we now know that when the people fall into the trap of misplacing the trust into lies and deceptions, the result is the accumulation of wealth by political, respectively, ‘technological’ populists. 144 ibid. 145 giulio prisco ‘the dao raises more than $117 million in world's largest crowdfunding to date’ bitcoin magazine (may 16, 2016), retrieved from <https://bitcoinmagazine.com/articles/the-dao-raises-more-than-million-in-world-slargest-crowdfunding-to-date-1463422191/> accessed 27 april 2019. 146 ibid. see also samuel falkon, ‘the story of the dao — its history and consequences’ the medium (24 december 2017), retrieved from <https://medium.com/swlh/the-story-of-the-dao-its-history-and-consequences71e6a8a551ee>, accessed 26 april 2019. ‘[o]n june 17, 2016, a hacker found a loophole in the coding that allowed him to drain funds from the dao. in the first few hours of the attack, 3.6 million eth were stolen, the equivalent of $70 million at the time. once the hacker had done the damage he intended, he withdrew the attack.’ 147 eric larcheveque , ‘2018: a record-breaking year for crypto exchange hacks’, coindesk (december 29, 2018), retrieved from <https://www.coindesk.com/2018-arecord-breaking-year-for-crypto-exchange-hacks> accessed 25 april 2019. 95 technological populism and its archetypes 3.2.3. anonymity— anarchy with a drop of privacy cryptocurrencies provide anonymity.148 this aspect of cryptocurrencies is appealing to both privacy-wary individuals, who legitimately want to protect themselves, and to criminals who want to engage in shady transactions. in bitcoin, although all transactions conducted by the user are publicly visible, it is the public key (a unique set of numbers and letters that represents them (bitcoin address).149 more precisely, the blockchain provides ‘pseudonymity’ because the user’s identity is hidden behind a pseudonym.150 the anonymity provided by blockchain can be reversed by various techniques that link the bitcoin address to the identity of the person.151 for instance, if the user purchases a digital currency from an exchange using a bank account, the exchange or wallet provider has the knowledge of the identity of the person. techniques that are more complex can also be used to tackle anonymity.152 however, de-anonymizing requires time, technological expertise, and money. despite the possibility of de-anonymization, the cost involved makes it practically difficult, which is one of the reasons that attract the use of digital currencies. this is exemplified by the donation page of wikileaks: “bitcoins cannot be easily tracked back to you and are safer and faster alternative to other donation methods. […] similar to bitcoin, litecoin offers very fast and secure transactions worldwide, and there are many exchanges allowing you to trade for litecoins.”153 the wikileaks donation page reflects the typical mind-set of cryptocurrency users, i.e., cryptocurrencies provide anonymity. in the era of mass surveillance, collection, processing, and misuse of personal data by governments and giant corporations, it might be necessary to ensure anonymity/pseudonymity.154 thus, blockchain promoters have used the ability of the technology to provide a bit of 148 hanna halaburda and m. miklos sarvary, beyond bitcoin, the economics of digital currencies (1137506423, palgrave macmillan 2016), p. 100. 149 pedro franco pedro franco, understanding bitcoin, cryptography, engineering and economics (1119019133, wiley 2015), p. 209. 150 ibid. 151 ibid 209. 152 ibid cp. 13. 153 wikileaks official website, donation section, retrieved from <https://shop.wikileaks.org/donate#db3> accessed on 16 july 2017. 154 see leon hempel and hans lammerant, impact assessments as negotiated knowledge, in gutwirth serge, leenes ronald and hert paul de, reforming european data protection law, vol 20 (9789401793841 9401793840, 2015 edn, dordrecht: springer netherlands 2015), p. 141. njcl 2019/2 96 privacy, while they encourage anarchy and potential lawlessness in the digital space. in a paper published in 2019, foley et al, documented that “[…] approximately one-quarter of bitcoin users are involved in illegal activity…, around $76 billion of illegal activity per year involves bitcoin (46% of bitcoin transactions), which is close to the scale of the us and european markets for illegal drugs.”155 anonymity is one of the promises of blockchain-based transactions that stands out, as terrorist organizations seem to be actively taking advantage of it.156 an intriguing question to ask is how regulators could watch without taking measures while a system that aspires to revolutionize finance openly preaches anonymity (anarchy). moreover, why are ‘people’ supporting this technology that undermines their safety and disrupts the institutions on which their society is built? while the answers to these questions are certainly many, we suggest one of our own: ‘technological populism’. during the 2016 us presidential campaign, the then-candidate trump speaking to his supporters stated: “i could shoot somebody in the middle of the 5th avenue and i wouldn’t lose voters.”157 his statement echoed the power of his populist promises in blinding his voters to his obvious flaws. the blockchain support base is similarly blinded by false promises of blockchain technology. this is why there has not been a major backlash from society, proportionate to the level of anarchy that the technology has helped advance by eroding rule of law. 3.3. summing up: the false promises of technological populism cryptocurrencies and blockchain, be it in finance or other industries, have not delivered the game-changing efficiency and empowerment they advertised. the technology is deeply rooted in ideas that political populists also communicate to their constituencies and it is marketed using populist rhetoric. thus, disrupting the existing financial system and industry, giving back disenfranchised individuals control over money, data 155 foley, karlsen and putniņš, 1798. 156 nikita malik, ‘how criminals and terrorists use cryptocurrency: and how to stop it’, forbes, april 31, 2018, retrieved from <https://www.forbes.com/sites/nikitamalik/2018/08/31/how-criminals-andterrorists-use-cryptocurrency-and-how-to-stop-it/#6db1da683990> accessed 11 april 2019. 157 steve holland & ginger gibson, ‘donald trump: 'i could shoot somebody, and i wouldn’t lose any voters'’, reuters, jan. 23, 2016, retrieved from <https://www.reuters.com/article/us-usa-election-idusmtzsapec1nfeqlyn> accessed 11 april 2019. 97 technological populism and its archetypes and other aspects of their lives are all used to rally support for the technology. the developers of blockchain promised to perform miracles through decentralization or dlt, eliminating intermediaries and the long-standing trust in them and replacing it by trust in computation and by protecting identities in conducting transactions. in a desperate attempt to sell the idea and secure its wider adoption, they framed the foundation of the technology based on rhetorics of empowering the disenfranchised, ‘the people’ vs ‘elitist institutions’ and ‘us’ vs ‘them.’ the evidence demonstrates that the large part of the promise of the technology is nothing more than demagoguery backed by technology. the outcome is not just a faulty technology that is struggling to justify its existence, but billions of dollars transfer of wealth from ‘the people’ to the new ‘elites’. ‘technological populists’ created the technology, created high electricity-consuming algorithms and machines to mine the assets based on it,158 manipulated prices,159 enabled criminals to engage in illegal activities. they were motivated by lucrative payments, collected money from the public through crowd-funding named icos, and managed to manipulate regulators into abstaining from timely regulation. 4. explaining the rise of technological populism in the last part of the article, we briefly examine why technological populism have risen to the level where they go without being checked by the society and regulators. by examining the role of various stakeholders in a democratic society in the rise of populist leaders and the corresponding role of stakeholders in regulation of blockchain, we argue that a combination of different extraneous factors contributed to the rise of this kind of populism. we identify as factors that contributed to the phenomenon: the failure of media and the intelligentsia in advancing honest policy debate, and regulatory oversight. 158 alex hern, ‘bitcoin’s energy usage is huge – we can't afford to ignore it’ the guardian (wed 17 jan 2018), retrieved from <https://www.theguardian.com/technology/2018/jan/17/bitcoin-electricity-usagehuge-climate-cryptocurrency> accessed 25 april 2019. 159 jay adkisson ‘why bitcoin is so volatile’, forbes (february 9, 2018), retrieved from <https://www.forbes.com/sites/jayadkisson/2018/02/09/why-bitcoin-is-sovolatile/#1be885e539fb> accessed april 26, 2019. njcl 2019/2 98 4.1. the role of media and intellectual sycophants the media and the intelligentsia have their own role in constructing the technology ‘hype’. in this regard, we observe a parallel between the way the media built representations of blockchain and theways in which they built candidate trump or other populist leaders. 4.1.1. the media the media has been painting a pink picture of blockchain from the very outset. for instance, it advertised technological populism by stating that cryptocurrencies will bank the unbanked,160 i.e., those who have no access to a credit card or debit card and hence are excluded from the financial system.161 160 paul vigna and michael j. casey, ‘bitcoin for the unbanked: cryptocurrencies that go where big banks won’t, foreign affairs’ (foreign affairs, 25 october 2017), retrieved from <https://www.foreignaffairs.com/sponsored/bitcoin-unbanked> accessed 06 july 2018; steve forbes, ‘how bitcoin will end world poverty’ (forbes magazine, 02 april 2015, retrieved from <https://www.forbes.com/sites/steveforbes/2015/04/02/how-bitcoin-will-endworld-poverty/#62cee38f2a5a> accessed 6 july 2018 and george basiladze, ‘how cryptocurrencies can help bank the unbanked’ (fin. magnets, 16 august 2015), retrieved from <https://www.financemagnates.com/cryptocurrency/bloggers/howcryptocurrencies-can-help-bank-the-unbanked/> accessed 6 july 2018. 161 eric sammons, ‘how cryptocurrencies like dash help the poor’ dash force news (august 23, 2017), retrieved from <https://www.dashforcenews.com/cryptocurrencieslike-dash-help-poor/> accessed 21 october 2018. the claim proved to be false because (a) credit card or debit card is a perquisite for acquiring cryptocurrencies from exchange platforms in many cases and (b), cryptocurrencies are expensive, and transactions in them are risky that the unbanked is not inclined to engage in. 161 to acquire any cryptocurrency, a user must have a bank account, unless the user is computer scientist or skilled in the field who has a powerful computer or a specialized cryptocurrency mining device and the ability to solve complex cryptographic puzzles. see barski and wilmer, p. 1. another common method of acquiring cryptocurrencies is through transfer to a receiver’s digital wallet by a sender in exchange for physical cash or an asset of value. acquiring cryptocurrency for physical cash requires a series of communications mostly over the dark web to engage in illegal and illicit activities or to hide the illegal nature of the acquisition of the cryptocurrency. even if no illegal motive is involved, average users have no incentive to engage in a cash-based transaction to access an asset whose use is limited vastly to the digital space. certainly, the unbanked have neither the means, nor the incentive to engage in these kinds of transactions. therefore, today for the most part, cryptocurrencies are acquired from, stored, and traded on exchange platforms that the unbanked do not have access to. see katie benner and sheera frenkel, ‘drug dealers targeted in sweep of illicit online marketplaces’ the new york times (washington dc., 26 june 2018), retrieved from <https://www.nytimes.com/2018/06/26/us/politics/drug-dealers-dark-webarrests.html> accessed 17 october 2018. 99 technological populism and its archetypes in december 2017, the financial times published an opinion titled ‘bitcoin, blockchain and the fight against poverty’ highlighting hernardo de sotos' initiative to use blockchain to register property rights.162 even if blockchain enables property registration in a reliable manner, it is not clear how that benefits the poor. blockchain technology is exceedingly technical and requires infrastructures such as reliable electricity,163 internet, and computers, things that the poor struggle with in the first place. there is no evidence so far that blockchain and cryptocurrencies would lift people out of poverty. after a decade long campaign, the efficiency of new technology should not be evaluated solely on potential, but on results. various forms of populism have always found an echo in the media. the most telling example is the hundreds of hours of interview conducted with candidate trump until it became apparent that he constituted serious a threat in the elections.164 blockchain populism is no different. 4.1.2. the intelligentsia our research identified two categories of intellectual minionism.. the first consists of those who participate in the ‘hype’ of the technology by all means possible, including intellectual dishonesty. the second involves turning a blind eye to the adverse effect of the technology on rule of law and consumer welfare while emphasizing the potential industrial application of the technology. 4.1.2.1. hype by all means? bitcoin enthusiasts have compared it to gold in a manner aimed at ‘hyping’ users and investors.165 the comparison focused on the process of creation of bitcoinmining a term that also describes gold extraction process166 and the competitive prices for the two.167 often, the cryptocurrency-gold comparison is based on the notion that gold is 162 gillian tett, ‘bitcoin, blockchain and the fight against poverty’ the financial times (22 december 2017), retrieved from <https://www.ft.com/content/60f838ea-e51411e7-8b99-0191e45377ec> accessed 29 june 2018. 163g.f. ‘why bitcoin uses so much energy’ the economist (july 9, 2018), retrieved from <https://www.economist.com/the-economist-explains/2018/07/09/why-bitcoinuses-so-much-energy> accessed 18 october 2918. 164 david sillito, ‘donald trump: how the media created the president’, bbc (14 nov. 2016), retrieved from <https://www.bbc.com/news/entertainment-arts-37952249> accessed 11 april 2016. 165 jocelyn aspa, is bitcoin the new gold?, investing news (sep. 2017), retrieved from <https://investingnews.com/daily/tech-investing/fintech-investing/bitcoin-the-newgold/> accessed on 13 january 2018. 166 id. 167 id. njcl 2019/2 100 expensive just because people subjectively view it as more valuable relative to other metallic commodities that are perhaps as durable and functional. hence, goes the argument, if the users view cryptocurrencies as valuable, there is no reason not to treat them like gold. reflecting this sentiment, prentis argues: ‘the price of traditional commodities, like gold, silver, and agricultural products, vary in accordance with their demand and scarcity. when more people want a commodity that has a fixed supply, the price rises. similarly, the price of bitcoin fluctuates according to the same fixed supply model…. bitcoins are considered rare because there is a fixed supply of them, leading users to be willing to pay increasing prices to control them. the value of a bitcoin is ultimately driven by supply and demand—a coin is worth whatever someone is willing to pay for it.’168 according to prentis, it is appropriate to treat bitcoin as commodity169, asserting that bitcoin has inherent value in its ability to reduce transaction cost by enabling less costly two-party transactions than traditional three-party transactions.170 in hindsight, as indicated by bis, bitcoin does not scale with high volume transactions and is a poor substitute for money. while it is undeniable that users/speculators are willing to pay for bitcoin as much as they are willing to pay for gold, it is farfetched to argue that bitcoin has intrinsic value. in examining whether that is true, godlove argues that “it has more characteristics in common with commodities than with currency, except for the most essential: it has no inherent value.”171 if intrinsic value is a value of a commodity judged independently of its monetary use or value of a thing for its own sake172 the question becomes whether cryptocurrencies remain useful when stripped of their ability to transfer funds. bitcoin has also been compared with subterranean property.173 in 2014, the us district court of western district of washington handled a 168 mitchell prentis, ‘digital metal: regulating bitcoin as a commodity’ [case western reserve university school of law] 66 case western reserve law review 609, p. 628. 169 ibid 626. 170 ibid 629 (“this means that the inherent value of a bitcoin is found in the difference of transaction costs between an online three-party exchange, and a two-party exchange.”) 171 nicholas godlove, ‘regulatory overview of virtual currency’ [university of oklahoma college of law] 10 oklahoma journal of law and technology 67, p. 26. 172 michael j. zimmerman, intrinsic vs. extrinsic value, the stanford encyclopaedia of philosophy (2015), retrieved from https://plato.stanford.edu/entries/value-intrinsic-extrinsic/. 173 casey doherty, ‘bitcoin and bankruptcy’ (alexandria) [american bankruptcy institute] 33 american bankruptcy institute journal 38, pp. 28–33. 101 technological populism and its archetypes case in which it considered, inter alia, whether a contract to mine and deliver a certain amount of bitcoins constitutes an executory contract174. examining the case, doherty wrote an article in which he stated that ‘bitcoin also shares similarities to “subterranean” commodities through its extraction process, as demonstrated by in re cli holdings.’175 citing doherty’s article, borroni, in addressing the legal framework for bitcoin in the eu, wrote ‘…the qualification of bitcoins as a commodity stems from the case in re cli holdings, whereby the court treated bitcoins like a “subterranean commodity” (for example oil), due to the similarities arising from the “extraction process” shared by both of them.’176 doherty’s article and, by extension, borroni’s, make a factually incorrect suggestion that the court drew a parallel between bitcoin and subterranean properties. in re cli holdings177 on or about 14th of august 2013, bitvestment entered into a bitcoin services agreement with coinlab, cli holdings inc. and their respective affiliates (amended agreement).178 as per the agreement, bitvesment paid the debtor, 75, 000 usd in return for which the debtor agreed to mine and deliver 7,984.006735 btc to bitsvestment179. the debtor breached the contract failing to deliver the bitcoins mined after the amended agreement, after which bitvestment filed a lawsuit in the us district court for the southern district of ny against the debtor seeking, inter alia, specific performance180. on november 5, 2013, the district court stayed the action against the debtor because the debtor filed chapter 11 bankruptcy,181 subsequently to which it filed a motion to reject the contract.182 the debtor’s motion for rejection of the contract was based on u.s.c. § 365, which allows the judge to approve the rejection of the executory contract by the trustee183. the court dismissed the motion. 174 in re cli holdings, case no. 13–19,746 (w.d. wash. 2013). 175 doherty, pp. 28–33. 176 andrea borroni, a fuzzy set in the legal domain: bitcoins according to us legal formants, in gabriella gimigliano, bitcoin and mobile payments : constructing a european union framework (palgrave macmillan 2016). 177 in re cli holdings inc., washington western bankruptcy court, case no. 13-19746kao (feb. 7, 2014), motion to dismiss chapter 11 bankruptcy, p. 2. 178 ibid. 179 ibid. 180 ibid. 181 ibid. 182 in re cli holdings inc., washington western bankruptcy court, case no. 13-19746kao (15 november 2013). 183 11 u.s.c. §365(a). njcl 2019/2 102 in its reasoning, the court reaffirmed that the key feature of executory contracts is that the “obligations of both parties are so far unperformed that the failure of either party to complete performance would constitute a material breach and thus excuse the performance of the other.”184 it ruled that since bitvestment has performed its obligation (paying 75, 000 usd), the debtor is the only party to the agreement with an ongoing obligation, namely to mine and deliver to bitvestment the bitcoins for which reason the contract was not executory185. whether bitcoin is a commodity or not was irrelevant in the case. in spite of this, doherty compared bitcoin with subterranean property.186 he stated that “the court, in keeping with the analogous majority view of oil and gas precedent (although not citing it), found that the debtor could not reject a contract where the only performance of the interest-holder was to receive production.”187 the court did not cite oil and gas precedents (by doherty’s own admission), but he still used the case to draw a parallel between bitcoin and subterranean properties. we cannot ignore the fact that commodities such as oil have physical existence and intrinsic value, whereas cryptocurrencies do not. to argue that cryptocurrencies are commodities and not money by using a judicial decision makes the claim more convincing. nevertheless, it is neither intellectually insightful nor honest, to misuse judicial decisions only to ‘hype’ the technology and advance the agenda of technological populists. 4.1.2.2. a 21st century dilemma: to regulate or not to regulate? some scholars held the view that despite the technological origin of transactions based on blockchain, for the most part, the existing legal regulations are capable of being enforced against them, if enforcement 184 in re cli holdings inc., washington western bankruptcy court, case no. 13-19746 ka (12 dec. 2013) , order denying debtor's motion to reject executory contract with bitvestment partners llc, p. 1. since the court’s order cites the parties’ submissions, the reasoning of the court is found in the creditor (bitvestments’s) objection to debtor’s motion to reject executory contract. see in re cli holdings inc., washington western bankruptcy court, case no. 13-19746-kao (29 nov. 2013), bitvestment partners llc’s objection to debtor’s motion to reject executory contract, p. 4. the court relied on the definition of executory contracts provided by the ninth circuit in marcus & millichap inc. v munple, ltd. (in re munple), 868 f.2d 1129, 1130 (9th cir.1989), cited by bitvestment in its objection to the debtor’s motion for the rejection of the contract. 185 id. 186 supra note 174. 187 id. 103 technological populism and its archetypes authorities issued the appropriate guidelines.188 these categories of scholars generally call for ‘technology neutral’ or ‘functional interpretation’ of the legal rules. but, the intelligentsia that stands behind the technology is quick to suggest that because the technology is at its nascent stage, regulators should cuddle it,189 even if ten years have passed since it was introduced and a select few have made fortunes out of it. for instance, michèle finck alluded to, inter alia, a regulatory sandbox that should allow startup companies to experiment their innovation without complying with existing regulatory regimes.190 in a paper published in 2018, she claims to provide regulatory techniques. instead she provides a cursory overview of blockchain use cases and an outline of possible regulatory approaches gathered from existing practices, described positively with no insightful normative regulatory theory. in order to advance her narrative, she praises the technology by mentioning how it helped poor people in africa: “in africa, blockchain has brought banking services to the unbanked, most famously through bitpesa, which provides blockchain-based mobile banking. companies such as bitpesa and bitspark moreover allow for the fast and cheap transfer of remittances.”191 in support of her assertion, she cites the website of bitpesa, the company that alleges to make money transfer in africa cheaper. however, the information provided by bitpesa should not be taken at face value. bitpesa cannot transfer money to a customer that does not have access to a bank account and a mobile payment infrastructure. the assertion that it brought banking services to the unbanked is completely unsubstantiated and misleading, to say the least. to make this clear, we list the steps necessary to conduct payment using bitcoin in africa, according to bitpesa’s own terms and conditions. 192 ▪sender opens bitpesa account and purchases bitcoin; 188 marina fyrigou-koulouri, ‘blockchain technology: an interconnected legal framework for an interconnected system’ [case western reserve university school of law] 9 journal of law, technology and the internet 1, p. 7; philipp hacker and chris thomale, crypto-securities regulation: icos, token sales and cryptocurrencies under eu financial law (2017), p. 23 and gikay asress adimi, ‘european consumer law and blockchain based financial services: a functional approach against the rhetoric of regulatory uncertainty’ [ubiquity press] 24 tilburg law review. 189 michèle finck, blockchains: regulating the unknown (german law journal 2018), pp. 675, 677. 190 ibid 675, 677. 191 ibid 672. 192 bitpesa terms and conditions, retrieved from <https://www.mybfx.co/terms> accessed 11 april 2019. njcl 2019/2 104 ▪sender authorizes transfer by bitpesa of a given amount of bitcoin to the designated payee’s bank account; ▪bitpesa debits the sender’s account and transfers the specified amount fewer charges to the payee’s bank account in local currency; ▪bitpesa transfers the money to the receiver’s bank account with mobile payment services. obviously, the payment system does nothing special to provide banking service to the unbanked. in fact, an unbanked person—someone who has no access to a bank account, credit card or debit card, and hence is excluded from the financial system193— cannot access bitpesa payment system because local currency account is a prerequisite for the payment system to work. in 2015, bitpesa filed a petition against safaricom for the latter’s refusal to allow the former to use a mobile payment infrastructure because it engages in bitcoin-based transactions, without having a license from the central bank of kenya. the central bank did not give authorization for it did not recognize bitcoin transfer as money transfer.194 the dispute clearly shows that bitpesa needs not only an existing local currency account but also mobile payment infrastructure to provide financial services in kenya. the example of bitpesa underlines that not only are the media and industry experts spreading technological propaganda but also scholars. without engaging in objective scientific analysis of the technology, the intelligentsia risks becoming the mouthpiece for technological populists, by merely echo-chambering what the latter propagate. 4.1.3. regulatory oversight another important reason for the surge of blockchain as an omnipresent and versatile innovation is the thoughtless regulatory restraint in certain jurisdictions, especially in the european union. a reasonable restraint from putting in place a drastic regulation that stifles innovation is understandable to a large degree. as twigg-flesner suggests, a regulatory uncertainty caused by disruptive technologies195 should not 193 eric sammons, ‘how cryptocurrencies like dash help the poor’ dash force news (august 23, 2017), retrieved from <https://www.dashforcenews.com/cryptocurrencieslike-dash-help-poor/> accessed 21 october 2018. 194 lipisha consortium ltd and bitpesa lted vs safaricom, high court of kenya, constitutional and human rights division, petition no. 512, 2015, retrieved from: <https://www.scribd.com/document/293343842/ruling?ad_group=100652x157442 5x54a5f51c12eb6b6fbb235182716a471e&campaign=skimbitltd&keyword=66014902 6&medium=affiliate&source=hp_affiliate> accessed 11 april 2019. 195 katyal defines disruptive innovation as follows: ‘disruptive innovation goes beyond improving existing products; it seeks to tap unforeseen markets, create products to solve 105 technological populism and its archetypes trigger the implementation of new legal rules until the disruptive technology has also disruptive effect on the law.196 premature regulatory reform may deliver legal rules that are unsuitable or unworkable or detrimental to innovation.197 nonetheless, unduly prolonged restraint could also have a detrimental effect on consumer rights198 and on the smooth functioning of the market. therefore, regulatory authorities, faced with a disruptive technology that challenges the existing legal rules should not merely point out the potential or actual regulatory uncertainty and sit idly. at least the existing legal rules should be enforced with respect to the technologybased challenges. this well-established conventional wisdom has been ignored by governments in dealing with blockchain-based transactions. the degree of regulatory self-restraint differs from jurisdiction to jurisdiction, which permitted blockchain-based businesses to engage in regulatory arbitrage.199 on the one extreme, there is china, which has declared icos categorically illegal in 2017.200china considered blockchain-based crowdfunding as mostly fraudulent with no sustainable business model and concrete product to offer, a sentiment shared by wikipedia’s founder, wales: “there are a lot of these initial coin offerings which in my opinion problems consumers don't know that they have, and ultimately to change the face of industry. we are all the beneficiaries of disruption.’ katyal neal, ‘disruptive technologies and the law’ 102 georgetown law journal 1685, p. 1685. 196 christian twigg-flesner, “disruptive technology disrupted law? how the digital revolution affects (contract) law” in alberto de franceschi, european contract law and the digital single market : the implications of the digital revolution (intersentia 2016) pp. 21, 25, 26. ‘the disruptive effect of a particular development can be gauged by considering whether specific issues can be dealt with by applying the existing legal rules to the particular issues that have been identified in respect of the issues. thus, if it is possible to maintain the existing rules but to clarify how these should be applied to the to the context of the new development, then the disruptive effect to the law is minimalindeed, such an approach may reflect the robust design of existing legal rules and their potential for extending these to new circumstance.’ 197 ibid 25. 198 ibid 24. 199 asress adimi gikay, ‘how the new generation cryptocurrencies decoded the investment contract code: analysis of us and eu laws’ (2018) 10 bocconi legal papers 311, 344. see also gregory klumov ‘how various countries benefit and suffer from regulation arbitrage today’, bitcoinist(april 21, 2018), retrieved from <https://bitcoinist.com/countries-benefit-suffer-regulation-arbitrage/ > accessed 29 april 2019. 200 david meyer, ‘china's central bank is banning initial coin offerings’ fortune (september 4, 2017), retrieved from <http://fortune.com/2017/09/04/ico-chinacentral-bank-ban/> accessed 29 april 2019. njcl 2019/2 106 are absolute scams and people should be very wary of things that are going on in that area”.201 a report published in 2018 confirmed that 80% of the icos were indeed fraud.202 china has also been considering banning bitcoin mining due to its wasteful electricity consumption.203 on the other extreme, the eu showed reluctance to apply existing regulatory rules to blockchain based transactions until recently. the eu market is peculiarly vulnerable to potential market failure due to lack of reasonably robust regulation or regulatory decision pertaining to blockchain. due to the lack of commitment to enforcing existing legal rules to icos, some icos raised funds largely from the eu market.204 a middle ground is taken by the united states, that adopted a more balanced approach by applying the existing legal rules to various blockchain based transactions and business entities. the us financial crimes enforcement network (fincen) issued a guideline that extends the application of the bank secrecy act to cryptocurrencies back in 2013 to cryptocurrency payments.205 the sec has applied securities regulation 201 joumanna bercetche, ‘icos — the hottest craze in cryptocurrencies — is an “absolute scam”, wikipedia founder jimmy wales says’, cnbc, 5 october 2017, retrieved from: < https://www.cnbc.com/2017/10/05/ico-or-initial-coin-offerings-arean-absolute-scam-wikipedias-jimmy-wales.html l> accessed 29 april 2019. 202 shobhit seth, ‘$9 million lost each day in cryptocurrency scams’ (investopedia, 2 april 2 2018), retrieved from <https://www.investopedia.com/news/80-icos-arescams-report%20/> accessed 17 october 2018. 203 edwin chan, ‘china plans to ban cryptocurrency mining in renewed clampdown’ bloomberg (april 19, 2019), retrieved from <https://www.bloomberg.com/news/articles/2019-04-09/china-plans-to-bancryptocurrency-mining-in-renewed-clampdown> accessed 27 april 2019. 204 angel token ico white paper states the following: ‘government agencies in some jurisdictions have made statements that we interpret such that they consider some initial coin offerings and token sales as investments/offers that are to be regulated in some way. therefore citizens, residents, (tax or otherwise) and green card holders from the following countries are strictly prohibited from participating in this ico: – united states of america (including all outlying territories) – the people's republic of china ("prc") – singapore – new zealand – united kingdom (including the isle of man, northern ireland, and the channel islands.’ angel token ico white paper, disclaimer, p. 2, retrieved from <https://angelinvestors.io/wp-content/uploads/2017/11/angeltoken-white-paper-3_0.pdf>, accessed 29 april 2019. hence, about half of funds raised in icos in 2017 is raised from the european market. reuters, ‘europe is pouring a staggering amount of cash into new cryptocurrencies’, fortune (30 november 2017), retrieved from <http://fortune.com/2017/11/30/ico-initial-coin-offeringbitcoin-europe/> accessed 29 april 2019. 205 financial crimes enforcement network, ‘application of fincen’s regulations to persons administering, exchanging, or using virtual currencies’ (18 march 2013), fin2013-g001. https://www.cnbc.com/joumanna-bercetche/ 107 technological populism and its archetypes to blockchain-based financial instruments (securities).206 on december 11 2017, the sec issued a cease and desist order compelling munchee inc. to return funds raised from investors in return for tokens sold in violation of securities law.207 the eu, while regarded as the model for regulating the market and protecting consumers, has tactically been ignoring implementing balanced regulatory measure by allowing the technology to serve as a tool for anarchy. for a long time, the european securities and market authority (esma) has been ambivalent about whether the existing legal rules governing offer of securities are applicable to blockchain-based assets. it provided a positive answer only in january 2019.208 perhaps more tellingly, the european commission and the parliament concluded by early 2016 that the existing anti-terrorism and countering terrorism finance (aml/ctf) does not apply to cryptocurrency exchanges and digital wallet providers. when the parliament finally decided to implement a directive to fill the regulatory gap, which it approved in 2018,209 it extended the effective date of the directive to 2020.210 until 2020, the parliament and the commission are willing to let exchange platforms conduct their business without complying with obligations as know-your-customer (kyc) or report suspicious transactions. why should a payment service provider transferring 50 dollars on behalf of its customer be subjected to the kyc requirement that imposes burdensome obligations on the financial institution as well as the 206 sec, report of investigation pursuant to section 21(a) of the securities exchange act of 1934(2017), sec release 34-81207, p. 12, retrieved from <https://www.sec.gov/litigation/investreport/34-81207.pdf> accessed 6 july 2018 & in the matter of munchee inc, sec administrative proceeding file no. 3-18304, retrieved from < https://www.sec.gov/litigation/admin/2017/33-10445.pdf> accessed 6 july 2018. 207 sec administrative proceeding file no. 3-18304(n 166) 208 see esma, esma advice: initial coin offering (9 january 2019) & eba, report with advice for the european commission on crypto-assets (january 9, 2019). 209 directive (eu) 2018/843 of the european parliament and the council of 30 may 2018 amending directive (eu) 2015/849 on the prevention of the use of the financial system for the purposes of money laundering or terrorist financing, and, amending directives 2009/138/ec, ojeu, l 156/43. 210 id at art. 42. recital 8 of the directive recognizes that ‘providers engaged in exchange services between virtual currencies and fiat currencies (that is to say coins and banknotes that are designated as legal tender and electronic money, of a country, accepted as a medium of exchange in the issuing country) as well as custodian wallet providers are under no union obligation to identify suspicious activity.’ njcl 2019/2 108 customer,211 while intermediaries and users using cryptocurrencies could transfer thousands of dollars without being bound by similar requirements? compared to china and the us, the regulatory abstinence of the eu is the result of either ineffectiveness or regulatory capture. neither is better or worse than the other. what we underline is that the rhetoric of blockchain advocates has turned most stakeholders into active defenders or passive observers, both categories being enablers. 5. conclusion: a call for technological populism consciousness the article showed that there are conspicuous similarities between populistic discourse and the rhetoric supporting the ‘hype’ of blockchain technology, which led us to propose the introduction of a new concept, which we called ‘technological populism’. our research revealed that blockchain manifestos are neither technological, nor programmatic documents, but mere communication strategies resembling populist speeches, meant to attract supporters and create polarization. in addition, we delved into the promises of blockchain technology and showed that key elements of populist rhetoric, such as disruption of the old order, empowerment of ‘the people’ against the ‘elites’, replacement of compromised institutions are also central to blockchain manifestos. however, we also pointed out that the promises of blockchain technology find little support in reality and we found that the paradoxes of political populism – the potential for misappropriation for own profit and lack of substance – are easily identifiable in regard to blockchain technology as well. thus, we debunked the promises of decentralization, trustlessness (trust in computation) or anonymity/pseudonimity. lastly, we advanced an explanation for the emergence of technological populism and the reasons for its success. while accepting that multitudes of answers are possible, our article identified and argued that two extraneous factors are the most plausible explanation: the wide support from the media and the intelligentsia and regulatory oversight. the former provided technological populism with the necessary forum 211 d. hopton, money laundering: a concise guide for all business (gower 2009), p. 78, ‘it is often said that there are three parts to the kyc process: first, to satisfy yourself that the prospective customer is who they claim to be; second, to ascertain the nature of the proposed relationship; and third, to obtain enough information about the proposed customer’s business so as to ascertain the legitimacy of the relationship.’ 109 technological populism and its archetypes and legitimacy. the latter permitted the businesses centred on the technology to operate without complying with regulatory standards and rule of law, which made it economically efficient to create different ventures with no sustainable business model. ultimately, regulatory oversight and indecision created the conducive environment, as populism thrives on inefficient institutions. all the above prove our initial postulate that similar discursive elements and paradoxes connect political and technological discourse, which justifies the introduction of the new concept of technological populism. as in the case of political populism, a definition of technological populism can only be based on its main traits because its confinements remain fluid. we, thus, defined it as the phenomenon by which technological innovations that promise and promote the disruptive effects as societal benefits and claim to solve pressing socio-economic problems by empowering the ‘disenfranchised’ and replacing the ‘elites’ are ‘hyped’ for the economic and commercial benefits of a select few. this begs a final question: quo vadis? what should we do about technological populism and how to control or curb its negative effects? in our view, the answer to these questions starts with acknowledging the existence of the problem. such first step should enable regulators and policymakers to quit their self-induced denial and regulatory stupor and act, not just react. we understand that technology will always be one step ahead in terms of innovation. nevertheless, being conscious of technological innovations with little real-world relevance, i.e., being able to identify and distinguish between genuine benefits and populistic promises of technology, should enable regulators to provide adequate and timely responses to threats faced by citizens and businesses alike. it would also save consumers from investing their hard-earned money into technocratic projects that serve only the interests of a select few. cisg advisory council opinion no. 6* calculation of damages under cisg article 74 by cisg advisory council nordic journal of commercial law issue 2006 #2 nordic journal of commercial law issue 2006 #2 2 to be cited as: cisg-ac opinion no. 6, calculation of damages under cisg article 74. rapporteur: professor john y. gotanda, villanova university school of law, villanova, pennsylvania, usa. adopted by the cisg-ac at its spring 2006 meeting in stockholm, sweden. reproduction of this opinion is authorized. jan ramberg, chair eric e. bergsten, michael joachim bonell, alejandro m. garro, roy m. goode, john y. gotanda, sergei n. lebedev, pilar perales viscasillas, peter schlechtriem, ingeborg schwenzer, hiroo sono, claude witz, members. loukas a. mistelis, secretary. the cisg-ac is a private initiative supported by the institute of international commercial law at pace university school of law and the centre for commercial law studies, queen mary, university of london. the international sales convention advisory council (cisg-ac) is in place to support understanding of the united nations convention on contracts for the international sale of goods (cisg) and the promotion and assistance in the uniform interpretation of the cisg. at its formative meeting in paris in june 2001, prof. peter schlechtriem of freiburg university, germany, was elected chair of the cisg-ac for a three-year term. dr. loukas a. mistelis of the centre for commercial studies, queen mary, university of london, was elected secretary. the cisg-ac has consisted of: prof. emeritus eric e. bergsten, pace university; prof. michael joachim bonell, university of rome la sapienza; prof. e. allan farnsworth, columbia university school of law; prof. alejandro m. garro, columbia university school of law; prof. sir roy m. goode, oxford; prof. sergei n. lebedev, maritime arbitration commission of the chamber of commerce and industry of the russian federation; prof. jan ramberg, university of stockholm, faculty of law; prof. peter schlechtriem, freiburg university; prof. hiroo sono, faculty of law, hokkaido university; prof. claude witz, universität des saarlandes and strasbourg university. at subsequent meetings, prof. jan ramberg was elected as the chair of the cisg-ac for the term june 2004 to june 2007 and the cisg-ac elected as additional members prof. pilar perales viscasillas, universidad carlos iii de madrid, prof. ingeborg schwenzer, university of basel, and prof. john y. gotanda, villanova university school of law. for more information please contact <l.mistelis@qmul.ac.uk>. mailto:l.mistelis@qmul.ac.uk nordic journal of commercial law issue 2006 #2 3 opinion 1. article 74 reflects the general principle of full compensation. 2. the aggrieved party has the burden to prove, with reasonable certainty, that it suffered loss. the aggrieved party also has the burden to prove the extent of the loss, but need not do so with mathematical precision. 3. the aggrieved party is entitled to non-performance damages, which is typically measured by the market value of the benefit of which the aggrieved party has been deprived through the breach, or the costs of reasonable measures to bring about the situation that would have existed had the contract been properly performed. a. the aggrieved party is entitled to any net gains prevented as a result of the breach. b. lost profits recoverable under article 74 may include loss of profits that are expected to be incurred after the time damages are assessed by a tribunal. c. lost profits include those arising from lost volume sales. 4. the aggrieved party is entitled to additional costs reasonably incurred as a result of the breach and of measures taken to mitigate the loss. 5. under article 74, the aggrieved party cannot recover expenses associated with litigation of the breach. 6. the aggrieved party is entitled to damages for pecuniary loss resulting from claims by third parties as a result of the breach of contract. 7. the aggrieved party is entitled to damages for loss of goodwill as a consequence of the breach. 8. if there has been a breach of contract and then the aggrieved party enters into a reasonable substitute transaction without first having avoided the contract, the aggrieved party may recover damages under article 74, that is, the difference between the contract price and the substitute transaction. 9. damages must not place the aggrieved party in a better position than it would have enjoyed if the contract had been properly performed. a. in calculating the amount of damages owed to the aggrieved party, the loss to the aggrieved party resulting from the breach is to be offset, in principle, by any gains to the aggrieved party resulting from the non-performance of the contract. b. punitive damages may not be awarded under article 74 of the convention. nordic journal of commercial law issue 2006 #2 1. the secretariat commentary provides: since article 70 [ draft counterpart to cisg article 74] is applicable to claims for damages by both buyer and the seller and these claims may arise out of a wide range of situations, including claims for ancillary damages to a request that the party in breach perform the contract or to a declaration of avoidance of a contract, no specific rules have been set forth in article 70 describing the appropriate method of determining “ the loss … suffered … as a consequence of the breach.” the court or the arbitral tribunal must calculate the loss in the manner which best suits the circumstances. secretariat commentary, art. 70 [draft counterpart to cisg art. 74], ¶ 4, reprinted in honnold, documentary history of the uniform law for international sales, kluwer 1989, p. 449 [hereinafter “ secretariat commentary” ], also available at <http://cisgw3.law.pace.edu/cisg/text/secomm/secomm-74.html>. there exists no official commentary on the cisg. the secretariat commentary is on the 1978 draft of the convention. nevertheless, the commentary reflects that secretariat’s impressions of the purposes and effects of the commission’s work and provides a helpful analysis of official text of the cisg. see kritzer, guide to practical applications of the united nations convention on contracts for the international sale of goods, kluwer, 1989, p. 2 (“ [the secretariat] commentaries are the closest available counterpart to an official commentary on the convention and, when they are relevant, constitute the most authoritative citations to the meaning of the convention that one can find.” ). 2. see schlechtriem/schwenzer/stoll/gruber, commentary on the u.n. convention on the international sale of goods, 2nd ed., oxford, 2005, art. 74, ¶ 2; honnold, uniform law for international sales, 3rd ed., kluwer, 1998, p. 445 (citing treitel, remedies for breach of contract, oxford, 1998, p. 82). 3. see farnsworth, damages and specific relief, 27 am. j. comp. l. pp. 247, 249 (1979); sutton, measuring damages under the united nations convention on the international sale of goods, 50 ohio state l.j. pp. 737, 742 (1989). 4. cisg arts. 74, 77. 5. see harris/tallon, contract law today: anglo-french comparisons, oxford 1989, p. 274; draetta, et al., transnational contract law in the law of transnational business transactions, federation press, 2003, § 4:50; robinson v. harman 1 exch p. 850 (1848); the unique mariner [1979] 1 lloyd’s rep. 37, 54; waddams, the law of damages, canada law book limited, 1983, ¶ 536; corbin, corbin on contracts, west, 1952, p. 525; canada, asamera oil corp. v. sea oil & general corp., supreme court of canada, 1979, 1 s.c.r. p. 663. 4 comments to cisg advisory council opinion no. 6 1. article 74 reflects the general principle of full compensation. 1.1 article 74 does not provide specific guidelines for calculating damages.1 instead, it gives the tribunal the authority to determine the aggrieved party’s “ loss suffered … as a consequence of the breach” based on the circumstances of the particular case. the purpose of article 74 is to place the aggrieved party in the same pecuniary position it would have been in had the breach not occurred and the contract been properly performed.2 in other words, it is designed to give the aggrieved party the “ benefit of the bargain.” 3 accordingly, article 74 is to be liberally construed to compensate an aggrieved party for all disadvantages suffered as a result of the breach. however, all claims for damages, including under article 74, are subject to limitations imposed by the doctrines of foreseeability and mitigation.4 1.2 the principle of full compensation for breach of contract established by article 74 is expressed in many national laws.5 in addition, the principle is set forth in both the unidroit principles http://cisgw3.law.pace.edu/cisg/text/secomm/secomm-74.html nordic journal of commercial law issue 2006 #2 6. unidroit principles art. 7.4.2; pecl art. 9:502. 7. see sapphire international petroleums ltd. v. national iranian oil co., arbitral award, 15 march 1963, reprinted in 35 i.l.r. pp. 136, 182 (1967); delagoa bay and east african railway co. (u.s. and great britain v. portugal) (1900), summarized in pertinent part in whiteman, damages in international law, william s. hein & co., 1943, vol. 3, pp. 1694, 1697; see also westberg, international transactions and claims involving government parties: case law of the iran-u.s. claims tribunal, int’l. law inst., 1991, p. 190. the arbitrator in the celebrated sapphire case explained this principle as follows: according to the generally held view, the object of damages is to place the party to whom they are awarded in the same pecuniary position that they would have been in if the contract had been performed in the manner provided for by the parties at the time of its conclusion. … this rule is simply a direct deduction from the principle of pacta sunt servanda, since its only effect is to substitute a pecuniary obligation for the obligation which was promised but not performed. it is therefore natural that the creditor should thereby be given full compensation. this compensation includes loss suffered (damnum emergens), for example expenses incurred in performing the contract, and the profit lost (lucrum cessans), for example the net profit which the contract would have produced. sapphire, 35 i.l.r. pp. 185-86. 8. cisg art. 6. 9. farnsworth, farnsworth on contracts, aspen, 2004, vol. 3, § 12.18. 10 commentators have asserted that the cisg imposes a burden of providing evidence of damages on a claimant. see enderlein/maskow, international sales law, oceana publications 1992, p. 298. however, the cisg does not expressly require that damages be proved with certainty. see saidov, methods of limiting damages under the vienna convention on contracts for the international sale of goods, § 5 (2001), available at <http://cisgw3.law.pace.edu/cisg/biblio/saidov.html> . 11 see united states, delchi carrier s.p.a. v. rotorex corp., u.s. court of appeals (2nd circuit), 6 dec. 1996, cisg-online.ch 140; see also finland, helsingin hoviokeus, 26 oct. 2000, cisg-online.ch 1078; switz., bezirksgericht der saane, 20 feb. 1997, cisg-online.ch 426; arbitration, icc court of arbitration, 23 jan. 1997 cisg-online.ch 236. one commentator examining cisg cases in the russian federation concludes that arbitration tribunals there have consistently applied their own discretion to determine the level of proof necessary. see saidov, cases on cisg decided in the russian federation, 7 vindobona j. int’l com. l. & arb. pp. 1-62, 50 (2003). 5 and the principles of european contract law (pecl).6 it is also consistent with decisions of many international tribunals.7 1.3 it should be noted at the outset that parties may agree upon the remedies available for breach of contract.8 for example, they may limit the scope of liability in the event that a party terminates the contract because of certain events. in addition, they may include a liquidated damages provision, which provides for a specified amount of damages to be paid by a party who repudiates the agreement. however, some jurisdictions may refuse for public policy reasons to enforce such a clause.9 2. the aggrieved party has the burden to prove, with reasonable certainty, that it suffered a loss. the aggrieved party also has the burden to prove the extent of the loss, but need not do so with mathematical precision. 2.1 article 74 does not explicitly address to what extent aggrieved parties must prove that they have suffered a loss in order to recover damages under that provision.10 as a result, there has been controversy over whether this matter is implicitly addressed by the convention or whether it is a procedural matter to be resolved according to domestic law. some courts and tribunals have held that the issue is a procedural matter beyond the scope of the convention.11 however, relying on such an approach could be counterproductive and lead to differential treatment of similarly situated parties. 2.2 in order to recover damages for breach of contract, the aggrieved party must prove that it has suffered a loss as a result of the breach. in common law countries, the requisite level of proof is often found in the requirement that the claimant prove “ certainty of damages.” this typically http://cisgw3.law.pace.edu/cisg/biblio/saidov.html nordic journal of commercial law issue 2006 #2 12 see united states, bagwell v. middle s. energy, u.s.court of appeals (5th cir.), 1986, 797 f.2d p. 1298; united states, locke v. united states, u.s.court of claims,1960, 283 f.2d p. 521; unites states, kozlowski v. kozlowski, new jersey supreme court,1979, 403 a.2d p. 902; chitty on contracts, 24th ed., sweet & maxwell, 1977, vol. 1, §1562; carter/harland, contract law in australia, 4th ed., lexisnexis, 2002, ¶¶ 2117; see also restatement, contracts (second) § 352 (1981) (u.s.); dobbs, law of remedies, west, 1993, §§ 12.4(3), 12.9(2); mcgregor, mcgregor on damages, 14th ed., sweet & maxwell, 1980, § 261; see also waddams, op. cit., ¶ 1051; arbitral award, final award in case no. 78445 of 1996, reprinted in xxvi y.b. com arb. pp. 167, 175 (2001) (citing india, state of kerala v. k. bhaskaran, air (1985) kerala p. 55); robert dunn, recovery of damages for lost profits, 5th ed., cromwell-smith, 1998, § 1.6; gotanda, recovering lost profits in international disputes, 36 geo j. int’l l. p. 61 (2005). 13 see simont, belgium, in transnational litigation, oceana, 2003, p. bel-64; vargas/lira, brazil, in transnational litigation, oceana, 1997, p. bra-11. 14 wirth et al., switzerland, in transnational litigation, oceana, 1997, p. swi-77. 15 the helsinki court of appeals dealt with a similar scenario, where the seller had refused delivery of plastic carpets that the buyer had not previously been in the business of selling. see finland, helsingin hoviokeus, 26 oct. 2000, cisg-online.ch 1078. in this case the buyer had entered into a requirements contract with a third party for the resale of the plastic carpets. id. the court, in estimating the buyer’s damage as a result of the seller’s breach, held that the buyer’s sales goal could not be used as basis for estimating lost profits. id. 16 arbitral award, himpurna california energy ltd. v. p.t. (persero) perusahaan listruik negara, final award of 4 may 1999, reprinted in xxv y.b. com. arb. pp. 13, 83-84 (2000). 6 means the aggrieved party must prove with reasonable certainty that a loss was sustained or will be sustained.12 some civil law countries also require that damages be reasonably certain in their existence but not in amount,13 while others impose a higher standard of proof to recover damages, particularly with respect to claims for lost profits.14 2.3 the existence of differing rules concerning the proof of damage could lead to the differential treatment of similarly situated parties. for example, buyers attempting to prove future losses often rely on assumptions about market prices and the amount of future sales. if a seller wrongfully refuses to deliver a new product or a product that the buyer had not previously been in the business of selling, there may be little concrete evidence on which the aggrieved buyer can base its damages claim, which would mainly consist of loss of profit.15 in such a case, countries requiring a high level of proof with regard to the fact that the aggrieved party suffered a loss would likely not allow the recovery of lost profits under article 74. however, in countries that have a more relaxed level of proof, the aggrieved party may be able to recover such damages under article 74. this result would be unfair and undermine the goal of the convention to provide a uniform law on the sale of goods. in addition, the former approach would be contrary to the principle of full compensation. it also could provide an incentive for a party to breach its contractual obligations. as one arbitral tribunal, in a non-cisg case, explained: [i]f recovery were limited to what a claimant has spent in reliance on a contract which has been breached, an incentive would be created which is contrary to the contractual morality: obligors would generally find it in their interest to breach contracts which turn out to be valuable to their co-contractant. parties do not enter into contracts involving risk in order to be repaid their costs. to limit the recovery of the victim of a breach to its actual expenditures is to transform it into a lender, which is intolerable when that party was full risk for the amount of the investments made on the strength of the contract.16 2.4 furthermore, from a policy perspective, the breaching party should not be able to escape liability because the breaching party’s wrongful act caused the difficulty in proving damages with nordic journal of commercial law issue 2006 #2 17 see united states, southwest battery corp. v. owen, texas supreme court, 1938, 115 s.w.2d p. 1097 (“ a party who breaks his contract cannot escape liability because it is impossible to state or prove a perfect measure of damages.” ); united states, super valu stores, inc. v. peterson, alabama supreme court, 1987, 506 so.2d p. 317 (“ [t]he risk of uncertainty must fall on the defendant whose wrongful conduct caused the damages.” ) 18 united states, mid-america tablewares, inc. v. mogi trading co., u.s.court of appeals (7th cir.), 1996, 100 f.3d p. 1353. 19 see zeller, damages under the convention on contracts for the international sale of goods, oceana, 2005, pp. 158-59 (noting substance-procedure distinction allows courts to apply local law that they are familiar with and leads to forum shopping, and, in some cases where procedural law has been applied instead of an international convention, “ the application of domestic procedural law disported the process of what could have been a uniform application of substantive law” ). 20 see orlandi, procedural law issues and law conventions, 5 uniform l. rev. p. 23 (2000); see also, united states, sun oil co. v. wortman, u.s. supreme court, 1998, 486 u.s. p. 717 (“ except at the extremes, the terms ‘substance’ and ‘procedure’ precisely describe very little except dichotomy, and what they mean in a particular context is largely determined by the purposes for which the dichotomy is drawn.” ); united states, hanna v. plumer, u.s.supreme court,1965, 380 u.s. p. 460 (“ the line between ‘substance’ and ‘procedure’ shifts as the legal context changes. each implies different variables depending upon the particular problem for which it is used.” ); see also gotanda, awarding interest in international arbitration, 90 am j. int’l l. p. 40 (1996) (noting that “ many countries regard the awarding of interest as substantive, while others deem rules concerning interest procedural” ). 21 see bianca/bonell/knapp, commentary on the international sales law, the 1980 vienna sales convention, giuffrè, milano, 1987, art. 7, ¶¶ 2.2.1-2.3.1 (stating that in cases of ambiguities or obscurities in text and gaps, “ courts should to the largest possible extent refrain from resorting to the different domestic laws and try to find a solution within the convention itself” by looking “ to the underlying purposes and policies of individual provisions as well as of the convention as a whole” ). 22 bianca/bonell/bonell, op. cit., art. 7, ¶ 2.3.2.2; see saidov, standards of proving loss and determining the amount of damages, 22 j. cont. l. p. 1 (mar. 2006). 7 absolute certainty.17 as one united states court noted, “ it is particularly in the area of quantifying the amount of lost profits that courts impose the risk of uncertainty on the breaching party whose breach gave rise to the uncertainty.” 18 2 . 5 m o r e o v e r , r e l y i n g o n a p p li c a b le p r o c e d u r a l l a w t o r e s o lv e t h i s is s u e m ay b e counterproductive.19 this is because whether a matter is considered substantive or procedural may vary from jurisdiction to jurisdiction and may depend on the circumstances of a particular case.20 instead, the analysis should focus on whether the matter is governed by the convention by examining “ the purposes and policies of individual provisions as well as the convention as a whole” and giving due regard to the need for a uniform interpretation.21 2.6 given the need to promote the convention’s international character and the need to promote uniformity in the convention’s application, and in light of the purposes and policies of article 74, the aggrieved party bears the burden of proving with reasonable certainty such party has suffered a loss as a result of the breach. the imposition of a “ reasonable” standard should not be viewed as radical. rather, it is consistent with the convention as a whole. as one commentator notes: [o]n several occasions the convention refers to the parties as “ reasonable” persons (see, e.g., articles 8(2) and (3); 25; 35(1)(b); 60; 72(2); 75; 77; 79(1); 85; 86; 88(2)), requires that a particular act must be accomplished or a notice given within a “ reasonable time” (see, e.g., articles 18(2); 33(3); 39(1); 43(1); 47; 49; 63; 64; 65; 73(2)), and distinguishes between “ reasonable” and “ unreasonable” expense, inconvenience or excuse (see, e.g., article 43; 37; 48; 87; 88(2) and (3)). these references demonstrate that under the convention the “ reasonableness” test constitutes a general criterion for evaluating the parties’ behavior to which one may resort in the absence of any specific regulation.22 nordic journal of commercial law issue 2006 #2 23 see eiselen, remarks on the manner in which the unidroit principles of international commercial contracts may be used to interpret or supplement article 74 of the cisg, ¶ k, available at <http://cisgw3.law.pace.edu/cisg/principles/uni74.html>; blase/höttler, remarks on the damages provisions in the cisg, principles of european contract law (pecl) and unidroit principles of international commercial contracts (upicc), available at <http://cisgw3.law.pace.edu/cisg/text/peclcomp74.html>. 24 art. 7.4.3. 25 art. 7.4.3 cmt. 1 (emphasis added). 26 art. 9:501(2) (emphasis added). 27 see hahnkamper, austria, in transnational litigation, oceana, 1999, p. aus-88; simont, op. cit., p. bel-63 (belgium); wirth, op. cit., p. swi-76 (switz.) (citing gauch/schluep, schweizerisches obligationenrecht, allgemeiner teil, zürich, 6th ed., 1995, vol. 2, pp. 2624, 2630, 2726; restatement, contracts (second) § 352 (1981) (u.s.); see also gotanda, lost profits, op. cit., p. 87 (“ [i]n general, the claimant must prove lost profits with reasonable certainty. in many countries though, the certainty rule applies only to the fact that the breach resulted in claimant’s loss of future revenues and not to the amount of profits it lost.” ). 28 finland, helsingin hoviokeus, 26 oct., 2000, cisg-online.ch 1078; russia, ica arbitral tribunal, 27 july, 1999, cisgonline.ch 779; united states, delchi carrier s.p.a. v. rotorex corp., u.s.court of appeals (2nd circuit), 6 dec. 1995, cisgonline.ch 140; see also teevee toons, inc. v. gerhard schubert gmbh, no. 00 civ. 5189 (rcc) (u.s. dist. ct. s.d.n.y. aug. 23, 2006), available at <http://cisgw3.law.pace.edu/cases/060823u1.html>. 29 cf. c.c. art. 1226 (italy); bw art. 6:105 (neth.); united states, california lettuce growers v. union sugar co., california supreme court, 1955, 289 p.2d pp. 785, 793. comments to the american u.c.c. “ reject[s] any doctrine that damages must be calculable with mathematical accuracy,” stating that “ [c]ompensatory damages are often best approximate; they have to be proved with whatever definiteness and accuracy the facts permit, but no more.” u.c.c. § 1-106 cmt. 1 (u.s.). the unidroit principles states that “ where the amount of damages cannot be established with a sufficient degree of certainty, the assessment is at the discretion of the court.” unidroit principles art. 7.4.3(3). 30 see united states, butler v. westgate state bank, kansas supreme court, 1979, 596 p.2d p. 156; united states, alliance tractor & implement co. v. lukens tool & die co., nebraska supreme court, 1979, 281 n.w.2d p. 778; united states, houston exploration, inc. v. meredith, nevada supreme court, 728 p.2d p. 437 (1986); united states, edwards v. container kraft & paper supply co., california court of appeals, 1958, 327 p.2d p. 622; restatement, contracts (second) § 352 cmt. b (1981) (u.s.). in one tribunal in a non-cisg case, the claimant calculated its claimed lost profits on the basis of detailed forecasts of expected results during the relevant time period, including the forecasted production capacity of a factory that the respondent failed to complete, the forecasted sales of the product that was to be made at the factory (based largely on statements from the claimant’s customers that they would have bought certain quantities of the product at prices that were competitive with those offered by the claimant’s competitors). the tribunal “ accept[ed] that the claimed amount of loss of profit fairly represents what the claimant would have earned during the relevant period of time, if production according to the agreement had been performed.” sweden, arbitration institute of the stockholm chamber of commerce, interim award of 17 july 1992 and final award of 13 jul. 1993, reprinted in pertinent part in xxii y.b. com. arb. p. 197 (1997). 8 2.7 requiring the aggrieved parties to prove, with reasonable certainty, that that party suffered a loss is consistent with the unidroit principles and the pecl.23 the unidroit principles states: “ [c]ompensation is due only for harm, including future harm, that is established with a reasonable degree of certainty.” 24 the comments further provide that this “ reaffirms the well-known requirement of certainty of harm . … ” 25 the pecl states: “ [t]he loss for which damages are recoverable include: (a) non-pecuniary loss; and (b) future loss which is reasonably likely to occur.” 26 2.8 this requirement is also in accord with many national laws.27 furthermore, it is consistent with the decisions of a number of courts and tribunals that have imposed a requirement that damages be proved with reasonable certainty.28 2.9 if aggrieved parties are able to meet the burden of proving damages with reasonable certainty, they then have the burden to prove the extent of damages, but need not do so with mathematical precision.29 the aggrieved party must only provide a basis upon which a tribunal can reasonably estimate the extent of damages. an aggrieved party may be able to do this through, for example, the use of expert testimony, economic and financial data, market surveys and analyses, or business records of similar enterprises.30 this requirement strikes a balance between the need for evidence http://cisgw3.law.pace.edu/cisg/principles/uni74.html http://cisgw3.law.pace.edu/cisg/text/peclcomp74.html http://cisgw3.law.pace.edu/cases/060823u1.html nordic journal of commercial law issue 2006 #2 31 as the tribunal in final award in case no. 8362 of 1995 pointed out, in a non-cisg case: with respect to the calculation of the amount of damages, counterbalancing factors are taken into account under the law: on the one hand, there must be a sound basis upon which alleged damages are to be calculated. they cannot be the product of sheer speculation unsupported by tangible evidence. on the other hand, the law will not reward a party in breach by depriving the other party of compensation merely because no precise basis for determining the amount of damages exists. arbitral award, final award in case no. 8362 of 1995, reprinted in pertinent part in xxii y.b. com. arb. pp. 164, 177 (1977). 32. farnsworth, op. cit., § 12.9; see, e.g., germany, lg trier, 12 oct. 1995, cisg-online.ch 160. the secretariat commentary provides: if the goods delivered had a recognized value which fluctuated, the loss to the buyer would be equal to the difference between the value of the goods as they exist and the value of the goods would have had if they had been stipulated in the contract. since this formula is intended to restore him to the economic position he would have been in if the contract had been performed properly, the contract price of the goods is not an element of the calculation of damages. secretariat commentary, op. cit., art. 70 [draft counterpart to cisg art. 74, ¶ 7. 33. see schlechtriem/schwenzer/stoll/gruber, op. cit., art. 74, ¶14. the secretariat commentary states: where the seller delivers and the buyer retains defective goods, the loss suffered by the buyer might be measured in a number of different ways. if the buyer is able to cure the defect, the loss would often be equal to the cost of the repairs. if the goods delivered were machine tools, the buyer’s loss might also include the loss resulting from lowered production during the period the tools could not be used. secretariat commentary, op. cit., art. 70 [draft counterpart to cisg art. 74], ¶ 6. 34. see austria, ogh, 14 jan., 2002, cisg-online.ch 643; see also canada, nova tool and mold inc. v. london industries inc., ontario court, 16 dec. 1998, cisg-online.ch 572; germany, ag müchen, 23 june 1995, cisg-online.ch 368. failed attempts to repair goods may also be compensated. see united states, delchi carrier s.p.a. v. rotorex corp., u.s.court of appeals (2nd circuit), 6 dec. 1995, cisg-online.ch 140. 9 upon which tribunals may base an award of damages and the recognition that the difficulty of proving that any damages in fact stem from the breaching party’s wrongful act.31 3. the aggrieved party is entitled to non-performance damages, which is typically measured by the market value of the benefit of which the aggrieved party has been deprived through the breach, or the costs of reasonable measures to bring about the situation that would have existed had the contract been properly performed. 3.1 under article 74, an aggrieved party is entitled to be compensated for the value of its unrealized contractual expectation in order to receive the benefit of the bargain. this loss is sometimes termed non-performance loss, direct loss, or loss in value. it is often measured by “ the difference between the value to the aggrieved party of the performance that should have been received and the value to that party of what, if anything, actually was received.” 32 3.2 in other cases, the aggrieved party may undertake measures to place it in the same position that it would have been in had the contract been properly performed. in such circumstances, the aggrieved party is entitled to recover the costs of those measures, provided that they were reasonable.33 for example, when a seller delivers defective goods and the buyer repairs them, tribunals have awarded the aggrieved buyer, among other things, the expenses incurred in repairing the goods.34 in addition, where a seller is unjustifiably delayed in delivering the goods and the buyer undertakes measures to overcome the temporary loss of the goods, tribunals have awarded the aggrieved buyer the expenses it incurred in overcoming the loss of the benefit of performance. for example, in the decision of the oberlandesgericht köln, 8 january 1997, the seller of tanning machines did not return by the agreed upon date machines that it had taken back to adjust. the buyer then hired a third party to treat its leather goods. the provincial court of nordic journal of commercial law issue 2006 #2 35. see germany, olg köln, 8 jan., 1997, cisg-online.ch 217. 36. secretariat commentary, op. cit., art. 70 [draft counterpart to cisg art. 74], ¶ 7. 37. for a discussion of the differences between the cisg damages provisions and the american uniform commercial code, which has been adopted in some form by most states, see flechtner, remedies under the new international sales convention: the perspective from article 2 of the u.c.c., 8 j.l. & com. pp. 53, 97-107 (1988). 38. unidroit principles of international commercial contracts art. 7.4.2 (2004). for a comparison of the damages provisions of unidroit principles and the convention, see eiselen, op. cit.; see also garro, the gap-filling role of the unidroit principles in international sales law: some comments on the interplay between the principles and the cisg, 69 tulane l. rev. pp. 1149, 1152 (1995). 39. principles of european contract law (pecl) art. 9:502 (prepared by the commission on european contract law, ole lando and hugh beale eds., 2000). for a comparison of the damages provisions of the pecl, see blase/höttler, op. cit. 40. an aggrieved party may suffer losses resulting from the devaluation of currency when a debtor fails to make a payment when due and, in the interim between the maturity of the obligation and the receipt of payment, the exchange rate between the currency of the agreement and the aggrieved party’s local currency declines. then, upon conversion into its local currency, the aggrieved party does not receive the value that it expected under the contract. see uncitral digest of case law on the united nations c o n v e n t i o n o n t h e i n t e r n a t i o n a l s a l e o f g o o d s , a v a i l a b l e a t <http://daccessdds.un.org/doc/undoc/gen/v04/555/63/pdf/v0455563.pdf>; see also f.a. mann, the legal aspect of money, oxford, 4th ed., 1982, p. 286. 10 appeal ruled that, under article 74, the buyer was entitled to recover the sum paid to the third party because the hiring of that party was viewed as reasonable under the circumstance.35 3.3 the secretariat commentary provides the following additional example: 36 the contract provided for the sale of 100 tons of grain for a total price of $50,000 fob. when the delivered grain had more moisture in it than allowable under the contract description and, as a result of the moisture, there had been some deterioration in quality. the extra cost to buyer of drying the grain was $1,500. if the grain had been as contracted, its value would have been $55,000, but because of the deterioration caused by the moisture after it was dried the grain was worth only $51,000. contract price $50,000 value the grain would have had if as contracted $55,000 value of grain as delivered $51,000 $ 4,000 extra expenses of drying the grain $ 1,500 loss arising out of the breach $ 5,500 3.4 this approach is in accord with the unidroit principles and the pecl.37 unidroit principles article 7.4.2(1) provides: “ the aggrieved party is entitled to full compensation for harm sustained as a result of non-performance. such harm includes both any loss which it suffered and any gain of which it was deprived . . . .” 38 similarly, pecl article 9:502 states: “ the general measure of damages is such sum as will put the aggrieved party as nearly as possible into the position in which it would have been if the contract had been duly performed. such damages cover the loss which the aggrieved party has suffered and the gain of which it has been deprived.” 39 3.5 an aggrieved party also may recover losses resulting from declining exchange rates if the aggrieved party can prove that it would have received a higher monetary value if the breaching party had paid the money owed pursuant to the contract.40 the aggrieved party’s loss in this situation can http://daccessdds.un.org/doc/undoc/gen/v04/555/63/pdf/v0455563.pdf nordic journal of commercial law issue 2006 #2 41. see switzerland, hg zurich, 5 feb. 1997, cisg-online.ch 327; new zealand, issac naylor & sons ltd. v. new zealand cooperative wool marketing, 1981, 1 n.z.l.r. p. 361; see also vroegop, exchange losses on an international sale of goods, 1982 n.z.l.j. pp. 3-4. 42. see eiselen, op. cit.; saidov, cases on cisg decided in the russian federation, 7 vindobona j. int’l com. l. & arb. pp. 1, 44-45 (2003); see also enderlein/maskow, op. cit., p. 298. 43. see, germany, lg heidelberg, 27 jan. 1981, available at <http://cisgw3.law.pace.edu/cases/810127g1.html> (ulis precedent); russia, tribunal of international commercial arbitration at the russian federation chamber of commerce and industry (icac), 21 apr. 1994, summarized in pertinent part in saidov, op. cit., p. 44 n.197; see also saidov, op. cit., pp. 44-5 (examining cases and concluding that icac has generally rejected recovery of exchange rate losses under theory that loss is creditor’s domestic issue and risk should not be shifted to debtor). in general, the principle of nominalism applies only to single currency transactions and is not inconsistent with the recovery of exchange rate losses in multi-currency international contracts. see brand, exchange loss damage and the uniform foreign-money claims act: the emperor hasn’t all his clothes, 23 law & pol’y int’l bus. pp. 1, 44 (1992). 44. see mann, op. cit., pp. 108, 286; brand, op. cit., p. 44. 45. see also brand, op. cit., pp. 43-44. 46. see switzerland, dt ltd. v. b. ag, hg st. gallen, 3 dec. 2002, cisg-online.ch 727; switzerland, hg zürich, 5 feb. 1997, cisg-online.ch 327; netherlands, gruppo imar v. protech horst, district court roermond, 6 may 1993, cisgonline.ch 454; see also germany, olg düsseldorf, 14 jan. 1994, cisg-online.ch 119. 47. see germany, olg düsseldorf, 14 jan. 1994, cisg-online.ch 119; see also schlechtriem/schwenzer/stoll/gruber, op. cit., art. 74, ¶ 17. 11 be measured by the difference between the converted value of the currency at the time payment was due under the contract and the value of the converted currency at the time of payment.41 3.6 the following example illustrates this point. assume that a contract calls for a buyer to pay u.s. $10,000 upon delivery of goods to a seller in country x where the currency is the euro and the rate of exchange (at the time of delivery) for u.s. $10,000 is euro $10,000. the buyer then wrongfully refuses to pay the seller and the seller files a suit in an american court to collect. however, by the time that the court enters judgment in favor of the seller, us $1 is worth only euro $0.7692. thus, awarding the seller u.s. $10,000 would, in effect, give the seller only euro $7692. the seller is thus entitled to its payment under the contract (u.s. $10,000), plus an additional u.s. $3,000, which would give the seller the equivalent of euro $10,000. 3.7 while the convention does not explicitly address how courts and tribunals should treat the issue of loss resulting from fluctuating exchange rates, it is consistent with the principle of full compensation that the aggrieved party be compensated for the loss.42 there has been some confusion over whether loss resulting from the devaluation of currency may be recovered under the convention, primarily because of the principle of nominalism and the rule that a creditor ordinarily bears the risk of declining exchange rates.43 while a creditor/aggrieved party may indeed bear the risk of fluctuating exchange rates over the course of the contract, such party does not continue to bear the risk after the debt has matured.44 if this were the case, the aggrieved party would be assigned a risk that it did not intend to assume under the contract and, when the currency of payment is in steady decline, a debtor would have an incentive to delay payment for as long as possible.45 3.8 numerous courts have awarded damages for exchange rate losses under article 74.46 however, they have limited compensation to situations in which the creditor/aggrieved party can show that if it had received payment when due, the aggrieved party would have obtained a higher value by converting the money into its local currency.47 but when a creditor of a foreign currency debt usually conducts its business in a different currency, presumably such party would immediately convert the foreign currency and therefore be entitled to the value determined by the exchange http://cisgw3.law.pace.edu/cases/810127g1.html nordic journal of commercial law issue 2006 #2 4 8 . s e e s w i t z e r l a n d , d t l t d . v . b . a g , h g s t . g a l l e n , 3 d e c . 2 0 0 2 , c i s g o n l i n e . c h 7 2 7 ; s e e a l s o schlechtriem/schwenzer/stoll/gruber, op. cit., art. 74, ¶ 17. 49. see italy, tessile v. ixela, district court pavia, 29 dec. 1999, cisg-online.ch 678; germany, olg düsseldorf, 14 jan. 1994, cisg-online.ch 119; see also enderlein/maskow, op. cit., p. 302. in tessile v. ixela, an italian seller brought a claim for the remainder of the unpaid purchase price of high fashion textiles, where the contract called for payment in italian lira. the seller claimed damages due to monetary devaluation of the italian lira. however, the court stated that “ [n]othing is due by right of greater damages from monetary devaluation because, in the period of time involved here, the legal interest rates have always been greater than the rate of inflation.” id. thus, according to the court, ordinary currency devaluation is intended to be compensated through the awarding of interest. 50. see new zealand, issac naylor & sons ltd. v. new zealand cooperative wool marketing, 1981, 1 n.z.l.r. p. 361; united kingdom, milliangos v. george frank (textiles) ltd., 1976 a.c. pp. 443, 465; mann, op. cit., pp. 286-87. 51. see unidroit principles art. 6.1.9(4); pecl art. 7:108(3). 52. see pecl art. 7:108 cmt.; restatement (third) of foreign relations law § 823(2) (1986) (u.s.). pecl art. 9:510 cmt. 53. relying on national laws to compensate an aggrieved party for loss due to a change in the exchange rate would result in similarly situated parties receiving different results because such laws differ from country to country. see generally gotanda, supplemental damages in private international law, kluwer, 1998, § 4 (surveying national laws on damages in foreign currencies and noting that there are three general dates on which the convention should be performed: date of breach, date of judgment, and date of payment). but cf. united states, delchi carrier s.p.a. v. rotorex corp., u.s.court of appeals (2nd circuit), 6 dec. 1995, cisgonline.ch 140 (applying new york breach-date rule to convert italian lira to u.s. dollars); united states, schmitz-werke v. rockland, u.s.court of appeals (4th circuit), 21 jun. 2002, cisg-online.ch 625. 54. see cisg art. 74; see also secretariat commentary, op. cit., art. 70 [draft counterpart to cisg art. 74], ¶ 3. 55. see cisg art. 74. 56. see secretariat commentary, op. cit., art. 70 [draft counterpart to cisg art. 74], ¶ 3. 57. see id. 12 rate at maturity of the obligation.48 losses may also arise from the devaluation of currency when the currency of agreement is also the creditor’s local currency. this situation is distinct from losses resulting from declining exchange rates; generally these losses have not been regarded as compensable.49 3.9 many national laws and courts have compensated aggrieved parties for exchange rate losses.50 in addition, both the unidroit principles and the pecl also provide aggrieved parties a remedy for declining exchange rates after maturity of the debt.51 however, they do so through requiring that payment be made according to the applicable rate of exchange prevailing either when the payment is due or at the time of payment. in other words, instead of awarding the loss from the devaluation of currency as damages, the unidroit principles and the pecl explicitly provide for essentially the same result by allowing a tribunal to fix the damages according to an appropriate exchange rate so that the aggrieved party does not suffer a loss because of a change in the exchange rate postbreach.52 since the convention does not contain an explicit provision governing this issue, it is appropriate to consider the loss as damages recoverable under article 74.53 a. the aggrieved party is entitled to any net gains prevented as a result of the breach. 3.10 lost profits are the only type of damages specifically mentioned in article 74.54 article 74 provides that a claimant may recover for breach of contract, “ a sum equal to the loss, including loss of profit, suffered … as a consequence of the breach.” 55 the secretariat commentary explains that specific reference to lost profits was included because “ in some legal systems the concept of ‘loss’ standing alone does not include loss of profit.” 56 3.12 the convention does not provide specific guidance on calculating lost profits. individual tribunals are given the authority to calculate damages on a case-by-case basis.57 damages for loss of nordic journal of commercial law issue 2006 #2 58. see id., ¶ 3; schlechtriem/schwenzer/stoll/gruber, op. cit., art. 74, ¶22. 59. see schlechtriem/schwenzer/stoll/gruber, op. cit., art. 74, ¶2. 60. see gotanda, lost profits, op. cit., p. 99. 61. see, united states, southwest battery corp. v. owen, texas supreme court, 1928, 115 s.w.2d pp. 1097, 1099; united states, super valu stores, inc. v. peterson, supreme court of alabama, 1987, 506 so. 2d pp. 317, 330. 62. see ¶¶ 2.1-2.13. 63. see dunn, op. cit., § 6.1. the most common form of expenses saved are variable costs, which include all “ charges composing an essential element in the cost of manufacture or … service. essential elements in such cost[s] … are confined to expenditures that would necessarily have been made in the performance of the contract.” id., § 6.5 (quoting united states, oakland california towel co. v. sivils, california court of appeals, 1942, 52 cal. app. 2d pp. 517, 520). 64. unidroit principles art. 7.4.2; pecl art. 9:502. 65. pecl art. 9:502 cmt. c. 66. see schlechtriem/schwenzer/stoll/gruber, op. cit., art. 74, ¶ 22; see also unidroit principles art. 7.4.2(1) cmt. 2. 67. the classic example involves breach of a contract denying a contestant the chance to win a beauty pageant. see united kingdom, chaplin v. hicks, 1911, 2 k.b. p. 786. 13 profit are to be calculated in accordance with article 74’s principle of full compensation – that is, the goal is to place the aggrieved party in the same position it would have been in economically if the contract had been performed.58 domestic practices that limit damages for lost profits are not to be applied.59 3.13 determining lost profits is not an exact science, and some of the methods used to calculate lost profits are complicated.60 therefore, precise calculation of such damages may not be possible. moreover, in some cases, the breach may prevent an aggrieved party from being able to prove damages with precision. in these circumstances, the breaching party should not be able to escape liability on the ground that lost profits are uncertain.61 thus, an aggrieved party is not required to prove with exact certainty and precision the amount of profits it lost as a result of the breach; it needs only to prove the loss with reasonable certainty.62 3.14 under article 74, an aggrieved party is entitled to net gains prevented, that is, net profits lost as a result of the breach of contract. in general, net profits are calculated by subtracting from gross profits the expenses saved as a result of the aggrieved party being excused from performance.63 this practice is consistent with both the unidroit principles and the pecl.64 in particular, the comment to article 9:502 of the pecl provides: the aggrieved party must bring into account in reduction of damages any compensating gains which offset its loss; only the balance, the net loss, is recoverable. similarly, in computing gains of which the aggrieved party has been deprived, the cost it would have incurred in making those gains is a compensating saving which must be deducted to produce a net gain. compensating gains typically arise as the result of a cover transaction concluded by the aggrieved party. … a compensating saving occurs where the future performance from which the aggrieved party has been discharged as the result of the non-performance would have involved the aggrieved party in expenditure.65 3.15 in certain cases, aggrieved parties may seek damages for the loss of chance or opportunity to earn a profit.66 this may occur when, following a breach of contract, an aggrieved party claims to have suffered a loss from a missed opportunity to engage in an opportunity for gain.67 what separates a loss of chance from the general category of loss of profits is the existence of some contingency or unknown fortuitous event between the promisor’s performance and the promisee’s nordic journal of commercial law issue 2006 #2 68. one commentator asserts that loss of chance can be treated in two ways – as an issue of “ recoverability of losses” or as a “ standard of proving losses” issue. see saidov, damages: the need for uniformity, paper presented at 25 years united nations convention of contracts for the international sale of goods (cisg) § 3.4, p. 9 (vienna mar. 15-16, 2005). cf. murray, murray on contracts, lexisnexus, 4th ed., 2001, § 121[c]. 69. see saidov, damages: the need for uniformity, op. cit., § 3.4, p. 10; schlechtriem/schwenzer/stoll/gruber, op. cit., art. 74, ¶ 22. 70. schlechtriem/schwenzer/stoll/gruber, op. cit., art. 74, ¶ 22, n.98. 71. see saidov, damages: the need for uniformity, op. cit., § 3.4, p. 9; melvin aron eisenberg, probability and chance in contract law, 45 ucla l. rev. pp. 1005, 1049 (1998). 72. in such a situation the breaching party could still be liable for other damages incurred by the aggrieved party as a result of the breach. at least one court interpreting cisg article 74 has denied the recoverability of the loss of chance. see switzerland, hg zürich, 10 feb., 1999, cisg-online.ch 488. in this case, the court addressed whether a buyer could set off the seller’s claims of damages with, among other claims, a claim that the seller’s failure to deliver art books to an exhibition on time prevented the buyer from receiving more offers. the buyer contended that, “ as one of three european publishing houses specializing on the production of such catalogues, buyer would have received at least a third of the commissions.” the court held that such a chance of profit was not recoverable, stating that “ buyer’s loss of profit must be considered normal for the buyer’s kind of business and the seller at the time of conclusion of contract, must have been in the position to foresee such a consequence.” id. however, the court acknowledged that, had the seller been aware of this potential type of loss, such loss would have been recoverable. 73. murray, op. cit., § 121 (” these departures from the reasonable certainty requirement are explicable only on the basis that courts are simply unwilling to permit a breaching party to avoid liability solely on the basis of the plaintiff's difficulty of proving loss where it was clear at the time of formation that such loss would be impossible to prove with reasonable certainty.” ). 74. unidroit principles art. 7.4.3(2). 75. see united kingdom, chaplin v. hicks, 1911, 2 k.b. p. 786; united states, kansas city, m & o. ry. co. v. bell, tx. ct. of civil appeals, 1917, 197 s.w. p. 322; united states, wachtel v. national alfalfa journal co., iowa supreme court, 1920, 176 n.w. p. 801; see also restatement (second) on contracts § 348(3) (u.s.); murray, op. cit., § 121; simont, op. cit., p. bel-64 (belgium); nicholas, op. cit., p. 228. 14 realization of gain. in this circumstance, a breach by the promisor prevents the promisee’s chance of profit from coming to fruition.68 because a contingency must occur before profits will be realized, an aggrieved party typically is unable to prove with reasonable certainty that a profit would have been made if the contract had been properly performed. accordingly, damages for the loss of a chance or opportunity to profit ordinarily are not recoverable under article 74.69 3.16 the prohibition on damages for loss of chance or opportunity does not apply when the aggrieved party purposely enters into a contract in order to obtain a chance of earning a profit.70 in such a case, the chance of profit is an asset,71 and, when a party chooses to enter into a contract to obtain such a chance, the party is entitled to compensation when the promisor unjustifiably does not perform. otherwise, a promisor could breach that contract with impunity72 and avoid “ liability solely on the basis of the [aggrieved party's] difficulty of proving loss where it was clear at the time of formation that such loss would be impossible to prove with reasonable certainty.” 73 moreover, allowing recovery in this circumstance would be consistent with the full compensation principle of article 74. it also finds support in article 7.4.3 of the unidroit principles, which provides for recovery of damages for the loss of chance to profit.74 in addition, allowing damages for loss of chance would be consistent with the practice of a number of countries.75 b. lost profits recoverable under article 74 may include loss of profits that are expected to be incurred after the time damages are assessed by a tribunal. 3.19 under article 74, an aggrieved party is entitled to recovery of not only profits lost prior to the judgment, but also for future lost profits, to the extent that such lost profits can be proved nordic journal of commercial law issue 2006 #2 76. see schlechtriem/schwenzer/stoll/gruber, op. cit., art. 74, ¶ 22. 77. pecl art. 9:501(2)(b) cmt. f. the comment provides the following illustration: e is appointed sales manager of f’s business under a three-year service contract. she is to be paid a salary and a commission on sales. after 12 months e is wrongfully dismissed, and despite reasonable efforts to find an alternative post she is still out of work when her action for wrongful dismissal is heard six months later. e is entitled to damages not only for her accrued loss of six months salary but also for the remaining 18 months of her contract, due allowance being made for her prospects of finding another job meanwhile. she is also entitled to damages for loss of the commission she probably would have earned. id., illustration 8. 78. see u.c.c. § 2-708(2) (u.s.) (lost volume seller exception). for more information on how the lost volume seller exception operated under the u.c.c., see anderson, damages under the uniform commercial code, west, 2nd ed., 2003, § 2-708:14. 15 with reasonable certainty and subject to the principles of foreseeability and mitigation.76 while the convention does not expressly state that future losses are recoverable, its recovery is consistent with the principle of full compensation. this approach is in accord with the pecl article 9:501(2)(b) and unidroit principles article 7.4.3, which allow for recovery of future losses. in particular, the comment to article 9:501(2)(b) explains: the loss recoverable by the aggrieved party includes future loss, that is, loss expected to be incurred after the time damages are assessed. this requires the court to evaluate two uncertainties, namely the likelihood that future loss will occur and its amount. as in the case of accrued loss before judgment … this covers both prospective expenditures which would have been avoided but for the breach and gains which the aggrieved party could reasonably have been expected to make if the breach had not occurred.77 c. lost profits include those arising from lost volume sales. 3.20 under article 74, an aggrieved party may be able to recover lost profits in a lost volume situation. traditionally, when a buyer fails to uphold its obligations under the contract, the seller’s damages are measured by the difference between the contract price and the price at which the goods can be resold in the market (or the price of the substitute transaction). if the seller resells the goods at the same price, however, it is presumed that the seller suffered no damages. nevertheless, if the seller was capable of selling to multiple buyers, then the second transaction would not be a substitute for the first, but simply a second sale. therefore, damages measured under the traditional formula would be “ inadequate to put the seller in as good a position as performance would have done,” and the aggrieved party should be able to recover damages for lost sales volume.78 3.21 the following example illustrates the rationale for awarding lost profits in a lost volume situation: if a private party agrees to sell his automobile to a buyer for $2,000, a breach by the buyer would cause the seller no loss (except incidental damages, that is, the expense of a new sale) if the seller was able to sell the automobile to another buyer for $2,000. but the situation is different with dealers having an unlimited supply of standard-priced goods. thus, if an automobile dealer agrees to sell a car to a buyer at the standard price of $2,000, a breach by the buyer injures the dealer, even though he is able to sell the automobile to another for $2,000. if the dealer nordic journal of commercial law issue 2006 #2 79. united states, neri v. retail marine corp., new york court of appeals, 1972, 285 n.e.2d p. 311(quoting hawkland, sales and bulk sales, ali, 1958 ed., pp. 153-54). 80. see schlechtriem/schwenzer/stoll/gruber, op. cit., art. 75, ¶ 11. allowing an aggrieved party to recover lost profits in addition to damages already including lost profits would place that party in a better economic position than if the contract had been performed. see germany, lg münchen 6 apr. 2000, cisg-online.ch 665. 81 see korpela, article 74 of the united nations convention on contracts for the international sale of goods, § 3.3.2, pace rev. of the cisg 2004-05 (forthcoming); cf. u.c.c. § 2-710 (u.s.). under article 77, “ [a] party who relies on a breach of contract must take such measures as are reasonable in the circumstances to mitigate the loss, including loss of profit, resulting from the breach.” cisg art. 77. see generally honnold, op. cit., pp. 456-64; see also saidov, methods of limiting damages under the vienna convention for the international sale of goods, (dec. 2001), available at <http://cisgw3.law.pace.edu/cisg/biblio/saidov.html>. 8 2 s e e e . g . , a r b i t r a t i o n , i c c a r b i t r a t i o n c a s e n o . 7 5 8 5 , 1 j a n . , 1 9 9 2 c i s g o n l i n e . c h 1 0 5 ; s e e a l s o schlechtriem/schwenzer/stoll/gruber, op. cit., art. 74, ¶ 18. 83 see germany, lg landshut, 5 apr., 1995, cisg-online.ch 193; austria, vienna arbitral tribunal, 15 jun. 1994 cisgonline.ch 691; sweden, arbitration institute of the stockholm chamber of commerce case no. 107/1997, available at <http://cisgw3.law.pace.edu/cases/980107s5.html>. 84 see e.g., united states, delchi carrier s.p.a. v. rotorex corp., u.s.court of appeals (2nd circuit), 6 dec. 1995, cisg-online.ch 140. 16 has an inexhaustible supply of cars, the resale to replace the breaching buyer costs the dealer a sale, because, if the breaching buyer had performed, the dealer would have made two sales instead of one. the buyer’s breach, in such a case, depletes the dealer’s sales to the extent of one, and the measure of damages should be the dealer’s profit on one sale.79 3.22 accordingly, it is consistent with the principle of full compensation for an aggrieved party to recover lost profits for lost volume sales. however, an aggrieved party may not recover lost profits for lost volume under article 74 and, in addition, damages under article 75's substitute transaction formula because, in that circumstance, the aggrieved party would receive double recovery.80 4. the aggrieved party is entitled to additional costs reasonably incurred as a result of the breach and of measures taken to mitigate the loss. 4.1 in some circumstance a breach of contract may cause an aggrieved party to incur additional costs in attempts to avoid further loss.81 these expenses, which are sometimes referred to as incidental damages, are for loss in addition to the aggrieved party’s loss in value from being deprived of performance under the contract. while article 74 does not explicitly provide for the payment of incidental damages, an aggrieved party is entitled to recover these damages under the article’s principle of full compensation provided, among other things, that they are reasonable. 4.2 article 74 provides no exhaustive list of incidental damages that may be recoverable. in the case where a buyer rejects the goods without justification or refuses to make payment upon delivery of the goods as agreed in the contract, additional costs incurred by an aggrieved party in order to avoid greater loss may include costs incurred in storing or preserving goods.82 in the case of a breach by the seller, incidental damages may include costs incurred in storing or preserving goods that have been delivered late, or which are defective, and are to be returned to the seller,83 as well as expenses for the expedited shipment of alternative goods.84 furthermore, an aggrieved buyer may be able to recover, as incidental damages, reasonable added expenses incurred in http://cisgw3.law.pace.edu/cisg/biblio/saidov.html http://cisgw3.law.pace.edu/cases/980107s5.html nordic journal of commercial law issue 2006 #2 8 5 see, e.g., sweden, arbitration institute of the stockholm chamber of commerce case no. 107/1997, available at http://cisgw3.law.pace.edu/cases/980107s5.html; germany, bgh, 25 jun.1997, cisg-online.ch 277; see also schlechtriem/schwenzer/stoll/gruber, op. cit., art. 74, ¶ 19; korpela, op. cit. § 3.3.2; cf. u.c.c. § 2-715(1) (u.s.). 86 see united states, zapata hermanos sucesores v. hearthside baking co., u.s.court of appeals (7th circuit), 2002, 13 f.3d pp. 385, 388; flechtner/lookofsky, viva zapata! american procedure and cisg substance in a u.s. circuit court of appeal, vindobona j. int’l com. l. & arb. p. 93 (2003). under this view, as a matter of procedural law, the recovery of litigation expenses is to be determined by reference to domestic law or applicable rules for resolving the dispute. see zapata, op. cit., 313 f.3d p. 388; see also schlechtriem/schwenzer/stoll/gruber, op. cit., art. 74, ¶ 20 (“ the compensation of costs of litigation . . . is governed exclusively by the relevant lex fori.” ); but cf. schlechtriem/schwenzer/schlechtriem, op. cit., introduction, p. 7 (“ if national courts simply qualify the recoverability of litigation costs and lawyers’ fees as a procedural matter to be decided under their own lex fori, thereby circumventing article 74 and the analysis of whether such costs are a risk to be borne by any party having to litigate in the u.s., there will soon be more enclaves of domestic law, which for the deciding judge may seem self-evident and which conform to his or her convictions, formed by historic rules and precedents, but which will not be followed in other jurisdictions and, thereby, will cause an erosion of the uniformity achieved.” ). 87 see generally felemegas, the award of counsel's fees under article 74 cisg, in zapata hermanos sucesores v. hearthside baking co. (2001), available at <http://cisgw3.law.pace.edu/cisg/biblio/felemegas1.html>; zeller, interpretation of article 74 zapata hermanos v. hearthside baking where next?, 2004 nordic j. com. law 1, available at <http://www.njcl.utu.fi>. 88 see ¶ 2.5. one commentator has proposed an outcome determinative test to be applied by courts in judging whether an issue is substantive or procedural. see generally orlandi, procedural law issues and law conventions, 5 uniform l. rev. p. (2000). use of an outcome determinative test in the united states has generated much confusion, particularly with respect to the applicability of the federal rules of civil procedure in situations where it conflicts with state law. as a result, the united states supreme court eventually ruled that the outcome determinative test did not determine the validity of the federal rules of civil procedure in cases where the rules conflicted with state law. see united states, hanna v. plumer, op. cit.; see also chemerinsky, federal jurisdiction, aspen, 4th ed., 2003, p. 321 (noting that “ problem with the outcome determinative test is that virtually any rule can determine the outcome of a case” ). 89 see carruthers, the substance and procedure distinction in conflict of laws: a continuing debate in relation to damages, 53 int’l & comp. l.q. p. 691 (2004). 17 ascertaining whether the goods are in conformity with the contract insofar as a defect was actually established and notice to the other party was given.85 5. under article 74, the aggrieved party cannot recover expenses associated with litigation of the breach. 5.1 article 74 does not explicitly address the payment of attorneys’ fees and costs incurred by an aggrieved party in connection with seeking relief for the breach of contract from a third party, such as a court or arbitration tribunal (“ litigation expenses” ). some courts and commentators believe that the recovery of litigation expenses is a procedural matter outside the scope of the convention’s substantive damages provisions.86 however, other courts and commentators argue that based on article 7(1), the convention mus t be interpreted autonomously that characterizations of domestic law are irrelevant, and that recourse to domestic law should be made only as a last resort. under this view, it is argued that article 74 must be broadly interpreted in accordance with the principle of full compensation, which necessarily calls for the conclusion that an aggrieved party should be able to recover expenses associated with vindicating its rights. otherwise, the aggrieved party would remain less than whole.87 5.2 the issue of whether litigation expenses should be considered as damages for purposes of article 74 cannot be resolved through a substance/procedure distinction. whether a matter is considered substantive or procedural may vary from jurisdiction to jurisdiction and may depend on the circumstances of a particular case.88 relying upon such a distinction in this context is outdated and unproductive.89 instead, the analysis should focus on whether the payment of litigation expenses is deliberately excluded from the convention and, if not, whether the issue http://cisgw3.law.pace.edu/cases/980107s5.html http://cisgw3.law.pace.edu/cisg/biblio/felemegas1.html http://www.njcl.utu.fi nordic journal of commercial law issue 2006 #2 90 cisg art. 7(2). one commentator notes: there is strong opinion in favor of the view that the label given by domestic law is not conclusive as to whether a particular matter ... falls within the convention (honnold, uniform law, 97). the substance rather than the label or characterization of competing rule of domestic law determines whether it is displaced by the convention. in determining such questions, the tribunal, it is submitted, should be guided by the provisions of article 7, and give to the convention the widest possible application consistent with its aim as a unifier of legal rules governing the relationship between parties to an international sale. bianca/bonell/khoo, op. cit., art. 4, ¶ 3.3.5. 91 honnold, op. cit., p. 109; see also schlechtriem/schwenzer/schlechtriem, op. cit., art. 7, ¶¶ 27-29. 92 articles 45 and 61 provide equivalent remedies to both buyer and seller, respectively, following a failure of the other party to perform its obligations. see cisg arts. 45, 61; see also liu, comparsion of cisg article 45/61 remedial provisions and counterpart pecl articles 8:101 and 8:102, 2004 nordic j. com. l. pp. 1, 2 available at <http://cisgw3.law.pace.edu/cisg/text/anno-art-61.html> (discussing parallel remedies available to buyer and sellers). 93 see flechtner, recovering attorneys' fees as damages under the u.n. sales convention: a case study on the new international commercial practice and the role of case law in cisg jurisprudence, with comments on zapata hermanos sucesores, s.a. v. hearthside baking co., 22 nw. j. int’l l. & bus. pp. 121, 151 (2002); keily, how does the cookie crumble? legal costs under a uniform interpretation of the united nations convention on contracts for the international sale of goods, 2003 nordic j. com. l. 1, § 5.6, available at http://www.njcl.utu.fi; vanto, attorneys’ fees as damages in international commercial litigation, 15 pace int’l l. rev. pp. 203, 221 (2003). 94 see vanto, op. cit., p. 221; see also flechtner, op. cit., p. 151; keily, op. cit., § 6.2(b). one commentator has argued that the gap identified by the anomaly would be filled by domestic law in accordance with article 7(2). see zeller, op. cit., p. 10. this, however, would not resolve the problem as successful respondent may still not be able to recovery their litigation costs. another commentator argues that a claimant breaches a duty of loyalty when it files a breach of contract action, but the tribunal determines that the respondent was not in breach. he argues that, in such case, attorneys’ fees and costs may be awarded under the convention. see felemegas, op. cit., p. 126. this proposal, however, stems from an overly strained interpretation of the convention. neither the language nor the structure of the convention supports the imposition of liability for attorneys’ fees and costs on the claimant in such circumstance. see flechtner, op. cit., p. 152. interpreting article 74 to provide for the recovery of litigation expenses incurred by a successful claimant also may conflict with otherwise applicable procedural laws and rules that regulate the amount of attorneys’ fees that may be recovered. for example, in a number of countries, awards of attorneys’ fees are calculated pursuant to a fixed fee schedule that may result in an award amounting to less than the actual fee incurred. if article 74 were interpreted to allow for the recovery of litigation expenses, then these laws and rules presumably would be preempted by the convention because they would be inconsistent with the principle of full compensation. such preemption would, however, would result in disuniformity between the claimant and respondent. due to the anomaly discussed above, a successful respondent would be forced to recover expenses associated with litigation under domestic laws, but because of preemption such laws would not apply to successful claimants. such an unequal treatment is patently unfair and contrary to the convention. of course, one may argue that the ability to recover attorneys’ fees and costs is a substantive matter that is governed by the convention, but the determination of the amount is a procedural matter that is subject 18 may be resolved “ in conformity with the general principles on which [the convention] is based or, in the absence of such principles, in conformity with law applicable by virtue of the rules of private international law.” 90 5.3 while article 74 does not explicitly provide for the recovery of litigation expenses as damages, it does not prohibit their recovery. in addition, the history that led to the drafting of article 74 is silent on the issue. thus, the matter is not one that explicitly falls outside the convention and it is appropriate to consider whether the issue may be resolved through a liberal interpretation of article 74 or “ an analogical application of specific provisions of the convention.” 91 5.4 although article 74's principle of full compensation appears to support the view that litigation expenses should be recoverable in order to make the aggrieved party whole, such an interpretation would be contrary to the principle of equality between buyers and sellers as expressed in articles 45 and 61.92 if legal expenses were awarded as damages under article 74, an anomaly would result where only a successful claimant would be able to recover litigation expenses.93 the ability to recover damages under article 74 is grounded on a breach of contract; thus, a successful respondent will not be able to recover its legal expenses if the claimant has not committed a breach of contract.94 therefore, the purpose of awarding attorneys’ fees and costs, to make a http://cisgw3.law.pace.edu/cisg/text/anno-art-61.html http://www.njcl.utu.fi; nordic journal of commercial law issue 2006 #2 to applicable local law and rules. this distinction is highly artificial and would be contrary to the principle of full compensation and the need for uniformity, particularly because recovery of litigation expenses would vary depending on the applicable procedural law or rules. 95 other policy reasons for awarding attorneys’ fees and costs include deterrence and punishment. see reinganum/louis l. wilde, settlement, litigation, and the allocation of litigation costs, 17 rand j. econ. p. 557 (1986) (discussing the deterrence function awarding attorneys’ fees serves); wetter/priem, costs and their allocation in international commercial arbitrations, 2 am. rev. int'l arb. p. 249, 329 (1991) (arguing that courts awarded costs and fees in order to punish an unsuccessful plaintiff for bringing a false claim or to fine a losing defendant for unjustly refusing the plaintiff's right). the later is clearly not a policy to be furthered by article 74. moreover, interpreting the cisg to provide for one-way fee shifting would not serve the goals behind such a regime. one-way fee shifting statutes are typically enacted to encourage law suits in certain areas because it is in the public interest to do so or to equalize the litigation strength between the parties, particularly in suits between governments and private parties of modest means. see generally krent, explaining one-way fee shifting, 79 va. l. rev. p. 2039 (1993). claimants in cisg suits do not need one-way fee shifting as incentive to bring suit. nor do such suits as a routine matter involve claimants of modest means suing governments. thus, the purposes for construing the cisg as providing for a one-way fee shifting scheme are not compelling. 96 see keily, op. cit., § 6.2(b); see also bianca/bonell/bonell, op. cit., ¶ 2.2.1 (stating that, in interpreting the convention, “ courts are expected to take a much more liberal attitude and to look, wherever appropriate, to the underlying purposes and policies of individual provisions as well as the convention as a whole” ). 97. see schlechtriem/schwenzer/stoll/gruber, op. cit., art. 74, ¶ 21. 98. see schlechtriem/schwenzer/stoll/gruber, op. cit., art. 74, ¶ 21 (citing cases). 99. see germany, olg munchen, 28 jan. 1998, cisg-online.ch 339; germany, lg bielefeld, 2 aug., 1996. 100. see germany, bgh, 25 nov. 1998, cisg-online.ch 353. 101. see anderson, op. cit., § 11.3; schlechtriem/schwenzer/stoll/gruber, op. cit., art. 74, ¶ 21. 19 prevailing party whole for costs incurred in litigation, will not be realized in those cases where the respondent prevails.95 remedies are the core of contract law, and to interpret article 74 to create unequal recovery of damages between buyers and sellers is contrary to the design of the convention.96 however, article 74 does not preclude a court or arbitral tribunal from awarding a party its attorneys’ fees and costs when the contract provides for their payment or when authorized by applicable rules. 6. the aggrieved party is entitled to damages for pecuniary loss resulting from claims by third parties as a result of the breach of contract. 6.1 a breach of contract may not only cause an aggrieved party to suffer direct and incidental losses, but also losses from dealing with third parties. these losses are sometimes called consequential damages.97 for example, in the case of a breach by the buyer, a seller may suffer consequential damages resulting from the termination of contracts with suppliers,98 or fees resulting from a dishonored check.99 a buyer may be able to recover consequential damages when the seller delivers defective goods, the buyer resells them to third parties, and the buyer incurs liability to the third parties for defective or non-performance.100 6.2 like direct and incidental damages, these damages are subject to limitations of foreseeability and mitigation. however, these concepts may be more likely to limit the availability of consequential damages.101 nordic journal of commercial law issue 2006 #2 102. see schlechtriem/schwenzer/stoll/gruber, op. cit., art. 74, ¶ 12; blase/höttler, op. cit.; djakhongir saidov, methods of limiting damages under the vienna convention on contracts for the international sale of goods, 14 pace int’l l. rev. pp. 307, 328 (2001). but see germany, lg münchen, 30 aug. 2001, cisg-online.ch 668 (holding that damages due to loss of goodwill are not av ai la bl e under convention). commentators argue, however, that the reasoning in that case was unsound. s e e schlechtriem/schwenzer/stoll/gruber, op. cit., art. 74, ¶ 12, n.55; see also waddams, op. cit., p. 535 (noting “ no cogent reason why damages should not be given for loss of reputation in a contract case” ); mcgregor, op. cit., § 38 (same). 103. see schlechtriem/schwenzer/stoll/gruber, op. cit., art. 74, ¶ 12; but see saidov, op. cit., pp. 329-32 (arguing for category of non-material damages for injury to business reputation). 104. see france, sté calzados magnanni v. sarl shoes general international, ca grenoble, 21 oct. 1999, cisg-online.ch 574; switzerland, hg zurich, 10 feb. 1999, cisg-online.ch 488; germany, lg darmstadt, 9 may 2000, cisg-online.ch 560. 105. blasé/höttler, op. cit. 106. see unidroit principles art. 7.4.2 cmt. 5; pecl art. 9:501(2) and n.4; see also blasé/höttler, op. cit. numerous jurisdictions applying the american uniform commercial code also permit recovery of damages due to loss of goodwill. see anderson, op. cit., § 11:31. 107. commentators explain: many businesspeople think of goodwill in terms of a company’s relationship with its customers; that is, a company with good service generates goodwill among its customers. although this is an accurate interpretation of goodwill, there are several others. for example, under the so-called excess earnings method for estimating business value, a company is worth the sum of the fmv [fair market value] of its tangible assets and its goodwill. in this scenario, goodwill is calculated as the capitalized value of the company’s “ above average” earnings or rate of return. in other words, the goodwill is a reflection of the fact that the subject company is earning a return greater than the norm for investments of a similar risk. thus, goodwill in this instance is the company’s ability to earn above-normal profits. . . . the final interpretation of goodwill relates to a company’s balance sheet. gaap [generally accepted accounting principles] does not allow a company to estimate the value of its goodwill and then place this figure on the balance sheet. the historical cost principle makes such an entry impossible under gaap. however, in the case of a business acquisition, goodwill can be placed on the postacquisition balance sheet, reflecting the excess purchase price paid over the fmv of the identifiable tangible assets. in practice, this excess may be allocated to other intangible assets besides goodwill (e.g., customer base, trade name). gabehart/brinkley, the business valuation book, a.m.a., 2002, pp. 116-17. 108. see anderson, op. cit., § 11:31; saidov, op. cit., p. 330. 109. see hg zurich 10 feb. 1999, op. cit. 20 7. the aggrieved party is entitled to damages for loss of goodwill as a consequence of the breach. 7.1 pecuniary damages caused by a loss of goodwill also are, in principle, compensable under article 74.102 however, article 74 does not permit recovery of non-material loss.103 therefore, recovery of damages for loss of goodwill is available only if the aggrieved party can establish with reasonable certainty that it suffered a financial loss because of a breach of contract.104 7.2 while article 74 does not expressly provide for the recovery of loss of goodwill, such damages are permitted under the article’s principle of full compensation.105 in addition, both pecl article 9:501(2)(a) and unidroit principles article 7.4.2 allow for recovery of goodwill.106 7.3 goodwill, however, is notoriously difficult to define.107 thus, its loss is difficult to measure. loss of goodwill can simply refer to a loss of future lost profits. loss of goodwill also has been defined as a decline in business reputation or commercial image, quantified by the retention of customers. alternatively, loss of goodwill has been defined as the decrease in the value of a business interest.108 because there is no uniform definition, some tribunals have required a higher level of proof for damages resulting from a loss of goodwill. for example, in the decision of handelsgericht des kantons zurich, 10 february 1999, the commercial court stated that damages resulting from a loss of goodwill must be “ substantiated and explained concretely.” 109 in addition, in the decision of landgericht darmstadt, 9 may 2000, the district court denied damages for loss of goodwill because the buyer was unable to “ calculate the exact losses resulting nordic journal of commercial law issue 2006 #2 110. see germany, lg darmstadt, 9 may 2000, cisg-online.ch 560. 111. see ¶¶ 2.1-2.9 (discussing level of proof/certainty requirement); see also anderson, op. cit., § 11.3 (rejecting any “ stringent standard of certainty” for damages due to loss of goodwill) (quoting mccormick, handbook on the law of damages, west, 1935, p. 677; saidov, op. cit., p. 330. of course, the aggrieved party will still have to prove, among other things, that such damages were foreseeable. in fact, some have asserted that there exists a stricter foreseeability test for loss of goodwill. see schlechtriem/schwenzer/stoll/gruber, op. cit., art. 74, ¶ 46. 112. waddams, op. cit., p. 628; lg darmstadt, 9 may 2000, op. cit.; see also anderson, op. cit., § 11.3 (stating that “ lost future profits that are not attributable to an erosion of the customer base do not constitute a loss of goodwill” ). 113. see lg darmstadt, 9 may 2000, op. cit. (citing danger of double recovery). 114. id. 115. see id. 116. cf. united states, lewis river golf v. o.m. scott & sons, wash. supreme court, 1993, 845 p.2d p. 987 (awarding u.s. $664,340 in damages for breach of contract and u.s. $1,026,800 in damages for loss on subsequent sale of business, which included loss resulting from damage to its reputation or goodwill). 21 from the damaged reputation.” 110 however, the fact that goodwill may be difficult to measure should not result in a requirement of a higher level of proof to obtain such damages. indeed, requiring that damages for loss of goodwill be calculated exactly would, in many cases, place an insurmountable burden on the aggrieved party and would thwart article 74's principle of full compensation. it is consistent with article 74 that, like other damages recoverable under the article, damages for loss of goodwill may be awarded if, among other things, the aggrieved party can prove with reasonable certainty that its reputation has been damaged by the breach.111 7.4 in certain cases, the loss of goodwill may be measured by loss of profits. however, these cases present a potential for double recovery because of the overlap between goodwill damages and lost profits damages. specifically, compensation for the decrease in the value of the aggrieved party’s commercial interest may equal the compensation it would receive for the lost future profits.112 in this circumstance, the aggrieved party cannot claim damages for the loss of return customers resulting from a loss of goodwill and future lost profits.113 this situation occurred in the decision of landgericht darmstadt, 9 may 2000.114 in that case, the buyer accused the seller of delivering defective goods and refusing to pay the contract price. in a counterclaim, the buyer claimed damages resulting from a loss of turnover and a loss of business reputation. the district court explained that there was no basis for the buyer’s claim for damages for a loss of goodwill. the court stated that “ the [buyer] cannot claim a loss of turnover, on the one hand – which could be reimbursed in the form of lost profits – and then, on the other hand, try to get additional compensation for a loss of reputation.” 115 7.5 nevertheless, there may be circumstances when an aggrieved party could recover damages for a loss of goodwill and lost profits. for example, when the promisor’s breach eventually causes the promisee’s business to fail, the promisee may be able to recover, inter alia, lost profits from the date of the breach until the day the when the business failed, and then damages for the destruction of its business, the value of which may include lost profits and lost goodwill.116 nordic journal of commercial law issue 2006 #2 117. see generally farnsworth, op. cit., pp. 216, 225. 118. cisg art. 75. 119. cf. germany, olg hamburg, 28 feb. 1997, cisg-online.ch 261. 120. see schlechtriem, damages avoidance of the contract and performance interest under the cisg, festschrift apostolous georgiades, athens (forthcoming 2006); see also farnsworth, op. cit., pp. 224-27. in this situation, the aggrieved party is also entitled to any incidental and consequential damages. 121. schlechtriem, op. cit., p. 4. in calculating the amount of damages owed to the aggrieved party, the loss to the aggrieved party resulting from the breach must be offset by any gains to the aggrieved party resulting from the non-performance of the contract. professor schlechtriem notes: if the buyer liquidates the contract by claiming performance interest without avoiding the contract, he has to keep the nonconforming goods, the value of which has to be taken into account in the computation of the buyer’s total damages. if he resells the goods – even at a high discount because of their non-conformity – the proceeds have to be accounted for in the calculation of damages. likewise, if he claims performance interest because the seller was in delay in delivering the goods, but then tenders, although late, and the buyer has to take delivery, because he cannot avoid (since the delay might not amount to a fundamental breach or an additional period of time was not set), the value of the goods bought as cover, if and insofar as they can be utilized, or the proceeds from reselling them, have to be taken into account. id., p. 6. 22 8. if there has been a breach of contract and then the aggrieved party enters into a reasonable substitute transaction without first having avoided the contract, the aggrieved party may recover damages under article 74, that is, the difference between the contract price and the substitute transaction. 8.1 the aggrieved party can sometimes avoid part of its loss as a result of the breach by entering into a substitute transaction.117 if the aggrieved party avoids the contract and, within a reasonable time and a reasonable manner thereafter enters into a substitute transaction, it may recover damages under article 75 measured by the difference between the contract price and the substitute transaction together with any further damages.118 nevertheless, sometimes an aggrieved party may, either under a duty to mitigate or as a precautionary measure, or both, enter into a substitute transaction after a breach but before avoiding the contract. in this circumstance, the aggrieved party should be able to calculate damages using the same method for recovering damages under article 75.119 that is, when the aggrieved party enters into a substitute transaction without first having avoided the contract, the aggrieved party may recover as damages under article 74 the difference between the contract price and the substitute transaction, provided that such transaction is reasonable.120 the rationale for this approach has been explained as follows: [a] buyer who has received non-conforming goods, the non-conformity not amounting to a fundamental breach of contract allowing avoidance, must be allowed to conclude a cover purchase in order to continue with his production and/or perform his contracts with his clients. despite the absence of avoidance and, therefore, the inapplicability of article 75 of the cisg, the buyer must be allowed to calculate its damages on the basis of the costs of the cover transaction.121 nordic journal of commercial law issue 2006 #2 122. schlechtriem/schwenzer/stoll/gruber, op. cit., art. 74, ¶ 32. 123. see farnsworth, op. cit., § 12.9; treitel, op. cit., §§ 149-50; see also pecl art. 9:502 n.4 (citing numerous cases and authorities). 124. unidroit principles art. 7.4.2. 125. id., cmt. 3. 126. pecl: art. 9:502 cmt c. 23 9. damages must not place the aggrieved party in a better position than it would have enjoyed if the contract had been properly performed. a. in calculating the amount of damages owed to the aggrieved party, the loss to the aggrieved party resulting from the breach is to be offset, in principle, by any gains to the aggrieved party resulting from the non-performance of the contract. 9.1 in some cases, a breach may provide monetary benefits to an aggrieved party by allowing it to avoid some loss or save expenses that it would otherwise have incurred. in that event, the compensable loss suffered by the aggrieved party as a result of the breach is to be offset by the benefits that the aggrieved party received because of the non-performance of the agreement. as commentators point out, “ however, advantages gained are not to be taken into account if there is no adequate connection with the loss and are related to the injured party’s own expenditure (e.g., insurance); it would be contrary to the principle of good faith (article 6(1)) for the liable party to be exempted by them.” 122 9.2 this approach is consistent with the practice in most countries,123 as well as with the unidroit principles and the pecl. the unidroit principles article 7.4.2 states that account must be taken of “ any gain to the aggrieved party resulting from its avoidance of cost or harm.” 124 the comment to that article explains that the purpose of this language is to ensure that an aggrieved party is not enriched by damages for non-performance. accordingly, “ account must be taken of any gain resulting to the aggrieved party from non-performance, whether that be in the form of expenses which it had not incurred (e.g., it does not have to pay the cost of a hotel room for an artist who fails to appear), or of a loss which it had avoided (e.g., in the event of the nonperformance of what would have been a losing bargain for it).” 125 9.3 by contrast, the pecl does not explicitly state that any loss to the aggrieved party must be offset by any gain resulting from the breach. however, the comment to pecl article 9:502 states: the aggrieved party must bring into account in reduction of damages any compensating gains which offset its loss; only the balance, the net loss, is recoverable. similarly, in computing gains of which the aggrieved party has been deprived, the cost it would have incurred in making those gains is a compensating saving which must be deducted to produce a net gain. compensating gains typically arise as the result of a cover transaction concluded by the aggrieved party. but it is for the non-performing party to show that the transaction generating the gains was indeed a substitute transaction, as opposed to a transaction concluded independently of the default. a compensating saving occurs where the future performance from which the aggrieved party has been discharged as the result of the non-performance would have involved the aggrieved party in expenditure.126 nordic journal of commercial law issue 2006 #2 127. secretariat commentary, op. cit., art. 70 [draft counterpart to cisg art. 74], ¶ 5. 128. for a comparative study of punitive damages, see gotanda, punitive damages: a comparative analysis, 42 colum. j. transnat’l l. p. 391 (2004). the prohibition on punitive damages does not, in principal, apply to claims for liquidated damages. 129. cisg art. 74. 130. id. 24 9.4 the secretariat commentary provides the following illustrations of the appropriate measure of damages under article 74: example [a]: the contract provided for the sale for $50,000 fob of 100 machine tools which were to be manufactured by the seller. buyer repudiated the contract prior to the commencement of manufacture of the tools. if the contract had been performed, seller would have had total costs of $45,000 of which $40,000 would have represented costs incurred only because of the existence of this contract (e.g., materials, energy, labour hired for the contract or paid by the unit of production) and $5,000 would have represented an allocation to this contract of the overhead of the firm (cost of borrowed capital, general administrative expense, depreciation of plant and equipment). because buyer repudiated to [the] contract, seller did not expend the $40,000 in costs which would have been incurred by reason of the existence of this contract. however, the $5,000 of overhead which were allocated to this contract were for expenses of the business which were not dependent on the existence of the contract. therefore, those expenses could not be reduced and, unless the seller has made other contracts which have used his entire productive capacity during the period of time in question, as a result of buyer's breach seller has lost the allocation of $5,000 to overhead which he would have received if the contract had been performed. thus, the loss for which buyer is liable in this example is $10,000. contract price $50,000 [less] expenses of performance which could be saved $40,000 [equals] loss arising out of breach $10,000. example [b]: if, prior to buyer's repudiation of the contract in example [a], seller had already incurred $15,000 in non-recoverable expenses in part performance of the contract, the total damages would equal $25,000. example [c]: if the product of the part performance in example [b] could be sold as salvage to a third party for $5,000, seller's loss would be reduced to $20,000.127 b. punitive damages may not be awarded under article 74 of the convention. 9.5 the convention does not provide for the payment of punitive damages. punitive damages, also called exemplary damages, are sums awarded in excess of any compensatory or nominal damages in order to punish a party for outrageous misconduct.128 such damages may not be awarded under article 74 because it limits damages to “ a sum equal to the loss, including loss of profit, suffered by the other party as a consequence of the breach.” 129 furthermore, awarding punitive damages is precluded under the convention even if domestic law permits them for breach of contract because the convention does not provide for their payment.130 however, nordic journal of commercial law issue 2006 #2 131. see enderlein/maskow/knapp, op. cit., p. 544. it should be noted that an award of punitive damages may violate an applicable mandatory rule of law. in such case, the award or the portion of the awarding punitive damages may be invalid or unenforceable. see generally gotanda, awarding punitive damages in international commercial arbitration in the wake of mastrobuono v. shearson lehman hutton, inc., 38 harv. int’l l.j. p. 59 (1997). 25 parties may agree to allow a court or tribunal to award punitive damages, to the extent permitted under applicable law.131 cisg advisory council opinion no. 6: annex (case overview) country/ arbitration court / tribunal date docket no. cisgonline no. details arbitral ad hoc 15 march 1963 case name: sapphire international petroleums ltd. v. national iranian oil co. • the tribunal stated that damages for breach of contract are based on full compensation for economic loss. • reprinted in 35 i.l.r. 136 (1967). arbitral icc 1 jan. 1992 case no. 7585 105 • the tribunal awarded damages to seller for storage costs of machinery for production line of foamed boards. • case abstract and commentary: http://cisgw3.law.pace.edu/cases/927585i1.html arbitral arbitration institute of the stockholm chamber of commerce 13 july 1993 interim award of 17 july 1992 and final award of 13 july 1993 • the tribunal held the chinese battery manufacturer liable for damages, because the loss of profit experienced by the swedish buyer was foreseeable and a fair representation of prospective earnings during the relevant time period. • reprinted in pertinent part in xxii y.b. com. arb. (1997). arbitral tribunal (russia) icac 21 apr. 1994 61/1993 • the tribunal denied exchange rate damages, because changes in currency rates were the creditor’s “ domestic affair.” • reprinted in pertinent part in saidov, op. cit., p. 44 n.197 http://cisgw3.law.pace.edu/cases/940421r1.html arbitral icc 1995 final award in case no. 8362 of 1995 • in this non-cisg case, the tribunal held that when calculating damages, the following “ counterbalancing factors” are considered: while there must be a sound basis for calculation, the breaching party cannot escape liability simply because the amount of damages cannot be determined. • reprinted in pertinent part in xxii y.b. com. arb. 164, 177 (1997). http://cisgw3.law.pace.edu/cases/927585i1.html http://cisgw3.law.pace.edu/cases/940421r1.html nordic journal of commercial law issue 2006 #2 26 arbitral icc 1996 final award in case no. 78445 of 1996 • the tribunal held the indian manufacturer met its burden of providing reasonable proof of its lost profits, because the claimant only has to provide a “ reasonable estimate of the loss, based on such elements as are available” and not prove them with absolute certainty. • reprinted in xxvi y.b. com. arb. 167, 175 (2001) arbitral icc 23 jan. 1997 8611/hv/j k 236 • the tribunal ruled that the question concerning the extent the aggrieved party has to prove that they suffered damages is a procedural matter beyond the scope of the convention. • case text, abstract, and commentary: http://cisgw3.law.pace.edu/cases/978611i1.html arbitral arbitration institute of the stockholm chamber of commerce 1997 case no. 107/1997 • the tribunal held the seller’s goods did not conform to the contract and awarded the buyer foreseeable damages including, the cost of storing and preserving goods, the cost of freight, insurance, and duties associated with delivery to customers. • case text, abstract, and commentary: http://cisgw3.law.pace.edu/cases/980107s5.html arbitral ad hoc 4 may 1999 case name: himpurna california energy ltd. v. p.t. (persero) perusahaan listruik negara final award of 4 may 1999 • the tribunal stated that if damages were limited to what the aggrieved party has spent in reliance on the contract, the breaching party would have an incentive to breach when the contract is no longer in their financial interest. • reprinted in xxv y.b. com. arb. 13, 83-84 (2000). arbitral tribunal (russia) icac 27 july 1999 302/1996 779 • the tribunal ruled that the russian seller had failed to give the swedish buyer notice of avoidance of the contract within a reasonable time after the seller knew or should have known the relevant facts. • case text, abstract, and commentary: http://cisgw3.law.pace.edu/cases/990727r1.html austria vienna arbitral tribunal 15 june 1994 sch-4366 691 • the court awarded damages to buyer for cost of storing rolled metal sheets before resale. http://cisgw3.law.pace.edu/cases/940615a3.html austria ogh 14 jan. 2002 7 ob 301/01t 643 • the court held that the buyer was entitled to recover losses as a result of the seller’s nonperformance, including loss of foreseeable profits and the cost of repairing the defective goods. however, since the seller’s contract excluded consequential damages, the buyer could not recover other damages it suffered in relation to its contract with another consumer. • case text, abstract, and commentary: http://cisgw3.law.pace.edu/cases/020114a3.html canada supreme court of canada 1979 case name: asamera oil corp. v. sea oil & general corp • the court awarded damages for the failure to return shares of asamera stock based on the “ highest intermediate value of the stock between the time of its conversion and a reasonable time after the owner” had notice to replace it. p. 662 avoidable losses are not recoverable. • citation: 1 s.c.r. 633 http://cisgw3.law.pace.edu/cases/978611i1.html http://cisgw3.law.pace.edu/cases/980107s5.html http://cisgw3.law.pace.edu/cases/990727r1.html http://cisgw3.law.pace.edu/cases/940615a3.html http://cisgw3.law.pace.edu/cases/020114a3.html nordic journal of commercial law issue 2006 #2 27 canada ontario court 16 dec. 1998 case name: nova tool and mold inc. v. london industries inc. 97-gd41311 windsor 572 • the court held that the buyer was entitled to damages for the measures undertaken to place the buyer in the position it would have been in if the seller had performed the contract, i.e. the extra costs incurred by changing producers and “ graining” the molds. • case text, abstract, and commentary: http://cisgw3.law.pace.edu/cases/981216c4.html finland helsinki court of appeals 26 oct. 2000 s 00/82 1078 • in a case where, the seller wrongfully refused to deliver a product the buyer had not previously been in the business of selling, the court, in estimating the buyer’s damage as a result of the seller’s breach, held that the buyer’s sales goal could not be used as basis for estimating lost profits. • case text, abstract, and commentary: http://cisgw3.law.pace.edu/cases/001026f5.html france ca grenoble 21 oct. 1999 case name: sté calzados magnanni v. sarl shoes general international 96j/00101 574 • the court held that the french buyer was, in principle, entitled to damages resulting from the spanish seller’s breach of contract and that the buyer could recover its loss of commercial reputation only if it could prove that such loss resulted in monetary damages. • case text, abstract, and commentary: http://cisgw3.law.pace.edu/cases/991021f1.html germany lg heidelberg 27 jan. 1981 o 116/81 • the court ruled that the seller bears the risk of suffering exchange rate damages based on “ financial nominalism” [ulis precedent]. the court held that since the contract did not evidence an agreement to the contrary, the nominal value of the sum stated was definitive and the seller could not claim damages from the buyer based on currency fluctuation. • case text, abstract, and commentary: http://cisgw3.law.pace.edu/cases/810127g1.html germany olg düsseldorf 14 jan. 1994 17 u 146/93 119 • the court awarded damages for exchange rate losses under article 74. exchange rate damages are available when the aggrieved party can show that if it had received payment when due it would have obtained a higher value by converting the money into its local currency. • case text, abstract, and commentary: http://cisgw3.law.pace.edu/cases/940114g1.html germany lg landshut 5 apr. 1995 54 o 644/94 193 • the court awarded buyer damages for costs incurred in storing and returning defective sports clothing • case text, abstract, and commentary: http://cisgw3.law.pace.edu/cases/950405g1.html germany ag muchen 23 june 1995 271 c 18968/94 368 • the court ruled that the aggrieved party is entitled to recover the costs of measures undertaken to place it in the same position it would have been had the contract been properly performed. thus, the aggrieved party was compensated for repairing defective goods. • case text, abstract, and commentary: http://cisgw3.law.pace.edu/cases/950623g1.html germany lg trier 12 oct. 1995 7 ho 78/95 160 • the court ruled that nonperformance loss is calculated by taking the difference between the value to the aggrieved party of the expected performance and the value to the aggrieved party of what, if anything, was actually received. • case text, abstract, and commentary: http://cisgw3.law.pace.edu/cases/951012g1.html http://cisgw3.law.pace.edu/cases/981216c4.html http://cisgw3.law.pace.edu/cases/001026f5.html http://cisgw3.law.pace.edu/cases/991021f1.html http://cisgw3.law.pace.edu/cases/810127g1.html http://cisgw3.law.pace.edu/cases/940114g1.html http://cisgw3.law.pace.edu/cases/950405g1.html http://cisgw3.law.pace.edu/cases/950623g1.html http://cisgw3.law.pace.edu/cases/951012g1.html nordic journal of commercial law issue 2006 #2 28 germany lg bielefeld 2 aug. 1996 12 o 120/95 • the court awarded seller costs of dishonored checks. • case text, abstract, and commentary: http://cisgw3.law.pace.edu/cases/960802g1.html germany olg köln 8 jan. 1997 27 u 58/96 217 • the seller of tanning machines did not return, by the agreed upon date, machines that it had taken back to adjust. the buyer then hired a third party to treat its leather goods. the court ruled that, under article 74, the buyer was entitled to recover the sum paid to the third party because the hiring of that party was viewed as reasonable under the circumstance. • case text, abstract, and commentary: http://cisgw3.law.pace.edu/cases/970108g1.html germany olg hamburg 28 feb. 1997 1 u 167/95 261 • the court awarded damages using the formula set forth in article 75 even though there had been no avoidance of contract. • case text, abstract, and commentary: http://cisgw3.law.pace.edu/cases/970228g1.html germany bgh 25 june 1997 viii zr 300/96 277 • the court ruled that damages can be awarded for assessment of damage to the goods • case text, abstract, and commentary: http://cisgw3.law.pace.edu/cases/970625g2.html germany olg munchen 28 jan. 1998 7 u 3771/97 339 • the court awarded seller “ protest fees” incurred in trying to cash buyer’s check. • case text, abstract, and commentary: http://cisgw3.law.pace.edu/cases/980128g1.html germany bgh 25 nov. 1998 viii zr 259/97 353 • the court stated that “ [t]he seller’s liability includes the consequential damages that the buyer suffered through reimbursement to her customer for the damages caused by the foil non-conformity.” • case text, abstract, and commentary: http://cisgw3.law.pace.edu/cases/981125g1.html germany lg münchen 6 apr. 2000 12 hko 4174/99 665 • the court denied the buyer’s claim for lost profits on the grounds that awarding damages to buyer based on substitute transaction formula under article 75 made the buyer whole. • case text, abstract, and commentary: http://cisgw3.law.pace.edu/cases/000406g1.html germany lg darmstadt 9 may 2000 10 o 72/00 560 • the court ruled that damages due to loss of goodwill are available only if financial loss is established. • case text, abstract, and commentary: http://cisgw3.law.pace.edu/cases/000509g1.html germany lg münchen 30 aug. 2001 12 hko 5593/01 668 • the court held that damages due to loss of goodwill are not available under convention. • case text, abstract, and commentary: http://cisgw3.law.pace.edu/cases/010830g1.html italy district court pavia 29 dec. 1999 case name: tessile v. ixela 678 • losses resulting from declining exchange rates are generally regarded as not being compensable. according to the court, ordinary currency devaluation is intended to be compensated through the awarding of interest. the tribunal denied the right to recover losses due to monetary devaluation where currency of agreement was also creditor’s local currency. • case text, abstract, and commentary: http://cisgw3.law.pace.edu/cases/991229i3.html http://cisgw3.law.pace.edu/cases/960802g1.html http://cisgw3.law.pace.edu/cases/970108g1.html http://cisgw3.law.pace.edu/cases/970228g1.html http://cisgw3.law.pace.edu/cases/970625g2.html http://cisgw3.law.pace.edu/cases/980128g1.html http://cisgw3.law.pace.edu/cases/981125g1.html http://cisgw3.law.pace.edu/cases/000406g1.html http://cisgw3.law.pace.edu/cases/000509g1.html http://cisgw3.law.pace.edu/cases/010830g1.html http://cisgw3.law.pace.edu/cases/991229i3.html nordic journal of commercial law issue 2006 #2 29 netherland s district court roermond 6 may 1993 case name: gruppo imar v. protech horst 920159 454 • the tribunal awarded damages for exchange rate losses under article 74. • case text, abstract, and commentary: http://cisgw3.law.pace.edu/cases/930506n1.html new zealand court of appeal, wellington 14 august 1981 case name: isaac naylor & sons ltd. v. new zealand cooperative wool marketing • the court awarded damages for exchange rate losses. • citation: 1 n.z.l.r. 361 switzerland (arbitral award). hg zurich 31 may 1996 zhk 273/95 • case text, abstract, and commentary: http://cisgw3.law.pace.edu/cases/960531s1.html switzerland hg zurich 5 feb. 1997 hg 95 0347 327 • the court awarded damages for exchange rate losses under article 74. • case text, abstract, and commentary: http://cisgw3.law.pace.edu/cases/970205s1.html switzerland bezirksgerich t der saane 20 feb. 1997 t 171/95 426 • the court ruled that thequestion of to what extent the aggrieved party has to prove that they suffered damages is a procedural matter beyond the scope of the convention. • case text, abstract, and commentary: http://cisgw3.law.pace.edu/cases/97022s1.html switzerland hg zürich 10 feb., 1999 hg 970238.1 488 • the court denied the recoverability of damages under article 74 for the loss of chance. • case text, abstract, and commentary: http://cisgw3.law.pace.edu/cases/990210s1.html switzerland hg st. gallen 3 dec. 2002 case name: dt ltd. v. b. ag hg.1999.8 2-hgk 727 • the court awarded damages for exchange rate losses under article 74. a creditor is entitled to claim damages for any suffered exchange rate loss due to the breach. she may claim the amount calculated on the more favorable exchange rate at maturity. when a creditor of a foreign currency debt usually conducts its business in a different currency, presumably such a party would immediately convert the foreign currency and therefore be entitled to the value determined by the exchange rate at maturity of the obligation. • case text, abstract, and commentary: http://cisgw3.law.pace.edu/cases/021203s1.html united kingdom court of appeal 1911 case name: chaplin v. hicks • the court ruled that an aggrieved party could recover damages for loss of chance to win a beauty pageant, because such damages should have been within the contemplation of the parties at the time the contract was formed. • citation: 2 k.b. 786 united kingdom court of appeal 1976 case name: milliangos v. george frank (textiles) ltd. • the court awarded damages for exchange rate losses. • citation: 1976 a.c. 443, 465 http://cisgw3.law.pace.edu/cases/930506n1.html http://cisgw3.law.pace.edu/cases/960531s1.html http://cisgw3.law.pace.edu/cases/970205s1.html http://cisgw3.law.pace.edu/cases/97022s1.html http://cisgw3.law.pace.edu/cases/990210s1.html http://cisgw3.law.pace.edu/cases/021203s1.html nordic journal of commercial law issue 2006 #2 30 united states tx. ct. of civil appeals 1917 case name: kansas city, m & o. ry. co. v. bell • the court held that damages for loss of chance are special damages that are only recoverable if the contracting parties are aware of these potential damages at the time the contract is made. • citation: 197 s.w. 322 united states iowa supreme court 1920 case name: wachtel v. national alfalfa journal co. • the court held damages for loss of chance were recoverable by a person actively participating in a sales contest that was unexpectedly cancelled, because both parties could have anticipated such damages at the time the contract was made. • citation: 176 n.w. 801 united states texas supreme court 1938 case name: southwest battery corp. v. owen et al. • since the plaintiff failed to promptly meet the defendants’ car battery needs, the court awarded the plaintiff the difference between money owed and defendants’ lost profits, holding that the party in breach cannot escape liability simply because it is impossible for the aggrieved party to precisely calculate his damages. • citation: 115 s.w.2d 1097 united states cal. court of appeals 1942 case name: oakland california towel co. v. sivils • as a result of the defendant’s breach of the linen supply contract, the court awarded the plaintiff the difference between what payments would have accrued if the contract were completed, less the expenses plaintiff would have incurred by performance. the court held that overhead costs are fixed costs that were unaffected by non-performance of the contract, and thus, not deducted from the plaintiff’s damages. • citation: 126 p.2d 651 united states california supreme court 1955 case name: california lettuce growers v. union sugar co. • the court stated that, even though the aggrieved party has the burden of proving damages, such damages need not be plead with mathematical precision. • citation: 289 p.2d 785 united states california court of appeals 1958 case name: edwards v. container kraft & paper supply co. • the court held that the plaintiff, whose former employer enjoined him from building a competitive business, could recover for loss of prospective profits for an unestablished business, because the occurrence and extent of such damages were established with reasonable certainty. the court noted that an aggrieved party can establish the extent of damages through the use of expert testimony, economic and financial data, market surveys and analyses, or business records of similar enterprises. • citation: 327 p.2d 622 united states united states court of claims 1960 case name: locke v. united states • the court held that where the loss of chance for profit is not outweighed by risk of loss and where the aggrieved party can prove calculable damages with reasonable certainty, the court should value those lost opportunity damages. • citation: 283 f.2d 521 nordic journal of commercial law issue 2006 #2 31 united states united states supreme court 1965 case name: hanna v. plumer • the u.s. supreme court abandoned the substanceprocedure distinction for determining the validity of a federal rule of civil procedure where it may conflict with a state law because such test was unworkable. • citation: 380 u.s. 460 united states ny court of appeals 1972 case name: neri v. retail marine corp. • the court held that, although the breaching buyers are entitled to recover their deposit, this amount must be offset by the seller’s loss of profit on the sale and incidental damages. • citation: 285 n.e.2d 311 united states kansas supreme court 1979 case name: butler v. westgate state bank • the court held that an aggrieved party could establish the extent of damages through the use of expert testimony, economic and financial data, market surveys and analyses, or business records of similar enterprises. • citation: 596 p.2d 156 united states nebraska supreme court 1979 case name: alliance tractor & implement co. v. lukens tool & die co. • the court affirmed plaintiff’s award of damages from machine manufacturer, because the evidence “ was sufficient to furnish a reasonable certain factual basis for the computation of probable losses” of this relatively new business. • citation: 281 n.w.2d 778, 782. united states us court of appeals (5th cir.) 1986 case name: bagwell coatings v. middle s. energy • a fireproofing contractor on a nuclear power station was awarded damages when the defendant breached a contract provision regarding access, because the court held that plaintiff proved to a reasonable certainty that a loss was sustained or will be sustained even though the exact amount of the loss was unknown. • citation: 797 f.2d 1298 united states nevada supreme court 1986 case name: houston exploration, inc. v. meredith • the court held that the plaintiff’s expert testimony should have been admitted at trial in order proffer an evidenciary basis for lost profits of a new business enabling the jury to weigh the testimony and reasonably ascertain the losses. • citation: 728 p.2d 437 united states supreme court of alabama 1987 case name: super valu stores, inc. v. peterson • the court held that the inability of the aggrieved party to precisely calculate one’s damages does not enable the breaching party who caused the damage to escape liability. therefore, the risk of uncertainty of the jury’s calculation must fall on the breaching party. • citation: 506 so. 2d 317, 330 united states wash. supreme court 1993 case name: lewis river golf v. o.m. scott & sons • the court held that expert testimony assessing plaintiff’s loss of business goodwill was not too speculative; therefore, the plaintiff buyer was entitled to damages for loss of profits and for loss of business reputation that resulted from weeds in the seller’s seed supply. • citation: 845 p.2d 987 nordic journal of commercial law issue 2006 #2 32 united states us court of appeals (7th cir.) 1996 case name: mid-america tablewares, inc. v. mogi trading co • the court held the plaintiff was entitled to damages for lost profits, because the defendant contractor could have anticipated them and bore the risk of uncertainty in establishing damages as the breaching party. • citation: 100 f.3d 1353 united states us court of appeals (2nd cir.) 6 december 1995 case name: delchi carrier spa v. rotorex corp. 95-7182, 95-7186 140 • the question of to what extent the aggrieved party has to prove that they suffered damages is a procedural matter beyond the scope of the convention. damages only need to be proved with reasonable certainty. the aggrieved party is entitled to recover the costs of measures undertaken to place it in the same position it would have been had the contract been properly performed. • citation: 71 f.3d 1024 • case text, abstract, and commentary: http://cisgw3.law.pace.edu/cases/951206u1.html united states united states supreme court 1998 case name: sun oil co. v. wortman • “ except at the extremes, the terms ‘substance’ and ‘procedure’ precisely describe very little except dichotomy, and what they mean in a particular context is largely determined by the purposes for which the dichotomy is drawn.” • citation: 486 u.s. 717 united states us court of appeals (7th cir.) 2002 case name: zapata hermanos sucesores v. hearthside baking co. • the court held that issues concerning the awarding of attorneys’ fees and costs were to be resolved under domestic procedural law and not under cisg article 74. • citation: 13 f.3d 385, 388 • case text, abstract, and commentary: http://cisgw3.law.pace.edu/cases/021119u1.html united states us court of appeals (4th cir.) 21 june 2002 case name: schmitz-werke v. rockland 625 • in a case involving the cisg, the court applied maryland law to resolve the exchange rate issue. • citation: 37 fed.appx. 687 • case text, abstract, and commentary: http://cisgw3.law.pace.edu/cases/020621u1.html united states us district court, southern district of new york 12 august 2006 case name: teevee toons, inc. (d/b/a tvt records) & steve gottlieb, inc. (d/b/a biobox) v. gerhard schubert gmbh 00 civ. 5189 (rcc) • the court denied the defendant’s summary judgment motion with respect to tvt’s claims under cisg article 74 for funds paid for the schubert system, its labor and service, administration of the biobox project, and lost profits, because tvt is entitled to seek damages equal to losses resulting from the breach that were foreseeable at the time the contract was created. • case text, abstract, and commentary: http://cisgw3.law.pace.edu/cases/060823u1.html http://cisgw3.law.pace.edu/cases/951206u1.html http://cisgw3.law.pace.edu/cases/021119u1.html http://cisgw3.law.pace.edu/cases/020621u1.html http://cisgw3.law.pace.edu/cases/060823u1.html lakiteksti1_lop.pmd nordic journal of commercial law, issue 2004 #1 1 non-implementation of wto dispute settlement decisions and liability actions mervi pere nordic journal of commercial law issue 2004 #1 nordic journal of commercial law, issue 2004 #1 2 1. introduction 1.1. non-implementation of wto dispute settlement decisions and liability actions the world trade organization was established in 1995 and the european community and its member states became thereby bound by an over whelming number of international obligations in the field of international trade. the entering into force of the wto agreements has been followed by a f lood of cases to the european court of justice where the applicants have attempted to challenge community law provisions on the basis of the international obligations imposed on the community by virtue of the provisions of the wto agreements and the decisions made in the framework of the wto dispute settlement mechanism. the case law of the ecj concerning the effect of wto law in the community legal order has been characterised by ‘judicial self-restraint’ and deference to the discretion of the political and executive institutions of the community. as a general rule, the possibility of private parties to challenge community measures on the basis of wto law has been ruled out. under some circumstances wto provisions, however, may become available to private parties. the reluctance of the court to let private parties to rely on wto law may, however, sometimes lead to situations the acceptability of which can be questioned from the point of view of effective judicial protection of the rights of individuals. the transatlantic disputes concerning the banana import regime of the ec and the community’s ban on importation of beef from cattle treated with hormones are notorious. the wto dispute settlement organs condemned the community measures in the bananas1 and hormones2 cases but the ec failed to amend its legislation to comply with wto law. as an european, one might to sympathise with the ec for protecting the health of its citizens and refusing to lift the ban on importation of hormone-treated meat. there is, however, more at stake than the respect of international commitments. the non-compliance by the community also causes damage to private businesses operating within the community. most tangibly the consequences of the community’s wto-illegal behaviour have affected the community businesses that have suffered heavy losses in face of the retaliator y measures resorted to by the united states under the authorisation of the w to dispute settlement body (dsb). article 288(2) ec provides that in the case of non-contractual liability, the community shall be held liable for the damage caused by its institutions or by its servants in the performance of their duties. recently, several actions for damages under this article have been brought by private parties in order to claim compensation for the damage they have suffered due to the wto-illegal behaviour of the community. these cases are connected to the non-implementation of the international obligations imposed on the community in the bananas and hormones cases by the w to dispute settlement organs. only a few of the cases have led to a judgement so far, and these are the first cases dealing with the issue of whether private entities can invoke wto law in the context of actions for damages. these cases and their chances of success are the main subject of this article. the court has rejected all the actions it has dealt with so far and the chances of success of the future actions do not seem very high. first, we are dealing with wto law and the court has been ver y reluctant to let private parties to rely on it. second, it has been extremely rare that actions for damages under article 288(2) ec have succeeded. the problem is, however, worth discussing. first of all, an advocate general recently suggested that individuals should be allowed to rely on wto law in liability actions under some circumstances where non-implementation by the community of dsb decisions is involved3. the ecj did not explicitly accept or reject such a suggestion but the question nordic journal of commercial law, issue 2004 #1 3 remains an open one. moreover, there have recently been some signs of relaxation of the extremely strict criteria for community liability. 1.2. focus and structure the relationship between the wto and the european community is a complicated issue, as was already the relationship between the predecessor of wto, gatt 1947, and the ec. at the international level the ec, as all the other signatories, is bound by the wto agreements according to the rules of public international law. the effect of wto law at the national level is, however, to be determined by the legal orders of each member (state) of the organisation. in general terms this article concentrates on the relationship of the two organisations from the point of view of how the effect wto law has been seen and determined in the ec legal order. more specifically, the article will focus on the issue whether private parties can invoke wto dispute settlement decisions in liability actions. the jurisprudence of the european courts concerning the possibility of private parties to challenge community law provisions on the basis of wto law and the effect of the case law on liability actions will be in the centre of the attention. of particular importanc for the purposes of this article are the cases involving w to dispute settlement decisions. it is also necessary to examine the rules governing the non-contractual liability of the community to some extent. this will be done mainly to explain what requirements those rules set on the rule to be relied on in a liability action and whether the wto law provisions can fulfil such requirements. there are three general conditions that have to be met in order for the community to incur liability: unlawfulness of the conduct of the institutions, the existence of damage and a causal link between the first two. as the fulfilment of the two latter conditions may depend significantly on the circumstances of an individual case, they will be only briefly described in order to give a full picture of the conditions of liability but remain otherwise outside the scope of this study. the condition of unlawfulness will be given more attention, especially as to what requirements they set on the nature of the rule breached. the applicants that have brought liability actions and claimed compensation for the damage they have suffered due to the non-implementation by the community of wto dispute settlement decisions have also relied on fundamental principles of community law as a foundation for their actions. such pleas will, however, mainly remain outside the scope of the article as it concentrates on invocation of w to law. the main purpose of the article is to assess the problem whether, and under what circumstances, can private parties benefit from wto dispute settlement outcomes in liability actions that involve nonimplementation by the community of a ruling or recommendation made by the wto dispute settlement body. to be able to examine this problem properly, it is necessary to first shed some light on the position of individual in respect to wto law in the community legal order and assess how private parties may benefit from the wto law in general. second, and more importantly, it will be analysed if, and how, the means available to invoke wto can be used by individuals to enforce adopted wto panel and appellate body reports in case the ec does not comply with them. the analysis thereby also attempts to shed some light on the level of judicial protection of the individual in the european community legal order with regard to wto law and wto dispute settlement decisions in particular. the aim is to find out whether a “judicial deficit” exists in the community system for the protection of individuals in case of adopted wto panel and appellate body reports and whether there is a need for the nordic journal of commercial law, issue 2004 #1 4 remedy under article 288(2) ec as one of its functions of which has considered to be to compensate for such a “judicial deficit”. the parts 2 and 3 also describe and explain the rather special characteristics of the jurisprudence of the ecj relating to the general lack of justiciability of wto law. in order to assess the chances of success of liability actions brought by private parties against the community institutions to get compensated for the loss they have suffered due to the non-implementation by the ec of wto dispute settlement findings, it is necessary to assess how these decisions have been treated by the court and what arguments have been brought up. some attention will be given to the underlying reasons for the stance taken by the court but the purpose of this paper is not to go very deep into the discussion of the reasons in political-economic level. part 4 discusses some relevant characteristics of the action for damages under article 288 (2) ec. it attempts to give a general over view to the position of the form of action in the community system of judicial protection and takes into account the recent developments in the case law. the conditions for bringing a successful liability action will be described briefly in order to get a full picture of the requirements to be fulfilled. it is necessary to describe the general characteristics of the action in order to illuminate what is at issue in the actions for damages brought due to the non-implementation of dsb decisions by the community and how such actions differ from actions for annulment. part 5 presents the most important cases that deal with the issue of whether private parties may rely on w to law in the context of liability actions and involve non-implementation by the community of dsb decisions given in bananas and hormones cases. particularly important are the recent biret cases4 and they will be given particular attention. part 6 deals the issue of invocation of wto law in actions for damages in more detail. it discusses how the general rules developed in the actions under art. 230 and art. 234 ec affect liability actions. first it is determined, whether it is necessary for a provision of international law to be directly effective to be invoked in a liability action. the second issue is whether private parties can benefit from the nakajima doctrine in liability actions in case of non-implementation of dsb decisions. the third issue relates to the biret cases, which could be interpreted to imply that private parties might be allowed to rely on dsb decision in actions for damages under some circumstances. such a potential effect of dsb decisions will be discussed in light of the reasoning on which the court has based its stance to the effect of wto law. of great importance to this discussion is the opinion of advocate general in biret. part 7 makes some observations on whether the applicant can establish the unlawfulness of the behaviour of the community institutions in a case where the dsb has confirmed the wto-nonconformity of community action as the criteria for community liability require. first, it will be discussed whether the condition that the rule of law relied on is intended to confer rights on individuals can be met when a wto rule is invoked. this condition is crucial for the purposes of this article. second, it will be discussed the main aspects that have to be taken into account in establishing that the breach has been sufficiently serious for the purposes of a liability action. this is important mainly to understand whether unlawfulness could be established when the community institutions have failed to implement a wto dispute settlement decision. 1.3. method and sources the article is based on the analysis of the case law of the european court of justice and the court of first instance and on the interpretations presented by commentators of that jurisprudence. most nordic journal of commercial law, issue 2004 #1 5 important cases dealt with are the ones establishing the rules on the relationship between the wto law and the community legal order on the one hand, and the ones determining the conditions of the non-contractual liability of the community on the other. in the centre of the focus are the cases, which deal with both issues. particular attention is given to the recent biret case and to the opinion of advocate general alber preceding the judgement of the ecj in that case. the relationship between the wto and the eu is a controversial issue, which is well illustrated by the occasionally peculiar, and most certainly debatable case law of the ecj. it has provoked intense discussion and an abundance of articles. most helpful in f leshing out how private parties can rely on wto law in community courts has been a recent and comprehensive article by snyder5. the present author will attempt to use other articles in such a way that the main lines of reasoning are taken into account. by contrast, the potential liability of the community for infringements of its international agreements has been a neglected issue in the literature. the liability of the ec for non-implementation of dsb decisions has been discussed by zonnekeyn6 and reinisch7 and also briefly by peers8 and davies9, and these articles provide for the main guidance of the analysis. several articles and books concerning the conditions of community (also member state) liability in general will be used to obtain a more profound picture of the problem10. 2. wto agreements and the individual in the ec legal order 2.1. the status of international agreements in the ec legal order the eu’s constituent treaties lack provisions clearly stating the relationship between international law and community law. article 300(7) ec provides that international agreements of the community “shall be binding on the institutions of the community and on member states.” as to the effects of international law in the community legal order, the treaties remain silent. neither are there provisions on how international law should enter the ec legal order, or of possible review of legality in the light of international law.11 in the absence of legislative guidance, it has been up to the european court of justice to determine the relationship between international and community law. one of the basic rules developed in the jurisprudence of the ecj relates to the hierarchical position of the international agreements of the community. on one hand, the provisions of international agreements should be compatible with the founding treaties. on the other hand, they are superior to the secondar y legislation of the community12. infringement of the international obligations of the community is thus, in principle, one of the possible grounds for finding acts of the institutions invalid. moreover, international agreements concluded under article 300 ec have been considered as acts of institutions. their provisions form “an integral part of community law” from the moment of their coming into force13. when an international agreement of the community becomes a part of community law, it also is touched by the unique features of the system. thereby it can be attributed with direct effect if certain conditions are met14. in the kupferberg case the court ruled that a provision of a free trade agreement with portugal was directly effective, since the provision was unconditional, sufficiently precise, and its direct application was within the purpose of the agreement15. if direct effect is established, the agreements become enforceable also at the domestic level, and not only at a purely international level, and individuals become able to invoke the provisions of such treaties before national and community courts.16 2.2. routes of action private parties may attempt to challenge community law provisions on the basis of wto law mainly in three ways. first, private parties are non-priviledged applicants in an action for annulment pronordic journal of commercial law, issue 2004 #1 6 vided in article 230 ec. the conditions for admissibility have been difficult to fulfil and the situation remains the same also in the light of the recent case law17. second form of action available is the action for damages under article 288(2) ec. liability actions for a breach of wto law, based in particular on the rulings made in the context of wto dispute settlement mechanism, have lately increased in number. the third and a common route has been an indirect action. private parties can initiate proceedings in national courts and claim that national or community measure are incompatible with w to law. the domestic court may, or in some occasions must, then make a referral to the ecj. 2.3. exclusion of ‘direct effect’ of wto agreements 2.3.1. ‘legalisation’ of the gatt/wto system ever since the international fruit company case18 decided in 1972 the court has been reluctant to let individuals to rely on gatt/wto law. in that case the ecj held that the gatt 1947 agreement was not directly effective and upheld its case law firmly during the existence of the old system. the establishment of the wto and the new gatt 1994 provoked many scholars to argue that the premise on which the gatt was held to lack direct effect could no longer exist due to the significant ‘legalisation’ of the system19. the main argument of the court regarding the old gatt was that the dispute settlement provisions were characterised by a great degree of flexibility. the w to agreements certainly are a significant upgrade of the old gatt system, with several new extensions.20 first and foremost, the dispute settlement system was dramatically reformed and virtually turned into a (quasi-)judicial procedure21. 2.3.2. portugal v. council the portugal v. council case22 was an action for annulment under article 230 ec introduced by portugal against a 1996 council decision23 on the conclusion of agreements between the community and india and pakistan concerning the arrangements in the area of market access for textile products. the portuguese government alleged that the implementation of these agreements adversely affected its textile industry and claimed that the contested decision constituted a breach of wto law, in particular of certain rules and fundamental principles of gatt 1994, the agreement on textiles and clothing and the agreement on import licensing procedures. the ecj decided in its judgement in 1999 to uphold its old gatt 1947 case law and refused to review community law in light of wto obligations. it came into a firm conclusion that “having regard to their nature and structure, the wto agreements are not in principle among the rules in the light of which the court is to review the legality of measures adopted by the community institutions24.” it is notable that the court did not explicitly use the term direct effect in its final conclusion. neither were the arguments of portugal based on the claim that the wto agreements had direct effect. instead, it tried to distinguish the whole question of direct effect from its assertion that member states should be allowed to assert wto law as a basis for evaluating the validity of community law.25 although the procedure concerned a direct action brought by a member state, it is clear that the reasoning of the ecj was so fundamental that the position it took can be applied in all relevant procedures. the same rules are applied when individuals challenge ec law in actions for annulment or when they bring an action to national courts relying on w to law and the domestic court refers the case to the ecj26. it is now utterly clear that the main rule is that the wto agreements cannot nordic journal of commercial law, issue 2004 #1 7 be relied on by individuals to review the legality of the acts of the european community in national or in community courts. the jurisprudence of the court concerning gatt/wto law has, on occasion, been harshly criticised by commentators partly on the basis that it differs significantly from how other international agreements have been dealt with in the case law. why is the court so reluctant as regards recognising the direct effect of wto agreements? are there sound (legal) reasons for such reluctance?27 the court based its judgement in portugal partly on new arguments as the uruguay round agreements had done away with many of the arguments relied on by the court to deny direct effect to gatt provisions. it underlined the nature of the wto as a forum for intergovernmental negotiation between its members, and that the wto agreements themselves did not determine how they should be implemented but let this to be determined according to the national legal orders of its members. 2.4. why are wto agreements not justiciable? 2.4.1. wto agreements do not determine how they should be implemented the court began in portugal by indicating that it was only where an international agreement did not itself settle what effects it has in the internal legal order of the contracting parties that such effects would fall to be decided by national courts. the uruguay round negotiations did not result in any explicit provision on the effect of wto agreements in the domestic legal orders of the contracting parties. the court needed thus to examine whether the wto agreements otherwise determine how they should be implemented on the national (or community) level. it found that, even though the agreements differ significantly from the provisions of gatt 1947, “in particular by reason of the strengthening of the system of safeguards and the mechanism for resolving disputes, the system resulting from those agreements nevertheless accords considerable importance to negotiations between the parties28.” the ecj then went on to examine the nature of the wto dispute settlement mechanism and found that, although the main purpose of the mechanism is to secure the withdrawal of the measures in question if they are found to be inconsistent with wto rules, the w to dispute settlement understanding (dsu) provides that where the immediate withdrawal of the measures is impracticable compensation may be granted on an interim basis29. next it concluded that the dsu provides that when a member fails to fulfil its obligation to implement the rulings, the dsb shall, if so requested, enter into negotiations, with a view to finding a mutually acceptable compensation30. consequently, the court reached the conclusion that “to require the judicial organs to refrain from applying the rules of domestic law which are inconsistent with the wto agreements would have the consequence of depriving the legislative or executive organs of the contracting parties of the possibility afforded by article 22 of that memorandum of entering into negotiated arrangements even on a temporary basis31.” as a result, the ecj found that the wto agreements do not determine the appropriate legal means of ensuring that they are applied in good faith in the legal order of the contracting parties32. 2.4.2. lack of reciprocity next, the ecj turned to the community legal order and assessed whether it provides grounds for using wto agreements as a basis for judicial review of community acts. it refused the possibility of such a review relying on the lack of reciprocity on the part of the community’s trading partners in the performance of the agreements. according to the court, wto agreements are based on reciprocal and mutually advantageous arrangements, and the lack of reciprocity in their implementation might lead to disuniform application of the w to rules33. moreover, if the community judicature were to ensure that community law complies with w to rules, it would “deprive the legislative or nordic journal of commercial law, issue 2004 #1 8 executive organs of the community of the scope for manoeuvre enjoyed by their counterparts in the community’s trading partners34.” if the ecj had opened the door for actions brought by private parties invoking the wto law it would have bound the community far more strongly to the w to agreements than is the case in its main trading partners. such a strengthened enforceability as the empowerment of individuals would lead to would be more than the community is required to do under public international law. the reciprocity argument is undoubtedly political in nature but, nevertheless, rather convincing. if the community judiciar y tied the hands of the political and executive institutions by allowing direct effect to wto law the ec could end up in a disadvantageous position. the benefits of its legal system could be exploited by others while the ec, and the exporters of ec goods, would be faced with the limited enforceability in domestic courts of other contracting parties. this could also limit the “bargaining power” of the community and put it in a more difficult external position.35 2.4.3. institutional balance the ecj rejected the request of portugal essentially because a legal review by the court of wto agreements would bind the legislative and executive organs of the community so that they would no longer enjoy similar room for manoeuvre as similar bodies of the community’s major trading partners36. reciprocity is the cornerstone of the judgement but, in the end, it is not reciprocity as such which leads the court to deny direct effect to w to law. instead, it is the constitutional concern of the impact of potential direct effect on the political institutions of the union.37 the court is clearly willing to leave a considerable amount of discretion to the political organs of the union with regard to wto law. the ‘judicial self-restraint’ exercised by the court is based on the premise that the legislative and executive institutions should have the dominant roles in the field of foreign policy38. empowering private actors (and also courts at the same time) in the enforcement of wto law by allowing individuals to rely on the agreements would deprive the legislative and executive organs of the community of a considerable part of the discretion they would otherwise enjoy. there is thus an apparent conf lict between foreign policy discretion and the judicial protection of the ‘rights’ that international law might confer to individuals39. the court has been criticised for its concern of tying the hands of the eu’s legislative and executive institutions. it allegedly went so far that the respect for the principle of trias politica can hardly be traced in the judgement40. perhaps the reluctance of the court to interfere with the political institutions of the union can be seen as overt judicial policy-making but, as eeckhout suggests, the large discretion the court had in the case could only be filled through judicial policy-making41. considerations of a level playing field in external relations, have been claimed to be especially crucial concerning the eu since it is one of the major powers, and therefore bears a lot of global responsibility42. by denying direct effect to wto agreements, the eu reserves itself a chance to take into account non-economic values in its actions to a wider extent than it could if a categorically monist approach to wto norms would have been accepted. it is clear that the w to as it is now concentrates clearly on trade issues. human rights, labour and environmental issues, on the other hand, have been taken into consideration in a rather modest way, at least compared to the eu, although it is clear that such an extremely comprehensive trade regime inevitably has effects on those concerns.43 thus, by limiting the enforceability of the wto law on the national level, the ec reserves itself the right to take those values, or public interest, into account44. the interpretation of the court corresponds with the explicitly stated will of the council expressed nordic journal of commercial law, issue 2004 #1 9 in the preamble of its decision concluding the wto agreement. it declared as follows: “by its nature, the agreement establishing the world trade organisation, including the annexes thereto, is not susceptible to being directly invoked in community or member state courts”45. advocate general saggio doubted the legal relevance of the statement at the community level46. he concluded that it is the responsibility of the judiciary to ensure that the international obligations of the community are respected by the institutions and the member states and the council may not by an act of secondary legislation limit the court’s jurisdiction. thus, the preambular statement is, according to saggio, simply a policy statement and cannot affect the jurisdiction of the community or national courts to interpret and apply the wto agreements.47 the court stated that it found its interpretation to correspond with what was stated in the preamble to the council decision on the effect of the agreements. the court was rather careful though, and did not rely on the wording of the statement as a decisive factor for its conclusion but merely stated that its conclusion corresponds with it, which still leaves the significance of the council declaration debatable.48 it appears to be in any case more relevant in the court’s view than many would argue. 2.4.4. the nature of the w to agreement the ecj pointed out in portugal that the wto agreement is founded “on the principle of negotiations with a view to entering into reciprocal and mutually advantageous arrangements and is thus distinguished, from the point of view of the community, from the agreements concluded between the community and non-member countries which introduce a certain asymmetry of obligations, or create special relations of integration with the community49.” by this statement the court attempted to distinguish the w to agreements from other community agreements, to which significantly different rules seem to apply. the ec’s bilateral agreements have concerned trading partners with which the ec traditionally has close ties with, such as parties to association agreements50 or parties to the yaound– convention51. in contrast to the wto agreements, the parties to such agreements were in a weaker bargaining position than the community, so that the ec has the economic and political means of encouraging compliance. often in the case of the agreements in question it has also been an intention of the community to create specific rights and advantages for the other party. 52 even though there are features that characterise the international agreements that have been considered directly effective that distinguish them from the multilateral wto agreements, the reasoning of the court is not difficult to criticise53. for instance eeckhout finds it the least convincing part of the judgement54. the legal reasoning of the ecj may be poor but the scope importance of the new organisation is undoubtedly enormous. the uruguay round agreements, indeed, are fundamentally different from the other international agreements of the community. they brought enormous subject areas of national economic regulation under gatt/wto discipline and subjected the whole to a new and far more binding dispute resolution system55. the agenda of the wto is also expanding and unpredictable, especially since the decision-making power of the wto panels and appellate body are relatively autonomous56. the agreements therefore require a complex balance of powers among the community institutions57. 2.5. nakajima doctrine 2.5.1. establishment and reconfirmation of the doctrine the application of the nakajima doctrine involves a situation where a provision lacking direct effect becomes applicable for other reasons58. the exceptional situations where the wto law has been nordic journal of commercial law, issue 2004 #1 10 allowed a stronger enforceability in ec law were introduced in the fediol59 and nakajima60 cases. the continued relevance of the doctrine after the establishment of the wto was confirmed in portugal. there the exception to the general rule that the court does not review the lawfulness of community measures in the light of wto rules was defined in the following terms: “it is only where the community intended to implement a particular obligation assumed in the context of the w to, or where the community measure refers expressly to the precise provisions of the wto agreements, that it is for the court to review the legality of the community measure in question in the light of the wto rules61.” the first limb of the exception deals with a situation where the community has intended to implement a particular obligation deriving from wto law. this type of effect of the gatt/wto law was introduced by the court in the nakajima case, which concerned anti-dumping measures62. the claim was that the community’s basic anti-dumping legislation did not comply with the rules of the gatt anti-dumping code. its purpose was to get individual anti-dumping measures annulled as unlawful and inapplicable pursuant to article 241 ec. the ecj did not consider direct effect relevant in the case but held that the community was under an obligation to ensure compliance with the gatt provisions and its implementing measures. therefore it could review the latter in the light of their parent measure.63 private parties are also allowed to challenge community measures on the basis of wto law where the implementation measure explicitly refers to a precise wto law provision. this second limb of the exception derives from the fediol case. the case concerned the so-called new commercial policy instrument by virtue of which companies could bring complaints to the commission alleging that third countries engaged in illicit commercial practices incompatible with gatt rules. the ecj ruled that such companies are entitled to request the court to exercise its powers of review over the legality of the respective commission decisions in light of the gatt rules64. even though the court has frequently recognised the nakajima principle, they have tended to avoid applying it by their interpretation of wto law65. it is of great importance to note that the ecj recently strengthened the principle in petrotub66 where it applied the principle to a council regulation imposing definitive anti-dumping duties. the case is an example of the application of the first limb of the exception. the court found that the community adopted the concerned basic regulation in order to satisfy its obligations arising from the 1994 anti-dumping code and intended to implement particular obligations laid down in it. consequently, it was for the court to review the legality of the regulation imposing definitive anti-dumping duties in the light of those particular obligations of the gatt anti-dumping code.67 most striking and unusual element of the case is that the ecj, indeed, found that there was an inconsistency between the community measure and the wto provision and, consequently, annulled the regulation. 2.5.2. scope of application the scope of application of the nakajima doctrine is not entirely clear. when does an intention to implement a particular obligation undertaken in the framework of the wto exist? could the community institutions prevent the application of the exception by simply keeping in mind not to explicitly refer to the international obligation in community legislation? there are two approaches to the nakajima doctrine, which give somewhat different answers to these questions. according to the first approach, even under the first limb of the exception the source of the particular obligation must be identified with reference to the relevant wto agreement or the dispute nordic journal of commercial law, issue 2004 #1 11 settlement report68. in this view the second limb would apply where reference is made to a precise provision in an agreement, or to precise findings made in a report. this view, arguably, finds support in the nakajima and petrotub cases as the court ruled in both cases that there was an “intention to implement” because there was a reference to the gatt anti-dumping code in the preamble of the basic anti-dumping regulation69. this approach means that the scope for application of the doctrine can be controlled by preambular language and is thus within the discretion of the institutions.70 the second approach is more receptive towards the principle. it suggests that the nakajima exception may apply when the intent to implement can be determined from the context of the adoption of a measure. consequently, there may be cases of intention to implement even where there is no reference to a particular wto provision71. this is supported by the fact that the court consistently refers to two distinct implementation exceptions72. zonnekeyn advocates for this view and suggests that a rational reading of nakajima reveals that the ecj used a contextual and teleological approach in the case. consequently, an omission to refer to a particular wto law obligation in a community act would not suffice to prevent the application of the exception.73 the case italy v. council supports this approach since there the intention to implement was determined from the context of the adoption of a measure74. moreover, the requirement of an express referral would appear to conflict also with the case law on the duty to state reasons of the institutions75. in my view, it cannot be ruled out that the court could in the future apply the exception in the absence of a referral to a particular obligation under wto law. even though such referral has been involved in nakajima and petrotub, it cannot be concluded that the ecj has limited its own discretion in this regard and excluded the possibility of judicial review in the absence of such a referral. the first approach clearly fully respects the discretion of the political institutions, which appears to be a crucial element in the application of the exception. however, the institutions probably could also prevent the doctrine as it is considered in the second approach from applying by avoiding all reference to wto law.76 the discussion described above shows that a reformulation of the nakajima doctrine would be welcome to clarify under which circumstances it can be applied. in addition to the ambivalence of the formulation “intended to implement”, the exact meaning of “a particular obligation assumed in the context of the w to” remains unclear and would require a more precise definition. moreover, at its present form, referring to obligations “the community intended to implement” the formulation seems to emphasise the intentions of the community institutions rather than any legal obligations that might be involved77. the last consideration might, though, correspond to the level of judicial deference the court has been willing to show to the political institutions of the community. the nakajima case law78 can be seen to reflect the way the court is seeking a balance between sovereign international discretion for the ec on one hand and judicial control and private interests on the other79. the doctrine only applies where the court is certain that the community institutions have legislated in order to transpose an international obligation into community law. making wto law available to private applicants under these exceptional circumstances does thus not limit the margin of discretion the court has been willing to leave to the political organs of the community. the task of assessing whether the international obligation has been correctly and completely transposed should, however, be considered to be within the remit of the court.80 the application of the nakajima doctrine by the court has, until recently, been minimalist. the reconfirmation of the doctrine in petrotub might imply, though, that the importance of the exception is increasing and the ecj is pointing the way for private parties to rely on it when they challenge community measures on the basis of wto law. such direction of the case law would be preferable nordic journal of commercial law, issue 2004 #1 12 as the doctrine offers a possibility for the court to develop its case law to a more justifiable direction. 2.6. other exceptional ways to rely on wto rules 2.6.1. consistent interpretation while the nakajima doctrine deals with a clear conflict between community law and wto law, the principle of consistent interpretation offers a less drastic approach. it sets the obligation to interpret community law, as far as possible, in the light of the obligations arising from international agreements binding on the community. the obligation derives from the primacy of international agreements concluded by the community over provisions of secondary community legislation. the ecj has acknowledged that the wto law forms a part of community law for the purposes of this principle and the obligation of wto law consistent interpretation is thus well established as regards interpretation of provisions of community law81. more recently, the obligation has been extended to cover also interpretation of national law in the light of the w to law. in hermes international82, a case concerning trips, the ecj set an obligation for the domestic courts to interpret national rules “in the light of the wording and purpose” of nondirectly effective provisions of international agreements. thus, such provisions should operate in the same way as in the case of non-directly effective directives.83 consistent interpretation means that the interpretation of national or community law should be adapted to the international obligations of the community irrespective of whether the obligation has direct effect or not. as known from the context of indirect effect of directives, in certain circumstances the results of direct and indirect effect may very well be similar84. even though indirect effect is far less efficient in creating legal certainty than direct effect, it provides for an important way to enforce wto law if applied effectively. the importance of consistent interpretation is, however, limited. the relevant ec or national legislation to be interpreted must, first of all, exist. if a provision exists, it must be sufficiently flexible to be interpreted. the obligation does not apply if there is a manifest conflict between wto law and the provisions to be interpreted.85 moreover, the ecj has not usually been inclined to apply the principle of consistent interpretation in cases involving challenges by private applicants to the validity of community measures, which are allegedly contrary to international obligations. on the contrary, it has been more typical for the court to use the obligation to require member states and their courts to follow or give effect to international obligations.86 the issue of institutional balance arises again here. a possible explanation for the selective use of the principle can be found in the reluctance of the court to interfere where the institutions have not considered that there is a conf lict between the international obligations and community law87. 2.6.2. recent evolutions the ecj appears to be willing to improve the enforceability of wto law under certain circumstances. this is illustrated well by the statements it made in the biotechnology case88. the case involved an action brought by the netherlands for the annulment of a directive on the legal protection of biotechnological inventions89. the applicant pleaded, inter alia, that the obligations created by the directive for member states are in breach of the trips agreement. the ecj interpreted the plea as being a complaint by a member state that the directive required them to breach their own obligations under wto law90. it did not, however, find that the directive created any such obligations on the member states. what is remarkable is that, as the court will nordic journal of commercial law, issue 2004 #1 13 refuse to review compatibility in the case of a direct breach by the community of its own obligations, it will now review compatibility in case of an indirect breach which results in the member states having to depart from their international obligations91. it is questionable whether there is a tenable distinction between a provision resulting in direct or indirect breach92. in dior/tuk93 the ecj opened the door for individuals to rely directly on any provision of wto law in shared competence areas within fields in respect of which the ec had not yet legislated when the legal system of a member state allows for such a direct effect94. however, as the community extends its legislative activities to areas of shared competence the opening of possible direct effect will be closed again95. the obligation of domestic courts to closely co-operate with the community courts probably renders the possibility of national courts giving direct effect to a specific wto provision rather remote anyhow, as the reasoning on the basis of which the ecj has concluded that w to agreements have no direct effect concerns the most essential aspects of the agreements96. 2.7. level of protection of individuals there are major conflicts of interests involved as regards the effect of wto law in the ec legal order. on one hand, there is a clash between the rights of private parties and the discretion given to the political bodies of the community. on the other hand, promoting trade and non-economic values do not always go hand in hand97. the margin of manoeuvre left to the institutions appears to be crucial in balancing these interests. limited enforceability allows the institutions a wide discretion in transposing wto obligations into community legal order and thereby allows it to take into account non-economic interests. the exceptions make wto law available to private parties once the institutions have clearly signalled the intention to implement wto law within the community legal order. they are limited in their import and subject to a restricted interpretation. the position of the ecj with regard to the lack of direct effect of wto agreements appears to be wise at least in terms of political economy98. the exceptional ways to rely on wto law appear to be a fair attempt to strike a balance between the conflicting interests involved. they make wto law available also for individuals and may prove nearly as effective as direct effect in integrating wto law in ec law. which areas of wto law remain closed to individuals as a matter of ec law? the areas of exclusive competence of the community cover gatt in total and parts of gats and trips and much of these areas fall under the nakajima exception. as regards the shared competence areas of trips, they are said to be under “a shadow of indirect effect”. consequently, any parts of gatt and the parts of gats and trips within community competence, concerning which ec legislation does not refer to w to provisions or transpose them into ec law cannot be invoked by individuals in the community courts. the same applies to the shared competence areas of gats99. some are not, on the other hand, pleased with the situation. one commentator claims that the ec is left almost without judicial control in the area of international trade100. it should, however, be born in mind that the community will usually bear harsh economic consequences of its allegedly protectionist acts on the international law level after such measures have been condemned by the wto dispute settlement organs. the lack of direct effect of w to law does not imply that the ecj has given the community institution permission to breach wto law. the central problem related to this work is that individual undertakings may suffer heavily of wtoillegal action of the institutions condemned at the international level by the wto dispute settlement organs and the continued exercise of judicial self-restraint might deprive them of any possibility nordic journal of commercial law, issue 2004 #1 14 to have their rights enforced. it has been argued that the ecj should strengthen the legal effects of the findings of the wto dispute settlement organs, as greater legal effects are the minimum requirement from the perspective of the principle of legality101. at the same time that for instance snyder argues in favour of “an appropriate balancing of constitutional values” that the exceptional ways to rely on wto law may prove nearly as effective as direct effect in integrating wto law in ec law, she admits that there is a major gap in community law as regards adopted wto dispute settlement reports102. 3. wto dispute settlement decisions in the ec legal order 3.1. the status of rulings of judicial bodies set by an international agreement the ecj has confirmed that the ec may enter into an international agreement whereby a judicial entity is established if the structure and jurisdiction of such entity is compatible with the ec treaty103. the court made a statement on judicial systems for the settlement of disputes and on the relationship of such systems with the community law in opinion 1/91 on the eea agreement, in which it examined the compatibility of the proposed eea court system with the community law. in principle, the compatibility of a system of courts flows from the general competence and capacity of the community to act in international level, or as the ecj phrased it: “the community’s competence in the field of external relations and its capacity to conclude international agreements necessarily entails the power to submit to the decisions of a court which is created or designated by such an agreement as regards the interpretation and application of its provisions.”104 if an agreement to which the community is a party establishes a judicial organ to settle disputes between the community and other parties to the agreement, the decisions of that organ will bind the ecj if the latter is required to rule on the meaning of the agreement as part of the community legal order105. however, the ecj has established in its opinion that the member states and the community institutions should ensure that the pre-eminent role of the ecj under the treaties will not be prejudiced.106 it set up certain conditions under which it is bound by another court: “where, however, an international agreement provides for its own system of courts, including a court with jurisdiction to settle disputes between the contracting parties to the agreement, and, as a result, to interpret its provisions, the decisions of that court will be binding on the community institutions, including the court of justice. those decisions will also be binding in the event that the court of justice is called upon to rule on, by way of preliminary ruling or in direct action, on the interpretation of an international agreement, in so far as the agreement is an integral part of the community legal order”107. by saying that, the ecj emphasised the binding character of judicial decisions on disputes between the contracting parties to an agreement108. moreover, as the ecj assumed the eea agreement not to be directly effective, it implicitly established that the agreement in question itself does not need to have direct effect for the purposes of binding character of judicial decisions on disputes between contracting parties to an international agreement.109 procedurally the wto dispute settlement system offers similarly strong checks and balances and procedural guarantees as the project of a common eea court did110. the case law of the ecj in opinion 1/91 has been considered to indicate that the court should accept binding interpretations of wto law made by the dispute settlement organs in cases brought before it111. nordic journal of commercial law, issue 2004 #1 15 3.2. legal obligation to implement dsb rulings and recommendations 3.2.1. general the legally binding nature of the outcomes of wto dispute settlement at the level of international law should be separated from their effect in the community legal order. the former aspect, i.e. whether the community is bound by the decisions, will be analysed in the light of the rules of public international law and the agreement in question. thus, one should firstly have a look at the wording of the dsu in order to define the nature of the obligation set on a wto member state as a result of dispute settlement proceedings. the new mechanism for the settlement of disputes established as a result of the uruguay round negotiations has been claimed to entail a significant ‘legalisation’ of the system compared to dispute settlement under gatt 1947112. at present, the wto dispute settlement is a compulsory and binding system with stringent deadlines. under the old system a consensus in favour of a report of a panel or appellate body was required for its adoption, which meant that a dissatisfied party could block consensus and prevent adoption of the report. the dsu reversed the requirement and provides that the reports are adopted unless there is a consensus not to adopt them.113 the shift from “positive consensus” requirement to that of “negative consensus” along with the establishment of a standing appellate body composed of independent experts are the main features of the new system that have persuaded many to emphasise its judicial character. by contrast, in the system under gatt 1947 commercial policy played a significantly more important role114. 3.2.2. relevant provisions article 3 dsu provides that a solution mutually acceptable to the parties to the dispute consistent with the covered agreements is clearly to be preferred. in the absence of such a solution, “the first objective of the dispute settlement mechanism is usually to secure the withdrawal of the measures concerned”. only if the immediate withdrawal of the measure is impracticable compensation should be resorted to as a temporary measure pending the withdrawal of the measure which is inconsistent with a covered agreement. the last resort is the possibility of suspending the application of concessions or other obligations under the covered agreements on a discriminatory basis vis-a-vis the other member, subject to authorisation by the dsb of such measure. article 21 (3) dsu states that “if it is impracticable to comply immediately with the recommendations and rulings, the member concerned shall have a reasonable period of time to do so.” if there are no implementing measures by the end of the reasonable period article 22 (1) dsu provides that compensation and the suspension of concessions or other obligations are temporary measures available. however, “neither compensation nor the suspension of concessions or other obligations is preferred to full implementation of a recommendation to bring a measure into conformity with the covered agreements.” according to article 22 (2) dsu the member concerned should after a reasonable period of time has lapsed, if so requested, enter into negotiations with a view to developing mutually acceptable compensation. if no satisfactory compensation has been agreed on time, the other party to the dispute may request authorisation from the dsb to suspend the application of concessions. as to the nature of the retaliatory measures, article 22 (8) dsu provides that the “suspension of nordic journal of commercial law, issue 2004 #1 16 concessions or other obligations shall be temporary and shall only be applied until such time as the measure found to be inconsistent with a covered agreement has been removed, or the member that must implement recommendations or rulings provides a solution to the nullification or impairment of benefits, or a mutually satisfactory solution is reached.” the dsb shall “continue to keep under surveillance the implementation of adopted recommendations or rulings, including those cases where compensation has been provided or concessions or other obligations have been suspended but the recommendations to bring a measure into conformity with the covered agreements have not been implemented.” 3.2.3. nature of the obligation there is some ongoing debate as regards the nature of the legal obligation of wto members under the w to dispute settlement. the main disagreement concerns the question whether implementation of rulings and recommendations and compensation, or even acceptance of retaliation, can be considered as separate options. in other words, does the international law obligation deriving from a dispute settlement report give the option either to compensate with trade or other measures, or alternatively to fulfil the ruling or recommendation of the report and bring its practices or law into consistency with the wto law?115 one interpretation,116 presented by jackson, is that “an adopted dispute settlement report establishes an international law obligation upon the member in question to change its practice to make it consistent with the rules of the w to agreement and its annexes. in this view, the “compensation” (or retaliation) approach is only a fallback in the event of noncompliance”117. zonnekeyn represents the same line of reasoning and states that: “by accepting compensation, the respondent member in a dispute, in se, recognises the binding effect of wto law since it acknowledges that its legislation or other measures are in breach of wto law. the compensation mechanism was not meant to give wto members complete freedom to leave wto inconsistent measures in place and does not, as a matter of principle, accord a “right” to violate a legal obligation entered into under an international agreement.”118 moreover, “compensation is not a method of settling disputes but simply a temporary instrument to ensure that any benefits accruing to the other members are not nullified or impaired as a result of the failure to comply within the reasonable period of time set in the particular case and that the defaulting party is not encouraged to persist indefinitely in its failure to comply”119. an opposite view is that the wto rules are not “binding” in the traditional sense but rely, instead, upon voluntary compliance120. non-compliance with international legal obligations is seen as a traditional option for ‘realpolitik’ by governments based on cost-benefit analysis121. it was phrased by bello as follows: “like the gatt rules that preceded them, the wto rules are simply not “binding” in the traditional sense. when a panel established under the wto dispute settlement understanding issues a ruling adverse to a member, there is no prospect of incarceration, injunctive relief, damages for harm inf licted or police enforcement. the wto has no jailhouse, no bail bondsmen, no blue helmets, no truncheons or tear gas. rather, the wto – essentially a confederation of sovereign national governments – relies upon voluntary compliance. the genius of the gatt/wto system is the f lexibility with which it accommodates the national exercise of sovereignty, yet promotes compliance with its trade rules through incentives.” 122 a textual analysis of the dsu shows that the language is ambiguous enough to give support to each nordic journal of commercial law, issue 2004 #1 17 of the competing views123. the present authors are inclined to find the argumentation of the advocates of the former approach more convincing as one of main objectives of the wto is to create a stable and predictable multilateral trading system124. considering compliance to be voluntary would seriously undermine such features of the system. the possibility afforded by the dsu to maintain the condemned measures for a temporary period after the ruling is important, as such flexibility is crucial in cases where important socio-economic and political considerations are involved125. however, the dsu does not provide for a possibility to maintain wto-illegal measures permanently. in the end, there is a ‘real’ obligation to comply. 3.3. non-compliance with dsb rulings and recommendations in actions for annulment 3.3.1. case law as regards the effect of the wto dispute settlement outcomes in the ec legal order, some authors have argued that at some point the denial of direct effect should recede before the principle of legality. it has been suggested that adopted wto dispute settlement results is where the line should be drawn, and it should be possible to review the legality of ec measures in light of them126. the ecj has, however, not yet been persuaded by such line of reasoning. on the contrary, the characteristics of the wto dispute settlement appears to be one of the main reasons why the ecj and the cfi have refused to accord direct effect to wto agreements. the conclusion drawn by the ecj in portugal from the article 22(1) and (2) dsu was that “to require the judicial organs to refrain from applying the rules of domestic law which are inconsistent with the wto agreements would have the consequence of depriving the legislative or executive organs of the contracting parties of the possibility afforded by article 22 of that memorandum of entering into negotiated arrangements even on a temporary basis”127. the margin of manoeuvre and importance of negotiations referred to in the case were most likely brought up by the court bearing in mind in particular the implementation phase of dsb rulings and recommendations. the view that even adopted dsb decisions do not create an absolute and immediate obligation of compliance clearly was a reason for the denial of the direct effect of the wto agreements128. there was no dsb decision connected to the portugal case and no such ruling or recommendation was invoked. therefore, it is necessary to examine how this specific issue has been dealt with elsewhere in the case law. the chemnitz129 case involved an action for annulment of a commission decision addressed to the applicant rejecting a request for additional import licence under the transitional measures provided for in council regulation 404/93130 on the common organisation of the market in bananas. the applicant based its action, among other grounds, on the allegation that an adopted appellate body report had declared the overall system of licences for the importation of third-country bananas incompatible with gatt. it submitted that decisions of the dsb are mandator y and might have direct effect in community law. the cfi rejected the argument on the basis that the commission had adopted amendments to the regulation, and thus acted to bring the arrangements into compliance with the ab report and the decision of the dsb131. the rather striking element in the judgement is that there was not even any discussion of the possibility that the modification of the regulation might have failed to achieve compliance132. the cfi also found that the applicant had not established a link in law between the dsb decision and the action for annulment. it held that “in order for a provision in a decision to have direct effect on a person other than the addressee, that provision must impose on the addressee an unconditional and sufficiently clear and precise obligation vis-ƒ-vis the person concerned.” consequently, as the applicant did not put forward any arguments to show that these conditions were met, the court found no need to consider whether dsb decisions have ‘direct effect’ or not133. the nordic journal of commercial law, issue 2004 #1 18 application of such a requirement renders the possibility of private parties to rely on dsb decisions in actions for annulment in any event rather remote. also in comafrica134 the applicant invoked a decision of the dsb. the cfi did not state specifically that adopted panel reports did not have ‘direct effect’ here either. nevertheless, it rejected the argument concerning the dsb as irrelevant based on the reasoning that any final wto ruling will leave open the possibility for the commission to pay compensation or will entail a modification of the system in force, which does not rule out that the applicants could derive advantages in future years135. there was a w to dispute settlement decision involved also in pfizer136 and intervet137 but the court avoided ruling anything on their effect in the ec legal order. when an adverse wto panel or appellate body report and its deliberate non-implementation by the ec is involved, it is obvious that politically ver y sensitive matters are present. the approach of the courts relating to matters involving dsb decisions has been rather careful, as these recent cases relating to the hormones dispute138 well illustrate. this demonstrates well the judicial deference of the courts to the community legislature in politically sensitive matters139. 3.3.2. comments even though the court has been relatively careful with its statements relating to the effect of adopted wto panel or appellate body reports, the approach of the ecj in portugal and of the cfi in chemnitz and comafrica ref lects their clear unwillingness to review community law in the light of the wto dispute settlement results. as a general rule the ‘direct effect’ of wto reports in annulment actions seems to be ruled out by the court140. it might still be argued, though, that the use of the wto dispute settlement should be allowed where the ec has not even attempted to either to implement an adopted report or to agree compensation, or if it has not purported to implement the report and negotiations on compensation have failed141. cottier has advocated for the principle of compliance as a basis of the policy of the ec towards adopted wto reports142. if the ec deliberately ignores an adopted report and decides upon expir y of the reasonable period allocated to refrain from offering compensation and to take into account the threat and execution of potential sanctions, cottier suggests that the report should be ‘directly effective’ under certain circumstances. such decisions can be deliberately taken, and take into account the risk of sanctions in an overall balance of foreign policy interests. if the non-compliance is arbitrary and shows mere political expediency, ‘direct effect’ should be allowed143. compelling reasons not to implement, on the other hand, would prevent such an effect144. there are significant arguments against the abovementioned approaches. the reciprocity argument applies to all circumstances where the ec has failed to implement a report. the ‘direct effect’ of panel reports could place a huge amount of power in the hands of third states. they could rely on the court of justice to enforce a ruling or recommendation and would, thus, have no need to negotiate compensation in good faith145. one argument against the enforceability of a wto rule, the breach of which has been confirmed by the dsb, is that as the w to system is generally limited to orders for specific performance and ex nunc termination of the unlawful measure146, a declaration by the ecj that an ec measure if unlawful operates as a rule ex tunc. this is, however, not an insurmountable problem since the ecj could rely on article 231(2) ec and decide that part of the effects of the measure in question shall be considered as definitive rendering its ruling prospective in practice147. nordic journal of commercial law, issue 2004 #1 19 in my view, the arguments for the exclusion of automatic ‘direct effect’ of panel and appellate body reports seem convincing. allowing such an effect would not be in accordance with the core principles underlying the argumentation of the court as regards the effect of wto law. if private parties would be allowed to invoke the dispute settlement findings, the discretion of the institutions would be considerably reduced and the opportunities for mutually advantageous adjustments could be prevented. the downside of negotiated arrangements is, however, that they could have a price internally when some private firms could be badly injured by the compensation offered or imposed in exchange for a violation of the rules. ‘direct effect’ does not, however, appear to be the appropriate remedy against the risk taken by individual economic operators. instead, a remedy limiting the discretion of the institutions less harshly than ‘direct effect’ would be preferable. 3.4. applicability of the nakajima doctrine at first sight the implementation of an international obligation set on the community by a dsb ruling or recommendation seems like a clear case of application of the nakajima exception. if the community institutions refer to a specific wto panel or appellate body report when adopting a measure or adopt a measure which attempts to implement such a report, it should be open to individuals to rely on that ruling as grounds to consider a community act invalid. for example peers supports the idea that the enforceability of wto dispute settlement results could be improved by the application of the doctrine. he finds especially strong arguments for the review of ec acts in light of wto dispute settlement reports when the community has purported to implement a w to report. however, its implementation attempts have subsequently been condemned by wto arbitrators, as has been the case in ‘the banana saga’148. it would be exceedingly difficult to argue against the application of the nakajima exception if a panel or appellate body report was directly referred to in the contested act. however, the ec legislative organs have omitted such direct referrals in the legislative measures adopted to comply with the wto dispute settlement outcomes that have so far been challenged in the community courts149. it is also difficult to find credible arguments for the assumption that the modification of the community legislation in order to comply with a dispute settlement decision is not adopted “in order to implement a particular obligation.” to start with, the requirement of “a particular obligation assumed in the context of the wto”, can easily be identified in the panel and appellate body reports adopted by the dsb, which instruct the community to bring its laws and regulations into conformity and identify the relevant wto rules. as eeckhout phrased it: “it is hard to envisage a more precise identification of relevant obligations than that resulting from wto dispute settlement”150. the requirement of an intention to implement is more problematic. the legislative measures adopted by community institutions as a result of w to panel and appellate body reports in the bananas case clearly were adopted in order to implement the obligations, at least in the generally accepted meaning of the term151. the preamble to council regulation 1637/98 explicitly refers to wto commitments152. admittedly, no such referral to wto provisions or to the wto dispute can be found in the commission regulation 2362/98153. the council regulation, however, mandated the commission to establish a wto-compatible banana regime and implementing the council regulation is the sole purpose of the adopted provision154. the cfi, however found in a liability action that the nakajima exception does not apply to the 1998 commission regulation155. if the non-compliance of the ec with wto dispute settlement findings takes the form of passivity on the part of the ec, the position of a private applicant harmed by the community inaction is even more difficult. when no measures are adopted, an action for annulment cannot be brought. the nordic journal of commercial law, issue 2004 #1 20 nakajima exception cannot thus be of any benefit to individuals in case of an omission. this brings us back to the scope of manoeuvre of the institutions, which would be put in jeopardy if this was not the case. 3.5. can consistent interpretation benefit the applicants? private applicants are not likely to benefit from consistent interpretation when they attack community law on the basis of non-compliance with dsb rulings and recommendations156. first, the lack of implementing measures naturally prevents the application of the exception. second, even if the institutions have undertaken to amend community law to achieve compliance, it would be difficult for the court to find that community measures can be given an interpretation consistent with wto obligations when an incompatibility has already been found by the dsb. finally, the applicability of consistent interpretation is questionable in the light of the general reluctance of the ecj to apply the principle in actions involving challenges by private parties to the validity of community measures claimed to be in conflict with wto obligations157. 3.6. should the enforceability of dispute settlement outcomes be improved? the overview to the enforceability of the wto dispute settlement outcomes in the ec legal order shows that so far they have not been given any legal effect at all. the lack of ‘direct effect’ of dsb rulings and recommendations seems well founded but the same cannot be said about the very minimalist application of the nakajima doctrine. the case law illustrates well the shortcomings of the nakajima exception and the principle of consistent interpretation. the exceptional ways to rely on wto law cannot be used effectively in respect to dsb rulings and recommendations. thus, the level of protection they provide for private parties is not the same as in connection to w to agreements in general. it is doubtful whether it is appropriate that the community law does not provide any kind of protection for private parties against the community institutions acting in breach of the judicial obligation set on the community. one can also question whether it is acceptable to leave the matter on the level of international law where the measures of enforcement are on a different level than within domestic law and private parties are left out of possibilities to protect their private interests. especially the lack of justiciability or any kind of effect of wto dispute settlement outcomes in ec legal order illustrate well the clash between rights of private parties and the discretion given to the political bodies of the community. when the institutions, for one reason or another, ignore their international obligations imposed by the wto dispute settlement organs, the only problem is not the apparent lack of respect of international commitments. private economic operators within the community may also suffer heavily from the non-compliance of the community. the situation seems most unjustified when the other party to the dispute resorts to retaliatory measures, which may lead to companies having absolutely nothing to do with the original dispute to suffer heavy losses. in particular the narrow scope of application of the nakajima exception shows that the problem, again, boils down to the question of the margin of discretion of the political institutions of the community. as the court has clearly been willing to respect the discretion of the institutions also after the community measures have been condemned at the level of the wto law, it could be that a solution limiting the discretion of the institutions to a lesser degree would meet less resistance within the court and allow it to take into account the principle of legal certainty. nordic journal of commercial law, issue 2004 #1 21 4. relevant aspects of the non-contractual liability of the ec for discretionary measures 4.1. the basis of ec liability the non-contractual liability of the european community is based on the article 288(2) ec, which provides that “in the case of non-contractual liability, the community shall, in accordance with the general principles common to the laws of the member states, make good any damage caused by its institutions or by its servants in the performance of their duties.” the community may incur liability for damage caused by adopting wrongful acts but it is also clear that omissions by the community institutions may give rise to liability in so far as the institutions have infringed a legal obligation to act158. article 235 ec explicitly states that the european court of justice has the jurisdiction in disputes relating to compensation for damage described in the art. 288 ec. the general conditions for the liability of the community have been clearly defined in the case law of the ecj. in order for the ec to incur non-contractual liability the applicant must prove, first, that the institution against which the action is brought has acted unlawfully. second, the applicant must show that actual damage has occurred. finally, there must be a direct causal link between the wrongful act and the damage complained of159. moreover, in the field of discretionar y measures, the community liability is subject to stricter conditions. under the schöppenstedt formula, as modified by the bergaderm case, an action for damages against a community institution will only be successful if a sufficiently serious breach of a rule of law for intended to confer rights on individuals can be shown160. bergaderm restated the conditions for imposing community liability in the same terms as in the conditions for the liability of the member states for a breach of community law. 4.2. independent form of action the action for damages under article 288(2) ec is an independent form of action. that is to say that it is not necessary first to bring an action for annulment under article 230 ec to determine the unlawfulness of the contested measure or an action for failure to act under article 232 ec. nevertheless, an action for compensation brought on the basis of an act which has not been annulled requires the establishment of the unlawfulness of the contested measure161. an act which is not illegal cannot form the basis of an action in compensation162. illegality is required but prior annulment is not necessary. the action for damages has a different purpose as a part of the community system for the protection of individuals than the action for annulment. as the latter aims at setting aside a specific measure, the purpose of an action for damages is to repair the damage caused by an institution163. 4.3. a developing remedy the remedy under article 288(2) ec has earlier been considered a measure of sanction against the community institutions for a ver y serious breach of law. more recently, it has rather started to resemble the right available for those who have suffered harm as a result of a breach of community law by a member state. the remedy is now seen as one available to individuals who have suffered an infraction of a community law right arising through the fault of the community institutions 164. the action for damages under article 288(2) ec comprises an important element in the system built up to ensure the full effectiveness of the rules of community law and of the effective protection of the rights which those rules confer. one of the functions of the remedy has been considered as being compensation for a possible “judicial deficit” found in the community system for the protection of individuals. the possibility of claiming damages where injuries have been caused by acts which cannordic journal of commercial law, issue 2004 #1 22 not be challenged, provides for a new and additional opportunity for bringing court proceedings165. the test for triggering the non-contractual liability of the community has been very difficult to fulfil. it is widely acknowledged by commentators that the principles developed by the ecj and their application tend to frustrate, rather than foster, the chances of success of applicants seeking for compensation166. ward finds an element of irony in the case law as the court, despite the express mandate in article 288 for the court to protect individuals against abuse of authority on the part of the community institutions, has in fact minimised the accountability of ec decision makers for unlawful conduct167. fines considers the restrictive mechanisms developed by the court worrying from the point of view of legal certainty. she claims that the community institutions are in fact quasi non-liable and the protection of the victim is not guaranteed168. the court has also been accused of using a double standard, depending on whether remedies are sought against member states or against community institutions169. one reason behind the case law has probably been that the court wanted to ensure that the fledgling community institutions were not undermined by extensive challenge through judicial review procedures170. effectiveness of the community order and effective judicial protection do not usually point in the same direction. adequate protection of individuals involved challenging the activities of the still fragile and young ec institutions171. there have been contemporary pressures confronting the court to relax the test for accountability under article 288(2), which would increase applicants’ chances of success in non-contractual liability claims172. for example ward contends that given: “the prominence of ‘protection of the individual’ as a value in the enforcement of community law, and the role of the imperative of ‘effective judicial protection’ in improving member state remedies and procedural rules, it may become increasingly difficult for the community judicature to refrain from internalising similar principles when the legality of community measures is questioned by private sector actors173.” also waelbrook made similar statements some years ago and speculated then that the court’s new case law will lead in practice to an opening of the extremely strict conditions of community liability174. it appears that a step to this direction was recently taken as the court made a new attempt to unify the criteria of member state and community liability and sought inspiration from the rules governing the former to determine the circumstances under which the community may incur liability175. the case law will show how big a step we are dealing with in practice. at least the applicants have now good grounds to refer to the less strict rules governing the state liability for the support of their cases176. 4.4. principle of parallelism the principle of parallelism was introduced in the brasserie du p˜cheur case. it requires that the conditions under which a state may incur liability should not, in the absence of particular justification, differ from those governing the liability of the community institutions in like circumstances. the doctrine is based on the basic idea that the protection of the rights which individuals derive from community law cannot vary depending on whether a national authority or a community authority is responsible for the damage177. the judgement of the ecj in bergaderm case increased the relevance of the parallelism argument in determining the conditions of the community liability. at the same time the judgement unified the nordic journal of commercial law, issue 2004 #1 23 conditions of community and member state liability, it also brought a new element to the case law: the reversal of inf luence. as the court had earlier as a rule sought inspiration from the rules governing community liability to determine the conditions for member state liability, now the influence was reverse178. in bergaderm the court referred to brasserie du p˜cheur as an authority on the interpretation of article 288 (2) ec179 and reiterated there the principle of parallelism. therefore, it is justifiable to draw analogies form the rules governing the member state liability to determine whether or not the community can be held liable under certain circumstances. it should be noted, though, that there are important disparities between community and state liability. this relates to the different constraints under which the community and the national legislature operate within the bounds of the ec legal order. as the community acts as the primary legislature, the national legislature is bound by the principle of primacy180. therefore, some gaps may still remain in the analogy. 4.5. the condition of unlawfulness 4.5.1. a breach of a rule of law under the schöppenstedt formula, the applicant has been required to demonstrate a breach of a superior rule of law for the protection of the individual in order to establish the liability of the ec181. the expression was replaced in bergaderm with the condition that the defendant institution must have infringed “a rule of law intended to confer rights on individuals”182. bergaderm deleted the reference to a breach of a “superior” rule of law. what is the significance of this aspect of the judgement? it sees that the court has not in general placed much importance on the requirement that the rule of law must be superior in its case law. thus, the omission of the term does not make a real difference183. according to the case law, following types of norms can in principle qualify as superior rules of law: treaty provisions or other primary community law, general principles of law and community acts which in formal ranking stand higher than the community act which caused damage184. the general principles of community law that the ecj has accepted to operate as superior rules law include the principle of protection of legitimate expectations185, the principle of proportionality186, the principle of equal treatment187, the principle of proper administration188, the principle of care189, and the prohibition of misuse of powers190. the ecj has also held that fundamental rights form an integral part of the general principles of law protected by the court. consequently, such rights as the right to property and the freedom to pursue an economic activity have also been recognised as superior rules of law for the purposes of a liability action against the community191. here the important question is whether an international agreement binding on the community can act as such a rule of law that its violation could give rise to the liability of the ec. since the international agreements form an integral part of the ec legal order and are hierarchically superior to secondary community law, the provisions of such agreements are in general able to trigger the liability of the ec. however, the problem in respect to the wto law is that it often has been considered that an international agreement should have direct effect in order to be invoked in an action for damages against the community. the issue is, however, not entirely clear and will be discussed in more detail below in the part discussing the invocation of w to law in liability actions. 4.5.2. the rule of law confers rights on individuals the court has accepted as a general rule common to the member states the principle that the nordic journal of commercial law, issue 2004 #1 24 violation of a legal provision may only entail liability for its author if the provision in question is designed to protect the interests of the category to which the individual concerned belongs192. despite the different phraseology used in bergaderm, the requirement that the rule must intend to protect the individual remains conceptually the same193. in practice, the court has applied the requirement rather liberally and, at least as regards internal community law, the condition that the rule of law must be for the protection of the individual is not very difficult to satisfy194. in a concrete case it may, however, prove to be problematic. when the applicant wants to bring a compensation action against the community for a breach of wto rules, it is likely that this requirement is the most difficult condition to meet. 4.5.3. sufficiently serious breach if an infringement of rights protected under the terms of a (superior) rule of law has been found, the degree of seriousness of the breach will be assessed next. in the areas of legislation where the community legislature enjoys wide discretionary powers195, it may incur liability only if the measure adopted cannot be appropriately justified. in such areas of legislation the responsibility to compensate may arise only if “the institution concerned has manifestly and gravely disregarded the limits on the exercise of its powers”196. in its case law the court has traditionally referred to two elements in determining whether such disregard has occurred: the degree of harm suffered by individuals as a result of the measure, and the extent to which the law has been violated197. in the light of the bergaderm judgement, the interpretation of the ecj of the term ‘serious breach’ in the context of member state liability has now been confirmed to be of importance in the article 288 (2) ec case law198. the seriousness of the breach committed by community institutions will now be dependent upon factors mentioned in brasserie du p˜cheur, which include “the clarity and precision of the rule breached, the measure of discretion left by that rule to the national or community authorities, whether the infringement and the damage caused was intentional or involuntary, whether any error of law was excusable or inexcusable”199. 4.6. the conditions of damage and causal link the second essential element for a successful action for damages under art. 288(2) ec is the establishment of damage200. in general, the damage is required to be certain, specific, proved and quantifiable for the community to incur liability201. however, the fact that the amount of damage cannot be precisely quantified in the application will not render the claim inadmissible202. the court will most commonly award damages for economic loss but also other types of damages can be awarded203. in quantifying the damage, the extent to which the damage has been incorporated in the selling prices of the complainant undertaking will be taken into account in accordance with the principle of unjust enrichment204. the ecj has held that there is a general duty to mitigate and the damages will be reduced if the applicant fails to do so205. finally, there is the requirement of a causal link206 between the breach of an obligation resting on the state and the damage sustained by the injured parties207. causation is explicitly required by article 288(2) ec. the causal nexus between the wrongful act or omission and the damage sustained should be direct immediate and exclusive. it is assessed from a hypothetical perspective according to which there is no causality involved where the same result would have occurred in the same way even in the absence of the wrongful community act or omission in question.208 nordic journal of commercial law, issue 2004 #1 25 5. article 288(2) ec case law involving non-implementation of dsb decisions 5.1. background bananas and hormones disputes private parties have recently brought several actions for damages to the community courts in connection to the bananas209 and hormones210 disputes at the level of wto. the applicants have initiated the proceedings in order to get compensated for the loss they have suffered due to the non-compliance by the ec with the international obligations to change its legislation imposed by the wto panel and appellate reports in the transatlantic disputes211. the companies that have initiated proceedings can be divided into two different groups. the first group consists of the banana operators who have not been allowed to benefit from the volume of licences and tariff quota to which they are entitled to on the basis of the panel and appellate body reports212 and of the importers affected by the prohibition on the importation of beef from cattle treated by hormones condemned by the decision of the dsb213. the second group is the european companies affected by the retaliatory measures taken by the united states following the community’s failure to implement the rulings and recommendations of the dsb214. as regards the hormones case, the ec stated after the dsb gave its recommendation that it intended to comply with its wto obligations, and was granted a reasonable period to do so. that did not take place. however, more than four years after the reasonable period lapsed, a directive has finally been adopted in order to comply with the appellate body report215. its compatibility with the w to obligations may, however, very well be challenged in the future. as regards the bananas dispute, a resolution is finally at sight216. it is not likely, though, that this will represent an end to actions for compensation brought by private companies for financial loss caused by the outgoing regime. 5.2. main issue the dsb decisions in the bananas and hormones cases have imposed obligations to the community to take action to amend its legislation to comply with the adopted dispute settlement reports. it is questionable whether the fact that the wto dispute settlement organs have confirmed the unlawfulness of the community measures, repeatedly concerning the banana regime, suffices to trigger the liability of the ec217. the applicants are required to show that the schöppenstedt conditions are fulfilled218. they thus need to show that a sufficiently serious breach of a rule of law intended to confer rights on individuals has occurred. the applicants have basically relied on two categories of rules as “rules of law intended to confer rights on individuals” that have been breached. the first set of rules is wto law, consisting of the agreements and of the dispute settlement findings. there are, arguably, two separate requirements that these rules have to fulfil for purposes of an action for damages. first, it is clear that rule in question has to meet the condition for liability that it is intended to confer rights on individuals. second, the rules should be susceptible to be relied on by private parties. there is, however, some disagreement as to the issue whether or not the invoked rule needs to have direct effect for the purposes of a compensation action. apparently frustrated by the reluctance of the court to let individuals to rely on w to law, many of the applicants have relied also on other grounds to establish unlawfulness. various principles of community law have been clearly identified as superior rules of law in cases involving non-implementation by the ec of dsb decisions. the pleas in question remain outside the scope of this thesis. nordic journal of commercial law, issue 2004 #1 26 however, davies for instance considers it unlikely that the applicants could ‘circumvent’ the lack of direct effect of wto law by relying on these grounds219. among others, the following principles have been invoked: the protection of legitimate expectations220, the principle of proportionality221, the principle of equal treatment222, the right to property223, the right of freedom to pursue a trade or business224, the principle of pacta sunt servanda and the principle of sound administration225. the defendant institutions have not been found to have breached any of the invoked principles in the concerned cases in such a manner that a compensation action would have succeeded. 5.3. atlanta a finding made within the wto dispute settlement system declaring a provision of community law incompatible with the wto law was invoked first time in an action for damages in the atlanta226 case. before the cfi the applicant claimed compensation for the damage caused by council regulation 404/93227, which prompted it to cancel shipping contracts for the transport of bananas, the cost of which it remained liable for. atlanta claimed that the import restrictions of the regulation were contrary to gatt. the cfi rejected the argument by simply referring to germany v. council228 where the ecj had discarded a similar argument put forward by the plaintiff and dismissed the action229. on appeal230, atlanta submitted several pleas, the first one of which was based on the appellate body report establishing the incompatibility of the community’s common organisation of the market in bananas with w to law231. the court found the plea inadmissible, since it was only raised the first time at the stage of reply even though nothing prevented the applicant from submitting it at the time of its application to the ecj. the court came to this conclusion despite the fact that the decision of the dsb was not in fact published until six months after the lodging of the appeal. according to the reasoning of the court, the appellant could have maintained its plea of a breach of the provisions of gatt, raised before the cfi, and adduced in particular the wto dispute settlement in support of its argument that the provisions of gatt were of direct effect232. atlanta left thus open the question whether an adopted panel or appellate body report could contain rules of law protecting the individuals on which private applicants could rely on in an action for damages. advocate general alber interpreted in biret the judgement to support the view that a liability action based on the community’s non-compliance with a dsb decision could succeed. he reasoned that the finding of the ecj that the appellant could have maintained its plea and adduced in particular the dispute settlement mechanism set up within the wto in 1995 in support of its argument that the provisions of gatt were of direct effect expressly indicates the possibility that the new wto dispute settlement mechanism could alter the effects of wto law in ec legal order233. 5.4. cordis, bocchi and t. port the cases cordis234, bocchi235 and t. port236 were all actions for damages brought to the cfi by applicants in connection to the bananas dispute in order to get compensated for the loss they had suffered as a result of the application of commission regulation 2362/98237. the commission adopted the regulation in order to implement the council regulation 404/93238, which had been amended by council regulation 1637/98239 in order to comply with the decision of the dsb which declared certain aspects of the banana import regime of the community incompatible with the wto rules240. the key issue in all three cases was the effect of the community’s wto infringement on actions for damages241. to establish the unlawfulness of the commission’s conduct, all the applicants claimed that the detailed rules for the calculation of the reference quantity for the grant of import licences contained in the commission regulation infringed the gatt, the gats and the agreement on nordic journal of commercial law, issue 2004 #1 27 import licensing procedures. the applicants apparently wished to distance themselves from the argument that wto law contains rules of law intended to confer rights on individuals, since they did not put such argument directly to the court242. instead, they sought in the first place to rely on rules of law internal to the community legal order and argued that the community institutions were guilty of misuse of powers. since the community arrangements for banana imports had been declared incompatible with the wto rules by a decision of the dsb having the force of res judicata and the community had undertaken to rectify the infringements concerned, the institutions were, in the applicant’s view, precluded from adopting further provisions in breach of those rules243. despite of the attempts made by the applicants not to base their case on the effect of wto law, the cfi made it quite clear that it is not willing to review the community measures in the light of w to law in an action for damages any more than in other types of actions. it began by repeating the general conditions for liability and referring to bergaderm and noted, that the right to reparation requires that the law infringed is intended to confer rights on individuals. next, the cfi reiterated the core aspects of portugal and stated that the validity of community law cannot be challenged in the light of wto law. it concluded that “the wto rules are not in principle intended to confer rights on individuals”, and therefore “the community cannot incur non-contractual liability as a result of infringement of them”244. with regard to the argument that the commission had misused its powers, the applicants referred to the nakajima exception at the oral hearing for the support of their case245. the cfi rejected also these arguments246. 5.5. biret 5.5.1. judgements of the cfi the origins of the biret cases247 are in the hormones case between the ec and the united states. the us brought the case to the wto dispute settlement claiming that the ec’s ban on the importation of beef from cattle treated with hormones for growth promotion purposes violated the sps agreement248. the appellate body confirmed that the community measures violated the sps agreement. it came to that conclusion essentially on the ground that there had not been a sufficiently specific scientific analysis of the cancer risks associated with the use of certain hormones as growth hormones249. the dsb adopted the report of the appellate body and requested the community to bring the measures found to be inconsistent with the sps agreement into conformity with its obligations under that agreement250. the applicants brought actions under article 288(2) ec before the cfi against the community for compensation for the damage they had suffered as a result of the import ban of beef treated with certain hormones. they maintained that the council action was unlawful on the ground that it was in breach of the sps agreement251 and submitted that the dsb had confirmed that the directives in question conflicted with wto law. the applicants argued that their case differs from portugal in two respects. first, here the community rules were the subject of express criticism on the part of the dsb. second, the community’s breach of its obligations was not temporary and negotiable. rather, it was permanent, as the community had expressed its intention to maintain the embargo despite the current state of scientific research. thus, the argument that the dispute settlement mechanism is flexible was, according to the applicant, immaterial in the case252. furthermore, the applicants argued that the judgement in portugal f louts the wording of article 300(7) ec and conf licts with the established case-law to the effect that international agreements form an integral part of the community legal order253. nordic journal of commercial law, issue 2004 #1 28 the cfi was not persuaded by the arguments put to it by the applicants and dismissed the actions. it stated that it is firmly established case-law that in the view of their nature and structure the wto agreements: 1. do not in principle form part of the rules by which the ecj and the cfi review the legality of acts adopted by community institutions under article 230 ec; 2. cannot be relied on by individuals before the courts; 3. any infringement of them will not give rise to non-contractual liability on the part of the community254. the cfi also stressed that “the purpose of the w to agreements is to govern relations between states or regional organisations for economic integration and not to protect individuals.” it reiterated the argumentation familiar from portugal that the judicial review of community law in light of such agreements would deprive the legislative and executive bodies of the community of the discretion enjoyed by similar bodies of the community’s trading partners255. also the applicability of the nakajima exception was considered – and rejected256. the cfi rejected the possibility that a dsb decision might in any way alter the effect of wto law in ec legal order. it concluded that there is an inescapable and direct link between the dsb decision and the plea alleging infringement of the sps agreement. the decision could therefore be taken into consideration only if the court had found that agreement to have direct effect in the context of a plea alleging the invalidity of the directives in question. for the support of this conclusion the cfi referred to the findings made by ecj in the atlanta case257. 5.5.2. appeals to the ecj biret introduced an appeal against the judgement of the cfi. it claimed, primarily, that the cfi had misconstrued article 300(7) ec and negated its effectiveness. the judgement did not, according to the appellant, “address the argument that the community, in acceding to the dispute settlement system set up by the wto agreements, undertook to observe the procedure and the authority of dsb decisions.” in the alternative, biret requested the ecj to develop its case-law and to acknowledge that all or part of w to agreements have direct effect and mentioned various reasons which militate in favour of recognition of the court’s power to review whether community law complies with the wto law258. advocate general alber delivered identical, and quite revolutionary, opinions in the cases259. he sided with the applicants and proposed that the community may be held liable for the non-implementation of wto dispute settlement decisions after the prescribed reasonable period to comply has lapsed. under such circumstances, private parties should, according to alber, be allowed to rely on w to law in community courts to trigger the liability of the community. the ecj did not agree with the advocate general who suggested that the case should be referred back to the cfi. instead, it rejected the appeal. it is important to note, however, that the dismissal of the case did not indicate a clear rejection of the arguments presented by alber either. rather, the ecj avoided expressly rejecting or accepting, as zonnekeyn named it, the “copernican innovation” of alber. the ecj found on appeal that the reasoning of the cfi was insufficient to deal with the plea put forward by the applicant concerning the infringement of the sps agreement. according to the ecj, the cfi missed the central question to the arguments put forward by the applicant. the issue it should have addressed was whether the legal effects of the dsb decision provided grounds for a review of community legislation in light of wto rules in an action for damages, and thus called into question the court’s finding that the wto rules did not have direct effect260. nordic journal of commercial law, issue 2004 #1 29 in addition to the disregard of the duty to state reasons, the ecj found that the cfi made an error of law as regards the scope of the atlanta judgement. it stated that the case is irrelevant since the plea in question was rejected as inadmissible and did not examine the substance of the plea261. consequently, atlanta did not provide for any support for the finding of the cfi that a dsb decision cannot be taken into consideration if the court has not found the sps agreement to have direct effect. next, the ecj turned to the question whether there were other grounds on which the rejection of the plea could be founded. it ended up dismissing the plea on the ground that no damage to the appellant had occurred after the reasonable period granted for the ec for compliance with the dsb decision had expired. the reasoning was that the courts may not carry out a review of the legality of the community measures before the period before the date the reasonable time to comply expires. such review would render ineffective the grant of a reasonable period for compliance. as regards the time after the reasonable period expired, the ecj found that, since the applicant could have not suffered any damage (because it was in judicial liquidation), the community cannot have incurred liability262. what is remarkable is that the ecj left open the possibility that community could incur liability damages for failure to implement a wto ruling in a case where conditions are right. in biret the issue of liability was not further dealt with only due to the circumstances in the case. the ecj, notably, did not reject the cases on the basis of the lack of ‘direct effect’ of wto agreements. it rather seemed to reproach the cfi for relying too much on this aspect of the case law and to reject the view of that the lack of ‘direct effect’ of wto agreements automatically means that a dsb ruling cannot be relied on in liability actions. the approach of the ecj to the effect of wto law appears to be more relaxed than that of the cfi. first, it did not confirm what the cfi considered to be established case-law that an infringement of wto agreements will not give rise to non-contractual liability of the community. instead, it referred to paragraph 61 of the judgement of the cfi and agreed only with the usual obser vation that the wto agreements are not in principle among the rules in light of which the court is to review the legality of the acts of its institutions263. in the meantime, the cfi had reiterated its finding that it is settled case law that any infringement of wto agreements will not give rise to non-contractual liability on the part of the community in the dole fresh fruit case264. the case was an action for compensation for damage suffered by the introduction of the banana export licence scheme by council decision 94/800. the applicant attempted to rely on wto law but the plea was held inadmissible as a new plea. nevertheless, the cfi pointed out that the argument was “completely irrelevant” on the above mentioned ground. second, the ecj did not maintain a similar argument as the cfi submitted stating that the dsb decision could only have taken into consideration if the court had found the sps agreement to have direct effect. instead, it avoided the issue of unlawfulness and turned directly to the second condition of community liability, the existence of damage. whether such approach ref lects mere circumspection on the part of the court in a politically sensitive matter or a genuine willingness to give effect to wto dispute settlement outcomes in the community legal order remains to be seen in future cases. in any event, it is clear that the liability of the community may, in any event, only extend to the time after the reasonable period for the compliance with the dsb decision has expired and to the damage occurred after such period has lapsed. nordic journal of commercial law, issue 2004 #1 30 it should be noted that the ecj, indeed, did not really discuss the issue of unlawfulness in biret. even though the judgements leave the impression that the court might be inclined to recognise invocability of w to law in limited circumstances, there are other hurdles left on the way of bringing a successful liability action for non-implementation of wto dispute settlement results. the ecj did not deal at all with the condition that the rule of law invoked in an action for damages under article 288(2) ec should be one intended to confer rights on individuals. neither did it assess whether the breach was sufficiently serious to trigger the liability of the community institutions. as a conclusion of the discussed cases, it can be said that neither the cfi nor the ecj had been required to adjudicate on the question of whether or not wto law contains rules of law which can form the foundation for an action for damages before biret265. in biret such an argument was directly put to the court but the judgement of the ecj nevertheless left the issue somewhat unclear. 5.6. ‘innocent exporters’ cases the implications of biret will possibly be seen in the ‘innocent exporters’ cases that are at the moment pending in the court of first instance266. it will be interesting to see how the cfi reacts to the new developments and interprets the cases267. the applicants in the cases are european traders who seek compensation from the ec institutions because of their perceived losses resulting from the us measures to suspend concessions in the transatlantic bananas dispute. their main argument is that the community should be held responsible for the fact that the us has resorted to retaliator y measures as a response to the ec’s failure to implement the dsb rulings and recommendations268. they maintain that the measures imposed by the us and the damage they have caused are the direct consequence of the ec maintaining in force a system of rules the wto has already ruled unlawful269. the companies that have suffered losses in the face of the us measures are mainly comparatively small firms and their lines of business do not relate to importing bananas in any manner270. in a sense, these exporters have suffered on behalf of the entire community271. therefore, there is a clear political need for regulation or other kind of solution providing for the possibility for the companies to obtain compensation. in fact, there was a proposal in the european parliament to establish a compensation fund for these companies272. it has, however, been seen as questionable whether such compensation would not amount to an unlawful subsidy under wto law273. at present, an action for damages against the community institutions appears to be the only possibility for the companies to obtain compensation. the commentators that have discussed the chances of success of these actions have identified some specific issues, which might cause problems to the applicants. rosas found it altogether unlikely that the claims will be successful274. first, he recalled that the measures to suspend concessions are taken by the us, and not the ec275. therefore, it might be difficult to establish the causal link between the unlawful conduct and suffered damage. however, both reinisch and zonnekeyn rejected such a view as the disruption of the causal nexus would only take place if the us measure would be unlawful as such and would thus be the cause of the damage. as the dsb approved the retaliatory measures, they are not unlawful and do not disrupt the causal link276. in the present author’s view, it should not prevent the condition of causality of being met that the harmful measures are taken by the us. the community institutions were aware that such measures could be taken and, in a way, the ec accepted the measures when it intentionally breached the obligations imposed by the wto reports. second, rosas argued that private traders do not have a subjective right to a certain level of tariff concessions277. the issue whether wto law can confer rights on individuals will be discussed below. nordic journal of commercial law, issue 2004 #1 31 suffice it to say that this probably is the strongest argument against the community liability. rosas also found that the fact that suspension of concessions is a mechanism, which is built into the dsu system itself and constitutes one of four modes of implementation which would prevent the success of the actions278. the present author interprets the argument to imply that ‘choosing’ to be targeted by retaliatory measures is comparable to complying with the obligations and no liability can arise as the community has not acted unlawfully. such reasoning is not convincing as suspension of concessions cannot, in my view, be considered as a “mode of implementation”. it, rather, is a temporary measure that can be used to put pressure on the other party to end its non-compliance with interntional obligations. 6. invocation of wto law in actions under article 288(2) ec 6.1. is direct effect required? 6.1.1. community liability in the context of international agreements the jurisprudence of the community courts on invocability of the wto law in general was discussed above. as noted, it is settled case law that the wto agreements are not in principle among the rules in light of which the court is to review the legality of measures adopted by the community institutions279. does the requirement of direct effect apply in actions for damages? does wto law contain provisions that qualify as (superior) rules of law for the purposes of an action for damages? international agreements of the community qualify as rules of law to be relied on in a liability action, since they according to the case law form an integral part of the community legal order and have priority over secondary community law280. there seems, however, to be no definitive answer to the question whether community liability for breaches of international agreements will arise only in cases where an agreement can be shown to have direct effect281. neither the ecj or the cfi has explicitly ruled that wto agreements should have direct effect in order to be invoked in an action under article 288(2) ec282. in stimming283 the applicant claimed that a regulation infringed the gatt 1947, the direct effect of which was categorically ruled out. the court did not discuss the argument because the applicant did not specify which gatt rules he was referring to284. ag mayras did, however, address the issue. he presented serious doubts as to private parties invoking gatt rules in liability actions and appeared to suggest that such action would require the agreement to have direct effect285. another advocate general expressed a clearly opposite view. ag lenz was of the opinion in the italian bananas case that the possibility that in exceptional cases an infringement of provisions of gatt might give rise to a liability in damages for the community. he specified that “in particular, one might envisage a case where in such a situation the community makes no use of the possibilities provided for in gatt of freeing itself from its obligations, but agrees that the dispute should be decided by a neutral tribunal, and then however refuses to comply with the decision”286. as the “neutral tribunal” referred to by lenz hardly can be but a gatt panel, or a w to panel or the appellate body at present, what he most likely meant by his statement was that a private trader could claim damages against the community when it refuses to comply with a wto panel287. the more recent cases dealing with wto law already discussed above offer some guidance but do not resolve the issue. in cordis, bocchi and t.port the statements of the cfi that suggested that the ec cannot incur liability as a result of infringement of wto rules appeared to be based on the view that wto rules are not intended to confer rights on individuals rather than on their lack of direct effect288. the reference to ‘the rights of individuals’ cannot be assimilated with direct effect289. the ver y nordic journal of commercial law, issue 2004 #1 32 notion of direct effect appears to indicate that provisions having such effect confer rights on individuals290 but, by contrast, it is possible that a provision confers rights on individuals despite of its lack of direct effect291. also some commentators have doubted whether private parties may invoke w to law as a standard of reviewing the conduct of the ec institutions in an action under article 288(2) ec. maresceau suggested that direct effect of the invoked international provision would be a conditio sine qua non for allowing compensation for violation of international agreements. he found that the lack of direct effect of gatt to constitute an insurmountable obstacle for bringing a liability action founded on a breach of the agreement292. more recently, other commentators have been convinced by the judgements of the ecj and cfi in portugal, and cordis, bocchi and t.port and considered it established case law that w to rules can not constitute superior rules of law in a compensation action under article 288 (2) ec293. the biret case is quite interesting in this context. the finding of the cfi, that the dsb decision in question could be taken into consideration only if the court had found the sps agreement to have direct effect, clearly implies that also the cfi considered direct effect as a prerequisite for relying on wto law in a liability action. also advocate general alber was of the view that the relevant wto rules the applicant wishes to submit should have direct effect in order for the compensation action to succeed. the condition is in his view cumulative to the requirement that the rule invoked in intended to confer rights on individuals294. the ecj, however, clearly rejected the straightfor ward position of the cfi but the meaning of the judgement of the ecj still remains somewhat ambiguous. the findings of the ecj in biret could imply that under very specific circumstances wto rules can be relied on in actions under art. 288(2) ec despite their general lack of direct effect. similarly as zonnekeyn, the present author finds the position of alber that certain rules “are suddenly blessed with direct effect in the framework of a damages claim” rather unconvincing295. in the author’s view the most reasonable solution could be to consider that, under the specific circumstances pointed out by the ecj, certain provisions become invocable despite their lack of direct effect, as is the case when the nakajima doctrine is applied. this exception would, however, apply only in liability actions. 6.1.2. parallelism – direct effect a condition for member state liability? some commentators have referred to the case law of the ecj with regard to the liability of the member states to support their views of the necessity of direct effect of the invoked provision in actions for damages296. as the jurisprudence involving community liability provides for no final answer to the question whether or not direct effect is required, it is necessary to examine the rules governing the member state liability in this context. as the ecj apparently wants to harmonise the liability doctrines, it would be clearly against the trend to consider direct effect as a condition of community liability if it is not required for a member state to incur liability. in the francovich297 case, which introduced the possibility of holding member states liable for a breach of community law the court held that the directive invoked in the case was not required to have direct effect in order to be invoked in an action for damages against a member state298. from francovich the conclusion can be drawn that the condition for member state liability that the measure is intended to confer rights on individuals to exist in the context of international agreements may be fulfilled whether direct effect exists or not299. consequently, the lack of direct effect of the wto agreements would not as such prevent member state liability from arising under some circumstances when its provisions have been breached300. in principle, the present author sees no compelling reason not to apply the same reasoning to the community liability as well301. nordic journal of commercial law, issue 2004 #1 33 some commentators see that allowing individuals to claim damages against member states even where the community provisions they wish to rely on were not directly effective is the most important element of francovich302. therefore not allowing private parties to rely on wto rules because of their lack of direct effect would miss the core of the rules of the jurisprudence303, especially if the court truly wishes to unify the conditions of community and state liability. it should be noted, however, that as clear as francovich appears to be, it is possible to interpret the judgement also in another way. according to van gerven the court did not in fact base the applicant’s right to reparation directly on the provisions of the directive which conferred specific rights, but used these provisions to flesh out provisions of the treaty and of the directive which, in themselves, were sufficiently precise and unconditional in order to base the right to reparation thereon in principle. he contends that provisions that lack direct effect may not give rise to liability, since, by definition, individuals cannot rely upon such provisions in order to derive rights from them.304 6.2. relevance of the nakajima doctrine 6.2.1. applicability in actions under article 288(2) ec when the applicability of the doctrine in the context of an action for damages under article 288(2) ec is considered, it should be noted that the exception can be applied under the same circumstances as in other types of actions. when the liability of the community is invoked on the basis of the nakajima doctrine, the direct effect of wto law becomes a non-issue305. if the conditions for the application of the doctrine were met, the applicant would, however still be required to show that the behaviour of the defendant institution is unlawful and that the other conditions for a successful liability action are met. the community would thus not incur liability even though its actions were reviewed under the on the basis of the nakajima doctrine if the rule of law relied on by the applicant was not intended to confer rights on individuals. 6.2.2. cases relating to the bananas dispute the community banana import regime was challenged in a liability action in cordis, bocchi and t.port. in these cases the cfi rejected the applicants’ argument that the community was guilty of misuse of powers in adopting the commission regulation 2362/98. the applicants claimed that the regulation contained infringements of wto rules despite of the fact that the community had given an undertaking to the dsb to repeal the provisions of its regulations which conflicted with w to rules. even though the applicants did not rely on the nakajima exception in the clearest possible way306, the cfi considered the applicability of the doctrine to the case and concluded as follows: “neither the reports of the wto panel of 22 may 1997 nor the report of the wto standing appellate body of 9 september 1997 which was adopted by the dispute settlement body on 25 september 1997 included any special obligations which the commission intended to implement, within the meaning of the case-law, in regulation no 2362/98. the regulation does not make express reference either to any specific obligations arising out of the reports of wto bodies or to specific provisions of the agreements contained in the annexes to the wto agreement”307. the cfi rejected thus the relevance of the doctrine without analysis, even though it is hard to find any other reason for amending the community’s banana import regime but the appellate body report308. therefore, it is not surprising that the finding has been harshly criticised by commentators309. as mentioned above, it is clear that the contested commission regulation was adopted to establish a wto-compatible regime in line with the panel and appellate body reports. it was adopted nordic journal of commercial law, issue 2004 #1 34 with the sole purpose to implement council regulation 1637/98, which explicitly refers to wto obligations and was adopted, even according to the cfi310, in order to comply with the dsb decision of 25 september 1997. the ecj dealt with a similar situation quite differently in the kloosterboer case311. the case concerned a challenge by a preliminary reference against a commission regulation imposing additional duties on frozen chicken fillets. the plaintiff argued that the duties infringed both the wto agreement on agriculture (aa) and the council regulation which had been amended with a view to implementing the provisions on additional duties of the aa. the relevant provisions of the council regulation were a direct copy of the aa provisions and the intent to implement emerged expressly from its preamble. the advocate general considered that this was a clear case for applying the nakajima exception. the ecj seemed to be evading the question since it conducted its analysis mostly with reference only to the implementing council regulation and not the aa. even though the ecj did not explicitly say that it was applying the nakajima exception, the case has been seen as “an ideal example” of its application.312 to the defence of the cfi in cordis, bocchi and t.port it has been said that it looked at the commission regulation in isolation and was therefore entirely correct since the provision does not contain any indication of an intention to implement wto obligations313. it has been suggested that the court should come to a different conclusion when it will be required to consider the commission regulation in light of the 1998 council regulation. it will be invited to do so in the chiquita314 and cartondruck315 cases. it has been submitted that the court should then consider whether the reference in the council regulation to wto law is specific enough to indicate an intention to implement particular wto obligations as the regulations in question are so closely connected. in banatrading316 the applicant was suing the council for damages on the grounds that the entire banana regime since 1993 was in violation of wto law. it argued at the hearing that, despite of the lack of direct effect of w to agreements, it was none the less for the court to review the legality of the community measure in question in the light of the wto rules where the wto has found that there has been a breach of those rules, the community has undertaken to implement the recommendations and subsequent decisions of the dispute settlement body and has not taken the measures necessary to comply with the recommendations and decisions within the prescribed time-limit317. the cfi rejected the argument as a new plea in law and did not discuss it any further318. in the present author’s view there is no compelling reason why the court could not apply the nakajima exception in the future actions challenging the community banana regime. on the other hand, it is possible for the court to continue with the ver y narrow interpretation of the doctrine and rule that the wording in the council regulation does not trigger the application of the doctrine. in the light of the its ver y clear reluctance to review the community banana regime in light of wto it seems unlikely that it would suddenly change its standpoint and limit the judicial deference it has shown to the discretion of the institutions. 6.2.3. cases relating to the hormones dispute the cfi found the nakajima doctrine inapplicable also in biret. it held that the circumstances of the case did not correspond to either of the situations where the doctrine could be applied. since the contested directives were adopted several years before the entry into force of the sps agreement, it is not logically possible for them either to give rise to a specific obligation entered into under that agreement or to refer expressly to some of its provisions319. the cfi thus did not consider the applicability of the nakajima doctrine in relation to the dsb decision. it is explained by the fact that the nordic journal of commercial law, issue 2004 #1 35 community had not yet taken any final action to amend its legislation in connection to the hormones dispute. the findings of the cfi in connection to the applicability of the nakajima doctrine were not subsequently questioned by the ecj, unlike some of the other conclusions the cfi had drawn. the advocate general, however, assessed further whether the doctrine should be applied after all. in particular, alber discussed whether the statement made by the community that it intended to comply with its w to obligations but needed a reasonable time do so, can be considered as a community measure taken with the intention to implement a particular obligation assumed in the context of the wto. alber, however, came into the conclusion that the statement was given in respect to the wto and belongs to the area of international law. it cannot, as such, produce such legal effects as the application of the nakajima doctrine would require320. in september 2003 a directive was finally adopted to implement the 1998 dsb recommendation321. the new provision refers expressly to the wto ruling, which indicates that private parties should now be able to ask the courts to review the legality of the directive in the light of the relevant wto provisions and case-law by applying the nakajima doctrine322. this clearly involves a situation where the community institutions have used their discretion and deliberately made wto available to individuals. the wto ruling is referred to in the preamble to the directive in the following way: “in the light of the results of a dispute settlement case brought before the world trade organisation (wto) by the united states of america and by canada (the hormones case) and recommendations made in that respect by the wto dispute settlement body on 13 february 1998, the commission immediately initiated a complementary risk assessment, in accordance with the requirements of the agreement on the application of sanitary and phytosanitary measures (wto-gatt) as interpreted by the appellate body in the hormones case, of the six hormonal substances (…) whose administration for animal growth promotion purposes is prohibited by directive 96/22/ec”323. if the court were to improve the protection of the individuals in respect to the wto-illegal behaviour of the community institutions, especially as regards non-implementation of the outcomes of dispute settlement, the nakajima doctrine perhaps is not the best solution, as can be seen from biret. the doctrine can not be applied in the absence of implementing measures. it is difficult to see why individuals should be let to rely on dsb decisions when the community has attempted to implement them but failed in it while, by contrast, if the decisions were completely ignored, individuals could not enforce them in any manner. 6.3. invocability of wto law in case of non-implementation of dsb decisions? 6.3.1. biret – a new exception established? it is possible to interpret the judgement of the ecj biret in the way that a new exception to the general rule concerning the effect of wto law in the ec legal order was established and wto law was made available to private parties under certain circumstances in actions under art. 288 (2) ec324. the ecj did not explicitly state so but at least it left open the possibility that a liability action for failure to implement a wto ruling could succeed if the damage arises subsequent to the period within which the eu should have implemented the wto ruling. it will not be seen until the advent of future cases as to which direction the case law develops. advocate general alber was firmly advocating for allowing ‘direct effect’ to wto rules in biret under the circumstances of the case: there was an adverse dsb decision addressed to the community involved, the reasonable period for its implementation had lapsed and the ec had failed to withdraw nordic journal of commercial law, issue 2004 #1 36 or amend its wto incompatible directives. a more thorough analysis of this new approach to the invocability of wto dispute settlement decisions will probably be helpful to shed some light on the meaning of the biret judgement of the ecj, although it remains to be seen if similar reasoning will be used by the court. the potential adoption of a new exception will be analysed in the light of the most important aspects behind the general reluctance of the court to let private parties to rely on w to law. 6.3.2. limits of applicability both the ecj and advocate general were of the view that private parties should not, in any event, be allowed to rely on wto law before the reasonable period granted for the implementation of the panel and appellate body reports has lapsed325. therefore, the possible liability of the community would extend only to damage suffered by the applicant after such a period has expired. the ec would thus not incur liability, for example, for losses suffered from the beginning of the establishment of a w to-illegal banana import regime, or the introduction of the import ban on hormone treated meat, or even from adoption of the dispute settlement reports. the position of the companies claiming compensation for the damage they have suffered on account of retaliatory measure taken by the other parties to the disputes would not be affected by the limitation, since these measures are generally resorted to after the period for compliance have lapsed. 6.3.3. effect on the margin of manoeuvre of the institutions what appears to be common to all of the exceptional ways for private parties to make use of wto law is that the application of the exceptions does not interfere with the institutional balance the courts have been carefully guarding. the analysis of the applicability of the nakajima doctrine showed that this applies to it and the same appears to be the case concerning the effect of wto law introduced by the ecj in the biotechnologies case326 and the principle of consistent interpretation. it is therefore necessary to assess whether, and to what extent, the review of relevant community action or inaction after the period for implementation of a dsb decision has expired in a liability action would undermine the institutional balance maintained by the court. advocate general alber discussed the issue quite broadly and started by giving a rather detailed analysis of the wto dispute settlement system. he essentially argued that there is no permanent alternative to complying with rulings and recommendations of the dsb and underlined that compliance cannot, in the end, be avoided by negotiations between the parties to the dispute327. it should be noted, however, that the ecj emphasised in portugal that to require the judicial organs to refrain from applying w to inconsistent rules would have the consequence of depriving the legislative or executive organs of the possibility of entering into negotiated arrangements even on a temporary basis328. alber further stressed that, even though non-implementation may be a commercial policy option, it is not under any circumstances a legally valid option, as under the w to law there is no discretion left to the legislative and executive organs that could be limited by recognising direct effect to wto law. the existence of such a commercial policy option on the whole is due to the lack of enforcement measures under international law. the fact that suspension of concessions is the only measure under international law to coerce the community to comply with the dsb decision cannot, as the advocate general in my opinion quite rightly argued, be used as an argument by the court to justify that they are not respected. the court had a choice to make between accepting the commercial policy option through the exercise of judicial self-restraint329, or respecting the principle of legality by recognising the binding effect of the dsb decisions and the right of individuals to rely on them in a compensation action. alber urged the court to make a decision in the favour of the latter. nordic journal of commercial law, issue 2004 #1 37 what the present author finds more noteworthy in the opinions is the arguments alber submitted to distinguish between giving effect to dsb decisions in liability actions on one hand, and in actions that could lead to annulment on the other. as an action for damages cannot as such compel the institutions to adopt or withdraw any measures to change the legislation, the risk of the success of such an action would lead to a lower degree of limitation of the discretion of the institutions than would an action conceivably resulting in the annulment of a measure. alber made it clear that the type of effect of dsb decisions he advocates for is only to be applied in actions for damages and would merely give the applicant the right to claim compensation from the community. consequently, in biret the action could have not resulted in the court requiring the institutions to allow the import of beef treated with hormones330. implementing the wto dispute settlement recommendations given in bananas and hormones cases involves taking important socio-economic and political considerations into account. as regards the prohibition of import of beef treated with hormones it is obvious that health and consumer protection were crucial for the introduction of the measures adopted by the institutions and remain central in the (non-)implementation of the dsb recommendation331. with regard to the issue of common market organisation for bananas, some member states of the ec believe that they have a moral responsibility towards some of the acp countries producing bananas and immediate compliance with the dsb rulings could have put such interests into jeopardy332. we are, thus, dealing with situations where the discretion of the community institutions plays an important role. however, the interests of some private operators can be in a clear conflict with the more general interests, as for example the position of the companies targeted by punitive duties well illustrates. accepting the type of effect of dsb decisions proposed by alber could perhaps be desirable. at the same time it could not compel the institutions to adopt or amend legislation which conflicts with the highly important general interests concerned, it would still guarantee that the rights of private parties are not entirely ignored when the community is acting in a manifestly wto-illegal manner. in the present author’s view, this would lead to a better balance of interest than giving effect to dsb decisions in annulment actions, or not according them any effect at all. it would still be wrong to say that the possibility to bring actions for damages invoking w to law even under these exceptional circumstances would not limit the discretion of the institutions in any manner. naturally the risk of liability arising as a consequence of their actions affects the decision-making of the legislative organs. it increases the pressure on the institutions in respect to implementing rulings and recommendations of the dsb. however, the significance of such limitation of discretion should be weighed against the principle of legality. accepting the proposed type of effect of dsb decisions in liability action would mean giving much more respect to the latter than has been the case so far. 6.3.4. reciprocity argument the ecj did not make any inquiries in biret whether any of its major trading partners would also allow a liability claim based on measures found to be in violation of wto law by the dsb. as it did not even mention such considerations, it might be prepared to waive the requirement of reciprocity in this connection333. the advocate general submitted some observations on the issue. his attitude towards the reciprocity argument in general is quite critical. he contended that the argument is a pure policy argument only disguised as a legal argument by calling it the “principle of reciprocity”334. first, alber acknowledged that the us legislation has excluded the possibility of private claims against nordic journal of commercial law, issue 2004 #1 38 wto-illegal provisions. he went on and considered that the council’s unilateral statement335 could not as such establish a similar position for wto law in the community legal order. alber came to a similar conclusion as ag saggio in portugal and considered that the statement the council made in the preamble of its decision concluding the wto agreement lacks legal relevance in the community legal order mainly on the ground that the court is under article 300 (7) ec bound by the wto agreement and a provision of secondary community law may not conflict with treaty provisions. alber also reminded of the rule laid down by the ecj in kupferberg that lack of reciprocity may not as such prevent the direct effect of an international agreement binding on the community336. he did not elaborate much on what makes the argument less important to the proposed effect than it is with regard to wto law in general. he found it doubtful whether the community’s position in negotiations really could be weakened by allowing ‘direct effect’ to wto law in a limited manner in actions for damages. such effect would, according to alber, only occur if it were possible for the parties to the dispute to agree that wto-illegal provisions could remain in force permanently.337 finally, alber emphasised that the principle of legality would be trumped if the court would find such a policy argument more important. the type of effect proposed here is clearly far more limited than the one in issue in portugal. the risk of being systematically faced with liability for the harm caused by retaliator y measures could weaken the community’s position in negotiations and limit its ‘bargaining power’ to some extent. the argument is, however, less forceful than if the effect could lead to the annulment of the community measure. it should be noted that the court does not apply the argument consistently as it did not consider the lack of reciprocity an obstacle when it established the nakajima exception and reconfirmed its applicability in the framework of w to law, even though the application of the exception renders the legal effects of wto agreements within the community legal system further reaching than in the legal systems of the community’s main trading partners338. therefore, in the present author’s view the principle of reciprocity cannot as such prevent the court from letting private parties to rely on w to law under the exceptional circumstances under consideration. 7. establishing unlawfulness 7.1. general if the ecj considers that wto law could be relied on by private parties in a liability action, the applicants would still have to show that the behaviour of the community institutions was unlawful. the liability cases in issue involve situations where the wto dispute settlement organs have confirmed the unlawfulness of the conduct of the institutions. whether this suffices to trigger the liability of the community will be assessed in the light of the schöppenstedt conditions. the applicant would, thus, have to show that the wto rules relied on are intended to confer rights on individuals. this condition will undoubtedly be very difficult to meet. if the applicant would succeed in this, he would still have to prove that the breach was sufficiently serious. in biret unlawfulness was claimed to be constituted by the adoption of directives imposing a wto incompatible ban on importation of hormone treated beef339 and the subsequent failure by the ec to withdraw or amend these measures within the prescribed reasonable time340. correspondingly, the community has, allegedly, acted unlawfully when it has adopted the wto-illegal banana import regime and failed to amend it to comply with the dsb decisions given in connection to the bananas dispute. nordic journal of commercial law, issue 2004 #1 39 7.2. does wto law contain rules intended to confer rights on individuals? the ecj has said on numerous occasions, although not in actions under article 288(2) ec, that wto provisions are not intended to confer rights on individuals, which they can rely on before the courts341. as noted, the cfi has recently made similar statements also in liability actions342. the requirement in question seems to be the most difficult precondition of liability to meet. in the light of the statements of the ecj and the cfi, it seems that accepting that some of the wto provisions could be intended to confer rights on individuals would mean, especially for the cfi, adopting a new stance. the opinions of advocate general alber in biret urged the court to change its view and brought up several arguments in support of the view that the sps agreement, indeed, is intended to confer rights on individuals.343 the ecj did not discuss the issue but, instead, rejected the plea on the basis that no damage had been suffered. the cfi stressed in biret that “the purpose of the wto agreements is to govern relations between states or regional organisations for economic integration and not to protect individuals”344. it is true that the wto is an inter-governmental organisation in which private business operators do not have any direct role345. they have, however, been claimed to be the main beneficiaries of the multilateral trading system346. for example petersmann considers that “the formulation of international trade rules in terms of rights and obligations of states is no convincing reason for preventing individuals from invoking precise and unconditional international guarantees of freedom and non-discrimination”, such as the gatt rules underlying the customs union rules of the ec treaty347. indeed, one of the most important reasons for the establishment of a ‘rule-oriented’ international economic system by the wto agreements was the security and predictability it guarantees for private business operators, which enable them to plan better for longer-term investment and operate in the commerce between nations with vastly differing governmental and cultural structures348. in section 301 case the wto panel recognised that: “proving security and predictability to the multilateral trading system is another central object and purpose of the system (…) the security and predictability on question are of ‘multilateral trading system’. the multilateral trading system is, per force, composed not only of states but also, indeed mostly, of individual economic operators. the lack of security and predictability affects mostly these individual operators. trade is conducted most often and increasingly by private operators. it is through improved conditions for these private operators that members benefit from wto disciplines.” 349 it is clear, at least in the light of the panel report in the section 301 case, that at the level of wto the rules appear to be envisaged to be for the protection of the individuals. the approach is very different of than the view of the ecj and the cfi as the following passage of the section 301 case well illustrates: “it would be entirely wrong to consider that the position of individuals is of no relevance to the gatt/wto legal matrix. many of the benefits to members which are meant to flow as a result of the acceptance of various disciplines under the gatt/wto depend on the activity of individual economic operators in the national and global market places. the purpose of many of these disciplines, indeed one of the primary objects of the gatt/wto as a whole, is to produce certain market conditions which would allow this individual to f lourish”350. it should be noted that the ecj has held in the kampffmeyer351 case that if a rule has the function of protecting or developing the general interest, this will not necessarily prevent it from having a dual purpose in that it also has the function of protecting the interests of individuals. the fact that the wto agreements have as their purpose the protection of a general interest – namely the liberalisation nordic journal of commercial law, issue 2004 #1 40 of trade – does not as such exclude that the provisions can protect the interests of individuals at the same time.352 neither has the applicant been required to prove that the rule of law alleged to have been breached is intended to protect the specific interests of the individual concerned. instead, it has been sufficient to show that the rule is for the protection of the individuals generally353. the condition is, thus, easier to satisfy than the requirement of direct and individual concern under article 230(4) ec, which has been applied ver y strictly by the courts354. alber argued that the provisions of the sps agreement in specific aim to abolish discriminator y measures, which restrict the private business operators’ right of freedom to pursue trade. he also submitted that the wto agreements regulate primarily market access rules and within the ec legal order similar rules, for instance article 25 ec, are directly applicable. this part of the reasoning of advocate general is not necessarily watertight bearing in mind the established case law of the court, according to which the similarity between provisions of ec treaty and of international agreements does not indicate that the provisions should be interpreted in the same way. the reason for this is that the purposes of other agreements vary from that of ec treaty355. clearly there are huge differences between the objectives of the ec treaty and the wto agreements356. 7.3. does the non-implementation of dsb rulings and recommendations involve a suffi ciently serious breach? 7.3.1. the brasserie du pecheur criteria the actions for damages brought due to non-implementation of dsb decisions in bananas and hormones cases involve targeting community action or inaction in legislative fields characterised by the exercise of wide discretion357. in such areas of legislation the applicant has been required to show that the institution concerned has manifestly and gravely disregarded the limits on the exercise of its powers in order to establish a sufficiently serious breach358. even though the criteria have been notoriously difficult to fulfil, the discretion of the institutions is not unlimited as has been seen for example in the sofrimport359 and mulder360 cases. earlier, the ecj seemed to demand that the conduct of the defendant institution lying behind the illegality be shown to be verging on the arbitrary361. it has, however, subsequently held that fault in the nature of arbitrariness is not required for liability362. some commentators have suggested that arbitrariness would still have to be demonstrated in circumstances in which the discretion of the institution adopting the legislation is as wide that the institutions have almost unrestricted powers of action363. after the bergaderm judgement, that strengthened the significance of the principle of parallelism, it might be thought that it is sufficient for the applicants to show that the breach is sufficiently serious in the light of the criteria established by the ecj in brasserie du pecheur. accordingly, the factors to be taken into account are the clarity and preciseness of the rule, whether the infringement and damage caused was intentional or involuntary, whether any error of law was excusable or inexcusable and the measure of discretion left by that rule to the national or community authorities364. it seems convincing to maintain that the wto rules dealt with are adequately clear and precise especially as they have been dealt with during the wto dispute settlement procedure and their content has been clarified by the wto organs. neither can an excusable error of law be involved after the wto-breach has been confirmed and a specific obligation to amend the legislation has been set. reinisch simply contends that the dsb decision excludes any discretion the violated wto nordic journal of commercial law, issue 2004 #1 41 rule could otherwise leave to the community authorities 365. as regards the intentional or involuntary nature of the breach and the damage caused, it would appear somewhat peculiar to maintain that the institutions were not aware that their action was in breach of wto law, in particular as regards the failure to amend the condemned rules. zonnekeyn asserts that it was so obvious that the amendments to the banana import regime were contrary to wto law that one could argue that the ec consciously tried to avoid the implementation of the wto rulings366. naturally the same applies to the disregard of the dsb recommendation in the hormones case. both commentators who have discussed this problem, reinisch and zonnekeyn, agree that the breach can be seen as sufficiently serious in the light of the brasserie du p˜cheur conditions367. it is not entirely clear whether it is enough that these conditions are met for the community to incur liability. therefore, a brief look at the other conditions the have been considered essential in the case law concerning actions under art. 288 (2) ec will be necessary. 7.3.2. other conditions in assessing the seriousness of the breach made by community institutions, the court has taken into account the consequences of the breach. in the ireks-arkady case the violation of the superior rule of law was qualified as manifest and grave because it affected a limited and clearly defined group of commercial operators and went beyond the bounds of the economic risks inherent in the activities in the sector concerned368. as regards the ‘innocent exporters’ cases, it is clear that the punitive import duties applied to a particular group of products affect a limited and clearly defined group of companies369. whether or not the companies will otherwise be affected by the upholding of wto-illegal banana import regime or the ban on importation of hormones treated beef, depends on the circumstances of each case. it might be thought that the liability actions based on non-implementation of w to dispute settlement should be rejected if a large number of traders had been affected by the breach. it is clear that that such a factor cannot any longer affect the assessment of gravity of the breach. in the hnl case one of the grounds to reject the claim was that the contested measure affected a very large category of traders. the case law was, however, relaxed in that regard in mulder370. there the ecj considered that the damage need only be confined to a ‘clearly defined group’, as opposed to a ‘limited group’. the court appeared to agree with the view that the fact that loss has been caused to a large number of traders rather constitutes an indicator of the seriousness of the breach than a ground for rejecting the claim, even though such conclusion might have serious financial implications.371 as regards the condition that the consequences of the behaviour of the defendant institution were serious, in the sense that they exceeded the bounds of the economic risks inherent in carrying on business in the relevant sector of the market372, the unification of the conditions of community and member state liability makes it arguable, whether the condition should be taken into consideration at present. a similar condition is not to be met under the rules governing the member state liability373. tridimas seems to consider that the condition remains a requirement for community liability also after bergaderm374. craig and de b³rca, on the other hand, have taken the view that the applicant should no longer, as a matter of principle, have to show that the loss suffered was serious, since it is not a part of the brasserie du p˜cheur test375. if the court is serious about unifying the conditions also in practice, the condition should not be taken into consideration. what may cause problems to the applicants is that a breach has not been considered sufficiently nordic journal of commercial law, issue 2004 #1 42 serious where the community institution has exercised its discretion in the way it did because of an overriding public interest which justified the harm caused to individual interests376. the court has tried to justify the general difficulty of recovering compensation from the community for loss caused by its measures as follows: “the legislative authority, even where the validity of its measures is subject to judicial review, cannot always be hindered in making its decisions by the prospect of applications for damages whenever it has occasion to adopt legislative measures in the public interest which may adversely affect the interests of individuals377.” what makes the situation slightly problematic is that there is no clear definition for “an overriding public interest” but it is dealt with subjectively on a case by case basis378. nonetheless, it is the superior rule of law which will set the limitation on the freedom of action by the community institution379. 8 conclusion the overview to the position of the individual in relation to the wto law within the community legal order shows that the ecj has categorically ruled out the possibility that private parties could challenge community measures on the basis of wto law provisions. instead, the court has supported a limited enforceability of wto law. wto law rules may become available to private parties through the application of the nakajima doctrine and the principle of consistent interpretation. the ecj has also more recently introduced new situations where private parties may be allowed to rely on wto law provisions. the statements made in the biotechnologies and dior/tuk cases can be seen to ref lect the discomfort the ecj appears to be experiencing with the general position that the wto agreements are not considered justiciable and cannot be relied on by private applicants380. the lack of justiciability of wto law relates to the conflict between the empowerment of individuals and courts on one hand and the discretion of the political and executive institutions of the community on the other. the exceptions developed in the case law make wto available to private parties making sure at the same time that the margin of discretion of the community institutions is not seriously undermined. they can be seen as fair attempts by the court to strike a balance between the power of the community institutions and the interests of the individuals. the solution appears to be wiser in the current international setting than allowing direct effect to wto law, thereby tying the hands of the community institutions at the international level. in principle, the present author agrees with this. the analysis above showed, however, that the exceptions have several shortcomings and their limited applicability can leave important gaps to the system. one of such gaps exists in the case of wto dispute settlement decisions. the analysis of how such decisions have been dealt with in actions for annulment showed that so far they have not been given any effect in the community legal order despite of their, arguably, binding nature at the international law level. the ‘direct effect’ of dsb decisions appears to be, in the present author’s opinion, rightfully ruled out and the very narrow approach to the nakajima doctrine has prevented the decisions from becoming available to private parties through the application of that exception. neither can the principle of consistent interpretation benefit the applicants in any manner in this context. what is the effect of the general rules on invocation of wto law on liability actions? what makes the question interesting is that it has been considered that a rule of law does not necessarily have to be directly effective in order to be invoked in a liability action. the cfi has, however, adopted a stance according to which it follows from the position of w to law in community legal order that it nordic journal of commercial law, issue 2004 #1 43 cannot benefit private parties in liability actions unless an exception applies. the ecj seemed to reproach the cfi in biret for taking such a shortcut. the cfi examined the applicability of the nakajima exception in liability cases involving non-implementation by the ec of dsb decisions. the inadequacies of the doctrine apply similarly to liability actions and other types of actions. first, the exception is of no use if the ec has ignored the dsb decision and not even attempted to implement it. there is no convincing reason for distinguishing between the position of the applicant, on one hand, in a situation where the ec has attempted to implement a dsb decision but failed in it and, on the other hand, in a situation where the ec has not taken any action in order to amend its condemned legislation. second, the scope of application of the nakajima exception is very narrow. this implies that the institutions have a complete freedom to control the application of the exception by means of preambular language. this of course fits neatly in the picture where the court exercises judicial self-restraint and is not willing to limit the discretion of the institutions. it was shown that allowing private parties to rely on wto law in liability actions would not limit the discretion of the institutions to a similar extent as making wto available to the applicants in actions, which could lead to annulment. this is mainly because the applicant can merely claim compensation in a liability action and the court cannot compel the institutions to take any legislative measures. since the nakajima exception applies, in principle, similarly in both types of actions, such considerations cannot, however, be taken into account in its application. taking into account these shortcomings of the exception, it can be concluded that if the court wished to enhance the legal effects of an adopted wto dispute settlement finding the community does not comply with, the nakajima exception probably does not provide for the best means to it. the biret case gave some indications that the ecj might be willing to let private parties to rely on wto law provisions in liability actions under the circumstances that there is a dsb decision obligating the ec to amend its legislation but it has failed to do so within the prescribed reasonable period of time. the community could in any event incur liability only for damage suffered by the applicant after the period for the implementation has lapsed. in order to determine whether such an ‘exception’ could be established, it was necessary to assess whether or not the proposed type of effect of wto law would clash with the underlying principles of the case law of case law of the ecj regarding the effect of wto law in the community legal order. the fact that the community’s main trading partners, at least the us, do not allow a similar effect to wto law in their legal order would speak against the exception. however, this is not a compelling reason to reject such an effect as the principle of reciprocity has not been applied consistently as also the nakajima exception allows such effects to wto law in ec legal order that do not exist in the legal orders of its main trading partners. the effect of the exception on the margin of manoeuvre of the community institution is crucial. it can be concluded that establishing the type of effect in question would limit the discretion of the institutions to some extent but not as forcefully as if dsb decisions were allowed to relied on by private parties in other types of actions. deciding whether to accept the exception involves a careful balancing of interests. the interests of individuals and the importance principle of legality should be weighed against the commercial policy interests of the community and the wide discretion of its political institutions. in the present author’s view the balancing of interests should under the limited circumstances in question lead to allowing private parties to rely on wto law. nordic journal of commercial law, issue 2004 #1 44 even though private parties were allowed to rely on wto law in liability actions, they would still have to show that the defendant institutions have acted unlawfully. this would require the applicant to establish that the wto provision relied on are intended to confer rights on individuals. it seems that this is the biggest obstacle in bringing a successful action for damages on the basis of wto law as both the cfi and the ecj have stated that the w to agreements are not intended to confer rights on individuals. as regards the chances of success of the liability actions brought due to non-implementation by the ec of dsb decisions from the point of view of establishing the sufficient seriousness of the breach, it can be concluded that in the light of the (arguable) relaxation of the relevant conditions, it does not appear to be ruled out that the applicants might succeed in showing that the breach was sufficiently serious. however, if the court is not really serious about unifying the conditions of community and member state liability also in practice, the possibility for the actions in question to succeed is extremely hard to reach even though the applicants were otherwise allowed to rely on wto provisions. (footnotes) 1 european communities – regime for the importation, sale and distribution of bananas, report of the panel of 22 may 1997, wt/ds27/ r; european communities – regime for the importation, sale and distribution of bananas, report of the appellate body of 9 september 1997, wt/ds27/ab/r. 2 european communities – measures concerning meat and meat products (hormones), report of the panel of 18 august 1997, wt/ds26/ r/usa; european communities – measures concerning meat and meat products (hormones), report of the appellate body of 16 january 1998, wt/ds26/48/ab/r. 3 the opinions of advocate general alber of 15 may 2003 in cases c-93/02 p, biret internationa sa v. council and c-94/02 p, etablissements biret and cie sa v. council, not yet reported. 4 cases c-93/02 p, biret international sa v. council and c-94/02 p, etablissements biret and cie sa v. council, not yet reported. 5 snyder, 2003. 6 mainly zonnekeyn, 2001a; zonnekeyn, 2003. 7 reinisch, 2000. 8 peers, 2001b. 9 davies, 2003. 10 the most important of these include: tridimas, 2001; wakefield, 2002; ward, 2000. 11 it does not follow from article 300 (7) ec that the community should give effect to its international obligations in a certain way. it also cannot be concluded from it that when the ec fails to respect its international obligations, review of legality should be an option. klabbers, 2000, p. 271. 12 cases 21-24/72, international fruit co.nv v. produktschap voor groenten en fruit, [1972] 1219. 13 case 181/73, haegeman v. belgium, [1974] ecr 449. since no supplementary measure transposing the provisions into the ec legal order is needed to form an integral part of that legal order, the court appears to adhere to a monist approach to the relationship between international law and community law. lenaerts – de smijter, 2000, p. 104. however, the status of wto law in ec legal order has provoked many to argue that the approach is dualist rather than monist. 14 normally, in public international law, individuals are third parties to international agreements even if intended to be the nordic journal of commercial law, issue 2004 #1 45 beneficiaries. treaties have a binding effect only between the signatories. cheyne, 1994, p.586. the effects of treaties in national legal orders vary from one state to another. in some states the legal system allows individuals to invoke the provisions of treaties in courts if, normally, treaty has been attributed with direct effect. schermers, 1982, p. 567. 15 case 104/81, hza mainz v. kupferberg [1982] ecr 3641. 16 schermers, 1982, p. 567. 17 see case jego-qu–r– where the cfi quite revolutionarily tried to introduce a change in the conditions for access to court and upa, where the ecj strictly overruled cfi’s decision. case t-177/01, jego qu–r– v. commission [2002] ecr ii-2365; case c-50/00p, union de pequenos agricultores v. council [2002] ecr i-6677. 18 cases 21-24/72, international fruit co.nv v. produktschap voor groenten en fruit, [1972] 1219. 19 the discussion between the establishment of the wto and the ruling of the ecj in portugal v. council was extensive. see inter alia monta»a i mora, 1996; eeckhout, 1997; scott, 1995; louis, 2000; lauwaars, 2000; petersmann, 1995. 20 eeckhout, 1997, p. 42. 21 in addition to that, the most notable features in the new system are the single undertaking approach, the abolition of the socalled grandfather rights, a legal personality for the new organisation and the stringent conditions required for adopting safeguard measures. monta»a i mora, 1996, p. 51. see for a comprehensive examination of the main changes in the mechanism petersmann, 1997, pp. 177-199. 22 case c-149/96 portugal v. council,[1999] ecr i-9395. see for more detailed comments inter alia eeckhout, 2002; zonnekeyn, 2000; rosas, 2000; desmedt, 2000; peers, 2001; van den broek, 2001; griller, 2000. 23 council decision 96/386/ec of 26 february 1996 concerning the conclusion of memoranda of understanding between the european community and the islamic republic of pakistan and between the european community and the republic of india on arrangements in the area of market access for textile products, [1996] oj l153/47. 24 case c-149/96 portugal v. council [1999] ecri 8395, para. 47. 25 ibid. para. 32. 26 griller, 2000, p. 442. 27 the issue is by its nature as such that it is impossible to entirely exclude from discussion the political considerations underlying the more or less legal reasoning. 28 case c-149/96 portugal v. council [1999] ecri 8395, para. 36. 29 ibid. para. 37. 30 ibid. para. 39. 31 case c-149/96 portugal v. council [1999] ecri 8395, para. 40. 32 ibid. para. 41. the finding of the court that wto agreements do not provide neither for mandatory or suggested direct effect of any parts of the agreement seems correct. it has been argued that the wto itself prefers negotiations to clear and unconditional judgements and does not expect, or want, its members to accord direct effect to wto rules. due to the complex character of the rules and mechanisms, the disputes concerning the application of wto rules might be best resolved before the wto’s dispute settlement bodies. certainly there would be a danger that other instances, i.e. national or even community courts, would not be capable of giving appropriate and consistent interpretation of the rules. see, pischel, 2001, p. 130; eeckhout, 1997, p. 50. contra petersmann, 2001, p. 105. 33 case c-149/96 portugal v. council [1999] ecri 8395, para. 45. the court came to this conclusion regardless of the fact that it had stated in kupferberg that “the fact that the courts of one of the parties consider that certain of the stipulations in the agreement are of direct application whereas the courts of the other party do not recognise such direct application does not in itself constitute a lack of reciprocity in the implementation of the agreement.” case c-104/81 hza mainz v. kupferberg [1982] ecr 3641, para. 18. it would seem at first sight that the doctrine of non-reciprocity in respect of direct effect conf licts with such nordic journal of commercial law, issue 2004 #1 46 position but, as kuijper puts it, “it does not stand up to scrutiny when a treaty may have such important and wide-ranging consequences for the national economy as does the gatt, and now the wto and its annexes. in the case of such a treaty, the party whose constitutional and judicial system does not know the mechanism of direct effect of treaty provisions – or, worse still, specifically excludes such direct effect – places itself in such a favourable position that it becomes fundamentally unfair to its trading partners. in this way it shields itself against what was called above the most powerful enforcement mechanism for treaties, and its negotiators, when discussing interpretation and application of the treaty, arrive with free hands at the table, contrary to their counterparts from countries with direct effect, whose hands are tied by the interpretations of their courts.” kuijper, 1995, p. 64. 34 case c-149/96 portugal v. council [1999] ecri 8395, para. 46. 35 see for an analysis on the political ground s behind the court’s case law pischel, 2001. 36 case c-149/96 portugal v. council [1999] ecri 8395, para. 46. 37 eeckhout, 2002, p. 96. 38 snyder, 2003, p. 331. 39 van den broek, 2001, p. 440. note that the question whether wto law confers rights to individuals is very debatable. 40 according to zonnekeyn, the marge de manoeuvre argument of the ecj is ”clearly not a legal argument and an assault to the “trias politica” principle.” see zonnekeyn, 2000b, p. 299. 41for the defence of the court can be said that at least it did not try disguise its true grounds behind the judgement by formal legal reasoning. eeckhout, 2002, p. 96. the current view of the court on the relationship between the wto law and ec law have seems quite realistic. as snyder put it, the ecj “articulated a view of the relationship between wto law and ec law which was less legalistic, more politically cognisant and hence more realistic in the current international setting. it began to point the way toward a much more coherent conception of the relation between the two sites, notably with regard to who should make the basic decisions about the impact of wto law in the ec legal order and how such decisions should be made.” snyder, 2003, p. 329. 42 the same does not, however, necessarily apply to the same extent with respect to the implementation of dsb rulings and recommendations. see cottier – schefer, 1998, pp. 112, 117. 43 see for a comprehensive work on the relationship between the eu and the wto and on how the two sites take non-economic interests into account, dillon, 2002. 4 4 this is not to say that the commercial policy interests would not, more or less, play the main role here. 45 council decision 94/800 ec of 22 december 1994 concerning the conclusion on behalf of the european community, as regards matters within its competence, of the agreements reached in the uruguay round multilateral negotiations (1986-1994), [1994] oj l336/1, last recital of the preamble. 46 as regards the effects of the preambular statement at international level, saggio considered it very clear that a unilateral interpretation of the agreement made in the context of an internal adoption procedure cannot limit the effects of the agreement itself. this is in accordance with customary law on the interpretation of treaties, which was embodied in the vienna convention of 22 may 1969. 47 para. 20 of the opinion of advocate general saggio of 25 february 1999 in the case c-149/96 portugal v. council [1999] ecri 8395. 48 case c-149/96 portugal v. council [1999] ecri 8395, para. 48. 49 case c-149/96 portugal v. council [1999] ecri 8395, para. 42. 50 case c-17/81 pabst & richarz v. hauptzollant oldenburg [1982] ecr 1331; case c-12/86 demirel v. stadt schwäbisch gm·nd, [1987] ecr 3719; case c-192/89 sevince v. staatsecretaris van justitie, [1990] ecr i-346. 51 meaning acp countries. case c-87/75 bresciani v. amministrazione italiana delle finanze, [1976] ecr129. nordic journal of commercial law, issue 2004 #1 47 52 snyder, 2003, p. 334. see also rosas, 2000, p. 813. 53 see for a critical and thorough analysis of this aspect of portugal v. council, griller, 2000, p. 457 – 460; peers, 2001a, p. 121. 54 eeckhout, 2002, p. 95. 55 dillon described the nature of wto law as follows: “gatt/wto-law is not merely a set of international obligations, freely undertaken, falling only on the regulatory efficiency of the community. rather (…) it is a unique kind of law, having openended implications, capable of interfering with legislative and regulatory programmes of the widest variety.” dillon, 2002, pp. 6, 384. 56 such autonomy might, according to snyder, lead to “the phenomena of judicial self-empowerment and “creeping competence”, whit which the wto probably is not equipped with to deal with. snyder, 2003, p. 333. 57 snyder, 2003, p. 333. 58 the applicants raised an ‘absence of direct effect’ -argument in the cases where the exception was established. the court decided with apparent ease not to look for direct effect. it may appear somewhat odd taking into account how the court has insisted on direct effect otherwise in connection to wto law and international agreements in general. see klabbers, 2003, pp. 287-288. 59 case c-70/87, fediol v. commission, [1989] ecr 1781. 60 case c-69/89, nakajima v. council [1991] ecr i-2069. 61 case c-149/96, portugal v. council,[1999] ecr i-9395, para. 49. 62 case c-69/89, nakajima v. council [1991] ecr i-2069. 63 eeckhout, 1997, p. 44. see also case c-280/93, germany v. council [1994] ecr i-4973 and case c-188/88, nmb v. commission, [1992] ecr i-1689. 6 4 case c-70-87, fediol v. commission, [1989] ecr 1781 para 21. the ‘new commercial policy instrument’ has subsequently been replaced by the trade barriers regulation. council regulation 3286/94/ec [1994] oj l349/71. 65 cases t-33 and 34/98, petrotub sa and republica sa v. council, [1999] ecr ii-3837; c-352/96, italy v. council, [1998] ecr i-6937; t-55/99, confederacion expanola de trasporte de mercancias (cetm) v. commission, [2000] ecr ii-3207. 66 case c-76/00p, petrotub sa and republica sa v. council and commission [2003] ecr i-2877. 67 case c-76/00p, petrotub sa and republica sa v. council and commission [2003] ecr i-2877, para. 56. 68 see e.g. griller, 2000b, p. 464. 69 according to the preamble, the regulation was “adopted in accordance with existing international obligations, in particular those arising from article vi of the general agreement and from the anti-dumping code.” case c-69/89 nakajima v. council [1991] ecr i-2069, paras. 30-31. in petrotub: “the preamble to the basic regulation, and more specifically, the fifth recital therein, shows that the purpose of that regulation is, inter alia, to transpose into community law as far as possible the new and detailed rules contained in the 1994 anti-dumping code.” case c-76/00p, petrotub sa and republica sa v. council and commission [2003] ecr i-2877, para. 55. 70 davies, 2003, p. 320. 71 naturally, a more general reference to wto commitments is required. 72 see peers, 2001b, p. 610. 73 see zonnekeyn, 2001b, p. 602. similarly, see snyder, 2003, p. 347. 74 the ecj stated that: “by adopting the regulation pursuant to agreements concluded with non-member countries following negotiations conducted on the basis of article xxiv (6) of gatt, the community sought to implement a particular obligation entered into within the framework of gatt.” case c-352/96, italy v. council [1998] ecr i-6973, para. 20. nordic journal of commercial law, issue 2004 #1 48 75 snyder, 2003, p. 347. case c-45/86, commission v. council, [1987] ecr 1493. 76 see similarly, davies, 2003, p. 318. 77 snyder, 2003, p. 347. 78 along with the application of the principle of consistent interpretation. 79 an interesting parallel exists with the direct effect of directives in internal european law. the court has refused to give directives horizontal direct effect but has effectively enlarged the scope of directives by the quasi-horizontal effect resulting from the marleasing case. the approach reaches a balance between sovereignty and individual rights leaving governments a certain amount of discretion and at the same time ensuring that they comply with their obligations. van den broek, 2001. p. 438. 80 the rather limited scope for the actual application of the doctrine is explicable on the basis that the court does not wish to interfere with executive discretion. davies, 2003, p. 323. 81 case c-61/94, commission v. germany, [1996] ecr i-3989. 82 case c-53/96 hermes international v. fht marketing choice bv [1998] ecr i-3603. 83 weatherill – beaumont, 1999, p. 417. the formula is similar to the one used in the case c-106/89 marleasing sa v. la comercial international de alimentacion sa [1990] ecr i-4135. 8 4 neuwahl, 1996, p. 321. 85 snyder, 2001, p.363. see also neuwahl, 1996, p. 322; trachtman, 1999, p. 677. 86 davies, 2003, p. 321. for instance in the case c-61/94 commission v. germany [1996] ecr i-3989 the german government argued that community law precluded it from complying with the international dairy agreement. the ecj rejected the argument on the basis of the obligation to interpret community law in a manner consistent with international agreements. 87 davies, 2003, p. 321. 88 case c-377/98, kingdom of the netherlands v. european parliament and council of the eu [2001] ecr i-6229. 89 directive of the european parliament and of the council 98/44/ec [1998] oj l213/13. 90 case c-377/98, kingdom of the netherlands v. european parliament and council of the eu [2001] ecr i-6229, para. 55. 91 see also the opinion of advocate general jacobs of 14 june 2001 in case c-377/98, kingdom of the netherlands v. european parliament and council of the eu [2001] ecr i-6229. ag jacobs argued inter alia that “it is in any event desirable as a matter of policy for the court to be able to review the legality of community legislation in the light of treaties binding the community. there is no other court which is in a position to review community legislation; thus if this court is denied competence, member states may be subject to conflicting obligations with no means of resolving them.” 92 it seems logical that the court, as davies suggested, introduced the rather unconvincing distinction between a directive which brings the community itself in breach of its international obligations and a directive which requires the member states to breach their international obligations in order to avoid an overt interference with the separation of powers. davies, 2003, pp. 322-323. 93 joined cases c-300/98, parfums christian dior v. tuk consultancy bv and c-392/98, assco ger·ste gmbh, rob van dijk v. wilhelm layher gmbh & co kg, layher bv, [2000] ecr i-11307, para. 48. 94 van den broek, 2001, p. 416. the ecj stated in para. 48 that “in a field in respect of which the community has not yet legislated and which consequently falls within the competence of the member states, the protection of intellectual property, and measures adopted for that purpose by the judicial authorities, do not fall within the scope of community law.” 95 van den broek, 2001, p. 416. 96 see opinion of advocate general cosmos in cases c-300/98 and c-392/98, parfums christian dior v. tuk consultancy bv, [2000] ecr i-11307, paras. 56 – 82. nordic journal of commercial law, issue 2004 #1 49 97 rosas, 2000, p. 816. 98 the position of the eu has been described in the following way: “the effect of wto rules is intended to be limited to international responsibility without threatening the predominance of national (or community) rules in a domestic context. it is a strategy of combining the utmost effect of wto law abroad with a view to foster market access rights while leaving traditional constitutional allocations of power at home as unimpaired as possible.” cottier – schefer, 1998, p. 111. 99 snyder, 2003, p. 364. 100 van den broek, p. 440. 101 eeckhout, 1997, p. 53. 102 snyder, 2003, pp. 362, 364. 103 zonnekeyn, 1999, p. 719. 104 opinion 1/91 (re the eea agreement) [1991] ecr 6079 para. 40. 105 macleod – hendry – hyett, 1996, p. 137. 106 macleod – hendry – hyett, 1996, p. 137. see opinion 1/76 (re the draft agreement for a laying up fund for the rhine) [1977] ecr 741, opinion 1/91 (re the eea agreement) [1991] ecr 6079 and opinion 1/92 (re the eea agrreement) [1992] ecr i-2821. 107 opinion 1/91 (re the eea agreement) [1991] ecr 6079 para. 39. 108 eeckhout, 1997, p. 52. 109 opinion 1/91 (re the eea agreement) [1991] ecr 6079 para 21. 110 cottier, 1998, p. 371. 111 zonnekeyn, 2000a, p. 108. 112 see for a comprehensive analysis of the changes in the system: petersmann, 1997, pp. 177-199. 113 palmeter – mavroidis, 1999, p. 153. 114 see inter alia the opinion of ag alber in case c-93/02 p, biret international v. council, para. 74. 115 jackson, 1998, p. 85. 116 see waincymer, 2002, ch. 9.7 for summary on the different views on the issue. 117 jackson, 2000, p. 163. 118 zonnekeyn, 2000a, p. 103. 119 zonnekeyn, 2001a, p. 259. 120 lukas calls this approach “pragmatic” as the former is “legalistic”. see lukas, 1995, p. 197-199. 121 see for an assessment of the political and legal costs of non-compliance: cottier, 1998, p. 364-367. 122 bello, 1996, 416-417. 123 article 3(7) for instance indicates that in the absence of a mutually acceptable solution, the first objective is usually to secure the withdrawal of the measures concerned if they are inconsistent with the agreement. this supports the non-binding nature of the obligation. on the other hand, to argue to the contrary, one may refer to article 22 (1) or to the part of the article 3(7), which states that compensation should be resorted to only if immediate withdrawal is impractical and only as a temporary measure. see waincymer, 2002, ch. 9.7.2. nordic journal of commercial law, issue 2004 #1 50 124 see united states – sections 301-310 of the trade act of 1974, report of the panel of 22 december 1999, wt/ds152/r, para. 7.76. 125 see kessie, 2000, p. 4. 126 eeckhout, 1997, p. 53. see also davies, 2003, p. 317 and louis, 2000, p. 504. louis finds that such a “position, which consists in admitting the legal value of wto provisions once that have been clarified through what is more and more like to a due process of law seems reasonable. conversely the immediate recognition of direct effect would interfere with this perspective. it would bring in the mechanism an element of automatism contrary to the intergovernmental trust of the system.” 127 note that the ecj also explicitly referred to the legal position of the community after the reasonable period for implementation has expired. c-149/96 portugal v. council [1999] ecri 8395, para. 39-40. emphasis added. 128 eeckhout, 2002, p. 104. see also omega where the court stated that “ the resolution of disputes concerning wto law is based, in part, on negotiations between the contracting parties. withdrawal of unlawful measures is indeed the solution recommended by wto law, but other solutions are also authorised, for example settlement, payment of compensation or suspension of concessions. joined cases c-27/00 & c210/00, the queen v. secretary of state for the environment, transport and the regions ex parte omega air ltd; omega air ltd. aero engines ireland ltd, omega aviation services ltd. v. irish aviation authority [2002] ecr i2569, para. 89. 129 case t254/97, fruchthandelgesellschaft mbh chemnitz v. commission [1999] ecr ii-2743. 130 council regulation 404/93/ec [1993] oj l47/1. 131 case t254/97, fruchthandelgesellschaft mbh chemnitz v. commission [1999] ecr ii-2743, paras. 26-27. 132 davies, 2003, p. 324. 133 case t254/97, fruchthandelgesellschaft mbh chemnitz v. commission [1999] ecr ii-2743, para. 30. 134 case t-230/97 comafrica spa and dole fresh fruit europe ltd & co v. commission [1997] ecr ii-3031. 135 ibid. para. 40. 136 see case t-13/99, pfitzer amimal health sa v. council [2002] ecr ii-1961. 137 see t-212/99, intervet international bv formerly hoechst roussel vet gmbg v. commission [2002] ecr 1445. 138 european communities – measures concerning meat and meat products (hormones), report of the appellate body of 16 january 1998, wt/ds26/48/ab/r. 139 see snyder, pp. 338-339. 140 eeckhout, 2002, p. 104. see also peers, 2001a, p. 116. also davies finds it “highly unlikely that a private applicant would ever be able to rely on a decision of the dsb in order to invalidate a regulation.” davies, 2003, p. 309. 141 peers, 2001a, p. 116. 142 as the ec is now faced with decisions which are binding in international law, and brought about in respect of due process of law and procedures equivalent to judicial settlement in national or international law. 143 cottier, 1998, pp. 373-375. 144 legal distinction between different types of non-implementation based on the motives and reasons stated in support of noncompliance would probably prove problematic. see peers, 2001a, p. 117. 145 peers, 2001a, p. 117. peers does not argue that dsb decisions should not have any effect at all but rather argues that the effect should be based on the nakajima doctrine. similarly, see eeckhout, 2002, p. 110. 146 petersmann, 1997, p. 139. 147 bourgeois, 2001, p. 121. nordic journal of commercial law, issue 2004 #1 51 148 such a situation is the first one of the three different scenarios described by peers, which may lead to a different end result. the second scenario involves a situation where the ec has purported to implement a panel report and it has been agreed at wto level that the implementation is correct. in this case the ec act should not be reviewed in light of the panel report even if the applicant disagree with the wto-compatibility. in the third scenario the ec’s purported implementation has been challenged at wto level but the dispute has not been concluded yet. in this unlikely case ec courts should suspend the case. peers, 2001a, p. 117. 149 such referrals have been omitted in all other ‘implementing’ measure concerned except for the very recent directive adopted as a result of the hormones case. the directive explicitly refers to a dsb recommendation. it appears clear that the nakajima exception applies if that directive is challenged on the basis of wto obligations. directive 2003/74/ec of the european parliament and of the council of 22 september 2003 amending council directive 96/22/ec concerning the prohibition on the use in stockfarming of certain substances having a hormonal or throstatic action and of beta-agonists, [2003] oj l262/17. 150 eeckhout, 2002, p. 107. 151 “implementation” as defined in the case law seems to have a different meaning from the common sense or generally accepted meaning. snyder, 2003, p. 347. see for a comprehensive list of ‘evidence’ supporting the view that the 1998 and 2001 legislation adopted as a result of the banana dispute was intended to implement wto obligations peers, 2001b, pp. 611-612, 614-615. see also zonnekeyn, 2001b, pp. 603-604. 152 the regulation explicitly provides that “the community’s international commitments under the world trade organisation (wto) and to the other signatories of the fourth acp-ec convention should be met, whilst achieving at the same time the purposes of the common organisation of the market in bananas.” council regulation 1637/98/ec [1998] oj l210/28, second recital of the preamble. 153 commission regulation 2362/98/ec [1998] oj l293/32. 154 see peers, 2001b, p. 611. 155 the cfi found that neither the panel report nor the appellate body report adopted by the dsb “included any special obligations which the commission intended to implement.” it also found that the commission regulation in question does not make express reference to any specific obligations arising of the reports of wto bodies. case t-18/99, cordis obst und gem·se grosshandel gmbh v. commission [2001] ecr ii-0913, para. 59. the findings will be discussed further below. they apply in this context to other types of actions as well. 156 in general, as the dispute settlement results clearly are part of the wto law, ec acts should, as far as possible, interpreted in the light of panel and appellate body reports. peers, 2001a, p. 118. case t-256/97 beuc v. commission [2000] ecr i-1209 confirms the application of the principle of consistent interpretation to w to rules. 157 davies, 2003, p. 321. 158 steiner, 1995, p. 146. see for example case c-146/91, kydep v. council and commission [1994] ecr i-4199, para. 58 159 case 4/69, alfons l·tticke gmbh v. commission [1971] ecr 325, para. 10. 160 case 5/71, zuckerfabrik schöppenstedt v. council, [1971] ecr 975 at 984, para 11; case c-352/98p laboratories pharmaceutiques bergaderm and goupil v. commission [2000] ecr i-5291. 161 wakefield, 2002, p. 43. 162 except for the very rare cases where the liability of the community for valid legislative (‘strict liability’) acts might occur. see for an overview of conditions bronkhorst, 1997, pp. 153-167. 163 brealey – hoskins, 1994, p. 232. 164 wakefield, 2002, p. xv, 89. the right to get compensated for damage caused by the communities has even been regarded as a fundamental right. see schermers – waelbrook, 2001, p. 520. 165 schermers – waelbrook, 2001, p. 548. see also fines, 1997, p. 23. fines is of the opinion, though, that the remedy does not fulfill this function. nordic journal of commercial law, issue 2004 #1 52 166 this is well illustrated by the fact that up until the year 1996 there had been only 8 successful article 288 (2) claims brought to the community courts. opinion of ag tesauro in joined cases c-46/93 and c-48/93 brasserie du p˜cheur sa v. federal republic of germany and factortame iii and the queen v. secretary of state for transport ex parte factortame limited and others [1996] ecr i-1029, n 65. 167 ward, 2000, pp. 8-10. 168 see fines, 1997, pp. 21-23. 169 as the court “ forces national tribunals to offer the citizen full protection, that is remedies which are much more effective than those which, in comparable situations, are available against community institutions.” caranta, 1995, p. 725. also ward points out that imperatives of a different nature than of ‘the individual’ and the need for an ‘effective remedy’ have prevailed when disgruntled subjects have questioned the legality of community measures. ward, 2000, p. 11. 170 ward, 2000, p. 11. 171 kilpatrick, 2000, p. 8-9. 172 ward, 2000, p. 289. 173 ward, 2000, p. 322. 174 waelbroeck perceived such direction in the case law as the court had shown a more flexible approach in accepting liability of institutions even in the context of their legislative activity. waelbroeck, 1997. p. 335. 175 case c-352/98p laboratories pharmaceutiques bergaderm and goupil v. commission [2000] ecr i-5291 176 for instance the seriousness of the breach is assessed according to a more relaxed criteria in the context of member state liability. some argue that the same standard now applies to community liability as well. see craig – de burca, 2003, p. 557. 177 joined cases c-46/93 and c-48/93, brasserie du p˜cheur v. germany and r. v. secretary of state for transport, ex parte factortame and others, [1996] ecr i-1145, para. 42. 178 tridimas, 2001, p. 326. see also reinisch, 2000, p. 44. 179 case c-352/98p laboratories pharmaceutiques bergaderm and goupil v. commission [2000] ecr i-5291, para 40. 180 tridimas, 2001, p. 322. 181 case 5/71, zuckerfabrik schöppenstedt v. council, [1971] ecr 975 at 984, para 11 182 case c-352/98p laboratories pharmaceutiques bergaderm and goupil v. commission [2000] ecr i-5291, para 62. 183 rather, the breach of a “superior” rule of law has been considered to be implicit in the concept of unlawfulness which normally is a condition for community liability to arise. see tridimas, 2001, pp. 328-329. on the other hand, aalto is of the opinion that the requirement of a “superior” rule of law was central to the differences between community and member state liability. aalto, 1999, p. 96. in my opinion deleting the reference to a superior rule is not crucial as it still in a way remains as a condition, since a measure can only breach another rule if the latter is superior. see similarly para. 76 of opinion of ag tesauro in joined cases c-46/93 and c-48/93 brasserie du p˜cheur sa v. federal republic of germany and factortame iii and the queen v. secretary of state for transport ex parte factortame limited and others [1996] ecr i-1029. 184 tridimas, 2001, p. 329; craig – de burca, 2003, pp. 549-550. 185 e.g. case 74/74, cnta v. commission [1975] ecr 533, para. 44, where the court held that the commission had infringed a superior rule of law by failing to include in a regulation “transitional measures for the protection of the confidence which a trader might legitimately have had in the community rules.” see also schermers – waelbroeck, 2001, p. 554. 186 joined cases 63-69/72, werhahn v. council [1973] ecr 1229; case t-489/93, unifruit hellas v. commission [1994] ecr ii-1201. 187 e.g. joined cases 83 and 94/76, 4, 15 and 40/77, hnl and others v. council and commission, [1978] ecr 1209, para. 5; case 238/78, ireks-arkady [1979] ecr 2955, para. 11; case t-489/93, unifruit hellas v. commission [1994] ecr ii-1201, paras. 76-80. nordic journal of commercial law, issue 2004 #1 53 188 case t-105/96, pharos v. commission [1998] ecr ii-285, paras. 73-78. 189 case t-167/94, nölle v. council and commission [1995] ecr ii-2589, para. 76. 190 case c-119/88, aerpo and others v. commission [1990] ecr i-2189, para. 19. 191 see schermers – waelbroeck, 2001. p. 554 and lenaerts – arts, 1999, pp. 264-265. 192 the requirement resembles the german ‘schutznormtheorie’, according to which the state is liable only when it breaches a legal norm that protects a subjective public right of the injured party. such rule must be intended to protect a specific circle of individuals to which the injured party belongs, and not only individuals in general. similar principles are known also in england and in the netherlands. the ecj has in practice applied the condition more liberally. schermers – waelbroeck, 2001, p. 553-554. 193 tridimas, 2001, p. 327. 194 there are, however, some principles of community law that have not been considered to have the protection of individuals as their purpose. the ecj has held, for instance, that the objective of the rules governing the division of powers between the community institutions is to maintain a balance between the institutions, and not to protect the individual. 195 in bergaderm, the ecj placed a particular emphasis on the degree of discretion enjoyed by the author of the act for the purpose of determining whether or not the breach is serious. the requirement of a sufficiently serious breach applies to all acts in relation to which the institution concerned enjoys wide discretionary powers irrespective of whether the measure is legislative or administrative in nature. by contrast, if the violation occurs in circumstances where the institution in question has only considerably reduced, or even no discretion, the mere infringement of community law may be sufficient to establish the existence of a sufficiently serious breach to be found. case c-352/98p laboratories pharmaceutiques bergaderm and goupil v. commission [2000] ecr i-5291, para. 44. the ecj referred there to hedley lomas, a case dealing with the liability of a member state. case c-5/94, the queen v. maff, ex parte hedley lomas [1996] ecr i-2553. 196 joined cases 83 and 94/76, 4, 15 and 40/77, hnl and others v. council and commission, [1978] ecr 1209, para 6. 197 tridimas, 1998, p. 23. 198 see craig – de b³rca, 2003, p. 555. 199 joined cases c-46/93 and c-48/93 brasserie du p˜cheur sa v. federal republic of germany and factortame iii and the queen v. secretary of state for transport ex parte factortame limited and others [1996] ecr i-1029, para. 56. 200 for a more specific analysis, see toth, 1997, p. 180-191. 201 although the treaty requires the community to make good “any damage”, a more restrictive approach has been applied in the case law of the court. 202 brealey – hoskins, 1994, p. 234. the ecj held that it can declare the ec liable for “imminent damage foreseeable with sufficient certainty even if the damage cannot yet be precisely assessed”. a reason for this view is that ”to prevent even greater damage it may prove necessary to bring the matter before the court as soon as the cause of damage is certain.” joined cases 5660/74, kampffmeyer v. commission and council [1976] ecr 711, para. 8. 203 such as damages for personal injuries and for pain and suffering. damages may also be claimed for penalties paid for repudiation of contracts, for lost profit on concluded of foreseeable contracts and for the wrongful abolition of production refunds. brealey – hoskins, 1994, pp. 234-235. 20 4 van gerven, 1994, p. 30. 205 douglas-scott, 2002, p. 401. the duty to mitigate derives from a general principle common to the legal systems of the member states “to the effect that the injured party must show reasonable diligence in limiting the extent of his loss or risk having to bear the damage himself.” joined cases 104/89 and 37/90,. mulder ii [1992] ecr i-3061, para. 26. 206 for a more specific analysis, see toth, 1997, p. 191-198. 207 as formulated in bergaderm. case c-352/98p laboratories pharmaceutiques bergaderm and goupil v. commission [2000] ecr i-5291, nordic journal of commercial law, issue 2004 #1 54 para 42. 208 toth, 1997, p. 192. 209 see for details of the dispute: jackson – grane, 2001; komuro, 2000. 210 see for details of the dispute: pardo quintillan, 1999, pp. 156-166; dillon, 2002, pp. 131-140. 211 european communities – regime for the importation, sale and distribution of bananas, report of the panel of 22 may 1997, wt/ ds27/r; european communities – regime for the importation, sale and distribution of bananas, report of the appellate body of 9 september 1997, wt/ds27/ab/r; european communities – measures concerning meat and meat products (hormones), report of the panel of 18 august 1997, wt/ds26/r/usa; european communities – measures concerning meat and meat products (hormones), report of the appellate body of 16 january 1998, wt/ds26/48/ab/r. 212 cases c-104/97 p, atlanta ag v. european community [1999] ecr i-6983; t-18/99, cordis obst und gem·se grosshandel gmbh v. commission [2001] ecr ii-0913; t-30/99, bocchi food trade international gmbh v. commission [2001] ecr ii-0943; t-52/99, t.port gmbh & co. kg v. commission [2001] ecr ii-0981; t-3/99, banatrading gmbh v. council [2001] ecr ii-2123; t-57/00, banankompaniet ab and skandinaviska bananimporten ab v. council and commission, judgement of 6 march of 2003, not yet reported. 213 cases c-93/02 p, biret internationa sa v. council, not yet reported; c-94/02 p, etablissements biret and cie sa v. council, judgements of 30 september 2003, not yet reported. 214 the so-called ‘innocent exporters’ case include at least: case t-69/00, fiamm spa and fiamm technologies inc. v. commission and council; case t-151/00, le laboratoire du bain v. council and commission; case t-301/00, groupe fremaux sa and palais royal inc. v. council and commission; case t-320/00, cartondruck gmbh & co. kg v. commission and council and case t-383/00, beamglow ltd. v. council, european parliament and commission. all these cases are still pending. case law followed until 31 december 2003. 215 on the basis of the results of further analysis of the risks associated with the use of the substances in question a directive seeking to maintain the prohibition was adopted. directive 2003/74/ec of the european parliament and of the council of 22 september 2003 amending council directive 96/22/ec concerning the prohibition on the use in stockfarming of certain substances having a hormonal or throstatic action and of beta-agonists, [2003] oj l262/17. 216 the commission approved a regulation that would implement a new banana regime. the regulation is a result of an understanding reached by the ec and us pursuant to which the ec would introduce a tariff-only regime for imports of bananas no later than the beginning of the year 2006. see in more detail jackson – grane, 2001, p. 591. council regulation 216/2001/ec [2001] oj l031/2 and commission regulation 896/2001/ec [2001] oj l126/6. 217 zonnekeyn, 2001a, p. 262. 218 since we are dealing with discretionary measures. it is now rather the degree of discretion enjoyed by the defendant institution than the fact whether the required measure is legislative or non-legislative in nature that counts for the application of the schöppentstedt formula as modified by bergaderm. see craig – de burca, p. 549. 219 see davies, p. 317. 220 cases c-93/02 p, biret internationa sa v. council and c-94/02 p, etablissements biret and cie sa v. council; case t-52/99, t.port gmbh & co. kg v. commission [2001] ecr ii-0981; case t-69/00, fiamm spa and fiamm technologies inc. v. commission and council, pending. 221 case t-30/99, bocchi food trade international gmbh v. commission [2001] ecr ii-0943; case t-52/99, t.port gmbh & co. kg v. commission [2001] ecr ii-0981. 222 case t-30/99, bocchi food trade international gmbh v. commission [2001] ecr ii-0943; case t-52/99, t.port gmbh & co. kg v. commission [2001] ecr ii-0981. 223 case t-52/99, t.port gmbh & co. kg v. commission [2001] ecr ii-0981; case t-69/00, fiamm spa and fiamm technologies inc. v. commission and council, pending. 224 case t-30/99, bocchi food trade international gmbh v. commission [2001] ecr ii-0943 225 case t-69/00, fiamm spa and fiamm technologies inc. v. commission and council, pending. nordic journal of commercial law, issue 2004 #1 55 226 case t-521/93, atlanta and others v. european community [1996] ecr ii-1707. 227 council regulation 404/93/ec [1993] oj l47/1. 228 case c-280/93, germany v. council [1994] ecr i-4973. 229 the cfi concentrated in the case mainly on pleas based on breach of certain fundamental rights. the plea concerning infringement of gatt was one of the ten pleas the cfi did not discuss in detail. case t-521/93, atlanta and others v. european community [1996] ecr ii-1707, para. 77. 230 case c-104/97 p, atlanta ag v. european community [1999] ecr i-6983. 231 european communities – regime for the importation, sale and distribution of bananas, report of the appellate body of 9 september 1997, wt/ds27/ab/r; 232 case c-104/97 p, atlanta ag v. european community [1999] ecr i-6983, paras. 17-23. 233 para 73 of the opinion of ag alber in c-93/02p, biret international sa v. council [2003]. 23 4 case t-18/99, cordis obst und gem·se grosshandel gmbh v. commission [2001] ecr ii-091. 235 case t-30/99, bocchi food trade international gmbh v. commission [2001] ecr ii-0943. 236 case t-52/99, t.port gmbh & co. kg v. commission [2001] ecr ii-0981. 237 commission regulation 2362/98/ec [1998] oj l293/32. 238 council regulation 404/93/ec [1993] oj l47/1. 239 council regulation 1637/98/ec [1998] oj l210/28. 240 note that this was explicitly mentioned by the cfi. see cases cordis, bocchi and t.port, para. 8. 241 the applicants also attempted in each case to base their actions on other issues, including the duty to state reasons, proportionality, equal treatment and the right to pursue trade. 242 the judgement in the portugal case was given after the lodging of the appeals. the parties were called on to submit their observations on the possible consequences of the judgement. the applicants admitted that the wto provisions did not have general direct effect but this did not affect the argumentation based on rules internal to community legal order. e.g. case t-30/ 99, bocchi food trade international gmbh v. commission [2001] ecr ii-0943, para. 38-39. 243 case t-18/99, cordis obst und gem·se grosshandel gmbh v. commission [2001] ecr ii-0913, para. 34. the applicant put forward an argument that since the ec had given an undertaking to the dsb to repeal the provisions conflicting with the wto rules, it had acted in breach of the principle nemini licet venire contra factum proprium when putting that undertaking into practice by adopting a regulation containing infringements of those rules. the court rejected the argument because an act of a community institution is vitiated by misuse of powers only if it was adopted with the exclusive or main purpose of achieving an end other than stated and the applicant did not even allege that the commission had acted in such a way. paras. 35, 52-54. 244 e.g. case t-18/99, cordis obst und gem·se grosshandel gmbh v. commission [2001] ecr ii-0913, para. 51. 245 eeckhout, 2002, p. 108. 246 see 6.2.2. for further analysis. 247 case t-174/00, biret internationa sa v. council [2002] ecr ii-17 and case t-210/00, etablissements biret and cie sa v. council [2002] ecr ii-47. 248 the ec adopted directive 81/602 which requires that member states prohibit the administering to farm animals of substances designed to promote growth. council directive 81/602/eec [1981] oj l222/32. directive 88/146 requires that member states prohibit importation of animals and of meat from animals to which have been administered the prohibited hormonal substances. council directive 88/146/eec [1988] oj l70/16. those directives were repealed by directive 96/22, which confirmed nordic journal of commercial law, issue 2004 #1 56 the prohibition and added a substance to the list of prohibited substances. council directive 96/22/ec [1996] oj l125/3. 249 european communities – measures concerning meat and meat products (hormones), complaint by the united states, report of the appellate body of 16 january 1998, wt/ds26/48/ab/r. 250 see mcneils, 2001, pp. 192-194. 251 they also claimed that the community was in breach of the principle of protection of legitimate expectations. 252 case t-174/00, biret international sa v. council, [2002] ecr ii-17, para. 58. 253 ibid. para. 59. 25 4 case t-174/00, biret international sa v. council, [2002] ecr ii-17, para. 61. 255 ibid. para. 62. 256 ibid. paras. 63-64. see 6.2.3. 257 case t-174/00, biret internationa sa v. council, [2002] ecr ii-17, para. 67. 258 case c-93/02p, biret internationa sa v. council, [2002] paras. 38-46. 259 the opinions of the advocate general alber of 15 may 2003 in cases c-93/02 p, biret internationa sa v. council and c-94/02 p, etablissements biret and cie sa v. council. 260 case c-93/02p, biret international sa v. council [2003], para. 56. 261 case c-93/02p, biret international sa v. council [2003], para. 59. 262 ibid. paras. 61-64. 263 compare case c-93/02p, biret international sa v. council [2003], para. 52 and case t-174/00, biret internationa sa v. council, [2002] ecr ii-17, para. 61. 26 4 case t-56/00, dole fresh fruit international ltd. v. council and commission [2003] 265 davies, 2003, p. 314. also the opinions of advocate general alber of 15 may 2003 in cases c-93/02 p, biret internationa sa v. council and c-94/02 p, etablissements biret and cie sa v. council 266 case t-69/00, fiamm spa and fiamm technologies inc. v. commission and council; case t-151/00, le laboratoire du bain v. council and commission; case t-301/00, groupe fremaux sa and palais royal inc. v. council and commission; case t-320/00, cartondruck gmbh & co. kg v. commission and council; case t-383/00, beamglow ltd. v. council, european parliament and commission.. all the cases are still pending. case law followed until 31 december 2003. 267 in my opinion it is rather unlikely that the cfi would come up with anything ‘inventive’, taking into consideration the way the ecj in the upa case put the cfi back to its place after its judgement in j–go-qu–r– relaxing the criteria of admissibility of actions for annulment brought by individuals. case t-177/01, j–go qu–r– v. commission [2002] ecr ii-2365; case c-50/00p, union de peque»os agricultores v. council [2002] ecr i-6677. see also ragolle, 2003, p. 100. 268 rosas, 2001, p. 140. 269 see zonnekeyn, 2001a, p. 253-254. 270 see kessie, p. 8. they include for instance manufacturers of batteries, bath products, cotton linen and cardboard cartons. 271 zonnekeyn, 2001a, p. 265. 272 reinisch, 2000, p. 51. 273 zonnekeyn, 2001, p. 265, note 52. nordic journal of commercial law, issue 2004 #1 57 274 by contrast, zonnekeyn is of the view that the companies have a reasonable chance to succeed despite the restrictive application of the criteria for community incurring liability. zonnekeyn, 2001a, p. 261. 275 rosas, 2001, p. 140. 276 reinisch, 2000, pp. 45, 51; zonnekeyn, 2001a, p. 271. 277 rosas, 2001, p. 140. 278 ibid. 279 case c-149/96 portugal v. council,[1999] ecr i-9395, para. 47; also inter alia case c-76/00p, petrotub and republica v. council [2003] ecr i-79; case c-93/02p, biret international sa v. council [2003] not yet reported, para. 52. 280 for example fines concluded on the basis of the odigitria case that liability can occur on the basis of a unilateral approach to external relations. fines, 1997, p. 27. in odigitria the cfi accepted the condition that an action under article 288 (2) ec could only be successful if a sufficiently serious breach of a superior rule of law for the protection of individuals as being relevant to determining community liability in the field of external relations. case t-572/93, odigitria aae v. council and commission [1995] ecr ii-2025. 281 see for an overview of jurisprudence and academic writing on the issue: gasparon, 1999, pp. 619-622. 282 zonnekeyn, 2001a, p. 265. 283 case 90/77, helmut stimming kg v. commission [1978] ecr 995. discussed in gasparon, 1999, p. 621. 28 4 case 90/77, helmut stimming kg v. commission [1978] ecr 995, para. 107. 285 opinion of ag mayras in case 90/77, helmut stimming kg v. commission [1978] ecr 995. 286 the opinion of advocate general lenz in case c-469/93, amministrazione della finanze dello stato v. chiquita italia spa [1995] ecr i-4533, para. 21. 287 see monta»a i mora, 1996, pp. 50-51. 288 similarly, zonnekeyn, 2003, p. 764. peers, on the other hand, interprets the statements of the cfi to imply that a measure could not be classified as an act intending to confer rights on individuals unless that measure could be relied on in courts. in any event, he claims that such finding of cfi was blatantly wrong and ‘direct effect’ is not a pre-condition for liability. peers, 2001b, p. 612. e.g. case t-18/99, cordis obst und gem·se grosshandel gmbh v. commission [2001] ecr ii-0913, para. 51. 289 zonnekeyn, 2001a, p. 265. 290 see gasparon, 1999, p. 615. contra aalto, 1999. pp. 86-89. 291 as was the case in joined cases c-6/90 and c-9/90, francovich and others v. italy [1991] ecr i-5357. 292 maresceau, 1986, p. 118. see similarly gilsdorf – oliver, ‘haftung der gemeinschaft und ihrer bediensten – artikel 215’ in h. von der groeben – j. thiesing – c.-d. ehlermann (eds.): kommentar zum eu-/eg-vertrag, vol. 5, fifth edition, 1997, para. 36 as quoted in reinisch, 2000, p. 46. 293 see craig – de b³rca, 2003, p. 550. 29 4 the opinion of the ag alber in cases c-93/02 p, biret internationa sa v. council and c-94/02 p, etablissements biret and cie sa v. council, para. 46. the same view is supported by davies who is of the opinion that “since wto rules cannot be relied upon, the legal position of applicants would not be improved even if wto rules did confer rights on them.“ davies, 2003, p. 310. 295 see zonnekeyn, 2003, p. 765. 296 see zonnekeyn, 2003, pp. 764-765; peers, 2001b, p. 612. nordic journal of commercial law, issue 2004 #1 58 29 7 joined cases c-6/90 and c-9/90, francovich and others v. italy [1991] ecr i-5357. 298 the ecj has explicitly said that the lack of direct effect does not exclude liability. aalto, 1999, p. 101. 299 gasparon, 1999, p. 616. 300 aalto, 1999, p. 101. 301 a commentator has suggested that holding the community liable for a breach of wto law would be more likely than the liability of a member state. see manin, 1997, pp. 413-415 as quoted in aalto, 1999, p. 101. 302 see snyder, 1993, p. 9. 303 peers, 2001b, p. 612. 30 4 see van gerven, 1994, pp. 21-22. he reasoned that provisions may be insufficiently precise or too conditional for specific rights to be derived therefrom, but may nevertheless be used in order to make operative a right to reparation that can be based on other, in that respect sufficiently precise and unconditional, community law provisions. 305 zonnekeyn, 2001a, p. 267. 306 according to eeckhout the applicants merely referred to the exception in a rather confusing way at the oral hearing. eeckhout, 2002, p. 108. 307 case t-18/99, cordis obst und gem·se grosshandel gmbh v. commission [2001] ecr ii-0913, para. 59. 308 davies, 2003, p. 324. 309 especially peers, 2001b and zonnekeyn, 2001b. see also eeckhout, 2002, p. 107. 310 see case t-18/99, cordis obst und gem·se grosshandel gmbh v. commission [2001] ecr ii-0913, para.8. 311 case c-317/99, kloosterboer rotterdam bv v. minister van landbouw, natuurbeheer en visserij [2001] ecr i-9863. 312 snyder, 2003, p. 344. 313 davies, 2003, p. 319. also the fact that the applicants did not really base their case on the nakajima doctrine has been considered to explain the outcome and lack of reasoning. see eeckhout, 2002, p. 108. 314 case t-19/01, chiquita v. commission,, pending. see davies, 2003, p. 319. 315 case t-320/00, cartondruck gmbh & co. kg v. commission and council; t-383/00. see zonnekeyn, 2001a, p. 254. 316 case t-3/99, banatrading gmbh v. council of the eu [2001] ecr ii-2123. 317 ibid. para. 38. 318 the cfi understood the argument as being based on portugal where the ecj confirmed the applicability of the nakajima exception in the context of the wto agreements. the applicant was not allowed to rely on portugal as a new matter of law, since they should have known at the time of bringing the case about the similar exception applying in the context of gatt 1947 case law. case t-3/99, banatrading gmbh v. council of the eu [2001] ecr ii-2123, paras. 38, 46-49. peers criticises the cfi for dismissing of the argument as out of time. he contends that since the court considered the gatt 1947 and gatt 1994 as legally distinct treaties, rulings on their legal effect should logically also be considered as legally distinct rulings. see peers, 2001a, p. 609. 319 case t-174/00, biret international sa v. council, [2002] ecr ii-17, para. 64. 320 the opinion of the advocate general alber in case c-93/02p, biret international sa v. council [2003], paras. 66-69. 321 directive 2003/74/ec of the european parliament and of the council amending council directive 96/22/ec concerning the prohibition on the use in stockfarming of certain substances having a hormonal thyrostatic action and of beta-agonists [2003] oj l262/17. nordic journal of commercial law, issue 2004 #1 59 322 zonnekeyn, 2003, p. 763, note 11. 323 directive 2003/74/ec of the european parliament and of the council amending council directive 96/22/ec [2003] oj l262/17, 3rd recital of the preamble. 324 see berg, 2003, http://www.amrecht.com/berg1.shtml. 325 case c-93/02p, biret international sa v. council [2003], para 62. 326 case c-377/98, kingdom of the netherlands v. european parliament and council of the eu [2001] ecr i-6229. 327 para. 83 of the opinion of ag alber of 15 may 2003 in the case c-93/02p, biret international sa v. council [2003], not yet reported. 328 case c-149/96 portugal v. council,[1999] ecr i-9395, para. 40. 329 which would in any case only be a temporary option as acknowledged by the ecj in case c-149/96 portugal v. council,[1999] ecr i-9395, para. 40. 330 para. 93 of of the opinion of ag alber of 15 may 2003 in the case c-93/02p, biret international sa v. council [2003], not yet reported. 331 while the international community and the wto are pressuring the ec to change its stance, internal pressures, namely that eu consumers do not want hormones treated beef, are heavily weighted to the other extreme. mcnelis, 2001, p. 207. as there was an equivalent ban on the use of hormones by the ec’s own farmers, the ec was, allegedly, politically speaking totally unable to withdraw the ban. abbott, 2002, p. 7. 332 while it also has been suggested that the commission does not want to alienate the powerful distributors of bananas. see kessie, 2000, p. 5. 333 berg, 2003, http://www.amrecht.com/berg1.shtml. 33 4 para. 102 of the opinion of ag alber of 15 may 2003 in the case c-93/02p, biret international sa v. council [2003], not yet reported. 335 the council stated that “by its nature, the agreement establishing the world trade organisation, including the annexes thereto, is not susceptible to being directly invoked in community or member state courts” council decision 94/800 ec of 22 december 1994 concerning the conclusion on behalf of the european community, as regards matters within its competence, of the agreements reached in the uruguay round multilateral negotiations (1986-1994), [1994] oj l336/1, last recital of the preamble. 336 case c-104/81 hza mainz v. kupferberg [1982] ecr 3641, para. 18. note, however, that the ecj did not find its arguments in portugal to conflict with kupferberg, since it did not base them on the lack of reciprocity as such but on disuniform application of the wto rules it might lead to. 337 para. 102 of the opinion of ag alber of 15 may 2003 in the case c-93/02p, biret international sa v. council [2003], not yet reported. 338 monta»a i mora, 1996, p. 47. see also peers, 2001, p. 121. 339 the sps agreement applies also to measures adopted before its coming into force. para. 41 of the opinion of ag alber of 15 may 2003 in the case c-93/02p, biret international sa v. council [2003], not yet reported. 340 a duty to act is required for the purposes of the community incurring liability due to an omission. the recommendation of the dsb of 13 february 1998 establishes such an obligation. para. 43 of the opinion of ag alber of 15 may 2003 in the case c93/02p, biret international sa v. council [2003], not yet reported. 341 see, for example, joined cases c-300/98, parfums christian dior v. tuk consultancy bv and c-392/98, assco ger·ste gmbh, rob van dijk v. wilhelm layher gmbh & co kg, layher bv, [2000] ecr i-11307, para. 44. 342 the cfi held that it is clear that “the wto agreement and its annexes are not intended to confer rights on individuals which nordic journal of commercial law, issue 2004 #1 60 they could rely on in court.” case t-52/99, t.port gmbh & co.kg v. commission [2001] ecr ii-0981, paras. 46. see also case t174/00, biret international sa v. council, [2002] ecr ii-17, para. 62. 343 paras. 115-119 of the opinion of the advocate general alber in case c-93/02p, biret international sa v. council [2003]. 34 4 case t-174/00, biret international sa v. council, [2002] ecr ii-17, para. 62. 345 different domestic legal systems merely sometimes provide for an indirect access to the wto dispute resolution. in the ec such measure is the trade barriers regulation (council regulation 3286/94/ec). see lukas, 1995, pp. 185-192. 346 kessie, 2000, p. 2. 347 petersmann, 1997, p. 238. 348 jackson, 1998, p. 77. 349 wt/ds152/r, united states – sections 301-310 of the trade act of 1974, report of the panel of 22 december 1999, para. 7.76. 350 ibid. para. 7.73. 351 the ecj stated in the case, inter alia, that “the fact that these interests are of a general nature does not prevent their including the interests of individual undertakings such as the applicants.” joined cases 5, 7, and 13 to 24/66, kampffmeyer v. commission [1967] ecr 245. 352 see para. 118 of the opinion of the ag alber in case c-93/02p, biret international sa v. council [2003], not yet reported. 353 zonnekeyn, 2001a, p. 263. case c-282/90, vreugdenhil v. commission [1992] ecr i-1937. 35 4 joined cases 5, 7, and 13 to 24/66, kampffmeyer v. commission [1967] ecr 245. 355 the ecj ruled in polydor that a provision of the free trade agreement between the community and portugal was not to be interpreted in the same way as a provision of the eec treaty even though the provisions were identically worded. case 270/80, polydor ltd. and rso records inc. v. harlequin record shops ltd. and simons records ltd. [1982] ecr 329. 356 see also zonnekeyn, 2003, p. 767. 357 cap undoubtedly is a legislative field characterised by the exercise of such discretion. ward, 2000, p. 310. see also case t-30/ 99, bocchi food trade international gmbh v. commission [2001] ecr ii-0943, para. 91. 358 ward, 2000, p. 310. joined cases 83, 94/76, 4, 15, 40/77, hnl and others v. council and commission [1978] ecr 1209. 359 case c-152/88, sofrimport sarl v. commission [1990] ecr i-2477. 360 joined cases c-104/89 and c-37/90, mulder ii [1992] ecr i-3061 361 joined cases 116 &124/77, amylum v. council and commission [1979] ecr 3497, para 19; case 143/77 koninklijke scholten-honig v. council and commission [1979] ecr 3583, para. 16. 362 for example arnull included arbitrariness to the conditions of liability. in the stahlwerke peine-salzgitter ruling the ecj explicitly pointed out that conduct verging on the arbitrary is not a condition of liability. see arnull, 1997, p. 141 and case c-220/91p, commission v. stahlwerke peine salzgitter [1993] ecr i-2393. 363 see wakefield, 2002, p. 123-124. 36 4 joined cases c-46/93 and c-48/93 brasserie du p˜cheur sa v. federal republic of germany and factortame iii and the queen v. secretary of state for transport ex parte factortame limited and others [1996] ecr i-1029, para. 56. 365 see reinisch, 2000, p. 50. 366 zonnekeyn, 2001a, p. 269. see similarly reinisch, 2000, p. 50. 367 zonnekeyn, 2001a, p. 269; reinisch, 2000, p. 49. nordic journal of commercial law, issue 2004 #1 61 368 case 238/78 ireks-arkady [1979] ecr 2955, para. 11. 369 zonnekeyn, 2001a, p. 269. 370 joined cases c-104/89 and c-37/90, mulder ii [1992] ecr i-3061; see also opinion of ag van gerven, para. 28. 371 arnull, 1997, p. 148. see also ward, 2000, p. 311. 372 a commercial undertaking is considered to have volunteered to the economic risk and uncertainties inherent in the sector in which it is operating. joined cases 83 and 94/76, 4, 15 and 40/77, hnl and others v. council and commission, [1978] ecr 1209, para 7. see wakefield, 2002, p. 89. see also arnull, 1997, pp. 141, 146. 373 tridimas, 1998, p. 23. 374 he refers to the situation as an important gap in the analogy between community and state liability. see tridimas, 2001, p. 329. 375 craig – de b³rca, 2003, p. 557. 376 van gerven, 1994, p. 27; wakefield, 2002, pp. 88-89. 377 joined cases 83 and 94/76, 4, 15 and 40/77, hnl and others v. council and commission, [1978] ecr 1209, para 5. see also arnull, 1997, p. 150. 378 wakefield, 2002, p. 128. in any case, the effects of a measure on individuals which are known or ought to be known to the adopting institutions should be considered before the adoption of legislation in general interest, even though it might be necessary for these individual interests to be overriden. microsoft word diener_keithwilliam.doc nordic journal of commercial law issue 2008#1 recovering attorneys’ fees under cisg: an interpretation of article 74* by keith william diener * the author wishes to thank professor steve charnovitz for his advisement and numerous editorial reviews of this essay; professor albert kritzer and dr. bruno zeller for their thoughtful comments on earlier drafts of this essay; and professor dinah shelton for her academic influence on inter alia: this essay. the author also wishes to express his gratitude to pace university school of law and the judges of the clive m. schmitthoff essay competition for awarding an earlier version of this essay first prize in the 2007 round of the esteemed essay competition. nordic journal of commercial law issue 2008#1 1 part i: framing the controversy 1. introduction to the essay the subject of this essay is the recoverability of attorneys’ fees under the united nations convention on contracts for the international sale of goods (cisg). the recoverability of attorneys’ fees under the cisg is one of the most controversial issues in contemporary cisg jurisprudence. domestic courts, international arbitral tribunals, and domestic arbitral tribunals diverge as to why, how, and whether to award attorneys’ fees under cisg governed contracts. the recoverability of attorneys’ fees under the domestic laws of nations signatory to the cisg is governed primarily by two diametric rules: the american rule and the loser-pays rule. the american rule is the rule adopted almost exclusively by the united states1 and “calls for litigants to bear their own legal expenses: in the absence of an explicit statutory or contractual provision to the contrary, each party to a dispute must bear his own attorneys’ fees.”2 the american rule is considered a general rule of u.s. procedure, although there are numerous exceptions to the rule that either allow or require the recovery of attorneys’ fees as a remedy, one such exception is the inherent authority given to federal courts to award attorneys’ fees in instances of extreme bad faith.3 in fact, the united states has over one-hundred federal statutes that modify the american rule so as to allow for the recovery of attorneys’ fees; these statutes are applicable to such fields as: antitrust, copyright, pension, federal antidiscrimination, and securities.4 additionally, the revised uniform commercial code §5-111(e) requires that attorneys’ fees be recoverable as damages for a breach of a letter of credit.5 these numerous statutes modify the general american rule that disallows the recovery of attorneys’ fees. 1 japan also adopts the american rule, but japan only recently acceded to the cisg in july 2008 and the cisg has not yet gone into force in japan; it will go into force in japan on august 1, 2009. see: dinah shelton, remedies in international human rights law, 2nd ed. 48 (oxford university press 2005). 2 jarno vanto, attorney’s fees as damages in international commercial litigation, 15 pace int’l l. rev. 203, 204 (spring 2003). 3 zapata hermanos sucesores v. hearthside banking co., 313 f.3d 385, 388 (7th cir. 2002). see also: chambers v. nasco, inc., 501 u.s. 32, 52-55 (1991). attorneys’ fees are also recoverable in the united states in certain class actions and certain derivative shareholder suits. see: shelton, supra note 1 at 48, note 176 (“fees are also awarded plaintiffs in class actions where the plaintiff has preserved or generated a common fund for the benefit of the class and in shareholders’ derivative suits where the defendant is perceived to benefit from the suit.”) 4 zapata hermanos sucesores v. hearthside banking co., 313 f.3d 385, 388 (7th cir. 2002). see also: shelton, supra note 1 at 48, note 176. 5 revised ucc §5-111(e) reads: “reasonable attorney's fees and other expenses of litigation must be awarded to the prevailing party in an action in which a remedy is sought under this article.” nordic journal of commercial law issue 2008#1 2 the loser-pays rule, sometimes referred to as the “english rule,” is adopted in almost every nation party to the cisg except the united states.6 the loser-pays rule designates “that the party losing the dispute will be held liable for the legal fees of both parties to the proceedings.”7 this rule has a number of variations, but is accepted in some form or another in a “nearly universal” manner.8 cisg article 74 is the general damages provision for breaches of cisg governed contracts. article 74 allows the recovery of foreseeable and consequential losses, including losses of profit, for breaches of cisg governed contracts. the controversy over attorneys’ fees arises because the courts and tribunals of the cisg parties have rendered inconsistent and contradictory opinions as to whether a “loss” in article 74 includes attorneys’ fees. this essay addresses the many methods by which courts, tribunals, and commentators have dealt with the question of whether attorneys’ fees are a “loss” under cisg article 74. the essay also puts forward a unique method of interpreting article 74 by appealing to principles that have previously not been used to interpret article 74, concluding that attorneys’ fees are recoverable under the substantive term, ”loss” in article 74. the united nations convention on contracts for the international sale of goods, sometimes referred to as the “vienna convention,” and yet others as the “cisg,” is the most recent in a series of attempts at a unified, international sales law.9 the origins of the cisg can be traced to the 1930s when a group of distinguished european legal experts convened under the patronage of the international institute for the unification of private law (unidroit).10 by 1935 these western european scholars had completed a preliminary draft of a sales convention.11 this progress was temporarily suspended upon the rise of world war ii, but following the war the scholars reconvened in 1951 to continue their legacy.12 numerous drafts were issued over the subsequent years including a draft uniform law on the formation of a contact that was circulated in 1958, and a uniform law for the international sale of goods, drafts of which were circulated in 1956 and 1963.13 following these events, 28 nations met at the 1964 hague convention during which they finalized these drafts.14 these efforts culminated in two international conventions: one presented the uniform law for the international sale of goods (ulis), and the other the uniform law on the formation of contracts for the international 6 vanto, supra note 2 at 204-205. 7 vanto, supra note 2 at 205-206. 8 vanto, supra note 2 at 205. 9 see generally: e. allan farnsworth, the vienna convention: history and scope 18 int’l law. 17 (winter 1984). 10 peter winship, new rules for international sales, 68 a.b.a.j. 1230 (october, 1982). 11 john o. honnold, uniform law for international sales, 3rd ed., 5 (kluwer law international 1999). 12 id. at 5. 13 honnold, supra note 11 at 5. 14 honnold, supra note 11 at 5. nordic journal of commercial law issue 2008#1 3 sale of goods (ulf).15 all of the “[s]tates ratifying these 1964 conventions agreed to incorporate the uniform laws into their domestic legislation.”16 finally, in 1972 the conventions went into effect after their ratification by five nations.17 the 1964 conventions had a “minimal impact on international commerce,” and were never ratified by the united states, so the redrafting of a new international sales law was initiated by the united nations.18 the ulf and ulis, although falling short of attaining unanimous international support, laid a foundation upon which the united nations could later build.19 in 1966 the general assembly of the united nations created uncitral, the u.n. commission on international trade law, to attempt to harmonize and unify international trade.20 uncitral convened for the first time in 1968 and by its second meeting of 1969 appointed a 14-member working group, including the united states, to study the previous conventions and redraft an international sales law.21 the working group was instructed to determine what changes would need to be made to the ulis and ulf to accommodate the various needs of the many nations, particularly the needs of nations outside of western europe because western european views had dominated the drafting of the relatively unsuccessful ulis and ulf.22 over the subsequent years the cisg was created and finalized through multinational efforts spearheaded by uncitral. from 1970 to 1978 the working group continued to revise the conventions over nine more meetings, and in 1978, in its eleventh session, adopted a draft convention that combined and revised the rules of the ulf and the ulis.23 this draft was accompanied by a secretariat commentary, which is the “closest counterpart to an official commentary,”24 provided for the present day cisg. the secretariat commentary was distributed to the many nations and international organizations with the draft cisg.25 with minor revision, the cisg was then approved in the 1980 vienna conference. the conference was composed of representatives from sixty-two countries and eight international organizations;26 it spanned the months of march and april of 1980.27 the final text of the 15 honnold, supra note 11 at 5. 16 winship, supra note 10 at 1230-1234. 17 honnold, supra note 11 at 5-6. 18 winship, supra note 10 at 1230-1234. 19 winship, supra note 10 at 1230-1234. 20 winship, supra note 10 at 1230-1234. 21 farnsworth, supra note 9 at 17-20. 22 farnsworth, supra note 9 at 17-20. 23 farnsworth, supra note 9 at 17-20. 24 see e.g.: http://www.cisg.law.pace.edu/cisg/text/secomm/secomm-07.html (last visited january 19, 2007). 25 farnsworth, supra note 9 at 17-20. 26 honnold, supra note 11 at 10. nordic journal of commercial law issue 2008#1 4 cisg was issued in six official languages: english, russian, french, spanish, arabic, and chinese.28 the convention was finalized with eighty-eight substantive articles as well as thirteen other articles (relating to such things as effective date and reservations).29 the cisg is the most successful, unified international sales law to date although attaining uniformity in interpretation remains a challenge to all parties concerned. the cisg represents a pinnacle of modern history in that after over half a century’s efforts there is a uniform international sales law among seventy-one of the world’s nations.30 this stress on uniformity may be a bit misleading because there is much disagreement as to how certain provisions of the cisg should be interpreted, and as to the meaning of the many concepts within the text of the cisg itself. one of the most controversial topics within cisg jurisprudence is whether attorneys’ fees are recoverable as damages under article 74 or not. infra, this paper discusses in detail the need for a uniform interpretation regarding the recoverability of attorneys’ fees under article 74 of the cisg.31 the following section addresses the cisg provisions relevant to interpretation and damages; subsequent to the following section is an analysis of the cisg arbitral and court decisions across the many nations. 2. interpreting the cisg damages provisions 2.1. introducing the hierarchy of interpretation cisg article 7 contains the methodology of interpreting the provisions of the cisg; it contains a hierarchy of interpretation that is used to interpret each provision of the cisg.32 every provision of the cisg must be interpreted in accord with the mandate of article 7(1) and the interpretational hierarchy set out in article 7(1-2).33 this section lays out the interpretational methodology of the cisg as contained in article 7(1-2). this section then 27 farnsworth, supra note 9 at 17-20. 28 honnold, supra note 11 at 11. 29 farnsworth, supra note 9 at 17-20. 30 see: http://www.cisg.law.pace.edu/cisg/countries/cntries.html (last visited january 19, 2007) (for the present status of who is a party to the cisg). 31 see: sections iii-vi of this paper. 32 the predecessor to the cisg, the ulis, contained a similar provision (ulis article 17) for interpreting the ulis. 33 for legal scholarship addressing article 7 interpretations, see e.g.: vanto, supra note 2; john felemegas, an interpretation of article 74 cisg by the us circuit court of appeals, 15 pace int’l l. rev. 91 (spring 2003); john y. gotanda, awarding damages under the united nations convention on the international sale of goods: a matter of interpretation, 37 geo. j. int’l l. 95 (fall 2005); and, bruno zeller, damages under the convention on contracts for the international sale of goods (oceana publications 2005). for u.s. case law addressing article 7 interpretations, see e.g.: zapata hermanos sucesores v. hearthside banking co., 313 f.3d 385 (7th cir. 2002); chicago prime packers, inc. v. northam food trading co., et al., 320 f.supp.2d 702 (n.d.ill. 2004); ajax tool works, inc. v. can-eng manufacturing ltd., 2003 wl 223187 (n.d. ill.), prod. liab. rep. (cch) p 16, 516; mcc-marble ceramic center, inc. v. ceramica nuova d’agonistino, s.p.a., 144 f. 3d 1384, 1389 (11th cir. 1998); and, delchi carrier spa v. rotorex corporation, 71 f.3d 1024 (2nd cir. 1995). nordic journal of commercial law issue 2008#1 5 presents articles 74 and 77: the damages provisions relevant to the recovery of attorneys’ fees for breaches of cisg governed contracts. 2.2. the top of the hierarchy of interpretation: article 7(1): article 7(1) contains the general rule of interpretation for the cisg which informs all of the provisions of the convention including article 7(2). article 7(1) provides: in interpreting this convention, regard is to be had to its international character and to the need to promote uniformity in its application and the observance of good faith in international trade (emphasis added). the text clearly manifests three requirements of an article 7(1) interpretation: (i) regard be had to the convention’s international character, (ii) regard be had to the need to promote uniformity in application of the convention, and (iii) that good faith in international trade be observed in its interpretation. 2.3. the next steps in the hierarchy of interpretation: article 7(2) article 7(2) comes into play when matters that are governed by the convention are “not expressly settled” by the interpretational techniques of article 7(1).34 when matters within the scope of the convention are not expressly settled, article 7(2) is used to fill the gaps. as john honnold put it, article 7(2) “is designed to help the law adapt and grow in the light of new circumstances.”35 article 7(2) provides: questions concerning matters governed by this convention which are not expressly settled in it are to be settled in conformity with the general principles on which it is based or, in the absence of such principles, in conformity with the law applicable by virtue of the rules of private international law (emphasis added). article 7(2) does not apply unless the matters concerned are “governed by the convention” and the matters concerned are “not expressly settled” in the convention. only if these two prerequisites are met does the interpreter attempt to settle the matters “in conformity with the general principles on which it is based,” and only if there are no principles that apply, does the interpreter settle the matter “in conformity with the law applicable by virtue of the rules of private international law.” 34 cisg article 7(2). 35 honnold, supra note 11 at 88. nordic journal of commercial law issue 2008#1 6 2.4. interpreting the damages provisions of the cisg the recovery of damages under cisg governed contracts is guided primarily by articles 74 through 78.36 other articles specify rights and obligations of the buyer and seller specific to damages.37 regarding the recoverability of losses, articles 74 and 77 impose four requirements for a party seeking damages in breach of contract actions. additionally, article 75 allows for the recovery of damages when a contract is avoided that includes the damages for breach of contract provided in article 74. the victim of the breach in a breach of contract action is subject to the duty to reasonably mitigate damages under article 77. article 77 provides: a party who relies on a breach of contract must take such measures as are reasonable in the circumstances to mitigate the loss, including loss of profit, resulting from the breach. if he fails to take such measures, the party in breach may claim a reduction in the damages in the amount by which the loss should have been mitigated. the secretariat commentary notes that article 77 “states a duty owed by the injured party to the party in breach…in this case the duty owed is the obligation of the injured party to take actions to mitigate the harm he will suffer from the breach so as to mitigate the damages he will claim.”38 any damages recoverable for breach of contract must be reasonably mitigated by the victim of the breach and if the victim does not reasonably mitigate then the party in breach “may claim a reduction in the damages in the amount by which the loss should have been mitigated.”39 the amount that should have been mitigated is a question of the facts and circumstances surrounding the individual case. the duty to reasonably mitigate damages is the first requirement for recovery in a breach of contract action. article 74 imposes three additional requirements before damages can be recovered for breach of cisg governed contracts. article 74 provides: damages for breach of contract by one party consist of a sum equal to the loss, including loss of profit, suffered by the other party as a consequence of the breach. such damages may not exceed the loss which the party in breach foresaw or ought to have foreseen at the time of the conclusion of the contract, in light of the facts and matters of which he then 36 article 78 relates to interest on sums not paid; article 77 covers the duty to mitigate damages; articles 75 and 76 provide for damages and duties relating to the avoidance of the contract; and article 74 is the general provision on damages for breaches of cisg contracts. 37 see: appendix a to this paper for the rights and obligations of the buyer compared and contrasted to the rights and obligations of the seller. 38 secretariat commentary, available at: http://www.cisg.law.pace.edu/cisg/text/secomm/secomm-77.html (last visited january 15, 2007). 39 cisg article 77. nordic journal of commercial law issue 2008#1 7 knew or ought to have known, as a possible consequence of the breach of contract (emphasis added). the second requirement for breach of contract actions is that there is a “loss” involved in the adjudication. the amount of damage recovery will be a “sum equal to the loss, including loss of profits,” but as was discussed by the u.s. seventh circuit, if the alleged damage does not constitute a loss then it is not recoverable under article 74.40 the meaning of “loss,” although seemingly simple, is a highly controversial topic within cisg jurisprudence.41 take, for example, the divergent views as to whether attorneys’ fees constitute a loss under article 74.42 the secretariat commentary clarifies that the “basic philosophy of the action for damages is to place the injured party in the same economic position he would have been in if the contract had been performed.”43 therefore, a “loss” according to the commentary entails placing the victim of the breach in the same economic position she would have been in but for the breach. the third requirement for breach of contract actions is that the “loss” is a “consequence of the breach.” whether a loss is a consequence of a breach is to be determined on a case-by-case basis taking into account all of the relevant circumstances of the case. as the secretariat commentary states, “the court or arbitral tribunal must calculate that loss in the manner which is best suited to the circumstances,”44 in determining whether it is a consequence of the breach. the circumstantial leniency in determining whether a “loss” is a consequence of the breach is somewhat limited by the fourth requirement: foreseeability. the foreseeability standard contained in article 74, that a party’s loss is limited to that which it “foresaw or ought to have foreseen” at the time the contract was completed is influenced by the french code of civil procedure’s (fccp) foreseeability standard.45 fccp §1150 provides a limitation on damages to those “which were foreseen or which could have been foreseen at the time of the contract,” subject to some provisos.46 it has also been noted that the famous 1854 english decision, hadley v. baxendale,47 on which the u.s. foreseeability standard is based, made 40 zapata hermanos sucesores v. hearthside banking co., 313 f.3d 385, 387-389 (7th cir. 2002). 41 see: infra: sections iii-vi. 42 see: infra: sections iii-vi. 43 secretariat commentary, available at: http://www.cisg.law.pace.edu/cisg/text/secomm/secomm-74.html (last visited january 15, 2007). see also: honnold, supra note 13 at 445. 44 secretariat commentary, available at: http://www.cisg.law.pace.edu/cisg/text/secomm/secomm-74.html (last visited january 15, 2007). 45 honnold, supra note 11 at 448. 46 one such proviso is “willfulness.” see: honnold, supra note 11 at 448. 47 hadley v. baxendale, 9 exch. 341, 156 eng. rep. 145 (1854). nordic journal of commercial law issue 2008#1 8 a positive reference to this french law in its opinion.48 the majority of legal systems in the world have foreseeability standards that exclude unforeseeable losses or damages.49 in sum, in order to recover under a breach of contract there must be a “loss,” the “loss” must be a foreseeable, consequence of the breach, and the victim of the breach must have mitigated this loss lest the “loss” get reduced by the amount that the party should have mitigated. the damages provisions of the cisg must be interpreted under the hierarchy of interpretation set out in articles 7(1-2). the following section relays the problems with developing a uniform, international interpretation of article 74 by surveying the divergent decisions on the recoverability of attorneys’ fees under article 74 by the many parties to the cisg. following the survey of cisg decisions, this paper addresses an article 7 interpretation of articles 74 and 77, concluding that article 7 requires that attorneys’ fees be recoverable as a “loss” under article 74. 3. survey of cisg decisions on the recovery of attorneys’ fees 3.1. introducing the decisions attorneys’ fees are recoverable as damages in the courts of almost every country party to the cisg except the united states. this section first provides examples of the many international and domestic arbitral panels that award attorneys’ fees in cisg governed disputes. second, this section surveys the case law from china, germany, belgium, finland, and switzerland to show that each of these countries regularly award attorneys’ fees in cisg disputes. finally, this section discusses in detail the leading u.s. case that disallows the recovery of attorneys’ fees under the cisg, zapata hermanos sucesores v. hearthside banking co. (zapata).50 zapata is a decision of the 7th circuit court on appeal from the united states district court for the northern district of illinois.51 the supreme court thereafter denied the petition for a writ of certiorari to the zapata ruling of the 7th circuit,52 and at the time of the writing of this article, neither the supreme court nor any other u.s. circuit courts have directly spoken on the topic of the recoverability of attorneys’ fees under cisg governed contracts. 48 honnold, supra note 11 at 447-448. 49 secretariat commentary, available at: http://www.cisg.law.pace.edu/cisg/text/secomm/secomm-74.html (last visited january 15, 2007). 50 zapata hermanos sucesores v. hearthside banking co., 313 f.3d 385 (7th cir. 2002). 51 zapata hermanos sucesores, s.a. v. hearthside baking co., inc., 155 f.supp.2d 969 (n.d.ill. aug 22, 2001) (no. 99 c 4040). 52 zapata hermanos sucesores, s.a. v. hearthside baking co., inc., 540 u.s. 1068, 124 s.ct. 803, 157 l.ed.2d 732, 71 uslw 3589, 72 uslw 3364, 72 uslw 3373 (u.s. dec 01, 2003) (no. 02-1318). nordic journal of commercial law issue 2008#1 9 3.2. international and national arbitral decisions international and national arbitral tribunals consistently award attorneys’ fees in actions governed by the cisg. often, these arbitral panels have rules explicitly authorizing the arbitrators to award attorneys’ fees as the circumstances of the case may require.53 the russian federation arbitral tribunal as well as the international chamber of commerce arbitral panel have both determined that attorneys’ fees fall under the substantive term, “loss” in article 74 of the cisg and are recoverable as damages. other arbitral tribunals, including the china international economic & trade arbitration commission (cietra) and the schiedsgericht der handelskammer [arbitral tribunal] of hamburg, germany have similarly held that attorneys’ fees are a recoverable ”loss” under article 74 of the cisg. the russian federation tribunal of august 15, 2003 found that the seller had breached a contract governed by the cisg by sending nonconforming goods, and allowed the recovery of attorneys’ fees.54 the tribunal analyzed the amount of damages under article 74 of the cisg and disallowed recovery of moral damages. the tribunal stated it is “of the opinion that, based on article 74 cisg, such claim [for moral damages] cannot be granted.”55 nevertheless, the tribunal granted the buyer’s “claim to recover attorneys' fees taking into consideration the volume of the documents submitted in support [of the claims], the length of the hearings and the award rendered.”56 the russian tribunal found that although article 74 of the cisg bars the recovery of moral damages, it does not bar the recovery of attorneys’ fees. the russian federation tribunal considered three contracts between buyer and seller in the june 17, 2004 panel decision resulting in various awards including the awarding of attorneys’ fees to the injured claimant.57 this decision is complicated by the fact that one contract was governed by the law of cyprus, one was governed by russian law, and one contract was governed by the cisg.58 the panel determined that the claimant was entitled to, inter alia: “reimbursement of the damages in the form of loss of profit…founded on art. 74 cisg.”59 in this complicated panel decision which was decided under three different bodies of law, the tribunal awarded attorneys’ fees to the complainant in accord with the authority granted them 53 for instance, the russian federation rules, §9 states: “the winning party may demand that the other party be obliged to reimburse his reasonable expenses incurred in connection with the arbitral proceedings and, in particular, the expenses connected with defending his interests through legal representatives.” 54 russia 15 august 2003 arbitration proceeding 57/2001. available at: http://cisgw3.law.pace.edu/ cases/030815r1.html (last visited march 7, 2007). 55 id. 56 id. 57 russia 17 june 2004 arbitration proceeding 186/2003 (barter transaction). available at: http://cisgw3.law.pace.edu/ cases/040617r1.html (last visited march 7, 2007). 58 id. 59 id. nordic journal of commercial law issue 2008#1 10 by §9 of the rules of arbitration expenses and fees, the rule authorizing arbitrators to award reasonable legal costs.60 the russian federation tribunal has regularly awarded attorneys’ fees in cisg governed disputes, although the panel decision of june 6, 2003 reveals a caveat for buyers and sellers arbitrating in the russian federation.61 this tribunal found under article 74 and 77 of the cisg and the unidroit principles that the seller was liable to buyer for two-thirds of the claim the buyer alleged.62 as to the caveat, the tribunal determined that “the winning party may demand that the other party reimburse reasonable expenses incurred in connection with the arbitration and, in particular, legal expenses. however, the [buyer] did not present evidence of his legal expenses. therefore, the tribunal denies such claim.”63 in other words, because the buyer did not provide evidence of his legal expenses, the tribunal refused to award the buyer otherwise awardable attorneys’ fees. the international chamber of commerce’s court of arbitration held in a 1992 decision that attorneys’ fees are recoverable as a “loss” under article 74 of the cisg.64 the icc panel awarded not only attorneys’ fees as a “loss” under article 74 but also all “legal costs” which extend beyond attorneys’ fees.65 as another icc panel clarified: “'legal costs' do not encompass only attorneys' fees but also the costs of a party itself provided that they are reasonable and incurred in connection with the preparation and presentation of the arbitration case.”66 the 1992 panel decision determined attorneys’ fees are a foreseeable, consequence of the breach so are recoverable as a “loss” under cisg article 74. the cietac (china) arbitral panel decision of may 14, 1996 determined in a breach of contract action that the breaching buyer was liable for attorneys’ fees under article 74 of the cisg.67 the dispute arose over four signed letters of sale confirmation of which the buyer only paid a small percentage of the designated costs.68 the panel decided the buyer was liable for cost, interest, arbitration fees, and that “the expenses of attorney handling the case and attorney fee…are 60 russian federation rule, supra note 133. 61 russia 6 june 2003 arbitration proceeding 97/2002. available at: http://cisgw3.law.pace.edu/ cases/030606r1.html (last visited march 7, 2007). 62 id. 63 id. 64 icc arbitration case no. 7585 of 1992 (foamed board machinery). available at: http://www.unilex.info/ case.cfm?pid=1&do=case&id=134&step=fulltext (last visited march 7, 2007). 65 id. 66 icc arbitration case no. 10329 of 2000 (industrial product case). available at: http://cisgw3.law.pace.edu/ cases/000329i1.html (march 7, 2007). 67 china 14 may 1996 cietac arbitration proceeding (down coat case). available at: http://cisgw3.law.pace.edu/ cisg/wais/db/cases2/960514c1.html (last visited march 7, 2007). 68 id. nordic journal of commercial law issue 2008#1 11 indirect losses caused by [buyer]'s breach, and [seller] has provided certificate of such expenses, so [buyer] shall indemnify [seller] such expenses.”69 the cietac arbitrators determined that attorneys’ fees are a “loss” and are recoverable as damages under cisg article 74.70 the cietac again awarded attorneys’ fees as a foreseeable, consequence of the breach under cisg article 74 in the february 12, 1999 panel decision.71 as the tribunal decision reads: “the [seller] submitted evidence of…damages, and evidence of the attorneys' fee, investigation cost, and traveling fee, which was accepted by the tribunal. according to article 74, the arbitral tribunal decided that the…loss was a foreseeable loss that can be expected and should be expected by the [buyers] when entering into the contract, which then shall be indemnified by the [buyers].”72 the cietac tribunal awarded not only attorneys’ fees but the costs of traveling and investigation costs under cisg article 74 to the seller who was the victim of the breach of contract. another cietac arbitral tribunal determined that the breaching buyer had to pay the seller’s attorneys’ fees but because the seller did not submit the actual costs of his attorneys’ fees, that the buyer had to pay the standard rate of attorneys’ fees.73 the tribunal decided: “the respondent [buyer] should bear only part of payable attorney fees to the claimant [seller]…according to the standard charge by professional attorneys, because the [seller] did not submit the appointment contract with attorneys, nor did he note expressly the relation with this case in his attorney fee receipt.”74 even though the seller did not provide the actual cost of attorneys’ fees, the cietac tribunal still awarded attorneys’ fees.75 a 1996 hamburg (germany) arbitral tribunal determined that the victim of the breach can recover attorneys’ fees under the cisg.76 the uncitral case abstract for this decision clarified, “the arbitral tribunal, in rendering its award on the costs of the proceedings, held 69 id.(quoting english translation.) 70 many cietac tribunals have also determined that attorneys’ fees are a foreseeable consequence of the breach. see e.g.: china 6 august 1996 cietac arbitration proceeding (lacquer handicraft case), available at: http://cisgw3.law.pace.edu/cisg/wais/db/cases2/960806c1.html (last visited march 8, 2007). 71 china 12 february 1999 cietac arbitration proceeding (nickel plating machine production line equipment case). available at: http://cisgw3.law.pace.edu/cisg/wais/db/cases2/990212c2.html (last visited march 8, 2007). 72 id. 73 china 18 december 1996 cietac arbitration proceeding (lentil case). available at: http://cisgw3.law.pace.edu/cisg/wais/db/cases2/961218c1.html (last visited march 8, 2007). 74 id. 75 another cietac decision similarly limited the amount of recoverable attorneys’ fees because the victim of the breach did not submit evidence of actual cost. see: china 31 december 1997 cietac arbitration proceeding (lindane case), available at: http://cisgw3.law.pace.edu/cisg/wais/db/cases2/971231c1.html (last visited march 8, 2007). 76 germany 21 june 1996 hamburg arbitration proceeding. available at: http://cisgw3.law.pace.edu/ cases/960621g1.html (last visited march 7, 2007). nordic journal of commercial law issue 2008#1 12 that the [seller] could claim its attorney's fees for the arbitration proceedings as damages according to articles 61 and 74 cisg.”77 this is a supplementary decision addressing solely the recovery of attorneys’ fees following an earlier decision on the same facts rendered by the same tribunal.78 this supplementary decision solidifies the panel’s earlier determination to award attorneys’ fees under cisg article 74. in short, both international and national arbitral tribunals have consistently awarded attorneys’ fees under article 74 of the cisg. the following subsection surveys the various methods that domestic courts outside of the united states have taken in determining whether attorneys’ fees should be awarded under cisg governed contracts. this subsection is followed by an analysis of the united states’ courts. 3.3. domestic courts outside of the united states 3.3.1. varying domestic courts outside of the united states domestic courts outside of the united states generally award attorneys’ fees under cisg governed disputes. some award attorneys’ fees for the same reason the arbitral tribunals do, that is, because attorneys’ fees are a “loss” under article 74. other domestic courts determine attorneys’ fees are not directly considered in the convention, so domestic law is used under article 7(2) to fill the gap; these courts apply their domestic rules as to the recovery of attorneys’ fees. and yet others combine the two approaches: these courts state that attorneys’ fees are a “loss” under article 74 but they calculate the amount of the award by use of their domestic law. these latter methods have led to inconsistent cisg opinions both across national boundaries and even within individual nations. as this section will display, by deferring to domestic law in determining whether attorneys’ fees are recoverable and in calculating them, the many courts have rendered opinions that contravene the uniform, international nature of the convention in derogation of the mandate of article 7(1).79 additionally, domestic law based determinations as to attorneys’ fees pose problems of predictability for contractual parties.80 the following evaluates case law from china, germany, belgium, finland, and switzerland. the various approaches to the recovery of attorneys’ fees in cisg governed disputes are represented well by this sampling of cases. 77 id. although the clout abstract clarifies this point of attorneys’ fees, the questions of attorneys’ fees are somewhat ambiguous in the text of the case itself. 78 germany 21 march 1996 hamburg arbitration proceeding. available at: http://cisgw3.law.pace.edu/ cases/960321g1.html (last visited march 7, 2007). 79 article 7(1) reads: “in the interpretation of the convention, regard is to be had to its international character and to the need to promote uniformity in its application and the observance of good faith in international trade.” 80 discussed infra, section v-vi. nordic journal of commercial law issue 2008#1 13 3.3.2. china china has consistently awarded attorneys’ fees in cisg disputes, but has not clearly stated whether they are awarding attorneys’ fees under cisg article 74 or chinese law. in one case, the chinese appellate court confirmed the lower court’s decision to award attorneys’ fees in a cisg governed dispute.81 the court’s reasoning implied the award of attorneys’ fees for the breach of contract was due to its international obligations rather than domestic law. the court affirmed the award because: “paying the attorneys' fee accords with international practices.”82 a chinese maritime court issued a similarly ambiguous decision.83 this dispute arose over the failure in shipment of 60,000 tons of iron ore that was contracted to be shipped to the buyer via a chartered ship. the court stated the contract was governed both by the convention and the maritime law of china. the court held that the contract was breached and awarded attorneys’ fees because they are “necessary expenses to settle disputes in a society governed by law…”84 in both of these cases the chinese court, or perhaps the translation, did not state whether the attorneys’ fees are recoverable because of article 74 of the cisg or pursuant to chinese law. 3.3.3. germany the german courts have consistently held that attorneys’ fees constitute a “loss” under article 74 of the cisg, but generally defer to german domestic law to calculate the amount of attorneys’ fees. the german courts often draw the distinction between prelitigation fees and litigation fees in their domestic calculations, and sometimes award the former but not the latter. however, sometimes whether the court is awarding prelitigation or litigation fees is unclear.85 and yet at other times, it seems clear that the german courts are awarding both 81 china 17 july 2000 higher people's court [appellate court] of he'nan province (minterrnet s.a. v. he'nan local product import and export company). available at: http://cisgw3.law.pace.edu/cases/000717c1.html (last visited march 8, 2007). 82 id. 83 china 5 march 2002 guangxi beihai maritime court (sino-add (singapore) pte. ltd. v. karawasha resources ltd.). available at: http://cisgw3.law.pace.edu/cisg/wais/db/cases2/020305c1.html (last visited march 8, 2007). 84 id. 85 see generally: harry m. flechtner, recovering attorneys’ fees as damages under the u.n. sales convention (cisg): the role of case law in the new international commercial practice with comments on zapata hermanos v. hearthside baking, 22 nw. j. int’l l. & bus. 121 (winter 2002) (arguing that many of the nonunited states cases that appear from their english translation to award attorneys’ fees are actually only awarding prelitigation and not litigation expenses). see also: germany, 22 july 2004 appellate courtdusseldorf, available at: http://cisgw3.law.pace.edu/cases/040722g1.html (last visited february 21, 2008); and, germany, 21 june 2006 lower court landsberg (dust ventilator case), available at: http://cisgw3.law.pace.edu/cases/060621g1.html (last visited february 18, 2008). nordic journal of commercial law issue 2008#1 14 litigation and prelitigation fees. the courts of germany are a fine example of the erratic results that arise from a non-uniform interpretation of cisg article 74. a number of german courts have determined that attorneys’ fees are recoverable as a “loss” under cisg article 74. for example, a 2003 german district court held that attorneys’ fees are recoverable as a “loss” under cisg article 74.86 the court reasoned that recovery in this breach of contract action was allowed under article 74 but the method of calculating the amount of attorneys’ fees was governed by german domestic law.87 similarly, a 2002 lower german court held that “the term "loss" in art. 74 sent[ence] 1 cisg, encompasses the cost of pursuing one’s rights,” including attorneys’ fees.88 in this latter case also, the court calculated the amount of attorneys’ fees in accord with german domestic law.89 german courts, although determining that the term “loss” in article 74 entails attorneys’ fees have employed their domestic rules to calculate the amount of attorneys’ fees that can be recovered. in importing these rules, the german courts sometimes award attorneys’ fees from litigation and at others only for prelitigation as is apparently in accord with their domestic law. professor harry m. fletchner90 suggests that many of the german cases that appear from their english translation to award attorneys’ fees are actually only awarding prelitigation and not litigation expenses.91 he addresses specifically a 1996 decision that holds prelitigation expenses recoverable and yet litigation expenses non-recoverable.92 these inconsistencies flow from the application of domestic law as a means of calculating recoverable attorneys’ fees. 3.3.4. belgium the belgium courts are inconsistent in the awarding of attorneys’ fees in cisg governed disputes. one belgium district court93 held that the seller can recover attorneys’ fees, after a discussion of article 74. the court stated that “the claim of the [seller] can be allowed…on the 86 lg berlin, 103 0 213/02, march 23, 2003, (f.r.g.). available at http://cisgw3.law.pace.edu/ cases/030321g1.html (last visited january 7, 2007). 87 id. 88amtsgericht viechtach, no. 1 c 419/01, april 1, 2002 (f.r.g.) available at: http://cisgw3.law.pace.edu/ cases/020411g1.html (last visited january 7, 2007) (quoting the english translation). 89 many german cases have similarly held that the term “loss” in article 74 encompasses attorneys’ fees. see e.g.: germany 13 march 1997 lower court berlin-tiergarten, available at: http://www.cisg.law.pace.edu/ cisg/wais/db/cases2/970313g1.html (last visited march 8, 2007). 90 flechtner, supra note 85 at 121. 91 flechtner, supra note 85 at 128-135. 92 decision of july 11, 1996, oberlandesgericht dusseldorf no. 6 u 152/95, available at http://cisgw3.law.pace.edu/ cases/960711g1.html (last visited january 7, 2007). 93 decision of february 25, 2004, rechtbank van koophandel hasselt, available at http://cisgw3.law.pace.edu/ cases/040225b2.html (last visited january 8, 2007). nordic journal of commercial law issue 2008#1 15 basis of articles 74 and 78 of the vienna sales convention.”94 no discussion is offered in this case of a domestic law governing the recoverability of attorneys’ fees or a statement that attorneys’ fees are a “loss” under article 74, nonetheless “the court…direct[ed] the [buyer] to compensate the [seller] for the legal costs incurred.”95 it is not stated explicitly in this opinion whether the court awarded attorneys’ fees as a “loss” under article 74 or whether the court thought attorneys’ fees excluded from the ambit of article 74 and awarded them as a matter of domestic law. the same belgium court, in another case, did not allow the victim of the breach of contract to recover attorneys’ fees claimed under the cisg. in this 2004 district court opinion, the belgium court did not allow the prevailing party in the cisg breach of contract action to recover attorneys’ fees. 96 this court did not appeal to the cisg in determining the victim of the breach could not recover, but rather stated the recovery was banned because of a belgium law that barred compensation in this circumstance.97 this appeal to domestic belgium law, rather than the cisg in disallowing the recovery of attorneys’ fees indicates that either belgium courts do not accept that attorneys’ fees are considered a “loss” under article 74 or that in this instance the belgium law trumped the cisg. 3.3.5. finland finland adopts the “loser pays” rule, which provides the losing party to the lawsuit has to pay the prevailing party’s legal fees. in an appellate court decision, a buyer sought damages including loss of profit due in part to non-conforming goods and in part from an avoided cisg governed contract, but the buyer lost on these counts.98 the buyer also claimed the seller had never paid the invoices the buyer sent to seller, and won on this count. the court decided, as to attorneys’ fees: by and far, [buyer] has lost this case. the part concerning the invoices that [buyer] won comprises only a small part of the entire trial and claims presented, especially when considering the grounds for the claims and the claims in their entirety and therefore is inconsequential in relation to the division of the parties' legal expenses. therefore, 94 id. 95 decision of february 25, 2004, rechtbank van koophandel hasselt, available at http://cisgw3.law.pace.edu/ cases/040225b2.html (last visited january 8, 2007) (quoting the english translation). 96 decision of february 25, 2004, rechtbank van koophandel hasselt (k bvba v. bv), available at http://cisgw3.law.pace.edu/cases/040225b1.html (last visited january 8, 2007). see also: zeller, supra note 59 at 145 (dr. bruno zeller has noted this case was rendered on the same day and by the same judge as the previous belgium case, supra note 175, that allowed the recovery of attorneys’ fees). 97 id. 98 finland 12 april 2002 turku court of appeal (forestry equipment case). available at: http://cisgw3.law.pace.edu/ cisg/wais/db/cases2/020412f5.html (last visited march 8, 2007). nordic journal of commercial law issue 2008#1 16 [buyer] has to compensate [seller] and its owner for their legal expenses in their entirety. [buyer] has admitted the amount to be correct.99 even though the buyer won on the invoices in this case, the court determined that the buyer had substantially lost, and so attributed to the buyer the legal expenses of the seller. in this case, in a cisg governed lawsuit, finland applied its own domestic law (the “loser-pays” rule) in determining the buyer had to pay attorneys’ fees to the seller. 3.3.6. switzerland swiss courts have consistently held that attorneys’ fees are recoverable in cisg governed disputes, but some appeal to article 74 in justifying the award and others appeal to swiss law to justify the award of attorneys’ fees. a 1996 swiss court100 held that a party is allowed to recover attorneys’ fees for both litigation and prelitigation expenses for cisg governed contracts, and this court awarded the fees under swiss law. the court ruled that “the plaintiff [seller] who has won on the merits has a claim for the costs of litigation…which must be fixed at the sum of sf [swiss franks] 8,830 including: sf 6,000 for the honorarium paid to its counsel; sf 200 for the expenses of the latter; and sf 2,630 in compensation of litigation fees.”101 in stating the authority for the awarding of attorney fees, this swiss court referred to the code of civil procedure rather than article 74 cisg. one year later, a 1997 swiss court 102 held that all attorneys’ fees are recoverable under a cisg governed contract as a “loss” in accordance with article 74. the swiss court held that all attorneys’ fees (both pre-litigation and litigation fees) are recoverable as a “loss” under article 74 so long as they are reasonable.103 the court determined that the “costs of the current swiss attorney of the [seller] are neither specified in detail nor unusually high. they are therefore, according to general practice, to be considered in the final award regarding the parties' costs.”104 the court’s awarding of attorneys’ fees is not to be confused with its awarding of court costs, which was done under its domestic law. the court’s domestic law requires that the “costs of the 99 id. 100 decision of march 11, 1996, appellate court (tribunal cantonal) canton vaud 11 march 1996 [no. 01 93 1061] [163/96/ba and 164/96/ba]; available at http://cisgw3.law.pace.edu/cisg/wais/ db/cases2/960311s2.html (last visited january 8, 2007). 101 id. (quoting english translation); (authority was claimed under the swiss code of civil procedure, article 92, paragraph 1). 102 decision of december 19, 1997. handelsgericht des kantons aargau (switzerland), no. or.97. 00056, available at http://cisgw3.law.pace.edu/cases/971219s1.html (last visited january 8, 2007). 103 id. 104 id. (quoting english translation); (the court cited the authority of section 6(1) einführungsgesetz zum bürgerlichen gesetzbuch [german code on the conflict of laws], to support this finding). nordic journal of commercial law issue 2008#1 17 proceedings are to be paid by the parties according to the relation in which they prevail or are defeated…”105 although the court costs are configured under domestic law, the attorneys’ fees are determined in this case to be a “loss” under article 74 of the cisg and hence recoverable.106 as the preceding manifests, of the cases surveyed,107 most domestic courts, domestic arbitral tribunals, and international arbitral tribunals that have spoken on the issue of the recoverability of attorneys’ fees have found them recoverable in cisg governed disputes. the manner in which these courts award attorneys’ fees as a function of article 74, domestic law, or a combination of the two varies but generally these courts award attorneys’ fees. the next section examines the court decision by the united states’ 7th circuit that excludes attorneys’ fees from the ambit of article 74 and prescribes the recoverability of attorneys’ fees to be a matter of domestic procedural law. this decision effectively announced to the world that the united states will not award attorneys’ fees for litigation under cisg governed disputes. 3.4. united states courts 3.4.1. general remarks the united states courts have had few opportunities to speak directly on the recoverability of attorneys’ fees in cisg governed disputes. the u.s. supreme court has not heard the question of the recoverability of attorneys’ fees in cisg governed disputes, and only one u.s. circuit court has made a determination as to whether they are recoverable in the united states. the 7th circuit court’s opinion, zapata hermanos sucesores v. hearthside banking company108 is the leading u.s. case on the recoverability of attorneys’ fees. this subsection traces the issue of attorneys’ fees in zapata from the united states district court for the northern district of illinois’s109 opinion that awarded attorneys’ fees under a combination of domestic and cisg 105 id. 106 id. 107 this assessment could be rebutted if, as more courts speak on the topic of the recovery of attorneys’ fees under cisg article 74, they hold the contrary by stating attorneys’ fees are non-recoverable as damages. nonetheless, my present research indicates that the majority of courts will be prone to award attorneys’ fees for breaches of cisg governed contracts but the function by which they will award them is unclear at this point (i.e., whether attorneys’ fees are awarded as a matter of domestic law, as a ‘loss’, or as a combination of the two in these other countries is unclear). 108 zapata hermanos sucesores v. hearthside banking co., 313 f.3d 385 (7th cir. 2002). 109 zapata hermanos sucesores, s.a. v. hearthside baking co., inc., 155 f.supp.2d 969 (n.d.ill. aug 22, 2001) (no. 99 c 4040). nordic journal of commercial law issue 2008#1 18 law, through the 7th circuit’s reversal as to attorneys’ fees, and then to the denial of the writ of certiorari to the zapata ruling of the 7th circuit by the united states supreme court.110 3.4.2. the facts of zapata this dispute arose simply over an alleged breach of contract between mexican corporation, zapata, and u.s. wholesaler, lenell.111 zapata was a mexican supplier of cookie tins that supplied hearthside baking co., inc. d/b/a maurice lenell cooky co. (lenell), a u.s. cookie wholesaler with the cookie tins that lenell used to package and sell his cookies.112 both the u.s. and mexico are parties to the cisg, so when lenell refused to pay zapata the almost $900,000 due under invoices, zapata sued under the convention for breach of contract in the district court for the northern district of illinois.113 of the one-hundred and ten invoices that zapata sued over, the district court judge granted judgment as a matter of law on ninety-three of them, totaling $850,000.114 the money due under the other seventeen invoices was then submitted to the jury and the jury found in favor of lenell.115 the judge dismissed a number of counterclaims filed by lenell and the jury found in favor of zapata on the others, and also awarded zapata $350,000 for the ninety-three invoices zapata had prevailed on, for prejudgment interest.116 the judge thereafter awarded zapata $550,000 in attorney’s fees, for the fees incurred throughout the litigation.117 on appeal, the 7th circuit affirmed the district court’s judgment in part, and reversed as to attorneys’ fees.118 3.4.3. the northern illinois district court (a) the outcome of the district court the district court reasoned that article 74 of the cisg allowed for the award of attorneys’ fees as a “loss” in cisg governed disputes, and further that in the present case wherein lenell 110 zapata hermanos sucesores, s.a. v. hearthside baking co., inc., 540 u.s. 1068, 124 s.ct. 803, 157 l.ed.2d 732, 71 uslw 3589, 72 uslw 3364, 72 uslw 3373 (u.s. dec 01, 2003) (no. 02-1318). 111 zapata hermanos sucesores v. hearthside banking co., 313 f.3d 385, 387 (7th cir. 2002). 112 id. at 387. 113 id. at 387. 114 id. at 387. 115 id. at 387. 116 id. at 387-388. 117 id. at 387-388, 391. 118 zapata hermanos sucesores v. hearthside banking co., 313 f.3d 385, 391 (7th cir. 2002). nordic journal of commercial law issue 2008#1 19 acted in bad faith, that attorneys’ fees were recoverable under domestic law. pursuant to this reasoning, the district court awarded zapata $550,000 in attorneys’ fees. (b) the cisg rationale the court first addressed the american rule’s inapplicability, and then presented two intertwined reasons for allowing the recovery of attorneys’ fees under this cisg governed contract. the district court rejected the contention of lenell’s counsel that attorneys’ fees are not recoverable because of the american rule. the american rule is a general rule which disallows the recovery of attorneys’ fees in federal courts unless if there is a statute or contract providing otherwise. in this instance, the court reasoned, the parties stipulated that the cisg applied and the parties entered into an agreement subsequent to the contract, on june 8, 2001, which stated in part: as of the dates when [buyer] issued its purchase orders for the tins described in the invoices attached as group exhibit a to [seller's] complaint in this case, [buyer] foresaw or should have foreseen that if lenell failed to pay for the tins that it ordered, received and accepted, [seller] would incur litigation costs including attorneys fees, to seek payment of the invoices for said tins…the court shall determine if attorney’s fees are recoverable as a matter of law. the preceding stipulation was admissible evidence of the intent of the parties under cisg article 8(3) because it was the “subsequent conduct of the parties.”119 the court coupled this stipulation with an unconstrained reading of article 74 to determine that attorneys’ fees were recoverable. the court determined that article 74 of the cisg, when read with a mind towards uniformity, required that foreseeable, consequential damages were recoverable under this provision.120 the court took into account non-u.s. court decisions that awarded attorneys’ fees in similar situations, and in line with uniformity which is stressed in many articles of the convention, looked to the language of article 74. article 74 clearly stated that a “foreseeable” loss that is a 119 article 8(3) provides the courts should be “…giving due consideration…to all relevant circumstances of the case including negotiations, any practices which the parties have established between themselves, usage and any subsequent conduct of the parties.” 120 article 74 reads: “damages for breach of contract by one party consist of a sum equal to the loss, including loss of profit, suffered by the other party as a consequence of the breach. such damages may not exceed the loss which the partying breach foresaw or ought to have foreseen at the time of the conclusion of the contract, in the light of the facts and matters of which he then knew or ought to have known, as a possible consequence of the breach of contract.” nordic journal of commercial law issue 2008#1 20 “consequence of the breach” is recoverable. given lenell’s own stipulation that attorney’s fees were foreseeable and were a consequence of the breach (above), the court determined that attorneys’ fees were recoverable under cisg article 74. the combination of the cisg, an international convention, requiring the attorneys’ fees as recoverable and the contractual stipulation that the court should determine if attorneys’ fees are recoverable led the district court to determine that the american rule was inapplicable in this circumstance.121 thus, the district court determined that attorneys’ fees were recoverable in this circumstance under article 8 and article 74 of the cisg. the district court then turned to justify the award under the domestic law of the united states. (c) the domestic rationale the “searchlight of the analysis is…properly focused on the language of the convention,” and yet under domestic law, in this instance of bad faith, the district court determined that attorneys’ fees were awardable also under domestic law.122 the district court cited the supreme court’s decision chambers v. nasco,123 which stated under domestic law federal courts have the inherent power to impose attorney’s fees as damages when bad faith is the cause of additional expenses.124 in the present case, the district court considered lenell’s refusal to pay for hundreds of thousands of cookie tins and its refusal to offer a legal defense for not paying as constitutive of bad faith.125 this refusal both to pay and to offer a defense continued throughout the litigation and, in turn, made the litigation more expensive for zapata.126 as the district court concluded, “this is a case of an extreme bad faith refusal to pay, both before and during this litigation…”127 therefore, the awarding of attorneys’ fees was found to be dually justified by the district court: one, by the substantive provisions of the cisg, and two, under the supreme court precedent allowing federal courts to award attorneys’ fees in circumstances of extreme bad faith. 121 zapata hermanos sucesores, s.a. v. hearthside baking co., inc., 2001 wl 1000927, at 3 (n.d.ill. aug 29, 2001). 122 zapata hermanos sucesores, s.a. v. hearthside baking co., inc., 2001 wl 1000927, at 3 (n.d.ill. aug 29, 2001). 123 chambers v. nasco, 501 u.s. 32, 45-46 (1991). 124 zapata hermanos sucesores, s.a. v. hearthside baking co., inc., 2001 wl 1000927, at 4-5 (n.d.ill. aug 29, 2001). see also: chambers v. nasco, 501 u.s. 32, 45-46 (1991); hall v. cole, 412 u.s. 1, 15 (1973); roadway express inc. v. piper, 447 u.s. 752, 766 (1980); and, hutto v. finney, 437 u.s. 679, 689 n. 14 (1978). 125 zapata hermanos sucesores, s.a. v. hearthside baking co., inc., 2001 wl 1000927, at 4-6 (n.d.ill. aug 29, 2001). 126 id at 4-5. 127 zapata hermanos sucesores, s.a. v. hearthside baking co., inc., 2001 wl 1000927, at 6 (n.d.ill. aug 29, 2001). see also: elisabeth opie, special featurezapata hermanos sucesores s.a. v. hearthside baking co., inc. d/b/a maurice lenell cooky co., 6 vj 25, 26 n. 4 (2002). nordic journal of commercial law issue 2008#1 21 3.4.4. the seventh circuit court’s reversal as to attorneys’ fees (a) the outcome of the seventh circuit court the seventh circuit, in an opinion written by judge posner, reverses the dual justification of the district court. the seventh circuit determines that attorneys’ fees are neither recoverable under the cisg nor, in this instance, under the supreme court bad faith precedent. (b) the cisg rationale (i) introducing the three arguments the circuit court offers three lines of argument for excluding attorneys’ fees from the substantive ambit of cisg article 74. the first line is what i have called the “apparent” argument; the second line is what i have named the “procedural” argument, and the third i have termed the “anomalous” argument. in light of these three lines of argument, the circuit court determines that attorneys’ fees are not recoverable under the cisg. each will be introduced in this section; an analysis of these arguments is offered infra.128 (ii) the “apparent” argument the circuit court determines that it is “apparent” that attorneys’ fees are not intended to be considered a “loss” under cisg article 74. the court reasons that there is no mention of attorneys’ fees in the cisg, in its drafting history, or in the cases under it: there is no suggestion in any of these sources that attorneys’ fees are considered a “loss” but no suggestion that they are not considered to be a “loss” under article 74 of the convention.129 therefore, the court contends, that it “seems apparent” that “loss” does not include attorneys’ fees for litigation, but could include “certain pre-litigation legal expenditure” as incidental damages.130 (iii) the “procedural” argument the circuit court resolves that the matter of attorneys’ fees is not expressly settled in the cisg, so attorneys’ fees are to be evaluated under article 7(2), and concludes that the domestic procedural law of the united states governs attorneys’ fees.131 according to article 7(2), if a matter is not expressly settled by the convention, then it is to be settled “in conformity with 128 see: section iv to this paper. 129 zapata hermanos sucesores v. hearthside banking co., 313 f.3d 385, 388 (7th cir. 2002). 130 id. at 388. 131 id. at 388. nordic journal of commercial law issue 2008#1 22 the general principles upon which it is based, or in the absence of such principles, in conformity with the law applicable by virtue of the rules of private international law.” the circuit court reasons that since there are no general principles applicable, that domestic law should be used to fill this gap. anyways, the circuit court emphasizes, the “convention is about contracts, not about procedure,” and the recovery of attorneys’ fees is a matter of the procedural law of the united states.132 thus, according to the circuit court, attorneys’ fees are excluded from the substantive provisions of the cisg and are left as a matter of domestic procedural law. (iv) the “anomalous” argument the circuit court’s third line of argument is that an interpretation of “loss” under article 74 that includes attorneys’ fees would lead to anomalous results.133 the court elaborates that article 74 is conditional upon there being a breach of contract and no damages are recoverable unless the court determines there is a breach of contract.134 if “loss” in article 74 were to include attorneys’ fees, then only a prevailing plaintiff in a breach of contract action would be able to recover attorneys’ fees. a prevailing defendant would not be able to recover attorneys’ fees under article 74 because there is no breach of contract found by the court if the defendant prevails.135 these anomalous effects are, according to the court, yet “another reason to reject the interpretation,” of the term “loss” in article 74 that would allow for the recovery of attorneys’ fees.136 in sum, the seventh circuit overturns the district courts’ decision to allow attorneys’ fees to be recoverable as a “loss” in article 74 for the preceding three reasons. the seventh circuit also poses a series of questions regarding the effects of such an interpretation and whether the u.s. would have agreed to such an interpretation in the drafting of the convention.137 the seventh circuit is skeptical that the u.s. would have signed the convention if attorneys’ fees were to be deemed recoverable, this skepticism is manifested in the opinion’s query: “how likely is it that the united states would have signed the convention had it thought that in doing so it was abandoning the hallowed american rule?”138 the seventh circuit determines that attorneys’ fees are not recoverable under the substantive provisions of the cisg, but are a matter for the 132 id. at 388. 133 id. at 388. 134 cisg article 74. 135 zapata hermanos sucesores v. hearthside banking co., 313 f.3d 385, 388 (7th cir. 2002). (the court also notes that recovery for breach of contract is subject to the cisg article 77 requirement that parties mitigate damages). 136id .at 388. 137 id. at 389. 138 id. at 389. nordic journal of commercial law issue 2008#1 23 domestic procedural law of the forum. and, the procedural law of the u.s. is the “american rule” which bars litigants from recovering attorneys’ fees in cases concerning contracts for the sale of goods. (c) the domestic rationale the seventh circuit, after concluding the american rule is applicable, further determines that the supreme court’s “bad faith” justification for awarding attorneys’ fees was misapplied by the district court. the federal court’s inherent authority to award attorneys’ fees in instances of extreme bad faith is “to be exercised sparingly”139 and cannot be extended to provide federal courts with a remedy unavailable under state law when, as in this case, the substantive law of the state provides the rules of decision. federal courts have the inherent authority to award attorneys’ fees in cases of extreme bad faith for cases arising under federal law, but under the erie doctrine, federal courts cannot award attorneys’ fees for cases arising under substantive state law.140 extending the inherent authority of federal courts to award attorneys’ fees to cases governed by state law would allow the erie doctrine to be circumvented by essentially renaming “punitive damages” (a matter of substantive state law) as “attorneys’ fees” and this, the seventh circuit contends, cannot be constitutionally done.141 the authority for federal courts to award attorneys’ fees, regardless of the erie problems, the circuit court confirms, is to be used in rare and extreme circumstances. the seventh circuit makes “clear that it is a residual authority, to be exercised sparingly, to punish misconduct (1) occurring in the litigation itself, not in the events giving rise to the litigation…and (2) not adequately dealt with by other rules, most pertinently here rules 11 and 37 of the federal rules of civil procedure, which lenell has not been accused of violating.”142 the circuit court reiterates that lenell’s failure to pay (breach of contract) and refusal to offer a defense for the breach, is hardly the scenario previous courts considered when awarding attorneys’ fees for 139 id. at 391. 140 zapata hermanos sucesores v. hearthside banking co., 313 f.3d 385, 390 (7th cir. 2002). (the court cites as authority for this: united states ex rel. treat bros. co. v. fidelity & deposit co. of maryland, 986 f.2d 1110, 1119-20 (7th cir. 1993); see also chambers v. nasco, inc., 501 u.s. 32, 52-55 (1991); association of flight attendants, aflcio v. horizon air industries, inc., 976 f.2d 541, 548-50 (9th cir. 1992); and, o'melveny & myers v. fdic, 512 u.s. 79, 83-85, 87-88 (1994).) 141 zapata hermanos sucesores v. hearthside banking co., 313 f.3d 385, 390 (7th cir. 2002). 142 id. at 391. nordic journal of commercial law issue 2008#1 24 reasons of bad faith.143 if the district court’s interpretation were to be adopted, the circuit court says, the authority to award attorneys’ fees would be extended to almost every breach of contract action arising in a federal court. the seventh circuit thus reverses the district court’s awarding of attorneys’ fees to zapata because the district court exceeded its authority in awarding attorneys’ fees under domestic law, and because attorneys’ fees are not governed by the cisg but rather are a matter of the procedural law of the united states. the procedural law of the united states bars the recovery of attorneys’ fees in actions concerning breaches of contracts for the sale of goods under the “american rule,” so attorneys’ fees are not recoverable in this case. following the decision of the seventh circuit, the counsel for zapata petitioned the supreme court of the united states for a writ of certiorari.144 the united states government submitted a brief as amicus curiae for the petition for writ, submitting to the supreme court that the seventh circuit court’s opinion is correct as to attorneys’ fees.145 the united states as amicus curiae argued, inter alia: “the court of appeals correctly held that attorneys’ fees are not a form of “loss” under article 74 of the convention and its decision does not conflict with the decision of any other court of appeals”146 the united states supreme court thereafter denied the petition for writ of certiorari. the following section analyzes the arguments made by the seventh circuit which have rendered all subsequent claims for attorneys’ fees under cisg governed contracts in the seventh circuit moot. 147 143 id. at 391.(the circuit court cites this list of authority for its rationale, see: morganroth & morganroth v. delorean, 213 f.3d 1301, 1318 (10th cir. 2000); association of flight attendants, afl-cio v. horizon air industries, inc. 976 f.2d 541, 558-550 (9th cir. 1992); and, shimman v. international union of operating engineers, local 18, 744 f.2d 1226, 1232-1233 and n. 9 (6th cir. 1984) (en banc)). 144 zapata hermanos sucesores, s.a. v. hearthside baking co., inc., 540 u.s. 1068, 124 s.ct. 803, 157 l.ed.2d 732, 71 uslw 3589, 72 uslw 3364, 72 uslw 3373 (u.s. dec 01, 2003) (no. 02-1318). 145 brief for the united states as amicus curiae (no. 02-1318), on petition for a writ of certiorari to the united states court of appeals for the seventh circuit, in the supreme court of the united states_ zapata hermanos sucesores, s.a., petitioner v. hearthside baking company, d/b/a maurice lenell cooky company respondent. available at: http://cisgw3.law.pace.edu/cisg/biblio/zapata4.html (last visited march 9, 2007). 146 id. 147 see also: ajax tool works, inc. v. can-eng manufacturing ltd., 2003 wl 223187 (n.d. ill.), prod. liab. rep. (cch) p 16, 516; and, chicago prime packers, inc. v. northam food trading co., et al., 320 f.supp.2d 702 (n.d.ill. 2004) (for instances of where a u.s. district court has used zapata to deny requests for attorneys’ fees). nordic journal of commercial law issue 2008#1 25 part ii: analysis of the controversy 4. a critique of the seventh circuit’s opinion: zapata 4.1. introducing the critique the 7th circuit court’s opinion in zapata offered three strong arguments for not allowing the recovery of attorneys’ fees under cisg contracts in the united states. judge posner, who wrote the opinion, intricately delineated the reasons why attorneys’ fees are not recoverable as damages under article 74 of the cisg. i have termed these arguments: (i) the “apparent” argument, (ii) the “procedural” argument, and (iii) the “anomalous” argument. these arguments have since become the subject of critique for many commentators who are not satisfied with the 7th circuit court’s decision and reasoning. the arguments and critique are considered in the following. 4.2. addressing the “apparent” argument judge posner of the 7th circuit realizes that there is no mention of whether attorneys’ fees should be considered a “loss” under article 74 of the cisg or anywhere in the drafting history of the convention.148 the opinion goes on to state that even though there is no mention of attorneys’ fees, that it is “apparent” that attorneys’ fees were not intended to be included in the substantive meaning of the term “loss” in article 74.149 judge posner further queries into the likelihood that the united states would have signed the convention if the u.s. would have had to give up the american rule in signing: the rule that prohibits the recovery of attorneys’ fees as damages for breaches of contracts for the sale of goods.150 considering these two factors: that the u.s. probably would not have given up the american rule, and that it is “apparent” that attorneys’ fees are not considered a “loss” under article 74, judge posner determines that attorneys’ fees are not recoverable under article 74 of the cisg. judge posner makes the valid point that it would be unusual for the united states to give up a rule firmly embedded in its own laws in order to become party to an international convention. nonetheless, in signing the cisg the united states sacrificed many rules firmly rooted in its laws. both the parole evidence rule and the statute of frauds, two doctrine of united states law of common law origin, were superseded by the laws of the cisg. it would not be unreasonable, 148 zapata hermanos sucesores v. hearthside banking co., 313 f.3d 385, 388 (7th cir. 2002). 149 id. 150zapata hermanos sucesores v. hearthside banking co., 313 f.3d 385, 388 (7th cir. 2002). (these two points are made separately in the opinion but i have combined them here because addressing them in this fashion, i believe, is in accord with the court’s reasons for dismissing an interpretation of article 74 that would allow for the recovery of attorneys’ fees as a “loss.”) nordic journal of commercial law issue 2008#1 26 in light of these two concessions, to think that the united states by signing the cisg conceded also to allow for the recovery of attorneys’ fees as a “loss” under article 74. the 11th circuit in mcc-marble ceramic center v. ceramica nuova d’agostino, s.p.a.151 affirmed that article 8 of the cisg trumps the parol evidence rule, an integral rule that is part of the united states laws. the 11th circuit held, unquestionably that “the cisg…precludes the application of the parol evidence rule, which would otherwise bar the consideration of evidence concerning a prior or contemporaneously negotiated oral agreement.”152 cisg article 8 requires that courts consider both the subjective intent of the parties to the contract and “all relevant circumstances of the case including negotiations….”153 in order to fulfill this mandate to consider negotiations, u.s. courts have had to deny the application of the parol evidence rule in favor of article 8’s mandate for cases brought in u.s. courts under the cisg.154 the cisg also superseded the statute of frauds provision that is well embedded both in the uniform commercial code and u.s. common law when signing the cisg.155 article 11 of the cisg states explicitly that ‘a contract of sale need not be concluded in or evidenced by writing and is not subject to any other requirement as to form. it may be proved by any means, including witnesses.” the requirement that contracts be in writing absent certain exceptions (the statute of frauds) is well established in u.s. law particularly in §2-201 of the ucc, a model rule that has been adopted by almost every state.156 the united states was willing to give up the doctrine of the statute of frauds and the parol evidence rule for cisg governed contracts, two common-law rules firmly embedded in united states’ law, in order to sign on to the cisg. it is not implausible to think the united states was also willing to give up the more recent, noncommon law rule that prevents the recovery of attorneys’ fees in order to sign on to the cisg. the 7th circuit failed to consider that although it is unlikely that the u.s. would have given up its “american rule” in signing the cisg, it is even less likely that almost every other country signatory to the cisg would concede to the united states by allowing it to maintain its rule 151 mcc-marble ceramic center v. ceramica nuova d’agostino, s.p.a. 144 f.3d 1384 (1998). 152 id. at 1392. 153 cisg article 8(3). see also: bruno zeller, interpretation of article 74zapata hermanos v. hearthside bankingwhere next?, 1 nordic journal of commercial law 1-11, 4 (2004) (for a similar argument). 154 see also: mitchell aircraft spares v. european aircraft serv. ab, 23 f. supp. 2d 915 (1998) (the court holding that the cisg allows courts to consider parol evidence to determine subjective intent under article 8(1) of the cisg). 155 uniform commercial code (ucc) § 2-201. formal requirements; statute of frauds (contains a rule subject to exceptions that contracts must be in writing). 156 ucc §2-201 entitled formal requirements, statute of frauds, states: “(1) except as otherwise provided in this section a contract for the sale of goods for the price of $500 or more is not enforceable by way of action or defense unless there is some writing sufficient to indicate that a contract for sale has been made between the parties and signed by the party against whom enforcement is sought or by his authorized agent or broker. a writing is not insufficient because it omits or incorrectly states a term agreed upon but the contract is not enforceable under this paragraph beyond the quantity of goods shown in such writing….” nordic journal of commercial law issue 2008#1 27 and contravene uniformity. as the court’s opinion itself states, most other countries in the world abide by some variation of the “loser-pays” rule that allocates to the losing party the responsibility of paying the winning party’s attorneys’ fees.157 it is highly unlikely that every other country signatory to the convention would intend to contravene a uniform interpretation by allowing the united states to maintain a different rule as to attorneys’ fees than almost every other country that is party to the convention. article 74 could be seen as a compromise between the two views because it allows the prevailing plaintiff to recover attorneys’ fees as damages but not the prevailing defendant, when a “loss” in article 74 is read so as to include attorneys’ fees. the “american rule” itself is filled with exceptions, as the 7th circuit notes, and international sales contracts could easily be another exception to the rule disallowing parties to recover attorneys’ fees. the u.s. has over one-hundred federal statutes that modify the american rule so as to allow for the recovery of attorneys’ fees.158 judge posner specifies that, “federal antidiscrimination, antitrust, copyright, pension, and securities laws all contain fieldspecific provisions modifying the american rule (as do many other field specific statutes). an international convention on contract law could do the same.”159 this is true that the convention could act as an exception to the american rule, but the 7th circuit contends that because there is no mention of attorneys’ fees anywhere in the legislative history or the text of the cisg that attorneys’ fees are a matter not expressly settled in the convention so they must be analyzed under article 7(2).160 this is correct, but the court goes on to reason that there are no general principles upon which the convention is based that would be applicable in this instance, so they must resort to domestic law (i.e., the american rule). it is this last step in the analysis that most commentators have criticized. a number of commentators state that the court was mistaken in its assessment that there are no general principles applicable in this instance. jarno vanto, for example, contends that the court’s conclusion in zapata was correct, but that “the court failed to create internationally acceptable grounds for excluding attorneys’ fees from the sphere of article 74.”161 vanto argues that the court too quickly deferred to domestic procedural law without examining the international principles as required by article 7(2) of the convention.162 according to vanto, in looking to domestic procedural law the court missed an opportunity to develop an international 157 zapata hermanos sucesores v. hearthside banking co., 313 f.3d 385, 388 (7th cir. 2002). 158 shelton, supra note 1 at 48 (“more than 100 american federal statutes now authorize courts to award attorney’s fees”). 159 zapata hermanos sucesores v. hearthside banking co., 313 f.3d 385, 388 (7th cir. 2002). 160 id. 161 vanto, supra note 2 at 221. 162 vanto, supra note 2 at 221. nordic journal of commercial law issue 2008#1 28 interpretation in line with the purpose of the cisg, viz., uniformity.163 similarly, a number of commentators assert that there is a principle of “full compensation” embodied in article 74,164 and the 7th circuit did not address this principle of full compensation.165 this decision by judge posner not to address any general principles in the cisg may well be because of disagreement over the meaning of a “principle” in article 7(2). infra, this essay discusses the underlying jurisprudential considerations that are represented in the meaning of the term “principle” in article 7(2).166 in saying that it is “apparent” that attorneys’ fees are not included under the term “loss” in article 74, judge posner is correct insofar as under united states contract laws for the sale of goods it is apparent that a “loss” does not include attorneys’ fees. the uniform commercial code does not allow recovery of attorneys’ fees under article 2, the article addressing contracts for the sale of goods.167 this model law has been adopted in almost every state in the u.s., so it is apparent in the u.s. that contracts for the sale of goods do not allow the recovery of attorneys’ fees. however, in the arena containing all the other countries signatory to the cisg besides the united states, the “loser-pays” rule is adopted in one variation or another in a “nearly universal” manner.168 moreover, certain types of contracts in the united states do allow for the recovery of attorneys’ fees. under the revised article 5 of the ucc, which has been adopted in almost every u.s. state, §5-111(e) not only allows but requires the recovery of reasonable attorneys’ fees including litigation expenses, in letter of credit actions.169 these points all raise questions as to whether it is really “apparent” that attorneys’ fees are not considered a “loss” under article 74 cisg. 163 vanto, supra note 2 at 221. 164 see e.g.: joseph lookofsky, in dubis pro conventione? some thoughts about opt-outs, computer programs and preemption under the 1980 vienna sales convention (cisg), 13 duke j. of comp. & int'l l. 263 (2003; and, bojidara borisova, remarks on the manner in which the principles of european contract law may be used to interpret or supplement article 75 of the cisg, 1 nordic journal of commercial law 1-6 (2003). 165 see e.g.: bruno zeller, interpretation of article 74zapata hermanos v. hearthside bankingwhere next?, 1 nordic journal of commercial law 1-11, 4 (2004). 166 section v to this paper. this discussion will perhaps clarify the term “principle” so that prospectively courts can ascertain and apply the general principles of article 7(2). 167 uniform commercial code (ucc), article 2 (specifically, §2-701 through §2-725). 168 vanto, supra note 2 at 205. 169 ucc §5-111(e) (“reasonable attorney's fees and other expenses of litigation must be awarded to the prevailing party in an action in which a remedy is sought under this article”). see also: carter h. klein, attorney’s fees in letter of credit cases under ucc §5-111(e), 9 documentary credit world 10 (nov/dec 2005). nordic journal of commercial law issue 2008#1 29 4.3. addressing the “procedural” argument judge posner’s second reason for concluding that attorneys’ fees are not recoverable as a “loss” under article 74 is because: “the convention is about contracts, not about procedure.”170 judge posner suggests that the “american rule” is not a field-specific rule, but rather is a general rule of u.s. procedure.171 the court reasons that since the convention is about contracts and not about procedure, attorneys’ fees which are a part of general procedural law in the united states are not recoverable as a “loss” under the substantive term “loss” in article 74. the 7th circuit’s opinion contends that the rules of different nations vary in whether they allow the recovery of attorneys’ fees, but no one would say that french contract law differs from u.s. because the winner of a contract suit in france is entitled to be reimbursed by the loser, and in the u.s. not. that is an important difference but not a contract-law difference. it is a difference resulting from differing procedural rules of general applicability.172 judge posner argues that the allowance of the recovery of attorneys’ fees is not a matter of the substantive contract law, but rather is a matter of the procedural law of the forum. this “procedural” argument has led to some very creative responses by critics, and i have recognized at least two interrelated, strong lines of argument in the literature. the first line of argument claims that classifying attorneys’ fees as procedural contravenes the mandate in article 7(1) requiring uniformity in interpretation.173 and, the second line of argument suggests that attorneys’ fees in the context of the cisg are substantive law, and not procedural, in other 170 zapata hermanos sucesores v. hearthside banking co., 313 f.3d 385, 388 (7th cir. 2002). 171 id. 172 id. 173 gotanda, supra note 33. see also: carruthers, the substance and procedure distinction in conflict of laws: a continuing debate in relation to damages, 53 int’l & comp. l.q. p. 691 (2004); and, cisg a-c opinion no. 6, calculation of damages under article 74, rapporteur: professor john y. gotanda, villanova university school of law, villanova, pennsylvania, usa., available at: http://www.cisg.law.pace.edu/cisg/cisg-ac-op6.html (last visited march 6, 2007). nordic journal of commercial law issue 2008#1 30 words, the 7th circuit did not have regard for the convention’s international character.174 i am most sympathetic to these arguments, and we will consider each in turn.175 classifying attorneys’ fees as a matter of procedural law will contravene the mandate for a uniform interpretation required by article 7(1) of the cisg.176 the 7th circuit court’s classification of attorneys’ fees as procedural and outside the ambit of the convention will allow each jurisdiction to award attorneys’ fees in accord with the domestic laws of the jurisdiction regardless of whether they are considered substantive or procedural law in the jurisdiction. the united states will not award litigation attorneys’ fees but may sometimes award prelitigation attorneys’ fees as incidental damages, according to the 7th circuit court’s decision.177 at the same time, switzerland can award both prelitigation and litigation fees for every cisg breach of contract action. as one swiss court held, “all costs incurred in the reasonable pursuit of a claim are refundable, which included retaining a lawyer in the country of each party.”178 whereas the swiss court allows recovery of all attorneys’ fees and the u.s. court allows no recovery of litigation expenses but sometimes the recovery of non-litigation expenses, another jurisdiction may disallow any recovery for any attorneys’ fees incurred during litigation and prelitigation. even more so, there could be any other number of variant laws, both substantive and procedural, that allow or disallow the recovery of attorneys’ fees based on country or jurisdiction specific laws.179 the 7th circuit court’s decision to allow the recovery of attorneys’ fees to be determined on a domestic basis allows the inconsistent holdings under the cisg as to attorneys’ fees to remain inconsistent. this counter argument essentially is making two claims: one, that the “procedural” argument does not promote a uniform application of the 174 zeller, supra note 33; and, john felemegas, an interpretation of article 74 cisg by the us circuit court of appeals, 15 pace int’l l. rev. 91, 121 (spring 2003) (the distinction between substantive and procedural laws “could be termed artificial or technical”). 175djakhongir saidov, standards of proving loss and determining the amount of damages, 22 j. of contract l. 1 (march 2006) (saidov suggests that there may be a third line of argument which claims the convention can govern procedural matters, citing, herber in p schlechtriem (ed), commentary on the un convention on the international sale of goods (cisg), 2nd ed, 46, (clarendon press, oxford 1998)). moreover, albert kritzer of pace university school of law pointed out that cisg article 11 guides procedural matters by providing how to prove the existence of a contract, so the cisg arguably does govern some procedural matters potentially including attorneys’ fees (email correspondence). 176 article 7(1) reads: “in the interpretation of this convention, regard is to be had to its international character and to the need to promote uniformity in its application and the observance of good faith in international trade.” 177 zapata hermanos sucesores v. hearthside banking co., 313 f.3d 385, 388 (7th cir. 2002). see also: sorenson v. fio rito, 90 ill.app.3d 368, 45 ill. dec. 714, 413 n.e.2d 47, 5052 (1980); and, tull v. gundersons, inc., 709 p.2d 940, 946 (colo.1985); and, restatement (second) of contracts § 347, comment c (1981). 178 decision of december 19, 1997. handelsgericht des kantons aargau (switzerland), no. or.97. 00056, quotation from the english case abstract available at: http://cisgw3.law.pace.edu/cases/971219s1.html (last visited december 28, 2006). 179 see generally: vanto, supra note 2 (for a delineation of the variant laws on attorneys’ fees in a number of countries). nordic journal of commercial law issue 2008#1 31 cisg, and two, that the “procedural” argument does not give regard to the international character of the cisg. as to uniformity, a number of commentators contend that the substantive-procedural distinction employed by the 7th circuit thwarts the mandate of a uniform application of the cisg.180 as professor gotanda proposes, “relying on a substance/ procedure distinction in cases where jurisdictions differ over the classification of a matter is counterproductive and…can lead to conflicting results.”181 whether a matter is considered substantive or procedural, professor gotanda asserts, often varies between jurisdictions and the facts of an individual case.182 by allowing such conflicting results based on jurisdictional interpretations, a court “undermines the legitimacy of the convention and thwarts its goal of creating uniform rules.”183 that is, the convention is a matter of international law and domestic categorization of items into substantive or procedural should not be used to interpret the international convention. and, this faulty distinction is the root of the non-uniform interpretation that derogates from the aim of a uniform international sales law, according to these commentators.184 as to not giving regard to the international character of the convention, many commentators argue that the 7th circuit did not take into account the international character of the convention as required by article 7(1) when deeming attorneys’ fees as procedural.185 this argument suggests that the substantive-procedural distinction employed by the 7th circuit was suffering from the homeward trend, that is, the tendency to interpret an international convention by the importation of domestic meanings, rather than international meanings.186 these commentators claim that the international meaning of “loss” within the context of the 180 gotanda, supra note 33 at 122. see also: carruthers, supra note 173 at 691; and, cisg a-c opinion no. 6, calculation of damages under article 74, rapporteur: professor john y. gotanda, villanova university school of law, villanova, pennsylvania, usa. 181 gotanda, supra note 33 at 122. 182 gotanda, supra note 33 at 122. 183 gotanda, supra note 33 at 120. 184 see also: chiara giovannucci orlandi, procedural law issues and uniform law conventions, uniform law review, vol. v, no. 1, 23 (2000); and, cisg a-c opinion no. 6, calculation of damages under article 74, §5.2, rapporteur: professor john y. gotanda, villanova university school of law, villanova, pennsylvania, usa., available at: http://www.cisg.law.pace.edu/cisg/cisg-ac-op6.html (last visited march 6, 2007).(“relying upon such a [substance-procedure] distinction in this context is outdated and unproductive”); and, peter schlechtriem, legal costs as damages in the application of un sales law, forthcoming (2008). contra harry fletcher & joseph lookofsky, viva zapata! american procedure and cisg substance in a u.s. circuit court of appeal, 7 vindobona journal of international commercial law and arbitration (2003) 93-104; and, harry fletcher & joseph lookofsky, zapata retold: attorneys fees are (still) not governed by cisg, forthcoming (2008). 185zeller, supra note 33 at 143-167, and, felemegas, supra note 174 at 121 (the distinction between substantive and procedural laws “could be termed artificial or technical”). 186zeller, supra note 33 at 143-167. nordic journal of commercial law issue 2008#1 32 cisg includes attorneys’ fees. in other words, what may be considered procedural law in the united states was transmuted into substantive law via the term “loss” in article 74 of the cisg, and attorneys’ fees are recoverable as a “loss.” the delineation of substantive and procedural law is complicated because the same term or the same standard in one context can be given a procedural role whereas the exact same term or standard in another context will be considered substantive. perhaps judge posner is correct and attorneys’ fees are generally a matter of procedural law within the united states, nevertheless, at times attorneys’ fees even in the united states are a matter of substantive law. take, for example, revised §5-111(e) of the uniform commercial code which requires the payment of attorneys’ fees in letter of credit actions. the ucc is a substantive body of law and the inclusion of attorney’s fees under the “remedies” heading of §5-111 has, in effect, transmuted attorneys’ fees from general procedural law into a substantive body of law. ucc §5-111(e) provides that “reasonable attorney's fees and other expenses of litigation must be awarded to the prevailing party in an action in which a remedy is sought under this article.” in addition to attorneys’ fees, other remedies provided in §5-111 include incidental damages187 and damages resulting from the breach,188 both of which are damages considered to be substantive law even within the united states. by analogy, the cisg term “loss” has transmuted attorneys’ fees into the substantive law of the cisg even though it may generally be procedural law within the united states. as dr. zeller remarks, “in essence, the application of a domestic procedural law distorted the process of what could have been a uniform application of substantive law.”189 therefore, it has been argued, that attorneys’ fees are considered substantive law under the cisg, rather than procedural. other commentators suggest that the recovery of attorneys’ fees as a “loss” is in accord with the principle of “full compensation” recognized by the cisg so should be given the substantive content required by the international convention.190 the principle of full compensation under the secretariat commentary, does not explicitly state any types of damages that are recoverable but only that the principle of full compensation is limited by the principles of foreseeability, mitigation, and that the loss must be a consequence of the breach.191 given that these are the only explicit limitations on a ‘loss’ under article 74, it seems apparent that attorneys’ fees should be considered a “loss,” and hence recoverable for breaches of contracts for the international sale of goods. 187 ucc §5-111(b) and §5-111(c). 188 ucc §5-111(b) and §5-111(c). 189 zeller, supra note 33 at 159. 190 zeller, supra note 33 at 143-167. 191 secretariat commentary, available at: http://www.cisg.law.pace.edu/cisg/text/secomm/secomm-74.html (last visited january 15, 2007). nordic journal of commercial law issue 2008#1 33 attorneys’ fees are considered as a “loss” under article 74 of the cisg, and a “loss” is generally considered to be a substantive term. djakhongir saidov maintains that standards of proving loss and what constitutes a “loss” are often contained in canons of law that are traditionally considered substantive law.192 he provides the example of the unidroit principles which are generally considered substantive law; these principles contain provisions pertaining to the certainty of loss.193 moreover, saidov points out, “the standard of certainty with which loss needs to be proved is contained in a separate provision in the us restatement (second) of contracts containing rules on contracts which seem to be traditionally regarded as rules on substantive law.”194 the “loss” provision in article 74 is a substantive provision and like the exceptions to the american rule (e.g., antitrust, copyright, letters of credit, etc.), the substantive term “loss” in article 74 should trump the general procedural law of the united states.195 despite that judge posner is correct insofar as generally the procedural law of the united states governs the recovery of attorneys’ fees, according to these commentators, judge posner’s conclusion is flawed because article 74 of the cisg, like article 5 of the ucc and the united states federal statutes that exceed one-hundred in number, allows attorneys’ fees to be awarded as damages. 4.4. addressing the “anomalous” argument the final argument offered by the 7th circuit for excluding attorneys’ fees from the term “loss” under article 74 is that this interpretation would result in anomalies.196 judge posner suggested that if the interpretation of “loss” included attorneys’ fees, then “the prevailing plaintiff in a suit under the convention would…get his attorneys’ fees reimbursed more or less automatically…but what if the defendant won?”197 if the defendant won, he would be unable to recover attorneys’ fees under article 74, because recovery is conditional upon a breach of contract. if there is no breach, then there can be no “loss” recovered under article 74 by the defendant. this is the “anomalous” result flowing from “loss” in article 74 of the cisg being 192 saidov supra note 175. 193 article 7.4.3 unidroit principles. see also: saidov supra note 175 at 51. 194 saidov supra note 175 at 51 (referring to §352 of the restatement (second) of contracts). 195 zeller, supra note 33 at 143-167. 196 zapata hermanos sucesores v. hearthside banking co., 313 f.3d 385, 388 (7th cir. 2002). 197 id. at 389. judge posner is particularly concerned about allowing the recovery of attorneys’ fees for prevailing plaintiffs and not for prevailing defendants in the u.s. because if this recovery is allowed in the u.s., then foreign courts may implement their domestic rules if the defendant prevails. this will both allow prevailing defendants to recover attorneys’ fees under domestic law and prevailing plaintiffs to recover attorneys’ fees under the cisg. this is a justifiable worry by judge posner, but it is presuming bad faith by the other parties to the convention, and “good faith” is also a requirement of interpretation. i believe that we must presume that if the u.s. acts in good faith in interpreting this provision by allowing the recovery of attorneys’ fees as a ‘loss’ under article 74, then other countries will similarly follow and proceed with their interpretations in good faith without the incorporation of domestic laws. nordic journal of commercial law issue 2008#1 34 interpreted so as to include attorneys’ fees: the prevailing plaintiff can recover attorneys’ fees but the prevailing defendant cannot. this “anomalous” result, the court says, “is another reason to reject the interpretation,”198 that allows attorneys’ fees to be recoverable as a “loss.” the “anomalous” result argument was addressed in the reply brief for the petitioner for writ of certiorari in zapata.199 counsel for petitioner argued that the, complaint that the recovery of attorneys' fees under article 74 would produce anomalous results is also easily refuted when one considers that attorneys' fees would only be recoverable as damages. it is hardly anomalous that only a plaintiff (or counterplaintiff) would be able to recover damages. after all, that is how lawsuits work.200 counsel for petitioner’s argument is a bit succinct, but it makes the valid point that damages for breach of contract actions under article 74 are only recoverable by a prevailing plaintiff or counter-plaintiff. when a defendant prevails, the defendant does not argue that he should get the damages the plaintiff would have gotten had the plaintiff prevailed because if he does not get such damages it will result in anomalies. no, rather the defendant gets nothing except for the satisfaction of having won the lawsuit. on the other hand, if the plaintiff prevails the plaintiff receives all foreseeable losses flowing as a consequence of the breach (presuming she properly mitigated damages). from this perspective, allowing the plaintiff to recover any damages for breach of contract without the defendant being able to recover the same damages has an anomalous result. granted, the defendant can bring a counter-claim for breach of contract and if the defendant brings such a claim then all anomalies will disappear, including the anomaly resulting from allowing the recovery of attorneys’ fees as a “loss” under article 74. thus, “anomalous results” is a faulty justification for excluding attorneys’ fees from the quantum of damages under article 74. i suggest further that even if attorneys’ fees are excluded from the meaning of the term “loss” under article 74, that there will still be anomalous results. the 7th circuit is concerned with the anomalous results of the relationship between the prevailing plaintiff and the prevailing defendant that will occur if attorneys’ fees are recognized as a loss. the court did not consider the anomalous results that will occur between the prevailing plaintiff in one suit and the prevailing plaintiff in another suit, or, for that matter, the prevailing defendant in one suit and the prevailing defendant in another suit, if attorneys’ fees are excluded from the scope of “loss” under article 74. as excluded from the scope of “loss,” prevailing plaintiffs in some jurisdictions will be capable of recovering attorneys’ fees whereas prevailing plaintiffs in other jurisdictions will not. likewise, prevailing defendants in some jurisdictions will be capable of 198 id. at 388. 199 reply brief for the petitioner, on petition for a writ of certiorari to the united states court of appeals for the seventh circuit, zapata hermanos sucesores v. hearthside banking co., no. 02-1318. 200 id. at para. a4. nordic journal of commercial law issue 2008#1 35 recovering attorneys’ fees whereas prevailing defendants in other jurisdiction will not be capable of recovering such fees. for instance, prevailing plaintiffs in switzerland can recover attorneys’ fees but prevailing plaintiffs in the united states cannot.201 this is an anomalous result of the relationship between prevailing plaintiffs that flows from the decision of the 7th circuit. the same anomalous result occurs between prevailing defendants in different jurisdictions. in short, anomalies will be the result whether or not the united states allows the recovery of attorneys’ fees as a “loss” under article 74. given the foregoing analysis, an interpretation of article 74 to include attorneys’ fees as a “loss,” is a viable and reasonable option for other united states circuit courts or even the supreme court. 5. underlying jurisprudential considerations 5.1. positivism versus natural law the contradictory interpretations on the recovery of attorneys’ fees are not merely rooted in the variant interpretations of the term “loss” under article 74 of the cisg but are caused, in part, by the various interpretations of the term “principle” in article 7(2) of the cisg. article 7(2) mandates that when a term within the scope of the convention is not expressly settled that the term be settled in conformity with the general principles on which the convention is based. the meaning of the term “principle” in the context of article 7(2) has been interpreted by different commentators in accord with their underlying theories of jurisprudence. positivist theorists look to the convention as a rule of recognition and pull principles from the text of the convention or find the principles in other rules that the rule of recognition authorizes and validates as law. conversely, natural law theorists look within and beyond the text in their attempt to find principles, natural law theorists believe that there are general principles underlying the universe and the law attempts to encapsulate them. the convention is mankind’s attempt to recognize these general principles, so any appeal to these principles in the interpretation of the law is wholly justified, or even in the case of traditional natural law theory, it is required.202 historically, natural law theorists such as st. thomas aquinas believed that if a law is not in accord with the natural law principles of the universe, then the alleged law is a pseudo-law, and not a law at all.203 the contradictory interpretations of article 74 of the cisg are rooted in these underlying jurisprudential considerations. natural law theorists use article 7(2) to decipher the “general principles” underlying the convention by appealing to natural law principles, that is, by appealing to principles that are 201see: supra section iii. 202 diener, keith w., a defense of soft positivism: justice and principle processes (for a synopsis and the highlights of the debate between positivists and natural law theorists) (2006), available at: http://etd.gsu.edu/theses/ available/etd-04172006-125357/unrestricted/diener_keith_w_200601_ma.pdf (last visited march 2, 2007). 203 diener, supra note 202 at 1-75. nordic journal of commercial law issue 2008#1 36 not necessarily recognized explicitly in the text of the convention as valid principles to use in interpreting gaps in the convention. they attempt to infer from the provisions of the convention a natural law principle that is encapsulated in a provision or provisions of the convention and apply them to interpret other provisions of the convention. these principles are justified in their use, according to the natural law theorist, simply because they are natural law, the highest law.204 natural law theorists claim that rules and principles are logically distinct entities.205 generally, rules are considered by natural law theorists to be rigid and inflexible. if a rule comes into conflict with another rule then one rule is considered invalid and the other remains valid.206 principles are different than rules because they are flexible: two principles can come into conflict with another without one being deemed invalid. principles are weighted so that when they come into conflict one outweighs the other without invalidating eitherthey both remain valid.207 as seen as logically distinct entities, a natural law theorist by this very reasoning must look to natural law principles rather than the rules stated in the text of the convention to interpret and settle terms that are not expressly settled under article 7(2). thus, according to the natural law view, the general principles underlying the convention referred to in article 7(2) are none other than natural law principles.208 positivist theorists, on the other hand, decipher the “general principles” underlying the convention by appealing to what is recognized as a valid principle under the rule of recognition, in this case, the cisg. rules of recognition are the master rule per a jurisdiction or per the laws that come within the scope of the rule. in the realm of international law, the rule of recognition states what is considered valid law within the area of law stated in the convention to countries signatory to the convention. the cisg acts as the rule of recognition for international contracts for the sale of goods for the parties to the convention. the cisg also validates the use of domestic law and private international law in international sales law under the bottom rung of the hierarchy of interpretation provided in article 7(2), via the rules of private international law including the choice of law rules.209 204 diener, supra note 202 at 1-75. 205 diener, supra note 202 at 1-75. 206 diener, supra note 202 at 1-75. 207 diener, supra note 202 at 1-75. 208 diener, supra note 202 at 1-75. 209 article 7(2) explicitly recognizes the use of private international law, it states “questions concerning matters governed by this convention which are not expressly settled in it are to be settled in conformity with the general principles on which it is based or, in the absence of such principles, in conformity with the law applicable by virtue of the rules of private international law.” nordic journal of commercial law issue 2008#1 37 positivists assert that the difference between rules and principles is not a logical distinction, but rather the difference is a matter of degree.210 rules can come into conflict with other rules and can remain in force despite the conflict, and at other times one will be invalidated. similarly, principles can remain in force when they come into conflict with other principles but at times one or the other is invalidated. i have argued elsewhere that principles and rules are not logically distinct entities in part because they undergo many of the same processes in the law, but i will not repeat these arguments here.211 rules and principles, as entities whose difference is merely a matter of degree (i.e., a principle may be a bit more flexible than a rule but is nonetheless generally similar to a rule), are both validated by their recognition in the master rule, in this case the cisg. the positivist, by this logic, looks within the text of the cisg to determine what principles have been recognized by the cisg in determining the general principles upon which the convention is based under article 7(2).212 5.2. the natural law approach to the interpretation of article 74 numerous commentators look beyond the text of the convention to discover the general principles upon which the convention is based. these commentators apply the discovered principles to interpret the convention under article 7(2) and, pursuant to these principles, determine that article 74 does not allow for the recovery of litigation expenditures as attorneys’ fees. the principle of equality between buyer and seller, a principle deemed to underlie the cisg by natural law commentators, is offered in its strongest form by professor john y. gotanda pursuant to what he has called the “interpretative approach” to the interpretation of the cisg.213 professor gotanda abstracts the principle of equality by inference from other articles of the convention as a general principle and applies it to article 74, concluding that the general principle of equality limits the meaning of the term “loss” in article 74 by excluding fees relating to litigation from the quantum of recoverable damages.214 professor gotanda contends that the principle of equality is embedded in articles 45 and 61 of the convention, and that “interpreting article 74 as providing for the recovery of attorney’s fees and costs as damages would be contrary to the principle of equality between buyers and sellers as expressed in articles 45 and 61.”215 gotanda does not elaborate as to where this 210 diener, supra note 202 at 1-75. 211diener, supra note 202 at 1-75. 212 article 7(2), supra note 209. 213 gotanda, supra note 33 at 130. see also: troy keily, how does the cookie crumble? legal costs under a uniform interpretation of the united nations convention on contracts for the international sale of goods, 1 nordic journal of commercial law 1, 19 (2003) (“it is reasonable to suggest that the cisg recognizes a general principle of equality or reciprocity between the buyer and seller”). 214 gotanda, supra note 33 at 130. 215 gotanda, supra note 33 at 130. nordic journal of commercial law issue 2008#1 38 principle of equality is manifest in these articles, but the only conceptual manifestation of a principle of equality in articles 45 and 61 is in the fact that these two articles point to the same damages clauses for both the buyer and the seller. both articles 45(1)(b) and 61(1)(b) respectively state the seller and the buyer may, “claim damages as provided in articles 74 to 77.” the use of verbatim language in articles 45 and 61 leads gotanda to infer that there is a natural law principle of equality underlying these clauses and thus the cisg as a whole. according to the principle of equality between the buyer and seller, gotanda asserts, attorneys’ fees for litigation cannot be recoverable as damages under article 74 because an interpretation allowing recovery of litigation expenses would lead to anomalous results.216 the anomalous results are an asymmetry between the ability of the plaintiff and the defendant to recover damages pursuant to article 74. article 74 is conditional upon there being a breach of contract, so only if the plaintiff prevails and a breach of contract is found by the court would the plaintiff be able to recover litigation expenses.217 in the converse, if a breach of contract is not found by the court, then the defendant would not be able to recover litigation expenses. this asymmetry, gotanda reasons, is in violation of the principle of equality between the buyer and the seller underlying the convention. therefore, an interpretation of article 74 in conformity with the principle of equality does not allow parties to recover attorneys’ fees.218 the principle of “full compensation” is a generally accepted general principle upon which article 74 of the convention is based. the principle of “full compensation” is explicitly recognized in the secretariat commentary to the 1978 draft of the cisg,219 and is almost unanimously accepted by commentators as a general principle upon which the convention is based.220 this principle is from either a positivist or a natural law perspective a principle upon which the convention is based pursuant to its recognition in the convention itself. gotanda claims that the principle of full compensation is limited by other principles recognized in the convention, particularly the mitigation requirement of article 77221 and the foreseeability requirement of article 74.222 the limitations on the principle of full compensation are 216 gotanda, supra note 33 at 130. 217 article 74 requires a breach of contract to be applicable: “damages for breach of contract by one party consist of a sum equal to the loss, including loss of profit, suffered by the other party as a consequence of the breach....” 218 gotanda, supra note 33 at 130. 219 secretariat commentary, available at: http://www.cisg.law.pace.edu/cisg/text/secomm/secomm-74.html (“the principle of recovery of the full amount of damages….”) (last visited march 3, 2007). 220 id. 221 article 77 requires mitigation: “a party who relies on a breach of contract must take such measures as are reasonable in the circumstances to mitigate the loss, including loss of profit, resulting from the breach. if he fails to take such measures, the party in breach may claim a reduction in the damages in the amount by which the loss should have been mitigated.” 222 article 74 requires foreseeability: “…such damages may not exceed the loss which the party in breach foresaw or ought to have foreseen at the time of the conclusion of the contract, in the light of the facts and matters of which he then knew or ought to have known, as a possible consequence of the breach of contract.” nordic journal of commercial law issue 2008#1 39 recognizable limitations placed by the convention itself, and are recognized pursuant to either a positivist or a natural law reading of the convention. the natural law theorist, however, takes these limitations on full compensation a step beyond the positivist recognition of them in the rule, and infers a general principle of “limitation on damages” from these principles that limit damages. professor gotanda considers that the principles of foreseeability and mitigation should be conjoined with the limitation placed on recoverability for “nonmaterial loss, which includes emotional injury, mental suffering, and ‘moral damages’ [that] is not recoverable under the convention based on article 5 and a reading of the convention as a whole.”223 these numerous limitations, including article 5’s disallowance of recovery “for death or personal injury,” when intratextually224 read, gotanda seems to say, reveal a general principle of “limitations on damages.” this general principle of “limitations on damages” underlying the cisg limits the scope of the principle of “full compensation” by excluding inter alia, attorneys’ expenses related to litigation from the quantum of recoverable damages. based on the principles of “equality” and “limitation on damages” professor gotanda has put forth the position, in accord with a natural law approach to jurisprudence, that litigation fees are not recoverable as damages under article 74 of the cisg. professor gotanda concedes that although litigation expenses are not recoverable that prelitigation expenses “cannot be separated from other incidental expenses resulting from a breach of contract,”225 and are recoverable as damages under article 74. the mitigation requirement under article 77 will often require that parties to the contract engage legal services to fully mitigate their damages. parties often hire attorneys to write letters of request or use various legal services to mitigate damages, and in accord with the principle of “continuation of the contract” parties are required to engage these legal services.226 allowing recovery for prelitigation expenditures is outside the “limitations on damages” principle because they are required by the principle of mitigation and are recoverable as damages under article 74 of the cisg, according to gotanda. professor gotanda’s natural law approach to interpreting article 74 requires that prelitigation expenses be recoverable but does not allow for the recovery of litigation expenses. 5.3. the positivist approach to the interpretation of article 74 positivist influenced commentators look to the cisg as a rule of recognition and read from it principles that are explicitly recognized and validated by the cisg. these principles are either found within the text of the cisg itself, or are referenced in the cisg as applicable law and 223 gotanda, supra note 33 at 120-130. 224 i use the term “intratextual” consistent with the holistic meaning given it in: akhil reed amar, intratextualism, 112 harv. l. rev. 747 (february, 1999). 225 gotanda, supra note 33 at 130. 226 gotanda, supra note 33 at 130. nordic journal of commercial law issue 2008#1 40 through this reference are validated in their use. positivist proponent, dr. bruno zeller, uses these recognized principles in his “four corners approach” to the interpretation of the cisg.227 he looks to the four corners of the convention as a rule of recognition to determine the principles upon which the convention is based as is required by article 7(2) for matters within the scope of the cisg that are not expressly settled.228 dr. zeller’s use of recognized principles in his interpretation of article 74 leads to the conclusion that both litigation and prelitigation fees are recoverable as damages for breaches of cisg governed contracts as a “loss.”229 dr. zeller looks to the cisg to ascertain what principles can be validly used under article 7(2) of the cisg in determining whether a “loss” under article 74 includes attorneys’ fees. dr. zeller claims that the concept of “loss” as used in article 74 of the cisg includes attorneys’ fees under the principle of “full compensation.”230 dr. zeller asserts that the principle of full compensation is limited in scope by the principles of mitigation, foreseeability, and the principle requiring the loss be a “consequence of the breach,” but that these limitations do not exclude attorneys’ fees as recoverable damages.231 zeller contends, assuming the party has properly mitigated damages, that “[t]he only consideration is whether these losses were foreseeable at the conclusion of the contract and whether they are a direct consequence of the breach.”232 the natural law influenced theorist generally also adopts the foreseeability, mitigation, and consequence of the breach principles and none argue convincingly that attorneys’ fees are excluded from the scope of article 74, so “[a]rguably there is no debate that attorney’s fees are a foreseeable expense due to any breach of contract,”233 zeller assures us. the principle of full compensation is explicitly acknowledged in the secretariat commentary as a principle that places the victim of the breach in the same economic position she would have been in but for the breach of contract.234 the principle of full compensation by its very definition must include attorneys’ fees under the definition of “loss” under article 74 because any other resolution would be in derogation of this principle upon which the cisg is based. the principle of full compensation is limited by the foreseeability, consequence of the breach, 227 bruno zeller, four-corners the methodology for interpretation and application of the un convention on contracts for the international sale of goods (may 2003), available at: http://www.cisg.law.pace.edu/cisg/biblio/4corners.html (last visited march 3, 2007). 228 id. 229 zeller, supra note 33 at 130, 143-167. 230 zeller, supra note 33 at 130, 143-167. 231 zeller, supra note 33 at 130, 143-167. 232 zeller, supra note 33 at 154. 233 bruno zeller, interpretation of article 74zapata hermanos v. hearthside bankingwhere next?, 1 nordic journal of commercial law 1-11, 4 (2004). 234 secretariat commentary, available at: http://www.cisg.law.pace.edu/cisg/text/secomm/secomm-74.html (“the principle of recovery of the full amount of damages….”) (last visited march 3, 2007). nordic journal of commercial law issue 2008#1 41 and mitigation principles, but these principles do not generally exclude attorneys’ fees from the scope of the full compensation principle, according to zeller. the “principle of full compensation” is recognized within the convention, but i prefer to call it the principle of the “full recovery of loss” because this naming is more faithful to the text of the convention. article 74 refers to the “recovery of loss,” and the secretariat commentary refers explicitly to the “the principle of recovery of the full amount of damages.” 235 the following analysis affirms zeller’s reading that these recognized principles generally do not limit the scope of the principle of the “full recovery of loss” to such an extent as to exclude attorneys’ fees. the principle of the “full recovery of loss” is limited in scope by the mitigation requirement explicitly recognized in article 77, but unless if a party fails to mitigate damages properly, attorneys’ fees will be recoverable under the principle of the “full recovery of loss.”236 for instance, there may be a circumstance that a party does not mitigate her damages by paying overwhelmingly excessive attorneys’ fees for litigation, in which case these unreasonable attorneys’ fees may be excluded from recovery based on the principle requiring mitigation of damages. generally, however, attorneys’ fees are fully recoverable as a “loss” under the principle of the “full recovery of loss” embodied in article 74. the principle of the “full recovery of loss” is limited in scope by the foreseeability requirement explicitly recognized in article 74, but foreseeability will rarely if ever disallow the recovery of attorneys’ fees under the principle of the “full recovery of loss.”237 the foreseeability standard is somewhat controversial because some believe it is an objective standard, and some both an objective and subjective standard. on the one hand, it has been suggested that the foreseeability standard is “essentially an objective standard, where the question is whether a reasonable person in the position of the promisor and with knowledge of the circumstances surrounding the conclusion of the contract, ought to have foreseen the possible losses at the time of the conclusion of the contract.”238 as an objective standard, the foreseeability standard does not limit the scope of the principle of the “full recovery of loss” because objectively, a contracting party generally knows that they will be responsible for the payment of all damages resulting from the breach including attorneys’ fees. it has been suggested, on the other hand, that the cisg foreseeability standard differs from the traditional common law standard in that it contains both an objective and subjective aspect. as one commentator states, “article 74…provides an objective and subjective foreseeability test: 235 secretariat commentary, available at: http://www.cisg.law.pace.edu/cisg/text/secomm/secomm-74.html (last visited march 5, 2007) (“the principle of recovery of the full amount of damages”). 236 zeller, supra note 33 at 110, 143-167. 237 zeller, supra note 33 at 105, 143-167. 238 damon schwartz, the recovery of lost profits under article 74 of the u.n. convention on contracts for the international sale of goods, 1 nordic journal of commercial law 1-16, 3 (2006). nordic journal of commercial law issue 2008#1 42 ‘damages may not exceed the loss which the party in breach foresaw or ought to have foreseen…’”239 taking into account the subjective aspect, an argument can be put forth that subjectively a party did not foresee that attorneys’ fees would be recoverable as damages. such an argument would make sense, perhaps, when offered by a united states’ party wherein attorneys’ fees are generally not recoverable in contractual disputes for the sale of goods. nevertheless, it is unlikely that this subjective reasoning will ever overwhelm the objective awarding of attorneys’ fees in contractual disputes on an international basis.240 in short, attorneys’ fees are almost always foreseeable to parties entering into a contract together so the principle of foreseeability does not prevent attorneys’ fees from being recoverable under the principle of the “full recovery of loss.” the third limitation on the principle of the “full recovery of loss” is that the loss must be a consequence of the breach: this is the consequential principle recognized in article 74, but the consequential principle does not prevent attorneys’ fees from being recoverable under article 74.241 whether a loss is a consequence of the breach is a question of causality, and even under the strictest “but for” causality test attorneys’ fees are a consequence of a breach of contract.242 if a party did not breach the contract, then there would be no reason to hire and pay an attorney to litigate a breach of contract action, that is, but for the breach of contract, the attorneys’ fees would not have to be paid. so, the third and final principle limiting the principle of the “full recovery of loss” does not exclude attorneys’ fees from the scope of the principle of the “full recovery of loss.” the foregoing analysis reveals that from a positivist reading of the cisg, the three recognized principles that limit the scope of the principle of the “full recovery of loss” do not limit it in such a fashion as to exclude attorneys’ fees. 6. the vienna convention on the law of treaties 6.1. the meaning of “principle” in article 7(2) the controversy lies in the meaning of the term “principle” as it is used in article 7(2) of the cisg, and whether a principle has the meaning attributed it by natural law theorists (selfvalidating natural law principles that are not necessarily recognized in the rule), or the meaning attributed it by positivists (as only different from rules in degree, and validated by their recognition in the rule), or even a third meaning different than the meanings offered by these theories. the provision of article 7(2) that states “questions concerning matters governed by this convention which are not expressly settled in it are to be settled in conformity with the 239 jeffrey s. sutton, measuring damages under the united nations convention on contracts for the international sale of goods, 50 ohio st. l.j. 737, 744 (1989). 240 see: supra, section iii. 241 zeller, supra note 33 at 124, 143-167. 242 zeller, supra note 33 at 124, 143-167. nordic journal of commercial law issue 2008#1 43 general principles on which it is based…” was added after the 1978 draft of the convention, so there is no secretariat commentary on this provision that could aid in determining a conclusive meaning.243 article 7 is itself the instrument of interpretation of the convention that is to be used to interpret the other provisions of the convention, and when a meaning within article 7 is unclear there is no guidance within the cisg as to how to resolve the controversy. in public international law, when a meaning in a provision is unclear courts employ the vienna convention on the law of treaties of 1969 (vclt) as the method of interpreting the meaning of the questionable provision, specifically, articles 31 and 32 of the vclt speak to interpretation. articles 31 and 32 of the vclt have been adopted by international courts as customary international law and pursuant to this status of customary international law are used to interpret public treaties almost universally in international courts.244 the cisg is primarily a private law convention because it concerns the rights and obligations of buyers and sellers, rather than a public law convention that concerns the rights and obligations of states. because there is no clear methodology for interpreting article 7(2) of the cisg, i suggest the vclt can be used at the very least for pragmatic purposes to aid in determining the meaning of “principle” under article 7(2) of the cisg.245 the general rule of interpretation of treaties is contained in article 31 of the vclt which reads in pertinent part: 1. a treaty shall be interpreted in good faith in accordance with the ordinary meaning to be given to the terms of the treaty in their context and in the light of its object and purpose. 2. the context for the purpose of the interpretation of a treaty shall comprise, in addition to the text, including its preamble and annexes…. 243 see the match-up between the 1978 draft article and the adopted article 7 of the cisg, available at: http://www.cisg.law.pace.edu/cisg/text/matchup/matchup-d-07.html (last visited march 3, 2007). 244 see e.g.: case concerning legality of force, serbia and montenegro v. portogul, 2004 icj lexis 14, para. 102 (“the court will thus proceed to the interpretation…of the statute, and will do so in accordance with customary international law, reflected in article 31 of the 1969 vienna convention on the law of treaties”). see also: united statesmeasures treating exports restraints as subsidies, world trade organization, report of the panel, wt/ds194/r, 29 june 2001, para. 8.18, para. 8.64. 245 see generally: joseph lookofsky, walking the article 7(2) tightrope between cisg and domestic law, 25 j.l. & com. 87 (fall 2005) (for analyses outlining the importance of a proper interpretation of article 7(2) of the cisg). nordic journal of commercial law issue 2008#1 44 (i) textual analysis the vclt article 31(1) requires that the ordinary meaning be taken into account when interpreting a treaty. the ordinary meaning of “principle”246 as defined by merriam-webster is: “1 a: a comprehensive and fundamental law, doctrine, or assumption b (1): a rule or code of conduct (2): habitual devotion to right principles <a man of principle> c: the laws or facts of nature underlying the working of an artificial device 2: a primary source : origin 3 a: an underlying faculty or endowment <such principles of human nature as greed and curiosity> b: an ingredient (as a chemical) that exhibits or imparts a characteristic quality…”247 this ordinary meaning does not suggest a conclusion as to whether the word “principle” when standing alone means the interpretation given it by natural law theorists nor does it suggest the interpretation given it by positivists. to the contrary, the ordinary meaning suggests that either interpretation is correct when the term “principle” is standing alone. the positivists advocate that a principle is a “rule” whereas natural law theorists are proponents of the “laws or facts of nature” view; both are provided for within the definition of “principle.” 6.2. context 6.2.1. multiple aspects of context the vclt article 31 (1-2) requires that the context of a provision be taken into account when interpreting a treaty. as regards the context of “principles,” the context of the term within the provision, the context of the provision in the convention, and the context of the provision in light of the cisg preamble must all be considered. 6.2.2. context of “principle” within article 7(2) as to the context of the term within the provision, the meaning attributed to “principle” can be ascertained by looking at its syntax within the sentence. the relevant segment of article 7(2) reads: “questions concerning matters governed by this convention which are not expressly settled in it are to be settled in conformity with the general principles on which it is based…” within the syntax of this sentence, there are two relationships that shed light on the meaning attributed to “principles.” the first is the relationship between the phrase “settled in conformity with” and “principle” and the second is the relationship between “on which it is based” and 246 i have used “principle” and “principles” interchangeably in this section as the latter is merely the plural form of the former. 247 merriam-webster online dictionary, available at: http://209.161.33.50/dictionary/principle (last visited march 3, 2007). nordic journal of commercial law issue 2008#1 45 “principle.” additionally, the adjective “general” magnifies that these principles affect the whole of the convention.248 the relationship between “settled in conformity with” and “principle” reveals that these principles are to guide the interpretation of the provision in such a way that unsettled matters can become settled. “settled” denotes a conclusive resolution, and this is apparent both from its definition and its relationship to “not expressly settled,” the latter of which denotes something that is unresolved.249 in order to guide an interpretation so as to settle it, the principles must be clearly stated and not merely speculative, for speculation as to which principles apply will not result in a resolution, but will complicate matters by leaving issues in the convention unsettled. the relationship between “settled in conformity with” and “principles” reveals that the principles must be capable of settling matters. given that natural law principles are extremely broad and there is no clear meaning as to what these principles entail nor as to how many there are, they are less capable of resolving unsettled issues in the convention than are positivist ruletype principles. the first relationship thus weighs towards the positivist definition of principle. the second relationship, that between “principle” and “on which it is based” relays that the convention is based on principles because the “it” in “on which it is based” refers back to the antecedent, “convention.” the intentional referral to the “convention” in this case provides weight for the positivist, recognized rule-based definition of principle. if the drafters had intended for natural law principles to be applicable, then they would have referred to the “universe” or the “world” or even to “natural law” rather than the “convention.” the drafters must have referred to the convention rather than the universe for a reason and meaning must be given to this reference to the “convention” rather than the “universe.” furthermore, “based” in the transitive sense that it is used in article 7(2) is defined as a “basis for.” 250 the convention can thus be read as the basis for the “principles” rather than the universe being the basis for these principles, as natural law theory would propose. the second relationship thus also weighs towards the positivist definition of “principle” because the convention, rather than the universe, is stated to be based on these principles. 248 merriam-webster defines “general” as: “1: involving, applicable to, or affecting the whole2: involving, relating to, or applicable to every member of a class, kind, or group <the general equation of a straight line>3: not confined by specialization or careful limitation4: belonging to the common nature of a group of like individuals : generic5 a: applicable to or characteristic of the majority of individuals involved : prevalent b: concerned or dealing with universal rather than particular aspects6: relating to, determined by, or concerned with main elements rather than limited details <bearing a general resemblance to the original>…” available at: http://209.161.33.50/dictionary/general (last visited march 4, 2007). 249 merriam-webster defines “settle” in this context as: “5 a: to fix or resolve conclusively <settle the question>…” available at: http://209.161.33.50/dictionary/settled (last visited march 4, 2007). 250 merriam-webster defines “base” as “1 : to make, form, or serve as a base for 2 : to find a base or basis for — usually used with on or upon.” available at: http://209.161.33.50/dictionary (last visited march 4, 2007). nordic journal of commercial law issue 2008#1 46 6.2.3. context of article 7(2) in the convention (a) the influence of article 7(1) on article 7(2) the context of article 7(2) within the convention is significant because of its placement immediately after article 7(1), and its placement under the “general provisions” heading. article 7(1) states the general rule of interpretation of the convention requiring that: “in the interpretation of the convention, regard is to be had to its international character and to the need to promote uniformity in its application and the observance of good faith in international trade.” article 7(2), which immediately follows article 7(1) is the rule of interpretation for matters within the scope of the convention that are not expressly settled in the convention. as informed by article 7(1), the general rule of interpretation, any “gap filling” that takes place under article 7(2) must also be done with regard to the convention’s international character, desire for uniformity in application, and in good faith. (b) international character regarding the international character of the convention, it must be determined whether the natural law reading or the positivist reading of “principle” better gives regard to the international character of the convention. arguably, natural law principles are universal principles that underlie everything in the world, internationally, so natural law principles would be the most rational choice when having regard for the convention’s international character. on the other hand, article 7(1) instructs the interpreter to have regard to the convention’s international character and what better means of determining the character of the convention than looking to the convention itself? the convention is an international agreement between numerous parties and in signing onto the convention the parties have not implicitly signed on to natural law principles that could be applied by interpreters discretionarily, but rather they have signed on to the principles enunciated in the text of the convention. the international character of the convention is best determined by looking to the convention itself and the parties thereto, not to principles outside of the convention. this consideration also weighs towards the positivist definition of a “principle,” as principles recognized within the convention. (c) uniformity in application the discretion given under a natural law approach to “principles” leaves it largely up to the individual interpreter to decipher principles and how they are to apply to the convention. the natural law interpreter need only allege that somewhere in the convention a principle of natural law is embodied and via this principle, the convention should be interpreted. allowing the interpreter to have this largely unfathomed discretion can easily lead to a multitude of principles that may or may not underlie the convention, and, in effect, lead to a non-uniform application of the convention. for example, if one interpreter sees a principle of equality in a nordic journal of commercial law issue 2008#1 47 provision and applies this principle to interpret the provision, but another interpreter does not see the principle of equality and does not use it to interpret the provision, then the two interpreters will have different interpretations of the same provision. these various interpretations conflict with the uniformity requirement of article 7(1). the positivist definition of principle, as similar to a rule and recognized in the text, does not give rise to this problem of uniformity. because all interpreters are looking to the same text to discover what principles are validated there will be agreement as to what principles the convention is based on, because only those recognized by the convention will be a basis for interpretation. although the positivist definition of principle will not entirely preclude any nonuniform interpretations, it will promote uniformity by limiting the discretion of the interpreter to the use of principles recognized by the rule. 6.2.4. placement of article 7 under “general provisions” the drafters of the convention placed article 7 under the heading “general provisions” with articles 8 through 13. what these seven articles all share in common is that they are provisions that apply generally to the convention and they clarify the meanings of terms within the convention. take, for example, article 11 which expresses “a contract of sale need not be concluded in or evidenced by writing….” this article clarifies the meaning of a “contract” and expressly includes non-written contracts within its meaning. whenever the word contract appears in the convention, pursuant to the general provision article 11, it includes non-written contracts. by analogy, article 7(2) speaks of “principles,” so whenever a principle appears in the convention it can be used as a means of interpretation pursuant to the general provision, article 7. neither article 11 nor article 7 is reaching beyond the rule, but rather are applicable generally to the convention itself. the heading “general provisions” is distinguished from another heading, the “sphere of application.” the “sphere of application” heading includes articles 1 through 6. these six articles state when the convention applies by expressly including and excluding certain types of circumstances. if the drafters of the convention intended to delineate a sphere of application that included natural law then they would have placed article 7(2) under the “sphere of application” heading rather than the “general provisions” heading. the latter of which is filled with provisions that inform the other provisions of the convention without extending the scope or applicability of the convention. 6.2.5. context of 7(2) in light of the cisg’s object and purpose the vclt article 31(2) expressly states the preamble to a treaty shall be considered as context when interpreting a treaty provision, and article 31(1) states that the context shall be taken into account in light of a treaty’s object and purpose. the preamble to the cisg states, in pertinent part, that the object and purpose of the cisg is the “adoption of uniform rules which govern nordic journal of commercial law issue 2008#1 48 contracts for the international sale of goods.” the preamble, much like article 7(1), stresses that the cisg is a uniform system for the governance of international sales contracts. it is unlikely that the drafters of the cisg intended for natural law principles which can so easily contravene the uniform rules of the cisg to be included within its scope by appealing to selfvalidating principles that are not recognized in the text to interpret the cisg. rather, in accord with a uniform interpretation of the cisg, the positivist definition which gives clear guidance as to what principles are valid and applicable within the cisg promotes the uniformity that is stressed both in the preamble and article 7(1). the object and purpose of the cisg is to adopt a uniform sales law, and again, if natural law principles are the means of interpreting the treaty, then the object and purpose of uniformity is not fulfilled. the positivist definition of “principle,” as different in degree from a rule and validated by recognition in the cisg is in accord with the ordinary meaning of “principle,” context of “principle,” and the object and purpose of the cisg. although an article 31 of the vclt analysis prescribes the positivist definition of a “principle,” the vclt provides a supplementary means of interpretation in article 32 that can be used to confirm the resultant meaning of an article 31 analysis. article 32 reads, in relevant part: recourse may be had to supplementary means of interpretation, including the preparatory work of the treaty and the circumstances of its conclusion, in order to confirm the meaning resulting from the application of article 31…. 6.3. supplementary means of interpretation the vclt article 32 provides that the preparatory work as well as the circumstances of the conclusion of the treaty can be taken into account to confirm a meaning of a treaty provision, in this case the meaning of the term “principle.” the preparatory work and circumstances of conclusion include both the secretariat commentary to the 1978 draft cisg and the legislative history leading to the adoption of the final draft cisg. the legislative history of article 7(2) reveals that its initiation was influenced by ulis article 17.251 the records of the 1980 vienna diplomatic conference state that article 7 was a compromise rendered by the german democratic republic between the views of the czechoslovak and the italian.252 this compromise is present-day article 7, and was adopted in the 1980 vienna conference by 17 votes to 14 votes, with 11 abstentions.253 as the conference records indicate, the compromise involved including a segment similar to “article 17 of ulis 251 legislative history, 1980 vienna diplomatic conference, summary records of meetings of the, first committee, 5th meeting, thursday, 13 march 1980, at 3 p.m. available at: http://www.cisg.law.pace.edu/ cisg/firstcommittee/meeting5.html (last visited march 4, 2007). 252 id. 253 id. nordic journal of commercial law issue 2008#1 49 which laid down that questions not expressly settled therein were to be settled in conformity with the general principles on which the convention was based.”254 therefore, the meaning of “principle” in article 17 of the ulis will have some relevance to the meaning of “principle” in the cisg, as it has been said that when a term "has received a clear judicial interpretation, the subsequent statute which incorporates the same word or the same phrase in a similar context must be construed so that the word or phrase is interpreted according to the meaning that has previously been assigned to it."255 article 17 of the ulis provides: “questions concerning matters governed by the present law which are not expressly settled therein shall be settled in conformity with the general principles on which the present law is based,” and was interpreted in the 1978 netherlands appellate court decision, amran v. tesa.256 this case takes the positivist approach to a principle by looking to the text of the cisg to pull out principles that have been validated by their recognition in the cisg. the court, when determining there is a principle of reasonableness in the ulis, states: "[i]n ulis one finds in articles 10, 11, 22, 26(1), 26(4), 37, 42(2), 61(2), 74, 88 and 91 the expressions 'reasonable', 'unreasonable' and 'reasonably'. 'reasonableness' is therefore one of the 'general principles' by which, in accordance with article 17 ulis, questions not expressly settled in the uniform sales law shall be answered."257 the court’s method of decision in amran v. tesa, of looking to the principles recognized in the ulis itself rather than natural law principles beyond the text of the rule confirms that the positivist meaning of “principle” was adopted by the court in the time of the ulis. this provides persuasive evidence that the positivist meaning of “principle” was also intended in article 7(2) of the cisg. the legislative history for article 7(2) is sparse because the provision was added in the 1980 vienna conference and was not in existence at the time of the draft 1978 cisg. the 1978 draft cisg was accompanied by a secretariat commentary which was distributed to all of the prospective parties along with the draft cisg.258 although there was no article 7(2) and hence no secretariat commentary on it, the secretariat commentary to the 1978 draft often spoke of “principles” when discussing the articles of the convention. the secretariat commentary further confirms that “principles” as used in article 7(2) of the cisg are principles recognized by the cisg, in accord with the positivist definition of principles. the secretariat commentary speaks of the “principle of foreseeability,”259 the 254 id. 255 f.a. mann, uniform statutes in english law, 99 law quarterly review 382-383 (1983). 256 netherlands 5 january 1978 appellate court amsterdam (amran v. tesa), available at: http://cisgw3.law.pace.edu/ cases/780105n1.html (last visited march 4, 2007). 257 id. 258 farnsworth, supra note 9. 259 secretariat commentary, available at: http://www.cisg.law.pace.edu/cisg/text/secomm/secomm-74.html (last visited march 5, 2007) (“this principle of excluding the recovery of damages for unforeseeable losses is found in the majority of legal systems”). nordic journal of commercial law issue 2008#1 50 “principle of full compensation” (aka, the principle of the “full recovery of loss”), 260 and the principle of “mitigation,”261 when discussing principles in the cisg, but makes no mention of natural law-type principles. in fact, the secretariat commentary suggests that there is not a principle of equality between the buyer and the seller. the secretariat commentary to article 57 of the 1978 draft [became article 61] reveals there is contrast between the buyer and the seller’s rights and obligations under the cisg, and particularly their rights as to remedies. the commentary states, the buyer has only two principal obligations, to pay the price and to take delivery of the goods, whereas the seller's obligations are more complex. therefore, the seller has no remedies comparable to the following which are available to the buyer: reduction of the price because of non-conformity of the goods…right to partially exercise his remedies in the case of partial delivery of the goods…right to refuse to take delivery in case of delivery before the date fixed or of an excess quantity of goods….262 this passage shows that total equality between the buyer and seller was not anticipated in the drafting of the cisg, as is manifest by the different obligations and rights of the buyer when compared to the seller, and particularly the different rights as to remedies. these differences cut against a natural law-type principle of equality. furthermore, there is no mention of a principle of equality in the commentary to articles 45 or 61, which provides further support that the natural law view of principles is not the meaning given to “principle” in article 7(2) of the cisg. in other words, the principles of article 74 and 77 were explicitly recognized as principles in the commentary to these provisions and these are the same principles recognized by the cisg in its provisions whereas the principle of equality is nowhere to be found in the cisg and is not mentioned in the secretariat commentary. using the interpretational method set out in articles 31 and 32 of the vclt, i conclude that the meaning of “principle” in article 7(2) of the cisg is the meaning given it by positivists. that is, a “principle” is recognized in the provisions of the cisg and validated by its recognition in the rule rather than by an appeal to natural law. therefore, if a principle is not recognized by the cisg as a valid principle it cannot be used for the purposes of gap filling under article 7(2). 260 secretariat commentary, available at: http://www.cisg.law.pace.edu/cisg/text/secomm/secomm-74.html (last visited march 5, 2007) (“the principle of recovery of the full amount of damages”). 261 secretariat commentary, available at: http://www.cisg.law.pace.edu/cisg/text/secomm/secomm-77.html (last visited march 5, 2007) (“contains a principle of mitigation”). 262 secretariat commentary, available at: http://www.cisg.law.pace.edu/cisg/text/secomm/secomm-61.html (last visited march 5, 2007). nordic journal of commercial law issue 2008#1 51 7. beyond the vclt interpretation 7.1. introducing two additional arguments under a vclt interpretation it has been shown that “principle” as used in article 7(2) does not include natural law-type principles, but there are further reasons for rejecting the natural law approach to interpretation of the cisg. this subsection presents two additional arguments for disregarding the natural law approach, even assuming that natural law principles can justifiably be used in the interpretation of the convention: (i) the natural law “principle of equality” contradicts the text of the convention, and (ii) the scope of the natural law principle of “limitations of damages” is too broad. each is considered in turn in the following. 7.2. the natural law approach contradicts the convention as you will recall, professor gotanda contends that there is a principle of equality manifest in articles 45 and 61 of the cisg. the principle of equality, apparently, arises from the use of verbatim language in the cisg, which provides both the buyer and seller may “claim damages as provided in articles 74 to 77.”263 it has already been suggested that the alleged principle of equality is not sufficient to justify excluding attorneys’ fees from the scope of damages.264 i agree, and reason that because all damages are not subject to the principle of equality, assuming there is a principle of equality, that it has first to be shown that attorneys’ fees are within the scope of this alleged principle of equality before a principle of equality can justify excluding attorneys’ fees from the damage award under article 74. articles 45 and 61 of the cisg themselves reveal that there are limits to the principle of equality. articles 45(1)(a) refers to the rights of the seller upon breach and article 61(1)(a) refers to the rights of the buyer upon breach; these two provisions reference different articles in the cisg. article 45(1)(a) states that “if the seller fails to perform any of his obligation under the contract or this convention, the buyer may: (a) exercise the rights provided in articles 46 to 52,”265 whereas article 61(1)(a) states: “if the buyer fails to perform any of his obligations under the contract or this convention, the seller may: (a) exercise the rights provided in articles 62 to 65.”266 this disparity reveals that even if there is a principle of equality, that it is limited in its scope by the variant rights and obligations of the buyer. 263 article 45(1)(b) and article 61(1)(b). 264 john felemegas, an interpretation of article 74 cisg by the us circuit court of appeals, 15 pace int’l l. rev. 91, 121, 126 (spring 2003). 265 cisg article 45(1)(a). 266 cisg article 61(1)(a). nordic journal of commercial law issue 2008#1 52 the rights and obligations of the buyer are not identical to the rights and obligations of the seller under the cisg. i have set out in appendix a to this paper the rights and obligations of the buyer versus the rights and obligations of the seller. as one can see, the buyer and seller are not equal under the cisg because they are given different rights and obligations. take, for example, articles 48 and 50 which provide for limitations and reductions of damages for the buyer without any corresponding provision or rights for the seller. in other words, the buyer and the seller are not given absolute equality in their damage allocation because they are given different rights and obligations, and particularly different rights as to damages.267 even assuming there is a principle of equality between the buyer and the seller, it is not absolute, and all questions of damages do not fall within its ambit. the argument that the cisg should not include attorneys’ fees cannot be sustained, then, by claiming that the anomalous results violate a principle of equality without also showing that attorneys’ fees are intended to be within the scope of this principle. 7.3. the scope of the natural law principle is too broad the natural law principle of “limitations on damages” places a limit on the principle of “full compensation” so as to exclude attorneys’ fees, according to gotanda.268 he argues that the limitations on full compensation as provided by the foreseeability requirement, the mitigation requirement, the exclusion of recovery for moral damages, and article 5’s prohibition on recovery for death or personal injury all combine to create a principle of “limitations on damages.”269 pursuant to this principle of limitations on damages, attorneys’ fees are excluded from the scope of the full compensation principle, gotanda seems to say. professor gotanda is correct in stating there are limitations on damages and that certain damages are excluded from the convention, but the convention does not expressly exclude attorneys’ fees from the quantum of recoverable damages. the convention states a number of explicit limitations on damages, including foreseeability,270 mitigation,271 and the prohibition on damages for death or personal injury,272 but nowhere in the convention or in the legislative history to the convention is it stated that these limitations extend to the recovery of attorneys’ fees. the only explanation for gotanda’s extension of “limitations of damages” to attorneys’ fees for litigation is via a principle of limitations of damages that he finds underlying the convention. such a principle is in direct contradiction to the principle of “full compensation,” 267 see: appendix a to this paper. 268 gotanda, supra note 33 at 129-130. 269 gotanda, supra note 33 at 129-130. 270 article 74. 271 article 77. 272 article 5. nordic journal of commercial law issue 2008#1 53 and even if it conceptually exists, it has not been shown that the scope of this principle of “limitations on damages” extends to attorneys’ fees for litigation 8. completing the interpretation of the term “loss” in article 74 8.1. adopting the positivist approach in light of the preceding vclt analysis and the additional flaws of the natural law reading of the cisg, i adopt the positivist approach to the interpretation of the cisg. in doing so, i adopt that the principle of the “full recovery of loss” is limited in scope by the principles of foreseeability, the consequential principle, and the principle of mitigation. simultaneously, i adhere to the belief that only in rare circumstances will these three principles limit the scope of the principle of the “full recovery of loss” to such an extent as to exclude attorneys’ fees, as we have discussed supra.273 in line with this underlying jurisprudential theory i have realized a number of principles recognized as valid in the text of the cisg that can aid in the interpretation of the term “loss” under article 74. the subsequent analysis will discuss the principle of “reasonableness,” the principle of “mutual benefit,” and the principle of “equality between states.” i conclude that an interpretation of article 74 in conformity with these general principles upon which the convention is based provides support for the conclusion that attorneys’ fees are recoverable as a “loss” under article 74 of the convention. 8.2. the principle of “reasonableness” there is a principle of reasonableness underlying the cisg; the cisg explicitly refers to “reasonableness” or “unreasonableness” forty-seven times in its text.274 article 7(2) instructs that the convention be interpreted in conformity with the principles upon which it is based, so the convention should be interpreted in conformity with “reasonableness.” thus if an interpretation is unreasonable, then it is not in conformity with the general principle of “reasonableness.” we are therefore looking for a reasonable interpretation of the term “loss” or “loss of profit” as it is used in article 74, to discover whether a reasonable interpretation of the term “loss” or “loss of profit” can include attorneys’ fees or not. i suggest that the ordinary meaning of a term is generally a reasonable meaning,275 so by evaluating the ordinary meaning we shall be able to determine if attorneys’ fees can reasonably be considered a “loss” or “loss of profit.” 273 section v to this paper. 274 joseph lookofsky, walking the article 7(2) tightrope between cisg and domestic law, 25 j.l. & com. 87, 89 note 15 (fall 2005). 275 keith w. diener, constitutional interpretations and the benefits of meaning originalism, 48 dialogue #2-3 (april 2006) (addressing the benefits of looking to the meaning of terms in constitutional interpretations. many of these benefits exist also for the purpose of treaty interpretation). nordic journal of commercial law issue 2008#1 54 when considering the ordinary meaning of “loss” in the context of article 74, a reasonable interpretation of “loss” can include attorneys’ fees. article 74 reads, in pertinent part, “damages for breach of contract by one party consist of a sum equal to the loss, including loss of profit, suffered by the other party as a consequence of the breach…” the ordinary meaning of “loss” in this context, as defined in merriam-webster is a “decrease in amount, magnitude, or degree.”276 in light of this ordinary meaning, article 74 can be read as: damages for breach of contract by one party consist of a sum equal to the decrease in amount, magnitude, or degree, including the decrease in amount, magnitude, or degree of profit, suffered by the other party as a consequence of the breach. the question then turns on the meaning of “profit” and whether attorneys’ fees fall under the phrase “loss of profit.” if they do, then attorneys’ fees are required to be reimbursed as a “loss of profit” because article 74 states explicitly that a “loss of profit” is recoverable. if attorneys’ fees are not a “loss of profit” then they may still be recoverable as a “loss”. the meaning of “profit,” as defined in merriam-webster is: 1: a valuable return : gain 2: the excess of returns over expenditure in a transaction or series of transactions; especially : the excess of the selling price of goods over their cost 3: net income usually for a given period of time 4: the ratio of profit for a given year to the amount of capital invested or to the value of sales 5: the compensation accruing to entrepreneurs for the assumption of risk in business enterprise as distinguished from wages or rent.277 given the ordinary meaning of “profit” and “loss,” article 74 can be read as: damages for breach of contract by one party consist of a sum equal to the decrease in amount, magnitude, or degree, including the decrease in amount, magnitude, or degree of the net income over a period of time suffered by the other party as a consequence of the breach… or, damages for breach of contract by one party consist of a sum equal to the decrease in amount, magnitude, or degree, including the decrease in amount, magnitude, or degree of the valuable return or gain suffered by the other party as a consequence of the breach… 276 the complete definition is very unhelpful, but reads: “1: destruction, ruin2 a: the act of losing possession : deprivation<loss of sight> b: the harm or privation resulting from loss or separation c: an instance of losing3: a person or thing or an amount that is lost: as a plural : killed, wounded, or captured soldiers b: the power diminution of a circuit or circuit element corresponding to conversion of electrical energy into heat by resistance4 a: failure to gain, win, obtain, or utilize b: an amount by which the cost of something exceeds its selling price5: decrease in amount, magnitude, or degree6: the amount of an insured's financial detriment by death or damage that the insurer is liable for…” available at: http://209.161.33.50/dictionary/loss (last visited march 6, 2007). 277 merriam-webster available at: http://209.161.33.50/dictionary/profit (last visited march 6, 2007). nordic journal of commercial law issue 2008#1 55 given the ordinary meaning of “loss” and “profit” it is reasonable to interpret “loss of profit” as including attorneys’ fees. if this is the case, then attorneys’ fees are required to be awarded under article 74 because it states explicitly that a loss includes a “loss of profit.” even if attorneys’ fees are not to be considered a “loss of profit” in the context of the cisg, it is reasonable to interpret “loss” as including attorneys’ fees. thus, interpreting the cisg in conformity with the principle of reasonableness leads to the conclusion that attorneys’ fees can reasonably be considered a “loss” or even a “loss of profit” under article 74. 8.3. recognition of the principles of “mutual benefit” and “equality between states” 8.3.1. recognition in the rule the principles of “mutual benefit” and “equality between states” are explicitly recognized in the preamble to the cisg. the relevant section of the cisg preamble reads “the development of international trade on the basis of equality and mutual benefit is an important element in promoting friendly relations among states…” there is compelling support for using these principles for gap filling under article 7(2) of the cisg for matters within the scope of the cisg that are not expressly settled.278 as one commentator states, the principles of mutual benefit and equality between states can: “be used to fill gaps because those principles can be counted among, or have an influence on, the basic rules underlying the convention...”279 furthermore, the vienna convention on the law of treaties provides persuasive support for the use of the preamble. the vclt states the context of a treaty provision includes its preamble and annexes, and the context is to be taken into account in interpreting a treaty.280 the principles of “mutual benefit” and “equality between states” are public law principles that recognize a uniform international sales law benefits and promotes equality between the states party to the convention. one commentator suggests that these principles were included to recognize that developing countries party to the convention were on equal ground with the developed parties, and that both developing and developed countries will benefit from the 278 see: joseph lookofsky, the 1980 united nations convention on contracts for the international sale of goods, in: blainpain, gen. ed., international encyclopedia of laws – contracts 18 (kluwer law international 2000); horacio a. grigera naón, the un convention on contracts for the international sale of goods, in: horn/schmittoff eds., the transnational law of international commercial transactions: studies in transnational economic law (kluwer 1982) 92; and, amy h. kastely [u.s.], unification and community: a rhetorical analysis of the united nations sales convention, 8 nw j. int'l l. & bus. 574 (1988). contra see: peter schlechtriem, uniform sales law 38 n.111 (1986); and, john o. honnold, uniform law for international sales 541 (kluwer 1999). 279 fritz enderlein & dietrich maskow, international sales law 19-20 (oceana publications 1992). 280 vienna convention on the law of treaties (1969), article 31. nordic journal of commercial law issue 2008#1 56 adoption of the cisg.281 another commentator suggests that although these are obligations between states, they have relevance to commercial law, when referring to the preamble he states: emphasis is placed here on two of the particularly important principles of international trade, 'equality' and 'mutual benefit', which should also govern the relations between states . . . they expressly refer to the relations between states. however, it is exactly this part of the preamble which is relevant for commercial relations as well, for equal and mutually beneficial relations between states in this context have to be specified in the respective commercial relations, including sales contracts.282 in other words, the relationship between states party to the cisg should be governed by the principles of “mutual benefit” and “equality between states” in their transactions involving the international sale of goods. having recognized the principles of mutual benefit and equality between states in the preamble as governing the relationship between states party to the cisg, we shall now turn to how the term “loss” in article 74 of the cisg is to be interpreted in conformity with these principles under article 7(2). 8.3.2. the principle of “mutual benefit” an interpretation of the term “loss” in cisg article 74 in conformity with the principle of mutual benefit requires that attorneys’ fees be recoverable as a “loss.” the principle of mutual benefit signifies the agreement by cisg parties that a uniform international sales law will mutually benefit the parties to the cisg.283 the failure of the cisg to create a uniform, international sales law will be to the detriment of the parties to the cisg and in violation of the principle of mutual benefit. an interpretation of “loss” that does not include attorneys’ fees will similarly be in derogation of the principle of mutual benefit for two reasons: one, such an interpretation will create predictability problems, and two, such an interpretation will create uniformity problems. both of these factors are suggested by commentators to decrease the use of the convention and thwart the aim of a uniform, international sales law. excluding attorneys’ fees from the quantum of recoverable damages leads to inconsistent results internationally because almost every nation party to the cisg allows the recovery of attorneys’ 281 john felemegas, the united nations convention on contracts for the international sale of goods: article 7 and uniform interpretation, para. 3b, pace university essay (february 2001). available at: http://www.cisg.law.pace.edu/cisg/biblio/felemegas-pre.html (last visited march 7, 2007). 282 enderlein & maskow, supra note 279 at 21. 283 enderlein & maskow, supra note 279 at 21. nordic journal of commercial law issue 2008#1 57 fees in cases brought under the cisg.284 this inconsistency poses problems with predictability, and the lack of predictability is a reason that many lawyers seek to opt-out of the convention.285 it has been suggested that there is a “reluctance of the result-oriented international business community and international legal practitioners to embrace the convention because of the unpredictability of law in international sales transactions.”286 this reluctance is pursuant to the inconsistent and even contradictory judicial decisions rendered in the many nations signatory to the cisg.287 as one commentator states, “u.s. courts are in a position to develop a method of interpretation under the convention that provides predictable results to the international business community.”288 by allowing attorneys’ fees to be fully recoverable under article 74, predictability of result will be solidified, and the proliferation of opting-out of the convention will decrease. in turn, the states will be mutually benefited through the acceptance and use of a uniform, international sales law and, in the words of the cisg preamble, “friendly relations among states” will be promoted. the lack of predictability caused by disallowing the recovery of attorneys’ fees under article 74 is intertwined with the lack of uniformity such a decision creates. a number of commentators believe that uniformity in application is the key to the success of the convention.289 one such commentator contends, “uniform application is fundamental for the successful harmonisation of laws by international treaty. accordingly, to the extent that compromises within the text of the cisg derogate from its uniform application, they also detract from the success of the cisg as an exercise in harmonisation.”290 the inability to harmonize an interpretation of the cisg detracts from the purpose of a uniform sales law and, in turn, from the principle of mutual benefit because parties to the cisg cannot benefit from a unified system of international sales 284 see: supra section iii. again, this generalization is based on the countries that are surveyed in this essay and the culmination of present sources available on the topic. it is unlikely, but it could turn out to be otherwise as more courts in a greater number of countries-party to the cisg issue opinions on the topic. see also: david b. dixon, que lastima zapata! bad ruling on attorneys' fees still haunts u.s. courts, 38 u. miami inter-american law review 405 (winter 2006-2007). 285 cisg article 6 allows parties to “opt-out”, it reveals that: “the parties may exclude the application of this convention or, subject to article 12, derogate from or vary the effect of any of its provisions.” v. susanne cook, recent developments relating to cisg: the u.n. convention on contracts for the international sale of goods: a mandate to abandon legal ethnocentricity, 16 j.l. & com. 257 (spring 1997) (arguing that the lack of predictability leads to attorneys’ opting out). 286 id. at 258. 287 id. 288 v. susan cook, the u.n. convention on contracts for the international sale of goods: a mandate to abandon legal ethnocentricity, 16 journal of law and commerce 257, 262 (1997). 289 philip hackney, in the united nations convention on the international sale of goods achieving uniformtiy? 61 la. l. rev. 473, 476 (winter, 2001). see also: frank diedrich, maintaining uniformity in international uniform law via autonomous interpretation: software contracts and the cisg, 8 pace international l. rev. 303 (1996). 290 troy keily, harmonisation and the united nations convention on contracts for the international sale of goods, 1 nordic journal of commercial law 1-21, 8 (2003). nordic journal of commercial law issue 2008#1 58 law without consistent interpretations. in short, by allowing attorneys’ fees to be recoverable under article 74 of the cisg, both uniformity and predictability of result will be promoted, which will increase the use of the convention and contribute to its success. predictability and uniformity will, hence, benefit all countries party to the convention. 8.3.3. the principle of “equality between states” the principle of equality between states requires that article 74 be interpreted so as to include attorneys’ fees because a disparity in distribution of cisg cases across national boundaries will arise if attorneys’ fees are left to domestic law. an uneven distribution of cisg cases is in violation of the principle of equality explicitly stated in the preamble to the cisg, and will be destructive to the friendly relations among states. as the u.s. chamber institute for legal reform stated, “in today’s global economy, many companies conduct business all over the world. when disputes arise from these global activities, plaintiffs now can search the world for the most favorable jurisdiction in which to press their claims.”291 the preclusion of attorneys’ fees from the ambit of the cisg will make jurisdictions that do not preclude the recovery of attorneys’ fees under their domestic laws more favorable than jurisdictions that preclude attorneys’ fees. as the italian tribunale di rimini magnified in dicta of a cisg opinion, the application of substantive uniform law has an additional advantage compared to the application of the rules of private international law: the avoidance of forum shopping, an activity which aims at reaching the most favorable jurisdiction for the interests of the litigating parties. forum shopping would be avoided by the application of the same substantive law in different contracting states…292 the italian court also determined that forum shopping was not alone a per se reason that substantive international law should be used over domestic law, but that forum shopping is a relevant factor among many.293 disallowing the recovery of attorneys’ fees under the cisg, and leaving attorneys’ fees to be awarded under the laws of each signatory country will lead to forum shopping as well as an uneven distribution of cases across national boundaries. uneven 291 u.s. chamber institute for legal reform, global forum shopping: an international dilemma, march 24, 2004. available at: http://www.instituteforlegalreform.com/issues/globalforum_intl%20dilemma.pdf (last visited march 7, 2007). the status quo that existed before the implementation of a uniform sales law created problems of law, choice of law, and animosity between states; hence the attempt to create a uniform sales law across national boundaries. 292 italy 26 november 2002 district court rimini (al palazzo s.r.l. v. bernardaud di limoges s.a.) (quoting the english translation). available at: http://www.cisg.law.pace.edu/cases/021126i3.html (last visited march 7, 2007). 293 id. see also: franco ferrari, international sales law and the inevitability of forum shopping: a comment on tribunale di rimini 26 november 2002, 23 journal of law and commerce 169 (2004). nordic journal of commercial law issue 2008#1 59 distribution of a case load is in violation of the principle of equality between states so attorneys’ fees should be recoverable as damages under the cisg. therefore, an interpretation of cisg article 74 in conformity with the recognized principles of equality between states, mutual benefit, and reasonableness requires that attorneys’ fees be recoverable under the cisg, and that the matter not be left to the domestic law of the judicial forum. 9. implications of and alternatives to the proposed interpretation 9.1. introducing the implications and alternatives the interpretation of article 74 presented in this essay has a number of implications for united states courts, if the interpretation were to be adopted by, say, a u.s. circuit court. this section discusses the implications of adopting an interpretation of article 74 that allows for the recovery of attorneys’ fees as well as some thoughts on an international, autonomous meaning of “loss”; comity; and a method by which parties entering into cisg contracts can ensure that attorneys’ fees are recoverable under their cisg governed contracts. 9.2. potential implications a number of worries arise when faced with a possible circuit court split, but i insist that the dichotomy of views within u.s. law is a temporary, necessary occurrence that progresses towards the long-term aim of uniformity in cisg interpretation. as has been discussed, the aims of the cisg as a whole, as set out in its preamble, include inter alia: uniformity and that the convention be interpreted with regard to its international character. the importance of these aims of an international interpretation and uniformity are further magnified in the hierarchy of interpretation stated in cisg article 7. circuit courts that interpret article 74 so as to include attorneys’ fees under the substantive term, “loss” will digress little from the purposes of uniformity and international regard in the short term, and will be essential to achieving these aims in the long term. given the current, inconsistent state of the law regarding the recovery of attorneys’ fees under cisg governed contracts among domestic courts of the many nations, a circuit court split within the united states will digress little from the aim of uniformity because there is already a lack of uniformity in this area of law.294 additionally, the small digression from uniformity caused by a circuit court split is overwhelmed by the potential for unanimous uniformity of interpretation and application that could potentially be the result of the split. in other words, although on its face a split of circuits will hinder the goals of the cisg by digressing from uniformity, it is the only 294 see: supra, section iii. nordic journal of commercial law issue 2008#1 60 way (absent an amendment to the united states’ laws) that uniformity in interpretation and application can truly be achieved in the long term. circuit courts that adopt an interpretation of article 74 that allows for attorneys’ fees to be recoverable as a “loss” will lead to temporary problems of predictability within the united states, but these problems of predictability will influence the supreme court to hear the question and resolve the issue. as mentioned above, predictability is one reason that contracting parties opt-out of the convention in favor of the domestic law of a particular forum.295 predictability, in this manner, plays into the principle of mutual benefit, a principle that is vital to the cisg and explicitly recognized in its preamble. a decision by a circuit court to interpret article 74 so as to allow for the recovery of attorneys’ fees will lead to problems of predictability for potential contractual parties because parties litigating in u.s. circuits that have not rendered a final decision on the recoverability of attorneys’ fees under the cisg could adopt either an interpretation that allows for the recovery of attorneys’ fees or an interpretation that does not, such as that of the seventh circuit court’s zapata opinion. these problems of predictability will perhaps lead to more opting-out of the convention by prospective contractual parties and will contravene the principle of mutual benefit. nevertheless, the transitory circuit split will, in this author’s view, lead to the supreme court hearing the issue and resolving the international controversy over attorneys’ fees under the cisg within the united states once and for all. upon resolution by the u.s. supreme court, the transitory predictability problems will likely be resolved. 9.3. an autonomously international interpretation the interpretation given to the term “loss” in article 74 that includes attorneys’ fees need not be extended beyond the unique, international context of the cisg. there is a distinction between the meaning attributed to the term “loss” in u.s. statutes that would, under the “american rule,” purportedly exclude attorneys’ fees from its ambit and the meaning of the term “loss” in the context of the cisg which includes attorneys’ fees within its scope. the latter of these meanings is the autonomous, international definition of “loss” within the context of article 74 cisg, and need not be extended beyond this niche of international sales law. a multitude of support is available for the proposition that the terms used in the cisg are to be given an autonomous, international meaning.296 additionally, all courts, in their 295 see: section vi to this paper. 296 see: secretariat commentary, available at: http://www.cisg.law.pace.edu/cisg/text/secomm/secomm-07.html (last visited january 14, 2007); and, honnold, supra note 13 at 88-114; and, zeller, supra note 33 at 43-167. nordic journal of commercial law issue 2008#1 61 interpretation of the cisg, should avoid the homeward trend.297 the homeward trend is the tendency to use domestic legal meanings in the interpretation of the cisg, rather than adopting the autonomous, international meaning.298 therefore, by interpreting the term “loss” in article 74 in accord with an international, autonomous meaning that is distinct from the meanings given to the term “loss” in the u.s., there is no likelihood that the meaning attributed to “loss” in the context of the cisg will spill over into other areas of united states law. 9.4. a note on comity even if the interpretation of article 74 that allows for the recovery of attorneys’ fees is not adopted by other circuit courts, comity requires that attorneys’ fees be recoverable. united states law requires that when u.s. law and the law of another country are in conflict, then the u.s. law should give way to the foreign law.299 as was determined in the u.s. supreme court case, societe nationale,300 the question of comity is whether “there is in fact a true conflict between domestic and foreign law,” and if there is a true conflict, then comity requires that the u.s. law give way to the foreign law.301 if attorneys’ fees are truly a matter of the domestic law of the forum as zapata indicates, then for the purposes of the comity analysis, the “american rule” is the law of the u.s. and the “loser-pays rule” is the law of the foreign country (because almost every country party to the cisg adopts this domestic rule aside from the u.s.).302 these two rules are diametrically opposed: the u.s. rule does not allow for the recovery of attorneys’ fees and yet the foreign country’s rule requires the recovery of attorneys’ fees. because there is a direct conflict between u.s. law and foreign law, the law of the u.s. must give way to the foreign law under the supreme court precedent of societe nationale. therefore, even if the circuit court does not determine that attorneys’ fees are directly recoverable under article 74, the circuit court should determine that the foreign rule which allows for the recovery of attorneys’ fees will apply because of the direct conflict between the foreign rule and the u.s. rule. in other words, comity requires the application of the foreign rule which allows for the recovery of attorneys’ fees in cisg governed disputes. 297 zeller, supra note 33 at 43-167. 298 zeller, supra note 33 at 43-167. 299 see e.g.: hartford fire insurance co. v. california, 509 u.s. 764 (1993); and, societe nationale industrielle aerospatiale v. united states dist. court for southern dist.of iowa, 482 u.s. 522, 555 (1987). 300 societe nationale industrielle aerospatiale v. united states dist. court for southern dist.of iowa, 482 u.s. 522, 555 (1987). 301 id. 302 vanto, supra note 2 at 204. nordic journal of commercial law issue 2008#1 62 9.5. freedom of contract contractual parties that desire to ensure that attorneys’ fees will be recoverable in the case of breaches of cisg governed contracts can contractually stipulate that attorneys’ fees must be recoverable. cisg article 6 allows parties to a contract to “derogate from or vary the effect of any of its [the convention’s] provisions.” under article 6, the parties to the contract can derogate from article 74 by stating explicitly that attorneys’ fees are to be recoverable under their contract even in the united states. although there is no guarantee that the u.s. will enforce a contractual provision requiring the recovery of attorneys’ fees, there is a strong policy argument that freedom of contract trumps this procedural rule of the jurisdiction. parties can also contractually stipulate that the location of the cisg governed trial will take place in a jurisdiction and under the laws of a country that awards attorneys’ fees, such as switzerland. although such ‘forum shopping’ is in contravention of the principle of equality between states, there may be few other choices unless the united states’ circuit courts determine that article 74 allows for the recovery of attorneys’ fees. therefore, through careful contractual stipulations, parties can assure that they are fully compensated for these foreseeable losses that arise as a consequence of a breach of the contract (viz., attorneys’ fees). 10. concluding remarks an international, uniform interpretation of the cisg requires that attorneys’ fees be recoverable under the substantive term “loss” in article 74. the substantive term “loss,” when interpreted in conformity with the “general principles” on which the convention is based also requires that attorneys’ fees are a recoverable “loss.” in accord with the cisg text, the context of article 7, and the object and purpose of the cisg, the “principles” of article 7(2) are the rule-like principles recognized and validated by the cisg. a natural law reading of the cisg both betrays the text of the convention and derogates from a uniform interpretation of the cisg. an interpretation of cisg article 74 in conformity with the general principles on which the convention is based requires attorneys’ fees to be recoverable under the substantive term, “loss.” united states circuit courts can justifiably interpret cisg article 74 in an autonomous, international manner so as to include attorneys’ fees under the substantive term, “loss.” in lieu of this interpretation, comity requires the application of the ‘loser-pays’ rule, and parties can contractually stipulate the recovery of attorneys’ fees and jurisdictions that allow the recovery of attorneys’ fees in the clauses of their cisg governed contracts. nordic journal of commercial law issue 2008#1 63 appendix a variant rights and obligations of the seller and the buyer cisg article rights of the buyer corresponding article for rights of the seller article 46(1) the buyer may require performance by the seller of his obligations unless the buyer has resorted to a remedy which is inconsistent with this requirement. article 62 article 46(2) if the goods do not conform with the contract, the buyer may require delivery of substitute goods only if the lack of conformity constitutes a fundamental breach of contract and a request for substitute goods is made either in conjunction with notice given under article 39 or within a reasonable time thereafter. x article 46(3) if the goods do not conform with the contract, the buyer may require the seller to remedy the lack of conformity by repair, unless this is unreasonable having regard to all the circumstances. a request for repair must be made either in conjunction with notice given under article 39 or within a reasonable time thereafter. x article 47(1) the buyer may fix an additional period of time of reasonable length for performance by the seller of his obligations. article 63(1) article 47(2) unless the buyer has received notice from the seller that he will not perform within the period so fixed, the buyer may not, during that period, resort to any remedy for breach of contract. however, the buyer is not deprived thereby of any right he may have to claim damages for delay in performance. article 63(2) article 48(1) subject to article 49, the seller may, even after the date for delivery, remedy at his own expense any failure to perform his obligations, if he can do so without unreasonable delay and without causing the buyer unreasonable inconvenience or uncertainty of reimbursement by the seller of expenses advanced by the buyer. however, the buyer retains any right to claim damages as provided for in this convention. ∗ article 48(2) if the seller requests the buyer to make known whether he will accept performance and the buyer does not comply with the request within a reasonable time, the seller may perform within the time indicated in his request. the buyer may not, during that period of time, resort to any remedy which is inconsistent with performance by the seller. ∗ article 48(3) a notice by the seller that he will perform within a specified period of time is assumed to include a request, under the preceding paragraph, that the buyer make known his decision. ∗ article 48(4) a request or notice by the seller under paragraph (2) or (3) of this article is not effective unless received by the buyer. ∗ nordic journal of commercial law issue 2008#1 64 article 49(1) the buyer may declare the contract avoided: (a) if the failure by the seller to perform any of his obligations under the contract or this convention amounts to a fundamental breach of contract; or (b) in case of non-delivery, if the seller does not deliver the goods within the additional period of time fixed by the buyer in accordance with paragraph (1) of article 47 or declares that he will not deliver within the period so fixed. article 64(1) article 49(2) however, in cases where the seller has delivered the goods, the buyer loses the right to declare the contract avoided unless he does so: (a) in respect of late delivery, within a reasonable time after he has become aware that delivery has been made; (b) in respect of any breach other than late delivery, within a reasonable time: (i) after he knew or ought to have known of the breach; (ii) after the expiration of any additional period of time fixed by the buyer in accordance with paragraph (1) of article 47, or after the seller has declared that he will not perform his obligations within such an additional period; or (iii) after the expiration of any additional period of time indicated by the seller in accordance with paragraph (2) of article 48, or after the buyer has declared that he will not accept performance. article 64(2) « article 50 if the goods do not conform with the contract and whether or not the price has already been paid, the buyer may reduce the price in the same proportion as the value that the goods actually delivered had at the time of the delivery bears to the value that conforming goods would have had at that time. however, if the seller remedies any failure to perform his obligations in accordance with article 37 or article 48 or if the buyer refuses to accept performance by the seller in accordance with those articles, the buyer may not reduce the price. x article 51(1) if the seller delivers only a part of the goods or if only a part of the goods delivered is in conformity with the contract, articles 46 to 50 apply in respect of the part which is missing or which does not conform. x article 51(2) the buyer may declare the contract avoided in its entirety only if the failure to make delivery completely or in conformity with the contract amounts to a fundamental breach of the contract. x article 52(1) if the seller delivers the goods before the date fixed, the buyer may take delivery or refuse to take delivery. x article 52(2) if the seller delivers a quantity of goods greater than that provided for in the contract, the buyer may take delivery or refuse to take delivery of the excess quantity. if the buyer takes delivery of all or part of the excess quantity, he must pay for it at the contract rate. x key to data tables: x = no corresponding rights or obligations to those of the designated article. ∗ = contains variant rights or obligations of both the buyer and the seller in the designated article. « = there are minor differences (certain rights or obligations added or deleted) between the corresponding provisions. nordic journal of commercial law issue 2008#1 65 cisg article rights of the seller corresponding article for rights of the buyer article 62 the seller may require the buyer to pay the price, take delivery or perform his other obligations, unless the seller has resorted to a remedy which is inconsistent with this requirement. article 46(1) article 63(1) the seller may fix an additional period of time of reasonable length for performance by the buyer of his obligations. article 47(1) article 63(2) unless the seller has received notice from the buyer that he will not perform within the period so fixed, the seller may not, during that period, resort to any remedy for breach of contract. however, the seller is not deprived thereby of any right he may have to claim damages for delay in performance. article 47(2) article 64(1) the seller may declare the contract avoided: (a) if the failure by the buyer to perform any of his obligations under the contract or this convention amounts to a fundamental breach of contract; or (b) if the buyer does not, within the additional period of time fixed by the seller in accordance with paragraph (1) of article 63, perform his obligation to pay the price or take delivery of the goods, or if he declares that he will not do so within the period so fixed. article 49(1) article 64(2) however, in cases where the buyer has paid the price, the seller loses the right to declare the contract avoided unless he does so: (a) in respect of late performance by the buyer, before the seller has become aware that performance has been rendered; or (b) in respect of any breach other than late performance by the buyer, within a reasonable time: (i) after the seller knew or ought to have known of the breach; or(ii) after the expiration of any additional period of time fixed by the seller in accordance with paragraph (1) of article 63, or after the buyer has declared that he will not perform his obligations within such an additional period. article 49(2) « article 65(1) if under the contract the buyer is to specify the form, measurement or other features of the goods and he fails to make such specification either on the date agreed upon or within a reasonable time after receipt of a request from the seller, the seller may, without prejudice to any other rights he may have, make the specification himself in accordance with the requirements of the buyer that may be known to him. x article 65(2) if the seller makes the specification himself, he must inform the buyer of the details thereof and must fix a reasonable time within which the buyer may make a different specification. if, after receipt of such a communication, the buyer fails to do so within the time so fixed, the specification made by the seller is binding. x platform intermediaries in the sharing economy: questions of liability and remedy kim østergaard* and søren sandfeld jakobsen** * professor, phd, copenhagen business school ** professor, phd, aalborg university njcl 2019/1 21 abstract national and international characteristics of sharing economy imply that a platform intermediary may hold a dominant legal and economic position between a debtor and a creditor. legally, such an agent1 will be the commercial link between the performance debtor and the performance creditor. hence, the platform intermediary’s contractual obligations do not appertain to the performance creditor by default but to the economic and legal nexus between the committed and legitimate contractors. yet recent legal practice in danish substantive law, along with a series of court rulings, indicates that a platform intermediary may under certain circumstances be considered duty subject in relation to the performance creditor. in such cases, the platform intermediary—though originally deemed an agent—is contractually obliged to the performance debtor. this creates two interesting legal issues which are analysed in our article. first, we address the requirements and circumstances which may lead to the platform intermediary being directly liable to the performance creditor in case of non-performance of the sharing economy service in question. secondly, we analyse which remedies the performance creditor can impose on the intermediary in a situation where the intermediary is considered contractually obliged to the performance debtor. 1. introduction the danish law of obligations would usually consider intermediaries under the laws covering agency. this stems from the fact that an intermediary acts as a commercial link between the performance creditor and the performance debtor in a contractual relationship (by fulfilling such roles as commission agent, commercial agent, property or insurance broker). the deciding factor is that the intermediary acts on behalf of the principal—typically the performance debtor in this case—committing this entity to a third party (the performance creditor). yet the intermediary does not become a party to the contract and thus undertakes no obligations toward the third party.2 it should be noted that under danish law, retailers are not legally regarded as intermediaries because retailers act in their own name and at their own risk and are therefore directly liable to the performance creditor. a boom-period in electronic communication and the sharing economy has seen intermediaries assume a very central role not afforded to them previously. the provider of an electronic sharing economy service (hereinafter: “the platform intermediary” or simply “the intermediary”) 1 in accordance with danish law, the notion of an agent or intermediary is considered a subcategory of the overall concept of intermediaries. another subcategory includes commission agents and various brokers. 2 regarding the law of intermediaries, see for instance lennart lynge andersen and palle bo madsen, aftaler og mellemmænd, (7.th edn, karnov group 2017.), chapter 4, especially p. 274 ff. platform intermediaries: liability and remedy 22 acts in practice as the electronic and commercial link between a performance creditor of the said service (often a consumer) and the performance debtor (often a business entity, such as trivago.com). the performance debtor can also be a private individual, as witnessed in cases involving airbnb.com or gomore.dk. from a danish law perspective, this article focuses on the legal role of platform intermediaries which provide access to a sharing economy service. it investigates the details determining when an intermediary is no longer just an intermediary facilitating a relationship between the contractual parties, but rather an obligated party to the contract. in such instances, we also explore which remedies the performance creditor can impose on the intermediary if a contract has been breached. in danish legislation pertaining to agency, the platform intermediary is undoubtedly an ‘agent’ according to the general use of the term.3 this covers a set of rules stating that an intermediary who is serving a principal can conclude an agreement with a third party who then also commits itself to the principal.4 nevertheless, it is uncertain whether the platform intermediary is also an agent in line with the more specific meaning under which the term is also used, namely as one acting in the name and at the expense of the principal, according to section 10, para 1, of the contracts act5. the answer will depend on a specific assessment of the setup and structure of the individual sharing economy service. a feature of these new services is that there is no personal contact between the parties involved—including the platform intermediary and performance debtor (the presumed principal of the platform intermediary). all contact is exclusively conducted electronically via the platform (online service). this applies to both the intention of the performance debtor to deliver the service in question under the agreed terms and conditions, and to the intention of the performance creditor to purchase the service under the outlined terms. since all contact between the parties, as well as the actual agreement conclusion, takes place electronically via the platform, it is probable that by simply using the platform service, the performance debtor has equipped the platform intermediary with the mandate to act on their behalf. if so, the relationship can be interpreted as a relationship between a principal and an agent, where the platform intermediary acts in the name and at the expense of the performance debtor. in the situation outlined above, the rules stipulated in chapter 2 of the contracts act shall apply. however, these rules primarily relating to the relationship between a principal and a third party (the external 3 lennart lynge andersen and palle bo madsen, aftaler og mellemmænd, (7.th edn karnov group 2017), p. 282 f. 4 a commercial agent can act solely as the commercial link between the vendor and the purchaser. moreover, it can even have power of attorney to conclude the contract with a third party. 5 consolidated act no. 193 of march 2nd 2016. njcl 2019/1 23 relationship) are not directly relevant to the main issue of this article: whether the platform intermediary under certain conditions can in fact be regarded as a party to the contract with the performance creditor, thus incurring liability to the performance creditor in the event of default by the performance debtor. section 25 of the contracts act concerning an agent’s liability to third parties relates to situations in which an agent claims to possess the mandate of a third party but in fact does not. this provision is also irrelevant in the present context where, as mentioned, the possible liability of the intermediary is in focus in the event of default by the performance debtor. it is characteristic of sharing economy services that the performance debtor does not transfer ownership of the asset in question to the performance creditor. rather, a temporary right to use the asset is granted—as is the case with airbnb, where the performance service consists of providing housing for a very short term. with carpooling services such as gomore, the performance consists of the owner/driver of the car allowing for the carriage of passengers for a certain distance. as a result, the contract is central in determining the time and usage made available to the performance creditor by the service.6 hence, depending on the lex causae of the contract, in a sharing economy setting a performance creditor usually gets a usage right for a certain period. this means it is not possible to apply national purchasing legislation to the legal relationship;7 nor is there a ready recourse to any existing international purchasing legislation.8 instead, the contracts concluded in conjunction with sharing economy services generally take the form of various types of service agreements that are rarely statuteregulated and are therefore not subject to any lex specialis in the relationship between the performance debtor and the performance creditor. consequently, the contractual basis used by the intermediary to underpin its dealings with the performance debtor and the performance creditor is crucial when determining the legal position, as is the contractual basis between the performance debtor and the performance creditor. the latter contract is often drafted by the platform intermediary as part of the entire standardized contractual setup of the platform service. it is 6 in view of this concept of sharing economy services, a commercial platform such as amazon.com or ebay.com is not considered within the scope of the sharing economy since the performance debtor acts as a professional. in most transactions of this kind, there is a transfer of the property right of the goods in question—which in our view is not characteristic of sharing economy services. hence, such commercial platforms are not considered further in this article. 7 in accordance with danish sales of goods act, consolidated act no. 140 of february 17 2014. 8 cisg does not apply to international consumer purchases, cf. cisg art. 2 (a). thus, a choice of law is necessary, which in danish jurisdiction should take place in accordance with the rome convention. in the other eu member states, it should take place in accordance with rome i. cisg is applicable to international civil purchases. platform intermediaries: liability and remedy 24 important to assess these contracts in relation to any relevant statutory provisions under the contract lex causae. this includes assessing whether there are restrictions on the contractual freedom and, if so, making contractual supplementation based on the general and/or special part of the law of obligations to determine the legal relationship between the respective counterparties. in this context, a performance creditor will clearly wish to identify the party against whom prospective claims must be raised in case of a breach of contract. will it be the platform intermediary or the performance debtor?9 and on what legal basis? subsequently, it is essential to determine which remedies may be applied by the performance creditor. our article presents a sequenced response to these questions, beginning with a brief introduction to the platform intermediary’s position under danish law of obligations, where the premise is that the intermediary acts on behalf of another and therefore is not considered a party to the contract with the performance creditor. however, the assumption in the present context is that this premise cannot always be upheld in regard to sharing economy services. consequently, we analyse the requirements and circumstances which may lead to the platform intermediary being directly liable to the performance creditor in case of non-performance of the sharing economy service in question based on danish substantive law. we then examine which remedies the performance creditor can impose on the intermediary in a situation where the intermediary may be regarded as a duty subject. 2. the concept of intermediaries as noted above, the law of intermediaries rests on an agent/principal relation (agent used in a broad sense) where it is not the intermediary but the principal who is bound by the contract and thus the principal is liable to the third party. consequently, any legal claims or remedies in the case of non-performance must be directed against the principal and not against the intermediary. electronic platform intermediaries are not covered by the sort of lex specialis regulation applied to other intermediaries such as commercial agents (who are regulated by an eu directive)10 or commissioners (who are regulated by a national danish statute based on a nordic law cooperation).11 article 3, no. 9 of the package travel directive12 does 9 the possibility of making joint remedies toward the platform intermediary and the performance debtor will not be discussed in this article. 10 council directive (eec) 653/1986 1986 on the coordination of the laws of the member states relating to self-employed commercial agents [1986]. 11 in accordance with danish law consolidated act no. 332, 31 march 2014. 12 directive (eu) 2302/2015 of the european parliament and of the council of 25 november 2015 on package travel and linked travel arrangements, amending regulation (ec) no 2006/2004 and directive 2011/83/eu of njcl 2019/1 25 contain a definition of an intermediary: “'retailer' means a trader other than the organizer who sells or offers for sale packages combined by an organizer.” yet while the directive contains this definition, it does not constitute a separate and general eu law intermediary concept within or outside the directive. consequently, the content and legal effects of the intermediary concept, including platform intermediaries, must be determined outside the scope of the package travel directive according to the lex causae contract. this means that the intermediary concept must be clarified in accordance with the national legal order, resulting from a governing law clause in the contract. if such parameters are absent, clarification must be sought according to international private law rules applicable in the country in which a case is brought. in the case of a purely national relationship, it is not relevant to determine the choice of law as it must therefore be the national understanding of the concept of intermediaries that should be directly assumed. danish law contains a number of so-called facilitation rules which are applied when the performance creditor acts as a consumer. these facilitation rules establish that when a contact is concluded between two parties where one of which acts a trader, the contract must be considered as a consumer contract. consequently, the other party can rely on certain consumer protection rules. the significance of these facilitation rules extends as far as to cover platform intermediaries in the sharing economy where the intermediary facilitates the conclusion of a contract between a performance creditor and a performance debtor via the digital platform, and in which the performance creditor is often a consumer. the contracts act, section 38 a, para 3 contains such a facilitation rule, which was added into the act in the context of implementing the unfair contracts directive in consumer agreements.13 however, the directive itself does not contain a provision similar to section 38 a, para 3. the danish provision can therefore be regarded as a further protection and extension of the consumer concept, which is not problematic, since the directive is a minimum directive. similarly, the consumer contracts act contains a facilitation rule in section 3, para 3. the danish consumer rights act14 is an implementation of the consumer rights directive. however, as with the unfair contracts directive, the consumer rights directive does not contain a rule of dissemination, meaning that the danish provision can also be considered as a further protection of the consumer.15 whereas the contracts act is a lex generalis that the consumer can invoke regardless of the european parliament and of the council and repealing council directive 90/314/eec [2015]. 13 council directive (eec) 93/1993 on unfair terms in consumer contracts [1993]. 14 act no. 1457 17 december 2013. 15 the authors have not conducted systematic research to establish whether the other eu member states have enacted similar rules of intermediaries in any acts. platform intermediaries: liability and remedy 26 the agreement situation, the focus of the consumer agreement act16 and the underlying directive are distance selling agreements (and agreements concluded outside the trader's business location) and thus lex specalis in relation to agreements in general. both acts and the underlying consumer agreement directive are therefore relevant in the field of sharing economy services.17 the sale of goods act contains a corresponding facilitation rule in section 4 a, paragraph 1, though as described in the introduction, the sale of goods act will most often have no particular relevance in relation to sharing economy services, because it only applies where there is a transfer of ownership of the movable property in question, which is rarely the case in relation to sharing economy services. the same applies to the facilitation rule in section 1, para 1 of the credit contracts act.18 credit agreements relating to sharing economy services do not appear to be relevant to the current development stage of the services. hence, neither the sale of goods act nor the credit contracts act will be mentioned further in this context. 3. the intermediary concept in danish law as clarified above, there is no lex specialis in danish law that regulates how the intermediary concept is to be determined in relation to sharing economy services. hence, this must be done on the basis of case law and legal theory. based on the special facilitation rules in section 38 a, para 3 of the contracts act; on section 2, para 3 of the consumer agreement act; and on section 4 a, para 2 of the sales of goods act, it appears that three cumulative conditions need to be fulfilled for a party to be regarded as a facilitator subject to these set of rules.19 while the sales of goods act will rarely apply to sharing economy services, both the contracts act and consumer contracts act can prove relevant to services of this type. moreover, the conditions deriving from these rules in terms of defining the notion of a facilitator also appear relevant in relation to sharing economy services where the platform intermediary facilitates the agreement between a performance debtor and a performance creditor. the three requisite cumulative conditions are that the intermediary must: 1) be a trader, 2) perform an activity in connection with the 16 act no. 1457 17 december 2013 about consumer agreements. 17 directive 83/2011/ec of the european parliament and of the council on consumer rights, amending council directive 93/13/eec and directive 1999/44/ec of the european parliament and of the council and repealing council directive 85/577/eec and directive 97/7/ec of the european parliament and of the council [2011]. 18 consolidated act no. 1336 26 november 2015. 19 marie jull sørensen, “digitale formidlingsplatforme – formidlingsreglen i dansk forbrugerret”, (2017) ugeskrift for retsvæsen, u.2017b.119. njcl 2019/1 27 conclusion of the contract between the creditor and the debtor, and 3) not be the performing debtor.20 first, the condition of the intermediary being a trader is entirely in line with what is applicable according to the law of agency in general (except where a general authority in an employment relationship exists). the condition will probably always be met by platform intermediaries providing sharing economy services, as these are primarily commercial businesses selling services and advertisement space on the platform. second, the condition that the intermediary must play an active role in the conclusion of an agreement between the two contracting parties, the performing debtor and the performing creditor, will also most likely be fulfilled for platform intermediaries. the active role of the intermediaries stems from the mere fact that they have developed and provided the digital platform through which the agreement between the performance debtor and the performance creditor is concluded and through which all the steps in the transaction process have taken place. in other words: if there were no platform service, there would be no contract between the parties and no platform in cyberspace for the parties to even establish contact with each other in an easy way. it is important that the activity is aimed at the conclusion of the agreement between the parties.21 the activity consisting of making advertising space available on the intermediary's online platform (which is usually a very important source of income for the intermediary), is not per se deemed to fulfil the requirement for activity.22 thirdly, the intermediary must not be the performance debtor (direct contracting party of the performance creditor) and thereby obligated to fulfil the performance obligations according to the contract.23 as described, it inheres to the nature of the intermediary relationship that this entity does not act on their own behalf but on behalf of a third party (the principal) who is thus bound by the agreement. therefore, if the intermediary has no intention of being bound by the contract as a direct contracting party, the intermediary cannot act as an agent and at the same time be a performance debtor. 4. when is an agent reservation valid? as noted, the basis of danish law regarding intermediaries (and thus also platform intermediaries) is that they are only acting on behalf of another party, typically the performance debtor who offers a service via the digital platform. hence, the intermediary is therefore not regarded as a liability subject to the performance debtor, and claims resulting from a 20 ibid p. 120 f. 21 see also marie jull sørensen, digitale formidlingsplatforme – formidlingsreglen i dansk forbrugerret, ugeskrift for retsvæsen, u.2017b.119 with reference to case law. 22 ibid p. 121. 23 ibid. platform intermediaries: liability and remedy 28 breach of contract must be directed by the performance creditor against the performance debtor and not against the intermediary in accordance with the general principle of contractual relativity. however, this starting point has been challenged by a court decision concerning the online platform goleif.dk24 which acts as an intermediary where you can find airline tickets to locations all over the world. via the platform, customers can compare prices from multiple airlines and proceed to ticket purchasing immediately. in its ruling, the danish eastern high court, contrary to the ruling of the district court of roskilde, stated that the goleif.dk platform was directly liable to a person who in a consumer capacity had bought two flights from copenhagen to nice, only to experience that the airline went bankrupt during the consumer’s stay in france. goleif.dk’s general terms and conditions contained a reservation stating that the platform provider only acts an intermediary between the consumer and the airline carriers and therefore is not the consumer’s contract party. hence, the judgment raises questions about whether it is possible to ascertain which cumulative requirements a platform intermediary must meet to have a contractually valid intermediary reservation so that possible claims must be addressed to the performance debtor in accordance with the general rule regarding the liability of intermediaries towards third parties. in its decision, the eastern high court initially concluded that there is no doubt that the underlying agreement between the subsequently bankrupted airline and goleif.dk (the internal relationship) meant that goleif.dk only acted as an intermediary between the airline as seller and the consumer as buyer. however, the appellant (the consumer) claimed that he had formed the impression that the contract was entered into with goleif.dk via the platform website, thereby contending that goleif.dk— along with the airline—must be regarded as the consumer’s direct contract party (the external relationship). the consumer stressed that his sole contact had been with goleif.dk, which also received the payment and to which he electronically submitted a request for the tickets. one of the key premises in the judgment is that although it seems clear that travel agents generally do not act in their own name when selling flights but act only as an intermediary for the airline carriers, this relationship cannot be regarded as widely known by the consumers. having made a general assessment of the website of goleif.dk, the high court therefore found that the consumer could assume they were dealing with goleif.dk. this was affirmed despite the fact that the website makes it possible to choose between flights from multiple airlines. based on this premise, we can conclude that the level of knowledge expected of a consumer is different and lower compared with what is expected when a contracting party acts as a professional. in this regard, 24 forbrugerombudsmanden som mandatar for martin windfeld velin v den danske rejsegruppe filial af svenska resegruppen ab u.2016.1062 ø. njcl 2019/1 29 the consumer bears no professional risk. the court emphasised the general impression of the website and the fact that the consumer was under the impression that he contracted directly with goleif.dk, which thus had to be regarded as the consumer's contracting party. a second key premise is that the goleif.dk website did not make it sufficiently clear that customers were not trading with goleif.dk, but instead with the airline delivering the flight. intermediary status was signalled via the booking flow on the website, as well as in the terms and conditions beneath the heading "responsibility for the implementation of the journey" which stated that goleif.dk acted as "intermediary" and that goleif.dk did not "sell" trips in their own name. however, the court found that it could not be assumed that a general consumer could determine his legal position in relation to goleif.dk solely on basis of this information. in addition, goleif.dk was described in the travel conditions as "technical organizer" without this term being described in detail. furthermore, both the booking flow on the website and the terms and conditions described an opportunity for the consumer to purchase “bankruptcy coverage” from the travel agency. this premise speaks to whether goleif.dk can be deemed to have achieved a valid agent reservation both contractually and from the information on their website. in this regard, the high court attaches decisive importance to the reservation not being explicitly stated, since the consumer acting as an agreement reader is not able to correctly decode the implications associated with the wording of the contract. hence, for an agent reservation to be valid it must be written in plain, clear and intelligible language. these requirements are the cumulative conditions for intermediary reservations to be considered validly agreed inter partes in consumer contracts. in a decision from 2018, the western high court concluded that the accommodation platform booking.com exhibited a valid intermediary reservation when they provided accommodation at a farm hotel in sweden. the appellant in denmark, acting as a consumer, argued that booking.com must be regarded as the contracting party and therefore be subject to the contractual obligations. the consumer claimed that the accommodation service suffered from actual deficiencies as the farm hotel was under renovation during the stay. the high court stated: the booking confirmation contains the name and address of the specific accommodation that is reserved, as well as the duration and price of the stay. it also appears that payment is made at the place of residence during the stay, that cancellation and change fees are determined by the place of residence, and that you can contact the place of residence if you need help with the reservation. from booking.com's terms and conditions, which [the appellant] has accepted, it appears that he entered into a direct contractual platform intermediaries: liability and remedy 30 relationship with the place of residence, and that booking.com acted exclusively as a link between him and his place of residence. accordingly, [the appellant] should have understood that he entered into an overnight stay with the place of residence, and that booking.com alone acted as an intermediary of the agreement. the first two sentences of the judgment concern identifying, on a contractual basis, the contracting party of the consumer. the contract leaves no doubt as to who is performing the service and that the remuneration shall be paid directly to the place of residence. the main contractual terms in relation to the performance of the contract are also agreed directly with the place of residence. it is therefore clear in this case that the place of residence is the performance debtor, and that this role does not fall to the intermediary platform, booking.com. it is also clear that the place of residence must be regarded as the consumer’s contracting party, since the contract makes evident that booking.com is purely an intermediary platform and that the consumer is contracting directly with the place of residence. though not directly determined by the high court, we must nevertheless regard it as central that the contractual criteria regarding adoption, clarity and clearness are met. in this regard, the high court assumes that the applicant as a consumer should have understood that the place of accommodation constitutes a party to the agreement, not booking.com. thus, the western high court, like the eastern high court in the goleif judgment, developed a functional definition of what can be expected of a consumer in terms of linguistically decoding the contract and its related legal implications. in contrast to the goleif judgment, the cumulative requirements for the adoption of a valid intermediary reservation were met in the booking.com case because of the contract conclusion process and informative language. consequently, it was easier in this instance for the consumer to correctly decode his legal position and the implications of the respective roles and obligations of the performance debtor and the intermediary platform. regarding the validity of intermediary reservations, a central feature of the two judgments is that an assessment of the consumer as the agreement reader is included. as a result, notions about the qualities a composite consumer ‘figure’ might possess substantially affect the demands that can be made upon the consumer when contracting with a trader.25 in eu law, a concept of the consumer denoted as “the average consumer” has been developed, and this concept has been applied in cases 25 in the judgment published in the danish weekly law reports u.2018.1374 s, the principle was established that between two professional parties there is no enhanced requirement to conclude an agent reservation. njcl 2019/1 31 such as gut springenheide.26 accordingly, the average consumer is defined as a reasonably well-informed and reasonably observant and circumspect consumer an assessment reached without ordering an expert report or commissioning a consumer research poll.27 thus this far, the precise meaning of the concept has not been outlined by the european court of justice, but it objectifies the notion of the average consumer and thereby differs from current perceptions of a consumer. consequently, it can be argued that the average consumer currently exists as a legal fiction. professional literature has suggested using alternate terms such as the normal consumer or the typical consumer. questions persist though as to whether such alternative conceptual formulations are based on a corresponding legal fiction.28 for now, in any case, we must acknowledge the issue but place it beyond the scope of this article. concerning the functional delimitation of consumer agreements, various consumer characteristics have been posited to be contrasted with those of the trader : the relatively low degree of professionalization, the relatively modest economic strength, the lack of economies of scale, and (other missing) cost advantages.29 a trader is supposed to act as a professional. this includes among other things necessary knowledge of their industry as well as the capacity to spread financial risk across several transactions—characterized as diversification in an economic sense, and pulverization in a legal sense. the functional demarcation of the consumer concept implies that consumers act outside their profession and are therefore assumed to have limited or perhaps no knowledge of the service or product type to be contracted. an obvious next step, then, is to note one of the assumptions on which the new institutional economic theory is based, namely that the individual actor is limited rationally and acts without pertinent information to be found in legal acts such as the package travel directive. intermediaries may try to compensate for this via a set of disclosure requirements for the contractual basis, but the consumer is unable to 26 case c-210/96 gut springenheide gmbh and rudolf tusky v oberkreisdirektor des kreises steinfurt amt für lebensmittelüberwachung (1998) and references to case law in paragraph 30. see for instance c-126/91 (yves rocher) and c-315/92 (clinique). 27 ibid, paragraph 31. 28 ibid with references. 29 peter møgelvang-hansen, forbrugerrollen som retligt begreb, in hyldestskrift til jørgen nørgaard, (1st edn, juristog økonomforbundets forlag 2003), p. 528. this is a rather early development regarding notions of what characterizes a consumer. platform intermediaries: liability and remedy 32 process and translate all relevant information as a result of cognitive constraints. 30 in relation to the current case-law, cited above, the assessment of the court includes consideration of the performance creditor acting as a consumer, thereby placing less demand on his knowledge of the market. the degree of involvement from the performance debtor is also important in terms of how the consumer must logically understand the contractual situation. in the booking.com case, it seems very difficult to avoid the conclusion that the place of residence must be deemed the consumer’s contracting party and thus the obligor under the contract. finally, it appears that if a valid intermediary reservation is to be achieved, it must be clear, precise, easily intelligible, and written in a shared language. 5. can the platform intermediary be held liable? if so, on what basis? thus far, our study of agent reservations has shown that the clear starting point in danish law of obligations is that the intermediary does not incur any liability to the performance creditor, who must instead adhere to their contracting party (the performance debtor). however, we must also consider whether there is a basis for deviating from this starting point in relation to sharing economy services where the intermediary often plays an active and facilitating role throughout the course of the contract. this prompts a dual line of inquiry. first, we must examine the legal basis for holding an intermediary responsible where appropriate. second, in instances where a liability for the performance debtor’s defaults can be imposed on the intermediary, we must ask what breach of contract remedies the performance creditor can claim against the platform intermediary. this would include examining whether the performance creditor may have the same remedies against the intermediary as against the performance debtor. in relation to the first line of inquiry, it appears that various law of obligation arguments can be considered in support of this: 5.1. the platform intermediary as the direct contracting party a liability may arise from the fact that an intermediary construction is overridden or invalidated. this would void an intermediary’s contractual 30 in this sense, economic theory could contribute to qualifying the legal requirements to the contract in order to solve the problem of imperfect and asymmetric information between the parties. thus, law and economics could contribute to qualifying the concept of the consumer. however, cognitive limitations attached to each individual cannot be solved, although the problem of imperfect and asymmetric information can to some extent be solved by applying extensive information requirements in the pre-contractual phase and to the content of the contract. njcl 2019/1 33 agent reservation so that the intermediary is effectively regarded as a direct contractor and thus directly liable to the performance creditor. this was the case in the above-mentioned goleif judgment in which the high court (contrary to the district court) concluded that goleif did not make it sufficiently clear to the consumer that it only acted as an intermediary for the performance debtor (the airline). hence, goleif was deemed the consumer's direct contractual party and thus liable for the loss sustained by the customer due to the airline’s bankruptcy. the sparse ratio decidendi may be taken to mean that when goleif was legally regarded as the consumer’s direct contracting party, the airline had to be considered as a subcontractor to goleif. in accordance with the general law of obligations principle stating that a contract party is liable for its subcontractors, goleif could be charged with the loss suffered by the bankruptcy of the airline carrier.31 it is not surprising that the intermediary construction can be contractually overruled based on an overall assessment of the circumstances of the case. it is the real relationship behind the contractual construction which is crucial, not whether the intermediary formally denotes itself as an intermediary.32 in consumer relations, the intermediary must act as the professional party and make an extra effort to clarify to the consumer that the intermediary platform only serves as an intermediary for the actual contracting party—as illustrated by the goleif judgment. however, the fact that the intermediary, goleif, asserted liability in the case is more surprising, as a claim for compensation fundamentally requires a basis of liability, which does not appear to exist in this case. a strict liability—liability without fault—requires a clear legal basis, as in section 24 of the sales of goods act.33 if no legal basis for strict liability is present, as in this case, the basis shifts toward liability negligence.34 however, it is not in itself negligent to go bankrupt. hence, the subcontractor, the airline, had not been negligent. nor had goleif’s actions created grounds for incurring liability toward the consumer. consequently, there does not seem to be any culpa in the contract chain and therefore no immediate basis for compensation.35 as a result, the decision of the high court seems questionable regarding this point. 31 mads bryde andersen & jospeh loookofsky, lærebog i obligationsret i, (4th edn, karnov group 2015), p. 256. 32 see also the ruling of the ecj in c-149/15. 33 pursuant to section 24 of the danish sales of goods act the vendor of generic goods incurs a reserved strict liability. 34 mads bryde andersen & jospeh lookofsky, lærebog i obligationsret i, (4th edn, karnov group 2015), p. 249. 35 compare the ruling of the ecj in c-402/03, skov æg. platform intermediaries: liability and remedy 34 5.2. liability for breach of warranty another situation where the intermediary may incur liability to the performance creditor is if the intermediary can be said to have issued a warranty to the performance creditor for the fulfilment of the contract by the performance debtor. a warranty liability implies that the intermediary incurs a strict liability for the default of the performance debtor. hence, it is not necessary to document negligence.36 whether the intermediary can be said to have given an implied warranty of the performance debtor's proper fulfilment of the contract must rely on an interpretation of the contractual relationship. however, this will rarely be the case, as the intermediary will usually be clear and emphatic about their intermediary status, stating in various ways that they can in no way vouch for the performance debtor's fulfilment of the agreement. in particular, this must apply in relation to sharing economy services where the intermediary has neither a commercial nor a legal interest in issuing a warranty. moreover, unlike a manufacturer, the platform intermediary is not in any way involved in the manufacturing process and will therefore in practice have difficulties meeting a warranty obligation or providing specific performance (see below regarding remedies in case of a breach of contract). however, as both the goleif judgment and the judgment by the european court of justice in c149/15, wathelet indicate, it is largely the consumer’s point of view that is adopted in the interpretation of the contractual basis by the courts. hence, it may not require much before a declaration from the intermediary regarding the fulfilment of the contract will be interpreted as an actual warranty. 5.3. secondary liability if the intermediary construction cannot be set aside from a contractual perspective, the intermediary can conceivably incur a secondary liability, either via considerations of identification or the principle on vicarious liability laid down in the danish law of king christian v 3-19-2 (hereinafter danish law). a claim based on identification is well-known from company law through instances where the director and sole proprietor of a small company manages the operation and incurs loss of third parties under circumstances where there has been a breach of law (see for example u 2003.1264 h and u 1999.326 ø). exceptionally, this could also be the case if identification is held regarding a group of companies who otherwise are viewed as independent legal entities (see for example, u 1997.1642 h and u 1968.766 h).37 36 bernhard gomard, obligationsret, 1. del, (5th edn., juristog økonomforbundets forlag 2016) p. 239 ff. 37 for more detail, see erik werlauff, selskabsret, (8th revised edn, karnov group 2010), p. 532 f. and p. 581 ff. njcl 2019/1 35 in relation to sharing economy services, it is probably very rare that such personal or corporate coincidences between the performance debtor and the intermediary platform exist and thereby trigger liability based on company law identification considerations. in principle, the different legal entities that appear in digital sharing economy services must also be regarded as independent legal persons from a consumer point of view. however, identity views are not unknown in the law of obligations. the decisive consideration here is whether the debtor lets another person enter their control sphere, whereby this other person then acts in a way that gives rise to a liability (see for example, u 1999.892 v).38 it would be untenable for the performance creditor if the debtor could not be held responsible simply because they had left the performance of the contract to another.39 the same mindset underpins the principle of vicarious liability (liability of employer).40 based on the principle found in danish law 319-2, an employer is liable for the damages caused by an employee’s negligent action during work performed for the employer as part of their employment.41 the employer thus assumes responsibility for the employee's negligent acts, regardless of whether the employer has acted negligently. hence, the employer holds a strict (secondary) liability in relation to the employee. vicarious liability covers all employees of a company or organization and applies to both public and private companies. it further applies both in and outside of contract, and the employee's own liability (in relation to claims from an injured party or recourse from the employer) is limited in both respects pursuant to section 23 of the liability act.42 vicarious liability includes actions performed by the employee as part of the employment relationship. however, in the case of non-contractual liability (torts), liability does not apply to unusual (abnormal) actions by the employee.43 38 mads bryde andersen & joseph lookofsky, lærebog i obligationsret i, (4th edn, karnov group 2015)p. 201. the case in u 1999.892 ø involves a rather different situation to any instances that one might expect to arise in conjunction with the exchange of services in sharing economy. however, the case might support the notion that the more the platform intermediary is able to control the services and effect the performance debtor’s ability to provide the service in question, the more likely it becomes that the platform intermediary can incur liability for the breach of contract by the performance debtor. 39 see mads bryde andersen & joseph lookofsky, lærebog i obligationsret i, (4th edn, karnov group 2015)p. 201, and henry ussing, obligationsret, p. 114. 40 henry ussing (p. 114) argues that a general liability for assistants is to a certain extent already within the scope of dl 3-19-2. however, such a general extension of vicarious liability has so far found no support in case law. 41 regarding vicarious liability in general, see bo von eyben & helle isager, lærebog i erstatningsret, (8th edn, juristog økonomforbundets forlag 2015), chapter 6. 42 ibid, p. 164 ff. 43 see bo von eyben & helle isager, lærebog i erstatningsret, (8th edn., juristog økonomforbundets forlag 2015), p. 155 f., as well as, for instance, u 1994.215 ø platform intermediaries: liability and remedy 36 in sharing economy services where the contractual relationship between the intermediary platform and the performance debtor may in fact constitute an employer/employee relationship, the rules regarding vicarious liability will lead the intermediary to be liable for the negligent actions of the performance debtor, irrespective of whether the intermediary itself has acted culpably. a very prominent example of this may turn out to be the uber platform, where uber’s position is that the private drivers who transport customers throughout the world are selfemployed and not employees under uber's control. according to uber, the platform service only connects these self-employed drivers with the customers. however, this has been challenged in a number of litigations in the us and various other countries where the claim is that uber exercises such control over the drivers that in a legal sense an employment relationship exists.44 this would also mean that uber holds a vicarious liability for the driver's culpable actions in accordance with the principle laid down in dl 3-19-2. corresponding litigations are also pending regarding other platform services resembling uber.45 in december 2017, the european court of justice ruled that the uber service is inextricably linked to being a physical transport service and cannot be regarded as an information society service where other (and less strict) rules apply under eu law.46 whether this judgment is of importance to the relationship between uber and the performance debtors (the drivers) and the performance creditors (the customers) is still unknown. 5.4. accountability and risk considerations in general finally, based on more general liability and risk considerations, we should examine whether there may be situations where the intermediary is deemed closest to bearing the risk of the performance debtor’s breach of contract. if so, it must be assumed that the intermediary has undertaken a professional risk. however, the obligation law-based point of departure is the opposite, namely that it is the contracting party which is liable for any circumstances resulting in a breach.47 in the goleif judgment, the intermediary was only held liable for the consumer's claim for damages because goleif in the specific legal relationship was considered directly bound by the contract with the consumer. concerning sexual harassment on behalf of the employee. in accordance with the principle of freedom of contract, the parties are entitled to make the employer liable for even abnormal actions conducted by the employee. 44 see www.classaction.com for cases pending in the usa, and https://www.ft.com/content/84de88bc-c5ee-11e7-a1d2-6786f39ef675 for cases pending in great britain (links accessed at the latest on january 2019) 45 ibid. 46 case c-434/15, asociasión profesional elite taxi. 47 mads bryde andersen & jospeh lookofsky, lærebog i obligationsret i, (4th edn, karnov group 2015), p. 201 and bernhard gomard, obligationsret, 2. del, (5th edn, juristog økonomforbundets forlag 2016), p. 55 ff. njcl 2019/1 37 outside such cases, in instances where the intermediary cannot be held liable based on an issued warranty or an employment relationship, the general presumption must oppose the intermediary being liable based on general risk considerations. such liability must in any case assume that the sharing economy service in question establishes such a close relationship between the platform intermediary and the performance debtor that the default of the performance debtor is within the immediate control of the intermediary, according to the comments above regarding identity consideration. it is difficult to say when a situation like this may arise; yet it can hardly be excluded entirely given the current multitude of sharing economy services, as well as the frequently close involvement of the platform intermediary in the contractual set-up and in the performance debtor’s performance itself. 6. remedies if intermediary liability is possible as per the above considerations, then we must inquire as to which specific remedies can be imposed on the intermediary. initially, it is essential to note that neither the unfair contracts directive nor the distance sales directive contain provisions regarding intermediary liability. they include no stipulations as to what remedies—if any—the performance creditor may claim against the intermediary if the contractual basis does not decide this. thus, there are no specialized rules on contractual liability for platform intermediaries. in the absence of a lex specialis, this implies that the injured party can rely on the general rules and principles of the law of obligations, as well as more specialized principles developed for certain types of contracts, such as sales of goods contracts or rental contracts. at the current stage of the sharing economy, there are probably no specialized principles that will apply to this new type of contractual relationship. thus, if the issue is not contractually regulated, the performance creditor must invoke the remedies resulting from the general part of the law of obligations. in a situation where the platform intermediary can in fact be held liable, according to part 5 above, the starting point is that the performance creditor can invoke the same remedies against the intermediary as against the performance debtor. this is immediately evident in a situation such as the goleif judgment described above, where the intermediary is considered to be the performance creditor’s direct contracting party and thus immediately obliged under the agreement.48 the consumer could therefore invoke the right for compensation directly against goleif. in a situation where the intermediary cannot be regarded as a direct contractual party but nevertheless can be held primarily or secondarily liable based on the views discussed above under section 5, the question is whether the 48 see also mads bryde andersen & jospeh loookofsky, lærebog i obligationsret i, (4th edn, karnov group 2015), p. 201. platform intermediaries: liability and remedy 38 performance creditor can invoke all ordinary contractual remedies against the intermediary. in the absence of specific rules in the field, this should be assumed to be the case. as a matter of principle, once it has been established that the intermediary is liable on one basis or another, the interest of the performance creditor speaks in favour of having equal access to making remedies applicable to the intermediary just as against the performance debtor. however, this starting point may be modified in practice (see below). the general contractual remedies include: (1) the right to claim compensation, the liability basis being negligence, and meeting the other cumulative compensation conditions; (2) the right to claim specific performance (which does not preclude a compensation claim); (3) cancellation if the breach of contract must be deemed material; (4) replacement delivery reallocation in contracts regarding generic goods if the defect is material; and (5) a proportionate reduction of the price if the product suffers from a depreciating defect. on the other hand, there is no general right to claim remedy to the lack of conformity by repair in danish law of obligations.49 in consumer purchases covered by the sales of goods act, the consumer has a right to redress, according to section 78(1), but this is of little relevance in this case since, as noted, most of the sharing economy services relate to services that fall outside the scope of the sales of goods act section 78(1). of course, a right to claim remedy to the lack of conformity by repair can be derived from the contract. in contracts for the provision of ongoing services, a right for the performance creditor to claim redress is more obvious and will often follow from or be interpreted by the contractual terms. contracts for sharing economy services such as short-term housing rental, storage, or rental of various types of movable property, often exhibit this explicitness. for services where the performance debtor is obliged to make continuous improvements or maintenance (such as leasing of machinery or it equipment), a remedy will to an even greater extent follow from the contract or an interpretation thereof. the right to compensation is probably in practice the remedy that will be claimed most often in relation to a platform intermediary. it is also the remedy claimed in the goleif judgment, where the high court states that the intermediary is liable to pay damages to the consumer to cover the purchase of replacement tickets to return to copenhagen from nice. as discussed above, the result is surprising insofar as neither the intermediary nor the airline acted culpably in the case, meaning that there seems to be no basis for a damage liability at all. as discussed above, it is central to the definition of the platform intermediary concept that platform intermediaries may not also fulfil the role of performance debtor. they must be strictly an intermediary who 49 ibid, p. 209 ff. see also bernhard gomard, obligationsret, 2. del, (4th edn, juristog økonomforbundets forlag 2011), p. 86 ff. see however u.2012.950 h. njcl 2019/1 39 operates a digital platform through which the performance debtor and the customer can connect and contract with each other. this must imply—as per the goleif judgment—that in practice it will not be possible for a platform intermediary to perform specific performance in connection with sharing economy services, as the platform does not control accommodation, cars, flight tickets, or whatever the subject-matter of the contract may be. for this reason, the injured party will very often be denied any claim to specific performance or replacement delivery, which is why these remedies cannot be regarded as particularly relevant in the sharing economy. in practice, the performance creditor can very often only exercise the right to compensation to recover the loss that may be incurred. the right of injured parties to demand cancellation in the event of material default is more relevant in the sharing economy—unless, of course, a service (such as accommodation provision) has already been performed, in which case the possibility of returning the services due to the cancellation is no longer present. in practice, the cancellation right is therefore often primarily of significance where there is an anticipatory breach of contract. however, if the performed service suffered from actual and impaired deficiency, a proportional reduction in the purchase price could become a remedy which is relevant and in practice probably quite central (at least where the right to damages is not present because the conditions are not met). this may be obvious if, for example, the apartment in a platformbased short-term rental service has not been cleaned at the time of the rental, but will be somewhat harder if, for instance, the driver in a platform-based car-pooling service is perceived as unpleasant and offensive. overall, in sharing economy cases where the platform intermediary is deemed to be liable to the consumer, the fact that the intermediary conceptually does not coincide with the performance debtor means that the consumer will be restricted concerning the remedies that may be relied on under the general law of obligations. most likely to prove relevant, then, will be the right to claim compensation or a proportionate reduction in the price, namely the economic remedies. 7. conclusion sharing economy services are characterized by the existence of a tripartite relationship between the performance debtor (the provider of the service concerned), the performance creditor (the buyer of the service) and the platform intermediary operating the online platform service through which the contact between the parties is communicated and the contract between them is concluded. thus, the platform intermediary acts as an intermediary and agent for the performance debtor, who is bound to the performance creditor by the legal transactions that are concluded electronically through the platform service. this article has explored the platform intermediaries: liability and remedy 40 question of whether the platform intermediary may incur liability to the performance creditor in the event of breach of contract by the performance debtor. we have also asked, where applicable, what contractual remedies may be available to the performance creditor. sharing economy services are not specially regulated. yet a few statutory rules in contract law and consumer contract law are also relevant to these new types of service where the contract concluded via the platform service is a consumer contract. since sharing economy services are usually services and thus not covered by the sale of goods act (notably, they do not fall under the intermediary provision in section 4(a), para 2), the general rules of obligations law will serve as supplementary and facultative rules for the legal relationships of the parties. from the few and scattered rules regarding intermediary services we can deduce that three cumulative conditions must be fulfilled before a service is an intermediary service. the intermediary must: 1) be a trader, 2) perform an activity in connection with the conclusion of the contract between the creditor and the debtor, and 3) not be the performing debtor. these three conditions will generally be met with regard to part-finance services. the main rule under danish law is that it is not the intermediary but the principal (the performance debtor) who is bound by the intermediary's dispositions and thus liable to the performance creditor. case law, in particular in the case of the goleif judgment, shows that the main rule may be waived if the intermediary does not apply a clear, understandable, and common language (both in the course of the agreement and subsequently). this must enable the consumer to correctly decode the performance creditor and the platform intermediary's respective roles and obligations. considerations issuing from the law of obligations mean that the intermediary may be considered liable to the performance creditor. this may transpire if the intermediary is deemed to be— in reality—the direct contracting party of the performance debtor. in this respect, the degree of involvement by the intermediary in the contractual process and fulfilment is central. a liability may also be imposed based on identification considerations, although this must be regarded as a distant prospect, at least in the present development stage of the sharing economy. finally, platform intermediary liability may be based on secondary liability considerations. in this respect, a power of directions from the platform intermediary towards the performance debtor may be decisive to state a liability. in the absence of a contract regulation or lex specialis rules, the use of defaulting remedies directed at the intermediary should be supported on the general part of the law of obligations. however, the remedies will in practice most likely be limited to the financial remedies of compensation and proportional reduction. njcl 2019/1 41 the sharing economy holds some clear potential in terms of using resources in a better and more environmentally sustainable manner; especially when an individual’s use of a resource is too infrequent to make buying or renting it an obvious choice. as a result, the sharing economy is very likely here to stay and will no doubt grow rapidly in the years to come. nevertheless, a number of unresolved legal issues persist. however, these issues are relatively complex, which reduces the extent to which we can draw a simple or settled picture of the legal position within this contemporary and interesting area of the law. 3 wiencken pedersen 71 civil liability for the key investment information sheet in denmark stefan westh wiencken* and rasmus schou pedersen** * attorney, dla piper denmark law firm, denmark ** assistant attorney, dla piper denmark law firm, denmark civil liability for the kiis 74 1. introduction ..................................................................................... 75 2. the kiis and the parties’ responsibility for its contents .................................................................................................................. 78 2.1. what is the kiis? .................................................................... 78 2.2. project owner ........................................................................ 80 2.2.1. the crowdfunding project owners’ main roles in respect to the kiis .................................. 80 2.2.2. danish law aspects .................................................... 82 2.2.3. the civil liability for the kiis for the project owner .............................................................................. 83 2.3. the crowdfunding service provider ........................... 85 2.3.1. the crowdfunding service providers’ main role in respect to the kiis .................................... 85 2.3.2. the crowdfunding service providers’ responsibility for the kiis ..................................... 85 2.3.3. local danish law aspects ....................................... 86 2.3.4. the civil liability for the kiis for the crowdfunding service provider ......................... 86 3. conclusion .......................................................................................... 88 njcl 2022/2 75 abstract articles 23(9) and 24(4) of the ecspr sets out the liability of “at least” the project owner or its administrative, management or supervisory bodies for the information given in the key investment information sheet (kiis). further, articles 23(10) and 24(5) of the ecspr oblige eu member states to ensure that their laws, regulations and administrative provisions on civil liability apply to those responsible for the key investment information sheet in situations where the sheet contains misleading or inaccurate information and where the information sheet omits key information needed to aid potential investors. no danish legislation has been enacted regulating civil liability for the key investment information sheet. this article discusses the civil liability regime between the project owner and the csp who are involved in preparing the key investment information sheet. the article finds that the project owner is the main responsible for the accuracy of the key investment information sheet and as such will be the party to mainly be held responsible for any civil claims resulting from errors and omissions in the information sheet. until legislation is enacted otherwise, the crowdfunding service providers’ civil liability for the key investment information sheet would most likely be limited to such errors, misleading information and omissions in the information sheet that result from inadequate procedures adopted by the crowdfunding service providers or their failure to comply with such procedures. 1. introduction the aim of this article is to shed light on the civil liability attaching to the key investment information sheet, or “kiis”, in connection with equity crowdfunding via a crowdfunding service provider from a danish law perspective. the specific anatomy of crowdfunding is yet to be discovered and developed, and the recently adopted eu crowdfunding regulation (“ecspr”) is the first step towards a unified eu-based approach on this public funding method. the ecspr aims at strengthening the eu crowdfunding market by levelling the playing field and opting for a balanced approach between the level of investor protection and the burden of obligations for crowdfunding service providers (the platform) and project owners (the owner of the crowdfunding project in question). the ecspr offers a transitional period whereby all crowdfunding service providers within the scope of the ecspr that operates under applicable national law must be authorized under the ecspr in order to continue its operations. according to article 48(1) in the ecspr, the transitional period runs until 10 november 2022, though with possible extension being considered, at which point in time the crowdfunding service provider must either be authorized under the ecspr or discontinue its operations. esma considers national law as either a specific civil liability for the kiis 76 crowdfunding regime, other applicable legislation, or simply the private law appliable to crowdfunding transaction in a member state.1 denmark has not adopted any tailored legislation for crowdfunding purposes and consequently any danish crowdfunding service providers are regulated by the relevant provisions in mifid ii2 and the danish implementing regulation. it could be argued that the ecspr is indeed a risk based regulatory approach as the ecspr is directly binding in all member states and the applicability of the ecspr presupposes a crowdfunding offer of up to eur 5,000,000.3 any offers above eur 5,000,000 will be outside the scope of the ecspr and fall within the scope of other eu financial law, for example the prospectus regulation.4 in denmark, the threshold for prospectuses is eur 8,000,000 and consequently any public offerings under this threshold are not subject to any disclosure requirements. the ecspr will impose disclosure requirements for inter alia equity crowdfunding when a crowdfunding service provider is used as an intermediary between the investor and the project owner in order to fund the project owners’ crowdfunding project. crowdfunding may play a crucial role in the financing of small and medium sized enterprises (sme’s) and especially start-up’s that have limited access to traditional financial resources like bank financing and financial markets due to a lack of profitability and track record. this article focuses on equity crowdfunding as equity instruments nature have a higher risk than debt instruments. consequently, equity investors will take on additional risk and when it comes to crowdfunding projects as the project owner in question will often be a start-up with limited track record and no proof of concept. to reduce the risk of poor investment decisions, the ecspr imposes disclosure obligations in order 1 answer 2.1 in esma q&a on the european crowdfunding service providers for business regulation of 20 may 2022. esma reference: esma35-42-1088. 2 full title being directive 2014/65/eu of the european parliament and of the council of 15 may 2014 on markets in financial instruments and amending directive 2002/92/ec and directive 2011/61/eu text with eea relevance. 3 article 1(2)(c) in the ecspr, where crowdfunding offers with a consideration of more than eur 5 000 000 are to be calculated over a period of 12 months as the sum of (i) the total consideration of offers of transferable securities and admitted instruments for crowdfunding purposes as defined in points (m) and (n) of article 2(1) of this regulation and amounts raised by means of loans through a crowdfunding platform by a particular project owner; and (ii) the total consideration of offers to the public of transferable securities made by the project owner referred to in point (i) of this point in its capacity as an offeror pursuant to the exemption under article 1(3), or article 3(2), of regulation (eu) 2017/1129. 4 full title being regulation (eu) 2017/1129 of the european parliament and of the council of 14 june 2017 on the prospectus to be published when securities are offered to the public or admitted to trading on a regulated market, and repealing directive 2003/71/ec. see for example article 33 of delegated regulation 2019/980. njcl 2022/2 77 to foster the prospective investor with relevant information about the project owner and the crowdfunding project in question by publicizing a key investment information sheet. the ecspr distinguishes between two types of investors – nonsophisticated investors and sophisticated investors. the latter is defined as “any natural or legal person who is a professional client by virtue of point (1), (2), (3) or (4) of section i of annex ii to directive 2014/65/eu or any natural or legal person who has the approval of the crowdfunding service provider to be treated as a sophisticated investor in accordance with the criteria and the procedure laid down in annex ii to this ecspr”, and consequently a non-sophisticated investor can have the approval of the crowdfunding service provider to opt out of the investor protection pertaining non-sophisticated investors. the key investor protection measures in the ecspr are laid down in articles 20 (entry knowledge test), 21 (pre-contractual reflection period) and 23 (key investment information sheet). the entry knowledge test is a prerequisite for any non-sophisticated investors who wishes to invest through a crowdfunding service provider. according to article 21 in the ecspr, the crowdfunding service provider must assess whether and which crowdfunding services offered are appropriate for the prospective non-sophisticated investor by gaining information about non-sophisticated investors experience, investment objectives, financial situation and basic understanding of risks involved in investing in general and the risks regarding the investments offered at the crowdfunding platform. depending on the non-sophisticated investors answers to the entry test, the crowdfunding service provider may issue a risk warning and tell the non-sophisticated investor that any investment through the crowdfunding service provider may be inappropriate.5 according to article 22(5), the crowdfunding service shall require prospective non-sophisticated investors to simulate their ability to bear loss calculated as 10% of their net worth based on information stipulated in article 22(5)(a-c), e.g. regular income, assets, existing and future financial commitments. if a non-sophisticated investors’ commitment exceeds eur 1,000 or 5% of that investor’s net worth (calculated in accordance with article 22(5)), the crowdfunding service provider must ensure that the investor receives a risk warning, provides explicit consent to the crowdfunding service provider and that the investors prove to the crowdfunding service provider that the investor understands the investment in question and the attached risks cf. article 22(7). according to article 22 in the ecspr, non-sophisticated investors must be offered a reflection period following their investment commitment, whereby the commitment can be withdrawn. this 5 article 21(4) in the ecspr. civil liability for the kiis 78 information must be given by the crowdfunding service provider in an accurate, clean and timely manner as further described in article 22(6). while the investor protection measures described above may help investors understand their risk to bear losses and their rights to withdraw from a crowdfunding investment, one of the classic conditions is the provision of information from the seller of financial instruments – for crowdfunding purposes the information provided by the project owner in the key investment information sheet. we will briefly discuss the disclosure requirements in the key investment information sheet below and analyse the civil liability attaching to its content. 2. the kiis and the parties’ responsibility for its contents 2.1. what is the kiis? before further examining the civil liability for the kiis6 by the relevant parties in the crowdfunding environment, we summarize the content and purpose of the kiis from a general investor protection perspective and according to the ecspr. the aim of the kiis is generally to foster the prospective investor with information about the crowdfunding project in question and thereby removing information asymmetries between the investor and the project owner. the kiis is a pre-contractual document that must be presented to the investor before any investment decision is made. consequently, the overall aim is to make information available to increase certainty and reduce risk. the kiis is mainly regulated by articles 23 and 24 of the ecspr. each crowdfunding offer covered by the ecspr shall be accompanied by a key investment information sheet. the kiis must contain information regarding, among other things: • the project owner(s), • the crowdfunding project, • main features of the crowdfunding process, such as minimum target capital to be reached, deadline, and amount of own funds committed by project owner, • main risks associated with funding the project, • information related to offered securities, such as subscription price, terms of payment, • investor rights, • information related to loans, such as duration and term of the loan, interest rates, mitigation measures, and schedule for repayment, • fees and information, such as how and to whom an investor may address a complaint, as well as 6 in danish: ”dokument med central investorinformation”. njcl 2022/2 79 • a warning to potential investors that participating entails a risk of loss of their investment in full or in part. the content of the kiis are mainly regulated in article 23(6), annex i of the ecspr and a delegated regulation in the form of a regulatory technical standard (“rts”) that has yet to be adopted.7 the aim of the rts is to draw of a technical standard, whereby the kiis is drawn up subject to a uniform approach and the same information requirements. the purpose of the kiis is to provide information relating to the project and its owner(s) to enable the potential investors to make an informed investment decision. there are also requirements for how the kiis shall be prepared and presented. accordingly, the kiis shall be “fair, clear and not misleading and shall not contain any footnotes, other than those with references, including quotations where appropriate, to the applicable law”.8 further, the kiis “shall be presented on a stand-alone, durable medium that is clearly distinguishable from marketing communications and consist of a maximum of six sides of a4-sized paper format if printed.”9 the main purpose of the kiis is therefore investor protection. to this effect, similarities can be drawn between the kiis under the ecspr and both the key information document to be prepared under eu regulation no. 1286/20141011 and the prospectus summary under the prospectus regulation. the main parties responsible for the kiis are the project owner and the crowdfunding service provider. the overall roles of the two are best summarized in preamble 51 of the ecspr (our underlining): “the key investment information sheet should also take into account, where available, the specific features and risks associated with project owners, and should focus on material information about the project owners, the investors' rights and fees, and the type of transferable securities, admitted instruments for crowdfunding purposes and loans offered. the key investment information sheet should be drawn up by the 7 a draft rts has been presented in esma’s final report on ecspr, please refer to page 131ff. full title: “final report – draft technical standards under the european service providers for business regulation” of 10 november 2021. esma reference: esma3542-1183. 8 articles 23(7) and 24(3) of the ecspr. 9 articles 23(7) and 24(3) of the ecspr. 10 full title being ecspr (eu) no 1286/2014 of the european parliament and of the council of 26 november 2014 on key information documents for packaged retail and insurance-based investment products (priips). see for example section ii of said regulation. 11 articles 23(15) and 24(8) of the ecspr state that, if a kiis is drawn up in according with the ecspr, the crowdfunding service provider shall be considered to have satisfied its obligation to draw up a key information document under regulation (eu) no 1286/2014. civil liability for the kiis 80 project owners, because the project owners are in the best position to provide the information required to be included therein. however, since it is the crowdfunding service providers that are responsible for providing the key investment information sheet to prospective investors, it is the crowdfunding service providers that should ensure that the key investment information sheet is clear, correct and complete.” in contrary to a prospectus under the prospectus regulation, the kiis is not approved by a competent authority. as such, the kiis will not undergo scrutiny from any official authority for approval before publication. this is further emphasized in the draft rts, where it must be stated that “this crowdfunding offer has neither been verified nor approved by [competent authorities – insert full denomination of competent authority/ies] or the european securities and markets authority (esma).”12 the two main parties in preparing the kiis and providing the document to the public, the project owner and the crowdfunding service providers, have different responsibilities under the ecspr in relation to the kiis. as also discussed in the remainder of this section 2, they will also have different types of civil liability for the contents of the kiis in case of errors or omissions. for sake of completeness, the existing of a legal basis for liability is not sufficient to award damages under danish law. other factors such as the existence of a loss, causation, foreseeability and potential own fault must also be assessed in determining whether damages can be awarded. it falls outside the scope of this article to discuss these requirements and the principles that regulate them any further. 2.2. project owner 2.2.1. the crowdfunding project owners’ main roles in respect to the kiis a “project owner” is defined as any natural or legal person who seeks funding through a crowdfunding platform, according to article 2(1)(h) of the ecspr, and a “crowdfunding project” means the business activity or activities for which a project owner seeks funding through the crowdfunding offer. in connection with equity crowdfunding – the aim of this article – the project owner must publish a kiis that contains the relevant information laid down in the ecspr and the rts. the kiis is based on information from the project owner about the crowdfunding project in question. as this article discusses investmentbased equity crowdfunding, the kiis must include information about the 12 annex to the rts, where the draft technical format of the kiis is presented – starting with warnings. please refer to the draft rts on page 135 in the esma’s final report on ecspr. njcl 2022/2 81 shares or admitted instruments for crowdfunding purposes that are offered in a crowdfunding project. in the draft rts, where the technical requirements have been presented, the project owner must make a responsibility statement titled “responsibility for the information provided in this key investment information sheet” and declare the following: “the project owner declares that, to the best of its knowledge, no information has been omitted or is materially misleading or inaccurate. the project owner is responsible for the preparation of this key investment information sheet.” the responsibility statement is inspired from the prospectus regulation that also contains a knowledge qualifier to stress that the project owner can only be reprehensible for information that the project owner has knowledge of. it lies implicit in the statement that the kiis has been drawn up in accordance with the relevant disclosure obligations in the ecspr and the rts. it follows from article 23(10) of the ecspr that: “member states shall ensure that their laws, regulations and administrative provisions on civil liability apply to natural and legal persons responsible for the information given in a key investment information sheet, including any translation thereof, in at least the following situations: (a) the information is misleading or inaccurate; or (b) the key investment information sheet omits key information needed to aid investors when considering whether to finance the crowdfunding project.” this regulatory approach corresponds with the prospectus regulation13 and the general approach by the european court of justice (“cjeu) in immofinanz, where the cjeu ruled the following in paragraph 40 of the judgement:14 “while it is true that, unlike article 25(1) of the prospectus directive, article 28(1) of the transparency directive and article 14(1) of the market abuse directive do not expressly refer to the civil liability regimes in the member states, the fact remains that the court has previously ruled that, in respect of the award of damages and the possibility of an award of 13 article 11(2) in the prospectus regulation. 14 judgment of the court (second chamber), 19 december 2013: alfred hirmann v immofinanz ag. in the context of prospectus liability, please refer to page 417, section iv “unlawfulness and imputability” in danny busch “prospectus liability and litigation, the influence of the eu prospectus rules on private law in danny busch et al: prospectus regulation and prospectus liability, oxford university press (2020). civil liability for the kiis 82 punitive damages, in the absence of european union rules governing the matter, it is for the domestic legal system of each member state to set the criteria for determining the extent of the damages, provided that the principles of equivalence and effectiveness are observed (see, by analogy, joined cases c295/04 to c-298/04 manfredi and others [2006] ecr i-6619, paragraph 92, and the judgment of 6 june 2013 in case c-536/11 donau chemie and others [2013] ecr, paragraphs 25 to 27).” in the context of danish law, there are no national provisions governing the civil liability for project owners. the fallback is the general provisions of civil liability/general laws on tort in denmark (“dansk rets almindelige erstatningsregler”). the general provisions require a basis of liability (typically fault) and that the person in question has acted in a negligent way as further described in the following section. 2.2.2. danish law aspects civil liability under danish tort law requires a basis for liability and generally, such basis must be either fault-based (culpa) or no-fault based.15 as no specific danish law has been drawn up to state that no-fault liability attaches to the contents of the kiis, the fallback is the fault-based liability (culpa) which is based on case law. the culpa rule or fault rule is regarded as the classical rule of liability in denmark and involves “the comparison between the cause of the damage and the normal conduct and attitude of a reasonable man (bonus pater familias)”.16 as the liability for kiis will depend on its contents (or omissions therefrom), it follows that the project owner misleads or gives inaccurate information through act or omission may become liable under the fault rule (culpa). further to the basis of liability, any award of damages must be based on a loss from the investor(s) having relied upon the kiis being correct. it is out of the scope of this article to discuss how to prove any loss in relation to a financial investment, but a general example would be that a loss will occur if the initial pricing has been wrong in connection with the investment and consequently the investor bought a share that doesn’t have the perceived value. in such a situation, the investor would claim damages on the basis of the difference between the price paid and the fair market value, the latter ultimately proving to be lower than the price paid at the time. in order to invest, the investor will be presented with the kiis for the crowdfunding project. the kiis must contain inter alia “key annual financial figures and ratios for the project owner for the last three years”, 15 bo von eyben, helle isager, lærebog i erstatningsret (9th edn 2019), page 24. 16 bernhard gomard: recent development in the danish law of tort, scandinavian studies in law, volume 41, pages 233-248. njcl 2022/2 83 a “description of the crowdfunding project, including its purpose and main features” and “main risk types”.17 the provision of such information must be done be the project owner, meaning the legal person issuing shares, and in the context of danish law, this liability will likely lie with the legal person’s management, i.e. the board of directors and executive board. the kiis must be “fair, clear and not misleading” according to article 22(7) in the ecspr. consequently, the question to what extent inaccuracies or untrue statements in the kiis may result in liability. in the danish court decision u.2013.1107.h regarding liability for the contents of a prospectus, the supreme court ruled the omissions in the prospectus must be material in order to be liable.18 if the same standards for liability were to be projected onto the contents of the kiis, the fact that the kiis may contain inaccuracies or errors is not enough to support a claim for damages. the inaccuracies or errors must be material for the investors’ assessment of the crowdfunding project and the project owner. 2.2.3. the civil liability for the kiis for the project owner as the kiis is limited in its length19 there is a natural constraint on the volume of information that can be presented. this limits the level of information that is provided to the investors, and the risk of relevant information being omitted is consequently increased. article 23(11) of the ecspr stipulates that crowdfunding service providers must have in place and apply adequate procedures to verify the completeness, correctness and clarity of the information contained in the kiis. article 23(12) of the ecspr obliges the crowdfunding service providers to signal any findings relating to an omission, mistake or inaccuracy in the kiis that could have a “material” impact on the expected return of the investment in question to the project owner, who shall promptly complete or correct that information. if the project owner does not complete or correct the information promptly, the crowdfunding service provider shall suspend the crowdfunding offer. accordingly, article 23(12) of the ecspr supports that there is a materiality threshold based on the crowdfunding project in question and could be understood as though minor inaccuracies are acceptable and does not invoke any need to suspend the offer. this further supports an argument that the liability review between a prospectus and a kiis would 17 reference is made to the draft rts on page 135 in the esma’s final report on ecspr. 18 see page 299f. in poul krüger andersen and nis jul clausen with assistance of jesper lau hansen børsretten, (6, edn. 2019), djøf 19 six sides of a4-sized paper if printed cf. article 22(7) in the ecspr. if information about any investor rights in accordance with section 5 in annex i to the regulation exceeds one a4-sized paper if printed, the remainder shall be produced in an annex attached to the kiis civil liability for the kiis 84 be similar, meaning that errors and omissions must be material to form a basis of liability. we note that article 23(12) concerns the obligations on the crowdfunding service provider to help ensure that the kiis is correct. accordingly, although the article could be read as both being lenient on the crowdfunding service providers (not given them the responsible to identify errors and omissions that are not material) and to avoid disrupting the information flow to investors by compelling the project owner to correct such errors and omissions, the provision also accepts the reality that errors and omissions will reach the potential investors and that not all such are relevant to correct. this suggests that inaccuracies or errors must be material for the investors assessment of the crowdfunding project and the project owner. it follows from the review above that the board of directors or the executive board in the project owner is liable for the information provided in the kiis. liability is based on the culpa rule and can only occur if the information in the kiis is misleading, inaccurate or if any information has been omitted – and such information must be material for the prospective investors’ assessment and understanding of the crowdfunding project. there would therefore likely be a similar basis for liability review of a kiis as under a prospectus. we note that a clear distinction between the kiis and the contents of for example a key information document (kid) under eu regulation no. 1286/2014 or a prospectus summery must be made. the latter are also examples of concentrated investment information material. however, there will be underlying documents providing more detailed information (for example a prospectus). as such, the kiis does not offer the responsible persons for the kiis to include supplementing information as a part of the kiis or assume that the reader of the kiis familiarizes itself with supplemental information. the counterweight in terms of investor protection and protection of the project owner is that the project owner can choose to draw up a prospectus instead and opt into the prospectus regulation. however, this would mean that the project owner cannot market the shares on the crowdfunding platform. the fact that the size of the crowdfunding offers may not exceed eur 5,000,000 ensures a limited exposure for the general investing public. as the market for crowdfunding services will now be regulated by the ecspr, it is likely that the market will adapt and develop further. as no existing “best practice” or supporting case law have been developed yet under the ecspr, it will likely evolve now as all existing crowdfunding platforms must comply with the ecspr following the transition period. consequently, we will likely see that a uniform approach to the contents of kiis will be adopted like prospectuses and kid where the market has developed best practices and uniform approaches. in contrary to prospectuses, the kiis will not be approved by a competent authority before its publication. however, the supervisory njcl 2022/2 85 authorities in the member states and esma will likely follow and monitor the market and issue warnings or guidance in order to improve the conduct of the project owners and the crowdfunding service providers if any risks are identified. 2.3. the crowdfunding service provider 2.3.1. the crowdfunding service providers’ main role in respect to the kiis the crowdfunding service providers’ responsibilities for the kiis are mainly regulated in the ecspr. there are only a few provisions in danish law outside the ecspr specifically regulating crowdfunding service providers. these are mainly found in the danish financial business act (the “danish fba”)20 and will be described briefly below. to understand the crowdfunding service providers’ responsibilities for the kiis, the role of the crowdfunding service providers in a crowdfunding project should be considered. a key role for the crowdfunding service providers is to match the funding interests between the project owners, seeking funding, and the potential investors, seeking investment opportunities. one of the ways the crowdfunding service providers facilitate these interests is by marketing the project owner’s project, including the kiis, towards the potential investors. given that the potential investors will have to rely on information facilitated by the crowdfunding service providers, the crowdfunding service providers have certain obligations with respect to the accuracy of the contents of the kiis, regardless that they are a third party to the project owner. another reason for this is to provide additional investor protection given that there is no requirement for governmental approval of the kiis under the ecspr. the obligations of the crowdfunding service providers are laid down in the ecspr. 2.3.2. the crowdfunding service providers’ responsibility for the kiis as stated above, the ecspr provides in the preamble that crowdfunding service providers shall “ensure that the key investment information sheet is clear, correct and complete”. this principle is expressed in article 23(11), stating that crowdfunding service providers “shall have in place and apply adequate procedures to verify the completeness, correctness and clarity of the information contained in the key investment information sheet”. there are no other provisions in the ecspr concerning the crowdfunding service providers’ responsibilities for the contents of the kiis. where the preamble broadly sets out the crowdfunding service providers’ obligation to verify the kiis, the 20 in danish: ”lov om finansiel virksomhed”. civil liability for the kiis 86 governing provisions in the ecspr limits the responsibilities for the crowdfunding service providers to have adequate procedures. as also stated above, the ecspr states that member states shall ensure that their rules on civil liability apply to the natural and legal persons responsible for the kiis, at least in situation where (i) the information is misleading or (ii) key information is omitted.21 as of writing, no laws have been enacted in denmark specifically setting out the civil liability for the contents of the kiis by the crowdfunding service provider (or the project owner for that matter). the civil liability of a crowdfunding service provider for the contents of the kiis is therefore currently only regulated by the ecspr and the general laws on tort in denmark. 2.3.3. local danish law aspects the main changes to danish law caused by the ecspr have been the adoption of law no. 1163 of 8 june 2021, changing the danish financial business act (“danish fba”) to encompass the supervision of the ecspr under the merits of the danish financial supervisory authority. the new rules are primarily enacted by way of inserting a new chapter 20a in the danish fba. although no rules on civil liability have been enacted, the above cited law does regulate certain types of criminal liability for violation of the ecspr. for example, violation of articles 23(2)-(14) and 24 of the ecspr has with the law become punishable by fine or imprisonment up of to 4 months.22 according to the preparatory works of the amended law, “articles 23(2)-(14) and 24 of the ecspr regulates a document with a key investment information sheet” and that “an example of a criminal act is a failure by the crowdfunding service provider to provide to the potential investors all information required by articles 23 and 24”23. in general, under danish tort law, a failure to comply with legislation could form basis of civil liability by the legal or natural person. 2.3.4. the civil liability for the kiis for the crowdfunding service provider the crowdfunding service providers’ civil liability for the content of the kiis must be determined based on the ecspr and general principles under danish law as there are currently no legislation enacted locally governing such liability. in the ecspr, as described in section 2.2 above, the project owner is responsible for drawing up the kiis and in a fair, clear and not misleading manner. further, the project owner shall correct any mistakes, omissions and inaccuracies after they have been identified. 21 article 23(10) of the ecspr. 22 section 373(2) of the danish fba. 23 proposed bill no. 193 of 24 march 2021. njcl 2022/2 87 in the ecspr, the crowdfunding service providers have (limited) responsibilities to have adequate procedures in place to verify the completeness, correctness and clarity of the information contained in the key investment information sheet. this should be read in conjunction with the project owners’ responsibilities for drawing up the kiis. in general, the project owners themselves will be the only ones with the knowledge required to draw up the kiis in a manner which complies with the standards set out in the ecspr. crowdfunding service providers will by nature of their involvement in a crowdfunding project not necessarily obtain the information required about the project owner or the project. this is further emphasised by the level of due diligence required to be made by crowdfunding service providers of the project owner which is also limited. such due diligence shall as a minimum include obtaining the following evidence24: “(a) that the project owner has no criminal record in respect of infringements of national rules in fields of commercial law, insolvency law, financial services law, antimoney laundering law, fraud law or professional liability obligations; that the project owner is not established in a noncooperative jurisdiction, as recognised by the relevant union policy, or in a high-risk third country pursuant to article 9(2) of directive (eu) 2015/849” as such, the crowdfunding service providers’ civil liability under the ecspr for the kiis would most likely be limited to errors, misleading information and omissions in the kiis to the extent they result from inadequate procedures adopted by the crowdfunding service providers or their failure to comply with such procedures. naturally, if crowdfunding service providers adopt procedures by which they elect to perform a more comprehensive due diligence of the project owner than stated above or the project itself, they will be better prepared to identity errors and omissions in the kiis, and their basis of liability would likely be broader. there are currently no standards or guidance on eu level or local danish level with respect to the crowdfunding service providers procedures described. such standards would help in providing guidance on the procedures to be drafted and implemented by crowdfunding service providers as they would be a factor in determining their civil liability for the kiis.25 24 article 5(2) in the ecspr. 25 as of writing, there is no danish form to apply as a crowdfunding service provider. until such form is made by the danish fsa, esma’s application form must be used. in section 18 of the form, the application must provide a description of its procedures on the kiis. however, there is no requirement to attach the procedures themselves. civil liability for the kiis 88 it can be debated whether law no. 1163 of 8 june 2021, changing the danish fba, is more extensive than the basis for potential liability on the crowdfunding service provider’s liability for the contents of the kiis under the ecspr. as stated above civil liability under danish tort law requires a basis for liability. generally, such basis must be either fault-based (culpa) or nofault based26. no-fault based liability must be stipulated by either law or case law27 which is not the case for law no. 1163 of 8 june 2021. however, fault-based liability can occur if an act or omission violates generally accepted behavioural patterns, for example, the failure to comply with regulations.28 given the responsibilities on the crowdfunding service provider for complying with the ecspr as set out in the preparatory works for law no. 1163 of 8 june 2021, one could argue that, in case of errors in a kiis, the crowdfunding service providers has not complied with law no. 1163 of 8 june 2021 resulting in a basis for liability for the provider. however, we do not view the preparatory works as the legislator’s intention to expand the civil liability of the crowdfunding service provider’s civil liability compared to the ecspr. no other circumstances indicate this, and such liability would most likely not be considered consistent with the principle of conforming interpretation of national legislation. accordingly, until other rules are enacted stipulating otherwise, the crowdfunding service provider should under the ecspr only be liable for errors, misleading information and omissions in the kiis to the extent they result from the provider’s inadequate procedures. such adequate procedures would likely be sufficient to rightly claim the existence of a fault-based liability basis. 3. conclusion in can be concluded the ecspr contains a balanced approach between the level of investor protection and the burdens of the project owner in relation to the magnitude of pre-contractual information that must be provided. the kiis is limited in its contents and accordingly does not impose a lot of burdens on the project owner. pre-contractual information is only useful to base an investment decision on if its contents are true and correct. if not, the investor should have access to remedies in order to be compensated for any subsequent loss. the main responsible party for the kiis under the ecspr is the project owner. the project owner will be liable for errors, misleading information and omission in the kiis. the liability is vested with the 26 bo von eyben, helle isager, lærebog i erstatningsret (9th edn 2019), page 24. 27ibid. page 24. 28 ibid. page 97. njcl 2022/2 89 management of the project owner, meaning the board of directors or the executive board. any misleading information or omissions must be material in order to form a basis of liability. it is expected that good practises for kiis will develop and consequently it will be easier to assess the level of detail in kiis disclosures and evaluate whether or not material information have been left out or misstated. the crowdfunding service providers’ civil liability under the ecspr for the kiis would most likely be limited to such errors, misleading information and omissions in the kiis to the extent they result from inadequate procedures adopted by the crowdfunding service providers or their failure to comply with such procedures. 1 availability of the disgorgement of profits under the cisg ece baş-süzel * gökçe kurtulan-güner * dr. ece baş süzel, associate professor, istanbul bilgi university law faculty, ece.bas@bilgi.edu.tr  dr. gökçe kurtulan güner, assistant professor, istanbul bilgi university law faculty, gokce.kurtulan@bilgi.edu.tr. 1. introduction .................................................................................... 20 2. understanding the remedy of disgorgement of profits21 3. the case of second sales .............................................................. 24 4. the case of breach of obligation other than the delivery of the goods and payment of the purchase price .............. 29 5. disgorgement of profits as a way of calculating loss or as a remedy on its own ................................................................... 33 availability of disgorgement 20 abstract the united nations convention on contracts for the international sale of goods (cisg or the convention) does not expressly state whether the remedy of disgorgement of profits can be awarded in cases of breach of contract. in this article, we argue that the disgorgement of profits is available both as a method for the calculation of damages under art. 74 and as a remedy on its own when the remedy of compensatory damages fails to fulfill its functions. therefore, we argue that the disgorgement of profits is in line with art. 7(1) and art. 7(2) of the convention. however, the availability of the disgorgement of profits shall not be understood as undermining the primacy of compensatory damages and should be accepted only in exceptional cases, namely where second sales of nonsubstitutable goods and breaches of certain contractual stipulations make the calculation of loss impossible or impracticable. 1. introduction when looking at the remedies system of the united nations convention on contracts for the international sale of goods’ (cisg), typical contract law remedies that can generally be found in national legislations are apparent, such as avoidance, specific performance, damages, the right to withhold performance and the right to ask for repair or replacement. however, the remedy of disgorgement of profits is nowhere mentioned in the convention, travaux préparatoires, or initial commentaries.1 this should not come as a surprise because the disgorgement of profits has only recently become a popular academic and judicial topic,2 and when the convention was drafted, it was not thought of as a remedy in case of a breach.3 the primary remedy for a breach of contract in common law systems has traditionally been damages and, in civil law, specific performance;4 therefore, the theoretic race between the remedies has concerned these two, leaving the disgorgement issue out of the discussion. it follows that the (unconscious) absence of the disgorgement of profits alone does not allow us to claim that the 1 nils schmidt-ahrendts, ‘disgorgement of profits under the cisg’, in ingeborg scwenzer and lisa spagnolo (eds), state of play: the 3rd annual maa schlechtriem cisg conference (international commerce and arbitration) (eleven international publishing 2010), 96. 2 mathias siems, ‘disgorgement of profits for breach of contract: a comparative analysis’ (2003) 7 edinburgh law review 27, 43. 3 see schmidt-ahrendts (n 1), 96. 4 see for example jacob s. ziegel, 'the remedial provisions in the vienna sales convention: some common law perspectives', in galston & smit (eds), international sales: the united nations convention on contracts for the international sale of goods (matthew bender 1984), ch. 9, 8-9. njcl 2020/2 21 convention excludes this remedy.5 therefore, it becomes imperative to discuss from a theoretical and practical perspective whether there is any scope for allowing the disgorgement of profits under the cisg because, as schwenzer and hachem have correctly stated, if the cisg fails to adapt to the new circumstances and dynamic nature of international trade, it is doomed to lose popularity and uniform application.6 the purpose of this article is to discuss whether and how the aggrieved party may be granted the profits made by the breaching party under the cisg. the discussion is two-pronged. the first question we will try to answer is whether the disgorgement of profits can be inferred from an interpretation of the cisg’s existing stipulations, particularly art. 74, in accordance with art. 7(1) of the convention. the second question is whether there is an internal gap within the convention and, if so, whether this gap can be filled in light of art. 7(2) of the convention in a way that allows for the disgorgement of profits realized by the aggrieved party. before analyzing whether the breaching party can be successfully stripped of their gains under the relevant provisions of the cisg, it would be helpful to understand what is meant by the disgorgement of profits through a comparative lens. 2. understanding the remedy of disgorgement of profits the remedy of disgorgement of profits can be briefly summarized as stripping the breaching party of the gains they made through the breach of contract. its contrast with the ordinary remedy of damages is clear: the former takes into account the change in the economic position of the breaching party, whereas the latter is based on the loss that the innocent party has suffered.7 in other words, the first impression that the disgorgement remedy gives is that it is not concerned with the position of 5 milena djordjevic, ‘article 74’, in stefan kröll, loukas mistelis and pilar peralesviscassilas (eds), un convention on contracts for the international sales of goods (cisg) (2nd edn, beck hart nomos 2018) para 61. 6 ingeborg schwenzer and pascal hachem, ‘the scope of the cisg provisions on damages’, in djokhongir saidov and ralph cunnington (eds), contract damages: domestic and international perspectives (hart publishing 2008), 93. 7 djordjevic (n 5), para 62; schmidt-ahrendts (n 1), 93; lionel smith, ‘disgorgement of the profits of breach of contract: property, contract and efficient breach’ (1994) 24 canadian business law journal 121, 122; onni rostila, disgorgement and the cisg comparative and future perspectives, thesis, university of lapland, finland, 2017, 13. the disgorgement of profits has even been described as the mirror image counterpart (das spiegelbildliche gegenstück) of the damages. see tobias helms, gewinnherausgabe als haftungrechtliches problem (mohr siebek 2007) 3. availability of disgorgement 22 the aggrieved party but rather that of the breaching party. there are two crucial questions following this first impression. the first question is whether this first impression can be misleading in certain cases. the second question is whether the correctness of this first impression should completely exclude the possibility of the disgorgement of profits under the cisg. in other words, even though the remedy of disgorgement of profits may contradict the main principles of compensatory damages, should this contradiction be interpreted as meaning that there is no room for disgorgement? the general approach to the disgorgement of profits implies a certain prejudice that this remedy is of a punitive character8 and therefore has no place in a system that does not give rise to punitive or preventive remedies in the field of private law.9 in fact, this bias can also be seen in comparative findings. generally speaking, the systems that regulate the disgorgement remedy one way or another usually permit it only in exceptional circumstances and usually in tortious liability cases or in cases of negotiorum gestio.10 however, it is usually disregarded that the disgorgement does not have to be understood as a sui generis and possibly punitive remedy, but also as a way of calculating damages.11 in the latter case, the disgorgement of profits is renamed by some authors as “gain-based damages,”12 and this choice phrase (which is perhaps at first glance surprising or even oxymoronic) articulates that the objective is compensating the aggrieved party, even though the position of the breaching party is taken into account. when analyzing whether there is a place for disgorgement within the convention’s system of remedies, this distinction always has to be kept in mind. nonetheless, the line between the punitive and compensatory types of disgorgement of profits is not always easily drawn. 8 djordjevic (n 5), para 65. 9 see e.g., nils schmidt-ahrendts and mark czarnecki, ‘article 74’, in christoph brunner (ed), un kaufrechtcisg (2nd edn, stämpfli verlag 2014) para 18. 10 for a comparative overview of the disgorgement of profits under various legal systems, see ewoud hondius and andre janssen (eds), disgorgement of profits gain-based remedies throughout the world (springer 2015). for a detailed and comparative study of the concept of negotiorum gestio, see duncan sheehan, ‘negotiorum gestio: a civilian concept in the common law?' (2006) 55 the international and comparative law quarterly 253. 11 helms (n 7) 5–6, marius jan stucki, vorteilsherausgabe nach vorsa ̈tzlichen vertragsverletzungen im nationalen und internationalen recht, thesis, universita ̈t bern, switzerland, 2018, 83. 12 see e.g., djordjevic (n 5), para 63; james edelman, gain-based damages: contract, tort, equity and intellectual property (hart publishing 2002) 21; jessica rickett, ‘disgorgement for breach of contract: my loss, your gain’ (2001) 9 auckland university law review 375, 376. njcl 2020/2 23 independent of the punitive/preventive or compensatory nature of the disgorgement remedy, the goal remains the safeguarding of the principle of pacta sunt servanda. in other words, the disgorgement of profits is thought to motivate the parties to fulfill their contractual obligations.13 from this perspective, the disgorgement remedy seems to be in line with cisg art. 7(1), which sets the observance of good faith in international trade as a general goal.14 due to its limited scope, this article is not the right place to discuss what is meant by good faith, as the issue represents an eternal debate. however, it would not be wrong to assume that the philosophy of the convention is to prevent or deter opportunistic behavior; therefore, art. 7 may be considered an argument in favor of allowing the remedy of disgorgement of profits.15 nevertheless, another important provision that should be considered is art. 74, which embodies the principle of full compensation.16 at first glance, the disgorgement remedy appears to contradict art. 74 of cisg because the former takes into account the profits made by the breaching party, whereas the latter depends on the loss suffered by the other party. however, there may be circumstances in which it is impossible or impracticable to calculate the loss, or there may be no way other than the disgorgement of profits to assure the performance of the contract. to assess whether there is any scope for allowing the disgorgement of profits under the cisg, this article will take into consideration two different scenarios as a starting point. the first is the second sales cases in which the seller breaches the contract by selling the promised goods (naturally at a higher price) to a third party. the other scenario is the cases in which one of the parties breaks a contractual clause related to an issue other than the delivery of goods and the payment of the purchase price (e.g., a non-compete clause). some authors refer to the latter as “agency problem cases” because they almost always stem from a principal–agent problem where the party to the contract is not in an optimal position to monitor a potential breach by the other.17 at the risk of reducing the excitement of the reader, perhaps it should be stated that the remedy of 13 schmidt-ahrendts (n 1), 93. 14 edgardo muñoz and david obey ament-guemez, ‘calculation of damages on the basis of the breaching party’s profits under the cisg’ (2017) 8 journal of international commercial law 201, 208; florence eicher, ‘pacta sunt servanda: contrasting disgorgement damages with efficient breaches under article 74 cisg’ (2018) lse law review 29, 33. 15 see eicher (n 14), 35. 16 schmidt-ahrendts and czarnecki (n 9), para 8. 17 katy barnett, accounting for breach of contract: theory and practice (hart publishing 2012), 4. availability of disgorgement 24 disgorgement of profits finds meaning (and more importantly, legitimacy) only in cases where the damages become dysfunctional or inadequate to remedy a breach,18 which is, in fact, the common characteristic shared by these two scenarios. 3. the case of second sales a frequently encountered breach of a sales contract is when the seller resells the goods that were promised to the first buyer beforehand. the seller does this knowing full well that they will have to compensate the buyer’s loss, but they proceed with a second sale anyway because they will most likely profit despite the compensation obligation.19 in other words, the seller — usually a merchant who is supposed to be a homo economicus — breaches the contract because they believe it is economically profitable or efficient to do so. in principle, in the case of such a breach of contract, the compensation of the buyer for the loss suffered is the sufficiently adequate remedy, and the disgorgement of profits is not necessary at first sight.20 however, there may be situations in which the compensatory damages fail to remedy the breach and put the buyer in an equivalent economic position as if there had been no breach. it is in those cases exactly that the remedy of disgorgement of profits may be allocated a compensatory role. the typical situation wherein the criterion of “loss suffered” fails to provide adequate compensation for the buyer in the case of a second sale is when the goods are of a unique nature.21 it goes without saying that the concept of uniqueness can be understood in different ways and there is no universal guide for its interpretation. in our view, uniqueness shall always be correlated with the possibility of substitution.22 the possibility of substitution means that the goods are purchasable from another seller, even if they might be sold at a higher price and/or under less favorable contractual conditions. if the goods are bought at a higher price than in the original contract, the difference in the price constitutes at least part of the damages. a custom-designed energy turbine, a special type, and vintage of wine or a piece of art may all be non-substitutable. in all of these cases, the price of the resale contract may be thought of as equal to 18 see also ernest j. weinrib, ‘punishment and disgorgement as contract remedies’ (2003) 78 chicago-kent law review 55, 55–6. 19 muñoz and ament-guemez (n 14), 205. 20 barnett (n 17), 94. see also anne florence bock, gewinnherausgabe als folge einer vertragsverletzung (helbing lichtenhahn verlag 2010), 56. 21 barnett (n 17), 94. 22 see barnett (n 17), 94 ff. njcl 2020/2 25 the loss that the aggrieved party has suffered because there is no other way to calculate the loss.23 granting the aggrieved party the chance to strip the seller of the profits made from the second sale is (in exceptional cases such as these) in line with the principle of full compensation embodied in art. 74. the principle of full compensation usually put forward as a counterargument for the disgorgement of profits24 requires that the aggrieved party not be overcompensated because of the breach of contract. in other words, if the breaching party has made a profit, even though they are obliged to compensate the aggrieved party, such an economically efficient transaction should be respected.25 nevertheless, as much as the principle of full compensation can be interpreted as an obstacle to the possibility of granting the disgorgement of profits, the opposite reasoning can also be deduced in exceptional cases. that is because the mirror image of the prevention of overcompensation is the prevention of undercompensation. as expressly noted by the cisg advisory council in their 6th opinion, art. 74 of the cisg aims to “compensate the aggrieved party for all the disadvantages suffered as a result of the breach.”26 hence, if not taking into account the gains made by the party in breach of contract will result in undercompensation of the aggrieved party, such a path should be allowed. this is, as mentioned above, first and foremost the case in the sale of unique goods. in these cases, the remedy of disgorgement of profits is not only in line with the principle of full compensation but also the most efficient way of calculating damages.27 the basic idea is that if the seller was able to find an alternative purchaser at a higher price, the buyer could have too.28 this reasoning alone proves that the compensation-only dogma (as burrows puts it) is not corroborated by either the principles or policies of the convention.29 23 see djordjevic (n 5), para 62. 24 djordjevic (n 5), para 63; schmidt-ahrendts (n 1), 93. 25 it is usually stated that the disgorgement of profits is an inefficient remedy in contract law according to cost analysis because it prevents a more efficient allocation of resources. for a thorough discussion on this topic, see sidney delong, ‘the efficiency of a disgorgement as a remedy for breach of contract’ (1989) 22 indiana law review 737. 26 cisg-ac opinion no. 6, calculation of damages under cisg article 74. rapporteur: professor john y. gotanda, villanova university school of law, villanova, pennsylvania, usa. 27 delong (n 25), 747. see also muñoz and ament-guemez (n 14), 212. 28 delong (n 25), 748. 29 andrew burrows, ‘are “damages on the wrotham park basis” compensatory, restitutionary, or neither?’, in djokhongir saidov and ralph cunnington (eds), contract damages: domestic and international perspectives (hart publishing 2008), 175 ff. availability of disgorgement 26 we believe that the uniqueness of the resold goods would not be the problematic part of assessing the possibility of substitution. what is more challenging is to decide whether the disgorgement of profits shall be allowed in cases where the goods are not of a unique nature, but they are also not easily substitutable due to special circumstances. the famous adras case before the supreme court of israel represents an interesting example of the latter scenario.30 it should be noted that even though the adras case was not governed by the cisg but by its predecessor, the convention relating to a uniform law on the international sale of goods ('ulis'), and the decision regarding the disgorgement of profits was not based on ulis but on national law on unjust enrichment, the facts remain interesting for our discussion. in the adras case, an israeli buyer and a german seller agreed on the sale of 7,000 tonnes of iron. the delivery was delayed and ultimately only partially performed due to the outbreak of the yom kippur war. the seller then sold the remaining iron to a local buyer at a higher price. the buyer succeeded in stripping the seller of the profits made through the resale of the goods. the grounds on which the judgment was given will not be discussed here as they are principally concerned with the availability of recourse to domestic rules on unjust enrichment despite the presence of a contract, rather than the availability of the disgorgement of profits in case of a breach of contract in the context of the ulis itself. allow us to twist the facts of the case slightly in order to demonstrate what is problematic in terms of the issue of substitutability. in our hypothetical adras-like case, the german seller agrees to sell 7,000 tonnes of iron to an israeli buyer, and due to the outbreak of war, no one else can either produce or sell iron to the buyers in this country. the german seller opportunistically breaches the contract and sells the iron to another buyer at a higher price. could the buyer in the first contract have a claim on this sale’s price? we believe that the answer to this question should be affirmative, not because the goods are unique (they are, in fact, qualified as generic goods), but because they are not easily substitutable from elsewhere under the given conditions. therefore, as it is not possible for the buyer to prove their loss based on a concrete or abstract cover transaction, the second sale shall be taken as a handle point in assessing the quantum of loss.31 30 adras chmorey binyan v. harlow & jones gmbh, supreme court of israel, 2 november 1988, available at http://cisgw3.law.pace.edu/cases/881102i5.html. 31 it should be noted that, in the context of second sales, restricting the application of the remedy of disgorgement of profits to cases in which the goods are not easily substitutable is in line with the principle of mitigation of loss embodied in art. 77 of the cisg, which njcl 2020/2 27 the comparative findings also support allowing the disgorgement of profits as a means of calculating loss (i.e., the gain-based damages). we see perhaps the most explicit recognition of gain-based damages in dutch law.32 under the dutch civil code art. 6:104, in case of compensation for loss arising from contractual or tortious liability, if the judge deems it fair, they may allow the disgorgement of profits on the condition that the aggrieved party makes such a request. this rule is especially important if the amount of the loss cannot be proved and/or if the aggrieved party has incurred significantly less loss compared to the gains made by the breaching party. however, it should be noted that the stipulation under the dutch civil code is exceptional.33 for instance, neither the german civil code (bgb), the swiss code of obligations (or)34 nor the turkish code of obligations (tco)35 expressly approves this method of calculating loss. according to art. 50/ii of the tco and art. 42/ii of the or, “where the exact value of the loss or damage cannot be quantified, the court shall estimate the value at its discretion in the light of the normal course of events (…).” on the other hand, these provisions that give significantly wide discretion to judges do not prohibit taking into account the profits made by the breaching party when assessing the quantum of damages. therefore, it would not be wrong to conclude that a judge may use their stipulates that “a party who relies on a breach of contract must take such measures as are reasonable in the circumstances to mitigate the loss....”. in the case of second sales, this means that the aggrieved party shall, within an appropriate period of time and at a reasonable price, purchase substitute goods in order to keep their loss as low as possible. it has been (in our view rightfully) put forward that the general availability of the disgorgement of profits in cases of second sales would disincentivize the aggrieved parties to mitigate the loss. therefore, the principle of mitigation requires limited recourse to the remedy of disgorgement of profits, as suggested by this article. in common law scholarship, one may encounter another distinction, namely the one between contracts concerning particular or determined goods and those concerning indeterminate instances of a type of a thing. according to this distinction, if the contract of sales was related, the disgorgement remedy does not apply (e.g., in the sale of bushels of merchantable wheat, because no particular wheat was promised). see, e.g., nicholas w. sage, ‘disgorgement: from property to contract’ (2016) 66 university of toronto law journal 244, 253–5. we believe that this distinction cannot be applied either in principle or authority to the cisg. 32 stucki (n 11), 84. 33 stucki (n 11), 84; bock (n 20), 135. 34 bock (n 20), 135; ece baş süzel, gerçek olmayan vekaletsiz i̇ş görme menfaat devri yaptırımı (on iki levha 2015), 157 ff. 35 other than art. 50/ii of tco, there are special regulations regarding gain-based damages under turkish law. see baş süzel (n 34), 157 ff. availability of disgorgement 28 discretion to strip the breaching party of the profits made through the breach in the name of compensation36. when it comes to german law, §285 bgb sheds light on the possibility of the disgorgement of profits in the case of second sales.37 according to this section, if the seller has sold the unique or nonfungible goods initially promised to the buyer to a third party, the original buyer has a right to claim the substitute performance (i.e., the profits made by the breaching party).38 however, it should be recognized that, in cases beyond the scope of impossibility and §285 bgb, the current standing of the german doctrine seems rather in opposition to the disgorgement of profits.39 in english law, the disgorgement of profits for breach of contract can be considered a rather recent development following the groundbreaking decision made by the house of lords in 2000.40 however, it should not go without saying that, in english law, one of the main requisites for gain-based damages is the inadequacy of the remedy of compensatory damages.41 in other words, the disgorgement of profits is considered a subsidiary remedy or supplementary method that adds to the already existing and conventional remedies.42 36 see, e.g., stucki (n 10), 83–5 for swiss law and baş süzel (n 34), 157 ff for turkish law. 37 see helms (n 7) 310; franz hofmann, ‘gewinnherausgabe bei vertragsverletzungen’ (2013) 213 archiv für die civilistische praxis 469, 477 ff.; reinhard zimmermann, ‘damages and interest’, in reinhard zimmermann and nils jansen (eds), commentaries on european contract laws (oup 2018), 1464. 38 siems (n 2), 36 ff. 39 in german law, the principle is the same as in turkish/swiss law, which is full compensation and a sum equal to the loss. according to §249 bgb, “a person who is liable in damages must restore the position that would exist if the circumstance obliging him to pay damages had not occurred.” regarding the loss of profits, there is a special regulation in §252 bgb: “the damage to be compensated for also comprises the lost profits. those profits are considered lost that in the normal course of events or in the special circumstances, particularly due to the measures and precautions taken, could probably be expected.” to ask for a loss of profit, the aggrieved party only needs to prove the circumstances that give rise to the probability of profit without a loss event. the prevailing view suggests that the profits of the breaching party cannot be claimed as damages. 40 attorney general v. blake and another [2000] ukhl 45; [2000] 4 all er 385; [2000] 3 wlr 625 (27th july, 2000). 41 edelman (n 12), 154; solène rowan, remedies for breach of contract: a comparative analysis of the protection of performance (oup 2012), 157. 42 rowan (n 41), 158. njcl 2020/2 29 4. the case of breach of obligation other than the delivery of the goods and payment of the purchase price the other scenario in which the disgorgement of profits may be used as an efficient and adequate remedy in case of a breach of a sales contract is when one of the parties breaches an obligation other than the primary obligations, namely the delivery of the goods and the payment of the purchase price. such a breach usually (but not necessarily) occurs when one of the parties breaches a negative provision of the contract, such as the obligation not to resell the goods within a certain time limit or, in certain areas, the obligation not to violate fair-trade standards or the obligation not to employ children during the production process, etc. as mentioned before, some authors refer to them as “agency problem cases” because they almost always include problems of information asymmetry and monitoring difficulties, which are inherent in the general concept of the principal–agent problem.43 correlating cases of this type with the remedy of disgorgement of profits seems more controversial than the previous category of second sales. that is because the preventive character of the disgorgement of profits makes its presence more strongly felt, and these cases bring into mind what common law lawyers refer to as “restitution for wrongs,”44 which is based on the idea that no one shall be permitted to profit from their wrongdoing.45 more clearly, it invites notions of prevention and punishment. the obvious commonality between this line of cases and the previous category of second sales is the difficulty in calculating and proving the loss. if the seller breaches the negative contractual stipulation of non-compete and sells the goods to someone else, could the buyer claim the disgorgement of the profits the seller made through the sale? if the seller violates a contractual clause foreseeing that the seller has to comply with certain fair-trade rules or a prohibition regarding the 43 barnett (n 17), 118. 44 rickett (n 12) 376. for a similar expression, see smith (n 6) 121 ff. 45 john d. mccamus, ‘disgorgement for breach of contract: a comparative perspective’ (2003) 36 loyola of los angeles law review 943, 945; edelman (n 12), 81. see also cisg-ac opinion no. 6 (n 25) para 2.4: “furthermore, from a policy perspective, the breaching party should not be able to escape liability because the breaching party’s wrongful act caused the difficulty in proving damages with absolute certainty.” even posner, who is one of the pioneers of the efficient breach doctrine, has stated that an exception should be made for opportunistic breaches of contract and disgorgement of profits shall be allowed in these cases. see richard a. posner, economic analysis of law (5th edn, aspen law & business 1998), 130–1. availability of disgorgement 30 employment of children, could the buyer strip the seller of any gains that are equal to the savings the seller made as a result of this breach? allow us to make a circular argument and start the reasoning from the result. assuming that the parties have not agreed on a penalty or liquidated damages clause in their contract, if the aggrieved party fails to prove or fully calculate the loss that they have suffered following the breach of such a contractual stipulation, unless the judge or arbitrator allows the disgorgement of profits the breaching party has made, the violated contractual clause has no economic value and is no different from a mere compilation of words with no legal force. the contractual stipulation only has an economic value if the aggrieved party is substantially compensated one way or another. in other words, the remedy of disgorgement of profits in these cases seems in line with the hypothetical intention and agreement of the parties, which admittedly lends some weight to the implied contractual clause argument.46 the parties to an international sales contract are by definition merchants.47 that means that if the parties have agreed on a contractual clause providing for a non-compete deal or prohibiting the use of child workers, for example, this should be considered as reflected in the contract price.48 it follows that the buyer or the seller, upon agreeing to a contractual stipulation related to an issue other than the delivery of the goods and the payment of the price for the goods, has paid an extra premium. the presumed existence of this premium indicates that the parties also wished for this obligation to be performed or, in the case of non-performance, for an adequate remedy to be granted. the parties are in principle free to contract a penalty clause or liquidated damages, but even if they fail to do so, this shall not mean that they have waived any pecuniary outcome for the breach.49 therefore, the remedy of disgorgement of profits seems perfectly in line with the hypothetical intention of the parties, which begs the question: is it in line with the general principles of the convention? it would not be wrong to say that the question of the availability of disgorgement of profits is only one part of the wider problem of the 46 see, e.g., richard o’dair, ‘restitutionary damages for breach of contract and the theory of efficient breach: some reflections’ (1993) 46 current legal problems 113, 122 ff. 47 article 2/1(a) of the cisg excludes consumer sales. 48 see schmidt-ahrendts (n 1), 101. 49 see also hofmann (n 37), 503–4. njcl 2020/2 31 applicability of what is referred to as the performance principle.50 the developing recognition of the enforcement of performance interests has also given rise to the broader availability of the disgorgement remedy, especially in common law countries.51 unlike the economic benefits principle, the performance interest principle takes into account what the creditor could have reasonably expected from the performance of the contract.52 the traces of this principle can be easily found in various articles of the convention, such as art. 46, which provides for a claim for repair or replacement in case of defective performance. this indicates that the convention does not simply reduce the contractual claims to pecuniary loss but adopts a wider approach that lends support to the performance interests of the aggrieved parties. this deduction is also closely related to the preferred philosophical approach to the concept of a contract in a given system. if a system looks at contracts from the perspective of holmes,53 which assumes that a contract gives the breaching party an option between performing or paying damages, it would be difficult to argue that the remedy of disgorgement of profits has a leg to stand on in this system — at least not as a remedy for a breach of contract simpliciter.54 however, if a system adds a moral element to the contract or makes the safeguarding of the contract one of its principal objectives, either to increase trust in the system or to reduce transaction costs and overall economic waste, then the disgorgement of profits may have a place in the given system. this principle, also known as pacta sunt servanda (which is one of the general 50 see brian coote, ‘contract damages, ruxley, and the performance interest’ (1997) 56 the cambridge law journal 537, 541; schwenzer and hachem (n 5), 93 ff; ingeborg scwenzer, pascal hachem and christopher kee, global sales and contract law (oup 2012), paras 44.22 ff. for a critical approach to the relationship between the performance principle and gain-based awards, see rowan (n 41), 160 ff. 51 sage (n 31), 244. 52 see also schwenzer, hachem and kee (n 50) paras 44.27 ff. the fact that the damages for a breach of contract under the cisg are based on the expectation interest principle supports this view. see rostila (n 6), 3. 53 oliver wendell holmes, ‘the path of the law’ (1897) 10 harvard law review 457, 462: “the duty to keep a contract at common law means a prediction that you must pay damages if you do not keep it,and nothing else.” 54 our anaylsis in this article is limited to cases of breach of a sales contract, thus a contract simpliciter. this is important because it essentially takes the morality argument out of the equation, unlike the breach of a fiduciary relationship. even though the concept of an opportunistic or cynical breach can also appear in sales contract cases, making a distinction between different types of breaches seems in line with neither the principles of the convention nor the practicability requirements. see also mccamus (n 45), 961. availability of disgorgement 32 principles of the convention),55 necessitates the refusal of the first view that oversimplifies the contract as an option between performance or compensation and provides for at least a prima facie approval of the disgorgement of profits as a remedy available under the cisg.56 as noted earlier, in case of a second sale of unique or nonsubstitutable goods, the disgorgement of the profits made through the breach does not in itself contradict the damages-only perspective (in other words, the economic benefit principle). however, the issue becomes more complicated in case of a breach of a contractual stipulation other than the delivery of goods or the payment of the price because determining the economic benefit tied to the specific contractual clause can be difficult unless the parties have agreed on a penalty clause or liquidated damages. schwenzer and hachem argue that almost every contractual clause has a determinable market value.57 according to them, if the seller breaches a contractual stipulation, such as the prohibition of employing children, the loss suffered can be easily determined, as there is also a market for goods sold by the sellers who employ children. this may seem correct at first sight; however, it begs the question of how such market value is to be proven. it is one thing to accept that the buyer has a performance interest that should be safeguarded, and the disgorgement of the profits made by the breaching party assures this; it is another thing to look for the market price of the goods produced or sold under the circumstances that were meant to be avoided in the contract. the value allocated to contractual stipulations of this kind does not always constitute a competitive element; hence, it is not always calculable. more clearly, the existence of an assumed premium paid by the parties does not always mean that this premium is quantifiable or equal to any similar commercial transaction. we believe that the difficulty and sometimes impossibility of determining the market value of the breach is the main reason why the disgorgement of profits should be considered the most suitable remedy in this category of cases. however, the difference between this line of thought and the one put forth for the first category of cases should be underlined. this theoretical distinction is further elaborated below. 55 ulrich magnus, ‘die allgemeinen grundsätze im un-kaufrecht’ (1995) 59 rabels zeitschrift für ausländisches und internationales privatrecht 469, 480. 56 see schmidt-ahrendts (n 1), 93. 57 schwenzer and hachem (n 5), 96. njcl 2020/2 33 5. disgorgement of profits as a way of calculating loss or as a remedy on its own the disgorgement of profits as the odd one out is a direct result of the fact that the concept of disgorgement is insufficiently understood by the courts, lawyers, and scholars.58 there is no general consensus on when it can or should be awarded and under what conditions. in this part, we try to clarify that there are two possible (and not mutually exclusive) ways of understanding and adapting the disgorgement of profits under the convention. before moving forward with these explications, it should be underlined that the inadequacies of compensatory damages represent the point of origin for both. in other words, as weinrib has correctly stated, the disgorgement of profits cannot be considered in isolation from the goals and the possible ineffectiveness or insufficiency of the remedy of damages.59 as mentioned above, the discussion of the compatibility of the disgorgement of profits with the cisg may follow two possible paths. the first possibility is to accept that the availability of the disgorgement of profits can be deduced from an in-depth and accurate interpretation of the convention’s articles in light of art. 7(1).60 to be more precise, this part of the discussion is concerned with the fitness of the disgorgement of profits in one of its articles, which in our case is art. 74 on damages.61 the question is, therefore, whether the wording and the ratio legis of art. 74 permit the judge or arbitrator to award the disgorgement of profits made by the breaching party. we have concluded that such an interpretation of art. 74 is possible; however, it should be restricted to exceptional cases.62 the most typical example of this set of cases is when the seller sells the promised goods to a third-party buyer, often at a higher price than in the first contract. in this type of case, the loss suffered by the aggrieved party is generally calculable, either through the price of a cover transaction (which is also referred to as the concrete method)63 or the market price 58 on the same view for common law systems, see sage (n 31), 245. 59 weinrib (n 18), 55. 60 see e.g. schmidt-ahrendts (n 1), 92. 61 see muñoz and ament-guemez (n 14), 205 ff. 62 muñoz and ament-guemez (n 14), 205–6. 63 see article 75 of the cisg. on the issue of whether the price difference between the first contract and the cover transaction could be claimed even if the contract were not avoided, see peter schlechtriem and petra butler, un law on international sales (springer 2009), 216 ff. availability of disgorgement 34 (the abstract method).64 if a convincing calculation through one of those methods is possible, then there is no need to discuss whether the profits made through the breach can be taken as a starting point for the quantification of loss. this would only be relevant if the loss were incalculable without taking the second sale price into account. as mentioned above, in an economic world where almost every type of good that can be the subject of an international sales contract has a determinable price, only the second sales of unique or non-substitutable goods would be relevant for assessing the applicability of the disgorgement of profits. even though the observance of good faith in international trade is one of the main objectives of the convention, it does not follow that it aims to deter every kind of breach of contract. in other words, if the buyer is put in the same economic position as they would have been had the breach not occurred, despite the undercompensation risk that is embedded in the remedy of damages,65 the wording and the rationale of art. 74 require damages to be the primary and default remedy. however, when it comes to goods that cannot be the subject of a cover transaction or those without a market price (in other words, in those cases where the aforementioned common methods of calculation of loss fail to function), the interpretation of art. 74 in light of art. 7(1) of the convention, which requires that good faith in international trade shall be observed, permits us to conclude that the profits made by the breaching party can also be taken into account as a subsidiary procedure. on the other hand, the same justification cannot always be easily made for the second category of cases, where one of the parties breaches a contractual stipulation related to an issue other than the delivery of goods or the payment of the price. that is because the loss suffered by the aggrieved party may not always be determinable unless they have agreed on a specific sum for the breach. needless to say, every case has to be assessed on its own and with regard to the specific circumstances. for instance, even though the disgorgement of profits and the damages remedy under art. 74 seem reconcilable in case of the violation of a noncompete clause, the same is not true for the violation of a clause against the employment of children. that is why, in this line of cases, the disgorgement of profits shall be considered a remedy on its own or as a subsidiary remedy separate from the remedy of compensatory damages. 64 see art. 76 of the cisg. 65 bock (n 20), 115 ff.; steve thel and peter siegelman, ‘you do have to keep promises: a disgorgement theory of contract remedies’ (2011) 52 william and mary law review 1181, 1185. njcl 2020/2 35 in the case of a breach of a non-compete clause, the same argument that is usually made for the second sale of unique goods can be convincing, which is that if the seller sold it to a third-party buyer at a higher price, the buyer could have too.66 therefore, the difference between two contract prices (which is practically equal to the profits made by the seller) is equivalent to the hypothetical loss suffered by the aggrieved buyer. similar reasoning can be applied to the breach of a non-compete clause. however, for the breach of a non-compete clause, the aggrieved party could have sold or bought the goods in the relevant market or during the relevant period at the price of the contract with the third party. hence, the profits made through the breach may be considered equal to the loss suffered by the contracting party. more clearly, the broad interpretation of art. 74, which permits the profits made by the breaching party to serve as a starting point for the calculation of loss, is again applicable in this line of cases.67 however, as smith puts it, “so long as we remain convinced that the compensation is the only response available for breach of contract, intractable problems arise.”68 since the cisg is only concerned with international sales contracts, the number of these intractable problems is naturally lower than in the general contract law, but they exist nonetheless. if the rules of compensation fail to address this type of problem, then the solution must be sought elsewhere. our view is that the disgorgement of remedies, as a remedy on its own, can be awarded under the cisg without having recourse to national laws. in other words, the non-regulation of the disgorgement of profits under the cisg indicates that there is an internal gap within the convention and this gap should be filled in accordance with the general principles on which the convention is based, in accordance with art. 7(2). various underlying reasons for allowing the disgorgement of profits may be identified. one of the cornerstones of this remedy is the fairness and equitable concerns that it satisfies.69 the laissez-faire approach is shared by the convention only to the extent that the aggrieved party is provided with an adequate remedy. in other words, in cases where the damages or other legal remedies fail to safeguard a reasonable balance between the parties, the disgorgement of profits may step in as a subsidiary remedy in order to reinstate the disturbed contractual balance. one can think of at least three arguments in favor of this standpoint. 66 see schmidt-ahrendts (n 1), 98–9; stucki (n 11), 83. 67 ingborg schwenzer, ‘artikel 74’, in peter schlechtriem, ingeborg schwenzer and ulrich schröter (eds), kommentar zum un-kaufrecht (7th edn, ch beck 2019), para 43. 68 smith (n 6) 125. 69 bock (n 20), 100; hofmann (n 37), 484. availability of disgorgement 36 first of all, claiming otherwise would easily cloud the uniform application goal of the convention. the cisg is currently applied to international sales contracts concluded between buyers and sellers located in 93 countries.70 this constitutes a significant segment of the globe, and the number of contracting states continues to rise. it follows that the disputes arising from the convention can be brought before the courts of 93 jurisdictions in addition to the arbitral tribunals. therefore, the uniform application of the convention (which is also expressly mentioned in art. 7(1)) is imperative for the convention to serve its purpose and remain functional.71 in other words, claiming that there is an external gap in the cisg that should be filled in accordance with national law rules should be considered the very last resort.72 if an alternative solution can be found within the limits of the convention, this should be the principal path to take. claiming that the disgorgement of profits cannot be found within the set of rules of the convention would undermine its comprehensive character. therefore, considering the issue of disgorgement of profits as a question governed by (but not expressly settled by) the convention would be in line with the goal of promotion of uniformity. furthermore, allowing the breaching party to gain from the breach to the detriment of the aggrieved party and leaving the latter worse off would also be against the spirit of the convention. it would not be wrong to state that the cisg is based on the idea of finding an effective and fine balance between parties’ interests. for instance, while art. 46 gives the buyer the right to require performance, art. 48 gives the seller the right to a cure. while art. 49 gives the buyer the right to avoid the contract, it also restricts it crucially through the doctrines of fundamental breach and nachfrist. an overall evaluation of the rights and remedies regulated under the convention shows that it tries to walk a thin line between the interests of both the seller and the buyer. if the disgorgement of profits is not allowed, and in cases where the ordinary compensation mechanism fails to function (either because the loss is incalculable or unprovable), that would mean that the breaching party is allowed to keep all the gains made through the breach and the aggrieved party has to be consoled with merely non-pecuniary remedies (e.g., avoidance of the contract). 70 https://uncitral.un.org/en/texts/salegoods/conventions/sale_of_goods/cisg/status 71 schmidt-ahrendts (n 1), 95. 72 see also felix hartmann, ‘ersatzherausgabe und gewinnhaftung beim internationalen warenkauf: zugleich ein beitrag zum einfluss des un-kaufrechts auf die entwicklung eines ku ̈nftigen europa ̈ischen vertragsrechts’ (2009) internationales handelsrecht 189, 190. njcl 2020/2 37 last but not least, allowing the disgorgement of profits may also manifest as a matter of justice.73 the remedy of disgorgement of profits is based on the idea that the breaching party shall not benefit from their own wrongdoing.74 corrective justice considerations, which also form the basis for the remedy of damages,75 may make it necessary to disgorge the breaching party of the profits in certain cases. as is well known, the main logic of corrective justice dictates that a given remedy should aim to undo the breach and correct it in a preferred way, usually in terms of monetary compensation in contract law.76 to be deemed fair from the corrective justice perspective, the damages must also “be the measure of the wrong,” which is broadly the breach of contract.77 therefore, if the injustice stemming from the breach of contract cannot be sufficiently remedied through the award of damages (as in the aforementioned examples), then another remedial form representing the rights and interests of the aggrieved party shall come into play. in other words, in cases where the compensatory damages fail to remedy the breach, it makes sense from the perspective of corrective justice to allow the disgorgement of profits as a subsidiary remedy in order to correct the disturbed contractual balance. as edelman has said, “to do otherwise would be to legitimate the wrong.”78 one might think that allocating a preventive and corrective role to the contractual remedies would make sense only in a system that takes the presence and the degree of the breaching party’s fault into account.79 therefore, the preventive purpose may never stand under the convention since it adapts a strict liability approach and, in principle, rejects the assessment of fault. however, when further consideration is given to this deduction, the opposite conclusion seems also possible. even though the convention’s remedial system is not based on the fault element, there are some breaches of contract that are by their very nature linked to wrongful behavior. the breach of a negative covenant would be a prime example of this. how can the debtor violate a contractual stipulation where they promise not to do something without any fault? it requires a high level of imagination to think of such a breach. therefore, we believe that the 73 siems (n 2), 49. 74 weinrib (n 18), 73. 75 rostila (n 6), 29. 76 see weinrib (n 18), 59–60. see also rostila (n 6), 27. 77 weinrib (n 18), 75. 78 edelman (n 12), 81. see also hofmann (n 37), 491–3. 79 schwenzer, hachem and kee (n 50), para 44.09. on this discussion, see also rostila (n 6), 14. availability of disgorgement 38 absence of the fault requirement in the cisg’s remedial system cannot be perceived as an argument against the allocation of preventive objectives to the damages remedy and the allowance of the disgorgement of profits in certain cases. on a final note, the existing literature has argued that art. 84(2) of the cisg may be applied per analogiam in order to support the disgorgement claims. 80 art. 81(2) stipulates that in case of avoidance of contract, both parties are required to restitute what they have obtained from the other, and art. 84 regulates how this restitution will take place. if the object of the restitution is money, then the seller must pay interest. if the object of the restitution is the delivered goods, then the buyer must return these goods. in the latter scenario, if the buyer has profited from the goods that they are obliged to return, then these profits must also be restituted. according to some authors, the obligation to account for all the benefits derived from these goods may be considered an analogical basis for allowing the disgorgement of profits.81 however, we do not share this view. the ratio legis of art. 84 and the remedy of disgorgement of profits diverge. the disgorgement of profits is related to the profits made in relation to the breach, whereas a link between the breach and the profits is not necessary according to art. 84(2), which provides for the return of the profits (e.g., the legal and natural fruits) with the goods. the position of the buyer — or more clearly, whether the avoidance was caused by the breach committed by the buyer or the seller — also has no bearing on the application of art. 84(2).82 80 see, e.g., hartmann (n 72), 191 ff; eicher (n 14), 33 ff. 81 hartmann (n 72), 191 ff; eicher (n 14), 33 ff. art. 84(2) stipulates that “(2) the buyer must account to the seller for all benefits which he has derived from the goods or part of them: (a) if he must make restitution of the goods or part of them; or (b) if it is impossible for him to make restitution of all or part of the goods or to make restitution of all or part of the goods substantially in the condition in which he received them, but he has nevertheless declared the contract avoided or required the seller to deliver substitute goods.” 82 christiana fountoulakis, ‘artikel 84’, in peter schlechtriem, ingeborg schwenzer and ulrich schröter (eds), kommentar zum un-kaufrecht (7th edn, ch beck 2019), para 22. opinion 20 in template cisg advisory council* opinion 20 hardship under the cisg * michael bridge, chair yesim atamer, eric bergsten, joachim bonell, sieg eiselen lauro gama, alejandro garro, roy goode, john gotanda, han shiyuan, johnny herre, pilar perales viscasillas, ingeborg schwenzer, hiroo sono, claude witz, members. milena djordjević, secretary. 1. opinion ................................................................................................... 5 2. comments .............................................................................................. 6 introduction ....................................................................................... 6 2.1. the following rules on hardship apply, unless the contract otherwise provides .......................................... 11 2.1.1. hardship risk allocation: ....................................... 12 relevant threshold: ........................................................... 12 agreed remedies: ................................................................... 13 2.2. the cisg governs cases of hardship ............................. 15 2.3. a party is bound to fulfil its obligations even if performance has become more onerous, unless there is hardship ................................................................................ 17 2.4. there is hardship when a change of circumstances beyond the control of a party makes performance excessively onerous, if that party could not reasonably be expected to have taken the change into account or to have avoided or overcome it or its consequences ................................................................... 17 hardship as an impediment beyond control: ............. 18 hardship as an unforeseeable event: ........................... 19 hardship as an event that cannot be avoided or overcome: ...................................................................... 20 2.5. such hardship may arise when the cost of performance has increased or the value of the performance has diminished ............................................. 20 2.6. such hardship may also arise from events occurring before the conclusion of the contract if the parties did not know and could not have been aware of these events ............................................................................ 20 2.7. in assessing whether hardship exists the following nonexclusive factors should be taken into account ............................................................................................ 23 whether the risk of a change of circumstances was assumed by either party: ..................................................... 25 whether the contract is of a speculative nature: ............ 25 whether and to what extent there have been previous market fluctuations: .......................................................... 26 the duration of the contract: .................................................. 27 whether the seller has obtained the goods from its own supplier: ..................................................................................... 27 whether either party has hedged against market changes: .................................................................................... 28 2.8. the party affected by hardship must give notice to the other party of the circumstances and its effect on its ability to perform. if the notice is not received by the other party within a reasonable time after the party affected knew or ought to have known of the hardship situation, it is liable for damages resulting from such non-receipt ................. 28 2.9. in case of hardship, nothing prevents either party from exercising any right other than to claim damages and require performance of the obligation affected by hardship ........................................................... 29 2.9.1. exemption from liability in damages: ................ 30 specific performance excluded: ..................................... 31 suspension of performance: .............................................. 32 price reduction: .................................................................... 33 avoidance by a party’s declaration: ............................ 33 right to claim interest: ..................................................... 34 2.10. the exemption due to hardship has effect for the period during which hardship exists. ............................ 34 2.11. under the cisg, the parties have no duty to renegotiate the contract in case of hardship. ....... 34 2.12. under the cisg, a court or arbitral tribunal may not adapt the contract in case of hardship .............. 38 2.13. under the cisg, a court or arbitral tribunal may not bring the contract to an end in case of hardship. ............................................................................................ 42 njcl 2021/1 4 introduction of the cisg-ac the cisg-ac started as a private initiative supported by the institute of international commercial law at pace university school of law and the centre for commercial law studies, queen mary, university of london. the international sales convention advisory council (cisgac) is in place to support understanding of the united nations convention on contracts for the international sale of goods (cisg) and the promotion and assistance in the uniform interpretation of the cisg. at its formative meeting in paris in june 2001, prof. peter schlechtriem of freiburg university, germany, was elected chair of the cisg-ac for a three-year term. dr. loukas a. mistelis of the centre for commercial law studies, queen mary, university of london, was elected secretary. the founding members of the cisg-ac were prof. emeritus eric e. bergsten, pace university school of law; prof. michael joachim bonell, university of rome la sapienza; prof. e. allan farnsworth, columbia university school of law; prof. alejandro m. garro, columbia university school of law; prof. sir roy m. goode, oxford, prof. sergei n. lebedev, maritime arbitration commission of the chamber of commerce and industry of the russian federation; prof. jan ramberg, university of stockholm, faculty of law; prof. peter schlechtriem, freiburg university; prof. hiroo sono, faculty of law, hokkaido university; prof. claude witz, universität des saarlandes and strasbourg university. members of the council are elected by the council. at subsequent meetings, the cisgac elected as additional members prof. pilar perales viscasillas, universidad carlos iii, madrid; professor ingeborg schwenzer, university of basel; prof. john y gotanda, villanova university; prof. michael g. bridge, london school of economics; prof. han shiyuan, tsinghua university, prof. yesim atamer, istanbul bilgi university, turkey, and prof. ulrich schroeter, university of mannheim. prof. jan ramberg served for a three-year term as the second chair of the cisgac. at its 11th meeting in wuhan, people’s republic of china, prof. eric e. bergsten of pace university school of law was elected chair of the cisgac and prof. sieg eiselen of the department of private law of the university of south africa was elected secretary. at its 14th meeting in belgrade, serbia, prof. ingeborg schwenzer of the university of basel was elected chair of the cisgac. 5 cisg-ac opinion 20 1. opinion article 79 cisg (1) a party is not liable for a failure to perform any of his obligations if he proves that the failure was due to an impediment beyond his control and that he could not reasonably be expected to have taken the impediment into account at the time of the conclusion of the contract or to have avoided or overcome it or its consequences. (2) if the party's failure is due to the failure by a third person whom he has engaged to perform the whole or a part of the contract, that party is exempt from liability only if: (a) he is exempt under the preceding paragraph; and (b) the person whom he has so engaged would be so exempt if the provisions of that paragraph were applied to him. (3) the exemption provided by this article has effect for the period during which the impediment exists. (4) the party who fails to perform must give notice to the other party of the impediment and its effect on his ability to perform. if the notice is not received by the other party within a reasonable time after the party who fails to perform knew or ought to have known of the impediment, he is liable for damages resulting from such non-receipt. (5) nothing in this article prevents either party from exercising any right other than to claim damages under this convention. 1.the following rules on hardship apply, unless the contract otherwise provides. 2.the cisg governs cases of hardship. 3.a party is bound to fulfil its obligations even if performance has become more onerous, unless there is hardship. 4.there is hardship when a change of circumstances beyond the control of a party makes performance excessively onerous, if that party could not reasonably be expected to have taken the change into account or to have avoided or overcome it or its consequences. 5.such hardship may arise when the cost of performance has increased or the value of the performance has diminished. 6.such hardship may also arise from events occurring before the conclusion of the contract if the parties did not know and could not have been aware of these events. 7. in assessing whether hardship exists the following nonexclusive factors should be taken into account: a) whether the risk of a change of circumstances was assumed by either party; b) whether the contract is of a speculative nature; c) whether and to what extent there have been previous market fluctuations; d) the duration of the contract; e) whether the seller has obtained the goods from its own supplier; f) whether either party has hedged against market changes. 8. the party affected by hardship must give notice to the other party of the circumstances and its effect on its ability to perform. if the notice is njcl 2021/1 6 not received by the other party within a reasonable time after the party affected knew or ought to have known of the hardship situation, it is liable for damages resulting from such non-receipt. 9. in case of hardship, nothing prevents either party from exercising any right other than to claim damages and require performance of the obligation affected by hardship. 10. the exemption due to hardship has effect for the period during which hardship exists. 11. under the cisg, the parties have no duty to renegotiate the contract in case of hardship. 12. under the cisg, a court or arbitral tribunal may not adapt the contract in case of hardship. 13. under the cisg, a court or arbitral tribunal may not bring the contract to an end in case of hardship. 2. comments introduction 0.1 unexpected changes of circumstances may constitute one of the major problems parties face in international trade, especially for those in long term or complex contracts. trade at a global scale has augmented the likelihood for greater imponderables given the involvement of multiple actors from different countries in production and procurement of goods linked to various contracts. changes in political and economic policies, social unrest and natural phenomena are among the events that could considerably affect the very basis of the bargain between contracting parties. there may be a global or regional pandemic, an earthquake, a flood, a terrorist attack, a sudden increase on import tariffs in one of the production countries, forcing the producer to resort to countries with much higher production costs; import or export bans may hinder the envisaged flow of goods; or price fluctuations that were not foreseeable at the time of the conclusion of the contract may make the performance by the seller unduly burdensome or may devaluate the contract performance for the buyer. 0.2 in all legal systems, the principle pacta sunt servanda or sanctity of contract places the burden of such changes in the original contracting conditions upon the obligor. however, since the classic roman law, the concurrent principle of impossibilium nulla est obligatio, or there is no obligation to perform impossible things,1 has constituted a valid exemption to perform. furthermore, under the canon law doctrine of rebus 1 the digest 50.17.185 also cited in james gordley, 'impossibility and changed and unforeseen circumstances', the american journal of comparative law, 52/3 (2004), 513-30 at 514. 7 cisg-ac opinion 20 sic stantibus, an unforeseeable and extraordinary change of circumstances rendering a contractual obligation significantly burdensome was given due consideration in determining liability.2 since early days, impossibility, force majeure or the like have become grounds for exemption in every legal system.3 however, the question whether simple changes in the surrounding economic conditions, also known as hardship, may exempt the debtor from liability for lack of performance has been a highly debated issue in various legal systems and under some international law instruments.4 0.3 today, many civil law jurisdictions accept the theory of hardship.5 the most recent acknowledgement by statute can be found in france.6 english law seems to reject any notion of relief for changed 2 konrad zweigert and hein kötz, introduction to comparative law (third edn.: oxford clarendon press, 1998).: “this doctrine may be traced through the middle ages from the glossattors right up to grotius and pufendorf; it was accepted in the codex maximilianeus bavaricus civilis of 1756 and then in the prussian general land law of 1764”. see also dubravka klasiček and marija ivatin, 'modification or dissolution of contracts due to changed circumstances', izmjena i raskid ugovora zbog promijenjenih okolnosti., 34/2 (2018), 27-55 at 29. 3 germany § 275 cc; italy art. 1256 cc; france: art. 1218 cc; united states § 265 restatement (2d) of contracts (restatement), § 2-615 uniform commercial code (ucc). for similar rules in other legal systems see, schwenzer, hachem, and kee, global sales and contract law at 651 et seq. 4 zweigert and kötz, introduction to comparative law at 520-22. the actual trigger for this discussion was the enormous rise in prices due to world war i (1914-1918), see hannes rösler, 'hardship in german codified private law: in comparative perspective to english, french and international contract law ', european review of private law 15 (2007) at 491. 5 argentina art. 1091 cc; armenia art. 467 cc; austria §§ 936, 1052, 1170 bgb a through analogy; azerbaijan art. 422 cc, bolivia art. 581(1)(4) cc; brazil art. 478, 479 cc; china art. 26 prc contract law interpretation (2) and art. 227-2 cc; colombia art. 868 com c; croatia art. 369 civil obligations act; egypt: art. 147(2) cc; france art. 1195 cc; germany § 313 bgb; greece art. 388 cc; italy art. 1467 cc, iraq art. 146(2) cc; kuwait art. 198 cc; libya art. 147 cc; lithuania art. 6.204 cc; montenegro art. 128 law on obligations; paraguay: art. 672 cc; portugal art. 437 cc; qatar art. 171 (2) cc; russia art. 451 cc; slovenia art. 112 obligations code; syria: art. 148(2) cc; taiwan art. 227-2 cc; the netherlands art. 6:258 cc (bw); ukraine art. 652 cc. see also schwenzer, hachem, and kee, global sales and contract law at 666. 6 article 1195 of the new french civil code (2016) for the first time allows a private law contract to be modified in case of a change of circumstances. before, french law was not favourable to the concept of hardship; the theory of imprévision applied to administrative contracts only. see francois chénedé, le nouveau droit des obligations et des contrats: consolidations innovations perspective (france: dalloz, 2016) at 142, para. 25.51; alain bénabent, droit des obligations (16 edn., précis domat droit privé; france: lgdj, 2017) at 253, para. 309. njcl 2021/1 8 circumstances that do not amount to impossibility.7 however, an exception may be granted to this general rule under the doctrine of “frustration of contract” if the performance of the contract is rendered useless by the change of circumstances.8 in the united states a party may be exempted if as a result of supervening events, performance of the contract, though remaining physically possible, has become severely more burdensome for that party.9 0.4 at the international level, the 2016 unidroit principles on international commercial contracts (unidroit picc),10 as well as other uniform soft law projects such as the 1999 principles on european contract law (pecl),11 the 2008 draft of a common frame of reference (dcfr),12 and the principles of latin american contract law (placl),13 expressly provide for exemption of liability in case of a substantial change of circumstances. in 1985, 2003 and 2020, the international chamber of commerce (icc) published model clauses on hardship.14 7 h. g. beale and joseph chitty, chitty on contracts (london: sweet & maxwell, 2010) at paras. 23-061; schwenzer, hachem, and kee, global sales and contract law at 652, para. 45.13. 8 schwenzer, hachem, and kee, global sales and contract law at 652, para. 45.13; christoph brunner, force majeure and hardship under general contract principles: exemption for non-performance in international arbitration (international arbitration law library, 18; the hague: kluwer law international, 2008) at 410. 9 united states § 2-615 ucc. the restatement second, contracts 2d, reiterates this position: see american law institute restatement on the law of contracts (2ed, american law institute publishers, st paul, minnesota, 1981) § 261; the seminal case on this rule is transatlantic financing corporation, appellant, v. united states of america, appellee, 363 f.2d 312 (d.c. cir. 1966) cited in alissa palumbo, modern law of sales in the united states, ed. ingeborg schwenzer (international commerce and arbitration, 17; the hague: eleven international publishing, 2015) at 165, 66; also see larry dimatteo, international contracting: law and practice (third edition edn; the netherlands: wolters kluwer, 2013) at 264, para. 7.23. 10 see international institute for the unification of private law, principles of international commercial contracts, 2016 (unidroit picc) article 6.2.3. 11 see commission on european contract law, principles of european contract law (pecl) article 6:111, comment note 1, 328. 12 see study group on a european civil code, draft common frame of reference (dcfr) article iii – 1:110. 13 see the principles of latin american contract law 2018 (placl), article 84, available at rodrigo momberg and stefan vogenauer, 'the principles of latin american contract law: text, translation, and introduction', uniform law review/revue de droit uniforme, 23/1 (2018). 14 icc, force majeure and hardship, paris 1985 (icc publ no. 421); icc force majeure clause 2003 and icc hardship clause 2003, developed by the icc commission on commercial law and practice, draftsman-in-chief: charles debattista, icc publication no. 650, icc publishing, 2003 (icc force majeure and hardship clause 2003); icc 9 cisg-ac opinion 20 0.5 the 1980 un convention on the international sale of goods (cisg), however, does not contain a specific provision dealing with questions of hardship. article 79 cisg relieves a party from paying damages only if the breach of contract was due to an impediment beyond its control. 0.6 this opinion supports the application of article 79 cisg to govern situations of economic impediments also known as hardship. for the sake of good order, economic impediment and hardship will be used as synonyms in this opinion and refer to change of circumstances that fundamentally alter the equilibrium of the contract, in making performance by one party significantly more onerous or in decreasing its value considerably. 0.7 this opinion reviewed different state court decisions and arbitral awards where the application of the cisg to hardship scenarios has been considered up to this date.15 in one case, it was considered that article 79 cisg did not govern hardship situations and applied, instead, domestic law.16 in the remaining cases, the judge or arbitrator decided that hardship was a type of impediment governed by article 79 cisg. only in one case, did a court find that the requirements in article 79 cisg were met and ordered that the parties should renegotiate the contract.17 annex 1 provides a summary of the above case law, focusing on the threshold leading to an economic impediment and the remedies available under the cisg according to courts and arbitral tribunals. force majeure and hardship clauses march 2020, available at https://iccwbo.org/content/uploads/sites/3/2020/03/icc-forcemajeure-hardshipclauses-march2020.pdf 15 these cases were gathered from the internet, using the traditional research engines, such as google, yahoo.com, etc. and from the most known cisg case law webpages, such as cisg-online, pace cisg database, unilex and uncitral clout: tribunale civile di monza, 14 january1993, cisg-online case no. 540; hof van cassatie, 19 june 2009, cisg-online case no. 1963; france cass civ 1ère, 30 june 2004, cisg– online case no. 870 (goods involved: cases made from polyurethane foam); rechtbank van koophandel, tongeren, 25 january 2005, no 1960, cisg-online case no. 1106 (goods involved: steel); bulgarian chamber of commerce and industry, 12 february 1998, cisg-online case no. 436 (goods involved: steel rope); separate award, scc arbitration no. v2014/078/080, 31 may 2017, cisg-online case no.4683, paras. 25942597 (as an argument of the respondent [gazprom] that the arbitral tribunal neither addressed nor contradicted); rechtbank van koophandel, hasselt, 2 may 1995, cisgonline case no. 371; cour d'appel de colmar, 12 june 2001, cisg-online case no. 694; oberlandesgericht hamburg, 28 february 1997, no 167, cisg-online case no. 261: cietac, 2 may 1996, cisg–online case no. 1067 (based on frustration). 16 tribunale civile di monza, 14 january1993, cisg-online case no. 540. 17 hof van cassatie, 19 june 2009, cisg-online case no. 1963. njcl 2021/1 10 0.8 this opinion also considered a good number of seminal works from scholars dealing with the issue of hardship under the cisg. most scholars agree that hardship is a type of impediment governed by article 79 cisg.18 there are, nevertheless, a few differences of opinion regarding the threshold of economic impediments under article 79 cisg and the remedies resulting from the convention. annex 2 summarizes this scholarship and provides for relevant excerpts of the authors’ individual views. 0.9 this opinion also makes reference to provisions in other uniform law projects –the unidroit picc, the pecl, the dcfr and the placl– and several domestic law provisions dealing with hardship or similar impediments from a comparative law perspective. annex 3 analyzes these international soft law and domestic law provisions. 0.10 in light of the ongoing debate in case law and doctrine regarding the application of the cisg to hardship situations, and the wide catalogue of answers provided by comparative law, this opinion furnishes an 18 yesim m. atamer, 'article 79', in stefan kröll, loukas mistelis, and pilar perales viscasillas (eds.), un convention on contracts for the international sale of goods commetary (münchen: hart publishing, 2011) at 1088, 89 para. 79; michael g. bridge, the international sale of goods (4th fourth edn; oxford: oup, 2018) at 618, para. 12.72; brunner, force majeure and hardship under general contract principles: exemption for nonperformance in international arbitration at 213; cisg ac opinion no. 7, exemption of liability for damages under article 79 of the cisg, rapporteur: professor alejandro garro, 12 oct 2007; franco ferrari and marco torsello, international sales law cisg (in a nutshell: west academic publisher, 2014) at 326, 27; harry m. flechtner, 'the exemption provisions of the sales convention including comments on hardship doctrine and the 19 june 2009 decision of the belgian cassation court', belgrade law review, 59/3 (2011) at 93; harry m. flechtner, 'uniformity and politics: interpreting and filling gaps in the cisg', in peter mankowski and wolfgang wurmnest (ed.), festschrift für ulrich magnus. zum 70. geburtstag (sellier european law publishers 2014) at 200, 01; john o. honnold and harry m. flechtner, uniform law for international sales (the hague: kluwer law international, 2009) at 627, para. 432.2, ingeborg schwenzer, 'article 79', in ingeborg schwenzer (ed.), schlechtriem & schwenzer: commentary on the un convention on the international sale of goods (4th edn; london: oup, 2016) at 1142, para. 31; yasutoshi ishida, 'cisg article 79: exemption of performance, and adaptation of contract through interpretation of reasonableness full of sound and fury, but signifying something', pace international law review, 30/2 (2018) at 364-68; joseph lookofsky, understanding the cisg (fourth worldwide edition edn., law & business: wolters kluwer, 2012) at 150, para. 6.32; peter schlechtriem and petra butler, un law on international sales (berlin: springer, 2009) at 203, para. 91; peter schlechtriem, 'transcript of a workshop on the sales convention: leading cisg scholars discuss contract formation, validity, excuse for hardship, avoidance, nachfrist, contract interpretation, parol evidence, analogical application, and much more by harry m. flechtner', journal of law & commerce, 18 (1999) at 236, 37; schwenzer, hachem, and kee, global sales and contract law at 670, para. 45.98. 11 cisg-ac opinion 20 acceptable solution according to the needs of the international trade community for legal efficiency and certainty. this opinion provides the necessary guidelines to determine the existence of hardship under article 79 cisg. it also sets out the obligations of the parties and the remedies available in hardship situations pursuant to the convention’s objective to promote uniformity in its application and the observance of good faith in international trade.19 in particular, it clarifies that the parties have no duty to renegotiate the contract and that a court or arbitral tribunal may not adapt the contract or bring it to an end in case of hardship under the cisg. 2.1. the following rules on hardship apply, unless the contract otherwise provides 1.1 the terms of the contract should be the starting point to determine whether hardship exists and its consequences. the parties may expressly or impliedly agree upon the allocation of the risk of events leading to hardship. they may also agree upon the relevant threshold of hardship and the remedies that the aggrieved party may be entitled to. different hardship model clauses are available for this purpose,20 including the 1985, 2003 and 2020 editions of the icc hardship clause.21 this determination is done by contract interpretation pursuant to article 8 cisg. 19 a mandate of art. 7 cisg. 20 see for example, clause 16.3 (hardship) of standard model contract for international commercial sale of goods and clause 9.4 of the international long-term supply of goods, by ” international trade centre (itc), model contracts for small firms: legal guidance for doing international business (geneva: itc, 2010) at 54, 55, 70, 71. available at available at http://www.intracen.org/workarea/downloadasset.aspx?id=37603; see clauses in patrick ostendorf, international sales terms (münchen: hart publishing, 2014) at 121. and ulrich magnus, 'application of boilerplate clauses under german law', in guiditta corderomoss (ed.), boilerplate clauses, international commercial contracts and applicable law (london: cambridge university press, 2011) at 206, 07. 21 icc, force majeure and hardship, paris 1985 (icc publ no. 421); icc force majeure clause 2003 and icc hardship clause 2003, developed by the icc commission on commercial law and practice, draftsman-in-chief: charles debattista, icc publication no. 650, icc publishing, 2003 (icc force majeure and hardship clause 2003); icc force majeure and hardship clauses march 2020, available at https://iccwbo.org/content/uploads/sites/3/2020/03/icc-forcemajeure-hardshipclauses-march2020.pdf njcl 2021/1 12 2.1.1.hardship risk allocation: 1.2 it is up to the parties to define their respective spheres of risk in the contract.22 one party may have expressly or impliedly assumed the risk for a fundamental change of circumstances or, on the contrary, certain risks may have been expressly or impliedly excluded.23 1.3 a hardship clause in a cisg contract may expressly exclude the possibility to rely on hardship. a similar clause may narrow down the events that may entitle a party to exemption under the same doctrine. the choice of an incoterms rule determines the point of delivery and places the risk as regards transport, export or import control, tariffs, etc. on one of the parties. despite such allocation of risks and duties, a party might demonstrate that delivery or performance of obligations under an incoterms or contract clause have been affected by an impediment that meets the requirements of article 79 cisg. 1.4 the speculative nature of long term contracts with fixed price clauses may, in some cases, be regarded as an implied acceptance of the risks of changing market conditions.24 1.5 prior practices between the parties or international usages under article 9 cisg, may integrate the contract with respect to risk allocation. relevant threshold: 1.6 whether a party is affected by hardship, i.e. when the equilibrium of the contract has been fundamentally altered, may also be agreed upon by the parties. a provision in their contract may establish the degree of increase in the costs of performance or of the decrease in the value of performance necessary for a hardship exemption. the icc hardship 22 bulgarian chamber of commerce and industry, 12 february 1998, cisg-online case no. 436; it is also believed that the risk allocation is dependent on the parties’ choice of law at the beginning: see generally gustavo moser, 'choice of law, brexit and the ‘ice cream flavour’ dilemma', kluwer arbitration blog (december 2018: wolters kluwer, 2018). see also ewan mckendrick, 'article 6.2.2', in stefan vogenauer (ed.), commentary on the unidroit principles of international commercial contracts (picc) (second edn; oxford: oup, 2015c) at 818, para. 15. a best practice analysis of force majeure and hardship contract clauses is provided in ostendorf, international sales terms at 121 et seq. 23 see brunner, force majeure and hardship under general contract principles: exemption for non-performance in international arbitration at 147, 48. avery w. katz, 'remedies for breach of contract under the cisg', international review of law and economics, 25 (2006) at 391; cisg ac opinion no. 7, exemption of liability for damages under article 79 of the cisg, rapporteur: professor alejandro garro, 12 oct 2007, comment para. 39; mckendrick, 'article 6.2.2', at 818, para. 15.: “assumption of risk need not to be express; it can be inferred from the circumstances or from the nature of the contact”. 24 brunner, force majeure and hardship under general contract principles: exemption for nonperformance in international arbitration at 439, 40. 13 cisg-ac opinion 20 clause 2020, for example, states a threshold for change in circumstances that may differ from the criterion found in domestic laws and international uniform law.25 1.7 prior practices between the parties or international usages under article 9 cisg may also fill the gaps in the contract on the question of threshold. agreed remedies: 1.8 the parties may agree upon the consequences or remedies to ensue when hardship takes place. for example, the icc hardship clause 2020 edition provides that the parties are bound to negotiate alternative contractual terms that reasonably allow to overcome the consequences of the changed circumstances within a reasonable time after the invocation of the clause.26 1.9 the parties may plan in advance some contractual or procedural mechanisms to encourage renegotiation of their obligations in case of hardship. stipulating an agreed sum in case of breach of renegotiations in good faith may encourage continuance and provide some certainty to traders.27 1.10 the parties may also agree on having the performances under a contract rebalanced by a third party in case of hardship. different hardship model clauses provide for such a possibility,28 perhaps influenced by the 25 see icc hardship clause 2020, para. (2)(a)(b) “2. notwithstanding paragraph 1 of this clause, where a party to a contract proves that: a) the continued performance of its contractual duties has become excessively onerous due to an event beyond its reasonable control which it could not reasonably have been expected to have taken into account at the time of the conclusion of the contract; and that b) it could not reasonably have avoided or overcome the event or its consequences, the parties are bound, within a reasonable time of the invocation of this clause, to negotiate alternative contractual terms which reasonably allow to overcome the consequences of the event”. 26 see icc hardship clause 2020, para. (2)(b), which was already in the icc hardship clause 2003 para. (2)(b). 27 pascal hachem, agreed sums payable upon breach of an obligations, ed. ingeborg schwenzer (international commercial law, 7; the hague: eleven international publishing, 2011) at 45. 28 see for example, clause 16.3 (hardship) of standard model contract for international commercial sale of goods and clause 9.4 of the international long-term supply of goods, by the international trade center (an agency of the world trade organization): “[option: see comment at the beginning of article [..]. add if wished; otherwise delete. (4). if the parties fail to reach agreement on the requested revision within [specify time limit if appropriate], a party may resort to the dispute resolution procedure provided in article 21. the [court/arbitral tribunal] shall have the power to make any revision to this contract that it finds just and equitable in the circumstances or to terminate this contract at a date and on terms to be fixed” (itc), njcl 2021/1 14 1985 edition of the icc hardship clause.29 long term supply contracts often contain clauses for the revision of prices combined with multi-tier dispute resolution clauses that promote preliminary talks and negotiation.30 adaptation may also be exercised by a named third party, usually an expert in the field,31 often practiced in the revision of price clauses in long term contracts. but the contract might be directly or subsidiarily adapted by a court or an arbitrator, depending on the drafting of the contract. the icc hardship clause 2003 had abandoned the remedy of revision of the contract by a third party. option 3b of the latest edition of the icc hardship clause (2020), reintroduces a similar option entitling the parties to request the adaption or termination of the contract by a judge or arbitrator.32 the judge or arbitrator may decide on these two alternatives, opting for termination in those cases where adaptation is not reasonably possible.33 1.11 option 3a of the icc hardship clause 2020 provides that, if the parties are unable to agree on alternative contract terms, the aggrieved party may terminate the contract on its initiative. under option 3c, either model contracts for small firms: legal guidance for doing international business at 54, 55, 70, 71. available at http://www.intracen.org/workarea/downloadasset.aspx?id=37603. 29 icc, force majeure and hardship, paris 1985 (icc publ no. 421): “third alternative (5). if the parties fail to agree on the revision of the contract within a time-limit of 90 days of the request, either party may bring the issue of revision before the arbitral forum, if any, provided for in the contract, or otherwise the competent courts.”, available at https://www.trans-lex.org/700650/_/iccforce-majeure-and-hardship-paris-1985-/ 30 see clauses in ostendorf, international sales terms at 121. and magnus, 'application of boilerplate clauses under german law', at 206, 07. see also clause 9.4 of the international long-term supply of goods, by the international trade center (an agency of the world trade organization): “[option: see comment at the beginning of article [..]. add if wished; otherwise delete. (4). if the parties fail to reach agreement on the requested revision within [specify time limit if appropriate], a party may resort to the dispute resolution procedure provided in article 21. the [court/arbitral tribunal] shall have the power to make any revision to this contract that it finds just and equitable in the circumstances or to terminate this contract at a date and on terms to be fixed” (itc), model contracts for small firms: legal guidance for doing international business at 54, 55, 70, 71. available at http://www.intracen.org/workarea/downloadasset.aspx?id=37603 31 the icc hardship clause 1985 stipulates, for example, that: “fourth alternative, 5. failing an agreement of the parties on the revision of the contract within a time-limit of 90 days of the request either party may refer the case to the icc standing committee for the regulation of contractual relations in order to obtain the appointment of a third person (or a board of three members) in accordance with the provisions of the rules for the regulation of contractual relations of the icc. the third person shall decide on the parties' behalf whether the conditions for revision provided in paragraph 1 are satisfied. if so he shall revise the contract on an equitable basis in order to ensure that neither party suffers excessive prejudice.” 32 icc hardship clause 2020, para. 3 option b. 33 see icc hardship clause 2020, comments under option 3. 15 cisg-ac opinion 20 party may request the judge or arbitrator to declare the termination of the contract. 2.2. the cisg governs cases of hardship 2.1 the cisg advisory council opinion no. 7 has already determined that article 79 cisg covers hardship situations.34 opinion no. 7 addresses the drafting history of article 79,35 where the question whether economic difficulties should give rise to an exemption was highly controversial.36 this background led some scholars to argue that there was no room to consider hardship under article 79 cisg,37 especially during the first years after the coming into force of the convention.38 yet, there was no clear exclusion of hardship from the events leading to exemption under article 79 cisg.39 34 cisg ac opinion no. 7, exemption of liability for damages under article 79 of the cisg, rapporteur: professor alejandro garro, 12 oct 2007, rule 3.2. comment para. 38. 35 cisg ac opinion no. 7, exemption of liability for damages under article 79 of the cisg, rapporteur: professor alejandro garro, 12 oct 2007, rule 3.1. comment paras. 29 and 30. see also brunner, force majeure and hardship under general contract principles: exemption for non-performance in international arbitration at 216; atamer, 'article 79', at 1088, para. 78. 36 see brunner, force majeure and hardship under general contract principles: exemption for non-performance in international arbitration at 216; atamer, 'article 79', at 1088, para. 78. 37 cisg ac opinion no. 7, exemption of liability for damages under article 79 of the cisg, rapporteur: professor alejandro garro, 12 oct 2007, rule 3.1. comment para. 26, citing b. nicholas, impracticability and impossibility in the u.n. convention on contracts for the international sale of goods, in international sales: the united nations convention on contracts for the international sale of goods § 5.02, at 5-4 (parker school of foreign and comparative law, columbia university, ed. nina m. galston & hans smit, 1984), available at <http://cisgw3.law.pace.edu/cisg/biblio/nicholas1.html>. 38 scholars taking this view include bernard audit, la vente internationale de marchandises. convention des nations unies du 11 avril 1980, paris, lgdj, at 174,75 cited by brunner, force majeure and hardship under general contract principles: exemption for non-performance in international arbitration at 216, fn. 1100; b. nicholas, impracticability and impossibility in the u.n. convention on contracts for the international sale of goods, in international sales: the united nations convention on contracts for the international sale of goods § 5.02, at 54 (parker school of foreign and comparative law, columbia university, ed. nina m. galston & hans smit, 1984), available at <http://cisgw3.law.pace.edu/cisg/biblio/nicholas1.html>; tallon, in bianca-bonell commentary on the international sales law, giuffrè: milan (1987), para. 3.1.2., available at: http://www.cisg.law.pace.edu/cisg/biblio/tallon-bb79.html 39 the norwegian delegation proposed that paragraph 3 of article 65 of the 1978 uncitral draft convention should be changed in the following way: “[…] nevertheless, the party who fails to perform is permanently exempted to the extent that, after the impediment is removed, the circumstances are so radically changed that it would be manifestly unreasonable to hold him liable”. see the norwegian proposal njcl 2021/1 16 2.2 today, however, it is more or less unanimously accepted in court and arbitral decisions,40 as well as in scholarly writings,41 that article 79 cisg governs hardship situations. in addition, general principles underlying the cisg, such as reasonableness and duty to cooperate (e.g., arts. 39, 46, 48 and 54 cisg) may be taken into account in the context of a situation of hardship. 2.3 accordingly, there are no legal grounds to resort to domestic concepts of hardship,42 as there is no gap in the cisg regarding the debtor’s invocation of economic impediments.43 if one were to hold otherwise, domestic concepts such as frustration of purpose, rebus sic stantibus, fundamental mistake or wegfall der geschäftsgrundlage would all (a/conf.97/c.1/l.191/rev.1) in united nations conference on contracts for the international sales of goods, vienna, 10 march-11 april 1980 (official records, new york, 1981) 381. 40 however, courts have often decided that the equilibrium of the contract was not fundamentally altered. therefore, the alleged impediment was non-existent. see bulgarian chamber of commerce and industry, 12 february 1998, cisg-online case no. 436; rechtbank van koophandel, hasselt, 2 may 1995, cisg-online case no. 371; tribunale civile di monza, 29 march 1993, cisg-online case no. 102; cour d'appel de colmar, 12 june 2001, cisg-online case no. 694; hof van cassatie, 19 june 2009, cisg-online case no. 1963 granting a right to renegotiate the contract to a seller for a 70% price increase in steel after the conclusion of the contract, separate award, scc arbitration no. v2014/078/080, 31 may 2017, cisg-online case no.4683. para.2662 (as an argument of the respondent [gazprom] that the arbitral tribunal neither contradicted nor expressly accepted). these decisions can be found by searching the case number on the cisg-online website at http://www.cisg-online.ch/ . 41 in addition to cisg ac opinion no. 7 see schwenzer, 'article 79', at 1142, para. 31; schlechtriem and butler, un law on international sales at 203, para. 91; brunner, force majeure and hardship under general contract principles: exemption for non-performance in international arbitration at 213; atamer, 'article 79', at 1088, para. 79; honnold and flechtner, uniform law for international sales at 627, para. 432.2; joseph lookofsky, understanding the cisg (fourth worldwide edition edn., law & business: wolters kluwer, 2012) at 150, para. 6.32; ishida, 'cisg article 79: exemption of performance, and adaptation of contract through interpretation of reasonableness full of sound and fury, but signifying something', at 364, 65. 42 honnold and flechtner, uniform law for international sales at 615, 27, paras. 425, 32.2; schwenzer, 'article 79', at 1142, para. 31; separate award, scc arbitration no. v2014/078/080, 31 may 2017, cisg-online case no.4683. para.2662 (as an argument of the respondent [gazprom] that the arbitral tribunal neither contradicted nor expressly accepted). 43 flechtner, 'the exemption provisions of the sales convention including comments on hardship doctrine and the 19 june 2009 decision of the belgian cassation court', at 97; taking a different view see tribunale civile di monza, 14 january1993, cisg-online case no. 540. 17 cisg-ac opinion 20 have to be considered, which would undermine unification of the law of sales in a very important area.44 2.3. a party is bound to fulfil its obligations even if performance has become more onerous, unless there is hardship 3.1 a party’s right to require the other party to perform the agreed obligation follows from the binding character of the contract and the principle of pacta sunt servanda reflected in articles 28, 46, 62, etc. cisg.45 a party must perform its obligations irrespective of the burden it could face in performing.46 in other words, the terms of the contract must nonetheless be followed even if that party experiences important losses instead of the expected profits. 3.2 however, the principle of pacta sunt servanda is not an absolute one. when unforeseen and unavoidable circumstances are such that they lead to a fundamental alteration of the equilibrium of the contract, they may create an impediment exempting a party from performance and liability pursuant to article 79 cisg. 2.4. there is hardship when a change of circumstances beyond the control of a party makes performance excessively onerous, if that party could not reasonably be expected to have taken the change into account or to have avoided or overcome it or its consequences 4.1 article 79(1) cisg provides that a party is exempted from liability for damages only if the failure to perform is due to, first, an 44 cisg ac opinion no. 7, exemption of liability for damages under article 79 of the cisg, rapporteur: professor alejandro garro, 12 oct 2007, rule 3.1, comment para. 26. 45 florian mohs, 'article 62', in ingeborg schwenzer (ed.), schlechtriem & schwenzer: commentary on the un convention on the international sale of goods (4th edn; london: oup, 2016) at 906, para. 1; ulrich g. schoeter, 'does the 1980 vienna sales convention reflect universal values? the use of the cisg as a model for law reform and regional specificities', loy. l.a. int’l & comp. l. rev. , 41/1 (2018) at 20. 46 see ulrich magnus, 'general principles of the un-sales law', rabels zeitschrift fur auslandisches und internationales privatrecht, 59/3, 4 (1995) at 486-87 : “(2) pacta sunt servanda. -the basic rule that contracts are binding is not expressly mentioned in the cisg. however, it is implied in numerous provisions, such as art. 30 and 53 cisg, which determine the duty to deliver and the duty to effect payment. particularly arts. 71-73 and 79 show that the binding effect of the contract cannot be avoided in cases such as a simple change of circumstances or frustration of contract, but only if the requirements listed in these provisions are present; without the binding nature of the contract these provisions would not make sense”. njcl 2021/1 18 impediment beyond its control, second, that such party could not reasonably be expected to have taken this impediment into account at the time of the conclusion of the contract and, third, to have avoided or overcome this impediment or its consequences.47 4.2 hardship may be regarded as a special type of “impediment” under article 79 cisg; all that is added on the level of prerequisites is a clarification of the term impediment. the mere fact that performance has been rendered more onerous than could reasonably have been anticipated at the time of the conclusion of the contract does not exempt a party from performing the contract.48 in international law instruments, hardship may be found only if the performance of the contract has become excessively onerous49 or if the utility of performance has considerably decreased, 50or if the equilibrium of the contract has been fundamentally altered.51 as addressed next, a similar approach should be taken under the cisg. hardship as an impediment beyond control: 4.3 only impediments that are outside of a party’s sphere of control can lead to exemption under article 79 cisg. objective circumstances that prevent performance usually encompass nature’s events such as floods, storms, fire, frosts, epidemics, etc. they also include state or human interventions, for example, new legislation, government acts, war, terrorist attacks, etc.52 these “external” circumstances are different from personal or corporate ones which impair a party’s ability to perform. 4.4 the distinction between a party’s sphere of risk and external impediments will primarily result from the parties’ allocation of risks in the contact, their practices or international usages under article 9 cisg. unless otherwise agreed, the disadvantaged party will carry the risk for circumstances that have their origin in its own person or corporation. for example, labour strikes, financial strain or difficulties, etc. even unforeseeable illness, arrest, death of the disadvantaged party or key individuals in their corporation, attachment of assets, may not amount to 47 regarding force majeure, art. 7.1.7(1) unidroit picc; art. 8:808(1) pecl; art. iii – 3:104(1) dcfr are practically identical to article 79(1); art. 89 placl. the same holds true for the icc force majeure clause. however, the latter gives a list of events that may amount to an impediment. 48 mckendrick, 'article 6.2.1', at 812, para. 1; schwenzer, 'article 79', at 1135, para 15. 49 article 6:111(2) pecl; article iii – 1:110(2) dctr; icc hardship clause 2003 para. 2(a); icc hardship clause 2020 para. 2(a); art. 84(1) placl. 50 art. 84(1) placl. 51 article 6.2.2 unidroit picc; see mckendrick, 'article 6.2.2', at 824, para.2. 52 schwenzer, 'article 79', at 1136, 37, paras. 17, 18. 19 cisg-ac opinion 20 an impediment beyond control since according to trade usages, such events are part of an organization’s sphere of risks.53 hardship as an unforeseeable event: 4.5 hardship, as a type of impediment,54 can only exempt the disadvantaged party from liability if the event causing the imbalance could not reasonably have been taken into account by that party at the time of the conclusion of the contract.55 if the events could have been foreseen, then it must be assumed that the disadvantaged party has taken the risk, unless such risk is contractually allocated to the other party.56 4.6 in the case of drastic price increase due to market fluctuations, a look at historic price movements during a reasonable past period (pursuant to the eisenberg formula57) may determine whether, under “a reasonable expectation test” the disadvantaged party could have foreseen the price increase leading to the hardship situation.58 this information could also help in assessing whether or not that party could have impliedly assumed the risk of a price increase in the market concerned. courts and arbitral tribunals applying the cisg have considered that events leading to the value alteration in some commodities are part of the risk assumed by the buyer and thus, foreseeable.59 53 ibid., at 1138, para. 19. 54 brunner, force majeure and hardship under general contract principles: exemption for nonperformance in international arbitration at 421.: “it has been seen above that the requirements of the force majeure and hardship exemptions are essentially the same, with the only qualification that the latter’s scope is limited to those ‘impediments’ or events which ‘fundamentally alter the equilibrium of the contract’. see also atamer, 'article 79', at 1089, para. 81.: “the prerequisites of hardship can be deduced by way of analogy from art. 79(1) since both concepts aim at solving parallel problems”. 55 mckendrick, 'article 6.2.2', at 817, para. 12; schwenzer, hachem, and kee, global sales and contract law at 672, para. 45.107; clayton p. gillette and steven d. walt, the un convention on contracts for the international sale of goods (new york: cambridge university press, 2016) at 310; dimatteo, international contracting: law and practice at 265, para. 7.23. atamer, 'article 79', at 1089, para. 81. 56 gillette and walt, the un convention on contracts for the international sale of goods at 310; atamer, 'article 79', at 1089, para. 81; brunner, force majeure and hardship under general contract principles: exemption for non-performance in international arbitration at 398. 57 melvin a. eisenberg, 'impossibility, impractiability, and frustration', journal of legal analysis, 1/1 (2009) at 245. 58 ishida, 'cisg article 79: exemption of performance, and adaptation of contract through interpretation of reasonableness full of sound and fury, but signifying something', at 374, 77. 59 france cass civ 1ère, 30 june 2004, cisg–online case no. 870 (goods involved: cases made from polyurethane foam); rechtbank van koophandel, tongeren, 25 january 2005, no njcl 2021/1 20 hardship as an event that cannot be avoided or overcome: 4.7 the impediment must be one that cannot reasonably be avoided or overcome.60 4.8 whether a party can be expected to overcome an economic impediment has to be decided by taking the threshold for hardship into account. if the increase in costs does not exceed the relevant threshold, the disadvantaged party may be obliged to make a higher sacrifice. for example, the seller may have to turn to another supplier or consider alternative possibilities for the transportation of the goods. 2.5. such hardship may arise when the cost of performance has increased or the value of the performance has diminished 5.1 either an increase in the cost of performance or a decrease in the value of the performance received may give rise to hardship.61 this means that the disadvantaged party can be either the seller or the buyer. as pointed out by some authors, one may assume that a situation is unfair whenever “the supply of material need[ed] to manufacture certain goods unexpectedly becomes so reduced in quantity and inflated of price that only a minority of manufactures that require this material can continue production […]. comparable unfairness can result if extreme and unexpected currency dislocations make it impossible for sellers to continue to produce or buyers to purchase”.62 the unidroit picc and placl expressly incorporate this double aspect of economic impediment.63 2.6. such hardship may also arise from events occurring before the conclusion of the contract if the parties did not know and could not have been aware of these events 6.1 in cases of force majeure (objective impediments) under article 79 cisg, it is more or less unanimously held that it is irrelevant whether the 1960, cisg-online case no. 1106 (goods involved: steel); bulgarian chamber of commerce and industry, 12 february 1998, cisg-online case no. 436 (goods involved: steel rope). 60 atamer, 'article 79', at 1089, para. 81; brunner, force majeure and hardship under general contract principles: exemption for non-performance in international arbitration at 398; schlechtriem and butler, un law on international sales at 201, para. 89. 61 see brunner, force majeure and hardship under general contract principles: exemption for non-performance in international arbitration at 221, 23. 62 honnold and flechtner, uniform law for international sales at 628, para. 432.2. 63 art. 6.2.2(1) unidroit picc and art. 84(1) placl: “if after its conclusion, performance of the contract becomes excessively onerous or the utility of performance considerably decreases”. 21 cisg-ac opinion 20 impediment arose after the conclusion of the contract or if it already existed at the time of conclusion.64 if the specifically contracted goods had already been destroyed at the time of the conclusion of the contract, but the seller did not know about it nor could have prevented this fact, the seller may be exempted under article 79(1) cisg. 6.2 in cases of hardship, however, it has been argued that the changed circumstances must have occurred after the conclusion of the contract.65 this is the position taken by domestic legal systems.66 similarly, the wording in international instruments is clearly based upon this assumption.67 although the wording of article 6.2.1 unidroit picc seems to point in the same direction,68 article 6.2.2(a) picc clarifies that hardship may be found if either the events that are causing the imbalance of the performances occur or if they become known to the disadvantaged party after the conclusion of the contract. despite the wording of art. 6.2.2, some submit that the imbalance must necessarily occur after the conclusion of the contract.69 6.3 whether an initial gross imbalance between the performances of the parties, due to circumstances neither known to the parties nor avoidable, may amount to hardship under article 79 cisg, one has to consider what other remedies the disadvantaged party could rely upon when discovering that, already at the time of the conclusion of the contract, there had been a gross disparity between the respective values of the agreed obligations. most likely under domestic laws, as well as under international soft law instruments, initial circumstances, such as gross 64 schwenzer, 'article 79', at 1134, para. 13; atamer, 'article 79', at 1073, para. 48; ferrari and torsello, international sales law cisg at 325; schlechtriem and butler, un law on international sales at 202, para. 89. 65 brunner, force majeure and hardship under general contract principles: exemption for nonperformance in international arbitration at 398, 99. 66 argentina art. 1091 cc; armenia art. 467 cc; austria §§ 936, 1052, 1170 a through analogy; azerbaijan art. 422 cc, bolivia art. 581(1)(4) cc; brazil art. 478, 479 cc; china art. 26 prc contract law interpretation (2); colombia art. 868 com c; egypt: art. 147(2) cc; iraq art. 146(2) cc; kuwait 198 cc; france art. 1195 cc; germany § 313 bgb; italy art. 1467 cc; greece art 388 cc; netherlands art. 6:258 civil code (bw); portugal art. 437 cc;: libya: art. 147(2); lithuania: art. 6.204 cc; paraguay: art. 672 cc; qatar art. 171 (2); russia: art. 451(2) cc; slovenia: art. 112 co; syria: art. 148(2) cc; taiwan: art. 227-2 cc; ukraine: art. 652 cc see the position in most systems in schwenzer, hachem, and kee, global sales and contract law at 669, para. 45.96 et seq. 67 see art.6:111 pecl, comment b (ii). art. 6.2.1 unidroit picc; art. 84 placl (otherwise the applicable provision is art. 85 frustration placl). 68 art. 6.2.1 unidroit picc: "where the performance … becomes more onerous …" (emphasis added). 69 see mckendrick, 'article 6.2.2', at 817, para. 10. njcl 2021/1 22 disparity between the parties’ performances, will give rise to remedies for mistake.70 these coexisting remedies may be tolerated within one single legal system; difficult problems, however, can arise when dealing with sales contracts under the cisg.71 6.4 as it is debated whether the cisg contains a provision on mistake, and if so to what extent, this question would have to be resolved relying on the otherwise applicable domestic law.72 however, this may well lead to unpredictable results. for example, it might be questionable at what point in time production costs rose, be it before the conclusion of the contract or only afterwards. furthermore, uniformity in such an important area of the sales law would be endangered by applying domestic rules on mistake to this question. it is exactly these considerations that, in the case of force majeure, compel the same treatment for initial and subsequent impediments.73 thus, if the goods have been destroyed at the time of the conclusion of the contract, domestic rules declaring such a contract as being void are excluded.74 the same reasoning should apply in cases of hardship. the cisg notion of hardship or economic impediment should be interpreted and understood in the broadest sense, encompassing any change of circumstances after the conclusion of the contract, as well as initial circumstances rendering performance excessively onerous.75 70 mm van rossum and j hijma, 'validity', in e.h. hondius d. busch, h.j. van kooten, h.n. schelhaas, w.m. schrama (ed.), the principles of european contract law and dutch law. a commentary (the hague: kluwer law, 2002) at 193; restatement on the law of contracts § 266 ("existing impracticability or frustration"). the same solution is proposed by mckendrick under unidroit picc see mckendrick, 'article 6.2.2', at 817, para. 10.: “when the event occurs prior to the conclusion of the contract, the affected party may be able to avoid the contract on the ground of mistake”. 71 patrick c. leyens, 'cisg and mistake, uniform law vs. domestic law : the interpretative challenge of mistake and the validity loophole', in pace international law review (ed.), review on the convention for the international sale of goods 2002-2003 (munich: sellier, 2005) at 15. 72 it is argued that a party can rely on mistake where the cisg and the domestic law provide the same remedies. for a detailed discussion about this matter see ibid., at 34; stefan kröll, 'selected problems concerning the cisg's scope of application', journal of law and commerce, 25 (2005) at 55. 73 schwenzer, 'article 79', at 1134, para. 13. 74 schwenzer, hachem, and kee, global sales and contract law at 670, para. 45.98. 75 ibid. 23 cisg-ac opinion 20 2.7. in assessing whether hardship exists the following nonexclusive factors should be taken into account a. whether the risk of a change of circumstances was assumed by either party; b. whether the contract is of a speculative nature; c. whether and to what extent there have been previous market fluctuations; d. the duration of the contract; e. whether the seller has obtained the goods from its own supplier; f. whether either party has hedged against market changes. 7.1 there is no fixed threshold for giving rise to a hardship excuse under article 79 cisg. this has been recognized by other international instruments. for example, the comments to article 6.2.2 unidroit picc,76 in its first edition of 1994 suggested that an alteration amounting to 50% or more would likely amount to a “fundamental” alteration, but the 2004, 2010 and 2016 unidroit picc editions, as well as other uniform law projects,77 refrain from recommending any exact figure.78 7.2 relying on a thorough comparative analysis of domestic solutions, one author has suggested that, as a general rule of thumb in standard situations, a threshold of at least 100% should be favored.79 however, most decisions dealing with hardship under article 79 concluded that even a price increase or decrease of 100% would not suffice.80 7.3 even apparent excessive increases or decreases in the value of parties’ performances may not render the contract economically impossible in some scenarios.81 the price for the goods purported to be incorporated by the buyer into a final product could have doubled after the conclusion of the contract, but just before the seller had bought such 76 mckendrick, 'article 6.2.2', at 816, para. 8. 77 art.6:111 pecl; art. 6.2.3 unidroit picc; section iii1:110 dcfr; art. 84(1) placl. 78 mckendrick, 'article 6.2.2', at 816, para. 8. 79 brunner, force majeure and hardship under general contract principles: exemption for nonperformance in international arbitration at 428-35. 80 cietac, 2 may 1996, cisg–online case no. 1067 (based on frustration); rb hasselt, 2 may 1995, cisg–online case no. 371; ca colmar, 12 june 2001, cisg–online case no. 694 (the buyer failed to prove the 50% fall in the selling price of the goods, the [buyer] does not prove the state of "necessity" which would allow it to terminate the contract). 81 gillette and walt, the un convention on contracts for the international sale of goods at 312. njcl 2021/1 24 inputs from a third party. if the price of the buyer’s final product has been proportionally augmented, either as a consequence of an increase in the input’s price or a sudden increase of its demand in the relevant marketplace, the hardship event may not have been the cause of a substantial alteration in the equilibrium of the contract. assuming that a disruption of such “equilibrium” entails consequences for both parties, hardship is excluded in this case as long as the buyer had not a previous contract with a costumer, a cost increase to the seller not having a predictable effect on the buyer.82 7.4 in order to determine whether a party may be expected to overcome a situation of hardship one may resort to “reasonable expectation test”.83 under this test, a party may be exempted under article 79 cisg in case the performance, though technically possible, calls for spending huge costs, grossly disproportionate to the value of the obligation. in such a case, the aggrieved party may be exempted under article 79 cisg as long it established that the financial loss it will suffer is significantly greater than the risk of loss a “reasonable person” is expected to assume at the time of the formation of the contract.84 in the case of devalued currency, it is suggested that if the parties were aware that the contract was one for a fixed valuation, the failing party should be exempted because that is what the parties intended, thus, expected.85 that being said, unless otherwise agreed, the reasonable expectations of the parties at the time of the conclusion of the contract are that the seller covers the risk against falling prices while assuming the risk that prices will increase. conversely, it is to be expected that, unless otherwise agreed, the buyer covers against the risk of raising prices, while assuming the risk that market prices may decline after the conclusion of the contract.86 7.5 in ascertaining whether any alteration amounts to hardship, primary consideration is to be given to the circumstances of the individual case. the following non-exclusive elements may be taken into account. 82 ibid. 83 ishida, 'article 79: exemption of performance, and adaptation of contract through interpretation of reasonableness full of sound and fury, but signifying something', at 367, 68. 84 ibid. 85 ibid., at 371, 72. 86 john y. gotanda, 'dodging windfalls: damages based on market price, actual loss, and appropriate awards ', in villanova university (ed.), villanova public law and legal theory working paper series (2015) at 6., available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2683525. 25 cisg-ac opinion 20 whether the risk of a change of circumstances was assumed by either party: 7.6 as commented above, the parties may allocate in their contract the risk for a fundamental change of circumstances.87 contract interpretation through article 8 cisg is paramount in determining whether a party may rely on hardship or not. the choice of an incoterms rule determines the point of delivery and places the risk as regards transport, export or import control, tariffs, etc. on one of the parties. despite such allocation of risks and duties, a party might prove that delivery or performance of other obligations under an incoterms or contract clause have been affected by an impediment that complies with the requirements of article 79 cisg. prior practices between the parties or international usages under article 9 cisg, may integrate the contract in this matter. whether the contract is of a speculative nature: 7.7 if the contract is highly speculative, a party may be presumed to have assumed the risk involved in the transaction.88 a german court of second instance did not exempt a seller from liability under article 79 cisg even though the market price for the contract item, iron molybdenum from china, had risen by 300%.89 the court reasoned that in a trade sector, with highly speculative traits, the threshold for allowing hardship should be raised.90 87 see brunner, force majeure and hardship under general contract principles: exemption for non-performance in international arbitration at 147, 48. katz, 'remedies for breach of contract under the cisg', at 391; cisg ac opinion no. 7, exemption of liability for damages under article 79 of the cisg, rapporteur: professor alejandro garro, 12 oct 2007, comment para. 39; mckendrick, 'article 6.2.2', at 818, para. 15.: “assumption of risk need not to be express; it can be inferred from the circumstances or from the nature of the contact”. 88 icc award, 26 august 1989, no 6281, cisg-online case no. 8; rechtbank van koophandel, tongeren, 25 january 2005, no 1960, cisg-online case no. 1106. see also brunner, force majeure and hardship under general contract principles: exemption for nonperformance in international arbitration at 220. mckendrick, 'article 6.2.2', at 816, para. 8.: “the threshold is likely to be higher where the parties have entered into a highly speculative contract or the contract has been concluded in a market that is highly volatile”. 89 oberlandesgericht hamburg, 28 february 1997, no 167, cisg-online case no. 261. 90 oberlandesgericht hamburg, 28 february 1997, no 167, cisg-online case no. 261. njcl 2021/1 26 7.8 other courts and arbitral tribunals have held that, in cases of speculative transactions, a party may have to accept even a tripled market price.91 whether and to what extent there have been previous market fluctuations: 7.9 courts and arbitral tribunals interpreting article 79(1) cisg have been very reluctant to exempt a party affected by fluctuations of prices.92 as such, typical fluctuations of price in the commodity trade generally will not give rise to an acknowledgement of hardship.93 7.10 however, in 2009 the cour de cassation of belgium overturned the earlier decision of an appeal court in dealing with economic hardship.94 in this case, the price of the steel sold unexpectedly rose by about 70%. the appellate court decided that the issue regarding economic hardship was not dealt with by the cisg, applying french domestic law in allowing the seller’s counterclaim for an amount based on a higher price.95 the cour de cassation rejected the application of french domestic law, holding that there was an internal gap in the cisg (article 7(2)) to be filled by the general principles of international trade. where a party invokes change in circumstances fundamentally disrupting the contractual equilibrium, the belgian highest court held that one of those principles are to be found in the unidroit picc, and entitled said party to request re-negotiation of the contract.96 91 olg hamburg, 28 february 1997, cisg–online case no. 261; icc ct arb no. 6281, 26 august 1989,cisg-online case no. 8 (a price increase of 13.16% is not enough)tribunale civile di monza, 14 january 1993, cisg-online case no. 540 (a price increase of 43.71% is not enough, but applying italian domestic law: article 1467 cc) 92 price fluctuations are considered foreseeable by most courts and arbitral tribunals: see rb tongeren, 25 january 2005, cisg–online case no. 1106; france cass civ 1ère, 30 june 2004, cisg–online case no. 870; ca colmar, 12 june 2001, cisg–online case no. 694 (the buyer failed to prove the 50% fall in the selling price of the goods, the [buyer] does not prove the state of "necessity" which would allow it to terminate the contract)); int ct bulgarian cci, 12 february 1998, cisg–online case no. 436; rb hasselt, 2 may 1995, cisg–online case no. 371; icc ct arb no. 6281, 26 august 1989, cisg–online case no. 8 (it refers to price increase but the applicable law is yugoslavian law); tribunale civile di monza, 14 jan 1993, cisg-online case no. 540 (the applicable law was the italian cc: article 1467 of the civil code). 93 schlechtriem and butler, un law on international sales at 204, para7.1.3; gillette and walt, the un convention on contracts for the international sale of goods at 312. 94 see hof van cassatie, 19 june 2009, cisg-online case no. 1963. 95 id. 96 id. 27 cisg-ac opinion 20 7.11 although this decision is welcomed for discarding the application of domestic law provisions on hardship over the cisg, it has been criticized for its low standard of value alteration and the application of the unidroit picc to fill in a cisg gap that does not exist (see para. 0 below).97 the duration of the contract: 7.12 the time factor causes that hardship events are more likely to occur in some long-term contracts.98 however, in principle, the same standard should apply irrespective of the duration of contracts. 7.13 a lower threshold of alteration in the parties’ performance may only apply in contracts of extended duration if the disadvantaged party’s financial ruin is imminent.99 in this regard, the point in time when the hardship event takes place is relevant to calculate the value of the outstanding performances with respect to the total contract value.100 for example, if the value of a ten year contract is forecasted by the disadvantaged party at 100%, and the hardship events took place during the fifth year resulting in that party receiving 30% of the forecasted value, the adjudicator should consider the remaining 70% forecasted value for the next five years while assessing whether the parties’ performances have suffered a fundamental disequilibrium. whether the seller has obtained the goods from its own supplier: 7.14 all circumstances affecting performance should be considered in determining whether a party might be exempted due to hardship. in some instances, the seller may have bought the goods or otherwise secured them from its supplier before the hardship event takes place. the price might have considerably and unforeseeably increased after that time, yet the contract might not be speculative in nature, however, if the seller receives the goods before the occurrence of the hardship event, the seller may not rightfully withhold delivery and resale the goods for a larger profit to a second buyer. 97 see flechtner, 'the exemption provisions of the sales convention including comments on hardship doctrine and the 19 june 2009 decision of the belgian cassation court', at 98. 98 brunner, force majeure and hardship under general contract principles: exemption for nonperformance in international arbitration at 438. 99 ibid., at 439. 100 ibid., at 462, 63. njcl 2021/1 28 whether either party has hedged against market changes: 7.15 whether any of the parties has hedged or secured against changes in the market should be considered in assessing the existence of hardship. for example, if a seller has bought insurance against hardship, the amount of such insurance may be considered in determining whether the seller can overcome the impediment or not. 2.8. the party affected by hardship must give notice to the other party of the circumstances and its effect on its ability to perform. if the notice is not received by the other party within a reasonable time after the party affected knew or ought to have known of the hardship situation, it is liable for damages resulting from such nonreceipt 8.1 pursuant to article 79(4) cisg, a party failing to perform shall provide timely notice of the impediment and its effect on his ability to perform.101 this requirement is an expression of the underlying principle of cooperation in cisg contracts; it is intended to alert the other party on whether it should itself take remedial action, reduced damages under article 77 cisg and/or – when a fundamental breach exists – avoid the contract.102 this notice requirement applies to hardship situations and follows the same objectives as other types of impediments.103 8.2 the notice must be given within a reasonable time after the party affected knew or ought to have known of the hardship. in order to fulfill its purpose, the notice must describe the changes in the economic circumstances, their gravity, nature and duration with sufficient detail.104 notice may have to be given in multiple stages, depending on the relevant market’s state (e.g. the degree of abruptness or fluctuation in the obligation’s value) or the nature of the impediment turning the performance excessively onerous. whether notice is given within a reasonable time depends on the circumstances and the parties’ agreement, 101 cisg ac opinion no. 7, exemption of liability for damages under article 79 of the cisg, rapporteur: professor alejandro garro, 12 oct 2007, comment para. 1. 102 yesim m. atamer, 'article 79', in stefan kröll, loukas mistelis, and pilar perales viscasillas (eds.), un convention on contracts for the international sale of goods commetary (second edn; münchen: hart publishing, 2018) at 1077, para. 95; brunner, force majeure and hardship under general contract principles: exemption for non-performance in international arbitration at 342. 103 schwenzer, hachem, and kee, global sales and contract law at 672, para. 45.108. 104 schwenzer, 'article 79', at 1147, para. 45; atamer, 'article 79', at 1077, para. 95; brunner, force majeure and hardship under general contract principles: exemption for nonperformance in international arbitration at 342. 29 cisg-ac opinion 20 such as the means available or possibility to transmit the notice and whether the performance on time was of the essence.105 8.3 the notice is not subject to any form requirements. unlike article 27 cisg, under article 79(4) cisg the risk that the notice fails to reach the addressee within a reasonable time is placed on the party affected by hardship.106 however, a teleological reading of this provision, in light of the principle of good faith in article 7(1) cisg), may exempt the aggrieved party from the obligation to give notice if the other party was aware of the relevant circumstances.107 8.4 a party’s failure to give notice does not preclude it from invoking the exemption under article 79 cisg. the general exemption from damages in article 79(5) cisg remains unaffected. the consequences of a failure to give proper and timely notice of the hardship situation is liability for losses resulting from it. the other party could claim its reliance losses. these might consist of, for example, expenses incurred in reliance that the contract would be performed during the time within which the notice should have been received.108 lost profits may also lie in the case of late delivery affected by hardship if the buyer resells the goods to a third party after the expiration of the time when notice should have been received by the buyer.109 2.9. in case of hardship, nothing prevents either party from exercising any right other than to claim damages and require performance of the obligation affected by hardship 9.1 article 79(5) cisg relieves the disadvantaged party only from the obligation to pay damages.110 other cisg principles, including reasonableness of performance (articles 46 and 48 cisg) and the need to interpret the remedies available to the parties in good faith (article 7(1) cisg)111 may also have an impact on releasing the disadvantaged party from its obligation to perform the contract while the impediment exists. 105 brunner, force majeure and hardship under general contract principles: exemption for nonperformance in international arbitration at 343. 106 atamer, 'article 79', at 1077, para. 96. 107 in relation to impediments in general see, schwenzer, 'article 79', at 1147, para. 47. 108 atamer, 'article 79', at 1077, para. 97. 109 brunner, force majeure and hardship under general contract principles: exemption for nonperformance in international arbitration at 343. 110 flechtner, 'uniformity and politics: interpreting and filling gaps in the cisg', at 201. 111 diana akikol, 'article 46', in brunner and gottlieb (ed.), commentary on the un sales law (the netherlands: wolters kluwer, 2019) at 348, para. 14; atamer, 'article 79', at 1053, para. 39. njcl 2021/1 30 among the remedies not affected by an exemption under article 79 cisg are the other party’s right to suspend performance (art. 71 cisg), reduce the contract price (art. 50), avoid the contract (arts. 48(1) and 64(1) cisg) or any of its instalments (art. 73 cisg), claim interest (art. 78 cisg) or expenses incurred in the preservation of the goods (arts. 85 and 86 cisg).112 2.9.1.exemption from liability in damages: 9.2 as stated in cisg-ac opinion no. 7, if the non-performance is due to an impediment under article 79 cisg, the disadvantaged party is relieved, first and foremost, from its obligation to pay damages during the time such impediment exists.113 the same damages exemption should follow from a court’s or arbitral tribunal’s determination of hardship.114 as 112 schwenzer, 'article 79', at 1151, para. 56; honnold and flechtner, uniform law for international sales at 640, para. 435.4; brunner, force majeure and hardship under general contract principles: exemption for non-performance in international arbitration at 366. 113 cisg ac opinion no. 7, exemption of liability for damages under article 79 of the cisg, rapporteur: professor alejandro garro, 12 oct 2007, rule 1. comment para. 6; brunner, force majeure and hardship under general contract principles: exemption for nonperformance in international arbitration at 345; atamer, 'article 79', at 1060, para.13; schwenzer, 'article 79', at 1148, para. 50; schwenzer, hachem, and kee, global sales and contract law at 663, para. 45.60. one author asserts that express exemption to pay damages was not necessary because an impediment under article 79 cisg would fall under the category of unforeseeable damages under 74 cisg, see ishida, 'cisg article 79: exemption of performance, and adaptation of contract through interpretation of reasonableness full of sound and fury, but signifying something', at 340. however, ishida seems to miss the point that the foreseeability requirement in article 74 cisg regards the damages as a possible consequence of the breach rather than the breach itself or the impediment causing the latter. he also forgets that the cisg remedies system follows the strict liability approach and that article 79 works as an exoneration of liability rather than a damages’ limitation provision. 114 regarding the unidroit picc some authors seem to have a different view. commenting article 6.2.3 picc, mckendrick considers that hardship does not in itself exclude the defendant’s liability for non-performance, see mckendrick, 'article 6.2.3', at 821, para. 10. he cites a cam arbitral award, holding that article 6.2.3 picc does not provide the remedy of damages’ exemption but a duty to renegotiate, the remedy of contract adaptation or termination by the tribunal; and since the breaching party did not request any of those remedies, the tribunal decided not to exempt it from damages, skipping a determination of whether hardship had taken place. in spite of such incorrect understanding, it seems clear that once hardship is found and a court or tribunal decides to adapt a contract or terminate it upon a party’s request, the latter should be exempted to pay any damages arising out of the contract modification or termination, see 31 cisg-ac opinion 20 stated in cisg-ac opinion no. 10, the exemption from paying damages under article 79 cisg includes an exemption to pay the so-called “agreed sums”, i.e. penalty clauses or liquidated damages (if they are at all valid under the governing domestic law), unless the parties have agreed otherwise in their contract.115 specific performance excluded: 9.3 whether the exemption under article 79 cisg also extends to the right to request performance has been a subject of considerable debate because of the wording of article 79(5) cisg.116 this provision states that nothing prevents either party from exercising any right other than to claim damages under this convention.117 the wording of 79(5) cisg would suggest that a party to the contract may claim, in principle, specific performance in spite of the impediment endured by the other. at the vienna conference, a proposal by the german delegation aimed at clarifying that performance could not be insisted on in case of a continued impediment was rejected.118 it was considered that no problem would arise in practice in case the disadvantaged party suffered actual impediments, whereas the categorical removal of the right to performance could impair the accessory rights of the other party.119 nowadays it seems to be undisputed that performance cannot be demanded as long as the arbitral award of 30 november 2006, centro de arbitraje de méxico, paragraph 251, available at unilex http://www.unilex.info/case.cfm?pid=1&do=case&id=1149&step=fulltext 115 cisg-ac opinion no. 10, agreed sums payable upon breach of an obligation in cisg contracts, rapporteur: dr. pascal hachem, (2012), rule 5. see also hachem, agreed sums payable upon breach of an obligations at 138; brunner, force majeure and hardship under general contract principles: exemption for non-performance in international arbitration at 346, 47. 116 atamer, 'article 79', at 1061, paras. 16, 17; schwenzer, 'article 79', at 1050, para. 53. 117 article 8:101(2) pecl clearly states that where a party’s non-performance is excused, alongside with the right to claim damages, the right to performance is likewise excluded. see article 8:101 pecl “(2) where a party's non-performance is excused under article 8:108, the aggrieved party may resort to any of the remedies set out in chapter 9 except claiming performance and damages”. 118 ishida, 'cisg article 79: exemption of performance, and adaptation of contract through interpretation of reasonableness full of sound and fury, but signifying something', at 343, 44. 119 see document a/conf.97/c.1/l.191/rev.1 in united nations conference on contracts for the international sales of goods, vienna, 10 march-11 april 1980 (official records, new york, 1981) 381. schwenzer, 'article 79', at 1050, para. 53. njcl 2021/1 32 impediment exists.120 the same consequences should follow in case of hardship, which is a type of impediment.121 9.4 the exemption to perform due to hardship applies to the obligation to perform the contract under articles 46(1) and 62 cisg, to deliver substitute goods under article 46(2) cisg and to cure any nonconformity of the goods by repair under article 46(3) cisg.122 the same reasoning appears in other international instruments, such as article 7.2.2(b) unidroit picc.123 the rule may be drawn from the possibility to request performance unless it is unreasonable under articles 46 and 48 cisg in light of the obligation to interpret the cisg in good faith under article 7(1) cisg.124 suspension of performance: 9.5 a party has the right to suspend performance of its obligation if, after the conclusion of the contract, it becomes apparent that the other party will not perform a substantial part of its obligations. article 71(1)(a)(b) cisg does not expressly mention hardship among the grounds for suspension, but the disadvantaged party’s “serious deficiency in his ability to perform” under article 71(1)(a) cisg might encompass impediments like hardship. 9.6 article 71 cisg restricts the right to suspension or stoppage in transit to situations in which performance has not yet become due. nevertheless, a party may withhold its performance when an obligation has become due and there is an impediment under article 79 cisg preventing the seller from delivering the goods or the buyer from paying 120 atamer, 'article 79', at 1065, para. 27; honnold and flechtner, uniform law for international sales at 642, para. 435.5; ishida, 'cisg article 79: exemption of performance, and adaptation of contract through interpretation of reasonableness full of sound and fury, but signifying something', at 449-51; peter huber, 'article 46', in mistelis, kröll and perales-viscasillas (ed.), un convention on contracts for the international sale of goods (hamburg: beck, 2018) at 678, para. 19. 121 schwenzer, 'article 79', at 1150, 51, para. 55; huber, 'article 46', at 879, para. 23; akikol, 'article 46', at 348, 49, para. 14; atamer, 'article 79', at 1052, para. 35. 122 akikol, 'article 46', at 348, para. 14; atamer, 'article 79', at 1053, para. 39. 123 article 7.2.2 unidroit picc: where a party who owes an obligation other than one to pay money does not perform, the other party may require performance, unless: [...] (b) performance or, where relevant, enforcement is unreasonably burdensome or expensive; [...] 124 akikol, 'article 46', at 348, para. 14; atamer, 'article 79', at 1053, para. 39. 33 cisg-ac opinion 20 the purchase price. a proper notice of hardship by the disadvantaged party will allow the other party to withhold performance of its obligations and, thus, avoid further losses. price reduction: 9.7 article 50 cisg entitles the buyer to reduce the price of nonconforming goods in the same proportion as the value that conforming goods have at the time of delivery. a hardship exemption under article 79 cisg can rarely occur when the non-conforming goods have already been delivered. however, a buyer may claim price reduction if, for example, the non-conformity consists in missing parts of the goods that the seller is unable to deliver due to hardship. avoidance by a party’s declaration: 9.8 the right to avoid the contract under articles 49(1) and 64(1) cisg presupposes that the non-performance amounts to a fundamental breach of contract. whether such a fundamental breach exists largely depends upon the circumstances of the individual case.125 article 25 cisg circumscribes a fundamental breach of contract as the non-performance resulting in such detriment to the other party as substantially to deprive it of what it is entitled to expect under the contract.126 one of the central questions in hardship cases is whether it is possible and –having regard to the other party’s expectations – just and reasonable that the breach be remedied.127 9.9 in the hypothetical case where, after the conclusion of the contract, the acquisition costs for the seller have doubled from 100 to 200, the seller may propose delivering the goods if the buyer is willing to pay a higher purchase price, let us say 150. the buyer may opt for refusing to accept the seller’s offer, proceed to a cover purchase and sue the seller for 100 (the difference between the contract price and the price of the substitute purchase). the court or arbitral tribunal should then have to decide whether the seller is exempted from its obligations due to hardship 125 ulrich schroeter, 'article 25', in ingeborg schwenzer (ed.), schlechtriem & schwenzer: commentary on the un convention on the international sale of goods (4th edn; london: oup, 2016) at 424, paras. 13 et seq. oberlandesgericht stuttgart, 12 march 2001, cisg-online case no. 841; cietac, 30 october 1991, cisg-online case no. 842. 126 similar provision is article 7.3.1(2) unidroit picc, article 8:103 pecl and article iii – 3:502(2) dcfr. 127 cisg ac opinion no. 5, the buyer's right to avoid the contract in case of nonconforming goods or documents rapporteur: professor ingeborg schwenzer, 7 may 2005, comment 3. njcl 2021/1 34 or whether the seller´s willingness to deliver the goods on different terms (at 150) amounted to a fundamental breach of contract, giving the buyer the right to avoid the contract. the court here will have to consider whether, under the circumstances of the case, it would have been just and reasonable for the buyer to pay 150 (which the seller was willing to accept) rather than 200 (in a substitute transaction). giving due regard to all circumstances, the court or tribunal might find for the seller if it considers that the buyer should have consented to renegotiate the price in order to mitigate its loss. right to claim interest: 9.10 a buyer that has delayed payment of the purchase price due to a temporary hardship situation under article 79 cisg, shall pay interest on it as of the date of payment agreed in the contract.128 the rule applies to any monetary obligation that has not been paid timely due to hardship, unless delay has been caused by the other party’s conduct.129 2.10. the exemption due to hardship has effect for the period during which hardship exists. 10.1 a claim for specific performance under the original terms of the contract (articles 46(1) and 62 cisg) will not be enforceable as long as the substantial disequilibrium in the party’s performances persists.130 neither an obligation to deliver substitute goods (article 46(2) cisg) nor an obligation to cure any non-conformity of the goods by repair (article 46(3) cisg) may be enforced against the disadvantage party during the time where hardship exists.131 2.11. under the cisg, the parties have no duty to renegotiate the contract in case of hardship. 11.1 parties may, if they agree to do so, renegotiate their contract in case of hardship. renegotiation of the terms of the contract is the most rational solution in some hardship cases and in others the most practical solution. if the parties voluntarily renegotiate, they could address any market or value distortion in a faster and efficient manner. cisg case law 128 cisg-ac opinion no. 14, interest under article 78 cisg, rapporteur: professor dr yeşim m. atamer, 22 october 2013), rule 7, comment paras. 3.47 and 3.48. 129 id., comment, para. 3.47. 130 schwenzer, 'article 79', at 1150, 51, para. 55; atamer, 'article 79', at 1068, paras. 35, 36; akikol, 'article 46', at 349, para. 15. 131 akikol, 'article 46', at 348, para. 14; atamer, 'article 79', at 1053, para. 39. 35 cisg-ac opinion 20 shows that parties try to solve different issues amicably, before claiming any remedies under the convention.132 11.2 renegotiation, however, as negotiation, is based on willingness and trust. constructive and cooperative renegotiation cannot be forced upon the parties by coercion.133 the parties’ freedom to modify their contract is the primary source for a new balance between the parties’ obligations. the possibility of having a contract rebalanced by common agreement primarily rests on the parties’ freedom to agree, beforehand, on which steps to take in case of hardship. different model hardship clauses state such possibility,134 including the icc hardship clause 2003 and 2020.135 11.3 in addition, there are factual incentives for the parties to renegotiate their contract in a hardship situation, in their best interests under the current system of cisg remedies. the traditional remedies under the cisg, in combination with the duty to mitigate any loss in article 77 cisg,136 may induce the parties to renegotiate their obligations and to distribute risks evenly in the uncertainty brought by every hardship situation.137 132 hannaford (trading as torrens valley orchards) v australian farmlink pty ltd acn 087 011 541 [2008] fca 1591, 24 october 2008, unilex case no. 1366 available at http://www.unilex.info/case.cfm?id=1366; icc arbitration case no. 11849 of 2003 (fashion products case), available at http://cisgw3.law.pace.edu/cases/031849i1.html; republic of korea 29 april 2010 daegu district court, available at http://cisgw3.law.pace.edu/cases/100429k3.html. 133 günter roth, ' § 313 bgb', in wolfgang krüger (ed.), münchener kommentar zum bürgerlichen gesetzbuch (5 edn; muchen: ch beck, 2007) at para. 93. 134 see for example, clause 16.2 (hardship) of standard model contract for international commercial sale of goods and clauses 9.2 and 9.3 of the international long-term supply of goods, by the international trade center (an agency of the world trade organization): (itc), model contracts for small firms: legal guidance for doing international business at 54, 55, 70, 71., available at http://www.intracen.org/workarea/downloadasset.aspx?id=37603. 135 see icc hardship clause 2003, para. (2)(b); icc hardship clause 2020, para. (2)(b). 136 see ingeborg schwenzer and simon manner, 'the pot calling the kettle black: the impact of the nonbreaching party's (non) behaviour on its cisg-remedies', in camilla andersen and ulrich schroeter (eds.), sharing international commercial law across national boundaries – festschrift for albert h kritzer ( london: wildy, simmonds & hill, 2008) at 480. for the duty to mitigate in domestic legal systems see schwenzer, hachem, and kee, global sales and contract law at 630, para. 44.256 et seq. also see finland § 70(1) sale of goods act; germany § 254 bgb; norway § 70(1) sale of goods act; sweden § 70(1) sale of goods act; switzerland art. 44 co; arts. 7.4.7, 7.4.8 unidroit picc, articles 9:504 and 9:505 pecl; arts. iii.-3:704 and iii.-3:705 dcfr. 137 article 77 cisg can clearly constitute a rule for a fair distribution of risks in case of hardship despite the contrary opinion of some scholars, see atamer, 'article 79', at 1091, para. 85. buyers will not automatically reject an offer to renegotiate, avoid the contract njcl 2021/1 36 11.4 in comments to the cisg-ac opinion no. 7, the question whether the parties may have a duty to renegotiate based upon the mandate to interpret the cisg in good faith (article 7(1) cisg) was posed without further elaboration.138 this opinion no. 20 clarifies that, unless otherwise indicated in the contract, the cisg does not impose upon the parties an obligation to renegotiate the contract in case of hardship. 11.5 a duty to renegotiate that operates as a cisg default rule would not be suitable. an impediment under article 79 cisg only releases the party in breach from the obligation to compensate any damages resulting such breach.139 there is no duty to renegotiate under article 79 cisg, and the impracticability associated with enforcing such a duty makes it advisable not to impose it. 11.6 first, it is more than questionable whether and how the breach of an obligation to renegotiate would be redressed. article 79 cisg, like most domestic and international legal systems, does not stipulate any means to enforce the duty to renegotiate imposed upon the parties (see 0 above).140 imposing a duty to negotiate where there are no means of specific enforcement amounts to nothing more than a best practices declaration. the duty to negotiate would gain importance only if breaching it was sanctioned.141 11.7 second, cases of hardship involve fact situations in which it can hardly be determined whether a party refusing or breaking off negotiations acted in bad faith.142 imposing renegotiation is especially unsuitable for and sue for damages in case of lack of delivery at the agreed price. the costs of bringing a claim and the uncertainty of the court’s decision may act as disincentives in long term distribution contracts or scenarios where the goods are to be integrated into a manufacturing process or to inventory waiting to be resold, especially at times where the hardship and related doctrines are gaining momentum in b2b transactions. in one case, for example, a court in the netherlands held that a seller should have agreed on a change of delivery terms requested by the buyers, and ordered the seller to deliver the goods within 14 days after judgment, see rechtbank arnhem, 31 january 2008, cisg-online case no. 2016. 138 cisg ac opinion no. 7, exemption of liability for damages under article 79 of the cisg rapporteur: professor alejandro garro, 12 oct 2007, comment para. 40. 139 schwenzer, 'article 79', at 1148, para. 50; flechtner, 'uniformity and politics: interpreting and filling gaps in the cisg', at 201. 140 see for example, armenia art. 467 cc; azerbaijan art. 422 cc; france art. 1195 cc; lithuania art. 5.204 cc; russia art. 451 cc; ukraine art. 652 cc. also see schwenzer, hachem, and kee, global sales and contract law at 673, para. 45.112. 141 this is only envisaged by article 6:111(3)(c) pecl, according to which a court may award damages for the loss suffered through a party refusing to negotiate or breaking off negotiations contrary to good faith and fair dealing. 142 these criticisms were recognized by the drafters of the dcfr, who, according to the official comments, decided not to impose an obligation to negotiate (although, they 37 cisg-ac opinion 20 international transactions calling for promptness and legal certainty, which militate against lengthy or tedious negotiations.143 parties resorting to the courts or arbitration are most likely to have exhausted their efforts to reach an amicable solution before getting involved in the costs and inconvenience of filing an action .144 clear cases of bad faith, however, may be taken into account upon allocating the costs of proceedings.145 11.8 for hardship cases, some international instruments provide an obligation to renegotiate the original contract terms that became imbalanced or excessively onerous.146 this duty to renegotiate rests on a duty to act in good faith,147 which is common to many civil law systems.148 made an attempt at renegotiation a prerequisite to the obligor’s right to obtain relief), see art. iii.-1:110, comment c dcfr. 143 atamer, 'article 79', at 1091, para. 84. 144 ishida, 'cisg article 79: exemption of performance, and adaptation of contract through interpretation of reasonableness full of sound and fury, but signifying something', at 372. 145 brunner, force majeure and hardship under general contract principles: exemption for nonperformance in international arbitration at 483. 146 article 6.2.3(1) undroit picc, article 6:111(2) pecl 1999 as well as article iii – 1:110(3)(d) dcfr; art. 84(1) placl. however, mckendrick explains that in the case of unidroit picc the duty to renegotiate does not come from the wording of article 6.2.3 (“entitled to request negotiations”) but from the general principle of good faith in article 1.7 and the parties’ duty to co-operate under article 5.1.3 picc, see mckendrick, 'article 6.2.3', at 819, para. 1, fn. 53. 147 brunner, force majeure and hardship under general contract principles: exemption for nonperformance in international arbitration at 480, 81; mckendrick, 'article 6.2.3', at 819, para. 1. see also icc award, march 1999, no 5953, clunet 1990, 1056. 148 the principle of good faith found its way into almost every civil law system through the reception of roman law. see france article 1104(1) cc; italy article 1337 cc; germany § 242 bgb; switzerland article 2 zgb. the new french civil code endorsed the principle in article 1104(1), see chénedé, le nouveau droit des obligations et des contrats: consolidations innovations perspective at 19, para. 21.24. good faith is also a contract integration principles engrained in latin american laws, see edgardo muñoz, modern law of contracts and sales in latin-america, spain and portugal, ed. ingeborg schwenzer (international commerce and arbitration, 6; the hague: eleven international publishing, 2011) at 270. common law systems, however, tend to refrain from accepting good faith as a general principle of contract law: see michael g. bridge, 'does anglo-canadian law need a doctrine of good faith?', canadian bus lj, 9 (1984) at 426; gunther teubner, 'legal irritants: good faith in british law or how unifying law ends up in new divergencies', modern law review, 61 (1998) at 11. njcl 2021/1 38 but other legal systems, not only those pertaining to the common law tradition,149 do not impose a duty to renegotiate.150 11.9 the belgium cour de cassation and some authors have considered that there is a gap in article 79 cisg as far as the consequences of hardship are concerned and that this gap might be filled according to article 7(2) cisg by relying on the unidroit picc, which requires the parties to renegotiate the contract.151 this approach poses some difficulties. it has been disputed that article 7(1) cisg imposes an obligation upon the parties to act in good faith during their contract conclusion and performance.152 besides, article 7 cisg requires an autonomous interpretation and the filling in of internal gaps in accordance with its own principles. thus, all solutions developed must be based on the convention itself.153 2.12. under the cisg, a court or arbitral tribunal may not adapt the contract in case of hardship 12.1 adaptation is not contemplated or allowed under the cisg.154 the fact that the cisg provisions governing exemption do not authorize contract adaptation by a court or arbitral tribunal, does not create a “gap” in the cisg; it rather shows a rejection of the adaptation remedy, as 149 see united states § 2-615 (a) ucc stating that "[d]elay in delivery or non-delivery … is not a breach of his duty under a contract for sale if performance as agreed has been made impracticable by the occurrence of a contingency…." for a discussion of the impracticability doctrine in american law see, palumbo, modern law of sales in the united states at 165, 66. 150 see argentina art. 1091 cc; italy arts. 1467-1469 cc; the netherlands arts. 6:258 and 6:260 bw. see for further references, brunner, force majeure and hardship under general contract principles: exemption for non-performance in international arbitration at 480. 151 hof van cassatie, 19 june 2009, cisg-online case no. 1963; schlechtriem and butler, un law on international sales at 204, para. 91. 152 bridge, the international sale of goods at 509, para. 10.41; ingeborg schwenzer and pascal hachem, 'article 7', in ingeborg schwenzer (ed.), schlechtriem & schwenzer: commentary on the un convention on the international sale of goods (4th edn; london: oup, 2016) at 127, para. 17. 153 schwenzer, hachem, and kee, global sales and contract law at 45, para. 3.54. 154 neither adaptation of the contract is contemplated in the following domestic laws: italy art. 1467 cc; bolivia art. 581 cc, brazil art. 478 and 479 cc; slovenia art. 112 code of obligations. the icc hardship clause 2003 states in para 3 that "… the party invoking this clause is entitled to termination of the contract." on article 1467 of the italian codice civile, see brunner, force majeure and hardship under general contract principles: exemption for non-performance in international arbitration at 506. 39 cisg-ac opinion 20 recorded in the travaux préparatoires.155 considering that hardship is a matter governed by the cisg, the remedies available for such type of impediment should be found in article 79 cisg. in this regard, article 79(5) cisg specifically states that the aggrieved party may exercise any right under the convention except for damages. consequently, this provision expressly sets out the remedies by reference to those explicitly stated in articles 45 and 61 cisg. adaptation by a court or arbitral tribunal is not contemplated by those provisions. 12.2 for the same reasons, no period of grace may be granted to the disadvantaged party in a situation of hardship when the other party is entitled to a remedy for breach of contract under the cisg (articles 45(3) and 61(3) cisg). 12.3 moreover, it is not consistent or necessary to create a different legal remedy for economic impediments that differs from the remedy that already exists under article 79 cisg. the solution envisaged by the remedy of contract adaptation takes out from of the parties’ hands what the latter may be able to achieve better. this approach contradicts the parties’ autonomy to fix the hardship situation. 12.4 it has been advocated that article 50 cisg, on reduction of the purchase price, evidences a general principle so as to adjust a contract to changed circumstances.156 however, the right to reduce the contract price in article 50 cisg derives from a breach of contract incurred by the other party; in other words, it is the adverse consequence of a breach of contract and an efficient way to redress the damage caused by the breach. granting price reduction does not depart from the parties’ initial expectations under the contract, whereas adaptation of the contract in case of hardship works against the party not responsible for the impediment. 12.5 furthermore, it has been suggested that adaptation may lie under a “reasonable expectation test”, proposed as another of the principles upon which the cisg is based (article 7(2) cisg): a judge or an arbitrator first determines where a party could “reasonably” be expected to overcome an impediment and, if not, he or she may adapt the 155 flechtner, 'the exemption provisions of the sales convention including comments on hardship doctrine and the 19 june 2009 decision of the belgian cassation court', at 98. 156 schlechtriem, 'transcript of a workshop on the sales convention: leading cisg scholars discuss contract formation, validity, excuse for hardship, avoidance, nachfrist, contract interpretation, parol evidence, analogical application, and much more by harry m. flechtner', (adhering to schlechtriem view see, ishida, 'cisg article 79: exemption of performance, and adaptation of contract through interpretation of reasonableness full of sound and fury, but signifying something', at 378, 79. njcl 2021/1 40 contract by ordering a solution “reasonably” expected to be taken.157 relying on articles 39 and 60 cisg, which allow the integration of the contract, it has been submitted that courts may in some instances rewrite cisg contracts in light of the surrounding circumstances, trade usages or prior practices.158 however, the task of integrating a contract works under the assumption that the parties have not agreed otherwise, whereas adapting a contract calls for a departure from the original deal concluded by the parties. adaptation of contractually agreed terms entails the exercise of extraordinary powers requiring an express provision in the cisg confirming such faculty for adjudicators. 12.6 in the last comment of the cisg advisory council’s opinion no. 7, it is stated that in case negotiations fail, there are no guidelines under the convention for a court or arbitrator to adjust, or revise the terms of the contract so as to restore the balance of the performances.159 the same comment also states that cisg article 79(5) may be relied upon to open up the possibility for a court or arbitral tribunal to determine what is owed to each other, thus adapting the terms of the contract to the changed circumstances.160 as a party in arbitration proceeding pointed out, cisg advisory council’s statement did not suggest that the remedy of contract adaptation was contemplated in article 79 cisg, because allowing a court or arbitral tribunal “to determine what is owed to each other” does not give the adjudicator the power to adjust a term of the contract.161 12.7 some authors have proposed to rely on article 6.2.3(4) unidroit picc as constituting either a general principle upon which the cisg is based under article 7(2) cisg162 or an international usage in the sense of article 9(2) cisg in order to reach the desirable result of adaptation.163 that approach also poses some difficulties. first, as stated 157 see ishida, 'cisg article 79: exemption of performance, and adaptation of contract through interpretation of reasonableness full of sound and fury, but signifying something', at 359, 72, 79, 80. 158 see ibid. 159 cisg ac opinion no. 7, exemption of liability for damages under article 79 of the cisg, rapporteur: professor alejandro garro, 12 oct 2007, comment 3.2, para. 40. 160 ibid para. 40. 161 separate award, scc arbitration no. v2014/078/080, 31 may 2017, cisg-online case no.4683, para. 2568 as an argument of the respondent (gazprom) that the arbitral tribunal neither contradicted nor expressly accepted. 162 schlechtriem, 'transcript of a workshop on the sales convention: leading cisg scholars discuss contract formation, validity, excuse for hardship, avoidance, nachfrist, contract interpretation, parol evidence, analogical application, and much more by harry m. flechtner', at 236, 37. 163 schlechtriem and butler, un law on international sales at 204, para. 91; atamer, 'article 79', at 1091, 92, para. 86. 41 cisg-ac opinion 20 above, there is no gap in the cisg regarding the remedies in case of hardship. second, although there might be an overlapping between certain trade usages and some of the provisions in the unidroit picc, the latter were not conceived as a restatement of international trade usages. the remedy of contract adaptation by an arbitral tribunal or court in case of hardship is contemplated in many civil law legal systems164 and at the international level too,165 but it is not internationally accepted.166 whether adaptation of the contract or some of its clauses by a third party constitutes a usage in some industries must be established pursuant to article 9(2) cisg. 12.8 the situation may be different when the contract has already been fulfilled by one side. thus, a buyer may have complied with its obligation to pay the price in a foreign currency of which the value, for example, increased by 100% since the time of the conclusion of the contract, resorting to an excessively onerous bank credit and placing its financial survival at peril. commenting on the hardship provisions in the unidroit picc, it has been stated that a remedy for hardship must relate to obligations that remain to be performed, precluding a party from claiming greater payment for work already done.167 yet, with few exceptions,168 most provisions on hardship do not clarify whether a party may be exempted from obligations that have already been performed.169 arguably, the text of hardship provisions excusing a party from performing, such as article 79 cisg, may be interpreted against exempting liability for performance that has been already rendered, given that the very notion of impediment calls for events which “could not have been overcome”, past performance being an indication that the 164 argentina art. 1091 cc; armenia art. 467 cc; azerbaijan art. 422 cc, bolivia art. 581(1)(4) cc; china art. 26 prc contract law interpretation (2) and art. 227-2 cc; colombia art. 868 com c; croatia art. 369 civil obligations act; egypt art. 147(2) cc; france art. 1195 cc; germany § 313(1) bgb; greece art. 388 cc; iraq art. 146(2) cc; kuwait 198 cc; libya: art. 147(2); lithuania: art. 6.204 cc; montenegro art. 128 law on obligations; paraguay art. 672 cc, only in unilateral contracts; portugal art. 437 cc; qatar art. 171 (2) cc; russia art. 451(2) cc; syria art. 148(2) cc; taiwan art. 227-2 cc; the netherlands art. 6:258 dutch civil code; ukraine art. 652 cc. 165 article 6.2.3(4) unidroit picc, article 6:111(3) pecl as well as article iii – 1:110(2)(b) dcfr; art. 84 placl. 166 flechtner, 'the exemption provisions of the sales convention including comments on hardship doctrine and the 19 june 2009 decision of the belgian cassation court', at 102. 167 commenting art. 6.6.2 unidroit picc mckendrick, 'article 6.2.2', at 815, para. 4. 168 see colombia art. 868 ccom “prestación de futuro cumplimiento a cargo de una de las partes”. 169 that is the case of art. 6.2.2. unidroit picc; art. 6:111 pecl; art. 84 placl. njcl 2021/1 42 disadvantaged party is not in a position to claim that the “ultimate limit of sacrifice” has been exceeded.170 12.9 ultimately, whether a contract may be adapted with regard to obligations already fulfilled should be answered by interpreting the parties’ behavior. a party who performed under the terms agreed without having raised the issue of hardship may give rise to a presumption that the imbalance threshold has not been reached. however, if the party affected by hardship went ahead with the performance of the obligation only after receiving assurances by its counterparty of subsequent renegotiations or a set-off against future deliveries, or if it was reasonable for the disadvantaged party to rely on prior renegotiation or adaptation practices, industry usages, the parties may be deemed to have impliedly agreed to the possibility of adapting the contract after performance.171 2.13. under the cisg, a court or arbitral tribunal may not bring the contract to an end in case of hardship. 13.1 the possibility of termination (or “avoidance” as in the language of the cisg) of the contract by a court or arbitral tribunal as a result of hardship is envisaged by the international instruments172 and many of the legal systems considered in this opinion.173 in common law jurisdictions, ipso facto termination (also called ipso iure termination)174 is the 170 schwenzer, 'article 79', at 1135, 36, para. 15. however, most hardship rules do not impose the “not to overcome” requirement but, instead, provide the “substantial imbalance”, “more onerous” or “excessive onerous” prerequisite, e.g. austria §§ 936, 1052, 1170a bgb; france art. 1195 cc; germany § 313 bgb; netherlands art 6:258 bw; greece art 388 cc; portugal art 437 cc. moreover, article 6.2.3(2) unidroit picc states that the request for negotiations does not in itself entitle the disadvantaged party to withhold performance. this provision highlights the possibility that renegotiations and other hardship remedies may take place despite performance by the disadvantaged party. 171 this could result from the application of the principle of estoppel in articles 16 and 29 cisg. 172 art. 6.2.3(4) unidroit picc; art. 6:111(3) pecl; art. iii.-1:110(2) dcfr; art. 84(3) placl. 173 argentina art. 1091 cccom; armenia art. 467 cc; azerbaijan art. 422 cc; bolivia ar. 581 cc; brazil art. 478 cc; china art. 26 prc; colombia art. 868 ccom; croatia art. 369 co; france art. 1195 cc; germany sec. 313; greece art. 388 cc; italy art. 1497 cc; lithuania art. 5.204 cc; montenegro art. 128 co; paraguay art. 672; portugal art. 437 cc; russia art. 451 cc; slovenia art. 112 co; the netherlands art. 6:258 cc; united states section 2-615 ucc, section 261 restatement second on contracts. 174 see schwenzer, hachem, and kee, global sales and contract law at 754, para. 47.182.: “where avoidance of the contract does not require any action by the parties or by the adjudicators, this mechanism is sometimes termed ‘ipso facto avoidance’, sometimes it is called ‘ipso iure avoidance’. the first term focuses on the factual circumstances leading to 43 cisg-ac opinion 20 only remedy under the doctrine of frustration.175 legal systems differ, however, with regard to the preference of the termination solution over other remedies such as negotiation or contract adaptation. in some systems, termination is clearly preferred over adaptation,176 while in others adaptation is favoured over termination.177 13.2 there are also some differences in relation to the relevant mechanism by which termination operates in cases of hardship. in some legal systems termination takes effect ex nunc and only by an order of the court or arbitral tribunal.178 other legal systems follow the english remedy under the doctrine of frustration of contract, embracing the termination of the contract ipso facto, as of the moment the contract is frustrated.179 both approaches, however, contradict the cisg modern solution of termination (avoidance as in its own language) by declaration by the aggrieved party;180 which is also the first proposed remedy under the icc hardship clause 2020 should the parties fail to reach a solution through negotiation.181 under this mechanism a notice given by the aggrieved party is sufficient for the contract to be terminated, the effects of termination taking place upon that moment.182 the advantages in comparison to the requirement of termination by court judgment is certainty and speed. when a contract is terminated ipso facto, the consequences may have taken effect without the parties being aware of it, whereas termination by court avoidance while the second term focuses in the legal operation following this act. hence, although the terms are not synonymous, in the context of the mechanism of avoidance there is no difference as concerns the subject matter: avoidance of the contract without an act by the parties or the adjudicators”. 175 see for example united states art. 2-615 ucc, restatement second of contracts § 261 and e. allan farnsworth, 'the restatement (second) of contracts', rabels zeitschrift für ausländisches und internationales privatrecht, 47/2 (1983), 336-40 at 340. 176 see for example, argentina 1041 cc; brazil art. 478 and 479 cc; russia art. 451(2) cc. in bolivia art. 581 cc and italy art. 1467 cc avoidance is the sole remedy available. 177 see for example, germany § 313(1) bgb; france art. 1195 cc; colombia art. 868 com c. 178 see for example, argentina art. 1091 cc; bolivia art. 581(1)(4) cc; brazil art. 478, 479 cc; colombia art. 868 com c; paraguay art. 672 cc; russia art. 451(2) cc; slovenia art. 994 com c; see also schwenzer, hachem, and kee, global sales and contract law at 674, para. 45.119. 179 see for example united states art. 2-615 ucc, restatement second of contracts § 261 and farnsworth, the restatement (second) of contracts at 340; schwenzer, hachem, and kee, global sales and contract law at 754, para. 47.183. 180 art. 26 cisg; for breach of contract see art. 7.3.2(1) unidroit picc and art. 9:303(1) pecl. 181 see icc hardship clause, para. 3, option a. 182 schwenzer, hachem, and kee, global sales and contract law at 758, para. 47.198. njcl 2021/1 44 declaration will be impractical in many instances, especially where a party needs to conclude a substitute transaction in order to cover the other party’s breach. 13.3 consequently, the remedy of termination by party declaration under the cisg is the proper remedy to end contract in case of hardship. 1 nordic journal of commercial law is publishing this paper with the consent of singapore international arbitration centre. the paper was presented at a joint uncitral-siac conference in singapore and will be published as part of a book by the singapore international arbitration centre * acknowledgement: the author of this paper would like to express deep and sincere gratitude to professor albert h. kritzer, pace university institute of international commercial law. he provided all the copies of the published cietac awards involving with the cisg to the author, under the kindest help from the china international economic and trade arbitration commission (“ cietac” ). his constructive suggestions, warm encouragement and excellent advices helped the author complete this paper on the cietac awards reported. the author also warmly thanks professor john y. gotanda at villanova university school of law (us) and mr. djakhongir saidov at the norwich law school, university of east anglia (uk) for their detailed review and constructive comments on the earlier draft of this paper. last but not the least, the author would like to thank the united nations commission on international trade law (“ uncitral” ) and singapore international arbitration centre (“ siac” ), which co-organize the conference on the cisg in september 2005, for the opportunity they provided to the author for sharing his research with other researchers. ** dong wu, associate with haiwen & partners, beijing, p.r.china, 2004 to present; ll.m., 2004, ll.b., 2001, peking university school of law, beijing, p.r.china. email address: wudong@pku.edu.cn. cietac's practice on the cisg1* by dong wu** nordic journal of commercial law issue 2005 #2 mailto:wudong@pku.edu.cn nordic journal of commercial law issue 2005 #2 1 the website of the wto, url at <http://stat.wto.org/countryprofile/wsdbcountrypfview.aspx?language=e&country=cn>. 2 the website of the wto, url at <http://www.wto.org/english/news_e/pres05_e/pr401_e.htm>. 3 some foreign researchers have also done relevant research on china and the cisg, such as: zeller, bruno [australia], cisg and china, in: michael r. will ed., rudolf meyer zum abschied: dialog deutschland-schweiz vii, faculté de droit, université de genève (1999) 7-22, at <http://www.cisg.law.pace.edu/cisg/biblio/zeller.html>. 4 notice on making preparation for enforcing the cisg ([87] waijingmaofazi no.2) (guanyu zuohao zhixing xiaoshou hetong gongyue zhunbei gongzuo de tongzhi – in chinese), issued by moftec. 5 notice on certain probrems to be noticed when enforcing the cisg (guanyu zhixing lianheguo guoji huowu xiaoshou hetong gongyue ying zhuyi de jige wenti – in chinese), issued by moftec. 2 i. introduction 1. china and cisg the united nations convention on contracts for the international sale of goods (hereinafter referred to as the “ cisg” ) has been regarded as the most important uniform international law for the sale of goods so far. china signed the cisg on 30 september 1981 and deposited its instrument of ratification on 11 december 1986. as of 1 january 1988, the cisg became effective in relation to china. according to the statistics of the world trade organization (hereinafter referred to as the “ wto” ) issued in april 2005,1china’s exports and imports of merchandise ranked the fourth and third respectively in the world in year 2003. china’s shares in the world total merchandise exports and imports of 2003 were 5.8% and 5.3%, respectively. according to the wto news,2in 2004 china became the largest merchandise trader in asia, and the third largest exporter and importer in world merchandise trade. china’s shares in the world total merchandise exports and imports of 2004 respectively reached 6.5% and 5.9%. evidently, china has been playing a role of increasing importance in the world trade including the trade of goods. considering that the contracting states of the cisg include other leading trading states, especially u.s., germany and the republic of korea, which are also the main trade partners of china, the cisg accordingly deserves increasing attention in china from the chinese side.3 chinese governmental and judicial bodies have been aware of the importance and the potential influence of the cisg ever since 1987. before the cisg came into force, the then ministry of foreign trade and economic cooperation (the predecessor of the ministry of commerce, hereinafter referred to as “ moftec” ) issued a notice on 22 january 19874 requesting relevant governmental agencies and companies to make preparation for the forthcoming cisg’s entry into force in relation to china, including but not limited to, to comply with the cisg, to study the cisg, to modify and complete the standard contracts then in use, and to keep aware of the developments of the number of the contracting states of the cisg. on 4 december 1987, the then moftec further circulated a notice on certain issues meriting attention regarding implementation of the cisg,5 which was shortly endorsed by the supreme people’s court on 10 http://stat.wto.org/countryprofile/wsdbcountrypfview.aspx?language=e&country=cn http://www.wto.org/english/news_e/pres05_e/pr401_e.htm http://www.cisg.law.pace.edu/cisg/biblio/zeller.html nordic journal of commercial law issue 2005 #2 6 notice of forwarding the certain problems to be noticed when enforcing the cisg of moftec (fa [jing]fa [1987] no.34) (zhuanfa duiwai jingji maoyibu guanyu zhixing lianheguo guoji huowu xiaoshou hetong gongyue ying zhuyi de jige wenti de tongzhi – in chinese), issued by the supreme people’s court. 7 see the chinese cases involving the cisg reported at the online cisg database of pace law school, url at <http://www.cisg.law.pace.edu/cisg/text/casecit.html#china>. in addition, a number of chinese writings on the cisg h a v e a l s o b e e n r e p o r t e d . s e e t h e b i b l i o g r a p h y l i s t e d a t t h e c i s g d a t a b a s e o f p a c e l a w s c h o o l a t <http://www.cisg.law.pace.edu/cisg/biblio/biblio-chi.html >. 8 for the introduction of the cietac, see its official website, url at <http://www.cietac.org.cn/english/introduction/intro_1.htm#2>. 9 the foreword published online is at <http://www.rit.cn/whxs/guo/shownews.asp?newsid=2755>. 10 for the awards translated into english and uploaded, please see the webpage at the database of pace law school, at <http://www.cisg.law.pace.edu/cisg/text/casecit.html#china>. since all the cietac awards reported will be accessible to researchers at the database of pace law school, in this essay the author will quote the identification labels of cases provided in the aforesaid database when referring to relevant cases, such as “ award of 27 february 1996 [cisg/1996/11] (wool case)” . in the cases translated, their original online links 3 december 1987.6 since the cisg entered into force, more and more courts and arbitral rulings in which the cisg has been applied have been reported in the past years.7 2. cietac and cietac awards according to the information provided on its official website,8 china international economic and trade arbitration commission (hereinafter referred to as “ cietac” , also known as the court of arbitration of china chamber of international commerce as from 1 october 2000) is a permanent international commercial arbitration institution which independently and impartially resolves, by means of arbitration, contractual or non-contractual, international economic and trade disputes. cietac may also arbitrate any other domestic disputes submitted to it by agreement between parties. cietac, formerly known as the foreign trade arbitration commission, was set up in april 1956 within the china council for the promotion of international trade in accordance with the decision of 6 may 1954 by the former government administration council of the central people's government of china. at the same time, the provisional rules of the arbitration procedure were formulated by the china council for the promotion of international trade. to meet the needs of the continuing development of china's economic and trade relations with foreign countries after the adoption of the reform and openingup policy, the foreign trade arbitration commission was restructured into the foreign economic and trade arbitration commission in 1980 and renamed cietac in 1988. cietac has its headquarters in beijing and a sub-commission in shenzhen and shanghai each. in the past few years, cietac has become the first world arbitration forum in terms of caseload. its awards are recognized and enforced in more than 140 countries and regions. its arbitration rules were revised respectively in 1988, 1994, 1995, 1998, 2000 and 2005. chinese arbitral awards involving the cisg were mainly made by cietac. since 1988, nearly 200 cietac awards involving the cisg have been reported and published in various sources. the most important publication so far is the compilation of cietac arbitration awards (zhongguo guoji jingji maoyi zhongcai weiyuanhui caijueshu huibian – in chinese pinyin) published by the law press in may 2004, which includes the full texts of almost all of the awards rendered by the cietac until 2000. in its foreword, the editors forecast that the awards made after 2000 would be published later.9 these reported cases are in the process of being translated into english and will be available in the online cisg database of pace law school.10 thanks to the queen http://www.cisg.law.pace.edu/cisg/text/casecit.html#china http://www.cisg.law.pace.edu/cisg/biblio/biblio-chi.html http://www.cietac.org.cn/english/introduction/intro_1.htm#2 http://www.rit.cn/whxs/guo/shownews.asp?newsid=2755 http://www.cisg.law.pace.edu/cisg/text/casecit.html#china nordic journal of commercial law issue 2005 #2 or pages in books in chinese, if available, are and will be provided at the online database. considering the accessibility and for convenience, this essay will not quote the original pages in the chinese books of the cases again in the footnotes. for more information, please see the addendum of this essay. 11 such as: article 145 paragraph 1 of the general principles of the civil law of the people’s republic of china; article 5 of the law of the people’s republic of china on economic contracts involving foreign interest; article 126 of the contract law of the people’s republic of china. with regard to introduction of the aforesaid laws, please see part ii.1.3 in the text of this essay. 12 e.g., award of 28 december 1994 [cisg/1994/15] (round steel case). in this case, the business place of one party was in singapore, the other in germany. 13 award of 31 july 1997 [cisg/1997/24] (axle sleeves case). 4 mary case translation program and the work of pace law school and the participants, nonchinese speaking researchers will have access to the latest development of china’s practice relating to the cisg. based on the published cietac awards involving the cisg, the author of this essay will carry out a survey of these cases and provide certain comments on some critical issues in the chinese legal context with a view to providing a source of information for further study on china’s practice on the cisg. due to the limited availability of awards, this essay is not intended to be an exhaustive research, but a stepping-stone for more elaborated study. ii. cisg issues that have emerged from cietac awards 1. application of the cisg 1.1. by virtue of article 1(1)(a) pursuant to article 1(1)(a), the cisg shall apply to cases if contracts of sale of goods are entered into between parties whose relevant places of business are in different contracting states. in the cietac awards, most cases to which the cisg applied fall in this category. since the principle of “ autonomy of the parties” is recognized under article 6 of the cisg as well as the prc laws11, the tribunals have been willing to check the sales contracts to confirm that the parties have not excluded the application of the cisg. when applying article 1(1)(a), the tribunals frequently stated that the parties had not stipulated the applicable law in their contracts. it is easy to understand that in most cietac awards the place of business of one party is in china. the contracting states of the other parties’ places of business included most of the contracting states which have trading connections with china, e.g., u.s., germany, france, italy, switzerland, australia, austria, new zealand and singapore. nevertheless, in a small proportion of cases, the two parties are located in two different states, with neither located in china.12 when article 1(1)(a) applied, article 2 was rarely referred to as in most cases there generally was no need for the tribunals to discuss the term “ goods” . article 3 was also seldom invoked in most cases. in one case, a chinese seller manufactured and sold the goods (axles) to a u.s. buyer according to the technical drawings provided by the buyer.13 though article 3 was not explicitly invoked, the tribunal held that this scenario falls in the category of sales of goods. in another case, a u.s. buyer claimed that the agreement concluded by the two parties was of the form of a “ cooperative sale of goods” and that the u.s. firm did nothing more than act as the “ cooperator” of the chinese seller to assist the latter in selling the goods in u.s. however, based on the nordic journal of commercial law issue 2005 #2 14 award of 26 september 1994 [cisg/1994/12] (umbrella case). 15 bruno zeller has also noticed that the cisg was often not deemed as overriding or prevailing over the prc laws in china’s practice, and the cisg and prc laws were applied in parallel in many cases. see, bruno zeller, supra note 3. 16 such as: article 145 paragraph 2 of the general principles of the civil law of the people’s republic of china; article 5 of the law of the people’s republic of china on economic contracts involving foreign interest; article 126 of the contract law of the people’s republic of china. 17 such as: award of 7 july 1997 [cisg/1997/20] (isobutyl alcohol case). 18 the gpcl was adopted by the 4th meeting of the sixth national people’s congress on 12 april 1986 and came into force as of 1 january 1987. the gpcl so far has played as law at the highest hierarchy in the field of civil laws before the civil code is promulgated in the future. 19 see supra note 11. 20 award of 23 july 1997 [cisg/1997/23] (polypropylene case). 5 evidence presented, the tribunal found that the transaction involved a contract for the sale of goods.14 one noteworthy phenomenon was that some tribunals applied solely the cisg in the awards, while some applied both the prc laws and the cisg in parallel in their awards.15 as a substantive law convention, the cisg shall prevail over the domestic laws, no matter the private international law or the substantive law of the forum, except in the case of application of the limited reference to the law applicable by virtue of the rules of private international law in article 7(2). it seemed that in some cases the cietac tribunal disregarded the limitations to the authorization provided in article 7(2) of the cisg and referred to the rules of private international law directly regardless of whether the issues were governed by the cisg or not. in these cases, faced with a situation in which a contract concluded between two parties in two contracting states contains no applicable law clause, some tribunals held that, according to the principle of the “ closest connection” provided for in relevant chinese laws, the chinese domestic laws16 should apply after setting out the facts found. in addition, considering that the two parties are located in two contracting states of the cisg, they held that the cisg might apply in parallel.17 from the viewpoint of the author, this approach might have been taken by arbitrators more familiar with the domestic laws who may have regarded such laws as easier to apply, an approach that can impair the international character of the cisg and its uniformity in application. article 142 of general principles of the civil law of the people’s republic of china (hereinafter referred to as the “ gpcl” )18 also to some extent contributes to the parallel application of the cisg and prc laws, which will be further discussed in part ii.1.3. 1.2. by virtue of the principle of “ autonomy of the parties” the principle of autonomy of the parties is recognized in a number of prc civil and commercial laws.19 the tribunal would respect the choice of laws made by the parties, whether explicitly indicated in their contracts or subsequently during the arbitration process. if they chose the cisg as the governing law, the tribunals would also apply the cisg, even if article 1(1)(a) was not applicable, i.e., either or both parties were in non-contracting state. for instance, in one case, the dispute arose between a chinese seller and a japanese buyer. though they did not stipulate their choice of law in the contract, both of them invoked the prc laws and the cisg during the arbitration. therefore, the tribunal applied the prc laws and the cisg regardless of the fact that japan is not a contracting state of the cisg.20 the same nordic journal of commercial law issue 2005 #2 21 award of 16 august 1996 [cisg/1996/39] (dioctyl phthalate case). see, also award of 17 october 1996 [cisg/1996/47] (tinplate case); award of 26 june 1997 [cisg/1997/17] (monohydrate zinc sulfate case); award of 8 september 1997 [cisg/1997/27] (bopp film case); award of 21 may 1999 [cisg/1999/26] (excavating machine case). 22 article 153 paragraph 1 of the basic law of the hong kong special administrative region of the people’s republic of china provides that: “ the application to the hong kong special administrative region of international agreements to which the people's republic of china is or becomes a party shall be decided by the central people's government, in accordance with the circumstances and needs of the region, and after seeking the views of the government of the region.” therefore, as united kingdom is not a contracting state of the cisg, the cisg as a convention conceded by china is subject to article 153 paragraph 1 with regard to its effectiveness in hong kong. at present, no decisions by the central people’s government on the application of cisg in hong kong have been made. for further reference, see the list of international treaties applicable to hong kong provided by the department of justice of hong kong, at < http://www.legislation.gov.hk/interlaw.htm>. the case of macau, discussed infra at note 30, is similar to that of hong kong. from the viewpoint of the author, except that the parties choose the cisg as governing law of the contract or the cisg is applied according to the relevant provisions in the prc laws as discussed in part ii.1.3, when judges or arbitrators of mainland china hear the cases between the parties from hong kong (or macau) and mainland china, the cisg in principle is not applicable. however, when judges or arbitrators of other countries hear cases between parties from these two regions and other contracting states, the cisg might be applied according to their understanding of the status of hong kong and macau under the cisg. see discussion of this subject by ulrich schroeter in “ the status of hong kong and macao under the united nations convention on contracts for the international sale of goods” (december 2003), at <http://cisgw3.law.pace.edu/cisg/biblio/schroeter4.html>. 23 such as: award of 28 april 1995 [cisg/1995/08] (rolled wire rod coil case); award of 5 february 1996 [cisg/1996/07] (stibium case); award of 29 march 1996 [cisg/1996/15] (caffeine case); award of 4 april 1996 [cisg/1996/18] (veneer wood case); award of 15 november 1996 [cisg/1996/52] (oxytetracycline hcl case); award of 11 april 1997 [cisg/1997/05] (silicon metal case); award of 27 june 1997 [cisg/1997/18] (kidney beans case); award of 20 november 1997 [cisg/1997/32] (rebar coil case); award of 28 january 1999 [cisg/1999/06] (refrigerating machine case); award of 2 april 1999 [cisg/1999/18] (grey cloths case); award of 11 february 2000 [cisg/2000/02] (silicon metal case). 24 such as: award of 4 april 1996 [cisg/1996/18] (veneer wood case); award of 27 june 1997 [cisg/1997/18] (kidney beans case); award of 23 july 1997 [cisg/1997/23] (polypropylene case); award of 21 may 1999 [cisg/1999/26] (excavating machine case). 6 situation repeated in a case between a chinese buyer and a korean seller in 1996, at a time when the republic of korea had not yet acceded to the cisg.21 given that before 1 july 1997 hong kong was under the jurisdiction of the great britain which has not yet acceded to the cisg and after 1 july 1997 hong kong still reserves certain freedom of applying of the treaties concluded by the prc,22 hong kong may not be autonomously deemed as a region under the jurisdiction of a contracting state of the cisg.. however, there have been some cases between parties from mainland china and hong kong, even between two parties both from hong kong, in which the cisg was also applied if both parties chose it as the applicable law.23 in the event that the cisg is applied based on the parties’ choice of the cisg during the arbitration, the prc laws are frequently applied as well since the parties would generally refer to both the cisg and domestic laws.24 the cisg itself does not touch upon the application problem when either or both parties are from a non-contracting state but choose it as applicable law. this issue, judging upon the validity of the choice of law made by the parties, is left to the different states, including non-contracting states. from the practice of cietac, it can be found that the cietac tribunals are likely to respect the autonomy of the parties and accept the application of cisg under such circumstances. the present author is of the view that this positive attitude would help to enhance the application as well as the influence of the cisg, and the merchants from non-contracting states may therefore have increased opportunities to get to know the cisg and become familiar with it. http://www.legislation.gov.hk/interlaw.htm http://cisgw3.law.pace.edu/cisg/biblio/schroeter4.html nordic journal of commercial law issue 2005 #2 25 the lecfi was adopted by the 10th meeting of the standing committee of the sixth national people’s congress on 21 march 1985, came into force on 1 july 1985 and was overruled by the contract law of the people’s republic of china (the “ contract law” ) as of 1 october 1999. probably because of the existence of article 142 of the gpcl, the contract law has no corresponding articles as article 5 and 6 in the lecfi. 26 article 2.8 of the notice of replies by the supreme people’s court to certain questions in application of the lecfi provided the same contents as that of article 142 paragraph 2 of the gpcl. 7 1.3. application of the cisg as prc laws permit in some contracts between two parties, where either one or both are from non-contracting states, the prc laws were chosen as the applicable law of the contracts. also, in some other cases, the tribunals applied the prc laws according to the principle of the closest connection in some cases where no laws had been chosen by the parties either of whom was from a non-contracting state. in these two categories of cases, when applying the prc laws, the tribunals may also apply the cisg as a convention or international practice pursuant to the provisions in the prc laws. article 5 of the law of the people’s republic of china on economic contracts involving foreign interest (hereinafter referred to as the “ lecfi” )25 provided: “ for matters that are not covered in the law of the people’s republic of china, international practice shall be followed.” article 6 of the lecfi provided: “ where an international treaty which is relevant to a contract, and to which the people’s republic of china is a contracting party or a signatory, has provided differently from the law of the people’s republic of china, the provisions of the international treaty shall prevail, with the exception of those clauses on which the people’s republic of china has declared reservation.” article 142 paragraphs 2 and 3 of the gpcl respectively provide: “ if any international treaty concluded or acceded to by the people's republic of china contains provisions differing from those in the civil laws of the people's republic of china, the provisions of the international treaty shall apply, unless the provisions are ones on which the people's republic of china has announced reservations.” “ international practice may be applied to matters for which neither the law of the people's republic of china nor any international treaty concluded or acceded to by the people's republic of china has any provisions.” article 6 of the lecfi provided slightly different requirements from article 142 of the gpcl, which required the international treaty “ relevant to a contract” . whereas the gpcl was promulgated later than the lecfi, after the gpcl coming into force, the supreme people’s court took the same approach as article 142 of the gpcl in its judicial interpretation of the lecfi.26 article 142 paragraph 2 of the gpcl does not clearly state whether the scope of application provisions in the treaty itself should be taken into consideration in applying such international nordic journal of commercial law issue 2005 #2 27 award of 11 april 1997 [cisg/1997/05] (silicon metal case). 28 award of 30 june 1999 [cisg/1999/30] (peppermint oil case). 29 award of 26 march 1993 [cisg/1993/06] (cement case). 30 the contract law as the uniform contract law was adopted by the 2nd meeting of the ninth national people’s congress on 15 march 1999 and superseded the lecfi, the economic contract law of the people’s republic of china and the law of the people's republic of china on technology contracts as of 1 october 1999, thus ending the situation that there were three contract laws in china in different fields. 8 treaty. nevertheless, from the practice of cietac, it can be found that in the tribunals’ approaches, the main preconditions for applying article 142 paragraph 2 of the gpcl are: (i) the prc laws including the gpcl are applicable; (ii) the international treaty is concluded or acceded to by china. therefore, in cases in which the prc laws apply, the provisions in the cisg differing from those in the prc laws will prevail, except for those on which china has announced reservations. whether the parties are located in contracting states is not considered as a precondition by the tribunals. for example, in a case between a mainland seller and a hong kong buyer, the prc laws applied according to the clause of choice of law in the contract and the relevant facts. the tribunal then applied the cisg as an “ international treaty” based on the aforesaid provisions in the prc laws.27 in other cases, the cisg may apply as “ international practice” as well according to the aforesaid provisions. for example, this attitude was taken by a tribunal dealing with a dispute arose between a chinese seller and an english buyer. according to the principle of the closest connection, the prc laws were applied by the tribunal. though great britain is not a contracting state of the cisg, the tribunal held the cisg could also be applied as international practice pursuant to article 5 of the lecfi on the ground that the cisg had been recognized widely at international level.28 this also happened in a case between a mainland seller and a hong kong buyer.29 as of 1 october 1999, the contract law of the people’s republic of china (hereinafter referred to as the “ contract law” )30 came into force and superseded the lecfi and the supreme people’s court’s judicial interpretation thereof. however, in the contract law, there is no such clause as article 142 of the gpcl. therefore, at present, article 142 of the gpcl reflects china’s attitude toward the international treaties it has concluded or acceded to and the relationship between the domestic laws and the international treaties, at least in the fields of civil matters. from the viewpoint of the author, article 142 of the gpcl in effect enhances the possibilities of the application of the cisg to parties from non-contracting states. some tribunals’ approaches under which the cisg was applied as international practice or custom reflect the influence of the cisg and also provide opportunities for the cisg to be accepted by more and more international merchants. however, when dealing with disputes between two parties from different contracting states as mentioned in part ii.1.1 above, the cisg shall apply according to its articles per se and exclude the application of domestic laws in principle as aforesaid, no matter whether relevant provisions in domestic laws are the same as those in the cisg or not. in regarding the application of the cisg as resting upon relevant provisions in prc laws being different from those of the cisg, article nordic journal of commercial law issue 2005 #2 31 see, chen zhidong / wu guihua [china], lianheguo guoji huowu xiaoshou hetong gongyue shiyong yuanze jingxi – jian ping woguo minfatongze di 142 tiao [analysis of the principles of application of the cisg -comments on article 142 of the chinese general principle of civil law – in chinese], in: dangdai faxue yanjiu [contemporary legal science research], shanghai (2002.3), total no.37, 10-19. also see, chen zhidong, wu jiahua [china], lun lianheguo guoji huowu xiaoshou hetong gongyue zai zhongguo de shiyong – jian ping woguo minfa tongze di 142 tiao [on the application of the cisg in china – commentary on article 142 of the general principles of civil law of the prc – in chinese], in: faxue [law science], beijing (2004.10), 107-118; and ding wei [china], shiji zhi jiao zhongguo guoji sifa lifa huigu yu zhanwang [review and expectation on the legislation of the international private law in china at the end of 20th century – in chinese], in: zhengfa luntan [forum of laws and politics], beijing (2001.3), 127-134. however, some prc researchers held that the prc laws did not provide that treaties should prevail over the domestic laws. see, chen hanfeng / zhou weiguo / jiang hao [china], guoji tiaoyue yu guoneifa de guanxi ji zhongguo de shijian [the relationship of international treaties and domestic laws and china’s relevant practice – in chinese], in: faxue luntan [legal forum], jinan (2000.2), 117-123. 32 e.g., award of 23 october 1996 [cisg/1996/48] (channel steel case). 33 award of 1 april 1997 [cisg/1997/02] (fishmeal case). 34 this judicial interpretation was adopted on 26 january 1988 by the supreme people’s court. according to article 178, if the subject matter of a civil relation is located in the territory of a foreign country, the relation in question shall be considered a foreign-related civil relation. 9 142 in the gpcl in effect adds in an additional precondition for applying the cisg, which to certain extent impairs the international character of the cisg.31 in the cases under the category discussed in part ii.1.3, an additional issue deserving certain attention is cietac’s approach in relation to article 1(1)(b) and china’s reservation on it. in such cases, the tribunals applied the prc laws by virtue of the principle of the closest connection and then applied the cisg according to the aforesaid provisions in the prc laws. since the principle of the closest connection is regarded as a rule of private international law provided by the prc laws, though the tribunals apparently based the application of the cisg on the aforesaid provisions in the prc laws other than article 1(1)(b) directly, this in effect complied with article 1(1)(b) of the cisg when the rules of private international law lead to the application of the prc laws.32 however, china has made a reservation on this article, thus excluding its application in china. the prc laws do not clearly regard the cisg as part of the domestic law so that when the prc laws apply, the cisg may not naturally apply as part of the prc laws; but the aforesaid provisions show that the prc laws per se permit the application of the cisg and other international treaties or international practice in certain cases. china’s reservation on article 1(1)(b) in effect mainly excludes the application of the cisg when the rules of private international law lead to the application of the law of the contracting states except china. a case between two chinese parties fell in this category as well.33 because the goods sold were floating goods transited from peru to china, the contract was deemed as contract involving foreign elements under article 178 of the interpretation by the supreme people’s court on several issues regarding the application of the gpcl.34 the tribunal applied the lecfi according to the closest connection principle, and further the cisg and international practice based on article 5 and 6 of the lecfi. 1.4. application in error there also several cases in which the cisg was applied by error. for example, the tribunal hearing a case between a chinese seller and a japanese buyer applied the cisg by mistakenly believing nordic journal of commercial law issue 2005 #2 35 award of 7 november 1996 [cisg/1996/50] (stone products case). other examples as: award of 2 april 1997 [cisg/1997/03] (wakame case); award of 15 december 1997 [cisg/1997/34] (hot-rolled coils case). 36 e.g., award of 27 february 1996 [cisg/1996/11] (wool case), award of 4 september 1996 [cisg/1996/41] (natural rubber case) and award of 18 november 1996 [cisg/1996/53] (channel steel case). 37 see, award of 1 february 2000 [cisg/2000/01] (silicon and manganese alloy case).in effect, the case of macau is similar as that of hong kong as discussed in supra note 22. article 138 of the basic law of the macau special administrative region of the people’s republic of china provides that: “ the application to the macao special administrative region of international agreements to which the people's republic of china is a member or becomes a party shall be decided by the central people's government, in accordance wit h t he c ir cum st an ces a nd ne eds o f t he r egi on, and after seeking the views of t he go vern men t o f t he region.“ international agreements to which the people's republic of china is not a party but which are implemented in macao may continue to be implemented in the macao special administrative region. the central people's government shall, as necessary, authorize or assist the government of the region to make appropriate arrangements for the application to the region of other relevant international agreements.” at present, the list of international treaties applicable to macau pro vided by t he offi ci al webs it e of mac au d oes not inc lude th e ci sg . see the list at <http://www.gov.mo/egi/portal/s/treaty/rights-of-child/treaty_en.htm >. however, see ulrich schroeter’s paper on the status of macau under the cisg, supra note 22. 38 john o. honnold held that according to article 7(1), good faith should be applied when interpreting the cisg. see, john o. honnold, uniform law for international sales under the 1980 united nations convention (3rd ed), kluwer law international, 1999, p.100. moreover, the view that good faith is one of the “ general principles” in article 7(2) has been held by many researchers, the secretariat of the uncitral and domestic judges and arbitrators. see, bonell, c. m. bianca & m. j. bonell (ed), commentary on the international sales law the 1980 vienna sales convention, giuffrèamilan, 1987, at 85. see also henry mather [u.s.], “ choice of law for international sales issues not resolved by the cisg” , 20 journal of law and commerce (spring 2001), pp.155-208; online version at < http://www.cisg.law.pace.edu/cisg/biblio/mather1.html>, part i, a. nives povrzenic [croatia], “ interpretation and gap-filling under the united nations convention on contracts for the international sale of goods” (1997 pace essay), online version at < http://www.cisg.law.pace.edu/cisg/text/gapfill.html>. the foreign cases supporting such viewpoint include: iccæäëû¹ú¼êéì»á/icc arbitration case no. 7331 of 1994, at <http://cisgw3.law.pace.edu/cases/947331i1.html> (“ [g]eneral principles of international commercial practice, including the principle of good faith, should govern the dispute. . . [f]or the present dispute, such principles and accepted usages are most aptly contained in the [cisg]. . . .” ); germany 5 october 1998 oberlandesgericht hamburg, [english translation available at <http://cisgw3.law.pace.edu/cases/981005g1.html>]. 10 japan had acceded to the cisg.35 another case is macau. in several cietac cases, the tribunals deemed that portugal was a contracting state of the cisg by mistake. since macau was under the jurisdiction of portugal before it was handed over by portugal to china on 20 december 1999, such tribunals held that the cisg applied to the cases between the parties from the mainland of china and macau.36 following china’s resumption of sovereignty over macau, one tribunal held that macau was under the jurisdiction of china and the cisg continued to be effective in macau when hearing the disputes between the parties from macau and other contracting states, which was also an example of applying the cisg in error.37 2. methodology of interpretation 2.1. good faith article 7(1) of the cisg provides for the principle of “ autonomous interpretation” , which requires that regard be given to the international character of the cisg and to the need to promote uniformity in its application. regretfully, however, the tribunals seldom referred to article 7(1). article 7(1) of the cisg also requires regard for the observance of good faith in international trade in the interpretation of the cisg, which gives rise to certain different understandings of good faith under the cisg.38 http://www.gov.mo/egi/portal/s/treaty/rights-of-child/treaty_en.htm http://www.cisg.law.pace.edu/cisg/biblio/mather1.html http://www.cisg.law.pace.edu/cisg/text/gaphttp://cisgw3.law.pace.edu/cases/947331i1.html http://cisgw3.law.pace.edu/cases/981005g1.html nordic journal of commercial law issue 2005 #2 39 for example, see: award of 26 march 1993 [cisg/1993/06] (cement case); award of 20 may 1999 [cisg/1999/24] (red tiles case). 40 award of 4 june 1999 [cisg/1999/28] (industrial raw material case).many researchers have also held that good faith is a principle directly binding upon the parties. see, bonell, c. m. bianca & m. j. bonell (ed), supra note 38, at 84; john klein [u.s.], “ good faith in international transactions” , 15 liverpool law review (1993), pp.115-141; online version at <http://www.cisg.law.pace.edu/cisg/biblio/klein.html >; phanesh koneru [india and the united states], “ the international interpretation of the un convention on contracts for the international sale of goods: an approach based o n g en er a l p r i nc i p le s” , 6 m i nn es o t a j o ur n a l of g l o b a l t r a de ( 1 9 9 7 ) , pp.1 05 -1 52 , onli ne versi on at < http://www.cisg.law.pace.edu/cisg/biblio/koneru.html>; franco ferrari [italy], “ uniform interpretation of the 1980 uniform sales law” , part iv, 24 georgia journal of international and comparative law (1994) 183-228, online version at <http://www.cisg.law.pace.edu/cisg/biblio/franco.html>; paul j. powers [u.s.], “ defining the indefinable: good faith and the united nations convention on contracts for the international sale of goods” , 18 journal of law and commerce (1999), pp.333-353, online version at < http://www.cisg.law.pace.edu/cisg/text/e-text-07.html >; peter schlechtriem, uniform sales law the un-convention on contracts for the international sale of goods, published by manz, vienna: 1986, commentary on article 7, online version at <http://www.cisg.law.pace.edu/cisg/biblio/schlechtriem-7.html>& peter schlechtriem [germany], “ good faith in german law and in international uniform laws” , in: centro di studi e ricerche di diritto comparato e straniero diretto da m. j. bonell, saggi, conferenze e seminari no. 24 (february 1997); online version at < http://soi.cnr.it/~crdcs/crdcs/schlechtriem.htm >; troy keily [australia], “ good faith and the vienna convention on contracts for the international sale of goods” , in: vindobona journal of international law and arbitration, issue 1 (1999), pp.15-40, online version at <http://www.cisg.law.pace.edu/cisg/biblio/keily.html >. john felemegas held that the roles of good faith under article 7(1) and 7(2) should be distinguished. see, john felemegas [australia], “ the united nations convention on contracts for the international sale of goods: article 7 and uniform interpretation” , pace review of the convention on contracts for the international sale of goods (cisg), kluwer law international (2000-2001), pp.115-265; online version at <http://www.cisg.law.pace.edu/cisg/biblio/felemegas.html>. chapter 3, 5. 41 award of 11 february 2000 [cisg/2000/02] (silicon metal case). 42 e.g., award of 8 april [cisg/1999/21] (wool case); award of 7 january 2000 [cisg/2000/06] (cysteine case); award of 7 march 2002 [cisg/2002/01] (lube oil case). 11 in some cietac awards, good faith was just generally mentioned as a requirement for parties to comply with.39 for example, in one case, a u.s. buyer rejected the documents and requested a chinese seller to reduce the price because of a clerical error made by the carrier on the bill of lading (hereinafter referred to as “ b/l” ). the tribunal held that the error was not so substantial as to make this breach fundamental and that the buyer should accept the goods according to the principle of good faith.40 in another case, the tribunal treated good faith as an interpreting criterion for the tribunal to apply. it was a case between a mainland seller and a hong kong buyer, in which the tribunal was of the view that under the term cfr the buyer’s obligation to establish the letter of credit (hereinafter referred to as “ l/c” ) should not be rigidly interpreted as conduct to be completed before he received the notification of preparation of the goods from the seller, otherwise it would go against the requirements to observe good faith in international trade in article 7(1) of the cisg.41 2.2. gap filling according to the aforesaid article 142 paragraphs 2 and 3 of the gpcl, the cisg itself is regarded as a source of law for filling gaps in the prc laws. however, the gap filling to be discussed here is to fill the gaps in the cisg according to article 7(2). article 7(2) provides that questions concerning matters governed by the cisg which are not expressly settled in it are to be settled in conformity with the general principles on which it is based or, in the absence of such principles, in conformity with the law applicable by virtue of the rules of private international law. however, the tribunals tended to jump directly to the law applicable by virtue of the rules of private international law, and eventually the prc laws.42 http://www.cisg.law.pace.edu/cisg/biblio/klein.html http://www.cisg.law.pace.edu/cisg/biblio/koneru.html http://www.cisg.law.pace.edu/cisg/biblio/franco.html http://www.cisg.law.pace.edu/cisg/text/e-text-07.html http://www.cisg.law.pace.edu/cisg/biblio/schlechtriem-7.html http://soi.cnr.it/~crdcs/crdcs/schlechtriem.htm http://www.cisg.law.pace.edu/cisg/biblio/keily.html http://www.cisg.law.pace.edu/cisg/biblio/felemegas.html nordic journal of commercial law issue 2005 #2 43 e.g., award of post-1989 [cisg/1990/01] (cloth wind coats case); award of 23 december 1996 [cisg/1996/57] (carbazole case); award of 31 july 1997 [cisg/1997/24] (axle sleeves case). 44 see, award of june 1999 [cisg/1999/03] (peanut kernel case). in this case, a dutch buyer argued that the practice between the two parties was that the buyer might establish the l/c after he and the chinese seller inspected the goods together and agreed on the quality of the goods. however, their written contract required the buyer to issue the l/c without these preconditions. the tribunal finally held: “ even if, during their long term cooperation, both parties have followed the practice of inspecting goods first and applying for a l/c later, the written provisions contrary to that practice that are set forth in the contract shall prevail over a default inference of practice.” 45 e.g., award of 18 december 1996 [cisg/1996/56] (lentils case); award of 8 april [cisg/1999/21] (wool case). 46 e.g., award 23 april 1995 [cisg/1995/07] (australian raw wool case). 12 2.3. usage and practices practices established between the parties would be binding upon the parties when they had been found established.43 uncommonly, in one case the tribunal held that the written contract should prevail over the practice when the provisions in the contract differed from their practice.44 with regard to the usages in international trade, such as incoterms and ucp 500, the tribunals would normally apply them when applicable, however, in most case relying upon article 142 of the gpcl or article 5 in the lecfi instead of article 9 of cisg.45 sometimes the usage of a particular industry might also be invoked by one party to support his claims, and the tribunal would require the party to prove the said usage to meet the requirements under article 9(2) of the cisg that the usage was “ widely known to, and regularly observed by, parties to contracts of the type involved in the particular trade concerned” .46 3. formality, conclusion and alteration of the contract 3.1. china’s reservation on article 11 china has declared a reservation on article 11 according to article 96 of the cisg. pursuant to article 12, article 11, article 29 or part ii of the cisg that allow a contract of sale or its modification or termination by agreement or any offer, acceptance or other indication of intention to be made in any form other than in writing does not apply when one party is in china. china’s aforesaid reservation was consistent with article 7 of the lecfi, which provided that the contract is concluded by the parties when they have reached a written agreement on the terms and have signed the contract. this position reflected the attitude of chinese legislators at that time toward contracts involving foreign elements, possibly because there were not many such contracts and they were often concerned with material economic interests. however, more than one decade later, the lecfi was superseded by the contract law, of which article 10 provides that a contract may be entered into by parties in writing, oral or other forms unless the relevant laws and regulations require or the parties agree to employ written form. article 36 of the contract law further provides that, notwithstanding that written form is required under relevant laws and regulations, or agreed on by parties, if one party has implemented its major obligations and the other party has accepted its performance, the contract has been concluded even though no written form is used. the chinese legislators’ attitude towards the formality of contracts has changed to give parties more freedom of choice and meet the ever-changing needs in practice. nordic journal of commercial law issue 2005 #2 47 liu chao [china] baoliu, or chehui? – ping woguo dui lianheguo guoji huowu xiaoshou hetong gongyue di 11 tiao de baoliu [maintenance, or withdrawal? – comments on china’s reservation for article 11 of the cisg – in chinese], in: nanjing jingji xueyuan xuebao [journal of nanjing university of economics], nanjing (2001.3), 63-65. also see, ding wei, in cisg di 11 tiao de baoliu ying fou chehui [should china’s reservation for article 11 of cisg be withdrawn? in chinese], in: faxue [law science], beijing (1999.7), 22-27. wang jiwen [china], woguo dui lianheguo guoji huowu xiaoshou hetong gongyue de baoliu wenti [on the china’s reservation of the cisg – in chinese], in: jiangxi caijing daxue xuebao [journal of jiangxi university of finance and economics], nanchang (2004.2), no.32, 79-82. 48 in a discussion published as cisg di 11 tiao de baoliu ying fou chehui [should china’s reservation for article 11 of cisg be withdrawn? in chinese], in: faxue [law science], beijing (1999.7), 22-27, si pingping was of the view that reservation on article 11 excluded the obligation to accept contracts not concluded by writing but the reservation per se did not obligate china to exclude the validity of contract not concluded by writing. therefore, if the contract law employed the new attitude, the prc courts might replied on it to admit the non-written contracts without withdrawing the reservation on article 11. zhu lanye also opined that there was no need to withdraw the reservation because the reservation excluded article 11 of the cisg and made the formality of contracts determined by the applicable law. ding wei’s viewpoint was that under the existing reservation international sales contracts are still required to be concluded by writing unless china withdraws its reservation. 49 award of 17 october 1996 [cisg/1996/47] (tinplate case). see, also: award of 29 september 1997 [cisg/1997/28] (oxidized aluminum case); award of 31 december 1997 [cisg/1997/37] (lindane case). 50 award of 6 september 1996 [cisg/1996/42] (engines case). 51 in award of 30 june 1999 [cisg/1999/30] (peppermint oil case), the two parties disputed on the conclusion of contract. the buyer provided a contract with his signature, but the seller alleged that such signature was later added in by the buyer merely for the arbitration. the tribunal dismissed the seller’s allegation because he did not provide persuasive evidences and ruled that the contract concluded. however, to make its decision better established, the tribunal in addition listed the facts that both parties had implemented their obligations under the contract as further proof. 52 award of 25 december 1998 [cisg/1998/11] (basic pig iron case). 13 china, however, has not withdrawn its reservation on article 11 of the cisg after the contract law came into force. although the cisg may be interpreted as “ law” for the purpose of article 36 of the contract law and thus regarded as reconciling article 36 of the contract law and china’s reservation under the cisg, an inconsistency still exists and there seems to be no uniform opinion and practices on it. accordingly, some chinese researchers suggest that this reservation should be withdrawn,47 while some other researchers maintain that there is no need withdrawing the reservation.48 in a cietac case, the tribunal held that, according to china’s reservation on article 11 the modification of the contract proposed by one party via fax did not become effective because the other party did not respond to the proposal.49 similarly, the tribunal in another case accepted only the written materials evidencing the parties’ original agreements in respect of the disputed parts of goods (subassemblies of engines) and declined the non-written evidences, based on china’s reservation on article 11 of the cisg.50 however, no cietac cases have been reported since the entry into force of the contract law in which mere non-written agreements are recognized under the cisg by the tribunals.51 3.2. offer and acceptance according to article 14(1) of the cisg, a proposal must be sufficiently definite to constitute an offer, which requires it to indicate the goods and expressly or implicitly fix or makes provision for determining the quantity and the price. in an interesting case between a chinese seller and a swiss buyer,52 the contract provided that, after a specific date agreed on, the seller should deliver 20,000 tons of pig iron with the price to be negotiated by the parties, of which 10,000 tons of the goods were specified to be basic pig iron and the other 10,000 tons of goods “ either basic pig iron or foundry pig iron” . the dispute over nordic journal of commercial law issue 2005 #2 53 award of 10 june 2002 [cisg/2002/02] (rice agricultural products case). 54 e.g., award of 26 june 1997 [cisg/1997/17] (monohydrate zinc sulfate case); award of 29 september 1997 [cisg/1997/28] (oxidized aluminum case); award of 16 december 1997 [cisg/1997/35] (hot dipped galvanized steel coils case); award of 19 december 1997 [cisg/1997/36] (steel case). 55 award of 1 april 1993 [cisg/1993/02] (steel products case). 56 award of 23 february 1995 [cisg/1995/01] (jasmine aldehyde case). 14 whether the contract had been concluded with regard to the second 10,000 tons of goods was one of the key issues of this case. though not explicitly stated, the parties maintained and the tribunal held that the contract might be divided. to analyze whether the part of contract on the second 10,000 tons of goods had been concluded, by referring to article 14(1), the tribunal decided that since the goods had not been specified, the proposal with regard to the second 10,000 tons of goods was not sufficiently definite; this meant that this part of the contract was not concluded. as regards the first 10,000 tons of goods, the tribunal held that the part of the contract pertaining to them had been concluded, and the way to determine the price had also been expressly stipulated, i.e., “ price to be mutually agreed between the parties” , so as to exclude the application of article 55 of the cisg. article 19 of the cisg sets forth how to determine whether a reply to an offer constitutes an acceptance or a counter-offer. in one case between a chinese seller and a swedish buyer under the term fob,53 the buyer in his reply to the seller modified certain provisions in respect of the shipment, e.g., the requirement of the age of ship, to which the seller did not object in time but later argued this had materially altered the offer and refused to implement the contract. the tribunal held that, this modification was not material because under fob it was the buyer’s obligation to arrange the shipment. as the seller objected with undue delay, the reply was deemed a valid acceptance and the contract was concluded. 3.3. modification and termination of the contract the parties may reach agreement to modify or terminate a contract under article 29 of the cisg. considering china’s reservation on article 11, only written modification and termination are permitted. fax as one of the forms of writing is frequently employed during the negotiation process; therefore, the tribunal may find the parties’ intention from faxes to each other. without a written response, a receiver’s mere silence is not deemed as acceptance of the sender’s proposal of modification or termination.54 with regard to the meeting of minds during the negotiation between the parties on the modification or termination of the contract, one tribunal held that article 19 should apply.55 the parties may modify a contract by way of entering into a supplemental agreement. a chinese seller and a u.s. buyer reached a compensation agreement specifying the amount and forms of compensations.56 the tribunal decided that the cisg applied to the whole case and made relevant adjustment to the compensation agreed in the compensation agreement according to the cisg. nordic journal of commercial law issue 2005 #2 57 for examples, see: award of 18 april 1991 [cisg/1991/01] (silicate-iron case); award of 4 september 1996 [cisg/1996/41] (natural rubber case); award of 10 october 1996 [cisg/1996/45] (petroleum coke case); award of 15 november 1996 [cisg/1996/52] (oxytetracycline hcl case); award of 23 april 1997 [cisg/1997/07] (groundnut case); award of 24 april 1997 [cisg/1997/09] (oxidized aluminum case); award of 10 july 1997 [cisg/1997/21] (carbamide case); award of 30 november 1997 [cisg/1997/33] (canned oranges case); award of 1 february 2000 [cisg/2000/01] (silicon and manganese alloy case). 58 e.g., award of 5 september 1994 [cisg/1994/10] (equipment case); award of 22 january 1996 [cisg/1996/04] (palm oil case); award of 4 april 1997 [cisg/1997/04] (black melon seeds case); award of 18 august 1997 [cisg/1997/26] (vitamin c case); award of 27 july 2000 [cisg/2000/03] (steel scraps case); award of 10 august 2000 [cisg/2000/04] (silicon metal case). 59 e.g., award of 2 april 1999 [cisg/1999/18] (grey cloths case). in this case, the buyer claimed that the seller did not deliver the goods (grey cloths) according to the contract, and the seller alleged that he had delivered to a third party for dyeing as instructed by the buyer. the tribunal supported the seller’s position based on relevant evidences. 60 award of 11 april 1994 [cisg/1994/06] (old paper case). 15 4. obligations of the seller and remedies of the buyer (except for damages) 4.1. obligations of the seller 4.1.1. delivery of the goods under article 30 of the cisg, which summarizes the seller’s obligations, the seller’s essential obligation is to deliver the goods. this is one major topic of disputes before the cietac tribunals. obviously, when the seller did not deliver the goods at all, the tribunal would easily find that he had breached the contract,57 sometimes explicitly indicating such failure constituted a fundamental breach.58 however, in some cases, when foreign trade agents or other third parties are involved, the situation might become a little complicated.59 4.1.2. handing over the documents relating to the goods in international trade, documents relating to the goods, especially the b/l which is normally deemed as representing the title to the goods, are essential to the buyer. to hand over the documents in some cases may substitute for the specific delivery of the actual goods, therefore constituting another main obligation of the seller. such documents shall conform to the stipulations in the contract. in one case where the term cif was selected by the parties, the seller handed over the b/l for some installments of goods with the freight unpaid, which was found by the tribunal as a breach of contract.60 as the l/c and b/l are frequently used in international trade, the obligation of seller to hand over a b/l conforming to the requirements set out in the l/c is always connected with whether the seller has fulfilled his obligations and whether the buyer shall pay. the arrangement of the l/c itself constitutes an independent legal relationship between parties thereto. when the tribunal is hearing a dispute between the buyer and seller arising from the sales contract, whether the documents presented by the seller and alleged by the bank as non-conforming are nonconforming or not, is still subject to the stipulations of the sales contract. for instance, a chinese buyer refused to pay the price by alleging that an austrian seller did not provide a set of conforming b/ls under the arrangement of the l/c, but the tribunal held that the nonconformity in the b/l was not fundamental in the context of the sales contact and the buyer had nordic journal of commercial law issue 2005 #2 61 award of 15 february 1996 [cisg/1996/10] (hot-rolled plates case). 62 award of 25 june 1997 [cisg/1997/16] (art paper case). 63 such as: award of 22 may 1996 [cisg/1996/25] (broadcasting equipments case); award of 25 november 1996 [cisg/1996/02] (chromium ore case). 64 such as: award of 18 september 1996 [cisg/1996/43] (agricultural products case). 65 see, award of 26 october 1996 [cisg/1996/49] (cotton bath towel case). in this case, because no sample was sealed up by the parties together, the tribunal eventually found the goods (cotton bath towels) non-conforming for not fitting for purposes for the goods of the same description ordinarily used according to article 25(2)(a). see, also: award of 22 march 1995 [cisg/1995/05] (costumes case). 66 e.g., award of 5 september 1994 [cisg/1994/10] (equipment case). 67 see, uncitral digest of case law on the cisg, article 35, a/cn.9/ser.c/digest/cisg/35, paragraph 9, at <http://www.uncitral.org/uncitral/en/case_law/digests/cisg.html>. 68 award of 10 july 1993 [cisg/1993/09] (heliotropin case). 69 article 62(2) of the contract law may to some extent be of reference. it provides that the national or industrial standards for qualities of goods shall apply, where the contract does not provide the qualities of goods, the parties cannot reach supplementary agreement and the relevant article in the contract and their trade practice cannot help to specify the requirements of qualities. 70 award of 8 march 1996 [cisg/1996/12] (old boxwood corrugated carton case). 16 no basis to declare the contract avoided.61 a similar case between a chinese buyer and a korean seller was also reported.62 4.1.3. conformity of the goods in addition to non-delivery of goods, another frequently-seen breach is the delivery of nonconforming goods by the seller. under article 35 of the cisg, the goods delivered by the seller shall conform with the contract in quantity, quality, description, package and other aspects. the cietac tribunals in different cases have found various situations in which the goods delivered did not conform with the contract, the quality of the goods not conforming to the contractual requirements being an oft-found example.63 if a sample of goods had been accepted and confirmed by the parties, the goods should possess the qualities of the sample.64 if, however, no sample had been considered by the parties, the tribunal would be inclined to employ other criteria, such as those set out in article 35(2)(a) of the cisg.65 if the contract provided for special descriptions of goods, such as the origin or the manufacture time, the goods should conform with such descriptions.66 though not explicitly stated, article 35(2)(a) may be used by the tribunal as the basis to pronounce certain quality standards, which was also found in other contracting states.67 in one case decided in 1993,68 the tribunal held that the qualities of goods should conform with not only the contract, but also the national or industrial standards of the origin of goods, and the qualities published or declared by the manufacturer.69 in another case, the tribunal tried to refer to international quality standards when examining the validity of the inspection report.70 special packaging and shipment might be required according to the chemical characteristics of the goods. in one case of a chinese seller selling heliotropin (jasmine aldehyde) to a u.s. firm under the term cif, the seller needed to package the goods under a certain temperature and ship them as soon as practical. however, the seller did not comply with the contract, resulting in the loss of http://www.uncitral.org/uncitral/en/case_law/digests/cisg.html nordic journal of commercial law issue 2005 #2 71 award of 23 february 1995 [cisg/1995/01] (jasmine aldehyde case). 72 award of 20 january 1994 [cisg/1994/02] (hydraulic press machine case). 73 award of 16 july 1996 [cisg/1996/31] (hot-rolled steel plates case). 74 award of 29 march 1999 [cisg/1999/14] (flanges case). also see, award of 30 march 1999 [cisg/1999/16] (flanges case). 75 see, award of 4 august 1988 [cisg/1988/01] (calculator assembly parts case); award of 12 december 1994 [cisg/1994/14] (sunflower seeds and groundnut case); award of 16 may 1995 [cisg/1995/10] (leather suitcases case); award of 31 july 1996 [cisg/1996/34] (sport shoes case); award of 18 september 1996 [cisg/1996/43] (agricultural products case); award of 26 june 1997 [cisg/1997/17] (monohydrate zinc sulfate case); award of 13 october 1997 [cisg/1997/30] (printing machine case); award of 5 april 1999 [cisg/1999/19] (air conditioner equipments case). 76 award of 28 september 1996 [cisg/1996/44] (gloves case). 77 article 41 provides: “ if a dispute over the understanding of the standard terms occurs, it shall be interpreted according to general understanding. where there are two or more kinds of interpretation, an interpretation unfavorable to the party supplying the standard terms shall be preferred. where the standard terms are inconsistent with non-standard terms, the latter shall be adopted.” 17 goods. the tribunal decided that the goods did not conform to the contract and the seller was in breach.71 when the buyer has known or could not have been unaware of the lack of conformity of goods at the time of the conclusion of the contract, the seller under article 35(3) is not liable for such lack of conformity. in one case, a chinese buyer had bought before from an italian seller the same type of machine with the same defects.72 as in the present case the buyer did not specify in the sales contract that such defects should be excluded, the tribunal therefore decided that, according to article 35(3), the buyer should have known of such defects and the seller was not liable for this. the seller, under article 36 of the cisg, is liable for any lack of conformity existing at the time the risk passes to the buyer.73 in one case, the tribunal distinguished between evident superficial defects and latent defects of goods.74 the tribunal was of the view that with regard to the evident superficial defects, the buyer should raise his objection within a reasonable period of time according to article 38 and article 39(1); with regard to the latent defects, the buyer was entitled to raise his objection according to article 39(2). 4.1.4. buyer's duty to examine the goods and give timely notice the duty of buyer to examine the goods and give a timely notice of lack of conformity of the goods under article 38 and 39 of the cisg is related to the non-conformity of goods discussed. according to article 38(1) of the cisg, the buyer shall examine the goods within as short a period as is practical in the circumstances. when no examination had been carried out within a practicable period of time according to article 38 and the goods had been taken, the buyer would be deemed by the tribunal as having waived his right of examination.75 when examination had been made, it should be done within as short a period as is practical. in one case, considering that the distance between the unloading place and the examination place was about one day’s ride, the tribunal accepted the examination report completed within three to four days after unloading.76 within the period provided by the contract or deemed reasonable according to article 39(1), the buyer may have raised certain defects of goods, but it is not clear whether the buyer is required to notify the seller of all of the defects. on this point, in one case the tribunal has held that this is a gap of the cisg. by referring to article 41 of the contract law7 7 and article 4.6 of the nordic journal of commercial law issue 2005 #2 78 article 4.6 “ contra proferentem rule” provides: “ if contract terms supplied by one party are unclear, an interpretation against that party is preferred.” 79 award of 7 january 2000 [cisg/2000/06] (cysteine case). 80 e.g., award of 20 february 1994 [cisg/1994/03] (cysteine case); award of 31 july 1997 [cisg/1997/24] (axle sleeves case). 81 e.g., award of 23 february 1995 [cisg/1995/01] (jasmine aldehyde case). 82 e.g., award of 7 may 1997 [cisg/1997/12] (horsebean case). 83 see, award of 5 july 1993 [cisg/1993/08] (copperized steel pipes case); award of 6 september 1996 [cisg/1996/42] (engines case); award of 23 july 1997 [cisg/1997/23] (polypropylene case); award of 30 march 1999 [cisg/1999/17] (electric heater case); award of 20 april 1999 [cisg/1999/23] (filling machine case). 84 article 18 of the lecfi provides: “ if a party fails to perform the contract or its performance of the contractual obligations does not conform to the agreed terms. which constitutes a breach of contract, the other party is entitled to claim damages or demand other reasonable remedial measures. if the losses suffered by the other party cannot be completely made up after the adoption of such remedial measures, the other party shall still have the right to claim damages.” 18 unidroit principles of international commercial contracts,78 the tribunal decided that the clause in the contract should be interpreted against the seller who prepared the contract and recognized the buyer’s additional allegations of defects of goods after the period provided for in the contract had expired.79 when the buyer resold the goods without examination, some tribunals held that the buyer had given up the right to examine the goods and had accepted the goods.80 however, in other cases in which the goods at the destination were directly delivered to the end user or sub-buyer, some tribunals decided that the buyer might still be entitled to raise his objection in respect of the qualities of goods if the examination was done according to article 38.81 in some cases, the subbuyer’s right of examination might be directly provided for in the contract and thus supported by the tribunal.82 articles 38(2) and 38(3) of the cisg were also frequently invoked by the cietac tribunals, especially in cases in which the goods after arriving at the ports of china would be further transported to some inland destination.83 4.2. remedies of the buyer (except for damages) as damages is the remedy most frequently claimed and ruled on in the cietac awards, this essay will discuss it separately in the following part ii.6. therefore, the remedies of the buyer discussed here and of the seller discussed in part ii.5.2 will be those provided in the cisg except for damages. 4.2.1. specific performance in the case of the seller in breach and the buyer claiming specific performance according to article 46(1), article 28 of the cisg allows judges or arbitrators to order specific performance according to the lex fori. article 18 of the lecfi84 did not explicitly provide for the remedy of specific nordic journal of commercial law issue 2005 #2 85 for the comparative study on specific performance under the cisg and gpcl, lecfl and economic contract law of the people’s republic of china, see: shen, jianming [china]: the remedy of requiring performance under the cisg and the relevance of domestic rules, in: 13 arizona journal of international and comparative law (1996), pp. 253-306, online version at < http://www.cisg.law.pace.edu/cisg/biblio/shen1.html#a1 >. 86 article 110 of the contract law provides: “ where one party to a contract fails to perform the non-monetary debt or its performance of non-monetary debt fails to satisfy the terms of the contract, the other party may request it to perform it except under any of the following circumstances: it is unable to be performed in law or in fact; the object of the debt is unfit for compulsory performance or the performance expenses are excessively high; or the creditor fails to request for the performance within a reasonable time period.” 87 award of 30 october 1991 [cisg/1991/04] (roll aluminum case). 88 award of 20 january 1994 [cisg/1994/02] (hydraulic press machine case). 89 for the comparative study on avoidance of contract under the cisg and gpcl, lecfl and economic contract law of the people’s republic of china, see: shen, jianming [china]: declaring the contract avoided: the u.n. sales convention in the chinese context, in: 10 new york international law review (1997), pp. 7-57, online version at < http://www.cisg.law.pace.edu/cisg/biblio/shen.html >. 90 such as: award of 25 february 1993 [cisg/1993/05] (terylene draw-texturing machine case); award of 20 july 1993 [cisg/1993/10] (shaping machine case); award of 25 october 1994 [cisg/1994/13] (high tensile steel bars case); award of 22 january 1996 [cisg/1996/04] (palm oil case); award of 23 december 1996 [cisg/1996/57] (carbazole case); award of 5 august 1997 [cisg/1997/25] (cold-rolled coils case); award of 29 january 2000 [cisg/2000/08] (steel bottle case). 91 see, award of 6 april 1994 [cisg/1994/05] (printing machine case); award of 22 may 1996 [cisg/1996/25] (broadcasting equipments case); award of 18 august 1997 [cisg/1997/26] (vitamin c case); award of 19 december 1997 [cisg/1997/36] (steel case). 19 performance but only the “ damages and other reasonable remedial measures” .85 however, the contract law in its article 11086 provides for the remedy of specific performance. nevertheless, maybe because of the international character of international sales contracts and the relevant obstacles for specific performance, there are only a few cietac awards in which specific performance as a remedy had been granted to the buyer. one case was reported in which the tribunal decided that the contract should continue to be performed and the seller should deliver the goods.87 4.2.2. to require repair under article 46(3), the buyer may require the seller to remedy the lack of conformity by repair. in the aforesaid case between the chinese buyer and the italian seller in part ii.4.1.3, the seller was found not liable for the defects of goods under article 35(3); however, the tribunal required the seller to repair the machine by replacing a new part at his own cost, while dismissing the other claims of buyer.88 4.2.3. to declare the contract avoided the buyer under article 49 of the cisg may declare the contract avoided. if the contract is declared avoided, the parties shall perform their obligations under articles 81 to 84. especially if both parties have performed the contract, in principle the seller shall reimburse the price to the buyer and the buyer shall return the goods to the seller.89 the typical circumstance is that the seller is in fundamental breach so that the buyer is entitled to declare the contract avoided under article 49(1)(a).90 in such cases, article 25 was frequently invoked to check whether the seller was in fundamental breach.91 http://www.cisg.law.pace.edu/cisg/biblio/shen1.html#a1 http://www.cisg.law.pace.edu/cisg/biblio/shen.html nordic journal of commercial law issue 2005 #2 92 award of 22 march 1995 [cisg/1995/05] (costumes case). 93 article 29 of the lecfi provided: “ a party shall have the right to notify the other party that a contract is rescinded in any of the following situations: (1) if the other party has breached the contract, thus adversely affecting the economic benefits they expected to receive at the time of the conclusion of the contract… ” for readers’ reference, article 94 of the contract law is cited as follows: “ the parties to a contract may rescind the contract under any of the following circumstances: (1) the purpose of the contract is not able to be realized because of force majeure; (2) one party to the contract expresses explicitly or indicates through its acts, before the expiry of the performance period, that it will not perform the principal debt obligations; (3) one party to the contract delays in performing the principal debt obligations and fails, after being urged, to perform them within a reasonable time period; (4) one party to the contract delays in performing the debt obligations or commits other acts in breach of the contract so that the purpose of the contract is not able to be realized; or (5) other circumstances as stipulated by law.” though no “ fundamental breach” is explicitly used, its item (4) is deemed as similar to article 25 of the cisg to certain extent. 94 award of 25 june 1997 [cisg/1997/16] (art paper case). 95 see, award of 22 march 1995 [cisg/1995/05] (costumes case); award of 24 april 1997 [cisg/1997/09] (oxidized aluminum case). 96 e.g., award 23 april 1995 [cisg/1995/07] (australian raw wool case); award of 10 october 1996 [cisg/1996/45] (petroleum coke case); award of 1 february 2000 [cisg/2000/01] (silicon and manganese alloy case). 97 e.g., award of 15 february 1996 [cisg/1996/10] (hot-rolled plates case); award of 30 april 1997 [cisg/1997/10] (ferromolybdenum alloy case). 98 e.g., award of 17 april 1996 [cisg/1996/19] (gas purifiers case). 20 in one case in which a chinese seller sold down wear to a czech buyer at a comparatively low price, the tribunal held what the buyer was entitled to expect under article 25 should be goods conforming with the contract or the profits the buyer might get by resale.92 if the qualities of goods, especially the percentage of the down wadded in, conformed to the standards as claimed by the buyer, the price would have been several times higher than that in the contract. considering the level of price, the tribunal decided that the goods that the buyer was entitled to expect were just those consistent with such price. to weigh the extent of the seller’s breach, the tribunal further interpreted the word “ substantially” (“ shizhixing de” – in chinese pinyin) in article 25 as “ mostly” (“ dabufen de” – in chinese pinyin) or “ basically” (“ jibenshang” – in chinese pinyin). however, in another case, the tribunal when analyzing whether the seller was in fundamental breach relied more upon the provision in article 29(1)93 of the lecfi than article 25 of the cisg, which to some extent is not in accordance with the autonomous interpretation required by article 7(1) of the cisg.94 in addition, pursuant to article 26 of the cisg, a declaration of avoidance of the contract may not be effective without notice to the other party, which was also decided in some cietac cases.95 when the seller wrongly deemed the buyer in fundamental breach and declared the contract avoided so as to reject the delivery of the goods, the seller himself might be exposed to the risk of being found in fundamental breach by the tribunal.96 correspondingly, the buyer is also at his own risk to judge whether the seller is in fundamental breach when the buyer declines to perform his obligation to pay the price.97 when the seller has delivered the goods, the buyer would lose his right to declare the goods avoided, but the buyer might still have opportunities to do so under the exceptions provided for under article 49(2)(b)(i), especially if the goods have defects.98 the buyer may also according to article 47(1) fix an additional grace period for the seller to perform his obligations, at the nordic journal of commercial law issue 2005 #2 99 such as: award of 15 november 1996 [cisg/1996/52] (oxytetracycline hcl case). 100 award of 5 september 1994 [cisg/1994/10] (equipment case). 101 award of 19 september 1994 [cisg/1994/11] (steel case). 102 award of 25 december 1998 [cisg/1998/10] (basic pig iron case). 103 e.g., award of 23 december 1996 [cisg/1996/57] (carbazole case). 104 e.g., award of 22 may 1996 [cisg/1996/25] (broadcasting equipments case); award of 27 july 2000 [cisg/2000/03] (steel scraps case). 105 e.g., award of 30 october 1991 [cisg/1991/04] (roll aluminum case); award of 30 november 1998 [cisg/1998/08] (glassware case); award of 27 july 2000 [cisg/2000/03] (steel scraps case).also see, award of 30 march 1999 [cisg/1999/17] (electric heater case). in this case, the seller was not found in fundamental breach. the tribunal decided that the reduction of price should be adopted. when the seller refunded the reduced part of price, the tribunal held that he under article 84(1) should pay relevant interests. 106 such as: award of 8 august 1996 [cisg/1996/36] (diaper machine case); award of 9 august 1996 [cisg/1996/37] (shirts case); award of 18 september 1996 [cisg/1996/43] (agricultural products case); award of 28 september 1996 [cisg/1996/44] (gloves case); award of 20 april 1999 [cisg/1999/23] (filling machine case); award of 21 may 1999 [cisg/1999/26] (excavating machine case). 107 award of 30 march 1999 [cisg/1999/17] (electric heater case). 21 expiration of which the buyer may further declare the contract avoided under article 49(1)(b) or 49(2)(b)(ii) when applicable.99 in a case, a swiss seller only delivered parts of goods at the expiration of the additional period fixed by the buyer, and the tribunal decided that the buyer might declare the contract avoided.100 a similar case was reported with respect to a contract for sale of steel between a chinese buyer and an italian seller.101 in considering whether the buyer had to send a notice to the seller to declare the contract avoided at the expiration of the additional period of time, one tribunal was of the view that it was not necessary as the buyer had explicitly indicated his intention when he granted the seller such additional period.102 if the buyer has successfully declared the contract avoided, under article 81(2) and article 84 of the cisg, when the parties have performed the contract, the buyer is obligated to return the goods to the seller with accounting to the seller for benefits it has derived from the goods103 and the seller is obligated to return the price to the buyer with the payment of certain interest.104 the seller’s obligation to pay interest on the refundable price under article 84 is to some extent different from the duty of the seller to pay interest under article 78.105 the buyer may in addition according to article 45(2) claim damages according to articles 74 to 77, which will be discussed separately in following part ii.6. 4.2.4. to reduce the price the buyer’s right to reduce the price when the goods did not conform with the contract under article 50 of the cisg has been supported by the tribunals in a number of cietac awards.106 in one case, the buyer claimed damages, but the tribunal found that the evidence and basis provided by the buyer for his claim for damages were not sufficient and voluntarily pursuant to article 50 decided on the reduction of price as the reasonable remedy in such circumstances.107 nordic journal of commercial law issue 2005 #2 108 such as: award of 23 april 1997 [cisg/1997/07] (groundnut case); award of 30 april 1997 [cisg/1997/10] (ferromolybdenum alloy case); award of 22 may 1997 [cisg/1997/13] (soybean oil case); award of 26 june 1997 [cisg/1997/17] (monohydrate zinc sulfate case); award of 21 july 1997 [cisg/1997/22] (yam-dyed fabric case); award of 16 december 1997 [cisg/1997/35] (hot dipped galvanized steel coils case); award of 6 january 1999 [cisg/1999/04] (wool case); award of 12 february 1999 [cisg/1999/08] (chrome plating machine case); award of 12 february 1999 [cisg/1999/09] (nickel plating machine case); award of 1 march 1999 [cisg/1999/12] (canned oranges case); award of 8 april [cisg/1999/21] (wool case); award of 31 december 1999 [cisg/1999/32] (steel coil case). 109 e.g., award of 15 february 1996 [cisg/1996/10] (hot-rolled plates case); award of 16 june 1997 [cisg/1997/15] (leather case); award of 1 april 1997 [cisg/1997/02] (fishmeal case). 110 award of 25 june 1997 [cisg/1997/16] (art paper case). 111 award of 28 january 1999 [cisg/1999/06] (refrigerating machine case). 22 5. obligations of the buyer and remedies of the seller (except for damages) 5.1. obligations of the buyer 5.1.1. payment of the price under articles 53 and 54 of the cisg, one of the buyer’s main obligations is to pay the price for the goods. in international trade, the l/c is one of the most frequently used payment methods. when the contract provides a l/c as the payment method, the buyer is obligated to establish the l/c as required by the contract. if the buyer fails to issue the l/c, he will be found in breach by the tribunal.108 however, the issuance of the l/c is not the end of the buyer’s obligation to pay. according to the relevant international practice for an l/c, especially ucp 500 of the international chamber of commerce, the l/c agreement itself constitutes a legal relation that is separate from the sales contract between the seller and buyer. the reasons for which a bank declines to pay the seller, especially the non-conformity of the documents presented by the seller with the l/c, might not be directly relied on by the buyer, unless such non-conformity constitutes a breach of contract under the sales contract itself. therefore, when the buyer does not fulfill the obligation of payment eventually, even if the l/c has been issued, the buyer under the sales contract shall still pay the seller by means of the l/c or by substitute methods.109 for instance, in one case, the tribunal held that the non-conformity of documents with the l/c was not fundamental under the sales contract so that the buyer might not declare the contract avoided and the buyer should still pay the price when the method of payment by l/c became void.110 in another interesting case,111 even after the buyer had paid the money to the issuing bank, the buyer might still be obligated to pay the seller directly under the sales contract when the issuing bank was in insolvency to pay the seller. the tribunal in addition implied that it was the buyer’s duty to choose a reliable and solvent issuing bank. in general, the l/c shall arrive at the seller by the time of shipment. this obligation of the buyer was indicated in one case, in which on the expiration day of the issued l/c the buyer promised he would modify the l/c in the following days and requested the seller to ship the goods first, but the seller rejected shipment of the goods unless the l/c had been duly extended. the tribunal, referring to relevant international practice, works of some chinese and u.s. scholars and sections 2-325(1) and 5-106 of the uniform commercial code of u.s., decided that the seller was entitled to receive the formal l/c or formal notice from the issuing bank before shipment and had no duties nordic journal of commercial law issue 2005 #2 112 award of 18 december 1996 [cisg/1996/56] (lentils case). 113 award of 21 july 1997 [cisg/1997/22] (yam-dyed fabric case). 114 award 23 april 1995 [cisg/1995/07] (australian raw wool case). 115 e.g., award of 5 september 1994 [cisg/1994/10] (equipment case); award of 16 december 1997 [cisg/1997/35] (hot dipped galvanized steel coils case); award of 10 october 1996 [cisg/1996/45] (petroleum coke case). 116 award of 11 february 2000 [cisg/2000/02] (silicon metal case). 117 e.g., award of 30 march 1994 [cisg/1994/04] (boletus edulis case). 118 such as award of 14 february 1996 [cisg/1996/09] (bicycle case). 119 such as award of 26 november 1998 [cisg/1998/07] (old paper case). 120 e.g., award of 8 march 1996 [cisg/1996/13] (horsebean case); award of 16 august 1996 [cisg/1996/39] (dioctyl phthalate case); award of 25 november 1996 [cisg/1996/02] (chromium ore case); award of 18 december 1996 [cisg/1996/56] (lentils case). 23 to accept the buyer’s oral commitments.112 the buyer’s obligation to issue the l/c before shipment was stated in another case as well.113 however, how long before the shipment that the buyer should issue the l/c might differ in different cases. the tribunal once in one case decided that twelve days before the shipment was sufficient even if the seller alleged the practice to be at least fifteen days.114 moreover, the buyer might need to modify the l/c as to enable the seller to submit conforming documents and arrange the shipment, if the parties reached new agreements while implementing the contract, or under article 47 of the cisg, the buyer granted the seller an additional period of time to perform his obligations.115 however, the duty of seller to send notice of shipment was correspondingly deemed to be required under certain terms selected. for instance, in one case, the tribunal held that under the term cfr, the buyer might not modify the l/c until the seller notified the buyer of the shipment.116 with regard to the time of payment, article 58 of the cisg was invoked by the tribunal in one case to support the buyer’s claim for getting the documents for the goods and an opportunity to examine the goods before he paid the price.117 other payment methods, e.g., d/a (document against acceptance)118 and t/t (telegraphic transfer)119 may also be employed. in such cases, the buyer was also bound by article 54 of the cisg to pay the price in due manner. 5.1.2. taking delivery under articles 53 and 60 of the cisg, the buyer shall take all reasonable acts in order to enable the seller to make delivery and for the buyer to take delivery of the goods. the term fob is often used in international trade. according to incoterms 1990 and 2000 which were applied frequently in the cietac awards reported, under the term fob, the buyer shall contract at his own expense for the carriage of the goods from the named port of shipment to enable the seller to deliver the goods on board the vessel nominated by the buyer. when the buyer failed to nominate the vessel as required by the contract, he would be found in breach by the tribunal.120 the buyer’s failure to take delivery may also occur in other circumstances. in one case, a u.s. buyer refused to take delivery because he could not procure the necessary approvals of relevant nordic journal of commercial law issue 2005 #2 121 award of 7 may 1997 [cisg/1997/11] (sanguinarine case). 122 such as: award of 12 december 1994 [cisg/1994/14] (sunflower seeds and groundnut case); award of 16 may 1996 [cisg/1996/24] (cashmere sweaters case); award of 31 may 1996 [cisg/1996/27] (children’s jackets case); award of 15 october 1996 [cisg/1996/46] (canned chufa case); award of 13 january 1999 [cisg/1999/05] (latex gloves case). 123 e.g., award of 30 august 1996 [cisg/1996/40] (brake pads case); award of 15 october 1996 [cisg/1996/46] (canned chufa case); award of 15 december 1998 [cisg/1998/09] (shirts case); award of 28 january 1999 [cisg/1999/06] (refrigerating machine case); award of 25 february 1999 [cisg/1999/10] (cotton vest case); award of 25 february 1999 [cisg/1999/11] (women’s trousers case); award of 25 march 1999 [cisg/1999/13] (women’s trousers case); award of 28 may 1999 [cisg/1999/02] (veneer import case); award of 31 may 1999 [cisg/1999/27] (indium ingots case); award of 11 june 1999 [cisg/1999/29] (agricultural chemical products case); award of 30 june 1999 [cisg/1999/31] (axletree case); award of 16 may 1996 [cisg/1996/24] (cashmere sweaters case). 124 e.g., award of 18 december 1996 [cisg/1996/56] (lentils case); award of 28 november 1996 [cisg/1996/54] (molyoxide case). 125 such as: award of 1 march 1999 [cisg/1999/12] (canned oranges case). however, in this case, the tribunal invoked article 64(1)(a), which actually should be article 64(1)(b). 24 u.s. government agencies. after dismissing the buyer’s allegation of force majeure, the tribunal decided that the buyer was in fundamental breach of contract because of his failure to take delivery.121 5.2. remedies of the seller (except for damages) as mentioned above, the remedy of damages will be separately discussed in the following part ii.6 and only the other remedies of the seller decided in the cietac awards will be discussed here. 5.2.1. specific performance pursuant to article 62 of the cisg, the seller may require the buyer to perform the contract, with article 28 being taken into consideration as well. if the buyer had accepted the goods, the tribunals in many cases decided that the buyer should perform his obligations to pay the price when he was in breach.122 when the buyer was obligated to pay the price in arrears, besides the price, according to article 78 the tribunal would normally require the buyer to pay relevant interest to the seller at an annual rate ranging from 5% to 8%.123 5.2.2. to declare the contract avoided the seller may also declare the contract avoided according to article 64 of the cisg . when the buyer is in fundamental breach, e.g., refusing to pay the price, the seller may declare the contract avoided under article 64(1)(a)124. when the seller has granted the buyer an additional period of time to perform his obligations and the buyer does not do so at the expiration of such time, the seller may also declare the contract avoided pursuant to article 64(1)(b).125 in one case, after issuing the l/c, the buyer denied to accept the goods and the corresponding documents and requested a reduction of price by alleging that the documents did not conform with the l/c. the tribunal found the non-conformity in the documents was just a minor clerical error, and therefore decided that the buyer was in fundamental breach for denying the goods and allowed the seller to nordic journal of commercial law issue 2005 #2 126 award of 4 june 1999 [cisg/1999/28] (industrial raw material case). 127 e.g., award of 6 january 1999 [cisg/1999/04] (wool case). 128 award of 8 april [cisg/1999/21] (wool case). 129 award of 4 june 1999 [cisg/1999/28] (industrial raw material case). 130 v. knapp, c. m. bianca & m. j. bonell (ed), supra note 38, at 543. 25 declare the contract avoided.126 in such cases, when declaring the contract avoided the seller often at the same time claimed damages.127 article 26 of the cisg applies when the seller intends to declare the contract avoided. in one case, a fax notice sent by the seller to the buyer was deemed enough.128 and in an exceptional case, the tribunal held that when the buyer had apparently repudiated the contract, the seller need not send the notice to the buyer.129 6. damages of all the remedies available to the parties in the cisg, the remedy of damages is the most popular one claimed and ruled on by the cietac tribunals. under article 45(1)(b) of the cisg, the buyer may claim damages as provided in articles 74 to 77, and such right will not be excluded when he claims other remedies according to article 45(2). similar rights are provided for the seller in article 61(1)(b) and 61(2). 6.1. types of losses article 74 of the cisg generally provides an aggrieved party with damages consisting of “ a sum equal to the loss, including loss of profit, suffered … as a consequence of the breach.” according to some commentators, article 74 covers two main categories of losses to be compensated, i.e., the diminution of the aggrieved party’s property and his loss of profit.130 in the cietac awards reported, the losses of the aggrieved party for which damages awarded have also fallen into these two main categories. 6.1.1. diminution of the aggrieved party’s property in this category of losses, “ actual losses” or “ direct losses” , by which the tribunals used to describe certain losses already incurred, were awarded in a number of the cietac cases. price difference, as particularly provided for in articles 75 and 76 of the cisg, often appeared in the cietac cases reported, though with certain exceptional cases to be elaborated in the following sections. in addition, the author will also discuss the expenditures for arbitration as a separate type of loss since the damages for them were frequently awarded according to the arbitration rules of cietac. – “ actual losses” and “ direct losses” nordic journal of commercial law issue 2005 #2 131 e.g., award of 25 october 1994 [cisg/1994/13] (high tensile steel bars case). 132 e.g., award of 10 may 1996 [cisg/1996/22] (hot-rolled coils case). 133 e.g., award of 6 march 1997 [cisg/1997/01] (men’s shirts case). 134 e.g., award of 16 august 1996 [cisg/1996/39] (dioctyl phthalate case). 135 e.g., award of 16 august 1996 [cisg/1996/39] (dioctyl phthalate case). 136 e.g., award of 6 march 1997 [cisg/1997/01] (men’s shirts case). 137 e.g., award of 7 july 1997 [cisg/1997/20] (isobutyl alcohol case). 138 e.g., award of 7 january 2000 [cisg/2000/06] (cysteine case). 139 e.g., award of 10 october 1996 [cisg/1996/45] (petroleum coke case). 140 e.g., award of 18 september 1996 [cisg/1996/01] (lanthanide compound case); award of 17 october 1996 [cisg/1996/47] (tinplate case); award of 31 december 1997 [cisg/1997/37] (lindane case). 141 e.g., award of 2 june 1997 [cisg/1997/14] (graphite electrodes scraps case). 142 e.g., award of 31 december 1997 [cisg/1997/37] (lindane case). 143 e.g., award of 18 september 1996 [cisg/1996/01] (lanthanide compound case)“ direct losses” and “ indirect losses” were d i s c u s s e d i n j o s e p h l o o k o f s k y ’ s c o m m e n t a r y o n a r t i c l e 7 4 o f t h e c i s g a t <http://www.cisg.law.pace.edu/cisg/biblio/loo74.html>. (published in j. herbots editor / r. blanpain general editor, international encyclopaedia of laws contracts, suppl. 29 (december 2000)) he stated that these two terms described different damages measured by the promisee's expectation. however, in the cietac awards, when the tribunals used these two terms, it was hard to say they were measured by the expectation of aggrieved party. 144 such as: award of 12 february 1996 [cisg/1996/08] (coated art paper case); award of 2 may 1996 [cisg/1996/21] (ferro-molybdenum alloy case); award of 28 november 1996 [cisg/1996/54] (moly-oxide case); award of 7 may 1997 [cisg/1997/12] (horsebean case); award of 23 july 1997 [cisg/1997/23] (polypropylene case). 26 in some cietac awards, when describing relevant losses of the aggrieved party, some tribunals used two concepts, i.e., the “ actual losses” (“ shiji sunshi” – in chinese pinyin) and “ direct losses” (“ zhijie sunshi” – in chinese pinyin). the “ actual losses” that the tribunals ever awarded included: the compensation paid by the aggrieved party to his sub-buyer supported by the court’s judgment,131 the storage fees paid,132 freight133 and transshipment freight,134 fees for loading and unloading,135 price difference,136 fees for issuing the l/c, inspection fees,137 and import fees.138 on the contrary, the lost profit was not deemed by some tribunals as actual losses.139 the “ direct losses” decided in the cietac awards included: the compensation paid by the buyer to his sub-buyer,140 price difference,141 and fees for issuing and modifying the l/c.142 lost profit was clearly regarded as an indirect loss in one case.143 from the aforesaid types of losses covered by the “ actual losses” or “ direct losses” , it can be concluded that these two concepts seemed to refer to the diminishment or impairment that the aggrieved party’s existing properties actually incurred, especially the expenditures by the aggrieved party. however, lost profit, as the damages to the expected or future interests of the aggrieved party, has not actually resulted in the losses of the aggrieved party’s existing properties, thus regarded as non-actual or indirect losses. meanwhile, in many cases the tribunals did not use the terms “ actual losses” or “ direct losses” . in respect of most types of losses mentioned above and other expenditures by the aggrieved party, they stated the expenditures the aggrieved party had been incurred item by item.144 when the loss of profits had been awarded by the tribunals, the tribunal in some cases would deny recovery of some expenditures, because the tribunal held that such expenditures were normal costs which would still have occurred even if the contract had been duly performed. the viewpoint of http://www.cisg.law.pace.edu/cisg/biblio/loo74.html nordic journal of commercial law issue 2005 #2 145 such as: award of 2 may 1996 [cisg/1996/21] (ferro-molybdenum alloy case). in this case, the tribunal awarded the buyer his losses of profit in form of the price difference. with regard to the fees for issuing the l/c, the tribunal held that they were normal costs and should not be recovered. however, the additional fees for handling the l/c were awarded. also see, award of 26 october 1996 [cisg/1996/49] (cotton bath towel case). in this case, the freight and customs fees were considered as normal costs not to be recovered when the losses of profit were awarded. for other similar examples, see: award of 11 april 1997 [cisg/1997/05] (silicon metal case); award of 2 june 1997 [cisg/1997/14] (graphite electrodes scraps case); award of 30 november 1997 [cisg/1997/33] (canned oranges case); award of 31 december 1997 [cisg/1997/37] (lindane case); award of 25 december 1998 [cisg/1998/10] (basic pig iron case); award of 12 february 1996 [cisg/1996/08] (coated art paper case). 146 such as: award of 15 february 1996 [cisg/1996/10] (hot-rolled plates case); award of 12 july 1996 [cisg/1996/28] (chrome-plating machines production-line equipment case); award of 12 july 1996 [cisg/1996/29] (chromeplating machines production-line case); award of 10 october 1996 [cisg/1996/45] (petroleum coke case); award of 7 may 1997 [cisg/1997/12] (horsebean case); award of 22 may 1997 [cisg/1997/13] (soybean oil case); award of 8 october 1997 [cisg/1997/29] (industrial tallow case); award of 16 december 1997 [cisg/1997/35] (hot dipped galvanized steel coils case); award of 12 february 1999 [cisg/1999/08] (chrome plating machine case); award of 12 april 1999 [cisg/1999/22] (bud rice dregs case); award of 20 may 1999 [cisg/1999/25] (waste aluminum ingots case); award of 4 june 1999 [cisg/1999/28] (industrial raw material case); award of 10 august 2000 [cisg/2000/04] (silicon metal case); award of 10 june 2002 [cisg/2002/02](rice agricultural products case). 147 such as: award of 30 april 1997 [cisg/1997/10] (ferro-molybdenum alloy case). the tribunal held that it was reasonable that the seller resold the goods one month after the avoidance considering the relevant facts. see also: award of 18 august 1997 [cisg/1997/26] (vitamin c case). in this case, the buyer bought the substitute goods via its sister company, which was regarded as in reasonable manner by the tribunal considering the current price. for other examples, see award of 25 december 1998 [cisg/1998/11] (basic pig iron case); award of 7 january 2000 [cisg/2000/06] (cysteine case). 148 award of 8 april [cisg/1999/21] (wool case). 149 e.g., award of 30 july 1996 [cisg/1996/33] (ferro-molybdenum alloy case); award of 25 december 1998 [cisg/1998/10] (basic pig iron case); award of 11 february 2000 [cisg/2000/02] (silicon metal case). 27 the tribunal was that, besides the lost profit, only the additional expenditures incurred due to the breach should be recovered.145 – price difference the price difference claimed under articles 75 and 76 of the cisg was often awarded in the cietac awards. the price difference has covered so many types of losses that it is not appropriate to be deemed as a separate type of loss. it sometimes was equal to loss of profit in some circumstances to be discussed in part ii.6.1.2. however, in other cases, the price difference might cover the losses already incurred. in addition, in some cietac awards, the methods to calculate price difference provided for in articles 75 and 76 might be used by the tribunals, even if articles 75 and 76 per se could not be applied since their preconditions were not met. therefore, the author hereby would like to discuss the price difference as a separate issue. when the buyer had bought or the seller had resold the substitute goods, the tribunal would decide the price difference to be recovered according to article 75.146 under article 75, the tribunal often needed to decide whether the goods were bought or resold in a reasonable manner and within a reasonable time.147 for example, in one case a seller resold the goods to a third party before he sent the notice of avoidance to the buyer.148 considering the current price was falling, the tribunal held that the resale was a measure to mitigate losses under article 77, but it also held that the seller should resell the goods only after the declaration of avoidance of the contract. in such circumstances, the tribunal further held that either article 75 or 76 might still apply to this case, and adopted the resale price at last. when the reasonableness required by article 75 was not proved by the party, the tribunal would turn to article 76.149 for instance, the tribunal once held that the buyer bought the substitute nordic journal of commercial law issue 2005 #2 150 award of 4 september 1996 [cisg/1996/41] (natural rubber case). 151 such as: award 23 april 1995 [cisg/1995/07] (australian raw wool case); award of 12 january 1996 [cisg/1996/03] (scrap copper case); award of 29 march 1996 [cisg/1996/15] (caffeine case); award of 30 july 1996 [cisg/1996/32] (ferro-molybdenum alloy case). 152 such as award of 14 march 1996 [cisg/1996/14] (dried sweet potatoes case). in this case, the cif price was turned into fob price to be compared. also see award of 2 may 1996 [cisg/1996/21] (ferro-molybdenum alloy case). in this case, the issuing fees of the l/c were deemed as cost to be deducted when calculating the price difference. for other examples, see: award of 16 august 1996 [cisg/1996/39] (dioctyl phthalate case); award of 15 november 1996 [cisg/1996/52] (oxytetracycline hcl case); award of 6 january 1999 [cisg/1999/04] (wool case). 153 award of 24 april 1997 [cisg/1997/09] (oxidized aluminum case). 154 award of 1 february 2000 [cisg/2000/01] (silicon and manganese alloy case). 155 such as award of 18 april 1991 [cisg/1991/01] (silicate-iron case). in this case, fob was used and the uploading port was deemed as the place of delivery. for other examples, see: award of 19 september 1994 [cisg/1994/11] (steel case). 156 such as award of 18 april 1991 [cisg/1991/01] (silicate-iron case). in this case, the current price of the delivery port was the main basis to be compared; meanwhile, the tribunal also referred to the price offered by a third party under the same conditions. also see award of 30 november 1997 [cisg/1997/33] (canned oranges case). in this case, the buyer’s intention ever made to the seller was considered by the tribunal when no current price was found. for other examples, see award of 1 march 1999 [cisg/1999/12] (canned oranges case); award of 30 june 1999 [cisg/1999/30] (peppermint oil case). 157 such as: award of 12 february 1999 [cisg/1999/08] (chrome plating machine case); award of 12 february 1999 [cisg/1999/09] (nickel plating machine case). in these cases, the tribunals directly invoked article 74 as the basis to decide the party in breach to compensate the aggrieved party for expenditures for arbitration (including attorney’s fees, traveling fees and investigation fees). 28 goods not within a reasonable time and selected the current price at the end of two months after avoidance to be compared with the contract price.150 in other cases, article 76 was also applied directly when no substitute goods were bought or resold.151 moreover, when calculating the price difference to be recovered under article 75 and 76, the tribunal would take freight, fees, taxes or other cost into consideration.152 in respect of the recovery of price difference, some interesting cietac awards are noteworthy. in one case, the buyer did not purchase substitute goods or declare the contract avoided. however, the tribunal held that the method provided in article 76 still might be employed to calculate the damages. eventually, it required the seller to compensate the buyer for the difference between the contract price and the current price at the time and place of delivery that would have been the case if the contract had been implemented.153 in another case, though neither party expressly declared the contract avoided, the tribunal took the date that the seller informed the buyer of his intention not to ship the goods as the date of avoidance on which the current price was fixed.154 under article 76(2), the current price is the price prevailing at the place where delivery of the goods should have been made or, if there is no current price at that place, the price at such other place as serves as a reasonable substitute. the place of delivery in many cases was determined in accordance with the term used.155 however, the tribunals sometimes would adopt certain substitute methods to determine the price as reasonable based on relevant facts or circumstances of the particular cases.156 – expenditures for arbitration in most cases, the applicant claimed recovery of expenditures for the arbitration, including attorneys’ fees, traveling fees and fees for applying properties preservation if incurred. article 74 of the cisg may also be interpreted as covering such expenses.157 however, when dealing with nordic journal of commercial law issue 2005 #2 158 such as: award of 25 november 1996 [cisg/1996/02] (chromium ore case); award of 6 march 1997 [cisg/1997/01] (men’s shirts case); award of 1 april 1997 [cisg/1997/02] (fishmeal case); award of 11 april 1997 [cisg/1997/05] (silicon metal case); award of 27 june 1997 [cisg/1997/18] (kidney beans case); award of 10 july 1997 [cisg/1997/21] (carbamide case); award of 5 august 1997 [cisg/1997/25] (cold-rolled coils case); award of 29 september 1997 [cisg/1997/28] (oxidized aluminum case); award of 31 december 1997 [cisg/1997/37] (lindane case); award of 15 december 1998 [cisg/1998/09] (shirts case); award of 28 january 1999 [cisg/1999/06] (refrigerating machine case); award of 1 march 1999 [cisg/1999/12] (canned oranges case); award of 29 march 1999 [cisg/1999/14] (flanges case); award of 30 march 1999 [cisg/1999/16] (flanges case); award of 7 april [cisg/1999/20] (pvc suspension resin case); award of 8 april [cisg/1999/21] (wool case); award of 12 april 1999 [cisg/1999/22] (bud rice dregs case); award of 20 may 1999 [cisg/1999/25] (waste aluminum ingots case); award of 11 june 1999 [cisg/1999/29] (agricultural chemical products case); award of 30 june 1999 [cisg/1999/30] (peppermint oil case); award of 31 december 1999 [cisg/1999/32] (steel coil case); award of 29 january 2000 [cisg/2000/08] (steel bottle case); award of 27 july 2000 [cisg/2000/03] (steel scraps case); award of 10 august 2000 [cisg/2000/04] (silicon metal case). 159 chi n es e v er si o ns o f 1 9 9 4 , 1 9 9 5 a n d 1 9 9 8 versions at the official website of the ci et ac at < http: //www. ciet ac.org. cn/sh iwu/zhongcaishiwu.asp?type=sw5 >, and english version of 2000 versi on at < http://www.cietac.org.cn/english/rules/rules_3.htm >. there was no article providing for the expenses for the arbitration in the 1988 version of the arbitration rules of cietac. in the recently revised 2005 version of arbitration rules of cietac, this article has been amended and renumbered as article 46(2) as follows: “ the arbitral tribunal has the power to decide in the award, according to the specific circumstances of the case, that the losing party shall compensate the winning party for the expenses reasonably incurred by it in pursuing its case. in deciding whether the winning party’s expenses incurred in pursuing its case are reasonable, the arbitral tribunal shall consider such factors as the outcome and complexity of the case, the workload of the winning party and/or its representative(s), and the amount in dispute, etc.” (from the cietac’s official website; english version at < http://www.cietac.org.cn/english/rules/rules.htm >.) the latest amendment does not limit the recovery of expenses by 10% of the total amount awarded to the winning party, but replaces it with criterion of reasonableness weighed by more flexible factors subject to the discretion of the tribunal. 160 such as: award of 6 february 1997 [cisg/1997/38] (silicon-carbide case); award of 2 june 1997 [cisg/1997/14] (graphite electrodes scraps case); award of 16 june 1997 [cisg/1997/15] (leather case); award of 25 june 1997 [cisg/1997/16] (art paper case); award of 8 october 1997 [cisg/1997/29] (industrial tallow case); award of 13 january 1999 [cisg/1999/05] (latex gloves case); award of 20 april 1999 [cisg/1999/23] (filling machine case); award of 10 june 2002 [cisg/2002/02](rice agricultural products case). 161 e.g., award of 25 december 1998 [cisg/1998/10] (basic pig iron case); award of 6 january 1999 [cisg/1999/04] (wool case). 29 such claims, the tribunals would more often invoke the arbitration rules of cietac, which clearly provided its power to decide such expenses.158 in the cietac cases reported, article 59 of the relevant versions (1994, 1995, 1998 and 2000) of the arbitration rules was frequently invoked as such a basis for awarding the aforesaid expenditures for arbitration, which provided: “ the arbitration tribunal has the power to decide in the arbitral award that the losing party shall compensate a proportion of the expenses reasonably incurred by the winning party in dealing with the case. the amount of such compensation shall not in any case exceed 10% of the total amount awarded to the winning party.” 159 when applying this article, the tribunal would comply with the limit set out in it, i.e., 10% of the total amount awarded to the winning party, which sometimes might not lead to recovery of the winning party’s expenses in full. in addition, the tribunal would request the applicant to provide concrete amounts and evidence of such expenses, without which it would dismiss such claims.160 if the party did not win the arbitration, i.e., not all of his claims were being supported, the tribunal would not allow full recovery of his expenses.161 http://www.cietac.org.cn/shiwu/zhongcaishiwu.asp?type=sw5 http://www.cietac.org.cn/english/rules/rules_3.htm http://www.cietac.org.cn/english/rules/rules.htm nordic journal of commercial law issue 2005 #2 162 e.g., award of 7 august 1993 [cisg/1993/11] (semi-automatic weapons case); award of 26 october 1993 [cisg/1993/12] (frozen beef case). 163 e.g., award of 30 january 1996 [cisg/1996/05] (compound fertilizer case). 164 e.g., award of 29 march 1999 [cisg/1999/14] (flanges case). the tribunal adopted 15% as the margin rate of the aggrieved buyer might get. see also, award of 31 january 2000 [cisg/2000/09] (clothes case). in this case, the tribunal awarded the lost profit as 20% of the total price to the buyer. 165 award of 27 july 2000 [cisg/2000/03] (steel scraps case). 166 award of 10 may 1996 [cisg/1996/22] (hot-rolled coils case). also see, award of 31 december 1999 [cisg/1999/32] (steel coil case). 167 e.g., award of 26 october 1993 [cisg/1993/12] (frozen beef case); award of 11 april 1997 [cisg/1997/05] (silicon metal case). 168 e.g., award of 2 may 1996 [cisg/1996/21] (ferro-molybdenum alloy case). in some cases, the party might only claim price difference under article 75 or 76, but not expressly indicated his lost profit. such as: award of 25 december 1998 [cisg/1998/10] (basic pig iron case). 169 such as: award of 12 february 1996 [cisg/1996/08] (coated art paper case); award of 14 march 1996 [cisg/1996/14] (dried sweet potatoes case); award of 26 october 1996 [cisg/1996/49] (cotton bath towel case); award of 4 april 1997 [cisg/1997/04] (black melon seeds case). 170 such as: award of 17 october 1996 [cisg/1996/47] (tinplate case); award of 10 july 1997 [cisg/1997/21] (carbamide case). 171 award of 26 october 1996 [cisg/1996/49] (cotton bath towel case). 30 6.1.2. loss of profit under article 74 of the cisg, damages for lost profits are expressly provided to be compensated. considering the foreseeability of such lost profit to the party in breach, the tribunal has in a number of cases awarded the aggrieved party the corresponding compensation. how to calculate the lost profits was an outstanding question the tribunal often had to deal with. in some cases, the seller claimed for the difference between the contract price and the actual production cost of the goods,162 or the gross profit from which was deducted the costs to be paid (namely the net profit),163 which was supported by the tribunal. a certain margin rate deemed as reasonable has also been adopted by the tribunal in some cases,164 while the tribunal once denied adopting a fixed profit rate in one case since no evidence was provided.165 in addition, different types of price difference might also be held by the tribunal as lost profit of the aggrieved party and ruled recoverable from the party in breach. for instance, in some cases, the difference between the prices of the contract of the supplier with the seller and the sales contract of the seller and buyer was decided as the lost profit of the seller.166 in such cases, the price of the supply contract was equal to the cost of the seller in effect. moreover, the price difference between the contract price and the lower price of resale actually made by the party was also calculated as lost profit.167 in some cases reported, the lost profit under article 74 was deemed to be covered by the price difference under article 76, and the latter was awarded to the aggrieved buyer as lost profit.168 in other cases, the price difference between the contract price and the price of the intended resale to sub-buyer which could not be realized due to the breach was held to be lost profit,169 while in some of the cases relevant customs duties, value added taxes or other fees were deducted from the gross profit as normal costs.170 for instance, in one case, the buyer resold the goods at discounted prices due to the quality defects.171 the tribunal awarded him the difference between the contract price and the resale price. in addition, the buyer claimed a lost profit on the difference he would nordic journal of commercial law issue 2005 #2 172 award of 27 june 1997 [cisg/1997/18] (kidney beans case). 173 award of 8 march 1996 [cisg/1996/12] (old boxwood corrugated carton case). see also, award of 2 june 1997 [cisg/1997/14] (graphite electrodes scraps case). 174 e.g., award of 18 september 1996 [cisg/1996/01] (lanthanide compound case); award of 30 march 1999 [cisg/1999/16] (flanges case). 175 see, the secretariat commentary on article 74 of the cisg, online version at <http://www.cisg.law.pace.edu/cisg/text/secomm/secomm-74.html>. 176 this may also be supported by the tribunals’ attitudes on the liquidated damages in the contracts to some extent. such attitudes have their basis in relevant prc laws as well. article 20 of the lecfi provided that: “ the parties may agree in a contract that, if one party breaches the contract, it shall pay a certain amount of liquidated damages to the other party; they may also agree upon a method for calculating the damages resulting from such a breach. the liquidated damages as stipulated in the contract shall be regarded as compensation for the losses resulting from breach of contract. however, if the contractually agreed liquidated damages are far more or far less than is necessary to compensate for the losses resulting from the breach, the party concerned may request an arbitration body or a court to reduce or increase them appropriately.” in several cietac cases, the applicant’s claim for the punitive damages provided in the contract was not supported by the tribunal, because the tribunal held that he had been recovered for his losses. see, award of 22 january 1996 [cisg/1996/04] (palm oil case). also see, award of 6 february 1997 [cisg/1997/38] (silicon-carbide case). in this case, the tribunal, according to the aforesaid article 20 of the lecfi, reduced the liquidated damages stipulated in the contract considering the actual amount of the buyer’s losses.however, the contract law makes minor adjustment. article 114 of the contract law provides that: “ the parties to a contract may agree that one party shall, when violating the contract, pay liquidated damages of certain amount in light of the breach, or may agree upon the calculating method of compensation for losses resulting from the breach of contract. “ if the agreed liquidated damages are lower than the losses caused, any party may request the people's court or an arbitration institution to increase them; if they are excessively higher than the losses caused, any party may request the people's court or an arbitration institution to make an appropriate reduction.” therefore, if the agreed liquidated damages are higher that the actual losses, but not “ excessively higher than” the latter, they will be awarded to the aggrieved party by the tribunals. however, if they are lower than the losses caused, the aggrieved party may claim for full compensation regardless of the amount of liquidated damages stipulated in the contact. 177 award of 30 november 1997 [cisg/1997/33] (canned oranges case). in this case, a german buyer bought cans of oranges from a chinese seller. when the seller did not deliver the goods and committed a fundamental breach, the buyer bought goods from spain as substitute goods and claimed for the price difference under article 75. however the tribunal held that the spanish goods the buyer bought were different from the goods under the contract in specification, origins, production time and volumes so that they were not goods in replacement. as no current price in chinese market was proved by the parties, the tribunal adopted the price the parties ever agreed on during their negotiation as the substitute price of the current price. in addition, the difference between the contract price in the resale contract and the contract price with relevant fees deducted was deemed as lost profit. 31 have obtained by reselling to the sub-buyer with whom he had concluded a sales contract. the tribunal also decided to have the seller compensate the buyer for such losses. when the intended resale was not proved by the aggrieved party, the tribunal in one case directly took 10% of the contract price as the buyer’s lost profit, which it deemed reasonable.172 in another case, the difference between the prices of the intended resale to sub-buyer and the actual resale made was deemed as damages including the lost profits, while the normal costs that would still have occurred if the contract had been performed, such as inspection fees, unloading fees and so on, were not compensated.173 in addition, in some cases, if the aggrieved party was also found in breach of contract and found partly reliable for the losses, the tribunal overruled his claim for lost profit.174 there are some cases in which the price difference under article 75 or 76 and the lost profit under article 74 were both awarded by the tribunal. however, under article 74, the aggrieved party should not be placed in a better economic position than he would have been in if the contract had been performed by being compensated via damages.175 this principle has also been accepted by cietac awards.176 for instance, in one case, the buyer’s price difference under article 76 and lost profits of the margin he would have obtained from the resale to sub-buyer were both adopted by the tribunal.177 http://www.cisg.law.pace.edu/cisg/text/secomm/secomm-74.html nordic journal of commercial law issue 2005 #2 178 award of 1 march 1999 [cisg/1999/12] (canned oranges case). see also, award of 7 january 2000 [cisg/2000/06] (cysteine case). 179 award of 10 august 2000 [cisg/2000/04] (silicon metal case). in this case, the seller was found in fundamental breach, and the buyer’s claim for price difference after the contract was avoided was adopted by the tribunal according to article 75. therefore, the tribunal’s reason of denying the buyer’s claim for lost profit seemed in contradiction with its own awards to certain extent. 180 such as: award of 14 february 1996 [cisg/1996/09] (bicycle case); award of 27 february 1996 [cisg/1996/11] (wool case); award of 30 april 1996 [cisg/1996/20] (jacks and bearing brackets case); award of 16 may 1996 [cisg/1996/24] (cashmere sweaters case). 181 e.g., award of 12 january 1996 [cisg/1996/03] (scrap copper case); award of 29 march 1996 [cisg/1996/15] (caffeine case); award of 10 may 1996 [cisg/1996/22] (hot-rolled coils case). 182 e.g., award of 16 august 1996 [cisg/1996/39] (dioctyl phthalate case). 183 award of 18 august 1997 [cisg/1997/26] (vitamin c case). 184 such as: award of 9 january 1993 [cisg/1993/03] (sesame seed cake case); award of 25 february 1999 [cisg/1999/10] (cotton vest case); award of 25 february 1999 [cisg/1999/11] (women’s trousers case). 185 e.g., award of 6 march 1997 [cisg/1997/01] (men’s shirts case). 186 e.g., award of 23 february 1995 [cisg/1995/01] (jasmine aldehyde case). 187 e.g., award of 23 december 1996 [cisg/1996/57] (carbazole case). 188 e.g., award of 12 april 1999 [cisg/1999/22] (bud rice dregs case). 189 e.g., award of 16 may 1995 [cisg/1995/10] (leather suitcases case). 190 e.g., award of 15 february 1996 [cisg/1996/10] (hot-rolled plates case); award of 29 march 1996 [cisg/1996/15] (caffeine case). 32 however, in one case, the tribunal, when deciding to require the buyer to compensate the seller his price difference under articles 75 and 76, denied the seller’s claim for lost profit by holding that the price difference awarded had covered his lost profit.178 in another case, the tribunal held that the awarded price difference indicated that the tribunal actually maintained “ the performance of the original contract” so that the buyer’s claim for lost profit was dismissed.179 6.2. interest under article 78 of the cisg, if one party fails to pay the price or any other sum that is in arrears, he is obligated to pay interest to the other party. in the cietac awards, besides the price that should be paid by the buyer,180 the “ other sum” to be paid by the party in arrears under article 78 has included: the price difference,181 “ actual losses” (mainly transportation fees and other expenditures paid).182 in one case, when the seller did not deliver the goods, the buyer bought part of goods from a third party. with regard to the part of substitute goods bought, the tribunal decided the price difference was that between the prices of the two contracts; and with regard to the remaining part not replaced, the price difference was that between the contract price and the current price at the time of avoidance. the tribunal further decided the former price difference was sum in arrears and relevant interest should be paid, however, the latter part of price difference was not in arrears and no interest was to be awarded.183 the cisg does not expressly provide for how to determine the interest rate, which is left to the tribunals to decide. in the cietac awards reported, the tribunal has adopted the relevant deposit rates,184 and the relevant loan rates in different cases.185 more frequently, it has directly determined a fixed annual rate it deemed reasonable, e.g., 5%186, 6%,187 7%,188 8%,189 9%,190 nordic journal of commercial law issue 2005 #2 191 e.g., award of 16 june 1997 [cisg/1997/15] (leather case). 192 e.g., award of 23 october 1996 [cisg/1996/48] (channel steel case); award of 11 november 1996 [cisg/1996/51] (rubber overshoes case); award of 20 may 1999 [cisg/1999/24] (red tiles case). 193 e.g., award of 31 may 1999 [cisg/1999/27] (indium ingots case). 194 e.g., award of 20 may 1999 [cisg/1999/25] (waste aluminum ingots case). 195 award of 28 november 1996 [cisg/1996/54] (moly-oxide case). 196 award of 11 june 1999 [cisg/1999/29] (agricultural chemical products case). 197 award of 19 september 1994 [cisg/1994/11] (steel case). 198 award of 28 april 1995 [cisg/1995/08] (rolled wire rod coil case). 199 e.g., award of 8 march 1996 [cisg/1996/12] (old boxwood corrugated carton case); award of 5 august 1997 [cisg/1997/25] (cold-rolled coils case); award of 20 may 1999 [cisg/1999/25] (waste aluminum ingots case). 200 e.g., award of 31 december 1997 [cisg/1997/37] (lindane case). 201 e.g., award of 12 january 1996 [cisg/1996/03] (scrap copper case). 33 10%191and other rates. the tribunal would also consider the currency to be paid as different rates applied to chinese currency, u.s. dollars and other foreign currencies.192 in respect of the period of time during which the interest is to be calculated, the tribunals seemed to consider relevant facts and circumstance in particular cases, such as the interest on the price in arrears to be calculated from the date of delay,193 the interest on the price difference to be calculated as of the resale date.194 in one case, the buyer did not establish the l/c which constituted a fundamental breach, so the seller later resold the goods. the tribunal clearly distinguished between the interest on the total price to be calculated from the original payment date to the resale date, and the interest on the price difference from the resale date to the date of the awards made.195 in addition, as regards compound interest, the tribunal on one occasion denied the party’s claim for compound interest by stating that no contractual or legal basis had been found.196 6.3. limitation of damages 6.3.1. foreseeability pursuant to article 74 of the cisg, one main limitation of damages is that “ the damages may not exceed the loss which the party in breach foresaw or ought to have foreseen at the time of the conclusion of the contract, in the light of the facts and matters of which he then knew or ought to have known, as a possible consequence of the breach of contract” . if the aggrieved party was able to prove the party in breach had foreseen the damages at the time of conclusion of contract, such as the sub-buyer signed on the contract,197 or the sub-buyer directly issued the l/c to the seller,198 or the buyer had informed the seller of the existence of the resale or sub-buyer,199 his claim for such losses would be adopted by the tribunal. the loss of failed resale due to breach of contract was also sometimes deemed as foreseeable because resale of goods to the sub-buyer was quite normal in international trade.200 the fluctuation of the market price, which was quite normal and reasonable in international trade, was also decided by the tribunal as foreseeable by the party in breach.201 the loss of tax preferential treatments was also once found nordic journal of commercial law issue 2005 #2 202 e.g., award of 16 august 1996 [cisg/1996/39] (dioctyl phthalate case). in this case, the loss of tax rebate enjoyed by a chinese seller was awarded by the tribunal by holding that it was foreseeable. 203 e.g., award of 23 april 1997 [cisg/1997/07] (groundnut case). in this case, an indonesian buyer claimed the loss of tax exemption he would have got if the contract was duly performed, but the tribunal deemed that it was not foreseeable by the seller considering the relevant facts. also see, award of 28 november 1996 [cisg/1996/54] (moly-oxide case). in this case, the tribunal decided the loss of tax rebate of a chinese seller could not be foreseeable by a u.s. buyer at the time of conclusion of the contract. 204 such as: award of 4 september 1996 [cisg/1996/41] (natural rubber case). in this case, the foreign exchange difference between the contract price and the price of the contract between the buyer and sub-buyer was found not foreseeable by the seller. other examples: award of 30 october 1991 [cisg/1991/04] (roll aluminum case); award of 25 february 1993 [cisg/1993/05] (terylene draw-texturing machine case); award of 7 may 1997 [cisg/1997/12] (horsebean case); award of 27 june 1997 [cisg/1997/18] (kidney beans case); award of 7 july 1997 [cisg/1997/20] (isobutyl alcohol case); award of 1 february 2000 [cisg/2000/01] (silicon and manganese alloy case). 205 award of 20 december 1993 [cisg/1993/13] (equipment case). 206 award of 11 august 1994 [cisg/1994/09] (bicycle case). 207 award of 6 august 1996 [cisg/1996/35] (lacquer handicraft case). see also: award of 26 october 1996 [cisg/1996/49] (cotton bath towel case); award of 26 november 1998 [cisg/1998/06] (gloves case). 208 e.g., award of 18 december 1996 [cisg/1996/56] (lentils case). 209 e.g., award of 31 january 2000 [cisg/2000/09] (clothes case). 210 such as: award of 10 march 1995 [cisg/1995/03] (polyethylene case); award of 11 april 1997 [cisg/1997/05] (silicon metal case); award of 5 august 1997 [cisg/1997/25] (cold-rolled coils case); award of 20 january 1998 [cisg/1998/01] (polyester thread case); award of 6 january 1999 [cisg/1999/04] (wool case). 211 such as: award of 20 february 1994 [cisg/1994/03] (cysteine case). 34 as foreseeable in the circumstances of some cases,202 but in other cases the tribunal decided to the contrary in the relevant circumstances.203 in the cietac awards reported, some losses claimed by aggrieved party were found by the tribunals as not foreseeable by the party in breach at the time of conclusion of contract considering relevant facts.204 for example, in one case, the profit margin (50% of the costs) claimed by the aggrieved party, which was found too high in comparison to the normal profits that the party would foresee, was deemed not reasonable and therefore unforeseeable by the party in breach.205 if the compensation claimed had exceeded the total price of the contract, the tribunal might decide it was beyond the party’s foreseeability considering relevant facts.206 in some cases, the aggrieved party might claim for compensation for loan interest since he obtained a loan from relevant banks to perform the contract. some tribunals decided that such losses were not foreseeable,207 but there were some cases reported in which the tribunal held that the party as an international trader ought to have foreseen such loans and the interest thereon.208 other remote losses, such as loss of clients, were held by the tribunal as not foreseeable by the party in breach.209 6.3.2. duty to mitigate the losses in many cietac awards, another limitation of damages arises from article 77 of the cisg, under which the aggrieved party has the duty to mitigate the losses. if he fails to do so, the amount of loss that should have been mitigated may be claimed by the party in breach to be deducted from damages.210 in some cietac cases reported, the aggrieved party’s duty to mitigate the losses was deemed in connection with his duty to preserve the goods under articles 85 to 88.211 for instance, in one case, the goods were returned by the buyer to the seller according to their agreement after the goods were found non-conforming. however, the goods were stored in hong kong and not nordic journal of commercial law issue 2005 #2 212 award of 6 june 1991 [cisg/1991/03] (cysteine monohydrate case). 213 e.g., award of 5 september 1994 [cisg/1994/10] (equipment case). 214 award of 12 july 1996 [cisg/1996/28] (chrome-plating machines production-line equipment case). 215 such as: award of 5 february 1996 [cisg/1996/07] (stibium case); award of 25 november 1996 [cisg/1996/02] (chromium ore case); award of 7 january 2000 [cisg/2000/06] (cysteine case); award of 8 april [cisg/1999/21] (wool case). 216 such as: award of 5 august 1997 [cisg/1997/25] (cold-rolled coils case); award of 20 january 1998 [cisg/1998/01] (polyester thread case); award of 10 august 2000 [cisg/2000/04] (silicon metal case). 217 award of 8 march 1996 [cisg/1996/12] (old boxwood corrugated carton case). 218 award of 8 september 1997 [cisg/1997/27] (bopp film case). 219 award of june 1999 [cisg/1999/03] (peanut kernel case). 220 e.g., award of 31 january 2000 [cisg/2000/09] (clothes case). however, in this case, the tribunal held that the buyer should have notified the seller before the buyer repaired the goods. 221 award of 18 august 1997 [cisg/1997/26] (vitamin c case). 222 award of 28 november 1996 [cisg/1996/54] (moly-oxide case). 223 such as: award of 27 july 2000 [cisg/2000/03] (steel scraps case); award of 30 march 1999 [cisg/1999/16] (flanges case); award of 22 march 1995 [cisg/1995/05] (costumes case); award of 2 april 1999 [cisg/1999/18] (grey cloths case); award of 10 may 1994 [cisg/1994/07] (carbamide case); award of 4 january 1995 [cisg/1995/02] (shirts case). 35 transported to the destination port in shenzhen, which incurred a lot of storage fees.212 the tribunal decided that the buyer under article 86(1) and 88(2) was obligated to preserve and dispose the goods. his failure to do so resulted in the losses being increased; therefore, under article 77 certain losses were decided to be borne by him. the measures available to the aggrieved party under article 77 shall be reasonable in the circumstances. the tribunal has decided in some cases that no such measures were available under certain circumstances,213 e.g., the goods were made to the order of the buyer and hard to resell them.214 the resale of goods215 or purchasing substitute goods216 in certain circumstances would be found as reasonable measures. in one case, considering the location of goods and the relevant transportation fees, the tribunal decided that it was reasonable that the buyer sold the goods to a sub-buyer at a discounted price.217 late resale, e.g., after the preservation period of goods had been expired,218 or a long time after the contract had been repudiated by the other party,219 would be treated as a violation of the duty to mitigate losses. reparation of goods was also mentioned as a reasonable measure in one case.220 whether the time to take such measures was reasonable or not was also considered by the tribunals. in one case, the buyer bought substitute goods three days after declaring the contract avoided when the market price was rapidly rising, which was deemed reasonable by the tribunal.221 in another case, the tribunal accepted that the buyer took relevant measures three months after the contract was declared avoided based on relevant facts.222 6.4. burden of proof though the burden of proof is not generally expressly allocated in the cisg, the tribunals in a number of cases requested the party making the claims to bear the burden of proof of establishing his claim.223 the basis for this may also be found in the arbitration rules of cietac. in the 2000, 1998, 1995 and 1994 versions of the arbitration rules of cietac which were mainly applied in the cietac awards reported, article 38 provided that “ the parties shall produce evidence in support of the facts on which their claim, defense or counterclaim is based,” and “ the arbitration tribunal nordic journal of commercial law issue 2005 #2 224 also see: article 26 in 1988 version of the arbitration rules of cietac, and articles 36 and 37 in 2005 version of the arbitration rules of cietac. 225 also see: article 28 in 1988 version of the arbitration rules of cietac, and article 38 in 2005 version of the arbitration rules of cietac. in some cietac cases, the tribunals executed such power, such as: award of 29 march 1999 [cisg/1999/14] (flanges case); award of 30 march 1999 [cisg/1999/16] (flanges case). 226 award of 6 september 1996 [cisg/1996/42] (engines case). 227 award of 25 june 1997 [cisg/1997/16] (art paper case). 228 e.g., award of 23 february 1995 [cisg/1995/01] (jasmine aldehyde case). 229 award of 10 may 1996 [cisg/1996/22] (hot-rolled coils case). 230 award of 1 april 1997 [cisg/1997/02] (fishmeal case). in this case, after checking the evidence the tribunal found that the seller had performed his obligations and the buyer should claim for relevant damages against the carrier. 36 may, on its own initiative, undertake investigations and collect evidence as it considers necessary.” 224 article 39 further provides that the arbitration tribunal may consult an expert or appoint an appraiser for clarification of the specific issues relating to a case.225 7. passing of risk incoterms are often adopted in contracts for the international sale of goods. incoterms as international practice has been respected and applied by the cietac tribunals. for instance, in one case under the term fob, the tribunal referred to the incoterms applicable then and article 67 of the cisg, and decided that the risk passed to the buyer when the goods crossed the shipboard.226 the buyer shall perform his obligation to pay the price if the loss of or damages to the goods occurs after the risk has passed to him under article 66 of the cisg. for instance, in one case, the goods suffered total loss as the ship sunk during the transportation. the tribunal according to article 66 decided the buyer was still bound to pay the price under the term cfr.227 nevertheless, according to article 66, if the loss of or damage to the goods after the risk has passed to the buyer is due to an act or omission of the seller, the seller shall be liable for such loss or damage. in one case of a chinese firm selling heliotropin (jasmine aldehyde) to a u.s. buyer under the term cif, the buyer specially requested the seller to be careful of the temperature requirement of the goods and requested the seller to arrange proper packaging and direct shipment. however, the seller did not pay sufficient attention to this and just reminded the carrier via phone. when the goods arrived at the destination, the buyer found the goods almost lost in total due to improper packaging and a long period of transshipment. the tribunal decided that under cif, the risk had passed when the goods were delivered on board, however, pursuant to article 66, the seller should still be liable for the loss as his act and omission caused such loss.228 it was stated as the precondition of the passage of risk by the tribunal in another case that the goods had been identified.229 the tribunal in that case explicitly mentioned the seller’s obligation to identify the goods under article 32(1) of the cisg, but did not directly refer to article 67(2). the passage of risk in respect of goods sold in transit provided in article 68 was once heard by the cietac tribunal. in the case article 68 applied, the tribunal held that the risk should be accidents or natural disasters, and that non-seaworthiness and unreasonable delay should not be deemed as risks.230 nordic journal of commercial law issue 2005 #2 231 award of 27 february 1996 [cisg/1996/11] (wool case). 232 award of 29 march 1996 [cisg/1996/15] (caffeine case). 233 award of 30 january 1996 [cisg/1996/05] (compound fertilizer case). 234 award of 11 april 1994 [cisg/1994/06] (old paper case). 235 award of 12 december 1994 [cisg/1994/14] (sunflower seeds and groundnut case). 236 e.g., award of 29 march 1999 [cisg/1999/14] (flanges case). 237 e.g., award of 18 september 1996 [cisg/1996/01] (lanthanide compound case). 238 award of 29 september 1997 [cisg/1997/28] (oxidized aluminum case). 37 8. anticipatory breach of contract and installment contracts when an anticipatory breach occurs, the aggrieved party may suspend the performance of his obligations under article 71 of the cisg. for instance, in one case the buyer did not issue the l/c under the contract and the seller sent notice to the buyer according to article 71(3). the tribunal found that under article 71(2), the seller was entitled to prevent the goods being handed over to the buyer by ordering the carrier to change the destination port, which was also deemed by the tribunal as a reasonable measure to preserve the goods under article 85.231 under article 72(1) of the cisg, a party may declare the contract avoided when the other party will clearly commit a fundamental breach of contract before the date for performance. for instance, in one case that the seller explicitly presented his intention to repudiate the contract, the tribunal found this would constitute a fundamental breach under article 72(1).232 in such cases, the tribunal once clarified under article 72(3) the party did not need to give notice to the party who had announced his intention not to perform the contract.233 article 73 of the cisg provides for the circumstances when the aggrieved party may declare the contract avoided in case of installment contracts. for instance, in one case, among the total fourteen installments of goods, the seller under the term cif handed over the b/l with freights unpaid in respect of four installments thereof and this resulted in the goods being auctioned off by the carrier to get the delayed freights.234 the tribunal decided that since the seller was obligated to pay the freight under cif, he had committed a fundamental breach with regard to such four installments of goods and should return the prices to the buyer. in another case, the tribunal decided that the aggrieved party may declare the contract avoided with respect to the installments according to article 73(1).235 when the aggrieved party intends to invoke article 73(2) so as to declare the contract avoided for the future, he shall be prudently confirmed that a fundamental breach will occur with respect to future installments.236 in some cases, he might be subject to the risk of being found not to have had good grounds to so believe and be in breach himself.237 however, if it was apparent that a party would commit a fundamental breach with regard to future installments, the aggrieved party would be deemed not to have taken reasonable measures to mitigate the loss, if he did not declare the contract avoided timely according to article 73(2). for example, in one case, a seller sold aluminum to a buyer in three installments and the buyer did not perform his obligation with respect to the first installment and requested to cancel the contract.238 however, the seller still bought the second installment of goods from suppliers and shipped it to the destination port in such circumstances. the tribunal therefore held that the seller did not mitigate the loss. nordic journal of commercial law issue 2005 #2 239 such as article 24 of the lecfi, and article 117 of the contract law. 240 award of 15 december 1998 [cisg/1998/09] (shirts case). 241 award of 7 may 1997 [cisg/1997/11] (sanguinarine case). 242 award of 30 november 1997 [cisg/1997/33] (canned oranges case). 243 award of 31 december 1996 [cisg/1996/58] (high carbon tool steel case). 244 e.g., award of 29 september 1997 [cisg/1997/28] (oxidized aluminum case). 245 such as: award of 14 march 1996 [cisg/1996/14] (dried sweet potatoes case); award of 2 may 1996 [cisg/1996/21] (ferro-molybdenum alloy case). 38 9. exemptions for the party in breach under the cisg, the party in breach may allege that he is not liable for damages for his failure to perform obligations by invoking article 79. although the term “ force majeure” is not used in article 79, when applying it the tribunal normally would use the term “ force majeure” (“ bukekangli” – in chinese pinyin) that was already adopted in domestic laws.239 however, in one exceptional case, the tribunal directly used the description in article 79,240 which might conform to the original intention of the drafters of the cisg best so as to avoid using domestic legal concepts. the impediment mentioned in article 79 shall not be expected by the party at the time of the conclusion of the contract. for example, in one case, a u.s. buyer alleged that the u.s. federal environment law promulgated in 1993 requiring him to obtain approval from the u.s. environmental protection agency, constituted an impediment in article 79.241 however, the tribunal found the law was published before the conclusion of the contract and decided that the buyer should have expected its influence. in another case, the natural disaster the seller claimed as an impediment preventing him to prepare the canned oranges occurred before the conclusion of the contract seller’s claim was thus overruled by the tribunal as well.242 in addition, only a real impediment not expected by the party at the time of the conclusion of the contract may be deemed as an impediment under article 79. for instance, in one case, a chinese buyer tried to invoke a regulation adopted by the prc government as an impediment preventing him from performing his obligation to issue the l/c.243 the tribunal found the contract was concluded before the regulation came into force and the regulation did not apply to the contract retroactively so that the regulation would not be a real impediment to the buyer. under article 79, the impediment shall at the same time be beyond the party’s control and one that could not be overcome or avoided. the party’s personal reasons leading to failure to perform his obligations, such as his capacity of reimbursement being doubted by the bank and his incompetence to apply for the issuing of l/c,244 were not accepted by the tribunal as impediments under article 79. when a party sought to claim for exemption according to article 79, the tribunal would request him to provide relevant persuasive proof, especially issued by certain authorities or governmental agencies in charge, which was also often stipulated in the contract.245 nordic journal of commercial law issue 2005 #2 39 iii. conclusion in conclusion of this survey on cietac awards, it can be seen that a number of provisions of the cisg have been applied in cietac cases. when applying such provisions, the tribunals have made certain interpretations to them. in the author’s viewpoint, some of the interpretation have helped the cisg be applied to particular circumstances, and thus promoted the cisg in the aspects of its flexibility, acceptability and development. moreover, some issues the cietac tribunals faced were those arising from the context of china and china’s legal system, such as the application of the cisg discussed in part ii.1. on such issues, the cietac tribunals have made beneficial explorations and contributed to the diversity of the practices and researches on the cisg. however, on such special issues, the non-exhaustive commentary in this essay only provides a preliminary research result, subject to the dynamic practices of the cietac tribunals and further research thereon. however, some interpretation made by the tribunals might not comply with the international character of the cisg and to some extent even impaired the uniform application of the cisg. nevertheless, they also provide valuable experiences for future tribunals to be cautious of the possible errors. according to the publication plan of the cietac mentioned above, more cietac awards on the cisg will be published. the author expects more and more valuable cases to be reported, which will be good for research on the cisg and its further development. nordic journal of commercial law issue 2005 #2 40 addendum: cietac awards cited the cietac awards cited in this paper are listed below. the goods involved in the contracts and the main provisions of the cisg invoked by the tribunals are also identified. with regard to the case for which english translations are available, the corresponding links at the cisg database of pace law school are indicated as well (as of 31 august 2005). for all the cietac awards reported, please see the webpage of the cisg database of pace law school at <http://www.cisg.law.pace.edu/cisg/text/casecit.html#china>. thanks again to the queen mary case translation program co-held by queen mary, university of london and institute of international commercial law at the pace university school of law, and all the participants thereof. pre-1993 cietac awards award of 4 august 1988 [cisg/1988/01] (calculator assembly parts case), art. 39 english translation available at <http://cisgw3.law.pace.edu/cases/880804c1.html> award of post-1989 [cisg/1990/01] (cloth wind coats case), arts. 9, 53, 60, 74, 77 english translation available at <http://cisgw3.law.pace.edu/cases/900000c1.html> award of 18 april 1991 [cisg/1991/01] (silicate-iron case). art. 76(1) english translation available at < http://cisgw3.law.pace.edu/cases/910418c1.html > award of 6 june 1991 [cisg/1991/03] (cysteine monohydrate case). arts. 9, 77, 79, 86(1), 88(2) english translation available at < http://cisgw3.law.pace.edu/cases/910606c1.html > award of 30 october 1991 [cisg/1991/04] (roll aluminum case). arts. 25, 47, 49, 64, 75, 76, 77, 78, 81, 84(1) english translation available at < http://cisgw3.law.pace.edu/cases/911030c1.html > 1993 cietac awards award of 9 january 1993 [cisg/1993/03] (sesame seed cake case). arts. 35, 61(2), 63, 64, 74, 77, 78, 88 english translation available at <http://cisgw3.law.pace.edu/cases/930109c1.html> award of 25 february 1993 [cisg/1993/05] (terylene draw-texturing machine case). arts, 25, 74, award of 26 march 1993 [cisg/1993/06] (cement case). art. 53, award of 1 april 1993 [cisg/1993/02] (steel products case). arts. 18, 19, 74, 75, 76 english translation available at <http://cisgw3.law.pace.edu/cases/930401c1.html> award of 5 july 1993 [cisg/1993/08] (copperized steel pipes case). art. 38 award of 10 july 1993 [cisg/1993/09] (heliotropin case). arts. 8, 9, 35, 74, 77 english translation available at <http://cisgw3.law.pace.edu/cases/930710c1.html> award of 20 july 1993 [cisg/1993/10] (shaping machine case). arts. 25, 49, 74, 81, 84 english translation available at <http://www.cisg.law.pace.edu/cisg/wais/db/cases2/930720c1.html> award of 7 august 1993 [cisg/1993/11] (semi-automatic weapons case). arts. 74, 78, 79 english translation available at <http://cisgw3.law.pace.edu/cases/930807c1.html> award of 26 october 1993 [cisg/1993/12] (frozen beef case). arts. 25, 64, 74, 75, 76, 78, 81 english translation available at <http://cisgw3.law.pace.edu/cases/931026c1.html> award of 20 december 1993 [cisg/1993/13] (equipment case). art. 74 english translation available at <http://cisgw3.law.pace.edu/cases/931220c1.html> http://www.cisg.law.pace.edu/cisg/text/casecit.html#china http://cisgw3.law.pace.edu/cases/880804c1.html http://cisgw3.law.pace.edu/cases/900000c1.html http://cisgw3.law.pace.edu/cases/910418c1.html http://cisgw3.law.pace.edu/cases/910606c1.html http://cisgw3.law.pace.edu/cases/911030c1.html http://cisgw3.law.pace.edu/cases/930109c1.html http://cisgw3.law.pace.edu/cases/930401c1.html http://cisgw3.law.pace.edu/cases/930710c1.html http://www.cisg.law.pace.edu/cisg/wais/db/cases2/930720c1.html http://cisgw3.law.pace.edu/cases/930807c1.html http://cisgw3.law.pace.edu/cases/931026c1.html http://cisgw3.law.pace.edu/cases/931220c1.html nordic journal of commercial law issue 2005 #2 41 1994 cietac awards award of 20 january 1994 [cisg/1994/02] (hydraulic press machine case). art. 35 award of 20 february 1994 [cisg/1994/03] (cysteine case). arts. 86(1), 88(2) award of 30 march 1994 [cisg/1994/04] (boletus edulis case). arts. 35, 38, 58, 71, 77 english translation available at <http://cisgw3.law.pace.edu/cases/940330c1.html> award of 6 april 1994 [cisg/1994/05] (printing machine case). arts. 25, 46, 48, 84 e n g l i s h t r a n s l a t i o n a v a i l a b l e a t <http://www.cisg.law.pace.edu/cisg/wais/db/cases2/940406c1.html> award of 11 april 1994 [cisg/1994/06] (old paper case). art. 30 award of 10 may 1994 [cisg/1994/07] (carbamide case). art. 1 award of 11 august 1994 [cisg/1994/09] (bicycle case). art. 74 english translation available at <http://cisgw3.law.pace.edu/cases/940811c1.html> award of 5 september 1994 [cisg/1994/10] (weaving machines, tools and accessories case). arts. 25, 47. 74, 77, 84 english translation available at <http://cisgw3.law.pace.edu/cases/940905c1.html> award of 19 september 1994 [cisg/1994/11] (steel case). arts. 47, 49, 74, 76 english translation available at <http://cisgw3.law.pace.edu/cases/940919c1.html> award of 26 september 1994 [cisg/1994/12] (umbrella case). art. 1 award of 25 october 1994 [cisg/1994/13] (high tensile steel bars case). arts. 23, 25, 49, 74, 76 english translation available at <http://cisgw3.law.pace.edu/cases/941025c1.html> award of 12 december 1994 [cisg/1994/14] (sunflower seeds and groundnut case). art. 73 english translation available at <http://cisgw3.law.pace.edu/cases/941212c1.html> award of 28 december 1994 [cisg/1994/15] (round steel case). art. 74 1995 cietac awards award of 4 january 1995 [cisg/1995/02] (shirts case). arts. 33, 35, 38(1), 58(1), 78 english translation available at >http://cisgw3.law.pace.edu/cases/950104c1.html> award of 23 february 1995 [cisg/1995/01] (jasmine aldehyde case). arts. 38(2), 39(1), 66, 74, 78 english translation available at <http://cisgw3.law.pace.edu/cases/950223c1.html> award of 10 march 1995 [cisg/1995/03] (polyethylene case). arts. 32, 68 award of 22 march 1995 [cisg/1995/05] (down jackets and winter coat case). arts. 8, 25, 26, 35, 49, 50, 74, 77 english translation available at <http://cisgw3.law.pace.edu/cases/950322c1.html> award of 23 april 1995 [cisg/1995/07] (australian raw wool case). arts. 9(2), 25, 49, 54, 64, 74, 76 english translation available at <http://cisgw3.law.pace.edu/cases/950423c1.html> award of 28 april 1995 [cisg/1995/08] (rolled wire rod coil case). art. 6, 74, 79 english translation available at <http://cisgw3.law.pace.edu/cases/950428c1.html> award of 16 may 1995 [cisg/1995/10] (leather suitcases case). art. 78, 1996 cietac awards award of 12 january 1996 [cisg/1996/03] (scrap copper case). arts. 74, 76, 78 english translation available at <http://www.cisg.law.pace.edu/cisg/wais/db/cases2/960112c1.html> award of 22 january 1996 [cisg/1996/04] (palm oil case). art. 75 http://cisgw3.law.pace.edu/cases/940330c1.html http://www.cisg.law.pace.edu/cisg/wais/db/cases2/940406c1.html http://cisgw3.law.pace.edu/cases/940811c1.html http://cisgw3.law.pace.edu/cases/940905c1.html http://cisgw3.law.pace.edu/cases/940919c1.html http://cisgw3.law.pace.edu/cases/941025c1.html http://cisgw3.law.pace.edu/cases/941212c1.html http://cisgw3.law.pace.edu/cases/950104c1.html http://cisgw3.law.pace.edu/cases/950223c1.html http://cisgw3.law.pace.edu/cases/950322c1.html http://cisgw3.law.pace.edu/cases/950423c1.html http://cisgw3.law.pace.edu/cases/950428c1.html http://www.cisg.law.pace.edu/cisg/wais/db/cases2/960112c1.html nordic journal of commercial law issue 2005 #2 42 english translation available at <http://cisgw3.law.pace.edu/cases/960122c1.html> award of 30 january 1996 [cisg/1996/05] (compound fertilizer case). arts. 8, 25, 26, 49(1), 51(2), 72, 74, 76, 77 english translation available at <http://cisgw3.law.pace.edu/cases/960130c1.html> award of 5 february 1996 [cisg/1996/07] (antimony ingot case). arts. 6, 8, 25, 52(1), 53, 54, 61, 72(1) 75, 77, 78 english translation available at <http://cisgw3.law.pace.edu/cases/960205c2.html> award of 12 february 1996 [cisg/1996/08] (coated art paper case). art. 74 english translation available at <http://cisgw3.law.pace.edu/cases/960212c1.html> award of 14 february 1996 [cisg/1996/09] (bicycle case). arts. 53, 61, 78 award of 15 february 1996 [cisg/1996/10] (hot-rolled plates case). arts. 25, 49(1)(a), 75, 78 award of 27 february 1996 [cisg/1996/11] (wool case). arts. 53, 71, 77, 78, 85 english translation available at <http://cisgw3.law.pace.edu/cases/960227c1.html> award of 8 march 1996 [cisg/1996/12] (old boxwood corrugated carton case). arts. 35, 45, 74, 77, 78, 88 english translation available at <http://cisgw3.law.pace.edu/cases/960308c1.html> award of 8 march 1996 [cisg/1996/13] (horsebean case). arts. 30, 60 award of 14 march 1996 [cisg/1996/14] (dried sweet potatoes case). arts. 74, 75, 76, 78, 79(1) english translation available at <http://cisgw3.law.pace.edu/cases/960314c1.html> award of 29 march 1996 [cisg/1996/15] (caffeine case). arts. 6, 47, 72, 74, 75, 76, 77, 78 english translation available at <http://www.cisg.law.pace.edu/cisg/wais/db/cases2/960329c1.html> award of 4 april 1996 [cisg/1996/18] (veneer wood case). art. 1 award of 17 april 1996 [cisg/1996/19] (gas purifiers case). arts. 26, 39, 49 award of 30 april 1996 [cisg/1996/20] (jacks and bearing brackets case). arts. 30, 53, 74, 78 english translation available at <http://cisgw3.law.pace.edu/cases/960430c1.html> award of 2 may 1996 [cisg/1996/21] (ferro-molybdenum alloy case). arts. 7, 74, 76, 78, 79 english translation available at <http://cisgw3.law.pace.edu/cases/960502c1.html> award of 10 may 1996 [cisg/1996/22] (hot-rolled steel plates case). arts. 8, 29, 32, 74, 78 english translation available at <http://cisgw3.law.pace.edu/cases/960510c1.html> award of 16 may 1996 [cisg/1996/24] (cashmere sweaters case). arts. 62, 78 award of 22 may 1996 [cisg/1996/25] (broadcasting equipments case). art. [-] award of 31 may 1996 [cisg/1996/27] (children’s jackets case). art. 1 award of 12 july 1996 [cisg/1996/28] (chrome-plating machines production-line equipment case). arts. 74, 75, 77, 78, 87 english translation available at <http://cisgw3.law.pace.edu/cases/960712c1.html> award of 12 july 1996 [cisg/1996/29] (chrome-plating machines production-line case). arts. 74, 75 english translation available at <http://cisgw3.law.pace.edu/cases/960712c3.html> award of 16 july 1996 [cisg/1996/31] (hot-rolled steel plates case). arts. 35, 36, 38, 39, 74, 78 english translation available at <http://cisgw3.law.pace.edu/cases/960716c1.html> award of 30 july 1996 [cisg/1996/32] (ferro-molybdenum alloy case). arts. 47(2), 74 award of 30 july 1996 [cisg/1996/33] (ferro-molybdenum alloy case). arts. 75, 79 award of 31 july 1996 [cisg/1996/34] (sport shoes case). arts. 38(2), 49(1)(a) award of 6 august 1996 [cisg/1996/35] (lacquer handicraft case). arts. 30, 53, 61, 74, 78 english translation available at <http://cisgw3.law.pace.edu/cases/960806c1.html> award of 8 august 1996 cietac arbitration award [cisg/1996/36] (diaper machine case). arts. 50, 78 award of 9 august 1996 cietac arbitration award [cisg/1996/37] (shirts case). arts. 30, 78 award of 16 august 1996 [cisg/1996/39] (dioctyl phthalate case). arts. 18, 25, 35, 74, 75, 77, 78, 80 http://cisgw3.law.pace.edu/cases/960122c1.html http://cisgw3.law.pace.edu/cases/960130c1.html http://cisgw3.law.pace.edu/cases/960205c2.html http://cisgw3.law.pace.edu/cases/960212c1.html http://cisgw3.law.pace.edu/cases/960227c1.html http://cisgw3.law.pace.edu/cases/960308c1.html http://cisgw3.law.pace.edu/cases/960314c1.html http://www.cisg.law.pace.edu/cisg/wais/db/cases2/960329c1.html http://cisgw3.law.pace.edu/cases/960430c1.html http://cisgw3.law.pace.edu/cases/960502c1.html http://cisgw3.law.pace.edu/cases/960510c1.html http://cisgw3.law.pace.edu/cases/960712c1.html http://cisgw3.law.pace.edu/cases/960712c3.html http://cisgw3.law.pace.edu/cases/960716c1.html http://cisgw3.law.pace.edu/cases/960806c1.html nordic journal of commercial law issue 2005 #2 43 english translation available at <http://cisgw3.law.pace.edu/cases/960816c1.html> award of 30 august 1996 [cisg/1996/40] (brake pads case). art. 62 award of 4 september 1996 [cisg/1996/41] (natural rubber case). arts. 45, 74, 75, 76, 77, 78 english translation available at <http://cisgw3.law.pace.edu/cases/960904c1.html> award of 6 september 1996 [cisg/1996/42] (engines case). arts. 67, 85, 96 award of 18 september 1996 [cisg/1996/43] (agricultural products case). arts. 39, 50 award of 18 september 1996 [cisg/1996/01] (lanthanide compound case). arts. 25, 64, 73, 74 english translation available at <http://cisgw3.law.pace.edu/cases/960918c1.html> award of 28 september 1996 [cisg/1996/44] (gloves case). art. 38 award of 10 october 1996 [cisg/1996/45] (petroleum coke case). art. 74 award of 15 october 1996 [cisg/1996/46] (canned chufa case). art. 53 award of 17 october 1996 [cisg/1996/47] (tinplate case). art. 11 award of 23 october 1996 [cisg/1996/48] (channel steel case). art. 78 award of 26 october 1996 [cisg/1996/49] (cotton bath towel case). arts. 35(2), 74 award of 7 november 1996 [cisg/1996/50] (stone products case). art. [-] award of 11 november 1996 [cisg/1996/51] (rubber overshoes case). arts. 53, 78 award of 15 november 1996 [cisg/1996/52] (oxytetracycline hcl case). arts. 47, 75 award of 18 november 1996 [cisg/1996/53] (channel steel case). arts. 30, 34 award of 25 november 1996 [cisg/1996/02] (chromium ore case). arts. 61(2), 74, 77 english translation available at <http://cisgw3.law.pace.edu/cases/961125c1.html> award of 28 november 1996 [cisg/1996/54] (moly-oxide case). art. 77 award of 18 december 1996 [cisg/1996/56] (lentils case). arts. 8, 54, 71, 74, 78 english translation available at < http://cisgw3.law.pace.edu/cases/961218c1.html> award of 23 december 1996 [cisg/1996/57] (carbazole case). arts. 9, 25, 45, 74, 77 award of 31 december 1996 [cisg/1996/58] (high carbon tool steel case). arts. 72, 79 1997 cietac awards award of 6 february 1997 [cisg/1997/38] (silicon-carbide case). arts. 4, 9, 25 english translation available at <http://cisgw3.law.pace.edu/cases/970206c1.html> award of 6 march 1997 [cisg/1997/01] (men's shirts case). arts. 74, 75, 77, 78 english translation available at <http://cisgw3.law.pace.edu/cases/970306c1.html> award of 1 april 1997 [cisg/1997/02] (fishmeal case). art. 68 award of 2 april 1997 [cisg/1997/03] (wakame case). art. 53, 78 award of 4 april 1997 [cisg/1997/04] (black melon seeds case). arts. 45, 74 award of 11 april 1997 [cisg/1997/05] (silicon metal case). arts. 38, 46, 77 award of 23 april 1997 [cisg/1997/07] (groundnut case). art. 74 award of 24 april 1997 [cisg/1997/09] (oxidized aluminum case). arts. 74, 75, 76 english translation available at <http://cisgw3.law.pace.edu/cases/970424c1.html> award of 30 april 1997 [cisg/1997/10] (ferro-molybdenum alloy case). art. 69 award of 7 may 1997 [cisg/1997/11] (sanguinarine case). art. 79(1) award of 7 may 1997 [cisg/1997/12] (horsebean case). art. 75 award of 22 may 1997 [cisg/1997/13] (soybean oil case). art. 53 award of 2 june 1997 [cisg/1997/14] (graphite electrodes scraps case). art. 74 award of 16 june 1997 [cisg/1997/15] (leather case). arts. 30, 53, 54 http://cisgw3.law.pace.edu/cases/960816c1.html http://cisgw3.law.pace.edu/cases/960904c1.html http://cisgw3.law.pace.edu/cases/960918c1.html http://cisgw3.law.pace.edu/cases/961125c1.html http://cisgw3.law.pace.edu/cases/961218c1.html http://cisgw3.law.pace.edu/cases/970206c1.html http://cisgw3.law.pace.edu/cases/970306c1.html http://cisgw3.law.pace.edu/cases/970424c1.html nordic journal of commercial law issue 2005 #2 44 award of 25 june 1997 [cisg/1997/16] (art paper case). arts. 9, 25, 30, 49(1), 53, 60, 67, 74, 78, 79 english translation available at <http://cisgw3.law.pace.edu/cases/970625c1.html> award of 26 june 1997 [cisg/1997/17] (monohydrate zinc sulfate case). art. 29 award of 27 june 1997 [cisg/1997/18] (kidney beans case). arts. 25, 49, 64, 74 english translation available at < http://www.cisg.law.pace.edu/cisg/wais/db/cases2/970627c1.html> award of 7 july 1997 [cisg/1997/20] (isobutyl alcohol case). art. 20 award of 10 july 1997 [cisg/1997/21] (carbamide case). art. 74 award of 21 july 1997 [cisg/1997/22] (yam-dyed fabric case). arts. 25, 64(1), 74, 75, 78 english translation available at < http://cisgw3.law.pace.edu/cases/970721c1.html> award of 23 july 1997 [cisg/1997/23] (polypropylene case). arts. 38, 74 award of 31 july 1997 [cisg/1997/24] (axle sleeves case). arts. 9, 38, 39, 84(1) english translation available at <http://cisgw3.law.pace.edu/cases/970731c1.html> award of 5 august 1997 [cisg/1997/25] (cold-rolled coils case). art. 49 award of 18 august 1997 [cisg/1997/26] (vitamin c case). arts. 25, 26, 31(a), 45(1), 49, 67(2), 74, 75, 76, 77, 78 english translation available at < http://cisgw3.law.pace.edu/cases/970818c1.html> award of 8 september 1997 [cisg/1997/27] (bopp film case). arts. 25, 35, 74, 88(2) english translation available at < http://cisgw3.law.pace.edu/cases/970908c1.html> award of 29 september 1997 [cisg/1997/28] (oxidized aluminum case). arts. 38, 74, 77 award of 8 october 1997 [cisg/1997/29] (industrial tallow case). arts. 25, 75, 78 award of 13 october 1997 [cisg/1997/30] (printing machine case). art. 38(1) award of 20 november 1997 [cisg/1997/32] (rebar coil case). art. 1 award of 30 november 1997 [cisg/1997/33] (canned oranges case). arts. 74, 79 award of 15 december 1997 [cisg/1997/34] (hot-rolled coils case). art. 18(3) award of 16 december 1997 [cisg/1997/35] (hot dipped galvanized steel coils case). art. 29 award of 19 december 1997 [cisg/1997/36] (steel case). arts. 29(1), 47, 49, 51, 72 award of 31 december 1997 [cisg/1997/37] (lindane case). arts. 11, 29, 45, 49, 74 1998 cietac awards award of 20 january 1998 [cisg/1998/01] (polyester thread case). arts. 45, 74, 77 english translation available at <http://cisgw3.law.pace.edu/cases/980120c1.html> award of 26 november 1998 [cisg/1998/06] (gloves case). art. 53 award of 26 november 1998 [cisg/1998/07] (old paper case). art. 1 award of 30 november 1998 [cisg/1998/08] (glassware case). art. 84(1) award of 15 december 1998 [cisg/1998/09] (shirts case). art. 79(1) award of 25 december 1998 [cisg/1998/10] (basic pig iron case). arts. 74, 75, 76, 78 english translation available at < http://cisgw3.law.pace.edu/cases/981225c2.html> award of 25 december 1998 [cisg/1998/11] (basic pig iron case). arts. 14(1), 23, 55, 75 1999 cietac awards award of 6 january 1999 [cisg/1999/04] (australian wool case). arts. 25, 53, 54, 60, 61, 64, 74, 75, 76, 77 english translation available at <http://cisgw3.law.pace.edu/cases/99010c1.html> award of 13 january 1999 [cisg/1999/05] (latex gloves case). art. 53 http://cisgw3.law.pace.edu/cases/970625c1.html http://www.cisg.law.pace.edu/cisg/wais/db/cases2/970627c1.html http://cisgw3.law.pace.edu/cases/970721c1.html http://cisgw3.law.pace.edu/cases/970731c1.html http://cisgw3.law.pace.edu/cases/970818c1.html http://cisgw3.law.pace.edu/cases/970908c1.html http://cisgw3.law.pace.edu/cases/980120c1.html http://cisgw3.law.pace.edu/cases/981225c2.html http://cisgw3.law.pace.edu/cases/99010c1.html nordic journal of commercial law issue 2005 #2 45 award of 28 january 1999 [cisg/1999/06] (refrigerating machine case). art. 1 award of 12 february 1999 [cisg/1999/08] (chrome plating machine case). arts. 74, 75, 78 award of 12 february 1999 [cisg/1999/09] (nickel plating machine case). arts. 74, 75, 78 english translation available at <http://cisgw3.law.pace.edu/cases/990212c2.html> award of 25 february 1999 [cisg/1999/10] (cotton vest case). arts. 74, 78 award of 25 february 1999 [cisg/1999/11] (women’s trousers case). arts. 74, 78 award of 1 march 1999 [cisg/1999/12] (canned oranges case). arts. 64(1)(a), 74 award of 25 march 1999 [cisg/1999/13] (women’s trousers case). arts. 74, 78 award of 29 march 1999 [cisg/1999/14] (flanges case). arts. 36, 38, 39, 40 award of 30 march 1999 [cisg/1999/16] (flanges case). arts. 36, 38, 39, 40, 60, 80 award of 30 march 1999 [cisg/1999/17] (electric heater case). arts. 35(1), 38, 50 award of 2 april 1999 [cisg/1999/18] (grey cloths case). art. 49 award of 5 april 1999 [cisg/1999/19] (air conditioner equipments case). art. 38(1) award of 7 april 1999 [cisg/1999/20] (pvc suspension resin case). art. 35(1) award of 8 april 1999 [cisg/1999/21] (wool case). arts. 25, 26, 30, 53, 58, 63 64, 74, 75, 76, 77 english translation available at <http://cisgw3.law.pace.edu/cases/990408c1.html> award of 12 april 1999 [cisg/1999/22] (bud rice dregs case). arts. 25, 30, 35, 45, 74, 75, 76, 78 english translation available at < http://cisgw3.law.pace.edu/cases/990412c1.html> award of 20 april 1999 [cisg/1999/23] (filling machine case). art. 38 award of 20 may 1999 [cisg/1999/24] (red tiles case). art. 1 award of 20 may 1999 [cisg/1999/25] (waste aluminum ingots case). art. 74 award of 21 may 1999 [cisg/1999/26] (excavating machine case). art. 50 award of 28 may 1999 [cisg/1999/02] (veneer import case). arts. 74, 76, 77, 78, 84(1) english translation available at <http://cisgw3.law.pace.edu/cases/990528c1.html> award of 31 may 1999 [cisg/1999/27] (indium ingots case). art. 78 award of june 1999 [cisg/1999/03] (peanut kernel case). arts. 8, 9, 74, 76, 77 english translation available at <http://cisgw3.law.pace.edu/cases/990600c1.html> award of 4 june 1999 [cisg/1999/28] (industrial raw material case). art. 34 award of 11 june 1999 [cisg/1999/29] (agricultural chemical products case). arts. 61, 62, 78 award of 30 june 1999 [cisg/1999/30] (peppermint oil case). arts. 9, 18, 19, 74, 78 english translation available at < http://cisgw3.law.pace.edu/cases/990630c1.html> award of 30 june 1999 [cisg/1999/31] (axletree case). arts. 61, 62, 78 award of 31 december 1999 [cisg/1999/32] (steel coil case). arts. 8, 9, 59, 74, 77, 78 english translation available at <http://cisgw3.law.pace.edu/cases/991231c1.html> 2000 cietac awards award of 7 january 2000 [cisg/2000/06] (cysteine case). arts. 7, 8, 35, 38, 74, 77, 78 english translation available at <http://cisgw3.law.pace.edu/cases/000107c1.html> award of 29 january 2000 [cisg/2000/08] (steel bottle case). art. 49(1)(a) award of 31 january 2000 [cisg/2000/09] (clothes case). arts. 25, 38, 46, 73, 74, 77, 78 english translation available at <http://www.cisg.law.pace.edu/cisg/wais/db/cases2/000131c1.html> award of 1 february 2000 [cisg/2000/01] (silicon and manganese alloy case). arts. 25, 26, 49(1), 63(1), 64(1), 74, 75, 76 english translation available at <http://cisgw3.law.pace.edu/cases/000201c1.html> http://cisgw3.law.pace.edu/cases/990212c2.html http://cisgw3.law.pace.edu/cases/990408c1.html http://cisgw3.law.pace.edu/cases/990412c1.html http://cisgw3.law.pace.edu/cases/990528c1.html http://cisgw3.law.pace.edu/cases/990600c1.html http://cisgw3.law.pace.edu/cases/990630c1.html http://cisgw3.law.pace.edu/cases/991231c1.html http://cisgw3.law.pace.edu/cases/000107c1.html http://www.cisg.law.pace.edu/cisg/wais/db/cases2/000131c1.html http://cisgw3.law.pace.edu/cases/000201c1.html nordic journal of commercial law issue 2005 #2 46 award of 11 february 2000 [cisg/2000/02] (silicon metal case). arts. 7(1), 25, 74, 75, 76 english translation available at <http://cisgw3.law.pace.edu/cases/000211c1.html> award of 27 july 2000 [cisg/2000/03] (steel scraps case). arts. 25, 49, 74, 84(1) english translation available at <http://cisgw3.law.pace.edu/cases/000727c1.html> award of 10 august 2000 [cisg/2000/04] (silicon metal case). arts. 25, 45, 49, 74, 75, 77 english translation available at <http://cisgw3.law.pace.edu/cases/000810c1.html> 2002 cietac awards award of 7 march 2002 [cisg/2002/01] (lube oil case). art. 4 english translation available at <http://cisgw3.law.pace.edu/cases/020307c1.html> award of 10 june 2002 [cisg/2002/02] (rice agricultural products case). arts. 19, 26, 74, 75, 78 english translation available at <http://cisgw3.law.pace.edu/cases/020610c1.html> http://cisgw3.law.pace.edu/cases/000211c1.html http://cisgw3.law.pace.edu/cases/000727c1.html http://cisgw3.law.pace.edu/cases/000810c1.html http://cisgw3.law.pace.edu/cases/020307c1.html http://cisgw3.law.pace.edu/cases/020610c1.html * ms. lachmi singh is currently a phd candidate at the university of birmingham school of law; llb (honours) 2004, university of birmingham; b.a. political science 2001, university of toronto. the author is the recipient of the university of birmingham's postgraduate teaching assistantship scholarship and currently teaches in the areas of contract law and international sale of goods. caveat emptor: are decisions more favourable to the seller on matters relating to letters of credit? an examination of cietac decision of 4 june 1999 by lachmi singh* nordic journal of commercial law issue 2006 #2 nordic journal of commercial law issue 2006 #2 2 taken from world trade organization database data from march 2004 http://stat.wto.org/countryprofile/ wsdbcountrypfview.aspx?language=e&country=cn 3 http://stat.wto.org/countryprofile/wsdbcountrypfview.aspx?language=e&country=cn 4 the share in world total exports and imports of merchandise. breakdown by main commodity group: agricultural products refer to food and raw materials, fuels and mining products include ores and other minerals; fuels and non-ferrous metals. manufactures refer to iron and steel, chemicals, other semi-manufactures, machinery and transport equipment, textiles, clothing and other consumer goods. 5 supra 2 6 the people's republic of china has made an article 95 cisg declaration and is therefore not bound by article 1(1)(b) cisg. see: http://www.cisg.law.pace.edu/cisg/countries/cntries-china.html 7 except the united kingdom, ireland, and portugal 8 formerly established under the name foreign trade arbitration commission (1956) renamed cietac in 1988. see: http://www.cietac.org.cn/english/introduction/intro_1.htm 9 the new york convention 1958 (convention on the recognition and enforcement of foreign arbitral awards) has been acceded to by 135 countries as of may 1, 2005 2 1. introduction the people’s republic of china (prc) has long been a source of much speculation for economists and trade pundits; with its staggering population of 1,296,500,0002 it has become a force to be reckoned with. it is with china’s accession to the world trade organization (wto) on december 11, 2001 that one can assess the impact and volume of trade that has taken place over the past 5 years. to put this in perspective, worldwide china is ranked third overall in merchandise import and exports in 2004.3 also, in 2004 in the area of merchandise trade4 which consists of agricultural products, fuels and mining products, and manufactured products, china commanded a 6.46% share in the world’s total exports and 5.88% share in the world’s total imports.5 with these figures in mind, we now turn to the legal implications of this trade. it is evident to any lawyer that with such vast amounts of transactions being conducted everyday, legal disputes are almost certain to follow. the united nations convention on contracts for the international sale of goods 1980, (hereinafter referred to as ‘cisg’ or ‘convention’), has been in effect in china since january 1, 1988, and governs all international sale of goods transactions between contracting member states.6 this is important given that china’s largest trading partners are: the united states, the european union,7and the republic of korea. the united states, korea, and most of the european union member states are contracting states under the cisg. while most scholarly material written on the cisg focuses on the decision making of national courts, this article will instead examine a decision made by the chinese international economic and trade arbitration commission (cietac).8 cietac is one of the largest and most important arbitration institutions in china, with over 200 disputes reported involving the application of the cisg. many contracting parties choose arbitration as their preferred method of dispute resolution because of its advantages: efficiency of speed, low costs, and internationally binding decisions under the 1958 new york convention.9 http://stat.wto.org/countryprofile/ http://stat.wto.org/countryprofile/wsdbcountrypfview.aspx?language=e&country=cn http://www.cisg.law.pace.edu/cisg/countries/cntries-china.html http://www.cietac.org.cn/english/introduction/intro_1.htm nordic journal of commercial law issue 2006 #2 10 gao xiang and ross buckley (2003). the unique jurisprudence of letters of credit: its origin and sources. 4 san diego international law journal p. 91 3 this article examines what is considered one of the most important issues under the cisg, that of fundamental breach. in order for a buyer or seller to avoid the contract, they must prove that the breach in question is fundamental in order to justify abandoning their contractual obligations. although there are many reasons why an innocent party might try to avoid the contract, this writer will focus on cietac decision of 4 june 1999 (industrial raw materials case), which dealt with inter alia documentary letters of credit. we will look at the rules regarding documentary credits as established by the uniform customs practice for documentary credits of the icc (ucp 500), and the need for strict compliance. following this, we will briefly examine the criteria needed to establish fundamental breach under article 25 cisg. this article will then present an analysis of cietac decision of 4 june 1999 (industrial raw materials case), to determine if the arbitration tribunal arrived at a decision that is conducive to uniform interpretation of the cisg. in this case, the reader will have to bear in mind the seriousness of the breach and whether it justifies avoidance of the contract. was the decision more favourable to the seller? how would a reasonable person in the trade involved regard this situation? in addition, should the buyer have been entitled to some form of remedy for the seller’s breach of his contractual obligations? finally, this article will present what could be an alternative approach for buyers and sellers when faced with a dispute in their contractual arrangements. 2. letters of credit in order to understand why this issue is important, it is first necessary to understand the nature of the letter of credit. a letter of credit may assume many of the characteristics of a contract. however, it does not follow true contractual principles, instead it may be best described as a mercantile specialty.10 in most international sales of goods contracts, parties will require that the contract price be paid either by a documentary letter of credit or a standby letter of credit. the reason for this being that most buyers and sellers are likely to be unknown to each other and given that they are located in different countries, a letter of credit will make the transaction more secure. letters of credit are also useful when one party does not have sufficient financial history, assets, or credit to support good faith credit terms. 2.1. types there are two main types of letters of credit: documentary letters of credit and standby letters of credit. documentary letters of credit are the most common, and are used on an individual transaction, order, or invoice basis. they generally have specific conditions applied to them, such as being irrevocable by the buyer and confirmed by the issuing bank. standby letters of credit are used as a backup should the buyer fail to pay the contract price as agreed upon. thus, a standby letter of credit allows the buyer to ensure the security of the transaction with the seller by showing that it can uphold its promise to pay the price. nordic journal of commercial law issue 2006 #2 11 john f. dolan (1992). the correspondent bank in the letter-of-credit transaction. 109 banking law journal p. 396 (september-october) see also: http://www.drfurfero.com/articles/art03/art03.html 12 david c. howard (1984). the application of compulsory joinder, intervention, impleader and attachment to letter of credit litigation 52 fordham law review p. 957 see also: supra 9 13 article 3: credits v. contracts: a. credits, by their nature, are separate transactions from the sales or other contract(s) on which they may be based and banks are in no way concerned with or bound by such contract(s), even if any reference whatsoever to such contract(s) is included in the credit. consequently, the undertaking of a bank to pay, accept and pay 4 2.2. how doletters of credit work? a typical documentary letter of credit works in the following way: once the buyer has concluded the contract with the seller, the buyer will request its bank (issuing bank) to open a letter of credit in favour of the seller (beneficiary). the issuing bank, in order to fulfil this request, sends the letter of credit details to the seller’s bank (advising bank). the advising bank endorses the letter of credit and sends the beneficiary (seller) the details. the seller examines the details of the letter of credit to make sure that they are correct. if needed, the seller will contact the buyer and ask for the necessary amendments to be made. once the seller is satisfied with the conditions of the letter of credit, the goods are shipped and the seller presents the documents to the advising bank. the advising bank examines the documents against the details on the letter of credit and the international chamber of commerce (ucp 500) rules. if they are in order, the bank will send them to the issuing bank for payment. if the details are not correct, the advising bank tells the seller and waits for corrected documents. the issuing bank examines the documents from the advising bank and if they are in order, pays the money as promised. if the details are not correct, the issuing bank contacts the buyer for authorisation to pay or accept the documents. if acceptable, the issuing bank releases the documents to the buyer, and pays the money as agreed. the buyer receives the documents from the issuing bank and collects the goods. the seller receives the payment through the advising bank. the advising bank notifies the seller that payment has been made. to put this in perspective, it is more straightforward to view the letter of credit process as three separate obligations. the first obligation is found in the contract for the sale of goods, which sets out the responsibilities of the buyer and seller. the second obligation is between the buyer (applicant) and his chosen bank (issuing bank), whereby the bank agrees to ensure the creditworthiness of the buyer. the final obligation is found in the letter of credit itself, in which the issuing bank promises to pay the seller the contractual sum upon tendering of documents, which strictly comply with the terms of the letter of credit. as each of these obligations are independent of each other, no party to any of these three separate obligations can be held responsible for the performance of another obligation.11 2.3. principle of independence one of the doctrines upon which letters of credit are built consists of the principle of independence. this means that the responsibility on the part of the issuing bank to pay the seller under the terms and conditions of the letter of credit is a separate obligation and is entirely severed from the contractual relationship between the buyer and seller. therefore, the issuing bank must honour the payment under the letter of credit irrespective of any problems or disputes that arise under the contractual transaction for the sale of goods, unless fraud can be proven.12 this principle is embodied in articles 3 and 4 of the ucp 500, which stress that the banks are in no way concerned or bound by the underlying sales contract.13 http://www.drfurfero.com/articles/art03/art03.html nordic journal of commercial law issue 2006 #2 draft(s) or negotiate and/or to fulfil any other obligation under the credit, is not subject to claims or defences by the applicant resulting from his relationships with the issuing bank or the beneficiary. b. a beneficiary can in no case avail himself of the contractual relationships existing between the banks or between the applicant and the issuing bank. article 4: documents v. goods/services/performances. in credit operations all parties concerned deal with documents, and not with goods, services and/or other performances to which the documents may relate. 14 27 lloyd’s list l.r. 49, 52 (h.l.) (1927) 15 371 so 2d 545 p. 546 16 1 lloyd’s rep 236 (1993) 17 2 h.k.l.r. 35 (1991) 18 roy goode (1994-1995). abstract payment undertakings and the rules of the international chambers of commerce 39 st. louis university law journal p. 725 19 780 s.w. 2d 313 (tex. ct. app. 1989) 5 2.4. principle of strict compliance the other principle that the letter of credit system is based on; an arguably the most important is the principle of strict compliance. the rules governing this principle state that if the seller wishes to be paid under the letter of credit transaction, then documents which comply with the letter of credit must be tendered. in a similar regard to the principle of independence as presented above, once the documents which on their face conform to the terms and conditions of the letter of credit are met then the issuing bank must honour their obligation to pay. this rule is strict in the sense that presentation of documents which almost conform will not be sufficient to render payment. if the issuing bank chooses to pay under these circumstances, it does so at its own risk and may not be reimbursed by the buyer. while the rules of strict compliance are not explicitly mentioned in the ucp 500, it has for many years been embodied in judicial decisions both in the english courts and well as the united states. we can see for example in cases such as equitable trust v dawson partners,14 where it was stated by lord sumner, “ there is no room for documents which are almost the same or which will do just as well.” this was supported by the decision in fidelity national bank v dade county15 which states “ compliance with the terms of a letter of credit is not like pitching horseshoes. no points are awarded for being close.” the ucp 500 states in article 13(a) and 14, that upon receiving the documents the issuing bank must decide the basis of the documents alone whether or not they appear on their face to be in compliance with the terms and conditions of the letter of credit. furthermore, the bank is not required to clarify any ambiguities or discrepancies. in the case seaconsar far east v bank markazi jomhouri islami iran16 it was stated that the bank was correct in rejecting the non-conforming documents even though the discrepancy in question was trivial. however, it has been argued that this does not mean the document will be deemed nonconforming if it “ fails to dot every ‘i’ or cross every ‘t’ or contains obvious typographical errors.” this can be seen in the case hing yip fat co. v the diawa bank ltd.17 where it was held that the use of the word “ industrial” rather than “ industries” on a letter of credit application was an obvious typographical error.18 also, in the case of new braunfels national bank v. odiorne19 it was held that strict compliance can mean something other than absolute or perfect compliance. therefore, the courts will have to decide whether the typographical error in question has the potential to have severe repercussions for the transaction. one can observe from examining the process presented above that the letter of credit process is very technical and there are many things with the potential to go wrong. indeed, in commercial nordic journal of commercial law issue 2006 #2 20 the simplification of international trade procedures board. 21 clive m. schmitthoff (1988). selected essays on international trade, chia-jui cheng ed. p. 432 22 ibid. 23 ibid. 24 ronald j. mann (2000). the role of letters of credit in payment transactions, 98 michigan law review p. 2494 25 ibid, p. 437 26 article 49(1)(a) and article 64 (1)(a) cisg 6 reality the letter of credit process can be revised many times before it is deemed to be in conformity with the documents identifying the contractual terms. in a study undertaken in the united kingdom by the midland bank and sitpro20 in the mid 1980’s, the amount of letter of credit transactions that failed upon first presentation of documents was staggering.21 out of 1,143 presentations, 51.4 % failed to meet the strict compliance standard, however most were accepted upon re-tender.22 furthermore, 23.7% of those that failed were due to discrepancies in transport documentation. in other studies carried out in countries such as hong kong and australia, the failure rate was as high as 90% in some cases.23 these numbers have not decreased. in a more recent study undertaken it was found that documents did not conform to the letter of credit 73% of the time.24 the question remains as to under what circumstances can such non-conformities be deemed a fundamental breach under the cisg. some experts have asserted that courts should apply a legal test rather than a commercial one when examining non-conforming documents; specifically they should inquire whether there is a substantial and more to the point a real discrepancy.25 3. fundamental breach at the juncture, it is important to examine the requirement of a fundamental breach in order to justify avoidance of the contract under the cisg; albeit briefly. the convention defines fundamental breach under the provisions of article 25 cisg: a breach of contract committed by one of the parties is fundamental if it results in such detriment to the other party as substantially to deprive him of what he is entitled to expect under the contract, unless the party in breach did not foresee and a reasonable person of the same kind in the circumstances would not have foreseen such a result. there are many ambiguous terms in this provision for which the convention offers no clarification. these include terms such as: ‘substantially to deprive,’ ‘entitled to expect,’ ‘did not foresee,’ and ‘reasonable person of the same kind in the circumstances.’ these vague terminologies pose a potential threat to the correct interpretation that is to be given to the convention, even more so when one considers the implications of the buyer or seller being able to avoid the contract rests on establishing fundamental breach.26 in order to decipher the meaning of this provision, the convention provides interpretative guidance in the form of article 7 cisg: (1) in the interpretation of this convention, regard is to be had to its international character and to the need to promote uniformity in its application and the observance of good faith in international trade. nordic journal of commercial law issue 2006 #2 27 c.m. bianca and m.j. bonell (1987). commentary on the international sales law: the 1980 vienna sales convention giuffre: milan, p. 75 28 the closest thing the convention has to a reliable official commentary. 29 robert hillman, ‘cross-references and editorial analysis article 7’ available at http://cisgw3.law.pace.edu/ cisg/text/hillman.html 30 for the purposes of the present law, a breach of contract shall be regarded as fundamental wherever the party in breach knew, or ought to have known, at the time of the conclusion of the contract, that a reasonable person in the same situation as the other party would not have entered into the contract if he had foreseen the breach and its effects. 31 c.m. bianca and m.j. bonell (1987). commentary on the international sales law: the 1980 vienna sales convention. giuffre: milan, p. 206 32 see id p. 207 33 see id 7 (2) questions concerning matters governed by this convention which are not expressly settled in it are to be settled in conformity with the general principles on which it is based or, in the absence of such principles, in conformity with the law applicable by virtue of the rules of private international law. from the above, it can be ascertained that in order to promote uniformity in the convention one can look to the general principles upon which the convention is based to answer any ambiguities which may arise. the solution to filling any gaps which may be evident in the convention was provided for in article 7(2) cisg, which creates a hierarchical system for judges and arbitrators to adhere to. in order to resolve gaps in the convention, one had to first look to its internal principles and only when this method was exhausted could external principles be brought in as a last resort.27 the convention itself, neither in its provisions nor in the secretariat commentary,28 states what these general principles are, but the academic literature assists in this matter. scholars put forth what is considered to be the four basic policies underlying the cisg: freedom of contract, promotion of co-operation and reasonableness to preserve the contract, facilitation of exchange even in the event that something goes wrong, and to provide compensation for the aggrieved party.29 thus, in order to understand the ambiguous terms embodied in article 25 cisg, we will look to the legislative history of the provision in addition to academic literature to shed some light on the subject. the origins of fundamental breach can be found in ulis article 10,30 which was drafted with an aim to prevent avoidance from inconsequential contractual breaches.31 although the provisions under this article contained both elements of subjectivity and objectivity, it was criticised as being too hypothetical in that the party in breach would have to possess what is referred to as, ‘ex-postfacto’ knowledge of the events.32 as a result of these criticisms, when the committee to re-examine and create a new uniform law was established by uncitral, it was mandated that a more ‘material’ test was needed.33 this gave rise to the current provision under article 25 cisg, however, as we can see there are many problems that still exist. the author will proceed by examining each of the ambiguous phraseology in an attempt to get at the root of what criteria are needed to establish fundamental breach under the convention. http://cisgw3.law.pace.edu/ nordic journal of commercial law issue 2006 #2 34 andrew babiak (1992). ‘defining “ fundamental breach” under the united nations convention on contracts for the international sale of goods’ 6 temple international and comparative law journal p.119 35 alexander lorenz (1998). ‘fundamental breach under the cisg’ available at http://cisgw3.law.pace.edu/cisg/biblio/ lorenz.html see also: c.m. bianca and m.j. bonell (1987). commentary on the international sales law: the 1980 vienna sales convention. giuffre: milan 36 see id. see also yearbook vii 1976 at 101 37 see id 38 alexander lorenz (1998). ‘fundamental breach under the cisg’ available at http://cisgw3.law.pace.edu/ cisg/biblio/lorenz.html 39 see id p. 215 8 3.1. substantial deprivation in order for a breach to be ‘fundamental,’ the breach must cause a ‘detriment’ that substantially deprives the non-breaching party of its reasonable expectations. the cisg, however, does not define the term ‘detriment.’34 it is argued that, “ detriment fills the function of filtering out certain cases as for example where breach of a fundamental obligation has occurred but not caused injury.” 35 for example, taking the case of an antedated bill of lading, although the seller would be committing a fundamental breach of his obligations, if the breach does not cause the buyer any injury, it can be argued that detriment does not occur. it is important to recall that one of the significant principles of the cisg is the preservation of the contract and ensuring both parties receive the fruits of the contract. the draft commentary stated that, “ the determination whether the injury is substantial must be made in light of the circumstances of each case for example, the monetary value of the contract, the monetary harm caused by the breach, or the extent to which the breach interferes with other activities of the injured party.” 36 furthermore, when the party whose interests were infringed decides that continuing to be bound to the contract impedes his business activities to such an extent that he can no longer be expected to be bound, avoidance will be the remedy he seeks for no other remedy in the convention will satisfy the breach caused.37 3.2. expectation the two concepts of substantial detriment and contractual expectation are fused together, since detriment can be characterised as a fundamental breach if the injured party has no further interest in accepting performance of the contract.38 some delegations present at the drafting of the convention thought the reference to expectations under the contract represented a great improvement, while others claimed it was less flexible and introduced an element of subjectivity. i disagree with this suggestion. in examining the legislative history of this article, there is nothing to suggest that it is merely the expectation of the injured party alone that is taken into consideration. thus, in order to differentiate between a substantial and insubstantial detriment it is not only the decision maker’s opinion of the non-breaching party expectations that matter, instead it is connected to the terms of the contract.39 3.3. foreseeability the test of foreseeability as set out in article 25 cisg is meant to preclude a fundamental breach where the substantial detriment occurs unforeseeably; it is a mechanism which allows the party in breach to evade avoidance of the contract. since it is improbable that the party in breach will http://cisgw3.law.pace.edu/cisg/biblio/ http://cisgw3.law.pace.edu/ nordic journal of commercial law issue 2006 #2 40 alexander lorenz (1998). ‘fundamental breach under the cisg’ available at http://cisgw3.law.pace.edu/ cisg/biblio/lorenz.html 41 leonardo graffi (2003). ‘case law on the concept of “ fundamental breach” in the vienna sales convention’ revue de droit d e s a f f a i r e s i n t e r n a t i o n a l s / i n t e r n a t i o n a l b u s i n e s s l a w j o u r n a l n o 3 . 3 3 8 3 4 9 a v a i l a b l e a t : http://cisgw3.law.pace.edu/cisg/biblio/graffi.html 42 andrew babiak (1992). ‘defining “ fundamental breach” under the united nations convention on contracts for the international sale of goods’ 6 temple international and comparative law journal p.122 see also c.m. bianca and m.j. bonell (1987) commentary on the international sales law: the 1980 vienna sales convention. giuffre: milan p. 219 43 “ in determining the intent of a party or the understanding a reasonable person would have had, due consideration is to be given to all relevant circumstances of the case including the negotiations, any practices which the parties have established between themselves, usages and any subsequent conduct of the parties.” 44 harry m. flechtner (1998). ‘the several texts of the cisg in a decentralized system: observations on translations, reservations and other challenges to the uniformity principle in article 7(1)’17 journal of law and commerce pp. 187-217 available at http://cisgw3.law.pace.edu/cisg/biblio/flecht1.html 45 alexander lorenz (1998). ‘fundamental breach under the cisg’ available at http://cisgw3.law.pace.edu/ cisg/biblio/lorenz.html 46 leonardo graffi (2003). ‘case law on the concept of “ fundamental breach” in the vienna sales convention’ revue de droit d e s a f f a i r e s i n t e r n a t i o n a l s / i n t e r n a t i o n a l b u s i n e s s l a w j o u r n a l n o 3 . 3 3 8 3 4 9 a v a i l a b l e a t : http://cisgw3.law.pace.edu/cisg/biblio/graffi.html 47 (1) the parties are bound by any usage to which they have agreed and by any practices which they have established between themselves. (2) the parties are considered, unless otherwise agreed, to have impliedly made applicable to their contract or its formation a usage of which the parties knew or ought to have known and which in international trade is widely known to, and regularly observed by, parties to contracts of the type involved in the particular trade concerned. 9 acknowledge they foresaw the detriment in question the ‘reasonable person standard’ was established.40 where substantial detriment is deemed to exist, the party in breach has to show that he did not foresee the negative result, nor would a reasonable person have foreseen it, in order to escape avoidance. thus, it will be necessary to evaluate this in light of whether business people in the same product market would have foreseen the detriment; the reason for this is that standards of reasonableness will vary amongst the different areas.41 a reasonable person is considered to be a reasonable merchant of the same socio-economic background, so all of the standards of the trade would have to be met. in addition to the circumstances of the particular case, market conditions both regionally and globally must be considered, as well as legislation, political climate, and prior dealings42 as stated in article 8(3).43 the question arises as to the point in time when the detrimental result has to be foreseen; article 25 does not state whether foreseeability should be decided at the time the contract was formed, or when the breach took place.44 some scholars contend that since the contractual terms establishes the rights and responsibilities of the buyer and seller, then the decisive time for when foreseeability is determined should be when the contract is formed. if not, one party could provide the other with further information, thereby changing what was deemed to be a substantial interest and could now give rise to a fundamental breach.45 others, however, disagree with this, arguing that if we take the notion of good faith into account, then credence must be given to any information received by the party in breach after the contract was formed.46 4. can defects in letters of credit or documents relating to letters of credit constitute a fundamental breach? it is widely accepted as established above that letters of credit are a common method of payment under international sales contracts. in addition, the rules of the icc in regards to such sales contracts are considered by courts and academics to be usages within the meaning of article 9(2)47 http://cisgw3.law.pace.edu/ http://cisgw3.law.pace.edu/cisg/biblio/graffi.html http://cisgw3.law.pace.edu/cisg/biblio/flecht1.html http://cisgw3.law.pace.edu/ http://cisgw3.law.pace.edu/cisg/biblio/graffi.html nordic journal of commercial law issue 2006 #2 48 cisg-ac opinion no 5, the buyer's right to avoid the contract in case of non-conforming goods or documents 7 may 2005, badenweiler (germany). rapporteur: professor dr. ingeborg schwenzer, ll.m., professor of private law, university of basel. 49 article 53: the buyer must pay the price for the goods and take delivery of them as required by the contract and this convention. article 54: the buyer's obligation to pay the price includes taking such steps and complying with such formalities as may be required under the contract or any laws and regulations to enable payment to be made. 50 article 30: the seller must deliver the goods, hand over any documents relating to them and transfer the property in the goods, as required by the contract and this convention. article 34: if the seller is bound to hand over documents relating to the goods, he must hand them over at the time and place and in the form required by the contract. if the seller has handed over documents before that time, he may, up to that time, cure any lack of conformity in the documents, if the exercise of this right does not cause the buyer unreasonable inconvenience or unreasonable expense. however, the buyer retains any right to claim damages as provided for in this convention. 51 ingeborg schwenzer (2005). “ the danger of domestic preconceived views with respect to the uniform interpretation of the cisg: the question of avoidance in the case of nonconforming and documents.” 36 victoria university of wellington law review p. 795 10 cisg.48 thus, it is accepted that the ucp 500 will be applicable either by express contractual reference by the parties or alternatively as a recognised international usage under the convention. under the convention, it is the principal responsibility of the buyer to pay the contractual price for the goods as set out in articles 53 and 54 cisg.49 in the same respect, it is the responsibility of the seller to hand over any documents relating to the goods as set out in articles 30 and 34 cisg.50 it is acknowledged both by international sales practice and ucp 500 article 3 that letters of credit are considered to be separate transactions from the sales contract on which it may be based and the bank is in no way concerned with or bound by the sales contract. while this may be true, it can be argued that from examining the process by which a letter of credit is approved and paid, documents required by the sales contract, need to be in conformity with the letter of credit before payment can be made. otherwise, this is what is known as tendering ‘unclean’ documents. furthermore, the need for ‘clean’ or conforming documents is embodied in article 13(a) of the ucp 500 in addition to articles 20-38 which address the requirements of specific documents such as bills of lading, sea waybills, and commercial invoices. this notion is supported by professor ingeborg schwenzer, rapporteur for the recent opinion issued by the cisg advisory council. she states, “ if the contract provides for payment by documentary credit, this implies that the documents have to be "clean" in every respect. otherwise, the buyer has the right to avoid the contract.51 other scholars, however, oppose this view and instead argue that the doctrine of independence under the letter of credit rules means that even when the documents are nonconforming, there is still an underlying obligation for the buyer to pay for the goods if they comply with the contract. this article has thus far stressed the importance of fundamental breach and the need for strict compliance between the documents and the letter of credit. it has been shown that, under the provisions of the convention both the buyer and seller have core obligations to perform. it is now necessary to examine one such decision made by cietac, to determine if the principles on which the convention is based are being upheld and applied by this governing body. nordic journal of commercial law issue 2006 #2 52 china 4 june 1999 cietac arbitration proceeding (industrial raw material case) 11 5. examination of cietac decision of 4 june 1999 (industrial raw materials case) 5.1. facts of the case in a case involving a u.s. buyer and a chinese seller for the sale of industrial raw materials, the contract stipulated that payment was to be made by letter of credit.52 after the signing of the contract, the buyer opened the letter of credit in accordance with the terms of the contract. however, when the letter of credit was presented to the paying bank for negotiation, it was dishonoured because the bill of lading was dated 1999 instead of 1998. the seller then requested that the buyer accept this disparity and redeem the bill of lading; the buyer did not redeem the bill of lading but instead asked for a price reduction for the disparity. the seller denied this request and when the buyer refused to make payment the seller resold the goods for a lesser sum. 5.2. buyer’s arguments the buyer argued that it was the seller who breached the contract by not delivering a complete set of documents as required by article 34 cisg. in fact, the seller in its correspondence with the buyer, admitted that the misdated bill of lading was the seller’s own fault and when the bank asked for the documents to be cured the seller failed to do so in a timely manner. the buyer is in the business of trading and thus was not the end buyer for the goods; he had already arranged for the goods to be resold to his downstream buyers. it is commonly accepted that in documentary sales a wrongly dated bill of lading can have severe repercussions for the buyer trying to resell the goods. therefore, even in the event that the sellers breach of article 34 cisg is not deemed fundamental, nevertheless the buyer should be entitled to some remedy for the trouble he will encounter with his other buyers in trying to resell the goods. 5.3. arbitration tribunal’s decision in this case the arbitration tribunal held that even though, “ under the usual circumstances, the documents must strictly comply with the letter of credit,” in this case the non-compliance does not constitute a breach since, “ it is easy for [seller], [buyer] or any person with international trade knowledge to know that this was obviously a typing error.” the tribunal found that the mistake on the bill of lading would not have affected the buyer taking delivery of the goods and would not have constituted a barrier to the buyer reselling the goods. the tribunal further goes on to state that, the buyer failed to act in accordance with good faith and in this situation the buyer should have used its own credit rather than that of the bank to pay for the goods. therefore, this was not considered a fundamental breach and the buyer was expected to pay for the price of the goods including interest. nordic journal of commercial law issue 2006 #2 53 boris kozolchyk (1990). strict compliance and the reasonable document checker, 56 brook law review p. 65 54 the financial times, july 2, 1986 55 note: this decision was entered as exceptional as neither buyer nor seller received any benefit. 12 5.4. analysis of decision first, this writer believes that it is important to note that whilst most arbitral tribunals consist of a panel of three arbitrators, this particular case involved a sole arbitrator as the amounts being claimed were less than rmb 500,000 and therefore summary procedure applied. i find this decision most troublesome since it goes against the provisions of the convention. it is understood that the letter of credit is a separate transaction from the sale of goods contract. however, it cannot be disputed that in order for the price to be paid under a letter of credit, the contract and its accompanying documents need to be in conformity. the seller in this case did breach his obligations to hand over conforming documents under article 34 cisg, this is not in dispute. the dispute arises as to whether the discrepancy in the document was substantial enough to either avoid the contract or allow for some other remedy under the convention. while it has been argued that some typing errors for example, a word spelled wrong, ‘mashine’ instead of ‘machine’ might be permissible under the ucp 500 rules, an error such as the year on a bill of lading will not be tolerated as seen in article 23 ucp. in order to understand why this decision does not fully appreciate the buyer’s position in this set of circumstances, it is necessary to examine the nature of the bill of lading as an instrument in international sales. in the family of transport documents, the bill of lading is key, as it represents a negotiable document of title. thus, the non-conformity in question must be weighed in accordance with the value of the document. for example, a bill of lading is one of a trio of documents that make up a basic cif documentary sales contract; therefore, one can argue that without this document there is no evidence of the goods being shipped. many academics and practitioners in the international sales forum support this notion, indeed, they stress the importance of the merchantability of documents, in this case the buyer relies on the merchantability of the bill of lading in order to resell the goods in an efficient and profitable manner.53 the repercussions of such an error go much further than the bank failing to honour the letter of credit. if the buyer in a string sale tried to resell the documents, his sub buyer could refuse to take possession of the non-conforming documents. in its decision the arbitrator states, “ the typing mistake of the date in the bill of lading would not affect the buyer taking delivery of the goods.” however, in this case the buyer is a trader. he is not interested in taking possession of the goods as he is not the end buyer. it is the documents which he requires to resell the goods to his other buyers and such documents need to be conforming in all respects, especially the documentary instrument of title, the bill of lading. in addition to this, the contract itself called for payment to be made by letter of credit. therefore it can be argued that the buyer had performed his obligation to pay the price by opening the letter of credit, but it is the seller who failed to perform his duties in supplying non-conforming documents. in the case of shansher jute mills ltd. v. sethia,54 it was held that when the documents tendered were non-conforming, the sellers who did not or could not present correct documents, were not entitled to recover the price of the goods from the buyers.55 furthermore, it can be argued that even though the principle of independence between the letter of credit and the underlying contract still remain, once the method of payment stipulated in the contract is that of a nordic journal of commercial law issue 2006 #2 56 article 50 cisg 57 indeed there are other opinions presented on this issue that are divergent to my own. some experts contend that the tribunal was correct in its interpretation of the facts, for example it has been argued that this was a case of a buyer acting in bad faith, trying to get a reduction in price because of a typographical error. furthermore, it is argued that the buyer, under the underlying contract, is not entitled to the same strict compliance standard (with all the terms of the contract) as the bank is under the letter of credit agreement. others put forth the opinion that there are not enough facts presented to render a correct decision. i have attempted to present a clear, concise argument taking into consideration these comments, the result being the conclusion that i have reached. there is merit to these other arguments however, one has to separate the issues and examine not only the facts presented, albeit limited, but also the spirit of the convention and a clear rationale of its provisions. 13 letter of credit then such a stipulation becomes a term of the contract. therefore, it is the seller who breaches his obligations under the sales contract and the buyer should either be entitled to avoid the contract in such a case or be entitled to one of the remedies set out under the convention. i find the suggestion of the tribunal that the buyer find other means by which to pay the price a substantial sum somewhat questionable as the very reason for which parties use a letter of credit is because they often lack the ability to finance their own credit. one other point worthy of mention is the fact that when the discrepancy was discovered by the issuing bank, a request was made for there to be a revision. such an action is permissible under article 48 cisg, the right of the seller to cure any defects. in this case, however, the seller failed to make the revisions in a timely manner. whether the issue was one of time or simply a matter of the defects being incurable, the facts of the case do not say. however, this writer feels the assertion by the tribunal that the buyer acted in bad faith by asking for a price reduction as unfounded, as the buyer could have just as easily avoided the contract altogether. instead, the buyer tried to renegotiate with the seller to keep the contract alive, a measure that was refused by the seller. the circumstances of this case should constitute a fundamental breach under the meaning of article 25 cisg, as the buyer was substantially deprived of what he was entitled to expect under the contract, and the seller could have foreseen what the repercussions of a wrongly dated bill of lading would mean for the letter of credit as well as the buyer’s other customers. a reasonable person involved in this trade would know that this non-conformity was not a simple typing error, as it would have serious consequences for the buyer. in the event that these circumstances did not constitute a fundamental breach, the buyer should have been entitled to a price reduction,56 as this was not an unreasonable request given the fact that he would have suffered a loss trying to resell these documents to his other buyers. 6. alternative solutions upon reading the outcome of this decision as well as other cietac arbitral decisions, one cannot help but notice that there is a lack of analysis or rationale given in the parts of the judgement that pertain to the cisg. the interpretation and examination put forth by this writer concerning cietac decision of 4 june 1999 (industrial raw materials case), is only one perspective and understandably, others will disagree.57 however, it is necessary at this juncture to examine what could be a possible alternative approach to this case. nordic journal of commercial law issue 2006 #2 58 richard hyland (1987). conformity of goods to the contract under the united nations sales convention and the uniform commercial code, peter schlechtriem ed. einheitliches kaufrecht und nationals obligationenrecht, baden-baden: nomos p. 305-341 59 ibid, see also: article 8: (1) for the purposes of this convention statements made by and other conduct of a party are to be interpreted according to his intent where the other party knew or could not have been unaware what that intent was. (2) if the preceding paragraph is not applicable, statements made by and other conduct of a party are to be interpreted according to the understanding that a reasonable person of the same kind as the other party would have had in the same circumstances. (3) in determining the intent of a party or the understanding a reasonable person would have had, due consideration is to be given to all relevant circumstances of the case including the negotiations, any practices which the parties have established between themselves, usages and any subsequent conduct of the parties. 60 supra 56 p. 332 14 first, in order to determine whether a non-conformity has occurred, examination of the contract is required. this is known as the contract principle, whereby the business decisions are left to the parties of the contract, emphasising the strong theme of party autonomy under the convention.58 the convention stipulates that the seller must hand over documents at the time and place in the form required by the contract and in return the buyer must pay the price as required under the contract. it is proposed that by abiding by the contract principle, uniformity of the convention is upheld, thereby preserving its international character. in the case at hand, once again we must return to the contract itself where it is stipulated that payment is to be made by letter of credit, an obligation which has duties for both the buyer and seller to perform. moving away from the contract principle, we encounter another problem when examining nonconformities that may arise. specifically, here we are looking at how to assess statements or acts which could have legal consequences for the performance of the contract. some of these statements or acts can be interpreted according to article 8 cisg.59 in order to avoid divergent interpretations by the courts as to what constitutes a reasonable person, hyland puts forth what is known as the ‘discussion principle’ whereby a party should not be allowed to rely on an ambiguous statement or act without first attempting to clarify it.60 this principle places a responsibility of each of the parties to discuss the terms of the contract and to resolve any discrepancies or ambiguities that exist, this measure helps to promote good faith and potentially avoid termination of the contract later on down the road. by encouraging this discussion, the parties can resolve any disputes amongst themselves and courts would have to respect the agreements reached. we can apply this principle to the case at hand, as there are many times when this dispute could have been clarified by further negotiations from both parties. for example, when the discrepancy in the bill of lading was discovered and the seller knew such a breach would be difficult to cure, the prudent thing to do would have been to renegotiate with the buyer for the price of the goods. did the buyer make his position as a trader during the contractual negotiations known? the facts of the case do not permit an answer. however, one can reason that if the seller had to resell the goods for a loss to another company why not renegotiate the price with the buyer and avoid litigation altogether? 7. conclusion this article has attempted to present an insight into one of the decisions made by cietac in relation to the issue of compliance of documents with letters of credit. the aim is not to cast dispersions on the integrity of the decision makers, instead it is to present to the parties to whom the cisg applies the potential problems that can arise within their contractual disputes. one is nordic journal of commercial law issue 2006 #2 15 concerned that when fundamental breach is invoked the tribunal does not provide much rational for why the breach may or may not be fundamental under the provisions of article 25 cisg. many proponents of the convention endeavour to ensure its success by demonstrating that its provisions can cope with the intricacies and technicalities of international sales transactions. it is only with the analysis of decisions by governing bodies can one determine if the cisg is being correctly applied. this writer would advocate a more hands on approach to applying the convention, whereby decisions could be cited on their merit and analysis. when courts and tribunals fail to engage in the sprit and meaning of the provisions set out in the convention, then its success as an instrument of international law is in doubt. the people’s republic of china with its vast amounts of trade being conducted everyday, in addition to the wealth of cisg decisions being handed down has the potential to significantly influence the success of the convention as an instrument of international sales law. nordic journal of commercial law issue 2009#1 reciprocity under the gnu general public licenses by pessi honkasalo nordic journal of commercial law issue 2009#1 2 1. introduction forming the question the gnu general public licenses are the most widely used open source software licenses worldwide. according to a license breakdown statistics from freshmeat.net, one of the largest software repositories, some 70 percent of applications that are released under an open source license carry that of gnu1. here, the reference to the gnu general public licenses is made in plural, for there are in all three gnu software licenses: a) the gnu general public license (gpl), b) the gnu lesser general public license (lgpl) and c) the gnu affero general public license (agpl)2. of these, the gpl is far and away the most popular. the prevalence of the lgpl is approximately one tenth thereof, and the latest entrant, agpl, is still rather marginal, albeit increasingly used latterly.3 each of the licenses has, however, its intended use and, in that regard, particular contractual provisions and effects, which naturally influence the potential penetration. such elements form the very research problem of this study, so that at this stage it suffices to say that, on average, the gpl is used for programs, the lgpl for libraries and the agpl for software that is commonly run over a network. notwithstanding the fact that most projects licensed under the gnu software licenses are unquestionably of minor importance or intended for a limited audience, the great social significance of these licenses stems from the other fact that some of the most widely used computer software is gnu-licensed, as well. examples of such programs include, among others, the linux kernel, the gcc compiler collection, mysql database server, perl programming language, openoffice.org productivity suite, java development kit, samba file and print services, qt development framework, iptables filter control tool, the cvs concurrent versioning 1 freshmeat.net 2008b. by the time of writing, the exact number was 70.88% equalling 31,538 branches out of 44,539. 2 hereafter, the abbreviated versions of the names are used when referring to any separate license. due to the technical nature of the subject matter, this study includes quite a few abbreviations and acronyms, all of which are explained in the list of abbreviations on p. 119 supra. furthermore, unshortened names are used where the terms are figured for the first time in the text. 3 palamida 2008. nordic journal of commercial law issue 2009#1 3 system and launchpad code hosting platform, which are all licensed under a gnu software license4. many factors can drive a decision about technology architecture, information management, systems integration or software licensing in general. history, legacy systems, internal politics and the location of key people within an organisation may all be relevant, as well as other commercial motives, such as cost considerations and offerings of competing vendors. what tends to be on a lower level of priority, if indeed is properly considered at all, is the legal or regulatory impact of such a decision.5 however, since various contractual restraints contained in proprietary and open source licenses, respectively, may at a later time be proven to mean a significant effect on the contemplated use or even the dilution of the whole investment, judicial risk analysis ought to constitute an essential part of the planning work of a licensing strategy. now, therefore, the purpose of this work is to interpret the reciprocity clauses included in the gnu software licenses, viz. which obligations they impose on the licensee and what sort of activity triggers such commitments. looking at prior studies, one can find many general statements in the literature that characterise the gpl as possessing something called the ‘viral effect’6, the lgpl as being ‘persistent’7 and the agpl as offering a plug for the ‘application service provider (asp) loophole’8 in the ordinary gpl. however, the more precise meaning of such effects and the demarcation between various forms of combinations and modifications—as well as defining which acts constitute derivatives of functional relevance with regard to reciprocally licensed software—have been subject to unfortunately diminutive analysis in our jurisdiction9. my aim is to systematise the mechanisms of reciprocity under the doctrine of gnu software licenses. first, i seek to offer, from the legal point of view, the intellectual readiness for making strategic licensing decisions in relation to the gpl and its derivatives for undertakings that are directly or indirectly conducting business in the computing industry. it is fundamental for developers to appreciate how the licenses affect the extent to which they can adapt the licensed software, and under what restrictions. nevertheless, secondly, the factual audience is much wider. according to the statistics from a recent survey, more than half of the enterprises are 4 freshmeat.net 2008a; canonical 2009. 5 millard 2008. 6 see manner 2001, 15; dixon 2004, 24–25. 7 see lerner and tirole 2005, 23; ghosh and soete 2006, 930. 8 see välimäki 2002, 854 fn. 27; babcock 2007, 42. 9 välimäki’s seminal research being a welcome exception. the perceptions built into his doctoral thesis have proffered fertile ground for this author’s further interpretations and systematisations. see välimäki 2005, 123– 138. nordic journal of commercial law issue 2009#1 4 using open source applications in their organisations today, and an additional ten percent plan to do so during this year10. further, by 2012, research firm gartner, inc. believes that 80 percent of all commercial software applications will include open source components11. inasmuch as the gnu software licenses hold the lion’s share of the open source market, it is highly probable that one wishes to be conscious of one’s risk position in such arrangements to eschew being legally exposed for violations of the license requirements. exclusions as stated above, this study focuses on the reciprocity obligations contained in the gnu software licenses, also known as ‘copyleft’12. such reciprocity can be further divided into three more precise, albeit not exact, categories, depending on the terms of the license agreement13: a) standard reciprocity obligation means that the distribution terms of the source code must be maintained so that, should the program be further developed, the license terms cannot be changed or the program made proprietary. nonetheless, should the source code be combined with another source code in order to create a new work, standard reciprocity obligation does not apply to the combined work. b) under strong reciprocity obligation, the same basic rule applies, but also adaptations and compilations of any kind whatsoever must keep the license terms intact. in spite of all, the obligation is not triggered preparatory to the time of distribution of the software. c) network reciprocity obligation is an augmented version of strong reciprocity, as far as the mere use over a network of a piece of software covered by such a license is interpreted as distribution, whereas in the former two brands the interpretation of the term encompasses only a downloadable or fixed software package. for the purposes of research, it is not the core areas of provisions that are especially interesting but, rather, fringes and overlaps; their interconnection. in order to be able to particularise the pith and functionality of each category within the set-down limit for the number of pages with 10 cio 2008. 11 ars technica 2008. 12 all the technical terms used herein will be explicated in the respective sections of text, where their meanings are further elaborated. for example, as regards ‘copyleft’, see ch. 0 infra. 13 välimäki 2005, 117–119. välimäki uses only notions of standard and strong reciprocity, while considers the third class merely as a modification of the latter; he speaks of a ‘network use obligation’. i deem it appropriate to make a clearer distinction, for the functional difference is rather significant, and there are also three separate gnu software licenses, respectively. nordic journal of commercial law issue 2009#1 5 an adequate precision, i have delimited the research task into the above-mentioned specific form. in that regard, this study contains the following exclusions. at the time of writing, there are overall 62 open source licenses that have undergone the approval process of the open source initiative (osi), and several more are currently seeking approval14. many of them share common characteristics and functionalities, differing only in some nuances. some, for one, are clearly aimed for special purposes15. however, because the gnu software licenses constitute a block possessing over two thirds of the market, i have deemed it well-grounded to limit the dissection hereunder to the member licenses of the gnu phalanx. but on the other hand, i consider the inclusion of the agpl in this work, in spite of its relatively low penetration, justifiable inasmuch as the license in question forms together with the gpl and lgpl a coherent system, which is expedient to be studied en bloc. in addition, according as the demand for the asp model increases, there is a strong possibility that the agpl’s significance will rise accordingly.16 further, within the system of gnu software licenses, all but the latest versions of the licenses have been excluded. hence, this study discusses the reciprocity obligations under versions 3 of the gnu general public licenses, namely gplv3, lgplv3 and agplv3 for short. the final versions of the former two were released on 29 june 2007 and that of the latter on 18 november 2007, each preceding a thorough revision process and several draft versions. the previous version of the gpl, gplv2, originates from june 1991; the predecessor of the lgplv3, lgplv2.1, is effective as of february 1999; and the original agpl, agplv1, is dated march 2002. each of these, and indeed even the more antecedent versions, can still be referred to in the license grant but the free software foundation (fsf), the publisher of the gnu software licenses, recommends using the latest versions17. thus far some 3,800 projects have explicitly converted to version 3 and nearly 6,900 projects are licensed under a certain other version of the gnu software licenses ‘or any later version’ of it18. pursuant to s. 14 of the 14 osi 2006. 15 see, e.g., the educational community license (epl), the nasa open source agreement (nosa) and the open group directory test suite license (ogdtsl). 16 for more information regarding the agpl, see ch. 0 infra. 17 stallman 2007. 18 palamida 2008. nordic journal of commercial law issue 2009#1 6 gplv3, in that event the licensee has the option of following the terms and conditions either of that numbered version or of any later version19. the older versions of the gnu software licenses are similar in spirit to the present ones, but differ in detail as the later editions have addressed some new problems and concerns. all text has completely been rewritten for versions 3; used terms have been altered widely and new definitions are given. in view of these facts, i find it consistent not to analyse the legal state against two contractual subtexts, but that of the more recent one. that being said, it is still probable that the comments provided hereafter will apply mutatis mutandis to the prior versions as well, for the updates did not remarkably affect the reciprocity proper20. the third contextual exclusion is the express concentration on the provisions of reciprocal nature. the gnu software licenses are thoroughbred licensing agreements containing terms with regard to, among others, the rights of the contracting parties, acceptance, downstream licensing, patents licenses, the warranty disclaimer and limitation of liability. this study covers only the first-mentioned. thus, emphasis is laid not so much on the licensing issues of a new system that is devised from scratch but rather on matters related to the use and distribution of a product that includes source code covered by the gnu software licenses, version 3. in consequence, the perspective adopted here is that of copyright law. copyright is—for the moment, at least—both nationally and internationally the predominant form of protection for computer programs21. as regards patent protection, s. 1(2)(3) of the patents act (550/1967) and art. 52(2)(c) of the european patent convention (epc; sops 8/1996) exclude software from patentability to the extent that a patent application relates to a computer program ‘as such’. however, although a literal interpretation might suggest on the contrary, patents have been granted to software also in the european patent practice, insomuch as the invention makes a contribution in a technical field22. as an answer to this trend, s. 11 of the gplv3 provides an 19 consequently, if the new license version gives additional permissions, those permissions are available immediately to all users of the program, but if the license imposes tighter requirements, it will not restrict the use of the current version of the program, because the program can still be used under the present license version. developers, for their part, are not obliged to release subsequent modifications of their programs under any later license version. moreover, the additional permission users may have does not require the licensor to fulfil any corresponding terms herself, since no additional obligations are imposed on any author or copyright holder as a result of the licensee’s choosing to follow a later version (gplv3, s. 14, para. 4). 20 compare, e.g., gplv3, s. 5 with gplv2, s. 2. 21 see s. 1(2) of the copyright act; art. 1(1) of the council directive 91/250/eec; art. 4 of the wipo copyright treaty (wct); art. 10(1) of the agreement on trade-related aspects of intellectual property rights (trips). on the history of the legal protection of software, see wipo 1985, 147–149. 22 prh 2003; epo 2008. nordic journal of commercial law issue 2009#1 7 explicit patent license23. the whole patenting scheme, however, would require plenty of space for a profound analysis, whereupon it is not covered here. another risk factor in respect of open source software in general, and that covered by the gnu software licenses as well, has to do with the division of risks among the contracting parties pertaining to infringements on intellectual property rights (ipr) by third parties24. it differs radically from the liability distribution applied commonly in the licensing of proprietary, closed source software. whereas the suppliers of conventional software engineering normally agree to indemnify the customer and hold it harmless against claims made by infringed third parties, the gnu software licenses start from the premise that the liability for ipr infringements is shifted onwards in the licensing chain onto the licensee. this stems from the general endeavours of osi and the related licenses to promote the distribution of software; they aim to lower the threshold of a licensor for granting rights to the source code it has developed.25 without proper intellectual preparedness as to the functionalities of the licenses, the risk position of a licensee may become substantially insecure where she affiliates a software component licensed under one of the gnu software licenses to her own end product. again, this study tries to set up that informational framework, but to the questions related to warranties and liabilities only cursory references can be devoted in respective chapters. finally, i shall make a remark about the adjective exclusions: some software packaging systems require the would-be licensees to click through or otherwise indicate assent to the terms of a gnu software license. in the legal literature, these kinds of arrangements are called ‘click wrap’ agreements. such agreements and their corporeal predecessors, ‘shrink wrap’ agreements, have been subject to wide-ranging academic debate26. no finnish legal praxis is on hand, but in a united states (us) case procd, inc. v zeidenberg27 such contracts were held enforceable and, at any rate, one can argue that since the methods have been utilised in software licensing for 23 in this author’s view, the said provision means—in all but mere pass-through distribution, where no patent license is granted—that in the distribution of a gplv3-covered work, the copyright of which one owns in part, patent license is granted to the work on whole, not just to the particular component. however, the license does not cover the changes made by subsequent actors in the chain of distribution. 24 for further classification to that effect, see anniina huttunen’s laudable master’s thesis lähdekoodin lisensointi gpl-lisenssillä ja lisenssinantajan vastuu kolmansien patenttioikeuden loukkauksista [turku] 2007, where the licensor’s liability for infringements of patent rights by third parties is discussed. 25 the open source definition and the philosophy of the free software movement are pinned down more in chs. 0– 0 infra. 26 see gringras 1996, passim; germanowski 1998, passim; rowland and campbell 2002, 28–32; hemmo 2003a, 156–157. 27 86 f.3d 1447 (7th cir. 1996). there is a line of cases that follows procd, inc. v zeidenberg, see, e.g., brower v gateway 2000, inc., 676 n.y.s.2d 569 (n.y. app. div. 1998). nordic journal of commercial law issue 2009#1 8 decades28, they have become in accordance with the customs of the trade. therefore, the problem of accession and other issues with regard to the standard conditions of contracts are not in focus hereafter, but are taken for granted29. furthermore, except for this mention, virtually nothing will be said on the advantages and weaknesses of software development itself based on open source software vis-à-vis the traditional, proprietary model of software development. it is certain that open source does under no circumstances guarantee comprehensive documentation, especially as regards the origins of the software30. collaborative development also generates technical challenges in respect of revision control and compatibility of systems31, so that each actor must decide against or in favour of open source on the grounds of individual needs; this work is merely an objective description of the prevailing legal status. source material the jurisdictional starting point for this study is that of the substantive law of finland. however, as the subject matter is distinctively universal, it seems justifiable that also observations about other jurisdictions are made to the appropriate extent. there are at least three valid reasons for this. first, the gnu software licenses have been released by an american organisation, the fsf. the interconnectedness of the licenses and title 17 of the united states code (usc), which in its chapters 1 through 8 and 10 through 12 contains the us copyright law, were writ large especially regarding the terminology of the previous versions32. during the last license revision process a more globalised approach was taken by defining more terms in the license texts, and comments were welcomed from all ready quarters so that, consequently, altogether four discussion drafts of the gplv3 were framed on the grounds of the received feedback. 28 välimäki 2009, 145–146. 29 however, it should also be noted that the gnu software licenses do not require anyone to accept them in order to receive and run software so licensed (gplv3, s. 9). hence, the licenses do not have to be accepted until modification or redistribution of a covered work takes place. since these actions would infringe copyright, were no permission to the contrary granted in the license, the argument of indicated acceptance is arguably extraordinarily plausible with regard to gnu software licenses. 30 bradbury 2004, 6. 31 fogel 2001, 10–12. 32 välimäki 2007, 15. the gplv2 uses terms such as ‘distribution’ and to ‘use’ that are defined in 17 usc 101, whereas the corresponding terms in the gplv3 are to ‘convey’ and to ‘propagate’ that carry no such linkages. nordic journal of commercial law issue 2009#1 9 nevertheless, the interpretation of the licenses is still ultimately conditional on the national copyright law33. second, the gnu software licenses have not yet been subject to any legal proceedings in finland. as a matter of fact, even worldwide there is very little case law in this area34. therefore, one has to utilise all the available trial documents in order to discover, to the appropriate extent, the underlying principles and common denominators35. i have worked on the basis that systematisations, no matter how consistent or coherent they are, must also be justified, and that justification is only achievable by building it upon legal usage as well36. in respect of theories regarding the sources of law, the said approach is trouble-free for if an applicable legal principle can be derived from foreign case law, it is practicable unless certain contraindications exist. comparative legal arguments may suggest feasible constructions for the problems of interpretation and are, as a result, permitted sources of law.37 third, the bulk of the earlier research has been carried out in other jurisdictions, notably under the anglo-saxon legal order. hence, most of the literature addressing the subject matter is of foreign origin. however, it is important to take cognisance of the quality of the copyright act (404/1961) related to the private international law, according to which only works of finnish origin are under s. 63 thereof protected by the act. protection for other, non-finnish works is granted by means of international treaties, to wit the berne convention for the protection of literary and artistic works (sops 79/1986); the rome convention for the protection of performers, producers of phonograms and broadcasting organizations (sops 56/1983); the wipo treaties (823–824/2005) and the trips (sops 4–5/1995). in an industry extremely global, the significance of this is that if an open source software project were on the grounds of jurisdictional basis deemed to be of foreign origin—as the case often might be—the secondary sources referred to at the beginning of this paragraph turn out rather relevant.38 33 gplv3 process definition. 34 see welte 2008. 35 the situation is comparable with the principles of interpretation under the law of transport. see selvig 1986, 7– 19; sisula-tulokas 2007, 42–46, 55–56. 36 cf. pöyhönen 2003, 68–69. 37 aarnio 1989, 235–236. see also tolonen 2003, 126–132. 38 an example: the copyright holders of gplv3-licensed software file a suit against a finnish company in helsinki district court for copyright infringement. if the court finds that the program in question is not of finnish origin, the judgement will be passed by virtue of the law that, according to the connecting factor rules of the private international law, is deemed bound up with the software, the programmers of which each might hail from a different country.—art. 3 of the berne convention includes the principle of ‘national treatment’ and trips, art. 4 the clause of most favoured nation (mfn). nordic journal of commercial law issue 2009#1 10 this study is a contribution to the ongoing scholarly debate concerning the gnu software licenses. it is founded on the theoretical frames of reference and the phrasing of questions expressed in pre-existing studies and leads up to offer a disquisition as to the essence of the reciprocity obligations under versions 3 by charting the functionalities as they are represented at present moment in a nordic judicial system.39 the object is achieved by making the most of the available sources of law, including the legislative history. in this context the content of substantive law is predominantly reduced to national legislation, european union (eu) directives and international conventions governing copyright. nonetheless, because the research problem pertains to the interpretation of the terms and conditions of civil licensing agreements, the very text of the licenses is of considerable relevance to the matter where mandatory legislation related to the law of copyright does not provide to the contrary. in private law, dispositions made by the parties within the limits of discretionary legal provisions constitute the prevailing legal relationship between them. the form of the arrangement is thus mainly for the contracting parties to decide. in this respect, if the meaning of a contractual clause is not obvious but necessitates interpretation, the interpreter must attempt to discover the purposes of the parties on the grounds of preliminary works and other relevant circumstances. as mentioned above, the revision of the latest gnu software licenses involved a public comment process with two to four discussion drafts and an accompanying rationale document for each license. ordinarily we cannot know in retrospect the foundations or the raison d’être of any solution opted in an agreement, but these preliminary works that are open and accessible to all on the web make an exception. the interpretative effect of such transparent material is deemed analogous to the role of a bill in the interpretation of the corresponding law and, accordingly, is brought hereunder to bear on if needs be40. methodology methodologically this study follows the approach of legal dogmatics. for the reasons stated above, in addition to sheer scientia iuris also the methods of comparative law are utilised on the appropriate connections. as to dogmatics, i have assumed an ideology of interpretation that applies the prevailing law in a manner of speaking the viewpoint of a judge. thereby, the focus 39 in order for readers influenced by other legal traditions, mainly continental and common law systems, to actually understand the contents, i have chosen to write this thesis in english, which has been the lingua franca of science, too, since the end of the second world war. 40 hemmo 2003a, 583–590. see also art. 5:102 of the principles of european contract law, art. 4.3 of the unidroit principles of international commercial contracts and art. ii.–8:102(1) of the draft common frame of reference (dcfr). nordic journal of commercial law issue 2009#1 11 is hereunder the analysis of the semantic meaning of stipulatory texts, both legislative and contractual, the purposes and intentions of the draftsmen and the established practices of the case law.41 the rationale behind such an approach is the informational interest to find out, what is the stand of the substantive law on various ways of exploiting computer programs that have been published under a gnu software license. i find that eliciting noteworthy matters with regard to those circumstances is best done by using said methods and being objectively disposed towards the research subject. the progression of the study is as follows: this first chapter provides an overview of the work’s thematic structure. it is followed by a concise chapter offering the relevant background information, which presents the statutory frame of reference and conventions regarding software licensing, the open source software development method as an antithesis of the firstmentioned as well as the fundamentals of the philosophical outlook behind the fsf and how this historical baggage has influenced the formation of the gnu software licenses. thereafter, attention is paid to the rôle that the gnu software licenses have in the exchange of software. in the conflict of assignments, licenses and pledges with regard to ipr, time priority forms the basis for collision resolution; protection provided by good faith is not thinkable in this area42. however, as the gnu software licenses are of non-exclusive nature, more important than cogitating erga omnes principles is defining the rights and obligations in the contractual relation. this is done in the third chapter by interpreting the contractual stipulations contained in the gplv3, lgplv3 and agplv3 as to reciprocity. basing on the findings and prima facie risk analysis of the preceding part, the fourth chapter then expresses the system of various forms of modifications under this doctrine. the gnu software licenses rely heavily on the functionalities and characteristics of copyright law, whereupon the guidelines for decision-making bestowed by such institutional support ultimately constitute the definite legal statuses. the idea–expression divide that prevails the reasoning related to the law of copyright provides for the test of substantial similarity, which can be utilised in demarcating the territories of independent, combined and modified works. the last chapter contains a précis of the arguments and discusses matters that especially ought to be taken into account where decisions relating, directly or indirectly, to the gnu software licenses are made. full texts of the terms and conditions contained in the licenses have been appended at the back. 41 siltala 2001, 121–123. 42 tuomisto 1993, 118–119; millqvist 2006, 129. nordic journal of commercial law issue 2009#1 12 2. background conventions of software licensing legal protection of computer programs in accordance with s. 1(2) of the copyright act, computer programs are protected by copyright as literary works. copyright does not protect the mere ideas and principles, which underlie any element of software, but the protection applies to the expression of a computer program, be it in any form whatsoever43. article 1(3) of the council directive 91/250/eec on the legal protection of computer programs (hereinafter referred to as the ‘software directive’) further provides that a computer program is protected if it is original in the sense that it is the author’s own intellectual creation; no other criteria are to be applied to determine the eligibility for protection. by virtue of s. 43 of the copyright act, protection is granted for the life of the author and for 70 years after her death or after the death of the last surviving author44. as to the authorship of computer programs, the copyright act starts from the premise that the person who has created a work has copyright therein (s. 1[1]). in consequence, the author of a computer program is the natural person or group of natural persons who has created the program. however, in accordance with s. 40b(1) of the copyright act, where a computer program is created by an employee in the execution of her duties or following the instructions given by her employer, the employer is exclusively entitled to exercise all economic rights in the program so created, unless otherwise provided by contract (s. 27[3])45. subject to certain exceptions, the exclusive rights of the copyright holder include the right to do or to authorise, first, the permanent or temporary reproduction of a computer program by any means and in any form, in part or in whole. accordingly, insofar as loading, displaying, running, transmission or storage of the computer program necessitates this kind of reproduction; such acts are subject to authorisation by the copyright holder. in the second place, without prejudice to the rights of a person who alters the program, the translation, adaptation, arrangement and any other alteration of a computer program and the reproduction of the results thereof are restricted acts as well. thirdly, the copyright holder has the exclusive right to authorise any form of distribution to the public, including the rental, of the original 43 strömholm 1970, 88 ff.; haarmann 2005, 96–98. 44 where the computer program is an anonymous or pseudonymous work, the term of protection is 70 years from the time that the computer program is first lawfully made available to the public (s. 44[1]). 45 he 161/1990 vp, 54. nordic journal of commercial law issue 2009#1 13 computer program or of copies thereof46. (copyright act, s. 2; see also software directive, art. 4.) as mentioned above, however, the protection provided by copyright is not absolute by any means but is subject to various limitations included in c. 2 of the copyright act. sections 25j and 25k therein provide special provisions concerning computer programs. to begin with, in the absence of specific contractual provisions, the reproduction of software does not require authorisation by the copyright holder where it is necessary for the use of the computer program by the lawful acquirer in accordance with its intended purpose, including for error correction47. moreover, the making of a back-up copy by a person who has a right to use the computer program cannot be prevented by contract insofar as it is necessary for that use. also, the person having a right to use a copy of a computer program is entitled, without the authorisation of the copyright holder, to observe, study or test the functioning of the program in order to determine the ideas and principles which underlie the elements of the program, if she does so while performing any of the acts of loading, displaying, running, transmitting or storing the program that she is entitled to do. in accordance with s. 25j(4) of the copyright act, any contractual provision on the contrary is automatically null and void. in addition, detailed rules in respect of decompilation exist. decompilation is a term for the process of obtaining source code from compiled, machine-readable object code48. in this respect, the authorisation of the copyright holder is not required where the reproduction of the source code is indispensable to obtain the information necessary to achieve interoperability of an independently created computer program with other programs. however, decompilation is permitted only provided that the following conditions are met: a) the decompiler must have a license to use the program to be decompiled, b) the information necessary to achieve interoperability must not previously have been readily available in the public domain and 46 subject to the first-sale doctrine. see s. 19 of the copyright act, according to which the first sale in the european community (ec) of a copy of a program by or with the consent of the copyright holder exhausts the distribution right within the ec of that copy, with the exception of the right to control further rental of the program or a copy thereof. 47 as regards error correction, however, recital 18 of the software directive provides conversely by stating that ‘[…] the acts of loading and running necessary for the use of a copy of a program which has been lawfully acquired, and the act of correction of its errors, may not be prohibited by contract’ (emphasis added). välimäki (2009, 52–53) argues that a technical error has occurred in the finishing of the directive and that the user’s right in that regard was intended non-discretionary. cf. takki 2002, 182. 48 rowland and campbell 2002, 35 fn. 39. see also freedman 2000, 43–44. nordic journal of commercial law issue 2009#1 14 c) the decompilation process must be confined to the parts of the target program relevant to interoperability.49 it should be noted that by virtue of s. 25k(2) of the copyright act the above-mentioned provision does not permit the information obtained through its application to be (1) used for goals other than to achieve the interoperability; (2) to be given to others; (3) to be used for the development, production or marketing of a computer program substantially similar in its expression or (4) to be used for any other act that infringes copyright. in general, property is composed of interests having a net asset value50. common law countries make use of a concept called the reification of relations, which means treating rights as if they were things by applying, as far as possible, the same principles and terms to intangible assets as to corporeal things51. for example, in the united kingdom (uk) goods are defined by s. 61(1) of the sale of goods act (1979 c. 54) as personal chattels other than things in action and money, whereas the finnish sale of goods act (355/1987) applies, under s. 1(1) thereof, to the sale of property other than real property. such conceptual definitions and divergences therein amount, however, functionally very little to the subject matter. whilst it is not semantically valid under the finnish legal system to speak of an ‘owner’ of a copyright, in our jurisdiction copyright as an ipr constitutes a form personal property that enjoys protection relating to the law of property; pursuant to s. 15(1) of the constitution of finland (731/1999), the property of everyone is protected. the government proposal regarding the revision of the basic rights and liberties contained in the constitutions provides that, in addition to proprietary rights, the constitutional protection of property encompasses for instance limited rights in rem, rights to a claim, delinquent obligations for money payment by government officials and ipr having a net asset value as well52. in a computer program, the copyright is concentrated particularly upon its source code, which is a collection of statements and declarations written in a computer programming language that allows the programmer to communicate with the computer using a reserved number of instructions. once the source code has for processing purposes been converted into an 49 see he 211/1992 vp, 10–11. 50 kartio 2004, va111.33149. 51 lawson and rudden 2002, 81–82. e.g., s. 655 of the civil code of the state of california provides that ‘[t]here may be ownership of all inanimate things which are capable of appropriation or of manual delivery; of all domestic animals; of all obligations; of such products of labor or skill as the composition of an author, the good will of a business, trade marks and signs, and of rights created or granted by statute.’ (emphasis added.) 52 he 309/1993 vp, 62. nordic journal of commercial law issue 2009#1 15 executable object file by a compiler, the file is encoded in binary form and is composed merely of sequences of two symbols, 0 and 1.53 decompilation of an executable program in order to generate source code, where the copyright holder has wanted to keep it secret, constitutes an infringement of copyright, except for when it is necessary to achieve interoperability54. therefore, the computing industry has traditionally appreciated the intellectual property contained in code modules and subroutines to be their biggest competitive advantage and asset, which must be kept out of the reach of outsiders at full stretch in order to prevent adaptation of the program. this, for its part, has had a significant impact on the used licensing practices. standard patterns a unique thing connected with computer programs, which differentiates them from other literary or artistic works, is the fact that each and every time a program is being used, copies thereof are unavoidably made along with it55. pursuant to s. 11a(1) of the copyright act, temporary acts of reproduction are exempted from the exclusive reproduction right of the author56. however, subsection 2 of the same section provides that such an exemption does not apply to computer programs57, whereupon for all practical purposes the use of software necessitates a permission derived from the copyright holder58, which normally occurs in the format of a license agreement. retail software is hence sold as licensed products. software licensing means the utilisation of the exclusive rights of the copyright holder, that is to say the right to copy, distribute and alter the software59. the pecuniary value underlying a computer program is thus actualised by 53 takki 2002, 61–63; elo and hasu 2003, 2–6; oksanen 2004, 28–29. cf. kemppinen 2006, 235–236. 54 castrén 2006b, yj111.48303. 55 bainbridge 1999, 90–93. 56 the provision further requires the reproduction in question to (1) be transient or incidental, (2) be an integral and essential part of a technological process, (3) have as its sole purpose the enabling of a transmission in a network between third parties by an intermediary or a lawful use of a work to be made and (4) have no independent economic significance. 57 article 1(2)(a) of the directive 2001/29/ec of the european parliament and of the council on the harmonisation of certain aspects of copyright and related rights in the information society (hereinafter referred to as the ‘copyright directive’), which is the legal basis for the national provision at issue, provides that the directive leaves the existing community provision relating to the legal protection of computer programs, i.e., the software directive, intact (he 28/2004 vp, 84–85). 58 see kko 1998:91; software offered using an asp model being a remarkable exception. that model of software deployment and its relevance to the subject matter are elaborated in ch. 0 infra. 59 in terms of information technology (it), also the right of correction and further development. nordic journal of commercial law issue 2009#1 16 offering a copy of the work to quarters taking an interest therein60. in accordance with s. 27(2) of the copyright act, the transfer of a copy does not constitute a transfer of the copyright. thereby, the foundation of the licensing of both open source software and its antipode, proprietary software, is that in neither case does the granting of a—more or less permissive— license to a licensee mean an assignment of the copyright as a whole but rather limited components thereof. the authorisation is normally effective only insofar as the licensee adheres to the terms and conditions of the license61. it is a common practice that the licenses of proprietary software restrict the rights of a licensee to the fullest extent permitted by the peremptory provisions contained in the legislation. to that end, the licensee is typically granted a non-exclusive, non-transferable limited right to make a certain amount of copies and to use the program within internal business operations, without the right to correct errors, develop the program and further distribute it. moreover, most such license agreements include an express prohibition to decompile the program or otherwise cause or permit reverse engineering or disassembly that aims at disentangling the source code, unless required by imperative law for interoperability. 62 the potential for allocation as to proprietary licensing agreements is often very small: a license belongs to a certain person to whom it is initially granted. the prohibition of transferring a license without a prior written assent by the licensor stems from the commercial patterns of conventional software development and is built into the licenses in order to avoid price erosion.63 therefore, the right to transfer a license even within a consolidated corporation, in context of business assignments or in case of contemplated outsourcing or subcontracting must be reserved, if possible, by means of additional negotiations. finally, irrespective of the cause of termination, proprietary licensing agreements generally start from the assumption that the user is in that event obliged to destroy the copies of the software currently in its possession. this means in practice that in case the licensor of the computer program, inter alia, is declared bankrupt, closes down its operations or is a target of a corporate acquisition, the availability of the source code or an extension of the contract is not a foregone conclusion.64 in order to avoid such a compulsory replacement of the product and to assure the possibility to purchase substitutive maintenance from another supplier, licensing agreements may contain an escrow provision where the licensor agrees to hold a copy of the application, 60 välimäki 2009, 143–150. 61 takki 2002, 96–97, 169. provided that the breach of contract is substantial, the licensing agreement can be dissolved also without a specific stipulation thereof (hemmo 2003b, 349–350). 62 see adobe 2008; apple 2008; corel 2007; ibm 2008; microsoft 2008; oracle n.d. 63 takki 2002, 106–110, 168. 64 morgan 2007, 89. nordic journal of commercial law issue 2009#1 17 with the source code, that the client can access should the vendor fail to perform its contractual obligations.65 open source software already since the 1970s computer software has also been licensed under models where the copyright holder waives a part of the entitlements belonging to it on the grounds of copyright; as opposed to for example the record industry the maxim of reserving all possible rights was proven not always to be the most successful method in the computing industry66. exponents of the open source development method argue that making human-readable source code available to all licensees exploits the possibilities of distributed peer review and transparency of process, which ultimately leads to more powerful, reliable and inexpensive software67. nevertheless, open source does not merely mean access to the source code. osi has published a ten-clause open source criteria that the distribution terms of an open source license must meet in order to gain their quasi-official approval. the definition contains sine qua non as follows:68 table 1. open source definition # criterion specification a) free redistribution the license cannot restrict the licensee from either selling the software or giving it away for free b) access to the source code the source code of the program must be readily available and must not impede subsequent development by being intentionally obfuscated c) modified versions the license must allow adaptation of the work and allow modified versions to be redistributed under the same license d) code integrity the license may require modified versions to be distributed as the original base source code plus separate patches in order to ensure that modifications are readily distinguishable from the original e) non-discrimination the license cannot discriminate against any group or individual f) commercialisation fields of application, such as commercial use, cannot be restricted g) license distribution the license rights automatically apply to anyone to whom the software is redistributed without requiring another license h) no product restrictions the license cannot make the rights depend on the software remaining a part of a particular software distribution i) no co-distribution restrictions the license cannot restrict what software it is allowed to be distributed with 65 vapaavuori 2002, 1068–1070. in finland, for instance the helsinki region chamber of commerce acts as an escrow agent for source code deposits; see helsinki region chamber of commerce 2005. 66 välimäki 2009, 146. 67 raymond 2000, passim. 68 osi 2004. cf. rosen 2004, 8–11. nordic journal of commercial law issue 2009#1 18 j) technology independence the license cannot require gestures like click wrap to establish a contract between the licensor and the licensee open source licenses use the essence of copyright law—the power to exclude and its inherent analogue, the equally large power to authorise69—by not focusing on how to prohibit others from using works so licensed but, instead, granting the licensees some of the copyright holders’ exclusive powers. that is to say, they subtract from copyright rather than add to it.70 open source licenses that contain reciprocal obligations further refine the perspective by laying stress not merely on prima facie freedoms but also on preserving the subsequent open distribution of works. thus, it seems that the fundamental purpose of this so-called doctrine of copyleft, which allows others to modify and redistribute ‘copylefted’ works, is to deny anyone the right to exclusively exploit the results of a creation71. lack of exclusive powers, however, does not render any party’s economic possibilities unfeasible since pure open source products can be capitalised either offensively by providing value adding support, training and consultation services or defensively by means of cost avoidance. the trade-off between the decision to disclose technology and the ability to appropriate the returns from that technology is ultimately a managerial issue, for which the science of law can only offer the juridical case.72 gnu software licenses free software foundation the fsf publishes the gpl, the lgpl and the agpl. whereas open source in general can be seen as a pragmatic development model free from moral attitudes, the fsf is a political movement, equipped with ethical and social values, that campaigns for computer users’ freedom. their idea of free software is not sold strictly on business-case grounds but it builds upon the notion of unrestricted freedom to run, to study and to change computer programs, as well as to redistribute copies thereof, with or without changes.73 69 see s. 27(1) of the copyright act. 70 working group on libre software 2000, 20–21. 71 laurent 2004, 4. see also vaidhyanathan 2001, 153–159. 72 see deek and mchugh 2008, 265–293, and the references therein, for an analysis concerning the economics of open source. west (2003, 1278–1280) provides a discussion as to shifting from proprietary to open source strategies. cf. com (88) 172 final, 173. 73 fsf 2008b. the philosophy of open source considers proprietary software as a suboptimal solution; as against for the free software movement, proprietary programs are a social problem, if anything. nordic journal of commercial law issue 2009#1 19 in 1984 the fsf launched the development of the free operating system gnu, which is nowadays used by millions and known by the name of gnu/linux. the first version of the gnu general public license was written for use with programs released as part of the gnu project. it was designed specifically to protect freedom for all users of a program.74 it is important to notice, nonetheless, that distributing copies of a program for a fee is by no means restricted either in the open source definition or under the gnu software licenses, the point being that whilst charging is permitted, users are according to their freedom not obliged to pay the distribution fee in order to use the software75. gnu general public license initially each gnu program was licensed under its own general public license mentioning the name of the program it applied to. version 1 of the gnu general public license was published on february 1989 in order to allow any program to refer to it without the need for separate modifications.76 the gplv1 provided that any vendor distributing binaries must also make the human readable source code available under the same licensing terms and that modified versions, as a whole, had to be distributed under the terms and conditions thereof77. the gnu general public license, version 2 was published on june 1991, introducing fairly small changes. arguably the most significant innovation was the new section 7, according to which a licensee who is imposed by circumstances contradicting the conditions of the gplv2 may not, as a consequence, distribute gpl-covered software at all78. the following 17 years witnessed the increasing popularity of open source software and the gpl becoming the principal license in that regard. nevertheless, also the technological and legal environments were naturally evolved by leaps. to that end, in order to respond to various development trends, the latest version of the gnu general public license addresses three challenges in particular that are, according to the fsf, facing the ecosystem of open source79. first, s. 6 requires the distributor to provide the licensee 74 fsf 2008c. 75 gplv3, s. 4. as always, the pricing strategies are dependent upon the characteristics of the marketplace. it is often so that enterprise software itself is free and customers pay for ongoing support, maintenance and integration assistance. see kotler, et al. 1999, 678–709 and more specifically mcallister 2006, 36. 76 fsf 1989. 77 gplv1, ss. 2(b) and 3. 78 for instance, should a patent license not permit the royalty-free redistribution of a program by all parties receiving copies directly or indirectly through the patent licensee, the only way she can satisfy both it and the gplv2 is to refrain entirely from distribution. 79 smith 2007; stallman 2007. nordic journal of commercial law issue 2009#1 20 with whatever information or data is necessary to install modified software on a device running programs licensed under the gplv3. second, in accordance with s. 3, no covered work is deemed part of an effective technological measure under any applicable law fulfilling obligations under art. 11 of the wct80. third, s. 11 provides that along with the distribution of software covered by gplv3, the licensor must provide every recipient with any patent licenses necessary to exercise the rights granted in the present license, and should a licensee institute patent proceedings against other users, the license of the former is automatically terminated81. gnu lesser general public license in computing, collections of standard programs and subroutines, which are stored and available for immediate use by means of a technological procedure known as linking, are called software libraries82. they basically provide a range of modules to serve as building blocks in new programs83. the lgpl is a set of additional permissions on top of the gpl, originally intended specifically for software libraries84. in accordance with ss. 2 through 4 of the lgplv3, the license places reciprocal obligations on the program itself but does not apply those restrictions to other software that merely links with the program. modification of the portions of the lgpl-covered component contained in the combined work and reverse engineering for debugging such modifications, however, must not be effectively restricted. as a consequence, libraries licensed under the lgpl may rather freely be combined also with proprietary applications85. 80 examples of such legal provisions being on the domestic front c. 5a of the copyright act, which implements c. iii of the copyright directive, and in the us s. 103 of the digital millennium copyright act (dmca) 112 stat. 2860 (1998). 81 the formulation of the patents clause is largely caused by the patent cooperation agreement between microsoft corporation and novell, inc. regarding patent coverage for their respective users, which was announced on 2 november 2006; see microsoft 2006.—by contrast, red hat, inc., a major linux and open source technology provider, entered on 6 june 2008 into a patent litigation settlement agreement with datatern, inc. and amphion innovations plc that protects not only the company but also the upstream and downstream members of the red hat community, as defined in the agreement. the whole text of the settlement is made publicly available. (red hat 2008.) 82 wordnet 2006. 83 jaeger and metzger 2006, 38–39. 84 stallman 1998. additional permissions contained in the lgplv3 except some of the requirements of the host license, viz. the gplv3, by virtue of s. 7 thereof. 85 turner 2004. nordic journal of commercial law issue 2009#1 21 gnu affero general public license in the past few years there has been a rising interest in on-demand software, which is provided by an asp to customers over a network, a model also known as ‘software as a service’ (saas). from the perspective of a saas consumer, it-related capabilities provided as a service mean access to technology-enabled facilities without knowledge of, expertise with or control over the very technology infrastructure that supports them.86 the ordinary gpl does not require anyone to accept it in order to acquire, install, use or inspect software. it obliges the licensee only if the latter distributes software made from gplcovered code and needs to be accepted only when redistribution occurs.87 however, as regards ‘distribution’ of application programs through web services or computer networks, no factual publication in the sense related to the law of copyright occurs, since the interaction happens only over a network, with no transfer of a copy88. the gpl thus permits making a modified version and letting the public access it on a server without releasing its source code. to that end, s. 13 of the agplv3 expressly requires the operator of a network server to provide the source code of the modified version running there to the users of that server. 3. reciprocity theoretical bases anglo-saxon jurisdictions draw a clear distinction between a copyright license and a contract concerning a copyrighted work; licenses are unilateral permissions to use someone’s property, whereas contracts are exchanges of obligations89. in the us, a license is enforced under copyright law at the federal level but a contract, instead, is enforceable under contract law, which varies from state to state90. furthermore, with regard to licenses, provisions contained in the legal document and thus forming the essence of a transaction may under common law be either conditions or covenants. conditions are based directly on copyright, but covenants are 86 ford 2007, 15; kaiserwerth 2008, 2–9. 87 moglen 2001. 88 vedenkannas 2002, 866–867. see also, a more theoretical approach, kivimäki 1948, 256–259.—the earning logic of saas is not founded on making and administering copies of the work but on controlling the access to the service (kulmala 2003, 58). 89 collin 2004, 68, 179–180. 90 see jones 2003. the remedies available are not the same. in the event of copyright infringement, the relevant possible devices for redress are (1) actual or statutory damages and (2) an injunction prohibiting infringing distribution. cf. kumar 2006, 24–35. nordic journal of commercial law issue 2009#1 22 added above and beyond any such conditions—i.e., they are merely contractual—and only the violation of the first-mentioned constitutes copyright infringement.91 the us court of appeals for the federal circuit recently ruled in jacobsen v katzer92 that open source licenses create conditions on the scope of the license, and failure to comply with those conditions may amount to a breach of copyright. the ruling denotes in practice that also the reciprocity obligations contained in the gnu software licenses can hardly be characterised as mere contractual covenants, for the subject matter thereof and language therein are similar to what was upheld by the court as conditional.93 in our jurisdiction, no such subtle separation of concepts exists, but licenses are simply contracts. available remedies, however, vary depending on whether copyright infringement or breach of contract is the case. there are special legal provisions concerning the systems of contractual (s. 26 of the copyright act) and forced licenses (ss. 17 to 19a of the copyright act), but when it comes to the voluntary agreement on authorising use of copyright to a licensee, any specific sources of law governing them are not available. domestic legal literature represents licensing agreements as a sui generis type of contract that is being administered mainly by the standard theories of law of obligations and that can case-specifically also be influenced by the analogical interpretation of the special regulation regarding other types of contracts94. consequently, from the finnish point of view, the matters of form amount to very little in respect of analysing the legal positions derived from a license in force between the parties thereto. it is the factual content of the juristic act that is of the essence. nonetheless, the competence of a licensor originates from the exclusive rights conferred upon her by virtue of copyright law. it means that copyright defines the framework against which the possibilities of disposition are to be dissected and that the final result is the product of both contractual and statutory factors. the discussion hereunder follows said premises. in this chapter 3 i shall first untangle the substance of the different categories of reciprocity contained in the gnu software licenses and then, by implication, elucidate what the consequences of non-compliance are. this is done predominantly by means of interpreting the license texts themselves and assessing the justifications found in various preparatory documents, where necessary. chapter 4 then 91 gomulkiewicz 2009, 10–14. see also rosen 2008, 4–5. 92 535 f.3d 1373 (fed. cir. 2008). 93 the case in question concerned with the artistic license 1.0. the artistic license uses the traditional language of conditions by noting that the rights to copy, modify and distribute are granted provided that the conditions are met, which the court found to be of considerable relevance. this same phrasing is contained in the gnu software licenses; see, e.g., gplv3, ss. 2 and 4 to 7. 94 see vuorijoki 2004, va111.56753. nordic journal of commercial law issue 2009#1 23 discusses the systematic outcome of said analysis, to wit the different groups of subsequent works based on their relationship with the original ones and how to differentiate between them. here the matter is examined on the grounds of national and community legislation, further refined by legal praxis, as well as relevant forms of legislative history, for the contents of the classes is ultimately a question of copyright law.95 as regards definitions, it was mentioned above that the original gnu software licenses were drafted with specific attention to the us legal order. the wordings contained several terms that were taken directly from title 17 of the usc. by so doing, versions 2 of the licenses were by definition dependent upon the details of us copyright law. however, in the course of time, practical experiences with the international use of license texts so formulated revealed certain variations in copyright laws that lead to substantial differences among jurisdictions in the effective requirements and, ultimately, the consequences of the licenses. the gplv3 process definition therefore started from the premise that, to the extent possible, versions 3 of the gnu software licenses ought to reduce the difficulties of internationalisation96. the greatest complexity pertained to the notion of ‘distribution’, a us legal term of art (17 usc 101) and a well-established non-legal term describing commercial transfers of software. section 2(1) of the finnish copyright act speaks of ‘making available to the public’, which is the closest counterpart to distribution in many other countries as well97. the problem of using terms defined by categories drawn from some particular national copyright statute in a global license is that it easily leads to variations in meaning. distribution, for instance, reportedly in some jurisdictions would not include network transfers of software but might include interdepartmental transfers of physical copies within an organisation98. to that end, versions 3 of the gnu software licenses no more contain any references to distribution but use factually-based terminology instead. this is achieved by introducing two new terms, ‘propagation’ and ‘conveying’, which are defined by behaviour, not by statutory categories. in consequence, to propagate a work means to do anything with it that, without permission, would make one liable for infringement under applicable copyright law, except executing it on a computer or modifying a private copy (gplv3, s. 0). to convey a work, for its part, means any kind of propagation that enables other parties to make or receive copies (ibid.). 95 license terms themselves are contractual stipulations, but the substantive rights granted by the gnu software licenses are defined under applicable local copyright law. 96 gplv3 process definition. 97 see, e.g., ss. 2(1) of lag (1960:729) om upphovsrätt till litterära och konstnärliga verk (sweden), lov om opphavsrett til åndsverk m.v. (norway) and bekendtgørelse af lov om ophavsret (denmark) as well as s. 18 of the copyright, designs and patents act 1988 (c. 48) (uk). cf. s. 17 of gesetz über urheberrecht und verwandte schutzrechte (germany). 98 opinion on denationalization of terminology – gplv3. nordic journal of commercial law issue 2009#1 24 propagation, therefore, includes by virtue of s. 2(1) of the copyright act (1) making copies of the work and (2) making the work available to the public, with or without modification. in other jurisdictions it may include, as a consequence of the definition, other actions as well. activities that constitute propagation of copies to others, then, are conveying. argumentum e contrario would provide that, for instance, giving a copy of gplv3-covered software to a colleague is propagation, not conveying, as long as the officials use the program in their work within an organisation, rather than personally, because the organisation as a legal entity is not making copies available to others. other examples of propagation that does not enable other parties to make or receive copies is making personal copies of a program or privately viewing it. for the sake of simplicity, term propagation will be used to describe the exclusive rights of the copyright holder to dispose of the work and transfer of copies of software will be referred to as conveying throughout the remaining, gnu software license specific parts of this study. standard reciprocity central idea the focus of reciprocity, core legal mechanism of the gnu software licenses, has been expressed in the preamble of the gplv3: to protect your rights, we need to prevent others from denying you these rights or asking you to surrender the rights. therefore, you have certain responsibilities if you distribute copies of the software, or if you modify it: responsibilities to respect the freedom of others.99 despite a somewhat belletrist manner of representation, the idea is clear: users are free to modify and share software contributions but only under the same terms. this ensures that improvements to software remain available to previous contributors, thus providing them an incentive to make the initial contributions at the outset, and to future contributors alike. aigrain suggests that this method leads up to ensuring the sustainability of innovation in the software, which takes place, as he calls it, in a ‘protected commons’100. manifestos aside, the proper reciprocity conditions of legally binding nature are set forth in s. 5 of the gplv3, which provides that any licensee of a program covered by the gplv3 may convey a work based on the program contingent upon certain conditions being met. the most important one is subsection 5c, according to which the conveyor is under an obligation to 99 emphasis added. 100 aigrain 2002, 3. see also deek and mchugh 2008, 250–251. nordic journal of commercial law issue 2009#1 25 license the entire work, as a whole, under the gplv3 to anyone who comes into possession of a copy. the gplv3 thus applies to the whole of the work and all its parts regardless of how they are packaged. this is the very essence of reciprocity. the reciprocity obligation contained in the gplv3 is of strong nature, for the license does not recognise any exceptions on the grounds of the proportion of the original program to the material attached to it—or to which it is attached. strong reciprocity obligation is triggered once and for all where conveying occurs and a portion, which by its characteristics possesses relevance related to copyright law, of gplv3-licensed code is involved101. by contrast, the lgplv3 embodies a slightly more moderate form of compulsion, so-called standard reciprocity. it loosens the obligation in respect of combined works by providing that a licensee of a program licensed under it may convey a work produced by combining or linking software with the program governed by the lgplv3 under terms of her own choice. this additional permission shall be scrutinised first. combining work with code released under lgplv3 should the licensee modify a copy of a covered work governed by the lgplv3, she may convey a copy of the modified version under either the same license or the gplv3 (lgplv3, s. 2). if she chooses the latter, none of the additional permissions of the lgplv3 apply to that copy.102 the provision represents reciprocity par excellence. combinations, instead and subject to particular conditions, are not covered by the standard reciprocity. in accordance with s. 0 of the lgplv3, a combined work can be produced by means of combining or linking. in modern software development, there is a tendency of separating parts of the software into distinct modules that can contain code and data providing services to independent programs103. the common mechanism for achieving this is the use of libraries, i.e., collections of subroutines and classes. the specification of the communication between libraries and applications that use them is called an interface, definitions of which make it possible to use the library by combining it to other programs. this combination, in turn, can generally be achieved by either static linking, where the library is copied into a target application at compile time and a stand-alone executable file is produced, or dynamic linking, 101 cf. ch. 0 infra. 102 this ensues already from s. 7 of the gplv3, which provides that a conveyor of a gplv3-covered work may at her option remove any additional permission, such as those contained in the lgplv3, from that copy or from any part of it. 103 mcdermid 1991, 20/14–15. nordic journal of commercial law issue 2009#1 26 where the contents of the library are loaded into an application program at runtime and remain separate files on disk.104 hence, combining referred to in the lgplv3 comes down to making some sort of use of an interface provided by a library module, but not being otherwise based on it105. were the latter provision fulfilled, it would be a question of modification, not combination, and the normal reciprocity obligation of s. 2 of the lgplv3 would apply106. linking an external component into a work covered by lgplv3 is thus an instance of modification, wherefore the lgplv3 or gplv3, alternatively, will override. if lgplv3-covered code is linked into a main program, the license terms of that main program have no obligations from the lgplv3. consequently, combined works recognised by the lgplv3 may be conveyed under terms up to the individual, if certain conditions are met. first, s. 4 of the lgplv3 provides that the license terms must allow any kind of modification of the lgplv3-covered software components contained in the combined work and reverse engineering for the search and procurement of defects in such modifications. second, the conveyor must take care of attaching prominent copyright and license notices and references to the work (lgplv3, sub-ss. 4a–4c). third, pursuant to subsection 4e of the lgplv3, the conveyor is obliged to provide the necessary installation information for installing and executing a modified version of the combined work produced by recombination with altered lgplv3-covered code, if she would otherwise be required to provide such information under s. 6 of the gplv3107. finally, in accordance with subsection 4d of the lgplv3, the conveyor of combined works must accomplish one of the two alternatives. she may either (1) use a suitable shared library mechanism for linking with the lgplv3-covered program or (2) convey any lpglv3-licensed source code of the combined work under the lgplv3 and the dependent work under such license terms and in such re-linkable form that a user is able to produce a modified combined work without any technological or legal barriers to doing so. subsubsection 4d1 of the lgplv3 further provides that an appropriate shared library mechanism is one that uses at run time a copy of the library already present on the user’s 104 daintith 2004, 268, 298, 419. see also mcdermid 1991, 46/3–8. 105 in accordance with s. 0 of the lgplv3, defining a subclass of a class defined by the library is deemed a mode of using an interface provided by the library. it is not obvious, however, whether this specification applies to all cases of data type inheritance, or is merely an exception. 106 the demarcation between separate, combined and modified works is in greater detail reverted to in ch. 4 infra. 107 the requirement relates to systems that incorporate reciprocally licensed software, but use hardware to prevent users from running modified versions of the software on that hardware. the creation of systems of this kind is known as ‘tivoisation’; see ch. 0 infra and further brooks 2007, 56. nordic journal of commercial law issue 2009#1 27 computer system, and will operate properly with a modified version of the library that is interface-compatible with the particular version of the library with which the combined work was made in the first place. thus, in order to satisfy these requirements, the combining must occur dynamically, and the proprietary parts of the combined work must not refuse to function irrespective of the internal operations of the library as long as the features of the interface remain similar to the original one. if the conveyor chooses to link the lgplv3-licensed library to the combined work statically, the combining occurs at compile time and the library cannot be utilised independently on runtime requests. therefore, the conveyor must provide her licensees with any code, data and utility programs needed for reproducing the combined work; any details about the internals of the main program are not required. this corresponding application code may be in object code or source code form, but in any event the lgplv3 provides that it must be suitable for the user to produce a modified combined work by editing the library and then recombining or re-linking the result. (lgplv3, subsub-s. 4d0.) the users’ right for this cannot be denied in the license of the combined work, for otherwise the work might not be conveyed at all (arg. gplv3, s. 12). consequently, it seems that linking is permitted where users are able to modify the library themselves and are provided with the necessary source code and instructions for so doing. the architecture of the main program must, of course, be designed in a way that makes the relinking with lgplv3-covered source separately from the main program possible, and the license terms of the combined work must allow reverse engineering to debug the new versions of the library that are linked with the main program108. the factual term for the ‘linking’ operation is dependent upon the characteristics of particular programming languages and other technological circumstances. such variance, however, carries no legal relevance with regard to the lgplv3, for the combination that forms a single work is not limited to linking. instead, combined works are defined with references to both linking and combining in general, and these terms are used invariably together throughout the license text. for example, traditional linking and its counterpart in object-oriented programming languages, inheritance, are both instances of combining, and the result in both cases is a combined work, not a modification, that can be licensed any way the conveyor sees fit.109 as a result of dynamic linking, it is also possible to combine not the entire library, but only parts of it. pursuant to s. 3 of the lgplv3, the object code form of an application may 108 under the ec legal order, this requirement stems to a great extent already from the provisions of the software directive, art. 6. see s. 25k of the copyright act. 109 cf. slashdot 2003. nordic journal of commercial law issue 2009#1 28 incorporate material from a header file that is part of the lgplv3-covered program110. such object code can be conveyed under whichever license, if the incorporated material is limited to numerical parameters and comparable quantities, or small code snippets111. should the incorporation cover more material, the conveyor is obliged to give prominent notice with each copy of the object code that a program licensed under the lgplv3 is used in it and that the particular program and its use are covered by the present license (lgplv3, sub-s. 3a). the obligation is thus substantially milder than where a work that uses the library is conveyed together with the latter, as no requirements in respect of source code, installation information or copyright notices are set upon the conveyor. corresponding source and conveying thereof as regards legal instruments requiring that beneficiaries receive a program in source code form or can obtain it in such form should they wish, the meaning and content of the very term are an issue of great substance. in the context of gnu software licenses, the source code for a work means the preferred form of a program for making modifications to it (gplv3, s. 1). the definition is not bound to technical epithets but functional convenience. correspondingly, object code is in s. 1 of the gplv3 defined to mean any non-source form the work. object code, therefore, includes any kinds of transformed versions of the source code, and the definition also means that intentionally shrouded or obfuscated source does not qualify for the reciprocity obligation112. all versions of the gnu software licenses require the conveyor to provide the entire source code necessary to build the piece of software that is governed by such license, including supporting libraries, compilation scripts, etc. (gplv3, s. 1). providing source merely of the latest development code does not fulfil the requirement, but users must be offered the chance to obtain the source code for the exact object code they have received. thus, the definition of corresponding source means that the provided sources must correspond precisely to the conveyed binaries; the licensor is obliged to make sure that she possesses the source code form for each version of the program that has been conveyed for as long as s. 6 of the gplv3 provides. 110 this provision can be criticised for using a somewhat vague terminology, for it is not apparent what the license means by ‘header file’; no definition is on hand. header files are typically files that are automatically included in another source file by the compiler, but some programming languages use different naming schemes instead. 111 with regard to the last-mentioned, to wit macros, inline functions and templates, the license text sets a limit of ten or fewer lines in length. however, many programming languages do not constrain the length of the code lines by any means, whereupon it would have been more consistent to have set the restriction on the number of characters instead. 112 gplv3-dd1, 8–9. see deek and mchugh (2008, 241) for more information. nordic journal of commercial law issue 2009#1 29 however, s. 1 of the gplv3 draws the line of corresponding source code at system libraries, so that the provision of certain core components of operating systems is not required. by definition, system libraries also include software that may not come directly with the operating system, but that all users of the gnu-licensed program can reasonably be expected to possess. the formulation arguably means that standard libraries of common programming languages, also gplv3-incompatible ones, would be included therein.113 the preliminary works of the gplv3 suggest that the more low-level the functionality provided by such a library is, the more likely it is to be qualified for the system library extension114. if the library meets the criteria, the requirement to convey source for the whole program will not include it, even if a linked executable containing it is conveyed115. moreover, under the fifth paragraph of s. 1 of the gplv3, the corresponding source need not include anything that users can regenerate automatically from other parts of the conveyed source code. in addition to the requirement of no manual intervention, the provision does not contain any additional modifiers. from the process for public comment, the problematic nature of the paragraph’s wording as it now stands emerged, for the automatic regeneration can in some cases be extremely time-consuming or even unachievable in practice. various techniques that require integer factorisation of large numbers or use of external dependencies are available, whereupon it was suggested that the text ought to read ‘regenerate automatically and conveniently’, or suchlike.116 the concerns expressed by the commentators did not, however, touch a chord among the drafters. it would be, therefore, still possible for a mala fide conveyor to try to escape her obligation to provide source code by means of resorting to such manipulation and argue that users can indeed regenerate the rest of the source automatically, even if it took several years. as a supplement to the terms and conditions contained in the gplv3, s. 0 of the lgplv3 speaks, in addition, of the minimal corresponding source for a combined work. the term is defined to mean the corresponding source for the combined work, excluding any source code for portions of the combined work that, considered in isolation, are based on the work that 113 section 1 of the gplv3 provides that the system libraries of an executable work include anything, other than the work as a whole, that is included in the normal form of packaging a major essential component of a specific operating system, but which is not part of such a component, and serves only to enable the use of the work with such a component, or to implement an interface that is an official standard or that is widely used among developers working in a particular programming language, for which an implementation is available to the public in source code form. 114 gplv3-dd1, 9. 115 consequently, it is possible to use a proprietary module or one that is licensed under an incompatible license in programs that are governed by a gnu software license, insofar as the present module can be deemed to count as a ‘system library’. 116 see gplv3 comments in file ‘gplv3-draft-4’. nordic journal of commercial law issue 2009#1 30 uses the library, and not on the library proper with which the combined work was made117. hence, depending on the way of production of the combined work118, the conveyor of a work produced by combining material under her control with an lgplv3-covered software component is not necessarily obliged to provide her licensees with any of the source code that is not based on the component in question. how, then, should the corresponding source be conveyed and what should be the charge for this? section 6 of the gplv3 specifies several manners for providing the necessary source code depending on the way of the conveyance of the object code form of the covered work. the available options can be summarised as follows: table 2. ways of conveying corresponding source subs. form of conveyance providing the source code price supplementary conditions 6a physical product or medium accompanied on a physical medium no further charge 6b physical product or medium written offer to give anyone who possesses the object code 1) on a physical medium 2) access from a network server119 1) reasonable direct costs 2) no charge offer must be valid for 1) 3 years minimum 2) as long as the conveyor offers support for the product model 6c individual copies copy of the written offer pursuant to subs. 6b allowed only 1) occasionally 2) non-commercially 3) if received the object with such an offer 6d offering access from a designated place equivalent access no further charge conveyor is obligated to ensure that the source is available as long as the object code is being offered 6e peer-to-peer transmission informing other peers where is being offered under sub-s. 6d120 no charge 117 see also lgplv3-dd2, 6. 118 static linking requires the conveyance of the corresponding application code (which does not necessarily have to be in source code form) whereas dynamic linking necessitates, subject to the quantity and quality of the incorporated material, the use of a shared library mechanism. cf. ch. 0 supra. 119 the provision varies from the corresponding subsection of preceding license versions, according to which the conveyor was specifically required to provide the source on physical media by mail, if any user would prefer that method to an access from a network server; see gplv2, sub-s. 2b. nordic journal of commercial law issue 2009#1 31 irrespective of the chosen way of conveying, the corresponding source must under the first and seventh paragraphs of s. 6 of the gplv3 always (1) be in machine-readable form, (2) be in a format that is publicly documented and (3) require no special password or key for unpacking, reading or copying. thus, the conveyor of object code is prevented from purporting to satisfy her obligations under the section by providing source code in some private, locked or digitallyrestricted form. measures against circumvention the continuous development and growing accessibility of it have rendered copying and distribution of data exceedingly fast and affordable121. in response, copyright holders have begun to make use of so-called technological measures that provide access control for digital media122. those, in turn, have given impetus to activists to take counter-measures by designing tools that enable hacking of different access controls. finally the wipo copyright treaty, adopted in 1996, established the international background for the anti-circumvention regulation of technological measures.123 the contracting parties to the wct are pursuant to art. 11 thereof obliged to provide adequate legal protection and effective legal remedies against the circumvention of effective technological measures that are used by authors in connection with the exercise of their rights under the wct or the berne convention and that restrict acts, which are not authorised by the authors or permitted by law. the prohibition of circumventing technological measures applies, nonetheless, merely to measures that are classified ‘effective’. article 11 of the wct avoids any definition in respect of effectiveness, presumably in view of the resistance to its draft version, so that the exact content of the class is ultimately a question of applicable national law124. in accordance with s. 3 of the gplv3, however, works licensed under gplv3 are not under any circumstances to be deemed 120 those who do not obtain the object code from the conveyor who has chosen option 6d are outside the scope of that particular provision. therefore, the conveyor in question does not need to give them any access to the source code. consequently, a licensee is in compliance with subsection 6e so long as she knows and informs other peers where the object code and its corresponding source are publicly available at no charge. cf. opinion on bittorrent propagation – gplv3. 121 km 1987:8, 25–26, 156, 195; he 161/1990 vp, 16. 122 see opinion on digital restrictions management – gplv3. 123 hietanen, oksanen and välimäki 2007, 15–23. for more information about the legal framework concerning technological measures, see gasser 2006, 6–21. 124 see crnr/dc/55, art. 13(3) and further lai 1999, 80–81. under art. 6(3) the copyright directive, technological measures are deemed effective where the use of a protected work or other subject matter is controlled by the copyright holders through application of an access control or protection process, such as encryption, scrambling or other transformation of the work or other subject matter or a copy control mechanism, which achieves the protection objective. cf. helho 22.5.2008 1427 (final judgement). nordic journal of commercial law issue 2009#1 32 part of an effective technological measure under whichever applicable law fulfilling obligations under the article concerned. further, the second paragraph of the same section contains a waiver, according to which a conveying party relinquishes the power to forbid the circumvention of technological measures. the waiver, however, applies only to the extent that such circumvention is accomplished through the exercise of rights granted in the gnu software licenses with respect to the covered work. consequently, the gplv3 does not prohibit the use digital rights management (drm). by contrast, the license allows one to use code released under the gplv3 in order to develop a drm technology, but if that technology is at a later time circumvented and the present software then further conveyed without any such technological measures, no remedies related to the law of copyright are at disposal, for pursuant to s. 3 of the gplv3 the drm technology that was circumvented was not such an effective measure that would enjoy protection under, for instance, c. 5a of the copyright act. the lgplv3 instead, as a standard reciprocity license, provides that combined works may be conveyed without the need to be bound by s. 3 of the gplv3 (lgplv3, s. 1). thus, the conveyor of an lgplv3-covered work has the right to assert that the work is protection against copying without having to waive any right, which the gplv3 would otherwise require, to forbid the circumvention of technological measures. moreover, she is not obliged to disclaim any intention to limit operation or modification of the work but may do so against the users thereof as a means of enforcing her or third parties’ statutory rights (arg. gplv3, s. 3 i.f.). strong reciprocity modifying works released under gplv3 the functionality of strong reciprocity is founded on the rule that modifications of software that is governed by the gplv3 can by all means remain private and do under no circumstances have to be conveyed, but—this is essential—if they are in fact conveyed then the conveyance must be done under the same license. whilst the license explicitly precludes the inclusion of software licensed under the gplv3 in publicly conveyed proprietary programs, this does not affect programs used only internally within an organisation; unless conveying occurs, the licensees are free to make a modified version and use it in any way they see fit without ever releasing it outside the organisation125. thus, strong reciprocity does not mean that one is obliged to convey the modifications she has made to the software, only that if she does so, the 125 other persons are not allowed to demand any gplv3-licensee to deliver a copy of a program such licensed that has not been conveyed. the same applies to using a program or a modification thereof on a public web site to operate the said service. the agplv3 makes an exception in this regard, see ch. 0 infra. nordic journal of commercial law issue 2009#1 33 modifications and modified versions must be licensed exclusively under the terms of the gplv3. the conveyance of software that is affected by the gplv3 is stipulated in sections 4 through 6 of the license. in short, the gplv3 requires that no one is allowed to change the license terms of a gplv3-covered program or a modified work thereof, otherwise conveying is not allowed; actions to the contrary constitute an infringement of copyright. section 12 of the gplv3 expressly states that any conditions otherwise imposed on the licensee contradicting the conditions of the said license do not excuse her from the provisions of the gplv3. if one cannot convey covered software so as to satisfy simultaneously the obligations under the gplv3 and any other pertinent obligations, then as a consequence one may not convey it at all. under s. 4 of the gplv3, the licensee is permitted to convey verbatim copies of the source code of any work licensed under the license as she received it, provided that she (1) publishes on each copy a copyright notice, (2) keeps intact all notices stating that the gplv3 and any nonpermissive terms added in accordance with s. 7 thereof apply to the code, (3) keeps intact all notices of the absence of any warranty and (4) gives all recipients a copy of the gplv3 along with the source code. for the avoidance of doubt, the second paragraph of the section provides that, for each copy that is conveyed, any price or no price may be charged, and support or warranty protection may be offered for a fee126. the propagation or modification of a gplv3-covered work is not permitted except as expressly provided (gplv3, s. 8). modification, in this context, is in s. 0 of the gplv3 defined to mean copying from or adapting all or part of the work in a fashion that requires copyright permission, other than the making of an exact copy; the resulting work is called a ‘modified version’ of or a ‘work based on’ the earlier work. to that end, in accordance with s. 5 of the gplv3, conveying a work based on the gplv3-covered program, or the modifications to produce it from the program, is allowed under the terms of section 4, provided that certain conditions are met. of these, the provision contained in subsection 5c is the most significant one, as it constitutes the legal core of strong reciprocity. modified versions of gplv3-covered software must be licensed entirely under the gplv3. the license will therefore apply to the work as a whole, which in situ is the incorporeal aggregate derived from the definitions contained in the license texts and the rules set out in the present 126 by contrast, s. 10 of the gplv3 provides that one is not permitted to impose any further restrictions on the exercise of the rights granted or affirmed under the license. the prohibition means that license fees or royalties may under no circumstances be effectively imposed, since users cannot under the system of gplv3 be required to pay when they receive a copy of a program. anyone who conveys gplv3-covered software for a fee is not obliged to make it also available to the public without a charge, but any licensee who has paid the fee and therefore received a copy, may under the same section release it to the public with or without a fee. nordic journal of commercial law issue 2009#1 34 doctrines of copyright law, as discussed in chapter 4 below. subsection 5c of the gplv3 expressly provides that the requirement to license all the material that constitutes a work concerns all parts thereto, regardless of how they are packaged. conveyors may not use some artificial packaging constructions of a modified work to evade the reciprocity obligation. similarly, a component that is conveyed separately but is designed only to be used in combination with and as a part of a specific gplv3-covered program should according to the license be considered a part of that program and not as a separate work, whereupon it, too, should be licensed under the gplv3. it stems from the definition of the corresponding source contained in the fourth paragraph of s. 1 of the gplv3 that it includes, among others, interface definition files associated with source files for the work, and the source code for shared libraries and dynamically linked subprograms that the work is specifically designed to require. with regard to the gplv2, it was not completely clear whether dynamic linkage would constitute the creation of a modified work127. by contrast, under the gplv3 it seems apparent that an administrator of justice may, by virtue of the license text, start from the premise that a licensee cannot avoid complying with the requirements of the gplv3 by dynamically linking an add-on component to the original version of a program, with the exception of meeting the criteria for a system library (arg. gplv3, s. 1, para. 3). similarly, since the license text speaks of modules with which the program is ‘specifically designed’ to work, if one can interchange the gplv3-licensed module for another one, which is not governed by that license, the precondition does not appear fulfilled. in that case, the module would not form a part of the overall work, whereupon the program itself would not be governed by the gplv3. conveying to outside contractors notwithstanding anything to the contrary, s. 2 of the gplv3 gives an explicit permission for a client to provide a copy of its modified software to a contractor exclusively for that contractor to modify it further, or run it, on behalf of the client. those making or running the software must do so exclusively on the user’s behalf as well as under the user’s direction and control. the position of the contractor is thus comparable with that of the user’s employees in how they are limited to act128. 127 rosen 2001, 2; curran 2008, 43. cf. jaeger 2005, 75–76; fsf 2008a. 128 cf. s. 2(1) of the employment contracts act (55/2001), according to which employment consists of an employee agreeing personally to perform work for an employer under the employer’s direction and supervision in return for pay or some other remuneration. nordic journal of commercial law issue 2009#1 35 nonetheless, the control permitted under s. 2 of the gplv3 can only be exercised over each client’s own copyrighted changes to the gplv3-covered program. the parts of the program obtained from other contributors must be provided for the contractor abiding by the abovedescribed procedure. this supplementary condition has been included in order to prevent the exception concerning the conveyance to outside contractors to be converted into a device of making a program available to users or customers without meeting the requirements set forth in ss. 4–6 of the gplv3129. consequently, within the limits of the provision, the users of gplv3-covered software are permitted to contract with non-employee developers working offsite to make modifications intended for the client’s private or internal use130. similarly, they are permitted to make an arrangement with a third party to operate their data centres or suchlike. the contractor agrees in a non-disclosure agreement (nda) not to release the modified version developed by her unless she is advised to the contrary by the client. such arrangements do not conflict with the general system of the gnu software licenses, for no gplv3-covered code is being conveyed under a nda outside the relationship on assignment between the client and the contractor. the client maintains her right to convey the modified version further, albeit she will probably choose not to exercise that right. entity transactions mergers, acquisitions, buyouts and other corporate control transactions inevitably entail a certain level of uncertainty with regard to the rights and liabilities being transferred131. at present, these transactions increasingly involve organisations with assets that are governed by a gnu software license132. accordingly, concerns have appeared about whether and to what extent such transactions activate the conveying-related requirements of said licenses for programs that previously have been used and modified internally or by outside contractors, pursuant to s. 2 of the gplv3133. versions 3 of the license texts are now giving an explicit answer to the question. transfers of organisational assets as well as other types of control transactions are referred to in s. 10 of the gplv3 as ‘entity transactions’. the second paragraph of the section in question automatically causes any propagation resulting from these entity transactions to have the same 129 see gplv3-dd4, 12. 130 cf. ch. 0 supra. 131 lajoux and elson 2000, 161–162. see also howson 2003, 14–29. 132 see the statistics contained in the final paragraph of ch. 0 supra. 133 gplv3-dd2, 23. nordic journal of commercial law issue 2009#1 36 effect as though conveying had occurred under the terms of substantial sections concerning conveyance.134 the definition arguably means that, for all practical purposes, parties to an entity transaction seem not to be able to avoid the consequences of the gnu software licenses, irrespective of how the details of the deal have been structured. for instance, should an operative entity of an undertaking be sold, the seller that has been using gplv3-covered software internally is not allowed to keep control of a trade secret embodied in its improvements by keeping the source code for itself and assigning only the binaries, for each party receives automatically whatever licenses to the work the predecessor in interest had or could give. in practice, the licenses that are received by the successor in interest are comprised of all upstream licenses in the chain of propagation and the license and a right to possession of the corresponding source of the software that has been used internally, modified or unmodified. the predecessor in interest might not, however, always be able to obtain the corresponding source. for example, a three-year written offer to provide the corresponding source might have expired by the time of the entity transaction135. therefore, the right to possession of the source code is subject to the predecessor having it or being able to obtain it with reasonable efforts (gplv3, s. 10, para. 2 i.f.). technical barriers to modification the gplv3 also introduced provisions that respond to the practice of conveying programs that are covered by a gnu software license in devices that employ technical means to restrict users from installing and running modified versions136. in accordance with s. 6 of the gplv3, the right to convey object code in a defined class of user products is conditional upon providing whatever information is required to enable a recipient to replace the object code embodied in the product with a functioning modified version. a ‘user product’ is in the license defined to mean (1) any tangible personal property that is normally used for personal, family or household purposes and (2) anything designed or sold for incorporation into a dwelling. pursuant to gplv3, s. 6, para. 3, ambiguities are to be resolved in favour of coverage under the definition. moreover, the words ‘normally used’ in the consumer product definition must be deemed to refer to a typical or common use of a class of the product, rather than the status of a 134 the provision was introduced in draft 2 of the gplv3 to establish a default background rule to reduce costs caused by the performance of due diligence investigations in connection with business transactions, where potential acquirers evaluate the target company or its assets for acquisition (gplv3-dd2, 23). 135 see table 2 on p. virhe. kirjanmerkkiä ei ole määritetty.. 136 gplv3-dd1, 9; gplv3-dd2, 7–9; gplv3-dd3, 9–12. see also the preamble of the gplv3. nordic journal of commercial law issue 2009#1 37 particular user, or expected or actual uses by a particular user. finally, the existence of substantial non-consumer uses of a product does not negate a determination that it is a consumer product, unless such non-consumer uses represent the only significant mode of use of that product.137 under s. 3 of the consumer protection act (38/1978), consumer goods are defined as goods that are offered to natural persons or which such persons acquire, to an essential extent, for their private households. according to the government proposal concerning the amendment of the consumer protection act, as regards marketing, the target group, not the object thereof, constitutes the deciding factor of the judgement138. as a consequence, the definition of user products in the gnu software licenses is appreciably concordant with the finnish practice of interpretation. for products so defined, the corresponding source must be accompanied by the necessary installation information, should the conveying occur as part of a transaction where the right of possession and use of a user product is transferred to the recipient in perpetuity or for a fixed term (gplv3, s. 6, para. 5). the particular characterisation of the transaction is immaterial; it is the subject matter, not the form that is of determining relevance. installation information, for its part, refers under the fourth paragraph of the section to any information that is required to install and execute a covered work from a modified version of its corresponding source. installation information would therefore include, for instance, the necessitated signing keys, with which the hardware of a user product authenticates the software against a valid cryptographic signature before functioning139. the information must suffice to ensure that the continued operation of the modified object code is in no case interfered with or prevented solely because modifications have been made140. it is good to note that the requirement to provide installation information does not include a requirement to continue to offer support service, warranty, or updates for a modified work or for the user product where it has been installed (gplv3, s. 6, para. 6). the same bears upon warranty that is being provided in accordance with s. 4 of the gplv3. no explicit provision is on hand, but i deem that the possibility to offer a guarantee engagement, which is voided if the user modifies the software it applies to, is an implicit quality of the license, since the licensor 137 until draft 4 of the gplv3, the draft versions of the license document contained a reference to the magnussonmoss warranty act (15 usc 2301 et seq.), a federal consumer protection statute in the us. as a response to the objection to country-specific legal references in the license text (see gplv3 comments in file ‘gplv3-draft-3’), it was replaced later on with an encapsulation of the judicial and administrative principles established over the past three decades in the us concerning the magnuson-moss consumer product definition. (gplv3-dd4, 11.) 138 he 360/1992 vp, 45–46. 139 fsf 2008a. 140 naturally, the requirement will not apply if no party retains the ability to install modified object code on the user product for instance on the grounds that the work has been installed in read-only memory (gplv3, s. 6, para. 5 i.f.). nordic journal of commercial law issue 2009#1 38 cannot be presupposed to provide a warranty that covers all feasible activities with regard to a program governed by a gnu software license. network reciprocity making software available only in binary executables is merely one way of keeping it secret. another variety, which is currently receiving much attention in the software industry, is simply allowing an access to the functionality of a piece of software over a network without the availability of executables whatsoever. pursuant to ss. 2(3)(1) and (3) of the copyright act, a work is made available to the public, inter alia, when it is communicated to the public by wire or wireless; or when copies of it are offered for sale, rental or lending, or are otherwise distributed to the public. as per this definition, it is not always obvious whether a computer program has been made available to the public141. it seems clear that copies of a work may as well be distributed in physical distribution media as by offering access to them in a network server (kko 1999:115)142. however, an application that is accessed via web browser over a network such as the internet arguably does not meet the threshold of publication, unless a copy of the application is transferred to the client. in other words, running web-based applications and suchlike programs provided by an asp, is comparable to the mere use of a work, which lies outside the scope of application of the copyright law.143 to that end, one of the most controversial issues during the drafting process of the gplv3 was whether to add an obligation to make the source code available for software licensed under the gplv3 if an access to it was provided over a network144. eventually, no requirements about the public use on network servers of modified versions of programs that are governed by the gplv3 were added in that particular license. by contrast, s. 0 of the gplv3 explicitly states that mere interaction with a user through a computer network, with no transfer of a copy, is not conveying under the framework of the gnu software licenses. the fsf decided to provide the option of controlling modified network use through an alternative license, the agplv3. 141 see also km 1987:8, 181–182. 142 cf. niiranen and tarkela 1998, 170–171, which precedes the judgement of the supreme court. 143 välimäki 2009, 41–42. see also reed 2004, 102 ff. 144 see gplv3 comments in file ‘gplv3-draft-1’ and gplv3 comments in file ‘gplv3-draft-2’. drafts 1 and 2 of the gplv3 allowed in their clause 7b4 licensors to add a requirement to publish source to users interacting with modified versions remotely through a network. however, some commentators considered that requirement to be too burdensome and expressed concern about the administrative costs of checking code for it. publishing the agplv3 as a separate license made it easier to determine which code has the source publication requirement. (gplv3-dd2, 29–31.) nordic journal of commercial law issue 2009#1 39 the agplv3 embodies the text of the gplv3, slightly adapted for the new name, and an additional paragraph in s. 13 that requires people who modify the software to publicly provide source code when users interact with the software over a network. the modified version is obliged to ‘prominently offer’ the corresponding source, which means that anyone who modifies the software is not compelled to assure herself that every user of the software receives a copy of the source code, but it must be readily available to users. the requirement is corresponding to that in gplv3, subsection 6d. the agplv3 speaks of ‘network interaction’ without any additional qualifiers. a literal interpretation of the section therefore suggests that the method of present interaction includes not only traditional graphical user interfaces (guis) that users manipulate for web applications, but also employing other kinds of communications protocols, such as sending requests for email or hypertext retrieval. the scope of the definition encompasses any interaction now known or later developed for use over a group of interconnected computers, for it is not dependent upon the technological methods of implementation. that was also the author’s intent in drafting the license145. however, the interpretation of interaction cannot arguably be extended to software that is not designed to interact with users through a network, but happens to do so where it is being run over some network protocol. virtually any program can be used remotely through specialised tools that support logging into remote machines and executing commands therein, but such environmental factors cannot be decisive rather than the design solutions made by the author. section 13 of the gplv3 grants, as an exception to the rest of its terms, licensees thereof the permission to link or combine any covered work with a work licensed under the agplv3 into a single combined work, and to convey the resulting work. the terms of the gplv3 will continue to apply to the part that is the covered work, but the special requirements of s. 13 of the agplv3 will appertain to the combination as it is. the compatibility is one-way for works licensed under the agplv3 cannot as such be reverted back to the gplv3 (arg. gplv3, s. 13)146. agplv3, s. 13, para. 1 provides that the corresponding source of the resulting work, which must be held available to users, includes also any gplv3-covered code that is incorporated into it. the provision ensures that licensees cannot escape their obligations by placing their modifications into gplv3-licensed modules that carry no requirements concerning interaction through a network147. 145 ‘the [agplv3] needs to cover all the various protocols and means for network interaction in order to fully achieve its purpose’ (apglv3-dd2). 146 naturally, if the modified version does no more support the network interaction presumed by the agplv3, the obligation is not triggered in that regard. 147 see gplv3-fin, 19. nordic journal of commercial law issue 2009#1 40 as noted above, the use of a work covered by copyright, as such, is not a part of the exclusive economic rights belonging to the copyright holder148. therefore, it would prima facie appear that the network use obligation would constitute, according to the common law terminology, a covenant to, not a condition of, the agplv3, since the obligation would not be something that must be satisfied in order for the licensee to be licensed at all but merely a term that the licensee agrees to when she accepts the license. nonetheless, ‘using’ a computer program normally means, also in all cases that are relevant in respect of s. 13 of the agplv3, running it. by definition, a computer operates by running a program that is loaded into its memory, and every time a program is being run, a copy of it is made in the operating memory.149 that is an instance of making copies of a work which, for one, belongs to the exclusive rights of disposition enjoyed by copyright holders.150 in accordance with s. 25j(1) of the copyright act, any person who has legally acquired a computer program is entitled to make such copies of the program as may be necessary for its use for the intended purpose. section 25j(5) moreover provides that any contractual provision limiting the use of a computer program in accordance with subsections 2 through 4 of the present section is void. however, since subsection 1 is not included in the prohibition, contracting parties are by law free to stipulate even the right to temporary acts of reproduction151. if the licensee oversteps the limits of use permitted by the license, the activity constitutes a breach of contract, not copyright infringement152. nevertheless, nothing other than the license grants someone who is not the copyright holder a permission to modify any covered work, since under art. 4(b) of the software directive the exclusive rights of the copyright holder include the right to do or to authorise any alteration of a computer program153. moreover, in accordance with s. 28 of the copyright act, in the absence of agreement to the contrary, the person to whom copyright has been transferred may not alter the work or transfer the copyright to others. consequently, running as an asp an altered version of agplv3-covered software that does not offer users interacting with it remotely an opportunity to receive the source code effectively 148 haarmann 2005, 111. in accordance with s. 2(1) of the copyright act, copyright includes, subject to the limitations stated in c. 2 of the act, the exclusive right to dispose of the work by (1) making copies of it and by (2) making it available to the public. pursuant to s. 2(3), a work is made available to the public when (1) it is communicated to the public by wire or wireless; (2) it is performed in public; (3) copies of it are offered for sale, rental or lending, or are otherwise distributed to the public; or (4) it is displayed in public. 149 km 1987:8, 38. 150 he 161/1990 vp, 12, 52–53. 151 see also km 1987:8, 270–271. 152 he 211/1992 vp, 9. 153 section 2(1) of the copyright act provides in effect for the same. nordic journal of commercial law issue 2009#1 41 means that the modification has not occurred in accordance with the license. the entitlement provided by s. 25j(1) of the copyright act encompasses only situations where the actions are necessary for using a program for its ‘intended purpose’. if a program licensed under the agplv3 has been modified by maintaining the support for remote access but removing the possibility to receive the source code, the program is no more utilised within the scope of the license provisions, whereupon the result is not merely a breach of contract but has to be deemed as infringing copyright (cf. kko 2008:45). this, in turn, possesses some significant effects with regard to the enforcement of the license. enforcement of reciprocity obligations fundamentals since the gnu software licenses are copyright licenses in character, the copyright holders of the software are the ones who have the power to enforce them154. traditionally, however, the enforcement of the license requirements has been handled privately through negotiation and out of court agreements. the social pressure related to the consequences of non-compliance— detrimental publicity, loss of goodwill, etc.—has assisted in reaching amicable settlements.155 however, if taking legal action becomes necessary, the licenses themselves and ultimately the copyright law offer a somewhat solid basis for bringing a suit against the infringer156. in europe, the district court of munich i confirmed in 2004 that the gpl can effectively become part of an agreement and is enforceable under the german law157. on the other side of the atlantic the first, as far as is known, lawsuits for violations of the gpl were filed in 2007158. 154 section 6 of the copyright act provides that, if a work has two or more authors whose contributions do not constitute independent works, the copyright belongs to the authors jointly. however, each one of them is entitled to bring an action of infringement. see km 1953:5, 51. 155 fsf 2005; vetter 2006, 244; välimäki 2009, 212–213. cf. kumar 2006, 4–5, who sees the settling of lawsuits as a consequence of uncertainty with regard to the legal groundwork. 156 if a computer program is not original enough (see ch. 0 infra) to be copyrighted but still possesses a certain amount of originality, which differentiates it from other products and expresses its commercial source, it is also conceivable that the unfair business practices act (1061/1978) applies (sorvari 2007, 395). in such a case, should a breach of a gnu software license incur a risk of interference as to the commercial source, the breaching entrepreneur may under s. 6(1) of the present act be prohibited from continuing or repeating such practice, which prohibition may be reinforced through a conditional fine. 157 az: 21 o 6123/04; see welte 2004. the precedent was upheld in 2006 through a judgement issued by the district court of frankfurt am main (geschäftsnr.: 2-6 0 224/06), which confirmed the validity of gnu software licenses in respect of german legal order (welte 2006). 158 sflc 2007. nordic journal of commercial law issue 2009#1 42 what is said about termination and remedies for copyright infringement in this chapter 0 apply equally to all the gnu software licenses, for the lgplv3 incorporates the terms and conditions of the gplv3, supplementing them by some additional permissions, and the agplv3 consists of the text of the gplv3 plus an additional paragraph in s. 13 concerning remote network interaction, which alterations do not modify the functionality thereof in respect of enforcement. for that reason, references to license sections are here made only to the gplv3, but the same legal basis pertains to each license. in accordance with s. 2 of the gplv3, the license does not control the right of the licensee to run the program in any way (cf. gplv3, s. 9). by contrast, section 8 provides that any attempt to propagate or modify in contravention of the license is void and will automatically terminate the licensee’s rights under the gplv3. thus, the right to exercise even internal or private propagation and modification is perpetual only as long as one’s rights have not been terminated. section 10 of the gplv3 contains a provision of automatic licensing, but violators are barred from claiming the benefit of that functionality and thus avoiding the termination of rights for certain software by simply obtaining a new copy of that piece of software by virtue of gplv3, s. 8, para. 4. nevertheless, in exchange for the automatic nature of the termination, the license from a particular copyright holder will be reinstated, should the licensee cease the violation of the gplv3 in its entirety. this reinstatement of rights can be either (1) provisional, unless and until the copyright holder explicitly and finally terminates the license, or (2) permanent, if the copyright holder fails to notify the licensee of the violation by some reasonable means prior to 60 days after the cessation. (para. 2.) moreover, a violator who has never received notice of a gplv3 violation from a particular copyright holder with respect to any gplv3-covered software is eligible for permanent reinstatement, should she cure the violation prior to 30 days after her receipt of the notice (para. 3). thus, the termination procedure involves a 60-day period of repose and a 30-day cure opportunity for first-time violators. it is noteworthy that the provision regarding first-time violators, which was added for the purpose of someone who accidentally runs afoul of the rules159, may entail difficult questions concerning necessitated evidence160. those parties who fail to adhere to the stipulated time limits or cure the violations in aggregate ultimately forfeit all rights under the license; except for the permission to run the unmodified program (see gplv3, s. 2). should they wish to reinstate their rights to propagate and modify, 159 see gplv3-dd3, 33. 160 if no concentrated database of license violations, that is both real time and dependable, exists, it is rather simple for the violator to profess to qualify for the exception of the third paragraph of s. 6 of the gplv3. nordic journal of commercial law issue 2009#1 43 they must request an explicit reinstatement of rights from the copyright holders, who are fee to condition the reinstatement upon optional requirements.161 remedies for copyright infringement chapter 49 of the penal code (39/1889) and ss. 56a–56f of the copyright act set forth criminal sanctions for the infringements of copyright. the discussion hereunder, however, omits the questions of criminal responsibility and solely focuses on civil remedies available for the copyright holders, in this case the licensor of gnu-covered software162. to start with, when a judicial decision is taken finding an infringement of copyright, a court of justice may under s. 56g of the copyright act issue against the infringer an injunction aimed at prohibiting the continuation of the infringement163. the injunction may also be issued as a preliminary injunction in accordance with c. 7, s. 3 of the code of judicial procedure (4/1734)164. liability for an infringement actualises regardless of the degree of negligence and irrespective of the infringer acting in bona or mala fide. copyright does not recognise protection provided by good faith, except for cases where a copy of a work has been made for private use.165 moreover, s. 57(1) of the copyright act provides that any person who uses a work in violation of the act is obliged to pay the author fair compensation for such use. if the use is made wilfully or through negligence, the infringer must, in addition to the mere fair compensation, pay damages for any other loss, including for mental suffering and other injury (s. 57[2] of the copyright act). as regards fair compensation in respect of computer programs, it is an established practice of the supreme court that the amount of it is considered equal to that of the normal license fee, unless the special characteristics of the case presume otherwise (kko 1998:91, kko 1999:115); the compensation contains no punitive element. liability for 161 kuhn, williamson and sandler 2008, 11–12. in progress software corporation v mysql ab, 195 f. supp. 2d 328 (d. mass. 2002), the judge implied in her order to grant partial summary judgement that a breach of the gplv2 by failure to include the corresponding source could be cured by conveying it in later versions. given that the gplv3 contains provisions as to the automatic reinstatement of rights, the statement appears inaccurate at least under the framework of versions 3. 162 for the special characteristics of criminal responsibility, see sorvari 2007, 191 ff. 163 see also the act concerning the securing of evidence production in civil actions pertaining to intellectual property rights (344/2000). 164 he 26/2006 vp, 20. in such cases, the petitioner must be able to establish a probability that she has an enforceable right and that there is a danger that the opposing party hinders or undermines the realisation of that right or decreases essentially its value or significance; see norrgård 2002, 177–186. 165 sections 57(1) i.f. and 58(1) i.f. of the copyright act. nordic journal of commercial law issue 2009#1 44 compensation is related to the infringement of the financial interest belonging to the copyright holder, and if no valid tariff is available, the court must appraise the amount on a case-by-case basis by taking cognisance of the purpose, scale and harmfulness of the unauthorised use (kko 2007:63)166. therefore, although in the gnu software license context programs are often licensed without charge and thereupon establishing economic loss is troublesome, a court that recognises the business models and income formation channels related to the open source software paradigm may arguably arrive at a reasonable quantum of compensation. infringement that is proved to result from negligence on the infringing party’s side leads up also to passing judgement with regard to damages for any other loss. pursuant to s. 57(4) of the copyright act, the provisions of the tort liability act (412/1974) are also applicable to the damages referred to in the second subsection. accordingly, liability for damages follows the general principle of full compensation167. in addition to forfeited profits, examples of coverable loss would be expenses caused by the detection of the infringement as well as supervisory acts related to the law of copyright168. if no evidence concerning the amount of loss is available or evidence can only be presented with difficulty, the court has the power to assess the amount, within reason (c. 7, s. 6 of the code of judicial procedure). liability for legal costs is determined by the common rules contained in c. 21 of the code of judicial procedure. apart from injunction, compensation and damages, the copyright act also contains provisions as to forfeiture (s. 58), publication of a ruling (s. 59a), prevention of material’s supply (s. 60a) and decision on interruption (s. 60c), which are available within the limits enacted. of these, especially the possibility of forfeiture appears interesting with regard to the gnu software licenses, for a court may, at the request of the injured party, prescribe, according to what it deems reasonable, that (1) a copy of a work that has been produced, made available to the public or altered in a manner contrary to the copyright act, as well as (2) any instrument intended for the making of copies, are to be destroyed, altered in specific ways, delivered to the injured party against compensation corresponding to the cost of manufacture, or rendered incapable of unauthorised use. 166 see also lehtonen 1998, 206–207. 167 the foundation of c. 2, s. 1 of the tort liability act is that a person who deliberately or negligently causes injury or damage to another is liable for damages in full. however, the damages may be adjusted if the liability is deemed unreasonably onerous in view of the financial status of the person causing the injury or damage and the person suffering the same, and the other circumstances. nonetheless, if the injury or damage has been caused deliberately, full damages are to be awarded unless it is deemed that there are special reasons for a reduction in the damages. 168 sorvari 2007, 312–315. nordic journal of commercial law issue 2009#1 45 assessment of risk position one of the most famous characterisations of the gnu software licenses was expressed by craig mundie, microsoft senior vice president, in his speech given on the commercial software model at the new york university stern school of business in 2001, where he said: some of the most successful [open source software] technology is licensed under the […] gpl. the gpl mandates that any software that incorporates source code already licensed under the gpl will itself become subject to the gpl. when the resulting software product is distributed, its creator must make the entire source code base freely available to everyone, at no additional charge. this viral aspect of the gpl poses a threat to the intellectual property of any organization making use of it.169 congruently, some have expressed contentions that inadvertent incorporation of code governed by a gnu software license into a proprietary product can necessitate coercion to release one’s proprietary code under the present license170. section 11 of the gplv3 is indeed designed to prevent patents from being used to render a gplv3-covered program proprietary de facto, but copyright-wise the ipr cannot be said to be threatened. as mentioned in the preceding chapter, copyright holders whose interests are affected by an infringing activity can bring an action for compensation and possibly damages as well as apply for an injunction and, where appropriate, the other remedies referred to in c. 7 of the copyright act. what they are not able to do, by virtue of copyright law, is to require the conveying of an infringing work on altered terms, since the copyright act carries no provisions for that regard. consequently, should a defendant be found to have wrongfully included code that is covered by a gnu software license in its own proprietary work, she can be condemned to pay compensation for the conveyance that has already occurred, and prevented from conveying her product further. what about forfeiture; can the court prescribe the source code of the whole product be delivered to the injured party against compensation corresponding to the cost of manufacture? section 58(1) of the copyright act refers to any ‘typographical material, printing 169 mundie 2001, emphasis added. he continued, ‘it also fundamentally undermines the independent commercial software sector because it effectively makes it impossible to distribute software on a basis where recipients pay for the product rather than just the cost of distribution.’ the argument is not completely accurate, for s. 4 of the gplv3 provides that the conveyor may charge any price for each copy that she conveys, and offer support or warranty protection for a fee. 170 see henry 2003; epstein 2004. nordic journal of commercial law issue 2009#1 46 block, mold and other instrument or device’.171 it seems probable that the provision encompasses only tangible objects, and an expansive interpretation, which would cover even the source code of a computer program, appears unfounded172. in any event, in accordance with s. 4(1) of the copyright act, a person who has adapted a work has copyright in that work in its new form. her right to dispose of it is subject to the copyright in the original work, but the right to exclude and the consequent power to license remain exclusively at the discretion of the copyright holder. the reciprocity obligations under different gnu software licenses can be outlined in a way expressed by illustration 1 below. the outer limit of each circle delineates the boundary unto which the reciprocity obligations of the license that is restricted to its area extend. each circle also incorporates all the other circles and obligations that are situated within it. consequently, the reciprocal requirements of the lgplv3 apply only to the conveyance of modifications, those of the gplv3 to the conveyance of modifications and combinations alike, and the agplv3 covers both the conveyance and network use of modifications as well as combinations. none of the current gnu software licenses makes reciprocal demands with regard to internal propagation173, but such obligation is conceivable and would constitute the strictest form of reciprocity. all the relevant actions related to the law of copyright that occur in the scope of the license trigger the reciprocity obligation described in chapters 0 through 0 of this thesis, respectively. 171 cf. 17 usc 506(b), which provides that when a person is convicted of a criminal infringement, as defined in subsection (a), the court in its judgement of conviction shall, in addition to the penalty therein prescribed, order the forfeiture and destruction or other disposition of all infringing copies and all implements, devices, or equipment used in the manufacture of such infringing copies. 172 see also kivimäki 1966, 186–187; sorvari 2007, 329–333. 173 see gplv3 comments in file ‘gplv3-draft-4’, where it was suggested that the current scope of propagation, as defined in s. 0 of the gplv3, without conveying includes a possible weakness with regard to some trade and membership associations with a significant number of members, since internal propagation in such organisations would be equivalent of conveying in all but name. nordic journal of commercial law issue 2009#1 47 illustration 1. imaginable and actual scopes of reciprocity within the system of gnu software licenses all rights granted under the gnu software licenses are granted for the term of copyright on the program, and are irrevocable provided the stated conditions are met (gplv3, s. 2). that said, developers who are interested in utilising code so licensed and whose intended use would trigger the reciprocity obligation are given principally two options by the licenses174. first, since copyright protects only the tangible implementation or expression of an idea, not the idea itself, she could produce herself a similar software component that provides the same functionality. second, she may use the code governed by a gnu software license and abide by the terms thereof. if one chooses neither, it is a question of copyright infringement, which can be discontinued and redressed by means of the above-mentioned remedies. the infringing source code, however, cannot be forced to be released under a gnu software license, or any license 174 see also kumar 2006, 17. nordic journal of commercial law issue 2009#1 48 for that matter, but it stays with the proprietor175. since the license has been terminated under s. 8 of the gplv3, earning financial benefit by making copies of that work or making it available to the public is not possible before entering into an agreement with the copyright holder of the original work, if the proprietary software cannot be deemed as a new and independent work in the meaning of s. 4(2) of the copyright act but falls into the category of the first subsection, where its copyright is subject to the right in the original work. szattler, however, argues that the reciprocal requirements of the gnu software licenses might be regarded as consideration rather than just as limitations of granted rights and, if that were the case, a claimant could in the event of infringement file a suit for a breach of contract. consequently, a court could oblige the infringer to publish the code at issue.176 consideration is a common law term for a legal fact that is required from a promise in order to meet the requirements for the formation of a contract; the claimant must be able to show that she has bought the defendant’s promise either by doing some act in return for it or by offering a counter-promise.177 by contrast, at civil law the question is not whether a promise is supported by consideration, but a contract is made where two or more parties willingly bind themselves into a legal act that arouses obligations and corresponding rights between the contracting parties178. under common law, it can be concluded that the gnu software licenses do not form a contract, since the license texts do not evidence the necessitated meeting of minds with regard to consideration179. however, the total legal obligations of the parties arising out the agreement governed by a gnu software license might in a civil law jurisdiction lead to a conclusion that such a document is deemed a regular contract rather than a proper copyright license180. 175 cf. the action by the fsf to recover damages and to enjoin future infringement arising from the infringement of its copyrights by cisco systems, inc. submitted to the us district court of southern district of new york on 11 december 2008, available at http://www.fsf.org/licensing/complaint-2008-12-11.pdf. the prayer for relief includes requests as follows: ‘(1) that the court issue injunctive relief against defendant, and that defendant, its directors, principals, officers, agents, representatives, servants, employees, attorneys, successors and assigns, and all others in active concert or participation with defendant, be enjoined and restrained from copying, modifying, distributing or making any other infringing use of plaintiff’s software; (2) that the court order defendant to pay plaintiff’s actual and consequential damages incurred, in an amount to be determined at trial or, in the alternative, statutory damages as set forth in 17 usc 504(c); (3) that the court order defendant to account for and disgorge to plaintiff all profits derived by defendant from its unlawful acts; (4) that the court order defendant to pay plaintiff’s litigation expenses, including reasonable attorney’s fees and costs of this action; and (5) that the court grant plaintiff any such further relief as the court may deem just and proper.’—in this regard, the complaint makes to source code no reference whatsoever. 176 szattler 2007, 72–73. 177 furmston 1991, 70–73. see also rudanko 1998, 72–73. 178 hemmo 2003a, 10–15; tolonen 2004, va111.4995. cf. zitting 1989, 472–474. 179 kumar 2006, 16–24, who argues that the licenses are enforceable by the licensee through a promissory estoppel action. for the introduction to that doctrine, see spencer bower and turner 1966, 332–358. 180 cf. nimmer 2005. http://www.fsf.org/licensing/complaint-2008-12-11.pdf. nordic journal of commercial law issue 2009#1 49 the contractual approach has an impact on the connecting factor rules and the applicable law181, but it would also betoken a significant concern in respect of enforcement. the general effects of obligations involve specific performance, which can be fulfilled by execution, where necessary182. were, for example, the provision to convey also the corresponding source, where conveying a gplv3-covered work in object code form occurs in accordance with s. 6 of the gplv3, deemed as a contractual obligation, a court of justice would in principle be entitled to order proprietary source code to be published as a consequence of a breach of contract. under finnish law, however, liability for specific performance is confined by restrictions founded on characteristics of the obligation, obstacles to performance and the impracticality of the specific performance; secondary obligations and obligations of the obligee do not entitle to discrete specific performance183. due to the special construction of reciprocal open source licenses, it could be argued that the requirement to provide source code is comparable with a secondary obligation, for practically the gnu software licenses specify limitations to the licensor’s grant of rights, not burdens to the licensee184. a prayer to release all the source code on account of a minor breach could also constitute hardship. an interpretation analogous to s. 23(1) of the sale of goods act would suggest that the licensee is not obliged to perform the obligation if the performance would require sacrifices that are disproportionate to the licensor’s interest in performance, as the case might arguably be. specific performance is impractical where other legal remedies offer an adequate legal protection to the obligee. if the licensor is able to seek reimbursement and a restraining order in the form of injunction, the need for a claim for specific performance seems dubious.185 that is especially the case where only small amounts of code governed by a gnu software license have been incorporated into a proprietary product or where the code utilised in a violating manner forms only a diminutive portion of the end product; de minimis non curat lex. such a finding would also be congruent with the solutions adopted in the international collections of principles with regard to contract law. in accordance with the unidroit principles of international commercial contracts, where a party who owes an obligation other than one to pay money does not perform, the other party may require performance, unless the party entitled to performance may reasonably obtain performance from another source (unidroit, 181 see szattler 2007, 73–77. 182 hakulinen 1958, 49. 183 aurejärvi 1988, 82–83. 184 hakulinen 1958, 56. e.g., s. 6 of the gplv3 provides that ‘[y]ou may convey a covered work in object code form under the terms of sections 4 and 5, provided that you also convey the machine-readable corresponding source under the terms of this license’ (emphasis added). 185 arg. saarnilehto 2005, 100–101. nordic journal of commercial law issue 2009#1 50 art. 7.2.2[c]). the principles of european contract law provide for essentially the same in art. 9:102(2)(d) thereof186. perhaps the most convincing argument against specific performance stems, nonetheless, from the license texts themselves. under s. 8 of the gplv3 any attempt to propagate or modify a covered work will automatically terminate the license. the provision is subject to certain possibilities to reinstatement referred to above, but if they are not resorted, the license—or contract—is terminated. moreover, even a permanent reinstatement under subsection 8b of the gplv3 does not affect the judgement, for it necessitates ceasing all violation of the license. any action to the contrary will trigger the provision of automatic termination anew. accordingly, all contractual commitments expire upon the termination of a contract. if the termination is induced by a contracting party, liability for occurred damages may ensue, but specific performance is not available any longer. in the aforementioned cases the liability for damages follows the principles of contractual liability, whereupon the damages constitute compensation also for economic loss that is not connected to personal injury or damage to property187. however, with regard to the gnu software licenses there might often be situations where the mileage aspired after by the licensor consists merely of future reciprocal paybacks and has thereby no economic value at all, since software has been licensed without charge188. taking legal policy into account, it would de lege ferenda appear justifiable in connection with gross license violations for a court to order the infringing code to be released through specific performance in place of unsubstantial compensation. by contrast, such real argument ought not to appertain to occurrences of minor negligence, for causing a complete loss in value of a proprietary program would there be disproportionate and thus ungrounded. 4. demarcation institutional support legislation the copyright act entered into force on 1 september 1961. under s. 73 thereof, it repealed the act on copyright in products of intellectual activity (174/1927; hereinafter referred to as 186 the draft common frame of reference, by contrast, recognises no such exception; see dcfr, art. iii.– 3:302(3). 187 cf. c. 5, s. 1 of the tort liability act. 188 see jacobsen v katzer, n. 92 supra. nordic journal of commercial law issue 2009#1 51 the ‘old copyright act’). prior to the force of the last-mentioned statute, the copyright regime of the grand duchy of finland and, as of 1917, the republic of finland was regulated by the decree relating to the rights of writers and artists in respect of the products of their labour (8/1880; hereinafter referred to as the ‘decree of 1880’). already the gracious proposal of the imperial majesty concerning the decree of 1880 proposed in its s. 7 that the translator of a literary work should enjoy to her translation a right identical to what is accorded to the author of the original work189. furthermore, with regard to independent works, s. 8(2) of the proposal provided that unauthorised reformation of a literary work by means of adaptation, modification or addition were to be deemed to constitute a copyright infringement, unless the new work could be interpreted as forming an independent work190. the decree of 1880 contained no provisions as to combining works or parts thereof and whether such creation of compilations would constitute a separate object of copyright. the legislative council published its proposal for the old copyright act in 1920. under s. 4(1) of the proposal, it was propounded that the author ought to receive the same exclusive rights that she has in respect of her work also to translation and adaptation thereof. it stems reputedly from the very character of copyright that the work created by an author deserves protection in both the original and an altered form191. however, in accordance with s. 5, also a work based on the original one deserves to be an object of legal protection, so that the author of the translation or adaptation was to have copyright in the present work in that new form. this derivative copyright maintains the copyright in the original work infrangible. the stipulation was commensurate with art. 2(3) of the berne convention, which provides that translations, adaptations, arrangements of music and other alterations of a literary or artistic work shall be protected as original works without prejudice to the copyright in the original work.—creating a substantially original work, which only loosely pertains to the underlying work, was not to be considered as alteration (s. 4[3] of the proposal).192 what, then, makes a work substantially original? the preliminary works for the swedish copyright legislation provide that such alteration must affect the ‘inner form’ of a work. consequently, since copyright does not protect the underlying ideas, the concept may be borrowed but the manner of representation must be substantially original.193 189 he 3/1876 vp, 3. 190 he 3/1876 vp, 4. the law committee considered in its report subsection 2 as possibly misleading and in any event unnecessary for the courts, whereupon it recommended the removal thereof (lavm 8/1876 vp, 14). 191 legislative council 1920, 28–29. 192 legislative council 1920, 1–2, 29. 193 sou 1956:25, 136–137. nordic journal of commercial law issue 2009#1 52 the proposal of the legislative council also touched upon the question of combination. section 6 thereof provided that, if a work was to be compiled of separate works by several contributors, each one would have copyright in her own contribution. moreover, if also the work that concerns the consolidation of separate contributions could be deemed to constitute a form of creative intellectual work, the performing party ought to have copyright in the combined work.194 in the latter case, the combiner was to be justified in deciding in favour of making the combined work available to the public by herself, irrespective of the contributors195. the resultant government proposal and thereupon the old copyright act differed from the stand of the legislative council predominantly with regard to the general structure; the provisions concerning independent, combined and modified works were more verbose but substantively concordant196. the same applies in many respects to the report of the commission concerning the proposal for the current copyright act, which is an essential preliminary work in respect of finnish copyright law197. the report describes alteration as not exactly achieving a new creation but rather giving the original work a new form. therefore, the copyright of the altering party is secondary in respect that her right is dependent upon the assent by the copyright holder of the original work.198 as sections 4 and 5 of the copyright act have remained unamended since the coming into force thereof, characterisations concerning the demarcation of various derivative works expressed during the lengthy legislative history have remained valid199. in 1991, the copyright act was amended by act 34/1991 to include specific rules governing computer programs. prior to the amendment, the copyright commission had published its fourth preliminary report concerning, inter alia, the legal protection of software. in the report, the commission reiterates the fact that a computer program enjoys protection also in an altered 194 legislative council 1920, 2, 21–22. cf. art. 2(5) of the berne convention: ‘collections of literary or artistic works such as encyclopaedias and anthologies which, by reason of the selection and arrangement of their contents, constitute intellectual creations shall be protected as such, without prejudice to the copyright in each of the works forming part of such collections.’ 195 legislative council 1920, 30. nonetheless, her right of disposal was only to be in connection with the combined work as a whole. 196 he 89/1926 vp, 3–7. unlike the proposal of the legislative council, the government proposal contained only one bill common to all intellectual works, excluding photographs. the reading of the matter in committees involved various comments on different directions; see lavm 13/1926 vp; suvm 108/1926 vp; ev 89/1926 vp. 197 km 1953:5, 8, 44. the report of the commission contains rather few objective amendments vis-à-vis the old copyright act. the main reason for passing a new law was the tendency towards uniform statutes in each nordic country. (km 1953:5, 42–43.) 198 km 1953:5, 49–50. 199 he 23/1960 vp does contentually not depart much from the results of the nordic preparation. cf. km 1953:5, 6–35. nordic journal of commercial law issue 2009#1 53 form but, if the input of the altering party is creative and original, the latter has derivative copyright in the altered work in accordance with s. 4(1) of the copyright act. however, adapting software from one programming language to another is more often than not a technical operation that does not call for creative effort, whereupon the adapting party is not granted copyright.200 the government proposal regarding the amendment provides some guidance as to applying the provision of drawing freely on a computer program. it states that employing the system, logic, algorithms, principles and concepts of an existing work would constitute a first-hand copyright in accordance with s. 4(2) of the copyright act, if the new form of expression was independent enough.201 at the community level, it is similarly clear that while programs are accorded protection, underlying logic or algorithms thereof are not copyrightable subject matter. accordingly, software having essentially the same functions of existing programs is still, despite superficial resemblance, considered as an independent invention insofar that the development has been carried out without ‘undue’ inspiration.202 if similarities in the source code that implement the ideas, rules and principles of the program occur as between inter-operative software, where the constraints of an interface are such that in the circumstances no different implementations are possible, then no copyright infringement will normally occur203. in conclusion, copyright in respect of computer programs is concentrated particularly upon the source code thereof. therefore, conventional alteration that does not involve the complete rewriting of the code base implicates prima facie that the modification has occurred in the sense of s. 2 of the copyright act. if the conducted acts, however, are rather insignificant or lacking originality, it is pursuant to kivimäki’s nomenclature an instance of ‘non-proper’ modification, whereupon no new form of the original work has emerged but copyright-wise the program remains unaltered204. such non-proper modification does not require a permission of the copyright holder and cannot, in proportion, be forbidden by the last-mentioned205. 200 km 1987:8, 178. 201 he 161/1990 vp, 16–17, 50. 202 com (88) 172 final, 182–183. in its proposal for the software directive, the commission describes the algorithms from which a program is built up being ‘the equivalent of the words by which the poet or the novelist creates his work of literature, or the brush strokes of the artist or the musical scales of the composer’ (com (88) 816 final – syn 183, 5). cf. europarl 1990, 81. 203 com (88) 816 final – syn 183, 8. see also eesc 1989, 5. in such circumstances it is said that the idea and expression have merged (hass 2007, 388). 204 kivimäki 1948, 103–104. 205 välimäki 2009, 37. nordic journal of commercial law issue 2009#1 54 case law as mentioned above, there is no finnish case law concerning computer programs released under the gnu software licenses206. furthermore, the precedents decided heretofore by the supreme court related to the law of copyright in general are not pertinent to the present phrasing of the question. however, guidelines for decision-making with regard to delimiting the dividing line between permitted and prohibited copying and altering, respectively, can be derived from some judgements issued by the courts of appeal. in practise, the decision is made comparing the similitude of two programs: expert witnesses present evidence as to what extent the original work and the alleged copy are similar under the framework of the copyright act and the court then assesses what sort of legal relevance ought to be merited to the points of resemblance207. the third versions of the gnu software licenses are bound up with the principles of copyright law even more than before. whereas the gplv2 applies in accordance with s. 0 thereof to any program or other work that contains a notice stating it may be distributed under the terms of the present license, under s. 0 of the gplv3 the program only refers to works that are copyrightable. furthermore, it is the specific intention of the draftsmen that the gnu software licenses are pure copyright licenses, plus a patent grant, which contain no contractual elements whatsoever208. therefore, the scope of the licenses and, ultimately, risk positions of the licensees are dependent upon the definitions of applicable copyright law, whereupon the threshold of originality and other relevant factors related to the law of copyright must be discussed with the intention of analysing definitive legal statuses. in order to be accorded the exclusive rights provided by the copyright act in the first place, the program must hold a certain level of originality209. since there are no requirements—or possibilities, for that matter—for registering the copyright in finland, everything written creates an ex ante assumption of copyright protection from the occasion it is put in fixed form210; under art. 5(2) of the berne convention, the enjoyment and the exercise of copyright shall not be subject to any formality. however, literary works including computer programs are protected 206 this author is aware of one case tried before the helsinki court of appeal that concerned a manual licensed under the gpl, where the court considered that the license terms had no relevance to the dispute between the author and the publisher. see helho 14.6.2007 1963 (final judgement). 207 välimäki 2009, 66. 208 moglen 2001; gplv3-dd2, 20. this stand was especially apparent in draft 1 of the gplv3, where the title of s. 9 was ‘not a contract’; see gplv3-dd1, s. 17. 209 km 1953:5, 44. according to the report of the commission, such a requirement stems from the ‘very nature’ of the subject matter. 210 cf. 17 usc 408 et seq. registration of copyright betokens substantial procedural advantages in respect of enforcement; see ginsburg 1992, 162–163. nordic journal of commercial law issue 2009#1 55 only insofar as they are original in the sense that they are their author’s own intellectual creations (see, explicitly, art. 1[3] of the software directive). when applied to software, the principle means that in order to enjoy these rights a program must represent such individual character that it excludes the possibility of someone else arriving at a nearly uniform outcome211. accordingly, in case rho 13.10.1992 1128 (final judgement) it was not demonstrated that the applications subject to prima facie unauthorised copying would be results of such creative work that would embody the protected contribution of individual labour in the sense of the copyright act212. the issue of similitude does not actualise until it has been established ex post that a computer program outruns the necessitated threshold of originality. once it has been proven that the work as such enjoys copyright protection, the next phase follows. the landmark decision in that regard is that of helho 28.12.1999 3571 (final judgement). in the case, the appellant demanded the defendants’ conviction for copyright offence and misuse of a business secret, because they had apparently copied parts of the appellant’s source code and made software so constructed available to the public. according to the appellant, the copied parts covered 40 percent of the whole program: allegedly some 90 percent of the code for the memory segment of the communicative portion and approximately 25 percent of the code for the application program were copied. the court commenced by elucidating that whilst the appellant’s computer program meets the minimal standards of originality en bloc, it does not necessarily mean that each part of the program is protected in accordance with the copyright act as well. also the separate portions must, in order to enjoy copyright protection, meet the criterion of originality213. the evidence was that between 10 and 15 percent of the total quantity of the source code of the defendants’ software had been copied from appellant’s prior code. however, the facts that the programs were constructed by the same programmers, the programs implemented the same functionality, the guis were similar, the used programming language enabled the programmers to vary rather little and the structure of the payment terminal reduced to implement certain matters in certain fashion could all account for the resemblances. moreover, the functionality of certain identical modules was defined by the standards for banking and telecommunications so that the formulations therein were to be considered as simple routine code. consequently, the court 211 copyright council 2008:13, 8. 212 pursuant to the judgement of the district court of frankfurt am main concerning the validity of the gpl (see n. 157 supra), ‘nur eine gänzlich banale programmierleistung’ is not sufficiently original to warrant copyright protection. 213 the court build on the disquisition provided by computer science professors in their expert opinions, according to which it is customary to exploit parts from existing software in the programming work of a new product. such exploitation may infringe copyright, should the existing parts be creative to the extent that they meet the minimum standards of originality. nordic journal of commercial law issue 2009#1 56 deemed the copied parts to be either inconsequential or insignificant, whereupon the complaint of the appellant was dismissed. therefore, the copyright protection is absent not only from the parts of the code that are so trivial that the functionality intended therein can be effectively implemented in only one way, but also where ideas are merged into their expressions in such a way that it is impossible to give to the same idea a differing form of appearance214. for instance, if the purpose of a program sets imperative boundary conditions on the source code through, say, confines of an operating environment, sets of technical standards or exigencies of compatibility, then, to that extent, copyright protection will be denied from those modules215. the relevance of the above-mentioned decision by the helsinki court of appeal is that it essentially approved of the principles on how to establish copyright infringement for software developed first in the leading us case computer associates international, inc. v altai, inc.216, where the court proposed the so-called substantial similarity test217. the test consists of three phases: first, the structure of the code is abstracted. second, the parts that are not protected by copyright are filtered out. third, the protected parts are set against each other in order to detect the similarities.218 the criterion of substantial similarity arguably provides the authority applying the law with a workable method of drawing a distinction between the tangible implementation or expression of an idea and the idea itself. under this approach, the ideas of a computer program are comparable to the purposes thereof, but due to the dynamic abstraction process, each module is given its own purpose. should the purpose be implementable only in one way, it does not suffice for crossing the threshold of originality. prior to the aforementioned decision, the prevailing us test for copyright infringement was established in the cause célèbre case of whelan associates, inc. v jaslow dental laboratory, inc.219, in which the choice of the abstraction level was deemed a static operation and, to that end, a low standard was elected220. the result was an attempt to apply the classic idea–expression dichotomy, where the purpose of the whole program was defined as its idea. consequently, any part of the software package that was not absolutely necessary for the purpose would constitute 214 ang 1994, 112. 215 välimäki 2009, 67. 216 982 f.2d 693 (2nd cir. 1992). 217 klami and neejärvi 1997, 593–594. 218 mylly 2005, 761; diver 2008, 128–129. accordingly, the method is also known as ‘abstraction–filtration– comparison’. 219 797 f.2d 1222 (3rd cir. 1986). 220 hass 2007, 387–388. nordic journal of commercial law issue 2009#1 57 the protected expression.221 the problem of the said analysis lies in the fact that software can serve for numerous purposes. such static abstraction operation would effectively lead to a situation where the dichotomy becomes obsolete; expression so defined would be accorded too strong a protection.222 as far as i can see, the substantial similarity test is an approach to break down the copyright protection of computer programs into smaller components. instead of using the monolithic notion of a ‘work’, which can inflict distortions on the scope of protection, one can analytically identify and assort non-protectable elements. consequently, computer programs are protected primarily as a code, but the protection does not necessarily cover all parts thereof. under the present test, a program is first examined in terms of its structure rather than the specific sequences of code. the purpose of the operation is to resolve the functionality of each procedure and subroutine (paras. 75–82). against this knowledge, following elements are to be sifted out from the protectable core: (1) elements dictated by efficiency, (2) elements dictated by external factors and (3) elements taken from the public domain (paras. 83–107). finally the remaining parts can be compared for substantial similarity (para. 108). therefore, the main criterion in respect of the comparison is that resemblances are located in those factually relevant parts. the substantial similarity test has been used in the uk as well. in ibcos computers ltd v barclays mercantile highland finance ltd223 the high court of justice approved of the method that copyright infringement analysis required in respect of computer programs multiple levels of abstraction and comparison.224 to that end, the court outlined a four-part approach that can be expressed as follows225: a) what are the works or works in which the claimant claims copyright? b) is each such work ‘original’ in the sense of art. 1 of the software directive? c) has copying from that work occurred? d) has a substantial part of that work been reproduced? the criterion of a substantial part was further refined in cantor fitzgerald international v tradition (uk) ltd226, according to which not only the program as a whole but also the 221 diver 2008, 128. 222 ang 1994, 145. 223 [1994] fsr 275. 224 hass 2007, 390–391. 225 see freedman 2000, 38. 226 [2000] rpc 95. nordic journal of commercial law issue 2009#1 58 individual modules and techniques used therein ought to be examined, but the definite judgement on substantiality is to be made in relation to the aggregate of the work; it has no relevance to the matter, whether or not the copied part is necessary for the technological functioning227. moreover, since the allegedly copied sections must be original and not dictated by external factors in order to be protectable, the focus of the assessment should accordingly lie in the quality, not the quantity of the code.228 the creativity perceived in components that have been exploited in an infringing manner constitutes a more significant factor in judicial appraisal than some rigid numerical limits. in finland, a recent decision by the vaasa court of appeal follows the international development trends. in vho 17.5.2005 712 (final judgement) computer programs that had been made using a software development environment (sde) were not deemed original enough, since the sde itself, the used programming language, the purposed use of the software and the process equipment that the software was designed to control each necessitated certain implementations by the software development. consequently, the programmers’ freedom of design choice, and thereby possibilities to conduct original and creative programming, was circumscribed by external consideration, which led to a non-protectable set of operations in the end product. the essentials of the assessment concerning similitude and the resultant conclusion of the comparison follow rather closely the principles set forth in the abovementioned foreign proceedings on establishing software copyright infringements with regard to the source code. thus, even an obvious similarity will not constitute an infringement of copyright if it is a corollary of determining extrinsic factors229. in accordance with s. 55(1) of the copyright act, the council of state appoints the copyright council, the purpose of which is to assist the ministry of education in the handling of matters pertaining to copyright and to issue opinions regarding the application of the present act230. the opinions of the copyright council are merely of recommendatory nature and do not legally bind neither the applicant nor her adverse party. despite the absence of judicial power, nonetheless, the copyright council is a de facto organ for legal protection, since the parties ordinarily conform to its opinions by not taking further legal action thereafter. again, the 227 hass 2007, 391 fn. 96. 228 freedman 2000, 38–39. 229 in computer associates international, inc. v altai, inc., the court mentioned (1) the mechanical specifications of the computer on which a particular program is intended to run, (2) the compatibility requirements of other programs with which a program is designed to operate in conjunction, (3) computer manufacturers’ design standards, (4) demands of the industry being serviced, and (5) widely accepted programming practices within the computer industry as instances of such factors. 230 for the composition and decision-making process of the council, see ss. 18–23 of the copyright decree (547/1995). nordic journal of commercial law issue 2009#1 59 copyright council is also an organ acquainted with the specific concerns in the sector of copyright, whereupon the opinions issued by it are often utilised during litigation.231 the copyright council has discussed the matters interrelated to the law of copyright and computer programs in several of its opinions. in opinion 1996:3, the council took the view that an application was not original and creative enough so as to attain the threshold of originality. the routine in question was formed predominantly according to the manual and by utilising the features of the parent program. the choices made in order to dispose of the data processing problem did not attest to such originality that someone else could not have concluded equally in solving the same problem. therefore, according to the copyright council, the determinations conducted were rather dictated by the outcome and thus mainly constituted a testimony to mechanical unravelling.232 by contrast, in opinion 1997:12 the council looked upon a computer program, which contained 140 command lines, as a literary work. the program was implemented with a programming language of a logic unit that controls the manufacture of bakery products and it dovetailed the functions of the production equipment.233 the view of the council was subsequently accepted by the supreme court in kko 2008:45, according to which the software in question fulfilled the requirement of originality and was thereby copyrighted pursuant to s. 1(2) of the copyright act. the copyright council has assessed the threshold of originality in respect of computer programs also in its opinions 2005:7, 2006:5, 2006:12 and 2008:13. in all of these, the programs were deemed to outrun the minimum and receive copyright protection234. in summary, the copyright council is also of the opinion that the bases of a computer program as well as the circumstances necessary to implement the idea thereof are not copyrighted as such. in order to identify such necessities, the software must be conceptually divided into smaller functional divisions, and certain divisions that merely employ standard techniques do not enjoy protection although the program as a whole would do so. however, the council can be criticised for occasionally pitching the threshold of originality on too low a level. for instance, in copyright council’s opinion 2003:10 it regarded utilities that solved a small data processing problem in diverging environments as protectable works. the council justified its assessment by arguing that each utility had required from its author possibly several days’ work 231 lappalainen 2007, pr111.12314. see also haarmann 2006, 42. 232 copyright council 1996:3. 233 copyright council 1997:12. 234 see copyright council 2005:7, 9–10; copyright council 2006:5, 10–11; copyright council 2006:12, 9; copyright council 2008:13, 16. nordic journal of commercial law issue 2009#1 60 contribution, whereupon they count as the results of individual labour.235 the case went afterwards before the vaasa court of appeal (vho 17.5.2005 712), where the court traversed the opinion of the copyright council on the grounds that the source code of the programs contained only elements that were dictated by external factors, expressions which are not copyrightable236. separate and independent works limitations and exceptions to copyright the exclusive rights granted to authors or their assignees under copyright law do not apply to all situations but are subject to certain limitations and exceptions237. under art. 13 of the trips, for example, the member states shall confine limitations and exceptions to exclusive rights to certain special cases on two conditions. such instances must not (1) conflict with a normal exploitation of the works and (2) unreasonably prejudice the legitimate interests of the rights holder238. in the us, the limited use of copyrighted material without requiring permission from the copyright holder has been implemented by means of the fair use doctrine (17 usc 107), whereas some other common law jurisdictions operate under the notion of fair dealing (e.g., ss. 29–31 of the copyright, designs and patents act 1988)239. by contrast, continental european civil law copyright systems tend to avoid such open-ended provisions but favour the principle of numerus clausus instead. to that end, in finland the limitations on copyright are placed in c. 2 of the copyright act. nevertheless, irrespective of the divergences as to the flexibility of the restrictions under national copyright laws, it can be noted that basically all such concepts exclude the operations of commercial nature—more or less according to rule— from the scope of application240. other more fundamental boundaries of copyright are begotten by the idea–expression divide. since copyright protects the form in which ideas are expressed rather than the ideas themselves, software can as a consequence be developed to achieve the same results to the extent that the 235 copyright council 2003:10, 12–13. 236 cf. oksanen 2004, 30. 237 haarmann 2005, 154. whether such limitations and exceptions are seen reducing some idealised form of copyright or providing a balance to the rights of copyright in the form of ‘user rights’, is a matter of philosophy of copyright; see nrc 2000, 136–139. 238 see also art. 9(2) of the berne convention and art. 10 of the wct for other embodiments of this ‘three-step test’. 239 senftleben 2004, 162–166. 240 km 1980:12, 87; rowland and campbell 2002, 35; senftleben 2004, 65; landau 2006, 26–27. nordic journal of commercial law issue 2009#1 61 basic concepts can be expressed differently.241 accordingly, although algorithms are essential to the way computers process information as software is written by specifying an algorithm using declarations, expressions and statements, from the copyright’s point of view they merely represent certain ideas behind the system design242. algorithms are ultimately expressed in the form of source code, which together with a possible gui is the only directly perceivable and thereby copyrightable part of a program243. however, the uk case cantor fitzgerald international v tradition (uk) ltd referred to above makes for interesting reading also as to the extent of copyright protection. ‘software architecture’ alludes to two important characteristics of a computer program, to wit the hierarchical structure of procedural components and the structure of data244. such characteristics are not directly perceivable from the source code but the high court of england and wales nevertheless took the view that the software architecture is capable of protection if a substantial part of the programmer’s skill, labour and judgement had gone into it245. already in ibcos computers ltd v barclays mercantile highland finance ltd it had been held that copyright can subsist in the software architecture where the modular components are combined in a way that can be deemed to form a copyrightable compilation. in accordance with nova productions ltd v mazooma games ltd and bell fruit games ltd246, also a gui can fulfil the uk requirements for copyright protection, but as an artistic work, not a computer program. in the us, the attitudes towards bestowing copyright protection upon software architecture have been more reserved. in whelan associates, inc. v jaslow dental laboratory, inc., the court held that copyright protection of computer programs might extend beyond the programs’ literal code to their structure, sequence, and organisation. however, the court deciding the case of computer associates international, inc. v altai, inc. disapproved. according to it, analysing the scope of copyright protection in terms of ‘structure’ was ambiguous and identifying structure with ‘sequence’ and ‘organisation’ fallacious. consequently, copyright may be infringed even if no literal code is copied but the analysis ought to follow the test of substantial similarity. as regards guis, it is arguably settled case law that the functionalities thereof are non-protectable in the us. it stems already from art. 9(2) of the trips and art. 2 of the wct that copyright 241 com (88) 172 final, 182. 242 km 1987:8, 177–178. 243 see välimäki 2009, 15, who speaks of the ‘surface’ of software. 244 pressman 1994, 327–328. 245 freedman 2000, 38–39. the court considered the overall structure of the system at a high level of abstraction and the allocation of functions between various programs as analogous to a plot of a novel or play. under the anglo-saxon legal order, taking a plot even without plagiarising any part of the particular manner of expression might be sufficient to amount to copyright infringement (rebikoff 2001, passim). 246 [2007] ewca civ. 219. nordic journal of commercial law issue 2009#1 62 protection does not extend to the methods of operation as such. nonetheless, it seems conceivable that under special circumstances a gui could enjoy copyright protection through the doctrine of compilations.247 all the cases under discussion have been tried before an anglo-saxon court, which is primarily due to the geographical and financial distribution of the software industry248. domestic precedent courts have yet to pass a ruling on these matters, so that the legal state in finland is somewhat unclear. however, the multilateral conventions concerning copyright have been entered into with a view to create a system that guarantees protection meeting certain minimum requirements for authors in all the member states249. this congruent international background provides for the assumption that the foundations described above were applicable to finland as well, unless valid contraindications exist. in any event, granted that the software architecture or the gui would suffice to enjoy copyright protection, anyone can draw freely on the structural design or the graphical methods of operation to create a new and independent work, copyright in which is not subject to the rights in the original program. for instance, copyright in a technological standard that defines what sort of architectural solutions must be used in interfaces in order to guarantee the compatibility of different systems does not set any limitations upon the implementer of the standard based on copyright law, since art. 1(2) of the software directive protects the original expression of interface specifications, not specifications as such250. the decision of vho 17.5.2005 712 confirms the meagre protection of interfaces by noting that since the programming alternatives available in respect of such abstractions are often limited, it is difficult for these portions of software to outrun the threshold of originality251. however, if the architecture specifies certain things on source code level, copyright may again have relevance to the matter, for it is the concrete written form of a computer program that copyright ultimately covers. independence from licenses the final paragraph of s. 5 of the gplv3 provides that a compilation of a covered work with other separate and independent works, which are not by their nature extensions of the covered 247 see lai 1999, 77–79; mylly 2005, 763. cf. välimäki 2009, 22–24. 248 forbes 2007. 249 haarmann 2005, 26. 250 band and katoh 1995, 242–243. the european commission takes the view that implementation of a specification does not constitute copying, but leads to a clearly distinct work; see case t-201/04 r microsoft corporation v commission of the european communities [2004] ecr ii-4463, para. 168 et seq. 251 mylly 2005, 756. nordic journal of commercial law issue 2009#1 63 work and which are not combined with it with the intention of forming a larger program, is called an aggregate. inclusion of a covered work in an aggregate does not cause the gplv3 to apply to the other parts of the aggregate, if the compilation and its resulting copyright are not used to limit the access or legal rights belonging to the users of the compilation beyond what the individual works permit. it is a foregone conclusion that if, broadly speaking, neither of two programs is a modified version of the earlier one or otherwise based on it, they are separate and independent works. for example, proprietary software may be bundled with an installer program that is licensed under a gnu software license without there being a need to assess, whether the terms of that license apply to the installed software. the answer is in the negative as the installer and the files it installs remain unconnected, for the copyright status of data does not change regardless of programmatic processing252. unless substantial parts of the output are copied from the processing program, the exclusive rights conferred by copyright law do not extend to output, but the latter inherits the qualities of the input.253 under s. 1 of the gplv3 the corresponding source for a work in object code form includes the source code for shared libraries and dynamically linked subprograms that the work is specifically designed to require. thus, even a separately-conveyed component that can be reasonably considered an independent and separate work in itself but is designed specifically for use in combination with a work governed by a gnu software license must according to the license be, on account of this dependence, licensed under compatible terms254. however, such independent modules that are by no means derived from the original program and are not conveyed only to be used in combination with and as a part of a specific program licensed under a gnu software license are not affected by the license terms in question255. thus, software covered by a gnu software license can be conveyed in conjunction with proprietary systems, provided that the instances of both classes are not combined in a way that would make them effectively a single program. by contrast, as regards programs lacking such independence, subsection 5c of the gplv3 is unconditional in its language by stating that works based on a gplv3-covered program may be conveyed exclusively on condition that the entire work, as a whole, is licensed under the present license to anyone who comes into possession of a copy. however, notwithstanding any contractual stipulations to the contrary and as a consequence of the principles referred to 252 see also s. 2 of the gplv3. 253 km 1987:8, 65 ff. 254 gplv3-dd1, 12; gplv3-dd2, 13. 255 gplv3-dd3, 46–47. drafts 1 and 2 of the gplv3 contained an explicit provision in that regard, but the fact is still inherent in other sections of the license. nordic journal of commercial law issue 2009#1 64 above, use of the idea or inclusion of elements of a program governed by a gnu software license that are either a) unoriginal, b) dictated by efficiency, c) dictated by external factors or d) taken from the public domain256 does not cause the license in question to apply to the new program. instead, the last-mentioned is to be deemed a separate work for copyright law purposes and, therefore, may be licensed under whichever terms. this is due to the fact that copyright offers computer programs general erga omnes protection, which nevertheless, in contrast to patents, encompasses merely the form of expression thereof257. the legislator has deemed it good legal policy to motivate competition by enabling anyone to exploit the well-known techniques and methods of software industry in order to create and further develop economic substitutes that are founded on the same idea and perform the same tasks as the original products258. if these new programs have been implemented in an original way without having recourse to the protectable elements of the primary work, they are both protected irrespective of each other259. thus, a work must be licensed under a gnu software license only as long as any substantial portion of parts so covered is present in the subsequent version260. it has been defined in s. 0 of the gplv3 that ‘“the program” refers to any copyrightable work licensed under this license’261. since the licensed subject matter is determined against the system of copyright law, incorporating non-protectable elements in a work that is being licensed 256 the public domain is a range of abstract materials that are not owned or controlled by anyone, thus making them available to be used for any purpose without any requirements of permission (välimäki 2002, 856). in our jurisdiction, the author may waive her droit d’auteur with binding effect only in relation to use that is limited in character and extent (s. 3[3] of the copyright act) and the waiver of financial rights must occur separately for each function of exclusive rights (kivimäki 1948, 322–323). for discussion with regard to placing a work in the public domain in the us, see samuels 1993, 158–162. 257 see castrén 2006a, yj111.50906. 258 he 161/1990 vp, 16. 259 km 1987:8, 178. 260 see also gplv3-dd1, 16. 261 emphasis added. in that regard, the section additionally provides that ‘copyright’ also means copyright-like laws that apply to other kinds of works. further to n. 156 supra, it is an interesting question whether the unfair business practices act could be considered as a copyright-like law. the topic, however, is too broad to be discussed here and is better explored in a separate study. nordic journal of commercial law issue 2009#1 65 under terms that are not compatible with those of the present gnu software license does not arguably constitute even a breach of contract. since non-protectable elements are by definition not copyrightable, i find it implicit in the license texts that the reciprocal license grant does not encompass elements that, considered in isolation, do not enjoy copyright protection but such parts are exempted from the scope of the licenses and may, therefore, be freely utilised. the interpretation is concordant with the takings of attitude by the fsf, as they have accentuated that the gnu software licenses are not contracts and have expressly approved of my reading in respect of parts taken from the public domain262. it is difficult to see how the construction could differ as regards other forms of non-protectable elements. naturally, figuring out which parts of a program are presumably non-protectable is a casespecific operation that necessitates application of the substantial similarity test by the party wishing to separate such parts from the rest. in the end, only the court of final instance is competent to pronounce on the validity of the demarcation once and for all. it is noteworthy that whilst, for instance, comments with the same contents, similar indentations and other suchlike circumstances do not render two separate computer programs into copies of the same work, the same applies vice versa: ostensible alteration such as line division, indentation, information embedded in the source code or operating with upper and lower case does not affect the judicial comparison test, since it cannot transfigure a copy into a modification or independent work263. combined works subject to the exceptions set forth above, lgplv3-covered software can be incorporated in a proprietary system merely on certain boundary conditions. the gnu software licenses start from the premise that a work incorporating material covered by such a license forms an extended version of the latter. section 2 of the lgplv3 provides that if the licensee modifies a copy of a program so licensed, the modified copy may not be conveyed under terms other than those of either lgplv3 or gplv3, if it is conveyed at all. however, the specific class of combined works may pursuant to s. 4 of the lgplv3 essentially be conveyed under terms of one’s own choice264. in the framework of lgplv3, a combined work means a product that is produced by combining or linking an application with an lgplv3-covered library. an application, for its part, is defined as any work that makes use of an interface provided by such a library, but which is not otherwise based on it. (lgplv3, s. 0.) 262 see moglen 2001; fsf 2008a. 263 copyright council 1998:16, 9–10. 264 see ch. 0 supra with regard to the requirements concerning different ways of incorporation and combination. nordic journal of commercial law issue 2009#1 66 section 5 of the copyright act provides that a person who, by combining works or parts of works, creates a literary compilation has copyright therein, but her rights do not restrict the rights in the individual works. these compilations must, in order to enjoy copyright protection, be intellectual creations as such, which denotes that the selection and articulation of the works contained in the compilation have occurred according to a certain original scheme265. combined works referred to in the lgplv3 may, therefore, be literary compilations in the sense of the present section. whether the operation is in respect of the copyright act classified to fall into the category of s. 4(1) or s. 5 bears, however, no particular relevance, since they both necessitate the permission of the person holding copyright in the original work266. it stems from the explication of an application that only such combining that can be deemed a mode of using an interface provided by the library can produce a combined work and thereby entitle to the exception as to reciprocity267. combining that forms a single work is not limited to static or dynamic linking, which is meaningful only in certain technological circumstances, so that modules may form a combined program even if they are not linked sensu stricto268. therefore, lgplv3-covered programs that provide one or more interfaces can be used through those interfaces in proprietary applications irrespective of the licenses thereof. the only legal restriction that the lgplv3 imposes in such situations is that users cannot be prevented from running debuggers on the combined works (s. 4 of the lgplv3). as a consequence, only if the library itself is being modified, the assessment follows the principles discussed in the following chapter269. 265 km 1953:5, 50. 266 koktvedgaard and levin 2007, 73. 267 it is not obvious whether the present provision, or the gnu software licenses in general, ought to be interpreted in dubio contra proferentem. the licenses have been drafted by the fsf, which could be characterised as an interest group, but in all cases except where that organisation itself acts as a licensor neither party has formulated the terms rather than merely adheres thereto. furthermore, the advantage of size may case-specifically exist on either the licensor’s or licensee’s side. since the documented revision and update process of the gnu software licenses from version 2 to version 3 makes the objective interpretation of the contractual relation possible, verbatim reading of the licenses appears well-founded; see km 1990:20, 342–343; hemmo 2003, 581; wilhelmsson 2008, 97 ff. 268 see gplv3-fin, 18. 269 the program licensed under the lgplv3 needs not necessarily be a subroutine library. for instance, the openoffice.org office application suite is governed by the present license so as to ensure that the published improvements to the software itself become available for everyone but, at the same time, enable the commercial conveyance of add-ons and plug-ins that make use of the interfaces provided by the application suite (openoffice.org 2008). nordic journal of commercial law issue 2009#1 67 modified works communications based analysis under s. 0 of the gplv3, to modify a work means to copy from or adapt all or part of a work in a fashion requiring copyright permission, other than the making of an exact copy. by such definition, linking or combining a protectable gplv3-covered code with other material appears to form a single modified work, conveying of which must occur exclusively under the present license (gplv3, sub-s. 5c). as regards the functional scope affected by reciprocity, it stems from the elucidation of corresponding source contained in s. 1 of the gplv3 that the cumulative modified work is to include also those dynamically linked subprograms that the work is specifically designed to require, ‘such as by intimate data communication or control flow between those subprograms and other parts of the work’. the license text contains no further definition on what is meant by such intimate data communication or control flow270. the rationale documents, instead, provide that the notion is intended to describe interaction and knowledge so intricate and detailed that it implies a module being particularly produced to depend upon a gplv3-covered element271. the fsf’s opinion has been further elaborated on its web page that contains answers to commonly-asked questions concerning the gnu software licenses272. in response to a query about the difference between an ‘aggregate’ and other kinds of ‘modified versions’, they state to believe that a proper criterion for demarcating the line between two separate programs and one program with two parts is ultimately conditional upon communication, both the mechanism thereof and what kinds of information are interchanged. under this view, including modules in the same executable file would betoken that they are certainly combined in one program. the same would apply to modules that are designed to run linked together in a shared address space and make function calls to each other273. by contrast, if two programs use for communication a mechanism that is normally used between separate programs, it creates a prima facie assumption of separateness274. nonetheless, should the 270 the wording of the provision was similar in draft 1 of the gplv3. in draft 2, ‘complex’ was substituted for ‘intimate’, which some readers had found unclear (gplv3-dd2, 7). however, ‘intimate’ was restored in draft 3 anew, following from further public discussion; see gplv3 comments in file ‘gplv3-draft-2’. 271 gplv3-dd3, 42. 272 fsf 2008a. 273 according to the fsf, using shared memory to communicate with complex data structures is somewhat equivalent to dynamic linking. on the contrary, were a module invoked by a function that creates a separate address space for the child, it would arguably be a separate program. 274 the fsf lists pipelines, inter-process sockets and command line arguments as examples of such communication mechanisms. nordic journal of commercial law issue 2009#1 68 programs exchange complex internal data structures, the semantics of the communication would then be intimate enough to refute the assumption and constitute a basis to consider two parts as combined into a larger program. pursuant to this interpretation, if a library is released under the gplv3, any program that uses it must, too, be under the same or a compatible license, because the program as it is actually run includes the library275. since the gplv3 refers to dynamically linked subprograms that the work is specifically designed to require, communication limited to invoking the primary function of a module with few options forms, however, a borderline case276. the interpretation assumed by the fsf is supported by case micro star v formgen inc.277, where the us court of appeals for the ninth circuit took the view that map files were relevant adaptations of the original game in respect of copyright law. the map files did not copy any code or graphics of the game but were linked to the graphics library thereof. as a consequence, the files generated new audiovisual displays when the game was run. according to the court, although these displays came entirely out of the source art library of the game, the incorporation of copyright protected expression was evidenced by the fact that the map files could only be used with the present game. a rather low premium was placed on technological details. instead, the court construed the infringement on the basis of the outcome that results from the use of the map files.278 worldwide, there is apparently no record that anyone would have circumvented a strongly reciprocal gnu software license by means of dynamic linking and subsequently contested when threatened by the copyright holder with the institution of legal proceedings, which suggests that the industry de facto approves of the fsf’s interpretation. as regards static linking, there has been one litigation where the issue was almost taken under de jure analysis. in 2001 was filed the case of progress software corporation v mysql ab279, where proprietary software was allegedly compiled inside the binary distribution of a gpl-covered database management system280. in the preliminary injunction, the court stated that whether a program linked to software governed by the gpl can be considered a derivative work of that software raises a 275 as regards object-oriented languages, the fsf are of the opinion that ‘subclassing’ is creating a work based on the earlier work. lgplv3, s. 0 specifically provides that, for the purposes of the present license, defining a subclass of a class defined by an lgplv3-covered library is deemed a mode of using an interface of the library. 276 fsf 2008a. 277 154 f.3d 1107 (9th cir. 1998). 278 see välimäki 2009, 40. 279 see n. 161 supra. 280 välimäki 2005, 134–135. nordic journal of commercial law issue 2009#1 69 factual dispute281. the case was, however, settled before judgement was passed, so that the issue still forgoes an authoritative opinion. critique of communicative interpretation the reasoning of micro star v formgen inc. ensues from the prevailing practice amongst anglosaxon jurisdictions, according to which the original elements in the plot of a copyrightable literary work may be considered a substantial part of the work and, therefore, copyright in the original work may be infringed even if the actual language has not been copied at all282. in view of that, the court in question held that the infringed work was the story itself, whereby the stories ‘told’ in the map files were sequels, the subject matter of which belonged to the exclusive rights of the copyright holder. under finnish legal order, however, plots cannot be copyrighted283. as a result, the finding of copyright infringement presumes that protected material from a pre-existing work has been substantially incorporated into a subsequent work. to that end, relying on another case concerning runtime alteration tried before the same ninth circuit seems more legitimate. in lewis galoob toys, inc. v nintendo of america, inc.284, the concurrent altering of digital information that originated in a data storage device was not deemed copyright infringement, since the infringing work would have to incorporate a portion of the copyrighted work in some form. jaeger and metzger argue that, if software components are loaded into the memory of a computer simultaneously and thereafter linked, they practically become a single executable, so that the legal assessment of the arrangement ought not to differ from physical incorporation285. in principle, the argument appears justified for law should address itself to the essence of matters. however, copyright is by definition protection for the format, in this case literal code, whereupon the interpretation cannot be accepted; the coverage of functionality would require the backing of institutional support. the definitions of modification and propagation contained in the gnu software licenses are strongly connected with the exclusive rights conferred upon the copyright holder under the applicable copyright law286. making of an exact copy, executing a work on the computer and modifying a private copy (cf. s. 25j of the copyright act) are all specifically excluded from their 281 majerus 2003. 282 see rebikoff (2001) and the cases referred to therein. 283 copyright council 1986:8; copyright council 1994:9. 284 964 f.2d 965 (9th cir. 1992). 285 jaeger and metzger 2006, 39–40. 286 they refer to a ‘fashion requiring copyright permission’ and ‘infringement under applicable copyright law’, respectively. nordic journal of commercial law issue 2009#1 70 scope, which leaves actions referred to in ss. 2, 4(1) and 5 of the copyright act remaining287. any attempt to propagate or modify a gplv3-covered work except as expressly provided in the license document terminates the rights under the license (gplv3, s. 8). therefore, a product that uses the functionality of a gplv3-covered component without incorporating any portions of the latter cannot, in our jurisdiction, arguably be said to propagate or modify in contravention of the license. as a result, dynamically linking applications to libraries licensed under the gplv3 would not trigger reciprocity, since such applications ought to be deemed separate and independent works, barring where the source code of the gplv3-covered software component per se has been altered. by contrast, the significance of intimate data communication or control flow actualises in situations where also the material governed by the gplv3 has been modified in a way that would, without permission, make the licensee liable for copyright infringement. for example, a licensee could attempt to escape the requirement of subsection 5c of the gplv3 by placing all her improvements in a separate subprogram and merely modifying the main program to dynamically link thereto. now, if she conveys the main program in accordance with the gplv3 but does not include the source code of the runtime component, will it satisfy the license? no. addition of modules and other parts to a program results in a new program based on the old program, if the alteration physically affects the literal code of the latter. the definition of the corresponding source means that irrespective of the method of combination all non-system libraries, subprograms and suchlike that the work is designed to require must also be licensed under a gplv3-compatible license, at the risk of the conclusion that modification, propagation or both have occurred contrary to the license and therefore s. 2 of the copyright act288. in the present case, the licensee has designed the work to require the external component and, since such alteration requires the permission of the copyright holder, the licensee’s right to dispose of the improved version, as a whole, is subject to the copyright in the original work (see art. 4[b] of the software directive)289. only if the component meets the criteria for a system library set forth in the third paragraph of s. 1 of the gplv3, the conveyance of combinations formed by gplv3-covered and proprietarily licensed software products is possible, since the corresponding source does not include the system libraries of the work (gplv3, s. 1). system libraries are by definition core components of the operating system that may not necessarily come directly with it but that all users of the software in question can reasonably be expected to have (see ibid.). programs governed by the 287 cf. art. 4 of the software directive. 288 see also gplv3-fin, 10. 289 the rule has not been expressed unequivocally in the copyright act, but the interaction of ss. 2, 4(1) and 5 thereof leads to the conclusion that the copyright holder has the exclusive right to exploit the new works formed by modifying of the original; see haarmann 2006, 103. nordic journal of commercial law issue 2009#1 71 gplv3 may therefore be combined with such gplv3-incompatible components and conveyed in one.290 however, the definition of major components has been drafted using relatively objective terminology, so that the expected degree of success of an effort to invoke the provision without strong factual grounds appears rather low. remote network interaction irrespective of the assessment whether a work is an original or a modified version, strong reciprocity is not triggered until transfer of copyrightable material occurs or is enabled (gplv3, s. 0)291. this is where the agplv3 comes in. section 13 of the agplv3 provides that if the licensee modifies an agplv3-covered program, the modified version must offer all users interacting with it remotely through a computer network an opportunity to receive the corresponding source of the present version292. the material scope of the reciprocity follows the rules set forth in the preceding chapter, but already remote network interaction activates the obligation. remote network interaction is not one of the exclusive rights of the copyright holder referred to in s. 2 of the copyright act or art. 4 of the software directive293. however, since alteration is, the copyright holder may on her license grant authorise such action in general, but impose certain boundary conditions294. as this is the case with regard to the agplv3, a licensee who consequently oversteps the license grant renders herself guilty of copyright infringement for committing a restricted act without authorisation295. thus, the advantage of the agplv3 for an author who designs software for network server use is obvious: she is able to receive the benefit of any modifications to her original work the same as conventional developers may exploit any improvements on conveyed software. in accordance with s. 13 of the agplv3, network reciprocity extends to all interacting users only. therefore, use in private computer networks securely sharing any part of an organisation’s information or operational systems with its members does not require the organisation to 290 see smith 2007. 291 cf. gplv3-dd3, 40. 292 provided, naturally, that the modified version supports such interaction. 293 see n. 148 supra. under the latter section of law, restricted acts include (1) the permanent or temporary reproduction; (2) the translation, adaptation, arrangement and any other alteration; and (3) any form of distribution to the public of a computer program. 294 cf. s. 2(1) of the copyright act; art. 4(b) of the software directive. 295 such modification does not, for the reasons discussed in ch. 0 supra, entitle to the exception of s. 25j(1) of the copyright act either. nordic journal of commercial law issue 2009#1 72 release the corresponding source to any third parties296. outside intranet environments, an asp affected by the agplv3 can naturally control and limit use of the service by agreement297. however, in line with other gnu software licenses, anyone who has access to the service and chooses to receive the corresponding source thereof may under conditions stated in ss. 4 through 6 and 13 of the agplv3, respectively, freely release it to the public, with or without a fee. 5. conclusive remarks on account of the analysis explicated in chapter 4 above, we are now able to refine the scope of reciprocity contained in the gnu software licenses. in view of that, the respective reciprocity obligations are triggered as of the moment when (1) protected material from a program licensed under a gnu software license has been substantially incorporated into a subsequent work in accord with illustration 2 below and (2) the activity referred to in the present license— conveyance or remote network interaction—has taken place. illustration 2. process of identifying protectable elements of gnu-covered software it should be noted that, unless the first-mentioned criterion has been met, such software components that only dynamically link to a program governed by a gnu software license should arguably be separated de lege lata as independent works. granted that in such cases the 296 as regards occurrences of unauthorised use, such users are not probably first in line demanding their opportunity to receive the source code. at any rate, it could be argued that the concept of ‘interaction’ necessitates certain two-way effect that objects have upon one another, which is conceptually absent from unauthorised use. 297 see, in that regard, lampola, et al. 2003, 27–30. nordic journal of commercial law issue 2009#1 73 program as it is actually run includes also the dynamically linked module, no alteration occurs in concrete or permanent form. copyright comprises the right to dispose of a work in specific functions, none of which pertains to factual usage. neither applicable legislation nor legislative history or legal usage supports the interpretation that would extend to the protection of functionality; teleological arguments alone cannot justify the extension beyond literal code. construction of the framework for assessing the conditions according to which dynamic linking could nevertheless be construed as alteration in the sense of copyright law is a task that must be performed by subsequent research. having said that, the complex connecting factor rules of private international law betoken that even purely domestic actors cannot be lulled into certainty as to the legal state concerning their software. as micro star v formgen inc. evidences, there are jurisdictions and circumstances under which developers ought to be cautious, especially where the work is designed to considerable rely upon other software. another solution is to deploy software by way of the saas method. the gnu software licenses do not place any conditions on licensees that merely make copies of programs so covered and run them. moreover, s. 0 of the gplv3 permits anyone the freedom to make modifications and use them privately, without ever conveying them to third parties. placing the program on a server machine for the public to interact to is under the present section not conveying. in such cases, therefore, the asp is not obliged to release the modified sources in the first place, whereupon the issue of dynamic linking does not actualise at all, unless the vendor has utilised protectable material licensed under the agplv3. if the licensee decides to be bound by a gnu software license, the license under which she licenses her modifications does not necessarily need to be the particular license that governs the code being utilised. two licenses are compatible if they permit the use of the licensed material in the prospective way. for instance, a program that is combined with a gplv3-covered program must be released under a license compatible with the present one, so that the combination itself is consequently available under the gplv3. license terms are compatible with those of the gplv3 where code released under them can be combined with gplv3covered code to form a larger program, which is then conveyed under the gplv3. therefore, the alterations made by a subsequent developer may be licensed under a permissive or standard reciprocity license per se, but the outcome as a whole is governed by the more restrictive one. however, only reciprocally licensed modifications by parties who do not hold copyright in the original work are able to prohibit the original author from converting the product’s license into proprietary at a later time, barring the complete rewrite of protectable subsequent elements. that is the core of reciprocity. technologically speaking, open source software allows developers to recycle existing code to fill specific needs rather than write new software from scratch. such development approach offers the potential for more flexible technical procedures and quicker innovation, thus helping to produce reliable, high quality software in an economic manner. for this reason, detailed legal analysis as to the risks and benefits associated with the licenses governing the legal relationships pertaining to open source software enables the market actors to make reasoned decisions thereof, and ultimately decreases the transaction costs of migrating thereto. nordic journal of commercial law issue 2009#1 74 appendices appendix 1. gnu general public license, version 3, 29 june 2007 copyright © 2007 free software foundation, inc. <http://fsf.org/> everyone is permitted to copy and distribute verbatim copies of this license document, but changing it is not allowed. preamble the gnu general public license is a free, copyleft license for software and other kinds of works. the licenses for most software and other practical works are designed to take away your freedom to share and change the works. by contrast, the gnu general public license is intended to guarantee your freedom to share and change all versions of a program—to make sure it remains free software for all its users. we, the free software foundation, use the gnu general public license for most of our software; it applies also to any other work released this way by its authors. you can apply it to your programs, too. when we speak of free software, we are referring to freedom, not price. our general public licenses are designed to make sure that you have the freedom to distribute copies of free software (and charge for them if you wish), that you receive source code or can get it if you want it, that you can change the software or use pieces of it in new free programs, and that you know you can do these things. to protect your rights, we need to prevent others from denying you these rights or asking you to surrender the rights. therefore, you have certain responsibilities if you distribute copies of the software, or if you modify it: responsibilities to respect the freedom of others. for example, if you distribute copies of such a program, whether gratis or for a fee, you must pass on to the recipients the same freedoms that you received. you must make sure that they, too, receive or can get the source code. and you must show them these terms so they know their rights. developers that use the gnu gpl protect your rights with two steps: (1) assert copyright on the software, and (2) offer you this license giving you legal permission to copy, distribute and/or modify it. for the developers’ and authors’ protection, the gpl clearly explains that there is no warranty for this free software. for both users’ and authors’ sake, the gpl requires that modified versions be marked as changed, so that their problems will not be attributed erroneously to authors of previous versions. http://fsf.org/ nordic journal of commercial law issue 2009#1 75 some devices are designed to deny users access to install or run modified versions of the software inside them, although the manufacturer can do so. this is fundamentally incompatible with the aim of protecting users’ freedom to change the software. the systematic pattern of such abuse occurs in the area of products for individuals to use, which is precisely where it is most unacceptable. therefore, we have designed this version of the gpl to prohibit the practice for those products. if such problems arise substantially in other domains, we stand ready to extend this provision to those domains in future versions of the gpl, as needed to protect the freedom of users. finally, every program is threatened constantly by software patents. states should not allow patents to restrict development and use of software on general-purpose computers, but in those that do, we wish to avoid the special danger that patents applied to a free program could make it effectively proprietary. to prevent this, the gpl assures that patents cannot be used to render the program non-free. the precise terms and conditions for copying, distribution and modification follow. terms and conditions 0. definitions “this license” refers to version 3 of the gnu general public license. “copyright” also means copyright-like laws that apply to other kinds of works, such as semiconductor masks. “the program” refers to any copyrightable work licensed under this license. each licensee is addressed as “you”. “licensees” and “recipients” may be individuals or organizations. to “modify” a work means to copy from or adapt all or part of the work in a fashion requiring copyright permission, other than the making of an exact copy. the resulting work is called a “modified version” of the earlier work or a work “based on” the earlier work. a “covered work” means either the unmodified program or a work based on the program. to “propagate” a work means to do anything with it that, without permission, would make you directly or secondarily liable for infringement under applicable copyright law, except executing it on a computer or modifying a private copy. propagation includes copying, distribution (with or without modification), making available to the public, and in some countries other activities as well. to “convey” a work means any kind of propagation that enables other parties to make or receive copies. mere interaction with a user through a computer network, with no transfer of a copy, is not conveying. nordic journal of commercial law issue 2009#1 76 an interactive user interface displays “appropriate legal notices” to the extent that it includes a convenient and prominently visible feature that (1) displays an appropriate copyright notice, and (2) tells the user that there is no warranty for the work (except to the extent that warranties are provided), that licensees may convey the work under this license, and how to view a copy of this license. if the interface presents a list of user commands or options, such as a menu, a prominent item in the list meets this criterion. 1. source code the “source code” for a work means the preferred form of the work for making modifications to it. “object code” means any non-source form of a work. a “standard interface” means an interface that either is an official standard defined by a recognized standards body, or, in the case of interfaces specified for a particular programming language, one that is widely used among developers working in that language. the “system libraries” of an executable work include anything, other than the work as a whole, that (a) is included in the normal form of packaging a major component, but which is not part of that major component, and (b) serves only to enable use of the work with that major component, or to implement a standard interface for which an implementation is available to the public in source code form. a “major component”, in this context, means a major essential component (kernel, window system, and so on) of the specific operating system (if any) on which the executable work runs, or a compiler used to produce the work, or an object code interpreter used to run it. the “corresponding source” for a work in object code form means all the source code needed to generate, install, and (for an executable work) run the object code and to modify the work, including scripts to control those activities. however, it does not include the work’s system libraries, or general-purpose tools or generally available free programs which are used unmodified in performing those activities but which are not part of the work. for example, corresponding source includes interface definition files associated with source files for the work, and the source code for shared libraries and dynamically linked subprograms that the work is specifically designed to require, such as by intimate data communication or control flow between those subprograms and other parts of the work. the corresponding source need not include anything that users can regenerate automatically from other parts of the corresponding source. the corresponding source for a work in source code form is that same work. nordic journal of commercial law issue 2009#1 77 2. basic permissions all rights granted under this license are granted for the term of copyright on the program, and are irrevocable provided the stated conditions are met. this license explicitly affirms your unlimited permission to run the unmodified program. the output from running a covered work is covered by this license only if the output, given its content, constitutes a covered work. this license acknowledges your rights of fair use or other equivalent, as provided by copyright law. you may make, run and propagate covered works that you do not convey, without conditions so long as your license otherwise remains in force. you may convey covered works to others for the sole purpose of having them make modifications exclusively for you, or provide you with facilities for running those works, provided that you comply with the terms of this license in conveying all material for which you do not control copyright. those thus making or running the covered works for you must do so exclusively on your behalf, under your direction and control, on terms that prohibit them from making any copies of your copyrighted material outside their relationship with you. conveying under any other circumstances is permitted solely under the conditions stated below. sublicensing is not allowed; section 10 makes it unnecessary. 3. protecting users’ legal rights from anti-circumvention law no covered work shall be deemed part of an effective technological measure under any applicable law fulfilling obligations under article 11 of the wipo copyright treaty adopted on 20 december 1996, or similar laws prohibiting or restricting circumvention of such measures. when you convey a covered work, you waive any legal power to forbid circumvention of technological measures to the extent such circumvention is effected by exercising rights under this license with respect to the covered work, and you disclaim any intention to limit operation or modification of the work as a means of enforcing, against the work’s users, your or third parties’ legal rights to forbid circumvention of technological measures. 4. conveying verbatim copies you may convey verbatim copies of the program’s source code as you receive it, in any medium, provided that you conspicuously and appropriately publish on each copy an appropriate copyright notice; keep intact all notices stating that this license and any non-permissive terms added in accord with section 7 apply to the code; keep intact all notices of the absence of any warranty; and give all recipients a copy of this license along with the program. you may charge any price or no price for each copy that you convey, and you may offer support or warranty protection for a fee. nordic journal of commercial law issue 2009#1 78 5. conveying modified source versions you may convey a work based on the program, or the modifications to produce it from the program, in the form of source code under the terms of section 4, provided that you also meet all of these conditions: a) the work must carry prominent notices stating that you modified it, and giving a relevant date. b) the work must carry prominent notices stating that it is released under this license and any conditions added under section 7. this requirement modifies the requirement in section 4 to “keep intact all notices”. c) you must license the entire work, as a whole, under this license to anyone who comes into possession of a copy. this license will therefore apply, along with any applicable section 7 additional terms, to the whole of the work, and all its parts, regardless of how they are packaged. this license gives no permission to license the work in any other way, but it does not invalidate such permission if you have separately received it. d) if the work has interactive user interfaces, each must display appropriate legal notices; however, if the program has interactive interfaces that do not display appropriate legal notices, your work need not make them do so. a compilation of a covered work with other separate and independent works, which are not by their nature extensions of the covered work, and which are not combined with it such as to form a larger program, in or on a volume of a storage or distribution medium, is called an “aggregate” if the compilation and its resulting copyright are not used to limit the access or legal rights of the compilation’s users beyond what the individual works permit. inclusion of a covered work in an aggregate does not cause this license to apply to the other parts of the aggregate. 6. conveying non-source forms you may convey a covered work in object code form under the terms of sections 4 and 5, provided that you also convey the machine-readable corresponding source under the terms of this license, in one of these ways: a) convey the object code in, or embodied in, a physical product (including a physical distribution medium), accompanied by the corresponding source fixed on a durable physical medium customarily used for software interchange. b) convey the object code in, or embodied in, a physical product (including a physical distribution medium), accompanied by a written offer, valid for at least three years and valid for as long as you offer spare parts or customer support for that product model, to give anyone who possesses the object code either (1) a copy of the corresponding source for all the software in the product that is covered by this license, on a durable physical medium customarily used for software interchange, for a price no more than your reasonable cost of nordic journal of commercial law issue 2009#1 79 physically performing this conveying of source, or (2) access to copy the corresponding source from a network server at no charge. c) convey individual copies of the object code with a copy of the written offer to provide the corresponding source. this alternative is allowed only occasionally and noncommercially, and only if you received the object code with such an offer, in accord with subsection 6b. d) convey the object code by offering access from a designated place (gratis or for a charge), and offer equivalent access to the corresponding source in the same way through the same place at no further charge. you need not require recipients to copy the corresponding source along with the object code. if the place to copy the object code is a network server, the corresponding source may be on a different server (operated by you or a third party) that supports equivalent copying facilities, provided you maintain clear directions next to the object code saying where to find the corresponding source. regardless of what server hosts the corresponding source, you remain obligated to ensure that it is available for as long as needed to satisfy these requirements. e) convey the object code using peer-to-peer transmission, provided you inform other peers where the object code and corresponding source of the work are being offered to the general public at no charge under subsection 6d. a separable portion of the object code, whose source code is excluded from the corresponding source as a system library, need not be included in conveying the object code work. a “user product” is either (1) a “consumer product”, which means any tangible personal property which is normally used for personal, family, or household purposes, or (2) anything designed or sold for incorporation into a dwelling. in determining whether a product is a consumer product, doubtful cases shall be resolved in favor of coverage. for a particular product received by a particular user, “normally used” refers to a typical or common use of that class of product, regardless of the status of the particular user or of the way in which the particular user actually uses, or expects or is expected to use, the product. a product is a consumer product regardless of whether the product has substantial commercial, industrial or non-consumer uses, unless such uses represent the only significant mode of use of the product. “installation information” for a user product means any methods, procedures, authorization keys, or other information required to install and execute modified versions of a covered work in that user product from a modified version of its corresponding source. the information must suffice to ensure that the continued functioning of the modified object code is in no case prevented or interfered with solely because modification has been made. if you convey an object code work under this section in, or with, or specifically for use in, a user product, and the conveying occurs as part of a transaction in which the right of possession and use of the user product is transferred to the recipient in perpetuity or for a fixed term (regardless of how the transaction is characterized), the corresponding source conveyed under this section must be accompanied by the installation information. but this requirement does nordic journal of commercial law issue 2009#1 80 not apply if neither you nor any third party retains the ability to install modified object code on the user product (for example, the work has been installed in rom). the requirement to provide installation information does not include a requirement to continue to provide support service, warranty, or updates for a work that has been modified or installed by the recipient, or for the user product in which it has been modified or installed. access to a network may be denied when the modification itself materially and adversely affects the operation of the network or violates the rules and protocols for communication across the network. corresponding source conveyed, and installation information provided, in accord with this section must be in a format that is publicly documented (and with an implementation available to the public in source code form), and must require no special password or key for unpacking, reading or copying. 7. additional terms “additional permissions” are terms that supplement the terms of this license by making exceptions from one or more of its conditions. additional permissions that are applicable to the entire program shall be treated as though they were included in this license, to the extent that they are valid under applicable law. if additional permissions apply only to part of the program, that part may be used separately under those permissions, but the entire program remains governed by this license without regard to the additional permissions. when you convey a copy of a covered work, you may at your option remove any additional permissions from that copy, or from any part of it. (additional permissions may be written to require their own removal in certain cases when you modify the work.) you may place additional permissions on material, added by you to a covered work, for which you have or can give appropriate copyright permission. notwithstanding any other provision of this license, for material you add to a covered work, you may (if authorized by the copyright holders of that material) supplement the terms of this license with terms: a) disclaiming warranty or limiting liability differently from the terms of sections 15 and 16 of this license; or b) requiring preservation of specified reasonable legal notices or author attributions in that material or in the appropriate legal notices displayed by works containing it; or c) prohibiting misrepresentation of the origin of that material, or requiring that modified versions of such material be marked in reasonable ways as different from the original version; or d) limiting the use for publicity purposes of names of licensors or authors of the material; or nordic journal of commercial law issue 2009#1 81 e) declining to grant rights under trademark law for use of some trade names, trademarks, or service marks; or f) requiring indemnification of licensors and authors of that material by anyone who conveys the material (or modified versions of it) with contractual assumptions of liability to the recipient, for any liability that these contractual assumptions directly impose on those licensors and authors. all other non-permissive additional terms are considered “further restrictions” within the meaning of section 10. if the program as you received it, or any part of it, contains a notice stating that it is governed by this license along with a term that is a further restriction, you may remove that term. if a license document contains a further restriction but permits relicensing or conveying under this license, you may add to a covered work material governed by the terms of that license document, provided that the further restriction does not survive such relicensing or conveying. if you add terms to a covered work in accord with this section, you must place, in the relevant source files, a statement of the additional terms that apply to those files, or a notice indicating where to find the applicable terms. additional terms, permissive or non-permissive, may be stated in the form of a separately written license, or stated as exceptions; the above requirements apply either way. 8. termination you may not propagate or modify a covered work except as expressly provided under this license. any attempt otherwise to propagate or modify it is void, and will automatically terminate your rights under this license (including any patent licenses granted under the third paragraph of section 11). however, if you cease all violation of this license, then your license from a particular copyright holder is reinstated (a) provisionally, unless and until the copyright holder explicitly and finally terminates your license, and (b) permanently, if the copyright holder fails to notify you of the violation by some reasonable means prior to 60 days after the cessation. moreover, your license from a particular copyright holder is reinstated permanently if the copyright holder notifies you of the violation by some reasonable means, this is the first time you have received notice of violation of this license (for any work) from that copyright holder, and you cure the violation prior to 30 days after your receipt of the notice. termination of your rights under this section does not terminate the licenses of parties who have received copies or rights from you under this license. if your rights have been terminated and not permanently reinstated, you do not qualify to receive new licenses for the same material under section 10. nordic journal of commercial law issue 2009#1 82 9. acceptance not required for having copies you are not required to accept this license in order to receive or run a copy of the program. ancillary propagation of a covered work occurring solely as a consequence of using peer-to-peer transmission to receive a copy likewise does not require acceptance. however, nothing other than this license grants you permission to propagate or modify any covered work. these actions infringe copyright if you do not accept this license. therefore, by modifying or propagating a covered work, you indicate your acceptance of this license to do so. 10. automatic licensing of downstream recipients each time you convey a covered work, the recipient automatically receives a license from the original licensors, to run, modify and propagate that work, subject to this license. you are not responsible for enforcing compliance by third parties with this license. an “entity transaction” is a transaction transferring control of an organization, or substantially all assets of one, or subdividing an organization, or merging organizations. if propagation of a covered work results from an entity transaction, each party to that transaction who receives a copy of the work also receives whatever licenses to the work the party’s predecessor in interest had or could give under the previous paragraph, plus a right to possession of the corresponding source of the work from the predecessor in interest, if the predecessor has it or can get it with reasonable efforts. you may not impose any further restrictions on the exercise of the rights granted or affirmed under this license. for example, you may not impose a license fee, royalty, or other charge for exercise of rights granted under this license, and you may not initiate litigation (including a cross-claim or counterclaim in a lawsuit) alleging that any patent claim is infringed by making, using, selling, offering for sale, or importing the program or any portion of it. 11. patents a “contributor” is a copyright holder who authorizes use under this license of the program or a work on which the program is based. the work thus licensed is called the contributor’s “contributor version”. a contributor’s “essential patent claims” are all patent claims owned or controlled by the contributor, whether already acquired or hereafter acquired, that would be infringed by some manner, permitted by this license, of making, using, or selling its contributor version, but do not include claims that would be infringed only as a consequence of further modification of the contributor version. for purposes of this definition, “control” includes the right to grant patent sublicenses in a manner consistent with the requirements of this license. nordic journal of commercial law issue 2009#1 83 each contributor grants you a non-exclusive, worldwide, royalty-free patent license under the contributor’s essential patent claims, to make, use, sell, offer for sale, import and otherwise run, modify and propagate the contents of its contributor version. in the following three paragraphs, a “patent license” is any express agreement or commitment, however denominated, not to enforce a patent (such as an express permission to practice a patent or covenant not to sue for patent infringement). to “grant” such a patent license to a party means to make such an agreement or commitment not to enforce a patent against the party. if you convey a covered work, knowingly relying on a patent license, and the corresponding source of the work is not available for anyone to copy, free of charge and under the terms of this license, through a publicly available network server or other readily accessible means, then you must either (1) cause the corresponding source to be so available, or (2) arrange to deprive yourself of the benefit of the patent license for this particular work, or (3) arrange, in a manner consistent with the requirements of this license, to extend the patent license to downstream recipients. “knowingly relying” means you have actual knowledge that, but for the patent license, your conveying the covered work in a country, or your recipient’s use of the covered work in a country, would infringe one or more identifiable patents in that country that you have reason to believe are valid. if, pursuant to or in connection with a single transaction or arrangement, you convey, or propagate by procuring conveyance of, a covered work, and grant a patent license to some of the parties receiving the covered work authorizing them to use, propagate, modify or convey a specific copy of the covered work, then the patent license you grant is automatically extended to all recipients of the covered work and works based on it. a patent license is “discriminatory” if it does not include within the scope of its coverage, prohibits the exercise of, or is conditioned on the non-exercise of one or more of the rights that are specifically granted under this license. you may not convey a covered work if you are a party to an arrangement with a third party that is in the business of distributing software, under which you make payment to the third party based on the extent of your activity of conveying the work, and under which the third party grants, to any of the parties who would receive the covered work from you, a discriminatory patent license (a) in connection with copies of the covered work conveyed by you (or copies made from those copies), or (b) primarily for and in connection with specific products or compilations that contain the covered work, unless you entered into that arrangement, or that patent license was granted, prior to 28 march 2007. nothing in this license shall be construed as excluding or limiting any implied license or other defenses to infringement that may otherwise be available to you under applicable patent law. nordic journal of commercial law issue 2009#1 84 12. no surrender of others’ freedom if conditions are imposed on you (whether by court order, agreement or otherwise) that contradict the conditions of this license, they do not excuse you from the conditions of this license. if you cannot convey a covered work so as to satisfy simultaneously your obligations under this license and any other pertinent obligations, then as a consequence you may not convey it at all. for example, if you agree to terms that obligate you to collect a royalty for further conveying from those to whom you convey the program, the only way you could satisfy both those terms and this license would be to refrain entirely from conveying the program. 13. use with the gnu affero general public license notwithstanding any other provision of this license, you have permission to link or combine any covered work with a work licensed under version 3 of the gnu affero general public license into a single combined work, and to convey the resulting work. the terms of this license will continue to apply to the part which is the covered work, but the special requirements of the gnu affero general public license, section 13, concerning interaction through a network will apply to the combination as such. 14. revised versions of this license the free software foundation may publish revised and/or new versions of the gnu general public license from time to time. such new versions will be similar in spirit to the present version, but may differ in detail to address new problems or concerns. each version is given a distinguishing version number. if the program specifies that a certain numbered version of the gnu general public license “or any later version” applies to it, you have the option of following the terms and conditions either of that numbered version or of any later version published by the free software foundation. if the program does not specify a version number of the gnu general public license, you may choose any version ever published by the free software foundation. if the program specifies that a proxy can decide which future versions of the gnu general public license can be used, that proxy’s public statement of acceptance of a version permanently authorizes you to choose that version for the program. later license versions may give you additional or different permissions. however, no additional obligations are imposed on any author or copyright holder as a result of your choosing to follow a later version. nordic journal of commercial law issue 2009#1 85 15. disclaimer of warranty there is no warranty for the program, to the extent permitted by applicable law. except when otherwise stated in writing the copyright holders and/or other parties provide the program “as is” without warranty of any kind, either expressed or implied, including, but not limited to, the implied warranties of merchantability and fitness for a particular purpose. the entire risk as to the quality and performance of the program is with you. should the program prove defective, you assume the cost of all necessary servicing, repair or correction. 16. limitation of liability in no event unless required by applicable law or agreed to in writing will any copyright holder, or any other party who modifies and/or conveys the program as permitted above, be liable to you for damages, including any general, special, incidental or consequential damages arising out of the use or inability to use the program (including but not limited to loss of data or data being rendered inaccurate or losses sustained by you or third parties or a failure of the program to operate with any other programs), even if such holder or other party has been advised of the possibility of such damages. 17. interpretation of sections 15 and 16 if the disclaimer of warranty and limitation of liability provided above cannot be given local legal effect according to their terms, reviewing courts shall apply local law that most closely approximates an absolute waiver of all civil liability in connection with the program, unless a warranty or assumption of liability accompanies a copy of the program in return for a fee. end of terms and conditions how to apply these terms to your new programs if you develop a new program, and you want it to be of the greatest possible use to the public, the best way to achieve this is to make it free software which everyone can redistribute and change under these terms. nordic journal of commercial law issue 2009#1 86 to do so, attach the following notices to the program. it is safest to attach them to the start of each source file to most effectively state the exclusion of warranty; and each file should have at least the “copyright” line and a pointer to where the full notice is found. <one line to give the program’s name and a brief idea of what it does.> copyright (c) <year> <name of author> this program is free software: you can redistribute it and/or modify it under the terms of the gnu general public license as published by the free software foundation, either version 3 of the license, or (at your option) any later version. this program is distributed in the hope that it will be useful, but without any warranty; without even the implied warranty of merchantability or fitness for a particular purpose. see the gnu general public license for more details. you should have received a copy of the gnu general public license along with this program. if not, see <http://www.gnu.org/licenses/>. also add information on how to contact you by electronic and paper mail. if the program does terminal interaction, make it output a short notice like this when it starts in an interactive mode: <program> copyright (c) <year> <name of author> this program comes with absolutely no warranty; for details type ‘show w’. this is free software, and you are welcome to redistribute it under certain conditions; type ‘show c’ for details. the hypothetical commands ‘show w’ and ‘show c’ should show the appropriate parts of the general public license. of course, your program’s commands might be different; for a gui interface, you would use an “about box”. you should also get your employer (if you work as a programmer) or school, if any, to sign a “copyright disclaimer” for the program, if necessary. for more information on this, and how to apply and follow the gnu gpl, see <http://www.gnu.org/licenses/>. the gnu general public license does not permit incorporating your program into proprietary programs. if your program is a subroutine library, you may consider it more useful to permit linking proprietary applications with the library. if this is what you want to do, use the gnu lesser general public license instead of this license. but first, please read <http://www.gnu.org/philosophy/why-not-lgpl.html>. appendix 2. gnu lesser general public license, version 3, 29 june 2007 copyright © 2007 free software foundation, inc. <http://fsf.org/> http://www.gnu.org/licenses/ http://www.gnu.org/licenses/ http://www.gnu.org/philosophy/why-not-lgpl.html http://fsf.org/ nordic journal of commercial law issue 2009#1 87 everyone is permitted to copy and distribute verbatim copies of this license document, but changing it is not allowed. this version of the gnu lesser general public license incorporates the terms and conditions of version 3 of the gnu general public license, supplemented by the additional permissions listed below. 0. additional definitions as used herein, “this license” refers to version 3 of the gnu lesser general public license, and the “gnu gpl” refers to version 3 of the gnu general public license. “the library” refers to a covered work governed by this license, other than an application or a combined work as defined below. an “application” is any work that makes use of an interface provided by the library, but which is not otherwise based on the library. defining a subclass of a class defined by the library is deemed a mode of using an interface provided by the library. a “combined work” is a work produced by combining or linking an application with the library. the particular version of the library with which the combined work was made is also called the “linked version”. the “minimal corresponding source” for a combined work means the corresponding source for the combined work, excluding any source code for portions of the combined work that, considered in isolation, are based on the application, and not on the linked version. the “corresponding application code” for a combined work means the object code and/or source code for the application, including any data and utility programs needed for reproducing the combined work from the application, but excluding the system libraries of the combined work. 1. exception to section 3 of the gnu gpl you may convey a covered work under sections 3 and 4 of this license without being bound by section 3 of the gnu gpl. 2. conveying modified versions if you modify a copy of the library, and, in your modifications, a facility refers to a function or data to be supplied by an application that uses the facility (other than as an argument passed when the facility is invoked), then you may convey a copy of the modified version: nordic journal of commercial law issue 2009#1 88 a) under this license, provided that you make a good faith effort to ensure that, in the event an application does not supply the function or data, the facility still operates, and performs whatever part of its purpose remains meaningful, or b) under the gnu gpl, with none of the additional permissions of this license applicable to that copy. 3. object code incorporating material from library header files the object code form of an application may incorporate material from a header file that is part of the library. you may convey such object code under terms of your choice, provided that, if the incorporated material is not limited to numerical parameters, data structure layouts and accessors, or small macros, inline functions and templates (ten or fewer lines in length), you do both of the following: a) give prominent notice with each copy of the object code that the library is used in it and that the library and its use are covered by this license. b) accompany the object code with a copy of the gnu gpl and this license document. 4. combined works you may convey a combined work under terms of your choice that, taken together, effectively do not restrict modification of the portions of the library contained in the combined work and reverse engineering for debugging such modifications, if you also do each of the following: a) give prominent notice with each copy of the combined work that the library is used in it and that the library and its use are covered by this license. b) accompany the combined work with a copy of the gnu gpl and this license document. c) for a combined work that displays copyright notices during execution, include the copyright notice for the library among these notices, as well as a reference directing the user to the copies of the gnu gpl and this license document. d) do one of the following: 0) convey the minimal corresponding source under the terms of this license, and the corresponding application code in a form suitable for, and under terms that permit, the user to recombine or relink the application with a modified version of the linked version to produce a modified combined work, in the manner specified by section 6 of the gnu gpl for conveying corresponding source. 1) use a suitable shared library mechanism for linking with the library. a suitable mechanism is one that (a) uses at run time a copy of the library already present on the user’s computer system, and (b) will operate properly with a modified version of the library that is interface-compatible with the linked version. e) provide installation information, but only if you would otherwise be required to provide such information under section 6 of the gnu gpl, and only to the extent that such nordic journal of commercial law issue 2009#1 89 information is necessary to install and execute a modified version of the combined work produced by recombining or relinking the application with a modified version of the linked version. (if you use option 4d0, the installation information must accompany the minimal corresponding source and corresponding application code. if you use option 4d1, you must provide the installation information in the manner specified by section 6 of the gnu gpl for conveying corresponding source.) 5. combined libraries you may place library facilities that are a work based on the library side by side in a single library together with other library facilities that are not applications and are not covered by this license, and convey such a combined library under terms of your choice, if you do both of the following: a) accompany the combined library with a copy of the same work based on the library, uncombined with any other library facilities, conveyed under the terms of this license. b) give prominent notice with the combined library that part of it is a work based on the library, and explaining where to find the accompanying uncombined form of the same work. 6. revised versions of the gnu lesser general public license the free software foundation may publish revised and/or new versions of the gnu lesser general public license from time to time. such new versions will be similar in spirit to the present version, but may differ in detail to address new problems or concerns. each version is given a distinguishing version number. if the library as you received it specifies that a certain numbered version of the gnu lesser general public license “or any later version” applies to it, you have the option of following the terms and conditions either of that published version or of any later version published by the free software foundation. if the library as you received it does not specify a version number of the gnu lesser general public license, you may choose any version of the gnu lesser general public license ever published by the free software foundation. if the library as you received it specifies that a proxy can decide whether future versions of the gnu lesser general public license shall apply, that proxy’s public statement of acceptance of any version is permanent authorization for you to choose that version for the library. appendix 3. gnu affero general public license, version 3, 19 november 2007 copyright © 2007 free software foundation, inc. <http://fsf.org/> http://fsf.org/ nordic journal of commercial law issue 2009#1 90 everyone is permitted to copy and distribute verbatim copies of this license document, but changing it is not allowed. preamble the gnu affero general public license is a free, copyleft license for software and other kinds of works, specifically designed to ensure cooperation with the community in the case of network server software. the licenses for most software and other practical works are designed to take away your freedom to share and change the works. by contrast, our general public licenses are intended to guarantee your freedom to share and change all versions of a program—to make sure it remains free software for all its users. when we speak of free software, we are referring to freedom, not price. our general public licenses are designed to make sure that you have the freedom to distribute copies of free software (and charge for them if you wish), that you receive source code or can get it if you want it, that you can change the software or use pieces of it in new free programs, and that you know you can do these things. developers that use our general public licenses protect your rights with two steps: (1) assert copyright on the software, and (2) offer you this license which gives you legal permission to copy, distribute and/or modify the software. a secondary benefit of defending all users’ freedom is that improvements made in alternate versions of the program, if they receive widespread use, become available for other developers to incorporate. many developers of free software are heartened and encouraged by the resulting cooperation. however, in the case of software used on network servers, this result may fail to come about. the gnu general public license permits making a modified version and letting the public access it on a server without ever releasing its source code to the public. the gnu affero general public license is designed specifically to ensure that, in such cases, the modified source code becomes available to the community. it requires the operator of a network server to provide the source code of the modified version running there to the users of that server. therefore, public use of a modified version, on a publicly accessible server, gives the public access to the source code of the modified version. an older license, called the affero general public license and published by affero, was designed to accomplish similar goals. this is a different license, not a version of the affero gpl, but affero has released a new version of the affero gpl which permits relicensing under this license. the precise terms and conditions for copying, distribution and modification follow. nordic journal of commercial law issue 2009#1 91 terms and conditions 0. definitions “this license” refers to version 3 of the gnu affero general public license. “copyright” also means copyright-like laws that apply to other kinds of works, such as semiconductor masks. “the program” refers to any copyrightable work licensed under this license. each licensee is addressed as “you”. “licensees” and “recipients” may be individuals or organizations. to “modify” a work means to copy from or adapt all or part of the work in a fashion requiring copyright permission, other than the making of an exact copy. the resulting work is called a “modified version” of the earlier work or a work “based on” the earlier work. a “covered work” means either the unmodified program or a work based on the program. to “propagate” a work means to do anything with it that, without permission, would make you directly or secondarily liable for infringement under applicable copyright law, except executing it on a computer or modifying a private copy. propagation includes copying, distribution (with or without modification), making available to the public, and in some countries other activities as well. to “convey” a work means any kind of propagation that enables other parties to make or receive copies. mere interaction with a user through a computer network, with no transfer of a copy, is not conveying. an interactive user interface displays “appropriate legal notices” to the extent that it includes a convenient and prominently visible feature that (1) displays an appropriate copyright notice, and (2) tells the user that there is no warranty for the work (except to the extent that warranties are provided), that licensees may convey the work under this license, and how to view a copy of this license. if the interface presents a list of user commands or options, such as a menu, a prominent item in the list meets this criterion. 1. source code the “source code” for a work means the preferred form of the work for making modifications to it. “object code” means any non-source form of a work. a “standard interface” means an interface that either is an official standard defined by a recognized standards body, or, in the case of interfaces specified for a particular programming language, one that is widely used among developers working in that language. nordic journal of commercial law issue 2009#1 92 the “system libraries” of an executable work include anything, other than the work as a whole, that (a) is included in the normal form of packaging a major component, but which is not part of that major component, and (b) serves only to enable use of the work with that major component, or to implement a standard interface for which an implementation is available to the public in source code form. a “major component”, in this context, means a major essential component (kernel, window system, and so on) of the specific operating system (if any) on which the executable work runs, or a compiler used to produce the work, or an object code interpreter used to run it. the “corresponding source” for a work in object code form means all the source code needed to generate, install, and (for an executable work) run the object code and to modify the work, including scripts to control those activities. however, it does not include the work’s system libraries, or general-purpose tools or generally available free programs which are used unmodified in performing those activities but which are not part of the work. for example, corresponding source includes interface definition files associated with source files for the work, and the source code for shared libraries and dynamically linked subprograms that the work is specifically designed to require, such as by intimate data communication or control flow between those subprograms and other parts of the work. the corresponding source need not include anything that users can regenerate automatically from other parts of the corresponding source. the corresponding source for a work in source code form is that same work. 2. basic permissions all rights granted under this license are granted for the term of copyright on the program, and are irrevocable provided the stated conditions are met. this license explicitly affirms your unlimited permission to run the unmodified program. the output from running a covered work is covered by this license only if the output, given its content, constitutes a covered work. this license acknowledges your rights of fair use or other equivalent, as provided by copyright law. you may make, run and propagate covered works that you do not convey, without conditions so long as your license otherwise remains in force. you may convey covered works to others for the sole purpose of having them make modifications exclusively for you, or provide you with facilities for running those works, provided that you comply with the terms of this license in conveying all material for which you do not control copyright. those thus making or running the covered works for you must do so exclusively on your behalf, under your direction and control, on terms that prohibit them from making any copies of your copyrighted material outside their relationship with you. nordic journal of commercial law issue 2009#1 93 conveying under any other circumstances is permitted solely under the conditions stated below. sublicensing is not allowed; section 10 makes it unnecessary. 3. protecting users’ legal rights from anti-circumvention law no covered work shall be deemed part of an effective technological measure under any applicable law fulfilling obligations under article 11 of the wipo copyright treaty adopted on 20 december 1996, or similar laws prohibiting or restricting circumvention of such measures. when you convey a covered work, you waive any legal power to forbid circumvention of technological measures to the extent such circumvention is effected by exercising rights under this license with respect to the covered work, and you disclaim any intention to limit operation or modification of the work as a means of enforcing, against the work’s users, your or third parties’ legal rights to forbid circumvention of technological measures. 4. conveying verbatim copies you may convey verbatim copies of the program’s source code as you receive it, in any medium, provided that you conspicuously and appropriately publish on each copy an appropriate copyright notice; keep intact all notices stating that this license and any non-permissive terms added in accord with section 7 apply to the code; keep intact all notices of the absence of any warranty; and give all recipients a copy of this license along with the program. you may charge any price or no price for each copy that you convey, and you may offer support or warranty protection for a fee. 5. conveying modified source versions you may convey a work based on the program, or the modifications to produce it from the program, in the form of source code under the terms of section 4, provided that you also meet all of these conditions: a) the work must carry prominent notices stating that you modified it, and giving a relevant date. b) the work must carry prominent notices stating that it is released under this license and any conditions added under section 7. this requirement modifies the requirement in section 4 to “keep intact all notices”. c) you must license the entire work, as a whole, under this license to anyone who comes into possession of a copy. this license will therefore apply, along with any applicable section 7 additional terms, to the whole of the work, and all its parts, regardless of how they are packaged. this license gives no permission to license the work in any other way, but it does not invalidate such permission if you have separately received it. nordic journal of commercial law issue 2009#1 94 d) if the work has interactive user interfaces, each must display appropriate legal notices; however, if the program has interactive interfaces that do not display appropriate legal notices, your work need not make them do so. a compilation of a covered work with other separate and independent works, which are not by their nature extensions of the covered work, and which are not combined with it such as to form a larger program, in or on a volume of a storage or distribution medium, is called an “aggregate” if the compilation and its resulting copyright are not used to limit the access or legal rights of the compilation’s users beyond what the individual works permit. inclusion of a covered work in an aggregate does not cause this license to apply to the other parts of the aggregate. 6. conveying non-source forms you may convey a covered work in object code form under the terms of sections 4 and 5, provided that you also convey the machine-readable corresponding source under the terms of this license, in one of these ways: a) convey the object code in, or embodied in, a physical product (including a physical distribution medium), accompanied by the corresponding source fixed on a durable physical medium customarily used for software interchange. b) convey the object code in, or embodied in, a physical product (including a physical distribution medium), accompanied by a written offer, valid for at least three years and valid for as long as you offer spare parts or customer support for that product model, to give anyone who possesses the object code either (1) a copy of the corresponding source for all the software in the product that is covered by this license, on a durable physical medium customarily used for software interchange, for a price no more than your reasonable cost of physically performing this conveying of source, or (2) access to copy the corresponding source from a network server at no charge. c) convey individual copies of the object code with a copy of the written offer to provide the corresponding source. this alternative is allowed only occasionally and noncommercially, and only if you received the object code with such an offer, in accord with subsection 6b. d) convey the object code by offering access from a designated place (gratis or for a charge), and offer equivalent access to the corresponding source in the same way through the same place at no further charge. you need not require recipients to copy the corresponding source along with the object code. if the place to copy the object code is a network server, the corresponding source may be on a different server (operated by you or a third party) that supports equivalent copying facilities, provided you maintain clear directions next to the object code saying where to find the corresponding source. regardless of what server hosts the corresponding source, you remain obligated to ensure that it is available for as long as needed to satisfy these requirements. nordic journal of commercial law issue 2009#1 95 e) convey the object code using peer-to-peer transmission, provided you inform other peers where the object code and corresponding source of the work are being offered to the general public at no charge under subsection 6d. a separable portion of the object code, whose source code is excluded from the corresponding source as a system library, need not be included in conveying the object code work. a “user product” is either (1) a “consumer product”, which means any tangible personal property which is normally used for personal, family, or household purposes, or (2) anything designed or sold for incorporation into a dwelling. in determining whether a product is a consumer product, doubtful cases shall be resolved in favor of coverage. for a particular product received by a particular user, “normally used” refers to a typical or common use of that class of product, regardless of the status of the particular user or of the way in which the particular user actually uses, or expects or is expected to use, the product. a product is a consumer product regardless of whether the product has substantial commercial, industrial or non-consumer uses, unless such uses represent the only significant mode of use of the product. “installation information” for a user product means any methods, procedures, authorization keys, or other information required to install and execute modified versions of a covered work in that user product from a modified version of its corresponding source. the information must suffice to ensure that the continued functioning of the modified object code is in no case prevented or interfered with solely because modification has been made. if you convey an object code work under this section in, or with, or specifically for use in, a user product, and the conveying occurs as part of a transaction in which the right of possession and use of the user product is transferred to the recipient in perpetuity or for a fixed term (regardless of how the transaction is characterized), the corresponding source conveyed under this section must be accompanied by the installation information. but this requirement does not apply if neither you nor any third party retains the ability to install modified object code on the user product (for example, the work has been installed in rom). the requirement to provide installation information does not include a requirement to continue to provide support service, warranty, or updates for a work that has been modified or installed by the recipient, or for the user product in which it has been modified or installed. access to a network may be denied when the modification itself materially and adversely affects the operation of the network or violates the rules and protocols for communication across the network. corresponding source conveyed, and installation information provided, in accord with this section must be in a format that is publicly documented (and with an implementation available to the public in source code form), and must require no special password or key for unpacking, reading or copying. nordic journal of commercial law issue 2009#1 96 7. additional terms “additional permissions” are terms that supplement the terms of this license by making exceptions from one or more of its conditions. additional permissions that are applicable to the entire program shall be treated as though they were included in this license, to the extent that they are valid under applicable law. if additional permissions apply only to part of the program, that part may be used separately under those permissions, but the entire program remains governed by this license without regard to the additional permissions. when you convey a copy of a covered work, you may at your option remove any additional permissions from that copy, or from any part of it. (additional permissions may be written to require their own removal in certain cases when you modify the work.) you may place additional permissions on material, added by you to a covered work, for which you have or can give appropriate copyright permission. notwithstanding any other provision of this license, for material you add to a covered work, you may (if authorized by the copyright holders of that material) supplement the terms of this license with terms: a) disclaiming warranty or limiting liability differently from the terms of sections 15 and 16 of this license; or b) requiring preservation of specified reasonable legal notices or author attributions in that material or in the appropriate legal notices displayed by works containing it; or c) prohibiting misrepresentation of the origin of that material, or requiring that modified versions of such material be marked in reasonable ways as different from the original version; or d) limiting the use for publicity purposes of names of licensors or authors of the material; or e) declining to grant rights under trademark law for use of some trade names, trademarks, or service marks; or f) requiring indemnification of licensors and authors of that material by anyone who conveys the material (or modified versions of it) with contractual assumptions of liability to the recipient, for any liability that these contractual assumptions directly impose on those licensors and authors. all other non-permissive additional terms are considered “further restrictions” within the meaning of section 10. if the program as you received it, or any part of it, contains a notice stating that it is governed by this license along with a term that is a further restriction, you may remove that term. if a license document contains a further restriction but permits relicensing or conveying under this license, you may add to a covered work material governed by the terms of that license document, provided that the further restriction does not survive such relicensing or conveying. nordic journal of commercial law issue 2009#1 97 if you add terms to a covered work in accord with this section, you must place, in the relevant source files, a statement of the additional terms that apply to those files, or a notice indicating where to find the applicable terms. additional terms, permissive or non-permissive, may be stated in the form of a separately written license, or stated as exceptions; the above requirements apply either way. 8. termination you may not propagate or modify a covered work except as expressly provided under this license. any attempt otherwise to propagate or modify it is void, and will automatically terminate your rights under this license (including any patent licenses granted under the third paragraph of section 11). however, if you cease all violation of this license, then your license from a particular copyright holder is reinstated (a) provisionally, unless and until the copyright holder explicitly and finally terminates your license, and (b) permanently, if the copyright holder fails to notify you of the violation by some reasonable means prior to 60 days after the cessation. moreover, your license from a particular copyright holder is reinstated permanently if the copyright holder notifies you of the violation by some reasonable means, this is the first time you have received notice of violation of this license (for any work) from that copyright holder, and you cure the violation prior to 30 days after your receipt of the notice. termination of your rights under this section does not terminate the licenses of parties who have received copies or rights from you under this license. if your rights have been terminated and not permanently reinstated, you do not qualify to receive new licenses for the same material under section 10. 9. acceptance not required for having copies you are not required to accept this license in order to receive or run a copy of the program. ancillary propagation of a covered work occurring solely as a consequence of using peer-to-peer transmission to receive a copy likewise does not require acceptance. however, nothing other than this license grants you permission to propagate or modify any covered work. these actions infringe copyright if you do not accept this license. therefore, by modifying or propagating a covered work, you indicate your acceptance of this license to do so. nordic journal of commercial law issue 2009#1 98 10. automatic licensing of downstream recipients each time you convey a covered work, the recipient automatically receives a license from the original licensors, to run, modify and propagate that work, subject to this license. you are not responsible for enforcing compliance by third parties with this license. an “entity transaction” is a transaction transferring control of an organization, or substantially all assets of one, or subdividing an organization, or merging organizations. if propagation of a covered work results from an entity transaction, each party to that transaction who receives a copy of the work also receives whatever licenses to the work the party’s predecessor in interest had or could give under the previous paragraph, plus a right to possession of the corresponding source of the work from the predecessor in interest, if the predecessor has it or can get it with reasonable efforts. you may not impose any further restrictions on the exercise of the rights granted or affirmed under this license. for example, you may not impose a license fee, royalty, or other charge for exercise of rights granted under this license, and you may not initiate litigation (including a cross-claim or counterclaim in a lawsuit) alleging that any patent claim is infringed by making, using, selling, offering for sale, or importing the program or any portion of it. 11. patents a “contributor” is a copyright holder who authorizes use under this license of the program or a work on which the program is based. the work thus licensed is called the contributor’s “contributor version”. a contributor’s “essential patent claims” are all patent claims owned or controlled by the contributor, whether already acquired or hereafter acquired, that would be infringed by some manner, permitted by this license, of making, using, or selling its contributor version, but do not include claims that would be infringed only as a consequence of further modification of the contributor version. for purposes of this definition, “control” includes the right to grant patent sublicenses in a manner consistent with the requirements of this license. each contributor grants you a non-exclusive, worldwide, royalty-free patent license under the contributor’s essential patent claims, to make, use, sell, offer for sale, import and otherwise run, modify and propagate the contents of its contributor version. in the following three paragraphs, a “patent license” is any express agreement or commitment, however denominated, not to enforce a patent (such as an express permission to practice a patent or covenant not to sue for patent infringement). to “grant” such a patent license to a party means to make such an agreement or commitment not to enforce a patent against the party. nordic journal of commercial law issue 2009#1 99 if you convey a covered work, knowingly relying on a patent license, and the corresponding source of the work is not available for anyone to copy, free of charge and under the terms of this license, through a publicly available network server or other readily accessible means, then you must either (1) cause the corresponding source to be so available, or (2) arrange to deprive yourself of the benefit of the patent license for this particular work, or (3) arrange, in a manner consistent with the requirements of this license, to extend the patent license to downstream recipients. “knowingly relying” means you have actual knowledge that, but for the patent license, your conveying the covered work in a country, or your recipient’s use of the covered work in a country, would infringe one or more identifiable patents in that country that you have reason to believe are valid. if, pursuant to or in connection with a single transaction or arrangement, you convey, or propagate by procuring conveyance of, a covered work, and grant a patent license to some of the parties receiving the covered work authorizing them to use, propagate, modify or convey a specific copy of the covered work, then the patent license you grant is automatically extended to all recipients of the covered work and works based on it. a patent license is “discriminatory” if it does not include within the scope of its coverage, prohibits the exercise of, or is conditioned on the non-exercise of one or more of the rights that are specifically granted under this license. you may not convey a covered work if you are a party to an arrangement with a third party that is in the business of distributing software, under which you make payment to the third party based on the extent of your activity of conveying the work, and under which the third party grants, to any of the parties who would receive the covered work from you, a discriminatory patent license (a) in connection with copies of the covered work conveyed by you (or copies made from those copies), or (b) primarily for and in connection with specific products or compilations that contain the covered work, unless you entered into that arrangement, or that patent license was granted, prior to 28 march 2007. nothing in this license shall be construed as excluding or limiting any implied license or other defenses to infringement that may otherwise be available to you under applicable patent law. 12. no surrender of others’ freedom if conditions are imposed on you (whether by court order, agreement or otherwise) that contradict the conditions of this license, they do not excuse you from the conditions of this license. if you cannot convey a covered work so as to satisfy simultaneously your obligations under this license and any other pertinent obligations, then as a consequence you may not convey it at all. for example, if you agree to terms that obligate you to collect a royalty for further conveying from those to whom you convey the program, the only way you could satisfy both those terms and this license would be to refrain entirely from conveying the program. nordic journal of commercial law issue 2009#1 100 13. remote network interaction; use with the gnu general public license notwithstanding any other provision of this license, if you modify the program, your modified version must prominently offer all users interacting with it remotely through a computer network (if your version supports such interaction) an opportunity to receive the corresponding source of your version by providing access to the corresponding source from a network server at no charge, through some standard or customary means of facilitating copying of software. this corresponding source shall include the corresponding source for any work covered by version 3 of the gnu general public license that is incorporated pursuant to the following paragraph. notwithstanding any other provision of this license, you have permission to link or combine any covered work with a work licensed under version 3 of the gnu general public license into a single combined work, and to convey the resulting work. the terms of this license will continue to apply to the part which is the covered work, but the work with which it is combined will remain governed by version 3 of the gnu general public license. 14. revised versions of this license the free software foundation may publish revised and/or new versions of the gnu affero general public license from time to time. such new versions will be similar in spirit to the present version, but may differ in detail to address new problems or concerns. each version is given a distinguishing version number. if the program specifies that a certain numbered version of the gnu affero general public license “or any later version” applies to it, you have the option of following the terms and conditions either of that numbered version or of any later version published by the free software foundation. if the program does not specify a version number of the gnu affero general public license, you may choose any version ever published by the free software foundation. if the program specifies that a proxy can decide which future versions of the gnu affero general public license can be used, that proxy’s public statement of acceptance of a version permanently authorizes you to choose that version for the program. later license versions may give you additional or different permissions. however, no additional obligations are imposed on any author or copyright holder as a result of your choosing to follow a later version. 15. disclaimer of warranty there is no warranty for the program, to the extent permitted by applicable law. except when otherwise stated in writing the copyright holders and/or other parties provide the program “as nordic journal of commercial law issue 2009#1 101 is” without warranty of any kind, either expressed or implied, including, but not limited to, the implied warranties of merchantability and fitness for a particular purpose. the entire risk as to the quality and performance of the program is with you. should the program prove defective, you assume the cost of all necessary servicing, repair or correction. 16. limitation of liability in no event unless required by applicable law or agreed to in writing will any copyright holder, or any other party who modifies and/or conveys the program as permitted above, be liable to you for damages, including any general, special, incidental or consequential damages arising out of the use or inability to use the program (including but not limited to loss of data or data being rendered inaccurate or losses sustained by you or third parties or a failure of the program to operate with any other programs), even if such holder or other party has been advised of the possibility of such damages. 17. interpretation of sections 15 and 16 if the disclaimer of warranty and limitation of liability provided above cannot be given local legal effect according to their terms, reviewing courts shall apply local law that most closely approximates an absolute waiver of all civil liability in connection with the program, unless a warranty or assumption of liability accompanies a copy of the program in return for a fee. end of terms and conditions how to apply these terms to your new programs if you develop a new program, and you want it to be of the greatest possible use to the public, the best way to achieve this is to make it free software which everyone can redistribute and change under these terms. to do so, attach the following notices to the program. it is safest to attach them to the start of each source file to most effectively state the exclusion of warranty; and each file should have at least the “copyright” line and a pointer to where the full notice is found. <one line to give the program’s name and a brief idea of what it does.> copyright (c) <year> <name of author> nordic journal of commercial law issue 2009#1 102 this program is free software: you can redistribute it and/or modify it under the terms of the gnu affero general public license as published by the free software foundation, either version 3 of the license, or (at your option) any later version. this program is distributed in the hope that it will be useful, but without any warranty; without even the implied warranty of merchantability or fitness for a particular purpose. see the gnu affero general public license for more details. you should have received a copy of the gnu affero general public license along with this program. if not, see <http://www.gnu.org/licenses/>. also add information on how to contact you by electronic and paper mail. if your software can interact with users remotely through a computer network, you should also make sure that it provides a way for users to get its source. for example, if your program is a web application, its interface could display a “source” link that leads users to an archive of the code. there are many ways you could offer source, and different solutions will be better for different programs; see section 13 for the specific requirements. you should also get your employer (if you work as a programmer) or school, if any, to sign a “copyright disclaimer” for the program, if necessary. for more information on this, and how to apply and follow the gnu agpl, see <http://www.gnu.org/licenses/>. bibliography literature aarnio 1989 aarnio, aulis. laintulkinnan teoria. yleisen oikeustieteen oppikirja. porvoo: wsoy, 1989. ang 1994 ang, steven. “the idea-expression dichotomy and merger doctrine in the copyright laws of the u.s. and the 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an electronic lexical database, edited by christiane fellbaum. princeton, nj: princeton university, 2006. available: http://wordnet.princeton.edu/perl/webwn?s=library. working group on libre software 2000 working group on libre software. free software / open source: information society opportunities for europe? information society and media directorate-general, 2000. available: http://eu.conecta.it/paper.pdf. table of cases european union case t-201/04 r microsoft corporation v commission of the european communities [2004] ecr ii-4463 71 finland kko 1998:91 17, 50 kko 1999:115 43, 50 kko 2007:63 50 kko 2008:45 47, 68 helho 28.12.1999 3571, record no. r99/661 63 helho 14.6.2007 1963, record no. s06/2434 61 helho 22.5.2008 1427, record no. r07/2622 36 rho 13.10.1992 1128, record no. r91/351 62 vho 17.5.2005 712, record no. r03/1245 66, 68, 71 germany landgericht frankfurt am main, record no. 26 o 224/06 47, 63 landgericht münchen i, record no. 21 o 6123/04 47 http://gpl-violations.org/news/20060922-dlink-judgement_frankfurt.html http://gpl-violations.org/ http://wordnet.princeton.edu/perl/webwn?s=library. http://eu.conecta.it/paper.pdf. nordic journal of commercial law issue 2009#1 119 united kingdom cantor fitzgerald international v tradition (uk) ltd [2000] rpc 95 66, 70 ibcos computers ltd v barclays mercantile highland finance ltd [1994] fsr 275 65, 70 nova productions ltd v mazooma games ltd and bell fruit games ltd [2007] ewca civ. 219 70 united states of america brower v gateway 2000, inc., 676 n.y.s.2d 569 (n.y. app. div. 1998) 7 computer associates international, inc. v altai, inc., 982 f.2d 693 (2nd cir. 1992) 64, 67, 70 jacobsen v katzer, 535 f.3d 1373 (fed. cir. 2008) 24, 57 lewis galoob toys, inc. v nintendo of america, inc., 964 f.2d 965 (9th cir. 1992) 79 micro star v formgen inc., 154 f.3d 1107 (9th cir. 1998) 78, 79, 84 procd, inc. v zeidenberg, 86 f.3d 1447 (7th cir. 1996) 7 progress software corporation v mysql ab, 195 f. supp. 2d 328 (d. mass. 2002) 49, 78 whelan associates, inc. v jaslow dental laboratory, inc., 797 f.2d 1222 (3rd cir. 1986) 64, 70 6. abbreviations agpl = gnu affero general public license asp = application service provider c. = chapter [of statutes] ch. = chapter com = commission document for other institutions cvs = concurrent versions system dcfr = draft common frame of reference dd = discussion draft dmca = digital millennium copyright act drm = digital rights management ec = european community ecr = european court reports eec = european economic community eesc = european economic and social committee epc = convention on the grant of european patents (european patent convention) nordic journal of commercial law issue 2009#1 120 epo = european patent office eu = european union europarl = european parliament ev = response of parliament ewca = court of appeal of england and wales ff. = following fn. = footnote [external to the thesis] fsf = free software foundation, inc. fsr = fleet street reports he = government proposal helho = helsinki court of appeal ipr = intellectual property rights it = information technology lavm = report of the law committee lgpl = gnu lesser general public license gcc = gnu compiler collection gnu = gnu’s not unix [recursive acronym] gpl = gnu general public license gui = graphical user interface kko = supreme court of finland km = report of a commission mfn = most favoured nation n. = footnote [internal to the thesis] n.d. = no date nda = non-disclosure agreement no. = number nrc = national research council osi = open source initiative para. = paragraph prh = national board of patents and registration of finland rho = rovaniemi court of appeal rom = read-only memory rpc = reports of patent cases nordic journal of commercial law issue 2009#1 121 s. = section saas = software as a service sde = software development environment sops = treaty series of the statute book of finland sou = swedish government official reports sub-s. = subsection suvm = report of the grand committee syn = cooperation procedure trips = agreement on trade-related aspects of intellectual property rights uk = united kingdom of great britain and northern ireland unidroit = international institute for the unification of private law us = united states usc = united states code v = version; versus vho = vaasa court of appeal vp = parliamentary session wct = wipo copyright treaty wipo = world intellectual property organization zeller precontractual damages 1 precontractual damages as a result of an irrevocable offer – a resolution within the cisg bruno zeller* and robert walters** * bruno zeller, b. com, b. ed, master of international trade law (deakin), ph.d (the university of melbourne). professor of transnational commercial law, university of western australia. adjunct professor murdoch university and sir zelman cowen centre, victoria university, melbourne. ** robert walters llb (victoria), mppm (monash), ph.d law (victoria), lecturer victoria law school, victoria university, melbourne, adjunct professor, european faculty of law, the new university, slovenia, europe. 1. introduction .................................................................................... 34 2. equitable estoppel a brief analysis .................................... 39 3. article 16 the discussion .......................................................... 42 3.1. article 16 ................................................................................. 44 3.2. article 4 ................................................................................... 45 4. conclusion ......................................................................................... 50 njcl 2020/1 34 abstract this paper is written in response to the arguments that have been put forward by anne rossen, maria pedersen, and thomas neumann, titled “how far does the dynamic doctrine go? looking for the basis of precontractual liability in the cisg”. on the backdrop of this paper, it is worth noting that the united nations convention on contracts for the international sale of goods (cisg) is one of the most successful international commercial law treaties ever devised. it has been ratified by most of the world's important trading countries and has become a template for the drafting of commercial law treaties. the cisg is considered a self-executing treaty, as it creates a private right of action in federal court under federal law. it provides the default set of rules that govern contracts for the sale of goods between parties located in different contracting states. in some cases, the cisg also addresses situations in which only one of the parties is located in a contracting state. this article argues that the cisg can accommodate breaches of precontractual conditions through the same procedure applied to breaches of contract. it is a controversial issue but, nevertheless, it is arguable that the cisg can cover the internal gap via general principles embedded within its four corners. for this reason, this article will look at article 16(2). in particular, the following issues will be relevant: the revoking of an irrevocable offer; the effects of article 4; and the effects of articles 7177. 1. introduction this paper is written in response to the article “how far does the dynamic doctrine go? looking for the basis of precontractual liability in the cisg?”, by anne rossen, maria pedersen and thomas neuman.2 therefore, two preliminary points need to be raised in relation to article 16. first, article 16(2), once applied, creates a situation of reliance. secondly, the uncitral principles (upicc), in the 2016 edition, note that article 2.1.4 has been directly copied from the cisg. the comment points to the core problem of article 16 and, hence, article 2.1.4, upicc, by noting that there is no prospect of reconciling the civil and common law divide on this issue. thus, the main rule is included, followed by the 2 anne rossen, maria pedersen,thomas neuman, ‘how far does the dynamic doctrine go? looking for the basis of precontractual liability in the cisg?’ [2020] nordic journal of commercial law 1. 35 precontractual damages exception.3 it follows that there is a strong argument to suggest that, in retaining the article, upicc must have recognised its importance and usefulness, and has seen the need to harmonise the law on this issue. this importance is highlighted by the fact that the differences among underlying legal traditions are, on this issue, irreconcilable. another issue is relevant. namely, the argument presented by rossen et all that “ it would be wrong to let the cisg expand in scope and to reintroduce such issues into the cisg. expanding the scope of the cisg to encompass precontractual liability may, therefore, be ’overstepping the spirit of the international consensus’” 4 two points are to be made. firstly, article 7(2) “itself implies, by referring to general principles on which the convention is based, that it is admissible to go beyond the text itself”.5 the second point to be made is that, though international consensus is the driving force in the construction and interpretation of the cisg, many issues, such as penalty clauses and the interpretive methodology in article 8 are not based on consensus. rather, many principles are either based on common law or civil law. hence, a choice had to be made. consensus is not the issue; it is harmonisation of sales laws which is the important point. comments made by kastely in 1988 are still important. namely: “the text of the convention seeks to establish, in short, a rhetorical community in which readers first assent to the language and values of the text itself, and then use language and values to inform their relations with one another”.6 upicc is clearly demonstrating that assent to values as contained in the text leads to harmonisation of transnational contract law. the text of upicc also demonstrates that harmonisation is the aim of drafting a transnational instrument. consensus between transnational law instruments is only possible though harmonisation. therefore, whenever possible, issues must be decided within the cisg and the otherwise governing domestic law must be the last resort. after all, consensus is a compromise between different views, which is the point in the debate on article 16. hence, the consensus must be cisg-based and not civil or common law-based, which, in the execution, produces different results. 7 3 unidroit principles 2016, international institute for the unification of private law, 39. 4 rossen et al how far (n 2) 10. 5gert brandner, admissibility of analogy in gap-filling under the cisg, http://cisg.law.pace.edu/cisgbiblio/brandner.html (accessed 4 june 2020). 6 amy kastely, ‘unification and community: a rhetorical analysis of the united nations sales convention’, [1988] northwestern journal of international law and business 574. 7 rossen et al how far (n 2) 11-12. njcl 2020/1 36 the ideal outcome of any business negotiations should be the successful completion of a contact. however, not all negotiations culminate in the creation of a binding contract. business negotiations can be classified into three stages: the first stage involves preliminary negotiations in which each party feels free to withdraw, the second stage in which agreement 'in principle' has been reached, and the third where that agreement often being expressed in a 'letter of intent' and a stage in which the contract is complete.8 the question is: at what stage do legal obligations arise? two points are clear. first, no legal obligations are expected to arise in the stage of preliminary negotiations. second, once the third stage is reached that is, a contract is completed -, a legal relationship has been concluded. however, at the second stage where the parties anticipate the signing of a contract and all activities are directed towards the performance of the intended economic activity, the matter becomes unclear.9 the problem is that “[…] the parties are no longer strangers to each other as presumed by tort law, nor are they parties to a contract which contract law requires to trigger all the rights and duties […]”.10 rossen et al, in their excellent paper, argue that “the convention is generally not able to deal with all situations of precontractual liability as the legal grounds for allowing it is too erratic. for situations not covered by art. 16, one must therefore rely on the otherwise applicable domestic law.”11 this paper argues that the cisg does cover this issue, as the solution is to be found in the application of the general principle of recovery of damages. moreover, it is undisputed that, in general, the issue is one of the legal treatments of an offer. there is no doubt that legal obligations arise once an offer is made. the cisg, in part ii, sets out requirements in relation to an offer in articles 14 to 18. in essence, the rule of the cisg is that an offer, once accepted, generates the legal obligations of a contract. it also clearly regulates the issues surrounding the validity of an offer that is, either acceptance or revocation. article 16(2)(a), however, treats an irrevocable offer differently. simply put, it can only be revoked by the 8 michael spence, protecting reliance: the emergent doctrine of equitable estoppel. (bloomsbury, 1999) 83. 9 bruno zeller, protecting reliance: equitable estoppel and the cisg – a comparative analysis [2007] 9 european journal of law reform 4, 641. 10 ingeborg schwenzer, pascal hachem and christoffer kee, global sales and contract law (oxford university press 2012) 275. 11 rossen et al how far (n 2) 31. 37 precontractual damages buyer, either through rejection or lapse of time. the seller, during the stipulated period, is bound by the offer. an interesting problem arises when the buyer, during the fixed period of the offer, incurred costs in preparation of the acceptance or rejection as the case might be. if the buyer rejected the offer, that would be the end of the matter, but if the seller withdraws the offer, a problem does arise. namely, the seller is in breach of article 16 revoking an irrevocable offer. the question of damages is now an issue. however, it must be noted that it is obvious that, if no damages have accrued, there is only a moral breach, which is not discussed in this paper. nonetheless, as malik noted already in 1985, this issue is a controversial one. the controversy arises from the fact that “the issue is treated in a different manner in different legal systems. in some legal systems (e.g., english) an offer is generally revocable, while in some others (e.g., german and swiss) it is irrevocable. to further complicate the issue there are number of countries whose legal systems evidence a middle course between revocability and irrevocability of offers (e.g., french, and u.c.c. to a certain extent).” 12 nonetheless, article 16 of the cisg has accepted the compromise rule on the issue of irrevocable offers. the issue, therefore, concerns what will happen if an irrevocable offer has been revoked. it is clear that there is a breach, as a rule has been broken. the simple point is that the very inclusion of article 16 produces a situation where a right has been created and no remedy has been provided. more importantly, one fact that is indisputable has been outlined by malik, who argues the revocation of an irrevocable offer is a legal nullity. hence, “[t]he offeree may ignore the ‘revocation’ and communicate his acceptance to conclude the contract and in the event of non-performance, proceed to claim damages”.13therefore, the “nullity” is founded on the fact that article 16(2) mandates that the offer cannot be revoked. the fact that the offeree is entitled to accept the offer is thus undisputed. the alternative is that the buyer might not wish to conclude the contract for whatever reasons he might have but, rather, sue on the breach of article 16. it will be argued that, because of the two choices a buyer has, both must be governed by the cisg and not the otherwise governing law. the question in this case regards how an aggrieved party can seek redress, 12 shahdeen malik, offer: revocable or irrevocable. will art. 16 of the convention on contracts for the international sale ensure uniformity? (http://www.cisg.law.pace.edu/cisg/biblio/malik.html (accessed 2 june 2020). 13 malik (n 14). njcl 2020/1 38 specifically if they have incurred losses, such as preparation of plans for the installment of a machine. the problem of how damages can be obtained within the cisg or whether the matter must be resolved by the otherwise governing law is the first issue to be resolved. the otherwise governing laws are only applicable if there is a gap in the cisg or if the cisg explicitly excluded its application. “given the invitation to courts to fill in the gaps in the cisg by reference to its underlying principles and to interpret its provisions in a manner that promotes good faith in international trade, this leaves open the possibility that such terms could be construed quite broadly.”14 hence, the problem which needs to be overcome is whether article 4 along with articles 71 to 77 are applicable. the buyer, in essence, has incurred the losses in good faith. a comparative solution was offered by the supreme court in denmark. the court elicited a general principle found not only in article 16(2)(b) but also in cases where the seller rejected a valid fundamental breach, thereby giving weight to the fact that the issue of damages extends beyond breaches of contract, also touching upon precontractual issues. the court noted: but as the seller had unjustifiably refused to accept the buyer's avoidance, the buyer was entitled to revoke its avoidance in accordance with cisg general principles, articles 7(2) and 16(2)(b) cisg. the buyer was then entitled to repair the machine and recover damages for the expenses incurred, article 74 cisg.15 professor lookofsky, in his editorial remarks, referred to the comments of professor schlechtriem, who noted: “professor schlechtriem has persuasively argued that the ‘matter’ of whether a declaration of avoidance is binding upon the declaring party is "governed but not settled" by the convention and that "estoppel," a cisg general principle, can be used to ‘settle’ it.”16 the question, therefore, is whether the expectation interest which can be recouped under article 74 is unquestionably applicable also in cases of precontractual breaches. as noted above, in common law, a party can 14 donald j. smythe, ‘the road to nowhere: caterpillar v. usinor and cisg claims by downstream buyers against remote sellers’, 2 geo. mason j. journal of international commercial law, (2011) 143. 15 djakhongir saidov, research handbook on international and comparative sale of goods law, https://iicl.law.pace.edu/cisg/case/denmark-h%c3%b8jesteret-supremecourt-denmark (accessed 2 june 2020). 16 saidov (n 17). 39 precontractual damages rely on the principle of equitable estoppel. however, as schlechtriem noted, “estoppel” is a general principle under the cisg, it is important to understand in brief the meaning of estoppel in common law. the importance is that schlechtriem certainly did not have in mind that common law estoppel is to be used in cisg cases. no doubt, he merely referred to a principle which has no actual ‘name’ in the cisg but, for simplicity sake, can be referred to as having the same effect as the common law estoppel. this paper therefore will provide a brief analysis of the common law principle of equitable estoppel in part ii, followed by part iii, where the applicability of the cisg in relation to governing precontractual liability is discussed. part iv will conclude the paper. 2. equitable estoppel a brief analysis simply put, equity supplements the common law, providing a separate and distinct body of principle that mitigates its rigours. in legione v hateley,17 mason and deane jj identified three general classes of estoppel: estoppel of record, estoppel of writing, and estoppel in pais, which they described in the following terms: “estoppel in pais includes both the common law estoppel which precludes a person from denying an assumption which formed the conventional basis of a relationship between himself and another or which he has adopted against another by the assertion of a right based on it and estoppel by representation which was of later development with origins in chancery. it is commonly regarded as also including the overlapping equitable doctrines of proprietary estoppel and estoppel by acquiescence or encouragement”.18 however, brennan j stated the problem in the following way: “...the unconscionable conduct which gives rise to the equity [is] the leaving of another to suffer detriment occasioned by the conduct of the party against whom the equity is raised.”19 spence, in essence, noted four conditions which must be established before a party can rely on estoppel. first, a representation is made; second, the aggrieved party relies on the representation; third, the party is worse off. fourth, it would be unconscionable for the representor to go back on 17 legione v. hateley 1983 152 clr 406. high court of australia. 18 legione v. hateley 1983 152 clr 406. high court of australia, [430]. 19 waltons stores (interstate) ltd. v. maher (1988) 164 clr 387, at 427. australian high court. njcl 2020/1 40 his promise without compensation.20 of interest is the decision in verwayen, where the court noted that a promissory estoppel is also “applicable to parties in a pre-contractual relationship."21 in this context, british steel corporation v. cleveland bridge and engineering co ltd22 is also of interest. the facts are simple. an engineering company was asked to fabricate steel constructions suitable for a building. the plaintiffs were iron and steel manufacturers. the defendant, cleveland bridge, approached the plaintiff to produce a variety of cast-steel nodes for the project. cleveland bridge subsequently sent a letter of intent to the plaintiff, british steel. in that letter, they indicated that a contract was to be concluded. the terms to be agreed upon were included in the defendant's standard form contract. furthermore, cleveland bridge requested british steel to commence work immediately, "pending the preparation and issuing to you of the official form of sub-contract.”23 goff j noted: “in most cases, where work is done pursuant to a request contained in a letter of intent, it will not matter whether a contract did or did not come into existence, because, if the party who acted on the request is simply claiming payment, his claim will usually be based on a quantum meruit, and it will make no difference whether that claim is contractual or quasi-contractual.”24 there was no formal contract concluded but, in this case, the defendant insisted on the manufacture of nodes. arguably, the fact that work was done either with the knowledge or implied knowledge of the defendant would not have made any difference. hence, by analogy, the situation could have been the same as under article 16. two arguments are possible. first, as spence observed, a claim for precontractual performance was successful because the court assumed that there was an implied contract collateral to the one which was the subject of the negotiations.25 the second argument is based on the fact that compensation is possible, as it relies on a contract-like doctrine which 20 michael spence, protecting reliance: the emergent doctrine of equitable estoppelbloomsbury, 1999). chapters. 2 & 3. 21 commonwealth v. verwayen (1990) 170 clr 394, [454]. 22 british steel corporation v. cleveland bridge and engineering co ltd [1984] 1 all er [504]. 23 british steel corporation [504]. 24 british steel corporation [510]. 25 michael spence, (n 22) 90. 41 precontractual damages is concerned with fulfilling the parties' reasonable expectations.26 the expectation is founded on the principle of quasi-contracts: “the court will look at the true facts and ascertain from them whether or not a promise to pay should be implied, irrespective of the actual views of intention of the parties at the time when the work was done, or the service rendered.”27 arguably, the cisg does not include a principle of quasi-contract, as, first, the principle of consideration is not part of the cisg, and, second, article 8 would resolve the issue of the actual intent of the parties. the argument is best put by the federal district court [new york] noting: “the fact that article 16(2)(b) appears to employ a modified version of promissory estoppel suggests that if a plaintiff were to bring a promissory estoppel claim to avoid the need to prove the existence of a ‘firm offer’, that claim would be pre-empted by the cisg. the cisg establishes a modified version of promissory estoppel that does not appear to require foreseeability or detriment, and to apply an american or other version of promissory estoppel that does require those elements would contradict the cisg and stymie its goal of uniformity”.28 a further us case29 demonstrates the difficulty in deciding the issue of whether equitable estoppel once pleaded ought to be entertained when there is a breach of article 16. in the end, the court decided to follow geneva pharmaceuticals tech. corp and in maintaining that the cisg will deal with the issue and not caterpillar, inc. v. usinor industeel.30 based on the above and in summary, it is clear that the cisg can only govern business relationships which are founded on a contractual relationship. this is made abundantly clear in article 4 and 71 to 77. by the same token, it can also be seen that the cisg, in essence, embraces the general thought behind equitable estoppel – namely, the principle of good faith as noted in article 7(1) – and, arguably, the reasoning behind article 16 in the cisg and article 2.1.4 in the unidroit principles 26 spence (n 27) 90. 27 william lacey (hounslow) ltd., v. davies, [1957] 2 all e.r. 712, at 718. 28 pharmaceuticals tech. corp. v. barr labs. inc nos. 98 civ. 861 (rws) and 99 civ. 3607 (rws), (s.d.n.y. sep. 27, 2002) 29 asia telco technologies v. brightstar int'l corp. u.s. district court for the southern district of florida , 15-20608-civ-scola. 30 caterpillar, inc. v. usinor industeel 393 f. supp. 2d 659, (n.d. ill) [676]. njcl 2020/1 42 (upicc). a powerful argument, as advocated by schlechtriem,31 is that the cisg, through the notion of good faith, has embedded into the convention that unconscionable conduct in any form results in a breach and is governed by the cisg unless explicitly excluded. in other words, if a particular issue is not explicitly excluded, the starting point of any discussion or analysis must be that the cisg governs the issue. any discussion must also be aware of the requirements set out in article 16(2) which states "reflects the judgment … that in commercial relations, and particularly in international commercial relations, the offeree should be able to rely on any statement by the offeror which indicates that the offer will be open for a period of time."32 3. article 16 the discussion to start with, it is interesting to note that honnold predicted that article 16 of the cisg would lead to an interpretation challenge. he pointed to the crucial issue – namely, that the cisg certainly governs the revocation of offers but, because the cisg only governs breaches of contracts, the remedies available under the cisg only pertain to breaches of contract and not breaches of article 16.33 not surprisingly, some academics argue that any damage emanating from a breach of article 16 is outside the sphere of the cisg. the criticism was based on a russian arbitral decision where the court stated: “in accordance with article 7 cisg and the requirements of ‘observance of good faith in international trade' the international arbitration practice has concluded to apply to contracts for international sales the anglo-american principle of estoppel.”34 although this decision is dated, it was not a correct application of the cisg, as it is established and contained within article 7 that 31 see schlechtriem in schlechtriem & schwenzer, commentary, art. 27, para. 14; accord müller-chen, id., art.45, para. 15(bb). 32 secretariat commentary cmt. http://www.cisg.law.pace.edu/cisg/text/secomm/secomm-i 6.html (accessed 5 june 2020). 33 john honnold, uniform law for international sales under the 1980 united nations convention (kluwer law and taxation publishers, 1991), 212. 34 russia, tribunal of international commercial arbitration at the russian federation chamber of commerce and industry, case no 302/1996, 27 july 1999, http://cisgw3.law.pace.edu/cases/990727rl.html (accessed 5 june 2020). 43 precontractual damages domestic principles cannot be applied to a contract governed by the cisg. this was confirmed in caterpillar v usinor industeel,35 where the court stated that "the cisg pre-empts plaintiff's ucc and promissory estoppel claims only if such claims fall within the scope of the cisg."'36 the crucial issue in the cisg always hinges around the intent of the parties, bringing article 8 into play. the question is whether the influence of article 8 can be extended to include the interpretation of precontractual duties. considering that article 8 requires the parties to be aware of their intentions, a contract is not only interpreted in an objective fashion but also with the subjective intent of the parties in mind. thus, certain pre-contractual duties must be drawn within the sphere of application of the cisg. schlechtriem argues that pre-contractual duties compel the parties to disclose relevant information to each other; specifically, matters which pertain to conditions or conformity of goods.37 that said, it can be argued that article 8 only comes into play if article 16(2)(b) is pleaded that is, if an implied time is fixed. however, with the increased use of the cisg, a mature view of the ability and breadth of application of the cisg has been developed. this paper rejects the idea that the drafting history carries weight in the interpretation of the cisg, as if it were essentially “frozen in time”. rather, the cisg is a living document38 and moves with the time. with the increased use and practical experience, new insights are gained, “therefore, what the drafters discussed may generally carry little weight when assessing the understanding and extent of good faith39, and other relevant sources must be consulted.”40 hence, a look at the problem using sources within the cisg – of article 16 needs to be examined again. 35 caterpillar, inc. and caterpillar mexico, s.a. v. usinor industeel, usinor industeel (u.s.a.), inc. and leeco steel products, inc., us dist ct (illinois), 30 march 2005, http://cisgw3.law.pace. edu/cases/050330ul.html, cisg-online no 1007. 36 ibid. 37 p. schlechtriem, ‘intro to arts. 14-24’, in p. schlecht'iem & i. schwenzer (eds.) commentary on the un convention on the international sale of goods (cisg) (oxford university press, 2005), para 6b. 38 bruno zeller, ‘the observance of good faith in international trade’ in andré janssen and olaf meyer, cisg methodology (sellier. european law publishers, 2009) 138. 39 ibid. 40 rossen et al how far (n 2) 16. njcl 2020/1 44 3.1. article 16 the starting point needs to be article 16 which states: (1) until a contract is concluded an offer may be revoked if the revocation reaches the offeree before he has dispatched an acceptance. (2) however, an offer cannot be revoked: (a) if it indicates, whether by stating a fixed time for acceptance or otherwise, that it is irrevocable; or (b) if it was reasonable for the offeree to rely on the offer as being irrevocable and the offeree has acted in reliance on the offer. as far as irrevocable offers are concerned, article 16 is usefully divided into two segments. first, subsection (2)(a) notes that an offer cannot be revoked if it states a fixed time for acceptance. the offeror does not need to do this expressly but, rather, his intent to be bound can be deduced from the circumstances relevant to the interpretation of the offer and, particularly, from his setting a fixed period during which the offer is open (article 16(2)(a)).41 secondly, the offer also cannot be revoked if “it was reasonable for the offeree to rely on the offer as being irrevocable and the offeree has acted in reliance on the offer.”42 it is obvious that the words “cannot be revoked” denotes a right and, hence, it also requires remedies to safeguard that right. the provision is designed to cover those cases in which not just the offer itself but other conduct by the offeror or the special circumstances and exigencies of the proposed transaction enable and necessitate the offeree's presumption that the offer would be valid for a certain length of time, such as when calculations or cover transactions had to be and actually were made. the starting point is the seminal case of geneva pharmaceuticals v. barr labs. inc.43, which ruled specifically on article 16(2)(b). the court noted that “commentary on the cisg has not specifically addressed the issue 41 ibid. 42 article 16(2)(b). 43 geneva pharmaceuticals technology corp. v. barr laboratories, inc, u.s. district court for the southern district of new york, may 2002 case no./docket no.99civ3607(rws). 45 precontractual damages of whether it should preclude a claim for promissory estoppel.”44 in addition, a commentary by henry mather was noted, namely: “paragraph 2(b) looks very much like american promissory estoppel doctrines, although it does not expressly require that the offeree's reliance must have been foreseeable to the offeror and does not expressly require that the offeree's reliance be detrimental. despite these omissions, we can expect that many tribunals will apply paragraph 2(b) in much the same fashion as american courts have used promissory estoppel”.45 the problem with this observation was that it encouraged the homeward trend which is specifically disallowed in article 7. however, the court recognised the error and stated: “the cisg establishes a modified version of promissory estoppel that does not appear to require foreseeability or detriment, and to apply an american or other version of promissory estoppel that does require those elements would contradict the cisg and stymie its goal of uniformity”.46 the subparagraph (2)(b) must be read in conjunction with article 8, establishing that the intentions of the parties will determine whether it was reasonable for the offeree to rely on the offer as being irrevocable. thus, the facts in each case would determine whether the reasonable person would have assumed that an offer is irrevocable. the issue which appears to be unresolved, therefore, is whether the cisg excludes any form of precontractual liability from its scope. put differently, whether the gap which is evident – can be filled by general principles or whether there is a need to rely on the otherwise applicable domestic law. 3.2. article 4 article 4 only governs the formation of the contract and the rights and obligations of the seller and buyer arising from such a contract. because article 4 governs the formation of the contract, article 16 forms part of the process of forming a contract. hence, embedded in article 16, is that a fixed time, when the offer is irrevocable, forms part of the formation of contract and, therefore, is governed by the cisg. this is not controversial; it is obvious. however, when there is a breach of article 16, the question is whether this is still within the sphere of the cisg. this 44 ibid. 45 henry mather, ‘firm offers under the ucc and the cisg’, 105 dick. l.rev. 31, 48. 46 geneva (n 43). njcl 2020/1 46 paper argues that this question is part of article 4, as the breach has been committed within the stage of contract formation and, hence, article 4 is not applicable that is, article 4 does not mandate that a revocation of a fixed term needs to be governed by the otherwise applicable law. rossen et all agree on this point, as they note that it “cannot be concluded that precontractual liability is excluded from the scope of the convention merely from the wording of art. 4 and the wording ‘formation of contract’.”47 it is argued that the cisg can fill the gap as, in essence, a contract has been formed, as there was an offer of a fixed time and an acceptance, and no revocation is present. it is further argued that the first contract then can be subsumed into the formal contract of delivery of goods. in english common law, a fixed term is only valid if it is supported by consideration. in essence, an offer has been made which has been accepted and is supported by consideration. the same argument can be applied in relation to the cisg. as the cisg does not require consideration, only an offer and an acceptance are required in order to support a fixed term. the offer not only concerns the supply of goods it is also, by implication, providing a fixed time in which the offer must be accepted or rejected. the point is that there is no material difference between article 16(1) and (2). subsection 2 follows the general principle that the conduct of a party to the contract can be relied upon as noted in article 8. in the case of article 16, this principle is reinforced by article 9(2) which builds on article 8 and notes: (2) the parties are considered, unless otherwise agreed, to have impliedly made applicable to their contract or its formation a usage of which the parties knew or ought to have known and which in international trade is widely known to, and regularly observed by, parties to contracts of the type involved in the particular trade concerned. the usage in question is article 16 namely, the irrevocable offer. it is argued that, if the offer is not a precondition to the actual offer, why draw a distinction between an actual or implied event, as noted by the two subsections? as malik has noted, the revocation of an irrevocable offer is a legal nullity.48 this is so as the offer is irrevocable. hence, revocation is not possible without a remedy. it follows therefore that the aggrieved party can accept the offer within the allocated time and subsequently 47 rossen et al how far (n 2) 7. 48 malik (n 14) 2. 47 precontractual damages enliven, if necessary, the breach regulations within the convention. in essence, an implied contract has been created by article 16(2) and acceptance closes the circle. as the breaching of article 16 is a nullity the contract is still afoot, and the question of beach and remedies must be addressed. 3.3 breach and remedies for damages it is clear that a breach of article 16(2) is not a breach of a contract of sale, but a contract, as noted above. the issue, therefore, is whether articles 71 to 77, though not applicable, support a principle to claim damages for a breach of article 16. the principles underlying articles 71 and, more specifically, article 72(2) arguably support a remedy for a breach of article 16.49 article 71, as an example, states: (1) a party may suspend the performance of his obligations if, after the conclusion of the contract, it becomes apparent that the other party will not perform a substantial part of his obligations as a result of: (a) a serious deficiency in his ability to perform or in his creditworthiness; or (b) his conduct in preparing to perform or in performing the contract. however, this article is not relevant, as the aggrieved party namely the buyer is not in any position to suspend any performance. it is the seller who can suspend his performance, which is the breach of article 16. the argument in relation to anticipatory breach is somewhat different and, here, article 72(1) comes into play. it states: “(1) if prior to the date for performance of the contract it is clear that one of the parties will commit a fundamental breach of contract, the other party may declare the contract avoided”. on the backdrop of the above, the fact that the breaching party attempted to revoke the irrevocable offer makes it clear that the party has committed a fundamental breach. to repeat the argument above, an offer has been made – namely, the observance of a strict time limit -, and the 49 ibid. njcl 2020/1 48 seller has breached that undertaking, hence committing a fundamental breach before the buyer could accept the offer. therefore, he is deprived of a chance to gain income. the oberlandesgericht jena50 confirmed that a breach of article 16(2) is a fundamental breach pursuant to article 25 and damages relying on article 74 are allowed. simply put, performance must be widely interpreted, and the emphasis must be put on “prior to performance” as noted in article 72(1). logically, therefore, the right to damages is not dependent on a contract. the principle that can be derived from article 71 and 72 is that if a contract cannot be performed, the breaching party is liable to pay compensation that is, damages. a breach of article 16 also falls into the category that a contract cannot be made and, hence, by analogy, the effects are the same as if the contract had been performed. in other words, damages have accrued. it must be remembered that article 16 does not allow the seller to breach his undertaking. therefore, as noted above, the buyer can simply accept the offer. however, it would be irrational to ask the buyer to accept the contract first and then wait for the seller to breach the contract before he can sue for breach of contract. no doubt the cisg has not contemplated such an action, as it is fraught with danger. hence, in relation to recovering the losses, the same principles as discussed above apply. namely, that the aggrieved party can rely on principles contained in article 81(2), which notes: “(2) a party who has performed the contract either wholly or in part may claim restitution from the other party of whatever the first party has supplied or paid under the contract. if both parties are bound to make restitution, they must do so concurrently”. the aggrieved party has indeed performed a preliminary part in the overall obligation if money is spent in preparation of the acceptance. hence, article 81 is applicable. it needs to be noted again that the party who performs preliminary but essential parts of a contract is the party who does so in reliance of its ability to accept the contract. in addition, article 74 is not negatively affecting the ability to ask for damages in case of a breach of article 16. schlechtriem notes that damages are always monetary compensation in accordance with article 74 (1). moreover, the loss to the party affected must have been caused by the other party's breach, whether this was a result of a late or non-conforming 50 mitec automotive ag v. ford motor company, 5 u 1042/12, december 8, 2015. 49 precontractual damages performance or a result of no performance at all. he goes on to say that the only damages that must be compensated are those which the party in breach foresaw or ought to have foreseen at the time of the conclusion of the contract. thus, the reason is that a “breach” must be interpreted within the four corners of the cisg. one important issue is that interpretation cannot be executed without taking note of article 7 and, in this case, the principle of good faith is applicable. it is certainly a breach of good faith to cancel an irrevocable offer upon which the other party, relying on its mandatory character, incurred expenses. the effects of breaching a contract are not dissimilar, in character, to breaching article 16. in both cases, the affected party relied on the promise and, hence, any breach of a cisg article is, in nature, the same. rosenberg et al also commented that the convention did intend to govern breaches of article 16(2) and that “the principle underlying article 74 (that damages be available to the innocent party) should enable the buyer to recover damages fort its reliance expenditure.”51 therefore, article 74 becomes applicable, but only insofar as the damages do “not exceed the loss which the party in breach foresaw or ought to have foreseen” at the conclusion of the binding promise. whether it is the contract or article 16 is irrelevant. both are binding in character. thus, it is reasonable that only losses which are a direct consequence of the breach are claimable, thereby excluding loss of profit. in addition, upicc will also be useful in determining this issue. rossen et al also noted that “in this regard upicc, … provide helpful tools to fill out the missing details in the cisg, but only to the extent that such does not expand the scope of the cisg.”52 it is correct that missing details can be filled by taking recourse to upicc, but to argue that it cannot expand the scope is troublesome, as any clarification supplied by upicc will, in essence, widen the scope of the cisg. it must be noted that bergsten argued that upicc is “in many respects a further development of the cisg itself.”53 this is highlighted by the fact that upicc included, in essence, article 16 into their own regime. the question is why including a principle into the 2016 edition if the drafting history, as noted by rossen et al, was, to say the least, troubled in the drafting of article 16. it is a strong argument to suggest that the drafters of upicc did see a solution and did not simply copy a “mistake” 51 mark rosenberg, ‘the vienna convention: uniformity in interpretation for gapfilling – an analysis and application’, [1992] australian business law review 442, 460. 52 rossen et al how far (n 2) 30. 53 eric bergsten, in john felemegas (ed.) an international approach to the interpretation of the united nations convention of the contracts for the international sale of goods, ( cambridge, 2007), ix. njcl 2020/1 50 as this paper has demonstrated. the “mistake” would be to include a rule into the cisg which, in effect, needs to be referred to the otherwise governing law when it could have been simply left out. upicc included article 2.1.15 which supplies the answer. it notes: (1) a party is free to negotiate and is not liable for failure to reach an agreement. (2) however, a party who negotiates or breaks off negotiations in bad faith is liable for the losses caused to the other party. (3) it is bad faith, in particular, for a party to enter into or continue negotiations when intending not to reach an agreement with the other party. simply put, this article confirms the principle of freedom of contract but, at the same time, bad faith in breaking off negotiations like a breach of article 16 cisg or article 2.1.4 upicc. rossen et all did discuss the application of good faith at length. however, this paper, understanding the solution of upicc in relation to a fixed time, argues that, by analogy, the application of good faith, which is also contained in the cisg in conjunction with other arguments, will supply the answer. namely, a breach of article 16 can be resolved within the cisg, as upicc does not widen the scope but merely supplies a confirmation that good faith, in conjunction with other principles, can resolve the issue. this is in line with the fact that the general principle in the cisg is “‘contracting cost reduction, ‘which requires contracting parties to reduce the cost of executing and performing under cisg contracts.”54 4. conclusion it is obvious that article 4 is clear in noting that the cisg only governs “the formation of the contract of sale and the rights and obligations of the seller and the buyer arising from such a contract.” it is also clear that article 16 is only an offer and, hence, a contract has not been formed but, as malik argues, the revocation of an irrevocable offer is a legal nullity. therefore, “[t]he offeree may ignore the "revocation" and communicate his acceptance to conclude the contract and in the event of non-performance, proceed to claim damages. 55 any damages emanating from revoking the 54 steven d. walt, 'the modest role of good faith in the cisg' [2015]33 boston university international law journal 41. 55 malik, (n 14) n 2. 51 precontractual damages offer within the irrevocable time does not enliven articles 71 to 77, as these articles and others for that matter are only relevant upon breach of a contract. consequently, there are only two possible avenues for an aggrieved party that seeks to recoup their losses. first, to overcome this issue, it can rely on the otherwise applicable domestic law, which will fill the perceived gap. second, can rely on general principles within the cisg, which is the proper law to govern this issue. moreover, a breach of article 16 creates a nullity that is, a revocation of the offer is not permitted. this action therefore must be treated as it has not occurred. this leaves the option of accepting the offer open. to argue that the application of good faith might produce different results and, hence, bring uncertainties to the cisg56, is a dangerous argument, as good faith as noted in article 7 must be observed in the interpretation of the cisg. the breaching party has already indicated, by falsely revoking the irrevocable offer, that at least doubts as to their willingness to perform the contract are present. this brings article 72(1) into play and the aggrieved party can avoid the contract. after avoidance, article 81(2) will assist to recoup the losses, as the aggrieved party has partially performed the contract. this is indicated by the fact that the aggrieved party has incurred expenses which they would not have without the knowledge that they still have the option to accept.57 by treating the revocation as a nullity, all options as to a formation of the contract are opened and full compensation can be sought. arguably, this analysis is supported by the principle of good faith, as the aggrieved party would not have incurred expenses if they would have had any doubt as to the unwillingness of the other party to execute the contract. after all, having an irrevocable offer puts the offeree in a position to accept the offer and, hence, form a contract. in conclusion, the cisg is able to compensate an aggrieved party because the revocation of the offer still leaves the aggrieved party in a position to conclude the contract and, thereby, take full advantage of the cisg. hence, it does not have to rely on the otherwise governing law, as no gap exists. importantly, gap-filling specifically by upicc preserves “the advantage of uniform law: it avoids the dependency on the forum which allows the parties to know which law to applies.”58this is especially important in breaches of 56 rossen et al how far (n 2) 12. 57 it goes without saying that should they not accept the offer all expenses which they incurred cannot be recovered as no contract has been formed. 58 brandner admissibility of analogy (n 6). njcl 2020/1 52 article 16, as domestic law is divided on this issue and commercial certainty is achieved. lakiteksti6_lop.pmd nordic journal of commercial law, issue 2004 #1 1 comparison of cisg article 45/61 remedial provisions and counterpart pecl articles 8:101 and 8:102 liu chengwei* nordic journal of commercial law issue 2004 #1 nordic journal of commercial law, issue 2004 #1 2 a. remedies available to a party are a key consideration for that party, particularly if the contract is breached. however, issues relating to remedial provisions are difficult and central substantive issues have been the focus of a large part of the discussion and deliberation surrounding application of commercial law.1 at the same time, no aspect of a system of contract law is more revealing of its underlying assumptions than is the law that prescribes the relief available for breach of contract.2 it is where a system’s solutions to a large proportion of real world disputes in commercial transactions are to be found. in practical terms, it may be said that the remedial scheme is the substantive heart of a particular system of contract law, which will be a powerful support for the harmonization of actual outcomes and improve the reliability of the often unpredictable results of disputes.3 b. generally speaking, the remedies available to an aggrieved party for a breach of contract can in all significant legal systems be classified into three basic categories. -firstly, an aggrieved party may be able to claim specific performance. as such, specific perfor mance hardly gives the aggrieved party exactly the performance to which he was entitled to, unless it is supplemented with some kind of an additional remedy, such as monetary relief. -secondly, the aggrieved party may have the right to require substitutionary relief. a relevant relief here is compensation, and almost always a monetary compensation for the loss that the party has suffered for performance not received. -finally, the aggrieved party may have the right to put an end to the contractual relationship. in such a case, the third remedy can also be seen in that the aggrieved party is put into a position where he would have been had the contract never been made. the three categories are not exclusive in that monetary compensation will also very often be available together with a claim for specific performance and an act to put an end to the contract. furthermore, the above mentioned basic categories of remedies also appear in different variations, such as a right to price reduction and suspension of performance.4 c. the cisg follows the above mentioned three-category system. the remedies available for a breach of contract are summarized under the convention in arts. 45 and 61. these articles set forth reciprocal remedies for the buyer and seller for breach of contract. according to art. 45(1) which specifies remedies for breach of contract by the seller, in case of a seller’s non-compliance with a contract or cisg obligation, in principal the following five legal remedies (defects rights) are at the buyer’s disposal: right to performance (art. 46(1)); right to cure (art. 48); right to avoid the contract because of a fundamental breach of contract (art. 49(1)(a)); right of price reduction (art. 50, sentence 1); -right to damages (art. 45(1)(b) in connection with arts. 74-77).5 thus, art. 45 offers an over view of the remedies available to the buyer in the event of a breach — specific performance, avoidance, compensatory damages, and price reduction. in a parallel manner, the seller’s remedies are enumerated at art. 61(1) when the buyer is in default. although the remedies available to the seller under art. 61(1) are comparable to those available to the buyer under art. 45(1), they are less complicated. this is so because the buyer has only two principal obligations, to pay the price and to take delivery of the goods, whereas the seller’s obligations are more complex. therefore, the seller has no remedies comparable to the following which are available to the buyer: reduction of the price because of non-conformity of the goods (art. 50), right to partially exercise his remedies in the case of partial delivery of the goods (art. 51), and right to refuse to take deliver y in nordic journal of commercial law, issue 2004 #1 3 case of deliver y before the date fixed or of an excess quantity of goods (art. 52).6 d. under the convention the notion “breach of contract” covers all failures of a party to perform any of his obligations.7 the notion of breach of contract under the cisg comprises any non-fulfilment of contractual obligations. those obligations may have their origin not only in the contract between parties, but also in the convention, established practices and usages (art. 9). this refers to non-fulfilment of obligations by the seller and to non-performance of obligations by the buyer. the rights of the other party are provided for in parallel: compare art. 45 et seq. with art. 61 et seq. there is no distinction between breaches of main obligations or breaches of auxiliar y obligations, rather, a distinction is made between fundamental breaches of contract and other breaches of contract (art. 25). a breach of contract constitutes an objective fact; no matter whether the party who commits the breach is at fault or not.8 in other words, by contrast with the ulis approach where each individual type of breach was followed by the proper remedy, the cisg uses the uniform term of breach of contract, which under the cisg comprises any non-fulfilment of contractual obligations whether the party who commits the breach is at fault or not. e. this is true of the pecl, which also uses the unitary concept of non-performance (for the sake of simplicity, the term non-performance is used here equally to the cisg term breach) both for the excused and the non-excused non-performance. it is noted that non-performance as used in the pecl covers failure to perform an obligation under the contract in any way, whether by a complete failure to do anything, late performance or defective performance. furthermore, it covers both excused and nonexcused non-performance.9 on the other hand, according to pecl art. 8:101, the remedies available for non-performance depend upon whether the non-performance is not excused, is excused due to an impediment under art. 8:108 or results from behavior of the other party. a non-performance which is not excused may give the aggrieved party the right to claim performance — recover y of money due (art. 9:101) or specific performance (art. 9:102) — to claim damages and interest (arts. 9:501 through 9:510), to withhold its own performance (art. 9:201), to terminate the contract (arts. 9:301 through 9:309) and to reduce its own performance (art. 9:401). if a party violates a duty to receive or accept performance, the other party may also make use of the remedies just mentioned.10 thus, the pecl also generally corresponds with the major legal systems in providing the above mentioned threecategory remedial system. f. however, under certain conditions the breaching or non-performing party may be exempted from certain consequences of a failure to perform his obligations while the other remedies remain unaffected and are still available to the aggrieved party. textually, the excuse granted in art. 79 cisg exempts only the breaching party from liability for damages. all the other remedies of the other parties are not affected by this excuse, i.e., demand for performance, reduction of the price or avoidance of the contract.11 the secretariat commentary clearly states: “even if the impediment is of such a nature as to render impossible any further performance, the other party retains the right to require that performance under article 42 or 58 [draft counterpart of cisg article 46 or 62].”12 in other words, even in case of impossibility, the other party could ask for specific performance — a result that is hardly convincing.13 by contrast, pecl art. 8:101(2) specifies that where there is an impediment which fulfils the conditions set by pecl art. 8:108, the aggrieved party may resort to any of the remedies set out in pecl chapter 9 except claiming performance and damages. any form of specific performance (arts. 9:101 and 9:102) is by definition impossible.14 however, this rigid solution might lead to some unreasonable situations particularly in case of temporary impediments. although it seems to amount to an obvious contradiction because it is supposed that performance is not possible, it has become clear at least that the right to performance continues to exist in the event of temporary grounds for exemption and that auxiliary claims that are related to it, like interest, continue to accumulate.15 nordic journal of commercial law, issue 2004 #1 4 g. despite the exempted remedies difference, there is agreement between the cisg and the pecl that the fact that the non-performance is caused by the creditor’s act or omission has an effect to that extent on the remedies open to the obligee. this is expressed by either cisg art. 80 or pecl art. 8:101(3). it would be contrary to good faith and fairness for the creditor to have a remedy when it is responsible for the non-performance. in such a case, the most obvious situation is the so-called mora creditoris, where the creditor directly prevents performance (e.g., access refused to a building site). but there are other cases where the creditor’s behavior has an inf luence on the breach and its consequences. in other cases where there is also a non-performance by the debtor, the creditor may exercise the remedies for non-performance to a limited extent. when the loss is caused both by the debtor -which has not performed -and the creditor -which has partially caused the breach by its own behavior -the creditor should not have the whole range of remedies. the creditor’s contribution to the non-performance has an effect on the remedy “to the extent that (the other party’s) failure to perform (is) caused by its own act or omission.” in other words, this effect may be total, that is to say that the creditor cannot exercise any remedy, or partial. the exact consequence of the creditor’s behavior will be examined with each remedy.16 in any event, a non-performance which is due solely to the other party’s wrongful prevention does not give the latter any remedy. in most of the systems, the party who has prevented performance will himself be the non-performing party against whom the remedies may be exercised.17 h. among other things, it is to be noted that cisg art. 45(2)/61(2) provides that a party who resorts to any remedy available to him under the contract or this convention is not thereby deprived of the right to claim any damages which he may have incurred. thus, the cumulation of damage claims with other remedies is explicitly contemplated. in other words, either art. 45(2) or art. 61(2) rejects the notion that the buyer/seller is forced to elect between claiming damages and exercising the other remedies conferred on him under the convention, viz., specific performance and avoidance. the common law position is the same and, in particular, it is basic law that a buyer who rejects nonconforming goods or cancels the contract on some other ground is not thereby deprived of his entitlement to damages.18 thus, the right to claim damages exists either as an exclusive right or as a supplementary right besides the right to require performance or payment, to reduce the price or to avoid the contract. the rule in cisg art. 45(2)/61(2) is followed and furthered in a separate art. 8:102 under the pecl. as is stated: “remedies which are not incompatible may be cumulated.” a party which is entitled to withhold its performance and to terminate the contract may first withhold and then terminate. a party which pursues a remedy other than damages is not precluded from claiming damages. a party which terminates the contract may, for instance, also claim damages.19 i. it is a truism that a party cannot at the same time pursue two or more remedies which are incompatible with each other. thus a party cannot at the same time claim specific performance of the contract and terminate it. if a party has received a non-conforming tender, it cannot exercise its right to reduce its own performance and at the same time terminate the contract. a non-performance which causes the aggrieved party to suffer a loss may give it a right to be compensated for that loss, but it cannot be awarded more than the “réparation intégrale”. thus, if it has accepted a non-conforming tender, the value of which is less than that of a conforming tender, and if it has claimed or obtained a reduction of the price corresponding to the decrease in value, it cannot also claim compensation for that same decrease in value as damages. when two remedies are incompatible with each other, the aggrieved party will often have to choose between them. however, pecl art. 8:102 does not preclude an aggrieved party which has elected one remedy from shifting to another later, even though the later remedy is incompatible with the first remedy elected. if, after having claimed specific performance, it learns that the defaulting party has not performed or is not likely to do so within a reasonable time, the aggrieved party may terminate the contract. on the other hand, an election of a remnordic journal of commercial law, issue 2004 #1 5 edy is often definite and will preclude later elections of incompatible remedies. a party which has terminated the contract cannot later claim specific performance, because by giving notice of termination the aggrieved party may have caused the other party to act in reliance of the termination. if a defaulting party has adapted itself to a claim for specific performance and taken measures to perform within a reasonable time, the aggrieved party cannot change its position and terminate the contract. this applies when the defaulting party has received a notice fixing an additional time for performance. the rule is in accordance with the widely accepted principle that when a party has made a declaration of intention which has caused the other party to act in reliance of the declaration the party making it will not be permitted to act inconsistently with it. this follows from the general principle of fair dealing.20 j. however, it should be mentioned here that not only the obligations of the parties but also the remedies may be changed by them in their contract. the provisions in either cisg art. 45/61 or pecl arts. 8:101 and 8:102 are premised on the assumption that the parties have not chosen some other remedy or remedies within their contractual relationship. any such remedies chosen by the parties would always prevail. contractual freedom is thus the rule, also ref lecting the starting point for various legal systems in general. moreover, it is important to note that the remedies available for a breach of contract will be subject to, not only the express agreement made between the parties, but also any practice or usage which can be regarded as an implied part of the agreement. in case of a breach of contract it is, therefore, necessary to first look into the contract executed between the parties or any practice or usage of relevance.21 only if the agreement and any relevant practice or usage is silent, the provisions of the applicable rules – cisg, unidroit principles or pecl or any other laws — concerning remedies will be at hand. however, it should also be noted that, in cases of such remedies chosen by the parties or implied by relevant practice or usage, potential uncertainty may arise depending on the types of remedies chosen by the parties. this becomes a clearer problem in the context of the cisg, art. 4 of which sets forth the scope of its application and expressly excludes “the validity of the contract or of any of its provisions or of any usage.” moreover, although the cisg does give the parties the freedom to choose their own remedies, it is not necessarily clear that these remedies will be enforced the same way in ever y country, if at all.22 k. finally, it is to be noted that, under the convention, art. 45(3)/61(3) each provides that if the entitled party resorts to a remedy for breach of contract, no court or arbitral tribunal may delay the exercise of that remedy by granting a period of grace either before, at the same time as, or after the buyer has resorted to the remedy. such provision seems desirable in international trade.23 thus, domestic laws that permit the courts or arbitral tribunals to grant a seller in breach extra time to perform are expressly excluded. this is mainly because the convention specifically rejects the idea that in a commercial contract for the international sale of goods the party may, as a general rule, avoid the contract merely because the contract date for performance has passed and the obligated party has not as yet performed its obligations. in these circumstances, as a general rule, the other party may do so if, and only if, the failure to perform on the contract date causes him substantial detriment [results in such detriment to the other party as substantially to deprive him of what he is entitled to expect under the contract] and the party in default foresaw or had reason to foresee such a result. as a result of this rule in the convention, there was no reason to allow the buyer/seller to apply to a court for a delay of grace, as is permitted in some legal systems. moreover, the procedure of applying to a court for a delay of grace is particularly inappropriate in the context of international commerce, especially since this would expose the parties to the broad discretion of a judge who would usually be of the same nationality as one of the parties.24 nonetheless, if the parties have expressly referred to an arbitral procedure that allows such feature, the arbitration rule should prevail over art. 45 or 61, following the principle of art. 6. but, the mere fact that the parties are litigating before a court whose procedure allows some “délai de grace” should not be regarded as an agreement to have such a rule nordic journal of commercial law, issue 2004 #1 6 apply.25 _________________________________________________________________________ footnotes * ll.m. of renmin university of china; attorney-at-law on global law office; 37th floor, jing guang center, hu jia lou, chaoyang district; beijing 100020 china; <lexway@mail.com>. 1. “among the provisions in the draft convention on contracts for the international sale of goods which were the most difficult to formulate and are among the most likely to generate controversy are those dealing with the remedies of buyer and seller for breach of contract by the other party. many aspects of the law of sales reflect merchant practice, and to the extent that this practice is standardized in international sales transactions, the problems in formulating the text of the draft convention were reduced. however the provisions in respect of breach of contract do not reflect merchant practice. they reflect the efforts of lawyers from many legal systems to reconcile their views on the appropriate actions to be taken by the parties and by a tribunal in case of breach. the result has been a series of provisions which … are in general harmony with one another but which will often be unfamiliar to lawyers from any given legal system.” see eric e. bergsten & anthony j. miller in “the remedy of reduction of price”: 27 american journal of comparative law (1979) 255-277 at 255. available online at <http://cisgw3.law.pace.edu/cisg/ biblio/bergsten.html>. this is a commentary on the remedy of reduction of price under art. 46 of the 1978 draft convention, from which the basic concept of price reduction under cisg art. 50 remains unchanged but nevertheless differs from the latter in several respects. for comparison of art. 46 of the 1978 draft with cisg art. 50, see the match-up, available online at <http:/ /cisgw3.law.pace.edu/cisg/text/matchup/matchup-d-50.html>. 2. see e. a llan farnsworth in “damages and specific relief”: 27 american journal of comparative law (1979)247-253. available online at <http://cisgw3.law.pace.edu/cisg/biblio/farns.html>. 3. for example, when commenting on chapter 7 of the unidroit principles, arthur rosett states that: “in practical terms, it is the substantive heart of the whole principles. it is where the principles’ solutions to a large proportion of real world disputes in commercial transactions are to be found. it is here that the remedial consequences of serious failures of performance are defined: orders of performance, damages, contract termination by rescission, and restitution. these are difficult and central substantive issues. indeed, chapter 7 is probably the most imaginative synthesis to emerge in this generation of some of the most difficult practical questions of contract law. it will be a powerful support for the harmonization of actual outcomes and improve the reliability of the often unpredictable results of disputes. the substantive content of chapter 7 is important as an illustration of the creative power of the unidroit principles.” see arthur rosett in “unidroit principles and harmonization of international commercial law: focus on chapter seven”. available online at <http://www.unidroit.org/english/publications/review/articles/1997-3.htm>. 4. see jussi koskinen in “cisg, specific performance and finnish law”: publication of the faculty of law of the university of turku, private law publication series b:47 (1999). available online at <http://cisgw3.law.pace.edu/cisg/biblio/koskinen1.html>. 5. see the decision by the swiss commercial court (handelsgericht) aargau [or.2001.00029], 5 november 2002, translated by martin f. koehler. available online at <http://cisgw3.law.pace.edu/cases/021105s1.html>. 6. see secretariat commentary on art. 57 of the 1978 draft [draft counterpart of cisg art. 61], comment 2. available online at <http://cisgw3.law.pace.edu/cisg/text/secomm/secomm-61.html>. 7. see fritz enderlein in “rights and obligations of the seller under the un convention on contracts for the international sale of goods”: petar sarcevic & paul volken eds., international sale of goods: dubrovnik lectures, oceana (1996), p. 188. available online at <http://cisgw3.law.pace.edu/cisg/biblio/enderlein1.html>. 8. see fritz enderlein, dietrich maskow, international sales law: united nations convention on contracts for the international sale of goods, oceana publication (1992), p. 174. available online at <http://cisgw3.law.pace.edu/cisg/biblio/enderlein.html>. 9. see comment and notes to the pecl: art. 8:101. note 1. available online at <http://cisgw3.law.pace.edu/cisg/text/ peclcomp45.html>. 10. ibid., comment b. 11. see secretariat commentary on art. 65 of the 1978 draft [draft counterpart of cisg art. 79], comment 8. available online at nordic journal of commercial law, issue 2004 #1 7 <http://cisgw3.law.pace.edu/cisg/text/secomm/secomm-79.html>. 12. ibid., comment 9. 13. it could be argued that paragraph (5) of cisg art. 79 entails unrealistic results. it would allow an action for specific performance in a case where the goods are destroyed and thus, the performance is physically impossible. see denis tallon, in commentary on the international sales law the 1980 vienna sales convention, c.m. bianca & m.j. bonnell eds., giuffrè: milan (1987), p. 588. 14. see comment and notes to the pecl: art. 8:108. comment d. available online at <http://cisgw3.law.pace.edu/cisg/text/ peclcomp79.html>. 15. in this respect, the unidroit principles have found a flexible answer to the question of what is to become of the right to performance. unlike either the cisg or the pecl which specifies the remedies, though differing from each other slightly, which the aggrieved party cannot resort to in case of exemption, the unidroit principles adhere to the principle that the excuse is general, but in art. 7.1.7(4) they make important exceptions in determining certain claims which are not affected by force majeure, namely the right to terminate the contract or withhold delivery or request interest on money due. the official comment makes some of its deliberations clear: “in some cases the impediment will prevent any performance at all but in many others it will simply delay performance and the effect of the article will be to give extra time for performance. it should be noted that in this event the extra time may be greater (or less) than the length of the interruption because the crucial question will be what is the effect of the interruption on the progress of the contract.” see comment 2 on art. 7.1.7 unidroit principles of international commercial contracts.) 16. supra. fn. 10. 17. supra. fn. 9, note 3. 18. see jacob s. ziegel in “report to the uniform law conference of canada on convention on contracts for the international sale of goods”: comment 2. available online at <http://cisgw3.law.pace.edu/cisg/text/ziegel45.html>. 19. see comment and notes to the pecl: art. 8:102. comment a. available online at <http://cisgw3.law.pace.edu/cisg/text/ peclcomp45.html>. 20. ibid., comments b, c. 21. supra. fn. 4. 22.one such example would be if the parties operating under the cisg specifically agreed that the only available remedy was specific performance. under english law, e.g., specific performance is a discretionary remedy. while it is unlikely that the parties would agree to such a remedy, there would be no conflict between the agreement for specific performance and art. 46 of the cisg. on the other hand, an english court applying general legal principles would be unlikely to grant specific performance where the court did not consider that the situation merited the exercise of discretion in favour of specific performance. a more likely issue is the question of the quantum of damages agreed by the parties. under the cisg, there is no limit on the amount of compensation that may be agreed to be paid upon breach of a contract. in contrast, english common law draws a distinction between genuine pre-estimates of damage (referred to as “liquidated damages”) versus clauses viewed as punitive or penal. penalty clauses are considered invalid and will not be enforced by an english court. so while the parties are generally free to choose their own remedies, english law will not enforce all of the remedies, at least not to the same degree. (see peter a. piliounis in “the remedies of specific performance, price reduction and additional time (nachfrist) under the cisg: are these worthwhile changes or additions to english sales law?” (1999). available online at <http://cisgw3.law.pace.edu/cisg/biblio/ piliounis.html>.) 23. see secretariat commentary on art. 41 of the 1978 draft [draft counterpart of cisg art. 45], comment 6. available online at <http://cisgw3.law.pace.edu/cisg/text/secomm/secomm-45.html>; see also secretariat commentary on art. 57 of the 1978 draft [draft counterpart of cisg art. 61], comment 6. available online at <http://cisgw3.law.pace.edu/cisg/text/secomm/ secomm-61.html>. 24. see secretariat commentary on art. 43 of the 1978 draft [draft counterpart of cisg art. 47], comments 4, 5. available online at <http://cisgw3.law.pace.edu/cisg/text/secomm/secomm-47.html>; see also secretariat commentary on art. 59 of the 1978 draft [draft counterpart of cisg art. 63], comments 4, 5. available online at <http://cisgw3.law.pace.edu/cisg/text/secomm/ secomm-63.html>. nordic journal of commercial law, issue 2004 #1 8 25. see bernard audit in “the vienna sales convention and the lex mercatoria”: lex mercatoria and arbitration, rev. ed., t. carboneau ed.; juris publishing (1998) p. 285 n.47. 5 sorensen steen the fundraiser's transfer of personal data from the european union to the united states in context of crowdfunding activities nicolai kjærgaard sørensen* & ulla steen** * assistant attorney, master of laws. ** chief consultant, phd. njcl 2022/2 117 1. introduction ................................................................................... 119 2. transfer of personal data to indiegogo in the light of eu law ................................................................................................ 120 3. safe transfer of data to the us – eu requirements ....... 122 4. the fundraisers use of standard contractual clauses . 125 5. another layer of security transfer impact assessment (tia) ..................................................................................................... 126 6. indiegogo terms of use and tia in view of edpb recommendations ........................................................................... 129 7. crowdfunding and supplementary measures encrypted data – likely to work ? ................................................................ 131 8. in search of valid means for transfer of personal data to indiegogo .................................................................................... 133 9. the way ahead for the fundraiser's transfer of personal data to the us ................................................................................. 135 personal data transfer to the us 118 abstract european start-up companies must overcome more ‘transfer hurdles’ when personal data is transferred from the european union to the us (united states of america) as part of crowdfunding campaign activities. transfer of personal data is commonly not associated with (small scale) crowdfunding activities. however, the strict rules of the eu gdpr (european general data protection regulation) on safeguarding personal data apply to all companies when data is transferred from the eu to the us regardless the size of the business. this article identifies exchange of personal data that takes place between primarily fundraiser and crowdfunding service provider in different steps of fundraising campaigns. the framework for rewardbased crowdfunding for goods production that is provided by the us based indiegogo platform is used as example and context. the article highlights by way of example the obligations that must be met by european fundraisers as "data controllers" when personal data is transferred to indiegogo. no easy solutions are provided by either european union or national data protection authorities on how to establish an adequate level of personal data protection. paradigms on how to secure transfer of personal data to third countries are available in form of so-called standard contractual clauses, but still conditions for transfer of personal data from europe to the us are hard to comply with. apart from entering into an inter partes agreement on use of standard contractual clauses with the crowdfunding platform provider, a european fundraiser must furthermore make a so-called "transfer impact assessment" to ensure that third party access to personal data is avoided. in the case of transfer of personal data from the eu to the us the fundraiser must consider using encryption of data as a "supplementary measure" to block third party access. encryption of data is however not suitable for exchange of data in a dynamic crowdfunding campaign so other means for protection of data must be found and applied. the reason and explanation for making data transfers from the eu to the us that hard for e.g., fundraisers are thus to be found at interstate level in the relation between the eu and the us. according to eu law, more specifically the gdpr and several of the provision of the charter of fundamental rights of the european union, us security legislation authorises a disproportionate access for us intelligence services to citizens' personal data. a solution on manageable transfer of personal data from the eu to the us may be found before the end of 2022, since a new tadp (trans-atlantic data privacy framework) is currently being negotiated between eu and us at top politician level. however, the implementation of the tadp may take som time since the eu legislative framework needs adjustments to make the new transfer possibilities operational. njcl 2022/2 119 1. introduction the overall legal framework that governs transfer of personal data from the eu (european union) to the us (united states of america) is the gdpr (the general data protection regulation)1. however, electronical transfer of personal data to the us is currently hard to combine with gdpr compliance for more reasons, even though transfers of personal data from the eu to the us form part of every-day business around the eu – e.g. when european companies approach crowdfunding platforms located in the us.2 "indiegogo" is an example of an us based platform bringing fundraisers and backers together around reward-based crowdfunding having production of goods as target. the platform provider offers various services supporting especially fundraisers in the process from start-up of a campaign over prototype and product production to shipping.3 the flows of "investments" (or contributions) from backers to fundraisers are enormous viewed in context of indiegogo's annual turnover.4 "indiegogo" is based in the us, and both fundraisers and backers approaching the platform are inquired to agree to the crowdfunding platform's privacy policy and make themselves familiar with further terms of use, cookie policies etc.5 both fundraisers and backers must transfer personal data to the service provider in the process of start-up of a fundraising campaign, and possibly in later production steps of goods. transfer of money from backer to fundraiser involves e.g. use of personal data to which the crowdfunding service provider or third party transfer manager needs access.6 european based companies that consider crowdfunding for goods production at indiegogo or other us based platform should carefully 1 regulation (eu) 2016/679 of the european parliament and of the council of 27 april 2016 on the protection of natural persons with regard to the processing of personal data and on the free movement of such data, and repealing directive 95/46/ec (general data protection regulation) [2016] oj l119/1. 2 european commission, 'eu trade relationships by country/region, united states' <https://ec.europa.eu/trade/policy/countries-and-regions/countries/united-states/> accessed 26 june 2022. 3 indiegogo, inc., 'what we do' <https://www.indiegogo.com/about/what-we-do> accessed 26 june 2022. 4 growjo, 'indiegogo revenue and competitors' <https://growjo.com/company/indiegogo> accessed 26 june 2022. 5 indiegogo, inc., 'terms of use' (effective december 20, 2021) <https://www.indiegogo.com/about/terms> accessed 26 june 2022; indiegogo, inc., 'privacy policy' (effective december 20, 2021) <https://indiegogo.trsnd.co/policies> accessed 26 june 2022. 6 indiegogo, inc., 'privacy policy' (effective december 20, 2021) <https://indiegogo.trsnd.co/policies> accessed 26 june 2022. personal data transfer to the us 120 identify and analyse the nature of the wanted data in a broader (legal) perspective before signing up for campaign and transfer of any personal data. when eu based companies transfer personal data to us based crowdfunding platforms, according to the eu legal framework, including the gdpr, the companies must ensure a "adequate level" of protection of the personal data transferred. however, under eu law the us is classified an "unsafe" country in context of transfer of personal data from the eu, since us security legislation provides nsa (the national security agency) disproportionate access to personal data, including personal data kept by us companies. the us security legislation thus conflicts with the data protection requirements as set out in the gdpr and several of the provision of the charter (charter on fundamental rights in the european union)7, including article 8 on protection of personal data.8 this makes transfer of personal data from the eu as set out in chapter v of the gdpr complicated and time consuming. 2. transfer of personal data to indiegogo in the light of eu law indiegogo is a crowdfunding platform located in san francisco and is known to attract tech products.9 the life-cycle process of crowd funding for goods production includes at least four stages; concept, prototype, production, and shipping. the backer or contributor may contribute to the campaign when it’s launched or as long as the campaign runs to get access to the potential/up-coming project.10 fig. 1. source: indiegogo, 'what we do' <https://www.indiegogo.com/about/what-we-do> accessed 26 june 2022. crowdfunding for goods production includes lots of activities related to development and promotion of the potential up-coming 7 charter of fundamental rights of the european union [2012] oj c326/391. 8 case c-311/18 facebook ireland and schrems [2020], paras 168-202. 9 indiegogo, inc., 'terms of use' (effective december 20, 2021) <https://www.indiegogo.com/about/terms> accessed 26 june 2022. 10 indiegogo, inc., ‘backer faq’, <https://support.indiegogo.com/hc/enus/articles/115002383767-backer-faq> accessed 28 june 2022. njcl 2022/2 121 product, including transfer of personal data from the fundraiser to the crowdfunding platform.11 pursuant to article 2(1) gdpr, "processing of personal data" is subject to gdpr in the eu. the indiegogo platform addresses this fact in its privacy policy, stating that gdpr applies to individuals in the eu.12 the question whether the eu-based fundraiser's transfer of personal data to indiegogo in the us also constitutes "processing of personal data" emerges clearly from the so-called schrems ii-judgment from june 2020.13 according to the cjeu, the operation of having personal data transferred from an eu member state to a third country constitutes processing of personal data carried out in a member state.14 therefore, also when the fundraiser transfers data out of the eu to indiegogo based in the us, the gdpr must be complied with. the so-called data controller has the main responsibility when it comes to gdpr compliance.15 pursuant to art. 4(7) gdpr, the data controller means the natural or legal person which, alone or jointly with others, determines the purposes and means of the processing of personal data. the following appears from indiegogo's privacy policy: "indiegogo is "the data controller" of personal data collected by all of indiegogo, and we are responsible for deciding how personal data is collected, used, and disclosed."16 afterwards, indiegogo gives an account of its legal grounds for use and disclosure of personal data and the rights of the individuals in the eu pursuant to gdpr.17 this may have a reassuring effect for the fundraiser transferring personal data to this platform. everything seems totally compliant at first glance. however, indiegogo's privacy policy should not be overvalued in relation to the specific processing of personal data, which takes place when transferring personal data to indiegogo. even though the fundraiser transfers personal to a data controller, also the fundraiser classifies as data controller in this context. therefore, both indiegogo and the fundraiser are data controllers in relation to the personal data transferred from the fundraiser to indiegogo. this is due to the fact that the fundraiser also 11 indiegogo, inc., 'privacy policy' (effective december 20, 2021) <https://indiegogo.trsnd.co/policies> accessed 26 june 2022. 12 indiegogo, inc., 'privacy policy' (effective december 20, 2021) <https://indiegogo.trsnd.co/policies> accessed 26 june 2022. 13 case c-311/18 facebook ireland and schrems [2020]. 14 case c-311/18 facebook ireland and schrems [2020], para 83. 15 peter blume, den nye persondataret (2nd edition, juristog økonomforbundets forlag, 2018) 73 ff. 16 indiegogo, inc., 'privacy policy' (effective december 20, 2021) <https://indiegogo.trsnd.co/policies> accessed 26 june 2022. 17 indiegogo, inc., 'privacy policy' (effective december 20, 2021) <https://indiegogo.trsnd.co/policies> accessed 26 june 2022. personal data transfer to the us 122 decides the purpose and means of the processing of the personal data in question, including making the decision that the personal data should be transferred to indiegogo in order to receive indiegogo's crowdfunding service.18 when the fundraiser as a data controller wants to proceed with a transfer of personal data to indiegogo, the fundraiser is subject to several requirements under eu law. 3. safe transfer of data to the us – eu requirements first, the fundraiser must identify the transfers of personal data to indiegogo that will take place as a part of the specific crowdfunding activity. this must be done before the transfer takes place.19 indiegogo inquires different kinds of data from a fundraiser in the support of crowdfunding for goods production, which also emerges from indiegogo’s privacy policy that together with indiegogo’s terms of use constitute the full agreement between the fundraiser and indiegogo: “identifiers: registration information such as name, country of residence, gender, date of birth, email address, phone number, username, and password. commercial information: fundraiser (and backer) financial information: information to be submitted to thirdparty payment processor when creating a campaign including limited banking information, contact information such as your phone number, email address, mailing address. compliance information, including e.g., government id, information needed for tax forms, other information required by our third-payment processor. information chosen to public share, including information sent to other platform user, post etc. that indiegogo must collect according to us federal/state law internet/network or device information 18 datatilsynet and justitsministriet, 'vejledning om dataansvarlige og databehandlere' [2017] page 7-12 <https://www.datatilsynet.dk/media/7/6/dataansvarlige%20og%20databehandlere.p df> accessed 26 june 2022. 19 european data protection board, 'recommendations 01/2020 on measures that supplement transfer tools to ensure compliance with the eu level of protection of personal data' [2021] version 2.0, page 10-11 <https://edpb.europa.eu/system/files/202106/edpb_recommendations_202001vo.2.0_supplementarymeasurestransferstools_en.p df> accessed 26 june 2022. njcl 2022/2 123 o information obtained from a third party, such as a site or platform provider, about the use of our site or services on third-party platforms or devices. o location information, including provided by a mobile or other device interacting with one of our sites or applications (including through beacon technologies), or associated with your ip address, where we are permitted by law to process this information. o activity information about your use, and the use by any person(s) you authorize through your account, of our sites and applications, such as the content you view or post, how often you use our services, and your preferences. o usage, viewing, technical, and device data when you visit our sites, use our applications on third-party sites or platforms, or open emails we send, including your browser or device type, unique device identifier, and ip address. any miscellaneous data provided by a fundraiser, including professional or employment related data, public gender reveal, photo, video, etc.”20 "personal data" is a very broad concept as personal data is not only any information relating to an identified person such as name, but also information relating to an identifiable person according to article 4(1) gdpr. this means that data like an email address, a phone number, banking information, government id or an ip address, that indiegogo according to it's privacy policy may inquire from the fundraiser, also falls within the material scope of gdpr, if this data alone or combined with other data can be ascribed to a natural person.21 however, not every kind of data is "personal data" that falls within the material scope of gdpr according to article 2(1) gdpr, and thereby the rules on third country transfers. for instance, data regarding a legal entity, more specifically the company itself (company name, cvr number, contact information etc.), is not "personal data".22 on the other hand, the rules apply to all personal 20 indiegogo, inc., 'privacy policy' (effective december 20, 2021) <https://indiegogo.trsnd.co/policies> accessed 26 june 2022. 21 regulation (eu) 2016/679 of the european parliament and of the council of 27 april 2016 on the protection of natural persons with regard to the processing of personal data and on the free movement of such data, and repealing directive 95/46/ec (general data protection regulation) [2016] oj l119/1, preamble 26, 30. 22 regulation (eu) 2016/679 of the european parliament and of the council of 27 april 2016 on the protection of natural persons with regard to personal data transfer to the us 124 data relating to natural persons in the course of a professional activity, such as the employees of a company/organisation, business email addresses that reveals the identity of a natural personal or employees’ phone numbers. moreover, information in relation to one-person companies may constitute personal data where it allows the identification of a natural person. this fact is important to stress in a crowdfunding context, as many of the fundraisers are entrepreneurs launching their first company. when the above-mentioned "personal data" is identified, the fundraiser must identify the transfer tools to rely on when transferring personal data to indiegogo according to chapter v of the gdpr. these transfer tools aim to ensure that the level of protection of natural persons guaranteed by the gdpr is not undermined when transferring personal data out of the eu to a third country like the usa. 23 article 45 gdpr provides for the transfer of personal data to a third country, which pursuant to a commission decision, provides an "adequate level of protection", also known as a secure third country. the usa is not a safe third country, and for now, in case of third country transfers to indiegogo article 45 gdpr cannot be used as a basis for the transfer. gdpr art. 46, however, contains several additional transfer bases that can be used when transferring personal data to an insecure third country such as the united states. for private companies like fundraisers transferring personal data to another private company like indiegogo, the following transfer bases are currently available:24 • "binding corporate rules" pursuant to article 46(2)(b) and 47 gdpr • standard contractual clauses adopted by the european commission pursuant to article 46(2)(c) gdpr. • contractual clauses entered into between the fundraiser and indiegogo on an ad hoc basis pursuant to article 46(3)(a). in situations where neither article 45 nor 46 gdpr can be used as a tool for transfer, a third country transfer can also be carried out on the basis of the exceptions in article 49 gdpr. however, the exceptions the processing of personal data and on the free movement of such data, and repealing directive 95/46/ec (general data protection regulation) [2016] oj l119/1, preamble 14. 23 european data protection board, 'recommendations 01/2020 on measures that supplement transfer tools to ensure compliance with the eu level of protection of personal data' [2021] version 2.0, page 11-13 <https://edpb.europa.eu/system/files/202106/edpb_recommendations_202001vo.2.0_supplementarymeasurestransferstools_en.p df> accessed 26 june 2022. 24 datatilsynet, 'overførsel af personoplysninger til tredjelande' [2022] 4th edition, page 16. <https://www.datatilsynet.dk/media/637902777513932912/vejledning%20om%20ov erf%c3%b8rsel%20til%20tredjelande.pdf> accessed 26 june 2022 njcl 2022/2 125 must be interpreted restrictively and relate mainly to processing activities that are occasional and not characterised by repetition25 . as crowdfunding for goods production includes development of the potential up-coming product, the fundraiser may transfer personal data to indiegogo on an ongoing basis. for this reason, the fundraiser may not rely on the exceptions in article 49 gdpr. in consequence, it may only be the binding corporate rules, standard contractual clauses and ad hoc-contractual clauses that are available as transfer tools. however, binding corporate rules are primary intended for major concerns and may be resource demanding to compose. also, the ad hoc-contractual clauses are resource demanding to compose. moreover, the corporate rules and ad hoc-contractual clauses must be approved by the national data protection authority and the european data protection board (edpb).26 therefore, in practice, the most relevant transfer tool for the fundraiser is the standard contractual clauses adopted by the european commission pursuant to article 46(2)(c) gdpr. 4. the fundraisers use of standard contractual clauses in a legal context, the standard contractual provisions form an annex to a decision adopted by the commission, and the standard contractual clauses can be found on the european commission's website.27 the standard contractual clauses enjoin the fundraiser and indiegogo a range of liabilities, which, in overall, correspond to the liabilities in the gdpr.28 the standard contractual clauses combine general clauses with a modular approach to cater for various transfer scenarios. in addition to the general clauses, the parties should only select the module applicable to their situation29. as both the fundraiser and indiegogo are data controllers, they 25 henrik udsen, it-ret (4th edition, ex tuto publishing a/s, 2019) 448; european data protection board, 'guidelines 2/2018 on derogations of article 49 under regulation 2016/679' [2018] page 4 f. <https://edpb.europa.eu/sites/default/files/files/file1/edpb_guidelines_2_2018_dero gations_en.pdf> accessed 26 june 2022. 26 datatilsynet, 'overførsel af personoplysninger til tredjelande' [2022] 4th edition, page 16. <https://www.datatilsynet.dk/media/637902777513932912/vejledning%20om%20ov erf%c3%b8rsel%20til%20tredjelande.pdf> accessed 26 june 2022. 27 european commission, 'standard contractual clauses for international transfers' (4 june 2021) <https://ec.europa.eu/info/law/law-topic/data-protection/internationaldimension-data-protection/standard-contractual-clauses-scc/standard-contractualclauses-international-transfers_en> accessed 26 june 2022 28 henrik udsen, it-ret (4th edition, ex tuto publishing a/s, 2019) 439 ff. 29 commission implementing decision (eu) 2021/914 of 4 june 2021 on standard contractual clauses for the transfer of personal data to third countries pursuant to regulation (eu) 2016/679 of the european parliament and of the council [2021] oj l199/31, preamble 10. personal data transfer to the us 126 should select the module 1-clauses, which apply to controller-to-controller transfers. indiegogo's terms of use underlines that especially the standard contractual clauses form an important transfer tool when the fundraiser transfers personal data to indiegogo. according to the terms of use, the fundraiser is entitled to ensure compliance with the european data controller obligations under applicable european data protection law, including the current standard contractual clauses.30 moreover, indiegogo has published the relevant standard contractual clauses on its own website, more specifically the standard contractual clauses applicable for transfers from one data controller to another. however, in the pre-filled annexes of the standard contractual clauses, indiegogo presupposes that the standard contractual clauses applies when indiegogo itself transfers personal data about a contributor/backer to a campaign owner/fundraiser.31 therefore, when transferring personal data to indiegogo, the fundraiser must take initiative to enter the standard contractual clauses with indiegogo and to make sure to adapt the annexes so that they reflect the specific transfers from the fundraiser to indiegogo in question. however, even though the fundraiser may manage to enter the standard contractual clauses with indiegogo, the fundraiser cannot use the standard contractual clauses uncritically without any further considerations, even though that the standard contractual clauses are accepted as a valid starting point for transfer of personal data to unsafe third country. 5. another layer of security transfer impact assessment (tia) in the schrems ii-judgment, the cjeu thus stated that the use of the standard contractual clauses implies that the european data controller must verify, on a case-by-case basis, whether the law of the third country ensures adequate protection "essentially equivalent” to that guaranteed by eu law, specified gdpr as interpreted in the light of the fundamental rights guaranteed by the charter.32 this assessment can be called a "tia" ("transfer impact assessment"). the cjeu's requirement for a tia originates from article 44 gdpr, which sets out that a third country data transfer must have legal basis in chapter v of the gpdr regulation, but also the additional rules in gdpr. one of these additional rules includes article 5(2) gdpr 30 indiegogo, inc., 'terms of use' (effective december 20, 2021) <https://www.indiegogo.com/about/terms> accessed 26 june 2022. 31 indiegogo, inc., standard contractual clauses for campaign owners (effective december 20, 2021) <https://indiegogo.trsnd.co/policies?name=standard-contractualclauses-for-campaign-owners#european-commission-standard-contractual-clauses> accessed 26 june 2022. 32 case c-311/18 facebook ireland and schrems [2020], paras 105 and 134. njcl 2022/2 127 regarding the "accountability" principle, stating that the data controller is responsible for compliance with gdpr, but also that the controller must be able to demonstrate this compliance. by conducting a tia, the fundraiser may demonstrate how it will ensure adequate protection when transferring personal data to a third country by transferring personal data to indiegogo. when the fundraiser wants to transfer personal data to the us based indiegogo, the fundraiser must, as part of its tia, consider paragraph 168 to 202 in the schrems ii-judgment. in these paragraphs, the cjeu took into account the fundamental rights of the charter.33 pursuant to article 6(1) of the teu (treaty on european union), the charter applies at treaty-level in eu law. 34 the charter codifies several fundamental rights. 35 according to the preamble 4 of the gdpr, the gdpr respects all fundamental rights and observes the freedoms and principles recognised in the charter. therefore, the charter must be taken into account in the interpretation of the gdpr, and the cjeu ascribe great importance to the charter when ruling on questions relation to data protection law.36 in the schrems ii-judgment, the cjeu compared american national security legislating authorising mass surveillance of non-us citizens with article 7, 8, 47 and 52(1) of the charter. 37 article 7 states the right to respect for private and family life. article 8 determines the right to protection of personal data. article 47 the right to an effective remedy and to a fair trial. article 52(1) determines that any limitation on the exercise of the rights recognized by the charter must be provided for by law and that any limitation may be made only if they are necessary and genuinely meet objectives of general interest etc. (proportionality). in the schrems ii-judgment, the cjeu held, among other things, that the us security legislation in the foreign intelligence surveillance act (hereafter "fisa") section 702, executive order 12333 and presidential policy directive 28, does not lay down limitations of the us intelligence services' collection of personal data on non-us citizens.38 consequently, the fundraiser transferring personal data to indiegogo is facing a legal barrier arising from a conflict between us security legislation and the fundamental rights of the eu charter of fundamental rights.39 this conflict applies although the fundraiser has entered standard 33 case c-311/18 facebook ireland and schrems [2020], paras 168-202. 34 jonas christoffersen and others, eu’s charter om grundlæggende rettigheder med kommentarer (2nd edition, juristog økonomforbundets forlag, 2018) 40. 35 christina d. tvarnø and ruth nielsen, retskilder og retsteorier (5th edition, juristog økonomforbundets forlag, 2017) 102. 36 peter blume, databeskyttelsesret (5th edition, juristog økonomforbundets forlag, 2018) 60. 37 case c-311/18 facebook ireland and schrems [2020], paras 168-202. 38 case c-311/18 facebook ireland and schrems [2020], paras 168-202. 39 nicolai kjærgaard sørensen, 'overførsel af personoplysninger til usa og europakommissionens standardkon-traktbestemmelser i lyset af eu-retten og grundlæggende rettigheder' (2021), page 31-33 personal data transfer to the us 128 contractual clauses with indiegogo, as those clauses are not legally binding for authorities in third countries.40 therefore, transfer of personal data to the us on the basis of standard contractual clauses shows a clash between the legislative framework, more specifically eu law and us security legislation, and the contractual framework, namely the standard contractual clauses entered into between the fundraiser and indiegogo. as the standard contractual clauses in force were adopted by the european commission in the wake of the schrems ii-judgment, the standard contractual clauses contain several provisions addressing this issue. for instance, clause 14 regarding local laws and practices affecting compliance with the standard contractual clauses requires the data exporter (the fundraiser) and the data importer (indiegogo) to "[…] warrant that they have no reason to believe that the laws and practices in the third country of destination applicable to the processing of the personal data by the data importer, including any requirements to disclose personal data or measures authorising access by public authorities, prevent the data importer from fulfilling its obligations under these clauses."41 moreover, clause 14 states that the parties, in providing the abovementioned warranty, have taken due account to a number of elements, including the laws and practices of the third country of destination.42 in other word, the parties shall in accordance with the schrems ii-jugdment conduct a tia. also indiegogo's terms of use seems to reflect the schrems iijudgment. here, indiegogo underlines that the fundraiser as a data controller under applicable eu law must ensure transfers and conduct any required data protection impact assessments (tia).43 <https://projekter.aau.dk/projekter/files/415520765/specialet.pdf> accessed 26 june 2022. 40 case c-311/18 facebook ireland and schrems [2020], paras 125 and 132. 41 annex to the commission implementing decision on standard contractual clauses for the transfer of personal data to third countries pursuant to regulation (eu) 2016/679 of the european parliament and of the council [2021] c(2021) 3972 final, clause 14. 42 annex to the commission implementing decision on standard contractual clauses for the transfer of personal data to third countries pursuant to regulation (eu) 2016/679 of the european parliament and of the council [2021] c(2021) 3972 final, clause 14. 43 indiegogo, inc., 'terms of use' (effective december 20, 2021) <https://www.indiegogo.com/about/terms> accessed 26 june 2022. njcl 2022/2 129 6. indiegogo terms of use and tia in view of edpb recommendations in the schrems ii judgment, the cjeu did not make any clear definition of the factors that may be included as part of the data controller's tia. therefore, when conducting the tia, further guidance is required. in this context european data protection board edpb is central. pursuant to article 70(1) gdpr, edpb shall ensure the consistent application of gdpr, and for the purpose of this, edpb can issue guidelines and recommendations. in the wake of the schrems ii judgment, edpb issued recommendations 01/2020 (recommendations 01/2020 on measures that supplement transfer tools to ensure compliance with the eu level of protection of personal data)44, that among other things aims to help data exporters (entities transferring data to third countries) with the conduct of the tia. it is important to note that the recommendations are not legally binding according to article 288, last sentence of the tfeu (treaty on the functioning of the european union).45 however, according to article 68(3) gdpr, edpb among other things consists of the head of the data protection authorities from each member state. therefore, it must be expected that each data protection authority supervises in accordance with the recommendations, which is why the recommendations is of great practical significance.46 the recommendations underline that the tia first and foremost must be based on legislation publicly available.47 consequently, when the fundraiser transfers personal data to indiegogo in the usa, the fundraiser should consider whether the personal data transferred may be subject to the us security legislation that the cjeu deemed to be contrary to the data protection afforded by eu law. 44 european data protection board, 'recommendations 01/2020 on measures that supplement transfer tools to ensure compliance with the eu level of protection of personal data' [2021] version 2.0, page 9, 11-13 <https://edpb.europa.eu/system/files/202106/edpb_recommendations_202001vo.2.0_supplementarymeasurestransferstools_en.p df> accessed 26 june 2022. 45 consolidated version of the treaty on the functioning of the european union [2012] oj c 326/49, 288. 46 peter blume, persondatarettens kilder og metode (1st edition, djøf forlag, 2020) 48 f. and 64; udsen, henrik udsen, it-ret (4th edition, ex tuto publishing a/s, 2019) 457 and 473. 47 european data protection board, 'recommendations 01/2020 on measures that supplement transfer tools to ensure compliance with the eu level of protection of personal data' [2021] version 2.0, page 17 <https://edpb.europa.eu/system/files/202106/edpb_recommendations_202001vo.2.0_supplementarymeasurestransferstools_en.p df> accessed 26 june 2022. personal data transfer to the us 130 regarding fisa section 702, this legislation authorizes collection of "foreign intelligence information"48. this definition is very broad as it does not only include information that is necessary in the interest of national security, but any information from a foreign power or territory that is merely related to the conduct of foreign affairs49. therefore, if the fundraiser is based in the eu, the personal data transferred may be "foreign intelligence information", even though that the data is transferred as part of a crowdfunding purpose. however, pursuant to fisa section 702, the american authorities may only collect personal data from "electronic communications service providers"50. however, this definition may include any company that gives others, including the company's own employees, access to communicate electronically via, for example, e-mail. this regardless of what else might be the company's primary business area.51 therefore, indiegogo may also fall within this definition. regarding e.o. 12333, this legislation authorises the intelligence services to collect and store data before it reaches the us and there is subject to the provisions of fisa. the surveillance activities based on e.o. 12333 are thus not regulated by law, and therefore the fundraiser cannot give any formal guarantee that personal data transferred to indiegogo will not be subject to surveillance under e.o. 12333.52 the assessment above reveals that the personal data transferred to indiegogo might be subject to surveillance that is contrary to the data protection afforded by eu law, as the american legislation gives wide authority for surveillance. however, it is unsure whether the personal data transferred to indiegogo falls within the practical scope of the american application of fisa section 702 and e.o. 12333. in this situation, the american legislation is according to the recommendations 01/2020 "problematic legislation".53 as it also appears from recommendations 01/2020, it should be noted that it is not only the us security legislation itself that the fundraiser needs to take into account when conducting the tia. for instance, the fundraiser should also take into consideration all the actors participating 48 50 u.s.c. § 1881a(h)(2)(a)(v) (2018). 49 50 u.s.c. § 1801(e)(2)(b) (2018). 50 50 u.s.c. § 1881a(h)(2)(a)(vi) (2018). 51 h. marshall jarrett and michael w. bailie, searching and seizing computers and obtaining electronic evidence in criminal investigations (office of legal education, executive office for united states attorneys) 117 <https://www.justice.gov/file/442111/download> accessed 26 june 2022. 52 case c-311/18 facebook ireland and schrems [2020], para 63. 53 european data protection board, 'recommendations 01/2020 on measures that supplement transfer tools to ensure compliance with the eu level of protection of personal data' [2021] version 2.0, page 17-18 <https://edpb.europa.eu/system/files/202106/edpb_recommendations_202001vo.2.0_supplementarymeasurestransferstools_en.p df> accessed 26 june 2022. njcl 2022/2 131 in the transfer, including other data controllers, and any envisaged onward transfer from indiegogo to another company.54 in a crowdfunding context this could be a third-party transfer manager who may need personal data from the fundraiser transferred to indiegogo for financial compliance purposes etc. 55 such onward transfers might undermine the protection afforded by the standard contractual clauses, as the third-party transfer manager not just like that is bound by the standard contractual clauses entered into between the fundraiser and indiegogo. however, the standard contractual clauses address this issue, as it appears from clause 8 that the data importer, indiegogo, shall not disclose the personal data to a third party located outside the eu, for instance a third-party transfer manager located in the us or another third country, unless this third party is or agrees to be bound by the standard contractual clauses which the fundraiser and indiegogo have adopted. otherwise, indiegogo may only transfer the personal data to the third-party transfer manager under certain particulars, for instance if the third-party transfer manager is located in a safe third country according to article 45 gdpr.56 7. crowdfunding and supplementary measures encrypted data – likely to work ? if the fundraiser's tia shows that the standard contractual clauses does not ensure a protection essentially equivalent to that guaranteed by eu law due to "problematic legislation", according to the schrems ii judgment the fundraiser may provide "supplementary measures" to those offered by the standard contractual clauses 57. as the ecj in the schrems ii judgment did not define the supplementary measures and what those measures could consist of, also in this connection is recommendations 01/2020 very useful, as the recommendations also aims to help with the identification of appropriate "supplementary measures". according to the recommendations, there will be situations where only appropriately implemented "technical measures" might impede or render ineffective access by public authorities in third countries to personal data, for 54 european data protection board, 'recommendations 01/2020 on measures that supplement transfer tools to ensure compliance with the eu level of protection of personal data' [2021] version 2.0, page 15, 22 <https://edpb.europa.eu/system/files/202106/edpb_recommendations_202001vo.2.0_supplementarymeasurestransferstools_en.p df> accessed 26 june. 55 indiegogo, inc., 'privacy policy' (effective december 20, 2021) <https://indiegogo.trsnd.co/policies> accessed 26 june 2022. 56 annex to the commission implementing decision on standard contractual clauses for the transfer of personal data to third countries pursuant to regulation (eu) 2016/679 of the european parliament and of the council [2021] c(2021) 3972 final, clause 8. 57 case c-311/18 facebook ireland and schrems [2020], para 133. personal data transfer to the us 132 surveillance purposes. such technical measure could be encryption of the data transferred to the third country which exclude access to the data transferred.58 in the indiegogo privacy policy, indiegogo appears to know that technical measures should be taken into consideration: "how we protect your information and data rentention […] we have implemented technical, administrative, and physical security measures that are designed to protect user information from unauthorized access, disclosure, use, and modification. we regularly review our security procedures to consider appropriate new technology and methods. however, please be aware that despite our best efforts, no security measures are perfect or impenetrable."59 indeed, no security measures are perfect or impenetrable, and in its privacy policy, indiegogo does not mention anything about encryption of data before it is transferred to indiegogo. this may be for good reasons: if the fundraiser encrypts the personal data before transferring the data to indiegogo, this will prevent the entire purpose of the transfer as indiegogo may only store the data but cannot access the data in the clear. regardless of this fact, in the annex 2 of the recommendations 01/2020, edpb states that transfer of personal data for business purposes where the data importer (in this case indiegogo) needs access to data transferred, and the data importer is located in a third country where the public authorities are granted a disproportionate access to the data the edpb is incapable of envisioning an effective technical measure to prevent that access from infringing on the data subject’s fundamental rights.60 this applies even though indiegogo encrypts the data after having received the personal data from the fundraiser, as indiegogo according to 58 european data protection board, 'recommendations 01/2020 on measures that supplement transfer tools to ensure compliance with the eu level of protection of personal data' [2021] version 2.0, page 21-23 <https://edpb.europa.eu/system/files/202106/edpb_recommendations_202001vo.2.0_supplementarymeasurestransferstools_en.p df> accessed 26 june 2022. 59 indiegogo, inc., 'privacy policy' (effective december 20, 2021) <https://indiegogo.trsnd.co/policies> accessed 26 june 2022. 60 european data protection board, 'recommendations 01/2020 on measures that supplement transfer tools to ensure compliance with the eu level of protection of personal data' [2021] version 2.0, page 34 and 35 <https://edpb.europa.eu/system/files/202106/edpb_recommendations_202001vo.2.0_supplementarymeasurestransferstools_en.p df> accessed 26 june 2022. njcl 2022/2 133 fisa section 702 may also be obligated to hand over encryption keys to us intelligence agencies.61 however, according to the recommendations 01/2020, the fundraiser has a last option, as it can decide to proceed with the transfer without being required to implement supplementary measures, if the fundraiser considers that it has no reason to believe that the american "problematic legislation" will be applied, in practice, to the transferred data and/or indiegogo.62 it is important to stress that this is not a risk-based assessment, and the fundraiser cannot take into consideration the likelihood of american surveillance of the transferred data in question. this must be seen in the context of the fact that the requirement for a legal ground for transfers in chapter v of the gdpr regulation is binary: either the fundraiser has a legal ground or not. this is reflected in the recommendations 01/2020, as the fundraiser according to edpb needs to demonstrate the practical application of the american legislation with a "detailed report" based on "relevant", "objective", "reliable", "verifiable" and "publicly available or otherwise accessible" information.63 8. in search of valid means for transfer of personal data to indiegogo in annex 3 of the recommendations, edpb mentions examples of sources where the information could be obtained from, for instance relevant case-law, resolutions and reports from intergovernmental organization, reports, and analysis from competent regulatory networks etc. moreover, the fundraiser can take into consideration whether indiegogo can confirm that it has not received requests for access to data 61 50 u.s.c. § 1881a(a),(i)(1) (2018); european data protection board, 'recommendations 01/2020 on measures that supplement transfer tools to ensure compliance with the eu level of protection of personal data' [2021] version 2.0, page 29 <https://edpb.europa.eu/system/files/202106/edpb_recommendations_202001vo.2.0_supplementarymeasurestransferstools_en.p df> accessed 26 june 2022. 62 european data protection board, 'recommendations 01/2020 on measures that supplement transfer tools to ensure compliance with the eu level of protection of personal data' [2021] version 2.0, page 18 and 19 <https://edpb.europa.eu/system/files/202106/edpb_recommendations_202001vo.2.0_supplementarymeasurestransferstools_en.p df> accessed 26 june 2022. 63 european data protection board, 'recommendations 01/2020 on measures that supplement transfer tools to ensure compliance with the eu level of protection of personal data' [2021] version 2.0, page 19 <https://edpb.europa.eu/system/files/202106/edpb_recommendations_202001vo.2.0_supplementarymeasurestransferstools_en.p df> accessed 26 june 2022. personal data transfer to the us 134 from u.s. public authorities in the past and that it is not prohibited from providing information about such requests or their absence.64 taking into consideration indiegogo's comprehensive privacy policy, nothing indicates that indiegogo is in possession of the abovementioned requested information. quite the reverse, as indiegogo seems to acknowledge that us national security law affects the possibility of compliance with eu law: "we may share the categories of information identified above for the following business and commercial purposes: […] 6. when we share your personal information with third parties […] to comply with legal process (including to comply with national security or law enforcement requirements) […]."65 however, because of the fundraiser's customer relation to indiegogo, the fundraiser may particularly if this is done in cooperation with other fundraisers be able to ask indiegogo for the above-mentioned relevant information so that the transfer maybe can take place in accordance with eu law. as it appears from recommendations 01/2020, the data exporter and data importer need to cooperate to make the assessment, even though, when all come to all, it is the data exporter's, the fundraisers, responsibility that the transfer from the eu to the us takes place in accordance with eu law.66 however, as it appears from the abovementioned presentation, a tia is a piece of hack work. conduction a tia requires resources and time which is something that a fundraiser may not have, especially not in the start-up phase. 64 european data protection board, 'recommendations 01/2020 on measures that supplement transfer tools to ensure compliance with the eu level of protection of personal data' [2021] version 2.0, page 47 and 48 <https://edpb.europa.eu/system/files/202106/edpb_recommendations_202001vo.2.0_supplementarymeasurestransferstools_en.p df> accessed 26 june 2022. 65 indiegogo, inc., 'privacy policy' (effective december 20, 2021) <https://indiegogo.trsnd.co/policies> accessed 26 june 2022. 66 european data protection board, 'recommendations 01/2020 on measures that supplement transfer tools to ensure compliance with the eu level of protection of personal data' [2021] version 2.0, page 18 <https://edpb.europa.eu/system/files/202106/edpb_recommendations_202001vo.2.0_supplementarymeasurestransferstools_en.p df> accessed 26 june 2022. njcl 2022/2 135 9. the way ahead for the fundraiser's transfer of personal data to the us the current european legal framework for transfer of personal data to third countries is made to ensure an adequate level of protection of the personal data transferred from the eu. the analyses above reveal that fundraising campaigns involve supply of personal data from fundraiser (and backer) to crowdfunding service provider in the different steps of a crowdfunding campaign. as shown above such exchange of data is however hardly manageable in context of the strict rules of the gdpr and the charter when the crowdfunding platform is based in the us. the american intelligence and surveillance laws and possible us government access to eu citizens personal data have established barriers to transfer of personal data from the eu to the us in many different data exchange contexts. this has left european and us companies with cross border transfers problems that can only be solved at interstate level. solutions have been discussed between the european commission and the us, and on 25 march 2022, the european commission, and the u.s government announced that they had agreed in principle on a new socalled "trans-atlantic data privacy (tadp) framework". currently, the u.s government and the european commission are cooperating with a view to translate the framework into legal document that will need to be adopted by both the eu and the us to put the new tadp framework in place. 67 therefore, european companies cannot rely on the statement from the european commission and the us yet. reportedly, under the new framework the us is to put in place new safeguards to ensure that us surveillance activities are necessary and proportionate etc., and the us intelligence agencies is to adopt procedures to ensure effective oversight of the coming new privacy standard. 68 on 7 october 2022, president biden signed the "executive order on enhancing safeguards for united states signals intelligence activities". according to the white house, the executive order among other things "adds further safeguards for u.s. signals intelligence activities, including requiring that such activities [are] conducted only in pursuit of defined national security objectives" and only when the intelligence activities are "necessary" and "proportionate". moreover, a new "multi-layer mechanism" is intended to be established for individuals to obtain "independent and binding review and redress of claims" that personal data 67 european commission, 'european commission and united states joint statement on trans-atlantic data privacy framework' (25 march 2022) <https://ec.europa.eu/commission/presscorner/detail/en/ip_22_2087> accessed 26 june 2022 68 european commission, 'european commission and united states joint statement on trans-atlantic data privacy framework' (25 march 2022) <https://ec.europa.eu/commission/presscorner/detail/en/ip_22_2087> accessed 26 june 2022 personal data transfer to the us 136 collected through us intelligence services was collected or handled illegally. an appeal body, "the civil liberties protection officer", will conduct an initial investigation of qualifying complaints received, and a new "data protection review court" is to "provide independent and binding review" of the civil liberties protection officer's decisions.69 what from fundraisers’ perspective is important is to be ensured that well-functioning, valid and reliable settings are established on both us and european side to be able to do everyday business: transferring of personal data to the us. however, some further political, legal and juridical steps have to be taken and the european business sector still needs to have patience. now, the european commission has to determine whether the new executive order provides an "adequate level of protection" and, if so, draft an "adequacy decision" under article gdpr 45 stating that the tadp. it should be noticed that the organization "noyb", founded by max schrems who filed the claim leading to the schrems ii-judgment, as a "first reaction" to the new executive order has stated that the executive order is "unlilely to satisfy eu". despite that the new executive order uses words as "necessary" and "proportionate", noyb does not think that there is any indication that the us mass surveillance will change in practice, as the eu and us have different understandings of these words. moreover, according to noyb the new "court" mentioned in the executive order will not be a court in the normal legal meaning of article 47 of the charter or the us constitution, but a "body within the us government's executive branch."70. until a new framework for transfer of personal data from europe to the us has been established, european fundraisers transferring personal data to crowdfunding platforms located in the us are advised to conduct a tia as good as possible and in compliance with recommendation 01/2020 in order to demonstrate "accountability" pursuant to article 5(2) gdpr. if the tia shows that the fundraiser cannot ensure an adequate protection of the personal data transferred, it must consider using a european based crowdfunding platform instead. 69 the white house, 'fact sheet: president biden signs executive order to implement the european union-u.s. data privacy framework' (7 october 2022) <https://www.whitehouse.gov/briefing-room/statements-releases/2022/10/07/factsheet-president-biden-signs-executive-order-to-implement-the-european-union-u-sdata-privacy-framework/> accessed 30 october 2022. 70 noyb, 'first reaction: executive order on us surveillance unlikely to satisfy eu law' (7 october 2022) <https://noyb.eu/en/new-us-executive-order-unlikely-satisfy-eulaw> accessed 30 october 2022. 1 cattelan neumann 1 status artis: research in the law and practice of crowdfunding stefano cattelan* & thomas neumann** * phd, master of laws. research assistant at the clear project: crowdfunding, law, education, and research, at aalborg university, denmark. https://orcid.org/0000-0002-4730-3434. ** phd, master of laws. associate professor of commercial law and chair of the clear project: crowdfunding, law, education, and research at aalborg university, denmark. the author discloses an economic interest below a total of €10,000 placed through the following crowdfunding service providers: brickshare/the many, flexfunding, kameo, lendino and mintos. https://orcid.org/0000-0002-0477-7429. status artis of crowdfunding 8 1. introduction ....................................................................................... 9 1.1. growing business and growing legislative efforts ................................................................ 9 1.2. definitions and actors ...................................................... 13 2. non-investment crowdfunding models ............................... 16 2.1. overview ................................................................................... 16 2.2. donation crowdfunding .................................................. 17 2.3. reward-based crowdfunding .......................................... 21 3. investement crowdfunding models ....................................... 25 3.1. overview ................................................................................... 25 3.2. debt-based crowdfunding ................................................ 27 3.3. equity crowdfunding ......................................................... 31 4. conclusion and perspectives ...................................................... 36 5. bibliography on legal scholarship ......................................... 39 5.1. scholarship on donation crowdfunding .................. 39 5.2. scholarship on reward crowdfunding ....................... 41 5.3. scholarship on debt-based crowdfunding ............... 43 5.4. scholarship on equity crowdfunding ......................... 47 njcl 2022/2 9 abstract the present article aims to provide a comprehensive overview of the state of the art of legal science on crowdfunding and to lay the foundation for the understanding of some of its key concepts, facilitating the development of future legal research. this paper demonstrates that legal scholarship seems to not take full comparative advantage of the fact that many concerns are common across jurisdictions, such as encouraging sme development through access to risk capital or ensuring the protection of the unsophisticated investor. it also shows that scholarship and legislative efforts, predominantly in the us and the eu, are most often focused on investment crowdfunding and that these efforts usually attempt to define the obligations of the crowdfunding service provider, striking a balance between stimulating access to risk capital for start-ups and scaling up the crowdfunding business while, at the same time, protecting investors in particular the unsophisticated ones. even though it is challenging to legally define specific crowdfunding services, the commonly used typology of crowdfunding is found to be meaningful in a legal context, as it denotes the applicable legal framework. considering that there is a correlation between the clarity of regulation in a country and the volume of crowdfunding, and given that crowdfunding is growing as both a method of finance and as a business, the time is ripe for legal scholars to direct their attention to the field. in doing so, they assist the actors in the market, the legislators, and the judiciary. 1. introduction crowdfunding is no longer a complete novelty and several publications have been devoted to various aspects of this phenomenon. however, it appears that the focus has been on the economical, entrepreneurial, and financial aspects of crowdfunding. research in the legal and regulatory aspects of crowdfunding has only recently shown signs of vitality. the present article aims to provide a comprehensive overview of the state of the art of legal science on crowdfunding and to lay the foundation for the understanding of some of its key concepts, facilitating the development of future legal research. thus far, legal scholarship appears to have been patchy and disconnected. this paper demonstrates that legal scholarship often addresses common themes across jurisdictions and therefore could benefit from a more integrated, comparative, and internationally focused approach. 1.1. growing business and growing legislative efforts although crowdfunding as a concept has existed for a long time, it only recently took off as a mass phenomenon in its online form. the enormous potentialities of the internet 2.0 made it possible to connect status artis of crowdfunding 10 fundraisers and funders across different countries and continents.1 in the aftermath of the 2008-2009 financial crisis, banks and financial institutions reduced credit outputs and increased constraints on access to capital the so-called credit crunch.2 in reaction, struggling companies, ambitious individuals, start-ups, and social campaigners started to view crowdfunding as a viable alternative to bank lending and other traditional capital raising methods.3 especially small and medium enterprises (smes), which play a major role in the economy and provide employment to a large portion of the world population, may benefit from access to risk capital via crowdfunding. smes have always experienced difficulties in accessing credit, a phenomenon that amplifies itself in times of economic crisis especially innovative smes and start-ups.4 from the 2000s onwards, several forms of crowdfunding have evolved to serve fundraisers’ and funders’ various needs. the scholarship usually relies on four primary types of crowdfunding.5 first, donation 1 zachary fialkow, ‘crowd-fundamentals: balancing rapidly advancing crowdfunding innovation with protections for consumers’ (2017) 4 emory corporate governance and accountability review 391, 392. 2 douglas arner, janos barberis and ross buckley, ‘the evolution of fintech: a new post-crisis paradigm?’ (university of hong kong faculty of law research paper 047 2015); ‘the impact of the global crisis on sme and entrepreneurship financing and policy responses’ (report of the centre for entrepreneurship, smes and local development oecd 2009). 3 leopoldo esposito, ‘il crowdfunding, uno strumento alternativo di finanziamento’ (2019) 1 rivista bancaria minerva bancaria 97, 97-100; gianlucca quaranta, ‘crowdfunding. il finanziamento della folla, o dei ‘folli’?’ (2016) 6 diritto ed economia dell’impresa 249. regarding the impact of the financial crisis, see de kristof de buysere, oliver gajda, ronald kleverlaan, and dan marom, ‘a framework for european crowdfunding’ (2012) 8(4) modern economy 1; alma pekmezovic and gordon walker, ‘the global significance of crowdfunding: solving the sme funding problem and democratizing access to capital’ (2016) 7(2) william and mary law review 351. 4 thorsten beck, asli demirguc, and dorothe singer, ‘is small beautiful? financial structure, size and access to finance’ (2013) 52 world development 19; scott shane and nicos nicolau, ‘exploring the changing institutions of early-stage finance’ (2018) 14(6) journal of institutional economics 1121; pekmezovic and walker (n 3) 347; alina dibrova, ‘analysis of crowdfunding in european union: performance and perspectives’ (2017) 98 contemporary issues in finance: current challenges from across europe 37; bis, ‘sme access to external finance’ 2012 bis economics paper no 16 ; andrew freeman, ‘challenging myths about the funding of small businesses’: finance for growth’ (demos 2013). 5 the cambridge centre for alternative finance (ccaf) developed the most detailed typology of crowdfunding models in its industry reports, cf. tania ziegler, rotem shneor, kieran garvey, karsten wenzlaff, nikos yerolemou, rui hao, et al., ‘expanding horizons: the 3rd european alternative finance industry report’ (cambridge center for alternative finance 2018), 28-30; tania ziegler, rotem njcl 2022/2 11 crowdfunding, where the contributors receive no material or monetary return in exchange for their donation. second, reward-based crowdfunding, where the contributors receive perks, discounts, or early access to the funded product or service in exchange for their contribution.6 third, debt-based crowdfunding, where the investors receive interests from the lendee on the money contributed. fourth, equity crowdfunding, where the investors receive a stake in the company in exchange for their contribution. the two former crowdfunding types are usually categorised as non-investment crowdfunding, while the latter two are referred to as investment types. this foundational taxonomy is established both in economics and law literature, although further subdivisions are seen especially regarding investment crowdfunding.7 in the last few years, the number of crowdfunding platforms and the amount of money raised have continued to increase. if we exclude the unique context of china, global volumes concerning alternative finance have grown by 28% from € 42 billion in 2016 to € 55.5 billion in 2017 -, growing by a further 48% to € 79 billion in 2018 (see fig. 1 below). more specifically, the european alternative finance market (including the united kingdom) grew from € 10.6 billion in 2017 to € 15.9 billion in 2018, which represents a 52% year-on-year increase.8 note that all currencies in this paper have been converted to € by the average currency rate for the year in question. smes, which constitute the backbone of the european economy, are hoped to become the primary beneficiaries of such growth of the crowdfunding market, fostering economic recovery and new entrepreneurial activities.9 across all macroregions, debt-based crowdfunding remains the dominating crowdfunding type in terms of volume, while non-investment crowdfunding is relegated to a fraction of the total, albeit socially significant (see table below).10 shneor, karsten wenzlaff, ana odorovic, daniel johanson, rui hao, et al., ‘shifting paradigms: the 4th european alternative finance benchmarking report’ (cambridge center for alternative finance 2019), 31-35; tania ziegler and rotem shneor (eds.), ‘the global alternative finance benchmarking report’ (cambridge centre for alternative finance 2020) 31. see also de buysere et al. (n 3) 10-11; de quesada ce, ‘crowdfunding in europe’ (2018) 3 european contract law in the digital age 103, 109. 6 jeremy c short, david ketchen, aaron mckenny, thomas allison, and r duane ireland, ‘research on crowdfunding: reviewing the (very recent) past and celebrating the present’ (2017) entrepreneurship theory and practice 149, 150. 7 see below section 3. 8 ibid. 26. see also dibrova (n 4) 38-40. 9 ibid. 39. 10 raghavendra p. rau, ‘law, trust, and the development of crowdfunding’ (social science research network 2020) 4. status artis of crowdfunding 12 region debt equity non-investment apac € 7.6 b € 394.9 m € 313.1 m china € 74.0 b € 0.06 m € 8.8 m europe € 9.6 b € 849.2 m € 8.8 m lac € 4.1 b € 43.3 m € 92.6 m mena € 640.7 m € 11.3 m € 17.9 m ssa € 0.9 b € 13.9 m € 50.3 m uk € 7.3 b € 547.4 m € 1.9 b us, canada € 43.2 b € 1.7 b € 666.1 m fig. 1. total volume by region and model categories in 2020. (apac = asia-pacific, excluding china; lac = latin america and the caribbean; mena = middle east and north africa; ssa = sub-saharan afrika). original data from ziegler, shneor, wenzlaff et al., the 2nd global alternative finance market benchmarking report, 44. currencies converted to € using the 2020 average rate from usd to euro of 0.877. furthermore, the internationalisation of crowdfunding campaigns is on the rise. not only is there a notable increase in the number of firms that operate in multiple jurisdictions, but also an increasing number of cross-border activities across regions. all the above mentioned four models are concerned by this trend.11 finally, the growth of crowdfunding as a business is challenged by fragmented national legislation.12 national legislators, as well as the eu, are increasingly aware of the need to regulate this dynamic fundraising method. on the one hand, crowdfunding carries enormous potential for the funding of smes, start-ups and social goals, but, on the other, its nature and characteristics present challenges as far as fraud and funders’ protection are concerned.13 generally speaking, donation and reward 11 ziegler, shneor, wenzlaff et al (n 5) 25. 12 karsten wenzlaff, ana odorovic, tania ziegler and rotem shneor, ‘crowdfunding in europe: between fragmentation and harmonization’ in rotem shneor, liang zhao and bjorn-tore flåten (eds), advances in crowdfunding: research and practice (springer international publishing 2020), 373-375. 13 gerry tsoukalas, simone marinesi and volodymyr babich, ‘updating the crowdfunding narrative’ (2019) 7(5) public policy initiative 1; dean hanley and paul bork, ‘crowdfunding: a new way to raise capital, or a cut-back in investor protection?’ (2012) 26(6) insights 44; douglas cumming, lars hornuf moein karami and denis schweizer, ‘disentangling crowdfunding from fraudfunding’, in ssrn electronic journal (2016); chen ding, anil kavuri and alistair milne, ‘lessons from the rise and fall of chinese peer-to-peer lending’ (2021) 22 journal of banking regulation 133; sondes mbarek and donia trabelsi, ‘crowdfunding without crowdfooling: prevention is better than cure’, in kent baker, lynnette purda-heeler and njcl 2022/2 13 based crowdfunding have thus far been subject to a minimal regulatory effort by legislators. in contrast, debt-based and equity crowdfunding have been subject to more legislative scrutiny and attention. indeed, their higher complexity and their inclusion in the broader category of alternative finance appear to require specific rules.14 besides, as shown in the chart above, investment-based crowdfunding now involves much larger capitals, and individual contributions tend to be more significant compared to non-investment crowdfunding. before turning to the state of the art of each of the four crowdfunding types, it is necessary to establish who the involved actors are and how fundamental concepts are defined at present. after providing the state of the art and thereby extrapolating the current trends in crowdfunding research, a bibliography of legal scholarship is provided in the hope that it will encourage and further future internationally oriented legal scholarship. a bibliography is created for each of the four crowdfunding types and therefore duplicates may occur regarding materials that are concerned with more than one of the four crowdfunding types. 1.2. definitions and actors crowdfunding has no firm definition in scholarship, though the following statement seems to encapsulate the essence of most definitions and the traits of the trade: crowdfunding is “[t]he efforts by entrepreneurial individuals and groups – cultural, social, and for profit – to fund their ventures by drawing on relatively small contributions from a relatively large number of individuals using the internet, without standard financial intermediaries”.15 three parties are involved in crowdfunding transactions; the fundraiser, the funder, and the platform (“tripartite business”).16 first, the fundraiser (or borrower, investee) is defined as any individual or entity that proposes a public call for the financing of a project with a particular purpose.17 second, the funder (or contributor, investor, lender, backer, supporter) can be defined as any individual or organisation that provides finance by answering a public call for the funding of a project with a particular purpose.18 the advantages of crowdfunding for the funders may samir saadi, (eds) corporate fraud exposed (emerald publishing limited 2020) 221. 14 fialkow (n 1) 398. 15 see sunghan ryu, beauty of crowdfunding: blooming creativity and innovation in the digital era (routledge 2020), 16, where more definitions are listed. the cited definition is attributed to ethan mollick, ‘the dynamics of crowdfunding: an exploratory study’ (2014) 29 journal of business venturing 1 in the above work. 16 de quesada (n 5) 109. 17 rotem, shneor and liang zhao, ‘introduction: from fundamentals to advances’ in rotem shneor, liang zhao, nad bjørn-tore flåten (n 12) 3-4. 18 ibid. status artis of crowdfunding 14 be financial as well as non-financial. customer engagement may be enhanced by allowing influence on the design of future products and future consumption opportunities while at the same time the customers’ sense of belonging to a certain group or community is strengthened.19 third, the crowdfunding platform (or platform, crowdfunding service provider) can be defined as “an internet application linking fundraisers and their potential backers while facilitating the exchanges between them in accordance with pre-specified conditions”.20 such intermediaries make their income in the forms of campaign success fees and payments for supporting services and may, despite their intermediary role, be in their own contractual relationship with the fundraiser as well as the funder. a salient role of the crowdfunding platform is to create a trustworthy framework for bringing fundraisers and funders, who are unknown to each other, together. hence, each successfully completed campaign enhances the platform’s own reputation, making them more attractive facilitators for future fundraising initiatives.21 however, platforms usually specify in their terms of use and contracts that they do not guarantee to funders that the money raised by the campaign will actually be used for the goals stated by the fundraisers.22 crowdfunding platforms operate under regulations set by each national jurisdiction where they are based. however, the crowdfunding business seems characterised by an international nature, with platforms increasingly diversifying their activities outside their headquarters country in order to reach fundraisers and funders abroad.23 the fact that the internationalisation of platforms and cross-border flows of capital are 19 more specific terms are used to refer to the different crowdfunding models: donors (in donation crowdfunding), investors (in equity crowdfunding), sponsors (reward crowdfunding), and lenders (debt crowdfunding). ibid. 4; norbert steigenberger, ‘why supporters contribute to reward-based crowdfunding’ (2017) 23(2) international journal of entrepreneurial behavior & research 336. 20 rotem shneor, ‘crowdfunding models, strategies, and choices between’, in shneor, zhao, and flåten (n 17) 21-22. 21 rotem shneor and bjorn-tare flåten, ‘opportunities for entrepreneurial development and growth through online communities, collaboration, and value creating and co-creating activities’ in hans kaufmann and riad shams (eds), entrepreneurial challenges in the 21st century (palgrave macmillan 2015); paul belleflamme, nessrine omrani and martin peitz, ‘the economics of crowdfunding platforms’ (2015) 33 information economics and policy 11. 22 in case of mismanagement concerning the money raised by a campaign, funders will have to recover their contribution directly from the fundraisers, a perilous endeavour. see de quesada (n 5) 111; steven c. bradford, ‘shooting the messenger: the liability of crowdfunding intermediaries for the fraud of others’ (2015) 83 university of cincinnati law review 371. 23 for an overview, see oliver gajda (ed), review of crowdfunding regulation: interpretations of existing regulation concerning crowdfunding in europe, north america and israel (brussels: european crowdfunding network 2017). njcl 2022/2 15 gaining momentum, notably across europe, presents its own challenges concerning cross-border regulation and enforcement.24 also, in light of the regulatory fragmentation hinted at above, public authorities are often seen as additional stakeholders in the crowdfunding process. although they are “not directly involved in each transaction, [they] do carry great influence on the way the industry develops, and how each party to the crowdfunding transaction interacts with the other”.25 more specifically, legislative acts and regulations provide the rules by which the different types of crowdfunding may be practised. indeed, they define compliance requirements primarily aimed at consumer/investor protection and market integrity. however, at the same time, public authorities have also vested interests in supporting new channels for the financing of social and entrepreneurial goals in their jurisdictions, facilitating greater public contributions to initiatives that align with government policies and agendas and that would otherwise remain underfunded.26 throughout the 2010s, crowdfunding platforms seeking to offer their services across the european union member states’ borders have faced the lack of common rules and diverging licensing requirements.27 24 on the internationalisation of platforms, see ziegler et al shifting paradigms: the 4th european alternative finance benchmarking report (n 5) 48-52. the report highlights that in the european context, platforms operating from small open economies (e. g. the baltic countries and ireland) seem to be benefiting more from international operations, while platforms operating in relatively large home markets (i.e. france, spain and germany) tend to rely primarily on the growth of the domestic market. 25 shneor et al. (n 12) 4. 26 ibid. 4-5. on the role of institutions, see nir kshetri, ‘success of crowd-based online technology in fundraising: an institutional perspective’ (2015) 21(2) journal of international management 100. 27 this has resulted in high compliance and operational costs, which prevented crowdfunding platforms from efficiently scaling the provision of their services. as a result, small businesses had fewer financing opportunities available to them, while investors faced less choice and more uncertainty when investing cross-border. european commission, proposal for a regulation of the european parliament and of the council on european crowdfunding service providers (ecsp) for business, 2018/0048, 2018; proposed regulation on european crowdfunding service providers (ecsp) for business, position paper of the european crowdfunding network, 8 october 2018; proposed regulation on european crowdfunding service providers (escp) for business position paper of the european crowdfunding network, trialogue stage, 2 october 2019. see also antonella francesca cicchiello, ‘harmonizing the crowdfunding regulation in europe: need, challenges, and risks’ (2020) 32(6) journal of small business & entrepreneurship 585; dirk zetzsche and christina preiner, ‘cross-border crowdfunding: towards a single crowdfunding market for europe’ (2017) 8 ebi working paper series; wenzlaff, odorović, ziegler and shneor, ‘crowdfunding in europe: between fragmentation and harmonization’, in shneor, zhao, and flåten (n 12), 373-390. status artis of crowdfunding 16 hence, the european crowdfunding market has been lagging behind other regions. more recently, the european union has shown the willingness to create a coherent and harmonised crowdfunding market. after a number of proposals and tentative steps, the new regulation on european crowdfunding service providers (ecsp) for business was adopted in december 2020.28 the ecsp regulation will enter into force in november 2021. the new eu regulation lays down common rules for the member states relating to equity crowdfunding and debt-based crowdfunding services. thus, it does not concern non-investment crowdfunding types. the ecsp regulation allows platforms to apply for an eu passport based on a single set of rules, which will enable them to offer their services across the eu with a single authorisation. the new rules are expected to both boost crowdfunding campaigns and enhance the investor protection framework. they lay down harmonised rules regarding information disclosure for fundraisers, platform governance, risk management, and the improvement of national authorities’ supervisory powers.29 the ecsp rules are further addressed below at 3.1. further regional legislative developments are seen in both the us and china. these are described further below. 2. non-investment crowdfunding models 2.1. overview thinking that crowdfunding is a “method to obtain money from large audiences, where each individual provides a small amount, instead of raising large sums from a small group of sophisticated investors”30, it is obvious that this is no new phenomenon. donation crowdfunding can be seen as a simple fundraising campaign, which could take place through any media. donation and reward crowdfunding have always played a role in financing creative and cultural projects. a well-known example from 1885 is the pedestal of the statue of liberty, which was paid for by 160,000 people donating less than a dollar on average. contributors donated to the project only for benevolent reasons and in return for having their name printed in joseph 28 regulation (eu) 2020/1503 of the european parliament and of the council of 7 october 2020 on european crowdfunding service providers for business and amending regulation (eu) 2017/1129 and directive (eu) 2019/1937. cf. zetzsche and preiner, ‘cross-border crowdfunding: towards a single crowdfunding market for europe’. 29 rasmus mandøe jensen and christian scott uhlig, ‘european crowdfunding platforms new opportunities for alternative financing for start-ups and smes’ (plesner 2020): <https://www.plesner.com:443/insights/artikler/2020/10/europeancrowdfunding-platforms?sc_lang=da-dk> accessed 15 april 2021. 30 shneor, zhao, and flåten (n 12) 1 attributes the definition to paul belleflamme p, thomas lambert, and armin schwienbacher, ‘crowdfunding: tapping the right crowd’ (2014) 29(5) journal of business venturing 585. njcl 2022/2 17 pulitzer’s newspaper, the new york world. before pulitzer’s fundraising campaign, the statue was at risk of not being erected at all or even relocated to other cities that were able to pay the pedestal’s costs.31 actual reward crowdfunding, where the contributor receives a benefit in return for a contribution, is also an old phenomenon. rewards in return for donations are known to have been used by artists such as mozart and beethoven. around the time that mozart and beethoven were children, alexander pope successfully crowdfunded his translation of the famous ancient greek poem iliad into english by promising 750 contributors that they would be mentioned in the acknowledgements and receive a copy of the first edition of the work.32 while fundraising from a crowd is nothing new, the novelty of crowdfunding lies in the use of the internet to reach many more potential contributors, who may be geographically spread over vast distances. nowadays, it is possible to reach contributors virtually anywhere and the world has seen significant longdistance cross-border fundraising.33 donation and reward crowdfunding were the first to appear in an online context and from here the debt-based and equity crowdfunding models have developed. 2.2. donation crowdfunding charitable fundraising through the use of a crowdfunding platform is characterised by the fact that the contributors (funders or donors) receive “no material but immaterial, social rewarding in return for their contributions” and that they are, as with any fundraising, driven by their benevolent reasons and desire to participate in efforts to solve “real world problems”.34 hence, the donation crowdfunding model is sometimes also referred to as 31 see ryu (n 15) 14; rodrigo davies, ‘the statue of liberty and america’s crowdfunding pioneer’ bbc news (24 april 2013) <https://www.bbc.com/news/magazine-21932675> accessed 28 december 2020. 32 ryu (n 15) 13. 33 the creation of the george floyd memorial constitutes a recent example of successful donation-based campaigns, which confirmed the effectiveness of this fundraising method in supporting social goals. following mr. floyd’s killing by a minneapolis police officer, his relatives launched a crowdfunding campaign on gofundme which raised almost $ 14 million amid ongoing protests for his death in several countries. see julie bort, ‘george floyd’s gofundme accounts have raised over $13.7 million for his family ... and counting’ (business insider, 8 june 2020): <https://www.businessinsider.com/george-floyd-memorial-gofundme-has-raisedmillion-2020-6> accessed 25 may 2021; chelsea ritschel, ‘george floyd’s gofundme receives most donations of all time’ (the independent, 5 june 2020): <https://www.independent.co.uk/life-style/george-floyd-gofundme-donationsrecord-protests-memorial-a9551561.html> accessed 25 may 2021. 34 ricarda bouncken, malvine komorek and sascha kraus, ‘crowdfunding: the current state of research’ (2015) 14(3) international business 407, 409; de quesada (n 5) 112. status artis of crowdfunding 18 charity crowdfunding. however, it is difficult to unequivocally distinguish donation and rewards models in practice as they are often mixed. donation crowdfunding is most often used to finance “humanitarian, social, or artistic projects”35 but also medical and educational projects attract donations.36 in some regions, neglected children or the elderly are major receivers of donations through charity crowdfunding,37 which could be linked to the general culture of donation in a society.38 one significant crowdfunding service provider is gofundme charity. the platform was formerly operating under the name crowdrise, which was established as early as 2010 and later acquired by gofundme. while being registered in the united states, the platform demonstrates the inherent international character that the crowdfunding business has. indeed, gofundme charity offers fundraising services to fundraisers in almost twenty countries, including most of the european union, uk, us, and canada, but accepts donations worldwide.39 the market for donation crowdfunding for 2016 was estimated by the university of oxford and saïd business school to be € 0.50 billion/year.40 a few years later, gofundme charity reported that they 35 franck juredieu and sébastien mayoux, ‘crowdfunding legal framework: an international analysis’, in jerome meric, isabelle maque, and julienne brabet (eds.) international perspectives on crowdfunding: positive, normative and critical theory (emerald 2016) 81, 83; bouncken, komorek and kraus (n 34) 409. see also www.kickstarter.com (accessed 15 february 2021) who categorises projects as “arts, comics and illustration, design and tech, film, foods and craft, games, music, and publishing”. 36 gofundme charity operates with project categories medical, memorial, emergency, charity and education. 37 zhichao ba, yuxiang zhao, liqin zhou, and shijie song, ‘exploring the donation allocation of online charitable crowdfunding based on topical and spatial analysis: evidence from the tencent gongyi’ (2020) 57 information processing & management. 38 krishnamurthy suresh, stine øyna and ziao haque munim, ‘crowdfunding prospects in new emerging markets: the cases of india and bangladesh’ in shneor, zhao, and flåten (n 12) 297-318. 39 countries blocked from donating: afghanistan, haiti, libya, saint kitts and nevis, syria, bangladesh, saint lucia, timor-leste, kosovo, iran, myanmar (burma), saint vincent and the grenadines, african republic, iraq, pakistan, turkey, south sudan, uzbekistan, palestine, lebanon, ghana, cuba, singapore, kosovo, sudan, korea (north) according to gofundme charity countries blocked from donating <https://charitysupport.gofundme.com/hc/en-us/articles/360050070451-countriesblocked-from-donating> accessed 18 march 2021. 40 michele scataglini and marc ventresca, ‘funding the un sustainable development goals: lessons from donation-based crowdfunding platforms’ (social science research network, scholarly paper id 3328731 2019), 37. njcl 2022/2 19 raised more than € 8 billion.41 given that the total charity market, of which charity crowdfunding may take up an increasing part, is estimated to be approximately € 355 billion/year, it is no neglectable business to service providers, fundraisers, criminals, and lawmakers.42 the fact that some jurisdictions leave donation crowdfunding largely unregulated43 enables platforms to become global marketplaces,44 but at the same time, the lack of crowdfunding specific regulation also opens the door to fraud and malpractice.45 with most contributions in donation crowdfunding campaigns being less than € 50, it is unlikely that each individual contributor will pursue any legal action. however, there may be a lot of money involved for the fraudulent fundraiser.46 popular media has recently reported convictions due to various fundraising crimes through donation crowdfunding, including for example fake cancer treatments (approx. € 50,000) or withholding money collected for a homeless veteran (approx. € 355,000).47 while donation crowdfunding is subject to the general regulation of public fundraising in each jurisdiction,48 the predominant legislative development focuses on debt-based crowdfunding and equity crowdfunding,49 most likely because donation crowdfunding and reward 41 gofundme charity social fundraising data for nonprofits: the complete report <https://charity.gofundme.com/c/guides/nonprofit-social-fundraising-data-report> accessed 18 march 2021 and gofundme charity a year in giving gofundme 2019 <https://www.gofundme.com/2019> accessed 18 march 2021. 42 scataglini and ventresca (n 40) 37. 43 thomas lee hazen, ‘crowdfunding or fraudfunding social networks and the securities laws why the specially tailored exemption must be conditioned on meaningful disclosure’ (2012) 90 north carolina law review 1735, 1737. ‘equity crowdfunding & peer-to-peer lending’ (legalink 2019) <https://www.legalink.ch/xms/files/publications/legalink__equity_crowdfunding__peer-to-peer_lending.pdf> accessed 21 november 2020, 91. 44 scataglini and ventresca (n 40). 45 ying zhao, phil harris and wing lam, ‘crowdfunding industry history, development, policies, and potential issues’ (2019) 19 journal of public affairs 1. 46 gofundme charity, social fundraising data for nonprofits: the complete report <https://charity.gofundme.com/c/guides/nonprofit-social-fundraising-data-report> accessed 18 march 2021. 47 bbc news, woman guilty of fake cancer gofundme fundraising fraud, 20 november 2020 <https://www.bbc.com/news/uk-england-kent-55021836> accessed 18 march 2021, and bill hutchinson, alleged ringleader of $400,000 gofundme scam hit with federal indictment (abc news, 9 january 2020) <https://abcnews.go.com/us/alleged-ringleader-400000-gofundme-scam-hitfederal-indictment/story?id=68169208> accessed 18 march 2021. 48 i.e. denmark in lov nr 511 af 26/05/2014 and bek nr 160 af 26/02/2020. 49 see gajda (n 23). status artis of crowdfunding 20 crowdfunding are not considered an investment product per se.50 it is unknown from legal scholarship whether donation crowdfunding is in need of more, less, or different regulation, as legal scholarship on donation crowdfunding is very scarce.51 however, it is obvious that crowdfunding is a target of fraud as any other activity, and the scale of fraud may reach further and wider when relying on the internet. it has been pointed out that the most effective way to combat fraud is to combine regulation, internal auditing with the platform, and a critical attitude by investors a funder beware/caveat emptor principle.52 in retrospect, it is therefore no surprise that china became the breeding ground in 2014-2015 for what turned out to be a major crowdfundingbased ponzi scheme, as there was almost no regulation in place at the time. the investment platform ezubao was founded in 2014 and within two years the people behind the platform had managed to defraud 900,000 investors through their fake crowdfunding platform containing mostly fake investment projects. even though the chinese courts eventually convicted the people behind the € 8 billion scam,53 it serves to show the need for at least some degree of preventive regulation.54 in addition, the subsequent regulatory reaction by the chinese authorities was perhaps an overreaction, as it cut the crowdfunding market by more than 40% and confirms the difficulty in balancing the need for regulation while avoiding over regulating.55 even though donation crowdfunding is regulated by the general rules of public fundraising in a jurisdiction, the fact that crowdfunding takes place online raises questions about the applicable law and its 50 osborne clarke, ‘regulation of crowdfunding in germany, the uk, spain and italy and the impact of the european single market’ (european crowdfunding network ecn 2013). 51 see bibliography on scholarship relating to donation crowdfunding below under 5.1. 52 chad albrecht et al., ‘ezubao: a chinese ponzi scheme with a twist’ (2017) 24 journal of financial crime 256, 259. 53 ibid; reuters, ‘leader of china’s $9 billion ezubao online scam gets life; 26 jailed’ reuters (12 september 2017) <https://www.reuters.com/article/us-chinafraud-iduskcn1bn0j6> accessed 5 november 2020. 54 china subsequently regulated the market, a development that is described further below under 3.2. for more on the regulatory conundrum, see tsai c-h, ‘to regulate or not to regulate? a comparison of government responses to peer-topeer lending among the united states, china, and taiwan’ (2019) 87 university of cincinnati law review 1077. 55 according to ziegler and shneor (n 5) 132, the market saw a 40% drop due to stricter regulation. see also lin lin, ‘managing the risks of equity crowdfunding: lessons from china’ (2017) 17(2) journal of corporate law studies 327; kang yuan and xu duoqui, ‘legal governance on fintech risks: effects and lessons from china’ (2020) 7(2) asian journal of law and society 275; ding, kavuri, and milne (n 14). njcl 2022/2 21 enforcement, since the fundraiser, the crowdfunding platform and the contributor may very well be located in different jurisdictions. the question of applicable law and enforcement aside, the crowdfunding industry and fundraisers can benefit from having some regulation in place that both enables crowdfunding and increases trust in the system and the platforms. scholarship points out that crowdfunding is a way to harness the wider community’s will to contribute to, for example, a policy development, such as achieving the 17 sustainable development goals set by the un.56 one may wonder if international or regional legislative efforts can eliminate some of the legal fragmentation that exists and, in turn, increase trust in crowdfunding as a method of finance, helping to realise the inherent potential of crowdfunding to develop sustainable business practice and technologies.57 in relation to crowdfunding in china, it has been stated that crowdfunding may trigger “an upsurge of public support and [thus] elevating issues prioritised by the government, [hence] micro-charities may serve as an input institution in the spirit of ‘responsive authoritarianism’”58 and thereby perhaps expand the space for civil society. in sum, donation crowdfunding has strong international characteristics, with economic, developmental, and democratic potential. legislative efforts and scholarship are scarce and leave room for further legal research. the purpose of such research could be to tease out palpable criteria for classifying donation crowdfunding as well as exploring whether the current legal framework facilitates trust, limits fraud, recognises the international character of the business, and strikes a fair and equitable balance between the interests involved. however, authors are right in stating that the level of risk of fraud undermines the positives of crowdfunding, including donation crowdfunding, and therefore regulation is required if crowdfunding is to have a future as a driver of initiative, creativity, and solidarity.59 2.3. reward-based crowdfunding the reward-based model is characterised by the contributor receiving a benefit in return for a contribution. the benefit, or perk, may be unrelated to the product being backed, such as a poster or a cap, or it may be directly related to the product by way of early access or right to purchase the backed product at a discounted rate once it is released. 56 scataglini and ventresca (n 40). 57 matthias lehmann, ‘global rules for a global market place? regulation and supervision of fintech providers’ (2020) 38 boston university international law journal 118. 58 kellee tsai and qingyan wang, ‘charitable crowdfunding in china: an emergent channel for setting policy agendas?’ (2019) 240 the china quarterly 936, 958. 59 michelle cumyn and justin ilboudo wend-nongdo, ‘l’encadrement juridique du sociofinancement au quebec’ (2019) 60 cahiers de droit 699, 734. status artis of crowdfunding 22 reward-based crowdfunding is often tiered so that the bigger the contribution, the more benefits are received. several platforms combine the reward-based model with the donations model, allowing contributors to pledge either a small amount as a donation or a larger amount in return for a reward. combined models may be effective, since they appeal to both philanthropic focused contributors, who often donate early in the fundraising process, and reward focused contributors, who often donate late in the fundraising process.60 cultural production most often relies on reward crowdfunding and, in particular, music production hence the term culture crowdfunding.61 some platforms do not vet the fundraising projects, thus creating ample opportunity for anyone to seek funding from the crowd.62 however, even though crowdfunding creates an opportunity for the individual artist, one has to be aware that the growth of cultural crowdfunding is partly due to cuts in public funding.63 the most successful campaigns relying on the reward-based model have mass appeal and it is therefore natural that they often are creative products or consumer products.64 for those categories, rewards crowdfunding is a way to gain working capital and an initial demand test65 while ensuring advance cover of the production costs.66 the rewards model is now also used to fund litigation in return for a reward such as access to products or services ‘saved’ if the supported party wins the lawsuit.67 a rewards campaign can be the first step towards developing and testing out new products and a way to generate user involvement. however, although the involvement of the customers is key to funding the campaign, it may also turn customers away. when oculus vr in 2012 raised € 1.9 million in a reward campaign to develop their product, it generated a lot of bad will for both the platform and oculus vr when the latter decided to sell the company to facebook for € 1.55 billion just two 60 shungan ryu, keongtae kim and young-gul kim, ‘reward versus philanthropy motivation in crowdfunding behavior’ (2016) 87 pacis 2016 proceedings 15; de quesada (n 5) 113-114. 61 anders rykkja, natalia maehle, ziaul haque, and rotem shneor, ‘crowdfunding in the cultural industries’ in shneor, zhao, flåten (n 13) 423-435. 62 andrew schwartz, ‘the gatekeepers of crowdfunding’ (2018) 75 washington and lee law review 885, 895. 63 rykkja et al. (n 61) 423-435. 64 peter chapman, ‘crowdfunding’, in jelena madir (ed.), fintech: law and regulation (edward elgar publishing limited 2019), 51-52. 65 de buysere et al (n 5) 18. 66 chapman (n 65) 51-52. 67 manuel a gomez, ‘crowdfunded justice: on the potential benefits and challenges of crowdfunding as a litigation financing tool’ (2015) 49 university of san francisco law review 307. njcl 2022/2 23 years later a sale that the many contributors received no monetary stake in, but felt they had been instrumental in.68 one third of crowdfunding platforms in europe are rewards-based ones.69 the european market raised € 98 million in 201570 and € 158.80 million in 201771. one significant platform in the market is kickstarter.com, which at the time of writing had more than € 4.25 billion in pledges where the category ‘games’ and ‘design’ attracted € 1.25 billion and € 1.05 billion in pledges respectively.72 two variations of the reward model exist, a keep-it-all and an all-or-nothing model. while the all-ornothing model attracts more contributions because it demonstrates the fundraisers commitment and places the risk of not reaching the set target on the fundraiser,73 the keep-it-all model may make sense if the fundraiser intends to supplement the crowdfunding capital with funding from a venture capitalist to reach the target.74 reward-based crowdfunding is not subject to any specialised legislation. however, in most jurisdictions, it is governed by the general laws of contracts, sales, marketing and consumer protection, and notably not by the financial and securities regulation.75 offering products in exchange for early capital is often seen by scholars as a pre-sale and not 68jack wroldsen, ‘crowdfunding investment contracts’ (2017) 11 virginia law and business review 543, 548-549. 69 european commission, ‘commission staff working document: crowdfunding in the eu capital markets union’, swd (2016)154, 03/05/2016 <https://ec.europa.eu/transparency/regdoc/rep/10102/2016/en/10102-2016-154-enf1-1.pdf> accessed 27 november 2020, 9 70 ibid. 10. 71 ziegler et al., shifting paradigms: the 4th european alternative finance benchmarking report (n 5) 31. 72 kickstarter, ‘stats’ https://www.kickstarter.com/help/stats accessed 15 february 2021. 73 douglas j. cumming, gael leboeuf and armin schwienbacher, ‘crowdfunding models: keep‐it‐all vs. all‐or‐nothing’ (2020) 49 financial management 331; garry a. gabison, ‘the incentive problems with the all-or-nothing crowdfunding model’ (2016) 12 hastings business law journal 489. 74 xihan guo, gongbing bi and jiancheng lv, ‘crowdfunding mechanism comparison if there are altruistic donors’ (2020) european journal of operational research s0377221720308900 <https://linkinghub.elsevier.com/retrieve/pii/s0377221720308900> accessed 15 november 2020. 75 patrick møller toftegård and martin christial krull, netværksfinansiering en guide til crowdfunding (lett 2016), 18-20; tobias hans tröger, ‘regulation of crowdfunding in germany’ (2018) safe working paper no. 199 <https://www.ssrn.com/abstract=3122987> accessed 28 december 2020, 17; clarke (n 51) 32; hector simón-moreno, ‘the legal framework on crowdfunding in spain’ (2016) 4 revue internationale des services financiers/international journal for financial services 13, 15. status artis of crowdfunding 24 an investment. therefore, the rewards model is not governed by securities laws.76 even though some state-specific securities laws in the us may apply, federal securities law in the us does not apply when the purchaser is motivated by a desire to consume the product.77 hence, fundraisers may choose to raise funds through reward-based crowdfunding as it avoids most regulation, especially the detailed and demanding securities regulation.78 it has been stated that reward crowdfunding in the uk legal context will likely be treated as pre-paid goods or services without guarantee that the contributor will actually receive the product.79 in terms of legal implications, one should probably distinguish between reward-based crowdfunding where a perk is received and pre-purchase where the funded product itself is to be received80 -, as this may affect whether the general contract law applies or not in some jurisdictions. however, the legal obligations between the fundraiser and the contributor(s) are largely undetermined in scholarship81 and deserve attention to create predictability for the stakeholders. despite the importance, no legislative efforts have been identified that will deter fundraisers from being trapped in a development promise they cannot fulfil and ensure that contributors understand that when it comes to delivery time, final design and function, rewards crowdfunding is different from purchasing off-the-shelf products82 and so should the legal implications be too. the lack of a crowdfunding-specific legal framework and the lack of legal scholarship in the field amplifies the importance of the contractual framework drafted by the platform. in this regard, kickstarter’s terms of use have been criticised for creating room for fraud and leaving the contributor without any real remedies83 , and this is most likely not unique to the terms of kickstarter. legal analysis could 76 blair bowman, ‘a comparative analysis of crowdfunding regulation in the united states and italy’ (2015) 33 wisconsin international law journal 318, 325. patricia h. lee, ‘access to capital or just more blues? issuer decision-making post sec crowdfunding regulation’ (2016) 18 transactions: the tennessee journal of business law 19, 31. 77 bowman (n 76) 325-326. 78 alexa lam, ‘less is more? different regulatory responses to crowdfunding and why the hong kong model stacks up well’ (2018) 48 hong kong law journal 191, 193. 79 chapman (n 64) 52. 80 steven bradford, ‘crowdfunding and the federal securities laws’ (2012) columbia business law review 1, 16. 81 christofer moores, ‘kickstart my lawsuit: fraud and justice in rewards-based crowdfunding’ (2015) 49 uc davis law review 383, 389. 82 jay h. ganatra, ‘when a kickstarter stops: exploring failures and regulatory frameworks for the rewards-based crowdfunding industry’ (2016) 68 rutgers university law review 48. 83 moores (n 81) 390-391. njcl 2022/2 25 assist in both classifying reward-based crowdfunding in relation to existing contract law regimes and establishing a legal framework that balances the need to combat fraud and promote innovation. it has been suggested that platforms could, or should, make use of online dispute resolution mechanisms to handle the, often low value, claims involved.84 3. investement crowdfunding models 3.1. overview the above mentioned non-monetary models usually receive the most media coverage, especially concerning socially significant campaigns on platforms such as gofundme or kickstarter. however, platforms that offer monetary returns to crowdfunders have grown at a faster pace in recent years, and are now moving much larger amounts of money.85 indeed, investment-based crowdfunding is a more modern creature, which originated in the us and the uk at the end of the 2000s, then spreading across the globe.86 the central characteristic of all investmentbased crowdfunding is that it involves financial return for the funders (or contributors, investors, lenders). however, funders often choose to support a campaign for non-financial motives, because they believe in the campaign’s potentialities and objectives, as well as “the investee’s chances of success”.87 unlike traditional finance, investment crowdfunding puts the contributors, belonging to a crowd, in closer contact with the project owner.88 investment-based crowdfunding is usually subdivided in two main categories: debt-based crowdfunding (or loan-based crowdfunding, peerto-peer lending, crowdlending) and equity crowdfunding (or crowdinvesting). further subdivisions have been identified by commentators.89 investment-based crowdfunding constitutes nowadays a 84 anjanette raymond and abbey stemler, ‘trusting strangers: dispute resolution in the crowd’ (2015) 16 cardozo journal of conflict resolution 357. 85 for a comprehensive typology of investment crowdfunding subtypes, see rotem shneor, crowdfunding models, strategies, and choices between them, in shneor et al (n 12) 24-25; sondes mbarek and donia trabelsi, ‘crowdfunding without crowdfooling: prevention is better than cure’ in kent baker h, lynnette purda-heeler and samir saadi (eds), corporate fraud exposed (emerald publishing limited 2020) 221; de quesada (n 5) 116. 86 chapman (n 64) 52; eleanor kirby and shane worner, ‘crowd-funding: an infant industry growing fast’ (iosco 2014) staff working paper of the iosco research department, 12. 87 olivier joffre and donia trabelsi, ‘le crowdfunding: concepts, réalités et perspectives’ (2018) 44(273) revue française de gestion 69. 88 ibid. 70. 89 the taxonomy proposed by the ccaf and the university of agder once again appears the more widely accepted one: ziegler et al., shifting paradigms: the 4th european alternative finance benchmarking report (n 5) 31. status artis of crowdfunding 26 dynamic branch of alternative finance and fintech. it holds great potential for the democratisation of access to financial capital and investment, making it possible for investors and fundraisers to bypass the traditional gatekeepers the banks.90 however, various regulatory and legal aspects remain problematic, which could hinder the full development of investment crowdfunding in the long term. indeed, the financial sector has historically been characterised by a continuous and reciprocal chase between financial innovation and regulation, the so-called “regulatory dialectic”. this interplay appears accentuated in investment crowdfunding because of the accelerated pace of technological progress characterising the early twenty-first century.91 furthermore, since investors typically contribute only small sums in projects, investment crowdfunding appeals to what has been dubbed “retail” or “consumer” investors as distinguished from sophisticated or professional investors. the main issue is that retail investors usually have limited capacity to assess a business’s prospects and related risks. as a result, they are prone to making investment decisions subject to biases and herding behaviour, following the crowd. apart from potential losses to investors, this can cause capital to be misallocated to low-quality entrepreneurial projects instead of more solid ones. these risks raise 90 kirby and worner (n 86) 14; bill frezza, ‘caveat emptor banking: peer-to-peer lending challenges too-big-to-fail status quo’ forbes (2003), online version: https://www.forbes.com/sites/billfrezza/2013/08/13/caveat-emptor-banking-peer-topeer-lending-challenges-too-big-to-fail-status-quo/?sh=2ff9e9aa3bdc; raymond michaels, ‘how crowdfunding is challenging the banking sector’ international banker (14 september 2015); de quesada (n 5) 105; robert shiller, ‘capitalism and financial innovation’ (2013) 69 financial analysts journal 21-22; alessandro cordova, johanna dolci j and gianfranco gianfrate, ‘crowdfunding’, in daniele archibugi and andrea filippetti (eds), the handbook of global science, technology, and innovation (john wiley & sons ltd. 2015) 245-266. 91 eugenia macchiavello, ‘financial-return crowdfunding and regulatory approaches in the shadow banking, fintech and collaborative finance era’ (2017) 14(4) european company and financial law review 662; tsai chang-hsien, ‘to regulate or not to regulate: a comparison of government responses to peer-topeer lending among the united states, china, and taiwan’ (2019) 87(4) university of cincinnati law review 1077-1122. on financial innovation, see scott frame w and lawrence white, ‘technological change, financial innovation, and diffusion in banking’, in allen berger, philip molyneux and john wilson (eds.), the oxford handbook of banking (oup 2009); josh lerner and peter tufano, ‘the consequences of financial innovation: a counterfactual research agenda’ (2011) nber working paper no. 16780 <https://www.nber.org/system/files/working_papers/w16780/w16780.pdf> accessed 14 april 2021; josef ackerman, ‘financial innovations: balancing private and public interests’, in miachel haliassos (ed), financial innovation: too much or too little? (cup 2013). njcl 2022/2 27 important questions for regulators, who must elaborate balanced and innovative solutions.92 these concerns constitute the focal point of the newly passed ecsp regulation, which applies to debt-based crowdfunding and equity crowdfunding across the eu.93 the regulation provides harmonised rules on the organisation and operation as a crowdfunding service provider, authorisation and supervision of platforms, and investor protection. it is worth noting that the ecsp regulation is very detailed and relies on further technical standards drafted by european securities and market authority (esma). the technical standards are expected by the time the ecsp regulation enters into force on 10 november 2021. 3.2. debt-based crowdfunding debt-based crowdfunding (or loan-based crowdfunding, crowdlending, peer-to-peer lending) has been subject to some attention by legal scholars in recent years.94 in debt-based crowdfunding, an investee will raise finance by way of a loan from multiple lenders. in return, the investee agrees to pay the principal plus interest according to an agreed schedule. debt-based crowdfunding platforms emerged in the mid-2000s with zopa being established in the uk in 2005, prosper and lendingclub in the united states soon after.95 these platforms were created to connect potential lenders (or investors) to potential borrowers (or lendees, fundraisers). especially in the last few years, the number of active 92 john armour and luca enriques, ‘the promise and perils of crowdfunding: between corporate finance and consumer contracts’ (2017) law working paper n° 366/2017 european corporate governance institute 58. 93 see regulation (eu) 2020/1503 of the european parliament and the council on european crowdfunding service providers for business and amending regulation (eu) 2017/1129 and directive (eu) 2019/1937; directive (eu) 2020/1504 of the european parliament and the council amending the directive (2014/65/eu) relating on markets in financial instruments. 94 see bibliography below at 5.3 for an overview on the existing legal scholarship concerning debt-based crowdfunding. sharath chandupatla and manal shah, ‘peerto-peer lending and equity-based crowd funding status quo and the leap forward’ (2019) 9(1) nirma university law journal 103-104; catherine houssa, ‘le peer-to-peer lending: un disrupteur innovant à l’avenir encore incertain’ 2016 2 stradalex: forum financier / droit bancaire et financier 75-84. 95 ziegler and shneor, lending crowdfunding: principles and market development, in shneor, zhao, and flåten (n 12) 63; alexander bachmann, alexander becker, daniel buerckner et al., ‘online peer-to-peer lending – a literature review’ (2011) 16(2) journal of internet banking and commerce 1; garry bruton, susanna khavul, donald siegel et al., ‘new financial alternatives in seeding entrepreneurship: microfinance, crowdfunding, and peer-to-peer innovations’ (2015) 39(1) entrepreneurship theory and practice 9. status artis of crowdfunding 28 platforms has increased.96 in contrast to equity crowdfunding, in debtbased crowdfunding the borrower does not surrender any portion of the company’s ownership. for the lender, the prospect of a capital and interest repayment schedule may be attractive as a yield generating opportunity, as opposed to the possibility of a dividend and/or capital gain later in the future.97 although debt-based, or peer-to-peer lending (p2p), is not easily defined in a strict manner, the model can usefully be described as the “matching of investors (lenders) and project owners (borrowers) through the use of an electronic information system (the platform) managed by a service provider, which as a legal person facilitates the granting of loans”.98 here, the term ‘peers’ refers to both individuals and businesses. indeed, debt-based crowdfunding is usually divided into two main categories depending on the nature of the borrower. first, p2p business lending, whereas “individuals or institutional funders provide a loan to a business borrower”.99 second, p2p consumer lending, “understood as individuals or institutional funders who provide a loan to a consumer borrower”.100 in both types, the platform acts as the intermediary between borrowers and lenders, vetting prospective borrowers.101 given their need to build trust and a respectable platform, it is in the interest of the crowdfunding service providers to vet prospective borrowers. hence, a degree of self-regulation in the business is to be expected. in terms of numbers, debt-based crowdfunding models exhibit high year-on-year growth rates and account for the majority of funds raised across all macroregions, such as europe, north america and the asiapacific.102 for instance, in 2017, p2p business lending accounted for € 466.60 million across european markets, or 14% of the total. p2p consumer lending accounted for € 1,392.38 million, or 41% of the total, the largest single category by far.103 in 2018, if we exclude the uk, debtbased crowdfunding models accounted for approximately € 7,745.00 million overall.104 the global covid19 crisis is likely to impact p2p 96 tanja jørgensen, ‘peer-to-peer lending – a new digital intermediary, new legal challenges’ (2018) 1 nordic journal of commercial law 234. 97 chapman (n 64) 53. 98 jørgensen (n 96) 234. 99 ibid. 234. 100 ibid. 235. 101 for the typical procedure for the obtention of a p2p financement, see rainer lenz, ‘peer-to-peer lending: opportunities and risks’ (2016) 7(4) european journal of risk regulation 688. 102 rau (n 11) 4; ziegler et al., shifting paradigms: the 4th european alternative finance benchmarking report (n 5) 31; de quesada (n 5) 114. 103 ziegler et al., shifting paradigms: the 4th european alternative finance benchmarking report (n 5), 31. 104 ziegler and shneor (n 5), 41. the uk continues to be the largest p2p market in europe, although its share is decreasing year after year. njcl 2022/2 29 numbers’, although the industry’s prospects remain positive.105 commentators have highlighted that institutional investors are increasingly becoming involved in debt-based crowdfunding.106 debt-based crowdfunding can provide a cheaper and promising funding opportunity for both consumer and business borrowers, while usually offering higher interest rates to lenders compared to traditional and more structured forms of investment.107 however, debt-based crowdfunding comes with its own set of risks and legal challenges. thus, the need for balanced regulations and investor protection is particularly felt among commentators.108 looking at china, which by far is the bigger market for debt-based crowdfunding provides an illustrative example as it has been the object of recent scholarship. indeed, chinese p2p lending expanded by a factor of sixty between 2013 and 2017, dwarfing all other markets109. in 2017, p2p lending volumes in china peaked at € 292.18 billion, while in the us, the second largest market volumes reached only € 15.46 billion.110 p2p lending met both the demand for alternative financing sources for chinese smes and savers’ demand for a better investment alternative. in a few years, it attracted million of retail investors.111 105 for an overview, see tania ziegler and et al., ‘the global covid-19 fintech market rapid assessment report’ (ccaf, world bank and world economic forum 2020). 106 eugenia macchiavello, ‘peer-to-peer lending and the “democratization” of credit markets: another financial innovation puzzling regulators’ (2014-2015) 21 columbia journal of european law 537; kathryn judge, ‘the future of direct finance: the diverging paths of peer-to-peer lending and kickstarter’ (2015) 50 wake forest law review 603, 613. 107 regarding the benefits of p2p lending, see kirby and worner (n 86) 21-22. the authors list: 1) helping economic growth through new and increasing flows of credit to smes and other users in the real economy; 2) filling a gap left by banks; 3) lower cost of capital/high returns leveraging off a lower cost basis; 4) creating a new product for portfolio diversification; 5) cost efficiency and convenience; increased competition in a sector traditionally dominated by a few providers. 108 more in general, among the risks of p2p lending, kirby and worner (n 86) 23-28, list: 1) risk of default; 2) platform risk; 3) risk of fraud; 4) information asymmetry; 5) risk of investor inexperience (retail investors); 6) liquidity risk; 7) risk of cyber-attack. see also lenz, "peer-to-peer lending: opportunities and risks", 688-700. with regard to the us, see andrew verstein, ‘the misregulation of person-to-person lending’ (2011) 45 uc davis law review, 445. 109 ding, kavuri and milne, (n 14) 134. see also lin (n 55) 327; yuan and xu (n 55) 275. 110 ding, kavuri and milne (n 13) 134. 111 traditionally in china “the interest rate is kept artificially low by the state so that cheap loans become status artis of crowdfunding 30 however, the country recently saw the closure of hundreds of p2p lending platforms due to issuers’ defaults. this was caused, as foreseen by some scholars, by the poor level of oversight and regulation imposed by chinese authorities on p2p platforms.112 in the 2010s, the authorities allowed the industry’s numbers to rise exponentially in what effectively was, until 2015, a regulatory vacuum, as opposed to the traditionally tightly regulated chinese financial sector. furthermore, many platforms applied the ‘guarantee’ model, under which a p2p platform not only matches lenders and borrowers, acting as an intermediary, but also provides guarantees for the lender’s principal and interests. due to the lack of specific regulation, platforms allowed underserved borrowers to receive financing, which in turn made the investments riskier for consumer lenders.113 the ensuing series of financial scandals, platform failures, frauds and massive ponzi schemes received ample media coverage.114 in reaction, the chinese government imposed a more stringent and comprehensive regulatory framework, the 2016 interim measures on online lending, which is described as the “cornerstone” of the chinese regime.115 these interventions inevitably increased the operational costs for platforms, making it difficult for them to sustain themselves and causing a steep contraction of the p2p lending market and the number of active p2p platforms in the country.116 the chinese case of study highlights the inherent difficulty of striking a balance between investor protection and business promotion.117 european institutions in recent years have shown to be aware of the necessity to strike such a delicate balance.118 one may available to borrowers”, and this made p2p lending even more attractive to investors compared to traditional financial instruments (so-called “policy of financial repression”). in ding, kavuri and milne (n 13) 135. 112 shen wei, ‘internet lending in china: status quo, potential risks and regulatory options’ (2015) 31 computer law & security review 793. 113 ding, kavuri and milne (n 13) 136. 114 amanda lee, ‘china’s p2p lenders face tough 2020 amid tighter regulation’ south china morning post (7 january 2020); emily feng, ‘chinese government faces peer-to-peer lending scandals dilemma’ financial times (12 november 2018); ‘leader of china’s $9 billion ezubao online scam gets life; 26 jailed’, reuters (12 september 2017); joe zhang, ‘collapse of china’s disgraced p2p sector offers important lessons’ nikkei asia (10 february 2020) <https://asia.nikkei.com/opinion/collapse-of-china-s-disgraced-p2p-sector-offersimportant-lessons> accessed 4 february 2021. 115 ding, kavuri and milne (n 13) 137. 116 ibid. 134. in 2018, the chinese market volume fell to € 174.70 billion, compared to € 23.10 billion in the us. 117 see fialkow (n 1) 391-405; yuan and xu (n 56) 275-304. 118 see, for instance: european commission, ‘commission staff working document: crowdfunding in the eu capital markets union’ <https://ec.europa.eu/transparency/regdoc/rep/10102/2016/en/10102-2016-154-enf1-1.pdf> accessed 27 november 2020; european commission and european njcl 2022/2 31 wonder what the impacts of the recently passed ecsp regulation in the eu may be in this regard. while legal scholarly opinion is extremely scarce and leaves the field wide open, it is seen in the preparatory works that crowdfunding in europe is “[...] characterised by its highly heterogeneous nature, shaped by the different starting points of nascent national crowdfunding sectors across the eu, and largely determined by the incumbent regulatory frameworks”. the european commission concluded already in 2016 that crowdfunding is rapidly developing, is transforming the financial system, and has the potential to become a key source of sme finance.119 prior to any legislative action, the predictability of law, transaction costs, authorisation of crowdfunding service providers, the conduct of crowdfunding businesses, and investor protection had the attention of the european commission.120 3.3. equity crowdfunding debt-based crowdfunding does not allow investors to acquire stakes in the business or venture they wish to finance. to fill this gap, equity crowdfunding (or crowd investing) has evolved as a further alternative fundraising channel. it complements, more than substitutes, the traditional source of equity funding represented by venture capitalists.121 equity crowdfunding enables companies, start-ups, and entrepreneurs to obtain capital from a large range of investors, each of them acquiring a small piece of equity. specialised online platforms act as intermediaries, and investors receive shares in the company in return for their investment, enjoying the opportunity to be part of the business instead of mere creditors.122 this aspect makes equity crowdfunding more complex than crowdfunding network (aisbl), ‘european commission. directorate general for financial stability, financial services and capital markets union. and european crowdfunding network aisbl., ‘identifying market and regulatory obstacles to cross-border development of crowdfunding in the eu: final report’ (publications office 2017) <https://data.europa.eu/doi/10.2874/65957> accessed 28 december 2020’. cf. jørgensen (n 96) 258-260. 119 european commission, commission staff working paper (n 118) 30-31. 120 ibid. 30-31; european commission and european crowdfunding network (n 118). 121 venture capitalists and angel investors have traditionally focused their resources on established businesses or on highly innovative firms with the potential for fast growth, usually located in clusters of innovation, such as silicon valley. see alan tomczak and alexander brem, ‘a conceptualized investment model of crowdfunding’ (2013) 15(4) venture capital: an international journal of entrepreneurial finance 335, 351-355; david groshoff, ‘equity crowdfunding as economic development?’ (2016) 38 campbell law review 48. see bibliography below at 5.4 for an overview on the existing legal scholarship concerning equity crowdfunding. 122 marina nehme, ‘regulating crowd equity funding: the why and the how’ (2018) 45(1) journal of law and society 116; tao huang and yuan zhao, ‘revolution of securities law in the internet age: a review on equity crowd-funding’ (2017) 33 computer law & security review 802. status artis of crowdfunding 32 debt-based crowdfunding from a contractual perspective, since “the transaction between the investor and the promoter is not a single exchange contract, or a loan, but it has instead a more associative nature that approximates it to the field of corporate law”.123 the investor base in equity crowdfunding is usually composed of a motley “group of individuals with varying levels of professional and educational backgrounds and investor professionalism”.124 in addition, angel and venture capital investors themselves are starting to make use of the opportunities offered by equity crowdfunding platforms. while investors’ motivations for investing are heterogeneous, a wish for financial returns generally appears to be the common driving force.125 the equity crowdfunding market grew significantly in the early 2010s across the world. however, from 2016 onwards, volumes in some regions have experienced declines driven by regulatory uncertainty and restraints.126 across european countries (excluding the uk) equity-based crowdfunding accounted for € 210.93 million, or 6 % of the crowdfunding market in 2017.127 in 2018, the amount rose to € 740.00 million, or 11,5 % of the total volume.128 on the one hand, equity crowdfunding certainly holds promise for entrepreneurs as an innovative source of financing and a remedy to smes' traditional shortfall of capital.129 on the other hand, recent studies suggest that, based on the so-called pecking-order-theory, entrepreneurs usually prioritise internal funds whenever possible, then external capital obtained through debt, including both traditional types and debt-based crowdfunding, turning to equity crowdfunding only as a last resort.130 in 123 de quesada (n 5) 116. 124 anna lukkarinen, ‘equity crowdfunding: principles and investor behaviour’, in shneor, zhao, and flåten (n 12) 96, 108; see also kim keongtae and siva visawanathan, ‘the experts in the crowd: the role of experienced investors in a crowdfunding market’ (2019) 43(2) mis quarterly 347. 125 ibidem; krista tuomi and richard t. harrison, ‘a comparison of equity crowdfunding in four countries: implications for business angels’ (2017) 26(6) strategic change 609; anna lukkarinen, jyrki wallenius and tomi seppälä, ‘investor motivations and decision criteria in equity crowdfunding’ (2017) ssrn electronic journal 1. 126 lukkarinen (n 125) 93-94. 127 ziegler et al., shifting paradigms: the 4th european alternative finance benchmarking report (n 5) 31. 128 ziegler and shneor (n 5) 41. 129 nehme (n 122) 118-123; lars hornuf and armin schwienbacher, ‘should securities regulation promote crowdinvesting?’ (2017) 49 small business economics 579. 130 xavier walthoff-borm, armin schwienbacher, and tom vanacker, ‘equity crowdfunding: first resort or last resort?’ (2018) 33(4) journal of business venturing 513; brage humphries, ‘funding the future: marketplace lending equity crowdfunding, and bank lending’ 2020 24(1) north carolina banking institute 229. njcl 2022/2 33 addition, equity crowdfunding may only generate a financial return in the long run and, of course, only if the investee proves successful. like venture capitalists, equity crowdfunders invest in nascent businesses with all the related uncertainties and risks. however, unlike venture capitalists “retail crowdfund investors usually lack specialist expertise about the prospects of the business projects they back, which leaves them more exposed to poor selection”.131 furthermore, they do not take control rights because the costs of doing so outweigh the benefits, given crowdfunding investors’ lack of expertise and high coordination costs. this lack of control leaves them more exposed than a venture capitalist to opportunistic and potentially fraudulent conduct by the fundraiser after the investment is made.132 the literature review carried out for the purpose of this paper shows that us legal literature on equity crowdfunding is three times the amount compared to european writings. the finding is not surprising, as the us was one of the first countries to implement legislative initiatives on the subject starting from 2012. however, commentators generally view the current us regulatory regime as unsatisfactory.133 indeed, until 2012 equity crowdfunding in the us remained regulated by the securities laws first issued in 1933, after the great depression.134 securities laws are designed to regulate financial products deemed to be securities, imposing costly registration procedures to the issuers.135 the us congress designed the securities act with a focus on disclosure of information about investments, more than on the quality of investments in itself. us legislators believed that full and truthful disclosure would allow individuals to make informed investing decisions, while the u.s. securities and exchange commission (sec) acted as the watchdog.136 the cession of equity crowdfunding shares, which are securities, was initially subjected to the requirements of the securities laws. this seemed too burdensome since the object of crowdfunding investments were empirical evidence suggests that firms listed on equity crowdfunding platforms are usually less profitable, often presenting excessive debt levels, and have more intangible assets than matched firms not listed on these platforms. 131 armour and enriques (n 92) 12. 132 ibid. 133 regarding the regulation of equity crowdfunding in the us, see fialkow (n 1) 391405; abbey stemler, ‘equity-based crowdfunding: allowing the masses to take a slice of the pie’, in méric, maque, and brabet (n 35) 219-232. 134 joan heminway, ‘selling crowdfunded equity: a new frontier’ (2017) 70 oklahoma law review 189, 195. 135 under us federal law, the term “security” broadly covers all traded financial assets, usually divided in three: 1) equity securities, namely stocks; 2) debt securities, e.g., bonds and banknotes; 3) derivatives, e.g., options. cf. rafael porrata-doria, ‘resolving the crowdfunding conundrum: the experience of the united states and spain’ (2020) 9(2) american university business law review 219, 240. 136 christine hurt, ‘pricing disintermediation: crowdfunding and online auction ipos’ (2015) university of illinois law review 217, 234-235. status artis of crowdfunding 34 relatively small sums. therefore, the american congress intervened in 2012 with title iii of the jumpstart our business startups act (jobs act). it outlined an exemption for crowdfunding from many securities law requirements, in order to boost this new alternative finance method.137 thus, title iii of the jobs act (also known as crowdfund act, or “capital raising online while deterring fraud and unethical nondisclosure act”) opened the door for wider participation in crowdfunding by allowing non accredited investors to make limited investments in privately held companies.138 the jobs act maintained the distinction between consumer and accredited investors, the latter being defined only by their higher net-worth.139 under title iii, entrepreneurs and small business owners may utilise the crowdfunding exemption to raise up to us $ 1 million within a oneyear period without registering the sales with the sec. however, the legislator still envisaged requirements concerning disclosure, registration of the crowdfunding service provider, and capital limitations. any investor, whether accredited or unaccredited, could invest in companies relying on the crowdfunding exemption, albeit with a max cap determined by their income or net worth.140 in order to make title iii effective at the federal level, especially in terms of consumer equity crowdfunding, the sec needed to adopt implementing regulations. the latter were released only in october 2015, entering into force in may 2016.141 since its inception, a number of 137 heminway (n 134) 191. 138 jumpstart our business startups act, pub. l. no. 112-106, 126 stat. 306 (2012). 139 commentators highlight how wealth in itself is not a real indicator of whether an investor is sophisticated or not. cf. porrata-doria (n 135) 224. 140 more specifically: jobs act, § 302 (a) amending section 4 of the securities act of 1933 “... (b) the aggregate amount sold to any investor by an issuer, including any amount sold in reliance on the exemption provided under this paragraph during the 12-month period preceding the date of such transaction, does not exceed—(i) the greater of $2,000 or 5 percent of the annual income or net worth of such investor, as applicable, if either the annual income or the net worth of the investor is less than $100,000; and (ii) 10 percent of the annual income or net worth of such investor, as applicable, not to exceed a maximum aggregate amount sold of $100,000, if either the annual income or net worth of the investor is equal to or more than $100,000...”. 141 lee (n 76) 23. see also thomas coke, ‘why the new crowdfunding rules are important but ultimately a letdown’ (2017) 17 journal of business & securities law 218; david groshoff (n 121) 48; max isaacson, ‘the so-called democratization of capital markets: why title iii of the jobs act fails to fulfill the promise of crowdfunding’ (2016) 20 north carolina banking institute 440; marquise rivon, ‘don’t let them fool ya: examining the sec rules on crowdfunding and their effect on small business growth’ (2016) 44 rutgers law records 21; ‘the 2017 state of regulation crowdfunding: us securities-based crowdfunding under title iii of the jobs act’ (crowdfund insider, 15 january 2018); amy wan, ‘title iii njcl 2022/2 35 scholars have lamented the complexity and costs for intermediaries and issuers of this equity crowdfunding regulatory regime.142 besides, it has been noted that it did not really prevent crowdfunding from becoming a “market of lemons”.143 other commentators remain sceptical regarding the so-called wisdom of the crowds, considering that non-sophisticated investors are still likely to make poor investment decisions and incomplete risk assessments, especially considering the limited information available to them.144 others continue to underline that the danger of fraudulent offerings is amplified because the small volume of individual investments makes it uneconomical and difficult to get redress via the traditional legal remedies, while enforcing a judgement vis-à-vis impecunious fraudsters remains unlikely.145 existing legal literature in the us has so far focused on the regulatory regime devised by the legislator from the jobs act onwards, its shortcomings and suggested improvements.146 the securities watchdog, the sec, remains concerned with investor protection, while legislators confront the need to boost smes’ access to capital through equity crowdfunding. that being said, the sec is currently reflecting on modifying its regulations to address some of the weaknesses highlighted by practitioners and scholars alike.147 in other words, the analysis of the interplay between financial innovation / inclusion and investor protection / fraud avoidance so far has taken the lion’s share of us legal literature on crowdfunding. in comparison to the us, european legal literature on equity crowdfunding appears still in its infancy, focusing on each jurisdiction’s regulatory approach to equity crowdfunding.148 indeed, throughout the crowdfunding became legal on may 16: what it does & what’s still lacking’ (crowdfund insider, 17 may 2016). 142 porrata-doria (n 135) 256-260; dylan j. hans, ‘rules are meant to be amended: how regulation crowdfunding’s final rules impact the lives of startups and small businesses’ (2018) 83(3) brooklyn law review 1089; lee (n 77) 21: “the author contends that for the high-growth issuers targeted by the legislation, crowdfunding is likely to be too expensive, too complex and have too great of liability risk to undertake, when the issuer has other financing alternatives.” 143 hurt (n 136) 254-255. 144 porrata-doria (n 135) 254; melissa baucus and cheryl mitteness, ‘crowdfrauding: avoiding ponzi entrepreneurs when investing in new ventures’ (2016) 59 business horizons 37, 39; garry gabison, ‘equity crowdfunding: all regulated but not equal’ (2015) 13 depaul business & commercial law journal 359, 369. 145 steven c. bradford, ‘online arbitration as a remedy for crowdfunding fraud’ (2018) 45 florida state university law review 1169. 146 for instance, see stemler (n 133) 231. most legal articles on the subject were published between 2014 and 2017. 147 porrata-doria (n 135) 256. 148 for instance, see nehme (n 122); macchiavello e, “la travagliata evoluzione normativa dell’equity crowdfunding in italia, il nuovo regolamento consob e la status artis of crowdfunding 36 2010s the regulatory framework remained fragmented across the continent. while some states, such as france (ordonnance 2014-559), spain (ley 5/2015), italy (decreto legge 179/2012), and the uk (fca 2014), introduced specific laws regulating equity crowdfunding, other states opted for the application of the general rules while yet others simply have maintained a ban on equity crowdfunding.149 the uk has consistently remained the major market for equity crowdfunding, although its neighbours are increasing their share of the total volumes of equity crowdfunding raised across the continent.150 in november 2021, the entering into force of the ecsp regulation across the eu member states will likely provide new momentum to european scholarship on equity crowdfunding. 4. conclusion and perspectives upon examination, almost 300 unique publications on crowdfunding law have been identified globally.151 by comparison, it is evident that crowdfunding, as an area of legal scholarship, is still in its infancy. knowing that the amount of money raised through crowdfunding is growing, domestic and regional legislators increase their efforts to regulate, and that there is a documented “correlation between regulatory clarity – the introduction of an explicit legal crowdfunding regulation in a country – and the volume of crowdfunding in the subsequent year”.152 the time is ripe for legal scholars to contribute to the development of the market. no matter the specific type, and possible crowdfunding-specific legislation, like the ecsp regulation in the eu aside, crowdfunding activities are governed by general legal frameworks, such as marketing law prospettiva di regolazione del crowdfunding a livello europeo: una disciplina destinata a breve vita?” (2018) 3 rivista di diritto bancario | dottrina e giurisprudenza commentata 1; de quesada (n 5) 121-132; lars klöhn, lars hornuf and tobias schilling, ‘the regulation of crowdfunding in the german small investor protection act: content, consequences, critique, suggestions’ (2016) 13(2) european company law 56; isabella wichmann and josephine worm andersson, ‘aktiebaseret crowdfunding en ny spiller inden for alternativ finansiering i danmark’ (2016) nordisk tidsskrift for selskabsret 21. 149 national legislation relating specifically to crowdfunding is also seen in belgium: belgisch staatsblad, 20 december 2016, wet tot regeling van de erkenning en de afbakening van crowdfunding en houdende diverse bepalingen inzake financiën; finland: crowdfunding act (734/2016); portugal: lei n. 102/2015 regime jurídico do financiamento colaborativo; denmark: lbk n. 763 af 23/07/2019 § 1, stk. 3, which prohibits limited liability companies (as different to joint stock company) to publicly offer equity, thus limiting equity crowdfunding to zero in practice. 150 respectively, € 732.50 million in the uk and € 743.35 million across the other european countries in 2018. see ziegler, shneor, wenzlaff et al (n 5) 41. 151 see section 5, ‘bibliography on legal scholarship’ where a total of 186 unique sources are referenced to the benefit of future scholarship. 152 rau (n 10) 5. njcl 2022/2 37 and intellectual property law.153 these provide part of the picture of the regulatory framework of crowdfunding activities and should be considered by legal scholars. despite focusing on various crowdfunding models and different jurisdictions, legal scholarship is often concerned with questions of how to regulate a highly internationalised market, how to encourage development to the benefit of innovation and, at the same time, protect the often-unsophisticated investors. legal researchers should beware that the regulation dialectic may taint crowdfunding, that investors may be unable to assess prospects and risks properly, and that presumptions of crowd wisdom may in fact be mindless herd behaviour. virtually all legal scholarship in the field relies on a distinction between investment and non-investment crowdfunding types and categorises crowdfunding models into four basic types: the donation model, the rewards model, the debt-based model, and the equity model. while there are several other crowdfunding sub-models, there is a consistent reference to the four primary types in the literature, which correlates with the fact that the general legal framework is often dependent on the four types. legislators appear to recognise, welcome, and react to the disruptive nature that crowdfunding has on the financial market and that it is part of a larger trend concerning democratisation and digitalisation of the financial sector. much of the legal writings seem to focus on the us jobs act and less on european initiatives. however, there is an overlap in themes across scholarship as it often addresses predictability of law, conduct of the crowdfunding businesses, protection of investors / disclosure, and access to risk capital. legal scholars who desire to carry out comparative studies will have at least some footing to do so in the pool of literature. further legal studies may help abate some of the uncertainties of interpreting the legal framework of crowdfunding. moreover, they could provide a critical and comparative opinion to the benefit of crowdfunding service providers forum shopping, harmonisation, and development of national and regional legislation. all stakeholders in crowdfunding, the investors, the crowdfunding service providers, the fundraisers, and public authorities too, have a mutual interest in a common and predictable legal framework to increase trust in crowdfunding as a source of finance. even though crowdfunding is still not the typical source of risk capital for start-ups, the sector is growing fast in both the volumes of money raised, types of crowdfunding services, and the number of service providers. as a result, one may wonder if crowdfunding provides a useful method for civil society to help kick-start the economy in a post-pandemic world. 153 møller toftegård and krull (n 75) 42-46. status artis of crowdfunding 38 both legislators and legal scholars have largely overlooked donation and reward-based crowdfunding. one problem attached to these crowdfunding types is that it is difficult to distinguish between donation and reward-based crowdfunding, as they are often mixed in practice. the distinction is critical for deciding whether the general legal framework regarding public fundraising or the laws of contract and sales apply to the activity. another problem is that it is unknown whether these frameworks are predictable enough to create trust in crowdfunding and to effectively decide the default legal obligations of fundraisers and crowdfunding service providers. it is unknown whether the many consumer protection measures in place, especially in europe, apply, and whether they are possible to modify in crowdfunding pre-sales situations as there may be good reasons to do so. it is problematic that donation and rewards-based crowdfunding provide the opportunity of testing initial demand and involving consumers in product development on one hand when, on the other hand, the legal relationship between funder and fundraiser remains unexplored. one may fear that, over time, this will lead to disappointed stakeholders and therefore less trust and use of crowdfunding. investment crowdfunding has attracted more legal scholars than the non-investment types. in addition to the concerns already raised, the focus on investor protection is stronger in the literature addressing debt-based and equity crowdfunding. the disruption of the financial markets becomes particularly apparent here, as crowdfunding relies on more lax regulation to work the best. at the same time, stakeholders have an interest in combating fraud that undermines the trust that is instrumental to crowdfunding. legislators attempt to strike the right balance between protecting the retail or unsophisticated investors while still encouraging smes’ access to risk capital. the lessons from china may be useful to legal scholars in this regard. investment-based crowdfunding also enjoys the most attention of legislators and the preponderant part of legal research is devoted to the us legal framework in this regard. the recent eu regulation of ecsps is largely unaddressed in the literature at this point. the legislative roadmap from domestic law into the harmonised eu regulation is not described by scholars, despite it being valuable to the interpretation and critique of the regulation. in summary, it can be concluded that the comprehensive overview of the state of the art of legal science on crowdfunding reveals several concerns that legal scholars may address. while many key concepts of crowdfunding are somewhat established in the literature, the legal scholarship seems not to take full comparative advantage of the fact that many concerns are common across jurisdictions, such as encouraging sme development through access to risk capital or ensuring the protection of the unsophisticated investor. to stimulate further development of the legal aspects of crowdfunding, a categorised bibliography is attached below. njcl 2022/2 39 5. bibliography on legal scholarship to support and foster new legal scholarship, we provide a bibliography of legal scholarship relevant to each of the four crowdfunding types. it should be noted that while many listed publications are concerned with one type of crowdfunding, there are several publications concerned with several of the crowdfunding types. hence, these latter materials are categorised under each of the relevant crowdfunding types. materials published after 1 may 2021 have not been considered.154 5.1. scholarship on donation crowdfunding ‘review of crowdfunding regulation 2017: interpretations of existing regulation concerning crowdfunding in europe, north america and israel’ (2017) bowman b, ‘a comparative analysis of crowdfunding regulation in the united states and italy’ (2015) 33 wisconsin international law journal 318 bradford cs, ‘crowdfunding and the federal securities laws’ (2012) 2012 columbia business law review 1-151 buysere k et al., ‘a framework for european crowdfunding’ (2012) chapman p, ‘crowdfunding’, fintech: law and regulation (edward elgar publishing limited 2019) clarke o, ‘regulation of crowdfunding in germany, the uk, spain and italy and the impact of the european single market’ (european crowdfunding network (ecn) 2013) cumyn m and wend-nongdo ji, ‘l’encadrement juridique du sociofinancement au quebec’ (2019) 60 cahiers de droit 699 davis ke and gelpern a, ‘peer-to-peer financing for development: regulating the intermediaries’ (2010) 42 new york university journal of international law and politics durdenic k, ‘crowdfunding croatian legal perspective and comparison to other sources of financing’ (2017) 41 public sector economics 259 esposito l, “il crowdfunding, uno strumento alternativo di finanziamento” (2019) 1 rivista bancaria minerva bancaria 97 european commission, ‘commission staff working document: crowdfunding in the eu capital markets union’, swd(2016)154, 03/05/2016 farnkoff bj, ‘crowdfunding for biotechs: how the sec’s proposed rule may undermine capital formation for startups’ (2013) 30 journal of contemporary health law & policy 131 154 for the most updated bibliography, we kindly refer to the online version accessible at www.theclearproject.dk. status artis of crowdfunding 40 fialkow z, ‘crowd-fundamentals: balancing rapidly advancing crowdfunding innovation with protections for consumers’ (2017) 4 emory corporate governance and accountability review 391 furnari sl, ‘equity-based crowdfunding: the issuer’s perspective’ (master of laws, 2015) gomez ma, ‘crowdfunded justice: on the potential benefits and challenges of crowdfunding as a litigation financing tool’ (2015) 49 university of san francisco law review 307 hazen tl, ‘crowdfunding or fraudfunding social networks and the securities laws why the specially tailored exemption must be conditioned on meaningful disclosure’ (2012) 90 north carolina law review 1735 hurt c, ‘pricing disintermediation: crowdfunding and online auction ipos’ (2015) university of illinois law review 217 james tg, ‘far from the maddening crowd: does the jobs act provide meaningful redress to small investors for securities fraud in connection with crowdfunding operations’ (2013) 54 boston college law review 37 juredieu f and mayoux s, ‘crowdfunding legal framework: an international analysis’, international perspectives on crowdfunding: positive, normative and critical theory (2016) lavens p, ‘een evenwicht tussen flexibele financiering en investeerdersbescherming’ (2015) 52 jura falconis 91 lee ph, ‘access to capital or just more blues? issuer decisionmaking post sec crowdfunding regulation’ (2016) 18 transactions: the tennessee journal of business law 19 mathews k, ‘crowdfunding, everyone’s doing it: why & how north carolina should too’ (2015) 94 north carolina law review 276 metrejean ct and a. mckay b, ‘donation-based crowdfunding and nontaxable gifts’ [2018] journal of accountancy møller toftegård p and krull mc, netværksfinansiering en guide til crowdfunding (lett) quaranta g, “crowdfunding. il finanziamento della folla, o dei ‘folli’?” (2016) 6 diritto ed economia dell’impresa 249 rau pr, ‘law, trust, and the development of crowdfunding’ (social science research network 2020) ssrn scholarly paper id 2989056 accessed 5 november 2020 schwartz aa, ‘the gatekeepers of crowdfunding’ (2018) 75 washington and lee law review 885 simón-moreno h, ‘the legal framework on crowdfunding in spain’ (2016) 4 revue internationale des services financiers/international journal for financial services 13 shneor r, zhao l and flåten b-t (eds), advances in crowdfunding: research and practice (springer international publishing 2020) njcl 2022/2 41 short jc et al., ‘research on crowdfunding: reviewing the (very recent) past and celebrating the present’ (2017) entrepreneurship theory and practice 149 solar plaza, ‘crowdfunding legal framework overview’ from the renewable energy crowdfunding conference 5 november 2015 tröger th, ‘regulation of crowdfunding in germany’ [2018] safe working paper no. 199 tsai ks and wang q, ‘charitable crowdfunding in china: an emergent channel for setting policy agendas?’ (2019) 240 the china quarterly 936 wroldsen j, ‘crowdfunding investment contracts’ (2017) 11 virginia law and business review 543 5.2. scholarship on reward crowdfunding bowman b, ‘a comparative analysis of crowdfunding regulation in the united states and italy’ (2015) 33 wisconsin international law journal 318 bradford cs, ‘crowdfunding and the federal securities laws’ (2012) columbia business law review 1-151 buysere k et al., ‘a framework for european crowdfunding’ (2012) catalini c, fazio c and murray f, ‘can equity crowdfunding democratize access to capital and investment opportunities?’ [2016] ssrn electronic journal <http://www.ssrn.com/abstract=2780551> accessed 29 december 2020 chapman p, ‘crowdfunding’, fintech: law and regulation (edward elgar publishing limited 2019) clarke o, ‘regulation of crowdfunding in germany, the uk, spain and italy and the impact of the european single market’ (european crowdfunding network (ecn) 2013) durdenic k, ‘crowdfunding croatian legal perspective and comparison to other sources of financing’ (2017) 41 public sector economics 259 esposito l, “il crowdfunding, uno strumento alternativo di finanziamento” (2019) 1 rivista bancaria minerva bancaria 97 european commission, ‘commission staff working document: crowdfunding in the eu capital markets union’, swd (2016) 154, 03/05/2016 <https://ec.europa.eu/transparency/regdoc/rep/10102/2016/en/101 02-2016-154-en-f1-1.pdf> accessed 27 november 2020 fialkow z, ‘crowd-fundamentals: balancing rapidly advancing crowdfunding innovation with protections for consumers’ (2017) 4 emory corporate governance and accountability review 391 furnari sl, ‘equity-based crowdfunding: the issuer’s perspective’ (master of laws, 2015) status artis of crowdfunding 42 ganatra jh, ‘when a kickstarter stops: exploring failures and regulatory frameworks for the rewards-based crowdfunding industry’ (2016) 68 rutgers university law review 48 gomez ma, ‘crowdfunded justice: on the potential benefits and challenges of crowdfunding as a litigation financing tool’ (2015) 49 university of san francisco law review 307 hurt c, ‘pricing disintermediation: crowdfunding and online auction ipos’ (2015) university of illinois law review 217 lam a, ‘less is more? different regulatory responses to crowdfunding and why the hong kong model stacks up well’ (2018) 48 hong kong law journal 191 lavens p, ‘een evenwicht tussen flexibele financiering en investeerdersbescherming’ (2015) 52 jura falconis 91 lee ph, ‘access to capital or just more blues? issuer decisionmaking post sec crowdfunding regulation’ (2016) 18 transactions: the tennessee journal of business law 19 møller toftegård p and krull mc, netværksfinansiering en guide til crowdfunding (lett) moores c, ‘kickstart my lawsuit: fraud and justice in rewardsbased crowdfunding’ (2015) 49 uc davis law review 383 piattelli u, ‘capitolo 3 profili generali: una breve panoramica sulle norme e i regolamenti che potrebbero applicarsi al crowdfunding’, crowdfunding in italia: una regolamentazione all’avanguardia o un’occasione mancata? 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yesim atamer, eric bergsten, joachim bonell, harry flechtner, lauro gama, alejandro garro, roy goode, john gotanda, han shiyuan, johnny herre, pilar perales viscasillas, ulrich schroeter, ingeborg schwenzer, hiroo sono, claude witz, members. sieg eiselen, secretary. 1. opinion ................................................................................................ 38 2. comments ............................................................................................ 39 2.1. rule 1 ............................................................................................. 2.1.1. standards ...................................................................... 39 2.1.2. determining the conformity of goods and standards ...................................................................... 40 2.2. rule 2 ............................................................................................ 2.3. rule 3 ............................................................................................. 2.4. rule 4 ............................................................................................. 2.4.1. general .......................................................................... 45 2.4.2. the parties’ statements and conduct before and after the conclusion of the contract .... 46 2.4.3. whether the buyer has drawn the seller’s attention to the standard ................................... 46 2.4.4. whether the seller has expressed a public commitment to the standard ................................ 47 2.4.5. prior dealings between the parties.................... 47 2.4.6. the extent of the buyer’s involvement in designing the goods and advising the seller as to the manufacturing or production process ............................................................................ 48 2.4.7. the parties’ expertise in relation to the goods ........................................................................................... 49 2.4.8. the business identity, characteristics, standing and size of the seller and the buyer ................. 49 2.4.9. whether the parties are in the same industry, trade, organisation, association or initiative that has adopted or follows the standard and whether compliance with the standard is required or expected ............................................... 50 2.4.10. the price* .................................................................... 50 2.4.11. the nature, complexity and prominence of the standard ............................................................... 51 2.4.12. the accessibility of information regarding the standard ............................................................... 52 2.4.13. whether the standard is incorporated in the seller’s code of conduct or the buyer’s code of conduct for suppliers, provided that they are publicly available .............................................. 52 2.4.14. the existence of competing standards ........... 53 2.4.15. any relevant trade usage that is not based on the standard in question ................................. 53 2.5. rule 5.1 ...................................................................................... 54 2.5.1. applicability at the place of use of the goods54 2.5.2. applicability at the buyer’s place of business . 54 2.6. rule 5.2 ...................................................................................... 55 2.6.1. general .......................................................................... 55 2.6.2. the seller’s prior dealings at that place, such as whether the seller had a branch or subsidiary or promoted goods of the same kind at that place ................................................................ 56 2.6.3. whether the standard at that place is the same as that at the seller’s place of business ........... 56 3. footnotes .......................................................................................... 57 37 introduction of the cisg-ac the cisg-ac started as a private initiative supported by the institute of international commercial law at pace university school of law and the centre for commercial law studies, queen mary, university of london. the international sales convention advisory council (cisgac) is in place to support understanding of the united nations convention on contracts for the international sale of goods (cisg) and the promotion and assistance in the uniform interpretation of the cisg. at its formative meeting in paris in june 2001, prof. peter schlechtriem of freiburg university, germany, was elected chair of the cisg-ac for a three-year term. dr. loukas a. mistelis of the centre for commercial law studies, queen mary, university of london, was elected secretary. the founding members of the cisg-ac were prof. emeritus eric e. bergsten, pace university school of law; prof. michael joachim bonell, university of rome la sapienza; prof. e. allan farnsworth, columbia university school of law; prof. alejandro m. garro, columbia university school of law; prof. sir roy m. goode, oxford, prof. sergei n. lebedev, maritime arbitration commission of the chamber of commerce and industry of the russian federation; prof. jan ramberg, university of stockholm, faculty of law; prof. peter schlechtriem, freiburg university; prof. hiroo sono, faculty of law, hokkaido university; prof. claude witz, universität des saarlandes and strasbourg university. members of the council are elected by the council. at subsequent meetings, the cisgac elected as additional members prof. pilar perales viscasillas, universidad carlos iii, madrid; professor ingeborg schwenzer, university of basel; prof. john y gotanda, villanova university; prof. michael g. bridge, london school of economics; prof. han shiyuan, tsinghua university, prof. yesim atamer, istanbul bilgi university, turkey, and prof. ulrich schroeter, university of mannheim. prof. jan ramberg served for a three-year term as the second chair of the cisgac. at its 11th meeting in wuhan, people’s republic of china, prof. eric e. bergsten of pace university school of law was elected chair of the cisgac and prof. sieg eiselen of the department of private law of the university of south africa was elected secretary. at its 14th meeting in belgrade, serbia, prof. ingeborg schwenzer of the university of basel was elected chair of the cisgac. 38 1. opinion article 35 cisg (1) the seller must deliver goods which are of the quantity, quality and description required by the contract and which are contained or packaged in the manner required by the contract. (2) except where the parties have agreed otherwise, the goods do not conform with the contract unless they: (a) are fit for the purposes for which goods of the same description would ordinarily be used; (b) are fit for any particular purpose expressly or impliedly made known to the seller at the time of the conclusion of the contract, except where the circumstances show that the buyer did not rely, or that it was unreasonable for him to rely, on the seller’s skill and judgement; (c) possess the qualities of goods which the seller has held out to the buyer as a sample or model; (d) are contained or packaged in the manner usual for such goods or, where there is no such manner, in a manner adequate to preserve and protect the goods. (3) the seller is not liable under subparagraphs (a) to (d) of the preceding paragraph for any lack of conformity of the goods if at the time of the conclusion of the contract the buyer knew or could not have been unaware of such lack of conformity. 1. the conformity of goods is determined not only by their quantity, quality, description, or packaging, but also by compliance with standards affecting the use of the goods, such as public law regulations and industry codes. 2. the relevant standards are those at the time of the conclusion of the contract. 3. under article 35(1), the seller must deliver goods which comply with the standards expressly or impliedly agreed upon. 4. in assessing whether, under article 35(2), the seller must deliver goods that comply with a given standard, the following factors may be taken into account: (a) the parties’ statements and conduct before and after the conclusion of the contract; (b) whether the buyer has drawn the seller’s attention to the standard; (c) whether the seller has expressed a public commitment to the standard; (d) any prior dealings between the parties; (e) the extent of the buyer’s involvement in designing the goods and advising the seller as to the manufacturing or production process; (f) the parties’ expertise in relation to the goods; (g) the business identity, characteristics, standing and size of the seller and the buyer; (h) whether the parties are in the same industry, trade, organisation, association or initiative that has adopted or follows the standard and whether compliance with the standard is required or expected; (i) the price; 39 (j) the nature, complexity and prominence of the standard; (k) the accessibility of information regarding the standard; (l) whether the standard is incorporated in the seller’s code of conduct or the buyer’s code of conduct for suppliers, provided that they are publicly available; (m) the existence of competing standards; (n) any relevant trade usage that is not based on the standard in question. 5.1 the seller may have an obligation to deliver goods that comply with local standards: (a) applicable at the place of use of the goods if, at the time of the conclusion of the contract, the seller knew or could not have been unaware of that place; (b) in any other case, applicable at the buyer’s place of business. 5.2 in assessing whether such standards are to be complied with, regard may be had to the following factors, in addition to those in rule 4: (a) whether the seller knew or could not have been unaware of the relevant standard at the place of the intended use; (b) the seller’s prior dealings at that place, such as whether the seller had a branch or subsidiary or promoted goods of the same kind at that place; (c) whether the standard at that place is the same as that at the seller’s place of business. 2. comments 2.1. rule 1 1. the conformity of goods is determined not only by their quantity, quality, description, or packaging, but also by compliance with standards affecting the use of the goods, such as public law regulations and industry codes. 2.1.1. standards 1.1. many products today have some corresponding standard(s) concerning their composition, features, such as health and safety, or the process to be followed in making them. a standard can be understood as a benchmark or a level of quality or attainment, with reference to which something is evaluated or the compliance with which is desirable or expected.1 the international organisation for standardization (iso) defines a standard as ‘a document that provides requirements, specifications, guidelines or characteristics that can be used consistently to ensure that materials, products, processes and services are fit for their purpose’.2 it is helpful to distinguish ‘public’ from ‘private’ standards. the former are adopted by state organisations, often being contained in public law regulations, or by inter-governmental organisations, such the united nations, international labour organisation or codex alimentarius commission.3 public standards can be mandatory or voluntary. other standards are ‘private’ in the sense that they are produced by non-state 40 bodies, initiatives, associations and organisations. these can be: companies, adopting their own standards or codes of conduct, (such as tesco nature’s choice)4; national industry bodies, such as the british retail consortium (brc) and its brc global standards;5 international consortia of companies and their global standards, such as globalg.a.p. (‘good agricultural practice’),6 the global food safety initiative (gfsi)7 or the equator principles (ep) association;8 international organisations that adopt standards across various industries and sectors, such as the iso that adopts standards in a wide range of areas, including technology, food safety, agriculture, healthcare, environment;9 civil society, represented by non-profit non-governmental organisations (ngos), such as the fairtrade foundation10 that promulgate what might called ‘ethical’ standards, concerning human rights, child labour and other labour standards, environmental protection, sustainability and corruption. being adopted by non-state actors, private standards are voluntary. however, they can become mandatory or quasi-mandatory.11 the former is the case where a private standard is incorporated into a national regulatory framework.12 the example of the latter is where standards are applied by the majority of businesses in a particular sector and/or where compliance with such standards is required by large companies (usually, buyers) dominating the relevant sector or supply chain.13 1.2. the existence of such standards raises the question of their relationship with the convention on contracts for the international sale of goods (cisg) that governs the rights and obligations of the parties arising from a ‘contract’ of the sale of goods. being a contract law instrument that seeks to assign duties, risks, liabilities and remedies between the two contracting parties, the cisg is not concerned with giving effect to any such standards. however, buyers often claim that sellers breach a contract and/or the convention if the goods do not meet a particular public or private standard. an important question therefore is: to what extent should such standards be taken into account in defining the seller’s obligations as to the conformity of goods under article 35 cisg? this opinion addresses this question, providing guidance as to the degree to which standards should be taken into account in interpreting a contract, governed by the cisg, and article 35 cisg. 2.1.2. determining the conformity of goods and standards 1.3. it is increasingly recognised that the conformity of goods comprises the relationship of the goods with their surrounding environment, of which standards are an important part.14 thus, the conformity of goods should in principle be determined not only by their quantity, quality, description, or packaging, but also by compliance with standards affecting the use of the goods. according to article 35(1) cisg, 41 the ‘conformity’ of goods comprises their quantity, quality, description, containment or packaging. standards, whether public or private, are often concerned with these aspects of conformity, as well as with many others, such as technical, ethical, environmental and health and safety considerations and/or the process of designing, manufacturing or producing the goods. it must also be stressed that when interpreting the contract under article 35(1), regard must be had to all relevant circumstances, as is made clear by article 8(3) cisg.15 given that standards deal with various aspects and features of the goods, the standards can be such a ‘relevant circumstance’ or factor that must be taken into account when interpreting the contract. 1.4. some key terms as to the conformity of goods, implied under article 35(2), focus on the use of the goods. article 35(2)(b) is concerned with the seller’s obligations where a particular purpose, for which the goods are intended to be used, has been made known to the seller. article 35(2)(a), in turn, provides a fall-back rule, according to which goods are to be ‘fit for the purposes for which goods of the same description would ordinarily be used’.16 standards can affect the use of the goods, whether it is the use flowing from the particular purpose under article 35(2)(b) or the ordinary use under article 35(2)(a), including their containment or packaging (article 35(2)(d)). thus, if a standard is contained in public law regulations, the use of the goods may be affected if they do not comply with this standard. even if a standard is not mandatory, companies in a given market, sector or supply chain may have to comply with such a standard in order to enter, remain in the market or carry on business effectively if such compliance is expected by within that market or sector17 and/or required by a company dominating a supply chain (usually, the buyer).18 2.2. rule 2 2. the relevant standards are those at the time of the conclusion of the contract. 2.1. if a particular standard is in principle relevant to determining the conformity of goods under the cisg, the question arises as to the point in time with reference to which the standard in question is to be taken. the question is important where the standard in question changes subsequent to the time of the conclusion of the contract, such as where new scientific evidence about an aspect of the goods19 or suspicions about the goods being unsafe emerge after the contract is made.20 the convention’s general rule in article 36(1) is that the seller is liable for a lack of conformity which exists ‘at the time when the risk passes to the 42 buyer’.21 however, this point is for assessing the seller’s conformity obligations in their entirety and it needs to be distinguished from the point in time at which a particular standard is to be taken. the timing of a standard is more closely aligned with the parties’ agreement than with the time of the passage of risk and, specifically, with the allocation of risks between the parties. for this reason, the relevant standards are those at the time of the conclusion of the contract. whether the goods in fact meet the relevant standards is, however, to be assessed with reference to the time when the risk passes to the buyer, as required by article 36(1). 2.2. it can be argued that in determining the seller’s obligations as to the conformity of goods it is ‘artificial’ to ignore changes in standards, arising after the contract is made, particularly if they arise because of the newly emerging scientific evidence that becomes available at the time of legal proceedings.22 however, if changes to standards made after the contract is made are taken into account, the seller’s conformity obligations can never be tested with reference to a fixed point in time and would be continuously subject to any changes in standards occurring up to the time of legal proceedings.23 such a position would be unfair and unsettling to sellers. in contrast, the time of making the contract is when the contracting parties assume risks associated with their contractual performance. taking standards at the time of the conclusion of the contract promotes legal certainty and predictability that parties need to be able to effectively and reliably plan and manage their potential risks, liabilities and costs. the contracting parties’ intention may be that the seller ought to comply with standards, affecting the use of the goods, as they are at a time subsequent to the conclusion of the contract. if so, such an intention needs to be made clear in the contract, so as to effectively derogate from the rule that the relevant standards are those at the time of the conclusion of the contract. 2.3. rule 3 3. under article 35(1), the seller must deliver goods which comply with the standards expressly or impliedly agreed upon. 3.1. based on the principle of freedom of contract, article 35(1) cisg gives primacy to the contract.24 if the contract requires the seller to deliver goods that comply with a particular standard, the seller is in breach of contract if the goods do not comply with the contractually specified standard. the parties can expressly incorporate a given standard or, alternatively, a document, such as public law regulations or an industry code, that contain a standard.25 some such standards may be concerned with the goods’ physical features, whereas some others focus on the manufacturing process, setting out, for instance, benchmarks of safety, 43 sustainability, duties of care, environmental protection or ethical considerations.26 3.2. article 8 cisg makes clear that the parties may agree on the need for the goods to comply with a certain standard implicitly. whether that is the parties’ intention needs to be determined by interpreting their statements and conduct in the light of all relevant circumstances of the case, such as those set out in article 8(3).27 an implicit intention that the goods ought to comply with a particular standard may be inferred, for example, from the practice established between the parties or by virtue of a trade usage to this effect.28 in some cases, a contract, whilst lacking an express provision, may still contain formulations that reflect the intention for the goods to comply with a certain standard, such as where: the contract provides that the goods are to be ‘ce approved’;29 and, before the contract was made, the seller had known that the goods were to be used in the european union and had presented itself to the buyer as an international supplier with the ce certification. in this case, the parties can be taken to have intended, by virtue of article 8(3) cisg, that the seller was required to deliver goods that comply with standards in the directives of the european community.30 3.3. more difficult cases for determining whether there was an implicit intention for a seller to comply with a certain standard are those where there are no relevant contractual provisions. all relevant circumstances need to be taken into account and balanced against one another, as is exemplified by a cisg case31 that concerned a sale of wheat flour by a dutch seller to a belgian buyer for further resale to mozambique. the seller had added a substance containing potassium bromate, capable of causing cancer and damaging dna structures, to the flour which upon delivery to mozambique was confiscated by the authorities. there was evidence that the import of flour enriched with potassium bromate was de facto permitted in mozambique and that a company appointed by the mozambican government had tested the batches of wheat before shipment and had issued a clean report for the purpose of an import license. the court held the seller liable. first, it was evident from the pre-contractual exchanges between the parties that the quality of the flour was very important to the buyer and that the seller declared the flour to be of very high quality. it was held that the buyer could reasonably interpret the seller’s statement as warranting that the bread improvers would be of a quality corresponding, at least, to international standards. secondly, the use of potassium bromate had been banned in the netherlands and in the eu, of which the seller was aware. thirdly, it was also prohibited by the codex alimentarius, an international 44 public standard,32 which both the netherlands and mozambique have agreed to use and, for this reason, the court regarded the codex as the ‘appropriate general standard’. taken together, these factors pointed towards the seller’s liability, overriding a contrary factor, namely, that the import of such goods to mozambique was de facto permitted.33 3.4. the parties’ implicit intention that the goods ought to comply with a given standard should not be inferred lightly. if a buyer wants to ensure such compliance, the buyer can bargain for and contractually incorporate such an obligation of the seller.34 this point is particularly relevant in global supply chains where the end-buyers are often the ones setting the standards throughout the chain:35 a powerful and sophisticated commercial party’s failure to expressly incorporate a standard, the compliance with which it later demands, into the contract points to the intention not to require the seller to comply with it. some regard should also be had to a close relationship and potential overlap between inferring an implicit intention under article 35(1) and implying a term that the goods must be fit for any particular purpose impliedly made known to the seller under article 35(2)(b)).36 article 35(2)(b) is subject to two restrictions: (1) that in article 35(3);37 and (2) the displacement of the rule in article 35(2)(b), where the circumstances show that the buyer did not rely or it was unreasonable for the buyer to rely on the seller’s skill and judgement. article 35(1) is not subject to the same restrictions,38 but it should not be seen and used as a way of establishing the seller’s liability by means of a lower threshold39 because, in contrast with article 35(2)(b),40 it requires a term to be contractually incorporated. 2.4. rule 4 4. in assessing whether, under article 35(2), the seller must deliver goods that comply with a given standard, the following factors may be taken into account: (a) the parties’ statements and conduct before and after the conclusion of the contract; (b) whether the buyer has drawn the seller’s attention to the standard; (c) whether the seller has expressed a public commitment to the standard; (d) any prior dealings between the parties; (e) the extent of the buyer’s involvement in designing the goods and advising the seller as to the manufacturing or production process; (f) the parties’ expertise in relation to the goods; (g) the business identity, characteristics, standing and size of the seller and the buyer; 45 (h) whether the parties are in the same industry, trade, organisation, association or initiative that has adopted or follows the standard and whether compliance with the standard is required or expected; (i) the price; (j) the nature, complexity and prominence of the standard; (k) the accessibility of information regarding the standard; (l) whether the standard is incorporated in the seller’s code of conduct or the buyer’s code of conduct for suppliers, provided that they are publicly available; (m) the existence of competing standards; (n) any relevant trade usage that is not based on the standard in question. 2.4.1. general 4.1. the cisg implies a number of terms relating to the conformity of goods, unless the parties have agreed otherwise (article 35(2)). these terms are those requiring the goods to be: ‘fit for the purposes for which goods of the same description would ordinarily be used’ (article 35(2)(a)); ‘any particular purpose expressly or impliedly made known to the seller at the time of the conclusion of the contract’ (article 35(2)(b)); ‘possess the qualities of goods which the seller has held out to the buyer as a sample or model’ (article 35(2)(c)); ‘are contained or packaged in the manner usual for such goods or, where there is no such manner, in a manner adequate to preserve and protect the goods’ (article 35(2)(d)). as explained, the existence of a standard, affecting the use of the goods, can be a factor in determining the conformity of goods under these terms implied under the convention. 4.2. the tests implied under article 35(2) are highly fact-sensitive and need to be interpreted within the context surrounding the contract, of which standards affecting the use of the goods are a part. whether compliance with a given standard is part of the conformity under these implied tests must be determined on a case-by-case basis. a wide range of factors may then be relevant to deciding whether a given standard should influence the seller’s conformity obligations under article 35(2). the factors may be conflicting in that some factors may point in favour of the seller’s liability, whereas some others may point in favour of the seller’s not being responsible for complying with the standard in question. the weight to be attributed to each factor is a matter of the particular circumstances of the case. determining the seller’s conformity obligations under article 35(2) should ultimately be the result of a careful balance of all the relevant factors, set out in rule 4(a)-(n). 46 2.4.2. the parties’ statements and conduct before and after the conclusion of the contract 4.3. what the parties say or do before or after the conclusion of the contract can be highly relevant to determining conformity under article 35(2).41 the examples of pre-contractual statements or conduct pointing in favour of a given standard being relevant to determining conformity under article 35(2) include:42 the seller’s presenting itself as a supplier of high quality products, who complies with ‘all applicable standards’,43 or gives assurances that its products will be acceptable to the industry;44 or the buyer’s stressing the importance and/or its expectation of receiving high quality goods45 meeting the relevant standards. another example is where, before the contract is made, the seller makes a public commitment, such as that published in the press or publicised in a press release, to observing a certain standard. the publicly expressed commitment to a certain standard creates a reasonable expectation that the seller will follow this standard in its contracts with its counter-parties and can be relevant to determining conformity under article 35(2).46 4.4. the same statements and conduct can feature both before and after the contract is made. for instance, the seller may continuously, before and after making the contract, advertise itself as a member of a particular industry association and present this association’s logo in its pre and post-contractual communications with the buyer.47 if so, these representations by the seller are relevant to determining conformity under article 35(2) with reference to a standard adopted by this industry association. an example of the relevant post-contractual conduct is the buyer’s reliance on the goods’ compliance with a given standard,48 such as where after making the contract with its seller the buyer: makes the resale arrangements of the goods to be delivered by the seller; and represents to its sub-buyer or incorporates a term into a sub-sale contract that the goods will comply with that standard. 2.4.3. whether the buyer has drawn the seller’s attention to the standard 4.5. whether the buyer has drawn a particular standard to the seller’s attention is likely to indicate the relevance of that standard to determining conformity under article 35(2). the buyer’s making known to the seller the need to comply with a given standard is likely to trigger the seller’s obligation under article 35(2)(b)49 (namely, that the particular purpose of the intended use of the goods requires compliance with that standard). in contrast, the buyer’s merely making known to the seller the existence of a standard may fall short of a clear communication of a particular purpose 47 under article 35(2)(b). however, such a communication is still part of the context against which article 35(2)(b) and article 35(2)(a) and (d) are to be interpreted because it signals the importance of the standard to the buyer; otherwise, the buyer would not have mentioned its existence to the seller. 2.4.4. whether the seller has expressed a public commitment to the standard 4.6. the seller may express a public commitment to observing particular standards, such those made in the press, publicised press releases or its publicised codes of conduct.50 such public commitments are part of the context against which terms implied under article 35(2) should be interpreted. such a commitment can be relevant, for example, to determining what constitutes the ordinary use of the goods (article 35(2)(a)) or the ‘usual manner’ in which goods are to be contained or packaged (article 35(2)(d)), particularly if other suppliers in the same sector have also declared their adherence to these standards. the fitness for a particular purpose test (article 35(2)(b)) is less relevant because the seller’s expression of its commitment to a standard does not normally communicate a particular purpose for which the buyer intends to use the goods (the first part of article 35(2)(b)).51 however, this factor is highly relevant to determining whether the buyer relied or whether it was reasonable for the buyer to rely on the seller’s skill and judgement (the second part of article 35(2)(b)). 4.7. generally, there is tension between a seller’s declaration of commitment to particular standards, particularly those of ethical nature,52 and its argument that it does not have an obligation to comply with them. from a policy perspective, it may be desirable for sellers to have such an obligation because by making public declarations of commitment to certain standards, companies often seek to induce the public to do business with them or promote a positive commercial image. holding sellers liable for non-compliance with the declared standards helps protect the public and encourages sellers to stay true to their public representations.53 2.4.5. prior dealings between the parties 4.8. prior dealings between the parties can reveal their knowledge, individual expectations as well as expectations in the relevant commercial environment, all of which are part of the context against which article 35(2) is to be interpreted. if the parties’ previous contract(s) for the same goods required the seller to comply with the standard in question or to 48 deliver certificates showing compliance with it,54 this factor can point to the relevance of that standard for determining the goods’ fitness for a particular purpose.55 the parties’ incorporation of that standard in their previous contract(s) may also reflect a broad understanding within their respective commercial sector or market concerning what constitutes the ‘ordinary use’ of the goods (article 35(2)(a)) or the ‘usual manner’ of their containment or packaging (article 35(2)(d)). even if their previous contract(s) for the same goods did not expressly require compliance with a given standard, but the seller observed that standard in performing those contract(s), that fact can still be relevant. for instance, the buyer may rely on the expected compliance with the standard by representing to its subbuyer that the goods will comply with that standard. if the seller was aware of such a representation before making the contract with the buyer, this factor together with the seller’s prior observance of the standard can point in favour of the implicit communication of a particular purpose to the seller (article 35(2)(b)). 4.9. caution is needed, however, in deciding whether a seller’s obligation to comply with a particular standard should be implied under article 35(2) based on the parties’ previous dealings. a powerful countervailing consideration is that, in the examples in paragraph 4.8, the buyer has not incorporated any such term in the contract or has not expressly communicated a relevant particular purpose under article 35(2)(b), which is not difficult to do. this may well evidence that the parties did not intend the seller to comply with the standard.56 2.4.6. the extent of the buyer’s involvement in designing the goods and advising the seller as to the manufacturing or production process 4.10. the buyer’s involvement in designing the goods and advising the seller as to the manufacturing or production process is a factor pointing against implying a duty on the seller to comply with a standard. in this case, the seller is to some degree relying on the buyer in terms of how the contract ought to be performed. the greater the buyer’s involvement, the greater is the weight to be attributed to this factor in pointing to the parties’ intention that the seller was not expected to comply with a standard. otherwise, the buyer would have communicated the need to comply with the standard during its involvement in designing the goods or when advising the seller. the seller’s reliance on the buyer57 also points against implying a term under article 35(2)(b) because the buyer does not rely or it is unreasonable for the buyer to rely on the seller’s skill and judgement. 49 2.4.7. the parties’ expertise in relation to the goods 4.11. the level and balance of the parties’ expertise in relation to the goods are a factor with particular relevance under article 35(2)(b). the greater the buyer’s expertise, the greater is the expectation that the buyer will draw the need to comply with a standard to the seller’s attention, triggering the seller’s obligation under article 35(2)(b).58 the implicit communication of a particular purpose (the first part of article 35(2)(b)) should not therefore be inferred lightly where the buyer possesses substantial expertise. if the buyer’s expertise in respect of the goods is equal to or greater than that of the seller,59 that may also lead to the conclusion that the buyer does not rely or that it is unreasonable for the buyer to rely on the seller’s skill and judgement (the second part of article 35(2)(b)). 2.4.8. the business identity, characteristics, standing and size of the seller and the buyer 4.12. various characteristics relating to the identity, characteristics, standing and size of the parties’ business can be relevant to determining conformity under article 35(2). if both parties have well-known and established reputations as ethical businesses, the seller’s obligation to comply with an ethical standard may be implied under various tests under article 35(2). the seller will be aware of the buyer’s identity as an ethical business and, being such a business itself, the seller’s skill and judgement may well be relied upon by the buyer (the second part of article 35(2)(b)). similar reasoning can apply even where only the buyer has a strong reputation as ethical business, but the seller knows that the buyer always sells goods at markets, specialising in organic or fair trade products, or where the focus on ethical standards is evident from the name of the buyer’s business.60 these circumstances may suffice to implicitly communicate to the seller that the goods’ intended use requires compliance with certain ethical standards (the first part of article 35(2)(b)).61 however, if the buyer has greater expertise in relation to ethical goods than the seller, that may point against the buyer’s reliance on the seller’s skill and judgement (the second part article 35(2)(b)).62 4.13. if both parties identify themselves and have reputations as ethical businesses, possibly also reflecting the ethical nature of the market/sector in which they operate, that can mean that: the particular purpose of use of the goods requires compliance with certain ethical standards (article 35(2)(b));63 the goods’ ordinary use (article 35(2)(a)) or ‘usual’ manner of packaging or containment (article 35(2)(d)) should also be interpreted with reference to such standards.64 50 4.14. the size of and resources available to the parties are also of relevance. compare one seller, a large multinational company with considerable resources, with another who is a small inexperienced company with inconsiderable resources. it is reasonable to expect the former to investigate and/or have much greater knowledge of the existence and content of standards affecting the use of the goods.65 the knowledge of a particular purpose, requiring compliance with such standards, can be implied under article 35(2)(b) more readily in respect of the former seller, than the latter. 4.15. if the buyer is a large multinational business, it can also be expected to investigate or know about the existence and content of the relevant standards and draw the seller’s attention to them. this factor in itself demands caution when deciding whether to infer an implicit communication of a particular purpose (the first part of article 35(2)(b)). the buyer’s superior access to resources can mean that there is no reliance on the seller’s skill and judgement (the second part of article 35(2)(b)). conversely, if the buyer is a small company with inconsiderable resources, there is much lower expectation that this buyer would know the relevant standards and their content. in itself, this factor sets the scene for a lower threshold for inferring an implicit communication of a particular purpose under article 35(2)(b). 2.4.9. whether the parties are in the same industry, trade, organisation, association or initiative that has adopted or follows the standard and whether compliance with the standard is required or expected 4.16. where the parties are in the same industry, trade, organisation, association or initiative that has adopted or follows the standard and where compliance with the standard is required or expected, this factor can implicitly communicate to the seller that the particular purpose of using the goods necessitates compliance with that standard (article 35(2)(b)).66 this factor also indicates a common commercial context within which the parties operate. therefore, compliance with that standard can be part of the ‘ordinary use’ of the goods (article 35(2)(a)) or of the ‘usual manner’ of containment or packaging (article 35(2)(d)). 2.4.10. the price*67 4.17. the price can be a powerful indicator of what can be expected of the goods from the perspectives of tests in article 35(2). if the contract price corresponds to high quality or premium goods that are associated with a particular standard, this price points in favour of an implicit 51 communication of a particular purpose that requires compliance with this standard (article 35(2)(b)). conversely, if the price is much lower than the value of high-quality/premium goods, associated with this standard, this points against inferring an implicit communication of such a particular purpose. 4.18. generally, a low contract price indicates that the goods were not intended to be premium goods.68 so, even if compliance with a certain standard would otherwise be required under article 35(2), an uncharacteristically low price can evidence that the goods were not intended to comply with any standard.69 2.4.11. the nature, complexity and prominence of the standard 4.19. the nature of a standard, such as whether it is mandatory or voluntary, is relevant under article 35(2). if the buyer is aware of the mandatory character of a standard, it can be reasonably expected to draw this standard to the seller’s attention. this factor on its own points to a high threshold for implying a seller’s duty under article 35(2)(b). the seller’s awareness of the relevant standard and its mandatory nature sets the context for implying an obligation under article 35(2)(b) more readily than in the previous example. the mandatory nature of a standard can also make it relevant to determining the goods’ ‘ordinary use’ (article 35(2)(a)) or ‘usual manner’ of containment or packaging (article 35(2)(d)).70 4.20. if a standard is voluntary or advisory, the weight to be attributed to it depends largely on its significance in practice. if, despite being voluntary, the standard is widely expected to be complied with in a relevant market, industry or sector, it should be treated similarly to mandatory standards (quasi-mandatory).71 another example of its significance is where its voluntary character is temporary, with it being widely expected that it will inevitably become mandatory.72 in these examples, the standard is relevant to determining a particular purpose (article 35(2)(b)), ‘ordinary use’ (article 35(2)(a)) and the ‘usual manner’ of containment or packaging (article 35(2)(d)). if the standard does not have such practical significance, its relevance is much weaker. 4.21. high complexity of a standard can decrease its relevance under article 35(2). if compliance with such a standard requires special knowledge, expertise, experience or resources, this factor points against inferring an implicit communication of a particular purpose to the seller without such knowledge, expertise and resources (the first part of article 35(2)(b)).73 its skill and judgement are also unlikely to be relied upon (the second part of article 35(2)(b)). the relevance of such a standard may also be weak under article 35(2)(a) or (d). these tests are premised on a 52 common understanding or acceptance, within a trade or market, of what constitutes the goods’ ‘ordinary use’ or ‘usual manner’ of containment or packaging. if a market comprises a wide range of parties with different levels of business sophistication, it is unlikely that a highly complex standard, which is difficult for many parties to follow, has gained general acceptance. 4.22. the more prominent a standard, whether private or public, the greater is its relevance for inferring an implicit communication of a particular purpose (article 35(2)(b)) and determining the ‘ordinary use’ (article 35(2)(a)) or the ‘usual manner’ of containment or packaging (article 35(2)(d)). 2.4.12. the accessibility of information regarding the standard 4.23. the more accessible the information regarding the standard, the greater is its relevance under article 35(2). if this information is publicly visible, easily found and identifiable (eg, via internet search engines and identifiable without difficulty on a relevant webpage), available in widely spoken languages (eg, english), this sets a favourable context for the seller to be in a position to know about the existence and content of the standard, affecting the use of the goods, and consequently the need to comply with it (article 35(2)(b)). these factors are also conducive to this standard being relevant under article 35(2)(a) and (d). 2.4.13. whether the standard is incorporated in the seller’s code of conduct or the buyer’s code of conduct for suppliers, provided that they are publicly available 4.24. the considerations in paragraphs 4.6 and 4.7 are applicable to cases where the standard is incorporated in the seller’s code of conduct. the incorporation of the standard in the buyer’s code of conduct can also be relevant in the context of article 35(2). in principle, such incorporation can implicitly make known to the seller a particular purpose that the intended use requires compliance with those standards (article 35(2)(b)). such an interpretation can only be adopted if two conditions are met, whereby the seller can be expected to know about the standard and the need to comply with it. first, the buyer’s code of conduct must be addressed to its suppliers, rather than being its internal code. secondly, this code must be publicly available and otherwise accessible74 to the seller. at the same time, the buyer’s failure to expressly incorporate the standard in the contract is a countervailing factor militating against implying an obligation under article 35(2)(b) lightly. this factor may even warrant the conclusion that the seller was not intended to comply with the standard 53 because the tests under article 35(2) that could otherwise lead to such an obligation are not applicable.75 4.25. the incorporation of the standard in the seller’s code or the buyer’s code for its suppliers can also be relevant under article 35(2)(a) and (d). for example, the incorporation of the standard in the end-buyer’s code for its suppliers may be relevant to what constitutes the ‘ordinary use’ or ‘usual manner’ of containment or packaging in the context of a particular supply chain. however, this consideration needs to be counterbalanced against the buyer’s failure to incorporate the standard in the contract or communicate it clearly to the seller, which can point strongly to the intention that no compliance with the standard was required. 2.4.14. the existence of competing standards 4.26. the existence of competing standards can militate against the relevance of the standard in question to implying obligations under article 35(2)(a), (b) or (d).76 this is particularly so if the standards are of similar prominence and/or the extent to which they are followed in a relevant market, sector or industry is also similar. in these circumstances, there is no one standard that can claim common acceptance so as to be relevant to determining the ‘ordinary use’ or the ‘usual manner’ of containment or packaging (article 35(2)(a) and (d)). it may also be difficult to establish an implicit communication that the use of the goods required their compliance with the standard in question, as opposed to other existing standards (article 35(2)(b)). 2.4.15. any relevant trade usage that is not based on the standard in question 4.27. if a trade usage is based on the standard in question, an obligation of comply with it will be implied by virtue of contract interpretation under article 35(1).77 therefore, in determining the seller’s obligations under article 35(2), a usage is relevant insofar as it is not based on this standard. a usage in a given trade sector may be of general nature, requiring sellers to comply with the applicable industry standards. in this example, a usage is not based on any particular standard, but requires compliance with industry standards in general. conversely, a usage may provide that sellers are not required to comply with any standards, unless specifically informed to the contrary by their buyers; or may be based on a standard other than that in question. in these latter examples, the standard in question is not relevant under article 35(2). 54 2.5. rule 5.1 the seller may have an obligation to deliver goods that comply with local standards: (a) applicable at the place of use of the goods if, at the time of the conclusion of the contract, the seller knew or could not have been unaware of that place; (b) in any other case, applicable at the buyer’s place of business. 2.5.1. applicability at the place of use of the goods 5.1. rule 5.1 is concerned with standards that are specific to a particular place (local standards). it provides for general fall-back guidance as to whether under article 35(2) the seller must comply with local standards at the place of use of the goods. different positions are advanced in cases and commentary on whether, by default, the seller is required under article 35(2) to comply with such local standards. considering the significance of this question and the divergence of views, it is important for there to be a steer as to how risks should be allocated between the contracting parties in order to promote legal certainty, consistency and uniformity in the convention’s application.78 according to rule 5.1(a), the seller may have an obligation to comply with local standards applicable at the place of use of the goods if, at the time of the conclusion of the contract, the seller knew or could not have been unaware of that place. thus, subject to various factors that may be relevant,79 rule 5.1(a) signals its preferred allocation of risk: namely, the seller should have an obligation to comply with local standards at the place of use of the goods.80 the rationale is twofold. first, if the seller knew or could not have been unaware of the place of use of the goods, it should investigate the existence of any local standards, affecting the use of the goods.81 if they exist, it is reasonable to expect the seller to understand that compliance with local standards is necessary or required. secondly, this position is in line with how the convention allocates risks between the contracting parties in the context of the question whether the seller has an obligation to deliver goods free from rights or claims of a third party based on industrial property or other intellectual property (ip).82 as article 42(1)(a) cisg makes clear, the seller does have such an obligation if the right or claim is based on ip ‘under the law of the state where the goods will be resold or otherwise used, if it was contemplated by the parties at the time of the conclusion of the contract that the goods would be resold or otherwise used in that state’. 2.5.2. applicability at the buyer’s place of business 5.2. rule 5.1(b) is applicable where the seller neither knew nor could not have been unaware of the place of use of the goods. in this case, subject to various relevant factors,83 the seller may have an obligation to comply with standards applicable at the buyer’s place of business. the rationale is that in this situation it is reasonable for the seller to expect that 55 the goods will be used at the place where the buyer has its place of business. therefore, if there are local standards at that place, affecting the use of the goods, such standards should be complied with.84 this approach is once again line with the convention’s allocation of risk in the context of rights or claims arising from ip. if article 42(1)(a) is not applicable, under article 42(1)(b) the seller has an obligation to deliver goods free from third parties’ ip rights or claims ‘under the law of the state where the buyer has his place of business’. 2.6. rule 5.2 5.2 in assessing whether such standards are to be complied with, regard may be had to the following factors, in addition to those in rule 4: (a) whether the seller knew or could not have been unaware of the relevant standard at the place of the intended use 2.6.1. general 5.3. the fall-back guidance in rule 5.1 is not prescriptive as it does no more than provide that the seller may have an obligation to comply with local standards in places specified in rule 5.1(a) and (b). this is so because the question whether the seller has an obligation under article 35(2) to comply with local standards is highly fact-sensitive. determining whether the seller has such an obligation is ultimately a balancing exercise, with various relevant factors having to be weighed against one another. rule 5.2 makes clear that the factors in rule 4 are relevant to determining whether the seller has an obligation under rule 5.1 to comply with local standards. rule 5.2 goes further and identifies other factors, in addition to those in rule 4, that are specific to the question whether the seller has an obligation to comply with local standards applicable at a particular place. 5.4. one such context specific factor is presented in rule 5.2(a): namely, whether the seller knew or could not have been unaware of the relevant standard at the place of the intended use. if so, this factor points to it being reasonable and fair to expect the seller to comply with local standards.85 this is so particularly under article 35(2)(b) as the seller’s actual or implied knowledge is likely to constitute a communication of a particular purpose that the goods will be used in a particular place:86 without compliance with the standards in that place, affecting the use of the goods, they cannot be used there. however, there may be other relevant but competing factors, such as the buyer’s having equal or greater expertise than that of the seller and/or the standards being complex and different depending on the importing country’s region. in one case,87 this latter set of factors prevailed over the seller’s knowledge of there being 56 local standards affecting the use of the goods, resulting in no obligation being implied on the seller to comply with local standards. 2.6.2. the seller’s prior dealings at that place, such as whether the seller had a branch or subsidiary or promoted goods of the same kind at that place 5.5. the seller’s prior dealings at the place of the intended use of the goods is relevant to determining whether the seller: had actual or implied knowledge of the existence of local standards, affecting the use of the goods, at that place; and an obligation to comply with those standards.88 in addition to showing the relevance of this factor, rule 5.2(b) gives examples of such prior dealings. they include the cases where the seller had a branch or subsidiary in the place of the intended use of the goods or its prior experience of promoting the goods of the same kind at that place.89 2.6.3. whether the standard at that place is the same as that at the seller’s place of business 5.6. according to rule 5.2(c), whether the standard at that place is the same as that at the seller’s place of business is relevant to whether the seller has an obligation to comply with the local standard at the place of the intended use of the goods. the relevance of this factor varies depending on which provision in article 35(2) is applicable. as far as article 35(2)(b) is concerned, in itself the fact of the standard being the same in the place of use of the goods and in the seller’s place of business adds nothing to the seller’s knowledge of a particular purpose. if the seller has knowledge of the place of the intended use of the goods (rule 5.1(a)) and, where applicable, the standard there (rule 5.2(a)), the seller’s liability flows from rule 5.1(a) and rule 5.2(a) (and possibly rule 5.2(b)). in this situation, the fact that the standard is the same in both places is of no significance. if the seller has no knowledge of the place of use of the goods, the fall-back guidance in rule 5.1(b) points to the seller’s obligation to comply with the standard in the buyer’s place of business. in this case, the mere fact that the standard in the seller’s place of business is the same as that in the buyer’s place of business changes nothing in terms of the seller’s knowledge of a particular purpose of the use of the goods (the first part of article 35(2)(b)). however, this factor is relevant to the ‘reliance on the skill and judgement’ provision (the second part of article 35(2)(b))90 because it weakens the seller’s ability to argue that the buyer did not rely or that it was unreasonable for the buyer to rely on the seller’s skill and judgement. the standard in the seller’s place of business being the same 57 as that in the place of use of the goods normally demonstrate that the seller has the required skill and judgement to comply with it. 5.7. this factor is directly relevant to determining the ‘ordinary use’ (article 35(2)(a)) or the ‘usual manner’ of containment or packaging (article 35(2)(d)). since the seller’s place of business and the place of the intended use of the goods are the places that are relevant to the parties’ contract, the ‘ordinary use’ of the goods or their ‘usual manner’ of containment or packaging should be defined in a way that is compliant with the standard applicable in both these places.91 put differently, these two places and the same standard applicable in them constitute the relevant context with reference to which the ‘ordinary use’ or ‘usual manner’ of containment or packaging should be determined.92 3. footnotes 1 see <http://www.oxforddictionaries.com/definition/english/standard>. 2 see <http://www.iso.org/iso/home/standards.htm>. 3 ‘the codex alimentarius was established by fao and the world health organization in 1963 to develop harmonised international food standards, which protect consumer health and promote fair practices in food trade’ (<http://www.codexalimentarius.org/>). 4 <http://www.tesco.com/csr/g/g4.html>. 5 <http://www.brcglobalstandards.com/>. for examples of british standards in respect of heating appliances and carbon dioxide for industrial use, see medivance instruments ltd v gaslane pipework services ltd, vulcana gas appliances ltd [2002] ewca civ 500 and messer uk ltd and anr v britvic soft drinks ltd [2002] ewca civ 548, respectively. 6 <http://www.globalgap.org/uk_en/who-we-are/about-us/>. 7 <http://www.mygfsi.com/about-us/about-gfsi/what-is-gfsi.html>. 8<http://equator-principles.com/index.php/about-ep/governance-and-management>. 9 <http://www.iso.org/iso/home/about.htm>. 10 <http://www.fairtrade.org.uk/en/what-is-fairtrade/who-we-are>. 11 see d saidov, ‘standards and conformity of goods in sales law’ [2017] lmclq 65, 68-71. 12 see, eg, g smith, ‘interaction of public and private standards in food chain’ (2009) oecd food, agriculture and fisheries working papers no. 15, oecd publishing, 3233. 13 see, eg, ibid, 24. 14 see, eg, h collins, ‘conformity of goods, the network society, and the ethical consumer’ (2014) 5 european rev private l 619; i schwenzer, ‘conformity of the goods – physical features on wane?’ in i schwenzer and l spagnolo (eds), state of play: the 3rd annual maa schlechtriem cisg conference (the hague: eleven international publishing, 2012) 103-106; k maley, ‘the limits to the conformity of goods in the united nations convention on contracts for the international sale of goods (cisg)’ (2009) 12 int’l trade business l rev 82. 15 art 8(3) cisg: ‘in determining the intent of a party or the understanding a reasonable person would have had, due consideration is to be given to all relevant circumstances of 58 the case including the negotiations, any practices which the parties have established between themselves, usages and any subsequent conduct of the parties.’ 16 art 35(2)(a). 17 take, for example, electronic industry citizenship coalition (eicc), that comprises more than 100 companies, probably including all major companies (see <http://www.eiccoalition.org/about/members/>). not only do the eicc members subscribe and are held accountable to a common code of conduct, but many of them have also adopted their own codes of conduct. in addition to the eicc members, thousands of suppliers of those companies are required to implement the eicc code (see: <http://www.eiccoalition.org/about/members/>; g nimbalker, c cremen, y kyngdon and h wrinkle, ‘the truth behind the barcode: electronic industry trend’, at: <http://www.baptistworldaid.org.au/assets/behindthebarcode/electronicsindustry-trendsreport-australia.pdf>, 15, (for the results of a survey of 39 eicc members, according to which 82% out of those companies have a code of conduct that covers core ilo principles)). 18 see, eg, smith (n 12). for the structure of supply chains, see f cafaggi, ‘sales in global supply chains: a new architecture of the international sales law’ in d saidov (ed), research handbook on international and comparative sale of goods law (edward elgar 2019; forthcoming). 19 see, eg, canton appellate court basel, 22 august 2003, 33/2002/sas/so, (switzerland) <http://cisgw3.law.pace.edu/cases/030822s1.html>, where the contract, made in 1996 on ddp terms, required the food products to be free from genetically modified organisms (gmo). the seller argued that more than two years after the contract had been made (1999) the amount of gmo found in the delivered goods (between 0.1 and 1%) was declared by the authorities in the buyer’s country (switzerland) as being gmo free. the court rejected this argument stating that 1997 (when the goods seem to have been delivered and inspected and when no such change to the regulations was yet made) was decisive. 20 see, eg, federal supreme court, viii zr 67/04, 2 march 2005 (germany) <http://cisgw3.law.pace.edu/cases/050302g1.html>, where the contract was made in april 1999, but in june 1999 suspicions arose that the meat originating in belgium contained dioxin. these suspicions led, between june and july, to the adoption of regulations in germany, the eu and belgium declaring the meat unmarketable unless accompanied by a certificate declaring it as ‘dioxin free’. 21 drawing any analogy with art. 42 is inappropriate because under art. 42 the goods’ freedom from third parties’ intellectual property rights or claims is to be assessed with reference to the time of delivery of the goods as to opposed to the time when risk passes to the buyer (art. 36(1)), as is required when assessing conformity under art. 35. in other words, the requirements as to the time of assessing whether the seller has complied with its obligations under arts. 35 and 42 are different under these two provisions. 22 see, eg, the english case henry kendall & sons v william lillico & sons ltd [1962] 2 ac 31, 75 and 108-109 (per lord reid and lord guest). see also the dissenting view of lord pearce (ibid, 119). 23 e mckendrick, goode on commercial law, 5th edn (london, penguin books 2016), para. 11.93. 24 see also art 6 cisg. 25 see, eg, icac arbitration, 168/2001, 17 february 2003 <http://cisgw3.law.pace.edu/cases/030217r1.html>; cietac arbitration, 16 july 59 1996 <http://cisgw3.law.pace.edu/cases/960716c1.html>; ginza pte ltd v vista corporation pty ltd [2003] wasc 11. 26 standards may also be concerned with a procedure or criteria to be followed during the inspection of the goods. in this case, a buyer’s failure to observe such standards may lead to its claim of a lack of conformity being rejected. see, eg, cietac arbitration, 27 october 1997 <http://cisgw3.law.pace.edu/cases/971027c1.html>, where the standard (russian gost), applicable to hot-rolled steel coils required that surface defects be established by examining the entire consignment and that thickness be measured by taking samples ‘at a distance of not less than 1.5 turns from the end of the rolled length’. the tribunal did not accept the results of the inspection, which did not meet these requirements. 27 see note 15 above. see also art 8(1) and (2) cisg. 28 see art 9 cisg; also art 8(3) cisg. 29 see: <http://www.ce-marking.org/what-is-ce-marking.html> (‘the letters “ce” are the abbreviation of french phrase “conformité européene” which literally means "european conformity". the term initially used was “ec mark” and it was officially replaced by “ce marking” in the directive 93/68/eec in 1993. “ce marking” is now used in all eu official documents….ce marking on a product is a manufacturer's declaration that the product complies with the essential requirements of the relevant european health, safety and environmental protection legislation, in practice by many of the so-called product directives.’). 30 see taurus importgesellschaft j seebohm mbh v wide loyal industries ltd [2009] hkec 1236, a case decided under the law of hong kong. the court held that although ‘ce approved’ was only ‘a placed mercantile or trade term and not a legal term used either in the european community directives or even in german law’, the seller had committed a breach of contract (see para. [66]). the court accepted evidence that the ce mark was a ‘passport into europe’ and held that ‘[w]ithout full compliance with all the relevant directives, it is difficult to see how it can be “a passport into europe” for the products involved’ (para. [71]). 31 appellate court’s-gravenhage, 99/474, 23 april 2003 (netherlands), <http://cisgw3.law.pace.edu/cases/030423n1.html>. 32 see n 3. 33 the court also held that accepting the argument that the import of such goods was de facto permitted would mean ‘that products unfit for human consumption could be delivered without contractual sanction by a seller from a highly developed country to a purchaser from a less developed country, who due to the contract may rightfully expect to have delivered to him a product that is reliable according to international standards and fit for human consumption’ (appellate court’s-gravenhage, 23 april 2003 (netherlands), point 8). for the argument that sales laws can play a regulatory function of promoting minimum benchmarks of quality in a society, see d saidov, ‘quality control, public law regulations and the implied terms of quality’ [2015] lmclq 491. 34 in a similar vein, p schlechtriem, ‘non-material damages – recovery under the cisg?’ (2007) 19 pace int’l l rev 89, 100-101. 35 see, e.g., lc backer, ‘economic globalization and the rise of efficient systems of global private law making: wal-mart as global legislator’ (2007) 39 connecticut l rev 1741; er pedersen and m andersen, ‘safeguarding corporate social responsibility (csr) in global supply chains: how codes of conduct are managed in buyer-supplier relationships’ (2006) 6 j public affairs 228; f cafaggi, ‘the regulatory functions of 60 transnational commercial contracts: new architectures’ (2013) 36 fordham int’l l j 1557. 36 see d saidov, conformity of goods and documents the vienna sales convention (oxford, hart publishing 2015) 72-74. 37 art. 35(3): ‘the seller is not liable under subparagraphs (a) to (d) of the preceding paragraph for any lack of conformity of the goods if at the time of the conclusion of the contract the buyer knew or could not have been unaware of such lack of conformity.’ 38 for the discussion of the consequences of the buyer’s pre-contractual knowledge of a lack of conformity in the context of art 35(1), see, eg, saidov (n 36) 38-41. 39 see s kröll in s kröll, l mistelis and p perales viscasillas (eds), un convention on contracts for the international sale of goods – a commentary, 2nd edn (münchen, ch beckhart publishing-nomos 2018) art. 35, para. 48. 40 that does not require a particular purpose to be a contractual term; a mere communication of a particular purpose to the seller is sufficient under art 35(2)(b). 41 see also article 8(3) cisg. 42 these examples are particularly relevant where a given standard contains high, rigorous or demanding requirements in respect of the goods. 43 see, eg, cortem spa v controlmatic pty ltd [2010] fca 852. 44 see arl lighting (manitoba) ltd v dixon arl lighting (manitoba) ltd [1998] bcj no 2442, a canadian case, para. [13], for the seller’s statement to the buyer that ‘[o]ur quality program will assure you a product which will be acceptable to the industry’. 45 see, eg, appellate court’s-gravenhage, 23 april 2003 (netherlands) (n 31). 46 see also rule 4(c) and comments on it in paras. 4.6. 4.7. 47 see, eg, arl lighting (n 44), where the buyer relied on the fact that: the seller, a manufacturer, was a member of north american die casters association (nadca) and advertised itself as such; and the nadca ‘logo’ was present in several communications before and after the conclusion of the contract. 48 see, eg, arl lighting (n 44). 49 see, eg, supreme court, 8 march 1995, viii zr 159/94 (germany) <http://cisgw3.law.pace.edu/cases/950308g3.html>; kingspan environmental ltd v borealis a/s [2012] ewhc 1147 (comm). 50 many companies today adopt their own codes of conduct. the majority of top 500 companies in the us and the uk have adopted some kind of code of conduct (<http://www.ilo.org/global/standards/introduction-to-international-labourstandards/international-labourstandards-use/lang--en/index.htm>). 51 although it is not inconceivable that the buyer’s entering into a contract with the seller, who declared adherence to certain standards, or some other act of the buyer’s reliance on the seller’s public declaration can potentially make known to this seller a particular purpose that the goods were bought for the use requiring compliance with these standards. 52 there are many examples of ethical standards, such as those contained in: international instruments (international labour organisation (ilo) conventions, un convention on the rights of the child or the universal declaration of human rights); international initiatives (e.g., the un global compact (ungc), the ‘kimberly process’ (kp)); nongovernmental organisations’ documentation (e.g., iso 14001 or sa8000); or industry coalitions’ documents (e.g., electronic industry citizenship coalition (eicc)). 53 see, similarly, draft common frame of reference (dcfr), comment a on art 2:303, in c von bar and e clive (eds), principles, definitions and model rules of european private law: draft common frame of reference (dcfr) (munich, sellier european law publishers, 2009) 61 vol ii, 1296. see also appellate court’s-gravenhage, 23 april 2003 (netherlands) (nn 31 and 33), where the convention’s conformity rules are seen as performing broader societal goals. 54 district court ellwangen, 1 kfh o 32/95, 21 august 1995 (germany) <http://cisgw3.law.pace.edu/cases/950821g2.html> (the amount of ethylene oxide in paprika exceeded the level permissible under the german food safety laws whilst the contract required the seller to deliver the certificate of the absence of aflatoxins and salmonellae). 55 in that this factor points in favour of an implicit communication of a particular purpose that the intended use of the goods requires compliance with the standard in question (see ibid). 56 see the opening words of art 35(2) (‘except where the parties have agreed otherwise) and art 6 cisg. 57 on the question whether contracts involving the provision of drawings, know-how, technical specifications, technology or formulae fall within the cisg, see the cisg-ac opinion no. 4, ‘contracts for the sale of goods to be manufactured or produced and mixed contracts (article 3 cisg)’, rule 5 and paras. 2.13-2.15 in the comments, available at: <https://www.cisgac.com/file/repository/cisg_ac_opinion_4_english_.pdf>. 58 see appellate court arnhem, 97/700 and 98/046, 27 april 1999 (netherlands) <http://cisgw3.law.pace.edu/cases/990427n1.html>. where the german buyer of mobile units argued the seller had committed a breach because they did not meet the construction standards in force in germany. even possible mention by the buyer to the seller of the existence of special requirements with respect to mobile units, together with the fact that the parties had a long-standing relationship and the seller’s knowledge that the goods would be used in germany, was deemed insufficient to imply an alleged term into the contract. the court took the view that the buyer was just as an expert in mobile units as the seller was, and although the parties have had-long standing business dealings, the buyer never carried out sufficiently thorough investigations of whether the seller had been taking those special standards into account. on this basis, it was held that it was the buyer’s responsibility to point out to the seller those specific requirements which were applicable to mobile units. 59 the result in ibid may be partly explained by the fact that the buyer was, like the seller, an expert in the manufacture of mobile units. 60 see, eg, i schwenzer and b leisinger, ‘ethical values and international sales contracts’ in r. cranston, j. ramberg and j ziegel (eds), commercial law challenges in the 21st century: jan hellner in memorium (stockholm: stockholm centre for commercial law juridiska institutionen, 2007) 266. 61 this reasoning applies with greater force where the buyer’s business standing is that of a market leader in promoting ethical products. 62 see also comment on paragraph (f) above. 63 for a similar point in the context of english law and labour standards, see m bridge, the sale of goods, 3rd edn (oup oxford, 2014) para. 7.112. 64 for the examples of some such standards, see n 52. 65 see, e.g., i schwenzer in i schwenzer (ed), schlechtriem & schwenzer commentary on the un convention on the international sale of goods (cisg), 4th edn (oxford, oup 2016) art. 35, para. 19; i schwenzer, p hachem and c kee, global sales and contract law (oxford, oup 2012) para. 31.138 (arguing that much greater knowledge of the regulations in the 62 country of use can be expected of a multinational company than of a small business which exports the goods to that country for the first time). 66 see kingspan environmental ltd v borealis a/s (n 49) para. [645]. 67 68 it may, of course, be that a low price simply reflects a good bargain struck by the buyer or a particular agreement structured in that way because of the parties’ other arrangements or transactions. 69 this can lead to the inapplicability of tests under art 35(2) by virtue of either the opening words of this article (‘except where the parties have agreed otherwise’) or art 6 cisg. 70 however, in practice a mandatory standard may not be enforced by the authorities and not regarded as important by the market. in this case, the weight attributed to the standard’s mandatory nature may have to be lower. see, eg, a uk case bramhill v edwards [2004] ewca civ 403 (non-compliance of a vehicle with the requirements as to width under the applicable regulations was not held to be a breach of the satisfactory quality test in s. 14(2) of the uk sale of goods act 1979, because in practice such vehicles were still able to be insured and the authorities did not enforce the regulations strictly, which meant that there was no real risk of prosecution). see also activa dps europe sarl v pressure seal solutions limited t/a welltec system (uk) [2012] ewca civ 943. 71 see n 12 and the accompanying paragraph in the main text. 72 see, eg, a uk case hazlewood grocery ltd v lion foods ltd [2007] ewhc 1887 (qb). 73 see appellate court arnhem (n 58), where the seller was not liable for non-compliance with standards in germany because of their complexity flowing from each german state imposing different construction standards. 74 see further para. 4.21. 75 by virtue of either the opening words of article 35(2)(b) or art 6 cisg. for similar analyses, see the main text accompanying nn 35, 56 and 69. 76 see, eg, appellate court arnhem (n 58). 77 see para. 3.2. 78 cf j honnold (updated and revised by h flechtner), uniform law for international sales under the 1980 united nations convention, 4th edn (the netherlands, wolters kluwer law & business 2009) p. 335. 79 see rules 4 and 5.2. 80 see, eg, rj & am smallmon v transport sales limited and grant alan miller [2011] nz ca 340 (the seller’s knowledge that trucks would be used in australia was a communication of a particular purpose, but it was not reasonable for the buyer to rely on the seller’s skill and judgement). to the contrary, see, eg, supreme court, 8 march 1995 (germany) (n 49) (‘the agreement regarding the…place of destination is in itself…neither under subsection (a) nor under subsection (b) of cisg 35(2) sufficient to judge whether the mussels conform with the contract pursuant to certain cadmium standards used in germany…decisive is that a foreign seller can simply not be required to know the not easily determinable public law provisions and/or administrative practices of the country to which he exports’); supreme court, 2 ob 100/00w, 13 april 2000 (austria) <http://cisgw3.law.pace.edu/cases/000413a3.html>; district court rotterdam, 295401/ha za 07-2802, 15 october 2008 (netherlands) <http://www.cisg.law.pace.edu/cisg/wais/db/cases2/081015n2.html>. for a similar approach in english law, see, e.g., sumner permain & co v webb & co [1922] 1 kb 55; phoenix distributors ltd v l b clarke (london) ltd [1966] 2 lloyd’s rep 285; affirmed [1967] 1 lloyd’s rep 518 (ca). 63 81 see p schlechtriem, ‘uniform sales law in the decisions of the bundesgerichtshof’ at <http://cisgw3.law.pace.edu/cisg/biblio/schlechtriem3.html>; p schlechtriem and p butler, un law on international sales (berlin, heidelberg, springer-verlag 2009) p. 119; kröll (n 39) para. 126. 82 see, eg, see kröll (n 39) para. 127. to the contrary, see cm bianca in cm bianca and j bonell (eds), commentary on the international sales law (milan, giuffrè 1987) art. 35, para. 3.2. 83 see rules 4 and 5.2. 84 to the contrary, see, eg, appellate court saarbrücken, 5 u 426/96-54, 17 january 2007 (germany) <http://cisgw3.law.pace.edu/cases/070117g1.html> (a case involving the sale of marble panels where the court held that the standards in the seller’s country were controlling). 85 see, eg, supreme court, 8 march 1995 (germany) (n 49). 86 see cortem spa v controlmatic pty ltd (n 43). 87 see appellate court arnhem (n 58). 88 see, eg, appellate court grenoble, 93/4126, 13 september 1995 (france) <http://cisgw3.law.pace.edu/cases/950913f1.html> (in the light of the parties’ dealings that had lasted for several months, the seller knew that the goods would be marketed in france and should have interpreted the buyer’s order as being conditional on the goods complying with the ‘marketing regulations of the french market’). 89 see supreme court, 8 march 1995 (germany) (n 49); medical marketing v internazionale medico scientifica, 1999 wl 311945, us distric court for the eastern district of louisiana <http://cisgw3.law.pace.edu/cases/990517u1.html>. for the discussion of the broader relevance of prior dealings between the contracting parties, see rule 4(d) and comments 4.8-4.9. 90 see schlechtriem (n 90). 91 see, similarly, schwenzer, hachem and kee (n 65) para. 16. 92 this line of reasoning is relevant regardless of whether the legal nature of the rules in article 35(2) is seen as based on the parties’ presumed intentions or detached or independent from such intentions. * submitted in partial fulfillment of the requirement for the degree of master of laws in the columbia law school, columbia university ** attorney-at-law, schellenberg wittmer, geneva, switzerland; ll.m. columbia law school. anticipatory breach under the united nations convention on contracts for the international sale of goods* by mercédeh azeredo da silveira** nordic journal of commercial law issue 2005 #2 nordic journal of commercial law issue 2005 #2 1 harry m. flechtner, the cisg’s impact on international unification efforts: the unidroit principles of international commercial contracts and the principles of european contract law, inthe 1980 uniform sales law – old issues revisited in the light of new experiences 169, 169 (franco ferrari ed., guiffrè 2003). 2 see the preamble to the unidroit principles 2004, as well as art. 1:101(1) and (2) pecl. 2 i. introduction intricate issues of contract law stem from a rather plain question: is one party, suspecting that the other party will not fulfill his obligations in compliance with the terms of the contract, entitled, prior to the date agreed upon for performance, to suspend his own performance and demand additional guarantees, or even to avoid the contract? international uniform law envisages a number of situations in which a breach is said to have occurred prior to the time agreed upon for performance. in the area of international sales contracts, arts. 71, 72, and 73(2) of the united nations convention on contracts for the international sale of goods (hereafter ” cisg” ), applicable to both the buyer and the seller, lay down, on the one hand, the situations in which an anticipatory breach is deemed to have occurred and, on the other hand, the remedies available to the aggrieved party. in other words, these provisions designate the circumstances in which, even though no breach of contract has yet been committed and the time for performance of the obligation has not yet elapsed, a party may, in order to protect his own interests, temporarily stop complying with his contractual obligations or completely free himself from those obligations. in this respect, arts. 71, 72, and 73(2) cisg differ from arts. 49 and 64 cisg, which govern the right of the aggrieved party to avoid the contract when performance is overdue, that is when the other party has actually committed a fundamental breach of contract. art. 71 and art. 72 cisg differ in their purpose, their conditions of application, and the solutions that they provide. art. 72 cisg is based on the anglo-american doctrine of anticipatory breach and authorizes the innocent party to declare the contract avoided, without the need to wait until the breach materializes on the date when performance is due, if it is clear that the other party will commit a fundamental breach of contract. art. 71 cisg, on the other hand, merely authorizes the innocent party to suspend performance if it becomes apparent that the other party will not perform a substantial part of his obligations. in other words, whereas art. 72 cisg is aimed at the termination of the contractual relationship and the release of the parties of their obligations, art. 71 cisg is aimed at keeping the contract intact and on foot. art. 73(2) cisg, in turn, deals with the issue of anticipatory breach in the specific context of installment contracts. the unidroit principles of international commercial contracts (hereafter ” unidroit principles” ) and the principles of european contract law (hereafter ” pecl” ), represent, like the cisg, attempts to ” promote the unification and/or harmonization of international commercial law.” 1 today, at the international and european level, the unidroit principles and the pecl respectively constitute, in the field of transnational commercial contracts, the two sources of nonbinding or soft law2 most commonly referred to. these two sets of principles are largely inspired by the cisg. indeed, the governing council of unidroit recognized, in its introduction to the unidroit principles, that ” to the extent that the unidroit principles address issues also nordic journal of commercial law issue 2005 #2 3 governing council of unidroit, introduction to the unidroit principles (1994), available online at <http://www.jus.uio.no/lm/unidroit.international.commercial.contracts.principles.1994. commented/2>. this is for the most part, but not in all instances, the case. 4 michael joachim bonell, the unidroit principles of international commercial contracts and the vienna sales convention – alternative or complementary instruments?, inunif. l. rev. 29, 30 (1996). 5 commission of european contract law, principles of european contract law parts i and ii combined and revised xxv (ole lando and hugh beale eds., 2000). 6 trevor bennett, comments on article 71, incesare massimo bianca & michael joachim bonell, commentary on the i n t e rn a t i o n a l s a l e s – t h e 1 9 8 0 v i e nn a s a l es co nvent io n 51 3, 51 8 (g iuffrè 19 87 ), ava ila ble on l i ne a t <http://www.cisg.law.pace.edu/cisg/biblio/bennett-bb71.html>; see also joseph lookofsky, the 1980 united nations convention on contracts for the international sale of goods, ininternational encyclopedia of laws – contracts, suppl. 29, 147 (j. herbots & r. blanpain eds., kluwer law international 2000). 3 covered by the cisg, they follow the solutions found in that convention.” 3 in fact, the cisg was ” an obligatory point of reference in the preparation of the unidroit principles.” 4 similarly, the cisg was, for the drafters of the pecl, ” a particularly fruitful source of ideas.” 5 with these considerations in mind, the present study will attempt, beyond the boundaries of comparative analysis, to draw conclusions regarding the impact of the cisg, with respect to the issue of anticipatory breach, on both the unidroit principles, and the pecl. ii. suspension of performance 1. purpose and rationale of the rule granting one party the right to declare himself released from his contractual obligations whenever he suspects that his contracting partner will breach the contract would contradict two of the main aims the cisg is striving to achieve – on the one hand, that of keeping international commercial contracts intact as long as possible so as to promote good faith, loyalty, and seriousness in international transactions, and, on the other hand, that of avoiding an overload of transnational litigation. nevertheless, the drafters of the cisg considered that the party who is under the contractual obligation of performing the contract first or under the obligation of performing preparatory acts, deserves protection if it is highly likely that the other party will not perform a substantial part of his obligations. indeed, the drafters believed that if it appears that one party will not perform his obligations, ” it would be inappropriate for the other party to be required to continue with his performance of the contract, which could result in his suffering an irrevocable loss.” 6 thus, in particular, the seller who has agreed to deliver goods on credit ought to be protected in cases in which, prior to the time of delivery, the buyer becomes insolvent or has otherwise manifested that he is unable to pay for the goods. similarly, the buyer who has agreed to pay the price of the goods prior to their delivery ought to be protected in cases in which, prior to the time of payment, the seller’s insolvency or some other circumstance makes it apparent that he will not deliver the goods. consequently, the drafters have agreed that if it is highly likely that one party will commit a substantial breach of contract (but not necessarily a fundamental breach in the sense of art. 25 cisg), art. 71 cisg should protect the other party by authorizing him to suspend performance. in other words, the party – buyer or seller -whose interests are threatened by the other party’s potential failure to comply with his contractual or conventional obligations may be temporarily released from his obligation to perform the contract. http://www.jus.uio.no/lm/unidroit.international.commercial.contracts.principles.1994. http://www.cisg.law.pace.edu/cisg/biblio/bennett-bb71.html nordic journal of commercial law issue 2005 #2 7 fritz enderlein & dietrich maskow, international sales law: united nations convention on contracts for the international sale of goods; convention on the limitation period in the international sale of goods 285 (oceana publications 1992), available online at <http://www.cisg.law.pace.edu/cisg/biblio/enderlein.html>; jelena vilus, provisions common to the obligations of the seller and the buyer, ininternational sale of goods: dubrovnik lectures 239, 241 (petar s a r c e v i c & p a u l v o l k e n e d s . , o c e a n a p u b l i c a t i o n s 1 9 8 6 ) , a v a i l a b l e o n l i n e a t <http://www.cisg.law.pace.edu/cisg/biblio/vilus.html>;john o. honnold, uniform law for international sales under the 1980 united nations convention 430 (3rd ed., kluwer law and taxation publishers 1999), available online at <http://www.cisg.law.pace.edu/cisg/biblio/honnold.html>. 8 honnold, supra note 7, at 430. 9 peter schlechtriem, uniform sales law – the un-convention on contracts for the international sale of goods 94 (manz 1986), available online at <http://www.cisg.law.pace.edu/cisg/biblio/schlechtriem.html>. 10 karl h. neumayer & catherine ming, convention de vienne sur les contrats de vente internationale de marchandises 461 (cedidac 1993). 11 liu chengwei, remedies for non-performance: perspectives from cisg, unidroit principles & pecl § 9.2 (2003), available online at <http://www.cisg.law.pace.edu/cisg/biblio/chengwei.html>. 12 neumayer/ming, supra note 10, at 459. 4 2. grounds for suspension & types of performances subject to suspension a. grounds for suspension of performance according to art. 71(1) cisg, ” a party may suspend the performance of his obligations if, after the conclusion of the contract, it becomes apparent that the other party will not perform a substantial part of his obligations as a result of: (a) a serious deficiency in his ability to perform or in his creditworthiness; or (b) his conduct in preparing to perform or in performing the contract.” thus, the parameters, under art. 71 cisg, on which the right of the innocent party to suspend performance of his obligations depend, are the following: (i) the fact that it becomes apparent that a breach will be committed, closely linked to the issue of the degree of certainty that the said breach will occur; (ii) the magnitude of the future breach; and (iii) the various possible indicia that the breach will be committed. regarding parameter (i), as stated above, art. 71(1) cisg provides that ” a party may suspend the performance of his obligations if, after the conclusion of the contract, it becomes apparent that the other party will not perform a substantial part of his obligations” (emphasis added). the incapacity to perform must be objectively recognizable;7 in other words, a neutral observer of the concerned international commercial branch, in the same circumstances, would conclude that there are ” objective grounds showing substantial probability of non-performance.” 8 indeed, ” the apparent inability to perform must not only induce subjective fears with regard to the performance of the contract but it must also enable objective observers to foresee non-performance.” 9 in sum, art. 71 cisg requires, on the one hand, that an objective and reasonable observer would conclude that it is highly likely that one party will fail to perform a substantial part of his obligations10 and, on the other hand, that ” the party wishing to suspend performance could hold [the relevant information] to be true. if the party suspending performance could hold the information available to be true, the risk falls to the other party.” 11 provided, as required under art. 71 cisg, that the incapacity to perform has become apparent only after the conclusion of the contract, the innocent party may suspend performance of his obligations even if the circumstances that caused the said incapacity already existed at the time of the conclusion of the contract.12 indeed, ” the aim of the proposal that led to the present formulation was to permit a suspension of performance even when the circumstances that made http://www.cisg.law.pace.edu/cisg/biblio/enderlein.html http://www.cisg.law.pace.edu/cisg/biblio/vilus.html http://www.cisg.law.pace.edu/cisg/biblio/honnold.html http://www.cisg.law.pace.edu/cisg/biblio/schlechtriem.html http://www.cisg.law.pace.edu/cisg/biblio/chengwei.html nordic journal of commercial law issue 2005 #2 13 schlechtriem, supra note 9, at 92. the proposal, which corresponded to art. 73(1) of the convention relating to a uniform law on the international sale of goods (hereafter ” ulis” ), was intended to prevent the party likely not to perform his obligations from insisting on performance by the other party, maintaining that his situation had not deteriorated after the conclusion of the contract but was already unsatisfactory before that date since he had previously failed to perform his obligations to third parties. 14 schlechtriem, supra note 9, at 93. 15 bennett, supra note 6, at 524. 16 enderlein/maskow, supra note 7, at 285, according to whom ” the right to suspend performance must not lead to a situation where contracts are thoughtlessly concluded. in spite of the inclusion of the circumstances existing at the conclusion of the contract, the first party still has the obligation to examine the creditworthiness of the other party.” 17 chengwei, supra note 11, § 9.2. 18 bennett, supra note 6, at 522. 19 schlechtriem, supra note 9, at 94. even though the formulation in art. 62(1) of the 1978 draft (counterpart of the actual art. 71(1) cisg) – which provided that the deterioration must give ” good grounds to conclude” that the other party will not perform – was considered too subjective, the present formulation should not indicate a restriction to the sole cases in which non-performance is absolutely certain (see a/conf. 97/c.1/sr.37 at 11§ 95 (= o.r. 431)). in the opinion of the canadian delegate, there is not even an appreciable difference between the formulation ” it becomes apparent” and ” good grounds to conclude that the other party will not perform” (see a/conf. 97/c.1/sr.38 at 2 § 8 (= o.r. 433); see also a/conf.97/c.1/sr.37 at 12 § 104 (= o.r. 432)). 20 honnold, supra note 7, at 430. 5 the obligor’s performance doubtful had existed before, but had not become apparent until after the conclusion of the contract.” 13 if it was already apparent at the conclusion of the contract that one party would not be able to perform, the other party may not suspend performance.14 ” if those circumstances were generally apparent but not in fact known by the party wishing to suspend performance, it is not clear whether the article would be held to be applicable, but probably it would be held not to be.” 15 indeed, given, on the one hand, the duty of each party, at the time of the conclusion of the contract, to examine the creditworthiness of the other party, and, on the other hand, the fact that the incapacity to perform must be objectively recognizable, it seems that the right to suspend performance should not be available if one party’s defective economic situation was generally apparent but not in fact known to the other party.16 ” a party would have the right to suspend performance only if he was aware of the bad economic situation of the other party at the conclusion of the contract and can prove that the other party’s economic situation considerably worsened.” 17 the text of the convention does not provide specific criteria for determining the degree of certainty required for reaching the conclusion that a party ” will not” perform a substantial part of his obligations. nevertheless, given that the applicability of art. 71(1) cisg is to be founded on objective considerations, ” strictly construed, the language of the article seems to require that the likelihood of the apprehended non-performance amount to a virtual certainty by normal business standards.” 18 absolute certainty is however not a requirement under art. 71 cisg. first, ” it must be remembered that the cases in which it can be stated with absolute certainty that a particular ” deficit” will lead to an inability to perform are very infrequent.” 19 the party seeking suspension is frequently incapable of assessing precisely the probability that a non-performance will occur, but he is merely in a position to assert, based on a party-subjective appreciation of the circumstances, that it is likely that such non-performance will occur. second, ” circumstances that make it ‘apparent’ that the other party will not perform need not establish a certainty of non-performance since the initial appearance may be modified by clarification of the situation or by the removal of the initial barriers to performance,” 20 given adequate assurance of performance may be provided (see article 71(3) cisg, infra ii.4). third, one should note that, as discussed in detail hereafter (infra ii.6.), the degree of certainty that a breach will be committed, required under art. 71 cisg, nordic journal of commercial law issue 2005 #2 21 schlechtriem, supra note 9, at 93. 22 schlechtriem, supra note 9, at 93. several decisions point out that the buyer’s submissions to the court failed to indicate that the seller would not perform a substantial part of his obligations: germany oberlandesgericht [olg] [provincial c o u r t o f a p p e a l ] d r e s d e n , 2 7 d e c e m b e r 1 9 9 9 , 2 u 2 7 2 3 / 9 9 , a v a i l a b l e o n l i n e a t <http://cisgw3.law.pace.edu/cases/991227g1.html>; switzerland zürich handelskammer [zhk] [zürich chamber o f c o m m e r c e ] , a r b i t r a l a w a r d n o . 2 7 3 / 9 5 , 3 1 m a y 1 9 9 6 , a v a i l a b l e o n l i n e a t <http://cisgw3.law.pace.edu/cases/960531s1.html>. 23 bennett, supra note 6, at 521. germany landgericht [lg] [district court] berlin, 15 september 1994, 52 s 247/94, available online at <http://cisgw3.law.pace.edu/cases/940915g1.html>. 24 bennett, supra note 6, at 519. 25 schlechtriem, supra note 9, at 94. 26 see germany olg hamm, 23 june 1998, 19 u 127/97 (clout case no. 338), available online at <http://cisgw3.law.pace.edu/cases/980623g1.html> and switzerland zhk arbitral award no. 273/95, supra note 22. 27 enderlein/maskow, supra note 7, at 286-287. 28 enderlein/maskow, supra note 7, at 286-287. 29 see austria oberster gerichtshof [ogh] [supreme court], 12 february 1998, 2 ob 328/97t (clout case no. 238), available online at <http://cisgw3.law.pace.edu/cases/980212a3.html>, according to which art. 71(1)(a) cisg covers cases in which a party is subject to an insolvency proceeding or has completely ceased to pay but not in which payment is slow. 30 see belgium tribunal commercial [district court] bruxelles, 13 november 1992, a.r. 2700/90, available online at <http://www.cisg.law.pace.edu/cisg/wais/db/cases2/921113b1.html>, which recognizes the applicability of the convention and the right of the seller to suspend delivery because the buyer failed to pay the price under a prior contract, but which fails to cite art. 71 cisg. 31 neumayer/ming, supra note 10, at 460. 6 is lower than the degree of certainty required under art. 72 cisg, which provides for avoidance of the contract in case of anticipatory (fundamental) breach. in conclusion, art. 71 cisg does not require absolute certainty that a breach will occur. as to the magnitude of the breach (parameter (ii)), art. 71(1) cisg requires, in order for one party to be entitled to suspend performance of his obligations, that it becomes apparent that the other party will fail to perform ” a substantial part of his obligations.” the right to suspend depends on how important the obligation is to the party relying on it.21 nevertheless, as a general rule, the ” performance of ‘relatively minor’ (cf. 320(2) german civil code) obligations may not be forced by suspending one’s own performance.” 22 as explained below (infra ii.6.), it is however not necessary that the suspected breach be fundamental in the sense of art. 25 cisg.23 in other words, art. 71 cisg ” enables the convention to provide for a party to suspend performance where the other party’s breach, while substantial, may not be sufficiently fundamental to justify avoidance.” 24 the importance, for the obligee, of the jeopardized obligation must however have been recognizable to the obligor at the time of the conclusion of the contract.25 finally, as to the various possible indicia that a breach will be committed (parameter (iii)), art. 71(1)(a) cisg mentions, in the first place, a ” serious deficiency in [the] ability to perform.” 26 such deficiency can relate to both the seller and the buyer. the cause of the deficiency is irrelevant; it does not have to be the result of anybody’s fault nor does anybody have to be responsible for it.27 ” there may be a deficiency in the ability of a party to perform a contract even if the party’s financial situation is excellent.” 28 the said deficiency may be either subjective (for example insolvency,29 non-performance of other parallel contracts,30 or expiration of a license) or objective (for example forthcoming strike, fire in the manufacturer’s factory, official public order having an impact on the contract or its performance, such as the prohibition to export currency from the buyer’s country or embargo measures).31 a deficiency in the buyer’s ability to perform, for instance, ” can be the result of a fob business where there is insufficient storage room on http://cisgw3.law.pace.edu/cases/991227g1.html http://cisgw3.law.pace.edu/cases/960531s1.html http://cisgw3.law.pace.edu/cases/940915g1.html http://cisgw3.law.pace.edu/cases/980623g1.html http://cisgw3.law.pace.edu/cases/980212a3.html http://www.cisg.law.pace.edu/cisg/wais/db/cases2/921113b1.html nordic journal of commercial law issue 2005 #2 32 enderlein/maskow, supra note 7, at 286. 33 neumayer/ming, supra note 10, at 461. 34 germany olg hamm, 19 u 127/97, supra note 26; austria olg linz, 23 may 1995, 1r 64/95-34, available online at <http://cisgw3.law.pace.edu/cases/950523a3.html>, see also austria ogh, 6 february 1996, 10 ob 518/95 (clout case no. 176) (aus.), available online at <http://cisgw3.law.pace.edu/cases/960206a3.html>. 35 see austria ogh, 2 ob 328/97t, supra note 29. 36 chengwei, supra note 11, § 9.2. 37 chengwei, supra note 11, § 9.2. see also hungary arbitration court of the chamber of commerce and industry of b u d a p e s t , a r b i t r a l a w a r d v b / 9 4 1 2 4 , 1 7 n o v e m b e r 1 9 9 5 , a v a i l a b l e o n l i n e a t <http://cisgw3.law.pace.edu/cases/951117h1.html>, in which the seller was found entitled to suspend performance of his obligations on the grounds that the buyer had failed to open an effective bank guarantee (the bank guarantee had been opened with a date that had already expired); china international economic & trade arbitration commission, arbitral award cisg/1996/11, 27 february 1996, available online at <http://cisgw3.law.pace.edu/cases/960227cl.html>. 38 see belgium rechtbank [district court] van koophandel hasselt, 1 march 1995, a.r. 3641/94, available online at <http://cisgw3.law.pace.edu/cases/950301b1.html>, and belgium tribunal commercial bruxelles, a.r. 2700/90, supra note 30 (not citing art. 71), which found the seller entitled to suspend his obligations given the buyer’s seven-month delay in payment, respectively non-payment, of the price under earlier sales contracts. 39 chengwei, supra note 11, § 9.2. 40 the following cases cite subparagraph (b): netherlands rb [district court] 's hertogenbosch, 9981/haza 95-2299, 2 october 1998, available online at <http://cisgw3.law.pace.edu/cisg/ wais/db/cases2/981002n1.html>; hungary arbitration court attached to the hungarian chamber of commerce and i n d u s t r y , a r b i t r a l a w a r d v b 9 4 1 3 1 , 5 d e c e m b e r 1 9 9 5 ( c l o u t c a s e n o . 1 6 4 ) , a v a i l a b l e o n l i n e a t <http://cisgw3.law.pace.edu/cases/951205h1.html>; germany lg berlin, 52 s 247/94, supra note 23. 7 board a ship.” 32 a deficiency in the seller’s ability to perform may be made apparent, for example, by recurrent delays in deliveries in violation of mandatory contractual deadlines, or by the delivery of damaged goods to the buyer or even to third parties if the existence of the defects causes serious doubts regarding the performance of the contract, for example if the defects indicate a lack of command of the technique required.33 in germany, the buyer was found to be entitled to suspend his obligations on the basis of the seller’s inability to deliver goods free of restrictions imposed by the seller’s supplier.34 the ” serious deficiency in [a party’s] creditworthiness,” mentioned in art. 71(1)(a) cisg as a second possible circumstance that may make it apparent that that a breach will be committed,35 ” should be interpreted broadly and cover the event where the economic situation of a guarantor or provider of a guarantee deteriorates.” 36 just like the deficiency in a party’s ability to perform, a deficiency in creditworthiness can relate to both parties: ” not only to the buyer who is obligated to pay the price of the goods, but also to the seller who may find himself incapable of financing manufacture of the sold goods. the creditworthiness of the buyer may even play a role when he is the one to perform first, e.g., in the case of advance payment or the opening of a letter of credit.” 37 a serious deficiency in the buyer’s creditworthiness can become manifest, for example, through delays in or the absence of payments due with respect to other orders.38 if, as a result of this deficiency, it becomes apparent that the buyer will not be able to pay the price of the goods that are to be delivered by virtue of the contract in question, the seller is released from his obligation to manufacture and/or deliver those goods. ” however, a deficiency in the creditworthiness of the buyer is no reason for suspending performance when the financial situation of the buyer has not changed since the conclusion of the contract and when there are growing doubts on the part of the seller in regard to setting the buyer a time limit for payment.” 39 art. 71(1)(b) cisg refers to the defaulting party’s ” conduct in preparing to perform or in performing the contract.” 40 this paragraph is to be understood in the light of arts. 32 and 34 cisg, on the one hand, regarding the seller’s obligations, and arts. 54, 60, and 65 cisg, on the http://cisgw3.law.pace.edu/cases/950523a3.html http://cisgw3.law.pace.edu/cases/960206a3.html http://cisgw3.law.pace.edu/cases/951117h1.html http://cisgw3.law.pace.edu/cases/960227cl.html http://cisgw3.law.pace.edu/cases/950301b1.html http://cisgw3.law.pace.edu/cisg/ http://cisgw3.law.pace.edu/cases/951205h1.html nordic journal of commercial law issue 2005 #2 41 see for example germany lg berlin, 52 s 247/94, supra note 23. 42 germany lg berlin, 52 s 247/94, supra note 23. 43 hungary arbitral award vb/94124, supra note 37. 44 hungary arbitral award vb/94131, supra note 40. 45 chengwei, supra note 11, § 9.2; see alsolookofsky, supra note 6, at 148. by contrast, yinghao yang, suspension rules under chinese contract law, the ucc and the cisg: some comparative perspectives, in 18(7)china law & practice 23 (euromoney publications 2004), available online at <http://www.cisg.law.pace.edu/cisg/biblio/yang.html>, maintains that there is nothing in the text of the cisg that can support the view that art. 71(1)(b) cisg goes beyond the promisor’s conduct directly connected to the current contract; in particular, he points out that ” in almost all reported cases where cisg 71(1)(b) was applied, ‘conduct’ has been interpreted as those actions directly related to the current contract,” whereas in cases in which the buyer’s non-payment of previous orders was referred to, the court applied the ” creditworthiness” standard of art. 71(1)(a) cisg, rather than art. 71(1)(b) cisg. yang concludes that ” if the conduct is not directly related, then the promisee can only rely on cisg 71(1)(a).” 46 bennett, supra note 6, at 520. 47 honnold, supra note 7, at 427. 48 enderlein/maskow, supra note 7, at 284. 8 other hand, regarding the buyer’s obligations. indeed, not only the contract, but also the convention, may impose the performance of preliminary acts, such as the making of shipment arrangements (art. 32 cisg), the handing over of documents (art. 34 cisg), the opening of a letter of credit (art. 64 cisg), or the supplying of specifications for goods (art. 65 cisg).41 thus, the following have, for instance, been held to fall under art. 71(1)(b) cisg: a promisor's supply of non-conforming goods in the current contract,42 a failure to provide a bank guarantee as agreed,43 and the non-payment of the price.44 furthermore, the conduct referred to in art. 71(1)(b) cisg ” may also refer to the fulfillment of other contracts . . . and is independent of the financial situation...it may also cover the use of certain unfitting raw materials in performing obligations under similar contracts.” 45 for example, ” a buyer who has contracted for precision parts, which he intends to use immediately upon delivery, may discover that, although there has been no deterioration in the seller's ability to perform and deliver parts of the quality required, defective deliveries are being made to buyers with similar needs. if the reason for these defective deliveries is that the seller has been using raw material from a particular source and if the seller is proposing to use material from that source for the contract in question, the buyer will be entitled to suspend his performance.” 46 in sum, the failure to perform necessary preliminary acts may constitute, in compliance with art. 71(1)(b) cisg, a valid ground for suspension of performance, by the innocent party, of his obligations. in certain circum stances, the failur e mentioned in art. 71(1)(b) cisg may even constitute a breach of contract sufficiently fundamental to entitle the aggrieved party to avoid the contract (arts. 49(1)(a) and 64(1)(a) cisg) or to initiate the nachfrist procedure (arts. 47(1) and 63(1) cisg). nevertheless, even in such cases, if the aggrieved party still wishes to pursue performance of the contract or if the grounds for avoidance of the contract are unclear, suspension of his own performance rather than avoidance of the contract remains available to this party,47 provided that this choice is not more detrimental to the defaulting party (see infra ii.6.). b. types of performances subject to suspension art. 71 cisg ” relates to any party and any obligation.” 48 if the conditions of art. 71 cisg are satisfied, both (advance) performance of the contract and acts regarding preparation of the performance of the contract, imposed by the contract itself or by the convention, may be http://www.cisg.law.pace.edu/cisg/biblio/yang.html nordic journal of commercial law issue 2005 #2 49 schlechtriem, supra note 9, at 93. the suspending party does not breach the contract if the suspension is rightful; see g e r m a n y l g s t e n d a l , 1 2 o c t o b e r 2 0 0 0 , 2 2 s 2 3 4 / 9 4 ( f . r . g . ) , a v a i l a b l e o n l i n e a t <http://cisgw3.law.pace.edu/cisg/text/001012g1german.html>, according to which suspension is not a breach but a unilateral right to modify the time for performance; icc award no. 8786, january 1997, available online at <http://cisgw3.law.pace.edu/cases/978786i1.html>, which stated that the buyer would not have breached if he had exercised the right to suspend. 50 germany olg dresden, 2 u 2723/99, supra note 22. 51 enderlein/maskow, supra note 7, at 284. 52 bennett, supra note 6, at 519-520. 53 enderlein/maskow, supra note 7, at 284. 54 honnold, supra note 7, at 427. 9 suspended by the innocent party, buyer or seller,49 provided that there is a reciprocal relationship between the obligation suspended and the counter-performance.50 indeed, ” what are required are not only acts in performance of the contract, but also those in preparation of performance which, therefore, can also be suspended” 51. thus, the seller is entitled not only to delay the delivery (arts. 31-34 cisg) but also to interrupt the manufacture of the goods or their procurement if he becomes aware of the buyer’s impending insolvency or if it simply becomes apparent that the buyer will not pay the price. similarly, the buyer may not only delay the payment of the price but also suspend the establishment of a letter of credit (arts. 54-59 cisg) or the organization of the taking over of the goods (art. 60 cisg) if, for example, it becomes apparent that the seller will not deliver the goods, or if the seller has been delivering defective goods to other buyers with similar needs, using raw material from a particular source that the seller intends to use also for the contract in question. more precisely, in cases of deficiency in the seller’s ability to perform, ” by suspending performance the buyer will render it unnecessary to make a prepayment, to establish a letter of credit to cover the price of future deliveries or to take preliminary steps such as the making of shipping arrangements or the handing over of documents.” 52 furthermore, one may hold that art. 71 cisg also allows the suspension of the seller’s obligation to deliver substitute goods under art. 46 cisg, i.e., an obligation which presupposes an earlier breach of contract. indeed, ” it is quite logical to include the obligation to deliver substitute goods if it has become doubtful as a consequence that the price will be paid.” 53 in conclusion, the remedies available to the innocent party, under art. 71 cisg, are limited to suspension of performance of the contract (including, for the seller, the obligation to deliver substitute goods), and suspension of performance of duties to be fulfilled in preparation of performance of the contract. the seller, for example, is not authorized to dispose of goods held for the buyer, nor is the buyer authorized to purchase goods to replace those that ought to be provided by the seller.54 according to art. 75, such remedies are available solely when the contract has been avoided. http://cisgw3.law.pace.edu/cisg/text/001012g1german.html http://cisgw3.law.pace.edu/cases/978786i1.html nordic journal of commercial law issue 2005 #2 55 art. 71(2) provides that ” if the seller has already dispatched the goods before the grounds described in the preceding paragraph become evident, he may prevent the handing over of the goods to the buyer even though the buyer holds a document which entitles him to obtain them. the present paragraph relates only to the rights in the goods as between the buyer and the seller.” 56 the proposal that the buyer, too, should be granted the right to revoke a money transfer order (formulated as follows: ” if a party has already dispatched the goods or sent the money (including having had issued a letter of credit) for the goods before the grounds mentioned in paragraph (1) become evident, he may prevent the handing over of the goods or the payment of the money even though the other party holds a document that entitles him to delivery of the goods or payment of the money, as the case may be. this paragraph relates only to rights in the goods or in the money as between the buyer and the seller.” ), was rejected during the drafting of the cisg ” because there was fear of a serious impairment of the international payment transactions and because in many countries the non-payment of a cheque constitutes a criminal act. no such protection is needed in the case of the opening of a letter of credit because the seller usually cannot have access to the letter of credit before having delivered” (secretariat commentary on art. 62 of the 1978 draft [draft counterpart of art. 71 cisg], § 10, available online at <http://www.cisg.law.pace.edu/cisg/text/secomm/secomm-71.html>;chengwei, supra note 11, § 9.3. 57 secretariat commentary on art. 62 of the 1978 draft, supra note 56, § 10. 58 honnold, supra note 7, at 423. 59 honnold, supra note 7, at 432. 10 3. prevention of the handing over of goods already dispatched a. right of the seller to stop goods in transit unlike the first paragraph of art. 71 cisg, applicable to both the seller and the buyer, the second paragraph of the same provision55 only relates to the seller.56 this paragraph deals with cases in which, after the goods have been dispatched, it becomes apparent (or, as the law formulates, ” evident” ) that the buyer will not perform his obligation to pay the price. the seller is authorized to suspend performance of his obligation to deliver the goods by preventing the carrier from handing them over to the buyer, even if the buyer holds a document, such as an ocean bill of lading, which entitles him to obtain them and even if they were originally sold on terms granting the buyer credit after receipt of the goods.57 clearly, the provision is useful only if, on the one hand, the threat of non-payment is discovered after the goods have been dispatched but before they are handed over, and, on the other hand, ” the seller has not retained control over the goods, as by the retention of a negotiable bill of lading (art. 58(2))” .58 the right to stop goods in transit ” is available without regard to whether risk of loss has passed to the buyer.” 59 the general rules on the transfer of the risk to the buyer provide the following: if the contract of sale involves carriage of the goods, the risk passes at the time when the goods are handed over to the first carrier (art. 67(1) cisg); in respect of goods sold in transit, the risk passes to the buyer at the time of the conclusion of the contract (art. 68 cisg); in cases that do not fall within arts. 67 and 68 cisg, the risk passes to the buyer when he takes over the goods (art. 69 ab initio cisg). such rules do not affect the right of the seller, if the conditions of art. 71(2) cisg are satisfied, to prevent the handing over of the goods to the buyer. indeed, first, the object of the provisions on the passing of the risk and that of art. 71(2) cisg differ: the rules on the passing of the risk concern cases of accidental loss of or damage to the goods, whereas art. 71(2) cisg addresses situations in which it appears that the buyer will not be able to pay the price. thus, the circumstances leading to the passing of the risk to the buyer are independent from those in which the seller has a right to suspend performance of his obligation to deliver the goods (obligation which the seller is capable of performing but voluntarily decides not to perform). second, art. 71(2) and the provisions on the passing of the risk are to be considered complementary provisions: if, after the time defined under arts. 67(1), 68, or 69 cisg as the time when the risk passes to the http://www.cisg.law.pace.edu/cisg/text/secomm/secomm-71.html nordic journal of commercial law issue 2005 #2 60 honnold, supra note 7, at 432. 61 secretariat commentary on art. 62 of the 1978 draft, supra note 56, § 11; chengwei, supra note 11, § 9.3; albert h. kritzer, guide to practical applications of the united nations convention on contracts for the international sale of goods 461 (kluwer law and taxation publishers 1988). 62 enderlein/maskow, supra note 7, at 288, according to whom ” if an obligee of the buyer has the goods or if he has pledged title in the goods from a document, the rights of the seller are not governed by the cisg but by the otherwise applicable domestic law;” see also lookofsky, supra note 6, at 149. 63 honnold, supra note 7, at 433. 64 vilus, supra note 7, at 243-244. 11 buyer, it becomes apparent that the buyer will not pay the price of the goods purchased, the provisions on the transfer of the risk only compel the buyer to pay the price, but do not grant any direct protection to the seller. indeed, by stating that the risk is transferred to the buyer for example when the goods are handed over to the first carrier or at the time the contract is concluded, arts. 67 and 68 cisg only provide that, after this point in time, even if the goods are accidentally damaged or lost, the buyer is compelled to pay their price; but arts. 67(1), 68, and 69 cisg do not grant the seller the right to take measures to ensure that the buyer will pay the sum due, nor do these provisions provide any remedy in case the payment never occurs. consequently, art. 71(2) and the provisions on the passing of the risk must be read in conjunction: after the time defined as the time when the risk passes to the buyer, the latter is bound by the obligation to pay the price; additionally, if it appears that the buyer will not perform his obligation, the seller may instruct the carrier not to hand the goods over to the buyer. ” for similar reasons domestic rules that ” property” or ” title” has passed to the buyer may not undermine the narrow and specific rights conferred by article 71(2).” 60 such issues are excluded from the scope, ratione materiae, of the convention (art. 4(b) cisg). b. limitation of the impact of the seller’s instructions art. 71(2) in fine cisg indicates that this paragraph ” relates only to the rights in the goods as between the buyer and the seller.” in other words, the seller’s right to prevent delivery of the goods to the buyer neither impairs the rights of third persons to whom the buyer has resold the goods or who have obtained title in the goods, nor does it affect the relationship between the carrier and the buyer. first, under the cisg, ” the seller loses the right to order the carrier not to hand over the goods if the buyer has transferred the document to a third party who has taken it for value and in good faith.” 61 the relationship between the buyer and his obligee remains intact.62 the applicable domestic rules protecting the property rights of good faith purchasers determine whether the said third party has acquired rights in the goods overriding the seller’s right, under the cisg, to prevent delivery to the buyer.63 in this respect, ” the most common situation referred to in art. 71 is the case in which the goods are in transit. in such circumstances there is a common law institution called ‘stoppage in transitu’ which the seller can use when the buyer has delivered the documents to a third person. this is clear from the formulation of art. 71 which emphasizes that ‘the present paragraph relates only to the rights in the goods as between the buyer and the seller.’ the view is held that in such cases the seller cannot claim the goods from a third party on the basis of the convention, but he might do so under the applicable national law.” 64 in other words, the seller may exercise his rights against third parties only if domestic rules on secured transactions nordic journal of commercial law issue 2005 #2 65 schlechtriem, supra note 9, at 94. 66 honnold, supra note 7, at 433. 67 schlechtriem, supra note 9, at 94; see also lookofsky, supra note 6, at 149. 68 secretariat commentary on art. 62 of the 1978 draft, supra note 56, § 12; kritzer, supra note 61, at 461. indeed, the rules governing the carrier’s obligation to follow the consignor’s orders to withhold the goods from the consignee depend on the selected mode of transportation, and on the applicable international conventions and national laws; chengwei, supra note 11, § 9.3; honnold, supra note 7, at 433, consequently holds that ” the carrier, of course, can have no objection to delivering the goods to the person who is entitled to them if the procedures suggested above protect the carrier against third party claims. (in any case the carrier is normally entitled to receive any unpaid freight before delivering the goods.)” 69 chengwei, supra note 11, § 9.3. 70 bennett, supra note 6, at 520-521. 71 chengwei, supra note 11, § 9.3. 72 enderlein/maskow, supra note 7, at 288. 73 enderlein/maskow, supra note 7, at 288. 74 chengwei, supra note 11, § 9.3. 75 honnold, supra note 7, at 433. 76 chengwei, supra note 11, § 9.3. 12 permit it.65 in this respect, honnold nonetheless states that ” even a third party who holds documents that control delivery may not have rights under domestic law that would cut off the seller’s right to the goods. the essential point is that domestic law can be expected to honor the seller’s rights against the buyer established by article 71(2) cisg and give the seller as much protection against third persons as domestic law accords to other persons in the seller’s position.” 66 second, the seller’s right to stop the goods in transit does not affect the relationship between the carrier and the buyer, and ” whether the carrier or warehouse keeper must follow the seller’s order depends on the freight or warehouse contract, hence, on domestic law.” 67 indeed, the question whether the carrier is obligated or allowed to follow the instructions of the seller where the buyer holds a document which entitles him to claim them is governed by the terms of the contract concluded for carriage as well as the appropriate law of the form of transport in question.68 under the cisg, there is no obligation compelling the carrier to comply with the seller’s request for stoppage.69 consequently, the carrier may be precluded, given his obligations under municipal and international law, from withholding the goods from the buyer. in such circumstances, the effective operation of art. 71(2) cisg could be quite limited.70 if the carrier and the seller are bound by a contractual relationship, ” giving relevant orders to the carrier or forwarding agent in question” 71 remains the only available device for the seller to exercise his right to stoppage and thus prevent the handing over of the goods to the buyer. ” otherwise, [the seller] would have to call in a court.” 72 ” if the buyer’s country has acceded to the cisg, or if the domestic rules of that country also provide for a right to stop the goods in transit, the seller may try to enforce this right through the courts, e.g. by ways of distress or temporary injunction.” 73 otherwise, if the carrier voluntarily stops the goods in transit, he may expose himself to a claim for damages from the buyer.74 consequently, to protect the carrier, the seller should require the buyer to deliver the documents to the seller or to the carrier75 (see arts. 62 and 71(2) cisg), or directly, on the basis of the right to stop performance, request the buyer not to take measures against the carrier.76 nordic journal of commercial law issue 2005 #2 77 belgium hof van beroep [appellate court] gent, 26 april 2000, 1997/ar/2235, available online at <http://cisgw3.law.pace.edu/cases/000426b1.html>, which points out that notice is not ” immediate” when related to deliveries made seven and fourteen months before. 78 schlechtriem, supra note 9, at 94. 79 chengwei, supra note 11, § 9.4. the following statements or acts have been found to constitute sufficient notice: the buyer refused to pay the costs of warehousing furniture when it had earlier agreed to contribute to these costs (germany olg hamm, 19 u 127/97, supra note 26); a letter from the buyer to the seller in which the buyer refused to accept nonconforming items and offered to return them (germany lg berlin, 52 s 247/94, supra note 23). on the other hand, there was insufficient notice in the following circumstances: the buyer failed to pay the price (germany lg stendal, 22 s 234/94, supra note 49); a letter with mentioning defects under other contracts (belgium hof van beroep gent, 1997/ar/2235, supra note 77). 80 chengwei, supra note 11, § 9.4. 81 uncitral digest of case law on the united nations convention on the international sale of goods, ad art. 71 cisg, a/cn.9/ser.c/digest/cisg/71 (8 june 2004). see germany lg stendal, 22 s 234/94, supra note 49; russia federation chamber of commerce and industry arbitration award no. 302/1996, 27 july 1999, in 27 rozenberg, practika of mejdunarodnogo commercheskogo arbitrajnogo syda: haychno-practicheskiy commentariy (1999-2000); germany amtsgericht [ag] [petty district court] frankfurt a.m., 31 january 1991, 32 c 1074/90-41 (clout case no. 51), available online at <http://www.cisg.law.pace.edu/cisg/wais/db/cases2/910131g1.html>, in which the buyer was entitled to damages given the seller’s failure to give immediate notice that he was suspending delivery. 13 4. notice of suspension and adequate assurance of performance a. notice of suspension according to art. 71(3) cisg, a party who has either suspended performance before dispatch of the goods in compliance with paragraph (1), or stopped the goods in transit pursuant to paragraph (2), must immediately give notice of the suspension to the other party. thus, even though one party may suspend the contract without prior notification of intention to suspend, he is compelled to inform the other party of the suspension immediately after it has taken place.77 such notice allows the recipient to provide the party suspending performance with adequate assurance of performance, and thus reinstate the latter’s obligation to resume performance. the notice is subject to art. 27 cisg and consequently need not be received by the addressee to become effective: it is effective upon dispatch.78 in other words, the risk of transmission of the notice is borne by the addressee. however, given that the purpose of the notice of suspension is to allow the addressee to provide adequate assurance of performance and thus allow the parties to communicate and cooperate in order to maintain the contract on foot, it is in the interest of the party suspending performance to ensure that the notice of suspension is received by the addressee. similarly, even though the party notifying suspension of performance is under no obligation to indicate, in the notice, the grounds for suspension, ” it may be inferred from the principle of good faith that grounds should be stated so as to enable the other party to decide what action is to be taken.” 79 scholarly writings have pointed out that if the aggrieved party fails to give notice of suspension, he does not lose the right to suspend performance, but he may have to satisfy the claims for damages by the other party.80 on the other hand, courts uniformly conclude that in the absence of due notice, the aggrieved party may not only have to satisfy the other party’s claims for damages, but moreover may no longer rely on his right to suspend performance.81 furthermore, ” if the party suspending performance neglects to send notice, the other party may have the right to...avoid the contract if he can show that, had he been promptly notified, he would have produced adequate http://cisgw3.law.pace.edu/cases/000426b1.html http://www.cisg.law.pace.edu/cisg/wais/db/cases2/910131g1.html nordic journal of commercial law issue 2005 #2 82 schlechtriem, supra note 9, at 94-95. 83 enderlein/maskow, supra note 7, at 290. 84 kritzer, supra note 61, at 461. 85 secretariat commentary on art. 62 of the 1978 draft, supra note 56, § 13; kritzer, supra note 61, at 461. 86 honnold, supra note 7, at 434. 87 honnold, supra note 7, at 434. 88 honnold, supra note 7, at 434. 89 honnold, supra note 7, at 434. 90 secretariat commentary on art. 62 of the 1978 draft, supra note 56, § 13. 91 honnold, supra note 7, at 434. 92 chengwei, supra note 11, § 9.5. 93 chengwei, supra note 11, § 9.5. 14 assurance. the suspension is no longer justified, from the moment the assurance would have barred the right to suspend performance, and, from that moment, constitutes a breach of contract.” 82 b. adequate assurance of performance pursuant to art. 71(3) cisg, a party who has suspended performance ” must continue with performance if the other party provides adequate assurance of his performance.” in this respect, ” even though there is no express requirement under the cisg, the suspending party should inform the other party that he considers the offered assurance adequate and will continue with performance.” 83 for the assurance provided to be adequate, it must show either that the circumstances that led to the suspension never existed, that these circumstances have been overcome (” give reasonable security to the first party … that the other party will perform” 84), or that ” the first party will be compensated for all his losses from going forward with his own performance.” 85 in the second alternative (adequate assurance that the circumstances that led to the suspension have been overcome), the party required to give adequate assurance of performance must provide evidence of concrete facts or action removing the threat that he ” will not perform a substantial part of his obligations.” 86 merely reassuring the party who suspended performance that the obligation will be performed or reiterating the existence of the obligation is insufficient.87 clearly, offering immediate performance or performing without delay satisfies the condition set out by art. 71(3) cisg. but a vast range of other steps may be undertaken to provide adequate assurance of performance. for example, the buyer may bring the proof that he has reestablished current payments in cases where the threat of non-payment had emanated from the fact that the buyer had suspended payment of his current obligations.88 the buyer may also require the issuance by a bank of an irrevocable letter of credit in favor of the seller.89 he may offer a guarantee by a reputable bank or other such party that the latter would pay if the buyer failed to do so, or even offer a security interest in sufficient goods owned by the buyer to assure the seller of reimbursement.90 similarly, for example, in cases of threats to continued performance by the seller resulting from a strike or the loss of a source of necessary materials, the seller may show that the strike has been settled or that a new source of materials has been obtained for the manufacture of the goods.91 also, ” if export of the goods sold was prohibited, but the seller later obtained an export license, the requirement of adequate assurance would be fulfilled.” 92 finally, if performance was suspended by a party because the other party had declared that he would not perform his contractual obligations, a new statement of the latter, indicating that he intends and is able to perform, will be considered adequate assurance of performance. 9 3 in all cases, nordic journal of commercial law issue 2005 #2 94 honnold, supra note 7, at 434. 95 honnold, supra note 7, at 433-434 96 honnold, supra note 7, at 435. 97 schlechtriem, supra note 9, at 93. 98 bennett, supra note 6, at 522-523. 99 honnold, supra note 7, at 435, which provides the following example: ” suppose that a contract made on june 1 requires the seller to manufacture goods to the buyer’s specifications and deliver them on september 1. on july 1, before the seller has had time to manufacture the goods, the seller is entitled under article 71(1) to suspend performance. the seller immediately notifies the buyer of the suspension but the buyer does not provide adequate assurance of his performance until august 15. if completion of manufacture would require a month the right of ‘suspension’ would be nullified if the seller must deliver the goods by september 1.” 100 chengwei, supra note 11, § 9.5. 101 honnold, supra note 7, at 436; jacob s. ziegel, the remedial provisions in the vienna sales convention: some common law perspectives, in matthew bender, international sales: the united nations convention on contracts for the international sale of goods 9-1, 9-35 (galston & smit ed., 1984), available online at <http://www.cisg.law.pace.edu/cisg/biblio/ziegel6.html>. 15 ” developing an adequate solution to such problems calls for good faith consultation between the parties.” 94 given the fact that suspension of performance by one party is authorized, under art. 71(1) cisg, only if there is a threat of non-performance of ” a substantial part” of the other party’s obligations, the former might be under the obligation to restore performance, even if the assurance of performance provided in compliance with art. 71(3) cisg shows that performance might not be complete nor perfect. indeed, the assurance provided is to be considered adequate, in the sense of art. 71(3) cisg, even if it indicates that the performance will not be in absolute conformity with the contractual terms, provided that the non-conformity is insubstantial.95 thus, for example, adequate assurance is considered to have been provided even if it shows that the performance will be slightly delayed. in such a case, however, the aggrieved party remains entitled to claim damages on the basis of art. 74 cisg.96 the convention does not address the question whether, after adequate assurance of performance has been provided, the party who previously suspended performance is compelled to resume performance of his obligations within the initial time-frame specified in the contract. nevertheless, there seems to be a consensus, among legal scholars, that the answer to this question is negative. schlechtriem holds that the time for delivery may be prolonged: ” if the buyer unexpectedly offers payment or adequate assurances of performance according to article 71(3), the seller who cannot meet the initial delivery date because of his justified suspension is not in fault. he is therefore not liable for the late performance to the extent the delay corresponds to the suspension of preparations.” 97 similarly, in bennett’s opinion, ” there seems to be a clear implication that the seller is entitled to a reasonable adjustment of the date of supply to take account of the suspension.” 98 honnold, in turn, maintains that ” it seems that, at least in some circumstances, the right to ‘suspend’ performance must carry with it an extension of the time for continued performance … the problem calls for a reasonable adjustment to the new situation.” 99 thus, for example, the suspending party may extend the period for performance by the time that has passed since he has interrupted his preparatory work.100 if the request for adequate assurance of performance is justified and the non-performing party fails to provide assurance of performance or if the assurance provided is inadequate, the innocent party may continue to suspend performance of the contract or of obligations that ought to be fulfilled in preparation of performance of the contract, such as, for example, the production of a good.101 http://www.cisg.law.pace.edu/cisg/biblio/ziegel6.html nordic journal of commercial law issue 2005 #2 however, harry m. flechtner, remedies under the new international sales convention: the perspective from article 2 of the u.c.c., in 8 j. l. & com. 53, 95 (1988), holds that the answer to the question whether, if adequate assurance is note forthcoming, the aggrieved party may continue to suspend his performance indefinitely, should be negative. he maintains that ” permitting indefinite suspension where the threatened breach is not fundamental, therefore, would undermine article 72, which permits avoidance only where it is clear that a fundamental breach will occur. two solutions are possible: (1) article 71 could be construed to require that the suspending party either avoid the contract or end its suspension within a reasonable time after demanding adequate assurances; (2) the standards for the seriousness of the threatened breach in articles 71 and 72 could be treated as equivalent. neither solution, however, is supported by the text of the convention.” in turn, yang, supra note 45, states that the fact that the cisg is silent as to the consequences of the failure to provide assurance of performance is a ” troubling loophole,” and that ” without a contractual provision giving [the promisee] the right to cancel the contract, he would probably have to resume the contract performance even after asserting the suspension right.” 102 in such a case, art. 71 cisg was initially the only provision applicable, given that, even though the breach suspected was of fundamental nature, it was merely apparent, but not clear, that it would occur. however, if the requested party fails to provide adequate assurance, then it becomes clear, in the sense of art. 72 cisg, that a breach will be committed, and the contract may be avoided on the basis of this provision. 103 chengwei, supra note 11, § 9.5; see also john. w. carter, party autonomy and statutory regulation: sale of goods, 6 journal of contract law 93, 106 (north ryde nsw 1993), available online at <http://www.cisg.law.pace.edu/cisg/biblio/carter3.html>. it is however important to note that this opinion departs from that of other authors: enderlein/maskow, supra note 7, at 290, maintain that ” if the other party provides no assurance, this can be seen as an indication of an anticipatory, fundamental breach of contract, and the party empowered to suspend performance of his obligations can avoid the contract under art. 72. he may, however, also wait until the time for performance has passed and, in the case of nonperformance, avoid the contract under articles 49 or 64;” similarly, bennett, supra note 6, at 524, asserts that ” frequently, … a failure to provide an adequate assurance will justify a conclusion that a fundamental breach will be committed and avoidance for anticipatory breach will be possible;” finally, honnold, supra note 7, at 436 also states that ” b’s failure to respond with assurances of performance may make it ‘clear’ that b will commit a fundamental breach of contract – a ground for avoiding the contract under article 72;” he nevertheless adds that ” such failure to provide assurances will not always justify avoidance” (footnote 17). 104 see art. 81(1), according to which the party who declares the contract avoided retains the right to claim any damages resulting from the breach of the contract by the other party; kritzer, supra note 61, at 462; vilus, supra note 7, at 244; secretariat commentary on art. 62 of the 1978 draft, supra note 56, § 16. 16 furthermore, given that a party who failed to respond with assurances of performance has thus made it clear that he will not perform (see infra ii.6.), if the nature of the non-performance is such as to constitute a fundamental breach of contract, the innocent party may avoid the contract for anticipatory fundamental breach of contract, in compliance with the requirements of art. 72 cisg (see infra iii.). it is however important to stress that, as explained hereafter in detail (infra ii.6.), this is true only if the suspected breach is, in itself, fundamental in the sense of art. 25 cisg.102 indeed, ” a failure to provide an adequate assurance does not automatically provide a right of avoidance and there is therefore no mechanism by which a party may demand an assurance of performance and treat a failure to respond with an adequate assurance as a fundamental breach” 103 (emphasis added). in other words, in all cases in which the suspected breach is not fundamental, the contract survives the threat of non-performance and the absence of adequate assurance of performance. consequently, if the suspected breach is not fundamental, it is only if the defaulting party does not perform at the time agreed upon by the parties (or fixed by the convention) for performance, and if such non-performance constitutes a fundamental breach of contract, that the aggrieved party may declare the contract avoided (arts. 25, 49, 64, and 81 cisg). in any case, whether the contract be or be not declared avoided, if the failure to provide adequate assurance of performance causes the party suspending performance to suffer damages, these may, as stated above, be recovered, on the basis of art 74 cisg.104 if the party requested to provide adequate assurance of performance brings evidence that the alleged grounds for suspension in fact never existed or that suspension was not justified, the suspending party may be held liable for having breached the contract by suspending performance http://www.cisg.law.pace.edu/cisg/biblio/carter3.html nordic journal of commercial law issue 2005 #2 105 chengwei, supra note 11, § 9.2. 106 enderlein/maskow, supra note 7, at 289. 107 prior to the date on which one party is required to perform, the other party may declare the contract avoided only if the conditions of art. 72 cisg are met (see infra iii.), whereas after the date on which the former is required to perform, the latter may declare the contract avoided only if the conditions of art. 49 or 64 cisg are satisfied. furthermore, avoidance of one or more installments of a contract for delivery of goods by installments is governed by art. 73 cisg (see infra iv.). see germany lg stendal, 22 s 234/94, supra note 49. 108 as explained in the secretariat commentary on article 62 of the 1978 draft, supra note 56, § 5, ” under the convention on the limitation period in the international sale of goods, art. 8, that period would be four years. that convention does not prescribe as to whether the rights under the contract are terminated or whether it is the right of a party to commence an action to enforce such a right which is terminated.” 17 of his obligations in the absence of legitimate grounds. more particularly, depending on the obligation suspended, ” if the first party. . . refuses to perform his obligations unfoundedly, he [may commit] a fundamental breach of contract.” 105 the other party is consequently entitled to claim all the remedies made available by the convention in cases of breach of contract. he may for example claim damages, ” not only … because of the delay but also because of the costs incurred in providing additional assurances.” 106 various events can put an end to a party’s right, under art. 71 cisg, to suspend his obligation to perform. indeed, the obligation to perform may remain suspended only until the other party performs his obligations, until this party provides adequate assurance of performance of his obligations, until the first party declares the contract avoided (if the conditions of arts. 72, 49 or 64 cisg are met, see infra iii.),107 or until the period of limitation applicable to the contract has expired.108 5. impact of the cisg on subsequent uniform sets of principles art. 7.3.4 unidroit principles provides that ” a party who reasonably believes that there will be a fundamental non-performance by the other party may demand adequate assurance of due performance and may meanwhile withhold [his] own performance. where this assurance is not provided within a reasonable time the party demanding it may terminate the contract.” similarly, art. 8:105(1) pecl states that ” a party who reasonably believes that there will be a fundamental non-performance by the other party may demand adequate assurance of due performance and meanwhile may withhold performance of [his] own obligations so long as such reasonable belief continues.” although these two provisions provide, just like art. 71 cisg, for mechanisms of suspension of the creditor’s obligations, their conditions of application differ from those of art. 71 cisg. indeed, whereas under art. 71(1) cisg, a sufficient condition, for the creditor to be entitled to suspend his obligations, is that it be ” apparent that the other party will not perform a substantial part of [his] obligation,” under art. 7.3.4 unidroit principles and art. 8:105(1) pecl, it is necessary that the creditor reasonably believe that there will be a fundamental non-performance for termination to be triggered. the wording of the latter provisions consequently reveals that the drafters of the two sets of principles considered that the party who fears that a breach will be committed may stop performing his own obligations and thus take action to protect his interests only if the suspected breach is of fundamental nature, that is only if the suspected breach would be such as to deprive the aggrieved party of his interest in the contract. in other words, under the nordic journal of commercial law issue 2005 #2 109 harry m. flechtner, the several texts of the cisg in a decentralized system: observations on translations, reservations and other challenges to the uniformity p rinciple in article 7(1), 17 j. l. & com. 187, § ii.a. (1998), available online at <http://www.cisg.law.pace.edu/cisg/biblio/flecht1.html>. see also lookofsky, supra note 6, at 148, according to whom ” a promisee’s prospective failure to perform a ‘substantial part’ of [his] obligations, although obviously significant, is presumably intended to denote something less than a ‘fundamental breach.’” see germany lg berlin, 52 s 247/94, supra note 23. 110 enderlein/maskow, supra note 7, at 286. 18 unidroit principles and the pecl, unless the suspected breach is fundamental, a party may not, prior to the time when the breach actually occurs, back out of his obligations, even if it is clear that a breach will be committed. in conclusion, rather than being compared to art. 71(1) cisg, art. 7.3.4 unidroit principles and art. 8:105 pecl should be examined together with art. 72(2) cisg, according to which ” if time allows, the party intending to declare the contract avoided must give reasonable notice to the other party in order to permit him to provide adequate assurance of his performance” (see infra iii.3.). 6. hierarchy and interplay between the right to suspend performance and the right to avoid the contract art. 71 and art. 72 cisg do not only clearly differ in their wording and in the remedies they provide; they also seem to differ in their conditions of application. whereas art. 71 cisg requires the future breach to be a non-performance of a ” substantial part” of the debtor’s obligation, art. 72 cisg requires the future breach to be ” fundamental” in the sense of art. 25. also, whereas art. 71 cisg purports to be applicable only if it ” becomes apparent” that the breach will be committed, art. 72 cisg purports to be applicable only if it is ” clear” that the breach will be committed. these distinctions in terminology convey substantive differences between the two provisions. first, regarding the nature or gravity of the suspected breach, ” the drafters would not have used two different phrases (‘fundamental breach’ as opposed to non-performance of ‘a substantial part of his obligations’), and, in particular, two different adjectives describing the seriousness of the breach (‘fundamental’ as opposed to ‘substantial’), had they not intended to distinguish the seriousness of the threatened breach that would meet the standards of the respective articles.” 109 in other words, the breach needs to be more ” serious” to trigger the more drastic remedy of avoidance of the contract (art. 72 cisg) rather than mere suspension of performance (art. 71 cisg). logically, this statement means that if the more onerous conditions of art. 72 cisg are satisfied, then so are those of art. 71 cisg. in other words, it seems that when it is clear that a fundamental breach of contract will be committed, the aggrieved party is entitled to choose between suspending performance of his obligations and avoiding the contract. some authors thus hold that ” if the expected non-performance were at the same time a fundamental breach of contract, the obligor would have a choice between suspension of performance under article 71, or avoidance of the contract under article 72.” 110 indeed, according to these authors, ” if an anticipatory breach occurs, the innocent party may want to enforce specific performance in which case [he] would make use of [his] right to suspend performance under article 71 rather than to http://www.cisg.law.pace.edu/cisg/biblio/flecht1.html nordic journal of commercial law issue 2005 #2 111 sieg eiselen, remarks on the manner in which the unidroit principles of international commercial contracts may b e u s e d t o i n t e r p r e t o r s u p p l e m e n t a r t i c l e s 7 1 a n d 7 2 o f t h e c i s g ( 2 0 0 2 ) , a v a i l a b l e o n l i n e a t <http://www.cisg.law.pace.edu/cisg/principles/uni71,72.html#er>, and remarks on the manner in which the principles of european contract law may be used to interpret or supplement articles 71 and 72 of the cisg (2002), available online at <http://www.cisg.law.pace.edu/cisg/peclcomp71,72.html>, who maintains that ” in certain circumstances, a party may be entitled to rely on either article 71 or article 72.” 112 enderlein/maskow, supra note 7, at 292; see also bennett, supra note 6, at 528 et seq. 113 albert h. kritzer, overview comments on reasonableness, available online at <http://www.cisg.law.pace.edu/cisg/text/reason.html>. schlechtriem, supra note 9, at 39, also states that ” the rule that the parties must conduct themselves according to the standard of the ‘reasonable person’ . . . must be regarded as a general principle of the convention.” 114 kritzer, supra note 113. 115 see also commission on european contract law, comment and notes on pecl 1:302, in principles of european contract law: parts i and ii 126, 127 (ole lando and hugh beale eds., kluwer law international 2000), available online at <http://www.cisg.law.pace.edu/cisg/text/reason.html>. 116 honnold, supra note 7, at 101. 117 frans j.a. van der velden, the law of international sales: the hague conventions 1964 and the uncitral uniform sales code 1980 – some main items compared, in hague-zagreb essays 4 on the law of international trade 46, 52 (voskuil & wade eds., nijhoff 1983). 19 avoid the contract under article 72 even if [he] is entitled to do so.” 111 it seems, however, that it is only in theory that the innocent party benefits from such a choice. as explained in the following paragraphs, such a solution could be unreasonable in that it could lead to unfair results, and consequently be prohibited (indirectly) by art. 77 cisg (mitigation of losses) and the general principle of reasonableness. first, if the conditions of art. 72 cisg are met, the innocent party, who envisages the suspension of the performance of his obligations under art. 71 cisg until the time for performance by the other party has expired, should take art. 77 cisg into consideration, and conclude that the ” contract should definitely be avoided where an immediate avoidance would mitigate the losses.” 112 second, suspending performance rather than avoiding the contract could violate the principle of reasonableness, which is ” a general principle of the cisg.” 113 given the fact that the cisg does not define this concept, kritzer maintains that the pecl’s definition, ” which fits the manner in which this concept is used in the cisg,” 114 ought to be taken into consideration. pursuant to art. 1:302 pecl, ” reasonableness is to be judged by what persons acting in good faith and in the same situation as the parties would consider to be reasonable. in particular, in assessing what is reasonable the nature and purpose of the contract, the circumstances of the case, and the usages and practices of the trades or professions involved should be taken into account.” 115 coming close to the definition of reasonableness under art. 1:302 pecl, honnold states that under the cisg, ” what is ‘reasonable’ can appropriately be determined by ascertaining what is normal and acceptable in the relevant trade.” 116 van der velden, in turn, interprets the concept of reasonableness as entailing, among other things, an ethical standard of behavior leading one to be judicious and fair.117 in the light of this definition of the concept of reasonableness, even though there is no doubt that if the conditions of art. 72 cisg are satisfied, those of art. 71 cisg are a fortiori met, the innocent party’s choice to suspend performance of his obligations rather than avoid the contract could be inadmissible. indeed, in cases where the non-performing party is not at fault (the suspected nonperformance does not dependent on his conduct and will), given that suspension of performance by the other party does not free the non-performing party from his obligation to comply with the http://www.cisg.law.pace.edu/cisg/principles/uni71,72.html#er http://www.cisg.law.pace.edu/cisg/peclcomp71,72.html http://www.cisg.law.pace.edu/cisg/text/reason.html http://www.cisg.law.pace.edu/cisg/text/reason.html nordic journal of commercial law issue 2005 #2 118 the uncitral digest of case law on the united nations convention on the international sale of goods, supra note 81; austria ogh, 2 ob 328/97t, supra note 29. in this case, if the innocent party chooses to suspend performance with respect to future installments, it must give notice in accordance with art. 71(3) cisg (russia federation chamber of commerce and industry arbitration award no. 302/1996, supra note 81). 119 eiselen, remarks on the manner in which the unidroit principles of international commercial contracts may be used to interpret or supplement articles 71 and 72 of the cisg, supra note 111. 120 chengwei, supra note 11, § 9.6.2; see also eiselen, supra note 111. 121 trevor bennett, comments on article 72, in cesare massimo bianca & michael joachim bonell, commentary on the i n t e rn a t i o n a l s a l e s – t h e 1 9 8 0 v i e nn a s ales co nvent io n 52 5, 52 9 (g iuffrè 19 87 ), ava i la b l e o nl i n e a t <http://www.cisg.law.pace.edu/cisg/biblio/bennett-bb72.html>. 20 terms of the contract, merely suspending rather than avoiding the contract could lead to unfairly detrimental consequences for the non-performing party and could, in t hat s ense, be ” unreasonable.” for example, this is the case if a party suspends performance until the date fixed by the contract for performance and a fundamental breach occurs at that time, allowing the party who had suspended performance to seek specific performance by the other party (art. 46 and 62 cisg). this is unfairly detrimental to the latter party, who was not at fault at the outset, and who would have been freed from all his obligations, had the contract been initially avoided in compliance with art. 72 cisg. in such a situation, suspension of performance by the aggrieved party should therefore be considered contrary to general considerations of reasonableness. the same reasoning is applicable if both the conditions of art. 71 cisg and those of art. 73 cisg are satisfied. indeed, ” the right to suspend under article 71 applies both to contracts of sale for a single performance and to installment contracts governed by article 73. when the preconditions of both articles are satisfied, the aggrieved party may choose between suspending performance and avoiding the contract with respect to future installments under article 73(2),” 118 provided that opting for suspension of performance is not more detrimental to the defaulting party than avoiding the contract with respect to the said future installments. now, if both art. 71 and art. 72 cisg are available because, on the one hand, the conditions of art. 72 cisg are satisfied, and, on the other hand, the innocent party is, in the light of the above considerations regarding reasonableness, entitled to choose either remedy, this party will often start by suspending performance of his own obligations. in this manner, first, the innocent party is able to protect himself without delay (art. 71 cisg does not require that notice of suspension be given prior to the moment when suspension actually takes place, whereas art. 72 cisg requires that the innocent party give the other party reasonable notice of his intent to declare the contract avoided). second, by merely suspending performance of his obligations, the innocent party gives the other party a last chance to perform in compliance with the terms of the contract before putting an end to it. consequently, ” if there is any doubt on whether, due to the conduct of the other party or the prevailing circumstances, there is an anticipatory breach objectively speaking, a party should rather exercise the right to suspend performance under article 71 cisg and require an adequate assurance from the other party than issue a notice of avoidance under article 72(2).” 119 ” it is a safer option because the giving of a notice of avoidance in terms of art. 72(2) under circumstances where it is not warranted may in itself constitute an anticipatory breach entitling the other party to avoid the contract.” 120 hence, it is often only after one party has suspended performance of his obligations and only if the other party fails to provide adequate assurance of performance, that the former will avoid the contract. notice of suspension given by the innocent party should therefore, in cases in which both art. 71 and art. 72 cisg are available, preferably comply with the requirements of both provisions:121 such notice should indicate that http://www.cisg.law.pace.edu/cisg/biblio/bennett-bb72.html nordic journal of commercial law issue 2005 #2 122 schlechtriem, supra note 9, at 96. 123 honnold, supra note 7, at 437; see also enderlein/maskow, supra note 7, at 286, who hold that under art. 72, ” a greater certainty than in article 71 regarding the right to suspend performance of obligations is required;” bennett, supra note 121, at 528; eiselen, remarks on the manner in which the unidroit principles of international commercial contracts may be used to interpret or supplement articles 71 and 72 of the cisg, supra note 111; anton k. schnyder & ralf michael straub, in kommentary zum un-kaufrecht, rn 24, rn 25 (honsell ed., springer 1997), who hold that this is the proper interpretation when due regard is paid to the history and drafting of art. 71 and art. 72 cisg; flechtner, supra note 101, at 94; lookofsky, supra note 6, at 148. 124 see jacob s. ziegel, report to the uniform law conference of canada on convention on contracts for the international sale of goods, available online at <http://www.cisg.law.pace.edu/cisg/text/ziegel71.html>, according to whom art. 71 cisg was intended to be invoked more easily than art. 72 cisg; see also lookofsky, supra note 6, at 148, according to whom a comparison of the terms of art. 71 ” with the rules set forth in article 72 indicates that the convention makes it somewhat easier to suspend than avoid.” 125 the french version of art. 71(1) is the following: ” une partie peut différer l'exécution de ses obligations lorsqu'il apparaît, après la conclusion du contrat, que l'autre partie n'exécutera pas une partie essentielle de ses obligations;” in turn, art 72(1) reads: ” si, avant la date de l'exécution du contrat, il est manifeste qu'une partie commettra une contravention essentielle au contrat, l'autre partie peut déclarer celuici résolu.” the spanish version of art. 71(1) provides: ” cualquiera de las partes podrá diferir el cumplimiento de sus obligaciones si, después de la celebración del contrato, resulta manifiesto que la otra parte no cumplirá una parte sustancial de sus obligaciones;” in turn, art. 72(1) reads: ” si antes de la fecha de cumplimiento fuere patente que una de las partes incurrirá en incumplimiento esencial del contrato, la otra parte podrá declararlo resuelto.” 126 the clearest example where this has been applied is icc award no. 8786, supra note 49. see also austria schiedsgericht der börse für landwirtschaftliche in wien [arbitral tribunal vienna] s 2/97, 10 december 1997, available online at <http://cisgw3.law.pace.edu/cases/971210a3.html>. in switzerland zivilgericht saane [district court], 20 february 1997, t 171/95 (clout case no. 261), available online at <http://cisgw3.law.pace.edu/cases/970220s1.html>, and switzerland zhk arbitral award no. 273/95, supra note 22, reliance on art. 72 cisg was rejected due to a lack of evidence that there was an intention to repudiate; it was not clear that a breach would be committed. 21 the party giving the notice has suspended performance of his obligations and that he intends to avoid the contract in case of failure, by the other party, to provide adequate assurance of performance. if the party who received the notice provides adequate assurance of performance, the other party is compelled to resume performance and is prohibited from declaring the contract avoided. the second issue relates to the question whether the degree of certainty required under art. 71 cisg that a breach of contract will occur, is lower than that required under art. 72 cisg. this issue has been profusely debated. the wording used in the two provisions is not the same: art. 71 cisg requires that ” it [become] apparent” that the debtor will not perform a substantial part of his obligations, whereas art. 72 cisg requires that it be ” clear that one of the parties will commit a fundamental breach.” nevertheless, some authors maintain that both provisions require the same degree of certainty, i.e., in both cases, the innocent party must have attained a degree of virtual or quasi certainty that a breach will occur. schlechtriem, for example, maintains that ” the different formulations do not require different degrees of certainty – such a requirement would hardly be practicable anyway. . . the decisive factor in all three provisions – arts. 71, 72(1) and 73(2) – is whether a reasonable person would be convinced that a breach of contract is certain to occur.” 122 on the other hand, the majority of authors who have examined the question have come to the conclusion that ” standards for suspension are less rigorous than the standards for avoidance under article 72.” 123 the difference in terminology was, according to these authors, consciously drafted124 and is also found in the french and spanish versions of the cisg.125 some court decisions also seem to hold the view that art. 72 cisg requires a higher standard of prospective certainty than art. 71 cisg.126 ” this approach is also supported by the provisions of articles 7.3.3 and 7.3.4 of the unidroit principles, where there is a clearly formulated difference in the requirements. in terms of article 7.3.3, it is required that it be clear that there will be a http://www.cisg.law.pace.edu/cisg/text/ziegel71.html http://cisgw3.law.pace.edu/cases/971210a3.html http://cisgw3.law.pace.edu/cases/970220s1.html nordic journal of commercial law issue 2005 #2 127 eiselen, remarks on the manner in which the unidroit principles of international commercial contracts may be used to interpret or supplement articles 71 and 72 of the cisg, supra note 111. 128 schlechtriem, supra note 9, at 95-96. 129 as stated above, enderlein/maskow, supra note 7, at 290, maintain that ” if the other party provides no assurance, this can be seen as an indication of an anticipatory, fundamental breach of contract, and the party empowered to suspend performance of his obligations can avoid the contract under art. 72. he may, however, also wait until the time for performance has passed and, in the case of non-performance, avoid the contract under articles 49 or 64.” similarly, bennett, supra note 6, at 524, asserts that ” frequently, . . . a failure to provide an adequate assurance will justify a conclusion that a fundamental breach will be committed and avoidance for anticipatory breach will be possible.” finally, honnold, supra note 7, at 436 also states that ” b’s failure to respond with assurances of performance may make it ‘clear’ that b will commit a fundamental breach of contract – a ground for avoiding the contract under article 72,” but he nevertheless indicates that ” such failure to provide assurances will not always justify avoidance” (note 17). 130 chengwei, supra note 11, § 9.5; carter, supra note 103. 131 ziegel, supra note 124. 22 fundamental non-performance, whereas in terms of article 7.3.4 there need only be a reasonable belief on the part of the innocent party that there will be a fundamental non-performance.” 127 at the time of the drafting of the cisg, such difference was ” accepted and justified on the grounds that the remedy in article 71(1) differs in seriousness from the remedy in article 72(1). under article 71(1), the suspension applies only to obligations still to be performed and leaves the contract intact, whereas, under article 72(1), an avoidance of the contract is possible.” 128 indeed, art. 71 cisg allows one party to suspend performance not only if the threat of non-performance by the other party concerns the obligation to pay the price, to accept delivery of the goods, or to deliver the goods, but also if the non-performance relates to acts to be performed in a view to paying the price, accepting the delivery, or delivering the goods. art. 71 cisg is used as a tool available to the innocent party to put pressure on the other party by momentarily – until adequate assurance of performance is provided – suspending performance of his obligations. under art. 72 cisg, the innocent party’s aim is not to compel the other party to comply with his obligations; the goal is not, like under art. 71 cisg, to ” save” the contract, but rather to put an end to it. the third issue concerns the consequences of the failure to provide adequate assurance of performance, given that art. 71 cisg does not specify them. as stated above (supra ii.4.), opinions vary as to what these consequences are and therefore as to the interplay between art. 71 and art. 72 cisg. is a failure or a refusal to provide adequate assurance of performance in itself a fundamental breach authorizing avoidance under art. 72 cisg, or does such failure only make it clear that the breach suspected under art. 71 cisg will be committed? if one party fails to provide adequate assurance of performance, is the other party only entitled to continue suspending performance of his obligations, or does he have an additional right to consider the contract repudiated by the other party? many authors maintain that in case of failure to provide assurance of performance in compliance with art. 71(3) cisg, the innocent party is entitled to invoke art. 72 cisg on anticipatory repudiation and thus declare the contract avoided.129 the author of the present paper agrees with the opinion of other authors, who hold that ” a failure to provide an adequate assurance does not automatically provide a right of avoidance and there is therefore no mechanism by which a party may demand an assurance of performance and treat a failure to respond with an adequate assurance as a fundamental breach.” 130 thus, the statement according to which ” under art. 71 the party seeking assurance of performance is only entitled to suspend his own performance pending the provision of the sought assurance [, and] it is only if adequate assurance is not furnished that he is entitled to avoid the contract” 131 is accurate only if the suspected breach is of fundamental nordic journal of commercial law issue 2005 #2 23 nature. if the non-performing party fails to provide assurance of performance and the suspected breach is not of fundamental nature, the innocent party is only entitled to continue to suspend performance of the contract or of obligations that ought to be fulfilled in preparation of performance of the contract (supra ii.4.; see however footnote 101). this view is supported by a comparative analysis of the cisg and the relevant provisions of the unidroit principles. under art. 7.3.4 unidroit principles, if the innocent party reasonably suspects – but is not necessarily certain – that the other party will commit a fundamental nonperformance, the former may demand adequate assurance of performance from the latter. in case of failure by the latter to provide such assurance of performance within a reasonable period of time, the innocent party is entitled to terminate the contract. a close connection is thus established, in the unidroit principles, between one party’s failure to provide adequate assurance of performance in cases in which it is not ” clear” that a breach will be committed, and the other party’s corresponding right to avoid the contract. this mechanism however clearly departs from the hierarchy established between art. 71 and art. 72 cisg. first, art. 71 cisg, which – like art. 7.3.4 unidroit principles – authorizes suspension of performance in cases it which it is not ” clear” but merely ” apparent” that a breach will be committed, does not mention any right of one party to declare the contract avoided in case of failure by the other party to provide assurance of performance. second and most importantly, in case of failure by one party to provide adequate assurance of performance, art. 7.3.4 unidroit principles authorizes the other party to avoid the contract only if the suspected non-performance is of fundamental nature. consequently, even though the failure to provide, under art. 71 cisg, adequate assurance may – just like under art. 7.3.4 unidroit principles – make it ” clear,” in the sense of art. 72 cisg, that a breach will be committed, such a failure does not in itself constitute a fundamental breach, nor does it transform the suspected mere breach into a fundamental breach. in conclusion, under the cisg, if the breach initially suspected is not fundamental, avoidance of the contract is prohibited, even in cases of failure to provide adequate assurance of performance. iii. avoidance prior to the date for performance 1. purpose and rationale of the provision one of the fundamental purposes of the convention is to maintain international commercial contracts intact and to allow their performance even in adverse circumstances, in order to promote loyalty and good faith in international commercial transactions. therefore, the convention was drafted so as to permit avoidance of international sales contracts only in cases in which, clearly, continuation would cause one party or both parties irreparable harm. in other words, arts. 49 and 64 cisg authorize the buyer and the seller respectively to avoid the contract only if the other party has committed a fundamental breach of contract in the sense of art. 25 cisg. in sum, avoidance of the contract under the cisg is clearly a remedy of extrema ratio. a priori, art. 72 cisg seems to contradict the spirit of the convention. first, this provision authorizes one party to avoid the contract when no breach has actually occurred and the time for performance has not yet elapsed. second, art. 72 cisg is not limited to cases of objective impossibility of performance but is also applicable in cases of subjective inability to perform (see infra iii.2.). consequently, even though art. 72 cisg provides that the contract may, in theory, be nordic journal of commercial law issue 2005 #2 132 bennett, supra note 121, at 527-528. 133 schlechtriem, supra note 9, at 95. 134 chengwei, supra note 11, § 9.6.2; see also commission on european contract law, comment and notes on pecl 9:304, in principles of european contract law: parts i and ii 416, 417 (ole lando and hugh beale eds., kluwer law international 2000), available online at <http://www.cisg.law.pace.edu/cisg/text/peclcomp72.html>. 24 avoided only if it is objectively ” clear” or certain that a fundamental breach will occur, the risk remains that a contract be avoided even though the difficulties faced by one party in the performance of his obligations would in fact have been overcome before the time agreed upon by the parties for performance. art. 72 cisg is nevertheless the result of a compromise that satisfied the member states. the drafters came to the conclusion that if, at one point in time before the time agreed upon for performance, it is objectively ” clear” that a fundamental breach will be committed, the interests of the party threatened by the breach ought to be primarily protected. indeed, the drafters considered that art. 71 cisg (right to suspend performance, supra ii.) might not grant sufficient protection if the suspected breach is of fundamental nature, and they considered that the protection of the threatened interests requires that the innocent party be entitled to declare the contract avoided, for example, so as to expeditiously enter into another contract, or remove uncertainty regarding financial commitments.132 however, with regard to the principle according to which avoidance of contract is a remedy of last resort, the drafters complied with ” the desire expressed by developing countries to permit the party whose breach is presumed to provide assurances and thereby to prevent the avoidance (article 72(2)).” 133 2. conditions of avoidance of the contract pursuant to art. 72(1) cisg, ” if prior to the date for performance of the contract it is clear that one of the parties will commit a fundamental breach of contract, the other party may declare the contract avoided.” given the fact that avoidance of contract is a remedy of extrema ratio, in particular when based on the prospect of a breach (rather than on a breach that has actually taken place), art. 72 cisg precisely circumscribes the two conditions that ought to be satisfied for one party to be authorized to declare the contract avoided. the first condition relates to the degree of certainty that a breach will be committed. the second condition concerns the nature and magnitude of the breach. a. degree of certainty that a breach will occur art. 72(1) cisg requires, as a first condition, that the party who intends to declare the contract avoided ensure that it is ” clear” that the other party will commit a fundamental breach of contract. ” a mere suspicion, even a well-founded one, is not sufficient.” 134 even though art. 72 cisg does not explicitly identify the degree of clarity or certainty that ought to be reached, a higher degree of clarity is required for the application of art. 72 cisg than for the application of art. 71 cisg (see considerations above, supra ii.6.). nevertheless, scholars and courts agree that art. 72 cisg does http://www.cisg.law.pace.edu/cisg/text/peclcomp72.html nordic journal of commercial law issue 2005 #2 135 chengwei, supra note 11, § 9.6.2; germany lg berlin, 30 september 1992, 99 o 123/92, available online at <http://cisgw3.law.pace.edu/cases/920930g1.html>, in which the court held that for avoidance, the probability of a future breach must be very high, but almost complete certainty is not required; germany olg düsseldorf, 14 january 1994, 17 u 146/93 (clout case no. 130), available online at <http://cisgw3.law.pace.edu/cases/940114g1.html>. one decision stated that a claim of anticipatory repudiation must be supported by the conditions ” (1) that the defendant intended to breach the contract before the contract’s performance date and (2) that such breach was fundamental” (united states federal district court, northern district of illinois, 7 december 1999 (clout case no. 417)). 136 germany lg berlin, 52 s 247/94, supra note 23; see also germany olg düsseldorf, 18 november 1993, 6 u 228/92, available online at <http://cisgw3.law.pace.edu/cases/931118g1.html>; germany lg krefeld, 28 april 1993, 11 o 210/92, available online at <http://cisgw3.law.pace.edu/cases/930428g1.html>; australia supreme court of q u e e n s l a n d , 1 7 n o v e m b e r 2 0 0 0 , c i v i l j u r i s d i c t i o n n o . 1 0 6 8 0 o f 1 9 9 6 , a v a i l a b l e o n l i n e a t <http://cisgw3.law.pace.edu/cases/001117a2.html>. 137 honnold, supra note 7, at 438. 138 enderlein/maskow, supra note 7, at 291. 139 robert koch, the concept of fundamental breach of contract under the united nations convention on contracts for the international sale of goods (cisg), in review of the convention on contracts for the international sale of goods (cisg) 1998 177, 306 (kluwer law international 1999). 140 secretariat commentary on article 63 of the 1978 draft [draft counterpart of art. 72 cisg] § 2, available online at <http://www.cisg.law.pace.edu/cisg/text/secomm/secomm-72.html>. 25 not require absolute and unshakable certainty that a breach will be committed.135 in a 1992 german decision, the landgericht (district court) berlin stated that, under art. 72 cisg, a very high degree of probability is required (” eine an sicherheit grenzende wahrscheinlichkeit” ).136 in fact, it transpires from the mechanisms provided for in art. 72(2) and (3) cisg that absolute certainty is not required. art. 72(2) cisg envisages the possibility that adequate assurance of performance be provided and the contract be eventually performed, even if it was initially ” clear” that a breach would be committed. in turn, art. 72(3) cisg indicates that a party’s declaration ” that he will not perform his obligations” empowers the other party to declare the contract avoided even though the declaration of the repudiating party does not make it absolutely ” clear” that he will not change his mind and perform by the due date.137 the mechanisms provided for in art. 72(2) and (3) cisg also show that it is precisely at the time of the declaration of avoidance that it must be objectively clear that a breach will be committed. in other words, the innocent party is not compelled to ensure that, at all times until the moment fixed for performance, there will be objective certainty that a breach will occur. otherwise, the only situations covered by art. 72 cisg would be those in which it has become impossible for one party to perform his obligations; art. 72(2) and (3) cisg would never be enforced and would consequently have remained a dead letter. after all, ” an anticipatory, fundamental breach of contract is, except when there is an express statement by the obligor, a presumption which is based on objective factors” 138 at a particular moment in time. in any case, the suspicion that a fundamental breach of contract will be committed must be objectively founded. indeed, as explained above (supra ii.6.), just as the contract may not be suspended, under art. 71 cisg, on the basis of one party’s merely subjective fear, under art. 72 cisg, a fortiori, the contract may not be avoided on the basis of such subjective fear. rather, objective grounds must show that it is ” clear that one of the parties will commit a fundamental breach of contract.” 139 it is important to note here that the failure to provide, in compliance with art. 72(3) cisg, adequate assurance of performance (see infra iii.3.), makes it objectively clear that a breach will be committed. indeed, the secretariat has articulated that ” the failure by a party to give adequate assurance that he will perform when properly requested to do so under [draft] article 62(3) [counterpart of the current art. 71(3)] may help make it ‘clear’ that he will commit a fundamental breach.” 140 scholars similarly maintain that it is ” possible to conclude that the promisor’s failure to provide adequate assurance in accordance with paragraph (2) of article 72 http://cisgw3.law.pace.edu/cases/920930g1.html http://cisgw3.law.pace.edu/cases/940114g1.html http://cisgw3.law.pace.edu/cases/931118g1.html http://cisgw3.law.pace.edu/cases/930428g1.html http://cisgw3.law.pace.edu/cases/001117a2.html http://www.cisg.law.pace.edu/cisg/text/secomm/secomm-72.html nordic journal of commercial law issue 2005 #2 141 koch, supra note 139, at 305; see also, for the same conclusion, bennett, supra note 6, at 524; kritzer, supra note 61, at 466, who maintains that ” the failure by a party to give adequate assurances that he will perform when properly requested to do so under article 71(3) may help make it ‘clear’ that he will commit a fundamental breach.” see also the decisions of germany olg düsseldorf, 17 u 146/93, supra note 135, and of germany lg berlin, 99 o 123/92, supra note 135, in which both courts held that failure to provide adequate assurance by the buyer made it clear that he would not pay the purchase price. 142 bennett, supra note 121, at 528. 143 bennett, supra note 121, at 528. 144 this assertion is not in agreement with the view expressed by koch, supra note 134, at 306, according to whom the causes of the non-performance under art. 72 cisg are strictly the same as those mentioned under art. 71(1) cisg; indeed, koch holds (in agreement with hans g. leser, commentary on the un convention on the international sale of goods, ad art. 72, n. 21 (peter schlechtriem ed., 1998)) that in both cases, there must be objective grounds showing a high degree of probability that the promisor will not perform a substantial part of his obligations as a consequence of a serious deficiency in his ability to perform or in his creditworthiness, or as a result of his conduct in preparing to perform or in performing the contract. 145 the wording of the draft art. 63 and the current art. 72(1) are identical, with the one exception that the current text refers to ” a fundamental breach of contract” , whereas the draft art. 63 referred to ” a fundamental breach;” the secretariat commentary on the draft art. 63 is consequently of primary relevance to the interpretation of the current art. 72 cisg. 146 secretariat commentary on article 63 of the 1978 draft, supra note 140, § 2; kritzer, supra note 61, at 466, who specifies that even though the imposition of an embargo or monetary controls which renders future performance impossible justifies the other party’s avoidance of the contract under art. 72 cisg, the non-performing party may be excused from damages by virtue of art. 79 cisg. 147 enderlein/maskow, supra note 7, at 291. hans stoll, zur haftung bei erfüllungsverweigerung im einheitlichen kaufrecht 618 et seq, (rabelsz, 1988), criticizes such combination because, in his view, different conclusions have to be drawn when it comes to the right of the entitled party to claim damages: there would be an immediate right to claim damages in cases of refusal, by the debtor, to perform, whereas in other cases, such claim would not be available before the performance is due, and/or there would be no such claim at all of the obligor is not liable under art. 79 or 80 cisg. 148 enderlein/maskow, supra note 7, at 291. 26 makes it ‘clear’ that he will commit a fundamental breach.” 141 thus, if one party suspects that the other will commit a fundamental breach of contract and requests assurance of performance in compliance with art. 71(3) cisg, the latter party’s failure to provide such assurance makes it ” clear,” in the sense of art. 72(1) cisg, that the breach will be committed. under art. 72 cisg, as opposed to art. 71 cisg, ” there is no requirement that the anticipated breach be clear as a result of any particular conduct or circumstances.” 142 indeed, whereas art. 71 cisg specifies the circumstances that may cause one party not to perform a substantial part of his obligations, art. 72 cisg does not list the situations that may lead to the conclusion that a fundamental breach will be committed. under the latter provision, ” it is sufficient that [the breach] be clear whatever the clarity results from.” 143 in other words, the future occurrence of a fundamental breach may be made manifest, just as under art. 71 cisg, by a serious deficiency in the debtor’s ability to perform or in his creditworthiness, or may follow from his conduct in preparing to perform or in performing the contract, but it may also result from other circumstances not expressly mentioned in the text of the law.144 according to the secretariat’s commentary on the draft of art. 63 (counterpart of the current art. 72 cisg145), ” the future fundamental breach may be clear either because of the words or actions of the party which constitute a repudiation of the contract or because of an objective fact, such as the destruction of the seller’s plant by fire or the imposition of an embargo or monetary controls which will render impossible future performance.” 146 indeed, art. 72 ” combines in one rule the refusal to perform and an anticipated objective impossibility to perform.” 147 in the absence of objective circumstances making performance impossible (such as insolvency of the obligor or the initiation of bankruptcy proceedings148), the contract may also be avoided for a number of nordic journal of commercial law issue 2005 #2 149 in this respect, it is important to note that if one party declares that it will not perform its obligations, but eventually does so in compliance with the terms of the contract, the other party may not be held liable for having declared the contract avoided and such declaration brings the contract to an end. 150 chengwei, supra note 11, § 9.6.2. 151 honnold, supra note 7, at 438. 152 united states federal district court, northern district of illinois, supra note 130. 153 schlechtriem, supra note 9, at 95. 154 honnold, supra note 7, at 438. 155 germany olg düsseldorf, 17 u 146/93, supra note 135; germany lg berlin, 52 s 247/94, supra note 23. 156 australia supreme court of queensland, supra note 136. 27 ” subjective reasons” which make it clear, in the sense of art. 72 cisg, that a breach will be committed. the secretariat commentary, scholarly writings, and case law have articulated the following few examples of circumstances – which are not objective circumstances leading to an absolute certainty that performance has, forever, become impossible – in which the innocent party is entitled to consider that it is ” clear,” in the sense of art. 72(1) cisg, that a fundamental breach will be committed. firstly, the contract may be avoided by one party if, as expressly envisaged by art. 72(3) cisg, the other party repudiates the said contract, either through his actions, or by declaring that he will not perform his obligations or that his performance will be defective.149 for example, the seller or the buyer is deemed to have repudiated the contract if he declares that he will not perform his obligations, or if he denies the very existence of the sale contract.150 also, the seller is deemed to have repudiated the contract if he resells to a third party the goods that he had contracted to deliver to the buyer, or if he resells either the plant where he had pledged himself to manufacture the goods for the buyer, or the machines with which he had agreed to produce the goods for the buyer.151 thus, for instance, allegations, if proved, that the seller stated he would ” no longer feel obligated” to perform and would ” sell the material elsewhere” entitle the buyer to avoid the contract.152 it is important to note here that if the aggrieved party does not respond to repudiation by declaring the contract avoided, he may be obliged to accept performance if the party who repudiated the contract changes his mind. secondly, schlechtriem maintains that ” the frequent cases in which a demand for new terms or alleged contract violations by the other side are used as a pretext for not performing one’s own obligations” constitute, ” in most cases,” a ground for immediate avoidance.153 ” this proposition was probably intended to govern situations in which one party (a) demands new terms from the other (b), coupled with an unconditional declaration that a ‘will not perform’ [his] obligations. avoidance by b should not be triggered if a informs b of the need to negotiate a modification of their agreement (cf. art. 29). in any event, a response by b that goes beyond a notice of suspension of b’s counter-performance and a request for assurance (art. 71) may be hazardous since it may provide grounds for a to avoid the contract on the ground that b has repudiated under art. 72(1).” 154 finally, the precondition of paragraph (1), that it be ” clear” that a fundamental breach will be committed, has been found to be satisfied in the following circumstances: the buyer failed to pay for prior shipments;155 the buyer failed to open a letter of credit;156 the seller failed to reduce the nordic journal of commercial law issue 2005 #2 157 icc award no. 8786, supra note 49. 158 switzerland zhk arbitral award no. 273/95, supra note 22. 159 enderlein/maskow, supra note 7, at 291; vilus, supra note 7, at 244. 160 hossam el-saghir, editorial remarks regarding the comparison of art. 8:103 pecl and art. 25 cisg, in guide to article 25 – c o m p a r i s o n w i t h p r i n c i p l e s o f e u r o p e a n c o n t r a c t l a w ( p e c l ) , a v a i l a b l e o n l i n e a t <http://www.cisg.law.pace.edu/cisg/text/peclcomp25.html>; peter schlechtriem, commentary on the un convention on the international sale of goods (cisg) 177 (clarendon press 1998). 161 el-saghir, supra note 160. 162 switzerland zivilgericht saane, t 171/95, supra note 126. 163 icc award no. 8574, september 1996, available online at <http://cisgw3.law.pace.edu/cases/968574i1.html>. 164 switzerland zhk arbitral award no. 273/95, supra note 22. 165 enderlein/maskow, supra note 7, at 292. 166 enderlein/maskow, supra note 7, at 292. 28 price and to commit to deliver fashion goods on time;157 the seller deliberately stopped delivering the goods.158 b. magnitude of the suspected breach the second condition imposed by art. 72(1) cisg for the innocent party to be entitled to declare the contract avoided is that the suspected breach be fundamental in the sense of art. 25 cisg. this condition applies to both suspected defective performances and suspected delayed performances, if the time for performance is of the essence of the contract or if the contract stipulates that a delay in performance constitutes a fundamental breach of contract. according to art. 25 cisg, ” a breach of contract committed by one of the parties is fundamental if it results in such detriment to the other party as substantially to deprive him of what he is entitled to expect under the contract, unless the party in breach did not foresee and a reasonable person of the same kind in the same circumstances would not have foreseen such a result.” an example of anticipatory fundamental breach often encountered is bankruptcy.159 the history of art. 25 cisg indicates that the term ” so as substantially to deprive him of what he is entitled to expect under the contract” does ” not refer to the extent of the damage, but instead to the importance of the interests which the contract and its individual obligations actually create for the promisee.” 160 consequently, there is a fundamental breach of contract only if the aggrieved party, as a result of the breach, not only loses interest in the performance of the contract, but also suffers a detriment.161 consequently, there is no anticipatory fundamental breach in the following situations: the seller has held back the goods;162 the seller expressed an interest in stopping deliveries but also agreed to continue negotiations;163 the buyer failed to pay one installment.164 c. declaration of avoidance if the conditions of art. 72(1) cisg are satisfied and notice of avoidance has been given (see infra iii.3.), the innocent party may declare the contract avoided. ” there is no time limit for such declaration. if the entitled party first decides to wait, he may avoid the contract at any time before the period for performance expires,” 165 provided that the conditions of art. 72(1) cisg are satisfied at the time of the declaration. given its prompt effect, a declaration of avoidance cannot be withdrawn once it has become effective.166 http://www.cisg.law.pace.edu/cisg/text/peclcomp25.html http://cisgw3.law.pace.edu/cases/968574i1.html nordic journal of commercial law issue 2005 #2 167 enderlein/maskow, supra note 7, at 291; bennett, supra note 121, at 528. 168 kritzer, supra note 61, at 466; lookofsky, supra note 6, at 150. 169 bennett, supra note 121, at 528. 170 honnold, supra note 7, at 438. 171 chengwei, supra note 11, § 9.7.1. 172 enderlein/maskow, supra note 7, at 293. 29 ” if a party declares the contract avoided without a fundamental breach of contract by the other party being anticipated, the former commits a fundamental breach of contract” 167 and is compelled to accept the latter’s performance. indeed, if, at the time performance was due, no fundamental breach would in fact have occurred, the original expectation that a breach would be committed may not have been ” clear,” and the declaration of avoidance may consequently be void. in such a case, the party who attempted to avoid would be in breach of the contract given his own failure to perform.168 in other words, the action of the party who declared the contract avoided ” may be invalid and lead to the result that his own subsequent non-performance amounts to a breach and possible liability for damages.” 169 consequently, the declaration of avoidance is to be considered as wrongful and may in turn constitute a repudiation of the contract, giving the other party the right to avoid the contract in accordance with art. 72(1) cisg.170 3. advance notice of intent to avoid the contract and adequate assurance of performance a. advance notice of intent to avoid the contract pursuant to art. 72(2) cisg, ” if time allows, the party intending to declare the contract avoided must give reasonable notice to the other party in order to permit him to provide adequate assurance of his performance.” ” the notice of the party intending to declare the contract avoided demanding that the other party provide adequate assurance of the performance, as art. 72(2) cisg allows in such a case, seems to be the best solution to relieve the former party from doubts about occurrence of the other party’s breach and reduces the risk he would otherwise be taking.” 171 thus, the notice of the innocent party requesting adequate assurance of performance primarily serves two purposes. first, for the party who suspects without certainty that a breach will be committed, it does not compel him to wait until the date of performance, unable to protect his interests, and then incur losses if the other party eventually does not perform. second, the obligation of giving notice in compliance with art. 72(2) cisg and the opportunity thus granted to the non-performing party to provide adequate assurance of performance prevent hasty declarations of avoidance in cases in which it eventually appears that the other party would have performed his obligations in compliance with the terms of the contract. thus, the obligation of giving notice protects the party wishing to avoid the contract from wrongfully declaring the contract avoided and consequently being held liable in damages. the notice is subject to art. 27 cisg. it does not need to be received by the addressee to become effective. therefore, ” if it is lost, the party entitled to avoid the contract does not lose that right. but he should in his own interest make sure that the notice reaches the other party.” 172 art. 72(3) cisg provides a first exception to the general obligation to give notice of intent to avoid the contract. indeed, this paragraph states that ” the requirements of the preceding paragraph do not apply if the other party has declared that he will not perform his obligations.” thus, if a party has repudiated the contract (which is, according to schlechtriem, the most nordic journal of commercial law issue 2005 #2 173 schlechtriem, supra note 9, at 95. in china international economic & trade arbitration commission, arbitral award cisg/1996/05, 30 january 1996, available online at <http://cisgw3.law.pace.edu/cases/960130cl.html>, the arbitral tribunal held that by declaring in a fax that ” ... it is impossible to deliver the goods. we will try to find other sources, but because it is hard to find such goods, the possibility is low ... due to the above reasons, [buyer] needs to make arrangements for non-delivery (including bank guarantee, etc.),” the seller had clearly expressed that he would not perform his delivery obligation. the tribunal concluded that in such circumstances, according to art. 72(3) cisg, the party intending to declare the contract avoided (the buyer) needed not notify the other party. 174 schlechtriem, supra note 9, at 95; chengwei, supra note 11, § 9.6.3. 175 enderlein/maskow, supra note 7, at 293. 176 enderlein/maskow, supra note 7, at 292. 177 enderlein/maskow, supra note 7, at 292. 178 sieg eiselen, remarks on the manner in which the unidroit principles of international commercial contracts may be used to interpret or supplement articles 71 and 72 of the cisg and remarks on the manner in which the principles of european contract law may be used to interpret or supplement articles 71 and 72 of the cisg, supra note 111. there are however strong contrary views on this issue; see, for example, germany lg düsseldorf, 9 july 1992, 31 o 223/91, available online at <http://cisgw3.law.pace.edu/cases/920709g1.html>. 179 enderlein/maskow, supra note 7, at 292-293, who maintain that ” in the very interest of the obligee, it should be reasonable in most cases to give notice of an avoidance of contract. this is contradicted by circumstances only where there is absolute certainty of future fundamental breaches of contract . . . even in the event of the other party’s bankruptcy, his receiver could prefer fulfillment to avoidance of the contract.” 180 chengwei, supra note 11, § 9.6.3; see also schlechtriem, supra note 9, at 95. 30 frequent situation), the other party may declare the contract avoided without having first given notice of his intent to do so173 (for a more detailed analysis of the consequences of a repudiation of the contract, see infra iii.6.). also, ” since [art. 72(3)’s] exception also covers the frequent cases in which a demand for new terms or alleged contract violations by the other side are used as a pretext for not performing one’s own obligations, immediate avoidance still remains an option in most cases.” 174 nonetheless, one should remember that declaring the contract avoided, if it has been repudiated by the other party, is a right, not an obligation. if the aggrieved party does not avoid the contract, and if the debtor of the obligation changes his mind, the latter may still perform the contract.175 the obligation to give notice, under art. 72(2) cisg, suffers a second exception: the party who intends to declare the contract avoided is under no obligation of giving reasonable notice if time does not allow it. as a general rule, ” given the sophisticated means of communication, it is hardly imaginable that time would not allow to give notice to the other party of the intended avoidance of the contract.” 176 nevertheless, two situations may be envisaged in which one ought to consider that time does not allow the party wishing to avoid the contract to give notice of his intent. first, the contract may be declared avoided without prior notice of intent, if such notice would result in a delay which would be prejudicial to the interests of the innocent party. second, sending a notice of intent is not a condition to the declaration of avoidance if the time-span between the moment when notice would have been given and the expiration of the time for performance would be too short for the addressee of the notice to provide adequate assurance of performance in compliance with art. 72(2) cisg.177 in other words, notice to the other party is unnecessary in cases where the delivery date is so near that adequate assurance could not be provided in time. indeed, ” the object of the notice requirement is to enable the other party to provide adequate assurance of his performance. if that has become impossible, then the necessity to give notice must surely fall away.” 178 notice must be ” reasonable,” and it is reasonable only if the addressee has a chance to provide assurance of performance.179 ” where there is little chance that the other party can still provide security – for example, where a delivery cannot be made because of war – notice will often be unnecessary.” 180 consequently, the following conclusion may be reached: notice of one party’s intent to avoid the contract is unnecessary in all situations in which it is objectively certain that a http://cisgw3.law.pace.edu/cases/960130cl.html http://cisgw3.law.pace.edu/cases/920709g1.html nordic journal of commercial law issue 2005 #2 181 eiselen, remarks on the manner in which the unidroit principles of international commercial contracts may be used to interpret or supplement articles 71 and 72 of the cisg and remarks on the manner in which the principles of european contract law may be used to interpret or supplement articles 71 and 72 of the cisg, supra note 111. 182 koch, supra note 139, at 305-306. 183 koch, supra note 139, at 306; honnold, supra note 7, at 434 by analogy. 184 koch, supra note 139, at 306. 185 enderlein/maskow, supra note 7, at 292-293. 186 bennett, supra note 121, at 528, who adds that ” the giving of notice under paragraph (2) will be in the interests of the party proposing to declare the contract avoided because its effect will be to establish whether it is in fact ‘clear’ that the fundamental breach will be committed, thereby removing the risk of liability arising in consequence of an invalid declaration” (p. 530); koch, supra note 134, at 305; kritzer, supra note 61, at 466; decisions of germany olg düsseldorf, supra note 130 and germany lg berlin, supra note 130. 31 fundamental breach will be committed. in any event, ” if there is doubt on whether the innocent party should have informed or not, the court ought to rule in favor of the innocent party, i.e., that there was no duty to inform.” 181 b. adequate assurance of performance as mentioned earlier, the object of the obligation to give notice of intent to declare the contract avoided is ” to permit [the other party] to provide adequate assurance of his performance” (art. 72(2) cisg). ” what constitutes an adequate assurance varies depending on the circumstances, including the standing and integrity of the promisor, his previous conduct in relation to the contract, and the nature of the event that creates uncertainty as to his ability and willingness to perform.” 182 as a general rule, an assurance of performance is deemed adequate if it gives reasonable security to the creditor of the obligation either that the debtor will perform or that the creditor will be compensated for all losses incurred in executing his own performance. as stated above, a reassuring statement, i.e., a mere statement of intention and ability to perform will generally be considered insufficient.183 ” in most instances, a new term of payment against documents, a guarantee by a reputable bank, or a letter of credit issued by a reputable bank will be required.” 184 ” if there is serious doubt as to the seller’s performing of his obligations, he could also provide a guarantee of performance. he could also explain in which way he can and will deliver the goods in time, in the agreed quality and free from third party rights or claims (e.g., use of subcontractors, increase in the production capacity, cancellation of other obligations to deliver, acquisition of licenses, etc.).” 185 ” the absence of an assurance of performance in response to a notice under . . . paragraph [(2)] would normally tend to make it clear that a breach is going to occur” 186 (see supra iii.2.). consequently, in all cases in which the innocent party is under the obligation to give notice of his intent to declare the contract avoided, the failure of the other party to provide adequate assurance of performance is a necessary and sufficient condition for the avoidance of the contract. in other words, with the exception of cases of repudiation of the contract and cases in which time does not allow the party who intends to declare the contract avoided to give reasonable notice to the other party, the former may declare the contract avoided if and only if the debtor of the obligation fails to provide adequate assurance of performance. a parallel may therefore be established between the obligation to provide adequate assurance of performance, with regard to anticipated nondelivery, non-payment, or failure to take delivery, under art. 72(2) cisg, and the nachfrist procedure under arts. 49(1)(b) and 64(1)(b) cisg. the purpose of both mechanisms is the same, namely to give the obligor a last chance to perform his obligation and thus ” remove the nordic journal of commercial law issue 2005 #2 187 koch, supra note 139, at 308. 188 enderlein/maskow, supra note 7, at 292. 189 chengwei, supra note 11, § 9.6.1; see also commission on european contract law, supra note 134, at 418. lookofsky, supra note 6, at 150, nevertheless points out that the convention itself contains no specific rule regarding an immediate action for damages in case of anticipatory fundamental breach. he stresses that section ii of chapter v of the convention deals with damages in cases of actual breach (damages being based, under the cisg, on the failure of a party to perform his obligations under the contract or the convention; see art. 45 and 61). he concludes that ” if an action for damages under articles 74-76 is to be based upon a ‘breach by anticipatory repudiation,’ we might say that a cisg promise to perform in the future ‘by implication includes an engagement not deliberately to compromise the probability of performance. . .’ the cisg protects the expectation interest of the promisee in general, and the promisee should be entitled that his performance expectation be protected against anticipatory repudiation as well.” 190 honnold, supra note 7, at 439. 191 see secretariat commentary on art. 63 of the 1978 draft, supra note 140, § 4. the match-up indicates that paragraph (1) of art. 63 of the 1978 draft and paragraph (1) of art. 72 cisg are substantially identical. paragraphs (2) and (3) of the official text are new; see the match-up, available online at <http://www.cisg.law.pace.edu/cisg/text/matchup/matchup-d72.html>. see also kritzer, supra note 61, at 466; leser, supra note 144, at 541; lookofsky, supra note 6, at 150. leif sevón, obligations of the buyer under the un convention on contracts for the international sale of goods, in international sale of goods: dubrovnik lectures 203, 228 (petar sarcevic & paul voken eds., oceana publications 1986), however, states that ” as the seller may even resort to a requirement for performance after the buyer’s breach has amounted to a fundamental breach, it can hardly be assumed that the buyer could, at this stage, require the seller to take steps to mitigate his damage.” 32 performance obstacles which give rise to the right to avoidance. while the ‘nachfrist-type’ procedure eliminates uncertainty when performance is overdue, the adequate assurance procedure eliminates uncertainty concerning performance that is not yet due.” 187 both mechanisms aim at maintaining the contract on foot. 4. consequences of the avoidance of the contract the declaration results in prompt avoidance of the contract; no agreement by the other party, nor any assistance by the courts is required.188 furthermore, ” a party which exercises a right to terminate the contract for anticipatory non-performance has the same rights as on termination for actual non-performance and is therefore entitled to exercise any other remedies available to actual non-performance, including damages, except that damages are not recoverable where the nonperformance at the due date would be excused” 189 (arts. 74 to 76 cisg). thus, the consequences of a declaration of avoidance include, on the one hand, the right to claim restitution of whatever the avoiding party has supplied or paid under the contract (art. 81(2) cisg), and, on the other hand, the right to recover damages (art. 81(1) cisg). regarding damages, in all cases in which a party wrongfully repudiates the contract, the other party, who declared the contract avoided, is allowed to resell or repurchase the goods that were the object of the first contractual agreement, regardless of the fact that the party who repudiated the contract might change his mind and eventually offer to perform his obligations within the timeframe set by the contract. ” in addition, by virtue of article 75, a reasonably prompt resale or repurchase (even prior to the date for performance) may fix the damages for which the repudiating party will be liable.” 190 furthermore, even when it is clear that a fundamental breach of contract will occur, the duty to mitigate the loss, mentioned under art. 77 cisg, may require the party who intends to invoke that breach to take measures to protect his interests, to reduce his loss, including loss of profit, resulting from the breach, even prior to the contract date for performance.191 thus, for instance, ” if it is clear that a non-delivery of goods amounting to a fundamental breach is going to occur and that the amount of the losses expected to result from the breach is greater if prompt action is not taken to make alternative arrangements for the supply http://www.cisg.law.pace.edu/cisg/text/matchup/matchup-dnordic journal of commercial law issue 2005 #2 192 bennett, supra note 121, at 529. 193 honnold, supra note 7, at 438. 194 according to art. 9:304 pecl, ” where prior to the time for performance by a party it is clear that there will be a fundamental non-performance by it, the other party may terminate the contract.” 195 according to art. 7.3.3 unidroit principles, ” where prior to the date for performance by one of the parties it is clear that there will be a fundamental non-performance by that party, the other party may terminate the contract.” 196 chengwei, supra note 11, § 9.6.1. 197 eiselen, remarks on the manner in which the unidroit principles of international commercial contracts may be used to interpret or supplement articles 71 and 72 of the cisg, supra note 111. 198 chengwei, supra note 11, § 9.6.1. 199 commission on european contract law, supra note 134, at 417. 200 commission on european contract law, supra note 134, at 417. 33 of the goods, the obligation to mitigate losses requires avoidance action under article 71 even before the breach has occurred.” 192 in case of wrongful declaration of avoidance (i.e., if the conditions of art. 72(1) cisg were in fact not satisfied, for instance, if it appears that in fact it was not ” clear” that a breach would occur, or the suspected breach was not of fundamental nature), the party who declared the contract avoided is under the obligation to accept performance by the other party, and may be considered by the latter as having repudiated the contract under art. 72(1).193 5. impact of the cisg on subsequent uniform sets of principles the wording of art. 9:304 pecl1 9 4 is almost identical to that of art. 7.3.3 unidroit principles.195 furthermore, the notion of anticipatory breach adopted by these two provisions is very close to that of art. 72(1) cisg. the rationale of all three provisions is the same: a party to a contract cannot reasonably be expected to continue to be bound by it if it has become clear that the other party will commit a fundamental breach, cannot or will not perform at the due date.196 furthermore, in all three sets of rules and principles, ” any fundamental non-performance is regarded as a breach of contract, whether the performance was possible or not. thus where substantial performance becomes impossible, even if such impossibility results from circumstances beyond the control of the obligor, non-performance or mal-performance is still regarded as a breach.” 197 as a consequence, all three provisions ” are said to establish the principle that a nonperformance which is to be expected is to be equated with a non-performance which occurred at the time when performance fell due.” 198 art. 7.3.3 unidroit principles and art. 9:304 pecl are largely inspired by art. 72 cisg, not only with respect to the notion of anticipatory breach on which they are founded, but also with respect to the conditions of avoidance that each provision lays out. in all three cases, ” anticipatory non-performance” means ” an obvious unwillingness or inability to perform where the failure in performance would be fundamental within art. 8:103” 199 pecl. furthermore, under the unidroit principles, the pecl, and the cisg, the party faced with an anticipatory nonperformance may terminate the contract at any time, provided that two conditions are satisfied. first, the inability or unwillingness to perform must be manifest; a mere suspicion, even wellfounded, is insufficient.200 under the unidroit principles and the pecl, however, mere doubts as to the ability or willingness to perform allow the creditor of the performance to demand assurance of performance under art. 7.3.4, respectively art 8:105; meanwhile, he may withhold nordic journal of commercial law issue 2005 #2 201 commission on european contract law, supra note 134, at 417; chengwei, supra note 11, § 9.6.2. 202 for examples of situations in which it is clear that a fundamental breach will be committed, see supra iii.2. 203 eiselen, remarks on the manner in which the unidroit principles of international commercial contracts may be used to interpret or supplement articles 71 and 72 of the cisg and remarks on the manner in which the principles of european contract law may be used to interpret or supplement articles 71 and 72 of the cisg, supra note 111. 204 eiselen, remarks on the manner in which the unidroit principles of international commercial contracts may be used to interpret or supplement articles 71 and 72 of the cisg and remarks on the manner in which the principles of european contract law may be used to interpret or supplement articles 71 and 72 of the cisg, supra note 111. 34 performance of his own obligations201 (see infra for a more detailed analysis of this specificity of the unidroit principles and the pecl). second, the threatened non-performance must be fundamental in the sense of art. 25 cisg, respectively art. 7.3.1 unidroit principles and 8:103 pecl. the provisions of the cisg regarding anticipatory avoidance of the contract however differ, in various respects, from those of the unidroit principles and the pecl. first, the scope of application of art. 72(1) cisg seems to be narrower than that of art. 7.3.3 unidroit principles and of art. 9:304 pecl. indeed, some authors maintain that whereas art. 72(1) cisg requires that the debtor of the obligation be the author (” will commit” ) of the fundamental breach, the conditions of art. 9:304 pecl and art. 7.3.3 unidroit principles are satisfied if it is clear202 that ” there will be” a fundamental non-performance, regardless of the identity of the author of the non-performance. nevertheless, this distinction does not hold an important place beyond the boundaries of a theoretical comparative analysis.203 second, the interplay between provisions governing suspension of performance and provisions governing avoidance of the contract differs between the cisg, on the one hand, and the unidroit principles and pecl, on the other hand. as explained above (supra ii.5.), even though the unidroit principles and the pecl grant to the innocent party, as does art. 71(1) cisg, a right to suspend performance of his obligations, in the context of the two sets of nonbinding principles, such right may only be exercised if the suspected breach is of fundamental nature. consequently, the innocent party benefits from no remedy (similar to that provided by art. 71 cisg) if the suspected breach is not of fundamental nature. furthermore, the difference, between cases of suspension of performance and cases of avoidance of the contract, in the required degree of certainty that a breach will occur, seems to be clearer in the unidroit principles and in the pecl than in the cisg. whereas art. 7.3.3 unidroit principles and art. 9:304 pecl, pertaining to the avoidance of the contract, require that it be objectively clear that a fundamental non-performance will occur, art. 7.3.4 unidroit principles and art. 8:105 pecl, pertaining to the suspension of performance, only require that there be a subjective reasonable belief, on the part of the innocent party, that there will be a fundamental non-performance.204 as to the provisions of the cisg, both art. 71 and art. 72 cisg require that the future occurrence of the breach be objectively recognizable, but the degree of certainty that a breach will occur, is higher under art. 72 cisg than under art. 71 cisg. the drafters of the two sets of non-binding principles have thus avoided an on-going debate similar to the one opposing the two formulations ” it is clear,” under art. 72 cisg, and ” it becomes apparent,” under art. 71(1) cisg, that a breach will be committed. third, the cisg’s approach to avoidance of the contract is more lenient than that of the unidroit principles and the pecl. indeed, under art. 72(2) and (3) cisg, the innocent party nordic journal of commercial law issue 2005 #2 205 eiselen, remarks on the manner in which the unidroit principles of international commercial contracts may be used to interpret or supplement articles 71 and 72 of the cisg and remarks on the manner in which the principles of european contract law may be used to interpret or supplement articles 71 and 72 of the cisg, supra note 111. 206 chengwei, supra note 11, § 9.6.3; see also eiselen, remarks on the manner in which the unidroit principles of international commercial contracts may be used to interpret or supplement articles 71 and 72 of the cisg and remarks on the manner in which the principles of european contract law may be used to interpret or supplement articles 71 and 72 of the cisg, supra note 111. 207 eiselen, remarks on the manner in which the unidroit principles of international commercial contracts may be used to interpret or supplement articles 71 and 72 of the cisg, supra note 111. 208 eiselen, remarks on the manner in which the principles of european contract law may be used to interpret or supplement articles 71 and 72 of the cisg, supra note 111. 209 see eiselen, remarks on the manner in which the unidroit principles of international commercial contracts may be used to interpret or supplement articles 71 and 72 of the cisg, supra note 111. 210 chengwei, supra note 11, § 9.7.2; see unidroit, official commentary on art. 7.3.4, § 3, available online at <http://www.cisg.law.pace.edu/cisg/principles/uni71,72.html>, and commission on european contract law, comment and notes on pecl 8:105, in principles of european contract law: parts i and ii 370, 371 (ole lando and hugh beale eds., kluwer law international 2000), available online at <http://www.cisg.law.pace.edu/cisg/text/peclcomp71.html#8:105>. 35 is under the obligation, when time allows it, to give to the other party notice of his intent to declare the contract avoided, unless the other party has clearly announced his intention not to perform his obligations. as already mentioned, the object of the notification is to grant the addressee a last chance to provide adequate assurance of performance and thus prevent a declaration of avoidance. under art. 7.3.3 unidroit principles and art. 9:304 pecl, there is no such obligation.205 indeed, ” a party is not obligated to inform the other party, but may as a precaution require an adequate assurance of due performance, failing which that party is entitled to terminate the agreement” 206 (art. 7.3.4 unidroit principles and art. 8:105 pecl). fourth, the unidroit principles and the pecl establish a close connection between suspension of performance and avoidance of the contract, which is absent from the cisg. according to art. 7.3.4 unidroit principles and art. 8:105 pecl, a party who reasonably believes that there will be a fundamental non-performance by the other party may demand adequate assurance of performance and meanwhile may withhold performance of his own obligations; if the requested assurance is not provided within a reasonable time, the party who demanded it may terminate the contract. there is thus a ” close connection between the provisions of article 7.3.3 and 7.3.4” 207 unidroit principles, as well as ” between the provisions of article 9:304 and 8:105” 208 pecl. if a party is uncertain as to whether there will be a fundamental breach, but reasonably suspects that it may occur, that party is, according to art. 7.3.4 unidroit principles and art. 8:105 pecl, entitled to demand an adequate assurance of performance from the other party. failure to provide such assurance is a sufficient ground, under art. 7.3.4 unidroit principles and art. 8:105 pecl, to terminate the contract.209 ” in other words, if the aggrieved party does not receive adequate assurance of performance and still believes on reasonable grounds that performance will not be forthcoming, it may terminate the contract … the other party’s failure to give the assurance requested is itself treated as a fundamental nonperformance under the two sets of principles, giving the aggrieved party the right to terminate the contract and also a right to damages where the deemed non-performance is not excused.” 210 more precisely, the failure to provide adequate assurance of performance turns a reasonable subjective belief that a breach could occur into an objective certainty or clarity (required under art. 7.3.3 unidroit principles and art. 9:304 pecl for avoidance of the contract), which authorizes the innocent party to declare the contract avoided. such a close connection between suspension of performance and avoidance of the contract is absent from the cisg for the following reason. http://www.cisg.law.pace.edu/cisg/principles/uni71,72.html http://www.cisg.law.pace.edu/cisg/text/peclcomp71.html#8:105 nordic journal of commercial law issue 2005 #2 211 this opinion is not unanimous. see supra ii.6.. 212 see eiselen, remarks on the manner in which the unidroit principles of international commercial contracts may be used to interpret or supplement articles 71 and 72 of the cisg, supra note 111. 213 secretariat commentary on art. 66 of the 1978 draft [draft counterpart of art. 81 cisg] § 2, available online at <http://www.cisg.law.pace.edu/cisg/text/secomm/secomm-81.html>. 214 schlechtriem, supra note 9, at 107. 36 whereas the provisions of the unidroit principles and the pecl governing suspension and avoidance of the contract both apply only if the (objectively or subjectively) suspected breach is fundamental, under the cisg, only art. 72 cisg, governing avoidance of the contract, requires that the suspected breach be of fundamental nature. for the innocent party to be entitled to suspend the contract, in compliance with art. 71 cisg, it is sufficient that it be apparent that a breach of a substantial part of the debtor’s obligations will be committed. thus, the suspected breach, under art. 71 cisg, is generally not of fundamental nature and, as explained above (supra ii. 4. and 6.), the failure to provide adequate assurance of performance in compliance with art. 71(3) cisg does not, in itself, constitute a fundamental breach.211 such failure only makes it clear that a breach will be committed but does not modify the nature of that breach. it is therefore logical that art. 71 cisg does not provide a right, for the innocent party, to avoid the contract if the other party has failed to provide adequate assurance of performance. under the unidroit principles and the pecl, even if it is initially not objectively ” clear” that a breach will be committed, given that the suspected breach is fundamental, the drafters have agreed that failure to provide adequate assurance of performance should authorize the innocent party to declare the contract avoided. in conclusion, it appears that even though the unidroit principles and the pecl seem to have installed a more strict standard than the cisg in that they do not grant the innocent party any remedy if the suspected breach is not fundamental, it is easier for the innocent party, under these principles than under the cisg, to declare the contract avoided. also, if it is ” clear,” under the unidroit principles or the pecl, that a fundamental non-performance will occur, ” there is no requirement to give notice as is the case with article 72 of the cisg.” 212 hence, the structure of the unidroit principles and the pecl allow the innocent party to enter rapidly into another contractual relationship and thus preserve his commercial interests. regarding the effects of contract termination, the unidroit principles and the pecl share some common rules with the cisg. like art. 81(1) ab initio cisg, art. 7.3.5(1) unidroit principles and art. 9:305(1) pecl provide that both parties are released from their obligation to execute future performances and lose the right to claim future performances. thus, in all three systems, in case of avoidance of the contract, ” both parties are released from their obligations to carry out the contract: the seller need not deliver the goods and the buyer need not take delivery or pay for them.” 213 furthermore, art. 9:305(2) pecl and art. 7.3.5(3) unidroit principles stipulate, like art. 81(1) in fine cisg, that ” avoidance does not affect any provision of the contract for the settlement of disputes or any other provision of the contract governing the rights and obligations of the parties consequent upon the avoidance of the contract” , such as, for example, the right to seek damages for breach of contract (expressly mentioned under art. 7.3.5(2) unidroit principles). indeed, ” an avoidance only <redirects’ the main obligations of the contract; it does not void the contract ab initio. under article 81 cisg, damage claims for breach, dispute-settlement mechanisms (arbitration clauses), liquidated damages and penalty clauses, etc. are not affected by avoidance (article 81 sentence two).” 214 http://www.cisg.law.pace.edu/cisg/text/secomm/secomm-81.html nordic journal of commercial law issue 2005 #2 215 francesco g. mazzotta, commentary on cisg article 81 and its pecl counterparts, § 3, available online at <http://www.cisg.law.pace.edu/cisg/text/peclcomp81.html#er>. 216 the right of a party to claim, under art. 81(2) cisg, restitution may however be ” limited by other rules which fall outside the scope of the convention, such as bankruptcy or other insolvency procedures, and/or exchange control laws or other restrictions on the transfer of goods or funds [preventing] the transfer of the goods or money to the demanding party in a foreign country” (mazzotta, supra note 215, at § 1). 217 mazzotta, supra note 215, at § 1. 218 mazzotta, supra note 215, at § 2. 219 mazzotta, supra note 215, at § 2. 37 there is, however, an important difference, regarding the effects of contract termination, between the pecl, on the one hand, and the cisg and the unidroit principles, on the other hand. under the cisg and the unidroit principles, restitution subsequent to termination is the rule, whereas under the pecl, it is the exception. ” while the cisg [and the unidroit principles tend] to eliminate the consequences of an already partially performed contract, the pecl tends to maintain the exchange when it is satisfactory for both parties.” 215 art. 81(2) cisg stipulates that ” a party who has performed the contract either wholly or in part may claim restitution from the other party of whatever the first party has supplied or paid under the contract. if both parties are bound to make restitution, they must do so concurrently.” 216 art. 7.3.6(1) unidroit principles provides the same general principles, however moderated by paragraph (2) of the same provision: ” on termination of the contract either party may claim restitution of whatever [he] has supplied, provided that such party concurrently makes restitution of whatever [he] has received. if restitution in kind is not possible or appropriate allowance should be made in money whenever reasonable. however, if performance of the contract has extended over a period of time and the contract is divisible, such restitution can only be claimed for the period after termination has taken effect.” in other words, as a general rule, all that has been exchanged in compliance with the contract must be restituted after termination: each party can claim restitution of whatever he has paid or supplied under the contract, and if both parties have to make restitution, restitution must be made concurrently.217 on the contrary, under the pecl, a restitution duty exists only when ” one party has conferred a benefit on the other party without receiving the promised counter-performance in exchange.” 218 indeed, the termination of a contract in compliance with the provisions of the pecl does not undo what has taken place before termination: the performances received must neither be returned, nor must restitution of their value be made. it stems from arts. 9:305, 9:307, and 9:308 pecl, that restitution subsequent to termination is appropriate only in certain circumstances, namely when the property transferred has become useless, as a consequence of the termination, for the party who received it (art. 9:306 pecl), and when a party, by performing his contractual obligation, has conferred a benefit upon his co-contracting party, but has not received the corresponding counter-performance (arts. 9:307 and 9:308 pecl). the rules of the cisg, on the one hand, and those of the pecl and the unidroit principles, on the other hand, also differ with respect to the effects of the impossibility, for a party, to restitute the goods received in substantially the same condition as when they were delivered. under the cisg, if a party is unable to restitute the goods in substantially the same condition as when he received them, he is prohibited from avoiding the contract. indeed, according to art. 82(1) cisg, ” the buyer loses the right to declare the contract avoided [… ] if it is impossible for him to make restitution of the goods substantially in the condition in which he received them.” in other words, ” the ability to return the goods received in substantially the condition in which one received them is <a prerequisite for avoiding the contract [… ].’” 219 nevertheless, art. 82(2) cisg, http://www.cisg.law.pace.edu/cisg/text/peclcomp81.html#er nordic journal of commercial law issue 2005 #2 220 u n i d r o i t , o f f i c i a l c o m m e n t a r y o n a r t . 7 . 3 . 6 ( 1 9 9 4 ) , a v a i l a b l e o n l i n e a t <http://www.jus.uio.no/lm/unidroit.international.commercial.contracts.principles.1994.commented/7.3.6>. 221 unidroit, supra note 220, which provides the following illustration: ” a, who has contracted to excavate b's site, leaves it after only half the work has been performed. b, who then terminates the contract, will have to pay a a reasonable sum for the work done, measured by the value that work has for b.” 222 mazzotta, supra note 215, at § 2. 38 which deals with the issue of allocation of risk of loss of the goods before avoidance of the contract, provides three exceptions to the general rule stated under art. 82(1) cisg. the buyer is entitled to declare the contract avoided, even if he cannot make restitution of the goods in compliance with art. 82(1) cisg, if (a) the damages to the goods are not due to the buyer’s act or omission; (b) the deterioration or consumption of the goods results from the examination as required by art. 38 cisg; or (c) the goods are sold in the normal course of business or consumed or transformed by him in the normal course of use before he discovered, or should have discovered, their lack of conformity. under art. 9:309 pecl, a party may, after termination of the contract, recover a reasonable amount for the value of the performance rendered to the other party, if the former has rendered a performance and has not received payment or counterperformance for it, and if that performance cannot be refunded by the other party. similarly, art. 7.3.6(1) unidroit principles provides that ” if restitution in kind is not possible or appropriate allowance should be made in money whenever reasonable.” restitution in kind is, for example, not appropriate when the aggrieved party has received part of the performance and wants to retain that part.220 ” the purpose of specifying that allowance should be made in money ‘whenever reasonable’ is to make it clear that allowance should only be made if, and to the extent that, the performance received has conferred a benefit on the party claiming restitution.” 221 in conclusion, with the exception of the three specific cases mentioned above, the cisg, which addresses, in art. 82 cisg, the issue of termination, does not allow the avoidance of the contract if the goods cannot be restituted. on the contrary, under the pecl and the unidroit principles, restitution is not a prerequisite to termination (art. 9:309 pecl and 7.3.6 unidroit principles). ” neither the convention, nor the pecl [, nor the unidroit principles] have any specific provisions dealing with: (i) the expenses incurred in making restitution; (ii) the rights acquired by third parties; (iii) the location where the restitution must be made and (iv) the buyer's responsibility when the goods that must be returned are destroyed after the effective date of a declaration of avoidance.” 222 as to damages, according to art. 81(1) cisg, art. 7.4.1 unidroit principles, and art. 8:102 pecl, the fact that a party has resorted to the avoidance remedy does not deprive him of his right to claim damages (unless, under art. 7.4.1 unidroit principles and art. 8:101(2) and 8:108 pecl, the non-performance at the due date would have been excused). regarding the issue of computation of damages, art. 74 cisg provides that ” damages for breach of contract by one party consist of a sum equal to the loss, including loss of profit, suffered by the other party as a consequence of the breach. such damages may not exceed the loss which the party in breach foresaw or ought to have foreseen at the time of the conclusion of the contract, in the light of the facts and matters of which he then knew or ought to have known, as a possible consequence of the breach of contract.” although not expressly stated, the principle of full http://www.jus.uio.no/lm/unidroit.international.commercial.contracts.principles.1994.commented/7.3.6 nordic journal of commercial law issue 2005 #2 223 see the following relevant cases: austria ogh, 14 january 2002, 7 ob 301/01t, available online at <http://cisgw3.law.pace.edu/cases/020114a3.html>; austria ogh, 28 april 2000, 1 ob 292/99v, available online at <http://cisgw3.law.pace.edu/cases/000428a3.html>; germany olg hamburg, 26 november 1999, 1 u 31/99, available online at <http://cisgw3.law.pace.edu/cases/991126g1.html>; austria internationales schiedsgericht der bundeskammer der gewerblichen wirtschaft [arbitral tribunal vienna] sch-4318, 15 june 1994, available online at <http://cisgw3.law.pace.edu/cases/940615a4.html>. see also victor knapp, comments on article 74 cisg, in cesare massimo bianca & michael joachim bonell, commentary on the international sales – the 1980 vienna sales convention 538, 543 (giuffrè 1987), available online at <http://cisgw3.law.pace.edu/cisg/biblio/enderlein-art74.html> 224 friedrich blase & philipp höttler, remarks on the damages provisions in the cisg, principles of european contract law (pecl) and unidroit principles of international commercial contracts (upicc) § 2 (2004), available online at <http://www.cisg.law.pace.edu/cisg/biblio/blase3.html>. 225 commission on european contract law, comment and notes on pecl 9:502, in principles of european contract law: parts i and ii 535, 539 (ole lando and hugh beale eds., kluwer law international 2000), available online at <http://www.cisg.law.pace.edu/cisg/text/peclcomp74.html#cnpc>, which reads: ” the aggrieved party must bring into account in reduction of damages any compensating gains which offset its loss; only the balance, the net loss, is recoverable. similarly, in computing gains of which the aggrieved party has been deprived, the cost it would have incurred in making those gains is a compensating saving which must be deducted to produce a net gain.” 226 blase/höttler, supra note 224, at § 3. 39 compensation is an underlying principle of the cisg.223 this principle is laid down in art. 7.4.2(1) unidroit principles and art. 9:502 pecl. furthermore, the foreseeability test contained in art. 74 cisg is also an element taken into account in the two sets of non-binding principles, under art. 9:504 pecl, respectively art. 7.4.4 unidroit principles. nevertheless, whereas the cisg loosely requires that the loss be foreseen as a ” possible consequence” of the breach, under the unidroit principles and the pecl, the loss suffered must be a ” likely result” of the nonperformance. thus, ” there is a distinct difference in the wording resulting in a different standard to be applied by the cisg, on the one hand, and the [unidroit principles] and pecl, on the other hand. hence, the [unidroit principles] and the pecl cannot serve as a persuasive authority to clarify a real question concerning a matter which, despite being expressly settled in the convention, arguably remains ambiguous.” 224 to the question whether the amount of damages should be reduced by any advantage from which the creditor benefited as a result of the debtor’s breach, art. 7.4.2(1) unidroit principles brings a positive answer. the cisg and the pecl provide no express rule governing the issue. nevertheless, the official commentary on art. 9:502 pecl clearly points out that ” the aggrieved party must bring into account in reduction of damages any compensating gains which offset [his] loss.” 225 in the context of the cisg, the answer is generally affirmative on the basis of the principle of full compensation, and ” the mechanisms of both pecl and [unidroit principles] can be used as persuasive authority in confirming the solution predominantly favored under the regime of the cisg.” 226 6. art. 72 cisg – a provision aiming at protecting the interests of one party or at penalizing the behavior of the other? art. 72 cisg is the successor of art. 76 ulis, which provided that ” where prior to the date fixed for performance of the contract it is clear that one of the parties will commit a fundamental breach of the contract, the other party shall have the right to declare the contract avoided.” art. 72 cisg is the only provision of the convention which authorizes the buyer and the seller to avoid the contract for fundamental breach by the other party before the time for performance by the http://cisgw3.law.pace.edu/cases/020114a3.html http://cisgw3.law.pace.edu/cases/000428a3.html http://cisgw3.law.pace.edu/cases/991126g1.html http://cisgw3.law.pace.edu/cases/940615a4.html http://cisgw3.law.pace.edu/cisg/biblio/enderlein-art74.html http://www.cisg.law.pace.edu/cisg/biblio/blase3.html http://www.cisg.law.pace.edu/cisg/text/peclcomp74.html#cnpc nordic journal of commercial law issue 2005 #2 227 chengwei, supra note 11, § 9.7.1. 228 enderlein/maskow, supra note 7, at 293. 229 honnold, supra note 7, at 439. 40 latter party has elapsed. it thus complements arts. 49 and 64 cisg, which authorize the buyer, respectively the seller, to avoid the contract when performance is overdue. art. 72(1) cisg’s primary purpose is to protect the interests of the party for whom it has become objectively ” clear,” after the conclusion of the contract, that the other party will commit a fundamental breach. indeed, this provision allows the former to terminate the contract and thus avoid the losses he would have suffered, had he performed his own obligations and waited until the date agreed upon for the other party’s performance, and had this other party failed to perform his obligations. furthermore, art. 72(2) cisg protects ” the interests of a party who has reason to believe that the other will be unable or unwilling to perform the contract at the due date but who cannot or may be reluctant to terminate the contract immediately in case it transpires that the other party would after all have performed. consequently, it enables a party who reasonably believes that there will be a fundamental non-performance by the other party to demand an assurance of performance from the other party and in the meantime to withhold [his] own performance.” 227 in addition, considering art. 72(3) cisg, one may conclude that art. 72 cisg was also drafted to prevent the party who regrets having entered the contractual relationship, from declaring himself discharged from his obligations or from acting as if he were released from his contractual obligations. in this perspective, art. 72 cisg also serves as a legal basis for penalizing the party who repudiates the contract. indeed, if one party repudiates the contract, the other party need not give him reasonable notice of his intent prior to declaring the contract avoided. consequently, the law does not grant to the party who repudiates the contract the possibility to provide adequate assurance of performance – or merely to declare that he has changed his mind, i.e., that he is willing and capable of performing his obligation – and thus to prevent the avoidance of the contract. therefore, even if the party who declared that he would not perform the contract changes his mind and eventually performs his obligations in compliance with the terms of the contract, the other party may not be held liable for having declared the contract avoided. indeed, in case of repudiation of the contract by the obligor, ” the obligee does not have to wait and see whether the obligor changes his mind; he can avoid the contract immediately. in such a case, the declaration of an intended non-performance of the contract is irrevocable.” 228 in other words, if a party repudiates the contract, he bears the risk that the contract be at any time avoided. consequently, ” where a’s avoidance responds to b’s wrongful repudiation and therefore is clearly justified (art. 72(3)), a’s declaration of avoidance makes it possible for a to resell (or repurchase) the goods called for by the initial contract; a need not be concerned lest b change [his] mind and tender performance.” 229 nordic journal of commercial law issue 2005 #2 230 secretariat commentary on art. 64 of the 1978 draft [draft counterpart of art. 73 cisg], available online at <http://www.cisg.law.pace.edu/cisg/text/secomm/secomm-73.html>; chengwei, supra note 11, § 10.1. for a similar s t a t e m e n t i n t h e c a s e l a w , s e e i c c a w a r d n o . 9 8 8 7 , a u g u s t 1 9 9 9 , a v a i l a b l e o n l i n e a t <http://cisgw3.law.pace.edu/cases/999887i1.html> (chemical substance); switzerland hg. k. zürich, 30 november 1998, hg 950357 (clout case no. 251), available online at <http://cisgw3.law.pace.edu/cases/981130s1.html> (lambskin coats); germany schiedsgericht der hamburger freundschaftlichen arbitrage [arbitral tribunal], 29 december 1998 (clout case no. 293), available online at <http://cisgw3.law.pace.edu/cases/981229g1.html> (cheese); spain audiencia provincial [appellate court] de barcelona, 3 november 1997, 729/96-b (clout case no. 246), available online at <http://cisgw3.law.pace.edu/cases/971103s4.html> (manufactured springs); switzerland hg. k. z ü r i c h , 5 f e b r u a r y 1 9 9 7 , h g 9 5 0 3 4 7 ( c l o u t c a s e n o . 2 1 4 ) , a v a i l a b l e o n l i n e a t <http://cisgw3.law.pace.edu/cases/970205s1.html> (sunflower oil); france cour d'appel [ca] [appeal court] g r e n o b l e , 2 2 f e b r u a r y 1 9 9 5 , 9 3 / 3 2 7 5 ( c l o u t c a s e n o . 1 5 4 ) , a v a i l a b l e o n l i n e a t <http://cisgw3.law.pace.edu/cases/950222f1.html> (jeans); china chansha intermediate peoples' court economic chamber case no. 89, 18 september 1995, available online at <http://cisgw3.law.pace.edu/cases/950918c1.html> (molybdenum iron alloy); germany lg ellwangen, 21 august 1995, 1 kfh o 32/95, available online at <http://cisgw3.law.pace.edu/cases/950821g2.html> (peppers); icc award no. 8128, 1995, available online at <http://cisgw3.law.pace.edu/cases/958128i1.html> (chemical fertilizer). 231 switzerland hg. k. zürich, hg 950357, supra note 230. 232 enderlein/maskow, supra note 7, at 294; see also bennett, supra note 121, at 534. 233 thus, ” if a party commits a breach of contract, and the obligee wishes to draw conclusions for other contracts, he may probably do so on the basis of article 72” (enderlein/maskow, supra note 7, at 294). 234 schlechtriem, supra note 9, at 96. 41 iv. anticipatory breach in installment contracts 1. introduction to installment contracts ” the contract calls for the delivery by installments if it requires or authorizes the delivery of goods in separate lots.” 230 it is not necessary that the contract provide for delivery of similar goods (the goods do not have to be fungible) at all times231 or that there be an agreement that the goods be delivered on fixed dates. in fact, the contract may well provide for deliveries of various sorts of goods or for partial deliveries; furthermore, instead of having contractually fixed dates for delivery, the contract may allow that deliveries be asked for when needed.232 art. 73 cisg is only applicable to contracts providing for the delivery of goods by installments.233 more particularly, art. 73 cisg ” is concerned with successive deliveries, not installment payments. by analogy, however, article 73(2) can also apply to missed payments if they coincide with installment deliveries … article 73(2) is also applicable to other breaches by the buyer, such as not taking delivery of an installment.” 234 2. purpose of the rule art. 51 cisg grants to the buyer the right to partially avoid the contract, on the basis of arts. 46 to 50 cisg, ” if the seller delivers only a part of the goods or if only a part of the goods delivered is in conformity with the contract.” the second paragraph of the same provision further stipulates that ” the buyer may declare the contract avoided in its entirety only if the failure to make delivery completely or in conformity with the contract amounts to a fundamental breach of the contract.” thus, first, ” article 51 is not specifically directed at contracts which provide for deliveries of goods http://www.cisg.law.pace.edu/cisg/text/secomm/secomm-73.html http://cisgw3.law.pace.edu/cases/999887i1.html http://cisgw3.law.pace.edu/cases/981130s1.html http://cisgw3.law.pace.edu/cases/981229g1.html http://cisgw3.law.pace.edu/cases/971103s4.html http://cisgw3.law.pace.edu/cases/970205s1.html http://cisgw3.law.pace.edu/cases/950222f1.html http://cisgw3.law.pace.edu/cases/950918c1.html http://cisgw3.law.pace.edu/cases/950821g2.html http://cisgw3.law.pace.edu/cases/958128i1.html nordic journal of commercial law issue 2005 #2 235 trevor bennett, comments on article 73, in cesare massimo bianca & michael joachim bonell, commentary on the i nt erna tiona l s ales – t h e 1 9 8 0 vi e nn a s a le s c o nv en t i o n 5 3 1 , 5 3 3 ( g i uf f rè 19 87 ), ava ila ble online at <http://www.cisg.law.pace.edu/cisg/biblio/bennett-bb73.html>. 236 chengwei, supra note 11, § 10.1. 237 bennett, supra note 235, at 533. 238 bennett, supra note 235, at 534. 239 in the following decisions, the conditions of art. 73(2) cisg were considered satisfied and the aggrieved party entitled to declare the contract avoided for future installments: france ca grenoble, 93/3275, supra note 230, in which the buyer assured the seller that he would resell the goods in south america, but sold the first installment in spain, interfering with the seller’s marketing there; the court held that the fundamental breach committed by the buyer justified the seller’s 42 by installments, that is, in separate lots.” 235 instead, art. 51 cisg is applicable where the contract intended the goods to be delivered as a whole, but the seller failed to deliver part of the goods or delivered goods that were in part defective. second, art. 51 cisg grants only to the buyer the right to protect his interests in case of breach by the seller. finally, art. 51 cisg does not address the issue of anticipatory breach in installment contracts, but only governs the right to terminate the part of the contract affected by the breach or the entire contract if the breach, even though pertaining only to part of the goods that ought to be delivered, amounts to an actual fundamental breach of the entire contract. as far as installment contracts are concerned, art. 73(2) cisg deals specifically with the possibility to avoid the contract with respect to future installments, if the breach of one installment indicates ” the probability of a breach of installment obligations not yet due.” 236 this article appears as a necessary complement to art. 51 cisg: art. 73 cisg deals specifically with installment contracts and grants rights to both the buyer and seller, except in paragraph (3).237 paragraphs (1) and (3) of art. 73 cisg do not address situations of anticipatory breach and their analysis is consequently beyond the scope of the present paper. 3. grounds for avoidance of future installments according to art. 73(1) cisg, ” in the case of a contract for delivery of goods by installments, if the failure of one party to perform any of his obligations in respect of any installment constitutes a fundamental breach of contract with respect to that installment, the other party may declare the contract avoided with respect to that installment.” art. 73(2) cisg further provides that if one party’s failure to perform any of his obligations in respect of any installment gives the other party good grounds to conclude that a breach in respect of installments not yet due will occur, the latter may declare the contract avoided with regard to these future installments, provided that he does so within a reasonable time. thus, art. 73(2) cisg sets forth three cumulative conditions that ought to be satisfied for the non-breaching party to be authorized to declare the contract avoided with respect to future installments. first, a breach of contract with respect to any of the installments must have occurred. second, even though ” the failure itself is not required to constitute a fundamental breach,” 238 it must give the non-breaching party ” good grounds to conclude that a fundamental breach of contract will occur with respect to future installments.” in other words, there must be an anticipatory fundamental breach with respect to future installments. third, the declaration of avoidance with respect to future installments must be made ” within a reasonable time of the failure to perform” (this third condition will be addressed infra iii.4.).239 http://www.cisg.law.pace.edu/cisg/biblio/bennett-bb73.html nordic journal of commercial law issue 2005 #2 avoidance of the contract for future installments; germany lg ellwangen, 1 kfh o 32/95, supra note 230, in which the buyer had good grounds to believe that the seller would be unable to deliver peppers that satisfied food safety regulations; switzerland hg. k. zürich, hg 95 0347, supra note 230, in which the seller made no delivery despite taking payment; switzerland zhk arbitral award no. 273/95, supra note 22, in which the seller failed to deliver the first installment; germany schiedsgericht der hamburger freundschaftlichen arbitrage, supra note 230, in which the seller stated that he would not make further deliveries; hungary arbitration court attached to the hungarian chamber of commerce and industry, arbitral award in case no. vb/97142, 25 may 1999 (clout case no. 265), available online at <http://www.uncitral.org/english/clout/mal-thesaurus/mal-abstract266-e.htm>, in which the seller refused to deliver further cherries because of a dramatic increase in the market price for the cherries; spain audiencia provincial de barcelona, 729/96-b, supra note 230, in which late delivery of three installments caused disruption of the buyer's production; icc award no. 9887, supra note 230, in which the seller delivered poor quality goods. 240 enderlein/maskow, supra note 7, at 296; bennett, supra note 235, at 536 et seq. 241 bennett, supra note 235, at 536-537. 242 chengwei, supra note 11, § 10.2. 243 enderlein/maskow, supra note 7, at 296; bennett, supra note 235, at 535. 244 bennett, supra note 235, at 534-535. 245 vilus, supra note 7, at 246-247. in the following cases, it was found that the seller had good grounds to avoid the contract: hungary arbitration award no. vb/94124, supra note 37, in which the failure to open a letter of credit gave good grounds to conclude that the buyer would not pay; france ca grenoble, 93/3275, supra note 230, in which the buyer would continue to breach a contract term that prohibited the buyer from reselling the goods in specified markets. in china international economic & trade arbitration commission, arbitral award cisg/1996/01, 18 september 1996, available online at <http://www.cisgw3.law.pace.edu/cases/960918cl.html>, the arbitral tribunal held that, even though the buyer had not opened the letter of credit pertaining to the first installment within the time-frame set by the contract, given that he had clearly expressed his intention to open the letter of credit pertaining to the second installment and that he had not indicated any intention to decline to open the letters of credit for the remaining installments, the seller wrongly considered that there was an ” anticipatory breach of contract.” 43 according to the first condition, a breach of contract with respect to any of the installments must have occurred. thus, in contrast with the conditions of suspension and avoidance under arts. 71 and 72 cisg, neither a deficiency in the ability to perform or in the creditworthiness, nor a declaration of an intention not to perform is sufficient240 for the conditions of art. 73(2) cisg to be satisfied. ” it is doubtful whether the grounds [that allow the non-breaching party to conclude that a fundamental breach will occur] can derive from, say, the bankruptcy of the other party or a statement by him that he does not intend to perform his obligations with respect to future installments. in such a case the appropriate course would be to proceed under article 72, if it is otherwise applicable.” 241 thus, as far as future installments are concerned, art. 73(2) cisg does not support the view that a party’s refusal to perform constitutes, in itself, a fundamental breach.242 it is however not required that the failure itself constitute a fundamental breach. a mere breach may also lead to the conclusion that a fundamental breach will be committed in the future.243 indeed, ” a breach which is not by itself fundamental may in its context, for example, a series of such breaches over a period of time, provide the necessary ground for concluding that a fundamental breach will occur. nor is it a condition precedent to the applicability of the paragraph that avoidance action has been taken for the installment in which the failure occurred.” 244 the second condition, namely the condition that the failure by one party to perform any of his obligations in respect of any installment give the non-breaching party ” good grounds to conclude that a fundamental breach of contract will occur with respect to future installments” is an application, to installment contracts, of art. 72 cisg regarding anticipatory breaches.245 however, the terms ” good grounds to conclude” set a less onerous and more subjective standard for avoidance than the objective standard of certainty that must be reached under art. 72 cisg, http://www.uncitral.org/english/clout/mal-thesaurus/mal-abstract266-e.htm http://www.cisgw3.law.pace.edu/cases/960918cl.html nordic journal of commercial law issue 2005 #2 246 k o c h , s u p r a n o t e 1 3 9 , a t 3 1 0 ; h o n n o l d , s u p r a n o t e 7 , a t 4 4 3 , a v a i l a b l e o n l i n e a t <http://www.cisg.law.pace.edu/cisg/biblio/ho73.html>; see also chengwei, supra note 11, § 10.1. 247 secretariat commentary on art. 64 of the 1978 draft, supra note 230, § 5. the match-up between art. 64 of the 1978 draft and the current art. 73 indicates that the two provisions are substantively the same. 248 secretariat commentary on art. 64 of the 1978 draft, supra note 230, § 6. 249 bennett, supra note 235, at 534. 250 flechtner, supra note 101. 251 chengwei, supra note 11, § 10.2. 252 enderlein/maskow, supra note 7, at 296. 253 in spain audiencia provincial de barcelona, 729/96-b, supra note 230, the buyer who was entitled to avoid the contract as to future installments effectively avoided the contract when it gave notice to the seller within 48 hours of the third late delivery. 44 according to which it must be ” clear” that a fundamental breach of contract will be committed.246 the secretariat expressly pointed out that ” it should be noted that article 64(2) [draft counterpart of cisg article 73(2)] permits the avoidance of the contract in respect of future performance of an installment contract even though it is not ‘clear’ that there will be a fundamental breach of the contract in the future as would be required by art. 63 [draft counterpart of cisg article 72].” 247 ” the test of the right to avoid under article 64(2) [draft counterpart of cisg article 73(2)] is whether a failure to perform in respect of an installment gives the other party good reason to fear that there will be a fundamental breach in respect of future installments. the test does not look to the seriousness of the current breach. this is of particular significance where a series of breaches, none of which in itself is fundamental or would give good reason to fear a future fundamental breach, taken together does give good reason for such fear” 248 (for a more detailed comparative analysis of art. 72 and 73(2) cisg, see infra iv.6.) 4. declaration of avoidance within a reasonable period of time the condition according to which the creditor of the obligation must declare the contract avoided for the future within a reasonable period of time lacks clarity. first, it does not specify when the reasonable period of time starts running. second, it does not define according to which parameters the period of time must be ” reasonable.” as to the first issue, some commentators have advocated that the reasonable period of time starts running at the time of the occurrence of the failure to perform by the breaching party.249 one could also imagine that the reasonable period of time should start at the time the aggrieved party discovers (or could have discovered) the breach. however, these solutions are problematic in cases in which it is not a specific event of non-performance but a series of non-conforming installments that constitute ” good grounds to conclude that a fundamental breach of contract will occur,” as well as in cases in which the past non-performance(s) involved non-delivery. consequently, an appropriate solution seems to be to consider that the reasonable period of time starts running when the creditor of the obligation has acquired ” good grounds” indicating that a fundamental breach will be committed.250 ” such a standard is very uncertain, but it offers the only hope for dealing with the variety of circumstances that will arise.” 251 as to the parameters that ought to be taken into account to determine the period of time which is ” reasonable,” ” the length of the interval between the latest and the next installment and/or its reception and payment” 252 should be taken into account.253 the declaration of avoidance is subject to art. 27 cisg. http://www.cisg.law.pace.edu/cisg/biblio/ho73.html nordic journal of commercial law issue 2005 #2 254 under art. 9:302 pecl, it is appropriate to allow the aggrieved party to terminate in relation to the non-performed unit without affecting the rest of the contract, if the non-performance that has occurred is fundamental precisely regarding that specific ” unit” of the contract, if the unit not performed does not affect the rest of the contract significantly, and if the non-performance is not likely to be repeated (commission on european contract law, comment and notes on pecl 9:302, in principles of european contract law: parts i and ii 411, 411-412 (ole lando and hugh beale eds., kluwer law international 2000), available online at <http://www.cisg.law.pace.edu/cisg/text/peclcomp51.html>). 255 if the non-performance is fundamental to the contract as a whole, art. 9:302 in fine allows termination of the ” contract as a whole,” the parties being, in this case, according to art. 9:305 pecl, released from all their future obligations (the rights and obligations that have accrued up to the time of termination remaining unchanged, except in the cases provided for in art. 9:306 and 9:308 pecl) (christopher kee, remedies for breach of contract where only part of the contract has been performed: comparison between provisions of cisg (articles 51, 73) and counterpart provisions of the principles of european contract law, available online at <http://www.cisg.law.pace.edu/cisg/text/ peclcomp51.html>). 256 bennett, supra note 235, at 536-537. 257 bennett, supra note 235, at 534. 258 honnold, supra note 7, at 443. 259 chengwei, supra note 11, § 10.2. 45 5. impact of the cisg on subsequent uniform sets of principles no counterpart to art. 73(2) cisg is found in the unidroit principles, which simply do not address the issue of anticipatory breaches in installment contracts. as regards the pecl, a priori, art. 9:302 seems to be the corresponding provision of art. 73 cisg, rather than that of art. 51 cisg. more precisely, art. 9:302 ab initio pecl seems to be the counterpart of art. 73(1) cisg,254 and art. 9:302 in fine pecl seems to correspond to art. 73(3) cisg.255 however, neither of these two provisions of the pecl addresses the issue of anticipatory breach in installment contracts. 6. relationship between general principles regarding anticipatory breach and anticipatory breach in installment contracts art. 72 and art. 73(2) cisg both govern situations of anticipatory breach. however, whereas the former authorizes avoidance of the entire contract, the latter provides for avoidance, in installment contracts, ” for the future.” furthermore, the conditions of avoidance set forth by art. 72 cisg differ from those of art. 73(2) cisg. first, whereas art. 72 cisg applies only if it is ” clear” that a fundamental breach of contract will be committed, art. 73(2) cisg merely requires that there be ” good grounds to conclude that a fundamental breach of contract will occur.” second, whereas art. 72 cisg does not specify the circumstances that may lead to the conclusion that it is ” clear” that a fundamental breach will be committed, art. 72(3) cisg requires that the suspected fundamental breach ” have been preceded by, and indeed derived from, an actual failure to perform obligations.” 256 thus, under art. 73 cisg, ” avoidance in respect of [future] installments is dependant on an anticipatory breach of contract the occurrence of which is not required to be ” clear” as it is in article 72.” 257 the rationale underlying the difference of standard in the conditions of avoidance set by the two said articles is the following: in the context of the application of art. 73(2) cisg, a breach of contract has already been committed;258 thus, one party has already violated one of his obligations with respect to one installment and this, in particular, constitutes a ground for the assumption that a fundamental breach will occur (some scholars call this ” non-reliance approach based on an actual breach” 259). in other words, art. 73(2) cisg takes into consideration the fact that, http://www.cisg.law.pace.edu/cisg/text/peclcomp51.html http://www.cisg.law.pace.edu/cisg/text/ nordic journal of commercial law issue 2005 #2 260 chengwei, supra note 11, § 10.2; see also koch, supra note 139, at 311. 261 bennett, supra note 235, at 537. 262 marco torsello, remedies for breach of contract under the 1980 convention on contracts for the international sale of goods (cisg), in quo vadis cisg? 43, 85 (f. ferrari ed., paris/brussels/munich, 2005); see also franco ferrari, gap-filling and interpretation of the cisg: overview of international case law, in international business law journal 221, 229 (2003), in which the author states that the ” favor contractus” principle is one of the general principles on which the cisg is based. 263 torsello, supra note 262, at 58. 264 torsello, supra note 262, at 59. 46 legitimately, the innocent party might no longer be able to rely on the other party’s commitment, given the breach that has already occurred. under this article, even if the debtor provides adequate assurance of performance, the creditor remains entitled to declare the contract avoided with respect to future installments if a breach has already been committed. conversely, ” neither the [debtor]’s failure to provide adequate assurance of performance on demand due to a deterioration of creditworthiness, nor his declaration that he will not perform, [alone,] give the [creditor] the right to avoid the contract. an actual failure to perform must instead be the basis for avoidance of future installments.” 260 one similarity between art. 72 and art. 73(2) cisg is, nevertheless, that in neither article does the law provide details regarding the degree of clarity or the strength of the grounds that may lead a party to believe that a fundamental breach will be committed, nor does the law describe the acts or circumstances that may cause or result in a fundamental breach of contract by one party. a final distinction between art. 72 and art. 73(2) cisg must be pointed out: unlike art. 72 cisg, art. 73(2) cisg does not require that the declaration of avoidance be preceded by a notice of intention to the other party; rather, it is necessary, under art. 73(2) cisg, that the declaration of avoidance be made ” within a reasonable time,” ” a requirement which is not included in article 72 at least in express terms.” 261 v. concluding remarks in view of the above analysis, one must conclude that arts. 71, 72, and 73(2) cisg bear witness to the fact that ” the convention aims at preserving the parties’ commitments and at favoring the performance of their agreement, thus relying on a general principle of favor contractus.” 262 more particularly, these provisions, pertaining to the issue of anticipatory breach of contract, may be counted among those contributing to one of the main purposes of the cisg, namely to allow performance of international sales contracts, even if such performance is imperfect, by inducing ” the party in breach to spontaneously cure.” 263 it is only in the exceptional situations in which it is clear that a fundamental breach will be committed, and generally only if the author of the future breach fails to provide adequate assurance of performance, that the other party – the innocent party – is authorized to declare the contract avoided. under art. 71 cisg, if it becomes apparent that one party will not perform a substantial part of his obligation, the other party may suspend performance of his obligations, ” thus stimulating the breaching party’s cure, though at the same time preventing the harshness of post-avoidance restitutions.” 264 the innocent party is however compelled to restore performance if the other party provides adequate assurance of performance. such assurance may be considered adequate even if nordic journal of commercial law issue 2005 #2 265 flechtner, supra note 1, at 187. 266 torsello, supra note 262, at 50; see also clayton p. gillette & steven d. walt, sales law – domestic and international 189 et seq. (foundation press, 2002); amin dawwas, non-performance and damages under the cisg and the unidroit principles, in 31 comparative law review 225, 226 (1997). 47 it shows that performance might not be complete and perfect. furthermore, the failure, by one party, to provide adequate assurance of performance does not constitute, in itself, a fundamental breach, and consequently does not authorize the other party to declare the contract avoided. in turn, the conditions that ought to be satisfied, under art. 72 cisg, for the innocent party to be entitled to declare the contract avoided, are more onerous than those of art. 71 cisg. they require that the future occurrence of the breach be objectively ” clear” (rather than just ” apparent” ) and that the suspected breach be of fundamental nature. furthermore, in the case of art. 72 cisg, the innocent party must give notice to the other party prior to the declaration of avoidance, in order to allow the latter party to provide adequate assurance of performance. finally, art. 73(2) cisg allows the avoidance of the contract for the future only if ” one party’s failure to perform any of his obligations in respect of any installment gives the other party good grounds to conclude that a fundamental breach of contract will occur with respect to future installments.” it stems from the comparative analyses conducted in chapters ii, iii, and iv that due to the ” substantial, even pervasive” 265 influence of the cisg, the remedial systems of the unidroit principles and the pecl were also founded on the general principle that termination of the contract should be available to the aggrieved party in a limited number of cases, and only if the other party has committed or will commit a fundamental non-performance. furthermore, in the absence of suspected fundamental non-performance, these two sets of principles do not grant any protection to the innocent party. finally, neither of these two sets of principles addresses the issue of anticipatory breach in installment contracts; thus, even if the commission of a fundamental breach is suspected, the innocent party has no right to declare the contract avoided for future installments. the remedial systems of the cisg, the unidroit principles, and the pecl are founded on a basic dichotomy regarding ” the standard that parties have to comply with in order to satisfactorily perform the obligations stemming from the contract that they are bound to. this issue may be addressed either in positive terms, thus analyzing what the debtor is required to do in order to be discharged from his obligations, or in negative terms, by way of focusing on what degree of lack of performance triggers negative legal consequences for the non-performing party.” 266 if the law imposes on the debtor a standard of perfect tender, any ” mere breach” will entitle the creditor to seek avoidance of the contract. on the other hand, if, to satisfy the requirements of the law, the debtor is merely compelled to offer substantial performance, only ” a fundamental breach” will allow the creditor to seek avoidance of the contract. the provisions of the cisg, the unidroit principles, and the pecl relating to the issue of anticipatory breach authorize the avoidance of the contract only if the breach suspected is of fundamental nature. this indicates that the standard that the parties have to comply with in order to satisfactorily perform their obligations is a standard of substantial performance rather than a one of perfect tender. indeed, even if the debtor has not fulfilled perfectly all of his obligations, avoidance of the contract is prohibited, so long as the breach is not fundamental. similarly, the creditor of an obligation is prohibited from suspending performance of his obligations if assurance nordic journal of commercial law issue 2005 #2 267 indeed, if perfect tender were the standard the debtor was compelled to achieve, the creditor, seeking to discharge himself from his contractual obligations, would be in a position to ” opportunistically take advantage of the possibility to reject any tender which is less than perfect” (torsello, supra note 262, at 51). 268 torsello, supra note 262, at 51. 48 of performance has been provided by the debtor, even if such assurance indicates that the performance will not be perfect, so long as the imperfection is insubstantial, that is, so long as the assurance provided indicates that the debtor will comply with substantial performance standards. ” while this … solution reduces the possibility of strategic behavior on the part of the creditor,267 it enhances that of strategic behavior on the part of the debtor, who may opportunistically perform his obligation in a way that, although substantially fulfilling the required standard, ranges below the average standard performance.” 268 nevertheless, one may conclude that this solution favors the performance of the contract by limiting the right to avoid the contract and thus promotes good faith and efficiency in international commercial transactions. table of cases germany amtsgericht [petty district court] frankfurt a.m., 31 january 1991, 32 c 1074/90-41 (clout case no. 51), available online at <http://cisgw3.law.pace.edu/cisg/cases/910131g1.html> germany lg düsseldorf, 9 july 1992, 31 o 223/91, available online at <http://cisgw3.law.pace.edu/cases/920709g1.html> germany landgericht berlin, 30 september 1992, 99 o 123/92, available online at <http://cisgw3.law.pace.edu/cases/920930g1.html> belgium tribunal commercial [district court] bruxelles, 13 november 1992, a.r. 2700/90; r.g. 4.825.91, available online at <http://cisgw3.law.pace.edu/cases/921113b1.html> germany landgericht krefeld, 28 april 1993, 11 o 210/92, available online at <http://cisgw3.law.pace.edu/cases/930428g1.html> germany oberlandesgericht düsseldorf, 18 november 1993, 6 u 228/92, available online at <http://cisgw3.law.pace.edu/cases/931118g1.html> germany oberlandesgericht düsseldorf, 14 january 1994, 17 u 146/93 (clout case no. 130), english translation available online at <http://cisgw3.law.pace.edu/cases/940114g1.html> austria internationales schiedsgericht der bundeskammer der gewerblichen wirtschaft [arbitral tribunal vienna] sch4318, 15 june 1994, english translation available online at <http://cisgw3.law.pace.edu/cases/940615a4.html> germany landgericht [district court] berlin, 15 september 1994, 52 s 247/94, english translation available online at <http://cisgw3.law.pace.edu/cases/940915g1.html> icc award no. 8128, 1995, english translation available online at <http://cisgw3.law.pace.edu/cases/958128i1.html> france cour d'appel [appeal court] grenoble, 22 february 1995, 93/3275 (clout case no. 154), english translation available online at <http://cisgw3.law.pace.edu/cases/950222f1.html> belgium rechtbank [district court] van koophandel hasselt, 1 march 1995, a.r. 3641/94, available online at <http://cisgw3.law.pace.edu/cases/950301b1.html> austria oberlandesgericht linz, 23 may 1995, 1r 64/95-34, available online at <http://cisgw3.law.pace.edu/cases/950523a3.html> germany landgericht ellwangen, 21 august 1995, 1 kfh o 32/95, english translation available online at <http://cisgw3.law.pace.edu/cases/950821g2.html> china chansha intermediate peoples' court economic chamber case no. 89, 18 september 1995, english translation available online at <http://cisgw3.law.pace.edu/cases/950918c1.html> hungary arbitration court of the chamber of commerce and industry of budapest, arbitral award vb/94124, 17 november 1995, available online at <http://cisgw3.law.pace.edu/cases/951117h1.html> hungary arbitration court attached to the hungarian chamber of commerce and industry, arbitral award vb/94131, 5 december 1995 (clout case no. 164), english translation available online at <http://cisgw3.law.pace.edu/cases/951205h1.html> china international economic & trade arbitration commission, arbitral award cisg/1996/05, 30 january 1996, english translation available online at <http://cisgw3.law.pace.edu/cases/960130cl.html> austria oberster gerichtshof, 6 february 1996, 10 ob 518/95 (clout case no. 176), english translation available online at http://cisgw3.law.pace.edu/cases/960206a3.html http://cisgw3.law.pace.edu/cisg/cases/910131g1.html http://cisgw3.law.pace.edu/cases/920709g1.html http://cisgw3.law.pace.edu/cases/920930g1.html http://cisgw3.law.pace.edu/cases/921113b1.html http://cisgw3.law.pace.edu/cases/930428g1.html http://cisgw3.law.pace.edu/cases/931118g1.html http://cisgw3.law.pace.edu/cases/940114g1.html http://cisgw3.law.pace.edu/cases/940615a4.html http://cisgw3.law.pace.edu/cases/940915g1.html http://cisgw3.law.pace.edu/cases/958128i1.html http://cisgw3.law.pace.edu/cases/950222f1.html http://cisgw3.law.pace.edu/cases/950301b1.html http://cisgw3.law.pace.edu/cases/950523a3.html http://cisgw3.law.pace.edu/cases/950821g2.html http://cisgw3.law.pace.edu/cases/950918c1.html http://cisgw3.law.pace.edu/cases/951117h1.html http://cisgw3.law.pace.edu/cases/951205h1.html http://cisgw3.law.pace.edu/cases/960130cl.html http://cisgw3.law.pace.edu/cases/960206a3.html nordic journal of commercial law issue 2005 #2 49 china international economic & trade arbitration commission, arbitral award cisg/1996/11, 27 february 1996, english translation available online at <http://cisgw3.law.pace.edu/cases/960227cl.html> switzerland zürich handelskammer [zürich chamber of commerce], arbitral award no. 273/95, 31 may 1996, english translation available online at <http://cisgw3.law.pace.edu/cases/960531s1.html> china international economic & trade arbitration commission, arbitral award cisg/1996/01, 18 september 1996, english translation available online at <http://www.cisgw3.law.pace.edu/cases/960918cl.html> icc award no. 8574, september 1996, english text available online at <http://cisgw3.law.pace.edu/cases/968574i1.html> icc award no. 8786, january 1997, english text available online at <http://cisgw3.law.pace.edu/cases/978786i1.html> switzerland handelsgericht des kantons zürich, 5 february 1997, hg 95 0347 (clout case no. 214), available online at <http://cisgw3.law.pace.edu/cases/970205s1.html> switzerland zivilgericht saane [district court], 20 february 1997, t 171/95 (clout case no. 261), english translation available online at <http://cisgw3.law.pace.edu/cases/970220s1.html> spain audiencia provincial [appellate court] de barcelona, 3 november 1997, 729/96-b (clout case no. 246), available online at <http://cisgw3.law.pace.edu/cases/971103s4.html> austria schiedsgericht der börse für landwirtschaftliche in wien [arbitral tribunal vienna] s 2/97, 10 december 1997, english translation available online at <http://cisgw3.law.pace.edu/cases/971210a3.html> austria oberster gerichtshof [supreme court], 12 february 1998, 2 ob 328/97t (clout case no. 238), available online at <http://cisgw3.law.pace.edu/cases/980212a3.html> germany oberlandesgericht hamm, 23 june 1998, 19 u 127/97 (clout case no. 338), english translation available online at <http://cisgw3.law.pace.edu/cases/980623g1.html> netherlands rb [district court] 's hertogenbosch, 2 october 1998, 9981/haza 95-2299, available online at <http://cisgw3.law.pace.edu/cisg/cases/981002n1.html> switzerland handelsgericht des kantons zürich, 30 november 1998, hg 950357 (clout case no. 251), english translation available online at <http://cisgw3.law.pace.edu/cases/981130s1.html> germany schiedsgericht der hamburger freundschaftlichen arbitrage [arbitral tribunal], 29 december 1998 (clout case no. 293), english translation available online at <http://cisgw3.law.pace.edu/cases/981229g1.html> hungary arbitration court attached to the hungarian chamber of commerce and industry, arbitral award in case no. vb/97142, 25 may 1999 (clout case no. 265), available online at <http://www.uncitral.org/english/clout/malthesaurus/mal-abstract266-e.htm> russia federation chamber of commerce and industry arbitration award no. 302/1996, 27 july 1999, english translation available online at <http://cisgw3.law.pace.edu/cases/990727r1.html> icc award no. 9887, august 1999, english text available online at <http://cisgw3.law.pace.edu/cases/999887i1.html> germany oberlandesgericht hamburg, 26 november 1999, 1 u 31/99, english translation available online at <http://cisgw3.law.pace.edu/cases/991126g1.html> united states federal district court, northern district of illinois, 7 december 1999 (clout case no. 417), available online at <http://cisgw3.law.pace.edu/cases/991207u1.html> germany oberlandesgericht [provincial court of appeal] dresden, 27 december 1999, 2 u 2723/99, english translation available online at <http://cisgw3.law.pace.edu/cases/991227g1.html> belgium hof van beroep [appellate court] gent, 26 april 2000, 1997/ar/2235, english translation available online at <http://cisgw3.law.pace.edu/cases/000426b1.html> austria oberster gerichtshof, 28 april 2000, 1 ob 292/99v, english translation available online at <http://cisgw3.law.pace.edu/cases/000428a3.html> germany landgericht stendal, 12 october 2000, 22 s 234/94, english translation available online at <http://cisgw3.law.pace.edu/cisg/text/001012g1.html> australia supreme court of queensland, 17 november 2000, civil jurisdiction no. 10680 of 1996, available online at <http://cisgw3.law.pace.edu/cases/001117a2.html> austria oberster gerichtshof, 14 january 2002, 7 ob 301/01t, english translation available online at <http://cisgw3.law.pace.edu/cases/020114a3.html> http://cisgw3.law.pace.edu/cases/960227cl.html http://cisgw3.law.pace.edu/cases/960531s1.html http://www.cisgw3.law.pace.edu/cases/960918cl.html http://cisgw3.law.pace.edu/cases/968574i1.html http://cisgw3.law.pace.edu/cases/978786i1.html http://cisgw3.law.pace.edu/cases/970205s1.html http://cisgw3.law.pace.edu/cases/970220s1.html http://cisgw3.law.pace.edu/cases/971103s4.html http://cisgw3.law.pace.edu/cases/971210a3.html 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http://cisgw3.law.pace.edu/cisg/biblio/ziegel6.html http://cisgw3.law.pace.edu/cisg/text/ziegel71.html 1 towards a uniform standard of rules 5 and 6 of the iba guidelines on party representation in international arbitration pilar perales viscasillas* * professor of commercial law at university carlos iii de madrid. this work is part of the research project of the ministry of economy, industry and competitiveness (der2016-78572-p). the text of this article corresponds largely with the conference delivered on may 9, 2019 on the occasion of the general assembly of the portuguese association of arbitration, held in lisbon. towards a uniform standard 1. introduction .................................................................................. 112 2. consensus in the international arbitration community: reality or chimera? ....................................................................... 116 3. the consensus on soft law instruments ............................ 119 3.1. the incorporation by reference of the iba guidelines on party representation ......................... 120 3.2. the influence of the iba guidelines 5 and 6 in other regulations........................................................................... 122 3.3. the regulations under review: similarities ............. 124 3.4. the regulations under review: differences ........... 132 4. conclusions ..................................................................................... 134 towards a uniform standard 112 abstract the rules applicable to arbitration of both hard and soft law share the importance of the independence and impartiality of the arbitrator. a particular treatment of a type of conflict of interest that may occur during the arbitration procedure is that regulated by rules 5 and 6 of the iba guidelines on party representation in international arbitration (2013), referring to a modification in the team of representatives or legal advisors of one of the parties that causes a conflict of interest in one of the arbitrators that seriously questions his independence or impartiality, and that consequently opens the door to his possible disqualification, and to the need to protect the integrity of the arbitration procedure by the arbitrators. in this paper, we analyze if the standards provided in rules 5 and 6 to resolve the conflict of interest between lawyers and arbitrators have received a favorable response within the arbitration community. and if so, whether an international consensus can be achieved that can serve as a model for a future code of ethics at a truly transnational level. 1. introduction the rules applicable to arbitration of both hard and soft law share the importance of the independence and impartiality of the arbitrator. the principles of independence and impartiality are ethical principles of arbitration2, upon which its legitimacy depends3. the arbitrators are expected to avoid direct or indirect conflicts of interest4. obviously, not only arbitrators should avoid conflicts of interest, but also should lawyers. a particular treatment of a type of conflict of interest that may occur during the arbitration procedure is that regulated by the iba guidelines 2 this paper is written under research project der2016-78572-p. the scholars turn the ethics of the arbitrators in relation to the obligations of disclosure and independence and impartiality. thus, among others: ramón mullerat, ethical rules for arbitrators, anuario de justicia alternativa, 2005, pp.77 et seq; josé carlos fernández rozas, clearer ethics guidelines and comparative standards for arbitrators, liber amicorum bernardo cremades, madrid, la ley, 2010, p.416; and silvano domenico orsi, ethics in international arbitration: new considerations for arbitrator´s and counsel, arbitration brief, 2013, vol.3, issue 1, pp.92 et seq, proposing the creation of a global ethic code (id., pp.106 et seq). 3 see: ignacio madalena/nicolás rivera montoya, función y deberes del árbitro. in flores sentíes, h., (editor), retos contemporáneos del arbitraje internacional. ciudad de méxico: tirant lo blanch, 2018, p.76. 4 catherine rogers, ética del abogado en el arbitraje internacional. in flores sentíes, h., (editor), retos contemporáneos del arbitraje internacional. ciudad de méxico: tirant lo blanch, 2018, pp.285-330; s. wilske, y s. hughes, tácticas arbitrales de guerrilla y estándares mínimos de ética en el arbitraje internacional. in flores sentíes, h., (editor), retos contemporáneos del arbitraje internacional. ciudad de méxico: tirant lo blanch, 2018, pp.367-394; and günther j. horvath/stephen wilske, guerrilla tactics in international arbitration. wolters kluwer, 2013, pp.26-27. njcl 2019/2 113 on party representation in international arbitration (2013) (hereinafter, guidelines or rules), rules 5 and 65, which indicate that: “5. once the arbitral tribunal has been constituted, a person should not accept representation of a party in the arbitration when a relationship exists between the person and an arbitrator that would create a conflict of interest, unless none of the parties objects after proper disclosure. 6. the arbitral tribunal may, in case of breach of guideline 5, take measures appropriate to safeguard the integrity of the proceedings, including the exclusion of the new party representative from participating in all or part of the arbitral proceedings”. as seen, there is a situation where a modification in the team of representatives or legal advisors of one of the parties that causes a conflict of interest in relation to one of the arbitrators that seriously undermines his independence or impartiality6, and that consequently opens the door to his possible disqualification, and to the need to protect the integrity of the arbitration procedure by the arbitrators. these are situations in which the arbitral tribunal has already been formally constituted, and the legal representatives of the parties have also been fixed or formally determined; typically, lawyers are already appointed when the arbitrators are chosen, and, in fact, in the request for arbitration and in their response, such data is normally provided7. as we said, the question arises when, during the procedure, there is some change or modification in relation to the initially appointed representatives of the parties; several different situations may occur: i) inclusion of a lawyer in the legal team that will attend the hearing on the merits of the matter. this was what happened in the famous 5 the fact that the comments to these rules indicate that: “in such case, the arbitral tribunal may, if compelling circumstances so justify, and where it has found that it has the requisite authority, consider excluding the new representative from participating in all or part of the arbitral proceedings”, has led some authors to question whether the guidelines really grant such power to the arbitral tribunal. see. felix dasser, a critical analysis of the iba guidelines on party representation. the sense and non-sense of guidelines, rules and other para-regulatory texts in international arbitration. asa special series nº37, asa, juris, 2015, p.41. 6 in this work we are not going to make a distinction between the terms independence/impartiality, a debated issue, as it is well known. there is abundant legal literature in this regard, but see: alfonso gómez-acebo, party-appointed arbitrators in international commercial arbitration, wolters kluwer, 2016, pp.69-96; and carlos matheus, la independencia e imparcialidad del árbitro en el arbitraje doméstico e internacional, palestra, 2016, pp.179 et seq. 7 this is the case in most arbitration regulations. for example, rules of the court of arbitration of the international chamber of commerce (icc), arts.4.3. b) y 5.1 b). towards a uniform standard 114 hrvatska case8, where, just ten days before the hearing, which had been scheduled for two weeks, the defendant´s legal representation sent the list of people including the name of mr. david mildon qc of the essex court chambers in london. the conflict of interest arose between mr. mildon and the president of the arbitral tribunal which was "a door tenant at the same chambers". ii) modification of the legal team by including a lawyer not initially considered. unlike the previous case, there is an alteration with the objective of formally introducing a new lawyer into the legal team. this happened in another well-known case, the rompetrol case9, where the main lawyer in the case communicated her decision to leave the firm and so a new lawyer began to lead the team. this new lawyer, mr. legum, had worked for 4 years and until seven months before at the same law firm of the arbitrator appointed by the plaintiff. iii) change of the law firm: without modifying the names of the persons in charge of the defense of one of the parties, there is a variation of the law firm responsible for the defense. it is, consequently, the integration of the original team of lawyers in a new office that creates a conflict of interest with one of the arbitrators. conflicts of interest that arise may be of greater or lesser intensity: the arbitrator is a partner or works in the firm, the arbitrator is a counsel of the firm, the arbitrator performs advisory work for the firm, the arbitrator has relatives in the firm or friendly relations with lawyers of the new office, etc. essentially, the conflict between the arbitrator and the lawyer enters the red list10 or the orange list of the 2014 iba guidelines on conflicts of interest in international arbitration11. these newly described situations, even though not frequent in practice, are not at all unknown given the duration of the arbitration proceedings and the global framework of the practice and the mobility of lawyers. as the introduction to the iba guidelines on conflicts of interest, no. 1 points out: 8 hrvatska elektroprivreda, d.d. v. the republic of slovenia, (icsid case no. arb/05/24) tribunal's ruling regarding the participation of david mildon qc in further stages of the proceedings, 6 may 2008. 9 the rompetrol group, n.v., v. romania, icsid case no. arb/06/3, decision of the tribunal on the participation of a counsel, 14 january 2010. 10 thus, the following circumstances that are related to the issue at hand are listed in the waiver red list: “2.3 arbitrator’s relationship with the parties or counsel. 2.3.1 the arbitrator currently represents or advises one of the parties, or an affiliate of one of the parties. 2.3.2 the arbitrator currently represents or advises the lawyer or law firm acting as counsel for one of the parties. 2.3.3 the arbitrator is a lawyer in the same law firm as the counsel to one of the parties”. 11 within the orange list, the circumstances indicated in guideline 3.3 stand out. njcl 2019/2 115 "the growth of international business, including larger corporate groups and international law firms, has generated more disclosures and resulted in increased complexity in the analysis of disclosure and conflict of interest issues”. it is uncertain to what extent, when the conflict reaches an arbitrator and a single lawyer, it must affect all of them without having in view the concrete conflict that arises. however, as a general rule, the situation should be addressed through a conservative solution and only in extreme cases should the removal of the lawyer who created the conflict be decided12. returning to the text of the iba, the response given by the iba guidelines on party representation to the problem at hand derives from case law regarding investment arbitration and takes advantage especially of the solution given to this issue in one of the best-known cases, the hvratska case. in general terms, the iba guidelines on party representation has generated a good deal of controversy among international scholars. we do, however, wonder if the standards provided in rules 5 and 6 to resolve the conflict of interest between lawyers and arbitrators have received a favorable response within the arbitration community. and if so, whether an international consensus can be achieved that can serve as a model for a future code of ethics at a truly transnational level. the creation of an international code of ethics is a matter of a hot discussion presently and it will be one of the main topics of discussion among the international arbitration community in the coming years. there are several authors who have supported the idea of a code of ethics in international arbitration. we highlight, for the purposes of this work, the authors who conclude on this need by confronting, above all, the cases related to investment arbitration, hvratska, rompetrol and fraport13, and the different solutions that the courts reached in these cases14. however, it should be noted that the fraport case refers to a 12 another approach in the us seems to be followed, as noted by a.s. rau, arbitrators without powers?. disqualifying counsel in arbitral proceedings, the center for global energy, international arbitration and environmental law, the university of texas at austin school of law. research paper no. 2014-01, june 2014, nº38 in relation to usa case law: “in fact, in most cases where a court has decided to “disqualify” counsel, the result is that the entire law firm is expected to withdraw completely from the representation--the disqualification “radiates” out to disable the firm from accepting the matter, treating those who practice together, no matter how large the firm, as “one lawyer”. 13 fraport ag frankfurt airport services worldwide v. republic of the philippines (icsid case no. arb/03/25) (annulment proceeding). decision on application for disqualification of counsel, 18 september 2008. 14 doak bishop, ethics in international arbitration, p.10. the author indicates that:“the arbitrators found themselves blown out to sea and ill-equipped with nothing more than a coastal chart. and therein lies the problem. the 3 tribunals —faced with similar issues— created 3 different solutions (…). simply put, the arbitrators needed a sextant and a star chart — a code of conduct for counsel” towards a uniform standard 116 different conflict: the one that arises between the new lawyer and one of the parties to the proceedings due to an issue arising from the duty of confidentiality, and that raises further problems related to the malpractice of lawyers, such as the discussion about whether it is possible to resolve these issues by arbitration, the powers of arbitrators to sanction these behaviors, and interference with the standards of professional ethics. these issues, and others related to the lawyer's malpractice -such as the so-called guerrilla tacticsare the ones that are receiving the most criticism from a sector of the scholars (infra 2), and converge with the conflict that concerns us in this paper in the affectation of the integrity of the arbitration procedure and the fair conduct of the proceedings. 2. consensus in the international arbitration community: reality or chimera? statistics on the use of soft law instruments leave us with less optimistic figures in relation to the iba guidelines on party representation in international arbitration, as it is the least used instrument, compared to other texts of the iba15. one reason is the fact that, for a reputed sector of the international arbitration community, the inclusion of rules about the professional conduct of lawyers has been very problematic, since they are understood to be beyond the scope of control of the iba, of the parties and of the arbitral tribunal. firstly, the criticisms of the iba guidelines on party representation are framed in a general debate about the role that soft law instruments can play in practice, especially with regard to the soft law rules that will be applied during the arbitration procedure. this debate, that concerns the very essence of arbitration regulation, is not so much about discussing singular provisions adopted in the soft law texts, but about whether to move towards a regulatory model in arbitration. the debate is about regulation itself16. this question, however, is outside the scope of this work. (id., p.8); and catherine a. rogers, ethics in international arbitration, oxford university press, 2014, nº6.151-6.157. 15 report on the reception of the iba arbitration soft law products (2016), where it is stated that: “the 57% of the arbitrations referred/used the iba guidelines on conflict of interest. this was the most used soft law instrument. 48% iba rules on the taking of evidence, y 16% iba guidelines on party representation”. 16 michael schneider, president´s message, yet another opportunity to waste time and money on procedural skirmishes: the iba guidelines on party representation, 31 asa bulletin 3/2013 (september), p.498: “but the objections which must be raised against the guidelines go beyond some problematic provisions. it is the regulation itself which causes mischief”. and id., p.500: “however, regulating the conduct of party representatives as the iba now has done is the wrong answer and one can only hope that the iba guidelines on party representation quickly fall into oblivion or, better, never are applied”. njcl 2019/2 117 secondly, another of the criticisms of the iba's text reaches the amalgam that occurs in its rules between issues that are said to be essentially different: the question of the conflict of interests between lawyers and arbitrators derived from the hypotheses outlined above and that affect questions of independence and impartiality of the arbitrators, and other issues related to conflicts of interest that occur between lawyers and the parties to the procedure, such as those arising from the violation of the duty of confidentiality. in addition, there is another series of conflicts that may occur during the procedure and that affects all of its participants – conflicts derived from a bad practice or inappropriate behavior of one of the parties during the procedure; in these cases, both arbitrators and the other party of the procedure are affected. thus, the swiss doctrine, which has been especially critical towards the iba guidelines on party representation, both in general and in particular in the case of guideline 6, which is relevant to the conflict of interest at hand, gives us the key to their main concern about the rules at this point: “at the origin of this misconception is the amalgamation in the guidelines between rules of professional conduct and rules regulating the arbitration procedure. while the latter may be regulated by the parties to an arbitration and by the arbitral tribunal appointed by them, the former fall within the responsibility of those professional bodies that regulate the exercise of the legal profession. the iba has no power to interfere with these professional regulations, nor do the parties and arbitral tribunals. this gives rises to difficulties which are reflected in several provisions of the guidelines”17. adding, also, the rejection of the remedies provided, and particularly to the power given to the arbitrators to discipline lawyers by imposing sanctions: “the “remedies” – the term “sanctions” would seem more appropriate – include admonitions, inferences, cost sanctions and “any other appropriate measure in order to preserve the fairness and integrity of the proceedings”; guideline 6 even provides for the possibility of the “exclusion” of a party representative”18. however, the issue is clarified because it is not so much that the arbitrators do not have such powers, when, in fact, it is understood that they have them. instead, the issue is that those powers are specifically mentioned in the guidelines, thus opening the door to greater litigation and possibilities of disturbances during the procedure. thus, it is indicated that: 17 schneider, president´s message, p.499. 18 schneider, president´s message, p.499-500. towards a uniform standard 118 “many of the sanctions for misconduct provided by the guidelines may be available to arbitrators already today as part of an arbitrator’s duty and power to ensure the “integrity and fairness of the arbitral proceedings”, as specified in guideline 1. occasionally such powers may have been recognised or even used in the past. however, once they are spelled out in guidelines and widely publicised, they raise the appetite of litigators and motions for their application risk to become ordinary tools in the proceedings, causing additional waste of time and money and contributing further to the disenchantment of the users with international arbitration as widely practiced today”19. basically, the aversion of the swiss arbitration association (asa) toward the iba guidelines focuses, above all, on the excessive power granted to arbitrators to sanction the misconduct or unethical conduct of lawyers. these are issues that are not the responsibility of the arbitrators, which should focus on the resolution of the merits of the case. they are not competent, in the opinion of the asa, because those are matters that are regulated by professional associations which are also the appropriate bodies to impose sanctions, or because it is ultimately up to the courts to decide them20. that is, the severe criticisms made to the iba text are not related to the solution given to the conflict of interests that concerns us, which is more linked to the question of the independence and impartiality of the arbitrators than to a question related to the ethics of the lawyers21. this does not prevent, but on the contrary, advises that these issues are addressed within a future code of ethics because, as already stated, questions of ethics in arbitration can touch upon the nuclear issue of the independence and impartiality of the arbitrators. at the same time, it must be recognized that there is a very thin line of distinction and there may be border situations between these two issues. 19 schneider, president´s message, p.500. 20 swiss arbitration association (asa), asa board position, geisinger/schneider/dasser, iba guidelines on party representation in international arbitration comments and recommendations by the board of the swiss arbitration association (asa), nº5, available at the asa web site, nº1, y nº2. see also: elliott geisinger, president´s message, counsel ethics in international arbitration –could one take things a step further?, available at the asa web site, pp.453-454; dasser, a critical analysis, p.39; and domitille baizeau, the iba guidelines on party representation in international arbitration: a plea for caution, bcdr (bahrain chamber for dispute resolution) international arbitration review, 2015, nº2, pp.351354. 21 in agreement: anne-carole cremades, the creation of a global arbitration ethics council: a truly global solution to a global problem, 24 noviembre 2015; and elliott geisinger, soft law” and hard questions: asa´s initiative in the debate of counsel´s ethics in international arbitration, the sense and non-sense of guidelines, rules and other para-regulatory texts in international arbitration. asa special series, nº37, 2015, p.19. see. general rule 7 b) iba guidelines on the conflict of interests. https://www.lalive.law/data/publications/biar_2-2_domitille_baizeau.pdf http://arbitrationblog.kluwerarbitration.com/2015/11/24/the-creation-of-a-global-arbitration-ethics-council-a-truly-global-solution-to-a-global-problem/ http://arbitrationblog.kluwerarbitration.com/2015/11/24/the-creation-of-a-global-arbitration-ethics-council-a-truly-global-solution-to-a-global-problem/ njcl 2019/2 119 few authors have realized this, and curiously enough, there were those in favor of not regulating arbitration excessively22. so, even the opponents of the iba rules do not question the benefits of guidelines 5 and 6 (or the other texts that have decided to follow the same solutions, such in the case of the arbitration rules of the london court of international arbitration) (lcia) 23. a different matter is whether the solution must be in the hands of the arbitrators or of the arbitral institutions24-although the international consensus is that it is for the arbitrators to decide-, or if these rules are suitable to become the model for a regulation global international arbitration25. be that as it may, it is found that the arbitration community, including the most critical sectors of the iba rules on party representation, mostly agree that the arbitrators have the duty to protect the integrity of the procedure when the modification in the legal team causes a conflict of interest with the arbitrator by which its independence and impartiality is called into question and that this is a matter that ought to be subject to regulation. 3. the consensus on soft law instruments one of the criticisms made to procedural soft law and particularly the iba rules on party representation is the possibility that multiple regulations would lead to contradictory or irreconcilable solutions to one another: “initiatives by individual associations like the iba or arbitration institutions like the lcia generate a risk of fragmentation between different – and potentially contradictory – “rules” or “codes”. this in turn would likely undermine the very legitimacy of the rules/codes that may be adopted, since offending counsel could point to differences to argue that there is no international consensus”26. 22 in a way, it seems that the critics of the iba rules are also in favor, see: for example dasser, a critical analysis, pp.55-57, that in relation to the conflict of interest between lawyers and arbitrators derived from the situations contemplated in the cases hvratska and rompetrol, the author does believe that they can be addressed through a simple modification of the arbitration rules. 23 geisinger, soft law, p.19. 24 see geisinger, soft law, pp.19-20, considering that these issues must be kept within the orbit of the independence and impartiality of the arbitrators (reasons why the lcia approach seems acceptable), and rejecting that the arbitrators are the ones who decide that issue but the arbitral institutions. id., pp. 22-25 contrary to the arbitrators assuming a decision-making power in relation to issues related to attorney´s ethics. 25 dasser, a critical analysis, p.53, considers that they should not be a model, especially, he thinks, not in the case of the guidelines that are a recipe for additional disputes and disruptions. 26 geisinger, president´s message, p.454. towards a uniform standard 120 in view of the above, it is necessary to assess whether the reported situation occurs in the soft law instruments in relation to the purpose of this work. we anticipate that this is not the case and that an international consensus can be derived among the different instruments that regulate this issue and that are based on the innovative model of the iba rules on party representation27. 3.1. the incorporation by reference of the iba guidelines on party representation we do not refer in this section to those instruments that expressly regulate the hypotheses object of this work, but those other instruments that indirectly integrate the same solution as the iba rules when incorporating by referencing the said instrument and, therefore, rules 5 and 6 will also apply. recently, we are watching the indirect incorporation or the incorporation by reference of several instruments of soft law into arbitration rules but also through other kinds of instruments. it is the arbitration institutions themselves that have decided to support the use of arbitration soft law by increasing its visibility and practical importance. this incorporation by reference is made in relation to self-created texts and incorporating texts prepared by other institutions. for example, article 5 of the code of ethics of the philippine dispute resolution center (pdrc) adopts several instruments: “pdrci hereby adopts as its code of ethics for arbitration the: (a) rules of ethics for international arbitrators adopted by the international bar association (“iba”); (b) 2014 iba guidelines on conflicts of interest in international arbitration; and (c) iba guidelines on party representation in international arbitration, to the extent that they do not conflict with any provision of philippine law”. 27 it is precisely considered that certain ethical standards have been consolidated in the arbitration, analyzing article 21 of the rules of arbitration of the bahrain chamber for dispute resolution: james castello, party representation: does article 21 mark a trend?, bahrain chamber for dispute resolution, international arbitration review, december 2017, vol.4, nº2, p.358. this rule includes also situations different from those contemplated in sections 5 and 6 of the iba guidelines related to the behavior of dishonest lawyers, malpractice, and guerrilla tactics, which can be sanctioned by the arbitral tribunal. in the doctrine it has been considered that rules 5 and 6 the iba guidelines “and now, at least arguably, as reflecting established international arbitral practice” (baizeau, pp.347-348); or what: “is a noteworthy balancing of the competing considerations and may be regarded as groundbreaking in light of the fundamental principle in arbitration that parties are free to select a party representative of their choosing” (edna sussman, ethics in international arbitration: soft law guidance for arbitrators and party representatives. soft law in international arbitration. editors: lawrence w. newmann/michael j. radine. jurisnet, llc 2014, pp.253-254). njcl 2019/2 121 other arbitration rules receive similar treatment, although sometimes through formulas that are not as imperative in regard to the application of the rules of soft law but serve the same practical purpose. for example, article 1.1.1 of the arbitration rules of the lagos chamber of commerce international arbitration center (laciac) (2016): “by accepting to act as legal practitioner or party representative in an arbitration conducted under the laciac rules, a legal practitioner or party representative agrees to be guided by the above stated overriding objective and by the international bar association guidelines on party representation in international arbitration”. in addition to the agreement to incorporate the iba guidelines on party representation in the contract itself, or more appropriately in the arbitration agreement expressly or indirectly by reference, the guidelines may be included later once the dispute has arisen on the occasion of the first procedural order, and so the agreement will also involve the arbitrators, who sometimes suggest their incorporation to the parties. in addition, there is the recent tendency of arbitral institutions to recommend, with the help of the parties when necessary, the incorporation of soft law instruments either directly in their own arbitration regulations (i) or in line with other instruments (ii): (i) an example of the first is the arbitration rules of the australian center for international commercial arbitration, acica rules, 2016, which establishes in article 8.2 that: “each party shall use its best endeavours to ensure that its legal representatives comply with the international bar association guidelines on party representation in international arbitration in the version current at the commencement of the arbitration”. likewise, the arbitration rules del arbitrators’ and mediators’ institute of new zealand (aminz rules, 2017), rule 14.2 on party representation: “14.2. unless the parties agree otherwise and subject to any provision of these rules to the contrary, the parties and the arbitral tribunal shall have regard to, but will not be bound by, the iba guidelines on party representation in international arbitration and on conflicts of interest in international arbitration, in each case as current at the notice date”28. 28 and also identical proposal in relation to the iba rules on evidence, art.61.3: “unless the parties agree otherwise, and subject to the provisions of these rules which may provide to the contrary, the arbitral tribunal shall have regard to, but not be bound by, the iba rules of evidence as current at the notice date”. towards a uniform standard 122 (ii) an example of the latter is the note to the parties and the arbitral tribunal on the conduct of arbitration in accordance with the icc arbitration rules of february 1, 2019, no. 48, which, in relation to the conduct of the participants in the arbitration (section iv), encourages the parties and arbitral tribunals to take into account and, where appropriate, adopt the iba guidelines on party representation in international arbitration. the fact that the icc note draws the attention of the parties and the arbitrators to the iba guidelines and therefore the possible inclusion of this soft law instrument as part of the agreement of the parties generates the perception and conviction of the arbitration community about the preferred solution to be given to the conflicts of interest object of this paper. 3.2. the influence of the iba guidelines 5 and 6 in other regulations among the texts that follow the model of the iba guidelines 5 and 6 on party representation, article 18 of the lcia arbitration rules (2014) is the most important one, since it was also the first arbitration rules to include regulation on party representatives29. it states that: 18.3. following the arbitral tribunal’s formation, any intended change or addition by a party to its legal representatives shall be notified promptly in writing to all other parties, the arbitral tribunal and the registrar; and any such intended change or addition shall only take effect in the arbitration subject to the approval of the arbitral tribunal. 18.4. the arbitral tribunal may withhold approval of any intended change or addition to a party’s legal representatives where such change or addition could compromise the composition of the arbitral tribunal or the finality of any award (on the grounds of possible conflict or other like impediment). in deciding whether to grant or withhold such approval, the arbitral tribunal shall have regard to the circumstances, including: the general principle that a party may be represented by a legal representative chosen by that party, the stage which the arbitration has reached, the efficiency resulting from maintaining the composition of the arbitral tribunal (as constituted throughout the arbitration) and any likely wasted costs or loss of time resulting from such change or addition. 29 the lcia arbitration rules were the first to regulate the ethics of legal representatives: vicent. s. dattilo, ethics in international arbitration: a critical examination of the lcia general guidelines for the parties´ legal representatives. georgia journal of international and comparative law, 2016, vol.44, p.647, p.649 and p.650. also included are the arbitration rules that apply the lcia rules, such as the dubai international financial centre. see. difc-lcia arbitration rules, 1 october 2016; or lcia/miac arbitration rules, 2018. njcl 2019/2 123 subsequently, other arbitration rules or other soft law texts have followed these regulations. for example, article 21, sections 1 and 2, of the rules of arbitration of the bahrain chamber for dispute resolution (1 october 2017) “1. (…) that there shall be no addition to any party’s legal representatives following the appointment of the arbitral tribunal without the prior written approval of the arbitral tribunal. 2. the arbitral tribunal may decline to approve an addition to any party’s legal representatives if, on proper disclosure, a relationship exists between the proposed additional legal representative and any member of the arbitral tribunal that would create a conflict of interest jeopardizing the composition of the arbitral tribunal or the integrity of the proceedings”. likewise, and without prejudice to the incorporation by reference of the entire iba rules in section 2, rule 14.1 on party representation of the arbitration rules of the arbitrators ’and mediators’ institute of new zealand (2017) establishes that: “14.1. any addition or change to a party’s legal representation after the issue of the notice of arbitration and the answer (as appropriate) must be notified to the other parties and to the arbitral tribunal within 7 days of such addition or change. the parties agree that, in order to ensure the integrity of the proceedings, the arbitral tribunal may refuse to permit a party’s added or changed legal representative to appear where the appearance of such legal representative might arguably require the recusal of a member of the arbitral tribunal”. it is also the focus of the recent code of good arbitration practices of the spanish club of arbitration of 2019 (cbbpp/cea), which replaces the previous code of 2005 that was intended exclusively for arbitration institutions, while the new one makes recommendations to arbitrators, arbitral institutions, lawyers, experts, and third-party funders. the ccbbpp/cea in relation to the appointment of lawyers establishes that30: ”108 the parties shall be free to appoint and dismiss their lawyers. 109 the parties shall identify all of the lawyers who are advising them. this disclosure must be made as soon as possible after their engagement, by providing their names and addresses and attaching their authorisations. 30 the english text can be found at: https://www.clubarbitraje.com/wpcontent/uploads/2019/01/code-of-best-practices-in-arbitration-of-the-spanisharbitration-club.pdf. towards a uniform standard 124 110 in the event of the dismissal or resignation of all of a party’s lawyers, without the appointment of their successors within a time that is reasonable or otherwise established by the arbitrators, it shall be understood that the party is representing itself. 111 once the arbitrators have been appointed, if changes occur within the initially appointed legal teams, then the arbitrators may, after hearing the parties, reject those changes in a reasoned decision, with a view to safeguarding the integrity of the proceeding. 112 the integrity of the proceeding shall be deemed adversely affected in the following circumstances: a) if the party instituting the change is acting with dilatory intent or in abuse of process; or b) if there is a conflict of interest between the new lawyer and any of the arbitrators”. 3.3. the regulations under review: similarities contrasting the solutions expressly accepted in the aforementioned texts leads us to the conclusion that there is great convergence when addressing the issue at hand, and that the differences are minimal, although it is also worth highlighting that their objective is that the terms of the debate can be established within a future international code of ethics (infra 3.4). the different regulations accept the conflict of interest between the legal representatives of the party and the arbitrator when a change is made in the former during the arbitral procedure, but they do not expressly address the reverse situation, which, however, can be treated under the general rules on independence and impartiality, which would imply the duty of the arbitrator to resign from the procedure, and his resistance could imply his removal by the competent body31. the essential principle that derives from all the regulations is that there is no absolute and unlimited right of the parties to the arbitration to change or modify the legal representation during the arbitration procedure. therefore, although at a first sight it seems that there is a contradiction between two opposing rights that seem to be conceived as fundamental and equal -the right of the parties to choose their lawyer and the right to have an independent and impartial arbitrator32-, the principle 31 in one case, it was indicated that: “it may be said that such conflicts are bound to arise, especially in large international law firms. but this risk is known by their lawyers and such conflicts, whenever they arise, may be best dealt with internally (i.e. within the law firm) and not be resolved at the expense of the opposing party whose trust in the arbitrator’s impartiality or independence might be otherwise be broken”, lcia reference no. 111947, decision rendered 4 september 2012, nº42. 32 on this issue, i have previously written indicating that they are not rights that are on an equal footing either from the constitutional perspective of the rights, nor from the perspective of their analysis under the arbitrations law. see pilar perales viscasillas, capítulo 2. la integridad del procedimiento arbitral. anuario de arbitraje 2019. madrid: civitas, 2019. njcl 2019/2 125 that prevails is that the right of the parties to modify their legal representation is subject to not creating a conflict of interest with the arbitrators33. the second essential principle that is drawn from these regulations is that arbitrators have the power to decide about this conflict of interest and, therefore, they can reach a decision whether to authorize the change or remove the lawyer from the procedure. in the absence of explicit regulation in the arbitration laws34, it is considered that there is an implicit power of the arbitral tribunal to decide those issues that may affect the integrity of the arbitration procedure35, and for this purpose various arguments have been resorted to: it falls within the inherent powers of arbitrators, it is a reflection of the principles of good faith, the right to due process or an efficient procedure, etc. with greater or lesser nuances, this has been considered in jurisprudence, especially in relation to cases regarding investment arbitration, which has been enthusiastically followed by the doctrine and interest groups, that have expressly accepted that power for the arbitrators in the different instruments of soft law. the 33 see further: pilar perales viscasillas, la integridad del procedimiento arbitral (el conflicto de interés entre abogados y árbitros). anuario de arbitraje 2019. civitas: thomson-reuters, 2019, pp.43-88. 34 section 1042 (2) procedural civil code (germany): “lawyers (“rechtsanwälte”) may not be excluded from acting as authorised representatives”. simlarly, canon iv c of the code of ethics for arbitrators in commercial disputes, american arbitartion association (1 march 2004): “the arbitrator should not deny any party the opportunity to be represented by counsel or by any other person chosen by the party”. 35 international law association, ila resolution nº4/2016, inherent and implied powers of international arbitral tribunals recommendations, adopted at the 77ª ila conference, johannesburg, south africa, 7-11 august, 2016, 7.c) considering as part of the inherent powers of the arbitrators those that are necessary “to preserve jurisdiction, maintain the integrity of proceedings, and render an enforceable award”; and 2.b) iii): “inherent power: arbitral tribunals should consider whether the issue before them risks undermining their jurisdiction, impugning the integrity of proceedings, or leading to their issuing an unenforceable award”. and margaret moses, ‘the growth of arbitrator power to control counsel conduct’, kluwer arbitration blog, november 12 2014. without considering it irrelevant, but considering that the issue is no longer discussed: “it is now well-established that tribunals have jurisdiction to assess counsel conflicts of interest and, when appropriate, exclude counsel (or experts)”: catherine a. rogers, and a. wiker, “fraport v. philippines, icsid, and counsel disqualification: the power and the praxis” (november 28, 2014). journal of world investment and trade, 2014, p.8. even the asa, especially critical in general with the iba guidelines on party representation understands this: geisinger/schneider/dasser, nº2.1: “under most if not all frequently used arbitration rules arbitrators have, expressly or implicitly, the powers to ensure the “fundamental fairness and integrity” of the proceedings”. towards a uniform standard 126 clearest example in case law is the hrvatska case36, which is not contradicted, despite the harsh criticism made by the rompetrol case, where it was considered that these powers should only be exercised in extraordinary circumstances37. regarding this inherent power of the arbitral tribunal, it must be able to be exercised either when a specific request to change one of the lawyers is made, or when it is made to change the law firm as a whole, which logically also implies the individual lawyers. the distinction between whether the arbitral tribunal could only have jurisdiction over individual lawyers, but not over the law firm will not make sense when the conflict of interest is provoked precisely in relation to the law firm itself. otherwise, the change of individually affected lawyers would not be sufficient to resolve certain conflicts of interest. a third point of coincidence between the texts being compared is that both regulate the protection of the integrity of the arbitration procedure and the protection of the fair conduct of the arbitration proceedings, so that both the conflict of interest object of this paper as well as other situations that relate more to the malpractice of lawyers are jointly regulated. as it has been previously seen, the latest situations are those whose regulation provokes the more radical criticisms to the iba guidelines on party representation. however, the fact that they are regulated in the same instrument does not mean that the treatment and legal answers to be given to these issues ought to be identical, and indeed, 36 see. also considering positively the powers of the arbitral tribunal on the basis of that case: alexis mourre, chapter 25: about procedural soft law, the iba guidelines on party representation and the future of arbitration, in shaughnessy, p., and tung, s., (eds), the powers and duties of an arbitrator: liber amicorum pierre a. karrer, kluwer law international, 2017, p.248: “the icsid arbitral tribunal in hvratska was right in considering that “as a judicial formation governed by public international law, the tribunal has an inherent power to take measures to preserve the integrity of its proceedings”, which entails the power to exclude a newly introduced counsel from a hearing when his representation of a party would create a situation of conflict of interest such as to imperil the constitution of the tribunal; we do not see any reason, though, why the same proposition should not be true in commercial arbitration. depriving the arbitral tribunal of such powers would have highly undesirable consequences”. see further: jeffry waincymer, reconciling conflicting rights in international arbitration: the right to choice of counsel and the right to an independent and impartial tribunal, arbitration international, 26, 2010, nº4, pp.614 et seq. commenting precisely on article 17 of the uncitral arbitration rules, it is considered that the doctrine of the implicit powers of the arbitral tribunal may play a residual role when the tribunal proposes an unusual procedural measure as in the case at hand, citing the hvratska case. see. jan paulsson/georgios petrochilos, uncitral arbitration. wolters kluwer, 2018, p.122. 37 rompetrol case, nº15: “it plainly follows that a control of that kind would fall to be exercised rarely, and then only in compelling circumstances”. in fact, the doctrine that has analyzed the case coincides by pointing out that the court in rompetrol is really considering that it has implicit jurisdiction to decide on the removal of a lawyer in order to preserve the arbitration procedure. see. waincymer, p.608. njcl 2019/2 127 as we shall see, the legal situations and the corresponding legal responses can be perfectly separated. in the absence of legal definitions of what should be understood by the integrity of the arbitration procedure and about the reasons for its special protection, it is useful to refer to the definitions established jurisprudentially or doctrinally. for the integrity of the arbitration procedure we can consider the principle established in the hrvatska case38: “the tribunal's obligation as guardian of the legitimacy of the arbitral process is to make every effort to ensure that the award is soundly based and not affected by procedural imperfection”. the arbitral tribunal conveys in the hrvatska case a known principle in arbitration: the duty of the arbitral tribunal to render an award that is valid and, therefore, enforceable, hence the breach of the duty of independence/impartiality would jeopardize the enforceability of the award39, which means contrasting this issue with the public order of the state where recognition will be sought. although this duty of the arbitral tribunal is not always expressly adopted in many arbitration laws, including the uncitral model law on international commercial arbitration, it is an explicit duty in relation to precisely two of the texts we are commenting on: the rules of the iba on party representation and also article 18.4 lcia arbitration rules that refer to “the finality of any award”. more generally, it is also observed that some arbitration rules, notably the icc rules (art.41), extend said obligation to the court itself, which is important in the case at hand because the court is responsible for deciding on the refusal of the arbitrators. however, the integrity of the arbitration procedure cannot only be related to the enforceability of the award, especially if it is thought that the award could potentially be recognized and executed in multiple countries since it is also connected with the very essence of the arbitration and its legitimacy. the foregoing does not prevent, but rather advises, that the arbitrators have in mind the potential countries of execution when issuing the award and, in particular, the issues related to public order as a reason for denial of the enforcement. also, the court in the hvratska case alluded to the principle of immutability of an arbitral tribunal validly constituted to justify the removal of the new lawyer: 38 hrvatska case, nº15. 39 fernando pérez lozada, duty to render enforceable awards: the specific case of impartiality and independence, spain arbitration review, 2016, nº27, p.72. towards a uniform standard 128 “even fundamental principles must, however, give way to overriding exceptions. in this case, the overriding principle is that of the immutability of properly constituted tribunals (article 56(1) of the icsid convention)”40. the other great principle, that of the fair conduct of the procedure, was established in the fraport case where the power of the arbitrators was also considered to control the proper and fair conduct of the procedure (fair conduct of the proceedings): “obligation to make sure that generally recognized principles relating to conflict of interest and the protection of the confidentiality of information imparted by clients to their lawyers are complied with (fraport case)”41. in fraport, unlike hvratska, the conflict of interest occurred between a party and its lawyer, and on this the tribunal stated that it could not pronounce on "the deontological responsibilities or jurisdiction over the parties’ legal representatives in their own capacities"42, that is to say, that there is no power to rule on an allegation of misconduct under any such professional rules as may apply”43. the iba guidelines mix the different situations of conflict and malpractice under a single instrument and merge the two principles as if they were one: the task force undertook to determine whether such differing norms and practices may undermine the fundamental fairness and integrity of international arbitral proceedings”44. and rule 1, and its comments: “the integrity and fairness of the arbitral proceedings”, to which the effectiveness and enforceability of the award are added in the commentary to rules 26-27: “to preserve the integrity, effectiveness and fairness of the arbitration and the enforceability of the award”. logically, the iba guidelines do so because, when considering the different approaches under the three investment arbitration cases already referred to, they needed to support and justify the policy legislative decisions adopted in the text, that is, to expressly confer power on arbitrators to punish lawyers in cases of malpractice, and regardless of whether they formally want to maintain deference for professional standards of ethics that are not displaced by the text of the iba. however, the iba guidelines did not intend to invest the arbitrators with powers that are reserved for professional associations45. it is thus possible to base a very different result to that derived from both the fraport case as we have seen, as from the rompetrol case, since in the latter it was seriously questioned that, on the basis of the hvratska case, it could be considered 40 hvratska case, nº25. 41 fraport case, nº37, also pointing out that: “indeed, such principles are of fundamental importance to the fairness of the arbitration process”. 42 fraport case, nº39. 43 fraport case, nº39. 44 preamble to the iba guidelines on party representation. 45 rule 3. and preamble to the iba guidelines on party representation. njcl 2019/2 129 a more general principle that allowed to exclude a lawyer from the procedure46. that the drafters of the iba guidelines seem to have been aware of this merger of the two principles is revealed when examining rules 4-6, which deal with the cases covered by this work and that only expressly refer to the integrity of the procedure both in the rule specifically considers (rule 5) as in the commentary to them, as compared to rules 26-27, which consider the two principles as a unit. in fact, the iba rules, although they certainly regulate both issues in the same instrument, seem to consider them from a different angle and in separate provisions to the other issues that are understood as lawyer´s malpractice. moreover, a different perspective of legislative policy is also observed regarding the applicable remedies, possibly because the drafters were aware of the criticisms that would arise from regulating the issues of lawyers' malpractice. while for the breach of rule 5 the possible exclusion of the representative from his participation, totally or partially, is expressly provided for in the procedure, rule 26 on remedies for improper conduct fails to mention the possible removal of the representative, although it may be considered within letter d) of rule 26 which, as a tailor's box, provides that the arbitrators may adopt any appropriate measure aimed at maintaining the justice and integrity of the procedure. that said, what seems to be evident from the iba text is that the conflict between lawyers and arbitrators such as that expressed in rule 5, if necessary, can cause the lawyer to be removed regardless of the reason that generated it, that is, regardless of whether the change has been made legitimately or with another intention: to delay the procedure, boycott it, or any other reckless conduct or in bad faith. when the conflict of interest has arisen between the lawyer and the arbitrator, if it is serious enough, only the removal of the lawyer will be possible. if the conflict is not serious enough to justify the removal, and if, in addition, such change responds to illegitimate or spurious reasons, the lawyer may be sanctioned in milder ways, such as those indicated in rule 26. outside these cases, it seems that the malpractice of the lawyer or representative would not justify the extreme sanction of his expulsion. this approach is also continued by the lcia text. the regulation further emphasizes the treatment of different matters, although without directly referring to any principle but by reference to the principle of “fair, efficient and expeditious means for the final resolution of the parties' dispute”, since it deals in the same article with all the variety of phenomena (arts. 18.3 and 4, on the one hand, and 18.5, on the other), although in terms of remedies the same approach as the iba guidelines is followed. the lcia rules regulates the principles and rules of conduct in articles 18.5 and in the annex, as well as the sanctions in section 6 of article 18, avoiding referring to the possible expulsion of the lawyer. even in the case of the lcia 46 rompetrol case, nº22-23. towards a uniform standard 130 rules, there is still greater prevention as i will indicate later in the following section. on the other hand, the new ccbbpp/cea (2019) only refers to the principle of the integrity of the procedure and giving a definition to it in which the two types of matters or issues are clearly integrated (nº112): the integrity of the proceeding shall be deemed adversely affected in the following circumstances: a) if the party instituting the change is acting with dilatory intent or in abuse of process; or b) if there is a conflict of interest between the new lawyer and any of the arbitrators. undoubtedly, the commented texts could have kept the two issues and the principles separate, since, as indicated very correctly, in relation to the issue at hand, it is not about disciplining the lawyer47 but to determine if a party that can endanger the integrity of the procedure can be allowed to have an unlimited right to change lawyers48. rather: “it is that disqualification of counsel must rest on the same basis that---had the argument been made---would justify the disqualification of a member of the tribunal. and this is as it should be, for in either case the gravamen of the complaint is to raise precisely the same doubts about the integrity of the decision-making process”49. leaving aside a purist perspective in legal interpretation, and if we consider that we are faced with principles that do not have a uniform formulation50 and that can be interpreted broadly51, there should not be 47 for example, they seem to observe the issue as a sanction: castello, pp.363-364, commenting art.21 of the bahrein arbitration rules; and guideline 1.2 siarb guidelines on party-representative ethics, 26 april 2018: “a party representative shall not abuse the arbitral process or its procedures”, pointing out in the comment to situations related to this paper where: “deliberately timed last-minute amendments, or other applications to the tribunal or the courts, intended solely to harass the opponent or cause unnecessary delay or disruption to the arbitral process”. 48 waincymer, p.612. 49 rau, nº25. 50 legitimacy, in addition to transparency, often evokes notions of good governance and predictability: doak bishop/margrete stevens, the compelling need for a code of ethics in international arbitration: transparency, integrity and legitimacy, p.15. integrity of the procedure understood as affecting the pillars of the right to due process: madalena/rivera, p.92. 51 for example, considering situations that would enter as “guerrilla tactics,” the arbitral tribunal in the case of libananco holdings co limited (claimant) and republic of turkey (respondent) (icsid case, no.arb/ 06/8) decision on preliminary issues, 23 june 2008, issued one month after the hvratska case, considered the principle of integrity and that of good, nº78:“it must be regarded as endowed with the inherent powers required to preserve the integrity of its own process – even if the remedies open to it are necessarily different from those that might be available to a domestic court of law in an njcl 2019/2 131 major inconveniences in merging the two issues under the integrity principle of the arbitration procedure, as does the ccbbpp/cea. for the supporters of its regulation, the unification of both matters under the principle of the integrity of the procedure undoubtedly presents an advantage in that it grants power to the arbitrators and the sanctions to be imposed under the lens of the hvratska case while trying to get as far away as possible from the interference with the principles and rules of professional ethics that may be applicable. it will not be surprising, therefore, that one of the defenses against critics of the iba guidelines affects this point: “the iba party representation guidelines are strictly limited to matters pertaining to the conduct of the procedure. they do not include anything, for example, about attorney’s fees or attorney-client relationship. every single issue that is dealt with in the guidelines pertains to the preservation of the integrity and fairness of the proceedings (…). the starting point is that arbitral tribunals have the power to deal with matters of counsel conduct, insofar as measures are necessary to ensure the integrity of the arbitral proceedings”52. these other cases of necessary protection of the integrity of the arbitration procedure may arise on the occasion of a variety of situations related, for example, to the inappropriate conduct of lawyers (verbal or physical aggression, or those known as “guerrilla tactics, for example, in the case at hand, it could be the choice of a lawyer that creates a conflict with the court to “torpedo” the procedure)53, which may lead to the icsid member state. the tribunal would express the principle as being that parties have an obligation to arbitrate fairly and in good faith and that an arbitral tribunal has the inherent jurisdiction to ensure that this obligation is complied with; this principle applies in all arbitration, including investment arbitration, and to all parties, including states (even in the exercise of their sovereign powers)”. 52 see. mourre, chapter 25, p.248. 53 dasser, a critical analysis, p.41; tom cummins, the iba guidelines on party representation in international arbitration – levelling the playing field?, arbitration international, 2014, vol.30, nº3, p.439, and p.448; and edna sussman/solomon ebere, all’s fair in love and war – or is it? reflections on ethical standards for counsel in international arbitration, the american review of international arbitration (aria), 2011, vol.22, nº4, p.612, who conducted their study in relation to the so-called "guerrilla tactics" and without giving a definition of what should be understood by guerrilla tactics, respondents were free to consider certain behaviors as such, in particular the creation of conflicts, citing as a relevant example the cases of change of lawyer during the arbitration process to create a conflict with an arbitrator. a curious and possibly almost impossible example in practice would be that of a defendant's lawyer who nominates a series of arbitrators with obvious conflicts of interest in the hope of sabotaging the procedure with the inevitable incidents of recusal. (william w. park, a fair fight: professional guidelines in international arbitration. boston towards a uniform standard 132 arbitrators having to take measures aimed at ensuring such protection54. in these situations, sanctions might be available in the distribution of costs55. otherwise, the conflict must be resolved ex-ante. accordingly, and depending on the circumstances, arbitrators can deal with issues related to the exclusion of the procedure of a lawyer or an expert56. 3.4. the regulations under review: differences regarding the different perspectives adopted by the texts mentioned, and while recognizing that some arbitration rules have decided not to regulate these situations57, it has been rightly pointed out that: “the lcia university school of law working paper, nº14-53 (october 7, 2014), p.14, who seems, however, to forget that this also requires the cooperation of successive arbitrators). 54 in favor of considering that arbitrators not only have the power but also the duty to sanction unethical conduct or contrary to the ethics of the lawyer based on the safeguard of the integrity of the arbitration procedure: madalena/rivera, pp.91-94; and ignacio madalena, ethics in international arbitration, int. a.l.r., 2012, 15(6) pp.251-254, both in general and in particular in the case of the conflict of interest object of this work, also indicating that the powers of the arbitrators would not be extended to lawyers if these are issues that do not have a direct impact on the procedure. there are, however, jurisdictions contrary to the arbitrators being able to decide on the removal of lawyers in cases of conflict of interest between the lawyer and the party, as is the case in the us legal system, see: o. franco pujol/o. muñoz rojo, la remoción del abogado en el arbitraje internacional. ¿una alternativa viable?. ciarglobal, abril 2018, pp.16-17. 55 this type of conflict and its reflection in costs is referred to by the icc commission report, decisions on costs in international arbitration. icc dispute resolution bulletin 2015, issue 2, p.16: “(iii) post-formation conflicts aimed at destabilizing the tribunal and the arbitration. these result, for example, from counsel appointments late in the proceedings that create a conflict of interest for an arbitrator. the arbitrator in question may be forced to resign, otherwise the enforceability of the award could be jeopardized. the tribunal may take into account any tactic deployed by a party to create such a conflict, and any costs arising out of such conduct”. 56 flughafen zürich ag v. venezuela, icsid case no arb/10/19, decision on proposal for disqualification of expert witness and exclusion of evidence, 29 august 2012. the arbitral tribunal, under the chairmanship of juan fernández-armesto, considered a case where the expert had received confidential information from the plaintiff so that he could present his financial offer of professional services, being that he finally served as the defendant's expert. the court considered its jurisdiction on the basis of rule 34.1 that empowers the court to decide on the admissibility of the evidence, and considered that it was not appropriate to exclude the expert because the information was not given confidentially, and the expert acknowledged that there was no read or disposed of it (nº34-38). 57 franco pujol/muñoz rojo, footnote 83 refer to the arbitration rules of the hong kong international arbitration centre (hkiac) that, although they initially foresaw the power of the arbitral tribunal to exclude a representative, they did not include it in the final text. it also does not appear in the new regulation of november 1, 2018 that njcl 2019/2 133 ‘approval’ and iba ‘exclusion’ would normally lead to the same result. however, the lcia formulation may have the merit of connoting respect for the parties’ original position, and certainly sounds less aggressive than disqualification”58. they escape, however, from that approach, not being indifferent the orientation of the announced rules, the situations in which the change of law firm occurs, which are not contemplated under the iba rules or under other texts that follow its formulation as art.21.1 rules of arbitration of the bahrain chamber for dispute resolution (1 october 2017). on the other hand, those situations could be understood within the scope of the lcia that refers to any intended change (...) by a party to its legal representatives. or under the ccbbp/cea which refers in general to any modification in the legal representation. however, in this case, neither the formulation of the lcia59 nor that of the ccbbp/cea serve to resolve the conflict of interest when there is a change of law firm for an elementary reason: they follow a preventive model based on authorization, and it is more than evident that the arbitral tribunal has no power to authorize or disallow the professional destiny of the group of lawyers; furthermore, it seems that both the formulation of the lcia and of the ccbbp/cea60 do not give powers to the arbitrators to decide on the expulsion of the lawyer. in this regard, it is to be noted that the text of the lcia, as well as the ccbbpp/cea, avoids referring expressly to the exclusion of the lawyer as one of the measures that could be taken in the case of noncompliance with the ethical rules. even in the case of the ccbbpp/cea, it could have been understood differently if this power of the arbitrators had finally been adopted expressly in the cea model arbitration rules of the same date, since in accordance with article 26.2, it is established that among the powers of the arbitrator are adopting measures to maintain the establishes in its articles 13.6 and 13.7 the free election of the representatives, although subject to the principles of a fair and effective conduct of the procedure, as well as the obligation to promptly communicate the change in legal representation once the arbitral tribunal has been constituted. 58 park, a fair fight, p.24; w.w. park, equality of arms in arbitration: costs and benefits, in v. heuzé et al. (eds.), mélanges en l’honneur de pierre mayer 663 (lgdj 2015), p.24. see also: franco pujol/muñoz rojo, p.12. 59 nor that of other regulations as derived from article 21.2 of the rules of arbitration of the bahrain chamber for dispute resolution (1 october 2017). 60 later the code refers to possible penalties without specifically mentioning the possible removal of the lawyer:132 if a lawyer breaches any of the duties described in this section, then the arbitrators, after hearing both parties and the lawyer concerned, may adopt any of the following measures: a) caution the lawyer verbally or in writing; b) draw adverse inferences when evaluating the evidence; c) take the lawyer’s conduct into consideration when awarding costs; d) notify the matter to any bar associations with which the lawyer is registered, for the determination of ethical responsibilities; and e) adopt any other measure in order to preserve the integrity of the proceedings. towards a uniform standard 134 integrity of the proceeding, including written or verbal cautions to the lawyers, but the last sentence of this rule or order the change of lawyers or experts was finally deleted in the final draft continuing with the differences, the aforementioned texts adopt different solutions to solve the problem that oscillate between preventive measures (ex-ante) (or authorization model) aimed at requesting authorization from the arbitral tribunal to authorize/reject the modification of the legal equipment (example of the lcia and ccbbpp/cea), and resolving measures (or sanctioning model) that even pointing out the duty of not creating inappropriate relationships resolves the conflict (ex-post) preventing the participation of the representative (example, iba guidelines), without prejudice to a mixed criterion61. 4. conclusions the analysis carried out in this paper leads us to the following conclusions: (i) a trend in international arbitration has been consolidated by which, under the principles of protection of the integrity of the arbitral procedure and immutability of the arbitral tribunal that has been validly constituted and that of the fair conduct of the procedure, arbitrators have the power to resolve the conflict of interest that arises between the right to an independent arbitrator and the right to choose a lawyer when there is an intention to change the latter. this right of the parties is subject to the duty of not creating inappropriate relationships with the members of the arbitral tribunal. (ii) the arbitrators, in deciding on the indicated conflict, have the power to decide the removal of the lawyer. (iii) the differences between the rules of arbitration and other soft law instruments, as they have been analyzed, do not have enough weight or entity to distort the conclusions reached. (iv) future regulation of this issue either in line with the arbitration regulations themselves or in an code of ethics for arbitrators or lawyers should respond broadly to the problem at hand by means of a wording that includes both the situations of incorporation of a new lawyer and the change of the law firm, while accepting a preventive (ex ante) and conflict resolution (ex post) approach. 61 in a way, this approach is found in the arbitration rules del arbitrators’ and mediators’ institute of new zealand (2017), rule 14 on party representation. effects of avoidance: perspectives from the cisg, unidroit principles and pecl and case law by chengwei liu nordic journal of commercial law issue 2005 #1 nordic journal of commercial law issue 2005 #1 1 see secretariat commentary on art. 72 of the 1978 draft [draft counterpart of cisg article 76]: comment 2; available at: <http://www.cisg.law.pace.edu/cisg/text/secomm/secomm-76.html>. 2 see denis tallon in commentary on the international sales law: the 1980 vienna sale convention, cesare massimo bianca & michael joachim bonell eds., milan (1987), p. 601; available at: <http://www.cisg.law.pace.edu/cisg/biblio/tallon-bb81.html>. 3 see john o. honnold, uniform law for international sales under the 1980 united nations convention, 3rd ed., kluwer law international, the hague (1999), p. 502; available at: <http://www.cisg.law.pace.edu/cisg/biblio/ho81.html>. 4 see secretariat commentary on art. 66 of the 1978 draft [draft counterpart of cisg article 81]: comment 1; available at: <http://www.cisg.law.pace.edu/cisg/text/secomm/secomm-81.html>. 5 see uncitral digest of case law on the united nations convention on the international sale of goods (8 june 2004), a/cn.9/ser.c/digest/cisg/81: digest 2; available at: <http://www.uncitral.org/english/clout/digest_cisg_e.htm>. 6 see harry m. flechtner in “remedies under the new international sales convention: the perspective from article 2 of the u.c.c.”: 8 journal of law and commerce (1988); p. 56; available at: <http://www.cisg.law.pace.edu/cisg/biblio/flecht.html>. 7 uncitral digest 3 on cisg art. 81; supra. n. 5. 8 see judgment by oberlandesgericht [appellate court] bamberg, germany 13 january 1999; no. 3 u 83/98. english translation by ruth m. janal; available at: <http://www.cisg.law.pace.edu/cases/990113g1.html>. 2 where the contract has been avoided, both parties are released from any future performance of their obligations and restitution of that which has already been delivered may be required.1 1. general under the united nations convention on contracts for the international sale of goods (1980; “cisg” or “convention”), the effects of avoidance are described in arts. 81 to 84, four articles of unequal importance dealing with the consequences which result from a declaration of avoidance accomplished by a party in accordance with the conditions set forth in cisg arts. 49, 51, 64, 72 and 73.2 among the four, art. 81 states the basic consequences of avoidance,3 while arts. 82 to 84 give “detailed rules for implementing certain aspects” of art. 81.4 from the outset, it is to be made clear that the convention does not apply to “consensual avoidance” – i.e., termination of the contract that occurs where the parties have, by mutual consent, agreed to cancel the contract and to release each other from contractual obligations – but rather is properly limited to cases where one party “unilaterally” avoids the contract because of a breach by the other party.5 avoidance is the process through which an aggrieved party, by notice to the other side, terminates the contractual obligations of the parties. if the contract is not avoided, the convention contemplates that the basic exchange of goods and price will be completed despite a breach, with damages or other remedies to compensate for defects in the exchange.6 that is to say, failure to effectively avoid the contract means that the parties remain bound to perform their contractual obligations. courts have found a failure of effective avoidance where a party failed to follow proper procedures for avoidance (i.e., lack of timely and specific notice of avoidance to the other party) or where a party lacked substantive grounds for avoiding (e.g., lack of fundamental breach).7 in any event, as a rule, only avoidance of contract makes it clear that the contract will not be performed. when the contract is avoided, the parties lose the right to perform and regain their freedom of disposition. up until then it is their duty to remain loyal to the contract.8 on the nordic journal of commercial law issue 2005 #1 9 uncitral digest 2 on cisg art. 81; supra. n. 5. 10 see judgment by oberster gerichtshof [supreme court], austria 29 june 1999; no. 1 ob 74/99k. english translation by dr. peter feuerstein, translation edited by todd j. fox; available at: <http://www.cisg.law.pace.edu/cases/990629a3.html>. 11 see denis tallon, supra. n. 2; p. 602. 12 see comment and notes to pecl art. 9:309: notes; available at: <http://www.cisg.law.pace.edu/cisg/text/peclcomp81.html>. 13 see mirghasem jafarzadeh in “buyer's right to withhold performance and termination of contract: a comparative study under english law, vienna convention on contracts for the international sale of goods 1980, iranian and shi'ah law” (december 2001); available at: <http://www.cisg.law.pace.edu/cisg/biblio/jafarzadeh1.html>. 14 see florian mohs in “commentary on the manner in which articles 7.3.5 and 7.3.6 of the unidroit principles compare with articles 81 and 82 of the cisg”, (january 2004); available at: <http://www.cisg.law.pace.edu/cisg/principles/uni81,82.html>. 3 other hand, however, in cases of “consensual avoidance,” it has been asserted, the rights and obligations of the parties are governed by the parties' termination agreement.9 in this regard, a relevant ruling is found in [austria 29 june 1999 oberster gerichtshof [supreme court]]:10 “the cisg does not regulate […] the consequences deriving from a consensual avoidance of contract. it is up to the parties to reach adequate arrangements or agree upon adequate provisions for the avoidance (citations omitted). should, however, as here, no adequate arrangements have been made, the resulting gaps are to be filled under the cisg and not through recourse to national law (citation omitted). in so far as the parties do not autonomously regulate the legal consequences of the consensual avoidance of the contract in their agreement for avoidance – particularly the bearing of risk, the place of performance and the bearing of the costs – the remaining gap must be filled by interpretation according to art. 7(2) cisg ...” in addition, it is to be made clear that art. 81 et seq cisg are effective only between the parties. they do not affect the consequences with regard to third parties, namely those which may follow from contracts entered into by the buyer prior to the avoidance (resale, rental, etc.). this issue is governed by the applicable law.11 2. the cisg approach: retrospective or prospective? arguably, the various legal systems exhibit great differences in concepts and terminology when dealing with the effects of termination or avoidance. the differences in the practical results obtained are not so great but are still significant. the most apparent difference is between systems such as the french which treats résolution as essentially retrospective and those such as the common law which sees termination as essentially prospective.12 as regards the question whether termination has retrospective or prospective effects on the contract, however, it is hard to say that the convention adopted any single approach.13 to discuss this matter, it is to be firstly made clear:14 “according to the retroactive approach, the contract is void ab initio (ex tunc), which means that the parties are placed in the situation they would be in had the contract never been concluded. by contrast, under the prospective approach, the contract remains in existence with the restitutionary obligations being the reverse of the original obligations of performance.” nordic journal of commercial law issue 2005 #1 15 uncitral digest 1 on cisg art. 81; supra. n. 5. 16 see joseph lookofsky in “the 1980 united nations convention on contracts for the international sale of goods”: j. herbots editor / r. blanpain general editor, suppl. 29 international encyclopaedia of laws contracts, kluwer law international (december 2000), p. 167; available at: <http://www.cisg.law.pace.edu/cisg/biblio/loo81.html>. 17 see denis tallon, supra. n. 2; p. 602. 18 see joseph lookofsky, supra. n. 16; p. 167. 19 see denis tallon, supra. n. 2; p. 602. 20 see joseph lookofsky, supra. n. 16; p. 167. 21 see judgment by schiedsgericht der handelskammer [arbitral tribunal] hamburg, germany 21 march 1996; no. partial award o f 2 1 m a r c h 1 9 9 6 : y e a r b o o k c o m m . a r b ' n x x i i , a l b e r t j a n v a n d e n b e r g e d . ( k l u w e r 1 9 9 7 ) ; a v a i l a b l e a t : <ink"http://cisgw3.law.pace.edu/cases/960321g1.html"http://www.cisg.law.pace.edu/cases/960321g1.html>. 4 it is clear that, art. 81, governing the general consequences that follow if one of the parties avoids the contract or some part thereof,15 sets forth the two consequences: (1) avoidance of the contract releases both parties from their obligations under it, subject to any damages which may be due. avoidance does not affect any provision of the contract for the settlement of disputes or any other provision of the contract governing the rights and obligations of the parties consequent upon the avoidance of the contract. (2) a party who has performed the contract either wholly or in part may claim restitution from the other party of whatever the first party has supplied or paid under the contract. if both parties are bound to make restitution, they must do so concurrently. release for the future: the primary effect of avoidance is to relieve both parties of their obligations to perform; i.e., the seller need not deliver the goods, and the buyer need not pay.16 that is to say, once a contract has been (validly) declared avoided by one of the parties, both parties, as a rule (first sentence, art. 81(1)), are released from all their obligations for the future. if the contract is partially avoided, the parties are released from their obligations only as to that part of the contract which has been avoided.17 exceptions to the release: on the other hand, although avoidance of the contract releases both parties from their performance obligations, it does not eliminate all rights and obligations which arose out of the contract.18 in this regard, two respects are to be particularly outlined: – the first sentence of art. 81(1) specifies that the release takes place “subject to any damages which may be due.” as opposed to the situation in which a contract is avoided because it has become impossible to perform (art. 79), avoidance, in the instant case, does not prevent the injured party from claiming damages on account of the nonperformance by the other party of one of his obligations.19 thus, though the party in breach need not deliver or pay, that party remains liable for any loss suffered by the other party as a consequence of the breach.20 in this regard, it is expressly held in [germany 21 march 1996 hamburg arbitration award]: “where, […], the contract is terminated and damages for failure to perform are claimed under art. 74 cisg et seq., one uniform right to damages comes into existence, which […] prevails over the consequences of the termination of a contract provided for in arts. 81-84 cisg.”21 – the second sentence of art. 81(1) states another restriction: the avoidance does not affect two categories of clauses: (a) clauses relating to the “settlement of dispute,” including mainly arbitration and renegotiation clauses – designed to resolve conflicts resulting nordic journal of commercial law issue 2005 #1 22 see denis tallon, supra. n. 2; p. 603. 23 see joseph lookofsky, supra. n. 16; p. 168. 24 see denis tallon, supra. n. 2; p. 603. 25 see joseph lookofsky, supra. n. 16; p. 168. 26 see victor knapp in commentary on the international sales law: the 1980 vienna sale convention, cesare massimo bianca & michael joachim bonell eds., milan (1987), p. 468; available at: <http://www.cisg.law.pace.edu/cisg/biblio/knapp-bb64.html>. 27 in principle, the party in breach will bear the reasonable expenses which both parties incur in relation to the making of restitution for goods or sums received prior to avoidance; as regards the non-breaching party's expenses, the breaching party is liable in damages for such losses as a consequence of the breach. (see joseph lookofsky, supra. n. 16; p. 168.) 28 see judgment by handelsgericht [commercial court] st. gallen, switzerland 3 december 2002; no. hg.1999.82-hgk. translation by stefan kuhm; available at: <http://www.cisg.law.pace.edu/cases/021203s1.html>. 29 see denis tallon, supra. n. 2; p. 604. 30 see peter schlechtriem in “uniform sales law the un-convention on contracts for the international sale of goods”, manz, vienna (1986); p. 107; available at: <http://www.cisg.law.pace.edu/cisg/biblio/schlechtriem.html>. 5 from unforeseeable changes in circumstances – and forum selection clauses; and (b) those which spell out the consequences of the non-performance of the contract: penalties, liquidated damages, clauses restricting or excluding liability.22 however, the question of whether such clauses remain binding will also depend on their validity, and this is normally a question for the applicable domestic law.23 that is to say, as a matter of fact, only where these clauses are valid according to the applicable law (which may not always be the case, especially concerning penalties), could they be deemed effective notwithstanding the avoidance of the contract.24 art. 81 provides a non-exhaustive list of contractual and convention obligations which continue even after avoidance. the duty of the buyer to take steps to preserve goods which he intends to reject constitutes another example of the kind of obligation not extinguished by avoidance.25 in any event, avoidance of the contract does not terminate either the right to claim damages or clauses which may prove useful in resolving a conflict between the parties. such express provisions are important because in many legal systems avoidance of the contract eliminated all rights and obligations which arose out of the existence of the contract. under such a view once a contract has been avoided, there can be no claim for damages for its breach and contract clauses relating to the settlement of disputes (usually arbitration clauses) terminate with the rest of the contract. no such effects are produced by the avoidance of the contract under the convention.26 restitution of the past: restitution is another effect of avoidance. according to art. 81(2), a party who has performed the contract either wholly or in part may claim restitution from the other party of whatever the first party has supplied or paid under the contract. if both parties are bound to make restitution, they must do so concurrently.27 that is to say, the declaration of avoidance has the consequence that both parties are vested with claims for restitution in respect of any performances in part previously rendered (relationship for restitution; art. 81(2) cisg).28 art. 81(2) is concerned only with the past. it does not pose a problem in abstract terms of retroactivity. its wording, however, implies the retrospective disappearance of the contract. by undermining the legal basis (some systems would refer to the notion of cause) of the contract, i.e., that on which the parties have performed their obligations, the avoidance renders any act accomplished prior to it void. this situation entails the application of the rules of unjust enrichment or quasi-contracts.29 thus, the following effects of avoidance have been expressly contemplated in cisg art. 81:30 nordic journal of commercial law issue 2005 #1 31 see anna kazimierska in “the remedy of avoidance under the vienna convention on the international sale of goods”: pace review of the convention on contracts for the international sale of goods, kluwer (1999-2000); p. 148; available at: <http://www.cisg.law.pace.edu/cisg/biblio/kazimierska.html>. 32 notes to pecl art. 9:309; supra. n. 12. 33 see florian mohs; supra. n. 14. 34 see fritz enderlein & dietrich maskow, international sales law: united nations convention on contracts for the international sale of goods, oceana publication (1992); p. 341; available at: <http://www.cisg.law.pace.edu/cisg/biblio/enderlein.html>. 35 see anna kazimierska, supra. n. 31; pp. 148-149. 36 see judgment by oberster gerichtshof [supreme court], austria 29 june 1999; supra. n. 10. 6 “an effective avoidance of the contract releases both parties from their obligations (article 81(1) sentence one) and obligates the parties to make restitution of whatever has been supplied or paid under the contract (article 81(2) sentence one). an avoidance only ‘redirects’ the main obligations of the contract; it does not void the contract ab initio. under article 81, damage claims for breach, dispute-settlement mechanisms (arbitration clauses), liquidated damages and penalty clauses, etc., are not affected by an avoidance (article 81[(1)] sentence two).” from art. 81, it should be concluded that under the convention, the contract is not nullified upon the exercise of the remedy of avoidance. some obligations of the parties are terminated and some remain in existence. the specific obligations characteristic of the sales contract end or performance already made in fulfilling these obligations has to be returned in goods or in price so that a situation is achieved as from before the conclusion of the contract. however, the contract remains in force as long as there are still claims of the parties under it, including claims for returning the goods or payment of the price. on these grounds, the contract cannot be considered as terminated either ex nunc or ex tunc, although legal doctrine does not adopt unified opinion on that question.31 indeed, even as regards domestic systems, it has been noted that as the differences are sometimes more apparent than real it may be helpful to consider the effect of “termination” in the various systems in a number of factual situations.32 that is to say, this question of principle should be left open because one can disregard the theoretical questions, but should address the practical consequences.33 in sum, art. 81 clearly shows that the avoidance of the contract does not nullify the latter and clarifies which are the obligations that are terminated or returned, respectively, and which remain in existence. it does not meet the character of the provision that there is a dispute on whether the avoidance has the effect of ex nunc or ex tunc.34 therefore, the discussion, whether the avoidance operates retrospectively or prospectively is said to be of little help as avoidance always releases the parties from future characteristic obligations and, at the same time, imposes on the parties reciprocal duties of restoration having retrospective effect.35 to conclude this section, the leading ruling found in [austria 29 june 1999 oberster gerichtshof [supreme court]] provides a very valuable guidance regards the convention’s effects of avoidance, which states:36 “according to the cisg, the contract is not entirely annulled by the avoidance, but rather it is ‘changed’ into a winding-up relationship (emphasis added) (citations omitted). the parties are released from their primary contractual obligations due to the avoidance according to art 81(1) cisg. exceptions from this are obligations for damages, as well as other provisions which regulate the consequences of the avoidance for the parties, as set out in the second sentence of art. 81(1) cisg. this encompasses all provisions connected with the undoing of nordic journal of commercial law issue 2005 #1 37 see florian mohs; supra. n. 14. 38 see francesco g. mazzotta in “commentary on cisg article 81 and its pecl counterparts” (2003); available at: <http://www.cisg.law.pace.edu/cisg/text/peclcomp81.html#er>. 7 the contract, such as the obligation to ‘return’ (rückgewahr / ‘restitution’) all items received in connection with the contract (citation omitted), including the obligation to send back delivered goods (citation omitted). along with restitution, the results of the (partial) performance of the contract must be dislodged, but not through the establishment of a hypothetical goal such as ‘as if the contract had been duly performed’ or ‘as if the contract had never been concluded.’ rather, as in roman law, the claim for the return of the rendered performance (rückforderung) is permitted and thereby tied to the item of performance itself (leistungssache) and to its fate (emphasis added). articles 81-84 cisg contain at their core a risk distribution mechanism (emphasis added), which within the framework of the reversal of the contract (restitution), overrides the general provisions on the bearing of risk contained in art. 66 et seq. cisg (citation omitted).” 3. counterpart rules under the unidroit principles/pecl the general effects of avoidance under the convention are virtually the same as of termination under the unidroit principles of international commercial contracts (1994; “unidroit principles”). in this respect, mohs provides the following comparison:37 – firstly, both parties are released from their obligations under the contract, art. 81(1) first sentence cisg/art. 7.3.5(1) unidroit principles. – secondly, possible damages claims are not precluded, art. 81(1) first sentence, second part cisg/art. 7.3.5(2) unidroit principles. – thirdly, dispute settlement clauses are not affected, art. 81(1) second sentence cisg/art. 7.3.5(3) unidroit principles. – fourthly, even other clauses which operate after avoidance or termination, respectively, are not affected, art. 81(1) second sentence, second part cisg/art. 7.3.5(3) second part unidroit principles. – finally, under both sets of rules either party may claim restitution of what has been performed, art. 81(2) first sentence cisg/art. 7.3.6(1) first part of the sentence unidroit principles. if both parties have received anything under the contract, restitution will take place concurrently, art. 81(2) second sentence cisg/art. 7.3.6(1) second part of the sentence unidroit principles. mazzotta gives a comparison of cisg art. 81 and its counterparts in the principles of european contract law (1998; “pecl”), where it is stated:38 “the principal provisions are to be found in pecl article 9:305, entitled effects of termination in general, which basically provides, much like cisg article 81, that termination nordic journal of commercial law issue 2005 #1 39 see comment on art. 7.3.5 unidroit principles: comment 1; available at: <http://www.cisg.law.pace.edu/cisg/principles/ uni81,82.html>. 40 see florian mohs; supra. n. 14. 41 see fritz enderlein & dietrich maskow, supra. n. 34; p. 341. 42 see florian mohs; supra. n. 14. 43 see francesco g. mazzotta, supra. n. 38. 44 see comment and notes to pecl art. 9:309: comment b; available at: <http://www.cisg.law.pace.edu/cisg/text/peclcomp81.html>. 8 releases both parties to the contract from their obligation to effectuate and receive future performance [pecl art. 9:305(1)], but that does not affect any provision of the contract for the settlement of disputes or any other provision which is to operate even after termination [pecl art. 9:305(2)].” a difference found is that, both art. 7.3.5(1) unidroit principles and pecl art. 9:305(1) stipulate that, as a rule, termination releases both parties from their obligation “to effect and to receive future performance,” thus stating “the general rule that termination has effects for the future.”39 from this, it is evident that termination under the unidroit principles or pecl has prospective effect. this becomes apparent when comparing the remedies of termination and avoidance (the latter, referring to rescission due to misrepresentation, etc.) within the unidroit principles. according to art. 3.17(1) unidroit principles (similarly pecl art. 4:115), “[a]voidance takes effect retroactively” which means that the contract should be regarded as never having been concluded. by contrast, in the case of termination of contract, the unidroit principles do not provide for retroactive effect, but rather refer to “future performance.” this difference shows that termination (the equivalent of “avoidance” under the convention) of the contract under the unidroit principles (or the pecl) only has prospective effect.40 in this regard, it is recalled that it does not meet the character of cisg art. 81 that there is a dispute on whether the avoidance has the effect of ex nunc or ex tunc.41 practically speaking, the question of principle can be left open and the practical consequences are answered by the convention itself.42 in essence, therefore, all three instruments provide that avoidance of a contract does not have retroactive effect, since they all expressly exclude that a terminated contract should be treated as never having been made.43 the idea behind the prospective approach adopted under both art. 7.3.5(1) unidroit principles and pecl art. 9:305(1), is that it would be very inconvenient to treat a contract which has been terminated as cancelled in the sense of never having been made. the pecl comment explains:44 – first, if the contract had never been made the aggrieved party might be precluded from claiming damages for loss of its expectations, which would not seem an appropriate outcome. pecl art. 8:102 states that a party does not lose its right to damages by exercising another remedy. – secondly, if the contract were cancelled in the sense of never having been made, this might prevent the application of dispute settlement clauses or other clauses which were clearly intended to apply even if the contract were terminated. therefore, this article states that termination is not retroactive and specifically states the position on the clauses just mentioned. – it would also be inconvenient to treat a contract which has been terminated as being retrospectively cancelled in the sense that performances received must be returned or restitution made of their value. this is not appropriate where the contract was to be performed over a period of time when there can be termination for the future without undoing what has been achieved already. nordic journal of commercial law issue 2005 #1 45 see florian mohs; supra. n. 14. 46 see francesco g. mazzotta, supra. n. 38. 47 see denis tallon, supra. n. 2; p. 602. 48 comment 2 of secretariat commentary on art. 66 of the 1978 draft [draft counterpart of cisg article 81]; supra. n. 4. 9 as already discussed above, as for the former two reasons, they have been well encompassed under cisg art. 81(1). on the other hand, as regards the third reason, in a comparison of the rules on restitution of both the cisg and the unidroit principles, mohs points out that both sets of rules correspond with regard to the fact that restitution takes place on avoidance or termination of the contract, respectively, to the fact that partial restitution is possible, on the question of what contractual provisions survive avoidance of the contract, and that, if both parties had already received performance, restitution must be made concurrently. however, they do not correspond on the legal mechanism to apply in situations where it is impossible for the avoiding party to return what it had received under the contract: the cisg generally bars the aggrieved party from avoiding the contract whereas the unidroit principles grants the other party allowance in money.45 in this area, the pecl follows basically the unidroit principles and therefore differs from the convention to a similar extent. in a comparison of the rules on restitution of both the cisg and the pecl, mazzotta notes, similarly to mohs, that the cisg clearly requires restitution of whatever was received as a condition to avoiding the contract. such differences arise out of the different understanding regarding the retroactivity concept. while both the convention and the pecl provide that avoidance of a contract does not have retroactive effect, since both expressly exclude that a terminated contract should be treated as never made, the cisg and the pecl differ on what survives after avoidance and on the regime to be applied to the performances made under the contract. these are major differences that must be taken into consideration when comparing the cisg and pecl. the difference between them is clear: while the cisg tends to eliminate the consequences of an already partially performed contract, the pecl tends to maintain the exchange when it is satisfactory for both parties.46 with such differences kept in mind, one may generally conclude, cisg art. 81 sets forth the two consequences which result from the avoidance of the contract:47 “as to the future, the parties are released from their obligations. as to the past, they must return what has been supplied or paid under it.” these two main consequences will be discussed in detail below, and where necessary, the counterpart rules of the two sets of principles will be taken into account. 4. release for the future but with certain preservations 4.1 both parties released from future performance the primary effect of the avoidance of the contract by one party is that both parties are released from their obligations to carry out the contract. the seller need not deliver the goods and the buyer need not take delivery or pay for them.48 according to cisg art. 81(1) (sentence one, first nordic journal of commercial law issue 2005 #1 49 see jelena vilus in “provisions common to the obligations of the seller and the buyer”: petar sarcevic & paul volken eds., international sale of goods: dubrovnik lectures, oceana (1986); p. 257; available at: <http://www.cisg.law.pace.edu/cisg/biblio/vilus.html>. 50 uncitral digest 3 on cisg art. 81; supra. n. 5. 51 see fritz enderlein & dietrich maskow, supra. n. 34; p. 342. 52 comment 3 of secretariat commentary on art. 66 of the 1978 draft [draft counterpart of cisg article 81]; supra. n. 4. 53 see joseph lookofsky, supra. n. 16; p. 167. 54 note 4 to pecl art. 9:309; supra. n. 12. 55 see florian mohs; supra. n. 14. 10 part), “avoidance of the contract releases both parties from their obligations under it.” the main consequence is that both parties are free in the sense that they are released from the duties and obligations assumed under the contract.49 that is to say, valid avoidance of the contract releases the parties from their executory obligations under the contract.50 specifically, what matters in particular are the obligations of the seller to deliver the goods and to transfer property in them as well as to hand over the documents (art. 30), and those of the buyer to pay the price and to take delivery of the goods (art. 53). insofar as they are not fulfilled at the time of the avoidance of the contract (notice to the other party – art. 26), they will not have to be fulfilled later, i.e., the other party could refuse to accept performance.51 on the other hand, partial avoidance of the contract under art. 51 or 73 releases both parties from their obligations as to the part of the contract which has been avoided (and gives rise to restitution under art. 81(2) as to that part).52 for example, where the buyer avoids with respect to a portion of the goods not delivered, the seller is released from his obligation to deliver the portion concerned, and the buyer need not pay for that portion.53 all systems now accept that where a contract for performance in successive parts or installments is terminated after some parts of it have been performed, it may be terminated for the future without the need to undo the completed parts (cf. cisg art. 73(2)).54 as compared to art. 81(1) cisg which simply states that the parties are released “from their obligations,” both unidroit principles art. 7.3.5(1) pecl art. 9:305(1) contain more specific a text releasing both parties from their obligation “to effect and to receive future performance.” according to mohs, the term performance might, at a first glance, suggest a restrictive interpretation in a way that the parties are not released from all of their obligations but from their obligations of performance only. under this viewpoint, the parties would not be released from ancillary obligations, e.g., the right of sole distribution. however, the structure of the provision shows that the obligations which continue to exist are exhaustively identified by paras. (2) and (3) of art. 7.3.5 unidroit principles. thus, as does the cisg, the unidroit principles (similarly the pecl), in general, release the parties from all obligations under the contract except with respect to damages, dispute settlement and other clauses which operate (even) after avoidance. especially with regard to the provision of para. (3), whether or not a clause qualifies under the prerequisites, e.g., the duty not to divulge confidential information or the duty to restrain from entering into competition, survive termination, is a question of contractual interpretation on a case-by-case basis.55 nordic journal of commercial law issue 2005 #1 56 comment 4 of secretariat commentary on art. 66 of the 1978 draft [draft counterpart of cisg article 81]; supra. n. 4. 57 see fritz enderlein & dietrich maskow, supra. n. 34; p. 342. 5 8 s e e j u d g m e n t o f i c c a r b i t r a t i o n c a s e n o . 9 9 7 8 o f m a r c h 1 9 9 9 ; a v a i l a b l e a t : < h t t p : / / w w w . c i s g online.ch/cisg/urteile/708.htm>. 59 see fritz enderlein & dietrich maskow, supra. n. 34; p. 342. 60 see judgment of icc arbitration case no. 9978 of march 1999; supra. n. 58. 61 see fritz enderlein & dietrich maskow, supra. n. 34; p. 342. 62 see judgment of icc arbitration case no. 9978 of march 1999; supra. n. 58. 11 4.2 preservation of the right to claim damages in some legal systems avoidance of the contract eliminates all rights and obligations which arose out of the contract. in such a view once a contract has been avoided, there can be no claim for damages for its breach.56 in this respect, art. 81(1) (sentence one, second part) provides a mechanism to avoid that result by specifying that the avoidance of the contract is “subject to any damages which may be due.” indeed, arts. 45 and 61 have already made it clear that claims for damages can be asserted apart from other legal consequences of breaches of contract, thus also apart from avoidance.57 this general rule is put “in more specific terms” for the right to avoid the contract in art. 81(1) cisg.58 this provision in art. 81(1) “any damages which may be due,” refers in particular to claims for damages which have arisen in connection with the obligations from which the party is now released.59 in this regard, it is held in [icc march 1999 international court of arbitration, case 9978]:60 “this wording does not refer to a new claim for damages arising due to the seller's failure to refund the purchase price received from the buyer [or due to the buyer’s failure to return the goods received from the seller]. rather, this wording provides for the continuation of any claims for damages which may exist due to the seller's violation of his primary obligation under the contract or under art. 30 et seq. cisg (citation omitted) [or due to the buyer’s violation of his primary obligation under the contract or under art. 53 et seq. cisg]. this continuing claim for damages covers the part of the loss which exceeds the interest claim under art. 84(1) cisg (citation omitted).” according to enderlein & maskow, however, the term “damages which may be due” is in this context conceived as a bit tight, for the same should apply to obligations to pay penalties under the contract in their different manifestations. according to them, damages, for instance, have to be paid because of delay, even if the contract is later avoided because of that delay and even if damages arise because of avoidance, which in their view come under sentence two of art. 81(1).61 but in this respect, one should note:62 “new claims for damages may arise after avoidance only with respect to the violation of those contractual duties which already existed prior to the avoidance of the contract and which are left untouched by the avoidance according to art. 81(1) cisg (citation omitted).” in any event, justified under the clear preservation in art. 81(1) of the right to claim damages, many decisions have recognized that responsibility for damages for breach survives avoidance, and have awarded damages to the avoiding party against the party whose breach triggered the nordic journal of commercial law issue 2005 #1 63 uncitral digest 4 on cisg art. 81; supra. n. 5. 64 see judgment of icc arbitration case no. 7645 of march 1995: yearbook comm. arb'n xxvi, albert jan van den berg, ed. (kluwer 2001) pp. 130-152; available at: <http://www.cisg.law.pace.edu/cases/957645i1.html>. 65 see judgment by federal arbitration court for the moscow region [cassation instance]; russian federation 27 april 2001; no. kg-a40/1946-01. english translation by yelena kalika; available at: <http://www.cisg.law.pace.edu/cases/010427r2.html>. 66 see judgment by handelsgericht [commercial court] st. gallen, switzerland 3 december 2002; supra. n. 28. 67 see judgment by tribunal of international commercial arbitration at the russian federation chamber of commerce and industry; russian federation 7 june 1999; no. 238/1998. english translation by gilyana bovaeva, translation edited by mykhaylo danylko; available at: <http://www.cisg.law.pace.edu/cases/990607r1.html>. 68 see, e.g., judgment by bezirksgericht [district court] der saane (zivilgericht), switzerland 20 february 1997; no. t 171/95. english translation by stefan kuhm; available at: <http://www.cisg.law.pace.edu/cases/970220s1.html>. 69 see judgment by schiedsgericht der handelskammer [arbitral tribunal] hamburg, germany 21 march 1996; supra. n. 21. 12 avoidance.63 for instance, it is held in [icc march 1995 international court of arbitration, case 7645]:64 “the declaration of avoidance by [buyer] ... had as a consequence that the contract ended and [buyer] automatically became entitled to damages suffered by the breach of contract by [seller], all in accordance with art. 81(1) and art. 74 et seq. of the cisg.” it is repeated in [ink"http://cisgw3.law.pace.edu/cases/010427r2.html"russian federation 27 april 2001 arbitation court [appellate court] for the moscow region]:65 “pursuant to article 81(1) cisg, avoidance of the contract does not release parties from their obligations to pay damages which they may claim under the convention.” again, it is stated in [switzerland 3 december 2002 handelsgericht [commercial court] st. gallen]:66 “a confirmation of this unilateral right to have an agreement altered and avoided does not deprive [seller] of his right to claim damages under art. 74 et seq. cisg (see arts. 61(2) and 81 cisg).” in any event, art. 81 cisg in principle permits recovery of damages under avoidance of the contract.67 it explicitly stipulates the principle that an aggrieved party does not forfeit his right to claim damages if he petitions for any other remedies. therefore, the declaration of avoidance does not exclude any claim for damages.68 just as the court in [germany 21 march 1996 hamburg arbitration award] states:69 “where […] the contract is terminated and damages for failure to perform are claimed under art. 74 cisg et seq., one uniform right to damages comes into existence, which […] prevails over the consequences of the termination of a contract provided for in arts. 81-84 cisg.” like cisg art. 81(1), unidroit principles art. 7.3.5(2) reads: “termination does not preclude a claim for damages for non-performance.” although no counterpart is specifically introduced in the pecl, the same result may be reached by virtue of the general rule of pecl art. 8:102, which states partly: “in particular, a party is not deprived of its right to damages by exercising its right to any other remedy.” it is clearly stated in the pecl comment: “a party which pursues a remedy other than damages is not precluded from claiming damages. a party which terminates the nordic journal of commercial law issue 2005 #1 70 see comment and notes to pecl art. 8:102: comment a; available at: <http://www.cisg.law.pace.edu/cisg/text/peclcomp45.html>. 71 comment 2 on art. 7.3.5 unidroit principles; supra. n. 39. 72 see denis tallon, supra. n. 2; p. 603. 73 see comment and notes to pecl art. 9:305: comment b; available at: <http://www.cisg.law.pace.edu/cisg/text/peclcomp81.html>. 74 see fritz enderlein & dietrich maskow, supra. n. 34; p. 342. 75 note 3 to pecl art. 9:309; supra. n. 12. 76 see filanto v. chilewich, judgment by u.s. district court, southern district of new york [federal court of first instance]; 14 april 1992; no. 92 civ. 3253 (clb); available at: <http://www.cisg.law.pace.edu/cases/920414u1.html>. 13 contract may, for instance, also claim damages.”70 thus, under each of the three instruments, the general rule is:71 “the fact that, by virtue of termination, the contract is brought to an end, does not deprive the aggrieved party of its right to claim damages for non-performance.” 4.3 contract provisions remaining in existence aiming at preventing the disappearance of clauses which may prove useful in resolving a conflict between the parties,72 certain contractual clauses are preserved despite avoidance. this is made clear in the following relevant rules: – cisg art. 81(1) (sentence two): “avoidance does not affect any provision of the contract for the settlement of disputes or any other provision of the contract governing the rights and obligations of the parties consequent upon the avoidance of the contract.” – unidroit principles art. 7.3.5(3): “termination does not affect any provision in the contract for the settlement of disputes or any other term of the contract which is to operate even after termination.” – pecl art. 9:305(2): “termination does not affect any provision of the contract for the settlement of disputes or any other provision which is to operate even after termination.” each of these provisions makes it clear, that termination is not retroactive and specifically states the position on the clauses just mentioned.73 hereby, a widely recognized rule is repeated.74 most systems now accept that termination will not affect the application of clauses such as arbitration clauses which were intended to apply despite termination.75 as regards “any provision of the contract for the settlement of disputes,” it is frequently applied to an arbitration clause; for instance, in [united states 14 april 1992 federal district court [southern dist. ny] (filanto v. chilewich)], it is stated that:76 “contracts and the arbitration clauses included therein are considered to be ‘severable’, a rule that the sale of goods convention itself adopts with respect to avoidance of contracts generally.” as regards “any other provision of the contract governing the rights and obligations of the parties consequent upon the avoidance of the contract,” this language has been applied to preserve, despite avoidance of the contract in which it was contained, the legal efficacy of a “penalty” clause nordic journal of commercial law issue 2005 #1 77 uncitral digest 4 on cisg art. 81; supra. n. 5. 78 see judgment of icc arbitration case no. 9978 of march 1999; supra. n. 58. 79 see judgment by oberster gerichtshof [supreme court], austria 29 june 1999; supra. n. 10. 80 see fritz enderlein & dietrich maskow, supra. n. 34; p. 342. they further state: “the surviving conditions can be multifaceted (citation omitted). they relate to general questions of cooperation between the parties, like agreement of general business terms whose individual elements again have to be examined according to that criterion, agreements on the form of declarations, a general obligation to cooperate, obligations to maintain secrecy, a reservation of title up to restitution, limitation of claims, and the applicable law (annotation omitted). another group of conditions refers to the modalities of performance, i.e., commercial terms, risk bearing, packaging, procurement of licenses, which can play a role where the return of the goods or of the price is concerned. of particular practical relevance are those agreements which deal with liability, such as penalties, liquidated damages and damage clauses, including possibilities of exemption and restrictions, the amount of interest, etc.” (ibid., p. 343.) 81 see florian mohs; supra. n. 14. 82 comment 3 on art. 7.3.5 unidroit principles; supra. n. 39. 83 see fritz enderlein & dietrich maskow, supra. n. 34; p. 342. 84 comment 5 of secretariat commentary on art. 66 of the 1978 draft [draft counterpart of cisg article 81]; supra. n. 4. 14 requiring a seller who failed to deliver to make certain payments to buyer.77 for instance, it is held in [icc march 1999 international court of arbitration, case 9978]:78 “art. 81(1) cisg provides that avoidance does not affect the validity of any contract provision governing the rights and duties of the parties consequent upon the avoidance of the contract. it is generally agreed (emphasis added) that this rule also applies to p/ld [penalty/liquidated damages]-clauses (citations omitted).” it is also noted in [austria 29 june 1999 oberster gerichtshof [supreme court]], art. 81(1) preserves other contractual provisions connected with the undoing of the contract, such as clauses requiring the return of delivered goods or other items received under the contract.79 indeed, the second category of clauses is “a description of general features;” what is referred to here is “not only those rights and obligations which are ancillary to an avoidance of the contract, like a respective penalty, but such which are to help solve a conflict between the parties (citation omitted) and which, of course, are of special importance when that conflict aggravates so that the contract is terminated early.”80 generally speaking, whether or not a clause qualifies under the prerequisites, is a question of contractual interpretation on a case-by-case basis.81 in sum, notwithstanding the general rule that termination of the contract releases both parties from their duty to effect and to receive performance, there may be provisions in the contract which survive its termination. this is the case in particular with provisions relating to dispute settlement but there may be others which by their very nature are intended to operate even after termination.82 one should note, however, that the rule does not remedy deficiencies which lead to non-validity of such a clause under national law, including that based on other conventions.83 that is to say, the rule preserving certain clauses, would not make valid an arbitration clause, a penalty clause, or other provision in respect of the settlement of disputes if such a clause was not otherwise valid under the applicable national law. the rule states only that such a provision is not terminated by the avoidance of the contract.84 nordic journal of commercial law issue 2005 #1 85 comment 6 of secretariat commentary on art. 66 of the 1978 draft [draft counterpart of cisg article 81]; supra. n. 4. 86 see fritz enderlein & dietrich maskow, supra. n. 34; p. 342. 87 see florian mohs; supra. n. 14. 88 uncitral digest 4 on cisg art. 81; supra. n. 5. 89 see fritz enderlein & dietrich maskow, supra. n. 34; p. 341. 90 comment 7 of secretariat commentary on art. 66 of the 1978 draft [draft counterpart of cisg article 81]; supra. n. 4. 91 uncitral digest 5 on cisg art. 81; supra. n. 5. 15 4.4 other obligations surviving it is particularly noted in the secretariat commentary, the enumeration in art. 81(1) of two particular obligations arising out of the existence of the contract which are not terminated by the avoidance of the contract is not exhaustive. some continuing obligations are set forth in other provisions of this convention. for example, art. 86(1) provides that “if the buyer has received the goods and intends to reject them, he must take such steps to preserve them as are reasonable in the circumstances”; and art. 81(2) permits either party to require of the other party the return of whatever he has supplied or paid under the contract. other continuing obligations may be found in the contract itself or may arise out of the necessities of justice.85 according to enderlein & maskow, however, the secretariat's commentary’s declaring nonexhaustive the two named conditions which continue in existence, is not convincing because the second condition actually is a description of general features.86 it is here recalled, that in comparing the cisg approach and the unidroit principles approach, mohs notes, the structure of art. 7.3.5 shows that the obligations which continue to exist are exhaustively (emphasis added) identified by paras. (2) and (3) of art. 7.3.5 unidroit principles.87 whether or not structured in an exhaustive or non-exhaustive manner, the relevant rules clearly indicate that an avoided contract “is not entirely annulled by the avoidance,” and certain contractual obligations remain viable even after avoidance.88 on the other hand, under the convention, the obligations which characterize the contract as a sales contract and which are stipulated in arts. 30 and 53 end or have to be returned in goods or in price.89 this pertains to the restitution of the past and will be discussed below. 5. restitution of the past 5.1 restitution in general (a) cisg art. 81(2) it will often be the case that at the time the contract is avoided, one or both of the parties will have performed all or part of his obligations. sometimes the parties can agree on a formula for adjusting the price to the deliveries already made. however, it may also occur that one or both parties desires the return of that which he has already supplied or paid under the contract.90 thus, for parties that have wholly or partially performed their contractual obligations, the first sentence of art. 81(2) creates a right to claim restitution from the other side of whatever the party has “supplied or paid under the contract.”91 according to the secretariat commentary, this nordic journal of commercial law issue 2005 #1 92 comment 9 of secretariat commentary on art. 66 of the 1978 draft [draft counterpart of cisg article 81]; supra. n. 4. 93 uncitral digest 8 on cisg art. 81; supra. n. 5. 94 see judgment by china international economic and trade arbitration commission [cietac] (prc), china 30 october 1991; no.: cisg/1991/04: 19 journal of law & commerce (2000) 283-293. english translation by yu weizhong and frank n. fisanich; available at: <http://www.cisg.law.pace.edu/cases/911030c1.html>. 95 see judgment by landgericht [district court] landshut, germany 5 april 1995; no.: 54 o 644/94. english translation by dr. peter feuerstein, translation edited by ruth m. janal; available at: <http://www.cisg.law.pace.edu/cases/950405g1.html>. 96 see judgment by federal court, south australian district, adelaide, australia 28 april 1995; no.: sg 3076 of 1993; fed no. 275/95; available at: <http://www.cisg.law.pace.edu/cases/950428a2.html>. 97 see denis tallon, supra. n. 2; p. 605. 98 see fritz enderlein & dietrich maskow, supra. n. 34; p. 343. 99 comment 10 of secretariat commentary on art. 66 of the 1978 draft [draft counterpart of cisg article 81]; supra. n. 4. 16 provision differs from the rule in some countries that only the party who is authorized to avoid the contract can make demand for restitution. instead, it incorporates the idea that, as regards restitution, the avoidance of the contract undermines the basis on which either party can retain that which he has received from the other party.92 on the other hand,the second sentence of art. 81(2) emphasizes that, where both parties are required under the first sentence of the provision to make restitution (i.e., where both parties have “supplied or paid” something under an avoided contract), then mutual restitution is to be made “concurrently.”93 consistent with the principle of mutual restitution, the tribunal in [china 30 october 1991 cietac arbitration award] has ordered simultaneous restitution of the goods by an avoiding buyer and restitution of the price by a breaching seller;94 the court in [germany 5 april 1995 landgericht [district court] landshut] holds, where the prerequisites for a declaration of avoidance are satisfied, under cisg art. 81(2) second sentence, the parties must make restitution concurrently.95 thus, it is held in [australia 28 april 1995 federal district court, adelaide (roder v. rosedown)], an avoiding seller need not make restitution of the buyer’s payments until delivered goods were returned.96 in this context, in a bilateral contract, avoidance constitutes the reverse of performance.97 apart from the mutual restitution rule, it is “a condition for the claim to return what has been supplied or paid that the right to such return is asserted. this is justified because the parties may wish to leave what has been supplied or paid, respectively, with the other party.”98 thus, the restitution is not available where the other party has not asserted the right to such return. furthermore, one should also note that the right of either party to require restitution as recognized by cisg art. 81(2),99 “may be thwarted by other rules which fall outside the scope of the international sale of goods. if either party is in bankruptcy or other insolvency procedures, it is possible that the claim of restitution will not be recognized as creating a right in the property or as giving a priority in the distribution of the assets. exchange control laws or other restrictions on the transfer of goods or funds may prevent the transfer of the goods or money to the demanding party in a foreign country. these and other similar legal rules may reduce the value of the claim of restitution. however, they do not affect the validity of the rights between the parties.” nordic journal of commercial law issue 2005 #1 100 uncitral digest 5 on cisg art. 81; supra. n. 5. 101 see judgment by landgericht [district court] düsseldorf, germany 11 october 1995; no. 2 o 506/94. english translation by dr. peter feuerstein, translation edited by ruth m. janal; available at: <http://www.cisg.law.pace.edu/cases/951011g1.html>. 102 see judgment by handelsgericht [commercial court] st. gallen, switzerland 3 december 2002; supra. n. 28. 103 see judgment by landgericht [district court] düsseldorf, germany 11 october 1995; supra. n. 101. 104 see judgment of icc arbitration case no. 9978 of march 1999; supra. n. 58. 105 uncitral digest 5 on cisg art. 81; supra. n. 5. 106 see judgment by oberster gerichtshof [supreme court], austria 29 june 1999; supra. n. 10. 17 of most significance, it has been almost universally recognized that avoidance of the contract is a precondition for claiming restitution under art. 81(2).100 thus, for instance, it is held in [germany 11 october 1995 landgericht [district court] düsseldorf]:101 “an obligation of the [seller] for the repayment of the purchase price exists under art. 81(2) cisg only after an avoidance of the sales contract by the buyer, the preconditions of which [avoidance] are regulated by art. 49 cisg [for seller’s right to avoidance, by cisg art. 64].” moreover, even in cases where such substantial preconditions of avoidance specified under cisg art. 49/64 are satisfied, it is to be kept in mind, that it is only where the party’s declaration of avoidance was validly expressed according to art. 26 by sending a notice to the other party, that the avoiding party is consequently entitled to restitution of the performance already tendered according to cisg art. 81(2) sentence one. in any event, once the avoiding party’s declaration validly causes the termination of his contract pursuant to the system of the cisg, this contract will be altered into “a relationship for restitution.”102 in this regard, it is held in [germany 11 october 1995 landgericht [district court] düsseldorf]:103 “an obligation of the [seller] for the repayment of the purchase price exists under art. 81(2) cisg only after an avoidance of the sales contract by the buyer, the preconditions of which [avoidance] are regulated by art. 49 cisg. the avoidance of the contract is thus a constitutive right (emphasis added) of the buyer, which changes the contractual relationship into a restitutional [winding-up] relationship (arts. 81-84 cisg).” among other things, “the true nature of the restitution system established in art. 81 et seq. cisg” should not be misinterpreted; according to the court in [icc march 1999 international court of arbitration, case 9978]:104 “this system does not establish a condictio indebiti in the proper sense. for this reason, a reference to the rules of unjust enrichment of the applicable domestic law is neither necessary nor permissible (citation omitted). rather, the system is based on the roman law model of actio quanti minoris (citation omitted).” put another way, the restitutionary obligation imposed by art. 81(2) is not intended to put the other party in the position it would have been in had the contract been fully performed or had not been concluded, but instead requires the restitution of the actual goods delivered, even if those goods are damaged during that return.105 this is the ruling found in [austria 29 june 1999 oberster gerichtshof [supreme court]]:106 nordic journal of commercial law issue 2005 #1 107 see judgment by handelsgericht [commercial court] st. gallen, switzerland 3 december 2002; supra. n. 28. 108 see comment on art. 7.3.6 unidroit principles: comment 1; available at: http://www.cisg.law.pace.edu/cisg/principles/ uni81,82.html>. 109 see florian mohs; supra. n. 14. 110 comment b on pecl art. 9:305; supra. n. 73. 18 “along with restitution [art. 81(2)], the results of the (partial) performance of the contract must be dislodged, but not through the establishment of a hypothetical goal such as ‘as if the contract had been duly performed’ or ‘as if the contract had never been concluded.’ rather, as in roman law, the claim for the return of the rendered performance (rückforderung) is permitted and thereby tied to the item of performance itself (leistungssache) and to its fate (emphasis added).” in particular, as regards the restitution under the convention, the result should be in conformity with that described by the court in [switzerland 3 december 2002 handelsgericht [commercial court] st. gallen], which states:107 “the aforementioned relationship of restitution is predominantly influenced and governed by the result that both parties will be released from any contractual obligations under their sales contract subject to any due and payable claims for damages (art. 81(1) cisg). in the event that one of the parties has partly or wholly performed his obligations thereunder, this party may claim restitution of his performance (art. 81(2) cisg). […].” (b) unidroit principles art. 7.3.6 under the unidroit principles, art. 7.3.6(1) provides in the first sentence that: “on termination of the contract either party may claim restitution of whatever it has supplied, provided that such party concurrently makes restitution of whatever it has received.” according to the comment, this article provides for “a right for each party to claim the return of whatever it has supplied under the contract provided that it concurrently makes restitution of whatever it has received”; it also applies to: “the situation where the aggrieved party has supplied money in exchange for property, services etc. which it has not received or which are defective. money returned for services or work which have not been performed or for property which has been rejected should be repaid to the party who paid for it and the same principle applies to custody of goods and to rent and leases of property.”108 thus, compared with the cisg, both sets of rules provide for restitution of what has been performed under the contract, art. 81(2) cisg / art. 7.3.6(1) first sentence unidroit principles.109 however, it would be inconvenient to treat a contract which has been terminated as being retrospectively cancelled in the sense that performances received must be returned or restitution made of their value. this is not appropriate where the contract was to be performed over a period of time when there can be termination for the future without undoing what has been achieved already.110 consequently, art. 7.3.6(2) unidroit principles continues, providing that, “if nordic journal of commercial law issue 2005 #1 111 comment 3 on art. 7.3.6 unidroit principles; supra. n. 108. 112 see florian mohs; supra. n. 14. 113 see anna kazimierska, supra. n. 31; p. 147. see also comment 3 of secretariat commentary on art. 66 of the 1978 draft [draft counterpart of cisg article 81]; supra. n. 4. 114 see fritz enderlein & dietrich maskow, supra. n. 34; p. 343. 115 see florian mohs; supra. n. 14. 116 see comment and notes to pecl art. 9:307: comment a; available at: <http://www.cisg.law.pace.edu/cisg/text/peclcomp81.html>. 117 comment c on pecl art. 9:305; supra. n. 73. 118 comment a on pecl art. 9:307; supra. n. 116. 19 performance of the contract has extended over a period of time and the contract is divisible, such restitution can only be claimed for the period after termination has taken effect.” two points are to be stressed regarding this rule: (a) the rule “only applies if the contract is divisible”; (b) in such a case, restitution can “only be claimed in respect of the period after termination.”111 on the other hand, a party can also, contrary to the misleading language of art. 7.3.6(2) unidroit principles, avoid with respect to the (past) defective performance, if failure to deliver a later installment makes the earlier installments useless.112 in such cases, cisg art. 73(3) enables the avoidance of the contract as a whole. indeed, even under cisg, if the contract is partially avoided, the rules governing its effects are also only relevant to that part of the contract, which has been avoided.113 therefore, in the case of a partial avoidance this restitution (under cisg art. 81(2)), naturally, applies only insofar as the performance already made is concerned.114 particularly, restitution will not take place for deliveries already made if the installments are independent according to art. 73 cisg, which, however, does not address the question of avoidance of contracts extending over a period of time in general as under art. 7.3.6(2) unidroit principles, but does address the most relevant situation in international sales law practice, i.e., the contract for delivery of goods by installments. the cisg and the unidroit principles provisions will, however, quite often produce the same or, at least, similar results.115 (c) pecl arts. 9:307 and 9:308 under the pecl, art. 9:305 states the general rule that termination of a contract has no retroactive effect. it does not follow from the fact that the contract has been terminated that the party which has performed can get restitution of what it has supplied.116 however, even though termination is forward looking in the way just explained, “there are situations in which it is appropriate to ‘undo’ what has taken place before termination. thus the aggrieved party may need the right to reject a performance already received if termination means that it is of no value to it; either party may need to recover money already paid to the other party if nothing has been received in return; and either may need to be able to recover other property which has been transferred.”117 therefore, the pecl “give a restitutionary remedy after termination, where one party has conferred a benefit on the other party but has not received the promised counter-performance in exchange. the benefit may consist of money paid (article 9:307), other property which can be returned (article 9:308) or some benefit which cannot be returned, e.g. services or property which has been used up (article 9:309).”118 these points are dealt with in pecl art. 9:306 (“a party which terminates the contract may reject property previously received from the other party if its value to the first party has been fundamentally reduced as a result of the other party's nonnordic journal of commercial law issue 2005 #1 119 see comment on pecl art. 9:306; available at: <http://www.cisg.law.pace.edu/cisg/text/peclcomp81.html>. 120 see francesco g. mazzotta, supra. n. 38. 121 comment b on pecl art. 9:307; supra. n. 116. 122 see francesco g. mazzotta, supra. n. 38. 123 see comment and notes to pecl art. 9:308: comment a; available at: <http://www.cisg.law.pace.edu/cisg/text/peclcomp81.html>. 124 see francesco g. mazzotta, supra. n. 38. 125 see florian mohs; supra. n. 14. 126 comment c on pecl art. 9:307; supra. n. 116. 127 comment d on pecl art. 9:308; supra. n. 123. 20 performance.”) as well. thus art. 9:306 provides “the right to reject the useless property,” where “there is a possibility that the aggrieved party may have received from the other some property which is of no value to it because of the other party's non-performance itself or because it has terminated the contract and will therefore not receive the rest of the performance.”119 of more specific relevance are pecl arts. 9:307 and 9:308, which both “subject the restitution to the instance where one party has conferred a benefit but has not received the promised counterperformance.”120 respectively, under pecl art. 9:307 (“on termination of the contract a party may recover money paid for a performance which it did not receive or which it properly rejected.”), “a party may claim back money which it has paid for a performance which it did not receive. this rule has general application where a party which has prepaid money rightfully rejects performance by the other party or where the latter fails to effect any performance, article 9:301. it applies equally to contracts of sale, contracts for work and labor and contracts of lease.”121 on the other hand, pecl art. 9:308 (“on termination of the contract a party which has supplied property which can be returned and for which it has not received payment or other counterperformance may recover the property.”) introduces “the same principle although it deals with property other than money.”122 pecl art. 9:308, “provides restitution after termination where a party has supplied a performance other than money without receiving the counter-performance, and the performance can be restored. if the contract is terminated it may claim back what it has supplied under the contract.”123 thus, the pecl introduces a set of rules, among others, the principle that restitution of the money paid is subject to the circumstance that the party who paid for a performance did not receive it or it was properly rejected (9:307); and the rule according to which the party who supplied property will be entitled to restitution, where possible, only in absence of payment or counter-performance by the other party (9:308).124 as for partial restitution, it is recalled that under the cisg, partial restitution is allowed expressly in accordance with art. 81, whereas under the unidroit principles, this possibility must be deduced from the text of art. 7.3.6.125 nevertheless, partial restitution is made possible under either the cisg or the unidroit principles. the pecl makes no difference on this point. it is stated in the comment on pecl art. 9:307: “where a contract is to be performed over a period of time, or in installments, and the performance is divisible, the rule applies to payments made in respect of so much of the performance as was not made or has been rejected. […]. if the aggrieved party is entitled to terminate under article 9:302 in respect of a part of a contract, it may recover a payment made in respect of that part.”126 it is also stated that pecl art. 9:308 “applies to contracts which are to be performed in parts. if the aggrieved party is entitled to terminate in respect of a part under article 9:302, it may recover property transferred under that part of the contract.”127 nordic journal of commercial law issue 2005 #1 128 see uncitral digest of case law on the united nations convention on the international sale of goods (8 june 2004), a/cn.9/ser.c/digest/cisg/82: digest 1; available at: <http://www.uncitral.org/english/clout/digest_cisg_e.htm>. 129 uncitral digest 5 on cisg art. 81; supra. n. 5. 130 see john o. honnold, uniform law for international sales under the 1980 united nations convention, 3rd ed., kluwer law international, the hague (1999), p. 509; available at: <http://www.cisg.law.pace.edu/cisg/biblio/ho82.html>. 131 see secretariat commentary on art. 67 of the 1978 draft [draft counterpart of cisg article 82]: comment 2; available at: <http://www.cisg.law.pace.edu/cisg/text/secomm/secomm-82.html>. 132 see peter schlechtriem, supra. n. 30; p. 105. 133 see fritz enderlein & dietrich maskow, supra. n. 34; p. 346. 134 see judgment of icc arbitration case no. 9978 of march 1999; supra. n. 58. 21 5.2 approaches regarding impossible or inappropriate restitution (a) cisg arts. 82 and 83 whereas art. 81(2) gives the parties to an avoided contract a claim for restitution of whatever such party has supplied or paid under the contract, art. 82 deals with the effect of an aggrieved buyer's inability to make restitution of goods substantially in the condition in which they were delivered.1 2 8 under art. 82, a buyer's inability to make restitution of delivered goods “substantially in the condition in which he received them” will, subject to important exceptions, forfeit the buyer's right to avoid the contract (or to require the seller to deliver substitute goods).129 specifically, art. 82(1) embodies a principle, generally accepted in domestic law,130 that the buyer’s right to avoidance is conditioned in the following way: the buyer loses the right to declare the contract avoided or to require the seller to deliver substitute goods if it is impossible for him to make restitution of the goods substantially in the condition in which he received them. according to the secretariat commentary, this rule recognizes that “the natural consequences of the avoidance of the contract […] is the restitution of that which has already been delivered under the contract. therefore, if the buyer cannot return the goods, or cannot return them substantially in the condition in which he received them, he loses his right to declare the contract avoided” under cisg art. 49.131 thus, the ability to return the goods is “a prerequisite for avoiding a contract,” and if the aggrieved buyer cannot return the goods, he is barred from avoiding the contract.132 in respect of this forfeit, it is to be noted that art. 81(2) relates merely to the right of the buyer to avoid the contract.133 it is pertinently held in [icc march 1999 international court of arbitration, case 9978]:134 “while the buyer's right to avoid the contract and claim restitution may be foreclosed if he is unable to restitute the goods received by him in an unimpaired condition (art. 82 cisg), a similar rule does not exist with respect to the purchase price received by the seller. the restitution system is based on the notion that monies received by the seller from the buyer can always be restituted. this is why art. 84(1) cisg imposes an automatic duty upon the seller to pay interest on the purchase price. this duty is automatic because it is assumed that the seller has benefited from being in possession of the purchase price since the moment of payment to him (citation omitted).” nordic journal of commercial law issue 2005 #1 135 see fritz enderlein & dietrich maskow, supra. n. 34; p. 346. 136 see john o. honnold, supra. n. 130; p. 510. 137 see fritz enderlein & dietrich maskow, supra. n. 34; p. 346. 138 see peter schlechtriem, supra. n. 30; p. 106. 139 comment 3 of secretariat commentary on art. 67 of the 1978 draft [draft counterpart of cisg article 82]; supra. n. 131. 140 uncitral digest 1 on cisg art. 82; supra. n. 128. 141 see francesco g. mazzotta in “commentary on cisg article 82 and pecl article 9:309” (2003). available online at <http://cisgw3.law.pace.edu/cisg/text/peclcomp82.html>. schlechtriem notes in respect of this exception as specified in cisg art. 82(2)(a): “therefore, where defects have caused the damage or loss, the buyer's right to demand substitute goods or to avoid the contract is not affected. additionally, the fact that a defect causes further deterioration of an item, thus leading to its (further) impairment or complete destruction is not attributable to the buyer's behavior as long as he could not have recognized and prevented it. in any case, under article 82(2)(a), the buyer is presumably responsible for the acts or omissions of his personnel. on the other hand, in my opinion, the acts of third persons can only be attributed to the buyer if his act or -especially – his omission has made it possible for the third persons to affect the goods. these questions do not turn on whether the buyer was at fault. on 22 in any event, from the provision of art. 82(1), it follows that the buyer’s right to avoid the contract lapses when the goods can no longer be restituted.135 actually speaking, this restriction does not lead to serious injustice to an aggrieved buyer: even if the buyer may not avoid the contract or require the seller to deliver substitute goods the buyer may recover damages resulting from the seller’s breach of contract (arts. 74-76).136 indeed, there are so many important exceptions to this principle that the principle itself should constitute an exception.137 above all, it is to be made clear, that loss or damage to the goods “does not in all cases eliminate the right to avoid the contract”; according to art. 82(1), “insubstantial damage is irrelevant.”138 it is clearly stated in the secretariat commentary:139 “it is not necessary that the goods be in the identical condition in which they were received; they need be only in ‘substantially’ the same condition. although the term ‘substantially’ is not defined, it indicates that the change in condition of the goods must be of sufficient importance that it would no longer be proper to require the seller to retake the goods as the equivalent of that which he had delivered to the buyer even though the seller had been in fundamental breach of the contract.” further, art. 82(2) “creates three very broad exceptions to the rule of article 82(1)”:140 (a) if the impossibility of making restitution of the goods or of making restitution of the goods substantially in the condition in which the buyer received them is not due to his act or omission; (b) if the goods or part of the goods have perished or deteriorated as a result of the examination provided for in article 38; or (c) if the goods or part of the goods have been sold in the normal course of business or have been consumed or transformed by the buyer in the course of normal use before he discovered or ought to have discovered the lack of conformity. in respect of the above three exceptions, while the construction of arts. 82(2)(b) and 82(2)(c) is rather straightforward, some explanation is required as to art. 82(2)(a). it is generally understood that under art. 82(2)(a), the buyer is responsible for damages caused by acts or omissions by his personnel and by third persons, if he made it possible, by means of acts or omissions, for them to damage the goods. in particular, as to damages provoked by third persons, it is deemed that “that the buyer must not merely have provided the opportunity for third persons or force majeure to affect the goods, but also have increased this chance by his act or omission.”141 nordic journal of commercial law issue 2005 #1 the other hand, more than mere physical causation is probably required before the buyer's remedies are lost. otherwise, destruction caused by an accident or force majeure could be attributed to the buyer – e.g., his taking possession unless the goods would have been destroyed while under the seller's control as well. the words ‘due to’, however, permit the restrictive interpretation that the buyer must not merely have provided the opportunity for third persons or force majeure to affect the goods but also have increased this chance by his act or omission.” (see peter schlechtriem, supra. n. 30; p. 106.) 142 see john o. honnold, supra. n. 130; p. 509. 143 see denis tallon in commentary on the international sales law: the 1980 vienna sale convention, cesare massimo bianca & michael joachim bonell eds., milan (1987), p. 609; available at: <http://www.cisg.law.pace.edu/cisg/biblio/tallon-bb82.html>. 144 see francesco g. mazzotta, supra. n. 38. 145 see judgment by oberster gerichtshof [supreme court], austria 29 june 1999; supra. n. 10. 146 see secretariat commentary on art. 68 of the 1978 draft [draft counterpart of cisg article 83]; available at: <http://www.cisg.law.pace.edu/cisg/text/secomm/secomm-83.html>. if the contract contains a penalty clause, the statement buyer “retains all other remedies under the contract” also makes it clear that the buyer has the right to avail himself of the remedy provided in that clause (to the extent permitted by the gap filling law), even though the buyer has lost the right to declare the contract avoided. (see also fritz enderlein & dietrich maskow; supra. n. 34; p. 348.) 147 see john o. honnold, uniform law for international sales under the 1980 united nations convention, 3rd ed., kluwer law international, the hague (1999), p. 513; available at: <http://www.cisg.law.pace.edu/cisg/biblio/ho83.html>. 148 see denis tallon in commentary on the international sales law: the 1980 vienna sale convention, cesare massimo bianca & michael joachim bonell eds., milan (1987), p. 610; available at: <http://www.cisg.law.pace.edu/cisg/biblio/tallon-bb83.html>. 149 see florian mohs; supra. n. 14. 150 comment 1 on art. 7.3.6 unidroit principles; supra. n. 108. 151 comment 2 on art. 7.3.6 unidroit principles; supra. n. 108. 23 since, particularly art. 81(2) states “three exceptions that make deep inroads on this general rule,”142 the principle contemplated in art. 81(1) is “finally of minor interest.”143 thus, while, on the one hand, by art. 81(1) “the convention clearly requires that whatever is exchanged between the parties because of the contract must be returned, and if this is not possible, subject to the exceptions considered by cisg article 82, avoidance of the contract is no longer an option”;144 on the other hand, according to art. 82(2), “the principle of returning the goods undamaged as a prerequisite to exercising the right of avoidance suffers considerable restrictions which turn the principle into an exception (citation omitted).”145 moreover, art. 83 expressly states that the buyer who has lost the right to declare the contract avoided in accordance with art. 82 retains “all other remedies under the contract and this convention,” which includes, for instance, the right “to claim damages” under art. 45(1)(b), “to require that any defects be cured” under art. 46, or “to declare the reduction of the price” under art. 50.146 art. 83, although perhaps unnecessarily,147 will thus alleviate the scruples of judges who, owing to their national tradition, are disinclined to draw all the consequences implicit in the texts of the articles of the convention.148 (b) unidroit principles art. 7.3.6(1), second sentence in a comparison of the rules on restitution of both the cisg and the unidroit principles, one discovers that “they do not correspond on the legal mechanism to apply in situations where it is impossible for the avoiding party to return what it had received under the contract: the cisg generally bars the aggrieved party from avoiding the contract whereas the unidroit principles grants the other party an allowance in money.”149 in this respect, the second sentence of unidroit principles art. 7.3.6(1) states: “if restitution in kind is not possible or appropriate allowance should be made in money whenever reasonable.” thus, if the non-performing party cannot make restitution it must make allowance in money for the value it has received.150 the considerations seem to be:151 nordic journal of commercial law issue 2005 #1 152 note 6 to pecl art. 9:309; supra. n. 12. 153 see peter schlechtriem, in “some observations on the united nations convention on contracts for the international sale of goods”: the frontiers of liability, vol. 2 (peter birks ed. 1994). 154 see florian mohs; supra. n. 14. 155 ibid. it is nevertheless noted that, “the cisg provisions must be applied de lege lata and thus cannot be overruled by means of interpretation using a totally different concept, such as that of the unidroit principles. even in situations governed, but not expressly settled by the cisg, the principles of the convention and not the principles of the unidroit principles are to be used to fill any gaps.” (ibid.) 156 see francesco g. mazzotta, supra. n. 38. 24 “there are instances where instead of restitution in kind, allowance in money should be made. this is the case first of all where restitution in kind is not possible. […]. allowance in money is further envisaged by para. (1) of this article whenever restitution in kind would not be ‘appropriate’. this is so in particular when the aggrieved party has received part of the performance and wants to retain that part.” under some systems, a party who has received property may not be permitted to terminate the contract either as a whole, where it was for a single performance, or, where it was by installments, in relation to the part already received, if he cannot return what he has received, for instance because he has consumed or resold it. generally, this rule applies where the inability to restore is attributable to the acts of the party who received the goods.152 as indicated above, art. 82 follows this approach, albeit it is subjected to certain exceptions. on the other hand, however, there are good reasons to advocate an entirely different solution for the problem of restitution or inability of the avoiding party to restitute, namely, treating this as a problem of responsibility of the parties for performance of their obligation to restitute and not as one of a bar to avoidance.153 it is the approach of the unidroit principles, which differs in this respect from the cisg:154 “the main difference in concept is that, according to art. 82(1) cisg, the convention, in principle, bars the buyer from avoiding the contract if he cannot make restitution of the goods whereas the unidroit principles treat this situation as a question of liability, art. 7.3.6(1) second sentence unidroit principles.” (c) pecl arts. 9:306 and 9:309 as indicated above, unlike cisg art. 82, inability to restore is not a bar to termination under the unidroit principles. in a comparison of the rules on restitution of both the cisg and the unidroit principles, it has been said that the cisg approach is based on a roman law principle and was already antiquated at the time the convention had been drafted. the unidroit principles approach is modern and, more importantly, sensible and has thus been implemented into the pecl and into various domestic laws of contract by reform statutes.155 the general approach adopted in the pecl is that, upon termination of a contract, both parties are released from their duties to effect and to receive performance (pecl art. 9:305). a restitution duty, which does not affect the right to terminate the contract, may arise only where one party has conferred a benefit on the other party without receiving the promised counterperformance in exchange.156 however, in many contracts a literal restoration is not possible. this applies to work and labor, services, the hiring out of goods, the letting of premises, and the nordic journal of commercial law issue 2005 #1 157 comment h on pecl art. 9:308; supra. n. 123. 158 comment a on pecl art. 9:307; supra. n. 116. 159 see francesco g. mazzotta, supra. n. 141. 160 comment b on pecl art. 9:309; supra. n. 12. 161 comment 2 on art. 7.3.6 unidroit principles; supra. n. 108. 25 carriage and custody of goods. a party which has received a performance of this kind cannot give it back. on the other hand, the aggrieved party cannot claim back the goods or other tangibles when it has become impossible or would involve the defaulting party in an unreasonable effort or expense.157 particularly, in contracts for sale or barter, restoration may become impossible when the goods have perished or have been consumed or resold. in all these situations, the party which has received a performance which it cannot return might restore the value of it and various legal systems provide for such a restitution.158 thus, pecl art. 9:309 provides that: “on termination of the contract a party which has rendered a performance which cannot be returned and for which it has not received payment or other counter-performance may recover a reasonable amount for the value of the performance to the other party.” according to pecl art. 9:309, recovery for performance that cannot be returned, is subject to the following requirements:159 “(i) that there is a termination of the contract; (ii) that a party has rendered performance and has not received payment or counter-performance for it; and (iii) that performance cannot be returned by the other party.” if these requirements are met, the entitled party may recover a reasonable amount for the value of the performance rendered to the other party. among other things, pecl art. 9:309 sets the rules on how to calculate the amount of recovery, i.e., a reasonable amount. specifically, the pecl comment states:160 “the party which has received the benefit should not be required to pay the cost to the other of having provided it, if the net benefit to it is less, since it is only enriched by the latter amount. […]. occasionally it may happen that the net benefit to the recipient is greater than the cost of providing it. then the recipient should not be liable under this article for more than an appropriate part of the contract price.” here the unidroit principles should be recalled, where it is stated:161 “the purpose of specifying that allowance should be made in money ‘whenever reasonable’ is to make it clear that allowance should only be made if, and to the extent that, the performance received has conferred a benefit on the party claiming restitution.” in any event, it frequently happens that after a contract has been terminated one party is left with a benefit which cannot be returned – either because the benefit is the result of work which cannot be returned, or because property which has been transferred has been used up or destroyed – but for which it has not paid. the other party may have a claim for the price, but this will depend upon the agreed payment terms and the price may not yet be payable. it may have a claim for damages, but the party which has received the benefit may be the aggrieved party, or, though it is the one which has failed to perform, it may not be liable for damages because its non-performance nordic journal of commercial law issue 2005 #1 162 comment a on pecl art. 9:309; supra. n. 12. 163 comment on pecl art. 9:306; supra. n. 119. 164 see francesco g. mazzotta, supra. n. 38. 165 comment on pecl art. 9:306; supra. n. 119. 166 see francesco g. mazzotta, supra. n. 38. 167 see francesco g. mazzotta, supra. n. 141. 26 was excused. it would be unjust to allow it to retain this benefit without paying for it, and pecl art. 9:309 requires it to pay.162 in certain other circumstances, under many different types of contract there is a possibility that the aggrieved party may have received from the other some property which is of no value to it because of the other party's non-performance itself or because it has terminated the contract and will therefore not receive the rest of the performance.163 in such cases, it should have the right to reject the useless property and pecl art. 9:306, which “clearly is not compatible with the cisg set of rules,”164 so provides, which states that: “a party which terminates the contract may reject property previously received from the other party if its value to the first party has been fundamentally reduced as a result of the other party's non-performance.” also, in such cases the aggrieved party could in the alternative claim damages or reduction in price for the reduced value that the property received now has to it. however, it will often be more convenient for it simply to return the unwanted property than to have to dispose of it some other way and, since it is by definition the aggrieved party, it seems appropriate to give it the right to reject. there will be a considerable advantage in rejecting the property if the aggrieved party has not yet paid for it, as the party can thus avoid having to pay even a reduced price.165 as either pecl art. 9:309 or art. 9:306 indicates, the difference between the cisg and the pecl is clear: “while the cisg tends to eliminate the consequences of an already partially performed contract, the pecl tends to maintain the exchange when it is satisfactory for both parties.”166 in a comparison of the restitution between the cisg and the pecl, it is stated:167 “the two sets of rules contained in the respective regimes of the sales convention and the principles of european contract law are quite different. cisg article 82 deals exclusively with whether avoidance is still possible even when goods cannot be returned. as a general rule in the convention, avoidance of the contract is not possible, unless one of the exceptions listed in cisg article 82(2) occurs. […]. pursuant to cisg, if the buyer cannot make restitution for what he received, the contract cannot be avoided unless one of the exceptions set by cisg article 82(2) is met. the pecl do not require any restitution as a condition for avoidance. therefore, while under the cisg restitution is an obligatory step toward the avoidance of a contract, under the pecl restitution is only a possible consequence of the avoidance of a contract. in fact, a restitution remedy arises only where there was a performance for which payment was not made.” nevertheless, it is recalled that in a comparison of the rules on restitution of both the cisg and the unidroit principles (which seems to indicate the relationship between the cisg and the pecl), one argues, “due to the wide range of exceptions to the bar of avoidance under art. 82(2)(a) to (c) cisg and the objective equalization of benefits according to art. 84(2) cisg, restitution under the two set of rules will quite often produce the same or, at least, a similar result. nordic journal of commercial law issue 2005 #1 168 see florian mohs; supra. n. 14. 169 uncitral digest 5 on cisg art. 81; supra. n. 5. 170 see secretariat commentary on art. 69 of the 1978 draft [draft counterpart of cisg article 84]: comment 1; available at: <http://www.cisg.law.pace.edu/cisg/text/secomm/secomm-84.html>. under this article, where the seller is under an obligation to refund the price, he must pay interest from the date of payment to the date of refund (cisg art. 84(1). however, where the buyer must return the goods, it is less obvious that he has benefited from having had possession of the goods. therefore, cisg art. 84(2) specifies that the buyer is liable to the seller for all benefits which he has derived from the goods only if (1) he is under an obligation to return them or (2) it is impossible for him to make restitution of the goods or part of them but he has nevertheless exercised his right to declare the contract avoided or to require the seller to deliver substitute goods. (ibid.; comment 3.) 171 see francesco g. mazzotta, supra. n. 38. 172 see florian mohs; supra. n. 14. 173 comment h on pecl art. 9:308; supra. n. 123. it is additionally noted in the unidroit principles comment that: “both the rule in art. 7.1.3 on the right to withhold performance and art. 7.2.2 on specific performance of non-monetary obligations apply with appropriate adaptations to a claim for the restitution of property. thus the aggrieved party cannot claim the return of goods when this has become impossible or would put the non-performing party to unreasonable effort or expense (see art. 7.2.2 (a) and (b)). in such cases the non-performing party must make allowance for the value of the property. see art. 7.3.6(1).” (comment 4 on art. 7.3.6 unidroit principles; supra. n. 108.) 27 furthermore, one should give broad application to the exceptions of para. (2) and thereby limit the bar of art. 82(1) cisg.”168 of particular significance is cisg art. 84. under art. 84(2), a buyer who must make restitution of goods to a seller must also “account to the seller” for all benefits it derived from the goods before making such restitution; similarly, a seller who must refund the price to the buyer must also, under art. 84(1), pay interest on the funds until they are restored, although it has been held that, beyond such right to interest, a seller is not liable in damages for losses caused when it refused to give restitution of the price to the buyer.169 this article 84 thus reflects “the principle that a party who is required to refund the price or return the goods because the contract has been avoided […] must account for any benefit which he has received by virtue of having had possession of the money or goods.”170 (d) a summary in sum, both the pecl and the unidroit principles introduce “the idea that there are circumstances in which it might be inappropriate to make the restitution”; such an idea is not shared with the cisg, however.171 specifically speaking, “they do not correspond on the legal mechanism to apply in situations where it is impossible for the avoiding party to return what it had received under the contract: the cisg generally bars the aggrieved party from avoiding the contract whereas the unidroit principles [or the pecl] grants the other party allowance in money.”172 alternatively, in cases where restitution is impossible or too onerous, it is said that the rules on right to performance (pecl arts. 9:101 to 9:103) “apply mutatis mutandis to the claim for restitution.” in any event, the aggrieved party cannot claim back the goods or other tangibles when it has become impossible or would involve the defaulting party in an unreasonable effort or expense.173 nordic journal of commercial law issue 2005 #1 174 see florian mohs; supra. n. 14. 175 see fritz enderlein & dietrich maskow; supra. n. 34; p. 344. 176 see francesco g. mazzotta, supra. n. 38. 177 see florian mohs; supra. n. 14. 178 comment 11 of secretariat commentary on art. 66 of the 1978 draft [draft counterpart of cisg article 81]; supra. n. 4. 179 see anna kazimierska, supra. n. 31; p. 147. 28 5.3 problems concerning the restitution as a whole, as indicated by the above discussions, the rules on restitution of both the cisg and the unidroit principles (or the pecl), “correspond with regard to the fact that restitution takes place on avoidance or termination of the contract, respectively, to the fact that partial restitution is possible, on the question of what contractual provisions survive avoidance of the contract, and that, if both parties had already received performance, restitution must be made concurrently.”174 as convincing as this rule may sound,175 it is not superfluous to mention that neither the convention nor the pecl (or the unidroit principles) has any specific provisions dealing with: (i) the expenses incurred in making restitution; (ii) the rights acquired by third parties; (iii) the location where the restitution must be made and (iv) the buyer's responsibility when the goods that must be returned are destroyed after the effective date of a declaration of avoidance.176 (a) question (i): expenses incurred in making restitution among these questions, it is believed question (i) may be settled exhaustively by, for instance, the cisg itself. firstly, with respect to compensation for loss of use, art. 84 cisg applies, which grants the seller a claim for all benefits which the buyer derived from the goods. secondly, although the convention does not expressly address the issue of compensation for expenditure, general principles of the convention can be used to fill this internal gap in accordance with art. 7(2) cisg by way of a damages claim.177 this is supported in the secretariat commentary, which states:178 “the person who has breached the contract giving rise to the avoidance of the contract is liable not only for his own expenses in carrying out the restitution of the goods or money, but also the expenses of the other party. such expenses would constitute damages for which the party in breach is liable. however, the obligation under article 73 [draft counterpart of cisg article 77] of the party who relies on the breach of the contract to ‘take such measures as are reasonable in the circumstances to mitigate the loss’ may limit the expenses of restitution which can be recovered by means of damages if physical return of the goods is required rather than, for example, resale of the goods in a local market where such resale would adequately protect the seller at a lower net cost.” in a word, “the non-performing party may be required by the other party to cover all costs incurred to return that which has been supplied or paid. this rule, although not provided in the convention, is acknowledged by the doctrine.”179 nordic journal of commercial law issue 2005 #1 180 uncitral digest 9 on cisg art. 81; supra. n. 5. 181 see peter schlechtriem, supra. n. 30; p. 107. several decisions have dealt with this conflict. for instance, in [28 march 2002 u.s. district court [illinois] (usinor industeel v. leeco steel products)], a court found that an avoiding seller’s restitutionary rights under article 81(2) were trumped by the rights of one of buyer’s creditors that had obtained and perfected, under national law, a security interest in the delivered goods: the court ruled that the question of who had priority rights in the goods as between the seller and the third party creditor was, under cisg article 4, beyond the scope of the convention and was governed instead by applicable national law, under which the third party creditor prevailed. this was the result even though the sales contract included a clause reserving title to the goods in the seller until the buyer had completed payment (which buyer had not done), because the effect of that clause with respect to a non-party to the sales contract was also governed by national law rather than the cisg, and under the applicable law the third party’s claim to the goods had priority over seller’s. another court, in contrast, found in [australia 28 april 1995 federal district court, adelaide (roder v. rosedown)] that an avoiding seller could recover goods from a buyer that had gone through insolvency proceedings after the goods were delivered. in this case, however, the seller had a retention of title clause that was valid under applicable national law and that had survived the buyer’s now-completed insolvency proceedings, and there apparently was no third party with a claim to the goods that was superior to seller’s under national law. thus the two cases described in this section do not appear to be inconsistent. indeed, the later case cited the earlier case in support of its analysis. 182 comment 5 on art. 7.3.6 unidroit principles; supra. n. 108. 183 comment b on pecl art. 9:308; supra. n. 123. 29 (b) question (ii): rights acquired by third parties as for question (ii), various outcomes seem to follow in accordance with the applicable national law. for instance, under the convention, an avoiding seller’s right to restitution of delivered goods under art. 81(2) can come into conflict with the rights of third parties (e.g., the buyer’s other creditors) in the goods. such conflicts are particularly acute where the buyer has become insolvent, so that recovery of the goods themselves is more attractive than a monetary remedy (such as a right to collect the price or damages) against the buyer.180 in substance, however, the convention governs “only […] the rights and obligations of the seller and the buyer arising from such a contract.” thus, question (ii) is beyond the scope of the convention; whether the buyer's restitution obligations to the seller can prevail over claims of his other creditors are matters to be decided by domestic law, which also governs the details of the transfer in restitution.181 the cisg approach is basically followed by unidroit principles art. 7.3.6:182 “in common with other articles of the principles, art. 7.3.6 deals with the relationship between the parties and not with any rights which third persons may have acquired on the goods concerned. whether, for instance, an obligee of the buyer, the buyer's receivers in bankruptcy, or a purchaser in good faith may oppose the restitution of goods sold is to be determined by the applicable national law.” the pecl makes no difference in this respect:183 “like other principles article 9:308 deals exclusively with the relationship between the parties and not with the effect which the contract may have on the property in goods sold or bartered. whether a creditor of the buyer, the buyer's receivers in bankruptcy, or a bona fide nordic journal of commercial law issue 2005 #1 184 uncitral digest 7 on cisg art. 81; supra. n. 5. 185 see judgment by landgericht [district court] landshut, germany 5 april 1995; supra. n. 95. 1 8 6 s e e c l o u t a b s t r a c t n o . 3 1 2 [ c o u r d ’ a p p e l p a r i s f r a n c e 1 4 j a n u a r y 1 9 9 8 ] ; a v a i l a b l e a t : <http://www.cisg.law.pace.edu/cases/980114f1.html>. 187 see judgment by oberster gerichtshof [supreme court], austria 29 june 1999; supra. n. 10. 188 see peter schlechtriem, supra. n. 30; p. 108. 189 see fritz enderlein & dietrich maskow; supra. n. 34; p. 346. according to them, this is justified because it presupposes a fundamental breach of contract by the seller. where the impossibility is caused by grounds which would have led to the lapsing of the right to avoidance, the implementation of the avoidance of the contract would also be thwarted by it. this also follows from the synallagmatic connection of the obligations involved in restitution. there may be modifications to the disadvantage of the seller when he delays a justified avoidance or does not demand restitution of the goods within a reasonable period. even more 30 purchaser may oppose the restitution of goods sold is to be determined by the applicable national law.” (c) question (iii): location where the restitution must be made related to question (iii), several decisions address the problem of where the obligation to make restitution under cisg art. 81(2) should be performed. this question has arisen either as a direct issue, or as a subsidiary matter related to a court’s jurisdiction or to the question of who bears risk of loss for goods that are in the process of being returned by the buyer.184 for instance, in determining whether an avoiding buyer offered the breaching seller restitution of delivered goods at the proper location, the court in [germany 5 april 1995 landgericht [district court] landshut] has held that the issue of the place for restitution is not expressly settled in the cisg, nor can the cisg provision dealing with the place for seller’s delivery (art. 31) be applied by analogy, so that the matter must be resolved by reference to national law – specifically (in this case), the law governing the enforcement of a judgment ordering such restitution.185 employing somewhat similar reasoning, the court in [france 14 january 1998 cour d'appel [appellate court] paris] holds, the cisg does not expressly settle where a seller must make restitution of the price under art. 81(2), that the cisg provision governing the place for buyer’s payment of the price (art. 57(1)) did not contain a general principle of the convention that can be used to resolve the issue, and thus that the matter must be referred to applicable national law.186 however, in contrast to the reasoning of the foregoing decisions which led to the application of national law to the issue of the place for restitution, the court in [austria 29 june 1999 oberster gerichtshof [supreme court]], notes that the cisg does not expressly deal with the question, but resolves the issue by reference to the cisg itself without recourse to national law: it fills the “gap” pursuant to art. 7(2) by identifying a general principle that the place for performing restitutionary obligations should mirror the place for performing the primary contractual obligations.187 (d) question (iv): buyer’s responsibility when goods destroyed a fourth matter left open is the buyer's responsibility when the goods to be returned are destroyed after the effective date of a declaration of avoidance.188 enderlein & maskow submit in this regard, “basically it should be proceeded analogously to how one would have proceeded before the declaration of avoidance. where the impossibility is caused because of circumstances under [cisg art. 82] paragraph (2) (of which only subpara. (a) is of relevance here), the right to avoid the contract remains in effect on the general conditions.”189 nordic journal of commercial law issue 2005 #1 radical solutions, even though not applicable in the view of enderlein & maskow, are offered by those authors who infer from art. 70 a deferral of the passing of risk or a falling back of the risk on the first party. (see fritz enderlein & dietrich maskow; supra. n. 34; p. 346.) however, this art. 70 is deemed a fourth exception in the secretariat commentary: “a fourth exception to the rule states in article 67(1) [draft counterpart of cisg article 82(1)] is to be found in article 82 [draft counterpart of cisg article 70] which states that if the seller has committed a fundamental breach of contract, the passage of the risk of loss under article 79, 80 or 81 [draft counterpart of cisg article 67, 68 or 69] does not impair the remedies available to the buyer on account of such breach.” (comment 5 of secretariat commentary on art. 67 of the 1978 draft [draft counterpart of cisg article 82]; supra. n. 131.) 190 see judgment by oberlandesgericht [appellate court] münchen; germany 28 january 1998. no. 7 u 3771/97. english t r a n s l a t i o n b y r u t h m . j a n a l , t r a n s l a t i o n e d i t e d b y c a m i l l a b a a s c h a n d e r s e n ; a v a i l a b l e a t : <http://www.cisg.law.pace.edu/cases/980128g1.html>. (that court rules: “contrary to the decision of the court of first instance, the [seller's] claim for restitution of it£ 88,000,000 cannot be based on art. 81(2) cisg. the [seller] does not claim restitution of what he has supplied under the contract, but of the reimbursement made to the [buyer] of her supposed advance payment. the [seller's] claim is justified on account of unjust enrichment. the remedy is the condictio indebiti, as the [seller] intended to perform an obligation under a supposed legal cause, which turned out to be non-existent when the [buyer's] check went to protest. the claim underlies the italian provisions on unjust enrichment, since the condictio indebiti is governed by the law applying to the agreement which the performance was based upon (citations omitted). in the present dispute, a supposed advance payment was to be reimbursed following the cancellation of the sales contract. the law governing the contract is the cisg and, on matters not settled by the convention, italian law, as the [seller's] performance was to characterize the contract (annotation omitted).”) 191 see peter schlechtriem, supra. n. 30; p. 108. 192 uncitral digest 6 on cisg art. 81; supra. n. 5. 193 comment 1 on art. 7.3.6 unidroit principles; supra. n. 108. 194 comment g on pecl art. 9:308; supra. n. 123. 31 in [germany 28 january 1998 oberlandesgericht [appellate court] münchen], however, the court finds that the seller's claim was not governed by cisg art. 81(2) because that provision deals only with what a party has “supplied or paid under the contract,” whereas the seller was seeking reimbursement for a refund made after the contract was cancelled. instead, the court holds, the seller's claim was based on unjust enrichment principles and was governed by applicable national law.190 in any event, the convention does not completely regulate the effects of avoidance;191 not all restitution claims arising out of a terminated sales contract are governed by the cisg.192 nevertheless, it has been clarified that the rule also applies when the aggrieved party has made a bad bargain.193 restitution may be claimed when the aggrieved party has performed all its obligations under the contract and only the other party's obligation to pay the price remains outstanding. it does not matter that the property is worth more than was to be paid for it so that by obtaining restitution the aggrieved party escapes a bad bargain.194 nordic journal of commercial law issue 2009#1 cisg advisory council: opinion no. 8 calculation of damages under cisg articles 75 and 76 by john y. gotunda nordic journal of commercial law issue 2009#1 2 to be cited as cisg-ac opinion no. 8, calculation of damages under cisg articles 75 and 76. rapporteur: professor john y. gotanda, villanova university school of law, villanova, pennsylvania, usa. adopted by the cisg-ac following its 12th meeting in tokyo, japan, on 15 november 2008. reproduction of this opinion is authorized. eric e. bergsten, chair michael joachim bonell, michael g. bridge, alejandro m. garro, roy m. goode, john y. gotanda, sergei n. lebedev, pilar perales viscasillas, ingeborg schwenzer, hiroo sono, claude witz, members sieg eiselen, secretary * * the cisg-ac is a private initiative supported by the institute of international commercial law at pace university school of law and the centre for commercial law studies, queen mary, university of london. the international sales convention advisory council (cisg-ac) is in place to support understanding of the united nations convention on contracts for the international sale of goods (cisg) and the promotion and assistance in the uniform interpretation of the cisg. at its formative meeting in paris in june 2001, prof. peter schlechtriem of freiburg university, germany, was elected chair of the cisg-ac for a three-year term. dr. loukas a. mistelis of the centre for commercial law studies, queen mary, university of london, was elected secretary. the founding members of the cisg-ac were prof. emeritus eric e. bergsten, pace university school of law; prof. michael joachim bonell, university of rome la sapienza; prof. e. allan farnsworth, columbia university school of law; prof. alejandro m. garro, columbia university school of law; prof. sir roy m. goode, oxford, prof. sergei n. lebedev, maritime arbitration commission of the chamber of commerce and industry of the russian federation; prof. jan ramberg, university of stockholm, faculty of law; prof. peter schlechtriem, freiburg university; prof. hiroo sono, faculty of law, hokkaido university; prof. claude witz, université des saarlandes and strasbourg university. members of the council are elected by the council. at subsequent meetings, the cisg-ac elected as additional members prof. pilar perales viscasillas, universidad de la rioja; professor ingeborg schwenzer, university of basel; prof. john y. gotanda, villanova university; and prof. michael g. bridge, london school of economics; prof. jan ramberg served for a three-year term as the second chair of the cisg-ac. at its 11th meeting in wuhan, people's republic of china, prof. eric e. bergsten of pace university school of law was elected chair of the cisg-ac and prof. sieg eiselen of the department of private law of the university of south africa was elected secretary. nordic journal of commercial law issue 2009#1 3 article 75 cisg if the contract is avoided and if, in a reasonable manner and within a reasonable time after avoidance, the buyer has bought goods in replacement or the seller has resold the goods, the party claiming damages may recover the difference between the contract price and the price in the substitute transaction as well as any further damages recoverable under article 74. article 76 cisg (1) if the contract is avoided and there is a current price for the goods, the party claiming damages may, if he has not made a purchase or resale under article 75, recover the difference between the price fixed by the contract and the current price at the time of avoidance as well as any further damages recoverable under article 74. if, however, the party claiming damages has avoided the contract after taking over the goods, the current price at the time of such taking over shall be applied instead of the current price at the time of avoidance. (2) for the purposes of the preceding paragraph, the current price is the price prevailing at the place where delivery of the goods should have been made or, if there is no current price at that place, the price at such other place as serves as a reasonable substitute, making due allowance for differences in the cost of transporting the goods. nordic journal of commercial law issue 2009#1 4 opinion 1.1 articles 75 and 76 set forth ways to calculate damages when a contract has been avoided. 1.2 articles 75 and 76 do not replace article 74. rather, they provide aggrieved parties with alternative methods that may be used to measure damages when a contract has been avoided. 1.3 damages recoverable under articles 75 or 76 should not place the aggrieved party in a better position than it would have enjoyed if the contract had been performed properly. 2.1 under article 75, an aggrieved party is entitled to recover as damages the difference between the contract price and the price of the substitute transaction. 2.2 the contract price is the price fixed in the contract or the price as determined under article 55. 2.3 the price in any substitute transaction may be used to calculate damages under the formula set forth in article 75 only if the aggrieved party made a substitute transaction in a reasonable manner and in a reasonable time. 2.4 in the event that the aggrieved party's substitute transaction was unreasonable, damages may be calculated according to article 76 or article 74. 3 an aggrieved party entitled to damages under article 75 may also recover any further damages under article 74. 4.1 under article 76, an aggrieved party is entitled to recover as damages the difference between the price fixed by the contract and the current price. 4.2 in order for damages to be calculated pursuant to article 76, the contract must fix, expressly or implicitly, a price for the goods. 4.3 the current price is the price generally charged for such goods sold under comparable circumstances in the trade concerned. 4.4 the time at which the current price is to be established is the time of avoidance, which is the moment when avoidance was declared; provided, however, that if the aggrieved party avoids the contract after taking over the goods, then the current price is to be determined at the time of such taking over. 4.5 (a) the location at which the current price is to be established is the place where the delivery of the goods should have been made. (b) if there exists no current price at the place of delivery, the current price is to be established at a reasonable substitute place. 5. if the contract does not fix a price or there is no current price within the meaning of article 76, damages may be calculated under article 74. 6. an aggrieved party entitled to damages under article 76 may also recover any further damages under article 74. nordic journal of commercial law issue 2009#1 5 comments 1.1 articles 75 and 76 set forth ways to calculate damages when a contract has been avoided under the convention, if a party fails to perform its contractual obligations, the aggrieved party has various remedies, including the right to claim damages.1 the principles concerning the calculation of damages are set forth in articles 74 through 76.2 the purpose of these provisions is to place the aggrieved party in the position that it would have been in had the contract been performed.3 to effectuate that purpose, article 74 provides for the recovery of both actual loss suffered and net gains prevented.4 articles 75 and 76 set forth ways that an aggrieved party can measure damages when a contract has been avoided.5 article 75 provides a method for calculating damages if the aggrieved party avoided the contract and entered into a substitute transaction. if the aggrieved party has avoided the contract but has not entered into a substitute transaction, then article 76 permits the abstract calculation of damages under certain conditions. 1.2 articles 75 and 76 do not replace article 74. rather, they provide aggrieved parties with alternative methods that may be used to measure damages when a contract has been avoided in cases where a contract has been avoided, articles 75 and 76 provide alternative methods for calculating damages. however, these provisions are not mandatory in nature; aggrieved parties 1 see cisg arts. 45, 61. while articles 74 through 77 set forth the rules concerning damages, numerous other articles can affect the right to or calculation of damages. see cisg arts. 6, 7, 8, 9, 66, 80, 85, 86, 87, 88. 2 see cisg arts. 74-76. article 77 provides rules for mitigating damages. see cisg art. 77. articles 79 and 80 provide certain exemptions from liability. see cisg arts. 79, 80. 3 see h. stoll & g. gruber in p. schlechtriem & i. schwenzer, commentary on the u.n. convention on the international sale of goods, 2d edition, oxford, new york, 2005, art. 74 2; j. honnold, uniform law for international sales, 3d edition, kluwer, the hague, 1999, § 403 (citing treitel, remedies, 1998, 82). 4 for a discussion of the calculation of damages under article 74, see cisg-ac opinion no. 6, calculation of damages under cisg article 74 (spring 2006). 5 see cisg arts. 75, 76. nordic journal of commercial law issue 2009#1 6 can choose whether to calculate damages pursuant to them.6 thus, articles 75 and 76 do not replace article 74; they supplement and work in connection with it.7 an aggrieved party may find it more advantageous to have damages calculated pursuant to article 75 or 76, as opposed to article 74, because seeking damages under article 74 requires an aggrieved party to prove with a requisite degree of certainty that it suffered a loss and may necessitate that the aggrieved party ”open its books, i.e., ... disclose its internal calculations, its customers and other business connections, etc.”8 by contrast, articles 75 and 76 do not require such disclosures in order to recover damages pursuant to them. 1.3 damages recoverable under articles 75 or 76 should not place the aggrieved party in a better position than it would have enjoyed if the contract had been performed properly damages under articles 75 and 76, like those under article 74, are compensatory in nature and should not provide the aggrieved party with a windfall. accordingly, recovery under these provisions should not place the aggrieved party in a better position than it would have been in had the contract been performed.9 for example, an aggrieved buyer that has avoided a contract and made a cover purchase above the contract price in order to fulfill a standing contract for resale to a third party generally may not claim damages of both the difference between the contract price and the price of the cover purchase as well as profits lost on the subsequent resale.10 6 see p. huber & a. mullis, the cisg -a new textbook for students and practitioners, sellier, münchen, 2007, § 13(vii)(1). 7 articles 75 and 76 also work in conjunction with article 77. for example, although article 75 does not require the aggrieved party to conduct a substitute transaction, failure to do so may breach article 77's obligation to mitigate damages. see art. 77 cisg; see also arbitral award, tribunal of international commercial arbitration at the russian federation chamber of commerce and industry 6 june 2000, cisg-online no. 1249 (pace) (tribunal noting that an aggrieved buyer did not meet its obligation to mitigate damages due to its failure to avoid the contract and engage in a substitute transaction.). recovery under article 76 may also be impacted by article 77, because the obligation to mitigate damages may require that the aggrieved party engage in a substitute transaction if doing so would concretely establish damages that would be less than those calculated abstractly under article 76. see huber & mullis, the cisg § 13(vii)(3)(b). 8 p. schlechtriem, calculation of damages in the event of anticipatory breach under the cisg, 2006, §§ i, iii (available at <http://www.cisg-online.ch/cisg/fs%20hellner.pdf>) (”schlechtriem, calculation of damages”); see also cisg-ac opinion no. 6, calculation of damages under cisg article 74 (spring 2006). 9 see schlechtriem, calculation of damages, op. cit. (stating ”the abstract calculation of damages under the market price rule may initially produce odd results if current prices for the goods are decisive” and that ”windfall profits could be controlled and avoided to a certain extent under the duty to mitigate damages contained in art. 77 cisg”). 10 see germany, lg münchen (furniture case), 6 april 2000, cisg-online.ch 665, english translation available at <http://cisgw3.law.pace.edu/cases/000406g1.html>. http://www.cisg-online.ch/cisg/fs%20hellner.pdf http://cisgw3.law.pace.edu/cases/000406g1.html nordic journal of commercial law issue 2009#1 7 2.1 under article 75, an aggrieved party is entitled to recover as damages the difference between the contract price and the price of the substitute transaction article 75 provides a method for calculating damages when the contract has been avoided and the ”buyer has bought goods in replacement or the seller has resold the goods.”11 under these circumstances, an aggrieved party ”may recover the difference between the contract price and the price in the substitute transaction as well as any further damages recoverable under article 74.”12 the purpose of article 75 is to ensure that the aggrieved party will receive the benefit of the bargain of the avoided contract if the aggrieved party mitigates its damages by engaging in a substitute transaction.13 the rationale for article 75 has been explained as follows: if the contract is declared avoided for breach by the buyer, the seller is free to resell the goods. as a rule, it will be in his interest to do so. analogously, if the contract is avoided for breach by the seller, the buyer will be interested in purchasing the same goods from another seller if possible. if the non-breaching party succeeds in reselling or replacing the goods, his effective loss will thereby be diminished. article 75 takes this into account and sets forth special rules for calculating damages in such cases.14 2.2 the contract price is the price fixed in the contract or the price as determined under article 55. in order to calculate damages under article 75, there must exist a ”contract price.” the ”contract price” is the price expressly or implicitly fixed in the avoided original contract or the price in the avoided original contract as determined under article 55.15 article 55 provides that when a contract has been ”validly concluded” but does not expressly or implicitly fix the price, the price will be the ”generally charged” price for those goods at the time the contract was concluded, unless the parties provide otherwise.16 11 see cisg art. 75. 12 see id. 13 see stoll & gruber, op. cit., art. 75, 1. 14 see v. knapp, in c. bianca & m. bonnell, commentary on the international sales law, the 1980 vienna sales convention, giuffrè, milano, 1987, art. 75 2.1. both the unidroit principles and the pecl contain provisions similar to article 75 of the convention. see unidroit principles art. 7.4.5; pecl art. 9:506. 15 see cisg art. 55. see stoll & gruber, op. cit., art. 76 5. 16 see cisg art. 55. nordic journal of commercial law issue 2009#1 8 2.3 the price in any substitute transaction may be used to calculate damages under the formula set forth in article 75 only if the aggrieved party made a substitute transaction in a reasonable manner and in a reasonable time. damages are only compensable under article 75 if: (1) in the case of a breach by the buyer, the seller sold the goods or, in the case of a breach by the seller, the buyer has purchased replacement goods; and (2) the substitute transaction was reasonable under the circumstances.17 thus, an aggrieved party must act as a ”careful and prudent businessman” would act while observing the relevant trade practices.18 the aggrieved party need not exhaust all possible avenues of research prior to engaging in a resale or cover purchase. all the circumstances surrounding the substitute transaction will be evaluated; therefore, a transaction that was carried out above the market price may, nevertheless, meet the reasonableness standard.19 the secretariat commentary explains: for the substitute transaction to have been made in a reasonable manner ... it must have been made in such a manner as is likely to cause a resale to have been made at the highest price reasonably possible in the circumstances or a cover purchase at the lowest price reasonably possible. therefore, the substitute transaction need not be on identical terms of sale in respect of such matters as quantity, credit or time of delivery so long as the transaction was in fact in substitution for the transaction which was avoided.20 the substitute transaction also must be made within a reasonable time after avoidance.21 the time period for a reasonable substitute transaction begins when the aggrieved party in fact declares the contract avoided.22 the duration of the reasonable time window will depend inter alia on the existence and variability of a market for the goods. for example, if the goods have a 17 see cisg art. 75. 18 see stoll & gruber, op. cit., art. 75 6; see also arbitral award, icc 8128/1995 (chemical fertilizer case), cisg-online.ch 526, english translation available at <http://cisgw3.law.pace.edu/cases/958128i1.html>. 19 see arbitral award, icc 8128/1995 (chemical fertilizer case), cisg-online.ch 526, english translation available at <http://cisgw3.law.pace.edu/cases/958128i1.html> (factors such as time constraints on the aggrieved party will be considered in determining whether the price of a substitute transaction was reasonable); see also stoll & gruber, op. cit., art. 75 6. 20 see secretariat commentary, art. 71 [draft counterpart to cisg art. 75], 4 (available at <http://cisgw3.law.pace.edu/cisg/text/secomm/secomm-75.html>). the secretariat commentary is on the 1978 draft of the convention; there exists no official commentary on the cisg. nevertheless, the commentary reflects that secretariat's impressions of the purposes and effects of the commission's work and provides a helpful analysis of official text of the cisg. see a. kritzer, guide to practical applications of the united nations convention on contracts for the international sale of goods, kluwer, 1990 (”[the secretariat] commentaries are the closest available counterpart to an official commentary on the convention and, when they are relevant, constitute the most authoritative citations to the meaning of the convention that one can find.”). 21 see stoll & gruber, op. cit., art. 75 7. 22 see secretariat commentary, op. cit., art. 71 5. http://cisgw3.law.pace.edu/cases/958128i1.html http://cisgw3.law.pace.edu/cases/958128i1.html http://cisgw3.law.pace.edu/cisg/text/secomm/secomm-75.html nordic journal of commercial law issue 2009#1 9 fluctuating market price, what constitutes a reasonable period may be relatively short.23 by contrast, goods that are seasonal or unique may result in a longer period being considered reasonable.24 some courts and commentators maintain that article 75 may be used to calculate damages in cases where the substitute transaction occurs prior to the avoidance of the contract, if the obligor has unambiguously declared that it will not perform under the terms of the contract.25 this position, however, is inconsistent with the explicit language of article 75, which states that the substitute transaction take place ”after avoidance” of the contract. avoidance of the contract is required to conduct a substitute transaction because it is the declaration of avoidance that terminates the rights of the parties under the contract and gives the aggrieved party the freedom to seek its performance interest elsewhere.26 in addition, the substitute transaction must be in fact a replacement for the avoided transaction. identifying a single transaction as a substitute may be difficult for an aggrieved party that often deals in contracts similar to the avoided one. such a party has several options, including identifying a substitute transaction prior to engaging in it, choosing the first transaction after avoidance as the substitute, or proceeding abstractly under article 76.27 there is no requirement that the terms of the substitute transaction be identical to those of the avoided one, but it may be necessary to adjust damages based on differences in the contract terms and to account for either expenses saved or additional expenditures.28 23 see, e.g., germany, olg hamburg (iron molybdenum case), 28 february 1997, cisg-online.ch 261, english translation available at <http://cisgw3.law.pace.edu/cases/970228g1.html>. 24 see, e.g., germany, olg düsseldorf (shoe case), 14 january 1994, cisg-online.ch 119, english translation available at <http://cisgw3.law.pace.edu/cases/940114g1.html> (ruling three months reasonable period for sale of seasonal goods). 25 see germany, olg hamburg (iron molybdenum case), 28 february 1997, cisg-online.ch 261, english translation available at <http://cisgw3.law.pace.edu/cases/970228g1.html> (allowing calculation under article 75 despite no formal avoidance of the contract, when necessary to uphold general fairness under the principle of good faith). see stoll & gruber, op. cit., art. 75 5. 26 see germany, olg bamberg (fabric case), 13 january 1999, cisg-online.ch 516, english translation available at <http://cisgw3.law.pace.edu/cases/990113g1.html> (calculation under article 75 inappropriate when aggrieved buyer made cover purchase prior to avoiding the contract). in such case, damages may be calculated under article 74. 27 see knapp, op. cit., art. 76 § 2.4; see honnold, op. cit., § 410.1. 28 see secretariat commentary, op. cit., art. 71 3-4. http://cisgw3.law.pace.edu/cases/970228g1.html http://cisgw3.law.pace.edu/cases/940114g1.html http://cisgw3.law.pace.edu/cases/970228g1.html http://cisgw3.law.pace.edu/cases/990113g1.html nordic journal of commercial law issue 2009#1 10 2.4 in the event that the aggrieved party's substitute transaction was unreasonable, damages may be calculated according to article 76 or article 74. a prerequisite to recovery under article 75 is a finding by the tribunal that the substitute transaction was ”reasonable.”29 controversy exists over the appropriate method for calculating damages when an aggrieved party has made substitute transaction that is found to be unreasonable. under one approach, if an aggrieved party entered into a substitute transaction that was not made in a reasonable manner, the situation is viewed as being the same as if no substitute transaction had taken place.30 thus, damages may be calculated abstractly under article 76 without regard to the second transaction, assuming that the requirements are satisfied for calculating damages pursuant to article 76 (for example, there exists a ”price fixed in the contract” and a ”current price for the goods”).31 if, however, damages cannot be calculated under article 76, then damages are to be calculated under article 74. the decision of olg hamm, 16 january 1992, illustrates this approach.32 in that case, after the buyer breached a contract for the sale of 200 tons of bacon, the seller avoided the contract and resold the goods for approximately 25% of the contract price. the court determined that the contract had been properly avoided, but the resale of the goods had not been done in ”in a reasonable manner” and, therefore, did not fall within article 75. accordingly, the court calculated damages abstractly under article 76, rather than concretely under article 75.33 another approach for determining damages when the substitute transaction is found to be unreasonable calls for a concrete calculation under article 75, but with an adjustment to the price of the substitute transaction to account for the factor(s) that made it unreasonable.34 under this approach, the aggrieved party cannot claim damages that exceed what it would have obtained if the substitute transaction had been reasonable.35 however, this approach is not consistent with article 75's expressed prerequisite that the substitute transaction be made ”in a reasonable manner and within a reasonable time after avoidance.”36 additionally, determining 29 see id. at 4. 30 see id. at 6. 31 see knapp, op. cit., art. 75 § 2.6. 32 see germany, olg hamm (frozen bacon case), 22 september 1992, cisg-online.ch 75, english translation available at <http://cisgw3.law.pace.edu/cases/920922g1.html> (declaring that article 76 should be used in this circumstance). 33 see id. 34 see stoll & gruber, op. cit., art. 75 9. 35 see id. 36 see cisg art. 75. one commentator notes that ”this solution would create unnecessary uncertainty and is too far from the wording of the provisions which clearly points to either art. 76 or art. 74 cisg in those cases.” huber, op. cit., § 13(vii)(2)(a)(bb) fn.1051. http://cisgw3.law.pace.edu/cases/920922g1.html nordic journal of commercial law issue 2009#1 11 the adjustment necessary to achieve a result equivalent to a reasonable substitute transaction requires an inquiry into the market price of the goods. therefore, if the goods have a market price, calculating the damages in an unreasonable substitute transaction under the adjustment approach to article 75 will almost always produce the same result as an abstract calculation under article 76.37 where the aggrieved party has entered into a substitute transaction in an unreasonable manner, it is consistent with the design and purposes of the damages sections of the convention to bar application of article 75 and instead allow an aggrieved party to calculate damages abstractly under article 76 or concretely under article 74. this approach finds support in the secretariat commentary: if the resale or cover purchase is not made in a reasonable manner or within a reasonable time after the contract was avoided, damages would be calculated as though no substitute transaction had taken place. therefore, resort would be made to article 72 [the draft counterpart of cisg article 76] and, if applicable, to article 70 [the draft counterpart of cisg article 74].38 3. an aggrieved party entitled to damages under article 75 may also recover any further damages under article 74. under article 75, an aggrieved party may recover any ”further damages” under article 74. the purpose of this provision is to ensure that an aggrieved party can be made whole when its expectation interests are not satisfied by the substitute transaction formula in article 75.39 the ”further damages” clause allows the aggrieved party to recover incidental and consequential damages in addition to the damages recovered under article 75.40 ”further damages” may include, inter alia: (1) costs associated with the substitute transaction under article 75;41 (2) loss 37 see stoll & gruber, op. cit., art. 75 9. 38 see secretariat commentary, op. cit., art. 71 6. while neither the unidroit principles nor the pecl expressly address the issue of how to calculate damages when the substitute transaction is unreasonable, their structures for calculating damages are analogous to the convention and lead to the conclusion that the same result would be reached under these instruments. see unidroit principles arts. 7.4.1-7.4.6; see pecl arts. 9:506-9:507 39 see honnold, op. cit., § 415. the unidroit principles and the pecl both provide that where the market price damage formula does not give the aggrieved party the ”benefit of the bargain,” that party may seek additional damages. see unidroit principles art. 7.4.6; see pecl art. 9:507. the american uniform commercial code (u.c.c.) allows for recovery of incidental damages and consequential damages (including lost profits) when the market price damage formula does not make the promisee whole. see u.c.c. § 2-708(2); see also u.c.c. §§ 2-706, 2-712. 40 see stoll & gruber, op. cit., art. 75 10; see flechtner, remedies under the new international sales convention: the perspective from article 2 of the u.c.c., 8 j.l. & com. pp. 53, 97-107 (1988) at 53, 95. 41 see stoll & gruber, op. cit., art. 75 10; see flechtner, remedies under the new international sales convention: the perspective from article 2 of the u.c.c., 8 j.l. & com. pp. 53, 97-107 (1988) at 53, 95. nordic journal of commercial law issue 2009#1 12 caused by the delay in locating a substitute transaction;42 (3) loss due to a change in the interest rates or in the currency exchange rate between the date that the transaction was supposed to have occurred under the contract and the substitute transaction;43 (4) costs to a seller of an unsuccessful tender of goods or their necessary storage;44 and (5) costs associated with the failed transaction.45 in certain transactions, it may not be appropriate to award lost profits as ”further damages.” this may occur when, for example, the substitute transaction provides the aggrieved party with the same opportunity to profit that the avoided transaction provided.46 in such a circumstance, where the substitute transaction itself replaced the profits lost on the original transaction, allowing an aggrieved party to recover additional lost profits would place that party in a better economic position than if the contract had been performed. the decision of lg münchen, 6 april 2000, illustrates this point.47 there, the seller breached the contract by failing to deliver furniture the buyer intended to resell to a third party. the buyer was forced to purchase substitute furniture at a higher price. the buyer then fulfilled its agreement with the third party. the district court denied the buyer's claim for lost profits, reasoning that awarding damages to the buyer based on the substitute transaction formula under article 75 made the buyer whole.48 the combination of the profit made on the sale to the third party and the damages under article 75 satisfied the buyer's expectation interest. 42 see stoll & gruber, op. cit., art. 75 10; see also united states, delchi carrier s.p.a. v. rotorex corp., u. s. court of appeals (2d circuit), 6 december 1995, cisg-online.ch 140 (noting that labor expenses associated with plant shutdown due to breach might be available if they were variable costs). 43 see germany, lg krefeld (shoe case), 28 april 1993, cisg-online.ch 101 (”further damages awarded to the seller included the attorney's fees the seller incurred to declare the contract avoided, the interest the seller paid for loans, and the loss it suffered from the devaluation of the italian lira since the date on which the buyer should have paid originally.”). 44 see switzerland, hg aargau (cutlery case), 26 september 1997, cisg-online.ch 329, english translation available at <http://cisgw3.law.pace.edu/cases/970926s1.html> (awarding, in case where buyer breached by refusing to accept goods when tendered, further damages that included purchase price of goods which seller could not resell and transportation costs for unsuccessful tender); see also united states, delchi carrier s.p.a. v. rotorex corp., u. s. court of appeals (2d circuit), 6 december 1995, cisg-online.ch 140 (awarding damages for shipping, customs, and incidentals related to rejection and return of defective goods). 45 see arbitral award, icc 8128/1995 (chemical fertilizer case), cisg-online.ch 526, english translation available at <http://cisgw3.law.pace.edu/cases/958128i1.html> (awarding, in case where buyer supplied the breaching seller with custom sacks to be used in the delivery of the goods, costs of new sacks used in substitute transaction); see also united states, delchi carrier s.p.a. v. rotorex corp., u. s. court of appeals (2d circuit), 6 december 1995, cisg-online.ch 140 (awarding damages relating to machinery only purchased for use with undelivered goods). 46 see stoll & gruber, op. cit., art. 75 11. 47 see germany, lg münchen (furniture case), 6 april 2000, cisg-online.ch 665, english translation available at <http://cisgw3.law.pace.edu/cases/000406g1.html>. 48 see id. http://cisgw3.law.pace.edu/cases/970926s1.html http://cisgw3.law.pace.edu/cases/958128i1.html http://cisgw3.law.pace.edu/cases/000406g1.html nordic journal of commercial law issue 2009#1 13 it would also be inappropriate for an aggrieved party to recover damages under article 75's substitute transaction formula and, in addition, lost profits caused by lost volume sales under article 74 as ”further damages.” the aggrieved party would receive a double recovery if it were to receive damages based on the substitute transaction and lost volume damages which presume that a substitute transaction never took place.49 an aggrieved party must choose either to proceed under article 75 or to pursue lost volume damages under article 74, but it cannot do both.50 however, in the case of a true lost volume seller, the subsequent transaction may be treated as being one additional to, rather than a replacement for, the avoided transaction.51 in such a situation where the subsequent transaction would have occurred regardless of the avoidance of the original transaction, the lost volume seller may calculate its damages under articles 76 or 74 and, in addition, retain the profit made on the subsequent transaction. 4.1 under article 76, an aggrieved party is entitled to recover as damages the difference between the price fixed by the contract and the current price. article 76 provides that when an aggrieved party has avoided the contract but has not made a substitute transaction under article 75, it is entitled to damages measured by ”the difference between the price fixed by the contract and the current price ... as well as any further damages recoverable under article 74.”52 this approach has been described as an abstract method for calculating damages, which is in contrast to the concrete method for measuring damages set forth in article 75.53 article 76 provides an alternative means to article 75 for determining damages when the contract has been avoided but, (1) in the case of an aggrieved buyer, that party has not bought goods in replacement pursuant to article 75 or, (2) in the case of an aggrieved seller, that party has not resold the goods pursuant to that provision.54 it is important to point out, however, 49 see germany, olg hamburg (jeans case), 26 november 1999, cisg-online.ch 515, english translation available at <http://cisgw3.law.pace.edu/cases/991126g1.html> (citing danger of double recovery). 50 see stoll & gruber, op. cit., art. 75 11. 51 see generally official comment to unidriot principles, art. 7.4.5 1. 52 see cisg art. 76(1); cf. u.c.c. §§ 2-708(1) (seller's market price damages), 2-713 (buyer's market price damages); see also flechtner, op. cit., at 99 (discussing the differences between the u.c.c.'s manner for measuring market price damages and method set forth in the cisg). 53 as noted, an aggrieved party may alternatively seek recovery under article 74. however, as peter schlechtriem pointed out, in some cases it may be more advantageous for an aggrieved party to seek damages under article 76. see schlechtriem, calculation of damages, op. cit., § iii (”the market price rule has great advantages for the aggrieved parties in transborder cases especially, for it dispenses with proving concrete damages and, thereby, avoids the hazards of diverging domestic procedural rules on taking and evaluating of evidence, e.g., as to who acts as fact-finder (jury or judge) or what degree of probability constitutes full proof, i.e. reasonable or 99% certainty, or whether the judge has discretion to estimate the aggrieved party's damages, such as under § 287 german code of civil procedure.”). 54 see cisg art 76. http://cisgw3.law.pace.edu/cases/991126g1.html nordic journal of commercial law issue 2009#1 14 that a concrete determination of damages under article 75 is generally preferred to abstract determination under article 76, and ordinarily takes precedence if the requirements of article 75 are met.55 the purpose of article 76 has been explained as follows: [under article 76,] a concrete demonstration of the non-performance loss is not necessary. the rule is based on the premise that the promisee has the right to make a substitute transaction at the current price. the promisor must bear the costs of a substitute transaction. however, he should not gain an advantage if the promisee has not carried out such a transaction but has instead taken another course of action.56 article 76 may be used to calculate damages even if an aggrieved party has made a substitute transaction, if the purchase or resale was not made in a reasonable manner or within a reasonable time after the contract was avoided.57 since the requirements for calculating damages pursuant to article 75 have not been met, and damages may be calculated under article 76 as though no substitute transaction has taken place. article 76 may also be used, instead of article 75, to calculate damages where the aggrieved party is ”continuously in the market” for the particular good of the type in question.58 in the case of a true lost volume seller, where the aggrieved party engaged in multiple transactions similar to the avoided one, it may not be possible to identify a specific substitute, and, therefore, impossible to calculate damages concretely under article 75.59 the aggrieved party may then pursue damages under the abstract calculation of article 76 and seek further damages under article 74.60 55 see germany, olg hamm (frozen bacon case), 22 september 1992, cisg-online.ch 75, english translation available at <http://cisgw3.law.pace.edu/cases/920922g1.html> (noting that in the presence of a substitute transaction, concrete calculation of damages under article 75 prevails over abstract calculation under article 76). 56 see stoll & gruber, op. cit., art. 76 1. 57 see secretariat commentary, op. cit., art. 72 [draft counterpart of art. 76 cisg] 2. 58 see e.a. farnsworth, farnsworth on contracts, 3d edition, aspen, new york, 2004, p. 252; see also p. schlechtriem, uniform sales law -the un-convention on contracts for the international sale of goods, manz, vienna, 1986, p. 97. 59 see knapp, op. cit., art. 76 § 2.4. see also j. ziegel, the remedial provisions in the vienna sales convention: some common law perspectives, in n. galston & h. smit, eds., international sales: the united nations convention on contracts for the international sale of goods, m. bender, new york, 1984, § 9.05. 60 the unidroit principles article 7.4.6 contains a provision analogous to article 76. see unidroit principles art. 7.4.6; official comment to unidroit principles, art. 7.4.6 1. see also arbitral award, icc 8502 (rice case), 1 november 1996, cisg-online.ch 1295 (discussing cisg art. 76 and unidroit principles 7.4.6). similarly, the pecl also contains a provision for calculating damages abstractly. see pecl art. 9:507. http://cisgw3.law.pace.edu/cases/920922g1.html nordic journal of commercial law issue 2009#1 15 4.2 in order for damages to be calculated pursuant to article 76, the contract must fix, expressly or implicitly, a price for the goods. article 76 states that the contract price is the ”price fixed by the contract.”61 unlike article 75, which allows the contract price to be determined pursuant to article 55, article 76 requires the contract itself to either expressly or implicitly fix a price for the goods as a prerequisite to calculating damages under article 76.62 it has been suggested that article 76 may be used to calculate damages for contracts with open price terms.63 this approach derives from the view that the principle of full compensation should allow a price to be fixed pursuant to article 55.64 however, this interpretation is contrary to the text of article 76 and should be avoided.65 as such, if there is no price fixed in the contract, article 76 is inapplicable and an aggrieved party that has avoided the contract without making a substitute transaction may pursue damages under article 74. 4.3 the current price is the price generally charged for such goods sold under comparable circumstances in the trade concerned. abstract calculation of loss under article 76 is only possible if the contract goods have a current price.66 the requirement that a current price exists does not mandate that there be an official or unofficial market quotation for the goods in question.67 a current price is established by the 61 see cisg art. 76(1). 62 see stoll & gruber, op. cit., art. 76 3. 63 see schlechtriem, calculation of damages, op. cit., §§ iv. 1, 3(b). 64 see id. 65 see stoll & gruber, op. cit., art. 76 5; see also summary of records of meetings of the first committee, 37th meeting, consideration of the report of the drafting committee to the committee, article 71 and 72 [became cisg article 75 and cisg article 76], 7 april 1980, available at <http://www.cisg.law.pace.edu/cisg/firstcommittee/meeting37.html>. 66 see estonia, tallinna ringkonnakohus (novia handelsgesellschaft mbh v. as maseko), 19 february 2004, cisg-online.ch 826, english translation available at <http://cisgw3.law.pace.edu/cases/040219e3.html> (holding seller was required to provide adequate proof as to existence of current price for tomato paste in order to recover damages under article 76). 67 see knapp, op. cit., art. 76 § 3.3; see also official comment to unidroit principles, art. 7.4.6 2 (”this will often, but not necessarily, be the price on an organised market.”). however, ”goods which are made under special order by the buyer” may necessitate that damages be calculated under article 74 instead of article 76. see f. enderlein & d. maskow, international sales law, oceana, new york, 1992, art. 76 § 2. http://www.cisg.law.pace.edu/cisg/firstcommittee/meeting37.html http://cisgw3.law.pace.edu/cases/040219e3.html nordic journal of commercial law issue 2009#1 16 price generally charged for the sale of goods of the same kind and on comparable terms.68 thus, establishing a current price within the meaning of article 76 requires an objective basis for determining the value of the goods and is not possible when the goods are valued based on subjective needs.69 furthermore, an adjustment may be necessary to account for any differences in terms between the avoided transaction and the market price.70 4.4 the time at which the current price is to be established is the time of avoidance, which is the moment when avoidance was declared; provided, however, that if the aggrieved party avoids the contract after taking over the goods, then the current price is to be determined at the time of such taking over. under article 76, the current price is to be determined ”at the time of avoidance.” the time of avoidance is ”the moment in time when the avoidance was declared.”71 however, if the aggrieved party avoids the contract ”after taking over the goods,” then the current price is to be determined instead at the ”time of such taking over.”72 this applies 68 see germany, olg celle (vacuum cleaners case), 2 september 1998, cisg-online.ch 506, english translation available at <http://cisgw3.law.pace.edu/cases/980902g1.html> (stating ”[t]he current price is the price that is generally charged for goods of the same kind in the respective industry under comparable circumstances”); see also b. nicholas, the vienna convention on international sales, 105 l.q. rev. 230, 1989, fn. 30. to determine if the goods are comparable, a tribunal may look to cisg article 35, which sets forth the requisite factors for conforming goods. cf. arbitral award, icc 8740 (russian coal case), 1 october 1996, cisg-online.ch 1294. 69 see arbitral award, icc 8740 (russian coal case), 1 october 1996, cisg-online.ch 1294. the comment to the unidroit principles article 7.4.6 explains that ”current price” is the price is determined in comparison with the price that is generally charged for the same or similar goods or services. evidence of the current price may be obtained from professional organizations and chambers of commerce, among other sources. see official comment to unidroit principles art. 7.4.6 2. although the pecl provides for the recovery of damages equal to the difference between contract price and the current price, it does not define that term in the text or in the comment and notes. see pecl art. 9:507. 70 see arbitral award, cietac (silicon and manganese alloy case), 1 february 2000, cisg/2000/01, english translation available at <http://cisgw3.law.pace.edu/cases/000201c1.html> (appropriate to apply a percentage reduction when current price is based on goods of superior quality to those of avoided contract). see arbitral award, cietac (silicate-iron case), 18 april 1991, cisg/1991/01, english translation available at <http://cisgw3.law.pace.edu/cases/910418c1.html> (inappropriate to use published price of goods that did not incorporate the same delivery terms as the avoided contract). 71 see stoll & gruber, op. cit., art. 76 11. the 1978 draft convention (article 72(1)) referred to the moment the injured party first could have declared avoidance as the reference point for the time of avoidance. this was designed to prevent the aggrieved party from speculating at the other's expense. this language, however, was found objectionable because it was too uncertain and gave too much discretion to courts that would interpret this provision, particularly in cases of anticipatory breach. see knapp, op. cit., art. 76 §§ 2.9.1-2.9.3. 72 neither the unidroit principles nor the pecl contain language as detailed as article 76 on determining the time at which the current price is to be established. both provide that the current price is to be determined at the time the contract is terminated. see unidroit principles art. 7.4.6; see pecl art. 9:507. http://cisgw3.law.pace.edu/cases/980902g1.html http://cisgw3.law.pace.edu/cases/000201c1.html http://cisgw3.law.pace.edu/cases/910418c1.html nordic journal of commercial law issue 2009#1 17 regardless of whether the buyer knew at the time of ”taking over the goods” that there existed grounds to avoid the contract.73 this provision is designed to ”prevent[] an avoiding buyer who has received delivery from manipulating the time of avoidance in order to increase the seller's liability.”74 cases of anticipatory breach, when the aggrieved party avoids the contract prior to the date that performance was due, may lead to inaccurate assessments of damages under article 76.75 this is because, in a fluctuating market, there is no guarantee that the market price at the time of performance will be the same as the price at the time that the contract was avoided. therefore, it may be appropriate to calculate damages based upon the current price at the time of avoidance for the goods in the futures market at the time of performance. however, in some cases there may not be such price available. if there is no futures market for the goods, the current price at the time of avoidance should be used to calculate damages even in the case of anticipatory breach.76 this follows the text of article 76 as well as the rationale that the market price need not reflect all the terms of the avoided contract.77 article 2 of the u.c.c. normally measures the seller's market price damages at the time for tender and the buyer's damages at the time the buyer learned of the breach. however, if the breach is an anticipatory repudiation and the action comes to trial before the repudiator's performance is due, the u.c.c. market price damages are measured at the time the aggrieved party learned of the repudiation. see flechtner, op. cit., at 99-100. 73 see stoll & gruber, op. cit., art. 76 11. 74 flechtner, op. cit., at 99. this double test was apparently adopted because some delegates felt that the test in the draft article (the time when the aggrieved party first had the right to avoid the contract) was too vague, and because others were concerned that the substitution of the time of actual avoidance might enable the aggrieved party to postpone avoidance to take advantage of a fluctuating market. on the other hand, the time of delivery was not generally suitable either because there might not have been any delivery as in the case of an anticipatory repudiation. thus, the final text of article 76 was regarded as an appropriate compromise. see j. ziegel in report to the uniform law conference of canada on convention on contracts for the international sale of goods, 1981 (available at <http://cisgw3.law.pace.edu/cisg/text/ziegel76.html>). 75 see schlechtriem, calculation of damages, op. cit., preliminary remarks. 76 see id., §§ iii(2)(c), (d). 77 see secretariat commentary, op. cit., art. 71 4. http://cisgw3.law.pace.edu/cisg/text/ziegel76.html nordic journal of commercial law issue 2009#1 18 4.5 (a) the location at which the current price is to be established is the place where the delivery of the goods should have been made. (b) if there exists no current price at the place of delivery, the current price is to be established at a reasonable substitute place. article 76 specifies determining the current price first by looking to ”the price prevailing at the place where delivery of the goods should have been made.”78 the ”place where delivery should have been made” is determined pursuant to article 31.79 if no current price exists at the place of delivery, the current price is then determined to be ”the price at such other place as serves as a reasonable substitute. ...”80 there are no universal criteria for determining whether another place serves as a reasonable substitute.81 in general, a substitute place is reasonable if, taking into account transportation costs to the substitute location, an average merchant under the circumstances (from the point of view of both the buyer and seller) would find such a place suitable.82 typically, this place is the location that is the most physically proximate.83 at first glance, the lack of a current price at the place of 78 cisg art. 76. 79 article 31 states: if the seller is not bound to deliver the goods at any other particular place, his obligation to deliver consists: (a) if the contract of sale involves carriage of the goods -in handing the goods over to the first carrier for transmission to the buyer; (b) if, in cases not within the preceding subparagraph, the contract relates to specific goods, or unidentified goods to be drawn from a specific stock or to be manufactured or produced, and at the time of the conclusion of the contract the parties knew that the goods were at, or were to be manufactured or produced at, a particular place -in placing the goods at the buyer's disposal at that place; (c) in other cases -in placing the goods at the buyer's disposal at the place where the seller had his place of business at the time of the conclusion of the contract. cisg art. 31. article 31 differentiates between ordinary sales and sales involving the carriage of goods. when the contract of sale involves the carriage of goods, the place of delivery will be the place where the seller hands over the goods to the first carrier for transmission to the buyer. in a case between an italian buyer and a swiss seller, for example, an italian court held the place of performance was england, since the goods had been delivered to a carrier in sheffield. see italy, tribunale di reggio emilia (industrial machinery case), 3 july 2000, cisg-online.ch 771, english translation available at <http://cisgw3.law.pace.edu/cases/000703i3.html>; see also netherlands hoge raad, 26 september 1997, cisg-online.ch 286. 80 cisg art. 76(2). under u.c.c. §§ 2-708(1) and 2-713(2), market price damages are measured at the place of tender for the seller and, in many cases, also for the buyer. see u.c.c. §§ 2708(1), 2-713(2) (1978). however, u.c.c. § 2-713(2) measures the market price at the place of arrival where the buyer has rejected or revoked acceptance after the goods arrived. see u.c.c. § 2713(2). 81 see enderlein & maskow, op. cit., art. 76 § 11. 82 see knapp, op. cit., art. 76 § 3.4. 83 see stoll & gruber, op. cit., art. 76 10. http://cisgw3.law.pace.edu/cases/000703i3.html nordic journal of commercial law issue 2009#1 19 delivery may suggest that no current price exists at all.84 however, if delivery was in the seller's country and the buyer avoided the contract after arrival and inspection in the buyer's country, the buyer may be unable establish a market price in the seller's country.85 in such a case, the buyer may resort to a reasonable substitute location. 5. if the contract does not fix a price and there is no current price within the meaning of article 76, damages may be calculated under article 74. article 76 does not explicitly state how damages are to be calculated if there exists no price fixed by the contract or a current price cannot be determined. in such event, damages may be calculated under article 74.86 6. an aggrieved party entitled to damages under article 76 may also recover any further damages under article 74. like article 75, article 76 states that the aggrieved party is entitled not only to the difference between the price fixed by the contract and the current price, but also to any further damages recoverable under article 74. these damages may include additional losses, including lost profit, for which the formula set forth in article 76 alone would not provide compensation. the secretariat commentary provides the following illustrations of the calculation of damages under article 76: example [a]. the contract price was $50,000 cif. seller avoided the contract because of buyer's fundamental breach. the current price [at the time of avoidance] for goods of the contract description at the place where the goods were to be handed over to the first carrier was $45,000. seller's damages ... were $5,000. example [b]. the contract price was $50,000 cif. buyer avoided the contract because of seller's non-delivery of the goods. the current price [at the time of avoidance] for goods of the contract description at the place the goods were to be handed over to the first carrier was $53,000. buyer's extra expenses caused by the seller's breach were $2,500. buyer's damages under articles [76 and 74] were $5,500.87 when an aggrieved party seeks both damages under article 76 and further damages under article 74, the total amount of damages awarded should not place the aggrieved party in a 84 see enderlein & maskow, op. cit., art. 76 § 11. 85 see honnold, op. cit., § 413. 86 see knapp, op. cit., art. 76 § 3.7. 87 see secretariat commentary, op. cit., art. 72 8. nordic journal of commercial law issue 2009#1 20 better position than it would have been in had the contract been properly performed.88 for example, assume that a seller rightfully avoided a contract because of the buyer's fundamental breach and did not resell the goods. the price fixed in the contract for the goods was $50,000 and the relevant market price of comparable goods at the time of avoidance of the contact was $45,000. under article 76, the seller's damages are $5,000. in this case, the seller still has the goods and, presumably, can resell them for the current price; therefore, if the seller also claims that article 74 entitles it to recover the profit it would have made on the sale under the contract, the claim for lost profit should be denied.89 awarding the seller lost profits would provide it with a windfall because the seller still has the goods and, presumably, can resell them for the current price. if, however, the price at which the seller can now sell the goods has fallen since the time of avoidance, the seller might argue that it is entitled to further damages. nevertheless, article 77 requires that a party take reasonable measures to mitigate its loss, including loss of profit, resulting from the breach. therefore, if it fails to do so, the other party may claim a reduction in the damages of the amount by which the loss should have been mitigated. in most cases, ”further damages” under article 76 would be similar to the damages available under article 75. however, there are some notable differences.90 if an aggrieved party proceeds under article 76, it can claim its loss which exceeds the difference between contract price and the market price.91 for example, if the seller breached the contract in a rising market and thereby caused the buyer to miss an opportunity to resell the contract goods for 50% above the market price, the buyer should theoretically be able to recover this 50% difference as ”further damages.”92 these damages would be available if the buyer proceeds under article 76, but not if it proceeds under article 75 because conducting a cover purchase would have preserved the opportunity to profit from the third party transaction.93 additionally, lost profits may be appropriate as further damages under article 76 when the aggrieved party claims lost volume damages. 88 see knapp, op. cit., art. 76 § 2.7. 89 it is assumed that this case does not involve lost volume sales. 90 see stoll & gruber, op. cit., art. 76, n. 39. 91 see id. the promisee must have attempted to mitigate this loss under article 77 in order to recover. 92 this assumes that the damages were foreseeable and the aggrieved party undertook appropriate mitigation efforts. 93 see id., art. 75 11. microsoft word article5.doc conformity of goods in the 1980 united nations convention of contracts for the international sale of goods by teija poikela1 nordic journal of commercial law issue 2003 #1 1 teija poikela is attorney at studio legale sutti, milan, italy and is currently on research leave. nordic journal of commercial law, issue 2003 #1 2 1 introduction the art 35 of the 1980 united nations convention of contracts for the international sale of goods states that «(1) the seller must deliver goods which are of the quantity, quality and description required by the contract and which are contained or packaged in the manner required by the contract. (2) except where the parties have agreed otherwise, the goods not conform to the contract unless they: (a) are fit for the purposes for which the goods of the same description would ordinarily be used; (b) are fit for any particular purpose expressly or impliedly made known to the seller at the time of conclusion of the contract, except where the circumstances show that the buyer did not rely, or that it was unreasonable for him to rely, on the seller's skill and judgement; (c) possess the qualities of the goods which the seller has held out to the buyer as a sample or as a model; (d) are contained or packaged in the manner usual for such goods or, where there is no such manner, in a manner adequate to preserve and protect the goods. (3) the seller is not liable under sub-paragraph (a) to (d) of the preceding paragraph for any lack of conformity of the goods if at the time of the conclusion of the contract the buyer knew or could not have been unaware of such lack of conformity.» this study will focus on the meaning of the term «non-conformity» as understood by article 35 of the convention, (the cisg), and on providing an overlook of case law in its application. also the solutions adapted by certain domestic legal systems are studied.2 in the social sciences it is coming to be recognized that one of the greatest difficulties is that of statement, and that many disputes are due to the imperfections of the language. also jurisprudence is in need of semantic analysis. the difficulty of using words does not press upon the ordinary man because it usually does not matter to him whether, for instance, he calls a number of stones a «heap» or not. all that matters is that he should make his meaning clear enough for the purpose at hand.3 in law, however, it is different, for therein we draw sharp conclusions based upon these words of gradation. the question, whether a man is left in freedom or detained in a mental institution, depends on whether he is classified as sane or insane in the legal sense, as also does the question whether his dispositions of property are upheld or not. 4 in fact, the language of law has long been a source of concern to the society. it has been the subject of continuous literary criticism and satire. critics have highlighted its technical terms, its convolutions and its prolixity. calls have regularly been made for the use of a simpler style. some improvements have been made in response to those calls, but legal language remains largely unintelligible to most non-lawyer members of the society. in some cases, the obscurity may arise from the complexity of the law and of its subject matter. in other 2the current situation in the united kingdom was chosen to be studied more accurately because it is not a contracting state of the cisg. as regards the position of the scotland, from the comparative studies' point of view it is rather interesting since it has adopted elements from both english and european legal traditions, making it an example of so called mixed legal system. this derives from historical reasons. by the act of settlement of 1707 scotland kept its legal system and courts. the scottish legislator, judges and practitioners follow developments of english case and statutory law with particular interest. mikkola, p. 52 3 glanville williams, in lloyd's introduction to jurisprudence, p. 1181 4 glanville williams, p. 1183 nordic journal of commercial law, issue 2003 #1 3 cases, however, it is due to the complexity of the language in which the law is expressed. while this is particularly painful truth in many domestic realms, international conventions tend to make an exception from this rule; since a lot of time and effort is given in the drafting of the conventions and as it is kept in mind that the interpreters the users of the conventions will have different legal backgrounds, it is necessary to strive for clear wording. the linguistic definition of the term «conformity» is one based on agreement and congruity, and thus largely a subjective term. however, for the purpose of a legal context, a larger degree of certainty is required from a term.5 to find out the real meaning of the term, we have to study the prevailing interpretation of it.6 throughout the work on uniform laws realists have been saying: «even if you get uniform laws you will not get uniform results.» in fact, laws often use concepts that are local mental inventions that lack equivalent concepts in other legal systems. 7 international unification is, in fact, impossible. we should, however, consider the alternatives: conflicts of rules that are unclear and vary from forum to forum; national systems of substantive law expressed in doctrines and languages that, for many of us, are impenetrable. what is possible is to make law for international trade a bit more accessible and predictable. 8 2 vienna convention 2.1 historical background the need for a convention the legal structures, as well as any other structures in the society, must change as does change the society itself. karl popper compares the situation of legal knowledge and its development to a situation of development of a town. to enable the development to take place it is not enough to repair and fix the existing entities. once in a while one has to try to see the whole from a distance and have courage to remove what is old or not working, in order to construct something new, something that is based on current circumstances prevailing in the society. this is the case in international trade. in the era of globalization, when the national borders are losing their original significance, updating national laws doesn't suffice; there is a need for international, uniform regulation. 5 baasch andersen, chapter i.1. see also sacco, langue et droit, in italian national reports, p. 1 and castronovo , carlo who comments principles of european contract law in vita notarile 2000, i, p. 1193: »àla lingua prescelta tende a costringere i concetti e le categorie negli stampi ad essa propri, sicchè il rischio è quello di adottare gli istituti giuridici che costituiscono il prodotto di quella lingua sul piano del diritto. dall'altro, se per evitare tale inconveniente si adotta un linguaggio giuridicamente inusitato, si rischia di costruire figure incomprensibili per gli stessi giuristi che quella lingua hanno sempre avuto quale lingua giuridica madre. si tratta allora di non diventare prigionieri della lingua nella quale si formula il disposto normativo limitandosi a riprodurne gli istituti giuridici che le sono propri originariamente, senza dare vita però a qualcosa che, in quanto magari diverso, se diverso deve essere, dall'istituto che in quella lingua ha trovato finora espressione, sia un prodotto di sintesi come i prodotti chimici che non hanno uguale nella realtà naturale, cioè una figura che finisce con il non avere molto senso giuridico.» 6 popper compared two types of researchers: critic is the one who studies new discoveries to be able to see prevailing theories in a new light, while neurotic is the one who studies new findings only to strengthen one's own outlook. 7 use of untranslatable civil law concepts was one of the reasons why the predecessor of the cisg was rejected by common law world. 8 honnold, journal of law and commerce, p. 207 nordic journal of commercial law, issue 2003 #1 4 considering that unification of the law of international trade promotes certainty of law and hence the circulation of goods and wealth, it's not surprising that through the ages there have been numerous attempts to uniform the laws regulating international trade, based on the idea of creating a transnational body of norms capable of beating the worst enemy of the merchants: the barriers constituted by national legislations.9 since the creation of an internationally accepted convention in the field of international trade required world-wide participation, the united nations commission for international trade law (hereinafter the uncitral) was established 1966 to revise the material concerning international trade. this body had its first session in 1968; in its first decade uncitral made notable progress in preparing uniform international rules for arbitration, carriage of goods by sea, negotiable instruments and the sales of goods. this progress was analyzed in a symposium issue of the american journal of comparative law. 10 one of the formidable efforts of uncitral to unify international commerce was the diplomatic conference of vienna, held from 10th of march to 11th of april 1980. sixty-two states and eight international organizations participated in the conference. at the end of the conference the draft of convention on contracts for the international sale of goods (the cisg), was approved unanimously.11 however, the convention did not enter into force, even in the first contracting states, until 1.1.1988, when the requirements of becoming effective were met. however, it should be noted, that in spite of the widespread adoption12 of the cisg, the application of its predecessors, ulis13 or ulf14, is not completely excluded: they can still be applied even between the contracting states if the cisg does not apply. when ernst rabel, a noted german jurist, in the course of preparing the first drafts for a uniform sales law, compiled and analyzed the legal rules regulating the seller's obligation with respect to the quality of the goods sold, he came to the conclusion that, while these are practical questions of everyday commerce, to the lawyer they are full on unresolved difficulties. the irregularities and lack of clarity were essentially caused by the irrational survival of a doctrine rooted in antiquity. subsequently, rabel uncovered the roots that are the roman, angloamerica and german laws. he also exposed the common core of all legal systems: that the seller shall assume the responsibility that the goods sold conform to the contractual agreement. the seller's obligation and liability, therefore, are not derived from any special warranty nor is he always liable for certain objective characteristics of the goods sold. with this opinion rabel subsequently shaped the further development of german law, even though it is under attack 9 ferrari, p. 5 10 honnold, p. 51 11 ferrari 1998, p. 6 12 the cisg has been ratified by 62 states and this makes it one of the most successful uniform international conventions to date. the contracting states are: argentina, australia, austria, belarus, belgium, bosnia-herzegovina, bulgaria, burundi, canada, chile, china (prc), colombia, croatia, cuba, czech republic, denmark, ecuador, egypt, estonia, finland, france, georgia, germany, ghana, greece, guinea, hungary, iceland, iraq, italy, kyrgyzstan, latvia, lesotho, lithuania, luxembourg, mauritania, mexico, mongolia, netherlands, new zealand, norway, peru, poland, republic of moldova, romania, russian federation, saint vincent and the grenadines, singapore, slovakia, slovenia, spain, sweden, switzerland, syrian arab republic, uganda, ukraine, united states of america, uruguay, uzbekistan, venezuela, serbia-montenegro (formerly yugoslavia) and zambia. 13 uniform law on international sales, the hague 1964 14 uniform law on the formation of contracts for the international sale of goods, the hague 1964 nordic journal of commercial law, issue 2003 #1 5 again. it laid also the basis of the first drafts of the later ulis. nothing describes this basic principle better than the statement by lord justice brett 1877: « the governing principle is that the thing offered or delivered under a contract of purchase and sale must answer the description of it which is contained in words in the contract, or which would be so contained if the contract were accurately drawn out.» 15 2.1.1 the position of the cisg in respect to national laws in general, the cisg takes precedence over the law of the contracting states but there are cases where it recedes in favor of individual regulations of certain states, either by virtue of the cisg directly, or by virtue of a reservation made by a contracting state. in the latter case, the consequences of a declaration of reservation are only, according to a widely held opinion, in the non-application of the convention to the affected contracts. it is in the first case that the rules of a particular state are positively called to apply in lieu of the stipulations of the convention, i.e. the prescriptions of the lex fori. above all, the cisg may be superseded, pursuant to its articles 90 and 94, by national laws.16 a good illustration of the linkage between the vienna convention and national law is provided by the law of the united states of america. the convention is part of the federal law of the u.s.a. and, as such overrides uniform commercial code, which is state law in the states which have given effect to it, 17 except if the parties have excluded the application of the convention in whole or part18 or in so far as a particular topic is not regulated by the convention. these topics include important parts of article 2 of the ucc this is the article dealing with sales such as the special trade terms and the provisions on passing of title, reservation for security and good faith. the same relationship exists between the cisg and other national systems of law. it will therefore be necessary in many cases to ascertain the national law governing the international sales contract.19 however, the crucial difference between the two must be borne in mind: the convention is a code applicable to sale of goods. the ucc is a collection of codes and one of these is a sales code. the ucc also contains rules on letters of credit, methods of perfecting security interests in goods and other commercial subjects; some of which can also be relevant to sales of goods.20 while the ulis is intended to be a self-contained code with regard to the topics regulated by it, and expressly excludes the rules of private international law, the draftsmen of the vienna convention were aware that measures of conflict avoidance can reduce the dangers of a conflict of laws but cannot completely exclude them. for this reason they have linked the cisg with national systems of private international law. 15 galston smit, 6-20 16 enderlein maskow, p. 11 17 these are all usa states and jurisdictions, except louisiana. the effect is that the vienna convention is law in louisiana, but article 2 of the ucc is not. 18 by virtue of art. 6 of the convention. if the parties adopt in their contract the law of a contracting state, their adoption would include the adoption of the state's private international law and they would then again adopt the convention; if they wish to exclude the convention, they have to adopt the domestic law of the contracting state. thus, a choice of law clause in favour of the law of new york makes the convention applicable, but a choice of law clause in favour of new york law excluding the cisg does not have this effect. 19 schmitthoff's export trade, p. 688 20 kritzer, p. 6 nordic journal of commercial law, issue 2003 #1 6 2.2 comparing the ulis and the cisg this linkage between the cisg and national laws occurs in two respects. first, cisg, like the uniform sales law, does not regulate all incidents of the international sales transaction. it does not regulate: a) the special trade terms for the delivery of goods and the fixing of the price, and b) passing of the title of goods.21 the reason for exclusion (b) is that the regulation of the passing of title in the various legal systems is so different that a uniform rule could not be established. in addition, the convention does not regulate the law governing the alleged invalidity of a contract on general grounds, such as fraud, misrepresentation, incapacity and so on. product liability is likewise not regulated by the convention. secondly, the cisg contains an express reference to national systems of private international law for the filling of gaps in the convention. art. 7(2) provides: «questions concerning matters governed by this convention not expressly settled in it are to be settled in conformity with the general principles on which it is based or, in the absence of such principles, in conformity with the law applicable by the virtue of the rules of private international law. « every convention which does not constitute an exhaustive source of its subject, but regulates only certain issues of it excluding others, can easily give rise to problems concerning the precise meaning of its provisions and to problems concerning necessity of filling the gaps that inevitably appear as a result of an incomplete regulatory structure. these issues may arise in relation to any international convention, but they are most accentuated in the uniform sales law as resulting from the vienna convention, since such issues generally arise in proportion to the number of legal systems represented by the various contracting states.22 whereas ulis has been adopted in the form of uniform law which contracting states, adhering to the special conventions of introducing the law to their national legal system, are bound to incorporate into their national law, the cisg has been shaped in the form of convention. in one document, it contains rules governing the relations between parties to contracts of sale as well as the international law instruments to put them into force. the cisg thus follows a new trend in the formal arrangement of a universal standardization of law that was already employed in the conventions on prescription, agency, factoring and leasing. prevailing opinions also expect meritorious rules of a contractual convention to be incorporated into the domestic law of the contracting states, so that they become binding on their legal subjects. yet there is a difference with uniform laws insofar as this incorporation elucidates the international character of the respective rule, underlines its special position in domestic law, and furthers an interpretation and application, which is aimed at standardization of law. consequently, it aims at an international harmony of decisions and represses a legal practice coined with national concepts, to which different jurisdictions tend to lean towards in the case of uniform laws. 23 an apparent expression thereof is that the use of the convention form provides, in cases of discrepancies, for an interpretation pursuant to the authentic text and not according to a translation into another language. incorporation into domestic law is effected by promulgating 21 22 ferrari, uniform interpretation of the 1980 sales law, p. 4 23 enderlein maskow, p. 8 nordic journal of commercial law, issue 2003 #1 7 the adopted convention and not by enacting a special law. the strengthening of the international character of contractual norms may even be more effectively achieved, if one dispenses with the auxiliary construction of integration into domestic law, and rather proceeds from the assumption that domestic law renounces its own regulations and their use for the benefit of the convention and the extent of its scope. when a state becomes party to a convention containing authoritative rules for its legal subjects, we would prefer to interpret that the rules become directly binding on its legal subjects as international rules. such a construction is even favored whenever domestic law refers to international norms. this reference may clear up matters, however it does not seem to us a condictio sine qua non, for it implies making the direct application of international norms dependent on national law, a practice that still is widespread. however, this is not to be desired, for the very reason that it would lead to a situation where some countries apply international treaty norms as integral part of their domestic law system whereas other countries directly apply them as international law.24 2.3 interpretation of the cisg since there is no supranational instance or supreme court before which international sales cases can be brought, the problems of uniformity must be solved in the domestic realm.25 the drafters of the cisg were aware of this problem, as evidenced by the fact that they inserted into the convention provision designed to reduce the danger of diverging interpretations.26 according to many of the legal writers who have dealt with the issue of interpretation of the cisg27, interpreting it one should always take into consideration that it is a result of international unification efforts that, unlike domestic statutes, was not elaborated with any particular legal system or language in mind. thus, it has been suggested that it is necessary to read the cisg not through the lenses of domestic law but rather in an autonomous manner, which is why in interpreting the cisg one should not resort to the meaning generally attached to certain expressions within the ambit of a particular legal system.28 many commentators have argued, that even where the expressions employed by the cisg are textually the same as expressions that have a specific meaning within a particular legal system, they must be interpreted autonomously. however, still there are some expressions that an interpreter must interpret «domestically,» despite the negative effect that may have on the uniformity the drafters of the cisg wanted to achieve. one such expression is «private international law.» 29 ferrari concludes that where the cisg makes reference to private international law, it refers to a domestic concept of private international law. more particularly, the cisg refers to the private international law of the forum. one important conclusion can be drawn from this: the obligation to interpret the cisg in an autonomous manner is not 24 enderlein maskow, p. 9 25 although a tribunal monitoring its application would be preferable, the uniformity of the cisg would seem well protected to a certain degree. see baasch andersen, 2.1.2 26 it has often been stated that it is only possible to reduce the danger of diverging interpretations; it is not possible to eliminate them altogether. see also lookofsky in «consequential damages in comparative context» 1980, p. 294 27 several papers have been written on the interpretation of the cisg. see among others m.j.bonell, «l'interpretazione del diritto uniforme alla luce dell'art. 7 della convenzione di vienna sulla vendita internazionale», rivista di diritto civile (1986/ii), 221 and s.cook, «note, the need for uniform interpretation of 1980 united nations convention on contracts for the international sale of goods», p.50 28 ferrari, uniform law review 2001-1, p. 204. see also ferrari in diritto e procedura civile, p. 282 29 even though the expression »private international law» is employed only twice by the cisg its importance should not be underestimated. this importance is due to the fact that the references to the de quo relate to the cisg's sphere of application, as well as to its gap-filling, two of the most relevant issues under the cisg. see ferrari, journal of law and commerce, 17, p. 250. nordic journal of commercial law, issue 2003 #1 8 absolute. this conclusion causes a new problem, that is, how does one identify the concepts that are not to be interpreted autonomously? unfortunately, the cisg does not offer any guidance, as it does not offer any guidance on the different, albeit related issue of how to determine which interpretation should be preferred when the convention itself gives rise to different autonomous interpretations. one must therefore conclude that the cisg's autonomous interpretation cannot, by itself, guarantee uniformity.30 the requirement of autonomous interpretation was expressly held by an arbitral award of the international chamber of commerce, which did not overtake the distinction made in french domestic law between non-conforming delivery and garantie de vîces caches.31 it may be noted, however, that the apparent or hidden nature of the defects, though not leading to the same results as in french domestic law, seems to play an important role in case law regarding examination and notice requirements. the independence of the cisg concept of lack of conformity has been affirmed also by the german supreme court: a german dealer in chemical products concluded four contracts for the purchase from a dutch company of cobalt sulphate with specific technical characteristics. the buyer refused to pay the price alleging, inter alia, that he was entitled to avoid the contracts because the goods were of a kind different from that agreed upon and therefore the delivery amounted in fact to a non delivery. the court did not follow the buyer's reasoning, which was clearly aimed at taking advantage of the subtle distinction drawn by german courts between a defect and an aliud pro alio. it stated that the cisg, contrary to german domestic law, does not make any difference between delivery of goods of a different kind and delivery of nonconforming goods.32 the court's refusal to apply a distinction, which «plagues» not only german law, but also that of other countries, is to be appreciated. this is all the more so as a previous decision of a german oberlandesgericht had cast doubts on the correct use by courts of the concept of non-conformity.33 the bundesgericht decision does not rule as on whether a delivery of goods, which are totally different from the ones indicated on the contract, should still be subject to the conventional rules on lack of conformity. it may be that in such extreme situations the courts would resort to other remedies such as the ones provided in case of mistake. 2.3.1 linguistic problems as already anticipated in the beginning of this study, the interpretation and application of a legal text is strictly dependent on its linguistic expressions. legal translation should therefore be considered as a relevant prerequisite for the introduction and application of uniform law texts in those countries whose language does not happen to be the official language of the international instrument to be applied. comparative law scholars have often stressed the difficulties and risks inherent in legal translation, that go far beyond the linguistic field, to 30 ferrari, cisg case law: a new challenge for interpreters, p. 253 31 icc court of arbitration, n. 6653/1993, journal de droit international, 1993, p. 140. the decision has been revised on other grounds by cour d'appel de paris, 6.4.1995 32 bgh 3.4.1996, zip, 1996, 1041. the buyer's contention in this case was clearly unfounded, because the seller had delivered the agreed upon chemical substance, though not conforming to the contractual specifications. this fact, however, does not diminish the importance of the decision. no undue burden is put on the buyer by requiring notice in all cases when the goods do not correspond to the contract. see veneziano. 33 olg düsseldorf 10.2.1994, 6 u 119/93. in this case a part of the delivered textiles (1/4) were of a different pattern and color than the one agreed upon. the court ruled that the delivery of a false color was to be treated as a non delivery, and that the seller could not declare the contract avoided since he did not fix an additional time for performance. veneziano, p. 42 nordic journal of commercial law, issue 2003 #1 9 range toward legal comparison, by reason of the relativity of the legal terminology employed in the various legal systems. 34 notwithstanding these difficulties it is of vital importance that an exact translation be achieved, as an improper one may certainly affect the operation of uniform law and impair the uniformity itself of the rules adopted. for example, the first unofficial italian version appears in respect of various points to be inappropriate and misleading, probably as a result of an unnecessarily technical approach to the translation process. a new and more correct italian version is now available. 2.4 the problems arising out of interpretation from the obligations to «have regard to the convention's international character,» 35 and to have regard «to the need to promote uniformity in its application» legal scholars have deduced that whoever has to apply the convention, must make efforts to adopt solutions which are tenable on an international level, solutions which can be taken into consideration in other contracting states as well. the more various concepts are interpreted autonomously, the more likely it is to achieve the desired result. on the other hand, some legal writers have interpreted the aforementioned obligation to mean that in applying the cisg, courts must take into account relevant decisions of other states. however, requiring interpreters to consider foreign decisions can create practical difficulties: foreign case law cannot easily be retrieved and is often written in a language unknown to the interpreter. 36 2.5 steps taken to overcome obstacles in order to overcome the obstacles that tend to hamper the uniform application of the cisg, various steps have been undertaken. there has been a great progress in the accessibility to international case law with the arrival of databases on the internet and collections of case law such as clout37 and unilex although this progress is primarily made for the legal systems of central europe and united states. nevertheless, the need of updated database of case law has been recognized elsewhere, too.38 however, the knowledge of foreign case law does not per se suffice to guarantee uniformity, just as knowledge of domestic case law does not avoid all interpretative problems within a particular jurisdiction, also because in the majority view foreign case law has a persuasive value only.39 the solution of another kind, proposed by bonell, is that uncitral should promote a creation of a sort of «permanent editorial board». the board should be composed only of representatives of states that have actually ratified the convention, it being understood that the smaller states, particularly those belonging to the 34 see also opinion of lord mcevan, in the cause david frape against emreco international ltd. 35 some courts have indeed referred to this obligation. for instance, a swiss court decision stating, «in interpreting cisg, one has to have a particular regard to its international character. the starting point of any interpretation must me the convention itself, not domestic law» as well as an italian tribunal (12.7.2000 tribunale di vigevano). reference to the need to avoid interpreting the convention in the light of domestic law may be found in some us cases as well: «although the cisg is similar to the ucc with respect to some provisions, it would be inappropriate to apply the ucc case law in construing contracts under the cisg», in claudia v. olivieri footwear ltd., 1998 westlaw 164824. 36 ferrari, uniform law review 2001-1, p. 205. see also honnold's view later in this study. 37 cloutcase law of uncitral texts unilexdatabase edited by prof. bonell, from the italian national research council (cnr) 38 as boggiano, a professor of law, university of buenos aires, states, » in the interpretation of uniform rules the main purpose of promoting international uniformity should be given serious consideration. in case law and practice this aim is nevertheless disregarded or at least not given adequate weight. full treatment of the whole case law and practice on uniform law in latin american countries would require an enormous apparatus that would exhaust the resources and powers of a single scholar, but such an exhaustive piece of work should be carried out if a vivid and realistic picture and not merely a summary of general rules is desired. such an enquiry is becoming ever more necessary and it is far from being futile.» 39 ferrari, uniform law review 2001-1, p. 206 nordic journal of commercial law, issue 2003 #1 10 same geographical region, may well appoint a common representative. such a composition of the board would ensure on the one hand that only those states which have actually ratified the convention play an active role in its implementation and, on the other, that equal attention be given to each national experience without privileging any country or region for political, economic or even purely linguistic reasons. each member of the board should be responsible for gathering judicial decisions and bibliographic material relating to the convention from his own country or region. the board as a whole should be concerned with the delicate task of reporting material thus collected. it should then proceed to a comparative analysis of the material collected.40 it has been even suggested that a supranational jurisdiction under the auspices of uncitral would be established that would act as a supervisor of the proper interpretation of the convention and settle international disputes in a neutral setting with objective and experienced judges. this idea has played a key role in the debate for a long time but is now perhaps more a possible option considering the present political climate. another less ambitious possibility would be to confer on uncitral the power to render advisory opinions in matters regarding the application and interpretation of the conventions elaborated under its auspices.41 2.6 cisg-contract interpretation of a contract means in the present context an activity that aims at confirming what the contracting parties actually did agree upon. if an agreement has parts that are unclear, those parts are given a meaning through the interpretative process. interpretation is needed when the parties' views regarding respective obligations differ and thus have to be confirmed by a third party. interpretation has to be differentiated from the gap-filling that, in its turn, aims at finding a reasonable solution for the situations that are not contractually agreed upon. in practice the task of the interpreter is somehow more difficult than it may seem; it is up to him to define the borderline between the two. the contract has to be interpreted before we can take a position as regards the presence of the gaps. moreover, the two activities may appear to be so similar with each other that, as a result, it is difficult to determine which one is needed. on the one hand the background material for gap-filling may be scarce to the extent to require interpretation but on the other hand it may appear that the interpreter is forced to rely on the complementary norms applicable to the contractual relationship.42 the interpretation should not be separated from the other phenomena of contract law, since interpretation usually takes place in the context of a broader decision-making. thus, the interpretation should not be limited to the material issues of the contract but include also other considerations, such as whether the contract was ever concluded, i.e. does a valid contract exist that may be interpreted. 2.6.1 approaches to interpretation alternative approaches to interpretation are the objective and the subjective approaches. the former looks for a natural interpretation taking as a starting point the expressions of common use, the term «common use» including also the specific language used on a particular 40 bonell, p. 242 41 kaczorowska, p. 129 42 oikeustoimilaikitoimikunnan mietintö 1990:20 nordic journal of commercial law, issue 2003 #1 11 professional sector. the latter, instead, starts from the parties' intention: the expressions are seen as reflecting parties' common intention and the purpose of the agreement. many prefer this latter approach since it conforms better with the principles of freedom of the contracting and the autonomy of the parties' will. considering that the parties are free to decide with whom to contract and on which conditions, it is natural to think that they are also free to decide which expressions to employ. those who object the use of subjective method claim that the interpretation is most needed exactly when the common intention is unclear and thus the subjective approach does not offer a real answer to the questions. those who defend the objective method allege that by employing the ordinary meaning of the words, a greater certainty of contractual relationships is achieved, also because the contracts often have an effect to undetermined group of third parties as well. this approach also excludes the uncertainty derived from speculations on what the contracting party actually meant by employing a certain expression. third parties' position counts also because some rights are transferable and the transferee needs to know the rights and obligations deriving from his new position.43 2.6.2 interpretation of a contract of sale it has been suggested, that when interpreter applies the finnish sale of goods act, the interpretation of a sales contract should be done respecting the same principles that are respected when interpreting any other type of contract. in any event, it may be prudent to take into account the principles applicable to the cisg, whether or not the convention applies. the nordic countries decided that the part ii of the convention would not be applicable; the most likely reason for this having been the need to keep the rules governing the formation of the contract similar to every type of the contract i.e. not creating a different regime for the contracts of sale of goods. anyhow, the cisg contains some important principles concerning the interpretation and application of the contract. cisg art. 8 states that the contractual expressions have to be interpreted in conformity with the intention of the party, unless the counterparty did not know it or could not have been aware of it, the purpose of the intention being the discovery of the parties' common purpose. the awareness of the counterparty's intention in this context should be understood as a common purpose. it follows that the party who does not accept the purpose of the counterparty must expressly draw other's attention to this fact. this is an expression of an underlying obligation of loyalty towards the other party.44 the situation in the u.k. is that, one cannot necessarily draw a conclusion that all their words have become part of the contract based on what the parties said. their statements may be classified either as terms of the contract or as «mere representation.» the distinction was long of great practical importance, but new developments have reduced its effect without lessening its conceptual significance. if a statement is a term of the contract, it creates a legal obligation for whose breach an appropriate action lies at common law. if it is a «mere presentation,» the position is much more complicated. it is clear that, if a party has been induced to make a contract by a fraudulent misrepresentation, he may sue in tort for deceit and may also treat the contract as voidable. but until recently it was believed to be principle of the common law that there should be «no damages for innocent misrepresentation,» and that, in this context, «innocent» meant any misrepresentation which was not fraudulent. in the nineteenth century, 43 in the judiciary interpretation certain principles are recalled, in order to favour a proper position. in the doctrine various principles have been broadly analized: the principles may be roughly divided into two categories, namely linguistic and judicial principles. 44 routamo ramberg, s. 30 nordic journal of commercial law, issue 2003 #1 12 equity indeed allowed the right of avoidance to a party who had been induced to make a contract by such an «innocent» misrepresentation, but this remedy was limited in a number of ways. by the misrepresentation act 1967, representees acquired a remedy that in most cases will be preferable to an action of negligence. section 2(1) of this act in effect gives a right to damages to anyone induced to enter a contract by a negligent misrepresentation, and casts upon the representor the burden of disproving the negligence. but where a statement is made neither fraudulently nor negligently, the injured party can still obtain damages only by showing that if forms part of this contract. contractual cartography remains important.45 3 the goods 3.1 the object of the sales contract: definitions of »goods» in the cisg the convention does not define «goods» but some of the exclusions specified in the art. 246 and other provisions of the convention provide guidance for construing this basic concept. it is clear that the «goods» governed by the convention must be tangible, corporeal things, and not intangible rights like those excluded by art. 2(d): stocks shares, investment securities and instruments evidencing debts, obligations or right to payment. the point is that these documents represent intangible rights a claim for payment or for receiving dividends or other payments from an enterprise.47 possible dispute over whether electricity is tangible (a quantum) or intangible (a wave) was avoided by the exclusion of electricity. on the other hand, a sale of gas is within the convention; a motion to exclude gas was defeated.48 the classification of computer software has led to controversy; some software seems difficult to distinguish from an exceedingly compact book or photograph record. here, as in other borderline areas, it seems prudent to state in the contract whether the convention applies. the conclusion that «goods» refer to tangible, corporeal things means that sales of patent rights, copyrights, trademarks and «know-how» are not governed by the convention.49 the convention does not address certain questions that arise frequently in the area of sales law; it does not contain provisions on letters of credit, methods of perfecting security interests in goods and other commercial subjects, many of which can be relevant to sales of goods.50 3.2 the meaning of «goods» in the u.k. until the advent of the sale of goods act of 1893, english sales of goods was, for the most part, contained in a vast body of case law. the provisions of the 1893 act remain the basis of english sales of goods law, although that act has now been re-enacted in the sale of goods act 1979 and been consolidated with more recent law relating to the sale of goods, particularly, some parts of the misrepresentation act of 1967, the unfair contract terms act of 1977 and sale and supply of goods act 1994 and sale of goods act (amendment) 1994. there is a 45 furmston, m.p., p. 127 46 art. 2: »this convention does not apply to sales: (a) of goods bought for personal, family or household use, unless the seller, at any time before or at the conclusion of the contract, neither knew nor ought to have known that the goods were bought for any such use; (b) by auction; (c) on execution or otherwise by authority of law; (d) of stocks, shares, investment securities, negotiable instruments or money; (e) of ships, vessels, hovercraft or aircraft; (f) of electricity. 47 art. 3(2) takes a similar approach in excluding the contracts in which the preponderant part of a party's obligations consists in the supply of labor or other services. see honnold, p. 101 48 delegates were clear that »gas» constituted »goods.» also sale of oil is covered. 49 honnold, p. 101 50 kritzer, p. 5 nordic journal of commercial law, issue 2003 #1 13 considerable mass of case law interpreting the act of 1893, much of which remains relevant to the interpretation of the act of 1979. 51 the enactment of the uniform laws on international sales act introduced the two uniform laws adopted by the hague conference of 1964 into the law of united kingdom. the act of 1967 was activated and the two uniform laws came into force in the united kingdom on august 18, 1972. 52 the sphere of application of the cisg is different from that of the uniform laws. while the latter are intended in principle to all international sales but enable an acceding state to restrict their application to sales contracts between parties who have their place of business or habitual residence in contracting states, the vienna convention realistically restricts its application to contracts between parties who have their place of business in different contracting states, or to cases in which the proper law of the contract is that of the contracting state. 53 the term «goods» is defined as including «all personal chattels other than things in action and money.» the term includes «emblements, industrial crowing crops, and things attached to or forming part of the land which are agreed to be severed before sale or under contract of sale.» the definition is fairly extensive but there are nevertheless some things that do not, or may not fall within this definition, for instance items of intellectual property and company shares. the question as to whether or not the sale of computer software should be treated as a sale of goods does not admit a simple answer. much of software is sold over the counter in stores in the same way as books and records. if there is a defect in the medium carrying the program, there is no difficulty in holding that there is a breach of the quality warranties of the sale of goods act. it does not seem to push this analysis much further to say that if a malicious person has infected the software with a virus which damages the data and other matter stored in the purchaser's computer, the seller should be liable under the sale of goods act. in the first place, that is a way of transferring liability to the person ultimately responsible, namely the software house, whom the shop supplying the software will no doubt sue in turn. secondly, the situation is analogous to that where, for example, an infected animal spreads disease through the purchaser's herd. but other software is either specially written for the customer, or requires extensive work to be done to adapt it to the customer's needs. there is no continuing relationship between the parties, which may eventually require the customer to have access to the source codes if the supplier goes into liquidation or is otherwise unable to continue to develop the program for the customer's needs. the sale of goods analogy, which presupposes a particular point in time when the parties can be said to have »sold the goods», seems inappropriate. clearly, if there are defects in the underlying product, the medium of an «off-thepeg» program which is to be adapted, then these can be dealt with under the sale of goods act. 51 atiyah adams, p. 1 see also the comments of tudway, in developments in english law affecting contracts for the international sales of goods, p.66 52 the order in council which gives effect to the two uniform laws provides that the uniform law on sales shall only apply if it has been chosen by the parties to the contract. (this regulation was admitted by the 1967 act. the united kingdom was entitled to restrict the scope of application of the uniform law on sales in this manner by virtue of art. 5 of the first convention). the uniform law on formation has only ancillary character and applies only to contracts to which the uniform law on sales is applied. while such a restriction considerably reduces the usefulness of the uniform laws, it might lead to a difficulty if one party to the contract is resident in the united kingdom and and the other in a country in which the uniform laws apply automatically. this raises a problem of private international law, namely that it has to be determined whether the applicable law of the contract is english or foreign law. in the latter case, the uniform laws apply to an english party who has not adopted them in contract, but in the former, they apply only if adopted by the parties. 53 schmitthoff's export trade, p. 687 nordic journal of commercial law, issue 2003 #1 14 but the contract to supply software adapted to customer's requirements will usually entail more than a mere undertaking on the part of the supplier to use reasonable care and skill. 54 the seller's assertions about the performance of the software will often be crucial. these representations may themselves, of course, give rise to a claim for damages for material misrepresentation. it is not wholly clear whether the term «goods» could cover human blood for transfusion or other similar items not ordinarily thought to be the subject of commerce. another point that requires comment is the latter part of the statutory definition. since the products of soil must always be sold with a view to their ultimate severance «under the contract of sale,» it appears that, whether or not they are also land within the meaning of the law of property act 1989, they are now always goods within the meaning of the sale of goods act. it is, however, still necessary to distinguish the products of the soil or «things attached to or forming part of the land» on the other hand, from the actual land itself, or interests therein, on the other. the sale of sand from a quarry, for example, is not a sale of things attached to or forming part of the land, but a sale of an interest in the land itself.55 3.2.1 different types of goods in the u.k. the subject matter of the contract of sale may be either existing goods owned or possessed by the seller, or future goods, or a spes, or chance. existing goods may be either specific or unascertained. future goods include goods not yet in existence, and goods in existence but not yet acquired by the seller. it is probably safe to say that future goods can never be specific goods within the meaning of the act. this certainly seems to be true of those parts of the act dealing with the passing of title. however, if sufficiently identified, future goods may be specific goods in some cases. a sale of 200 tons of potatoes to be grown on a particular piece of land was held to be a sale of specific goods, despite the fact that they were not existing goods, for the purposes of the common law rules of frustration.56 the sale of a spes chance must be distinguished from the contingent sale of future goods, though the distinction is not so much as to the subject matter of the contract but as to its construction. thus it is possible for a person to agree to buy future goods from a particular source and to take a chance) or, in the language appropriate to the sale of goods, the risk) of the goods never coming into existence. for example, a person may agree to buy whatever crop is 54 atiyah adams, p. 47 in the saphena computing ltd v. allied collection agencies ltd the purchasers sought damages for failure to supply software which was reasonably fit for the purpose for which it was required. it was held at first instance that there was implied term as to the fitness of the software for the purpose for which it was required, and that this obligation had not been fulfilled by the time the parties terminated their relationship, but the effect on the termination agreement was, inter alia, that the plaintiffs were not required to carry out further work on the software, and had to make available to the defendants the source codes in order that the defendants might make it reasonably fit for the purposes specified. the court of appeal upheld this decision. in new south wales it has been held that a supply of a package of conputer hardware and software together is a sale of goods within the act for the purposes of the implied terms as to quality and fitness, so these terms apply not merely to physical objects, but to the software programs contained in them. 55 atiyah adams, p. 49. in morgan v. russel (1909 1 kb 357) it was held that the sale of cinders and slag, which were not definite or detached heaps resting on the ground, was not a sale of goods but a sale of an interest in land and, therefore, the sale of goods act did not apply. similarly, in the australian case of mills v. stockman (1966-67 116 clr 61) a quantity of slate which had been quarried and then left on some land as waste material for many years was held to be part of the land, and not goods. the slate was »unwanted dross cast on one side with the intention that it should remain on the land indefinitely, and, by implication, that it should form part of the land. 56 failure of the crop was thus held to form the basis for avoidance of the contract. nordic journal of commercial law, issue 2003 #1 15 produced from a particular field at a fixed price. 57 there are at least three possible constructions: 1. it may be a contingent sale of goods within the section 5(2)58 in which case if the crop does not come into existence the contract will not become operative at all and neither party is bound. 2. alternatively, it may be an unconditional sale that is the seller may absolutely undertake to deliver the goods, so that in effect he warrants that there will be a crop in which case, if there is no crop, he will be liable for non-delivery. 3. thirdly, it may be a sale of a mere chance, that is the buyer may take the risk of the crop failing completely, in which case the price is still payable. 59 3.3 «goods» in finnish legislation the current law regulating commercial relationships in finland is sale of goods act (hereinafter fsga), enacted 1987. before it came into force, the only general provisions available dated as far as 1734. provisions relating to sales of specific goods were of course enacted throughout the years but many important issues were not regulated at all. at this point it has to be noted, however, that even in cases of the lack of a proper, up-to-date statute law, we can hardly speak of a total gap. since the very beginning of the existence of the finnish doctrine of the jurisprudence, a strong reference has been made to other nordic countries, due to the cultural and social similarities in these states. as regards the references to past writers in general, it has to be borne in mind that even though new rules of law are enacted and the old ones become non-effective, the ideas lying underneath do change slowly. the core of the law, the basic principles of just and unjust, defective and effective remain long unchanged. earlier, the rules regarding lack of conformity were scarce; the old sale of goods act (osga) 1:4 stated that: «if the goods sold are later noted to be defective, and if it's lawfully proved that the seller was aware of it but still did not disclose it, shall the seller take the goods back and return the performance of the counterparty; and shall he also settle his damages. if the goods bear a defect not visible, which of neither seller nor the buyer was aware of, shall the contract of sale be void, and shall the parties withdraw the respective performances. if it was agreed that the buyer shall keep the goods whether or not they turn out to be better or worse than what was agreed upon, shall the contract remain valid anyhow.» 60 this rule of law turned out to be rather problematic in practice; a situation where the rules concerning sale of movables were almost absent, raised a question whether those few existing rules were exhausting when it comes to determining the remedies in the case of defective goods. what followed was that it was alleged that the buyer could not claim for reduction of the price since the norms did not recognize it. furthermore, the scope of the application of the said rule has been under some discussions; some have claimed that the said rule is applicable only to the 57 such a transaction comes perilously close to a gamble but, as the seller stands to gain the same amount in any event, it appears that the sale cannot be a wager within the gaming act 1845. 58 section 5(2): »there may be a contract for a sale of goods the acquisition of which by the seller depends on a contingency which may or may not happen.» 59 atiyah adams, p. 52 60 there was also a specific rule concerning a sale of a horse: a trial of three days. nordic journal of commercial law, issue 2003 #1 16 sale of specific goods while the others alleged that it's applicable also to the sale of generic goods. 61 the osga 1:4 took a negative approach; it described the situation where the goods could be considered defective. given the scarcity of the rules of law, in order to obtain a more comprehensive idea of the concept, i find it appropriate to study the differing views in the doctrine of that time. according to chydenius, the defect has to be of a kind that reduces the value of the goods or renders them less suitable for their ordinary purpose, in a manner that a reasonable man would not have committed himself to the contract. hakulinen, instead, sees the goods defective whenever their value is reduced or their suitability to ordinary or contractually agreed purpose is reduced or extinguished. kivimäki, on his part, sets the criteria otherwise: «the defect is understood as a factor that renders the goods non-functional, whether it is a material, structural or other kind of factor. however, also the lack of a feature may be considered as such, if the seller knew that the buyer expected the goods to bear that certain character and the lack of it actually renders the goods different from what was agreed upon.62 this situation where finland did not have an up-to-date sale of goods act created a different set of problems. without a proper written law, a finnish party was in a weaker position from the beginning. the finnish party was often forced to accept the other party's choice of law without a chance for negotiations. the sale of goods act 1987 lifted the finnish parties from their disadvantageous starting point and gave them equal bargaining powers compared to those of their foreign business partners.63 given that finland has made a declaration to article 92 that it is not bound by part ii of the convention (formation of the contract), the parties have to pay attention to drafting the choice of law clause. it should be noted that the part ii of the convention might still be applicable to the contract of sale in finland if the rules of private international law lead to the application of the law of the country, which has ratified the cisg without an article 92 declaration.64 the fsga calls the object of the sale goods (tavara). the linguistic meaning of this word is a property which can be an object of an exchange on the market, and which can be assigned (tangibles). the term suits less to intangibles, such as rights. some difficulties appear when the borderline between a contract of service and a contract of sale needs to be drawn. supply of electricity is undisputedly considered a service. however, the rights based on such a contract may be object of the sales contract. gas and water, instead are regarded as goods in the meaning of fsga, according to their nature. more problematic are audiovisual electric transmissions. 61godenhielm, p. 88. but see kko 1948:ii:187 where the court held otherwise. 62 aaltonen, p. 99 considering different aspects of the seller's liability as regards the reduction of the value of the goods, it has to be borne in mind that the seller is not responsible of the effective commercial proficiency of the goods. 63 when the different possibilities to ratify the cisg were explored, it was discovered, that even though it was important to develop domestic sales law in accordance with international trends, the cisg was not suitable to form a new sales law as such. the cisg was a compromise between the different legal traditions and it was essentially developed for the needs of international trade. while some provisions were seen as self-evident, others were seen to be too imprecise for the purposes of a domestic sales law. on the other hand, if a sales law would have provisions concerning both international sale of goods and domestic sale of goods, the differences between the two would be easily detected and understood. however, it was discovered that several provisions would have to be modified for the purposes of domestic sales, which would eventually lead to a complex law. it was also feared that the solution would arouse suspicion among the foreign traders that the domestic traditions influence the interpretation of the cisg. kuoppala, chapter 1.2.2.3. 64 kuoppala, chapter 1.2.1 nordic journal of commercial law, issue 2003 #1 17 on the other hand, the fsga may be applicable even on the fields not covered by it, throughout the analogy. as regards computer products, the situation is more problematic, as we have seen above. there is no doubt that a computer falls to the category of «goods.» however, a computer does not work without its software. usually the software is not actually sold, but a license to use it may be granted. hence, the applicability of the fsga is problematic since the applicability requires that the goods be handed over to the buyer. 65 usually the object of the sale exists at the moment of the conclusion of the contract. this is, however, not a necessary requirement. also the goods that will come to an existence or can be determined only afterwards may be traded. it may well be that the buyer will in the end have nothing as a counterperformance; let us just think of a lottery ticket.66 4 lack of conformity 4.1 the cisg rules regarding lack of conformity the cisg article 35 determines when goods are deemed to conform to the contract, although it doesn't cover third party claims or claims based on industrial or other intellectual property; the latter are governed by cisg articles 41 and 42. cisg article 35 largely corresponds to article 33 ulis. however, the wording of cisg art.35 is substantially simpler and more precise than that of its predecessor. article 35 of the cisg begins by stating the basic rule that the goods must conform to the requirements of the contract, whereas art. 33 of ulis includes the basic rule as a subsidiary, catch-all provision. art. 35 of the cisg and art. 33 of the ulis differ as regards the classification of non-conformity in dogmatic terms. while under the ulis, non-conformity of the goods automatically constituted a failure to fulfil the delivery obligation, under the cisg non-conformity of the goods has no effect on delivery, but gives rise to the buyer's remedies under cisg art. 45.67 a further difference is to be found in article 33 (2) of the ulis, which declared immaterial discrepancies to be irrelevant. it was thought that such a rule is unjustified, if avoidance of the contract is possible only in the event of a fundamental breach of contract. 68 article 35(3) of the cisg is based on article 36 of the ulis. however, the latter provision did not include a sale by sample or model within its terms. 69 under the ulis the seller had not fulfilled his obligation to deliver the goods where he handed over goods which failed to conform to the requirements of the contract in respect of quality and description. however, under the cisg, if the seller has handed over or placed at the buyer's disposal goods which meet the general description of the contract, he has «delivered the goods» even though those goods do not conform to the contract in respect of quality and 65 routamo ramberg, p. 14 66 routamo ramberg, p. 11 67 even art 35 cisg noes not expressly treat delivery of different goods, it must be considered lack of conformity no matter how extreme is the deviation. see schlechtriem 2, p. 67. otherwise bianca in conformità dei beni e diritti dei terzi, p. 147, where he makes difference between the goods that do not conform to the description of the contract and the goods that are totally different than what was agreed upon. 68 an australian proposal that a provision corresponding to article 33(2) ulis should be included was rejected at the diplomatic conference. the canadian delegation withdrew a proposal that the requirement for the goods to be fit for ordinary and particular purposes should be applicable only to sales made by professional sellers and that the criteria governing fitness for ordinary use should be clarified. see schlechtriem, p. 275 69 schlechtriem, p. 275 nordic journal of commercial law, issue 2003 #1 18 quantity. it should be noted, however, that, even though the goods have been «delivered», the buyer retains his remedies for the non-conformity of the goods. 70 4.1.1 practical importance of art. 35 the case law interpreting cisg article 35 is scarcer than one would think; many decisions leave open the question of a defect and are solved on the basis of lack of examination or the notice of the non-conformity by the buyer or lack of evidence regarding those requirements. the limited number of cases is explained also by the fact that quite a few decisions concern requirements for avoidance of the contract.71 in order to rely on a lack of conformity, the buyer must comply with articles 38 and 39 which concern the burden of examining the goods and of giving notice of the non conformity. the failure to comply means loss of right to invoke a lack of conformity, except if the seller knew or ought to have known of it and did not disclose it to the buyer (cisg art. 40), or if the buyer was justified in not complying with the examination and notice requirements (cisg art. 44). furthermore, there is a cut-off period: after two years, the buyer cannot give notice even if a hidden defect is then discovered.72 when the buyer is entitled to rely on the lack of conformity, the whole set of remedies in the convention may be invoked, provided that the conditions set forth for each of them are present: avoidance (cisg art. 49), repair of substitution of goods (cisg art. 49), reduction of price (cisg art. 50), and in any case, damages (cisg arts. 7477). cisg article 35 is based on a uniform concept of »lack of conformity». that concept includes not only differences in quality, but also differences in quantity, delivery of an aliud 73 and defects in packaging. in so doing, the cisg differs materially from the most domestic laws on liability for defective goods, which often make a subtle distinction. in general, no significance is attached to the distinction, familiar in germanic legal systems, between ordinary characteristics of goods and a specific warranty that particular characteristics exist, or between peius and aliud, or between an aliud capable of being authorized by the buyer and which is not. nor has the french distinction between vice cachè and vice apparent been included in the cisg.74 finally, cisg art. 35 does not differentiate between conditions and warranties. this must be borne in mind when interpreting the concept of «conformity», because there is otherwise a risk that each 70 secretariat commentary, comma 2 71 see decisions tribunal cantonal du valais, 29.6.1998; bezirksgericht unterrheintal st. gallen 16.9.1998; oberster gerichtshof 30.6.1998; pretura di torino 30.1.1997; tribunale d'appello di cantone di ticino 15.1.1998 72 as a consequence of his negligence the buyer loses the right to claim a remedy from the seller on the basis of the lack of conformity. since a delivery that falls short is regarded as one type of a lack of conformity the negligent buyer may end up paying for goods that were never actually delivered. even though the consequence is very strict from the buyers' point of view, the sellers' need to know if the buyer intends to issue claims is far more important than the buyers' right to rely on the lack of conformity. it's important to protect the seller against claims, which arise long after the goods have been delivered. claims issued in that way are often of doubtful validity and when the seller receives his first notice of such a contention at a late date, it would be difficult for him to obtain evidence like the condition of the goods at the time of delivery, or to invoke the liability of a supplier from whom the seller may have obtained the goods or the materials for their manufacture. see kuoppala, chapter 1.1.2. 73 about difficulties in interpretation of said article, see also bianca in convenzione di vienna sui contratti di vendita internazionale di beni mobili, p. 147. 74 however, the nature of the defects does count: it has to be taken into consideration when valuating the length of the reasonable time of notice of lack of conformity. nordic journal of commercial law, issue 2003 #1 19 court will interpret cisg art. 35 in accordance with its own domestic legal classifications and that such differences in interpretation will hinder unification of the law.75 4.1.2 agreement between the parties cisg art. 35 provides that regard must be had first to the requirements of the contract. the primary test is, therefore, what characteristics of the goods are laid down in the contract by means of quantitative and qualitative descriptions. article adopts the premise that a defect must be defined by reference to what the contracting parties intended, a premise which is accepted by the prevailing opinion in various legal systems. the requirements may be expressly or impliedly determined in the contract. it is likely that in particular in an implied agreement reference is made to specific industry standards. the contractual requirements may be individually negotiated, but they may also follow from the standard business terms of the seller or the buyer. advertisements by the seller, in which, for example, he refers to particular qualities of the goods, may be taken into consideration in order to determine the conformity with the contract under cisg art. 35.76 the general rule of cisg article 35 is that the goods must conform to what the parties have agreed upon in the contract, the brevity of which does not immediately reveal its importance. the objective tests contained in the article are meant to play a subsidiary role in this respect. it must be borne in mind, that the agreement of the parties concerning quality, quantity and description does not need to be express. it may be implied by way of interpretation of their statements and conduct (cisg art. 8).77 specific requirements may be deduced, however, from the purpose and the circumstances of the contract, and from usage even if there is no direct agreement. 78 4.1.2.1 gap filling, parol evidence-rule where the parties' express agreement seems incomplete, e.g. as regards the quality of goods, we would normally turn to the cisg implied obligations to fill in the gaps. sometimes, however, the document that seems to represent the complete agreement between the parties does not, a party may claim, include all express oral statements made during the contract negotiations. is that party entitled to introduce evidence to prove that the oral statement is part of the written contract; perhaps even that the written contract does not mean what the words seem to say? the so-called parol evidence rule79 would deny any effect to the parties' alleged oral understanding, simply because that understanding would vary the written contract of sale. some jurisdictions might not be even allow presentation of any evidence for the purpose of proving that the oral statement was made. however, under the cisg (art. 11) a «contract of sale» may be proved by any means. since this language refers to all the contract terms allegedly agreed upon, a court should admit evidence of additional or different terms. this interpretation is supported by the cisg art. 8(3) requiring that in order to determine the intent of a party, «due consideration be given to all relevant circumstances of the case including the negotiations» etc. for these reasons the parol evidence rule is inapplicable to a cisg 75 schlechtriem, p. 275 76 schlechtriem, p. 277 77 veneziano, p. 44 78 enderlein maskow, p. 141 the question whether insignificant differences in quality have to be considered, remains open. a relevant australian proposal was not successful. 79 the parol evidence rule which is really a rule of substantial law applies only in the case of a fully »integrated» written instrument, but under some laws (e.g. texas state law) written agreements are presumed to be fully integrated. nordic journal of commercial law, issue 2003 #1 20 contract. so, if a prior statement has been made, we should give «due consideration» to that fact. a contrary statement in an american cisg case, which has been contradicted by another american court, is clearly out of tune with the international view.80 extrinsic evidence of a custom in the trade is permitted provided it is not contrary to an express provision in the written contract, or to establish that there is a collateral contract. the court may rectify a written agreement that by mistake does not accurately record the agreement of the parties although it may simply consider the amended contract without formally ordering its rectification. where one party has given another a verbal promise not to rely on a term in the general conditions and that promise has been accepted by another party, he cannot rely on that term if it would make the verbal contractual wholly illusory. 81 as previously stated in connection with the interpretation of a sales contract in the u.k., the fact that the cisg has removed the parol evidence hurdle does not mean that every precontractual statement will be given contractual effect. courts and arbitrators may still entertain a presumption of the completeness and correctness of writing and after hearing the witnesses the fact-finder may conclude that this presumption has not been overcome. even in cases where there is a clear proof that a given oral statement concerning a matter relevant to the sale that was made, cisg articles 8 and 11 do not automatically determine whether the statement should be treated as part of the contract, i.e., whether the statement-maker intended his precontractual statement to bind. what these cisg provisions do is to mandate courts and arbitral tribunals in an international sales case to allow proof of and to consider the effect of statements allegedly made.82 4.2 finland's rules of law on the conformity of goods the finnish sale of goods act differentiates the lack of conformity as regards the quality and third-party claims. this distinction makes difference when assessing the seller's responsibility; he is responsible of all the losses, direct and indirect, deriving from third-party claims if the lack of conformity existed at the moment of the conclusion of the contract. the responsibility is, however, excluded if the buyer was aware of the non-conformity at the determining moment. the fsga is directed to regulate the defects connected to the use and the properties of the goods. these so called factual defects include for example defects deriving from raw material, inaccurate manufacturing or structural erroneousness. the rules concerning the seller's obligation to remedy the defects are meant to cover specifically these cases, since defects of other kind would be extremely difficult or even impossible to remedy. 83 case law of finnish courts outlines the application of the rules concerning lack of conformity. 4.2.1 conformity with contract, section 17 the finnish sale of goods act, section 17 states: «the goods must conform to the contract in regard to description, quantity, quality and other properties and be contained or packaged in the manner required by the contract. 80 see case beijing metals v. american business center, 993 f.2d 1178 (5th cir 1993). the contract of sale of bacon was governed not by texas domestic law, but cisg. under art. 11 a contract of sale may be proved by any means, including witnesses. since this language refers to all the contract terms allegedly agreed upon, even a texas court should admit evidence of additional or different terms. bernstein lookofsky, p. 55 81 schmitthoff's export trade, p. 62 82 bernstein lookofsky, p. 57 83 routamo ramberg, p. 131 nordic journal of commercial law, issue 2003 #1 21 except where the parties have agreed otherwise, the goods must: (1) be fit for the purpose for which similar goods are ordinarily used; (2) be fit for any particular purpose for which the goods were intended if the seller knew or must have known of this purpose at the time of the conclusion of the contract and it was reasonable for the buyer to rely on the seller's skill and judgment; (3) possess the qualities of goods which the seller has held out as a sample or model; and (4) be contained or packaged in a manner that is usual or otherwise appropriate for similar goods, if packaging is necessary to preserve or protect the goods. if the goods do not conform to the provisions of paragraph 1 or 2, they are defective.» the cisg 35 has served as a model for the rules concerning lack of conformity in finnish sale of goods act in the section 17. the starting point for both of these regulations is the contract itself: the valuation is based on the requirements stated in the contract. when no such requirements are present in the contract, the gaps need to be filled with other norms. in this respect a distinction must be made between the interpretation of the contract and gap filling. as the wording of the cisg 35 leaves little, or no room at all whatsoever for extensive interpretation, fsga 17 has to be interpreted this way. those cases that are listed in the cisg 35(2) and which have served as a model for fsga 17 do not constitute an exhaustive list. when neither the contract itself nor the cases of fsga 17 do not offer guidance, it has to be decided how the «conformity with the contract» will be defined. 84 as regards to the quality of the goods, the seller's responsibility, when relying to the fsga 17, derives from his declaration of intention, irrespective of the fact whether or not the responsibility is based on the cases listed in 17. therefore, it's not necessary to examine whether or not the seller was aware of the lack of conformity; his responsibility ensues from it in any case. attention has to be paid to the fact that the requirement laid down by 17.2 «fit for the purpose for which similar goods are ordinarily used» has to be interpreted strictly. it doesn't regard bad quality. for example, a car that consumes remarkably lot of gasoline, or a piece of furniture manufactured of poor materials, is not defective in a sense of 17.2. 85 kko 1998:15086: the seller had the right to avoid the sale contract because the painting bought wasn't authentic even if the seller had expressly held out its authenticity. the seller relied on his original title; the painting had been bought from a noted auction room as authentic. the seller claimed that the notice of non-conformity was made too late: the contract had been concluded in the autumn 1991, the buyer had had the painting examined by professionals on 13.1.1995 and the notice of non-conformity was made 28.1.1995. the buyer avoided the contract 13.6.1995. the judges disagreed on the decision: the majority consented to the buyer's right to reduction of the total price (the aforementioned painting was a part of collection of several paintings that were bought at the same occasion) but a minority disagreed. the minority stated that the notice of non-conformity wasn't made timely and the buyer had lost his right to rely on the defects of the goods. 4.2.2 information relating to the goods, section 18 however, the definition of defective goods as stated by section 17 is not exhaustive: section 18 lays down additional rules concerning information relating to the goods: 84 routamo ramberg, p. 129 85 routamo ramberg, p. 130 86 korkein oikeus, kko, finnish supreme court nordic journal of commercial law, issue 2003 #1 22 «the goods are also defective if (i) they do not conform to information relating to their properties or use which was given by a person other than the seller when marketing the goods or otherwise before the conclusion of the contract and (ii) the information can be presumed to have had an effect on the contract87 the goods are also defective if (i) they do not conform to information relating to their properties or use which was given by a person other than the seller, either at a previous level of the chain of supply or on behalf of the seller, when marketing the goods or otherwise before the conclusion of the contract, and (ii) the information can be presumed to have had an effect on the contract. however, the goods shall not be considered defective if the seller neither knew nor ought to have known of the information that was given. the provisions of paragraphs 1 and 2 shall not be applied if the information has been corrected clearly and in time. in its decision 1991:153 the supreme court of finland has paid attention to the moment of the delivery of the goods instead of the moment of the conclusion of the contract, as the wording of the law presumes. the buyer had ordered gravel for a construction project. the seller, at the moment of delivery of the goods to the construction site, became aware of the purpose for which the gravel was intended, and realized its inappropriateness for the purpose. since the seller didn't inform the buyer of the inappropriateness, as he, being a professional on his field, should have done, the court ruled that the goods did not conform with the information provided by the seller.88 kko 2001 77: the seller had given an express warranty that the goods would be fit for the particular purpose disclosed by the buyer. the goods were yet to be manufactured at the moment of the conclusion of the contract. the seller had, however, expressly guaranteed the suitability of the goods for the particular purpose without having checked it. the seller's responsibility ensued from his negligence to assure himself of the suitability for the particular purpose. the conclusion was that the goods must conform to the information given to the buyer before concluding the contract. otherwise the goods are defective in the sense of 18. if the information to the buyer has been given at the time of conclusion of the contract, they are considered to «have had an effect on the contract.»89 in its decision 1998:51 the supreme court of finland stated that the second-hand car that had been driven for 73 000 kilometres instead of the 49 000 told to the buyer, didn't conform with the information given to the buyer. the court made a reference to the sections 17 and 18. 90 the seller's responsibility is not limited only to cases where the seller has given the information to a specific customer. it also includes the information given through a marketing campaign directed to the public. however, all the information given cannot be considered relevant. the seller's liability will ensue only if the information given has had an effect on the contract; the 87 the tokens (i) and (ii) are here and later in the text, as well as in the unofficial translation of ministery of justice, used only to facilitate the reading and understanding of the translation. they do not appear in the original finnish or swedish texts and should therefore not be used to identify any references to the act. 88 kko 1991:153 89 wilhelmsson sevón koskelo, p. 102 90 kko 1998:51 nordic journal of commercial law, issue 2003 #1 23 information must have been of reasonable importance to the buyer and the buyer must have been aware of the information before the conclusion of the contract. if the seller wants to free himself from claims deriving from wrongful information, he should correct the buyer's false belief before the conclusion of the contract. the seller's responsibility is not limited to a campaign launched by the seller himself, but it includes also the information given by an earlier link of the distribution chain or another person working for the seller. only if the seller wasn't and couldn't have been aware of this information, may the seller avoid the responsibility. however, the seller's knowledge of the wrongfulness of the information is insignificant. if a specific reservation concerning the truthfulness of the information is not made, the seller should be prepared to take responsibility of the wrongfulness, also in situations when he has acted in good faith.91 the seller is not responsible only for the information given, but also for failing to give information. the responsibility will ensue from the failure, if he knew or ought to haven known and the buyer could reasonably presume to be informed of. an additional condition is that the failure has had an effect on the contract. it may be concluded that 19.2 has to be seen as a minimum requirement of the seller's obligation to inform the buyer that cannot be displaced by a general remark limiting the responsibility. when the sale contract is concluded without «as is» clause, this seller's obligation is remarkably wider. when assessing the elements of a single case, this seller's obligation has to bee seen together with the buyer's awareness and his opportunity to examine the goods beforehand. 92 in case s 96/1215 helsinki court of appeal93 applied the cisg. the court saw no reason to change the judgment of the court of the first instance which stated that it was undisputed that the buyer had required that the sample goods should possess certain characters indicated in its orders, and had expressly drawn the seller's attention to this. considering the information and assurance from the seller's side it wasn't the buyer's duty to find out how the seller will carry out the manufacturing. the court held that the buyer did count on the seller's expertise and could rely on the results from the tests taken before the delivery. aaltonen has prepared a three-phase structure for classifying the promises of the seller. the starting point is the warranty (takuu) from the seller's side that the goods do or do not have a certain property. this kind of seller's commitment reflects a fundamental character of the goods. in case that character is lacking, the buyer may declare the contract avoided.94 even if the seller encouraged the buyer to examine the goods at the moment of the above promise, the invitation itself does not free the seller from the warranty. this form of warranty requires seller's particular commitment, and without it, the promise cannot be considered as a warranty. the next category is a seller who promises the buyer the goods to have a certain character, without a particular commitment to the promise. in ekström's view the seller's awareness of the defect is not a relevant factor; he is liable of it in any case.95 hakulinen, instead, claims the seller's responsibility of only for what has been stated of the goods. according to vihma, on the other hand, the contract cannot be avoided relying on the unawareness. vihma also strongly opposes to what has been said by chydenius, who, on his turn, claims that the unaware seller's 91 wilhelmsson sevón koskelo, p. 103 92 wilhelmsson sevón koskelo, p. 104 93 helsingin hovioikeus 30.6.1998 94 in terms of the cisg. 95 aaltonen, p. 131. vihma and kivimäki interpret the situation otherwise, see aaltonen, p. 132 -134. nordic journal of commercial law, issue 2003 #1 24 activity could be interpreted as fraudelent if he gets, by means of misleading information, the buyer to conclude the contract. the third category covers those promises that could be seen as sales promotion that cannot be considered as serious promises by a reasonable person. in practice it's not easy to make a difference between the last two. to try to transform the seller's promise to a term of the contract could be a solution. if it is not reasonably feasible, the promise would likely be regarded as sales promotion. 4.2.3 «as is» clause, section 19 in addition, there are rules concerning «as is» clause. section 19 states: «if the goods have been sold subject to an «as is» clause or a similar general reservation concerning their quality the goods shall, nevertheless, be considered defective if: 1. the goods do not conform to information relating to their properties or use which was given by the seller before conclusion of the contract and the information can be presumed to have had an effect on the contract; 2. the seller has, before the conclusion of the contract, failed to disclose to the buyer facts relating to the properties or the use of the goods which the seller could not have been unaware of and which the buyer reasonably could expect to be informed about and the failure to disclose the facts can be presumed to have had an effect on the contract; or 3. the goods are in essentially poorer condition that the buyer reasonably could expect taking into account the price96 and other circumstances. when second-hand goods are sold at an auction, they shall be considered sold «as is.» when applying the provisions of paragraph (1)(3), regard shall be had to the asking price of the auction.» often the seller, wanting to limit his liability, sells the good using «as they are» or similar general expression as a reservation as regards to the quality of the goods. this, however, doesn't free him from the responsibility ensuing from information that he or his representative has given. to achieve the said goal the contractual clause should be more specific. 97 the section 20 states that the buyer cannot rely on a defect that he could not have been unaware of at the time of the conclusion of the contract. this corresponds to the cisg 35(3). however, the convention and fsga differ here: the statement of the cisg 35(3) concerns only the cases listed in the subparagraph 2, and which correspond with the cases 1 4 of the section 17, while the 20 covers the buyer's awareness of defects in general. the buyer's 96 in the english doctrine the price is generally considered as a relevant factor in deciding what quality the buyer is entitled to expect. goods which are commonly sold for a variety of purposes are also commonly sold for a variety of prices. and this is not only because market prices may vary, but also because some uses may require goods of better quality, and goods fit for those purposes may therefore command a premium. so, in the example of the wrecked car sold as a source of spare parts, one would obviously expect the price to be very much lower than if the car was sold as a roadworthy vehicle for ordinary road use. hence, if the price was a normal sort of price, the buyer is entitled to expect the car to be roadworthy, if it was not a case of a car with an antiquarian value. in this case the transaction would be characterized as being about a sale of a »collector's car,» and the fact that it was not roadworthy, might not render it unsatisfactory. in short, the borderline cases of this sort, the court characterizes the deal will be crucial. atiyah adams, p. 156 97 wilhelmsson sevòn koskelo, p. 103. see also aaltonen, p. 169. a clause similar to this a so called «tel quell»-clause, which is widely used above all in the overseas sales. according to this clause, the buyer takes the chance that the goods are not as he expected. on the other hand, the tel quell-seller has no right to pick certain items those less valuable from a lot, and comply with his delivery obligation in this way. the clause is always somehow aleatory; using it the buyer assumes risks that, if realized, may endanger the purpose and the sense of the contract. the mala fede seller cannot be discharged from the liability. nordic journal of commercial law, issue 2003 #1 25 awareness is of a decisive nature when assessing his right to rely on a defect; one cannot suppose that the goods are «defective» if the buyer was aware of the discrepancies in the quality and still bought the goods. 98 kko 1992 158: after the contract of sale of an apartment had been concluded, it appeared that the apartment suffered of a structural defect. the seller was responsible of the apartment's conformity with the contract. the court took into consideration the inconvenience caused to the buyer, the responsibility of the housing corporation and the final cost that remained to be borne by the buyer. 4.3 relevant rules of law in the uk 4.3.1 parol evidence in the uk; what did the parties say or write? as a general rule, no contractual formality is required under english law. only exceptional circumstances demand a degree of formality either as a substantive or as a procedural requirement of contract. a contract may be made wholly by word of mouth, or wholly in writing, or partly by word of mouth and partly in writing. if the contract is wholly by word of mouth, its contents are a matter of evidence normally submitted to a judge sitting as a jury. what the parties said exactly must be found as a fact. for example in smith v. hughes99 where the question was whether the subject matter of a contract of sale was described by the vendor as «good oats» or as «good old oats.» with reference to international conventions one must point out that the rigidity of the literal rule has recently been eased, also in other common law countries.100 the exclusion of oral evidence to «add to, vary or contradict» a written document has often been pronounced in peremptory language but in practice its operation is subject to a number of exceptions. in the first place, the evidence may be admitted to prove a custom or trade usage and thus to «add» terms which do not appear on the face of the document and which alone give it the meaning which the parties wished it to possess. in the second place, there is no reason why oral evidence should not be offered to show that, while on its face the document purports to record a valid and immediately enforceable contract, it had been previously agreed to suspend its operation until the occurrence of some event, such as the approval of a third party, and that event had not yet taken place. the effect of such evidence is not to «add to, vary or contradict» the terms of a written contract, but to make it clear that no contract has yet become effective. thirdly, there is a limited equitable jurisdiction to rectify a written document where it can be shown that both parties under a common mistake executed it. finally, the exclusion of oral evidence is clearly inappropriate where the document is designed to contain only part of the terms where, in other words, the parties have made their contract partly in writing and partly by word of mouth. this situation is so comparatively frequent as in effect to deprive the ban on oral evidence of the strict character of a «rule of law» which has been attributed to it. it will be presumed, «that a document which looks like a contract is to be treated as the whole contract.» but this presumption, though strong, is not irrefutable. in each case the court must decide whether the parties have or have not reduced their agreement to the precise terms of an all-embracing written formula. the question is basically one of intention and, like all such 98 routamo ramberg, p. 129 99 (1871) lr 6 qb 597 100 ferrari, in uniform interpretation of the 1980 sales law, p. 6 nordic journal of commercial law, issue 2003 #1 26 questions, elusive and conjectural. it would seem, however, that the more recent tendency is to infer, if the inference is at all possible, that the parties did not intend the writing to be exclusive but wished it to be read in conjunction with their oral statements.101 4.3.2 conditions and warranties the sale of goods act states as follows: section 11: «when condition to be treated as warranty (1) where a contract of sale is subject to a condition to be fulfilled by the seller, the buyer may waive the condition, or may elect to treat the breach of condition as a breach of warranty and not as a ground for treating the contract as repudiated.» (2) whether a stipulation in a contract of a sale is a condition, the breach of which may give rise to a right to treat the contract as repudiated, or a warranty, the breach of which may give rise to a claim for damages but not a right to reject the goods and treat the contract as repudiated, depends in each case on the construction of the contract; and a stipulation may be a condition, though called a warranty in the contract. (3) subject to section 35a if a contract of sale is not severable and the buyer has accepted the goods or a part of them, the breach of a condition by the seller can only be treated as a breach of warranty and not as a ground for rejecting the goods and treating the contract as repudiated unless there is an express or implied term of the contract to that effect. (4) nothing in this section affects a condition or warranty whose fulfilment is excused by law because of impossibility or otherwise. (5) paragraph 2 of this section applies in relation to a contract made before 22nd of april 1967.» at the time when the old sale of goods act was passed, contractual obligations were generally thought of as falling into two principal classes, namely conditions and warranties. in addition, there existed a body of equitable rules governing mere misrepresentations. in the 1950s and 1960s, it was suggested in a number of decisions that the distinction between a condition and a warranty was not exhaustive.102 this development assumed two forms. on the one hand, it was said that there were terms even more important than conditions fundamental terms. on the other hand, it also came to be said that there was a category of terms mid-way between the condition and the warranty, namely innominate (intermediate) terms. both of these are considered further below.103 101 furmston, m.p., p. 126 102 there has been an assumption that all contractual terms had to fall within one class or another and that this distinction could, in principle, be drawn at the time when the contract was made. any term whose breach could possibly take a serious form naturally tended to be treated as a condition as a result of this approach. since the distinction related to the terms of the contract and not to the consequences of the breach and, indeed, had to be applied in theory as at the date when the contract was made, there was a tendency for many terms to be treated as conditions even though their breach only caused minor inconvenience or loss, or even none at all. the consequence of this was that in the law of sale of goods, the duties of the seller were traditionally treated very strictly. any deviation from the terms implied by the act justified the buyer in rejecting the goods. but it was also widely assumed by lawyers that there was nothing peculiar in the law of sale or even in the sale of goods act with respect to these questions. it was generally thought that the position was the same with respect to all the seller's duties. atiyah adams, p. 57 103 atiyah adams, p. 53 nordic journal of commercial law, issue 2003 #1 27 the buyer is entitled to reject the goods if a condition relating to them is broken. a condition is a term to which the parties, when making the contract, attribute such importance that it can truly be described as being of the essence of the contract.104 a condition has to be distinguished from the warranty, which is a contract term of less significance and which relates to matters collateral to the main purpose of the contract. in the case of breach of a warranty the buyer is not entitled to reject the goods. he has to retain them but may claim damages, which, if the goods have an available market, are prima facie, the difference between the value of the goods as delivered and the value that they would have if they had complied with warranty. 105 as a condition is treated as being of higher legal quality than warranty, every condition includes warranty a statement that cannot be reversed. the buyer is, therefore, at liberty to treat a broken condition as a broken warranty and, instead of rejecting goods, he may elect to keep them and claim the difference as damages. if the buyer is deemed by law to have accepted the goods and if, consequently, he has lost his right to reject them, he is bound henceforth to treat what originally was a condition, as a warranty and his only claim is for damages for breach of warranty.106 the distinction between conditions and warranties was originally based on two factors. one factor was the intention of the parties as expressed in the contract and, thus, the question into which category a stipulation fell was treated as one of construction. but often the intention of the parties in this respect was indeterminable from the words used; and so the courts relied secondly on the general requirement of significant failure in performing the contractual obligation. this is no longer the sole basis of the distinction but the courts still take it into account when deciding, in cases of first impression, whether particular terms are to be classified as conditions.107 the sale of goods act 1979 implies into a contract of sale certain terms that, in england and wales, are to be regarded as conditions. if the goods are described then the goods supplied must correspond with their description in the contract. they must be of satisfactory (previously «merchantable») quality.108 they must be fit for the particular purpose for which, with the knowledge of the seller, they are bought109 or, if the purpose of the goods in question is not made known to the seller, they must be fit for all the purposes for which such goods are commonly supplied. further, they must correspond the sample, if they have been ordered on the basis of a sample provided, or with sample and description. these terms are implied by law into contracts of sale but subject to the unfair contract terms act 1977, may be contracted out or varied.110 in addition to the statutorily implied conditions certain terms in international sales contracts are taken to be conditions. generally, terms as to time are held to be a condition of the 104 if a term is strictly a condition this means that its full performance is a condition of the other party's obligations; his duties are conditional on the performance of the counterparty. atiyah adams, p. 56 105 appropriate measure is the difference between value of goods on delivery and the value if warranty had been fulfilled. if he has not yet paid the full price, he may set off his claim for damages against the price in diminution or extinction of the latter. see case bence graphics international ltd. v. fasson u.k. ltd. (1998) q.b.87 106 schmitthoff's export trade, p. 85 107 treitel, p. 602 108 as to the difference between words of identity and words of quality see the case trasimex holding sa of panama v. addax bv of geneva (1997) ewca civ 2096 109 see case r.bartram and others v. try homes ltd. instalfoam and fibre ltd. owens corning sa (1998(ewca civ 1177 110 sale of goods act 1979, see also unfair contract terms act 1977. schmitthoff's export trade, p. 86 nordic journal of commercial law, issue 2003 #1 28 contract. 111 the port of loading in an f.o.b. contract is a condition, as is the name of a vessel and the type of vessel to be used for the carriage of the goods if they have, unusually, been agreed between the parties. in the absence of any such agreement it is a condition of the contract that the goods be carried on a vessel that is usual in the trade for the carriage of such goods. 112 it may therefore be seen, that a breach of a condition operates as a repudiation of the contract by the party in breach. consequently, a buyer who is entitled to reject the goods is in the same position as a buyer to whom the goods were not tendered at all,113 unless the breached term has to be treated as an innominate term, or if de minimis rule114 or special considerations, such as a trade custom or an agreement of the parties to the contrary, 115 apply. in a normal situation the buyer is entitled to claim damages from the seller for the non-delivery of the goods. 116 if he has paid the purchase price in advance he can recover it by way of damages, and if he has suffered other reasonably foreseeable loss, he can recover damages as well. the motivation for the buyer's desire to reject the goods is usually that the non-conforming goods that the seller has tendered are useless to him and that the claim for damages is his only remedy. the practical point in the distinction between the buyer's right to reject the goods on grounds that a condition of the contract is broken and his right to claim damages for breach of warranty is that in the former instance the buyer can often claim damages on a considerably higher scale than in the latter. where a party is entitled to damages, he is bound to take reasonable steps to mitigate his loss but he is not bound «to go hunting the globe» to find a market in a distant country, nor can it be held against him, if he has acted reasonably, that a method of mitigation more favorable to the defaulting buyer existed.117 since the term warranty is defined by section 61 as an « agreement with reference to goods which are the subject of the contract of sale, but collateral to the main purpose of such contract, the breach of which gives rise to a claim for damages but not a right to reject the goods and treat the contract as repudiated.» both the meaning and the legal effects are explained. however, the term «collateral» hallowed by usage is not very wisely chosen, for it may give the impression that a warranty is a term which is somehow outside the contract, whereas it is fact a term of the contract.118 4.3.3 implied condition as to title one of the most important conditions in a contract for the sale of goods is that the seller will pass to the buyer a good title at the time of the sale. the relevant section119 reads: 111 see case b.s. and n.limited (bvi) v. micado shipping ltd. (2000) civ 296 112 schmitthoff's export trade, p. 86 113 the seller may, however make a second tender of new goods if the time for delivery has not expired. compare with the cisg art. 48(1). 114 de minimis non curat lex. 115 the conditions of trade associations which e.g. in the commodity trade, are widely accepted, sometimes exclude the rejection of goods. 116 the measure of damages is the difference between the contract price and the market price, if there is an available market for the goods. the relevant market price that is prevalent at the date of delivery or, failing delivery, at the date of refusal to deliver. see case bmbf (no 12) ltd. v hartland and wolff shipbuilding and heavy industries ltd. (2000) ewca civ 862 117 see case skandia property (uk) ltd. vala properties bv v. thames water utilities ltd. (1999) ewca civ 1985 118 atiyah -adams, p. 63 119 act 1893 12(1) 1979 12(1) nordic journal of commercial law, issue 2003 #1 29 « (1) in a contract of sale there is an implied condition on the part of the seller that in the case of an agreement to sell he will have such a right at the time when the property is to pass. (2) in a contract of sale, other than one to which subsection (3) applies, there is also an implied warranty that a) the goods are free, and will remain free until the time when the property is to pass, from any charge of encumbrance not disclosed or known to the buyer before the contract of sale is made; and b) the buyer will enjoy quiet possession of the goods except so far as it may be disturbed by the owner or other person entitled to the benefit of any charge or encumbrance so disclosed or known (3) this subsection applies to a contract of sale in the case of which there appears from the contract or it is to be inferred from the circumstances an intention that the seller should transfer only such title as he or a third person may have. (4) in a contract to which subsection (3) applies, there is an implied warranty that all charges or encumbrances known to the seller and not known to the buyer have been disclosed to the buyer before the contract is made. (5) in a contract to which subsection (3) applies, there is also an implied warranty that none of the following will disturb the buyer's quiet possession of the goods, namely a) the seller; b) in a case where the parties to the contract intend that the seller should transfer only such title as a third person may have, that person; c) anyone claiming through or under the seller or that third person otherwise than under a charge or encumbrance disclosed or known to the buyer before the contract is made. (6) paragraph 3 of the schedule applies in relation to a contract made before 18th may 1973. it must be noticed that the seller undertakes to ensure that the buyer would thereafter have the power to transfer that title to subsequent purchaser. normally, the transfer of the title should give the buyer an ability to make such a transfer of a title. but in some instances, the one may not necessarily follow the other.120 120 in niblett v. confectioners' materials co, (1921) 3 kb 387, all er rep 459, english buyers bought from new york sellers a consignment of condensed milk. payment was agreed to be made in cash upon reception of the shipping documents. when the goods arrived, her majesty's customs detained the goods on the ground that they infringed a registered united kingdom trademark. the buyers were therefore compelled to remove the labels which carried the offending trademark from the cans before they were sold. the sale of the cans devoid of labels resulted in a loss. the buyers sued the sellers, claiming the breach of two implied undertakings. firstly, it was argued that the buyer did not enjoy the warranty of quiet possession of the goods. the court held that the warranty of the quiet possession was breached because the buyers »were never allowed to have quiet possession.» the second ground upon which the buyers rested their claim was the breach of the implied condition that the sellers were the owners of the goods and were able to pass a good title to the buyers. but that itself did not provide the buyers with a right of resale. the ability to transfer a good title to the buyers in this case did not confer upon that buyer an ability to resell and transfer a good title to a subsequent purchaser. therefore the court held that implied condition was also breached. scrutton lj wrote: »the respondents impliedly warranted that they had then a right to sell the goods. in fact they could have been restrained by injunction from selling the, because they were infringing the rights of third persons. if a vendor can be stopped by process of law from selling, he has not the right to sell.» marasinghe, p. 150 nordic journal of commercial law, issue 2003 #1 30 4.3.4 innominate term the innominate term is a contractual term that is neither a condition nor a warranty. its characteristic is that, if the contract is breached, the effect of the breach depends on the nature and gravity of the breach.121 if the breach is grave, the innocent party can treat the contract as repudiated, but if the breach is not serious the contract remains and the innocent party can only claim damages for any loss that he may have suffered. the concept of innominate term was developed in shipping contracts with respect to the stipulation that the ship should be seaworthy. unseaworthiness could be of serious or insignificant character and its effect on the contract varies according to the facts that made the ship unseaworthy. the concept on the innominate term was extended to other types of contract, notably to the contract of sale.122 an illustration of the application of the innominate term to the law of international sales is provided by the case cehave nv v. bremer handelsgeschellschaft mbh; the hansa nord. bremer handelsgeschellschaft, a german company, sold a quantity us u.s. orange pellets c.i.f. rotterdam to cehave, a dutch company. the pellets were to be used in the manufacture of cattle food. the contract was made on a form of the cattle food trade association that contained a term «shipment to be made in good condition.» the consignment in issue was about 3.400 metric tonnes and was carried in the hansa nord. the price at the time of arrival of the ship had fallen considerably. on discharge from the hansa nord the cargo ex hold vo.1 (1.260 tonnes) was found to be damaged but the cargo ex hold no. 2 (2.053 tonnes) was in good condition. the buyers rejected the whole consignment. the rotterdam court ordered its sale. it was purchased by a middleman for a sum that, after deduction of the expenses, amounted to an equivalent of one third of the original contracted price. the middleman sold the pellets the same day for the same price to the original buyers who took them to their factory and used them for the manufacture of cattle food although they received a somewhat smaller quantity of pellets than they would have done if part of the consignment had not been damaged. the total result of the transaction was that the dutch buyers received goods that they had agreed to buy for £ 100.000 at the reduced price of about £ 30.000. the case went to arbitration and then to the courts. the court of appeal held that the contractual term «shipment to be made in good condition» was not a condition within the meaning of the sale of goods act but was an innominate term.123 the court held that the buyers were not entitled to reject the whole consignment but were entitled too damages for the difference in the value between the damaged and conforming goods on arrival in rotterdam. the case was remitted to the arbitrators for the determination of these damages. 124 section 15a, inserted by the sale and supply of goods act 1994, provides that where the buyer would have a right to reject the goods on the grounds of a breach of sections 13, 14 or 15 and is not in the capacity of a consumer, he may not treat the breach as a breach of condition where it is so slight that it would be unreasonable to do so. the buyer in such a circumstances may only treat the breach as a breach of warranty, although the parties may provide otherwise expressly or 121 see cases alfred mcalpine plc. v. bai (run-off) ltd. (2000) ewca civ. 40 and manifest shipping company ltd. v. uni-polaris shipping company ltd and others (2001) ukhl 1 122 lord wilberforce referred to it as »the modern doctrine» when he said:»the general law of contract has developed along much more rational lines in attending to the nature and gravity of a breach or departure rather than in accepting rigid categories which do or do not automatically give right to rescind, and if the choice were between extending cases under sale of goods act 1893 into other fields, or allowing more modern doctrine to infect those cases, my preference would be clear.» 123 lord denning m.r. said: »if a small proportion of the goods sold was a little below that standard, it would be met by commercial men by the divergence was serious and substantial.» 124 schmitthoff's export trade, p. 88 nordic journal of commercial law, issue 2003 #1 31 implicitly. it is suggested, that entry into a contract on f.o.b. and c.i.f. terms implies that the parties do not intend section 15(a) to apply. however, the concept of the innominate term should not be overused. many terms are regarded by the parties as so essential that they qualify as conditions in the legal sense. this applies, in particular to most time clauses in commercial contracts e.g. in a f.o.b. contract a clause that «buyer shall give at least x consecutive days' notice of probable readiness of vessel(s).» similarly, in a c. and f. contract a clause that the ship shall sail directly from the port of loading to the port of discharge (direct shipment clause) was held to be a condition and not an innominate term.125 4.3.4.1 scope of the category of intermediate terms granted that the threefold classification of terms does exist, the question about into which category particular terms should be placed arises. in discussing this question we shall assume that the parties have not provided an express classification of the term in the contract itself; and that the court will generally apply a previous judicial classification of the term. our main concern will therefore be with previously unclassified terms. since judicial classification of a term as a warranty is rare, the important issue is whether a previously unclassified term is to be classified as a condition or as an intermediate term. the issue is difficult because it gives rise to a conflict between two policies. the first of these policies is to restrict the right to rescind to cases in which the breach causes serious prejudice to injured party, and so to prevent a party from rescinding for ulterior motives or on grounds that have been criticized as «excessively technical.» this policy favors the classification of terms as intermediate.126 this policy can, however, be excluded by evidence of contrary intention.127 based on case law the following conclusions can be drawn. firstly, the law has to have regard to the nature and gravity of the breach before it becomes possible to say whether the innocent party is entitled to repudiate a contract for breach of a term of a contract. secondly, it has been held, that the sale of goods act does not exhaustively divide all terms into conditions and warranties and that innominate terms can exist in contracts of sale of goods and that the express term that the goods have to be in good condition may be a term of that character. 128. 4.3.5 fundamental terms the third category of terms, the fundamental terms, emerged as a powerful weapon to strike down the effect of widely drafted exclusion clauses, which limited the range of remedies available to the buyer. it has been held by courts that where the seller commits a breach of a fundamental term, the contract would be considered to have suffered a fundamental breach, and as such could render the exclusion of liability clauses found in the protecting the seller inoperative. this gave the buyer a right to sue the seller for the breach despite the exclusion 125 schmitthoff's export trade, p. 89 126 it is illustrated by number of decisions. in tradax international s.a. v. goldschmidt s.a. a contract for the sale of barley contained the words »four per cent. foreign matters»; and they were held to amountonly to an intermediate term, so that the buyer was not allowed to reject merely because the goods delivered contained 4.1 per cent foreign matters. 127 tradax export s.a. v. european grain & shipping co. a contract for the sale of solvent extracted toasted soya bean meal contained the words »maximum 7.5 per cent. fibre.» these words were held to be a condition so that the buyer was entitled to reject when the goods were found to have a fibre content of 9.28 per cent. there was evidence that, in sales of the commodity in question, fibre content was normally a matter for price adjustment. it followed that, by taking the unusual step of specifying a maximum fibre content, the parties had provided evidence of their intention to depart from that normal practice and of giving the buyer the right to reject, should the specified percentage be exceeded. treitel ii, p. 609 128 atiyah adams, p. 59 nordic journal of commercial law, issue 2003 #1 32 clauses. the law regarding fundamental breach, however, was outside the sale of goods act, though applicable to a contract of sale. the sale of goods act preserved the application of the rules of the common law, therefore enabling, inter alia, the doctrine of fundamental breach to apply to a contract of sale. the sale of goods act does not refer to fundamental terms. instead, the effect on fundamental term may be found in the way the act deals with the breach of a condition. the act specifies that a breach of a condition may give rise to a right to treat the contract as repudiated or a warranty the breach of which may give rise to a claim for damages but not to a right to reject the goods and treat the contract as repudiated. 129 sometimes a breach may, by the operation of law, be reduced to the status of a breach of warranty. this occurs when the buyer has either accepted the goods or where the property in the goods has passed to the buyer in a contract of sale that is not severable. besides this, the buyer may, at his option, choose at any time to consider a breach of a condition as a breach of a warranty, in which case he may sue only for damages and not for a rescission of the contract. the act considers the implied condition as to title and implied condition as to merchantability of the goods as conditions for the breach of which the buyer is given a right to both repudiate the contract and sue for damages. 130 4.3.6 representations whether a statement is or is not a part of the contract is said to depend upon the intention of the parties, but this most elusive criterion is often of little use in this connection. this situation has come about especially since the courts have been prepared to hold that an oral statement may override the written terms of a contract. it is probably true to say that the courts are now much more ready to interpret a statement as a term of a contract than they were a hundred years ago. the tendency these days frequently appears to be for the courts to hold a statement to be a term of a contract when they think of it as reasonable to impose liability in damages on the person making the statement, and vice versa. thus to attempt to decide whether a statement is a term of a contract or a mere representation without reference to the result is, in many cases, like putting the cart before the horse. on the one hand, a statement as to the quality or state of the goods by a seller will almost invariably be held to be a term of the contract if the seller is a dealer in the goods. in the absence of a clear intention one way or the other, a statement is a term of the contract where the person making it had, or could reasonably have obtained, the information necessary to show whether the statement was true. to conclude, it seems to be unnecessary to make more than a brief reference to the possibility of an action for negligent misrepresentation at the suit of a buyer, whether or not he is able to establish that the representation amounts to a term of the contract. although it is now clear that an action for negligent misrepresentation will lie in some cases even at common law, it will not often be possible for a buyer to call to arms this cause of action in a case where the representation is not a term of the contract. but this is now of little importance for, under the misrepresentation act 1967, a contracting party is given a statutory cause of action for misrepresentation against the other contracting party. since the onus is placed on the representor to show that he had reasonable grounds to believe, and did believe up to the time the contract was made, that the facts represented were true, it seems probable that claims based on misrepresentation will in future frequently be joined with claims for damages for breach of condition or warranty. but damages the misrepresentation act may not be assessed in the same 129 sale of goods act 1893 and 1979, 61(2) and 62(2) respectively. 130 marasinghe, p. 148 nordic journal of commercial law, issue 2003 #1 33 way as damages for breach of a term of the contract, so the distinction may still be important in some cases.131 4.3.7 scots law much of what has been said in this chapter is, at best, interesting background information for the scots lawyer. the distinction of contractual terms into conditions and warranties is unknown in scots law, although its deployment to categorize the terms implied under the sale of goods act did cause some confusion until the passage of the sale and supply of goods act 1994. but as the implied terms are now defined in scotland without use of the words «condition» or «warranty,» this difficulty has ceased to cause trouble. the scottish approach to the customer's right to terminate a contract for the supply of goods following breach of an implied term by the supplier is now the same as it would be for any other contract, namely, to ask whether the breach is sufficiently «material» to justify the remedy. scots lawyers do, however, refer to contractual terms as warranties, usually when the term is an undertaking as to a state of fact, such as a condition of goods; but it does not follow from this that the only remedy from breach is damages. termination will be possible if the breach is material. the distinction between a contract term and a representation is well established in scots law, and the tests used in this regard in england are also applied in scotland. negligent and fraudulent misrepresentations are delicts, giving rise to claims for damages. there may be recovery for precontractual negligent misrepresentation under section 10 of the law reform (miscellaneous provisions)(scotland) act 1985.132 5 detailed analysis 5.1 quantity of goods 5.1.1 the cisg according to art 35(1) a difference in the quantity of the goods is considered to be nonconformity. the fact that the lack of quantity amounts to non-conformity is clearly stated by some decisions. courts refer to the same rules applicable for defective goods; in particular, the buyer must give notice to the seller within a reasonable time of discovery of the lack of quantity. 133 however, a difference has to be made as to whether or not the documents allow for a minimum quantity or they rigorously require one single delivery. notice has to be given only when the seller really delivers less than indicated in the documents. the seller may not invoke that notice has not been given if he was aware of the lack of conformity, e.g. if he himself made out the documents in accordance with the actually delivered quantity. 134 but what happens when the quantity of goods delivered by the seller is greater than the one agreed upon the contract? this fact pattern emerged in a case decided by the french supreme court: electronic components were ordered by a french company from a german one. one of 131 atiyah adams, p. 66 132 atiyah -adams macqueen, p. 89 133 olg düsseldorf 8.1.1993 riw 1993. tinned cucumbers were sold by a turkish company to a german one. a lesser quantity of cucumbers than the one agreed upon had been delivered. 134 enderlein maskow, p. 142 nordic journal of commercial law, issue 2003 #1 34 the buyer's contentions regarded the quantity of the delivered goods. the buyer alleged that the seller had delivered goods in excess and asked him to take them back. the lower instance court ruled that the buyer was obliged to pay the entire price because he should have immediately returned the excessive goods back instead of asking the seller to take them back. upon the buyer's claim that he was entitled to retain the goods until reimbursement by the seller of the reasonable expenses incurred in preserving the goods (art. 86(1)) the cour de cassation held that no evidence of such expenses had been provided by the buyer.135 commentators have criticized this decision, as far as treatment of excessive quantity is concerned. article 35(1) does not vouch for a distinction between delivery of a quantity lesser or greater than the one agreed upon in the contract: excessive quantity should be treated as a non conformity and the buyer should promptly examine the goods and give notice within a reasonable time, if he wants to rely on the remedies provided in the convention, but he is under no obligation to return the goods to the seller. should he decide to accept the excessive quantity, he is obliged to pay its entire price (art. 52 cisg).136 after all the considerations about what was agreed between the parties and how the parties are supposed to react, it should be taken into account the consequences to the parties; if it was essential to the buyer to have a full delivery immediately, or if it was of little difference to receive a part of the goods delayed, or not to receive this part at all, and the counterparty's knowledge of this fact. for example, if, based on a supply contract, the buyer delivers 90 % as agreed and the missing 10 % together with the next agreed delivery within a short period of time, attention must be paid to how much inconvenience was caused to each party and if it would have been reasonable to expect the vendor, by all means, to try to comply with her contractual duties at once. in any event, reasonability of the parties' claims is decided on a case by casebasis. 5.1.2 finland as regards a non-conforming delivery, the situation can be seen from two different points of view. the first one considers the lack of goods as a partial delay, while the second defines it as a specific defect: defect in quantity. similarly as with defects in quality, here it is also difficult to figure out a rule to identify the presence of defects. some general principles applicable to the non-conformity as regards quality are applicable also to the non-conformity as regarding quantity. which criteria we should utilize to find out whether a certain case is a delay or erroneous quantity? the first point to capture one's attention is the difference between the amount contracted and the one delivered. if the difference is remarkable, it is tempting to think that the seller never had intention to deliver the contractual amount. this turns the situation to the «seller's delay.» in the event of a minor difference, the situation is closer to the «defect in quantity.» both interpretations call for attention to the circumstances.137 the smaller the missing amount is, the more it is likely that the seller intended to perform a complete delivery and thus we can speak about quantitative defect. in order to draw the line between the two kinds of non-conformities, emphasis should be put on the seller's intention: if seller alleges to have performed a complete delivery, despite the lacking amount, we can consider this defect on quantity. 135 cour de cassation 4.1.1995. the supreme court confirms a decision of the cour d'appel de paris 22.4.1992. 136 veneziano, p. 43 137 aaltonen, p. 179 nordic journal of commercial law, issue 2003 #1 35 in a case of excessive delivery, the buyer is under a duty to separate the amount of goods contracted. if it is feasible without causing damage to them, it is not reasonable to deem the buyer entitled to reject the delivery. the contrary would cause remarkable damage to seller; returning of the goods and difficulties in finding another buyer for the whole delivery could result in unreasonable consequences. the buyer is anyhow entitled to claim from the seller the cost resulting from the separation. if the seller delivers the amount greater that what was contracted, in order to get rid of his stock, or to extend the business relation with the buyer, the buyer is entitled to discharge the contract. it would not be fair that the seller could, through the contract of sale, make the buyer accept the goods he did not order. the discrepancy between the amount ordered and the one actually delivered should be considered simply as another offer from the seller's side. scandinavian sale of goods acts do not expressly recognize the limits between which the amount delivered could freely fluctuate in cases of contracted maximum and minimum. almen concludes that when the minimum and the maximum are agreed, the fluctuation may be even greater that ten per cent. according to him, the party entitled to choose could not claim less than half of the maximum or more than twice the minimum. aaltonen rejects this approach, deeming it too vague and aleatory to be taken as a principle to follow. also raninen138 is in this view. he claims that «despite that we need not to be limited to the variance of ten per cent, we can certainly not go as far as almen goes.» aaltonen doubts whether the view regarding the «last ship rule» adopted by raninen could be really acceptable. according to last ship rule, the tolerance of fluctuation between the single deliveries concerns only the last ship. aaltonen presents an issue of recognizing the last ship loaded in case of a plurality of them. the point of the last ship rule, however, is elsewhere: it is not a question of which ship departed or arrived as first, but, that the rule can be applied only once and only after all the deliveries have been done. this usually coincides with the unloading of the last ship after which it is possible to confirm the total amount.139 the problem gets a bit more complex when the contracted amount is defined through the seller's capacity to produce and when his capacity is reduced for reasons beyond his influence. in such circumstances he cannot be considered liable for a non-conforming delivery. another difficult issue is an event when the seller has more than one commitment to his production and the remaining capacity has to be divided between the parties involved. 140 in practice it is rather difficult to recognize when the defect is of quality or quantity, since both of them can appear simultaneously. the quality of the goods may be expressed in terms of quantity: the width of the fabric or the volume of the container. 5.1.3 the uk where the delivery is of a quantity less than what was contracted, the buyer may in such a situation reject the whole or accept the lesser quantity. if the buyer does the latter then the goods must be paid for at the contract rate. where the seller delivers a quantity of goods greater than the contracted quantity the buyer has three options. the buyer may reject the whole or may accept only the quantity contracted and reject the rest. the third option is to accept the whole delivery. in any event the buyer must pay at the contract rate for the quantity accepted. when goods are rejected, whether relying on to the delivery of the wrong quantity or to some other lawful reason, such as the goods' defects, the buyer is not required to return such goods to 138 raninen, kauppatapalausuntoja, aaltonen, p. 184 139 aaltonen, p. 185 140 aaltonen, p. 188 nordic journal of commercial law, issue 2003 #1 36 the seller. it could suffice that the buyer were to inform the seller of the refusal to accept them. it is then left to the seller to arrange for their return.141 accordingly, the section 30(1) states. «where the seller delivers to the buyer a quantity of goods less than he contracted to sell, the buyer may reject them, but if the buyer accepts the goods so delivered he must pay for them at the contract rate.» the seller cannot excuse a short delivery on the ground that he will deliver the remainder in due course. section 31(1) states that: «unless otherwise agreed, the buyer of goods is not bound to accept delivery thereof by instalments.» there are doubtlessly circumstances where it can be inferred from the contract quantity and the time allowed for shipment that the sellers are entitled to ship more than one load, and therefore entitled to deliver in separate loads. but the general rule is that the seller must deliver in one load. where delivery in separate instalments is permissible under the contract, the question whether a shortfall in the quantity required permits the buyer to treat the whole contract as discharged is dealt by 31(2) of the act. 142 at first sight there seems no obvious reason why the buyer should not be required to accept that part which should have been delivered, whether or not he accepts the rest. but this is not the law, for 30(2) says: «where the seller delivers to the buyer a quantity of goods larger than he contracted to sell, the buyer may accept the goods included in the contract and reject the rest, or he may reject the whole.» the former law was very strict in its insistence on the correct quantity. any shortfall or any excess, no matter how small, was a breach of the section and justified rejection of all the goods. there was, and presumably still is, a principle of very limited application, de minimis non curat lex143 which could occasionally be invoked to excuse what would otherwise be a technical breach. 144 this is a legal principle of general application, but its applicability to any particular case seems to be a question of fact that depends, inter alia, on how far precise accuracy can be obtained, or whether there are limits of accuracy that are commercially reasonable. the principle ought seldom be applied, for there is no breach of warranty at all. there may perhaps be occasions when it might be applied in consumer sales.145 the fact that the buyer may be entitled to reject the whole of the goods delivered in the circumstances dealt with in section 30, means that the seller in such cases is treated as though 141 marasinghe, p.164 142 the subsection is not as strict in its requirements as section 30(1); a shortfall in quantity in one installment does not justify the buyer in treating the whole contract as discharged unless it is sufficiently serious to go to the root of the contract as a whole. the result may seem curious at first sight. leaving aside the effect of section 30, in a situation where a seller contracts to sell and deliver 62 suits to the buyer, but he only delivers 61, the buyer could reject the whole lot if the suits were delivered in one load. but if the suits are to be delivered in separate installments, the buyer's rights are regulated by section 31(2) and on these facts it has been held that the shortfall of one suit was not sufficiently serious to justify the buyer in treating the contract as completely avoidable. but the result is not as odd as it seems. where the parties do expressly contemplate installment deliveries, serious problems would arise if a shortfall in one installment gave a right to reject previous installments already accepted. so it is natural that such a right should be severely limited , and each installment treated as a separate delivery. atiyah adams, p. 105 143 the law pays no attention to trifles. 144 to illustrate the application of this principle in the present context, two cases, one on either side of the line, may be contrasted. in wilensko slaski towarzystwodrewno v. fenwick &co ltd (1938 3 all er 429) the sellers sold timber of specified measurements to the buyers. there were certain permitted, but strictly defined, variations from these specifications. slightly less than 1 per cent of the timber failed to comply with the contract requirements. the buyers were held entitled to reject the goods. on the other hand, in shipton anderson & co ltd v. weil bros &co ltd (1912 1 kb 574) the sellers contracted to sell to the buyers 4500 tons of wheat or 10 per cent more or less. the seller delivered 4950 tons and 55 lb, but they did not claim payment for the 55 lb. it was held that the buyers were not entitled to reject the goods. the excess over the stipulated amount being a little over 1 lb in 100 tons, the case clearly called for the application of the maxim de minimis. if it had not been applied in this case the rule would have lost all commercial importance. 145 atiyah adams, p. 107 nordic journal of commercial law, issue 2003 #1 37 he commits a breach of condition by delivering the wrong quantity. in this respect the duties of the seller are parallel to those laid down as regards sales by description. indeed, the whole of section 30 is merely an application of the duty to deliver goods conforming to the description imposed by section 13, and it is one of the peculiarities of the drafting of the act that section 13 is dealt with under the heading »conditions and warranties» while section 30 is dealt with under »performance of the contract.»146 the buyer's prima facie right of rejection means that he can always convert a breach of the quality into a breach of the rules as to quantity.147 the same close relationship between the duty to deliver the right quantity and the duty to deliver the right quality will be observed when we consider instalment contracts. here too, the buyer's right to reject is the same whether the breach consists of a short delivery or a delivery of wrong quality. for these reasons, it is undesirable for the law to distinguish between breaches of sections 13-15 and breaches of section 30, and in general the law does not do so. so it seems clear that the limitation on the right to reject in non-consumer sales introduced by the 1994 act should apply equally to breaches of the implied terms as to quality and to breaches of section 30. 148 5.2 quality of the goods 5.2.1 the cisg the first subsidiary rule (art 35(2)(a)) is that the goods must be «fit for the purposes for which the goods of the same description would ordinarily be used.» 149 the delivered goods are fit for the ordinary use when they possess normal qualities: i.e., the characteristics normally required from goods as described by the contract, and free from defects normally not expected in such goods. the cisg imposes these obligations because in the usual sale, and in the absence of contrary intent, today's international buyer is entitled to expect the goods to possess certain basic qualities even if the contract does not expressly so state. among the implied obligations as to quality, this subparagraph is of great practical importance: it is an international version of an implied warranty of fitness for ordinary use, familiar in many european domestic laws.150 the implied obligations apply irrespectively of the seller's good or bad faith. 146 atiyah adams, p. 109 147 if the seller contracts to deliver 100 tons of wheat of a certain quality and 10 tons are not of the desired quality and buyer rejects them, the seller will only have effectively delivered 90 tonnes, and the question will now be whether the shortfall is so slight that it would be unreasonable for the buyer to reject. more generally, though, the rules as to quality and the rules as to quantity were very similar in their effect, even if different in form. in particular, the close resemblance between the duties created by sections 13 and 30 is brought out all the more when they are examined in detail. in both cases, until the right of rejection was modified by the 1994 act, the slightest deviation from the terms of the contract was in effect a breach of condition, entitling the buyer to reject the goods. if the seller delivered goods that failed by the slightest margin to conform to the contract description, or if he delivered a fraction too much or too little, the buyer might reject the whole. the only quantification on this was that if the deviations were »microscopic», the seller might be able to plead de minimis. but this principle was, and presumably will continue to be, applied as rarely in cases of quantity. in fact, as suggested above, given the restrictions the right of rejection in non-consumer sales, it ought not to be, for the effect of applying it is that there is no breach of warranty at all. atiyah -adams, p. 110 148 atiyah adams, p. 110 149 the ulis mentioned the qualities necessary for the ordinary or commercial use of the goods the cisg has suppressed as superfluous this reference to commercial use, which is covered by the reference to ordinary use. 150 unlike many domestic laws, the cisg does not compel the decision-maker to distinguish between a breach of warranties and breach of obligations. this may well facilitate decision-making, especially in the light of the fact that the convention authorizes an award of monetary compensation for any breach along the lines of a non-fault regime. see lookofsky, p. 54 nordic journal of commercial law, issue 2003 #1 38 goods are often ordered by general description, without any indication as to intended use. still, goods are always purchased with some purpose in mind, and buyers are entitled to expect reasonable value for their money: bowling balls must be suitable for bowling, canned tomatoes must be suitable for consumption, etc. within the context of international trade, resale should be considered an ordinary use, so as a cisg buyer who purchases for resale in entitled to expect goods to be merchantable in the ordinary course of business. what is merchantable will then depend upon the reasonable expectations of the ultimate purchasers. the standard of «ordinary use» will rarely be internationally uniform; thus a question arises as to which market or geography we should consider as being determining.151 5.2.1.1 goods unfit for ordinary use goods are unfit for the ordinary use when a defect or a lack of proper characteristics impedes their material use or yield abnormally deficient results or take unusual costs. the goods are also unfit for normal use when the lack of proper characteristics or the defects, though not affecting the material use of the goods, lessen conspicuously their value affecting their trade use. the goods can be more or less fit for their purposes, but the seller must on the whole deliver goods of average fitness.152 the fitness of goods for ordinary use must be ascertained according to the standards of the seller's place of business. indeed, the seller is not supposed to know about specific requirements or limitations in force in other countries. only in some specific cases it is reasonable to expect seller's knowledge of buyer's local standards. 153 another position, however, holds that «ordinary use» should be defined by the standards of the country or region in which the buyer intends to use the goods (see the chapter conformity to requirements of the national law in buyer's country).154 hence, the quality may be more or less good, but at least it must not be significantly below the standard that can reasonably be expected according to the price and other circumstances. since the requirement of ordinary use of the goods can be met in quite varying quality, one may safely assume that the buyer can only insist on a certain minimum. the cisg doesn't describe any quality standards; e.g. the cars can be traded for resale but also for scrap metal. a specific problem relates to the period of durability or fitness, which plays a role in the foodstuffs and the pharmaceutical industries. since no general standards have emerged yet in this respect, a relevant agreement in the contract should be recommended.155 some domestic laws have solved the problem stating expressly that the seller of unascertained goods has to provide for goods of fair quality. the civil code of germany156, for instance, prescribes that in general the obligations to deliver unascertained goods are to be performed through goods of average kind and quality. similarly the united states uniform commercial 151 for example, the windows that are perfectly adequate for houses in warm countries, rarely meet the criteria of northern countries. 152 even though art. 35 does not contain express provision imposing on the seller a duty to deliver goods of average quality. see bianca, p. 280 153 in some legal systems the seller has the right to deliver goods whose quality is below average. under common law the goods must be merchantable. however, the goods are merchantable whether they are of high or low quality. enderlein maskow, p. 144 154 for example, in europe gasoline for the operation of cars is still understood as leaded gasoline, whereas the expectations of an american buyer who purchases gas on the rotterdam spot market might be directed toward unleaded gasoline. this example, though, seems to confirm the opposite solution. if in the seller's country the gasoline is understood as leaded gasoline, the buyer's request will also be understood as a request for leaded gasoline. naming the place where the buyer intends to use the gasoline is not sufficient per se to show that he needs a different type of fuel. bianca bonell, p. 274 155 enderlein maskow, p. 145 156 bgb 243 nordic journal of commercial law, issue 2003 #1 39 code requires the goods to be merchantable. however, in other domestic legislations, unless otherwise agreed, the seller may deliver goods of lower than average quality. it's significant, in this regard, that according to common law judges the seller has to deliver merchantable goods, but merchantable goods does not mean of good, or fair, or average quality.157 this position is further explained in the decision assuming that merchantable means that the goods are of such quality as to be saleable in the market under the description made in the contract. 158 5.2.2 finland the starting point here is the contract; only in the lack of the agreement as to quality do the circumstances and trade customs step in. every now and then a contract refers to the goods delivered in the past, which establishes case-by-case measure. moreover, the sellers may contract in conformity with the rules and classifications of chambers of commerce or other similar trade organizations. often such rules result from years of usage. the contract may speak of «first class,» «average,» or simply use adjectives such as «dry,» «humid,» «bleached» and so on. in this event, the terms used may be divided in two groups; terms that are generally used and those terms that appear only in the context of a single contractual relationship. the expression «good quality» has proved to be particularly confusing. 5.2.2.1 absence of an agreement in the finnish doctrine the view prevails according to which in the absence of any reference to quality of the goods, the seller has to deliver goods of basic quality. this does not actually solve the problem but only alters it: what is «standard quality» expected to be? a general reference can be made to the requirements of a particular sector of commerce. some allege that the buyer, who neglected to specify the required quality in the contract, cannot claim any better than the lowest acceptable quality. in other words, if the contract does not provide information, it is up to the seller to decide. some, on the other hand, prefer the interpretation according to which the buyer may claim better quality only if the goods were bought for resale. in this case the buyer may claim quality good enough to render the goods merchantable. in the context of a continuous business relationship it is natural to expect the quality similar to previous deliveries. the fourth view takes into account the price paid; the counterperformance has a decisive role when assessing what the counterparty may expect. it is somewhat complicated to try to construct a general rule regarding the required quality of goods when the contract itself doesn't inform us of it; to state that the circumstances are to be taken into consideration is hardly of great help in practice. anyhow, even trickier than that, is to determine what exactly does «the lowest acceptable» quality mean. when it comes to reference to previous deliveries, often there are none to refer to. hence the solution needs to be found elsewhere: the contract as a whole and other components of the contractual relationship may help in the interpretation. advanced trading and competition have resulted to a certain pricing policy that is more or less known by those who are active on a particular business. this could justify the expectations of a buyer of costly goods but it has to be pointed out, that the price cannot be the only decisive factor. a kind of a compromise could be found in the concept of «average quality.» since the contractual relation should be seen also as a relationship of 157 taylor v. combined buyers ltd, new zealand university law review (1924) 627, where it is clearly stated that »goods may be of inferior or even bad quality but yet fulfill the legal requirement of merchantable quality. for goods may be in the market in any grade, good, bad, or indifferent, and yet all equally merchantable. on a sale of goods there is no implied condition that they are of any particular grade or standard.» see bianca bonell, p. 281 158 bianca bonell, p. 281 nordic journal of commercial law, issue 2003 #1 40 cooperation, where both of the parties equally have rights and obligations, and if there are no particular reasons to favor one of the contracting partiesi.e. none of them was in a particularly weak position at the moment of the conclusion of the contract, none of them is a consumer, etc. «average quality» is seen as a half-way solution when seeking the balance between respective performances.159 according to aaltonen, for example the contracted place of the production of the goods is binding the seller and the goods produced elsewhere are not those contracted upon. 160 5.2.2.2 aliud pro alio when the seller delivers the goods different from what was contracted upon, the question arises as to what the seller actually did. did he perform a defective delivery, as the goods do not correspond with the description, or did he deliver at all? if the seller delivers goods slightly different, »golden» apples instead of »granny smith,» for instance, is the buyer entitled to reject the delivery. an apple is always an apple, but what if it was crucial for the buyer to have granny smiths, for the purpose he had in mind when ordering the goods. thus, again we come back to the buyer's intention and the seller's awareness of it. so if we consider aliud pro alio delivery as the seller's delay, the buyer could accept the goods, despite that the contractual performance did not take place. it follows that the buyer renounces his right to claim the goods contracted upon and, hence also the remedies he could have availed of relying on the delay. however, the rules governing a delay do not suit very well to the situation at hands. this is particularly true as regards the buyer's duty to examine the goods and give notice of the nonconformity. the rules of law and the principles governing deficiency of the goods allow much more flexible solutions than those governing a delay. one factor justifying this view is that if the buyer would not be obliged to react to aliud pro alio -delivery, it could cause excessive damage to the seller in good faith. this approach is definitely seller friendly, and its application requires that the seller was not acting in bad faith. so the decisive point appears to be, whether the seller had intention to comply his contractual obligation. once again we find ourselves studying the circumstances as a whole: the greater is the difference between the contracted and the delivered goods, the more it is difficult to the seller to prove that his intention was to comply.161 5.2.3 the uk the implied terms as to quality and fitness in sections 13-15 of the 1893 act represented an important step in the abandonment of the original common law rule of caveat emptor. the three primary terms laid down in the act now appear in these sections, and their combined effect is to give buyers a substantial degree of protection against the risk of the goods proving to have defects of quality or fitness for purpose. indeed, it is now unrealistic to treat the basic principle of the law as caveat emptor rather than caveat venditor. caveat emptor as early as 1617 we find it being argued that »the value of a jewel consists in the estimation of him who will buy it», but in the same case the court made it clear that a jewel was one thing, 159 aaltonen, p. 157 160 aaltonen, p. 162 note the differing view in the u.k. doctrine. 161 aaltonen, p. 194 nordic journal of commercial law, issue 2003 #1 41 silver162 something else. in all probability this also explains the famous case of chandelor v. lopus163. the defendant was a goldsmith who sold a »stone» to the plaintiff for £ 100, a considerable sum of money for the time, and affirmed it to be a »bezar stone.» the plaintiff complained that the stone was not a bezar stone, and sued for breach of warranty. however, he lost his case, the court declaring that the defendant had only affirmed, and not warranted, the stone to be a bezar stone. this decision, which in the twentieth century was resuscitated as a leading authority on sales warranty law, is often taken to be the origin of the doctrine of caveat emptor. and that doctrine is, in turn, taken to be evidence that the courts were uninterested in the fairness of an exchange, which they regarded as a matter for the parties alone. if a buyer failed to obtain a warranty, and in consequence made a bad bargain, that was regarded as his affair. but again, both the premise and the conclusion are highly suspect. the first thing to be noted is the peculiar nature of the stone in our case; a bezar stone apparently is a stone found in the stomach or intestines of certain animals, and was at one time believed to have magical antidotal or medicinal powers. even at the time when the courts still had some belief in just prices one can understand the reluctance of the court to attempt the value such a strange object, and perhaps even greater reluctance to attempt to discover whether it was indeed what the goldsmith said it was. in all probability the plaintiff was complaining not that it was not a bezar stone but that it did not have the magical qualities he had expected. it seems extraordinary that this case should have been regarded as laying the foundation of the later law of caveat emptor. nevertheless, with or without the help of the case, the doctrine seems to have gained a foothold in the law with the growing commercial freedom of enterprise in the seventeenth century. »no man can be cheated except it be with his own consent, and we commonly say caveat emptor.»164 in one sense, the three main implied terms lay down a series of duties upon the seller. in the first place, there is the implied term that if the goods are sold by description the goods must correspond with their description. this applies in far wider circumstances that those in which the two other terms apply but it does not afford lot of protection to the buyer, especially where the description of the goods is not detailed. the next implied term is that the goods must be of satisfactory quality. this does not apply in all the circumstances in which the first applies but, on the other hand, it affords the buyer a greater degree of protection, because goods that correspond with their description may not be of satisfactory quality. even this, however, may not suffice to protect the buyer, since the goods may correspond with their description and yet they may still be unsuitable for the buyer's purpose. hence, in still more limited circumstances, the buyer may be able to rely on the third implied term, namely that the goods must be fit for the purpose for which they were sold. the difficulties of exposition of this part of the law have unfortunately not been greatly reduced by the legislation of 1973-94, though there has been some gain in simplification.165 162 silver was sold by weight and had a measurable value. 163 (1603) cro. jac. 4, 79 e.r. 3 164 sir josiah child, in a new discourse on trade 1693. atiyah , p.179 165 atiyah -adams, p. 113 nordic journal of commercial law, issue 2003 #1 42 5.3 the purpose 5.3.1 the cisg according to the second standard (cisg art. 35(2)(b)), the seller must deliver goods which are also fit for any particular purpose of the buyer, provided that such purpose has expressly or impliedly been made known to the seller at the time of the conclusion of the contract. this criterion, which had its antecedent in the ulis 166, solves the problem of whether an express promise of the seller is necessary about the fitness of the goods for a special purpose when the buyer shows his intention to buy the goods for such a purpose. the solution is in accordance with a principle of fairness.167 the seller is not obligated to deliver goods which are fit for some special purpose which is not a purpose «for which goods of the same description would ordinarily be used» unless the buyer has «expressly or impliedly made known to the seller at the time of the conclusion of the contract» such intended use. the problem may arise if the seller would have no reason to expect to supply goods appropriate for such a purpose.168 in a german case169 the plaintiff, the buyer, alleged that the goods did not conform to the contract, as the fabric that the goods were made of couldn't be cut in an economical manner. the court held that the buyer had no right to refuse to pay the purchase price, as the fabric was in conformity with the contract. taking into account the quantity, quality and the description of the fabric, the court concluded that the fabric was fit for the production of skirts and dresses. the buyer had not provided the seller with information regarding the manner in which the fabrics had to be cut in order to be economical. buyers often know that they need goods of a general description to meet some particular purpose but they may not know enough about such goods to give exact specifications. in such a case the buyer may describe the goods desired by describing the particular use to which the goods are to be put. if the buyer expressly or impliedly makes known to the seller such purposes, the seller must deliver goods fit for that purpose. the purpose must be made known to the seller by the time of the conclusion of the contract so that the seller can refuse to enter the contract if he is unable to furnish goods adequate for that purpose.170 more problematic is the situation where the buyer, while negotiating the contract makes known to the seller the purpose, to which the goods are not suitable. various legal systems have adapted various approaches to said problem. an opinion prevails in italian doctrine, according to which the situation is comparable to that of an error. in these cases the emphasis is laid on the seller's knowledge of the intended final use of the goods. if this criterion is met, the buyer may rely on the invalidity of the contract and thus the dispute remains out of the scope of the application of the convention.171 166 ulis art. 3(e) 167 the provision does not deal with the case where the seller himself illustrates the special purpose the goods are fit for or where the buyer orders goods to be fit for a special purpose. in such cases it is clearly a question of contractual description. the convention's second criterion is intended for the case where the buyer merely displays the intention to use the goods for a particular aim. the solution favourable to the buyer could be reached by way of contract construction, but the uncertainties regarding this problem in the national laws justified an explicit statement. see bianca bonell, p. 275 168 see secretariat commentary, 6th comma. 169 landsgericht regensburg 24.9.1998 170 it is insufficient for the buyer to make the purpose of the goods known to the seller at a later date. see enderlein maskow, p. 145 171 bianca, in convenzione di vienna sui contratti di vendita internazionale di beni mobili, p. 148 nordic journal of commercial law, issue 2003 #1 43 the seller is not liable for failing to deliver goods for a particular purpose even if the particular purpose for which the goods have been purchased has in fact been expressly or impliedly made known to him if «the circumstances show that the buyer did not rely or that it was unreasonable for him to rely, on the seller's skill and judgment.» the circumstances may show, for example, that the buyer selected the goods by brand name or that he described the goods desired in terms of highly technical specifications. in such a situation it may be held that the buyer had not relied on the seller's skill and judgment in making the purchase. if the seller knew that the goods ordered by the buyer would not be satisfactory for the particular purpose for which they have been ordered it would seem that he would have to disclose this fact to the buyer. if the buyer went ahead and purchased the goods it would then be clear that he did not rely on the seller's skill and judgment. 172it would be also unreasonable for the buyer to rely on the seller's skill and judgment if the seller did not purport to have any special knowledge in respect of the goods in question. 173 if the buyer participates in choosing the goods, inspects the goods before he buys them, selects the manufacturing process, hands over the specifications or insists on a particular brand, he does not rely on the skill of the seller.174 however, the circumstances in which the buyer may not rely on the seller's skill and judgment cannot be specified in advance but must be ascertained case by case.175 5.3.2 finland if the seller could have reasonably expected that the buyer had the intention to resell the goods, they have to be of merchantable quality. a defect that reduces goods' attractiveness in the eyes of consumers is considered fundamental even though the goods would be, despite the defect, suitable to their purpose. here the finnish view differs from the german «mussels» cisgcase176. when assessing if the seller's awareness of the buyer's purpose could be deemed decisive, it cannot be considered sufficient that the seller knew the purpose.177 the buyer alleging seller's awareness of a particular purpose for which the goods were bought bears the burden of proof of such awareness. in particular cases the buyer may be exempted from this if the seller, for his experience or for other reasons, could not have been unaware of the particular purpose. 178 when a place of origin is named in the description of the goods, it is clear that the buyer may expect the goods to be of that origin.179 antique is supposed to be from a certain period of time although also other characteristics are often required. second hand goods are presumably 172 if the buyer did not rely on the seller's skill and judgment, then it is irrelevant whether the seller actually did give judgment or not. it could well be that the buyer informed the seller about a particular purpose and at the same time ordered goods with clear and detailed specifications. the seller will be obliged to counsel the buyer, but the seller will not be responsible if the buyer insists on his order and shows that he does not rely on the seller's judgment. enderlein, p. 157, dubrovnik lectures. 173 secretariat comentary, commas 7 10. see also bianca bonell, p. 275 174 enderlein maskow, p. 146 175 see also bianca bonell, p. 275 176bgh 8.3.1995. the case concerned new zealand mussels sold to a german buyer. the mussels contained a quantity of a harmful substance significantly greater than the advised levels published in directives of the german federal health department. the supreme court confirmed the finding of the lower court which in order to deny that the mussels were unfit for consumption, took into account that they are usually eaten in special occasions and only in small quantities. 177 for instance, in a case where a buyer intends to retail sell coffee and acquires the coffee from a wholesaler at a low price, we can suppose him as being aware of the possible defect of the goods. in the case of actual defects he has to resell the goods at a price lower than usually, but if the goods are defective to the extent of not being merchantable, then the buyer may rely on the defectiveness. the wholesale seller is presumably aware that the goods he is selling are bought for resale. 178 aaltonen, p. 166 179 however, some goods have acquired a generic name that originally was associated with a particular geographic location, even though they no longer have nothing to do with that location, such as french fries. nordic journal of commercial law, issue 2003 #1 44 defective to some extent; the level of quality is significantly lower compared with a new item. the typical problem arising from second hand sale is a fraudulent seller, whose promises do not correspond with the actual state of goods. 5.3.3 the uk the rules governing implied terms about quality or suitability are found in section 14: (1) except as provided by this section and section 15 and subject to any other statute, there is no implied condition or warranty about the quality or suitability for any particular purpose of goods supplied under a contract of sale. (2) where the seller sells goods in the course of business, there is an implied condition that the goods supplied under the contract are of satisfactory quality. (2a) for the purposes of this act, goods are of satisfactory quality if they meet the standard that a reasonable person would regard as satisfactory, taking into account the description of the goods, the price (if relevant) and all other relevant circumstances. (2b) for the purposes of this act the quality of goods includes their state and condition and the following qualities in appropriate cases: a) fitness for all the purposes for which the goods of the kind in question are commonly sold; b) appearance and finish; c) freedom from minor defects; d) safety; and e) durability. (2c) the conditions implied by subsection (2) do not extend to any instance making the quality of goods unsatisfactory a) which is specifically brought to the buyer's attention before the contract is made; b) where the buyer examines the goods before the contract is made, what that examination ought to have revealed; or c) in the case of a contract for sale by sample, which would have been apparent based on a reasonable examination of the sample. (1) where the seller sells goods in the course of business and the buyer, expressly or by implication, makes known a) to the seller; or b) to the credit-broker (where the purchase price or part of it is payable in instalments and the goods were previously sold by that credit-broker to the seller) 1 any particular purpose for which the goods are being bought, there is an implied condition that the goods supplied under the contract are reasonably fit for that purpose, whether or not that is a purpose for which such goods are commonly supplied, except where the circumstances show that the buyer does not rely, or that it is unreasonable for him to rely, on the skill and judgment of the seller or creditbroker. (2) an implied condition or warranty about quality or fitness for a particular purpose may be incorporated to a contract of sale by usage. (3) the preceding provisions of this section apply to a sale by a person who in the course of business is acting as agent for another as they apply to a sale by a principal in the course of a business, except where that other is not selling in the course of business and either the buyer knows that fact or reasonable steps are taken to bring it to the notice of the buyer before the contract is made. nordic journal of commercial law, issue 2003 #1 45 section 14(6) which provided the statutory definition of merchantable quality had as its main element the requirement that the goods should be reasonably fit for the purpose or the purposes for which goods of that kind were commonly bought. the new provisions provide that the quality of goods includes their state and condition. in this regard one must consider aspects of the quality of goods in their fitness for all the purposes for which goods of the kind are commonly sold. clearly, fitness for purpose was important indeed, an essential element of the concept of merchantable quality, and remains important under the new provisions. in this instance it must be noted that section 14(3) is also, and more specifically, concerned with fitness for purpose, but that subsection is aimed at situations where the goods are required for some particular purpose which has been made known to the seller. section 14(2) on the other and, concerns fitness for ordinary purposes, which do not have to be specifically made known to the seller.180 the question arises whether the new statutory definition clears up one major ambiguity that had previously been explored in the cases. many goods are used for a variety of purposes, and the goods supplied under the contract may be fit for some of these purposes while being unfit for the others. if the buyer has not made known to the seller the particular purpose he wanted the goods for in which case he could sue under section 14(3) are the goods to be treated as satisfactory/merchantable or not? in aswan engineering establishment co. v lupdine ltd181 the plaintiffs bought waterproofing compound in plastic pails for export to kuwait from the defendants: l had bought the pails from the second defendants, b. when the pails were unloaded on the quayside at kuwait, they were stacked in intense heat for some days. as a result the pails collapsed under their own weight and the waterproofing compound was lost. the plaintiffs sued l and succeeded on the grounds not stated in the reports. l then in turn claimed damages from b for breach of section 14(2) and (3), as well as in tort. only the former claim is considered here. so far as liability under section 14(2) was concerned, the problem obviously was that the pails were perfectly fit for most purposes for which such pails would be used; they were simply unfit to be stacked high in such intense heat. the court of appeal held that the goods satisfied the requirement that they should be of merchantable quality. it must be said, however, that the court reached this conclusion by looking at earlier case law first. section 14(6) required goods to be «as fit for the purpose or purposes for which goods of that kind are commonly bought» as it was reasonable to expect. the new provision requires «fitness for all the purposes for which goods of the kind in question are commonly supplied,» so that if the seller knows that goods are not fit for one of the purposes for which goods of the kind are commonly supplied, he must make this known to the buyer.182 180 in fact, the distinction between the two subsections has been muddied because such a wide interpretation has been given to section 14(3) that in practice it often covers ordinary purposes as well as special purposes; so the two subsections in practice overlap significantly. 181 (1987) 1 wlr 1 182 it is unlikely, however, that if the facts of the aswan case were to recur, and the case fell to be decided under the new provisions, the outcome would be any different. it therefore seems impossible at this point to avoid looking at some of the earlier case law. the particular point under consideration here was exhaustively discussed by the house of lords in case in henry kendall & sons v william lillico & sons ltd, (which is also examined in this study under »merchantability)» in which the plaintiffs bought for their pheasants animal feedstuff which turned out to be contaminated with a substance contained in brazilian ground nut extraction which was one of the ingredients of the feedstuff. the extraction was perfectly suitable to be used in making up animal feedstuffs for use for cattle and other animals; it was only unsatisfactory for use in making the feedstuff for pheasant and partridge chicks. the buyer claimed damages from the seller, and consequently the seller in his turn claimed damages from his seller who, instead, was not held liable since the goods were perfectly usable for one of the main purposes for which goods were commonly bought. nordic journal of commercial law, issue 2003 #1 46 the commodities sold under a general description may be bought by different buyers for a wide variety of uses. it would be unreasonable to say that because the goods are unsuitable for only one of these possible uses the goods were to be treated as non-merchantable. a buyer who complains that the goods were unsuitable just for the use he had in mind must try to bring his case under section 14(3) if he could so183 and could not expect to persuade the court that the goods were altogether non-merchantable. if the purposes for which the buyer requires the goods is not a common one, this will still be the case under the new provisions, but the outcome on the facts might be different.184 5.4 sample or model 5.4.1 the cisg subparagraphs (c) and (d) complete the cisg article 35 list of implied obligations. if the seller presents goods as a sample or model, the goods delivered must match the sample. in such a case, and unless otherwise agreed, the sample serves the same function as a »description required by the contract.» of course, if the seller indicates that the sample or model is different from the goods to be delivered in certain respects, he will not be held to those qualities of the sample or model but will be held only to those qualities that he has indicated are possessed by the goods to be delivered. 185 if the description of the goods in the contract and the model do not conform to each other, it may not be deduced, from the fact that without a description in the contract the model replaces an agreement; that the model shall have priority over contractual agreements. 186 5.4.2 finland the sale by sample differs from other types of sale for two different reasons. on the one hand, by presenting a sample the seller commits himself to deliver goods that are similar to the sample. on the other hand, the buyer cannot rely on the facts he should have noticed when examining the sample. samples may be divided into three categories; seller's sample is the one used to demonstrate what the goods will be like. minor differences between the sample and the goods are tolerated. buyer's sample is presented in order to illustrate to the seller how the goods should be: the buyer's sample is to be respected rigorously. the third category is so called sample of type. they merely describe the goods and demonstrate the type: if the goods delivered are of the same type with the sample shown, minor differences have to be tolerated. on the other hand, even though the sample had some defects the buyer ought to have noticed, he does not necessarily lose the right to rely on the said defect. sometimes the sample is used to demonstrate only one character of the goods; color, material or model. if the contractual 183 this would normally mean that he would have to show that he told the seller the particular purpose he had in mind. 184 atiyah adams, p. 143 185 secretariat commentary, comma 11 186 enderlein maskow, p. 147. see also van houtte, icc international court of arbitration bulletin, vol. 11/no. 2 (fall 2000) 27 n.10 (choice of law), 26 n.40 : cisg and complementary national law, 29 n. 55. tribunal ruled that "buyer could not argue that infected buckwheat delivered from china did not conform to the sample, as in the cereal business samples had a limited aim, being intended to define such type-specific characteristics as the kind of buckwheat and the colour and size of the kernel; they were irrelevant to phytosanitary purposes." 29-30 n.61: in a dispute over the quality of hulled buckwheat, sold cif from china to poland, the parties had agreed in the contract that the chinese phytosanitary authorities should inspect the conformity of buckwheat on shipment. although the quality was bad on arrival in poland, the product complied with contractual specifications according to the chinese inspection certificate. as the buyer had agreed to the determination of conformity through the chinese inspection, it was not entitled to compensation." see also the comments of enderlein in dubrovnik lectures, p. 157. nordic journal of commercial law, issue 2003 #1 47 description of the goods does not coincide with the sample, the sample prevails. however, if the seller, as a response to the seller's claim of non-conformity, alleges to have shown as a sample exactly the same goods as he later delivered, and that the buyer has had the possibility to notice the quality of the sample, a question rises as to what the point of the sample was. in any event, the goods have to correspond with the description. when evaluating the limits of tolerance, attention has to be paid to the nature of the sample; whether is was seller's, buyer's sample or sample of type.187 5.4.3 the uk both sale of goods acts of 1893 and of 1979 provide that a sale by sample must be express or should be implied from the terms of the contract. «in the case of a contract for sale by sample there is an implied condition (a) that the bulk will correspond with the sample in quality; (b) that the buyer will have a reasonable opportunity of comparing the bulk with the sample; (c) that the goods will be free from any defect, rendering them nonmerchantable, which would not be apparent on reasonable examination of the sample.» apart from c.i.f.188 contracts, the buyer would always have an opportunity to compare the bulk with the sample at the time the title and possession are passed. in a c.i.f. contract, title passes against the transfer of documents. the passage of property, however, is conditional upon the goods conforming to the contract. the buyer could repudiate the contract and reject the goods if they, upon arrival, were found not to conform to the samples against which the contract of sale was made. 189 when studying the relationship between section 13 and the common law distinction between representations and contractual terms, the first question to be examined is the effect of section 13 on the traditional common law distinction between mere representations on the one hand and terms of contract on the other. at first glance it may seem that section 13 does away with this distinction in case of sale by description since the section states, «there is an implied term that the goods shall correspond with the description.» if the section applied only to those parts of the description that amounted to contractual terms in any event, it would seem to be performing the somewhat odd and redundant function of declaring that it is an implied term that the seller must comply with an express term of the contract. however, despite this oddity, the section does not seem to obliterate the distinction between mere representations and contractual terms.190 it has been held that the section does not affect the traditional distinction 187 aaltonen, p. 202 188 incoterms 2000, cif means cost, insurance, freight. the cif contract places upon the seller the obligation to arrange for the shipping of the goods. the cost of freight is either included in the price quoted which is usual arrangement in these contracts or the buyer undertakes to pay upon their arrival. where the seller and the buyer are separated by large distances, it is sometimes to the buyer's advantage and to his convenience that the burdensome task of arranging the exportation of the goods is left to the seller, who often has knowledge of the local export requirements. the seller, therefore, must arrange for export licenses where these are needed and satisfy all local prerequisites prior to shipping. 189 marasinghe, p. 154 190 for instance, in t & j harrison v. knowles and foster (1918 1 kb 608) the sellers sold two ships to the buyers, each of which had been stated in particulars supplied to the buyers to have a deadweight capacity of 460 tons, but no reference was made to this in the actual memorandum of sale. in fact, the capacity of each ship was only 350 tons. in one sense these ships had been sold by description and the description certainly referred to their capacity. but the court of appeal held that the statements nordic journal of commercial law, issue 2003 #1 48 between mere representations and terms of the contract. for the sale to be by description, the description is influential in the sale so as to become an essential term of the contract. although this question remains tantalizingly uncommented on in the cases, it seems reasonably clear from some decisions of house of lords that section 13 of the act does not automatically convert any or all descriptive words into conditions, or even terms. it seems to have accepted that the only descriptive words that are to be treated as the subject of section 13 are words that identify the subject matter of the contract. words, which merely identify the goods in the sense of pointing out where they can be found, are not words of identity in this specific sense. however, a different view might be taken of contracts for the sale of unascertained future goods where each detail of the description must be assumed to be vital. we could summarize as follows: 1. descriptive words must first be analyzed to see whether they are contractual, or merely amount to representations. if they are misrepresentations only, the normal common law and equitable rules apply, as modified by the misrepresentation act 1967. 2. if the words are held to be contractual, it must next be seen whether there is an express term requiring compliance with the words of description. such a term may be a condition or a warranty, but is most likely to be an innominate term. the buyer's remedies of breach of such a term depend on the nature and consequences of the breach. 3. if there is nothing amounting to an express term, then the next stage is to see whether the description relates to unascertained future goods like commodities. in this event the term is a condition, and strict compliance is required, though a non-consumer buyer's right to reject is now modified by section 15 inserted by the 1994 act. 4. if the contract is of a different character, it must be inquired whether any item in the description of the goods amounts to a substantial ingredient in the identity of the things sold. if it does, compliance with the item will again be a condition. 5. in any other case, the requirement of compliance with descriptive words is not a condition, but a bare warranty or an intermediate or innominate term. this may seem complicated, but it does at least avoid putting the court into a straitjacket to enable the court to arrive whatever decision seems appropriate in the circumstances. section itself seems to have been largely forgotten in this discussion. it is almost impossible to reconcile some cases with the precise words of the act. indeed, it is not clear that section 13 actually does anything at all, since all it seems to say as now interpreted, is that where the seller uses words of description which would otherwise amount to condition, then it is an implied condition that the goods should comply with that description. this hardly seems worth saying, although, in bills propositions may be stated which are not designed in any sense to alter the law. it is perhaps unfortunate that section 13 appears to have been outside the terms of reference of the law commission's inquiry that led to the 1994 act. 191 5.4.3.1 sale by description «the sale by description» must apply to all cases where the purchaser has not seen the goods but is relying on the description alone. hence it follows that a sale must be by description if it is of future or unascertained goods. in addition, the term applies even where the buyer has seen the about the capacity were merely representations. however, in howard marine & dredging v. ogden ltd (1978 qb 574) in similar fact-pattern damages were awarded under the mispresentation act 1967. 191 atiyah adams, p. 120 nordic journal of commercial law, issue 2003 #1 49 goods. it has been made clear by section 13 that the term «sale by description» is wide enough to cover a sale even where the goods have been exposed for sale and selected by the buyer, as in the modern supermarket or department store. but a sale is not by description where the buyer makes it clear that he is buying a particular thing because of its unique qualities, and that no other will do, or where there is absolutely no reliance by the buyer on the description. actually, the only case of a sale not being by description occurs where the buyer makes it clear that he is buying a particular thing because of its unique qualities, and that no other will do. for this reason the sale of a manufactured item will nearly always be a sale by description except where it is second-hand because articles made to an identical design are not generally bought as unique goods but as goods corresponding to that design. 192 the real question at issue in deciding whether the sale should be classified as a sale by description is whether, on the true construction of the contract, the buyer has agreed to buy a specific chattel exactly as it stands to the exclusion of all liability on the part of the seller. for example, the buyer may examine a second-hand car and the seller may offer it for sale in terms which amount to saying: «there is the car, there is my offer; i guarantee nothing, take it or leave it.» in this event it is thought that the sale would be held to be a sale of a specific thing and not a sale by description. it is to be noted that section 13 applies even though the goods are not sold by a person who sells «in the course of a business.»193 moreover, the seller may deliver the contracted goods mixed with goods of a different description. here the buyer has two options in this situation. he may reject the whole or may accept the portion of the goods that conforms to the contract. in the latter case, the buyer must pay at the contract rate for the portion accepted. 5.4.3.2 the relationship between the description and the quality or fitness as section 14 deals with implied conditions as to the quality and fitness of the goods for a particular purpose, section 13 does not on the face of it deal with quality of fitness for purpose. it is quite possible for goods to be of satisfactory quality and fit for their purpose and yet not correspond with their description. conversely, if the goods do correspond with their description the fact that they are unsatisfactory or not fit for the purpose they are sold will not enable the buyer to plead a breach of section 13. in this event he will often be able to rely on section 14(2) or (3), but there are some circumstances in which a buyer may wish to use section 12 rather than section 14, even though his complaint may in a broad sense be said to be one of quality. first, as seen above, section 13 applies to a sale by a private seller while section 14 only applies to a seller who sells in the course of a business. so a person who buys from a nonbusiness seller can only complain about quality if he can bring his case under section 13. this explains a case where the buyer of the car had obtained damages for breach of the condition implied by section 13 the car was wrongly described as being of a certain year model. if the 192 a court in australia held that the sale of an ordinary pair of walking shoes was a sale by description, although the buyer had tried on and examined the shoes and might well have thought to be buying the particular pair as specific goods. even the purchase of a second-hand car which was fully examined by the buyer was held to be a sale by description because the buyer had relied in part on a newspaper advertisement issued by the seller. atiyah adams, p. 122 193 thus in varley v. whipp (1900 1 qb 513) the defendant agreed to buy from the plaintiff a second-hand machine, which was stated to have been new from previous year and hardly used at all. this was a gross misrepresentation, and the defendant could not rely on section 14, which imposes requirements as to merchantability and fitness for purpose, because the plaintiff was not a dealer in agricultural machinery. as the goods did not correspond with the description, it was held that there was a breach of section 13. changes made by later legislation are immaterial to this point. atiyah adams, p. 123 nordic journal of commercial law, issue 2003 #1 50 buyer had been buying from a business seller, he would probably have had a clearer case for damages under section 14 on the ground that the vehicle was not of merchantable quality. 194 but secondly, the buyer may wish to rely on section 13 because the goods are in fact of satisfactory quality in a general sense, but still do not amount to the goods he thought he was buying. in a hypothetical example, a person who buys a suit described as pure wool may very well want to return if he discovers it is not pure wool, even though it may be perfectly satisfactory, and of good quality. but he can only do that under section 13 because there would be no breach of section 14 on these areas. a third type of case in which a buyer might wish to rely upon section 13, even though his complaint is in a broad sense about quality, occurs where the contract contains a clause excluding liability for matters of quality, but not for matters of description something which could still happen despite the unfair contract terms act. particular problems often arise where goods are described in general terms, but some extraneous substance is included in the goods, which does not alter the general nature of the goods but significantly affects their utility. the point is illustrated by the decision of the house of lords in ashington piggeries ltd v. christopher hill ltd195where herring meal, which was contaminated with a substance that made it unsuitable for feeding to minks, was sold to the buyers because the goods were still properly described as «herring meal,» and it was pointed out that not every statement about the quality or fitness of the goods can be treated as a part of the description.196 there is still another type of case that may involve the relation between section 13 and the quality or fitness of the goods. if the contract calls for goods of a certain quality, this quality may itself become part of contract description, but it seems that statements as to quality will not usually be treated as part of the contract description. on the other hand, there are some cases in which quality and description significantly overlap. to take an example once given by lord denning, if the goods being sold are said to be «new-laid-eggs» this goes both to quality and description. however for most purposes such cases give rise to no special problems. breach by the seller will normally involve liability under sections 13 and 14, and the overlap is of no particular importance. it would only be of importance where the implied condition under section 14 is not applicable for some reason and the buyer has to rely exclusively on section 13. he may wish to argue that the term new-laid eggs implies not merely that the eggs are literally new laid, but that they are of good quality, because that is the natural implication of the term. conversely, if the buyer cannot complain about the quality he is not entitled to raise the same complaint under the guise of a failure to conform to description. 197 5.5 packaging 5.5.1 the cisg the buyer can also expect the goods to be packaged in the usual manner if there is one, or in a manner adequate to protect the goods. subparagraph (1)(d) makes it one of the seller's obligations in respect of the conformity of the goods that they «are contained or packaged in 194 atiyah adams, p. 124 195 see the citation of the same case earlier in this study. 196 atiyah adams, p. 125 197 atiyah adams, p. 126 nordic journal of commercial law, issue 2003 #1 51 the manner usual for such goods, or, when there is no such manner, in a manner adequate to preserve and protect the goods.» this provision which sets forth a minimum standard is not intended to discourage the seller from packaging the goods in a manner that will give them better protection from damage that would the usual manner of packing.198 the seller is free to provide better protection for the goods at his own cost. this is influenced not only by the category of the goods themselves, but also the means and duration of transport, the route, and the country of destination. whether or not interior packaging is required, or whether the goods are contained instead of packaged also depends on the means of transportation used and the category of goods involved. the concept of "an adequate manner" also includes that the seller reckoned with a foreseeable delay in transport and the possibility of a redirection in transit or a redispatch in case where he became aware of delay or redirection or redispatch at the time of concluding the contract.199 it does not matter whether the packaging is part of the goods, but the obligation to package the goods depends on what is customary. the seller has an obligation to package the goods not only when the goods are dispatched, but also under cisg article 31, subparagraphs (b) and (c) if the seller only has to place the goods at the disposal of the buyer. also in these cases, the goods have to be packaged so as to allow the buyer to load and transport them. if the buyer himself is to provide the packaging, a clear relevant clause has to be agreed in the contract. this may relate in particular to new goods, but also to such goods that have to be manufactured in a special way. 200 5.5.2 finland it has been disputed on whether the defects in the package may be considered as a defect of the goods. as usually the answer cannot be plainly positive or negative; it needs further analysis. attention must be paid to the goods themselves and how is the packaging. if the package exists only to render the delivery possible, it forms no such a part of the goods that, when defective, could render the goods defective. if the packaging is a substantial part of the goods or their merchantability, or if the conservation of the goods depends on it, it is surely deemed to have effect on the conformity of the goods. also when the package is erroneous for the information it provides, it will fall into the category »defect of goods.» 5.6 buyer's knowledge of non conformity the obligations in respect of quality in subparagraphs (1) (a) to (d) are imposed on the seller by the convention because in the usual sale the buyer would legitimately expect the goods to have such qualities even if they were not explicitly stated in the contract. however, if at the time of the contracting the buyer knew or could not have been unaware of non-conformity in respect of one of those qualities, he could not later say that he had expected the goods to conform in that respect. this rule does not go to those characteristics of the goods explicitly required by the contract and, therefore subject to the first sentence of paragraph (1). even if at the time of the conclusion of the contract the buyer knew that the seller would deliver goods that would not conform to the contract, the buyer has a right to contract for full performance from the seller. 198 at the 1980 vienna diplomatic conference the words »or where there is no such manner, in a manner adequate to preserve and protect the goods» were added to article 35. the explanation is the observation of a representative of australia, mrs. kamarul, who asked »what would happen if the goods were of a new type and there was no usual container or packaging for them?» the provision proposed by her delegation provided that in cases of new standards had not been established, the manner in which the goods would be contained or packaged should be adequate to preserve and protect them. secretariat commentary, comma 12. see also many european domestic sales laws and ulis 199 enderlein maskow, p. 147 200 enderlein maskow, p. 147 nordic journal of commercial law, issue 2003 #1 52 if the seller does not perform as agreed, the buyer may resort to any appropriate remedies at his disposal.201 the cisg provides no information on the yardstick against which «have to be aware» should be measured. there are several formulations in regard to it. apart from «knew» and «has become aware» there is «could not have been unaware» as well as «knew or ought to have known.» the wording «could not have been unaware» is often qualified as a gross negligence.202 according to some legal scholars203 this should not suffice. it has been held that there should be an objective and clearly recognizable deficiency of the goods, which must be obvious to the average buyer. circumstances, which suggest that the buyer could not have been unaware, would be given, for instance, if the seller had in the past sold to the buyer goods of poor quality without complaints from the buyer; or if the price corresponds to the price generally paid for poor quality goods. it is, however, not absolutely excluded for the seller to bear responsibility. if the buyer is aware of the non-conformity of the goods at the time of the conclusion of the contract, but insists on faultless quality, the responsibility will remain with the seller for he must be expected to remedy the deficiency.204 there are no express rules dealing with the case where the lack of conformity is attributable to the buyer himself, as, for example, defects in raw materials supplied by the buyer resulting in the lack of conformity of the goods manufactured by the seller. in the course of the 1977 uncitral session it was considered whether there should be a rule exempting the seller from the liability for the lack of conformity in such a case, if he was not aware and could not have been aware of the defect in the buyer's material or if the buyer insisted on its use after having been warned by the seller. the proposal was not accepted since the position was considered to be obvious. exemption of a seller who was unaware of the defect in materials delivered by the buyer follows necessarily from article 80. however, if the seller is aware of the defect in material, good faith requires him to inform the buyer of that fact.205 cisg article 35 does not lay down any express rules for the case where the seller has specifically warranted the existence of a quality or fraudulently concealed the defect. in the case of a specific warranty of quality there will in any event be a contractual agreement to that effect under cisg article 35(1), so that cisg article 35(3) will not apply. in the case of a fraudulent concealment of a defect, it can be inferred from the principle underlying article 40 (seller unable to rely on the buyer's conduct if he is acting in bad faith), in conjunction with cisg article 7(1), that the seller is liable even where the buyer could not have been unaware of the defect. a buyer is unaware of a defect merely on account of his gross negligence seems to be more worthy of protection than a seller who deliberately sets out to deceive the buyer.206 cisg article 35(3) relates only to cases of lack of conformity under cisg art. 35(2), and not to contractually agreed qualities of the goods or to their packaging under cisg art. 35(1). nor it is possible to apply it by analogy. this is appropriate having regard to the substance of the matter. prior knowledge of the buyer is inconceivable where there is a discrepancy in quantity or a delivery of an aliud. but also if the buyer is aware of a discrepancy in quality at the time of 201 secretariat commentary, commas 13 14 202 herber, r. in das uncitral-kaufrecht im vergleich zum österreichischen recht, p. 141. 203 see huber, u. in der uncitral-entwurf eines übereinkommens über internazionale warenkaufverträge, p.423 204 enderlein maskow, p. 149 205 schlechtriem, p. 284 206 schlechtriem, p. 286 nordic journal of commercial law, issue 2003 #1 53 the conclusion of the contract there can be no overall exemption from liability in the terms of cisg art. 35(3). in such circumstances, which characteristics were actually agreed for the purposes of cisg art. 35(1) must be determined in each case through interpretation. it may be that the quality of which the buyer was aware has become a term of a contract. however, it is also possible that the seller ought to produce the characteristics as required by the contract by the date for delivery or that he has to remedy their absence after delivery. that applies in particular where the buyer has no positive knowledge of the discrepancy in quality, but could merely «not have been unaware» of it. 207 bianca208 states that the seller is not liable for defects of the goods directly or indirectly resulting from their description. nor is he liable for the defects the buyer should reasonably expect. circumstances from which the buyer should reasonably deduce that the goods do not conform to the convention standards are, for example: (a) the seller had usually sold in the past to the buyer poor quality goods without complaints from the buyer; or (b) the price corresponds to the price generally paid for poor quality goods.209 the example (a) could well be extended to any kinds of goods: if the buyer already knows the product because of the previous acquisitions and afterwards orders more of it, he can hardly allege not to have been aware of the defects. views differ when it comes to another extension:210 possibility to extend the rule of cisg art. 35(3) to the lack of conformity covered by art. 35(1). bianca states, quite on the contrary, that the distinction must be kept clear between lack of conformity according to the convention's criteria (or usages), and according to express contractual provisions (an implied provision about the quality of the goods). this distinction does not introduce different rules based on different types of lack of conformity. when there is a special contractual provision, the seller's liability is instead based on the principle that the party may always rely on the engagement undertaken by the other party. the fact that the buyer knows or ought to know of the real condition of the goods is irrelevant because it does not change the content of what the seller has promised to the buyer nor can free him from his promise.211 the determination of whether the goods conform to the contract in the sense of cisg art. 35 is made at the moment the risk passes to the buyer. this is regulated in cisg article 36 of the convention. 212 the possibility remains that an implied warranty concerning the suitability for ordinary purposes will extend beyond the time the goods are accepted. the court determines the life of the warranty 213 or whether some provision must be made in the contract whereby, of course, cisg art. 8 may be consulted has not been clearly decided. hence the cisg article 36 may be applied in different fashions.214 207 schlechtriem, p. 286 208 bianca bonell, p. 279 209 bianca bonell, p. 279 210 see enderlein, in enderlein maskow, p. 146 211 bianca bonell, p. 280 212 however, the question of burden of proof was not decided. the position taken by the british delegate that the question could be left to the courts was not contradicted. 213 of course with due consideration to all of the circumstances. 214 schlechtriem 2, p. 68 nordic journal of commercial law, issue 2003 #1 54 5.7 conformity to requirements of the law in buyer's country 5.7.1 the cisg and the merchantability we may doubt that the seller should be bound to know all governmental provisions in the country where the goods will be traded; it's the buyer who should draw the seller's attention to them, as he is in a position to find and give information at lower costs. a different solution would infringe the need of uniform application of the convention (art. 7(1)). the seller is expected to comply only where he is expected to be aware of them, either because the buyer draws his attention to them, so that they become part of the contract, or else because analogous provisions also exist in the seller's country.215 on the other hand, the operation of national directives often leads to considerable damages to a buyer. the goods maybe destroyed or their sale is prohibited by order of public authority.216 in the doctrine, various interpretations can be found. schlechtriem is of the opinion that the «ordinary use« should be defined according to the standards of the country where the goods are directed. 217 bianca doesn't share the said opinion; according to him the reference should be made to the place of the seller, because only this view will lead to systematic interpretation of the convention. 218 an examination of current case law shows that the question is still unresolved. in the famous decision of german supreme court concerning the sale of contaminated mussels219, the goods were deemed to be conforming because they were «fit for the purposes for which goods of the same description would ordinarily be used». the court excluded that the seller should take into account special government provisions regarding merchantability of food products issued in the country where the goods are treated. 220 the starting point of the decision was that food regulations, to the extent that they should even have been applicable here, could be decisive for the determination of the quality of the goods required by the contract, and their violation is a defect in quality and not a defect in title. it is 215 this latter exception is not problematic: where the infringed provisions exist in both countries, the seller is expected to comply. in a case concerning wine mixed with water and declared unmarketable in germany by public authorities in application of ec-law, the violation of ec-provisions was considered relevant; the same provisions also applied in the seller's country, which was italy. lg trier 12.10.1995. 216 the change of the law of the buyer's country lead to a collapse of a long-term contract between a german brewery and an iranian importer after the new fundamentalist regime in iran had totally forbidden the importation of alcoholic drinks. bgh, njw 84, 1746. 217 schlechtriem in the seller's obligations under the united nations convention on contracts for the international sale of goods, in international sales 1984, pp. 6-21 218 bianca in conformità dei beni e diritti dei terzi in «convenzione di vienna sui contratti di vendita internazionale di beni mobili» 219 bgh 8.3.1995. the case concerned new zealand mussels sold to a german buyer. the mussels contained a quantity of a harmful substance significantly greater than the advised levels published in directives of the german federal health department. the supreme court confirmed the finding of the lower court which, in order to deny that the mussels were unfit for consumption, took into account that they are usually eaten in special occasions and only in small quantities. see the finnish commentary on the case, huber sundström, p. 756 220 however, there have been contrary opinions concerning this decision. karollus, for example doesn't agree with the court. from his point of view, it was essential, that the buyer didn't intend to eat the mussels but to resell them. the real issue under art. 35 (2)(a) is the quality a buyer can expect in the absence of detailed agreements. in his opinion, a buyer can expect a quality that is reasonably merchantable. for him it also seems clear that a buyer should neither be obliged to accept mussels with a bad taste nor to take heavily contaminated mussels. in both cases the goods are edible but probably unsaleable. the buyer's purpose was to resell the goods, and this purpose was frustrated. therefore it would have been correct to say that the mussels lacked the conformity. karollus, p. 51-94 nordic journal of commercial law, issue 2003 #1 55 true that public law regulations, just as technical standards, cultural traditions or religious convictions, are circumstances that have an influence on the goods. these circumstances interact with each other; for instance, ideological and other convictions are often converted into governmental rules and prohibitions. the violation of government regulations concerning the use of goods must not necessarily represent a defect in quality because the relevant area can perhaps disregard such governmental regulations for instance, in environmental law and readily consume and trade goods that violate a prohibition. 221 however, there are other decisions more sympathetic to buyers. a french company ordered from an italian seller various kinds of cheese including parmesan, in the framework of an existing business relationship. the buyer complained because the cheese was not wrapped and labelled conforming to french law on merchantability of goods. the court held, as the parties were in a business relationship, that the seller knew that the goods were to be sold in france. therefore, it should interpret the buyer's statements in the sense that the buyer would purchase only goods wrapped according to french law.222 the same result is reached in a german case concerning sale of paprika by a spanish seller. in the court's opinion, the parties, also in view of their previous commercial relationship, had impliedly agreed that the goods should comply with the standards provided by the german law of food. accordingly, the seller could not invoke lack of knowledge of such provisions.223 the solution cannot be properly deduced from the rule of article 42(1), which states that the seller must deliver goods which are free from any right or claim of a third party based on industrial property or other intellectual property under the law of the state where the goods will be resold or otherwise used (if it was contemplated by the parties that the goods would be resold or otherwise used in that state) or under the law of the state where the buyer has his place of business. however, this rule does not concern our problem. the existence of rights and claims of a third party is indeed normally relevant because the seller fails to transfer the full property of the goods and the buyer is therefore deprived, totally or partially, of what he is surely entitled to under the contract and the convention.224 under the convention the right solution has to be found on a case by case basis according to the circumstances. in general terms it may be said that the fact that the buyer makes known to the seller the country where the goods are to be used, is insufficient to bind the latter to deliver goods meeting the administrative and statutory requirements of that country.225 in practice, the 221 schlechtriem, p. 12, in uniform sales law in the decisions of bundesgerichtshof. it is rather interesting to note the effects of the mussel case; in a dispute between an italian seller and an american buyer, the plaintiff challenged the arbitral award alleging that the arbitrators exhibited manifest disregard of international sales law and that they refused to follow a german supreme court case interpreting the cisg. the plaintiff's claim was, however, dismissed. u.s. district court, eastern district of louisiana 17.5.1999. 222 cour d'appel de grenoble 13.9.1995 223 lg ellwangen 21.8.1995, further to the delivery of the second installment the german buyer received an official warning by a german association of spice traders that paprika imported from spain could contain traces of a harmful substance in a quantity greater than the levels admitted by a german law. a subsequent examination of the paprika delivered by the seller confirmed the suspicions. see veneziano, p. 45 when drafting the convention, there were several suggestions pro e contro. icc stated that the seller cannot be responsible for the conformity of the goods with administrative regulations in the buyer's country. such non-conformity would not touch on the purpose for which they are ordinarily used and the question whether they would be fit for the particular purpose of being used in the buyer's country would have to be answered by application of paragraph (1)(b). 224 bianca bonell, p. 282 225 bianca bonell, p. 283 nordic journal of commercial law, issue 2003 #1 56 sellers of international commerce tend to include in their general conditions of sale clause «the products are manufactured in conformity of the state of manufacture.» of course this is just one effort trying to avoid problems deriving from national legislations and their diversity, but it has proved to be a rather useful one.226 certainly the mussels' case is important not only for the application and interpretation of the cisg, but also for cases to be decided under the bundesgesetzbuch.227 however, one must nonetheless hope that this decision is not yet the final word on this question. 228 in principle, the buyer has to require performance of the contract if there is any lack of conformity under article 35 cisg. if an insufficient quantity has been delivered he may therefore first of all demand delivery of the missing quantity (articles 51(1) and 46(1)). if the lack of conformity takes another form (wrong quality, delivery of an aliud), the right to require performance, in the form of the delivery of substitute goods, exists only in so far as the lack of conformity represents a fundamental breach of the contract. repair of the goods may be required, unless it is unreasonable to do so. avoidance of the contract on the grounds of lack of conformity is only possible if the lack of conformity amounts to a fundamental breach of contract. in the case of goods intended for resale, even slight defects in quality in respect of which a repair is not possible or is unreasonable or is not performed by the seller, are likely to amount to a fundamental breach of contract. however, if the buyer can reasonably sell the imperfect goods elsewhere, there has been no fundamental breach. moreover, in the case of lack of conformity under cisg art. 35, also in the case of delivery of an insufficient amount, the buyer has a right to a price reduction under cisg art. 50 and to damages under cisg art. 74. as regards lack of conformity as a defense to a claim for payment of the price, the rules are laid down in cisg art. 58. 229 in the finnish jurisprudence it has been stated, that the mere fact that the buyer let the seller know the destination of the goods (i.e. the country) the seller is obliged to provide the goods conforming the circumstances of the destination.230 it has to be emphasized that the seller actually couldn't have been unaware of the destination. determining point is the moment of the conclusion of the contract. the reasoning behind this approach is the simple fact that the seller has to be in a situation to be able (1) to assess on which conditions he wants and can deliver the goods or (2) inform the buyer of his inability to deliver the goods conforming with the contract. 231 this view differs to some extent from the international approach. 5.7.2 the uk: merchantability of the goods the case summer permain & co v webb & co ltd232 reflects the english position. the sellers sold webb's indian tonic to the buyers, which they knew the buyers intended for resale in argentina. the tonic contained a quantity of salicylic acid that, unknown to both parties, made its sale illegal in the argentine. when the tonic reached argentina, it was seized and condemned by the authorities as unfit for human consumption. it was held that there had been 226another problem is, whether the general conditions of sale ever really became a part of the contract, since they are regrettably often enclosed to the invoice. it can be successfully argued, that the contract is concluded at the moment of acceptation of the offer, on conditions given above and that the conditions added afterwards do not bind the buyer. 227bundesgesetzbuch (bgb) is the german civil code 228 schlechtriem, p. 12, in uniform sales law in the decisions of the bundesgerichtshof 229 schlechtriem, p. 287 230 when the goods lack a certain character that the goods of that kind do not usually have, the buyer is entitled to consider the goods non-conforming if that certain character was agreed upon. aaltonen, p. 102 231 wilhelmsson sevòn koskelo, p. 105 232 (1922) 1 kb 55 nordic journal of commercial law, issue 2003 #1 57 no breach of section 14(2) as the goods could not be said to be non-merchantable by virtue of the provisions of argentinean law. there was nothing wrong with the quality of goods, which could have been resold by the buyers anywhere except in the argentine. goods were not nonmerchantable merely because they were not fit for the particular purpose. the buyer's complaint was really that the goods were not fit for the purpose they were sold, but they also failed under section 14(3) because they had ordered them under their trade name. atiyah claims that it is quite unreasonable to expect sellers to know the rules of law in operation in every country from which orders emanate, or into which a buyer wishes to export. these are matters within the sphere of knowledge of the buyer/exporter. it would be different if the seller had taken active steps to penetrate a target market so that the seller could be said to be exporting into that market. 233 merchantability of the goods is an important aspect of a contract for the sale of goods. the sale of goods act of 1979 included merchantability in two separate sections. these are: 14(2) where the seller sells goods in the course of business, there is an implied condition that the goods supplied under the contract are of merchantable quality, except that there is no such condition: (a) as regard defects specifically drawn to the buyer's attention before the contract is made; or (b) if the buyer examines the goods before the contract is made, as regards defects which that examination ought to reveal. 15(2) in the case of contract for sale by sample there is an implied condition (a) that the goods shall be free from any defect, rendering them non-merchantable, which would not be apparent based on a reasonably undertaken examination. the sale of goods act of 1893 did not define what «merchantability» meant, leaving it to be determined on a case-by-case basis. this led to an accumulation of case law of some considerable proportion surrounding the term «merchantability.» those who opposed defining merchantability argued that any definition of that word in a statute would result yet again in the accumulation of case law, interpreting the statutory definition. despite the force of this argument, the legislature defined merchantability in the 1979 statute as stated previously. the 1994 act substituted the «merchantability» by «satisfactory» but the importance of the merchantability in the sale of goods cannot be underestimated. it is the key to finding an obligation of the seller to provide goods of the quality that is commercially saleable. another thing important to note is that the merchantability provisions apply only when the seller is in the course of a business. the act of 1893 had no such a provision. therefore, the merchantability provision in the 1979 act would not apply to a sale if the sale was a private sale or if the agent who is selling were to inform the buyer that he was acting as an agent for a private seller. however, in international sale, it is most unlikely for a buyer to deal with a private seller. sales of the type considered here are always with an established company or suppliers or manufacturers who sell in the course of their business. it might also be pointed out that where the sale is by sample, the merchantability provisions apply whether or not the sale was made in the course of business. it is most unusual that a sale by sample could take place 233 atiyah adams, p. 143 nordic journal of commercial law, issue 2003 #1 58 with a private seller. private sellers are not in the habit of submitting samples at the precontractual stage. 234 the celebrated decision of ashington piggeries ltd v. christopher hill, laid down the implications of merchantability under the sale of goods act of 1893. the decision is applicable to the same provisions in the 1979 act. in that case, the appellants contracted with the respondents to prepare a particular type of food for feeding mink, from a formula supplied to them. the respondents had been in the business of manufacturing feed for poultry, pheasants, calves and pigs, but never before for mink. however, they accepted the challenge and agreed to produce the feed for which herring meal was one of the ingredients. the earlier preparations caused no problems but the later preparations for which norwegian herring meal was used, did. it was later found that the meal was contaminated with dmna. this contaminant caused the deaths of a number of minks. the appellants successfully sued the respondents for a breach of section 14(2) of the 1893 act, which required the goods to be merchantable. the house of lords held that the requirement that the goods bought for the purposes of section 14(2) should have been bought from the seller who sold goods »good of that description» was satisfied when the goods in question were bought from a seller who sells »goods of that kind.» the respondents were in business of selling animal feed to poultry, pheasants, calves and pigs, and these were goods of the same kind as those that the appellants ordered. the courts held that there was also a breach of section 14(1). the buyer had informed the seller of the particular purpose for which the goods were required so as to show that the buyer proposed to rely on the skill and judgment of the seller who dealt with goods of that description. having first decided that the goods of that description in the statute were tantamount to goods of that kind, the court held that the mink feed provided by the seller did not reasonably fit the purpose which the buyer had communicated to the seller, this being that the buyer intended them to be used for feeding the mink. this breached section 14(1). the buyer was free under section 14(1) to rely wholly on the seller's skill and judgment or rely partially on it. in the present instance, the reliance was partial and the seller's liability was to the extent to which the reliance was placed. it was partial because the seller was required to provide the meal according to a formula supplied by the buyer. in international sales transactions, the buyer normally deals with the seller and vice versa, at a distance. the buyer would, therefore, usually prefer to rely on the skill and judgment of the seller. the seller would be left to select the best possible product for the purpose that the buyer would expressly or impliedly make known to the seller. the seller in such a situation will be bound by both subsections 14(1) and 14(2) of the 1893 act. 235 234 (1972) ac 441 1 all er 847 235 ashington piggeries may be compared with henry kendall & sons v. william lilico & sons ltd (1968) 2 all er 444, 2 ac 31, 3 wlr 110. the plaintiffs bought, for feeding their pheasants, animal feeding stuff from the defendants. the feeding stuff contained brazilian groundnuts which were suitable for feeding cattle but not other animals. the plaintiffs lost some of the pheasants and alleged that the feed sold was non-merchantable. the house of lords held against the plaintiffs. the point made by the house of lords was that unless the buyer had made the seller aware both of the purpose for which the goods were required, and that the buyer was relying on the seller's skill and judgment to produce such goods, the goods supplied would not be non-merchantable because they did not suit the purpose which the buyer had in mind when the goods were bought. as long as the goods were suitable for some other purpose the goods were clearly merchantable. alluding to this line of thinking, lord reid wrote: »he ought either to have taken the necessary steps to bring sub-s (1) into operation or to have insisted that a more specific description must be inserted in the contract.» the alternative which the buyer had, other than invoking subsection (1) of section 14 of the 1893 act, was to ensure that a specific description of the goods he required was clearly included in the contract. that too would be sufficient to protect the buyer's interest in receiving the type of goods he desired to receive. »fitness for the purpose» is thereby linked to »merchantability» of the product. marasinghe, p. 154 nordic journal of commercial law, issue 2003 #1 59 thus, there were two approaches to the issues of deciding what the meaning of «merchantable quality» was. on the one hand, there was the view that the statutory definition really had little substantive content. the basis for this view was that vague, general terms like «merchantable» tend to be meaningless in practice indeed, a substantial degree of flexibility is needed in applying such general terms because of the very varied transactions that come within the law of sale of goods. the same can be said of the term «satisfactory.» all vague statements or definitions of the standard of quality required by law, it may be suggested, are somewhat vacuous in practice. they tend to be replaced with concepts of reasonableness that have substantial flexibility. most such standards give little guidance as to what kind of defects or damage will render goods unsatisfactory (non-merchantable under the former provisions), and are not of assistance in the practical application of the law. all rely heavily upon the test of reasonableness: would a reasonable buyer, if he knew the condition of the goods, accept them under the contract? would a reasonable buyer expect goods of that condition to be delivered under that sort of contract? tests, which depend so heavily upon standards of reasonableness, need to be somewhat circular in practice. what is the buyer entitled to expect under the contract? answer goods of satisfactory/merchantable quality. what is satisfactory/merchantable quality? answer goods of that quality roughly speaking which can reasonable be expected. what would the buyer reasonable expect? answer goods suitable for reasonable use. what is reasonable use? answer the sort of use which a reasonable buyer would intend, but also the use that was disclosed to the seller in the moment of the conclusion of the contract. and so on. 236 on the other hand, there was a court of appeal decision rogers v. parish (scarborough) ltd237 which suggested that the statutory definition of «merchantable quality» could in most cases be applied by a fact finder without any detailed analysis of old case law. it must be suggested that the reasoning in this case was fallacious. the court assumed here that the application of any statutory definition in the old section 14 was a question of fact, but the introduction of reasonableness into the definition meant that questions of evaluation were necessarily involved. it is not possible to posit the «reasonable man» and ask how he would behave as though that were a question of fact. how a reasonable man would behave in any given circumstances is not a fact, but an evaluation. questions of reasonableness require the court to provide the answer based on its sense of justice, but that means that detailed analysis and illustration must remain necessary unless every case is to be disposed of by an appeal to the court's idiosyncratic views on what justice demands. that would surely be quite unacceptable in such a large and important area of law as this. this same point can be made in relation to the new section, which provides that goods are satisfactory if they meet the standards that a reasonable person would regard as satisfactory.238 6 conclusion: the cisg and english law compared according to article 35(1) of the cisg, the seller is bound to deliver goods that are of the quality and description required by the contract. without analyzing the distinction between quality and description, article 35(2) then goes on to provide that the goods do not conform unless they satisfy the following four cumulative requirements: fitness for the purpose for which 236 atiyah adams, p. 140 237 (1987) qb 933 238 atiyah adams, p. 141 nordic journal of commercial law, issue 2003 #1 60 the goods of the same description would commonly be used; fitness for any particular purpose expressly or impliedly made known to the seller at the time of the conclusion of the contract, except where the buyer either does not rely or unreasonably relies upon the seller's skill and judgment; possession of the qualities of goods held out as a sample or model; and packaging or containment in a manner adequate to preserve and protect the goods. a buyer who succeeds under paragraph (2) will nevertheless fail under paragraph (3) if actually or imputedly aware of the lack of conformity of the goods at the contract date.239 the material on fitness for purpose in cisg article 35 substantially tracks its counterpart in english law. an english court, in the spirit of internationalism imposed as a rule of interpretation by article 7(1) of the cisg, should be open to the interpretation of other courts and sensitive to features of english law that have lent a slant to the interpretation of fitness for purpose in the sale of goods act. for example, other courts might interpret «particular purpose» as special purpose and not as a commonplace purpose, in the way that english courts have. given the other elements of the cisg article 35, however, this point may have no great particular importance.240 6.1 fitness for all ordinary purposes until changes in the law brought om by the sale and supply of goods act 1994, it could have been said that a seller, in order to comply with what was then the implied term of merchantable quality, needed to supply goods that were fit for only one of their ordinary purposes.241 a buyer seeking their fitness for a particular one or more of these ordinary purposes therefore had an incentive to make this known to the seller so as to display the reliance on the seller's skill and judgment under section 14(3). this position accorded with the remnants of the caveat emptor rule. the onus was on the buyer to disclose and not on the seller to interrogate. the revised merchantable, now satisfactory, quality term requires the goods «in appropriate cases» to be fit for all the purposes for which goods of the kind in question are commonly supplied. no such qualification, however, is to be found in the cisg article 35. suppose that the goods are not fit for one of these purposes and that the buyer either states at the contract conclusion date that he needs goods for another purpose, or states that he has no intention to apply the goods for the purpose for which they are unfit (and further does not use them for that purpose). in the former case, the buyer changes his mind and, in the latter, he opportunistically pounces on their selective unfitness in order to reject the goods and avoid the contract. an english court applying section 14 should conclude that liability is not appropriate in these two cases. a court applying cisg article 35 has no such resort but might interpret that provision in accordance with good faith to conclude that the buyer has no claim. 242 6.2 variable standard although there is no cross-reference of paragraph (2) to paragraph (1) of cisg article 35, the general rule of contractual conformity is to be found in the latter provision that measures the compliance with quality and description by reference to what is «required by the contract.» the express requirements of the contract will vary from case to case but there is no reference in paragraph (1) to an implied standard that is equivalent to satisfactory quality in section 14(2) of the sale of goods act, which takes into account of description and all relevant considerations, 239 the relationship between paragraphs (1) and (2) of art. 35 could be clearer. the latter paragraph cannot be regarded as a particular restatement of the former. in particular, the former requires the seller to deliver the agreed quantity; nothing in the latter speaks to quantity. 240 bridge, p. 80 241 note previously kendall v. lillico 242 bridge, p. 81 nordic journal of commercial law, issue 2003 #1 61 which may include the price. taking account of fitness for all ordinary purposes and giving a broad reading to description, it may be that in the absence in cisg article 35 of a broad, implied variable quality standard makes no practical difference. suppose, for example, that inferior goods are sold as a discounted price in a way that may persuade an english court that there has been a breach of section 14(2). it is very likely that some descriptive language will permit a court applying cisg article 35 to reach the same result. if there is no such qualifying language, a court might determine the scope of ordinary use by reference to the price paid. 243 6.3 description as stated before, description in the english law of sale is a difficult and technical concept. at one time, it was capable, in the case of unascertained goods, of embracing more or less all attributes of those goods. since the implied term of correspondence with description was a statutory condition, this meant that each and every descriptive statement was tantamount to an express contractual condition, so that the buyer could reject the goods and terminate the contract no matter how trivial the injury. as reaction set in against this position, description was confined to the essence or identity of the goods. 244 the practical consequence of this was that the law on description was brought into line with law on express warranties, where a breach in matters of quality and condition was treated as the breach of an intermediate stipulation, with the result that the buyer could reject the goods only if able to demonstrate a substantial deprivation of benefit. 245 in the case of article 35 of the cisg, however, it should be understood that description came into the text without its english history. the avoidance rules of the cisg do not allow for a technical exercise of rejection rights. in consequence, there is no reason to give anything other than a straightforward reading to the word in cisg article 35.246 6.4 reliance and examination cisg article 35 contains no exception based upon the buyer's examination of the goods, in the way that section 14(2c) of the sale of goods act does.247 it does however state in paragraph (3) that the buyer may not complain of a lack of conformity pursuant to cisg article 35(2) where there is actual or imputed notice of lack of conformity. this test may be somewhat more generous to the buyer who carelessly examines the goods than is english law. a further point concerns descriptive statements where the buyer does not in fact rely upon the seller. this was sufficient to persuade a majority of the court in harlingdon and leinster enterprises ltd v. hull fine art ltd248 that the seller had not committed a breach of the description condition in section 13 of the sale of goods act, which took the law in a new direction. there does not appear to be any warrant in cisg article 35 for so restricting the seller's liability. arguably, if the buyer has paid a certain price for goods described in a particular way, he should be entitled to reject the goods or claim a reduction of the price if a painting like that sold in the above case proves to be a forgery. there are few signs of any commitment to the caveat emptor ethic in the cisg.249 243 bridge, p. 81 244 note previous ashington piggeries v. christopher hill 245 see earlier presented cehave nv v. bremer handelsgeschellschaft mbh 246 bridge, p. 82 247 this covers both actual examination and defects especially drawn to the buyer's attention. 248 (1991) 1 qb 564 249 bridge, p. 82 nordic journal of commercial law, issue 2003 #1 62 6.5 express warranty and misrepresentation the sale of goods act contains no provision on express warranty. it is submitted that cisg article 35 should be read expansively to catch express warranty: goods are of the quality and description «required» by the contract if they conform to the seller's express warranties. 250 this will minimize discord between english courts and foreign tribunals if the latter do not recognize express warranties as such in those terms. misrepresentation presents a more challenging problem. one possibility is a statement made by the seller about the goods which is not incorporated as a term. another is a statement that is incorporated as a term but, under english law, also retains its separate identity as an inducing misrepresentation.251 under domestic english sales law, it is a matter of some difficulty to accommodate the law on misrepresentation and the law on breach of the contract of sale. according to section 1(a) of the misrepresentation act 1967, the victim of a misrepresentation that becomes a term does not thereby lose the right to rescind if otherwise he would be able to rescind the contract. in the case of misrepresentation that does not become a term, any incongruity in allowing the drastic remedy of rescission for a statement not important enough to constitute a contractual term can be dealt with by an exercise of the court's discretion under section 2(2) to declare the contract subsisting and award damages in lieu of rescission. where the misrepresentation becomes a contractual term, the court of appeal has, in one case252 declined to allow rescission when the higher right of rejection for breach of condition had been barred by an acceptance of the goods under section 35 of the sale of goods act. 253 6.6 misrepresentation and the cisg if the english courts were to exercise their discretion under section 2(2) of the misrepresentation act 1967 to declare the contract existing consonantly with the test of a fundamental breach in article 25 of the cisg, there would be no true discord between misrepresentation and the cisg. that discretion, however, was never meant to be exercised so extensively in a system of law that such a generous range of express and implied terms permitting contractual termination in the event of any breach would exist. if the law on misrepresentation were to run parallel to the cisg in english law, it would undermine the treatment by the latter of contractual avoidance for breach, unless english courts were able to take the approach in leaf v. international galleries and apply it imaginatively to a case where under the cisg, there never was a right of rejection and contractual avoidance. it is not easy to take this extra step when section 1(a) of the misrepresentation act is so clear on the survival of a misrepresentation as a misrepresentation despite its incorporation in the contract is a term. failing a solution along the lines of leaf, there does not appear to be an answer in the cisg itself. it cannot be said that the contract requires goods of a certain quality or description when a misrepresentation dealing with quality or description does not become a contractual term. 250 it is more difficult to fashion a role for express warranty in the cisg where the seller's statement does not deal directly with the goods. it may, for instance, relate to the existence of servicing facilities or spare parts. to avoid the difficulties of dépeçage, i.e. one agreement is governed by several legal systems, with express warranties being divided between the cisg and the otherwise applicable law, a court should not demand too direct a link between the statement and the very goods supplied. 251 in the case of both warranties and misrepresentations, the cisg permits an objective interpretation of the seller's statement in a way familiar to common law lawyers: article 8. nevertheless, art. 8(3) permits interpretation on the basis of subsequent conduct of the parties, not the case in english law. 252 leaf v. international galleries (1950) 2 kb 86 253 bridge, p. 83 is this consistent now with section 1(a) of the 1967 act, or may the language of that provision be interpreted broadly to catch, not just the ordinary rescission bars, but also the particular bar introduced in leaf v. international galleries? the approach taken in the said case could, where the term is an intermediate stipulation whose breach does not go to the root of the contract, be mimicked by deeming it to be a condition for the purpose of the acceptance bar on rejection. nordic journal of commercial law, issue 2003 #1 63 the best approach would be to exclude the doctrine of misrepresentation and not to apply the misrepresentation act in the case of contracts governed by the cisg that, since implementation of the cisg requires primary legislation, could be achieved on that occasion. for practical purposes misrepresentation operates parallel with the rules on breach of contract in english law. there would also be scope for the law of mistake in cases of serious misrepresentation if the doctrine of misrepresentation had not already occupied the field. to say that all misrepresentations go to validity would breach the spirit of the cisg, but to allow the law of the mistake of present scope to fill any gap in english law vacated by misrepresentation would not. the matter would then be removed from the scope of the cisg by article 4(a). this, of course, highlights another difficulty with the cisg and uniformity: different contracting states will have doctrines of mistake of varying scope. until uniformity of contract law is reached on the international stage, this problem will not be resolved. the difficulty of an expansive law of mistake overlapping the law on breach of contract, which can occur within a legal system, is addressed by article 3.7 of the unidroit principles, which states that a party may not avoid a contract on the ground of a mistake in circumstances where there is a contractual remedy for non-performance. if a contract dispute were to be governed by both the cisg and the unidroit principles, it could be a difficult question whether article 3.7 defers to the non-performance rules of the cisg as well as the non-performance rules of the unidroit principles themselves.254 7 finland: conclusions according to finnish writers, deficiency of the goods can bee seen as a two-fold concept, the first layer being an objective (abstract) level and the second being a subjective (concrete) level. however, a view this narrow can hardly bring a satisfying result; a more in-depth analysis is required. in the finnish doctrine have been studies among others, the following aspects of deficiency: visible/hidden; relevant /irrelevant, discrepancies in the quantity agreed upon and the quantity actually delivered. in search of a solution when it comes to visibility of a mistake, the answer could be found studying the parties' obligations to examine the goods. it is here when the professionalism or ignorance of the parties do count. while it can be concluded that the professional party can be deemed liable when reasonable diligence has been neglected, it cannot be alleged that the ignorance of a contracting party could be a valid excuse in doing so. this approach would discourage diligent commerce; the more one is diligent, the more would be required and vice versa. when assessing the relevance or irrelevance of the defect, the non-conformity is usually considered irrelevant if the defect does not hinder the ordinary use of the goods. if a contracting party could reject the goods, discharge the contract or even claim damages even for a minor deficiency, the certainty of law would be endangered.255 defining what is «relevant» has to be established on a case-by-case basis; it may seem rather futile to try to construct artificial rules while they do not serve in concreto. 256 254 bridge, p. 84 see also his analysis on the differences between the two regulations in »the international sale of goods revisited» , p. 143 onwards. 255 godenhielm, p. 119 256 godenhielm, p. 123 nordic journal of commercial law, issue 2003 #1 64 in practice, the importance of assessing the deficiency of the goods lies on its sequences; whether the buyer may rely on the non-conformity or not, and thereafter rely on the remedies provided by the rules of law. in order to evaluate the non-conformity, aaltonen has prepared a two-picture-construction, which clarifies his thought. the construction consists of, two circles, first of which is actually a composition of one small and one big circle, which have the same counterpoint. the space outside the bigger circle reflects the conformity of the goods, while the space between the bigger and the smaller circle indicates the position of a minor defect of the goods. as long as we remain in these two zones the deficiency is of minor nature and the buyer can hardly rely on it, but when we move inside the smaller circle, we enter the zone of a kind of deficiency which does matter and to which the buyer can rely on. in order to point out the significance of the seller's guarantees and warranties, aaltonen draws his second circle; this one is divided into sectors, each of which reflects a certain character of the goods. thus, if we think of the position of a buyer who has contracted on a fabric of a certain color, his possibilities to rely on alleged defects is not anymore limited to the inside of the inner circle, but has enlarged till the border of the outer circle. it is prudent to note here that this construction does not allow us to take into account consequences, which would render the construction aleatory, since the relevant sector of our picture being from the remedies' point of view is rather variable. this is proved, for instance, by assuming that the buyer of non-conforming goods accepts the delivery, despite of the defects. in the event of the acceptance, the buyer cannot rely on nonconformity at all. hence, we can conclude that the concept of conformity and non-conformity should be constructed remaining strictly on the ambit of the defect. the concept is, however destined to remain somehow vague and thus renders the exact definition impossible. nonconformity may be described and analyzed from various points of view. it may vary according to the objectivity or subjectivity of the narrator, but still remain largely beyond exact legal definitions, not least for the enormous variety of the situations where it may appear. aaltonen withdraws himself from further definitions and simply states that the goods are defective if they are not as they were bought. 257 8 the u.k. vs. the cisg there has been much debate of late as to whether the united kingdom should ratify the convention; critics on the convention have not merely asserted the superiority of english sales law, but have argued that the convention itself is incomplete and uncertain. by the time of the ratification of the newly prepared cisg, the law society of england and wales made the following objections to the convention: 1. the convention will not produce uniformity because it will be subject to differing national interpretations; 2. sophisticated commercial traders will find it easy to avoid the provisions of the convention; 3. the convention will more commonly apply by default, given the working of the convention's «opt-out» provision; 4. the convention will result in a diminished role for english law within the international trade arena. 5. 257 aaltonen, p. 148 nordic journal of commercial law, issue 2003 #1 65 one must assume that the latter reason is a major explanation for the dislike of the convention in the united kingdom.258 some commentators believe that the convention represents «a sensible compromise» incorporating «a prodigious amount of work and international collaborations spread over years» or simply «as good as can be expected.» on the other side, as the list of contracting states grows, an organized regulation of sales contracts at an international level begins to develop and this has obvious attractions as the business community across differing economic and political systems begins to speak in the same legal language. indeed, one of the strengths of the convention is that it is based upon accepted practices of international transactions and is ready to incorporate trade usages into its framework. again it is strongly driven by a policy that the parties should be free to contract and is not overbearing in its regulation of international sales. this is a delicate balancing act, but the convention seeks to achieve a form of lex mercatoria that sets the boundaries of commercial sales transactions in a clear, well-defined fashion leaving the parties to divide the middle ground. indeed the autonomy of the parties is recognized in its final form by the convention permitting the parties to exclude, in whole or in part, the application of its provisions. proponents of this viewpoint can argue legitimately that where the legal, economic and political systems vary as widely as those of the signatories to the convention, attempts at the total unification of sales law would be absurd. rather what is needed is a law that governs international sales as a separate species of transaction. such contracts do attract particular legal problems not least conflict of laws. the vagaries of private international law may leave business parties in considerable doubt as to the law applicable to the contract. on this view, the convention provides an island of certainty amid the stormy seas of international law.259 however, an extra effort is needed to emphasize advantages of the convention to businesses and lawyers in the u.k. as lord steyn noted in 1994, english lawyers, judges and politicians have a history of hostility towards multilateral conventions in general, which has already in the last century resulted in delayed ratification by the uk of some international treaties and conventions which have subsequently proved to be extremely successful. nevertheless, the lawyers in the u.k. have a duty to be able to advise their clients on the suitability of the cisg for a particular transaction and this requires a knowledge of the substantive law contained in the cisg in addition to an understanding of how the cisg is viewed in other countries involved in the transaction.260 one of the criticisms leveled against the cisg in the u.k. is that it does not match up to english standards of precision and drafting. it is well known characteristic of the common law that it favors concrete legal solutions to specific problems as opposed to general broad principles. in contrast, the drafting style of the cisg is often left open, firstly to encourage the development an application of general principles and secondly because in some cases, a more concrete solution could not be agreed upon the diplomatic conference. however, the extensive use of indefinite legal concepts and the abstract nature of many norms in the cisg does not lie well with the expectations of the english legal community, who argues that ambiguity in legislation leads to uncertainty in the law, which is especially undesirable in the tradition of commercial law.261 258 lee, p. 132 259 lee, p. 146 260 williams, p. 10 261 williams, p. 10 nordic journal of commercial law, issue 2003 #1 66 the drafting style of the cisg also belies a more fundamental difference with the english law. the emphasis on the general principles, allows for a more subjective approach to the interpretation of the contract in contrast to the objectivity of the english courts when interpreting the contract. the emphasis is on finding justice in the individual case as opposed certainty in contracts. this is similar to the approach taken in civil law countries, where a contract is enforceable if the court can find a subjective agreement between the parties (consensus ad idem meeting of the minds).262 9 comments the distinction among the various categories of lack of conformity is certainly not easy. this is confirmed by the criticisms made by several authors. the in-depth analysis made by many authors, and the tormenting case law, do not always allow us to keep the general framework clear. the following remarks are consequently intended to serve for this purpose. the delivery of goods other than those agreed upon seems to remain an entirely different concept from the delivery of the goods agreed upon. examples include the delivery of a painting by an unknown painter instead of one from a specific painter that had been warranted, or of wine instead of liqueur, or of a goat instead of a sheep. one may be tempted to point out that this will not happen very often, but it may happen and has happened. it has been put forward against this distinction that in case of delivery of other goods the seller a fortiori should be protected by a duty of a buyer to give an immediate notice of complaint, such as it is provided for in the case of defects and lack of quality, instead of being subject to the longer terms for the general action for breach of contract. however, if the purpose of the complaint is to allow the seller to immediately check the merits of the complaint, it seems much more difficult and urgent to establish the existence of a defect or lack of quality than it is a total difference, in the goods delivered since, as a rule, the delivery of other goods does not have to be ascertained immediately. the proper functioning, which has been contractually warranted, is also a sufficiently clear notion and, in fact, it has given rise to fewer disputes than the other classes of lack of conformity. the class of «defects», seen as a deficiency of the sold assets is also homogenous. as we have seen, bad wine, chipped bricks, and a scratched painting are typical examples of defects. it is suggested that the category of lack of quality may remain homogenous if its notion remains centered on the concept of quality as a merit of the goods being of a superior level in the desired attributes of the goods. in other words, they may be goods without defects but also without a certain quality. likewise there may be goods without defects that possess a quality, and it is possible that there are goods that possess a quality, but also a defect of deterioration. a classic example of quality is presented by first choice goods compared with others which are also free from defects but do not possess a specific quality. certainly when one confronts individual cases, it is possible to be faced with ambiguous situations. setting foot on the dangerous territory of exemplification, the delivery of a cheese of the requested type, but not of the requested variety of cheese, or the supply of wine produced in a different year, seem to constitute lack of promised quality, while the delivery of a type of normal lambskin instead of astrakhan seems to be the delivery of another type of goods because of their different origins, 262 williams, p. 11 nordic journal of commercial law, issue 2003 #1 67 the same conclusion must be made if a wine of a different producer is delivered. an example of a quality essential for use, which is made by the doctrine, is the minimum length of a pair of trousers. 263 in the framework of the international organizations and the conventions, the emphasis must be placed on the uniform interpretation and application. indeed, the wide acceptance and effective implementation of existing texts might be of greater value than the elaboration of new texts. thus, although it is important to keep on eye on the real challenges that lie ahead, a new approach must be taken to allow successful interpretation and application of substantive unified rules. however, in the application of unified rules the parties desire the same outcome as they would seek in a purely domestic matter that is, predictability, efficacy, equity and finality. furthermore, they also expect that their dispute will be solved in an identical manner in all contracting states. although much has been done in order to achieve this goal uniformity of solutions diversity continues. often the expectations of the parties involved in a dispute that must be solved in reference to unified rules clashes with the actual application of unified rules by municipal courts. this implies that the search for the most favorable forum is not yet over and the main objective of the unification has not yet been achieved. 264 the questions as to the necessity of general principles of law, such as the principle of good faith, in international trade law have been resolved by international arbitration the experience of international arbitration in relation to general principles of law demonstrates that the classical view of contracting parties as antagonistic individuals seeking to make maximum profits without any regard for the other party has been rejected by the international business community. although certainty and stability are needed in international dealings, flexibility has become increasingly important. it has been submitted that international trade conventions should acknowledge new complex reality and endorse the principle of good faith despite its inherent vagueness. however, it is important not only that the parties observe the good faith in their dealings but that national courts make use of the requirements of the principle of good faith while interpreting international trade conventions.265 in the case of the cisg the question of uniformity in application and interpretation of its provisions acquires a special importance. according to article 1(1)(b) for its application it is no longer necessary that a transaction has some connection with a contracting state. it suffices that conflict of law rules of the court before which the dispute is brought lead to the application of the law of a contracting state and that the places of business of the parties are in different states. under those circumstances, it is certainly wiser to adopt the cisg and make it familiar to the business community of a non-contracting state than to go against the mainstream.266 uniform law may also lead to benefits at both the macro and the micro level. uniform law reduces legal differences between countries and, hence, creates a level playing field between competitors in different countries that no longer have cost advantages or disadvantages based on the level of the regulation in their respective countries. uniform law thus avoids regulatory 263 rubino-sammartano, p. 255 264 kaczorowska, p. 54 265 kaczorowska, p.127 266 kaczorowska, p. 56 nordic journal of commercial law, issue 2003 #1 68 competition between different countries and forces competitors to compete on terms (such as price and quality) other than legal terms of the transaction.267 finally, the unification may be used or might bring about an improvement of the law existing in the countries participating in the unification effort. in the former case, unification is used indirectly to achieve objectives of domestic policies of justice departments where one fears that otherwise objection to change in the law may be too great or where one lacks necessary resources to embark upon a re-codification venture. in most cases, however, national policies are aligned to the policies of the unification-formulating agency but may as a side effect lead to an improvement of the present state of law. however, there are no guarantees that uniform texts will per se be better than existing national law. uniform law is not by necessity better law than national law. sometimes the argument is advanced that uniform law is better than domestic law because it is specifically written for international situations and thus, takes the interests of international commerce into account. the argument that uniform law is better suited for international transactions since its substantive provisions give due and better consideration to the needs and interests of international commerce remains to be verified. for instance, some uniform texts268 have been extended in some countries or are being contemplated to be extended to domestic relations. this argument proves that texts relating to international situations can sometimes be extended without any problem to domestic transactions and casts some doubt regarding the specific features of these uniform instruments in relation to international situations. 269 267 however, in the european union context, one has seen the opposite direction, particularly in the field of financial services where regulatory competition and deregulation and not total harmonization have been policy objectives. one might say that unification policies in this respect represent a tendency to centralize rule making at the international level where deregulation expresses a liberal, decentralized attitude towards unification. the former is based on the belief that unification matters and that the international scene should provide for a basis of cooperation between nation states. in commercial law, this would imply the need for a framework within which transactions and operations of merchants are encouraged. on the other hand, deregulatory policies would leave it to the market place to decide whether or not to develop uniform rules. theoretically, this would ultimately lead to a race to the bottom and delaware effects meaning that the market operators would choose rules that are least protective and least expensive. both models in their extreme forms are idealtypen which have been subject to scant empirical research. in the real world, one doesn't find either form but rather mixtures of both models in which these may be found in different degrees. de ly, p. 528 268 for example the 1929 warsaw convention, or the 1956 cmr 269 de ly, p. 529. 1 introduction 2 vienna convention 2.1 historical background the need for a convention 2.1.1 the position of the cisg in respect to national laws 2.2 comparing the ulis and the cisg 2.3 interpretation of the cisg 2.3.1 linguistic problems 2.4 the problems arising out of interpretation 2.5 steps taken to overcome obstacles 2.6 cisg-contract 2.6.1 approaches to interpretation 2.6.2 interpretation of a contract of sale 3 the goods 3.1 the object of the sales contract: definitions of »goods» in the cisg 3.2 the meaning of «goods» in the u.k. 3.2.1 different types of goods in the u.k. 3.3 «goods» in finnish legislation 4 lack of conformity 4.1 the cisg rules regarding lack of conformity 4.1.1 practical importance of art. 35 4.1.2 agreement between the parties 4.1.2.1 gap filling, parol evidence-rule 4.2 finland's rules of law on the conformity of goods 4.2.1 conformity with contract, section 17 4.2.2 information relating to the goods, section 18 4.2.3 «as is» clause, section 19 4.3 relevant rules of law in the uk 4.3.1 parol evidence in the uk; what did the parties say or write? 4.3.2 conditions and warranties 4.3.3 implied condition as to title 4.3.4 innominate term 4.3.4.1 scope of the category of intermediate terms 4.3.5 fundamental terms 4.3.6 representations 4.3.7 scots law 5 detailed analysis 5.1 quantity of goods 5.1.1 the cisg 5.1.2 finland 5.1.3 the uk 5.2 quality of the goods 5.2.1 the cisg 5.2.1.1 goods unfit for ordinary use 5.2.2 finland 5.2.2.1 absence of an agreement 5.2.2.2 aliud pro alio 5.2.3 the uk 5.3 the purpose 5.3.1 the cisg 5.3.2 finland 5.3.3 the uk 5.4 sample or model 5.4.1 the cisg 5.4.2 finland 5.4.3 the uk 5.4.3.1 sale by description 5.4.3.2 the relationship between the description and the quality or fitness 5.5 packaging 5.5.1 the cisg 5.6 buyer's knowledge of non conformity 5.7 conformity to requirements of the law in buyer's country 5.7.1 the cisg and the merchantability 6 conclusion: the cisg and english law compared 6.1 fitness for all ordinary purposes 6.2 variable standard 6.3 description 6.4 reliance and examination 6.5 express warranty and misrepresentation 6.6 misrepresentation and the cisg 7 finland: conclusions 8 the u.k. vs. the cisg 9 comments microsoft word article1.doc recovery of interest by liu chengwei* nordic journal of commercial law issue 2003 #1 * chengwei, liu. ll.m. of law school of renmin university of china, p.o. box 9-01 no. 1 (international law), law school of renmin university of china, 59 zhongguancun street, beijing 100872, china. e-mail: <genes@263.net>. nordic journal of commercial law, issue 2003 #1 2 today, interest is a standard form of compensation for the loss of the use of money. ordinarily, it is recoverable without proof of actual loss; damages are presumed because the delay in payment deprives the claimant of the ability to invest the sum owed.1 the determination of interest, [however], is not an issue to be simply resolved after the establishment of liability, but a question that deserves the strictest scrutiny.2 1. introduction it is noted that the modern institution of interest is deeply rooted in roman law,3 where it was a sum “due from a debtor who delayed or defaulted in repayment of a loan. the measure of the [amount] due for the default or delay was … the difference between the [claimant's] current position and what it would have been had the loan been timely and fully repaid.”4 in other words, the measure of interest due for the delay or default was id quod interest.5 in the modern world, interest generally acts as compensation for the loss of use of money.6 interest is a sum paid or payable as compensation for the temporary withholding of money.7 the rationale for this practice was articulated by the united states supreme court in 1896:8 “it is a dictate of natural justice, and the law of every civilized country, that a man is bound in equity, not only to perform his engagements, but also to repair all the damages that accrue naturally from their breach … every one who contracts to pay money on a certain day knows that, if he fails to fulfil his contract, he must pay the established rate of interest as damages for his non-performance. hence it may correctly be said that such is the implied contract of the parties.” the following discussion will focus on the topic of interest in the application of cisg. there is good reason for this approach. first, from an economic point of view, interest is far from minor. the importance of this loss must not be understated.9 second, a review of cisg decisions of the last decades clearly demonstrates that there are very few topics which have been of more than occasional practical importance, and among these, interest is one of the most important. interest under cisg, is the issue most often treated by both courts and commentators.10 2. overview of cisg approach on interest regulations on interest under cisg are at the same time very clear and very unsatisfactory.11 the provisions on interest were the subject of great controversy and differences of opinion at the 1980 vienna diplomatic conference, where the text of the present cisg was developed. on the one hand, there were those who wanted to delete these provisions altogether, whereas, on the other hand, others favored detailed provisions regulating the legal consequences in cases where the buyer fails to fulfill his major obligation, i.e., to pay the price.12 the interest question provoked extraordinary difficulties at the conference. the proposals at the conference reflected differing beliefs and divergent theoretical approaches to the duty to pay interest as well as to the conflicting practical needs.13 nordic journal of commercial law, issue 2003 #1 3 consequently, at the conference, it was difficult to agree on a solution that would satisfy the majority. the present version of article 78 is the result of a compromise reached at the plenary session and reads as: “if a party fails to pay the price or any other sum that is in arrears, the other party is entitled to interest on it, without prejudice to any claim for damages recoverable under article 74.” conflicting contradictory economical, political and religious views in the discussion of article 78 cisg led to this provision.14 it is said in this respect that:15 “art.78 is new and was added at vienna at the request largely of various european delegates who felt keenly that the convention would be seriously incomplete without some provision on an aggrieved party's entitlement to interest. however, there were sharp differences of opinion about the content of such a provision and art. 78 represents an uneasy compromise between those who were altogether opposed to an interest provision and those who wanted a statement, however bland, at least recognizing the right.” cisg art. 78 clearly provides that if a party fails to pay the price or any other sum that is in arrears, the other party is entitled to interest on it. as ruled by a switzerland court [10 february 1999 handelsgericht [commercial court] zürich]: “under art. 78 cisg, interest is due on any sum in arrears based on a sales contract governed by the convention.”16 but the text fails to stipulate how to determine what rate of interest to apply. in other words, article 78 cisg grants the general right to interest but is silent on the question of the applicable rate. the purpose of this provision, therefore, as a result of its general language and the prior rejections of specific formulas for calculating damages, may be limited -simply to authorizing interest damages and to leaving to the courts the task of formulating a method of determining the rate of interest.17 it is to be noted that, on the other hand, the text of the cisg contains two specific references to interest. art. 78 deals with the right to interest on “the price or any other sum that is in arrears”, with the exception of the instance where the seller has to refund the purchase price after the contract has been avoided, in which case article 84 of the convention applies. while art. 78 refers to interest that can be collected by the seller or the buyer and to interest on the price or any other sum that is in arrears, art. 84(1) refers solely to interest that can be collected by the buyer on the price (a liquidated amount). in other words, article 78 must be read in conjunction with article 84(1) of the convention, which contains a provision corresponding to article 78 for the case of the seller's obligation to refund the purchase price after avoidance of the contract. the question of interest is important in view of art. 84(1) which provides that “if the seller is bound to return the price, he must also pay the interest on it from the date on which the price was paid.” this is the accepted practice, that has been applied in muslim countries as well, and therefore it is indeed difficult to understand why the efforts to regulate this question met with such opposition.18 nevertheless, the meaning of the general rule as stipulated either in article 78 or in article 84(1) of the cisg is at the same time unclear, except for a starting point of interest accrual is briefly indicated in the latter; their languages give few hints as to how interest is to be nordic journal of commercial law, issue 2003 #1 4 computed and under what circumstances it is appropriate. in other words, the interest issue in the cisg itself is very brief, and perhaps vague, because during the legislative history of the convention, there was controversy over this issue.19 indeed, as to be demonstrated in the following discussion, the interest issue under the cisg has been deemed so vague that in fact it is seen as a gap in the convention, whose filling is again causing controversy. in any event, however, interest is a remedy under the cisg.20 in this regard, kritzer notes that several provisions provide a support for a creditors right to interest and he makes the following statement:21 “in assessing interest under the cisg, support for a creditor's right to interest is encountered under several provisions of the chapter [v of part iii] on provisions common to the obligations of the seller and the buyer: • under article 74, a provision of the section entitled damages. this article has to do with damages in general. it provides for recovery of the loss suffered as a consequence of a breach of contract. • under article 78, the provision of the section entitled interest. this article has to do with the situation in which a party fails to pay a ‘sum that is in arrears’. in this situation, ‘the other party is entitled to interest on it, without prejudice to any claim for damages recoverable under article 74.’ • under article 84(1), a provision of the section on effects of avoidance. this article has to do with a situation in which ‘the seller is bound to return the price’. in this situation, ‘he must also pay interest on it, from the date on which the price was paid.’” these regulations make it clear that interest is to be paid. moreover, as to be demonstrated below, the entitlement to interest is generally established in both domestic and international law, not only under the cisg. 3. in contrast with damages 3.1 generally granted under the heading of damages considering the commercial fact that the failure to receive funds is always a loss, for the very frequent case of delay in payment of money, most countries, either by statute or judicial decision, provide for the awarding of compensatory interest when a debtor has defaulted on a money payment. a few countries have laws that prohibit the payment of interest, primarily because it is inconsistent with their religious beliefs. even in some of these countries, however, exceptions allow interest in certain commercial transactions.22 a statutory duty to pay interest exists also under several international instruments. as mentioned in kritzer’s remarks above, under the convention, besides the general right to interest clearly granted under arts. 78, 84(1), support for a creditor's right to interest is also encountered under art. 74. as can be derived from the text of cisg article 74, it is clear that art. 74 grants damages for any breach of contract, including delay of payment. in this respect, behr states that “from article 74, it is clear that breach of contract damages cover the loss nordic journal of commercial law, issue 2003 #1 5 suffered by the party as a foreseen or foreseeable consequence of the breach, including lost profits. thus, in general, there is no problem in awarding interest under the heading of damages.”23 another commentator also states pertinently: “the general principle that is abundantly clear in relation to the payment of price and a failure to comply is to compensate the aggrieved party fully in order to restore the benefit of the bargain. in addition, the aggrieved party can recover additional expenses incurred such as transportation costs, among others, because the aggrieved party's ‘loss’ includes not only the lost profits and other damages but also any interest it could have earned had the defaulting party paid promptly.”24 these arguments are confirmed in the case law. for instance, in [31 august 1989 landgericht [district court] stuttgart] it is ruled pertinently: “plaintiff (seller) can recover loss of use of capital as damages. this is supported by article 74 based on the assumption that, in the event of default, the debtor is obligated to pay interest.”25 in order to confirm that the claim for interest was part of the general claim for damages, an icc arbitral tribunal also held in [october 1998 international court of arbitration, case 9333] as follows:26 “furthermore, one can consider the question whether interest does not after all constitute a part of the principal claim. for example, an author recently wrote: ‘from a functional perspective, the interest claim in art. 78 cisg, just as the one incorporated in art. 7.4.9 of the unidroit principles, and any statutory interest claim constitutes the minimum lump sum compensation for damages in areas where the creditor need not prove the actual damage incurred. it is a long-standing practice of international arbitrators, as well as of the iran-u.s. claims tribunal, to consider the interest claim as part of the general claim for damages.’ (klaus peter berger, “international arbitral practice and the unidroit principles of international commercial contracts”, american journal of comparative law, vol. 46, 199, p. 135 s.) […] “under article 104 of the swiss code of obligations, to which the contract is subject, every debtor being in delay with a payment of an amount of money owes interest of 5% per year on the sum in arrears. nothing in the contract suggested that the parties had intended to exclude the right to the payment of interest for delayed payment. such an exclusion would have been difficult to reconcile with the usages of international trade which are echoed by, among others, the united nations convention on contracts for the international sale of goods (cisg) and also the unidroit principles of international commercial contracts, referred to by the author mentioned above [as well as echoed by the pecl].” nordic journal of commercial law, issue 2003 #1 6 indeed, as indicated by another icc arbitral tribunal [1994 international court of arbitration, case 7331], “[i]t is [ac]knowledged in international law that claimants prevailing on the merits are entitled to receive interest on the principal amount awarded.”27 for instance, it is said that pecl art. 9:508(1) confers a general right to interest on primary contractual obligations to pay interest.28 particularly, there is no cogent reason for objecting to awarding interest in international law because of the absence of a settled rule as to the rate of interest or the date from which it begins to run. and it is usually the special reasons that are adduced by arbitrators in those cases in which interest is disallowed -for instance, if the claimants are guilty of delay in the prosecution of their claim, or if the award of interest is expressly excluded by the arbitration convention.29 however, the widely accepted rule is the one according to which the harm resulting from delay in the payment of a sum of money is subject to a special regime.30 3.2 recoverable independently without proof of actual loss as stated above, under the convention, arts. 78, 84(1) make it clear that interest is to be paid. it is also clear that interest can be recovered with or without demonstration of actual damages.31 in other words, the entitlement to interest also does not depend on the creditor being able to prove to have suffered any loss. therefore, interest can be claimed pursuant to article 78 independently from the damage caused by the payment in arrears.32 in this respect, it is observed in pertinent part by behr as follows:33 “interest as part of damages must be distinguished from legal interest. interest is addressed by article 78 while damages are governed by article 74 cisg. quite a significant number of the cases reviewed had to decide the question of interest under the heading of damages. this is because in many european countries legal interest rates are very low, and are independent from market developments. […] obviously, plaintiffs -generally unpaid sellers -want to recover interest at higher rates. “claims of this type have been successful at times. in a significant number of cases, however, interest under the heading of damages has been denied. in no case has this happened because the court misunderstood article 78 of cisg. one questionable case involved an intermingling of article 74 and article 78. in all the other cases, the courts correctly applied article 78 of cisg. […] “the reason most often given for not awarding damages was that plaintiffs either were unable or unwilling to prove damages arising from reliance on bank credit at higher interest rates. why plaintiffs failed to prove these damages is open to speculation. either, they in reality did not work on bank credit, which would call into question the argument some scholars have made that it is common practice to work on bank credit, or plaintiffs did not want to reveal financial information. “the practical problem of claiming interest by way of damages thus seems to be limited to the proof. […] ” nordic journal of commercial law, issue 2003 #1 7 indeed, under the convention, it takes the position of those countries in which interest is not necessarily a component of damages when art. 78 states that interest is recoverable “without prejudice to any claim for damages recoverable under article 74”.34 it is said in this respect: “while in some countries interest is not considered part of damages, the convention obviates any such discussion by expressly providing for it in article 78, emphasized by the phrase ‘without prejudice to any claim for damages recoverable under article 74.’ thus, it is irrelevant whether interest is considered part of damages because the general principle of full compensation compels that interest should be paid on all amounts due.”35 as is upheld in an icc case [1992 international court of arbitration, case 7585] where it is stated: “article 78 of vienna sales convention provides that the creditor is entitled to interest ‘without prejudice to any claim for damages’. the purpose of this provision is to make a distinction between interest and damages and to give compensation for the financial loss due to the mere fact that delay in payment has a financial cost. the same general idea is at the origin of article 84 which obliges the seller who is bound to refund the price, to pay interest on it from the date on which he received money.”36 it is even stated in another case [17 september 1993 oberlandesgericht [appellate court] koblenz]: “the claim of interest is legally based on art. 78 cisg. if a party to a contract fails to pay a price when due, the other party has a right to interest on this according to that regulation, without regard to a claim of damages under art. 74 cisg.”37 thus, under the cisg, “neither the exemptions of article 79 nor other requirements necessary to invoke the right to damages apply to article 78”38 similar approaches are adopted under the two sets of principles. in this context, the official comment on pecl art. 9:508 even states: “interest is not a species of ordinary damages. therefore the general rules on damages do not apply. interest is owed whether or not non-payment is excused under article 8:108. also, the aggrieved party is entitled to it without regard to any question whether it has taken reasonable steps to mitigate its loss.”39 3.3 entitled absolutely even in case of impediments it is recalled that at the vienna conference, the goal of the delegations that believed that a special interest provision was necessary was precisely to prevent interest from being considered as damages and thereby to maintain the obligation to pay interest in case of exemptions under article 79.40 in this regard, enderlein & maskow observe that the entitlement to interest under the cisg is characterized above all by two features: its normativity and its absoluteness; and the absoluteness, another characteristic clarifying the independence of interest from damages, is make clear by them as follows:41 “absoluteness means that the existence of grounds for release cannot remove the entitlement to interest. but, a reservation has to be made here, namely that this is not true of a failure caused by the other party's act or omission (article 80). the impediments under article 79, nordic journal of commercial law, issue 2003 #1 8 however, do not free from the obligation to pay interest (see also schlechtriem, 94, and following him somewhat restrainedly, nicholas/bb, 571, and stoll/freiburg, 279). a point in favour of this is that the entitlement to interest is not mentioned in article 79, paragraph 5, but could be explained with the genesis of the convention. we believe, however, that the economic background is also justification for such a solution. the party who does not pay a debt that is due, disposes of the sum of money required for it and/or does not have to procure it. he thus has an advantage vis-à-vis the other party which is compensated by the entitlement to interest of that party. this applies, in particular, to restrictions in the transfer of currency, often cited as an example, which shall not have the effect of a reason for exemption here. “but there are also voices who, assuming that interest is a part of the damages, want to permit an exemption on the ground of impediments (van der velden, 405). but, for the reasons given above, we cannot join them.” similar to the view of enderlein & maskow mentioned above, flambouras holds with this regard:42 “it is accepted that interest is owed even if the delay in the payment of price (or any other monetary obligation in general) is due to a force majeure event, since payment of interest is one of the rights that are referred to in cisg article 79(5). one point of view is that interest is not considered compensation, therefore the obligation to pay interest continues even if the debtor of the monetary obligation is discharged from his liability to pay compensation for breach of contract. the opposing view stresses that the obligation to pay interest may be classified as compensation. therefore, the debtor of the obligation will not have to pay interest when the impediment ceases to exist. “the former opinion appears preferable since (a) the cisg clearly distinguishes between interest payment obligation and damages and (b) the obligation to pay interest commences where payment has been delayed even if the creditor of the payment obligation has not suffered any damage from such delay and the debtor is not liable.” in schlechtriem’s view, it is even believed that: “the convention's interest provision will probably have practical impact only in the exceptional cases where the debtor can claim an exemption under article 79 for his default, such as when some impediment -for example, unforeseeable currency restrictions in the country of the debtor -temporarily relieves the debtor of his duty to pay under article 79(1) and (3). otherwise, it will generally be easier and more promising for the creditor -at least in countries with a free capital market -to claim the lost use of capital as damages in the amount of his own costs of credit according to article 74 rather than to expose himself to uncertainties as to the applicable law and its interest provision.”43 with great reservation about this argument bearing in mind the practical problem of claiming nordic journal of commercial law, issue 2003 #1 9 interest by way of damages which seems to be limited to the proof, the present author does not disagree with schlechtriem in his view that the entitlement to interest is not freed where the debtor can claim an exemption under article 79 for his default. in any event, cisg art. 78 conceives the obligation to pay interest as a general rule, so that a debtor still remains liable for interest payments even if his default is due to an impediment beyond his control and he is, therefore, not liable for damages under article 79. indeed, art. 7.4.9(1) of the unidroit principles expressly provides that “the aggrieved party is entitled to interest […] whether or not the non-payment is excused”. moreover, on the other hand, the force majeure provision (art. 7.1.7(4)) of the unidroit principles clearly sets out: “nothing in this article prevents a party from exercising a right to […] request interest on money due.” however, it is to be noted that if the delay is the consequence of force majeure, interest will still be due not as damages but as compensation for the enrichment of the debtor as a result of the non-payment as the debtor continues to receive interest on the sum which it is prevented from paying.44 thus, it may be concluded that the separation of interest from damages will allow a party to recover interest when there is no other evidence of damage suffered or when impediments under have excused the other party from being liable for damages.45 nevertheless, on the other hand, each of the three international instruments indicates that damage which exceeds interest can be claimed, hence interest can be counted towards the damages even when the two claims have different features.46 the following discussion will focus on the recoverability of such additional damages. 3.4 without prejudice to generally recoverable damages as can be derived from concerned texts, the entitlement to interest on sums in arrears is without prejudice to any claim by the creditor for damages generally recoverable. for instance, article 78 of the convention clearly provides that the creditor is entitled to interest “without prejudice to any claim for damages recoverable under article 74”. consequently, while the provisions of art. 78 do not mean much to many, on the other hand, others consider them to be useful since they enable the creditor to claim not only interest but also compensation under art. 74, which is not possible in some countries.47 furthermore, as the entitlement to interest and the claim for damages both exist, the claim for damages can compensate for the lack of an interest rate in the cisg, as proves the ruling in a case before the landgericht aachen (judgment of apri1 3, 1990 41 o 189/89, in: riw, 1990/6, p. 491 fol).48 it is also noted that: “article 84(1) contains a provision corresponding to article 78 for the case of the seller's obligation to refund the purchase price after avoidance of the contract. although it is not explicitly stated, the creditor should also on the basis of article 7 in conjunction with article 78 be able to claim damages for a violation of the duty to refund the price and measure his damages from the time the refund was due and in the amount of his own credit costs.”49 nordic journal of commercial law, issue 2003 #1 10 thus, damage claims under cisg remain unaffected even if they exceed the relevant interest rate.50 this approach is followed under the unidroit principles, where art. 7.4.9(3) reads: “the aggrieved party is entitled to additional damages if the non-payment caused it a greater harm.” similarly, pecl art. 9:508(2) provides that: “the aggrieved party may in addition recover damages for any further loss so far as these are recoverable under this section.” these provisions make it clear that the aggrieved party's remedy for non-payment or delay in payment is not limited to interest. it extends to additional and other loss recoverable within the limits laid down by the general provisions on damages. this might include, for example, loss of profit on a transaction which the aggrieved party would have concluded with a third party had the money been paid when due; a fall in the internal value of the money, through inflation, between the due date and the actual date of payment, so far as this fall is not compensated by interest.51 indeed, in cisg case law several courts correctly stated that article 78 and 74 of cisg allow claims for damages when a claimant incurs additional interest costs and when losses are incurred because capital is tied up in the transaction at issue.52 for instance, in a case before a switzerland court [21 september 1995 handelsgericht [commercial court] zürich], although the applicable austrian statutory interest rate amounted to 5%, the court held that the seller was entitled to the higher interest rate of 9.75% as further damages (arts. 78 and 74 cisg). in this respect, the court observed that the seller had only to prove the recourse to bank loans since it can be assumed that companies normally resort to external sources of credit to finance their activities.53 in another switzerland case [28 october 1998 bundesgericht [federal supreme court]], the court finally held that the sellers were entitled to recover interests. since cisg does not determine the interest rate (art. 78 cisg), the court applied the statutory interest rate provided by german law, as the law otherwise applicable to the contract. the sellers were also awarded a higher interest rate as further damages pursuant to arts. 78 and 74 cisg, since they provided sufficient evidence of recourse to bank loans.54 this issue is also dealt with by several german courts. for instance, in [24 april 1990 amtsgericht [lower court] oldenburg]55 and in [14 january 1994 oberlandesgericht [appellate court] düsseldorf]56, the courts both granted additional interest as damages (arts. 78 and 74 cisg). similarly, the unicitral abstract on an icc case [1992 international court of arbitration, case 7197] states: “the tribunal held that the interest rate to be awarded may be higher than the legal rate since the entitlement to interest under article 78 cisg was independent of any claim for damages under article 74 cisg. in the case in question, the tribunal found that the seller operated on the basis of credit for which it had to pay interest at the rate of 12% and applied that rate since the seller would have to obtain credit in order to replace the funds missing due to the non-payment by the buyer.”57 in a russian case [4 april 1998 arbitration award 387/1995], when the arbitration tribunal nordic journal of commercial law, issue 2003 #1 11 held the right of the seller to interest on the overdue sum, the ground is made on that interest could be regarded neither as penalties nor like damages according to art. 78 cisg under which the creditor is entitled to interest, without prejudice to any claim for damages recoverable under art. 74 cisg.58 of course, in order for this claim for damages to be successful, all requirements set forth in article 74 must be met.59 therefore, when the plaintiff has no shown evidence of any further loss, the court in [18 january 1994 oberlandesgericht [appellate court] frankfurt] did not award such additional damages: “the [seller's] claim for default interest at an amount of 13.5% could not be awarded. cisg, article 78 does not bar a claim for damages under cisg, article 74 to recover additional loss resulting from finance charges (herber/czerwenka, article 78, rn. 8). however, the [seller] has no shown evidence of any further loss caused by using credit (as to the burden of proof: von caemmerer-stoll, article 74, rn. 41). the submitted certificates issued by the banca d'ltalia only refer to the discount [rate] fluctuations.”60 indeed, the reason most often given for not awarding further damages claimed by the plaintiffs is that they either were unable or unwilling to prove damages arising from reliance on bank credit at higher interest rates. why plaintiffs failed to prove these damages is open to speculation.61 as to be furthered below when examining the applied interest rate in cisg case law, the practical problem in this context seems to be limited to the proof. in any event, on the other hand, that “[i]f the requirements of article 74 are fulfilled, the creditor, thus, may claim the full interest under article 74 cisg. article 78 cisg, therefore, mainly becomes important if the requirements for a damage claim are not fulfilled.”62 3.5 conclusions as indicated by the above discussions, on the one hand, in general, there is no problem in awarding interest under the heading of damages. it is a long-standing practice to consider the interest claim as part of the general claim for damages, which even is regarded as a usage of international trade echoed by, among others, the prevailing international instruments such as the cisg, unidroit principles and pecl. however, on the other hand, the two claims have different features. interest as part of damages must be distinguished from legal interest. the separation of interest from damages will allow a party to recover interest when there is no other evidence of damage suffered or when impediments under have excused the other party from being liable for damages. indeed, the practical problem of claiming interest by way of damages in most cases seems to be limited to the proof. in other words, the aggrieved party may not prove that it could have invested the sum due at a higher rate of interest or the non-performing party that the aggrieved party would have obtained interest at a rate lower than the legally applicable rate. thus, the harm is calculated as a lump sum.63 nordic journal of commercial law, issue 2003 #1 12 consequently, the aggrieved party's remedy for non-payment or delay in payment is not limited to interest. it extends to additional and other loss recoverable within the limits laid down by the general provisions on damages.64 in other words, interest is intended to compensate the harm normally sustained as a consequence of delay in payment of a sum of money. such delay may however cause additional harm to the aggrieved party for which it may recover damages, always provided that it can prove the existence of such harm and that it meets the requirements of certainty and foreseeability.65 4. interest on damages as stated above, one of the main ideas of cisg art. 78 is the general entitlement to interest which is rather far-reaching in substance.66 as to the sphere of application, article 78 cisg undoubtedly applies to interest on the purchase price.67 it is acknowledged in international law that claimants prevailing on the merits are entitled to receive interest on the principal amount awarded.68 of greatest practical relevance is interest on price claims. it was, however, useful to go beyond ulis and mention other claims, if only to avoid reverse conclusions.69 consequently, article 78 grants the right to interest on the purchase price or “any other sum that is in arrears”.70 this reference intimates that parties may seek interest in a broad spectrum of situations. in this context, however, it is questionable whether this language also extends to claims for damages, that is to say whether interest on damages can be claimed. the question arose among authors from the anglo-american legal family whether other sums were only meant to be such which are already liquidated, for which interest could be claimed under that legal system, or sums that have not yet been specified.71 in this respect, legal scholars seem to agree that one has a right to interest on damage claims under article 78 if the amount in question has been liquidated vis-à-vis the other party. whether this right to interest also applies to unliquidated sums, is controversial, however. the pertinent question, thus, does not appear to be if article 78 applies to damages at all, but rather when damages can be considered as being “in arrears” under article 78.72 in thiele’s discussion on this issue,73 it is firstly noted that whereas, for example, the lack of the applicable interest rate in the convention clearly constitutes a gap, article 78 cisg at least states that interest has to be paid on “any other sum in arrears”. since this expression is ambiguous, the issue whether article 78 also applies to unliquidated damages, is a question of interpretation of the text of article 78 cisg rather than a problem of gap-filling; therefore, article 7(1) instead of article 7(2) of the cisg should apply. leave open whether it is impossible or appropriate to distinguish, as thiele does, between questions of interpretation on the one hand and problems of gap-filling on the other, in applying cisg art. 7(1), thiele correctly points out that the primary method of interpretation remains the textual interpretation; in addition, the purpose of the convention, the legislative history, and the drafters’ intent may be taken into account. following these approaches, thiele analyzes mainly as follows: nordic journal of commercial law, issue 2003 #1 13 (a) even if the amount of damages to be paid is not fixed yet, the claim for damages is still a claim for a “sum”. in case of a breach of contract, the breaching party has to compensate the other party for the loss which that party has suffered. when it fails to do so, this “sum” may be considered as being “in arrears”. therefore, the textual interpretation may not be used as an argument against the application of article 78 to unliquidated damages. (b) the legislative history does not reveal that the drafters of the convention proceeded on the assumption that article 78 do not apply to damages unless those damages have been liquidated vis-à-vis the other party. in fact, the drafters did not even talk about the problem of unliquidated damages. therefore, the legislative history appears to be inconclusive as to the issue in question. (c) it does not matter whether the purpose of article 78 is intended to prevent undue enrichment on the debtor´s part, or on the other hand, to protect the creditor and indemnify him or her for the loss incurring from the debtor´s withholding of the sum in dispute. both purposes are best served when interest on damages can be recovered from the time the breach of contract occurs. regardless of whether the exact amount of damages has been specified yet, the breaching party still owes compensation to the other party from the time of the breach. because the aggrieved party is deprived of the use of the money from the moment of the loss, even though that amount has not been specified yet. finally, thiele concludes that: “damages under article 78, therefore, become due at the moment the contract is breached and the initial loss occurs. consequently, article 78 applies not only to liquidated but also to unliquidated damages.” this conclusion sounds persuasive when case law on this issue is examined. although most published decisions in which interest has been sought seem to deal with actions for the purchase price, in a dispute between a german seller and a swiss buyer decided in germany [5 april 1995 landgericht [district court] landshut], the court held pertinently that: “the [buyer's] claim for interest is provided basically by art. 78 cisg. according to the prevailing opinion, art. 78 cisg also applies to claims for damages (cf. von caemmerer / schlechtriem eberstein/bacher, kommentar zum einheitlichen un-kaufrecht, art. 78, annotation 15). the claim comes into existence with the occurrence of the loss. […]”74 in another action decided in switzerland [21 october 1999 kantonsgericht [district court] zug], it is similarly held that: “according to art. 78 cisg, if a party fails to pay the price or any other sum that is in arrears, the other party is entitled to interest on it, from the due date. interest accrues from the due date for claims of damages as well, i.e., from the original date of breach.”75 thiele’s conclusion mentioned above also seems persuasive when upicc art. 7.4.10 is taken into account, which clearly grants the right to interest on damages and gives further guidance by providing that: “unless otherwise agreed, interest on damages for non-performance of non-monetary obligations accrues as from the time of non-performance.” the official comment thereon states in nordic journal of commercial law, issue 2003 #1 14 pertinent part as:76 “this article determines the time from which interest on damages accrues in cases of non-performance of obligations other than monetary obligations. in such cases, at the time of non-performance the amount of damages will usually not yet have been assessed in monetary terms. the assessment will only be made after the occurrence of the harm, either by agreement between the parties or by the court. the present article fixes as the starting point for the accrual of interest the date of the occurrence of the harm. this solution is that best suited to international trade where it is not the practice for businesspersons to leave their money idle. in effect, the aggrieved party's assets are diminished as from the occurrence of the harm whereas the non-performing party, for as long as the damages are not paid, continues to enjoy the benefit of the interest on the sum which it will have to pay. it is only natural that this gain passes to the aggrieved party.” unfortunately, however, under the pecl it is stated that while art. 9:508(1) confers a general right to interest on primary contractual obligations to pay; the provision does not cover interest on secondary monetary obligations, such as damages or interest.77 no further clarification is given concerning why interest on damages is not covered under pecl art. 9:508(1). nevertheless, it is to be made clear that the pecl’s restriction on interest on interest, i.e. compound interest, in art. 9:508(1) may not be questionable. under the unidroit principles, art. 7.4.10 also takes no stand on the question of compound interest, which in some national laws is subject to rules of public policy limiting compound interest with a view to protecting the non-performing party.78 indeed, it is also said that article 78 cisg does not apply to interest payments on interest and, thus, gives no right to compound interest. one reason for this restriction is that compound interest does not appear to be widely accepted in international business transactions.79 in this respect, enderlein & maskow observe that: “interest is usually calculated on an annual basis. hence the question arises whether it should be capitalized respectively after one year, or whether the annual interest rate should be used as the multiplying factor and be multiplied by the entire delay period. in other words: whether compound interest can be claimed, in our view, this is not the case because, among other things, it is not customary in international sales law. there would have to be specific clues for it.”80 support for these scholars is also found in the cisg case law. for instance, in [november 1996 international court of arbitration, case 8502], the tribunal did not award the compound interest stating that the granting of compound interest is not a universally recognised principle in international trade.81 in [december 1998 international court of arbitration, case 8908], the arbitral tribunal did not award the capitalization of interest and held: “however, capitalization of interest is excluded, as from respondent's arbitration answer, since this is not provided for in the vienna convention and does not appear to be in keeping with international trade nordic journal of commercial law, issue 2003 #1 15 usages. revaluation is also included in the above mentioned rate.”82 5. prerequisite for entitlement to interest 5.1 no need for culpable default under the convention, the claim for interest payment stems from art. 78 cisg. it is held in [16 september 1991 landtgericht [district court] frankfurt] pertinently: “according to art. 78 cisg, one party can claim payment of accrued interest if the other party does not meet his obligation to pay the due and payable purchase price. it is sufficient enough that such a mature claim has not been paid at the agreed payment day. further, it is worth noting that there is no need for a default under german law (see eberstein, in: schlechtriem, art. 78 no. 11 cisg).” 83 indeed, the convention regulates the problem of interest very briefly in art. 78, it is quoted in [16 december 1991 pretore della giurisdizione [district court] locarno] that: “this article sanctions the principle that the run of interest does not depend on arrearage, but rather simply on the lack of payment of the price on time (cf berner tage für die juristische praxis 1990, wiener kaufrecht, page 208).”84 as is supported in [20 july 1995 landgericht [district court] aachen], where it is held: “according to this provision [cisg art. 78], the maturity of the obligation to pay the price or any other sum in arrears is sufficient for the right to request interest. a default must not be present (cf. eberstein/bacher, op. cit., annotation 9 to art. 78).”85 in [11 march 1996 tribunal cantonal [appellate court] vaud [01 93 1061]], it is also ruled: “the vienna convention contains a rule concerning the principle of interest and damages in case of breach of contract (arts. 74 and 78). pursuant to this rule, compensation is due as from the moment of occurrence of the damage or of the breach of contract. therefore, the obligation to pay the interest does not depend on the fact that the defaulting party was put into arrears; it is sufficient that the sum due was not paid within the term of payment (weber, vertragsverletzungsfolgen, in wiener kaufrecht, berne 1991, p. 208). other scholars are of the same opinion (wiegand, die pflichten des käufers und die folgen ihrer verletzung, in wiener kaufrecht, op. cit., p. 156; tercier, les contrats spéciaux, 2ème éd., 1995, p. 161, n. 1286).”86 more clearly, it is said in [12 december 2002 kantonsgericht [district court] zug] that the fact that a sum is in arrears is the only requirement for interest on arrears: “[…] if a party fails to pay the price or any other sum that is in arrears, the other party is entitled to interest on it, without prejudice to any claim for damages recoverable under art. 74 (art.78 cisg). consequently, the fact that a sum is in arrears is the only requirement for interest on arrears; a culpable delay in the meaning of swiss law with all its prerequisites is not necessary (cf. v.caemmerer/schlechtriem, kommentar zum einheitlichen nordic journal of commercial law, issue 2003 #1 16 un-kaufrecht, 3rd ed., munich 2000, art. 78 n. 7 et seq.). […]”87 5.2 not subordinate to formal request as indicated above, as to the requirements of article 78 cisg, it is said “the only condition is that the amount in question is ‘in arrears’”; there is no need for a culpable default in the meaning of many domestic systems, on the one hand. on the other hand, “[a]bsent any further requirements in the text of article 78 cisg, it is important to note that article 78 (unlike the legal systems of many other countries) does not require any formal notice of the claim in order to invoke the right to interest.”88 a look at the cisg case law will again provide a sound basis for this proposition. although there may be different voices,89 the controlling voice as demonstrated by the case law is that, unlike under many national laws, the entitlement to interest under the convention does not depend on any formal notice given to the debtor. many courts have ruled that it does not require any formal notice of the claim in order to invoke the right to interest. for instance, in [14 october 1992 amtsgericht [lower court] zweibrücken], the court awarded the seller interest (art. 78 cisg) and observed that under cisg the duty to pay interest for the delay in payment for the price is not conditional upon a formal request.90 in [24 january 1994 kammergericht [appellate court] berlin], the court also held that the right to interest is not subordinate to a formal request: “to the extent stated in the decision's tenor, the [seller]'s assignee may claim interest on the purchase price as compensation under arts. 78 and 74 cisg, from the time payment was due according to art. 58 cisg. a payment reminder notice was not necessary for this claim to arise. […]”91 also, in [20 march 1995 landgericht [district court] münchen], it is held: “the [seller] is entitled to interest for the mature claims for payment of the purchase price without having to send a reminder of payment, art. 78 cisg. […]”92 in [29 march 1995 cour d'appel [appellate court] grenoble], the court observed: “whereas, as to the interest, that article 78 cisg provides that the interest on overdue payments is owed when the debtor is in arrears; that, unlike french law, a formal request is not necessary;[…]”93 in [26 april 1995 cour d'appel [appellate court] grenoble (marques roque v. manin riviére)], the court ruled: “[…] article 78 of the cisg provides that any delay in payment gives rise to the payment of interest, without a legal demand being necessary. […]”94 similarly, in [11 march 1996 tribunal cantonal [appellate court] vaud [01 93 0661]] the court observed that according to art. 78 cisg, the obligation to pay interest for the delay in payment of the price is not subject to a formal request by the seller.95 in [30 november 1998 nordic journal of commercial law, issue 2003 #1 17 handelsgericht [commercial court] zürich], the seller was further awarded interest on the price (art. 78 cisg), without the need of a formal request by the seller.96 it is also ruled in [24 march 1999 landgericht [district court] flensburg] that: “under art. 78 cisg the [seller] has a right to interest on the purchase price in arrears without sending a request for payment.”97 in brief, no formal request for payment was considered necessary under cisg.98 interest is to be paid according to art. 78 cisg, without the need to make any request or comply with any formality.99 also, in [6 april 1995 cour d'appel [appellate court] paris], the appellate court held that the arbitral tribunal's decision to require the seller to pay interest on the refunded price even in the absence of a formal request by the buyer was supported by art. 84 cisg, which states that if the seller is bound to refund the price, it “must” (and not “may”) also pay interest on it from the date on which the price was paid.100 thus, contrary to what is sometimes provided in several legal systems, the right to interest doesn't need a formal notice.101 in sum, interest is payable whenever the delay in payment is attributable to the non-performing party, and this as from the time when payment was due, without any need for the aggrieved party to give notice of the default.102 5.3 conclusion: the only prerequisite is a sum in arrears. as indicated in the case law, “the fact that a sum is in arrears is the only requirement for interest on arrears”.103 as it is held in [12 november 1996 amtsgericht [lower court] koblenz]: “contrary to [what is sometimes provided in several legal systems, for instance,] german law, the only prerequisite for a claim for interest under art. 78 cisg is the maturity of the sum in arrears.”104 if a debtor does not pay an amount due, he, without a further demand being necessary, becomes obligated to pay interest according to art. 78 cisg.105 in other words, as ruled in [24 april 1997 oberlandesgericht [appellate court] düsseldorf]: “according to art. 78 cisg, the interest claim generally exists where a party fails to pay the due purchase-money claim. neither a reminder nor fault within the meaning of the german law is required therefore (cf. von caemmerer/schlechtriem/eberstein, loc. cit., art. 78 cisg, no. 9; herber/czerwenka, loc. cit., art. 78 cisg, no. 3). on the contrary, interest must be paid on the purchase price from the maturity date onward, whereas the maturity depends on the agreement of the parties [or, in the absence of such agreement, according to the convention]. […]”106 thus, the following conclusion may be drawn: “the only prerequisite for the entitlement to interest is the debtor's failure to comply with its obligation to pay the price or any other sum by the time specified in the contract or, absent such specification, by the convention.”107 6. starting points of interest accrual 6.1 for interest on purchase price: date of payment nordic journal of commercial law, issue 2003 #1 18 as indicated above, the interest issue in the cisg itself is very brief and perhaps vague. art. 78 cisg only sets forth the obligation to pay interest as a general rule but it does not set forth a time starting from which interests may be calculated. nevertheless, it is noted that the obligation to pay interest ends with the time of payment which is relatively uncomplicated.108 therefore, the following discussion will focus on the starting point of interest accrual. the general principle of full compensation requires that the plaintiff be paid interest from the date that payment should have been made.109 indeed the case law mentioned above also followed this approach. however, it is to be emphasized that, this date from which the interest accrues should be first of all determined in accordance with an agreement of the parties.110 this is noted, for instance, in [15 june 1994 vienna arbitration award sch-4366] where the tribunal held: “the interest is payable from the effective date of the obligation for payment of the purchase price. according to art. 58(1) of the cisg, this time is primarily determined by the agreements between the parties themselves; only in the absence of such a special agreement is it the time when the seller places the goods at the buyer's disposal in accordance with the contract. [. . .].”111 nevertheless, the court in [14 june 1994 amtsgericht [lower court] nordhorn] has pointed out that: “the [seller]'s claim for interest is justified under art. 78 cisg. according to that provision, interest is due from the time the claim was mature; a reminder of payment is not necessary. consequently, it would have been up to the [buyer] to submit that the parties reached a different agreement regarding the payment of interest. as the [buyer] failed to make an according submission, the interest was granted according to the [seller]'s request. […]”112 in any event, as ruled in [6 may 1993 arrondissementsrechtbank [district court] roermond], the entitlement to interest under art. 78 cisg, accrues from the date when payment was due which, in the absence of an agreement between the parties, was the date of delivery of the goods (art. 58 cisg).113 on the other hand, cisg article 84 (1) expressly stipulates that on a price to be refunded, interest must be paid from the date on which the price was originally paid. the same should apply to the refunding of the reduced price under article 50.114 in [1993 international court of arbitration, case 6653] the tribunal ruled that according to this text, interest is due for respondent [seller] to be paid to claimant [buyer] starting from the day of payment. the starting point of the interest is therefore the date of the payment of the item concerned. the interest aspired to by art. 84 is due even it had not been formally requested because, among others, article 84 of the convention sets forth that the seller must and not “can” pay interest.115 6.2 for interest on secondary obligations: date of non-performance the above discussion shows that the basic starting point for interest accrual is the date of nordic journal of commercial law, issue 2003 #1 19 payment, which has been fixed by or determinable from the contract or in the absence of an agreement between the parties, is to be determined by the applicable law. however, it is less clear when most of the other claims become due. without being able to enter into detail in respect of each concrete claim, enderlein & maskow believe that in regard to claims for damages, reimbursement of expenses and reduction of the price, hence secondary claims which emerge only when primary obligations under the contract are breached, from the aspect of interest, one should proceed on the assumption that they become due when they have been liquidated vis-à-vis the other party and in the amount in which later they turn out to be justified. another aspect is that they should have accrued at the time when they were charged and were not just expected in the future. the principle developed here for secondary claims is, in their view, also applicable to primary claims whose becoming due is not determined otherwise, like claims for reimbursement of auxiliary/additional expenses which are not included in the price, hence expenses for packaging, transport and insurance, as well as customs duties and taxes. they would become due with the issuance of the invoice.116 indeed, it is recalled that when discussing above whether interest on damages is granted, the pertinent question appears to be rather the accrual of interest on damages. in this respect, a court [21 october 1999 kantonsgericht [district court] zug] ruled that “according to art. 78 cisg, if a party fails to pay the price or any other sum that is in arrears, the other party is entitled to interest on it, from the due date. interest accrues from the due date for claims of damages as well, i.e., from the original date of breach. […]”117 the cisg practice is codified in art. 7.4.10 of the unidroit principles, where it is stated: “unless otherwise agreed, interest on damages for non-performance of non-monetary obligations accrues as from the time of non-performance.” the present article fixes as the starting point for the accrual of interest the date of the occurrence of the harm. this solution is that best suited to international trade where it is not the practice for businesspersons to leave their money idle. in effect, the aggrieved party's assets are diminished as from the occurrence of the harm whereas the non-performing party, for as long as the damages are not paid, continues to enjoy the benefit of the interest on the sum which it will have to pay. however, when making the final assessment of the harm, regard is to be had to the fact that damages are awarded as from the date of the harm, so as to avoid double compensation, for instance when a currency depreciates in value.118 6.3 dates determined according to relevant circumstances for the lack of a clear specification in cisg art. 78, the time from which to award interest is an issue producing divergent results in the courts. the case law demonstrates that different tribunals produce variations on the time for accrual. several courts have ruled that the interest accrued from the date determined according to relevant circumstances in the case. for instance, in [20 december 1994 tribunal cantonal [appellate court]], the court observed that since the seller had expressly claimed interest accruing from the date when he formally nordic journal of commercial law, issue 2003 #1 20 requested payment from the buyer, it could not award interest accruing from an earlier time.119 similarly, in [16 december 1996 rechtbank van koophandel [district court kortrijk], the court, though observing that cisg does not require a formal request for payment, decided that under the circumstances of the case interest accrued from the date of the seller's formal request for payment.120 in [28 march 1997 arbitration award 38/1996] it is held that: “[…] since prior to institution of the action, the [seller] did not claim annual interest from the [buyer], the tribunal has reached the conclusion that annual interest shall be paid on the principal sum of debt under the contract starting on the date of filing the action. as to the other amounts claimed for recovery from the [buyer], annual interest on them shall be awarded starting from the date of rendering of the present decision. […]”121 also, when a buyer sued for a refund of the purchase price [24 november 1989 pretura circondariale [district court] parma], contrary to what is provided in art. 84(1) cisg with regard to time of accrual of interest (from the date the buyer paid the purchase price to the seller), the court held that interest was payable from the date of avoidance of the contract.122 similarly, in [1995 international court of arbitration, case 8128], the tribunal ruled that interest related to the reimbursement of the cost of the sacks accrued from the time of partial avoidance of the contract, while interest related to the expenses due to the substitute purchase accrued from the time in which the bank of the buyer executed the payment for the replacement goods.123 yet another court in [1994 international court of arbitration, case 7565] ruled that interest should be awarded from the time when the aggrieved seller would “normally have resold” the goods after the buyer's breach: “interest shall be computed from january 1, 1992, on the assumption that the cargo would normally have been resold to [buyer's] customers by the end of december 1991. it shall accrue and be paid until full payment of the awarded amount.”124 still another variation was that interest should accrue from the expiration of the additional period of time fixed by the seller for performance.125 finally, the ruling in another case, [20 may 1991 juzgado nacional de primera instancia en lo comercial [national commercial court of first instance]], deserves a separate attention. in the case, the court found that arts. 53, 54, 57 and 58 cisg do not set down an explicit rule as to whether interest should accrue during the contractual term for deferred payment. nevertheless, accrual of interest during the agreed period in case of deferred payment constitutes a usage widely known and regularly observed in international trade (art. 9(2) cisg).126 the court ruled as follows:127 “[…] “4) articles 53, 54, 57 and 58 of the 1980 vienna convention refer to the buyer's obligation to pay the price as well as the place and time of payment. however, there is no express norm of the convention which can indicate the source or origin of [the amount of] of interest when payment was agreed to at a fixed period of time. payment of interest on nordic journal of commercial law, issue 2003 #1 21 such transactions is a widely spread and accepted practice in international commerce (art. [9(2)] 1980 vienna convention). “5) there are basically three types of international sale payment: documentary credit, documentary collection and/or bank transfer (boggiano op. cit., volume ii, p. 811). in this case, the adopted type was a documentary collection by banco quilmes, which was issued by a 180 days draft of exchange. this is clearly shown in the commercial invoice from p. 43 of the court file. […] in documentary collections, banks do not underwrite any payment obligations; instead, they act as a post office to the seller, handing over the documents that will allow the buyer to withdraw the goods (commercial invoice and bill of lading in this case), against the acceptance of the bills of lading drawn by the exporter, according to the time periods used in international trade, especially for manufactured goods or against bills of exchange payments. “6) as an established commercial practice, interest is not included in the commercial invoice, but it is instrumented separately either in a note of credit, or in another bill of exchange, or directly with a bill of exchange issued separately as the one used to draw operating capital. the procedure described takes place not only with a documentary collection, but also when a documentary credit is opened. commercial invoices used in international sales of goods never include interest. the trustee recommended dismissal of the [seller's] claim for the sum corresponding to interest. the trustee recommended that the interest claim be dismissed as it is recorded in a separate document. this position of the trustee is surprising [and incorrect] as international commercial practice accepts interest recorded in a separate document. “7) usages of international commerce have long been accepted in the commercial jurisprudence -as an example, by the fob, c&f, cif clauses regulated by the international chamber of commerce incoterms. usages of international commerce are presently accepted as a source of law applicable to international sales, even over the 1980 vienna convention, as the rule of the convention mandates in its art. 9(2). “8) on the other hand, the invoice corresponding to the price of the sale (p. 43) and that corresponding to the interest (p. 48), have both been issued on the same date, 23 january 1989, as is argued in the incidental proceeding (p. 1). such amounts of interest are instrumented in the bill of exchange whose copy is shown on p. 51. both bills of exchange were drawn on the same date, 9 february 1989 and, according to the copies at hand, they were accepted by the [buyer], even though the trustee expresses that they have not (p. 841 item b.). on the contrary, the court cannot see how the [buyer] could have withdrawn the sold goods 300 gloves on arrival in buenos aires, without acceptance of the bills of exchange by the [buyer]. nordic journal of commercial law, issue 2003 #1 22 “9) consequently, the interest claim filed by the [seller] is duly justified for it corresponds to declare the credit admissible for the sum of us $283.93 corresponding to 180 days interest since 9 february 1989. the sum of us $3,065.61 will be verified, as no challenge has been claimed in this respect. both sums are considered unsecured credits. […]” in all events, from the formulation of cisg art. 78 that interest is to be paid on sums in arrears, we can draw the conclusion that interest is to be paid from the time when the respective sum is due.128 7. general review of interest rate 7.1 gap in the convention as stated above, cisg recognizes the duty to pay interest (arts. 78, 84(1)), which exists under most legal systems and several international instruments such as the upicc and the pecl. “contrary to all other conventions and statutes, cisg does not, however, fix a rate of interest because it proved impossible to agree upon a standard: the discount rate was thought to be inappropriate for measuring credit costs; nor could agreement be reached on whether the credit costs in the seller's or the buyer's country were to be selected.”129 the present art. 78 cisg states only the principle obligation to pay interest and is silent on the details of the interest rate: it “only sets forth the obligation to pay interest as a general rule” but it does not, as discussed above, set forth a time starting from which interests may be calculated; nor does it, as to be discussed in this section, stipulate the rate of interest or how the rate is to be determined by a tribunal in the absence of explicit guidance from the convention. the lack of a specific interest rate or method to determine such an interest rate is especially aggravating, because article 78 cisg mandates an obligation to pay interest every time a payment is in arrears, without regard to fault. for this reason, a party will demand interest in addition to its demand for price, reduction of the price or damages almost every time a suit is brought under the cisg. it will be able to point to article 78 cisg to legitimate its title to interest, but the legitimacy of the claimed rate of interest remains in doubt.130 it is also noted that since the cisg does not state a specific interest rate in other provisions either. this shortcoming is to be compensated above all by agreement between the parties.131 it is said: “a contract clause that clearly spells out the method for calculating the rate of interest and those scenarios in which interest may be included in a damages award should eliminate much of the uncertainty surrounding this provision.”132 however, where the parties have agreed nothing, it is to some extent complex on what basis the amount of interest under the cisg will have to be calculated. as to be demonstrated below in the case law, some court decisions have deemed it so vague, that in fact, it is seen as a gap. accordingly, the question has been raised whether the drafters’ omission of a specific interest rate in the cisg has to be dealt with as a “lacuna praeter legem” or as a “lacuna intra legem”. while the former type of gap relates to issues that are governed by, but not expressly settled in the convention, the latter type of gap refers to issues that fall completely outside the scope of nordic journal of commercial law, issue 2003 #1 23 the convention. thus, in filling this gap in the convention, one must above all, technically, ascertain whether the gap is considered lacuna intra legem, as opposed to a lacuna praeter legem. in this respect, thiele observes as:133 “this distinction between ‘lacunae intra legem’ and ‘lacunae praeter legem’ has important consequences when one tries to fill the gaps. if a gap is to be treated as relating to an issue that is governed by the convention but not expressly settled in it, article 7(2) cisg applies. according to this provision, ‘lacunas praeter legem’ are to be settled in conformity with the general principles on which the convention is based. only when such principles cannot be determined, gaps of this kind may be filled by recourse to ‘the law applicable by virtue of the rules of private international law’. gaps ‘intra legem’, on the other hand, are not governed by the convention, and, thus, may be settled only by reference to the law otherwise applicable which, again, is to be determined according to the rules of private international law of the forum.” undoubtedly, the setting forth of a criterion to be used to decide whether a gap must be considered a lacuna intra legem or praeter legem would have favored the uniform application of the vienna sales convention. indeed, the solutions to the same problem can widely differ from each other depending on whether they were perceived as gaps intra legem or praeter legem.134 legal scholars and courts of different nations are in dispute on the question whether the lack of an interest rate in the convention has to be treated as a “lacuna praeter legem” or a “lacuna intra legem”. this remains a controversial subject for at least the following reasons: above all, the convention itself does not identify any clear criterion to determine when a matter has to be viewed as outside the scope of the convention as opposed to when the convention applies to the issue in question but does not expressly resolve it. moreover, in order to determine whether the lack of a fixed interest rate in the convention constitutes a gap praeter legem or a gap intra legem, the legislative history appears to be of not much avail. in any event, the legislative history appears to be unclear as to this matter.135 in a case of such doubt as to the drafters’ intent, one may conclude from the purpose of the cisg, like every international convention, is to provide uniformity in a specific area of law, that the drafters did not want to preclude courts from attempting to find a uniform solution under article 7(2) cisg to the issue in question. however, even if one proceeds from the assumption that the issue of interest rates is governed by the cisg, and, thus, article 7(2) cisg applies, it is not clear if there are any general principles in the convention that may help to determine the applicable interest rate. again, courts and legal scholars split on this point.136 in addition, as to be demonstrated below, there are a considerable number of decisions dealing with the issue of determining the appropriate interest rate under article 78 cisg. however, only few of these decisions engage in a thorough discussion of the problem in question. especially, very few decisions expressly state if they view the lack of a specific interest rate in article 78 as a gap “intra legem” or a gap “praeter legem”. nevertheless, from these decisions´ point of view, this question might not have great relevance. nordic journal of commercial law, issue 2003 #1 24 7.2 clear specification under unidroit principles and pecl in contrast with the gap in the convention, the two sets of principles provide clear guidance as to the rate of interest. upicc art. 7.4.9(2) provides that: “the rate of interest shall be the average bank short-term lending rate to prime borrowers prevailing for the currency of payment at the place for payment, or where no such rate exists at that place, then the same rate in the state of the currency of payment. in the absence of such a rate at either place the rate of interest shall be the appropriate rate fixed by the law of the state of the currency of payment.” the official comment on this provision states:137 “para. (2) of this article fixes in the first instance as the rate of interest the average bank short-term lending rate to prime borrowers. this solution seems to be that best suited to the needs of international trade and most appropriate to ensure an adequate compensation of the harm sustained. the rate in question is the rate at which the aggrieved party will normally borrow the money which it has not received from the non-performing party. that normal rate is the average bank short-term lending rate to prime borrowers prevailing at the place for payment for the currency of payment. “no such rate may however exist for the currency of payment at the place for payment. in such cases, reference is made in the first instance to the average prime rate in the state of the currency of payment. for instance, if a loan is made in pounds sterling payable at tunis and there is no rate for loans in pounds on the tunis financial market, reference will be made to the rate in the united kingdom. “in the absence of such a rate at either place, the rate of interest will be the ‘appropriate’ rate fixed by the law of the state of the currency of payment. in most cases this will be the legal rate of interest and, as there may be more than one, that most appropriate for international transactions. if there is no legal rate of interest, the rate will be the most appropriate bank rate.” in this regard, zoccolillo notes that careful examination of unidroit principle 7.4.9, shows that the wording of the text remedies most concerns that were voiced at the convention. the author states pertinently:138 “paragraph two of 7.4.9 stipulates that the rate of interest shall be the average bank short-term lending rate for prime borrowers prevailing for the currency of payment at the place of payment, or where no such rate exists, at that place, then the same rate in the state of the currency of payment. this formula, although similar to the ‘joint proposal’ raised at the diplomatic conference, is distinctly different. the main concern of the socialist and developing nation delegations was that by fixing the rate of interest in the seller’s country, socialist and developing nations who used their foreign export earnings to pay for their imports would be disadvantaged. this occurred since they would normally have to resort to credit on foreign markets well above what they would be compensated for under their own nordic journal of commercial law, issue 2003 #1 25 interest rates. unidroit principle 7.4.9 remedies this concern by fixing the applicable interest at a rate equal to the lending rate prevailing for the currency of payment at the place of payment. thus, socialist and developing nations, that maintain foreign accounts to pay for their imports and must resort to credit on those markets if a party defaults on the payment of the purchase price, are assured that they will receive adequate protection and an equal return of interest. “however, one problem could arise for nations that do not maintain foreign accounts for imports and require payment in their own states. these states would undoubtedly be duly compensated by a rate of interest fixed at the place of payment, i.e., their own state, but 7.4.9 does not guard against a debtor’s purposeful delay in payment so as to obtain cheap credit or accrue extra sums. thus, if the unidroit principles are to be applied to fix an interest rate, judges and arbitrators must prevent buyers from taking advantage of such situations. by applying the general principle of ‘unjust enrichment’ in article 84 in conjunction with 7.4.9, the aggrieved party would be made whole and the party in bad faith disgorged of all unduly received benefits.” also, pecl art. 9:508(1) follows briefly the approach adopted under the unidroit principles and reads in pertinent part that the applicable rate is “the average commercial bank short-term lending rate to prime borrowers prevailing for the contractual currency of payment at the place where payment is due”. it is stated in the comment: “the rate of interest is fixed by reference to the average commercial bank short-term lending rate. this rate applies also in the case of a long delay of payment since the creditor at the due date cannot know how long the debtor will delay payment. since interest rates differ, the lending rate for the currency of payment (article 7:108) at the due place of payment (article 7:101) has been selected because this is the best yardstick for assessing the creditor's loss. unless otherwise agreed, interest is to be paid in the same currency (cf. article 9:510 comment d) and at the same place as the principal sum. the parties are free to exclude or modify paragraph (1) e.g. by fixing the rate of default interest and/or its currency in their contract.”139 however, it remains questionable whether and how the rate contained in the two sets of principles could now be applied when the creation of a single rule on fixing the rate of interest could not be agreed upon at the vienna conference. the absence under the convention of a specific formula to calculate the rate of interest has led courts, as well as legal scholars, to argue for different approaches concerning the applicable rate under the convention. this will be evidenced by the cisg case law with different solutions proposed by concerned tribunals. nordic journal of commercial law, issue 2003 #1 26 8. rates applied in cisg case law 8.1 gap-filling in general 8.1.1 overview as indicated above, the rate issue under the convention has been deemed so vague that it is often seen as a gap. in [20 july 1995 landgericht [district court] aachen], the court noted that art. 78 cisg provides only for an obligation to pay interest. this norm does not say anything about the interest rate to be paid. thus there is a gap in the law; there is dispute about how to fill it.140 in filling this gap, thiele believes that, technically, a three-prong approach should be applied. following such a three-prong approach, the first step is to determine if the lack of a specific interest rate in article 78 cisg constitutes a gap “intra legem” or a gap “praeter legem”.141 however, courts and legal scholars split on this question, which is generally observed in [15 june 1994 vienna arbitration award sch-4366] as follows:142 “article 78 of the cisg, while granting the right to interest, says nothing about the level of the interest rate payable. in international legal writings and case law to date it is disputed whether the question is outside the scope of the convention with the result that the interest rate is to be determined according to the domestic law applicable on the basis of the relevant conflict-of-laws rules (see inter alia herber/czerwenka, internationales kaufrechts, 1991, 347; oberlandesgericht frankfurt, 13 june 1991 in recht der internationalen wirtschaft 1991, 591) or whether there is a true gap in the convention within the meaning of article 7(2) so that the applicable interest rate should possibly be determined autonomously in conformity with the general principles underlying the convention (see in this sense, for example, j.o. honnol, uniform sales law, 2nd edition, deventer, boston 1991, 525-526; icc arbitral award no. 6653 (1993), clunet 1993, 1040). […]” arguably, the lack of a specific formula to calculate the rate of interest has led some courts to consider this matter as one governed by, albeit not expressly settled in, the convention. other courts consider this matter one that is not governed at all by the convention. this difference in qualifying this matter has led to diverging solutions as to the applicable interest rate, since under the convention, the matters governed by, but not expressly settled in, the convention have to be dealt with differently than those falling outside the convention's scope.143 8.1.2 gap intra legem if, on the one hand, the issue of interest rate is not governed by the convention at all, i.e., if a gap “intra legem” exists, it must be settled in conformity with the law applicable by virtue of the rules of private international law, without any recourse to the “general principles” of article 7(2) cisg first. some courts consider the interest rate issue as one falling outside the convention's scope and nordic journal of commercial law, issue 2003 #1 27 therefore tend to apply directly applicable domestic law by virtue of private international law. for instance, in [15 january 1998 tribunale d'appello [appellate court] lugano], the court ruled: “the rate of the interest is not governed by the convention, and must therefore be determined by internal law resulting from the application of the pertinent rules of conflict of laws (honsell, op. cit., n. 10 to art. 84 cisg), […]”144 in [july 1999 international court of arbitration, case 9448], the court stated: “according to art. 78 cisg, if a party fails to pay the price or any other sum that is in arrears, the other party is entitled to interest on it. the rate to be applied is, however, a matter, in the first place, for the domestic law (farnsworth, in bianca-bonell, commentary an the international sales law, the 1980 vienna sales convention, page 570). therefore, the swiss code of obligations (co) is applicable, […]”145 also, it is further stated in [29 december 1999 tribunale [district court] pavia] as:146 “as far as interest on the sums not paid, it will be observed that the united nations convention provides only a general right to interest, without specifying which rate is to be applied. in light of the fact that the drafters of the convention have intentionally left the problem of the applicable rate unresolved, as one evinces from the travaux préparatoires, it cannot be maintained that this is an issue dealing with one of the areas which, by virtue of article 7(2) of the convention, should be governed by the general principles upon which the convention is based. instead, it is a question not at all addressed by the convention and which hence is to be resolved in light of the applicable law, that is to say, in light of [internal] italian law -such being the law of the seller, which art. 3(1) of the hague convention of 1955 beckons to. this solution corresponds besides to that adopted by foreign case law (see, for example, pretore della giurisdizione locarno-campagna 16 december 1991 [of switzerland] [<http://cisgw3.law.pace.edu/cases/911216s1.html>]) which, although not binding, is however to be taken into consideration as required by art. 7(1) of the cisg. consequently, interest is determined according to the measure of the legal rate in force in italy.” 8.1.3 gap praeter legem if, on the other hand, a gap praeter legem exists, i.e., interest rate is considered to be an issue that is governed by, albeit not expressly settled in, the convention, then article 7(2) cisg applies. before determining the law applicable to the issue of interest rates by invoking the rules of private international law of the forum, article 7(2) cisg requires the decision-maker to determine whether there are any general principles in the convention providing guidance to the issue in question. only if such principles cannot be found, the private international law of the forum may be invoked.147 there are decisions that hold that, under the convention, this interest rate constitutes a gap praeter legem; and therefore art. 7(2) applies. for instance, after indicating the divergent views concerning how to fill this gap, the court in [15 june 1994 vienna arbitration award sch-4366] ruled: “[…] this second view [there is a true gap in the convention within the meaning of article nordic journal of commercial law, issue 2003 #1 28 7(2) so that the applicable interest rate should possibly be determined autonomously in conformity with the general principles underlying the convention] is to be preferred, not least because the immediate recourse to a particular domestic law may lead to results which are incompatible with the principle embodied in art. 78 of the cisg, at least in the cases where the law in question expressly prohibits the payment of interest. […]”148 however, some courts display the intent to follow article 7 but do not pay sufficient attention to the general principles. they simply state that the convention has no general principles that are applicable to the interest rate problem. for instance, in [1994 international court of arbitration, case 7565], although the court also noted that, on the one hand: “according to article 7.2 of the convention, questions not expressly settled by it shall be determined either in accordance with the general principles on which it is grounded or by the law which shall be elected according to private international law.” on the other hand, the same court held that: “as the general principles do not settle the matter [...] and the parties have referred to the laws of switzerland, it seems justified to refer to article 73 of the swiss code of obligations whereby, in the absence of a determination of the rate of interest by agreement or law or usages, that rate shall be 5% per annum.”149 indeed, most courts considered, on the one hand, that interest rate is a gap covered under cisg art. 7(2); on the other hand, that it is an issue to be determined by the law applicable by virtue of private international law instead of under so-called general principles. for instance, the court in [20 december 1994 tribunal cantonal [appellate court] valais] considered the interest rate to be a question governed, but not expressly settled, by cisg (art. 7(2) cisg), but directly, without first reference to general principles underlying the cisg, applied the statutory rate of the state whose law would have been the governing law of the contract in the absence of cisg (italy).150 in [21 march 1996 hamburg arbitration award], the court held: “the claim to interest arises ex art. 78 cisg. as to the interest rate, national law applies subsidiarily, in the absence of a more specific regulation in the cisg, according to its art 7(2); here, it is the legal rate for bilateral commercial transactions.”151 similarly, in [29 june 1998 tribunal cantonal [appellate court] valais], the court observed that, pursuant to art. 7(2) cisg, the interest rate should be determined in accordance with the law otherwise applicable to the contract. as the swiss rules of private international law led to the application of italian law, the court applied the italian statutory interest rate.152 in [25 may 1999 landgericht [district court] berlin], it is also held: “[…] pursuant to art. 7(2) alt. 2 cisg, the amount of interest payable according to the cisg is based upon the law applicable by virtue of the rules of private international law (schlechtriem/herber, art. 7 cisg, n. 39). […]”153 in any event, in the case of gap praeter legem, as it was summarized in [20 july 1995 landgericht [district court] aachen]:154 “it has been argued that the interest rate must be determined by having recourse to the general principles of the cisg in order to achieve an internationally uniform regulation (cf. nordic journal of commercial law, issue 2003 #1 29 eberstein/bacher in von caemmerer / schlechtriem, kommentar zum einheitlichen un-kaufrecht, 2nd ed., art. 78, annotation 21, footnote 30). against this, it has been argued that a uniform solution could not be achieved at the conferences for the drafting of the cisg, as the different opinions about the interest obligation were irreconcilable (cf. op. cit., annotation 2). “preferable is the opinion that the interest rate is to be taken from the applicable national law supplementing the cisg, which in turn is to be determined in accordance with the conflict of laws rules of the forum state (cf. op. cit., annotation 21, footnote 31). […]” 8.1.4 summary in international legal writings and case law to date it is disputed whether the question of interest rate is outside the scope of the convention or whether there is a true gap in the convention within the meaning of article 7(2). in other words, it is questionable whether the lack of a specific interest rate in article 78 constitutes a gap “intra legem” or a gap “praeter legem”. nevertheless, from the cisg decisions´ point of view, this question might not have great relevance. particularly, it is noted that there is not one governing principle governing the rate of interest or the law applicable to the rate of interest. consequently, even starting with the article 7(2) approach, courts ultimately have to rely on the applicable domestic law by virtue of general private international law approach. indeed, the most significant difference, is not whether the issue at hand is a gap “intra legem” or a gap “praeter legem”, rather, the one as noted in [5 november 2002 handelsgericht [commercial court] des kantons aargau]: “[…] the amount of interest is not laid down in the un sales law. it is controversial, whether one must aim for autonomous contract gap-filling and a uniform solution or if recourse must be made to national law. in regard to national law, the mainly recommended recourse, it is again uncertain how the determination of that law within the scope of the conflicts of law is supposed to take place (schlechtriem/bacher, op. cit., note 27 and 32 to art. 78 cisg). […]”155 8.2 determined by the applicable domestic law 8.2.1 overview a vast majority of national courts and arbitral tribunals have thus far concluded that the rate of interest is to be calculated on the basis of the applicable domestic law. to date, 73 of the 148 cases involving cisg interest issue collected and published on the unilex database follow this approach.156 in this context, the recourse, in filling the interest rate gap, is frequently made to “the law governing the contract in the absence of cisg”, or with further guidance to “the law applicable by virtue of the rules of private international law”. as indicated above, some courts have expressly referred to article 7(2) cisg but concluding nordic journal of commercial law, issue 2003 #1 30 that there is no uniform principle stated in the convention regarding the amount of interest; and therefore resorted to the applicable law by virtue of rules of conflicts of law. nevertheless, these courts are of the opinion that the issue of interest rates is governed by the convention in the first place and, hence, a gap “praeter legem” exists. other courts, however, consider the issue of interest rates to be a matter which should be, in the first place, calculated according to the domestic law. in so doing, they apply the forum´s rule of private international law to determine the law applicable in absence of the cisg without reference to article 7(2). thus, these decisions seem to treat the question at hand as a matter not governed by the convention at all, i.e., as a gap intra legem. however, it is not always clear whether most decisions treat the issue as a gap “intra legem” or a gap “praeter legem”. nevertheless, it is noted: “in either case, if one has found that the appropriate interest rate should be determined by private international law rules, one must further choose a specific connecting factor, i.e., decide whether the issue of interest rates should follow the general law applicable to the sales contract or if a specific choice of law rule applies. this, however, is a question that may be only solved by national law since it concerns the non-uniform rules of the forum s private international law.”157 this is confirmed by the case law. from some cisg decisions´ point of view, this question at hand might not have great relevance. in either case, the ultimate recourse is frequently made to the applicable domestic law by virtue of rules of conflict of law. in this context, however, no special connecting points seem to have developed for the entitlement to interest.158 8.2.2 recourse to the law otherwise applicable by virtue of private international law the primary method which courts and literature use to arrive at an applicable law focuses on the law hypothetically applying to the contract in question if the cisg did not exist.159 as demonstrated by the case law, lots of courts held that the rate of interest be determined by the law governing the contract in the absence of cisg. for instance, in [16 december 1991 pretore della giurisdizione [district court] locarno], it is held that “the interest rate to be applied is the rate prescribed by the law which would be applicable if the vienna convention were not applied.”160 in [6 october 1995 amtsgericht kehl 3 c 925/93], absent an express provision in cisg, the court held that the interest rate was to be determined in accordance with the law otherwise applicable to the contract. in determining this the court had first to establish whether there was a valid choice of law clause in the contract.161 similarly, in [12 february 1996 tribunale d'appello [appellate court] lugano], the court held: “the cisg is silent on the issue of default interest, which results in the application of the law that would otherwise apply absent the convention (weber, id.). in the present case, since the parties did not choose the applicable law, the connection criterion must be applied, which leads to the application of the law of the seller (article 117, cpv. lit a ldip), that is, the italian law.”162 nordic journal of commercial law, issue 2003 #1 31 as to the law otherwise governing the contract in the absence of the cisg, it is above all determined by the parties with a valid choice of law clause agreed in the contract; and where they did not choose the applicable law, however, the connection criterion must be applied. in other words, as indicated in many cases, it is a question that may be only solved by virtue of rules of the forum´s private international law, which usually leads to the application of relevant domestic substantive law. for instance, in [26 september 1990 landgericht [district court] hamburg], the court ruled that “because the actually owed interest rate has not expressly been regulated within the cisg (v. caemmerer/schlechtriem/enderlein, loc. cit., art. 78, note 2), so that the interest rate has to be determined in accordance with the relevant national law, being applicable pursuant to the general principles of conflicts of laws (see art. 7(2) alt. 2 cisg; v. caemmerer/schlechtriem/enderlein, art. 78, note 3; bianca/bonell, loc. cit., art. 78, note 2.1).”163 similarly, in [24 april 1997 oberlandesgericht [appellate court] düsseldorf], the court ruled: “the un sales convention, however, does not regulate the amount of the interest rate. it depends on the relevant national law which is to be determined according to the general conflict-of-laws rules (cf. olg düsseldorf (senat) njw rr 1994, 506, 507; olg frankfurt/main njw 1994, 1013, 1014; von caemmerer/ schlechtriem/eberstein/bacher, loc. cit., art. 78 cisg, no. 21 with further citations; herber/czerwenka, loc. cit., art. 78 cisg, no. 6).”164 in some decisions, it is deemed as an approach in conformity with the “prevailing opinion” or even so-called “unanimous opinion” as such. for instance, in [5 april 1995 landgericht [district court] landshut], the court observed: “[…] the rate of interest is not regulated by art. 84 cisg. also, in art. 78 cisg no mention is made of the rate of interest. according to the prevailing opinion, the rate of interest within the scope of art. 78 cisg is governed by the applicable national law, which is determined by the rules of private international law. this notion is also applicable to art. 84 cisg.”165 furthermore, it is held in [5 november 1997 oberlandesgericht [appellate court] hamm]: “the cisg does not fix the applicable interest rate. according to unanimous opinion and the case law of this court (cf. iprax [iprax = praxis des internationalen privatund verfahrensrecht [german legal periodical] 1996, 197], the interest rate is to be settled in conformity with the law applicable by virtue of the rules of private international law. […]”166 similarly, in a switzerland case [21 october 1999 kantonsgericht [district court] zug], it is also stated: “it is a uniform opinion that the interest rate is governed by the law of the country which the nordic journal of commercial law, issue 2003 #1 32 rules of conflict of laws refer to as law of the contract (magnus, in: honsell, op. cit., at n.5, 9 and 12 on art. 78 cisg).”167 8.2.3 summary overwhelmingly, the vast majority of national courts and tribunals, especially those of germany and switzerland, have determined the amount of interest by reference to the law otherwise governing, by virtue of rules of conflict law of the forum, the contract in the absence of the cisg. there may be no sound basis, as long as this issue has not been settled either by the convention or parties’ agreement, to call, as some german and swiss courts did, a “unanimous opinion” or “uniform opinion” on how to calculate interest under the convention. nonetheless, an established or prevailing opinion exists. following such a prevailing opinion, the interest rate is determined by the applicable national law. german courts until now have almost always determined the amount of interest by reference to the national law applicable according to the rules of conflict of laws.168 to date, 33 of the 73 cases collected and published on the unilex database, where interest rate is determined by the domestic law governing the contract in the absence of the cisg, are decided before german courts.169 in this respect, it is noted: “according to german private international law, the applicable law is initially determined by choice of the parties. if there is neither express nor implied choice, the applicable law is ascertained according to the law of the country with which the contract is most closely connected. such connections primarily are found in the country of residence or place of business of the party carrying the characteristic obligation, this being, in the case of a sale, the seller. the question of rate of interest is considered to be part of the contract itself, thus it must be settled according to the same law as that of the contract itself.”170 another country, from which we have a great number of the decisions determining the amount of interest by reference to the national law applicable by virtue of the rules of conflict of law, is switzerland. up until now, 25 cases of the 73 cases collected and published on the unilex database following this approach are decided in switzerland.171 in this respect, it is noted in [20 december 1994 tribunal cantonal [appellate court]]: according to art. 117 lpil [lpil = swiss federal law on private international law], in case of a failure to choose the governing law, the contract is governed by the law of the state to which the contract is mostly related (art. 117(1) lpil); the contract is deemed to be related to the state in which the party which has to fulfill the principal obligation under the contract has its place of residence, or -if the contract forms part of professional or commercial activities -its place of business (art. 117(2) lpil); in contracts for the transfer of property, the duty of the owner is crucial for the determination of the governing law (art. 117(3) lpil). according to art. 118 lpil, sales of goods are governed by the convention on the law applicable to international sales of goods, adopted in the hague on 15 june 1955. rules of conflict of laws stated in that convention are applicable even if the law governing the contract is the law of a non-contracting state. art. 3(1) of the 1955 hague convention states that sales of goods are governed by the law of the state where the seller has its place of residence at the moment of the receipt of the offer, unless otherwise agreed by the parties.172 nordic journal of commercial law, issue 2003 #1 33 as evidenced by the decisions made by the vast majority of national courts and tribunals, there is a strong tendency, at least among german and swiss courts, to fix the applicable law according to the private international law of the court.173 this results in, on the other hand, different outcomes based on different regulations in non-unified private international law.174 needless to say, the cisg was adopted by the relevant countries precisely to prevent the application of national law.175 thus, by applying national law to fill the interest rate gap, national courts and arbitral tribunals may contravene the intent of the convention and further promote discontinuity.176 nevertheless, it is believed: “while this might be considered deplorable, in no respect are these differences a violation of the principle of uniformity in application of the convention. the lack of uniformity actually conforms to the standards of the convention. uniformity in the outcome of the case would obviously be preferable. this deficiency in the convention must be accepted. this is preferable to rewriting the convention without benefit of a new conference and a renewed convention.”177 in all events, in the vast majority of cases, the rate of interest is fixed according to the national law applicable by virtue of private international law of the court.178 despite some initial doubts as to which domestic law should be applied, currently there seems to be a tendency to apply the law which would be applicable to the sales contract if it were not subject to the vienna sales convention.179 however, while the question is open for further discussion, it would be shown below that there indeed are other justifications for deviating from the prevailing opinion. up until recently, there have been arbitral awards and court decisions from more than one jurisdiction not applying this approach.180 8.3 determined by domestic law of the interest-creditor 8.3.1 overview as indicated above, some courts applied the domestic law of a specific country by virtue of the rules of private international law of the forum. on the other hand, as to be demonstrated in this section, others applied the domestic law of the creditor without it being necessarily the law made applicable by the rules of private international law. some courts and tribunals have held that the issue of interest rates is governed by the law of the interest-creditor’s place of business. this approach is similar to the one claiming that interest is a form of damages.181 in respect of this approach, the ruling made by the court in [7 may 1993 richteramt [district court] laufen] deserves significant attention:182 “[…] following schlechtriem/eberstein (art. 78, para. 3), the law determined by the conflict of laws provisions shall be applicable, whereas following a dissenting and significant opinion, the rate of interest should be determined by the law of the interest-creditor (cf. the references in schlechtriem/eberstein, art. 78, para. 9). however, this controversy is only of significance when the seller is in arrears with his obligation to pay the price, e.g., with the liability for damages for defective goods under art. 74 cisg et seq.; here, applying the conflict of laws provisions, the rate of interest is determined by the statute of the seller, whereas the nordic journal of commercial law, issue 2003 #1 34 rate of interest is determined by the statute of the buyer when applying the law of the interest-creditor. in cases where, as brought forward by the [seller], the buyer is in arrears with his obligation to pay the price, which should be the majority of all cases, the rate of interest is -under both approaches -to be determined by the law of the seller, which in the case at issue is finnish law. […]” another point bearing significance is submitted by thiele in commentating on a german case: “moreover, the courts reference to the creditor s place of business sometimes may be misleading. in an action for recovery of the purchase price, the german landgericht stuttgart, for example, stated that the determination of the appropriate interest rate should be governed by the law of the creditor s place of business. at the same time, however, the court made a reference to article 28(2) einführungsgesetz zum bürgerlichen gesetzbuch [egbgb]. as a part of german private international law, this provision determines which law is applicable to contracts in general. absent a contractual agreement, article 28(2) egbgb requires the application of the seller s place of business. since in actions for the purchase price the law of the creditor s and the seller s place of business are identical, it is not always clear whether courts that purport to apply the law of the creditor s place of business, do not actually apply the law applicable to the contract in general.”183 8.3.2 general recourse to the law of the creditor's place of business despite this approach in question is only of significance when the seller is in arrears with his obligation to pay damages or refund the paid price. it is clear that the courts have occasionally applied the law of the creditor. for instance, in [16 september 1991 landtgericht [district court] frankfurt], the court held that the rate was the statutory rate of the seller's place of business: “the level of the interest rate has not been set forth in art. 78 cisg. consequently, the relevant obligor is to pay the interest rate which is due and payable pursuant to the relevant national substantive law of the creditor (see lg stuttgart, op. cit., p. 985 providing further literature references; asam/kindler, indemnification of any interest and/or money devaluation damages under the cisg, riw 1989, p. 842; eberstein, in: schlechtriem, art. 78 no. 11 cisg).”184 in [1992 international court of arbitration, case 7197], as cisg does not expressly specify the rate of interest payable, the court referred to austrian law as the law of the creditor's place of business.185 in [24 january 1994 kammergericht [appellate court] berlin], the court also granted the assignee the right to interest, at the interest rate of the creditor's country, italy (art. 78 cisg).186 in [9 december 1994 bezirksgericht [district court] arbon], the court held that interest was payable on the sums due to the claimant. as cisg does not determine the interest rate (art. 78 cisg), the court stated that it was to be determined in accordance with the domestic law of the creditor's country (austria).187 nordic journal of commercial law, issue 2003 #1 35 most often, the law of the creditor’s country is that of the seller’s place of business. thus, in [24 march 1992 fovárosi bíróság [metropolitan court]], the seller was awarded the purchase price plus interest at the rate fixed by the law of the country of the seller (creditor).188 in [21 october 1994 amtsgericht [lower court] riedlingen], the court held that the seller was entitled to interest (art. 78 cisg). since cisg does not determine the rate of interest, the court stated that the rate was to be determined in accordance with the domestic law applicable in the seller's country.189 similarly, in [25 october 1994 landgericht [district court] darmstadt], the court stated that the rate was to be determined in accordance with the domestic law applicable in the seller's country (argentina).190 on the other hand, in case of the refunding of the paid price under cisg art. 84, the interest-creditor is the buyer while the seller is the interest-debtor. therefore, in [15 april 1994 arbitration award 1/1993], the tribunal, following the creditor-approach, decided in favor of the buyer [interest-creditor] and ordered the seller to refund the price paid for the goods and to pay interest on this sum at the rate established by the law of the buyer's country.191 in this respect, it is to be noted that in [08 february 1995 oberlandesgericht münchen], the court determined that according to art. 84 cisg the buyer (interest-creditor) was also entitled to interest on the sum to be refunded. the court, however, in interpreting art. 84 cisg, applied the statutory interest rate of the (interest-debtor) seller's place of business (germany).192 also, in [5 february 1997 handelsgericht [commercial court] zürich], the court awarded the buyer the restitution of the advance payment plus interest (art. 78 cisg). however, as to the applicable rate of interest, the court applied the interest rate of the sellers' place of business, reasoning that this is the place in which the sellers usually invest their money.193 indeed, the latter two courts followed a debtor-approach, which is to be given more details infra. 8.4. 8.3.3 statutory rate vs. bank lending rate of interest among those decisions following the creditor-approach, there are some referring to the statutory rate of interest in accordance with the domestic law of the creditor’s state. for instance, in [24 april 1990 amtsgericht [lower court] oldenburg], the court held that the seller was entitled to interest accruing from the date when payment was due (arts. 59 and 78 cisg) at the statutory rate of interest in force in the seller's country (italy).194 similarly, in [18 january 1994 oberlandesgericht [appellate court] frankfurt], the court granted the seller the right to payment of the balance of the price as well as interest at the rate of 10% (statutory rate of the country of the creditor-seller).195 on the other hand, some other decisions have referred to bank lending rate, average or actual, of interest in accordance with the domestic law of the creditor’s state. several courts have awarded interest at the average bank lending rate of creditor’s state. for instance, in [3 april 1990 landgericht [district court] aachen], the court awarded interest at a rate of 12% for the period of delayed payment as the average bank lending rate at seller's place of business (arts. 61 (1)(b), 74 and 78 cisg).196 in [8 november 1995 rechtbank van koophandel [district court] hasselt], as cisg does not determine the interest rate, the court applied the average bank nordic journal of commercial law, issue 2003 #1 36 lending rate in the creditor's country (the seller's), because the creditor would have received interest on the sums due in that country had the debtor paid on time.197 similarly, in [9 october 1996 rechtbank van koophandel [district court] hasselt], the court applied the average bank lending rate in the creditor's country (the seller's), because the creditor would have received interest on the sums due in that country had the debtor paid on time.198 in respect of the bank lending rate awarded, it is to be noted that some russian courts have calculated interest, according to article 395 of the civil code of the russian federation in conjunction with cisg art. 78, at the actual credit rate of interest offered by banking institutions at the place of location of the creditor. for instance, in [28 march 1997 arbitration award 38/1996], the court held: “[…] since the interest rate is not set forth in the convention and since it cannot be determined in conformity with general principles pursuant to article 7(2) cisg, the provisions of the russian laws shall apply. under article 395 of the civil code of the russian federation, in case of delay of performance of money obligations, annual interest shall be recovered in the amount of the bank discount interest rate at the place of creditor's location. the [seller]'s claim of 12% annual interest does not exceed the interest rate used for short-term hard currency loans in russia.”199 in another case decided in russia [22 october 1998 arbitration award 196/1997], it is similarly held: “[…] the interest, though not specified in the cisg, is to be calculated in conformity with subsidiary applicable law, that is the russian federation civil code article 395, which provides that the interest for the use by the [buyer] of the unlawfully kept money is to be calculated on the basis of the bank interest rate at the [seller]'s place of business. the tribunal, thus, admits the certificate of 21 november 1997, issued by the cypriot central bank, presented by the [seller], which certifies that on the day of bringing the action before the tribunal the interest rate amounted to 8%. the [buyer] did not contest this certificate.”200 also, in [27 july 1999 arbitration award 302/1996], it is ruled: “the tribunal granted the claim of the [buyer] to recover annual interest on the granted sum of lost profit at the libor rate plus 2% per annum, on the basis of article 78 cisg and article 395 of the russian federation civil code that refers to the rate of bank loan at the place of creditor. the tribunal found that the mentioned rate of interest accorded to the rate which prevailed in switzerland (place of [buyer]'s (interest-creditor’s) company) respectively. the tribunal has also taken into account that [seller] raised no objections regarding the issue of rate of interest.”201 in [10 february 2000 arbitration award no. 340/1999], the tribunal stated: “[…] considering that the cisg does not provide the rate of interest, the amount of interest should be calculated in accordance with the rules of subsidiary applicable russian law. under article 395(1) of the russian federation civil code, the amount of interest for failure to perform a monetary obligation is calculated according to the actual credit rate of interest offered by banking institutions at the place of location of the creditor. from the calculation provided by [seller], it follows that he had calculated the interest in the amount of 22% per annum based on the reports of three banks. the tribunal has granted the seller's claim as to recovery of the interest in the mentioned amount on the sums granted by the tribunal in favor of the [seller] for the relevant periods of time.”202 nordic journal of commercial law, issue 2003 #1 37 8.3.4 summary some courts and tribunals have held that the issue of interest rates is governed by the law of the interest-creditor´s place of business, which finally refers to statutory rate or (commercially average or actual) bank lending rate. data available on the unilex database indicates that the creditor-approach is the secondly prevailing opinion in determining the rate, with 28 cases of the 148 cases involving cisg interest issue following this approach.203 yet in reality, sometimes the creditor-approach is not an application of the law of the creditor.204 some decisions listed above are clearly based on private international law which frequently leads to the law of the creditor's state. most possibly, it seems that national courts prefer to, in the absence of a rate fixed by agreement or referred otherwise in the domestic law, statutory rate. however, to the extent the creditor-approach is followed, it seems commercially persuasive to say that an average commercial interest rate should prevail over the statutory interest rate. thiele makes pertinent remarks when generally examining the two rates as follows:205 “finally, this paper suggests that an average commercial interest rate should prevail over the statutory interest rate. first of all, statutory interest rates make no difference between home and foreign currency and, thus, may not reflect on a foreign currency´s inflation rate. secondly, whereas statutory interest rates usually stay in force for a longer period of time, commercial interest rates are altered on a regular basis and, therefore, usually reflect the inflation rate. they are, thus, better suited to properly compensate the creditor. usually, however, there are two different interest rates for borrowing and depositing money. therefore, the question may be raised which of the two commercial rates should apply. in this context it is important to recall once again that the general principle underlying article 78 is to compensate the creditor for its loss. therefore, if the creditor was forced to borrow money from a bank, the prevailing commercial borrowing rate should apply. if, however, the creditor did not have to borrow money, it is nevertheless entitled to the interest it lost by not being able to invest the money owed to it. this interest is best reflected by the prevailing commercial deposit or savings rate.” 8.4 determined by domestic law of the interest-debtor this approach is similar to the one claiming that interest is meant to restitute benefits.206 it is said in this respect: “a general principle which can be taken from cisg is that the law at the place of business of the debtor of interest should be applied. this is because it is the debtor who has the use of the money while he is in arrears to the seller. it has been suggested that the purpose of article 78 is to deny the debtor these unjustified advantages. however, there is strong opposition to this approach. its detractors argue that the purpose of cisg is not taking advantages from the debtor but allowing the creditor to recover his costs by demonstrating damages.”207 while it is open for further discussion whether the purpose of article 78 is intended to prevent undue enrichment on the debtor´s part, or on the other hand, to protect the creditor and nordic journal of commercial law, issue 2003 #1 38 indemnify him or her for the loss incurring from the debtor´s withholding of the sum in dispute; there occasionally have been decisions referring to domestic law of debtor’s state.208 for instance, the two cases reviewed above ([08 february 1995 oberlandesgericht münchen], [5 february 1997 handelsgericht [commercial court] zürich]) which involve the refunding obligation under cisg art. 84 in effect follow the debtor-approach.209 in [11 march 1996 tribunal cantonal [appellate court] vaud [01 93 1061]], the court stated in pertinent part: “the only disputable obligation in the present case is that of the buyer which is established in switzerland. it is appropriate to refer to the rate applied in the place of establishment of the debtor (neumayer / ming, op. cit., p. 514). […]”210 in [11 march 1996 tribunal cantonal [appellate court] vaud [01 93 0661]], the court similarly held that the rate was to be determined in accordance with the domestic law of the buyer's country (switzerland) as the obligation of the buyer was the only disputed performance in the case at hand.211 also, in a case where a belgian buyer and a french seller were involved [16 december 1996 rechtbank van koophandel [district court kortrijk], the court awarded the seller payment of the price as well as interest under art. 78 cisg. as cisg does not specify the rate of interest payable, the court, considering the circumstances of the case, decided to award interest at the belgian (debtor’s) statutory rate.212 and in [21 march 2003 landgericht berlin], the court, after mentioning that the question is controversial, decided to apply the statutory rate of the debtor's country (germany): “the claim for payment of default interest ensues from art. 78 cisg in connection with sec. 288 bgb [bgb = bürgerliches gesetzbuch [german civil code]]. art. 78 cisg does not state anything concerning the actual interest rate owed by the defaulting party. opinions are widely divergent on this question, which interest rate shall be applicable. under any circumstances, it is arguable to apply the law of the state in which the debtor has his place of permanent residence, domicile or establishment (von caemmerer/schlechtriem, art. 78, note 32)”213 however, in another case, this debtor-approach was criticized to be an isolated deviating opinion. in [18 january 1994 oberlandesgericht [appellate court] frankfurt], it is held as:214 “[…] according to the isolated deviating opinion by stoll (festschrift für ferid, 1988, 495, 509f.; similar: von caemmerer-leser, article 84, rn. 13 on the obligation to pay interest under cisg article 84(1)), the legal rate [of interest] has to be determined by the domestic sales law of the debtor. whether or not stoll's opinion has to be followed did not have to be decided in the [previous] ruling of this court rendered on june 13, 1991, because in that case the [seller] at the very beginning limited her interest claim to 5%, a rate that is justified both under german and under french law. in this case, however, the court has to decide according to the prevailing legal opinion. since the amount of interest intentionally is not prescribed in the convention, the answer can only be taken from the rules of international private law. absent any point of reference, no principle can be derived from the convention such as saying that the domicile of the debtor would be decisive, because the duty to pay interest was aimed at preventing the withholding of money from being nordic journal of commercial law, issue 2003 #1 39 advantageous to the debtor (stoll as referred to above [festschrift für ferid, supra]) who still has the possibility to use or invest the funds as compared to payment. furthermore, this argument is not persuasive, since it is not guaranteed that the domestic legal rate [of interest] fully compensates for (see § 352 hgb) the advantage of non-payment and any other calculation of interest would erase the dividing line [between interest and] damages. the practical disadvantage of eventually being obliged to investigate foreign law to calculate the interest has to be accepted because of the partial incompleteness of the convention arising from unsettled disputes during the negotiation process (herber/czerwenka, article 78, rn. 1). besides, disadvantage can be diminished by the availability of adequate charts (piltz, § 5, rn. 415).” while the question is open for further discussion, it should be remembered that as different payment obligations may become due under any contract, this approach, which relates, to the payment in question rather than the underlying contract, appears preferable. nevertheless, as the creditor-approach does, it also takes a decidedly one-sided approach to solving the problem, which is unlikely to attract a large following.215 8.5 determined by domestic law of other places it is to be noted that both the creditor-approach and the debtor-approach discussed above relate to a specific place. there are also other places which may operate as a connection point in calculating interest under article 78 cisg. one such approach is found in the only 2 of the 178 cases collected by the unilex database, where the applicable rate was determined by domestic law of place of payment.216 in [9 august 1995 arrondissementsrechtbank [district court] almelo], the court stated that the rate was to be determined according to the law of the country where the price was to be paid (in this case german law as the law of the country where the seller had its place of business) (art. 57(1)(a) cisg).217 in [1992 international court of arbitration, case 7153], the court also held that the interest rate was to be determined in accordance with the law governing in the place of payment. the court stated:218 “moreover, the rate of said interest is not provided for in the convention, which is why we need to turn to the national law designated by the rule on conflict of laws. (cf. eberstein, in: v. caemmerer/schlechtriem, commentary on the uniform law of sales of the united nations -cisg -1990, article 78, end of line 3.) in this case, the court of arbitration believed the applicable law to be czech law, i.e., the law applicable at the place of payment. “it is true that the contract does not contain any provision as to the place of payment. in the absence of such a provision, article 57(1) of the convention nevertheless applies. the latter stipulates that the buyer is required to pay the price at the seller's place of business or, if the payment is to be made against the handing over of the goods, where said handing over takes place. […]” nordic journal of commercial law, issue 2003 #1 40 another approach referring to a specific place is found in [1994 international court of arbitration, case 7331], where the arbitral tribunal held that the seller was entitled to receive interest at the rate according to the law of the country in which the damage resulting from the delayed payment was suffered: in this case, the seller's country. the tribunal ruled:219 “regarding the precise rate of interest to be applied, there is no single internationally accepted rate of interest. this is reflected in the vienna convention, which only generally provides that parties are entitled to interest without specifying any particular rate of interest. it is, however, acknowledged in international law that where the parties are silent as to choice of law with respect to the payment of interest, the law of the state applies in which the damage resulting from the delayed payment is suffered. it is furthermore acknowledged in international law that such damage is suffered at the place of the creditor and in the creditor's market [citing icc arbitration cases 2375 of 1975 and 5460 of 1987]. therefore, this tribunal shall apply the rate of interest effective for commercial matter in the country of the creditor, the [seller].” however, differing interest rates in the relevant places (creditor’s or debtor’s place of business, place of payment or the place in which the damage resulting from the delayed payment is suffered) remain a problem. they might give rise to unjust enrichment or its opposite when one party has its place of business in a country with high inflation, even though the parties to a contract tend to avoid this by agreeing on a “hard” currency.220 this concern seems to be well remedied by the following approach. 8.6 determined by law of payment currency 8.6.1 overview other courts and legal scholars have suggested to refer to the law of the currency in which payment of the purchase price has to be made. it follows from the fact that interest rates are usually linked to the rate of inflation; and the “strong” currency is subject to much less inflation than the “weak” currency. in respect of this approach, thiele makes the following remarks:221 “however, even if one proceeds from the assumption that a creditor-focused approach is appropriate, one should take into account that interest rates are usually linked to the rate of inflation. therefore, if the creditor is located in a country with a ‘weak’ currency, the interest rate in this country for the country´s currency usually is high. if the creditor is located in a country with a ‘strong’ currency, the interest rate in that country for that country´s currency is low. accordingly, if the sum in question is to be paid in the creditor´s currency, the creditor´s law should apply because its interest rates compensate the creditor best for the delay of payment. if, however, the creditor is located in a country with a ‘weak’ currency and the payment currency is ‘strong’, the creditor is not harmed as much by the delay of payment as it would be when the payment currency was ‘weak’, especially when the creditor did not have to replace the sum in question by borrowing additional funds. this consequence results from the fact that the ‘strong’ currency is subject to much less inflation nordic journal of commercial law, issue 2003 #1 41 than the ‘weak’ currency. to award the creditor in addition to the lesser inflation rate the high interest rate of its country for that country´s currency may result in overcompensation and, thus, may lead to unjust results. accordingly, this paper suggests that in determining an appropriate interest rate under article 78, one also should take the payment currency into account.” 8.6.2 deemed as a commercially reasonable solution indeed, some decisions have clearly referred, as a commercially reasonable solution, to the law of payment currency. an interesting particular is to be noted: 9 of the 10 cases collected by the unilex database where it refers to interest rate currently used with respect to currency of account, were decided before arbitral tribunals.222 in particular, there are several icc decisions following this approach. for instance, in [1992 international court of arbitration, case 7585], where the contract price had to be paid in a currency other than that of the seller's place of business (german marks), as to interest the sole arbitrator expressly rejected the view according to which the applicable rate should be the rate in force in the state whose law is the law governing the contract or the rate in force at the place of business of the creditor. in his opinion, the rate of interest is linked to a precise currency. the sole arbitrator stated as follows:223 “the question of the rate of interest is not solved in the convention. the diplomatic conference did not agree on this issue (see official records i p. 138; ii p. 223-226, p. 388-392, 415-419, 429-430). “several solutions are conceivable: the rate in force in the state whose law is applicable; the rate in force in the place of business of the creditor; the rate in force in the place of procedure. “the arbitrator shares another view. in his opinion the rate of interest is linked to a precise currency. it would be rather illogical to base interest for the delayed payment of a price agreed in strong currency on the legal rate in force at a place of business located in a country which has a high inflation figure and consequently, a high rate of interest. ”the same reasoning would lead to the exclusion of the law applicable to the contract, the lex fori, or that of the place of payment. ”in the present case, the parties agreed that the price had to be paid in german marks. the first and the second down payments had been paid in dm. the same currency was used for the payment of the bank guarantee issued by seller. nordic journal of commercial law, issue 2003 #1 42 ”clearly, the financial aspects of the sale are linked with the german mark. the applicable rate of interest is therefore the german one. [...]” this approach was followed in another icc case [1993 international court of arbitration, case 6653]. in this case at hand, the court finally held that as cisg does not determine the rate of interest, the applicable rate was to be the one currently used in international trade with respect to eurodollars, the currency in which payment had to be made. the court stated there: “but then the convention does not regulate the method of determination of the percentage of interest. the arbitral tribunal finds that in matters of international commerce, the percentage that must be retained is the one that corresponds to the use which the creditor could have made of the sum to be reimbursed. consequently, it appears logical to retain a percentage currently applied between merchants and that conforms with the currency in which the settlement was made and in which the payment must be made. this solution, which is in the eyes of the arbitral tribunal the most logical one from the economic point of view, leads to retaining the percentage that operators of international commerce apply to settlements made in eurodollar, i.e., the one-year percentage of libor (london inter-bank offered rate), published every day in the wall street journal.”224 however, it is to be noted in [6 april 1995 cour d'appel [appellate court] paris], which involved an appeal against the above award of the arbitral tribunal of the icc case 6653/1993, the appellate court reversed that part of the arbitral award requiring the seller to pay interest at the libor rate, on the grounds that the convention is silent on the way in which the rate of interest is be determined, and that the decision to apply the libor rate had been taken by the arbitrators without the parties being given the possibility to make their defense on that point, whereas the international trade usage invoked by the buyer does not provide rules to determine the applicable rate.225 nevertheless, the appellate court did not reverse the part of the arbitral award because of its fault in applying the law of the currency in calculating the interest. also, in [december 1996 international court of arbitration, case 8769], the sole arbitrator decided to apply an interest rate that he deemed commercially reasonable, i.e., the interest rate of the currency in which damages had to be paid (austrian schillings), and in support of his finding he referred with no further explanation to art. 7.4.9 (2) of the unidroit principles: “claimant is entitled to interest on the sums awarded pursuant to art. 78 of the vienna convention. art. 78 vienna convention does not specify a particular interest rate. the sole arbitrator considers it appropriate to apply a commercially reasonable interest rate (see art. 7.4.9. subs. 2 unidroit princìples). the interest rate claimed is commercially reasonab[l]e for the award currency; austrian schillings.”226 and in [september 1997 international court of arbitration, case 8962], since the [seller] was entitled to payment in german currency [deutsch mark], the arbitrator held that the [seller] was entitled to interest using the market rate for deutsch mark on the date of default.227 similarly, in [september 1998 international court of arbitration, case 8908], the court held: nordic journal of commercial law, issue 2003 #1 43 “the vienna convention lays down a general rule, in article 78, that the liability for payment of a sum is subject to interest for late payment, but it does not lay down the criteria for calculating this interest. international case law presents a wide range of possibilities in this respect, but amongst the criteria adopted in various judgments, the more appropriate appears to be that of the rates generally applied in international trade for the contractual currency [...]. in concrete terms, since the contractual currency is the dollar and the parties are european, the applicable rate is the 3-month libor on the dollar, increased by one percentage point, with effect from the due date not respected up until full payment has been made.”228 also, several domestic courts or tribunals have followed this approach. for instance, in a hungary case [17 november 1995 budapest arbitration award vb 94124], after noting that cisg does not specify the interest rate, the court held that it would be improper to determine it according to the law otherwise applicable to the contract (hungarian law, as agreed upon by the parties), in particular taking into account the different inflation figures in the two countries involved (hungary and austria). since payment was to be made in austrian shillings, the court disregarded the provisions of the hungarian civil code fixing the interest rate at 20 % and granted interest at 5 % in accordance with the law of the state in whose currency payment was to be made.229 in a belgium case [25 april 2001 rechtbank van koophandel [district court] veurne], the court held that “this interest rate is determined according to the law of the currency of payment (cf. h. van houtte, ‘het weens koopverdrag in het belgish recht’, t.b.h., 1998, p. 344 e.v., inz. no. 33, pp. 352-353)”.230 and in a switzerland case [5 november 2002 handelsgericht [commercial court] des kantons aargau], it is held: “[…] the doctrine convincingly postulates that to determine the relevant national law, it is the connection to the currency that is decisive for the primary claim. (schlechtriem/bacher, id., note 33 to art. 78 cisg). decisive in this connection is the rule of the amount of the interest on arrears that is reached by the concerned system of laws (bacher, id., note 34 to art. 78 cisg).”231 8.6.3 summary in any case, the approach referring to the law of payment currency seems to be based on that it would be improper to determine the interest rate according to the law of a state other than that of the currency of payment, in particular when this other state has a weak currency and a high inflation figure. and therefore some courts follow this approach as a commercially reasonable solution; it is even deemed sometimes the most logical one from the economic point of view. the solution substantially corresponds to the one provided for in art. 7.4.9 (2) of the unidroit principles, though this provision was not always expressly referred to by some courts. indeed, as to be further demonstrated in next section, there still exist some other decisions establishing the interest rate in conformity to private international law according to nordic journal of commercial law, issue 2003 #1 44 art. 7(2) cisg, and deeming the applied rate to be reasonable preferably taking into consideration the state of the currency. in respect of this approach, it is also noted: “this solution can no longer lead to satisfactory solutions for a large amount of contracts, however, once the european currency union takes effect. the same is true for contracts already made specifying ecu as currency. in such instances, the currency no longer leads to the law of a single state, whose legal interest rate might then be applied.”232 8.7 unidentifiable law under compositive deliberations 8.7.1 leave open creditor-focused or debtor-focused there may exist some cases where the rate determined by the law of the creditor´s state and that determined by the law of the debtor´s state are identical. in such cases, some decisions leave open the question of whether to apply the statutory rate of the country of the interest-creditor or of the country of the interest-debtor. for instance, in [13 june 1991 oberlandesgericht [appellate court] frankfurt], the court referred to german private international law rules to ascertain the applicable law for the determination of the interest rate. the court left open whether the interest rate was the statutory rate in france (place of business of the seller/creditor) or that in germany (place of residence of the buyer/debtor) as the rates of interest in both countries were the same (5%).233 8.7.2 leave open focusing on a special connection or the law otherwise applicable in some other cases, it may also happen both the creditor-approach and the approach by virtue of private international law lead to the application of the law of the same country. for instance, in a case involving an italian seller and a buyer of italian nationality but with place of business in germany [13 april 2000 amtsgericht [lower court] duisburg], the buyer was ordered to pay the price plus interest, at the rate determined by italian domestic law (without having to decide whether this happened by virtue of a special connecting factor, that is the creditor’s place of business, or by virtue of the law otherwise applicable to the contract).234 it is held pertinently: “both approaches [the creditor-approach and the approach by virtue of private international law] lead to the application of italian national law, as the [seller] has his place of business in italy and the rules of german private international law (art. 28(2) egbgb) lead to the application of italian law.”235 in this respect, it is said: “since in actions for the purchase price the law of the creditor´s and the seller´s place of business are identical, it is not always clear whether courts that purport to apply the law of nordic journal of commercial law, issue 2003 #1 45 the creditor´s place of business, do not actually apply the law applicable to the contract in general.”236 8.7.3 preferably taking into consideration the state of the currency in those cases where which law was applied is not indicated, some decisions bear particular significance. in such decisions, the interest rate is determined in conformity to private international law according to art. 7(2) cisg, and deemed to be commercially reasonable preferably taking into consideration the state of the currency. in respect of this approach, the details were given in [5 december 1995 budapest arbitration award vb 94131]:237 “cisg art. 78 is silent on the amount of interest rate (see loewe, p. 95). it is accepted as a problem that it is neither logical nor fair to apply rules of one state on a sum that is expressed in the currency of another state if the currency of one of the states is stable or the influence of inflation is minor and the currency of the other state continuously diminishes in value. in austria, the inflation rate in 1994 and 1995 was on the average 3%, in hungary 20%. commenting on an award of the court of international arbitration of the austrian federal economic chamber in vienna, schlechtriem, in recht der internationalen wirtschaft 1995 pp. 593/94, proposed three ways of establishing the interest rate: (1) via the application of the lex contractus; (2) via the autonomous establishment of the interest rate by the court or arbitration tribunal through comparison of criteria for different bank rates; (3) in conformity to private international law according to art. 7(2) cisg, preferably taking into consideration the state of the currency. “schlechtriem advocates the last solution; the arbitrator agrees. therefore, the interest rate is to be established according to austrian law; according to § 352 para.1 of the commercial code, the rate is 5% for bilateral commercial activities. […]” similar ruling is also found in several other cases. for instance, in [31 august 1989 landgericht [district court] stuttgart], the court held that the rate was to be determined in accordance with the domestic law of the seller's country, as the country in which the seller is affected by the delayed payment, all the more so as payment was to be made in the currency of the seller's country. the court stated: “the cisg does not fix the rate of interest. this is a controversial subject. it is advisable to fall back on the national law of the creditor because the consequences of the debtor's nonfulfillment of his payment obligation take effect there and payment was due in italian currency. therefore, the debtor must carry the risk of paying the monetary debt in the foreign currency according to the rate of interest there. (references: stoll in schlechtriem, einheitliches kaufrecht und nationales obligationenrecht, 1987, §§ 279/280, 291; schlechtriem einheitliches un-kaufrecht, 1981, §§ 93/94).”238 nordic journal of commercial law, issue 2003 #1 46 similarly, in [30 december 1993 arrondissementsrechtbank [district court] arnhem], the court held that it was reasonable to apply german law in order to determine the rate of interest since the price was to be paid in german currency and the law applicable to the contract in the absence of cisg was german law.239 in [october 1996 international court of arbitration, case 8740], as the interest rate of 9 percent per annum was not disputed by either party and determined to be reasonable by the tribunal based on the currency in question, this rate was accepted by the tribunal.240 in [1997 international court of arbitration, case 8611], the sole arbitrator applied the german statutory interest rate, observing that german law was the law otherwise applicable to the contract and at the same time the law of the country in whose currency payment was to be made. this arbitrator stated: “[…] because art. 78 cisg does not, for obvious reasons, define the interest rate, the law applicable to this matter, in certain circumstances the monetary law, comes into force. both are part of german law which, in art. 352 of the commercial code concerning trade transactions, fixes the interest rate at 5%.”241 this approach is further supported in two recent cases. in [10 october 2001 oberlandesgericht [appellate court] rostock], since art. 78 cisg does not determine the interest rate, the court held that german domestic law was applicable, either as the law otherwise governing the contract, or as the law of the currency of the purchase price.242 and in [25 september 2002 oberlandesgericht [appellate court] rostock], the court granted the seller interest (art. 78 cisg) at the rate determined by german law, either because it was the law otherwise applicable to the contract, or because it was the law of the state in which currency the price had to be paid. it is stated: “[…] since art. 78 cisg does not provide for an interest rate, the rate needs to be determined by the national law which finds supplementary application or by the interest level of the country in whose currency the price is to be paid (cf. v.caemmerer/schlechtriem/bacher, op. cit., art. 78 n. 27, 33); either way, this leads to the application of german law in the present case.”243 8.7.4 summary thus, there often exist cases where different approaches discussed above lead to an identical rate or the application of the law of the same country. especially, in some decisions, the interest rate is determined in conformity to private international law, and deemed to be commercially reasonable preferably taking into consideration the state of the currency. in any case, the rules of conflict law, which often finally lead to the application of the substantive law (referring to statutory rate or commercial bank lending rate) of a specific country, undoubtedly play a predominant role. however, generally, courts rarely state the reasons they apply the law they choose to apply. nevertheless, on the grounds that the recourse to domestic law would lead to results contrary nordic journal of commercial law, issue 2003 #1 47 to those promoted by the convention, several decisions have sought a solution aiming at uniformity, one of the general principles on which the convention is based. as is to be discussed below. 8.8 approaches aiming at uniformity 8.8.1 recourse to general principles underlying cisg: full compensation several decisions have sought a solution on the basis of general principles on which the convention is based. however, the convention does not provide a list of these principles, nor does it indicate where any are to be found. in this respect it is noted: “in search of a uniform solution to the issue in question, some authors have suggested that one of the general principles of the convention is the principle of full compensation. therefore, these authors argue, an interest rate should be chosen that fully compensates the aggrieved party. consequently, these authors propose to calculate the interest under article 78 by means of the aggrieved party´s actual credit costs.”244 however, except for the only case [29 december 1999 tribunale [district court] pavia],245 never was express reference made to article 7(1) and its call for uniformity in any of the decisions reviewed. at least two arbitral courts have applied what seem to be general cisg principles. of the few arbitral court decisions applying general principles, only the austrian arbitral court tries to explain why its approach is “preferable” to the private international law approach. in [15 june 1994 vienna arbitration award sch-4366], the court stated in pertinent part:246 “one of the general legal principles underlying the cisg is the requirement of ‘full compensation’ of the loss caused (cf. art. 74 of the cisg). it follows that, in the event of failure to pay a monetary debt, the creditor, who as a business person must be expected to resort to bank credit as a result of the delay in payment, should therefore be entitled to interest at the rate commonly practiced in its country with respect to the currency of payment, i.e. the currency of the creditor's country or any other foreign currency agreed upon by the parties (cf. art. 7.4.9 of the principles of international commercial contracts prepared by the international institute for the unification of private law (unidroit), on which see m.j. bonell, an international restatement of contract law. the unidroit principles of international commercial contracts, transnational juris publications, irvington n.y., 1994, 114-115). the information received from the leading austrian banks is that the average ‘prime borrowing rates’ for us dollars and dm in austria in the period in question were 4.5% and 8%, respectively. the interest due from the [buyer] should be calculated at those rates.” in [15 june 1994 vienna arbitration award sch-4318], the court followed the same nordic journal of commercial law, issue 2003 #1 48 reasoning:247 “[…] one of the general principles underlying the cisg is that of ‘full compensation’ of the loss caused (cf. art. 74 of the cisg). it follows that, in the event of failure by the debtor to pay a monetary debt, the creditor, who as a business person must be expected to resort to bank credit as a result of the delay in payment, should therefore be entitled to interest at the rate commonly practised in its country with respect to the currency of payment, i.e. the currency agreed upon by the parties (cf. art. 7.4.9 of the principles of international commercial contracts prepared by the international institute of the unification of private law (unidroit), on which see m.j. bonell, an international restatement of contract law. the unidroit principles of international commercial contracts, transnational juris publications, irvington n.y., 1994, 114-115). the information received from the deutsche bundesbank is that the average ‘prime borrowing rate’ for us dollars in germany in the period in question was 6.25%. the interest due from the [seller] should be calculated at that rate.” it is to be noted that the above seeming recourse to so-called general principle of “full compensation” indeed finally focuses on the law of payment currency, which substantially corresponds to the one provided for in art. 7.4.9(2) of the unidroit principles. however, some authorities have criticized the theory of applying the general principle of “full compensation” from article 74’s damages provision within the context of interest since it confuses the distinct difference between interest and damages in the convention. nevertheless, the issue of whether or not interest is or is not part of damages would seem to be immaterial since the convention explicitly states that a party is entitled to interest without prejudice to any claim for damages.248 8.8.2 recourse to unidroit principles or pecl in [1995 international court of arbitration, case 8128], the arbitral tribunal applied the average bank short term lending rate to prime borrowers, being the solution adopted either by art. 7.4.9 of the unidroit principles and by art. 9:508 (ex art. 4.507) of the pecl. the arbitral tribunal considered that such rules were applicable as they must be considered general principles on which cisg is based (art. 7(2) cisg). in the case at hand, the london inter bank offered rate (libor) plus 2% required by the buyer corresponded to the bank short term lending rate to enterprises. the buyer was therefore awarded interest at the required rate.249 this decision suggests that the interest gap should be answered by the general principles on which the cisg is based, as article 7(2) stipulates. however, the principles from which the tribunal derived its solution do not come from the text of the convention. the tribunal instead, referred to unidroit principle article 7.4.9 and article 9:508 (ex art. 4.507) of the pecl as the general principles on which the cisg is based in setting the interest rate in accordance with the two principles at the average bank short-term lending rate. such an approach, however, creates possible distortions in the application of the convention by nordic journal of commercial law, issue 2003 #1 49 resorting to the unidroit principles or the pecl as a component of the general principles referenced in article 7(2) cisg. thus, care should be taken when the principles are embraced as general principles on which the cisg is based. careful examination of unidroit principle 7.4.9 and pecl art. 9:508, however shows that the wording of the texts remedies most concerns that were voiced at the vienna conference.250 8.8.3 recourse to international usages it is said that: “[b]efore one has recourse to a uniform conflict of laws rule, one should first decide whether any ‘substantive’ general principles may provide guidance as to the law applicable to interest rates under article 78. one of those substantive general principles may be inferred from article 9 cisg. absent any special agreement as to usage, article 9(2) states that a sales contract under cisg is subject to a ‘usage of which the parties knew or ought to have known and which in international trade is widely known to, and regularly observed by, parties to contracts of the type involved in the particular trade concerned’. therefore, if such a kind of usage applicable to the parties´ contract provides a specific interest rate, this usage should be used to supplement article 78.”251 again, in the private international law context, it is said that usage prevails based on article 9 of cisg, and that only in case of lack of established practices should applicable law be fixed according to private international law.252 indeed, some court decisions have invoked article 9 of the convention in order to solve the issue of the applicable rates of interest and determined the amount of interest payable according to the relevant trade usages. for instance, in [23 october 1991 juzgado nacional de primera instancia en lo comercial [national commercial court of first instance]], in order to ascertain whether the buyer was obliged to pay interest, the court expressly referred to the international trade usages on the basis of art. 9 cisg. in this respect the court held that payment of interest, “at an internationally known and used rate such as the prime rate”, constitutes “an accepted usage in international trade, even when it is not expressly agreed between the parties”, then granting the seller recognizance for its credit for interest “at the prime rate ... as required by the creditor”, without specifying which prime rate it was, and applying a rate of 10 %. in the same decision, the court also entitled another us seller, on the same grounds, to recover interest at the prime rate plus a spread of 2%, as provided in the contract.253 in another argentina case [6 october 1994 juzgado nacional de primera instancia en lo comercial [national commercial court of first instance]], with respect to interest accruing on the credit deriving from the performance of the second sales contract, the court determined interest at the rate of 12%, as a rate generally recognized in international trade. in the court reasoning, since cisg does not determine the interest rate, reference should be made to international trade usages “which are assigned by cisg itself a hierarchical position higher than the very same cisg provisions (art. 9 cisg)”.254 nordic journal of commercial law, issue 2003 #1 50 8.8.4 recourse to independent libor there are also other authors prefer the general principles approach by relying on the london inter-bank offered rate (libor), sometimes even classifying it as a “usage” under article 9(2) cisg. however, it is strongly said that the libor, applying a totally independent approach, does not conform to cisg or to private international law. this is a far from acceptable approach, because it precludes worldwide application in small everyday business transactions.255 in this respect, thiele makes the following remarks:256 “the general application of an interest rate that is used in specific international trade transactions, such as the libor, is more problematic, however. as stated above, gaps in the convention may be filled ‘in conformity with the general principles on which it is based’. there is no indication, however, that the convention was based on the external interest rates of the libor. furthermore, the libor may not be introduced to the convention by classifying it as a ‘usage’ under article 9(2) cisg either. as stated above, ‘usage’ under article 9(2) cisg requires that the usage is regularly observed by parties to contracts of the type involved in the particular trade concerned. the libor, however, is the rate at which banks in the london market offer dollar deposits to each other. whether parties to regular international sales transactions have reason to know of the libor is therefore doubtful. to extend the application of the libor to all international sales transactions, thus, would stretch the meaning of ‘usage’ under article 9(2). although the application of the libor would have the advantage of guaranteeing uniformity to the issue in question, this solution, therefore, is not compatible with article 7 cisg because there is no ‘general principle’ to this effect.” it is recalled that in [6 april 1995 cour d'appel [appellate court] paris], which involved an appeal against the award of the arbitral tribunal of the icc case 6653/1993, the appellate court reversed that part of the arbitral award requiring the seller to pay interest at the libor rate, on the grounds that the convention is silent on the way in which the rate of interest is be determined, and that the decision to apply the libor rate had been taken by the arbitrators without the parties being given the possibility to make their defense on that point, whereas the international trade usage invoked by the buyer does not provide rules to determine the applicable rate.257 nevertheless, several cases reviewed above have clearly calculated the interest by referring to libor.258 also, in [25 march 1998 arbitration award 491/1997], the court stated in part: “taking into account the fact that the annual rate of 5% which the [seller] claims does not exceed the libor rate usually applicable in international trade relations, the tribunal found it possible to grant the [seller]'s claim.”259 8.9 parties’ disposition 8.9.1 rate contractually agreed prevails based on the principle of autonomy, the rate of interest agreed upon by the parties should be nordic journal of commercial law, issue 2003 #1 51 applied. undoubtedly, the lack of a specific interest rate under the cisg is to be compensated above all by agreement between the parties. a contract clause that clearly spells out the rate or the method for calculating the rate of interest should eliminate much of the uncertainty. in [21 december 1992 zivilgericht [civil court] basel], the court awarded the rate of interest to which the parties had contractually agreed upon, and stated pertinently:260 “[…] the rate of interest is not provided for in the cisg. the cisg refers to the national law which the previously considered conflict of laws provisions refer to (cf. 2.). under para 352 of the austrian commercial code, the rate of interest laid down amounts to 5%. however, this rate of interest only applies if no rate of interest was agreed between the parties (cf. straube, commentary to the commercial code, n 1 ff. to para. 352). the general terms and conditions of trade of the [seller] which are printed on the back of the carbon copies of the letters of confirmation of 24 february 1989 submitted by the [buyer] to the court (in english with a reference to the ‘german translation’ on the ‘preceding page’) provide, in number 4.6, for a rate of interest which exceeds the bank rate of the austrian national bank by at least 3.5% (annex 4 to defendant's plea). according to the prevailing legal theory in austria, the general terms and conditions of trade are also valid if reference is first made to these in a confirmation (cf. code of commercial law, edited by fritz schoenherr and gunter nitsche, vienna 1981, page 288, e. 1b). the defendant does not in general contend that the general terms and conditions of trade of the [seller] had not become contractual content. that the bank rate of the austrian national bank 1989 was 5.5% or more according to the general terms and conditions of trade of the [seller] can, given the interest situation in austria, be regarded as established. therefore, it is to be established that the 9% interest claimed by the [seller] was agreed upon. thus the interest claim of the [seller] can also be awarded in full.” similarly, in [6 october 1994 juzgado nacional de primera instancia en lo comercial [national commercial court of first instance]], with respect to interest accruing on the credit deriving from the performance of the first sales contract, the court gave recognizance to the credit for interest at the rate of 24%, that is corresponding to the rate agreed upon by the parties. the court held this on the ground that cisg, as envisaged by its art. 6, grants the parties with the widest possibility of determining the contents of their contract.261 however, an interest rate fixed in standard terms is more problematic and deserves stricter scrutiny. for instance, while in [10 december 1997 vienna arbitration award s 2/97], the seller was further awarded interest on the sums due as damages (arts. 78 and 74 cisg) at the rate fixed by the seller's standard terms;262 in another case the fixed rate is not awarded. in [28 october 1999 oberlandesgericht [appellate court] braunschweig], it is held:263 “this court reverses the appealed decision only with respect to the damages resulting from a delay in payment. the [seller] may not rely on the interest clause contained in section 7 of nordic journal of commercial law, issue 2003 #1 52 his standard terms. this section of his standard terms determines delay damages as an abstract lump-sum without giving due consideration to the actual nature of the damages (cf. § 11 no. 5(b) agbg). following §§ 9 and 24 agbg, such a varying clause is also forbidden in business transactions. the cisg does not diverge from these provisions. the decision of the domestic german law to regard such a clause as invalid comes in under art. 4(a) cisg, art. 31(1) egbgb. because the [seller] does not submit a concrete basis for determining the interest rate, the [buyer's] duty to pay interest is based on cisg article 78, whereas the interest rate is to be determined by the law applicable by virtue of the rules of private international law, that is § 352 hgb (cf. ensthaler/achiles, after § 382, art. 78 n.3). consequently, the dm 3,887.40 interest determined by the court of first instance is to be replaced by only dm 2,556.10. “the interest on the [seller's] entire claim again is based on cisg art. 78, while the interest rate is determined by § 352 of the german commercial code (hgb). following the above reasoning, the decision on interest also needs to be adjusted so that the [seller] receives an interest rate no higher than 5% per annum. […]” 8.9.2 undisputed rate is usually awarded the second consequence following parties’ disposition is that an undisputed rate is usually awarded. for instance, in [october 1996 international court of arbitration, case 8740], as the interest rate of 9 percent per annum was not disputed by either party and determined to be reasonable by the tribunal based on the currency in question, this rate was accepted by the tribunal.264 similarly, in [3 july 1997 bezirksgericht [district court] st. gallen], the court awarded the seller the price indicated on the corrected invoice plus interest (art. 78 cisg). with respect to the interest rate, although the court pointed out the two leading theories on the determination of the interest rate under cisg (interest rate to be determined according to the domestic law governing the contract in the absence of cisg or according to the domestic law of the debtor's place), it awarded the swiss rate of interest, as that was the rate requested by the seller in the judicial complaint to which the buyer did not raise an objection during the court proceeding.265 also, in [30 july 2001 landgericht [district court] braunschweig], it is held: “under art. 78 cisg, [buyer] is entitled to interest. the rate of interest was not contested by [seller].”266 in [11 april 2002 amtsgericht [lower court] viechtach], it is similarly held: “since the [buyer] did not dispute the interest rate submitted by the [seller], the court grants the requested rate of 12%.”267 8.9.3 lower rate requested is certainly awarded in some cases, despite a statutory rate would have been applied by virtue of private international law, the court awards an inferior rate asked in the legal request of the entitled party. nordic journal of commercial law, issue 2003 #1 53 for instance, in [16 december 1991 pretore della giurisdizione [district court] locarno], the court held that the rate of interest be determined by the law governing the contract in the absence of cisg (in the case at hand, french law as the law of the seller's place of business). the relevant rate amounted to 9.5% but since the seller asked only for 6% interest rate, the court awarded the latter rate, “since this rate is inferior to the rate prescribed by law”.268 similarly, in [20 december 1994 tribunal cantonal [appellate court]], the court awarded the interest rate expressly referred to in seller's claim which was 2% lower than the italian statutory rate, and stated:269 “in the present case, application of those rules of conflict of laws leads to the application of italian law. this conclusion is also the result of the application of art. 117 lpil; the principal obligation under the present contract (delivery of blocks of stone) is the [seller's] responsibility, whose place of business is in italy. according to art. 1284 of the civil code of italy, the rate of default interest is 10%, unless a higher rate is fixed by the parties. the [seller] in the present case claims the default interest at the rate of 8%. therefore, it is possible to award a higher rate of default interest only if the court rules ultra petita.” also, in [21 january 1997 rechtbank van koophandel [district court] hasselt], the court held that the rate had to be determined in accordance with that provided for in the seller's standard terms if lower than the one required by the domestic law otherwise applicable to the contract.270 in [28 october 1997 tribunal cantonal [appellate court] valais], with regard to the interest rate, the court considered this to be a matter governed but not expressly settled by cisg (art. 7(2) cisg) and applied the statutory rate of the state whose law would have been the governing law of the contract in the absence of cisg (italy). however, the court awarded interest at the rate expressly referred to in the seller's counterclaim (5%) which was lower than the italian statutory rate (10%).271 in any case, following the principle of parties' disposition, the lower (than the applicable statutory or commercial bank lending rate by virtue of private international law) interest claimed is to be granted according to the legal request of the entitled party.272 whereas, on the other hand, the higher interest claimed by the entitled party would not be awarded unless relevant proof is submitted sufficiently. it is an issue deserving a further discussion below. 8.9.4 higher rate needs to be proved as indicated previously the creditor is generally entitled to interest without prejudice to any further damages recoverable. quite a significant number of the cases reviewed (supra. 3.4) had to decide the question of interest under the heading of damages. it is also noted that the practical problem of claiming interest by way of damages seems to be limited to the proof.273 and the burden of proving a further damage deriving from the late payment falls on the claimant. in this regard, it is often held that the burden of proof is a matter governed but not expressly settled in cisg, to be solved applying the general principle underlying the convention; and the claimant must prove its cause of action.274 nordic journal of commercial law, issue 2003 #1 54 in some decisions, evidence of the discount rate in plaintiff's country was not held to be sufficient evidence of damages. for instance, in [16 september 1991 landtgericht [district court] frankfurt], the court held that the rate was the statutory rate of the seller's place of business. further, as there was no evidence of any other damage suffered by the seller, no other damages were awarded. the court stated: “the [seller] does not have the right to claim any further interest under art. 74 cisg. the [seller] has not provided evidence for his disputed assertion that he borrows money continuously at an interest rate of 15% per annum. it is hereby irrelevant that the [seller] demonstrated that the discount interest rate was 12.5%, respectively 13.5% in italy. furthermore, any agreement to a higher interest rate than what is legally owed would require a document complying with the written form (art. 1284 par. 3 cc). in this case, however, the [buyer] has not provided such a document.”275 also, in [18 january 1994 oberlandesgericht [appellate court] frankfurt], the seller was not awarded the higher interest rate of 13,5% as further damages, since it had not given evidence of making recourse to bank loans. it is held: “the [seller's] claim for default interest at an amount of 13.5% could not be awarded. cisg, article 78 does not bar a claim for damages under cisg, article 74 to recover additional loss resulting from finance charges (herber/czerwenka,[30] article 78, rn. 8). however, the [seller] has no shown evidence of any further loss caused by using credit (as to the burden of proof: von caemmerer-stoll,[31] article 74, rn. 41). the submitted certificates issued by the banca d'ltalia only refer to the discount [rate] fluctuations.”276 similarly, in [24 april 1997 oberlandesgericht [appellate court] düsseldorf], the appellate court held that the seller had not proved it had taken out on at its place of business a bank loan in italian lire at a 16,5% rate of interest. it therefore awarded the statutory rate of 10% according to italian law as the law otherwise applicable to the contract. the court stated there: “the [seller], however, is not entitled to a further interest claim in form of the damage claim according to art. 74 cisg. apart from all the other requirements, such a damage claim is to be ruled out as the [seller] did not put forward and prove to utilize a bank credit amounting to the claim for which the [seller] demands interest exceeding the statutory interest rate. the certificate from bank n.a. which was submitted by the [seller] at first instance, merely gives information on the demanded credit rates. however, the certificate does not contain any information whatsoever as to whether the [buyer] actually makes use of a credit exceeding the principal claim.”277 however, it is to be noted that in another case [8 march 1995 amtsgericht [lower court] wangen], the seller was not entitled to the higher interest rate of 16,5% as further damages, since the court considered that the seller should have applied for obtaining a bank loan at the average market rate.278 and in [25 january 1996 landgericht [district court] münchen], a higher nordic journal of commercial law, issue 2003 #1 55 interest rate as further damages (art. 74 cisg) was not granted since the seller was not able to prove a causal connection between its recourse to bank loans and the buyer's non payment.279 in any case, the detailed analysis made by the court in [6 april 2000 landgericht [district court] münchen]:280 “the rate of interest on the sum in arrears comes to 5% p.a. (art. 78 cisg, art. 1284 cc). a claim for compensation of interest for drawn credit would require that the [seller] conduct his business with an ongoing bank credit which exceeds the sum claimed during the time the payment was in arrears. furthermore and this is decisive the credit has to be repaid by all of the payments received by the [seller] unless such payments must be used immediately for the interest owed on the credit. it is only in such a case that a loss in the meaning of art. 74 cisg, which exceeds the legal damage for delay, exists. the [seller] did not submit any facts demonstrating such a loss. “[seller] could only claim for payment of an overdraft interest rate if he had established to conduct his business while permanently using an overdraft facility. further, this overdraft had to extend his claim within these proceedings while [buyer] was in default. and most importantly, this overdraft would have had to be repaid with all incoming cash flow under his trade receivables, unless those cash flows were appropriated to redeem any accrued interest. only if that were the case, might one establish a claim for compensation of damages beyond the statutory default interest rate pursuant to art. 74 cisg. [seller] has not, however, demonstrated any facts as to the aforementioned ingredients to establish such a claim beyond the statutory default interest rate.” indeed, the reason most often given for not awarding further damages is that plaintiffs either were unable or unwilling to prove such damages arising from reliance on bank credit at a higher interest rates. it is often held that the claiming party was not entitled to the higher interest rate as further damages, since it has not provided sufficient evidence that it suffered losses higher than the legal interest rate by making recourse to bank loans.281 on the other hand, once relevant proof has been submitted sufficiently, higher rate is awarded. for instance, in [1 september 1994 kantonsgericht [district court] zug], the court applied the law otherwise applicable to the contract (in the case at hand, german law) and, as the seller had given evidence of having had recourse to bank loans, granted the higher interest rate of 12%.282 in [21 september 1995 handelsgericht [commercial court] zürich], although austrian statutory interest rate amounted to 5%, the court held that the seller was entitled to the higher interest rate of 9,75% as further damages (arts. 78 and 74 cisg). in this respect, the court observed that the seller had only to prove the recourse to bank loans since it can be assumed that companies normally resort to external sources of credit to finance their activities.283 also, in [5 december 1995 handelsgericht [commercial court] st. gallen], the seller was awarded a higher interest rate as further damages since it provided a bank certificate proving that it had paid interest on bank loans during a specific time period.284 similarly, in [5 march 1996 landgericht [district court] düsseldorf], the seller was finally nordic journal of commercial law, issue 2003 #1 56 awarded the purchase price and interest according to art. 78 cisg at the rate of 16,5%, as it had proved it had recourse at its place of business to a bank loan in italian lire at this rate of interest.285 in [25 june 1996 amtsgericht [lower court] bottrop], the seller was also granted a higher interest rate of 16,5% as further damages as it had proved a causal connection between its recourse to bank loans and the buyer's late payment.286 in [10 july 1996 handelsgericht [commercial court] zürich], the seller was also a higher interest rate as further damages according to art. 74 cisg, at the rate it was actually charged for a bank loan obtained after the buyer's refusal to pay the purchase price.287 thus, there also exist decisions where the claiming parties were also awarded a higher interest rate as further damages pursuant to arts. 78 and 74 cisg, since they provided sufficient evidence of recourse to bank loans. as indicated in [12 november 1996 amtsgericht [lower court] koblenz], “article 78 does not exclude the possibility to demand reimbursement under art. 74 cisg for losses suffered through a bank credit at a higher rate than the statutory interest rate.”288 in this regard, the pertinent ruling in [12 december 2002 kantonsgericht [district court] zug] deserves significance: “[…] a higher interest is only owed if the creditor proves that he was in fact due to the debtor's delay obliged to pay interest on debts at this rate, or that he lost this amount in interest on investments (cf. baumbach/hopt, handelsgesetzbuch, 29th ed., munich 1995, § 352 hgb n. 5).[…]”289 8.10 concluding remarks regarding the precise rate of interest to be applied, there is no single internationally accepted rate of interest. this is reflected in the convention, which only generally provides that parties are entitled to interest without specifying any particular rate of interest. in the vienna convention, nothing is said either in article 74 (damages) nor in articles 78, 84 (interests) about the rates nor the modus of calculation of interests where interests are due to a party in case of breach of contract by another party. art. 78 of the vienna convention, which lays down a general rule that the liability for payment of a sum is subject to interest for late payment, is the result of compromise which the contracting states reached after long discussions. however, it was not possible to reach an agreement on the interest rate. as a consequence of the partial incompleteness of the convention arising from unsettled disputes during the negotiation process, one of the most complex problems facing judges and arbitrators in adjudicating international commercial disputes falling under the cisg is which rate of interest to apply in fixing judgments and awards. as demonstrated above, there is a considerable number of decisions dealing with the issue of determining the appropriate interest rate under article 78 cisg. however, only few of these decisions engage in a thorough discussion of the problem in question. moreover, international case law presents a wide range of possibilities in this respect. attitudes of those who have ruled on interest under the cisg generally fall in either of two camps: rate of interest should be set nordic journal of commercial law, issue 2003 #1 57 in accordance with applicable domestic law; or rate of interest should be set aiming at uniformity, among other things, in accordance with general principles on which the convention is based. so far, none of the proposed uniform law approaches could find widespread acceptance. because of the problems and inconsistencies associated with them, this is unlikely to change in the near future.290 but amongst the criteria adopted in various judgments, there is a strong tendency, at least among german and swiss courts, to fix the applicable law according to the private international law of the court. however, up until recently, there have been arbitral awards and court decisions from more than one jurisdiction not applying this approach. it is apparent that if there is any uniformity in the application of national law as the interest rate gap filler, it is that there is uniform incongruity.291 therefore, calling one approach “unanimous” is at least incorrect, if not willfully misleading. any method, that is, except the one apparently favored by national courts the world over: by resorting to national law of conflicts, the question of interest enters a maze of different legislations, viewpoints and currencies.292 as indicated by the above review of the recent international case law, many tribunals have contributed to inconsistent results. undoubtedly, it should be noted that cisg obviously is far from perfect and must be developed by courts and scholars. but again, we should not replace cisg with what we consider better law. for it is fear of such a development that leads parties to avoid contracting under cisg and may induce countries not to adopt the convention.293 accordingly, parties to international sales contracts can only be urged to include provisions specifying the situations calling for interest and determining a specific interest rate in their contract, which is clearly available under article 6 of cisg. in any case, as long as this issue has not been settled either by statute or court decisions, parties to international sales transactions should avoid uncertainty by negotiating appropriate contractual interest rate provisions and procedures to trigger the accrual of interest.294 nordic journal of commercial law, issue 2003 #1 58 main abbreviations cisg/convention = united nations convention on contracts for the international sale of goods pecl/european principles = principles of european contract law upicc/unidroit principles = unidroit principles of international commercial contracts footnotes 1. see gotanda, john y. in “awarding interest in international arbitration”, 90 ajil (1996); pp. 41-42. available online at <http://tldb.uni-koeln.de/tldb.html>; tldb document id: 123400. 2. see alan f. zoccolillo, jr. in “determination of the interest rate under the 1980 united nations convention on contracts for the international sale of goods: general principles vs. national law”: 1 vindobona journal of international commercial law and arbitration (1997); pp. 3-43. available online at <http://www.cisg.law.pace.edu/cisg/biblio/zoccolillo.html>. 3. ibid. 4. see library of congress v. shaw, 478 u.s. 310, 315 n.2 (1986). (citing gotanda, supra. fn. 1 at n. 13.) 5. supra. fn. 2. 6. see dan b. dobbs, handbook on the law of remedies § 3.5, at 164 (1973). (citing zoccolillo, supra. fn. 2 at n. 5.) 7. see mccollaugh, 11 iran-u.s. cl. trib. rep. at 29; illinois central r.r case, 3 ann. dig. 257 (u.s: mex.gen. claims comm'n 1922), reprinted in part in 5 hackworth, digest §539, at 735. (citing gotanda, supra. fn. 1 at n. 12.) 8. see spalding v. mason, 161 u.s. 375, 396 (1896) (quoting curtis v. innerarity, 47 u.s. (6 how.) 146, 154 (1848)) 9. supra. fn. 2. zoccolillo believes with this regard: “in certain disputed international transactions, involving parties from countries with high interest rates, the interest awarded to a debtor can substantially add to an award or even exceed the original amount sought. thus, unless there is an equitable calculation of interest, the damages sought in an international proceeding could reflect only a fraction of a total debt a party in default may encounter.” (ibid.) 10. see volker behr in “the sales convention in europe: from problems in drafting to problems in practice”: 17 journal of law and commerce (1998); p. 266. available online at <http://www.cisg.law.pace.edu/cisg/biblio/behr.html>. 11. ibid., p. 268 12. see jelena vilus in “provisions common to the obligations of the seller and the buyer”: petar sarcevic & paul volken eds., international sale of goods: dubrovnik lectures, oceana (1986); ch. 7, p. 252. available online at <http://www.cisg.law.pace.edu/cisg/biblio/vilus.html>. 13. see peter schlechtriem in “uniform sales law the un-convention on contracts for the international sale of goods”, manz (1986); p. 99. available online at <http://www.cisg.law.pace.edu/cisg/biblio/schlechtriem-78.html>. 14. see andré corterier in “a new approach to solving the problem of the interest rate under article 78 cisg”: 5 international trade and business law annual (2000); p. 34. available nordic journal of commercial law, issue 2003 #1 59 online at <http://www.cisg.law.pace.edu/cisg/biblio/corterier.html>. in this respect, enderlein & maskow observe as follows: the regulation of interest has caused considerable difficulties, both in preparing and holding the diplomatic conference. those difficulties are reflected in the modesty of the results. in ulis there was a rule for interest in arrears in the event of payment in arrears of the price which provided for one per cent above the official discount rate in the creditor's country (article 83). no agreement could be achieved in preparing the draft cisg, however, so that the interest is mentioned only in what is now article 84, paragraph 1, hence interest on the price to be paid back (nicholas/bb, 568). the subject was taken up repeatedly at the diplomatic conference. religiously motivated prohibition or restriction of interest in islamic countries played a role in the debates, but by no means a decisive one (o.r., 416 fol). the main contentious issue was rather how the interest rate should be calculated. given the considerable movement in the money market, there were only few delegations which, like that of the frg, were in favour of a fixed interest rate, as a minimum (o.r., 416). but flexible interest rates were only possible through reference to an existing interest level. insofar the discussion revolved around the question of whether the interest level in the creditor's country or the one in the debtor's country should be decisive. at the time of the diplomatic conference there were serious differences between the western industrialized countries, where the amount of interest is formed in the market (naturally influenced by political measures) and had at that time reached considerable amounts, and most of the at that time called socialist countries where the interest was fixed by law and relatively low. it was against this background that the western industrialized countries aimed towards interest to be set according to the level of the creditor's country. this would have meant that debtors from those countries would have had to pay low interest to creditors from eastern countries, but by contrast, debtors from the latter countries high interest. it was pointed out in favour of this variant that the creditor would have to procure financing in replacement in his country. the eastern countries, and also many developing countries, opted for the reverse solution pointing to the fact that they would have to procure the means needed in their commercial relations with western partners in high-interest countries (c. in regard to the overall subject o.r., 223 fol; 388 fol, 415 fol, 429 fol). these differences of opinion caused by the differing interests could not be overcome even by compromise proposals (o.r., 138). furthermore, in light of the divergent methods used in forming interest in the countries involved, difficulties of a substantive and legal, technical kind become apparent in concretely determining the level of interest by reference. it was impossible, in the end, to come to a basic rule. (infra. fn. 41, pp. 310-311.) 15. see jacob s. ziegel in “report to the uniform law conference of canada on convention on contracts for the international sale of goods”. available online at <http://www.cisg.law.pace.edu/cisg/text/ziegel78.html>. 16. see judgment by hg zürich [hg = handelsgericht = commercial court], switzerland 10 february 1999; no.: hg 970238.1. english translation by ruth m. janal. available online at <http://cisgw3.law.pace.edu/cases/990210s1.html>. 17. see jeffrey s. sutton in “measuring damages under the united nations convention on the international sale of goods”: 50 ohio state law journal (1989); pp. 737-752. available online at <http://www.cisg.law.pace.edu/cisg/biblio/sutton.html>. nordic journal of commercial law, issue 2003 #1 60 18. supra. fn. 12, p. 253. 19. see the iranian revolutions and the islamic republic 11 (nikki r. keddre & eric hooglund, eds., 1986). (citing infra. fn. 19, at n. 204.) 20. see t.s. twibell in “implementation of the united nations convention on contracts for the international sale of goods (cisg) under shari'a law: will article 78 of the cisg be enforced when the forum is an islamic state?”: 9 international legal perspectives (1997); p. 71. available online at <http://www.cisg.law.pace.edu/cisg/biblio/twibell.html>. 21. see editorial remarks by albert h. kritzer on icc arbitration case no. 7531 of 1994. available online at <http://cisgw3.law.pace.edu/cases/947531i1.html>. 22. supra. fn. 1, p. 42. gotanda observes there: the practice of awarding interest as an element of damages is well established among the countries in europe. countries in north and south america generally authorize the awarding of interest to compensate a party for the loss of the use of money. like their european and north and south american counterparts, asian countries, such as china, india, japan and the republic of korea, generally allow interest to be paid when a debtor defaults on a money payment. several countries do not allow interest as part of an arbitral award. most of these countries are in the middle east and africa, and have legal systems based on shari'a (islamic law). the shari'a is based on the teachings of the koran, islam's holy book, which expressly prohibits the taking of interest, or riba. some islamic countries, such as egypt, have moved away from shari'a toward more western-style legal systems. in these countries, either the payment of interest is expressly permitted in certain circumstances or a similar fee is allowed as a “service” or as “administrative” costs. other countries, such as iran, have adopted fundamentalist islamic law, which strictly adheres to the shari'a principles, including the prohibition against the taking of interest. even in iran, however, there is a limited exception to this prohibition. (ibid., pp. 42-50) 23. supra. fn. 11. 24. see phanesh koneru in “the international interpretation of the un convention on contracts for the international sale of goods: an approach based on general principles”: 6 minnesota journal of global trade (1997); pp. 105-152. available online at <http://www.cisg.law.pace.edu/cisg/biblio/koneru.html>. 25. see judgment by lg stuttgart [lg = landgericht = district court], germany 31 august 1989; no.: 3 kfh o 97/89. english translation by jutta surovic. available online at <http://cisgw3.law.pace.edu/cases/890831g1.html>. 26. see judgment in icc arbitration case no. 9333 of october 1998. english translation by kirsten stadtländer. available online at <http://cisgw3.law.pace.edu/cases/989333i1.html>. 27. see judgment in icc arbitration case no. 7331 of 1994. cited in editorial remarks by albert h. kritzer. available online at <http://cisgw3.law.pace.edu/cases/947331i1.html>. 28. see comment and notes to the pecl: art. 9:508; comment b. available online at <http://www.cisg.law.pace.edu/cisg/text/peclcomp78.html>. 29. see lauterpacht, hersch, private law sources and analogies of international law, new york, toronto (1927); p. 145. tldb document id: 104200. 30. see comment 1 on upicc art. 7.4.9. available online at <http://www.cisg.law.pace.edu/cisg/principles/uni78.html>. 31. supra. fn. 11; see also supra. fn. 1. nordic journal of commercial law, issue 2003 #1 61 32. see unicitral case digest 3. available online at <http://www.cisg.law.pace.edu/cisg/text/anno-art-78.html>. 33. supra. fn. 10, pp. 283-284. 34. see joseph lookofsky in “understanding the cisg in scandinavia”, (1996); p. 82. (citing schneider, infra. fn. 45 at n. 73.) 35. supra. fn. 24. 36. see judgment in icc arbitration case no. 7585 of 1992. available online at unilex database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=134&step=fulltext>. 37. see judgment by olg koblenz [olg = oberlandesgericht = provincial court of appeal], germany 17 september 1993; no.: 2 u 1230/91. english translation by kirstin statländer. available online at <http://cisgw3.law.pace.edu/cases/930917g1.html>. 38. see christian thiele in “interest on damages and rate of interest under article 78 of the u.n. convention on contracts for the international sale of goods”: 2 vindobona journal of international commercial law and arbitration (1998); pp. 3-35. available online at <http://www.cisg.law.pace.edu/cisg/biblio/thiele.html>. 39. supra. fn. 28. 40. supra. fn. 13, pp. 99-100. 41. see fritz enderlein, dietrich maskow, international sales law: united nations convention on contracts for the international sale of goods, oceana publication (1992); p. 311. available online at <http://www.cisg.law.pace.edu/cisg/biblio/enderlein.html>. 42. see dionysios p. flambouras in “the doctrines of impossibility of performance and clausula rebus sic stantibus in the 1980 vienna convention on contracts for the international sale of goods and the principles of european contract law: a comparative analysis”: 13 pace international law review (fall 2001); p. 282. available online at <http://www.cisg.law.pace.edu/cisg/biblio/flambouras1.html>. 43. supra. fn. 13, p. 100. 44. supra. fn. 30. 45. see eric c. schneider in “measuring damages under the cisg”, available online at <http://www.cisg.law.pace.edu/cisg/text/cross/cross-74.html>. 46. supra. fn. 41, p. 315. in this respect, enderlein & maskow note that: “a claim for damages presupposes a breach of contract, as is the case in regard to the entitlement to interest when one assumes, as we do, that an excusable breach of contract is nonetheless a breach. the main difference, however, is that exemption under article 79 is possible in respect of the obligation to pay damages. hence, it may happen that there is an entitlement to interest and a damage exceeding interest can be proved, but there will be no right to claim damages because there is an impediment, such as restriction of the transfer of currency.” (ibid.) 47. supra. fn. 18. 48. supra. fn. 46. see <http://cisgw3.law.pace.edu/cases/900403g1.html>. 49. supra. fn. 43. 50. ibid. 51. supra. fn. 28, comment c. 52. supra. fn. 10, p. 284. 53. see case abstract of the judgment by hg zürich [hg = handelsgericht = commercial court], switzerland 21 september 1995; no. hg 930476. available online at unilex nordic journal of commercial law, issue 2003 #1 62 database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=159&step=abstract>. 54. see case abstract of the judgment by bundesgericht [= bger = supreme court] , 1. zivilabteilung, switzerland 28 october 1998; no. 4c.179/1998/odi. available online at unilex database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=382&step=abstract>. 55. see case abstract of the judgment by ag oldenburg in holstein [ag = amtsgericht = petty district court], germany 24 april 1990; no. 5 c 73/89. available online at unilex database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=5&step=abstract>. 56. see judgment by appellate court düsseldorf, germany 14 january 1994; no.: 17 u 146/93. english translation by ruth m. janal, translation edited by camilla baasch andersen. available online at <http://cisgw3.law.pace.edu/cases/940114g1.html>. 57. see case law on uncitral texts (clout) abstract no. 104: case abstract on icc arbitration case no. 7197 of [1992]. available online at <http://cisgw3.law.pace.edu/cases/927197i1.html>. 58. see case abstract of the judgment by tribunal of international commercial arbitration at the russian federation chamber of commerce and industry, russia 4 april 1998; no. 387/1995. available online at unilex database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=377&step=abstract>. 59. supra. fn. 32, digest 4. 60. see judgment by olg frankfurt [olg = oberlandesgericht = provincial court of appeal], germany 18 january 1994; no.: 5 u 15/93. english translation from 14 journal of law and commerce 201-207 (1995). available online at <http://cisgw3.law.pace.edu/cases/940118g1.html>. 61. supra. fn. 52. 62. supra. fn. 38. 63. supra. fn. 30. 64. supra. fn. 51. 65. supra. fn. 30, comment 3. 66. supra. fn. 41. 67. supra. fn. 38. 68. supra. fn. 27. 69. supra. fn. 41, p. 313. 70. in this respect, thiele notes: “this language [“any other sum that is in arrears”] has been interpreted to encompass expenses that one party had on behalf of the other as well as reimbursements when the purchase price is reduced according to article 50 cisg. although the language of article 78 cisg might suggest otherwise, the provision does not apply to interest payments on the refund of the purchase price if the purchase contract is avoided because this case is covered by the specific provisions of article 84 cisg.” (supra. fn. 38.) 71. supra. fn. 69. 72. supra. fn. 38. 73. ibid. 74. see judgment by lg landshut [lg = landgericht = district court], germany 5 april 1995; no.: 54 o 644/94. english translation by dr. peter feuerstein, translation edited by ruth m. nordic journal of commercial law, issue 2003 #1 63 janal. available online at <http://cisgw3.law.pace.edu/cases/950405g1.html>. 75. see judgment by kg zug [kg = kantonsgericht = district court], switzerland 21 october 1999; no.: a3 1997 61. english translation by dr. andrea vincze. available online at <http://cisgw3.law.pace.edu/cases/991021s1.html>. 76. see comment on upicc art. 7.4.10. available online at <http://www.cisg.law.pace.edu/cisg/principles/uni78.html>. 77. supra. fn. 28. 78. supra. fn. 76. 79. supra. fn. 38. 80. supra. fn. 46. 81. see case abstract of the judgment in icc arbitration case no. 8502 of 1996. available online at unilex database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=395&step=abstract> 82. see judgment in icc arbitration case no. 8908 of 1998. available online at unilex database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=401&step=fulltext>. 83. see judgment by district court (landgericht) frankfurt am main, germany 16 september 1991; no.: 3/11 o 3/91. english translation by stefan kuhm. available online at <http://cisgw3.law.pace.edu/cases/910916g1.html>. 84. see judgment by pretore della giurisdizione [district court] di locarno campagna (canton of ticino), switzerland 16 december 1991; no.: 15/91. english translation by danijela luksic. available online at <http://cisgw3.law.pace.edu/cases/911216s1.html>. 85. see judgment by lg aachen [lg = landgericht = district court], germany 20 july 1995; no.: 41 o 111/95. english translation by dr. peter feuerstein, translation edited by ruth m. janal. available online at <http://cisgw3.law.pace.edu/cases/950720g1.html>. 86. see judgment by tribunal cantonal vaud [canton appellate court], switzerland 11 march 1996; no.: 01 93 1061 [163/96/ba and 164/96/ba]. english translation by serge lapine, translation edited by chantal niggemann. available online at <http://cisgw3.law.pace.edu/cases/960311s2.html>. 87. see judgment by kg schaffhausen [kg = kantonsgericht = district court], switzerland 12 december 2002; no.: a3 2001 34. english translation by ruth m. janal. available online at <http://cisgw3.law.pace.edu/cases/021212s1.html>. 88. supra. fn. 38. 89. for instance, in [1994 international court of arbitration, case 7331], the icc arbitral tribunal even states: “it is also generally acknowledged that interest does not begin to accrue until proper notice of the claim has been given. in this case, there is no indication that proper notice was given before the filing of the request for arbitration.” (supra. fn. 27.) in [january 1997 international court of arbitration, case 8786], the tribunal award the interest running from the time when the [seller] put the [buyer] on notice to fulfill its obligation until payment was made by the [buyer] in full. (see case digest by daniel j. morse on icc arbitration case no. 8786 of january 1997. available online at <http://cisgw3.law.pace.edu/cases/978786i1.html>.) in this respect, the court in [12 february 1998 bulgaria chamber of commerce arbitration award, case 11/1996] interpreted in more details as follows: “according to article 78 cisg, if a party fails to pay the price or any other sum that is in nordic journal of commercial law, issue 2003 #1 64 arrears, the other party is entitled to interest on it. the convention only defines the principle that the party in arrears owes interest, without determining the amount of that interest. first, a debtor is in arrears when his liability becomes subject to execution. second, the creditor must invite the debtor to fulfill its liability voluntarily. “the [seller] did not claim for interest in his complaint. he only declares that a separate suit will be brought against the [buyer] for interest calculated according to the quarterly libor. there is no evidence proving that the [seller] invited the [buyer] to satisfy its debt and pay the interest upon it voluntarily. consequently, there is no evidence proving that the [buyer] is in arrears. “with the addition to the complaint received by the arbitral tribunal on 3 december 1997, the [seller] claims interest. the arbitral tribunal allowed this addition to the complaint with its ruling of 15 december 1997. after this act of the arbitral tribunal, the [buyer] is in arrears and owes the interest. the arbitral tribunal accepts that the [buyer] is in arrears from the date when the lawsuit was brought (3 december 1997), but not for the period before that date. with its addition to the complaint from 3 december 1997, the [seller] [creditor] cannot put in arrears the [buyer] [debtor] for a period preceding that date. this becomes clearer if we take into consideration the fact that according to the convention, the amount of the interest is not defined and has to be determined by the contracting parties themselves or by other means. the innocent party cannot be in arrears for the period before an invitation is made to voluntarily pay. “the arbitrate tribunal allows [seller]'s claim for interest only for the period after the addition to the complaint (3 december 1997), but not for the prior four years. ” 90. see case abstract of the judgment by ag zweibrücken [ag = amtsgericht = petty district court], germany 14 october 1992; no.: 1 c 216/92. available online at unilex database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=92&step=abstract>. 91. see judgment by kg berlin [kg = kammergericht = upper court berlin (similar to olg courts elsewhere in germany)], germany 24 january 1994; no.: 2 u 7418/92. english translation by ruth m. janal. available online at <http://cisgw3.law.pace.edu/cases/940124g1.html>. 92. see judgment by lg münchen [lg = landgericht = district court], germany 20 march 1995; no.: 10 hko 23750/94. english translation by ruth m. janal, translation edited by camilla baasch andersen. available online at <http://cisgw3.law.pace.edu/cases/950320g1.html>. 93. see judgment by ca grenoble [ca = cour d'appel = appeal court], france 29 march 1995; no.: 93/2821. english translation by charles sant 'elia. available online at <http://cisgw3.law.pace.edu/cases/950329f1.html>. 94. see judgment by ca grenoble [ca = cour d'appel = appeal court], france 26 april 1995; no.: 93/4879. english translation by charles sant 'elia. available online at <http://cisgw3.law.pace.edu/cases/950426f2.html>. 95. see case abstract of the judgment by tribunal cantonal vaud [canton appellate court], switzerland 11 march 1996; no.: 01 93 0661. available online at unilex database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=320&step=abstract>. 96. see case abstract of the judgment by hg zürich [hg = handelsgericht = commercial court], switzerland 30 november 1998; no.: hg 930634/o. available online at unilex nordic journal of commercial law, issue 2003 #1 65 database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=409&step=abstract>. 97. see judgment by lg flensburg [lg = landgericht = district court], germany 24 march 1999; no.: 2 o 291/98. english translation by ruth m. janal. available online at <http://cisgw3.law.pace.edu/cases/990324g2.html>. 98. see case abstract of the judgment by rechtbank [district court] van koophandel hasselt, belgium 8 november 1995; no.: a.r. 1970/95. available online at unilex database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=265&step=abstract>. 99. see case abstract of the judgment by tribunal de commerce [district court] namur, belgium 15 january 2002; no.: r.g. no. 985/01. available online at unilex database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=745&step=abstract>. 100. see case abstract of the judgment by ca paris [ca = cour d'appel = appeal court], france 6 april 1995; no.: unavailable. available online at unilex database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=200&step=abstract>. this case involves an appeal against the award of an arbitral tribunal of the icc international court of arbitration [1993 international court of arbitration, case 6653, infra. fn. 115.]. 101. quoted in the judgment in icc arbitration case no. 7585 of 1992, supra. fn. 36. 102. supra. fn. 30. 103. supra. fn. 87. 104. see judgment by ag koblenz [ag = amtsgericht = petty district court], germany 12 november 1996; no.: 16 c 1056/96. english translation by jarno vanto, translation edited by ruth m. janal. available online at <http://cisgw3.law.pace.edu/cases/961112g1.html>. 105. quoted in the judgment by handelsgericht [commercial court] des kantons aargau, switzerland 19 december 1997; no.: or.97.00056. english translation by andré corterier. available online at <http://cisgw3.law.pace.edu/cases/971219s1.html>. 106. see judgment by olg düsseldorf [olg = oberlandesgericht = provincial court of appeal], germany 24 april 1997; no.: 6 u 87/96. english translation by julian waiblinger. available online at <http://cisgw3.law.pace.edu/cases/970424g1.html>. 107. supra. fn. 32, digest 2. 108. supra. fn. 46. however, it is to be noted that since the payment in many cases is considered as effected only at a later date than that on which the debtor has caused it, a guess will have to be made as to the actual time of payment in calculating interest if the transfer of the principal claim and the interest is made simultaneously. (ibid.) 109. supra. fn. 24. 110. see case abstract of the judgment by lg verden [lg = landgericht = district court], germany 8 february 1993; no.: 9 o 85/92. available online at unilex database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=87&step=abstract>. 111. see judgment by internationales schiedsgericht der bundeskammer der gewerblichen wirtschaft [arbitral tribunal vienna], austria 15 june 1994; no.: sch-4366. english translation reproduced with permission of unilex database. available online at <http://cisgw3.law.pace.edu/cases/940615a3.html>. 112. see judgment by ag nordhorn [ag = amtsgericht = petty district court], germany 14 june 1994; no.: 3 c 75/94. english translation by ruth m. janal. available online at <http://cisgw3.law.pace.edu/cases/940614g1.html>. 113. see case abstract of the judgment by internationales schiedsgericht der bundeskammer nordic journal of commercial law, issue 2003 #1 66 der gewerblichen wirtschaft [arbitral tribunal vienna], netherlands 6 may 1993; no.: 920159. available online at unilex database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=94&step=abstract>. 114. supra. fn. 41, p. 314. 115. see judgment in icc arbitration case no. 6653 of 1993. available online at <http://cisgw3.law.pace.edu/cases/936653i1.html>. see also the ruling in [6 april 1995 cour d'appel [appellate court] paris], where the present case was appealed. (supra. fn. 100.) 116. supra. fn. 104. 117. supra. fn. 75. 118. supra. fn. 76. 119. see case abstract of the judgment by tribunal cantonal valais [canton appellate court], switzerland 20 december 1994; no.: c 323/94. available online at unilex database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=168&step=abstract>. 120. see case abstract of the judgment by rechtbank [district court] van koophandel kortrijk, belgium 16 december 1996; no.: a.r. 4328/93. available online at unilex database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=340&step=abstract>. 121. see judgment by tribunal of international commercial arbitration at the russian federation chamber of commerce and industry, russia 28 march 1997; no.: 38/1996. english translation by yelena kalika, translation edited by mykhaylo danylko. available online at <http://cisgw3.law.pace.edu/cases/970328r1.html>. 122. see case abstract of the judgment by pretura circondariale [court of first instance] di parma, sez. di fidenza, italy 24 november 1989; no.: 77/89. available online at unilex database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=62&step=abstract>. 123. see case abstract of the judgment in icc arbitration case no. 8128 of 1995. available online at unilex database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=207&step=abstract>. 124. see judgment in icc arbitration case no. 7565 of 1994. available online at unilex database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=141&step=fulltext>. 125. see case abstract of the judgment by bg st. gallen [bg = bezirksgericht = district court], switzerland 3 july 1997; no. 3pz 97/18. available online at <http://www.unilex.info/case.cfm?pid=1&do=case&id=306&step=abstract>. 126. see case abstract of the judgment by juzgado nacional de primera instancia en lo comercial no. 7 (buenos aires), argentina 20 may 1991; no.: 50.272. available online at unilex database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=14&step=abstract>. 127. see judgment by juzgado nacional de primera instancia en lo comercial no. 7 (buenos aires), argentina 20 may 1991; no.: 50.272. english translation by alejandra truscello. available online at <http://cisgw3.law.pace.edu/cases/910520a1.html>. 128. supra. fn. 69. 129. supra. fn. 28, note 1. 130. see andré corterier, supra. fn. 14. 131. in this respect, enderlein & maskow observe as follows: these cannot, because of the cisg, be countered anymore by national prohibitive rules for interest, which in many islamic countries have been considerably relaxed in regard to the economic sector. insofar a specific nordic journal of commercial law, issue 2003 #1 67 rule of the convention supersedes the general rule of article 4, sub-para. (a) according to which the convention does not cover questions of validity. the entitlement to interest in abstract terms is not limited by a ceiling so that in our view also, national restrictions in regard to the amount of interest do not prevail over farther-reaching party agreements. but these could be measured against relevant general provisions of national law which are aimed against unfair (immoral) behaviour. (supra. fn. 41, p. 312.) 132. supra. fn. 17. 133. supra. fn. 38. 134. see franco ferrari in “uniform application and interest rates under the 1980 vienna sales convention”: cornell review of the convention on contracts for the international sale of goods (1995); pp. 3-19. available online at <http://www.cisg.law.pace.edu/cisg/biblio/1ferrari.html>. 135. supra. fn. 38. in this respect, thiele observes that: “in this context it is noteworthy that the drafters of the convention were unable to reach a decision on the issue of interest rates. the reason for this disagreement was, among others, different views on the purpose of interest. finding a uniform solution was further hindered by the fact that some islamic laws expressly forbid the accrual of statutory interest. the final language of article 78, therefore, apparently was a compromise in order to prevent the convention from failing entirely. from this legislative history it may be inferred that the drafters of the convention intentionally left the determination of an interest rate unsettled. for example, as the legislative history reveals, the german proposal to include a fixed interest rate in the convention was expressly rejected. however, in order to determine whether the lack of an fixed interest rate in the convention constitutes a gap praeter legem or a gap intra legem, the legislative history appears to be of not much avail. this conclusion is based on the fact that the drafters also rejected the british proposal to expressly leave the determination of an interest rate to the law made applicable by the rules of international private law. this rejection may suggest that the drafters saw the question at issue not outside the scope of the convention but rather wanted it to be governed by article 7(2) cisg. in any event, the legislative history appears to be unclear as to this matter.” (ibid.) 136. supra. fn. 38. 137. supra. fn. 30, comment 2. 138. supra. fn. 2. 139. supra. fn. 28. 140. supra. fn. 85. 141. supra. fn. 38. 142. supra. fn. 111. 143. according to article 7, paragraph 2, of the convention, the former matters have to be settled in conformity with the general principles on which the convention is based or, in the absence of those principles, in conformity with the law applicable by virtue of the rules of private international law. however, if a matter is considered to fall outside the convention's scope, it must be settled in conformity with the law applicable by virtue of the rules of private international law, without any recourse to the “general principles” of the convention. (supra. fn. 32, digest 6.) 144. see judgment by lugano, cantone del ticino, la seconda camera civile del tribunale nordic journal of commercial law, issue 2003 #1 68 d'appello, switzerland 15 january 1998; no. 12.97.00193. english translation by charles sant 'elia, translation edited by angela maria romito. available online at <http://cisgw3.law.pace.edu/cases/980115s1.html>. 145. see judgment in icc arbitration case no. 9448 of july 1999. available online at <http://www.cisg-online.ch/cisg/urteile/707.htm>. 146. see judgment by tribunale [district court] di pavia, italy 29 december 1999; no. unavailable. english translation by charles sant 'elia, translation edited by angela maria romito. available online at <http://cisgw3.law.pace.edu/cases/991229i3.html>. 147. in other words, art. 7(2) cisg “only legitimizes the last available option when uniform law proves inadequate. it is undisputed that the application of the law of conflicts needs to remain ultima ratio. this should be obvious when considering the spirit of the uniform law: it is meant to create a uniform body of rules, clear, understandable and equally applicable to everyone. this aim is not served by the law of conflicts. the spirit of the cisg therefore demands that such questions are solved within the context of the cisg.” (see andré corterier, supra. fn. 14, pp. 35-36.) 148. supra. fn. 111. 149. supra. fn. 124. 150. supra. fn. 119. 151. see judgment by schiedsgericht der handelskammer [arbitral tribunal] hamburg, germany 21 march 1996; no.: partial award of 21 march 1996. yearbook comm. arb'n xxii. available online at <http://cisgw3.law.pace.edu/cases/960321g1.html>. 152. see case abstract of the judgment by tribunal cantonal du valais, iie cour civile [canton appellate court], switzerland 29 june 1998; no.: ci 97 288. available online at unilex database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=366&step=abstract>. 153. see judgment by lg berlin [lg = landgericht = district court], germany 25 may 1999; no.: 102 o 181/98. english translation by christian p. alberti, ll.m., translation edited by camilla baasch andersen. available online at <http://cisgw3.law.pace.edu/cases/990525g1.html>. 154. supra. fn. 85. 155. see judgment by hg aargau [hg = handelsgericht = commercial court], switzerland 5 november 2002; no.: or.2001.00029. english translation by martin f. koehler. available online at <http://cisgw3.law.pace.edu/cases/021105s1.html>. 156. see the data (dated to november, 2003) available online at <http://www.unilex.info/article.cfm?pid=1&pos=78&iid=104#iid104>. 157. supra. fn. 38. 158. supra. fn. 41, p. 312. 159. see andré corterier, supra. fn. 14, p. 38. 160. supra. fn. 84. 161. see case abstract of the judgment by amtsgericht kehl, germany 06 october 1995; no.: 3 c 925/93. available online at unilex database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=163&step=abstract>. 162. see judgment by cantone del ticino, la seconda camera civile del tribunale d'appello [appellate court ] [lugano], switzerland 12 february 1996; no.: 12.95.00300. english translation by francesco g. mazzotta. available online at nordic journal of commercial law, issue 2003 #1 69 <http://cisgw3.law.pace.edu/cases/960212s1.html>. 163. see judgment by lg hamburg [lg = landgericht = district court], germany 26 september 1990; no.: 5 o 543/88. english translation by stefan kuhm, translation edited by camilla baasch andersen. available online at <http://cisgw3.law.pace.edu/cases/900926g1.html>. 164. supra. fn. 106. 165. supra. fn. 74. 166. see judgment by olg hamm [olg = oberlandesgericht = provincial court of appeal], germany 5 november 1997; no.: 11 u 41/97. english translation by marko maljevac, translation edited by ruth m. janal. available online at <http://cisgw3.law.pace.edu/cases/971105g1.html>. 167. supra. fn. 75. see eva diederichsen in “commentary on oberlandesgericht frankfurt am main, 18 january 1994, 5 u 15/93”: 14 journal of law and commerce (1995); pp. 177-181. available online at <http://cisgw3.law.pace.edu/cases/940118g1.html>. see the data (dated to november, 2003) available online at <http://www.unilex.info/article.cfm?pid=1&pos=78&iid=104&cid=34#iid104>. these 33 cases are listed as: 3 july 1992 landgericht [district court] heidelberg; 22 september 1992 oberlandesgericht [appellate court] hamm; 14 october 1992 amtsgericht [lower court] zweibrücken; 8 february 1993 landgericht [district court] verden; 17 september 1993 oberlandesgericht [appellate court] koblenz; 10 february 1994 oberlandesgericht [appellate court] düsseldorf [6 u 119/93]; 10 february 1994 oberlandesgericht [appellate court] düsseldorf [6 u 32/93]; 2 march 1994 oberlandesgericht [appellate court] münchen; 14 june 1994 amtsgericht [lower court] nordhorn; 5 july 1994 landgericht [district court] giessen; 25 august 1994 landgericht [district court] düsseldorf; 25 october 1994 landgericht [district court] darmstadt; 9 november 1994 landgericht [district court] oldenburg; 8 february 1995 oberlandesgericht [appellate court] hamm; 20 march 1995 landgericht [district court] münchen; 5 april 1995 landgericht [district court] landshut ; 12 may 1995 amtsgericht [lower court] alsfeld; 22 june 1995 landgericht [district court] kassel; 20 july 1995 landgericht [district court] aachen; 27 july 1995 oberlandesgericht [appellate court] rostock; 25 january 1996 landgericht [district court] münchen; 29 january 1996 amtsgericht [lower court] augsburg ; 28 february 1996 landgericht [district court] oldenburg; 25 june 1996 amtsgericht [lower court] bottrop; 24 april 1997 oberlandesgericht [appellate court] düsseldorf; 5 november 1997 oberlandesgericht [appellate court] hamm; 28 january 1998 oberlandesgericht [appellate court] münchen; 11 march 1998 oberlandesgericht [appellate court] münchen; 24 march 1998 landgericht [district court] berlin; 28 october 1999 oberlandesgericht [appellate court] braunschweig; 13 april 2000 amtsgericht [lower court] duisburg; 10 october 2001 oberlandesgericht [appellate court] rostock; 25 september 2002 oberlandesgericht [appellate court] rostock.. 168. supra. fn. 10, p. 289. 169. see the data (dated to november, 2003) available online at <http://www.unilex.info/article.cfm?pid=1&pos=78&iid=104&cid=43#iid104>. these 25 cases are listed as: 16 december 1991 pretore della giurisdizione [district court] locarno; 21 december 1992 zivilgericht [civil court] basel; 9 september 1993 handelsgericht [commercial court] zürich; 6 december 1993 tribunal cantonal [appellate court] vaud; 1 september 1994 kantonsgericht [district nordic journal of commercial law, issue 2003 #1 70 court] zug; 15 december 1994 kantonsgericht [district court] zug; 20 december 1994 tribunal cantonal [appellate court] valais; 5 december 1995 handelsgericht [commercial court] st. gallen; 12 february 1996 tribunale d'appello [appellate court] lugano; 20 may 1996 tribunal [district court] glâne; 10 july 1996 handelsgericht [commercial court] zürich; 20 february 1997 court bezirksgericht der saane; 26 september 1997 handelsgericht [commercial court] aargau; 28 october 1997 tribunal cantonal [appellate court] valais; 3 december 1997 kantonsgericht [district court] nidwalden; 3 december 1997 kantonsgericht [district court] nidwalden; 29 june 1998 tribunal cantonal [appellate court] valais; 30 june 1998 tribunal cantonal [appellate court] valais; 21 september 1998 handelsgericht [commercial court] zürich; 28 october 1998 bundesgericht [federal supreme court]; 30 november 1998 handelsgericht [commercial court] zürich; 10 february 1999 handelsgericht [commercial court] zürich; 25 february 1999 kantonsgericht [district court] zug; 11 june 1999 handelsgericht [commercial court] des kantons aargau; 21 october 1999 kantonsgericht [district court] zug. 170. see judgment by tribunal cantonal valais [canton appellate court], switzerland 20 december 1994; no.: c 323/94. english translation by marina koukanova. available online at <http://cisgw3.law.pace.edu/cases/941220s1.html>. 171. supra. fn. 10, p. 294. 172. supra. fn. 10, p. 297. 173. supra. fn. 159. 174. supra. fn. 2. 175. supra. fn. 10, pp. 297-298. 176. supra. fn. 10, p. 286. 177. supra. fn. 134. 178. supra. fn. 173. 179. supra. fn. 159. 180. see judgment by ra laufen des kantons berne [ra = richteramt = district court], switzerland 7 may 1993; no.: unavailable. english translation by tobias koppitz. available online at <http://cisgw3.law.pace.edu/cases/930507s1.html>. 181. supra. fn. 38. 182. supra. fn. 83. 183. see case abstract on icc arbitration case no. 7197 of [1992]. available online at unilex database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=37&step=abstract>. 184. see case abstract of the judgment by kg berlin [kg = kammergericht = upper court berlin (similar to olg courts elsewhere in germany)], germany 24 january 1994; no.: 2 u 7418/92. available online at unilex database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=46&step=abstract>. 185. see case abstract of the judgment by bg arbon [bg = bezirksgericht = district court], switzerland 9 december 1994; no.: bg 341/1994. available online at unilex database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=172&step=abstract>. 186. see case abstract of the judgment by fb budapest [fb = fovárosi biróság = metropolitan court], hungary 24 march 1992; no.: 12.g.41.471/1991/21. available online at unilex database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=19&step=abstract>. 187. see case abstract of the judgment by ag riedlingen [ag = amtsgericht = petty district nordic journal of commercial law, issue 2003 #1 71 court], germany 21 october 1994; no.: 2 c 395/93. available online at unilex database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=116&step=abstract>. 188. see case abstract of the judgment by lg darmstadt [lg = landgericht = district court], germany 25 october 1994; no.: 18 o 848/92. available online at unilex database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=508&step=abstract> 189. see case abstract of the judgment by tribunal of international commercial arbitration at the russian federation chamber of commerce and industry, russia 15 april 1994; no.: 1/1993. available online at unilex database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=248&step=abstract>. 190. see case abstract of the judgment by olg münchen [olg = oberlandesgericht = provincial court of appeal], germany 08 february 1995; no.: 7 u 1720/94. available online at unilex database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=118&step=abstract>. 191. see case abstract of the judgment by hg zürich [hg = handelsgericht = commercial court], switzerland 5 february 1997; no.: hg 95 0347. available online at unilex database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=305&step=abstract>. 192. supra. fn. 55. 193. see case abstract of the judgment by olg frankfurt [olg = oberlandesgericht = provincial court of appeal], germany 18 january 1994; no.: 5 u 15/93. available online at unilex database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=40&step=abstract>. 194. see case abstract of the judgment by lg aachen [lg = landgericht = district court], germany 3 april 1990; no.: 41 o 198/89. available online at unilex database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=24&step=abstract>. 195. supra. fn. 98. 196. see case abstract of the judgment by rechtbank [district court] van koophandel hasselt, belgium 9 october 1996; no.: a.r. 2012/96. available online at unilex database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=264&step=abstract>. 197. supra. fn. 121. 198. see judgment by tribunal of international commercial arbitration at the russian federation chamber of commerce and industry, russia 22 october 1998; no.: 196/1997. english translation by alexander morari, translation edited by mykhaylo danylko. available online at <http://cisgw3.law.pace.edu/cases/981022r1.html>. 199. see judgment by tribunal of international commercial arbitration at the russian federation chamber of commerce and industry, russia 27 july 1999; no.: 302/1996. english translation by gilyana bovaeva, translation edited by mykhaylo danylko. available online at <http://cisgw3.law.pace.edu/cases/990727r1.html>. 200. see judgment by tribunal of international commercial arbitration at the russian federation chamber of commerce and industry, russia 10 february 2000; no.: 340/1999. english translation by mykhaylo danylko. available online at <http://cisgw3.law.pace.edu/cases/000210r1.html>. 201. see the data (dated to november, 2003) available online at <http://www.unilex.info/article.cfm?pid=1&pos=78&iid=100#iid100>; <http://www.unilex.info/article.cfm?pid=1&pos=78&iid=101#iid101>; nordic journal of commercial law, issue 2003 #1 72 <http://www.unilex.info/article.cfm?pid=1&pos=78&iid=102#iid102>. these 28 cases are listed as: icc 1992 international court of arbitration, case 7197; 1994 international court of arbitration, case 7531; 1994 international court of arbitration, case 7331; october 1998 international court of arbitration, case 9333. germany 31 august 1989 landgericht [district court] stuttgart; 3 april 1990 landgericht [district court] aachen; 24 april 1990 amtsgericht [lower court] oldenburg; 26 september 1990 landgericht [district court] hamburg; 13 june 1991 oberlandesgericht [appellate court] frankfurt; 16 september 1991 landtgericht [district court] frankfurt; 18 january 1994 oberlandesgericht [appellate court] frankfurt; 24 january 1994 kammergericht [appellate court] berlin; 21 october 1994 amtsgericht [lower court] riedlingen; 8 march 1995 amtsgericht [lower court] wangen; 6 october 1995 amtsgericht [lower court] kehl; 27 march 1996 landgericht [district court] oldenburg; 13 april 2000 amtsgericht [lower court] duisburg; 14 october 2002 oberlandesgericht [appellate court] köln. hungary 24 march 1992 fovárosi bíróság [metropolitan court]. russia 15 april 1994 arbitration award 1/1993; 9 september 1994 arbitration award 375/1993. switzerland 9 december 1994 bezirksgericht [district court] arbon; 21 september 1995 handelsgericht [commercial court] zürich; 3 july 1997 bezirksgericht [district court] st. gallen. argentina 23 october 1991 juzgado nacional de primera instancia en lo comercial [national commercial court of first instance]; 6 october 1994 juzgado nacional de primera instancia en lo comercial [national commercial court of first instance]. belgium 8 november 1995 rechtbank van koophandel [district court] hasselt; 9 october 1996 rechtbank van koophandel [district court] hasselt. 202. supra. fn. 178. see also the discussion quoted in supra. fns. 182, 183. 203. supra. fn. 38. 204. supra. fn. 159. 205. supra. fn. 10, p. 290. 206. 7 cases of the 148 cases involving cisg interest issue collected and published on the unilex database follow this debtor-approach. see the data (dated to november, 2003) available online at <http://www.unilex.info/article.cfm?pid=1&pos=78&iid=103#iid103>. these 7 cases are listed as: finland 27 march 1997 court of appeal of eastern finland; germany 13 june 1991 oberlandesgericht [appellate court] frankfurt; 21 march 2003 landgericht berlin; switzerland 11 march 1996 tribunal cantonal [appellate court] vaud [01 93 1061]; 11 march 1996 tribunal cantonal [appellate court] vaud [01 93 0661]; 5 february 1997 handelsgericht [commercial court] zürich; united states 9 september 1994 federal district court [northern dist. ny] (delchi carrier v. rotorex). 207. supra. fns. 192,193. 208. supra. fn. 86. 209. supra. fn. 95. 210. supra. fn. 120. 211. see judgment by lg berlin [lg = landgericht = district court], germany 21 march 2003; no.: unavailable. english translation by stefan kuhm, translation edited by camilla baasch andersen. available online at <http://cisgw3.law.pace.edu/cases/030321g1.html>. 212. supra. fn. 60. 213. supra. fn. 159. 214. see the data (dated to november, 2003) available online at nordic journal of commercial law, issue 2003 #1 73 <http://www.unilex.info/article.cfm?pid=1&pos=78&iid=105#iid105>. 215. see case abstract of the judgment by rb almelo [rb = arrondissementsrechtbank = district court], netherlands 9 august 1995; no.: 4367. available online at unilex database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=155&step=abstract>. 216. see judgment in icc arbitration case no. 7153 of 1992. english translation 14 journal of law and commerce (1995) 217-224. available online at <http://cisgw3.law.pace.edu/cases/927153i1.html>. 217. supra. fn. 27. 218. supra. fn. 159. 219. supra. fn. 38. 220. see the data (dated to november, 2003) available online at <http://www.unilex.info/article.cfm?pid=1&pos=78&iid=106#iid106>. these 9 cases are listed as: icc 1992 international court of arbitration, case 7585; 1993 international court of arbitration, case 6653; 1995 international court of arbitration, case 8128; december 1996 international court of arbitration, case 8769; september 1998 international court of arbitration, case 8908. austria 15 june 1994 vienna arbitration award sch-4366; 15 june 1994 vienna arbitration award sch-4318. hungary 17 november 1995 budapest arbitration award vb 94124; 5 december 1995 budapest arbitration award vb 94131. 221. supra. fn. 36. 222. supra. fn. 115. 223. supra. fn. 100. 224. see judgment in icc arbitration case no. 8769 of 1996. available online at unilex database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=397&step=fulltext>. 225. see case digest by daniel j. morse on icc arbitration case no. 8962 of january 1997. available online at <http://cisgw3.law.pace.edu/cases/978962i1.html>. 226. supra. fn. 82. 227. see case abstract of the judgment by arbitration court of the chamber of commerce and industry of budapest, hungary 17 november 1995; no.: vb 94124. available online at unilex database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=217&step=abstract>. 228. see judgment by rechtbank van koophandel [district court] veurne, belgium 25 april 2001; no.: a/00/00665. english translation by vincent naveaux, translation edited by sieg eiselen. available online at <http://cisgw3.law.pace.edu/cases/010425b1.html>. 229. supra. fn. 155. 230. see andré corterier, supra. fn. 14, pp. 38-39. 231. see case abstract of the judgment by olg frankfurt [olg = oberlandesgericht = provincial court of appeal], germany 13 june 1991; no.: 5 u 261/90. available online at unilex database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=4&step=abstract>. 232. see case abstract of the judgment by ag duisburg [ag = amtsgericht = petty court], germany 13 april 2000; no.: 49 c 502/00. available online at unilex database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=715&step=abstract>. 233. see judgment by ag duisburg [ag = amtsgericht = petty court], germany 13 april 2000; no.: 49 c 502/00. english translation by ruth m. janal, translation edited by camilla nordic journal of commercial law, issue 2003 #1 74 baasch andersen. available online at <http://cisgw3.law.pace.edu/cases/000413g1.html>. 234. supra. fn. 183. 235. see judgment by arbitration court of the chamber of commerce and industry of budapest, hungary 5 december 1995; no.: vb 94131. english translation by marko maljevac, translation edited by dr loukas mistelis. available online at <http://cisgw3.law.pace.edu/cases/951205h1.html>. 236. supra. fn. 25. 237. see case abstract of the judgment by rb arnhem [rb = arrondissementsrechtbank = district court], netherlands 30 december 1993; no.: 1992/1251. available online at unilex database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=61&step=abstract>. 238. see case digest by daniel j. morse on icc arbitration case no. 8740 of october 1996. available online at <http://cisgw3.law.pace.edu/cases/968740i1.html>. 239. see judgment in icc arbitration case no. 8611 of 1997. english translation by beate satory. available online at <http://cisgw3.law.pace.edu/cases/978611i1.html>. 240. see case abstract of the judgment by olg rostock [olg = oberlandesgericht = provincial court of appeal], germany 10 october 2001; no.: 6 u 126/00. available online at unilex database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=906&step=abstract>. 241. see judgment by olg rostock [olg = oberlandesgericht = provincial court of appeal], germany 25 september 2002; no.: 6 u 126/00. english translation by ruth m. janal, translation edited by veit konrad. available online at <http://cisgw3.law.pace.edu/cases/020925g1.html>. 242. supra. fn. 38. 243. supra. fn. 146. 244. supra. fn. 111. 245. see judgment by internationales schiedsgericht der bundeskammer der gewerblichen wirtschaft [arbitral tribunal vienna], austria 15 june 1994; no.: sch-4318. english translation reproduced with permission of unilex database. available at <http://cisgw3.law.pace.edu/cases/940615a4.html>. 246. supra. fn. 2. 247. supra. fn. 123. 248. supra. fn. 2. 249. supra. fn. 38. 250. supra. fn. 10, p. 290. 251. see case abstract of the judgment by juzgado comercial nacional de primera instancia en lo comercial no. 10, buenos aires, argentina 23 october 1991; no.: unavailable. available online at unilex database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=184&step=abstract>. 252. see case abstract of the judgment by juzgado comercial nacional de primera instancia en lo comercial no. 10, buenos aires, argentina 6 october 1994; no.: 56.179. available online at unilex database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=178&step=abstract>. 253. supra. fn. 174. nordic journal of commercial law, issue 2003 #1 75 254. supra. fn. 38. 255. supra. fn. 100. 256. supra. fns. 201, 224, 228, 249. 257. see judgment by tribunal of international commercial arbitration at the russian federation chamber of commerce and industry, russia 25 march 1998; no.: 491/1996. english translation by serge lapine, translation edited by mykhaylo danylko. available at <http://cisgw3.law.pace.edu/cases/980325r1.html>. 258. see judgment by zg basel [zg = zivilgericht = civil court], switzerland 21 december 1992; no.: p4 1991/238. english translation by yvonne p. salmon. available at <http://cisgw3.law.pace.edu/cases/921221s1.html>. 259. supra. fn. 254. 260. see case abstract of the judgment by schiedsgericht der börse für landwirtschaftliche in wien [arbitral tribunal vienna], austria 10 december 1997; no.: s 2/97. available online at unilex database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=346&step=abstract>. 261. see judgment by olg braunschweig [olg = oberlandesgericht = provincial court of appeal], germany 28 october 1999; no.: 2 u 27/99. english translation by jarno vanto, translation edited by ruth m. janal. available at <http://cisgw3.law.pace.edu/cases/991028g1.html>. 262. supra. fn. 240. 263. supra. fn. 125. 264. see judgment by lg braunschweig [lg = landgericht = district court], germany 30 july 2001; no.: 21 o 703/01 (028). english translation by dr. andrea vincze. available at <http://cisgw3.law.pace.edu/cases/010730g1.html>. 265. see judgment by ag viechtach [ag = amtsgericht = lower court], germany 11 april 2002; no.: 1 c 419/01. english translation by ruth m. janal, translation edited by camilla baasch andersen. available at <http://cisgw3.law.pace.edu/cases/020411g1.html>. 266. supra. fn. 84. 267. supra. fn. 172. 268. see case abstract of the judgment by rechtbank [district court] van koophandel hasselt, belgium 21 january 1997; no.: a.r. 1972/96. available online at unilex database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=262&step=abstract>. 269. see case abstract of the judgment by tribunal cantonal valais [canton appellate court], switzerland 28 october 1997; no.: c1 97 167. available online at unilex database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=311&step=abstract>. 270. supra. fn. 16. 271. supra. fn. 52. 272. see case abstract of the judgment by tribunale [district court] di pavia, italy 29 december 1999; no. unavailable. available online at unilex database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=442&step=abstract>. 273. supra. fn. 83. 274. supra. fn. 60. 275. supra. fn. 106. 276. see case abstract of the judgment by ag wangen [ag = amtsgericht = petty district nordic journal of commercial law, issue 2003 #1 76 court], germany 8 march 1995; no. 2 c 600/94. available online at unilex database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=120&step=abstract>. 277. see case abstract of the judgment by lg münchen [lg = landgericht = district court], germany 25 january 1996; no. 12 hko 2648/95. available online at unilex database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=192&step=abstract>. 278. see judgment by lg münchen [lg = landgericht = district court], germany 6 april 2000; no.: 12 hko 4174/99. english translation by stefan kuhm, translation edited by ruth m. janal. available at <http://cisgw3.law.pace.edu/cases/000406g1.html>. 279. for similar cases, see, e.g., 21 october 1994 amtsgericht [lower court] riedlingen; 9 november 1994 landgericht [district court] oldenburg; 20 march 1995 landgericht [district court] münchen; 5 april 1995 landgericht [district court] landshut; 12 may 1995 amtsgericht [lower court] alsfeld; 24 may 1995 oberlandesgericht [appellate court] celle; 27 march 1996 landgericht [district court] oldenburg; 1997 international court of arbitration, case 8611; 15 january 1998 tribunale d'appello [appellate court] lugano; 24 march 1999 landgericht [district court] flensburg; 13 april 2000 amtsgericht [lower court] duisburg; 9 may 2000 landgericht [district court] darmstadt; 22 august 2002 oberlandesgericht [appellate court] schleswig; 5 november 2002 handelsgericht [commercial court] des kantons aargau; etc. 280. see case abstract of the judgment by kg zug [kg = kantonsgericht = district court], switzerland 1 september 1994; no. a3 1993 84. available online at unilex database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=237&step=abstract>. 281. supra. fn. 53. 282. see case abstract of the judgment by hg st. gallen [hg = handelsgericht = commercial court], switzerland 5 december 1995; no.: hg 45/1994. available online at unilex database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=190&step=abstract>. 283. see case abstract of the judgment by lg düsseldorf [lg = landgericht = district court], germany 5 march 1996; no.: 36 o 178/95. available online at unilex database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=246&step=abstract>. 284. see case abstract of the judgment by ag bottrop [ag = amtsgericht = petty district court], germany 25 june 1996; no.: 12 c 177/96. available online at unilex database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=289&step=abstract>. 285. see case abstract of the judgment by hg zürich [hg = handelsgericht = commercial court], switzerland 10 july 1996; no.: hg 940513. available online at unilex database of <http://www.unilex.info/case.cfm?pid=1&do=case&id=381&step=abstract>. 286. supra. fn. 104. 287. supra. fn. 87. 288. see andré corterier, supra. fn. 14, p. 39. 289. supra. fn. 2. 290. supra. fn. 290. 291. supra. fn. 10, p. 299. 292. supra. fn. 168. on the other hand, however, it is also noted: “in evaluating the wide range of approaches taken by courts and proposed by legal scholars, one basic fact becomes clearly evident: cisg is not applied in the complicated cases but in the everyday case. everyday goods (tissues, clothes, shoes, socks, furniture, home appliances, live lambs, mussels) in nordic journal of commercial law, issue 2003 #1 77 everyday amounts (ranging from hundreds of u.s. dollars to thousands of u.s. dollars) are bought and sold in everyday contracts by everyday businessmen, most often unaware that cisg applies. in case of controversy, those everyday cases must be handled by either the parties themselves or by everyday lawyers, in everyday courts. interpretation of cisg must allow those businessmen and lawyers and judges to come to clear and convincing decisions. it is only the big and complex deals which generally are prepared by the skilled and experienced lawyers, or in case of controversy, handled by trained and experienced arbitrators.” (supra. fn. 10, p. 295.) ___________________________________________________________________________ ________ case index no. case footnote no. 1. 31august 1989 landgericht [district court] stuttgart 25,238 2.24 november 1989 pretura circondariale [district court] parma 122 3.3 april 1990 landgericht [district court] aachen 48, 196 4.24 april 1990 amtsgericht [lower court] oldenburg 55, 194 5.26 september 1990 landgericht [district court] hamburg 163 6.20 may 1991 juzgado nacional de primera instancia en lo comercial 126, 127 7.13 june 1991 oberlandesgericht [appellate court] frankfurt 233 8.16 september 1991 landtgericht [district court] frankfurt 83, 184, 275 9.23 october 1991 juzgado nacional de primera instancia en lo comercial 253 10.16 december 1991 pretore della giurisdizione [district court] locarno 84, 160, 268 11.1992 international court of arbitration, case 7153 218 12.1992 international court of arbitration, case 7197 57, 185 13.1992 international court of arbitration, case 7585 36, 101, 223 14.24 march 1992 fovárosi bíróság [metropolitan court] 188 15.14 october 1992 amtsgericht [lower court] zweibrücken 90 16.21 december 1992 zivilgericht [civil court] basel 260 17.1993 international court of arbitration, case 6653 115, 224 18.8 february 1993 landgericht [district court] verden 110 19.6 may 1993 arrondissementsrechtbank [district court] roermond 113 20.7 may 1993 richteramt [district court] laufen 182 21.17 september 1993 oberlandesgericht [appellate court] koblenz 37 22.30 december 1993 arrondissementsrechtbank [district court] arnhem 239 23.1994 international court of arbitration, case 7331 89, 127, 219 24.1994 international court of arbitration, case 7531 21 nordic journal of commercial law, issue 2003 #1 78 25.1994 international court of arbitration, case 7565 124, 149 26.14 january 1994 oberlandesgericht [appellate court] düsseldorf 56 27.18 january 1994 oberlandesgericht [appellate court] frankfurt 60, 195, 214, 276 28.24 january 1994 kammergericht [appellate court] berlin 91, 186 29.15 april 1994 arbitration award 1/1993 191 30.14 june 1994 amtsgericht [lower court] nordhorn 112 31.15 june 1994 vienna arbitration award sch-4318 247 32.15 june 1994 vienna arbitration award sch-4366 111, 142, 148, 246 33.1 september 1994 kantonsgericht [district court] zug 282 34.6 october 1994 juzgado nacional de primera instancia en lo comercial 254, 261 35.21 october 1994 amtsgericht [lower court] riedlingen 189 36.25 october 1994 landgericht [district court] darmstadt 190 37.9 december 1994 bezirksgericht [district court] arbon 187 38.20 december 1994 tribunal cantonal [appellate court] 119, 150, 172, 269 39.1995 international court of arbitration, case 8128 123, 249 40.08 february 1995 oberlandesgericht münchen 192 41.8 march 1995 amtsgericht [lower court] wangen 278 42.20 march 1995 landgericht [district court] münchen 92 43.29 march 1995 cour d'appel [appellate court] grenoble 93 44.5 april 1995 landgericht [district court] landshut 74, 165 45.6 april 1995 cour d'appel [appellate court] paris 100, 225, 257 46.26 april 1995 cour d'appel [appellate court] grenoble (marques roque v. manin riviére) 94 47.20 july 1995 landgericht [district court] aachen 85, 140, 154 48.9 august 1995 arrondissementsrechtbank [district court] almelo 217 49.21 september 1995 handelsgericht [commercial court] zürich 53, 283 50.06 october 1995 amtsgericht kehl 3 c 925/93 161 51.8 november 1995 rechtbank van koophandel [district court] hasselt 98, 187 52.17 november 1995 budapest arbitration award vb 94124 229 53.5 december 1995 budapest arbitration award vb 94131 237 54.5 december 1995 handelsgericht [commercial court] st. gallen 284 55.25 january 1996 landgericht [district court] münchen 279 56.12 february 1996 tribunale d'appello [appellate court] lugano 162 57.5 march 1996 landgericht [district court] düsseldorf 285 58.11 march 1996 tribunal cantonal [appellate court] vaud [01 93 1061] 86, 210 59.11 march 1996 tribunal cantonal [appellate court] vaud [01 93 0661] 95, 211 60.21 march 1996 hamburg arbitration award 151 nordic journal of commercial law, issue 2003 #1 79 61.25 june 1996 amtsgericht [lower court] bottrop 286 62.10 july 1996 handelsgericht [commercial court] zürich 287 63.october 1996 international court of arbitration, case 8740 240, 264 64.9 october 1996 rechtbank van koophandel [district court] hasselt 198 65.12 november 1996 amtsgericht [lower court] koblenz 104, 288 66.november 1996 international court of arbitration, case 8502 81 67.december 1996 international court of arbitration, case 8769 226 68.16 december 1996 rechtbank van koophandel [district court kortrijk 120, 212 69.1997 international court of arbitration, case 8611 241 70.january 1997 international court of arbitration, case 8786 89 71.21 january 1997 rechtbank van koophandel [district court] hasselt 270 72.5 february 1997 handelsgericht [commercial court] zürich 193 73.28 march 1997 arbitration award 38/1996 121, 199 74.24 april 1997 oberlandesgericht [appellate court] düsseldorf 106, 164, 277 75.3 july 1997 bezirksgericht [district court] st. gallen 125, 265 76.september 1997 international court of arbitration, case 8962 227 77.28 october 1997 tribunal cantonal [appellate court] valais 271 78.5 november 1997 oberlandesgericht [appellate court] hamm 166 79.10 december 1997 vienna arbitration award s 2/97 262 80.19 december 1997 handelsgericht [commercial court] aargau 105 81.15 january 1998 tribunale d'appello [appellate court] lugano 144 82.12 february 1998 bulgaria chamber of commerce arbitration award, case 11/1996 89 83.25 march 1998 arbitration award 491/1997 259 84.4 april 1998 arbitration award 387/1995 58 85.29 june 1998 tribunal cantonal [appellate court] valais 152 86.october 1998 international court of arbitration, case 9333 26 87.22 october 1998 arbitration award 196/1997 200 88.28 october 1998 bundesgericht [federal supreme court] 54 89.30 november 1998 handelsgericht [commercial court] zürich 96 90.december 1998 international court of arbitration, case 8908 82, 228 91.10 february 1999 handelsgericht [commercial court] zürich 16, 272 92.24 march 1999 landgericht [district court] flensburg 97 93.25 may 1999 landgericht [district court] berlin 153 94.july 1999 international court of arbitration, case 9448 145 95.27 july 1999 arbitration award 302/1996 201 96.21 october 1999 kantonsgericht [district court] zug 75, 117, 167 nordic journal of commercial law, issue 2003 #1 80 97.28 october 1999 oberlandesgericht [appellate court] braunschweig 263 98.29 december 1999 tribunale [district court] pavia 146, 245, 274 99.10 february 2000 arbitration award no. 340/1999 202 100.6 april 2000 landgericht [district court] münchen 280 101.13 april 2000 amtsgericht [lower court] duisburg 234, 235 102.25 april 2001 rechtbank van koophandel [district court] veurne 230 103.30 july 2001 landgericht [district court] braunschweig 266 104.10 october 2001 oberlandesgericht [appellate court] rostock 242 105.15 january 2002 tribunal de commerce [district court] namur 99 106.11 april 2002 amtsgericht [lower court] viechtach 267 107.25 september 2002 oberlandesgericht [appellate court] rostock 243 108.5 november 2002 handelsgericht [commercial court] des kantons aargau 155, 233 109.12 december 2002 kantonsgericht [district court] zug 87, 103 110.12 december 2002 kantonsgericht [district court] zug 289 111.21 march 2003 landgericht berlin 213 1. introduction 2. overview of cisg approach on interest 3. in contrast with damages 3.1 generally granted under the heading of damages 3.2 recoverable independently without proof of actual loss 3.3 entitled absolutely even in case of impediments 3.4 without prejudice to generally recoverable damages 3.5 conclusions 4. interest on damages 5. prerequisite for entitlement to interest 5.1 no need for culpable default 5.2 not subordinate to formal request 5.3 conclusion: the only prerequisite is a sum in arrears. 6. starting points of interest accrual 6.1 for interest on purchase price: date of payment 6.2 for interest on secondary obligations: date of non-performance 6.3 dates determined according to relevant circumstances 7. general review of interest rate 7.1 gap in the convention 7.2 clear specification under unidroit principles and pecl 8. rates applied in cisg case law 8.1 gap-filling in general 8.1.1 overview 8.1.2 gap intra legem 8.1.3 gap praeter legem 8.1.4 summary 8.2 determined by the applicable domestic law 8.2.1 overview 8.2.2 recourse to the law otherwise applicable by virtue of private international law 8.2.3 summary 8.3 determined by domestic law of the interest-creditor 8.3.1 overview 8.3.2 general recourse to the law of the creditor's place of business 8.3.3 statutory rate vs. bank lending rate of interest 8.3.4 summary 8.4 determined by domestic law of the interest-debtor 8.5 determined by domestic law of other places 8.6 determined by law of payment currency 8.6.1 overview 8.6.2 deemed as a commercially reasonable solution 8.6.3 summary 8.7 unidentifiable law under compositive deliberations 8.7.1 leave open creditor-focused or debtor-focused 8.7.2 leave open focusing on a special connection or the law otherwise applicable 8.7.3 preferably taking into consideration the state of the currency 8.7.4 summary 8.8 approaches aiming at uniformity 8.8.1 recourse to general principles underlying cisg: full compensation 8.8.2 recourse to unidroit principles or pecl 8.8.3 recourse to international usages 8.8.4 recourse to independent libor 8.9 parties’ disposition 8.9.1 rate contractually agreed prevails 8.9.2 undisputed rate is usually awarded 8.9.3 lower rate requested is certainly awarded 8.9.4 higher rate needs to be proved 8.10 concluding remarks main abbreviations footnotes case index opinion 21 in template cisg advisory council* opinion 21 delivery of substitute goods and repair under the cisg * michael bridge, chair yesim atamer, eric bergsten (em), joachim bonell (em), sieg eiselen lauro gama, alejandro garro, roy goode, john gotanda, han shiyuan, johnny herre, pilar perales viscasillas, ingeborg schwenzer, hiroo sono, claude witz (em), members milena djordjević, secretary. 1. opinion ................................................................................................. 48 2. comments ............................................................................................ 50 2.1. drafting history ................................................................... 52 2.2. interpretation ....................................................................... 54 2.2.1. a) application ............................................................... 54 2.2.2. b) delivery of substitute goods (article 46(2) cisg) .................................................... 61 2.2.3. c) repair (article 46(3) cisg) .................................. 68 2.2.4. d) consequences ......................................................... 70 2.2.5. e) seller’s right to cure under article 48 cisg ............................................................................................ 81 47 cisg-ac opinion 21 introduction of the cisg-ac the cisg-ac started as a private initiative supported by the institute of international commercial law at pace university school of law and the centre for commercial law studies, queen mary, university of london. the international sales convention advisory council (cisgac) is in place to support understanding of the united nations convention on contracts for the international sale of goods (cisg) and the promotion and assistance in the uniform interpretation of the cisg. at its formative meeting in paris in june 2001, prof. peter schlechtriem of freiburg university, germany, was elected chair of the cisg-ac for a three-year term. dr. loukas a. mistelis of the centre for commercial law studies, queen mary, university of london, was elected secretary. the founding members of the cisg-ac were prof. emeritus eric e. bergsten, pace university school of law; prof. michael joachim bonell, university of rome la sapienza; prof. e. allan farnsworth, columbia university school of law; prof. alejandro m. garro, columbia university school of law; prof. sir roy m. goode, oxford, prof. sergei n. lebedev, maritime arbitration commission of the chamber of commerce and industry of the russian federation; prof. jan ramberg, university of stockholm, faculty of law; prof. peter schlechtriem, freiburg university; prof. hiroo sono, faculty of law, hokkaido university; prof. claude witz, universität des saarlandes and strasbourg university. members of the council are elected by the council. at subsequent meetings, the cisgac elected as additional members prof. pilar perales viscasillas, universidad carlos iii, madrid; professor ingeborg schwenzer, university of basel; prof. john y gotanda, villanova university; prof. michael g. bridge, london school of economics; prof. han shiyuan, tsinghua university, prof. yesim atamer, istanbul bilgi university, turkey, and prof. ulrich schroeter, university of mannheim. prof. jan ramberg served for a three-year term as the second chair of the cisgac. at its 11th meeting in wuhan, people’s republic of china, prof. eric e. bergsten of pace university school of law was elected chair of the cisgac and prof. sieg eiselen of the department of private law of the university of south africa was elected secretary. at its 14th meeting in belgrade, serbia, prof. ingeborg schwenzer of the university of basel was elected chair of the cisgac. njcl 2021/1 48 1. opinion article 46 (1) […] (2) if the goods do not conform with the contract, the buyer may require delivery of substitute goods only if the lack of conformity constitutes a fundamental breach of contract and a request for substitute goods is made either in conjunction with notice given under article 39 or within a reasonable time thereafter. (3) if the goods do not conform with the contract, the buyer may require the seller to remedy the lack of conformity by repair, unless this is unreasonable having regard to all the circumstances. a request for repair must be made either in conjunction with notice given under article 39 or within a reasonable time thereafter. article 47 (1) the buyer may fix an additional period of time of reasonable length for performance by the seller of his obligations. (2) unless the buyer has received notice from the seller that he will not perform within the period so fixed, the buyer may not, during that period, resort to any remedy for breach of contract. however, the buyer is not deprived thereby of any right he may have to claim damages for delay in performance. article 48 cisg (1) subject to article 49, the seller may, even after the date for delivery, remedy at his own expense any failure to perform his obligations, if he can do so without unreasonable delay and without causing the buyer unreasonable inconvenience or uncertainty of reimbursement by the seller of expenses advanced by the buyer. however, the buyer retains any right to claim damages as provided for in this convention. (2) if the seller requests the buyer to make known whether he will accept performance and the buyer does not comply with the request within a reasonable time, the seller may perform within the time indicated in his request. the buyer may not, during that period of time, resort to any remedy which is inconsistent with performance by the seller. (3) a notice by the seller that he will perform within a specified period of time is assumed to include a request, under the preceding paragraph, that the buyer make known his decision. (4) a request or notice by the seller under paragraph (2) or (3) of this article is not effective unless received by the buyer. article 49 cisg (1) the buyer may declare the contract avoided: (a) if the failure by the seller to perform any of his obligations under the contract or this convention amounts to a fundamental breach of contract; […]. […] 49 cisg-ac opinion 21 i. application 1. delivery of substitute goods (article 46(2) cisg) and repair (article 46(3) cisg) are remedies not subject to article 28 cisg. 2. these remedies apply not only to non-conformity of the goods (article 35 cisg) but also in cases of third party rights or claims (article 41 cisg), as well as third party rights or claims based on industrial or intellectual property (article 42 cisg). ii. delivery of substitute goods (article 46(2) cisg) 3. under article 46(2) cisg, a fundamental breach of contract can only be found if the non-conforming goods cannot be used as intended and if it is reasonable for the buyer to refuse repair. 4. a buyer requiring delivery of substitute goods is subject to article 82 cisg. 5. the buyer’s right to require delivery of substitute goods is excluded if it is disproportionate having regard to all the circumstances. iii. repair (article 46(3) cisg) 6. the buyer may require the seller to remedy the non-conformity by repair unless this is unreasonable. in determining whether repair by the seller is unreasonable regard is to be had to: a. whether the buyer is better placed to arrange for repair of the goods; b. whether the seller offers to advance the costs for repair by the buyer or a third party; c. whether repair imposes costs on the seller that are disproportional to the actual or prospective loss of or benefit to the buyer. iv. consequences 7. if the goods have been combined with other goods or installed, the costs of retrofitting may be recovered as damages but in general are not borne by the seller as part of the remedy of delivery of substitute goods or repair. however, if in a mixed contract the seller has also assumed the obligation of combining or installing the goods the costs of retrofitting are borne by the seller as part of the remedy of delivery of substitute goods or repair. 8. in cases of delivery of substitute goods, or repair of the goods by delivery of substitute parts, a. the buyer must make restitution to the seller of the goods or parts first delivered; b. the seller must take back the goods or parts first delivered; c. the costs of restitution must be borne by the seller. 9. the buyer is not bound to njcl 2021/1 50 a. make restitution of benefits derived from the substituted nonconforming goods or parts first delivered; b. account for any betterment caused by the delivery of substitute goods, or repair of the goods by delivery of substitute parts. 10. after substitution or repair, the buyer has to comply with the examination and notice requirements of articles 38, 39 and 43 cisg. in case of non-conformity of the goods the two year cut off period (article 39(2) cisg) starts to run with the actual handing over of the substituted goods or repair. v. seller’s right to cure under article 48 cisg 11. under article 48 cisg the seller has a right to cure “subject to article 49”. the seller’s right to cure is excluded in case of a fundamental breach of contract, i.e., the goods are not usable and the non-conformity is not curable in time. 12. if both delivery of substitute goods and repair are adequate to remedy the non-conformity of the goods the seller may choose between the two forms of cure. 13. the buyer may fix an additional period of time of reasonable length for delivery of substitute goods or repair (article 47(1) cisg). however, it is not obliged to do so. subject to article 77 cisg and the seller’s right to cure under article 48 cisg, the buyer may instead immediately have recourse to other remedies available, such as damages or reduction of the purchase price. 14. during a reasonable length of time fixed by the buyer under article 47 cisg or by the seller under article 48(2) cisg and expressly or implicitly accepted by the buyer, the buyer may not resort to any remedy inconsistent with cure. 2. comments introduction 1.1 the most prevalent case of seller’s breach of contract is nonconformity of the goods.1 there are different possibilities to remedy this 1 the notion of non-conformity under art. 35 cisg is much broader than in most domestic legal systems. it does not only relate to defects in quality (peius) but rather it also encompasses defects in quantity, the delivery of goods of a different kind (description, aliud), as well as defects in packaging. also, non-conforming documents (accompanying documents or documentary sales) are encompassed by art. 35 cisg, cisg-ac opinion no. 5, the buyer's right to avoid the contract in case of non-conforming goods or documents, 7 may 2005, badenweiler (germany). rapporteur: professor dr. ingeborg schwenzer, ll.m., professor (em.) of private law, in schwenzer (ed.) the cisg advisory council opinions (den haag 2017), 101, 110-111 para. 4.7 et seq., also available at http://www.cisgac.com/cisgac-opinion-no5/. 51 cisg-ac opinion 21 non-conformity. first and foremost, the parties may contractually agree on remedies in case of non-conformity of the goods.2 the cisg provisions concerning remedies are non-mandatory.3 the parties may derogate from these default provisions according to article 6 cisg.4 if the parties do not derogate, the default remedies of the cisg apply. the provisions regarding these remedies, i.e., articles 46–49 cisg, are subject to constant confusion and debate.5 this does not only apply to the academic level, but also in practice.6 the remedies for non-conformity differ from those for other breaches due to several specificities. 1.2 the specificities of articles 46–49 cisg regarding the buyer’s and seller’s rights and duties will be elaborated on in this opinion. delivery of substitute goods and repair “are opportunities sought by sellers – to preserve good will, reduce damage liability and avoid the drastic remedy of avoidance.”7 the contractual bond between the parties should be preserved as far as possible and avoidance regareded as an ultima ratio under the cisg.8 thereby, additional transportation efforts and costs can be saved. the discussions on interpreting and applying articles 46–49 cisg require balancing the buyer’s and the seller’s interests. the typical civil law understanding is that pacta sunt servanda requires the seller to potentially 2 to apply the contractual remedies, the parties’ contract must be interpreted according to arts. 8, 9 cisg whereby trade usages play an important role. 3 cf., ingeborg schwenzer/pascal hachem, in schwenzer (ed.), schlechtriem & schwenzer commentary on the un convention on the international sale of goods (cisg) (4th ed., oxford 2016), art. 6 para. 28 for examples; see also sieg eiselen, adopting the vienna sales convention: reflections eight years down the line, 19 south african mercantile law journal (2007) 14, 17 et seq. 4 such a derogation of the cisg may be made explicitly or implicitly. schwenzer/hachem, in schlechtriem & schwenzer (n. 4) art. 6 para. 3; peter huber, in stefan kröll/loukas mistelis/pilar perales viscasillas (eds.), un-convention on the international sales of goods (cisg) (2nd ed., münchen 2018), art. 6 para. 14. 5 see in general, christiana fountoulakis, remedies for breach of contract under the united nations convention on the international sale of goods, era forum (2011) 12: 7–23; lachmi singh/benjamin leisinger, a law for international sale of goods: a reply to michael bridge, 20 pace international law review (2008) 161, 163 et seq.; peter schlechtriem, subsequent performance and delivery deadlines – avoidance of cisg sales contracts due to non-conformity of the goods, 18 pace international law review (2006) 83; ericson kimbel, nachfrist notice and avoidance under the cisg, 18 journal of law and commerce (1998-1999) 301, 301 et seq. 6 see for example landgericht (district court) zweibrücken, 19 march 2010, 6 hk. o 13/03, cisg-online 2794 on the issue of a claim for damages in case of repair by the buyer (followed by oberlandesgericht (court of appeal) zweibrücken, 29 october 2012, 8 u 22/10, cisg-online 2696 and bundesgerichtshof (german supreme court), 24 september 2014, viii zr 394/12, cisg-online 2545). 7 john o. honnold/harry flechtner, uniform law for international sales under the 1980 united nations convention (4th ed., alphen aan den rijn 2009), art. 46 para. 286. 8 uncitral, digest of case law on the cisg (2016), available at https://www.uncitral.org/pdf/english/clout/cisg_digest_2016.pdf, art. 46 para. 3. njcl 2021/1 52 perform more than once, while under the typical common law approach specific performance is not easily granted at all. analyzing this potential legal dichotomy and the parties’ interests, the international character of the cisg and the need to interpret the cisg autonomously must be borne in mind. 2.1. drafting history 1 in drafting articles 46 and 48 cisg, the role of specific performance, the relation of the seller’s right to cure in article 48 cisg and the buyer’s right to avoid the contract in article 49 cisg, as well as the notion of fundamental breach in articles 46 and 49 cisg were discussed in great detail. regarding both parties’ interests, the drafters focused on the seller’s interest in remedying any defect and the buyer’s interest in the contract’s execution.9 a) article 46 cisg 2.2 initially, article 46 cisg had two paragraphs: the general remedy to request performance, article 46(1), and the remedy to request delivery of substitute goods, article 46(2) cisg. repair was not included directly.10 in contrast, the preceding article 42 of the convention relating to a uniform law on the international sale of goods (ulis) spoke of repair, additional delivery, and substitute delivery. with this background, it was not surprising that the delegates in vienna in 1980 discussed whether to include repair directly in the cisg. in the end, the federal republic of germany, finland, norway, and sweden proposed to include article 46(3) cisg to limit the remedy of repair. the delegates argued that “in some cases the buyer's right to a reduction in price and damages constituted an adequate remedy, particularly when the goods concerned could easily be repaired by him or when the cost of repair to the seller would be unreasonably high”.11 france proposed to name the perspective of the “legitimate interests of the buyer” when evaluating the availability of repair.12 in the end, the delegates agreed on the current wording “having regard to all the circumstances” not limiting the perspective on the buyer’s interests.13 2.3 regarding the right to request specific performance in article 46(1) cisg, the delegates discussed the need to balance the buyer’s and the seller’s interests, different approaches in favoring the buyer’s or the 9 official records of the united nations conference on contracts for the international sale of goods, vienna, 10 march-11 april 1980 (united nations publication, sales no. e.81.iv.3), 351 para. 6. 10 cf., commentary on the draft convention on contracts for the international sale of goods prepared by the secretariat (secretariat’s commentary) / un doc. a/conf. 97/5, art. 42. however, it is possible that some delegates understood the previous art. 46 cisg to indirectly include repair, cf. official records (n. 10), 78, art. 42. 11 official records (n. 10), 335 para. 11. 12 official records (n. 10), 335 para. 15. 13 official records (n. 10), 335 para. 15 et seq. 53 cisg-ac opinion 21 seller’s “freedom to limit the legal consequences of defects”,14 and restricting the time within which such request can be made.15 the u.s.-american delegation proposed to amend specific performance “to rule out the remedy of specific performance in cases where the buyer could ‘purchase substitute goods without unreasonable additional expense or inconvenience’.”16 in rejecting the amendment, the opponents relied on pacta sunt servanda, one of the basic principles of the cisg,17 the effect of the amendment to “reduce the buyer's freedom to limit the legal consequences of defects”18 or to “encourage the seller to dishonour his obligations if the product he was selling was available on the market.”19 b) article 48 2.4 article 48 and, in particular, its relation to article 49 cisg caused much debate in vienna in 1980.20 regarding the relation of articles 48 and 49 cisg, the delegates tried “to establish a balance between the seller's right to remedy and the buyer's right to avoid.”21 also, the delegates understood that “[t]he essential thing was to define precisely what constituted a fundamental breach.”22 an indicative vote on the question of whether the seller’s right to remedy in article 48 cisg should prevail over the buyer’s right of avoidance guided the discussion. the question was denied.23 the delegates changed the introduction of article 48(1) cisg from “unless the buyer has declared the contract avoided in accordance with article 45,”24 to the current version. additionally, a singaporean amendment led to the change of the previous wording referring to “such delay as will amount to a fundamental breach of contract” to a mere “unreasonable delay” was adopted.25 14 the term freedom was used in this discussion by one of the delegates of the german democratic republic (gdr), official records (n. 10), 331 para. 58. 15 one of the u.s.-american delegates proposed such restriction, official records (n. 10), 334 para. 5. he argued that it would be important to clarify that the buyer may not change its mind while requesting the remedy. the proposal was supported by the u.k. but rejected in the end. 16 official records (n. 10), 330 para. 47. this proposal was supported by australia, italy, norway, and the u.k. the latter commented that it is “difficult to see what interest a buyer could have in forcing a seller to perform when it was possible for he himself to purchase substitute goods, without substantial additional expense or inconvenience, and obtain compensation for any additional costs incurred”, 331 para. 57. 17 raised by the delegation of the union of soviet socialist republics (ussr), official records (n. 10), 332 para. 67. 18 raised by the delegation of the gdr, official records (n. 10), 331 para. 58. the delegation added that this freedom “was widespread in commercial life and which should be extended rather than restricted.” 19 official records (n. 10), 332 para. 64. 20 official records (n. 10), 341 et seq. 21 u.s.-american delegation, official records (n. 10), 342 para. 47. 22 swedish delegation, official record (n. 10), 342 para. 48. 23 official records (n. 10), 342 para. 64. 24 art. 44(1) 1978 draft convention, published in official records (n. 10), 10. 25 official records (n. 10), 114 para. 3(ii), 351 paras. 5 et seq. njcl 2021/1 54 2.5 on the interaction of articles 48 and 46 cisg, notably two proposals to clarify their relation were rejected. first, one of the german delegates proposed that generally, the seller's right to remedy its failure to perform should prevail over the buyer's rights, especially its right to avoid the contract.26 second, one of the u.s.-american delegates proposed to amend article 48 cisg to implement the seller’s right to choose the manner of cure if a conflict between articles 46 and 48 cisg arises.27 the latter was rejected by 10 votes in favor and 10 votes against. however, lacking any discussion, it is not clear whether the votes against understood the clarification to be superfluous or opposed in substance. 2.2. interpretation 2.2.1.a) application aa) specific performance and article 28 cisg 1. delivery of substitute goods (article 46(2) cisg) and repair (article 46(3) cisg) are remedies not subject to article 28 cisg. 3.1 the general remedy to require specific performance in article 46(1) cisg is subject to article 28 cisg. concerning the remedies in articles 46(2) and (3) cisg it is, however, questionable whether article 28 cisg applies. the drafting history is ambiguous. on the one hand, the secretariat’s commentary discussed article 28 cisg only with regard to article 46(1) but not article 46(2) csig.28 on the other hand, one member state commented on the 1978 draft convention in a manner applying article 28 cisg to the remedy of repair.29 however, repair was not yet mentioned in the 1978 draft convention. 3.2 primarily, german and swiss authors favor the application of article 28 cisg in cases of articles 46(2) and (3) cisg.30 one argument is that articles 46(2) and (3) cisg are part of a general right to request specific performance and article 28 cisg applies to this general right.31 it is not surprising that primarily german authors rely on this argument 26 official records (n. 10), 341 para. 38. 27 official records (n. 10), 352 para. 32. 28 secretariat’s commentary (n. 11), art. 42 para. 10. 29 norway gave an example in respect to limiting the right to require repair of the goods, official records (n. 10), 78, art. 42 para. 1. 30 peter huber, in kröll/mistelis/perales viscasillas (n. 5), art. 46 paras. 31, 45; peter huber, in münchener kommentar zum bgb, band 4 (8th ed., münchen 2019), art. 46 para. 37; hanns-christian salger, in wolfgang witz/hanns-christian salger/manuel lorenz, international einheitliches kaufrecht (2nd ed., frankfurt 2016), art. 46 para. 1; müller-chen, markus, in schlechtriem & schwenzer (n. 4), art. 28 para. 6; christoph brunner/diana akikol/lucien bürki, in christoph brunner/benjamin gottlieb (ed.), commentary on the un sales law (cisg) (alphen aan den rijn 2019), art. 46 para. 9. 31 ulrich magnus, in dagmar kaiser (ed.), staudinger bgb (berlin 2018), art. 46 paras. 31, 64. 55 cisg-ac opinion 21 since, under german, i.e., civil, law the remedies of repair and delivery of substitute goods are considered to be remedies of specific performance. however, in other legal systems, especially common law systems, these remedies would not be regarded as remedies of specific performance.32 3.3 the arguments in favor of applying article 28 cisg to cases of articles 46(2) and (3) cisg do not convince. first, articles 46(2) and (3) cisg name different prerequisites than the general right to request specific performance under article 46(1) cisg. articles 46(2) and (3) cisg require fundamentality of the breach and reasonableness of the claim for repair. hence, articles 46(2) and (3) cisg are leges speciales “qualifying the general provision of article 28 cisg”.33 as honnold and flechtner correctly argue, it would contradict the “spirit of fairness” to restrict “the grounds for relief in some jurisdictions without requiring liberalization of the grounds in others”.34 second, applying article 28 cisg to articles 46(2) and (3) cisg ignores the interplay of articles 46(2) and (3) cisg, and the seller’s right to cure under article 48 cisg which is not restricted by article 28 cisg. some sellers would be privileged with a buyer who has no rights under articles 46(2) and (3) cisg. the harmony of articles 46(2) and (3) and article 48 cisg, balancing buyer’s and seller’s interests, would be disturbed.35 third, the approach suggested in rule no. 1 is in line with the wording and purpose of article 28 cisg. the wording of article 28 cisg states to “require performance” and is congruent with the wording in article 46(1) cisg, also stating to “require performance”. it differs, however, from the wording in articles 46(2) and (3) cisg, referring to the “delivery of substitute goods” and “repair”. the purpose of article 28 cisg is to bridge the “differences between the continental european legal system and the english and american legal system on the issue of the right to require specific performance”.36 this purpose does not apply to articles 46(2) and (3) cisg. specific performance is available in limited circumstances in the english and american legal systems.37 although their limitations differ from articles 46(2) and (3) cisg,38 their mere existence provides a 32 in fact, under the u.k. sale of goods act 1979, there is no formal right to cure. but see michael bridge, the sale of goods, (4th ed., oxford 2019), para. 10.135. 33 honnold/flechtner (n. 8), art. 46 para. 285.1. 34 honnold/flechtner (n. 8), art. 46 para. 285.1. 35 where the seller may use art. 48 cisg without being faced by a buyer enjoying art. 46(2), (3) cisg, an imbalance may result. during the negotiations in vienna in 1980, one of the u.s.-american delegates generally described that both articles are closely linked with each other, official records (n. 10), 344 para. 79. 36 markus müller-chen, in schlechtriem & schwenzer (n. 4), art. 28 para. 1. however, the author favors the approach opposing rule no. 1. 37 c.f., sect. 2-716(1) ucc for the u.s.-american understanding, and andrew burrows, remedies for torts, breach of contract, and equitable wrongs (4th ed., oxford 2019), 402 et seq. 38 these are, generally, uniqueness – physical or commercial –, the difficulty to assess damages, or the inadequacy to pay damages. njcl 2021/1 56 bridge to the english and american legal system, rendering article 28 cisg superfluous. 3.4 therefore, delivery of substitute goods and repair have a broader scope of application than the general right to request specific performance. whereas the general right to require specific performance is subject to article 28 cisg, the remedies in article 46(2) and (3) cisg are not. bb) non-conformity of the goods 2. these remedies apply not only to non-conformity of the goods (article 35 cisg) but also in cases of third party rights or claims (article 41 cisg), as well as third party rights or claims based on industrial or intellectual property (article 42 cisg). 3.5 the heading of section ii cisg, including articles 35, 41, and 42 cisg, differentiates between “conformity of the goods and third party claims”. the wording of articles 46(2) and (3) cisg only addresses nonconformity. hence, at first glance articles 46(2) and (3) cisg do not apply in case of third party rights or claims, article 41 cisg, or third party industrial or intellectual property rights or claims, article 42 cisg.39 this argument could be supported by the secretariat’s commentary on the 1978 draft convention, which explicitly states that article 46(2) cisg does not apply in cases of articles 41 and 42 cisg.40 additionally, one may note that articles 46(2) and (3) cisg only refer to article 39 cisg, not article 43 cisg. 3.6 however, a practical interpretation and understanding of articles 46(2) and (3) cisg favor their application in cases of articles 41 and 42 cisg, where appropriate.41 articles 46(2) and (3) cisg express a general principle in the cisg of balancing both parties’ interests in case of a breach of contract by the seller. in cases of articles 41 and 42 cisg both parties are often faced with similar issues as in the case of nonconformity.42 alternatively, some scholars differentiate between article 41 and 42 cisg and argue that articles 46(2) and (3) cisg apply only to 39 relying on a systematic reading huber, in kröll/mistelis/perales viscasillas (n. 5), art. 46 para. 7. see also axel metzger, seller’s liability for defects in title according to articles 41 and 42 of the cisg, in ingeborg schwenzer/yeşim atamer/petra butler (eds.), current issues in the cisg and arbitration (den haag 2014), 195, 199. 40 secretariat’s commentary (n. 11), art. 39 para. 8, art. 40 para. 12. 41 the same applies to art. 46(1) cisg, david tebel, liability for infringing goods, ph.d. thesis 2019 (in publication), part 6, a. iii. 1. 42 cf., tebel, liability for infringing goods (n. 42), part 6, a. iii. 1.; pascal hachem, in beck’scher online großkommentar bgb (ed. 01.08.2020, munich), art. 42 para. 28. 57 cisg-ac opinion 21 article 42 cisg.43 according to these authors, liability for defects under article 42 cisg is closer to non-conformity than to article 41 cisg.44 comparing articles 35, 41, and 42 cisg, it is evident that only articles 35(3) and 42(2)(a) cisg apply the same standard of the buyer’s knowledge.45 article 41 cisg would deviate from this standard since it does not even require positive knowledge of the buyer.46 3.7 the better view is to apply articles 46(2) and (3) cisg not only to article 42 cisg but even to article 41 cisg. whenever it is practically feasible to apply article 46(2) and (3) cisg to either article 41 or 42 cisg, there is no reason to deny the applicability in general. under article 41 cisg the seller must deliver goods which are free from any right or claim of a third party, excluding industrial property or other intellectual property rights. these may be property rights or other defects in title.47 delivery of substitute goods not subject to such third party rights may cure the defective performance (article 46(2) cisg). where the defects can be ‘repaired’ by fulfillment or termination of the third party right or claim through the seller,48 it is appropriate to apply article 46(3) cisg. 3.8 article 42 cisg requires delivery of goods free from any right or claim of a third party based on industrial property or other intellectual property rights. article 46(2) cisg may apply if the goods are only protected by intellectual property rights in one state of use. where the buyer intends to use the goods in several states and actually uses them, it has no interest in substituting all goods.49 similarly, if delivered goods may 43 kröll, in kröll/mistelis/perales viscasillas (n. 5), art. 42 para. 51; florian mohs, die vertragswidrigkeit im rahmen des art. 82 abs. 2 lit. c cisg, in internationales handelsrecht 2002, 59, 63. 44 mohs, die vertragswidrigkeit im rahmen des art. 82 abs. 2 lit. c cisg (n. 44), 63; see also hachem, in beck’scher online großkommentar bgb (n. 43), art. 42 para. 28. 45 mohs, die vertragswidrigkeit im rahmen des art. 82 abs. 2 lit. c cisg (n. 44), n. 34, citing yingxia su, die rechtsmängelhaftung des verkäufers nach un-kaufrecht und im chinesischen recht, praxis des internationalen privatund verfahrensrechts, 1997, 284, 287. 46 mohs, die vertragswidrigkeit im rahmen des art. 82 abs. 2 lit. c cisg (n. 44), n. 35, citing peter schlechtriem, conformity of the goods, seller’s obligations under the united nations convention on contracts for the international sale of goods, in nina galston/hans smit (ed.), international sales, 1984, § 6.03, 6–31. 47 e.g., bundesgerichtshof (german supreme court), 11 january 2006, viii zr 268/04, cisg-online 1200. 48 e.g., in obergericht (court of appeal) des kantons aargau, 3 march 2009, zor.2008.16/eb, cisg-online 2013, a swiss claimant ordered a prefabricated house from an austrian respondent, who relied on sub-contractors. since the respondent failed to pay the sub-contractors, the prefabricated house was not free from third party rights, here security rights. the claimant requested damages, art. 74 cisg, but could have equally requested repair in form of payment to the sub-contractors. 49 cf., tebel, liability for infringing goods (n. 42), part 6, a. iii. 1.; hachem, in beck’scher online großkommentar bgb (n. 43), art. 42 para. 28. njcl 2021/1 58 be used in different, non-infringing ways,50 this may guide the application of article 46(2) cisg. under article 46(3) cisg it may be possible that the third party is willing to grant the missing license.51 if, however, the costs for the license are prohibitively high these costs may render the repair unreasonable when, for example, conforming goods can be delivered in a non-infringing way.52 3.9 therefore, under a practical interpretation and understanding, both the buyer’s rights and seller’s protection under articles 46(2) and (3) cisg should apply in scenarios of articles 41 and 42 cisg.53 buyers confronted with goods not free from third party rights are treated equally to buyers faced with non-conforming goods. articles 46(2) and (3) cisg apply either directly or by analogy to third party rights or claims and third party industrial or intellectual property rights or claims.54 cc) defects in quantity 3.10 according to article 35(1) cisg, the seller must deliver goods which are of the quantity, quality, and description required by the contract. although defects in quantity and quality are both referred to as nonconformity,55 one may distinguish between non-conformity and partial non-delivery.56 this mutual reference may cause difficulties in applying either article 46(1) or (2) cisg. 3.11 as far as the defect in quantity is a partial non-delivery, for example instead of 100 timber planks only 90 planks are delivered, article 46(2) cisg does not apply; rather article 51 cisg applies.57 consequently, under article 51(1) cisg, the buyer can exercise its 50 tebel, liability for infringing goods (n. 42), part 6, a. iii. 1., providing the example of using textiles with a protected check pattern purchased with the intent to manufacture clothing to manufacture curtains which are also part of the buyer’s usual portfolio of goods. 51 cf., for example, oberster gerichtshof (austrian supreme court), 12 september 2006, 10 ob 122/05x, cisg-online 1364 para. 32. 52 tebel, liability for infringing goods (n. 42), part 6, a. iii. 1. 53 another approach is to generally dismiss the differentiation in terminology between arts. 35, 41, and 42 cisg in regard to remedies, rolf herber/beate czerwenka, internationales kaufrecht: kommentar zu dem übereinkommen der vereinten nationen vom 11. april 1980 über verträge über den internationalen warenkauf, (münchen 1991), art. 45 para. 2., see also art. 41, para. 10. for the opposing view see tebel, in brunner/gottlieb, (n. 31), art. 41 para. 26 and art. 42 para. 26. 54 for the analogy, see tebel, liability for infringing goods, (n. 42), part 6, a. ii. 55 schwenzer, in schlechtriem & schwenzer (n. 4), art. 35 paras. 4, 8. 56 e.g., kröll, in kröll/mistelis/perales viscasillas (n. 5), art. 35 para. 23 with further references; salger, in witz/salger/lorenz (n. 31), art. 35 para. 6. 57 honnold/flechtner (n. 8), art. 46 para. 283; huber, in kröll/mistelis/perales viscasillas (n. 5), art. 46 para. 8; müller-chen, in schlechtriem & schwenzer (n. 4), art. 51 para. 2. see on avoidance and art. 51(1) cisg 서울고등법원 (court of appeal seoul), 17 january 2013, 2012na27850, cisg-online 2832. 59 cisg-ac opinion 21 remedies only for the missing part. in such a case “delivery of substitute goods” is not conceivable. rather, the buyer may rely on the unrestricted right of specific performance under article 46(1) cisg to request delivery.58 3.12 if the delivered goods do not conform with the contract as regards their size or weight, e.g., the weight of a square meter of the goods is less than agreed upon, or timber planks are shorter than required under the contract, this amounts to a defect in quality or simply a nonconformity. article 46(2) cisg applies if the prerequisites are met. 3.13 finally, another scenario is where all goods are delivered but parts of them are non-conforming for other reasons than size or weight.59 the cisg refers to these scenarios as partial non-conformity. in order for cure being possible, the goods must be divisible.60 dd) defects in packaging 3.14 generally, a defect in packaging in itself will not give rise to a right to request delivery of substitute goods. however, the following scenarios have to be distinguished: if the packaging is part of the goods themselves, for example, the original packaging of branded goods, any deficiency constitutes a defect in quality. it is a matter of quality since the physical condition of the goods is not as agreed upon.61 if the packaging simply serves to protect the goods during the transport from the seller to the buyer, the applicability of articles 46(2) and (3) cisg depends on whether the goods have been affected by the defect in packaging.62 if the answer is no, there are no remedies whatsoever.63 if, however, the goods have been damaged or destroyed due to the defect in packaging, this again 58 peter huber, in peter huber/alastir mullis, the cisg (2nd ed., berlin 2014), 198 et seq. the buyer may also rely on art. 51(2) cisg in case the partial non-delivery constitutes a fundamental breach, see for example china international economic & trade arbitration commission, 18 september 2006, cisg/2006/24, cisg-online 2053. 59 e.g., within a delivery of 40.000 books 35% of the books had no cover, cour d’appel (court of appeal) d’orléans, 28 february 2008, 07/01189, cisg-online 5028. 60 bundesgericht (swiss supreme court), 16 july 2012, 4a_753/2011, cisg-online 2371. 61 see seller’s argumentation in cour de cassation (french supreme court), 23 january 1996, 93-16.542, cisg-online 159. in general, schwenzer, in schlechtriem & schwenzer (n. 4), art. 35 para. 9, for the definition of “quality”. 62 schwenzer, in schlechtriem & schwenzer (n. 4), art. 35 para. 33; see for example 湖北省 武汉经济技术开发区人民法院 (wuhan economic and technology development zone people’s court), 30 june 2000, cisg-online 2028. 63 kröll, in kröll/mistelis/perales viscasillas (n. 5), art. 35 para. 35. the seller did not breach its obligations under art. 35 cisg, cf. idem., para. 144. njcl 2021/1 60 amounts to a defect in quality which may entail the right to request delivery of substitute goods.64 dd) timely request 3.15 under articles 46(2) and (3) sentence 2 cisg, the buyer must request delivery of substitute goods or repair in conjunction with giving notice of non-conformity under article 39 cisg or within a reasonable time thereafter. if the seller knows about the non-conformity or could not have been unaware and, therefore, may not rely on the buyer not having given notice (article 40 cisg), the period of a reasonable time under articles 46(2) and (3) sentence 2 cisg commences when notice of nonconformity should have been given.65 3.16 in determining the length of such a reasonable time, the interests of both the seller and the buyer must be taken into account and balanced. on the one hand, the buyer must be given enough time to decide which remedy to pursue and to act accordingly.66 on the other hand, the seller’s interest in legal certainty must be taken into account.67 the time limit for requiring delivery of substitute goods and repair must be coordinated with the one laid down in article 49(2)(b) cisg for a declaration of avoidance.68 just like in determining the reasonable time under article 39 cisg, much will depend on the circumstances of the individual case,69 such as the nature of the goods, the market in question, etc. 3.17 if the buyer fails to comply with the time limit for requiring delivery of substitute goods or repair, it is restricted to the otherwise 64 kröll, in kröll/mistelis/perales viscasillas (n. 5), art. 35 para. 144. 65 pascal hachem, verjährungsund verwirkungsfragen bei cisg-verträgen, internationales handelsrecht 2017, 1, 3 et seq. 66 in this regard, the parties may need some time to negotiate the possibilities. see for example cour d’appel (court of appeal) colmar, 24 october 2000, 200002525, cisgonline 578. 67 cf., schlechtriem, subsequent performance and delivery deadlines – avoidance of cisg sales contracts due to non-conformity of the goods (n. 3), 93, on the purpose of time limits in arts. 46(2), (3) and art. 49(2)(b) cisg. 68 this applies to both arts. 46(2) and (3) sentence 2 cisg since the wording of both provisions is identical and both serve the purpose of legal certainty. see also huber, in kröll/mistelis/perales viscasillas (n. 5), art. 46 paras. 36, 50; müller-chen, in schlechtriem & schwenzer (n. 4), art. 46 paras. 33, 43; salger, in witz/salger/lorenz (n. 31), art. 46 para. 7. 69 hachem, verjährungsund verwirkungsfragen bei cisg-verträgen (n. 66), 4. see in general, cisg-ac opinion no. 2, examination of the goods and notice of non-conformity articles 38 and 39, 7 june 2004, london (england). rapporteur: professor eric e. bergsten, emeritus, pace university school of law, new york, in schwenzer (ed.) the cisg advisory council opinions (den haag 2017), 39, also available at http://www.cisgac.com/cisgac-opinion-no2/. 61 cisg-ac opinion 21 available remedies, i.e., a claim for damages, price reduction, and avoidance for fundamental breach.70 3.18 in the end, in case of non-conformity of the goods, the following usual sequence of periods results:71 after delivery, the buyer must examine the goods (article 38 cisg), followed by a reasonable time to give notice (article 39 cisg), whereupon the buyer may require delivery of substitute goods or repair within a reasonable time (articles 46(2) and (3) sentence 2 cisg; if the buyer did not already do so in its notice under article 39 cisg), followed again by a reasonable time granted to the seller for cure (article 47(1) cisg), and only thereafter, the time for declaring avoidance begins to run (article 49(2)(b)(ii) cisg).72 however, the buyer is not obliged to fix any period under article 47 cisg. it may, instead, immediately have recourse to other remedies available (rule no. 13). in practice, the seller is well advised to react immediately to the buyer’s notice under article 39 cisg and, if it is willing to cure, offer cure per articles 48(2) and (3) cisg. 2.2.2.b) delivery of substitute goods (article 46(2) cisg) aa) fundamental breach 3. under article 46(2) cisg, a fundamental breach of contract can only be found if the non-conforming goods cannot be used as intended and if it is reasonable for the buyer to refuse repair. 3.19 the right to deliver substitute goods under article 46(2) cisg requires a fundamental breach. this prerequisite is in line with the purpose of the cisg to avoid unnecessary costly returns of goods, also underlying the restriction of the buyer’s right to avoid the contract.73 70 the buyer loses the right to claim substitute delivery or repair. see, in general, handelsgericht (commercial court) zürich, 17 september 2014, hg130167-o/u, cisg-online 2656. 71 one has to bear in mind that this is merely a possible sequence with many variations in line with art. 49(2)(b)(i), (iii) cisg. 72 hachem, verjährungsund verwirkungsfragen bei cisg-verträgen (n. 66), 6. see for example sąd apelacyjny w białymstoku (court of appeal bialystok), 18 march 2016, i aca 177/15, cisg-online 4419. it is, however, possible to make an anticipatory declaration of avoidance together with the request to repair, see for example kantonsgericht (court of first instance) schaffhausen, 24 january 2004, 11/1999/99, cisg-online 960. generally, the declaration of avoidance can be combined with a notice of lack of conformity or with an additional period for performance, christiana fountoulakis, in schlechtriem & schwenzer (n. 4), art. 26 para. 8, with further case references. 73 huber, in kröll/mistelis/perales viscasillas (n. 5), art. 46 para. 33; uncitral, digest (n. 9), art. 46 para. 3, “avoidance of the contract should be available only as a last resort”. although this reasoning might not be compelling in the case of an exw contract, i.e., where there njcl 2021/1 62 3.20 generally, a breach is fundamental under article 25 cisg if it results in such detriment as substantially to deprive the buyer of what it is entitled to expect under the contract. primarily, the parties may agree on what they expect to be of the essence of the contract.74 whether or not a contractual agreement is of the essence is a matter of interpretation under article 8 cisg.75 if the interpretation of the contract does not clarify what amounts to a fundamental breach, the purpose of the sale becomes relevant. usually, a buyer who wants to use the goods itself is not interested in reselling. hence, in the usual case, it cannot be decisive whether the non-confrming goods could be resold.76 instead, the decisive factor is whether the goods are improper for the use intended by the buyer.77 however, a buyer who is in the resale business is interested in reselling the goods. thus, resaleability becomes relevant.78 to what extent resaleability or non-resaleability causes a fundamental breach is a case-bycase decision and due regard should be given to balancing the possibilities and interests of the buyer and seller.79 3.21 in cases where the seller, the buyer, or a third person can remedy the non-conforming goods by repair, there is usually not yet a fundamental breach.80 the buyer is restricted to require repair under article 46(3) cisg has been no transport of the goods, a fundamental breach is also required in these cases, cisg-ac opinion no. 5 (n. 2), para. 4.6. 74 e.g., the concrete age of an antique marble sculpture, handelsgericht (commercial court) zürich, 18 june 2012, hg060451, cisg-online 2660; a minimum shelf life of fresh pasta, oberlandesgericht (court of appeal) stuttgart, 27 november 2019, 3 u 239/18, cisg-online 5410, where the delay in delivery of only 3 days, thus, resulted in a fundamental breach. 75 according to schroeter, it is common in contracting practice to explicitly define certain obligations as ’fundamental’ or ’essential’, see ulrich schroeter, in schlechtriem & schwenzer (n. 4), art. 25 para. 21 n. 91. often the parties allocate specific central features to the goods, as apple juice concentrate to be unsweetened, rolls of aluminum to be of a certain thickness, and soy protein to not be genetically modified, see cisg-ac opinion no. 5 (n. 2), para. 4.2 with further reference. see also, urica, inc. v. pharmaplast s.a.e., u.s. district court for the central district of california, 8 august 2014, cisg-online 2952, paras. 85-87. 76 cisg-ac opinion no. 5 (n. 2), para. 4.3. 77 it may, however, be important whether the buyer can use the goods differently without unreasonable expenditures, see cisg-ac opinion no. 5 (n. 2), para. 4.3 n. 34; uncitral, digest (n. 9), art. 25 para. 8. 78 for example, kantonsgericht (court of first instance) schaffhausen, 27 january 2004, 11/1999/99, cisg-online 960. 79 if the goods are not resaleable at all, the breach is generally fundamental. if the defect does not hinder the resaleability, the decisive question is whether “resale can reasonably be expected from the individual buyer in [its] normal course of business”. cisg-ac opinion no. 5 (n. 2), para. 4.3. 80 cisg-ac opinion no. 5 (n. 2), para. 4.4 n. 41; schroeter, in schlechtriem & schwenzer (n. 4), art. 25 para. 50. in light of art. 48 cisg the oberlandesgericht (court of appeal) koblenz decided that the seller’s willingness to cure the defect is also decisive when 63 cisg-ac opinion 21 or claiming damages and a reduction of the purchase price. however, in exceptional circumstances, the mere possibility of repair does not hinder the fundamentality of the breach. in such exceptional circumstances, the breach becomes fundamental if it is reasonable for the buyer to refuse repair. an example of a reasonable refusal of repair is where timely delivery of conforming goods is of the essence of the contract. the practical importance of this example is questionable concerning article 46(2) cisg: if time is of the essence the buyer will usually not request delivery of substitute goods but revert to another remedy.81 3.22 in general, if the goods are usable by the buyer, there is no fundamental breach.82 the buyer is restricted to the remedies of repair (article 46(3) cisg),83 claim for damages (article 74 cisg), or reduction of the purchase price (article 50 cisg).84 even if repair is not possible but the goods are still usable, there is not necessarily a fundamental breach.85 bb) no differentiation between generic and identified goods 3.23 the application of article 46(2) cisg in case of identified goods is disputed. the traditional view in germanic legal systems is that delivery of substitute goods may only be considered in cases of defects in quality86 and where goods of a different kind have been delivered,87 therefore, almost exclusively in case of generic goods. if the contract relates to an identified object, delivery of a substitute object usually should not be expected from the seller.88 the argument is that in the case of determining whether a breach is fundamental or not, oberlandesgericht (court of appeal) koblenz, 31 january 1997, 2 u 31/96, cisg-online 256. see also uncitral, digest (n. 9), art. 46 para. 14. 81 see below comments on rule no. 11 on the importance of time being of the essence for a fundamental breach. 82 uncitral, digest (n. 9), art. 46 para. 13. the line should be drawn where the use would be an unreasonable burden, see schroeter, in schlechtriem & schwenzer (n. 4), art. 25 para. 54. 83 see for example, landgericht (district court) stade, 16 april 2015, 5 o 122/14, cisgonline 2668. 84 for example, federal arbitration court of north caucasus area, krasnodor, 3 october 2011, a63-4588/2010, cisg-online 2518, where the court did not discuss the fundamentality of the breach but relied on the seller’s failure to start repair within a reasonable period of time when granting art. 50 cisg. 85 bundesgerichtshof (german supreme court), 3 april 1996, viii zr 51/95, cisgonline 135; kantonsgericht (court of first instance) zug, 30 august 2007, a3 2006 79, cisg-online 1722. 86 peter schlechtriem/ulrich schroeter, internationales un-kaufrecht (6th ed., tübingen 2016), para. 455. 87 anton k. schnyder/ ralf m. straub, in heinrich honsell (ed.), kommentar zum unkaufrecht (2nd ed., wien 2010), art. 46 para. 18. 88 in exceptional circumstances art. 46(2) cisg may apply to identified objects. this is, for example, the case for an aliud delivery, i.e., the wrong object was delivered, magnus, njcl 2021/1 64 identified objects the remedy in article 46(2) cisg cannot be used to expand the seller’s obligations which are limited to the identified objects.89 however, it is more convincing not to differentiate categorically between generic and identified goods. rather, the substitutability of the goods and the parties’ interests in substitution should guide the application of article 46(2) cisg.90 first, the distinction between generic and identified goods is unknown to the cisg; the wording of article 46(2) cisg does not differentiate between generic and identified goods either. however, article 42 ulis explicitly differentiated between generic and identified goods.91 with this background, the omission in article 46(2) cisg must have been intentional. second, and on the one hand, the differentiation between generic and identified goods may cause difficulties, e.g., where the identified category of goods is not produced anymore.92 on the other hand, the differentiation between substitute delivery and repair may be difficult, e.g., repairing the significant parts of a good by delivering substitutions of these parts.93 categorically favoring repair over substitute delivery here is, thus, not useful. finally, the differentiation between generic and identified goods and the exclusion of substitute delivery in the case of identified goods is a traditional german civil law approach.94 however, even the german supreme court does not categorically apply this approach but differentiates in practice and pays much attention to the parties’ interests.95 3.24 therefore, a more practical approach is to rely on an interpretation of the contract and to determine the substitutability of the goods. the evaluation of whether article 46(2) cisg is useful and in staudinger bgb (n. 32), art. 46 para. 34, and where the parties concluded a new contract, huber, in kröll/mistelis/perales viscasillas (n. 5), art. 46 para. 37. 89 felix hartmann, beck’scher online großkommentar bgb (n. 43) art. 46 para. 31.1. 90 in this direction already claus-wilhelm canaris, die nacherfüllung durch lieferung einer mangelfreien sache beim stückkauf, juristenzeitung, 2003, 831, 834. 91 already the 1976 draft convention abolished this reference in its wording of art. 27(2), now art. 46(2) cisg. 92 this is the case in some of the cases against volkswagen, where the seller argues that the identified category of cars is not produced anymore and thus it is impossible to substitute the goods. in bundesgerichtshof (german supreme court), indicative order 8 january 2019, viii zr 225/17, the court dismissed this argument. 93 georg bitter, der nachlieferungsanspruch beim stück-, vorratsund gattungskauf in sachmängelfällen sowie beim untergang der sache, zeitschrift für wirtschaftsrecht 2007, 1881, 1885, on german law. 94 scholars argue that it would be impossible under sect. 275(1) german bgb to deliver a substitute good in case of identified goods since the seller is only obliged to deliver the identified object, see e.g., thomas ackermann, die nacherfüllungspflicht des stückverkäufers, juristenzeitung 2002, 378. 95 bundesgerichtshof (german supreme court), indicative order 8 january 2019, viii zr 225/17. 65 cisg-ac opinion 21 appropriate should be guided by the parties’ intentions and interests.96 such an approach is in line with the drafting history of the cisg: not only the nature of the goods but especially their substitutability guided the drafters to differentiate between repair and the delivery of substitute goods.97 cc) exclusion of article 46(2) cisg 3.25 the buyer’s right to request delivery of substitute goods is in the ordinary case excluded when the buyer is unable to make restitution of the goods first received (rule no. 4) and if delivery of substitute goods is disproportionate, regarding all the circumstances (rule no. 5). 4. a buyer requiring delivery of substitute goods is subject to article 82 cisg. 3.26 although the heading of section v, including article 82 cisg, is “effects of avoidance”, this provision applies also to the delivery of substitute goods. the clear wording of article 82 cisg requires its application and establishes an exclusion of article 46(2) cisg in some cases. according to article 82(1) cisg “[t]he buyer loses the right to […] require the seller to deliver substitute goods if it is impossible for him to make restitution of the goods substantially in the condition in which he received them”.98 article 82 cisg is based on the idea that restitution is the “natural consequence”99 of the delivery of substitute goods. the wording does not require restitution of the goods in the exact same condition.100 only if the change in the condition of the goods is of such importance that it would no longer be proper to require the seller to retake the goods as the equivalent of what it had delivered to the buyer, the buyer fails to fulfill its obligation.101 when goods perish in between the buyer’s request for 96 similar to bundesgerichtshof (german supreme court), indicative order 8 january 2019, viii zr 225/17, courts applying art. 46(2) cisg should interpret the parties’ intents to clarify whether art. 46(2) cisg is the appropriate remedy. see also in detail yeşim atamer, replacement of non-conforming goods ‘free of charge’: is there a need to differentiate between b2b and b2c sales contracts?, uniform law review 2020, 20 et seq. 97 official records (n. 10), 337 paras. 52 et seq. 98 but see the exceptions in art. 82(2) cisg. 99 secretariats commentary (n. 11), art. 67 para. 2. 100 especially, the mere usage by the buyer does not fulfill art. 82(1) cisg, e.g., sąd najwyższy (supreme court of poland), 13 september 2017, iv csk 662/16, cisgonline 4269. however, if the goods are processed, art. 82(1) cisg, e.g., tribunale di (district court) modena, 19 february 2014, 2340/2006, cisg-online 2751, if not art. 82(2)(c) cisg applies. 101 secretariats commentary (n. 11), art. 67 para. 3. njcl 2021/1 66 substitution and the delivery of substitute goods, the buyer’s claim for substitute goods is not excluded but the buyer may be liable in damages.102 5. the buyer’s right to require delivery of substitute goods is excluded if it is disproportionate having regard to all the circumstances. 3.27 whereas article 46(3) cisg refers to reasonableness for balancing both parties’ interests, there is no such requirement in article 46(2) cisg. the drafting history of article 46(2) cisg does not address disproportionality. the drafters discussed whether to lower the threshold for substitute delivery by replacing fundamentality with mere reasonableness of substitution.103 however, they did not discuss whether, in addition to the prerequisite of a fundamental breach, general disproportionality may hinder the claim under article 46(2) cisg. such an approach appears useful and in line with the convention’s primary purpose in article 46(2) cisg to save the seller’s transportation costs where they outweigh the buyer’s interest in receiving conforming goods.104 more generally, this purpose requires defining both parties’ interests and weighing them against each other.105 3.28 cases where the delivery of substitute goods is unreasonable may include a substitute not being available, being only available at very high costs, or constituting an upgrade.106 rule no. 5 satisfies this general requirement regarding substitute delivery. the approach of balancing both 102 but also here, the expections of art. 82(2) cisg applies. see in general on the allocation of risk the period between avoidance and redelivery cisg-ac opinion no. 9, consequences of avoidance of the contract, 15 november 2008, tokyo (japan). rapporteur: professor michael bridge, london school of economics, london, u.k., in schwenzer (ed.) the cisg advisory council opinions (den haag 2017), 101, 110-111 para. 3.18, also available at http://www.cisgac.com/cisgac-opinion-no9/. 103 a joint proposal by finland, the federal republic of germany, norway, and sweden provided that: “if the goods do not conform with the contract, the buyer may require the seller to remedy the lack of conformity by repair unless this is not reasonably practicable for the seller. a request for repair must be made either in conjunction with notice given under article 37 or within a reasonable time thereafter.” official records (n. 10), 112 b no. 3(viii). the proposal was dismissed with the arguments that substitute delivery generates economic consequences similar to avoidance, i.e., costs for transportation of restitution, and should thus be treated similarly. repair, however, is different in this regard, official records (n. 10), 337. 104 cf., secretariat’s commentary (n. 11), art. 42 para. 12. 105 relying on a general principle that “the law should not encourage economically irrational behaviour”, atamer comes to a similar conclusion, atamer, replacement of non-conforming goods ‘free of charge’: is there a need to differentiate between b2b and b2c sales contracts? (n. 97), 9. 106 alternatively, other scholars suggest an interpretation of art. 46(2) cisg in parallel to art. 79 cisg arguing that this provision gives the buyer the right to insist on performance as long as a commercially viable substitute exists and this substitute does not differ substantially from the original obligation, atamer, replacement of non-conforming goods ‘free of charge’: is there a need to differentiate between b2b and b2c sales contracts? (n. 97), 22. 67 cisg-ac opinion 21 parties’ interests is similar to that in article 46(3) and 48 cisg, both requiring the remedy to be reasonable under the circumstances of the case.107 also, the question may arise whether a clause introducing a cap on damages to a sales contract applies to substitute delivery, hence, potentially barring article 46(2) cisg if the costs for substitution exceed the cap.108 3.29 when examining proportionality in article 46(2) cisg the decisive criteria may be the seller’s position and ability to substitute the goods,109 the costs of substitution, the nature of the goods and their general substitutability,110 and the parties’ interests in the remedy.111 the examination needs to be objective. regarding the costs of substitution, a cap on damages may in some cases guide the examination. if the parties’ contract provides for a cap on damages, the parties may have arguably intended to limit costs for remedies, including substitute delivery, to that amount. for example, if the delivery of substitute goods would require the seller to produce goods in the amount of 28 million, but the contract limits damages to 20 million, it is questionable whether this cap renders the delivery of substitute goods disproportional.112 the outcome will depend on the wording of the contract and the parties’ intention for agreeing on the cap. it, therefore, remains a question of contract interpretation. 107 one may wish to apply art. 46(3) cisg by analogy, bearing in mind that the drafting history of art. 46(2) cisg reveals an unconscious gap. the argument raised in the drafting history that substitute delivery and repair differ in their approach to costs of transportation are not material in this regard. however, a broad interpretation of the purpose of art. 46(2) cisg leads to the same conclusion. 108 the problem of the 27th / 17th willem c. vis (east) international commercial arbitration moot addressed this issue. 109 there will usually be no lenience if the seller manufactures the goods. 110 cf., above at paras. 3.20 et seq. 111 the seller may, however, not be heard with the mere argument that it must deliver new products in order to fulfill its obligation under art. 46(2) cisg. 112 again, see, e.g., the problem of the 27th / 17th willem c. vis (east) international commercial arbitration moot. njcl 2021/1 68 2.2.3.c) repair (article 46(3) cisg) 6. the buyer may require the seller to remedy the non-conformity by repair unless this is unreasonable. in determining whether repair by the seller is unreasonable regard is to be had to: a. whether the buyer is better placed to arrange for repair of the goods; b. whether the seller offers to advance the costs for repair by the buyer or a third party; c. whether repair imposes costs on the seller that are disproportional to the actual or prospective loss of or benefit to the buyer. 3.30 under article 46(3) cisg the buyer may require the seller to remedy the lack of conformity by repair. this right to repair exists “unless this is unreasonable having regard to all circumstances”.113 in determining whether repair by the seller is unreasonable, the rules in litera a-c are intended to assist in balancing both parties’ interests.114 3.31 according to rule 6 litera a, repair may be unreasonable if the buyer is better placed to arrange for repair. the buyer may be better placed if the non-conformity can be easily removed by the buyer itself or a third party and, for example, if the seller is unable to repair the goods because it is not the manufacturer but only a retailer of the goods,115 or repair is technically too complex for the seller,116 the seller does not maintain repair services itself, or does not have access to third parties being able to repair the goods.117 also, if repair by the buyer itself or a third party is less expensive than repair by the seller,118 the buyer may be better placed to repair the goods. 113 art. 46(3) cisg. for an overview of the decisive factors for reasonableness, cf., müller-chen, in schlechtriem & schwenzer (n. 4), art. 46 para. 40. 114 cf., müller-chen, in schlechtriem & schwenzer (n. 4), art. 46 para. 40, for the requirement to balance the buyer’s interests against those of the seller. 115 salger, in witz/salger/lorenz (n. 31), art. 46 para. 8; see also michael will, in cesare m. bianca/michael j. bonell, (eds.), commentary on the international sales law (milan 1987), art. 46 para. 2.2.2.2; magnus, in staudinger bgb (n. 32), art. 46 para. 62. 116 cf., schelchtriem/schroeter (n. 87), para. 461, on technical difficulties. 117 see for example, the seller’s allegations in china international economic & trade arbitration commission, 21 october 2002, cisg/2002/16, cisg-online 1557, although the seller could not succeed with its submission. cf., additionally huber, in kröll/mistelis/perales viscasillas (n. 5), art. 46 para. 48. in general, the travaux préparatoires refer to the nature of the goods guiding the question of reasonability, official records (n. 10), 335 para. 20. 118 however, the mere fact that repair by the seller is costly does not render repair unreasonable, see kantonsgericht (court of first instance) schaffhausen, 27 january 2004, 11/1999/99, cisg-online 960. the correlation of the costs of repair with the purchase price is disputed, see müller-chen, in schlechtriem & schwenzer (n. 4), art. 46 para. 40 n. 109 for both views. also, the travaux préparatoires provide that the seller 69 cisg-ac opinion 21 3.32 under rule 6 litera b, the seller’s offer to advance the costs for repair by the buyer or a third person may render repair by the seller unreasonable. this consideration is closely connected to rule 6 litera a since the buyer will often be better placed to arrange for repair if it has all necessary monetary resources to repair. 3.33 rule 6 litera c weighs the costs of repair imposed on the seller with the actual or prospective loss of or benefit to the buyer.119 in determining the buyer’s loss, the general principles of calculation of damages have to be considered.120 the famous english ruxley case121 may serve as an example. the debtor was meant to build a seven-foot six-inch deep pool, but it was built to only six feet. the pool was safe for diving and the obligee never intended to put in a diving board. hence, curing the defect would not have been reasonable.122 there, the claim for damages for the costs of curing the defect was rejected; instead, a claim for damages for loss of “amenity” was granted. the same considerations may be introduced under the cisg’s general principle of mitigation of damages, as it is laid down in article 77 cisg. as a consequence, article 77 cisg should be applied by analogy when defining reasonableness in the sense of article 46(3) cisg.123 if the buyer were to engage a third party in repairing the goods and were to reclaim the costs incurred as damages, one would have to ask whether the buyer had properly mitigated its loss.124 could not refuse repair simply with the argument that it is costly, official records (n. 10), 335 para. 19. 119 cf., schlechtriem/schroeter (n. 87), para. 461, generally on unreasonability due to costs and hartmann, beck’scher online großkommentar bgb (n. 43), art. 46 para. 63, for an overview of different views on how to balance the seller’s costs and the buyer’s (potential) loss. 120 for the general principles on calculating damages under the cisg see cisg-ac opinion no. 6, calculation of damages under cisg article 74, 2006, stockholm (sweden), rapporteur: professor john y. gotanda, president of hawai‘i pacific university, hawai’i, usa, in schwenzer (ed.), the cisg advisory council opinions (den haag 2017), 125 et seq., also available at http://www.cisgac.com/cisgac-opinion-no6/. 121 ruxley electronics and construction limited (appellants) v forsyth (respondent), 29 june 1995, [1995] 3 all er 268, [1996] ac 344, [1995] 3 wlr 118, [1995] clc 905, [1995] ukhl 8. 122 curing the defect would have meant to build a new pool. here again, one could argue that the reparation of the pool by the buyer and the following claim for damages is unreasonable under art. 77 cisg. see in this regard ingeborg schwenzer/pascal hachem, the scope of the cisg provisions on damages, in djokhongir saidov/ralph cunnington (eds.), contract damages: domestic and international perspectives (london 2008), 91, 96. 123 whether art. 77 cisg can be applied to the remedy of specific performance in general or whether it should be limited to reduce a claim for damages need not to be discussed here. in general, for the application of art. 77 cisg to other remedies than damages see schwenzer, in schlechtriem & schwenzer (n. 4), art. 77 paras. 4–5. 124 the same applies to where the buyer repaired the goods itself and claims damages for compensating the costs of repair. cf., bundesgerichtshof (german supreme court), njcl 2021/1 70 to illustrate this issue, regard must be given to possible alternatives the buyer is faced with within the scenario of article 46(3) cisg. if a cover purchase is less expensive than repairing the non-conforming goods, the seller may refuse repair. in any case the buyer would not be entitled to claim the full cost of repairing the goods. instead, the buyer would only be entitled to compensation for the costs of the cover purchase. if the goods are usable as initially intended, but still may fail at some point in the future,125 the principle of mitigation may require the buyer to postpone any action until the actual failure of the goods occurs.126 whether the buyer has to postpone any action or not will depend on the probability of the failure to occur as well as on the consequences of a failure of the goods. will a failure cause personal injury to consumers, property damages, purely economic loss, no loss or other negative consequeces at all? at least in the latter case it does not seem reasonable to require the seller to repair the goods before they fail. 3.34 in the end, reasonableness remains an issue to be decided on a case-by-case basis.127 only if repair is impossible, it is clearly unreasonable.128 2.2.4.d) consequences 3.35 as a consequence of the buyer’s right to request either substitute delivery or repair, additional questions of costs, retrofitting, detailed issues of restitution – including benefits and betterment –, the application of articles 38, 39, and 43 cisg, the place of substitute delivery and repair, and the right to withhold performance arise. 24 september 2014, viii zr 394/12, cisg-online 2545 (not granting the claim for damages); olg graz, 22 november 2012, cisg-online 2459; ad hoc arbitration, 10 november 2010, cisg-online 2154; michael bridge, curing a seller’s defective tender or delivery of goods in commercial sales, in andrea büchler/markus müller-chen (eds.), festschrift für ingeborg schwenzer (bern 2011), 221, 232; honnold/flechtner (n. 8), para. 296.1. 125 for example, where the seller is obliged to produce and deliver 1.000 fire detectors to be sold to private consumers, 50 detectors failed to work, and it is uncertain whether more detectors will fail to work. 126 however, this is subject to the possible threat that the buyer’s claim is time barred by the applicable statute of limitations. 127 huber, in kröll/mistelis/perales viscasillas (n. 5), art. 46 para. 46. 128 cf., landgericht (district court) landsberg am lech, 21 june 2006, 1 c 1025/06, cisg-online 1460. the buyer, i.e., the claimant, proved that repair was impossible. however, since the seller previously failed twice to repair the court ruled that these failures suffice to render any further repair unreasonable. hence, it did not rule on the alleged impossibility. 71 cisg-ac opinion 21 aa) costs of substitute delivery and repair 3.36 in general, costs of repair and substitute delivery are borne by the seller.129 these costs are, inter alia, costs for material and personnel,130 costs for arranging repair or substitute delivery,131 or freight costs.132 although the wording of articles 46(2) and (3) cisg does not include these costs, both case law and scholars agree on that these costs should be borne, in principle, by the seller. case law and scholars differ, however, in their reasoning. some refer to the wording and purpose of article 48(1) cisg,133 others to the availability of a claim for damages under article 45(1)(b) and (2) cisg.134 concerning article 48(1) cisg the seller bears the costs in case of its own offered repair or substitute delivery. 135 this must be the case a fortiori under article 46 cisg. the 129 oberlandesgericht (court of appeal) graz, 22 november 2012, 3 r 192/12y, cisgonline 2459 on costs for repair, followed and partially upheld by oberlandesgericht (court of appeal) graz, 13 june 2013, 3 r 100/13w, cisg-online 2458; oberlandesgericht (court of appeal) hamm, 9 june 1995, 11 u 191/94, cisgonline 146, on delivery of substitute goods; atamer, replacement of non-conforming goods ‘free of charge’: is there a need to differentiate between b2b and b2c sales contracts? (n. 97), 1; hartmann, beck’scher online großkommentar bgb (n. 43), art. 46 paras. 49, 65. 130 e.g., in china international economic & trade arbitration commission (cietac), 31 may 2006, cisg/2006/01, cisg-online 1454, the tribunal ruled that costs for “total parts” and “labor fee” would be included. cf., also polimeles protodikio athinon (multimember court of first instance athens), 2009, 4505/2009, cisg-online 2228. 131 landgericht (district court) stade, 15 may 2014, 8 o 70/13, cisg-online 2988. 132 cf., landgericht (district court) oldenburg, 9 november 1994, 12 o 674/93, cisgonline 114. 133 oberlandesgericht (court of appeal) hamm, 9 june 1995, 11 u 191/94, cisgonline 146; see also atamer, replacement of non-conforming goods ‘free of charge’: is there a need to differentiate between b2b and b2c sales contracts? (n. 97), 7 on the discussion of the legal nature of the claim. some scholars refer additionally to a general principle underlying art. 48(1), according to art. 7(2) cisg, huber, in münchener kommentar zum bgb (n. 31), art. 46 para. 42; huber, in huber/mullis (n. 59), 203. 134 landgericht (district court) stade, 15 may 2014, 8 o 70/13, cisg-online 2988; landgericht (district court) zweibrücken, 19 march 2010, 6 hk. o 13/03, cisg-online 2794; oberlandesgericht (court of appeal) graz, 22 november 2012, 3 r 192/12y, cisg-online 2459 on costs for repair; china international economic & trade arbitration commission (cietac), 31 may 2006, cisg/2006/01, cisg-online 1454; hartmann, beck’scher online großkommentar bgb (n. 43), art. 46 paras. 49, 65. 135 hartmann, beck’scher online großkommentar bgb (n. 43), art. 48 para. 25. njcl 2021/1 72 claim for damages is based on articles 74 et seq.,136 including article 77 cisg.137 bb) costs of retrofitting 7. if the goods have been combined with other goods or installed, the costs of retrofitting may be recovered as damages but in general are not borne by the seller as part of the remedy of delivery of substitute goods or repair. however, if in a mixed contract the seller has also assumed the obligation of combining or installing the goods the costs of retrofitting are borne by the seller as part of the remedy of delivery of substitute goods or repair. 3.37 in case of repair or substitute delivery of incorporated goods, additional costs occur due to retrofitting. removal of the incorporated non-conforming goods and reinstallation of conforming goods generate additional costs.138 retrofitting and installation refer to all sorts of actions putting the goods in place so that they are ready for use. the definition of retrofitting and installation under this opinion is broad. 3.38 though not dealing with the cisg, the european court of justice (ecj) under the consumer sales directive139 ruled that the seller who is liable for the non-conformity of the goods must also bear the costs of retrofitting.140 the case before the ecj dealt with a b2c relationship, 136 e.g., in china international economic & trade arbitration commission (cietac), 31 may 2006, cisg/2006/01, cisg-online 1454. cf., cour d’appel (court of appeal) reims, 30 june 2015, 13/02339, cisg-online 2703, where it appears as if the court based the claim for reimbursement of transportation costs, which initially had to be borne by the buyer, on arts. 74, 46(2) cisg, although no substitute delivery was requested but price reduction under art. 50 cisg. 137 cf., polimeles protodikio athinon (multi-member court of first instance athens), 2009, 4505/2009, cisg-online 2228. 138 e.g., in bundesgerichtshof (german supreme court), 21 december 2011, viii zr 70/08, the initial price of the goods, floor tiles, was eur 1.190. they were not in conformity with the contract and needed to be removed. the buyer claimed damages in the amount of eur 5.830 for new tiles and retrofitting. prior to the bundesgerichtshof, the european court of justice dealt with this case in gebr. weber gmbh v jürgen wittmer (c-65/09) and ingrid putz v medianess electronics gmbh (c-87/09), european court of justice, 16 june 2011. 139 directive 1999/44/ec of the european parliament and of the council of 25 may 1999 on certain aspects of the sale of consumer goods and associated guarantees, succeeded by directive 2019/771 of the european parliament and of the council of 20 may 2019. 140 gebr. weber gmbh v. jürgen wittmer (c-65/09) and ingrid putz v. medianess electronics gmbh (c-87/09), european court of justice, 16 june 2011. the argument was primarily based on the wording of art. 3(3) directive 1999/44/ec, granting the consumer the 73 cisg-ac opinion 21 but it prompted the german legislator to revise the provisions in the german bgb in 2016, applicable to b2c and b2b contracts.141 the amendment was arguably based on the fact that limiting the application of the ecj’s judgment to b2c contracts may eventually preclude service providers facing consumer claims to recover damages from the retailer, in light of the fault principle applicable in german law.142 3.39 these considerations do not have any bearing under the cisg. under the cisg’s principle of strict liability, the seller of the goods is responsible for any non-conformity. it is not exempted under article 79 cisg if the non-conformity must be attributed to its supplier or the manufacturer of the goods.143 the full compensation principle of articles 74 cisg et seq. may encompass the claim for damages covering costs of retrofitting and installation.144 this claim for damages requires, right to require the seller to repair the goods or to replace them free of charge, unless that is impossible or disproportionate, para. 45. the same conclusion was reached as regards swedish law in a recent swedish supreme court case, högsta domstolen (swedish supreme court), 17 july 2018, nja 2018 s. 653. the case dealt with a service contract where one contractor made a wrongful installation of pipes in a floor later filled with concrete by another contractor engaged by the buyer. the contractor had to pay the costs for breaking up the floor, reinstalling the pipes and then cast the new concrete floor. in a sale of goods under swedish law, as well as danish and norwegian law, this would be regarded as costs of repair. 141 deutscher bundestag, drucksache 18/8486. the revised provision in sect. 439(3) bgb is in force since 1 january 2018. the german legislator chose to apply the revision also to business contracts to secure the right to redress, deutscher bundestag, drucksache 18/8486, 39. 142 under the fault principle in german law, the seller, as a retailer, usually cannot be found to be at fault for a breach caused by the manufacturer. the legislative action is perceived differently: some authors welcome the step, especially with regard to an economic analysis of the decision to make the manufacturer of the goods liable, florian bien, haftung für reine vermögensschäden in der absatzkette, zeitschrift für europäisches privatrecht 2012, 644, 649 et seq.; gerhard wagner, der verbrauchsgüterkauf in den händen des eugh: überzogener verbraucherschutz oder ökonomische rationalität?, zeitschrift für europäisches privatrecht 2016, 87, 102 et seq.; others criticize the approach stephan lorenz, einund ausbauverpflichtung des verkäufers bei der kaufrechtlichen nacherfüllung – ein paukenschlag aus luxemburg und seine folgen, neue juristische wochenschrift 2011, 2241; dagmar kaiser, eugh zum austausch mangelhafter eingebauter verbrauchsgüter, juristenzeitung 2011, 978. 143 this is fundamentally different from german law: liability of the seller does not include the supplier or manufacturer of the goods, bundesgerichtshof (german supreme court), 21 june 1967, viii zr 7, neue juristische wochenschrift 1967, 1903 et seq.; bundesgerichtshof (german supreme court), 15 july 2008, viii zr 211/07, neue juristische wochenschrift 2008, 2837 et seq. 144 e.g., oberster gerichtshof (austrian supreme court), 15 january 2013, 4 ob 208/12k, cisg-online 2398; oberlandesgericht (court of appeal) hamm, 9 june 1995, 11 u 191/94, cisg-online 146; brunner/akikol/bürki, in brunner/gottlieb, (n. 31), art. 46 para. 24; atamer, replacement of non-conforming goods ‘free of charge’: is there a need to njcl 2021/1 74 first, foreseeability of the resulting damages as a possible consequence of the breach.145 the decisive question is what a reasonable person in the shoes of the promisor and aware of the circumstances at the time of the conclusion of the contract ought to have foreseen.146 hence, the seller must have foreseen the retrofitting and installation. for example, in a sale of pipes, usable in many different ways, it is highly questionable whether the seller foresaw or ought to have foreseen that the pipes in one case were to be used on a construction site underwater. without having provided additional information, the seller in such a case is unlikely to be held liable for the costs required to reach the pipes underwater. 3.40 furthermore, as regards damages the buyer needs to adhere to article 77 cisg. it must take reasonable measures to mitigate the loss. regarding retrofitting, the issue may arise whether the seller or the buyer is liable for defective retrofitting by a service provider. 3.41 treating costs for retrofitting as damages is especially important where the parties agreed on a cap on damages below the costs of retrofitting. in such a case the seller is not obliged to pay above the cap if the interpretation of the clause providing for the cap on damages affirms the application of the cap in this scenario (cf., above at para. 3.29). 3.42 the general rule that retrofitting costs may be recovered by the buyer in a claim for damages does not apply where in a mixed contract the seller has undertaken the obligation to install the goods. in this scenario the seller was initially obliged to bear the costs for installation. the same rule must apply when it comes to cure.147 cc) restitution of non-conforming goods or non-conforming parts of the goods to the seller (1) general rules 8. in cases of delivery of substitute goods, or repair of the goods by delivery of substitute parts, a. the buyer must make restitution to the seller of the goods or parts first delivered; b. the seller must take back the goods or parts first delivered; differentiate between b2b and b2c sales contracts? (n. 97), 8. see more general, müller-chen, in schlechtriem & schwenzer (n. 4), art. 46 para. 36; magnus, in staudinger bgb (n. 32), art. 46 para. 50; schlechtriem/schroeter (n. 87), para. 459. alternatively to art. 74 cisg et seq., one may argue that costs of retrofitting are covered by a claim for reimbursement directly based on art. 46 cisg, cf. for this discussion atamer, replacement of non-conforming goods ‘free of charge’: is there a need to differentiate between b2b and b2c sales contracts? (n. 97), 7. 145 schwenzer, in schlechtriem & schwenzer (n. 4), art. 74 para. 50. 146 schwenzer, in schlechtriem & schwenzer (n. 4), art. 74 para. 51. 147 hence, the above comments on costs of repair and delivery of substitute goods can be applied. 75 cisg-ac opinion 21 c. the costs of restitution must be borne by the seller. 3.43 in case of delivery of substitute goods or repair of the goods by delivery of substitute parts, the initial delivery is wound up. article 46 cisg does not address this winding up, but section v does so. their principles must be applied to the delivery of substitute goods or repair of the goods by delivery of substitute parts even though the heading of their section v refers to avoidance only.148 however, its underlying purpose, dealing with the winding up, applies to those goods and parts substituted in the case of article 46 cisg. 3.44 rule no. 8 litera a requires restitution to the seller. although not expressly requiring the return, article 46 cisg is predicated on the assumption of restitution.149 the application of article 82 cisg in the case of article 46(2) cisg is made clear by the wording of article 82 cisg and was already favoured in the secretariat’s commentary.150 the same must apply where the goods are repaired by delivery of substitute parts. in both cases restitution will usually be in the interest of the parties. the buyer may not be interested in keeping the goods, since additional costs for storage or destruction may occur, and the seller instead may be able to make use of the goods returned.151 if it is impossible for the buyer to make restitution of the goods substantially in the condition in which it received them, it loses the right to require the seller to deliver substitute goods, according to article 82 cisg.152 3.45 correspondingly, under rule no. 8 litera b, the seller bears a duty to take back the goods. restitution reverses the initial sale, at least for the non-conforming parts of the goods.153 if the seller does not take back the goods the buyer may be obliged under articles 86–88 csig to dispose of or preserve the goods.154 hence, if the seller is unreasonably delayed 148 see above rule no. 4 and its comments. 149 müller-chen, in schlechtriem & schwenzer (n. 4), art. 46 para. 34. 150 secretariat’s commentary (n. 11), art. 42 para. 13, refering to art. 67 (now art. 82 cisg). see also cisg-ac opinion no. 9 (n. 103), para. 3.19 et seq. 151 generally, the buyer has no right to insist that the goods in restitution be returned concurrently against the delivery of substitute goods. the norwegian proposal under art. 81(2) cisg in regard to the delivery of substitute goods was rejected, official records (n. 10), 136, 387. however, if the non-conforming delivery occurred by concurrent exchange for payment of the purchase price, an exception appears justified in regard to the initial agreement of the parties, brunner/akikol/bürki, in brunner/gottlieb (n. 31), art. 46 para. 25. 152 see above rule 4. 153 cisg-ac opinion no. 9 (n. 103), para. 3.7 et seq. the requirement of taking back the initial goods can also result from prior usage between the parties, handelsgericht (commercial court) des kantons zürich, hg010395/u/zs, 24 october 2003, cisgonline 857. 154 art. 86 cisg applies in case of art. 46 cisg, klaus bacher, in schlechtriem & schwenzer (n. 4), art. 86 para. 5. njcl 2021/1 76 taking back the goods, the buyer may sell them by any appropriate means, in accordance with article 88(1) cisg. in case of disposal, the costs of disposal are borne by the non-performing party, i.e., the seller, in accordance with general principles.155 3.46 rule no. 8 litera c clarifies that the costs of the restitution must be borne by the seller, i.e., the party in breach. in the case of avoidance, it is questionable who should bear the costs of restitution. some scholars argue that generally, the party in breach should bear the costs.156 others argue that it is the party declaring avoidance that bears the costs – under the assumption that this party has a damages claim.157 however, the delivery of substitute goods or repair of the goods by delivery of substitute parts differs from avoidance: first, the buyer upholds the initial contract, and second, the seller always breached the contract. especially the latter aspect justifies the general rule that the costs of the restitution in case of delivery of substitute goods or repair of the goods by delivery of substitute parts must be borne by the seller.158 the claim for recovery of these costs is not a claim for damages. 3.47 finally, the place of performance for restitution needs to be determined. most scholars and case law agree that this is a question governed by the cisg159 but differ in determining the place of performance for restitution. similar to the dispute on costs of the restitution, some scholars favor determining the place in reversal to the initial contract, arguing that restitution is the reversal of the initial contract.160 others argue that the determination depends on the evaluation 155 cisg-ac opinion no. 9 (n. 103), para. 3.16 et seq. 156 cf., cisg-ac opinion no. 9 (n. 103), para. 3.16 et seq. 157 fountoulakis, in schlechtriem & schwenzer (n. 4), art. 81 para. 33. 158 in practice, there may be difficulties in differentiating between costs of retrofitting and restitution costs. the circumstances of the case will guide this determination – led by the questions where the focus of the individual circumstances is. 159 oberster gerichtshof (austrian supreme court), 29 june 1999, 1 ob 74/99k, cisgonline 483, relying on art. 7(2) cisg; brunner/santschi, in brunner/gottlieb (n. 31), art. 81 para. 8; rolf h. weber, in honsell (n. 88), art. 81 para. 21; huber, in huber/mullis (n. 59), 244; bridge, in kröll/mistelis/perales viscasillas (n. 5), art. 81 para. 23; huber, in münchener kommentar zum bgb (n. 31), art. 81 para. 15; schlechtriem/schroeter (n. 87), para. 777 et seq; fountoulakis, in schlechtriem & schwenzer (n. 4), art. 81 para. 26; cf., also cisg-ac opinion no. 9 (n. 103), para. 3.12. but see cour d’appel (court of appeal) de grenoble, 94/3859, 23 october 1996, cisgonline 305, applying the unidroit principles. 160 weber, in honsell (n. 88), art. 81 para. 21; huber, in huber/mullis (n. 59), 244; huber, in münchener kommentar zum bgb (n. 31), art. 81 para. 15; mankowski, in münchener kommentar zum hgb, band 5 (4th ed., münchen 2018), art. 81 para. 8; schlechtriem/schroeter (n. 87), para. 778; fountoulakis, in schlechtriem & schwenzer (n. 4), art. 81 para. 26; magnus, in staudinger bgb (n. 32), art. 81 para. 19. 77 cisg-ac opinion 21 of the party in breach.161 the place of performance should be at the place of the party not in breach. this approach values the adherence to the contract by the party not in breach.162 this latter approach is more convincing regarding the delivery of substitute goods or repair of the goods by delivery of substitute parts. again, the differences between avoidance and delivery of substitute goods, i.e., the contract is upheld, and the seller is in breach, speak against the mere reversal of the initial contract. (2) benefits and betterment 9. the buyer is not bound to a. make restitution of benefits derived from the substituted nonconforming goods or parts first delivered; b. account for any betterment caused by the delivery of substitute goods, or repair of the goods by delivery of substitute parts. 3.48 rule nos. 4 and 8 clarify that article 82 cisg applies to both the delivery of substitute goods and repair of the goods by delivery of substitute parts. therefore, the question may arise whether in these cases the buyer is bound to account for benefits it has derived from the goods originally delivered according to article 84(2) cisg. likewise, it may be questionable whether the buyer must account for any betterment in such cases. 3.49 rule no. 9 litera a discharges the buyer of making restitution of benefits derived from the substituted non-conforming goods or parts first delivered. benefits are all sorts of advantages derived from the substituted non-conforming goods or parts first delivered, including external advantages. benefits must be excluded from restitution since they are covered by the initial contract. the buyer was entitled to receive the benefits under the contract. since the contract is upheld, unlike in the case of avoidance, there is no ground for restitution of these benefits. the buyer’s right to benefit from the goods does not become unjustified by requesting delivery of substitute goods. also, the seller would be rewarded for not performing as required if it were to enjoy the benefits.163 therefore, the seller’s claims for restitution of benefits must be rejected in cases of 161 brunner/santschi, in brunner/gottlieb (n. 31), art. 81 para. 8; christian thiele, erfüllungsort bei der rückabwicklung von vertragspflichten nach art 81 un-kaufrecht, recht der internationalen wirtschaft 2000, 892, 895. 162 thiele, erfüllungsort bei der rückabwicklung von vertragspflichten nach art 81 un-kaufrecht, (n. 163), 895. 163 in parallel, the seller is not bound to refund the price and pay interest under art. 84(1) cisg in case of delivery of substitute goods or parts, bridge, in kröll/mistelis/perales viscasillas (n. 5), art. 84 para. 17. bridge, however, also provides a theoretical example to the contrary. njcl 2021/1 78 delivery of substitute goods or parts. article 84(2)(a) cisg does not apply in these cases.164 3.50 under rule no. 9 litera b the buyer is not bound to account for any betterment caused by the delivery of substitute goods or repair of the goods by delivery of substitute parts. betterment covers all sorts of improvements made to the delivered goods and other goods or values. the substituted goods have a longer lifetime than the original ones and, thus, cause betterment. another example is a substitution with a newer and better model of the goods.165 some scholars favor the buyer’s payment for betterment in any case.166 one may rely on the difference to rule no. 9 litera a, i.e., that the betterment derives from the new, not the originally delivered goods. the buyer was, thus, not directly entitled to receive the betterment under the contract. other scholars deny the payment for betterment167 because the betterment is forced upon the buyer.168 a third approach is to differentiate according to whether “the buyer enjoys an actual financial benefit from the substitute goods”.169 under this approach, only if the buyer enjoys, for example, a higher production outcome due to higher capacity of the replacement goods, or a higher profit margin due to the better model, the seller should have the right to claim for the price difference between the new and the old model. in light of the performance principle and the seller’s general warranty for the conformity of the goods under the cisg, however, it is most convincing to discharge the buyer from any accounting of betterments. the seller, i.e., the party in breach, fulfills its obligation under article 46(2) cisg. betterment is indeed a byproduct of the fact that the seller is unable to make a different substitution. the buyer does not intend to buy better and new goods. one would have 164 bridge, in kröll/mistelis/perales viscasillas (n. 5), art. 84 para. 17; brunner/santschi, in brunner/gottlieb (n. 31), art. 84 para. 7; huber, münchener kommentar zum bgb (n. 31), art. 84 para. 11; magnus, in staudinger bgb (n. 32), art. 46, para 48, art. 84 para. 20; weber, in honsell (n. 88), art. 84 para 12; schlechtriem/schroeter (n. 87), para. 781; mankowski, in münchener kommentar zum hgb (n. 162), art. 84 para. 12. however, mankowski suggests deducing any benefits from a claim for damages the buyer may additionally raise. 165 see atamer, replacement of non-conforming goods ‘free of charge’: is there a need to differentiate between b2b and b2c sales contracts? (n. 97), 12 et seq., for this example based on the volkswagen scandal in germany. 166 fountoulakis, in schlechtriem & schwenzer (n. 4), art. 84 para 5. 167 schlechtriem/schroeter (n. 87), para 781; huber, in münchener kommentar zum bgb (n. 31), art. 84, para. 11. see also schwenzer, in schlechtriem & schwenzer (n. 4), art. 74 para 44. 168 schwenzer, in schlechtriem & schwenzer (n. 4), art. 74 para 44. 169 atamer, replacement of non-conforming goods ‘free of charge’: is there a need to differentiate between b2b and b2c sales contracts? (n. 97), 24, referring to a parallel approach under english law, n. 86. 79 cisg-ac opinion 21 to assume such unfounded intention in order to make the buyer accountable for the betterment. dd) application of articles 38, 39 and 43 cisg 10. after substitution or repair, the buyer has to comply with the examination and notice requirements of articles 38, 39 and 43 cisg. in case of non-conformity of the goods the two-year cut off period (article 39(2) cisg) starts to run with the actual handing over of the substituted goods or repair. 3.51 articles 38, 39, and 43 cisg apply to goods that are delivered in substitution of the original goods as well as to the goods repaired.170 if the goods are still non-conforming the buyer may again make use of articles 45 cisg et seq.171 the costs of such an additional examination can be claimed as damages. 3.52 additionally, the two year cut off period under article 39(2) cisg applies anew.172 it generally starts to run with the actual handing over of the goods, i.e., the physical handing over.173 the purpose of article 39(2) cisg is to strike a fair balance and to protect buyers in cases where the defects are latent as well as to protect sellers against claims which arise long after the goods have been delivered.174 in cases of articles 46(2) and (3) cisg, these interests need to be protected regarding substituted or repaired goods. the physical handing over occurs anew in these cases. 3.53 if the substituted goods come from the same source as the goods first delivered it is questionable whether the seller is aware of any new lack of conformity or could not have been unaware of it, according to article 40 cisg. for example, in the case of non-conforming stones due to cracks in the stones that hinder processing the stones, this question arises if the delivery of substituted stones comes from the same rock as 170 cf., oberlandesgericht (court of appeal) nürnberg, 20 september 1995, 12 u 2919/94, cisg-online 267; landgericht oldenburg (district court oldenburg), 9 november 1994, 12 o 674/93, cisg-online 114; landgericht oldenburg (district court oldenburg), 6 july 1994, 12 o 3010/93, cisg-online 274; schlechtriem/schroeter (n. 87), para. 463. see also landgericht (district court) stendal, 12 october 2000, 22 s 234/99, cisg-online 592. 171 landgericht (district court) stendal, 12 october 2000, 22 s 234/99, cisg-online 592; müller-chen, in schlechtriem & schwenzer (n. 4), art. 46 paras. 37, 47; brunner/akikol/bürki, in brunner/gottlieb (n. 31), art. 46 para. 39; huber, in huber/mullis (n. 59), 203. 172 since this period should not be confused with the limitation periods, the seller’s interests and protection under any applicable limitation periods are not touched upon. 173 schwenzer, in schlechtriem & schwenzer (n. 4), art. 39 para. 25. 174 schwenzer, in schlechtriem & schwenzer (n. 4), art. 39 para. 23. njcl 2021/1 80 the stones first delivered.175 however, as article 40 cisg should be restricted to “special circumstances”,176 it will usually require more than the mere fact of the goods originating from the same source.177 ee) place of repair and delivery of substitute goods 3.54 it is commonly held that the place of repair is the buyer’s place of business, or where the goods are located.178 the place of delivery of substitute goods, however, is disputed. some scholars argue that the place of delivery of substituted goods should be the same as the place defined in the contract.179 thus, when the parties agree on exw, i.e., delivery at the seller’s premises, this determines the place of substitute delivery as well.180 however, under this approach the buyer is burdened with arrangements and risks – and at least in first place with costs. thus, the better view is to define the place of performance for the substitute delivery or repair as the place where the goods are located in accordance with the contract.181 this may save additional costs when disposing the goods in the local market182 and may even be more sustainable. the place where the goods are currently located can, however, be decisive only if the seller knew or could not have been unaware of the prospective location of the goods at the time of the conclusion of the contract. if this is not the case, it should be the buyer’s place of business. ff) right to withhold performance 3.55 if the buyer has not fulfilled its obligation under the contract, i.e., usually payment, it may withhold performance until the seller 175 cf., landgericht (district court) stendal, 12 october 2000, 22 s 234/99, cisg-online 592. 176 beijing light automobile co., ltd v. connell limited partnership, arbitral award, stockholm chamber of commerce, 5 june 1998, cisg-online 379. 177 see landgericht (district court) stendal, 12 october 2000, 22 s 234/99, cisg-online 592, art. 40 cisg holding that the requirements of art. 40 cisg were not fulfilled. according to the court, the mere fact that the stones came from the same rock was not sufficient to demonstrate that the seller knew or could not have been unaware of the lack of conformity. in case of repair, however, art. 40 cisg may apply where the buyer previously gave numerous notices and the seller tried to repair the same non-conformity without success, oberlandesgericht (court of appeal) zweibrücken, 29 october 2012, 8 u 22/10, cisg-online 2696. 178 huber, in münchener kommentar zum bgb (n. 31), art. 46 para. 61; magnus, in staudinger bgb (n. 32), art. 46 para. 66; müller-chen, in schlechtriem & schwenzer (n. 4), art. 46 para. 45; schnyder/straub, in honsell (n. 88), art. 46 para. 104b et seq. 179 huber, in huber/mullis (n. 59), 203. 180 cf., cour d'appel (court of appeal) de paris, 4 march 1998, 97/24418, cisg-online 535. 181 brunner/akikol/bürki, in brunner/gottlieb (n. 31), art. 46 para. 38, with further references. 182 cisg-ac opnion no. 9 (n. 103), para. 3.12. 81 cisg-ac opinion 21 performed under articles 46(2) and (3) cisg.183 the prevailing view derives this right to withhold performance from numerous provisions in the cisg, which may be called a general principle under article 7(2) cisg.184 the right to withhold performance “enables the buyer to raise the objection that the contract has not been (properly) performed and to withhold his own performance until such time as the other party is prepared to render (simultaneous) performance”.185 2.2.5.e) seller’s right to cure under article 48 cisg 3.56 article 48 cisg lays down the seller’s right to cure. it is a manifestation of the principle of favor contractus and of restricting avoidance of the contract wherever possible. this requires co-ordination of the buyer’s right to avoid the contract under article 49 cisg, the buyer’s right to request delivery of substitute goods or repair under articles 46(2) and (3) cisg, and its right to claim damages under articles 74 et seq. cisg. additionally, article 48 cisg, together with article 47 cisg, is a “tool for cooperation”.186 articles 48(2) and (3) cisg shed some light on the regulation of the seller’s and buyer’s cooperation. aa) relation of articles 48 and 49 cisg 11. under article 48 cisg the seller has a right to cure “subject to article 49”. the seller’s right to cure is excluded in case of a fundamental breach of contract, i.e., the goods are not usable and the nonconformity is not curable in time. 3.57 according to article 48(1) cisg the seller’s right to cure is “[s]ubject to article 49”, i.e., the buyer’s right to avoid the contract is not excluded by the seller’s right to cure.187 this provision has proven to be highly controversial in scholarly writing.188 the controversy focuses on the 183 in general, on the buyer’s right to withhold performance cisg-ac opinion no. 5 (n. 2), para. 4.18 et seq. 184 cisg-ac opinion no. 5 (n. 2), para. 4.19. 185 oberster gerichtshof (austrian supreme court), 8 november 2005, 4 ob 179/05k, cisg-online 1156. but see zodiac seats us llc v. synergy aerospace corp., u.s. district court for the southern district of texas, 8 april 2020, cisg-online 5172, differentiating that “there is no cisg provision entitling a buyer to withhold the full contract price due to receipt of partially nonconforming goods”. 186 only on art. 48 cisg, honnold/flechtner (n. 8), art. 48 para. 292. 187 this wording was implemented during the final negotiations in vienna in 1980, official records (n. 10), 115, 351 et seq. and chosen “since the buyer must retain the right to declare the contract avoided”, 351, para. 9. 188 michael bridge, the international sale of goods (4th ed. oxford 2018), para. 12.28; michael bridge, avoidance for fundamental breach, 59 international and comparative law quarterly (2010) 911, 928 et seq.; ulrich magnus, aufhebungsrecht des käufers und nacherfüllungsrecht des verkäufers im un-kaufrecht, in ingeborg schwenzer/günter hager njcl 2021/1 82 differentiation between article 48(1) and 49 cisg, concretely whether the seller may cure under article 48 cisg in case of a fundamental breach. 3.58 some scholars argue that the seller’s right to cure in article 48(1) cisg is excluded by the mere existence of a fundamental breach without having regard to the curability of the breach.189 other approaches are, first, that the fundamentality of the breach depends on the seller’s failure to cure – and, therefore, the curability of the breach –,190 second, that the exclusion of article 48(1) cisg in case of a fundamental breach depends on the sequence of declarations (of articles 48 and 49 cisg),191 and third, to weigh the relevance of non-conformity against the modalities of cure.192 all these approaches should be rejected with regard to a ‘simple’ fundamental breach, i.e., a breach only relating to the non-conformity while cure of the breach is possible. in addition to such breach, time must be of the essence.193 without this requirement, the seller’s right to cure could be “nullified” by an “unqualified application of art[icle] 49(1) [cisg]”.194 where time is of the essence, e.g., in case of an annual fair, the buyer may only declare avoidance if the non-conforming goods, i.e., goods for the fair, are not usable and not curable on time for the fair.195 if the goods are (eds.), festschrift für peter schlechtriem (tübingen 2003), 599, 602 et seq.; florian faust, specific performance, in schwenzer/atamer/butler (n. 40), 235, 242 et seq.; magnus, in staudinger bgb (n. 32), art. 48 para. 18 et seq.; müller-chen, in schlechtriem & schwenzer (n. 4), art. 48 para. 14 et seq. 189 cf., faust (n. 190), 242; müller-chen, in schlechtriem & schwenzer (n. 4), art. 48 para. 17. both emphasize the buyer does not need to declare avoidance. 190 martin karollus, un-kaufrecht: vertragsaufhebung und nacherfüllungsrecht bei lieferung mangelhafter ware, zeitschrift für wirtschaftsrecht, 1993, 490, 495 et seq. in this direction also honnold/flechtner (n. 8), art. 48 para. 296; huber, in münchener kommentar zum bgb (n. 31), art. 48 para. 11. 191 cf., huber, in münchener kommentar zum bgb (n. 31), art. 49 para. 33, for an overview. the author concludes, however, that the sequence of declarations should not be decisive. the above approach would lead to an unpractical race between seller and buyer without balancing their interests. (in addition, the drafting history demonstrates that the declaration of avoidance is not decisive for this differentiation as the delegates favored to delete the requirement of a declaration in the previous art. 44(1) sentence 1 1978 draft convention; see in detail also hartmann, beck online großkommentar (n. 43), art. 48 para. 17; brunner/akikol/bürki, in brunner/gottlieb (n. 31), art. 48 para. 11.) 192 landgericht (district court) linz, 30 june 2010, 5 cg 176/06m-62, cisgonline 3008: where the relevance of non-conformity prevails the buyer may avoid, and where the modalities of cure, i.e., the possibility to cure, prevail, art. 48(1) cisg should apply, schnyder/straub in honsell (n. 88), art. 48 para. 17 et seq., art. 49 para. 23. in this direction also huber, in münchener kommentar zum bgb (n. 31), art. 49 para. 28 et seq. 193 alternatively, if the seller does not cure within the time limit set by the buyer under art. 47(1) cisg or within its own time limit under art. 48(2) cisg. 194 honnold/flechtner (n. 8), art. 48 para. 296 n. 5. 195 usable is not to be confused with repairable, since repair will usually not be in the interest of the buyer due to the amount of time this would require. usability refers to the purpose of the contract, see above at 3.20 et seq. 83 cisg-ac opinion 21 usable, the buyer is limited to claim damages or reduction of the purchase price. fundamentality here is, hence, composed of non-usability and noncurability (in time). the requirement of time being of the essence safeguards an equal treatment of the seller and the buyer and balances their interests and upholds the principle of favor contractus. both parties’ interests are to fulfill the contract. unless time is of the essence, there is no reason to limit the seller’s right to cure in article 48 cisg. 3.59 therefore, the friction between the seller’s right to cure and the buyer’s right to avoid the contract under article 49(1)(a) cisg mainly depends on the definition of a fundamental breach.196 if a fundamental breach is denied in cases where cure is possible, and the seller is willing to perform cure within the limits of article 48(1) cisg, at least in practice, the controversy of the relation of articles 48 and 49 cisg proves to be fruitless. in the end, the buyer may only avoid the contract if the nonconformity amounts to a fundamental breach, i.e., goods being not usable and the non-conformity not being curable in time.197 bb) seller’s right to choose 12. if both delivery of substitute goods and repair are adequate to remedy the non-conformity of the goods the seller may choose between the two remedies. 3.60 in the case of non-conforming goods, cure may either take the form of delivery of substitute goods or repair. as described above, the 196 schroeter, in schlechtriem & schwenzer (n. 4), art. 25 para. 47 et seq.; müller-chen, in schlechtriem & schwenzer (n. 4), art. 48 para. 18. the predominant case law arguing that the right to avoid the contract trumps the seller’s right to cure must be analyzed under this clarification. see in particular international chamber of commerce (icc) international court of arbitration, 1994, cisg-online 565, and also oberster gerichtshof (austrian supreme court), 22 november 2011, cisg-online 2239; bundesgericht (swiss supreme court), 18 may 2009, cisg-online 1900; gerechtshof (court of appeal) arnhem, 7 october 2008, cisg-online 1749; cámara nacional de apelaciones en lo comercial (national court of appeal), 31 may 2007, cisgonline 1517; handelsgericht (commercial court) des kantons aargau, 5 november 2002, cisg-online 715; oberlandesgericht (court of appeal) köln, 4 october 2002, cisg-online 709; oberlandesgericht (court of appeal) koblenz, 31 january 1997, cisg-online 256. this case law shifts the relevant question to art. 25 cisg and whether there can be a fundamental breach if non-conformity can be cured in a reasonable manner. most cases deny this, unless time is of the essence. 197 cf., cisg-ac opinion no. 5 (n. 2), para. 4.4. in this direction also oberlandesgericht (court of appeal) linz, 18 may 2011, 1 r 181/10h, cisg-online 2443, denying a fundamental breach since the goods were usable and defects curable; handelsgericht (commercial court) des kantons, 5 november 2002, or.2001.00029, cisg-online 715, also denying a fundamental breach due to the fact that the goods were repairable and usable; peter huber, typically german? – two contentious german contributions to the cisg, njcl 2021/1 84 buyer may only require delivery of substitute goods where the nonconformity amounts to a fundamental breach of contract, especially where repair of the goods is not possible,198 and delivery of substitute goods is not disproportionate.199 the buyer may also require repair, subject to reasonableness.200 if both delivery of substitute goods and repair are available, the seller generally has the choice between the two forms of remedying the non-conformity.201 3.61 the seller’s choice depends on the potential quality of cure.202 both delivery of substitute goods and repair must be “adequate to remedy the non-conformity”. it is in the buyer’s interest that only where both manners of cure would be in line with article 35 cisg, the seller may choose. another criterion for the quality of cure could be the sustainability of either method of cure. at least where sustainability is a principle underlying the contractual relationship in question – for example where the contract explicitly refers to sustainability goals –, the method that is more sustainable may be the only adequate one. 3.62 in practice, the seller may use its right to choose only if it prefers the delivery of substitute goods to repair. if the buyer requires the delivery of substitute goods, implying that repair is not adequate, the seller must act in accordance with the buyer’s request. however, if the buyer requires repair, the seller may generally respond by offering delivery of substitute goods instead. the aim of limiting the buyer’s right to require delivery of substitute goods protects the seller.203 if the seller itself prefers delivery of substitute goods to repair and delivery of substitute goods is adequate 59 annals of the faculty of law in belgrade international edition (2011), 150, 154 et seq. on “reasonable use”. but see pattison outdoor advertising lp v. zon led lcc, supreme court of british columbia, 6 april 2018, cisg-online 3224, where a ‘simple’ fundamental breach justified avoidance, although the seller was in the process of curing. it should be noted that the court relied on other decisions not applying the cisg. 198 see above rule no. 3 and comments thereon. 199 see above rule no. 5 and comments thereon. 200 see above rule no. 6 and comments thereon. 201 cf., cour d'appel (court of appeal) de grenoble, 26 april 1995, 93/4879, cisgonline 154. the buyer requested substitute delivery (restoring a warehouse to a new state) but the court ruled that repair of some parts of the warehouse was sufficient under art. 46(3) cisg – otherwise the buyer would have been placed 40 times better. müllerchen, in schlechtriem & schwenzer (n. 4), art. 48 para. 6, emphasizing that the manner of cure must remedy the defect completely; faust (n. 190), 241. in general, huber, in kröll/mistelis/perales viscasillas (n. 5), art. 46 para. 42, art. 48 para. 25 et seq. 202 cf., bridge, curing a seller’s defective tender or delivery of goods in commercial sales (n. 125), 234, using the criterion of quality for differentiation between art. 48 and 49 cisg. rule no. 11 deals with this differentiation. according to bridge, poor cure is not effective. for the opposing view see secretariat’s commentary (n. 11), art. 44 para. 4. 203 the requirement of a fundamental breach in art. 46(2) cisg and the high threshold to approve a fundamental breach serve this protection. 85 cisg-ac opinion 21 within the limits of article 48(1) cisg, it is usually not to the detriment of the buyer.204 rather, the buyer benefits from this manner of cure. cc) limitation of the seller’s right to cure 3.63 article 48(1) cisg limits the seller’s right to cure to cases where it “can do so without unreasonable delay and without causing the buyer unreasonable inconvenience or uncertainty of reimbursement by the seller of expenses advanced by the buyer”. the following explanations are mere examples of interpreting the wording. it is not an exclusive interpretation limited to these scenarios. 3.64 first, cure must be effected “without unreasonable delay”, article 48(1) cisg. it has been argued in scholarly writing that the reasonable time in article 48(1) cisg has to be determined “according to the standard that is also used for the additional period of time in article 47(1)”.205 however, this approach disregards the different functions of these two periods. article 47(1) cisg binds the buyer and seeks to protect the seller in being granted enough time to perform its obligations.206 on the contrary, article 48(1) cisg protects the buyer; how long can the buyer reasonably be expected to accept cure by the seller? these different purposes do not require the two periods in articles 48(1) and 47(1) cisg to be of the same length.207 rather, unreasonable delay in article 48(1) cisg should be found where after a certain date the buyer can no longer be expected to accept performance by the seller.208 thus, the question is whether, at the time of cure effected by the seller, the buyer would be substantially deprived of what it can expect under the contract.209 204 if the manner of cure leads to a detriment for the buyer, it might be considered an unreasonable inconvenience under art. 48(1) cisg. 205 müller-chen, in schlechtriem & schwenzer (n. 4), art. 48 para. 10. see also huber, in kröll/mistelis/perales viscasillas (n. 5), art. 48 para. 9; christoph benicke, in münchener kommentar zum hgb (n. 162), art. 48 para. 8. 206 brunner/akikol/bürki, in brunner/gottlieb (n. 31), art. 47 para. 1. cf., official records (n. 10), 339 para. 4 et seq. 207 this is compatible with the drafting history requiring a flexible approach in art. 48(1) cisg, official records (n. 10), 351 para. 9. 208 cf. amtsgericht (local court) münchen, 23 june 1994, 271 c 18968/94, cisg-online 368. the mere fact that cure by the buyer or by a third person can be effected faster does not render the delay in itself unreasonable. but see salger, in witz/salger/lorenz (n. 31), art. 48 para. 3. 209 the delay is usually unreasonable if it amounts to a fundamental breach, handelsgericht (commercial court) des kantons zürich, 10 february 1999, hg 970238.1 cisg-online 488; huber, in kröll/mistelis/perales viscasillas (n. 5), art. 48 para. 9. the fact that the draft wording of art. 48 csig (i.e., art. 44 1978 draft convention) foresaw the delay amounting to a fundamental breach but had been changed does not exclude either statements. the draft wording of art. 48 cisg was: “without such delay as will amount to a fundamental breach of contract”. it had been changed because the double reference to art. 49 cisg and a fundamental breach in art. 48(1) cisg appeared inappropriate, see official records (n. 10), 351 para. 9. njcl 2021/1 86 thereby, the individual circumstances of the case must be taken into account;210 there is no definite point in time from which the delay should be calculated. in other words, an unreasonable delay can only be assumed where time is of the essence at the point in time when cure would be effected. to give an example: the buyer has ordered goods to be delivered on 1 april, goods which the buyer must deliver to a sub-buyer on 1 may, without having any other reasonable use for them. albeit the original delivery date not being of the essence, cure of non-conformity would be unreasonably delayed if it could not be effected before delivery to the subbuyer is due. 3.65 further, the seller is not allowed to cure if this implies any other unreasonable inconvenience to the buyer. in general, the term “unreasonable inconvenience” is to be understood in the same manner as in article 37 cisg.211 cases of “unreasonable inconvenience” occur where repair causes suspension or disruption of buyer’s production,212 buyer’s customers are threatening with actions for damages,213 or obviously unprofessional actions by the seller lead to several attempts of subsequent performance.214 most importantly, unreasonable inconvenience can be found where the buyer has lost trust in the seller’s ability or willingness to cure.215 however, the loss of trust must be reasonable in itself.216 otherwise it would be possible to circumvent the requirement of reasonableness in article 48 cisg. thereby, it is not the buyer’s point of view whether it lost trust in the seller, but rather the point of view of a reasonable third person in the shoes of the buyer is decisive.217 altogether, 210 the circumstances of each individual case are relevant for all three alternatives of reasonableness in art. 48 cisg, will, in bianca/bonell (n. 116), art. 48 para. 2.1.1.1.2. 211 huber, in münchener kommentar zum bgb (n. 31), art. 48 para. 7. 212 honnold, john o., uniform law for international sales (2nd ed., alphen aan den rijn 1991), art. 37 para. 245. 213 amtsgericht (local court) münchen, 23 june 1995, 271 c 18968/94, cisgonline 368. 214 bundesgerichtshof (german supreme court), 24 september 2014, viii zr 394/12, cisg-online 2545; müller-chen, in schlechtriem & schwenzer (n. 4), art. 48 para. 11, with further references; benicke, in münchener kommentar zum hgb (n. 162), art. 48 para. 7. further, “unreasonable inconvenience” can be found where the seller made an inadequate offer to cure, see tribunale (district court) di forli, 11 december 2008, 2280/2007, cisg-online 1729. 215 landgericht (district court) stade, 15 may 2014, cisg-online 2988; huber, in kröll/mistelis/perales viscasillas (n. 5), art. 48 para. 10. already, the delegates in vienna accepted that the seller should not be able to remedy where the buyer lost confidence in the seller’s ability to cure, official record (n. 10), 342 para. 52. 216 a merely subjective loss of trust should not be sufficient, schnyder/straub, in honsell (n. 88), art. 48 para. 25. 217 this objective perspective is generally decisive for determining reasonableness, landgericht (district court) stade, 15 may 2014, 8 o 70/13, cisg-online 2988; müllerchen, in schlechtriem & schwenzer (n. 4), art. 48 para. 9; magnus, in staudinger bgb (n. 32), art. 48 para. 14; schlechtriem/schroeter (n. 87), para. 449 n. 260. 87 cisg-ac opinion 21 it is to be considered that it is the seller’s right to cure. an “unreasonable inconvenience” may not only be inferred from the mere fact that cure by the buyer or a third person would be less burdensome for the buyer.218 likewise, the unsuccessful attempt of the first action by the seller itself does not lead to unreasonableness.219 3.66 finally, the seller may not cure the non-conformity if it causes uncertainty of reimbursement of expenses advanced by the buyer. it must be emphasized in the first place that the seller itself must bear all costs of remedying the failure to perform.220 thus, cases will be rare where the buyer has to advance expenses. possible situations are the buyer must dismantle the defective product, bear possible transportation costs to have the product repaired by the seller,221 disruption of production,222 or additional manpower is required on the side of the buyer. if the buyer raises the issue of insecurity of reimbursement of expenses, the seller may dismiss the buyer’s argument by giving adequate assurance of reimbursement of the buyer’s costs.223 dd) application of article 47(1) cisg 13. the buyer may fix an additional period of time of reasonable length for delivery of substitute goods or repair (article 47(1) cisg). however, it is not obliged to do so. subject to article 77 cisg and the seller’s right to cure under article 48 cisg, the buyer may instead immediately have recourse to other remedies available, such as damages or reduction of the purchase price. 3.67 in line with the clear wording of article 47(1) cisg,224 and the purpose of article 47 cisg, to offer another possibility for the buyer to initiate cure, fixing a period of time and using article 47(1) cisg cannot 218 for the opposing view see salger, in witz/salger/lorenz (n. 31), art. 48 para. 3. 219 cf. honnold/flechtner (n. 8), art. 37 para. 247; urs gruber, in münchener kommentar zum bgb (n. 31), art. 37 para. 14. 220 see above paras. 3.36 et seq. and oberlandesgericht (court of appeal) hamm, 9 june 1995, 11 u 191/94, cisg-online 146; huber, in kröll/mistelis/perales viscasillas (n. 5), art. 48 para. 20. 221 brunner/akikol/bürki, in brunner/gottlieb (n. 31), art. 48 para. 7. 222 müller-chen, in schlechtriem & schwenzer (n. 4), art. 48 para. 12. 223 bridge, curing a seller’s defective tender or delivery of goods in commercial sales (n. 125), 230. the adequate assurance would be the same as in arts. 71(3), 72(2) cisg. 224 “the buyer may fix an additional period of time” emph. add. thus, the secretariats commentary, art. 43 para. 8 stresses that “[i]n particular, the procedure envisaged by article 43 (i) is not mandatory”. njcl 2021/1 88 be mandatory.225 under article 47(1) cisg the buyer is “acting for the [seller’s] benefit, although not obliged to.”226 3.68 instead of fixing an additional period of time for the seller to perform, the buyer may immediately have recourse to other remedies. the circumstances may demand immediate repair or resale of the goods. such circumstances may be a factor in determining whether it would be unreasonably inconvenient to the buyer for the seller to remedy its failure to perform.227 however, even if the seller’s cure is not unreasonably inconvenient to the buyer, the question arises whether the buyer may resort to other remedies. the answer must be yes considering the wording and the drafting history of article 48(1) cisg, the general system of article 45(1) cisg and the fact that article 77 cisg offers a fruitful alternative to completely barring other remedies. 3.69 some scholars and case law228 deny the buyer’s right to opt for other remedies, arguing that the buyer’s remedies under article 45 cisg do not arise as long as the seller “has a right to cure”,229 that the seller’s right to cure is only limited by the buyer’s right to avoid the contract,230 or that article 80 cisg bars such a claim.231 however, neither the wording of article 48(1) cisg nor its drafting history reflect such a limited understanding. 3.70 first, the wording of article 48(1) cisg clarifies that cure is generally available even after the date of delivery. to this extent the provision accomplishes what article 37 cisg lays down for the time before the delivery date.232 additionally, the seller cannot cure when 225 oberlandesgericht (court of appeal) graz, 22 november 2012, 3 r 192/12y, cisgonline 2459; secretariat’s commentary (n. 11), art. 43 para. 8. 226 official records (n. 10), 339 para. 4. 227 see above para. 3.64 and also secretariat’s commentary (n. 11), art. 44 para. 9. 228 e.g., oberster gerichtshof (austrian supreme court), 14 january 2002, 7 ob 301/01t, cisg-online 643. 229 peter huber/markus altenkirch, buyer’s right to cure?, 4 european review of contract law (2008), 540, 544 et seq., see also miquel mirambell fargas, the seller’s right to cure under article 48 cisg (den haag 2018), 218. 230 marc-philippe weller/charlotte s. harms, der primat der nacherfüllung im gemeinsamen europäischen kaufrecht, zeitschrift für das privatrecht der europäischen union, 2012, 298, 300, relying on the wording of art. 48(1) cisg. 231 see in detail for an overview on this position and the first one till maier-lohmann, buyer’s self-repair of non-conforming goods versus seller’s right to cure under article 48 of the cisg, 24 uniform law review (2019), 59 et seq., who opposes both views. 232 art. 37 sentence 1 cisg reads: „if the seller has delivered goods before the date for delivery, he may, up to that date, deliver any missing part or make up any deficiency in the quantity of the goods delivered, or deliver goods in replacement of any non-conforming goods delivered or remedy any lack of conformity in the goods delivered, provided that the exercise of this right does not cause the buyer unreasonable inconvenience or unreasonable expense.“ 89 cisg-ac opinion 21 article 49 cisg applies.233 the wording of article 48(1) cisg is silent on any right of the buyer to cure234 and to make use of other remedies. yet, under article 48(1) sentence 2 cisg, the buyer retains any right to claim damages as provided for in the cisg. this right to request damages is not limited under article 48(1) cisg.235 especially, the limitations of article 47(2) sentence 2 or article 48(2) sentence 2 cisg do not apply, as the seller has no reason to rely on its second chance to perform in the situation of article 48(1) cisg.236 3.71 second, the drafting history demonstrates that article 48(1) cisg relates to the differentiation with article 49 cisg. in this regard, the delegates in vienna denied that the seller’s right to cure should prevail over the buyer’s right to avoid the contract.237 one may conclude that the cisg is, thus, “opposed to avoidance”238 but this does not lead to the conclusion that the buyer may not resort to other remedies. article 45(1) cisg offers the buyer the option to exercise the rights provided in articles 46 to 52 cisg or to claim damages as provided in articles 74 to 77 cisg, without any limitation of the buyer’s right to request damages only after having requested cure from the seller.239 delivery of non-conforming goods by the seller entitles the buyer to claim a sum equal to the loss suffered as a consequence of the breach. neither does the cisg distinguish between damages in lieu of performance and simple damages nor does it require the buyer to set a nachfrist before claiming damages in lieu of performance.240 therefore, there is no reason to exclude the buyer from invoking other remedies although the seller has a right to cure under article 48(1) cisg. 3.72 if the buyer unreasonably objects to the seller’s offer to cure under article 48(1) cisg, its claim for damages will be restricted by 233 hereby, art. 48(1) cisg clarifies that “[i]f the [goods] could be repaired within a few days, there was no fundamental breach”, as expressed by the delegation of the u.k. in the 1980 discussions in vienna, official records (n. 10), 342 para. 44. 234 honnold/flechtner (n. 8), art. 48 para. 296.1; to this extent in line with magnus, in staudinger bgb (n. 32), art. 48 para. 35. 235 till maier-lohmann, neuausrichtung der selbstvornahme und des art. 48 abs. 1 cisg, internationales handelsrecht 2018, 225, 228–229. 236 maier-lohmann, neuausrichtung der selbstvornahme und des art. 48 abs. 1 cisg (n. 237), 228–229. 237 official records (n. 10), 342 para. 64. 238 gyula eörsi, a propos the 1980 vienna convention on contracts for the international sale of goods, 31 the american journal of comparative law (1983), 333, 334. 239 till maier-lohmann, neuausrichtung der selbstvornahme und des art. 48 abs. 1 cisg (n. 237), 228. in this regard also honnold/flechtner (n. 8), art. 48 para. 296.1, arguing that “punishing buyers by denying damages […] would violate the mandate of article 7(1) to interpret the convention in a fashion that promotes good faith in international trade.” 240 peter huber/markus altenkirch, buyer’s right to cure? (n. 231), 544. the authors conclude, however, the opposite, that the buyer’s rights are limited by the seller’s right to cure. njcl 2021/1 90 article 77 cisg.241 applying article 77 cisg242 in these circumstances balances the economic interests of both parties: if the seller is able to repair the goods at a lower price than the buyer or a third party, the buyer may not be compensated for incurred higher costs.243 in fact, the application of article 77 cisg in the context of the delivery of substitute goods and repair was already proposed by the secretariat’s commentary on the 1978 draft convention. the commentary suggested that alternatively to the remedies in article 46 cisg, “the buyer may find it more advantageous to remedy the defective performance himself or to have it remedied by a third party. article [77], which requires the party who relies on a breach of contract to mitigate the loss, authorizes such measures to the extent that they are reasonable in the circumstances.”244 if the seller was able to cure but the buyer immediately had recourse to other remedies, this possibility has to be assessed under article 77 cisg.245 cure remains a concession to the seller, whereas requiring performance a right to the buyer.246 therefore, article 77 limits the buyer’s claim for damages in cases where the buyer’s direct recourse to other remedies, e.g., self-repair,247 is unreasonable. 241 maier-lohmann, buyer’s self-repair of non-conforming goods versus seller’s right to cure under article 48 of the cisg (n. 233), 66; honnold/flechtner (n. 8), art. 48 para. 296.1. 242 it is questionable whether art. 77 cisg is restricted to art. 74 cisg or whether it may also apply to art. 50 cisg to harmonize both solutions. the wording, the systematic position, and the drafting history of art. 77 cisg hinder the direct application to article 50 cisg, cf. secretariat’s commentary (n. 11), art. 73 para. 3; witz, in witz/salger/lorenz (n. 31), art. 77 para. 3; honnold/flechtner (n. 8), art. 77 para. 419.3. however, one may argue that the principle to mitigate damages laid down in art. 77 cisg is a general principle of the cisg (art. 7(2) cisg) and thus applies in comparable scenarios, cf. huber, in münchener kommentar zum bgb (n. 31), art. 77 para. 3; schwenzer, in schlechtriem & schwenzer (n. 4), art. 77 para. 4. 243 maier-lohmann, buyer’s self-repair of non-conforming goods versus seller’s right to cure under article 48 of the cisg (n. 233), 66. the buyer’s claim for damages will be reduced in line with art. 77 sentence 2. 244 secretariat’s commentary (n. 11), art. 42 para. 14. 245 rechtbank (district court) gelderland, 7296250, 25 january 2019, cisg-online 4400; rechtbank (district court) gelderland, 30 july 2014, c/05/250706 / ha za 13-630, cisg-online 2541; maier-lohmann buyer’s self-repair of non-conforming goods versus seller’s right to cure under article 48 of the cisg (n. 233), 70. 246 cf., bridge, curing a seller’s defective tender or delivery of goods in commercial sales (n. 125), 231. 247 see in general on the issue of damages in case of self-repair maier-lohmann, buyer’s self-repair of non-conforming goods versus seller’s right to cure under article 48 of the cisg (n. 233), for a similar approach and katarzyna kryla-cudna, damages for the cost of repair and the seller’s right to cure in international sales contracts, available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3521209 for the opposing approach. 91 cisg-ac opinion 21 ee) exclusion of other remedies 14. during a reasonable length of time fixed by the buyer under article 47 cisg or by the seller under article 48(2) cisg and expressly or implicitly accepted by the buyer, the buyer may not resort to any remedy inconsistent with cure. 3.73 article 47(1) as well as articles 48(2) and (3) cisg provide both parties with the opportunity to clarify any uncertainties regarding the performance of cure by setting a certain period of time. these provisions govern the situation in which the seller, after being notified according to article 39 cisg, offers cure (articles 48(2) and (3) cisg) or does not react (article 47(1) cisg). under article 47(1) cisg the buyer may fix an additional period of time of reasonable length for performance by the seller. under article 48(2) cisg the seller may request the buyer to make known whether it will accept cure within a specified period of time. according to article 48(3) cisg, the seller’s notice informing the buyer that it will perform within a specified period of time is assumed to include such a request. these provisions give legal effect to the communication between the parties in situations of cure.248 they seek to guarantee that during the respective periods of time the seller may cure without the buyer being able to resort to other remedies that would thwart the seller’s right to cure. during these periods, the seller reasonably relies on its second chance to perform and, thus, needs some form of protection. 3.74 in practice, conflicts may arise between the two parties setting different periods of time: the buyer may first set a period under article 47(1) cisg. as already mentioned, this period must be reasonable. what is reasonable must be determined on a case-by-case basis. relevant criteria are inter alia the nature of the goods, the initial length of the period to deliver, and the location of both parties and the goods (especially whether shipment is necessary or not).249 with regard to non-conformity, the additional period of time must give the seller a realistic opportunity to deliver substitute goods or repair the defective goods.250 if according to all these circumstances, the period is too short, it causes a reasonable period of time to commence.251 even if the seller does not react to the buyer setting this nachfrist period, the buyer is bound to its declaration during this period or – if it is too short – during a period of reasonable length. 248 honnold/flechtner (n. 8), art. 48 para. 297. an example where insufficient communication hindered seller’s right to cure is landgericht (district court) regensburg, 17 december 1998, 6 o 107/98, cisg-online 514. 249 huber, in kröll/mistelis/perales viscasillas (n. 5), art. 47 para. 10. 250 müller-chen, in schlechtriem & schwenzer (n. 4), art. 47 para. 6. 251 kantonsgericht (court of first instance) zug, 14 december 2009, a2 2001 105, cisg-online 2026; oberlandesgericht (court of appeal) naumburg, 27 april 1999, 9 u 146/98, cisg-online 512; müller-chen, in schlechtriem & schwenzer (n. 4), art. 47 para. 8. njcl 2021/1 92 however, if the seller simply rejects the buyer’s request for performance of cure (under article 47(1) cisg) without offering cure during an alternative period of time (under article 48(2) cisg), the buyer is no longer bound and may immediately resort to the remedies being otherwise available.252 first, in case of fundamentality of the non-conformity, these remedies could be avoidance or claim for damages calculated on the basis of a cover purchase. second, and in all other cases, the buyer may request a reduction of the purchase price or damages for the reduced value of the goods – the latter may be calculated on the basis of repair by a third party. however, if the seller, in turn, offers cure suggesting a longer period of time than the buyer’s period under article 47(1) cisg (constituting a request under article 48(2) cisg), it is now again the buyer’s turn to react within a reasonable time253 to this counter-proposal. if the buyer rejects the seller’s offer to cure within the specified period, the seller must perform cure within the reasonable time originally set by the buyer (under article 47(1) cisg).254 however, if the buyer does not react to the seller’s request under article 48(2) cisg, it may not, during that period, “resort to any remedy which is inconsistent with performance by the seller”.255 3.75 article 48(2) cisg also governs cases where the buyer did not set any additional period of time under article 47(1) cisg.256 if the buyer, in that situation, does not comply with the seller’s request within a reasonable time, the seller may perform within the time indicated in its request.257 if the buyer, however, objects, the seller may still perform within the time that is deemed to be reasonable under article 48(1) cisg. a conflict between articles 47(1) and 48(1) cisg does not arise since the buyer itself did not set a nachfrist. the buyer, in turn, may shorten this period by fixing itself an additional period of time of reasonable length under article 47(1) cisg. 252 the seller does not rely on its second chance to perform anymore and, thus, does not need any protection. 253 this period must be shorter than the period to cure itself, cf. huber, in kröll/mistelis/perales viscasillas (n. 5), art. 48 para. 32. 254 otherwise, the seller could circumvent the buyer’s proposed reasonable period of time in art. 47(1) cisg. 255 art. 48(2) sentence 2 cisg. 256 for example, handelsgericht (commercial court) aargau, 5 november 2002, or.2001.00029, cisg-online 715. 257 the purpose of art. 48(2) cisg is to protect the seller, müller-chen, in schlechtriem & schwenzer (n. 4), art. 48 para. 24. cisg advisory council opinion no 22 v2 1 cisg advisory council* opinion no. 22 the seller’s liability for goods infringing intellectual property rights under article 42 cisg * to be cited as: cisg-ac opinion no. 22, the seller’s liability for goods infringing intellectual property rights under article 42 cisg, rapporteur: dr. david tebel, rothorn legal, frankfurt am main, germany. adopted unanimously by the cisg advisory council following its 30th meeting, in rio de janeiro, on 7-9 august 2022. cisg-ac opinion 22 2 introduction of the cisg ac the cisg-ac started as a private initiative supported by the institute of international commercial law at pace university school of law and the centre for commercial law studies, queen mary, university of london. the international sales convention advisory council (cisg-ac) is in place to support understanding of the united nations convention on contracts for the international sale of goods (cisg) and the promotion and assistance in the uniform interpretation of the cisg. at its formative meeting in paris in june 2001, prof. peter schlechtriem of freiburg university, germany, was elected chair of the cisg-ac for a three-year term. dr. loukas a. mistelis of the centre for commercial law studies, queen mary, university of london, was elected secretary. the founding members of the cisg-ac were prof. emeritus eric e. bergsten, pace university school of law, prof. michael joachim bonell, university of rome la sapienza, prof. e. allan farnsworth, columbia university school of law, prof. alejandro m. garro, columbia university school of law, prof. sir roy m. goode, oxford, prof. sergei n. lebedev, maritime arbitration commission of the chamber of commerce and industry of the russian federation, prof. jan ramberg, university of stockholm, faculty of law, prof. peter schlechtriem, freiburg university, prof. hiroo sono, faculty of law, hokkaido university, prof. claude witz, universität des saarlandes and strasbourg university. members of the council are elected by the council. at subsequent meetings, the cisg-ac elected as additional members prof. pilar perales viscasillas, universidad carlos iii, madrid; prof. ingeborg schwenzer, university of basel; prof. john y. gotanda, villanova university; prof. michael g. bridge, london school of economics; prof. han shiyuan, tsinghua university and prof. yeşim atamer, istanbul bilgi university, turkey, prof. ulrich g. schroeter, university of mannheim, germany, prof. lauro gama, pontifical catholic university, justice johnny herre, justice of the supreme court of sweden, prof. harry m. flechtner, university of pittsburgh, prof. sieg eiselen, department of private law of the university of south africa, and prof. edgardo muñoz lópez, universidad panamericana, guadalajara, méxico. prof. jan ramberg served for a three-year term as the second chair of the cisg-ac. at its 11th meeting in wuhan, people's republic of china, prof. eric e. bergsten of pace university school of law was elected chair of the cisg-ac and prof. sieg eiselen of the department of private law of the university of south africa was elected secretary. at its 14th meeting in belgrade, serbia, prof. ingeborg schwenzer of the university of basel was elected chair and at its 24th meeting in antigua, guatemala, prof. michael g. bridge of the london school of economics was elected chair of the cisg-ac. at its 26th meeting in asunción, paraguay, ass. prof. milena djordjević, university of belgrade, serbia, was elected secretary, and she was reelected short after the 30th meeting in rio de janeiro. prof. pilar perales viscasillas of the university carlos iii of madrid was elected chair of the cisg-ac after the 30th meeting in rio de janeiro. njcl 2022/1 3 1. opinion article 42 (1) the seller must deliver goods which are free from any right or claim of a third party based on industrial property or other intellectual property, of which at the time of the conclusion of the contract the seller knew or could not have been unaware, provided that the right or claim is based on industrial property or other intellectual property: (a) under the law of the state where the goods will be resold or otherwise used, if it was contemplated by the parties at the time of the conclusion of the contract that the goods would be resold or otherwise used in that state; or (b) in any other case, under the law of the state where the buyer has his place of business. (2) the obligation of the seller under the preceding paragraph does not extend to cases where: (a) at the time of the conclusion of the contract the buyer knew or could not have been unaware of the right or claim; or (b) the right or claim results from the seller's compliance with technical drawings, designs, formulae or other such specifications furnished by the buyer. black letter rules 1. the cisg governs the seller’s liability for the delivery of goods that actually or allegedly infringe a third party’s industrial or other intellectual property (together “ip”) rights. in contrast, the infringement itself of ip rights is not governed by the cisg. 2. the notion of ip must be interpreted autonomously. under article 42 cisg, industrial property is encompassed by the broader category of intellectual property. for the purposes of article 42 cisg, ip encompasses all rights that protect a commercial or intellectual achievement by attributing that achievement to the right holder with effect for a defined territory. these rights include, in particular, patents, utility models, designs, trademarks, semiconductor designs, plant breeder’s rights, copyright and similar rights, as well as licence rights deriving from these rights. in addition, rights based on competition, tort or unjust enrichment laws, that protect commercial or intellectual achievements, are also ip rights for the purposes of article 42 cisg. 3. article 42 cisg applies also cisg-ac opinion 22 4 a. to goods produced by means of a process, consisting of a certain series of steps with which a defined result is achieved, that is protected by a process patent; b. to goods used to apply a process protected by a process patent; c. to goods encumbered by personality or personal name rights; d. to goods subject to measures of public authorities based on ip; and e. to rights and claims based on the ip of the seller. 4. the seller is liable if the goods are actually encumbered by thirdparty ip rights even if no claim is lodged. 5. the seller is liable for third-party claims that the goods infringe an ip right, regardless of whether this right in fact exists. such claims may even be obviously unfounded or frivolous. 6. the seller’s liability under article 42(1) cisg requires knowledge of only the existence of the ip right or claim. such knowledge exists when the seller cannot be unaware of the right or claim. this is determined by the circumstances of the individual case taking into account the following factors: a. the ip right’s i. publication in official publications or databases; ii. registration in official registers; iii. whether an ip right (most importantly a trademark) is wellknown in the relevant sector (notoriety); iv. whether an ip right can only be identified based on a deep understanding of the features and (internal) composition of the goods (technicity); and b. the goods’ i. nature; and ii. novelty; and c. the seller’s i. experience with the specific goods; ii. experience with the specific market; njcl 2022/1 5 iii. size of business and sophistication; iv. language skills; v. knowledge of the specific use intended by the buyer (in case of process patents); and d. any other relevant circumstances of the individual case. 7. in order to determine a state of use under article 42(1)(a) cisg, use is to be interpreted broadly and encompasses any action the buyer intends to take or to have taken with regard to the goods. use includes transit of the goods through a state other than the state of their destination. 8. contemplation by the parties of a state of use only requires that the seller can discern the buyer’s intention to use the goods in one or more specific states from the circumstances. in particular, the parties are considered to have contemplated a state of use if a. the buyer is active only in the market of that state and the seller could not have been unaware of this; or b. under the contract, i. transportation of the goods to or through that state is envisaged; ii. instruction manuals or other documents accompanying the goods are to be in a specific language other than the buyer’s language and this language is spoken only in that state; iii. the required design of the goods points to that state; or iv. mandatory or voluntary certificates that the goods are required to have are relevant only in that state. 9. states in the sense of article 42(1)(a) and (b) cisg include federal states together with all their constituent territories but not associations of states. if, however, the parties contemplate that the goods will be used only in a specific area of the state of use, the buyer cannot invoke encumbrances in different areas as a basis of the seller’s liability. 10. the seller’s knowledge and the identity of the relevant states are assessed at the time of conclusion of the contract. whether the goods are encumbered with ip rights or claims under article 42 cisg is assessed at the time of the passing of risk based on the cisg-ac opinion 22 6 general principle enshrined in article 36 cisg. in the case of delivery prior to the agreed date, the buyer is entitled to cure any encumbrance until the agreed date in accordance with the general principle stipulated in article 37 cisg. 11. the buyer’s knowledge of the encumbrance under article 42(2)(a) cisg should be assessed according to the same legal standard as the knowledge requirement for the seller under article 42(1) cisg. the same factors as in rule 6 should be considered taking into account any factual differences in the individual circumstances of the buyer and the seller. 12. the seller is not liable according to article 42(2)(b) cisg for an encumbrance if it is the inevitable result of the contract requiring the goods to comply with the specifications furnished by the buyer. however, the seller cannot rely on article 42(2)(b) cisg if the seller in addition to having knowledge of the ip right or claim pursuant to article 42(1) cisg knew or could not have been unaware that the buyer’s specifications would result in an encumbrance of the goods and did not inform the buyer about this. 13. where the seller is liable for an encumbrance of a third-party ip right or claim, the buyer has all the remedies listed in article 45 cisg. any provision which according to its wording is expressly limited to the delivery of non-conforming goods nevertheless applies to the delivery of goods encumbered with third-party ip rights or claims. 14. after the buyer has taken over the goods, the buyer bears the burden of proof regarding the requirements of the seller’s liability under article 42 cisg, including a. that the ip right or claim exists; b. that the goods are encumbered by ip right or claim; c. that the seller knew or could not have been unaware of the encumbrance; and d. that the state of use was contemplated by the parties. 15. the seller bears the burden of proof regarding the requirements of the defences pursuant to article 42 cisg, including njcl 2022/1 7 a. in a case where the buyer relies on an encumbrance in the state in which it has its place of business, that only a different state of use was contemplated at the time of the conclusion of the contract; b. in a case where the buyer invokes an infringement of a right, that there is no infringement, for example due to existing licenses; c. that the buyer knew or could not have been unaware of the ip right or claim; and d. that the encumbrance was the inevitable result of the contract requiring the goods to comply with the specifications furnished by the buyer. cisg-ac opinion 22 8 comments 1. the cisg governs the seller’s liability for the delivery of goods that actually or allegedly infringe a third party’s industrial or other intellectual property (together “ip”) rights. in contrast, the infringement itself of ip rights is not governed by the cisg. 1.1 sold goods frequently fall within the scope of ip rights. machines might be encompassed by patents, apparel by design rights, or virtually any good by trademark rights. digital content, which can fall within the scope of the cisg, e.g., in case of the sale of standard software, will almost always be subject to ip rights. if a good violates ip rights, it infringes these rights. this situation results in a triangular legal relationship between the holder of the ip right, the buyer and the seller: the holder of the ip right might have claims against the buyer and potentially also the seller of the infringing good. as a result of these claims of the holder of the ip right, there might also be claims between the buyer and the seller. 1.2 the cisg only applies to the contractual relation between the seller and the buyer.1 the questions whether the ip right exists and what claims the right holder has against the buyer and the seller are governed by the relevant domestic law.2 this usually is the law of the state for which protection is claimed,3 regarding tort claims the place of the tortious act.4 1.3 under the cisg, ip rights or claims which the goods infringe are third-party rights or claims the goods are encumbered with. whereas article 41 addresses the seller’s liability if the goods are not free from any right or claim of a third party in general, article 42 regulates the seller’s liability for goods encumbered with ip rights specifically. 2. the notion of ip must be interpreted autonomously. under article 42 cisg, industrial property is encompassed by the broader category of intellectual property. for the purposes of article 42 cisg, ip encompasses all rights that protect a commercial or intellectual achievement by attributing that achievement to the right holder with effect for a defined territory. these rights include, in particular, patents, utility models, designs, trademarks, semiconductor designs, plant breeder’s rights, copyright and similar rights, as well as licence rights deriving from these rights. in addition, rights based on competition, tort or unjust enrichment laws, that protect 1 schlechtriem/schwenzer/schwenzer, art. 42 para. 3; kröll et al./kröll, art. 42 para. 4. 2 müko bgb-gruber, art. 42 cisg para. 4; secretariat commentary, art. 40 para. 7; brunner/gottlieb/tebel, art. 42 para. 2. 3 art. 8(1) rome ii regulation; kröll et al./kröll, art. 42 para. 4; staudinger/ magnus, art. 42 para. 10; zhang, 86. 4 art. 8(2) rome ii regulation; staudinger/magnus, art. 42 para. 10. njcl 2022/1 9 commercial or intellectual achievements, are also ip rights for the purposes of article 42 cisg. 2.1 the notion of ip in the sense of article 42 must be interpreted autonomously.5 the classification of the right or claim in question as ip or otherwise under the domestic law governing the ip infringement thus is irrelevant. 2.2 article 42(1) encompasses encumbrances based on “industrial or other intellectual property”. it follows from this wording that intellectual property is the broader category and thus decisive for the scope of the provision.6 2.3 a broad understanding of the term ip, as used in article 42, should be applied.7 ultimately decisive is – as is the case regarding article 41 – that the right or claim is abstractly suited to impair the buyer’s use of the goods.8 2.4 article 42 should be distinguished from article 41 based on a functional-substantive interpretation of the term ip.9 criteria such as whether the right can be registered or whether it meets the threshold of originality are as irrelevant as the specific legal conception of the provisions establishing the protection of the ip.10 ip in this sense encompasses all rights that protect a commercial or intellectual accomplishment by attributing it to the right holder with an effect at least equivalent to a right in rem.11 this includes patent, utility model, design, trademark, semiconductor design, plant breed rights and copyrights,12 supplementary protection certificates as well 5 honsell/magnus, art. 42 para. 5; brunner/gottlieb/tebel, art. 42 para. 5; schwenzer/tebel, jusletter 17 september 2012, 1, 3, para. 8; reher, 103; detailed kremer, 106-108. 6 this approach of the cisg contrasts with the approach taken by some states which juxtapose intellectual and industrial property. 7 schlechtriem/schwenzer/schwenzer, art. 42 para. 4; piltz, para. 5–125; kröll et al./kröll, art. 42 para. 12; but see rauda/etier, vj 2000, 30, 36 (as exception provision art. 42 to be interpreted restrictively). 8 schlechtriem/schwenzer/schwenzer, art. 42 para. 4; brunner/gottlieb/ tebel, art. 42 para. 5; staudinger/magnus, art. 42 para. 9; kröll et al./kröll, art. 42 para. 13; reher, 104, 113. 9 schlechtriem/schwenzer/schwenzer, art. 42 para. 4; kröll et al./kröll, art. 42 para. 12; rauda/etier, vj 2000, 30, 35-36; brunner/gottlieb/tebel, art. 42 para. 5; schwenzer/tebel, jusletter 17 september 2012, 1, 3, para. 8; langenecker, 71; reher, 103. 10 schlechtriem/schwenzer/schwenzer, art. 42 para. 4; beckogk-hachem, art. 42 para. 8; langenecker, 71; kremer, 152-153, 158-159. 11 achilles, art. 42 para. 2; prager, 147; cf. also müko hgb-benicke, art. 42 cisg para. 2. cf. for the definition of intellectual property detailed kremer, 124159. 12 brunner/gottlieb/tebel, art. 42 para. 5; shinn, 2 minn. j. global trade (1993), 115, 122. cisg-ac opinion 22 10 as license rights deriving from these rights with effect in rem,13 trade secrets,14 but also rights protecting commercial or intellectual achievements based on competition, tort or unjust enrichment laws.15 guidance can be sought in article 2(2)(viii) of the 1967 convention establishing the world intellectual property organization16 which defines ip as “all […] rights resulting from intellectual activity in the industrial, scientific, literary or artistic fields”. 2.5 in cases of doubt, it should be decisive that the third-party right in question is of territorial nature.17 furthermore, ip third-party rights or claims encompassed by article 42 are dependent on the physical features of the goods and encompass all goods of the kind, whereas third-party rights or claims under article 41 are independent of the physical features of the goods and are specific to the individual good. finally, with particular regard to competition law, a strong indication that a right is based on ip is the competence of specialised ip courts for the specific violation of competition law18 – although the determination what amounts to a right based on ip under article 42 remains autonomous. 3. article 42 cisg applies also a. to goods produced by means of a process, consisting of a certain series of steps with which a defined result is achieved, that is protected by a process patent; b. to goods used to apply a process protected by a process patent; c. to goods encumbered by personality or personal name rights; d. to goods subject to measures of public authorities based on ip; and e. to rights and claims based on the ip of the seller. 3.1 article 42 directly applies to process patents which encompass the sold good and going beyond its wording also to process patents which encompass the use contemplated by the parties or the 13 achilles, art. 42 para. 2. 14 staudinger/magnus, art. 42 para. 11; achilles, art. 42 para. 2; metzger, rabelsz 73 (2009), 842, 863; vanduzer, 4 canadian international lawyer (2001) 187. 15 schlechtriem/schwenzer/schwenzer, art. 42 para. 4; kröll et al./kröll, art. 42 para. 13; but see for claims based on competition law herber/czerwenka, art. 42 para. 2; prager, 146. 16 schlechtriem/schwenzer/schwenzer, art. 42 para. 4; kröll et al./kröll, art. 42 para. 12; beckogk-hachem, art. 42 para. 7; metzger, rabelsz 73 (2009), 842, 863. 17 cf. bianca/bonell/date-bah, art. 42 para. 2.2. 18 germany: for example § 141 markeng. njcl 2022/1 11 ordinary use of the sold good. process patents do not protect manufactured things as such but a certain series of steps with which a defined result is achieved.19 in essence, a process patent prohibits two things, using the process and using a product directly obtained by that process.20 the latter prohibition directly affects the product as the good in question, and thus without issues triggers the direct application of article 42. encompassed are thus methods or processes protected by patents or utility models,21 as well as ip rights relating to things produced by using the goods.22 3.2 the former prohibition, however, is not directly targeted at the purchased good but rather at the way the good is used. this becomes particularly clear when considering that a process patent can also prohibit using generic goods in the specifically protected process. in such a scenario, the good itself is not necessarily affected by the process patent and thus not encumbered by this ip right. article 42 thus does not apply directly. since article 42, however, has the purpose of protecting the buyer’s interest in using the goods, article 42 applies if the goods cannot be used as intended under the contract or as they are generally used due to an ip right, either as a general principle in terms of article 7(2) or by way of analogy.23 in 19 the protection of process patents (in some legal systems also referred to as methods) is, for example, dealt with in article 28(1) lit. b the agreement on trade-related aspects of intellectual property rights (trips): “(b) where the subject matter of a patent is a process, to prevent third parties not having the owner's consent from the act of using the process, and from the acts of: using, offering for sale, selling, or importing for these purposes at least the product obtained directly by that process.” 20 cf. for this distinction in germany also § 9 sentence 2 no. 2 and 3 patg. 21 ogh 12 september 2006, cisg-online 1364; schlechtriem/schwenzer/ schwenzer, art. 42 para. 4; beckogk-hachem, art. 42 para. 9; schlechtriem/ schroeter, para. 440; rauda/etier, vj 2000, 30, 40; shinn, 2 minn. j. global trade (1993), 115, 132; honsell/magnus, art. 42 para. 6; witz/salger/lorenz/ salger, art. 42 para. 4; detailed bacher, fs schwenzer, 115, 118 et seq.; but see prager, 148; zhang, 87. too broad müko bgb-gruber, art. 42 cisg para. 6 (considering mere existence of a protected method or process sufficient without requiring that the buyer’s use of the goods can be impaired and consequently in favour of direct application). 22 schlechtriem/schroeter, para. 440; honsell/magnus, art. 42 para. 6; bacher, fs schwenzer, 115, 120-121; similar müko bgb-gruber, art. 42 cisg para. 6 (seller liable if no alternative sensible use of goods exists or contractually intended use is impaired); rauda/etier, vj 2000, 30, 40-41 (seller liable if no alternative sensible use of goods exists or seller can “foresee that the goods will be used in an infringing way”); but see prager, 148. too narrow beckogk-hachem, art. 42 para. 9 (seller only liable if good can only manufacture things encompassed by intellectual property right). 23 schlechtriem/schwenzer/schwenzer, art. 42 para. 4 (for direct application); beckogk-hachem, art. 42 para. 9 (making reference to art. 35(2) lit. a and b); cisg-ac opinion 22 12 order to properly balance the parties’ respective interests, however, this application is mainly appropriate where the purchased goods only can sensibly be used in the way prohibited by the process patent. regarding universally usable goods, additional requirements might apply (see infra para. 0). 3.3 article 42 cannot be applied directly to personality or name rights since these rights do not protect any intellectual achievement and thus are no ip rights.24 nevertheless, the comparable interests justify filling this unintentional lacuna by applying article 42 as a general principle in terms of article 7(2) or by way of analogy.25 3.4 according to its wording, article 42 only encompasses rights and claims “of a third party”. this term gives no indication of the legal basis upon which this party acts and thus includes public authorities as well as private parties.26 there is no hard-and-fast rule to classify public law encumbrances as non-conformities or third-party encumbrances.27 instead, a distinguishing factor has to be established that allows drawing a line between those public law encumbrances that render the goods non-conforming in terms of article 35 and those that constitute encumbrances in terms of articles 41 and 42 on a case by case basis. it appears preferable to use the reason for the public law measure as the distinguishing reher, 113-114; brunner/gottlieb/tebel, art. 42 para. 6; cf. also rauda/etier, vj 2000, 30, 39-40. 24 achilles, art. 42 para. 2; beckogk-hachem, art. 42 para. 10; brunner/ gottlieb/tebel, art. 42 para. 7; reher, 118-120; but see langenecker, 78-79 (regarding the material aspects); likewise kremer, 161 et seq. (the non-material aspects of such rights trigger the seller’s general liability pursuant to art. 41). 25 schlechtriem/schwenzer/schwenzer, art. 42 para. 5; ferrari et al./ ferrari, art. 42 cisg para. 6; achilles, art. 42 para. 2; metzger, rabelsz 73 (2009), 842, 863-864; brunner/gottlieb/tebel, art. 42 para. 7; müko bgbgruber, art. 42 para. 7; witz/salger/lorenz/salger, art. 42 para. 4; cf. also beckok-saenger, art. 42 para. 5 (“in any event” analogous application). in favour of direct application kröll et al./kröll, art. 42 para. 13; jurispk bgb-baetge, art. 42 cisg para. 5; kremer, passim; seemingly also soergel/lüderitz/ schüssler-langeheine, art. 42 para. 2; staudinger/magnus, art. 42 para. 12. against analogous application rauda/etier, vj 2000, 30, 36; seemingly also su, iprax 1997, 284, 286. 26 cf. beckogk-hachem, art. 41 para. 10; jurispk bgb-baetge, art. 41 cisg para. 16. but see staudinger/magnus, art. 41 para. 13; likewise honsell/ magnus, art. 41 para. 9; soergel/lüderitz/schüssler-langeheine, art. 41 para. 5; similar müko bgb-gruber, art. 41 cisg para. 13, 15; cf. also achilles, art. 41 para. 2; ferrari et al./ferrari, art. 41 cisg para. 3; piltz, para. 5–119; kiene, ihr 2006, 93, 94. 27 brunner/gottlieb/tebel, art. 41 para. 14. njcl 2022/1 13 factor.28 depending on whether this reason falls within the ambit of article 35, article 41 or article 42, the respective provision applies. 3.5 usually, a public law measure in itself does not form a separate defect but is only a reflex of a defect the measure results from.29 in exceptional cases in which a public law measure constitutes a separate defect, this defect is encompassed by article 42 if the reason of the measure falls within the ambit of article 42. this is, for example, the case if the reason the public authorities base their measure on does not actually exist. potentially unlawful public law measures that are not based on actual facts are comparable to unfounded claims which are encompassed by these provisions as well. in light of the parties’ interests, it makes no difference whether a third party raises a claim based on an inexistent right or a public authority which by law can act on its own initiative does so based on an inexistent right. hence, it is not required that the reason of the public law measure is based on existing facts; it suffices that the acting public authority claims to base its measure on this reason. the distinction between non-conformities and encumbrances based on the reason for the measure established above (see supra para. 3.5) must thus be made based on the facts as alleged by the public authority. the rare cases, however, in which a public authority acts without direct reason and without claiming to have a reason, constitute neither non-conformities nor legal defects, but instead random events that are attributed to the affected party’s sphere of risk via the rules on the passing of risk.30 3.6 according to its unequivocal wording, rights and claims of the seller do not fall within the scope of article 42.31 the majority of authors consider the underlying interests of the parties identical to situations covered by articles 41 and 42 and thus apply these provisions as a general principle in terms of article 7(2) or by way of analogy.32 28 schlechtriem/schwenzer/schwenzer, art. 41 para. 6; kröll et al./kröll, art. 41 para. 25; beckogk-hachem, art. 41 para. 9; brunner/gottlieb/tebel, art. 41 para. 14; kiene, ihr 2006, 93, 94-95. similar su, iprax 1997, 284, 286 (“distinguishing according to the nature”). 29 bgh 11 january 2006, cisg-online 1200; müko bgb-gruber, art. 41 cisg para. 15 (regarding seizures). 30 brunner/gottlieb/tebel, art. 41 para. 16; müko bgb-gruber, art. 41 cisg para. 15 (regarding seizure of the goods without cause). 31 müko bgb-gruber, art. 42 cisg para. 9; cf. also kröll et al./kröll, art. 42 para. 11; but see witz/salger/lorenz/salger, art. 41 para. 8 (seller can be “third party”). 32 for article 41: müko bgb-gruber, art. 41 cisg para. 11; kröll et al./kröll, art. 41 para. 22 (apparently limited to claims); cf. also schlechtriem/schwenzer/ schwenzer, art. 41 para. 15. for article 42: müko bgb-gruber, art. 42 cisg para. 9; cf. also kröll et al./kröll, art. 42 para. 11. but see piltz, para. 5–119; müko hgb-benicke, art. 41 cisg para. 6. cisg-ac opinion 22 14 oftentimes, however, the seller will not be entitled to invoke its ip rights due to the exhaustion doctrine since it willingly put the goods into circulation in the relevant state;33 if the seller nevertheless does so, however, it is liable for this claim. 4. the seller is liable if the goods are actually encumbered by third-party ip rights even if no claim is lodged. third-party rights are existing legal positions regarding the delivered thing.34 if the goods are in fact encumbered with an ip right, the seller is liable under article 42 even if the right holder does not lodge a claim against the buyer. 5. the seller is liable for third-party claims that the goods infringe an ip right, regardless of whether this right in fact exists. such claims may even be obviously unfounded or frivolous. 5.1 third-party claims are legal positions the third party purports to have, regardless whether they in fact exist.35 the primary consideration behind the provisions’ broad scope in this regard is that – as honnold aptly put it – the buyer “is not purchasing a lawsuit”.36 when determining the seller’s liability for encumbrances under the cisg, it is thus irrelevant whether the claim made by the third-party is well-founded. even claims that are obviously unfounded or frivolous in general constitute encumbrances of the goods for which the seller is liable.37 5.1 it is not required that the claims are raised in any particular form.38 particularly, it is not necessary that the third party brings legal action against the buyer.39 it is also not necessary that the claims are 33 schlechtriem/schwenzer/schwenzer, art. 42 para. 7; müko bgb-gruber, art. 42 cisg para. 9; achilles, art. 42 para. 3. 34 brunner/gottlieb/tebel, art. 41 para. 5. 35 brunner/gottlieb/tebel, art. 41 para. 11. 36 honnold/flechtner/honnold, art. 41 para. 266; cf. also müko bgb-gruber, art. 41 cisg para. 6; beckogk-hachem, art. 41 para. 12; bgh 11 january 2006, cisg-online 1200, para. 19. 37 schlechtriem/schwenzer/schwenzer, art. 41 para. 11; schwenzer/tebel, jusletter 17 september 2012, 1, 4, para. 11; beckok-saenger, art. 41 para. 5; müko bgb-gruber, art. 41 cisg para. 8; honsell/magnus, art. 41 para. 10; but see secretariat commentary, art. 39 para. 4; achilles, art. 41 para. 3; achilles, fs schwenzer, 1, 7-8; soergel/lüderitz/schüssler-langeheine, art. 41 para. 7; herber/czerwenka, art. 41 para. 6; hoyer/posch/niggemann, 93; galston/ smit/schlechtriem, 6–32; zhang, 77, 86; left open by bucher/schlechtriem, 120. 38 schlechtriem/schwenzer/schwenzer, art. 41 para. 12; kröll et al./kröll, art. 41 para. 17; müko bgb-gruber, art. 41 cisg para. 7. 39 schlechtriem/schwenzer/schwenzer, art. 41 para. 12; beckok-saenger, art. 41 para. 5. njcl 2022/1 15 asserted with such intensity that the buyer’s use of the goods is actually impaired.40 6. the seller’s liability under article 42(1) cisg requires knowledge of only the existence of the ip right or claim. such knowledge exists when the seller cannot be unaware of the right or claim. 6.1 the notion of knowledge under article 42(1) is to be interpreted autonomously. accordingly, there can be no recourse to categories of fault known in fault-based domestic legal systems when defining knowledge in a strict liability system like the cisg.41 6.2 the seller is not required to know the nature or details of the right42 or claim or classify the right or claim as based on ip. the seller further is not required to conduct a legal evaluation of the right or claim and is liable irrespective of its subjective evaluation of the existence of the right or the prospects of success of the claim.43 a legal analysis of the prospects of success of a claim in many cases will simply be too complicated to be expected of the seller. as regards technical ip rights like patents, for instance, determining whether a good is encompassed by the scope of the ip right can be a very complicated legal question that oftentimes is at the core of ip disputes.44 with regard to trademarks, the risk of confusion also is a complicated matter that mostly requires expert knowledge to assess correctly. finally, it is precisely the risk of whether a claim is founded that article 42 allocates to the seller by triggering the seller’s liability already in case of mere claims. requiring the seller to be aware that a claim is founded would negate this value judgement. article 42 hence allocates the legal risk, whether a claim is valid to the seller but not the factual risk whether a claim is brought at all. 6.3 with regard to the question which right or claim the seller must be aware of precisely, there are five possible scenarios: first, the goods are infringing an existing ip right without any claim being asserted. in this scenario, it is evident that the seller must be aware of the ip right. 40 but cf. kröll et al./kröll, art. 41 para. 17; müko hgb-benicke, art. 41 cisg para. 8; unclear su, iprax 1997, 284, 285. cf. also beckogk-hachem, art. 41 para. 14 (requiring that the third party shows its intention to impair the buyer’s use of the goods). 41 beckogk-hachem, art. 42 para. 16; kröll et al./kröll, art. 42 para. 27; janal, fs kritzer, 203, 217; langenecker, 171; prager, 162; cf. also piltz, para. 5–131. 42 brunner/gottlieb/tebel, art. 42 para. 10. 43 kröll et al./kröll, art. 42 para. 26; cf. also staudinger/magnus, art. 42 para. 22; brunner/gottlieb/tebel, art. 42 para. 10; but see achilles, art. 42 para. 9; reher, 157; cf. also müko hgb-benicke, art. 42 cisg para. 16; janal, fs kritzer, 203, 217. 44 cf. beckogk-hachem, art. 42 para. 17. cisg-ac opinion 22 16 6.4 second, the goods are not infringing any existing ip right, but the third party claims they do in relation to the buyer. since the seller is not required to conduct any legal evaluation, the seller’s knowledge of the ip right that the third party’s unfounded claim invokes is insufficient. rather, the seller must be aware of the claim itself. 6.5 third, the goods are infringing an existing ip right and a claim based on this very ip right is asserted in relation to the buyer. here, awareness of either the right or the claim triggers the seller’s liability. 6.6 fourth, the goods are infringing an existing ip right and a claim based on this very ip right is asserted in relation to another party. in this scenario, the question is whether the seller’s knowledge that the third party asserted a claim against another party is sufficient to trigger the seller’s liability for the goods’ encumbrance with the right if the third party never asserts its claim in relation to the buyer. the answer should be in the affirmative. knowledge of a claim based on a specific ip right includes knowledge of the ip right itself as minus. in order to distinguish this scenario from the second scenario, it can be summarised that knowledge of the right does not include knowledge of the claim, whereas knowledge of the claim includes knowledge of the right. 6.7 fifth, the goods are not infringing any existing ip right, but the third party claims they do first in relation to other parties and then in relation to the buyer. the wording of article 42(1) allows holding the seller liable in this situation. autonomously interpreted, the term “claim” does not necessarily include the party the claim is directed at. to the contrary, the natural use of the term “claim” requires additional specification against whom it is directed, that is, the party. accordingly, the claim raised against another party before the conclusion of the sales contract can be the same claim that is subsequently raised in relation to the buyer. consequently, it suffices that the seller is aware that a third party asserts a specific ip right45 while it is not required that the seller knows that the third party has done so in relation to the buyer – even if the ip right eventually proves non-existent46 or not encompassing the goods in question. 6.8 with regard to process patents that do not encompass the goods sold but nevertheless impair the contractually intended use of these goods, the seller does not have to arrive at the conclusion that the buyer’s use is impaired by the process patent. on the other hand, it cannot be sufficient for triggering liability that the seller knows of the existence of a process patent prohibiting one of many potential uses of universally usable goods. this issue is comparable to the territorial limitation: pursuant to article 42(1) lit. a, the seller is only liable for encumbrances in the state of use if use in this state was 45 müko bgb-gruber, art. 42 cisg para. 20. 46 kröll et al./kröll, art. 42 para. 26. njcl 2022/1 17 contemplated by the parties. this limitation protects the seller from being liable for encumbrances worldwide and thereby allows it to assess the risk associated with entering into the contract with the buyer. similarly, in order to assess this risk with specific regard to process patents, the seller cannot take into account all theoretically possible uses of universally usable goods. instead, the seller must discern the buyer’s intended use on which the infringement of the process patent is based (in parallel to the properly interpreted standard of contemplation under article 42(1) lit. a, see infra para. 0 et seq.).47 6.9 in parallel to article 42(1) lit. b, the seller further is liable for encumbrances with process patents prohibiting the ordinary use of the purchased goods irrespective of whether he can discern the buyer’s intended use. 6.10 the seller is not only liable pursuant to article 42 if it knows of the right or claim but also if it “could not have been unaware” of it. in practice, proving actual knowledge will oftentimes be difficult for the buyer.48 the notion of “could not have been unaware” is thus decisive for the scope of the limitation of the seller’s liability article 42 seeks to achieve.49 the crucial question in this regard is whether and if so to what extent the seller is expected to investigate for ip rights and claims. 6.11 in this context, many authors refer to a “duty to investigate”.50 the term “duty” in this regard is, however, misplaced. neither can the buyer compel the seller to conduct such an investigation, nor has it any immediate effects on the seller’s legal position whether it conducts an investigation or fails to do so. in particular, the seller obviously still is liable for the encumbrance if it did conduct a proper investigation and discovered the encumbrance but nevertheless sold the encumbered goods to the buyer. it is also undisputed that the seller is not in breach of its obligations if it did not conduct any investigation and the goods sold are not encumbered. in short, whether or not the individual seller in question actually conducts an investigation is irrelevant; rather, the reference to an investigation merely expresses what an abstract reasonable and diligent seller could not have been unaware of. therefore, it seems more appropriate to refer to an expectation to investigate instead of a duty to investigate. the issue is, however, mainly terminological. 47 brunner/gottlieb/tebel, art. 42 para. 12. 48 reher, 157; langenecker, 172-173. 49 langenecker, 176-177. 50 schlechtriem/schwenzer/schwenzer, art. 42 para. 15; beckogk-hachem, art. 42 para. 16-17; honnold/flechtner/flechtner, art. 42 para. 270.1; kröll et al./kröll, art. 42 para. 29-32; reher, 159; brunner/gottlieb/tebel, art. 42 para. 11, but see note 1632 in fine; cf. also piltz, para. 5–132. cisg-ac opinion 22 18 6.12 in essence, there are three positions advocated what degree of knowledge on the part of seller triggers its liability. the most restrictive position can be found in early writings on article 42 which read the reference to “could not have been unaware” as mere facilitation of proof.51 interestingly enough, some of these authors criticise this interpretation as being too burdensome for the buyer52 and consider it desirable that the seller is expected to investigate for ip rights.53 a middle-ground is suggested by some authors who expect the seller to investigate for ip rights only in case of specific indications that such rights exist in the relevant state.54 according to the majority of authors, however, the seller is generally expected to investigate for ip rights in the relevant state.55 6.13 to answer the question of whether the seller is expected to investigate for ip rights and claims, the standard “could not have been unaware” must be interpreted. the natural understanding of the phrase “could not have been unaware” is that due to the circumstances of the individual case, it was impossible for the relevant party not to be aware of certain facts, that is the party is expected to have been aware of these facts. the french56 and spanish57 language versions do not give any further indications in this regard, and neither do the non-authentic dutch58 and german59 translations. the wording as such does not indicate whether this expectation includes active investigations by the relevant party or is merely based on the party’s – passive – knowledge of the circumstances.60 51 prager, 167; huber, 43 rabelsz (1979), 413, 503; cf. also wolff, 75. against this detailed langenecker, 176 et seq.; cf. also rauda/etier, vj 2000, 30, 45 (“not a pleonasm of knowledge”). 52 huber, 43 rabelsz (1979), 413, 503. 53 prager, 169 et seq. 54 langenecker, 187 et seq.; janal, fs kritzer, 203, 217; soergel/lüderitz/ schüssler-langeheine, art. 42 para. 4. 55 beckok-saenger, art. 42 para. 12; honnold/flechtner/flechtner, art. 42 para. 270.1; schlechtriem/schwenzer/schwenzer, art. 42 para. 15; staudinger/magnus, art. 42 para. 22; herber/czerwenka, art. 42 para. 5; ferrari et al./ferrari, art. 42 cisg para. 15; piltz, para. 5–132; bacher, fs schwenzer, 115, 124; rauda/etier, vj 2000, 30, 45; cf. also beckogk-hachem, art. 42 para. 18 (perceptibility decisive); brunner/gottlieb/tebel, art. 42 para. 11; šarčević/volken/enderlein, art. 42, 180; reher, 160-161; secretariat commentary, art. 40 para. 6. 56 “[…] ne pouvait ignorer […]”. 57 “[…] no hubiera podido ignorar […]”. 58 “[…] niet onkundig had kunnen zijn […]”. 59 “[…] nicht in unkenntnis sein konnte […]”. 60 rauda/etier, vj 2000, 30, 46 for the english, spanish and french language versions. njcl 2022/1 19 6.14 from a systematic point of view, the phrase “could not have been unaware” is one of the three primary forms61 of knowledge referred to in the cisg.62 it must be distinguished from the standard “known”63 on the one hand and the standard “ought to have known”64 on the other hand. generally, these standards are described as hierarchical in that “could not have been unaware” is stricter than “ought to have known” but less strict than “known”.65 a systematic comparison of the instances in which these standards are used in the cisg indicates that the standard of “could not have been unaware” tends to be used to determine more severe consequences than the standard of “ought to have known”. how these standards are applied in these instances does, however, vary and does not allow to draw a clear line between the two standards.66 6.15 during the drafting of the cisg, after an initial general reluctance to address the issue of ip encumbrances at all was overcome,67 there was a lively debate on the interrelation of the notions of “known”, “could not have been unaware” and “ought to have known”. most of the debate focussed on article 8. yet, an unopposed statement made by the belgian delegation confirms that the perception was that the standard of “could not have been unaware” required the seller to investigate for ip rights: the belgian delegate “pointed out that the seller might have a heavy burden because in some cases he would have to undertake inquiries and research into industrial property rights, which he would not always be in a position to do” and suggested to change this wording of article 42(1).68 the belgian delegation’s assessment that the seller was expected to conduct an investigation was neither contradicted nor its suggestion followed to change the wording of article 42(1).69 the reasonable conclusion 61 the phrase “may be known” (art. 65(1)) is only of limited relevance. 62 honnold/flechtner/honnold, art. 35 para. 229; langenecker, 178-179; prager, 163. 63 the phrase “is aware of” (art. 69(2)) is synonymous. 64 the phrases “ought to have become aware of” (43(1)) and “discovered or ought to have discovered” (art. 39(1), art. 82(2)(c)) are synonymous. 65 langenecker, 179. 66 already during the drafting of the cisg, the u.s. delegation criticised the “careless” use of the different standards of knowledge in the cisg, y.b. viii [1977], 134 para. 19. cf. also the similar criticism by australia, y.b. viii [1977], 110 para. 7. 67 cf. art. 7(2) of the 1976 geneva draft expressly excluding “rights and obligations which might arise between the seller and the buyer because of the existence in any person of rights or claims which relate to industrial or intellectual property or the like”, y.b. vii [1976], 100; y.b. viii [1977], 41 para. 216 (voicing concern that “the regulation of industrial or intellectual property rights was too complex a matter to be resolved in the context of a draft convention on the international sale of goods”). 68 o.r., 327. 69 cf. langenecker, 182. cisg-ac opinion 22 20 from this is that the majority view during the drafting phase was that the standard “could not have been unaware” in article 42(1) required the seller to conduct investigations. this result is confirmed by the secretariat commentary. according to the commentary on article 42, “[t]he seller ‘could not have been unaware’ of the thirdparty claim if that claim was based on a patent application or grant which had been published in the country in question”.70 since the seller is not automatically aware of all published ip rights, the secretariat commentary’s standard expects the seller to investigate for such publications. 6.16 expecting the seller to investigate for ip rights also is in line with the purpose of article 42(1). the primary aim of this provision is to limit the seller’s liability for encumbrances of the goods with ip rights and claims compared to the general liability for encumbrances pursuant to article 41.71 the buyer’s interest is to receive goods free from encumbrances which it is usually entitled to without further limitations in accordance with the principle of strict liability. the seller, on the other hand, is interested in having its liability limited due to the specific (territorial) nature of ip rights and claims. accordingly, a reasonable interpretation of the provision requires balancing these factors and the respective interests attached to them.72 in consequence, article 42 must not be interpreted in a way that renders the seller’s liability for encumbrances based on ip meaningless nor in a way that renders the limitation of the seller’s liability meaningless. the notion of “could not be unaware” is the decisive parameter to achieve this balance. the broader this notion is interpreted, the closer the results are to a strict liability of the seller and the less effective is the seller’s limitation of liability.73 moreover, it must be taken into account that the seller’s liability already is significantly limited by the territorial limitation.74 furthermore, compared to article 41, the requirements for excluding the seller’s liability under article 42(2) are significantly more lenient. accordingly, the seller’s interests are given due regard75 even if it is generally expected to investigate for ip rights. 6.17 further, not expecting the seller to investigate for ip encumbrances in the relevant states would render the territorial limitation virtually meaningless. the purpose of the territorial limitation is to allow the seller to assess its liability risk. if the seller would only be liable for 70 secretariat commentary, art. 40 para. 6. 71 kröll et al./kröll, art. 42 para. 3; janal, fs kritzer, 203, 205; šarčević/ volken/enderlein, art. 42, 179. 72 cf. prager, 156-157. 73 cf. langenecker, 183. 74 langenecker, 183. 75 langenecker, 184. njcl 2022/1 21 encumbrances it was aware of or closed its eyes to, it would already be in the position to assess its liability even worldwide based on this knowledge. 6.18 the expectation to investigate for ip rights thus is a valuable tool to balance the interests of the parties. defining the scope of such expectation offers far superior possibilities to fine-tune this balance than outright rejecting any expectation of active investigations. the purpose of article 42 as limitation of the generally strict liability of the seller thus supports an interpretation of the standard “could not have been unaware” as expecting the seller to investigate for ip rights or claims. 6.19 moreover, economic considerations confirm that the seller should be expected to investigate for ip rights. the economically most efficient outcome would be to allocate the risk of an adverse effect to the party that can avoid this effect with the least effort, the socalled cheapest cost avoider.76 in the context of article 42, the question thus is whether it is more efficient to have the seller or the buyer investigate for ip rights or claims.77 as regards the question of whether the seller is expected to investigate at all, it is sufficient to attest that it is at least possible that under certain circumstances, the seller can conduct such investigation more efficiently. the only reasonable conclusion is to expect the seller to investigate for ip rights. from economic perspective, even if the seller is expected to investigate, it will not do so if it determines the cost of such investigation to be higher than the expectancy value of its potential liability; whereas, if the seller is not legally expected to investigate, it will not do so even if it determines the costs of such investigation to be lower that the expectancy value of its theoretical liability.78 6.20 defining the scope of the expected investigations still allows to more precisely allocate the investigations to the cheapest cost avoider. this way, the expectation to investigate can mitigate information asymmetries, reduce the cost of transacting, and improve the economic efficiency of markets.79 not expecting the seller to investigate for ip rights would, however, exclude the possibility of efficiently allocating the cost of an investigation altogether. 6.21 furthermore, the seller’s legal situation from the perspective of ip law must be considered. pursuant to many ip laws, selling goods encompassed by an ip right already constitutes an infringement the 76 metzger, rabelsz 73 (2009), 842, 852-853. 77 cf. smythe, 36 nw. j. int’l l. & bus. (2016), 509, 531. 78 cf. metzger, rabelsz 73 (2009), 842, 855. 79 smythe, 36 nw. j. int’l l. & bus. (2016), 509, 533. cisg-ac opinion 22 22 seller is liable for.80 the seller’s liability in this regard is not limited to ip rights the seller is aware of. rather, the seller is expected to investigate for ip rights by observing the market and the relevant publications.81 if such investigation can be expected from the seller in the interest of a third party to which the seller has no relation, it can be expected from the seller even more so in the framework of its contractual relationship with the buyer.82 at least expecting the seller to conduct an investigation for ip rights in relation to the goods sold cannot be considered overly onerous if the seller is expected to do so pursuant to the relevant ip laws in any case. 6.22 finally, a comparison with the legal regime governing nonconformities confirms this result. there is a certain parallelism between the seller’s liability for encumbrances in the state of use under article 42(1) lit. a and the seller’s liability for non-conformities arising from the goods’ non-compliance with public law standards in the state of use (or the buyer’s state) under article 35(2) lit. b.83 the parties’ interests in the case of the goods’ non-compliance with public law standards in the relevant state and in case of the goods’ infringement of ip rights in the relevant state are comparable. in particular, public law standards generally apply only in the state in question, just as ip rights do. from the perspective of the parties, it cannot make any difference whether the buyer’s use of the goods is impaired based on public law standards or private third-party rights. this parallelism specifically applies with regard to the knowledge requirements under both provisions.84 consequently, when 80 article 28(1) lit. a trips; switzerland: § 8(1) patg; art. 13(2) lit. c mschg; art. 9(1) desg; art. 5 lit. b tog; germany: § 14(3) no. 2 markeng; beckok markenr-mielke, § 14 markeng para. 225-227; § 9 sentence 2 no. 1 patg; mes, § 9 patg para. 37; § 11(1) sentence 2 gebrmg; benkard/scharen, § 11 gebrmg para. 4; § 38(1) sentence 2 designg; eichmann/von falckenstein/kühne/ eichmann, § 38 designg para. 53; § 6(1) sentence 2 no. 2 halblschg. in general metzger, rabelsz 73 (2009), 842, 856; janal, fs kritzer, 203, 216; cf. bacher, fs schwenzer, 115, 124. 81 germany: bgh 14 january 1958, grur 1958, 288, 290 – dia-rähmchen; bgh 3 march 1977, grur 1977, 598, 601 – autoskooter-halle; bgh 26 january 1993, grur 1993, 460, 464 – wandabstreifer; mes, § 139 patg para. 105; bgh 31 july 2008, grur 2008, 1104, 1107 – haus & grund ii; beckok markenr-goldmann, § 14 markeng para. 694; bgh 12 november 2009, grur 2010, 616, 620 – marionskochbuch.de; dreier/schulze/specht, § 97 urhg para. 78; metzger, rabelsz 73 (2009), 842, 856. 82 schlechtriem/schwenzer/schwenzer, art. 42 para. 15; metzger, rabelsz 73 (2009), 842, 857. 83 schlechtriem, iprax 1996, 12, 15-16; schlechtriem, iprax 2001, 161, 163; reher, 92; smythe, 36 nw. j. int’l l. & bus. (2016), 509, 535; beline, 7 univ. of pitts. journal tech. law & pol’y (2007) 6, 10; cf. also y.b. viii [1977], 139. 84 lurger, ihr 2001, 91, 101 note 87. njcl 2022/1 23 determining whether the seller can be expected to investigate for ip rights in the relevant state, guidance can be sought in the application of article 35(2) lit. b. with regard to article 35(2) lit. b, it is acknowledged that “if the seller knew or could not have been unaware of the place of use of the goods, it should investigate the existence of any local standards, affecting the use of the goods”. this is determined by the circumstances of the individual case taking into account the following factors: a. the ip right’s i. publication in official publications or databases; ii. registration in official registers; iii. whether an ip right (most importantly a trademark) is well-known in iv. the relevant sector (notoriety); iv. whether an ip right can only be identified based on a deep understanding of the features and (internal) composition of the goods (technicity); and 6.23 whether the seller cannot be unaware of the ip right or claim cannot be determined abstractly but must be determined based on the circumstances of the individual case.85 in doing so, the mainly decisive criteria are the objective accessibility of the information based on the ip right and the goods in question as well as the subjective proximity of the party to the information it is expected to acquire. 6.24 when determining the scope of the seller’s expected investigation, the first and foremost criterion is the accessibility of the information.86 the accessibility of the information defines how difficult it is objectively to acquire relevant information. nowadays, many ip registers can be accessed online and conveniently searched; this naturally affects what can be expected of the seller.87 6.25 the second relevant criterion is the proximity of the seller to the relevant information. hence, the scope of the seller’s investigation depends on the information it has access to at the relevant time.88 the information proximity thus defines how much of an effort the specific seller must make to acquire the relevant information. 85 müko bgb-gruber, art. 42 cisg para. 19; langenecker, 192. but cf. herber/ czerwenka, art. 42 para. 5 (“the seller always has to know published intellectual property rights”); similar secretariat commentary, art. 40 para. 6. 86 beckogk-hachem, art. 42 para. 18; brunner/gottlieb/tebel, art. 42 para. 11; cf. cisg advisory council opinion no. 19, standards and conformity of the goods under article 35 cisg, rapporteur saidov, rule 4 lit. k, para. 4.23. 87 cf. honnold/flechtner/flechtner, art. 42 para. 270.1; kröll et al./kröll, art. 42 para. 31. 88 shinn, 2 minn. j. global trade (1993), 115, 125 et seq.; cf. also achilles, art. 42 para. 8; bacher, fs schwenzer, 115, 126; janal, fs kritzer, 203, 220; metzger, rabelsz 73 (2009), 842, 862. cisg-ac opinion 22 24 generally, the seller can rely on the legal advice of specialised lawyers in the state of protection.89 6.26 the above-mentioned criteria must be determined by taking into account objective factors relating to the ip right in question and subjective factors relating to the specific seller. 6.27 it is obvious that the publication of ip rights facilitates their accessibility in the context of article 42 by way of an investigation. yet, some authors go as far as to categorically exclude any expectation of the seller to investigate for non-published rights.90 this reasoning fails to take into account well-known trademarks91 or encumbrances resulting from the protection of ip rights through competition or tort law. while these encumbrances are not published, they might very well be identifiable with reasonable effort by way of an investigation. to be considered well-known, a trademark must be generally known in the relevant sector.92 the required degree of awareness is usually quantified at between 5093 and 70%94 of the relevant market participants.95 publication is not required for a well-known trademark to be protected. given its status as being well-known, such a trademark should nevertheless be readily identifiable by way of an investigation – at least if the respective party is part of the relevant sector of the public based upon which the trademark is classified as well-known. hence, the threshold for the seller to be expected to identify published ip rights by way of investigation is generally lower than it is with regard to non-published rights. nevertheless, depending on the circumstances of the individual case, the seller can very well be expected to identify certain non-published rights by way of an investigation, like, for example, well-known trademarks. 6.28 according to some authors, the seller can only be expected to investigate for registered rights.96 for the seller to be expected to access the relevant registers, these must be readily accessible.97 again there is no hard and fast rule: the threshold to expect the seller to 89 kröll et al./kröll, art. 42 para. 34; galston/smit/schlechtriem, 6–34. 90 rauda/etier, vj 2000, 30, 48; cf. also kremer, 208 (duty to investigate only possible for registered or published intellectual property rights). 91 cf. article 6bis paris convention; article 16(2) sentence 2 trips agreement. 92 germany: bgh 2 april 1969, grur 1969, 607, 608-609 – recrin. 93 switzerland: bger 20 january 2004, 4c.229/2003, e.4.7.3. 94 germany: beckok markeng-weiler, § 4 para. 151. 95 germany: olg frankfurt am main 12 september 2012, beckrs 2012, 21368; ingerl/rohnke, § 4 markeng para. 31. 96 achilles, art. 42 para. 9; staudinger/magnus, art. 42 para. 22; jurispk bgbbaetge, art. 42 cisg para. 15; cf. also beline, 7 univ. of pitts. journal tech. law & pol’y (2007) 6. 97 cf. staudinger/magnus, art. 42 para. 22. njcl 2022/1 25 access readily available registers in its investigation certainly is significantly lower than with regard to non-registered rights. yet, the seller in principle is expected to investigate for non-registered ip rights as well.98 6.29 where the ip rights protect the technical or biological characteristics of the goods, the seller accordingly will usually be in a better position to investigate for such rights.99 the reason for this is that identifying such technical rights100 which might encumber certain goods requires a deep understanding of the features and (internal) composition of said goods. the buyer, on the other hand, will only be able to conduct a proper investigation if it has detailed knowledge of the technical composition of the goods, for example, because it manufactures comparable goods itself.101 in contrast, most nontechnical rights102 can be identified as potential encumbrance just from the visual appearance of the goods. here, not the technical or biological composition – of which usually only the seller has sufficient knowledge – is the basis for the potential infringement but the fact that the goods bear a trademark. concluding that the goods potentially violate the corresponding trademark right of a third party requires no specific knowledge of the goods.103 b. the goods’ i. nature; and ii. novelty; and 98 kröll et al./kröll, art. 42 para. 31; beckogk-hachem, art. 42 para. 18 (for all published intellectual property rights); langenecker, 195-196 (in case of concrete indications); metzger, rabelsz 73 (2009), 842, 854 (with economic argumentation); müko hgb-benicke, art. 42 cisg para. 20-21 (in case the sale in the buyer’s state was initiated by the seller or the seller offers the goods specifically to be used in the state of use); brunner/gottlieb/tebel, art. 42 para. 11. reluctant beckok-saenger, art. 42 para. 12; schlechtriem/schwenzer/schwenzer, art. 42 para. 15; vanduzer, 4 canadian international lawyer (2001), 187; janal, fs kritzer, 203, 215; piltz, para. 5–132 (“usually not”); witz/salger/lorenz/ salger, art. 42 para. 7 (“usually not”); staudinger/magnus, art. 42 para. 22 (regarding non-registered but published intellectual property rights); similar ferrari et al./ferrari, art. 42 cisg para. 15. 99 schlechtriem/schwenzer/schwenzer, art. 42 para. 15; langenecker, 191, 202-203; reher, 160; cf. also kröll et al./kröll, art. 42 para. 31; achilles, art. 42 para. 9. 100 technical rights include patents, utility models or semiconductor design rights; biological rights like plant breeder’s rights belong in this category as well. 101 schlechtriem/schwenzer/schwenzer, art. 42 para. 18; bacher, fs schwenzer, 115, 125-126; cf. also metzger, rabelsz 73 (2009), 842, 861-862. 102 non-technical rights include trademarks, copyright, design rights or protection of intellectual property via competition law or tort law. 103 cf. langenecker, 203; janal, fs kritzer, 203, 214. cisg-ac opinion 22 26 6.30 further the goods’ nature and novelty might influence the objective accessibility of the relevant information, eg a good is of such a novel and innovative type that it is difficult to identify relevant ip rights. c. the seller’s i. experience with the specific goods; ii. experience with the specific market; iii. size of business and sophistication; iv. language skills; v. knowledge of the specific use intended by the buyer (in case of process patents); and d. any other relevant circumstances of the individual case. 6.31 it has been established that investigating for technical ip rights requires in-depth knowledge of the features and (internal) composition of the goods in question. consequently, a relevant aspect of assessing the parties’ information proximity is how much experience they have with the goods in question.104 generally, the goods’ manufacturer has the most experience with the goods since it has unparalleled knowledge of how the goods work and how they were designed and it sometimes even holds technical ip rights encompassing the goods itself. accordingly, manufacturing the goods in question indicates that an investigation of technical ip rights can be expected.105 yet, also intermediary sellers are expected to investigate for ip rights.106 usually, the investigation expected of an intermediary seller will be less detailed than that of a seller which manufactured the goods in question.107 an intermediary seller can, however, be required to gather the information necessary to investigate for ip rights by contacting the manufacturer.108 6.32 the parties’ proximity to the relevant information increases proportionally to their experience with the specific market in the relevant state. hence, a seller who has experience with supplying 104 cf. cisg advisory council opinion no. 19, standards and conformity of the goods under article 35 cisg, rapporteur saidov, rule 4 lit. f. 105 schlechtriem/schwenzer/schwenzer, art. 42 para. 15 (without restriction to technical rights); langenecker, 191; bacher, fs schwenzer, 115, 125; cf. cisg advisory council opinion no. 19, standards and conformity of the goods under article 35 cisg, rapporteur saidov, rule 4 lit. e. 106 kröll et al./kröll, art. 42 para. 33; bacher, fs schwenzer, 115, 125. more reluctant metzger, rabelsz 73 (2009), 842, 854 (not without specific indications). 107 cf. kröll et al./kröll, art. 42 para. 33; similar achilles, art. 42 para. 9; brunner/gottlieb/tebel, art. 42 para. 11; cf. also janal, fs kritzer, 203, 215, 217; reher, 161 (the closer the seller to the manufacturing process of the goods the more thorough of an investigation is required of it). 108 schlechtriem/schwenzer/schwenzer, art. 42 para. 15; bacher, fs schwenzer, 115, 125. njcl 2022/1 27 goods to the relevant state109 or even has a branch there as well can be expected to investigate for less accessible ip rights. furthermore, with specific regard to well-known trademarks, a party can primarily be expected to identify a well-known trademark if the party is part of the relevant sector of the public the trademark is well-known in – this includes, in particular, being part of the usual distribution chain for goods in that sector. 6.33 sellers with extensive business operations and a high degree of sophistication, in particular with a dedicated legal department, can be expected to conduct more substantial and thus more onerous investigations.110 6.34 based on economic considerations, a party fluent in the language the investigation is to be conducted in is more likely to be expected to investigate for ip rights than a party who would need to enlist translators or other costly support.111 6.35 where ip encumbrances do not result from the features of the goods themselves, but from a specific way the goods are used – in particular methods or process patents, the scope of the seller’s expected investigation depends on the degree of knowledge it has of the specific use intended by the buyer. 6.36 in contrast, it is irrelevant for the scope of the investigation which party initiated the conclusion of the contract112 or the use of the goods in the relevant state.113 further, if the seller considers an investigation for ip rights unreasonable from a commercial perspective or impossible to conduct due to time constraints – for example in light of the low value of a first-time contractual relationship114 or the short period of time between contract 109 müko bgb-gruber, art. 42 cisg para. 19; beckogk-hachem, art. 42 para. 18; ferrari et al./ferrari, art. 42 cisg para. 15; beckok-saenger, art. 42 para. 12; cf. cisg advisory council opinion no. 19, standards and conformity of the goods under article 35 cisg, rapporteur saidov, rule 5.2 lit. b. 110 rauda/etier, vj 2000, 30, 47; cf. also beckogk-hachem, art. 42 para. 18; cisg advisory council opinion no. 19, standards and conformity of the goods under article 35 cisg, rapporteur saidov, rule 4 lit. g. 111 cf. langenecker, 204; but see janal, fs kritzer, 203, 219 referring to the buyer’s knowledge under art. 42(2) lit. a. 112 metzger, rabelsz 73 (2009), 842, 854; müko bgb-gruber, art. 42 cisg para. 19; piltz, para. 5–132; but see müko hgb-benicke, art. 42 cisg para. 19. 113 but see müko hgb-benicke, art. 42 cisg para. 20-21. 114 some authors reject a duty to investigate in these cases right away, cf. kröll et al./kröll, art. 42 para. 32; janal, fs kritzer, 203, 216-217; in the same direction also vanduzer, 4 canadian international lawyer (2001), 187. cisg-ac opinion 22 28 conclusion and delivery115 – it has to exclude this duty by way of an agreement with the buyer.116 6.37 additionally, all other relevant circumstances of the individual case must be taken into consideration to come to an appropriate outcome. 7. in order to determine a state of use under article 42(1)(a) cisg, use is to be interpreted broadly and encompasses any action the buyer intends to take or to have taken with regard to the goods. use includes transit of the goods through a state other than the state of their destination. 7.1 mirroring the territorial scope of ip rights, article 42 holds the seller liable only for encumbrances based on ip law under the law of certain states. depending on the circumstances of the case, these relevant states can be a state of use pursuant to article 42 (1) lit. a, the buyer’s state pursuant to article 42(1) lit. b, the seller’s state or a transit state. 7.2 pursuant to article 42(1) lit. a, the seller is liable for the goods’ encumbrance with ip rights or claims in the contemplated state of use. article 42(1) lit. a encompasses states “where the goods will be resold or otherwise used”. considering the provision’s purpose to protect the buyer’s interest in using the goods unimpaired by any ip rights or claims, the phrase “resold or otherwise used” should be interpreted broadly.117 it encompasses any action the buyer intends to be taken with regard to the goods. in line with the purpose of article 42 to comprehensively protect the buyer’s interest in using the goods unimpaired, where the parties at the relevant time contemplate any action to be taken with regard to the goods in a particular state, the seller is liable for any impairment to this action based on ip in that state. 7.3 the parties are free to contemplate multiple states of use.118 it furthermore is possible to combine resale and use in this regard; the 115 inclined to reject a duty to investigate in these cases müko bgb-gruber, art. 42 cisg para. 19. 116 regarding this possibility cf. schlechtriem/schwenzer/schwenzer, art. 42 para. 15; cf. also müko bgb-gruber, art. 42 cisg para. 26. 117 langenecker, 159-160. 118 kröll et al./kröll, art. 42 para. 17; müko bgb-gruber, art. 42 cisg para. 14; witz/salger/lorenz/salger, art. 42 para. 6; janal, fs kritzer, 203, 220; brunner/gottlieb/tebel, art. 42 para. 14; but see shinn, 2 minn. j. global trade (1993), 115, 130, cf. also 128 note 61; similar enderlein/maskow/ strohbach, art. 42 para. 6 (“relating to one state only each”); šarčević/volken/ enderlein, art. 42, 181 (“applies only to one country”). njcl 2022/1 29 parties can thus contemplate reselling the goods in certain states and additionally using the goods in certain other states.119 7.4 resale or use of the goods by anyone, including the buyer’s customers is encompassed by article 42(1) lit. a.120 the provision’s wording contains no limitation to resale or use specifically by the buyer. instead, the wording refers only to the act of reselling and using without even mentioning the acting party. the only reasonable inference that can be drawn from this open wording is that anyone can resell or use the goods in terms of article 42(1) lit. a. accordingly, the secretariat commentary acknowledges that “[i]t will even be the case that the buyer’s subpurchasers may take the goods to a third country for use”.121 further, when reselling the goods, the buyer is potentially liable in relation to its customer for the goods’ freedom from encumbrance in the state that is relevant to this customer. as a consequence, in relation to the seller, the buyer’s primary interest is that the goods are free from encumbrances in the state they are ultimately used by its customer. the buyer’s interest in the goods’ freedom from encumbrance in the state where the resale takes place is but a mere reflex of this primary interest. hence, a reasonable interpretation of article 42(1) lit. a must take into account this primary interest of the buyer. against this background, the distinction between the state “where” and the state “whereto” the goods are resold122 is accurate but irrelevant, since the customer’s state is not just the state “whereto” the goods are sold by the buyer, but also a state “where” the goods are resold if the customer decides to sell on the goods again or the customer’s state is a state “where” the goods are “used” if the customer decides to use the goods itself.123 7.5 in line with the appropriate broad interpretation, use includes all actions the buyer intends to be taken with regard to the goods – be it by the buyer or somebody else. accordingly, transit is use of the goods, even if initiated by the seller. the proponents of the opposing view who exclude encumbrances in the transit state from 119 schlechtriem/schwenzer/schwenzer, art. 42 para. 10; honsell/magnus, art. 42 para. 10; ferrari et al./ferrari, art. 42 cisg para. 11; rauda/etier, vj 2000, 30, 51. 120 cf. schlechtriem/schwenzer/schwenzer, art. 42 para. 10. this result is also implied by the example given by langenecker, 153. 121 secretariat commentary, art. 40 para. 4. 122 ogh 12 september 2006, cisg-online 1364 (the ogh was not in the position to render a final and binding decision but had to refer the dispute back to the court of first instance); cf. also staudinger/magnus, art. 42 para. 15; honsell/magnus, art. 42 para. 10; beckogk-hachem, art. 42 para. 20; langenecker, 160-161. 123 brunner/gottlieb/tebel, art. 42 para. 14 note 1650 in fine. cisg-ac opinion 22 30 the scope of article 42 mostly offer no reason for their view.124 the finding that transit is use and thus encumbrances in the transit state can trigger the seller’s liability under article 42 is confirmed by the fact that in certain jurisdictions already mere transit can infringe ip rights (even without the goods being put into circulation)125 and customs authorities even can take measures already based on the suspicion of infringement.126 excluding such encumbrances resulting from transit from the scope of article 42 would result in unwarranted gaps in the protection of the buyer’s interest in utilising the goods unhindered by encumbrances. 7.6 if transit is contemplated by the parties, the seller thus is liable for ip encumbrances in the transit state by virtue of direct application of article 42(1) lit. a. by way of example, the parties might make reference to an icc incoterms® for d-clause in their contract, requiring the seller to deliver the goods to a particular place whereas the buyer is responsible for the goods’ transport from that place on. if the place named in reference to the clause lies in a state that has not already been contemplated as a state of use, transit through that state is contemplated, and the seller is liable for encumbrances there. the situation is comparable if the parties opt for a c-clause under which the seller is responsible for arranging carriage of the goods also after the risk passes to the buyer. contemplation can also be based on practices or usages established between the parties or international trade usages.127 124 ferrari et al./ferrari, art. 42 cisg para. 13; müko bgb-gruber, art. 42 para. 11; müko hgb-benicke, art. 42 cisg para. 13; piltz, para. 5–129. 125 eu: article 9(4) regulation (eu) 2017/1001 of 14 june 2017 on the european union trade mark and article 10(4) directive (eu) 2015/2436 of 16 december 2015 to approximate the laws of the member states relating to trade marks; the provision is to be transposed into the member states’ trademark laws by 14 january 2019 pursuant to art. 54(1) directive (eu) 2015/2436; cf. also international association for the protection of intellectual property, border measures and other means of customs intervention against infringers (q208), available at http://aippi.org/ committee/border-measures-and-other-means-of-customs-intervention-againstinfringers (19 of the 41 respondents reported that pursuant to their domestic laws, goods in transit can be seized based on intellectual property infringement). 126 article 17(1) and 18(1) in conjunction with article 2(7)(a) regulation (eu) no. 608/2013; cf. rinnert, grur 2014, 241, 243 (“the lowest stage of likelihood”). 127 where a seller and a buyer concluded a string of contracts for the delivery of comparable or identical goods that were always shipped via a particular state, this can amount to a practice established between the parties pursuant to article 9(1) and result in the respective state being contemplated as a state of use. the same applies where certain goods shipped from one state to another by the means chosen by the parties are always transported via a particular state this might constitute an international trade usage that results in contemplation of the transit state as a state of use if the njcl 2022/1 31 7.7 if transit through the state in question was not contemplated by the parties, direct application of article 42 is not possible. if the seller does, however, unilaterally determine the transit route, thereby choosing the transit state, article 42 nevertheless applies either as a general principle in terms of article 7(2) or by way of analogy.128 if transit was not contemplated, the buyer’s interest in the goods’ freedom from encumbrances in the transit state is a reflex of its interest in freely using the goods in the contemplated state of use or its own state the goods are destined for. further, the seller is not unduly burdened if it is expected to investigate for ip rights in a transit state that was not contemplated but unilaterally chosen by itself. also with regard to the territorial limitation, the seller even is in a better position to assess its liability risk if it unilaterally chooses the transit state compared to cases of mere contemplation of the state of use intended by the buyer. the balance of interests in this regard – if at all – shifts in favour of the buyer, not the seller. where the relevant infringement is not based on mere transit but on the goods being put into circulation in the transit state, the seller is liable if the seller unilaterally decides to put the goods into circulation. in contrast, the seller is not liable where the buyer puts the goods into circulation in the transit state without the parties having contemplated so when concluding the contract. 7.8 if, on the other hand, the transit state is unilaterally chosen by the buyer, application of article 42 is not justified. yet, if in this situation the seller brings the goods into circulation without the buyer’s agreement – for example to repackage them – and thereby infringes an ip right resulting in loss of the goods, the buyer is discharged from its obligation to pay the purchase price under article 66 in fine. 8. contemplation by the parties of a state of use only requires that the seller can discern the buyer’s intention to use the goods in one or more specific states from the circumstances. in particular, the parties are considered to have contemplated a state of use if requirements of article 9(2) are met. depending on the sector in which the parties are active, examples might include transport of cargo via ship from asia to europe through the suez canal in egypt or (for a different route) the panama canal. in certain cases, also transport via aeroplane through schiphol airport in amsterdam, the netherlands or through frankfurt airport, germany might be customary. 128 cf. schlechtriem/schwenzer/schwenzer, art. 42 para. 14. differently beckogk-hachem, art. 42 para. 25 (violation of duty to diligently organize transport of the goods – article 66, however, only encompasses special risks associated with the transport and not defects of the goods; also there is no need to remove these cases from the carefully balanced system of articles 42 and 43); reher, 148 (in favour of a duty of the seller to warn the buyer of the goods’ encumbrance in the transit state “at most” if the seller has actual knowledge of the encumbrance). cisg-ac opinion 22 32 a. the buyer is active only in the market of that state and the seller could not have been unaware of this; or b. under the contract, i. transportation of the goods to or through that state is envisaged; ii. instruction manuals or other documents accompanying the goods are to be in a specific language other than the buyer’s language and this language is spoken only in that state; iii. the required design of the goods points to that state; or iv. mandatory or voluntary certificates that the goods are required to have are relevant only in that state. 8.1 the state of use is only relevant pursuant to article 42(1) lit. a “if it was contemplated by the parties at the time of the conclusion of the contract that the goods would be resold or otherwise used in that state”. based on the principle of party autonomy in article 6, the parties can agree that a particular state is relevant as a state of use. likewise, practices or usages applicable by virtue of article 9(1) or international trade usages applicable pursuant to article 9(2) can result in a particular state being contemplated as a state of use. with regard to the minimal requirements of the notion of contemplation, there is agreement that the term “contemplated” in the context of article 42(1) lit. a requires an objectively manifested intention of the buyer that the goods will be resold or used in the state in question.129 8.2 for the seller, however, it is sometimes required that he agrees to the buyer’s intended use,130 sometimes that he has actual knowledge.131 the majority of authors rightly consider it sufficient that the seller can discern from the circumstances of the contract conclusion that the buyer intends to use the goods in the respective state.132 the cisg consistently uses the term “agree” if an 129 müko bgb-gruber, art. 42 cisg para. 15; kröll et al./kröll, art. 42 para. 16; achilles, art. 42 para. 5; cf. schlechtriem/schwenzer/schwenzer, art. 42 para. 11. 130 janal, fs kritzer, 203, 221; rauda/etier, vj 2000, 30, 52; cf. also shinn, 2 minn. j. global trade (1993), 115, 128. 131 beckogk-hachem, art. 42 para. 21; probably also šarčević/volken/ enderlein, art. 42, 181 (“they must have taken this possibility into account, and not only the buyer but also the seller”). 132 schlechtriem/schwenzer/schwenzer, art. 42 para. 11; müko hgbbenicke, art. 42 cisg para. 9; kröll et al./kröll, art. 42 para. 16; achilles, art. 42 para. 5; jurispk bgb-baetge, art. 42 cisg para. 9; cf. also müko bgbgruber, art. 42 para. 15 (“sufficiently discernible”); staudinger/magnus, art. 42 para. 16 (“sufficient indication”); metzger, rabelsz 73 (2009), 842, 858 (indication by the buyer sufficient); prager, 158 (“sufficient indication”); cf. also zeller, 15 njcl 2022/1 33 agreement of the parties is required.133 the fact that the term “agree” is not used in article 42(1) lit. a thus strongly indicates that “contemplated by the parties” does not mean “agreed upon by the parties”.134 further, considering a seller to have contemplated circumstances it was not positively aware of is not easy to square with the natural meaning of the term “contemplate”.135 requiring actual knowledge, however, always burdens the party relying on such knowledge with an onus of proof almost impossible to meet.136 putting such an onus on the buyer in the framework of article 42 would not lead to adequate results. in line with this, many authors who require an agreement or actual knowledge with regard to article 42(1) lit. a are forced to objectify their purely subjective requirements as well.137 this widespread consensus that it is necessary to determine whether the parties contemplated the state of use based on objective criteria confirms that it is sufficient that the seller can discern the state of use from the circumstances. further support for this position can be found in a comparison of article 42(1) lit. a and article 35(2) lit. b. the prevailing opinion interprets article 35(2) lit. b as requiring that the seller can discern the particular purpose from the circumstances.138 despite the differences in the provisions’ wordings, reasonably interpreted, both provisions thus require that the seller can discern the relevant aspect from the circumstances. this outcome is also appropriate since both provisions have the purpose of protecting the buyer’s interests in using the goods unimpaired from any legal (article 42(1) lit. a) or factual (article 35(2) lit. b) hindrances. the standard of knowledge the seller is required to have of the intended use should accordingly be the same. finally, to achieve the purpose of article 42, that is to allow the seller to assess its liability risk, it is not necessary that the seller actually assessed its liability risk correctly. a seller that objectively is in the position to accurately assess its liability risk but fails to do so does not deserve to be protected from this failure. vj (2011), 289, 293 (art. 42(1) lit. b applies if “the seller does not know or could not reasonably have known the place where the goods are to be ultimately sold”). 133 articles 9(1); 29(1), (2); 35(2); 41 sentence 1; 58(3); 65(1); 96. 134 beckogk-hachem, art. 42 para. 21. 135 beckogk-hachem, art. 42 para. 21. 136 see for the parallel question whether “made known” in article 35(2) lit. b requires actual knowledge of the seller schlechtriem/schwenzer/schwenzer, art. 35 para. 23. 137 janal, fs kritzer, 203, 221 (the example given is that the parties agree upon shipment to a country other than the buyer’s place of business); rauda/etier, vj 2000, 30, 52; beckogk-hachem, art. 42 para. 21. 138 schlechtriem/schwenzer/schwenzer, art. 35 para. 23 with further references; but see beckogk-hachem, art. 42 para. 21. cisg-ac opinion 22 34 8.3 usually, some kind of statement or behaviour of the buyer will be the basis for an indication that the goods will be resold or otherwise used in a particular state. accordingly, it seems appropriate to seek guidance in the provision dealing with the interpretation of the parties’ statements and other conduct, that is article 8.139 in order to assess whether a state of use was contemplated by the parties, it thus is decisive whether a reasonable person in the shoes of the seller should have become aware of the use intended by the buyer on the basis of the contract and the given circumstances.140 relevant in this regard are the factors listed in article 8(3), most importantly the parties’ negotiations in general and the agreed delivery modalities specifically.141 since article 42(1) lit. a requires that the parties contemplated the state of use at the time of contract conclusion, only circumstances existing at or before that point in time can indicate to the seller that the goods will be resold or otherwise used in a particular state. the parties’ subsequent behaviour can only be relevant to confirm their understanding at the time of contract conclusion. furthermore, in line with article 9, usages known to or practices established between the parties can be relevant. 8.4 the threshold for contemplation by the parties in the sense of article 42(1) lit. a should not be set overly high with regard to a single state of use. if no state of use is contemplated pursuant to article 42(1) lit. a, the seller is liable for encumbrances in the buyer’s state pursuant to article 42(1) lit. b. therefore, the decisive question a reasonable seller would ask is whether it is more likely that the goods are to be used in the potential state of use or in the buyer’s state. the seller’s interests are not affected by this approach. abstractly, it makes no difference to the seller whether it is liable for the goods’ freedom from encumbrances in the buyer’s state or in a state of use. however, if the circumstances point to multiple states as states of use, the seller’s interests are affected. accordingly, in order to contemplate multiple states of use, it is not sufficient that, considered in isolation, the balance of probabilities tips in favour of the potential states of use. instead, the threshold must be higher, 139 cf. beckok-saenger, art. 42 para. 9; ferrari et al./ferrari, art. 42 cisg para. 10; janal, fs kritzer, 203, 221; beline, 7 univ. of pitts. journal tech. law & pol’y (2007) 6. cf. also schlechtriem/schwenzer/fountoulakis, art. 73 para. 36 (with regard to article 73(3)). 140 schlechtriem/schwenzer/fountoulakis, art. 73 para. 36 (with regard to article 73(3)); cf. also beline, 7 univ. of pitts. journal tech. law & pol’y (2007) 6 (“anything that would give the seller reasonable notice of the states in which the buyer would be considering use of the goods”). 141 schlechtriem/schwenzer/schwenzer, art. 42 para. 11; müko hgbbenicke, art. 42 cisg para. 9; kröll et al./kröll, art. 42 para. 16; achilles, art. 42 para. 5; jurispk bgb-baetge, art. 42 cisg para. 9. njcl 2022/1 35 that is further or more specific indications are required. this higher threshold is for example met if a reasonable seller would conclude from the circumstances that one of the states the indications point to is a transit state whereas the other is the state the goods are ultimately destined for in which the buyer intends to resell the goods to a customer located in a third state where the goods will be used. in any case, the buyer is well advised to expressly make the seller aware of its intention in a provable way not only, but specifically in cases in which it intends to use the goods in multiple states.142 8.5 finally, as indicated by the wording of article 42(1) lit. a (“contemplated […] that the goods would be […] used”, emph. add.),143 the parties are not required to contemplate any specific kind of use but merely that as opposed to how the goods will be used in the state in question. accordingly, it is sufficient that the parties contemplate at least one use of the goods in the state in question to trigger the seller’s liability for the goods’ freedom from encumbrances in that state with regard to all potential uses. if the seller wants to limit its liability to certain specific uses only, it must do so by mutual agreement. 8.6 applying these considerations, the parties have contemplated a state of use if the buyer is active only in the market of that state and the seller could not have been unaware of this;144 or under the contract transportation of the goods to or through that state is envisaged;145 142 cf. schlechtriem/schwenzer/schwenzer, art. 42 para. 11; beckogkhachem, art. 42 para. 22. 143 this equally applies to the authentic french (“[…] si les parties ont envisagé au moment de la conclusion du contrat que les marchandises seraient revendues ou utilisées dans cet etat […]”, emph. add.) and spanish (“[…] si las partes hubieren previsto en el momento de la celebración del contrato que las mercaderías se revenderían o utilizarían en ese estado […]”, emph. add.) language versions as well as the non-authentic dutch (“[…] indien partijen op het tijdstip waarop de overeenkomst werd gesloten, onder ogen hebben gezien dat de zaken zouden worden doorverkocht of anderszins gebruikt in die staat […]”, emph. add.) and german (“[…] wenn die parteien bei vertragsabschluß in betracht gezogen haben, daß die ware dort weiterverkauft oder verwendet wird […]”, emph. add.) translations. 144 schlechtriem/schwenzer/schwenzer, art. 42 para. 11. 145 kröll et al./kröll, art. 42 para. 16; müko bgb-gruber, art. 42 cisg para. 15; schlechtriem/schwenzer/schwenzer, art. 42 para. 11; müko hgbbenicke, art. 42 cisg para. 9; janal, fs kritzer, 203, 221; metzger, rabelsz 73 (2009), 842, 858; reher, 148; brunner/gottlieb/tebel, art. 42 para. 14. but see also beckok-saenger, art. 42 para. 9 (considering the place of delivery irrelevant). cisg-ac opinion 22 36 instruction manuals or other documents accompanying the goods are to be in a specific language other than the buyer’s language and this language is spoken only in that state;146 the required design of the goods147 points to that state;148 or mandatory or voluntary certificates the goods are required to have are relevant only in the state in question. 8.7 with the exception of the place of delivery,149 all of the above factors require further indications if they point to multiple states for these states to be contemplated as states of use.150 8.8 pursuant to article 42(1) lit. b, the buyer’s state is only relevant subsidiarily if no state of use was contemplated at the relevant time.151 in this regard, the operation of this provision thus is similar to the ordinary purpose the goods must be fit for pursuant to article 35(2) lit. a if no particular purpose was made known to the seller in terms of article 35(2) lit. b.152 if the buyer has multiple places of business, article 10 determines which of multiple places of business is the relevant one. 8.9 article 42(1) makes no reference to the seller’s state. accordingly, there are only three possibilities how the seller can be liable for encumbrances in its state: first, if the seller’s state was contemplated as a state of use;153 second, if ip rights existing in the state relevant in terms of article 42(1) lit. a or b are enforced in the seller’s state; and third, if ip rights protected in the seller’s state take effect indirectly via the applicable law in the relevant state.154 this corresponds with the general interests of the buyer since it is generally only in these situations that the buyer is interested in the goods’ freedom from ip encumbrances in the seller’s state.155 146 kröll et al./kröll, art. 42 para. 16; brunner/gottlieb/tebel, art. 42 para. 14. 147 for example power plugs of electronic devices. 148 cf. staudinger/magnus, art. 42 para. 17; rauda/etier, vj 2000, 30, 52 (considering the nature of the goods relevant). 149 but see rauda/etier, vj 2000, 30, 52; staudinger/magnus, art. 42 para. 17; ferrari et al./ferrari, art. 42 cisg para. 10 (requiring additional corroboration). 150 for the buyer’s activity in different markets: kröll et al./kröll, art. 42 para. 16; beckogk-hachem, art. 42 para. 21; janal, fs kritzer, 203, 222; metzger, rabelsz 73 (2009), 842, 858; brunner/gottlieb/tebel, art. 42 para. 14; but see müko hgb-benicke, art. 42 cisg para. 9; zeller, 15 vj (2011), 289, 296. 151 schlechtriem/schwenzer/schwenzer, art. 42 para. 12. 152 kröll et al./kröll, art. 42 para. 18; schlechtriem/schwenzer/schwenzer, art. 42 para. 12. 153 schlechtriem/schwenzer/schwenzer, art. 42 para. 13; langenecker, 163; prager, 160; brunner/gottlieb/tebel, art. 42 para. 16. 154 brunner/gottlieb/tebel, art. 42 para. 16. 155 cf. rauda/etier, vj 2000, 30, 55. njcl 2022/1 37 9. states in the sense of article 42(1)(a) and (b) cisg include federal states together with all their constituent territories but not associations of states. if, however, the parties contemplate that the goods will be used only in a specific area of the state of use, the buyer cannot invoke encumbrances in different areas as a basis of the seller’s liability. 9.1 pursuant to article 42(1) lit. a and b, the seller is liable for encumbrances in “the state” of use or of the buyer. the capitalised use of the term “state” in this provision evidences that the meaning of this term here is identical with the remaining capitalised references to the term “state” throughout the cisg. as is confirmed in particular by the cisg’s preamble (“the states parties to this convention”), article 1(1) lit. a (“when the states are contracting states”) and article 91(3) (“this convention is open for accession by all states”), “states” as referred to in the cisg are the entities that are or can become a party to the cisg as an international convention. this includes all entities recognised as states under public international law.156 this notion thus includes federal states together with all their constituent territories. further, the notion of state in the sense of article 42(1) lit. a and b does not include associations but rather states only.157 otherwise, a seller that sells to a buyer that has its place of business in the european union would – if the parties did not contemplate any state of use – be liable for encumbrances in the entire european union,158 which would unduly weaken the territorial limitation of article 42(1). 9.2 certain ip rights are protected only in part of the relevant state’s territory. examples include trademarks that are established not by registration but by use in the relevant market159 or in federal states when rights are protected under state law only with effect for the respective individual state.160 in article 93, the cisg distinguishes between the “contracting state” and its “territorial units”. based on the provision’s reference to “state”, the seller thus is liable for encumbrances existing only in parts of the state of use or the buyer’s state, even when the parties just contemplated use of the goods in the state as such without concretely contemplating using the goods in that specific part of the state.161 the same applies mutatis 156 schlechtriem/schwenzer/schroeter/ferrari (7th german edition), art. 91. 157 cf. for the parallel debate regarding the accession of associations of states to the cisg in the framework of artice 91(3): pro schroeter, fs kritzer, 425, 467-469; contra staudinger/magnus, art. 91 para. 5; basedow, fs schlechtriem, 165, 180181. 158 cf. langenecker, 158. 159 germany: § 4 no. 2 markeng; fezer, § 4 para. 129. 160 us: shinn, 2 minn. j. global trade (1993), 115, 128 note 63. 161 cf. shinn, 2 minn. j. global trade (1993), 115, 129; but see langenecker, 156; reher, 150. cisg-ac opinion 22 38 mutandis to the seller’s liability pursuant to article 42(1) lit. b if the buyer’s place of business is located in a part of the buyer’s state while the ip in question is only protected in another part of this state. if, on the other hand, the parties did contemplate using the goods only in a specific part of the state of use, the buyer gave the seller reason to conclude that the goods were to be used only in the partial territory. thereby, the buyer assumes the risk of encumbrances outside of this partial territory. invoking encumbrances existing only in another part of the state would hence constitute contradictory conduct prohibited by the principle of venire contra factum proprium.162 accordingly, the buyer’s conduct and statements indicating the use of the goods in a partial territory must be interpreted as triggering contemplating use only in that partial territory thereby effectively limiting the seller’s liability to this part only.163 9.3 the tendencies of harmonisation in the field of ip law result in an increasing number of ip rights that are protected not just in one but in several states.164 since generally treaties and conventions establishing ip rights with territories of protection encompassing the respective state parties are considered part of these states’ law, ip rights based on legislative acts with effect for several states exist “under the law” of the state of use or the buyer’s state respectively as referred to in article 42(1) lit. a and b. the same applies to ip protected under the law of supranational organisations of states like the european union. 9.4 the law relevant under article 42(1) lit. a and b is determined by virtue of the rules of international private law of the relevant state.165 10. the seller’s knowledge and the identity of the relevant states are assessed at the time of conclusion of the contract. whether the goods are encumbered with ip rights or claims under article 42 cisg is assessed at the time of the passing of risk based on the general principle enshrined in article 36 cisg. 162 cf. for this general principle schlechtriem/schwenzer/schwenzer/hachem, art. 7 para. 32. 163 rauda/etier, vj 2000, 30, 53-54; cf. for the same result langenecker, 156; reher, 150 (teleological restriction of the term state). 164 for example, the european union trade mark (art. 1(2) regulation (eu) 2017/ 1001 of the european parliament and of the council of 14 june 2017 on the european union trade mark) and the european union design in the european union (art. 1(3) council regulation (ec) no 6/2002 of 12 december 2001 on community designs) or the unitary patent for switzerland and liechtenstein (art. 4(1) 1978 treaty between the swiss confederation and the principality of liechtenstein on patent protection). 165 müko bgb-gruber, art. 42 cisg para. 12; beckok-saenger, art. 42 cisg para. 8; piltz, para. 5–129; honsell/magnus, art. 42 para. 8; staudinger/ magnus, art. 42 para. 15; reher, 146; prager, 159-160; but see kremer, 207-208 (only substantive law of the relevant state applies). njcl 2022/1 39 in the case of delivery prior to the agreed date, the buyer is entitled to cure any encumbrance until the agreed date in accordance with the general principle stipulated in article 37 cisg. 10.1 the relevant time to assess the parties’ knowledge of the encumbrance under article 42 is the time of the conclusion of the contract as per article 23. if the parties become aware of the ip right after this point in time, they are not liable pursuant to article 42, but both of them can be subject to a duty to inform the other party accordingly based on the parties’ general duty to cooperate. likewise, the relevant time to determine the relevant state under article 42(1) also is the time of the conclusion of the contract. subsequent changes do not affect the seller’s liability, neither with regard to the intended state of use166 nor to the buyer’s relevant place of business.167 it flows from the general principle of party autonomy as provided for in article 6, however, that the parties are free to change the relevant territories after contract conclusion by way of mutual agreement168 – as opposed to mere contemplation. 10.2 article 42 does not expressly stipulate the time relevant to assess whether the goods are encumbered with ip rights or claims. although many authors infer from the reference to the seller’s delivery obligation that the time of delivery is the relevant time to assess whether the goods are encumbered,169 this inference is not self-evident. in comparison, the parallel provision dealing with nonconforming goods, article 35(1) also provides that “the seller must deliver goods” that conform to the contractual requirements. with regard to non-conformities, however, article 36(1) defines the time relevant to determine whether the goods conform to the contract as “the time when the risk passes to the buyer”. article 36, however, expressly refers to “any lack of conformity” and thus does not apply directly to encumbrances of the goods pursuant to article 41 and 42. encumbered goods are not encompassed by references to goods not conforming to the contract in the cisg (see infra para. 105). 166 schlechtriem/schwenzer/schwenzer, art. 42 para. 11; langenecker, 162163; prager, 158; brunner/gottlieb/tebel, art. 42 para. 19. 167 kröll et al./kröll, art. 42 para. 19; brunner/gottlieb/tebel, art. 42 para. 19. 168 achilles, art. 42 para. 6. 169 herber/czerwenka, art. 42 para. 4; schlechtriem/schwenzer/schwenzer, art. 42 para. 8; müko bgb-gruber, art. 42 cisg para. 17; müko hgb-benicke, art. 42 cisg para. 5; kröll et al./kröll, art. 42 cisg para. 23; beckoksaenger, art. 42 para. 11; rauda/etier, vj 2000, 30, 42; reher, 124; prager, 150; but see šarčević/volken/enderlein, art. 42, 180; cf. also enderlein/ maskow/strohbach, art. 41 para. 6 (considering the time of contract conclusion relevant). cisg-ac opinion 22 40 10.3 this gap regarding the relevant time to assess the seller’s liability for ip encumbrances should be filled by applying the general principle enshrined in article 36(1). accordingly, the time of the passing of risk is the relevant point in time to determine the seller’s liability for encumbrances. an analysis of the drafting history suggests that the view that delivery of the goods is the relevant time to assess the seller’s liability for encumbrances results from a more or less unreflecting adoption of the legal situation under the ulis170 as the cisg’s predecessor without any further discussion of the issue during the cisg’s drafting phase.171 10.4 under the cisg, however, the ulis’ system was changed significantly – most importantly for the issue at hand, the passing of risk was linked to handing over of the goods instead of delivery172 and specific rules for delivery by placing the goods at the buyer’s disposal were implemented:173 the passing of risk pursuant to articles 67 to 69 is linked to the fact-based concept174 of handing over of the goods.175 while in most situations the time of delivery corresponds to the time of handing over of the goods and thus the time the risk passes,176 there are situations in which delivery is effected before the risk passes:177 if the goods are to be put at the buyer’s disposal in line with article 31 lit. b or c, delivery is effected if the goods are at the buyer’s disposal even if they are still in the custody of the seller. the risk, however, only passes once the buyer 170 the time relevant to assess the seller’s liability for encumbrances in terms of article 52 ulis was not expressly stipulated as well (zhang, 145; prager, 79). during the drafting conference in the hague, it was stated that the relevant time was the time of delivery, and that further specification of this point was superfluous (prager, 79). accordingly, it was generally assumed that the time of delivery was the relevant time to assess the seller’s liability pursuant to article 52 ulis (dölle/ neumayer, art. 52 para. 8). notably, however, under article 97(1) ulis, the passing of risk was linked to delivery (schlechtriem/schwenzer/hachem, art. 69 para. 1). delivery, in turn, was defined as “the handing over of goods which conform with the contract” by article 19(1) ulis, implementing the french concept of délivrance (galston/smit/schlechtriem, 6–7; audit, 179). 171 prager, 150. 172 schlechtriem/schwenzer/hachem, intro to art. 66-70 para. 13. 173 cf. honnold/flechtner/honnold, art. 31 para. 210. 174 schwenzer/hachem/kee, para. 38.40. 175 schwenzer/hachem/kee, para. 38.45; schlechtriem/schwenzer/hachem, intro to arts. 66-70 para. 16-17; art. 69 para. 1. 176 schlechtriem/schwenzer/widmer lüchinger, art. 31 para. 9. most importantly, if the contract involves carriage of the goods, both delivery (article 31 lit. a) and the passing of risk (article 67(1)) coincide with handing over the goods to the first carrier. 177 schlechtriem/schwenzer/widmer lüchinger, art. 31 para. 9; schlechtriem/schwenzer/hachem, art. 69 para. 1. njcl 2022/1 41 physically takes over the goods or breaches the contract by not doing so as stipulated by article 69(1). 10.5 against this background, an analysis of the parties’ interests should primarily inform determining the relevant point in time to assess the seller’s liability for encumbrances. the buyer is interested in the goods being free from ip encumbrances at the time it takes possession of the goods, that is at the time the goods are physically handed over to it. the seller’s interest, on the other hand, is that the point in time at which its liability is assessed is as late as possible. until the relevant point in time, the seller can still remove any encumbrances and thereby avoid being held liable by the buyer.178 furthermore, the seller is not unreasonably burdened by the risk of any new encumbrances arising after the conclusion of contract since its liability is limited to those encumbrances it knew or could not have been unaware of at the time of contract conclusion. consequently, the time of the passing of risk, as opposed to the delivery, is the relevant point in time to determine whether any encumbrances of the goods exist the seller is liable for. 10.6 strictly drawing the line at the time of the passing of risk to delimitate the seller’s liability would, however, unduly exclude liability for any claims raised after the passing of risk.179 applying the general principle derived from article 36(1) in fine offers a solution; this article provides that the seller is liable for non-conformities which exist at the time the risk passes, “even though the lack of conformity becomes apparent only after that time”. the underlying rationale is that while the non-conformity did not exist in its final form at the relevant time, the non-conformity was already inherent to the goods.180 this rationale also applies to claims raised after the passing of risk:181 if the claim is based on factual circumstances existent at the relevant time, it was already inherent to the goods and the seller should be held liable for it. accordingly, it must be assessed whether the circumstances, on which the encumbrance is based, exist at the relevant time in contrast to the encumbrance itself.182 in other words, the seller is liable for all claims that could 178 piltz, para. 5–122; honnold/flechtner/honnold, art. 37 para. 245.1, art. 41 para. 266 note 9; schlechtriem/schwenzer/schwenzer, art. 42 para. 8 (regarding art. 42). 179 reher, 124. in favour of such limitation of the seller’s liability šarčević/ volken/enderlein, art. 41, 179; cf. also enderlein/maskow/strohbach, art. 41 para. 5. 180 olg linz 23 january 2006, cisg-online 1377. 181 cf. achilles, art. 41 para. 5 (referring to art. 36(2) instead of art. 36(1) in fine). 182 cf. schlechtriem/schwenzer/schwenzer, art. 41 para. 16; beckoksaenger, art. 41 para. 7; müko hgb-benicke, art. 41 cisg para. 13; müko bgb-gruber, art. 41 cisg para. 16, art. 42 para. 17; kröll et al./kröll, art. 42 para. 29; zhang, 80. cisg-ac opinion 22 42 have been raised identically at the relevant time, even if they were raised only after this point in time. with regard to unfounded claims, it is not decisive whether the circumstances de facto existed at the time of the passing of risk but rather whether they existed at that time according to the allegations raised by the third party so that the unfounded claim could have been raised at the relevant time already.183 a similar logic applies with regard to the goods’ encumbrance with ip rights in a state of use or the buyer’s state if, at the time of the passing of risk, the goods have not yet reached this state and thus at this time do not yet infringe the relevant ip right. also in this scenario, the encumbrance is already inherent in the goods as it is clear that once they reach the contemplated state of use or (subsidiarily) the buyer’s state, they will infringe the relevant ip right. 10.7 in certain scenarios, it can be warranted to hold the seller liable for encumbrances coming into existence only after the relevant time to assess its liability. for example, the seller might violate or cancel existing license agreements with the right holder causing the goods to infringe the respective ip right or register a trademark in the relevant state encompassing the goods after the relevant time.184 article 36(2) addresses this situation with regard to nonconformities and should be applied as a general principle in terms of article 7(2) to encumbrances as well. the seller is under a general obligation to cooperate by loyally facilitating the success of the contractual relationship with the buyer and refraining from any actions preventing this success.185 the success of the contractual relationship can be hindered by physical deterioration of the goods resulting in a non-conformity as well as deteriorations of the buyer’s legal position. likewise, with regard to the related issue of breach of a guarantee of durability also addressed in article 36(2), there is no reason to treat guarantees of physical durability any different than guarantees of what could be referred to as legal durability.186 183 too far-reaching rauda/etier, vj 2000, 30, 43 (seller liable for “all claims whether or not they have a foundation and whether or not they are made before or after” the relevant time). 184 cf. schlechtriem/schwenzer/schwenzer, art. 41 para. 16 for the comparable scenario in relation to article 41: under a contract involving the carriage of goods, the seller is obliged to bear the transport costs but fails to do so resulting in the goods being encumbered with a lien or other security right of the carrier. 185 bgh 31 october 2001, cisg-online 617; staudinger/magnus, art. 30 para. 16; müko bgb-gruber, art. 30 cisg para. 8; brunner/dimsey, art. 30 para. 21. 186 by way of example, the seller of a machine that utilises a patented process might guarantee that the buyer will be entitled to make use of this machine for a certain period of time based on a license agreement between the seller and the right holder. if the license agreement is terminated before the time guaranteed by the seller has lapsed, njcl 2022/1 43 10.8 also with regard to premature delivery of encumbered goods, the seller should not be placed in a worse position than in case of early delivery of non-conforming goods. article 37 allows the seller to remedy any lack of conformity up to the date of delivery. this provision applies to encumbrances as a general principle in terms of article 7(2) or by way of analogy.187 article 37 is an expression of the general principle in terms of article 7(2) underlying the cisg as a whole that contractual relationships should be maintained as long as possible.188 the rationale of this principle of favor contractus leaves no room to distinguish between different causes that might result in unwinding the contract. 11. the buyer’s knowledge of the encumbrance under article 42(2)(a) cisg should be assessed according to the same legal standard as the knowledge requirement for the seller under article 42(1) cisg. the same factors as in rule 6 should be considered taking into account any factual differences in the individual circumstances of the buyer and the seller. 11.1 for the seller’s liability to be excluded by virtue of article 42(2) lit. a, the buyer must be aware of the existence of the right or claim; a legal evaluation whether the goods actually infringe the (alleged) right is not required. conversely, a false legal evaluation cannot protect the buyer from the exclusion of the seller’s liability. accordingly, a buyer who knows of the relevant ip right but (falsely) assumes that a valid license was granted knows of the encumbrance. this can be of particular relevance for sales of digital content, since in these cases, the buyer will usually be aware that ip rights exist with regard to the digital content sold and rely on an actual or assumed license. the relevant time to assess the buyer’s knowledge is the time of contract conclusion. any information which the buyer receives after contract conclusion is irrelevant for the exclusion of the seller’s liability pursuant to article 42(2) lit. a,189 but can result in a duty to inform the seller based on the parties’ general duty to cooperate.190 it appears as appropriate to hold the seller to its word like in case of non-conforming goods. 187 honnold/flechtner/honnold, art. 37 para. 245.1; müko bgb-gruber, art. 37 cisg para. 10; beckok-saenger, art. 37 para. 3. cf. also kröll et al./ kröll, art. 37 para. 9. cf. also for the same result piltz, para. 5–126; schlechtriem/schwenzer/schwenzer, art. 37 para. 6; staudinger/magnus, art. 37 para. 13. 188 schlechtriem/schwenzer/schwenzer, art. 37 para. 5; müko bgb-gruber, art. 37 cisg para. 1; staudinger/magnus, art. 37 para. 3; kröll et al./kröll, art. 37 para. 4. 189 kröll et al./kröll, art. 42 para. 40; brunner/gottlieb/tebel, art. 42 para. 21. 190 achilles, fs schwenzer, 1, 12; brunner/gottlieb/tebel, art. 42 para. 21. cisg-ac opinion 22 44 11.2 a significant number of authors are of the view that in determining whether the buyer could not have been unaware of the ip right or claim, it must be considered that the buyer cannot be expected to investigate for ip rights in the relevant states.191 what appears to be the majority of authors also expressly reject what they usually call a duty to investigate192 for the buyer but nevertheless submit that the buyer cannot be unaware of ip rights which are characterised as “obvious”,193 “widely known”,194 “internationally known”,195 “notorious”196 or which “cannot be overlooked”.197 a third view also rejects a general expectation to investigate on the part of the buyer but takes into account subjective qualities of the buyer and expects a professional buyer to be aware of well-known trademarks198 or even all ip rights in its industry.199 the fourth and final view is that in certain circumstances, the buyer is expected to investigate for ip rights in the relevant state as well.200 191 herber/czerwenka, art. 42 para. 6 (“generally not”); witz/salger/lorenz/ salger, art. 42 para. 8; šarčević/volken/enderlein, art. 42, 182; enderlein/ maskow/strohbach, art. 42 para. 9; piltz, para. 5–134; janal, fs kritzer, 203, 219 (who, however, does not expect the seller to actively investigate, as well); likewise prager, 174; soergel/lüderitz/schüssler-langeheine, art. 42 para. 6. 192 see supra para. 0 for the terminological issues in this regard. 193 achilles, art. 42 para. 11; cf. also rauda/etier, vj 2000, 30, 56. 194 rauda/etier, vj 2000, 30, 56; supreme court of israel 22 august 1993, cisgonline 1082 (buyer must be aware that boots with the widely known trademark levis infringe intellectual property rights in the state of use). 195 kröll et al./kröll, art. 42 para. 39; ferrari et al./ferrari, art. 42 cisg para. 17; zhang, 91-92. 196 ferrari et al./ferrari, art. 42 cisg para. 17; jurispk bgb-baetge, art. 42 cisg para. 17 (who nevertheless considers it “sensible” to contractually shift the duty to investigate to the buyer, para. 22). 197 müko bgb-gruber, art. 42 cisg para. 22; beckogk-hachem, art. 42 para. 28; reher, 173. 198 honsell/magnus, art. 42 para. 16; similar staudinger/magnus, art. 42 para. 26. 199 cour de cassation 19 march 2002, cisg-online 662 (shoes with counterfeited shoelaces), confirming the lower court’s decision ca rouen 17 february 2000, pace; ca colmar 13 november 2002, cisg-online 792 (shirts with protected fabric); tgi versailles 23 november 2004, cisg-online 953 (counterfeited furniture). 200 bacher, fs schwenzer, 115, 125-126; metzger, rabelsz 73 (2009), 842, 861862; shinn, 2 minn. j. global trade (1993), 115, 125 et seq.; zeller, 15 vj (2011), 289, 302; vanduzer, 4 canadian international lawyer (2001), 187; langenecker, 213; brunner/gottlieb/tebel, art. 42 para. 21. cf. also schlechtriem/ schwenzer/schwenzer, art. 42 para. 18 (rejecting an expectation to investigate „[a]s a rule“ but recognising such expectation in certain circumstances). njcl 2022/1 45 11.3 the last view is preferable. already when analysing the above approaches, it becomes apparent that, apart from the first approach, all approaches recognise that the buyer is expected to know certain ip rights it does not actually know of. although all approaches but the final approach expressly reject a so-called “duty to investigate” on the part of the buyer, they do not offer any explanation how the buyer is expected to gain knowledge of these certain ip rights. it is submitted that the only possible way the buyer can ex ante be expected to gain knowledge of ip rights unknown to it is by way of investigation. an interpretation of article 42(2) lit. a confirms that in determining whether the buyer cannot have been unaware of the ip right or claim, the buyer can be expected to investigate for ip rights. 11.4 as a starting point, it is noteworthy that the language used to describe the knowledge of the seller in article 42(1) and of the buyer, in article 42(2) lit. a are identical; this strongly indicates that the threshold of knowledge is also the same for the seller and the buyer.201 obviously, it is not reasonable to assume that by including the same language to establish the seller’s liability and to exclude the seller’s liability the drafters of the cisg intended the liability of the seller always to be excluded. consequently, article 42 only offers a reasonable solution for the goods’ encumbrance with ip right if the knowledge requirement with regard to the seller and the knowledge requirement with regard to the buyer yield different results. since these two standards are, however, identically worded, the solution to this conundrum is that the difference between the two standards is one of fact, not one of law. 11.5 the parallelism between article 42 and article 35(2) lit. b confirms this assessment. under article 35, it is increasingly held that to properly balance the parties’ interests with regard to the goods’ noncompliance with public law standards in the relevant state, the buyer can in certain circumstances be expected to investigate for such 201 prager, 174-175; vanduzer, 4 canadian international lawyer (2001), 187; zeller, 15 vj (2011), 289, 302; shinn, 2 minn. j. global trade (1993), 115, 125. cf. also janal, fs kritzer, 203, 214, 220; schwerha, 16 mich. j. int’l l. (1994– 1995), 441, 476; staudinger/magnus, art. 42 para. 26; soergel/lüderitz/ schüssler-langeheine, art. 42 para. 6; kremer, 208 (“the same applies to the knowledge of the buyer”). but see witz/salger/lorenz/salger, art. 42 para. 8; rauda/etier, vj 2000, 30, 56; enderlein/maskow/strohbach, art. 42 para. 9 (the general responsibility of the seller for the goods’ freedom from encumbrance leads to a different duty despite the identical wording); similar herber/czerwenka, art. 42 para. 2 (invoking that the seller is “usually more familiar with the technical and legal circumstances”); reher, 173 (different interpretations despite identical wording). cisg-ac opinion 22 46 standards in the relevant state.202 it is not conceivable why the buyer should be expected to investigate for public law standards but not for ip rights which in many cases are even more accessible than the former, especially when registered. 11.6 further, in an unfortunately unpublished statement the international chamber of commerce expressly stated that the references to the notion of “could not have been unaware” in article 42(1) and article 42(2) lit. a have to be interpreted consistently.203 the document in which this statement was made was referred to multiple times during the deliberations, yet the position advocated by the international chamber of commerce remained unopposed. 11.7 economic considerations support the finding that the buyer is expected to investigate for ip encumbrances as well. when it comes to assessing and avoiding legal risks associated with the goods’ use in the state of the buyer or a state chosen by the buyer, one should assume that the buyer could avoid the costs associated with these risks cheaper than the seller.204 in many cases, the buyer will have far superior knowledge of the legal situation in the relevant states.205 moreover, there undoubtedly are situations in which the buyer can more efficiently investigate for ip rights in the relevant state – for example, if the buyer is a global player who itself manufactures comparable goods and has significant experience in the relevant market whereas the seller is a small supplier who has not done business in the relevant market before. 11.8 these considerations are even reinforced by the fact that the buyer is required to investigate for such rights anyways under the relevant ip law since the buyer itself would be liable for the goods infringing any ip rights in the relevant state. if the buyer can be expected to do so for the benefit of the third-party holder of the ip right, it can even more so be expected to conduct an investigation when it comes to the contractual relationship with the seller. 202 saidov, 58 vill. l. rev. (2014), 529, 544 (“making the buyer bear the burden of investigating avoids higher costs, which would otherwise have to be incurred if this burden were borne by the seller”); cisg advisory council opinion no. 19, standards and conformity of the goods under article 35 cisg, rapporteur saidov, para, 4.14. 203 a/conf.97/8/add. 2, 20 as cited by prager, 175 note 182 (unpublished, prager, 164 note 154). 204 metzger, rabelsz 73 (2009), 842, 861-862; smythe, 36 nw. j. int’l l. & bus. (2016), 509, 535. cf. for the parallel line of argument with regard to article 35(2) lit. b cisg advisory council opinion no. 19, standards and conformity of the goods under article 35 cisg, rapporteur saidov, para. 4.15. 205 smythe, 36 nw. j. int’l l. & bus. (2016), 509, 535. njcl 2022/1 47 11.9 this analysis is not changed206 by the fact that there is a broad consensus that under article 35(3), the parallel provision dealing with exclusion of the seller’s liability due to knowledge of the buyer in case of non-conformities, the buyer is not required to examine the goods before the contract conclusion.207 in fact, there are fundamental differences between the interests of the parties under these two provisions. while non-conformities generally comprise all factual and legal circumstances concerning the relationship of the goods to their surroundings,208 the view that article 35(3) does not require an examination from the buyer appears to be limited to the goods themselves. in contrast, the question whether the buyer, for example, can be expected to investigate the goods’ compliance with public law standards in the buyers country before contract conclusion does not seem to have been the subject of in-depth analyses so far in the framework of article 35(3). the distinction between physical and non-physical features is, however, essential when comparing article 35(3) with article 42(2) lit. a.209 while any physical non-conformities result from the seller’s sphere, ip encumbrances relevant in the state the buyer intends to use the goods in or in the buyer’s own state are more closely associated with the buyer’s sphere. moreover, physical examination of the goods by the buyer before contract conclusion causes high costs and effort for both parties mainly in the context of an international sales contract where the buyer and the goods usually are not even located in the same state before delivery. in contrast, the buyer investigating for ip rights in states it conducts business in is significantly more feasible and does not require possession of the goods. 11.10 what the buyer cannot be unaware of is determined primarily by the information available to it at the time of contract conclusion.210 the criteria of accessibility of information, information proximity and the resulting economic considerations, as well as the relevant factors determining these criteria, apply to the buyer just as they apply to the seller. in some cases, this information will be insufficient to conduct an effective investigation for ip rights, and the buyer thus is not obliged to conduct a comprehensive investigation.211 a medium-sized buyer with no particular knowledge of the goods or the market will most likely be expected to investigate for well-known 206 in favour of a parallel interpretation of articles 35(3) and 42(2) lit. a piltz, para. 5133; schlechtriem/schroeter, para. 445. 207 schlechtriem/schwenzer/schwenzer, art. 35 para. 38 with references. 208 schlechtriem/schwenzer/schwenzer, art. 35 para. 9. 209 cf. also langenecker, 189-190 regarding ulis. 210 metzger, rabelsz 73 (2009), 842, 862; shinn, 2 minn. j. global trade (1993), 115, 125 et seq. 211 kröll et al./kröll, art. 42 para. 38; piltz, para. 5–134. cisg-ac opinion 22 48 and other obvious non-technical registered rights only. if the buyer, however, has equal212 or superior information,213 for example, because itself manufactures comparable goods,214 the buyer plans to use universally usable goods in a specific way that infringes an ip right215 or the ip rights in question are internationally known,216 the buyer might be expected to investigate for registered technical rights as well. additionally, if the buyer has specific knowledge of the relevant market – which is not unlikely if the buyer regularly operates in it – the buyer can even be in a better position than the seller to investigate for ip rights overall.217 in this regard, the buyer can be required to inquire with its customers situated in the relevant states of use as to the legal situation in their respective states.218 11.11 if the buyer knows or could not have been unaware of the encumbrance in terms of article 42(2) lit. a, the seller’s liability is excluded. the provision thus employs an all-or-nothing approach.219 12. the seller is not liable according to article 42(2)(b) cisg for an encumbrance if it is the inevitable result of the contract requiring the goods to comply with the specifications furnished by the buyer. however, the seller cannot rely on article 42(2)(b) cisg if the seller in addition to having knowledge of the ip right or claim pursuant to article 42(1) cisg knew or could not have been unaware that the buyer’s specifications would result in an encumbrance of the goods and did not inform the buyer about this. 212 likewise with economic arguments metzger, rabelsz 73 (2009), 842, 862; but see langenecker, 205 (only if the buyer has “significantly” better access to information than the seller); probably also rauda/etier, vj 2000, 30, 57 (“seller is not responsible if the buyer has made a bigger mistake than themselves”). 213 cf. cisg advisory council opinion no. 19, standards and conformity of the goods under article 35 cisg, rapporteur saidov, para. 4.11. 214 schlechtriem/schwenzer/schwenzer, art. 42 para. 18; bacher, fs schwenzer, 115, 126. 215 schlechtriem/schwenzer/schwenzer, art. 42 para. 18; bacher, fs schwenzer, 115, 120, 126. 216 beckok-saenger, art. 42 para. 13; kröll et al./kröll, art. 42 para. 39; ferrari et al./ferrari, art. 42 cisg para. 17; langenecker, 212. 217 smythe, 36 nw. j. int’l l. & bus. (2016), 509, 535. 218 cf. supreme court of israel 22 august 1993, cisg-online 1082 (“the appellant cannot claim that its customers did not need to inform it about a registered trade mark”). 219 langenecker, 196-197. but see supreme court of israel 22 august 1993, cisgonline 1082 (finding that “[w]here two parties cause damage, it is neither fair nor moral for one party to be liable for the full damage of the other” and that thus “allocating the liability is the desired result”); against this supreme court of israel 22 august 1993, cisg-online 1082, dissenting opinion justice goldberg; reich, pace. njcl 2022/1 49 12.1 pursuant to article 42(2) lit. b the seller’s liability is excluded if the encumbrance with an ip right results from the fact that the seller manufactured or bought the goods in accordance with specifications made by the buyer. 220 article 42(2) lit. b is based on the consideration that where the buyer causes the goods to fall within the ambit of an ip right by furnishing specifications the seller complied with, the seller is not liable for the resulting encumbrance.221 12.2 specifications in the sense of article 42(2) lit. b encompass “technical drawings, designs, formulae or other such specifications”. the catch-all element, in the end, evinces that the list is not exhaustive.222 the term “such” indicates that other specifications must be comparable to the expressly listed examples.223 this does not require that the specifications are made by way of a corporeal medium.224 rather, it is decisive that the 220 cf. prager, 176. cf. for the related question whether specifications of the buyer can be specifications in the sense of article 3(1): pro ca chambéry 25 may 1993, cisg-online 223; contra olg frankfurt am main 17 september 1991, cisg-online 28; hger zürich, 10 february 1999, cisg-online 488; schlechtriem/schwenzer/ schwenzer/hachem, art. 3 para. 8; kröll et al./mistelis/raymond, art. 3 para. 14; müko bgb-huber, art. 3 cisg para. 6; beckok-saenger, art. 3 para. 3; schlechtriem/schroeter, para. 66; cisg advisory council opinion no. 4, contracts for the sale of goods to be manufactured or produced and mixed contracts (article 3 cisg), rapporteur perales viscasillas, para. 2.13. 221 müko hgb-benicke, art. 42 cisg para. 24; ferrari et al./ferrari, art. 42 cisg para. 19; schlechtriem/schwenzer/schwenzer, art. 42 para. 20; kröll et al./kröll, art. 42 para. 41; staudinger/magnus, art. 42 para. 28; brunner/ gottlieb/tebel, art. 42 para. 22; cf. also bacher, fs schwenzer, 115, 127. but see prager, 178; langenecker, 230; reher, 176 (based on fault); rauda/etier, vj 2000, 30, 58; enderlein/maskow/strohbach, art. 42 para. 10; herber/ czerwenka, art. 42 para. 7 (based on superior knowledge of the buyer). 222 langenecker, 232. 223 this consideration is confirmed by a comparison with the authentic french version which refers to “autres spécifications analogues” (emph. add.) and the spanish language version referring to “otras especificaciones análogas” (emph. add.) as well as the non-authentic dutch translation referring to “andere soortgelijke specificaties” (emph. add.). notably, the non-authentic german translation only refers to “sonstigen angaben” and has rightly been described as “imprecise” in this regard: langenecker, 232; cf. also ferrari et al./ferrari, art. 42 cisg para. 20. prager, 177 note 188 alleges that the term “vergleichbar” (comparable) was omitted by other german authors; thereby prager seemingly overlooks that the term is missing in the official german translation. 224 langenecker, 232-233. cisg-ac opinion 22 50 specifications are intended to influence the way the goods are manufactured, designed or packaged.225 12.3 the provision further requires that the encumbrance “results from the seller’s compliance” with the specifications. the plain wording of the provision seems to indicate that every causal link suffices to trigger the exclusion of the seller’s liability. accordingly, every specification the buyer furnishes the seller with would exclude the latter’s liability. such interpretation would negate any possibility of the buyer to take influence the way the goods are manufactured, designed or packaged. the buyer having the ability to specify the features of the goods is, however, a crucial element of any sales contract.226 hence, not every logical causal link suffices for the encumbrance to “result from the seller’s compliance” with the specifications.227 12.4 in light of the principle of autonomous interpretation, an appropriate evaluative limitation of causation must be guided by the parties’ interests in the specific situation governed by this provision. against the background that article 42(2) lit. b only applies in cases in which the seller knew or could not have been unaware of the encumbrance, the buyer’s interest in receiving goods free from such encumbrances in this situation generally outweighs the seller’s interest in limited liability. it follows that a high threshold for causation should be employed in order to protect this reasonable interest of the buyer. causation in the sense of article 42(2) lit. b should thus be limited to cases in which the encumbrance was the inevitable result of the contract requiring the goods to comply with the specifications furnished by the buyer.228 12.5 for the encumbrance to be such an inevitable consequence, two requirements must be met: first, the specifications must be sufficiently precise.229 the specifications must leave no leeway, making it possible for the seller to comply with the specifications without resulting in the goods being encumbered.230 in the case of 225 cf. müko bgb-gruber, art. 42 para. 23; staudinger/magnus, art. 42 para. 29; achilles, art. 42 para. 12; reher, 176. 226 cf. langenecker, 235. 227 langenecker, 235. 228 witz/salger/lorenz/salger, art. 42 para. 9; langenecker, 235; cf. also kröll et al./kröll, art. 42 para. 42 (“actually caused”); reher, 176 (“result specifically from compliance with the specifications”). 229 supreme court of israel 22 august 1993, cisg-online 1082, sub 3(e); kröll et al./kröll, art. 42 para. 42; achilles, art. 42 para. 12; beckok-saenger, art. 42 para. 14; schlechtriem/schwenzer/schwenzer, art. 42 para. 21; müko hgbbenicke, art. 42 cisg para. 25; müko bgb-gruber, art. 42 cisg para. 23; herber/czerwenka, art. 42 para. 7; piltz, para. 5–135. 230 schlechtriem/schwenzer/schwenzer, art. 42 para. 21; beckok-saenger, art. 42 para. 14; kröll et al./kröll, art. 42 para. 42; witz/salger/lorenz/ njcl 2022/1 51 (unfounded) claims, this test must be applied on the basis of the allegations of the third party. second, the specifications must be binding for the seller.231 the seller thus cannot rely on non-binding specifications of the buyer.232 whether specifications are binding for the seller must be determined in the individual case by way of interpretation applying article 8; usages and practices pursuant to article 9 can also result in binding specifications.233 given that a buyer who furnishes binding specifications to the seller assumes the risk of encumbrances resulting from these specifications, it should not be assumed lightly that the buyer intends to do so. lack of experience in dealing with goods of the kind in question on the part of the buyer makes it is less likely that the buyer intends to have the seller blindly comply with the former’s specifications and more likely that compliance with the specifications is subject to their analysis for potential infringements by the more experienced seller. 12.6 since art. 42(2) lit. b is not based on fault of the buyer but merely on causation, the seller’s liability is even excluded if the buyer’s binding specifications unbeknownst to it caused an encumbrance. it is not necessary that the buyer is aware of the potential infringement.234 the buyer’s awareness of the risk of infringement resulting from its specifications can, however, be relevant with regard to a potential duty of the seller to inform the buyer of this very risk. 12.7 if the seller realises that the buyer’s specifications result in the risk of an infringement, the former must inform the latter accordingly due to the parties’ general duty to cooperate.235 a failure of the seller to comply with this information duty prevents it from relying on the salger, art. 42 para. 9; ferrari et al./ferrari, art. 42 cisg para. 20; reher, 176; janal, fs kritzer, 203, 223; piltz, para. 5–135; cf. also müko hgb-benicke, art. 42 cisg para. 25; galston/smit/schlechtriem, 6–34; similar beckogkhachem, art. 42 para. 29. 231 supreme court of israel 22 august 1993, cisg-online 1082, sub 3(e); langenecker, 236-237; achilles, art. 42 para. 12; staudinger/magnus, art. 42 para. 30; müko bgb-gruber, art. 42 cisg para. 23; piltz, para. 5–135. 232 beckogk-hachem, art. 42 para. 29; cf. also müko hgb-benicke, art. 42 cisg para. 24 (specifications in buyer’s sphere of risk). 233 langenecker, 237. 234 staudinger/magnus, art. 42 para. 31; müko bgb-gruber, art. 42 cisg para. 23; schlechtriem/schwenzer/schwenzer, art. 42 para. 21; kröll et al./ kröll, art. 42 para. 42; šarčević/volken/enderlein, art. 42, 183; soergel/ lüderitz/schüssler-langeheine, art. 42 para. 7. 235 schlechtriem/schwenzer/schwenzer, art. 42 para. 22; staudinger/ magnus, art. 42 para. 31; rauda/etier, vj 2000, 30, 59; müko bgb-gruber, art. 42 para. 24; kröll et al./kröll, art. 42 para. 43; soergel/lüderitz/ schüssler-langeheine, art. 42 para. 7; šarčević/volken/enderlein, art. 42, 183; achilles, art. 42 para. 12; secretariat commentary, art. 40 para. 10. cisg-ac opinion 22 52 exclusion of its liability236 and can result in a claim for damages of the buyer.237 notably, the threshold for the seller’s knowledge in this regard is higher than for the seller’s general knowledge of the encumbrance under article 42(1). whereas under article 42(1), the seller must only be aware of the right or claim as such and is not required to conduct a legal evaluation, for the seller to be obliged to inform the buyer of a risk of infringement resulting from the latter’s specifications, the seller must arrive or ought to have arrived at the (legal) conclusion that there is a significant risk that an ip right might be infringed. 12.8 specifications of the buyer that make the goods fall in the scope of an ip right violate a respective contractual protective duty of the buyer.238 this breach of contract entitles the seller to demand specific performance pursuant to article 62 in the form of noninfringing specifications and to set a corresponding additional period of time pursuant to article 63.239 if the buyer does not comply with this request, it fundamentally breaches the contract in terms of article 25 entitling the seller to avoid the contract pursuant to article 64(1) lit. a.240 the buyer is liable for losses incurred by the seller due to its compliance with the specifications (for example due to being subject to claims of the ip right holder) based on article 61(1) lit. b.241 if the seller complies with the specifications, although it is aware that this might lead to an infringement, its claim for damages is reduced based on article 77.242 article 80, however, does not apply since the seller did not cause the buyer’s failure to perform in the form of giving specifications leading to infringement. 236 müko bgb-gruber, art. 42 cisg para. 24; staudinger/magnus, art. 42 para. 31; beckok-saenger, art. 42 para. 14; rauda/etier, vj 2000, 30, 59; prager, 179; cf. also schlechtriem/schwenzer/schwenzer, art. 42 para. 22; ferrari et al./ferrari, art. 42 cisg para. 21 regarding the case that the seller knows of the potential infringement already at the time of contract conclusion. but see reher, 174-175; probably also piltz, para. 5–135. 237 schlechtriem/schwenzer/schwenzer, art. 42 para. 22 regarding the case that the seller learns of the potential infringement of the intellectual property right after conclusion of the contract. 238 schlechtriem/schwenzer/schwenzer, art. 42 para. 24; kröll et al./kröll, art. 42 para. 45; reher, 177. 239 schlechtriem/schwenzer/schwenzer, art. 42 para. 24; reher, 177. 240 kröll et al./kröll, art. 42 para. 45; schlechtriem/schwenzer/schwenzer, art. 42 para. 24; ferrari et al./ferrari, art. 42 cisg para. 21; müko hgbbenicke, art. 42 cisg para. 27. 241 müko hgb-benicke, art. 42 cisg para. 26; ferrari et al./ferrari, art. 42 cisg para. 21; schlechtriem/schwenzer/schwenzer, art. 42 para. 24. 242 schlechtriem/schwenzer/schwenzer, art. 42 para. 24. njcl 2022/1 53 12.9 the seller’s liability is excluded if the buyer fails to give proper notice of the encumbrance pursuant to article 43(1) and none of the exceptions of article 43(2) or article 44 applies. 13. where the seller is liable for an encumbrance of a third-party ip right or claim, the buyer has all the remedies listed in article 45 cisg. any provision which according to its wording is expressly limited to the delivery of non-conforming goods nevertheless applies to the delivery of goods encumbered with third-party ip rights or claims. 13.1 encumbrances are encompassed by the cisg’s uniform concept of breach of contract243 with article 45(1) as the central provision for the buyer’s remedies.244 in contrast to the general reference to the seller’s failure „to perform any of his obligations under the contract or this convention“ found in particular in article 45, articles 46(2), (3), 50, 51 and 82(2) lit. c refer to goods not conforming to the contract. 13.2 the former articles do not apply directly to encumbrances of the goods. as becomes clear from the title of part iii. chapter ii. section ii., the cisg establishes a dichotomy between “conformity of the goods” and “third party claims”.245 moreover, the cisg contains another notion which has to be juxtaposed with the notion of “goods do not conform with the contract”: article 45(1), the central provision of part iii. chapter ii. section iii. “remedies for breach of contract by the seller”, grants the buyer access to specific remedies “[i]f the seller fails to perform any of his obligations under the contract or this convention”. the title of this section referring to “breach of contract” as well as the synonymous246 wording of article 45(1) referring to the seller’s “fail[ure] to perform any of his obligations” thus contain broader categories the natural meaning of which encompasses goods which “do not conform with the contract” as well as goods which are encumbered with “third party claims”. in addition to the grammatical distinction this title makes, the provisions contained therein also can be divided into provisions dealing with conformity of the goods and provisions dealing with third-party rights or claims. doing so reveals a certain parallelism 243 honnold/flechtner/honnold, art. 45 para. 276; müko bgb-huber, art. 45 cisg para. 4; müko hgb-benicke, art. 45 cisg para. 1; honsell/schnyder/ straub, art. 45 para. 10; prager, 191. 244 cf. only schlechtriem/schwenzer/schwenzer, art. 42 para. 27; kröll et al./kröll, art. 42 para. 49; honsell/schnyder/straub, art. 45 para. 18. 245 kröll et al./bach, art. 50 para. 13; schlechtriem/schwenzer/müllerchen, art. 42 para. 22; hirner, 193; kremer, 76 note 70. 246 müko hgb-benicke, art. 45 para. 1; honsell/schnyder/straub, art. 45 para. 14; prager, 191. cisg-ac opinion 22 54 between the two sets of provisions.247 the cisg thus stipulates two distinct sets of obligations for the seller when it comes to the characteristics of the goods.248 13.3 the cisg’s legislative materials evince, however, that the conscious distinction between non-conformities and encumbrances was not meant to exclude the application of the provisions specifically dealing with non-conformities to encumbrances. rather, the drafting history confirms that the drafters – while deliberately distinguishing between non-conformities and encumbrances – consciously refrained from comprehensively regulating those matters for encumbrances which are dealt with in the cisg’s provisions which only refer to goods not conforming to the contract.249 this lacuna allows applying the provisions specifically dealing with non-conformities as general principles in terms of article 7(2) to encumbrances. 13.4 against this background, the buyer has the same remedies as it has with regard to non-confirming goods: in the first place, the buyer can claim specific performance according to article 46(1), with the restriction of article 28. specific performance can be rendered by delivery of unencumbered substitute goods,250 removal of the thirdparty right,251 a binding and effective declaration of the third party not to invoke its right or claim252 or the final and binding rejection of the third-party claim in court proceedings initiated by the seller.253 it does not suffice that the seller merely declares that it will 247 hirner, 194 (article 35 corresponding to articles 41, 42; article 39 to 43(1); article 40 to 43(2) and article 44 being applicable to both categories of defects). 248 honsell/schnyder/straub, art. 45 para. 54. 249 cf. hirner, 191; langenecker, 266. cf. o.r., 326 (norwegian delegate: “there was a gap as regards remedies for third-party claims in the existing text of sections ii and iii of chapter ii”); o.r., 327 (swedish delegate: “too late at the present stage to fill the gaps in the draft convention with regard to the remedies available to the seller and the buyer. […] the problem was too complex to be settled as easily as that, and he would prefer to keep the existing text, in spite of its shortcomings”); o.r., 361 (delegate from former german democratic republic: “had not yet been decided how the consequences of third-party claims were to be treated under the convention”). 250 schlechtriem/schwenzer/schwenzer, art. 41 para. 21; beckok-saenger, art. 41 para. 14; müko bgb-gruber, art. 41 cisg para. 21. if third parties, however, continue to assert claims against the buyer regarding the originally delivered goods, the seller is liable for this encumbrance. 251 schlechtriem/schwenzer/schwenzer, art. 41 para. 21; beckok-saenger, art. 41 para. 14; beckogk-hachem, art. 41 para. 23; kröll et al./kröll, art. 41 para. 39; müko bgb-gruber, art. 41 cisg para. 21. 252 schlechtriem/schwenzer/schwenzer, art. 41 para. 24; achilles, art. 41 para. 7; beckok-saenger, art. 41 para. 14; beckogk-hachem, art. 41 para. 23; müko bgb-gruber, art. 41 cisg para. 21; cf. also reher, 217. 253 kröll et al./kröll, art. 41 para. 39; beckogk-hachem, art. 41 para. 23. njcl 2022/1 55 indemnify the buyer.254 the seller can freely choose which of these forms of performance it wants to employ.255 thus, the buyer cannot require the seller to defend it against the third-party claims.256 legal costs incurred by the buyer in this regard, however, must be compensated. 13.5 according to their unequivocal wording, article 46(2) and (3) merely apply to non-conforming but cannot be directly applied to encumbered goods.257 against the background of the identified gap regarding the legal consequences in case of encumbered goods, the restrictions of article 46(2) and (3) apply as a general principle in terms of article 7(2) or by way of analogy.258 article 46(2) limits the buyer’s right to delivery of substitute goods to cases of fundamental breach, without the restrictions of article 28.259 the underlying rationale is that delivery of substitute goods effectively is comparable to avoidance of the contract, which in turn generally requires fundamental breach. this rationale applies equally with regard to encumbered goods.260 specifically, with regard to ip encumbrances, it is very well conceivable that the parties contemplated multiple states of use and the encumbrance exists in only one of these states allowing the buyer to sell or use the goods originally intended for this state in one of the other envisaged states 254 but see achilles, art. 41 para. 7. 255 metzger, rabelsz 73 (2009), 842, 848. 256 unclear in this regard: bianca/bonell/date-bah, art. 41 para. 2; müko bgbgruber, art. 41 cisg para. 6; staudinger/magnus, art. 41 para. 17; kröll et al./kröll, art. 41 para. 20; karollus, 123; galston/smit/schlechtriem, 6–31. 257 cf. only beckok-saenger, art. 41 para. 14; bucher/schlechtriem, s. 133; mohs, ihr 2002, 59, 60; secretariat commentary, art. 39 para. 8; brunner/ gottlieb/tebel, art. 41 para. 26, art. 42 para. 26. also cf. kremer, 76 regarding the cisg’s distinction between non-conformity and third-party rights and claims. but see herber/czerwenka, art. 41 para. 10. 258 mohs, ihr 2002, 59, 62 et seq.; beckogk-hachem, art. 42 para. 30; reher, 216-217; kröll et al./kröll, art. 42 para. 51; janal, fs kritzer, 203, 227, 229; cf. also cisg advisory council opinion no. 21, delivery of substitute goods and repair under the cisg, rapporteurs schwenzer/beimel, rule i.2., para. 3.9 (leaving decision between direct and analogous application open). but see beckok-saenger, art. 42 para. 15; müko bgb-gruber, art. 42 cisg para. 27; ferrari et al./ ferrari, art. 42 cisg para. 10; staudinger/magnus, art. 42 para. 32; prager, 203 et seq.; schlechtriem/schwenzer/schwenzer, art. 42 para. 28 (with reservations but ultimately “in any case”). cf. also different mohs, ihr 2002, 59, 62 et seq. (relying on a closer relation of the seller’s liability for intellectual property encumbrances with the liability for non-conformities is thus superfluous). 259 cisg advisory council opinion no. 21, delivery of substitute goods and repair under the cisg, rapporteurs schwenzer/beimel, i.2., para. 3.5. 260 cisg advisory council opinion no. 21, delivery of substitute goods and repair under the cisg, rapporteurs schwenzer/beimel, i.2., para. 3.6. cisg-ac opinion 22 56 of use. there is no reason why a buyer who received encumbered goods should be in a better position than a buyer who received nonconforming goods.261 in both cases, the seller has a reasonable interest in avoiding unnecessary shipping costs associated with restituting the goods if the buyer’s loss can equally well be compensated by an award of damages. 13.6 article 46(3) concerns the repair of the goods and protects the seller from unreasonable requests for repair. while the term repair appears to indicate physical interaction with the goods, it should be understood in a broader fashion and include all forms of remedying a defect without restituting the goods.262 consequently, repair of goods encumbered with ip rights or claims is possible, for example by removing the encumbrance. the provision aims to protect the seller from having to repair goods in particular where the repair costs would be disproportionately higher than the costs of acquiring substitute goods.263 this scenario can arise with regard to ip encumbrances (and general encumbrances) as well. for example, the third party might be willing to grant a license at a prohibitively high price whereas the goods can without issue be delivered or acquired in a non-infringing way which would still conform with the contract.264 such cases might include the delivery of generic goods of a certain trademarked colour which can easily be replaced by goods of a different colour. again, there is no reason why the buyer of encumbered goods should be better off than the buyer of nonconforming goods. 13.7 the buyer can furthermore avoid the contract based on article 49(1) lit. a if the breach of contract is fundamental in terms of article 25. a breach of contract, in particular, is fundamental if the third party has taken possession of the goods,265 is in the position to do so anytime266 or the buyer is prevented from or heavily restricted in using the goods due to other reasons based on the encumbrance.267 on the other hand, a breach of contract is not 261 cisg advisory council opinion no. 21, delivery of substitute goods and repair under the cisg, rapporteurs schwenzer/beimel, i.2., para. 3.9. 262 cf. schlechtriem/schwenzer/müller-chen, art. 46 para. 44. 263 schlechtriem/schwenzer/müller-chen, art. 46 para. 40. 264 cisg advisory council opinion no. 21, delivery of substitute goods and repair under the cisg, rapporteurs schwenzer/beimel, i.2., para. 3.8, note 51. 265 staudinger/magnus, art. 41 para. 24; honsell/magnus, art. 41 para. 20; müko bgb-gruber, art. 41 para. 24. 266 müko bgb-gruber, art. 41 cisg para. 24; beckok-saenger, art. 41 para. 13; beckogk-hachem, art. 41 para. 23; schlechtriem/schwenzer/schwenzer, art. 41 para. 24; staudinger/magnus, art. 41 para. 24; achilles, art. 41 para. 7; ferrari et al./ferrari, art. 41 cisg para. 12; zhang, 17, 170. 267 cf. müko bgb-gruber, art. 41 cisg para. 24; beckok-saenger, art. 41 para. 13; staudinger/magnus, art. 41 para. 24; zhang, 17. njcl 2022/1 57 fundamental if the buyer has a reasonable possibility to remove the encumbrance.268 it is, for example, reasonable for the buyer to remove the encumbrance if it is possible to set-off the sum required for this removal against the purchase price269 or the seller otherwise provides sufficient security.270 13.8 because the resale of encumbered goods itself usually constitutes an infringement of the relevant ip right, the seller’s breach of contract will, in most cases, be fundamental.271 it should be added that the buyer generally cannot be expected to sell the goods in a market where no protection is claimed for the ip right instead of the initially intended market272 and that, accordingly, the possibility to do so does not render the breach non-fundamental in terms of article 25. 13.9 in cases of obviously unfounded or frivolous claims, the breach of contract will usually not be fundamental in terms of article 25 since both the buyer and the seller will be readily able to fend off the claims.273 by way of exception, however, the breach can be fundamental if time was of the essence for the buyer, and the seller was aware of this.274 13.10 under article 82(1), the buyer loses its right to avoid the contract if it cannot restitute the goods. an exception is made from this rule under article 82(2) lit. c if the buyer sells on the goods before it discovered or ought to have discovered the relevant lack of conformity. since article 82(2) lit. c expressly refers to nonconforming goods it does not apply directly to encumbered goods.275 yet again, the provision applies as a general principle in terms of article 7(2) or by way of analogy.276 by allowing the buyer to avoid the contract despite being unable to restitute the goods because it used them in the normal course of business, article 82(2) lit. c, in essence, protects the buyer's interest in using the goods in 268 cf. schlechtriem/schwenzer/schwenzer, art. 41 para. 24; staudinger/ magnus, art. 41 para. 24; beckok-saenger, art. 41 para. 13; beckogkhachem, art. 41 para. 23; ferrari et al./ferrari, art. 41 cisg para. 12; zhang, 17; but cf. müko bgb-gruber, art. 41 cisg para. 24 (buyer’s possibility to remove encumbrance does “usually not” hinder fundamental breach). 269 cf. müko bgb-gruber, art. 41 cisg para. 24; kröll et al./kröll, art. 41 para. 43. 270 cf. kröll et al./kröll, art. 41 para. 43. 271 janal, fs kritzer, 203, 229. 272 kröll et al./kröll, art. 42 para. 52; janal, fs kritzer, 203, 229. 273 schlechtriem/schwenzer/schwenzer, art. 41 para. 11. 274 schlechtriem/schwenzer/schwenzer, art. 41 para. 11; schwenzer/tebel, jusletter 12 september 2012, 1, 4, para. 11. 275 brunner/gottlieb/tebel, art. 41 para. 27, art. 42 para. 26; mohs, ihr 2006, 59, 62-63. 276 mohs, ihr 2002, 59, 62 et seq.; reher, 241; janal, fs kritzer, 203, 229; but see kremer, 78. cisg-ac opinion 22 58 the normal course of business without having to worry about potentially having to restitute the goods in the future. with regard to encumbrances, the buyer is under no duty to examine the goods, as it is regarding non-conforming goods under article 38. the buyer of encumbered goods thus should have to worry even less about any defects once it has concluded the contract. it follows that when balancing the parties’ interests in the situation encompassed by article 82(2) lit. c, this balance tips even more in favour of the buyer of encumbered goods compared to the buyer of non-conforming goods. 13.11 article 50 allows the buyer to reduce the purchase price and only applies “[i]f the goods do not conform with the contract”. specifically in case of unforeseeable losses or losses that are not recoverable due to an exemption based on article 79,277 however, applying article 50 as a general principle in terms of article 7(2) or by way of analogy to encumbrances must be considered.278 generally, a buyer receiving encumbered goods is as interested in a reduction of the purchase price as a buyer receiving non-conforming goods. mere difficulties in computing the reduction of the purchase price in certain situations do not hinder application in situations where the reduction can be computed.279 13.12 curiously, also article 51 – stipulating that if only part of the goods delivered by the seller is defective, the buyer can exercise its remedies only in respect of the defective part – only refers to nonconforming goods. with regard to partially defective deliveries, however, there is no reason to distinguish between nonconformities and encumbrances – article 51 applies as a general principle in terms of article 7(2) or by way of analogy to encumbrances. 277 cf. zhang, 176. regarding art. 79 schlechtriem/schwenzer/schwenzer, art. 41 para. 24. too far-reaching achilles, art. 41 para. 7 (question “is superfluous”). 278 staudinger/magnus, art. 41 para. 26; honsell/magnus, art. 41 para. 20; enderlein/maskow/strohbach, art. 41 para. 15 et seq.; herber/czerwenka, art. 41 para. 10; jurispk bgb-baetge, art. 44 cisg para. 14; zhang, 175; detailed reher, 198-203. left open by schlechtriem/schwenzer/schwenzer, art. 41 para. 24. but see beckok-saenger, art. 41 para. 14; bucher/ schlechtriem, 132; secretariat commentary, art. 39 para. 8; hirner, 213-214. 279 cf. for this concern o.r., 360 (swedish delegate: “did not think it was appropriate to apply the remedy of price reduction to cases under article 39; that article applied not only to justified claims, but also to claims which might not be justified, and which therefore could not be exactly defined in monetary terms”). njcl 2022/1 59 13.13 with regard to damages, a buyer receiving encumbered goods can demand full compensation of its losses based on article 74.280 recoverable costs include the costs of an appropriate legal defence against the third party, particularly if the buyer cannot claim its legal costs based on the applicable procedural law281 or if this claim cannot be enforced. furthermore, the costs for removing the encumbrance are recoverable282 as well as lost profits due to loss of use.283 in case of a cover purchase, the damages can be calculated based on articles 75 and 76. the seller can generally invoke exclusion of its liability pursuant to article 79.284 yet, cases in which the seller is exempt from liability for encumbrances will be rare.285 mere ignorance of the seller regarding the third-party rights or claims is in any event insufficient.286 13.14 losses, such as legal costs, resulting from obviously unfounded claims are usually foreseeable in the sense of article 74 since this requirement is not aimed at the breach of contract but merely the resulting losses. depending on the circumstances of the individual case, the seller can be exempt from liability under article 79.287 if the buyer colludes with the third party, however, all its remedies are excluded by virtue of article 80.288 13.15 depending on the circumstances of the individual case, the buyer can be obligated to fend off the third-party claims itself. this is particularly the case if limitation periods are about to expire.289 this 280 notably, it is not the breach of contract that must be foreseeable, but rather the resulting loss in knowledge of the breach of contract which appears to have been overlooked by müko hgb-benicke, art. 41 cisg para. 12. 281 schlechtriem/schwenzer/schwenzer, art. 41 para. 24; beckok-saenger, art. 41 para. 14; müko bgb-gruber, art. 41 cisg para. 22; cf. also witz/salger/ lorenz/salger, art. 41 para. 7. 282 müko bgb-gruber, art. 41 cisg para. 22; staudinger/magnus, art. 41 para. 25. 283 beckok-saenger, art. 41 para. 14; metzger, rabelsz 73 (2009), 842, 849. 284 kröll et al./kröll, art. 41 para. 41; ferrari et al./ferrari, art. 41 cisg para. 12; bucher/schlechtriem, 133; but see müko hgb-benicke, art. 41 cisg para. 1112 (disregarding the cisg’s general system of liability in favour of strict liability). cf. also honsell/magnus, art. 41 para. 16 (in favour of strict liability but nevertheless considering art. 79 to be applicable). 285 schlechtriem/schwenzer/schwenzer, art. 79 para. 29. 286 kröll et al./kröll, art. 41 para. 41. 287 kröll et al./kröll, art. 41 para. 41; schwenzer/tebel, jusletter 12 september 2012, 1, 4, para. 11. 288 schlechtriem/schwenzer/schwenzer, art. 41 para. 11; schwenzer/tebel, jusletter 12 september 2012, 1, 4, para. 11; cf. also müko bgb-gruber, art. 41 cisg para. 8 (art. 41 “not applicable”). 289 kröll et al./kröll, art. 41 para. 20. cisg-ac opinion 22 60 obligation is based on the buyer’s duty to preserve the goods under article 86290 and on the parties’ general duty to cooperate flowing from article 7.291 furthermore, simply sitting idle can constitute a violation of the buyer’s duty to mitigate its loss under article 77.292 whether the buyer can be expected under its duty to mitigate to license infringing goods from the holder of the ip right will depend on the individual circumstances of the case.293 costs the buyer incurred in fending off the third-party claims are recoverable from the seller as damages.294 13.16 further, the buyer can invoke the encumbrance as a defence against the seller’s claim for payment of the purchase price pursuant to article 58.295 13.17 if the buyer has a reasonable excuse for failing to notify the seller of encumbrances under article 44, it retains the right to reduce the purchase price and claim damages as if it had complied with the duty to give notice, except for loss of profit.296 if the factual basis for the reasonable excuse is only temporary, the buyer has to give proper notice within a reasonable period of time after this basis ceases to exist.297 13.18 limitation periods are not governed by the cisg but by domestic law. the two-year cut-off period stipulated in article 39(2) does apply neither directly nor by way of analogy.298 14. after the buyer has taken over the goods, the buyer bears the burden of proof regarding the requirements of the seller’s liability under article 42 cisg, including a. that the ip right or claim exists; b. that the goods are encumbered by ip right or claim; c. that the seller knew or could not have been unaware of the encumbrance; and 290 staudinger/magnus, art. 41 para. 18; honsell/magnus, art. 41 para. 10; müko bgb-gruber, art. 41 para. 9; kröll et al./kröll, art. 41 para. 20. 291 müko bgb-gruber, art. 41 cisg para. 9; staudinger/magnus, art. 41 para. 18; honsell/magnus, art. 41 para. 10; ferrari et al./ferrari, art. 41 cisg para. 5. 292 cf. kröll et al./kröll, art. 41 para. 42. 293 cf. for the comparable position with regard to article 41 that the buyer cannot be expected to purchase stolen goods from the owner or its successor, olg dresden 21 march 2007, cisg-online 1626; kröll et al./kröll, art. 41 para. 42. 294 honsell/magnus, art. 41 para. 10; ferrari et al./ferrari, art. 41 cisg para. 5. 295 beckok-saenger, art. 41 para. 14; müko bgb-gruber, art. 41 cisg para. 23. 296 achilles, art. 44 para. 4; magnus, ihr 1999, 29, 34. 297 müko bgb-gruber, art. 44 cisg para. 12; staudinger/magnus, art. 44 para. 15; honsell/magnus, art. 44 para. 8; herber/czerwenka, art. 44 para. 3; ferrari et al./ferrari, art. 44 cisg para. 10; beckok-saenger, art. 44 para. 2. 298 staudinger/magnus, art. 41 para. 28. njcl 2022/1 61 d. that the state of use was contemplated by the parties. after the buyer has taken over the goods, the buyer bears the burden to prove the existence of the right or claim,299 that the third party at least claims that the goods fall within the scope of the ip right,300 the seller’s knowledge in this regard301 and that the state of use was contemplated at the time of contract conclusion.302 if the buyer lacks expert knowledge, the burden to prove that the goods are encompassed by the ip right can shift to the seller.303 15. the seller bears the burden of proof regarding the requirements of the defences pursuant to article 42 cisg, including a. in a case where the buyer relies on an encumbrance in the state in which it has its place of business, that only a different state of use was contemplated at the time of the conclusion of the contract; b. in a case where the buyer invokes an infringement of a right, that there is no infringement, for example due to existing licenses; c. that the buyer knew or could not have been unaware of the ip right or claim; and d. that the encumbrance was the inevitable result of the contract requiring the goods to comply with the specifications furnished by the buyer. the seller must prove that a state of use was contemplated at the time of contract conclusion if the buyer relies on an encumbrance in the state in which it has its place of business.304 if the buyer does not rely on any claim made but merely on the right of a third party, the seller must prove that there is no infringement, for example due to existing licenses.305 the same applies if the seller relies on the 299 bger 17 april 2012, 4a.591/2011, e. 2.3, cisg-online 2346; schlechtriem/ schwenzer/schwenzer, art. 42 para. 31; müller, 121. 300 bger 17 april 2012, 4a.591/2011, e. 2.3, cisg-online 2346 (if the buyer has multiple suppliers it must prove that specifically the goods of the seller are encumbered with intellectual property rights); ogh 12 september 2006, cisg-online 1364; schwenzer/tebel, jusletter 17 september 2012, 1, 5, para. 15. 301 schlechtriem/schwenzer/schwenzer, art. 42 para. 31; beckogk-hachem, art. 42 para. 31. 302 kröll et al./kröll, art. 42 para. 55; müko hgb-benicke, art. 42 cisg para. 28; prager, 158; müller, 122; not entirely clear in light of the hierarchy between art. 42(1) lit. a and b beckogk-hachem, art. 42 para. 31 (buyer has to prove that state of use was contemplated but seller has to prove that state of buyer is relevant). 303 ogh 12 september 2006, cisg-online 1364; schlechtriem/schwenzer/ schwenzer, art. 42 para. 31. 304 kröll et al./kröll, art. 42 para. 55. 305 janal, fs kritzer, 203, 211-212. cisg-ac opinion 22 62 exclusion of its liability due to the buyer’s knowledge of the ip right or claim or sufficiently detailed specifications made by the buyer.306 306 müko bgb-gruber, art. 42 cisg para. 28; ferrari et al./ferrari, art. 42 cisg para. 22. njcl 2022/1 63 addendum: cases cited austria oberster gerichtshof (austrian supreme court), 12 september 2006, cisg-online 1364 oberlandesgericht linz (higher regional court of linz), 23 january 2006, cisg-online 1377 france cour de cassation (french supreme court), 19 march 2002, cisg-online 662 cour d’appel colmar (court of appeal of colmar), 13 november 2002, cisg-online 792 cour d’appel rouen (court of appeal of rouen), 17 february 2000, pace cour d’appel chambéry (court of appeal of chambéry), 25 may 1993, cisg-online 223 tribunal de grande instance de versailles (district court versailles), 23 november 2004, cisg-online 953 germany bundesgerichtshof (german federal court of justice), 11 january 2006, cisg-online 1200 bundesgerichtshof (german federal court of justice), 31 october 2001, cisg-online 617 oberlandesgericht dresden (higher regional court of dresden), 21 march 2007, cisg-online 1626 oberlandesgericht frankfurt am main (higher regional court of frankfurt am main), 17 september 1991, cisg-online 28 israel ןוילעה טפשמה תיב , beit hamishpat haelyon (supreme court of israel), 22 august 1993, cisg-online 1082 switzerland bundesgericht (swiss federal supreme court), 17 april 2012, cisgonline 2346 handelsgericht zürich (commercial court of zurich), 10 february 1999, cisg-online 488